Proctor and Gamble 2005 Annual Report Download - page 56

Management’s฀Discussion฀and฀AnalysisThe฀Procter฀&฀Gamble฀Company฀and฀Subsidiaries
52
Interest฀Rate฀Management
Our฀policy฀is฀to฀manage฀interest฀cost฀using฀a฀mixture฀of฀fixed-rate฀and฀
variable-rate฀debt.฀To฀manage฀this฀risk฀in฀a฀cost฀efficient฀manner,฀we฀
enter฀into฀interest฀rate฀swaps฀in฀which฀we฀agree฀to฀exchange฀with฀the฀
counterparty,฀at฀specified฀intervals,฀the฀difference฀between฀fixed฀and฀
variable฀interest฀amounts฀calculated฀by฀reference฀to฀an฀agreed-upon฀
notional฀principal฀amount.฀
Interest฀rate฀swaps฀that฀meet฀specific฀conditions฀under฀SFAS฀No.฀133฀are฀
accounted฀for฀as฀fair฀value฀and฀cash฀flow฀hedges.฀For฀fair฀value฀hedges,฀
the฀changes฀in฀the฀fair฀value฀of฀both฀the฀hedging฀instruments฀and฀the฀
underlying฀debt฀obligations฀are฀immediately฀recognized฀in฀interest฀
expense฀as฀equal฀and฀offsetting฀gains฀and฀losses.฀The฀fair฀value฀of฀these฀
fair฀value฀hedges฀was฀a฀net฀asset฀of฀$17฀and฀$45฀at฀June฀30,฀2005฀and฀
2004,฀respectively.฀All฀existing฀fair฀value฀hedges฀are฀100%฀effective.฀As฀
a฀result,฀there฀is฀no฀impact฀to฀earnings฀due฀to฀hedge฀ineffectiveness.฀
For฀cash฀flow฀hedges,฀the฀effective฀portion฀of฀the฀changes฀in฀fair฀value฀
is฀reported฀in฀other฀comprehensive฀income฀and฀reclassified฀into฀interest฀
expense฀over฀the฀life฀of฀the฀underlying฀debt.฀The฀fair฀value฀of฀these฀cash฀
flow฀hedges฀was฀an฀asset฀of฀$3฀at฀June฀30,฀2005.฀There฀were฀no฀such฀
interest฀rate฀cash฀flow฀hedges฀at฀June฀30,฀2004.
Foreign฀Currency฀Management
We฀manufacture฀and฀sell฀our฀products฀in฀a฀number฀of฀countries฀
throughout฀the฀world฀and,฀as฀a฀result,฀are฀exposed฀to฀movements฀in฀
foreign฀currency฀exchange฀rates.฀The฀purpose฀of฀our฀foreign฀currency฀
hedging฀program฀is฀to฀reduce฀the฀risk฀caused฀by฀short-term฀changes฀in฀
exchange฀rates.
We฀primarily฀utilize฀forward฀contracts฀and฀options฀with฀maturities฀of฀
less฀than฀18฀months฀and฀currency฀swaps฀with฀maturities฀up฀to฀5฀years.฀
These฀instruments฀are฀intended฀to฀offset฀the฀effect฀of฀exchange฀rate฀
fluctuations฀on฀forecasted฀sales,฀inventory฀purchases,฀intercompany฀
royalties฀and฀intercompany฀loans฀denominated฀in฀foreign฀currencies฀
and฀are฀therefore฀accounted฀for฀as฀cash฀flow฀hedges.฀The฀fair฀value฀
of฀these฀instruments฀at฀June฀30,฀2005฀and฀2004฀was฀$47฀and฀$47฀in฀฀
assets฀and฀$131฀and฀$140฀in฀liabilities,฀respectively.฀The฀effective฀portion฀
of฀the฀changes฀in฀fair฀value฀for฀these฀instruments฀is฀reported฀in฀other฀
comprehensive฀income฀and฀reclassified฀into฀earnings฀in฀the฀same฀฀
financial฀statement฀line฀item฀and฀in฀the฀same฀period฀or฀periods฀during฀
which฀the฀hedged฀transactions฀affect฀earnings.฀The฀ineffective฀portion,฀
which฀is฀not฀material฀for฀any฀year฀presented,฀is฀immediately฀recognized฀
in฀earnings.฀
Certain฀instruments฀used฀to฀manage฀foreign฀exchange฀risk฀do฀not฀meet฀
the฀requirements฀for฀hedge฀accounting฀treatment.฀In฀these฀cases,฀the฀
change฀in฀value฀of฀the฀instruments฀is฀designed฀to฀offset฀the฀foreign฀฀
