Dominion Power 2000 Annual Report Download - page 46

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Notes to Consolidated Financial Statements (continued)
is determined based on market prices under comparable servicing
sales contracts or the present value of estimated future cash flows.
Dominion assesses the impairment of mortgage servicing rights
based on the fair value of those rights, and any impairment is
recognized through a valuation allowance.
Mortgage loans serviced require regular monthly payments from
borrowers. Income on loan servicing is generally recorded as pay-
ments are collected and is based on a percentage of the principal
balance of loans serviced. Loan servicing expenses are charged to
operations when incurred.
Mortgage Investments
Mortgage investments consist of subordinated bonds and interest-
only residual assets retained at securitization of mortgage loans.
Mortgage investments are classified as trading securities. Interest-
only strip residual assets are amortized in proportion to the esti-
mated income received but are analyzed quarterly to determine
whether prepayment experience, losses and changes in the interest
rate environment have had an impact on the valuation. Expected
cash flows of the underlying loans sold are reviewed based upon
current economic conditions and the type of loans originated and
are revised as necessary.
Derivatives — Other Than Trading
Dominion utilizes futures and forward contracts and derivative
financial instruments, including swaps, caps and collars, to manage
exposure to fluctuations in interest rates, lease payments, and nat-
ural gas and electricity prices.
These futures, forwards and derivative financial instruments are
deemed effective hedges when the item being hedged and the
underlying financial or commodity instrument show strong histori-
cal correlation. Dominion uses deferral accounting to account for
futures, forwards and derivative instruments which are designated
as hedges. Under this method, gains and losses (including the pay-
ment of any premium) related to effective hedges of existing assets
and liabilities are recognized in earnings in conjunction with earn-
ings of the designated asset or liability. Gains and losses related to
effective hedges of firm commitments and anticipated transactions
are included in the measurement of the subsequent transaction.
Cash flow from derivatives designed as hedges are reported in net
cash flow from operating activities.
Derivatives — Trading
The fair value method, which is used for those derivative transac-
tions which do not qualify for settlement or deferral accounting,
requires that derivatives are carried on the balance sheet at fair
value, with changes in that value recognized in earnings or common
shareholders’ equity. As part of Dominion’s strategy to market
energy from its generation capacity and to manage the risks related
thereto, it enters into contracts for the purchase and sale of
energy commodities. Dominion uses the fair value method for
its trading activities.
Options, swaps and future contracts are marked to market with
resulting gains and losses reported in earnings. Forward contracts,
initiated for trading purposes, are also marked to market with
resulting gains and losses reported in earnings. For swaps, forward
contracts, and options, market value reflects management’s best
estimates considering over-the-counter quotations, time value and
volatility factors of the underlying commitments. Exchange-traded
futures and options are marked to market based on exchange
closing prices.
Commodity contracts representing unrealized gain positions
are reported as Commodity contract assets; commodity contracts
representing unrealized losses are reported as Commodity contract
liabilities. In addition, purchased options and options sold are
reported as Commodity contract assets and Commodity contract
liabilities, respectively, at estimated market value until exercise or
expiration. Realized commodity contract revenues, net of related
cost of sales, settlement of futures contracts, amortization of
option premiums, and unrealized gains and losses resulting from
marking positions to market are included in Operating revenue.
Cash flow from trading activities is reported in net cash flow from
operating activities.
Other Derivatives
Dominion uses total return swaps to accumulate loans and securi-
ties for future sale as collateralized debt obligation securities.
Gains and losses from the settlements and sale of total return
swaps are recorded as Operating revenue and income — Other.
Total return swaps are marked to market with the corresponding
unrealized gains and losses also recorded in Operating revenue and
income — Other. Cash flow from total return swaps are reported in
net cash flow from operating activities. As of December 31, 2000,
all total return swaps relating to the above have been terminated.
Dominion has used total return equity swaps to reacquire
shares of its outstanding common stock. Dominion has recorded
all amounts received or paid in 2000 under such arrangements as
either increases or decreases to equity.
The net of amounts paid and amounts received under interest
rate swaps is reported as interest expense in the Consolidated
Statement of Income.
See Note 4 for discussion of recently issued accounting stan-
dards and their impact on the Company’s accounting for derivatives
in 2001.
Cash and Cash Equivalents
Current banking arrangements generally do not require checks to be
funded until actually presented for payment. At December 31, 2000
and 1999, accounts payable included the net effect of checks out-
standing but not yet presented for payment of $171 million and
$61 million, respectively.
For purposes of the Consolidated Statements of Cash Flows,
Dominion considers cash and cash equivalents to include cash on
hand and temporary investments purchased with a maturity of
three months or less.