The group prepared its 2005 UK GAAP results in accordance with SSAP 24 (Accounting for Pension Costs), with FRS 17 (Retirement Benefits) transitional disclosures provided in the notes to the accounts. FRS 17 became fully effective for accounting periods beginning on or after 1 January 2005. The group will not adopt FRS 17 and will move directly to IAS 19 (Employee Benefits).
Under SSAP 24, any pension scheme surplus or deficit identified at the most recent actuarial valuation is recognised gradually through the profit and loss account over the average expected future working lifetime of current employees. The net pension cost under SSAP 24 therefore includes both the cost of providing an additional year of pension benefits to employees (regular cost) and an element of the surplus / deficit relating to previous years (variation).
The difference between employer’s contributions paid and the SSAP 24 net pensions cost is recognised as a prepayment/accrual, resulting in a balance sheet position that does not necessarily reflect the actuarial position. Interest is calculated on this balance sheet entry and is also included within the net pension cost.
In accordance with IAS 19, any legal and constructive obligation for post employment benefit plans must be immediately recognised as an asset or liability on the balance sheet. Where actual experience differs from the assumptions made at the start of a financial year, actuarial gains and losses will be recognised through the statement of recognised income and expense.
The returns received on the pension scheme assets and the interest borne on the liabilities are recognised within finance costs under IAS 19. Under SSAP 24 all pension costs are recognised within operating profits.
The group operates a number of defined benefit pension schemes, which are independent of the group’s finances, for the substantial majority of its employees. Actuarial valuations of the schemes are carried out as determined by the pension scheme trustees at intervals of not more than three years, the rates of contribution payable and the pension cost being determined on the advice of the actuaries, having regard to the results of these valuations. In any intervening years, the actuaries review the continuing appropriateness of the contribution rates.
Defined benefit assets are measured at fair value while liabilities are measured at present value. The difference between the two amounts is recognised as an asset or liability in the balance sheet.
The cost of providing pension benefits to employees relating to the current year’s service is included in the income statement within other operating costs, whilst the difference between the expected return on scheme assets and interest on scheme liabilities is included within finance costs.
All actuarial gains and losses as at 1 April 2004, the date of transition to IFRS, were recognised in full. All future actuarial gains and losses are recognised outside the income statement in retained earnings and presented in the statement of recognised income and expense.
Impact
The adoption of IAS 19 increases the 2005 profit before tax by £4.5 million compared with UK GAAP, representing increased operating profits of £1.3 million and reduced finance costs of £3.2 million.
The derecognition of the UK GAAP SSAP 24 prepayment reduces net assets by £272.4 million (net of deferred tax). This prepayment reflects the lump sum payment of £320 million (pre tax) made at 31 March 2005. Net assets are then further reduced by the recognition of the IAS 19 deficit of £59.2 million (net of deferred tax).
The final price determinations for both water and electricity make explicit allowance for funding of the relevant elements of the pension scheme deficit.
Business Combinations (IFRS 3 / IAS 38)
Material Differences to UK GAAP
Under IFRS, the recognition test for intangible fixed assets acquired in business combinations is less restrictive than that of UK GAAP, and therefore more intangible assets will be separately identified from goodwill. FRS 10 (Goodwill and Intangible Assets) requires an intangible asset to be controlled by the entity through custody or legal rights and to be capable of disposal separately from the business. By contrast IAS 38 does not require an intangible to be separable from the entity if its ownership can be demonstrated through contractual or legal rights.
Goodwill is not amortised under IFRS, but rather subject to annual impairment reviews. Therefore, although it may be possible to carry goodwill for longer if the future cashflows are strong, there is the potential for increased volatility to be introduced to the income statement.
Intangible assets (other than goodwill) are stated at cost less accumulated depreciation and are amortised over their useful lives on a straight line basis.
Indicative IFRS Accounting Policy
Positive goodwill (representing the excess of the fair value of the consideration and associated costs over the fair value of the identifiable net assets acquired) arising on consolidation is capitalised.
Following initial recognition, positive goodwill is subject to impairment reviews, at least annually, and measured at initial value less accumulated impairment losses.
In accordance with IFRS 1 all business combinations prior to 1 April 1999 have been accounted for in accordance with UK GAAP applicable at the date of acquisition. All combinations completed subsequent to that date are recorded in accordance with IFRS.
