Morgan Stanley 2009 Annual Report Download - page 128

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
fee revenue is accrued (or reversed) quarterly based on measuring account/fund performance to date versus the
performance benchmark stated in the investment management agreement. Performance-based fees are recorded
within Principal transactions—investment revenues or Asset management, distribution and administration fees
depending on the nature of the arrangement.
Principal Transactions. See “Financial Instruments and Fair Value” below for principal transactions revenue
recognition discussions.
Financial Instruments and Fair Value.
A significant portion of the Company’s financial instruments is carried at fair value with changes in fair value
recognized in earnings each period. A description of the Company’s policies regarding fair value measurement
and its application to these financial instruments follows.
Financial Instruments Measured at Fair Value. All of the instruments within Financial instruments owned and
Financial instruments sold, not yet purchased, are measured at fair value, either through the fair value option
election (discussed below) or as required by other accounting pronouncements. These financial instruments
primarily represent the Company’s trading and investment activities and include both cash and derivative
products. In addition, Securities received as collateral and Obligation to return securities received as collateral
are measured at fair value as required by other accounting pronouncements. Additionally, certain Commercial
paper and other short-term borrowings (primarily structured notes), certain Deposits, Other secured financings
and certain Long-term borrowings (primarily structured notes and certain junior subordinated debentures) are
measured at fair value through the fair value option election.
Gains and losses on all of these instruments carried at fair value are reflected in Principal transactions—trading
revenues, Principal transactions—investment revenues or Investment banking revenues in the consolidated
statements of income, except for derivatives accounted for as hedges (see “Hedge Accounting” section herein
and Note 10). Interest income and expense and dividend income are recorded within the consolidated statements
of income depending on the nature of the instrument and related market conventions. When interest and
dividends are included as a component of the instruments’ fair value, interest and dividends are included
within Principal transactions—trading revenues or Principal transactions—investment revenues. Otherwise, they
are included within Interest and dividend income or Interest expense. The fair value of over-the-counter (“OTC”)
financial instruments, including derivative contracts related to financial instruments and commodities, is
presented in the accompanying consolidated statements of financial condition on a net-by-counterparty basis,
when appropriate. Additionally, the Company nets fair value of cash collateral paid or received against fair value
amounts recognized for net derivative positions executed with the same counterparty under the same master
netting arrangement.
Fair Value Option. The fair value option permits the irrevocable fair value option election on an
instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a
new basis of accounting for that instrument. The Company applies the fair value option for eligible instruments,
including certain loans and lending commitments, certain equity method investments, certain structured notes,
certain junior subordinated debentures, certain time deposits and certain other secured financings.
Fair Value Measurement—Definition and Hierarchy. Fair value is defined as the price that would be received
to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market
participants at the measurement date.
In determining fair value, the Company uses various valuation approaches and establishes a hierarchy for inputs
used in measuring fair value that maximizes the use of relevant observable inputs and minimizes the use of
unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are
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