Dominion Power 2005 Annual Report Download - page 33

Dominion 2005 31
assets and liabilities that nonregulated companies would not report
under accounting principles generally accepted in the United States
of America. When it is probable that regulators will permit the
recovery of current costs through future rates charged to cus-
tomers, we defer these costs as regulatory assets that otherwise
would be expensed by nonregulated companies. Likewise, we rec-
ognize regulatory liabilities when it is probable that regulators will
require customer refunds through future rates and when revenue is
collected from customers for expenditures that are not yet incurred.
Regulatory assets are amortized into expense and regulatory liabili-
ties are amortized into income over the recovery period authorized
by the regulator.
We evaluate whether or not recovery of our regulatory assets
through future regulated rates is probable and make various
assumptions in our analyses. The expectations of future recovery
are generally based on orders issued by regulatory commissions or
historical experience, as well as discussions with applicable regula-
tory authorities. If recovery of regulatory assets is determined to be
less than probable, the regulatory asset will be written off and an
expense will be recorded in the period such assessment is made.
We currently believe the recovery of our regulatory assets is proba-
ble. See Notes 2 and 14 to our Consolidated Financial Statements.
Accounting for gas and oil operations
We follow the full cost method of accounting for gas and oil explo-
ration and production activities prescribed by the Securities and
Exchange Commission (SEC). Under the full cost method, all direct
costs of property acquisition, exploration and development activi-
ties are capitalized and subsequently depreciated using the units-
of-production method. The depreciable base of costs includes
estimated future costs to be incurred in developing proved gas and
oil reserves, as well as capitalized asset retirement costs, net of
projected salvage values. Capitalized costs in the depreciable base
are subject to a ceiling test prescribed by the SEC. The test limits
capitalized amounts to a ceiling
— the present value of estimated
future net revenues to be derived from the production of proved gas
and oil reserves assuming period-end pricing adjusted for cash flow
hedges in place. We perform the ceiling test quarterly, on a coun-
try-by-country basis, and would recognize asset impairments to the
extent that total capitalized costs exceed the ceiling. In addition,
gains or losses on the sale or other disposition of gas and oil prop-
erties are not recognized, unless the gain or loss would significantly
alter the relationship between capitalized costs and proved
reserves of natural gas and oil attributable to a country.
Our estimate of proved reserves requires a large degree of judg-
ment and is dependent on factors such as historical data, engineer-
ing estimates of proved reserve quantities, estimates of the
amount and timing of future expenditures to develop the proved
reserves, and estimates of future production from the proved
reserves. Our estimated proved reserves as of December 31, 2005
are based upon studies for each of our properties prepared by our
staff engineers and reviewed by Ryder Scott Company, L.P. Calcula-
tions were prepared using standard geological and engineering
methods generally accepted by the petroleum industry and in
accordance with SEC guidelines. Given the volatility of natural gas
and oil prices, it is possible that our estimate of discounted future
net cash flows from proved natural gas and oil reserves that is used
to calculate the ceiling could materially change in the near-term.
The process to estimate reserves is imprecise, and estimates
are subject to revision. If there is a significant variance in any of our
estimates or assumptions in the future and revisions to the value of
our proved reserves are necessary, related depletion expense and
the calculation of the ceiling test would be affected and recognition
of natural gas and oil property impairments could occur. See Notes
2 and 29 to our Consolidated Financial Statements.
Income taxes
Judgment and the use of estimates are required in developing the
provision for income taxes and reporting of tax-related assets and
liabilities. The interpretation of tax laws involves uncertainty, since
tax authorities may interpret them differently. We establish liabilities
for tax-related contingencies in accordance with Statement of
Financial Accounting Standards (SFAS) No. 5, Accounting for Con-
tingencies, and review them in light of changing facts and circum-
stances. Ultimate resolution of income tax matters may result in
favorable or unfavorable impacts to net income and cash flows and
adjustments to tax-related assets and liabilities could be material.
In addition, deferred income tax assets and liabilities are provided,
representing future effects on income taxes for temporary differ-
ences between the bases of assets and liabilities for financial
reporting and tax purposes. We evaluate quarterly the probability of
realizing deferred tax assets by reviewing a forecast of future tax-
able income and the availability of tax planning strategies that can
be implemented, if necessary, to realize deferred tax assets. Failure
to achieve forecasted taxable income or successfully implement tax
planning strategies may affect the realization of deferred tax assets.
Other
Accounting standards
During 2005, 2004 and 2003, we were required to adopt several
new accounting standards, the requirements of which are discussed
in Note 3 to our Consolidated Financial Statements. The adoption of
Financial Accounting Standards Board (FASB) Interpretation No. 46
(revised December 2003), Consolidation of Variable Interest Enti-
ties. (FIN 46R) on December 31, 2003 with respect to special pur-
pose entities, affected the comparability of our 2005 and 2004
Consolidated Statements of Income to 2003’s as follows:
•We were required to consolidate certain variable interest lessor
entities through which we had financed and leased several new
power generation projects, as well as our corporate headquar-
ters and aircraft. In 2005 and 2004, our Consolidated State-
ments of Income reflect depreciation expense on the net
property, plant and equipment and interest expense on the debt
associated with these entities, whereas in 2003 the lease pay-
ments to these entities were reflected as rent expense in other
operations and maintenance expense.
•In addition, under FIN 46R, we report as long-term debt our
junior subordinated notes held by five capital trusts, rather than
the trust preferred securities issued by those trusts. As a result,
in 2005 and 2004 we reported interest expense on the junior
subordinated notes rather than preferred distribution expense
on the trust preferred securities.
Clearinghouse
During the fourth quarter of 2004, we performed an evaluation of
our Dominion Clearinghouse (Clearinghouse) trading and marketing
operations, which resulted in a decision to exit certain energy trad-
ing activities and instead focus on the optimization of our assets. In
January 2005 in connection with the reorganization, commodity
derivative contracts held by the Clearinghouse were assessed to
determine if they contribute to the optimization of our assets. As a
result of this review, certain commodity derivative contracts previ-
ously designated as held for trading purposes are now held for non-