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Fair Value Measurements
12 Months Ended
Jan. 01, 2017
Fair Value Disclosures [Abstract]  
Fair Value Measurements
Fair Value Measurements
The Company uses forward foreign exchange contracts to manage its exposure to the variability of cash flows, primarily related to the foreign exchange rate changes of future intercompany products and third-party purchases of materials denominated in a foreign currency. The Company uses cross currency interest rate swaps to manage currency risk primarily related to borrowings. The Company also uses equity collar contracts to manage exposure to market risk associated with certain equity investments. All three types of derivatives are designated as cash flow hedges.
Additionally, the Company uses interest rate swaps as an instrument to manage interest rate risk related to fixed rate borrowings. These derivatives are treated as fair value hedges. The Company uses forward foreign exchange contracts designated as net investment hedges. Additionally, the Company uses forward foreign exchange contracts to offset its exposure to certain foreign currency assets and liabilities. These forward foreign 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 (excluding equity collar contract) by either the Company or the counter-party. For equity collar contracts, the Company pledged the underlying hedged marketable equity securities to the counter-party as collateral. On an ongoing basis, the Company monitors counterparty credit ratings. The Company considers credit non-performance risk to be low, because the Company primarily enters into agreements with commercial institutions that have at least an investment grade credit rating. Refer to the table on significant financial assets and liabilities measured at fair value contained in this footnote for receivables and payables with these commercial institutions. As of January 1, 2017, the Company had notional amounts outstanding for forward foreign exchange contracts, cross currency interest rate swaps, interest rate swaps and equity collar contracts of $36.0 billion, $2.3 billion, $1.8 billion and $0.3 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 and losses associated with interest rate swaps and changes in fair value of hedged debt attributable to changes in interest rates are recorded to interest expense in the period in which they occur. Gains and losses on net investment hedges are accounted for through the currency translation account. On an ongoing basis, the Company assesses whether each derivative continues to be highly effective in offsetting changes 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 for forward foreign exchange contracts, cross currency interest rate swaps, net investment hedges and equity collar contracts. For interest rate swaps designated as fair value hedges, hedge ineffectiveness, if any, is included in current period earnings within interest expense. For the current reporting period, hedge ineffectiveness associated with interest rate swaps was not material.
During the fiscal second quarter of 2016, the Company designated its Euro denominated notes issued in May 2016 with due dates ranging from 2022 to 2035 as a net investment hedge of the Company's investments in certain of its international subsidiaries that use the Euro as their functional currency in order to reduce the volatility caused by changes in exchange rates.
During 2016, the change in the carrying value due to remeasurement of these Euro notes resulted in a $375 million pretax gain reflected in foreign currency translation adjustment, within the Consolidated Statements of Comprehensive Income.
As of January 1, 2017, the balance of deferred net losses on derivatives included in accumulated other comprehensive income was $285 million after-tax. For additional information, see the Consolidated Statements of Comprehensive Income and Note 13. The Company expects that substantially all of the amounts related to forward 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 contracts, net investment hedges and equity collar contracts. The amount ultimately realized in earnings may 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 cash flow hedges for the fiscal years ended January 1, 2017 and January 3, 2016:

(Dollars in Millions)
 
Gain/(Loss)
Recognized In Accumulated OCI
(1)
 
Gain/(Loss) Reclassified From
Accumulated OCI Into Income
(1)
 
Gain/(Loss) Recognized In
Other Income/Expense
(2)
Cash Flow Hedges by Income Statement Caption
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Sales to customers (3)
 
$
(65
)
 
(83
)
 
(47
)
 
(126
)
 
(1
)
 
(5
)
Cost of products sold (3)
 
(212
)
 
(22
)
 
(3
)
 
122

 
(15
)
 
14

Research and development expense (3)
 
(76
)
 
(3
)
 
(90
)
 
6

 

 
1

Interest (income)/Interest expense, net (4)
 
66

 
(40
)
 
37

 

 

 

Other (income) expense, net (3) (5)
 
(72
)
 
33

 
(7
)
 
60

 
2

 
1

Total
 
$
(359
)
 
(115
)
 
(110
)
 
62

 
(14
)
 
11

All amounts shown in the table above are net of tax.
(1) 
Effective portion
(2) 
Ineffective portion
(3) 
Forward foreign exchange contracts
(4) 
Cross currency interest rate swaps  
(5) 
Includes equity collar contracts

For the fiscal years ended January 1, 2017 and January 3, 2016, a loss of $56 million and a loss of $34 million, respectively, was recognized in Other (income) expense, net, relating to forward 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 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. forward foreign exchange contracts, interest rate contracts) 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 and debt securities which are classified as Level 2. 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 January 1, 2017 and January 3, 2016 were as follows:
 
 
2016
 
2015
(Dollars in Millions)
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Total (1)
Derivatives designated as hedging instruments:
 
 

 
 

 
 

 
 

 
 

Assets:
 
 

 
 

 
 

 
 

 
 

Forward foreign exchange contracts (7)
 
$

 
747

 

 
747

 
452

Interest rate contracts (2)(4)(7)
 

 
31

 

 
31

 
28

Total
 

 
778

 

 
778

 
480

Liabilities:
 
 

 
 

 
 

 
 

 
 

Forward foreign exchange contracts (8)
 

 
723

 

 
723

 
358

Interest rate contracts (3)(4)(8)
 

 
382

 

 
382

 
241

Equity collar contracts(8)
 

 
57

 

 
57

 

Total
 

 
1,162

 

 
1,162

 
599

Derivatives not designated as hedging instruments:
 
 

 
 

 
 

 
 

 
 

Assets:
 
 

 
 

 
 

 
 

 
 

Forward foreign exchange contracts (7)
 

 
34

 

 
34

 
33

Liabilities:
 
 

 
 

 
 

 
 

 
 

Forward foreign exchange contracts (8)
 

 
57

 

 
57

 
41

Available For Sale Other Investments:
 
 
 
 
 
 
 
 
 
 
Equity investments(5)
 
1,209

 

 

 
1,209

 
1,494

Debt securities(6)
 
$

 
12,087

 

 
12,087

 
8,316



(1) 
2015 assets and liabilities are all classified as Level 2 with the exception of equity investments of $1,494 million, which are classified as Level 1.
(2) 
Includes $23 million and $20 million of non-current assets for the fiscal years ending January 1, 2017 and January 3, 2016, respectively.
(3) 
Includes $382 million and $239 million of non-current liabilities for the fiscal years ending January 1, 2017 and January 3, 2016, respectively.
(4) 
Includes cross currency interest rate swaps and interest rate swaps.
(5) 
Classified as non-current other assets with the exception of $332 million of current assets for January 1, 2017. The carrying amount of the equity investments were $520 million and $528 million as of January 1, 2017 and January 3, 2016, respectively. The unrealized gains were $757 million and $979 million as of January 1, 2017 and January 3, 2016, respectively. The unrealized losses were $68 million and $13 million as of January 1, 2017 and January 3, 2016, respectively.
(6) 
Classified as current marketable securities.
(7) 
Classified as other current assets.
(8) 
Classified as accounts payable.

See Notes 2 and 7 for financial assets and liabilities held at carrying amount on the Consolidated Balance Sheet.