Microsoft 2007 Annual Report Download - page 40

PAGE 39
Equity and other investments may include both debt and equity instruments. Debt securities and publicly traded
equity securities are classified as available for sale and are recorded at market using the specific identification
method. Changes in market value are reflected in OCI (excluding other-than-temporary impairments). All other
investments, excluding those accounted for using the equity method, are recorded at cost.
We lend certain fixed-income and equity securities to enhance investment income. The loaned securities
continue to be carried as investments on our balance sheet. Collateral and/or security interest is determined
based upon the underlying security and the creditworthiness of the borrower. Cash collateral is recorded as an
asset with a corresponding liability.
Investments are considered to be impaired when a decline in fair value is judged to be other-than-temporary.
We employ a systematic methodology on a quarterly basis that considers available quantitative and qualitative
evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value,
we evaluate, among other factors, general market conditions, the duration and extent to which the fair value is
less than cost, and our intent and ability to hold the investment. We also consider specific adverse conditions
related to the financial health of and business outlook for the investee, including industry and sector performance,
changes in technology, operational and financing cash flow factors, and rating agency actions. Once a decline in
fair value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis in the
investment is established.
We use derivative instruments to manage exposures to foreign currency, equity price, interest rate and credit
risks, to enhance returns, and to facilitate portfolio diversification. Our objectives for holding derivatives include
reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible.
Derivative instruments are recognized as either assets or liabilities and are measured at fair value. The
accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the
resulting designation. For a derivative instrument designated as a fair-value hedge, the gain or loss is recognized
in earnings in the period of change together with the offsetting loss or gain on the hedged item attributed to the
risk being hedged. For a derivative instrument designated as a cash-flow hedge, the effective portion of the
derivative’s gain or loss is initially reported as a component of OCI and is subsequently recognized in earnings
when the hedged exposure affects earnings. The ineffective portion of the gain or loss is recognized in earnings.
For options designated either as fair-value or cash-flow hedges, changes in the time value are excluded from the
assessment of hedge effectiveness and are recognized in earnings. Gains and losses from changes in fair values
of derivatives that are not designated as hedges for accounting purposes are recognized in earnings.
Foreign Currency Risk. Certain assets, liabilities, and forecasted transactions are exposed to foreign currency
risk. We monitor our foreign currency exposures daily to maximize the overall effectiveness of our foreign
currency hedge positions. Options are used to hedge a portion of forecasted international revenue for up to three
years in the future and are designated as cash-flow hedging instruments under Statement of Financial Accounting
Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities. Principal currencies
hedged include the euro, Japanese yen, British pound, and Canadian dollar. Certain non-U.S. dollar denominated
securities are hedged using foreign exchange forward contracts that are designated as fair-value hedging
instruments under SFAS No. 133. Certain options and forwards not designated as hedging instruments under
SFAS No. 133 are also used to hedge the impact of the variability in exchange rates on accounts receivable and
collections denominated in certain foreign currencies and to manage other foreign currency exposures.
Equities Price Risk. Equity investments are subject to market price risk. From time to time, we use and
designate options to hedge fair values on certain equity securities. We determine the security, selected for
hedging by evaluating market conditions, up-front costs, and other relevant factors. Certain options, futures and
swap contracts, not designated as hedging instruments under SFAS No. 133, are also used to manage equity
exposures.
Interest Rate Risk. Fixed-income securities are subject to interest rate risk. The fixed-income portfolio is
diversified and consists primarily of investment grade securities to minimize credit risk. We use exchange-traded
option and futures contracts and over-the-counter swap contracts, not designated as hedging instruments under
SFAS No. 133, to hedge interest rate risk.
Other Derivatives. Swap contracts, not designated as hedging instruments under SFAS No. 133, are used to
manage exposures to credit risks, enhance returns, and to facilitate portfolio diversification. In addition, we may
invest in warrants to purchase securities of other companies as a strategic investment. Warrants that can be net
share settled are deemed derivative financial instruments and are not designated as hedging instruments. “To Be