JP Morgan Chase 2005 Annual Report Download - page 93

JPMorgan Chase & Co. /2005 Annual Report 91
When the SPE does not meet the QSPE criteria, consolidation is assessed pur-
suant to FIN 46R. Under FIN 46R, a VIE is defined as an entity that: (1) lacks
enough equity investment at risk to permit the entity to finance its activities
without additional subordinated financial support from other parties; (2) has
equity owners that lack the right to make significant decisions affecting the
entity’s operations; and/or (3) has equity owners that do not have an obligation
to absorb or the right to receive the entity’s losses or returns.
FIN 46R requires a variable interest holder (i.e., a counterparty to a VIE) to
consolidate the VIE if that party will absorb a majority of the expected losses
of the VIE, receive the majority of the expected residual returns of the VIE, or
both. This party is considered the primary beneficiary. In making this determi-
nation, the Firm thoroughly evaluates the VIE’s design, capital structure and
relationships among variable interest holders. When the primary beneficiary
cannot be identified through a qualitative analysis, the Firm performs a quan-
titative analysis, which computes and allocates expected losses or residual
returns to variable interest holders. The allocation of expected cash flows in
this analysis is based upon the relative contractual rights and preferences
of each interest holder in the VIE’s capital structure. For further details, see
Note 14 on pages 111–113 of this Annual Report.
All retained interests and significant transactions between the Firm, QSPEs
and nonconsolidated VIEs are reflected on JPMorgan Chase’s Consolidated
balance sheets or in the Notes to consolidated financial statements.
Investments in companies that are considered to be voting-interest entities
under FIN 46R in which the Firm has significant influence over operating
and financing decisions are accounted for in accordance with the equity
method of accounting. These investments are generally included in Other
assets, and the Firm’s share of income or loss is included in Other income.
For a discussion of private equity investments, see Note 9 on pages 103–105
of this Annual Report.
Assets held for clients in an agency or fiduciary capacity by the Firm are
not assets of JPMorgan Chase and are not included in the Consolidated
balance sheets.
Use of estimates in the preparation of consolidated
financial statements
The preparation of consolidated financial statements requires management
to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenue, expenses and disclosures of contingent assets
and liabilities. Actual results could be different from these estimates.
Note 1 – Basis of presentation
JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”), a financial holding
company incorporated under Delaware law in 1968, is a leading global
financial services firm and one of the largest banking institutions in the
United States, with operations worldwide. The Firm is a leader in investment
banking, financial services for consumers and businesses, financial transaction
processing, investment management, private banking and private equity. For a
discussion of the Firm’s business segment information, see Note 31 on pages
130–131 of this Annual Report.
The accounting and financial reporting policies of JPMorgan Chase and its
subsidiaries conform to accounting principles generally accepted in the
United States of America (“U.S. GAAP”) and prevailing industry practices.
Additionally, where applicable, the policies conform to the accounting and
reporting guidelines prescribed by bank regulatory authorities.
Certain amounts in the prior periods have been reclassified to conform to the
current presentation.
Consolidation
The consolidated financial statements include accounts of JPMorgan Chase
and other entities in which the Firm has a controlling financial interest. All
material intercompany balances and transactions have been eliminated.
The usual condition for a controlling financial interest is ownership of a
majority of the voting interests of an entity. However, a controlling financial
interest may also exist in entities, such as special purpose entities (“SPEs”),
through arrangements that do not involve controlling voting interests.
SPEs are an important part of the financial markets, providing market liquidity
by facilitating investors’ access to specific portfolios of assets and risks. They
are, for example, critical to the functioning of the mortgage- and asset-
backed securities and commercial paper markets. SPEs may be organized
as trusts, partnerships or corporations and are typically set up for a single,
discrete purpose. SPEs are not typically operating entities and usually have a
limited life and no employees. The basic SPE structure involves a company
selling assets to the SPE. The SPE funds the purchase of those assets by issu-
ing securities to investors. The legal documents that govern the transaction
describe how the cash earned on the assets must be allocated to the SPE’s
investors and other parties that have rights to those cash flows. SPEs can be
structured to be bankruptcy-remote, thereby insulating investors from the
impact of the creditors of other entities, including the seller of the assets.
There are two different accounting frameworks applicable to SPEs: the quali-
fying SPE (“QSPE”) framework under SFAS 140; and the variable interest
entity (“VIE”) framework under FIN 46R. The applicable framework depends
on the nature of the entity and the Firm’s relation to that entity. The QSPE
framework is applicable when an entity transfers (sells) financial assets to an
SPE meeting certain criteria defined in SFAS 140. These criteria are designed
to ensure that the activities of the entity are essentially predetermined at the
inception of the vehicle and that the transferor of the financial assets cannot
exercise control over the entity and the assets therein. Entities meeting these
criteria are not consolidated by the transferor or other counterparties, as long
as they do not have the unilateral ability to liquidate or to cause the entity
to no longer meet the QSPE criteria. The Firm primarily follows the QSPE
model for securitizations of its residential and commercial mortgages, credit
card loans and automobile loans. For further details, see Note 13 on pages
108–111 of this Annual Report.
Notes to consolidated financial statements
JPMorgan Chase & Co.