2. Basis of presentation and significant accounting policies and practices

Basis of presentation

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) and on the same basis as the audited financial statements included in our annual report on Form 10-K for the year ended December 31, 2016. The Consolidated Statements of Income, Comprehensive Income and Cash Flows for the periods ended September 30, 2017, and September 30, 2016, and the Consolidated Balance Sheet as of September 30, 2017, are not audited but reflect all adjustments that are of a normal recurring nature and are necessary for a fair statement of the results of the periods shown. Certain information and note disclosures normally included in annual consolidated financial statements have been omitted pursuant to the rules and regulations of the U.S. Securities and Exchange Commission. Because the consolidated interim financial statements do not include all of the information and notes required by GAAP for a complete set of financial statements, they should be read in conjunction with the audited consolidated financial statements and notes included in our annual report on Form 10-K for the year ended December 31, 2016. The results for the three- and nine-month periods are not necessarily indicative of a full year’s results.

The consolidated financial statements include the accounts of all subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. All dollar amounts in the financial statements and tables in these notes, except per-share amounts, are stated in millions of U.S. dollars unless otherwise indicated. We have reclassified certain amounts in the prior periods’ financial statements to conform to the current presentation, retrospectively applying the new accounting standard related to pension and other retiree benefit costs. See Changes in accounting standards – adopted standards for current period for further information.

Significant accounting policies and practices

Earnings per share (EPS)

Unvested share-based payment awards that contain non-forfeitable rights to receive dividends or dividend equivalents, such as our restricted stock units (RSUs), are considered to be participating securities and the two-class method is used for purposes of calculating EPS. Under the two-class method, a portion of Net income is allocated to these participating securities and, therefore, is excluded from the calculation of EPS allocated to common stock, as shown in the table below.

Computation and reconciliation of earnings per common share are as follows (shares in millions):

	For Three Months Ended September 30,
	2017							2016
	Net							Net
	Income			Shares		EPS		Income			Shares		EPS
Basic EPS:
Net income	$	1,285						$	1,018
Income allocated to RSUs		(11	)						(12	)
Income allocated to common stock
for basic EPS calculation	$	1,274			988	$	1.29	$	1,006			1,003	$	1.00

Adjustment for dilutive shares:
Stock compensation plans					20							20

Diluted EPS:
Net income	$	1,285						$	1,018
Income allocated to RSUs		(11	)						(11	)
Income allocated to common stock
for diluted EPS calculation	$	1,274			1,008	$	1.26	$	1,007			1,023	$	.98

	For Nine Months Ended September 30,
	2017							2016
	Net							Net
	Income			Shares		EPS		Income			Shares		EPS
Basic EPS:
Net income	$	3,338						$	2,548
Income allocated to RSUs		(32	)						(31	)
Income allocated to common stock
for basic EPS calculation	$	3,306			993	$	3.33	$	2,517			1,004	$	2.51

Adjustment for dilutive shares:
Stock compensation plans					21							18

Diluted EPS:
Net income	$	3,338						$	2,548
Income allocated to RSUs		(31	)						(31	)
Income allocated to common stock
for diluted EPS calculation	$	3,307			1,014	$	3.26	$	2,517			1,022	$	2.46

Potentially dilutive securities representing 5 million shares of common stock that were outstanding during the third quarter of 2017, and 6 million and 15 million shares outstanding during the first nine months of 2017 and 2016, respectively, were excluded from the computation of diluted earnings per common share for these periods because their effect would have been anti-dilutive. There were no potentially dilutive securities excluded from the computation of diluted earnings per common share during the third quarter of 2016.

Derivatives and hedging

We use derivative financial instruments to manage exposure to foreign currency exchange risk. These instruments are primarily forward foreign currency exchange contracts, which are used as economic hedges to reduce the earnings impact that exchange rate fluctuations may have on our non-U.S. dollar net balance sheet exposures. Gains and losses from changes in the fair value of these forward foreign currency exchange contracts are credited or charged to OI&E. We do not apply hedge accounting to our foreign currency derivative instruments.

In connection with the issuance of long-term debt, we use financial derivatives such as treasury rate lock agreements that are recognized in AOCI and amortized over the life of the related debt. The results of these derivative transactions have not been material.

We do not use derivatives for speculative or trading purposes.

Fair values of financial instruments

The fair values of our derivative financial instruments were not material as of September 30, 2017. Our investments in cash equivalents, short-term investments and certain long-term investments, as well as our deferred compensation liabilities, are carried at fair value. The carrying values for other current financial assets and liabilities, such as accounts receivable and accounts payable, approximate fair value due to the short maturity of such instruments. The carrying value of our long-term debt approximates the fair value as measured using broker-dealer quotes, which are Level 2 inputs. See Note 5 for a description of fair value and the definition of Level 2 inputs.

Changes in accounting standards – adopted standards for current period

Accounting Standards Update (ASU) No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory

This standard requires current and deferred income taxes resulting from the intra-entity transfer of any assets other than inventory to be recognized for financial reporting purposes when the transfer occurs rather than postpone recognition until the asset has been sold to an outside party, as currently allowed. This standard is required to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings and is effective for our interim and annual periods beginning January 1, 2018. As early adoption is permitted, we elected to early adopt this standard in the first quarter of 2017. The effect on our financial position and results of operations was not material.

