Discover 2011 Annual Report Download - page 73

61
Critical Accounting Estimates
In preparing our consolidated financial statements in conformity with GAAP, management must make judgments and
use estimates and assumptions about the effects of matters that are uncertain. For estimates that involve a high degree of
judgment and subjectivity, it is possible that different estimates could reasonably be derived for the same period. For estimates
that are particularly sensitive to changes in economic or market conditions, significant changes to the estimated amount from
period to period are also possible. Management believes the current assumptions and other considerations used to estimate
amounts reflected in our consolidated financial statements are appropriate. However, if actual experience differs from the
assumptions and other considerations used in estimating amounts in our consolidated financial statements, the resulting
changes could have a material effect on our consolidated results of operations and, in certain cases, could have a material effect
on our consolidated financial condition. Management has identified the estimates related to our allowance for loan losses, the
accrual of credit card customer rewards cost, the evaluation of goodwill and other nonamortizable intangible assets for potential
impairment, estimates of future cash flows associated with purchased credit-impaired loans and the accrual of income taxes as
critical accounting estimates.
Allowance for Loan Losses
We base our allowance for loan loss on several analyses that help us estimate incurred losses as of the balance sheet date.
While our estimation process includes historical data and analysis, there is a significant amount of judgment applied in
selecting inputs and analyzing the results produced to determine the allowance. We use a migration analysis to estimate the
likelihood that a loan will progress through the various stages of delinquency. The migration analysis considers uncollectible
principal, interest and fees reflected in the loan receivables. Management also estimates loss emergence by using other
analyses to estimate losses incurred from non-delinquent accounts. The considerations in these analyses include past
performance, risk management techniques applied to various accounts, historical behavior of different account vintages, current
economic conditions, recent trends in delinquencies, bankruptcy filings, account collection management, policy changes,
account seasoning, loan volume and amounts, payment rates, and forecasting uncertainties. Given the same information, others
may reach different reasonable estimates.
If management used different assumptions in estimating incurred net loan losses, the impact to the allowance for loan
losses could have a material effect on our consolidated financial condition and results of operations. For example, a 10%
change in management's estimate of incurred net loan losses could have resulted in a change of approximately $221 million in
the allowance for loan losses at November 30, 2011, with a corresponding change in the provision for loan losses. See “ - Loan
Quality” and Note 3: Summary of Significant Accounting Policies to our consolidated financial statements for further details
about our allowance for loan losses.
Customer Rewards Cost
We offer our customers various reward programs, including the Cashback Bonus reward program, pursuant to which we
offer certain customers a reward equal to a percentage of their purchase amounts based on the type and volume of the
customer's purchases. The liability for customer rewards is included in accrued expenses and other liabilities in our
consolidated statements of financial condition. We compute our rewards liability on an individual customer basis and it is
accumulated as qualified customers make progress toward earning a reward through their ongoing purchase activity. The
liability is adjusted for expected forfeitures of accumulated rewards. In determining the forfeiture estimate, we consider
historical rewards redemption and forfeiture behavior, the level of recent customer purchase activity and the terms of the
current rewards programs. We generally recognize reward costs as a reduction of discount and interchange revenue in the
consolidated statements of income.
If management used a different estimate of forfeitures, our consolidated statement of financial condition and results of
operations could have differed. For example, a 100 basis point decrease in the estimated forfeiture rate as of November 30,
2011, could have resulted in an increase in accrued expenses and other liabilities of approximately $12 million. The
corresponding increase in rewards cost would have been reflected as a decrease in discount and interchange revenue. See “ -
Other Income” and Note 3: Summary of Significant Accounting Policies to our consolidated financial statements for further
details about credit card rewards cost.
Goodwill and Other Nonamortizable Intangible Assets
We recognize goodwill when the purchase price of an acquired business exceeds the total of the fair values of the
acquired net assets. In addition, we have recognized certain other nonamortizable intangible assets in our acquisition of the
Diners Club business. As required by GAAP, we test goodwill and other nonamortizable intangible assets for impairment
annually, or more often if indicators of impairment exist. In evaluating goodwill for impairment, management must estimate the
fair value of the business unit(s) to which the goodwill relates. Because market data concerning acquisitions of comparable
businesses typically are not readily obtainable, other valuation techniques such as earnings multiples and cash flow models are
used in estimating the fair values of these businesses. Similarly, in evaluating the other nonamortizable intangible assets for
Table of Contents