Freddie Mac 2004 Annual Report Download - page 173

Real Estate Owned
REO is carried at the lower of cost or fair value (after deduction for estimated disposition costs).
Amounts expected to be received from third-party insurance or other credit enhancements are reported when
the claim is Ñled and are recorded as a component of Accounts and other receivables, net in the consolidated
balance sheets. Material development and improvement costs relating to REO are capitalized. Operating
expenses on the properties, net of any rental or other income, are included in REO operations income
(expense). Estimated declines in REO fair value that result from ongoing valuation of the properties are
provided for and charged to REO operations income (expense) when identiÑed. The resulting valuation
allowance is treated as a lower of cost or fair value adjustment to the basis of the properties. Any gains and
losses on REO dispositions are included in REO operations income (expense).
Income Taxes
Freddie Mac uses the asset and liability method of accounting for income taxes pursuant to
SFAS No. 109, ""Accounting for Income Taxes'' (""SFAS 109''). Under the asset and liability method,
deferred tax assets and liabilities are recognized based upon the expected future tax consequences of existing
temporary diÅerences between the Ñnancial reporting and the tax reporting basis of assets and liabilities using
enacted statutory tax rates. To the extent tax laws change, deferred tax assets and liabilities are adjusted, when
necessary, in the period that the tax change is enacted. Valuation allowances are recorded to reduce deferred
tax assets when it is more likely than not that a tax beneÑt will not be realized. For all periods presented, no
such valuation allowance was deemed necessary by management. Reserves are recorded for income tax and
contingent interest where the potential for loss is probable and reasonably estimable in accordance with
SFAS 5.
Income tax expense includes (a) deferred tax expense, which represents the net change in the deferred
tax asset or liability balance during the year plus any change in a valuation allowance and (b) current tax
expense, which represents the amount of tax currently payable to or receivable from a tax authority plus
amounts accrued for expected tax deÑciencies (including both tax and interest). Income tax expense excludes
the tax eÅects related to adjustments recorded to AOCI.
Stock-Based Compensation
In December 2002, FASB issued SFAS No. 148, ""Accounting for Stock-Based Compensation Ì
Transition and Disclosure Ì An Amendment of FASB Statement No. 123'' (""SFAS 148''). This statement
provides alternative methods of transition for a voluntary change to the fair value expense recognition method
of accounting for stock-based employee compensation under SFAS No. 123, ""Accounting for Stock-Based
Compensation'' (""SFAS 123''). The annual disclosure provisions of SFAS 148 are eÅective for Ñscal years
ending after December 15, 2002, and the interim disclosure provisions are eÅective for interim periods
beginning after December 15, 2002.
Freddie Mac initially adopted the fair value compensation expense provisions of SFAS 123 prospectively
for awards granted, modiÑed or settled on or after January 1, 2002, in accordance with SFAS 123's original
transition provision. However, as permitted by SFAS 148, Freddie Mac elected to adopt SFAS 123
retroactively to January 1, 1995. Accordingly, Freddie Mac records compensation expense equal to the
estimated fair value of the stock-based compensation on the grant date, amortized on a straight-line basis over
the vesting period, which is generally three to Ñve years for options, restricted stock and restricted stock units
and, starting in 2003, three months for the Employee Stock Purchase Plan (""ESPP''). The oÅset to the
recorded compensation expense is an adjustment to Additional paid-in capital in Freddie Mac's consolidated
balance sheets.
The fair value of options to purchase shares of Freddie Mac common stock, including options issued
pursuant to the ESPP, is estimated using a Black-Scholes option pricing model, taking into account the
exercise price and expected life of the option, the market value of the underlying stock and its expected
volatility, expected dividends on the stock and the risk-free interest rate for the expected term of the option.
The fair value of restricted stock and restricted stock unit awards is based on the grant-date fair value of
Freddie Mac's common stock.
As discussed in ""NOTE 11: STOCK-BASED COMPENSATION,'' awards under the company's stock
compensation plans, including employee stock options, restricted stock units (""RSUs'') and restricted stock,
generally provide for dividend-equivalent rights. For employee stock options, the dividend-equivalent feature is
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