NOTE 10

FINANCIAL INSTRUMENTS AND RELATED FAIR VALUE MEASUREMENTS

Receivable Securitizations

For trade receivables originated in Japan, the company has entered into agreements with financial institutions in which the entire interest in and ownership of the receivable is sold. The company continues to service the receivables in its Japanese securitization arrangement. Servicing assets or liabilities are not recognized because the company receives adequate compensation to service the sold receivables. The Japanese securitization arrangement includes limited recourse provisions, which are not material.

The following is a summary of the activity relating to the securitization arrangement.


as of and for the years ended December 31 (in millions)	2015			2014			2013

Sold receivables at beginning of year	$	104		$	114		$	157
Proceeds from sales of receivables		361			464			506
Cash collections (remitted to the owners of the receivables)		(384	)		(459	)		(519	)
Effect of currency exchange rate changes		—			(15	)		(30	)

Sold receivables at end of year	$	81		$	104		$	114

The net losses relating to the sales of receivables were immaterial for each year.

Concentrations of Credit Risk

The company invests excess cash in certificates of deposit or money market funds and diversifies the concentration of cash among different financial institutions. With respect to financial instruments, where appropriate, the company has diversified its selection of counterparties, and has arranged collateralization and master-netting agreements to minimize the risk of loss.

The company continues to do business with foreign governments in certain countries, including Greece, Spain, Portugal and Italy, which have experienced deterioration in credit and economic conditions. As of December 31, 2015 and 2014, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $211 million and $275 million, respectively.

Global economic conditions and liquidity issues in certain countries have resulted, and may continue to result, in delays in the collection of receivables and credit losses. Global economic conditions, governmental actions and customer-specific factors may require the company to re-evaluate the collectability of its receivables and the company could potentially incur additional credit losses. These conditions may also impact the stability of the Euro.

Fair Value Measurements

The fair value hierarchy under the accounting standard for fair value measurements consists of the following three levels:

•

Level 1 — Quoted prices in active markets that the company has the ability to access for identical assets or liabilities;

•

Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuations in which all significant inputs are observable in the market; and

•

Level 3 — Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company’s management about the assumptions market participants would use in pricing the asset or liability.

The following table summarizes the bases used to measure financial assets and liabilities that are carried at fair value on a recurring basis in the consolidated balance sheets.


		Basis of fair value measurement
(in millions)	Balance as of December 31, 2015	Quoted prices in active markets for identical assets (Level 1)	Significant other observable inputs (Level 2)	Significant unobservable inputs (Level 3)

Assets
Foreign currency hedges	$ 10	$—	$ 10	$—
Interest rate hedges	46	—	46	—
Available-for-sale securities	5,162	14	5,148	—

Total assets	$5,218	$14	$5,204	$—

Liabilities
Foreign currency hedges	$ 2	$—	$ 2	$—
Contingent payments related to acquisitions	20	—	—	20

Total liabilities	$ 22	$—	$ 2	$20


		Basis of fair value measurement
(in millions)	Balance as of December 31, 2014	Quoted prices in active markets for identical assets (Level 1)	Significant other observable inputs (Level 2)	Significant unobservable inputs (Level 3)

Assets
Foreign currency hedges	$ 51	$—	$ 51	$—
Interest rate hedges	89	—	89	—
Available-for-sale securities	35	35	—	—

Total assets	$175	$35	$140	$—

Liabilities
Foreign currency hedges	$ 23	$—	$ 23	$—
Interest rate hedges	—	—	—	—
Contingent payments related to acquisitions	45	—	—	45

Total liabilities	$ 68	$—	$ 23	$45

As of December 31, 2015, cash and equivalents of $2.2 billion included money market funds of approximately $500 million, which would be considered Level 2 in the fair value hierarchy.

For assets that are measured using quoted prices in active markets, the fair value is the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The investment in Baxalta common stock of $5.1 billion is categorized as a Level 2 security as these shares were unregistered as of December 31, 2015. The value of this investment is based on Baxalta’s common stock price as of December 31, 2015, which represents an identical equity instrument registered under the Securities Act of 1933, as amended. The majority of the derivatives entered into by the company are valued using internal valuation techniques as no quoted market prices exist for such instruments. The principal techniques used to value these instruments are discounted cash flow and Black-Scholes models. The key inputs are considered observable and vary depending on the type of derivative, and include contractual terms, interest rate yield curves, foreign exchange rates and volatility.

