ML030340148

Tennessee Valley Authority 2002 Annual Report

ML030340148
Person / Time
Site:	Browns Ferry, Watts Bar, Sequoyah   (CPPR-0092, DPR-033, DPR-052, DPR-068, DPR-077, DPR-079, NPF-090)
Issue date:	01/28/2003
From:	Burzynski M Tennessee Valley Authority
To:	Document Control Desk, Office of Nuclear Reactor Regulation
References
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Download: ML030340148 (125)

Text

Tennessee Valley Authority, 11 Ot Market Street, Chattanooga, Tennessee 37402-2801 January 28, 2003 U.S. Nuclear Regulatory Commission ATTN: Document Control Desk Washington, D.C. 20555-0001 Gentlemen:

In the Matter of

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Docket No. 50-327 50-259 Tennessee Valley Authority

)

50-328 50-260 50-390 50-296 50-391 TENNESEE VALLEY AUTHORITY (TVA) 2002 ANNUAL REPORT In accordance with the requirements of 10 CFR 50.71(b) and 10 CFR 140.21(e), enclosed are six copies of TVA's 2002 Annual Report. This report contains the financial data required by both regulations.

If you have questions regarding this report, please call Fred Mashbum at (423) 751-8817.

Sincerely, MauzynJ?

Manager Nuclear Licensing Enclosures cc (Enclosure):

U.S. Nuclear Regulatory Commission Region II Sam Nunn Atlanta Federal Center 61 Forsyth Street, SW, Suite 23T85 Atlanta, Georgia 30303-8931

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TENNESSEE VALLEY AUTHORITY 2002 ANNUAL REPORT

Cumberland Fossil Plant, TVA's lare.t coal-fired generating plant Steward of the Tennessee Valley's Resources TVA manages the Tennessee River system, balancing the public benefits of navigation, flood control, power production and transmission, water quality and recreation.

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table of contents 1 Financial Highlights 2 Corporate Profile 3 Power System Statistics 4 Chairman's Letter 8 Affordable Energy 12 Environmental Stewardship 16 Economic Development 20 Financial Table of Contents 21 Summary Analysis of Results of Operations and Financial Condition 22 Condensed Statements of Income 24 Condensed Balance Sheets 24 Condensed Statements of Cash Flows 27 Forward-Looking Statements 28 Certifications of the Members of the TVA Board of Directors 29 Certification of Chief Financial Officer 30 Report of Independent Accountants 31 Report of Management 32 Report of Inspector General 33 Board of Directors and Executive Committee 36 Investor Information Insert Information Statement Financial Highlights-Power Program At September 30 or for the years ended September 30, as appropriate (in millions)

Summary statements of income Operating revenues Operating expenses Operating income Other income, net Interest expense, net Income before loss on impairment of assets/plant cancellation Loss on impairment of assets/plant cancellation Net income (loss)

Total assets Discount notes Long-term debt, including current maturities Total indebtedness Cash flows from operations Construction expenditures

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$ 6,835 (5,186)

$ 6,999 (5,506)

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$ 1,015 (30) 21 ANNUAL REPORT 2002 1

corporate profile The Tennessee Valley Authority (TVA) is the nation's largest public power producer Wholly owned by the U S government, TVA was established by Congress in 1933 primarily to provide navigation, flood control and agricultural and industrial development and to promote the use of electric power in the Tennessee Valley region Througlh 158 public power utilities, TVA supplies electricity to 8 3 million people in the TVA service area. Along with affordable, reliable power, TVA delivers value to the regional economy by supporting a thriving river system and promoting economic growth Generation

• Nation's largest public power system

• 31,517 megawatts of capacity (net winter dependable)

• 11 fossil plants (59 units)

• 3 nuclear plants (5 units)

• 29 hydro plants (109 units)

• 6 combustion turbine plants (72 units)

• 14 solar energy sites

• 3 wind turbines

• 2 methane gas facilities

• 1 pumped storage plant (4 units)

• Customers 158 power distnbutors 62 directly served customers 11 exchange power arrangements Transmission Stewardship Economic Development

• Reliable even under severe conditions

• 99.999 percent reliability

• Well located for power transfers

• 17,000 miles of transmission lines

• 120,000 transmission-line structures

• 984 individual interchange and connection points

• 240,000 nght-of-way acres

• 80,000-square-mile service area

• Nation's fifth-largest river system

• 800 miles of commercially navigable waterways

• 49 dams for integrated river management

• 50 million short-tons of goods shipped annually

• $104 million in potential flood damage avoided in 2002

• 11,000 miles of public shoreline

• $328 million in tax-equivalent payments to Valley states and counties

• $1 3 billion total TVA employee compensation

• $22 million of economic development loan commitments to Valley businesses

• $2 billion spent in Valley states for products, fuel and services 2

TENNESSEE VALLEY AUTHORITY

TVA sponsorship supported a team of Tuskegee University engineering students-including Shirshir Kumar-David, Trey Raines and Keisha Richardson-as they built a solar-powered home in the Department of Energy's 2002 Solar Decathlon competition.

Power System Statistics At September 30 or for the years ended September 30, as appropriate System input (millions of kilowatt-hours)

System generation Hydro, including pumped storage Fossil Nuclear Combustion turbine Green power Total net generation Purchased Total system input System output (millions of kilowatt-hours)

Sales Municipalities and cooperatives Industries directly served Federal agencies and other Total sales Other Losses Total system output Net winter dependable capacity (megawatts)

System peak load (megawatts)-summer System peak load (megawatts)-winter Annual load factor (percent)

Number of employees as of September 30 Percent winter dependable capacity by fuel source Fossil Nuclear Hydro Combustion turbine

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10,205 94,930 45,179 1,190 18 9,508 100,118 45,615 1,073 5

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(1) 1 1 260 151,522 156,319 (3) 13,599 9,866 38 165,121 166,185 (1) 128,600 129,760 (1) 26,478 23,306 14 5,013 8,355 (40) 160,091 161,421 (1) 1,022 793 29 4,008 3,971 1

165,121 166,185 (1) 31,517 29,052 26,061 63.5 13,444 49%

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30,365 27,368 27,163 67.0 13,430 49%

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(5) 15 ANNUAL REPORT 2002 3

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The past year is best described as a year of challenge. Our region experienced a milder than normal winter, and the nation experienced the effects of a sluggish economy. Despite those conditions, the people of TVA focused on our core business, demonstrated excellence in achieving our performance goals and met customers' needs without a rate increase.

We brought on line 680 megawatts of new peaking capacity, set nine continu-ous-run records at our coal-fired plants, set a world record for safe, reliable generation at Browns Ferry Nuclear Plant, and invested in state-of-the-art equipment to further reduce emissions from our coal-fired plants We achieved the best reliability record ever for TVA's transmission system, and we had an outstanding year for employee safety Financially, we managed budget con-straints, completed a lease/leaseback of 680 megawatts of peaking capacity and reduced TVA's outstanding balance of bonds and notes by $120 million More than ever, throughout our operations, we are intent on setting and reaching goals that enable TVA to achieve excellence in business performance and public service. I am pleased to share with you this report on our perform-ance in 2002 and a look ahead at how we are committed to paving the way for accelerated progress in the future COMMITTED TO ENERGY In producing electricity for the 8 3 million people of the Tennessee Valley, the TVA power system met a peak demand of 29,052 megawatts and earned revenues of $6 8 billion The efficiency of our generating and transmission 4

TENNESSEE VALLEY AUTHiORITY

W 2, F' al FIN Director Bill Baxter system resulted in operating costs among the lowest in the industry. All TVA nuclear plants have earned the top performance ratings from the Institute of Nuclear Power Operations, and several of our fossil plants are nationally recog-nized for productivity and low costs. Average residential, commercial and industrial prices in the TVA region are 22, 14 and 16 percent below the national average, respectively, and we are beginning our fifth year with no rate increase.

COMMITTED TO THE ENVIRONMENT TVA serves as a steward of the Tennessee Valley's environment and manages the Tennessee River system to provide multiple benefits, including navigation, power supply, water supply and recreation.

At our coal-fired plants, we are achieving cleaner air for clearer skies by using the latest technologies to reduce emissions. Because these plants produced 63 percent of our total net generation last year, investments in air-quality equipment are investments in power system flexibility, as well as environmental quality.

Renewable energy is an important new frontier for power suppliers, and TVA's work is leading the way for others. We are partnering with customers to offer renewable power to consumers, and our Green Power Switche program uses solar, wind and methane gas as energy sources. The U.S. Department of Energy's National Renewable Energy Laboratory has ranked Green Power Switch on its top-1 0 list for energy production and customer participation.

We are also partnering with customers to make energy-efficient homes and ANNUAL REPORT 2002 5

__chairman's letter_

appliances more available to the people of the Valley We have made our own facilities more energy efficient, and we have earned national recognition from the U S. Department of Energy for our leadership in using energy more wisely.

COMMITTED TO ECONOMIC DEVELOPMENT TVA provides leadership for economic development in the region, which means more and better career opportunities for the people of the Valley TVA electricity fuels the Valley economy, attracting industries that create high-quality jobs. The result is not only a stronger economy for the region; it is also an opportunity for individuals to build better lives for themselves and their families.

In partnership with our customers and ndustnal development groups across the region, TVA helped companies create or retain more than 48,000 jobs over the past year TVAs economic development loan programs provided $22 million in loans, leveraging $180 million in investments from other sources Other TVA economic development efforts help businesses pinpoint the best locations for their facilities and provide analysis, data and technical services to help them thnve New efforts to promote the growth and expansion of minority-owned, women-owned and economically disadvantaged businesses mean they now have more opportunities for long-term success COMMITTED TO THE FUTURE As we prepare for electric utility industry restructuring, we are focusing on effective financial management. A comprehensive look at TVAs financial picture shows that TVA has invested wisely and effectively in new generating capacity, transmission system improvements and clean-air equipment-all essential elements of TVAs core business and long-term success Looking forward, TVA will continue to manage its finances effectively while supporting the investments necessary for an affordable, reliable power supply for our customers In the nation's current financial climate, TVA is more committed than ever to 6

TENNESSEE VALLEY AUTHORITY

conducting business in an open, forthright manner. We strive to instill in our investors, owners and customers the highest level of confidence in TVA to ensure that we deserve your continued support.

As a federal corporation, we are committed to ensuring financial integrity and to protecting our stakeholders by fully disclosing all meaningful financial and business information to the public in a timely, comprehensive and accurate manner. TVA continues to be subject to rigorous oversight by the legislative and executive branches of the U.S. government. Even so, my Board colleagues and I decided it is important to do more-by establishing the TVA Corporate Accountability and Disclosure Plan. Adherence to this plan will demonstrate TVA's commitment to full disclosure and the highest level of corporate ethics.

TVA's Strategic Objectives

• Improve life in the Tennessee Valley through integrated management of the river system and environmental stewardship

• Meet customers' needs with affordable, reliable electric power a Demonstrate leadership in sustainable economic development in the Valley

• Continue the trend of debt reduction

• Reduce TVA's delivered cost of power relative to the market

• Strengthen working relationships with all of TVA's stakeholders COMMITTED TO EXCELLENCE In a restructured industry, public power entities like TVA and the distributors of TVA power will be more important than ever. Public utilities will set the bench-mark for serving the public interest. As a federal corporation that our cus-tomers, our investors and the 8.3 million people of the Tennessee Valley can count on, TVA is committed to meeting the Valley's ever-growing needs for electricity, improving the quality of life in our region and fostering sustainable economic growth. Energy, the Environment and Economic Development are the elements of TVA's unique mission. Directors Skila Harris, Bill Baxter and I are proud to share with you this report on TVA's performance in those areas.

Glenn L. McCullough, Jr.

ANNUAL REPORT 2002 7

argy l1' 1~~~~~~~~~~~~~~~~~~~~~~~~~~I Production MIanager Pam Wlcoxon and *Mechanical Engineer Danny Sample at Raccoon Mountain pumped-storagefacztty TVA's power system is setting production records and operating efficiently and cost-effectively, and its performance and reliability for customers continue to improve. In 2002 TVA sold 160 bil-lion kilowatt-hours of electricity for total revenues of $6.8 billion. On August 5th, TVA met a peak power demand of 29,052 MW, the second highest of all time.

TVA's transmission system maintained 99 999 percent reliability for the year in delivering power to customers. This was possible in part because of ongoing improvements to the transmission system, including 109 miles of new lines and 32 new individual interchange and "Cullman Electric Cooperative has a connection points longstanding, true partnership with TVA. Looking forward to changes in our industry, folks will be hard pressed to find a better partner than the one we've had for more than 60 years."

-GRADY SNIT, president and CEO, Citlman Electric Cooperative, Cuitman, Alabatna PLANNING FOR GROWING POWER DEMAND TVA constantly assesses the changing demand for power in the region and the full range of options available to supply that demand 8 ITENNESSEE VALLEY AUTHiORITY

"Since second grade, Weekend Academy has taught me about character, responsibility, leadership, goal-setting and citizenship through activities and fun trips about different cultures, photography, music, money management, art, animals, plants, math, electricity and public speaking. Thank you, TVA, for the opportunity."

ek,AJleekend Academy studentALEXA CARTER, II, of Knoxville Inset: Chairman McCullough and Weekend Academy participants Alexa Carter, Milton Hill and Evan Lorhey in Knoxville Weather-adjusted power demand in the Valley is growing about 2 percent per year, requiring TVA to add an average of around 500 megawatts of capacity each year. To keep pace with rising demand, TVA has added over 5,000 megawatts of generating capacity in the past decade, much of it by getting more out of its existing plants through efficiency improvements and plant upgrades.

This past year, TVA added almost 700 megawatts of new combustion turbine capacity at its Lagoon Creek site in Tennessee and a new site in Kemper County, Mississippi. Also this year, looking toward the Valley's long-term power needs, the TVA Board voted to restart Browns Ferry Nuclear Plant Unit 1. Unit 1 is expected to add over 1,200 megawatts of clean, economical base-load generating capacity to TVA's power system in 2007. This new source of power will support TVA's mission of generating prosperity in the Tennessee Valley by decreasing TVA's delivered cost of power.

ANNUAL REPORT 2002 9

affordab en Earl Sbockey Alleni Leu is and Bruce Cox at 7h 's Systen; Operations Center in Chattanooga FINANCIALLY SOUND This year TVA reduced the outstanding balance of its bonds and notes by $120 million With a six-year total reduction of nearly $2 5 billion, TVA has reduced the balance from $27 7 billion at the beginning of 1997 to just over $25 billion today By using cost-effective leasing and by taking advantage of histoncally low interest rates, TVA has accomplished this reduction while still making investments in clean-air equipment, new generating capacity and transmission-system improvements that are essential to meeting the Valley's power needs.

"TVA bonds offer investors both safety and an attractive yield, a rare combination today, and they are easy to buy, track and sell."

-cUFF PLETSCHET, financial colznnist for te Oakland (Califomnia) Tribune 10 I TENNESSEE VALLEY AUTHORITY

"We're proud of the 99.999 percent reliability of our transmission system. By continuing to improve our reliability, we make it easier for our customers to do business, and that helps everyone in the Valley."

-JUO BOLANO, TVA transmission system operator

$2.0 40.0%

Since 1997, TVA has reduced annual net interest expense by more than

$500 million and lowered net interest expense as a percentage of revenue from 34 percent to 21 percent.

In 2002, TVA's delivered cost of power was 4.07 cents per kilowatt-hour.

This number reflects savings resulting from operational improvements achieved by TVA employees and TVA's continuing program of reducing interest expense by refinancing long-term debt at lower rates.

Residential electricity rates in the Tennessee Valley are 20 percent below the national and regional averages, and TVA customers have had only one general rate increase in 15 years. As TVA prepares for restructuring of the electric utility industry, it is complementing operational improvements with a focus on customer service. More flexible customer contracts-designed to be more responsive to customer needs-also will help TVA as it plans for future power supply.

$1.5-

$1.0-98 99 00 01 02 Interest Expense (in billions) 0 Percentage of Revenue ANNUAL REPORT 2002 11

-32.5%

- 25.0%

- 17.5%

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.environmental-stewardshipt.

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J Goose Pond Marina owner Tony Sampson and TVA Director Skila Harris As a public power provider, TVA is committed to improving its environmental performance while balancing its mission of supplying low-cost, reliable power with responsible stewardship of the Valley's resources. TVA seeks public input when making decisions related to the environment to ensure that its actions are responsive to the varied needs of Valley residents today and tomorrow.

As part of its long-term effort to meet regulatory requirements to improve air quality in the Tennessee Valley region, TVA has already installed six scrubbers and plans to build five additional scrubbers to reduce sulfur dioxide (SO2) emissions from its fossil power system. The additional scrubbers will cost about $1 3 billion and collectively are expected to reduce emissions by more than 200,000 tons per year TVA's SO 2 emissions are projected to be reduced by 85 percent from 1977 levels when the scrubbers are completed In addition, four of 18 planned selective catalytic reduction systems (SCRs) are now operable By 2005, when all of the SCRs are operating, TVA's nitrogen oxides (NOx) emissions during the summer ozone season are projected to be reduced by 75 percent from 1995 levels 12 TE\\\\ESSEE VALLEY AUTHORITY I

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"The Tennessee Valley Clean Marina Initiative is a great project.

We hope all marinas comply with its standards so we can all pass a cleaner river on to the next generation."

-TONY SAMPSON, Goose Pond llarina owner Goose Pond liiana, Scoltsboro, Alabama In the Southeast, TVA is also at the forefront of commercial development of renewable energy sources. TVA's Green Power Switch program was the first such renewable energy program in the region that combined power available from wind, solar and methane gas technologies. Conducted in "The river sy partnership with the distributors complex par of TVA power and environmental TVA's efforts groups, this program already has for the great earned two top-I 0 national and the envii rankings for energy production production o and customer participation.

electric pow

'stem is a vital and t of TVA. I appreciate to manage the reservoirs est benefit of the people ronment, as well as for the f low-cost, reliable ver."1

-Mayor THOMAS GRIFFITH, Anory, Mississippi ANNUAI. REPORT 2002 13

environmental stewardship Th1e Great Smoky liou ntamns National Park "I really appreciate the positive and collaborative relationship between the Great Smoky Mountains National Park and TVA. Projects such as the alternative-fuel vehicle experiment in Cades Cove and research activities such as our joint air-quality monitoring program provide positive benefits to both the Park and the citizens of our area."

-NIIKE TOLLEFSON, Park superintendent RESERVOIR OPERATIONS STUDY "How should TVA best balance the interests of navigation, flood control, power production, water quality and supply, land use and recreation'T" This was the question discussed in open meetings held across the Tennessee Valley as part of the comprehensive two-year Reservoir Operations Study TVA manages the Tennessee River system-the nation's fifth largest-for the multiple benefits listed above The findings of the Reservoir Operations Study will be used to help TVA determine whether changes in the operation of the river system can produce greater overall value for the people of the Valley 14 TENNESSEE VLLEY AUTIIORITI

"TVA's accumulated data and expertise in integrated resource management and economic development are key resources for citizens of our region."

-ROBB TURNER, executive director of the SouthernAppalachian Man and the Biosphere (SAMAB) program TVA Forest Ecologist Niki Nicholas and SAMAB Executive Director Robb Turner TRANSPORTATION AND FLOOD CONTROL The Tennessee River system is a major transportation artery, linking the Tennessee Valley's industries to world markets. In 2002, TVA's navigation channels and locks carried an estimated 50 million short-tons of cargo, with ports in 18 states depending on the river system for shipping. Valley industries save about $480 million each year on the cost of goods shipped by barge, compared with shipping by other, more expensive means of transportation.

TVA's flood control operations averted an estimated $90 million in damages in the Tennessee Valley in 2002. In coordination with the U.S. Army Corps of Engineers, TVA was called upon to restrict water flow into the Ohio River on three separate occasions of flooding in the Ohio and Mississippi river valleys this year. These efforts helped avert almost $14 million in damage, according to data provided by the Corps. Over the years, operation of the Tennessee River reservoir system and its dams has helped prevent more than $5 billion in flood damages in the Tennessee Valley and on the Ohio and Mississippi rivers.

ANXUAL REPORT 2002 15

TVA Director Bill Baxter and DENSO President Neal Ozeki Across the Tennessee Valley, TVA works in partnership with its customers, state and local leaders and regional industrial development associations to foster sustainable economic growth in the region. TVA economic development provides a diverse package of loans and technical services to stimulate capital investment and promote the creation and retention of high-quality jobs.

CREATING AND RETAINING JOBS In 2002, TVA and its partners helped companies create or retain more than 48,000 jobs TVA's economic development loan programs provided $22 million in loans, leveraging more than $180 million in funding from other sources. These funds are used to stimulate investment and create jobs. Loans from TVA are coordi-nated through a distributor of TVA power or a local government or economic development agency to assist new or expanding businesses and industries.

Additional information on potential ndustnal sites and existing buildings in the Valley region is provided through the electronic Site Selector system TVA's research capabilities provide economic, demographic and market data to local governments, business leaders and chambers of commerce.

16 TENNESSEE VALLEY AUT11ORITY

"The state of Tennessee offers a tremendous workforce, good energy resources and untiring support from its leaders.

East Tennessee is very good for business."

-NEAL OZEKI, president of DENSO llanufacturing Tennessee Inc DENSO plant in Maryville, Tennessee In the past year, five new companies-New Mather Metals, Novitec Tube Cutting Division, Quality Rework and Sorting, Toyo Automotive Products and Vermont Thread Gage-located their operations in the city of Franklin, Kentucky, bringing a total of 390 jobs to that community. This was the result of a successful partnership among TVA, its distributor customers in the area and local and state economic development organizations.

The decision by Lane Manufacturing to locate a furniture-making facility and 1,000 jobs over five years in Aberdeen, Mississippi, was the culmination of the efforts by the Appalachian Regional Commission, Mississippi "MLGW and TVA share a common vision-Development Authority, TVA, a catalyst for economic prosperity. Toget the Aberdeen Electric our efforts to support the growth of mino Department and community businesses are unparalleled and promote leaders.

economic development in our communiti We appreciate TVA's commitment."

-Herman Morris Jr, president and CEO, Memphis Light, Gas and Water Division ANNUAL REPORT 2002 l 17

-to be her rity e true es.

Dennis Griffin of the Franklin-Simpson County Industrial Authority and TVA Senior Economic Development Specialist Rick Starks helped locate five companies and create 390 jobs.

IMPROVING THE REGION'S ECONOMY Other Economic Development successes in the Valley in 2002 include the location of the TKA Fabco auto parts plant in Verona, Mississippi, the transfer of the former TVA Hartsville Nuclear Plant site for development as an industrial park, and the restart of the National Railway Equipment Company locomotive repair facility in Paducah, Kentucky.

Responding to a difficult economic climate, TVA focused on helping com-munities recover from the economic slowdown and ready themselves for the kind of economic development that works for their communities With TVA's help, communities can improve their long-term economic competitiveness by developing leadership skills, preparing strategic action plans and building community readiness for promoting economic development.

Working with private sector partners and state and local agencies through its Small and Minority Business Development Program, TVA also helps small and disadvantaged businesses improve customer service and create jobs 18 TENNESSEE VALLEY AUTUORITY

"Working in economic development is exciting when you see new industrial projects completed and the job opportunities that they create for people in your own community."

-DENNIS GRIFFIN, Franklin-Simpson County IndustrialAuthority Downtown Franklin, Kentcky The Memphis Business Academy has begun a two-year pilot program of increased education and training for businesses and their employees in the Memphis area. Sponsored by TVA, Memphis Light, Gas and Water and Memphis business leaders, this effort will serve as a model for other communities that want to increase the efficiency of minority-and women-owned businesses.

Nine regional banks participate in the Valley Coalition for Minority Economic Development, which provides loans to small, disadvantaged businesses. More than $6 million was leveraged through this partnership of TVA and the banks, helping regional companies create 155 jobs.

"Power, expertise and desire to serve are what TVA brings to the economic development arena.

We wouldn't be able to compete without TVA at the table."

-MIKE PHILPOT, executive director of the West Tennessee IndustrialAssociation AXNUAL REPORT 2002 19

financial table of contents 21 Summary Analysis of Results of Operations and Financial Condition Management's assessment of the company's financial condition, including the principal factors that affect the results of operations 22 Condensed Statements of Income Revenues, expenses, and net income for the current and past year 24 Condensed Balance Sheets The year-end status of assets, liabilities, and proprietary capital for the power program for the current and past year 24 Condensed Statements of Cash Flows Details of the sources and uses of cash for the power program for the current and past year 28 Certifications of the Members of the TVA Board of Directors The TVA Board members' certifications of the accuracy and completeness of information contained in the Summary Analysis 29 Certification of Chief Financial Officer The CFO's certification of the accuracy and completeness of information contained in the Summary Analysis 30 Report of Independent Accountants PricewaterhouseCoopers LLP's opinion on the financial statements 31 Report of Management Management's responsibilities for the fair presentation of the financial statements 32 Report of Inspector General The Office of the Inspector General's report on its review of PricewaterhouseCoopers LLP's audit of TVA's financial statements Insert Information Statement 20 lTENNESSEE VULLEY AUTI1ORITY

summary analysis of results of operations and financial condition The condensedfinancial information on the following pages is presented to the stakeholders of the Tennessee Valley Authority as a review of TVA 's operations for the fiscal year ended September 30, 2002. It is not considered a substitute for the fullfinancial statements, inclusive offootnotes, which appear on pages 46 through 70 of the 2002 Information Statement. The 2002 Information Statement is an integral part of this annual report, and investors should read the 2002 Information Statement in its entirety before making an investment decision.

General TVA is a wholly owned corporate agency and instrumentality of the United States, established by Congress in 1933 primarily to provide navigation, flood control, and agricultural and industrial development, and to promote the use of electric power in the Tennessee Valley region. Its electric power system is one of the largest in the United States and is required to be self-supporting from power system revenues and from system financing. TVA is prima-rily a wholesaler of power with three primary customer groups including distributors, industries and federal agencies.

In addition, TVA sells and buys power through exchange power agreements with most of the surrounding electric systems.

No tax dollars fund TVA's power system and river-management functions.

The Tennessee Valley Authority serves the people of the Tennessee Valley by producing reliable, affordable electric Generation Mix power, supporting sustainable economic development and maintaining steward-ship of the region's natural resources.

A corporation of the federal government, TVA operates like a business, using the best practices of private enterprise to achieve excellence in business operations and public service.

Business Strategy TVA's strategic objectives for competing in the energy market of the future encompass excellence in operating per-formance, leadership in economic devel-opment and sensitivity to our stakehold-ers' needs. Critical success factors have been developed and targets established to reach our goals. TVA strives to:

m Improve life in the Tennessee Valley through integrated management of the river system and environmental stewardship (billions of kWh) 175 140 105 70 35 0

Key Objectives and Indicators Performance Results

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Meet customers' needs with affordable, reliable electric power Demonstrate leadership in sustainable economic development in the Valley Improve life in the Tennessee Valley through integrated management of the river system and environmental stewardship Reduce TVA's delivered cost of power relative to the market Strengthen working relationships with all of TVA's stakeholders Customer-connection-point interruptions (interruptions per connection point)

Jobs added or retained (number)

Watershed water quality (number of watersheds rated good to fair out of a maximum 61 1)

Delivered cost of power (cents/kWh)

All injury rate (per 100 employees)

ANNUAL REPORT20 98 99 00 01 02 t

Q Other Nuclear Fossil &

Combustion Turbine Hydro Customer Operations Financial People 1.03 48,248 512 4.07 1.97 1.17 47,808 496 4.05 2.32 2002 21

summary analysis of results of operations and financial condition Sales of Electricity (billions ofkWb) 175 165

[8 99 00 01 02 155 -

145~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

135 1

125~~~~~

989 0

10

• Meet customers' needs witl affordable, reliable electric power

• Demonstrate leadership in sustainable economic de-,elopment in the Valley

• Continue the trend of debt reduction

• Reduce TVA's delivered cost of power relative to the market

• Strengthen working relationships with all of TVA's stakeholders Results of Operations Net income for 2002 was S73 million, compared with a net loss of S3,311 million for 2001 The net loss in 2001 resulted pnmanly from a loss on mpairment of long-lix ed assets of S3,419 million (See 'Loss on Impairment of Assets/'Plant Cancellation' at nght)

Operating Revenues Operating revenues were $6,835 million in 2002, compared with 6,999 million in 2001 The S164 million decrease was primarily due to a 170 million decline in interchange revenue as a result of lower market prices In addition, there was a weather-related $52 million decrease in energy sales to municipalities and cooperatives as a result of a Condensed Statements of Income-Powei-Progmn2wz For the years ended September 30 (in millions)

6 Operating revenues Sales of electricity Other Total operating revenues Operating expenses Fuel and purchased power Operating and maintenance Depreciation and amortization Tax equivalents Total operating expenses 4

Operating income l

Other income, net Interest expense, net Income before loss on impairment of assets/plant cancellation Loss on impairment of assets/plant cancellation Net income (loss) 22 TENNESSEE VALLEX AUTHORITY S 6,747 88 6,835 1,925 1,840 1,093 328 5,186 1,649 7

(1,429) 227 (154) 73

$ 6,897 102 6,999 1,989 1,660 1,542 315 5,506 1,493 248 (1,633) 108 (3,419)

S (3,311)

milder winter when compared with 2001. Sales to directly served industries increased by $73 million due to changes in product and service mix to certain customers.

Operating Expenses Operating expenses decreased $320 million, or 6 percent, from $5,506 million in 2001 to $5,186 million in 2002.

This decrease reflects a $64 million decrease in fuel and purchased power expense resulting from a 3 percent decrease in generation. Additionally, depreciation and amortization expense was $449 million lower as a result of accelerated amortization of regulatory assets during 2001 to offset an increase in Other Income. The decrease was offset by a $180 million increase in operating and maintenance expense due to increased outage and other costs in 2002 and increased tax-equivalent payments of

$13 million in 2002.

Other Income TVA had net other income of $7 million in 2002, com-pared with net other income of $248 million in 2001.

The 2001 net other income resulted primarily from a nonrecurring contract settlement in excess of $200 million.

Interest Expense Net interest expense declined $204 million from $1,633 million in 2001 to $1,429 million in 2002. Total outstand-ing indebtedness as of September 30, 2002, was $25.3 billion, with an average interest rate of 5.89 percent; as of September 30, 2001, the amount outstanding was

$25.4 billion, with an average interest rate of 6.57 percent.

Loss on Impairment of Assets/Plant Cancellation Due to changes in the three-to five-year forecast of energy supply and market opportunities, TVA elected not to complete a gas-fired combined-cycle plant that would have provided 510 megawatts of power in 2004.

Accumulated costs associated with the project total approximately $154 million, which TVA recognized as a loss in 2002.

During 2001 TVA identified certain assets for which estimated future cash flows provided through future rates were likely to be less than recorded book values.

Accordingly, TVA reduced the carrying amount of these assets by a total of $3,419 million, of which $2,220 million was attributable to deferred nuclear generating units,

$789 million was attributable to deferred debt refinancing costs and $410 million was attributable to plant held for future use. The ultimate disposition or use of these assets is unaffected by the asset value reductions.

Operating Revenues &

Operating Expenses (Millions)

$7,000 -

$6,000 -

$5,000 -

$4,000 -

$3,000 -

$2,000 -

$1,000-

$0-I IEE[

I"rr' EFiE'If 98 99 00 01 02 h

Revenue Tax Equiva ents t % Depreciation & Amortizat on D

Operating & Mainrtenance t t Fuel & Purchased Power Weather Degree Days (number of days) 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 98 99 00 01 02 Heating Degree Days Cool ng Degree Days Heating Days (Normal)

Cooling Days (Normal)

A Degree Day is a nit o measure used to express the extent to which temperatures vary tem a specific reference temperature during a given period. TvA uses 65 degres as its reference tempersture.

Liquidity and Capital Resources Capital Structure In 1959 TVA received congressional approval to issue bonds in order to finance its growing power program.

Since that time, TVA's power program has been required to be self-supporting. As a result, TVA funds its capital requirements through internal cash generation, debt issuance (subject to a congressionally mandated $30 billion limit) and other financing arrangements, including lease/leaseback agreements.

For primarily the first 25 years of TVA's existence, the U.S. Congress appropriated investments in TVA power facilities. TVA is required to pay the U.S. government a return on the appropriation investment in TVA power facilities, plus a repayment of the investment, as specified by law. The combined payment for 2002 was $50 million.

Total cumulative repayments and return on investment paid by TVA to the U.S. Treasury exceed $3.4 billion on the government's original appropriation investment of

$1.4 billion.

ANNUAL REPORT 2002 23 iE 7

mS t:

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summary analysis of results of operations and financial condition Condensed Balance Sheets-Power Programn At September 30 (n millions)

Assets Cash and cash equivalents Other current assets Property, plant and equipment, net Regulatory assets Other assets Total assets Liabilities and proprietary capital Current liabilities Long-term debt, net of discount Other liabilities Retained earnings Accumulated other comprehensive loss Other proprietary capital Total liabilities and proprietary capital Condensed Statements of Cash Flows-Power Programz For the years ended September 30 (in millions)

Cash flows from operating activities Net income (loss)

Items not requiring cash Changes in current assets and liabilities Other, net Net cash provided by operating activities Cash flows from investing activities Construction expenditures Nuclear fuel Other, net Net cash used in investing activities Cash flows from financing activities Long-term debt, net Short-term debt, net Proceeds from combustion turbine leasing, net Other, net Net cash provided by/(used in) financing activities Net change in cash and cash equivalents Cash and cash equivalents at beginning of penod Cash and cash equivalents at end of period IS SI 397 339 1,133 1,162 25,679 25,643 1,452 439 1,497 2,116

$30,158

$29,699

$ 4,809

$ 6,334 21,358 19,851 3,304 2,806 349 306 (150)

(106) 488 508

$30,158

$29,699 S

73

$ (3,311) 1,369 5,178 21 83 (116)

(36) 1,347 1,914 (1,231)

(1,015)

(146)

(94) 31 (82)

(1,346)

(1,191)

(600)

(2,361) 476 1,742 289 (29)

(108)

_ (84) 57 (732) _

58 (9) 339 348 397 339 24 l TENNESSEE VALLEY AUTHORIT

Net cash provided by power program operating activities decreased $567 million from 2001 to 2002. The decrease includes a decline in interchange revenue due to lower market prices influenced by new independent power producer generating plants. In addition to lower sales, operating and maintenance expenses increased due to planned (budgeted) maintenance and unplanned outages.

Funds were also used to pay current liabilities, which declined 24 percent during 2002.

Cash used in investing activities increased $155 million due to additional expenditures for capital projects of

$216 million and fabrication of nuclear fuel of $52 million, partially offset by cash received from other investing activities of $113 million primarily due to a decrease in long-term investments during 2002.

Net cash provided by financing activities increased $789 million from 2001 to 2002 as a result of reduced debt payments of $495 million and proceeds from a lease/lease-back of $320 million, partially offset by an increase in financing costs of $29 million related to bond issues.

Capital Requirements TVA has incurred and continues to incur substantial capital expenditures and operating expenses to comply with environmental requirements. Because these requirements change frequently, the total amount of these costs in the future is not now determinable. It is anticipated that environmental requirements will become more stringent and that compliance costs will increase. Although TVA cannot, with certainty, project the costs of additional emission control requirements for nitrogen oxides, sulfur dioxide and particulate matter beyond those required by the acid rain provisions of the 1990 Clean Air Act Amendments, the costs of these additional reductions could exceed $3 billion.

Cash Flows from Operations and Times Interest Earned (millions)

$1,600 i i

$1,200

$800 l

4 i

i t

l l,

$800-I

$400-

-3.Ox 2.5x 2.Ox f

r i, 1.5X 1,0I i

1 1.ox 0.5x o.ox 98 99 00 01 02 r

Cash Flows from Operations

-U-Times Interest Earned Construction Expenditures (nlliorns)

$1,250

$937

$625 On May 16, 2002, the Board of Directors initiated the return to service of Unit 1 at the Browns Ferry Nuclear Plant in northern Alabama in order to meet long-term energy needs in the Tennessee Valley. This decision advances the National Energy Policy that calls for the safe expansion of nuclear energy and it meets TVA's objective of providing affordable, reliable power to its customers.

