Dominion Power 2007 Annual Report Download - page 34

Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued
approach deemed appropriate under the circumstances and
applied consistently from period to period. If pricing information
is not available from external sources, judgment is required to
develop the estimates of fair value. For individual contracts, the
use of different valuation models or assumptions could have a
material effect on a contract’s estimated fair value.
For cash flow hedges of forecasted transactions, we estimate
the future cash flows of the forecasted transactions and evaluate
the probability of occurrence and timing of such transactions.
Changes in conditions or the occurrence of unforeseen events
could require discontinuance of hedge accounting or could affect
the timing of the reclassification of gains and/or losses on cash
flow hedges from accumulated other comprehensive income (loss)
(AOCI) into earnings.
U SE OF E STIMATES IN G OODWILL I MPAIRMENT T ESTING
As of December 31, 2007, we reported $3.5 billion of goodwill in
our Consolidated Balance Sheet. A significant portion resulted
from the acquisition of the former Consolidated Natural Gas
Company (CNG) in 2000.
In April of each year, we test our goodwill for potential
impairment, and perform additional tests more frequently if
impairment indicators are present and after a portion of goodwill
has been allocated to a business which we plan to dispose of. The
2007, 2006 and 2005 annual tests did not result in the recog-
nition of any goodwill impairment, as the estimated fair values of
our reporting units exceeded their respective carrying amounts.
As a result of the 2007 disposition of our non-Appalachian
E&P operations, goodwill was allocated to such operations based
on the relative fair values of the E&P operations being disposed of
and the Appalachian portion being retained. The impairment test
performed on the goodwill allocated to the retained Appalachian
operations showed no impairment. Also, in connection with the
2007 segment realignment, the goodwill allocated to our three gas
distribution subsidiaries was tested for impairment during the
fourth quarter of 2007. This interim test did not result in the
recognition of any goodwill impairment, as the estimated fair
values of these businesses exceeded their respective carrying
amounts.
In general, we estimate the fair value of our reporting units by
using a combination of discounted cash flows, and other valu-
ation techniques that use multiples of earnings for peer group
companies and analyses of recent business combinations involving
peer group companies. For our non-Appalachian E&P operations,
our regulated gas distribution subsidiaries held for sale and certain
DCI operations, negotiated sales prices were used as fair value for
the tests conducted in 2007. Fair value estimates are dependent
on subjective factors such as our estimate of future cash flows, the
selection of appropriate discount and growth rates, and the
selection of peer group companies and recent transactions. These
underlying assumptions and estimates are made as of a point in
time; subsequent modifications, particularly changes in discount
rates or growth rates inherent in our estimates of future cash
flows, could result in a future impairment of goodwill. Although
we have consistently applied the same methods in developing the
assumptions and estimates that underlie the fair value calcu-
lations, such as estimates of future cash flows, and based those
estimates on relevant information available at the time, such cash
flow estimates are highly uncertain by nature and may vary sig-
nificantly from actual results. If the estimates of future cash flows
used in the most recent tests had been 10% lower, the resulting
fair values would have still been greater than the carrying values of
each of those reporting units tested, indicating that no impair-
ment was present.
U SE OF E STIMATES IN L ONG - LIVED A SSET
I MPAIRMENT T ESTING
Impairment testing for an individual or group of long-lived assets
or for intangible assets with definite lives is required when
circumstances indicate those assets may be impaired. When an
asset’s carrying amount exceeds the undiscounted estimated future
cash flows associated with the asset, the asset is considered
impaired to the extent that the asset’s fair value is less than its
carrying amount. Performing an impairment test on long-lived
assets involves judgment in areas such as identifying circum-
stances that indicate an impairment may exist; identifying and
grouping affected assets; and developing the undiscounted and
discounted estimated future cash flows (used to estimate fair value
in the absence of market-based value) associated with the asset,
including probability weighting such cash flows to reflect expect-
ations about possible variations in their amounts or timing and
the selection of an appropriate discount rate. Although our cash
flow estimates are based on relevant information available at the
time the estimates are made, estimates of future cash flows are, by
nature, highly uncertain and may vary significantly from actual
results. For example, estimates of future cash flows would con-
template factors, which may change over time, such as the
expected use of the asset, including future production and sales
levels, and expected fluctuations of prices of commodities sold
and consumed.
In 2006, we tested the partially-completed Dresden Energy
merchant generation facility (Dresden) for impairment and con-
cluded that its carrying amount, as well as the estimated cost to
complete, was recoverable based on the probability of continued
construction and use at that time. As part of our ongoing asset
review to improve Dominion’s return on invested capital, we began
the process of exploring the sale of Dresden in the second quarter of
2007. Non-binding indicative bids were received and based on our
evaluation of these bids, we believed that it was likely that Dresden
wouldbesoldratherthancompletedandoperatedinourmerchant
fleet. This change in intended use represented a triggering event for
us to evaluate whether we could recover the carrying amount of our
investment in Dresden. This analysis indicated that the carrying
amount of Dresden would not be recovered. As a result, in the
second quarter of 2007, we recognized a $387 million ($252 mil-
lion after-tax) impairment charge to reduce Dresden’s carrying
amount to its estimated fair value in connection with the planned
sale of Dresden, which closed in September 2007.
In 2005, we tested gas and steam electric turbines held for
future development with a carrying amount of $187 million for
impairment and concluded that the carrying amount was recover-
able based upon the probability of future development as a mer-
chant generation project at that time. In the third quarter of
2007, we recognized an $18 million impairment charge ($12
million after-tax) for two of these gas turbines that were sold by
our merchant generation operations to our utility generation
operations based upon amounts to be recovered by our utility in
jurisdictional rate base. These turbines will be used in the
32 Dominion 2007 Annual Report