TD Bank 2005 Annual Report Download - page 112

TD BANK FINANCIAL GROUP ANNUAL REPORT 2005 Financial Results
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(d) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
U.S. GAAP requires all derivative instruments be reported on the
Consolidated Balance Sheet at their fair values, with changes in
the fair value for derivatives that are not designated as hedges
reported through the Consolidated Statement of Income. U.S.
GAAP provides specific guidance on hedge accounting including
the measurement of hedge ineffectiveness, limitations on hedging
strategies and hedging with intercompany derivatives. For fair
value hedges, the Bank is hedging changes in the fair value of
assets, liabilities or firm commitments and changes in the fair
values of the derivative instruments are recorded in income. For
cash flow hedges, the Bank is hedging the variability in cash flows
related to variable rate assets, liabilities or forecasted transactions
and the effective portion of the changes in the fair values of the
derivative instruments are recorded in other comprehensive
income until the hedged items are recognized in income. At the
end of fiscal 2005, deferred net gains (losses) on derivative instru-
ments of $(40) million (2004 – $90 million; 2003 – $(27) million)
included in other comprehensive income are expected to be
reclassified to earnings during the next fiscal year. Cash flow
hedges also include hedges of certain forecasted transactions
up to a maximum of 24 years, although a substantial majority is
under three years. The ineffective portion of hedging derivative
instruments’ changes in fair values are immediately recognized in
income. For fiscal 2005, under U.S. GAAP, the Bank recognized
pre-tax gains (losses) of nil (2004 – nil; 2003 – $(19) million) for
the ineffective portion of cash flow hedges.
Under previous Canadian GAAP, the Bank recognized only
derivatives used in trading activities at fair value on the
Consolidated Balance Sheet, with changes in fair value included
in income. However, as discussed in Note 1, as of November 1,
2003 the Bank prospectively adopted the CICA Accounting
Guideline on hedging relationships. This guideline resulted in
non-trading derivatives that arein ineffective hedging relation-
ships or that are hedges not designated in a hedging relationship
being carried at fair value.
In fiscal 2005, U.S. GAAP adjustments for derivative instru-
ments and hedging activities increased net interest income by
$130 million beforetax and decreased other income by
$417 million beforetax.
In fiscal 2004, the majority of the net income adjustment for
derivative instruments and hedging activities resulted from the
Bank entering into a hedge for the cash portion of the purchase
price for the proposed acquisition of Banknorth. Under U.S.
GAAP, the hedge of the proposed Banknorth acquisition is not
eligible for designation as a hedged transaction in a cash flow
hedge given that the forecasted transaction involves a business
combination. As a result, changes in the fair value of the deriva-
tive have been reported through U.S. GAAP net income and under
Canadian GAAP,the forecasted transaction is eligible for hedge
accounting, given that it is a hedge of foreign exchange risk.
(e) GUARANTEES
During fiscal 2003, the Bank adopted the U.S. interpretation on
guarantor’saccounting and disclosure requirements for guaran-
tees, including indirect guarantees of indebtedness of others. As
aresult, for U.S. GAAP purposes, the initial liability for obliga-
tions assumed with respect to guarantees issued or modified
after December 31, 2002 is recorded on the Consolidated
Balance Sheet at fair value. The total amount of the current liabil-
ities recorded on the Consolidated Balance Sheet is $55 million
for U.S. GAAP purposes in 2005 (2004 – $33 million). Under
Canadian GAAP, a liability is not recognized at the inception of a
guarantee. In fiscal 2005, U.S. GAAP adjustments for guarantees
increased non-interest expenses by $22 million before tax.
(f) LIABILITIES AND EQUITY
As of November 1, 2004, the Bank adopted the CICA amend-
ments to its accounting standard on financial instruments – dis-
closure and presentation on a retroactive basis with restatement
of prior periods. As a result of these amendments, the Bank was
required to classify its existing preferred shares and innovative
capital structures as liabilities and their corresponding distribu-
tions as interest expense for Canadian GAAP. However, under
U.S. GAAP preferred shares of the Bank (except preferred shares
of the Bank’s subsidiary TD Mortgage Investment Corporation)
continue to be considered equity and innovative capital structures
continue to be considered non-controlling interest. In addition,
under U.S. GAAP, preferred shares of the Bank’s subsidiary,
TD Mortgage Investment Corporation, continue to be presented
as a non-controlling interest on the Consolidated Balance Sheet,
and the net income applicable to the non-controlling interest
continues to be presented separately on the Consolidated
Statement of Income. Due to the prior period restatements for
Canadian GAAP, the Bank has reclassified the Consolidated
Financial Statements prepared on a U.S. GAAP basis. In fiscal
2005, U.S. GAAP adjustments for liabilities and equity increased
net interest income by $147 million.
(g) ACQUISITION OF TD BANKNORTH
For U.S. GAAP, the survival of TD Banknorth Inc., a company
created to effect the migratory merger that preceded the Bank’s
acquisition of TD Banknorth, has resulted in a full fair value step
up of the TD Banknorth balance sheet. The impact of the step
up for U.S. GAAP purposes is approximately a $2.2 billion
increase to the Bank’s goodwill and other intangibles offset with
approximately $2 billion in non-controlling interest and $200
million in future income taxes. There is no net impact on the
Bank’s U.S. GAAP net income since intangible amortization
and non-controlling interest have been increased by offsetting
amounts. For Canadian GAAP purposes, the migratory merger
is not considered substantive and only the Bank’sshare of TD
Banknorth assets and liabilities have been stepped up to fair
value as the Bank was deemed the acquiror under the purchase
method of accounting.
(h) RESTRUCTURING COSTS
Under previous Canadian GAAP, restructuring costs incurred by
the Bank could be accrued as a liability provided that a restructur-
ing plan detailing all significant actions to be taken had been
approved by an appropriate level of management, and significant
changes to the plan were not likely. U.S. GAAP and current
Canadian GAAP require that restructuring costs related to an
acquired company be included as a liability in the allocation of
the purchase price, thereby increasing goodwill. U.S. GAAP and
current Canadian GAAP also require that all restructuring costs
be incurred within one year of a restructuring plan’s approval by
management and that all employees to be involuntarily terminat-
ed be notified of their termination benefit arrangement.
(i) FUTURE INCOME TAXES
Under Canadian GAAP, the effects of income tax rate reductions
are recorded when considered substantively enacted. Under U.S.
GAAP, the effects of rate changes do not impact the measure-
ment of tax balances until passed into law.
(j) STOCK-BASED COMPENSATION
Until October 5, 2002, under the Bank’s stock option plan, option
holders could elect to receive cash for the options equal to their
intrinsic value, being the excess of the market value of the share
over the option exercise price at the date of exercise. In account-
ing for stock options with this feature, U.S. GAAP requires
expensing the annual change in the intrinsic value of the stock
options. For options that have not fully vested, the change in
intrinsic value is amortized over the remaining vesting period.
Under previous Canadian GAAP, no expenses were recorded and
cash payments to option holders were charged to retained earn-
ings on a net of tax basis. Effective October 6, 2002, the plan