Proctor and Gamble 2006 Annual Report Download - page 55

Millions of dollars except per share amounts or otherwise specified.
Notes to Consolidated Financial Statements The Procter &Gamble Company and Subsidiaries 53
Interest rate swaps that meet specific criteria under SFAS 133 are
accounted for as fair value and cash flow hedges. For fair value hedges,
the changes in the fair value of both the hedging instruments and the
underlying debt obligations are immediately recognized in interest
expense as equal and offsetting gains and losses. The fair value of
these fair value hedging instruments was a liability of $32 and an
asset of $17 at June 30, 2006 and 2005, respectively. All existing fair
value hedges are 100% effective. As a result, there is no impact on
earnings from hedge ineffectiveness. For cash flow hedges, the
effective portion of the changes in fair value of the hedging instrument
is reported in other comprehensive income and reclassified into
interest expense over the life of the underlying debt. The fair value of
these cash flow hedging instruments was an asset of $225 and $3 at
June 30, 2006 and 2005, respectively. During the next 12 months,
$62 of the June 30, 2006 balance will be reclassified from other
comprehensive income to earnings consistent with the timing of the
underlying hedged transactions. The ineffective portion, which is not
material for any year presented, is immediately recognized in earnings.
Foreign Currency Management
We manufacture and sell our products in a number of countries
throughout the world and, as a result, are exposed to movements in
foreign currency exchange rates. The purpose of our foreign currency
hedging program is to reduce the risk caused by short-term changes
in exchange rates.
To manage this exchange rate risk, we primarily utilize forward
contracts and options with maturities of less than 18 months and
currency swaps with maturities up to 5 years. These instruments are
intended to offset the effect of exchange rate fluctuations on
forecasted sales, inventory purchases, intercompany royalties and
intercompany loans denominated in foreign currencies and are
therefore accounted for as cash flow hedges. The fair value of these
instruments at June 30, 2006 and 2005 was $25 and $47 in assets
and $58 and $131 in liabilities, respectively. The effective portion of
the changes in fair value of these instruments is reported in other
comprehensive income and reclassified into earnings in the same
financial statement line item and in the same period or periods during
which the related hedged transactions affect earnings. The ineffective
portion, which is not material for any year presented, is immediately
recognized in earnings.
Certain instruments used to manage foreign exchange exposure of
intercompany financing transactions, income from international
operations and other balance sheet items subject to revaluation do not
meet the requirements for hedge accounting treatment. In these cases,
the change in value of the instruments is designed to offset the foreign
currency impact of the related exposure. The fair value of these
instruments at June 30, 2006 and 2005 was $17 and $57 in assets and
$19 and $108 in liabilities, respectively. The change in value of these
instruments is immediately recognized in earnings. The net impact of
such instruments, included in selling, general and administrative
expense, was $87, $18 and $80 of gains in 2006, 2005 and 2004,
respectively, which substantially offset foreign currency transaction and
translation losses of the exposures being hedged.
Net Investment Hedging
We hedge certain net investment positions in major foreign subsidiaries.
To accomplish this, we either borrow directly in foreign currency and
designate all or a portion of foreign currency debt as a hedge of the
applicable net investment position or enter into foreign currency swaps
that are designated as hedges of our related foreign net investments.
Under SFAS 133, changes in the fair value of these instruments are
immediately recognized in other comprehensive income, to offset the
change in the value of the net investment being hedged. Currency
effects of these hedges reflected in other comprehensive income were
a $786 after-tax loss, a $135 after-tax gain and a $348 after-tax loss
in 2006, 2005 and 2004, respectively. Accumulated net balances were
$1,237 and $451 after-tax losses in 2006 and 2005, respectively.
Commodity Price Management
Certain raw materials utilized in our products or production processes
are subject to price volatility caused by weather, supply conditions,
political and economic variables and other unpredictable factors.
To manage the volatility related to anticipated purchases of certain of
these materials, we use futures and options with maturities generally
less than one year and swap contracts with maturities up to five years.
These market instruments generally are designated as cash flow
hedges under SFAS 133. The effective portion of the changes in fair
value for these instruments is reported in other comprehensive
income and reclassified into earnings in the same financial statement
line item and in the same period or periods during which the hedged
transactions affect earnings. The ineffective portion is immediately
recognized in earnings. The impact of the Company’s commodity
hedging activity was not material to our financial statements for any
of the years presented.