Eversource 2008 Annual Report Download - page 55

For further information regarding the recognition of
revenue, see Note 1E, “Summary of Significant Accounting
Policies - Derivative Accounting,” to the consolidated
financial statements.
E. Derivative Accounting
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 are recorded at the
time of delivery or settlement.
The application of derivative accounting under SFAS
No. 133 is complex and requires management 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 the 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 FASB
Interpretation No. (FIN) 39, “Osetting of Amounts
Related to Certain Contracts - an Interpretation of APB
Opinion No. 10 and FASB Statement No. 105.”
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. CL&P and WMECO
have elected normal on many derivative contracts. If
facts and circumstances change and management can no
longer support this conclusion, then the normal exception
and accrual accounting is terminated and fair value
accounting is applied prospectively.
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
reflected in accumulated other comprehensive income.
Cash flow hedges include forward interest rate swap
agreements on proposed debt issuances. When a cash
flow hedge is settled, the settlement amount is recorded
in accumulated other comprehensive income and is
amortized into earnings over the term of the debt. In
addition, cash flow hedges impact earnings when hedge
ineectiveness is measured and recorded or when
the forecasted transaction being hedged is no longer
probable of occurring.
All but one of Select Energy’s remaining wholesale
marketing contracts are derivatives, and many of NU’s
regulated company contracts for the purchase or sale of
energy or energy-related products are derivatives.
EITF 03-11 addresses income statement classification
of derivatives that are not related to energy trading
activities. In accordance with EITF 03-11, the remaining
wholesale marketing contracts, which are marked-to-
market derivative contracts, are not considered to be
held for trading purposes, and sales and purchase activity
is reported on a net basis in fuel, purchased and net
interchange power.
EITF Issue No. 02-3, “Issues Involved in Accounting
for Derivative Contracts Held for Trading Purposes
and Contracts Involved in Energy Trading and Risk
Management Activities,” prohibited recording the initial
gains and losses on derivative contracts if their estimated
fair values are based on significant non-observable inputs.
Based upon the significance of non-observable capacity
prices to their valuation, the estimated initial fair values
of CL&P’s contracts for dierences (CfDs) were not
recorded on the balance sheet as of December 31, 2007.
These initial losses were recorded upon adoption of SFAS
No. 157 on January1, 2008. For further information, see
Note1F, “Fair Value Measurements,” to the consolidated
financial statements.
For further information regarding derivative contracts and
their accounting, see Note 3, “Derivative Instruments,” to
the consolidated financial statements.
F. Fair Value Measurements
On January 1, 2008, NU and its subsidiaries adopted SFAS
No. 157, “Fair Value Measurements,” which establishes
a framework for defining and measuring fair value
and requires expanded disclosures about fair value
measurements. SFAS No. 157:
• Defines fair value as the price that would be received
for the sale of an asset or paid to transfer a liability in
an orderly transaction between market participants at
the measurement date (an exit price).
• Establishes a three-level fair value hierarchy based
upon the observability of inputs to the valuations of
assets and liabilities.
• Requires consideration of the company’s own
creditworthiness and risk of nonperformance when
valuing its liabilities.
• Required prospective implementation with adjustments
to fair value reflected in earnings, similar to a change
in estimate, with exceptions including recognition of
previously deferred initial gains or losses described
below.
• Required recognition in retained earnings of previously
deferred initial gains or losses on derivative contracts
whose estimated fair values are based on significant
unobservable inputs. Recognition of the initial gains
or losses was previously prohibited under EITF 02-3.
CL&P’s initial gains and losses on its CfDs that would
have been recorded in retained earnings upon
adoption were recorded as regulatory assets and
liabilities because their costs or benefits are expected
to be fully recovered from or refunded to customers.
Upon adoption, the company applied SFAS No.
157 to the regulated and unregulated companies’
derivative contracts that are recorded at fair value and
to the marketable securities held in the Trust Under
Supplemental Executive Retirement Plan (SERP)
(“supplemental benefit trust”), established for non-
pension retirement benefits, and WMECO’s spent nuclear
fuel trust. The company also applied SFAS No. 157 to
investment valuations used to calculate the funded
status of NU’s pension and postretirement benefit plans
as of December 31, 2008. In 2009, the company will be
required to apply SFAS No. 157 to nonrecurring fair value
measurements of non-financial assets and liabilities, such
as goodwill and AROs.
As a result of adopting SFAS No. 157, the company
recorded a pre-tax charge to earnings of $6.1 million as
of January 1, 2008 related to derivative liabilities for its
remaining unregulated wholesale marketing contracts.
In 2008, the company recorded a $0.8 million pre-tax
benefit to partially reverse the exit price impact recorded
under SFAS No. 157 as the company served out rather
than exited the contracts.
The company also recorded changes in fair value of
certain derivative contracts of CL&P. Because CL&P is a
cost-of-service, rate regulated entity, the cost or benefit
of the contracts is expected to be fully recovered from
or refunded to CL&P’s customers, and an osetting
regulatory asset or liability was recorded to reflect
these changes. As of January1, 2008, implementing
SFAS No. 157 resulted in a total increase to CL&P’s
derivative liabilities, with an oset to regulatory assets,
of approximately $590 million, and a total decrease to
derivative assets, with an oset to regulatory liabilities, of
approximately $30 million.
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