The principal accounting policies adopted in the preparation of these financial statements are set out below. Further detail can be found in note A7.
Basis of preparation
The financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union (EU). They have been prepared on the historical cost basis, except for the revaluation of financial instruments, accounting for the transfer of assets from customers, and the revaluation of infrastructure assets to fair value on transition to IFRS.
The preparation of financial statements, in conformity with IFRS, requires management to make estimates and assumptions that affect the amounts of assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting periods presented. Although these estimates are based on management's best knowledge of the amount, event or actions, actual results, ultimately, may differ from these estimates.
The financial statements have been prepared on the going concern basis as the directors have a reasonable expectation that the group has adequate resources for a period of at least 12 months from the date of the approval of the financial statements, and that there are no material uncertainties to disclose.
In assessing the appropriateness of the going concern basis of accounting, the directors have reviewed the resources available to the group, taking account of the group's financial projections, together with its liquidity position with regards to available cash and undrawn committed borrowing facilities, as well as consideration of the group's capital adequacy. The board has also considered the magnitude of potential impacts resulting from uncertain future events or changes in conditions, the likelihood of their occurrence and the likely effectiveness of mitigating actions the directors would consider undertaking.
Adoption of new and revised standards
The following standards, interpretations and amendments, effective for the year ended 31 March 2019, are relevant to the group but have had no material impact on the group's financial statements:
- Amendments to IFRS 2 'Classification and Measurement of Share-based Payment Transactions' (issued on 20 June 2016).
The following standards, interpretations and amendments, effective for the year ended 31 March 2019, have had a material impact on the group's financial statements – this impact is discussed further below:
- IFRS 9 'Financial Instruments' (issued on 24 July 2014); and
- IFRS 15 'Revenue from Contracts with Customers' (issued on 28 May 2014) including amendments to IFRS 15: Effective date of IFRS 15 (issued on 11 September 2015).
IFRS 9 'Financial Instruments'
IFRS 9 'Financial Instruments' was adopted by the group on 1 April 2018. The standard replaces IAS 39 'Financial Instruments: Recognition and Measurement', and has been applied retrospectively in accordance with the standard's transition requirements. Comparative periods have not been restated, with any differences arising from retrospective application being recognised as an adjustment to retained earnings at the beginning of the period. This has resulted in retained earnings at the adoption date decreasing by £12.7 million with a corresponding credit of £13.8 million to the cost of hedging reserve, which is a separate component of equity newly recognised under IFRS 9, offset by a corresponding debit of £1.1 million to the cumulative exchange reserve. Further details of these adjustments are set out below.
Under IFRS 9, there is no longer a requirement for cross-currency basis spread adjustments to be incorporated in the test for the effectiveness of a hedge as was the case under IAS 39. IFRS 9 states that when an entity separates the foreign currency basis spread from a financial instrument, and excludes it from the designation of that financial instrument as the hedging instrument, the entity may apply the accounting such that the change in fair value resulting from the foreign currency basis spread can be recognised in other comprehensive income rather than in profit or loss to the extent that it relates to the hedged item. Under the standard this change in fair value relating to the basis spread adjustment, which effectively represents a liquidity charge inherent in foreign exchange contracts for exchanging currencies, shall be accumulated in a separate component of equity. This has been recorded as a cost of hedging reserve.
The group has adopted this accounting treatment under IFRS 9, resulting in the creation of a cost of hedging reserve with a brought forward balance of £13.8 million at 1 April 2018, being the accumulated fair value gains to date at this point relating to the basis spread adjustment on cross-currency swaps in place at the adoption date. The portion of the change in fair value due to changes in the cross-currency basis spread during the period, which has been recognised in other comprehensive income, has been a £2.2 million loss. This would have previously been incorporated within the fair value charge recognised in the income statement under IAS 39.
Where the group has chosen to measure borrowings at fair value through profit or loss, the portion of the change in fair value due to changes in the group's own credit risk, which has been a £6.6 million gain during the period, has been recognised in other comprehensive income rather than within profit or loss, and has been taken directly to retained earnings, meaning no opening retained earnings adjustment has been required.
