Eversource 2006 Annual Report Download - page 62

60 NU 2006 ANNUAL REPORT
revenues were recognized as services were provided, often on a
percentage of completion basis.
For further information regarding the recognition of revenue, see
Note 1E, “Summary of Significant Accounting Policies – Derivative
Accounting,” to the consolidated financial statements.
E. Derivative Accounting
The accounting treatment for energy contracts entered into varies and
depends on the intended use of the particular contract and on whether
or not the contract is a derivative. Non-derivative contracts are recorded
at the time of delivery or settlement. Most of the contracts that comprise
or comprised Select Energy’s wholesale marketing and competitive
generation activities are derivatives, and certain Utility Group contracts
for the purchase or sale of energy or energy-related products are
derivatives. Certain retail marketing contracts with retail customers
were not derivatives, while virtually all contracts entered into to supply
these customers were derivatives. Those retail contracts were sold to
Hess Corporation (Hess) on June 1, 2006. The application of derivative
accounting under SFAS No. 133, as amended, is complex and requires
management judgment in the following respects: election and
designation of the normal purchases and sales exception, identification
of derivatives and embedded derivatives, identifying hedge relationships,
assessing and measuring hedge ineffectiveness, and determining the
fair value of derivatives. All of these judgments, depending upon
their timing and effect, can have a significant impact on NU’s
consolidated earnings.
The fair value of derivatives is based upon the notional amount of
acontract and the underlying market price or fair value per unit.
When quantities arenot specified in the contract, the company
determines whether there is a notional amount using amounts
referenced in default provisions and other relevant sections of the
contract. The notional amount is updated during the term of the
contract, and such updates can have a material impact on mark-to-
market amounts.
The judgment applied in the election of the normal purchases and
sales exception (and resulting accrual accounting) includes the
conclusions that it is probableat the inception of the contract and
throughout its term that it will result in physical delivery and that the
quantities will be used or sold by the business over a reasonable
period in the normal course of business. If facts and circumstances
change and management can no longer support this conclusion,
then the normal exception and accrual accounting is terminated
and fair value accounting is applied.
Contracts that arehedging an underlying transaction and that qualify
as derivatives that hedge exposure to the variable cash flows of a
forecasted transaction (cash flow hedges) are recorded on the
consolidated balancesheets at fair value with changes in fair value
generally reflected in accumulated other comprehensive income.
Cash flowhedges impact earnings when the forecasted transaction
being hedged occurs, when hedge ineffectivenessis measured and
recorded, when the forecasted transaction being hedged is no longer
probableof occurring, or when there is an accumulated other
comprehensive lossand when the hedge and the forecasted
transaction being hedged are in a loss position on a combined basis.
The settlements of cash flow hedges are recorded in the same income
statement line item as the forecasted transaction, typically fuel,
purchased and net interchange power. Derivatives were accounted
for as cash flow hedges only if they were designated as hedges for
derivative contracts for which the company had elected the normal
purchases and sales exception. If the normal exception was terminated,
then the hedge designation was terminated at the same time. All
cash flow hedges expired or were transferred to Hess in 2006.
From April 1, 2005 through the June 1, 2006 sale of the business,
Select Energy reported the settlement of derivative and non-derivative
retail sales that physically delivered in revenues and the associated
derivative and non-derivative contracts to supply these contracts in
fuel, purchased and net interchange power. Select Energy reported
the settlement of all derivative wholesale contracts, including any
remaining full requirements sales contracts in fuel, purchased and net
interchange power as a result of applying mark-to-market accounting
to those contracts. Certain competitive generation related derivative
contracts that were marked-to-market beginning in the fourth quarter
of 2005 continued to be recorded in revenues until the contracts were
sold or realized.
Prior toApril 1, 2005, Select Energy reported the settlement of long-
term derivative contracts, including full requirements sales contracts
that physicallydelivered and werenot held for trading purposes on
agrossbasis, generally with sales in revenues and purchases in
expenses. Retail sales contracts were physically delivered and recorded
in revenues. Short-term sales and purchases represented power and
natural gas that was purchased toserve full requirements contracts
but was ultimately not needed based on the actual load of the customers.
This excesspower and natural gas was sold to the independent system
operator or to other counterparties. Prior to the March 9, 2005 decision
to exit the wholesale marketing business, for the three months ended
March 31, 2005 and for the year ended December 31, 2004, settlements
of these short-term derivative contracts that were not held for trading
purposes were reported on a net basis in fuel, purchased and net
interchange power.
For further information regarding these contracts and their
accounting, see Note 5, “Derivative Instruments,” to the consolidated
financial statements.
F.Utility Group Regulatory Accounting
The accounting policies of the Utility Group conform toaccounting
principles generally accepted in the United States of America applicable
to rate-regulated enterprises and historically reflect the effects of the
rate-making processin 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’sgeneration business and Yankee Gas’
distribution business, continue tobe cost-of-service rate regulated.
Management believes that the application of SFAS No. 71 to those
businesses continues to be appropriate. Management also believes it is
probablethat NU’sUtility Group companies will recover their investments
in long-lived assets, including regulatory assets. All material net
regulatory assets are earning an equity return, except for securitized
regulatory assets, which arenot supported by equity.Amortization and
deferrals of regulatory assets are included on a net basis in amortization
expense on the accompanying consolidated statements of income/(loss).