Note 1: Basis of Presentation

Our consolidated financial statements include the accounts of Textron Inc. and its majority-owned subsidiaries. We have prepared these unaudited consolidated financial statements in accordance with accounting principles generally accepted in the U.S. for interim financial information. Accordingly, these interim financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements. The consolidated interim financial statements included in this quarterly report should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the year ended January 1, 2011. In the opinion of management, the interim financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for the fair presentation of our consolidated financial position, results of operations and cash flows for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Certain prior period amounts have been reclassified to conform with the current year presentation.

Our financings are conducted through two separate borrowing groups. The Manufacturing group consists of Textron Inc. consolidated with its majority-owned subsidiaries that operate in the Cessna, Bell, Textron Systems and Industrial segments. The Finance group, which also is the Finance segment, consists of Textron Financial Corporation (TFC), its consolidated subsidiaries and three other finance subsidiaries owned by Textron Inc. We designed this framework to enhance our borrowing power by separating the Finance group. Our Manufacturing group operations include the development, production and delivery of tangible goods and services, while our Finance group provides financial services. Due to the fundamental differences between each borrowing group’s activities, investors, rating agencies and analysts use different measures to evaluate each group’s performance. To support those evaluations, we present balance sheet and cash flow information for each borrowing group within the consolidated financial statements. All significant intercompany transactions are eliminated from the consolidated financial statements, including retail and wholesale financing activities for inventory sold by our Manufacturing group and financed by our Finance group.

Note 2: Special Charges

In 2010, special charges included restructuring costs incurred under a restructuring program that was completed at the end of 2010. There were no special charges in the first quarter of 2011.

Restructuring costs by segment and type for the three months ended April 3, 2010 are as follows:

		Severance				Contract
(In millions)		Costs				Terminations				Total
Cessna		$	8			$	2			$	10
Bell			1				—				1
Finance			3				—				3
Corporate			(2	)			—				(2	)
		$	10			$	2			$	12

An analysis of our restructuring reserve activity is summarized below:

		Severance				Contract
(In millions)		Costs				Terminations				Total
Balance at January 1, 2011		$	57			$	5			$	62
Cash paid			(23	)			(1	)			(24	)
Balance at April 2, 2011		$	34			$	4			$	38

Note 3: Retirement Plans

We provide defined benefit pension plans and other postretirement benefits to eligible employees. The components of net periodic benefit cost for these plans are as follows:

										Postretirement Benefits
		Pension Benefits								Other Than Pensions
		April 2,				April 3,				April 2,				April 3,
(In millions)		2011				2010				2011				2010
Three Months Ended
Service cost		$	32			$	31			$	2			$	2
Interest cost			82				79				8				8
Expected return on plan assets			(98	)			(92	)			—				—
Amortization of prior service cost (credit)			4				4				(1	)			(1	)
Amortization of net loss			19				9				3				3
Net periodic benefit cost		$	39			$	31			$	12			$	12

Note 4: Share-Based Compensation

Share-based compensation expense includes restricted stock and stock option awards, as well as performance share units, restricted stock units, and deferred income plan stock unit awards which are payable in cash. The compensation expense we recorded in net income (loss) for our share-based compensation plans is as follows:

		Three Months Ended
		April 2,				April 3,
(In millions)		2011				2010
Compensation expense		$	36			$	23
Hedge income			—				(2	)
Income tax benefit			(13	)			(9	)
Total net compensation cost included in net income (loss)		$	23			$	12

Stock Options

The stock option compensation cost calculated under the fair value approach is recognized over the vesting period of the stock options. The weighted-average fair value of options granted per share was $10 and $7 in the first quarter of 2011 and 2010, respectively. We estimate the fair value of options granted on the date of grant using the Black-Scholes option-pricing model. Expected volatilities consider implied volatilities from traded options on our common stock, historical volatilities and other factors. We use historical data to estimate option exercise behavior, adjusted to reflect anticipated changes in expected life. The weighted-average assumptions used in our Black-Scholes option-pricing model for awards issued during the respective periods are as follows:

