Dominion Power 2006 Annual Report Download - page 69

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
option awards that were fullyvested at December 31, 2005. Such
amounts are reported as afinancing cash flow.
Restricted stock awards granted prior to January 1, 2006 con-
tain terms that accelerate vesting upon retirement. Our previous
practice was to recognizecompensation cost for these awards over
the statedvesting term unless vesting was actually accelerated by
retirement. Following our adoption of SFASNo. 123R, we con-
tinue to recognize compensation cost over the statedvesting term
forexisting restricted stock awards,but we are now required to
recognize compensation cost over the shorterof:(1)thestated
vesting term or (2) the period from the date of grant to the date
of retirement eligibility fornewly issued or modified restricted
stock awards with similar terms. In the year ended December 31,
2006, we recognized approximately $5 million of compensation
cost related to awards previously granted to retirement eligible
employees. At December 31, 2006, unrecognized compensation
cost forrestricted stock awards held by retirement eligible
employees totaled approximately $5 million.
Cash and Cash Equivalents
Current banking arrangements generally do notrequire checks to
be fundeduntil they are presented for payment. At December 31,
2006 and 2005, accounts payable included$125 million and
$150 million, respectively, of checks outstanding but not yet
presented forpayment. For purposes of ourConsolidated State-
ments of Cash Flows, we considercash and cash equivalents to
include cash on hand, cash in banks and temporary investments
purchased with an original maturity of three months or less.
Inventories
Materialsand supplies and fossil fuel inventories are valuedpri-
marily using the weighted-average cost method. Stored gas
inventory used in local gas distribution operationsisvalued using
the last-in-first-out (LIFO) method. Under the LIFOmethod,
thoseinventories were valued at $8 million at December 31, 2006
and $128 million at December 31, 2005. The decrease in
inventory from 2005 to 2006 reflects the sale of gas inventory at
The EastOhio Gas Company and the reclassification of the
inventory of The Peoples Natural GasCompany (Peoples) and
Hope Gas, Inc. (Hope) to assets held forsale. Based on the aver-
age price of gaspurchased during 2006, the cost of replacing the
current portion of stored gas inventory exceeded the amount
stated on aLIFO basis by approximately $211 million. Stored gas
inventory held by certain nonregulated gas operations is valued
using the weighted-average cost method.
Gas Imbalances
Natural gas imbalances occur when the physical amount of natu-
ral gasdelivered from or received by apipelinesystem or storage
facility differs from the contractual amount of natural gas deliv-
ered or received. We value these imbalancesduetoor from ship-
pers and operators at an appropriate index price at period end,
subject totheterms of our tariff forregulated entities. Imbalances
are primarily settled in-kind.Imbalances due to us from other
partiesare reported in other current assetsandimbalances that we
owe to other parties are reported in other current liabilities in our
Consolidated Balance Sheets.
Derivative Instruments
We use derivative instruments such as futures,swaps, forwards,
options andfinancial transmissionrights to manage the commod-
ity, currency exchange and financial market risks of our business
operations.
SFAS No. 133, Accounting forDerivative Instruments and
Hedging Activities,requires all derivatives, except thosefor which
an exception applies, to be reported in our Consolidated Balance
Sheets at fair value. Derivative contracts representing unrealized
gain positionsandpurchased options are reported as derivative
assets. Derivative contracts representing unrealized losses and
options sold are reported as derivative liabilities.One of the
exceptions to fair value accounting—normal purchases and nor-
malsales—may be elected when the contract satisfies certain cri-
teria, including arequirement that physical delivery of the
underlying commodity is probable. Expenses and revenuesresult-
ing from deliveries under normalpurchase contracts and normal
sales contracts, respectively, are includedin earnings at the time of
contract performance.
As part of our overall strategy to market energy and manage
related risks, we manage aportfolio of commodity-based
derivative instruments held for trading purposes. We use estab-
lished policies and procedures to manage the risks associated with
price fluctuations in these energy commodities and use various
derivative instruments to reduce risk by creating offsetting market
positions.
We also hold certain derivative instruments that are not held
fortrading purposes and are not designated as hedges for account-
ing purposes. However, to the extent we do not hold offsetting
positions forsuch derivatives, we believe these instruments repre-
sent economic hedges that mitigate our 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,
including amounts realized upon settlement, are presented in
revenue on a net basis as nonregulated electric sales, non-
regulated gas sales and other energy-related commodity sales.
Financially-Settled Derivatives—Not Heldfor Trading Purposes
and Not Designated 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 Heldfor Trading Purposes
and Not Designated as Hedging Instruments:Allunrealized
changes in fair value and settlements forphysical derivative
sales contracts are presented in revenues, while all unrealized
changes in fair value and settlements forphysical derivative
purchasecontracts are presented in expenses.
We recognize revenueor expense from all non-derivative
energy-related contracts on agross basis at the time of contract
performance, settlement or termination.
DERIVATIVE INSTRUMENTS DESIGNATED AS HEDGING
INSTRUMENTS
We designate a substantial portionof our derivative instruments
as either cash flow or fair value hedges for accounting purposes.
For all derivatives designated as hedges, we formally document
the relationship between the hedging instrument and the hedged
item, as well as the risk management objective and the strategy for
using the hedging instrument. We assess whether the hedging
relationship between the derivative and the hedged item is highly
effective at offsetting changes in cash flows or fair values both at
the inception of the hedging relationship and on an ongoing
68 DOMINION2006 Annual Report