Note 1. Summary of Significant Accounting Policies
Description of Business
Merrill Lynch & Co., Inc. ("ML & Co.") provides investment, financing, insurance, and related
services to individuals and institutions on a global basis through its broker, dealer, banking,
insurance, and other financial services subsidiaries. Its principal subsidiaries include:
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a U.S.-based
broker-dealer in securities;
Merrill Lynch International ("MLI"), a U.K.-based broker-dealer in securities and dealer
in equity derivatives;
Merrill Lynch Government Securities Inc. ("MLGSI"), a dealer in U.S. Government securities;
- Merrill Lynch Capital Services, Inc., a dealer in interest rate, currency, and credit derivatives;
- Merrill Lynch Investment Managers, LP, a U.S.-based asset management company;
Merrill Lynch Investment Managers Limited, a U.K.-based asset management company;
- Merrill Lynch Bank USA ("MLBUSA"), a U.S.-based FDIC insured bank;
Merrill Lynch Bank & Trust Co. ("MLB&T"), a U.S.-based FDIC insured bank;
Merrill Lynch International Bank Limited, a U.K.-based bank; and
Merrill Lynch Capital Markets Bank Limited, an Ireland-based bank.
Services provided to clients by ML & Co. and subsidiaries (collectively, "Merrill Lynch") include:
securities brokerage, trading, and underwriting;
investment banking, strategic services, including mergers and acquisitions, and other
corporate finance advisory activities;
origination, brokerage and related activities in swaps, options, forwards, exchange-traded
futures, other derivatives and foreign exchange traded products;
securities clearance and settlement services;
equity, debt, foreign exchange, commodities and economic research;
banking, trust, and lending services, including mortgage lending and related services;
- insurance sales and underwriting services; and
investment advisory and related recordkeeping services.
Basis of Presentation
The Consolidated Financial Statements include the accounts of Merrill Lynch and are presented
in accordance with accounting principles generally accepted in the United States of America and
prevailing industry practices. All material intercompany transactions and balances have
Certain reclassifications and format changes have been made to prior year amounts to conform to the current year presentation. Prior year amounts have been restated to reflect the 2000
merger of Herzog, Heine, Geduld, Inc. ("Herzog") with Merrill Lynch, which has been accounted
for as a pooling-of-interests (see Note 2 for further information). In addition, the Consolidated
Balance Sheets reflect the adoption of Statement of Financial Accounting Standards ("SFAS")
No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities." SFAS No. 140 eliminates the requirement to report collateral received from certain
repurchase agreement and securities lending transactions. SFAS No. 140 also requires the
reclassification of certain pledged assets and disclosures regarding collateral for the December 29, 2000 Consolidated Balance
Sheet, but does not require comparative information for periods
prior to December 29, 2000.
The Consolidated Financial Statements are presented
in U.S. dollars. Many non-U.S. subsidiaries have a functional
currency (i.e., the currency in which activities are primarily conducted) that is other than the U.S. dollar, often the currency of
the country in which a subsidiary is domiciled. Subsidiaries'
assets and liabilities are translated to U.S. dollars at year-end
exchange rates, while revenues and expenses are translated at
average exchange rates during the year. Adjustments that result
from translating amounts in a subsidiary's functional currency,
net of hedging gains or losses and related tax effects, are
reported in stockholders' equity as a component of
Accumulated other comprehensive loss. All other translation
adjustments are included in earnings.
In presenting the Consolidated Financial Statements, management makes estimates regarding certain trading inventory
valuations, the outcome of litigation, the carrying amount of
goodwill, the realization of deferred tax assets and recovery
of insurance deferred acquisition costs, and other matters that
affect the reported amounts and disclosure of contingencies in
the financial statements. Estimates, by their nature, are based
on judgment and available information. Therefore, actual results
could differ materially from those estimates.
Merrill Lynch defines cash equivalents as short-term, highly
liquid securities and interest-earning deposits with original
maturities of 90 days or less, other than those used for trading
purposes. For purposes of the Consolidated Statements of Cash
Flows, cash flows from trading derivatives are classified in operating activities.