		Three Months Ended
		April 2,				April 3,
		2011				2010
Dividend yield			0.3	%			0.4	%
Expected volatility			38.0	%			37.0	%
Risk-free interest rate			2.4	%			2.6	%
Expected lives (In years)			5.5				5.5

Stock option activity for the first quarter of 2011 is as follows:

										Weighted-
										Average
		Shares				Weighted-				Remaining
		Under				Average				Contractual
		Options				Exercise				Life
		(In thousands)				Price				(In years)
Outstanding at beginning of period			6,926			$	28.15				5.0
Granted			2,656				26.25
Exercised			(76	)			18.59
Canceled, expired or forfeited			(107	)			28.69
Outstanding at end of period			9,399			$	27.68				7.0
Exercisable at end of period			4,719			$	31.48				4.7

At April 2, 2011, our outstanding and exercisable options had an aggregate intrinsic value of $40 million and $20 million, respectively.

Restricted Stock Units

The 2011 activity for restricted stock units payable in stock and for restricted stock units payable in cash is provided below:

		Units Payable in Stock								Units Payable in Cash
						Weighted-								Weighted-
		Number of				Average Grant				Number of				Average Grant
(Shares in thousands)		Shares				Date Fair Value				Shares				Date Fair Value
Outstanding at beginning of year, nonvested			762			$	47.55				3,472			$	14.60
Granted			278				26.25				663				26.25
Vested			(290	)			(46.34	)			(769	)			(12.92	)
Forfeited			(21	)			(48.75	)			(89	)			(15.49	)
Outstanding at end of period, nonvested			729			$	39.87				3,277			$	17.32

Performance Share Units

The fair value of share-based compensation awards accounted for as liabilities includes performance share units. The fair value of these awards is based on the trading price of our common stock, less adjustments to reflect the fair value of certain awards for which dividends are not paid or accrued until vested, and is remeasured at each reporting period date. The 2011 activity for our performance share units is as follows:

						Weighted-
		Number of				Average Grant
(Shares in thousands)		Shares				Date Fair Value
Outstanding at beginning of year, nonvested			1,897			$	9.59
Granted			411				26.25
Outstanding at end of period, nonvested			2,308			$	12.56

Share-Based Compensation Awards

The value of the share-based compensation awards that vested and/or were paid during the respective periods is as follows:

		Three Months Ended
		April 2,				April 3,
(In millions)		2011				2010
Subject only to service conditions:
Value of shares, options or units vested		$	34			$	36
Intrinsic value of cash awards paid			20				8
Subject to performance vesting conditions:
Value of units vested			—				—
Intrinsic value of cash awards paid			1				5
Intrinsic value of amounts paid under Deferred Income Plan			—				8

Note 5: Comprehensive Income

Our comprehensive income, net of taxes, is provided below:

		Three Months Ended
		April 2,				April 3,
(In millions)		2011				2010
Net income (loss)		$	29			$	(8	)
Other comprehensive income (loss):
Recognition of prior service cost and unrealized losses on pension and postretirement benefits			18				10
Deferred gains on hedge contracts			6				7
Foreign currency translation and other			12				(9	)
Comprehensive income		$	65			$	—

Note 6: Earnings Per Share and Shareholders’ Equity

Earnings Per Share

We calculate basic and diluted earnings per share (EPS) based on net income, which approximates income available to common shareholders for each period. Basic earnings per share is calculated using the two-class method, which includes the weighted-average number of common shares outstanding during the period and restricted stock units to be paid in stock that are deemed participating securities as they provide nonforfeitable rights to dividends. Diluted earnings per share considers the dilutive effect of all potential future common stock, including stock options, restricted stock units and the shares that could be issued upon the conversion of our 4.50% Convertible Notes and upon the exercise of the related warrants. The convertible note call options purchased in connection with the issuance of the 4.50% Convertible Notes are excluded from the calculation of diluted EPS as their impact is always anti-dilutive.

