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) For derivatives designated in a cash flow hedge relationship, the effective portion of the  change in fair value is recognized as other comprehensive income. The ineffective portion  is immediately recognized in earnings. The amount recognized in accumulated other  comprehensive income is removed and included in earnings in the same period as the  hedged cash flows affect earnings under the same line item in the statement of income as  the hedged item. If the hedging instrument no longer meets the criteria for hedge  accounting, expires or is sold, terminated, exercised, or the designation is revoked, then  hedge accounting is discontinued prospectively. The amount recognized in accumulated  other comprehensive income is transferred to the income statement in the same period that  the hedged item affects profit or loss. If the forecast transaction is no longer expected to  occur, then the balance in accumulated other comprehensive income is recognized  immediately in earnings. For derivative or financial instruments designated as a hedge of the foreign currency  exposure of a net investment in foreign operations, foreign currency transaction gain or loss  that are designated as, and are effective as, an economic hedge of the net investment in a  foreign operation are reported in the same manner as the translation adjustment (in other  comprehensive income) related to the net investment. To the extent that the hedge is  ineffective, such differences are recognized in earnings.  Liberty Energy (California) (“Calpeco”) and Granite State Electric Company (“Granite State”)  enter into Power Purchase Agreements (“PPA”) for load serving requirements. These contracts  meet the exemption for normal purchase and normal sales and as such, are not required to be  recorded at fair value as derivatives and are accounted for on an accrual basis. Counterparties  are evaluated on an on-going basis for non-performance risk to ensure it does not impact the  conclusion with respect to this exemption. The Company utilizes valuation techniques that maximize the use of observable inputs and  minimize the use of unobservable inputs to the extent possible. The Company determines  fair value based on assumptions that market participants would use in pricing an asset or  liability in the principle or most advantageous market. When considering market participant  assumptions in fair value measurements, the following fair value hierarchy distinguishes  between observable and unobservable inputs, which are categorized in one of the following  levels: (x) Financial instruments and derivatives (continued)  (y) Fair value measurements  x Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or  liabilities accessible to the reporting entity at the measurement date. x Level 2 Inputs: Other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full  term of the asset or liability. x Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair  value to the extent that observable inputs are not available, thereby allowing for  situations in which there is little, if any, market activity for the asset or liability at  measurement date. 88 2012 Annual Report