The AES Corporation (AES)

Contract Accounting:

        The Company previously reported it lacked effective controls designed to ensure an adequate analysis and documentation of certain contracts, at inception and upon modification, to allow them to be adequately accounted for in accordance with U.S. GAAP. Certain of our contracts, at inception or upon modification, contain terms that trigger specific accounting treatment related to derivatives, hedges, lease accounting, variable interests and guarantees that our controls had not always effectively identified. These types of interconnections between accounting principles are significant factors that led to contract-related accounting adjustments in the Company's financial statements.

        During the course of remediating this material weakness, the Company developed a remediation plan which included, among other controls, a broad review of contracts by the Company's accounting department so that the Company can identify and properly account for leases, derivatives and hedging activities, variable interests under FIN No. 46(R), Consolidation of Variable Interest Entities and guarantees under FIN No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others—an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34. The completeness of the contract evaluation process is essential to establishing proper contract accounting in conformity with U.S. GAAP.

        The steps related to the remediation plan include the following:

•

engaged outside resources to assist management in refining comprehensive contract review policies and procedures for use by our subsidiaries when evaluating, reviewing and approving contracts that may qualify as derivatives or hedges, that may contain embedded derivatives, that may qualify as leases, or that may contain variable interests or guarantees;



•

developed an automated solution (implemented in February 2007) to collect and consolidate all material contracts at our subsidiaries to assist in the appropriate evaluation and documentation requirements in accordance with U.S. GAAP;



•

provided detailed training to subsidiaries on new policy and procedure guidance related to contract evaluation;

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•

centralized certain hedge assessments and valuations within the Corporate Accounting and Risk Management functions;



•

implemented an integrated automated software system to perform valuations, perform regression testing, document hedge effectiveness, calculate ineffectiveness and maintain a roll-forward of OCI for certain derivative instruments;



•

improved procedures to ensure the submission of contracts and contract modifications for U.S. GAAP evaluation;



•

provided additional training to both finance and non-finance employees who are responsible for hedging activities, development of power purchase agreements and negotiation of significant purchase contracts;



•

hired high level, qualified staff to provide expertise required to evaluate complex transactions and with knowledge and understanding of derivative valuation and hedge activities;



•

improved the review process to evaluate the accuracy of the accounting analysis for new and amended contracts;



•

established improved control procedures to identify variable interest entities for potential consolidation; and



•

performed an assessment of contracts dated prior to the implementation of the above controls (July 1, 2006) relative to the risk of additional errors. All contracts, which included a population of over 450, that were considered to have more than a minimal level of risk, were reviewed and analyzed to determine proper accounting treatment.

        The Company tested the operating effectiveness of the control steps described above, and concluded that, as of December 31, 2008, this previously reported material weakness has been remediated. While the Company believes that it has remediated the material weakness in this area, the Company will continue to evaluate the operating effectiveness of the controls that have been implemented to ensure that processes and procedures are continually enhanced and enforced to ensure timely recording, processing, summarizing and review of all significant contracts and contract modifications. Given the complexity of the industry in which the Company operates and the complexity of accounting assessments in the area of derivatives, hedges, lease accounting, variable interests and guarantees, no system of internal control process or environment will be able to provide absolute assurance that errors in the future will not occur, nor that judgments about accounting conclusions will not evolve over time. However, the Company believes it has established an effective internal control system over its contract accounting process that will allow for timely identification and assessment of potential accounting issues and the proper accounting treatment in the Company's financial statements.

