Risk Management and Derivatives

3 Months Ended

Aug. 31, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Risk Management and Derivatives

NOTE 9 — RISK MANAGEMENT AND DERIVATIVES

The Company is exposed to global market risks, including the effect of changes in foreign currency exchange rates and interest rates, and uses derivatives to manage financial exposures that occur in the normal course of business. As of and for the three months ended August 31, 2019, there have been no material changes to the Company's hedging program or strategy from what was disclosed within the Annual Report on Form 10-K. For additional information about the Company's derivatives and hedging policies refer to Note 1 — Summary of Significant Accounting Policies and Note 14 - Risk Management and Derivatives of the Annual Report on Form 10-K for the fiscal year ended May 31, 2019.

The majority of derivatives outstanding as of August 31, 2019 are designated as foreign currency cash flow hedges, primarily for Euro/U.S. Dollar, Japanese Yen/U.S. Dollar, British Pound/Euro and Chinese Yuan/U.S. Dollar currency pairs. All derivatives are recognized on the Unaudited Condensed Consolidated Balance Sheets at fair value and classified based on the instrument's maturity date.

The following table presents the fair values of derivative instruments included within the Unaudited Condensed Consolidated Balance Sheets as of August 31, 2019 and May 31, 2019:

	DERIVATIVE ASSETS					DERIVATIVE LIABILITIES
	BALANCE SHEET LOCATION	AUGUST 31,		MAY 31,		BALANCE SHEET LOCATION	AUGUST 31,		MAY 31,
(Dollars in millions)		2019		2019			2019		2019
Derivatives formally designated as hedging instruments:
Foreign exchange forwards and options	Prepaid expenses and other current assets	$	494	$	509	Accrued liabilities	$	16	$	5
Foreign exchange forwards and options	Deferred income taxes and other assets	29		—		Deferred income taxes and other liabilities	2		—
Total derivatives formally designated as hedging instruments		523		509			18		5
Derivatives not designated as hedging instruments:
Foreign exchange forwards and options	Prepaid expenses and other current assets	55		102		Accrued liabilities	37		46
Embedded derivatives	Prepaid expenses and other current assets	3		5		Accrued liabilities	1		1
Embedded derivatives	Deferred income taxes and other assets	—		6		Deferred income taxes and other liabilities	—		2
Total derivatives not designated as hedging instruments		58		113			38		49
TOTAL DERIVATIVES		$	581	$	622		$	56	$	54

The following table presents the amounts in the Unaudited Condensed Consolidated Statements of Income in which the effects of cash flow hedges are recorded and the effects of cash flow hedge activity on these line items for the three months ended August 31, 2019 and 2018:

	THREE MONTHS ENDED AUGUST 31,
	2019						2018
(Dollars in millions)	TOTAL			AMOUNT OF GAIN (LOSS) ON CASH FLOW HEDGE ACTIVITY			TOTAL		AMOUNT OF GAIN (LOSS) ON CASH FLOW HEDGE ACTIVITY
Revenues	$	10,660		$	8		$	9,948	$	5
Cost of sales	5,789			75			5,551		(44		)
Other (income) expense, net	(33		)	46			53		(9		)
Interest expense (income), net	15			(2		)	11		(2		)

The following tables present the amounts affecting the Unaudited Condensed Consolidated Statements of Income for the three months ended August 31, 2019 and 2018:

(Dollars in millions)	AMOUNT OF GAIN (LOSS) RECOGNIZED IN OTHER COMPREHENSIVE INCOME (LOSS) ON DERIVATIVES(1)				AMOUNT OF GAIN (LOSS) RECLASSIFIED FROM ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) INTO INCOME(1)
	THREE MONTHS ENDED AUGUST 31,				LOCATION OF GAIN (LOSS) RECLASSIFIED FROM ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) INTO INCOME	THREE MONTHS ENDED AUGUST 31,
	2019		2018			2019			2018
Derivatives designated as cash flow hedges:
Foreign exchange forwards and options	$	21	$	16	Revenues	$	8		$	5
Foreign exchange forwards and options	109		101		Cost of sales	75			(44		)
Foreign exchange forwards and options	33		26		Other (income) expense, net	46			(9		)
Interest rate swaps(2)	—		—		Interest expense (income), net	(2		)	(2		)
Total designated cash flow hedges	$	163	$	143		$	127		$	(50	)

(1) For the three months ended August 31, 2019 and 2018, the amounts recorded in Other (income) expense, net as a result of the discontinuance of cash flow hedges because the forecasted transactions were no longer probable of occurring were immaterial.

