pwc watergroup news: issue 19 · simon evans director – assurance uk watergroup february 2011 in...

Watergroup News

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Issue – 19February 2011

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WelcomeWelcome to the latest issue of the PwC Watergroup News. In this News Bulletin, we provide another selection of articles from our industry experts. Specifically, in this bulletin we:

Provide some updated guidance on the Carbon Reduction Commitment (CRC) Energy • Efficiency Scheme following the changes announced as part of the UK Spending Review 2010 which will now result in a significant additional cost to water companies;

Provide an update on the implications for water companies on the move towards IFRS at • an entity level. This follows the publication by the Accounting Standards Board in October 2010 of Financial Reporting Exposure Draft (FRED) 43: Application of Financial Reporting Requirements and FRED 44: Financial Reporting Standard for Medium-Sized Entities;

Provide some initial thoughts and reaction to Ofwat’s proposed changes to regulatory • compliance including a move towards a more risk based approach;

Provide a more detailed analysis of IFRIC 18 now that an industry consensus view appears to • have been reached on customer contributions with listed companies having issued their interim results incorporating first-time adoption notes;

Publish a short summary of recent industry news; and•

Provide a hyperlink to specific publications, articles and news on Ofwat’s website.•

If you would like to discuss any of these issues, the contact details of the team are attached and we look forward to hearing from you.

Simon EvansDirector – AssuranceUK WatergroupFebruary 2011

In this edition

What now for the CRC Energy Efficiency Scheme? 3

The future of UK GAAP 5

Regulatory compliance – introducing a risk based approach 8

Water companies and IFRIC 18 10

News stories 17

Ofwat links 20

PwC Watergroup 23

http://www.pwc.co.uk/eng/industries/water.html


What now for the CRC Energy Efficiency Scheme?IntroductionIn our last newsletter we provided some initial guidance on the CRC Energy Efficiency Scheme which started in April 2010.

Following updated guidance on the CRC Energy Efficiency Scheme following the changes announced as part of the UK Spending Review 2010 Henry Le Fleming (carbon reporting specialist at PwC) commented:

“The CRC has been a contentious scheme. A worrying proportion of companies covered by the scheme were behind with their necessary preparations. So the delay in the timetable for purchase of allowances will be welcomed by business.

The proposed retention by government of auction revenues is a big change to the scheme and will substantially increase compliance costs for businesses. If companies do not take steps to reduce their CRC carbon emissions, the bottom line is they will face increasing costs to buy the permits to comply with the scheme.

For a company with a £1 million energy bill (split 75% electricity, 25% gas) the cost of acquiring permits at £12 per permit in 2012 is likely to be in the region of £76,000. By 2014/2015, that cost will rise to £114,000, assuming the carbon allowance price rises to £18 per tonne by 2014/15 (as suggested in the Treasury documents). That’s an 11.4% increase on the costs of a £1m energy bill, before companies’ factor in the costs of managing compliance, e.g. reporting requirements with the scheme.

There are positive aspects to this change. It provides stronger and clearer incentives for companies covered by the scheme to invest in energy efficiency. Additionally the change in the timetable for the first purchase of allowances provides more time to prepare and delays the point at which companies’ need to commit cash to buying allowances.”

£1 billion cashback withdrawnThe UK Government has announced that, as part of the UK Spending Review 2010, the CRC Energy Efficiency Scheme will be simplified to reduce the burden on businesses. Full details have not yet been released, but the key changes are:

The first allowance sales for 2011-12 emissions will now take • place in 2012 rather than 2011.

Revenues from allowance sales totalling £1 billion a year • by 2014-15 will be used to support the public finances, including spending on the environment, rather than being recycled to participants.

The proposed retention by government of revenues from allowance sales is a massive change to the CRC Energy Efficiency Scheme - originally it had been designed to be revenue neutral. The implications are:

This will substantially increase compliance costs for • businesses.

It is unclear from the information released by the Treasury • what impact changes made will have on allowance prices.

It appears that there will no longer be an auction of • allowances from 2013. Allowances will be sold at a fixed price, starting at the rate of £12 per tonne in 2012, but estimated to rise to £16-£18 per tonne by 2014/15.

The positive aspect of this change is that it provides a strong • and clear financial incentive for companies covered by the scheme to invest in energy efficiency.

So,with the CRC registration deadline having passed on September 30, what happens next? Performance league tables are still likely to be published, so the reputation impact remains. For those who have missed the deadline, it is not yet clear how strictly the Environment Agency will enforce the £5,000 one-off and £500 per day maximum fines for not having registered. Companies with half hourly meters that have not registered, or that made an information disclosure, should still contact the Environment Agency and comply with the requirements. The level of proactive effort by organisations will be an important consideration in any decisions made by the regulator.

Registration is, however, only the first step of the CRC Energy Effifiency Scheme. For those that are full participants in the scheme, registration is the start of the journey, not the end. The hard work begins now.

When are the revised regulatory deadlines?There is limited information available at present. The main changes are a delay in purchasing allowances and a removal of the recycling payment. This diagram shows how the deadlines might now work.

Why do I have to take action now?2011Jan Jun Dec

JAN - MARCHPotential periodfor purchase ofallowances for2011/12?

31 JULY - SubmitAnnual Report andFootprint Report

31 JULY - SubmitAnnual Report

Surrender 2011/12allowances?

2012Jan Jun Dec

2013Jan Jun Dec

31 JULY - SubmitAnnual Report

Surrender 2012/13allowances?

JAN - MARCHPotential periodfor purchase ofallowances for2012/13?

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Key challenges in the next 18 months

Despite the changes there are a number of key challenges that remain. The ability to gather the raw numbers for the reports will rely upon the existence of effective processes, systems and controls to generate reliable and timely data. Unlike “registration data”, which comprised half hourly electricity consumption data, footprint and annual report data must also include all other site-based fuels, such as gas, oil, diesel and coal.

Those processes, systems and controls over fuel use data need to be established and “stress-tested”. This is so that management, and more specifically the nominated Senior Officer, can have confidence in their data and can compile reports easily, within the regulatory deadline. The regulatory reports will need to be delivered under time pressure during the limited four month period between the close of the reporting year (31 March 2011) and the need to submit correct and complete information to the Environment Agency by 31 July 2011. This could present challenges for organisations with a large number of sites. Developing the data collection systems and reporting structures will ensure that companies can overcome these problems, manage the risks and have confidence in their purchasing of allowances for the 2011/12 period and future years.

Looking aheadThe last 12 months have witnessed a backlash against the CRC, with a number of parties complaining to the Government about the amount of work involved in achieving and demonstrating compliance. Judging by the UK Spending Review announcements, such lobbying has been effective up to a point, but at a cost. What further change might be anticipated?

Full details of the changes announced in the UK Spending Review have not been released, leading to continued uncertainty over key aspects of the CRC scheme. What is clear, however, is that the Government is committed to a 34% reduction in CO2 emissions by 2020, and therefore regulatory action to support the achievement of this goal will be a fact of life going forward. However the exact nature of the regulations will be subject to change. The implications of this are twofold.

Providing for sound measurement and management of • energy and related carbon emissions is important regardless of the CRC. It will help companies comply with current regulations, reduce energy bills and help them understand the costs of any proposed changes to these regulations. The benefits of being better at carbon and energy management go beyond complying with the CRC.

There are going to be a variety of opportunities that • businesses can profitably realise from supporting the UK to achieve the 34% CO2 reduction target and by minimising the impact of any future regulatory or emissions tax costs to their business. If not already underway, companies should start to incorporate the impact of CO2 emissions into their business strategies (supported by credible, relevant and timely information).

Contacts

Carbon Reduction Commitment – Advisory

Henry le FlemingLondon+44 (0)207 213 [email protected]

Phil CaseLondon+44 (0)207 212 [email protected]

Carbon Reduction Commitment – Assurance

Atul PatelLondon+44 (0)207 212 [email protected]

Richard PorterLondon+44 (0)207 213 [email protected]

What now for the CRC Energy Efficiency Scheme?– Continued

mailto:[email protected]






The future of UK GAAPIntroduction

In our December 2009 issue of Watergroup News we considered the implications for water companies of a move to IFRS at an entity level following the July 2009 publication by the International Accounting Standards Board (IASB) of ‘IFRS for Small and Medium-sized Entities’. This standard provided a simplified version of IFRS, with far less onerous disclosure requirements but also measurement differences. The IASB’s intention was that companies can adopt IFRS for SMEs if they meet the relevant scope criteria. This will be if (a) their securities are not listed and (b) they are not a financial institution. Ninety-nine percent of private companies globally, as well as unlisted subsidiaries of listed groups are expected to be eligible to use IFRS for SMEs. Application in individual countries will depend upon local company law and tax legislation.

