eTrade 2007 Annual Report Download - page 98

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 (loss). 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 (loss)
on loans and securities, net, in the consolidated statement of income (loss). 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 operating 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 (loss). 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 (loss) on loans
and securities, net in the consolidated statement of income (loss). Derivative gains and losses that are not held as
accounting hedges are recognized as gain (loss) on loans and securities, net in the consolidated statement of
income (loss) as these derivatives do not qualify for hedge accounting under SFAS No. 133, as amended. If a
financial derivative ceases to be highly effective as a hedge, hedge accounting is discontinued prospectively and
the financial derivative instrument continues to be recorded at fair value with changes in fair value being reported
in the gain (loss) on loans and securities, net line item in the consolidated statement of income (loss).
Revenue Recognition
Operating Interest Income—Operating interest income is recognized as earned on interest-earning assets,
customer margin receivable balances, stock borrow balances, cash required to be segregated under regulatory
guidelines and fees on customer assets invested in money market funds. Operating interest income includes the
effect of hedges on interest-earning assets.
Operating Interest Expense—Operating interest expense is recognized as incurred on interest-bearing
liabilities, customer credit balances, interest paid to banks and interest paid to other broker-dealers through a
subsidiary’s stock loan program. Operating interest expense includes the effect of hedges on interest-bearing
liabilities.
Commission—The Company derives commission revenue from its retail and institutional customers.
Commission revenue from securities transactions are recognized on a trade date basis. The Company receives
commissions for providing certain institutional customers with market research and other information, which is a
common industry practice. Direct costs from these arrangements are expensed as the commissions are received,
in proportion to the cost of the total arrangement. As a result, payments for independent research are deferred or
accrued to properly match expenses at the time commission revenue is earned. For these arrangements, payments
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