(2) Gains and losses associated with terminated interest rate swaps, which were previously designated as cash flow hedges and recorded in Accumulated other comprehensive income (loss), will be released through Interest expense (income), net over the term of the issued debt.

	AMOUNT OF GAIN (LOSS) RECOGNIZED  IN INCOME ON DERIVATIVES						LOCATION OF GAIN (LOSS)   RECOGNIZED IN INCOME   ON DERIVATIVES
	THREE MONTHS ENDED AUGUST 31,
(Dollars in millions)	2019			2018
Derivatives not designated as hedging instruments:
Foreign exchange forwards and options	$	—		$	114		Other (income) expense, net
Embedded derivatives	(1		)	(2		)	Other (income) expense, net

CASH FLOW HEDGES

All changes in fair value of derivatives designated as cash flow hedges are recorded in Accumulated other comprehensive income (loss) until Net income is affected by the variability of cash flows of the hedged transaction. Effective hedge results are classified in the Unaudited Condensed Consolidated Statements of Income in the same manner as the underlying exposure. Derivative instruments designated as cash flow hedges must be discontinued when it is no longer probable the forecasted hedged transaction will occur in the initially identified time period. The gains and losses associated with discontinued derivative instruments in Accumulated other comprehensive income (loss) will be recognized immediately in Other (income) expense, net, if it is probable the forecasted hedged transaction will not occur by the end of the initially identified time period or within an additional two-month period thereafter. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company accounts for the derivative as an undesignated instrument as discussed below.

The total notional amount of outstanding foreign currency derivatives designated as cash flow hedges was approximately $8.9 billion as of August 31, 2019. Approximately $557 million of deferred net gains (net of tax) on both outstanding and matured derivatives in Accumulated other comprehensive income (loss) as of August 31, 2019, are expected to be reclassified to Net income during the next 12 months concurrent with the underlying hedged transactions also being recorded in Net income. Actual amounts ultimately reclassified to Net income are dependent on the exchange rates in effect when derivative contracts currently outstanding mature. As of August 31, 2019, the maximum term over which the Company hedges exposures to the variability of cash flows for its forecasted transactions was 21 months.

UNDESIGNATED DERIVATIVE INSTRUMENTS

The Company may elect to enter into foreign exchange forwards to mitigate the change in fair value of specific assets and liabilities on the Unaudited Condensed Consolidated Balance Sheets and/or the embedded derivative contracts. These undesignated instruments are recorded at fair value as a derivative asset or liability on the Unaudited Condensed Consolidated Balance Sheets with their corresponding change in fair value recognized in Other (income) expense, net, together with the re-measurement gain or loss from the hedged balance sheet position and/or embedded derivative contract. The total notional amount of outstanding undesignated derivative instruments was $4.2 billion as of August 31, 2019.

EMBEDDED DERIVATIVES

Embedded derivative contracts are treated as foreign currency forward contracts that are bifurcated from the related contract and recorded at fair value as a derivative asset or liability on the Unaudited Condensed Consolidated Balance Sheets with their corresponding change in fair value recognized in Other (income) expense, net, through the date the foreign currency fluctuations cease to exist.

At August 31, 2019, the total notional amount of embedded derivatives outstanding was approximately $370 million.

CREDIT RISK

As of August 31, 2019, the Company was in compliance with all credit risk-related contingent features, and derivative instruments with such features in a net liability position were immaterial. Accordingly, the Company was not required to post any collateral as a result of these contingent features. Further, as of August 31, 2019, the Company had $263 million of cash collateral received from various counterparties to its derivative contracts. The Company considers the impact of the risk of counterparty default to be immaterial.

For additional information related to the Company's derivative financial instruments and collateral, refer to Note 4 - Fair Value Measurements.