Note 10 Financial Instruments and Fair Value Measures

Risk Management Policy

The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. The company's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative instruments to reduce its exposure to foreign currency exchange rates. The company is also exposed to the risk that its earnings and cash flows could be adversely impacted by fluctuations in interest rates. The company periodically enters into interest rate swaps, based on judgment, to manage interest costs in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required.

Financial Instruments

Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $1.4 billion and $1.5 billion at December 31, 2014 and December 31, 2013, respectively, are designated as cash flow hedges and are recorded at fair value. Accumulated gains and losses as of December 31, 2014 will be included in cost of products sold at the time the products are sold, generally not exceeding twelve months.

The company enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. The contracts are marked-to-market, and resulting gains or losses are reflected in income and are generally offset by losses or gains on the foreign currency exposure being managed. At December 31, 2014 and December 31, 2013, AbbVie held notional amounts of $6.8 billion and $5.3 billion, respectively, of such foreign currency forward exchange contracts.

In 2014, the company entered into undesignated forward contracts with a total notional amount of $16.9 billion to hedge anticipated foreign currency cash outflows associated with the terminated proposed combination with Shire. A large portion of these contracts original maturity is in the first quarter of 2015 but were net settled in the fourth quarter of 2014. In 2014, the company realized $490 million in net foreign exchange loss associated with the Shire-related forward contracts.

AbbVie is a party to interest rate hedge contracts, designated as fair value hedges, totaling $8.0 billion at both December 31, 2014 and December 31, 2013. The effect of the hedge is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie recorded the contracts at fair value and adjusted the carrying amount of the fixed-rate debt by an offsetting amount.

The following table summarizes the amounts and location of AbbVie's derivative instruments as of December 31.

	Fair value—Derivatives in asset position					Fair value—Derivatives in liability position
(in millions)	2014		2013		Balance sheet caption	2014		2013		Balance sheet caption

Interest rate swaps designated as fair value hedges	$	—	$	—	n/a	$	180	$	432	Long-term liabilities
Foreign currency forward exchange contracts—
Hedging instruments		141		—	Prepaid expenses and other		—		61	Accounts payable and accrued liabilities
Others not designated as hedges		70		17	Prepaid expenses and other		63		12	Accounts payable and accrued liabilities

Total	$	211	$	17		$	243	$	505

While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets.

The following table summarizes the activity for derivative instruments and the amounts and location of income (expense) and gain (loss) reclassified into net earnings for the years ended December 31, 2014, 2013 and 2012, respectively. The amount of hedge ineffectiveness was not significant for the years ended December 31, 2014, 2013 and 2012.

	Gain (loss) recognized in other comprehensive (loss) income								(Expense) income and (loss) gain reclassified into income
(in millions)	2014		2013			2012			2014			2013			2012			Income statement caption

Foreign currency forward exchange contracts—
Designated as cash flow hedges	$	193	$	(77	)	$	(11	)	$	(79	)	$	—		$	24		Cost of products sold
Not designated as hedges		n/a		n/a			n/a			(523	)		81			(23	)	Net foreign exchange (loss) gain
Interest rate swaps designated as fair value hedges		n/a		n/a			n/a			252			(351	)		(81	)	Interest expense (income), net

The gain/(loss) related to fair value hedges is recognized in net interest expense and directly offsets the (loss)/gain on the underlying hedged item, the fixed-rate debt, resulting in no net impact to net interest expense for years ended December 31, 2014 and 2013.

Fair Value Measures

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

•	Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access;
•	Level 2—Valuations based on 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 certain assets and liabilities that are carried at fair value on a recurring basis in the consolidated balance sheet as of December 31, 2014:

			Basis of fair value measurement
(in millions)	Balance at 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
Cash and equivalents	$	8,348	$	1,214	$	7,134	$	—
Time deposits		9		—		9		—
Equity securities		13		13		—		—
Foreign currency contracts		211		—		211		—

Total assets	$	8,581	$	1,227	$	7,354	$	—


Liabilities
Interest rate hedges	$	180	$	—	$	180	$	—
Foreign currency contracts		63		—		63		—

Total liabilities	$	243	$	—	$	243	$	—

The following table summarizes the bases used to measure certain assets and liabilities that are carried at fair value on a recurring basis in the consolidated balance sheet as of December 31, 2013:

			Basis of fair value measurement
(in millions)	Balance at December 31, 2013		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable Inputs (Level 3)

Assets
Cash and equivalents	$	9,595	$	684	$	8,911	$	—
Time deposits		300		—		300		—
Equity securities		10		10		—		—
Foreign currency contracts		17		—		17		—

Total assets	$	9,922	$	694	$	9,228	$	—


Liabilities
Interest rate hedges	$	432	$	—	$	432	$	—
Foreign currency contracts		73		—		73		—
Contingent consideration		165		—		—		165

Total liabilities	$	670	$	—	$	505	$	165

The fair values for time deposits included in cash and equivalents and short-term investments are determined based on a discounted cash flow analysis reflecting quoted market rates for the same or similar instruments. The fair values of time deposits approximate their amortized cost due to the short maturities of these instruments. Available-for-sale equity securities consists of investments for which the fair value is determined by using the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The derivatives entered into by the company are valued using publicized spot curves for interest rate hedges and publicized forward curves for foreign currency contracts. The contingent consideration is valued using a discounted cash flow technique that reflects management's expectations about probability of payment.

