Wells Fargo 2006 Annual Report Download - page 78

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would have been classified as an operating cash inflow if
we had not adopted FAS 123(R).
Pro forma net income and earnings per common share
information are provided in the following table as if we
accounted for employee stock option plans under the fair
value method of FAS 123 in 2005 and 2004.
Stock options granted in each of our February 2005
and February 2004 annual grants, under our Long-Term
Incentive Compensation Plan (the Plan), fully vested upon
grant, resulting in full recognition of stock-based compensation
expense for both grants in the year of the grant under the
fair value method in the table above. Stock options granted
in our 2003 and 2002 annual grants under the Plan vest over
a three-year period, and expense reflected in the table for
these grants is recognized over the vesting period.
Earnings Per Common Share
We present earnings per common share and diluted earnings
per common share. We compute earnings per common share
by dividing net income (after deducting dividends on preferred
stock) by the average number of common shares outstanding
during the year. We compute diluted earnings per common
share by dividing net income (after deducting dividends on
preferred stock) by the average number of common shares
outstanding during the year, plus the effect of common stock
equivalents (for example, stock options, restricted share
rights and convertible debentures) that are dilutive.
Derivatives and Hedging Activities
We recognize all derivatives in the balance sheet at fair value.
On the date we enter into a derivative contract, we designate
the derivative as (1) a hedge of the fair value of
a recognized asset or liability, including hedges of foreign
currency exposure, (“fair value” hedge), (2) a hedge of a
forecasted transaction or of the variability of cash flows to
be received or paid related to a recognized asset or liability
(“cash flow” hedge) or (3) held for trading, customer
accommodation or asset/liability risk management purposes,
including economic hedges not qualifying under FAS 133,
Accounting for Derivative Instruments and Hedging Activities
(“free-standing derivative”). For a fair value hedge, we record
changes in the fair value of the derivative and, to the extent
that it is effective, changes in the fair value of the hedged
asset or liability attributable to the hedged risk, in current
period earnings in the same financial statement category as
the hedged item. For a cash flow hedge, we record changes
in the fair value of the derivative to the extent that it is
effective in other comprehensive income. We subsequently
reclassify these changes in fair value to net income in the
same period(s) that the hedged transaction affects net income
in the same financial statement category as the hedged item.
For free-standing derivatives, we report changes in the fair
values in current period noninterest income.
For fair value and cash flow hedges qualifying under FAS
133, we formally document at inception the relationship
between hedging instruments and hedged items, our risk
management objective, strategy and our evaluation of effec-
tiveness for our hedge transactions. This includes linking all
derivatives designated as fair value or cash flow hedges to
specific assets and liabilities in the balance sheet or to specific
forecasted transactions. Periodically, as required, we also
formally assess whether the derivative we designated in each
hedging relationship is expected to be and has been highly
effective in offsetting changes in fair values or cash flows of
the hedged item using the regression analysis method or, in
some cases, the dollar offset method.
We discontinue hedge accounting prospectively when
(1) a derivative is no longer highly effective in offsetting
changes in the fair value or cash flows of a hedged item,
(2) a derivative expires or is sold, terminated, or exercised,
(3) a derivative is dedesignated as a hedge, because it is
unlikely that a forecasted transaction will occur, or (4) we
determine that designation of a derivative as a hedge is no
longer appropriate.
When we discontinue hedge accounting because a deriva-
tive no longer qualifies as an effective fair value hedge, we
continue to carry the derivative in the balance sheet at its
fair value with changes in fair value included in earnings,
and no longer adjust the previously hedged asset or liability
for changes in fair value. Previous adjustments to the hedged
item are accounted for in the same manner as other compo-
nents of the carrying amount of the asset or liability.
When we discontinue cash flow hedge accounting because
the hedging instrument is sold, terminated, or no longer
designated (dedesignated), the amount reported in other
comprehensive income up to the date of sale, termination or
dedesignation continues to be reported in other comprehensive
income until the forecasted transaction affects earnings.
When we discontinue cash flow hedge accounting because
it is probable that a forecasted transaction will not occur, we
continue to carry the derivative in the balance sheet at its fair
value with changes in fair value included in earnings, and
immediately recognize gains and losses that were accumulated
in other comprehensive income in earnings.
(in millions, except per Year ended December 31,
share amounts) 2005 2004
Net income, as reported $7,671 $7,014
Add: Stock-based employee compensation
expense included in reported net
income, net of tax 1 2
Less:Total stock-based employee
compensation expense under the
fair value method for all awards,
net of tax (188) (275)
Net income, pro forma $7,484 $6,741
Earnings per common share
As reported $ 2.27 $ 2.07
Pro forma 2.22 1.99
Diluted earnings per common share
As reported $ 2.25 $ 2.05
Pro forma 2.19 1.97