Proctor and Gamble 2010 Annual Report Download - page 62

60 The Procter & Gamble Company Notes to Consolidated Financial Statements
Amounts in millions of dollars except per share amounts or as otherwise specified.
Interest Rate Risk 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 whereby 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 amount.
Interest rate swaps that meet specific accounting criteria are accounted
for as fair value or 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. For cash flow hedges, the effective portion of the changes in
fair value of the hedging instrument is reported in OCI and reclassified
into interest expense over the life of the underlying debt. The ineffective
portion for both cash flow and fair value hedges, which is not material
for any year presented, is immediately recognized in earnings.
Foreign Currency Risk Management
We manufacture and sell our products and finance operations 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 manage the volatility associated
with short-term changes in exchange rates.
To manage this exchange rate risk, we have historically utilized a
combination of forward contracts, options and currency swaps. As of
June30, 2010, we had currency swaps with maturities up to five years,
which are intended to offset the effect of exchange rate fluctuations
on intercompany loans denominated in foreign currencies. These swaps
are accounted for as cash flow hedges. The Company may utilize
and designate forward contracts and options to offset the effect of
exchange rate fluctuations on forecasted sales, inventory purchases
and intercompany royalties denominated in foreign currencies. The
effective portion of the changes in fair value of these instruments is
reported in OCI and reclassified into earnings in the same financial
statement line item and in the same period or periods during which
the related hedged transactions affect earnings. The ineffective portion,
which is not material for any year presented, is immediately recognized
in earnings.
The change in value of certain non-qualifying instruments used to
manage foreign exchange exposure of intercompany financing trans-
actions, income from international operations and certain balance sheet
items subject to revaluation is immediately recognized in earnings,
substantially offsetting the foreign currency mark-to-market impact
of the related exposure.
Net Investment Hedging
We hedge certain net investment positions in major foreign subsidiaries.
To accomplish this, we either borrow directly in foreign currencies and
designate all or a portion of foreign currency debt as a hedge of the
applicable net investment position or enter into foreign currency swaps
that are designated as hedges of our related foreign net investments.
Changes in the fair value of these instruments are immediately
recognized in OCI to offset the change in the value of the net invest-
ment being hedged. Currency effects of these hedges reflected in OCI
were after-tax gains of $789 and $964 in 2010 and 2009, respectively.
Accumulated net balances were after-tax losses of $3,270 and $4,059
as of June30, 2010 and 2009, respectively.
Commodity Risk Management
Certain raw materials used in our products or production processes
are subject to price volatility caused by weather, supply conditions,
political and economic variables and other unpredictable factors.
To manage the volatility related to anticipated purchases of certain
of these materials, we may use futures and options with maturities
generally less than one year and swap contracts with maturities up
to five years. These market instruments generally are designated as
cash flow hedges. The effective portion of the changes in fair value
for these instruments is reported in OCI 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 and non-qualifying portions, which are not material for
any year presented, are immediately recognized in earnings.
Insurance
We self-insure for most insurable risks. However, we purchase insurance
for Directors and Officers Liability and certain other coverage in
situations where it is required by law, by contract or deemed to be in
the best interest of the Company.
Fair Value Hierarchy
Accounting guidance on fair value measurements for certain financial
assets and liabilities requires that financial assets and liabilities carried
at fair value be classified and disclosed in one of the following three
categories:
Level 1: Quoted market prices in active markets for identical assets
or liabilities.
Level 2: Observable market-based inputs or unobservable inputs
that are corroborated by market data.
Level 3: Unobservable inputs reflecting the reporting entity’s own
assumptions or external inputs from inactive markets.
When applying fair value principles in the valuation of assets and
liabilities, we are required to maximize the use of quoted market prices
and minimize the use of unobservable inputs. We calculate the fair
value of our Level 1 and Level 2 instruments based on the exchange
traded price of similar or identical instruments where available or
based on other observable instruments. The fair value of our Level 3
instruments is calculated as the net present value of expected cash
flows based on externally provided or obtained inputs. Certain assets
may also be based on sales prices of similar assets. These valuations
take into consideration the credit risk of both the Company and our
counterparties. The Company has not changed its valuation techniques
in measuring the fair value of any financial assets and liabilities during
the year.