Cumulative net unrealized holding gains on available-for-sale equity securities totaled $3 million and $2 million at December 31, 2014 and December 31, 2013, respectively.

There have been no transfers of assets or liabilities between the fair value measurement levels. 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 and investments:

(in millions)

Fair value as of December 31, 2012	$	251
Payments		(131	)
Additions		28
Change in fair value recognized in earnings		17

Fair value as of December 31, 2013		165
Payments		(164	)
Other		—
Change in fair value recognized in earnings		(1	)

Fair value as of December 31, 2014	$	—

The contingent payments were primarily in connection with the acquisition of Solvay's U.S. pharmaceuticals business in 2010. The achievement of a certain sales milestone resulted in a payment of approximately $137 million in 2014 and $131 million in 2013 for which a liability was previously established. Additions of $28 million related to the acquisition of product rights in 2013. The change in fair value recognized in earnings was recognized in net foreign exchange loss and other income, net in the consolidated statements of earnings.

In addition to the financial instruments that the company is required to recognize at fair value on the consolidated balance sheets, the company has certain financial instruments that are recognized at historical cost or some basis other than fair value. The carrying values and fair values of certain financial instruments as of December 31, 2014 and 2013 are shown in the table below:

	Book values				Approximate fair values
(in millions)	2014		2013		2014		2013

Assets
Investments	$	95	$	108	$	145	$	129
Liabilities
Short-term borrowings		425		413		425		413
Current portion of long-term debt and lease obligations		4,021		18		4,033		18
Long-term debt and lease obligations, excluding fair value hedges		10,745		14,724		10,830		14,493

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

			Basis of fair value measurement
(in millions)	Fair value at 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	$	145	$	68	$	13	$	64

Total assets	$	145	$	68	$	13	$	64


Liabilities
Short-term borrowings	$	425	$	—	$	425	$	—
Current portion of long-term debt and lease obligations		4,033		4,012		21		—
Long-term debt and lease obligations, excluding fair value hedges		10,830		10,737		93		—

Total liabilities	$	15,288	$	14,749	$	539	$	—

The following table summarizes the bases used to measure the approximate fair values of the financial instruments as of December 31, 2013.

			Basis of fair value measurement
(in millions)	Fair value at December 31, 2013		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)

Assets
Investments	$	129	$	39	$	30	$	60

Total assets	$	129	$	39	$	30	$	60


Liabilities
Short-term borrowings	$	413	$	—	$	413	$	—
Current portion of long-term debt and lease obligations		18		—		18		—
Long-term debt and lease obligations, excluding fair value hedges		14,493		14,413		80		—

Total liabilities	$	14,924	$	14,413	$	511	$	—

Investments consist of cost method investments and held-to-maturity debt securities. Cost method investments include certain investments for which the fair value is determined by using the published market price per unit multiplied by the number of units held, without consideration of transaction costs. To determine the fair value of other 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 fair value of held-to-maturity debt securities was estimated based upon the quoted market prices for the same or similar debt instruments. The fair values of short-term and current borrowings approximate the carrying values due to the short maturities of these instruments.

The fair value of long-term debt, excluding fair value hedges, was determined by using the published market price for the debt instruments, without consideration of transaction costs, which represents a Level 1 basis of fair value measurement. The counterparties to financial instruments consist of select major international financial institutions.

Concentrations of Risk

The company invests excess cash in time deposits, money market funds and U.S. Treasury securities and diversifies the concentration of cash among different financial institutions. The company monitors concentrations of credit risk associated with deposits with financial institutions. Credit exposure limits have been established to limit a concentration with any single issuer or institution.

At December 31, 2014, AbbVie had approximately $240 million of net monetary assets denominated in the Venezuelan bolivar (converted at a rate of 6.3 VEF/USD) in its Venezuelan entity, which had net sales of $240 million in 2014. If AbbVie’s net monetary assets denominate in the Venezuelan bolivar had been converted at a rate of 12 VEF/USD at December 31, 2014, it would have resulted in a devaluation loss of $ 114 million in 2014.The company cannot predict whether there will be further devaluations of the Venezuelan currency or whether the use of the official rate of 6.3 will continue to be supported by evolving facts and circumstances. If circumstances change such that the company concludes it would be appropriate to use a different rate, or if a devaluation of the official rate occurs, it could result in a significant change to AbbVie's results of operations.

Three U.S. wholesalers accounted for 49 percent and 38 percent of total net accounts receivable as of December 31, 2014 and December 31, 2013, respectively, and substantially all of AbbVie's sales in the United States are to these three wholesalers. In addition, net governmental receivables outstanding in Greece, Portugal, Italy and Spain totaled $446 million at December 31, 2014 and $781 million at December 31, 2013.

HUMIRA is AbbVie's single largest product and accounted for approximately 63 percent, 57 percent and 50 percent of AbbVie's total net sales in 2014, 2013 and 2012, respectively.