TXU 2002 Annual Report - Financial Report

As a result of the opening of the Texas market to competition and related changes in systems and processes within the Electric Reliability Council of Texas (ERCOT), adjustments are recorded for accounts receivable from or payable to ERCOT related to system balancing and are recorded net in revenues. Such balances reflect estimates of volumetric data and are subject to adjustment as data is reconciled and final settlements are determined. Net accounts receivable from ERCOT totaled approximately $40 million at December 31, 2002, covering periods that date back to 2001.

Revenues reflect unrealized gains and losses related to large C&I retail contracts, including unrealized gains recorded upon inception of these contracts, as discussed below under “Commodity Contracts and Mark-to-Market Activities.” Results of wholesale portfolio management activities, which represent realized and unrealized gains and losses from transacting in energy-related contracts, are also reported as a component of revenues. As discussed above under “Financial Instruments and Mark-to-Market Accounting,” recognition of unrealized gains and losses involves a number of assumptions and estimates that could have a significant effect on reported revenues and earnings.

The historical financial statements for periods prior to 2002 included adjustments made to revenues for over/under recovered fuel costs. To the extent fuel costs incurred exceeded regulated fuel factor amounts included in customer billings, TXU Corp. recorded revenues on the basis of its ability and intent to obtain regulatory approval for rate surcharges on future customer billings to recover such amounts. Conversely, to the extent fuel costs incurred were less than amounts included in customer billings, revenues were reduced. Following deregulation of the Texas market on January 1, 2002, any changes to the fuel factor component of regulatory rate amounts are applied prospectively.

Accounting for Contingencies The financial results of TXU Corp. may be affected by judgments and estimates related to loss contingencies. Accruals for loss contingencies are recorded when management determines that it is probable that an asset has been impaired or a liability has been incurred and that such economic loss can be reasonably estimated. Such determinations are subject to interpretations of current facts and circumstances, forecasts of future events and estimates of the financial impacts of such events.

A significant contingency that TXU Corp. accounts for is the loss associated with uncollectible trade accounts receivable. The determination of such bad debt expense is based on factors such as historical write-off experience, agings of current accounts receivable balances, changes in operating practices, regulatory rulings, general economic conditions and customers’ behaviors. With the opening of the Texas electricity market to competition, many historical measures used to estimate bad debt experience may be less reliable. The changing environment, including effects of provider of last resort (POLR) rules (as discussed below under “Regulation and Rates”), billing delays due to new procedures within ERCOT and changes in systems and processes, and customer churn due to competitor actions has added a level of complexity to the estimation process. In 2002, TXU Corp. recorded bad debt expense of $171 million.

In connection with the opening of the Texas market to competition, the Texas Legislature established a retail clawback provision intended to incent affiliated retail electric providers (REPs) of utilities to actively compete for customers outside their historical service territories. As discussed in Note 15 to Financial Statements, a retail clawback liability arises if TXU Energy Company LLC (TXU Energy) retains more than 60% of TXU US Holdings Company’s (US Holdings) former residential and small business customers after the first two years of competition. The amount of the liability is based on the number of such customers as of January 1, 2004, less the number of new customers from outside the historical service territory multiplied by $90. In 2002, TXU Energy recorded a retail clawback accrual of $185 million ($120 million after-tax) reported in cost of energy sold and delivery fees in the statement of income. Over a two-year period beginning January 1, 2004, the liability would be paid to Oncor Electric Delivery Company (Oncor), which in turn would pass the credit to REPs, including TXU Energy, through reduced electricity delivery rates. The accrual reflects assumptions and estimates regarding the number of customers expected in and out of territory. The accrual is subject to further adjustment as the actual measurement date approaches.