Summary of Significant Accounting Policies

12 Months Ended

Dec. 31, 2011

Summary of Significant Accounting Policies

Summary of Significant Accounting Policies

1.             Summary of Significant Accounting Policies

Description of Business and Basis of Presentation

Pinnacle West is a holding company that conducts business through its subsidiaries; APS, SunCor, El Dorado, and formerly APSES.  APS, our wholly-owned subsidiary, is a vertically-integrated electric utility that provides either retail or wholesale electric service to substantially all of the state of Arizona, with the major exceptions of about one-half of the Phoenix metropolitan area, the Tucson metropolitan area and Mohave County in northwestern Arizona.  APS accounts for essentially all of our revenues and earnings, and is expected to continue to do so.  SunCor was a developer of residential, commercial and industrial real estate projects in Arizona, New Mexico, Idaho and Utah but in 2009 and 2010, essentially all of these assets were sold.  All activities for SunCor are now reported as discontinued operations (see Note 21). APSES provided energy-related projects to commercial and industrial retail customers in competitive markets in the western United States.  APSES was sold in 2011 and is now reported as discontinued operations (see Note 21). El Dorado is an investment firm.

Pinnacle West’s Consolidated Financial Statements include the accounts of Pinnacle West and our subsidiaries: APS, SunCor, APSES, and El Dorado. APS’s consolidated financial statements include the accounts of APS and certain VIEs relating to the Palo Verde sale leaseback.  Intercompany accounts and transactions between the consolidated companies have been eliminated.

We consolidate VIEs for which we are the primary beneficiary. We determine whether we are the primary beneficiary of a VIE through a qualitative analysis that identifies which variable interest holder has the controlling financial interest in the VIE. In performing our primary beneficiary analysis we consider all relevant facts and circumstances, including the design and activities of the VIE, the terms of the contracts the VIE has entered into, and which parties participated significantly in the design or redesign of the entity. We continually evaluate our primary beneficiary conclusions to determine if changes have occurred which would impact our primary beneficiary assessments. We have determined that APS is the primary beneficiary of certain VIE lessor trusts relating to the Palo Verde sale leaseback, and therefore APS consolidates these entities (see Note 20).

In preparing the consolidated financial statements, we have evaluated the events that have occurred after December 31, 2011 through the date the financial statements were issued.

Our consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments except as otherwise disclosed in the notes)  that we believe are necessary for the fair presentation of our financial position, results of operations and cash flows for the periods presented.  These consolidated financial statements and notes have been prepared consistently with the exception of the reclassification of certain prior year amounts on our Consolidated Statements of Income, Consolidated Balance Sheets, and Consolidated Statements of Cash Flows in accordance with accounting requirements for reporting discontinued operations (see Note 21) and the impacts related to the reclassification of regulatory assets and liabilities for the current portion (see Note 3).

Certain line items are presented in more detail on the Consolidated Statements of Cash Flows than was presented in the prior years.  Other line items are more condensed than the previous presentation.  The prior year amounts were reclassified to conform to the current year presentation.  These reclassifications had no impact on total net cash flow provided by operating activities.

The following tables show the impact of the reclassifications of prior years (previously reported) amounts (dollars in thousands):

Statement of Income for the Year Ended December, 2010	Aspreviously reported			Reclassifications for discontinued operations			Amount reported after reclassification for discontinued operations
Operating Revenues
Other revenues	$	82,967		$	(74,446	)	$	8,521
Operating Expenses
Operations and maintenance	877,406			(7,221		)	870,185
Depreciation and amortization	414,555			(76		)	414,479
Taxes other than income taxes	135,334			(6		)	135,328
Other expenses	65,651			(58,142		)	7,509
Other
Other income	6,368			19			6,387
Other expense	(9,764		)	(157		)	(9,921		)
Interest Expense
Allowance for borrowed fundsused during construction	(16,539		)	60			(16,479		)
Income Taxes	164,321			(3,452		)	160,869
Income From Continuing Operations	350,598			(5,747		)	344,851
Income From Discontinued Operations	19,611			5,747			25,358

Statement of Income for the Year Ended December, 2009	Aspreviously reported			Reclassifications for discontinued operations			Amount reported after reclassification for discontinued operations
Operating Revenues
Other revenues	$	26,723		$	(22,254	)	$	4,469
Operating Expenses
Operations and maintenance	831,863			(9,563		)	822,300
Depreciation and amortization	407,463			(109		)	407,354
Taxes other than income taxes	123,277			(7		)	123,270
Other expenses	24,534			(18,550		)	5,984
Other
Other income	5,278			(119		)	5,159
Other expense	(14,269		)	(31		)	(14,300		)
Interest Expense
Interest charges	237,527			239			237,766
Allowance for borrowed fundsused during construction	(10,430		)	51			(10,379		)
Income Taxes	136,506			2,045			138,551
Income From Continuing Operations	252,558			3,490			256,048
Income From Discontinued Operations	(179,794		)	(3,490		)	(183,284		)

