Goldman Sachs 2001 Annual Report Download - page 55

page 53 GOLDMAN SACHS ANNUAL REPORT 2001
As of November 2001, the firm adopted the provisions of
SFAS No. 140 relating to the accounting for collateral. SFAS No.
140 eliminates the requirement under SFAS No. 125 to report
collateral received from certain repurchase agreements and col-
lateralized financing arrangements. Comparative restatement
prior to November 2001 was required. Accordingly, collateral
previously recognized in the consolidated statement of financial
condition as of November 2000 of $5.35 billion has been dere-
cognized in these financial statements. SFAS No. 140 also
requires certain disclosures regarding collateral and separate
classification of certain pledged assets on the consolidated state-
ments of financial condition. Comparative reclassification of
these pledged assets and related disclosures prior to November
2001 were not required and, accordingly, were not reflected in
these financial statements.
Financial Instruments
Gains and losses on financial instruments and commission
income and related expenses are recorded on a trade date basis
in the consolidated statements of earnings. The consolidated
statements of financial condition generally reflect purchases and
sales of financial instruments on a trade date basis.
“Financial instruments owned” and “Financial instruments sold,
but not yet purchased” on the consolidated statements of finan-
cial condition are carried at fair value or amounts that approxi-
mate fair value, with related unrealized gains or losses
recognized in the consolidated statements of earnings. Fair value
is based generally on listed market prices or broker or dealer
price quotations. If prices are not readily determinable or if li-
quidating the firm’s position is reasonably expected to affect
market prices, fair value is based on either internal valuation
models or management’s estimate of amounts that could be real-
ized under current market conditions, assuming an orderly li-
quidation over a reasonable period of time. Certain financial
instruments, including over-the-counter (OTC) derivative instru-
ments, are valued using pricing models that consider, among
other factors, contractual and market prices, correlations, time
value, credit, yield curve, volatility factors and/or prepayment
rates of the underlying positions.
Derivatives–On November 25, 2000, the firm adopted SFAS
No. 133, “Accounting for Derivative Instruments and Hedging
Activities,” as amended. The adoption of this statement did not
have a material effect on the firm’s statements of financial con-
dition or the results of operations. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other con-
tracts (collectively referred to as derivatives), and for hedging
activities. It requires that an entity recognize all derivatives as
either assets or liabilities on the statement of financial condition
and measure those instruments at fair value. The accounting for
changes in the fair value of a derivative instrument depends on
its intended use and the resulting designation.
Most of the firm’s derivative transactions are entered into for
trading purposes. The firm uses derivatives in its trading activi-
ties to facilitate customer transactions, to take proprietary posi-
tions and as a means of risk management. Risk exposures are
managed through diversification, by controlling position sizes
and by establishing hedges in related securities or derivatives.
For example, the firm may hedge a portfolio of common stock
by taking an offsetting position in a related equity-index futures
contract. Gains and losses on derivatives used for trading pur-
poses are generally included in “Trading and principal invest-
ments” on the consolidated statements of earnings.
The firm also enters into derivative contracts, which are desig-
nated as fair-value hedges, to manage the interest rate and cur-
rency exposure on its long-term borrowings. These derivatives
generally include interest rate futures contracts, interest rate
swap agreements and currency swap agreements, which are pri-
marily utilized to convert a substantial portion of the firm’s fixed
rate debt into U.S. dollar-based floating rate obligations. The
gains and losses associated with the ineffective portion of these
fair-value hedges are included in “Trading and principal invest-
ments” on the consolidated statements of earnings and are not
material for the year ended November 2001.
Principal Investments–Principal investments are carried at
fair value, generally based upon quoted market prices or com-
parable substantial third-party transactions. Where fair value
is not readily determinable, principal investments are initially
recorded at cost. The carrying value of such investments is
adjusted when changes in the underlying fair values are readily
determinable, generally as evidenced by listed market prices or
transactions that directly affect the value of such investments.
Downward adjustments are made if management determines
that realizable value is less than the carrying value.
The firm is entitled to receive merchant banking overrides
(i.e., an increased share of a fund’s income and gains) when
the return on the fund’s investments exceeds certain threshold