AIG 2005 Annual Report Download - page 137

AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES
of AIG’s operating income. However, in certain instances,
1. Summary of Significant Accounting Policies
when income is not recognized upfront under EITF 02-03,
Continued
income is recognized over the life of the contract, where
Years Ended December 31, appropriate.
(in millions, except per share data) 2005 2004 2003 The discussion below relates to the derivative activities of
Numerator for diluted earnings per AIG (other than those of AIGFP) that qualify for hedge
share: accounting treatment under FAS 133.
Income before cumulative effect of For derivatives designated as hedges, on the date the
accounting changes $10,477 $9,983 $8,099 derivative contract is entered into, AIG designates the
Cumulative effect of accounting derivative as: (i) a hedge of the subsequent changes in the fair
changes, net of tax –(144) 9 value of a recognized asset or liability or of an unrecognized
Net income applicable to firm commitment (‘‘fair value’’ hedge); (ii) a hedge of a
common stock 10,477 9,839 8,108 forecasted transaction, or the variability of cash flows to be
received or paid related to a recognized asset or liability (‘‘cash
Interest on contingently convertible
flow’’ hedge); or (iii) a hedge of a net investment in a foreign
bonds, net of tax(a) 11 11 11
operation. Fair value and cash flow hedges may involve foreign
Adjusted net income applicable to
currencies (‘‘foreign currency hedges’’). The gain or loss in the
common stock(a) $10,488 $9,850 $8,119
fair value of a derivative that is appropriately and contempora-
Denominator for diluted earnings per neously documented, designated and is highly effective as a fair
share: value hedge is recorded in current period earnings, along with
Average shares outstanding 2,597 2,606 2,610 the loss or gain on the hedged item attributable to the hedged
Incremental shares from potential risk. The gain or loss in the fair value of a derivative that is
common stock:
appropriately and contemporaneously documented, designated
Average number of shares arising
and is highly effective as a cash flow hedge is recorded in other
from outstanding employee stock
comprehensive income, until earnings are affected by the
plans (treasury stock method)(b) 21 22 18
variability of cash flows. Of the amount deferred in Other
Contingently convertible bonds(a) 999
Comprehensive Income at December 31, 2005, AIG does not
Adjusted average shares expect a material amount to be reclassified into earnings over
outstanding – diluted(a) 2,627 2,637 2,637 the next twelve months. The portion of the gain or loss in the
Earnings per share: fair value of a derivative in a cash flow hedge that represents
Basic: hedge ineffectiveness is recognized immediately in current
Income before cumulative effect of period earnings. The amount of ineffectiveness was not
accounting changes $ 4.03 $ 3.83 $ 3.10 material for 2005, 2004 and 2003. The gain or loss in the fair
Cumulative effect of accounting value of a derivative that is appropriately and contemporane-
changes, net of tax –(0.06) – ously documented, designated and is highly effective as a hedge
Net income $ 4.03 $ 3.77 $ 3.10 of a net investment in a foreign operation is recorded in the
Diluted: foreign currency translation adjustments account within other
Income before cumulative effect of comprehensive income. Changes in the fair value of derivatives
accounting changes $ 3.99 $ 3.79 $ 3.07 used for other than hedging activities are reported in current
Cumulative effect of accounting period earnings (principally in realized capital gains and losses
changes, net of tax –(0.06) – for AIG’s insurance operations). AIG had no hedges that were
Net income $ 3.99 $ 3.73 $ 3.07 considered fair value hedges at December 31, 2005. At
December 31, 2005, AIG’s hedge accounting was limited to
(a) Assumes conversion of contingently convertible bonds due to the cash flow hedge accounting primarily related to the hedge of
adoption of EITF Issue No. 04-8 ‘‘Accounting Issues Related to
Certain Features of Contingently Convertible Debt and the Effect on forecasted transactions.
Diluted Earnings per Share.’’ AIG assesses, both at the hedge’s inception and on an
(b) Certain shares arising from employee stock plans were not included in ongoing basis, whether the derivatives used in hedging
the computation of diluted earnings per share where the exercise price of transactions are highly effective in offsetting changes in fair
the options exceeded the average market price and would have been
antidilutive. The number of shares excluded were 19 million, 7 million values or cash flows of hedged items.
and 26 million for 2005, 2004 and 2003, respectively. As of January 1, 2005 and December 31, 2005, the related
balance of accumulated derivative net loss arising from cash
(ee) Derivatives: AIG carries all derivatives in the consoli- flow hedges, net of tax, was $53 million and $25 million,
dated balance sheet at fair value. The financial statement respectively. Of the change in accumulated derivative net gain,
recognition of the change in the fair value of a derivative $3 million represents current period changes in fair values of
depends on a number of factors, including the intended use of derivatives used in cash flow hedge transactions, and $25 mil-
the derivative and the extent to which it is effective as part of lion represents current period reclassifications to operating
a hedge transaction. The changes in fair value of the derivative income.
transactions of AIGFP are currently presented as a component
AIG m Form 10-K 85