At December 29, 2000 and December 31, 1999, substantially all financial instrument assets and the majority of financial
instrument liabilities are carried at fair value or amounts that
approximate fair value. Fair values of financial instruments are
disclosed in Note 6.
Merrill Lynch's trading activities consist primarily of securities
brokerage, trading, and underwriting; derivatives dealing and
brokerage; and securities financing transactions. Trading assets
and trading liabilities consist of cash instruments (such as securities) and derivative instruments used for trading purposes or for
hedging other trading inventory.
Trading securities and other cash instruments (e.g., loans held
for trading purposes) are recorded on a trade date basis at fair
value. Included in trading liabilities are securities that Merrill
Lynch has sold but did not own and will therefore be obligated
to purchase at a future date ("short sales"). Changes in fair
value (i.e., unrealized gains and losses) are recognized as principal transactions revenues in the current period. Realized gains
and losses and any related interest amounts are included in
principal transactions revenues and interest revenues and
expenses, depending on the nature of the instrument.
Fair values of trading securities are based on quoted market prices, pricing models (utilizing indicators of general market
conditions or other economic measurements), or management's
estimates of amounts to be realized on settlement, assuming
current market conditions and an orderly disposition over a
reasonable period of time.
A derivative is typically defined as an instrument whose value
is "derived" from an underlying instrument or index such as a
future, forward, swap, or option contract, or other financial
instrument with similar characteristics. Derivative contracts
often involve future commitments to exchange interest payment
streams or currencies based on a notional or contractual amount
(e.g., interest rate swaps or currency forwards) or to purchase or
sell other financial instruments at specified terms on a specified
date (e.g., options to buy or sell securities or currencies).
Derivatives are often referred to as off-balance-sheet
instruments since neither their notional amounts nor the under-lying instruments are reflected on the balance sheet; however,
the fair values of trading derivatives are recorded in trading
assets and liabilities. Derivatives are reported separately as
assets and liabilities unless a legal right of setoff exists under a
master netting agreement enforceable at law. Balances related
to swap and forward transactions and foreign currency options
are included in Contractual agreements on the Consolidated
Balance Sheets. All other derivative balances are recorded in the
related trading asset or liability caption. The fair value of equity
options purchased, for example, is recorded in the Equities and
convertible debentures trading asset caption.
Changes in fair values of derivatives are recorded as principal transactions revenues in the current period. Fair values for
certain exchange-traded derivatives, principally futures and
certain options, are based on quoted market prices. Fair values
for over-the-counter ("OTC") derivative financial instruments,
principally forwards, options, and swaps, represent amounts
that would be received from or paid to a third party in settlement of these instruments. These amounts are determined
using pricing models based on the present value of estimated
future cash flows employing mid-market valuations with appropriate adjustments. These adjustments are integral components
of the mark-to-market process and relate to credit quality and
concentration, market liquidity, and exposure close-out costs
associated with unmatched positions. Adjustments are also
made for administrative costs incurred to service periodic cash
flows and to maintain hedges over the life of the contract. A
portion of income related to long-term contracts is recognized
as the related administrative costs are incurred.
New, complex instruments may have immature or limited
markets. The precision of the pricing model for a complex product, which involves multiple variables and assumptions, will
evolve over time. As the markets for these products develop,
Merrill Lynch continually refines its pricing models based on
experience to correlate more closely to the market risk of
SECURITIES FINANCING TRANSACTIONS
Merrill Lynch enters into repurchase and resale agreements and
securities borrowed and loaned transactions to accommodate
customers (i.e., matched-book), finance firm inventory positions, and obtain securities for settlement. Merrill Lynch also
engages in securities financing for customers through margin
lending (see Customer Transactions).
