American Express 2006 Annual Report Download - page 83

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notes to consolidated fi nancial statements
american express company
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 when the
Company enters into the contract. 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 formally documents its risk
management objectives and strategies for entering into
the hedge transactions. The Company formally assesses,
at inception and on a quarterly basis, whether derivatives
designated as hedges are highly effective in offsetting
the fair value or cash flows of hedged items. These
assessments usually are made through the application
of statistical measures. The Company only applies the
“short cut” method of hedge accounting in very limited
cases when this method’s requirements are strictly met.
Beginning in 2006, the Company discontinued using
the “short cut” method on any new transactions.
In accordance with its risk management 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.
subsidiaries, and certain non-U.S. subsidiaries file
a consolidated 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 the benefit of deferred tax assets
will not be realized. The Company does not provide for
federal income taxes on foreign earnings intended to be
permanently 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 examination
currently being conducted by the IRS covers 1997-2004.
Due to the inherent complexities of the business and
given the Company is subject to taxation in a substantial
number of jurisdictions, the Company is required to
make certain judgments and estimates. The Company
routinely assesses the likelihood of additional assessments
in each of the taxing jurisdictions, and has established
tax reserves that management believes to be adequate.
Once established, reserves are adjusted if more accurate
information is available or a change in circumstance, or
an event occurs necessitating a change to the reserves.
Restricted net assets of subsidiaries
Certain of the Company’s subsidiaries are subject to
restrictions on the transfer of net assets under debt
agreements and regulatory requirements. These
restrictions have not had any effect on the Company’s
shareholder dividend policy and management does
not anticipate any impact in the future. Procedures
exist to transfer net assets between the Company and
its subsidiaries, while ensuring compliance with the
various contractual and regulatory constraints. At
December 31, 2006, the aggregate amount of net assets
of subsidiaries that may not be transferred to American
Express’ Parent Company (Parent Company) was
approximately $6 billion.
RECENTLY ISSUED ACCOUNTING STANDARDS
SFAS No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans – an
amendment of the FASB Statements No. 87, 88, 106,
and 132(R)” (SFAS No. 158), requires the funded status
of pension and other postretirement plans to be recorded
on the balance sheet as of December 31, 2006, with a
corresponding offset, net of tax effects, recorded in
accumulated other comprehensive income (loss) within
shareholders’ equity. Under SFAS No. 158, all previously
unrecognized gains and losses, prior service costs and
credits, and remaining transition amounts under SFAS
Nos. 87 and 106 will be recognized in accumulated
other comprehensive income (loss), net of tax effects,
which is a component of shareholders’ equity and does
not result in an immediate charge to earnings. Those
previously unrecognized amounts will be amortized as
a component of net periodic pension expense in future
periods. Upon implementation of SFAS No. 158,
the Company recorded additional liabilities of $179
million in other liabilities, a reduction of assets of $416
million in other assets and a $396 million charge to
shareholders’ equity, net of a deferred income tax benefit