Contingent payments related to acquisitions consist of commercial milestone payments and sales-based payments, and are valued using discounted cash flow techniques. The fair value of commercial milestone payments reflects management’s expectations of probability of payment, and increases as the probability of payment increases or expectation of timing of payments is accelerated. The fair value of sales-based payments is based upon probability-weighted future revenue estimates, and increases as revenue estimates increase, probability weighting of higher revenue scenarios increase or expectation of timing of payment is accelerated.

The following table is a reconciliation of the fair value measurements that use significant unobservable inputs (Level 3), which consist of contingent payments related to acquisitions.


(in millions)	Contingent payments

Fair value as of December 31, 2013		$49
Additions		—
Payments		(3	)
Net gains recognized in earnings		(1	)
CTA		—

Fair value as of December 31, 2014		45
Additions		—
Payments		(3	)
Net gains recognized in earnings		(22	)
CTA		—

Fair value as of December 31, 2015		$ 20

The company recognized net gains of approximately $22 million in 2015 related to changes in estimates with respect to the probability of achieving certain sales milestones. The gain was reported in other expense (income), net. The company made minor sales-based payments in 2015 and 2014.

The following table provides information relating to the company’s investments in available-for-sale equity securities.


(in millions)	Amortized cost		Unrealized gains		Unrealized losses		Fair value
December 31, 2015		$732		$4,430		$—		$5,162
December 31, 2014		$ 20		$ 15		$—		$ 35

As discussed further in Note 7, the company recorded asset impairment charges related to its COLLEAGUE and SYNDEO infusion pumps and business optimization initiatives in 2015, 2014, and 2013. As these assets had no alternative use and no salvage value, the fair values, measured using significant unobservable inputs (Level 3), were assessed to be zero.

Book Values and Fair Values of Financial Instruments

In addition to the financial instruments that the company is required to recognize at fair value in the consolidated balance sheets, the company has certain financial instruments that are recognized at historical cost or some basis other than fair value. For these financial instruments, the following table provides the values recognized in the consolidated balance sheets and the approximate fair values.


	Book values				Approximate fair values
as of December 31 (in millions)	2015		2014		2015		2014

Assets
Investments	$	21	$	23	$	21	$	21
Liabilities
Short-term debt		1,775		913		1,775		913
Current maturities of long-term debt and lease obligations		810		785		818		790
Long-term debt and lease obligations		3,935		7,331		4,089		7,917

The following table summarizes the bases used to measure the approximate fair value of the financial instruments as of December 31, 2015 and 2014.


			Basis of fair value measurement
(in millions)	Balance as of December 31, 2015		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)

Assets
Investments		$ 21		$—		$ 2		$19

Total assets		$ 21		$—		$ 2		$19

Liabilities
Short-term debt		$1,775		$—		$1,775		$—
Current maturities of long-term debt and lease obligations		818		—		818		—
Long-term debt and lease obligations		4,089		—		4,089		—

Total liabilities		$6,682		$—		$6,682		$—


			Basis of fair value measurement
(in millions)	Balance as of December 31, 2014		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)

Assets
Investments		$ 21		$—		$ 8		$13

Total assets		$ 21		$—		$ 8		$13

Liabilities
Short-term debt		$ 913		$—		$ 913		$—
Current maturities of long-term debt and lease obligations		790		—		790		—
Long-term debt and lease obligations		7,917		—		7,917		—

Total liabilities		$9,620		$—		$9,620		$—

Investments in 2015 and 2014 include certain cost method investments and held-to-maturity debt securities.

The fair value of held-to-maturity debt securities is calculated using a discounted cash flow model that incorporates observable inputs, including interest rate yields, which represents a Level 2 basis of fair value measurement. In determining the fair value of cost method investments, the company takes into consideration recent transactions, as well as the financial information of the investee, which represents a Level 3 basis of fair value measurement.

The estimated fair values of current and long-term debt were computed by multiplying price by the notional amount of the respective debt instrument. Price is calculated using the stated terms of the respective debt instrument and yield curves commensurate with the company’s credit risk. The carrying values of the other financial instruments approximate their fair values due to the short-term maturities of most of these assets and liabilities.

In 2015 and 2014, the company recorded income of $38 million and $20 million, respectively, in other expense (income), net related to equity method investments, which primarily represented gains from the sale of certain investments as well as distributions from funds that sold portfolio companies. The company did not record any gains or loss within other expense (income), net related to equity method investments in 2013.