Baker Hughes 2009 Annual Report Download - page 126

52 Baker Hughes Incorporated
The following is a reconciliation of activity for the period
for assets measured at fair value based on significant unob-
servable inputs (Level 3).
Level 3
Fair Value Measurements
Auction Rate Securities
Balance as of December 31, 2007 $ 36
Total gains or (losses) realized and unrealized:
Included in earnings
(or changes to net assets) (25)
Included in other comprehensive income –
Balance as of December 31, 2008 $ 11
Total gains or (losses) realized and unrealized:
Included in earnings
(or changes to net assets) 4
Sales (15)
Included in other comprehensive income –
Balance as of December 31, 2009 $ –
Auction Rate Securities
The Company owned auction rate securities (“ARS”) that
were purchased in 2007 at an original cost of $36 million.
These ARS represented interests in three variable rate debt
securities, which are credit linked notes that generally combine
low risk assets and credit default swaps (“CDS”) to create a
security that pays interest from the assets’ coupon payments
and the periodic sale proceeds of the CDS. In December 2009,
we sold all ARS investments for $15 million and recorded a
gain of $4 million.
When estimating the fair value of the ARS investments we
used Level 3 inputs. These inputs were based on the underlying
structure of each security and their collateral values, including
assessments of the credit quality, the default risk, the expected
cash flows, the discount rates and the overall capital market
liquidity. Based on our ability and intent to hold such invest-
ments for a period of time sufficient to allow for any antici-
pated recovery in the fair value, we had classified all ARS as
noncurrent investments up until the sale in December 2009.
Non-qualified Defined Contribution Plan Assets
and Liabilities
We have a non-qualified defined contribution plan that
provides basically the same benefit as our Thrift Plan for cer-
tain non-U.S. employees who are not eligible to participate
in the Thrift Plan. In addition, we provide a non-qualified sup-
plemental retirement plan for certain officers and employees
whose benefits under the Thrift Plan and/or U.S. defined ben-
efit pension plan are limited by federal tax law. The assets of
both plans consist primarily of mutual funds and to a lesser
extent equity securities. We hold the assets of these plans
under a grantor trust and have recorded the assets along with
the related deferred compensation liability at fair value. The
assets and liabilities were valued using Level 1 inputs at the
reporting date and were based on quoted market prices from
various major stock exchanges.
NOTE 11. FINANCIAL INSTRUMENTS
Fair Value of Financial Instruments
Our financial instruments include cash and short-term
investments, noncurrent investments in auction rate securities,
accounts receivable, accounts payable, debt, foreign currency
forward contracts, foreign currency option contracts and inter-
est rate swaps. Except as described below, the estimated fair
value of such financial instruments at December 31, 2009
and 2008 approximates their carrying value as reflected in our
consolidated balance sheets. The fair value of our debt, foreign
currency forward contracts and interest rate swaps has been
estimated based on quoted year end market prices.
The estimated fair value of total debt at December 31, 2009
and 2008 was $2,126 million and $2,471 million, respectively,
which differs from the carrying amounts of $1,800 million
and $2,333 million, respectively, included in our consolidated
balance sheets.
Foreign Currency Forward Contracts
We conduct our business in over 90 countries around
the world, and we are exposed to market risks resulting from
fluctuations in foreign currency exchange rates. A number of
our significant foreign subsidiaries have designated the local
currency as their functional currency. We transact in various
foreign currencies and have established a program that primarily
utilizes foreign currency forward contracts to reduce the risks
associated with the effects of certain foreign currency expo-
sures. Under this program, our strategy is to have gains or
losses on the foreign currency forward contracts mitigate
the foreign currency transaction gains or losses to the extent
practical. These foreign currency exposures typically arise
from changes in the value of assets and liabilities which are
denominated in currencies other than the functional currency.
Our foreign currency forward contracts generally settle within
90 days. We do not use these forward contracts for trading or
speculative purposes. We designate these forward contracts as
fair value hedging instruments pursuant to ASC 815, Derivatives
and Hedging. Accordingly, we record the fair value of these
contracts as of the end of our reporting period to our consol-
idated balance sheet with changes in fair value recorded in
our consolidated statement of operations along with the
change in fair value of the hedged item.
At December 31, 2009 and 2008, we had outstanding
foreign currency forward contracts with notional amounts
aggregating $153 million and $125 million, respectively, to
hedge exposure to currency fluctuations in various foreign
currencies. These contracts are designated and qualify as fair
value hedging instruments. The fair value was determined
using a model with Level 2 inputs including quoted market
prices for contracts with similar terms and maturity dates.
Interest Rate Swaps
We are subject to interest rate risk on our debt and invest-
ment of cash and cash equivalents arising in the normal course
of our business, as we do not engage in speculative trading
strategies. We maintain an interest rate management strategy,
which primarily uses a mix of fixed and variable rate debt