Upon conversion of our 4.50% Convertible Notes, as described in Note 9, the principal amount would be settled in cash and the excess of the conversion value, as defined, over the principal amount may be settled in cash and/or shares of our common stock. Therefore, only the shares of our common stock potentially issuable with respect to the excess of the notes’ conversion value over the principal amount, if any, are considered as dilutive potential common shares for purposes of calculating diluted EPS.

The weighted-average shares outstanding for basic and diluted earnings per share are as follows:

		Three Months Ended
		April 2,				April 3,
(In thousands)		2011				2010
Basic weighted-average shares outstanding			276,358				273,174
Dilutive effect of Convertible Notes, warrants, stock options and restricted stock units			42,761				—
Diluted weighted-average shares outstanding			319,119				273,174

Stock options to purchase 4 million and 7 million shares of common stock outstanding are excluded from our calculation of diluted weighted-average shares outstanding for the three months ended April 2, 2011 and April 3, 2010, respectively, as the exercise prices were greater than the average market price of our common stock for the periods. These securities could potentially dilute earnings per share in the future.

For the three months ended April 3, 2010, the potential dilutive effect of 28 million weighted-average shares of Convertible Notes, warrants, stock options and restricted stock units was excluded from the computation of diluted weighted-average shares outstanding as the shares would have an anti-dilutive effect on the loss from continuing operations.

Note 7: Accounts Receivable and Finance Receivables

Accounts Receivable

Accounts receivable is composed of the following:

		April 2,				January 1,
(In millions)		2011				2011
Commercial		$	607			$	496
U.S. Government contracts			321				416
			928				912
Allowance for doubtful accounts			(18	)			(20	)
		$	910			$	892

We have unbillable receivables on U.S. Government contracts that arise when the revenues we have appropriately recognized based on performance cannot be billed yet under terms of the contract. Unbillable receivables within accounts receivable totaled $155 million at April 2, 2011 and $195 million at January 1, 2011.

Finance Receivables

Finance receivables by product line, which includes both finance receivables held for investment and finance receivables held for sale, are presented in the following table:

(Dollars in millions)		April 2, 2011								January 1, 2011
Aviation		$	2,028				49	%		$	2,120				46	%
Golf equipment			192				4				212				5
Golf mortgage			818				20				876				19
Timeshare			622				15				894				19
Structured capital			317				8				317				7
Other liquidating			164				4				207				4
Total finance receivables			4,141				100	%			4,626				100	%
Less: Allowance for losses			338								342
Less: Finance receivables held for sale			237								413
Total finance receivables held for investment, net		$	3,566							$	3,871

Credit Quality Indicators and Nonaccrual Finance Receivables

We internally assess the quality of our finance receivables held for investment portfolio based on a number of key credit quality indicators and statistics such as delinquency, loan balance to collateral value, the liquidity position of individual borrowers and guarantors, debt service coverage in the golf mortgage product line and default rates of our notes receivable collateral in the timeshare product line. Because many of these indicators are difficult to apply across an entire class of receivables, we evaluate individual loans on a quarterly basis and classify these loans/portfolios into three categories based on the key credit quality indicators for the individual loan. These three categories are performing, watchlist and nonaccrual.

We classify finance receivables held for investment as nonaccrual if credit quality indicators suggest full collection is doubtful. In addition, we automatically classify accounts as nonaccrual that are contractually delinquent by more than three months unless collection is not doubtful. Cash payments on nonaccrual accounts, including finance charges, generally are applied to reduce the net investment balance. We resume the accrual of interest when the loan becomes contractually current through payment according to the original terms of the loan or, if a loan has been modified, following a period of performance under the terms of the modification, provided we conclude that collection of all principal and interest is no longer doubtful. Previously suspended interest income is recognized at that time.

Accounts are classified as watchlist when credit quality indicators have deteriorated as compared with typical underwriting criteria, and we believe collection of full principal and interest is probable but not certain. All other finance receivables held for investment that do not meet the watchlist or nonaccrual categories are classified as performing.