During the period, fair value foreign exchange gains of £0.5 million have been recognised in the income statement, which would not have been recognised under previous accounting policies. This has resulted from the classification of an investment previously accounted for as an available-for-sale financial asset under IAS 39 'Financial Instruments: Recognition and Measurement' as a financial asset measured at fair value through profit or loss. Under IFRS 9, the available-for-sale category no longer exists and, given that the financial asset does not meet the criteria to be subsequently measured at amortised cost or fair value through other comprehensive income, subsequent measurement at fair value through profit or loss is deemed the most appropriate categorisation. As a result of this change in classification, a credit of £1.1 million in the cumulative exchange reserve, representing cumulative foreign exchange gains on the investment up to the adoption date, was reclassified to retained earnings as an opening balance sheet adjustment.
On adoption of IFRS 9, there were no financial assets or liabilities initially designated at fair value through profit or loss that have subsequently been reclassified out of this category.
The group has reassessed the effectiveness of existing accounting hedges on adoption of IFRS 9 and the documentation that supports any designation. Financial instruments that had been designated in an accounting fair value hedge relationship under IAS 39 continue to be designated as such under IFRS 9; however, the group has reassessed its position with regards to designating non-financial risks in hedge relationships, and has determined that in order to give a more representative view of operating costs it would be appropriate to designate existing and future swaps as being in a cash flow hedge relationship provided they meet the criteria for designation. This means that only the impact of any hedging ineffectiveness is recognised through fair value in the income statement, with movements reflecting the effective part of the swaps being recognised in other comprehensive income. At the maturity date the amounts paid/received will be recognised against operating costs in the income statement, including the effect of any fair value movements reflecting hedge effectiveness previously recognised in other comprehensive income.
Previously, no income relating to these swaps would have been recognised against corresponding operating expenses, with the £4.2 million gain for the year being recognised in full as a fair value movement included as part of finance expense. The treatment under IFRS 9 has led to the settlement of existing swaps in the period giving rise to income of £3.8 million recognised against operating expenses, with a fair value gain of £0.4 million recognised in other comprehensive income together with a corresponding increase in the cash flow hedge reserve as the hedge was fully effective.
A deferred tax charge of £0.8 million has been recognised in other comprehensive income during the period in relation to the above.
On transition to the expected credit loss model for impairing financial assets in accordance with the standard, the group has not been significantly impacted as under IAS 39 the group had always used a model which used historic cash collection rates to form an expectation of the estimated recoverability of trade receivables at a point in time. The simplified approach, whereby the company recognises full lifetime credit losses on initial recognition, has been adopted.
IFRS 15 'Revenue from Contracts with Customers'
The group adopted IFRS 15 on 1 April 2018, applying the standard retrospectively with the cumulative effect of initial application recognised at the date of initial application as an adjustment to retained earnings. Prior period comparatives have therefore not been restated. The group has elected to use the practical expedient whereby any contracts that were completed in accordance with accounting standards as at 31 March 2018 need not be restated on an IFRS 15 basis. This transition approach, which was made in accordance with the IFRS 15 transitional provisions, has resulted in a £2.6 million increase in retained earnings and reduction in deferred income on the adoption date due to a change in the period over which revenue relating to connection activities is recognised. This has also given rise to a tax credit of £3.3 million relating to the adjustment, which has resulted in an increase in retained earnings at the adoption date. The tax credit is greater than the £2.6 million increase in retained earnings on adoption of IFRS 15 due to the different tax treatments of various connection activities that make up the adjustment.
The two main areas of the group's activities considered in the adoption of IFRS 15 are:
- the provision of core water and wastewater services, accounting for more than 96 per cent of the group's revenue; and
- capital income streams relating to diversions work, and activities, typically performed opposite property developers, that facilitate the creation of an authorised connection through which properties can obtain water and wastewater services.
The adoption of IFRS 15 had no impact on the timing or amount of revenue recognised in relation to core water and wastewater services, which are deemed to be distinct performance obligations under the contracts with customers, though following the same pattern of transfer to the customer who simultaneously receives and consumes both of these services over time. No significant judgements are required in identifying customers of these services. In accordance with IFRS 15, revenue relating to these activities will be recognised over time as these performance obligations are satisfied.
There are two categories of capital income, both of which will be impacted by the adoption of IFRS 15:
- Diversions relating to the relocation of water and wastewater assets; and
- Activities that facilitate the creation of an authorised connection through which properties can obtain water and wastewater services.