Impact
IFRS 3 has a minimal impact on the net assets of the group, with the reduction in goodwill broadly offset by the recognition of newly identified intangible assets from business combinations (mainly relating to customer lists and contracts). However, IAS 12 (Income Taxes) requires a deferred tax liability to be created for any transfers from goodwill to intangible fixed assets. This deferred tax liability results in an increase in the goodwill arising on the business combination of £13.8 million as at 31 March 2005.
Since goodwill is no longer being amortised, the 2005 amortisation charge reduces by £7.5 million. Profit on sale or termination of operations for 2005 is reduced by £2.1 million due to the reversal of goodwill amortisation relating to businesses disposed of in 2004/05.
Deferred Tax (IAS 12)
Material Differences to UK GAAP
The major impact of IAS 12 for the group relates to discounting of deferred tax not being permitted. FRS 19 (Deferred Tax) permits, but does not require, a deferred tax asset or liability to be discounted and as a result the group has been able to apply a policy of discounting its deferred tax liability. However, IAS 12 does not permit discounting in any circumstances. This is of particular significance to a utility business where any reversal of timing differences is likely to be deferred long into the future due to the long asset lives of network assets.
The deferred tax impacts arising from any other IFRS adjustments are included in the relevant sections.
Indicative IFRS Accounting Policy
Deferred tax is provided, using the liability method, on all temporary differences at the balance sheet date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Such assets and liabilities are not recognised if the temporary difference arises from goodwill or from the initial recognition (other than in a business combination) of other assets and liabilities in a transaction that affects neither the tax profit nor the accounting profit.
Deferred tax is measured at the average tax rates that are expected to apply in the periods in which the temporary timing differences are expected to reverse, based on tax rates and laws that have been enacted or substantially enacted by the balance sheet date.
Impact
The inability to discount results in an increase in the balance sheet deferred tax liability of £952.0 million at 31 March 2005 and consequently a reduction in net assets.
The final price determinations for both water and electricity set prices allowing for tax on an anticipated cash basis and are therefore unaffected by deferred tax.
Dividends (IAS 10)
Material Differences to UK GAAP
IAS 10 (Events After the Balance Sheet Date) and SSAP 17 (Accounting for Post Balance Sheet Events) both distinguish ‘adjusting events’ from ‘non-adjusting events’ with similar definitions and applications. However, under IAS 10 dividends may not be recognised until they have been appropriately authorised and are no longer at the discretion of the entity. Therefore, if this occurs after the balance sheet date, the dividends are not recognised as a liability at the balance sheet date. However, they are disclosed in the notes to the accounts in accordance with IAS 1 (Presentation of Financial Statements).
Furthermore, dividends are no longer recognised within the income statement and are instead reported in the statement of recognised income and expense.
Indicative IFRS Accounting Policy
Dividends are recognised in equity in the period in which they are approved by the shareholders.
Impact
The final dividend of £219.4 million included with the UK GAAP financial statements for 2004/05 will be derecognised, thereby increasing the net assets of the group.
Other Differences
All other differences between IFRS and UK GAAP are included within the other column. The main such adjustments are:
| • | the impact of fair valuing share options granted after 7 November 2002 in accordance with IFRS 2; |
| • | the reclassification of software costs from tangible to intangible fixed assets in accordance with IAS 38; |
| • | the reclassification of long-term contract balances in accordance with IAS 11 (Construction Contracts); |
| • | amended depreciation and amortisation resulting from the application of IAS 36 and |
| • | the deferred tax impacts of all other adjustments. |
With the exception of deferred tax, the impact of these adjustments on profit before tax and net assets, both individually and in aggregate, is not considered to be material although the impact of IFRS 2 will increase going forward as more awards fall within its scope.
OTHER CONSIDERATIONS
Accounting for Derivatives (IAS 39)
The group is taking the exemption offered by IFRS 1 to apply IAS 39 with effect from 1 April 2005 rather than 1 April 2004 as is the case for all other IFRS. The comparative information for 2004/05 within the 31 March 2006 IFRS financial statements will therefore reflect derivatives accounted for under the existing UK GAAP accounting policy. However, for information purposes, the transition adjustment expected to be required on 1 April 2005 to recognise the fair value of derivatives and apply the hedge accounting provisions where elected is disclosed below.
In June 2005, the IASB published an amendment to IAS 39 in respect of the fair value option that is effective for accounting periods commencing on or after 1 January 2006. It is anticipated that this amendment will gain EU endorsement in due course which will enable United Utilities to have the option of electing to apply the fair value option in respect of its debt securities rather than applying hedge accounting.