A summary of finance receivables held for investment categorized based on the internally assigned credit quality indicators discussed above is as follows:

		April 2, 2011																January 1, 2011
(In millions)		Performing				Watchlist				Nonaccrual				Total				Performing				Watchlist				Nonaccrual				Total
Aviation		$	1,641			$	219			$	168			$	2,028			$	1,713			$	238			$	169			$	2,120
Golf equipment			122				46				24				192				138				51				23				212
Golf mortgage			205				200				235				640				163				303				219				685
Timeshare			166				40				357				563				222				77				382				681
Structured capital			290				27				—				317				290				27				—				317
Other liquidating			98				14				52				164				130				11				57				198
Total		$	2,522			$	546			$	836			$	3,904			$	2,656			$	707			$	850			$	4,213
% of Total			64.6	%			14.0	%			21.4	%							63.0	%			16.8	%			20.2	%

We measure delinquency based on the contractual payment terms of our loans and leases. In determining the delinquency aging category of an account, any/all principal and interest received is applied to the most past-due principal and/or interest amounts due. If a significant portion of the contractually due payment is delinquent, the entire finance receivable balance is reported in accordance with the most past-due delinquency aging category.

Finance receivables held for investment by delinquency aging category is summarized in the tables below:

		Less Than												Greater Than
		31 Days				31-60 Days				61-90 Days				90 Days
(In millions)		Past Due				Past Due				Past Due				Past Due				Total
April 2, 2011
Aviation		$	1,857			$	101			$	28			$	42			$	2,028
Golf equipment			162				10				4				16				192
Golf mortgage			527				11				3				99				640
Timeshare			326				38				80				119				563
Structured capital			317				—				—				—				317
Other liquidating			135				2				1				26				164
Total		$	3,324			$	162			$	116			$	302			$	3,904
January 1, 2011
Aviation		$	1,964			$	67			$	41			$	48			$	2,120
Golf equipment			171				13				9				19				212
Golf mortgage			543				12				7				123				685
Timeshare			533				14				6				128				681
Structured capital			317				—				—				—				317
Other liquidating			166				2				1				29				198
Total		$	3,694			$	108			$	64			$	347			$	4,213

At April 2, 2011, accrual status loans that were 90 days past due totaled $8 million. We had no accrual status loans that were 90 days past due at January 1, 2011. At April 2, 2011, the 60+ days contractual delinquency as a percentage of finance receivables held for investment was 10.71%, compared with 9.77% at January 1, 2011.

Impaired Loans

We evaluate individual finance receivables held for investment in non-homogeneous portfolios and larger accounts in homogeneous loan portfolios for impairment on a quarterly basis. Finance receivables classified as held for sale are reflected at the lower of cost or fair value and are excluded from these evaluations.

A finance receivable is considered impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement based on our review of the credit quality indicators discussed above. Impaired finance receivables include both nonaccrual accounts and accounts for which full collection of principal and interest remains probable, but the account’s original terms have been, or are expected to be, significantly modified. If the modification specifies an interest rate equal to or greater than a market rate for a finance receivable with comparable risk, the account is not considered impaired in years subsequent to the modification. No significant interest income was recognized on impaired loans in the first quarter of 2011 or 2010.

The average recorded investment in impaired loans for the first quarter of 2011 and 2010 are provided below:

						Golf				Golf								Other
(In millions)		Aviation				Equipment				Mortgage				Timeshare				Liquidating				Total
For the three months ended April 2, 2011
Impaired loans with a related allowance for losses recorded		$	145			$	5			$	190			$	341			$	18			$	699
Impaired loans with no related allowance for losses recorded			19				—				90				33				22				164
Total		$	164			$	5			$	280			$	374			$	40			$	863
For the three months ended April 3, 2010
Impaired loans with a related allowance for losses recorded		$	240			$	3			$	186			$	352			$	27			$	808
Impaired loans with no related allowance for losses recorded			12				1				111				54				63				241
Total		$	252			$	4			$	297			$	406			$	90			$	1,049