currency฀impact฀of฀intercompany฀financing฀transactions,฀income฀from฀
international฀operations฀and฀other฀balance฀sheet฀revaluations.฀The฀fair฀
value฀of฀these฀instruments฀at฀June฀30,฀2005฀and฀2004฀was฀$57฀and฀
$71฀in฀assets฀and฀$108฀and฀$26฀in฀liabilities,฀respectively.฀The฀change฀
in฀value฀of฀these฀instruments฀is฀immediately฀recognized฀in฀earnings.฀฀
The฀net฀impact฀of฀such฀instruments,฀included฀in฀selling,฀general฀and฀฀
administrative฀expense,฀was฀$18,฀$80฀and฀$264฀of฀gains฀in฀2005,฀฀
2004฀and฀2003,฀respectively,฀which฀substantially฀offset฀foreign฀currency฀
transaction฀and฀translation฀losses฀of฀the฀exposures฀being฀hedged.฀
Net฀Investment฀Hedging
We฀hedge฀certain฀of฀our฀net฀investment฀positions฀in฀major฀foreign฀
subsidiaries.฀To฀accomplish฀this,฀we฀either฀borrow฀directly฀in฀foreign฀
currency฀and฀designate฀a฀portion฀of฀foreign฀currency฀debt฀as฀a฀hedge฀
of฀net฀investments฀in฀foreign฀subsidiaries฀or฀enter฀into฀foreign฀currency฀
swaps฀that฀are฀designated฀as฀hedges฀of฀our฀related฀foreign฀net฀
investments.฀Under฀SFAS฀No.฀133,฀changes฀in฀the฀fair฀value฀of฀these฀
instruments฀are฀immediately฀recognized฀in฀other฀comprehensive฀income,฀
to฀offset฀the฀change฀in฀the฀value฀of฀the฀net฀investment฀being฀hedged.฀
Currency฀effects฀of฀these฀hedges฀reflected฀in฀other฀comprehensive฀
income฀were฀a฀$135฀after-tax฀gain,฀a฀$348฀after-tax฀loss฀and฀a฀$418฀
after-tax฀loss฀in฀2005,฀2004฀and฀2003,฀respectively.฀Accumulated฀net฀
balances฀were฀a฀$451฀and฀$586฀after-tax฀loss฀in฀2005฀and฀2004,฀
respectively.
฀
Commodity฀Price฀Management
Raw฀materials฀are฀subject฀to฀price฀volatility฀caused฀by฀weather,฀supply฀
conditions,฀political฀and฀economic฀variables฀and฀other฀unpredictable฀
factors.฀To฀manage฀the฀volatility฀related฀to฀certain฀anticipated฀inventory฀
purchases,฀we฀use฀futures฀and฀options฀with฀maturities฀generally฀less฀
than฀one฀year฀and฀swap฀contracts฀with฀maturities฀up฀to฀five฀years.฀These฀
market฀instruments฀are฀designated฀as฀cash฀flow฀hedges฀under฀SFAS฀
No.฀133.฀Accordingly,฀the฀mark-to-market฀gain฀or฀loss฀on฀qualifying฀
hedges฀is฀reported฀in฀other฀comprehensive฀income฀and฀reclassified฀
into฀cost฀of฀products฀sold฀in฀the฀same฀period฀or฀periods฀during฀which฀
the฀hedged฀transactions฀affect฀earnings.฀Qualifying฀cash฀flow฀hedges฀
currently฀recorded฀in฀other฀comprehensive฀income฀are฀not฀considered฀
material.฀The฀mark-to-market฀gain฀or฀loss฀on฀non-qualifying,฀excluded฀
and฀ineffective฀portions฀of฀hedges฀is฀immediately฀recognized฀in฀cost฀
of฀products฀sold.฀Commodity฀hedging฀activity฀was฀not฀material฀to฀our฀
financial฀statements฀for฀any฀of฀the฀years฀presented.
Note฀7฀Earnings฀Per฀Share฀and฀Stock฀Options
Net฀Earnings฀Per฀Common฀Share
Net฀earnings฀less฀preferred฀dividends฀(net฀of฀related฀tax฀benefits)฀are฀฀
divided฀by฀the฀weighted฀average฀number฀of฀common฀shares฀outstanding฀
during฀the฀year฀to฀calculate฀basic฀net฀earnings฀per฀common฀share.฀฀
Notes฀to฀Consolidated฀Financial฀StatementsThe฀Procter฀&฀Gamble฀Company฀and฀Subsidiaries
Millions฀of฀dollars฀except฀per฀share฀amounts฀or฀otherwise฀specified.