The UK Accounting Standards Board (ASB) has indicated that its overarching strategy is to achieve a common financial reporting framework for use in the UK. The ASB issued Financial Reporting Exposure Draft (FRED) 43: Application of Financial Reporting Requirements and FRED 44: Financial Reporting Standard for Medium-Sized Entities in October 2010 outlining a proposed future for reporting in the UK and Republic of Ireland. This followed a review of comments received in response to the Consultation Paper ‘Policy proposal: The future of UK GAAP’, issued in August 2009.

What is the latest position on the future of UK GAAP?

The main developments in the two Exposure Drafts issued are:

The move to an IFRS framework will be delayed by one year • or maybe more. Years beginning on or after 1 July 2013 will now be the earliest affected although early adoption will be permitted. There will be a minimum transfer time of 18 months from publication of a new standard to the effective date. This means that for water companies with a March accounting reference date, the first accounts affected will be the year ended 31 March 2015, whereas those companies with a December accounting reference date will be first affected in the year ended 31 December 2014.

EU-adopted IFRS measurement with reduced disclosures • will be available for subsidiaries.

The current cash flow and consolidation exemptions will • remain.

Transitional relief to be provided for dormant companies • so that transition to the new UK framework alone will not disturb dormancy.

What does this mean for you?

Water companies now have more time to plan for transition, and the risks and opportunities it may bring. Additional options have become available, both in terms of choice of GAAP and timing, as shown below:

Tier 1 Tier 2 Tier 3Publicly Accountable entities

Apply EU-adopted • IFRS

All other entities (not in Tier 1 or 3)

Apply UK-adopted • IFRS for SME* or EU adopted IFRS

Small entities eligible to apply FRSSE

Apply FRSSE•

Subsidiaries (Tier1S)Reduced disclosure

Subsidiaries (Tier2S)Reduced disclosure

*The ASB is proposing to call the amended IFRS for SME standard: Financial Reporting Standard for Medium Sized Entities (FRSME).

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What additional guidance has the board provided on the definition of ‘publicly accountable’?

The definition of what constitutes a ‘publicly accountable entity’ will be crucially important to water companies. As currently proposed, its strict interpretation doesn’t include water companies that are public interest entities without listed instruments, albeit the situation is arguably more complex where there are cross guarantees to a finance subsidiary. The ASB is looking to provide additional guidance to interpret ‘publicly accountable’. It will highlight the guidance within the Basis of Conclusions of the IFRS for SME.

However, the current definition is that an entity has public accountability if:

a) its debt or equity instruments are traded in a public market or it is in the process of issuing such instruments for trading in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets), or

b) as one of its primary businesses, it holds assets in a fiduciary capacity for a broad group of outsiders and/or is a deposit-taking entity for a broad group of outsiders. This is typically the case for banks, credit unions, insurance companies, securities brokers/dealers, mutual funds or investment banks.

The ASB lists the following entities as having public accountability: a quoted company per section 385 of the Companies Act 2006; a pension scheme, insurance companies, credit unions, building societies, an incorporated or registered friendly society, a bank, an employee benefit trust and investment, mutual funds, custodians, brokers and fund managers.

The majority of UK water groups will therefore need to make a choice between full IFRS, Full IFRS with reduced disclosures and IFRS for SMEs, although for public companies this will be a subsidiary company issue.

What amendments are the ASB considering to the current IFRS?In principle, the ASB has determined the changes to IFRS for SME’s should be as minimal as possible retaining maximum consistency with EU adopted IFRS while making use of exemptions in Company Law to avoid ‘gold plating’ of the standard. The proposed amendments to the IFRS for SME’s are:

Maintain existing disclosure exemptions on financial • instruments, cash flows and related parties currently available in UK GAAP.

Replace the tax section so it reflects IAS 12, ‘Income Taxes’, • on the grounds that the IFRS for SME requirements were inconsistent with IFRS.

Continue and broaden the exemption from preparing • consolidations with a reference to the Companies Act, which allows wider use of the exemption.

Additional transitional provisions for dormant companies to • avoid disturbing dormancy as a result of a move to IFRS.

How does this all fit with the EU Accounting Directives?In addition, changes will need to be made to both the IFRS for SME and the new Tier 1S and 2S (reduced disclosures) to comply with EU Accounting Directives. These changes include:

Removing certain presentation options (such as the • analysis of results of discontinued operations in the notes, the statement of financial position on a liquidity basis, government grants as a reduction of the carrying value of the asset).

Aligning Goodwill treatment (presumed 5 year life rather • than 10, impairments may be reversed and negative goodwill is not recognised immediately).

How will this impact subsidiaries that use Tier 1S?For those applying Tier 1S (EU IFRS with reduced disclosures) in addition to exemptions on financial instruments, cash flows and related parties currently available in UK GAAP there will be relief from:

Disclosures for areas managed on a group basis (business • combinations, share based payments, management of capital, defined benefit pension schemes, associates and impairment).

Disclosures not considered necessary for non-publicly • accountable entities (key management personnel, discontinued operations and comparative reconciliations for intangible and fixed assets).

What are the next steps?Comments on the Exposure Drafts are due by April 2011, a move to a final standard in mid 2011 and reporting under the new model for years beginning on or after 1 July 2013, although early adoption will be permitted. The ASB has agreed that a minimum transition time of eighteen months from the publication of the new standard to the effective date should be allowed.

The ASB is also reviewing the responses to their request to consider the costs and benefits of conversion.

The future of UK GAAP – Continued

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The future of UK GAAP – assessing strategy and options1. Tax planning opportunitiesAdoption of IFRS may have a significant tax impact. The finer details of the impact of converting to Full IFRS or IFRS for SMEs will need to be worked through, but based on conversions to full IFRS differences generally fall into four categories: a) No impact on tax; b) Impact mirrors change in financial statements; c) Impact may or may not differ in timing and amount to impact in financial statements; and d) Impact on transition only. Recognising which category applies is the key to reaching an informed position on the impact of reporting under the new GAAP.

2. Group simplificationLarge water groups with many subsidiaries may wish to take the opportunity to simplify the group structure prior to transition, to reduce the time and cost of conversion to IFRS. Early action might also reduce the costs associated with tagging of accounts for iXBRL purposes.

3. Impact on contracts which rely on GAAP measures - banking covenants and bonus arrangementsWater companies may wish to consider the impact of a change in GAAP on contracts with clauses linked to GAAP measures. For example, measurement of loan covenant ratios on an IFRS basis may result in a breach; transition to IFRS may result in greater income statement volatility that could impact achievement of employee performance bonuses. Such arrangements may need to be renegotiated or revisited in advance of the change in GAAP.

4. Distributable reserves A change in GAAP may result in a reduction in distributable reserves, for example from the allocation of pension deficits to individual subsidiaries or recording of deferred tax liabilities with no discounting. Water companies may wish to assess how the change will impact distributable reserves and plan accordingly.

5. Impact on acquisitionsWater companies contemplating acquisitions may wish to assess the impact of a change in GAAP in their acquisition model. Under full IFRS, transaction costs such as legal, accounting, and advisory fees must be expensed, and the way in which the deal is structured can have an impact on earnings for several years post-acquisition.

6. Overseas-parented groupsOverseas-parented groups may wish to consider how best to manage the transition to IFRS in their UK subsidiaries. In particular, the choice of GAAP should be made with regard to the position in other territories, as there may be an opportunity to converge the GAAPs across a number of locations, and to use the UK transition to create a roadmap for transition elsewhere in the group.

7. Systems and data requirements

Information requirements for measurement and disclosure will be more onerous under both full IFRS and FRSMEs. For example, additional financial instrument data will be required for all entities and HR data needed to make holiday pay accruals and key management compensation disclosures. Where the capture of additional data requires more than a simple system modification, water companies may need to think about how to approach this most efficiently.

8. ResourceResource may become scarcer as the mandatory transition date approaches, and water companies will need to plan to ensure they have sufficient resource, with the right skills, to deliver the transition.

Closing thoughtsIFRS for SME and the new Tier 1S and 2S (reduced disclosures) potentially represents a fundamental eradication of global GAAPs, including the replacement of current UK GAAP with IFRS/IFRS for SMEs.

UK water companies are likely to have the option of adopting full IFRS, full IFRS with reduced disclosures or IFRS for SMEs (known as FRSME). Management will need to understand the advantages and disadvantages of each. While adoption in the UK will not be required until 2014 at the earliest, our experience from 2005 is that those who planned for conversion well in advance reaped the benefits of doing so.

