Fair value hedges For derivatives designated as hedges of the exposure to changes in the fair value of a recognized asset or liability or a firm commitment (referred to as fair value hedges), the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. The effect of that accounting is to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value.

Interest rate swaps under which the Company agrees to pay variable rates of interest are designated as fair value hedges of fixed-rate debt. The Company also holds forward-starting interest rate swap agreements to fix the cost of funding a firmly committed lease for which payment terms are determined in advance of funding. This hedge relationship mitigates the changes in fair value of the hedged portion of the firm commitment caused by changes in interest rates. The net change in fair value of the derivatives and the hedged items is reported in earnings. For the year ended December 31, 2002, ineffectiveness losses of $8 were recorded in interest expense related to the forward-starting interest rate swaps. Ineffectiveness was insignificant for the year ended December 31, 2001.

For the years ended December 31, 2002 and 2001, $5 and $1 of gains related to the basis adjustment of certain terminated interest rate swaps were amortized to earnings. During 2003, the Company expects to amortize $8 of gains from the amount recorded in the basis adjustment of certain terminated fair value hedge relationships to earnings.

Cash flow hedges For derivatives designated as hedges of the exposure to variable cash flows of a forecasted transaction (referred to as cash flow hedges), the effective portion of the derivative’s gain or loss is initially reported in shareholders’ equity (as a component of accumulated other comprehensive income) and subsequently reclassified into earnings. The ineffective portion of the gain or loss is reported in earnings immediately.

Cash flow hedges used by the Company include certain interest rate swaps, foreign currency forward contracts, and commodity purchase contracts. Interest rate swap contracts under which the Company agrees to pay fixed rates of interest are designated as cash flow hedges of variable-rate debt obligations. The Company uses foreign currency forward contracts to manage currency risk associated with certain forecasted transactions, specifically sales and purchase commitments made in foreign currencies. The Company’s foreign currency forward contracts hedge forecasted transactions principally occurring up to five years in the future. Commodity derivatives, such as fixed-price purchase commitments, are used by the Company to hedge against potentially unfavorable price changes for items used in production.

The Company entered into certain commitments to purchase electricity at fixed prices over the next two years, a percentage of which are designated as cash flow hedges. The changes in fair value of the percentage of the commodity derivatives that are not designated in a hedging relationship are recorded in earnings immediately. There were no significant changes in fair value reported in earnings for the years ended December 31, 2002 and 2001.

At December 31, 2002 and 2001, net losses of $74 ($47 net of tax) and $172 ($108 net of tax) were recorded in accumulated other comprehensive income associated with the Company’s cash flow hedging transactions. For the years ended December 31, 2002 and 2001, losses of $46 and $14 (net of tax) were reclassified to cost of products and services. During the next year, the Company expects to reclassify to cost of products and services a loss of $22 (net of tax).

Derivative financial instruments not receiving hedge treatment The Company also holds certain non-hedging instruments, such as interest exchange agreements, interest rate swaps, warrants, conversion feature of convertible debt, and foreign currency forward contracts. The changes in fair value of these instruments are recorded in earnings. For the years ended December 31, 2002 and 2001, these non-hedging instruments resulted in gains of $25 and $15.

Note 20 – Arrangements with Off-Balance Sheet Risk

The Company is a party to certain arrangements with off-balance sheet risk in the normal course of business, as discussed below.

Guarantees In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of the Indebtedness of Others, which clarifies the requirements of SFAS No. 5, Accounting for Contingencies, relating to a guarantor’s accounting for and disclosures of certain guarantees issued. Refer to Note 2 for more information about the impact of FIN 45 on the Company’s financial statements.

Third-party guarantees The following tables provide quantitative data regarding the Company’s third-party guarantees. The maximum potential payments represent a “worst-case scenario,” and do not necessarily reflect results expected by the Company. Estimated proceeds from collateral and recourse represent the anticipated values of assets the Company could liquidate or receive from other parties to offset its payments under guarantees. The carrying amount of liabilities recorded on the balance sheet reflects the Company’s best estimate of future payments it may incur as part of fulfilling its guarantee obligations. Portions of certain liabilities were established in prior periods as part of the Company’s special charges due to the events of September 11, 2001.