Ford 2005 Annual Report Download - page 87

Ford Motor Company Annual Report 2005 84 Ford Motor Company Annual Report 2005 85
Notes to the Financial Statements
NOTE 20. DERIVATIVE FINANCIAL INSTRUMENTS (Continued)
Net Investment Hedges. We use foreign currency contracts to hedge the net assets of certain foreign entities to offset the
translation and economic exposures related to our investment in these entities. The change in the value of these derivatives is
recorded in OCI as a foreign currency translation adjustment. The ineffectiveness related to net investment hedges is recorded in
Cost of sales. Gains of $20 million, losses of $2 million, and gains of $95 million were recorded in 2005, 2004, and 2003,
respectively.
Other Derivative Instruments. As previously stated, some derivatives do not qualify for hedge accounting treatment or we
elect not to apply hedge accounting. In such cases, both the gains and losses are reported in Cost of sales or Interest income and
other non-operating income/(expense), net. The earnings impact primarily relates to the revaluation of foreign currency
derivatives, which are substantially offset by the revaluation on foreign denominated debt, and warrants.
Financial Services Sector
Ford Credit’s overall risk management objective is to maximize financing income while limiting the effect of changes in
foreign currencies and interest rates. Ford Credit faces exposure to currency exchange rates if a mismatch exists between the
currency of its receivables and the currency of the debt funding those receivables. Ford Credit executes cross-currency swaps and
foreign currency forwards to convert substantially all of the foreign currency debt obligations to the local currency of the
receivables. Interest rate swaps are used to manage exposure to re-pricing risk, which arises when assets and the debt funding
those assets have different re-pricing periods that consequently respond differently to interest rate changes. Regardless of hedge
accounting treatment, derivative positions are used only to manage identified exposures.
Cash Flow Hedges. Ford Credit designates certain interest rate swaps as cash flow hedges to manage the cash flow fluctuations
of floating-rate debt due to the changes in market interest rates. The impact to earnings associated with hedge ineffectiveness was
recognized in Revenues as a loss of $43 million and a gain of $12 million and $3 million in 2005, 2004 and 2003, respectively. In
assessing hedge effectiveness for cash flow hedges related to interest rates, Ford Credit uses the variability of cash flows method
and excludes accrued interest. Net interest settlements and accruals excluded from the assessment of hedge effectiveness were
expenses of $71 million, $354 million and $482 million in 2005, 2004, and 2003, respectively, and recorded in Interest expense.
While net interest settlements and accruals are excluded from hedge effectiveness testing, they are included in evaluating the
overall risk management objective.
Fair Value Hedges. Ford Credit designates certain interest rate swaps and cross currency swaps as fair value hedges to manage
the fair value fluctuations of fixed-rate debt due to the changes in market interest rates. Unrealized gains and losses related to
derivatives in fair value hedges, along with changes in the fair value of the underlying hedged exposure are recognized and
recorded in Revenues. The impact to earnings from hedge ineffectiveness was a loss of $1 million and a gain of $10 million and
$255 million in 2005, 2004 and 2003, respectively. In assessing hedge effectiveness, Ford Credit excludes accrued interest on the
receive and pay legs of the swaps. Net interest settlements and accrual income of $1.1 billion, $2.1 billion and $1.8 billion in
2005, 2004 and 2003, respectively, were recorded as a reduction in Interest expense. Ford Credit also excludes from the
assessment of hedge effectiveness foreign exchange adjustments, representing the portion of the derivative’s fair value attributable
to the change in foreign currency exchange rates for the reporting period, which were unfavorable adjustments totaling
$365 million in 2005 and favorable adjustments totaling $384 million and $1.3 billion in 2004 and 2003, respectively. While net
settlements and foreign currency adjustments are excluded from Ford Credit’s hedge effectiveness testing, they are included in
evaluating the overall risk management objective. The adjustments related to the foreign currency derivatives reported above were
offset by revaluation impacts on debt denominated in a currency other than the location’s functional currency, which was also
recorded in Revenues.
Net Investment Hedges. Ford Credit uses foreign currency forward exchange contracts and options to hedge the net assets of
certain foreign entities to offset the translation and economic exposures related to its investment in foreign entities. Changes in the
value of these derivatives are recorded in OCI as a foreign currency translation adjustment. Ineffectiveness, which is recognized in
Revenues, were losses of $13 million, $29 million and $17 million in 2005, 2004, and 2003, respectively.
Other Derivative Instruments. As previously stated, some derivatives do not qualify for hedge accounting treatment or Ford
Credit elects not to apply hedge accounting. In such cases, both the gains and losses are recorded in Revenues. The earnings