Inventories, Derivative Instruments & Hedging Activities

12 Months Ended

Jun. 30, 2011

Inventories, Derivative Instruments & Hedging Activities

Inventories, Derivative Instruments & Hedging Activities

Note 4. Inventories, Derivative Instruments & Hedging Activities

The Company values certain inventories using the lower of cost, determined by either the LIFO or FIFO method, or market.  Inventories of certain merchandisable agricultural commodities, which include inventories acquired under deferred pricing contracts, are stated at market value.

	2011			2010
	(In millions)
LIFO inventories
FIFO value	$	1,143		$	646
LIFO valuation reserve	(593		)	(225		)
LIFO inventories carrying value	550			421
FIFO inventories	5,590			3,218
Market inventories	5,915			4,232
	$	12,055		$	7,871

The Company recognizes all of its derivative instruments as either assets or liabilities at fair value in its consolidated balance sheet.  The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship.  The majority of the Company’s derivatives have not been designated as hedging instruments.  For those derivative instruments that are designated and qualify as hedging instruments, a reporting entity must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, a cash flow hedge, or a hedge of a net investment in a foreign operation.  As of June 30, 2011 and 2010, the Company has certain derivatives designated as cash flow hedges.  Within the Note 4 tables, zeros represent minimal amounts.

Derivatives Not Designated as Hedging Instruments

The Company generally follows a policy of using exchange-traded futures and exchange-traded and OTC options contracts to manage its net position of merchandisable agricultural commodity inventories and forward cash purchase and sales contracts to reduce price risk caused by market fluctuations in agricultural commodities and foreign currencies.  The Company also uses exchange-traded futures and exchange-traded and OTC options contracts as components of merchandising strategies designed to enhance margins.  The results of these strategies can be significantly impacted by factors such as the volatility of the relationship between the value of exchange-traded commodities futures contracts and the cash prices of the underlying commodities, counterparty contract defaults, and volatility of freight markets.  Exchange-traded futures and exchange-traded and OTC options contracts, and forward cash purchase and sales contracts of certain merchandisable agricultural commodities accounted for as derivatives by the Company are stated at fair value.  Inventories of certain merchandisable agricultural commodities, which include amounts acquired under deferred pricing contracts, are stated at market value.  Inventory is not a derivative and therefore is not included in the tables below.  Changes in the market value of inventories of certain merchandisable agricultural commodities, forward cash purchase and sales contracts, exchange-traded futures and exchange-traded and OTC options contracts are recognized in earnings immediately.  Unrealized gains and unrealized losses on forward cash purchase contracts, forward foreign currency exchange (FX) contracts, forward cash sales contracts, and exchange-traded and OTC options contracts represent the fair value of such instruments and are classified on the Company’s consolidated balance sheets as receivables and accrued expenses, respectively.

At March 31, 2010, the Company de-designated and discontinued hedge accounting treatment for certain interest rate swaps.  At the date of de-designation of these hedges, $21 million of after-tax gains was deferred in accumulated other comprehensive income (AOCI).  These gains remain in AOCI and are being amortized over 30 years.  The Company recognized in earnings $30 million of pre-tax gains and $59 million in pre-tax losses from these interest rate swaps for the year ended June 30, 2011 and 2010, respectively.

The following table sets forth the fair value of derivatives not designated as hedging instruments as of June 30, 2011 and 2010.

	2011				2010
	Assets		Liabilities		Assets		Liabilities
	(In millions)				(In millions)
FX Contracts	$	237	$	178	$	200	$	266
Interest Contracts	3		–		–		26
Commodity Contracts	2,766		2,553		2,727		3,152
Total	$	3,006	$	2,731	$	2,927	$	3,444

The following table sets forth the pre-tax gains (losses) on derivatives not designated as hedging instruments that have been included in the consolidated statements of earnings for the years ended June 30, 2011 and 2010.

	Years ended June 30
	2011			2010
	(In millions)
Interest Contracts
Interest expense	$	0		$	0
Other income (expense) - net	30			(57		)
FX Contracts
Net sales and other operating income	$	(14	)	$	0
Cost of products sold	150			61
Other income (expense) - net	43			(42		)
Commodity Contracts
Cost of products sold	$	(1,303	)	$	242
Total gain (loss) recognized in earnings	$	(1,094	)	$	204

Inventories of certain merchandisable agricultural commodities, which include amounts acquired under deferred pricing contracts, are stated at market value.  Inventory is not a derivative and therefore is not included in the table above.  Changes in the market value of inventories of certain merchandisable agricultural commodities, forward cash purchase and sales contracts, exchange-traded futures and exchange-traded and OTC options contracts are recognized in earnings immediately.

Derivatives Designated as Cash Flow Hedging Strategies

For derivative instruments that are designated and qualify as cash flow hedges (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of AOCI and reclassified into earnings in the same line item affected by the hedged transaction and in the same period or periods during which the hedged transaction affects earnings.  The remaining gain or loss on the derivative instrument that is in excess of the cumulative change in the cash flows of the hedged item, if any (i.e., the ineffective portion), hedge components excluded from the assessment of effectiveness, and gains and losses related to discontinued hedges are recognized in the consolidated statement of earnings during the current period.

