Note 11 — 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 gross notional amounts totaling $3.2 billion at March 31, 2017 and $2.6 billion at December 31, 2016 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 March 31, 2017 will be included in Cost of products sold at the time the products are sold, generally through the next twelve to eighteen months.  The amount of hedge ineffectiveness was not significant in 2017 and 2016.

 

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 including the British pound, 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 and European currencies.  At March 31, 2017 and December 31, 2016, Abbott held the gross notional amount of $14.0 billion and $14.9 billion, respectively, of such foreign currency forward exchange contracts.

 

In March 2017, Abbott repaid its $479 million foreign denominated short-term debt which was designated as a hedge of the net investment in a foreign subsidiary. At December 31, 2016, the value of this short-term debt was $454 million and changes in the fair value of the debt up through the date of repayment due to changes in exchange rates were recorded in Accumulated other comprehensive income (loss), net of tax.

 

Abbott is a party to interest rate hedge contracts totaling approximately $5.5 billion at March 31, 2017 and December 31, 2016 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.  The amount of hedge ineffectiveness was not significant in 2017 and 2016.

 

The following table summarizes the amounts and location of certain derivative financial instruments as of March 31, 2017 and December 31, 2016:

 

 

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 first three months of 2017 and 2016 and for certain other derivative financial instruments.  The amount of hedge ineffectiveness was not significant in 2017 and 2016 for these hedges.

 

 

Gains of $9 million and losses of $2 million were recognized in the first three months of 2017 and 2016, respectively, related to foreign currency forward exchange contracts not designated as a hedge. These amounts are reported in the Condensed Consolidated Statement of Earnings on the Net foreign exchange (gain) loss line.

 

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 March 31, 2017 and December 31, 2016 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.

 

 

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:

 

 

Equity securities are principally comprised of Mylan N.V. ordinary shares.  The fair value of the Mylan equity securities was determined based on the value of the publicly-traded ordinary shares. In the first quarter of 2017, Abbott sold 44 million ordinary shares of Mylan N.V which had a value of $1.7 billion.  As a result of this sale, Abbott’s ownership interest in Mylan N.V. decreased from approximately 14% to approximately 4.8%.  The fair value of 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 and other changes in fair value.  In the first quarter of 2017, the increase in the fair value of the contingent consideration was primarily due to the assumption of St. Jude Medical’s contingent consideration obligations.