In a 10-K filing with the Securities and Exchange Commission last week, Reliant Resources Inc. officially amended its earnings for the second and third quarters of 2001. The restatement, which was announced in early February by the company, relates to a correction in accounting treatment for a series of four structured transactions that apparently were inappropriately accounted for as cash flow hedges between May 2001 and Sept. 2001 (see Power Market Today, March 18).

The discovery was made by Reliant Resources’ accounting department and brought to the attention of its outside auditors, outside counsel and the audit committees of its board and the board of Reliant Energy, which is the 82% shareholder (see Power Market Today, Feb. 6). As a result of the internal review, two executives were placed on administrative leave by Reliant Resources.

The transactions were undertaken and accounted for as cash flow hedges, but Reliant Resources “now believes they did not meet the requirements of a cash flow hedge under Statement of Financial Accounting Standards No. 133,” which refers to derivative instruments and hedging activities. As a result, Reliant Resources added $108 million to its net income for the first nine months of 2001, instead of carrying the income through 2002 and 2003. “The company now believes the contracts should have been accounted for as a unit within each structured transaction rather than separately…accounted for as derivatives with changes in fair value recognized through the income statement.”

In general, according to the 10-K filing, “each structured transaction involved a series of forward contracts to buy and sell an energy commodity in 2001 and to buy and sell an energy commodity in 2002 or 2003. Each series of contracts in a structure were executed contemporaneously with the same counterparty and were for the same commodities, quantities and locations. The contracts in each structure were offsetting in terms of physical attributes.

“In two of the four structured transactions, a series of contracts were entered into with the same counterparty to mitigate credit exposure (the credit mitigation contracts). These…contracts mirrored the cash flows and terms from the other contracts in the structure, except for an upfront demand payment made to the counterparty in these two transactions…” Also, in “August 2001, the company entered into forward contracts with a different counterparty to buy and sell natural gas, a portion of which was inappropriately recorded in the fourth quarter of 2001. The counterparties to all of the structured transactions were independent third parties that are regularly engaged in the energy trading business.”

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