Contacts Simon Evans (Assurance)[email protected]+44 (0)121 232 2289

Suzanne Hunter (Structuring Services)[email protected]+44 (0)121 265 5476

The future of UK GAAP – Continued





Regulatory compliance – introducing a risk based approachIntroductionOfwat have recently published a number of discussion papers and held various stakeholder workshops underlining their commitment to a changed approach to regulatory compliance. In particular, there has been much talk of a move towards a more risk-based approach to regulatory reporting which could also lead to significant changes in the level of detailed annual reporting requirements. In this article, we provide some initial thoughts and reaction to these proposed changes to regulatory compliance.

So what have Ofwat said?The main publication which sets out much of what is proposed is Ofwat’s focus report issued in November 2010 ‘Getting it right for customers – how can we make monopoly water and sewerage companies more accountable?” This focus report introduced the proposed move towards a more risk based approach to regulatory compliance following on from two workshops with key stakeholders.

Ofwat recognise that change is required and the challenges in the future are different in nature, scale and complexity making the delivery of sustainable water and sewerage services increasingly difficult. In terms of regulatory compliance Ofwat believes that their current very detailed approach of checking compliance may not be proportionate; restrict innovation; not be the best use of resources given the large volume of data; be too focused on detail rather than the risky areas; not sufficiently take account of well developed and mature systems at water companies; and still not guarantee success of identifying regulatory breaches.

By proposing a move towards a more risk-based approach this marks a significant change to the way in which Ofwat seek to secure compliance. There will no longer be a ‘one size fits all’ approach with resources targeted on those areas where there

are material risks to customers, society, the environment and the economy. Instead of looking at data from every company on every service indicator every year, Ofwat have suggested that they will develop ways of identifying where there is a real risk. This will represent a significant change to managing the regulatory relationship and will need careful consideration to ensure that the new system is better than what it replaces.

Ofwat have also recognised that they will need to develop a transparent set of regulatory tools to enable them to identify risks and operate a risk-based approach to regulatory compliance. This could involve; annual compliance certificates that confirm compliance and highlight any particular concerns; in-depth compliance investigations focusing on either specific risks or companies that are considered to be high risk; information assurance through Internal Audit, data quality assurance systems, third party assurance through auditors and reporters; peer review and other data quality tools.

Ofwat have also issued further guidance in both December 2010 and January 2011 through introducing a first step for June Return 2011 in advance of further planned changes in 2012. For June Return 2011 Ofwat are not asking companies to provide detailed commentaries to the June Return marking a significant change for companies. They do still expect companies to submit detailed tables and a Board Overview, providing a summary of material issues and systems and processes in place. They have also asked companies to externally publish their June Returns on their websites at the point of submission to Ofwat.

Our thoughtsOverall, we welcome the proposed move towards a more risk-based approach. Information requirements have expanded significantly over the years since privatisation and the volume of information reported has continued to expand in both volume and complexity since the 2004 price review. Whilst there has been some real cause for concern on specific misreporting

issues in the sector, much effort has been made over recent years to improve governance processes, systems and controls to ensure that reporting is more accurate, reliable and complete. Nevertheless, the proposed change is quite a step-change for both the sector and the regulator. There are a number of unanswered questions at this stage as to how a risk-based approach may operate and any changes introduced will need to be worked through, so that the sector does not lose the benefits of a framework that has been relatively successful over the last two decades in improving sector wide performance and compliance.

We have set out some specific initial thoughts on areas impacted by a move towards a more risk based approach, covering both financial and non-financial data:

Financial DataDuplication of financial data in the June Return and the Regulatory AccountsIn terms of financial data, we believe there is a large amount of duplication between the June Return submission and the Regulatory Accounts that are published in mid July. If the financial information was consolidated into the Regulatory Accounts then this would undoubtedly reduce the regulatory burden.

Much of the financial data in tables 18-31 of the June Return is duplicated within the regulatory accounts which are published only a month after the existing June Return submission. The data in the Regulatory Accounts is also subject to a full audit opinion, whereas the June Return is only subject to agreed upon procedures work. So we believe that there would be a significant efficiency saving established from just having one regulatory submission on the financial numbers, being the Regulatory Accounts. This saving would involve both reduced management and auditor time.

This change, if made, may well require some changes to the Regulatory Accounting Guidelines. However, these are due

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Regulatory compliance – introducing a risk based approach – Continuedto be changed shortly anyway for accounting separation information which is not currently included in the Regulatory Accounts. Ofwat may also require the Regulatory Accounts to be accelerated from a timing perspective which should be achievable given the financial numbers have to be finalised at the time of submission of the June Return anyway.

Detailed commentaries on the June ReturnWe welcome Ofwat’s first step to remove the requirement to submit detailed commentaries on the June Return. However, we do believe that the Board Overview of the June Return is a very useful summary of each water companies’ performance and should include any significant points that would have been included in the detailed commentaries that are no longer required.

Longer term, we believe that if the June Return is no longer required then the Board Overview of the June Return could be collapsed into the requirements of the Operating and Financial Review included in the Annual Report and Accounts or Regulatory Accounts of each water company.

RAG 5.04 and Transfer Pricing in the Water IndustryTables 30 and 31 of the June Return currently require companies to prepare a very detailed commentary on transfer pricing and cost allocation. Whilst there may be more information requirements associated with cost allocation between the retail businesses and upstream assets in the future, we believe that the existing requirements on transfer pricing are often disproportionate to the risks involved given the level of transactions now existing between appointed businesses and other associated companies.

Over recent years many water companies have re-focused on their core water and waste water businesses with significantly reduced levels of capital and operating expenditure transactions taking place between appointed businesses and the rest of the

Group. Even where companies have had positive feedback from Ofwat on their June Return and Auditors report, they are still required to prepare a detailed commentary and provide a long form report from their statutory auditor.

We believe that much of the data requirements of RAG 5.04 can be collapsed into the Regulatory Accounts, which is subject to an audit opinion. In such a situation we would suggest that there is therefore no need for a detailed commentary from the Company or a separate long form report issued by the Company’s statutory auditor. Instead Ofwat could commission more in-depth reviews by the statutory auditor just in situations where a high risk exists or where there is evidence of non-compliance.

Non-Financial DataJune Return non-financial dataThe generation and publication of Non-Financial Data has become ever more important over recent years, and that is particularly true for the water sector, where there has been an ongoing and ever increasing requirement to report non-financial measures to Ofwat, which Ofwat then uses to assess performance across the industry. Following a number of high profile misreporting issues, in November 2005 Ofwat wrote to the Water Company Managing Directors (MDs) reminding them of their obligations to provide “reliable, accurate and complete” information (MD209).

The June Return Reporting Requirements require water companies to explain in their Board Overview how the Board has “satisfied itself that the information provided in the June Return is reliable, accurate and complete.” Significant progress has been made by water companies over recent years to improve governance, systems, processes and controls around the collection and reporting of such data.

Ofwat have indicated that moving to a risk-based approach could mean that they stop collecting information in the way that they have in the past. Clearly with so many improvements having been made to the reporting of data, it is important that any change does not jeopardize the improvements that have been made. Many companies may well continue to use many of the measures established as they represent key performance indicators in managing and controlling their business.

One possible solution, in the absence of a June Return, would be to work towards a common set of key performance indicators. These could then be reported on annually, possibly within each water companies Operating and Financial Review included in the Annual Report and Accounts / Regulatory Accounts.

Closing thoughtsThe proposals from Ofwat to move towards a more risk-based approach to regulatory compliance, whilst early stage, represent a significant step change for the industry and a change in direction away from an ever increasing and complex data reporting burden to something that is more proportionate. Whilst we welcome the direction of changes proposed, the devil is in the detail and this will need to be worked through very carefully by Ofwat and the sector over the coming months. We welcome the opportunity to discuss this further with you.

Simon Evans (Assurance)[email protected]+44 (0)121 232 2289

Contact




Water companies and IFRIC 18Water companies and IFRIC 18 – Transfers of Assets from Customers

IFRIC 18 deals with accounting for assets transferred from a customer in return for connection to a network or ongoing access to goods or services. It addresses the current diversity of practice, of recording the asset at fair value, acquisition cost or a nominal amount. IFRIC 18 only applies to entities adopting IFRS.

On 29 January 2009, International Financial Reporting Interpretations Committee Interpretation 18, Transfer of Assets from Customers, (“IFRIC 18” or “the Interpretation”) was issued by the IASB to address transactions involving the transfers of property, plant and equipment from ‘customers’.

