APS 2012 Annual Report Download - page 171

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
146
believe the economic hedges mitigate exposure to fluctuations in commodity prices, these
instruments have not been designated as accounting hedges. Contracts that have the same terms
(quantities, delivery points and delivery periods) and for which power does not flow are netted,
which reduces both revenues and fuel and purchased power costs in our Consolidated Statements of
Income, but does not impact our financial condition, net income or cash flows.
On June 1, 2012, we elected to discontinue cash flow hedge accounting treatment for the
significant majority of our contracts that had previously been designated as cash flow hedges. This
discontinuation is due to changes in PSA recovery (see Note 3), which now allows for 100% deferral
of the unrealized gains and losses relating to these contracts. For those contracts that were de-
designated, all changes in fair value after May 31, 2012 are no longer recorded through OCI, but are
deferred through the PSA. The amounts previously recorded in accumulated OCI relating to these
instruments will remain in accumulated OCI, and will transfer to earnings in the same period or
periods during which the hedged transaction affects earnings or sooner if we determine it is probable
that the forecasted transaction will not occur. Cash flow hedge accounting treatment will continue
for a limited number of contracts that are not subject to PSA recovery.
Our derivative instruments, excluding those qualifying for a scope exception, are recorded on
the balance sheet as an asset or liability and are measured at fair value; see Note 14 for a discussion
of fair value measurements. Derivative instruments may qualify for the normal purchases and
normal sales scope exception if they require physical delivery and the quantities represent those
transacted in the normal course of business. Derivative instruments qualifying for the normal
purchases and sales scope exception are accounted for under the accrual method of accounting and
excluded from our derivative instrument discussion and disclosures below.
Hedge effectiveness is the degree to which the derivative instrument contract and the hedged
item are correlated and is measured based on the relative changes in fair value of the derivative
instrument contract and the hedged item over time. We assess hedge effectiveness both at inception
and on a continuing basis. These assessments exclude the time value of certain options. For
accounting hedges that are deemed an effective hedge, the effective portion of the gain or loss on the
derivative instrument is reported as a component of OCI and reclassified into earnings in the same
period during which the hedged transaction affects earnings. We recognize in current earnings,
subject to the PSA, the gains and losses representing hedge ineffectiveness, and the gains and losses
on any hedge components which are excluded from our effectiveness assessment. As cash flow
hedge accounting has been discontinued for the significant majority of our contracts, effective
June 1, 2012, effectiveness testing is no longer being performed for these contracts.
Prior to the Settlement Agreement, for its regulated operations, APS deferred for future rate
treatment approximately 90% of unrealized gains and losses on certain derivatives pursuant to the
PSA mechanism that would otherwise be recognized in income. Due to the Settlement Agreement,
for its regulated operations, APS now defers for future rate treatment 100% of the unrealized gains
and losses for delivery periods after June 30, 2012 on derivatives pursuant to the PSA mechanism
that would otherwise be recognized in income. Realized gains and losses on derivatives are deferred
in accordance with the PSA to the extent the amounts are above or below the Base Fuel Rate (see
Note 3). Gains and losses from derivatives in the following tables represent the amounts reflected in
income before the effect of PSA deferrals.