Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company classifies certain assets and liabilities based on the following fair value hierarchy:

Items valued using internally generated models are classified according to the lowest level input or value driver that is significant to the valuation. The determination of fair value considers various factors including interest rate yield curves and time value underlying the financial instruments. For derivatives and debt securities, the Company uses a discounted cash flow analysis using discount rates commensurate with the duration of the instrument.

In determining the fair value of financial instruments, the Company considers certain market valuation adjustments to the “base valuations” calculated using the methodologies described below for several parameters that market participants would consider in determining fair value:

●

Counterparty credit risk adjustments are applied to financial instruments, taking into account the actual credit risk of a counterparty as observed in the credit default swap market to determine the true fair value of such an instrument.

●

Credit risk adjustments are applied to reflect the Company’s own credit risk when valuing all liabilities measured at fair value. The methodology is consistent with that applied in developing counterparty credit risk adjustments, but incorporates the Company’s own credit risk as observed in the credit default swap market.

The Company did not hold any equity and debt investments for the periods presented.

Certain non-financial assets such as property, plant and equipment, operating right-of-use assets, land, goodwill and intangible assets are also subject to nonrecurring fair value measurements if they are deemed to be impaired. The impairment models used for non-financial assets depend on the type of asset. There were no impairments of non-financial assets for the three and nine months ended September 30, 2021 and 2020, respectively.

Financial Assets and Liabilities Measured at Fair Value

The gross balances of derivative assets contained within prepaid expenses and other current assets in the Combined Balance Sheet at September 30, 2021 were $4 million. These financial instruments are categorized as Level 2 in the fair value hierarchy. There were no outstanding derivatives in the Combined Balance Sheet at December 31, 2020.

Financial Assets and Liabilities Not Measured at Fair Value

Accounts receivable are financial assets with carrying values that approximate fair value. Accounts payable,

other accrued expenses and short-term debt (excluding the current portion of long-term debt and including short-term finance lease liabilities) are financial liabilities with carrying values that approximate fair value. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy, except for short-term debt, which would be classified as Level 2.

Derivative Financial Instruments

Prior to the third quarter of 2021, Kyndryl did not independently execute derivative financial instruments to manage its foreign currency risk and instead participated in a centralized foreign currency hedging program administered by IBM. The hedging activity allocated to Kyndryl is for the management of the Company’s forecasted foreign currency expenses. In the third quarter of 2021, we began to execute trades to hedge the Company’s foreign exchange exposures, and this activity is recorded in the Company’s combined financial statements.

Foreign Exchange Risk

Anticipated Cost Transactions

The Company has foreign exchange derivative financial instruments designated as cash flow hedges to manage foreign currency risk that is deemed to be associated with the Company’s operations and has been allocated to the Company’s Combined Income Statement, up to and including the third quarter of 2021, based on its pro rata share of the underlying items hedged, where applicable, with the remainder allocated on a pro rata basis of revenue. Changes in fair value of derivatives designated as a cash flow hedge are recorded, net of applicable taxes, in other comprehensive income and subsequently reclassified into the same income statement line item as the hedged exposure when the underlying hedged item is recognized in earnings. The cash flows associated with derivatives designated as cash flow hedges are reported in cash flows from operating activities in the Combined Statement of Cash Flows.

At September 30, 2021, the total notional amount of forward contracts designated as cash flow hedges of forecasted foreign currency cost transactions was $227 million. The Company had no forward contracts outstanding under this program at December 31, 2020. The notional amounts of derivative instruments do not necessarily represent the amounts exchanged by the Company with third parties and are not necessarily a direct measure of the financial exposure. The maximum remaining length of time over which the Company hedged its exposure is approximately one year. At September 30, 2021, the weighted-average remaining maturity of these instruments was approximately 0.5 years.

The Company may also enter into master netting agreements with certain counterparties that allow for netting of exposures in the event of default or breach. However, in the Combined Balance Sheet, the Company does not offset derivative assets against liabilities with counterparties in master netting arrangements by counterparty, and there were no derivative instruments activity impacted by master netting agreements at September 30, 2021 and December 31, 2020.

At September 30, 2021, in connection with cash flow hedges of foreign currency cost transactions, the Company recorded net deferred gains of $3 million (before taxes) in AOCI. At December 31, 2020, there were no foreign exchange exposures that were recorded in the Company’s combined financial statements. The Company estimates that $3 million (before taxes) of deferred net gains on derivatives in AOCI at September 30, 2021 will be reclassified to net income within the next twelve months, providing an offsetting economic impact against the underlying anticipated transactions.

