Morgan Stanley 2010 Annual Report Download - page 82

Critical Accounting Policies.
The Company’s consolidated financial statements are prepared in accordance with accounting principles
generally accepted in the U.S., which require the Company to make estimates and assumptions (see Note 1 to the
consolidated financial statements). The Company believes that of its significant accounting policies (see Note 2
to the consolidated financial statements), the following involve a higher degree of judgment and complexity.
Fair Value.
Financial Instruments Measured at Fair Value. A significant number of the Company’s financial instruments
are carried at fair value. The Company makes estimates regarding valuation of assets and liabilities measured at
fair value in preparing the consolidated financial statements. These assets and liabilities include but are not
limited to:
• Financial instruments owned and Financial instruments sold, not yet purchased;
• Securities available for sale;
• Securities received as collateral and Obligation to return securities received as collateral;
• Certain Commercial paper and other short-term borrowings, including structured notes;
• Certain Deposits;
• Certain Securities sold under agreements to repurchase;
• Certain Other secured financings; and
• Certain Long-term borrowings, including structured notes.
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. A hierarchy for inputs is used in
measuring fair value that maximizes the use of observable prices and inputs and minimizes the use of
unobservable prices and inputs by requiring that the relevant observable inputs be used when available. The
hierarchy is broken down into three levels, wherein Level 1 uses observable prices in active markets, and Level 3
consists of valuation techniques that incorporate significant unobservable inputs, and, therefore require the
greatest use of judgment. In periods of market disruption, the observability of prices and inputs may be reduced
for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or
Level 2 to Level 3. In addition, a downturn in market conditions could lead to declines in the valuation of many
instruments. For further information on the fair value definition, Level 1, Level 2, Level 3 and related valuation
techniques, see Notes 2 and 4 to the consolidated financial statements.
Level 3 Assets and Liabilities. The Company’s Level 3 assets before the impact of cash collateral and
counterparty netting across the levels of the fair value hierarchy were $34.9 billion and $43.4 billion at
December 31, 2010 and December 31, 2009, respectively, and represented approximately 10% and 14% at
December 31, 2010 and December 31, 2009, respectively, of the assets measured at fair value (4% and 6% of
total assets at December 31, 2010 and December 31, 2009, respectively). Level 3 liabilities before the impact of
cash collateral and counterparty netting across the levels of the fair value hierarchy were $8.5 billion and $15.4
billion at December 31, 2010 and December 31, 2009, respectively, and represented approximately 4% and 9%,
respectively, of the Company’s liabilities measured at fair value.
Transfers In/Out of Level 3 during 2010. During 2010, the Company reclassified approximately $3.5 billion
of certain Corporate and other debt, primarily loans and hybrid contracts, from Level 3 to Level 2. The Company
reclassified these loans and hybrid contracts as external prices and/or spread inputs became observable, and the
remaining unobservable inputs were deemed insignificant to the overall measurement.
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