Apple 2003 Annual Report Download - page 49

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charge to earnings in the event a decline in fair value below the cost basis of one of these investments is determined to be other-than-
temporary.
The Company includes recognized gains and losses resulting from the sale or from other-than-temporary declines in fair value associated with
these investments in other income and expense. Occasionally, the Company uses short-term equity derivatives to
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manage potential dispositions of non-current debt and equity investments. Any gains or losses associated with such derivatives are recognized
currently in other income and expense.
Financial Instruments with Characteristics of Both Liabilities and Equity
On May 15, 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 150,
Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity
. SFAS No. 150 requires issuers to classify as
liabilities (or assets in some circumstances) certain freestanding financial instruments that embody obligations for the issuer and have
characteristics of both liabilities and equity. The Company adopted the provisions of SFAS No. 150 on June 29, 2003, which resulted in a
favorable cumulative-
effect type adjustment of approximately $3 million. This adjustment related to a forward purchase agreement that allowed
the Company to acquire 1.5 million shares of its common stock at an average price of $16.64 per share for a total cost of $25.5 million. The
Company settled this forward purchase agreement in August 2003, which resulted in an additional gain of approximately $6 million
representing the increase in fair value of the agreement from June 29, 2003 through the settlement date.
Derivative Financial Instruments
On October 1, 2000, the Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities . SFAS No. 133
establishes accounting and reporting standards for derivative instruments, hedging activities, and exposure definition. SFAS No. 133 requires
that all derivatives be recognized as either assets or liabilities at fair value. Derivatives that are not hedges must be adjusted to fair value
through income. If the derivative is a hedge, depending on the nature of the hedge, changes in fair value will either be offset against the change
in fair value of the hedged assets, liabilities, or firm commitments through earnings, or recognized in other comprehensive income until the
hedged item is recognized in earnings. Net of the related income tax effect of approximately $5 million, adoption of SFAS No. 133 resulted in
a favorable cumulative-effect type adjustment to net income of approximately $12 million. Net of the related income tax effect of
approximately $5 million, adoption of SFAS No. 133 resulted in a favorable cumulative-effect-type adjustment to other comprehensive income
of approximately $12 million, all of which was reclassified to earnings during 2001. Management does not believe that ongoing application of
SFAS No. 133 will significantly alter the Company's hedging strategies. However, its application may increase the volatility of other income
and expense and other comprehensive income.
For derivative instruments that hedge the exposure to variability in expected future cash flows that are attributable to a particular risk and that
are designated as cash flow hedges, the net gain or loss on the derivative instrument is reported as a component of other comprehensive income
in shareholders' equity and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. To
receive hedge accounting treatment, cash flow hedges must be highly effective in achieving offsetting changes to expected future cash flows on
hedged transactions. For derivative instruments that hedge the exposure to changes in the fair value of an asset or a liability or an identified
portion thereof that are attributable to a particular risk and that are designated as fair value hedges, the net gain or loss on the derivative
instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in earnings in the current
period. The net gain or loss on the effective portion of a derivative instrument that is designated as an economic hedge of the foreign currency
translation exposure of the net investment in a foreign operation is reported in the same manner as a foreign currency translation adjustment.
For forward contracts designated as net investment hedges, the Company excludes changes in fair value relating to changes in the forward carry
component from its definition of effectiveness. Accordingly, any gains or losses related to this component are recognized in current
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earnings. For derivative instruments not designated as hedging instruments, changes in fair value are recognized in earnings in the current
period.
For foreign currency forward contracts designated as cash flow hedges, hedge effectiveness is measured based on changes in the fair value of
the contract attributable to changes in the forward exchange rate. Changes in the expected future cash flows on the forecasted hedged
transaction and changes in the fair value of the forward hedge are both measured from the contract rate to the forward exchange rate associated
with the forward contract's maturity date. For currency option contracts, hedge effectiveness is measured based on changes in the total fair
value of the option contract. Hedge effectiveness is assessed by comparing the present value of the cumulative change in expected future cash
flows on the hedged transaction to changes in expected cash flow of the option hedge at maturity. The net gains or losses on derivative
instruments qualifying as cash flow hedges are reported as components of other comprehensive income in shareholders' equity and reclassified
into earnings in the same period or periods during which the hedged transaction affects earnings. Any hedge ineffectiveness is recognized in
current earnings in other income and expense. For interest rate swap agreements qualifying as fair value hedges, the Company assumes no