eTrade 2003 Annual Report Download - page 31

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Table of Contents
Index to Financial Statements
We have investments in certain publicly traded and privately held companies, which we evaluate for other-than-temporary declines in
market value. During 2003, we recognized $8.0 million of losses from other-than-
temporary declines in market value related to our investments
in privately held companies.
Valuation and accounting for financial derivatives
The Bank’s principal assets are residential mortgages and mortgage-backed securities, which typically pay a fixed interest rate over an
extended period of time. However, the principal sources of funds for the Bank are customer deposits and other short-term borrowings with
and floors, to manage this difference between long-term and short-term interest rates.
Accounting for derivatives differs significantly depending on whether a derivative is designated as a “hedge,” which is a transaction
intended to reduce a risk associated with a specific balance sheet item or future expected cash flow at the time it is purchased. In order to
qualify as a hedge, a derivative must be designated as such by management, who must also continue to demonstrate that the instrument
effectively reduces the risk associated with that item. We designated substantially all derivatives we held on December 31, 2003 as hedges. By
doing so, the balance sheet items that we determine are hedged in fair value hedge relationships and the derivatives themselves are adjusted to
market value, resulting in a net offset in the statements of operations to the extent the hedge is ineffective.
To determine whether a derivative instrument will continue to meet the effectiveness requirements, we must make assumptions and
judgments about the continued effectiveness of our hedging strategies and the nature and timing of forecasted transactions. If our hedging
strategies were to become significantly ineffective or our assumptions about the nature and timing of forecasted transactions were to be
inaccurate, we could no longer apply hedge accounting and our reported results would be significantly affected.
Estimates of effective tax rates, deferred taxes and valuation allowances
When we prepare our consolidated financial statements, we estimate our income taxes based on the various jurisdictions where we
conduct business. This requires us to estimate our current tax exposure and to assess temporary differences that result from differing treatments
of certain items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which we show on our
consolidated balance sheets in other assets. We must then assess the likelihood that our deferred tax assets will be realized. To the extent we
allowance in a reporting period, we record a corresponding tax expense on our statements of operations. Conversely, when it subsequently
becomes apparent that a valuation allowance is no longer required due to changes in circumstances, this portion of the valuation allowance is
reversed and reduces our overall income tax expense.
Management must make significant judgments to determine our provision for income taxes, our deferred tax assets and liabilities and any
valuation allowance to be recorded against our net deferred tax asset. Our net deferred tax asset as of December 31, 2003 and 2002 was $84.5
million and $112.2 million respectively, net of the valuation allowance of $70.2 million and $92.2 million respectively. We recorded the
valuation allowance to reflect uncertainties about whether we will be able to utilize some of our deferred tax assets consisting primarily of
certain net operating losses carried forward by both international and domestic subsidiaries as well as certain capital loss carryforwards before
they expire. The valuation allowance is based on our estimates of taxable income or capital gains expected to arise in the jurisdictions in which
we operate and the period over which our deferred tax assets will be realizable. During 2003, we reversed a portion of the valuation allowance
on capital loss carryforwards as a result of our gains associated with our investment in Softbank Investment Corporation (“SBI”).
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