Freddie Mac 2006 Annual Report Download - page 93

the gains or losses from such transfers that are accounted for as sales are discussed in ""NOTE 2: TRANSFERS OF
SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS'' to our consolidated Ñnancial statements.
Other
We extend other guarantees and provide indemniÑcation to counterparties for breaches of standard representations and
warranties in contracts entered into in the normal course of business based on an assessment that the risk of loss would be
remote. See ""NOTE 4: FINANCIAL GUARANTEES'' to our consolidated Ñnancial statements for additional
information.
We are a party to numerous entities that are considered to be variable interest entities, or VIEs, in accordance with
FASB Interpretation No. 46 (Revised December 2003), ""Consolidation of Variable Interest Entities (revised Decem-
ber 2003), an interpretation of APB No. 51,'' or FIN 46(R). These variable interest entities include low-income multifamily
housing tax credit partnerships, certain Structured Transactions and certain asset-backed investment trusts. See ""NOTE 3:
VARIABLE INTEREST ENTITIES'' to our consolidated Ñnancial statements for additional information related to our
signiÑcant variable interests in these VIEs.
As part of our credit guarantee business, we routinely enter into forward purchase and sale commitments for mortgage
loans and mortgage-related securities. Some of these commitments are accounted for as derivatives with their fair values
reported as either Derivative assets, at fair value or Derivative liabilities, at fair value on our consolidated balance sheets.
See ""RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for further information. Certain non-
derivative commitments are related to commitments arising from mortgage swap transactions and commitments to purchase
certain multifamily mortgage loans that will be classiÑed as held-for-investment. These non-derivative commitments totaled
$264.4 billion and $178.8 billion at December 31, 2006 and 2005, respectively. Such commitments are not accounted for as
derivatives and are not recorded on our consolidated balance sheets.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of Ñnancial statements in accordance with GAAP requires us to make a number of judgments,
estimates and assumptions that aÅect the reported amounts of our assets, liabilities, income, and expenses. Certain of our
accounting policies, as well as estimates we make, are critical to the presentation of our Ñnancial condition and results of
operations. They often require management to make diÇcult, complex or subjective judgments and estimates, at times,
regarding matters that are inherently uncertain. The accounting policies discussed in this section are particularly critical to
understanding our consolidated Ñnancial statements. Actual results could diÅer from our estimates and diÅerent judgments
and assumptions related to these policies and estimates could have a material impact on the consolidated Ñnancial
statements.
Our critical accounting policies and estimates relate to: (a) valuation of Ñnancial instruments; (b) issuances and
transfers of PCs and Structured Securities; (c) derivative instruments and hedging activities; (d) credit losses;
(e) amortization of cost basis adjustments using the eÅective interest method; and (f) impairment recognition on
investments in securities. For additional information about these and other signiÑcant accounting policies, including recently
issued accounting pronouncements, see ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to
our consolidated Ñnancial statements.
Valuation of Financial Instruments
A signiÑcant portion of our assets and liabilities are Ñnancial instruments that are recorded on our consolidated Ñnancial
statements at estimated fair value. The estimation of fair value applies to instruments that are complex in nature and
requires signiÑcant management judgments and assumptions. These judgments and assumptions, as well as changes in
market conditions, may have a material eÅect on our GAAP consolidated balance sheets and statements of income as well as
our consolidated fair value balance sheets.
Fair value is deÑned as the amount at which an asset or liability could be exchanged in a current transaction between
willing parties, other than in a forced or liquidation sale. The selection of a method to estimate fair value for each type of
Ñnancial instrument depends on both the reliability and availability of relevant market data. The amount of judgment
involved in estimating the fair value of a Ñnancial instrument is aÅected by a number of factors, such as the type of
81 Freddie Mac