IFRIC 18 was endorsed as effective for EU entities for financial entities for financial years commencing after 31 October 2009 (i.e. for years ending March 2011 onwards). However, the interpretation is to be applied prospectively to all ‘transfers’ made on or after 1 July 2009. In our view, even where an entity applies IFRIC 18 for the first time in a financial year commencing after 31 October 2009, it should still apply the interpretation’s requirements to transfers received after 1 July 2009. This will require a prior year adjustment where the impact is material.

IFRIC 18 sets out to ensure that when an item of property, plant and equipment meets the definition of an asset, it is recognised at its fair value on the date of the transfer, with the corresponding credit being recognised as revenue in line with International Accounting Standard 18 Revenue (“IAS 18”).

The Interpretation specifically relates to utilities (or more specifically water companies in this case) and covers the accounting arrangements related to:

Instances where water companies are provided “free of • charge” with assets, e.g. the adoption of water mains and sewers; and

The provision of new connections services by water • companies to their respective networks for which a fee is levied or contributions are received for new mains and sewer requisitions (usually called a “customer contribution”).

Background on the types of contribution and asset adoptions

This article will cover seven main categories of contribution and adopted assets;

1. Connection charges – This is a charge of approximately £350 per property and covered by Sections 42 and 72 of the Water Act 2003 to cover the cost of connection from the distribution main to a boundary box, stop-cock and domestic meter.

2. Infrastructure charges – Amount set by Ofwat for first domestic connections at approximately £300 for each of water and sewerage. The purpose of an infrastructure charge is not closely or well defined, though the underlying premise is that expansion in capacity should be funded by new development and not by existing customers through metered/unmetered water and sewerage charges.

3. Water requisitions under Section 41 of the Water Act 2003 – Legislation provides for a relevant deficit calculation over the first twelve years where the income streams fall short of the cost of fully servicing a loan covering the cost of the requisition. As an alternative, developers have historically been offered the alternative of paying 50% as a one-off amount. The Water Act 2003 embeds in legislation the requirement of offering a “discounted aggregate deficit” whereby predicted income streams are matched against expected loans cost, and shortfalls over 12 years discounted at rates provided by Ofwat. This reduces the expected lump sum contribution to around 20% of cost.

4. Adopted assets and self lay water mains – Developers are also

permitted to self-lay and compel water companies to buy in the main using a computation which is effectively (but not precisely) the reverse of that for requisition, resulting in an approximate 80% buy-in cost.

5. Sewer requisitions under Section 98 of the Water Act 2003 – Similar provisions exist for the requisitioning of sewers, however historically the majority of sewers have been self-lay. From 1996, first time sewerage now falls under s101a which requires a sewerage undertaker to provide, at their cost, mains sewerage to pre existing housing upon request. In addition to s98 sewer requisitions, there are occurrences whereby the uprating of operational structures is required to meet s98 obligations. In these instances capital contributions of the order of 50% were paid by developers toward the costs with the level of contribution bein a negotiated amount. Similar to water requisitions, the 2003 Act embeds in legislation the requirement to offer a “discounted aggregate deficit” for sewerage requisitions.

6. Adopted assets and sewers – Under Section 104 of the Water Act 2003, the cost to the developer of self-lay sewers is not recognised, albeit costs of supervision may be capitalised.

7. Diversions – Diversions are principally for the rerouting of water and sewerage infrastructure because of road schemes or site developments. Operational structures may be similarly re-sited because of required alternate use of land.

Please note that this article only covers the main categories of contribution, excluding government grants and also does not cover private sewer adoptions, which is not expected to become law until October 2011 and where there remains some level of uncertainty as to how the arrangements will work.

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Water companies and IFRIC 18 – ContinuedCurrent Accounting Arrangements under UK GAAP

Accounting for grants and contributions is broadly consistent in general terms under UK GAAP; SSAP 4 “Accounting for Government Grants” states that “It is also indicative of best practice for accounting for grants and assistance from other sources”.

Accounting policies disclosed in UK statutory accounts are relatively uniform across the water sector. A typical accounting policy under UK GAAP, extracted from the FY10 Annual Report for Anglian Water Services Limited is:

“Grants and contributions for capital expenditure include government grants, infrastructure and connection charges, developer payments for water and sewer requisitions, sewer adoption fees and other contributions from third parties.

Grants and contributions to capital expenditure, other than those relating to infrastructure assets, are credited to a deferral account within creditors and are released to the profit and loss account evenly over the expected useful life of the relevant asset.

Grants and contributions to capital expenditure on infrastructure assets are deducted from the costs of these assets. This policy is not in accordance with Schedule 1 of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008, which requires grants and contributions to be shown as deferred income, but has been adopted in order to show a true and fair view as, in the opinion of the Directors, while a provision is made for depreciation of infrastructure assets, these assets have no determinable finite economic life and hence no basis exists on which to recognise such contributions as deferred income. The financial effect of this departure is disclosed in note 12.

Revenue grants and contributions are credited to the profit and loss account in the year to which they apply.”

True and fair override

Consistent with many other utilities, water companies apply the true and fair override in respect of accounting for infrastructure contributions. These contributions are deducted from tangible fixed assets; this is a departure from the Companies Act 2006 which requires fixed assets to be included in the balance sheet at their purchase cost, with any contribution treated as deferred income. However, the inclusion of infrastructure contributions as an offset to fixed assets is believed to represent a true and fair view as they directly relate to the cost of the fixed assets used in the water and sewerage network and these assets have no determinable finite economic life and hence no basis exists on which to recognise such contributions as deferred income.

Management of most water companies wish to maintain this treatment in the UK GAAP statutory and regulatory accounts for the following reasons: to maintain consistency with the sector, comply with regulatory guidance, to better reflect the fixed asset value of the business which is more comparable with the RAV (which treats infrastructure contributions in a similar way) and the fact that no basis exists on which to recognise such contributions as deferred income.

Application of IFRIC 18

As stated above, IFRIC 18 specifically relates to utilities and deals with the situation where:

“……an entity may receive from its customers items of property, plant and equipment that must be used to connect those customers to a network and provide them with ongoing access to a supply of commodities such as electricity, gas or water. Alternatively, an entity may receive cash from customers for the acquisition or construction of such items of property, plant and equipment. Typically, customers are required to pay additional amounts for the purchase of goods or services based on usage.”

The scope of IFRIC 18 is covered in paragraphs 5 and 6.

Paragraph 5 states:

“Agreements within the scope of this Interpretation are agreements in which an entity receives from a customer an item of property, plant and equipment that the entity must then use either to connect the customer to a network or to provide the customer with ongoing access to a supply of goods or services, or to do both.”

The interpretation goes on to say, in paragraph 6, that it also applies to:

“agreements in which an entity receives cash from a customer when that amount of cash must be used only to construct or acquire an item of property, plant and equipment and the entity must then use the item of property, plant and equipment either to connect the customer to a network or to provide the customer with ongoing access to a supply of goods or services, or to do both.”

IFRIC 18 then goes on to outline how the contributions should be accounted for and makes reference to IAS 18 paragraph 13 which states that:

“The recognition criteria in this Standard are usually applied separately to each transaction. However, in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. For example, when the selling price of a product includes an identifiable amount for subsequent servicing, that amount is deferred and recognised as revenue over the period during which the service is performed. Conversely, the recognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole.”

The first point to address, is whether or not the customer contributions previously mentioned, are within the scope of IFRIC 18.

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Connection charges and adopted assets (self lay water mains and self laid sewers) are largely considered by UK water companies to be within the scope of IFRIC 18.

Infrastructure charges are argued to be outside of the scope of IFRIC 18, on the basis that the charge, which is received in cash, does not have to be directly used for constructing an asset to connect or to provide the customer with ongoing access. Whilst this is undoubtedly true, as infrastructure charges are poorly defined, it is clear that their overall purpose is for building additional capacity into the network, so that existing customers do not pay for growth in the network. Nevertheless, there is clearly some scope to apply paragraph 6 as infrastructure charges do not appear to meet the definition of a cash contribution under IFRIC 18.

Water and sewer requisitions are also believed to be outside the scope of IFRIC 18, given that the cash contribution is not used to specifically construct an asset to connect or to provide access to the network. Instead the contribution is a revenue deficit contribution to fund the notional interest cost on a 12 year loan to fund the construction of the asset when compared with the revenues generated by the new development. Whilst it might be argued that this is outside of the scope of IFRIC 18, its very nature implies that it is a “revenue deficit” contribution and should be treated as revenue as opposed to a capital contribution.

Diversion contributions are outside of the scope of IFRIC 18, but are specifically covered under paragraph 65 of IAS 16.

In summary, not all the contributions mentioned earlier are strictly within the scope of IFRIC 18, but we will cover the accounting for each type in this article anyway.

