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, 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 half of 2011.

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

		Severance				Contract
(In millions)		Costs				Terminations				Total
Three Months Ended July 3, 2010
Cessna		$	6			$	—			$	6
Textron Systems			1				—				1
Finance			2				1				3
		$	9			$	1			$	10
Six Months Ended July 3, 2010
Cessna		$	14			$	2			$	16
Bell			1				—				1
Textron Systems			1				—				1
Finance			5				1				6
Corporate			(2	)			—				(2	)
		$	19			$	3			$	22

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			(33	)			(1	)			(34	)
Balance at July 2, 2011		$	24			$	4			$	28

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
		July 2,				July 3,				July 2,				July 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				(2	)			(1	)
Amortization of net loss			19				9				3				3
Net periodic benefit cost		$	39			$	31			$	11			$	12
Six Months Ended
Service cost		$	64			$	62			$	4			$	4
Interest cost			164				158				16				16
Expected return on plan assets			(196	)			(184	)			—				—
Amortization of prior service cost (credit)			8				8				(3	)			(2	)
Amortization of net loss			38				18				6				6
Net periodic benefit cost		$	78			$	62			$	23			$	24

Note 4: Comprehensive Income

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

		Three Months Ended								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
(In millions)		2011				2010				2011				2010
Net income		$	90			$	82			$	119			$	74
Other comprehensive income (loss):
Recognition of prior service cost and unrealized losses on pension and postretirement benefits			15				10				33				20
Deferred gains on hedge contracts			2				—				8				7
Foreign currency translation and other			3				(32	)			15				(41	)
Comprehensive income		$	110			$	60			$	175			$	60

Note 5: 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 convertible notes and upon the exercise of the related warrants. The convertible note call options purchased in connection with the issuance of the convertible notes are excluded from the calculation of diluted EPS as their impact is always anti-dilutive.

Upon conversion of our convertible notes, as described in Note 8, 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								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
(In thousands)		2011				2010				2011				2010
Basic weighted-average shares outstanding			277,406				274,098				276,882				273,636
Dilutive effect of convertible notes, warrants, stock options and restricted stock units			37,802				28,299				40,379				28,133
Diluted weighted-average shares outstanding			315,208				302,397				317,261				301,769

Stock options to purchase 3 million shares of common stock outstanding are excluded from our calculation of diluted weighted-average shares outstanding for both the three- and six-month periods ended July 2, 2011 as the exercise prices were greater than the average market price of our common stock for the periods. Stock options to purchase 6 million shares of common stock outstanding are excluded from our calculation of diluted weighted-average shares outstanding for both the three- and six-month periods ended July 3, 2010 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.

Note 6: Accounts Receivable and Finance Receivables

Accounts Receivable

Accounts receivable is composed of the following:

		July 2,				January 1,
(In millions)		2011				2011
Commercial		$	572			$	496
U.S. Government contracts			320				416
			892				912
Allowance for doubtful accounts			(18	)			(20	)
		$	874			$	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 $165 million at July 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)		July 2, 2011								January 1, 2011
Aviation		$	1,985				52	%		$	2,120				46	%
Golf equipment			167				4				212				5
Golf mortgage			746				20				876				19
Timeshare			543				14				894				19
Structured capital			281				7				317				7
Other liquidating			102				3				207				4
Total finance receivables			3,824				100	%			4,626				100	%
Less: Allowance for losses			299								342
Less: Finance receivables held for sale			180								413
Total finance receivables held for investment, net		$	3,345							$	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 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:

		July 2, 2011																January 1, 2011
(In millions)		Performing				Watchlist				Nonaccrual				Total				Performing				Watchlist				Nonaccrual				Total
Aviation		$	1,640			$	203			$	142			$	1,985			$	1,713			$	238			$	169			$	2,120
Golf equipment			110				42				15				167				138				51				23				212
Golf mortgage			192				201				226				619				163				303				219				685
Timeshare			206				27				277				510				222				77				382				681
Structured capital			255				26				—				281				290				27				—				317
Other liquidating			44				2				36				82				130				11				57				198
Total		$	2,447			$	501			$	696			$	3,644			$	2,656			$	707			$	850			$	4,213
% of Total			67.2	%			13.7	%			19.1	%							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
July 2, 2011
Aviation		$	1,842			$	44			$	38			$	61			$	1,985
Golf equipment			144				11				3				9				167
Golf mortgage			522				12				—				85				619
Timeshare			425				—				—				85				510
Structured capital			281				—				—				—				281
Other liquidating			59				2				1				20				82
Total		$	3,273			$	69			$	42			$	260			$	3,644
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 July 2, 2011, accrual status loans that were 90 days past due totaled $7 million. We had no accrual status loans that were 90 days past due at January 1, 2011. At July 2, 2011, the 60+ days contractual delinquency as a percentage of finance receivables held for investment was 8.29%, 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. There was no significant interest income recognized on impaired loans in the first half of 2011 or 2010.

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

						Golf				Golf								Other
(In millions)		Aviation				Equipment				Mortgage				Timeshare				Liquidating				Total
For the six months ended July 2, 2011
Impaired loans with a related allowance for losses recorded		$	136			$	4			$	193			$	309			$	18			$	660
Impaired loans with no related allowance for losses recorded			20				—				92				48				18				178
Total		$	156			$	4			$	285			$	357			$	36			$	838
For the six months ended July 3, 2010
Impaired loans with a related allowance for losses recorded		$	210			$	4			$	183			$	357			$	24			$	778
Impaired loans with no related allowance for losses recorded			12				2				116				63				69				262
Total		$	222			$	6			$	299			$	420			$	93			$	1,040

A summary of impaired finance receivables, excluding leveraged leases, and related allowance for losses is provided below:

						Golf				Golf								Other
(In millions)		Aviation				Equipment				Mortgage				Timeshare				Liquidating				Total
July 2, 2011
Impaired loans with a related allowance for losses recorded:
Recorded investment		$	118			$	3			$	198			$	245			$	18			$	582
Unpaid principal balance			120				3				208				281				24				636
Related allowance			43				1				44				86				9				183
Impaired loans with no related allowance for losses recorded:
Recorded investment			22				—				96				77				10				205
Unpaid principal balance			22				—				102				77				51				252
Total impaired loans:
Recorded investment			140				3				294				322				28				787
Unpaid principal balance			142				3				310				358				75				888
Related allowance			43				1				44				86				9				183
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 potential outcomes based on their relative likelihood of occurrence using the probability-weighted approach.

The evaluation of our portfolios is inherently subjective as it requires estimates. These estimates include 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 10, 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 uncollectible.

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 $281 million of leveraged leases at both July 2, 2011 and July 3, 2010, in accordance with authoritative accounting standards:

																		Structured
																		Capital and
						Golf				Golf								Other
(In millions)		Aviation				Equipment				Mortgage				Timeshare				Liquidating				Total
For the six months ended July 2, 2011
Allowance for losses
Beginning balance		$	107			$	16			$	79			$	106			$	34			$	342
Provision for losses			16				(2	)			(1	)			10				1				24
Net charge-offs and transfers			(17	)			(3	)			(4	)			(28	)			(15	)			(67	)
Ending balance		$	106			$	11			$	74			$	88			$	20			$	299
Ending balance based on individual evaluations			43				1				44				86				9				183
Ending balance based on collective evaluation			63				10				30				2				11				116
Finance receivables
Individually evaluated for impairment		$	140			$	3			$	294			$	322			$	28			$	787
Collectively evaluated for impairment			1,845				164				325				188				54				2,576
Balance at end of period		$	1,985			$	167			$	619			$	510			$	82			$	3,363
For the six months ended July 3, 2010
Allowance for losses
Beginning balance		$	114			$	9			$	65			$	79			$	74			$	341
Provision for losses			16				7				51				32				(7	)			99
Net charge-offs			(30	)			(3	)			(41	)			(1	)			(13	)			(88	)
Ending balance		$	100			$	13			$	75			$	110			$	54			$	352
Ending balance based on individual evaluations			39				1				40				99				2				181
Ending balance based on collective evaluation			61				12				35				11				52				171
Finance receivables
Individually evaluated for impairment		$	163			$	7			$	304			$	448			$	85			$	1,007
Collectively evaluated for impairment			2,081				227				484				634				363				3,789
Balance at end of period		$	2,244			$	234			$	788			$	1,082			$	448			$	4,796

