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Derivative Financial Instruments
9 Months Ended
Sep. 30, 2011
Derivative Financial Instruments [Abstract] 
Derivative Financial Instruments
10. Derivative Financial Instruments
ASC Topic 815, “Derivatives and Hedging” (“ASC Topic 815”) requires companies to recognize all of its derivative instruments as either assets or liabilities in the Consolidated Balance Sheet at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation.
The Company is exposed to certain risks relating to its ongoing business operations. The primary risks managed by using derivative instruments are foreign currency exchange rate risk and interest rate risk. Forward contracts against various foreign currencies are entered into to manage the foreign currency exchange rate risk on forecasted revenue and expenses denominated in currencies other than the functional currency of the operating unit (cash flow hedge). Other forward exchange contracts against various foreign currencies are entered into to manage the foreign currency exchange rate risk associated with certain firm commitments denominated in currencies other than the functional currency of the operating unit (fair value hedge). In addition, the Company will enter into non-designated forward contracts against various foreign currencies to manage the foreign currency exchange rate risk on recognized nonfunctional currency monetary accounts (non-designated hedge). Interest rate swaps are entered into to manage interest rate risk associated with the Company’s fixed and floating-rate borrowings.
The Company records all derivative financial instruments at their fair value in its Consolidated Balance Sheet. Except for certain non-designated hedges discussed below, all derivative financial instruments that the Company holds are designated as either cash flow or fair value hedges and are highly effective in offsetting movements in the underlying risks. Such arrangements typically have terms between two and 24 months, but may have longer terms depending on the underlying cash flows being hedged, typically related to the projects in our backlog. The Company may also use interest rate contracts to mitigate its exposure to changes in interest rates on anticipated long-term debt issuances.
At September 30, 2011, the Company has determined that its financial assets of $42 million and liabilities of $55 million (primarily currency related derivatives) are level 2 in the fair value hierarchy. At September 30, 2011, the net fair value of the Company’s foreign currency forward contracts totaled a liability of $13 million.
As of September 30, 2011, the Company did not have any interest rate swaps and its financial instruments do not contain any credit-risk-related or other contingent features that could cause accelerated payments when the Company’s financial instruments are in net liability positions. We do not use derivative financial instruments for trading or speculative purposes.
Cash Flow Hedging Strategy
For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is subject to a particular currency risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of Other Comprehensive Income and reclassified into earnings in the same line item associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings (e.g., in “revenues” when the hedged transactions are cash flows associated with forecasted revenues). The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any (i.e. the ineffective portion), or hedge components excluded from the assessment of effectiveness, are recognized in the Consolidated Statements of Income during the current period.
To protect against the volatility of forecasted foreign currency cash flows resulting from forecasted sales and expenses, the Company has instituted a cash flow hedging program. The Company hedges portions of its forecasted revenues and expenses denominated in nonfunctional currencies with forward contracts. When the U.S. dollar strengthens against the foreign currencies, the decrease in present value of future foreign currency revenue and costs is offset by gains in the fair value of the forward contracts designated as hedges. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is offset by losses in the fair value of the forward contracts.
The Company had the following outstanding foreign currency forward contracts that were entered into to hedge nonfunctional currency cash flows from forecasted revenues and costs (in millions):
                 
    Currency Denomination  
    September 30,     December 31,  
Foreign Currency   2011     2010  
British Pound Sterling
  £ 6     £ 4  
Danish Krone
  DKK 65     DKK 31  
Euro
  € 304     € 122  
Norwegian Krone
  NOK 5,527     NOK 4,983  
U.S. Dollar
  $ 389     $ 247  
Japanese Yen
  ¥ 122     ¥ -  
Singapore Dollar
  SGD 3     SGD -  
Swedish Krone
  SEK 2     SEK -  
Fair Value Hedging Strategy
For derivative instruments that are designated and qualify as a fair value hedge (i.e., hedging the exposure to changes in the fair value of an asset or a liability or an identified portion thereof that is subject to a particular risk), the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in the same line item associated with the hedged item in current earnings (e.g., in “revenue” when the hedged item is a contracted sale).
The Company enters into forward exchange contracts to hedge certain firm commitments of revenue and costs that are denominated in currencies other than the functional currency of the operating unit. The purpose of the Company’s foreign currency hedging activities is to protect the Company from risk that the eventual U.S. dollar-equivalent cash flows from the sale of products to customers will be adversely affected by changes in the exchange rates.
The Company had the following outstanding foreign currency forward contracts that were entered into to hedge nonfunctional currency fair values of firm commitments of revenues and costs (in millions):
                 
    Currency Denomination  
    September 30,     December 31,  
Foreign Currency   2011     2010  
U.S. Dollar
  $ —     $ 1  
Non-designated Hedging Strategy
For derivative instruments that are non-designated, the gain or loss on the derivative instrument subject to the hedged risk (i.e. nonfunctional currency monetary accounts) are recognized in other income (expense), net in current earnings.
The Company enters into forward exchange contracts to hedge certain nonfunctional currency monetary accounts. The purpose of the Company’s foreign currency hedging activities is to protect the Company from risk that the eventual U.S. dollar-equivalent cash flows from the nonfunctional currency monetary accounts will be adversely affected by changes in the exchange rates.
The Company had the following outstanding foreign currency forward contracts that hedge the fair value of nonfunctional currency monetary accounts (in millions):
                 