The adoption of IFRS 15 did not result in any net income statement impact relating to diversions as income was previously recognised in line with the completion of diversion work. However, whereas this income was included in the income statement as a credit within infrastructure renewals expenditure (IRE) due to it representing a contribution towards these costs, under IFRS 15 it is now recognised within revenue, resulting in an increase in both the revenue and IRE expense balances. The adoption of the standard in the year has caused both balances to increase by £11.1 million. As there was no net impact to the income statement, there was also no net impact to earnings per share or diluted earnings per share as a result of this element of the new standard.
Significant judgement is required in relation to accounting for activities that facilitate an authorised network connection through which water and wastewater services can be delivered. Establishing such an authorised connection can involve a number of activities performed opposite developers, which are considered to be neither separable nor distinct and instead form a bundle of activities necessary to establish an authorised connection from which network access can be obtained and water and wastewater services can be provided. Costs incurred by the group in carrying out these activities are capitalised as property, plant and equipment to the extent they result in the creation or enhancement of assets. These activities are considered to form part of the group's ordinary activities associated with the operation, maintenance and expansion of a water and wastewater network and, because they are deemed to result in an exchange transaction, we have determined that they fall within the scope of IFRS 15 as transactions arising from contracts with customers.
In addition, as the group has a legal obligation to keep a connection in place for as long as a property requires water and wastewater services, these initial connection activities are deemed to result in a broader ongoing performance obligation that is not distinct from the ongoing supply of water and wastewater services. The right to benefit from this connection, and obtain water and wastewater services through it, is deemed to be transferable from the initial developer to subsequent occupants of a connected property. Accordingly, under IFRS 15, the element of the performance obligation associated with the connection activities is deemed to be satisfied over the period of time that water and wastewater services are expected to be provided through the connection, compared with the prior treatment under which deferred amounts were released to the income statement over the useful economic life of the related assets or, for certain items, immediately to the income statement. This estimated period is a matter of judgement. We estimate that an average connection will be in place for a period of 60 years and therefore revenue associated with connection activities will be recognised evenly over this period.
Contract liabilities are accounted for within deferred revenue. These contract liabilities relate to the revenue which is held on the balance sheet in respect of connection activities. As stated above, revenue is released and recognised evenly over a period of 60 years; therefore deferred income on the balance sheet will also be reduced evenly over the 60 year period on a connection-by-connection basis. The group will hold no material contract assets, meaning there will be no material impairments to contract assets under IFRS 9 given the new requirement to provide for expected credit losses for contract assets.
As noted above, we have applied IFRS 15 retrospectively, with the cumulative effect of initially applying the standard recognised as an adjustment to the opening retained earnings balance at the date of initial application, resulting in an increase of £2.6 million in retained earnings with the corresponding decrease being to deferred income. In line with the standard, contracts which were completed in accordance with current accounting standards at the date of initial application were not restated on an IFRS 15 basis. The impact of the change on ongoing revenue as a result of the revised period over which income is released to the income statement is that revenue of £13.4 million was recognised in the year relating to the amortisation of deferred income; had IFRS 15 not been adopted, this revenue recognised in the year would have been £9.9 million. The adoption of IFRS 15 has therefore resulted in an increase of revenue of £3.5 million. This has directly impacted the amount of revenue and profit of the group with the corresponding decrease of the adoption of IFRS 15 being in deferred income on the balance sheet. Accordingly, the group's EPS and diluted EPS for the year have also been affected. EPS was 53.3p and diluted EPS was 53.2p; had IFRS 15 not been adopted the EPS and diluted EPS of the group would have been 52.8p and 52.7p respectively.
New and revised standards not yet effective
At the date of authorisation of these financial statements, the following relevant major standards were in issue but not yet effective. The directors anticipate that the group will adopt these standards on their effective dates.
