United Utilities Group PLC – Annual report – 31 March 2021
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 under IFRS, including specific considerations in light of the COVID-19 pandemic.
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; however, has previously had bills de-recognised and has more than their current year debt outstanding.
This two-criteria approach resulted in a £27.1 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 £7.9 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 2021, an allowance for expected credit losses relating to household customer debt of £74.9 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 £1.3 million or reduced by £0.6 million respectively.
At the prior year balance sheet date, the expected future impact of the COVID-19 pandemic on the ability of some customers to pay their bills was specifically taken into consideration as part of the expected credit loss assessment for trade receivables. This gave rise to a further £16.7 million incremental increase in the allowance for expected credit losses based on judgements around the likely impact of the pandemic on the non-payment risk profile of the group’s customer base on a segmented basis.
A high level of uncertainty remains around how current economic conditions could impact the recoverability of household receivables, particularly in light of further lockdowns during the year. As government support schemes such as furlough unwind, this could result in increased unemployment and therefore further impact the ability of some customers to pay.
In recognition of this future uncertainty, the allowance for expected credit losses covering the group’s household customer base has been determined based on the assumption that cash collection experienced over the last two years continues into the future. This assumption supports the reported household bad debt charge of 2.2 per cent of household revenue and is considered to be a reasonable estimate of future collection. Had the group assumed that future collection was maintained at levels experienced during the last 12 months alone, the charge would have been increased by £2.6 million to 2.4 per cent of household revenue. If the group had assumed that future collection improved to an average of actual collection experienced over the last 3 years, then the bad debt charge would have reduced by £3.8 million to 1.8 per cent of household revenue.
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 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 2021 was £69.4 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 £4.8 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. Consumption patterns during the year have been significantly impacted by changes brought about by the COVID-19 pandemic, with household consumption having been above levels normally seen due to customers spending more time at home. As the year has progressed, the volume of household meter reads has gradually increased, resulting in the increased consumption during the pandemic period largely being captured in actual bills meaning that the level of estimation has reduced. By 31 March 2021, the system generated accrual had largely aligned to the independent automated meter read (AMR) data. AMR data is captured for around 25 per cent of all measured household customers, and this increase has been extrapolated across the remaining measured household customer base. The reasonableness of this approach has been validated through an assessment of bills raised in the period.
Accounting estimate – Due to temporary business closures required as a result of lockdown measures put in place by the UK Government, the level of non-household consumption has fallen significantly throughout the year ended 31 March 2021. Revenue in relation to wholesale charges billed to non-household retailers is recognised based on a series of settlement statements produced by the Central Market Operating System (CMOS), operated by Market Operator Services Ltd (MOSL). When generating bills in the absence of a current meter read, CMOS uses the 12 months prior to the last meter read to assess expected consumption. Depending on when a meter was last read, the calculated volumetric charge may not be wholly reflective of the consumption during the period estimated due to the impact that COVID-19 has had on different industries in the year. In recognition of this issue, MOSL advised non-household retailers in December 2020 that they should consider the trading status of their customers and amend their Yearly Volume Estimate to adjust the wholesale charges calculated by CMOS. The group has performed its own estimations of the adjustments required to these charges determined by CMOS, and has accrued for an additional £13.9 million of revenue in the year relating to non-household wholesale charges. This adjustment is based on an analysis of volume supplied for each particular end user at a supply point level, and comparing this with estimates in the CMOS system. Had this accrued income simply been based on the estimates calculated by CMOS, revenue would therefore have been £13.9 million lower, though based on the volumetric analysis performed management considers that this position would be overly prudent.
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 58 per cent of total spend in relation to infrastructure assets during the year. A change of +/- 1 per cent would have resulted in £4.0 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 37 per cent of total support costs. A change in allocation of +/- 5 per cent would have resulted in £2.1 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. The depreciation and amortisation expense for the year was £422.3 million. A 10 per cent increase in average asset lives would have resulted in a £39.2 million reduction in this figure and a 10 per cent decrease in average asset lives would have resulted in a £46.0 million increase in this figure.
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 £268.0 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 2021. 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 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.
Joint ventures – Water Plus
Accounting judgement – The group’s financial interests in Water Plus Group Limited, a joint venture with Severn Trent PLC, comprise an investment in the ordinary shares of Water Plus, and loans issued to the joint venture in the form of revolving credit facilities and a zero coupon shareholder loan note, further details of which are included in note A6.
Prior to 31 March 2021, it was proposed that existing working capital facilities extended to Water Plus by its shareholders would be restructured, resulting in each shareholder injecting a form of equity capital into the joint venture. United Utilities and Severn Trent would reconfigure an existing revolving credit facility, drawn-down to £32.5 million at the reporting date, into share capital, with the subscription price of this capital equalling the value of the cancelled revolving credit facility. On 23 April 2021, the revolving credit facility was formally cancelled and the group completed the purchase of share capital.
Judgement is required in determining whether, at the reporting date, this revolving credit facility forms part of the group’s long-term interest in Water Plus whose value would be reduced in accordance with the group’s share of joint venture losses in excess of the value of its equity investment when applying the equity method in accordance with IAS 28 ‘Investments in Associates and Joint Ventures’.
Notwithstanding the legal form, management view the revolving credit facility as forming part of the group’s long-term interest in Water Plus at the balance sheet date. Timing differences existed between shareholder agreement to provide additional share capital (pre year-end) and the execution of the transaction (post yearend). The group has therefore determined that, in substance, it had an additional long-term interest in the Water Plus group at the reporting date.
In the year-ended 31 March 2020, the group’s long-term interest in Water Plus was reduced to £nil. £5.3 million of unrecognised losses existed at the balance sheet date. These previously unrecognised losses, together with the group’s share of the Water Plus’s losses in the year ended 31 March 2021 of £8.9 million, have been allocated against the revolving credit facility at the balance sheet date. The £14.2 million total share of losses has been recognised in the group’s income statement for the year-ended 31 March 2021.
Had an alternative judgement been applied such that this revolving credit facility was not considered to be part of the group’s long-term interest in Water Plus, the group’s £5.3 million unrecognised share of Water Plus’s losses for the prior year and the group’s £8.9 million share of Water Plus’s losses for the current year would not have been recognised in the income statement resulting in a lower share of losses from joint ventures, and the carrying value of the amount owed by Water Plus in respect of the revolving credit facility would have been higher by this amount. See note A6 for further details.
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. In the prior year, depreciation was accelerated on a material value of bioresources facilities which were deemed to be commercially obsolete and for which no further use was planned, in part as a result of the group’s decarbonisation strategy. In the current financial year, depreciation was accelerated totalling £2.3 million at bioresource facilities impacted by changes in environmental legislative requirements.
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.
The group has looked to further enhance the accuracy of its useful life assessment through the introduction of more forward-looking information in asset life reviews. This includes the use of data from the Pioneer strategic asset planning system to assess the economic point of replacement for assets under future investment and performance scenarios. This information is to be used alongside other decommissioning data to inform useful economic 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.