2012   Financial Report of the United States Government

Notes to the Financial Statements

Note 1. Summary of Significant Accounting Policies

A. Reporting Entity

This Financial Report includes the financial status and activities of the executive branch, the legislative branch (the U.S. Senate and the U.S. House of Representatives report on a cash basis), and the judicial branch (which also reports on a cash basis) of the Government. The legislative and judicial branches report on a limited basis and are not required by law to submit financial statement information to Treasury. Appendix A of this report contains a list of organizations and agencies encompassed in the reporting entity for the Financial Report, as well as some organizations excluded from the reporting entity. Certain entities are excluded from the Financial Report because they are Government-Sponsored Enterprises (GSEs), such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Other entities are excluded from the Financial Report because their activities are not included in the Federal budget, such as the Thrift Savings Fund and the Board of Governors of the Federal Reserve System.

During fiscal year 2008, the Government began a number of additional emergency economic measures relating to the economy that involved various financing programs. Key initiatives effective beginning in fiscal year 2008 involved programs concerning Fannie Mae and Freddie Mac (GSEs), provision of a credit facility for GSEs and Federal Home Loan Banks, purchase of Mortgage-Backed Securities (MBS), and setup of a Money Market Guarantee Program (see Note 1.J—Investments in and Liabilities to Government-Sponsored Enterprises and Note 11—Investments in and Liabilities to Government-Sponsored Enterprises). The Emergency Economic Stabilization Act of 2008 (EESA) gave the Secretary of the Treasury temporary authority to purchase and guarantee assets from a wide range of financial institutions through the Troubled Asset Relief Program (TARP) (see Note 5—TARP Direct Loans and Equity Investments, Net).

Following U.S. Generally Accepted Accounting Principles for Federal entities (U.S. Generally-Accepted Accounting Principles (U.S. GAAP)), the Government has not consolidated into its financial statements the assets, liabilities, or results of operations of any financial organization or commercial entity in which Treasury holds either a direct, indirect, or beneficial equity investment. Even though some of the equity investments are significant, under Statement of Federal Financial Accounting Concepts (SFFAC) No. 2, these entities meet the criteria of paragraph 50 and do not appear in the Federal budget section “Federal Programs by Agency and Account.” As such, these entities are not consolidated into the financial reports of the Government. However, the values of the investment in such entities are presented on the balance sheet.

Material intragovernmental transactions are eliminated in consolidation, except as described in the Other Accompanying Information—Unmatched Transactions and Balances (see Note 1.T). The financial reporting period ends September 30 and is the same as used for the annual budget.

B. Basis of Accounting and Revenue Recognition

These financial statements were prepared using U.S. GAAP, primarily based on Statement of Federal Financial Accounting Standards (SFFAS). Under these principles:

The basis of accounting used for budgetary purposes, which is primarily on a cash and obligation basis and follows budgetary concepts and policies, differs from the basis of accounting used for the financial statements which follow U.S. GAAP. See the Reconciliations of Net Operating Cost and Unified Budget Deficit in the Financial Statements section.

The basis of accounting used and the detail of the basis for the Statement of Social Insurance (SOSI) and the Statement of Changes in Social Insurance Amounts are covered in Note 26—Social Insurance.

New Standards Issued and Not Yet Implemented

The Federal Accounting Standards Advisory Board (FASAB) issued the following new standards that are applicable to the Financial Report of the United States Government (FR), but are not yet implemented at the Governmentwide level for fiscal year 2012:

C. Loans Receivable, Mortgage-Backed Securities, and Loan Guarantee Liabilities, Net

Direct loans obligated and loan guarantees committed after fiscal year 1991 are reported based on the present value of the net cash flows estimated over the life of the loan or guarantee. The difference between the outstanding principal of the direct loans and the present value of their net cash inflows is recognized as a subsidy cost allowance. The present value of estimated net cashflows of the loan guarantees is recognized as a liability for loan guarantees.

The subsidy expense for direct or guaranteed loans disbursed during a fiscal year is the present value of estimated net cashflows for those loans or guarantees. A subsidy expense also is recognized for modifications made during the year to loans and guarantees outstanding and for reestimates made as of the end of the fiscal year to the subsidy allowances or loan guarantee liability for loans and guarantees outstanding.

