JP Morgan Chase 2006 Annual Report Download - page 97

JPMorgan Chase & Co. / 2006 Annual Report 95
Accounting for certain hybrid financial instruments
SFAS 155 applies to certain “hybrid financial instruments” which are financial
instruments that contain embedded derivatives. The standard establishes a
requirement to evaluate beneficial interests in securitized financial assets to
determine if the interests represent freestanding derivatives or are hybrid finan-
cial instruments containing embedded derivatives requiring bifurcation. SFAS 155
also permits an irrevocable election for fair value measurement of any hybrid
financial instrument containing an embedded derivative that otherwise would
require bifurcation under SFAS 133. The fair value election can be applied to
existing instruments on an instrument-by-instrument basis at the date of adop-
tion and can be applied to new instruments on a prospective basis.
The Firm adopted SFAS 155 effective January 1, 2006. The Firm has elected to fair
value all instruments issued, acquired or modified after December 31, 2005, that
are required to be bifurcated under SFAS 133, as amended by SFAS 138, SFAS
149 and SFAS 155. In addition, the Firm elected to fair value certain structured
notes existing as of December 31, 2005, resulting in a $22 million cumulative
effect increase to Retained earnings. The cumulative effect adjustment includes
gross unrealized gains of $29 million and gross unrealized losses of $7 million.
The substantial majority of the structured notes to which the fair-value election
has been applied are classified in Long-term debt on the Consolidated balance
sheets. The change in fair value associated with structured notes is classified
within Principal transactions revenue on the Consolidated statements of income.
For a discussion of Principal transactions and Long-term debt, see Notes 4 and
19 on pages 98–99 and 124–125, respectively, of this Annual Report.
Significant accounting policies
The following table identifies JPMorgan Chase’s other significant accounting
policies and the Note and page where a detailed description of each policy
can be found:
Business changes and developments Note 2 Page 95
Principal transactions activities Note 4 Page 98
Other noninterest revenue Note 5 Page 99
Pension and other postretirement employee
benefit plans Note 7 Page 100
Employee stock-based incentives Note 8 Page 105
Noninterest expense Note 9 Page 108
Securities Note 10 Page 108
Securities financing activities Note 11 Page 111
Loans Note 12 Page 112
Allowance for credit losses Note 13 Page 113
Loan securitizations Note 14 Page 114
Variable interest entities Note 15 Page 118
Goodwill and other intangible assets Note 16 Page 121
Premises and equipment Note 17 Page 123
Income taxes Note 24 Page 128
Accounting for derivative instruments
and hedging activities Note 28 Page 131
Off–balance sheet lending-related financial
instruments and guarantees Note 29 Page 132
Fair value of financial instruments Note 31 Page 135
Note 2 – Business changes and developments
Merger with Bank One Corporation
Bank One Corporation merged with and into JPMorgan Chase (the
“Merger”) on July 1, 2004. As a result of the Merger, each outstanding share
of common stock of Bank One was converted in a stock-for-stock exchange
into 1.32 shares of common stock of JPMorgan Chase. JPMorgan Chase
stockholders kept their shares, which remained outstanding and unchanged
as shares of JPMorgan Chase following the Merger. Key objectives of the
Merger were to provide the Firm with a more balanced business mix and
greater geographic diversification. The Merger was accounted for using the
purchase method of accounting, which requires that the assets and liabilities
of Bank One be fair valued as of July 1, 2004. The purchase price to complete
the Merger was $58.5 billion.
As part of the Merger, certain accounting policies and practices were conformed,
which resulted in $976 million of charges in 2004. The significant components
of the conformity charges were a $1.4 billion charge related to the decertifica-
tion of the seller’s interest in credit card securitizations, and the benefit of
a $584 million reduction in the allowance for credit losses as a result of
conforming the wholesale and consumer credit provision methodologies.