Balance Sheets - December 31, 2010	Aspreviously reported		Reclassifications for regulatory assets and liabilities			Amount reported after reclassification for regulatory assets and liabilities
Current Assets — Other regulatory assets	$	—	$	62,286		$	62,286
Current Assets — Deferred income taxes	94,602		30,295			124,897
Deferred Debits — Regulatory assets	1,048,656		(62,286		)	986,370
Current Liabilities — Deferred fuel andpurchased power regulatory liability	—		58,442			58,442
Current Liabilities — Other regulatoryliabilities	—		80,526			80,526
Deferred Credits and Other — Deferredincome taxes	1,833,566		30,295			1,863,861
Deferred Credits and Other — Deferredfuel and purchased powerregulatory liability	58,442		(58,442		)	—
Deferred Credits and Other — Regulatory liabilities	694,589		(80,526		)	614,063

Statement of Cash Flows for theYear Ended December 31, 2010	As previously reported			Reclassifications for regulatory assets and liabilities and to conform to current year presentation			Amounts reported after reclassification for regulatory assets and liabilities and to conform to current year presentation
Cash Flows from Operating Activities
Other current assets	$	5,246		$	4,129		$	9,375
Other current liabilities	5,204			(2,283		)	2,921
Change in other regulatory liabilities	54,518			2,283			56,801
Change in other long-term assets	(43,189		)	(4,751		)	(47,940		)
Expenditures for real estate investments	(622		)	622			—
Other changes in real estate assets	4,068			(4,068		)	—
Change in other long-term liabilities	(101,456		)	4,068			(97,388		)

Statement of Cash Flows for theYear Ended December 31, 2009	As previously reported			Reclassifications for regulatory assets and liabilities and to conform to current year presentation			Amounts reported after reclassification for regulatory assets and liabilities and to conform to current year presentation
Cash Flows from Operating Activities
Other current assets	$	24,647		$	13,759		$	38,406
Other current liabilities	29,274			28,006			57,280
Change in other regulatory liabilities	110,642			(27,992		)	82,650
Change in other long-term assets	(47,899		)	(16,730		)	(64,629		)
Change in other long-term liabilities	16,377			(4,216		)	12,161
Expenditures for real estate investments	(2,957		)	2,957			—
Other changes in real estate assets	(4,216		)	4,216			—

Accounting Records and Use of Estimates

Our accounting records are maintained in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Regulatory Accounting

APS is regulated by the ACC and the FERC.  The accompanying financial statements reflect the rate-making policies of these commissions.  As a result, we capitalize certain costs that would be included as expense in the current period by unregulated companies.  Regulatory assets represent incurred costs that have been deferred because they are probable of future recovery in customer rates.  Regulatory liabilities generally represent expected future costs that have already been collected from customers.

Management continually assesses whether our regulatory assets are probable of future recovery by considering factors such as changes in the applicable regulatory environment and recent rate orders applicable to other regulated entities in the same jurisdiction.  This determination reflects the current political and regulatory climate in the state and is subject to change in the future.  If future recovery of costs ceases to be probable, the assets would be written off as a charge in current period earnings.

See Note 3 for additional information.

Electric Revenues

We derive electric revenues primarily from sales of electricity to our regulated Native Load customers.  Revenues related to the sale of electricity are generally recorded when service is rendered or electricity is delivered to customers.  The billing of electricity sales to individual Native Load customers is based on the reading of their meters, which occurs on a systematic basis throughout the month.  Unbilled revenues are estimated by applying an average revenue/kWh to the number of estimated kWhs delivered but not billed.  Differences historically between the actual and estimated unbilled revenues are immaterial.  We exclude sales taxes and franchise fees on electric revenues from both revenue and taxes other than income taxes.

Revenues from our Native Load customers and non-derivative instruments are reported on a gross basis on Pinnacle West’s Consolidated Statements of Income.  In the electricity business, some contracts to purchase energy are netted against other contracts to sell energy.  This is called a “book-out” and usually occurs for contracts that have the same terms (quantities and delivery points) and for which power does not flow.  We net these book-outs, which reduces both revenues and fuel and purchased power costs.

Effective January 1, 2010, electric revenues also include proceeds for line extension payments for new or upgraded service in accordance with the 2009 retail rate case settlement agreement (see Note 3).  This revenue treatment continues through 2012, or until new rates are established in APS’s next general retail rate case, if that is before year end 2012.  Certain proceeds received under previous versions of the line extension policy, or for activities not involving an extension or upgrade of service (e.g., service relocations at the request of governmental entities or undergrounding of overhead facilities) will continue to be treated as contributions in aid of construction and will not impact electric revenues.

