Note 9 — Financial Instruments, Derivatives and Fair Value Measures

 

Certain Abbott foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany purchases by those subsidiaries whose functional currencies are not the U.S. dollar.  These contracts, with notional amounts totaling approximately $140 million at June 30, 2014 and December 31, 2013, respectively, are designated as cash flow hedges of the variability of the cash flows due to changes in foreign exchange rates and are recorded at fair value.   Accumulated gains and losses as of June 30, 2014 will be included in Cost of products sold at the time the products are sold, generally through the next twelve months.  The amount of hedge ineffectiveness was not significant in 2014 and 2013.

 

Abbott enters into foreign currency forward exchange contracts to manage currency exposures for foreign currency denominated third-party trade payables and receivables, and for intercompany loans and trade accounts payable where the receivable or payable is denominated in a currency other than the functional currency of the entity.  For intercompany loans, the contracts require Abbott to sell or buy foreign currencies, primarily European currencies and Japanese yen, in exchange for primarily U.S. dollars and other European currencies.  For intercompany and trade payables and receivables, the currency exposures are primarily the U.S. dollar, European currencies and Japanese yen.  At June 30, 2014 and December 31, 2013, Abbott held $13.1 billion and $13.8 billion, respectively, of such foreign currency forward exchange contracts.

 

Abbott has designated foreign denominated short-term debt as a hedge of the net investment in a foreign subsidiary of approximately $523 million and approximately $505 million as of June 30, 2014 and December 31, 2013, respectively.  Accordingly, changes in the reported value of this debt due to changes in exchange rates are recorded in Accumulated other comprehensive income (loss), net of tax.

 

Abbott is a party to interest rate swap contracts totaling approximately $1.5 billion at June 30, 2014 and December 31, 2013 to manage its exposure to changes in the fair value of fixed-rate debt.   These contracts are designated as fair value hedges of the variability of the fair value of fixed-rate debt due to changes in the long-term benchmark interest rates.  The effect of the hedge is to change a fixed-rate interest obligation to a variable rate for that portion of the debt.  Abbott records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount.  No hedge ineffectiveness was recorded in income in 2014 or 2013 for these hedges.

 

The following table summarizes the amounts and location of certain derivative financial instruments as of June 30, 2014 and December 31, 2013:

 

		Fair Value - Assets								Fair Value - Liabilities
(in millions)		June 30, 2014			Dec. 31, 2013			Balance Sheet Caption		June 30, 2014			Dec. 31, 2013			Balance Sheet Caption
Interest rate swaps designated as fair value hedges		$	106		$	87		Deferred income taxes and other assets		$	—		$	—		Post-employment obligations, deferred income taxes and other long-term liabilities
Foreign currency forward exchange contracts:
Hedging instruments		4			14			Prepaid expenses, deferred income taxes, and other receivables		—			—			Other accrued liabilities
Others not designated as hedges		67			70			Prepaid expenses, deferred income taxes, and other receivables		24			75			Other accrued liabilities
Debt designated as a hedge of net investment in a foreign subsidiary		—			—			n/a		523			505			Short-term borrowings
		$	177		$	171				$	547		$	580

 

The following table summarizes the activity for foreign currency forward exchange contracts designated as cash flow hedges, debt designated as a hedge of net investment in a foreign subsidiary and the amounts and location of income (expense) and gain (loss) reclassified into income in the second quarter and first six months of 2014 and 2013 and for certain other derivative financial instruments.  The amount of hedge ineffectiveness was not significant in 2014 and 2013 for these hedges.

 

		Gain (loss) Recognized in Other Comprehensive Income (loss)												Income (expense) and Gain (loss) Reclassified into Income
		Three Months Ended June 30						Six Months  Ended June 30						Three Months Ended June 30						Six Months  Ended June 30						Income Statement
(in millions)		2014			2013			2014			2013			2014			2013			2014			2013			Caption
Foreign currency forward exchange contracts designated as cash flow hedges		$	(3	)	$	14		$	(1	)	$	31		$	3		$	11		$	6		$	14		Cost of products sold
Debt designated as a hedge of net investment in a foreign subsidiary		(7		)	25			(18		)	75			n/a			n/a			n/a			n/a			n/a
Interest rate swaps designated as fair value hedges		n/a			n/a			n/a			n/a			8			(71		)	19			(81		)	Interest expense
Foreign currency forward exchange contracts not designated as hedges		n/a			n/a			n/a			n/a			(10		)	50			(23		)	140			Net foreign exchange loss (gain)

 

The interest rate swaps are designated as fair value hedges of the variability of the fair value of fixed-rate debt due to changes in the long-term benchmark interest rates.  The hedged debt is marked to market, offsetting the effect of marking the interest rate swaps to market.

 

The carrying values and fair values of certain financial instruments as of June 30, 2014 and December 31, 2013 are shown in the following table. The carrying values of all other financial instruments approximate their estimated fair values.  The counterparties to financial instruments consist of select major international financial institutions.  Abbott does not expect any losses from nonperformance by these counterparties.

 

		June 30, 2014						December 31, 2013
(in millions)		Carrying Value			Fair Value			Carrying Value			Fair Value
Long-term Investment Securities:
Equity securities		$	95		$	95		$	93		$	93
Other		35			31			26			24
Total Long-term Debt		(3,412		)	(4,033		)	(3,397		)	(3,930		)
Foreign Currency Forward Exchange Contracts:
Receivable position		71			71			84			84
(Payable) position		(24		)	(24		)	(75		)	(75		)
Interest Rate Hedge Contracts:
Receivable position		106			106			87			87

 

The fair value of the debt was determined based on significant other observable inputs, including current interest rates.

 

The following table summarizes the bases used to measure certain assets and liabilities at fair value on a recurring basis in the   balance sheet:

 

					Basis of Fair Value Measurement
(in millions)		Outstanding Balances			Quoted Prices in Active Markets			Significant Other Observable Inputs			Significant Unobservable Inputs
June 30, 2014:
Equity securities		$	19		$	19		$	—		$	—
Interest rate swap derivative financial instruments		106			—			106			—
Foreign currency forward exchange contracts		71			—			71			—
Total Assets		$	196		$	19		$	177		$	—
Fair value of hedged long-term debt		$	1,642		$	—		$	1,642		$	—
Foreign currency forward exchange contracts		24			—			24			—
Contingent consideration related to business combinations		75			—			—			75
Total Liabilities		$	1,741		$	—		$	1,666		75
December 31, 2013:
Equity securities		$	26		$	26		$	—		$	—
Interest rate swap derivative financial instruments		87			—			87			—
Foreign currency forward exchange contracts		84			—			84			—
Total Assets		$	197		$	26		$	171		$	—
Fair value of hedged long-term debt		$	1,623		$	—		$	1,623		$	—
Foreign currency forward exchange contracts		75			—			75			—
Contingent consideration related to business combinations		208			—			—			208
Total Liabilities		$	1,906		$	—		$	1,698		$	208

 

The fair value of the debt was determined based on the face value of the debt adjusted for the fair value of the interest rate swaps, which is based on a discounted cash flow analysis. The fair value of foreign currency forward exchange contracts is determined using a market approach, which utilizes values for comparable derivative instruments.  The fair value of the contingent consideration was determined based on an independent appraisal adjusted for the time value of money, exchange, payments and other changes in fair value. The change in contingent consideration from the previous year end primarily reflects the payment of contingent consideration in the first six months of 2014.