JP Morgan Chase 2005 Annual Report Download - page 33

JPMorgan Chase & Co. /2005 Annual Report 31
The Firm prepares its Consolidated financial statements using accounting
principles generally accepted in the United States of America (“U.S. GAAP”);
these financial statements appear on pages 87–90 of this Annual Report.
That presentation, which is referred to as “reported basis,” provides the reader
with an understanding of the Firm’s results that can be tracked consistently
from year to year and enables a comparison of the Firm’s performance with
other companies’ U.S. GAAP financial statements.
In addition to analyzing the Firm’s results on a reported basis, management
reviews the Firm’s and the lines’ of business results on an operating basis,
which is a non-GAAP financial measure. The Firm’s definition of operating
basis starts with the reported U.S. GAAP results. Operating basis excludes:
(i) merger costs, (ii) the nonoperating litigation charges taken and insurance
recoveries received with respect to certain of the Firm’s material litigation;
and (iii) costs related to the conformance of certain accounting policies as a
result of the Merger. Management believes these items are not part of the
Firm’s normal daily business operations and, therefore, not indicative of
trends, as they do not provide meaningful comparisons with other periods.
For additional detail on nonoperating litigation charges, see the Glossary of
terms on page 134 of this Annual Report.
In addition, the Firm manages its lines of business on an operating basis. In
the case of the Investment Bank, noninterest revenue on an operating basis
includes, in trading-related revenue, net interest income related to trading
activities. Trading activities generate revenues, which are recorded for U.S.
GAAP purposes in two line items on the income statement: trading revenue,
which includes the mark-to-market gains or losses on trading positions; and
net interest income, which includes the interest income or expense related to
those positions. The impact of changes in market interest rates will either be
recorded in Trading revenue or Net interest income depending on whether the
trading position is a cash security or a derivative. Combining both the trading
revenue and related net interest income allows management to evaluate the
economic results of the Investment Bank’s trading activities, which for GAAP
purposes are reported in both Trading revenue and Net interest income. In
management’s view, this presentation also facilitates operating comparisons
to competitors. For a discussion of trading-related revenue, see the IB on
pages 36–38 of this Annual Report.
In the case of Card Services, operating basis is also referred to as “managed
basis,” and excludes the impact of credit card securitizations on total net
revenue, the provision for credit losses, net charge-offs and loan receivables.
This presentation is provided to facilitate operating comparisons to competi-
tors. Through securitization, the Firm transforms a portion of its credit card
receivables into securities, which are sold to investors. The credit card receiv-
ables are removed from the consolidated balance sheet through the transfer
of the receivables to a trust, and the sale of undivided interests to investors
that entitle the investors to specific cash flows generated from the credit
card receivables. The Firm retains the remaining undivided interests as seller’s
interests, which are recorded in Loans on the Consolidated balance sheets.
A gain or loss on the sale of credit card receivables to investors is recorded in
Other income. Securitization also affects the Firm’s Consolidated statements
of income as interest income, certain fee revenue, recoveries in excess of
interest paid to the investors, gross credit losses and other trust expenses
related to the securitized receivables are all reclassified into credit card
income. For a reconciliation of reported to managed basis of Card Services
results, see page 46 of this Annual Report. For information regarding loans and
residual interests sold and securitized, see Note 13 on pages 108–111 of this
Annual Report. JPMorgan Chase uses the concept of “managed receivables”
to evaluate the credit performance and overall financial performance of the
underlying credit card loans, both sold and not sold: as the same borrower
is continuing to use the credit card for ongoing charges, a borrower’s credit
performance will affect both the loan receivables sold under SFAS 140 and
those not sold. Thus, in its disclosures regarding managed loan receivables,
JPMorgan Chase treats the sold receivables as if they were still on the balance
sheet in order to disclose the credit performance (such as net charge-off
rates) of the entire managed credit card portfolio. In addition, Card Services
operations are funded, operating results are evaluated, and decisions are
made about allocating resources such as employees and capital based upon
managed financial information.
Finally, commencing with the first quarter of 2005, operating revenue
(noninterest revenue and net interest income) for each of the segments and
the Firm is presented on a tax-equivalent basis. Accordingly, revenue from tax
exempt securities and investments that receive tax credits are presented in
the operating results on a basis comparable to taxable securities and invest-
ments. This non-GAAP financial measure allows management to assess the
comparability of revenues arising from both taxable and tax-exempt sources.
The corresponding income tax impact related to these items is recorded
within income tax expense. The Corporate sector’s and the Firm’s operating
revenue and income tax expense for the periods prior to the first quarter
of 2005 have been restated to be similarly presented on a tax-equivalent
basis. This restatement had no impact on the Corporate sector’s or the Firm’s
operating earnings.
Management uses certain non-GAAP financial measures at the segment level
because it believes these non-GAAP financial measures provide information
to investors in understanding the underlying operational performance and
trends of the particular business segment and facilitate a comparison of the
business segment with the performance of competitors.
Explanation and reconciliation of the Firm’s use of non-GAAP financial measures