Morgan Stanley 2014 Annual Report Download - page 96

Critical Accounting Policies.
The Company’s consolidated financial statements are prepared in accordance with U.S. GAAP, which require the
Company to make estimates and assumptions (see Note 1 to the Company’s consolidated financial statements in
Item 8). The Company believes that of its significant accounting policies (see Note 2 to the Company’s
consolidated financial statements in Item 8), the following policies 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 Company’s consolidated financial statements. These assets and liabilities include, but
are not limited to:
• Trading assets and Trading liabilities;
• AFS securities;
• Securities received as collateral and Obligation to return securities received as collateral;
• Certain Securities purchased under agreements to resell;
• Certain Deposits;
• Certain Commercial paper and other short-term borrowings, primarily structured notes;
• Certain Securities sold under agreements to repurchase;
• Certain Other secured financings; and
• Certain Long-term borrowings, primarily 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 quoted prices in active markets, Level 2 uses
valuations based on quoted prices in markets that are not active or for which all significant inputs are observable,
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 recategorized 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 valuation process, fair value definition, Level 1, Level 2,
Level 3 and related valuation techniques, and quantitative information about and sensitivity of significant
unobservable inputs used in Level 3 fair value measurements, see Notes 2 and 4 to the Company’s consolidated
financial statements in Item 8.
During the fourth quarter of 2014, the Company incorporated FVA into the fair value measurements of OTC
uncollateralized or partially collateralized derivatives, and in collateralized derivatives where the terms of the
agreement do not permit the reuse of the collateral received. The Company’s implementation of FVA reflects the
inclusion of FVA in the pricing and valuations by the majority of market participants involved in the Company’s
principal exit market for these instruments. In general, FVA reflects a market funding risk premium inherent in
the noted derivative instruments. The implementation of FVA required a number of important management
judgments including:
• Determining when sufficient market evidence exists to indicate that FVA should be incorporated into the
fair value measurements;
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