Contract Accounting:

        As of December 31, 2006, the Company reported it lacked effective controls designed to ensure an adequate analysis and documentation of certain contracts, at inception and upon modification, to allow them to be adequately accounted for in accordance with U.S. GAAP. As discussed below, certain of our contracts, at inception or upon modification, contain terms that trigger specific accounting treatment related to derivatives, hedges, lease accounting, variable interests and guarantees that our controls have not effectively identified. These types of interconnections between accounting principles are significant factors that led to contract-related accounting adjustments in the Company's financial statements. In 2007, the Company identified and reported a material adjustment related to a contract that was entered into in 2004 and should have been accounted for as a derivative in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, ("SFAS No. 133"), and reported adjustments for several errors related to accounting for embedded derivatives in contracts that were executed prior to 2006. The Company also previously reported it lacked an effective control to ensure that an adequate hedge valuation was performed and lacked effective controls to ensure preparation of adequate documentation of the on-going assessment of hedge effectiveness, in accordance with SFAS No. 133 for certain interest rate and foreign currency hedge contracts entered into prior to 2005. In

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2007, subsequent to the filing of the 2006 Form 10-K on May 23, 2007, the Company identified certain lease-related errors related to the accounting for contract modifications that occurred after the July 1, 2003 implementation of EITF 01-08, Determining Whether an Arrangement Contains a Lease, ("EITF 01-08"), whereby contract modifications had not been evaluated for proper lease accounting treatment. In 2007, the Company also identified a variable interest entity that should have been consolidated pursuant to FIN No. 46(R), Consolidation of Variable Interest Entities, ("FIN No. 46(R)").

        As a result, the Company determined that the lack of effective controls could result in a reasonable possibility of material misstatement and thus continued to represent a material weakness as of September 30, 2008.

Contract Accounting:

        As of December 31, 2006, the Company reported it lacked effective controls designed to ensure an adequate analysis and documentation of certain contracts, at inception and upon modification, to allow them to be adequately accounted for in accordance with U.S. GAAP. As discussed below, certain of our contracts, at inception or upon modification, contain terms that trigger specific accounting treatment related to derivatives, hedges, lease accounting, variable interests and guarantees that our controls have not effectively identified. These types of interconnections between accounting principles are significant factors that led to contract-related accounting adjustments in the Company's financial statements. In 2007, the Company identified and reported a material adjustment related to a contract that was entered into in 2004 and should have been accounted for as a derivative in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, ("SFAS No. 133"), and reported adjustments for several errors related to accounting for embedded derivatives in contracts that were executed prior to 2006. The Company also previously reported it lacked an effective control to ensure that an adequate hedge valuation was performed and lacked effective controls to ensure preparation of adequate documentation of the on-going assessment of hedge effectiveness, in accordance with SFAS No. 133 for certain interest rate and foreign currency hedge contracts entered into prior to 2005. In 2007, subsequent to the filing of the 2006 Form 10-K on May 23, 2007, the Company identified certain lease-related errors related to the accounting for contract modifications that occurred after the July 1, 2003 implementation of EITF 01-08, Determining Whether an Arrangement Contains a Lease, ("EITF 01-08"), whereby contract modifications had not been evaluated for proper lease accounting treatment. In 2007, the Company also identified a variable interest entity that should have been consolidated pursuant to FIN No. 46(R), Consolidation of Variable Interest Entities, ("FIN No. 46(R)").

        As a result, the Company determined that the lack of effective controls could result in a reasonable possibility of material misstatement and thus continues to represent a material weakness as of June 30, 2008.

Contract Accounting:

        The Company previously reported it lacked effective controls designed to ensure an adequate analysis and documentation of certain contracts, at inception and upon modification, to allow them to be adequately accounted for in accordance with U.S. GAAP. Certain of our contracts, at inception or upon modification, contain terms that trigger specific accounting treatment related to derivatives, hedges, lease accounting, variable interests and guarantees that our controls have not effectively identified. These types of interconnections between accounting principles are significant factors that led to contract-related accounting adjustments in the Company's financial statements.

        During the course of remediating this material weakness, the Company developed a remediation plan which includes, among other controls, a broad review of contracts by the Company's accounting department so that the Company can identify and properly account for leases, derivatives and hedging activities, variable interests under FIN No. 46(R) and guarantees under FIN No. 45. The completeness of the contract evaluation process is essential to establishing proper contract accounting in conformity with U.S. GAAP.

        Although the Company believes it has implemented appropriate controls to ensure remediation of the Contract Accounting material weakness, we will continue to assess the operating effectiveness of these controls as well as identify areas for improvement to the execution of the current controls, before concluding full remediation.

