Medtronic 2015 Annual Report Download - page 85

Medtronic plc
Notes to Consolidated Financial Statements (Continued)
forward starting interest rate derivative instruments that are designated and qualify as cash flow hedges are reported as a
component of accumulated other comprehensive loss. Beginning in the period in which the planned debt issuance occurs and the
related derivative instruments are terminated, the effective portion of the gains or losses are then reclassified into interest
expense, net over the term of the related debt. Any portion of the gains or losses that are determined to be ineffective are
immediately recognized in interest expense, net.
The Company uses interest rate derivative instruments designated as fair value hedges to manage the exposure to interest rate
movements and to reduce borrowing costs by converting fixed-rate debt into floating-rate debt. Under these agreements, the
Company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by
reference to agreed-upon notional principal amounts. Changes in the fair value of the derivative instrument are recorded in
interest expense, net, and are offset by changes in the fair value of the underlying debt instrument. The gains (losses) from
terminated interest rate swap agreements are recorded in long-term debt, increasing (decreasing) the outstanding balances of the
debt, and amortized as a reduction of (addition to) interest expense, net over the remaining life of the related debt. The cash
flows from the termination of the interest rate swap agreements are reported as operating activities in the consolidated
statements of cash flows.
In addition, the Company has collateral credit agreements with its primary derivative counterparties. Under these agreements,
either party is required to post eligible collateral when the market value of transactions covered by the agreement exceeds
specific thresholds, thus limiting credit exposure for both parties.
Fair Value Measurements The Company follows the authoritative guidance on fair value measurements and disclosures with
respect to assets and liabilities that are measured at fair value on both a recurring and nonrecurring basis. Under this guidance,
fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants as of the measurement date. The authoritative guidance also establishes a
hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of
unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market
participants would use in valuing the asset or liability, based on market data obtained from sources independent of the
Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would
use in valuing the asset or liability developed based upon the best information available in the circumstances. The categorization
of financial assets and financial liabilities within the valuation hierarchy is based upon the lowest level of input that is
significant to the fair value measurement. The hierarchy is broken down into three levels defined as follows:
•Level 1 — Inputs are quoted prices in active markets for identical assets or liabilities.
•Level 2 — Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for
identical or similar assets or liabilities in markets that are not active, and inputs (other than quoted prices) that
are observable for the asset or liability, either directly or indirectly.
•Level 3 — Inputs are unobservable for the asset or liability.
Financial assets that are classified as Level 1 securities include highly liquid government bonds within U.S. government and
agency securities, marketable equity securities, and exchange-traded funds for which quoted market prices are available. In
addition, the Company classifies foreign currency forward contracts as Level 1 since they are valued using quoted market prices
in active markets which have identical assets or liabilities.
The valuation for most fixed maturity securities are classified as Level 2. Financial assets that are classified as Level 2 include
corporate debt securities, U.S. government and agency securities, foreign government and agency securities, certificates of
deposit, other asset-backed securities, debt funds, and certain mortgage-backed securities whose value is determined using
inputs that are observable in the market or can be derived principally from, or corroborated by, observable market data such as
pricing for similar securities, recently executed transactions, cash flow models with yield curves, and benchmark securities. In
addition, interest rate swaps are included in Level 2 as the Company uses inputs other than quoted prices that are observable for
the asset. The Level 2 derivative instruments are primarily valued using standard calculations and models that use readily
observable market data as their basis.
Financial assets are considered Level 3 when their fair values are determined using pricing models, discounted cash flow
methodologies, or similar techniques, and at least one significant model assumption or input is unobservable. Level 3 financial
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