FORM 10-K

62

MDU RESOURCES G ROUP, INC.

PART II

Long-lived assets are reviewed to determine if a legal retirement obligation exists. If a legal retirement obligation exists, a determination

of the liability is made if a reasonable estimate of the present value of the obligation can be made. The present value of the retirement

obligation is calculated by inflating current estimated retirement costs of the long-lived asset over its expected life to determine

the expected future cost and then discounting the expected future cost back to the present value using a discount rate equal to the

credit-adjusted risk-free interest rate in effect when the liability was initially recognized.

These estimates and assumptions are subject to a number of variables and are expected to change in the future. Estimates and

assumptions will change as the estimated useful lives of the assets change, the current estimated retirement costs change, new legal

retirement obligations occur and/or as existing legal asset retirement obligations, for which a reasonable estimate of fair value could not

initially be made because of the range of time over which the Company may settle the obligation is unknown or cannot be estimated,

become less uncertain and a reasonable estimate of the future liability can be made.

Pension and other postretirement benefits

The Company has noncontributory defined benefit pension plans and other postretirement benefit plans for certain eligible employees.

Various actuarial assumptions are used in calculating the benefit expense (income) and liability (asset) related to these plans. Costs of

providing pension and other postretirement benefits bear the risk of change, as they are dependent upon numerous factors based on

assumptions of future conditions.

The Company makes various assumptions when determining plan costs, including the current discount rates and the expected long-term

return on plan assets, the rate of compensation increases and healthcare cost trend rates. In selecting the expected long-term return on

plan assets, which is considered to be one of the key variables in determining benefit expense or income, the Company considers both

current market conditions and expected future market trends, including changes in interest rates and equity and bond market performance.

Another key variable in determining benefit expense or income is the discount rate. In selecting the discount rate, the Company uses the

yield of a fixed-income debt security, which has a rating of "Aa" or higher published by a recognized rating agency, as well as other factors,

as a basis. The Company's pension and other postretirement benefit plan assets are primarily made up of equity and fixed-income

investments. Fluctuations in actual equity and bond market returns as well as changes in general interest rates may result in increased or

decreased pension and other postretirement benefit costs in the future. Management estimates the rate of compensation increase based

on long-term assumed wage increases and the healthcare cost trend rates are determined by historical and future trends.

The Company believes the estimates made for its pension and other postretirement benefits are reasonable based on the information that

is known when the estimates are made. These estimates and assumptions are subject to a number of variables and are expected to change

in the future. Estimates and assumptions will be affected by changes in the discount rate, the expected long-term return on plan assets, the

rate of compensation increase and healthcare cost trend rates. The Company plans to continue to use its current methodologies to

determine plan costs.

Income taxes

Income taxes require significant judgments and estimates including the determination of income tax expense, deferred tax assets and

liabilities and, if necessary, any valuation allowances that may be required for deferred tax assets and accruals for uncertain tax positions.

The effective income tax rate is subject to variability from period to period as a result of changes in federal and state income tax rates and/

or changes in tax laws. In addition, the effective tax rate may be affected by other changes including the allocation of property, payroll and

revenues between states.

The Company provides deferred federal and state income taxes on all temporary differences between the book and tax basis of the

Company's assets and liabilities. Excess deferred income tax balances associated with the Company's rate-regulated activities resulting

from the Company's adoption of SFAS No. 109 have been recorded as a regulatory liability and are included in other liabilities. These

regulatory liabilities are expected to be reflected as a reduction in future rates charged to customers in accordance with applicable

regulatory procedures.

The Company uses the deferral method of accounting for investment tax credits and amortizes the credits on electric and natural gas

distribution plant over various periods that conform to the ratemaking treatment prescribed by the applicable state public service commissions.

On January 1, 2007, the Company adopted FIN 48 as discussed in Item 8 ­ Notes 1 and 15. FIN 48 clarifies the application of SFAS No. 109

by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise's

financial statements. The criterion allows for recognition in the financial statements of a tax position when it is more likely than not that the

position will be sustained upon examination.

The Company believes its estimates surrounding income taxes are reasonable based on the information that is known when the estimates are made.