Derivatives

ASC 815 requires companies to recognize all derivative instruments in the consolidated balance sheet as either assets or liabilities at fair value. The accounting for changes in fair value of a derivative is dependent upon whether or not the derivative has been designated and qualifies for hedge accounting treatment and the type of hedging relationship. For derivatives designated and qualifying as hedging instruments, the company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation.

Cash Flow Hedging Strategy

The company uses derivative instruments in an attempt to manage its exposure to foreign currency exchange risk and interest rate risk. Foreign forward exchange contracts are used to manage the price risk associated with forecasted sales denominated in foreign currencies and the price risk associated with forecasted purchases of inventory over the next twelve months. Interest rate swaps are, at times, utilized to manage interest rate risk associated with the company’s fixed and floating-rate borrowings.

The company recognizes its derivative instruments as assets or liabilities in the consolidated balance sheet measured at fair value. A majority of the company’s derivative instruments are designated and qualify as cash flow hedges. Accordingly, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the fair value of the hedged item, if any, is recognized in current earnings during the period of change.

During 2012, the company was a party to interest rate swap agreements that qualified as cash flow hedges and effectively converted floating-rate debt to fixed-rate debt, so the company could avoid the risk of changes in market interest rates. The gains or losses on interest rate swaps are reflected in interest expense on the consolidated statement of comprehensive income (loss).

To protect against increases/decreases in forecasted foreign currency cash flows resulting from inventory purchases/sales over the next year, the company utilizes foreign currency forward contracts to hedge portions of its forecasted purchases/sales denominated in foreign currencies. The gains and losses are included in cost of products sold and selling, general and administrative expenses on the consolidated statement of comprehensive income (loss). If it is later determined that a hedged forecasted transaction is unlikely to occur, any prospective gains or losses on the forward contracts would be recognized in earnings. The company does not expect any material amount of hedge ineffectiveness related to forward contract cash flow hedges during the next twelve months.

The company has historically not recognized any material amount of ineffectiveness related to forward contract cash flow hedges because the company generally limits it hedges to between 60% and 90% of total forecasted transactions for a given entity’s exposure to currency rate changes and the transactions hedged are recurring in nature. Furthermore, the majority of the hedged transactions are related to intercompany sales and purchases for which settlement occurs on a specific day each month. Forward contracts with a total notional amount in USD of $176,784,000 and $189,793,000 matured during the twelve months ended December 31, 2012 and 2011, respectively.

Foreign exchange forward contracts qualifying and designated for hedge accounting treatment were as follows (in thousands USD):



	December 31, 2012					December 31, 2011
	Notional Amount		Unrealized Net Gain (Loss)			Notional Amount		Unrealized Net Gain (Loss)
USD / AUD	$	—	$	—		$	3,324	$	104
USD / CAD	17,620		(6		)	8,424		29
USD / CNY	—		—			8,130		(16		)
USD / EUR	59,510		(797		)	42,267		701
USD / GBP	2,519		(3		)	1,806		19
USD / NZD	—		—			8,256		86
USD / SEK	—		—			4,520		19
USD / MXP	6,954		141			14,029		(146		)
EUR / AUD	—		—			1,220		(48		)
EUR / CHF	—		—			5,433		(22		)
EUR / GBP	2,077		46			17,201		9
EUR / NZD	5,749		105			7,009		505
GBP / CHF	—		—			929		(5		)
GBP / SEK	4,154		25			1,690		12
CHF / SEK	—		—			271		(2		)
DKK / SEK	6,397		(47		)	—		—
NOK / CHF	—		—			436		(1		)
NOK / SEK	3,428		(4		)	—		—
	$	108,408	$	(540	)	$	124,945	$	1,244

Derivatives Not Qualifying or Designated for Hedge Accounting Treatment

The company utilizes foreign currency forward contracts that are not designated as hedges in accordance with ASC 815. These contracts are entered into to eliminate the risk associated with the settlement of short-term intercompany trading receivables and payables between Invacare Corporation and its foreign subsidiaries. The currency forward contracts are entered into at the same time as the intercompany receivables or payables are created so that upon settlement, the gain/loss on the settlement is offset by the gain/loss on the foreign currency forward contract. No material net gain or loss was realized by the company in 2012 or 2011 related to these forward contracts and the associated short-term intercompany trading receivables and payables.