The Unit 1 recovery project is expected to add approxi-mately 1,280 megawatts of generating capacity at an estimated cost of $1.8 billion and to take five years to complete. When Unit 1 returns to service, additional generation is expected to help lower the average cost of power and provide additional cash flow for accelerated debt reduction.

$312

$0 98 99 00 01 02 f

i Other WI Transmission I'

Nuclear Combustion Turbine Hydro J Fossil ANNIJAL RFPORT 2002 Co i 25

summary analysis of results of operations and financial condition Capital Resources During 2002 and 2001 TVA accessed the capital markets through cost-effective long-term financing structures and continued to expand its global investor base, as well as its domestic retail nx estor base During 2002 TVA offered

$600 million of global securities and S936 inillion of exchange bonds TVA continued to offer its retail targeted, medium-term note program, electronotes, ranging in size from $6 million to more than S60 million for a total of S584 million for the year In an effort to meet the growing demand for reliable power in its senice area, TVA has been involved in the construction of a series of new peaking combustion tur-bine units The first set of eight units was completed in the summer of 2000, and a second set of eight units was completed in the summer of 2001 TVA installed tx o additional sets of four units each during the summer of 2002 For the units acquired in 2000 and 2001, TVA con-sidered sexeral options related to the financing of the units' construction, including the use of debt and cash from operations as well as various leasing alternatlx es Of the financing options available to TVA, the leasing alternative xNas the most economically favorable to TVA.

TVA accounted for the respective lease proceeds of S300 million and S320 million for the 2000 and 2001 units, respectx ely, as financing obligations as required by generally accepted accounting pnnciples Accordingly, the aggregate outstanding financing obligations of $559 million in 2002 and $271 million in 2001 are included in Current Liabilities and Other Liabilities in TVA's 2002 year-end Balance Sheets Other Matters Risk Policies TVA is exposed to the following financial market risks

• Changes in interest rates e Foreign currency exchange rates

• Volatility of certain commodity and equity market prices

• Losses in the eent of counterparties' nonperformance To manage the olatility attributable to these exposures, TVA has entered into various nontradlng derivatix e transactions, principally an interest rate sap agreement, foreign currency svap contracts, and electriciLty, coal and natural gas contracts TVA has established a Risk Mlanagement Committee, which maintains responsibility for reviewing and approving controls and procedures for TVA-wide risk management activities including the o er-sight of models and assumptions used to measure risk, the review of counterparty exposure limits and the establishment of formal procedures regarding the use of financial hedging instruments With respect to hedging activities, TVA risk management policies allow the use of derivative financial instruments to manage financial exposures but prohibit the use of these instruments for speculative or trading purposes.

Contingencies The Enx ironmental Protection Agency (EPA) has issued TVA an administrative order directing TVA to install additional pollution-control equipment on 14 of its units and to evaluate whether more controls should be installed on other units TVA has challenged the validity of this order, and the Eleventh Circuit Court of Appeals has stayed the order pending its review The outcomes of this litigation and the EPA proceedings are uncertain If EPA substantially prevails, TVA could be required to incur capital costs in excess of $3 billion TVA has exposure to a number of additional significant contingencies including, but not limited to, potential costs associated wilth spent nuclear fuel and low-level radioactxe xaste disposal, environmental matters and pending litigation These, as well as other matters, are fully discussed in the Management's Discussion and Analysis and Notes to Financial Statements contained in the Information Statement Investors should read the Information Statement in its entirety prior to making any inx estment clecisions Resource Management TVA's responsibilities for managing public resources began wvith its creation in 1933 Today these resource management activities help sustain the interconnected tributaries and main stem of the Tennessee River, the nation's fifth-largest r er system Although similar resource management responsibilities are funded with taxpayer dollars elsevhere in the nation and funding for these TA programs had historically included federal appropriations, since 1999 TA has received no appro-priations for these activities The 652-mile-long river, the 42,000 miles of streams and tnbutanes and TVA's 49 dams and 14 navigation locks are a vital part of the nation's navigation system TVA's other responsibilities in managing the river system include reducing flood risk, producing hydro power and providing cooling water for TVA's fossil and nuclear plants Encompassing 41,000 square miles, the river and its 12 tributary watersheds touch 125 counties in portions of sexen states These 26 TE\\NESSEE VLLE ALTHORIT

resources are managed to accomplish the multiple objectives of water supply, flood control, navigation, electric power production, recreation and environmental protection.

Because Congress has not provided any appropriations to TVA to fund such activities since 1999, TVA spent 83 million in 2002 and $71 million in 2001 for essential stewardship activities, primarily using power revenues and funding the remainder with a combination of user fees and other forms of nonpower revenues and fund balances unused in prior years.

TVA retains responsibility for management of the remaining nonpower assets and settlement of nonpower obligations. TVA remains committed to carrying out those stewardship activities related to its management of the Tennessee River system and TVA properties and to safeguarding and equitably distributing the public benefits that are central to management of its integrated system.

TVA has direct stewardship responsibility for 650,000 reservoir surface acres available for recreation and other purposes, 11,000 miles of shoreline and 293,000 acres of public land. Reservoirs and recreation areas throughout the region provide outdoor recreation for millions of visitors each year, and TVA has set aside over 122,000 acres of the public lands it manages for natural resource protection, including the preservation of wildlife habitat.

Accounting Policies and Practices TVA prepares its financial statements in conformity with generally accepted accounting principles accepted in the United States of America applied on a consistent basis.

In some cases, financial statements reflect amounts based on the best estimates and judgment of manage-ment, giving due consideration to materiality.

TVA accounts for the financial effects of regulation in accordance with Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Forward-Looking Statements This annual report contains forward-looking statements relating to future events and future performance. Any statements regarding expectations, beliefs, plans, projections, predictions, estimates, objectives, intentions, or assumptions or otherwise relating to future events or performance may be forward-looking. In certain cases, forward-looking statements can be identified by the use of words such as "may," "will," "should," "expect," "anticipate,"

"believe," "intend," "project," "plan," "predict," "assume," "estimate," "objective,"

"possible," "potential," or other similar expressions. Some examples of forward-looking statements include statements regarding TVA's projections of future power and energy requirements; future costs related to environmental compliance; impacts of potential legislation on TVA and the likelihood of enactment of such legislation; strategic objectives; anticipated availability of nuclear waste storage facilities; projections of nuclear decommissioning costs; and impacts of pending litigation and administrative orders. Although TVA believes that the assumptions underlying the forward-looking statements are reasonable, TVA does not guarantee the accuracy of these statements.

Types of Regulation. As a result, TVA records certain regulatory assets and liabilities that would not be recorded on the balance sheet under generally accepted account-ing principles for nonregulated entities.

Additionally, TVA's system of internal controls is designed to provide reasonable assurance that assets are safe-guarded from loss or unauthorized use or disposition, and that transactions are executed in accordance with management's authorization and properly recorded to permit the preparation of financial statements in accor-dance with accounting principles generally accepted in the United States of America.

Controls and Procedures TVA's records are also subject to review by numerous government agencies including TVA's Inspector General, the General Accounting Office, the Congressional Budget Office and the Office of Management and Budget, as well as congressional committees as requested.

Additionally TVA's management, including the Chief Financial Officer, and the members of the Board of Directors have conducted an evaluation of the effective-ness of TVA's disclosure controls and procedures during November and December 2002. Based on that evalua-tion, members of the Board of Directors and the Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information necessary and appropriate for this Summary Analysis of Results of Operations and Financial Condition has been made known to them in a timely fashion. There have been no significant changes in inter-nal controls, or in factors that could significantly affect internal controls, subsequent to the date the members of the Board of Directors and Chief Financial Officer com-pleted their evaluation. In 2002, TVA, along with its external auditors, identified no deficiencies in the design and operation of its internal control procedures that were reportable control weaknesses.

Numerous factors could cause actual results to differ materially from those in the forward-looking statements. These factors include, among other things, new laws, regulations and administrative orders, especially those related to restructuring of the electric power industry and various environmental mat-ters; increased competition among electric utilities; legal and administrative proceedings affecting TVA; the financial environment; performance of TVA's generation and transmission assets; fuel prices; demand for electricity; changes in technology; changes in the price of power; loss of any significant customers or suppliers; creditworthiness of counterparties; weather condi-tions and other natural phenomena; changes in accounting standards; and unforeseeable events. New factors emerge from time to time, and it is not possible for management to predict all such factors or to assess the extent to which any factor or combination of factors may impact TVA's business or cause results to differ materially form those contained in any forward-looking statement. TVA undertakes no obligation to update any forward-looking state-ment to reflect developments that occur after the statement is made.

ANNUAL REPORT 2002 27 V

Lh er q

certifications of the members of the TVA board of directors Glenn L MNlcCullough, Jr, Skila Harris and Bill Baxtei individually certify that

1. 1 have reviewed the Summary Analysis of Results of Operations and Flnancial Condition (Analysis) contained in the Annual Report of the Tennessee Valley Authority,

2. Based on my knowledge, the information in this Analysis does not contain any untrue statement of a material fact or omilt to state a material fact necessary to make the statements made, in light of the circumstances under whlich suchI statements were made, not misleading witl respect to the period co% ered by this Analysis,

3. Based on my knowledge, the condensed financial statemiients and other financial information included in this Analysis fairly present in all material respects the financial condition, results of operations and cash flows of the Tennessee Valley Authority as of, and for, the periods presented in this Analysis,

4. I and the other certifiers are responsible for establishling and maintaining disclosure controls and procedures for the Tennessee Valley Authority and have a) designed such disclosure controls and procedures to ensure that the financial statements and other financial information relating to the Tennessee Valley Authority are made knom n to us by others particularly during the period in wvhich this Analysis is being prepared, b) evaluated the effectiveness of the Tennessee Valley Authority's disclosure controls and procedures as of a date withiln 90 days prior to the date of this Analysis (the 'Evaluation Date"), and c) presented in this Analysis conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date,

5. I and the other certifiers ha% e disclosed, based on our most recent evaluation, to the Tennessee Valley Authority's independent auditors and the Inspector General of the Tennessee Valley Authority:

a) all significant deficiencies in the design or operation of internal controls that could adversely affect the Tennessee Valley Authority's ability to record, process, summarize and report financial data and have identified for the Tennessee Valley Authority's independent auditors any material weaknesses in internal controls, and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Tennessee Valley Authority's internal controls, and 6.1 and the other certifiers have indicated in this Analysis wletler there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses Date: 1/13/2003 Chairman Director Director 28 TENNESSEE VALLEY AUTHORITY

certification of chief financial officer I, David N. Smith, certify that:

1. I have reviewed the Summary Analysis of Results of Operations and Financial Condition (Analysis) contained in the Annual Report of the Tennessee Valley Authority;

2. Based on my knowledge, the information in this Analysis does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Analysis;

3. Based on my knowledge, the condensed financial statements and other financial information included in this Analysis fairly present in all material respects the financial condition, results of opera-tions and cash flows of the Tennessee Valley Authority as of, and for, the periods presented in this Analysis;

4. I and the other certifiers are responsible for establishing and maintaining disclosure controls and procedures for the Tennessee Valley Authority and have:

a) designed such disclosure controls and procedures to ensure that the financial statements and other financial information relating to the Tennessee Valley Authority are made known to us by others particularly during the period in which this Analysis is being prepared; b) evaluated the effectiveness of the Tennessee Valley Authority's disclosure controls and procedures as of a date within 90 days prior to the date of this Analysis (the "Evaluation Date"); and c) presented in this Analysis our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. I and the other certifiers have disclosed, based on our most recent evaluation, to the Tennessee Valley Authority's independent auditors and the nspector General of the Tennessee Valley Authority:

a) all significant deficiencies in the design or operation of internal controls that could adversely affect the Tennessee Valley Authority's ability to record, process, summarize and report financial data and have identified for the Tennessee Valley Authority's independent auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Tennessee Valley Authority's internal controls; and

6. I and the other certifiers have indicated in this Analysis whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant defi-ciencies and material weaknesses.

Date: 1/13/2003 Chief Financial Officer and Executive Vice President of Financial Services ANNUAL REPORT 2002 l 29

report of independent accountants To the Board of Directors of the Tennessee Valley Authority We have audited, in accordance with auditing standards generally accepted in the United States of America and GovernwmentAuditing Standards issued by the Comptroller General of the United States, the balance sheets (power program and all programs) of the Tennessee Valley Authority as of September 30, 2002 and 2001, and the related statements of income (power program), changes in proprietary capital (power program and nonpower programs), comprehensive income (power program),

net expense and comprehensive income (nonpower programs), and cash flows (power program and all programs) for each of the three years in the period ended September 30, 2002 (not presented herein) appearing on pages 46 through 70 of the Tennessee Valley Authority 2002 Information Statement; and in our report dated December 19, 2002, we expressed an unqualified opinion on those financial statements In our opinion, the information set forth in the accompanying condensed financial statements is fairly stated, in all material respects, in relation to the financial statements from which it has been derived

/pr,c,Me tk4R-l e, c,<,.S L L PricewaterhouseCoopers LLP Knoxvtlle, Tennessee December 19, 2002 30 lTENNESSEE VALLEY AUTHORITY

report of management Management is responsible for the preparation, integrity, and objectivity of the finan-cial statements of the Tennessee Valley Authority as well as all other information con-tained in the annual report. The financial statements have been prepared in conformity with generally accepted accounting principles applied on a consistent basis and, in some cases, reflect amounts based on the best estimates and judgments of management, giving due consideration to materiality. Financial information contained in the annual report is consistent with that in the financial statements.

The Tennessee Valley Authority maintains an adequate system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that financial statements are prepared in accordance with generally accepted accounting principles, and that the assets of the corporation are properly safeguarded. The system of internal controls is documented, evaluated, and tested on a continuing basis. No internal control system can provide absolute assurance that errors and irregularities will not occur due to the inherent limitations of the effectiveness of internal controls; however, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived. No material internal control weaknesses have been reported to management.

PricewaterhouseCoopers LLP was engaged to audit the financial statements of the Tennessee Valley Authority and issue reports thereon. Its audits were conducted in accordance with auditing standards generally accepted in the United States of America and Governlment Auditing Standards issued by the Comptroller General of the United States. Such standards require a review of internal controls and an examination of selected transactions and other procedures sufficient to provide reasonable assurance that the financial statements neither are misleading nor contain material errors. The Report of Independent Accountants does not limit the responsibility of management for information contained in the financial statements and elsewhere in the annual report.

David N. Smith Chief Financial Officer and Executive Vice President of Financial Services n

ANNUAL REPORT 2002 31 I

report of inspector general A

December 30, 2002

.6 To the Board of Directors of the Tennessee Valley Authority The Tennessee Valley Authority contracted wvith the independent certified public accounting firm of PricewvaterlhouseCoopers LLI (PncexxaterlhouseCoopers) to auLdit the balance sheets (power program and all programs) as of September 30, 2002 and 2001, and the related statements of income (poxx er program), chalges in proprietary capital (pow er program and nonpover programs), comprelensive income (po er program),

net expense and comprehensixe income (nonpox\\er progralis), and caslh flovs (power program and all programs) for eacl of the three years in the period ended September 30, 2002 The contract requirecl the audit be done in accordance xx th generally accepted goxernmient auditing standards Under the Inspector General Act, the Office of the Inspector General (OIG) is respon-sible for taking appropriate steps to assure that any xxoik perforiied by nonfederal auditors, including PricewaterhouseCoopers, complies witl generally accepted govern-i.ment auditing standards The Chlief Financial Officers Act also places responsibilities on the OIG regarding TVA's annual financial statement audit In keeping xx ith our statutory responsibilities, ve reviexxed Iricevatei`houseCoopers' reports and related audit documentation, interviexNed their representatives, and peiformed sucl otier procedures as xe deemed appropriate in the circumstances to provide reasonable assurance that the audit wxas performed in accordance vwith generally accepted govern-iment auditing standards The objectxe of our rex%iew was not intended to enable us to expless, and ve do not express, an opinion on the Tennessee Valley Authlority's financial statements or on management's conclusions about the effectiveness of its system of internal control Pricew, aterlouseCoopers is responsible for the auditor's reports dated December 19, 2002, and the conclusions expressed in the reports Hoxvever our reviewv disclosed no instances xxhere Pricevaterl-ouseCoopers did not comply, in all material espects, Nith (generally accepted government auditing standards Our reviev xvas pelforlled in accordance vith generally accepted goxerinient auditing standards 4

Ben R agner Assistant Inspector General (Audits) 1

-J 32 TENNLVSEE Vr~LLLtii U1ORITY'

board of directors Glenn L. McCullough, Jr.

Chairman Was appointed to a six-year term as the 26th member of the TVA Board of Directors in November 1999... named Chairman by President Bush in July 2001... serves on the Electricity Advisory Board to U.S.

Department of Energy Secretary Spencer Abraham... board member of the Electric Power Research Institute (EPRI), the Institute of Nuclear Power Operations and the Memphis Chamber of Commerce... elected mayor of Tupelo, Mississippi, in 1997 after 14 years in private business

... was director of the Mississippi office of the Appalachian Regional Commission... member of the boards of the Economic Development Partnership of Alabama and the Mississippi Partnership for Economic Development... B.S. from Mississippi State Universiy.

Skila Harris Director NWas appointed by President Clinton to a nine-year term as the 25th member of the TA Board of Directors in November 1999... the first woman to hold the post of TVA Director... 17 years of public and private experience in the energy field... served in the Depaitment of Energy in both the Clinton and Carter administrations... from 1993 to 1997 served as special assistant to Vice President Al Gore and as chief of staff to Tipper Gore... was vice president for development and compliance at Steiner-Liff Iron and Metal Company from 1989 to 1992...

was a contract and project manager at the U.S. Synthetic Fuels Corporation

... B.A. in political science from Western Kentucky University...

M.A. in legislative affairs from George Washington University.

Bill Baxter Director Nas appointed by President Bush and sworn into office November 2001 to become the 27th member of the TVA Board of Directors... prior to his appointment he was chairman and chief executive officer of his family-owned business, Holston Gases Inc., headquartered in Knox-ille

... appointed commissioner of Economic and Community Development for the State of Tennessee... during his three-year tenure the state achieved three consecutive years of record private capital investment and job creation... is a board member of the Development Corporation and Friends of the Smokies... B.A. from Duke University and law degree from the University of Tennessee.

ANNUAL REPORT 2002 33

executive committee David N. Smith, Kathryn J. Jackson, Ellen Robinson, Joe Bynum, D LeAnne Stnbley, John A Scalice, Maureen Dunn, Ike Zeringue President and Chief Operating Officer Has more than 27 sears of expe-rience in the nuiclear industry directed the start-Lp and licensing of T 's NSats Bar \\uclear Plant and the recosery and restart of Browins Fer' NLClear Plant directed start-Lp, maintenance and opcration of Arizona lubhlic Sen ice Compan s Palo \\erde Unit 3 in 1993 became T\\A's Senior Vice l'resident of Nuclear Operations namcd Chief NLclear Officer and Execuri e N ice President of TnA NLclear in 1997 appointed in 1998 to his current position. sshich entails o ersight of T\\A s powxer production, transmission and rcsource-managcmc nt programs nuclear-enginecring degree from North Carolina State Uns ersit) gradatcd from Adsanced Management Program at Harvard Business School David N. Smith Chief Financial Officer and Executive Vice President, Financial Services Came to TNA as Chicf Financial Officer in 1995 naIcILd Exccutis e iLe resident of Financial Sen ices in 1996 has led rinancing of S23 hillion of debt through a ariety of global and domestic bond offcnngs since 1995 pre ousts o-founded Ody ssey Financi I a orporate consulting firn ind sened as ts executne director plased a crucial role in the reorginization of LTV Corporation, enahling it to emerge sicessftill from one of the largest and most complex bankruptcies in U S histor ss as ice prcsidcnt of corporate des elopment at Cyclops Corporation for 10 ears CPA certification in 1969 gradiate of Northssestern Unx ersirtv NIB in finance from Northwestern s Kellogg ScIool of Business Kathryn J. Jackson Executive Vice President, River System Operations and Environment, and Envionmental Executive Joined TA in 1991 after holding positions N itl Nestinghouse Electric Corporation and Alcoa IndLstries appointed to ctirrent position in 1999 sen ed as ice President, Tecinol-ogs Ads ancements, mu sing to Senior Vice Prcsident, Rcsource GroIp 1994-99 responsihilities include rer operations rsouLrce stessardship, sence and technolo-gy applications, enx lronnmcntal planning and regulatory affairs Public Poss er Institute chairs joint Institte for Encrgs and Fns ironment sen es on d isory boards of thc Sloan Foindation' Caregie NclIlon Elcctncitv Industry Center and Carnegie Atillon LIxcrsits Schx)l of Engineering mcmbcr of the Presidclnt s National SciLnc and Technologv Council stnecl is Presidential ippointee to the National Recre tion Likes Study Commanssion B S in phy sics from Groxe City College NI S in ndusnal engineenog manage-ment from the Unix ersity of PittsBurgh Mt S and Ph D in engineering and public policy from Carnegie Mcllon post-doctoral felloN ship, National Acaclemv of Engineering Ellen Robinson Executive Vice President, Communications and Government Relations Named to her currcnt position in June 2001 sencd as snior x ice president of commnications and gosernment affairs at CNII Global NV in Ricine,

isconsin, and btfore that as x ice president of communication, and goern-inent affairs it Case Corporation loined Case from Burson-M irsteller in New lork, where she was a icc president and a head of the business-to-business markcting unit B

in lotir-nalism from the L ni ersit of Ness Mlexico NI P from the cncrian Lniersity in

\\Nashington, D C Joseph R. Bynum Executive Vice President, Fossil Power Group Norkcd in T A engineerng and plant-optrations positions from 1972 to 1982 xNas plant man-iger of rizona Public Sen ice Comp in s 'alo Vcrde Nticlear Generating Station from 1982 to 1987 in 1987 namcd to a senior position in FN'A s Nuclear Pos er Oprations appointed Vice resident of NLClear Operations in 1989 sened as Vice President of ses eral N A fossil and Isdno organizations fromii 1993 to 1998, incliding Maintenance & Testing Sen ices, Fuel Supply & Fngineering and Fossil Opcrations named to current position in 1998 B S in clectrical nginering and M S in nuclear engineenng from Gcorgia Tech D. LeAnne Stribley Executive Vice President, Administration Appointed to hcr current position in 2000 joinLd T`VA as Vice President of Finante in 1995 assued additional responsibli-ties as Controller in 1997 promoted to th. position of Senior Vice l'residtnt of Finance and Controller in JlsI 2000 bc fore oiing TV, s as ice prcsident of finance and (hief finincial officer at Trasel Resources Nanagement Group Inc s as director of corporate finance at Ohio-based LTV Corporation from 1987 to 1994 henAcen 1981 and 1987, worked as assistant treasurer for the NXestern Company of North America, an offshore-drilling and ol-sersaices corporation natnse of Fort Vorth, Texas Cl t A in accounting from Texas %Nesles in Lnxersiry John A. Scalice Chief Nuclear Officer and Executive Vice President TVA Nuclear Came to TN in 1989 as Plant Alanagtr at NX itts Bar Nuclear Plant sen ed as Browxns Ferry Plant Man ger aecame Site N ie lresident it 'A atts 1tar in 1993 and plaved a kev role in the sLccessful licensing, start-up and operation of that nuclear unit scn ed as Senior N ic. President of Nuclear Operations in 1997 nained to his cirrcnt position in 1998 responsible for all man-agement of TN s three operating nuclear plants imiore than 30

) ears of exptrience in the nuclear mdustry in areas of plant operations, nuclear sccurity and rcactor engineering Senior Reactor Operating Liccnse 13 S in mechanical engineering and tI S in nuclear cngineering fron Polstechnical Institute of Ness ork Maureen Dunn Executive Vice President and General Counsel Namtd as TNA s General Counsel in 2001 adsises the 13oard on legal iiattcrs and senes as Sccrctary to the Corporation osersecs and coordinates all legal sxork for TNA joined T\\ in 1i)8 as n attorne assumed 34 TENNESSEL VALLE)

AUTHORtTN

S i

Mark 0. Medford, Ron Loving, Amy Burns, Jack Bailey, John Bradley, John E. Long Jr., Theresa A. Flaim, Anda A. Ray, Terry Boston position of Assistant General Counsel in 1986... B.S. in political science from LeMoyne College in Syracuse, N.Y.... a%

degree from Catholic University in Washington, D.C.

Mark 0. Medford Executive Vice President, Customer Service and Marketing Joine( TVA in 1989 as Vice President and NIclear Technical Director...served in several TVA executive positions before being named to his current posi-tion in 1996... responsible for relations between TVA and its customers...directs staffs that manage customer accounts, prodict development, pricing and marketing... has more than 26 years of piblic and private utility experience... before joining TVA, was manager of nuclear regulatory affairs at Southern California Edison...

served in U.S. Navy from 1971 to 1975 and was assigned to the staff of Vice Admiral H.G.

Rickover... B.S. and ME S.

degrees from Rice University.

M.B.A. fron California State Polytechnic University...

Ph.D. in executivre management from Claremont Gradiate School.

Ron Loving Senior Vice President, Performance Initiatives Has more than 30 years of expe-rience at TVA... is responsible for executive management of various operational performance-improvement initiatives...

currently leading effort to achieve optimal outage performance at TVA's fossil and hydro facilities

... promoted to Senior Vice President in December 2000...

served for three years as Vice President, Synterprise Group, an entrepreneurial business unit that provided engineering and business services to other TVA organizations... Vice President, Government Relations in TVA's Washington office, 1994-96...

B.S. in electrical engineering from Southern University... M.B.A.

from the University of Memphis.

Amy T Burns Vice President, Bulk Power Trading More than 27 years of experience with TVA... named to her current position in 2000... responsible for TVA's overall trading of bulk power in the wholesale market

... served as Mlanager of Fuel Supply Analysis in the Fossil Power Group, with the responsi-bility of planning, analysis and acquisition for TVA's $1.5 billion fossil fel program... joined TVA in 1975 as an accountant...

licensed CPA in state of Tennessee... BS. in accounting from Samford University.

Jack A. Bailey Senior Vice President, Power Resources & Operations Planning More than 20 years of experience in the nuclear industry...joined TVA in 1997 as Vice President of Engineering and Technical Services in TVA Nuclear...

worked for eight years at Arizona Public Service Company's Palo Verde Nuclear Generating Station and seven years at Virginia Powver's Surry Nuclear Power Station... an officer in the U.S.

Navy from 1976 to 1982...

B.S. in mathematics from the University of Texas at El Paso.

John Bradley Senior Vice President, Economic Development Joined TVA as Senior Vice President, Economic Development in 2002... responsibilities include recruitment and retention of capital investment and job creation, bsiness development, technical serices and comminity development... served as sen-ior vice president for economic development for the Memphis Regional Chamber of Commerce from 1996 to 2002... worked in Memphis Light, Gas & Water's economic development depart-ment from 1980 to 1996...

B.S. in business administration fron the University of Tennessee.

John E. Long Jr.

Executive Vice President, Human Resources Named to his current position in 2000... is also TVA's Designated Safety and Health Official...

since 1992 has sern'ed as a man-agement appointee to the TVA Retirement System Board...

joined TVA in 1980 as a Personnel Officer in the Engineering Division...BS. in business administration and M.B.A. from the University of Tennessee.

Theresa A. Flaim Senior Vice President, Strategic Planning and Analysis Joined TVA in 2002... responsible for developing strategies related to the ongoing competitive restruc-tuing of the electric-utility industry

... served for nine years as vice president of strategic planning for Niagara Mohawk... worked at the Solar Energy Research Instittite and the Los Alamos National Laboratory... B.A. in history from the University of Missotir...

M.S. and Ph.D. in resource eco-nomics from Cornell University.

Anda A. Ray Acting Vice President, Performance Initiatives More than 20 years of experience at TVA, beginning in Nuclear...

is responsible for executive management, oversight and align-ment of key corporate perform-ance improvement and change initiatives... chairs the Project Review and Approval Committee

... most recently served as Director of TVA's Public Powver Institute... before joining TVA, conducted research at AT&T in the area of laser and fiber optic communication... BS. in nuclear physics from AubIrn University... Ml.S. in solid state physics from Emory University.

Terry Boston Executive Vice President, Transmission/Power Supply More than 30 years of experience with TVA... named to his current position in 1999... oversees the planning, building, operating and maintaining of one of the nation's largest transmission and power supply networks... also pro-vides for transmission and related services to neighboring systems

... serves on the executive com-mittee for the Electric Power Research Institute National Reliability Initiative, on the board of directors for the Nortis American Energy Standards Board and on the Board's stake-holder committee for the North American Electric Reliability Council, as vice chairman on the Southeastern Electric Reliability Council board of directors and executis'e committee, and as 'ice president of CIGRE, the interna-tional Industrial Council of Large Electric Systems... ES. in engi-neering from Tennessee Tech...

M.S. in engineering administra-tion from the Uni'ersity of Tennessee.

ANNUAL REPOR1-2002 35

investor information Financing Goal TVA's financing goal is to offer unique invest-ment opportunities that provide exceptional value for both the investor and TVA Key Strengths of TVA Securities TvA is a wholly owned corporate agency of the U S government TVA's rated bonds receive the highest possible credit rating from Moody's Investors Service, Standard &

Poor's and Fitch Ratings (Aaa/AAA)

In 1959 Congress authorized TVA to sell bonds in public markets to finance its own power operations This allowed TVA's power system to become self-financing and fund its capital requirements with operating cash flow and power program financings TVA securities may be issued only for the purposes of VA's power program, including the provision of capital for TVA's power program and refunding of existing debt TVA securities are backed solely by the

,,' Inet power proceeds of the TVA power system and are neither obligations of nor guaranteed by the U.S. government. Both principal and interest on TVA secunties are generally exempt from state and local income taxes TVA securities are not exempt from estate, inheritance and gift taxes or from federal income tax TVA is not author-ized to issue equity securities Earnings Objective TVA is a corporation wholly owned by the U S. Government that finances its capital requirements through internally generated funds and power program financings.

Consistent with its federal charter, TVAs objective is to deliver a reliable supply of power to its customers at the lowest feasible cost TVA operates much like a non-profit corporation, so it does not accumulate a large amount of retained earnings Securities Listing All TVA bonds are publicly held. Two bonds, the Putable Automatic Rate Reset Securities (PARRS), are listed and traded on the New York Stock Exchange under the symbols TVC and TVE TVA issues a variety of debt securities in U S dollars and other currencies targeted to institutional and individual investors around the world TVA has investors in all 50 states and in 39 countries Investment Opportunities TVA issues debt in a variety of innovative structures, including PARRS, electronotes",

Quarterly Income Tiered Securities (QUINTS), discount notes, and an assort-ment of other debt securities As of September 30, 2002, TvA had 61 long-term public debt issues outstanding, totaling

$21 8 billion Of these, 30 issues were electronotess Investors understand and have confidence in TVA's business...

• TVA rated bonds receive the highest possible credit ratings (Aaa/AAA).

• Well-managed electric utility providing afford-able, reliable power to more than 8 3 million consumers

• Required by its found-ing charter, the TVA Act, to set rates sufficient to pay, among other things, debt service on outstanding bonds.

• Holders of TVA power bonds and discount notes are given first pledge of payment from net power proceeds

• Board appointed by the President of the United States and confirmed by the Senate

• Oversight of TvA provided by Congressional committees, an independent inspector general and the General Accounting Office 1

Form and Denomination Security electronotes" PARRS (2 issues)

QUINTS (5 issues) 2001 Series B Global 1998 Series A Estate Feature 1998 Series H Global 1996 Series C Global Other Power Bonds (20 issues)

Book-Entry Form The Depository Trust Company The Depository Trust Company Federal Reserve Bank System The Depository Trust Company Federal Reserve Bank System The Depository Trust Company The Depository Trust Company Federal Reserve Bank System Denomination*

$1,000

$25

$1,000

£1,000

$1,000

£1,000 DM1,000

$1,000 Payments Varies with offenng Quarterly Quarterly Annual Quarterly Semi-annual Annual Semi-annual

• Market prices and broker policies may require that investors pay more or less than par value for the security To receive a complete listing of TVA securities, call Investor Relations at 888-882-4975 TVA securities can be purchased through a broker, bank or other financial institution 36 TENNESSEE VLLEY AUTHORITY 4

A 28%

Diversification of TVA's Debt Portfolio 13%

Debt Maturities

• Short-Term

• 1 through 10 Years M 11 through 30 Years 31 through 50 Years is a retail bond program that offers bonds in a variety of structures targeted to individual investors.

Benefits include:

• Competitive interest rates

• State and local income tax exemption (generally)

• Bimonthly offerings (generally)

• $1,000 denominations

• Maturities from 1 to 30 years

• A variety of interest payments

• A survivor's option in some issues To learn more about electronotes go to www.tvaelectronotes.com.

TVA is an equal opportunity and affirmative action employer TVA also ensures that the benefits of programs receiving TVA financial assistance are available to all eligible persons regardless of race, color, sex, national origin, religion, disability or age. This document can be made in an alternate format upon request. This report is printed on 30% post-consumer recycled paper and uses soy-based inks.

1 35M 12/02 02-680 General Inquiries Ellen Robinson Executive Vice President, Communications and Govemment Relations Tennessee Valley Authority 400 West Summit Hill Drive Knoxville, TN 37902 Phone: 865-632-6263 Fax: 865-632-4760 E-mail: tvainfo@tva.com Home Page: www.tva.com Investor Inquiries Mailing Address Sylvia H. (Sissy) Caldwell Vice President, Investor Relations Tennessee Valley Authority 400 West Summit Hill Drive Knoxville, TN 37902 Web Site and E-mail Address www.tva.com/finance investor@tva.com Phone/Fax Numbers 888-882-4975 (toll-free in the U.S.)

888-882-4967 (toll-free outside the U.S.)

Fax: 865-632-3225 E-mail Alert E-mail alerts are messages that are conveniently delivered to a subscriber's e-mail address whenever certain new informa-tion is posted to TVA's Investor Resources Web pages. To learn more about how to subscribe to e-mail alerts, visit TVA's Web site at www.tva.com/finance.

ANNUJAL REPORI 2002 37

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Chattanooga Tennone Tennessee Valley Authority l

400 W Summit Hill Drive Knoxville, Tennessee 37902 www.tva.com

2002 INFORMATION STATEMENT TENNESSEE VALLEY AUTHORITY A Wholly Owned Corporate Agency and Instrumentality of the United States of America The Tennessee Valley Authority ("TVA" or the "Corporation") presents this Information Statement (this "Statement") for the information of stakeholders and potential purchasers of (1) its Power Bonds

("Power Bonds"), (2) its Discount Notes ("Discount Notes"), and (3) any other evidences of indebtedness

("Other Indebtedness") it may issue pursuant to the Tennessee Valley Authority Act of 1933, as amended, 16 U.S.C. §§831-831ee(2000) (the "Act" or the "TVA Act"). TVA issues Power Bonds pursuant to the Act and the Basic Tennessee Valley Authority Power Bond Resolution adopted by the Board of Directors of TVA (the "Board" or the "TVA Board of Directors" or "TVA's Board of Directors") on October 6, 1960, as amended on September 28, 1976, October 17, 1989, and March 25, 1992 (the "Basic Resolution"). TVA issues Discount Notes and Other Indebtedness pursuant to the Act and their authorizing resolutions. Power Bonds, Discount Notes and Other Indebtedness are collectively referred to in this Statement as "Evidences of Indebtedness."

