JP Morgan Chase 2008 Annual Report Download - page 125

JPMorgan Chase & Co./ 2008 Annual Report 123
The Firm considers discounted cash flow models to be its primary
method of determining the fair value of its reporting units. The mod-
els project levered cash flows for five years and use the perpetuity
growth method to calculate terminal values. The first year’s projected
cash flows are based on the reporting units’ internal budget fore-
casts for the upcoming calendar year (which are reviewed with the
Operating Committee of the Firm). To assess the reasonableness of
the valuations derived from the discounted cash flow models, the
Firm also analyzes market-based trading and transaction multiples,
where available. These trading and transaction comparables are used
to assess the reasonableness of the estimated fair values, as observ-
able market information is generally not available.
JPMorgan Chase’s stock price, consistent with stock prices in the
broader financial services sector, declined significantly during the last
half of 2008. JPMorgan Chase’s market capitalization fell below its
recorded book value, principally during the fourth quarter of 2008.
Although the Firm believes it is reasonable to conclude that market
capitalization could be an indicator of fair value over time, the Firm
is of the view that short-term fluctuations in market capitalization do
not reflect the long-term fair value of its reporting units.
Management applies significant judgment when determining the fair
value of its reporting units. Imprecision in estimating the future cash
flows of the Firm’s reporting units as well as the appropriate cost of
equity used to discount those cash flows can impact their estimated
fair values. If JPMorgan Chase’s common stock were to trade at the
level it was at the end of 2008 over a sustained period and weak
economic market conditions persist, these factors could indicate that
the long-term earnings potential of the Firm’s reporting units could
be adversely affected – which could result in supplemental impair-
ment testing during interim reporting periods and possible impair-
ment of goodwill in the future.
Income taxes
JPMorgan Chase is subject to the income tax laws of the various juris-
dictions in which it operates, including U.S. federal, state and non-U.S.
jurisdictions. These laws are often complex and may be subject to dif-
ferent interpretations. To determine the financial statement impact of
its accounting for income taxes, including the provision for income tax
expense and its unrecognized tax benefits, JPMorgan Chase must
make assumptions and judgments about how to interpret and apply
these complex tax laws to numerous transactions and business
events. Disputes over interpretations with the various taxing authori-
ties may be settled upon audit or administrative appeals. In some
cases, the Firm’s interpretations of tax laws may be subject to adjudi-
cation by the court systems of the tax jurisdictions in which it oper-
ates. JPMorgan Chase regularly reviews whether the Firm may be
assessed additional income taxes as a result of the resolution of these
matters, and the Firm records additional reserves as appropriate.
The Firm does not anticipate that current market events will adversely
impact the realizability of its deferred tax assets.
The Firm adjusts its unrecognized tax benefits as necessary when
additional information becomes available. The reassessment of
JPMorgan Chase’s unrecognized tax benefits may have a material
impact on its effective tax rate in the period in which it occurs.
ACCOUNTING AND REPORTING DEVELOPMENTS
Derivatives netting – amendment of FASB Interpretation
No. 39
In April 2007, the FASB issued FSP FIN 39-1, which permits offset-
ting of cash collateral receivables or payables with net derivative
positions under certain circumstances. The Firm adopted FSP FIN 39-
1 effective January 1, 2008. The FSP did not have a material impact
on the Firm’s Consolidated Balance Sheets.
Accounting for income tax benefits of dividends on share-
based payment awards
In June 2007, the FASB ratified EITF 06-11, which must be applied
prospectively for dividends declared in fiscal years beginning after
December 15, 2007. EITF 06-11 requires that realized tax benefits
from dividends or dividend equivalents paid on equity-classified
share-based payment awards that are charged to retained earnings
be recorded as an increase to additional paid-in capital and included
in the pool of excess tax benefits available to absorb tax deficiencies
on share-based payment awards. Prior to the issuance of EITF 06-11,
the Firm did not include these tax benefits as part of this pool of
excess tax benefits. The Firm adopted EITF 06-11 on January 1,
2008. The adoption of this consensus did not have an impact on the
Firm’s Consolidated Balance Sheets or results of operations.
Fair value measurements – written loan commitments
In November 2007, the SEC issued SAB 109, which revises and
rescinds portions of SAB 105. Specifically, SAB 109 states that the
expected net future cash flows related to the associated servicing of
the loan should be included in the measurement of all written loan
commitments that are accounted for at fair value through earnings.
The provisions of SAB 109 are applicable to written loan commit-
ments issued or modified beginning on January 1, 2008. The Firm
adopted SAB 109 on January 1, 2008. The adoption of this pro-
nouncement did not have a material impact on the Firm’s
Consolidated Balance Sheets or results of operations.
Business combinations/noncontrolling interests in consoli-
dated financial statements
In December 2007, the FASB issued SFAS 141R and SFAS 160, which
amend the accounting and reporting of business combinations, as
well as noncontrolling (i.e., minority) interests. For JPMorgan Chase,
SFAS 141R is effective for business combinations that close on or
after January 1, 2009. SFAS 160 is effective for JPMorgan Chase for
fiscal years beginning on or after December 15, 2008.