Subsidiary Cash and Foreign Currency Asset/Liability Management

The Company uses global treasury centers to manage the cash of its subsidiaries. These centers principally use currency swaps to convert cash flows in a cost-effective manner. Changes in fair value of derivatives not designated as hedges are reported in earnings in other (income) and expense. Cash flows from derivatives not designated as hedges are reported in cash flows from investing activities in the Combined Statement of Cash flows. The terms of these swap contracts are generally less than one year. The changes in the fair values of these contracts and of the underlying hedged exposures are generally offsetting and are recorded in other (income) and expense in the Combined Income Statement. At September 30, 2021 the total notional amount of derivative instruments in economic hedges of foreign currency exposure was $120 million, and there were no outstanding derivatives instruments at December 31, 2020.

The Effect of Derivative Instruments in the Combined Income Statement

The total amounts of income and expense line items presented in the Combined Income Statement in which the effects of cash flow hedges and derivatives not designated as hedging instruments are recorded, and the total effect of hedge activity on these income and expense line items are as follows:


					Gains (Losses) from
(Dollars in millions)	Total				Hedge Activity
For the three months ended September 30:	2021		2020		2021		2020
Cost of services	$	4,182	$	4,332	$	2	$	3
Selling, general and administrative expenses		854		654		—		(2)
Other (income) and expense		(17)		8		5		1

Gain (Loss) Recognized in Combined Income Statement

Combined

Recognized on

Attributable to Risk

(Dollars in millions)

Income Statement

Derivatives

Being Hedged

For the three months ended September 30:

Line Item

2021

2020

2021

2020

Derivative instruments not designated as hedging instruments:

Foreign exchange contracts

Other (income) and expense

—

Total

—


	Gain (Loss) Recognized in Combined Income Statement and Other Comprehensive Income
(Dollars in millions)					Combined	Reclassified				Amounts Excluded from
For the three months	Recognized in OCI				Income Statement	from AOCI				Effectiveness Testing (1)
ended September 30:	2021		2020		Line Item	2021		2020		2021		2020
Derivative instruments in cash flow hedges:
Foreign exchange contracts	$	3	$	—	Cost of services	$	2	$	3	$	—	$	—
					Selling, general and administrative expenses		—		(2)		—		—
					Other (income) and expense		4		1		—		—
Total	$	3	$	—		$	6	$	3	$	—	$	—

(1)	The Company’s policy is to recognize all fair value changes in amounts excluded from effectiveness testing in net income each period.

NA - not applicable


					Gains (Losses) from
(Dollars in millions)	Total				Hedge Activity
For the nine months ended September 30:	2021		2020		2021		2020
Cost of services	$	12,727	$	12,876	$	11	$	5
Selling, general and administrative expenses		2,421		2,123		(6)		2
Other (income) and expense		16		17		(3)		10

Gain (Loss) Recognized in Combined Income Statement

Combined

Recognized on

Attributable to Risk

(Dollars in millions)

Income Statement

Derivatives

Being Hedged

For the nine months ended September 30:

Line Item

2021

2020

2021

2020

Derivative instruments not designated as hedging instruments:

Foreign exchange contracts

Other (income) and expense

—

Total

—


	Gain (Loss) Recognized in Combined Income Statement and Other Comprehensive Income
(Dollars in millions)					Combined	Reclassified				Amounts Excluded from
For the nine months	Recognized in OCI				Income Statement	from AOCI				Effectiveness Testing (1)
ended September 30:	2021		2020		Line Item	2021		2020		2021		2020
Derivative instruments in cash flow hedges:
Foreign exchange contracts	$	3	$	—	Cost of services	$	11	$	5	$	—	$	—
					Selling, general and administrative expenses		(6)		2		—		—
					Other (income) and expense		(4)		10		—		—
Total	$	3	$	—		$	1	$	17	$	—	$	—

(1)	The Company’s policy is to recognize all fair value changes in amounts excluded from effectiveness testing in net income each period.

NA - not applicable

For the three and nine months ended September 30, 2021 and 2020, there were no gains or losses excluded from the assessment of hedge effectiveness for cash flow hedges, or associated with an underlying exposure that did not or was not expected to occur; nor are there any anticipated in the normal course of business.