Fannie Mae 2004 Annual Report Download - page 81

previously accounted for as fair value hedges. We recorded adjustments on these derivatives equal to foreign
currency translation adjustments of our foreign denominated debt. These foreign exchange derivatives should
have been independently recorded at fair value. The impact of correcting this error resulted in changes in the
fair value gain or loss associated with these derivatives, which was recognized in the consolidated statements
of income.
We incorrectly calculated interest expense by using inappropriate estimates in our amortization of debt cost
basis adjustments. We amortized discounts, premiums and other deferred price adjustments by amortizing these
amounts through the expected call date of the borrowings as opposed to amortizing these amounts through the
contractual maturity date of the borrowings. Additionally, we utilized a convention in the calculation that was
based on the average number of days of interest in a month regardless of the days contractually agreed upon.
We corrected these errors by recalculating amortization of these costs through the contractual maturity date of
the respective borrowings and using the contractual number of days in the month. The correction of these
errors resulted in changes in the recognition of “Interest expense” and “Debt extinguishment losses, net” in the
consolidated statements of income.
For the six-month period ended June 30, 2004, we recorded a pre-tax increase in net income of $3.0 billion
related to the accounting errors described above. In combination with the effect of these errors through
December 31, 2003 discussed above, the cumulative impact of the restatement of these errors on our
consolidated financial statements was to decrease retained earnings by $9.1 billion as of June 30, 2004. The
increase in net income in the six-month period ended June 30, 2004 was primarily the result of the loss of
hedge accounting, as the remaining errors described above had minimal impact on restated results for the six-
month period.
Commitments
We identified five errors associated with mortgage loan and security commitments. The most significant errors
were that we did not record certain mortgage loan and security commitments as derivatives under SFAS 133
and we incorrectly classified mortgage loan and security commitments as cash flow hedges, which resulted in
changes in fair value not being reflected in earnings. We also incorrectly interpreted SFAS No. 149,
Amendment of Statement 133 on Derivative Instruments and Hedging Activities (“SFAS 149”), and therefore
we incorrectly recorded a transition adjustment in 2003. In conjunction with the review of these transactions,
we identified the following additional errors associated with mortgage loan and security commitments: we did
not record certain security commitments as securities and we incorrectly valued mortgage loan and security
commitments.
The restatement adjustments associated with these errors resulted in a cumulative pre-tax increase in retained
earnings of $4.0 billion as of December 31, 2003. This pre-tax increase, combined with a commitments-related
gain of $135 million reflected in the 2004 consolidated financial statements, resulted in a cumulative pre-tax
increase in retained earnings of $4.1 billion as of December 31, 2004. The net impact on retained earnings,
including tax effects and the $185 million after-tax charge to “Cumulative effect of change in accounting
principle” as described below, was $2.5 billion as of December 31, 2004. After considering the increased
amortization recognized in restatement attributable to the commitments adjustment, the total net impact of
these commitment adjustments was an increase in retained earnings of $535 million, net of tax, as of
December 31, 2004. Each of the errors that resulted in these adjustments is described below.
Prior to July 1, 2003, we did not record as derivatives mortgage loan and security commitments that were
derivatives pursuant to SFAS 133, which resulted in a misstatement of our derivative assets and liabilities in
the consolidated balance sheets. The impact of correcting this error resulted in the recognition of these
commitments as derivatives at fair value in the consolidated balance sheets, with changes in the fair value of
these commitments recorded in the consolidated statements of income. This error impacted previously reported
results and varied substantially from period to period based on volume, prevailing interest rates and the market
price of the underlying collateral. The correction of this error also resulted in recording cost basis adjustments
to the acquired assets for the value of these derivatives as of their settlement date. These cost basis adjustments
are amortized into interest income over the life of the acquired assets. The impact of this amortization is
reflected in the “Amortization of Cost Basis Adjustments” section below.
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