American Express 2014 Annual Report Download - page 57

AMERICAN EXPRESS COMPANY
2014 FINANCIAL REVIEW
Derivative Instruments
Our primary derivative instruments are interest rate swaps and foreign currency forward agreements.
The fair value of our derivative instruments is estimated by using either a third-party valuation service that uses proprietary pricing
models, or by internal pricing models, where the inputs to those models are readily observable from actively quoted markets. We reaffirm
our understanding of the valuation techniques used by a third-party valuation service at least annually.
To mitigate credit risk arising from our derivative instruments, counterparties are required to be pre-approved and rated as investment
grade. In addition, we manage certain counterparty credit risks by exchanging cash and non-cash collateral under executed credit support
agreements. The non-cash collateral does not reduce the derivative balance included in the Other assets line but effectively reduces risk
exposure as it is available in the event of counterparty default. Based on the assessment of credit risk of our derivative counterparties, we do
not have derivative positions that warrant credit valuation adjustments.
In the measurement of fair value for our derivative instruments, although the underlying inputs used in the pricing models are readily
observable from actively quoted markets, the pricing models do entail a certain amount of subjectivity and, therefore, differing judgments in
how the underlying inputs are modeled could result in different estimates of fair value.
GOODWILL RECOVERABILITY
Goodwill represents the excess of acquisition cost of an acquired business over the fair value of assets acquired and liabilities assumed.
Goodwill is not amortized but is tested for impairment at the reporting unit level annually or when 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.
Our approach and methodology for conducting our goodwill impairment testing is described in Note 7 to the Consolidated Financial
Statements, but is fundamentally based on the measurement of fair value for our reporting units, which inherently entails the use of
significant judgment.
For valuation, we use a combination of the income approach (discounted cash flows) and market approach (market multiples) in
estimating the fair value of our reporting units.
Whenpreparingdiscountedcashflowmodelsundertheincomeapproach,weestimatefuturecashflowsusingthereportingunit’s
internal multi-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. To discount these cash flows we use our expected cost of equity, determined using a capital asset
pricing model. When using the market method under the market approach, we apply comparable publically traded companies’ multiples
(e.g., earnings, revenues) to our reporting units’ actual results. The judgment in estimating forecasted cash flows, discount rates and market
comparables is significant, and imprecision could materially affect the fair value of our reporting units.
Based upon the updated valuations for our reporting units, we have concluded goodwill is not impaired as of December 31, 2014, nor was
any goodwill written off during 2014. However, we could be exposed to increased risk of goodwill impairment if future operating results or
macroeconomic conditions differ significantly from management’s current assumptions.
INCOME TAXES
We are subject to the income tax laws of the U.S., its states and municipalities and those of the foreign jurisdictions in which we operate.
These tax laws are complex, and the manner in which they apply to the taxpayer’s facts is sometimes open to interpretation. In establishing a
provision for income tax expense, we must make judgments about the application of inherently complex tax laws.
Unrecognized Tax Benefits
We establish a liability for unrecognized tax benefits, which are the differences between a tax position taken or expected to be taken in a tax
return and the benefit recognized in the financial statements.
In establishing a liability for an unrecognized tax benefit, assumptions may be made in determining whether, and the extent to which, a
tax position should be sustained. A tax position is recognized only when it is more likely than not to be sustained upon examination by the
relevant taxing authority based on its technical merits. The amount of tax benefit recognized is the largest benefitthatmanagementbelieves
is more likely than not to be realized on ultimate settlement. As new information becomes available, we evaluate our tax positions and adjust
our unrecognized tax benefits, as appropriate.
Tax benefits ultimately realized can differ from amounts previously recognized due to uncertainties, with any such differences generally
impacting the provision for income tax.
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