Dominion Power 2005 Annual Report Download - page 31

Dominion 2005 29
Fair value is based on actively quoted market prices, if available.
In the absence of actively quoted market prices, we seek indicative
price information from external sources, including broker quotes
and industry publications. If pricing information from external
sources is not available, we must estimate prices based on avail-
able historical and near-term future price information and use of
statistical methods. For options and contracts with option-like char-
acteristics where pricing information is not available from external
sources, we generally use a modified Black-Scholes Model that
considers time value, the volatility of the underlying commodities
and other relevant assumptions. We use other option models under
special circumstances, including a Spread Approximation Model,
when contracts include different commodities or commodity loca-
tions and a Swing Option Model, when contracts allow either the
buyer or seller the ability to exercise within a range of quantities.
For contracts with unique characteristics, we estimate fair value
using a discounted cash flow approach deemed appropriate in the
circumstances and applied consistently from period to period. If
pricing information is not available from external sources, judgment
is required to develop the estimates of fair value. For individual con-
tracts, the use of different valuation models or assumptions could
have a material effect on the contract’s estimated fair value.
For cash flow hedges of forecasted transactions, we must esti-
mate the future cash flows of the forecasted transactions, as well
as evaluate the probability of occurrence and timing of such trans-
actions. Changes in conditions or the occurrence of unforeseen
events could require discontinuance of hedge accounting or could
affect the timing of the reclassification of gains and/or losses on
cash flow hedges from accumulated other comprehensive income
(loss)(AOCI) into earnings.
Use of estimates in goodwill impairment testing
As of December 31, 2005, we reported $4.3 billion of goodwill on our
Consolidated Balance Sheet, a significant portion of which resulted
from the acquisition of Consolidated Natural Gas Company (CNG) in
2000. Substantially all of this goodwill is allocated to our Generation,
Transmission, Delivery and Exploration & Production reporting units.
In April of each year, we test our goodwill for potential impairment,
and perform additional tests more frequently if impairment indicators
are present. The 2005 and 2004 annual tests did not result in the
recognition of any goodwill impairment, as the estimated fair values
of our reporting units exceeded their respective carrying amounts. In
2003, impairment charges of $78 million were recognized as a result
of interim tests conducted for certain DCI subsidiaries and our
discontinued telecommunications business.
We estimate the fair value of our reporting units by using a com-
bination of discounted cash flow analyses, based on our internal
five-year strategic plan, and other valuation techniques that use
multiples of earnings for peer group companies and analyses of
recent business combinations involving peer group companies.
These calculations are dependent on subjective factors such as our
estimate of future cash flows, the selection of appropriate discount
and growth rates, and the selection of peer group companies and
recent transactions. These underlying assumptions and estimates
are made as of a point in time; subsequent modifications, particu-
larly changes in discount rates or growth rates inherent in our esti-
mates of future cash flows, could result in a future impairment of
goodwill. Although we have consistently applied the same methods
in developing the assumptions and estimates that underlie the fair
value calculations, such as estimates of future cash flows, and
based those estimates on relevant information available at the
time, such cash flow estimates are highly uncertain by nature and
may vary significantly from actual results. If the estimates of future
cash flows used in the 2005 annual test had been 10% lower, the
resulting fair values would have still been greater than the carrying
values of each of those reporting units, indicating no impairment
was present.
Use of estimates in long-lived asset impairment testing
Impairment testing for an individual or group of long-lived assets or
intangible assets with definite lives is required when circumstances
indicate those assets may be impaired. When an asset’s carrying
amount exceeds the undiscounted estimated future cash flows
associated with the asset, the asset is considered impaired to the
extent that the asset’s fair value is less than its carrying amount.
Performing an impairment test on long-lived assets involves our
judgment in areas such as identifying circumstances indicating an
impairment may exist, identifying and grouping affected assets and
developing the undiscounted and discounted estimated future cash
flows (used to estimate fair value in the absence of market-based
value) associated with the asset, including the selection of an
appropriate discount rate. Although our cash flow estimates are
based on relevant information available at the time the estimates
are made, estimates of future cash flows are, by nature, highly
uncertain and may vary significantly from actual results. For exam-
ple, estimates of future cash flows would contemplate factors such
as the expected use of the asset, including future production and
sales levels, and expected fluctuations of prices of commodities
sold and consumed.
In 2005, we tested a group of gas and steam turbines held for
future development with a carrying amount of $187 million for
impairment. The results of our analysis indicated that these assets
were not impaired. In 2004, we did not test any significant long-
lived assets or asset groups for impairment as no circumstances
arose that indicated an impairment may exist. In 2003, reflecting a
significant revision in long-term expectations for potential growth in
telecommunications service revenue, we approved a strategy to
sell our interest in the telecommunications business. In connection
with this change in strategy, we tested the network assets to be
sold for impairment, using the revised long-term expectations for
potential growth. Our assets were determined to be substantially
impaired and were written down to fair value. We sold our telecom-
munications business in 2004.
Asset retirement obligations
We recognize liabilities for the expected cost of retiring tangible
long-lived assets for which a legal obligation exists. These asset
retirement obligations (AROs) are recognized at fair value as
incurred, and are capitalized as part of the cost of the related tangi-
ble long-lived assets. In the absence of quoted market prices, we
estimate the fair value of our AROs using present value techniques,
in which we make various assumptions including estimates of the
amounts and timing of future cash flows associated with retirement
Accounting for derivative contracts at fair value
We use derivative contracts such as futures, swaps, forwards,
options and financial transmission rights to buy and sell energy
-
related commodities and to manage our commodity and financial
markets risks. Derivative contracts, with certain exceptions, are
subject to fair value accounting and are reported on our Consoli-
dated Balance Sheets at fair value. Accounting requirements for
derivatives and related hedging activities are complex and may be
subject to further clarification by standard-setting bodies.