Exelon 2014 Annual Report Download - page 70

levels in anticipation of future financings and floating to fixed swaps for project financing. In addition, Generation enters into interest
rate derivative contracts to economically hedge risk associated with the interest rate component of commodity positions. The
characterization of the interest rate derivative contracts between the economic hedge and proprietary trading activity is driven by the
corresponding characterization of the underlying commodity position that gives rise to the interest rate exposure. Generation does
not utilize interest rate derivatives with the objective of benefiting from shifts or change in market interest rates. To manage foreign
exchange rate exposure associated with international energy purchases in currencies other than U.S. dollars, Generation utilizes
foreign currency derivatives, which are typically designated as economic hedges. The fair value of the agreements is calculated by
discounting the future net cash flows to the present value based on the terms and conditions of the agreements and the forward
interest rate and foreign exchange curves. As these inputs are based on observable data and valuations of similar instruments, the
interest rate and foreign exchange derivatives are primarily categorized in Level 2 in the fair value hierarchy. Certain exchange
based interest rate derivatives that are valued using unadjusted quoted prices in active markets are categorized in Level 1 in the fair
value hierarchy.
See QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK and Note 11—Fair Value of Financial Assets and
Liabilities and Note 12—Derivative Financial Instruments of the Combined Notes to Consolidated Financial Statements for additional
information regarding the Registrants’ derivative instruments.
Taxation
Significant management judgment is required in determining the Registrants’ provisions for income taxes, primarily due to the
uncertainty related to tax positions taken, as well as deferred tax assets and liabilities and valuation allowances. In accordance with
applicable authoritative guidance, the Registrants account for uncertain income tax positions using a benefit recognition model with a
two-step approach including a more-likely-than-not recognition threshold and a measurement approach based on the largest amount
of tax benefit that is greater than 50% likely of being realized upon ultimate settlement. If it is not more-likely-than-not that the benefit
of the tax position will be sustained on its technical merits, no benefit is recorded. Uncertain tax positions that relate only to timing of
when an item is included on a tax return are considered to have met the recognition threshold. Management evaluates each position
based solely on the technical merits and facts and circumstances of the position, assuming the position will be examined by a taxing
authority having full knowledge of all relevant information. Significant judgment is required to determine whether the recognition
threshold has been met and, if so, the appropriate amount of unrecognized tax benefits to be recorded in the Registrants’
consolidated financial statements.
The Registrants evaluate quarterly the probability of realizing deferred tax assets by reviewing a forecast of future taxable income
and their intent and ability to implement tax planning strategies, if necessary, to realize deferred tax assets. The Registrants also
assess their ability to utilize tax attributes, including those in the form of carryforwards, for which the benefits have already been
reflected in the financial statements. The Registrants record valuation allowances for deferred tax assets when the Registrants
conclude it is more-likely-than-not such benefit will not be realized in future periods.
Actual income taxes could vary from estimated amounts due to the future impacts of various items, including changes in income tax
laws, the Registrants’ forecasted financial condition and results of operations, failure to successfully implement tax planning
strategies, as well as results of audits and examinations of filed tax returns by taxing authorities. While the Registrants believe the
resulting tax balances as of December 31, 2014 and 2013 are appropriately accounted for in accordance with the applicable
authoritative guidance, the ultimate outcome of tax matters could result in favorable or unfavorable adjustments to their consolidated
financial statements and such adjustments could be material. See Note 14—Income Taxes of the Combined Notes to Consolidated
Financial Statements for additional information regarding taxes.
Accounting for Loss Contingencies
In the preparation of their financial statements, the Registrants make judgments regarding the future outcome of contingent events
and record liabilities for loss contingencies that are probable and can be reasonably estimated based upon available information.
The amounts recorded may differ from the actual expense incurred when the uncertainty is resolved. The estimates that the
Registrants make in accounting for loss contingencies and the actual results that they record upon the ultimate resolution of these
uncertainties could have a significant effect on their consolidated financial statements.
Environmental Costs. Environmental investigation and remediation liabilities are based upon estimates with respect to the number
of sites for which the Registrants will be responsible, the scope and cost of work to be performed at each site, the portion of costs
that will be shared with other parties, the timing of the remediation work, changes in technology, regulations and the requirements of
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