Meritor Acquisition and 2022 Financial Results
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a practical expedient, we have elected to recognize these costs of obtaining a contract as an expense when the related contract period is less than one year. When the period
exceeds one year, this asset is amortized over the life of the contract. We did not have any material capitalized balances at December 31, 2022 or 2021.
Extended Warranty
We sell extended warranty coverage on most of our engines and on certain components. We consider a warranty to be extended coverage in any of the following situations:
When a warranty is sold separately or is optional (extended coverage contracts, for example) or
When a warranty provides additional services.
The consideration collected is initially deferred and is recognized as revenue in proportion to the costs expected to be incurred in performing services over the contract period.
We compare the remaining deferred revenue balance quarterly to the estimated amount of future claims under extended warranty programs and provide an additional accrual
when the deferred revenue balance is less than expected future costs.
Foreign Currency Transactions and Translation
We translate assets and liabilities of foreign entities to U.S. dollars, where the local currency is the functional currency, at month-end exchange rates. We translate income and
expenses to U.S. dollars using weighted-average exchange rates. We record adjustments resulting from translation in a separate component of accumulated other comprehensive
loss (AOCL) and include the adjustments in net income only upon sale, loss of controlling financial interest or liquidation of the underlying foreign investment.
Foreign currency transaction gains and losses are included in current net income. For foreign entities where the U.S. dollar is the functional currency, including those operating
in highly inflationary economies when applicable, we remeasure non-monetary balances and the related income statement amounts using historical exchange rates. We include
the resulting gains and losses in income, including the effect of derivatives in our Consolidated Statements of Net Income, which combined with transaction gains and losses
amounted to a net loss of $8 million and a net gain of $2 million and $4 million for the years ended December 31, 2022, 2021 and 2020, respectively.
Fair Value Measurements
A three-level valuation hierarchy, based upon the observable and unobservable inputs, is used for fair value measurements. Observable inputs reflect market data obtained from
independent sources, while unobservable inputs reflect market assumptions based on the best evidence available. These two types of inputs create the following fair value
hierarchy:
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Level 1 - Quoted prices for identical instruments in active markets;
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Level 2 - Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived
valuations whose significant inputs are observable; and
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Level 3 - Instruments whose significant inputs are unobservable.
Derivative Instruments
We make use of derivative instruments in foreign exchange, commodity price and interest rate hedging programs. Derivatives currently in use are foreign currency forward
contracts, commodity swap and interest rate swaps and locks. These contracts are used strictly for hedging and not for speculative purposes.
Due to our international business presence, we are exposed to foreign currency exchange risk. We transact in foreign currencies and have assets, liabilities and investments in
subsidiaries denominated in foreign currencies. Consequently, our income experiences some volatility related to movements in foreign currency exchange rates. In order to
benefit from global diversification and after considering naturally offsetting currency positions, we enter into foreign currency forward contracts to minimize our existing
exposures (recognized assets and liabilities) and hedge forecasted transactions. Foreign currency forward contracts are designated and qualify as foreign currency cash flow
hedges. The unrealized gain or loss on the forward contract is deferred and reported as a component of AOCL. When the hedged forecasted transaction (sale or purchase)
occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged
transaction affects income. At December 31, 2022 and 2021, realized and unrealized gains and losses related to these hedges were not material to our financial statements.
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