FAIR VALUE MEASUREMENTS

The Company uses forward exchange contracts to manage its exposure to the variability of cash flows, primarily related to the foreign exchange rate changes of future intercompany product and third-party purchases of materials denominated in foreign currency. The Company also uses cross currency interest rate swaps to manage currency risk primarily related to borrowings. Both types of derivatives are designated as cash flow hedges. The Company also uses forward exchange contracts to manage its exposure to the variability of cash flows for repatriation of foreign dividends. These contracts are designated as net investment hedges. Additionally, the Company uses forward exchange contracts to offset its exposure to certain foreign currency assets and liabilities. These forward exchange contracts are not designated as hedges, and therefore, changes in the fair values of these derivatives are recognized in earnings, thereby offsetting the current earnings effect of the related foreign currency assets and liabilities. The Company does not enter into derivative financial instruments for trading or speculative purposes, or that contain credit risk related contingent features or requirements to post collateral. On an ongoing basis, the Company monitors counterparty credit ratings. The Company considers credit non-performance risk to be low, because the Company enters into agreements with commercial institutions that have at least an A (or equivalent) credit rating. As of September 29, 2013, the Company had notional amounts outstanding for forward foreign exchange contracts and cross currency interest rate swaps of $27.5 billion and $2.4 billion, respectively.

All derivative instruments are recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether the derivative is designated as part of a hedge transaction, and if so, the type of hedge transaction.

The designation as a cash flow hedge is made at the entrance date of the derivative contract. At inception, all derivatives are expected to be highly effective. Changes in the fair value of a derivative that is designated as a cash flow hedge and is highly effective are recorded in accumulated other comprehensive income until the underlying transaction affects earnings, and are then reclassified to earnings in the same account as the hedged transaction. Gains/losses on net investment hedges are accounted for through the currency translation account and are insignificant. On an ongoing basis, the Company assesses whether each derivative continues to be highly effective in offsetting changes in the cash flows of hedged items. If and when a derivative is no longer expected to be highly effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is included in current period earnings in Other (income) expense, net.

As of September 29, 2013, the balance of deferred net gains on derivatives included in accumulated other comprehensive income was $179 million after-tax. For additional information, see the Consolidated Statements of Comprehensive Income and Note 7. The Company expects that substantially all of the amounts related to foreign exchange contracts will be reclassified into earnings over the next 12 months as a result of transactions that are expected to occur over that period. The maximum length of time over which the Company is hedging transaction exposure is 18 months excluding interest rate swaps. The amount ultimately realized in earnings will differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity of the derivative.

The following table is a summary of the activity related to derivatives designated as hedges for the fiscal third quarters in 2013 and 2012:




	Gain/(Loss) Recognized in Accumulated OCI⁽¹⁾					Gain/(Loss) Reclassified from Accumulated OCI into Income⁽¹⁾				Gain/(Loss) Recognized in Other Income/Expense⁽²⁾
	Fiscal Third Quarters Ended
Cash Flow Hedges by Income Statement Caption	September 29, 2013			September 30, 2012		September 29, 2013		September 30, 2012		September 29, 2013	September 30, 2012
(Dollars in Millions)
Sales to customers⁽³⁾	$	25		30		17		(12	)	—	(1	)
Cost of products sold⁽³⁾	42			(61	)	51		(19	)	—	(1	)
Research and development expense⁽³⁾	(20		)	22		(14	)	43		—	—
Interest (income)/Interest expense, net⁽⁴⁾	7			28		(2	)	(2	)	—	—
Other (income)expense, net⁽³⁾	(13		)	(24	)	(8	)	19		—	1
Total	$	41		(5	)	44		29		—	(1	)

The following table is a summary of the activity related to derivatives designated as hedges for the fiscal nine months in 2013 and 2012:




	Gain/(Loss) Recognized in Accumulated OCI⁽¹⁾					Gain/(Loss) Reclassified from Accumulated OCI into Income⁽¹⁾				Gain/(Loss) Recognized in Other Income/Expense⁽²⁾
	Fiscal Nine Months Ended
Cash Flow Hedges by Income Statement Caption	September 29, 2013			September 30, 2012		September 29, 2013		September 30, 2012		September 29, 2013		September 30, 2012
(Dollars in Millions)
Sales to customers⁽³⁾	$	22		16		24		(42	)	—		(1	)
Cost of products sold⁽³⁾	220			(100	)	72		(53	)	4		(1	)
Research and development expense⁽³⁾	(27		)	33		(31	)	56		(3	)	—
Interest (income)/Interest expense, net⁽⁴⁾	15			(14	)	(6	)	(11	)	—		—
Other (income)expense, net⁽³⁾	(6		)	(25	)	(6	)	27		(1	)	—
Total	$	224		(90	)	53		(23	)	—		(2	)

All amounts shown in the tables above are net of tax.