TVA may offer Power Bonds and Other Indebtedness from time to time. TVA may offer Discount Notes for sale on a continuous basis by direct placement or through selected investment dealers, dealer banks, underwriters or underwriting syndicates. For each offering of Power Bonds, except for Power Bonds offered under a program on a continuous basis, TVA will prepare an offering circular describing the specific terms and conditions of the Power Bonds offered. For Power Bonds offered under a program on a continuous basis, TVA will prepare a single offering circular that describes the general terms and conditions common to all securities issued under the program. TVA will also prepare a single offering circular describing the general terms and conditions common to all Discount Notes offerings. For offerings of Other Indebtedness, TVA will either prepare an offering circular describing the specific terms and conditions of the particular offering or a more general offering circular, as TVA deems appropriate. For any offerings made through a program under which Other Indebtedness, Discount Notes or Power Bonds are offered on a continuous basis, the offering circular will describe how, if at all, the offering circular will be supplemented in order to reflect, among other things, the specific terms and conditions of the securities being offered. You should read this Statement, as it may be supplemented or amended, together with the appropriate offering circular, as it may be supplemented or amended, for each offering.

For each offering of an Evidence of Indebtedness, you should rely only on the information contained in (I) this Statement, (2) the relevant offering circular, and (3) any supplements or amendments to these documents approved by TVA. TVA has not authorized anyone to provide you with any information that is different from that found in this Statement and each relevant offering circular and any supplements or amendments to such documents. This Statement does not constitute an offer to sell or a solicitation of an offer to buy any Evidences of Indebtedness in any jurisdiction to any person to whom it is unlawful to make an offer or solicitation.

This Statement is accurate only as of its date. TVA may supplement, amend or replace this Statement from time to time, generally no more often than annually, to reflect its annual financial results or otherwise as TVA deems appropriate. However, TVA assumes no further duty to update this Statement. You should rely on the most recent supplements or amendments to or replacement of this Statement over different information in this Statement.

You may obtain additional copies of this Statement by writing to Tennessee Valley Authority, 400 West Summit Hill Drive, Knoxville, Tennessee 37902-1401, Attention: Investor Relations or by calling 1-888-882-4975.

Evidences of Indebtedness are not obligations of the United States of America, and the United States of America does not guarantee the payment of the principal of or interest on any Evidences of Indebtedness. TVA is not required to register Evidences of Indebtedness under the Securities Act of 1933 or to make periodic reports to the Securities and Exchange Commission under the Securities Exchange Act of 1934.

The date of this Information Statement is January 13, 2003.

TABLE OF CONTENTS Information Statement Page PART I Business.

1 Properties............................................................................

5 Legal Proceedings.

7 Certain Provisions of the Tennessee Valley Authority Act and Related Legislation................

8 The Basic Resolution; Power Bonds, Discount Notes and Other Indebtedness....................

I I1 PART II Selected Financial Data.

16 Management's Discussion and Analysis of Financial Condition and Results of Operations..........

18 Qualitative and Quantitative Disclosures about Market Risk..................................

37 Financial Statements and Supplementary Data..............................................

46 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....

74 PART HI Directors and Executive Officers..........................................................

74 Controls and Procedures.................................................................

76 PART IV Statistical & Financial Summaries............

76 Certifications..........................................................................

79 i

PART I BUSINESS General Forward Looking Information This Statement contains forward-looking statements relating to future events and future performance.

Any statements regarding expectations, beliefs, plans, projections, estimates, objectives, intentions, assump-tions or otherwise relating to future events or performance may be forward-looking.

In certain cases, forward-looking statements can be identified by the use of the words such as "may,"

'will," "should," "expect," "anticipate,' believe," intend," project," "plan," "predict," "assume,' esti-mate," "objective," "possible," "potential," or other similar expressions.

Some examples of forward-looking statements include statements regarding TVA's projections of future power and energy requirements; future costs related to environmental compliance; impacts of potential legislation on TVA and the likelihood of enactment of such legislation; strategic objectives; anticipated availability of nuclear waste storage facilities; projections of nuclear decommissioning costs; and impacts of pending litigation and various administrative orders which have been or may be issued.

Although TVA believes that the assumptions underlying the forward-looking statements are reasonable, TVA does not guarantee the accuracy of these statements. Numerous factors could cause actual results to differ materially from those in the forward-looking statements. These factors include, among other things, new laws, regulations, and administrative orders, especially those related to the restructuring of the electric power industry and various environmental matters; increased competition among electric utilities; legal and administrative proceedings affecting TVA; the financial and economic environment; performance of TVA's generation and transmission assets; fuel prices; demand for electricity; changes in technology; changes in the price of power; loss of any significant customers or suppliers; creditworthiness of counterparties; weather conditions and other natural phenomena; changes in accounting standards; and unforeseeable events. New factors emerge from time to time, and it is not possible for management to predict all such factors or to assess the extent to which any factor or combination of factors may impact TVA's business or cause results to differ materially from those contained in any forward-looking statement.

TVA undertakes no obligation to update any forward-looking statement to reflect developments that occur after the statement is made.

Fiscal Year Unless otherwise indicated, years (2002, 2001, etc.) in this Statement refer to TVA's fiscal years ended September 30.

Notes References to "notes" are to the Notes to Financial Statements contained in PART I.

The Corporation TVA is a corporate agency and instrumentality of the United States government created in 1933 by the Act and charged with providing navigation, flood control and agricultural and industrial development, while providing electric power to the Tennessee Valley region. TVA has developed and operates one of the largest electric power systems in the United States, having produced nearly 152 billion kilowatt-hours ("kWh") of electricity in 2002. TVA is wholly owned by the United States government and is administered by a board of three persons appointed by the President and confirmed by the United States Senate. Appointments are for nine-year staggered terms, with one term expiring each three-year interval.

1

Historically, the programs at TVA have consisted of power and nonpower programs. Revenues and expenses of the power program are segregated from other revenues and expenses. Substantially all of TVA's revenues and assets are attributable to its power program. For a discussion of the funding of TVA's nonpower programs, see "Management's Discussion and Analysis of Financial Condition and Results of Opera-tions" -

"Stewardship Responsibilities."

The Act requires the power program to be self-supporting from power system revenues and capital TVA raises through its power program financings. The Act authorizes TVA to issue Evidences of Indebtedness in an amount not exceeding $30 billion outstanding at any one time, the proceeds of which may be used only for the power program. See "The Basic Resolution; Power Bonds, Discount Notes and Other Indebtedness."

Under certain circumstances, the Act permits TVA to borrow up to $150 million for a period of one year or less from the United States Treasury (the "Treasury"). The Act requires TVA to obtain the approval of the Secretary of the Treasury of the issue date and maximum interest rate for any issuance of an Evidence of Indebtedness with a term of one year or longer. The Office of Management and Budget ("OMB") includes TVA's finances as part of the budgei of the United States.

The Act requires TVA to annually file a financial statement and complete report as to its business with the President and Congress. The Government Corporation Control Act authorizes the Comptroller General of the United States to periodically audit the transactions of TVA.

The Area Supplied by the Tennessee Valley Authority TVA supplies power in most of Tennessee, northern Alabama, northeastern Mississippi and southwestern Kentucky, and in small portions of Georgia, North Carolina and Virginia. TVA serves a population of about eight million people. Subject to certain minor exceptions, TVA may not without specific authorization by act of Congress enter into contracts which would have the effect of making it or the distributors of its power a source of power supply outside the area for which TVA or the distributors were the primary source of power supply on July 1, 1957.

Rates and Customers TVA is primarily a wholesaler of power. Its customers comprise three major groups: (1) distributors, consisting of municipalities and cooperatives; (2) industries that have large or unusual loads; and (3) federal agencies. Additionally, TVA has entered into exchange power arrangements with most of the electric systems that surround it.

The Act gives the Board sole responsibility for establishing the rates that TVA charges for power and authorizes the Board to include in power contracts terms and conditions that it judges necessary or desirable for carrying out the purposes of the Act. The Act requires TVA to charge rates for power which, among other things, will produce gross revenues sufficient to provide funds for ()

operation, maintenance and administration of its power system; (2) payments to states and counties in lieu of taxes; (3) debt service on outstanding Evidences of Indebtedness; and (4) annual payments to the Treasury in repayment of and as a return on the government's appropriation investment in TVA power facilities (the "Appropriation Invest-ment"). See "Certain Provisions of the Tennessee Valley Authority Act and Related Legislation" and "The Basic Resolution; Power Bonds, Discount Notes and Other Indebtedness" -

"Rate Covenant." Rates set by the Board are not subject to review or approval by any state or federal regulatory body. In a future restructured electric power industry (discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" -

"TVA and Competition"), it is possible, however, that the ability of the Board to set TVA's rates as specified in the TVA Act could be adversely affected by legislative changes or by competitive pressures.

A summary of power program operating revenues by customer type for each of the last five years ended September 30 is shown in "Selected Financial Data."

2

Municipal and Cooperative Distributors Sales to municipal and cooperative distributors accounted for approximately 86 percent of TVA's total revenues in 2002. TVA has long-term wholesale power contracts vith 158 municipal and cooperative distributors. All of these contracts require distributors to purchase substantially all of their electric power and energy requirements from TVA.

All distributors purchase power under one of three basic arrangements. Fifty-five distributors purchase power under contracts that require 10 years' notice to terminate and further provide that on each anniversary beginning on the tenth anniversary, one additional year is automatically added to the term. Four distributors have contracts that require 15 years' notice to terminate the contract. On each anniversary of these contracts, beginning on the fifth anniversary, one additional year is automatically added to the term. TVA has also offered distributors the option of moving from 10- or 15-year termination notice periods to a 5-year termination notice period. Ninety-nine distributors, including two of the largest, have entered into contractual arrangements of this type. Sales to these two distributors generated approximately 13 percent of TVA's total operating revenues in 2002. TVA has agreed that all of these term arrangements are deemed to provide for adequate recovery by TVA of any investment in generation and transmission facilities for service to the distributor.

TVA has received notice from one distributor which terminates its power contract with TVA in October 2007. A second distributor has also given a notice which seeks to so terminate its power contract in October 2007 conditioned upon the availability of transmission service from TVA. During 2002, sales to these distributors generated approximately one percent of TVA's total operating revenues. Once a power contract is terminated, the terminating distributor would have neither the obligation nor the right to take power or obtain transmission from TVA, absent the negotiation of new arrangements.

TVA's wholesale power contracts contain standard provisions specifying the wholesale rates, resale rates and terms and conditions under which power is to be distributed. Under these contracts, TVA, on a quarterly basis, may determine and make adjustments in the wholesale rate schedules necessary to enable TVA to meet all requirements of the Act and the financial covenants and provisions of its bond resolutions. The contracts provide for agreement between the parties on general or major changes in the wholesale schedules.

If, however, agreement is not reached, the contracts permit TVA to make changes in these schedules to carry out the objectives of the Act, to meet financial requirements and covenants and to comply with the provisions of its bond resolutions.

Most of the power contracts between TVA and the distributors of TVA power specify the resale rates that distributors charge the ultimate power consumers. These rates are revised from time to time to reflect changes in costs, including changes in the wholesale cost of power. They are designed to promote the Act's objective of providing an adequate supply of power at the lowest feasible rates.

A number of TVA distributors, including some with the largest loads, have expressed interest in further revising their wholesale power contracts to allow them more options respecting contract term and other matters, such as purchasing a portion of their power requirements from suppliers other than TVA. TVA agreed to work with distributors to develop additional contract flexibility and outlined a framework for additional contract options in June 2001. Distributors and the Tennessee Valley Public Power Association

("TVPPA"), an association which includes almost all distributors of TVA power, agreed to work with TVA to draft the new contract arrangements. Two teams are working to develop proposals, one on long-term contract options and the other on partial requirement options. TVA and the distributors have reached substantial agreement on long-term contract options. Under these arrangements, TVA would offer distributors a choice of 10-, 15-, and 20-year rolling-term contract options in exchange for certain benefits. The partial requirements option would permit distributors to buy up to 10 percent of their power from other suppliers or to generate a comparable amount themselves, following a two-year notice to TVA. Progress on this option has slowed due to uncertainty regarding transmission issues.

3

TVA has also entered into agreements with two distributors that significantly reduce TVA's involvement with their resale rates and which provide for TVA's termination notice period to generally be 10 years even if the distributor has chosen the 5-year option described above.

TVA is offering a discounted energy unit ("DEU") program to its distributors through which a distributor prepays a portion of the price of a block of kWhs and receives a credit on its power bill over a period of years (10, 15 or 20) for each kWh in the prepaid block. TVA has received expressions of interest from over 40. distributors interested in participating in this program. The amount of their indicated participation totals more than $50 million. TVA expects to enter into power contract supplements to implement the DEU program beginning in January 2003. Upon termination of the power contract, the DEU agreement will terminate unless TVA and the distributor agree to other supply arrangements. The number of distributors that ultimately decides to participate in the DEU program and the dollar amount of their participation may be more or less than that described above.

For a discussion of the effects of competition in the restructured electric power market, see "Manage-ment's Discussion and Analysis of Financial Condition and Results of Operations" -

"TVA and Competition."

Other Sources of Revenues Revenues from industries and federal agencies directly served and from exchange power arrangements with other power systems and other revenue accounted for approximately 14 percent of TVA's total power revenues in 2002. Contracts with industries directly served by TVA are normally for 10-year terms. These contracts are subject to termination by TVA or the customer upon a minimum notice period that varies according to the customer's contract demand and the period of time service has been provided to the location where it is to be terminated. TVA establishes the rates it charges to industrial customers it directly serves.

These rates normally are the same as those charged by the distributors of TVA power to large industries (those with demand greater than 25,000 kilowatts).

TVA generally sells power to federal agencies under the same contract terms and rates as directly-served industries. Contracts with federal agencies are normally for 10-year terms and are subject to termination by TVA or the federal agency upon a minimum notice period that varies according to the customer's contract demand and period of time service has been provided to the location where it is to be terminated.

TVA also has exchange power arrangements with 11 neighboring power systems. As part of the TVA self-financing legislation enacted by Congress in 1959, TVA was restricted to selling power outside of the TVA service area to what was then 14 power generating companies. Due to a number of mergers and acquisitions over the years, there are now 11 of these grandfathered organizations remaining. The agreements are open-ended but do have termination provisions.

Power and Energy Requirements TVA prepares annual forecasts of future power and energy requirements as part of its planning and budgeting process. TVA's forecast procedure involves producing a range of load forecasts for the explicit purpose of bounding the range of uncertainty associated with load growth. TVA produces the load forecasts probabilistically. TVA believes that there is a 90 percent probability that the actual load will be less than the high load forecast, a 50 percent probability that the actual load will be less than medium load forecast and a 10 percent probability that actual load will be less than the low load forecast. TVA's current load forecast through 2004 reflects an average annual peak growth rate of 3.1 percent, 2.2 percent and 0.6 percent for the high, medium and low load forecasts, respectively. TVA's current forecast of total system energy require-ments through 2004 reflect an average annual energy growth rate of 3.7 percent, 2.8 percent and 1.1 percent for the high, medium and low load forecasts, respectively. Numerous factors, such as weather conditions and the health of the regional economy, could cause actual results to differ materially from TVA's forecasts.

4

Fuel Management believes the sources and availability of fuel materials essential to its business should be adequate for the foreseeable future.

Coal consumption during 2002 was 42.4 million tons. Coal is purchased under contracts ranging from a single delivery to deliveries over several years. TVA coal inventory levels vary from plant to plant based upon a simulated inventory model. As of September 30, 2002, TVA had 19.7 days' system-wide coal supply in inventory at full burn. Coal inventory at September 30, 2002 and 2001 was $173 million and $170 million, respectively.

TVA has in place term coal contracts that for 2002 supplied 81 percent of TVA's total coal requirements.

The remaining 19 percent was purchased in the spot coal market under contracts with terms of one year or less. Thirty-four percent of TVA's coal supply comes from western states; the remainder comes from Illinois, Kentucky, Pennsylvania, Tennessee, Virginia and West Virginia. Thirty-four percent of TVA's coal supply is delivered by train, 28 percent is delivered by barge, and 25 percent is delivered by barge in combination with trains. The remainder is delivered by truck.

During 2002, TVA purchased approximately 87 percent of its natural gas requirements in the spot market and 13 percent pursuant to option contracts with maturities of one year or less. TVA purchases substantially all of its natural gas to operate combustion turbine peaking units. These combustion turbine units, which can also operate on distillate fuel, produced less than 1 percent of the electricity that TVA generated during 2002.

TVA owns all nuclear fuel held for its operating and deferred nuclear units. The net book value of this fuel was $319 million as of September 30, 2002. TVA will fill future uranium requirements by a combination of term and spot purchase contracts while maintaining diversity of supply source. TVA currently has approximately 90 percent of its forward five-year (2003-2007) uranium requirements either in inventory or under contract.

Under an interagency agreement entered into in 2001, DOE is to transfer to TVA at no cost a total of approximately 33 metric tons of surplus highly enriched uranium ("HEU"). However, TVA is responsible for the subsequent costs required to down blend and convert the HEU material to a form of material usable in the nuclear fuel assembly manufacturing process. In April 2001, TVA entered into a contract with Framatome ANP for down-blending and conversion services for the HEU material through Framatome ANP's subcontractor Nuclear Fuel Services and for fabricating the blended-down material into fuel assemblies to be used in TVA's nuclear plants. The estimated costs TVA will incur under this contract are not expected to exceed $525 million. TVA will defer the HEU down-blending and fuel assembly fabrication costs until such time as sufficient fuel is available for reactor unit reload. Deferred costs will be allocated to the reload assemblies and amortized as fuel expense over the fuel burn period in accordance with TVA's current nuclear fuel accounting policy.

PROPERTIES TVA's power system is one of the largest in the United States in capacity and in energy production. Its size permitted the construction of large facilities which resulted in lower unit costs. Most of TVA's dams were completed years ago when construction costs were far below present-day levels. In accordance with the Act, all real estate acquired by TVA is acquired in the name of the United States. See "Certain Provisions of the Tennessee Valley Authority Act and Related Legislation."

TVA's power generating facilities at September 30, 2002, included 29 hydroelectric plants, 11 coal-fired plants, 3 nuclear plants, I pumped storage hydroelectric plant, 6 combustion turbine plants, I windpower site, 2 methane gas generation sites and 14 solar photovoltaic sites. Energy is delivered to TVA customers over a transmission system of approximately 17,000 miles of lines, including 2,400 miles of extra-high-voltage (500,000 volt) transmission lines. The system interconnects with neighboring power systems at numerous points. TVA has various types of interchange arrangements with these systems. The extent and types of interchange transactions depend upon the characteristics of the systems' loads, the management policies of the 5

systems and other factors. Interchange arrangements are an essential part of TVA's efforts to minimize investment in electrical facilities, increase the reliability of service, effect operating economies and minimize the cost of electric energy.

While not generally subject to Federal Energy Regulatory Commission ("FERC") jurisdiction, TVA is voluntarily seeking ways to meet FERC's objectives to improve regional transmission control in a manner consistent with TVA's responsibilities under the TVA Act. TVA is moving forward on two initiatives. First, TVA is working to create a coordination agreement with other public power providers to develop a regional partnership that will allow its members to continue their public service mission and integrate with surrounding regional transmission organizations ("RTOs") for a seamless market. Second, TVA is working with neighboring utilities and RTOs -

including Southern Company, Entergy Corporation and the Midwest Independent System Operator to create a contractual arrangement that would encourage a seamless wholesale power market for much of the eastern interconnection.

Generating Resources During 2002, 64 percent of the power generated by the TVA coordinated system was by coal-fired plants and combustion turbines, 30 percent by nuclear and 6 percent by hydro.

The following table summarizes the winter net dependable capacity ("NDC") in megawatts ("MW") on TVA's coordinated system as of September 30, 2002:

Winter Net Dependable Generating Capacitv Units (MW)

TVA-Owned/Leased Facilities Hydro............................................................

109 3,305 Pumped Storage...........................

4 1,624 Coal-fired..........................................................

59 15,023 Nuclear....

5 5,751 Combustion Turbine......

72 4,643(2) 30,346 Other Facilities TAPOCO, Inc.

326()

U.S. Army Corp. of Engineers 405(4)

Choctaw Generation, LP....

440(5)

Total Capacity 31,517 (1) NDC as stated is the net power output which can be obtained for a period adequate to satisfy the daily load patterns under expected conditions of operation with equipment in an average state of maintenance excluding anfy fluctuations in capacity that may occur due to planned outages, unplanned outages and deratings. For planiing purposes, TVA currently estimates summer dependable total hydro capacity, includilng generation supplied under agreements with TAPOCO, Inc., and the Southeastern Power Xdmiiistration, of approximately,9!

,MW; coal-fred capacity, incliding Choctaw Generation plant capacity, of approximately 15,116 MW; nuclear 6power capacity of approximately 5,601 MW; and combustion turbine capacity (on oil at 95 degrees Fahrenheit) of approximately 3,843 MW, for a total summer NDC of approximately 30,477 MW.

(2) Combustion turbine capacity includes 9 MW for Meridian Naval Air Station diesel generators, 14 MW for Bellefonte Nuclear Plant diesel generators and 4,620 MW for turbines (on oil at 25 degrees Fahrenheit). As of September 30, 2002, 16 of TVA's combustion turbine units were leased to private entities and leased back to TVA under long-term leases. In December 2002, TVA leased and leased back 4 more of its combustion turbine units under long-term leases.

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(3) Four hydro plants owned by TAPOCO, Inc., a subsidiary of the Aluminum Company of America

("Alcoa"), are operated as part of the TVA power system. Under contractual arrangements with TAPOCO, Inc., electric power generated at these facilities is supplied to TVA. In return, TVA supplies electric power for Alcoa's aluminum plant operations located in Tennessee.

(4) The U.S. Army Corps of Engineers' eight hydro plants on the Cumberland River System have a total installed capacity of 975 MW, of which 405 MW of capacity is available to TVA under a marketing agreement with the Southeastern Power Administration.

(5) TVA has contracted with Choctaw Generation, L.P., for 440 MW from a lignite-fired generating plant in Chester, Mississippi. The contract has a 30-year term.

Under arrangements among TVA, the U.S. Army Corps of Engineers (the "CORPS") and the Southeastern Power Administration ("SEPA"), eight hydro plants of the CORPS on the Cumberland River System are operated in coordination with the TVA system. These arrangements further provide for capacity (405 MW) and energy from the Cumberland River System to be supplied to TVA by SEPA at the points of generation and the price paid for the power to be based on the operating and maintenance expenses and amortization of the power facilities. A portion of the output of the Cumberland River System is also made available to SEPA's customers outside the TVA region. The agreement with SEPA covering these arrangements for power from the Cumberland River System can be terminated upon three years' notice. This notice may be given beginning June 30, 2017.

TVA has also supplemented its existing generation portfolio with additional renewable resource assets (wind, solar and methane gas technologies). These assets account for about 5 MW of capacity. Current power projections indicate that in the near term ample power from generation sources within the TVA service area should be available to meet TVA's power needs at competitive prices.

LEGAL PROCEEDINGS The Environmental Protection Agency ("EPA") has commenced judicial and administrative actions against a number of utilities in the eastern U.S., including TVA, alleging that they have modified their coal-fired units without complying with new source review ("NSR") requirements. TVA contends EPA's enforcement action is based on a new interpretation of an old rule and that TVA has routinely maintained its power plants to ensure efficient, reliable power generation while complying with all requirements. EPA issued TVA an administrative order directing TVA to put new source controls on 14 of its coal-fired units and to evaluate whether more controls should be installed on other units. TVA has challenged the validity of this order in the Eleventh Circuit Court of Appeals, and the court has stayed the order pending review, has upheld its jurisdiction over the case, and heard oral argument on the merits in May 2002. The outcome of this litigation and the EPA proceedings is uncertain. It is not possible to predict with certainty what impact implementation of EPA's order would have on TVA if TVA's challenge is unsuccessful. If EPA substantially prevails, TVA could be required to incur capital costs in excess of $3 billion by 2010 to 2012. Any additional controls that TVA could be required to install on units as a result of this matter would, however, also be sufficient to comply with reduction requirements that are anticipated under the other air quality programs (discussed under "Management's Discussion and Analysis of Financial Condition and Results of Opera-tions" -

"Environmental Matters") through the 2010-2012 time period. Thus, because of the other environmental program requirements, TVA would, in any event, likely have to incur a substantial portion of the costs that might result from the EPA enforcement action, albeit the schedule for the installation of the controls could be somewhat accelerated by the EPA enforcement action. TVA fully supports the need to further reduce emissions from coal-fired plants and seeks a resolution that will not put TVA customers and the region at a disadvantage.

The National Parks Conservation Association ("NPCA") and the Sierra Club filed cases in federal district courts raising the same NSR allegations at TVA's Bull Run Fossil Plant and Colbert Fossil Plant Unit 5 as were raised in the EPA proceedings. Both cases have been stayed pending a decision from the Eleventh Circuit.

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Environmental groups are taking legal action against TVA, as well as against other utilities across the country, for allegedly violating opacity limits applicable to coal-fired plants.

The Alabama Environmental Council and the Sierra Club filed a lawsuit in federal district court in Florence, Alabama, alleging that TVAiviolated Clean Air Act opacity limits applicable to Colbert Fossil Plant between July 1, 1997 and June 30, 2002. The groups seek a court order requiring TVA to bring Colbert Fossil Plant into continuous compliance with the opacity limits, which would require TVA to incur substantial costs in addition to the costs TVA is already planning to incur for environmental controls and to pay civil penalties of up to approximately $250 million. TVA filed its answer to the lawsuit in November 2002.

• The Sierra Club gave notice in a September 26, 2002, letter that it intends to sue TVA for violating Clean Air Act opacity limits applicable to the John Sevier and Kingston Fossil Plants. The notice claims that TVA violated opacity standards at the two plants from July 1, 1997, to the present. The alleged opacity violations substantially overlap those that were challenged in a lawsuit filed by the NPCA two years ago in federal court in Knoxville, Tennessee. TVA ultimately prevailed in that lawsuit.

On December 28, 2001, Bowater Incorporated and Bowater Newsprint South, Inc. (together, "Bo-water") filed a lawsuit against TVA in federal court in Knoxville challenging TVA's charges for Economy, Surplus Power ("ESP") and Testing and Restart Power ("TRP") for two Bowater plants. In its complaint, Bowater alleges that in violation of the contract provision which states that TVA will charge ESP and TRP customers based on TVA's actual hourly incremental cost of providing ESP (1) TVA included certain alleged nonincremental costs in the prices for ESP and TRP and (2) when calculating such prices TVA used the cost of providing the most expensive 100 MWs of ESP sold during a given hour instead of the average cost in that hour of serving the entire ESP load. The complaint also alleges that TVA has been unjustly enriched as a result of these overcharges. The lawsuit seeks, among other things, compensatory damages in excess of $25 million and interest of more than $10 million. TVA believes that it will prevail in this lawsuit based on the information presently available.

TVA is a party to various other civil lawsuits and claims that have arisen in the ordinary course of its business. Although the outcome of these other civil lawsuits and claims cannot be predicted with any certainty, it is TVA's belief that their ultimate outcome should not have a materially adverse effect on TVA's financial position or results of operations.

CERTAIN PROVISIONS OF THE TENNESSEE VALLEY AJTHORITY ACT AND RELATED LEGISLATION The following sunmaries of certain provisions of the Act and related legislation are not complete and are qualified in their entireties by reference to the full texts of the Act and the related legislation.

Payments in Lieu of Taxes TVA is not subject to federalinco`ne taxes or to taxation by states or their subdivisions. However, the Act requires TVA to make payments in lieu of taxes to'states and counties in which the Corporation conducts power operations and in which the Corporation has acquired properties previously subject to state and local taxation. The basic amount of these payments is 5 percent of gross revenues from the sale of power during the preceding year excluding payments to other federal agencies and off-system sales with other utilities, with a provision for minimum payments under certain'circumstances. During 2002 and 2001, TVA made payments totaling $328 million and $315 million, respectively, to the states of Alabama, Georgia, Illinois, Kentucky, Mississippi, North Carolina, Tennessee and Virginia.

Payments to the Treasury The Act requires TVA to make certain payments to the Treasury each year from Net Power Proceeds in excess of those required for debt service, as a return on and reduction of the Appropriation Investment. The 8

Appropriation Investment totaled $488 million as of September 30, 2002. Net Power Proceeds are defined as the remainder of gross power revenues from TVA's power program after deducting

• the costs of operating, maintaining and administering its power properties (including multiple-purpose properties in the proportion that multiple-purpose costs are allocated to power) and

• payments to states and counties in lieu of taxes, but before deducting

• depreciation accruals or other charges representing the amortization of capital expenditures, pluis

• the net proceeds of the sale or other disposition of any interest in TVA's pow;er properties that constitute an operating unit or system.

Acquisition of Real Estate The Act empowers TVA to acquire real estate in the name of the United States of America by purchase or by exercise of the right of eminent domain, "and thereupon all such real estate shall be entrusted to the Corporation as the agent of the United States to accomplish the purposes of [the] Act." Thus, all references in this Statement to TVA properties, and to the amounts invested in TVA properties, should be read and construed in the light of this provision of the Act.

Other Legislation In October 1997 Congress enacted the Energy and Water Development Appropriations Act, 1998, Pub.

L. No. 105-62, 111 Stat. 1320, 1338 (1997). The paragraph captioned "TENNESSEE VALLEY AUTHORITY" in Title IV of this act (the "Appropriations Act Paragraph") requires TVA, beginning with 1999, to fund nonpower programs that constitute "essential stewardship activities" with revenues derived from one or more of various sources, including power revenues, notwithstanding provisions of the TVA Act and power bond covenants to the contrary. These programs historically had been funded with appropriated funds rather than power revenues.

The Appropriations Act Paragraph states:

For the purpose of carrying out the provisions of the Tennessee Valley Authority Act of 1933, as amended (16 U.S.C. ch. 12A), including hire, maintenance, and operation of aircraft, and purchase and hire of passenger motor vehicles, $70,000,000, to remain available until expended, of wvhich $6,900,000 shall be available for operation, maintenance, surveillance, and improvement of Land Between the Lakes; and for essential stewardship activities for which appropriations were provided to the Tennessee Valley Authority in Public Law 104-206, such sums as are necessary in fiscal year 1999 and thereafter, to be derived only from one or more of the following sources: nonpower fund balances and collections; investment returns of the nonpower program; applied programmatic savings in the power and nonpower programs; savings from the suspension of bonuses and awards; savings from reductions in memberships and contributions; increases in collections resulting from nonpower activities, including user fees; or increases in charges to private and public utilities both investor and cooperatively owned, as well as to direct load customers: Provided, That such funds are available to fund the stewardship activities under this paragraph, notwithstanding sections 11, 14, 15, 29, or other provisions of the Tennessee Valley Authority Act, as amended, or provisions of the TVA power bond covenants: Provided further, That the savings from, and revenue adjustments to, the TVA budget in fiscal year 1999 and thereafter shall be sufficient to fund the aforementioned stewardship activities such that the net spending authority and resulting outlays for these activities shall not exceed $0 in fiscal year 1999 and thereafter.

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Since 1999, Congress has provided no appropriations for TVA's nonpower programs. In compliance with the Appropriations Act Paragraph, TVA is and will continue funding its essential stewardship activities with funds from its power program (and other available funds) to the extent that Congress does not make appropriations for these activities. In 1999, the last year TVA received appropriated funds, it spent a total of approximately $75 million on essential stewardship activities, $30 million of which amount was power funds.

In 2002, TVA spent a total of approximately $83 million on essential stewardship activities, virtually all of which was power funds (see note 10- Stewardship Responsibilities), and TVA expects in 2003 to spend approximately the same amount of power funds on such activities as it did in 2002.

In 1998 Congress enacted legislation (Public Law No. 105-277, 112 Stat. 2681-543(1998)) that authorized TVA to prepay certain indebtedness TVA then owed to the Federal Financing Bank (the "FFB").

TVA prepaid the indebtedness in that same year. The legislation specifies that TVA shall not be permitted to obtain future financing from the FFB and requires TVA to use the savings from the prepayment to reduce its debt.

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THE BASIC RESOLUTION; POWER BONDS, DISCOUNT NOTES AND OTHER INDEBTEDNESS TVA issues Power Bonds pursuant to Section 15d of the Act and pursuant to the Basic Resolution. Power Bonds of each series must be further authorized by Supplemental Resolution. At September 30, 2002, TVA had US$20.1 billion, DM1.5 billion (issued in September 1996) and £450 million (£200 million issued in December 1998 and £250 million issued in July 2001) principal amount of Power Bonds outstanding. TVA may issue Power Bonds only to provide capital for TVA's power program (including refunding any Evidences of Indebtedness issued for like purposes) and only as authorized by law at the time of issuance. Power Bonds are payable as to both principal and interest solely from Net Power Proceeds, but TVA may, at its option, pay Power Bonds from the proceeds of refunding obligations or other funds legally available for such payment.

Net Power Proceeds for 2002, 2001 and 2000 were $2.8 billion, $3.3 billion and $3.0 billion, respectively.

Power Bonds are not obligations of or guaranteed by, the United States of America.

TVA intends from time to time to issue new Power Bonds with maturities and on terms determined in light of market conditions at the time of sale. TVA may sell new Power Bonds to dealers or underwriters, who may resell the new Power Bonds in public offerings or otherwise. Additionally, TVA may sell new Power Bonds directly or through other entities.

The offering circular, and any appropriate amendment or supplement to the offering circular, for each offering of new Power Bonds, except for new Power Bonds offered under a program on a continuous basis, will set forth the following information: (1) the aggregate principal amount, (2) maturity, (3) interest rate or method for determining such rate, (4) interest payment date(s), (5) purchase price to be paid to TVA, (6) any terms for redemption or other special terms, (7) form and denomination of new Power Bonds, (8) information as to any stock exchange listing, (9) the names of any dealers, underwriters or agents, (10) a description of any amendments or supplements to the Basic Resolution in connection with the sale of the new Power Bonds, and (11) other terms of the new Power Bonds.

For Power Bonds offered under a program on a continuous basis, TVA will prepare a single offering circular that describes the general terms and conditions common to all Power Bonds issued under the program.

The offering circular will describe how, if at all, the offering circular will be supplemented in order to reflect, among other things, the specific terms and conditions of the Power Bonds being offered. At the time of each sale, TVA will determine if the Power Bonds being sold will be subject to redemption prior to the maturity date and will establish the purchase price, principal amount, interest rate or interest rate formula, maturity date and certain other terms of such sale.

TVA also issues Discount Notes pursuant to Section 15d of the Act and in accord with Section 2.5 of the Basic Resolution. As of September 30, 2002, TVA had approximately $3.5 billion in Discount Notes outstanding. Discount Notes are payable solely from Net Power Proceeds, but TVA may, at its option, pay Discount Notes from the proceeds of refunding obligations or other funds legally available for such payment.

TVA intends to offer Discount Notes for sale on a continuous basis to a group of securities dealers selected by TVA, who will generally resell the notes. TVA will issue Discount Notes in a form and upon terms and conditions as it deems appropriate. Certain information respecting Discount Notes will be set forth in a Discount Notes offering circular and any appropriate supplement to the offering circular. Discount Notes are not obligations of or guaranteed by, the United States of America.

TVA may issue Other Indebtedness pursuant to Section 15d of the Act and in accordance with Section 2.5 of the Basic Resolution. An offering circular, and any appropriate amendment or supplement to the offering circular, for each offering of Other Indebtedness will set forth the following information: (I ) the aggregate principal amount, (2) maturity, (3) interest rate or method for determining such rate, (4) interest payment date(s), (5) purchase price to be paid to TVA, (6) any terms for redemption or other special terms, (7) form and denomination of Other Indebtedness, (8) information as to any stock exchange listing, (9) the names of any dealers, underwriters or agents, and (10) other terms of Other Indebtedness. Other Indebtedness will not be obligations of or guaranteed by, the United States of Anmerica.

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Income on Evidences of Indebtedness issued by TVA is subject to United States federal income taxation and various other federal tax consequences. There is no special exemption for Evidences of Indebtedness from federal estate and gift taxes. Under the Act, Evidences of Indebtedness are exempt both as to principal and interest from all taxation now or hereafter imposed by any state or local taxing authority except estate, inheritance and gift taxes. This exemption might not extend to franchise or other nonproperty taxes imposed on corporations or to gain or loss realized upon the sale or exchange of an Evidence of Indebtedness even though such gain might in some cases be treated as interest income for federal income tax purposes.

