JP Morgan Chase 2005 Annual Report Download - page 86

Management’s discussion and analysis
JPMorgan Chase & Co.
84 JPMorgan Chase & Co. /2005 Annual Report
In the normal course of business, JPMorgan Chase trades nonexchange-traded
commodity derivative contracts. To determine the fair value of these contracts,
the Firm uses various fair value estimation techniques, which are primarily
based upon internal models with significant observable market parameters.
The Firm’s nonexchange-traded commodity derivative contracts are primarily
energy-related contracts. The following table summarizes the changes in fair
value for nonexchange-traded commodity derivative contracts for the year
ended December 31, 2005:
For the year ended
December 31, 2005 (in millions) Asset position Liability position
Net fair value of contracts
outstanding at January 1, 2005 $ 1,449 $ 999
Effect of legally enforceable master
netting agreements 2,304 2,233
Gross fair value of contracts
outstanding at January 1, 2005 3,753 3,232
Contracts realized or otherwise settled
during the period (12,589) (10,886)
Fair value of new contracts 37,518 30,691
Changes in fair values attributable to
changes in valuation techniques
and assumptions ——
Other changes in fair value (11,717) (7,635)
Gross fair value of contracts
outstanding at December 31, 2005 16,965 15,402
Effect of legally enforceable master
netting agreements (10,014) (10,078)
Net fair value of contracts
outstanding at December 31, 2005 $ 6,951 $ 5,324
The following table indicates the schedule of maturities of nonexchange-
traded commodity derivative contracts at December 31, 2005:
At December 31, 2005 (in millions) Asset position Liability position
Maturity less than 1 year $ 6,682 $ 6,254
Maturity 1–3 years 8,231 7,590
Maturity 4–5 years 1,616 1,246
Maturity in excess of 5 years 436 312
Gross fair value of contracts
outstanding at December 31, 2005 16,965 15,402
Effects of legally enforceable master
netting agreements (10,014) (10,078)
Net fair value of contracts
outstanding at December 31, 2005 $ 6,951 $ 5,324
Nonexchange-traded commodity derivative contracts at fair value
compensation cost over the awards’ stated service period. For awards granted
to retirement-eligible employees in January 2006, which are subject to SFAS
123R, the Firm will recognize compensation expense on the grant date without
giving consideration to the impact of post-employment restrictions. This will
result in an increase in compensation expense for the fiscal quarter ended
March 31, 2006 of approximately $300 million, as compared with the
expense that would have been recognized under the Firm’s prior accounting
policy. The Firm will also accrue in 2006 the estimated cost of stock awards
to be granted to retirement-eligible employees in January 2007.
Accounting for conditional asset retirement obligations
In March 2005, FASB issued FIN 47 to clarify the term “conditional asset
retirement obligation” as used in SFAS 143. Conditional asset retirement
obligations are legal obligations to perform an asset retirement activity in
which the timing and/or method of settlement are conditional based upon a
future event that may or may not be within the control of the company.
The obligation to perform the asset retirement activity is unconditional even
though uncertainty exists about the timing and/or method of settlement.
FIN 47 clarifies that a company is required to recognize a liability for the
fair value of the conditional asset retirement obligation if the fair value of the
liability can be reasonably estimated and provides guidance for determining
when a company would have sufficient information to reasonably estimate
the fair value of the obligation. The Firm adopted FIN 47 on December 31,
2005. The implementation did not have a material impact on its financial
position or results of operations.
Accounting for Certain Hybrid Financial Instruments –
an Amendment of FASB Statements No. 133 and 140
In February 2006, the FASB issued SFAS 155, which applies to certain “hybrid
financial instruments,” which are instruments that contain embedded derivatives.
The new standard establishes a requirement to evaluate beneficial interests in
securitized financial assets to determine if the interests represent freestanding
derivatives or are hybrid financial instruments containing embedded derivatives
requiring bifurcation.
This new standard also permits an election for fair value remeasurement of any
hybrid financial instrument containing an embedded derivative that otherwise
would require bifurcation under SFAS 133. The fair value election can be
applied on an instrument-by-instrument basis to existing instruments at the
date of adoption and can be applied to new instruments on a prospective basis.
Currently, the Firm is planning to adopt this standard effective January 1, 2006.
In addition, the Firm is assessing to which qualifying existing and newly issued
instruments it will apply the fair value election. Implementation of this standard
is not expected to have a material impact on the Firm’s financial position or
results of operations.