IAS 1, paras 122, 125, 129, judgements and estimates separately identified with sensitivities including climate change, COVID – 19 and cost of living

United Utilities Group PLC – Annual report – 31 March 2022

Industry: utilities

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 carrying 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. As estimates carry with them an inherent level of uncertainty, the group performs sensitivity analysis where this is practicable and where, in management’s opinion, it provides useful and meaningful information. This sensitivity analysis is performed to understand a range of outcomes that could be considered reasonably possible based on experience and the facts and circumstances associated with individual areas of the financial statements that are subject to estimates. 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.

As part of the evaluation of critical accounting judgements and key sources of estimation uncertainty, the group has considered the implications of climate change on its operations and activities, further details of which are set out below.

The following paragraphs detail the estimates and judgements the group believes to have the most significant impact on the annual results as reported in accordance with IFRS, including specific considerations in light of current economic circumstances such as the cost of living experienced by customers.

Revenue recognition and allowance for doubtful receivables

Accounting estimate – The group recognises revenue generally at the time of delivery and when collection of the resulting receivable has been deemed probable. In estimating the amount of revenue to recognise, where 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 deemed probable. There are two different criteria whereby management does not recognise revenue for amounts which have been billed to those customers on the basis that collectability is not probable. These are as follows:

  • The customer has not paid their bills for a period of at least two years; and
  • The customer has paid their bills in the preceding two years, but has previously had bills de-recognised and has more than their current year debt outstanding.

This two-criteria approach resulted in a £26.6 million reduction in revenue compared with what would have been recognised had no adjustment been made for amounts where collectability is not probable. Had management made an alternative judgement that where customers have paid in the preceding two years, and have more than their current year debt outstanding, the recoverability of the entirety of their debt was deemed to be probable (i.e. the second criteria were disapplied), the required adjustment to revenue would have been £12.4 million lower.

Accounting estimate – At each reporting date, the company and each of its subsidiaries evaluate the estimated recoverability of trade receivables and record allowances for expected credit losses based on experience. Estimates associated with these allowances are based on, among 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 2022, an allowance for expected credit losses relating to household customer debt of £78.3 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 increased by £1.1 million or reduced by £0.5 million respectively.

Since early 2020, the group’s expected credit loss assessment in respect of trade receivables has been significantly impacted by the economic uncertainty brought about as a result of the COVID-19 pandemic. Whilst economic uncertainty linked to the COVID-19 pandemic has receded somewhat during the year ended 31 March 2022, with households and businesses adjusting to a new post-pandemic norm, a high level of economic uncertainty remains due largely to increases in the cost of living during the year and that are forecast to continue in the near future. This could have a significant impact on many of the group’s customers that could in turn affect the ability of some customers to pay their bills.

In recognition of this ongoing future uncertainty, the basis on which the allowance for expected credit losses covering the group’s household customer base is assessed has been updated during the year. Whereas in the prior year the allowance for expected credit losses was determined based on the assumption that cash collection experienced over the last two years continues into the future, this would no longer be expected to give a reasonable view of cash collection risk. This is because cash collection for the year has performed strongly and therefore may overstate future cash collection forecasts when considering the current economic climate, while cash collection for the year ended 31 March 2021 was impacted by the COVID-19 pandemic and resulted in much lower levels of cash collection than might be expected on an ongoing basis.

In light of this, a longer run four-year average of cash collection has been modelled and is deemed to give a more realistic forecast for future collection taking into account all of the above factors, including expected increases in the cost of living. This assumption supports the reported household bad debt charge of 1.8 per cent of household revenue. Had future cash collection been assessed based on the average cash collection during the current year only, the bad debt charge would have been 1.6 per cent of household revenue resulting in a reduction in the charge of £2.7 million, with similar results based on using average cash collection from the last two or last three years. If average cash collection from the prior year only was used the bad debt charge would have been 2.0 per cent of household revenue resulting in an increase in the charge of £3.4 million. Consideration of this range of reasonably possible scenarios indicates that, based on current levels of economic uncertainty, the allowance for expected credit losses is within a reasonable range, and that a longer run four year average results in a balanced position in light of current levels of uncertainty.

