McDonalds 2013 Annual Report Download - page 43

McDonald’s Corporation 2013 Annual Report | 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
Company's fair value hedges convert a portion of its fixed-rate
debt into floating-rate debt by use of interest rate swaps. At
December 31, 2013, $2.2 billion of the Company's outstanding
fixed-rate debt was effectively converted. All of the Company’s
interest rate swaps meet the shortcut method requirements.
Accordingly, changes in the fair value 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, 2013.
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, foreign currency
options and cross currency swaps.
The Company periodically uses interest rate swaps to
effectively convert a portion of floating-rate debt, including
forecasted debt issuances, into fixed-rate debt. The agreements
are intended to reduce the impact of interest rate changes on
future interest expense.
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 currency
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. In some 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 19 months for certain exposures
and are denominated in various currencies. As of December 31,
2013, the Company had derivatives outstanding with an equivalent
notional amount of $730.3 million that were used to hedge a
portion of forecasted foreign currency denominated royalties.
The Company excludes the time value of foreign currency
options from its effectiveness assessment on its cash flow hedges.
As a result, changes in the fair value of the derivatives due to this
component, as well as the ineffectiveness of the hedges, are
recognized in earnings currently. The effective portion 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 uses cross-currency swaps to hedge the risk of
cash flows associated with certain foreign currency denominated
debt, including forecasted interest payments, and has elected
cash flow hedge accounting. The hedges cover periods up to 47
months and have an equivalent notional amount of $346.9 million.
The Company manages its exposure to energy-related
transactions in certain markets by entering into purchase and sale
agreements. Previously, some of these agreements were
considered commodity forwards and the Company elected cash
flow hedge accounting, the impact of which was immaterial. In
2013, the Company determined these transactions were now
eligible for the normal purchase/normal sale scope exception,
which meant no further derivative or hedge accounting was
required.
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 $37.5 million for the
year ended December 31, 2013 and a net increase of $30.6
million for the year ended December 31, 2012. Based on
interest rates and foreign exchange rates at December 31, 2013,
the $2.3 million in cumulative cash flow hedging losses, after tax,
at December 31, 2013, 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
translation adjustments from these hedges are included in
shareholders’ equity in the foreign currency translation component
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, 2013, $4.7 billion of the
Company’s third party foreign currency denominated debt, $4.2
billion of intercompany foreign currency denominated debt, and
$827.4 million of derivatives were designated 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 instruments.
The counterparties to these agreements consist of a diverse group
of financial institutions and market participants. 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, 2013 and has master agreements that contain
netting arrangements. For financial reporting purposes, the
Company presents gross derivative balances in the financial
statements and supplementary data, even for counterparties
subject to 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, 2013, 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
collateral 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
management’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 still 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.