Pepsi 2008 Annual Report Download - page 89

87PepsiCo, Inc. 2008 Annual Report
We also use derivatives that do not qualify for hedge
accounting treatment. We account for such derivatives at market
value with the resulting gains and losses reected in our income
statement. We do not use derivative instruments for trading or
speculative purposes. We perform a quarterly assessment of
our counterparty credit risk, including a review of credit ratings,
credit default swap rates and potential nonperformance of the
counterparty. We consider this risk to be low, because we limit
our exposure to individual, strong creditworthy counterparties
and generally settle on a net basis.
COMMODITY PRICES
We are subject to commodity price risk because our ability to
recover increased costs through higher pricing may be limited
in the competitive environment in which we operate. This risk is
managed through the use of xed-price purchase orders, pricing
agreements, geographic diversity and derivatives. We use deriva-
tives, with terms of no more than three years, to economically
hedge price uctuations related to a portion of our anticipated
commodity purchases, primarily for natural gas and diesel fuel.
For those derivatives that qualify for hedge accounting, any inef-
fectiveness is recorded immediately. However, such commodity
cash ow hedges have not had any signicant ineffectiveness
for all periods presented. We classify both the earnings and cash
ow impact from these derivatives consistent with the underlying
hedged item. During the next 12 months, we expect to reclassify
net losses of $64 million related to cash ow hedges from accu-
mulated other comprehensive loss into net income. Derivatives
used to hedge commodity price risks that do not qualify for hedge
accounting are marked to market each period and reected in
our income statement.
In 2007, we expanded our commodity hedging program to
include derivative contracts used to mitigate our exposure to
price changes associated with our purchases of fruit. In addition,
in 2008, we entered into additional contracts to further reduce
our exposure to price uctuations in our raw material and energy
costs. The majority of these contracts do not qualify for hedge
accounting treatment and are marked to market with the resulting
gains and losses recognized in corporate unallocated expenses.
These gains and losses are then subsequently reected in
divisional results.
Our open commodity derivative contracts that qualify for hedge
accounting had a face value of $303 million at December 27, 2008
and $5 million at December 29, 2007. These contracts resulted in
net unrealized losses of $117 million at December 27, 2008 and
net unrealized gains of less than $1 million at December 29, 2007.
Our open commodity derivative contracts that do not qualify
for hedge accounting had a face value of $626 million at
December 27, 2008 and $105 million at December 29, 2007.
These contracts resulted in net losses of $343 million in 2008
and net gains of $3 million in 2007.
FOREIGN EXCHANGE
Our operations outside of the U.S. generate 48% of our net rev-
enue, with Mexico, Canada and the United Kingdom comprising
19% of our net revenue. As a result, we are exposed to foreign
currency risks. On occasion, we enter into hedges, primarily
forward contracts with terms of no more than two years, to
reduce the effect of foreign exchange rates. Ineffectiveness of
these hedges has not been material.
INTEREST RATES
We centrally manage our debt and investment portfolios consider-
ing investment opportunities and risks, tax consequences and
overall nancing strategies. We may use interest rate and cross
currency interest rate swaps to manage our overall interest
expense and foreign exchange risk. These instruments effectively
change the interest rate and currency of specic debt issuances.
Our 2008 and 2007 interest rate swaps were entered into con-
currently with the issuance of the debt that they modied. The
notional amount, interest payment and maturity date of the
swaps match the principal, interest payment and maturity date
of the related debt.
FAIR VALUE
In September 2006, the FASB issued SFAS 157, Fair Value
Measurements (SFAS 157), which denes fair value, establishes
a framework for measuring fair value, and expands disclosures
about fair value measurements. The provisions of SFAS 157 were
effective as of the beginning of our 2008 scal year. However, the
FASB deferred the effective date of SFAS 157, until the beginning
of our 2009 scal year, as it relates to fair value measurement
requirements for nonnancial assets and liabilities that are not
remeasured at fair value on a recurring basis. These include
goodwill, other nonamortizable intangible assets and unallocated
purchase price for recent acquisitions which are included within
other assets. We adopted SFAS 157 at the beginning of our 2008
scal year and our adoption did not have a material impact on
our nancial statements.
The fair value framework requires the categorization of assets
and liabilities into three levels based upon the assumptions
(inputs) used to price the assets or liabilities. Level 1 provides