IFRS 16 'Leases'
This standard, which replaces IAS 17 'Leases', IFRIC 4 'Determining Whether an Arrangement Contains a Lease', SIC-15 'Operating Leases – Incentives', and SIC-27 'Evaluating the Substance of Transactions in the Legal Form of a Lease', is effective for periods commencing on or after 1 January 2019. The group therefore adopted the standard on 1 April 2019 with the 31 March 2020 financial statements being the first which will be presented with IFRS 16 being applied. Under the provisions of the new standard, most leases, including the majority of those previously classified as operating leases where the group is the lessee, will be brought onto the statement of financial position as both a right-of-use asset and an offsetting lease liability. The typical items which the group leases include land, buildings, and vehicles. The right-of-use asset and lease liability are both based on the present value of lease payments due over the term of the lease, with the asset being depreciated in accordance with IAS 16 'Property, Plant and Equipment' and the liability increased for the accretion of interest (being the unwinding of the discounting applied to the future lease payments) and reduced by lease payments. The group does not act as a lessor.
The key judgements associated with adoption of this standard relate to the identification and classification of contracts containing a lease within the scope of IFRS 16, and the discount rate to use in calculating the present value of future lease payments on which the reported lease liability and right-of-use asset is based when the rate is not implicit in the lease contract.
The group has reassessed whether contracts it has entered into are, or contain, leases as defined by the new standard, so the new standard is being applied to a different population of contracts to those previously identified as containing leases under IAS 17 and IFRIC 4. Some new contracts have been identified as leases, while other contracts previously identified as operating leases under IAS 17 and IFRIC 4 will not be accounted for as leases under the new standard.
Due to the nature of the group's operations, many of the current operating leases have long remaining terms, which causes the discount rate to be a key factor in determining the value of the lease liability. Where the interest rate is not implicit in the lease, which is the case for materially all of the group's leases recognised under IFRS 16, the discount rate which is used to calculate the lease liability will be based on the relevant group company's nominal incremental borrowing rate adjusted for the payment profile and term of each lease.
The group intends to use the modified retrospective transitional approach permitted by the standard in which the right-of-use asset and lease liability brought onto the balance sheet on the adoption date will be based on the present value of future lease payments at the adoption date calculated using the appropriate discount rate at 1 April 2019. Under this approach there will be no effect on retained earnings recognised on transition. After the initial adoption of the standard, lease liabilities and right-of-use assets for new leases will be based on the corresponding discount rate at the date the new contract is entered into. Prior year comparatives will not be restated.
The group intends to apply recognition exemptions permitted by the standard in relation to short-term leases and leases of low-value items.
Based on the appropriate incremental borrowing rates at 31 March 2019, the right-of-use asset and liability brought onto the balance sheet is estimated to be £54.8 million. Absent new leases being entered into or cancellation of existing leases, the income statement charge in the year of adoption in respect of these leases is estimated to be £3.8 million, split between £2.2 million of depreciation of the assets and £1.6 million in relation to the finance charge recognised on the liabilities. This compares with £3.7 million of operating lease expenses that would have been recognised under IAS 17. The group does not expect the adoption of IFRS 16 to impact its ability to comply with any banking or financing covenants.
The actual impacts of adopting the standard on 1 April 2019 may differ from the figures quoted above as new accounting policies may be subject to change until the group presents its first financial statements that include the date of initial application.
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. 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. There are two different criteria whereby management does not recognise revenue for amounts which have been billed to the customer on the basis that collectability is not reasonably assured. 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 statements de-recognised and has more than their current year debt outstanding.
This two-criteria approach resulted in £18.0 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 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 reasonably assured (i.e. the second criteria were disapplied), the required adjustment to revenue would have been £12.8 million lower. 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, 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 2019, the allowance for doubtful receivables relating to household customer debt of £52.9 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 been £50.9 million or £53.5 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 2019 was £47.2 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 £4.2 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 26 per cent of total spend in relation to infrastructure assets during the year. A change of +/- one per cent would have resulted in £2.4 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 46 per cent of total support costs. A change in allocation of +/- one per cent would have resulted in £0.8 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 £393.2 million. A 10 per cent increase in average asset lives would have resulted in a £38.9 million reduction in this figure and a 10 per cent decrease in average asset lives would have resulted in a £39.5 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.
Joint ventures – Water Plus
Accounting estimate – The group has an equity investment in Water Plus Group Limited, a joint venture with Severn Trent PLC, the recoverability of which is considered with reference to the present value of the estimated future cash flows of the joint venture. Please see note 12 for details of the significant estimates relating to the recoverable amount of this investment, as well as an assessment of how sensitive the recoverable amount is to reasonably possible downside scenarios.
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.