Eversource 2008 Annual Report Download - page 39

impairment testing date. Management reviews triggering
events as defined under SFAS No. 142 throughout the year
and has determined that no triggering events occurred in
2008 that would have required interim testing before or
after October1st. Goodwill impairment is deemed to exist if
the net book value of a reporting unit exceeds its estimated
fair value and if the implied fair value of goodwill based on
the estimated fair value of the reporting unit is less than
the carrying amount of the goodwill. If goodwill is deemed
to be impaired, it is written o in the current period to the
extent it is impaired.
We completed our impairment analysis as of October 1,
2008 for the Yankee Gas goodwill balance of $287.6 million
and determined that no impairment exists. In performing
the required impairment evaluation, we estimated the fair
value of the Yankee Gas reporting unit and compared it
to the carrying amount of the reporting unit, including
goodwill. We estimated the fair value of Yankee Gas using
discounted cash flow methodologies and an analysis of
comparable companies or transactions. We review the
outcome of each of the approaches annually and weight
them appropriately to determine the fair value of Yankee
Gas. This analysis requires the input of several critical
assumptions, including future growth rates, cash flow
projections, operating cost escalation rates, rates of return,
a risk-adjusted discount rate, and long-term earnings and
merger multiples of comparable companies.
We determined the discount rate using the capital asset
pricing model methodology. This methodology uses
a weighted average cost of capital in which the ROE is
calculated using risk-free rates, stock premiums and a beta
representing Yankee Gas’ volatility relative to the overall
market. The discount rate fluctuates from year to year as it is
based on external market conditions. In 2008, the discount
rate decreased because the risk-free rate and the beta were
much lower in 2008 than in 2007 due to the current market
conditions and the stability of the natural gas industry in this
market. All of these assumptions are critical to the estimate
and can change from period to period.
Updates to these assumptions in future periods,
particularly changes in discount rates, could result in future
impairments of goodwill. Although our evaluations since
adopting SFAS No. 142 have not resulted in impairment,
the estimated fair value of Yankee Gas is sensitive to
changes in assumptions. For example, if the risk adjusted
discount rate increased from approximately 5.95 percent
to approximately 6.52 percent or the merger multiple of
comparable companies decreased from approximately 10.5
to approximately 9.7 and the weighting of our valuation
methodologies remained the same, then the estimated fair
value of Yankee Gas would be lower than its carrying value.
Income Taxes: Income tax expense is estimated annually
for each of the jurisdictions in which we operate. This
process involves estimating current and deferred income
tax expense or benefit as impacted by earnings and the
impact of temporary dierences resulting from diering
treatment of items, such as timing of the deduction and
expenses, for tax and book accounting purposes, as well
as, any impact of permanent dierences resulting from tax
credits, flow-through items, non-tax deductible expenses,
etc. The temporary dierences and flow-through items
result in deferred tax assets and liabilities that are
included in the consolidated balance sheets. The income
tax estimation process impacts all of our segments. In
accordance with the provisions of Accounting Principles
Board (APB) No. 28, “Interim Financial Reporting,” we
record income tax expense quarterly using an estimated
annualized eective tax rate. Adjustments to these
estimates can significantly aect our consolidated
financial statements.
Part of the annual process in making adjustments to these
estimates, as needed, is a reconciliation of the actual tax
positions and amounts included on our income tax returns
as filed in the fall of each year for the previous tax year to
the estimates or provisions made during the income tax
estimation process described above. In the third quarter of
2008, the impact of these return to provision adjustments
on income tax expense was a benefit of $3.2 million.
A reconciliation of expected tax expense at the statutory
federal income tax rate to actual tax expense recorded is
included in Note 1H, “Summary of Significant Accounting
Policies - Income Taxes,” to the consolidated financial
statements.
Eective on January 1, 2007, we implemented Financial
Accounting Standards Board (FASB) Interpretation No.
(FIN) 48, “Accounting for Uncertainty in Income Taxes
- an Interpretation of FASB Statement No. 109.” FIN 48
applies to all income tax positions previously filed in a tax
return and income tax positions expected to be taken in a
future tax return that have been reflected on our balance
sheets. FIN 48 addresses the methodology to be used
prospectively in recognizing, measuring and classifying the
amounts associated with tax positions that are deemed to
be uncertain, including related interest and penalties.
The determination of whether a tax position meets the
recognition threshold under FIN 48 is based on facts,
circumstances and information available to us. Once a tax
position meets the recognition threshold, the tax benefit
is measured using a cumulative probability assessment.
Assigning probabilities in measuring a recognized tax
position and evaluating new information or events in
subsequent periods could change previous conclusions
used to measure the tax position estimate. This requires
significant judgment. New information or events may
include tax examinations or appeals, developments in case
law, settlements of tax positions, changes in tax law and
regulations, rulings by taxing authorities and statute of
limitation expirations. Such information or events may have
a significant impact on our net income, financial position
and cash flows.
Derivative Accounting: Certain regulated companies’
contracts for the purchase or sale of energy or energy
related products are derivatives, along with all but one of
Select Energy’s remaining wholesale marketing contracts.
The application of derivative accounting under SFAS
No. 133, “Accounting for Derivative Instruments and
Hedging Activities,” as amended, is complex and requires
our judgment in the following respects: identification
of derivatives and embedded derivatives, election and
designation of the normal purchases and sales exception,
identifying, electing and designating hedge relationships,
assessing and measuring hedge ineectiveness, and
determining the fair value of derivatives. All of these
judgments, depending upon their timing and eect, can
have a significant impact on our consolidated financial
statements.
The fair value of derivatives is based upon the contract
terms and conditions and the underlying market price or
fair value per unit. When quantities are not specified in the
contract, the company determines whether it is a derivative
by using amounts referenced in default provisions and
other relevant sections of the contract. The estimated
quantities to be served are updated during the term of
the contract, and such updates can have a material impact
on mark-to-market amounts. The fair value of derivative
assets and liabilities with the same counterparty are oset
as permitted under FIN 39, “Osetting of Amounts Related
to Certain Contracts - an Interpretation of APB Opinion No.
10 and FASB Statement No. 105.” The actual experience on
our derivative contracts as they are settled has not resulted
in a material impact on earnings. For the year ended
December31, 2008, the realized gains on the wholesale
derivative contracts of Select Energy at settlement date
were $3 million ($5 million pre-tax).
The judgment applied in the election of the normal
purchases and sales exception (and resulting accrual
accounting) includes the conclusion that it is probable at
the inception of the contract and throughout its term that
it will result in physical delivery and that the quantities will
be used or sold by the business over a reasonable period in
the normal course of business. We currently have elected
normal on many regulated company derivative contracts.
If facts and circumstances change and we can no longer
support this conclusion, then the normal exception and
accrual accounting is terminated and fair value accounting
is applied prospectively.
In 2007, CL&P entered into CfDs with owners of plants
to be built or modified. The CfDs are derivatives that are
required to be marked to market on the balance sheet.
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