Derivative Instruments and Hedging Activities

6 Months Ended

Mar. 31, 2017

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Hedging Activities

Derivative Instruments and Hedging Activities

The Company selectively uses derivative instruments to reduce market risk associated with changes in foreign currency, commodities, stock-based compensation liabilities and interest rates. Under Company policy, the use of derivatives is restricted to those intended for hedging purposes; the use of any derivative instrument for speculative purposes is strictly prohibited. A description of each type of derivative utilized by the Company to manage risk is included in the following paragraphs. In addition, refer to Note 17, "Fair Value Measurements," of the notes to consolidated financial statements for information related to the fair value measurements and valuation methods utilized by the Company for each derivative type.

Cash Flow Hedges

The Company has global operations and participates in the foreign exchange markets to minimize its risk of loss from fluctuations in foreign currency exchange rates. The Company selectively hedges anticipated transactions that are subject to foreign exchange rate risk primarily using foreign currency exchange hedge contracts. The Company hedges 70% to 90% of the nominal amount of each of its known foreign exchange transactional exposures. As cash flow hedges under ASC 815, "Derivatives and Hedging," the effective portion of the hedge gains or losses due to changes in fair value are initially recorded as a component of AOCI and are subsequently reclassified into earnings when the hedged transactions occur and affect earnings. Any ineffective portion of the hedge is reflected in the consolidated statements of income. These contracts were highly effective in hedging the variability in future cash flows attributable to changes in currency exchange rates during the three and six months ended March 31, 2017 and 2016.

The Company selectively hedges anticipated transactions that are subject to commodity price risk, primarily using commodity hedge contracts, to minimize overall price risk associated with the Company’s purchases of lead, copper, tin and aluminum in cases where commodity price risk cannot be naturally offset or hedged through supply base fixed price contracts. Commodity risks are systematically managed pursuant to policy guidelines. As cash flow hedges, the effective portion of the hedge gains or losses due to changes in fair value are initially recorded as a component of AOCI and are subsequently reclassified into earnings when the hedged transactions, typically sales, occur and affect earnings. Any ineffective portion of the hedge is reflected in the consolidated statements of income. The maturities of the commodity hedge contracts coincide with the expected purchase of the commodities. These contracts were highly effective in hedging the variability in future cash flows attributable to changes in commodity prices during the three and six months ended March 31, 2017 and 2016.

The Company had the following outstanding contracts to hedge forecasted commodity purchases:

		Volume Outstanding as of
Commodity	Units	March 31, 2017	September 30, 2016
Copper	Pounds	7,350,000	5,849,000
Lead	Metric Tons	560	5,185
Aluminum	Metric Tons	2,349	2,620
Tin	Metric Tons	740	185

In September 2005, the Company entered into three forward treasury lock agreements to reduce the market risk associated with changes in interest rates associated with the Company’s anticipated fixed-rate note issuance to finance the acquisition of York International (cash flow hedge). The three forward treasury lock agreements, which had a combined notional amount of $1.3 billion, fixed a portion of the future interest cost for 5-year, 10-year and 30-year notes. The fair value of each treasury lock agreement, or the difference between the treasury lock reference rate and the fixed rate at time of note issuance, is amortized to interest expense over the life of the respective note issuance. In January 2006, in connection with the Company’s debt refinancing, the three forward treasury lock agreements were terminated.

Fair Value Hedges

The Company selectively uses interest rate swaps to reduce market risk associated with changes in interest rates for its fixed-rate bonds. As fair value hedges, the interest rate swaps and related debt balances are valued under a market approach using publicized swap curves. Changes in the fair value of the swap and hedged portion of the debt are recorded in the consolidated statements of income. In the third quarter of fiscal 2014, the Company entered into four fixed to floating interest rate swaps totaling $400 million to hedge the coupon of its 2.6% notes that matured in December 2016, three fixed to floating interest rate swaps totaling $300 million to hedge the coupon of its 1.4% notes maturing November 2017 and one fixed to floating interest rate swap totaling $150 million to hedge the coupon of its 7.125% notes maturing July 2017. In December 2016, the four remaining outstanding interest rate swaps were terminated. The Company had no interest rate swaps outstanding at March 31, 2017. There were eight interest rate swaps outstanding as of September 30, 2016.