Note 7: Inventories

		July 2,				January 1,
(In millions)		2011				2011
Finished goods		$	989			$	784
Work in process			2,309				2,125
Raw materials			418				506
			3,716				3,415
Progress/milestone payments			(1,154	)			(1,138	)
		$	2,562			$	2,277

Note 8: Debt

On May 5, 2009, we issued $600 million of 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 June 30, 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 September 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 a July 2, 2011 stock price of $23.94, the “if converted value” exceeds the face amount of the notes by $494 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 15.6 million net share issuance or a cash payment of $374 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 9: 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:

		Six Months Ended
		July 2,				July 3,
(In millions)		2011				2010
Accrual at the beginning of period		$	242			$	263
Provision			111				83
Settlements			(116	)			(113	)
Adjustments to prior accrual estimates			(7	)			—
Accrual at the end of period		$	230			$	233

Note 10: 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 11. 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 fair value amounts of these instruments that are designated as hedging instruments are provided below:

						Asset (Liability)
						July 2,				January 1,
(In millions)		Borrowing Group		Balance Sheet Location		2011				2011
Assets
Interest rate exchange contracts*		Finance		Other assets		$	29			$	34
Foreign currency exchange contracts		Manufacturing		Other current assets			42				39
Total						$	71			$	73
Liabilities
Interest rate exchange contracts*		Finance		Other liabilities		$	(5	)		$	(6	)
Foreign currency exchange contracts		Manufacturing		Accrued liabilities			(9	)			(2	)
Total						$	(14	)		$	(8	)

*		Interest rate exchange contracts represent fair value hedges.

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 July 2, 2011. At July 2, 2011 and January 1, 2011, we had interest rate exchange contracts with notional amounts of $0.9 billion and $1.1 billion, respectively.

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. At July 2, 2011 and January 1, 2011, we had foreign currency exchange contracts with notional amounts of $713 million and $635 million, respectively.

The Finance group also has investments in other marketable securities totaling $23 million and $51 million at July 2, 2011 and January 1, 2011, respectively, that are classified as available for sale. These investments are classified as Level 2 as the fair value for these notes was determined based on observable market inputs for similar securitization interests in markets that are relatively inactive compared with the market environment in which they were originally issued and based on bids received from prospective purchasers.

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 half 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 three years that qualify as cash flow hedges and are intended to offset the effect of exchange rate fluctuations on forecasted sales, inventory purchases and overhead expenses. At July 2, 2011, we had a net deferred gain of $28 million in Accumulated other comprehensive loss related to these cash flow hedges. Net gains and losses recognized in earnings and Accumulated other comprehensive loss on these cash flow hedges, including gains and losses related to hedge ineffectiveness, were not material in the three- and six-month periods ended July 2, 2011 and July 3, 2010. We do not expect the amount of gains and losses in Accumulated other comprehensive loss that will be reclassified to earnings in the next twelve months to be material.

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 foreign currency translation adjustment account within OCI, produced a $27 million after-tax gain in the first half of 2011, resulting in an accumulated net gain balance of $41 million at July 2, 2011. The ineffective portion of these hedges was insignificant.

