I NTERNAL U SE C OMPUTER S OFTWARE E FFECTIVE D ATE : D ECEMBER 30,

Statement of Purpose

Based on the fact that Xcel Energy is regulated by various government entities, the Corporate Controller is responsible for accounting policies for Xcel Energy within the framework of the Securities Exchange Commission (SEC), Financial Accounting Standards Board (FASB), Federal Energy Regulatory Commission (FERC), and state regulatory requirements. These policies will include establishing and maintaining effective internal controls as it relates to the books and records of Xcel Energy and the preparation of all consolidated external reports as required by the SEC, FERC, and the state regulators.

Within this framework, Capital Asset Accounting (CAA) will establish appropriate asset accounting policies. At the end of each month, in order to recognize the assets correctly on the company’s balance sheet, all transactions associated with the purchase of materials or labor to construct capital assets must be entered in a timely manner in order to meet the FERC and GAAP/SEC accounting requirements. These transactions are part of the reconciliations summarizing the costs included in the general ledger accounts for construction work in progress (CWIP) and retirement work in progress (RWIP).

This policy defines the rules surrounding the purchase or development of internal use computer software applications needed to conduct Xcel Energy operations and to comply with regulatory reporting requirements. Responsibility to assure proper internal controls are in place and a proper audit trail exists for costs charged to development projects rests with the business unit in accordance with the policy guidelines. It is CAA’s responsibility to maintain this policy and to ensure, in conjunction with the business unit personnel, consistent application of the procedures contained in the policy. CAA will monitor FERC regulations and other accounting rules that impact this policy and make changes as necessary to maintain accounting compliance. Thus, business units are responsible to understand and to adhere to the policy. CAA will assist business units to appropriately apply the policy.

Docket No. E002/GR-10-971 Exhibit___(LHP-2), Schedule 2 Page 2 of 12 Guidance

The Federal Energy Regulatory Commission (FERC) Uniform System of Accounts does not specifically cover accounting for computer software costs. To provide consistent accounting for such costs, the Chief of the Audit Division at FERC issued a memorandum on March 1, 1977, stating that major new software involving relatively large expenditures, where benefits are realized over several years, should be capitalized and amortized over the useful life of the software not to exceed five years. The recurring minor cost of maintaining or updating existing software and the minor cost of new software should be charged directly to expense.

On March 4, 1998, the American Institute of Certified Public Accountants (AICPA) published a Statement of Position (SOP) containing accounting guidance for internal use computer software that was cleared by the Financial Accounting Standards Board (FASB). This SOP applies to all nongovernmental entities and is effective for financial statements for fiscal years beginning after December 15, 1998. The internal use computer software policy will follow the guidelines contained in the SOP beginning with projects that will be in construction after December 31, 1998.

Definitions

Amortization Period – The period over which the individual software asset is used and useful. CAA – Capital Asset Accounting

Capital – The purchase or construction of a retirement unit that will be recorded on the balance sheet as an asset after meeting the GAAP criteria for being an asset

Capital Expenditure – Expenditures necessary to install or remove an asset

Child Work Order – This is a work order where the actual costs are accumulated. These are often called just work orders without the prefix “child”. The forecasting does not occur at this level.

Completion Date – The date upon which the construction is finished whereby all appropriate charges have been recognized to the capital work order and the final as-built has been determined CWIP – Construction Work in Process

FASB – Financial Accounting Standards Board FERC – Federal Energy Regulatory Commission

In service Date – The date upon which the asset is used and useful; it has entered its operating phase and it is contributing to the revenue of the Company either directly or indirectly

Maintenance Expenditure – Expenditures that relate to the periodic costs associated with the repairing the asset such that it can be returned to service, often grouped with Operating Expenditure as the term O&M

O&M – Operating and maintenance

Operating Expenditure – Expenditures that relate to the periodic costs associated with the daily running of the Company

Parent Work Order – Parent funding project work order that holds budget and projected in service information that can have one or several child work orders under it for the total project spending monitoring.

Docket No. E002/GR-10-971 Exhibit___(LHP-2), Schedule 2 Page 3 of 12 Useful Life – The period of time in which the benefits of the software development will be realized.

Content Definition

Capitalization of software follows a similar process to capitalization for all construction assets. It begins with a test of whether the work is capital or not. Work is capital when a retirement unit is being replaced or installed (e.g. the business area has demonstrated that the construction work will result in an asset owned by Xcel Energy or its operating companies). Software retirement units are shown below. The capitalization review applies a second test for minimum dollar invested, for which software below this minimum is not capitalized. This minimum dollar guideline is discussed below as well. The capitalization test is performed first when requesting a parent work order and again when requesting a child work order. It is the business unit’s responsibility to provide sufficient detailed information for CAA to accurately determine the proper classification of project costs. Capitalized Costs

Once a project has been defined as capital, the collection of capital costs into a construction work order may begin when both of the following have occurred:

• The preliminary project phase is complete (e.g. “What-if” stage, build versus buy decision)

• Management has committed to funding the specific software project and it is probable that the project will be completed with the software performing its intended function. The vendor selection process is O&M and does not need to be completed at this point. Software development costs that are to be capitalized should reflect only those costs directly associated with the development project. Training costs of any type are not directly associated with the development of the software and as such will be expensed as incurred.