Was an asset received?New connections

We will cover the new connection example here first. In providing a new connection, water companies will typically build new infrastructure for which the customer will then receive an invoice. In this sense the customer is typically a developer. Such infrastructure will then be maintained or repaired on an ongoing basis over its engineering life without any further charge being levied.

The cost of constructing or acquiring the necessary infrastructure should be treated as an asset of the water companies and accounted for in accordance with IAS 16 because it is a:

“…resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.”

IFRIC 18 and IAS 16 do not require generation of incremental revenue and only that the asset contributes to the generation of economic benefits. A new connection asset does meet the asset recognition criteria, as it generates economic benefits arising from the billing of a new customer. The fact that the asset does not generate incremental economic benefits, as it has no net impact on the RAV, is irrelevant.

Adopted assets

Sewers are currently adopted at nil cost under Section 104 of the Water Act 2003, with no accounting entries currently made. IFRIC 18 leads companies down the path of recognising these assets at fair value, even though they are not included in the RAV. There is, however, an interesting point about when these

infrastructure assets are controlled by water companies. UK water companies have generally concluded that sewers become controlled by the companies at the date of legal adoption, rather than at the point of connection, as this is the point at which the risks and rewards of ownership transfer. The ‘rewards’ associated with such items, most significantly the ability to bill the customers, are often obtained by the companies before adoption and do not change upon adoption. There is evidence of companies delivering services via adopted mains and sewers for periods in excess of 10 years before legal adoption occurs, if the required standards for adoption have not been met. Until the infrastructure is demonstrated to be of an appropriate standard and the company legally adopts the item there is no legal obligation to maintain the infrastructure.

Similarly, adopted assets contribute to the generation of economic benefits, rather than generating incremental economic benefits (where the RAV impact is zero). This means that an asset does still need to be recognised, as explained above for connection assets.

How should the asset be valued?

There has also been much discussion with utility companies on how fair values should be calculated.

Assuming that the asset definition has been met then the cost of the item shall be recognised under paragraph 7 of IAS 16. The cost on initial recognition should be measured at its fair value in accordance with paragraph 24 of IAS 16. In terms of deriving a fair value, a number of different approaches can be used such as third party prices, cost plus a margin or net present value of cash flows.

The most difficult area here is the adoption of self lay water mains and sewers.

Water companies and IFRIC 18 – Continued

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After much discussion, many water companies have concluded that the estimated third party cost, which is known at the date of adoption of items, represents a reasonable and reliable estimate of the value of the items received. This amount includes all the construction work required by the developer in bringing the items to a standard suitable for adoption. This would also be consistent with the value attributed to assets where cash is transferred to the companies for them to build the asset. There are certain situations where a cost may not easily be available, but in most instances a formulaic approach can be used to derive a deemed cost as this is already used for completion of table 36 of the June Return.

Impairment considerations

There is also likely to be no argument to immediately impair the asset. This is because impairment tests under IAS 36 are completed at a Cash Generating Unit (CGU) level and not at the individual asset level. Normally the CGU is the water and/or sewerage network as a whole, rather than just the discrete connection assets, with the connection assets also being treated as part of the wider network anyway.

How should the credit be accounted for?

IFRIC 18 refers to the revenue standard and IAS 18, paragraph 12 states that “When goods are sold or services are rendered in exchange for dissimilar goods or services, the exchange is regarded as a transaction which generates revenue.” The interpretation takes the view that the transfer of property, plant and equipment represents an exchange for dissimilar goods or services and hence that the entity shall record revenue.

The fact that revenue should generally be recorded is not disputed, but the question then arises as to the period over which the related revenue should be recognised.

Connection charges

Firstly, we will consider the treatment of new connection charges, which are clearly in scope for IFRIC 18.

Crucial to determining the accounting treatment of these customer contributions is whether the provision of new connections involves the provision of a single service (i.e. the connection itself or a number of separately identifiable services (i.e. the connection and its subsequent maintenance)). The ongoing supply of water to the new premise is a separate contractual obligation between the owner of the connection and with a company supplying water services. However, by putting the appropriate infrastructure in place the water companies are providing the means by which water can be distributed to end users. Without this infrastructure no water can be supplied.

The fundamental question therefore is whether new connections can be separated from the ongoing obligations to maintain the connection and related infrastructure and the provision of ongoing water services.

As mentioned above, IFRIC 18 refers to paragraph 13 of IAS 18 where the entity shall separately identify the separately identifiable services included in the agreement (i.e. connecting the customer to a network, providing the customer with ongoing access to a supply of goods and services, or both).

In this regard, the water companies’ obligations fall under the Water Act 2003 which leads to the long term obligation to provide a service to maintain the infrastructure (i.e. the contribution of the asset is inextricably linked to the long term obligation under the licence condition to maintain that infrastructure in order to provided a supply of water and/or sewerage services to that property).

Paragraph 20 of IFRIC 18 goes on to say in relation to ongoing services:

“If an ongoing service is identified as part of the agreement, the period over which revenue shall be recognised for that service is generally determined by the terms of the agreement with the customer. If the agreement does not specify a period, the revenue shall be recognised over a period no longer than the useful life of the transferred asset used to provide the ongoing service.”

When considering this point, we need to reflect on who the service is provided for and what that service represents. It has been argued that the service is not only the provision of assets suitable to provide water to the end customer but also for the maintenance and replacement of those assets in perpetuity.

Whilst there is no agreement with the end user for the future maintenance of the network, no such agreement is required because as highlighted above it is a requirement of the Act anyway and there would be no benefit in entering a contractual arrangement to discharge a statutory duty. In addition, as the ultimate property owner changes this has no bearing on the water companies continuing obligations.

Water companies have the statutory right, under the Water Act 2003, to reclaim the costs of providing a connection from ‘the person requiring the connection’. However, this does not in any way undermine their obligation to maintain the asset over the course of its useful economic life with the overall objective of maintaining the water supply to the end users.

It can also be argued that the provision of a new connection is a separate identifiable service and consequently the total customer contribution should be allocated to revenue in the income statement immediately rather than over the life of the service as represented by the useful economic life used for network assets.


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Per paragraph 15 of IFRIC 18, features that indicate that connecting the customer to a network is a separately identifiable service include:

a service connection is delivered to the customer and • represents stand-alone value to that customer;

the fair value of the service connection can be measured • reliably.

The standalone value point can be argued both ways. You could argue that the estimated purchase/sale consideration of any domestic or commercial property is expected to be higher if it is connected to the water network compared to a property that is not connected (in which case a discount would be given by the seller to reflect the time, effort and expense of getting a connection). Equally you can argue that that the connection itself has no value without on-going network access and that the water company has an ongoing maintenance obligation. This assists in the argument that an entity has an ongoing obligation to maintain the connection and that a new connection does not have standalone value without ongoing access to the network.

In the water connections market, it is difficult to argue that the service cannot be measured reliably with the cost regulated by Ofwat. Amounts invoiced to the customer will typically split the components of the new connections cost (i.e. connection fees are separately charged and priced and are distinct from ongoing access fees). However, the absence of a competitive market place for water connections could imply that the connection charge is not a fair value as such.

Paragraphs 16 and 17 are also not particularly helpful in the overall assessment;

“A feature that indicates that providing the customer with ongoing access to a supply of goods or services is a separately identifiable service is that, in the future, the customer making the transfer receives the ongoing access, the goods or services, or both at a price lower than would be charged without the transfer of the item of property, plant and equipment.

Conversely, a feature that indicates that the obligation to provide the customer with ongoing access to a supply of goods or services arises from the terms of the entity’s operating licence or other regulation rather than from the agreement relating to the transfer of an item of property, plant and equipment is that customers that make a transfer pay the same price as those that do not for the ongoing access, or for the goods or services, or for both.”

Once connected, customers have a right to receive ongoing access to the network under the terms of the regulatory licence. The price they pay for on-going access is dealt with through the standing charge included in unmeasured and measured water bills. There is no reduction in charge to the customer making the transfer as a result of any contribution paid by that customer. The ongoing access charge is the same for all customers – new customers pay the same as existing customers, or indeed, a new customer will pay the same amount regardless of how much or little their connection charge was. Furthermore, once the connection charge has been paid, there is no situation whereby it would ever have to be repaid.

Ongoing measured and unmeasured water bill charges are made to customers based on the level of allowed revenue determined at the last Price Control Review. Allowed revenues are set every 5 years, though the tariffs charged are adjusted for RPI annually and the K factor determined at the last Price Control Review. New connections are factored into the Price Control Review, but the connection assets themselves do not earn a regulatory return as there is no net impact on the RAV.

