First Data 2012 Annual Report Download - page 51

Derivative financial instruments. The Company uses derivative financial instruments to enhance its ability to manage its
exposure to certain financial and market risks, primarily those related to changes in interest rates and foreign currency exchange rates.
Interest rate swaps are entered into to manage interest rate risk associated with the Company’ s variable-rate borrowings. Cross-
currency swaps for various foreign currencies are entered into to manage foreign currency exchange risk associated with the
Company’ s initial investments in certain foreign subsidiaries or certain intercompany loans to foreign subsidiaries. Forward contracts
on various foreign currencies are entered into to manage foreign currency exchange risk associated with the Company’ s forecasted
foreign currency denominated sales or purchases. The Company’ s policy is to minimize its cash flow and net investment exposures
related to adverse changes in interest rates and foreign currency exchange rates. The Company’ s objective is to engage in risk
management strategies that provide adequate downside protection.
Derivative financial instruments are entered into for periods consistent with related underlying exposures and do not constitute
positions independent of those exposures. The Company applies strict policies to manage each of these risks, including prohibition
against derivatives trading, derivatives market-making or any other speculative activities. Although certain derivatives do not qualify
for hedge accounting, they are entered into for economic hedge purposes and are not considered speculative. The Company is
monitoring the financial stability of its derivative counterparties.
The Company designated interest rate swaps as cash flow hedges of forecasted interest rate payments related to its variable rate
borrowings and certain of the cross-currency swaps as foreign currency hedges of its net investment in a foreign subsidiary. During
2012, 2011 and 2010, certain of the Company’ s interest rate swaps previously designated as hedges for accounting purposes ceased to
be highly effective and the Company discontinued hedge accounting for the affected derivatives. Additionally, certain other interest
rate swaps, cross-currency swaps and forward contracts on various foreign currencies did not qualify or were not designated as
accounting hedges and did not receive hedge accounting treatment.
Derivative financial instruments are recognized in the Company’ s Consolidated Balance Sheets at their fair value. The
Company’ s derivatives are not exchange listed and therefore the estimated fair value of derivative financial instruments is modeled in
Bloomberg using the Bloomberg reported market data and the actual terms of the derivative contracts. These models reflect the
contractual terms of the derivatives, such as notional value and expiration date, as well as market-based observable inputs including
interest and foreign currency exchange rates, yield curves and the credit quality of the counterparties along with the Company’ s
creditworthiness in order to appropriately reflect non-performance risk. The Company’ s counterparties also provide it with the
indicative fair values of its derivative instruments which it compares to the results obtained using Bloomberg software. Considering
Bloomberg software is a widely accepted financial modeling tool and there is limited visibility to the preparation of the third-party
quotes, the Company chooses to rely on the Bloomberg software in estimating the fair value of its derivative financial instruments.
Inputs to the derivative pricing models are generally observable and do not contain a high level of subjectivity. While the Company
believes its estimates result in a reasonable reflection of the fair value of these instruments, the estimated values may not be
representative of actual values that could have been realized as of December 31, 2012 or that will be realized in the future. All key
assumptions and valuations are the responsibility of management.
With respect to derivative financial instruments that are afforded hedge accounting, the effective portion of changes in the fair
value of a derivative that is designated and qualifies as a cash flow hedge is recorded in OCI and reclassified into earnings in the same
period or periods during which the hedged transaction affects earnings. The effective portion of changes in the fair value of a net
investment hedge is recorded as part of the cumulative translation adjustment in OCI. Any ineffectiveness associated with the
aforementioned derivative financial instruments as well as the periodic change in the mark-to-market of the derivative financial
instruments not designated as accounting hedges are recorded immediately in “Other income (expense)” in the Consolidated
Statements of Operations. Refer to Note 6 to the Company’ s Consolidated Financial Statements in Item 8 of this Form 10-K for
additional information regarding the Company’ s derivatives.
Intangible assets. FDC capitalizes initial payments for new contracts, contract renewals and conversion costs associated with
customer contracts and system development costs. Capitalization of such costs is subject to strict accounting policy criteria and
requires management judgment as to the appropriate time to initiate capitalization. Capitalization of initial payments for contracts and
conversion costs only occurs when management is satisfied that such costs are recoverable through future operations, contractual
minimums and/or penalties in case of early termination.
The Company’ s accounting policy is to limit the amount of capitalized costs for a given contract to the lesser of the estimated
ongoing future cash flows from the contract or the termination fees the Company would receive in the event of early termination of the
contract by the customer. The Company’ s entitlement to termination fees may, however, be subject to challenge if a customer were to
allege that the Company was in breach of contract. This entitlement is also subject to the customer’ s ability to pay.
51