A summary of impaired finance receivables and related allowance for losses is provided below:

						Golf				Golf								Other
(In millions)		Aviation				Equipment				Mortgage				Timeshare				Liquidating				Total
April 2, 2011
Impaired loans with a related allowance for losses recorded:
Recorded investment		$	144			$	6			$	205			$	327			$	19			$	701
Unpaid principal balance			146				6				215				367				25				759
Related allowance			50				1				45				102				4				202
Impaired loans with no related allowance for losses recorded:
Recorded investment			20				—				94				41				19				174
Unpaid principal balance			20				—				98				41				75				234
Total impaired loans:
Recorded investment			164				6				299				368				38				875
Unpaid principal balance			166				6				313				408				100				993
Related allowance			50				1				45				102				4				202
January 1, 2011
Impaired loans with a related allowance for losses recorded:
Recorded investment		$	147			$	4			$	175			$	355			$	16			$	697
Unpaid principal balance			144				5				178				385				15				727
Related allowance			45				2				39				102				3				191
Impaired loans with no related allowance for losses recorded:
Recorded investment			17				—				138				69				30				254
Unpaid principal balance			21				—				146				74				89				330
Total impaired loans:
Recorded investment			164				4				313				424				46				951
Unpaid principal balance			165				5				324				459				104				1,057
Related allowance			45				2				39				102				3				191

Allowance for Losses We maintain the allowance for losses on finance receivables held for investment at a level considered adequate to cover inherent losses in the portfolio based on management’s evaluation and analysis by product line. For larger balance accounts specifically identified as impaired, including large accounts in homogeneous portfolios, a reserve is established based on comparing the carrying value with either a) the expected future cash flows, discounted at the finance receivable’s effective interest rate; or b) the fair value, if the finance receivable is collateral dependent. The expected future cash flows consider collateral value; financial performance and liquidity of our borrower; existence and financial strength of guarantors; estimated recovery costs, including legal expenses; and costs associated with the repossession/foreclosure and eventual disposal of collateral. When there is a range of potential outcomes, we perform multiple discounted cash flow analyses and weight the outcomes based on their relative likelihood of occurrence.

The evaluation of our portfolios is inherently subjective, as it requires estimates, including the amount and timing of future cash flows expected to be received on impaired finance receivables and the underlying collateral, which may differ from actual results. While our analysis is specific to each individual account, the most critical factors included in this analysis vary by product line. For the aviation product line, these factors include industry valuation guides, physical condition of the aircraft, payment history, and existence and financial strength of guarantors. For the golf equipment line, the critical factors are the age and condition of the collateral, while the factors for the golf mortgage line include historical golf course, hotel or marina cash flow performance; estimates of golf rounds and price per round or occupancy and room rates; market discount and capitalization rates; and existence and financial strength of guarantors. For the timeshare product line, the critical factors are the historical performance of consumer notes receivable collateral, real estate valuations, operating expenses of the borrower, the impact of bankruptcy court rulings on the value of the collateral, legal and other professional expenses and borrower’s access to capital.

We also establish an allowance for losses by product line to cover probable but specifically unknown losses existing in the portfolio. For homogeneous portfolios, including the aviation and golf equipment product lines, the allowance is established as a percentage of non-recourse finance receivables, which have not been identified as requiring specific reserves. The percentage is based on a combination of factors, including historical loss experience, current delinquency and default trends, collateral values, and both general economic and specific industry trends. For non-homogeneous portfolios, including the golf mortgage and timeshare product lines, the allowance is established as a percentage of watchlist balances, as defined on page 11, which represents a combination of assumed default likelihood and loss severity based on historical experience, industry trends and collateral values. In establishing our allowance for losses to cover accounts not specifically identified, the most critical factors for the aviation product line include the collateral value of the portfolio, historical default experience and delinquency trends; for golf equipment, factors considered include historical loss experience and delinquency trends; and for golf mortgage, factors include an evaluation of individual loan credit quality indicators such as delinquency, loan balance to collateral value, debt service coverage, existence and financial strength of guarantors, historical progression from watchlist to nonaccrual status and historical loss severity. For the timeshare product line, we evaluate individual loan credit quality indicators such as borrowing base shortfalls for revolving notes receivable facilities, default rates of our notes receivable collateral, borrower’s access to capital, historical progression from watchlist to nonaccrual status and estimates of loss severity based on analysis of impaired loans in the product line.