        The completed steps related to the remediation plan include the following:

•

engaged outside resources to assist management in refining comprehensive contract review policies and procedures for use by our subsidiaries when evaluating, reviewing and approving contracts that may qualify as derivatives or hedges, that may contain embedded derivatives, that may qualify as leases, or that may contain variable interests or guarantees;



•

developed an automated solution (implemented in February 2007) to collect and consolidate all material contracts at our subsidiaries to assist in the appropriate evaluation and documentation requirements in accordance with U.S. GAAP;



•

provided detailed training to subsidiaries on new policy and procedure guidance related to contract evaluation;



•

centralized hedge assessments and valuations within the Corporate Accounting and Risk Management functions;



•

improved procedures to ensure the submission of contracts and contract modifications for U.S. GAAP evaluation;



•

provided additional training to both finance and non-finance employees who are responsible for hedging activities, development of power purchase agreements and negotiation of significant purchase contracts: and



•

performed an assessment of all contracts dated prior to the implementation of the above controls (July 1, 2006) relative to the risk of additional errors. All contracts, which included a population of over 500, that were considered to have more than a minimal level of risk, were reviewed and analyzed to determine proper accounting treatment. As a result of this review, three contracts were determined to have been accounted for in error. Prior period results have been restated to reflect the correction of these errors.

        As noted, while the Company believes that it has reviewed its significant contracts, the Company will continue to evaluate the operating effectiveness of the controls that have been implemented to ensure that processes and procedures are in place to ensure timely gathering and review of all

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significant contracts and contract amendments. The Company will also continue to enhance the design of certain controls to address:

•

the process for reviewing new and amended contracts to evaluate the accuracy of the accounting analysis;



•

the process for ensuring the completeness of the population of contracts subject to the above accounting analysis;



•

the process for identifying variable interest entities for potential consolidation;



•

the systems and processes used to ensure the proper valuation of derivative instruments; and



•

the process for documentation of the on-going assessment of hedge effectiveness.

        The Company continues to implement the remediation plans of this material weakness and it will assess the operating effectiveness of these controls as well as identify areas for improvement to the current execution of certain controls prior to concluding full remediation. Until the remediation steps identified above are fully implemented, there remains a reasonable possibility of material misstatement. Accordingly, this item is a material weakness as of March 31, 2008.

PART II: OTHER INFORMATION

Contract Accounting:

        As of December 31, 2006, the Company reported it lacked effective controls designed to ensure an adequate analysis and documentation of certain contracts, at inception and upon modification, to allow them to be adequately accounted for in accordance with Generally Accepted Accounting Principles (United States). As discussed below, certain contracts, at inception or upon modification, contain terms that trigger specific accounting treatment related to derivatives, hedges, lease accounting, variable interests and guarantees, and controls have not been effectively identified. These types of interconnections between accounting principles are significant factors that led to contract-related accounting adjustments in the Company's financial statements. In 2007, the Company identified and reported a material adjustment related to a contract that was entered into in 2004 and should have been accounted for as a derivative in accordance with Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"), and reported adjustments for several errors related to accounting for embedded derivatives in contracts that were executed prior to 2006. The Company also previously reported it lacked an effective control to ensure that an adequate hedge valuation was performed and lacked effective controls to ensure preparation of adequate documentation of the on-going assessment of hedge effectiveness, in accordance with SFAS No. 133 for certain interest rate and foreign currency hedge contracts entered into prior to 2005. In 2007, subsequent to the filing of the 2006 Form 10-K on May 23, 2007, the Company identified certain lease-related errors related to the accounting for contract modifications that occurred after the July 1, 2003 implementation of Emerging Issues Task Force No. 01-08, Determining Whether an Arrangement Contains a Lease, whereby contract modifications had not been evaluated for proper lease accounting treatment. In 2007, the Company also identified a variable interest entity that should have been consolidated pursuant to Financial Accounting Standards Board Interpretation No. 46(R), Consolidation of Variable Interest Entities.

