DERIVATIVE FINANCIAL INSTRUMENTS

12 Months Ended

Dec. 31, 2013

DERIVATIVE FINANCIAL INSTRUMENTS

Note 9    DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments, primarily forward contracts, to mitigate risk associated with adverse movements in foreign currency exchange rates.

The Company generally enters into master netting arrangements, which are designed to reduce credit risk by permitting net settlement of transactions with the same counterparty. The Company presents its derivative assets and liabilities at their gross fair values on the consolidated balance sheets. The Company is not required to pledge, and is not entitled to receive, cash collateral related to these derivative transactions.

Net Investment Hedges. The Company hedges, on an after-tax basis, a portion of its net investment in Yahoo Japan with forward contracts to reduce the risk that its carrying value of its investment in Yahoo Japan will be adversely affected by foreign currency exchange rate fluctuations. At inception, the forward contracts had maturities ranging from 9 to 15 months. The Company applies hedge accounting on its forward contracts for the net investment hedge of Yahoo Japan. The total balance of the after-tax net investment hedge was less than the Yahoo Japan investment balance as of both December 31, 2012 and 2013. As such, the net investment hedge was considered to be effective, and, as a result, the changes in the fair value were recorded within accumulated other comprehensive income on the Company’s consolidated balance sheets. The Company recognizes net investment derivative instruments as either an asset or a liability on the Company’s consolidated balance sheets at fair value. The notional amounts of the foreign currency forward contracts were $3 billion as of December 31, 2012 and $1.3 billion as of December 31, 2013, respectively. The fair value of the foreign currency forward contract assets were $3 million and $209 million as of December 31, 2012 and 2013, respectively, and were included in prepaid expenses and other current assets on the Company’s consolidated balance sheets. Pre-tax gains of $3 million and $510 million were recorded as of December 31, 2012 and December 31, 2013, respectively, and were included in accumulated other comprehensive income on the Company’s consolidated balance sheets. The Company did not enter into any net investment hedges in the year ended December 31, 2011. The Company received $304 million in cash for settlement of certain foreign currency forward contracts during year ended December 31, 2013.

Cash Flow Hedges. The Company entered into foreign currency forward contracts designated as cash flow hedges of varying maturities through July 31, 2014. For derivatives designated as cash flow hedges, the effective portion of the unrealized gains or losses on these forward contracts is recorded in accumulated other comprehensive income on the Company’s consolidated balance sheets and reclassified into revenue on the consolidated statements of income when the underlying hedged revenue is recognized. If the cash flow hedges were to become ineffective, the ineffective portion would be immediately recorded in other income, net on the Company’s consolidated statements of income. The cash flow hedges were considered to be effective as of December 31, 2013. The total notional amount of the foreign currency forward contracts was $56 million as of December 31, 2013. The fair value of the foreign currency forward contract assets was $4 million as of December 31, 2013 which was included in prepaid expenses and other current assets on the Company’s consolidated balance sheets. A pre-tax net gain of $2 million was recorded as of December 31, 2013, which was included in accumulated other comprehensive income on the Company’s consolidated balance sheets. For year ended December 31, 2013, the Company recorded gains of $2 million, net of tax, for cash flow hedges, which were recorded in revenue in the consolidated statements of income. The Company received $2 million in cash for settlement of certain foreign currency forward contracts during the year ended December 31, 2013. The Company did not enter into any cash flow hedges in the years ended December 31, 2011 and 2012.

Balance Sheet Hedges. The Company hedges certain of its net recognized foreign currency assets and liabilities with foreign exchange forward contracts to reduce the risk that its earnings and cash flows will be adversely affected by changes in foreign currency exchange rates. These derivative instruments hedge assets and liabilities, including intercompany transactions, which are denominated in foreign currencies. The Company recognizes balance sheet derivative instruments as either an asset or a liability on the Company’s consolidated balance sheets at fair value. Changes in the fair value of these derivatives are recorded in other income, net on the Company’s consolidated statements of income. The notional amounts of these foreign currency forward contracts were $356 million and $393 million as of December 31, 2012 and 2013, respectively. As of December 31, 2012 and 2013, the fair value of the foreign currency forward contract liabilities were $5 million, and less than $1 million, respectively, and were included in accrued expenses and other current liabilities on the Company’s consolidated balance sheets. A loss of $3 million, a gain of $4 million, and a loss of $12 million were recorded for the years ended December 31, 2011, 2012, and 2013, respectively, and were included in other income, net on the Company’s consolidated statements of income. The Company received $7 million and paid a net $17 million in cash for settlement of certain foreign currency forward contracts during the years ended December 31, 2012 and 2013, respectively.

Forecasted Revenue Hedges. On October 2, 2013, the Company began hedging a portion of the forecasted revenue of certain international subsidiaries whose functional currencies are not the U.S dollar. This program attempts to reduce the risk that its revenue denominated in these currencies will be adversely affected by foreign currency exchange rate fluctuations. These derivatives are economic hedges and as such do not qualify for hedge accounting. The Company recognizes these derivative instruments as either assets or liabilities on the Company’s consolidated balance sheets at fair value. Changes in the fair value of these derivatives are recorded as a component of revenue in the Company’s consolidated statements of income. The Company did not have any derivative contracts related to the forecasted revenue hedge outstanding as of December 31, 2013. The Company did not enter into any forecasted revenue hedges in the years ended December 31, 2011 and 2012.

Foreign currency forward contracts activity for the year ended December 31, 2013 was as follows (in millions):

	Beginning fair value			Settlement			Gain (loss) recorded in other income, net			Gain (loss) recorded in other comprehensive income			Gain (loss) recorded in revenue			Ending fair value
Derivatives designated as hedging instruments:
Net investment hedges	$	3		$	(304	)	$	—		$	510	(1)	$	—		$	209
Cash flow hedges		—			(2	)		1			2	(2)		3	(3)		4
Derivatives not designated as hedging instruments:
Balance sheet hedges		(5	)		17			(12	)		—			—			—
Forecasted revenue hedges		—			—			—			—			—			—

⁽¹⁾  This amount does not reflect the tax impact of $193 million recorded during the twelve months ended December 31, 2013. The $317 million after tax impact of the gain recorded under other comprehensive income was included in accumulated other comprehensive income on the Company’s consolidated balance sheets.

⁽²⁾  This amount does not reflect the tax impact of less than $1 million recorded during the twelve months ended December 31, 2013. The less than $1 million tax impact of the gain was included in accumulated other comprehensive income on the Company’s consolidated balance sheets.

⁽³⁾  This amount does not reflect the tax impact of $1 million recorded during the twelve months ended December 31, 2013. The $2 million after tax impact was included the consolidated statements of income.