Resale and repurchase agreements are accounted for as
collateralized financing transactions and are recorded at their
contractual amounts plus accrued interest. Merrill Lynch's policy
is to obtain possession of collateral with a market value equal to
or in excess of the principal amount loaned under resale agreements. To ensure that the market value of the underlying collateral remains sufficient, collateral is valued daily, and Merrill
Lynch may require counterparties to deposit additional collateral
or return collateral pledged, when appropriate. Substantially all
repurchase and resale activities are transacted under master
netting agreements that give Merrill Lynch the right, in the
event of default, to liquidate collateral held and to offset receivables and payables with the same counterparty. Merrill Lynch
offsets certain repurchase and resale agreement balances with
the same counterparty on the Consolidated Balance Sheets.
Securities borrowed and loaned transactions are recorded
at the amount of cash collateral advanced or received. Securities
borrowed transactions require Merrill Lynch to provide the
counterparty with collateral in the form of cash, letters of credit,
or other securities. Merrill Lynch receives collateral in the form
of cash or other securities for securities loaned transactions. For
these transactions, the fees received or paid by Merrill Lynch are
recorded as interest revenue or expense. On a daily basis,
Merrill Lynch monitors the market value of securities borrowed
or loaned against the collateral value. Although substantially all
securities borrowing and lending activities are transacted under
master netting agreements, such receivables and payables with
the same counterparty are not set off on the Consolidated
On the Consolidated Balance Sheet as of December 29,
2000, all firm-owned securities pledged to counterparties
where the counterparty has the right, by contract or custom, to
sell or repledge the securities are classified as securities pledged
as collateral as required by SFAS No. 140, which does not
require the restatement of prior years presented for comparison.
As of December 31, 1999 such balances are included as trading
Interest rate swaps may be used to modify the interest rate
characteristics of long-term resale and repurchase agreements.
These swaps are accounted for on an accrual basis, with
amounts to be paid or received recognized as adjustments to
interest expense or revenue. (See the Non-trading Derivatives
section for additional information on accounting policy for
Investment Banking and Advisory Services
Underwriting revenues and fees for merger and acquisition
advisory services are accrued when services for the transactions
are substantially completed. Transaction-related expenses are
deferred to match revenue recognition.
Customer securities and commodities transactions are recorded
on a settlement date basis. Receivables from and payables to
customers include amounts due on cash and margin transactions. Securities owned by customers, including those that collateralize margin or other similar transactions, are not reflected
on the Consolidated Balance Sheets.
Commissions charged for executing customer transactions
are accrued on a trade date basis and are included in current
period earnings. Financial consultant compensation and benefits
expense is accrued in the same period as revenue is recognized.
Mutual fund distribution fee revenues are accrued as
earned, and redemption fee revenues are recognized upon
receipt. Certain compensation costs related to sales of rear-load open-end mutual funds are deferred to match revenue
Merrill Lynch's non-broker-dealer subsidiaries hold debt and
equity investments, which are primarily classified as available-for-sale.
Debt and marketable equity securities classified as available-for-sale are reported at fair value. Unrealized gains or
losses on these securities are reported in stockholders' equity as
a component of Accumulated other comprehensive loss, net of
applicable income taxes and other related items.
Debt securities that Merrill Lynch has the positive intent
and ability to hold to maturity are classified as held-to-maturity.
These investments are recorded at amortized cost unless a
decline in value is deemed other than temporary, in which case
the carrying value is reduced. The amortization of premiums or
accretion of discounts and any unrealized losses deemed other
than temporary are included in current period earnings.
Debt and marketable equity securities purchased principally
for the purpose of resale in the near-term are classified as
trading investments and are reported at fair value. Unrealized
gains or losses on these investments are included in current
Restricted equity investment securities or equity investment
securities without available market quotations held by non-broker-dealer subsidiaries are reported at the lower of cost or estimated net realizable value. Restricted equity investment
securities held by broker-dealer subsidiaries are recorded at
management's best estimate of fair value. Adjustments in carrying values are included in current period earnings.
Realized gains and losses on investments are included in
current period earnings. The cost basis of each investment
sold is specifically identified for purposes of computing realized
gains and losses.