        As a result of the errors identified above, the Company determined that the lack of effective controls in the processes described could result in a reasonable possibility of a material misstatement of the Company's annual or interim financial statements occurring that would not be prevented or detected on a timely basis. Accordingly, these deficiencies continue to represent material weaknesses as of December 31, 2007.

        These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated balance sheet as of December 31, 2007, and the related consolidated statements of operation, changes in stockholders' equity, cash flows, and financial

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statement schedules as of and for the year ended December 31, 2007, of the Company and this report does not affect our report on such financial statements and financial statement schedules.

        In our opinion, because of the effect of the material weaknesses identified above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

        We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2007, and the related consolidated statements of operations, changes in stockholders' equity, cash flows and the financial statement schedules as of and for the year ended December 31, 2007, of the Company and out report dated March 14, 2008 expressed an unqualified opinion on those financial statements and financial statement schedules and includes explanatory paragraphs relating to the adoption of Financial Accounting Standards Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" in 2007, Statement of Financial Accounting Standards No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans" in 2006, Financial Accounting Standards Board Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations" in 2005, and the restatements of the consolidated financial statements and financial statement schedules as discussed in Note 1.

/s/ Deloitte & Touche LLP

McLean, Virginia
March 14, 2008

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Contract Accounting:

        As noted above, the material weakness previously disclosed as a "Derivative Accounting" material weakness was restated to a "Contract Accounting" material weakness in the Company's August 2007 Form 10K/A. Although the material weakness was restated, the remediation plan disclosed prior to the restatement remained in place with the addition of the steps identified below. The Company believes it has implemented appropriate controls to ensure remediation of the previously identified material weakness, and will continue to assess the operating effectiveness of these controls as well as identify areas for improvement to the execution of current controls, before concluding on full remediation. During the third quarter of 2007 the Company made progress toward the completion of the remediation steps added after the August 2007 restatement. Such progress included the implementation of a new contract completeness certification process and the identification of certain contracts that will be subject to further US GAAP review. The Company also deployed additional online contract and derivative accounting training modules. As previously disclosed, the completed steps related to the remediation plan include the following:

•

Engaged outside resources to assist management in refining comprehensive contract review policies and procedures for use by our subsidiaries when evaluating, reviewing and approving

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contracts that may qualify as derivatives or hedges, that may contain embedded derivatives, that may qualify as leases, or that may contain guarantees;

•

Developed an automated solution (implemented in February 2007) to collect and consolidate all material contracts at our subsidiaries to assist in the appropriate evaluation and documentation requirements in accordance with US GAAP;



•

Provided detailed training to subsidiaries on new policy and procedure guidance related to contract evaluation; and



•

Centralized hedge assessments and valuations within the Corporate Accounting and Risk Management functions.

        Additional steps added to the remediation plan as a result of the restated material weakness and which have not been completed:

•

Improved procedures to ensure the submission of contracts and contract modifications for US GAAP evaluation; and



•

Additional training to both finance and non-finance employees who are responsible for hedging activities, development of power purchase agreements and negotiation of significant purchase contracts.

Contract Accounting:

As noted above, the material weakness previously disclosed as a “Derivative Accounting” material weakness has been restated to a “Contract Accounting” material weakness. Although the material weakness has been restated, the remediation plan in place prior to the restatement remains in place with the additional steps identified below. The Company believes it has implemented appropriate controls to ensure remediation of the previously identified material weakness, and will continue to assess the operating effectiveness of these controls as well as identify areas for improvement to the execution of current controls, before concluding on full remediation. The completed steps related to the remediation plan include the following:

·       Engaged outside resources to assist management in refining comprehensive contract review policies and procedures for use by our subsidiaries when evaluating, reviewing and approving contracts that may qualify as derivatives or hedges, that may contain embedded derivatives, that may qualify as leases, or that may contain guarantees;

·       Developed an automated solution (implemented in February 2007) to collect and consolidate all material contracts at our subsidiaries to assist in the appropriate evaluation and documentation requirements in accordance with US GAAP;

·       Provided detailed training to subsidiaries on new policy and procedure guidance related to contract evaluation; and

·       Centralized hedge assessments and valuations within the Corporate Accounting and Risk Management functions.

