Dominion Power 2002 Annual Report Download - page 37

impairments could occur in the future. See Notes 2 and 33 to
the Consolidated Financial Statements.
Use of Estimates in Impairment Testing
Dominion is required to test at least annually its goodwill for
potential impairment. As part of that test, Dominion is required
to determine the fair value of its reporting units. Dominion pro-
duces this estimate by using discounted cash flow analyses and
other valuation techniques based on multiples of earnings for
peer group companies, as well as analyses of recent business
combinations involving peer group companies. These calcula-
tions are dependent on many subjective factors, including the
selection of appropriate discount and growth rates, the selection
of peer group companies and recent transactions and manage-
ment’s estimate of future cash flows. The cash flow estimates
used by Dominion are based on the best information available at
the time the estimates are made. However, estimates of future
cash flows are highly uncertain by nature and may vary signifi-
cantly from actual results.
Dominion performed the transitional impairment test
upon adoption of Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and Other Intangible Assets, as of
January 1, 2002 and its annual test later in the year. The fair
value of each of Dominion’s reporting units exceeded the related
carrying amounts, resulting in no impairment. The underlying
assumptions and estimates involved in preparing these fair value
calculations could change significantly from period to period. If
Dominion’s estimates of the fair value of its reporting units are
substantially reduced, impairment may be indicated and
Dominion would be required to perform the second step of the
goodwill impairment test. That step measures the amount of
impairment, if any, and requires the further use of fair value
estimates. A goodwill impairment charge would result in a
charge to earnings, with a corresponding reduction of the
carrying amount of goodwill on the balance sheet. Dominion
had $4.3 billion and $4.2 billion of goodwill at December
31, 2002 and 2001, respectively. See Notes 2 and 18 to the
Consolidated Financial Statements for further discussion of
goodwill impairment tests.
Impairment testing for long-lived assets and intangible
assets with definite lives is required when circumstances indicate
that such assets may be impaired. In performing the impair-
ment test, Dominion would estimate the future cash flows asso-
ciated with individual assets or groups of assets. Impairment
results when the undiscounted estimated future cash flows are
less than the related asset’s carrying amount. If impaired, the
asset must be written down to its fair value, which is generally
calculated using the present value of its expected future net cash
flows, using an appropriate discount rate. Although cash flow
estimates used by Dominion are based on the best information
available at the time the estimates are made, estimates of future
cash flows are by nature highly uncertain and may vary signifi-
cantly from actual results.
Accounting for Retained Interests from Securitizations
Securitizations involve selling loans to qualifying unconsoli-
dated trusts in exchange for cash and retained interests.
Retained interests may include unsecured debt of the trust or
retained interests in the transferred loans. Dominion holds
retained interests from mortgage and commercial loans securi-
tized in prior years and classifies them as available-for-sale
investments, carried on the Consolidated Balance Sheets at fair
value. Quarterly, Dominion evaluates the key assumptions relat-
ing to valuing the retained interests. Those key assumptions
include loan prepayment speeds, credit losses, forward yield
curves and discount rates. Using a published forward yield
curve, cash flows, net of adjustments for expected credit losses
and loan prepayments, are discounted to determine the esti-
mated fair value of the retained interests. Loan prepayments
speeds and credit loss assumptions are based on actual historical
results and future estimates. The discount rate is risk adjusted
and is periodically compared to industry averages and recent or
similar transactions for reasonableness. Changes in interest rates
will result in a change in the forward yield curve and can result
in a change in the assumed amount of loan prepayments.
Changes in general economic conditions may impact actual
credit losses, thus impacting the credit loss assumption used in
Dominion’s quarterly evaluation. Income from the residual
interests is reported as other revenue. As discussed in Note 9 to
the Consolidated Financial Statements, during 2002, 2001 and
2000, Dominion made changes to these key assumptions,
resulting in impairment charges for those years. See also Notes
2 and 13 to the Consolidated Financial Statements for addi-
tional discussion of securitizations and retained interests and a
sensitivity analysis of key assumptions.
Accounting for Regulated Operations
Methods of allocating costs to accounting periods for operations
subject to federal or state cost-of-service rate regulation may dif-
fer from accounting methods generally applied by nonregulated
companies. When the timing of cost recovery prescribed by reg-
ulatory authorities differs from the timing of expense recogni-
tion used for accounting purposes, Dominion’s Consolidated
Financial Statements may recognize a regulatory asset for expen-
ditures that otherwise would be expensed. Regulatory assets
represent probable future revenue associated with certain costs
that will be recovered from customers through rates. Regulatory
liabilities represent probable future reductions in revenue associ-
ated with expected customer credits through rates. Management
makes assumptions regarding the probability of regulatory asset
recovery through future rates approved by applicable regulatory
authorities. The expectations of future recovery are generally
based upon historical experience, as well as discussions with
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Dominion ’02 Annual Report