OG&E 2009 Annual Report Download - page 74

years. Early application is permitted. The Company adopted this new standard effective January 1, 2010 and will include the required
disclosures in the Company’s Form 10-Q for the quarter ended March 31, 2010.
In 2004, the Company adopted a standard costing model utilizing a fully loaded activity rate (including payroll, benefits,
other employee related costs and overhead costs) to be applied to projects eligible for capitalization or deferral. In March 2008, the
Company determined that the application of the fully loaded activity rates had unintentionally resulted in the over-capitalization of
immaterial amounts of certain payroll, benefits, other employee related costs and overhead costs in prior years. To correct this issue,
in March 2008, the Company recorded a pre-tax charge of approximately $9.5 million ($5.8 million after tax) as an increase in Other
Operation and Maintenance Expense in the Condensed Statements of Operations for the three months ended March 31, 2008 and a
corresponding $8.6 million decrease in Construction Work in Progress and $0.9 million decrease in Other Deferred Charges and Other
Assets related to the regulatory asset associated with storm costs in the Condensed Balance Sheets as of March 31, 2008.
3. Fair Value Measurements
At December 31, 2009, the Company had no gross derivative assets measured at fair value on a recurring basis. At
December 31, 2009, the Company had approximately $0.7 million of gross derivative liabilities measured at fair value on a recurring
basis which are considered level 2 in the fair value hierarchy. The Company had no gross derivative assets or liabilities measured at
fair value on a recurring basis at December 31, 2008.
In the fourth quarter of 2009, the Company recorded an ARO for approximately $4.5 million related to OU Spirit, which is
measured at fair value on a nonrecurring basis and is considered level 3 in the fair value hierarchy. The inputs used in the valuation of
the ARO include the term of the OU Spirit lease agreement, the average inflation rate, market risk premium and the credit-adjusted
risk free interest rate. The term of the ARO of 35 years was determined by the OU Spirit lease agreement which states that the
Company will remove the wind turbines and related facilities at the time the lease expires. The inflation rate is calculated as an
average of multiple sources including the Gross Domestic Product, Consumer Price Index, etc. The market risk premium is calculated
using the U.S. treasury strip rate. The credit-adjusted risk free interest rate is calculated as the market risk premium plus 120 basis
points.
The three levels defined in the fair value hierarchy and examples of each are as follows:
Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to
access at the measurement date. An active market for the asset or liability is a market in which transactions for the asset or liability
occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either
directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the
full term of the asset or liability. Level 2 inputs include the following: (i) quoted prices for similar assets or liabilities in active
markets, (ii) quoted prices for identical or similar assets or liabilities in markets that are not active, (iii) inputs other than quoted prices
that are observable for the asset or liability or (iv) inputs that are derived principally from or corroborated by observable market data
by correlation or other means.
Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs shall be used to measure fair value to the
extent that observable inputs are not available. Unobservable inputs shall reflect the reporting entity’s own assumptions about the
assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). Unobservable
inputs shall be developed based on the best information available in the circumstances, which might include the reporting entity’s own
data. The reporting entity’s own data used to develop unobservable inputs shall be adjusted if information is reasonably available that
indicates that market participants would use different assumptions. An example of an instrument that may be classified as Level 3
includes the valuation of ARO’s such that there are no closely related markets in which quoted prices are available.
The impact to the fair value of derivatives due to credit risk is calculated using the probability of default based on Standard &
Poor’s Ratings Services (“Standard & Poor’s”) and/or internally generated ratings. The fair value of derivative assets is adjusted for
credit risk. The fair value of derivative liabilities is adjusted for credit risk only if the impact is deemed material.
The following table is a summary of the fair value and carrying amount of the Company’s financial instruments, including
derivative contracts related to the Company’s price risk management (“PRM”) activities, at December 31:
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