Direct loans obligated and loan guarantees committed before fiscal year 1992 are valued under two different methodologies within the Government: the allowance-for-loss method and the present-value method. Under the allowance-for-loss method, the outstanding principal of direct loans is reduced by an allowance for uncollectible amounts; the liability for loan guarantees is the amount the agency estimates would more likely than not require future cash outflow to pay default claims. Under the present-value method, the outstanding principal of direct loans is reduced by an allowance equal to the difference between the outstanding principal and the present value of the expected net cashflows. The liability for loan guarantees is the present value of expected net cash outflows due to the loan guarantees.

The MBS are treated similarly to direct loans made after fiscal year 1991, and the value of the Government’s position and the associated credit subsidy requirements are determined based on the net present value of the securities’ forecasted future cashflows. For more details on MBS, see Note 4—Loans Receivable, Mortgage-Backed Securities and Loan Guarantee Liabilities, Net.

D. Accounts and Taxes Receivable

Accounts receivable represent claims to cash or other assets from entities outside the Government that arise from the sale of goods or services, duties, fines, certain license fees, recoveries, or other provisions of the law. Accounts receivable are reported net of an allowance for uncollectible accounts. An allowance is established when it is more likely than not the receivables will not be totally collected. The allowance method varies among the agencies in the Government and is usually based on past collection experience and is re-estimated periodically as needed. Methods include statistical sampling of receivables, specific identification and intensive analysis of each case, aging methodologies, and percentage of total receivables based on historical collection.

Taxes receivable consist primarily of uncollected tax assessments, penalties, and interest when taxpayers have agreed the amounts are owed or a court has determined the assessments are owed. The Balance Sheets do not include unpaid assessments when neither taxpayers nor a court have agreed that the amounts are owed (compliance assessments) or the Government does not expect further collections due to factors such as the taxpayer’s death, bankruptcy, or insolvency (writeoffs). Taxes receivable are reported net of an allowance for the estimated portion deemed to be uncollectible. The allowance for doubtful accounts is based on projections of collectibles from a statistical sample of unpaid tax assessments.

E. TARP Direct Loans and Equity Investments, Net

Troubled Asset Relief Program (TARP) equity investments are accounted for at fair value, which is defined as the estimated amount of proceeds that would be received if the equity investments were sold to a market participant in an orderly transaction. Consistent with the present value accounting concepts embedded in SFFAS No. 2, Accounting for Direct Loans and Loan Guarantees, TARP direct loans and equity investments, net, disbursed and outstanding are recognized as assets at the net present value of their estimated future cashflows and outstanding asset guarantees are recognized as liabilities or assets at the net present value of their estimated future cashflows. Market risk is considered in the calculation and determination of the estimated net present values.

The subsidy allowance for TARP’s direct loans and equity investments represents the difference between the face value of the outstanding direct loan and equity investment balance and the net present value of the expected future cashflows and is reported as an adjustment to the face value of the direct loan or equity investment.

The recorded subsidy allowance for a direct loan or equity investment is based on a set of estimated future cashflows.

The Government used the following methodologies for valuation of the TARP direct loans and equity investments:

For more details on TARP, see Note 5—TARP Direct Loans and Equity Investments, Net.

F. Non-TARP Investments in American International Group, Inc.

The Non-TARP investments in American International Group (AIG), Inc. are recorded at fair value and represent the Government's non-TARP holdings of AIG common stock. The value of the non-TARP investments in AIG is based on the market value of the Government’s holdings of AIG common stock as of the reporting date.  (See Note 6—Non-TARP Investments in American International Group, Inc., Note 1.I—Debt and Equity Securities, and Note 9—Debt and Equity Securities for further details.)

G. Inventories and Related Property

Inventory is tangible personal property that is (1) held for sale, principally to Federal agencies, (2) in the process of production for sale, or (3) to be consumed in the production of goods for sale or in the provision of services for a fee. SFFAS No. 3, Accounting for Inventory and Related Property, requires inventories held for sale and held in reserve for future sale within the Government to be valued using either historical cost or latest acquisition cost (LAC). Historical cost methods include first-in-first-out, weighted average, and moving average. When LAC methods are used, the inventory is revalued periodically and an allowance account should be established for unrealized holding gains and losses.

