Dominion Power 2003 Annual Report Download - page 31

29.Dominion 2003
The selection of discount rates and expected long-term rates
of return on plan assets are critical assumptions. Dominion deter-
mines the expected long-term rates of return on plan assets for
pension plans and other postretirement benefit plans by using a
combination of:
• Historical return analysis to determine expected future risk
premiums;
• Forward looking return expectations derived from the yield on
long-term bonds and the price earnings ratios of major stock mar-
ket indices;
• Expected inflation and risk-free interest rate assumptions and
• The types of investments expected to be held by the plans.
Assisted by an independent actuary, management develops
assumptions, which are then compared to the forecasts of other
independent investment advisors to ensure reasonableness. An
internal committee selects the final assumptions. Discount rates
are determined from analyses performed by a third-party actuar-
ial firm of AA/Aa rated bonds with cash flows matching the
expected payments to be made under Dominion’s plans.
The following table illustrates the effect of changing the critical
actuarial assumptions discussed above:
Increase in 2004
Net Periodic Cost
Other
Actuarial Change in Pension Postretirement
Assumption Assumption Benefits Benefits
(millions)
Discount rate (0.25%) $12 $ 6
Rate of return on plan assets (0.25%) 10 1
Healthcare cost trend rate 1% N/A 22
Accounting for regulated operations
Methods of allocating costs to accounting periods for operations
subject to federal or state cost-of-service rate regulation may dif-
fer from accounting methods generally applied by nonregulated
companies. When the timing of cost recovery prescribed by regu-
latory authorities differs from the timing of expense recognition
used for accounting purposes, Dominion’s Consolidated Financial
Statements may recognize a regulatory asset for expenditures
that otherwise would be expensed. Regulatory assets represent
probable future revenue associated with certain costs that will be
recovered from customers through rates. Regulatory liabilities
represent probable future reductions in revenue associated with
expected customer credits through rates or amounts collected
from customers for expenditures not yet incurred. Management
makes assumptions regarding the probability of regulatory asset
recovery through future rates approved by applicable regulatory
authorities. The expectations of future recovery are generally
based on orders issued by regulatory commissions or historical
experience, as well as discussions with applicable regulatory
authorities. If recovery of regulatory assets is determined to be
less than probable, they would be expensed in the period such
assessment is made. See Notes 2 and 14 to the Consolidated
Financial Statements.
Accounting for gas and oil operations
Dominion follows the full cost method of accounting for gas and
oil exploration and production activities prescribed by the SEC.
Under the full cost method, all direct costs of property acquisi-
tion, exploration and development activities are capitalized and
subsequently depreciated using a unit-of-production method. The
depreciable base of costs includes estimated future costs to be
incurred in developing proved gas and oil reserves, as well as
capitalized asset retirement costs, net of projected salvage val-
ues. The calculations under this accounting method are depen-
dent on engineering estimates of proved reserve quantities and
estimates of the amount and timing of future expenditures to
develop the proved reserves. Proved reserves, and the cash flows
related to these reserves, are estimated based on a combination
of historical data and expected future activity. Actual reserve
quantities and development expenditures may differ from the
forecasted amounts.
In addition, Dominion has significant investments in unproved
properties, which are initially excluded from the depreciable
base. Until the properties are evaluated, a ratable portion of
the capitalized costs is periodically reclassified to the deprecia-
ble base, determined on a property-by-property basis, over
terms of underlying leases. Once a property has been evaluated,
any remaining capitalized costs are then transferred to the
depreciable base.
Capitalized costs in the depreciable base are subject to a
ceiling test prescribed by the SEC. The test limits capitalized
amounts to a ceiling
— the present value of estimated future net
revenues to be derived from the production of proved gas
and oil reserves assuming period-end hedge-adjusted prices.
Dominion performs the ceiling test quarterly, on a country-by-
country basis, and would recognize asset impairments to the
extent that total capitalized costs exceed the ceiling. Any impair-
ment of excess gas and oil property costs over the ceiling is
charged to operations. Given the volatility of natural gas and
oil prices, it is possible that Dominion’s estimate of discounted
future net cash flows from proved natural gas and oil reserves
could change in the near term. If natural gas or oil prices have
declined as of the date of the ceiling test, or if Dominion revises
its estimates of the quantities or timing of future production
from its proved reserves, recognition of natural gas and oil
property impairments could occur. See Notes 2 and 29 to the
Consolidated Financial Statements.
Accounting for retained interests from securitizations
Securitizations involve selling loans to qualifying unconsolidated
trusts in exchange for cash and retained interests. Retained inter-
ests may include unsecured debt of the trust or retained interests
in the transferred loans. Dominion holds retained interests from
mortgage and commercial loans securitized in prior years and
classifies them as available-for-sale investments, carried on the
Consolidated Balance Sheets at fair value. Quarterly, Dominion
evaluates the key assumptions relating to valuing the retained