(1) Effective portion

(2) Ineffective portion

(3) Foreign exchange contracts

(4) Cross currency interest rate swaps

For the fiscal third quarter ended September 29, 2013, no gain or loss was recognized and for the fiscal third quarter ended September 30, 2012, a gain of $35 million was recognized in Other (income)expense, net, relating to foreign exchange contracts not designated as hedging instruments.

For the fiscal nine months ended September 29, 2013 and September 30, 2012, a gain of $50 million and a gain of $9 million, respectively, were recognized in Other (income)expense, net, relating to foreign exchange contracts not designated as hedging instruments.

Fair value is the exit price that would be received to sell an asset or paid to transfer a liability. Fair value is a market-based measurement that is determined using assumptions that market participants would use in pricing an asset or liability. The authoritative literature establishes a three-level hierarchy to prioritize the inputs used in measuring fair value. The levels within the hierarchy are described below with Level 1 having the highest priority and Level 3 having the lowest.

The fair value of a derivative financial instrument (i.e., foreign exchange contract or cross currency interest rate swap) is the aggregation by currency of all future cash flows discounted to its present value at the prevailing market interest rates and subsequently converted to the U.S. dollar at the current spot foreign exchange rate. The Company does not believe that fair values of these derivative instruments materially differ from the amounts that could be realized upon settlement or maturity, or that the changes in fair value will have a material effect on the Company’s results of operations, cash flows or financial position. The Company also holds equity investments which are classified as Level 1 because they are traded in an active exchange market. The Company did not have any other significant financial assets or liabilities which would require revised valuations under this standard that are recognized at fair value.

The following three levels of inputs are used to measure fair value:

Level 1 — Quoted prices in active markets for identical assets and liabilities.

Level 2 — Significant other observable inputs.

Level 3 — Significant unobservable inputs.

The Company’s significant financial assets and liabilities measured at fair value as of September 29, 2013 and December 30, 2012 were as follows:



	September 29, 2013					December 30, 2012
(Dollars in Millions)	Level 1		Level 2	Level 3	Total	Total⁽²⁾
Derivatives designated as hedging instruments:
Assets:
Foreign exchange contracts	$	—	482	—	482	423
Cross currency interest rate swaps⁽³⁾	—		127	—	127	98
Total	—		609	—	609	521
Liabilities:
Foreign exchange contracts	—		181	—	181	252
Cross currency interest rate swaps⁽⁴⁾	—		10	—	10	10
Total	—		191	—	191	262
Derivatives not designated as hedging instruments:
Assets:
Foreign exchange contracts	—		37	—	37	75
Liabilities:
Foreign exchange contracts	—		15	—	15	23
Other Investments⁽¹⁾	$	405	—	—	405	1,247


(1)	Classified as non-current other assets. The change in the fair value from December 30, 2012 was primarily due to the sale of Elan American Depositary Shares.


(2)	As of December 30, 2012, these assets and liabilities are classified as Level 2 with the exception of Other Investments of $1,247 million which are classified as Level 1.


(3)	Includes $127 million and $96 million of non-current assets for September 29, 2013 and December 30, 2012, respectively.


(4)	Includes $5 million and $4 million of non-current liabilities for September 29, 2013 and December 30, 2012, respectively.

Financial Instruments not measured at Fair Value:

The following financial assets and liabilities are held at carrying amount on the consolidated balance sheet as of September 29, 2013:



(Dollars in Millions)	Carrying Amount		Estimated Fair Value
Financial Assets
Current Investments
Cash	$	2,701	2,701
Government securities and obligations	19,884		19,884
Corporate debt securities	611		611
Money market funds	1,399		1,399
Time deposits	633		633
Total cash, cash equivalents and current marketable securities	$	25,228	25,228

Fair value of government securities and obligations and corporate debt securities was estimated using quoted broker prices and significant other observable inputs.
Financial Liabilities

Current Debt	$	5,359	5,359
Non-Current Debt
2.15% Notes due 2016	898		932
5.55% Debentures due 2017	1,000		1,159
5.15% Debentures due 2018	898		1,041
4.75% Notes due 2019 (1B Euro 1.3503)	1,345		1,605
3% Zero Coupon Convertible Subordinated Debentures due in 2020	178		260
2.95% Debentures due 2020	542		564
3.55% Notes due 2021	446		470
6.73% Debentures due 2023	250		323
5.50% Notes due 2024 (500 GBP 1.6042)	797		965
6.95% Notes due 2029	296		404
4.95% Debentures due 2033	500		561
5.95% Notes due 2037	995		1,226
5.85% Debentures due 2038	700		832
4.50% Debentures due 2040	539		556
4.85% Notes due 2041	298		322
Other	66		66
Total Non-Current Debt	$	9,748	11,286

The weighted average effective interest rate on non-current debt is 5.12%.

Fair value of the non-current debt was estimated using market prices, which were corroborated by quoted broker prices and significant other observable inputs.