Eversource 2004 Annual Report Download - page 38

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Emerging Issues Task Force (EITF) Issue No. 03-11, “Reporting
Realized Gains and Losses on Derivative Instruments That Are Subject
to FASB Statement No. 133, and ’Not Held for Trading Purposes’ as
Defined in EITF Issue No. 02-3,” was derived from EITF Issue No. 02-3,
which requires net reporting in the income statement of energy trading
activities. Issue No. 03-11 addresses income statement classification
of revenues related to derivatives that physically deliver and are not
related to energy trading activities. Prior to Issue No. 03-11, there was
no specific accounting guidance that addressed the classification in the
income statement of Select Energy’s retail marketing and wholesale
contracts or the Utility Group’s power supply contracts, many of which
are non-trading derivatives.
On July 31, 2003, the EITF reached a consensus in Issue No. 03-11
that determining whether realized gains and losses on contracts that
physically deliver and are not held for trading purposes should be
reported on a net (sales and purchases both in expenses) or gross
(sales in revenues and purchases in expenses) basis is a matter of
judgment that depends on the relevant facts and circumstances.
The EITF indicated that existing accounting guidance should be
considered and provided no new guidance in Issue No. 03-11. In
Issue No. 03-11, the EITF did not provide transition guidance, which
management could have interpreted as becoming applicable on
October 1, 2003 for revenues from that date forward. However,
management applied its conclusion on net or gross reporting to all
periods presented to enhance comparability.
Select Energy reports the settlement of long-term derivative contracts
that physically deliver and are not held for trading purposes on a gross
basis, generally with sales in revenues and purchases in expenses.
Short-term sales and purchases represent power that is purchased
to serve full requirements contracts but is ultimately not needed based
on the actual load of the full requirements customers. This excess
power is sold to the independent system operator or to other
counterparties. For the years ended December 31, 2004 and 2003,
settlements of short-term derivative contracts that are not held for
trading purposes, are reported on a net basis in expenses.
The Utility Group reports the settlement of all short-term sales contracts
that are part of procurement activities on a net basis in expenses.
On June 25, 2003, the DIG cleared Issue No. C-20, which addressed the
meaning of “not clearly and closely related regarding contracts with a
price adjustment feature” as it relates to the election of the normal
purchase and sales exception to derivative accounting. The implementation
of this guidance was required for the fourth quarter of 2003 for NU. The
implementation of Issue No. C-20 resulted in CL&P recording the fair
value of two existing power purchase contracts as derivatives, one as a
derivative asset, and one as a derivative liability. An offsetting
regulatory liability and an offsetting regulatory asset were recorded,
as these contracts are part of stranded costs, and management believes
that these costs will continue to be recovered or refunded in rates.
Regulatory Accounting: The accounting policies of NU’s regulated utility
companies historically reflect the effects of the rate-making process
in accordance with SFAS No. 71, “Accounting for the Effects of Certain
Types of Regulation.” The transmission and distribution businesses of
CL&P, PSNH and WMECO, along with PSNH’s generation business and
Yankee Gas’ distribution business, continue to be cost-of-service rate
regulated, and management believes the application of SFAS No. 71
to that portion of those businesses continues to be appropriate.
Management must reaffirm this conclusion at each balance sheet date.
If, as a result of a change in circumstances, it is determined that any
portion of these companies no longer meets the criteria of regulatory
accounting under SFAS No. 71, that portion of the company will have
to discontinue regulatory accounting and write-off the respective
regulatory assets and liabilities. Such a write-off could have a material
impact on NU’s consolidated financial statements.
The application of SFAS No. 71 results in recording regulatory assets
and liabilities. Regulatory assets represent the deferral of incurred
costs that are probable of future recovery in customer rates. In some
cases, NU records regulatory assets before approval for recovery
has been received from the applicable regulatory commission.
Management must use judgment to conclude that costs deferred as
regulatory assets are probable of future recovery. Management bases
its conclusion on certain factors, including changes in the regulatory
environment, recent rate orders issued by the applicable regulatory
agencies and the status of any potential new legislation. Regulatory
liabilities represent revenues received from customers to fund expected
costs that have not yet been incurred or are probable future refunds
to customers.
Management uses its best judgment when recording regulatory assets
and liabilities; however, regulatory commissions can reach different
conclusions about the recovery of costs, and those conclusions could
have a material impact on NU’s consolidated financial statements.
Management believes it is probable that the Utility Group companies
will recover the regulatory assets that have been recorded.
Goodwill and Other Intangible Assets: SFAS No. 142, “Goodwill and Other
Intangible Assets,” requires that goodwill balances be reviewed for
impairment at least annually by applying a fair value-based test. NU
selected October 1st as the annual goodwill impairment testing date.
The goodwill impairment analysis impacts the Yankee Gas and the NU
Enterprises segment. Goodwill impairment is deemed to exist if the
net book value of a reporting unit exceeds its estimated fair value and
if the implied fair value of goodwill based on the estimated fair value
of the reporting unit is less than the carrying amount of the goodwill.
If goodwill is deemed to be impaired it will be written-off to the extent
it is impaired. This could have a significant impact on NU’s consolidated
financial statements.
NU has completed its impairment analyses as of October 1, 2004 for
all reporting units that maintain goodwill and has determined that no
impairments exist.
In performing the impairment evaluation required by SFAS No. 142,
NU estimates the fair value of each reporting unit and compares it
to the carrying amount of the reporting unit, including goodwill. NU
estimates the fair values of its reporting units using discounted cash
flow methodologies and an analysis of comparable companies or
transactions. The discounted cash flow analysis requires the input of
several critical assumptions, including future growth rates, operating
cost escalation rates, allowed ROE, a risk-adjusted discount rate,
and long-term earnings multiples of comparable companies. These
assumptions are critical to the estimate and are susceptible to
change from period to period.