Prudential 2006 Annual Report Download - page 109

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 recognized foreign currency asset or liability) 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 is a party to financial instruments that may contain derivative instruments that are “embedded” in the financial
instruments. 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.”
If it is determined that a 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 consistent with the earnings impact of the original
hedged cash flows.
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. Subsidiaries operating outside the U.S. are taxed, and income tax expense is recorded, based
on applicable foreign statutes. See Note 17 for a discussion of certain non-U.S. jurisdictions for which the Company assumes repatriation
of earnings to the U.S.
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.
New Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities,” including an amendment of FASB Statement No. 115. This statement provides
companies with an option to report selected financial assets and liabilities at fair value. This statement is effective for fiscal years
beginning after November 15, 2007 with early adoption permitted. The Company is currently assessing the impact of SFAS No. 159
on its consolidated financial position and results of operations.
PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT
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