Canon 2005 Annual Report Download - page 84

82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES
(19) Derivatives and Hedging Activities
Risk management policy
Canon operates internationally, exposing it to the risk of
changes in foreign currency exchange rates and interest rates.
Derivative financial instruments are comprised principally of for-
eign exchange contracts and interest rate swaps utilized by the
Company and certain of its subsidiaries to reduce these risks.
Canon assesses foreign currency exchange rate risk and interest
rate risk by continually monitoring changes in these exposures
and by evaluating hedging opportunities. Canon does not hold
or issue derivative financial instruments for trading purposes.
Canon is also exposed to credit-related losses in the event of
non-performance by counterparties to derivative financial
instruments, but it is not expected that any counterparties will
fail to meet their obligations, because most of the counterpar-
ties are internationally recognized financial institutions and
contracts are diversified across a number of major financial
institutions.
Foreign currency exchange rate risk management
Canon’s international operations expose Canon to the risk of
changes in foreign currency exchange rates. Canon uses for-
eign exchange contracts to manage certain foreign currency
exchange exposures principally from the exchange of U.S.
dollar and euro into Japanese yen. These contracts are primarily
used to hedge the foreign currency exposure of forecasted
intercompany sales and intercompany trade receivables which
are denominated in foreign currencies. In accordance with
Canon’s policy, a specific portion of foreign currency exposure
resulting from forecasted intercompany sales are hedged using
foreign exchange contracts which principally mature within
three months.
Interest rate risk management
Canon’s exposure to the risk of changes in interest rates relates
primarily to its debt obligations. The variable-rate debt obliga-
tions expose Canon to variability in their cash flows due to
change in interest rates. To manage the variability in cash flows
caused by interest rate changes, Canon enters into interest rate
swaps when it is determined to be appropriate based on
market conditions. The interest rate swaps change variable-rate
debt obligations to fixed-rate debt obligations by primarily
entering into pay-fixed, receive-variable interest rate swaps.
Fair value hedge
Derivative financial instruments designated as fair value hedges
principally relate to interest rate swaps associated with fixed
rate debt obligations. Changes in fair values of the hedged
debt obligations and derivative financial instruments desig-
nated as fair value hedges of these debt obligations are recog-
nized in other income (deductions). There is no hedging
ineffectiveness or net gains or losses excluded from the assess-
ment of hedge effectiveness for the years ended December 31,
2004 and 2003 as the critical terms of the interest rate swaps
match the terms of the hedged debt obligations.
Cash flow hedge
Changes in the fair value of derivative financial instruments
designated as cash flow hedges, including foreign exchange
contracts associated with forecasted intercompany sales and
interest rate swaps associated with variable rate debt obliga-
tions, are reported in accumulated other comprehensive
income (loss). These amounts are subsequently reclassified into
earnings through other income (deductions) in the same period
as the hedged items affect earnings. Substantially all amounts
recorded in accumulated other comprehensive income (loss) at
year-end are expected to be recognized in earnings over the
next twelve months. Canon excludes the time value compo-
nent from the assessment of hedge effectiveness.
The amount of the hedging ineffectiveness was not mate-
rial for the years ended December 31, 2005, 2004 and 2003.
The amount of net gains or losses excluded from the assess-
ment of hedge effectiveness (time value component) which
was recorded in other income (deductions) was net losses of
¥3,725 million ($31,568 thousand), ¥2,096 million and ¥490
million for the years ended December 31, 2005, 2004 and
2003, respectively.
Derivatives not designated as hedges
Canon has entered into certain foreign exchange contracts to
manage its foreign currency exposures. These foreign exchange
contracts have not been designated as hedges. Accordingly,
the changes in fair value of the contracts are recorded in earn-
ings immediately.
Contract amounts of foreign exchange contracts at Decem-
ber 31, 2005 and 2004 are set forth below:
December 31 Thousands of
Millions of yen U.S. dollars
2005 2004 2005
To sell foreign currencies ¥645,188 584,208 $5,467,695
To buy foreign currencies 46,424 34,201 393,424