Finance receivables held for investment are written down to the fair value (less estimated costs to sell) of the related collateral at the earlier of the date when the collateral is repossessed or when no payment has been received for six months unless management deems the receivable collectable. Finance receivables are charged off when the remaining balance is deemed to be uncollectable.

A rollforward of the allowance for losses on finance receivables held for investment and a summary of its composition, based on how the underlying finance receivables are evaluated for impairment, is presented below. The finance receivables reported in the following table specifically exclude $279 million and $283 million of leveraged leases at April 2, 2011 and April 3, 2010, respectively, in accordance with authoritative accounting standards.

																		Structured
																		Capital and
						Golf				Golf								Other
(In millions)		Aviation				Equipment				Mortgage				Timeshare				Liquidating				Total
For the three months ended April 2, 2011
Allowance for losses
Beginning balance		$	107			$	16			$	79			$	106			$	34			$	342
Provision for losses			11				—				(1	)			—				2				12
Net charge-offs and transfers			(8	)			(3	)			(3	)			(1	)			(1	)			(16	)
Ending balance		$	110			$	13			$	75			$	105			$	35			$	338
Ending balance based on individual evaluations			50				1				45				102				4				202
Ending balance based on collective evaluation			60				12				30				3				31				136
Finance receivables
Individually evaluated for impairment		$	164			$	6			$	299			$	368			$	38			$	875
Collectively evaluated for impairment			1,864				186				341				195				164				2,750
Balance at end of period		$	2,028			$	192			$	640			$	563			$	202			$	3,625
For the three months ended April 3, 2010
Allowance for losses
Beginning balance		$	114			$	9			$	65			$	79			$	74			$	341
Provision for losses			13				4				14				15				9				55
Net charge-offs and transfers			(10	)			(2	)			(11	)			—				(8	)			(31	)
Ending balance		$	117			$	11			$	68			$	94			$	75			$	365
Ending balance based on individual evaluations			52				1				43				77				1				174
Ending balance based on collective evaluation			65				10				25				17				74				191
Finance receivables
Individually evaluated for impairment		$	232			$	6			$	343			$	434			$	104			$	1,119
Collectively evaluated for impairment			2,171				169				502				768				553				4,163
Balance at end of period		$	2,403			$	175			$	845			$	1,202			$	657			$	5,282

Note 8: Inventories

		April 2,				January 1,
(In millions)		2011				2011
Finished goods		$	922			$	784
Work in process			2,261				2,125
Raw materials			456				506
			3,639				3,415
Progress/milestone payments			(1,186	)			(1,138	)
		$	2,453			$	2,277

Note 9: Debt

On May 5, 2009, we issued $600 million of 4.5% Convertible Notes with a maturity date of May 1, 2013 and concurrently purchased call options to acquire our common stock and sold warrants to purchase our common stock for the purpose of reducing the potential dilutive effect to our shareholders and/or our cash outflow upon the conversion of the Convertible Notes. For more information on these transactions, see Note 8 to the Consolidated Financial Statements in Textron’s 2010 Annual Report on Form 10-K. For at least 20 trading days during the 30 consecutive trading days ended March 31, 2011, our common stock price exceeded the $17.06 per share conversion threshold price set forth for these Convertible Notes. Accordingly, the notes are convertible at the holder’s option through June 30, 2011. We may deliver shares of common stock, cash or a combination of cash and shares of common stock in satisfaction of our obligations upon conversion of the Convertible Notes. We intend to settle the face value of the Convertible Notes in cash. Based on an April 2, 2011 stock price of $27.40, the “if converted value” exceeds the face amount of the notes by $652.6 million; however, after giving effect to the exercise of the call options and warrants, the incremental cash or share settlement in excess of the face amount would result in either a 19 million net share issuance or a cash payment of $532.6 million, or a combination of cash and stock, at our option. We have continued to classify these Convertible Notes as long-term based on our intent and ability to maintain the debt outstanding for at least one year through the use of various funding sources available to us.