The Department of Defense (DOD) holds the majority of the inventories within the Government and uses standard price and moving average cost methods for valuing most of its inventory. To a lesser degree, DOD also uses LAC methods adjusted for holding gains and losses to approximate the historical cost of resale inventory items remaining in its legacy system. DOD is continuing to transition inventories currently accounted for under the LAC methods, to be accounted for under the moving average cost methods, however, DOD still has supportability of inventory valuation issues.

When using historical cost valuation, estimated repair costs reduce the value of inventory held for repair. Excess, obsolete, and unserviceable inventories are valued at estimated net realizable value. When latest acquisition cost is used to value inventory held for sale, it is adjusted for holding gains and losses in order to approximate historical cost.

Related property includes commodities, seized monetary instruments, forfeited and foreclosed property, raw materials and work in process. Operating materials and supplies are valued at historical cost, latest acquisition cost, and standard price using the purchase and consumption method of accounting. Operating materials and supplies that are valued at latest acquisition cost and standard pricing are not adjusted for holding gains and losses.

H. Property, Plant, and Equipment

PP&E consists of tangible assets including buildings, equipment, construction in progress, and internal use software, assets acquired through capital leases, including leasehold improvements, and other assets used to provide goods and services.

I. Debt and Equity Securities

Debt and equity securities are classified as held-to-maturity, available-for-sale, and trading. Held-to-maturity debt and equity securities are reported at amortized cost, net of unamortized premiums and discounts. Available-for-sale debt and equity securities are reported at fair value. Trading debt and equity securities are reported at fair value.

J. Investments in and Liabilities to Government-Sponsored Enterprises

The senior preferred stock liquidity preference (preferred stock) and associated common stock warrant (warrant(s)) in GSEs are presented at their fair value as permitted by Office of Management and Budget (OMB) Circular No. A-136. This Circular includes language that generally requires agencies to value non-Federal investments at acquisition cost, and also permits the use of other measurement basis, such as fair value, in certain situations. Treasury performs annual valuations, as of September 30th, to provide a “sufficiently reliable” estimate of the outstanding commitments in order for Treasury to record the remaining liability in accordance with SFFAS No. 5, Accounting for Liabilities of the Federal Government. The valuations incorporated various forecasts, projections, and cashflow analyses to develop an estimate of the potential liability. Annual valuations are performed, as of September 30, of the preferred stock and warrants and any changes in valuation, including impairment, are recorded and disclosed in accordance with SFFAS No. 7, Accounting for Revenue and Other Financing Sources. Since the valuation is an annual process, the changes in valuation of the preferred stock and warrants are deemed usual and recurring. Accordingly, changes in valuation are recorded as an exchange transaction which is either an expense or revenue. Since the costs of preferred stock and warrants are exchange transactions, any change in valuation is also recorded as an exchange transaction.

The Federal Housing Finance Regulatory Reform Act of 2008 established the Federal Housing Finance Agency (FHFA), which was created to enhance authority over the GSEs and provide the Secretary of the Treasury with certain authorities intended to ensure the financial stability of the GSEs. Treasury entered into a Senior Preferred Stock Purchase Agreement (SPSPA) with each GSE. Based on U.S. GAAP, these contingent liquidity commitments, predicated on the future occurrence of any shareholders’ deficits of the GSEs, at the end of any reporting quarter are potential liabilities of Treasury. The potential liabilities to the GSEs are assessed annually and recorded at the gross amount, without the consideration of the increase in preferred stock liquidity preference, future dividend payments, or future commitment fees due to the uncertainties involved. For more detailed information on investments and liabilities of GSEs, refer to Note 11—Investments in and Liabilities to Government-Sponsored Enterprises.

K. Federal Debt

Accrued interest on Treasury securities held by the public is recorded as an expense when incurred, instead of when paid. Certain Treasury securities are issued at a discount or premium. These discounts and premiums are amortized over the term of the security using an interest method for all long-term securities and the straight line method for short-term securities. Treasury also issues Treasury Inflation-Protected Securities (TIPS). The principal for TIPS is adjusted daily over the life of the security based on the Consumer Price Index (CPI) for all Urban Consumers.

