Note 10 Financial Instruments and Fair Value Measures

Risk Management Policy

The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. The company's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative instruments to reduce its exposure to foreign currency exchange rates. The company is also exposed to the risk that its earnings and cash flows could be adversely impacted by fluctuations in interest rates. The company periodically enters into interest rate swaps, based on judgment, to manage interest costs in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required.

Financial Instruments

Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $1.5 billion and $1.4 billion at December 31, 2015 and December 31, 2014, respectively, are designated as cash flow hedges and are recorded at fair value. Resulting gains or losses are reflected in OCI. Accumulated gains and losses as of December 31, 2015 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding twelve months.

The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of earnings and are generally offset by losses or gains on the foreign currency exposure being managed. At December 31, 2015 and December 31, 2014, AbbVie held notional amounts of $6.8 billion and $6.8 billion, respectively, of such undesignated foreign currency forward exchange contracts.

In 2014, the company entered into undesignated forward exchange contracts with a total notional amount of $16.9 billion to hedge anticipated foreign currency cash outflows associated with the terminated proposed combination with Shire. A large portion of these contracts were originally due to mature in the first quarter of 2015 but were net settled in the fourth quarter of 2014. In 2014, the company realized $490 million in net foreign exchange losses associated with the Shire-related forward exchange contracts.

AbbVie is a party to interest rate hedge contracts, designated as fair value hedges, totaling $11.0 billion and $8.0 billion at December 31, 2015 and December 31, 2014, respectively. The effect of the hedge is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie recorded the contracts at fair value and adjusted the carrying amount of the fixed-rate debt by an offsetting amount.

The following table summarizes the amounts and location of AbbVie's derivative instruments in the consolidated balance sheets:

	Fair value—Derivatives in asset position					Fair value—Derivatives in liability position
as of December 31 (in millions)	2015		2014		Balance sheet caption	2015		2014		Balance sheet caption

Foreign currency forward exchange contracts—
Hedging instruments	$	33	$	141	Prepaid expenses and other	$	—	$	—	Accounts payable and accrued liabilities
Others not designated as hedges		28		70	Prepaid expenses and other		21		63	Accounts payable and accrued liabilities
Interest rate swaps designated as fair value hedges		9		—	Prepaid expenses and other		81		180	Other long-term liabilities

Total derivatives	$	70	$	211		$	102	$	243

While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets.

The unrealized gains/(losses) for the effective portions of the derivative instruments designated as cash flow hedges recognized in OCI were $122 million, $193 million and ($77) million for 2015, 2014, and 2013, respectively. The amount of hedge ineffectiveness was not significant for any of the years presented.

The following table summarizes the pre-tax amounts and location in the consolidated statements of earnings of net gains/(losses) recognized in the consolidated statements of earnings for derivative instruments, including the effective portions of the net gains/(losses) reclassified out of AOCI into net earnings for 2015, 2014, and 2013, respectively. See Note 12 for the amount of net gains/(losses) reclassified out of AOCI.

years ended December 31 (in millions)	2015			2014			2013			Statement of earnings caption

Foreign currency forward exchange contracts—
Designated as cash flow hedges	$	265		$	(79	)	$	—		Cost of products sold
Not designated as hedges		(155	)		(523	)		81		Net foreign exchange loss
Interest rate swaps designated as fair value hedges		108			252			(351	)	Interest expense, net

Total	$	218		$	(350	)	$	(270	)

The gain/(loss) related to fair value hedges is recognized in interest expense, net in the consolidated statements of earnings and directly offsets the (loss)/gain on the underlying hedged item, the fixed-rate debt, resulting in no net impact to interest expense, net for all periods presented.

Fair Value Measures

The fair value hierarchy under the accounting standard for fair value measurements consists of the following three levels:


	•	Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access;
	•	Level 2—Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuations in which all significant inputs are observable in the market; and
	•	Level 3—Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability.

The following table summarizes the bases used to measure certain assets and liabilities that are carried at fair value on a recurring basis in the consolidated balance sheet as of December 31, 2015:

			Basis of fair value measurement
(in millions)	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable Inputs (Level 3)

Assets
Cash and equivalents	$	8,399	$	798	$	7,601	$	—
Time deposits		8		—		8		—
Equity securities		111		111		—		—
Interest rate hedges		9		—		9		—
Foreign currency contracts		61		—		61		—

Total assets	$	8,588	$	909	$	7,679	$	—


Liabilities
Interest rate hedges	$	81	$	—	$	81	$	—
Foreign currency contracts		21		—		21		—

Total liabilities	$	102	$	—	$	102	$	—

The following table summarizes the bases used to measure certain assets and liabilities that are carried at fair value on a recurring basis in the consolidated balance sheet as of December 31, 2014:

			Basis of fair value measurement
(in millions)	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable Inputs (Level 3)

Assets
Cash and equivalents	$	8,348	$	1,214	$	7,134	$	—
Time deposits		9		—		9		—
Equity securities		13		13		—		—
Foreign currency contracts		211		—		211		—

Total assets	$	8,581	$	1,227	$	7,354	$	—


Liabilities
Interest rate hedges	$	180	$	—	$	180	$	—
Foreign currency contracts		63		—		63		—

Total liabilities	$	243	$	—	$	243	$	—

The fair values for time deposits included in cash and equivalents and short-term investments are determined based on a discounted cash flow analysis reflecting quoted market rates for the same or similar instruments. The fair values of time deposits approximate their amortized cost due to the short maturities of these instruments. Available-for-sale equity securities consists of investments for which the fair values are determined by using the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The derivatives entered into by the company are valued using publicized spot curves for interest rate hedges and publicized forward curves for foreign currency contracts.

