McDonalds 2011 Annual Report Download - page 35

• Fair Value Hedges
The Company enters into fair value hedges to reduce the
exposure to changes in the fair values of certain liabilities. The
fair value hedges the Company enters into consist of interest rate
swaps which convert a portion of its fixed-rate debt into floating-
rate debt. All of the Company’s interest rate swaps meet the
shortcut method requirements. Accordingly, changes in the fair
values of the interest rate swaps are exactly offset by changes in
the fair value of the underlying debt. No ineffectiveness has been
recorded to net income related to interest rate swaps designated
as fair value hedges for the year ended December 31, 2011. A
total of $2.0 billion of the Company’s outstanding fixed-rate debt
was effectively converted to floating-rate debt resulting from the
use of interest rate swaps.
• Cash Flow Hedges
The Company enters into cash flow hedges to reduce the
exposure to variability in certain expected future cash flows. The
types of cash flow hedges the Company enters into include
interest rate swaps, foreign currency forwards and foreign cur-
rency options.
The Company periodically uses interest rate swaps to effec-
tively convert a portion of floating-rate debt, including forecasted
debt issuances, into fixed-rate debt and the agreements are
intended to reduce the impact of interest rate changes on future
interest expense. At December 31, 2011, $250.0 million of the
Company’s anticipated debt issuances were effectively converted
to fixed-rate resulting from the use of interest rate swaps.
To protect against the reduction in value of forecasted foreign
currency cash flows (such as royalties denominated in foreign
currencies), the Company uses foreign currency forwards and
foreign currency options to hedge a portion of anticipated
exposures.
When the U.S. dollar strengthens against foreign currencies,
the decline in value of future foreign denominated royalties is
offset by gains in the fair value of the foreign currency forwards
and/or foreign currency options. Conversely, when the U.S. dollar
weakens, the increase in the value of future foreign denominated
royalties is offset by losses in the fair value of the foreign cur-
rency forwards and/or foreign currency options.
Although the fair value changes in the foreign currency
options may fluctuate over the period of the contract, the
Company’s total loss on a foreign currency option is limited to the
upfront premium paid for the contract. However, the potential
gains on a foreign currency option are unlimited as the settle-
ment value of the contract is based upon the difference between
the exchange rate at inception of the contract and the spot
exchange rate at maturity. In limited situations, the Company uses
foreign currency collars, which limit the potential gains and lower
the upfront premium paid, to protect against currency
movements.
The hedges cover the next 15 months for certain exposures
and are denominated in various currencies. As of
December 31, 2011, the Company had derivatives outstanding
with an equivalent notional amount of $228.0 million that were
used to hedge a portion of forecasted foreign currency denomi-
nated royalties.
The Company excludes the time value of foreign currency
options, as well as the forward points on foreign currency for-
wards, from its effectiveness assessment on its cash flow
hedges. As a result, changes in the fair value of the derivatives
due to these components, as well as the ineffectiveness of the
hedges, are recognized in earnings currently. The effective por-
tion of the gains or losses on the derivatives is reported in the
cash flow hedging component of OCI in shareholders’ equity and
reclassified into earnings in the same period or periods in which
the hedged transaction affects earnings.
The Company recorded after tax adjustments to the cash flow
hedging component of accumulated OCI in shareholders’ equity.
The Company recorded a net decrease of $10.4 million and
$1.5 million for the years ended December 31, 2011 and 2010,
respectively. Based on interest rates and foreign exchange rates
at December 31, 2011, the $4.6 million in cumulative cash flow
hedging gains, after tax, at December 31, 2011, is not expected
to have a significant effect on earnings over the next 12 months.
• Net Investment Hedges
The Company primarily uses foreign currency denominated debt
(third party and intercompany) to hedge its investments in certain
foreign subsidiaries and affiliates. Realized and unrealized trans-
lation adjustments from these hedges are included in
shareholders’ equity in the foreign currency translation compo-
nent of OCI and offset translation adjustments on the underlying
net assets of foreign subsidiaries and affiliates, which also are
recorded in OCI. As of December 31, 2011, a total of $4.3 billion
of the Company’s foreign currency denominated debt was des-
ignated to hedge investments in certain foreign subsidiaries and
affiliates.
• Credit Risk
The Company is exposed to credit-related losses in the event of
non-performance by the counterparties to its hedging instru-
ments. The counterparties to these agreements consist of a
diverse group of financial institutions. The Company continually
monitors its positions and the credit ratings of its counterparties
and adjusts positions as appropriate. The Company did not have
significant exposure to any individual counterparty at
December 31, 2011 and has master agreements that contain
netting arrangements. Some of these agreements also require
each party to post collateral if credit ratings fall below, or
aggregate exposures exceed, certain contractual limits. At
December 31, 2011, neither the Company nor its counterparties
were required to post collateral on any derivative position, other
than on hedges of certain of the Company’s supplemental benefit
plan liabilities where its counterparties were required to post col-
lateral on their liability positions.
INCOME TAX UNCERTAINTIES
The Company, like other multi-national companies, is regularly
audited by federal, state and foreign tax authorities, and tax
assessments may arise several years after tax returns have been
filed. Accordingly, tax liabilities are recorded when, in manage-
ment’s judgment, a tax position does not meet the more likely
than not threshold for recognition. For tax positions that meet the
more likely than not threshold, a tax liability may be recorded
depending on management’s assessment of how the tax position
will ultimately be settled.
The Company records interest and penalties on unrecognized
tax benefits in the provision for income taxes.
McDonald’s Corporation Annual Report 2011 33