L. Federal Employee and Veteran Benefits Payable

Generally, Federal employee and veteran benefits payable are recorded during the time employee services are rendered. The related liabilities for defined benefit pension plans, veterans’ compensation and burial benefits, post-retirement health benefits, life insurance benefits, and Federal Employees’ Compensation Act benefits are recorded at estimated present value of future benefits, less any estimated present value of future normal cost contributions. The estimated present value for veterans’ pension benefits is disclosed but is not included in the Federal employee and veteran benefits payable line. These benefits are expensed when services are provided.

Normal cost is the portion of the actuarial present value of projected benefits allocated as an expense for employee services rendered in the current year. Actuarial gains and losses (and prior service cost, if any) are recognized immediately in the year they occur, without amortization.

Gains and losses from changes in long-term assumptions used to estimate Federal employee pensions, Other Retirement Benefits (ORB), and Other Postemployment Benefits (OPEB) liabilities are reflected separately on the Statement of Net Cost and the components of the expense related to Federal employee pension, ORB, and OPEB liabilities are disclosed in Note 15—Federal Employee and Veteran Benefits Payable as prescribed by SFFAS No. 33. In addition, SFFAS No. 33 also provides a standard for selecting the discount rate assumption for present value estimates of Federal employee pension, ORB, and OPEB liabilities.

M. Environmental and Disposal Liabilities

Environmental and disposal liabilities are recorded at the estimated current cost of removing, containing, treating, and/or disposing of radioactive waste, hazardous waste, chemical and nuclear weapons, and other environmental contaminations, assuming the use of current technology. Hazardous waste is a solid, liquid, or gaseous waste that, because of its quantity or concentration, presents a potential hazard to human health or the environment. Remediation consists of removal, decontamination, decommissioning, site restoration, site monitoring, closure and post-closure cost, treatment, and/or safe containment. Where technology does not exist to clean up radioactive or hazardous waste, only the estimable portion of the liability, typically monitoring and safe containment is recorded.

N. Insurance and Guarantee Program Liabilities

Insurance and guarantee programs provide protection to individuals or entities against specified risks except for those specifically covered by Federal employee and veteran benefits, social insurance, and loan guarantee programs. Insurance and guarantee program funds are commonly held in revolving funds in the Government and losses sustained by participants are paid from these funds. Many of these programs receive appropriations to pay excess claims and/or have authority to borrow from the Treasury. The values of insurance and guarantee program liabilities are particularly sensitive to changes in underlying estimates and assumptions. Insurance and guarantee programs with recognized liabilities in future periods (i.e., liabilities that extend beyond one year) are reported at their actuarial present value.

O. Deferred Maintenance and Repairs

Deferred maintenance and repairs is maintenance and repairs that were not performed when they should have been or scheduled maintenance and repairs that were delayed or postponed. Maintenance is the act of keeping fixed assets in acceptable condition, including preventative maintenance, normal repairs, and other activities needed to preserve the assets, so they continue to provide acceptable service and achieve their expected life. Maintenance and repairs exclude activities aimed at expanding the capacity of assets or otherwise upgrading them to serve needs different from those originally intended. Deferred maintenance and repairs expenses are not accrued in the Statements of Net Cost or recognized as liabilities on the Balance Sheets. However, deferred maintenance and repairs information is disclosed in the Unaudited Required Supplementary Information section of this report.

P. Contingent Liabilities

Liabilities for contingencies are recognized on the Balance Sheets when both:

The estimated contingent liability may be a specific amount or a range of amounts. If some amount within the range is a better estimate than any other amount within the range, then that amount is recognized. If no amount within the range is a better estimate than any other amount, then the minimum amount in the range is recognized and the range is disclosed.

Contingent liabilities that do not meet the above criteria for recognition, but for which there is at least a reasonable possibility that a loss may have been incurred, are disclosed in Note 22—Contingencies.

Q. Commitments

In the normal course of business, the Government has a number of unfulfilled commitments that may require the use of its financial resources. Note 23—Commitments describes the components of the Government’s actual commitments that need to be disclosed because of their nature and/or their amount. They include long-term leases, undelivered orders, and other commitments.