The following summary of certain provisions of the Basic Resolution is not complete and is qualified in its entirety by reference to the full text of the Basic Resolution. See also "Certain Provisions of the Tennessee Valley Authority Act and Related Legislation" -"Other Legislation."

Application of Net Power Proceeds Section 2.3 of the Basic Resolution provides as follows.

Net Power Proceeds shall be applied, and the Corporation hereby specifically pledges them for application, first to payments due as interest on Bonds, on Bond Anticipation Obligations, and on any Evidences of Indebtedness issued pursuant to Section 2.5 which rank on a parity with Bonds as to interest; to payments of the principal due on Bonds for the payment of which other provisions have not been made and on any Evidences of Indebtedness issued pursuant to Section 2.5 which rank on a parity with Bonds as to principal and for the payment of which other provisions have not been made; and to meeting requirements of sinking funds or other analogous funds under any Supplemental Resolutions. The remaining Net Power Proceeds shall be used only for:

(a) Required interest payments on any Evidences of Indebtedness issued pursuant to Sec-tion 2.5 which do not rank on a parity with Bonds as to interest.

(b) Required payments of or on account of principal of any Evidences of Indebtedness which do not rank on a parity with Bonds as to principal.

(c) Minimum payments into the United States Treasury required by the Act in repayment of and as a return on the Appropriation Investment.

(d) Investment in Power Assets, additional reductions of the Corporation's capital obligations, and other lawful purposes related to the Power Program; provided, however, that payments into the United States Treasury in any fiscal year in reduction of the Appropriation Investment in addition to the minimum amounts required for such purpose by the Act may be made only if there is a net reduction during such year in the dollar amount of outstanding Evidences of Indebtedness issued for capital purposes, and only to such extent that the percentage of aggregate reduction in the Appropriation Investment during such year does not exceed the percentage of net reduction during the year in the dollar amount of outstanding Evidences of Indebtedness issued for capital purposes.

Section 2.4 of the Basic Resolution provides as follows.

The Corporation, having first adopted a Supplemental Resolution authorizing the issuance of a series of Bonds and pending such issuance, may issue Bond Anticipation Obligations and renewals thereof (including Interim Obligations to the Secretary of the Treasury) to be paid from the proceeds of such series of Bonds when issued or from other funds that may be available for that purpose.

Section 2.5 of the Basic Resolution provides as follows.

To assist in financing its Power Program the Corporation may issue Evidences of Indebtedness other than Bonds and Bond Anticipation Obligations, which may be payable out of Net Power Proceeds subject to the provisions of Section 2.3 hereof. Such other Evidences of Indebtedness may rank on a parity with but shall not rank ahead of the Bonds as to payments on account of the principal thereof or the interest thereon.

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See "Certain Provisions of the Tennessee Valley Authority Act and Related Legislation" -

"Other Legislation" and "Management's Discussion and Analysis of Financial Condition and Results of Opera-tions" -

"Stewardship Responsibilities" for a discussion of legislation relating to appropriations for TVA's nonpower programs and the funding of such programs, including the use of power revenues.

Rate Covenant Section 3.2 of the Basic Resolution provides as follows.

The Corporation shall fix, maintain, and collect rates for power sufficient to meet in each fiscal year the requirements of that portion of the present subsection (f) of section 15d of the Act which reads as follows:

The Corporation shall charge rates for power which will produce gross revenues sufficient to provide funds for operation, maintenance, and administration of its power system; payments to States and counties in lieu of taxes; debt service on outstanding bonds, including provision and maintenance of reserve funds and other funds established in connection therewith; payments to the Treasury as a return on the appropriation investment pursuant to subsection (e) hereof; payment to the Treasury of the repayment sums specified in subsection (e) hereof; and such additional margin as the Board may consider desirable for investment in power system assets, retirement of outstanding bonds in advance of maturity, additional reduction of appropriation investment, and other purposes connected with the Corporation's power business, having due regard for the primary objectives of the Act, including the objective that power shall be sold at rates as lowv as are feasible.

For purposes of this Resolution, "debt service on outstanding bonds," as used in the above provision of the Act, shall mean for any fiscal year the sum of all amounts required to be (a) paid during such fiscal year as interest on Evidences of Indebtedness, (b) accumulated in such fiscal year in any sinking or other analogous fund provided for in connection with any Evidences of Indebtedness, and (c) paid in such fiscal year on account of the principal of any Evidences of Indebtedness for the payment of which funds will not be available from sinking or other analogous funds, from the proceeds of refunding issues, or from other sources; provided, however, that for purposes of clause (c) of this definition Bond Anticipation Obligations and renewals thereof shall be deemed to mature in the proportions and at the times provided for paying or setting aside funds for the payment of the principal of the authorized Bonds in anticipation of the issuance of which such Bond Anticipation Obligations were issued.

The rates for power fixed by the Corporation shall also be sufficient so that they would cover all requirements of the above-quoted provision of subsection (f) of section 15d of the Act if, in such requirements, there were substituted for "debt service on outstanding bonds" for any fiscal year the amount which if applied annually for 35 years would retire, with interest at the rates applicable thereto, the originally issued amounts of all series of Bonds and other Evidences of Indebtedness, any part of which was outstanding on October 1 of such year.

Rates set by the Board are not subject to review or approval by any state or federal regulatory body. In a future restructured electric power industry (discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" -

"TVA and Competition"), it is possible, however, that the ability of TVA's Board to set TVA's rates as specified in the TVA Act and the Basic Resolution could be adversely affected by legislative changes or by competitive pressures.

Covenant for Protection of Bondholders' Investment Under the Act and Section 3.3 of the Basic Resolution, TVA must, in each successive five-year period beginning October 1, 1960, use an amount of Net Power Proceeds at least equal to the sum of (1) depreciation accruals and other charges representing the amortization of capital expenditures and (2) the net proceeds from any disposition of power facilities for either (a) the reduction of its capital obligations (including Evidences of Indebtedness and the Appropriation Investment) or (b) investment in Power Assets.

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Issuance of Additional Bonds and Other Evidences of Indebtedness The Act limits the issuance of Evidences of Indebtedness by TVA to a total of $30 billion outstanding at any one time. At September 30, 2002, TVA had approximately US$23.6 billion (including $3.5 billion of Discount Notes), DM1.5 billion (issued in September 1996) and £450 million (£200 issued in December 1998 and £250 million issued in July 2001) of Evidences of Indebtedness outstanding. The Basic Resolution and the Act permit the issuance of Power Bonds only to provide capital for TVA's power program, including the refunding of any Evidences of Indebtedness issued for that purpose.

Power Bonds, the terms and conditions of which may not be inconsistent with the Basic Resolution, must also be athorized by Supplemental Resolution. The Basic Resolution provides that each Supplemental Resolution authorizing the issuance of Power Bonds must contain a finding by the Board that after the authorized Power Bonds have been issued, gross revenues from TVA's power program will be adequate to meet the requirements of the Basic Resolution with respect to rates and the application of depreciation accruals. These requirements are described under "The Basic Resolution; Power Bonds, Discount Notes and Other Indebtedness" -

"Rate Covenant" and "Covenant for Protection of Bondholders' Investment."

Pending the issuance of Power Bonds authorized by a Supplemental Resolution, TVA may issue Bond Anticipation Obligations and renewals of Bond Anticipation Obligations (including Interim Obligations to the Secretary of the Treasury), to be paid from the proceeds of such Power Bonds when issued or from other funds that may be available for that purpose.

TVA may also issue Evidences of Indebtedness other than Power Bonds and Bond Anticipation Obligations, such as Discount Notes, to assist in financing TVA's power program. They may be payable out of Net Power Proceeds subject to the provisions of Section 2.3 of the Basic Resolution. They may not rank ahead of the Power Bonds as to principal or interest.

Mortgaging and Disposal of Power Properties TVA may not mortgage any part of its power properties and may not dispose of all or any substantial portion of these properties unless it provides for a continuance of the interest, principal and sinking fund payments due and to become due on all outstanding Evidences of Indebtedness, or for the retirement of such Evidences of Indebtedness.

Modifications of Resolutions and Outstanding Bonds The Basic Resolution provides for amendments to it, to any Supplemental Resolution and to any outstanding Power Bonds. Generally, TVA may make amendments to the respective rights and obligations of TVA and the bondholders with the written consent of the holders of at least 66213 percent in principal amount of the outstanding Power Bonds to which the amendment applies. However, TVA may not make changes in the maturity, principal amount, redemption premium or rate of interest or maturity of any interest installment, with respect to any Power Bond, or in the above percentage for any such consent, without the consent of the holder of such Power Bond.

Additionally, TVA may amend the Basic Resolution or any Supplemental Resolution without the consent of the bondholders in order (1) to close the Basic Resolution against the issuance of additional Power Bonds or to restrict such issuance by imposing additional conditions or restrictions; (2) to add other covenants and agreements to be observed by TVA or to eliminate any right, power or privilege conferred upon TVA by the Basic Resolution; (3) to modify any provisions to release TVA from any of its obligations, covenants, agreements, limitations, conditions or restrictions, provided that such modification or release shall not become effective with respect to any Power Bonds issued prior to the adoption of such amendment; (4) to correct any defect, ambiguity or inconsistency in, or to make provisions in regard to matters or questions arising under, the Basic Resolution or any Supplemental Resolution, so long as such amendments are not contrary to, or inconsistent with, the Basic Resolution or such Supplemental Resolution; or (5) to make any other modification or amendment which the Board by resolution determines will not materially and adversely affect the interests of holders of the Power Bonds.

14

Events of Default Any of the following shall be deemed an Event of Default under the Basic Resolution: (I) default in the payment of the principal or redemption price of any Power Bond vhen due and payable at maturity, by call for redemption or otherwise; (2) default in the payment of any installment of interest on any Power Bond when due and payable for more than 30 days; or (3) failure of TVA to duly perform any other covenant, condition or agreement contained in the Power Bonds or in the Basic Resolution or any Supplemental Resolution for 90 days after written notice specifying such failure has been given to TVA by the holders of at least five percent in aggregate principal amount of the then-outstanding Power Bonds.

Upon any such Event of Default, the holders of the Power Bonds may proceed to protect and enforce their respective rights, subject to the restrictions described below. The holders of at least five percent in aggregate principal amount of Power Bonds then outstanding shall, subject to certain restrictions, have the right and power to institute a proceeding (I ) to enforce TVA's covenants and agreements, (2) to enjoin any acts in violation of the rights of holders of Power Bonds, and (3) to protect and enforce the rights of holders of Power Bonds. Such holders have no right to bring any such action or proceeding against TVA unless they have given TVA written notice of an Event of Default and TVA has had a reasonable opportunity to take appropriate corrective action with respect thereto and has failed or refused to do so. Power Bonds do not provide for acceleration utpon an Event of Default.

Holders of a majority in aggregate principal amount of the outstanding Power Bonds have the right to direct the time, method and place of conducting any proceeding for any remedy available and may waive any default and its consequences, except a default in the payment of the principal of or premium, if any, or interest on any Power Bonds.

Fourth Amendatory Resolution to the Basic Resolution On March 25, 1992, TVA adopted a resolution amending the Basic Resolution, entitled "Fourth Amendatory Resolution to Basic Tennessee Valley Authority Power Bond Resolution" (the "Fourth Amendatory Resolution"), that (I ) deleted from the Basic Resolution limitations on issuance of Power Bonds formerly set forth as Section 3.4 thereof and (2) amended the Basic Resolution to permit issuance of other Evidences of Indebtedness under Section 2.5 thereof that rank on a parity with Power Bonds as to principal and interest. With the deletion of Section 3.4 of the Basic Resolution, Sections 3.5 through 3.10 were renumbered as appropriate. This amendatory resolution became effective December 16, 1999, with retroactive application to all Power Bonds issued after March 25, 1992.

15

PART II SELECTED FINANCIAL DATA The following selected financial data of TVA's power program for the years 1998 through 2002 have been derived from TVA's audited financial statements. These data should be read in conjunction with the audited financial statements and notes thereto (collectively the "Financial Statements") presented in "Financial Statements and Supplementary Data."

Condensed Statements of Income (in millions)

For the Years Ended September 30 Operating revenues................................

Operating expenses................................

Operating income.................................

Other income, net.................................

Interest expense, net...............................

Income/ (loss) before loss on impairment of assets/plant cancellation and cumulative effect of change in accounting principle.............................

(Loss)/gain on impairment of assets/plant cancellation and cumulative effect of change in accounting principle.......................................

Net income (loss)................................

2002 2001

$ 6,835

$ 6,999 (5,186)

(5,506) 1,649 1,493 7

248 (1,429)

(1,633) 227 108 (154)

(3,419) 73

$(3,311) 2000

$ 6,762 (5,019) 1,743 17 (1,736) 1999

$ 6,595 (4,926) 1,669 10 (1,777) 1998

$ 6,729 (4,549) 2,180 12 (1,959) 24 (98) 233 24 217 119 233 Condensed Balance Sheets (in millions)

At September 30 2002 2001 2000 1999 1998 Assets Current assets..................................

Property, plant and equipment....................

Investment funds................................

Deferred assets and other assets...................

TOTAL ASSETS............................

Liabilities and proprietary capital Current liabilities...............................

Other liabilities.................................

Long-term debt.................................

Total liabilities................................

Retained earnings...............................

Other proprietary capital.........................

Total proprietary capital........................

TOTAL LIABILITIES AND PROPRIETARY CAPITAL.................................

$ 4,809 3,304 21,358 29,471 349 338 687

$ 6,334 2,806 19,851 28,991 306 402 708

$ 4,793 2,455 21,753 29,001 3,652 528 4,180

$ 3,117 2,156 23,903 29,176 3,662 548 4,210

$ 4,440 2,007 23,020 29,467 3,580 568 4,148

$30,158

$29,699

$33,181

$33,386

$33,615 16

$ 1,530 25,679 659 2,290

$30,158

$ 1,501 25,643 725 1,830

$29,699

$ 1,426 28,314 840 2,601

$33,181

$ 1,318 28,417 731 2,920

$33,386

$ 1,656 28,891 578 2,490

$33,615

COMPARATIVE FIVE-YEAR DATA STATISTICAL AND FINANCIAL SUMMARIES For the Years Ended September 30 2002 2001 2000 1999 1998 Sales (millions of kWh) (a)

Municipalities and cooperatives.....

128,600 129,760 125,991 122,880 123,330 Industries directly served...............

26,478 23,306 22,204 22,885 18,514 Federal agencies and other......

5,013 8,355 11,376 10,190 21,293 Total sales...................

160,091 161,421 159,571 155,955 163,137 Operating revenues (millions of dollars) (a)

Electric Municipalities and cooperatives.......

5,856 5,908 5,676 5,510 5,554 Industries directly served 732 659 626 642 523 Federal agencies and other...........

159 330 361 357 556 Other...............................

88 102 99 86 96 Total revenues.......

6,835 6,999 6,762 6,595 6,729 Electric revenue per kWh (cents) 4.21 4.27 4.18 4.17 4.07 Winter net dependable generating capacity (megawatts)

Hydro(b).........................

5,660 5,677 5,544 5,492 5,491 Coal-fired fossil(c).......

15,463 15,050 15,042 15,049 15,003 Nuclear units in service.

5,751 5,715 5,729 5,729 5,620 Combustion turbine(d)......

4,643 3,923 3,154 2,232 2,384 Total capacity(e)......

31,517 30,365 29,469 28,502 28,498 System peak load (megawatts)-

summer...........................

29,052 27,368 29,344 28,295 27,253 System peak load (megawatts) -

winter 26,061 27,163 25,940 26,388 23,204 Percent gross generation by fuel source Coal-fired fossil.........

63%

64%

63%

63%

62%

Hydro............................

6%

6%

6%

7%

10%

Nuclear.30%

29%

31%

30%

28%

Combustion turbine........

1%

1%

NM NM NM Fuel cost per kWh (cents)

Coal-fired fossil.........

1.39 1.32 1.27 1.28 1.25 Combustion turbine.......

4.65 6.07 6.22 3.94 4.01 Nuclear...........................

0.41 0.44 0.49 0.51 0.71 Aggregate fuel cost per kWh net thermal generation.......

1.11 1.08 1.05 1.05 1.10 17

For the Years Ended September 30 2002 2001 2000 1999 1998 Fuel data Net thermal generation (millions of kWh)...........................

Billion Btu........................

Fuel expense (millions of dollars).....

Cost per million Btu (cents).........

Net heat rate......................

141,272 1,458,367 1,564 107.25 10,323 146,806 1,505,504 1,588 105.47 10,255 143,224 1,470,452 1,504 102.29 10,267 137,169 1,403,110 1,434 102.21 10,229 139,727 1,426,151 1,538 107.81 10,207 (a) Sales and revenues have been adjusted to include sales to other utilities.

(b) Includes 405 megawatts of capacity from the Corps of Engineers projects on the Cumberland River System and 326 megawatts of capacity from four hydro plants owned by TAPOCO, Inc.

(c) Includes 440 megawatts of capacity from a power purchase agreement under which TVA has contracted with Choctaw Generation, L.P., for power from a lignite-fired generation plant in Chester, Mississippi.

(d) As of September 30, 2002, includes sixteen 85 MW units subject to lease/leaseback arrangements.

(e) Total summer NDC for 2002, 2001, 2000, 1999 and 1998 was approximately 30,477 MW, 29,405 MW, 28,612 MW, 28,076 MW and 27,950 MW, respectively.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A")

explains the results of operations and general financial condition of TVA. The MD&A should be read in conjunction with the accompanying Financial Statements.

Results of Operations The following table compares operating results and selected statistics the years ended September 30:

Operating revenues.............................................

Operating expenses............................................

Operating income..............................................

Other income, net..............................................

Interest expense.............................................

Loss on impairment of assets/plant cancellation....................

Net income (loss).............................................

Sales (millions of kWh)........................................

Heating degree days............................................

Cooling degree days............................................

(dollars in millions) for TVA for 2002 2001

$ 6,835

$ 6,999 (5,186)

(5,506) 1,649 1,493 7

248 2000

$ 6,762 (5,019) 1,743 17 (1,429)

(1,633)

(1,736)

(154)

(3,419) 73

$(3,311) 24 160,091 161,421 159,571 2,978 3,671 1,999 1,830 2,829 1,974 2002 Compared to 2001 Net income for 2002 was $73 million compared with a net loss of $3,311 million for 2001. The

$3,384 million increase in earnings resulted primarily from a loss on impairment of long-lived assets of

$3,419 million in 2001.

18

Operating Revenues.

Operating revenues, consisting of sales of electricity and other power revenues, were $6,835 million in 2002, and $6,999 million in 2001, including sales of electricity of $6,747 million in 2002 and $6,897 million in 2001. The $150 million decrease in sales was primarily due to a $170 million decline in interchange revenue due to lower market prices influenced by new independent power producer generating plants coming on line in 2002. In addition, energy sales to municipalities and cooperatives declined by

$52 million primarily as a result of the warmer winter weather during 2002. There were 19 percent fewer heating degree days in 2002 as compared to 2001. Sales to directly served industries increased by $73 million from 2001 to 2002 due to changes in product and service mix to certain customers. Accordingly, total kWh sales to all customers decreased 1.3 billion kWh, from 161.4 billion in 2001 to 160.1 billion in 2002. Other power revenues consist of energy related services and miscellaneous revenues. The $14 million decrease from 2001 to 2002 is primarily due to a decline in wheeling revenues as a result of a lower level of interchange sales.

Weather Degree Days 4,000 3,500 3,000 3,000

1.

2,500 1,000 500 0

98 99 00 01 02 Heating Degree Days

,0.,H=i'-i > g Sigg- ^l Coaling Degree Days Heatng Degme Days (Nonnal)

Cooling Degree Days (Nonnal)

A "Weather Degree Day" is a unit of measure used to express the extent to which temperatures vary from a specific reference temperature during a given period. Companies may use standard reference figures of 80 degrees Fahrenheit for cooling degree days and 60 degrees Fahrenheit for heating degree days. Others sometimes use 65 degrees Fahrenheit as the standard reference for both heating and cooling degree days. TVA uses 65 degrees Fahrenheit.

Operating Expenses.

Total operating expenses, which are composed of fuel and purchased power, operating and maintenance, depreciation and amortization, and tax-equivalents, decreased $320 million, or 6 percent, from $5,506 million in 2001 to $5,186 million in 2002. Fuel and purchased power decreased by

$64 million, or 3 percent. This was primarily due to a corresponding 3 percent decrease in generation resulting in a reduction in fuel expense of $23 million and a decrease in the amount of power purchased of

$41 million due to lower power demand in 2002. Additionally, depreciation and amortization expense was

$285 million lower in 2002 reflecting a $325 million reduction in amortization of regulatory assets, net of increased depreciation expense of $40 million for capital projects placed in service in 2002. Accelerated amortization of regulatory assets decreased $164 million from $230 million in 2001 to $66 million in 2002 (see "Critical Accounting Policies" -

"Amortization Adjustments" below and note I -

Other Deferred Charges -Accelerated Amortization). The decreases in fuel and depreciation were partially offset by an increase in operating and maintenance expenses of $180 million in 2002 over 2001 as a result of increased outage and other costs. Tax equivalent payments increased $13 million in 2002 due to a higher revenue base in 2001, the measuring year for the 2002 payments.

19

Other Income.

TVA had net other income of $7 million in 2002 compared Xwith net other income of

$248 million in 2001. The 2001 net other income resulted primarily from a purchased power contract settlement in excess of $200 million.

Interest Expense. Net interest expense declined $204 million from $1,633 million in 2001 to $1,429 mil-lion in 2002. Total outstanding indebtedness, as of September 30, 2002, vas $25.3 billion, with an average interest rate of 5.89 percent; as of September 30, 2001 this amount outstanding w-as $25.4 billion, with an average interest rate of 6.57 percent.

Loss on Impairmenl of Assets/Plant Cancellation. In 2001, TVA identified certain assets for which estimated future cash flows provided through future rates were likely to be less than recorded book values.

Accordingly, TVA reduced the carrying amount of these assets by a total of $3,419 million, of which

$2,220 million was attributable to deferred nuclear generating units, $789 million was attributable to deferred debt refinancing costs and $410 million was attributable to plant held for future use (see note I -

Impairment of Assets).

Due to changes in the market forecast, TVA elected during 2002 not to complete a gas-fired combined-cycle plant that would have provided 510 megawatts of power in 2004. Accumulated costs of the project totaled approximately $154 million, which TVA recognized as a loss on plant cancellation.

2001 Compared to 2000 Net loss for 2001 was $3,311 million compared with net income $24 million for 2000. The reduction in earnings resulted primarily from a loss on impairment of long-lived assets of $3,419 million in 2001 (see "Loss on Impairment of Assets/Plant Cancellation" below and note I-Impairment of Assets).

Operating Revenuies.

Operating revenues were $6,999 million in 2001 compared with $6,762 million in 2000. The $237 million increase was primarily due to a $232 million increase in energy sales to municipalities and cooperatives as a result of the cold winter weather during 2001. Total kWh sales to municipalities and cooperatives increased 3.8 billion kWh, from 126.0 billion in 2000 to 129.8 billion in 2001. Sales to directly served industries increased by $33 million from 2000 to 2001 primarily due to implementation of a fixed-rate contract with a large manufacturing customer. Interchange sales Nere $27 million less in 2001 than in 2000 due to a decrease in interchange sales of 30 percent or 2.9 billion kWh.

Operating Expenses.

Operating expenses increased $487 million, or 9 percent, from $5,019 million in 2000 to $5,506 million in 2001. Fuel and purchased power costs increased $27 million primarily due to higher fossil fuel costs of $1 10 million due to a 5 percent increase in fossil generation, offset by lower nuclear and purchased power expense of $83 million. Operating and maintenance expenses of $1,660 million in 2001 were

$217 million higher than in 2000. This is a result of an increase in power production of 3 percent.

Depreciation and amortization expense of $1,185 million in 2000 increased $127 million to $1,312 million in 2001 primarily due to additional depreciation of $23 million on projects placed in service and amortization of regulatory assets of $104 million. The increase in tax equivalent payments of $7 million in 2001 was due to a higher revenue base in 2000, the measuring year for 2001 payments. Accelerated amortization increased

$109 million from 2000 to 2001 (see note I -

Other Deferred Charges -Accelerated Amortization).

Other Income.

TVA had net other income of $248 million in 2001 compared with net other income of

$17 million in 2000. The 2001 net other income resulted primarily from a purchased power contract settlement in excess of $200 million.

Interest Expense. Net interest expense declined $103 million from $1,736 million in 2000 to $1,633 mil-lion in 2001. Total outstanding indebtedness, as of September 30, 2001, was $25.4 billion, with an average interest rate of 6.57 percent; as of September 30, 2000 this amount outstanding was $26.0 billion, with an average interest rate of 6.83 percent.

Loss on Impairment of Assets/Plant Cancellation. The net change of $3,419 million in loss on impairment of assets/plant cancellation is due to actions taken as a result of TVA's periodic financial reviews.

In 2001, TVA identified certain assets for which estimated future cash flows provided through future rates 20

were likely to be less than recorded book values. Accordingly, TVA reduced the carrying amount of these assets by a total of $3,419 million, of which $2,220 million was attributable to deferred nuclear generating units, $789 million was attributable to deferred debt refinancing costs and $410 million was attributable to plant held for future use (see note I -

Impairment of Assets). No such assets were written off during 2000.

Liquidity and Capital Resources Capital Structure Primarily during the first 25 years of TVA's existence, the U.S. government made appropriation investments in TVA power facilities. In 1959, TVA received congressional approval to issue bonds in order to finance its growing power program. Since that time, TVA's power program has been required to be self-supporting. As a result, TVA funds its capital requirements through internal cash generation, through borrowings (subject to a congressionally-mandated $30 billion limit on the amount of outstanding Evidences of Indebtedness) or through other financing arrangements including lease/leaseback transactions.

TVA is required to pay the U.S. government a return on the appropriation investment in TVA power facilities, plus a repayment of the investment as specified by law. The combined payment for 2002 was

$50 million. Cumulative repayments and return on investment paid by TVA to the U.S. Treasury exceed

$3.4 billion on the government's appropriation investment of $1.4 billion, approximately $955 million of which TVA has repaid.

TVA's liquidity and capital measurements (dollars in millions) for its power program for the years ended September 30 are:

2002 2001 2000 Cash flow from operations.............

$1,347

$1,914

$1,584 Construction expenditures.............

$1,231

$1,015

$ 867 Operating cash flow to construction expenditures......

1.09x 1.89x 1.83x Times interest earned................

1.92x 2.20x 1.93x Comparative Cash Flow Analysis TVA's summary cash flows for its power program for the years ended September 30 are:

2002 2001 2000 Cash provided by/(used in):

Operating activities...........

$ 1,347

$ 1,914

$ 1,584 Investing activities........................................

(1,346)

(1,191)

(1,035)

Financing activities 57 (732)

(304)

Net increase (decrease) in cash and cash equivalents.....

58 (9) 245 2002 Compared to 2001 Net cash provided by power program operating activities decreased $567 million from 2001 to 2002. The decrease includes a decline in interchange revenue due to lower market prices influenced by new independent power producer generating plants. In addition to lower sales, operating and maintenance expenses increased due to planned (budgeted) maintenance and unplanned outages. Funds were also used to pay current liabilities, which declined 24 percent during 2002.

Cash used in investing activities increased $155 million due to additional expenditures for capital projects of $216 million and fabrication of nuclear fuel of $52 million, partially offset by cash received from other investing activities of $113 million primarily due to a decrease in long-term investments during 2002.

21

Net cash provided by financing activities increased $789 million from 2001 to 2002 as a result of reduced debt repayments of $495 million and proceeds from a lease/leaseback of $320 million, partially offset by an increase in financing costs of $29 million related to bond issues.

2001 Compared to 2000 Cash provided by power program operating activities increased $330 million from 2000 to 2001. This is primarily the result of increased sales to municipalities and cooperatives due to 15 percent greater weather degree days in 2001 and collection of a contract settlement offset by an increase in operating and maintenance expenses due to greater generation and purchased power to meet sales demands as well as funds provided by operating assets and liabilities.

Cash used in investing activities increased $156 million due to additional expenditures for capital projects of $148 million and an increase in long-term investments of $100 million. Cash provided by investing activities increased $90 million for a decrease in fabrication of nuclear fuel from the prior year.

Cash used by financing activities increased $428 million from 2000 to 2001 from an increase in debt repayments of $217 million and a decrease in net lease/leaseback proceeds of $329 million, offset by a decrease in financing costs of $119 million related to bond issues.

Capital Resources For purposes of refinancing outstanding debt, TVA continued to access capital markets through cost-effective, long-term financing structures and continued to expand its global investor base, as well as its domestic retail investor base. TVA offered global securities in December 2001, issuing $600 million of 15-year bonds with a put option in 2006. In April, TVA issued $936 million of new 10-year bonds with a lower coupon and a put option in 2004 in exchange for outstanding 10-year bonds with a higher coupon and a put option in May 2002. The extension of the early redemption feature motivated investors to exchange the existing bonds for the new bonds with a lower coupon. TVA continued to target retail investors through its medium-term note program, electronotes, offering 23 issues ranging in size from $6 million to more than $61 million, for a total of $584 million for the current year. Total electronotes outstanding at September 30, 2002, was

$869 million. During 2002, TVA redeemed outstanding long-term issues totaling approximately $2.7 billion.

Lease/Leaseback Transactions In an effort to meet the growing demand for power in its service area, TVA has been involved in the construction of a series of several new peaking combustion turbine units. The first set of eight units was completed in the summer of 2000, and a second set of eight units xvas completed in the summer of 2001. TVA completed two additional sets of four units each during the summer of 2002. Of the financing options available to TVA, leasing alternatives provided outcomes that were the most economically favorable to TVA.

At the commencement of the long-term lease and leaseback arrangements, the equity participant paid TVA rent in the amounts of $300 million for the first set of units and $320 million for the second set of units, representing the appraised values of the facilities. The financing costs of the lease agreements approximated a full-term implicit rate slightly belov 6 percent in the case of the first lease and just above 4 percent in the case of the second lease.

TVA accounted for the respective lease proceeds as financing obligations in accordance with Statement of Financial Accounting Standards ("SFAS") No. 66, Accounting for Sales of Real Estate, and SFAS No. 98, Accounting for Leases. Accordingly, the outstanding financing obligations of $559 million in 2002 and

$271 million in 2001 are included in Current Liabilities ($16 million and $6 million, respectively) and Other Liabilities ($543 million and $265 million, respectively) in TVA's 2002 and 2001 year-end Balance Sheets.

22

Cash Requirenients and Contractual Obligations TVA estimates future cash requirements for capital expenditures for property, plant and equipment additions, including clean air projects and new generation, will be as follows:

Actual Estimated Expenditures 2002 2003 2004 2005 (in millions)

Capital expenditures.........................

$1,231

$1,580

$1,484

$1,482 TVA also has contractual cash obligations, including minimum payments on operating leases and obligations, power purchase contracts and fuel purchase contracts (see note 9). TVA expects that cash provided by operating activities and new financing activities will be adequate to meet these estimated cash requirements, as well as capital expenditures. As of September 30, the amounts of contractual cash obligations maturing in each of the next five years and thereafter are shown below:

2003 2004 2005 2006 2007 Thereafter Total (in millions)

Leases........................

40 40 39 39 39 121 318 Lease/leaseback transactions 44 44 46 44 44 640 862 Power purchase obligations.......

137 113 136 136 124 2,390 3,036 Other obligations........

441 379 330 293 215 1,658 Fuel purchase obligations........

1,515 999 641 178 99 374 3,806 Debt.........................

3,492 2,336 2,065 2,621 1,051 13,690 25,255

$5,669

$3,911

$3,257

$3,311

$1,572

$17,215

$34,935 Leases Certain property, plant and equipment are leased under agreements with terms ranging from one to 30 years. Obligations under capital lease agreements in effect at September 30, 2002 total $36 million annually through 2007 and an aggregate of $121 million thereafter, for a total commitment of $301 million. Of this amount, $138 million represents the cost of financing. Obligations under non-cancelable lease agreements in effect at September 30, 2002, total $4 million for each of 2003 and 2004 and $3 million for each of 2005-2007.

There are no non-cancelable operating lease agreements in effect after that period. TVA also has cancelable lease agreements in effect at September 30, 2002, which total $2 million for 2003, $3 million for each of 2004 and 2005, $2 million for 2006 and $1 million for each of 2007-2013. Because of the nature of these cancelable lease agreements, they are not included in the commitment table above.

Lease/Leaseback Transactions Obligations under lease/leaseback transactions in effect at September 30, 2002 total $44 million annually for 2003 and 2004, $46 million for 2005, and $44 million annually for 2006 and 2007 and an aggregate of $640 million thereafter, for a total commitment of $862 million. Of this amount, $301 million represents the cost of financing (see notes 7 and 9).

Power Purchase Obligations TVA has an agreement for the purchase of power from a 440-megawatt, lignite-fired electric generating plant that requires TVA to purchase the plant's output for a 30-year period that began in April 2002. Pricing of the contract includes fixed and variable components with estimated power purchases approximating $3 billion for the remainder of the contract term. TVA also entered into long-term power supply agreements with a generator for supply from a facility that has a current generating capacity of 500 megawatts. These commitments extend through May 2007 with a future obligation for demand charges in the amount of $136 million. Agreements are in place with respect to five other projects. These five contracts are for durations of 2 23

to 12 years, the earliest of which began in 2000. Payments for the remainder of the terms of these five contracts are estimated to be approximately $38 million.

Under the Public Utility Regulatory Policies Act of 1978, TVA is obligated to purchase power from qualifying facilities. In 2002, a new facility qualified under this program, and as a result TVA could be required to take up to 800 MW of power during certain on-peak hours from the facility.

Other Obligations TVA has approximately $1.7 billion in long-term commitments consisting primarily of construction of generating assets and emission control facilities. Terms of the contracts extend into 2008.

Fuel Purchase Obligations TVA has approximately $2.7 billion in long-term fuel purchase commitments ranging in terms of up to seven years for the purchase and transportation of coal, and approximately $1.1 billion in long-term commitments ranging in terms of up to 10 years for the purchase of enriched uranium and fabrication of nuclear fuel assemblies.

Debt At September 30, 2002, TVA had outstanding short-term debt of $3,492 million and long-term debt at varying maturities and interest rates of $21,763 million for a total outstanding indebtedness of $25,255 million (see note 6).

Capital Requirements TVA has incurred and continues to incur substantial capital expenditures and operating expenses to comply with environmental requirements. Because these requirements change frequently, the total amount of these costs in the future is not now determinable. It is anticipated that environmental requirements will become more stringent and that compliance costs will increase, perhaps by substantial amounts. Although TVA cannot, with certainty, project the costs of additional nitrogen oxide, sulfur dioxide and particulate matter emissions controls beyond those required by the acid rain provisions of the 1990 Clean Air Act Amendments, the costs of these additional reductions could exceed $3 billion through 2020, exclusive of approximately $2 billion for planned scrubbers and selective catalytic reduction systems discussed in "Environmental Matters" below.

In Maich 2002, TVA's nuclear staff reported to the Board the results of a detailed cost and planning study which concluded that TVA can return Browns Ferry Unit I to service safely and economically. In May 2002, the Board initiated activities for the return of Browns Ferry Unit I to service. It is anticipated the project will cost approximately $1.8 billion and will take five years to complete. It is anticipated that Browns Ferry Unit I will provide approximately 1,280 MWs of capacity.

Significant Balance Sheet Changes Total power assets increased nearly $460 million during 2002 primarily due to the transition of a prepaid pension asset of approximately $800 million to a minimum pension liability of approximately $500 million due to valuation of the pension balances by independent actuaries. An intangible asset of approximately

$400 million has been recognized to properly account for the required pension changes. The offsetting charge of approximately $900 million has been recorded as a regulatory asset, as the Board has determined that these costs will be recovered through future revenues in compliance with the Act (see "Critical Accounting Policies" -

"Regulatory Assets and Liabilities" below).