Derivative contracts may be used to modify interest rate
characteristics of available-for-sale securities. Merrill Lynch also
uses derivatives to manage the currency exposure arising from
investments in non-U.S. subsidiaries (see Basis of Presentation
for accounting policy for these investments). Unrealized gains
and losses on these derivatives are reported net of tax in stockholders' equity as a component of Accumulated other comprehensive loss, along with unrealized gains and losses from
the hedged items (see Non-trading Derivatives section for additional information on accounting policy for non-trading
Lending and Related Activities
Merrill Lynch's lending and related activities include loan originations, syndications, securitizations, and servicing. Merrill
Lynch also engages in secondary market loan trading and margin lending (see Trading Activities and Customer Transactions,
Loans held for investment purposes, including consumer
and small business loans, are carried at their principal amount
outstanding. The allowance for loan losses is established
through provisions that are based on management's assessment
of the collectibility of the loan portfolio. Loans are charged off
against the allowance for loan losses when management determines that collection of principal is unlikely.
Loans held for sale, which include certain residential
mortgage and home equity loans, are reported at the lower of
cost (less allowance for loan losses) or estimated fair value
determined on a portfolio basis. Mortgage servicing assets and
residual interests in mortgage loans underlying Real Estate
Mortgage Investment Conduits and revolving trusts are
(1) recognized upon sales of loans when servicing is retained,
and (2) amortized into income in proportion to, and over the
estimated life of, net servicing income. Mortgage servicing
assets are initially recognized based upon an allocation of the
loan's original cost, in proportion to the resulting asset's fair
value, subsequently measured using the present value of future
cash flows, periodically evaluated for impairment, and included
in Other assets on the Consolidated Balance Sheets. Residual
interests are categorized as available-for-sale and reported
in Other investments on the Consolidated Balance Sheets
(see Investing Activities).
Merrill Lynch securitizes commercial and residential mortgage and home equity loans, government and corporate bonds,
and lease and trade receivables. Merrill Lynch may retain an
interest in the securitized assets in the form of residual interests,
one or more subordinated tranches, and/or servicing rights.
The gain or loss on sale of the receivables is determined with
reference to the previous carrying amount of the financial assets
transferred, which is allocated between the assets sold and the
retained interests, if any, based on their relative fair value at the
date of transfer. To obtain fair values, quoted market prices are
used if available. Where quotes are unavailable for retained
interests, Merrill Lynch generally estimates fair value based on
the present value of expected future cash flows using management's best estimates of the key assumptions, including credit
losses, prepayment rates, forward yield curves, and discount
rates, commensurate with the risks involved. Retained interests
in securitized receivables were not material at December 29,
2000. In 2000, cash proceeds from securitizations totaled
Merrill Lynch's unsecured general-purpose funding is principally
obtained from commercial paper and long-term borrowings.
Commercial paper, when issued at a discount, is recorded at the
proceeds received and accreted to its par value. Long-term borrowings are carried at the principal amount borrowed, net of
unamortized discounts or premiums.
Merrill Lynch uses derivatives to manage the interest rate,
currency, equity, and other risk exposures of its borrowings.
Derivatives that hedge the interest rate risk on borrowings are
generally accounted for on an accrual basis, with amounts to be
paid or received recognized as adjustments to the related interest expense. Unrealized gains and losses on other derivatives
hedging borrowings are recognized currently (see Non-trading
Derivatives section for additional information).
As part of its overall risk management strategy, Merrill Lynch
uses derivatives to manage its market risk exposures arising
from non-trading assets and liabilities. These exposures include
interest rate, currency, equity and other risks. Derivatives used
for hedging borrowings and other non-trading assets and liabilities must be effective at reducing the risk being managed and
be designated as a hedge at inception.
Realized gains and losses on early terminations of derivatives are deferred over the remaining lives of the hedged assets
or liabilities. At December 29, 2000 and December 31, 1999,
there were $6 million and $27 million, respectively, in deferred
gains relating to terminated derivative contracts.