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 household 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 dates of the last water 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 2022 was £145.8 million. Had actual consumption been 5 per cent higher or lower than the estimate of units supplied, this would have resulted in revenue recognised for unbilled amounts being £5.0 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 (PP&E) 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 as incurred.

Determining enhancement from maintenance expenditure requires an accounting judgement, particularly when projects have both elements within them. Enhancement spend was 57 per cent of total spend in relation to infrastructure assets during the year. A change of +/- 1 per cent would have resulted in £3.9 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 PP&E represent 40 per cent of total support costs. A change in allocation of +/- 5 per cent would have resulted in £2.3 million less/more expenditure being charged to the income statement during the period.

Accounting estimate – The estimated useful economic lives of PP&E 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 PP&E 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. The depreciation and amortisation expense for the year was £418.2 million. A 10 per cent increase in average asset lives would have resulted in a £38.2 million reduction in this figure and a 10 per cent decrease in average asset lives would have resulted in a £41.6 million increase in this figure.

Retirement benefits

Accounting estimate – The group operates two defined benefit pension 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 – Included within the group’s defined benefit pension scheme assets are assets with a fair value estimated to be £271.7 million that are categorised as ‘level 3’ assets within the IFRS 13 ‘Fair value measurement’ hierarchy, meaning that the value of the assets is not observable at 31 March 2022. Estimates of the fair value of these assets have been performed by the investment managers’ valuation specialists using the latest available statements of each of the funds that make up the total level 3 asset balance, updated for any subsequent cash movements between the statement date and the year end reporting date.

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 that 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.

Climate change

The group is continually developing its assessment of the impact that climate change has on the assets and liabilities recognised and presented in its financial statements.

The natural environment within which the group operates is constantly changing, and this influences how its water and wastewater services are to be delivered in the future. In addition, the group has embedded ambitious climate-related targets within its own operations, with this affecting the portfolio of assets required to deliver such services.

The impact of climate change has been considered in the preparation of these financial statements across a number of areas, predominantly in respect of the valuation of the property, plant and equipment held by the group.

Asset life reviews are undertaken regularly for facilities impacted by climate change, environmental legislation or the group’s decarbonisation measures. This can result in the acceleration of depreciation of assets that are deemed to be commercially obsolete or for which no further use is planned, in part as a result of the group’s decarbonisation strategy. In recent years this has resulted in material accelerations in respect of bioresources facilities impacted by changes in environmental legislative requirements. No further material accelerations were required in the current financial year, however this is subject to continuous assessment.

The group is exposed to potential asset write-downs following flooding resulting from extreme weather events, the frequency of which are expected to increase as the effects of climate change become more apparent. Following large-scale flooding, items are identified that have been damaged beyond repair and require immediate accounting write-downs. No such charges were required in the current financial year.

In addition to the risks posed by an increased likelihood of large-scale flooding events in future years, climate change also presents challenges relating to prolonged periods of hot and dry weather, the frequency of which is expected to increase. This could potentially impact the viability of certain types of assets in future years such as those associated with the intake of water from the natural environment, or require a strategic reconfiguration of assets to respond to such challenges. It is expected that if any such impact were to materialise this would be over a longer period of time rather than within a single financial year, and no financial impact has been identified in the current year.

In recent years the group has sought to further enhance the accuracy of its useful life assessments through the introduction of more forward-looking information in asset life reviews. This includes the use of disposal data to identify trends that may inform the group’s view of useful lives into the future. This information is used alongside other decommissioning data and data from strategic asset planning systems to inform useful asset lives.

The group mitigates the exposure that the carrying value of its book asset base has to climate-related risks through strategic planning activities that incorporate defined climate scenarios, climate change mitigation pledges, and long-term climate projections. The group installs permanent flood defences and other resilience measures at the most vulnerable facilities to protect its assets.