Freddie Mac 2012 Annual Report Download - page 226

substantially different, the transaction is accounted for as a modification of the existing debt. Fees paid to the creditor are
deferred and amortized over the life of the modified unsecured debt security using the effective interest method and fees paid
to third parties are expensed as incurred.
Derivatives
Derivatives are reported at their fair value on our consolidated balance sheets. Derivatives in a net asset position,
including net derivative interest receivable or payable, are reported as derivative assets, net. Similarly, derivatives in a net
liability position, including net derivative interest receivable or payable, are reported as derivative liabilities, net. We offset
fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair
value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement.
Changes in fair value and interest accruals on derivatives are recorded as derivative gains (losses) in our consolidated
statements of comprehensive income.
We evaluate whether financial instruments that we purchase or issue contain embedded derivatives. In accordance with
an amendment to derivatives and hedging accounting guidance regarding certain hybrid financial instruments, we elected to
measure newly acquired or issued financial instruments that contain embedded derivatives at fair value, with changes in fair
value recorded in our consolidated statements of comprehensive income. At December 31, 2012 and 2011, we did not have
any embedded derivatives that were bifurcated and accounted for as freestanding derivatives.
At December 31, 2012 and 2011, we did not have any derivatives in hedge accounting relationships; however, there are
amounts recorded in AOCI related to discontinued cash flow hedges which are recognized in earnings when the originally
forecasted transactions affect earnings. If it becomes probable the originally forecasted transaction will not occur, the
associated deferred gain or loss in AOCI would be reclassified to earnings immediately.
In the consolidated statements of cash flows, cash flows related to the acquisition and termination of derivatives, other
than forward commitments, are generally classified in investing activities. Cash flows related to forward commitments are
classified within the section of the consolidated statements of cash flows in accordance with the cash flows of the financial
instruments to which they relate.
REO
REO is initially recorded at fair value less costs to sell and is subsequently carried at the lower of cost or fair value less
costs to sell. When we acquire REO, losses arise when the carrying value of the loan (including accrued interest) exceeds the
fair value of the foreclosed property, net of estimated costs to sell and expected recoveries through credit enhancements.
Losses are charged off against the allowance for loan losses at the time of REO acquisition. REO gains arise and are
recognized immediately in earnings when the fair value of the foreclosed property less costs to sell plus expected recoveries
through credit enhancements exceeds the recorded investment in the loan (including all amounts due from the borrower).
Amounts we expect to receive from third-party insurance (primary mortgage insurance and pool insurance) and most
other credit enhancements are recorded as receivables when REO is acquired. The receivable is adjusted when the actual
claim is filed and is reported as a component of other assets on our consolidated balance sheets. We do not record receivables
for repurchase recoveries. We record these on a cash basis due to uncertainty of the timing and amount of collections.
Material development and improvement costs relating to REO are capitalized. Operating expenses specifically
identifiable with an REO property are included in REO operations income (expense) in our consolidated statements of
comprehensive income; all other expenses are recognized within other administrative expenses in our consolidated
statements of comprehensive income. 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 of accounting for income taxes under GAAP. 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 as well as
tax net operating loss and tax credit carryforwards. 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
221 Freddie Mac