R. Social Insurance

A liability for social insurance programs (Social Security, Medicare, Railroad Retirement, Black Lung, and Unemployment) is recognized for any unpaid amounts currently due as of the reporting date. No liability is recognized for future benefit payments not yet due. For further information, see the Unaudited Required Supplementary Information—Social Insurance section, and Note 26—Social Insurance.

S. Related Party Transactions

Federal Reserve System

The Federal Reserve System (FR System) was created by Congress under the Federal Reserve Act of 1913. The FR System consists of the Federal Reserve Board of Governors (Board), the Federal Open Market Committee (FOMC), and the FRBs. Collectively, the FR System serves as the nation’s central bank and is responsible for formulating and conducting monetary policy, issuing and distributing currency (Federal Reserve Notes), supervising and regulating financial institutions, providing nationwide payments systems (including large-dollar transfers of funds, automated clearinghouse ACH operations, and check collection), providing certain financial services to federal agencies and fiscal principals, and serving as the Government’s bank. Monetary policy includes actions undertaken by the FR System that influence the availability and cost of money and credit as a means of helping to promote national economic goals. The FR System also conducts operations in foreign markets in order to counter disorderly conditions in exchange markets or to meet other needs specified by the FOMC to carry out its central bank responsibilities. The FR System is not included in the federal budget. It is considered an independent central bank, and its decisions are not ratified by the executive branch of the Federal Government.

The Government interacts with the FRBs in a variety of ways, including the following:

The Government also consults with the FR System on matters affecting the economy and certain financial stability activities (Note 4—Loans Receivable, Mortgage-Backed Securities, and Loan Guarantee Liabilities, Net, Note 5—Troubled Asset Relief Program (TARP)—Direct Loans and Equity Investments, and Note 6—Non-TARP Investments in American International Group, Inc.). The above financial activities involving the Government are accounted for and disclosed in the Government consolidated financial statements. In accordance with SFFAC No. 2, Entity and Display, the FR System’s assets, liabilities, and operations are not consolidated into the Government’s financial statements, and are, therefore, not a part of the reporting entity.

Federal Reserve System Structure

The Board is an independent organization governed by seven members who are appointed by the President and confirmed by the Senate. The full term of a Board member is 14 years, and the appointments are staggered so that one term expires on January 31 of each even-numbered year. The Board has a number of supervisory and regulatory responsibilities for institutions including, among others, state-chartered banks that are members of the FR System, bank holding companies, and savings and loan holding companies. In addition, the Board has general supervisory responsibilities for the 12 FRBs, and issues currency (Federal Reserve Notes) to the FRBs for distribution. The FOMC is comprised of the seven Board members and five of the 12 FRB presidents, and is charged with formulating and conducting monetary policy primarily through open market operations (the purchase and sale of certain securities in the open market), the principal tool of national monetary policy. These operations affect the amount of reserve balances available to depository institutions, thereby influencing overall monetary and credit conditions.  The 12 FRBs are chartered under the Federal Reserve Act, which requires each member bank to own the capital stock of its FRB.  Supervision and control of each FRB is exercised by a board of directors, of which three are appointed by the Board of Governors of the FR System, and six are elected by their member banks.

The FRBs participate in formulating and conducting monetary policy, distribute currency and coin, and serve as fiscal agents for the Government, other federal agencies and fiscal principals. Additionally, the FRBs provide short-term loans to depository institutions and loans to participants in programs or facilities with broad-based eligibility in unusual and crucial circumstances when approved by the Board.

Federal Reserve System Assets and Liabilities

The FRBs hold Treasury and other securities in the SOMA for the purpose of conducting monetary policy. Treasury securities held by the FRBs totaled $1,646.8 billion and $1,665.4 billion at September 30, 2012, and 2011, respectively (Note 14—Federal Debt Securities Held by the Public and Accrued Interest). These assets are generally subject to the same market (principally interest-rate) and credit risks as other financial instruments. In the open market, the FR System purchases and sells Treasury securities as a mechanism for controlling the money supply.

The FRBs have deposit liabilities with Treasury and depository institutions. The FRBs issue Federal Reserve Notes, the circulating currency of the United States, which are collateralized by the Treasury securities and other assets held by the FRBs. Financial and other information concerning the FR System, including financial statements for the Board and the FRBs, may be obtained at http://www.federalreserve.gov.