Critical Accounting Policies TVA prepares its financial statements in conformity with generally accepted accounting principles accepted in the United States of America applied on a consistent basis and, in some cases, reflects amounts based on the best estimates and judgment of management, giving due consideration to materiality.

24

Revenue Recognition Policies Revenues from power sales are recorded as power is delivered to customers. TVA accrues estimated unbilled revenues for power sales provided to customers for the period of time from the end of the billing cycle to the end of the month (see note 12).

Regulatory Assets and Liabilities TVA accounts for the financial effects of regulation in accordance with SFAS No. 71, Accounting for the Effects of Certain Types of Regulation. As a result, TVA records certain regulatory assets and liabilities that would not be recorded on the balance sheet under generally accepted accounting principles for non-regulated entities.

TVA has approximately $1,452 million of regulatory assets (see note I -

Other Deferred Charges and Debt Issue and Reacquisition Costs) along with approximately $4.1 billion of deferred nuclear units as of September 30, 2002 (see note I -Impairment of Assets and note 2). In the event that restructuring of the utility industry changes the application of SFAS No. 71, TVA would be required to evaluate such regulatory assets and deferred nuclear units under the provisions of SFAS No. 101, Accounting for the Discontinuation of Application of SFAS No. 71. SFAS No. 101 establishes reporting criteria for an enterprise that ceases to meet the criteria for application of SFAS No. 71.

Actuarial Assumptions Net periodic pension cost is determined using assumptions as of the beginning of each year. Funded status is determined using assumptions as of the end of each year. The valuations performed at the end of 2001 were based on actuarial assumptions that were consistent for all of TVA's benefit plans. For 2002, TVA recognized pension income of about $40 million, postretirement benefit expense of $19 million, and workers compensation expense of approximately $64 million.

Effective with the September 30, 2002 measurement date for funded status, the discount rate was reduced from 7.5 percent to 7.05 percent and the cost of living rate was reduced from 3.0 percent to 2.3 percent to reflect current market and demographic conditions. Additionally, TVA modified its assumption related to mortality based on results of an experience study performed during the year and converted from 1994 to 1983 mortality tables. As a result of these changes, the September 30, 2002 projected benefit obligation decreased by nearly $128 million. The changes in assumptions had no effect on pension income for 2002, 2001 or 2000 but will reduce pension expense for 2003 by approximately $37 million (see note 8).

Derivatives Effective October 1, 2000, TVA adopted the provisions of SFAS Nos. 133, Accounting for Derivative Instruments and Hedging Activities, and 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities. Qualifying derivative contracts consisted of various purchased power option contracts and certain currency and interest rate swap agreements (see note 5-Foreign Currency and Interest Rate Swaps). In accordance with SFAS No. 133, these contracts qualify for cash-flow hedge treatment.

Accordingly, the effective portion of gains and losses related to such contracts is reported in accumulated other comprehensive income, vhile the ineffective portion is recognized through the creation of a regulatory asset/liability. The amounts accumulated in other comprehensive income and regulatory asset/liability are recognized in earnings upon settlement of the related contracts. Such treatment reflects TVA's ability and intent to account for these derivative instruments on a settlement basis for rate-making purposes.

Amortization Adjustments Annual provisions for amortization of deferred charges are adjusted as necessary in order to achieve certain earnings levels. Such earnings levels are set forth in resolutions adopted annually by the TVA Board of Directors in connection with the rate review process. The targeted earnings levels are based on requirements of the TVA Act and the Basic Resolution.

25

Normal Purchases and NVormal Sales Special Exemption A unique characteristic of the electric utility industry is that electricity cannot readily be stored in significant quantities, and, as a result, some contracts to buy and sell electricity afford the buyer some flexibility in determining when to take electricity, and in what quantity, to meet fluctuating demands. These contracts would normally qualify as derivatives, but because electricity cannot be readily stored and an entity engaged in selling electricity is obligated to maintain sufficient capacity to meet the electricity needs of its customers, an option contract for the purchase of electricity qualifies for the normal purchases and sales exemption described in Paragraph 10 of SFAS No. 133 and Derivatives Implementation Group ("DIG")

Issue No. C15, Scope Exceptions: Normal Purchases and N'ormal Sales Exception for Option-Type Contracts in Electricity. Contracts for the sale or purchase of power in future periods that meet the criteria of DIG Issue C15 have been categorized as "normal purchase, normal sales" contracts and arc exempted from recognition in the financial statements until power is delivered.

Nuclear Decommissioning Costs TVA's current accounting policy for nuclear decommissioning costs recognizes all obligations related to closure and removal of its nuclear units as incurred (see note I -Decommissioning Costs). TVA measures the liability for closure at the present value of the estimated cash flows required to satisfy the related obligation, discounted at a determined rate of interest in effect at the time of original fuel load. Earnings from decommissioning fund investments, amortization expense of the decommissioning regulatory asset and interest expense on the decommissioning liability are deferred in accordance with SFAS No. 71 (see note I-Decommissioning Costs and note 9 -Contingencies -Decomnmissioning Costs).

At September 30, 2002, the present value of the estimated future decommissioning cost of $891 million was included in other liabilities, and the unamortized regulatory asset of $556 million was included in deferred charges. The decommissioning cost estimates are based on prompt dismantlement and removal of a plant from service. The actual decommissioning costs may vary from the estimates because of changes in the assumed dates of decommissioning, changes in regulatory requirements, changes in technology and changes in the cost of labor, materials and equipment.

TVA maintains a decommissioning trust fund to provide funding for the ultimate decommissioning of its nuclear power plants. The fund is invested in securities selected to achieve a return in line with overall equity market performance. As of September 30, 2002, the decommissioning trust funds totaled approximately

$500 million, and as of November 30, 2002, the decommissioning trust funds totaled approximately

$570 million. This amount is less than the present value of the estimated future decommissioning costs. TVA is closely monitoring the status of its decommissioning trust fund in light of recent market performance and believes that, over the long term before the cessation of plant operations and the commencement of decommissioning activities, adequate funds from investments will be available to support decommissioning.

(TVA's nuclear power plants are currently authorized to operate until 2013-2035, depending on the facility, with an additional 20 years of operation at each plant in the event of license renewal (see "Nuclear Power Program" -"Operating License Extensions" below).)

New Accounting Standards and Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, Accounting for Asset Retirement Obligations, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. TVA is currently developing a policy related to the retirement of its long-lived assets and is evaluating the nature and scope of plant site and other long-lived asset retirements. Upon completion of the evaluation, cost estimates will be developed and used in the determination of all related asset retirement obligations. The associated asset retirement costs will be capitalized as part of the carrying amount of the long-lived asset.

SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The impact of adoption of SFAS No. 143 is not currently known.

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In October 2001, the FASB issued SFAS No. 144, Accounting for the mpairment or Disposal of Long-Lived Assets, which replaces SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. It also developed one accounting model for long-lived assets to be disposed of by sale, based on the framework established in SFAS No. 121, and addressed significant implementation issues. SFAS No. 144 requires that those long-lived assets be measured at the lower of the carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001 and, generally, are to be applied prospectively. The impact of adoption of SFAS No. 144 is not currently known.

The purpose of Emerging Issues Task Force ("EITF") Issue 02-3, Issues Related to Accounting for Contracts Involved in Energy Trading and Risk Management Activities, is to codify and reconcile the Task Force consensuses on previously issued EITF Issues No. 98-10, Accountingfor Contracts Involved in Energy Trading and Risk Management Activities, and No. 00-17, Measurinig the Fair Value of Energy-Related Contracts in Applying Issue No. 98-10, and EITF Abstracts, Topic No. D-105, Accounting in Consolidation for Energy Trading Contracts between Affiliated Entities When the Activities of One but Not Both Affiliates Are within the Scope of Issue No. 98-10. These EITF Issues and Abstracts address various aspects of the accounting for contracts involved in energy trading and risk management activities. At a special October 25, 2002 meeting, the Task Force reached a consensus to rescind EITF Issue No. 98-10, the impact of which is to preclude mark-to-market accounting for all energy trading contracts not within the scope of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The Task Force also reached consensus that gains and losses on derivative instruments within the scope of SFAS No. 133 should be shown net in the income statement if the derivative instruments are held for trading purposes. The consensuses reached effectively supercede the consensuses reached on this Issue at the June 19-20, 2002 EITF meeting.

The consensus regarding the rescission of Issue 98-10 is applicable for fiscal periods beginning after December 15, 2002. Energy trading contracts not within the scope of SFAS No. 133 purchased after October 25, 2002, but prior to the implementation of the consensus are not permitted to apply mark-to-market accounting. The adoption of EITF Issue 02-3 will have no impact on TVA's current operations.

TVA and Competition The electric utility industry has become increasingly competitive over the last decade. Competition is expected to continue to intensify, and restructuring legislation may dramatically change the way electric utilities do business in the future. Among the early initiatives that have begun to promote industry competition is the Energy Policy Act of 1992 (the "Energy Act"). The Energy Act and related FERC orders already allow competitors of a utility to access that utility's transmission system to sell electricity to other electric power suppliers and wholesale customers. In TVA's case, some special provisions apply.

Under the TVA Act, subject to certain minor exceptions, TVA may not currently enter into contracts that would have the effect of making it or the distributors of its power a source of power supply outside a statutorily specified area. However, under a special provision of the Energy Act (the "Anti-Cherrypicking Provision"), TVA is not required to provide its competitors access to its transmission system to transmit power for consumption within the area that TVA or the distributors of its power may serve. Thus, while TVA may not sell power outside its current service area, TVA cannot be compelled to permit its competitors to use its transmission system to sell power within TVA's service area.

In the future, it is likely that the current law that serves to limit competition between TVA and its competitors will change. In the past four years, numerous bills have been introduced in Congress designed to restructure the electric utility industry and mandate or promote competition in the industry. Within the context of restructuring legislation, some of the key issues for TVA are: ()

whether TVA rates and transmission system will be regulated by FERC, (2) whether TVA and the distributors of TVA power will be able to sell power outside the TVA service area and whether TVA will be required to provide its competitors access to its transmission system to transmit power for consumption within the TVA service area, (3) whether Congress will attempt to shorten the terms of TVA's present wholesale power contracts with the 27

distributors of its power, and (4) whether TVA will have the right to recover its power system investments that would no longer be economical under full and open market competition (stranded costs).

In the spring of calendar year 2000, TVA and the Tennessee Valley Public Power Association, an association comprising almost all of the distributors of TVA power, and the Tennessee Valley Industrial Committee ("TVIC"), an organization representing industries that TVA directly serves, reached consensus on draft legislation regarding the relationships betveen TVA and its customers in a restructured electric power industry. This draft legislation provided for: (I) simultaneous repeal on the effective date of the restructuring legislation of the Anti-Cherrypicking Provision and the provision that limits the area in which TVA and the distributors of TVA power can be a source of power supply, (2) renegotiation of power contract terms with a minimum termination notice period of three years, and a distributor option to take partial requirements from other suppliers with advance notice to TVA, (3) new limitations on TVA retail sales in TVA's current service area, (4) stranded cost recovery, (5) FERC regulation of TVA's transmission system, (6) TVA subjection to antitrust laws (with the exception of civil damages and attorney's fees), (7) reduc-tion of most of TVA's existing regulatory role with respect to distributors, and (8) limitation on new TVA generation to that needed to meet demand within the current TVA service territory. Reacting to changes within the electric power industry and regulatory developments in the restructuring of the industry, TVA has determined that it may be appropriate to reassess certain features of the draft legislation and is in the process of opening discussions in that regard with TVA's customers.

On July 31, 2002, FERC issued its Notice of Proposed Rulemaking on "Remedying Undue Discrimina-tion and Open Access Transmission Service and Standard Electricity Market Design," Docket No. RM0l-12-000, which, if ultimately implemented, would have far-reaching effects on electricity markets across the nation. FERC's overall objective is to create competitive wholesale electricity markets for the entire United States. FERC has stated it believes that a standard market design is needed to eliminate perceived undue discrimination in the provision of transmission service, eliminate inconsistent rules across the country, mitigate the exercise of market power, and, ultimately, drive down the price of power in wholesale markets. Because TVA is not currently subject to FERC's general jurisdiction, it will not be required to implement the standard market design rule if it is adopted by FERC. Nonetheless, to the extent that surrounding electric power systems continue transitioning toward markets with standard market design features, TVA will need to ensure that its future purchases of pover from those markets will be made in accordance with any new market rules and practices and that any of TVA's future sales of power into those markets will continue to be in accordance with the limitations of the Act.

Reactions to the FERC proposal have been mixed. Reactions from high-cost states in the Northeast, which have had a long history of centralized power pools, have been relatively more positive on both the market fundamentals and the need for a standardized market model than reactions from low-cost states. Some low-cost states fear that the proposal would lower prices in high-cost states at the expense of low-cost regions like the Southeast. Other critics have noted that the proposed rule would (I) unfairly eliminate native load preference, i.e., the policy of giving highest priority use of the transmission system to native load customers who have historically paid for that system; (2) lead to jurisdictional conflicts between state and federal regulators; and (3) lead to cost-shifting by failing to propose workable mechanisms for participant funding of new transmission investments. In addition to these substantive issues, criticism of FERC's aggressive timetable has been widespread. Reactions to the proposed rule have been so strong that draft legislation has been proposed that would constrain FERC's authority to move ahead.

The ultimate outcome of restructuring is highly uncertain at this time, making it extremely difficult to predict the ultimate market structure that will evolve, the timing of its evolution, and its ultimate impact on TVA. In February 2001, the United States General Accounting Office ("GAO") issued a report entitled "TENNESSEE VALLEY AUTHORITY, Debt Reduction Efforts and Potential Stranded Costs." In this report GAO said that, although TVA has made progress in reducing its level of debt and in recovering the cost of deferred assets and although its financial condition has improved, in light of its levels of debt and deferred assets, TVA's financial flexibility to respond to financial and competitive challenges is less than that of its likely competitors, and as a result TVA could have stranded costs if Congress enacts legislation that requires TVA to compete with other electricity providers. TVA disagrees with this report. TVA continues to believe 28

that it has certain cost advantages that would be beneficial in a restructured market. Its power prices are currently in the lowest quartile of the nation's prices, and its total power prices are average for the Southeast, a low-cost region. TVA will continue to develop plans and strategies designed to position TVA for competitive success in a restructured industry. Nevertheless, we cannot predict the outcome of any future electricity restructuring or its timing.

Business Strategy Strategic Objectives TVA's strategic objectives for competing in the energy market of the future encompass excellence in operating performance, economic leadership, and sensitivity to our stakeholders' needs. Critical success factors have been evaluated and targets established to reach our goals. TVA strives to:

Improve life in the Tennessee Valley through integrated nanagement of the river systemt and environmen-tal stewardship by balancing competing demands and optimization of the river system, and manage the environmental and safety impacts TVA's operations have on employees and the region; Meet customers' needs with affordable, reliable electric power by continuing to improve power reliability to meet customer requirements, providing flexible contracts, competitive pricing of products and services and achieve excellence in stakeholder relations and communications processes; Demonstrate leadership in sustainable economic development in the Valley by promoting development through targeted growth initiatives, and develop workforce capabilities required to be the supplier and employer of choice; Continue the trend of debt reduction (begun in 1997) by generating more electricity for less dollars and by investing prudently; Reduce TVA 's delivered cost of power relative to the market by achieving excellence in asset optimization and production processes; and Strengthen working relationships with all of TVA 's stakeholders by shaping the culture to model TVA's values and achieve excellence in the customer value and relationship processes.

Key Indicators and Objectives Strategic Objective Customer..............

Meet customers' needs with affordable, reliable electric power Demonstrate leadership in sustainable economic development in the Valley Meet customers' needs with affordable, reliable electric power Reduce TVA's delivered cost of power relative to the market Indicator Customer-connection-point interruptions (interruptions per connection point)

Jobs added or retained in the Valley Watershed water quality (number of watersheds rated good to fair out of a maximum of 611)

Delivered Cost of Power (cents/kWh) 2002 1.03 2001 1.17 People.................

Strengthen working relationship with all of TVA's stakeholders All injury rate (per 100 employees) 1.97 2.32 29 Measure Operations.............

Financial...............

48,248 47,808 512 496 4.07 4.05

Environmental Matters TVA's activities are subject to various federal, state and local environmental statutes and regulations.

Major areas of regulation affecting TVA's activities include air pollution control, vater pollution control and management and disposal of solid and hazardous wastes.

TVA has incurred and continues to incur substantial capital expenditures and operating expenses in order to comply with environmental requirements. Because these requirements change frequently, the total amount of such costs in the future is not now determinable. It is anticipated that environmental requirements will become more stringent and that compliance costs will increase, perhaps by substantial amounts.

Clean Air Developments Under the Clean Air Act. EPA has promulgated national ambient air quality standards for certain air pollutants, including sulfur dioxide ("SO 2"), particulate matter and ozone. Coal-fired generating units such as TVA's are considered major sources of pollutants that impact these standards, and TVA has implemented strategies to reduce its emissions in order to comply wivith these air quality standards.

Title IV of the Clean Air Act Amendments of 1990 ("CAAA") requires coal-fired generation units to reduce their SO, and nitrogen oxide emissions ("NO,") in two phases in order to control acid rain.

Compliance vith these requirements has resulted in substantial expenditures for the reduction of emissions at TVA's coal-fired generating plants. Through 2002, TVA had invested approximately $1 billion in capital improvements for acid rain compliance. TVA estimates it will spend an additional $85 million between 2003 and 2006 to complete switches to lower sulfur coals for acid rain compliance purposes.

TVA's strategy for complying vith the CAAA has included the use of flue gas desulfurization systems, or scrubbers, at tvo fossil units in addition to existing scrubbers on four other units, and the use of lower-sulfur coal at other fossil units to reduce SO, emissions. TVA has completed these scrubbers and is on schedule to complete the changeover to lower-sulfur coal.

NO, reductions vere required under the CAAA for 58 of TVA's 59 coal-fired units. The only TVA unit for vhich NO, reductions are not required under the CAAA is the Atmospheric Fluidized Bed Unit 10 at TVA's Shawnee Fossil Plant. The NO, reductions for the other 58 units were achieved through the installation of loxv-NO, burners and/or overfire air at 40 units and boiler optimization at the remaining 18 units. In 1996, TVA sclected an early election option for four of these 58 units, which allows the four units at John Sevier Steam Plant to be limited to Phase I NO, levels through 2007. In 2008, these four units will have to meet lower Phase II NO, levels. For the remaining 54 units, TVA has elected to average NO, emissions to meet a 54-unit NO, Averaging Plan. This option enables TVA to optimize the cost of NO, reduction while fully complying with the CAAA Title IV NO, requirements. In addition to its Title IV projects, TVA is in the process of installing selective catalytic reduction systems ("SCRs") or other NO, control technologies on at least 25 of its coal-fired units. This follows up on a commitment TVA has made to further reduce NO, emissions throughout its system. Installation of these SCRs will also comply with the EPA's State Implementation Plan NO, Reduction rule issued in 1998. Depending on future generation requirements, additional NO, controls may be required.

In TVA's continuing efforts to improve air quality in the Tennessee Valley and to comply with the Clean Air Act, TVA plans to design, build and operate five more scrubbers to further reduce SO, emissions from 12 of its coal-fired units. Although design of these scrubbers is scheduled to start in 2003, substantial construction activities are not expected to begin until TVA completes its SCR installation program in 2005.

Completion of the five scrubbers is expected by 2011.

The EPA has finalized new, more stringent National Ambient Air Quality Standards for particulate matter standards and ozone and a rule designed to reduce regional haze. Each of these rule-makings has been the subject of litigation and the EPA is in the process of developing implementation strategies for the ambient standards and readdressing several provisions of the regional haze rule. These actions may require TVA to make additional reductions of SO, emissions beyond those currently planned. TVA anticipates that compliance with the new regulations vill be required after 2010. The EPA has also determined that mercury 30

emissions from coal-fired plants should be reduced and is developing both a rule to reduce mercury and legislative packages that put mercury reductions in a multipollutant plan. Depending on the severity of the mercury reductions, TVA could incur additional substantial capital costs for control of mercury.

On February 14, 2002, the Bush Administration announced its "Clear Skies Initiative," which outlines legislative requirements for the phased reduction of SO2, NOV and mercury emissions from utilities during the period from 2008 to 2018. In July of 2002, legislation knowAn as the Clear Skies Act was introduced in Congress. A number of bills have been introduced in Congress that would result in significant decreases in emissions of NO,, SO2 and mercury, as ell as carbon dioxide. The timing and content of such legislation remains highly uncertain.

Expenditures related to clean air projects during 2002 and 2001 were approximately $400 million and

$200 million, respectively. The cost of the SCR strategy, includina 2001 and 2002 expenditures, is now estimated to be $1.3 billion, and the cost of the planned installation of five scrubbers is estimated to be

$1.3 billion. The total cost of future compliance with NO\\, SO, mercury and particulate matter requirements, however, cannot reasonably be determined at this time because of the uncertainties surrounding emerging EPA regulations, resultant compliance strategies, potential for the development of new emissions control technologies, court litigation, and future amendments to the Clean Air Act. However, total future costs through 2020 could exceed $3 billion, exclusive of the costs of the planned SCRs and scrubbers. These future controls will also apply towards any enforcement liability (see "Legal Proceedings").

The EPA has instituted judicial and administrative actions against a number of utilities in the eastern U.S., including TVA, alleging that they have modified their coal-fired units without complying with new source review ("NSR") requirements. TVA contends that the EPA's enforcement action is based on a new interpretation of an old rule and that TVA has routinely maintained its power plants to ensure efficient, reliable power generation while complying with all requirements. The EPA issued TVA an administrative order directing TVA to put new source controls on 14 of its coal-fired units and to evaluate whether more controls should be installed on other units. TVA has challenged the validity of this order, and the Eleventh Circuit Court of Appeals has stayed the order pending its review. The outcome of this litigation and the EPA proceedings is uncertain (see "Legal Proceedings").

The Bush administration has reviewed the energy implications of the EPA's new NSR interpretation and concluded that there is evidence that NSR impedes utilities from increasing the efficiency and performance of existing fossil-fuel generation. TVA has determined that if the EPA's nev interpretation becomes law, TVA could lose about 11 percent of the energy capabilities of its coal-fired system within three years through permit limits on use of its units. On November 22, 2002, EPA announced changes to its NSR program intended to address aspects of the program that have deterred companies from implementing projects that would enhance energy efficiency and decrease air pollution. These changes are not anticipated to affect TVA's commitments to emissions control projects discussed above or the NSR litigation.

See "Legal Proceedings" for a discussion of Clean Air Act legal proceedings, including those involving NSR.

Hazardous Substances The release and cleanup of hazardous substances are regulated under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA").

In a manner similar to many other industries and power systems, TVA has generated or used hazardous substances over the years. TVA is aware of hazardous-substance releases at eight offsite areas for which it may have some liability. TVA's potential liabilities for its share of cleanup costs at these sites are uncertain but are not expected to have significant impact on TVA's financial position or results of operations.

Water Quality Under the Clean Water Act ("CWA"), every point source which discharges pollutants into waters of the United States must obtain a National Pollutant Discharge Elimination System ("NPDES") permit specifying the allowable quantity and characteristics of the pollutants discharged. All of TVA's various point 31

sources operate under NPDES permits, including all of its major generating units. Compliance with NPDES requirements has necessitated substantial expenditures and may require additional expenditures in the future as NPDES permits come up for renewal and applicable requirements become more stringent.

The CWA allows the permitting authority to establish thermal limits less stringent than the water quality criteria if the discharger can demonstrate that the alternate limit will assure protection and propagation of a balanced, indigenous aquatic population. TVA has now been issued alternate limits at several of its facilities, and it is meeting these limits. Periodic monitoring of fish and other aquatic life is required to substantiate that the standard is still being met. The CWA also requires that the design, capacity, location and construction of cooling water intake structures reflect the best technology available for minimizing adverse environmental impacts. In December 2001, the EPA issued a national rule for implementing this statutory requirement at new intakes -

a rule which will require that future intakes meet specified criteria. EPA is currently engaged in rulemaking to address existing facilities -

a rule which, in its proposed form, will establish national performance standards for minimizing impact to aquatic life. The new rule should reduce environmental impact uncertainty and long-term monitoring requirements. The rulemaking for existing facilities, scheduled to be issued in August 2003 but likely to be delayed until February 2004, may require additional short-term monitoring at some existing TVA facilities, and may require some additional control or operational measures if control costs are not significantly greater than the environmental benefits to be derived from their use. The need for and cost of such potential changes is uncertain, but the requirements for facilities on reservoirs and large rivers where most TVA facilities occur are less stringent than for facilities on oceans, estuaries, tidal rivers, the Great Lakes and smaller rivers.

Solid and Hazardous Waste Management Under the Resource Conservation and Recovery Act ("RCRA"), the storage, transportation and disposal of hazardous wastes are regulated by EPA and the states. RCRA also allows EPA and the states to regulate solid wastes, and the states have EPA authorized programs for this. TVA has detailed procedures in place designed to ensure compliance with all applicable requirements for the management of hazardous wastes.

Additionally, TVA has instituted an approved supplier list for hazardous waste disposal contractors under which such contractors' financial status, compliance history and physical facilities and operations are reviewed before they are allowed to treat or dispose of any of the hazardous wastes generated by TVA facilities. TVA does not itself operate any hazardous waste disposal or treatment facilities but does operate a permitted hazardous waste storage facility in Muscle Shoals, Alabama. TVA maintains solid waste disposal permits for the solid waste disposal areas (e.g., fly ash, scrubber sludge, demolition materials and asbestos) it operates at some of its plant sites. TVA's costs in this area have not been substantial, but applicable requirements change frequently and are expected to become more stringent.

Miscellaneous Polychlorinated biphenyls ("PCBs") have been widely used as insulating fluids in electric equipment such as transformers and capacitors. Use of this equipment and the cleanup of released PCBs are regulated by EPA under the Toxic Substances Control Act. The TVA power system uses thousands of pieces of equipment that contain some level of PCBs. These pieces of equipment, when maintained properly, may continue to be operated under EPA's PCB regulations for the remainder of their useful lives. However, both international and domestic pressures are increasing to eliminate all use of PCBs. TVA has been phasing out much of this equipment as a matter of policy. The cost of phasing out the remainder of this equipment cannot be accurately determined at this time, but is expected to be at least $23 million. TVA has detailed procedures in place to continue operational compliance with EPA's PCB regulations and has not incurred substantial costs in this area.

There is public concern about whether there are adverse health effects from exposure to electric and magnetic fields ("EMF"). There are many sources of EMF, including electric transmission lines. Certain research, including a report by a National Academy of Sciences organization, has not found conclusive evidence that EMF causes adverse health effects. Other research, such as a report by the National Institute of Environmental Health Sciences, has found limited evidence that certain types of exposure to EMF are 32

carcinogenic. Research in this area continues. Substantial costs could be incurred by electric systems, including TVA, if EMF levels from transmission lines have to be reduced, but this appears unlikely at this time.

Nuclear Power Program Overview TVA has five operating nuclear units, three deferred nuclear units and one inoperative nuclear unit that is scheduled to be returned to service in 2007. Selected features of each of these units are described in the chart below.

Date of Date of Expiration Installed Net Capacity Expiration of Capacity Factor for of Operating Construction Nuclear Unit Status (Ivlw)

FY 2002 License License Sequoyah Unit I..........................

Operating 1,221 90.2 2020 Sequoyah Unit 2.......................... Operating 1,221 87.6 2021 Browns Fern' Unit 2 Operating 1,190 94.0 2014 Browxns Ferr Unit 3.............

Operating 1,190 94.6 2016 Watts Bar Unit I..........................

Operating 1,270 89.8 2035 Watts Bar Unit 2............

Deferred 2010 Bellefonte Unit I............

Deferred

()

Bellefonte Unit 2............

Deferred 2004 Browns Ferrv Unit I............

Inoperative 2013 (I)

Bellefonte Unit l's construction license was due to expire on October 1, 2001, and Bellefonte Unit 2's is due to expire on October 1, 2004. On July 11, 2001, TVA asked the Nuclear Regulatory Commission

("NRC") to extend the construction license for Bellefonte Unit I until October 1, 2011 and for Bellefonte Unit 2 until October 1, 2014. While the NRC considers TVA's request, Bellefonte Unit l's construction license is automatically extended on a day-by-day basis. Previously, Watts Bar Unit 2's construction license was similarl,y extended on a day-by-day basis while the NRC considered TVA's request to extend its construction license until 2010. At this time, TVA is aware of no issue that would result in the NRC's not granting TVA's request to extend the Bellefonte construction licenses.

Status of Ceritain Nutclear Units Browns Ferry Unit I was taken offline in 1985 for modifications and improvements. The undepreciated cost of Browns Ferry Unit I of $46 million is included in net completed plant and is being depreciated as part of the recoverable cost of the plant over the remaining license period. Reflecting the recent interest in the competitive cost of nuclear generation, the Board requested in September 2001 a technical study regarding the feasibility of recovering and restarting Browns Ferry Unit 1. In March 2002, TVA's nuclear staff reported to the Board the results of a detailed cost and planning study, which concluded that TVA can return Browns Ferry Unit I to service safely and economically. In May 2002, the Board of Directors initiated activities for the return of Browns Ferry Unit I to service in order to meet long-term energy needs in the Tennessee Valley. It is anticipated the Browns Ferry Unit I recovery project will add approximately 1,280 megawatts of generation at a cost of approximately $1.8 billion and will take five years to complete. When Unit 1 returns to service, it is expected additional generation will help lower the average cost of power and provide additional cash flow for accelerated debt reduction.

TVA has three units in deferred status. In 1988, TVA suspended construction activities on Watts Bar Unit 2, and the unit is currently in lay-up. Bellefonte Unit I and Unit 2 were deferred in 1988 and 1985, respectively. Estimated 2003 expenditures for the three deferred units are limited to lay-up, maintenance and ensuring that options for the use of the units remain viable.

In December 1994, TVA determined that it will not, by itself, complete Bellefonte Unit 1 and Unit 2 and Watts Bar Unit 2 as nuclear units. TVA's integrated resources planning process identified as a viable option 33

the conversion of the Bellefonte facility to a combined-cycle plant utilizing natural gas or gasified coal. In 1997 an independent team of technical and financial experts completed a feasibility study to evaluate options for the conversion of the Bellefonte Nuclear Plant to a fossil-fired plant. The feasibilitv study indicated that one of the most economic fossil conversion strategies would be to complete Bellefonte as a natural gas fired combined-cycle plant. TVA also issued an Environmental Impact Statement ("EIS") assessing the environmental impacts of various fossil conversion options. The EIS identified the natural gas fired combined-cycle plant alternative as the preferred option. Bellefonte remains in a deferred status; however, TVA is re-examining its nuclear and nonnuclear options for Bellefonte.

While future decisions on TVA's deferred units will ultimately impact the method of cost recovery, the TVA Board determined as of the end of 2001 that the values of some of its existing assets were not appropriate in a competitive marketplace. Certain nuclear assets, portions of Bellefonte Unit I and Unit 2 and Watts Bar Unit 2 in its entirety, were identified as assets for which the estimated future values were less than recorded book values. Consequently, for 2001 TVA revalued these assets downward by $2,220 million and recognized an impairment loss. The Board will establish rate adjustments and operating policies to ensure full recovery of the remaining cost of the Bellefonte units and compliance vith the requirements of the TVA Act (see "Business" -"Rates and Customers" and note I -Impairment of Assets).

Spent Nuclear Fuel TVA has entered into a contract with DOE for the disposal of spent nuclear fuel. Payments are based on TVA's nuclear generation and charged to expense. The provisions of the contract called for DOE to begin accepting spent nuclear fuel from utilities on January 31, 1998, the date provided by the Nuclear Waste Policy Act of 1982. However, as of September 30, 2002, DOE has accepted no spent fuel. As a result of this failure, in April 2001 TVA filed a breach of contract lawsuit against the United States in the Court of Federal Claims. TVA's spent nuclear fuel storage facilities will be sufficient to provide storage space for spent fuel generated in TVA's system through 2004 for its Sequoyah Nuclear Plant, 2005 for its Browns Ferry Nuclear Plant, and 2018 for its Watts Bar Nuclear Plant. TVA plans to extend storage capability through life-of-plant if necessary, by using dry storage casks in independent spent-fuel storage installations located at the Browns Ferry and Sequoyah Nuclear Plants. Such spent fuel arrangements require Nuclear Regulatory Commission

("NRC") approval. However, such arrangements have been approved by the NRC at other facilities throughout the United States.

Low-Level Radioactive Waste Low-level radioactive waste resulting from the normal operation of nuclear units includes such materials as disposable protective clothing, mops and filters. Disposal costs for low-level radioactive waste have increased significantly in recent years. Pursuant to the Low-Level Radioactive Waste Policy Act, each state is responsible for disposal of low-level radioactive waste generated in that state. States may form regional compacts to jointly fulfill their disposal responsibilities. The states of Tennessee and Alabama (where TVA's nuclear plants are located) have joined with other southeastern states to form the Southeast Compact Commission for Low-Level Radioactive Waste Management. This commission regulates the siting of new disposal facilities and the disposal of low-level waste within the southeastern states.

Until July 1995, the low-level waste generators located in the southeastern states were required to dispose of their radwaste at the Barnwell, South Carolina, disposal facility. South Carolina is no longer a member of the interstate compact serving the southeastern states and is now a member of the Atlantic Interstate Low-Level Radioactive Waste Compact. Recently, South Carolina announced volume caps that cannot be exceeded due to the acceptance of waste from states that are not members of the Atlantic Interstate Low-Level Radioactive Waste Compact. After June 2009, no waste will be accepted from such states, which include Tennessee and Alabama.

After reviewing its storage and disposal options for low-level radwaste management, TVA, in 1999, began storage of the type of low-level radwaste that had previously been sent to Barnwell at the storage facilities on two of TVA's plant sites. These facilities are sized to handle the anticipated storage needs for the foreseeable 34

life of TVA's operating plants. TVA continues to send some dry radioactive waste to the Envirocare of Utah disposal facility in Clive, Utah, when economic conditions permit, and may send dry radioactive waste to the Chem-Nuclear Systems, L.L.C., disposal facility in Barnwell, South Carolina.

Nuclear Insurance As of September 30, 2002, negotiation on the renewal of the Price-Anderson Act were still ongoing in Congress. While certain provisions of the Price-Anderson Act expired on August 1, 2002, the existing indemnification and limitation of liability plan continues to apply to TVA's nuclear plants. Under the Price-Anderson Act, the limit of liability from an accident at an NRC-licensed reactor is approximately $9.3 billion

($88 million for each of the NRC-licensed reactors in the United States), composed of primary and secondary layers of financial protection. This amount is periodically adjusted for inflation. For further information about this nuclear liability insurance and its deferred premium (see note 9 -

Contingencies -

Nuclear Insurance). In accordance with industry practice, TVA maintains certain liability insurance coverage for workers at its nuclear sites.

NRC regulations require nuclear power plant licensees to obtain $1.06 billion onsite property damage insurance coverage, and TVA has acquired $2.06 billion of such coverage per nuclear site, with a $2.5 million deductible. Some of the nuclear property insurance may require the payment of retrospective premiums of up to approximately $57 million in the event that losses by another insured party or TVA exceed available funds. In accordance with NRC regulations, the proceeds of nuclear property insurance are first used to ensure that the reactor is in safe and stable condition and that it can be maintained in a condition that prevents significant risk to the public. Next, the proceeds are used for decontamination or, if necessary, decommission-ing the reactor. Any excess proceeds insure against casualties to property.

Operating License Extensions The TVA Board of Directors also authorized the nuclear staff to ask the NCR for a 20-year extension of the operating licenses for all three reactors at the Browns Ferry Plant. Current expiration dates for the Browns Ferry units are:

Browns Ferry Unit I..............

