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DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES | 3 Months Ended
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Mar. 31, 2023
Derivative Instruments and Hedging Activities Disclosure [Abstract] |
DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES | DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES In the normal course of business, Eaton is exposed to certain risks related to fluctuations in interest rates, currency exchange rates and commodity prices. The Company uses various derivative and non-derivative financial instruments, primarily interest rate swaps, currency forward exchange contracts, currency swaps and commodity contracts to manage risks from these market fluctuations. The instruments used by Eaton are straightforward, non-leveraged instruments. The counterparties to these instruments are financial institutions with strong credit ratings. Eaton maintains control over the size of positions entered into with any one counterparty and regularly monitors the credit rating of these institutions. Such instruments are not purchased and sold for trading purposes. Derivative financial instruments are accounted for at fair value and recognized as assets or liabilities in the Consolidated Balance Sheets. Accounting for the gain or loss resulting from the change in the fair value of the derivative financial instrument depends on whether it has been designated as part of a hedging relationship, is effective and the nature of the hedging activity. Eaton formally documents all relationships between derivative financial instruments accounted for as designated hedges and the hedged item, as well as its risk-management objective and strategy for undertaking the hedge transaction. This process includes linking derivative financial instruments to a recognized asset or liability, specific firm commitment, forecasted transaction, or net investment in a foreign operation. These financial instruments can be designated as: •Hedges of the change in the fair value of a recognized fixed-rate asset or liability, or the firm commitment to acquire such an asset or liability (a fair value hedge); for these hedges, the gain or loss from the derivative financial instrument, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in income during the period of change in fair value. •Hedges of the variable cash flows of a recognized variable-rate asset or liability, or the forecasted acquisition of such an asset or liability (a cash flow hedge); for these hedges, the gain or loss from the derivative financial instrument is recognized in Accumulated other comprehensive income and reclassified to income in the same period when the gain or loss on the hedged item is included in income. •Hedges of the currency exposure related to a net investment in a foreign operation (a net investment hedge); for these hedges, the gain or loss from the derivative financial instrument is recognized in Accumulated other comprehensive income and reclassified to income in the same period when the gain or loss related to the net investment in the foreign operation is included in income. The gain or loss from a derivative financial instrument designated as a hedge is classified in the same line of the Consolidated Statements of Income as the offsetting loss or gain on the hedged item. The cash flows resulting from these financial instruments are classified in operating activities on the Condensed Consolidated Statements of Cash Flows. For derivatives that are not designated as a hedge, any gain or loss is immediately recognized in income. The majority of derivatives used in this manner relate to risks resulting from assets or liabilities denominated in a foreign currency and certain commodity contracts that arise in the normal course of business. Eaton uses currency exchange contracts and certain of its debt denominated in foreign currency to hedge portions of its net investments in foreign operations against foreign currency exposure (net investment hedges). The Company uses the spot rate method to assess hedge effectiveness when currency exchange contracts are used in net investment hedges. Under this method, changes in the spot exchange rate are recognized in Accumulated other comprehensive loss. Changes related to the forward rate are excluded from the hedging relationship and the forward points are amortized to Interest expense - net on a straight-line basis over the term of the contract. The cash flows resulting from these currency exchange contracts are classified in investing activities on the Condensed Consolidated Statements of Cash Flows. Derivative Financial Statement Impacts The fair value of derivative financial instruments recognized in the Consolidated Balance Sheets is as follows:
