Dominion Power 2004 Annual Report Download - page 67

Dominion is hedging the variability of cash flows, changes in the fair value
of the derivative are reported in accumulated other comprehensive income
(loss)(AOCI), to the extent effective in offsetting changes in the hedging
relationship, until earnings are affected by the hedged item. For cash flow
hedge transactions that involve a forecasted transaction, Dominion would
discontinue hedge accounting if the occurrence of the forecasted transac-
tion was determined to be no longer probable. Dominion would reclassify
any derivative gains or losses reported in AOCI to earnings when the fore-
casted item is included in earnings, if it should occur, or earlier, if it
becomes probable that the forecasted transaction would not occur.
Fair Value Hedges — Dominion also engages in fair value hedges by
using derivative instruments to mitigate the fixed price exposure inherent
in firm commodity commitments and certain natural gas inventory. In addi-
tion, Dominion has designated interest rate swaps as fair value hedges to
manage its interest rate exposure on certain fixed rate long-term debt. For
fair value hedge transactions, changes in the fair value of the derivative
will generally be offset currently in earnings by the recognition of changes
in the hedged item’s fair value.
Statement of Income Presentation — Gains and losses on derivatives
designated as hedges, when recognized, are included in operating revenue,
operating expenses or interest and related charges in the Consolidated
Statements of Income. Specific line item classification is determined based
on the nature of the risk underlying individual hedge strategies. The portion
of gains or losses on hedging instruments determined to be ineffective and
the portion of gains or losses on hedging instruments excluded from the
measurement of the hedging relationship’s effectiveness, such as gains or
losses attributable to changes in the time value of options or changes in
the difference between spot prices and forward prices, are included in
other operations and maintenance expense.
Derivative Instruments Held for Trading and Other Purposes
As part of its strategy to market energy and to manage related risks,
Dominion manages a portfolio of commodity-based derivative instruments
held for trading purposes, primarily natural gas and electricity. Dominion
uses established policies and procedures to manage the risks associated
with the price fluctuations in these energy commodities and uses various
derivative instruments to reduce risk by creating offsetting market positions.
Dominion may also hold certain derivative instruments that are not held
for trading purposes and are not designated as hedges for accounting pur-
poses. However, to the extent Dominion does not hold offsetting positions
for such derivatives, management believes these instruments would repre-
sent economic hedges that mitigate exposure to fluctuations in commodity
prices, interest rates and foreign exchange rates.
Statement of Income Presentation:
•Derivatives Held for Trading Purposes: All changes in fair value, includ-
ing amounts realized upon settlement, are presented in revenue on a
net basis as nonregulated electric sales, nonregulated gas sales and
other revenue.
•Financially-Settled Derivatives
— Not Held for Trading Purposes or Des-
ignated as Hedging Instruments:
All unrealized changes in fair value
and settlements are presented in other operations and maintenance
expense on a net basis.
•Physically-Settled Derivatives — Not Held for Trading Purposes or Des-
ignated as Hedging Instruments:
Effective October 1, 2003, all state-
ment of income related amounts for physically settled derivative sales
contracts are presented in revenue, while all statement of income
related amounts for physically settled derivative purchase contracts are
reported in expenses. For periods prior to October 1, 2003, unrealized
changes in fair value for physically settled derivative contracts are pre-
sented in other operations and maintenance expense on a net basis.
Effective January 1, 2003, Dominion recognizes revenue or expense
from all non-derivative energy-related contracts on a gross basis at the
time of contract performance, settlement or termination. Prior to 2003, all
energy trading contracts, including non-derivative contracts, were recorded
at fair value with changes in fair value reported in revenue on a net basis.
Investment Securities
Dominion accounts for and classifies investments in marketable equity and
debt securities in two categories. Debt and equity securities purchased and
held with the intent of selling them in the near term are classified as trad-
ing securities. Trading securities are reported at fair value with net realized
and unrealized gains and losses included in earnings. All other debt and
equity securities are classified as available-for-sale securities. These are
reported at fair value with realized gains and losses and any other-than-
temporary declines in fair value included in earnings and unrealized gains
and losses reported as a component of AOCI, net of tax.
Dominion analyzes all securities classified as available-for-sale to deter-
mine whether a decline in fair value should be considered other-than-tem-
porary. Retained interests from securitizations of financial assets are
evaluated in accordance with EITF Issue No. 99-20,
Recognition of Interest
Income and Impairments of Purchased and Retained Beneficial Interests in
Securitized Financial Assets
. For other securities, Dominion uses several cri-
teria to evaluate other-than-temporary declines, including length of time
over which the market value has been lower than its cost, the percentage of
the decline as compared to its average cost and the expected fair value of
the security. If the market value of the security has been less than cost for
greater than nine months and the decline in value is greater than 50% of its
average cost, the security is written down to its expected recovery value. If
only one of the above criteria is met, a further analysis is performed to eval-
uate the expected recovery value based on third party price targets. If the
third party price quotes are below the security’s average cost and one of the
other criteria has been met, the decline is considered other-than-temporary
and the security is written down to its expected recovery value.
Property, Plant and Equipment
Property, plant and equipment, including additions and replacements, is
recorded at original cost, including labor, materials, asset retirement costs,
other direct costs and capitalized interest. The cost of repairs and mainte-
nance, including minor additions and replacements, is charged to expense
as incurred. In 2004, 2003 and 2002, Dominion capitalized interest costs of
$70 million, $96 million and $95 million, respectively.
For electric distribution and transmission property and natural gas prop-
erty subject to cost-of-service utility rate regulation, the depreciable cost
of such property, less salvage value, is charged to accumulated deprecia-
tion at retirement. Cost of removal collections from utility customers and
expenditures not representing asset retirement obligations (AROs) are
recorded as regulatory liabilities or regulatory assets.
For generation-related property, cost of removal not associated with
AROs is charged to expense as incurred. Dominion records gains and
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