So, whilst paragraphs 15-17 could indicate that a new connection is a separately identifiable service, equally there are strong arguments the other way that a new connection has no standalone value without the ability to take ongoing access to water services. For example, if a third party has made the connection then the acceptance of the asset must be in return for providing ongoing access.

Determining whether the connection service of itself represents standalone value is a judgement for management to make.

If management decide it does represent standalone value then revenue should be recognised for that service when it is performed. If management decide the connection service does not have standalone value without ongoing access then revenue should be deferred and recognised over the life of the agreement (or the asset if the agreement is silent).

The accounting treatment on whether or not to reflect revenue immediately or to defer the revenue over the life of the related asset is a judgemental area that has been discussed extensively throughout the industry and the accounting profession. The conclusion can be argued both ways depending on the arguments and how these are presented. Whilst the indicative factors summarised in paragraphs 13 to 17 could point to the conclusion that the provision of the new connection is a separate service from the provision of ongoing use of network, it is reasonable to accept the view that the connection service does not represent standalone value due to its linkage with ongoing access, the requirement to maintain the connection and the fact that it is difficult to see that all of the sale criteria have been met under IAS 18 (i.e. the risks and rewards of ownership haven’t transferred and there is a continuing onerous maintenance obligation).

On the basis that the provision of a new connection involves an ongoing obligation to maintain the network infrastructure constructed and is not a separately identifiable service, in accordance with paragraph 20 of IFRIC 18, customer contributions should be allocated to deferred revenue and amortised over the useful life of the related asset.

We will now consider the other forms of contribution referred to earlier in this document:

Infrastructure charges

We have already covered the fact that water companies have generally concluded that these contributions are out of scope, because the charges do not relate to specific property, plant and equipment but instead the more generalised need to reinforce


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the network through overall growth in customer numbers and consumption. Whether this is the case or not, how should such contributions be treated?

There appears to be a robust argument (under IFRS and UK GAAP) for deferral of the contribution as the charge is linked to the need to provide ongoing access. This has the advantages of being closely aligned with the regulatory treatment and the consensus UK GAAP treatment. Often, a proportion of the charge is allocated to non-infrastructure, which would appear appropriate for most companies. The non-infrastructure split is likely to be appropriate as most of the reinforcement of the network takes place when building additional capacity into water and sewage treatment works, rather than building new trunk mains which is a relatively rare situation nowadays. The HMRC have raised an issue on the UK GAAP treatment of infrastructure charges, as some companies treat these as infrastructure which leads to the cash credit never being amortised back to the profit and loss account.

Water and sewer requisitions

Legislation provides for a relevant deficit calculation over the first twelve years where the income streams fall short of the cost of fully servicing a loan covering the cost of the requisition. Arguments have been put forward by the water companies that these contributions are out of scope. This is somewhat more difficult to argue than infrastructure charges as they are more directly related to the development of a water main or sewer, albeit they are a revenue deficit contribution rather than a contribution directly towards the capital cost.

There is, however, good logic to defer the revenue rather than recognise immediately. This can be argued one of two ways; either the contribution is more connected with providing ongoing access to the network (i.e. that water and sewer requisitions are not a separate service from ongoing access) and the revenue be spread over the life of the related assets or the

revenue deficit be spread over the actual time of the revenue deficit (a maximum of 12 years, being the life referred to for the deficit calculations in the Water Act 2003). Both conclusions have some merit.

Given the Water Act 2003 specifically refers to a revenue deficit contribution and a maximum of 12 years, this is considered a stronger argument. Indeed, in many cases, the revenue shortfall is in the first 2/3 years of the development. It is normally in these first 2/3 years that the water company experiences the revenue deficit. This is because the most significant revenue shortfall on funding the capital cost is as the housing estate or commercial development is built out; as it often takes a couple of years for customers to move in and start taking water and sewerage services. This would result in revenue being deferred over a shorter time period.

Adopted assets – self lay mains and sewers

The credit on adopted sewer assets will be fair valued, as mentioned previously. As with connection charges, the industry consensus view is that the revenue should be deferred over the life of the related assets as there is a continuing obligation to maintain these network assets. This is consistent with the view taken on connection charges, albeit it can again be argued both ways.

If such a credit was recognised to the income statement immediately, it would be unlikely to form part of the companies’ distributable reserves as the consideration received (i.e. the related asset) does not meet the definition of ‘qualifying consideration’ as defined by generally accepted accounting practice and clarified by Tech 01/09.

The consensus view on water mains adopted by the water company is that these are outside of the scope of IFRIC 18 as the company effectively acquires the asset, but there is some debate around whether this is purchased at fair value or an 80% of fair value.

Diversions

Diversions are out of scope:

These are out of scope of IFRIC 18 and already covered by paragraph 65 of IAS 16. Paragraph 65 of IAS 16 states: “Compensation from third parties for items of property, plant and equipment that were impaired, lost or given up shall be included in profit or loss when the compensation becomes receivable.”

Diversion contributions are therefore credited to revenue when receivable and will offset the disposal cost of the asset being taken out of use, if this has not reached the end of its depreciable life.


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Concluding remarks

Listed water companies have now issued their interim results for the 6 months ended 30 September 2010. No significant profit impact was recorded by these companies when adopting IFRIC 18 for the first time, but with most companies showing additional assets recognised at fair value with an equal and offsetting increase in deferred income within creditors.

The most difficult and judgemental area has been on how the credit should be accounted for and whether it should be recognised immediately as revenue or deferred.

There are arguments that can be made both ways and determining whether the connection service or asset adoption represents standalone value it is a judgement for management to make. If management decides that the service does not have standalone value without ongoing access then revenue should be deferred and recognised over the life of the agreement (or the asset if the agreement is silent).

Whilst the indicative factors summarised in paragraphs 13 to 17 could point to the conclusion that the provision of the new connection and adopted assets is a separate service from the provision of ongoing use of network, there are merits in arguing that connection charges and adopted assets do not represent standalone value due to their linkage with ongoing access, the requirement to maintain the assets and the fact that it is difficult to see that all of the sale criteria have been met under IAS 18 (given the risks and rewards of ownership haven’t transferred and there is a continuing onerous maintenance obligation).

On the basis that the provision of a new connection and the process of adopting assets involves an ongoing obligation to maintain the network infrastructure constructed and is not a separately identifiable service, in accordance with paragraph 20 of IFRIC 18, customer contributions should be allocated to deferred revenues and amortised over the useful life of the

related asset. This means that the water companies’ current accounting treatment could continue to be applied, albeit the credit would be posted to revenue as opposed to a credit against operating costs.

For infrastructure charges, there appears to be a robust argument (under IFRS and UK GAAP) for deferral of the contribution as the charge is linked to the need to provide ongoing access. This has the advantages of being closely aligned with the regulatory treatment and the consensus UK GAAP treatment.

For water and sewer requisitions under Sections 41 and 98 of the Water Act 2003, there is an argument to defer the revenue, but continuing debate as to whether the credit should be limited to a maximum of 12 years or the life of the related water and sewer assets.

Diversion contributions are covered by IAS 16 and credited to revenue when receivable and will offset the disposal cost of the asset being taken out of use, if this has not reached the end of its depreciable life.


Simon Evans (Assurance)[email protected]+44 (0)121 232 2289

Contact




News storiesWe set out below a selection of the key news stories in the sector since our last edition of Watergroup News, covering the period of July 2010 to December 2010.

Future price limitsIn July 2010, Ofwat issued a focus report titled “Beyond limits - How should prices for monopoly water and sewerage services be controlled?” Ofwat have launched a future price limits project. The main output from this project will be a framework setting out Ofwat’s aims for price limits and the principles envisaged.

Future price limits is just one of a number of projects within Ofwat’s future regulation programme amongst retail market reform, upstream market reform, accounting separation, future water charging, regulatory compliance, sustainable drainage and future scenario’s.

Ofwat also issued a discussion paper on possible market and regulatory reform with three broad models on how the water and sewerage sectors could be structured over the long term. The possible structures differ in two dimensions, being the level of market reform and the level of vertical disaggregation within the sectors. The three structures were:

1. The status quo: where new entrants can compete for customers in two main ways, by new appointments and through water supply licensing.

2. Some change: where there is retail competition for non-household customers following legal separation of incumbent retailers and an enhanced water supply licensing regime.

3. Extensive change: where in addition to model 2 there is further enhancement of water supply licensing by creation of a network licence along with separate price controls at different stages of the value chain.

Companies’ consolidated licencesIn September 2010, Ofwat published new draft consolidated licences for each company. This follows some 20 years of piecemeal changes of licences responding to various changes since privatisation.

Financial performance and expenditure of water companies in 2009/10

Ofwat published their financial performance and expenditure report ‘Financial performance and expenditure of the water companies in England and Wales 2009-10’ which examines the operating profits, cash flows and balance sheets of the regulated water companies.