Allowance for Doubtful Accounts

The allowance for doubtful accounts represents our best estimate of existing accounts receivable that will ultimately be uncollectible.  The allowance is calculated by applying estimated write-off factors to various classes of outstanding receivables, including accrued utility revenues.  The write-off factors used to estimate uncollectible accounts are based upon consideration of both historical collections experience and management’s best estimate of future collections success given the existing collections environment.

Utility Plant and Depreciation

Utility plant is the term we use to describe the business property and equipment that supports electric service, consisting primarily of generation, transmission and distribution facilities.  We report utility plant at its original cost, which includes:

·material and labor;

·contractor costs;

·capitalized leases;

·construction overhead costs (where applicable); and

·allowance for funds used during construction.

We expense the costs of plant outages, major maintenance and routine maintenance as incurred.  We charge retired utility plant to accumulated depreciation.  Liabilities associated with the retirement of tangible long-lived assets are recognized at fair value as incurred and capitalized as part of the related tangible long-lived assets.  Accretion of the liability due to the passage of time is an operating expense and the capitalized cost is depreciated over the useful life of the long-lived asset.  See Note 12.

APS records a regulatory liability for the asset retirement obligations related to its regulated assets.  This regulatory liability represents the difference between the amount that has been recovered in regulated rates and the amount calculated in accordance with guidance on accounting for asset retirement obligations.  APS believes it can recover in regulated rates the costs capitalized in accordance with this accounting guidance.

We record depreciation on utility plant on a straight-line basis over the remaining useful life of the related assets.  The approximate remaining average useful lives of our utility property at December 31, 2011 were as follows:

·Fossil plant — 18 years;

·Nuclear plant — 29 years;

·Other generation — 28 years;

·Transmission — 38 years;

·Distribution — 35 years; and

·Other — 7 years.

APS applied for twenty-year extensions of its operating licenses for each of the three Palo Verde units in December 2008.  On April 21, 2011, the NRC approved the extensions of the Palo Verde licenses.  The nuclear plant remaining life takes into consideration an ACC decision which authorizes the new Palo Verde Nuclear plant lives, effective January 1, 2012.

For the years 2009 through 2011, the depreciation rates ranged from a low of 1.30% to a high of 10.20%.  The weighted-average rate was 2.98% for 2011, 2.98% for 2010, and 3.06% for 2009.

Allowance for Funds Used During Construction

AFUDC represents the approximate net composite interest cost of borrowed funds and an allowed return on the equity funds used for construction of regulated utility plant.  Both the debt and equity components of AFUDC are non-cash amounts within the Consolidated Statement of Income.  Plant construction costs, including AFUDC, are recovered in authorized rates through depreciation when completed projects are placed into commercial operation.

AFUDC was calculated by using a composite rate of 10.25% for 2011, 9.2% for 2010, and 5.9% for 2009.  APS compounds AFUDC semi-annually and ceases to accrue AFUDC when construction work is completed and the property is placed in service.

Materials and Supplies

APS values materials, supplies and fossil fuel inventory using a weighted-average cost method.  APS materials, supplies and fossil fuel inventories are carried at the lower of weighted-average cost or market, unless evidence indicates that the weighted-average cost (even if in excess of market) will be recovered.

Fair Value Measurements

We account for derivative instruments, investments held in our nuclear decommissioning trust, certain cash equivalents and plan assets held in our retirement and other benefit plans at fair value on a recurring basis. Due to the short-term nature of net accounts receivable, accounts payable, and short-term borrowings, the carrying values of these instruments approximate fair value.  Fair value measurements may also be applied on a nonrecurring basis to other assets and liabilities in certain circumstances such as impairments. We also disclose fair value information for our long-term debt, which is carried at amortized cost (see Note 6).

Fair value is the price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between willing market participants on the measurement date. Inputs to fair value may include observable and unobservable data. We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

We determine fair market value using observable inputs such as actively-quoted prices for identical instruments when available. When actively quoted prices are not available for the identical instruments we use other observable inputs, such as prices for similar instruments, other corroborative market information, or prices provided by other external sources. For options, long-term contracts and other contracts for which observable price data are not available, we use unobservable inputs, such as models and other valuation methods, to determine fair market value.

The use of models and other valuation methods to determine fair market value often requires subjective and complex judgment. Actual results could differ from the results estimated through application of these methods.

See Note 14 for additional information about fair value measurements.

