United Utilities Group PLC – Annual report – 31 March 2018
Accounting policies (extract)
Critical accounting judgements and key sources of estimation uncertainty
In the process of applying its accounting policies set out in note A7, the group is required to make certain estimates, judgements and assumptions that it believes are reasonable based on the information available. These judgements, estimates and assumptions affect the amounts of assets and liabilities at the date of the financial statements and the amounts of revenues and expenses recognised during the reporting periods presented. Changes to these estimates, judgements and assumptions could have a material effect on the financial statements.
On an ongoing basis, the group evaluates its estimates using historical experience, consultation with experts and other methods considered reasonable in the particular circumstances. Actual results may differ significantly from the estimates, the effect of which is recognised in the period in which the facts that give rise to the revision become known.
The following paragraphs detail the estimates and judgements the group believes to have the most significant impact on the annual results under IFRS.
Revenue recognition and allowance for doubtful receivables
Accounting judgement – The group recognises revenue generally at the time of delivery and when collection of the resulting receivable is reasonably assured. When the group considers that the criteria for revenue recognition are not met for a transaction, revenue recognition is delayed until such time as collectability is reasonably assured. Management considers that where customers have not paid their bills within the last two years, or have not cleared previously outstanding arrears aged more than two years, collectability is not deemed to be reasonably assured, and therefore amounts billed to these customers are not recognised as revenue. This resulted in £20.3 million of amounts billed not being recognised as revenue during the year (net of cash receipts and credits). Had management made an alternative judgement that collectability was not reasonably assured where customers had not paid within one year or within three years, or had not cleared previously outstanding arrears within these time frames, this would have resulted in £0.9 million of revenue not being recognised during the year or £9.4 million additional revenue being recognised during the year respectively. Payments received in advance of revenue recognition are recorded as deferred income.
Accounting estimate – At each reporting date, the company and each of its subsidiaries evaluate the estimated recoverability of trade receivables and record allowances for doubtful receivables based on experience. Judgements associated with these allowances are based on, amongst other things, a consideration of actual collection history. The actual level of receivables collected may differ from the estimated levels of recovery, which could impact operating results positively or negatively. At 31 March 2018, the allowance for doubtful receivables of £63.4 million was supported by a six-year cash collection projection. Based on a five-year or seven-year cash collection projection the allowance for doubtful receivables would have been £64.3 million or £62.4 million respectively. Accounting estimate – United Utilities Water Limited raises bills in accordance with its entitlement to receive revenue in line with the limits established by the periodic regulatory price review processes. For water and wastewater customers with water meters, the receivable billed is dependent on the volume supplied including the sales value of an estimate of the units supplied between the date of the last meter reading and the billing date. Meters are read on a cyclical basis and the group recognises revenue for unbilled amounts based on estimated usage from the last billing through to each reporting date. The estimated usage is based on historical data, judgement and assumptions; actual results could differ from these estimates, which would result in operating revenues being adjusted in the period that the revision to the estimates is determined. Revenue recognised for unbilled amounts for these customers at 31 March 2018 was £40.2 million. Had actual consumption been five per cent higher or lower than the estimate of units supplied this would have resulted in revenue recognised for unbilled amounts being £3.8 million higher or lower respectively. For customers who do not have a meter, the receivable billed and revenue recognised is dependent on the rateable value of the property, as assessed by an independent rating officer.
Property, plant and equipment
Accounting judgement – The group recognises property, plant and equipment (PPE) on its water and wastewater infrastructure assets where such expenditure enhances or increases the capacity of the network, whereas any expenditure classed as maintenance is expensed in the period it is incurred. Determining enhancement from maintenance expenditure requires an accounting judgement, particularly when projects have both elements within them. Enhancement spend was 30 per cent of total spend in relation to infrastructure assets during the year. A change of +/- one per cent would have resulted in £2.3 million less/more expenditure being charged to the income statement during the period. In addition, management capitalises time and resources incurred by the group’s support functions on capital programmes, which requires accounting judgements to be made in relation to the appropriate capitalisation rates. Support costs allocated to PPE represent 58 per cent of total support costs. A change in allocation of +/- one per cent would have resulted in £0.9 million less/more expenditure being charged to the income statement during the period.