Key highlights were:

Operating profits increased by 7% to £3.5 billion, due to • higher revenues only partly offset by increased operating costs and capital maintenance charges.

Companies’ own overall return on capital was 7.2% in 2009-• 10 versus 6.8% in the prior year, but lower than the 7.5% assumed in the 2004 price limits.

Companies’ pre-tax profits increased significantly from £1.8bn • to £2.8bn with the financing adjustment contributing £0.8bn.

Operating expenditure increased by 1.7% in real terms to • £3.7 billion, 1.6% more than assumed price limits largely due to continued upward pressure from energy costs where a number of companies locked into forward contracts.

The companies invested £4.0 billion in maintaining and • improving assets, 11% more than that assumed in 2004 price limits, although 14.9% lower than in 2008-09.

Service and delivery – performance of the water companies in England and Wales 2009/10Ofwat issued in October 2010 their report on delivering services to customers ‘Service and delivery – performance of the water companies in England and Wales 2009-10’. This report includes Ofwat’s analysis of companies’ performance and where they are taking action on behalf of customers. Key highlights were:

In general, the companies delivered good levels of service • and reliability to most consumers.

The number of complaints fell to its lowest level since • 2005-06.

Most companies met their leakage targets, despite unusually • cold winter weather, although six companies failed to meet their targets. Most companies managed the increase in bursts effectively.

No water restrictions were imposed and all of the companies • achieved their targets for the security of their water supplies.

More action is required to maintain stable serviceability and • three companies have action plans in this regard.

Concern over the number of properties that are flooded as • a result of overloaded sewers and other causes, along with inconsistencies of reporting and data quality issues.

Good work done by companies on carbon accounting.•

Regulatory action at United Utilities (sewer flooding register • enforcement order), South West Water (weaknesses in systems and processes for recording written complaints and appointments) and Dwr Cymru (asset management systems and processes).

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News stories – ContinuedInterim DeterminationsIn October 2010, Ofwat set out its intended approach to interim determinations in the 2010/15 regulatory period. Notified items relate to increases in household bad debt and management costs, increases in the environmental improvement unit charge component of abstraction charges, climate change driven increases in the costs of balancing the supply and demand for water and costs associated with the impact of permit schemes made pursuant to the Traffic Management Act. Relevant changes in circumstances include a new or changed legal requirement, differences in the proceeds of land disposals from that assumed when price limits were last set and failure to achieve some output, funding for which was approved at the last price setting.

Discussion papersIn October, Ofwat issued a number of strategic discussion papers, including:

1. The treatment of regulated and unregulated business in setting price controls for monopoly water and sewerage services in England and Wales – exploring the treatment of regulated and unregulated services in relation to price controls.

2. The role and design of incentives for regulating monopoly water and sewerage services in England and Wales – exploring incentives in the context of how they are applied to the water and sewerage sectors as part of the price setting process.

3. Allocating risk and managing uncertainty in setting price controls for monopoly water and sewerage – discusses the risk environment in which our water and sewerage sectors operate.

Resilient suppliesIn November 2010, Ofwat issued a focus report “Resilient supplies – how do we ensure secure water and sewerage services?” which explores how Ofwat can make sure that consumers continue to receive effective and appropriate resilience provision that represents value for money.

Regulatory compliance – introducing a risk based approachOfwat issued further guidance in December 2010 on their proposed move towards a more risk based approach to regulatory compliance. In particular, they introduced a first step for June Return 2011 in advance of further planned changes in 2012. For June Return 2011 Ofwat are not asking companies to provide detailed commentaries to the June Return marking a significant change in thinking and approach. This follows on from Ofwat’s discussion paper in November 2010 “Getting it right for customers – How can we make monopoly water and sewerage companies more accountable?” which introduced this proposed move towards a more risk based approach to regulatory compliance following on from two workshops with key stakeholders.

Lessons from PR09 approach to setting price limits

In December 2010, Ofwat issued this report which considers the lessons from the 2009 price review (PR09) process. It looks at how Ofwat conducted and managed the price review, and how they worked and communicated with stakeholders. One of the notable conclusions was that the price review process had become increasingly burdensome and complex with the process to establish five year price limits taking too long.

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News stories – ContinuedWatergroup publicationsPwC Watergroup News Bulletin –Issue 18, July 10

PwC Watergroup News Bulletin –Issue 17, December 09

PwC Watergroup News Bulletin –Issue 16, June 09

PwC Watergroup News Bulletin –Issue 15, February 09

PwC Watergroup News Bulletin –Issue 14, November 08

PwC Watergroup News Bulletin –Issue 13, July 08

PwC Watergroup News Bulletin –Issue 12, May 08


PwC Watergroup News Bulletin –Issue 10, January 08

PwC Watergroup News Bulletin –Issue 9, November 07

PwC Watergroup News Bulletin –Issue 8, August 07

PwC Watergroup News Bulletin –Issue 7, July 07

PwC Watergroup News Bulletin –Issue 6, April 07



PwC Watergroup News Bulletin –Issue 3, August 06

PwC Watergroup News Bulletin –Issue 3, April 06


Other industry publications

Knowing your chances – Taking a price determination to the Competition Commission

Final cost submissions – are you prepared for increased challenge?

A world beyond recession: Utilities Global Survey 2009

Carbon Disclosure Project Report 2008 – FTSE 350

Carbon reporting report

Power Deals 2009 Annual Review

Power Deals 2010 Annual Review – coming soon (February 2011)

Please visit our publications page to obtain copies of all our most recent publications; http://www.pwc.co.uk/eng/industries/water_publications.html

Knowing your chancesTaking a price determination to the Competition Commission

Watergroup NewsIssue 18 – July 2010

Welcome >

http://www.pwc.co.uk/eng/industries/water_publications.html



Ofwat links

17/Dec/2010 Lessons from our approach to setting price limits (PR09) (PDF - 163 KBytes)

15/Dec/2010 Section 181 determination: Hopkins v Dŵr Cymru (Welsh Water) (PDF - 232 KBytes)

15/Dec/2010 GSS dispute: Pavey and Thames Water (PDF - 184 KBytes)

13/Dec/2010 Water Supply Licence application form (DOC - 470 KBytes)

13/Dec/2010 SSE Water’s application for a variation to serve the site at Hunter Avenue, Ashford (PDF - 35 KBytes)

9/Dec/2010 Ofwat financial transactions greater than £25k: November 2010 (XLS - 35 KBytes)

8/Dec/2010 Ofwat city briefing 8 December 2010 (HTML - 227 Bytes)

6/Dec/2010 NT 04/10: SSE Water applies for a variation to its appointment to include Great Western Park (HTML - 520 Bytes)

6/Dec/2010 Voluntary disclosure of expenditure 2010-11 Q2 (PDF - 194 KBytes)

6/Dec/2010 IN 10/01: Regulatory compliance – introducing a risk-based approach (PDF - 52 KBytes)

6/Dec/2010 H2orizons: November 2010 (PDF - 531 KBytes)

6/Dec/2010 Water Industry Act 1991, Section 13(1) Modification of the conditions of appointment of Bournemouth and West Hampshire Water plc (PDF - 78 KBytes)

1/Dec/2010 Ofwat’s response to Defra’s Draft Regulations and Proposals for Schemes for the Transfer of Private Sewers to Water and Sewerage Companies in England and Wales (PDF - 62 KBytes)

25/Nov/2010 Proposal to modify Southern Water’s licence (PDF - 45 KBytes)

24/Nov/2010 Statement of policy with respect to financial penalties pursuant to section 22A of the Water Industry Act 1991 (PDF - 158 KBytes)

24/Nov/2010 Summary of consultation responses to the Statement of policy with respect to financial penalties (PDF - 99 KBytes)

24/Nov/2010 Regulatory compliance workshop 2 and 4 November 2010 (HTML - 401 Bytes)

24/Nov/2010 Getting it right for customers - how can we make monopoly water and sewerage companies more accountable? (HTML - 4 KBytes)

24/Nov/2010 Ofwat forward programme 2011-12 to 2013-14 – draft for consultation (PDF - 671 KBytes)

19/Nov/2010 Price review 2009: companies’ submissions (HTML - 4 KBytes)

17/Nov/2010 OBM 09/10: Ofwat Board minutes - meeting held 14 October 2010 (PDF - 42 KBytes)

16/Nov/2010 Business Customer Forum note - meeting held 27 October 2010 (PDF - 47 KBytes)

12/Nov/2010 IB 14/10: Ofwat varies the appointment of water supplier at Kingsmere, Bicester (HTML - 2 KBytes)