Note 10: Accrued Liabilities

We provide limited warranty and product maintenance programs, including parts and labor, for certain products for periods ranging from one to five years. Changes in our warranty and product maintenance liabilities are as follows:

		Three Months Ended
		April 2,				April 3,
(In millions)		2011				2010
Accrual at the beginning of period		$	242			$	263
Provision			57				38
Settlements			(64	)			(58	)
Adjustments to prior accrual estimates			(6	)			(3	)
Accrual at the end of period		$	229			$	240

Note 11: Commitments and Contingencies

We are subject to legal proceedings and other claims arising out of the conduct of our business, including proceedings and claims relating to commercial and financial transactions; government contracts; compliance with applicable laws and regulations; production partners; product liability; employment; and environmental, safety and health matters. Some of these legal proceedings and claims seek damages, fines or penalties in substantial amounts or remediation of environmental contamination. As a government contractor, we are subject to audits, reviews and investigations to determine whether our operations are being conducted in accordance with applicable regulatory requirements. Under federal government procurement regulations, certain claims brought by the U.S. Government could result in our being suspended or debarred from U.S. Government contracting for a period of time. On the basis of information presently available, we do not believe that existing proceedings and claims will have a material effect on our financial position or results of operations.

Note 12. Derivative Instruments and Fair Value Measurements

We measure fair value at the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We prioritize the assumptions that market participants would use in pricing the asset or liability into a three-tier fair value hierarchy. This fair value hierarchy gives the highest priority (Level 1) to quoted prices in active markets for identical assets or liabilities and the lowest priority (Level 3) to unobservable inputs in which little or no market data exist, requiring companies to develop their own assumptions. Observable inputs that do not meet the criteria of Level 1 and include quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets and liabilities in markets that are not active are categorized as Level 2. Level 3 inputs are those that reflect our estimates about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances. Valuation techniques for assets and liabilities measured using Level 3 inputs may include methodologies such as the market approach, the income approach or the cost approach and may use unobservable inputs such as projections, estimates and management’s interpretation of current market data. These unobservable inputs are utilized only to the extent that observable inputs are not available or cost-effective to obtain.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The assets and liabilities that are recorded at fair value on a recurring basis consist primarily of our derivative financial instruments, which are categorized as Level 2 in the fair value hierarchy. The notional and fair value amounts of these instruments that are designated as hedging instruments are provided below:

						Notional Amount								Asset (Liability)
						April 2,				January 1,				April 2,				January 1,
(In millions)		Borrowing Group				2011				2011				2011				2011
Assets
Interest rate exchange contracts*		Finance				$	473			$	628			$	28			$	34
Investment in other marketable securities		Finance					26				51				26				51
Foreign currency exchange contracts		Manufacturing					655				534				43				39
Total						$	1,154			$	1,213			$	97			$	124
Liabilities
Interest rate exchange contracts*		Finance				$	469			$	451			$	(3	)		$	(6	)
Foreign currency exchange contracts		Manufacturing					86				101				(2	)			(2	)
Total						$	555			$	552			$	(5	)		$	(8	)

The fair values of derivative instruments for the Manufacturing group are included in either other current assets or accrued liabilities in our balance sheet. For the Finance group, these instruments are included in either other assets or other liabilities.