Net Investment Hedges

The Company enters into foreign currency denominated debt obligations to selectively hedge portions of its net investment in non-U.S. subsidiaries. The currency effects of the debt obligations are reflected in the AOCI account within shareholders’ equity attributable to Johnson Controls ordinary shareholders where they offset gains and losses recorded on the Company’s net investments globally. At March 31, 2017, the Company had one billion euro and 485 million euro bonds designated as net investment hedges in the Company's net investment in Europe. At September 30, 2016, the Company had 37 billion yen of foreign denominated debt designated as net investment hedge in the Company's net investment in Japan and one billion euro and 500 million euro bonds designated as net investment hedges in the Company's net investment in Europe.

Derivatives Not Designated as Hedging Instruments

The Company selectively uses equity swaps to reduce market risk associated with certain of its stock-based compensation plans, such as its deferred compensation plans. These equity compensation liabilities increase as the Company’s stock price increases and decrease as the Company’s stock price decreases. In contrast, the value of the swap agreement moves in the opposite direction of these liabilities, allowing the Company to fix a portion of the liabilities at a stated amount. As of March 31, 2017 and September 30, 2016, the Company had no equity swaps outstanding.

The Company also holds certain foreign currency forward contracts which do not qualify for hedge accounting treatment. The change in fair value of foreign currency exchange derivatives not designated as hedging instruments under ASC 815 are recorded in the consolidated statements of income.

The following table presents the location and fair values of derivative instruments and hedging activities included in the Company’s consolidated statements of financial position (in millions):

	Derivatives and Hedging Activities Designated as Hedging Instruments under ASC 815				Derivatives and Hedging Activities Not Designated as Hedging Instruments under ASC 815
	March 31,		September 30,		March 31,		September 30,
	2017		2016		2017		2016
Other current assets
Foreign currency exchange derivatives	$	20	$	41	$	9	$	49
Commodity derivatives	3		4		—		—
Other noncurrent assets
Interest rate swaps	—		1		—		—
Total assets	$	23	$	46	$	9	$	49
Other current liabilities
Foreign currency exchange derivatives	$	5	$	48	$	15	$	18
Liabilities held for sale
Foreign currency exchange derivatives	—		—		—		5
Current portion of long-term debt
Fixed rate debt swapped to floating	—		551		—		—
Long-term debt
Foreign currency denominated debt	1,588		938		—		—
Fixed rate debt swapped to floating	—		301		—		—
Noncurrent liabilities held for sale
Foreign currency denominated debt	—		1,119		—		—
Total liabilities	$	1,593	$	2,957	$	15	$	23

Counterparty Credit Risk

The use of derivative financial instruments exposes the Company to counterparty credit risk. The Company has established policies and procedures to limit the potential for counterparty credit risk, including establishing limits for credit exposure and continually assessing the creditworthiness of counterparties. As a matter of practice, the Company deals with major banks worldwide having strong investment grade long-term credit ratings. To further reduce the risk of loss, the Company generally enters into International Swaps and Derivatives Association (ISDA) master netting agreements with substantially all of its counterparties. The Company's derivative contracts do not contain any credit risk related contingent features and do not require collateral or other security to be furnished by the Company or the counterparties. The Company's exposure to credit risk associated with its derivative instruments is measured on an individual counterparty basis, as well as by groups of counterparties that share similar attributes. The Company does not anticipate any non-performance by any of its counterparties, and the concentration of risk with financial institutions does not present significant credit risk to the Company.

The Company enters into ISDA master netting agreements with counterparties that permit the net settlement of amounts owed under the derivative contracts. The master netting agreements generally provide for net settlement of all outstanding contracts with a counterparty in the case of an event of default or a termination event. The Company has not elected to offset the fair value positions of the derivative contracts recorded in the consolidated statements of financial position. Collateral is generally not required of the Company or the counterparties under the master netting agreements. As of March 31, 2017, and September 30, 2016, no cash collateral was received or pledged under the master netting agreements.

