JP Morgan Chase 2006 Annual Report Download - page 88

MANAGEMENT’S DISCUSSION AND ANALYSIS
JPMorgan Chase & Co.
86 JPMorgan Chase & Co. / 2006 Annual Report
Postretirement benefit plans
In September 2006, the FASB issued SFAS 158, which requires recognition in
the Consolidated balance sheets of the overfunded or underfunded status of
defined benefit postretirement plans, measured as the difference between
the fair value of plan assets and the amount of the benefit obligation. The
Firm adopted SFAS 158 on a prospective basis on December 31, 2006. SFAS
158 has no impact either on the measurement of the Firm’s plan assets or
benefit obligations, or on how the Firm determines its net periodic benefit
costs. For additional information related to SFAS 158, see Note 7 on pages
100–105 of this Annual Report.
Accounting for uncertainty in income taxes and changes in timing
of cash flows related to income taxes generated by a leveraged
lease
In July 2006, the FASB issued two pronouncements: FIN 48, which clarifies
the accounting for uncertainty in income taxes recognized under SFAS 109,
and the related FSP FAS 13-2. FIN 48 addresses the recognition and meas-
urement of tax positions taken or expected to be taken, and also provides
guidance on derecognition, classification, interest and penalties, accounting
in interim periods, and disclosure. FSP FAS 13-2 requires the recalculation of
returns on leveraged leases if there is a change or projected change in the
timing of cash flows relating to income taxes generated by a leveraged
lease. The Firm will apply FIN 48 to all of its income tax positions at the
required effective date of January 1, 2007 under the transition provisions of
the Interpretation. JPMorgan Chase currently estimates that the cumulative
effect adjustment to implement FIN 48 will increase the January 1, 2007
balance of Retained earnings by approximately $400 million. However, the
standard continues to be interpreted and the FASB is expected to issue
additional guidance on FIN 48, which could affect this estimate. Accordingly,
JPMorgan Chase will continue its assessment of the impact of FIN 48 on its
financial condition and results of operations. The guidance in FSP FAS 13-2
will also be effective for the Firm on January 1, 2007. Implementation of
FSP FAS 13-2 is expected to result in immaterial adjustments.
Fair value measurements
In September 2006, the FASB issued SFAS 157, which is effective for fiscal
years beginning after November 15, 2007, with early adoption permitted.
SFAS 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about assets and liabilities measured at fair
value. The new standard provides a consistent definition of fair value which
focuses on exit price and prioritizes, within a measurement of fair value, the
use of market-based inputs over entity-specific inputs. The standard also
establishes a three-level hierarchy for fair value measurements based on the
transparency of inputs to the valuation of an asset or liability as of the
measurement date. SFAS 157 nullifies the guidance in EITF 02-3 which
required the deferral of profit at inception of a transaction involving a deriv-
ative financial instrument in the absence of observable data supporting the
valuation technique. The standard also eliminates large position discounts
for financial instruments quoted in active markets and requires considera-
tion of nonperformance risk when valuing liabilities. Currently, the fair value
of the Firm’s derivative payables does not incorporate a valuation adjust-
ment to reflect JPMorgan Chase’s credit quality.
The Firm intends to early adopt SFAS 157 effective January 1, 2007, and
expects to record a cumulative effect after-tax increase to retained earnings
of approximately $250 million related to the release of profit previously
deferred in accordance with EITF 02-3. In order to determine the amount of
this transition adjustment and to confirm that the Firm’s valuation policies
are consistent with exit price as prescribed by SFAS 157, the Firm reviewed
its derivative valuations in consideration of all available evidence including
recent transactions in the marketplace, indicative pricing services and the
results of back-testing similar transaction types. In addition, the Firm expects
to record adjustments to earnings related to the incorporation of the Firm’s
nonperformance risk in the valuation of liabilities recorded at fair value and
for private equity investments where there is significant market evidence to
support an increase in value but there has been no third-party market trans-
action related to the capital structure of the investment. The application of
SFAS 157 involves judgement and interpretation. The Firm continues to
monitor and evaluate the developing interpretations.
Fair value option for financial assets and financial liabilities
In February 2007, the FASB issued SFAS 159, which is effective for fiscal
years beginning after November 15, 2007, with early adoption permitted.
SFAS 159 provides an option for companies to elect fair value as an alterna-
tive measurement for selected financial assets, financial liabilities, unrecog-
nized firm commitments, and written loan commitments. Under SFAS 159,
fair value would be used for both the initial and subsequent measurement
of the designated assets, liabilities and commitments, with the changes in
value recognized in earnings. The Firm is reviewing the recently released
standard and assessing what elections it may make as part of an early
adoption effective January 1, 2007.