Goldman Sachs 2007 Annual Report Download - page 50

Management’s Discussion and Analysis
We employ an oversight structure that includes appropriate
segregation of duties. Senior management, independent of the
trading and investing functions, is responsible for the oversight
of control and valuation policies and for reporting the results
of these policies to our Audit Committee. We seek to maintain
the necessary resources to ensure that control functions are
performed to the highest standards. We employ procedures for
the approval of new transaction types and markets, price
verification, review of daily profit and loss, and review of valuation
models by personnel with appropriate technical knowledge of
relevant products and markets. These procedures are performed
by personnel independent of the trading and investing functions.
For trading and principal investments where prices or valuations
that require inputs are less observable, we employ, where possible,
procedures that include comparisons with similar observable
positions, analysis of actual to projected cash flows, comparisons
with subsequent sales and discussions with senior business
leaders. See “ — Market Risk” below for a further discussion of
how we manage the risks inherent in our trading and principal
investing businesses.
Goodwill and Identifiable Intangible Assets
As a result of our acquisitions, principally SLK LLC (SLK) in
2000, The Ayco Company, L.P. (Ayco) in 2003 and our variable
annuity and life insurance business in 2006, we have acquired
goodwill and identifiable intangible assets. Goodwill is the cost
of acquired companies in excess of the fair value of net assets,
including identifiable intangible assets, at the acquisition date.
GOODWILL. We test the goodwill in each of our operating
segments, which are components one level below our three
business segments, for impairment at least annually in accordance
with SFAS No. 142, “Goodwill and Other Intangible Assets,”
by comparing the estimated fair value of each operating segment
with its estimated net book value. We derive the fair value of
each of our operating segments primarily based on price-earnings
and price-book multiples. We derive the net book value of our
operating segments by estimating the amount of shareholders’
equity required to support the activities of each operating
segment. Our last annual impairment test was performed during
our 2007 fourth quarter and no impairment was identified.
SUBPRIME MORTGAGE EXPOSURE. We securitize, underwrite and
make markets in subprime mortgages. As of November 2007,
the fair value of our long position in subprime mortgage cash
instruments was $2.11 billion (of which $507 million was
classified as level 3 within the fair value hierarchy), including
$316 million of collateralized debt obligations (CDOs) backed
by subprime mortgages. At any point in time, we may use cash
instruments as well as derivatives to manage our long or short
risk position in the subprime mortgage market.
OTHER FINANCIAL ASSETS AND FINANCIAL LIABILITIES. In addition
to “Financial instruments owned, at fair value” and “Financial
instruments sold, but not yet purchased, at fair value,” we
have elected to account for certain of our other financial assets
and financial liabilities at fair value under SFAS No. 155,
“Accounting for Certain Hybrid Financial Instruments
— a n
amendment of FASB Statements No. 133 and 140,” or SFAS
No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities.” Such financial assets and financial liabilities
include (i) certain unsecured short-term borrowings, consisting
of all promissory notes and commercial paper and certain
hybrid financial instruments; (ii) certain other secured financings,
primarily transfers accounted for as financings rather than sales
under SFAS No. 140 and debt raised through our William
Street program; (iii) certain unsecured long-term borrowings,
including prepaid physical commodity transactions; (iv) resale
and repurchase agreements; (v) securities borrowed and loaned
within Trading and Principal Investments, consisting of our
matched book and certain firm financing activities; (vi) corporate
loans, loan commitments and certificates of deposit issued by
Goldman Sachs Bank USA (GS Bank USA) as well as securities
held by GS Bank USA (previously accounted for as available-
for-sale); (vii) receivables from customers and counterparties
arising from transfers accounted for as secured loans rather
than purchases under SFAS No. 140; and (viii) in general,
investments acquired after the adoption of SFAS No. 159
where we have significant influence over the investee and
would otherwise apply the equity method of accounting. See
“ — Recent Accounting Developments” below for a discussion
of the impact of adopting SFAS No. 159.
CONTROLS OVER VALUATION OF FINANCIAL INSTRUMENTS. A
control infrastructure, independent of the trading and investing
functions, is fundamental to ensuring that our financial
instruments are appropriately valued and that fair value
measurements are reliable. This is particularly important where
prices or valuations that require inputs are less observable.
48 Goldman Sachs 2007 Annual Report