E-Z-GO 2002 Annual Report Download - page 46

Derivative Financial Instruments
All derivative instruments are reported on the balance sheet at fair value. Changes in the fair value of
derivative financial instruments are either recognized periodically in income or in shareholders’ equity as
a component of comprehensive income (loss) depending on whether the derivative financial instrument
qualifies for hedge accounting, and if so, whether it qualifies as a fair value, cash flow or net investment
hedge. Upon the adoption of Statement of Financial Accounting Standards (SFAS) No. 133 “Accounting
for Derivative Instruments and Hedging Activities,” Textron recorded a cumulative transition adjustment
to increase accumulated OCL by approximately $15 million, net of income taxes, to recognize the fair
value of cash flow hedges as of December 31, 2000. The cumulative effect of adoption was not material
to the consolidated statement of operations.
Textron is exposed to market risk, primarily from changes in interest rates, currency exchange rates and
securities pricing. To manage the volatility relating to these exposures, Textron nets the exposures on a
consolidated basis to take advantage of natural offsets. For the residual portion, Textron enters into vari-
ous derivative transactions pursuant to Textron’s policies in such areas as counterparty exposure and
hedging practices. Designation is performed on a specific exposure basis to support hedge account-
ing. Changes in fair value of financial instruments qualifying as fair value hedges are recorded in
income, offset in part or in whole by corresponding changes in the fair value of the underlying exposures
being hedged. Changes in fair values of derivatives accounted for as cash flow hedges, to the extent
they are effective as hedges, are recorded in OCL net of deferred taxes. Changes in fair value of deriva-
tives not qualifying as hedges are reported in income. Textron does not hold or issue derivative financial
instruments for trading or speculative purposes.
Prior to the adoption of SFAS No. 133, changes in market value of contracts that hedged firm foreign
currency commitments and intercompany transactions were generally included in the basis of the trans-
actions. Changes in the market value of the contracts that hedged anticipated transactions were gener-
ally recognized in net earnings.
Foreign currency denominated assets and liabilities are translated into U.S. dollars with the adjustments
from the currency rate changes being recorded in the cumulative translation adjustment account in
shareholders’ equity until the related foreign entity is sold or substantially liquidated. Foreign currency
financing transactions, including currency swaps, are used to effectively hedge long-term investments
in foreign operations with the same corresponding currency. Foreign currency gains and losses on the
hedge of the long-term investments are recorded in the cumulative translation adjustment account in
accumulated OCL with the offset recorded as an adjustment to the non-U.S. dollar financing liability.
Fair Values of Financial Instruments
Fair values of cash and cash equivalents, accounts receivable, accounts payable and variable-rate
receivables and debt approximate cost. The estimated fair values of other financial instruments, includ-
ing debt, equity and risk management instruments, have been determined using available market infor-
mation and valuation methodologies, primarily discounted cash flow analysis or independent investment
bankers. The estimated fair value of nonperforming loans included in finance receivables are based on
discounted cash flow analyses using risk-adjusted interest rates or the fair value of the related collateral.
Because considerable judgment is required in interpreting market data, the estimates are not necessari-
ly indicative of the amounts that could be realized in a current market.
Stock-Based Compensation
Textron’s 1999 Long-Term Incentive Plan (1999 Plan) authorizes awards to key employees. The 1999
Plan and related awards are described more in fully in Note 12. Stock-based compensation awards to
employees under the 1999 Plan are accounted for using the intrinsic value method prescribed in APB
25, “Accounting for Stock Issued to Employees” and related Interpretations. No stock-based employee
compensation cost related to stock options awards is reflected in net income as all options granted
under the 1999 Plan had an exercise price equal to the market value of the underlying common stock on
the date of grant. Employee compensation cost related to Textron’s performance share program and
restricted stock awards is reflected in net income over the awards’ vesting period. Textron has entered
into cash settlement forward contracts on its common stock to mitigate the impact of stock price fluctua-
tions on compensation expense. The following table illustrates the effect on net income and earnings
per share if Textron had applied the fair-value recognition provisions of FASB Statement No. 123,
“Accounting for Stock-Based Compensation”, to stock-based employee compensation.
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