FRB Residual Earnings Transferred to the Government

FRBs generate income from interest earned on securities, reimbursable services provided to federal agencies, and the provision of priced services to depository institutions, as specified by the Monetary Control Act of 1980. Although the FRBs generate earnings from carrying out open market operations (via the earnings on securities held in the SOMA account), their execution of these operations is for the purpose of accomplishing monetary policy rather than generating earnings. Each FRB is required by Board policy to transfer to the Government its residual (or excess) earnings, after providing for the cost of operations, payment of dividends, and reservation of an amount necessary to equate surplus with paid-in capital. These residual earnings may vary due to, among other things, changes in the SOMA balance levels that may occur in conducting monetary policy.  The FRB residual earnings of $82.0 billion and $82.5 billion for fiscal years ended September 30, 2012, and 2011, respectively, are reported as other taxes and receipts on the Statements of Operations and Changes in Net Position. Accounts and taxes receivables, net, includes a receivable for FRB’s residual earnings which represents the earnings due to the Treasury General Fund as of September 30, but not collected by the Treasury General Fund until after the end of the month. As of September 30, 2012, and 2011, interest receivable on FRB’s residual earnings are $2.3 billion and $1.6 billion, respectively (Note 3—Accounts and Taxes Receivables, Net).

Other Related Parties

The Government generally does not guarantee payment of the liabilities of GSEs such as Fannie Mae, Freddie Mac, or the Federal Home Loan Banks, which are privately owned. For further details regarding investments in or liabilities to Fannie Mae and Freddie Mac, see Note 11—Investments in and Liabilities to Government-Sponsored Enterprises.

The Secretary of Transportation has possession of two long term notes with the National Railroad Passenger Service Corporation (more commonly referred to as Amtrak). The first note is for $4 billion and matures in 2975 and the second note is for $1.1 billion and matures in 2082 with renewable 99 year terms. Interest is not accruing on these notes as long as the current financial structure of Amtrak remains unchanged. If the financial structure of Amtrak changes, both principal and accrued interest are due and payable. The Department of Transportation (DOT) does not record the notes in its financial statements because the present value of the notes was immaterial at September 30, 2012. These notes were discounted according to rates published in OMB M-11-12, Appendix C, Discount Rates for Cost Effectiveness Lease Purchase and Related Analyses with maturity dates of 2975 and 2082.

In addition, DOT has possession of all the preferred stock shares (109.4 million) of Amtrak. Congress, through DOT, has continued to fund Amtrak since approximately 1972; originally through grants, then, beginning in 1981, through the purchase of preferred stock, and then through grants again after 1997. The Amtrak Reform and Accountability Act of 1997 changed the structure of the preferred stock by rescinding the voting rights with respect to the election of the Board of Directors and by eliminating the preferred stock’s liquidation preference over the common stock. The Act also eliminated further issuance of preferred stock to DOT. DOT does not record the Amtrak preferred stock in its financial statements because, under the Corporation's current financial structure, the preferred shares do not have a liquidation preference over the common shares, the preferred shares do not have any voting rights, and dividends are neither declared nor in arrears.

Amtrak is not a department, agency or instrumentality of the Government or DOT. The nine members of Amtrak’s Board of Directors are appointed by the President of the United States and are subject to confirmation by the U.S. Senate. Once appointed, Board members, as a whole, act independently without the consent of the Government or any of its officers to set Amtrak policy, determine its budget and decide operational issues. The Secretary of Transportation is statutorily appointed to the nine-member Board. Traditionally, the Secretary of Transportation has designated the Administrator of the Federal Railroad Administration to represent the Secretary at Board meetings.

The Export-Import Bank of the United States (Ex-Im Bank) has contractual agreements with the Private Export Funding Corporation (PEFCO). PEFCO, which is owned by a consortium of private-sector banks, industrial companies and financial services institutions, makes medium-term and long-term fixed-rate and variable-rate loans to foreign borrowers to purchase U.S.-made equipment when such loans are not available from traditional private sector lenders on competitive terms. Ex-Im Bank’s credit and guarantee agreement with PEFCO extends through December 31, 2020. Through its contractual agreements with PEFCO, Ex-Im Bank exercises a broad measure of supervision over PEFCO’s major financial management decisions, including approval of both the terms of individual loan commitments and the terms of PEFCO’s long-term debt issues, and is entitled to representation at all meetings of PEFCO’s board of directors, advisory board and its exporters’ council.

