Eversource 2004 Annual Report Download - page 47

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Management is responsible for the preparation, integrity, and fair
presentation of the accompanying consolidated financial statements
of Northeast Utilities and subsidiaries (NU) and of other sections of
this annual report. These financial statements, which were audited by
Deloitte & Touche LLP, have been prepared in conformity with accounting
principles generally accepted in the United States of America using
estimates and judgments, where required, and giving consideration
to materiality.
Additionally, management is responsible for establishing and maintaining
adequate internal controls over financial reporting. Under the supervision
and with the participation of management, including our principal
executive officer and principal financial officer, NU conducted an
evaluation of the effectiveness of internal controls over financial
reporting based on criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO). Based on this evaluation under the
framework in COSO, management concluded that our internal control
over financial reporting was ineffective as of December 31, 2004.
Management identified a material weakness due to deficiencies in both
the design and operating effectiveness of internal controls associated
with the application of derivative accounting rules to certain wholesale
natural gas contracts entered into by the wholesale marketing portion
of NU Enterprises’ merchant energy segment. NU filed a Form 8-K on
January 26, 2005 to provide notice of the restatement of June 30, 2004
and September 30, 2004 reports on Form 10-Q due to this accounting
error. Restatements amounted to an increase in net income of $1.1
million for the quarter ended June 30, 2004 and a decrease in net
income of $47 million for the quarter ended September 30, 2004. Numerous
account balances were affected by these material misstatements,
primarily fuel, purchased and net interchange power, income tax
expense, derivative assets, derivative liabilities, retained earnings,
and accumulated other comprehensive income.
Accounting for derivative contracts is complex and requires a significant
amount of judgment and interpretation of the rules. During the second
and third quarters of 2004, management accounted for certain wholesale
natural gas contracts using the accrual method of accounting. Using
this method, changes in the fair value of the derivative contracts did
not impact net income currently. As a result of further analysis performed
through January 2005, management concluded that an error had been
made in interpreting the derivative accounting rules. This misinterpretation
led to a misapplication of the derivative accounting rules. These wholesale
natural gas contracts should have been recorded at fair value with
changes in fair value reflected currently in net income. The restatements
discussed above were required in order to apply fair value accounting
to these contracts. The material weakness occurred due to deficiencies
in both the design and operating effectiveness of the internal
control environment.
Management identified and is strengthening the effectiveness and design
of internal controls related to this matter. During the first quarter of 2005,
management is enhancing the effectiveness of internal controls by requiring
additional documentation for each wholesale derivative transaction
accounted for on an accrual basis. Management is also enhancing the
design of internal controls, as follows. Accounting management will review
and approve the accounting for all material transactions requiring
accounting judgments. Accounting reporting relationships will be
enhanced by having business unit controllers report to the corporate
controller for accounting and financial reporting matters.
These control enhancements are being implemented in the first quarter
of 2005. As a result, material misstatements in account balances
and related disclosures associated with this material weakness are
not expected in the future. However, until these controls or control
enhancements are concluded to be operating effectively, management
cannot determine if the material weakness described above will
be eliminated.
This material weakness was discussed with the Audit Committee of
the Board of Trustees and Deloitte & Touche LLP, our independent
registered public accounting firm. Deloitte & Touche LLP has issued
an attestation report on management’s assessment of internal controls
over financial reporting that can be found on the following page.
COMPANY REPORT ON INTERNAL
CONTROLS OVER FINANCIAL REPORTING