eTrade 2004 Annual Report Download - page 49

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 2004, we recognized $18.4 million of losses from other-than-temporary declines in market value related to our
investments.
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
interest rates that are fixed for a shorter period of time, if at all. The Bank purchases interest rate derivatives, including interest rate swaps, caps
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 for hedge accounting treatment, 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, 2004
as hedges.
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
In preparing our consolidated financial statements, we estimate our income tax expense based on the various jurisdictions where we
conduct business. This requires us to estimate our current tax obligations and to assess temporary differences between the financial statement
carrying amounts and the tax bases of assets and liabilities. These differences result in deferred tax assets and liabilities, which we show as
other assets on our consolidated balance sheets. We must then assess the likelihood that our deferred tax assets will be realized. To the extent
we believe that realization is not more likely than not, we establish a valuation allowance. When we establish a valuation allowance or increase
this allowance in a reporting period, we generally record a corresponding tax expense in our consolidated statements of operations. Conversely,
to the extent circumstances indicate that a valuation allowance is no longer necessary, that portion of the valuation allowance is reversed, which
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. Changes in our estimate of these taxes occur periodically due to changes
in the tax rates, changes in our business operations, implementation of tax planning strategies, resolution with taxing authorities of issues with
previously taken tax positions and newly enacted statutory, judicial and regulatory guidance. These changes, when they occur, affect accrued
taxes and can be material to our operating results for any particular reporting period. Taxes are discussed in more detail in Note 19 of the
consolidated financial statements.
Our net deferred tax asset as of December 31, 2004 and 2003 was $41.1 million and $84.5 million respectively, net of a valuation
allowance of $52.7 million and $70.2 million, respectively.
Valuation of goodwill and other intangibles
We review goodwill and purchased intangible assets with indefinite lives for impairment annually and whenever events or changes
indicate the carrying value of an asset may not be recoverable in accordance with
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