June 2007 Capital Adequacy Extension © Copyright 2007, CCRO. All rights reserved. Page 29 of 92 Figure 3.8: GAAP vs. Non-GAAP Earnings As is displayed in the figure above, the difference between GAAP and non-GAAP earnings can be significant, and consequently have meaningful implications depending on who is evaluating the financial statements. From a capital adequacy perspective, it is important to assess both aspects and determine the risk capital requirements in either instance of GAAP or non-GAAP earnings environments. An important piece of this example is the MTM portion of the portfolio. While certain MTM instruments can provide long term economic hedging, they may introduce short term accounting volatility. By analyzing the capital adequacy of a company from both GAAP and non- GAAP perspectives, one can assess the accounting and economic impacts of hedging strategies on the capital structure and make an assessment as to whether the cost / benefit is consistent with the companies overall risk tolerance. Recall from Figure 3.7 how earnings either add or detract from the equity of a company. Depending on the method of earnings determination (GAAP / non-GAAP), this can have a meaningful difference on the amount of equity available to fund risk capital requirements at any given discreet time increment. While the results may be different, the insights gained from the dual approach will provide a more complete picture of the capital adequacy of a company. GAAP vs Non-GAAP Difference of $24.9 Million