American Express 2005 Annual Report Download - page 74

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recorded in accumulated other comprehensive (loss)
income is recognized into earnings over the period
that the hedged item impacts earnings. For any
hedge relationships that are discontinued because it is
probable that the forecasted transaction will not
occur according to the original strategy, any related
amounts previously recorded in accumulated other
comprehensive (loss) income are recognized into
earnings immediately.
Fair value hedges
For derivative financial instruments that qualify as fair
value hedges, changes in the fair value of the derivatives
as well as of the corresponding hedged assets, liabilities
or firm commitments are recorded in earnings as a
component of other revenue. If a fair value hedge is
de-designated or terminated prior to maturity, previous
adjustments to the carrying value of the hedged item are
recognized into earnings to match the earnings pattern
of the hedged item.
Net investment hedges in foreign operations
For derivative financial instruments that qualify as net
investment hedges in foreign operations, the effective
portions of the change in fair value of the derivatives are
recorded in accumulated other comprehensive (loss)
income as part of the cumulative translation adjustment.
Any ineffective portions of net investment hedges
are recognized in other revenue during the period
of change.
Non-designated derivatives and trading activities
For derivative financial instruments that do not qualify
for hedge accounting, are not designated under SFAS
No. 133 as hedges or are comprised of customer or
proprietary trading activities, changes in fair value are
reported in current period earnings generally as a com-
ponent of other revenue, other operating expenses or
interest expense, depending on the type of derivative
instrument and the nature of the transaction.
Derivative financial instruments that qualify for
hedge accounting
Derivative financial instruments that are entered into for
hedging purposes are designated as such at the time that
the Company enters into the contract. As required by
SFAS No. 133, for all derivative financial instruments
that are designated for hedging activities, the Company
formally documents all of the hedging relationships
between the hedge instruments and the hedged items at
the inception of the relationships. Management also for-
mally documents its risk management objectives and
strategies for entering into the hedge transactions. The
Company formally assesses, at inception and on a quar-
terly basis, whether derivatives designated as hedges are
highly effective in offsetting the fair value or cash flows
of hedged items. Such assessments are usually made
through the application of statistical measures. The
Company only applies the “short cut” method of hedge
accounting in very limited cases when such require-
ments are strictly met. In accordance with its risk man-
agement policies, the Company generally structures its
hedges with very similar terms to the hedged items;
therefore, when applying the accounting requirements,
the Company generally recognizes insignificant
amounts of ineffectiveness through earnings. If it is
determined that a derivative is not highly effective as a
hedge, the Company will discontinue the application of
hedge accounting.
Income taxes
The Company, its 80 percent or more owned U.S. sub-
sidiaries and certain non-U.S. subsidiaries file a consoli-
dated federal income tax return. Deferred tax assets and
liabilities are determined based on the differences
between the financial statement and tax bases of assets
and liabilities using the enacted tax rates expected to be
in effect for the years in which the differences are
expected to reverse. A valuation allowance is established
when management determines that it is more likely than
not that the benefit of the deferred tax asset will not be
realized. The Company does not provide for federal
income taxes on foreign earnings intended to be perma-
nently reinvested outside the United States.
The Company is under continuous examination by the
Internal Revenue Service (IRS) and tax authorities in
other countries and states in which the Company has
significant business operations. The tax years under
examination vary by jurisdiction. The Company rou-
tinely assesses the likelihood of additional assessments
in each of the taxing jurisdictions resulting from these
examinations. Tax reserves have been established that
the Company believes to be adequate in relation to the
potential for additional assessments. Once established,
Notes to Consolidated
Financial Statements
AXP / AR.2005
[72 ]