Eversource 2005 Annual Report Download - page 59

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For further information regarding the recognition of revenue, see Note
1F “Derivative Accounting” to the consolidated financial statements.
F. Derivative Accounting
SFAS Nos. 133 and 149: In April of 2003, the FASB issued SFAS No. 149,
“Amendment of Statement 133 on Derivative Instruments and Hedging
Activities,” which amended SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities.” SFAS No. 149 incorporated
interpretations that were included in previous Derivative
Implementation Group guidance, clarified certain conditions, and
amended other existing pronouncements. It was effective for
contracts entered into or modified after June 30, 2003. Management
determined that the adoption of SFAS No. 149 did not change NU’s
accounting for wholesale and retail marketing contracts, or the ability
of NU Enterprises to elect the normal purchases and sales exception.
Certain Utility Group derivative contracts are recorded at fair value as
derivative assets and liabilities with offsetting amounts recorded as
regulatory liabilities and assets because the contracts are part of
providing regulated electric or gas service and because management
believes that these amounts will be recovered or refunded in rates.
EITF Issue No. 03-11: In 2003, the FASB ratified the consensus reached
by its Emerging Issues Task Force (EITF) in EITF Issue No. 03-11,
“Reporting Realized Gains and Losses on Derivative Instruments That
Are Subject to FASB Statement No. 133 and Not ‘Held for Trading
Purposes’ as Defined in Issue No. 02-3.” The consensus stated that
determining whether realized gains and losses on contracts that
physically deliver and are not held for trading purposes should be
reported on a net or gross basis was a matter of judgment that
depended on the relevant facts and circumstances. NU Enterprises
and the Utility Group have derivative sales contracts, and though these
contracts may result in physical delivery, management has determined,
based on the relevant facts and circumstances, that because these
transactions are part of the respective companies’ procurement activities,
inclusion in operating expenses better depicts these sales activities.
For the years ended December 31, 2005, 2004 and 2003, the settlement
of these derivative contracts that arenot held for trading purposes are
reported on a net basis in operating expenses.
For the period April 1, 2005 to December 31, 2005, Select Energy
reported the settlement of derivative and non-derivative retail sales
and certain other derivative contracts that physically deliver in revenues
and the associated derivative and non-derivative contracts to supply
these contracts in fuel, purchased and net interchange power.In addition,
Select Energy reported the settlement of all derivative wholesale
contracts, including full requirements sales contracts in fuel, purchased
and net interchange power as a result of applying mark-to-market
accounting to those contracts. Certain competitive generation related
derivative contracts that aremarked-to-market beginning in the fourth
quarter of 2005 continue to be recorded in revenues.
Prior to April 1, 2005, Select Energy reported the settlement of long-
term derivative contracts, including full requirements sales contracts
were physically delivered and were not held for trading purposes on a
gross basis, generally with sales in revenues and purchases in expenses.
Retail sales contracts were physically delivered and recorded in revenues.
Short-term sales and purchases represented power and natural gas that
was purchased to serve full requirements contracts but was ultimately
not needed based on the actual load of the customers. This excess
power and natural gas was sold to the independent system operator
or to other counterparties. For the three months ended March 31,
2005 and for the years ended December 31, 2004 and 2003,
settlements of these short-term derivative contracts that were not
held for trading purposes, were reported on a net basis in fuel,
purchased and net interchange power.
Accounting for Energy Contracts: The accounting treatment for energy
contracts entered into varies and depends on the intended use of the
particular contract and on whether or not the contract is a derivative.
Non-derivative contracts such as certain retail sales contracts are
recorded at the time of delivery or settlement. Most of the contracts
comprising Select Energy’s wholesale marketing and competitive
generation activities are derivatives, and certain Utility Group contracts
for the purchase or sale of energy or energy-related products are
derivatives. Certain retail marketing contracts with retail customers are
not derivatives, while virtually all contracts entered into to supply these
customers are derivatives. The application of derivative accounting under
SFAS No. 133, as amended, is complex and requires management
judgment in the following respects: election and designation of the
normal purchases and sales exception, identification of derivatives and
embedded derivatives, identifying hedge relationships, assessing and
measuring hedge ineffectiveness, and determining the fair value of
derivatives. All of these judgments, depending upon their timing and
effect, can have a significant impact on NU’s consolidated net income.
The fair value of derivatives is based upon the notional amount of a
contract and the underlying market price or fair value per unit. When
quantities are not specified in the contract, the company estimates
notional amounts using amounts referenced in default provisions and
other relevant sections of the contract. The notional amount is updated
during the term of the contract, and updates can have a material
impact on mark-to-market amounts.
The judgment applied in the election of the normal purchases and sales
exception (and resulting accrual accounting) includes the conclusions
that it is probable at the inception of the contract and throughout its
termthat it will result in physical deliveryand that the quantities will
be used or sold by the business over a reasonable period in the normal
course of business. If facts and circumstances change and management
can no longer supportthis conclusion, then the normal exception and
accrual accounting is terminated and fair value accounting is applied.
Cash flow hedge contracts that are designated as hedges for contracts
for which the company has elected the normal purchases and sales
exception can continue to be accounted for as cash flow hedges only if
the normal exception for the hedged contract continues to be appropriate.
If the normal exception is terminated, then the hedge designation
would be terminated at the same time.
Derivative contracts that are entered into for trading purposes are
recorded on the consolidated balance sheets at fair value, and changes
in fair value are recorded in earnings. Revenues and expenses for
these contracts are recorded on a net basis in revenues.
Contracts that are hedging an underlying transaction and that qualify as
derivatives that hedge exposure to the variable cash flows of a forecasted
transaction (cash flow hedges) are recorded on the consolidated
balance sheets at fair value with changes in fair value generally reflected
in accumulated other comprehensive income. Cash flow hedges impact
earnings when the forecasted transaction being hedged occurs, when