10/Nov/2010 Resilient supplies – how do we ensure secure water and sewerage services? (HTML - 4 KBytes)

10/Nov/2010 Ofwat’s response to ‘An Invitation to Shape the Nature of England’ (PDF - 155 KBytes)

2/Nov/2010 RD 15/10: Interest rates for requisitions and infrastructure charges – six-monthly review (HTML - 2 KBytes)

1/Nov/2010 Ofwat’s response to the call for evidence of the Ofwat review (PDF - 167 KBytes)

29/Oct/2010 Introducing a water supply licensing operational code and common contract – a consultation on guidance changes (PDF - 283 KBytes)

We have provided below links to the recent news and publications from the Ofwat web-site:

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http://www.ofwat.gov.uk/pricereview/pr09phase4/pap_pos_20101217pr09lessons.pdf

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Ofwat links – Continued28/Oct/2010 Annual Quality Assurance of Ofwat’s Initial

Serviceability Assessments 2009/10 A report for Ofwat prepared by Mott MacDonald (PDF - 510 KBytes)

28/Oct/2010 Service and delivery – performance of the water companies in England and Wales 2009-10 (HTML - 6 KBytes)

27/Oct/2010 PN 03/10: Water regulator reports improved service for customers yet leakage failures (HTML - 7 KBytes)

25/Oct/2010 Improving regulatory reporting and compliance A report prepared for Ofwat by Keith Harris (PDF - 111 KBytes)

22/Oct/2010 The form of the price control for monopoly water and sewerage services in England and Wales – a discussion paper (PDF - 804 KBytes)

22/Oct/2010 Involving customers in the price-setting process – a discussion paper (PDF - 241 KBytes)

21/Oct/2010 RD 14/10: Approval of charges schemes 2011-12: process and timetable (HTML - 28 KBytes)

21/Oct/2010 Sustainable water 20 October 2010 (HTML - 2 KBytes)

20/Oct/2010 The treatment of regulated and unregulated business in setting price controls for monopoly water and sewerage services in England and Wales – a discussion paper (PDF - 397 KBytes)

20/Oct/2010 Voluntary disclosure of expenditure 2010-11 Q1 (PDF - 160 KBytes)

20/Oct/2010 The role and design of incentives for regulating monopoly water and sewerage services in England and Wales … a discussion paper (PDF - 1 MBytes)

20/Oct/2010 Allocating risk and managing uncertainty in setting price controls for monopoly water and sewerage services – a discussion paper (PDF - 734 KBytes)

18/Oct/2010 Promoting support for vulnerable customers workshop 7 October 2010 (HTML - 831 Bytes)

14/Oct/2010 Water Industry Act 1991, Section 13 Proposals by the Water Services Regulation Authority (Ofwat) to modify the conditions of appointment (licence) of Bournemouth and West Hampshire Water plc as a water undertaker (PDF - 27 KBytes)

13/Oct/2010 RD 13/10: Interim determinations 2010-15 (HTML - 33 KBytes)

11/Oct/2010 Water Industry Act 1991 Section 13(1) Modification of the Conditions of Appointment of Bristol Water plc (PDF - 77 KBytes)

8/Oct/2010 RD 12/10: Financial arrangements for the provision of self-laid mains and requisitioned water mains and sewers or lateral drains (HTML - 2 KBytes)

5/Oct/2010 Consumer Council for Water’s response to Ofwat’s consultation on the acquisition of Cascal NV by Sembcorp Industries Ltd

Consumer Council for Water’s response to the completed acquisition of Cascal N.V by Sembcorp Industries Ltd and the regulatory issues arising for Bournemouth and West Hampshire Water Plc – a consultation by Ofwat (PDF - 110 KBytes)

5/Oct/2010 Consumer Council for Water’s response to Ofwat’s proposal to modify the appointment of Bristol Water

Consumer Council for Water’s response to Water Industry Act 1991 Section 13: A proposal by the Water Services Regulation Authority (Ofwat) to modify the Appointment of Bristol Water plc following the completed acquisition of Sociedad General de Aguas de Barcelona, S.A. by Suez Environnement (PDF - 102 KBytes)

1/Oct/2010 Ofwat’s response to Ofgem’s Energy Smart Metering Implementation Programme Prospectus (PDF - 59 KBytes)

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Ofwat links – Continued28/Sep/2010 Financial performance and expenditure of the

water companies in England and Wales 2009-10 (HTML - 2 KBytes)

28/Sep/2010 Comparative Study: Cost of new water supply connections work (Section 45 Water Industry Act 1991)

A report for Ofwat prepared by Hyder Consulting (UK) (PDF - 142 KBytes)

27/Sep/2010 Market Reform Finance Forum note - meeting held 14 September 2010 (PDF - 43 KBytes)

22/Sep/2010 Ofwat’s response to the Department for Business Innovation and Skills’ consultation on broadband deployment and sharing other utilities infrastructure (PDF - 44 KBytes)

21/Sep/2010 RD 11/10: Changes to COPI (HTML - 2 KBytes)

21/Sep/2010 Joint equality scheme 2010-13 (PDF - 267 KBytes)

20/Sep/2010 Prioritisation principles: application to the Competition Act 1998 (PDF - 90 KBytes)

20/Sep/2010 Prioritisation principles: application to the Competition Act 1998 Summary of consultation responses (PDF - 120 KBytes)

17/Sep/2010 RD 10/10: Companies’ consolidated licences (HTML - 7 KBytes)

17/Sep/2010 RD 09/10: Proposed changes to DG9: Reporting of calls abandoned (HTML - 3 KBytes)

2/Sep/2010 Voluntary disclosure of expenditure 2009-10 Q4 (PDF - 393 KBytes)

2/Sep/2010 Voluntary disclosure of expenditure 2009-10 Q3 (PDF - 341 KBytes)

31/Aug/2010 Customer Charges Data 2010–11 complete tables (PDF - 1 MBytes)

26/Aug/2010 IB 13/10 Ofwat varies the appointment of water and sewerage supplier at Graylingwell Park, Chichester (HTML - 2 KBytes)

26/Aug/2010 Variation of SSE Water’s appointment to include Graylingwell Park (PDF - 43 KBytes)

20/Aug/2010 Adaptation to climate change – statutory reporting (HTML - 4 KBytes)

19/Aug/2010 WSRA Resource Accounts 2009-10 Water Services Regulation Authority Resource Accounts 2009-10 (For the year ended 31 March 2010) (PDF - 2 MBytes)

16/Aug/2010 The completed acquisition of Cascal N.V by Sembcorp Industries Ltd and the regulatory issues arising for Bournemouth and West Hampshire Water Plc – a consultation by Ofwat (PDF - 60 KBytes)

13/Aug/2010 RD 08/10: Reporting of debt related matters 2009-10 (HTML - 5 KBytes)

13/Aug/2010 Water companies’ regulatory accounts for 2009-10 (HTML - 3 KBytes)

13/Aug/2010 Ofwat Business Customer Forum – Terms of Reference (PDF - 25 KBytes)

13/Aug/2010 Business Customer Forum note - meeting held 21 July 2010 (PDF - 38 KBytes)

13/Aug/2010 Business Customer Forum (HTML - 1 KBytes)

6/Aug/2010 Ofwat grants water supply licence to Avon Valley Water Ltd (HTML - 218 Bytes)

6/Aug/2010 Water supply licence: Avon Valley Water Ltd (PDF - 50 KBytes)

3/Aug/2010 IB 12/10 Ofwat proposes to vary the appointment of water and sewerage services supplier at Kingsmere, Bicester (HTML - 3 KBytes)

3/Aug/2010 Proposal to vary the appointments of SSE Water and Thames Water at Kingsmere,Bicester (PDF - 108 KBytes)

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PwC WatergroupSteve SnookUK Watergroup [email protected]+44 (0)121 265 6851

Simon EvansDirector, [email protected]+44 (0)121 232 2289

Johan Van Den Arend SchmidtPartner, Transaction Services – [email protected]+44 (0)20 7212 6584

Alan WalshSenior Manager, [email protected]+44 (0)121 265 5208

Richard LaikinDirector, [email protected]+44 (0)20 7212 1204

Richard PorterPartner, Risk Assurance [email protected]+44 (0)121 265 5398

Duncan MichieDirector, Market & Value [email protected]+44 (0)20 7804 7394

Nicola FomesSenior Manager, Market & Value [email protected]+44 (0)20 7212 8047

Trigvie Robbins-JonesDirector, Market & Value [email protected]+44 (0)20 7212 3399












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© 2011 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom), which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

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pwc watergroup news: issue 19 · simon evans director – assurance uk watergroup february 2011 in...

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