Insurance liabilities are future benefits payable under annuity
and interest-sensitive life insurance contracts and include
deposits received plus interest credited during the contract
accumulation period, the present value of future payments for
contracts which have annuitized, and a mortality provision for
certain products. Certain policyholder liabilities are also adjusted
for those investments classified as available-for-sale. Liabilities
for unpaid claims consist of the mortality benefit for reported
claims and an estimate of unreported claims based upon
Substantially all security investments of insurance
subsidiaries are classified as available-for-sale and recorded at
fair value. These investments support Merrill Lynch's in-force,
universal life-type contracts. Merrill Lynch records adjustments
to deferred acquisition costs and policyholder account balances
which, when combined, are equal to the adjustment that would
have been recorded if those available-for-sale investments had
been sold at their estimated fair values and the proceeds reinvested at current yields. The corresponding credits or charges
for these adjustments are recorded in stockholders' equity as a
component of Accumulated other comprehensive loss, net of
applicable income taxes.
Certain variable costs related to the sale or acquisition of
new and renewal insurance contracts have been deferred, to
the extent deemed recoverable, and amortized over the estimated lives of the contracts in proportion to the estimated gross
profit for each group of contracts.
Merrill Lynch maintains separate accounts representing
segregated funds held for purposes of funding variable life and
annuity contracts. Separate account assets are accounted for as
customer assets since the contract holders bear the risk of
ownership, consistent with Merrill Lynch's other investment
products. Accordingly, separate account assets and the related
liabilities are not consolidated with the assets and liabilities
of Merrill Lynch.
Merrill Lynch accounts for stock-based compensation in accordance with the intrinsic value-based method in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued
to Employees," rather than the fair value-based method in
SFAS No. 123, "Accounting for Stock-Based Compensation."
Compensation expense for stock options is not recognized since
Merrill Lynch grants stock options without any intrinsic value.
Compensation expense related to other stock-based compensation plans is recognized over the vesting period. For certain
stock-based compensation grants, the unamortized portion of
the grant value is reflected as a reduction of stockholders'
equity in Employee stock transactions on the Consolidated
Goodwill, which represents the cost of acquired businesses in
excess of fair value of the related net assets at acquisition, is
amortized on a straight-line basis. Goodwill associated with the
purchase of the Mercury Asset Management Group is amortized over 30 years. Goodwill related to other acquisitions is
amortized over periods generally not exceeding 15 years.
Merrill Lynch periodically assesses the recoverability of
goodwill by comparing expected undiscounted future cash
flows from the underlying business operation with recorded
goodwill balances. If such assessments indicate that the undiscounted future cash flows are not sufficient to recover the
related carrying value, the assets are adjusted to fair values.
Equipment and Facilities
Equipment and facilities primarily consist of technology hardware and software, leasehold improvements, and owned facilities. Equipment and facilities are reported at historical cost, net
of accumulated depreciation and amortization, except for land,
which is reported at historical cost.
Depreciation and amortization are computed using the
straight-line method. Equipment is depreciated over its
estimated useful life, while leasehold improvements are amortized over the lesser of the improvement's estimated economic
useful life or the term of the lease. Maintenance and repair
costs are expensed as incurred.
Included in the Occupancy and related depreciation
expense category was depreciation and amortization of $235
million, $207 million, and $193 million in 2000, 1999, and
1998, respectively. Depreciation and amortization recognized in
the Communications and technology expense category was
$611 million, $516 million, and $396 million for 2000, 1999,
and 1998, respectively.
Costs incurred in the development of internal-use software
are amortized over the useful life of the developed software,
generally not exceeding three years.
ML & Co. and certain of its wholly-owned subsidiaries file a
consolidated U.S. federal income tax return.
Merrill Lynch uses the asset and liability method in providing income taxes on all transactions that have been recognized
in the Consolidated Financial Statements. The asset and liability
method requires that deferred taxes be adjusted to reflect the
tax rates at which future taxable amounts will likely be settled
or realized. The effects of tax rate changes on future deferred
tax liabilities and deferred tax assets, as well as other changes in
income tax laws, are recognized in net earnings in the period
such changes are enacted. Valuation allowances are established
when necessary to reduce deferred tax assets to the amounts
expected to be realized.