Goldman Sachs 2004 Annual Report Download - page 77

notes฀to฀consolidated฀financial฀statements
GOLDMAN฀SAC H S ฀ 2004฀ A N N U A L ฀ R E P ORT ฀ ฀ ฀ 7 5
NOTE฀1
Description of Business
The Goldman Sachs Group, Inc. (Group Inc.), a Delaware cor-
poration, together with its consolidated subsidiaries (collec-
tively, the firm), is a leading global investment banking,
securities and investment management firm that provides a wide
range of services worldwide to a substantial and diversified
client base that includes corporations, financial institutions,
governments and high-net-worth individuals.
The firm’s activities are divided into three segments:
•฀in ve st m en t฀ ba n ki ng ฀– ฀The firm provides a broad range
of investment banking services to a diverse group of corpo-
rations, financial institutions, governments and individuals.
•฀tr adi ng฀ a n d฀ p r in c ipa l ฀ in v es t me n ts฀–฀The firm
facilitates customer transactions with a diverse group of
corporations, financial institutions, governments and indi-
viduals and takes proprietary positions through market
making in, and trading of, fixed income and equity products,
currencies, commodities and derivatives on such products.
In addition, the firm engages in floor-based and electronic
market making as a specialist on U.S. equities and options
exchanges and clears customer transactions on major stock,
options and futures exchanges worldwide. In connection
with the firm’s merchant banking and other investment
activities, the firm makes principal investments directly and
through funds that the firm raises and manages.
•฀as se t฀ ma nag eme nt฀ and฀ s ecuri ties฀ s ervic es฀– ฀The
firm offers a broad array of investment strategies, advice and
planning across all major asset classes to a diverse group of
institutions and individuals worldwide, and provides prime
brokerage, financing services and securities lending services
to mutual funds, pension funds, hedge funds, foundations
and high-net-worth individuals worldwide.
NOTE฀2
Significant Accounting Policies
BASIS฀OF฀ PRESENTATION
These consolidated financial statements include the accounts of
Group Inc. and all other entities in which the firm has a control-
ling financial interest. All material intercompany transactions
and balances have been eliminated. The firm determines
whether it has a controlling financial interest in an entity by first
evaluating whether the entity is a voting interest entity, a vari-
able interest entity (VIE) or a qualifying special-purpose entity
(QSPE) under generally accepted accounting principles.
•฀vo t i ng฀ i n t erest฀ entities ฀–฀Voting interest entities are
entities in which (i) the total equity investment at risk is
sufficient to enable the entity to finance itself independently
and (ii) the equity holders have the obligation to absorb
losses, the right to receive residual returns and the right to
make decisions about the entity’s activities. Voting interest
entities are consolidated in accordance with Accounting
Research Bulletin (ARB) No. 51, “Consolidated Financial
Statements,” as amended. ARB No. 51 states that the usual
condition for a controlling financial interest in an entity is
ownership of a majority voting interest. Accordingly, the
firm consolidates voting interest entities in which it has the
majority of the voting interest.
• var i a b le฀ intere s t ฀ e ntities – VIEs are entities that
lack one or more of the characteristics of a voting interest
entity. A controlling financial interest in a VIE is present
when an enterprise has a variable interest, or a combina-
tion of variable interests, that will absorb a majority of the
VIE’s expected losses, receive a majority of the VIE’s
expected residual returns, or both. The enterprise with a
controlling financial interest, known as the primary benefi-
ciary, consolidates the VIE.
The firm determines whether it is the primary beneficiary of
a VIE by first performing a qualitative analysis of the VIE
that includes, among other factors, its capital structure, con-
tractual terms, which variable interests create or absorb
variability, related party relationships and the design of the
VIE. Where qualitative analysis is not conclusive, the firm
performs a quantitative analysis. For purposes of allocating
a VIE’s expected losses and expected residual returns to the
VIE’s variable interest holders, the firm utilizes the “top
down” method. Under that method, the firm calculates its
share of the VIE’s expected losses and expected residual
returns using the specific cash flows that would be allocated
to it, based on contractual arrangements and/or the firm’s
position in the capital structure of the VIE, under various
probability-weighted scenarios.
The Financial Accounting Standards Board (FASB) issued
FASB Interpretation (FIN) No. 46-R, “Consolidation of
Variable Interest Entities,” in December 2003. FIN No. 46-R
replaced FIN No. 46, which was issued in January 2003. As
permitted, the firm adopted either FIN No. 46 or FIN
No. 46-R for substantially all VIEs in which it held a vari-
able interest as of November 2003. As of May 2004, the
firm adopted FIN No. 46-R for all VIEs in which it held a
variable interest.
• q s p e s – QSPEs are passive entities that hold financial assets
transferred to them and are commonly used in mortgage and
other securitization transactions. In accordance with
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