II. Background

FAS 133 was issued by the Financial Accounting Standards Board (FASB) in June 1998 and amended by FAS 138 in June 2000. FAS 133 and 138 require that all derivatives and certain embedded derivatives be reported on the balance sheet at fair market value.

Sierra enters into certain contracts, defined as derivatives by FAS 133 and 138, in order to purchase power, generation and transmission capacity, etc. The fixed price components of these contracts can vary substantially from market prices at any one time. FAS 133 and 138 require that the difference between the contract and the market price be recognized as a gain or loss every quarter, even though there is no associated cash flow. When the contract is actually settled, the expense is recognized as the actual contract price. The net gain or loss previously recognized is reversed.

Implementation of FAS 133 and 138 could cause significant volatility in Sierra's retained earnings and significantly impact its ability to pay dividends. Thus, Sierra's financing arrangements could be adversely affected and it is reasonable to establish regulatory accounts to offset the entries required by FAS 133 and 138.