    Currency Denomination  
    September 30,     December 31,  
Foreign Currency   2011     2010  
British Pound Sterling
  £ 8     £ 8  
Danish Krone
  DKK 120     DKK 115  
Euro
  € 97     € 97  
Norwegian Krone
  NOK 1,544     NOK 1,442  
U.S. Dollar
  $ 561     $ 328  
Swedish Krone
  SEK 19     SEK —  
Russian Ruble
  RUB 683     RUB 780  
Brazilian Real
  BRL —     BRL —  
Japanese Yen
  ¥ 351     ¥ —  
Singapore Dollar
  SGD 4     SGD —  
The Company has the following fair values of its derivative instruments and their balance sheet classifications (in millions):
                                                 
    Asset Derivatives     Liability Derivatives  
            Fair Value             Fair Value  
    Balance Sheet     September 30,     December 31,     Balance Sheet     September 30,     December 31,  
    Location     2011     2010     Location     2011     2010  
Derivatives designated as hedging instruments under ASC Topic 815
                                               
 
                                               
Foreign exchange contracts



   Prepaid and other current assets   $ 23     $ 28     Accrued liabilities   $ 37     $ 12  
Foreign exchange contracts

   Other Assets     5       12     Other Liabilities     8       1  
 
                                       
 
                                               
Total derivatives designated as hedging instruments under ASC Topic 815
          $ 28     $ 40             $ 45     $ 13  
 
                                       
 
                                               
Derivatives not designated as hedging instruments under ASC Topic 815
                                               
 
                                               
Foreign exchange contracts



   Prepaid and other current assets   $ 14     $ 7     Accrued liabilities   $ 10     $ 10  
 
                                       
 
                                               
Total derivatives not designated as hedging instruments under ASC Topic 815
          $ 14     $ 7             $ 10     $ 10  
 
                                       
 
                                               
Total derivatives
          $ 42     $ 47             $ 55     $ 23  
 
                                       
The Effect of Derivative Instruments on the Consolidated Statement of Income
($ in millions)
                                                                 
                                            Location of Gain (Loss)        
                                            Recognized in Income on     Amount of Gain (Loss)  
                    Location of Gain (Loss)                     Derivative (Ineffective     Recognized in Income on  
                    Reclassified from     Amount of Gain (Loss)     Portion and Amount     Derivative (Ineffective  
Derivatives in ASC Topic 815   Amount of Gain (Loss)     Accumulated OCI into     Reclassified from     Excluded from     Portion and Amount  
Cash Flow Hedging   Recognized in OCI on     Income     Accumulated OCI into     Effectiveness     Excluded from  
Relationships   Derivative (Effective Portion) (a)     (Effective Portion)     Income (Effective Portion)     Testing)     Effectiveness Testing) (b)  
    Nine Months Ended             Nine Months Ended             Nine Months Ended  
    September 30,             September 30,             September 30,  
    2011     2010             2011     2010             2011     2010  
 
                  Revenue     11       6                          
Foreign exchange contracts
    6       (14 )   Cost of revenue     38       (26 )   Other income (expense), net     11       5  
 
                                                   
Total
    6       (14 )             49       (20 )             11       5  
 
                                                   
                                                         
Derivatives in ASC Topic 815   Location of Gain (Loss)     Amount of Gain (Loss)     ASC Topic 815     Location of Gain (Loss)     Recognized in Income on  
Fair Value   Recognized in Income     Recognized in Income on     Fair Value Hedge     Recognized in Income on     Related Hedged  
Hedging Relationships   on Derivative     Derivative     Relationships     Related Hedged Item     Items  
            Nine Months Ended                     Nine Months Ended  
            September 30,                     September 30,  
            2011     2010                     2011     2010  
Foreign exchange contracts
  Revenue     —       (1 )   Firm commitments   Revenue     —       1  
 
                                               
Total
            —       (1 )                     —       1  
 
                                               
                         
Derivatives Not Designated as   Location of Gain (Loss)     Amount of Gain (Loss)  
Hedging Instruments under   Recognized in Income     Recognized in Income on  
ASC Topic 815   on Derivative     Derivative  
            Nine Months Ended  
            September 30,  
            2011     2010  
 
                       
Foreign exchange contracts
  Other income (expense), net     (20 )     8  
 
                   
Total
            (20 )     8  
 
                   
 
(a)   The Company expects that ($18) million of the Accumulated Other Comprehensive Income (Loss) will be reclassified into earnings within the next twelve months with an offset by gains from the underlying transactions resulting in no impact to earnings or cash flow.
 
(b)   The amount of gain recognized in income represents $11 million and $5 million related to the ineffective portion of the hedging relationships for the nine months ended September 30, 2011 and 2010, respectively, and $13 million and $8 million related to the amount excluded from the assessment of the hedge effectiveness for the nine months ended September 30, 2011 and 2010, respectively.