As the fair value option is not available at this point in time, the analysis below has been prepared on the assumption that the group will apply hedge accounting to the fullest extent possible to minimise potential income statement volatility.
Material Differences to UK GAAP
Under UK GAAP, debt is carried at its hedged amount and the fair values of derivatives are not recognised in the balance sheet.
Under IAS 39, the default treatment is for debt to be carried at amortised cost, whilst derivatives are recognised separately on the balance sheet at fair value with movements in those fair values reflected through the income statement.
This has the potential to introduce considerable volatility to both the income statement and balance sheet. Therefore, for fair value hedges, IAS 39 allows changes in the recognised value of hedged debt that are attributable to the hedged risk to be adjusted through the income statement.
In the case of cashflow hedges, movements in the fair value of derivatives are deferred within reserves until they can be recycled through the income statement to offset the future income statement effect of changes in the hedged risk.
In order to apply this treatment, it must be demonstrated that the derivative has been and will continue to be an effective hedge of the hedged risk within the debt item. Any hedge ineffectiveness, provided it is within the range deemed acceptable by IAS 39, is recognised immediately within the income statement.
Indicative IFRS Accounting Policy
New borrowings are stated at net proceeds received after the deduction of issue costs. The issue costs of debt instruments are amortised at a constant rate over the life of the instrument.
Interest rate swap agreements and financial futures are used to manage interest rate exposure, while the group enters into currency swaps to manage its exposure to fluctuations in currency rates. All financial derivatives are recognised in the balance sheet at fair value.
Where possible hedge accounting is applied. Therefore, where derivatives that are designated as fair value hedges meet the hedge effectiveness criteria specified in IAS 39, changes in the recognised value of hedged debt that are attributable to the hedged risk are adjusted through the income statement to offset changes in the fair value of derivatives.
For qualifying cashflow hedges, the fair value gain or loss associated with the effective portion of the cashflow hedge is recognised initially directly in shareholders’ equity, and recycled to the income statement in the periods when the hedged item will affect profit or loss.
Where changes in the fair value of a derivative differ to changes in the fair value of the hedged item, the hedge ineffectiveness is recorded in the income statement.
Impact
As a result of applying IAS 39, liabilities in respect of derivatives totalling £60.7 million will be recognised at 1 April 2005. This is offset by a reduction in gross debt to account for the hedged risk of£59.6 million, resulting in a reduction to net assets of £1.1 million (pre tax) compared with UK GAAP.
Retained Earnings
The summary financial statements presented above, show that the consolidated retained earnings decrease from £1,362.5 million to £224.7 million as a result of IFRS adoption. This is principally due to the inability to discount the deferred tax liability (£952.0 million) and the recognition of the pensions deficit under IAS 19 (£59.2 million) together with the derecognition of the SSAP 24 prepayment (£272.4 million). The effect of the IFRS restatements both at the consolidated and parent company level is shown below:
| | | | Group | | | Parent | |
| | | | £m | | | £m | |
| | | | | | | | |
| UK GAAP retained earnings | | | 1,362.5 | | | 1,193.6 | |
| IAS 10 Dividends | | | 219.4 | | | — | |
| IAS 12 Deferred tax discount | | | (952.0 | ) | | — | |
| IAS 19 Pensions (net of deferred tax) | | | (59.2 | ) | | (5.7 | ) |
| SSAP 24 Prepayment derecognition (net of deferred tax) | | | (272.4 | ) | | (5.9 | ) |
| Other adjustments | | | (73.6 | ) | | — | |
| | | |
| | |
| |
| IFRS retained earnings | | | 224.7 | | | 1,182.0 | |
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External dividends are paid out of the parent company retained earnings. The parent company has little in its balance sheet that is affected by IFRS, since the bulk of the group’s employees and fixed assets are attached to the subsidiaries and therefore the IAS 12 and IAS 19 adjustments are allocated accordingly. As a result the value of restatements reflected in the parent company accounts are insignificant compared to the total reserves under UK GAAP of £1,193.6 million. Therefore, IFRS does not impact upon the group’s dividend policy.
Only United Utilities PLC and United Utilities Electricity PLC have adopted IFRS as of 1 April 2005 as they have issued listed equity or debt and are required to prepare consolidated accounts. All other subsidiaries will continue to apply UK GAAP. In the case of United Utilities Water PLC, this matches the approach taken for regulatory accounting and protects distributable reserves. This will only be affected by future convergence between UK GAAP and IFRS.