The contractual agreements provide that Ex-Im Bank will (1) guarantee the due and punctual payment of principal and interest on export loans made by PEFCO and (2) guarantee the due and punctual payment of interest on PEFCO’s long-term secured debt obligations when requested by PEFCO. Related to the amounts for Ex-Im Bank as shown in Note 4—Loans Receivable, Mortgage-Backed Securities, and Loan Guarantee Liabilities, Net, these guarantees to PEFCO, aggregating $6.1 billion and $5.3 billion at September 30, 2012 and 2011, respectively, are included within the principal amounts guaranteed by the United States. The allowance related to these transactions is included within the guaranteed loan liability. Ex-Im Bank received fees totaling $0.03 billion in both fiscal years 2012 and 2011 for the agreements, which are included as earned revenue on the Statements of Net Cost.

T. Unmatched Transactions and Balances

The reconciliation of the change in net position requires that the difference between ending and beginning net position equals the excess of revenues over net cost, plus or minus prior-period adjustments.

The unmatched transactions and balances are needed to bring the change in net position into balance. The primary factors affecting this out of balance situation are:

Refer to the Other Accompanying Information—Unmatched Transactions and Balances for detailed information.

U. Derivatives

A derivative is a financial instrument or other contract with all three of the following characteristics:

An underlying is a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, or other variable. An underlying may be a price or rate of an asset or liability but is not the asset or liability itself. A notional (or face) amount is a number of currency units, shares, bushels, pounds, or other units specified in the contract. The settlement of a derivative instrument with a notional amount is determined by interaction of that notional amount with the underlying. The interaction may be simple multiplication, or it may involve a formula with leverage factors or other constants. A payment provision specifies a fixed or determinable settlement to be made if the underlying behaves in a specified manner.

The accounting for derivative instruments are governed by FASB Accounting Standards Codification (ASC) Topic 815, Derivatives and Hedging, which aims to highlight to financial statement users additional disclosures on an entity’s objectives in its use of derivatives and the method of accounting for such financial instruments. This standard requires that entities with derivatives disclose the following:

For further information, see Note 10—Derivatives.

V. Reclassifications

Certain amounts were reclassified in the fiscal year 2011 consolidated statement of net cost. The fiscal year 2011 allocation of federal employee benefit expenses from the OPM to all other agencies did not include an allocation for the benefit expense to the U.S. Postal Service (USPS). The fiscal year 2011 allocation of federal benefit expenses now includes an allocation of these expenses to USPS and resulted in an increase of USPS gross and net cost of $5.5 billion, as there was no change to the fiscal year 2011 USPS earned revenue amount. This $5.5 billion gross cost was reclassified from all the remaining agencies’ gross costs to reflect the benefit expense allocation to USPS.

Certain amounts were reclassified in the fiscal year 2011 reconciliation from net operating cost to the unified budget deficit. As a result of additional information obtained in fiscal year 2012 for credit reform and other loan activities, $6.2 billion included in the "all other" aggregate reconciling line item was reclassified to the credit reform and other loan activities reconciling line item.

Non-TARP Investment in American International Group, Inc. amounts were reclassified to debt and equity securities. See Note 9—Debt and Equity Securities.

The calculation and presentation of the components of the reconciliation of veterans' compensation and burial benefits liabilities shown in Note 15—Federal Employee and Veteran Benefits Payable were modified for fiscal year 2012 to better align the presentation of these veterans benefits liabilities with those of other agencies for improved consistency in government-wide OPEB reporting. As a result, the fiscal year 2011 presentation was also modified to conform to the fiscal year 2012 presentation. Neither the fiscal year 2011 ending liability or the related benefits expense changed as a result of this presentation change.

For fiscal years 2012 and 2011, one fund in each year  that was previously reported as an earmarked fund was reclassified to nonearmarked funds and recorded as a prior period adjustment. See Note 21—Prior Period Adjustments, for a prior period adjustment in fiscal year 2012 resulting from a change in accounting principle.

