American Express 2010 Annual Report Download - page 31

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GOODWILL
Description Assumptions/Approach Used
Effect if Actual Results Differ
from Assumptions
Goodwill represents the excess of
acquisition cost of an acquired company
over the fair value of assets acquired and
liabilities assumed. In accordance with
GAAP, goodwill is not amortized but is
tested for impairment at the reporting unit
level annually at June 30 and between
annual tests if events or circumstances
arise, such as adverse changes in the
business climate, that would more likely
than not reduce the fair value of the
reporting unit below its carrying value.
The Company assigns goodwill to its
reporting units for the purpose of
impairment testing. A reporting unit is
defined as either an operating segment or a
business one level below an operating
segment for which discrete financial
information is available that management
regularly reviews.
The goodwill impairment test utilizes a
two-step approach. The first step identifies
whether there is potential impairment by
comparing the fair value of a reporting unit
to its carrying amount, including goodwill.
If the fair value of a reporting unit is less
than its carrying amount, the second step
of the impairment test is required to
measure the amount of any impairment
loss.
Goodwill impairment testing involves
management judgment, requiring an
assessment of whether the carrying value
of the reporting unit can be supported by
its fair value using widely accepted
valuation techniques, such as the market
approach (earnings multiples or
transaction multiples for the industry in
which the reporting unit operates) or the
income approach (discounted cash flow
methods). The fair values of the reporting
units were determined using a combination
of valuation techniques consistent with the
market approach and the income approach.
When preparing discounted cash flow
models under the income approach, the
Company estimates future cash flows using
the reporting unit’s internal five year
forecast and a terminal value calculated
using a growth rate that management
believes is appropriate in light of current
and expected future economic conditions.
The Company then applies a discount rate
to discount these future cash flows to
arrive at a net present value amount, which
represents the estimated fair value of the
reporting unit. The discount rate applied
approximates the expected cost of equity
financing, determined using a capital asset
pricing model. The model generates an
appropriate discount rate using internal
and external inputs to value future cash
flows based on the time value of money
and the price for bearing the uncertainty
inherent in an investment. The Company
believes the resulting rate, 11.8 percent,
appropriately reflects the risks and
uncertainties in the financial markets
generally and in the Company’s internally
developed forecasts.
The Company has approximately $2.6
billion of goodwill as of December 31,
2010. The fair value of each of the
Company’s reporting units is above its
carrying value; accordingly, the Company
has concluded its goodwill is not impaired
at December 31, 2010. The Company could
be exposed to increased risk of goodwill
impairment if future operating results or
macroeconomic conditions differ
significantly from management’s current
assumptions.
29
AMERICAN EXPRESS COMPANY
2010 FINANCIAL REVIEW