Prudential 2003 Annual Report Download - page 110

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
When a derivative is designated as a foreign currency hedge and is determined to be highly effective, changes in
its fair value are recorded in either current period earnings or “Accumulated other comprehensive income (loss),”
depending on whether the hedge transaction is a fair value hedge (e.g., a hedge of a firm commitment that is to be
settled in a foreign currency) or a cash flow hedge (e.g., a foreign currency denominated forecasted transaction). When
a derivative is used as a hedge of a net investment in a foreign operation, its change in fair value, to the extent effective
as a hedge, is recorded in the cumulative translation adjustment account within “Accumulated other comprehensive
income (loss).”
If a derivative does not qualify for hedge accounting, all changes in its fair value, including net receipts and
payments, are included in “Realized investment gains (losses), net” without considering changes in the fair value of the
economically associated assets or liabilities.
The Company occasionally is a party to a financial instrument that contains a derivative instrument that is
“embedded” in the financial instrument. At inception, the Company assesses whether the economic characteristics of
the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of
the financial instrument (i.e., the host contract) and whether a separate instrument with the same terms as the embedded
instrument would meet the definition of a derivative instrument. When it is determined that (1) the embedded
derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of
the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the
embedded derivative is separated from the host contract, carried at fair value, and changes in its fair value are included
in “Realized investment gains (losses), net.”
When it is determined that the derivative no longer qualifies as an effective fair value or cash flow hedge or
management removes the hedge designation, the derivative will continue to be carried on the balance sheet at its fair
value, with changes in fair value recognized currently in “Realized investment gains (losses), net.” The asset or liability
under a fair value hedge will no longer be adjusted for changes in fair value and the existing basis adjustment is
amortized to the income statement line associated with the asset or liability. The component of “Accumulated other
comprehensive income (loss)” related to discontinued cash flow hedges is amortized to the income statement line
associated with the hedged cash flows over the original term of the hedge contract.
When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm
commitment, or because it is probable that the forecasted transaction will not occur by the end of the specified time
period, the derivative will continue to be carried on the balance sheet at its fair value, with changes in fair value
recognized currently in “Realized investment gains (losses), net.” Any asset or liability that was recorded pursuant to
recognition of the firm commitment is removed from the balance sheet and recognized currently in “Realized
investment gains (losses), net.” Gains and losses that were in “Accumulated other comprehensive income (loss)”
pursuant to the hedge of a forecasted transaction are recognized immediately in “Realized investment gains (losses),
net.”
Income Taxes
The Company and its eligible domestic subsidiaries file a consolidated federal income tax return that includes
both life insurance companies and non-life insurance companies. In addition to taxes on operations, the Internal
Revenue Code imposes an “equity tax” on mutual life insurance companies. Subsequent to the demutualization, the
Company is no longer subject to the equity tax. Subsidiaries operating outside the United States are taxed, and income
tax expense is recorded, based on applicable foreign statutes.
Deferred income taxes are recognized, based on enacted rates, when assets and liabilities have different values for
financial statement and tax reporting purposes. A valuation allowance is recorded to reduce a deferred tax asset to the
amount expected to be realized.
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