Kraft 2007 Annual Report Download - page 52

Also, see Note 5, Income Taxes, for information on how the closure of an IRS review of Altria’s consolidated federal income
tax return in 2006 impacted us.
Financial Instruments:
As Kraft operates globally, we use certain financial instruments to manage our foreign currency exchange rate and commodity
price risks. We monitor and manage these exposures as part of our overall risk-management program. Our risk management
program focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the
volatility of these markets may have on our operating results. We maintain foreign currency and commodity price risk
management strategies that seek to reduce significant, unanticipated earnings fluctuations that may arise from volatility in
foreign currency exchange rates and commodity prices, principally through the use of derivative instruments.
Financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging
instrument and the item being hedged, both at inception and throughout the hedged period. We formally document the nature of
and relationships between the hedging instruments and hedged items, as well as our risk-management objectives, strategies for
undertaking the various hedge transactions and method of assessing hedge effectiveness. Additionally, for hedges of forecasted
transactions, the significant characteristics and expected terms of the forecasted transaction must be specifically identified, and
it must be probable that each forecasted transaction will occur. If we deem it probable that the forecasted transaction will not
occur, we recognize the gain or loss in earnings currently.
By using derivatives to hedge exposures to changes in exchange rates and commodity prices, Kraft has exposure on these
derivatives to credit and market risk. We are exposed to credit risk that the counterparty might fail to fulfill its performance
obligations under the terms of the derivative contract. We minimize our credit risk by entering into transactions with high-
quality counterparties with investment grade credit ratings, limiting the amount of exposure we have with each counterparty and
monitoring the financial condition of our counterparties. We also maintain a policy of requiring that all significant,
non-exchange traded derivative contracts be governed by an International Swaps and Derivatives Association master agreement.
Market risk is the risk that the value of the financial instrument might be adversely affected by a change in foreign currency
exchange rates, commodity prices, or interest rates. We manage market risk by incorporating monitoring parameters within our
risk management strategy that limit the types of derivative instruments and derivative strategies, and the degree of market risk
that may be undertaken by the use of derivative instruments.
We record derivative financial instruments at fair value in our consolidated balance sheets as either current assets or current
liabilities. Changes in the fair value of derivatives are recorded each period either in accumulated other comprehensive
earnings / (losses) or in earnings, depending on whether a derivative is designated and effective as part of a hedge transaction
and, if it is, the type of hedge transaction. Gains and losses on derivative instruments reported in accumulated other
comprehensive earnings / (losses) are reclassified to the consolidated statement of earnings in the periods in which operating
results are affected by the hedged item. Cash flows from hedging instruments are classified in the same manner as the affected
hedged item in the consolidated statements of cash flows.
Commodity Trends
We are major purchasers of dairy, coffee, cocoa, wheat, corn products, soybean and vegetable oils, nuts, meat products, and
sugar and other sweeteners. We also use significant quantities of glass, plastic and cardboard to package our products, and
natural gas for our factories and warehouses. We continuously monitor worldwide supply and cost trends of these commodities
so we can act quickly to obtain ingredients and packaging needed for production. We purchase a substantial portion of our dairy
raw material requirements, including milk and cheese, from independent third parties such as agricultural cooperatives and
independent processors. The prices for milk and other dairy product purchases are substantially influenced by market supply and
demand, as well as by government programs. Dairy commodity costs on average were $750 million higher in 2007 than in 2006.
The most significant cost item in coffee products is green coffee beans, which are purchased on world markets. Green coffee
bean prices are affected by the quality and availability of supply, trade agreements among producing and consuming nations, the
unilateral policies of the producing nations, changes in the value of the U.S. dollar in relation to certain other currencies and
consumer demand for coffee products. In 2007, coffee bean costs on average were higher than in 2006. A significant cost item
in chocolate confectionery products is cocoa, which is purchased on world markets, and the price of which is affected by the
quality and availability of supply and changes in the value of the British pound sterling and the U.S. dollar relative to certain
other currencies. In 2007, cocoa bean and cocoa butter costs on average were higher than in 2006. Significant cost items in our
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