Accounting estimate – The estimated useful economic lives of PPE and intangible assets is based on management’s experience. When management identifies that actual useful economic lives differ materially from the estimates used to calculate depreciation, that charge is adjusted prospectively. Due to the significance of PPE and intangibles investment to the group, variations between actual and estimated useful economic lives could impact operating results both positively and negatively. As such, this is a key source of estimation uncertainty, although historically few changes to estimated useful economic lives have been required. The depreciation and amortisation expense for the year was £376.8 million. A 10 per cent increase in average asset lives would have resulted in a £33.6 million reduction in this figure and a 10 per cent decrease in average asset lives would have resulted in a £42.3 million increase in this figure.
Accounting estimate – The group operates two defined benefit schemes which are independent of the group’s finances. Actuarial valuations of the schemes are carried out as determined by the trustees at intervals of not more than three years. Profit before tax and net assets are affected by the actuarial assumptions used. The key assumptions include: discount rates, pay growth, mortality, and increases to pensions in payment and deferred pensions. It should be noted that actual rates may differ from the assumptions used due to changing market and economic conditions and longer or shorter lives of participants and, as such, this represents a key source of estimation uncertainty. Sensitivities in respect of the assumptions used during the year are disclosed in note A5.
Accounting estimate – The group has interests relating to its joint ventures in the form of equity investments and loans receivable, the recoverability of which are considered with reference to the present value of the estimated future cash flows of the joint ventures. Management tests whether any impairment exists in relation to the equity investments and loans receivable if adverse changes in conditions associated with the joint ventures suggest that this is appropriate. The estimated present value of these future cash flows is sensitive to the discount rate and terminal growth rate used in the calculation, together with the normalised level of working capital in the joint venture, all of which require management judgement. Testing of the carrying value has been performed during the year, which has involved a number of scenarios being modelled. Based on this testing, management believes there is sufficient headroom to support the carrying value of the group’s interests in joint ventures, although it is possible, on the basis of existing knowledge, that outcomes within the next financial year that are different from the assumptions used could require a material adjustment to the carrying amount of assets.
Derivative financial instruments
Accounting estimate – The model used to fair value the group’s derivative financial instruments requires management to estimate future cash flows based on applicable interest rate curves. Projected cash flows are then discounted back using discount factors which are derived from the applicable interest rate curves adjusted for management’s estimate of counterparty and own credit risk, where appropriate. Sensitivities relating to derivative financial instruments are included in note A4.
Provisions and contingencies
Accounting estimates – The group is subject to a number of claims incidental to the normal conduct of its business, relating to and including commercial, contractual, employment and environmental matters, which are handled and defended in the ordinary course of business. The group routinely assesses the likelihood of any adverse judgements or outcomes to these matters as well as ranges of probable and reasonably estimated losses. Reasonable estimates are made by management after considering information including notifications, settlements, estimates performed by independent parties and legal counsel, available facts, identification of other potentially responsible parties and their ability to contribute, and prior experience. A provision is recognised when it is probable that an obligation exists for which a reliable estimate can be made after careful analysis of the individual matter. The required provision may change in the future due to new developments and as additional information becomes available. The provisions in respect of these claims, based on management’s best estimates, totalled £19.5 million as at 31 March 2018 as set out in the ‘Other’ category in note 19; due to an inherent level of estimation uncertainty management estimate that there is an 80 per cent probability that the outcomes of these items will fall within a range of £10 million to £25 million. Matters that either are possible obligations or do not meet the recognition criteria for a provision are disclosed as contingent liabilities in note 23, unless the possibility of transferring economic benefits is remote.