eTrade 2006 Annual Report Download - page 91

Comprehensive Income—The Company’s comprehensive income is comprised of net income, foreign
currency cumulative translation adjustments, unrealized gains (losses) on available-for-sale mortgage-backed and
investment securities and the effective portion of the unrealized gains (losses) on financial derivatives in cash
flow hedge relationships, net of reclassification adjustments and related taxes.
Earnings Per Share—Basic earnings per share (“EPS”) is computed by dividing net income by the
weighted-average common shares outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were exercised or converted into common
stock. The mandatory convertible notes, as discussed in Note 17–Corporate Debt, will be reflected in diluted
earnings per share calculations using the treasury stock method as defined by SFAS No. 128, Earning per Share.
Under this method, the number of shares of common stock used in calculating diluted earnings per share (based
on the settlement formula applied at the end of the reporting period) is deemed to be increased by the excess, if
any, of the number of shares that would be issued upon settlement of the purchase contracts less the number of
shares that could be purchased by the Company in the market at the average market price during the period using
the proceeds to be received upon settlement.
Financial Derivative Instruments and Hedging Activities—The Company enters into derivative transactions
to protect against the risk of market price or interest rate movements on the value of certain assets, liabilities and
future cash flows. The Company must also recognize certain contracts and commitments as derivatives when the
characteristics of those contracts and commitments meet the definition of a derivative promulgated by
SFAS No. 133,as amended.
Each derivative is recorded on the balance sheet at fair value as a freestanding asset or liability. Financial
derivative instruments in hedging relationships that mitigate exposure to changes in the fair value of assets or
liabilities are considered fair value hedges under SFAS No. 133, as amended. Financial derivative instruments
designated in hedging relationships that mitigate the exposure to the variability in expected future cash flows or
other forecasted transactions are considered cash flow hedges. The Company formally documents at inception all
relationships between hedging instruments and hedged items and the risk management objective and strategy for
each hedge transaction.
Fair value hedges are accounted for by recording the fair value of the financial derivative instrument and the
change in fair value of the asset or liability being hedged on the consolidated balance sheet with the net
difference, or hedge ineffectiveness, reported as fair value adjustments of financial derivatives in other expense
excluding interest in the consolidated statement of income. Cash payments or receipts and related accruals during
the reporting period on derivatives included in fair value hedge relationships are recorded as an adjustment to
interest income on the hedged asset or liability. If a financial derivative in a fair value hedging relationship is no
longer effective, de-designated from its hedging relationship or terminated, the Company discontinues fair value
hedge accounting for the derivative and the hedged item. Changes in the fair value of these derivative
instruments no longer designated in an accounting hedge relationship are recorded in gain on sales of loans and
securities, net, in the consolidated statement of income. The accumulated adjustment of the carrying amount of
the hedged interest-earning asset or liability is recognized in earnings as an adjustment to interest income over
the expected remaining life of the asset using the effective interest method.
Cash flow hedges are accounted for by recording the fair value of the financial derivative instrument as
either a freestanding asset or a freestanding liability in the consolidated balance sheet, with the effective portion
of the change in fair value of the financial derivative recorded in AOCI, net of tax in the consolidated balance
sheet. Amounts are then included in interest expense as a yield adjustment in the same period the hedged
forecasted transaction affects earnings. The ineffective portion of the change in fair value of the financial
derivative is reported as fair value adjustments of financial derivatives in other expense excluding interest in the
consolidated statement of income. If it becomes probable that a hedged forecasted transaction will not occur,
amounts included in AOCI related to the specific hedging instruments are reported as gain on sales of loans and
securities, net in the consolidated statement of income. Derivative gains and losses that are not held as
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