2013 Browns Ferry Unit 2..............

2014 Browns Ferry Unit 3..............

2016 The original 40-year term on licenses per the Atomic Energy Act and the NRC regulations was based on economic and antitrust considerations -

not on limitations of technology.

Tritium Production Approved In September 2002, the NRC issued an amendment to the Watts Bar Nuclear Plant operating license, allowing TVA to irradiate tritium-producing burnable absorber rods at the plant for use by the U.S.

Department of Defense. TVA's license amendment permits it to install up to 2,304 of the rods into the Watts Bar reactor and irradiate them for one fuel cycle, which lasts about 18 months. TVA will then remove the irradiated rods for shipment to DOE's tritium-extraction facility at the Savannah River Site near Aiken, South Carolina. TVA expects to begin tritium production at Watts Bar in the fall of 2003. Also in September 2002, the NRC issued an amendment to the Sequoyah Nuclear Plant operating license allowing TVA to produce tritium at the plant. TVA will recover costs associated with the tritium production program, and TVA retains the right to operate the reactors for their primary mission of producing electricity.

Combustion Turbine Installations/Plant Cancellation TVA installed eight 85 MW natural-gas combustion turbines in time for the summer 2001 peak demands for power at its new Lagoon Creek site in West Tennessee. TVA also installed eight additional 85 MW natural-gas combustion turbines in 2002, four units at the existing Lagoon Creek site and four at TVA's 35

Kemper County, Mississippi site. This brings the total number of TVA combustion turbines to 72 units -

24 of which were put on the ground in three years.

TVA recently decided not to proceed with its plans to build a gas-fired, combined-cycle plant that would have provided 510 MWs of power initially scheduled to begin operation in 2003. Current pover projections indicate that in the near-term, ample power from generation sources within the TVA service area should be available to meet TVA's near-term power needs at competitive prices. Accumulated costs associated with the project total approximately $154 million, which was recognized as a loss on plant cancellation.

Stewardship Responsibilities TVA's responsibilities for managing public resources began with its creation in 1933. Today, these resource management activities help sustain the interconnected tributaries and main stem of the Tennessee River, the nation's fifth-largest river system. These resources are managed to accomplish the multiple objectives of flood control, navigation, electric power production, recreation and environmental protection.

Funding for these programs has historically included federal appropriations, power revenues and nonpower revenues such as user fees.

Prior to 2000, congressional appropriations provided most of the funding for TVA's nonpower programs.

TVA has obtained additional funds from revenues and user fees from the nonpower programs. In 1997, Congress enacted appropriations legislation that anticipated no further appropriations for the nonpower programs and required TVA, in the absence of appropriations, to fund certain nonpower programs constituting essential stewardship activities from various sources, which may include power revenues. Because Congress has not provided appropriations for TVA's nonpower programs since 1999, TVA primarily is using power funds (along with user fees, other forms of nonpower revenues and nonpower fund balances unused in prior years) for its essential stewardship activities in compliance with the 1997 appropriations legislation. In 1999, the last year TVA received appropriated funds, it spent a total of approximately $75 million on essential stewardship activities, $30 million of which amount was power funds. In 2000 and 2001, TVA spent a total of approximately $70 million on essential stewardship activities each year. TVA expenditures on essential stewardship activities increased to $83 million on these activities in 2002, reflecting increased expenditures associated with the Reservoir Operations Study and asset maintenance initiatives (see "Certain Provisions of the Tennessee Valley Authority Act and Related Legislation" -

"Other Legislation" and note 10).

Labor Agreements and Compensation On September 30, 2002, TVA had 13,444 employees, of which 5,274 were represented by unions. Neither the federal labor relations laws covering most private sector employees nor those covering most federal agencies are applicable to TVA. However, the Board has a long-standing policy of acknowledging and dealing with recognized representatives of its employees, which policy is reflected in long-term agreements to recognize the unions (or their successors) that represent TVA employees. Federal law prohibits TVA employees from engaging in strikes against TVA.

Salaries of regular TVA employees are limited by a federal pay cap (Executive Level IV, currently

$134,000). The federal pay cap makes it a challenge for TVA to recruit and retain top management talent. In response, TVA has developed and implemented supplementary compensation arrangements to reduce the impact of the pay cap and to enhance TVA's ability to attract and retain the caliber of executive talent required to manage one of the largest power systems in the country. Compensation is established considering compensation for similar positions in the relevant labor market and performance toward predefined TVA and business unit goals, both annual and long-term. TVA believes the implementation of these arrangements is within its legal authority. In the past, the General Accounting Office ("GAO") has expressed the opinion that some of TVA's compensation arrangements are not within TVA's legal authority. However, GAO has no authority to issue binding legal opinions on this matter or to stop any TVA payments. Congress has been aware of TVA's supplemental compensation arrangements and has not taken any action that would undermine TVA's position that the arrangements are within its legal authority.

36

In October 1995, the President issued an Executive Order requiring government corporations, including TVA, to submit information to OMB on bonuses paid to its senior executives. TVA submits information on these bonuses annually to OMB and also publicly disseminates this information. OMB approval of TVA's bonuses is not required.

Forward-Looking Information This Statement contains forward-looking statements relating to future events and future performance.

Any statements regarding expectations, beliefs, plans, projections, estimates, objectives, intentions, assump-tions or otherwise relating to future events or performance may be forward-looking.

In certain cases, forward-looking statements can be identified by the use of the words such as "may,"

"will," "should," "expect,' anticipate," "believe," "intend," "project," "plan," "predict," "assume,' esti-mate," "objective," "possible," "potential" or other similar expressions.

Some examples of forward-looking statements include statements regarding TVA's projections of future power and energy requirements; future costs related to environmental compliance; impacts of potential legislation on TVA and the likelihood of enactment of such legislation; strategic objectives; anticipated availability of nuclear waste storage facilities; projections of nuclear decommissioning costs; and impacts of pending litigation and various administrative orders which have been or may be issued.

Although TVA believes that the assumptions underlying the forward-looking statements are reasonable, TVA does not guarantee the accuracy of these statements. Numerous factors could cause actual results to differ materially from those in the forward-looking statements. These factors include, among other things, new laws, regulations and administrative orders, especially those related to the restructuring of the electric power industry and various environmental matters; increased competition among electric utilities; legal and administrative proceedings affecting TVA; the financial and economic environment; performance of TVA's generation and transmission assets; fuel prices; demand for electricity; changes in technology; changes in the price of power; loss of any significant customers or suppliers; creditworthiness of counterparties; weather conditions and other natural phenomena; changes in accounting standards; and unforeseeable events. New factors emerge from time to time, and it is not possible for management to predict all such factors or to assess the extent to which any factor or combination of factors may impact TVA's business or cause results to differ materially from those contained in any forward-looking statement.

TVA undertakes no obligation to update any forward-looking statement to reflect developments that occur after the statement is made.

QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Governance TVA does not engage in wholesale trading operations for the purposes of speculation. Rather, when necessary in order to supplement generation to meet its native load, TVA will engage in some aspects of physical trading. Further, TVA employs commodity-based instruments which include forwards and option contracts to manage risks associated with the market fluctuations in the price and transportation costs of certain commodities and fuels including, but not limited to, coal, natural gas and electricity.

The Board has established a Risk Management Committee, which is charged with governance and risk oversight for TVA. These functions include but are not limited to: review and direction of risk management strategy, review and monitoring risk indicators, review and approval of counterparty exposure limits, review of new instruments for Board approval, oversight of models and assumptions used to model risk, and controls regarding the use of hedging instruments. In addition, there are policies and procedures established to provide direction for daily operations.

TVA is exposed to market risks, including changes in interest rates, foreign currency exchange rates in association with TVA bonds, volatility of energy related commodities (electricity, natural gas, coal), equity market prices and losses in the event of counterparties' nonperformance. To manage the volatility attributed 37

to these exposures, TVA has entered into various nontrading derivative transactions, principally an interest rate swap agreement, foreign currency swap contracts, electricity contracts, coal contracts and natural gas contracts. Additionally, to manage environmental volatility, TVA has obtained options related to S02 allowances (see note 5 -

Commodity Contracts). The exposure to losses in the event of the counterparties' nonperformance has been mitigated through controls to determine the creditworthiness of counterparties before transactions take place.

Value at Risk The market risk exposure is measured through TVA's Value at Risk ("VaR") calculation. VaR is a single summary statistic of possible portfolio losses due to normal market movements for a given confidence level over a selected period of time. TVA measures VaR on a daily basis. TVA's VaR exposure for the electricity and natural gas commodities in which TVA has market positions, assuming each a 10-day holding period and a -day holding period, is as follows:

Electricity Electricity Value at Risk Associated with Energy Trading Contracts and Related Energy Derivative Contracts for the Year Ended September 30, 2002 Company Wide VaR (in millions) 95% Confidence level, ten-day holding period, two-tailed For the year ended September 30, 2002........................................

$ 2.42 Average for the period.

$ 7.17 High.................................................................

$24.39 Low..................................................................

$ 1.06 99% Confidence level, one-day holding period, two-tailed For the year ended September 30, 2002........................................

$ 0.99 Average for the period.

$ 2.92 High.................................................................

$ 9.95 Low.................................................................

$ 0.43 Notes The VaR calculations are for the TVA 5x16 electricity portfolio for 2002. The calculations are for the rolling forward 12-month portfolio. The VaR method used is the parametric variance/covariance method accepted as an industry standard.

Back-testing of the VaR calculation is done using a statistical procedure called the chi-square test. TVA performs back-tests of the actual daily Mark-to-Market (MTM) profit and loss fluctuations for 3-month, 6-month and 12-month periods. The chi-square values for all periods are within the selected significance level indicating a valid VaR calculation.

That is to say, that given a 95 percent confidence level at September 30, 2002, there is a 2.5 percent probability TVA's electricity portfolio could lose as much as $2.42 million over the next 10 days. The average VaR for the entire year for the 10-day holding period would be a loss of $7.17 million. Further, given a 99 percent confidence level at September 30, 2002, there is a 0.5 percent probability that TVA's electricity portfolio could lose as much as $0.99 million over the next day. The average VaR for the entire year for the 1-day holding period would be a loss of $2.92 million.

38

The historical performance of TVA's VaR calculation is represented in the following graph:

Electricity VaR (95% 10-Day)

$80.00

$70.00 0

C

$60.00

$50.00

$40.00

$30.00

$20.00

$10.00

$0.00

+ Low Average High l

) 30-Sep 1999 2000 2001 2002 Fiscal Year As indicated by the chart, TVA's electricity market risk exposure has been reduced since 1999 when VaR was first measured. This reduction was primarily due to four factors: lower forward market prices as of September 30, 2002; TVA's new peaking generation coming on line; lower market price volatility in recent years; and less dependence on the energy spot market for energy balancing requirements.

39

Natural Gas Natural Gas Value at Risk Associated with Energy Trading Contracts and Related Energy Derivative Contracts for the Year Ended September 30, 2002 Company Wide VaR (in millions) 95% Confidence level, ten-day holding period, two-tailed For the year ended September 30, 2002........................................

$19.79 Average for the period...............

$21.35 High.................................................................

$30.31 Low.................................................................

$13.18 99% Confidence level, one-day holding period, two-tailed For the year ended September 30, 2002........................................

$ 8.08 Average for the period...............

$ 8.71 High..................................................................

$12.36 Low.................................................................

$ 5.37 Notes The VaR calculations are for the TVA natural gas portfolio for 2002. The calculations are for the rolling forward 12-month portfolio. The VaR method used is the parametric variance/covariance method accepted as an industry standard.

Back-testing of the VaR calculation is done using a statistical procedure called the chi-square test. TVA performs back-tests of the actual daily MTM profit and loss fluctuations for 3-month, 6-month and 12-month periods. The chi-square values for all periods are within the selected significance level indicating a valid VaR calculation.

40

Natural Gas VaR (95% 10-Day)

$40.00

$35.00 I

$30.00 0

j- $25.00

$20.00

$15.00

$10.00 2001 Low Average

-. High 30-Sep 2002 Fiscal Year TVA has tracked natural gas VaR exposure since 2001. The graphs above indicate TVA's lower market risk exposure to natural gas since initially tracking this measure in 2001. This reduction was primarily due to lower gas prices and TVA's 2002 gas hedges, which reduced exposure to market price fluctuations.

Coal TVA's contracts with coal suppliers have specified rates and volumetric flexibility which limit TVA's exposure to market risk. Given TVA's contract mix, TVA is approximately 81 percent hedged to coal market risk exposure. Because of issues concerning coal's lack of fungibility and market transparency, TVA does not currently maintain a VaR calculation.

Other TVA Commodity Transactions TVA currently holds SO2 options for future years. SO, emission credits will be used for. TVA's fossil fleet and are not subject to market trading activities. The number of options from outside sources held is not material and the estimated VaR for future years is less than $1 million. The market risk is not material as of September 30, 2002.

TVA purchases fuel oil as a substitute fuel source for TVA's gas turbine fleet. TVA's hedge against market risk for fuel oil is use of natural gas and is captured in the natural gas VaR. The TVA fossil fuels group monitors the spread between fuel oil and natural gas for hedging purposes. During 2002, natural gas had a significant advantage over fuel oil. Therefore, TVA's fuel oil position was not materially affected by market risk.

TVA has no merchant capacity assets or transactions which expose TVA to market risk. TVA does have long-term transactions, the energy supplied under which will serve native load requirements (see note 9-Commitments -

Power Puirchase Obligations). The market risk associated with the structure of these transactions is captured in the VaR estimates above.

41

....~~~~~~~~~~~~~~--

Mark-to-Market Valuation Sensitivity analyses are performed on a daily and weekly basis to determine the market price impact to the energy portfolio when the market price moves beyond TVA's projections.

TVA also monitors the MTM fair value of energy assets in future years. MTM accounting reports contracts at their "fair value," the value a willing third party would pay for the particular contract at the time a valuation is made. These transactions include, but are not limited to, native systems load contracts, energy forwards, energy options or other energy derivative instruments for unit specific generation units. Due to the public service nature of its business, TVA historically values its resource positions for the year ahead.

When available, quoted market prices are used to record a contract's fair value. However, market values for energy trading contracts may not be readily determinable because the duration of the contracts exceeds the liquid activity in a particular market. If no active trading market exists for a commodity, holders of these contracts must calculate fair value using pricing models based on contracts with similar terms and risks. As of September 30. 2002, TVA's forward position on a MTM basis for all energy assets for all hours are as follows:

Source of Fair 'alue 2003 (in millions)

Owned Assets.

Actively Quoted.

Prices provided by external sources..............................................

3,901 Modeled.....

Tot al.

3,901 Average tenor of portfolio..............

year Note that prices quoted by external sources reflect independent broker quotations and publicly posted prices on electronic media such as IntercontinentalExchange.

Based on September 30, 2002 closing prices, the MTM value of TVA's energy portfolio for calendar 2003 is $3.9 billion as shown in the chart above. The fair value calculation determines a profit or loss for each source of fair value, e.g. load, based on market prices. For example, instead of using accrual accounting to calculate load revenue, the MTM calculation compares the load revenue from selling the generation to customers to the load revenue from selling the generation into the market. The difference is the Mark-to-Market value. Since TVA is almost completely hedged, only a small portion of power is bought and sold in the market so the market price has little impact on TVA margins.

Hedging Activities With respect to hedging activities, TVA risk management policies provide for the use of derivative financial instruments to manage financial exposures but prohibit the use of these instruments for speculative or trading purposes. Prior to October 1, 2000, TVA accounted for hedging activities using the deferral method, and gains and losses were recognized in the financial statements when the related hedged transaction occurred. During 2001, TVA adopted SFAS No. 133, AccountingJbr Derivative Instruiments and Hedging Activities, as amended by SFAS No. 138, Accountingfor Certain Derivative Instruments and Certain Hedging Activities. Derivative contracts to which TVA is a party that are covered by these standards include various purchase pover option contracts, certain fuel supply and pow er purchase agreements, and certain currency and interest rate sap agreements.

42

Cash Flow Hedges Included in Accumulated Other Comprehensive Loss on the Balance Sheet September 30, 2002 (in millions)

Portion Expected to Accumulated Other Be Reclassified to Comprehensive Earnings During Loss the Next 12 Months Maximum Term Interest Rate.................................

$ (19) 5 years Foreign Currency...........

(131) 29 years Total.......................................

$(t50)

In summary, based on TVA's overall market risk exposure position and risk controls, management does not anticipate a materially adverse effect on TVA's financial position or results of operations as a result of market fluctuations and market risk.

Credit Risk Credit risk is the exposure to economic loss that would occur as a result of a counterparty's nonperformance of its contractual obligations.

The majority of TVA's credit risk is limited to trade accounts receivable from delivered power sales to municipal and cooperative distributors, all located in the seven-state Tennessee Valley region. To a lesser extent, TVA is exposed to credit risk from industries and federal agencies directly served and from exchange pover arrangements with a small number of investor-owned regional utilities related to either delivered power or the replacement of open positions of longer-term purchased power or fuel agreements.

Where exposed to credit risk, TVA analyzes the counterparty's financial condition prior to entering into an agreement, establishes credit limits, monitors the appropriateness of those limits on an ongoing basis and employs credit mitigation measures, such as collateral or prepayment arrangements and master purchase and sale agreements to mitigate credit risk.

43

The table below summarizes TVA's counterparty credit risk exposure as of September 30, 2002:

Counterparty Credit Risk Exposure (in millions)

Trade Accounts Receivable:

Municipalities & Cooperative Distributors Investment Grade...................................................................

$392 Internally Rated -Investment Grade..............................

130 Noninvestment Grade.

0 Industries & Federal Agencies Directly Served Investment Grade.2.................................................................

26 Noninvestment Grade.

46 Internally Rated -Investment Grade..................................................

18 Internally Rated-Noninvestment Grade..............................................

6 Exchange Pover Arrangements Investment Grade..................................................................

4 Noninvestment Grade................................

I Internally Rated -

Investment Grade..........................

0 Internally Rated -

Noninvestment Grade..............................................

I Subtotal....

624 Other Accounts Receivable:

Miscellaneous Accounts.

44 Provision for Uncollectible Accounts.....................................................

(13)

Subtotal..

31 Total.......................................................

$655 TVA has concentrations of accounts receivable from four municipal customers that represented 32 percent of total accounts receivable as of September 30, 2002.

Rating Triggers As of September 30, 2002, TVA was a party to three swap contracts and five power purchase agreements that contained rating triggers. TVA's primary triggers in its power purchase agreements are based on the Edison Electric Institute ("EEI") standard contract agreement. Under most of the rating triggers, the amount of collateral that TVA will have to post under certain circumstances will increase if TVA's rated bonds are downgraded. The requirement to post collateral under any of these contracts, if triggered, would not have a material effect on TVA's financial condition.

Interest Rate and Foreign Currency Risk TVA manages its daily cash needs through issuance of Discount Notes and other short-term borrowings.

These borrowings expose TVA to fluctuations in short-term interest rates. TVA is not exposed to changes in interest rates on most of its long-term debt until such debt matures and may be refinanced at the then-applicable rates. An interest rate swap is used to hedge TVA's exposure related to its inflation-indexed accreting principal bonds, and currency swap contracts are used as hedges for foreign currency denominated debt issues (see note 5-Foreign Currency and Interest Rate Swaps). Based on TVA's overall interest rate exposure at September 30, 2002, including derivative and other interest rate sensitive instruments, a near-term one percentage point change in interest rates would not have had a material impact on TVA's financial position or results of operations.

44

Equity Price Risk See "Management's Discussion and Analysis of Financial Condition and Result of Operations"-

"Critical Accounting Policies" -

"Nuclear Decommissioning Costs, " note I -

Decommissioning Cosrs and note 9 -

Contingencies -

Decommissioning Costs.

Forward Contracts TVA enters into electricity forward contracts for the sole purpose of limiting or otherwise hedging its economic risks directly associated with meeting its power supply obligations in the Tennessee Valley region.

During 2002, TVA supplied approximately 6 percent of system requirements with power purchased under electricity forward contracts. These contracts qualify for normal purchase and normal sale accounting under SFAS No. 133, as interpreted by DIG Issue C15 (see "Management's Discussion and Analysis of Financial Condition and Result of Operations" -"Critical Accounting Policies" - "Normal Purchases and \\7ormal Sales Special Exemption"). At September 30, 2002, management does not anticipate a materially adverse effect on TVA's financial position or results of operations as a result of market fluctuations.

45

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA STATEMENTS OF INCOME -

POWER PROGRAM For the Years Ended September 30 (in millions) 2002 2001 2000 Operating revenues Sales of electricity Municipalities and cooperatives.......................................

$5,856

$ 5,908

$5,676 Industries directly served...........

732 659 626 Federal agencies and other..........

159 330 361 Other revenue.

88 102 99 Total operating revenues............

6,835 6,999 6,762 Operating expenses Fuel and purchased power............

1,925 1,989 1,962 Operating and maintenance...........

1,840 1,660 1,443 Depreciation and amortization.....

1....................................

1,027 1,312 1,185 Tax-equivalents.

328 315 308 Accelerated amortization (note 1)........

66 230 121 Total operating expenses............

5,186 5,506 5,019 Operating income.

1,649 1,493 1,743 Other income, net.

7 248 17 Income before interest expense and losses on plant cancellation and impairment of assets................................................

1,656 1,741 1,760 Interest expense Interest on debt.....................................................

1,468 1,601 1,695 Amortization of debt discount, issue, and reacquisition costs, net....

22 87 94 Allowance for funds used during construction......

(61)

(55)

(53)

Net interest expense.

1,429 1,633 1,736 Income before losses on plant cancellation and impairment of assets....

227 108 24 Loss on impairment of assets/plant cancellation (notes I andI2

_ (154)

(3,419) _

Net income (loss).

73

$(3,311) $

24 The accompanying notes arc aln integral part of these financial statements.

46

BALANCE SHEETS At September 30 (in millions)

Power Program All Programs 2002 2001 2002 2001 ASSETS Current assets Cash and cash equivalents Accounts receivable.............................................

Inventories at average cost and other Fuel.........................................................

Other........................................................

Total current assets..............................................

Property, plant, and equipment Completed plant.................................................

Less accumulated depreciation.....................................

Net completed plant............................................

Construction in progress..........................................

Deferred nuclear generating units..................................

Nuclear fuel and capital leases.....................................

Total property, plant, and equipment..............................

Investment funds................................................

397 655 173 305 1,530 31,207 (11,162) 20,045 1,040 4,113 481 25,679 339 400 343 720 655 720 170 272 1,501 30,467 (10,344) 20,123 923 4,110 487 25,643 173 305 1,533 32,219 (11,469) 20,750 1,040 4,113 481 26,384 659 725 659 170 272 1,505 31,485 (10,647) 20,838 923 4,110 487 26,358 725 Deferred charges and other assets Loans and other long-term receivables..............................

Debt issue and reacquisition costs..................................

Other deferred charges...........................................

Total deferred charges and other assets.............................

Total assets.....................................................

$ 30,158

$ 29,699

$ 30,889

$ 30,443 LIABILITIES AND PROPRIETARY CAPITAL Current liabilities Accounts payable................................................

Accrued liabilities..............................................

Accrued interest.................................................

Short-term debt.................................................

Current maturities of long-term debt................................

Total current liabilities..........................................

Other liabilities.................................................

Long-term debt Public bonds....................................................

Unamortized discount and other adjustments.........................

Total long-term debt.............................................

Commitments and Contingencies (note 9)

Proprietary capital Appropriation investment.........................................

Retained earnings..............................................

Accumulated other comprehensive loss..............................

Accumulated net expense of nonpower programs.....................

Total proprietary capital..........................................

700 $

710 220 235 397 389 3,492 3,016 1,984 4,809 6,334 3,304 2,806 3,304 2,806 21,763 (405) 21,358 488 349 (150) 20,375 (524) 19,851 508 306 (106) 687 708 Total liabilities and proprietary capital.............................

$ 30,158 $ 29,699

$ 30,889

$ 30,443 The accompanying notes are an integral part of these financial statements.

47 138 193 1,959 2,290 124 140 1,566 1,830 161 193 1,959 2,313 149 140 1,566 1,855 702 220 397 3,492 4,811 715 235 389 3,016 1,984 6,339 21,763 (405) 21,358 4,843 349 (150)

(3,626) 1,416 20,375 (524) 19,851 4,863 306 (106)

(3,616) 1,447

STATEMENTS OF CASH FLOWS For the Years Ended September 30 (in millions)

Power Program 2002 2001 2000 2002 2001 2000 Cash flows from operating activities Net powNer income (loss)................

Net expense of nonpower programs........

Items not requiring (providing) cash Depreciation and amortization..........

Accelerated amortization.............

Allowance for funds used during construction.......................

Nuclear fuel amortization..............

Loss on impairment of assets/plant cancellation........................

Other, net...........................

Changes in current assets and liabilities Accounts receivable Inventories and other..................

Accounts payable and accrued liabilities Accrued interest.....................

Other..

Net cash provided by operating activities.....

Cash flows from investing activities Construction expenditures Allowance for funds used during construction.........................

Nuclear fuel...........................

Other, net............................

Net cash used in investing activities.........

73

$(3.311) $

24 73

$(3,311) $

( 10)

(32) 1,084 1,471 1,289 1,093 1,482 66 230 121 66 230 24 (28) 1,299 121 (61)

(55)

(53)

(61)

(55)

(53) 142 158 177 142 158 177 154 3,419 (16)

(45) 66 (49)

(3) 7 (116) 1.347 (42)

(60) 234 (49)

(36) 1,914 (1,231)

(1,015) 61 (146)

(30)

(1,346) 55 (94)

(137)

(1,191) 154 3,419 25 (16)

(33) 42 19 61 (26)

(95) 1.584 66 (49)

(5) 7 (116) 1.344 (42)

(60) 226 (49)

(36) 1,897 25 42 19 42 (26)

(95) 1,547 (867)

(1,230)

(1,015)

(867) 53 (184)

(37)

( 1,035) 61 (146)

(29)

(1,344) 55 (94)

(129)

(1,183) 53 (184)

(38)

(1,036)

Cash flows from financing activities Long-term debt Issues..

Redemptions and repurchases..........

Short-term borrowings, net Proceeds from combustion turbine leasing, net.................................

Financing costs, net.....................

Other, net.............................

Payments to U.S. Treasury......

Net cash provided by /(used in) financing activities..............................

Net change in cash and cash equivalents....

Cash and cash equivalents at beginning of period...............................

Cash and cash equivralents at end of period...

2,120 (2,720) 476 289 (58)

(50) 57 58 339 397 2,708 (5,069) 1,742 (29)

(29)

(55)

(732)

(9) 348 339 2,250 (2,944) 292 300 (148)

(54)

(304) 245 103 348 2,120 (2,720) 476 2,708 (5,069) 1,742 2,250 (2,944) 292 289 (29) 300 (58)

(29)

(148)

(6)

(50)

(55)

(54) 57 57 343 400 (732)

(18) 361 343 (310) 201 160 361 The accompanying notes are an integral part of these financial statements.

48 All I'rograms

STATEMENTS OF CHANGES IN PROPRIETARY CAPITAL -POWER PROGRAM For the Years Ended September 30 (in millions) 2002 2001 2000 Retained earnings reinvested at beginning of period......

306

$ 3,652

$3,662 Net income (loss)..................................................

73 (3,311) 24 Return on appropriation investment..................

(30)

(35)

(34)

Retained earnings reinvested at end of period............

349 306 3,652 Accumulated other comprehensive loss................

(150)

(106)

Appropriation investment at beginning of period 508 528 548 Return of appropriation investment (20)

(20)

(20)

Appropriation investment at end of period 488 508 528 Proprietary capital at end of period........

687 708

$4,180 The accompanying notes are an integral part of these financial statements.

STATEMENTS OF CHANGES IN PROPRIETARY CAPITAL -

NONPOWER PROGRAMS For the Years Ended September 30 (in millions) 2002 2001 2000 Proprietary capital at beginning of period.....................................

$739

$771

$860 Net expense..............................................................

(10)

(32)

(28)

Transfers to other federal agencies (note 10)..................................

(56)

Other, net................................................................

(5)

Proprietary capital at end of period.................

$729

$739

$771 The accompanying notes are an integral part of these financial statements.

STATEMENTS OF COMPREHENSIVE INCOME (LOSS) -

POWER PROGRAM For the Years Ended September 30 (in millions) 2002 2001 2000 Net power income (loss).............

73

$(3,311) $24 Accumulated other comprehensive loss..........

(150)

(106)

Comprehensive (loss) income...........

(77) $(3,417) $24 The accompanying notes are an integral part of these financial statements.

STATEMENTS OF NET EXPENSE AND COMPREHENSIVE INCOME (LOSS) -

NONPOWER PROGRAMS For the Years Ended September 30 (in millions) 2002 2001 2000 Water and Land Stewardship............

$(10) $(32) $(26)

Economic Development.....................................................

(2)

Net expense and comprehensive loss (note 10).................................

$(10) $(32) $(28)

The accompanying notes are an integral part of these financial statements.

49

NOTES TO FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies General TVA is a wholly ovned corporate agency and instrumentality of the United States. It was established by the TVA Act with the objective of developing the resources of the Tennessee Valley region in order to strengthen the regional and national economy and the national defense by providing: (1) an ample supply of power vithin the region, (2) navigable channels and flood control for the Tennessee River System, and (3) agricultural and industrial development and improved forestry in the region. TVA carries out these regional and national responsibilities in a service area that centers on Tennessee and includes parts of Alabama, Georgia, Kentucky, Mississippi, North Carolina and Virginia.

TVA's operations have historically been divided into two types of activities, the power program and the nonpower programs. Substantially all TVA revenues and assets are attributable to the power program. The power program has historically been separate and distinct from the nonpower programs and is required to be self-supporting from power revenues and proceeds from power program financings. The power program receives no congressional appropriations and is required to make annual payments to the U.S. Treasury in repayment of, and as a return on, the government's appropriation investment in TVA power facilities. Until 2000, most of the funding for TVA's nonpower programs had been provided by congressional appropriations.

These programs are now funded largely with power funds. Certain nonpower activities are also funded by various revenues and user fees. See note 10 for a discussion related to future funding of TVA's nonpower programs.

Power rates are established by the TVA Board of Directors as authorized by the TVA Act. The TVA Act requires TVA to charge rates for power that, among other things, will produce gross revenues sufficient to provide funds for operation, maintenance, and administration of its power system; payments to states and counties in lieu of taxes; and debt service on outstanding indebtedness. Rates set by the Board are not subject to review or approval by any state or federal regulatory body. In a future restructured electric power industry, it is possible, however, that the ability of the Board to set TVA's rates as specified in the TVA Act could be adversely affected by legislative changes or by competitive pressures.

Five municipal customers, which accounted for an aggregate 27 percent of total power sales for 2002.

purchase power from TVA under long-term contracts that require 5 to 10 years' notice to terminate.

TVA prepares its financial statements in conformity with generally accepted accounting principles accepted in the United States of America applied on a consistent basis and, in some cases, TVA's financial statements reflect amounts based on the best estimates and judgment of management.

Fiscal Year Unless otherwise indicated, years (2002, 2001, etc.) refer to TVA's fiscal years ended September 30.

Cost-based Regiulation As a regulated entity, TVA is subject to the provisions of Statement of Financial Standards (SFAS")

No. 7 1, Accounting for the Effects of Certain T pes of Regulation. Accordingly, TVA records certain assets and liabilities resulting from the effects of the ratemaking process that vvould not be recorded under generally accepted accounting principles for nonregulated entities. Currently, the electric utility industry is predomi-nantly regulated on a basis designed to recover the cost of providing electric power to its customers. If cost-based regulation were to be discontinued in the industry for any reason, profits could be reduced and utilities might be required to reduce their asset balances to reflect a market basis less than cost. Discontinuance of cost-based regulation would also require affected utilities to write-off their associated regulatory assets (see note 9 -

Contingencies -

Cost-based Regulation).

50

Revenue Revenues from power sales are recorded as power is delivered to customers. TVA accrues estimated unbilled revenues for power sales provided to customers for the period of time from the end of the billing cycle to month's end (see note 12).

Off-system sales are presented in the accompanying Statements of Income -

Pow-er Program as a component of Sales of electricity -

Federal agencies and other.

Cash and Cash Equivalents Cash and cash equivalents include the cash available in commercial bank accounts and U.S. Treasury accounts, as well as short-term securities held for the primary purpose of general liquidity. Such securities mature within three months from the date of acquisition.

Inventories Coal, oil, limestone, tire-derived fuel inventories and materials and supplies inventories are valued using an average unit cost. A new average cost is computed after each transaction and issues are priced at the latest moving weighted average unit cost.

Inventories of natural gas (at the Egan storage facility) are relatively minor. Inventory is valued at the weighted average cost of gas, which is recalculated monthly.

Property, Plant and Equipnient, and Depreciation Additions to plant are recorded at cost, which includes direct and indirect costs and an allowance for funds used during construction. The cost of current repairs and minor replacements is charged to operating expense. Nuclear fuel is valued at the lower of cost or market using the average cost method for raw materials and the specific identification method for nuclear fuel in reactor. Amortization of nuclear fuel is calculated on a units-of-production basis and is included in fuel expense. The TVA Act requires TVA's Board of Directors to allocate the cost of completed multipurpose projects between the power and nonpower programs, subject to the approval of the President of the United States. The original cost of property retired, together with removal costs less salvage value, is charged to accumulated depreciation. Depreciation is generally computed on a straight-line basis over the estimated service lives of the various classes of assets.

Depreciation expense expressed as a percentage of the average annual depreciable completed plant was 3.33 percent for 2002, 3.28 percent for 2001 and 3.27 percent for 2000. Depreciation rates (percent) by asset class are as follows:

Asset Class 2002 2001 2000 Nuclear...........................................................

3.34 3.32 3.30 Coal-fired.........................................................

3.53 3.52 3.53 Hydro........................................................

1.79 1.79 1.77 Combustion Turbine.....

4.30 4.21 3.55 Transmission.

2.56 2.43 2.44 Other.............................................................

6.31 5.67 6.12 Deconmmin ission ing Costs TVA recognizes as incurred all obligations related to closure and removal of its nuclear units. Earnings from decommissioning investments, amortization of the decommissioning regulatory asset and interest expense on the decommissioning liability are deferred (see note 9 -

Contingencies -

Decon?m issioning Costs). TVA is currently evaluating the nature and scope of its decommissioning policy as it relates to all electric plant. The evaluation will be used to determine the need for recognition of additional asset retirement obligations as described in the recently issued SFAS No. 143, Accounting for Obligations Associated with Retirement of Long-Lived Assets. SFAS No. 143 will be effective for TVA in 2003.

51

Allowance for Funds U sed during Construction TVA capitalizes an allowance for funds used during construction. The allowance is applicable to construction in progress, excluding deferred nuclear generating units.

Other Deferred Charges Other deferred charges primarily include regulatory assets capitalized under the provisions of SFAS No. 71, Accounting for the Effects of Certain Types of Regulation.

Regulatory Assets.

At September 30, 2002 and 2001, other deferred charges included total unamortized regulatory assets of $1,452 million and $439 million, respectively, which for both years represent certain charges related to the closure and removal of nuclear units (see note I -

Decommissioning Costs). The 2002 balance also includes certain costs associated with TVA's September 30, 2002 minimum pension liability, as the Board has determined that such costs will be recovered through future revenues in compliance with the TVA Act. At September 30, 2000, the unamortized balance of regulatory assets of $372 million consisted of

$228 million, representing a transition obligation for certain postemployment benefits, and $144 million, representing certain charges related to the closure and removal of nuclear units (see note I -

Decommission-ing Costs). The $228 million transition obligation for certain postemployment benefits was fully amortized during 2001.

At September 30 2002 2001 (in millions)

Decommissioning costs................................

I......................

$ 556

$439 Adjustment to accrue minimum pension liability.................................

896

$1,452

$439 Accelerated Amortization.

