Algonquin Power & Utilities Corp. – Consolidated Financial Statements ALGONQUIN POWER & UTILITIES CORP.  Notes to the Consolidated Financial Statements  December 31, 2012 and 2011   (in thousands of Canadian dollars except as noted and amounts per share)  1.  Significant accounting policies (continued) (w) Income taxes  (x) Financial instruments and derivatives  2012 Annual Report 86 Income taxes are accounted for using the asset and liability method. Deferred tax assets and  liabilities are recognized for the future tax consequences attributable to differences between the  financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to  taxable income in the years in which those temporary differences are expected to be recovered  or settled. A valuation allowance is recorded against deferred tax assets to the extent that it is  considered more likely than not that the deferred tax asset will not be realized. The effect on  deferred assets and liabilities of a change in tax rates is recognized in earnings in the period that  includes the date of enactment. Income tax credits are treated as a reduction to current income  tax expense in the year the credit arises or future periods to the extent that realization of such  benefit is more likely than not.  The organizational structure of APUC and its subsidiaries is complex and the related tax  interpretations, regulations and legislation in the tax jurisdictions in which they operate are  continually changing. As a result, there can be tax matters that have uncertain tax positions. The Company follows ASC 740-10 and recognizes the effect of income tax positions only if  those positions are more likely than not of being sustained. Recognized income tax positions  are measured at the largest amount that is greater than 50% likely of being realized. Changes  in recognition or measurement are reflected in the period in which the change in judgment  occurs. APUC has classified its cash and cash equivalents and restricted cash as held-for-trading,  which are measured at fair value. Accounts receivable and notes receivable are measured at  amortized cost and there is no liquid market for these investments. Long-term liabilities,  convertible debentures, and other long-term liabilities are measured at amortized cost using the  effective interest method, adjusted for the amortization or accretion of premiums or discounts.  Transaction costs that are directly attributable to the acquisition of financial assets are  accounted for as part of the respective asset’s carrying value at inception. Transaction costs for  items classified as held-for-trading are expensed immediately. Transaction costs that are  directly attributable to the issuance of financial liabilities, costs of arranging the Company’s  credit facility and costs considered as commitment fees paid to financial institutions are  recorded in deferred financing costs. Deferred financing costs, premiums and discounts on  long-term debt are amortized using the effective interest method while deferred financing costs  relating to revolving credit facilities are amortized on a straight-line basis over the term of the  facility.  The Company uses derivative financial instruments as one method to manage exposures to  fluctuations in exchange rates, interest rates and commodity prices. APUC recognizes all  derivative instruments as either assets or liabilities in the Consolidated Balance Sheet at their  respective fair values. During 2011, none of the derivatives were designated in hedging  relationships for accounting purposes and, as a result, the changes in the fair value were  immediately recognized in the Consolidated Statements of Operations. In 2012, the Company  commenced applying hedge accounting to financial instruments used to manage its foreign  currency risk exposure and price risk exposure associated with sales of generated electricity. 