Additional steps added to the remediation plan as a result of the restated material weakness and which have not been completed:

·       Improved procedures to ensure the submission of contracts and contract modifications for US GAAP evaluation; and

·       Additional training will be provided in the future to both finance and non-finance employees who are responsible for hedging activities, development of power purchase agreements and negotiation of significant purchase contracts.

Contract Accounting:

As noted above, the material weakness previously disclosed as a “Derivative Accounting” material weakness has been restated to a “Contract Accounting” material weakness. Although the material weakness has been restated, the remediation plan in place prior to the restatement remains in place with

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the additional steps identified below. The Company believes it has implemented appropriate controls to ensure remediation of the previously identified material weakness, and will continue to assess the operating effectiveness of these controls as well as identify areas for improvement to the execution of current controls, before concluding on full remediation. The completed steps related to the remediation plan include the following:

·       Engaged outside resources to assist management in refining comprehensive contract review policies and procedures for use by our subsidiaries when evaluating, reviewing and approving contracts that may qualify as derivatives or hedges, that may contain embedded derivatives, that may qualify as leases, or that may contain guarantees;

·       Developed an automated solution (implemented in February 2007) to collect and consolidate all material contracts at our subsidiaries to assist in the appropriate evaluation and documentation requirements in accordance with US GAAP;

·       Provided detailed training to subsidiaries on new policy and procedure guidance related to contract evaluation; and

·       Centralized hedge assessments and valuations within the Corporate Accounting and Risk Management functions.

Additional steps added to the remediation plan as a result of the restated material weakness and which have not been completed:

·       Improved procedures to ensure the submission of contracts and contract modifications for US GAAP evaluation; and

·       Additional training will be provided in the future to both finance and non-finance employees who are responsible for hedging activities, development of power purchase agreements and negotiation of significant purchase contracts.

Contract Accounting:

The Company previously reported it lacked effective controls related to accounting for certain derivatives under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). In the May 2007 restatement, the Company reported adjustments for several derivative-related errors related to the accounting for embedded derivatives in contracts that were executed prior to 2006. The Company also previously reported it lacked an effective control to ensure that an adequate hedge valuation was performed and lacked effective controls to ensure preparation of adequate documentation of the on-going assessment of hedge effectiveness, in accordance with SFAS 133, for certain interest rate and foreign currency hedge contracts entered into prior to 2005. During the course of remediating this material weakness, the Company developed a remediation plan which includes, among other controls, a broad review of contracts by the Company’s accounting department so that the Company can identify and properly account for derivatives and hedging activities. After the May 2007 Restatement and as part of the Company’s review of contracts within the remediation effort for this material weakness, the Company identified certain lease-related errors related to the accounting for contract modifications that occurred

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after the July 1, 2003 implementation of EITF 01-08, Determining Whether an Arrangement Contains a Lease (EITF 01-8) . The contract modifications had not been evaluated for proper lease treatment. While leases are not derivative instruments, a contract must be evaluated as a lease and may be subject to the requirements of SFAS No. 133. These types of interconnections between accounting principles generally accepted in the United States (US GAAP) are a factor which played a significant role in the Company’s decision to broaden the remediation of the “Derivative Accounting” material weakness into one that would address the adequate accounting for contracts under US GAAP. The completeness of the contract evaluation process is essential to establishing proper contract accounting in conformity with US GAAP. Accordingly, the Company determined that the restatement of the “Derivative Accounting” material weakness to “Contract Accounting” more accurately reflects the ineffective operation of controls designed to ensure an adequate analysis and documentation of certain contracts, at inception and upon modification, to allow them to be adequately accounted for in accordance with US GAAP. The errors that have been identified during the remediation have been recorded in the May 2007 Restatement or the August 2007 Restatement as described in the Restatement section in Part I of this Form 10-K/A. As a result of these errors, and the lack of sufficient time to test operating effectiveness of newly implemented controls, the Company determined that the lack of effective controls could result in a more than remote likelihood of material misstatement and thus continues to represent a material weakness as of December 31, 2006.