Annual provisions for amortization of deferred charges are adjusted as necessary in order to achieve certain earnings levels. Such earnings levels are set forth in resolutions adopted annually by the TVA Board of Directors in connection with the rate review process. The targeted earnings levels are based on the requirements of the TVA Act and the Basic TVA Power Bond Resolution (see note 6 -Borrowing Authority). Such adjustments may result in either contraction or extension of the estimated amortization periods. The amortization of such assets is principally computed on a straight-line basis, over periods ranging from 3 to 15 years. As a result of surplus earnings levels in 2002, 2001 and 2000, TVA accelerated amortization of certain regulatory assets by $66 million, $230 million and $121 million, respectively.

Nuclear Fuel TVA's investment in the fuel used in the Sequoyah, Watts Bar and Browns Ferry units is being amortized and accounted for as a component of fuel expense.

Nuclear Refueling Outage Costs.

Nuclear refueling outage maintenance costs are deferred and amor-tized on a straight-line basis over the estimated period until the next refueling outage. The amounts of deferred outage costs at September 30, 2002, 2001 and 2000 were $85 million, $57 million and $73 million, respectively.

Investment Funds Investment funds consist primarily of trust funds designated to fund nuclear decommissioning require-ments and debt securities held-to-maturity (see note 9 -

Contingencies -

Decommissioning Costs).

Decommissioning funds are invested in portfolios of securities generally designed to earn returns in line with overall equity market performance. These investments are classified according to SFAS No. 115, Accounting for Certain Investments in Debt and Equiity Securities (see note 7 -

Invesment Funds).

52

Debt Issue and Reacquisition Costs Debt issue and reacquisition expenses, call premiums and other related costs are deferred and amortized (accreted) on a pooled straight-line basis over the weighted average life of TVA's debt portfolio. The unamortized balances of such debt issue and reacquisition costs at September 30, 2002 and 2001 were

$193 million and $140 million, respectively.

TVA has incurred premiums related to certain advanced refundings and also received and paid premiums in connection with the monetization of certain call provisions. In accordance with regulatory practices, TVA defers and amortizes such premiums on a pooled straight-line basis over the weighted average life of its public debt portfolio. In 2001, TVA charged the remaining deferred cost of $789 million against earnings (see note 1-Inpairment of Assets).

Tax Equivalents The TVA Act requires TVA to make payments to states and local governments where the power operations of the corporation are conducted and in which TVA has acquired properties previously subject to state and local taxation. The amount is 5 percent of gross receipts from the prior year's sale of power, excluding sales to other federal agencies and off-system sales with other utilities, with a provision for minimum payments under certain circumstances.

Plant Cancellation Due to changes in the market forecast, TVA elected during 2002 not to complete a gas-fired combined-cycle plant that would have provided 510 MW of power in 2004. Accumulated costs of the project totaled approximately $154 million, which TVA recognized as a loss on plant cancellation.

Inpairment of Assets During 2001, TVA identified certain assets for which the estimated future cash flows provided through future rates were likely to be less than recorded book values. Accordingly, TVA reduced the carrying amount of these assets by a total of $3,419 million, of which $2,220 million was attributable to deferred nuclear generating units, $789 million was attributable to deferred debt refinancing costs, and $410 million was attributable to plant held for future use. The ultimate disposition of these assets is unaffected by the asset value reductions (see note 1 -

Debt Issuie and Reacquisition Costs, and notes 2 and 3) in accordance with SFAS No. 71. This nonrecurring charge will have no effect on TVA's statutory obligation to set rates at levels necessary to produce revenues sufficient to pay the service on its debt and other expenses specified in the TVA Act.

Insurance TVA is primarily self-insured for property loss, workers' compensation, general liability, and automotive liability. TVA is also self-insured for health-care claims for eligible active and retired employees not covered by Medicare. Consulting actuaries assist TVA in determining certain liabilities for self-insured claims. TVA maintains nuclear liability insurance and nuclear property, decommissioning and decontamination insurance with an outside party (see note 9 -

Contingencies -

Nuclear Insurance).

Impact of New Accounting Standards Effective October 1, 2000, TVA adopted SFAS No. 133, Accounting for Derivative Instruments and HedgingActivities, as amended by SFAS No. 138, Accountingfor Certain Derivative Instruments and Certain Hedging Activities, which requires that certain derivative instruments be recorded on the balance sheet as either an asset or a liability measured at fair value. Changes in the fair value of derivatives are recognized in either net income or other comprehensive income, depending on the designated purpose of the derivative. For 2002 and 2001, accumulated other comprehensive loss includes mark-to-market swap valuation adjustments of $150 million and $106 million, respectively.

53

In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, Accounting for Asset Retirenent Obligations, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The statement is effective for financial statements issued for fiscal years beginning after June 15, 2002.

At the present time, TVA is unable to determine whether the implementation of this standard will be material to its results of operations or financial position.

In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which replaces SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. It also developed one accounting model for long-lived assets to be disposed of by sale, based on the framework established in SFAS No. 121, and addressed significant implementation issues. SFAS No. 144 requires that those long-lived assets be measured at the lower of the carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001, and, generally, are to be applied prospectively. At the present time, TVA is unable to determine whether the implementation of this standard will be material to its results of operations or financial position.

The purpose of Emerging Issues Task Force ("EITF") Issue 02-3, Issues Related to Accounting for Contracts Involved in Energy Trading and Risk Management Activities, is to codify and reconcile the Task Force consensuses on previously issued EITF Issues No. 98-10, Accountingfor Contracts Involved in Energy Trading and Risk Management Activities, and No. 00-17, Measuring the Fair Value of Energy-Related Contracts in Applying Issue Vo. 98-10, and EITF Abstracts, Topic No. D-105, Accounting in Consolidation for Energy Trading Contracts between Affiliated Entities When the Activities of One hut Not Both Affiliates Are within the Scope of Issue No. 98-10. These EITF Issues and Abstracts address various aspects of the accounting for contracts involved in energy trading and risk management activities. At a special October 25, 2002 meeting, the Task Force reached a consensus to rescind EITF Issue No. 98-10, the impact of which is to preclude mark-to-market accounting for all energy trading contracts not within the scope of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The Task Force also reached consensus that gains and losses on derivative instruments within the scope of SFAS No. 133 should be shown net in the income statement if the derivative instruments are held for trading purposes. The consensuses reached effectively supercede the consensuses reached on this Issue at the June 19-20, 2002 EITF meeting.

The consensus regarding the rescission of Issue 98-10 is applicable for fiscal periods beginning after December 15, 2002. Energy trading contracts not within the scope of SFAS No. 133 purchased after October 25, 2002, but prior to the implementation of the consensus are not permitted to apply mark-to-market accounting. The adoption of EITF Issue 02-3 will have no impact on TVA's current operations.

Management Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the related amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Other Certain reclassifications have been made to the 2001 financial statements to conform to the 2002 presentation.

54

2. Nuclear Power Program The nuclear power program at September 30, 2002, consists of nine units -five operating, three deferred and one inoperative -

at four locations, with investments in property, plant and equipment as follows and in the status indicated:

Installed Operating Capacity Completed Construction Fuel tTnits (Megawatts)

Plant. Net in Progress Deferred Investment (Dollars in millions)

Browns Ferry.2

.2 2,380

$ 2,607

$ 58

$175 Sequoyah.........................

2 2,442 1,769 115 86 Watts Bar........................

1 1,270 5,907 8

51 Bellefonte........................

4,113 Raw Materials................

7 Total 5..........................

5 6,092

$10,283

$181

$4,113

$319

• Browns Ferry Unit 1, an inoperative unit, is discussed below.

Browns Ferry Unit I was taken off-line in 1985 for modifications and improvements and will continue to remain in an inoperative status until recovered. In May 2002, the TVA Board of Directors initiated activities for the return of Unit I to service in order to meet long-term power requirements. The decision was made upon completion of the Detailed Scoping, Estimating and Planning project and the Final Supplemental Environmental Impact Statement, which demonstrate that Unit I can be returned to safe operation in a controlled manner and that operating the unit will have no significant, adverse impacts on the environment.

TVA has determined that restarting Unit I is the best alternative currently available among the mix of generation options. It is anticipated the Unit I recovery project will add approximately 1,280 megawatts of generation at a cost of approximately $1.8 billion and will take five years to complete. It is anticipated that when Unit I returns to service, additional generation will help lower the average cost of power and provide additional cash flow for accelerated debt reduction. The undepreciated cost of Unit I of $46 million is included in net completed plant and is being depreciated as part of the recoverable cost of the plant over the remaining license period.

TVA has three units in deferred status. In 1988, TVA suspended construction activities on Watts Bar Unit 2, and the unit is currently in lay-up. Bellefonte Units I and 2 were deferred in 1988 and 1985, respectively. Estimated 2003 expenditures for the three deferred units are limited to lay-up, maintenance and ensuring that options remain viable.

While future decisions on TVA's deferred units will ultimately impact the method of cost recovery, the TVA Board determined as of the end of 2001 that the value of some of its existing assets was not appropriate in the competitive marketplace. Certain assets, Bellefonte Units I and 2 and Watts Bar Unit 2, were identified as assets where the estimated future values were less than recorded book values. Consequently, in 2001 TVA revalued these assets dow,-nward by $2,220 million and recognized an impairment loss. The Board will establish rate adjustments and operating policies to ensure full recovery of the remaining cost of the Bellefonte units and compliance with the requirements of the TVA Act (see note I -

Impairment ofAssets).

55

3. Completed Plant -

Power Program Completed plant of the power program consisted of the following at September 30 after a downward revaluation adjustment during 2001 of $410 million to plant held for future use (see note 1 -

Impairment of Assets):

2002 2001 Accumulated Accumulated Cost Depreciation Net Cost Depreciation Net (in millions)

Coal-fired...........................

$ 8,579

$ 4,117

$ 4,462

$ 8,324

$ 3,877

$ 4,447 Combustion turbine........

1,151 292 859 837 251 586 Nuclear............................

14,778 4,495 10,283 14,747 4,025 10,722 Transmission........................

3,847 1,284 2,563 3,672 1,211 2,461 Hydro..............................

1,665 570 1,095 1,623 556 1,067 Other..............................

1,187 404 783 1,264 424 840 Total..............................

$31,207

$11,162

$20,045

$30,467

$10,344

$20,123

4. Proprietary Capital Appropriation Investment -Power Program The TVA Act requires TVA to make annual payments to the U.S. Treasury from net power proceeds as a return on the appropriations investment in the power system and as a repayment of that investment. The payments required by the TVA Act may be deferred under certain circumstances for not more than two years.

TVA paid $20 million each year for 2002, 2001 and 2000 as a repayment of the appropriation investment. In addition, TVA paid the U.S. Treasury $30 million in 2002, $35 million in 2001 and $34 million in 2000 as a return on the appropriation investment. The return is based on the appropriation investment as of the beginning of the year and on the computed average interest rate payable by the U.S. Treasury on its total marketable public obligations as of the same date (5.82 percent, 6.63 percent, and 6.34 percent at September 30, 2001, 2000, and 1999, respectively). Cumulative repayments and return on investment paid by TVA to the U.S. Treasury exceed $3.4 billion, on the government's appropriation investment of $1.4 billion, approximately $955 million of which TVA has repaid.

Accumulated Other Comprehensive Loss SFAS No. 130, Reporting Comprehensive Income, requires the disclosure of comprehensive income to reflect changes in capital that result from transactions and economic events from nonowner sources. The amounts included in other comprehensive loss were $150 million for 2002, $106 million for 2001, and $0 for 2000. The $150 million loss in 2002 and the $106 million loss for 2001 are due to market valuation adjustments for certain derivative instruments (see note I -

Impact of New Accounting Standards and note 5).

56

Total Other Comprehensive Income (Loss) Activity (in millions)

Accumulated other comprehensive income, September 30, 2000...........

0 Interest rate swap................................................

5 Foreign currency swaps.

26 Electricity purchase options...

20 Cumulative effect of adoption of SFAS No. 133 at October 1, 2000 51 Changes in fair value:

Interest rate swap................................................

(34)

Foreign currency swaps.................

(103)

Electricity purchase options..........

(20)

Accumulated other comprehensive loss, September 30, 2001..............

(106)

Changes in fair value:

Interest rate swap................................................

10 Foreign currency swaps............

(54)

Accumulated other comprehensive loss, September 30, 2002..............

$ (150)

5. Risk Management Activities and Derivative Transactions TVA has established a Risk Management Committee, which is charged with the responsibility of reviewing and approving controls and procedures for TVA-wide risk management activities, including the oversight of models and assumptions used to measure risk, the review of counterparty exposure limits and the establishment of formal procedures regarding the use of financial hedging instruments.

TVA is exposed to market risks, including changes in interest rates, foreign currency exchange rates and volatility of certain commodity and equity market prices. To manage the volatility attributable to these exposures, TVA has entered into various nontrading derivative transactions, principally an interest rate swap agreement, foreign currency swap contracts and option contracts.

TVA is exposed to losses in the event of counterparties' nonperformance and accordingly has established controls to determine the creditworthiness of counterparties in order to mitigate exposure to credit risk.

With respect to hedging activities, TVA risk management policies provide for the use of derivative financial instruments to manage financial exposures but prohibit the use of these instruments for speculative or trading purposes. Prior to October 1, 2000, TVA accounted for hedging activities using the deferral method, and gains and losses were recognized in the financial statements when the related hedged transaction occurred. During 2001, TVA adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. See further discussion related to TVA's adoption of SFAS No. 133 at note I-Impact of New Accounting Standards.

In accordance with SFAS No. 133, certain interest rate and foreign currency swap contracts were marked-to-market and resulted in losses of $44 million for 2002 and $106 million for 2001. Since such contracts represent cash flow hedges of certain commodity and debt transactions, the losses have been recognized in accumulated other comprehensive loss. Because of the highly effective nature of its hedging transactions, TVA was not required to recognize losses in the Statements of Income. If any loss! (gain) were to be incurred as a result of the early termination of an interest rate swap contract, any resulting charge/ (income) would be amortized over the remaining life of the associated bond as a component of interest expense.

Commodity Contracts TVA enters into contracts that hedge cash flow exposures to market fluctuations in the price and delivery of certain commodities. TVA expects to take or make delivery, as appropriate, under these forward contracts.

Accordingly, these contracts qualify for normal purchase and normal sale accounting under SFAS No. 133, 57

as interpreted by the Derivative Implementation Group ("DIG"). DIG Issue C15 escribes the criteria that must be met in order for such contracts to qualify for the use of normal purchase and normal sale accounting.

Gains and losses on cash flow hedges are deferred in other comprehensive income and recognized as adjustments to the carrying amount of the items hedged. Deferral of the gains and losses continues until the items hedged are recognized in income. Gains and losses on derivatives not qualifying for hedge accounting are deferred in accordance with SFAS No. 71.

Foreign Currency and Interest Rate Swaps During 1996, TVA entered into a currency swap contract as a hedge for a foreign currency denominated debt transaction. TVA issued DMI.5 billion of bonds and entered into a currency swap to hedge fluctuations in the DM exchange rate. TVA also entered into currency swap contracts during 2001 and 1999 as hedges for sterling-denominated debt transactions in which TVA issued 250 million and £200 million of bonds, respectively. Any gains or losses on the debt instruments due to the foreign currency transactions are offset by losses or gains on the swap contracts. At September 30, 2002 and 2001, the currency transactions resulted in net translation gains of $220 million and $322 million, respectively, which are included in the account "unamortized discount and other adjustments." However, the net translation gains were offset by correspond-ing losses on the swap contracts, which are recorded as a deferred liability. Additionally, in 1997 TVA issued

$300 million of inflation-indexed accreting principal bonds. The 10-year bonds have a fixed coupon rate that is paid on thc inflation-adjusted principal amount. TVA hedged its inflation exposure under the securities through a receive-floating, pay-fixed interest rate swap agreement.

Mark-to-Market of TVA Derivatives at September 30 2002 Balance 2001 2002 Year of Asset/(iabilitvi)

Balance Notional Expiration (in millions)

Interest Rate Swap..........

22 8

USD300 million 2007 Currency Swaps:

Deutschemark............

(328)

(358)

DM1.5 billion 2006 Sterling.

(35)

(40)

GBP200 million 2021 Sterling.................................

13 GBP250 million 2032 Coal Contracts -Volume Options.....

1 275 1 1 8 million tons 2007

6. Debt Borrowing A uth oritj The TVA Act authorizes TVA to issue bonds, notes, and other evidences of indebtedness up to a total of

$30 billion outstanding at any one time. TVA must meet certain financial tests that are contained in the TVA Act and the Basic TVA Power Bond Resolution. Debt service on these obligations, which is payable solely from TVA's net power proceeds, has precedence over the payment to the U.S. Treasury (see note 4 -

Approp)riation Investment -

Power Program).

Short-Term Debt The weighted average rates applicable to TVA short-term debt outstanding in the public market as of September 30, 2002, 2001 and 2000, were 1.74 percent, 2.90 percent and 6.53 percent, respectively. During 2002, 2001 and 2000, the maximum outstanding balances of short-term borrowings held by the public were (in millions) $3,497, $3,459 and $3,943, respectively. For these same years the average amounts (and weighted average interest rates) of short-term borrowings were approximately (in millions) $2,290 (1.95 percent),

$1,994 (4.90 percent) and $2,628 (5.94 percent), respectively.

58

Put and Call Options Bond issues of $4.5 billion held by the public are 'redeemable in whole or in part, at TVA's option, on call dates ranging from the present to July 2020 and at call prices ranging from 100 percent to 106 percent of the principal amount. Additionally, TVA has bond issues of $3.2 billion held by the public that are redeemable in whole or in part at the option of the respective bondholders, as follows: one bond issue totaling

$936 million, which matures in 2012, is redeemable in 2004 by the bondholders; a second issue totaling

$121 million, which matures in April 2036, is redeemable in 2006 at the option of the bondholders; a third issue totaling $1.5 billion, which matures in April 2036, is redeemable in 2006 at the option of the bondholders; and a fourth bond issue totaling $600 million which matures December 2016, is redeemable in 2007 by the bondholders. Each of these issues is reported in the debt schedule with maturity dates corresponding to the earliest redemption dates. Thirty-six additional issues totaling $1.3 billion, with maturity dates ranging from 2005 to 2030, include a provision for a right of redemption upon the death of a beneficial owner in certain specified circumstances.

Additionally, TVA has two issues of Putable Automatic Rate Reset Securities ("PARRS") outstanding.

After a fixed period of five years, the coupon rate on the PARRS may be reset downward under certain market conditions. Investors have the option to redeem the bonds at par if and when the interest rate is reset.

One PARRS issue totals $575 million, matures in June 2028 and has its first potential reset date in June 2003. The second issue of PARRS totals $525 million, matures in May 2029 and has its first potential reset date in May 2004.

Debt Outstanding Debt outstanding at September 30, 2002 and 2001 consisted of the following:

2002 2001 (in millions)

Short-term debt Discount notes (net of discount).........

$ 3,492

$ 3,016 Current maturities of long-term debt -

5.00% to 7.14%.-

1,984 Total short-term debt....................................

3,492 5,000 Long-term debt Maturing in 2004 -4.75%

to 6.79%.....................................

2,336 1,400 Maturing in 2005 -

6.375% to 7.15%....................................

2,065 2,065 Maturing in 2006 -5.25%

to 7.125%....

2,621 2,670 Maturing in 2007 -

3.50% to 6.643%....................................

1,051 336 Maturing in 2008 through 2045 -4.375% to 8.25%......

13,690 13,904 Total long-term debt.

21,763(1) 20,375(1)

Total indebtedness........................................................

$25,255

$25,375 (I) Excludes net translation gains from currency transactions of $220 million and $322 million at Septem-ber 30, 2002 and 2001, respectively, which are included in the account "unamortized discount and other adjustments."

Interest and Capital Costs During 2002, 2001 and 2000 cash paid for interest on outstanding indebtedness (net of amount capitalized) was $1,414 million, $1,471 million and $1,669 million, respectively. In addition to paying interest on outstanding indebtedness, TVA is required by the TVA Act to make annual payments to the U.S.

Treasury. The annual Treasury payments represent a repayment of the govemment's appropriation invest-ment, along with a return on the appropriation investment (see note 4 -Appropriation Investment -

Power Program).

59

7. Fair Value of Financial Instruments TVA uses the methods and assumptions described below to estimate the fair value of each significant class of financial instrument. The fair market value of the financial instruments held at September 30, 2002, may not be representative of the actual gains or losses that will be recorded when these instruments mature or if they are called or presented for early redemption.

The estimated values of TVA's financial instruments at September 30 are as follows:

2002 2002 2001 2001 Canring Fair Carrying Fair Amount Amount Amount Amount (in millions)

Cash and cash equivalents...............................

400 400 343 343 Investment funds.659 659 725 725 Loans and other long-term receivables.161 161 149 149 Short-term debt, net of discount.3,492 3,492 3,016 3,016 Long-term debt, net of discount.21,358 23,767 19,851 23,139 Other financing obligations.559 559 271 271 Cash and Cash Equivalents and Short-Term Debt Because of the short-term maturity of these instruments, the carrying amount approximates fair value.

Investment Fuinds Information on investments b major type at September 30 are as follows:

2002 2001 (in millions)

Equity securities held as trading...........................................

$503

$600 Debt securities held-to-maturity...........

149 119 Joint ventures....................................................................

7 6

$659

$725 These investments were primarily classified as trading securities and held-to-maturity securities. Gains and losses on trading securities are recognized in current earnings and subsequently reclassified to a regulatory asset account in accordance wvith TVA's decommissioning accounting policy. The fund had unrealized losses of $97 million in 2002. unrealized losses of $233 million in 2001 and unrealized gains of

$109 million in 2000. Held-to-maturity securities, purchased during September, approximate market value and are accounted for at amortized cost.

Loans and Other Long-Terni Receivables Fair values for these homogeneous categories of loans and receivables are estimated by determining the present value of future cash flows using a discounted rate equal to lending rates for similar loans made to borrowers with similar credit ratings and for the same remaining maturities. The carrying amount approxi-mates fair value.

Long-Tern? Debt Fair value of long-term debt traded in the public market is determined by multiplying the par value of the bonds by the market price nearest the balance sheet date. At September 30, 2002, the carrying amount of long-term debt was $21,358 million compared with a fair value of $23,767 million, and at September 30, 2001, the carrvino amount of long-term debt was $19,851 million compared with a fair value of $23,139 million.

60

Other Financing Obligations In 2002 and 2000, TVA received approximatcly $320 million and $300 million, respectively, in proceeds by entering into lease-leasebaick transactions for 16 ne\\v peaking combustion turbine units. Due to the nature of the transactions, the carrying amounts of the obligations and fair market values are equal. At September 30, 2002 and 2001, the total balances of the obligations were $559 million and $271 million, respectively.

Due to TVA's continuing involvement in the operation and maintenance of the units and its control over the distribution of power produced b the facilities during the leaseback term, TVA accounted for the respective lease proceeds of $320 million and $300 million as financing obligations as required in accordance wsith SFAS No. 66, Accouniting for Sales o Real Estate, and SFAS No. 98, Accounting for Leases.

Accordingly, the outstanding financing obligations of $559 million in 2002 and $271 million in 2001 are included in Current iabilities ($16 illioiI and $6 million, respectively) and Other Liabilities ($543 million and $265 million, respectively) in TVA's 2002 and 2001 year-end Balance Sheets.

8. Benefit Plans Pension Plani TVA has a defined benefit plan for most full-time employees that provides two benefit structures: the Original Benefit Structure and the Cash Balance Benefit Structure. The plan is controlled and administered by a legal entity separate from TVA, the TVA Retirement System ("TVARS"), which is governed by its own independent board of directors. The plan assets are primarily stocks and bonds. TVA contributes to the plan such amounts as are agreed upon by the TVA and TVARS boards of directors. No TVA contribution is legally required when the plan's assets are sufficient to meet its accrued liabilities, as determined by an independent outside actuary.

The pension benefit for a member participating in the Original Benefit Structure is based on the member's vears of creditable service, average base pay for the highest three consecutive years, and the pension rate for the member's age and years of service, less a Social Security offset.

The pension benefit for a member participating in the Cash Balance Benefit Structure is based on credits accumulated in the member's account and the member's age. A member's account receives credits each pay period equal to 6.0 percent of his or her straight-time earnings. The account also increases at an interest rate equal to the change in the Consumer Price Index ("CPI") plus 3.0 percent, with the provision that the rate may not be less than 6.0 percent nor more than 10.0 percent. The actual changes in the CPI for 2002 and 2001 vere 3.1 percent and 3.2 percent, wNhich resulted in interest rates of 6.1 percent and 6.2 percent, respectively.

TVARS also maintains a defined contribution plan, a 401 (k) plan, to which TVA makes matching contributions of 25 cents on the dollar (up to 1.5 percent of pay) for members participating in the Original Benefit Structure and of 75 cents on the dollar (up to 4.5 percent of pay) for members participating in the Cash Balance Benefit Structure.

Net pension income is determined using assumptions as of the beginning of each year. Funded status is determined using assumptions as of the end of each year. The valuations performed at the end of 2001 were based on actuarial assumptions that were consistent for all of TVA's benefit plans. For 2002, TVA recognized pension income of about $40 million, postretirement benefit expense of $19 million, and workers compensation expense of approximately $64 million.

Effective with the September 30, 2002 measurement date for funded status, the discount rate was reduced from 7.50 percent to 7.05 percent and the cost of living rate was reduced from 3.0 percent to 2.3 percent to reflect current market and demographic conditions. Additionally, TVA modified its assumption related to mortality based on results of an experience study performed during the year and converted from 1994 to 1983 mortality tables. As a result of these changes, the September 30, 2002 projected benefit obligation decreased by nearly $128 million for the year. The changes in assumptions had no effect on pension income for 2002, 2001 or 2000 but will reduce pension expense for 2003 by approximately $37 million.

61

The assumptions utilized to measure net pension income and the projected benefit obligations are as follows:

2002 2001 2000 Discount rate..........................

7.05 7.5 8.0 Cost of living rate..

2.3 3.0 3.0 Expected long-term rate of return........

9.0 9.0 10.0 Average increase in compensation.....................................

3-8%

3-8%

3-8%

During 2000, plan amendments were effected that enhanced certain pension benefits, resulting in approximately $250 million in additional pension-plan benefit obligations.

Other Postretirene Benefits TVA sponsors an unfunded postretirement plan that provides for nonvested contributions toward the cost of certain retirees' medical coverage. This plan formerly covered all retirees participating in the TVA medical plan, and TVA's contributions were a flat dollar amount based on the participants' ages and years of service and certain payments toward the plan costs. This plan now operates on a much more limited basis, covering only certain retirees and surviving dependents who do not qualify for TVARS benefits.

During 2000, these postretirement benefits were enhanced to help covered retirees offset the cost of medical coverage, resulting in approximately $16 million in additional postretirement benefit obligations.

The annu. l assumed cost trend for covered benefits was 8.5 percent in 2002, decreasing by one-half percent per year to a level of 5.0 percent in 2009 and thereafter. For 2001 and 2000, annual trend rates of 8.5 percent and 9.0 percent, respectively, were assumed. The effect of the change in assumptions of the cost basis was not significant. Increasing/ (reducing) the assumed healthf-care cost trend rates by 1 percent would increase/ (reduce) the accumulated postretirement benefit obligation ("APBO") as of September 30, 2002, by $33 million/ ($33 million) and the aggregated service and interest cost components of net periodic postretirement benefit cost for 2002 by $2 million/($2 million).

The weighted average discount rate used in determining the APBO was 7.05 percent for 2002, 7.5 percent for 2001 and 8.0 percent for 2000. Any net unrecognized gain or loss resulting from experience different from that assumed or from changes in assumptions, and exceeding 0 percent of the APBO, is amortized over the average remaining service period of active plan participants.

The assumptions utilized to measure other post-retirement benefits are as follows:

24)02 2001 2000 Discount rate.

7.05 7.5 8.0 Health-care trend rate..................................................

8.5 8.5 9.0 Cost of living rate.

2.3 3.0 3.0 Assumed ultimate trend rate...........

5.0 5.0 5.0 Assumed ultimate trend rate to be reached in year..........................

2009 2008 2008 Other Postemployn7ent Benefits Other postemployment benefits include workers' compensation provided to former or inactive employees and their beneficiaries and covered dependents for the period after employment but before retirement.

Adoption of SFAS No. 112, Enployers'Accounting for Postemplonient Benefits, in 1995 changed TVA's method of accounting from recognizing costs as benefits are paid to accruing the expected costs of providing these benefits. In connection with the adoption of SFAS No. 112 and related approval by its Board of Directors, TVA recorded the transition obligation as a regulatory asset. The regulatory asset was being amortized over approximately 15 years, whereby the annual expense approximated the expense that would have been recorded on an as-paid basis. In 2000, TVA accelerated amortization of the regulatory asset approximately $80 million, and in 2001 it accelerated the amortization by $194 million to complete the write-62

off of the regulatory asset. This acceleration was in accordance with TVA's accounting policy as previously described (see note 1 -Other Deferred Charges -Accelerated Amortization).

The components of pension expense and other postretirement benefits expense for the years ended September 30 were:

(in millions)

Change in benefit obligation Benefit obligation at beginning of year...........................

Service cost..................................................

Interest cost.................................................

Plan participants' contributions.................................

Amendments, including special events...........................

Actuarial (gain) /loss..........................................

Net transfers (to)/from variable fund/401 (k) plan................

Expenses paid................................................

Benefits paid.................................................

Benefit obligation at end of year................................

Change in plan assets Fair value of plan assets at beginning of year......................

Adjustments.................................................

Actual return on plan assets....................................

Plan participants' contributions.................................

Net transfers (to)/from variable fund/401(k) plan................

Employer contribution.........................................

Expenses paid................................................

Benefits paid.................................................

Fair value of plan assets at end of year...........................

Pension Benefits 2002 2001

$ 5,958 87 434 36 (289) 9 (4)

(330)

$ 5,901

$ 5,878 (5)

(496) 35 9

(4)

(330)

$ 5,087

$ 5,461 79 424 28 268 9

(4)

(307)

$ 5,958

$ 221 4

16 51 199 4

(64)

$ 431

$ 7,312 (1)

(1,159) 28 51 9

14 (4)

(307)

(65)

$ 5,878

=

Funded status................................................

Unrecognized net actuarial loss.................................

Unrecognized prior service cost.................................

Prepaid (accrued) benefit cost..................................

Amount recognized in statement of financial position..............

Prepaid benefit cost...........................................

Accrued benefit liability.......................................

Intangible asset...............................................

Regulatory asset..............................................

Net amount recognized........................................

$ (814) 1,229 419 834 (80) 418 456 794 794 (481) 419 896 834 $

794 63 Other Postretirement Benefits 2002 2001

$ 133 2

10 43 93 (60)

$ 221 43 17 (60)

$ (431) 63 161

$(207)

(207)

$(207)

$(221) 62 (43)

$ (202)

(202)

$(202)

Pension Benefits Other Postretirement Benefits (in nillions) 2002 2001 2000 2002 2001 2000 Components of net periodic benefit cost Service cost....

87

$ 78

$ 76 4

2 5

Interest cost.................................

434 424 367 16 10 11 Expected return on plan assets......

(597)

(599)

(602)

N/A N/A N/A Amortization of prior service cost..............

36 36 24 (4)

(4)

(6)

Amortization of transition obligation.....

Recognized net actuarial (gain)/loss.....

(39)

(19) 3 (2)

Net periodic benefit (income)......

(40)

(100)

(154) 19 6

10 Special events Total benefit (income)...............

$ (40)

$(100)

$(154) 19 6

10

9. Commitments and Contingencies Comitmrtents Leases/Leasebacks. Certain property, plant and equipment are leased under agreements with terms ranging from I to 30 years. Many of the agreements include purchase options or renewal options that cover substantially all the economic lives of the properties. Obligations under capital lease agreements in effect at September 30, 2002, total $36 million annually through 2007, and an aggregate of $121 million thereafter, for a total commitment of $301 million. Of this amount, $138 million represents the cost of financing.

Obligations under non-cancelable lease agreements in effect at September 30, 2002 total $4 million for each of 2003 and 2004 and $3 million for each of 2005-2007. There are no non-cancelable operating lease agreements in effect after that period. TVA also has cancelable lease agreements in effect at September 30, 2002 which total S2 million for 2003, $3 million for each of 2004 and 2005, $2 million for 2006 and $1 million for each of 2007-2013. Because of the nature of these cancelable lease agreements, they are not included in the commitment table below.

Obligations under combustion turbine lease/leaseback transactions in effect at September 30, 2002, total

$44 million annually for 2003 and 2004, $46 million for 2005, and $44 million for 2006 and 2007 and an aggregate of $640 million thereafter, for a total commitment of $862 million. Of this amount, $301 million represents the cost of financing.

Other Obligationis. TVA has approximately $1.7 billion in long-term commitments consisting primarily of construction of generating and emission control assets. Terms of the contracts extend into 2008.

Fuel Purchase Obligations. TVA has approximately $2.7 billion in long-term fuel purchase commit-ments, with terms up to seven years, for the purchase and transportation of coal and approximately $1.1 billion in long-term commitments, with terms of up to 10 years, for the purchase of enriched uranium and fabrication of nuclear fuel assemblies.

Power Purchase Obligations. TVA has an agreement for the purchase of power from a 440-megawatt, lignite-fircd electric generating plant that requires TVA to purchase the plant's output for a 30-year period which began in April 2002. Pricing of the contract includes fixed and variable components with estimated power purchases approximating $3 billion for the remainder of the contract term. TVA also entered into long-term power supply agreements with a generator for supply from a facility that has a current generating capacity of 500 megawatts. These commitments extend through May 2007 with a future obligation for demand charges in the amount of $136 million. Agreements are in place with respect to five other projects.

These five contracts are for durations of 2 to 12 years, the earliest of which began in 2000. Payments for the remainder of the terms of these five contracts are estimated to be approximately S38 million. Costs under these contracts are included in Fuel and purchased power and expensed as incurred.

64

Under the Public Utility Regulatory Policies Act of 1978, TVA is obligated to purchase power from qualifying facilities. In 2002, a new facility qualified under this program, and as a result TVA could be required to take up to 800 MW of power during certain on-peak hours from the facility.

The estimated commitments for TVA as of September 30, 2002 are as follows:

2003 2004 2005 2006 2007 Thereafter Total (in millions)

Leases...............................

40

$ 40

$ 39

$ 39

$ 39

$ 121

$ 318 Lease/leaseback transactions............

44 44 46 44 44 640 862 Power purchase obligations 137 113 136 136 124 2,390 3,036 Other obligations......................

441 379 330 293 215 1,658 Fuel purchase obligations...............

1,515 999 641 178 99 374 3,806 Tritium Produiction Approved.

In September 2002, the Nuclear Regulatory Commission ("NRC")

issued an amendment to the Watts Bar Nuclear Plant operating license, allowing TVA to irradiate tritium-producing burnable absorber rods at the plant for use by the U.S. Department of Defense. TVA's license amendment permits it to install up to 2,304 of the rods into the Watts Bar reactor and irradiate them for one fuel cycle, which lasts about 18 months. TVA will then remove the irradiated rods for shipment to DOE's tritium-extraction facility at the Savannah River Site near Aiken, South Carolina. TVA expects to begin tritium production at Watts Bar in the fall of 2003. Also in September 2002, the NRC issued an amendment to the Sequoyah Nuclear Plant operating license allowing TVA to produce tritium at the plant. TVA will recover costs associated with the tritium production program, and TVA retains the right to operate the reactors for their primary mission of producing electricity.

Contingencies Ntclear Insurance. The Price-Anderson Act sets forth an indemnification and limitation of liability plan for the U.S. nuclear industry. All NRC licensees, including TVA, maintain nuclear liability insurance in the amount of $200 million for each plant with an operating license. The second level of financial protection required is the industry's retrospective assessment plan, using deferred premium charges. The maximum amount of the deferred premium for each nuclear incident is approximately $88 million per reactor, but not more than $10 million per reactor may be charged in any one year for each incident. TVA could be required to pay a maximum of $528 million per nuclear incident on the basis of its six licensed units, but it would have to pay no more than $60 million per incident in any one year.

