NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES PREMISES AND EQUIPMENT GOODWILL AND OTHER INTANGIBLE ASSETS INTERNALLY DEVELOPED SOFTWARE DERIVATIVES USED FOR ASSET AND  LIABILITY MANAGEMENT PURPOSES PREVIOUS PAGE SEARCH BACK TO CONTENTS NEXT PAGE 53 Premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation and amortization. Management determines depreciation of premises and equipment using the straight-line method over the estimated useful lives of the particular assets. Leasehold improvements are amortized using the straight-line method over the terms of the leases. Accumulated depreciation and amortization on premises and equipment totaled $1.1 billion at December 31, 2003 and 2002. “Goodwill” represents the amount by which the cost of net assets acquired in a business combination exceeds their fair value. “Other intangibles” represent primarily the net present value of the future economic benefits to be derived from the purchase of core deposits. Other intangibles are amortized on either an accelerated or straight-line basis over periods ranging from 3 to 30 years. Effective January 1, 2002, Key adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which replaced Accounting Principles Board Opinion No. 17, “Intangible Assets.” Under the new accounting standard, companies are no longer permitted to amortize goodwill and other intangible assets deemed to have indefinite lives. This change reduced Key’s noninterest expense and increased net income by approximately $79 million, or $.18 per common share, for 2002.  Under SFAS No. 142, goodwill and certain intangible assets are subject to impairment testing, which must be conducted at least annually. Key has determined that its reporting units for purposes of this testing are its major business groups: Consumer Banking, Corporate and Investment Banking, and Investment Management Services.  The first step in this testing requires that the fair value of each reporting unit be determined. If the carrying amount of any reporting unit exceeds its fair value, goodwill impairment may be indicated and a second step of impairment testing is required. If such were the case, Key would assume that the purchase price of the reporting unit is equal to its fair value as determined in the first step and then allocate that purchase price to the fair value of the unit’s assets (excluding goodwill) and liabilities. Any excess of the assumed purchase price over the fair value of the reporting unit’s assets and liabilities represents the implied fair value of goodwill. An impairment loss would be recognized as a charge to earnings to the extent the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of goodwill. SFAS No. 142 required that any impairment losses resulting from its initial application be reported as a “cumulative effect of accounting change” on the income statement. Key was required to perform a transitional impairment test of goodwill as of January 1, 2002. In conducting this testing, Key used a discounted cash flow methodology to determine the fair value of its reporting units and a relative valuation methodology to review the fair values for reasonableness. Then, Key compared the fair value of each reporting unit with its carrying amount. Under SFAS No. 142, if the fair value of a particular reporting unit exceeds its carrying amount, no impairment is indicated and further testing is not required. Key completed its transitional goodwill impairment testing during the first quarter of 2002 and determined that no impairment existed as of January 1, 2002. Key’s accounting policies related to such derivatives reflect the accounting guidance in SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which became effective for Key as of January 1, 2001. This standard established the appropriate accounting and reporting for derivative instruments and for hedging activities. SFAS No. 133 requires that all derivatives be recognized as either assets or liabilities on the balance sheet at fair value. The accounting for changes in the fair value (i.e., gains or losses) of derivatives depends on whether they have been designated and qualify as part of a hedging relationship, and further, on the type of hedging relationship. For derivatives that are not designated as hedging instruments, the gain or loss is recognized immediately in earnings.  Key uses derivatives known as interest rate swaps and caps to hedge interest rate risk. These instruments modify the repricing or maturity characteristics of specified on-balance sheet assets and liabilities.  Software that is considered impaired is written down to its fair value. Software that is no longer used is written off to earnings immediately. When management decides to replace unimpaired software, amortization of such software is accelerated to the expected replacement date. Key relies on both company personnel and independent contractors to plan, develop, install, customize and enhance computer systems applications that support corporate and administrative operations. Software development costs, such as those related to program coding, testing, configuration and installation, are capitalized and included in “accrued income and other assets” on the balance sheet. The resulting asset ($106 million at December 31, 2003, and $105 million at December 31, 2002) is amortized using the straight-line method over its expected useful life (not to exceed five years). Costs incurred during both the planning and the post-development phases of an internal software project are expensed as incurred. Prior to the adoption of SFAS No. 142, goodwill was amortized using the straight-line method over the period (up to 40 years) that management expected the acquired assets to have value. Key reviewed goodwill and other intangibles for impairment when impairment indicators, such as significant changes in market conditions, changes in product mix or management focus, or a potential sale or disposition, arose. In most instances, Key used the undiscounted cash flow method in testing for impairment. In May 2001, Key recorded a goodwill impairment charge of $150 million as a result of management’s decision to downsize the automobile finance business. Key performs the annual goodwill impairment testing required by SFAS No. 142 in the fourth quarter of each year. Any impairment losses would be charged against income from operations. Key’s annual goodwill impairment testing was performed as of October 1, 2003, and it was determined that no impairment existed at that date. 