Only the following costs for development of internal-use computer software may be capitalized:

• External direct costs of materials and services in developing or obtaining the software

• Travel expenses incurred by employees in their duties directly associated with development

• Payroll and payroll related costs for employees directly associated with and who devote time to the software project, to the extent of the time spent directly on the project (labor costs for management of the project should not be capitalized unless the management personnel have a direct functional responsibility for the construction of the capital project)

• Interest costs or Allowance for Funds During Construction (AFDC)

Docket No. E002/GR-10-971 Exhibit___(LHP-2), Schedule 2 Page 4 of 12 project. For this reason, Administrative and General (A&G) costs and overhead costs will not be charged directly or allocated through departmental allocations to the capital project. Conversion of data from the old to the new system may involve cleansing and balancing of the data, creation of new or additional data, and conversion of the old data to the new system. Data conversion most often happens during the application development stage. All data conversion costs will be expensed however; the costs to develop or obtain software that allows for the automated conversion of the old data to the new system can be capitalized.

Sometimes internal-use computer software is purchased for use from a third party and the purchase price includes the software, training for the software, maintenance work to be completed by the third party, data conversion costs, reengineering costs, and rights to future upgrades and enhancements. The purchase price must be allocated between the categories and split between capital and expense according to the above guidelines.

The software development must pertain to a new product, not an expensive change to an existing system resulting in the continuing operation of the original functionality. For example, expenditures required to modify existing software systems to enable the processing of transactions in the year 2000 should be expensed. Some modifications could potentially extend the useful life of certain software, but such costs are generally maintenance expenditures because the work maintains the same functionality of the original software. Also, modifications cannot be capitalized if the original software system was expensed as it was developed.

Minimum Dollar Guidelines Software

The minimum dollar guidelines are applied after the potential project is reviewed for capitalization. If the project is deemed capital, then the project is tested against the minimum dollar amounts. On January 1, 2010, the minimum dollar rules change. All projects initiated before January 1, 2010 fall under the old minimum dollar guidelines. The old rules have varying limits depending on operating company if designed of just one operating company. If more than one operating company was involved, then the Xcel Energy common minimum value is applied. Beginning January 1, 2010, there is one minimum dollar value for all projects regardless of which operating company, one or many, are involved. The new minimum dollar guidelines include any common systems or any specific jurisdictional system development projects. Additionally, projects that are defined within the capitalization parameters of the retirement units listed below also will be considered under the new minimum dollar guidelines.

In addition to the software application development projects any packaged and licensed software exceeding the guidelines can be capitalized as internal use software. If there is a project where licenses or packaged software is purchased as a group to be placed in service at the same time the group can be reviewed for consideration as a capital purchase. CAA can provide a capital determination on specific projects where bundled purchase agreements are utilized.

Effective for software projects initiated before December 31, 2009

• Xcel Energy common systems - $1,000,000

Docket No. E002/GR-10-971 Exhibit___(LHP-2), Schedule 2 Page 5 of 12 • PSCo - $500,000 • SPS - $250,000 • Energy Markets - $500,000

Effective for software projects initiated after January 1, 2010

• All Software, all companies - $250,000 O&M Costs

The SOP guidelines that are followed for capitalization lists stages of project development as capital or O&M as a guideline to follow for the various activities that occur in those stages. The preliminary stage activity (O&M) is planning and review while the development stage activities (capital) are constructing the software application. Various activities can occur at anytime during the project life cycle and are to be classified in their relationship to the application development.

The following costs are expensed whenever they occur:

• Maintenance fees are not a direct cost of development. They will be expensed even if incurred during the application development stage.

• Extended Warranties are not capitalized, as they are not needed for asset development but rather offer extended protection for product reliability beyond the normal warranty period. See reference document on warranty and maintenance agreements:

Warranty Vs Maintenance Agreement

• Data conversion or input costs unless accomplished through a purchased or developed data conversion software package.

• Indirect activity relating to administrative support.

• Relocation and testing of other applications or operating software to or from existing machines to make room for the developed application.

• Preliminary analysis activity to determine technical and business needs in order to make a decision as to the type of software application that is needed.

• Costs to maintain or operate the system after it is in use.

