## Application of Critical Accounting Policies 

The Companies’ financial statements reflect the application of their accounting policies, which conform to accounting principles generally accepted in the United States of America. The Companies’ critical accounting policies include industry- specific accounting applicable to regulated public utilities and accounting for pensions and other postretirement benefits, contingencies, long-lived assets, derivative instruments, goodwill and leases. 

The critical accounting policies are as follows: 

## Accounting for Regulated Public Utilities - SFAS No. 71 

The Utilities are subject to SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation,” and, in accordance with SFAS No. 71, are subject to the accounting requirements of the Federal Energy Regulatory Commission (FERC) and state public utility regulatory authorities having jurisdiction. 

SFAS No. 71 specifies the economic effects that result from the cause and effect relationship of costs and revenues in the rate-regulated environment and how these effects are to be accounted for by a regulated enterprise. Revenues intended to cover some costs may be recorded either before or after the costs are incurred. If regulation provides assurance that incurred costs will be recovered in the future, these costs would be recorded as deferred charges or “regulatory assets” under SFAS No. 71. If revenues are recorded for costs that are expected to be incurred in the future, these revenues would be recorded as deferred credits or “regulatory liabilities” under SFAS No. 71. 

The Utilities’ principal regulatory assets and liabilities are detailed in Note B to the financial statements. The Utilities are each receiving or being credited with a return on all regulatory assets for which a cash outflow has been made. The Utilities are each paying or being charged with a return on all regulatory liabilities for which a cash inflow has been received. The regula- tory assets and liabilities will be recovered from customers, or applied for customer benefit, in accordance with rate provisions approved by the applicable public utility regulatory commission. 

## Accounting for Pensions and Other Postretirement Benefits 

The Utilities provide pensions and other postretirement benefits to substantially all of their employees and retirees. Con Edison’s unregulated subsidiaries also provide such benefits to certain of their employees. The Companies account for these benefits in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” and SFAS No. 106, “Employers’ Accounting for Postretirement Benefits other than Pensions.” In applying 

these accounting policies, the Companies have made critical estimates related to actuarial assumptions, including assump- tions of expected returns on plan assets, future compensation, health care cost trends and appropriate discount rates. See Notes E and F to the financial statements for information about these assumptions, actual performance, amortization of invest- ment and other actuarial gains and losses and calculated plan costs for 2003, 2002 and 2001. 

Primarily because of the amortization of previous years’ net investment gains, Con Edison of New York’s pension expense for 2003, 2002 and 2001 was negative, resulting in a credit to and increase in net income in each year. Investment gains and losses on plan assets are fully recognized in expense over a 15-year period (20 percent of the gains and losses for each year begin to amortize in each of the following five years and the amortization period for each 20 percent portion of the gains and losses is ten years). This amortization is in accordance with the Statement of Policy issued by the New York Public Service Commission (PSC) and is permitted under SFAS No. 87. 

The cost of pension and other postretirement benefits in future periods will depend on actual returns on plan assets and assumptions for future periods. Con Edison’s current estimate for 2004 is a reduction, compared with 2003, in the pension and other postretirement benefits net credit of $19 million after tax for Con Edison of New York and an increase, compared to 2003, in pension and other postretirement benefits expense of $1 million for O&R. This reduction reflects, among other fac- tors, the amortization of prior period actuarial losses associated with declines in the market value of assets in recent years, par- tially offset by the amortization of a gain on plan assets in 2003 and by the estimated impact in 2004 of recently enacted Medicare legislation (reduction in other postretirement benefit costs of $10 million after tax, including $9 million for Con Edison of New York and $1 million for O&R). 

Amortization of market gains and losses experienced in previ- ous years is expected to reduce Con Edison of New York’s pension and other postretirement benefit net credit by an addi- tional $25 million, after tax, in 2005. A 5.0 percentage point variation in the actual annual return in 2004 as compared with the expected annual asset return of 8.8 percent would change net income for Con Edison and Con Edison of New York by approximately $5 million in 2005, assuming no change in regu- latory treatment. 

In accordance with SFAS No. 71 and consistent with rate provisions approved by the PSC, O&R defers as a regulatory asset any difference between expenses recognized under SFAS No. 87 and the amounts reflected in rates for such 

