JP Morgan Chase 2006 Annual Report Download - page 96

94 JPMorgan Chase & Co. / 2006 Annual Report
When the SPE does not meet the QSPE criteria, consolidation is assessed pur-
suant to FIN 46R. Under FIN 46R, a VIE is defined as an entity that: (1) lacks
enough equity investment at risk to permit the entity to finance its activities
without additional subordinated financial support from other parties; (2) has
equity owners that lack the right to make significant decisions affecting the
entity’s operations; and/or (3) has equity owners that do not have an obligation
to absorb the entity’s losses or the right to receive the entity’s returns.
FIN 46R requires a variable interest holder (i.e., a counterparty to a VIE) to
consolidate the VIE if that party will absorb a majority of the expected losses
of the VIE, receive the majority of the expected residual returns of the VIE, or
both. This party is considered the primary beneficiary. In making this determi-
nation, the Firm thoroughly evaluates the VIE’s design, capital structure and
relationships among variable interest holders. When the primary beneficiary
cannot be identified through a qualitative analysis, the Firm performs a quan-
titative analysis, which computes and allocates expected losses or residual
returns to variable interest holders. The allocation of expected cash flows in
this analysis is based upon the relative contractual rights and preferences
of each interest holder in the VIE’s capital structure. For further details, see
Note 15 on pages 118–120 of this Annual Report.
Investments in companies that are considered to be voting-interest entities
under FIN 46R in which the Firm has significant influence over operating
and financing decisions are accounted for in accordance with the equity
method of accounting. These investments are generally included in Other
assets, and the Firm’s share of income or loss is included in Other income.
All retained interests and significant transactions between the Firm, QSPEs
and nonconsolidated VIEs are reflected on JPMorgan Chase’s Consolidated
balance sheets or in the Notes to consolidated financial statements.
For a discussion of the accounting for private equity investments, see Note 4
on pages 98–99 of this Annual Report.
Assets held for clients in an agency or fiduciary capacity by the Firm are
not assets of JPMorgan Chase and are not included in the Consolidated
balance sheets.
Use of estimates in the preparation of consolidated
financial statements
The preparation of consolidated financial statements requires management
to make estimates and assumptions that affect the reported amounts of
assets and liabilities, of revenue and expenses, and of disclosures of contin-
gent assets and liabilities. Actual results could be different from these esti-
mates. For discussion of critical accounting estimates used by the Firm, see
pages 83–85 of this Annual Report.
Foreign currency translation
JPMorgan Chase revalues assets, liabilities, revenues and expenses denomi-
nated in foreign (i.e., non-U.S.) currencies into U.S. dollars using applicable
exchange rates.
Gains and losses relating to translating functional currency financial statements
for U.S. reporting are included in Other comprehensive income (loss) within
Stockholders’ equity. Gains and losses relating to nonfunctional currency
transactions, including non-U.S. operations where the functional currency is
the U.S. dollar, are reported in the Consolidated statements of income.
Statements of cash flows
For JPMorgan Chase’s Consolidated statements of cash flows, cash is defined
as those amounts included in Cash and due from banks.
Note 1 – Basis of presentation
JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”), a financial holding
company incorporated under Delaware law in 1968, is a leading global
financial services firm and one of the largest banking institutions in the
United States, with operations worldwide. The Firm is a leader in investment
banking, financial services for consumers and businesses, financial transaction
processing, asset management and private equity. For a discussion of the
Firm’s business segment information, see Note 33 on pages 139–141 of this
Annual Report.
The accounting and financial reporting policies of JPMorgan Chase and its
subsidiaries conform to accounting principles generally accepted in the
United States of America (“U.S. GAAP”). Additionally, where applicable, the
policies conform to the accounting and reporting guidelines prescribed by
bank regulatory authorities.
Certain amounts in the prior periods have been reclassified to conform to the
current presentation.
Consolidation
The consolidated financial statements include the accounts of JPMorgan
Chase and other entities in which the Firm has a controlling financial interest.
All material intercompany balances and transactions have been eliminated.
The most usual condition for a controlling financial interest is the ownership of
a majority of the voting interests of the entity. However, a controlling financial
interest also may be deemed to exist with respect to entities, such as special
purpose entities (“SPEs”), through arrangements that do not involve controlling
voting interests.
SPEs are an important part of the financial markets, providing market liquidity
by facilitating investors’ access to specific portfolios of assets and risks. For
example, they are critical to the functioning of the mortgage- and asset-
backed securities and commercial paper markets. SPEs may be organized
as trusts, partnerships or corporations and are typically set up for a single,
discrete purpose. SPEs are not typically operating entities and usually have a
limited life and no employees. The basic SPE structure involves a company
selling assets to the SPE. The SPE funds the purchase of those assets by issu-
ing securities to investors. The legal documents that govern the transaction
describe how the cash earned on the assets must be allocated to the SPE’s
investors and other parties that have rights to those cash flows. SPEs can be
structured to be bankruptcy-remote, thereby insulating investors from the
impact of the creditors of other entities, including the seller of the assets.
There are two different accounting frameworks applicable to SPEs: the quali-
fying SPE (“QSPE”) framework under SFAS 140; and the variable interest
entity (“VIE”) framework under FIN 46R. The applicable framework depends
on the nature of the entity and the Firm’s relation to that entity. The QSPE
framework is applicable when an entity transfers (sells) financial assets to an
SPE meeting certain criteria defined in SFAS 140. These criteria are designed
to ensure that the activities of the entity are essentially predetermined at the
inception of the vehicle and that the transferor of the financial assets cannot
exercise control over the entity and the assets therein. Entities meeting these
criteria are not consolidated by the transferor or other counterparties, as long
as they do not have the unilateral ability to liquidate or to cause the entity
no longer to meet the QSPE criteria. The Firm primarily follows the QSPE
model for securitizations of its residential and commercial mortgages, credit
card loans and automobile loans. For further details, see Note 14 on pages
114–118 of this Annual Report.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JPMorgan Chase & Co.