TVA carries property and decontamination insurance of $2.06 billion at each licensed nuclear plant for the cost of stabilizing or shutting down a reactor after an accident. Some of this insurance may require the payment of retrospective premiums of up to a maximum of approximately $57 million.

Clean Air Developments.

Title IV of the Clean Air Act Amendments ("CAAA") of 1990 requires coal-fired generation units to reduce their sulfur dioxide ("SO2") and nitrogen oxide ("NO;') emissions in two phases in order to control acid rain. Compliance with these requirements has resulted in substantial expenditures for the reduction of emissions at TVA's coal-fired generating plants. Through 2002, TVA has invested approximately $1 billion in capital improvements for acid rain compliance. TVA estimates it will spend an additional $85 million from 2003 to 2006 to complete switches to lower sulfur coals for acid rain compliance purposes.

TVA's strategy for complying with the CAAA has included the use of flue gas desulfurization systems, or scrubbers, on two fossil units in addition to existing scrubbers on four other units, and the use of lower-sulfur coal at other fossil units to reduce SO2 emissions. TVA has completed these scrubbers and is on schedule to complete the changeover to lower-sulfur coal.

NO. reductions were required for 58 of TVA's 59 coal-fired units. The only TVA unit for which NO, reductions are not required under the CAAA is the Atmospheric Fluidized Bed Unit 10 at TVA's Shawnee Fossil Plant. The NO, reductions for the other 58 units were achieved through the installation of low-65

nitrogen-oxide burners and/or overfire air at 40 units and boiler optimization on the remaining I8 TVA units.

In 1996, TVA selected an early election option for 4 of these 58 units, which allow's the 4 units at John Sevier Fossil Plant to be limited to Phase I NO, levels through 2007. In 2008, these 4 units will have to meet lower Phase 2 NO, levels. For the remaining 54 units, TVA has elected to average NO, emissions to meet a 54 unit NO, Averaging Plan. This option enables TVA to optimize the cost of NO, reductions while fully complying with the CAAA Title IV NO, requirements. In addition to its Title IV projects, TVA is in the process of installing selective catalytic reduction systems ("SCRs") or other NO, control technology on at least 25 of its coal-fired units. SCRs are state-of-the-art NO, pollution technology. This followAs up on a commitment TVA made to further reduce NO, emissions on its system. Installation of these SCRs will also comply with the State Implementation Plan NO, Reduction rule issued by EPA in 1998. Depending on future generation requirements, additional NO, controls may be required.

In TVA's continuing efforts to improve air quality in the Tennessee Valley and to comply with the Clean Air Act, TVA plans to design, build and operate ive more scrubbers to further reduce SO emissions from 12 of its coal-fired units. Although design of these scrubbers is scheduled to start in 2003, substantial construction activities are not expected to begin until TVA completes its SCR installation program in 2005.

Completion of the five scrubbers is expected by 2011.

The Environmental Protection Agency ("EPA") has finalized new, more stringent National Ambient Air Quality Standards for particulate matter and ozone and a rule designed to reduce regional haze. Each of these rule-makings has undergone litigation and the EPA is in the process of developing implementation strategies for the ambient standards and readdressing several provisions of the regional haze rule. These actions may require TVA to make additional reductions of SO, emissions beyond those currently planned. TVA anticipates that compliance Nith the newN regulations wvill be required after 2010. The EPA has also determined that mercury emissions from coal-fired plants should be reduced, and is developing both a rule to reduce mercury and legislative packages that put mercury reductions in a multipollutant plan. Depending on the severity of the mercury reductions required by EPA, TVA could incur additional substantial capital costs for control of mercury.

On February 14, 2002, the Bush administration announced its "Clear Skies Initiative," which outlines legislative requirements for the phased reduction of SO,, NO, and mercury emissions from utilities during the period from 2008 to 2018. In July of 2002, legislation known as the Clear Skies Act was introduced in Congress. A number of bills have been introduced in Congress that would result in significant decreases in emissions of NO,, SO2 and mercury, as well as carbon dioxide. The timing and content of such legislation remains highly uncertain.

Expenditures related to the Clean Air projects during 2002 and 2001 were approximately $400 million and $200 million, respectively. The cost of the SCR strategy, including the 2001 and 2002 expenditures, is now estimated to be $1.3 billion, and the cost of the planned installation of five scrubbers is estimated to be

$1.3 billion. The total cost of' future compliance with NO,, SO2, mercury and particulate matter require-ments, however, cannot reasonably be determined at this time because of the uncertainties surrounding emerging EPA regulations, resultant compliance strategies, potential for the development of new emission control technologies, court litigation, and future amendments to the Clean Air Act. However, total costs through 2020 could exceed $3 billion, exclusive of the costs of the planned SCRs and scrubbers. These future controls will also apply to any eniforcement liability.

Thc EPA has instituted judiciaL and administrative actions against a number of utilities in the eastern U.S., including TVA, alleging ihat they have modified their coal-fired units without complying with new source review ("NSR") requirements. TVA contends EPA's enforcement action is based on a new interpretation of an old rule and that TVA has routinely maintained its power plants to ensure efficient, reliable power generation while complying with all requirements. EPA issued TVA an administrative order directing TVA to put new source controls on 14 of its coal-fired units and to evaluate whether more controls should be installed on other units. TVA has challenged the validity of this order, and the Eleventh Circuit Court of Appeals has staycd the order pending its review. The outcome of this litigation and the EPA proceedings is uncertain.

66

It is not possible to predict with certainty what impact implementation of EPA's order will have on TVA if TVA's challenge is unsuccessful. If EPA substantially prevails, TVA could be required to incur capital costs in excess of $3 billion by 2010 to 2012. Any additional controls that TVA could be required to install on units as a result of this matter would, however, also be sufficient to comply with reduction requirements that are planned or anticipated under the other air quality programs for that same time period, which are discussed above. Thus, because of the other environmental program requirements, TVA would, in any event, probably incur a substantial portion of the costs that might result from the EPA enforcement action, although the schedule for the installation of the controls could be somewhat accelerated by the EPA action. TVA fully supports the need to further reduce emissions from coal-fired plants and seeks a resolution that will not put TVA customers and the region at a disadvantage.

The Bush administration has reviewed the energy implications of the EPA's ne, NSR interpretation and concluded that there is evidence that NSR impedes utilities from increasing the efficiency and performance of existing fossil-fuel generation. TVA has determined that if the EPA's new interpretation becomes law, TVA could lose about 11 percent of the energy capabilities of its coal-fired system within three years through permit limits on use of its units. On November 22, 2002, EPA announced changes to its NSR program intended to address aspects of the program that have deterred companies from implementing projects that would enhance energy efficiency and decrease air pollution. These changes are not anticipated to affect TVA's commitments to emissions control projects discussed above or the NSR litigation.

The National Parks Conservation Association ("NPCA") and the Sierra Club filed cases in federal district courts raising the same NSR allegations at TVA's Bull Run Fossil Plant and Colbert Fossil Plant Unit 5 as were raised in the EPA proceedings. Both cases have been stayed pending a decision from the Eleventh Circuit.

Environmental groups are taking legal action against TVA, as well as against other utilities across the country, for allegedly violating opacity limits applicable to coal-fired plants.

• The Alabama Environmental Council and the Sierra Club filed a lawsuit in federal district court in Florence, Alabama, alleging that TVA violated Clean Air Act opacity limits applicable to Colbert Fossil Plant between July 1, 1997 and June 30, 2002. The groups seek a court order requiring TVA to bring Colbert Fossil Plant into continuous compliance with the opacity limits, which would require TVA to incur substantial costs in addition to the costs TVA is already planning to incur for environmental controls, and to pay civil penalties of up to approximately $250 million. TVA filed its answer to the lawsuit in November 2002.

• The Sierra Club gave notice in a September 26, 2002, letter that it intends to sue TVA for violating Clean Air Act opacity limits applicable to the John Sevier and Kingston Fossil Plants. The notice claims that TVA violated opacity standards at the two plants from July 1, 1997, to the present. The alleged opacity violations substantially overlap those that were challenged in a lawsuit filed by the National Parks Conservation Association two years ago in federal court in Knoxville, Tennessee. TVA ultimately prevailed in that lawsuit.

Hazardous Substances. The release and cleanup of hazardous substances are regulated under the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA"). In a manner similar to many other industries and power systems, TVA has generated or used hazardous substances over the years. TVA is aware of hazardous-substance releases at eight off-site areas for which it may have some liability. Under CERCLA, the release and cleanup of hazardous substances are regulated. Liability under CERCLA is generally viewed as joint and several; however, TVA's share of cleanup costs under CERCLA is not expected to have a significant impact on TVA's financial position or results of operations.

Pending Litigation. EPA has issued TVA an administrative order directing TVA to put new source controls on 14 of its units and to evaluate whether more controls should be installed on other units. TVA has challenged the validity of this order. It is not possible to predict with certainty what impact implementation of EPA's order would have on TVA if TVA's challenge is unsuccessful. If EPA substantially prevails, TVA 67

could be required to incur significant capital costs in order to implement EPA's order (see Clean Air Developments for a discussion of this litigation and other Clean Air Act legal proceedings).

On December 28, 2001, Bowater Incorporated and Bowater Newsprint South, Inc. (together, "Bowater") filed a lawsuit against TVA in federal court in Knoxville challenging TVA's charges for Economy Surplus Power ("ESP") and Testing and Restart Power ("TRP") for two Bowater plants. In its complaint, Bowater alleges that in violation of the contract provision which states that TVA will charge ESP and TRP customers based on TVA's actual hourly incremental cost of providing ESP (1) TVA included certain alleged nonincremental costs in the prices for ESP and TRP and (2) when calculating such prices TVA used the cost of providing the most expensive 100 megawatts of ESP sold during a given hour instead of the average cost in that hour of serving the entire ESP load. The complaint also alleges that TVA has been unjustly enriched as a result of these overcharges. The lawsuit seeks, among other things, compensatory damages in excess of

$25 million and interest of more than $10 million. TVA believes that it will prevail in this lawsuit based on the information presently available.

TVA is a party to various other civil lawsuits and claims that have arisen in the ordinary course of its business. Although the outcome of these other civil lawsuits and claims cannot be predicted with any certainty, TVA believes that their ultimate outcome should not have a material adverse effect on TVA's financial position or results of operations.

Decommissioning Costs.

Provision for decommissioning costs of nuclear generating units is based on the estimated cost to dismantle and decontaminate the facilities to meet NRC criteria for license termination.

Effective for 1998, TVA changed its method of accounting for nuclear decommissioning costs and related liabilities in order to comply with certain tentative conclusions as reached by the ASB in its project for closure and removal of long-lived assets, as well as certain rate-setting actions.

TVA recognizes as incurred all obligations related to closure and removal of its nuclear units. The liability for closure is measured as the present value of the estimated cash flows required to satisfy the related obligation and discounted at a determined risk-free rate of interest. The charge to recognize the obligation is effected by adjusting the corresponding regulatory asset. Earnings from decommissioning fund investments, amortization expense of the decommissioning regulatory asset and interest expense on the decommissioning liability are deferred in accordance with SFAS No. 71, Accounting for the Effects of Certain Types of Regulation. At September 30, 2002, the present value of the estimated future decommissioning cost of

$891 million was included in other liabilities, and the unamortized regulatory asset of $556 million was included in deferred charges. The decommissioning cost estimates are based on prompt dismantlement and removal of the plant from service. The actual decommissioning costs may vary from the estimates because of changes in the assumed dates of decommissioning, changes in regulatory requirements, changes in technology and changes in the cost of labor, materials and equipment.

TVA maintains a decommissioning trust fund to provide funding for the decommissioning of nuclear power plants. As of September 30, 2002, the decommissioning trust fund assets totaled approximately

$500 million and were invested in securities selected to achieve a return in line with overall equity market performance. TVA may find it necessary to provide additional decommissioning funding over the next several years if performance of the investment portfolio does not improve over recent years' performance. The need for additional funding could be eliminated if operating license extensions for Browns Ferrv Units 1, 2 and 3 are granted by the NRC. TVA plans to submit its application for Browns Ferry license extensions at the end of 2003. NRC has typically taken two years to review such applications, and several nuclear utilities have already received operating license extensions.

Cost-based Regulation. Regulatory assets for TVA total approximately $1,452 million at September 30, 2002, along with approximately $4.1 billion of deferred nuclear plant costs. Management cannot predict the potential impact, if any, of the change in the regulatory environment on TVA's future financial position and results of operations. (See note I -

Regulatory Assets.)

68

10. Stewardship Responsibilities During 2002, TVA continued to conduct certain nonpower programs, including managing navigable river channels, providing flood control and overseeing certain recreation facilities. TVA's responsibilities include general stewardship of land, water and wildlife resources.

Historically, nonpower programs were primarily funded vith federal appropriations. Certain nonpower program activities have also been funded with user fees and outside services revenues. In October 1997, Congress passed legislation that directed TVA to fund essential stewardship activities related to its management of the Tennessee River system and TVA properties with power funds in the event that there were insufficient appropriations or other available funds to pay for such activities in any year.

Beginning in 2000, Congress stopped providing appropriations to TVA to fund essential stewardship activities. Consequently, during 2000, 2001 and 2002, TVA paid $71 million, $72 million and $83 million, respectively, for essential stewardship activities primarily with power revenues. In addition, administrative jurisdiction over Land Between The Lakes was transferred to the Secretary of Agriculture effective October 1, 1999. As part of the transfer, TVA also assumed responsibility for certain transition expenses associated with the transfer. To date, TVA has paid $7.3 million of transition expenses with an estimated remaining liability of $2 million at September 30, 2002. TVA retains responsibility for management of the remaining nonpower assets and settlement of nonpower obligations.

As of September 30, 2000, TVA had transferred $56 million of property and equipment to the U.S.

Forest Service. After this transfer, the completed plant of the nonpower programs consists of multipurpose dams and other plant. At September 30, 2002, the net completed plant balances for multipurpose dams and other plant were $665 million and $40 million, respectively. At September 30, 2001, the net completed plant balances for multipurpose dams and other plant were $673 million and $43 million, respectively.

11. Unaudited Quarterly Financial Information A summary of the quarterly results of operations for the years 2002 and 2001 follows. The information has been prepared by TVA's management and is unaudited. It should be read in conjunction with the audited financial statements appearing herein. Results for interim periods may fluctuate as a result of weather conditions, changes in rates and other factors.

2002 First Second Third Fourth Total (in millions)

Operating revenues.............

$1,521

$1,653

$1,678

$ 1,983

$6,835 Income from operations..........

360 413 412 464 1,649 Income before loss on impairment of assets/plant cancellation 3

61 59 104 227 Net income (loss).............

3 (89) 51 108 73 2001 Operating revenues............

$1,715

$1,758

$1,627

$ 1,899

$ 6,999 Income from operations.........

469 303 371 350 1,493 Income before loss on impairment of assets/plant cancellation.

47 122 (25)

(36) 108 Net income (loss)............

47 122 (25)

(3,455)

(3,311)

12. Subsequent Events Effective during the first quarter of 2003, the TVA Board of Directors approved a change in the methodology for estimating unbilled revenue from electricity sales. The change was from a method using cumulative generation to a method using generation for the current billing period only as a basis for calculating 69

the unbilled energy. The impact of this change resulted in an increase in accounts receivable of $411 million.

A corresponding gain from the cumulative effect of the change is being deferred pending disposition.

TVA has received notice from one distributor which terminates its power contract with TVA in October 2007. A second distributor has also given a notice which seeks to so terminate its power contract conditioned upon the availability of transmission service from TVA. During 2001, sales to these two distributors generated approximately one percent of TVA's total revenues. Once a power contract is terminated, the terminating distributor would have neither the obligation nor the right to take power or obtain transmission from TVA, absent the negotiation of new arrangements.

70

REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors of the Tennessee Valley Authority In our opinion, the accompanying balance sheets (power program and all programs) and the related statements of income (power program), changes in proprietary capital (power program and nonpower programs), comprehensive income (power program), net expense and comprehensive income (nonpower programs), and cash flows (power program and all programs) present fairly, in all material respects, the financial position of the power program and all programs of the Tennessee Valley Authority at September 30, 2002 and 2001, and the results of its operations of the power program and nonpower programs and its cash flows of the power program and all programs for each of the three years in the period ended September 30, 2002, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Tennessee Valley Authority's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America and Governnent Auiditing Standards issued by the Comptroller General of the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In accordance with Government Auditing Standards, we have also issued our report dated December 19, 2002, on our consideration of the Tennessee Valley Authority's internal control over financial reporting and on our tests of its compliance with certain provisions of laws and regulations for the year ended September 30, 2002. That report is an integral part of an audit performed in accordance with Govern nient Auditing Standards and should be read in conjunction with this report in considering the results of our audit.

t 5

tzc6-<t cske80fs LLP PricewaterhouseCoopers LLP Knoxville, Tennessee December 19, 2002 71

REPORT OF MANAGEMENT Management is responsible for the preparation, integrity, and objectivity of the financial statements of the Tennessee Valley Authority as well as all other information contained in the Information Statement. The financial statements have been prepared in conformity with generally accepted accounting principles applied on a consistent basis and, in some cases, reflect amounts based on the best estimates and judgments of management, giving due consideration to materiality. Financial information contained in the Information Statement is consistent with that in the financial statements.

The Tennessee Valle) Authority maintains an adequate system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that financial statements are prepared in accordance with generally accepted accounting principles, and that the assets of the corporation are properly safeguarded. The system of internal controls is docunented, evaluated, and tested on a continuing bases. No internal control system can provide absolute assurance that errors and irregularities will not occur due to the inherent limitations of the effectiveness of internal controls; however, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived. No material internal control weaknesses have been reported to management.

PricewaterhouseCoopers LLP was engaged to audit the financial statements of the Tennessee Valley Authority and issue reports thereon. Its audits were conducted in accordance with auditing standards generally accepted in the United States of America and Gove-nment Auditing Standards issued by the Comptroller General of the United States. Such standards require a review of internal controls and an examination of selected transactions and other procedures suflicient to provide reasonable assurance that the linancial statements neither are misleading nor contain material errors. The Report of Independent Accountants does not limit the responsibility of management for information contained in the financial statements and elsewhere in the Information Statement.

David N. Smith Chief Financial Officer and Executive Vice President of Financial Services 72

REPORT OF INSPECTOR GENERAL To The Board of Directors of the Tennessee Valley Authority The Tennessee Valley Authority contracted with the independent certified public accounting firm of PricewaterhouseCoopers LLP ("PricewaterhouseCoopers") to audit the balance sheets (power program and all programs) as of September 30, 2002 and 2001 and the related statements of income (power program),

changes in proprietary capital (power program and nonpower programs), comprehensive income (power program), net expense and comprehensive income (nonpower programs), and cash flows (power program and all programs) for each of the three years in the period ended September 30, 2002. The contract required the audit be done in accordance with generally accepted government auditing standards.

Under the Inspector General Act, the Office of the Inspector General ("OIG") is responsible for taking appropriate steps to assure that any work performed by nonfederal

auditors, including PricewaterhouseCoopers, complies with generally accepted government auditing standards. The Chief Financial Officers Act also places responsibilities on the OIG regarding TVA's annual financial statement audit. In keeping with our statutory responsibilities, we reviewed PricewaterhouseCoopers' reports and related audit documentation, interviewed their representatives, and performed such other procedures as we deemed appropriate in the circumstances to provide reasonable assurance that the audit was performed in accordance with generally accepted government auditing standards.

The objective of our review was not intended to enable us to express, and ve do not express, an opinion on the Tennessee Valley Authority's financial statements or on management's conclusions about the effective-ness of its system of internal control. PricewaterhouseCoopers is responsible for the auditor's reports dated December 19, 2002, and the conclusions expressed in the reports. However, our review disclosed no instances where PricewaterhouseCoopers did not comply, in all material respects, with generally accepted government auditing standards. Our review was performed in accordance with generally accepted government auditing standards.

Ben R. Wagner Assistant Inspector General (Audits)

December 30, 2002 73

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOINTING AND FINANCIAL DISCLOSURE During 2002, there were no changes in or disagreements with TVA's independent auditors on accounting matters of financial disclosure.

PART III DIRECTORS AND EXECUTIVE OFFICERS TVA is administered by a board of directors composed of three persons appointed by the President and confirmed by the Senate. TVA's management structure includes a Management Committee which works with the Board to determine TVA's strategic mission and future direction, as well as an Executive Committee which provides management oversight and ensures that policies of the Board are carried out. The Board and selected officers, their ages, their years of employment with TVA and principal occupations for recent years are as follows:

'ear Term Age Year Appointed Expires Directors Glenn L. McCullough, Jr.....

48 1999 2005 Chairman Skila Harris................................

52 1999 2008 Director William W. Baxter.

49 2001 2011 Director Mr. McCullough was appointed to the Board in November 1999, and previously served as the mayor of Tupelo, Mississippi, beginning in 1997. Prior to his election as mayor of Tupelo, he was the director of the Mississippi office of the Appalachian Regional Commission. Chairman McCullough also worked in the family business, McCullough Steel Products, for 12 years.

Ms. Harris was appointed to the Board in November 1999. Prior to her current position, she served at DOE as Executive Director of the Secretary of Energy Advisory Board. From 1993 until 1997, she was a Special Assistant to Vice President Gore and Mrs. Gore's Chief of Staff. She came to the White House from Steiner-Liff Iron and Metal Company in Nashville, Tennessee, where she was Vice President for Develop-ment and Compliance. Ms. Harris served as a project manager at the U.S. Synthetic Fuels Corporation, and she was with DOE during the Carter Administration. She has also held positions with management and engineering consulting firms specializing in energy-related work.

Mr. Baxter was appointed to the Board in November 2001. Prior to joining the Board, Mr. Baxter was Chairman and Chief Executive Officer of Holston Gases Inc. of Knoxville, Tennessee. Before joining Holston Gases Inc. in 1981, Mr. Baxter was an attorney with Garrett, Coffee, McGee & Baxter in Knoxville. From December 1997 through December 2000, Mr. Baxter was Commissioner of the Department of Economic and Community Development for the State of Tennessee.

Year Commenced Age Employment Executive Officers Oswald J. Zeringue*.....................................................

57 1989 President and Chief Operating Officer John A. Scalice........................................

55 1989 Chief Nuclear Officer & Executive Vice President, TVA Nuclear 74

David N. Srnith*........................................................

Chief Financial Officer & Executive Vice President, Financial Services Maureen H. Dunn*......................................................

Executive Vice President and General Counsel John E. Long, Jr.*.......................................................

Executive Vice President, Human Resources Mark 0. Medford*

Executive Vice President, Customer Service and Marketing Ellen Robinson*.........................................................

Executive Vice President, Communications and Government Relations D. LeAnne Stribley*....................................................

Executive Vice President, Administration John Bradley*...........................................................

Senior Vice President, Economic Development Theresa A. Flaim*.......................................................

Senior Vice President, Strategic Planning and Analysis Year Commenced Age Employment 58 1995 53 1978 50 1980 56 1989 48 2001 48 1995 42 2002 53 2002

• Member of Management Committee Mr. Zeringue was named President and Chief Operating Officer in April 1998. Prior to his current position, he served as Chief Nuclear Officer & Executive Vice President (1997-1998), as Senior Vice President, Nuclear Operations (1993-1997), as Browns Ferry Site Vice President (1989-1993) and as Plant Manager of Palo Verde Nuclear Station, Arizona Public Service Company (1987-1989).

Mr. Scalice was named Chief Nuclear Officer & Executive Vice President, TVA Nuclear in June 1998.

Prior to his current position, he served as Acting Chief Nuclear Officer (beginning April 1998), as Senior Vice President of Nuclear Operations (1997-1998), as Watts Bar Site Vice President (1993-1997), as Plant Manager of Browns Ferry Nuclear Plant (1991-1993), as Plant Manager of Watts Bar Nuclear Plant (1989-1991) and as Plant Manager of Shoreham Nuclear Power Station, Long Island Lighting Company (1989).

Mr. Smith was named Chief Financial Officer in January 1995 and additionally was named Executive Vice President, Financial Services, in October 1996. Prior to his current position, he served as Executive Director of Odyssey Financial (1993-1994), as Vice President of Finance of LTV Corporation (1991-1993) and as Assistant Treasurer and Director of Corporate Finance of LTV Corporation (1986-1991).

Ms. Dunn joined TVA as an attorney in May 1978, assumed the position of Assistant General Counsel in September 1986, and assumed the position of Executive Vice President and General Counsel in January 2001.

Mr. Long was named Executive Vice President of Human Resources in October 2000. Prior to his current position, he served as a management appointee to the TVA Retirement System Board since 1992.

Mr. Long joined TVA in 1980 as a Personnel Officer in the Engineering Division.

Mr. Medford was named Executive Vice President of Customer Service and Marketing in December 1996. He joined TVA as Vice President and Nuclear Technical Director in 1989. Mr. Medford directs staffs that manage customer accounts, product development and pricing, marketing and economic development. He has more than 26 years of public and private utility experience and he is responsible for relations between TVA and its customers. Before joining TVA, Mr. Medford was manager of nuclear regulatory affairs at Southern California Edison.

Ms. Robinson was named Executive Vice President of Communications and Government Relations in June 2001. She served as senior vice president of communications and government affairs at CNH Global NV in Racine, Wisconsin and before that as vice president of communications and government affairs at Case 75

Corporation. Ms. Robinson joined Case from Burson-Marsteller in New York, where she was a vice president and a head of the business-to-business marketing unit.

Ms. Striblev was named Executive Vice President of Administration in December 2000. She joined TVA as Vice President of Finance in 1995 and assumed additional responsibilities as Controller in 1997. Before joining TVA, Ms. Stribley vas vice president of finance and chief financial officer at Travel Resources Management Group, Inc. Additionally, Ms. Stribley was director of corporate finance at Ohio-based LTV Corporation from 1987 to 1994, and between 1981 to 1987 she worked as assistant treasurer for the Western Company of North America, an offshore-drilling and oil-services corporation.

Mr. Bradley was named Senior Vice President of Economic Development in August 2002. He is responsible for recruitment and retention of capital investment and job creation, business development, technical services and community development. Mr. Bradley served as senior vice president for economic development for the Memphis Regional Chamber of Commerce from 1996 to 2002, and he worked in Memphis Light, Gas & Water's economic development department from 1980 to 1996.

Ms. Flaim was named as Senior Vice President of Strategic Planning and Analysis in June 2002. She is responsible for developing strategies related to the ongoing competitive restructuring of the electric-utility industry. She served for nine years as vice president of strategic planning for Niagara Mohawnk. Ms. Flaim worked at the Solar Energy Research Institute and the Los Alamos National Laboratory.

CONTROLS AND PROCEDURES TVA's management, including the Chief Financial Officer, and the members of the Board of Directors have conducted an evaluation of the effectiveness of TVA's disclosure controls and procedures during November and December 2002. Based on that evaluation, members of the Board of Directors and the Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information necessary and appropriate for this Statement has been made known to them in a timely fashion. There have been no significant changes in internal controls, or in factors that could significantly affect internal controls, subsequent to the date the members of the Board of Directors and Chief Financial Officer completed their evaluation.

In 2002, TVA, along with its external auditors, identified no deficiencies in the design and operation of its internal control procedures that vere reportable control weaknesses.

PART IV STATISTICAL & FINANCIAL SUMMARIES 76

STATISTICAL & FINANCIAL SIJMMARIES For the years ended September 30 2002 2001

20) 1999 1998 Sales (millions of kWb) (a)

Municipalities and cooperatives Industries directly served.........................................

Federal agencies and other.......................................

Total sales......................................................

Operating revenues (millions of dollars) (a)

Electric Municipalities and cooperatives Industries directly served...............................................

Federal agencies and other.............................................

Other...............................................................

Total revenues Electric revenue per kWh (cents) (b)...................................

Winter net dependable generating capacity (megawatts)

Hydro (c).

Fossil (e)..........................................................

Nuclear units in service................................................

Combustion turbine...................................................

Total capacity...............................................

System peak load (megawatts) -

summer................................

System peak load (megawatts) -

winter................................

Percent gross generation by fuel source Fossil..........

Hydro.

Nuclear.................................

Combustion turbine.................................................

Fuel cost per kWh (cents)

Fossil...............................................................

Com1bustion turbine...................................................

Nucleiar (f).......................................................

Aggregate fuel cost per kWh net thermal generation........................

Fuel data Net therinal generation (millions of kWh)................................

Billion Btu...........................................................

Fuel expcnsc (millions of dollars).......................................

Cost per million Btu (cents)............................................

Net heit rate.........................................................

128,600 26,478 5,013 160,091

$ 5,856 732 159 88

$ 6,835 4.21 5,660 15,463 5,751 4,643 31,517 29,052 26,290 129,760 23,306 8,355 161,421

$ 5,908 659 330 102

$ 6,999 4.27 5,677 15,050 5,7t5 3,923 30,365 27,368 27,163 1 25,991 22,204 11,376 1 59,571

$ 5,676 626 361 99

$ 6,762 4.18 5,492 15,049 5,729 2,232 28 502 29,344 25,940 122,880 22,885 111,190 1 55,955

$ 5.510 642 357 86

$ 6,595 4.17 5,492 15,049 5,729 2,232 28,502 28,295 26,388 123,330 18,514 21,293 163,137 5,554 523 556 96

$ 6,729 4.07 5,491 15,003 5,620 2,384 28,498 27,253 23,204 1997 1996 1995 1994 1993 114,771 17,359 27,198 159,328

$ 4,811 464 561 98 5,934 3.66 5,384 15,014 5,625 2,394 28,417 26,661 26,670 117,035 16,599 1 9,964 153,598

$ 4,980 452 430 89

$ 5,95 1 3.82 5,298 15,012 5,545 2,268 28 123 25,376 25,995 110,245 16,684 I 2,356 139,285 4,654 460 277 82 5,473 3.87 5,225 15,032 3,342 2,232 25,831 25,496 24,676 108,073 15,792 13,599 137,464

$ 4,582 452 441 71 5,546 3.87 5,242 15,032 3,342 2,264 25,880 23,398 24,723 105,566 16,196 10,952 132,714

$ 4,479 472 414 71 5,436 3.92 4,885(d) 1 5,088 3,365 2,284 25,622 23,878 21,666 1992 98,505 16,576 8,97(0 1 24,051

$ 4,266 472 342 71 5,151 3.97 4,885(d) 15,088 3,361 2,284 25,618 21,980 21,974 63%

64%

63%

63%

62%

61%

65%

71%

72%

77%

69%

6%

6%

6%

7%

10%

11%

11%

12%

14%

13%

14%

30%

29%

31%

30%

28%

28%

24%

17%

14%

10%

17%

1%

1%

NM NM NM NM NM NM NM NM NM 1.39 1.32 1.27 1.28 1.25 1.23 1.23 1.26 1.34 1.27 1.33 4.65 6.07 6.22 3.94 4.01 5.22 4.54 3.61 5.45 5.09 8.26 0.41 0.44 0.49 0.51 0.71 0.58 0.56 0.61 1.10 1.09 1.10 1.11 1.08 1.05 1.05 1.10 1.04 1.06 1.14 1.31 1.25 1.29 141,272 I,458,367 1,564 107.25 10,323 146,806 I,505,504 1,588 105.47 10,255 143,224 1,470,452 1,504 102.29 10,267 137,169 1,403,110 1,434 102.21 10,229 139,727 1,426,151 1,538 107.81 10,207 135,736 1,381,837 1,406 101.73 10,180 131,898 1,338,1 57 1,395 104.22 10,145 118,097 1,197,295 1,348 112.61 10,138 110,643 1,120,868 1,450 129.40 10,131 109,968 1,105,395 1,375 124.42 10,052 105,577 1,069,725 1,360 127.16 10,132 (a) Sales and revenues have been adjusted to include sales to other utilities.

(b) Excludes settlement payment from Department of Energy of $160 million for the years 1992-1994.

(c) Includes 405 megawatts of capacity from the Corps of Engineers projects on the Cumberland River System.

(d) Reflects expiration of TAPOCO exchange agreement in 1990 -renewed in 1994.

(e) Includes 440 megawatts of capacity from power purchase agreement under which TVA has contracted with Choctaw Generation, L.P., for power from a lignite-fired generation plant in Chester, Mississippi.

(f) TVA changed its method of expensing the interest component of nuclear fuel expense in 1995.

Independent Accountants The financial statements of TVA at September 30, 2002 and 2001, and for each of the three fiscal years in the period ended September 30, 2002, appended hereto as part of this Statement, have been audited by PricewaterhouseCoopers LLP, independent accountants, as stated in their report, dated December 19, 2002, uhich report is also appended hereto.

Any statements in this Statement involving matters of opinion, regardless of whether expressly so identified, are opinions only and not factual representations. This Statement is not a contract with the purchaser of any Pow-er Bonds, Discount Notes or Other Indebtedness.

This Statement has been approved by duly authorized officers of the Tennessee Valley Authority.

Tennessee 'alley Authority By: sl DAVID N. SMITH David N. Smith Chief'Financial Officer &

Executive Vice President, Finanacial rSevices Is!

RANDY TRUSLEY Randy Trusley Vice President and Controller 78

CERTIFICATIONS Glenn L. McCullough, Jr., Skila Harris and Bill Baxter, individually certify that:

1. I have reviewed this Information Statement of the Tennessee Valley Authority:

2. Based on my knowledge, the information in this Information Statement does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Information Statement;

3. Based on my knowledge, the financial statements, and other financial information included in this Information Statement, fairly present in all material respects the financial condition, results of operations and cash flows of the Tennessee Valley Authority as of, and for, the periods presented in this Information Statement;

4. I and the other certifiers are responsible for establishing and maintaining disclosure controls and procedures for the Tennessee Valley Authority and have:

a) designed such disclosure controls and procedures to ensure that the financial statements and other financial information relating to the Tennessee Valley Authority are made known to us by others particularly during the period in which this Information Statement is being prepared; b) evaluated the effectiveness of the Tennessee Valley Authority's disclosure controls and proce-dures as of a date within 90 days prior to the date of this Information Statement (the "Evaluation Date"): and c) presented in this Information Statement our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. I and the other certifiers have disclosed, based on our most recent evaluation, to the Tennessee Valley Authority's auditors and the Inspector General of the Tennessee Valley Authority:

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Tennessee Valley Authority's ability to record, process, summarize and report financial data and have identified for the Tennessee Valley Authority's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Tennessee Valley Authority's internal controls; and

6. I and the other certifiers have indicated in this Information Statement whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: January 13, 2003 Glenn L. McCullough, Jr.

Skila Harris Bill Baxter Chairman Director Director 79

I, David N. Smith, certify that:

1. I have reviewed this Information Statement of the Tennessee Valley Authority;

2. Based on my knowledge, the information in this Information Statement does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Information Statement;

3. Based on my knowledge, the financial statements, and other financial information included in this Information Statement, fairly present in all material respects the financial condition, results of operations and cash flows of the Tennessee Valley Authority as of, and for, the periods presented in this Information Statement;

4. I and the other certifiers are responsible for establishing and maintaining disclosure controls and procedures for the Tennessee Valley Authority and have:

a) designed such disclosure controls and procedures to ensure that the financial statements and other financial information relating to the Tennessee Valley Authority are made known to us by others particularly during the period in which this Information Statement is being prepared; b) evaluated the effectiveness of the Tennessee Valley Authority's disclosure controls and proce-dures as of a date within 90 days prior to the date of this Information Statement (the "Evaluation Date"); and c) presented in this Information Statement our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. I and the other certifiers have disclosed, based on our most recent evaluation, to the Tennessee Valley Authority's auditors and the Inspector General of the Tennessee Valley Authority:

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Tennessee Valley Authority's ability to record, process, summarize and report financial data and have identified for the Tennessee Valley Authority's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees vho have a significant role in the Tennessee Valley Authority's internal controls; and

6. 1 and the other certifiers have indicated in this Information Statement whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: January 13, 2003 David N. Smith Chief Financial Officer and Executive Vice President of Financial Services 80

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