ASU No. 2017-07, Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost

This standard amends the income statement presentation of the components of net periodic benefit cost for defined benefit pension and other postretirement plans. This standard requires us to: (1) disaggregate the current service cost component from the other components of net periodic benefit cost (the “other components”) and present it in the same line items on the statement of income as other current compensation costs for related employees and (2) present the other components outside of operating profit (i.e., in OI&E). This standard is required to be applied retrospectively and is effective for annual and interim periods beginning after December 15, 2017. As early adoption is permitted, we elected to adopt this standard as of the beginning of the first quarter of 2017. While the adoption of this standard did not impact Revenue, Net income, Earnings per common share or Cash flows from operating activities, the following components on the Consolidated Statements of Income for the three and nine months ended September 30, 2016, were affected:

	For Three Months Ended September 30, 2016					For Nine Months Ended September 30, 2016
	Reported		Recast			Reported		Recast
COR	$	1,395	$	1,391		$	3,849	$	3,836
Gross profit		2,280		2,284			6,107		6,120
R&D		356		353			1,027		1,016
SG&A		448		442			1,356		1,337
Operating profit:
Analog		949		957			2,399		2,426
Embedded Processing		220		224			591		603
Other		226		227			490		494
Total operating profit		1,395		1,408			3,480		3,523
OI&E		4		(9	)		14		(29	)

Changes in accounting standards – standards not yet adopted

ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606)

This standard provides a single set of guidelines for revenue recognition to be used across all industries and requires additional disclosures, which we are currently evaluating. It is effective for annual and interim reporting periods beginning after December 15, 2017. This standard permits early adoption and the use of either the retrospective or cumulative-effect transition method.

We currently anticipate adopting this standard using the cumulative-effect (i.e., modified retrospective) transition method, which would result in an adjustment to retained earnings for the cumulative effect of applying this guidance to contracts in process as of January 1, 2018. Under this approach, we would not restate the prior financial statements presented. The final adoption method will depend on the results of our ongoing assessment, which will be completed later in 2017.

Based on our current assessment, we believe the new standard will not have a material impact on our financial position and results of operations, as it is not expected to change the manner or timing of recognizing revenue. We recognize revenue on sales to customers and distributors upon satisfaction of our performance obligations when the goods are shipped. For consignment sales, we recognize revenue when the goods are pulled from consignment inventory.

ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities

Under this standard, all equity investments except those accounted for under the equity method are required to be measured at fair value. Equity investments that do not have a readily determinable fair value may, as a practical expedient, be measured at cost, adjusted for changes in observable prices minus impairment. This standard is effective for our interim and annual periods beginning January 1, 2018, and should be applied on a modified retrospective basis except for the amendments related to equity securities without readily determinable fair values, which would be applied on a prospective basis. We do not expect this standard to have a material impact on our financial position and results of operations, as nearly all of our equity investments are already recorded at fair value or under the equity method.

ASU No. 2016-02, Leases (Topic 842)

This standard requires all leases that have a term of over 12 months to be recognized on the balance sheet with the liability for lease payments and the corresponding right-of-use asset initially measured at the present value of amounts expected to be paid over the term. Recognition of the costs of these leases on the income statement will be dependent upon their classification as either an operating or a financing lease. Costs of an operating lease will continue to be recognized as a single operating expense on a straight-line basis over the lease term. Costs for a financing lease will be disaggregated and recognized as both an operating expense (for the amortization of the right-of-use asset) and interest expense (for interest on the lease liability). This standard will be effective for our interim and annual periods beginning January 1, 2019, and must be applied on a modified retrospective basis to leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. We do not plan to adopt this standard early. We are currently evaluating the potential impact of this standard on our financial position, but we do not expect it to have a material impact on our results of operations.

ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

This standard requires entities to use a current lifetime expected credit loss methodology to measure impairments of certain financial assets. Using this methodology will result in earlier recognition of losses than under the current incurred loss approach, which requires waiting to recognize a loss until it is probable of having been incurred. There are other provisions within the standard that affect how impairments of other financial assets may be recorded and presented, and that expand disclosures. This standard will be effective for our interim and annual periods beginning after December 15, 2019, and permits earlier application but not before December 15, 2018. The standard will be applied using a modified retrospective approach. We are currently evaluating the potential impact of this standard, but we do not expect it to have a material impact on our financial position and results of operations.

ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business

This standard affects areas of accounting such as acquisitions, disposals and goodwill. This standard provides guidance to evaluate whether transactions should be accounted for as an acquisition (or disposal) of assets or as a business combination. Under this new standard, if substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, it may be treated as an asset acquisition rather than a business combination. This standard is to be applied on a prospective basis and will be effective for us for annual periods beginning after December 15, 2017, including interim periods within those periods. Early adoption is permitted. The impact of this standard on our financial position, results of operation and related disclosures will be dependent upon the specific terms of any applicable future acquisitions or dispositions.

ASU No. 2017-05, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets

This standard provides guidance on the recognition and measurement of gains and losses from the transfer, sale or partial sale to noncustomers of nonfinancial assets (such as intangible assets, property, plant and equipment) or an ownership interest in a consolidated subsidiary that is not a business. This standard is to be applied on either a retrospective basis to all periods presented or on a modified retrospective basis (i.e., cumulative catch up as of the beginning of the earliest period presented) and will be effective for us for annual periods beginning after December 15, 2017, including interim periods within those periods. Earlier application is permitted. We are currently evaluating the timing of adoption and the potential impact of this standard on our financial position and results of operations, but we do not expect it to have a material impact.

ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities

This standard primarily applies to designated transactions for which companies have elected to apply optional hedge accounting, and makes more financial and non-financial hedging strategies eligible for such accounting. Given that our use of hedge accounting has been immaterial in the past, we do not expect this new standard to have a material impact on our financial position and results of operations.