(In millions) | Notional amount |  | Other current assets |  | Other noncurrent assets |  | Other current liabilities |  | Other noncurrent liabilities |  | Type of hedge |  | Term
March 31, 2023 |  |  |  |  |  |  |  |  |  |  |  |  |
Derivatives designated as hedges |  |  |  |  |  |  |  |  |  |  |  |  |
Currency exchange contracts | $ | 1,138 |  |  | $ | 49 |  |  | $ | 3 |  |  | $ | 14 |  |  | $ | 5 |  |  | Cash flow |  | 1 to 34 months
Commodity contracts | 48 |  |  | 4 |  |  | — |  |  | 1 |  |  | — |  |  | Cash flow |  | 1 to 12 months
Currency exchange contracts | 587 |  |  | 1 |  |  | — |  |  | — |  |  | — |  |  | Net investment |  | 3 months
Total |  |  | $ | 53 |  |  | $ | 3 |  |  | $ | 15 |  |  | $ | 5 |  |  |  |  |
Derivatives not designated as hedges |  |  |  |  |  |  |  |  |  |  |  |  |
Currency exchange contracts | $ | 4,977 |  |  | $ | 22 |  |  |  |  | $ | 14 |  |  |  |  |  |  | 1 to 12 months
December 31, 2022 |  |  |  |  |  |  |  |  |  |  |  |  |
Derivatives designated as hedges |  |  |  |  |  |  |  |  |  |  |  |  |
Currency exchange contracts | $ | 1,240 |  |  | $ | 35 |  |  | $ | 2 |  |  | $ | 17 |  |  | $ | 9 |  |  | Cash flow |  | 1 to 36 months
Commodity contracts | 64 |  |  | 4 |  |  | — |  |  | 2 |  |  | — |  |  | Cash flow |  | 1 to 12 months
Total |  |  | $ | 39 |  |  | $ | 2 |  |  | $ | 19 |  |  | $ | 9 |  |  |  |  |
Derivatives not designated as hedges |  |  |  |  |  |  |  |  |  |  |  |  |
Currency exchange contracts | $ | 4,683 |  |  | $ | 30 |  |  |  |  | $ | 14 |  |  |  |  |  |  | 1 to 12 months
The currency exchange contracts shown in the table above as derivatives not designated as hedges are primarily contracts entered into to manage currency volatility or exposure on intercompany receivables, payables and loans. While Eaton does not elect hedge accounting treatment for these derivatives, Eaton targets managing 100% of the intercompany balance sheet exposure to minimize the effect of currency volatility related to the movement of goods and services in the normal course of its operations. This activity represents the great majority of these currency exchange contracts. The cash flows resulting from the settlement of these derivatives have been classified in investing activities in the Condensed Consolidated Statements of Cash Flows. Foreign currency denominated debt designated as non-derivative net investment hedging instruments had a carrying value on an after-tax basis of $3,092 million at March 31, 2023 and $2,711 million at December 31, 2022. As of March 31, 2023, the volume of outstanding commodity contracts that were entered into to hedge forecasted transactions:
Commodity |  | March 31, 2023 |  |  |  |  |  | Term
Aluminum |  | 4 |  |  |  |  | Millions of pounds |  | 1 to 12 months
Copper |  | 7 |  |  |  |  | Millions of pounds |  | 1 to 12 months
Gold |  | 1,690 |  |  |  |  | Troy ounces |  | 1 to 12 months
Silver |  | 510,167 |  |  |  |  | Troy ounces |  | 1 to 12 months
The following amounts were recorded on the Consolidated Balance Sheets related to fixed-to-floating interest rate swaps:
(In millions) | Carrying amount of the hedged assets (liabilities) |  | Cumulative amount of fair value hedging adjustment included in the carrying amount of the hedged asset (liabilities) (a)
Location on Consolidated Balance Sheets | March 31, 2023 |  |  | December 31, 2022 |  | March 31, 2023 |  | December 31, 2022 |
Long-term debt | $ | (713) |  |  |  | $ | (713) |  |  | $ | (47) |  |  | $ | (48) |  |
(a) At March 31, 2023 and December 31, 2022, these amounts include the cumulative liability amount of fair value hedging adjustments remaining for which the hedge accounting has been discontinued of $47 million and $48 million, respectively. The impact of cash flow and fair value hedging activities to the Consolidated Statements of Income is as follows:
| Three months ended March 31, 2023
(In millions) | Net sales |  | Cost of products sold |  | Interest expense - net |  |
Amounts from Consolidated Statements of Income | $ | 5,483 |  |  | $ | 3,599 |  |  | $ | 50 |  |  |
Gain (loss) on derivatives designated as cash flow hedges |  |  |  |  |  |  |
Forward starting floating-to-fixed interest rate swaps |  |  |  |  |  |  |
Hedged item | $ | — |  |  | $ | — |  |  | $ | (3) |  |  |
Derivative designated as hedging instrument | — |  |  | — |  |  | 3 |  |  |
Currency exchange contracts |  |  |  |  |  |  |
Hedged item | $ | 2 |  |  | $ | (15) |  |  | $ | — |  |  |
Derivative designated as hedging instrument | (2) |  |  | 15 |  |  | — |  |  |
| Three months ended March 31, 2022
(In millions) | Net sales |  | Cost of products sold |  | Interest expense - net |  |
