Dominion Power 2006 Annual Report Download - page 70

basis. Any change in the fair value of the derivative that is not
effective at offsetting changes in the cash flows or fair values of the
hedged item is recognized currently in earnings. Also, we may
elect toexclude certain gainsorlosses on hedginginstruments
from the measurement of hedge effectiveness, such as gainsor
losses attributable to changes in the time value of options or
changes in the difference between spot prices and forward prices,
thus requiring that such changes be recorded currently in earn-
ings. We discontinue hedgeaccounting prospectively for
derivatives that cease to be highly effective hedges.
Cash Flow Hedges—Asignificant portion of our hedge strat-
egies represents cash flow hedges of the variable price risk asso-
ciated with the purchase and sale of electricity, natural gas, oil and
other energy-related products.Wealso use foreign currency for-
ward contracts to hedge the variabilityin foreign exchange rates
and interest rate swaps to hedge our exposureto variable interest
rates on long-term debt.For transactions in which we are hedging
the variabilityof cash flows, changes in the fair value of the
derivative are reported in accumulated other comprehensive
income (loss) (AOCI), to the extent effective at offsetting changes
in the hedged item, until earnings are affected by the hedged
item. For cash flow hedge transactions, we discontinue hedge
accounting if the occurrence of the forecasted transaction is
determined to be no longer probable. We reclassify any derivative
gainsorlosses reported in AOCI to earnings when the forecasted
item is included in earnings, if it should occur, or earlier, if it
becomes probablethat the forecasted transaction will not occur.
Fair Value Hedges—We also use fair value hedges to mitigate
the fixedprice exposure inherent in certain firm commodity
commitments and natural gas inventory. In addition, we have
designated interest rate swaps as fair value hedges to manage our
interest rate exposure on certain fixed rate long-term debt. For fair
value hedgetransactions, changes in the fair value of the
derivative are generally offset currently in earnings by the recog-
nition 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
operatingrevenue, operatingexpenses or interest and related
charges in our Consolidated Statements of Income. Specific line
item classification is determined based on the nature of the risk
underlying individual hedge strategies. The portionofgainsor
losses on hedginginstruments determined to be ineffective and
the portionof gainsor losses on hedginginstruments excluded
from the measurement of the hedging relationship’s effectiveness,
such as gainsorlosses attributable to changes in the time value of
options or changes in the difference between spot prices and
forward prices, are includedin other operations and maintenance
expense.
VALUATION METHODS
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 pricesbased on available
historicaland near-term future price information and certain stat-
istical methods, including regression analysis.
For options and contracts withoption-like characteristics where
pricing information is not available from external sources, we gen-
erally use amodified Black-Scholes Model that considers timevalue,
the volatility oftheunderlying commodities and other relevant
assumptions when estimating fairvalue. We use otheroption models
under specialcircumstances, including aSpread Approximation
Model, when contracts include different commodities or commodity
locations andaSwing Option Model, when contracts allow either
the buyer or seller the abilityto exercise within arange ofquantities.
For contracts with unique characteristics, we estimate fair value
using adiscounted cash flow approach deemed appropriate inthe
circumstances and applied consistently from period toperiod. If
pricinginformation is not available from external sources, judgment
is required to developtheestimates of fair value. For individual con-
tracts, the use ofdifferent valuation modelsorassumptions could
have amaterial effect on thecontract’s estimated fair value.
Investment Securities
We account forand classify investments in marketable equity and
debt securities in twocategories. Debt and equity securities pur-
chased and held with the intent of selling them in the near-term
are classifiedastrading securities. Trading securities are reported
at fair value with net realized and unrealized gainsand losses
included in earnings. All other debt and equity securities, includ-
ing all investments held by our nuclear decommissioning trusts,
are classifiedasavailable-for-sale securities. Available-for-sale
securities are reported at fair value with realized gainsand losses
and any other-than-temporary declines in fair value includedin
other income and unrealized gainsand losses reported as a
component of AOCI, net of tax.
We analyze all securities classified as available-for-sale to
determine whether adeclinein fair value should be considered
other thantemporary. We use several criteria to evaluate other-
than-temporary declines, including the length of time overwhich
the marketvalue has been lower than its cost, the percentageof
the decline as compared to its costandtheexpected fair value of
the security. In addition, retained interests from securitizations of
financial assetsare first evaluated in accordance with Emerging
Issues Task Force (EITF) Issue No. 99-20, Recognition of Interest
Income and Impairments of Purchased and Retained Beneficial
Interests inSecuritized Financial Assets.Ifadecline in fair value of
any security is determined to be other thantemporary, the secu-
rity is written down to its fair value at the end of the reporting
period.
In 2006, we changedourmethod of assessingother-than-
temporary declines such that the ability to hold individual secu-
ritiesfor aperiod of time sufficient toallowfor the anticipated
recovery in their market value must be demonstrated prior to the
consideration of the other criteria mentioned above. Since regu-
latory authorities limit our ability to oversee the day-to-day
management of our nucleardecommissioning trust fund invest-
ments, we do nothave the ability to hold individual securities in
the trusts. Accordingly, we consider all securities held by our
nuclear decommissioning trusts with market values below their
cost bases to be other-than-temporarily impaired.
Property, Plant and Equipment
Property, plant andequipment, including additions and replace-
ments, is recorded at original cost, including labor, materials,
asset retirement costsandother direct and indirect costsincluding
capitalized interest. The cost of repairsand maintenance, includ-
ing minor additions and replacements, is charged to expense as it
is incurred. In 2006, 2005 and 2004, we capitalized interest costs
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