Microsoft 2009 Annual Report Download - page 55

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PAGE 55
CASH-FLOW HEDGES
For a derivative instrument designated as a cash-flow hedge, the effective portion of the derivative’s gain (loss) is
initially reported as a component of other comprehensive income (“OCI”) and is subsequently recognized in earnings
when the hedged exposure is recognized in earnings. For options designated as cash-flow hedges, changes in the
time value are excluded from the assessment of hedge effectiveness and are recognized in earnings. Gains (losses)
on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge
ineffectiveness are recognized in earnings. During fiscal year 2009, we recognized the following gains (losses)
related to foreign exchange contracts:
(In millions)
Effective portion:
Gain recognized in OCI, net of tax effect of $472 $876
Gain reclassified from accumulated OCI into revenue $884
Amount excluded from effectiveness assessment and ineffective portion:
Loss recognized in other income (expense) $(314)
We estimate that $528 million of net derivative gains included in OCI will be reclassified into earnings within the next
12 months. No significant amounts of gains (losses) were reclassified from OCI into earnings as a result of
forecasted transactions that failed to occur during fiscal year 2009.
NON-DESIGNATED DERIVATIVES
Gains (losses) from changes in fair values of derivatives that are not designated as hedges are recognized in other
income (expense). Other than those derivatives entered into for investment purposes, such as commodity contracts,
the gains (losses) below are generally economically offset by unrealized gains (losses) in the underlying securities
and are recorded as a component of OCI. The amounts recognized during fiscal year 2009 were as follows:
(In millions)
Foreign exchange contracts $(234)
Equity contracts (131)
Interest-rate contracts 5
Credit contracts (18)
Commodity contracts (126)
Total $(504)
Gains (losses) for foreign exchange, equity, interest rate, credit, and commodity contracts presented in other income
statement line items were immaterial for fiscal year 2009 and have been excluded from the table above.
NOTE 6 FAIR VALUE MEASUREMENTS
SFAS No. 157 defines fair value as the price that would be received upon sale of an asset or paid upon transfer of a
liability in an orderly transaction between market participants at the measurement date and in the principal or most
advantageous market for that asset or liability. The fair value should be calculated based on assumptions that
market participants would use in pricing the asset or liability, not on assumptions specific to the entity. In addition,
the fair value of liabilities should include consideration of non-performance risk, including our own credit risk.
In addition to defining fair value, SFAS No. 157 expands the disclosure requirements around fair value and
establishes a fair value hierarchy for valuation inputs. The hierarchy prioritizes the inputs into three levels based on
the extent to which inputs used in measuring fair value are observable in the market. Each fair value measurement is
reported in one of the three levels, which is determined by the lowest level input that is significant to the fair value
measurement in its entirety. These levels are:
• Level 1 – inputs are based upon unadjusted quoted prices for identical instruments traded in active markets.