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81PepsiCo, Inc. 2009 Annual Report
gain or loss and then include it as a component of the cost of the
underlying hedged item. Upon determination that the underlying
hedged item will not be part of an actual transaction, we recognize
the related gain or loss in net income immediately.
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 reflected in our income statement.
We do not use derivative instruments for trading or speculative
purposes. We perform assessments of our counterparty credit risk
regularly, including a review of credit ratings, credit default swap
rates and potential nonperformance of the counterparty. Based
on our most recent assessment of our counterparty credit risk, we
consider this risk to be low. In addition, we enter into derivative
contracts with a variety of financial institutions that we believe are
creditworthy in order to reduce our concentration of credit risk
and generally settle with these financial institutions 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 fixed-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 fluctuations 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
ineffectiveness is recorded immediately. We classify both the
earnings and cash flow impact from these derivatives consistent
with the underlying hedged item. During the next 12 months,
we expect to reclassify net losses of $124 million related to these
hedges from accumulated other comprehensive loss into net
income. Derivatives used to hedge commodity price risk that
do not qualify for hedge accounting are marked to market each
period and reflected in our income statement.
Our open commodity derivative contracts that qualify for
hedge accounting had a face value of $151 million as of
December 26, 2009 and $303 million as of December 27, 2008.
These contracts resulted in net unrealized losses of $29 million as
of December 26, 2009 and $117 million as of December 27, 2008.
Our open commodity derivative contracts that do not qualify
for hedge accounting had a face value of $231 million as of
December 26, 2009 and $626 million as of December 27, 2008.
These contracts resulted in net losses of $57 million in 2009 and
$343 million in 2008.
FOREIGN EXCHANGE
Financial statements of foreign subsidiaries are translated into U.S.
dollars using period-end exchange rates for assets and liabilities
and weighted-average exchange rates for revenues and expenses.
Adjustments resulting from translating net assets are reported as a
separate component of accumulated other comprehensive loss within
common shareholders’ equity as currency translation adjustment.
Our operations outside of the U.S. generate 48% of our net
revenue, with Mexico, Canada and the United Kingdom comprising
16% of our net revenue. As a result, we are exposed to foreign
currency risks. On occasion, we may enter into derivatives, primarily
forward contracts with terms of no more than two years, to manage
our exposure to foreign currency transaction risk. Exchange rate gains
or losses related to foreign currency transactions are recognized as
transaction gains or losses in our income statement as incurred.
Our foreign currency derivatives had a total face value of
$1.2 billion as of December 26, 2009 and $1.4 billion as of
December 27, 2008. The contracts that qualify for hedge
accounting resulted in net unrealized losses of $20 million as of
December 26, 2009 and net unrealized gains of $111 million as
of December 27, 2008. During the next 12 months, we expect to
reclassify net losses of $20 million related to these hedges from
accumulated other comprehensive loss into net income. The
contracts that do not qualify for hedge accounting resulted in a
net gain of $1 million in 2009 and net losses of $28 million in 2008.
All losses and gains were offset by changes in the underlying
hedged items, resulting in no net material impact on earnings.
INTEREST RATES
We centrally manage our debt and investment portfolios consider-
ing investment opportunities and risks, tax consequences and
overall financing strategies. We use various interest rate derivative
instruments including, but not limited to, interest rate swaps, cross
currency interest rate swaps, Treasury locks and swap locks to
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