Foreign exchange forward contracts not qualifying or designated for hedge accounting treatment entered into in 2012 and 2011, respectively, and outstanding were as follows (in thousands USD):



	December 31, 2012					December 31, 2011
	Notional Amount		Gain (Loss)			Notional Amount		Gain (Loss)
CAD / USD	$	22,194	$	(90	)	$	2,146	$	12
EUR / USD	18,060		416			—		—
CHF / USD	2,144		42			3,419		(118		)
GBP / USD	3,514		60			—		—
CAD / AUD	1,508		3			—		—
EUR / AUD	1,928		51			—		—
GBP / AUD	1,356		26			—		—
NOK / AUD	1,039		40			—		—
NZD / AUD	2,128		25			—		—
SEK / CAD	—		—			2,545		52
EUR / CAD	—		—			4,244		(10		)
EUR / DKK	11,555		(28		)	3,482		—
	$	65,426	$	545		$	15,836	$	(64	)

The fair values of the company’s derivative instruments were as follows (in thousands):



	December 31, 2012				December 31, 2011
	Assets		Liabilities		Assets		Liabilities
Derivatives designated as hedging instruments under ASC 815
Foreign currency forward contracts	$	375	$	915	$	1,621	$	377
Interest rate swap contracts	—		316		18		388
Derivatives not designated as hedging instruments under ASC 815
Foreign currency forward contracts	687		142		64		128
Total derivatives	$	1,062	$	1,373	$	1,703	$	893

The fair values of the company’s foreign currency forward assets and liabilities are included in Other Current Assets and Accrued Expenses, respectively in the Consolidated Balance Sheets.

The effect of derivative instruments on the Statement of Operations and Other Comprehensive Income (OCI) was as follows (in thousands):



Derivatives in ASC 815 cash flow hedge relationships	Amount of Gain (Loss) Recognized in OCI on Derivatives (Effective Portion)			Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)			Amount of Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing)
Year ended December 31, 2012
Foreign currency forward contracts	$	(5,547	)	$	3,763		$	4
Interest rate swap contracts	54			—			—
	$	(5,493	)	$	3,763		$	4
Year ended December 31, 2011
Foreign currency forward contracts	$	925		$	(250	)	$	(7	)
Interest rate swap contracts	(370		)	—			—
	$	555		$	(250	)	$	(7	)

Derivatives not designated as hedging instruments under ASC 815							Amount of Gain Recognized in Income on Derivatives
Year ended December 31, 2012
Foreign currency forward contracts							$	545
Year ended December 31, 2011
Foreign currency forward contracts							$	83

The gains or losses recognized as the result of the settlement of cash flow hedge foreign currency forward contracts are recognized in net sales for hedges of inventory sales or cost of product sold for hedges of inventory purchases. In 2012, net sales were increased by $155,000 and cost of product sold was decreased by $3,608,000 for a net realized gain of $3,763,000. In 2011, net sales were increased by $3,080,000 and cost of product sold was increased by $3,330,000 for a net realized loss of $250,000 compared to a net gain of $2,803,000 in 2010.

The company recognized incremental expense of $600,000 and $385,000 in 2012 and 2011, respectively related to interest rate swap agreements which are reflected in interest expense on the consolidated statement of comprehensive income (loss).

A gain of $545,000 and a gain of $83,000 was recognized in selling, general and administrative (SG&A) expenses in 2012 and 2011, respectively, on ineffective foreign currency forward contracts as well as foreign currency forward contracts not designated as hedging instruments that are entered into to offset gains/losses on intercompany trade payables. The gains/losses on the non-designated hedging instruments were substantially offset by gains/losses also recorded in SG&A expenses on intercompany trade payables.