The gross and net amounts of derivative assets and liabilities were as follows (in millions):

	Fair Value of Assets						Fair Value of Liabilities
	March 31,			September 30,			March 31,			September 30,
	2017			2016			2017			2016
Gross amount recognized	$	32		$	95		$	1,608		$	2,980
Gross amount eligible for offsetting	(16		)	(21		)	(16		)	(21		)
Net amount	$	16		$	74		$	1,592		$	2,959

Derivatives Impact on the Statements of Income and Statements of Comprehensive Income

The following table presents the effective portion of pre-tax gains (losses) recorded in other comprehensive income (loss) related to cash flow hedges for the three and six months ended March 31, 2017 and 2016 (in millions):

Derivatives in ASC 815 Cash Flow Hedging Relationships	Three Months Ended March 31,						Six Months Ended March 31,
	2017			2016			2017		2016
Foreign currency exchange derivatives	$	(2	)	$	(4	)	$	6	$	(6	)
Commodity derivatives	3			1			5		(1		)
Total	$	1		$	(3	)	$	11	$	(7	)

The following tables present the location and amount of the effective portion of pre-tax gains (losses) on cash flow hedges reclassified from AOCI into the Company’s consolidated statements of income for the three and six months ended March 31, 2017 and 2016 (in millions):

Derivatives in ASC 815 Cash Flow Hedging Relationships	Location of Gain (Loss) Reclassified from AOCI into Income	Three Months Ended March 31,					Six Months Ended March 31,
		2017		2016			2017		2016
Foreign currency exchange derivatives	Cost of sales	$	8	$	4		$	16	$	9
Foreign currency exchange derivatives	Loss from discontinued operations	—		(9		)	—		(14		)
Commodity derivatives	Cost of sales	3		(5		)	4		(9		)
Forward treasury locks	Net financing charges	—		1			—		1
Total		$	11	$	(9	)	$	20	$	(13	)

The following table presents the location and amount of pre-tax gains (losses) on fair value hedges recognized in the Company’s consolidated statements of income for the three and six months ended March 31, 2017 and 2016 (in millions):

Derivatives in ASC 815 Fair Value Hedging Relationships	Location of Gain (Loss) Recognized in Income on Derivative	Three Months Ended March 31,					Six Months Ended March 31,
		2017		2016			2017			2016
Interest rate swap	Net financing charges	$	—	$	2		$	(1	)	$	(3	)
Fixed rate debt swapped to floating	Net financing charges	—		(2		)	2			3
Total		$	—	$	—		$	1		$	—

The following table presents the location and amount of pre-tax gains (losses) on derivatives not designated as hedging instruments recognized in the Company’s consolidated statements of income for the three and six months ended March 31, 2017 and 2016 (in millions):

		Amount of Gain (Loss) Recognized in Income on Derivative
Derivatives Not Designated as Hedging Instruments under ASC 815	Location of Gain (Loss) Recognized in Income on Derivative	Three Months Ended March 31,					Six Months Ended March 31,
		2017		2016			2017			2016
Foreign currency exchange derivatives	Cost of sales	$	2	$	1		$	3		$	3
Foreign currency exchange derivatives	Net financing charges	5		(7		)	9			(7		)
Foreign currency exchange derivatives	Income tax provision	—		—			(3		)	—
Foreign currency exchange derivatives	Income (loss) from discontinued operations	—		(8		)	5			(11		)
Equity swap	Selling, general and administrative	—		(2		)	—			(8		)
Total		$	7	$	(16	)	$	14		$	(23	)

The effective portion of pre-tax gains (losses) recorded in foreign currency translation adjustment ("CTA") within other comprehensive income (loss) related to net investment hedges were $(19) million and $1 million for the for the three months ended March 31, 2017 and 2016, respectively. The effective portion of pre-tax gains (losses) recorded in CTA within other comprehensive income (loss) related to net investment hedges were $28 million and $16 million for the for the six months ended March 31, 2017 and 2016, respectively. For the three and six months ended March 31, 2017 and 2016, no gains or losses were reclassified from CTA into income for the Company’s outstanding net investment hedges, and no gains or losses were recognized in income for the ineffective portion of cash flow hedges.