Apple 2014 Annual Report Download - page 60

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Derivative Financial Instruments
The Company uses derivatives to partially offset its business exposure to foreign currency and interest rate risk. The Company
may enter into forward contracts, option contracts, swaps, or other derivative instruments to offset some of the risk on
expected future cash flows, on net investments in certain foreign subsidiaries and on certain existing assets and liabilities.
However, the Company may choose not to hedge certain exposures for a variety of reasons including, but not limited to,
accounting considerations and the prohibitive economic cost of hedging particular exposures. There can be no assurance the
hedges will offset more than a portion of the financial impact resulting from movements in foreign currency exchange or interest
rates.
To help protect gross margins from fluctuations in foreign currency exchange rates, certain of the Company’s subsidiaries
whose functional currency is the U.S. dollar hedge a portion of forecasted foreign currency revenue. The Company’s
subsidiaries whose functional currency is not the U.S. dollar and who sell in local currencies may hedge a portion of forecasted
inventory purchases not denominated in the subsidiaries’ functional currencies. The Company typically hedges portions of its
forecasted foreign currency exposure associated with revenue and inventory purchases, typically for up to 12 months.
To help protect the net investment in a foreign operation from adverse changes in foreign currency exchange rates, the
Company may enter into foreign currency forward and option contracts to offset the changes in the carrying amounts of these
investments due to fluctuations in foreign currency exchange rates.
The Company may also enter into foreign currency forward contracts and option contracts to partially offset the foreign
currency exchange gains and losses generated by the re-measurement of certain assets and liabilities denominated in non-
functional currencies.
The Company may enter into interest rate swaps, options, or other instruments to manage interest rate risk. These instruments
may offset a portion of changes in income or expense, or changes in fair value of the Company’s long-term debt or
investments.
The Company records all derivatives in the Consolidated Balance Sheets at fair value. The Company’s accounting treatment for
these instruments is based on the hedge designation. The effective portions of cash flow hedges are recorded in AOCI until the
hedged item is recognized in earnings. Gains and losses related to changes in fair value hedges are recognized in earnings
along with a corresponding loss or gain related to the change in value of the underlying hedged item. The effective portions of
net investment hedges are recorded in other comprehensive income (“OCI”) as a part of the cumulative translation adjustment.
The ineffective portions of cash flow hedges and net investment hedges are recorded in other income and expense. Derivatives
that are not designated as hedging instruments are adjusted to fair value through earnings in the financial statement line item to
which the derivative relates.
Deferred gains and losses associated with cash flow hedges of foreign currency revenue are recognized as a component of net
sales in the same period as the related revenue is recognized, and deferred gains and losses related to cash flow hedges of
inventory purchases are recognized as a component of cost of sales in the same period as the related costs are recognized.
Deferred gains and losses associated with cash flow hedges of interest income or expense are recognized as a component of
other income/(expense), net in the same period as the related income or expense is recognized. The Company’s foreign
currency and interest rate transactions hedged with cash flow hedges as of September 27, 2014 are expected to occur within
12 months and four years, respectively.
Derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable the forecasted
hedged transaction will not occur in the initially identified time period or within a subsequent two-month time period. Deferred
gains and losses in AOCI associated with such derivative instruments are reclassified immediately into other income and
expense. Any subsequent changes in fair value of such derivative instruments are reflected in other income and expense unless
they are re-designated as hedges of other transactions. The Company did not recognize any significant net gains or losses
related to the loss of hedge designation on discontinued cash flow hedges during 2014, 2013 and 2012.
The gain/loss recognized in other income and expense for foreign currency forward and option contracts not designated as
hedging instruments was not significant during 2014, 2013 and 2012. These amounts represent the net gain or loss on the
derivative contracts and do not include changes in the related exposures, which generally offset a portion of the gain or loss on
the derivative contracts.
Apple Inc. | 2014 Form 10-K | 58