Amounts from Consolidated Statements of Income | $ | 4,843 |  |  | $ | 3,269 |  |  | $ | 32 |  |  |
Gain (loss) on derivatives designated as cash flow hedges |  |  |  |  |  |  |
Currency exchange contracts |  |  |  |  |  |  |
Hedged item | $ | 2 |  |  | $ | (3) |  |  | $ | — |  |  |
Derivative designated as hedging instrument | (2) |  |  | 3 |  |  | — |  |  |
Commodity contracts |  |  |  |  |  |  |
Hedged item | $ | — |  |  | $ | (1) |  |  | $ | — |  |  |
Derivative designated as hedging instrument | — |  |  | 1 |  |  | — |  |  |
Gain (loss) on derivatives designated as fair value hedges |  |  |  |  |  |  |
Fixed-to-floating interest rate swaps |  |  |  |  |  |  |
Hedged item | $ | — |  |  | $ | — |  |  | $ | 8 |  |  |
Derivative designated as hedging instrument | — |  |  | — |  |  | (8) |  |  |
The impact of derivatives not designated as hedges to the Consolidated Statements of Income is as follows:
| Gain (loss) recognized in Consolidated Statements of Income |  |  |  | Consolidated Statements of Income classification
| Three months ended March 31 |  |
(In millions) | 2023 |  | 2022 |  |  |  |
Gain (loss) on derivatives not designated as hedges |  |  |  |  |  |  |
Currency exchange contracts | $ | 11 |  |  | $ | (8) |  |  |  |  | Interest expense - net
Commodity contracts | — |  |  | 1 |  |  |  |  | Other expense (income) - net and Cost of products sold (a)
Total | $ | 11 |  |  | $ | (7) |  |  |  |  |
(a) In the second quarter of 2022, Eaton changed the presentation of gains and losses associated with derivative contracts for commodities that are not designated as hedges from Cost of product sold to Other expense (income) - net on the Consolidated Statements of Income. Prior period amounts have not been reclassified as they are not material. The impact of derivative and non-derivative instruments designated as hedges to the Consolidated Statements of Income and Comprehensive Income is as follows:
| Gain (loss) recognized in other comprehensive income (loss) |  | Location of gain (loss) reclassified from Accumulated other comprehensive loss |  | Gain (loss) reclassified from Accumulated other comprehensive loss
| Three months ended March 31 |  |  |  | Three months ended March 31
(In millions) | 2023 |  | 2022 |  |  |  | 2023 |  | 2022
Derivatives designated as cash flow hedges |  |  |  |  |  |  |  |  |
Forward starting floating-to-fixed interest rate swaps | $ | — |  |  | $ | 124 |  |  | Interest expense - net |  | $ | 3 |  |  | $ | — |
Currency exchange contracts | 31 |  |  | — |  |  | Net sales and Cost of products sold |  | 11 |  |  | — |
Commodity contracts | 2 |  |  | 5 |  |  | Cost of products sold |  | — |  |  | 1 |
Derivatives designated as net investment hedges |  |  |  |  |  |  |  |  |
Currency exchange contracts |  |  |  |  |  |  |  |  |
Effective portion | (14) |  |  | — |  |  | Gain (loss) on sale of business |  | — |  |  | — |
Amount excluded from effectiveness testing | 5 |  |  | — |  |  | Interest expense - net |  | 1 |  |  | — |
Non-derivative designated as net investment hedges |  |  |  |  |  |  |  |  |
Foreign currency denominated debt | (63) |  |  | 62 |  |  | Gain (loss) on sale of business |  | — |  |  | — |
Total | $ | (39) |  |  | $ | 191 |  |  |  |  | $ | 15 |  |  | $ | 1 |
The pre-tax portion of the fair value of currency exchange contracts designated as net investment hedges included in Accumulated other comprehensive loss were net losses of $14 million at March 31, 2023. The pre-tax portion of the fair value of the forward points included in Accumulated other comprehensive loss were net gains of $4 million at March 31, 2023. At March 31, 2023, a gain of $38 million of estimated unrealized net gains or losses associated with our cash flow hedges were expected to be reclassified to income from Accumulated other comprehensive loss within the next twelve months. These reclassifications relate to our designated foreign currency and commodity hedges that will mature in the next 12 months.

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- Definition The entire disclosure for derivative instruments and hedging activities including, but not limited to, risk management strategies, non-hedging derivative instruments, assets, liabilities, revenue and expenses, and methodologies and assumptions used in determining the amounts. + References Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -URI https://asc.fasb.org/topic&trid=2229140 Reference 2: http://www.xbrl.org/2003/role/disclosureRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 40 -Section 50 -Paragraph 5 -Subparagraph (f) -URI https://asc.fasb.org/extlink&oid=126731327&loc=d3e90205-114008 + Details
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