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in accounting for our derivatives for interest rate swaps and the oil and natural
gas hedges we have restated our consolidated financial statements for the year
ended December 31, 2004, as presented in this Form 10-K/A. In addition to the
financial statements for the year ended December 31, 2004, these changes in accounting
affect the four quarterly periods of 2004 and the three quarterly periods ended
September 30, 2005. See Note 3 and Note 14 to the Company's consolidated financial
statements. Under cash flow hedge accounting, the after-tax
change in the fair value of the open derivative positions (“fair value change”)
is reported as Other Comprehensive Income in the equity section of the balance
sheet. Alternatively, if the derivative does not qualify as a cash flow hedge,
mark-to-market accounting requires that the fair value change be reported in earnings.
For our cash flow commodity hedges, we had accounted for the realized gain or
losses on these hedging activities as being recognized in earnings as oil and
natural gas revenues when the forecasted transaction occurred. Our derivative
instruments had previously been accounted for as cash flow hedges. The
Company has determined that the derivatives entered into in 2004 and 2005 were
not timely designated as cash flow hedges and lacked sufficient documentation
to be accounted for as cash flow hedges. As a result, the Company is restating
its financial statements for the year ended December 31, 2004 and all the unaudited
quarterly periods in 2004 and the first three quarters of 2005. All such derivatives
in this restatement, including oil and gas derivatives and interest rate swaps,
are now classified as non-designated derivatives and are marked-to-market, with
realized and unrealized gains and losses being reflected as “mark-to-market gains
(losses) on derivatives, net” within the other income and expense section of the
Statement of Operations. In the process of restating
our financials to account for our derivatives on a mark-to-market basis, we discovered
certain computational errors in the fair value of the Company’s derivatives that
was previously reported in other comprehensive income in 2004 and 2005. These
errors resulted from the information we had relied upon to establish oil and gas
prices in connection with establishing the fair value of the derivatives. For
all the periods covered by our consolidated financial statements, we used a thirdparty
website source to obtain oil and gas market prices and to calculate the fair value
of the derivatives. However, we determined in the course of our evaluation that
the information from the third party provider was not entirely reliable and that
Houston Ship Channel market prices should have been used in the fair value computation
in place of New York Mercantile (“NYMEX”) index prices. Nevertheless, in marking
these derivatives to market, the gains and losses reflected in the other income
and expense have been based upon corrected fair valuations and were not based
upon the information from the third party provider. Additionally,
during the audit of Pinnacle Gas Resources, Inc., an error was discovered that
affects amounts that had previously been reported on the Company's quarterly reports
on Form 10-Q for the quarterly periods ended March 31, 2005, June 30, 2005 and
September 30, 2005. The error arose as a result of the incorrect accounting for
certain natural gas derivatives which had historically been accounted for using
the cash flow method. Pinnacle's management and its independent registered public
accountants have determined that these derivatives are not eligible for cash flow
hedge accounting. Accordingly, Pinnacle restated its 2005 quarters using the non-designated
derivatives accounting method. The relative change in the fair value of these
derivatives due to changing commodity price is reflected as a gain or loss in
Pinnacle’s earnings each quarter. Because the Company’s interest in Pinnacle is
accounted for using the equity method, the Company determined that the effect
of Pinnacle’s restatement of its financial statements required the Company to,
in turn, restate its own financial statements. Details
of these restatements are presented in this Form 10-K/A in Note 3 to the consolidated
financial statements. Where appropriate, notes to the consolidated financial statements
and certain other disclosures in this Form 10-K/A have been adjusted to conform
to these restatements. A summary of the restated periods is comprised as follows: | |