W. Fiduciary Activities

Fiduciary activities are the collection or receipt, and the management, protection, accounting, investment and disposition by the Government of cash or other assets in which non-Federal individuals or entities have an ownership interest that the Government must uphold. Fiduciary cash and other fiduciary assets are not assets of the Government and are not recognized on the Balance Sheet. See Note 25—Fiduciary Activities, for further information.

X. Use of Estimates

The Government has made certain estimates and assumptions relating to the reporting of assets, liabilities, revenues, expenses, and the disclosure of contingent liabilities to prepare these financial statements. There are a large number of factors that affect these assumptions and estimates, which are inherently subject to substantial uncertainty arising from the likelihood of future changes in general economic, regulatory and market conditions. As such, actual results will differ from these estimates and such differences may be material.

Significant transactions subject to estimates include loans receivable and MBS, TARP direct loans and equity investments; investments in other non-Federal securities (including GSEs and foreign and domestic public entities) and related impairment, if any; tax receivables; loan guarantees; depreciation; liability for liquidity commitment (GSEs); actuarial liabilities; contingent legal liabilities; environmental liabilities; credit reform subsidy costs; and insurance and guarantee program liabilities.

The Government recognizes the sensitivity of credit reform modeling to slight changes in some model assumptions and uses regular review of model factors, statistical modeling, and annual reestimates to reflect the most accurate cost of the credit programs to the U.S. Government. Two of the emergency economic programs that the Government implemented in the latter part of September 2008, the purchase program for MBS and the GSE credit line facility, are accounted for pursuant to the provisions of credit reform and the use of estimates as dictated by the Federal Credit Reform Act of 1990 (FCRA). FCRA loan receivables and loan guarantees are disclosed in Note 4—Loans Receivable, Mortgage-Backed Securities, and Loan Guarantee Liabilities, Net. Additionally, all TARP credit activity, including investments in common and preferred stock and loans and asset guarantees, are also subject to credit reform accounting (see Note 5—TARP Direct Loans and Equity Investments, Net).

The forecasted future cashflows used to determine credit reform amounts as of September 30, 2012, and 2011, are sensitive to slight changes in model assumptions, such as general economic conditions, specific stock price volatility of the entities in which the Government has an equity interest, estimates of expected default, and prepayment rates. Forecasts of future financial results have inherent uncertainty and the TARP Direct Loans and Equity Investments, Net line item as of September 30, 2012, and 2011, is reflective of relatively illiquid, troubled assets whose values are particularly sensitive to future economic conditions and other assumptions.

The GSE senior preferred stock purchase agreements (SPSPAs) provide that the Government will make funding advances to the GSEs, if needed at the end of any quarter. The FHFA, acting as the conservator, determines that the liabilities of either GSE, individually, exceed its respective assets. Valuation analyses are performed to attempt to provide a “sufficiently reliable” estimate of the outstanding commitment which is recorded as a liability in accordance with SFFAS No. 5. As part of the valuation exercise, Treasury prepared a series of long-range forecasts through 2025 to determine the implied amount of total liability. In fiscal year 2012, the SPSPAs were amended. For more detailed information on investments and liabilities of GSEs and the amended SPSPAs, see Note 11—Investments in and Liabilities to Government-Sponsored Enterprises.

Y. Credit Risk

Credit risk is the potential, no matter how remote, for financial loss from a failure of a borrower or a counterparty to perform in accordance with underlying contractual obligations. The Government takes on credit risk when it makes direct loans or credits to foreign entities or becomes exposed to institutions which engage in financial transactions with foreign countries.

The Government also takes on credit risk related to committed but undisbursed direct loans, liquidity commitment to GSEs, the MBS portfolio, investments, loans, and asset guarantees of the TARP, guarantee of money market funds, and the Terrorism Risk Insurance Program. Except for the Terrorism Risk Insurance Program, these activities focus on the underlying problems in the credit markets, and the ongoing instability in those markets exposes the Government to potential unknown costs and losses. The extent of the risk assumed is described in more detail in the notes to the financial statements, and where applicable, is factored into credit reform models and reflected in fair value measurements.

Last Updated:  February 27, 2013