For each of the commodity hedge programs described below, the derivatives are designated as cash flow hedges.  The changes in the market value of such derivative contracts have historically been, and are expected to continue to be, highly effective at offsetting changes in price movements of the hedged item.  Once the hedged item is recognized in earnings, the gains/losses arising from the hedge are reclassified from AOCI to either net sales and other operating income, cost of products sold, interest expense or other (income) expense – net, as applicable.  As of June 30, 2011, the Company has $1 million of after-tax gains in AOCI related to gains and losses from commodity cash flow hedge transactions.  The Company expects to recognize the $1 million of gains in its consolidated statement of earnings during the next 12 months.

The Company, from time to time, uses futures or options contracts to fix the purchase price of anticipated volumes of corn to be purchased and processed in a future month.  The objective of this hedging program is to reduce the variability of cash flows associated with the Company’s forecasted purchases of corn.  The Company’s corn processing plants currently grind approximately 75 million bushels of corn per month.  During the past 12 months, the Company hedged between 1% and 100% of its monthly anticipated grind.  At June 30, 2011, the Company has designated hedges representing 1% of its anticipated monthly grind of corn for the next 6 months.

The Company, from time to time, also uses futures, options, and swaps to fix the purchase price of the Company’s anticipated natural gas requirements for certain production facilities.  The objective of this hedging program is to reduce the variability of cash flows associated with the Company’s forecasted purchases of natural gas.  These production facilities use approximately 3.8 million MMbtus of natural gas per month.  During the past 12 months, the Company hedged between 48% and 58% of the quantity of its anticipated monthly natural gas purchases.  At June 30, 2011, the Company has designated hedges representing between 13% to 37% of its anticipated monthly natural gas purchases for the next 12 months.

The Company, from time to time, also uses futures, options, and swaps to fix the sales price of certain ethanol sales contracts.  The objective of this hedging program is to reduce the variability of cash flows associated with the Company’s sales of ethanol under sales contracts that are indexed to unleaded gasoline prices.  During the past 12 months, the Company hedged between 7 million to 17 million gallons of ethanol per month under this program.  At June 30, 2011, the Company has designated hedges representing between 1 million to 14 million gallons of contracted ethanol sales per month over the next 9 months.

To protect against fluctuations in cash flows due to foreign currency exchange rates, the Company from time to time will use forward foreign exchange contracts as cash flow hedges.  Certain production facilities have manufacturing expenses and equipment purchases denominated in non-functional currencies.  To reduce the risk of fluctuations in cash flows due to changes in the exchange rate between functional versus non-functional currencies, the Company will hedge some portion of the forecasted foreign currency expenditures.  At June 30, 2011, the Company has $2 million of after-tax gains in AOCI related to foreign exchange contracts designated as cash flow hedging instruments.  The Company will recognize the $2 million of gains in its consolidated statement of earnings over the life of the hedged transactions.

The Company, from time to time, uses treasury lock agreements and interest rate swaps in order to lock in the Company’s interest rate prior to the issuance or remarketing of its long-term debt.  Both the treasury-lock agreements and interest rate swaps were designated as cash flow hedges of the risk of changes in the future interest payments attributable to changes in the benchmark interest rate.  The objective of the treasury-lock agreements and interest rate swaps was to protect the Company from changes in the benchmark rate from the date of hedge designation to the date when the debt was actually issued.  At June 30, 2011, AOCI included $22 million of after-tax gains related to treasury-lock agreements and interest rate swaps, of which, $21 million relates to the interest rate swaps that were de-designated at March 31, 2010 as discussed earlier in Note 4.  The Company will recognize the $22 million of gains in its consolidated statement of earnings over the terms of the hedged items which range from 10 to 30 years.

The following tables set forth the fair value of derivatives designated as hedging instruments as of June 30, 2011 and 2010.

	2011				2010
	Assets		Liabilities		Assets		Liabilities
	(In millions)				(In millions)
Interest Contracts	$	–	$	–	$	0	$	0
Commodity Contracts	1		1		2		2
Total	$	1	$	1	$	2	$	2

The following table sets forth the pre-tax gains (losses) on derivatives designated as hedging instruments that have been included in the consolidated statement of earnings for the years ended June 30, 2011 and 2010.

	Consolidated Statement of	Years ended June 30
	Earnings Locations	2011			2010
		(In millions)
Effective amounts recognized in earnings
FX Contracts	Other income/expense – net	$	0		$	(1	)
Interest contracts	Interest expense	0			0
Commodity Contracts	Cost of products sold	375			(85		)
	Net sales and other operating income	(13		)	0
Ineffective amount recognized in earnings
Interest contracts	Interest expense	1			–
Commodity contracts	Cost of products sold	46			(55		)
Total amount recognized in earnings		$	409		$	(141	)