US Bank 2007 Annual Report Download - page 63

ACCOUNTING CHANGES
Note 2 of the Notes to Consolidated Financial Statements
discusses accounting standards adopted in the current year,
as well as, accounting standards recently issued but not yet
required to be adopted and the expected impact of these
changes in accounting standards. To the extent the adoption
of new accounting standards affects the Company’s financial
condition, results of operations or liquidity, the impacts are
discussed in the applicable section(s) of the Management’s
Discussion and Analysis and the Notes to Consolidated
Financial Statements.
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of the Company
comply with accounting principles generally accepted in the
United States and conform to general practices within the
banking industry. The preparation of financial statements in
conformity with generally accepted accounting principles
requires management to make estimates and assumptions.
The financial position and results of operations can be
affected by these estimates and assumptions, which are
integral to understanding the Company’s financial
statements. Critical accounting policies are those policies
that management believes are the most important to the
portrayal of the Company’s financial condition and results,
and require management to make estimates that are difficult,
subjective or complex. Most accounting policies are not
considered by management to be critical accounting policies.
Several factors are considered in determining whether or not
a policy is critical in the preparation of financial statements.
These factors include, among other things, whether the
estimates are significant to the financial statements, the
nature of the estimates, the ability to readily validate the
estimates with other information including third-parties or
available prices, and sensitivity of the estimates to changes in
economic conditions and whether alternative accounting
methods may be utilized under generally accepted
accounting principles. Management has discussed the
development and the selection of critical accounting policies
with the Company’s Audit Committee.
Significant accounting policies are discussed in Note 1
of the Notes to Consolidated Financial Statements. Those
policies considered to be critical accounting policies are
described below.
Allowance for Credit Losses The allowance for credit losses
is established to provide for probable losses inherent in the
Company’s credit portfolio. The methods utilized to estimate
the allowance for credit losses, key assumptions and
quantitative and qualitative information considered by
management in determining the adequacy of the allowance
for credit losses are discussed in the “Credit Risk
Management” section.
Management’s evaluation of the adequacy of the
allowance for credit losses is often the most critical of
accounting estimates for a banking institution. It is an
inherently subjective process impacted by many factors as
discussed throughout the Management’s Discussion and
Analysis section of the Annual Report. Although risk
management practices, methodologies and other tools are
utilized to determine each element of the allowance, degrees
of imprecision exist in these measurement tools due in part
to subjective judgments involved and an inherent lagging of
credit quality measurements relative to the stage of the
business cycle. Even determining the stage of the business
cycle is highly subjective. As discussed in the “Analysis and
Determination of Allowance for Credit Losses” section,
management considers the effect of imprecision and many
other factors in determining the allowance for credit losses.
If not considered, inherent losses in the portfolio related to
imprecision and other subjective factors could have a
dramatic adverse impact on the liquidity and financial
viability of a bank.
Given the many subjective factors affecting the credit
portfolio, changes in the allowance for credit losses may
not directly coincide with changes in the risk ratings of the
credit portfolio reflected in the risk rating process. This is
in part due to the timing of the risk rating process in
relation to changes in the business cycle, the exposure and
mix of loans within risk rating categories, levels of
nonperforming loans and the timing of charge-offs and
recoveries. For example, the amount of loans within
specific risk ratings may change, providing a leading
indicator of improving credit quality, while nonperforming
loans and net charge-offs continue at elevated levels. Also,
inherent loss ratios, determined through migration analysis
and historical loss performance over the estimated business
cycle of a loan, may not change to the same degree as net
charge-offs. Because risk ratings and inherent loss ratios
primarily drive the allowance specifically allocated to
commercial loans, the amount of the allowance for
commercial and commercial real estate loans might
decline; however, the degree of change differs somewhat
from the level of changes in nonperforming loans and net
charge-offs. Also, management would maintain an
adequate allowance for credit losses by increasing the
allowance during periods of economic uncertainty or
changes in the business cycle.
Some factors considered in determining the adequacy
of the allowance for credit losses are quantifiable while
other factors require qualitative judgment. Management
conducts an analysis with respect to the accuracy of risk
ratings and the volatility of inherent losses, and utilizes
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