Freddie Mac 2009 Annual Report Download - page 227

through credit enhancements. Losses are charged-off against the allowance for loan losses at the time of acquisition. REO
gains arise and are recognized immediately in earnings at disposition when the fair market value of the foreclosed property
less costs to sell and credit enhancements exceeds the carrying basis of the loan (including accrued interest). Amounts we
expect to receive from third-party insurance or other credit enhancements are recorded when the asset is acquired. The
receivable is adjusted when the actual claim is filed, and is a component of accounts and other receivables, net on our
consolidated balance sheets. Material development and improvement costs relating to REO are capitalized. Operating
expenses on the properties 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
identified. Any gains and losses from REO dispositions are included in REO operations income (expense).
Income Taxes
We use the asset and liability method to account for income taxes in accordance with the accounting standards for
income taxes. Under this method, deferred tax assets and liabilities are recognized based upon the expected future tax
consequences of existing temporary differences between the financial 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 net deferred tax
assets when it is more likely than not that a tax benefit will not be realized. The realization of these net deferred tax assets is
dependent upon the generation of sufficient taxable income or upon our intent and ability to hold available-for-sale debt
securities until the recovery of any temporary unrealized losses. On a quarterly basis, our management determines whether a
valuation allowance is necessary. In so doing, our management considers all evidence currently available, both positive and
negative, in determining whether, based on the weight of that evidence, it is more likely than not that the net deferred tax
assets will be realized. Our management determined that, as of December 31, 2009 and 2008, it was more likely than not
that we would not realize the portion of our net deferred tax assets that is dependent upon the generation of future taxable
income. This determination was driven by recent events and the resulting uncertainties that existed as of December 31, 2009
and 2008, respectively. For more information about the evidence that management considers and our determination of the
need for a valuation allowance, see “NOTE 15: INCOME TAXES.”
We account for tax positions taken or expected to be taken (and any associated interest and penalties) so long as it is
more likely than not that it will be sustained upon examination, including resolution of any related appeals or litigation
processes, based on the technical merits of the position. We measure the tax position at the largest amount of benefit that is
greater than 50% likely of being realized upon ultimate settlement. See “NOTE 15: INCOME TAXES” for additional
information.
Income tax benefit (expense) includes (a) deferred tax benefit (expense), which represents the net change in the deferred
tax asset or liability balance during the year plus any change in a valuation allowance, if any, and (b) current tax benefit
(expense), which represents the amount of tax currently payable to or receivable from a tax authority including any related
interest and penalties plus amounts accrued for unrecognized tax benefits (also including any related interest and penalties).
Income tax benefit (expense) excludes the tax effects related to adjustments recorded to equity.
Stock-Based Compensation
We record compensation expense for stock-based compensation awards based on the grant-date fair value of the award
and expected forfeitures. Compensation expense is recognized over the period during which an employee is required to
provide service in exchange for the stock-based compensation award. The recorded compensation expense is accompanied by
an adjustment to additional paid-in capital on our consolidated balance sheets. The vesting period for stock-based
compensation awards is generally three to five years for options, restricted stock and restricted stock units. The vesting
period for the option to purchase stock under the Employee Stock Purchase Plan, or ESPP, was three months. See
“NOTE 12: STOCK-BASED COMPENSATION” for additional information.
The fair value of options to purchase shares of our 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 an estimate of the expected
life of the option, the market value of the underlying stock, expected volatility, expected dividend yield, and the risk-free
interest rate for the expected life of the option. The fair value of restricted stock and restricted stock unit awards is based on
the fair value of our common stock on the grant date.
Incremental compensation expense related to the modification of awards is based on a comparison of the fair value of
the modified award with the fair value of the original award before modification. We generally expect to settle our stock-
based compensation awards in shares. In limited cases, an award may be cash-settled upon a contingent event such as
involuntary termination. These awards are accounted for as an equity award until the contingency becomes probable of
occurring, when the award is reclassified from equity to a liability. We initially measure the cost of employee service
received in exchange for a stock-based compensation award of liability instruments based on the fair value of the award at
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