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 half of 2011 and 2010. These assets were measured using significant unobservable inputs (Level 3) and include the following:

										Gain (Loss)
		Balance at								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
(In millions)		2011				2010				2011				2010
Finance group
Impaired finance receivables		$	407			$	519			$	(50	)		$	(104	)
Finance receivables held for sale			180				421				(14	)			(15	)
Other assets			91				87				(18	)			(26	)

Impaired Finance Receivables — Impaired nonaccrual finance receivables are included in the table above since the measurement of required reserves on our impaired finance receivables is significantly dependent on the fair value of the underlying collateral. Fair values of collateral are determined based on the use of appraisals, industry pricing guides, input from market participants, our recent experience selling similar assets or internally developed discounted cash flow models. Fair value measurements recorded on impaired finance receivables resulted in charges to provision for loan losses and primarily were related to initial fair value adjustments.

Finance Receivables Held for Sale — Finance receivables held for sale are recorded at the lower of cost or fair value. As a result of our plan to exit the non-captive Finance business certain finance receivables are classified as held for sale. At July 2, 2011, the finance receivables held for sale are primarily assets in the golf mortgage, other liquidating and timeshare product lines. Timeshare and other liquidating finance receivables classified as held for sale were identified at the individual loan level; whereas golf course mortgages were identified as a portion of a larger portfolio with common characteristics based on the intention to balance the sale of certain loans with the collection of others to maximize economic value. These finance receivables are recorded at fair value on a nonrecurring basis during periods in which the fair value is lower than the cost value.

There are no active, quoted market prices for our finance receivables. The estimate of fair value was determined based on the use of discounted cash flow models to estimate the exit price we expect to receive in the principal market for each type of loan in an orderly transaction, which includes both the sale of pools of similar assets and the sale of individual loans. The models we used incorporate estimates of the rate of return, financing cost, capital structure and/or discount rate expectations of current market participants combined with estimated loan cash flows based on credit losses, payment rates and credit line utilization rates. Where available, assumptions related to the expectations of current market participants are compared with observable market inputs, including bids from prospective purchasers of similar loans and certain bond market indices for loans perceived to be of similar credit quality. Although we utilize and prioritize these market observable inputs in our discounted cash flow models, these inputs are not typically derived from markets with directly comparable loan structures, industries and collateral types. Therefore, all valuations of finance receivables held for sale involve significant management judgment, which can result in differences between our fair value estimates and those of other market participants.

Other assets — Other assets include repossessed assets and properties, operating assets received in satisfaction of troubled finance receivables and other investments, which are accounted for under the equity method of accounting and have no active, quoted market prices. The fair value of these assets is determined based on the use of appraisals, industry pricing guides, input from market participants, our recent experience selling similar assets or internally developed discounted cash flow models. For our other investments, the discounted cash flow models incorporate assumptions specific to the nature of the investments’ business and underlying assets and include industry valuation benchmarks such as discount rates, capitalization rates and cash flow multiples.

Assets and Liabilities Not Recorded at Fair Value

The carrying value and estimated fair values of our financial instruments that are not reflected in the financial statements at fair value are as follows:

		July 2, 2011								January 1, 2011
		Carrying				Estimated				Carrying				Estimated
(In millions)		Value				Fair Value				Value				Fair Value
Manufacturing group
Long-term debt, excluding leases		$	(2,219	)		$	(2,776	)		$	(2,172	)		$	(2,698	)
Finance group
Finance receivables held for investment, excluding leases			2,878				2,639				3,345				3,131
Debt			(2,499	)			(2,442	)			(3,660	)			(3,528	)

Fair value for the Manufacturing group debt is determined using market observable data for similar transactions. At July 2, 2011 and January 1, 2011, approximately 44% and 33%, respectively, of the fair value of term debt for the Finance group was determined based on observable market transactions. The remaining Finance group debt was determined based on discounted cash flow analyses using observable market inputs from debt with similar duration, subordination and credit default expectations. We utilize the same valuation methodologies to determine the fair value estimates for finance receivables held for investment as used for finance receivables held for sale.