Cumulative net unrealized holding gains on available-for-sale equity securities totaled $47 million and $3 million at December 31, 2015 and December 31, 2014, respectively.

There have been no transfers of assets or liabilities between the fair value measurement levels.

In addition to the financial instruments that the company is required to recognize at fair value on the consolidated balance sheets, the company has certain financial instruments that are recognized at historical cost or some basis other than fair value. The carrying values and fair values of certain financial instruments are summarized in the table below:

	Book values				Approximate fair values
as of December 31 (in millions)	2015		2014		2015		2014

Assets
Investments	$	34	$	95	$	37	$	145
Liabilities
Short-term borrowings	$	406	$	425	$	406	$	425
Current portion of long-term debt and lease obligations	$	2,025	$	4,014	$	2,016	$	4,026
Long-term debt and lease obligations, excluding fair value hedges	$	29,312	$	10,718	$	29,143	$	10,803

The following table summarizes the bases used to measure the approximate fair values of the financial instruments as of December 31, 2015:

			Basis of fair value measurement
(in millions)	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable Inputs (Level 3)

Assets
Investments	$	37	$	—	$	—	$	37

Total assets	$	37	$	—	$	—	$	37


Liabilities
Short-term borrowings	$	406	$	—	$	406	$	—
Current portion of long-term debt and lease obligations		2,016		—		2,016		—
Long-term debt and lease obligations, excluding fair value hedges		29,143		27,061		2,082		—

Total liabilities	$	31,565	$	27,061	$	4,504	$	—

The following table summarizes the bases used to measure the approximate fair values of the financial instruments as of December 31, 2014:

			Basis of fair value measurement
(in millions)	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable Inputs (Level 3)

Assets
Investments	$	145	$	68	$	13	$	64

Total assets	$	145	$	68	$	13	$	64


Liabilities
Short-term borrowings	$	425	$	—	$	425	$	—
Current portion of long-term debt and lease obligations		4,026		4,005		21		—
Long-term debt and lease obligations, excluding fair value hedges		10,803		10,710		93		—

Total liabilities	$	15,254	$	14,715	$	539	$	—

Investments consist of cost method investments and held-to-maturity debt securities. To determine the fair values of other cost method investments, the company takes into consideration recent transactions, as well as the financial information of the investee, which represents a Level 3 basis of fair value measurement. The fair value of held-to-maturity debt securities was estimated based upon the quoted market prices for the same or similar debt instruments. The fair values of short-term and current borrowings approximate the carrying values due to the short maturities of these instruments.

The fair values of long-term debt, excluding fair value hedges and the term loans, were determined by using the published market price for the debt instruments, without consideration of transaction costs, which represents a Level 1 basis of fair value measurement. The fair values of the term loans were determined based on a discounted cash flow analysis using quoted market rates, which represents a Level 2 basis of fair value measurement. The counterparties to financial instruments consist of select major international financial institutions.

Concentrations of Risk

The company invests excess cash in time deposits and money market funds and diversifies the concentration of cash among different financial institutions. The company monitors concentrations of credit risk associated with deposits with financial institutions. Credit exposure limits have been established to limit a concentration with any single issuer or institution.

The functional currency of the company's Venezuela operations is the U.S. dollar due to the hyperinflationary status of the Venezuelan economy. Currency restrictions enacted in Venezuela require approval from the Venezuelan government to exchange Venezuelan bolivars (VEF) for U.S. dollars and require such exchange to be made at the official exchange rate established by the government. In the first quarter of 2014, the Venezuelan government expanded the number of exchange mechanisms to three rates of exchange. As of December 31, 2015, these were the official rate of 6.3; the Supplementary System for the Administration of Foreign Currency (SICAD) rate of approximately 13.5; and the Foreign Exchange Marginal System (SIMADI) rate of approximately 200. In the consolidated financial statements as of and for the year ended December 31, 2015, the company used the official rate of 6.3 VEF per U.S. dollar, and reported $317 million of net monetary assets and $210 million of net revenues denominated in the Venezuelan bolivar.

On February 17, 2016, the Venezuelan government announced that it plans to devalue the official rate of 6.3 to 10 VEF to U.S. dollars, and eliminate the SICAD rate of 13.5 VEF to U.S. dollars. The devaluation of the Venezuelan bolivar will result in a charge to AbbVie's results of operations in the first quarter of 2016. If AbbVie's net monetary assets denominated in the Venezuelan bolivar had been converted at a rate of 10 VEF to U.S. dollars at December 31, 2015, the company would have reported a devaluation loss of $117 million in 2015. If AbbVie's net monetary assets denominated in the Venezuelan bolivar had been converted at the SIMADI rate of 200 at December 31, 2015, the company would have reported a devaluation loss of $307 million in 2015.

The company cannot predict whether there will be further devaluations of the Venezuelan currency or whether the use of the official rate will continue to be supported by evolving facts and circumstances, which could result in a significant charge to AbbVie's results of operations at that time.

The company also continues to do business with foreign governments in certain oil-exporting countries, including Venezuela and Saudi Arabia, which have experienced a deterioration in economic conditions. Due to the decline in the price of oil, liquidity issues in certain countries may result in delays in the collection of receivables.

Three U.S. wholesalers accounted for 51 percent and 49 percent of total net accounts receivable as of December 31, 2015 and December 31, 2014, respectively, and substantially all of AbbVie's net revenues in the United States are to these three wholesalers. In addition, net governmental receivables outstanding in Greece, Portugal, Italy and Spain totaled $525 million at December 31, 2015 and $446 million at December 31, 2014.

HUMIRA (adalimumab) is AbbVie's single largest product and accounted for approximately 61 percent, 63 percent, and 57 percent of AbbVie's total net revenues in 2015, 2014, and 2013, respectively.