Radio Shack 2011 Annual Report Download - page 69

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NOTE 11 – DERIVATIVE FINANCIAL
INSTRUMENTS
We enter into derivative instruments for risk management
purposes only, including derivatives designated as hedging
instruments under the FASB accounting guidance on the
accounting for derivative instruments and hedging activities.
We do not hold or issue derivative financial instruments for
trading or speculative purposes. To qualify for hedge
accounting, derivatives must meet defined correlation and
effectiveness criteria, be designated as a hedge and result
in cash flows and financial statement effects that
substantially offset those of the position being hedged.
By using these derivative instruments, we expose
ourselves, from time to time, to credit risk and market risk.
Credit risk is the potential failure of the counterparty to
perform under the terms of the derivative contract. When
the fair value of a derivative contract is positive, the
counterparty owes us, which creates credit risk for us. We
minimize this credit risk by entering into transactions with
high quality counterparties and do not anticipate significant
losses due to our counterparties’ nonperformance. Market
risk is the adverse effect on the value of a financial
instrument that results from a change in the rate or value of
the underlying item being hedged. We minimize this market
risk by establishing and monitoring internal controls over
our hedging activities, which include policies and
procedures that limit the types and degree of market risk
that may be undertaken.
Interest Rate Swap Agreements: We previously used
interest rate-related derivative instruments to manage our
exposure to fluctuations of interest rates. In June and
August 2003, we entered into interest rate swap agreements
with underlying notional amounts of debt of $100 million and
$50 million, respectively, and both matured in May 2011.
These swaps effectively converted a portion of our long-term
fixed rate debt to a variable rate. We entered into these
agreements to balance our fixed versus floating rate debt
portfolio to continue to take advantage of lower short-term
interest rates. Under these agreements, we contracted to pay
a variable rate of LIBOR plus a markup and to receive fixed
rates of 7.375%.
The swap agreements were originally designated as fair
value hedges of the related debt and met the requirements to
be accounted for under the short-cut method, resulting in no
ineffectiveness in the hedging relationship. The periodic
interest settlements, which occurred at the same interval as
the interest payments on the 2011 Notes, were recorded as
interest expense. The gain or loss on these derivatives, as
well as the offsetting loss or gain on the related debt, was
recognized in current earnings, but had a net earnings
effect of zero due to short-cut method accounting.
In September 2009, we repurchased $43.2 million of our
2011 Notes. A portion of these notes were hedged by our
interest rate swaps. Upon repurchase of these notes, we
were required to discontinue the hedge accounting
treatment associated with these derivative instruments
which used the short-cut method. We held these
instruments until their maturities. Changes in fair value of
these instruments were recorded in earnings as an
adjustment to interest expense. These adjustments resulted
in increases in interest expense of $1.9 million, $3.4 million
and $0.6 million in 2011, 2010 and 2009, respectively.
NOTE 12 – FAIR VALUE MEASUREMENTS
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Basis of Fair Value Measurements
Fair Value
of Assets
Quoted Prices
in Active
Markets for
Identical Items
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
(In millions)
As of December 31, 2010
Derivatives Not Designated as
Hedging Instruments:
Interest rate swaps
(1) (2)
$1.9 -- $ 1.9 --
(1) These interest rate swaps served as economic hedges on our 2011 Notes and expired in May 2011
(2) Included in other current assets