Derivative Accounting

We are exposed to the impact of market fluctuations in the commodity price and transportation costs of electricity, natural gas, coal, emission allowances and in interest rates. We manage risks associated with market volatility by utilizing various physical and financial instruments that may qualify as derivatives, including futures, forwards, options and swaps. As part of our overall risk management program, we use such instruments to hedge purchases and sales of electricity and fuels. The changes in market value of such contracts have a high correlation to price changes in the hedged transactions.

We account for our derivative contracts in accordance with derivatives and hedging guidance, which requires all derivatives not qualifying for a scope exception to be measured at fair value on the balance sheet as either assets or liabilities.  Transactions with counterparties that have master netting arrangements are reported net on the balance sheet.  See Note 18 for additional information about our derivative instruments.

Loss Contingencies and Environmental Liabilities

Pinnacle West and APS are involved in certain legal and environmental matters that arise in the normal course of business.  Contingent losses and environmental liabilities are recorded when it is determined that it is probable that a loss has occurred and the amount of the loss can be reasonably estimated.  When a range of the probable loss exists and no amount within the range is a better estimate than any other amount, Pinnacle West and APS record a loss contingency at the minimum amount in the range.  Unless otherwise required by GAAP, legal fees are expensed as incurred.

Retirement Plans and Other Benefits

Pinnacle West sponsors a qualified defined benefit and account balance pension plan for the employees of Pinnacle West and its subsidiaries.  We also sponsor another postretirement benefit plan for the employees of Pinnacle West and our subsidiaries and provide medical and life insurance benefits to retired employees.  Pension and other postretirement benefit expense are determined by actuarial valuations, based on assumptions that are evaluated annually.  See Note 8 for additional information on pension and other postretirement benefits.

Nuclear Fuel

APS amortizes nuclear fuel by using the unit-of-production method.  The unit-of-production method is based on actual physical usage.  APS divides the cost of the fuel by the estimated number of thermal units it expects to produce with that fuel.  APS then multiplies that rate by the number of thermal units produced within the current period.  This calculation determines the current period nuclear fuel expense.

APS also charges nuclear fuel expense for the interim storage and permanent disposal of spent nuclear fuel.  The DOE is responsible for the permanent disposal of spent nuclear fuel and charges APS $0.001 per kWh of nuclear generation.  See Note 11 for information on spent nuclear fuel disposal and Note 23 for information on nuclear decommissioning costs.

Income Taxes

Income taxes are provided using the asset and liability approach prescribed by guidance relating to accounting for income taxes.  We file our federal income tax return on a consolidated basis and we file our state income tax returns on a consolidated or unitary basis.  In accordance with our intercompany tax sharing agreement, federal and state income taxes are allocated to each first-tier subsidiary as though each first-tier subsidiary filed a separate income tax return.  Any difference between that method and the consolidated (and unitary) income tax liability is attributed to the parent company.  The income tax liability accounts reflect the tax and interest associated with management’s estimate of the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement for all known and measurable tax exposures.  See Note 4.

Real Estate Investments

We did not have any real estate investments at December 31, 2011 and December 31, 2010 on our Consolidated Balance Sheets.  For the purposes of evaluating impairment, in accordance with the provisions on accounting for the impairment or disposal of long-lived assets; we classified our real estate assets, such as land under development, land held for future development, and commercial property as “held and used” in 2010 and 2009.  When events or changes in circumstances indicated that the carrying values of real estate assets considered held and used would not be recoverable, we compared the undiscounted cash flows that we estimated would be generated by each asset to its carrying amount.  If the carrying amount exceeded the undiscounted cash flows, we adjusted the asset to fair value and recognized an impairment charge.  The adjusted value became the new book value (carrying amount) for held and used assets.  Our internal models used inputs that we believe were consistent with those that would be used by market participants.

Cash and Cash Equivalents

We consider all highly liquid investments with a remaining maturity of three months or less at acquisition to be cash equivalents.

Intangible Assets

We have no goodwill recorded and have separately disclosed other intangible assets, primarily APS’s software, on Pinnacle West’s Consolidated Balance Sheets.  The intangible assets are amortized over their finite useful lives.  Amortization expense was $47 million in 2011, $45 million in 2010, and $35 million in 2009. Estimated amortization expense on existing intangible assets over the next five years is $42 million in 2012, $35 million in 2013, $28 million in 2014, $21 million in 2015, and $13 million in 2016. At December 31, 2011, the weighted average remaining amortization period for intangible assets was 7 years.

Investments

El Dorado accounts for its investments using either the equity method (if significant influence) or the cost method (if less than 20% ownership).

Our investments in the nuclear decommissioning trust fund are accounted for in accordance with guidance on accounting for certain investments in debt and equity securities. See Note 14 and Note 23 for more information on these investments.