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 currency 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 the first nine months of 2013 and 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 its 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 $51,251,000 and $131,923,000 matured during the three and nine months ended September 30, 2013 compared to forward contracts with a total notional amount in USD of $50,244,000 and $134,402,000 that matured during the three and nine months ended September 30, 2012.

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



	September 30, 2013					December 31, 2012
	Notional Amount		Unrealized Net Gain (Loss)			Notional Amount		Unrealized Net Gain (Loss)
USD / AUD	$	579	$	46		$	—	$	—
USD / CAD	10,330		(85		)	17,620		(6		)
USD / CNY	3,320		55			—		—
USD / CHF	232		7			—		—
USD / EUR	14,433		(368		)	59,510		(797		)
USD / GBP	692		22			2,519		(3		)
USD / NZD	465		4			—		—
USD / SEK	3,499		115			—		—
USD / MXP	2,846		11			6,954		141
EUR / CAD	450		12			—		—
EUR / CHF	1,555		17			—		—
EUR / GBP	5,389		(40		)	2,077		46
EUR / SEK	415		25			—		—
EUR / NZD	1,748		23			5,749		105
GBP / CHF	304		(8		)	—		—
GBP / SEK	1,099		52			4,154		25
DKK / SEK	1,051		(9		)	6,397		(47		)
NOK / SEK	926		66			3,428		(4		)
	$	49,333	$	(55	)	$	108,408	$	(540	)

Derivatives Not Qualifying or Designated for Hedge Accounting Treatment

The company also utilizes foreign currency forward exchange 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 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 exchange contract. No material net gain or loss was realized by the company in 2013 or 2012 related to these contracts and the associated short-term intercompany trading receivables and payables.

Foreign currency forward exchange contracts not qualifying or designated for hedge accounting treatment entered into in 2013 and 2012, respectively, and outstanding were as follows (in thousands USD):



	September 30, 2013					September 30, 2012
	Notional Amount		Gain (Loss)			Notional Amount			Gain (Loss)
CAD / USD	$	4,840	$	4		$	14,801		$	434
EUR / USD	12,273		166			9,906			134
CHF / USD	—		—			785			13
DKK / USD	13,517		62			—			—
GBP / USD	6,361		67			—			—
NOK / USD	4,486		12			—			—
NZD / USD	2,161		(8		)	3,146			40
SEK / USD	6,502		32			—			—
EUR / AUD	—		—			1,908			5
EUR / CAD	—		—			239			(15		)
EUR / DKK	—		—			(11,203		)	(27		)
AUD / CAD	878		(4		)	3,056			(38		)
AUD / EUR	1,788		248			—			—
AUD / GBP	298		38			—			—
AUD / NZD	—		—			1,048			15
EUR / NZD	—		—			90			(10		)
EUR / NOK	—		—			6			—
	$	53,104	$	617		$	23,782		$	551

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



	September 30, 2013				December 31, 2012
	Assets		Liabilities		Assets		Liabilities
Derivatives designated as hedging instruments under ASC 815
Foreign currency forward exchange contracts	$	626	$	681	$	375	$	915
Interest rate swap contracts	—		22		—		316
Derivatives not designated as hedging instruments under ASC 815
Foreign currency forward exchange contracts	685		68		687		142
Total derivatives	$	1,311	$	771	$	1,062	$	1,373

The fair values of the company’s foreign currency forward exchange contract 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 Comprehensive Income (Loss) 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)
Three months ended September 30, 2013
Foreign currency forward exchange contracts	$	(207	)	$	83		$	2
Interest rate swap contracts	33			(13		)	—
	$	(174	)	$	70		$	2
Nine months ended September 30, 2013
Foreign currency forward exchange contracts	$	505		$	(20	)	$	37
Interest rate swap contracts	433			(139		)	—
	$	938		$	(159	)	$	37
Three months ended September 30, 2012
Foreign currency forward exchange contracts	$	(2,522	)	$	1,241		$	(38	)
Interest rate swap contracts	(3		)	—			—
	$	(2,525	)	$	1,241		$	(38	)
Nine months ended September 30, 2012
Foreign currency forward exchange contracts	$	(2,956	)	$	2,706		$	(9	)
Interest rate swap contracts	(99		)	—			—
	$	(3,055	)	$	2,706		$	(9	)

Derivatives not designated as hedging instruments under ASC 815							Amount of Gain (Loss) Recognized in Income on Derivatives
Three months ended September 30, 2013
Foreign currency forward exchange contracts							$	361
Nine months ended September 30, 2013
Foreign currency forward exchange contracts							$	617
Three months ended September 30, 2012
Foreign currency forward exchange contracts							$	569
Nine months ended September 30, 2012
Foreign currency forward exchange contracts							$	551

The pre-tax gains or losses recognized as the result of the settlement of cash flow hedge foreign currency forward exchange contracts are recognized in net sales for hedges of inventory sales or cost of product sold for hedges of inventory purchases. For the three and nine months ended September 30, 2013, net sales were increased by $54,000 and $496,000 and cost of product sold was increased by $128,000 and increased by $453,000 for net realized loss of $74,000 and $43,000. For the three and nine months ended September 30, 2012, net sales were decreased by $146,000 and increased by $49,000, respectively, and cost of product sold was decreased by $1,487,000 and $2,804,000, respectively, for net realized gains of $1,341,000 and $2,853,000, respectively.

The company recognized expense of $23,000 and $328,000 for the three and nine months ended September 30, 2013, respectively, compared to expense of $147,000 and $419,000 for the three and nine months ended September 30, 2012, respectively, related to interest rate swap agreements, which is reflected in interest expense on the consolidated statement of comprehensive income (loss).

Gains of $361,000 and $617,000 versus gains of $569,000 and $551,000 were recognized in selling, general and administrative (SG&A) expenses for the three and nine months ended September 30, 2013 and September 30, 2012, respectively, on ineffective forward contracts and forward contracts not designated as hedging instruments that are entered into to offset gains/losses also recorded in SG&A expenses on intercompany trade payables. Any gains/losses on the non designated hedging instruments were substantially offset by gains/losses also recorded in SG&A expenses on intercompany trade payables.

The company has entered into foreign currency forward exchange contracts and interest rate swap contracts (the “agreements”) with various bank counterparties, each of which are subject to provisions which are similar to a master netting agreement. The agreements provide for a net settlement payment in a single currency upon a default by the company. Furthermore, the agreements provide the counterparty with a right of set off in the event of a default that would enable the counterparty to offset any net payment due by the counterparty to the company under the applicable agreement by any amount due by the company to the counterparty under any other agreement. For example, the terms of the agreement would permit a counterparty to a derivative contract that is also a lender under the company's Credit Agreement to reduce any derivative settlement amounts owed to the company under the derivative contract by any amounts owed to the counterparty by the company under the Credit Agreement. In addition, the agreements contain cross-default provisions that could trigger a default by the company under the agreement in the event of a default by the company under another agreement with the same counterparty. The company does not present any derivatives on a net basis in its financial statements and all derivative balances presented are subject to provisions that are similar to master netting agreements.