Kraft 2012 Annual Report Download - page 57

Certain derivatives are designated as cash flow hedges and qualify for hedge accounting treatment, while others do not
qualify and are marked to market through earnings. For cash flow hedges, changes in fair value are deferred in
accumulated other comprehensive earnings / (losses) within equity until the underlying hedged items are recognized in net
earnings. Accordingly, we record deferred cash flow hedge gains or losses in cost of sales when the related inventory is
sold and in interest and other expense, net, when the related debt interest expense is recorded. Cash flows from derivative
instruments are also classified in the same manner as the underlying hedged items in the consolidated statement of cash
flows. For additional information on the location of derivative activity within our operating results, see Note 11, Financial
Instruments.
To qualify for hedge accounting, a specified level of hedging effectiveness between the hedging instrument and the item
being hedged must be achieved at inception and maintained throughout the hedged period. Any hedging ineffectiveness is
recognized in net earnings when the change in the value of the hedge does not offset the change in the value of the
underlying hedged item. We formally document our risk management objectives, strategies for undertaking the various
hedge transactions, the nature of and relationships between the hedging instruments and hedged items, and method for
assessing hedge effectiveness. Additionally, for qualified hedges of forecasted transactions, we specifically identify the
significant characteristics and expected terms of the forecasted transactions. If it becomes probable that a forecasted
transaction will not occur, the hedge will no longer be effective and all of the derivative gains or losses would be
recognized in earnings in the current period.
When we use financial instruments, we are exposed to credit risk that a counterparty might fail to fulfill its performance
obligations under the terms of our agreement. We minimize our credit risk by entering into transactions with 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 with a duration of greater than one year be governed by an International Swaps and Derivatives
Association master agreement. We are also exposed to market risk as the value of our financial instruments 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 we use, and the degree of market risk that we hedge with derivative instruments.
Commodity cash flow hedges - We are exposed to price risk related to forecasted purchases of certain commodities that
we primarily use as raw materials. We enter into commodity forward contracts primarily for coffee beans, meat products,
sugar, wheat, and dairy products. Commodity forward contracts generally are not subject to the accounting requirements
for derivative instruments and hedging activities under the normal purchases exception. We also use commodity futures
and options to hedge the price of certain commodity costs, including dairy products, coffee beans, meat products, wheat,
corn products, soybean oils, sugar, and natural gas. Some of these derivative instruments are highly effective and qualify
for hedge accounting treatment. We also sell commodity futures to unprice future purchase commitments, and we
occasionally use related futures to cross-hedge a commodity exposure. We are not a party to leveraged derivatives and,
by policy, do not use financial instruments for speculative purposes.
Foreign currency cash flow hedges - We use various financial instruments to mitigate our exposure to changes in
exchange rates from third-party and intercompany actual and forecasted transactions. These instruments may include
forward foreign exchange contracts and foreign currency options. We primarily use these instruments to hedge our
exposure to the Canadian dollar.
Interest rate cash flow hedges - We use derivative instruments, including interest rate swaps, as part of our interest rate
risk management strategy. As a matter of policy, we do not use highly leveraged derivative instruments for interest rate
risk management. We primarily use interest rate swaps to hedge the variability of interest payment cash flows on a portion
of our future debt obligations. Substantially all of these derivative instruments are highly effective and qualify for hedge
accounting treatment.
Income Taxes:
We recognize tax benefits in our financial statements when our uncertain tax positions are more likely than not to be
sustained upon audit. The amount we recognize is measured as the largest amount of benefit that has a greater than
50 percent likelihood of being realized upon ultimate settlement.
We recognize deferred tax assets for temporary differences, operating loss carryforwards, and tax credit carryforwards.
Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion, or all, of the
deferred tax assets will not be realized. See Note 13, Income Taxes, for additional information.
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