Pepsi 2012 Annual Report Download - page 97

Note— Financial Instruments
We are exposed to market risks arising from adverse
changes in:
• commodity prices, affecting the cost of our raw materials
and energy;
• foreign exchange risks and currency restrictions; and
• interest rates.
In the normal course of business, we manage these risks
through a variety of strategies, including the use of deriva-
tives. Certain derivatives are designated as either cash flow or
fair value hedges and qualify for hedge accounting treatment,
while others do not qualify and are marked to market through
earnings. Cash flows from derivatives used to manage com-
modity, foreign exchange or interest risks are classified as
operating activities. We classify both the earnings and cash
flow impact from these derivatives consistent with the under-
lying hedged item. See “Our Business Risks” in Management’s
Discussion and Analysis for further unaudited information on
our business risks.
For cash flow hedges, changes in fair value are deferred
in accumulated other comprehensive loss within common
shareholders’ equity until the underlying hedged item is rec-
ognized in net income. For fair value hedges, changes in fair
value are recognized immediately in earnings, consistent with
the underlying hedged item. Hedging transactions are limited
to an underlying exposure. As a result, any change in the value
of our derivative instruments would be substantially offset
by an opposite change in the value of the underlying hedged
items. Hedging ineffectiveness and a net earnings impact
occur when the change in the value of the hedge does not
offset the change in the value of the underlying hedged item.
If the derivative instrument is terminated, we continue to defer
the related 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 on the hedge
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 instru-
ments for trading or speculative purposes. We perform
assessments of our counterparty credit risk regularly, includ-
ing 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 deriva-
tive contracts with a variety of financial institutions that we
believe are creditworthy in order to reduce our concentration
of credit risk.
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 and derivatives. In addition, risk to our
supply of certain raw materials is mitigated through purchases
from multiple geographies and suppliers. We use derivatives,
with terms of no more than three years, to economically hedge
price fluctuations related to a portion of our anticipated com-
modity purchases, primarily for agricultural products, metals
and energy. For those derivatives that qualify for hedge
accounting, any ineffectiveness is recorded immediately in
corporate unallocated expenses. Ineffectiveness was not
material for all periods presented. During the next 12 months,
we expect to reclassify net losses of $12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 $507million as of
December29, 2012 and $598million as of December31, 2011.
Our open commodity derivative contracts that do not qual-
ify for hedge accounting had a face value of $853million as of
December29, 2012 and $630million as of December31, 2011.
Foreign Exchange
Our operations outside of the U.S. generate 49% of our net
revenue, with Russia, Mexico, Canada, the United Kingdom and
Brazil comprising approximately 25% of our net revenue. As a
result, we are exposed to foreign currency risks.
Additionally, we are also exposed to foreign currency risk
from foreign currency purchases and foreign currency assets
and liabilities created in the normal course of business. We
manage this risk through sourcing purchases from local sup-
pliers, negotiating contracts in local currencies with foreign
suppliers and through the use of derivatives, primarily forward
contracts with terms of no more than two years. 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
$2.8 billion as of December 29, 2012 and $2.3 billion as of
December31, 2011. During the next 12 months, we expect to
reclassify net losses of $14million related to foreign currency
contracts that qualify for hedge accounting from accumu-
lated other comprehensive loss into net income. Additionally,
2012 PEPSICO ANNUAL REPORT 95
Notes to Consolidated Financial Statements