The Finance group’s interest rate exchange contracts are not exchange traded and are measured at fair value utilizing widely accepted, third-party developed valuation models. The actual terms of each individual contract are entered into a valuation model, along with interest rate and foreign exchange rate data, which is based on readily observable market data published by third-party leading financial news and data providers. Credit risk is factored into the fair value of these assets and liabilities based on the differential between both our credit default swap spread for liabilities and the counterparty’s credit default swap spread for assets as compared with a standard AA-rated counterparty; however, this had no significant impact on the valuation at April 2, 2011.

Foreign currency exchange contracts are measured at fair value using the market method valuation technique. The inputs to this technique utilize current foreign currency exchange forward market rates published by third-party leading financial news and data providers. These are observable data that represent the rates that the financial institution uses for contracts entered into at that date; however, they are not based on actual transactions so they are classified as Level 2.

Investments in other marketable securities represent investments in notes issued by securitization trusts that purchase timeshare notes receivables from timeshare developers and are classified as available for sale. Fair value for these notes was determined based on bids received from prospective purchasers and observable market inputs for similar securitization interests in markets that are relatively inactive compared with the market environment in which they were originally issued.

Fair Value Hedges

Our Finance group enters into interest rate exchange contracts to mitigate exposure to changes in the fair value of its fixed-rate receivables and debt due to fluctuations in interest rates. By using these contracts, we are able to convert our fixed-rate cash flows to floating-rate cash flows. The amount of ineffectiveness on our fair value hedges and the gain (loss) recorded in the Consolidated Statements of Operations were both insignificant in the first quarter of 2011 and 2010.

Cash Flow Hedges

We manufacture and sell our products in a number of countries throughout the world, and, therefore, we are exposed to movements in foreign currency exchange rates. The primary purpose of our foreign currency hedging activities is to manage the volatility associated with foreign currency purchases of materials, foreign currency sales of products, and other assets and liabilities in the normal course of business. We primarily utilize forward exchange contracts and purchased options with maturities of no more than 18 months that qualify as cash flow hedges. These are intended to offset the effect of exchange rate fluctuations on forecasted sales, inventory purchases and overhead expenses. At April 2, 2011, we had a net deferred gain of $29 million in OCI related to these cash flow hedges. As the underlying transactions occur, we expect to reclassify $15 million of after-tax gains into earnings in the next 12 months and $14 million of after-tax gains into earnings in the following 12-month period.

We hedge our net investment position in major currencies and generate foreign currency interest payments that offset other transactional exposures in these currencies. To accomplish this, we borrow directly in foreign currency and designate a portion of foreign currency debt as a hedge of net investments. We also may utilize currency forwards as hedges of our related foreign net investments. We record changes in the fair value of these contracts in other comprehensive income to the extent they are effective as cash flow hedges. If a contract does not qualify for hedge accounting or is designated as a fair value hedge, changes in the fair value of the contract are recorded in earnings. Currency effects on the effective portion of these hedges, which are reflected in the cumulative translation adjustment account within OCI, produced a $24 million after-tax gain in the first quarter of 2011, resulting in an accumulated net gain balance of $38 million at April 2, 2011. The ineffective portion of these hedges was insignificant.

Activity within accumulated other comprehensive loss and OCI related to the Manufacturing group’s foreign currency exchange contracts is provided in the following table:

						Three Months Ended
						April 2,				April 3,
(In millions)		Gain (Loss) Location				2011				2010
Amount of gain recognized in OCI						$	6			$	6
Effective portion of derivative reclassified from accumulated other comprehensive loss into income		Cost of sales					4				3

Assets Recorded at Fair Value on a Nonrecurring Basis

The table below presents those assets that are measured at fair value on a nonrecurring basis that had fair value measurement adjustments during the first quarter of 2011 and 2010. These assets were measured using significant unobservable inputs (Level 3) and include the following:

										Gain (Loss)
		Balance at								Three Months Ended
		April 2,				April 3,				April 2,				April 3,
(In millions)		2011				2010				2011				2010
Finance group
Impaired finance receivables		$	508			$	510			$	(33	)		$	(46	)
Finance receivables held for sale			237				598				(11	)			(10	)
Other assets			54				67				(6	)			(18	)