• Costs relating to modifications or the purchase of other fixed assets of the Company should follow that specific asset’s rules. If the work on that asset is O&M, it cannot be capitalized with the software. An example is reconfiguring cubes follows the furniture rules and is O&M. Buying new cubes is capital under the furniture rules and is capital to the furniture asset accounts.

In general, any costs that are not directly related to the application development, rollout, and testing should be expensed as O&M along with any subsequent maintenance activity following the

Docket No. E002/GR-10-971 Exhibit___(LHP-2), Schedule 2 Page 6 of 12 Retirement Units

Internal Use Computer Software

Software acquired, internally developed, or modified solely to meet internal needs of the Company. During development, use, or modification, no substantive plan exists or is being developed to market the software externally. Generally the purpose of the software application is to perform a task or function for the company electronically. Examples include general ledger, purchasing and payroll systems.

Module

Computer software development can be developed and put in service as one complete package or it may be developed and put into service in phases or modules. Several modules could be in development simultaneously or they may be developed individually on a scheduled timetable. Each module must:

• Have a clear division between it and other modules

• Have definite start and stop dates

• Be able to ‘stand alone’ if other modules of the same project were canceled

Prior to Jan 1, 2010 any module developed was required to be initiated with-in a two year period following the completion of the core application and was included as a component of the overall core application costs for capitalization determination. After Jan 1, 2010 each module is considered a stand alone application and must meet minimum dollar guidelines before it can be capitalized. As a stand alone application there is no time limit for the addition of any module to a core application.

Thus, each module must have a clear definition, definite start and stop dates, and be able to stand- alone. For example, if a company’s budgeting system is made up of two separate modules--capital and operating. They could be developed separately of one another and neither would have to be dependent on the other. This clear definition between the two modules as well as the ability to ‘stand alone’ would allow them to have separate in service dates.

Software development for large or unique projects may require development in phases over a substantial period of time. Phased development may include installing the software for different users at different times because of the size or complexity of the project. Each phase may have clear point of completion; however each phase is a continuation of the core application development and not a module component. Software with phased development or implementation is limited to a two year time frame for completion unless approval for an extended period is obtained from CAA. Please contact CAA (CAA hotline: 612-330-6490) to discuss new development projects or modules being added to existing systems at the time the dollars are being budgeted to be sure the expenditures qualify for capitalization. The cancellation of a phase or modules may cause the costs associated with other development activity to shift from capital to expense even if it is completed and classified.

Docket No. E002/GR-10-971 Exhibit___(LHP-2), Schedule 2 Page 7 of 12 Upgrade or Enhancements

Modifications to existing internal use software that result in significant additional functionality-that is, modifications to enable the software to perform tasks that it was previously incapable of performing. Generally, this would refer to the addition of, or the replacement of, an entire module not a few lines of code added here and there to gain the additional capability. New releases can be classified as an upgrade if the release is on new platform or contains sufficient improvements so as to provide new functionality for the system.

SOP 98-1 states:

That is, modifications to enable the software to perform tasks that it was previously incapable of performing. Upgrades and enhancements normally require new software specifications and may also require a change to all or part of the existing software specifications. In order for costs of specified upgrades and enhancements to internal-use computer software to be capitalized it must be probable that those expenditures will result in additional functionality.

Change in Functionality

Simply stated, this occurs when providing a new process or new task that the application was not able to perform in the previous version. This excludes updating an application to be able to work with some other new release of operating software or perform the same type of task in conjunction with other systems changes. These examples will not change the application function.

Licensed Software and Commercial Off The Shelf Software

The software purchased as part of an application development project or that is needed for the operating platform is sometimes referred to as licensed software and priced with a one time fee for unlimited use. When a licensed software application is part of a larger development project it is included in the larger application development cost for capitalization. When the license software is an operating system purchased at the time new hardware is purchased, it is included as part of the new hardware it is operating. Thus, the function that the software performs is the basis for how it will be classified.

Some licensed agreements are end user based or are priced based on number of sites. These should be packaged as one asset (if all are purchased at one specific point in time) for the specific project. Any annual fee based licensed application costs are to be expensed in the period for which the fee applies and any licensing for a limited period needs to be reviewed to determine the proper classification. Commercial Off The Shelf software (COTS) is sometimes referred to as packaged software or “plug and play” software and is subject to the above capitalization limits as well. Both licensed and COTS software can be considered as a group purchase when the software will be used as part of one project and all of the group will be in serviced at the same time.

Docket No. E002/GR-10-971 Exhibit___(LHP-2), Schedule 2 Page 8 of 12 Minor Units – Other Software

Operating Systems

Operating systems are programs that perform a very specific task, usually related to managing system resources. Operating systems contain a number of utilities for managing disk drives, printers, and other devices. Operating systems provide a software platform on top of which other programs, called application programs, can run. The application programs must be written to run on top of a particular operating system. Your choice of operating system, therefore, determines to a great extent