RD 04/07: Update of the regulatory accounting guidelines 1, 3 and 4
TO REGULATORY DIRECTORS OF ALL
WATER AND SEWERAGE COMPANIES
AND WATER ONLY COMPANIES
Dear Regulatory Director
UPDATE OF THE REGULATORY ACCOUNTING GUIDELINES 1, 3 AND 4
In October 2006, we wrote to you setting out our intention to carry out a review of the Regulatory Accounting Guidelines (RAGs). 'RD 14/06: Consultation - Review of the Regulatory Accounting Guidelines 1, 3 and 4 and the regulatory accounts tables (18-29) for the June returns 2007-10' sought views on a range of issues in connection with the review. Having taken into account the responses to this consultation, we have set out our revised RAGs 1, 3 and 4 in an attachment to this letter.
We consulted on a number of specific issues. The proposals were:
- to reflect the changes to statutory reporting requirements;
- to align the regulatory accounting tables with the inputs to our financial model 'Aquarius 3';
- to introduce a requirement for an 'Operating and Financial Review (OFR);
- to require directors to make a statement on the provision of information to auditors;
- to include a statement on the links between directors' remuneration and service performance (as required by the Water Industry Act 2003); and
- to clarify our guidance on the infrastructure renewals charge '(IRC)'.
We received 17 responses to our consultation. A list of respondents is included in Annex 1. Copies of the responses have been placed in our library except where they are marked confidential.
Respondents generally support our proposals to eliminate unnecessary differences between the historic cost accounts and the current cost accounts. Some companies were concerned that the resulting modifications to the financing and working capital adjustments in the current cost accounts would lead to re-statement of prior year calculations, however we do not require these changes to be implemented retrospectively.
Many respondents commented on what the calculation of the infrastructure renewals charge (IRC) should be. They stated that it would be useful if Ofwat could categorically state a defined period over which the IRC should be calculated. In addition they wanted clarity and consistency of approach across the industry and disagreed that different approaches should be taken. Ofwat's position regarding infrastructure renewals accounting has not changed. We have provided further clarification on infrastructure renewals accounting within RAG1 because some companies have in the past misinterpreted the RAG and as such the IRC reported in their regulatory accounts was not compliant with the RAGs.
Paragraph 1.4.7 in RAG 1.04 has been updated to say, 'Each company is responsible for determining its IRC policy and ensuring that it is in accordance with the RAGs. We do not necessarily expect companies to apply our price setting methodology for calculating the infrastructure renewals charge for the regulatory accounts. Rather each company should develop and apply a policy for calculating its infrastructure renewals charge that meets the requirement of the RAGs. A key component of this requirement is to link the charge with the company's own medium to long-term maintenance planning which will differ for each company.'
Paragraph 1.4.3 of RAG 1.04 explains over what period we expect the infrastructure renewals charge to be calculated, 'medium to long-term period.' The period should be directly linked to the company investment planning horizon and approach under the Capital Maintenance Common Planning Framework. It is up to the companies to decide exactly what period this should be. We don't necessarily expect all companies to have the same view and therefore we don't necessarily expect consistency between company's policy and that used by Ofwat in price setting. This has been the case, in the related area of depreciation, where companies have followed their own policy for depreciation which has not necessarily been consistent with that used by Ofwat in price setting.
Three respondents said it was incorrect to state that UK GAAP doesn't allow the use of renewals accounting, because paragraphs 97 to 99 of FRS15 do allow the use of renewals accounting. However these paragraphs do not allow for full renewals accounting, which is a requirement of the RAGs.
Paragraphs 97 to 99 of FRS15 set out how the infrastructure renewals charge can be used as an estimation of the statutory accounting depreciation charge for the infrastructure assets. In addition these paragraphs explain how the charge should be presented within the statutory accounts which is different to that required by infrastructure renewals accounting and the RAGs. The RAGs require the difference between the IRC and infrastructure renewals expenditure (IRE) to be held as an accrual or prepayment within the balance sheet. FRS15 however, requires the IRE to be treated as the depreciation charge for the period that is to be deducted from the carrying amount of the asset. Actual expenditure is capitalised as incurred. Paragraph 1.4.6 within RAG1.04 has been reworded to provide additional clarification.
One respondent stated that RAG 1 should be reworded so that only material changes in IRE are reflected in the IRC. We agree and have amended paragraph 1.4.8 to say, 'companies should ensure that any significant change in its long-run IRE forecasts are incorporated in the calculation of the IRC.'
There was a mixed response to our new requirement for an Operating and Financial Review (OFR). Many respondents stated that they felt that there was an overlap between this and the requirement for a commentary on the five year summary results. Some companies were concerned that this requirement would lead to a duplication of information that will be included in the business review in the statutory accounts where these are part of the same documents.
We have decided to dispense with the requirement for a commentary to the five-year review. We would also encourage companies to cross refer to text in the statutory accounts.
As part of the June returns process, we asked companies for clarification of what non-appointed activities were separated out from their results in the June return. Using the responses from these in the context of the legislation applying to water companies, we sought to provide further guidance on the clarification of non-appointed activities in Appendix 3 of RAG 3.
Some companies questioned whether some of the examples that we gave were actually non-appointed activities. We have changed the wording where appropriate in order to further clarify these examples. Some concerns were raised over the classification of meter reading commission as non-appointed. Our view is that, it would be incorrect for the costs of reading meters to be recorded twice, i.e. by the water only companies and then again in the form of a commission by the water and sewerage company that is provided with the reading.
We suggest that the water only company should classify the commission as non-appointed and that it should also apportion some of the meter reading costs (we would expect one half) as non-appointed. The water and sewerage company should then record the commission cost as an appointed business cost.
The revised RAGs will apply from the financial year-end 31 March 2007 onwards.
If you have any questions on this letter, please contact Robert Lee, Deputy Head of Regulatory Accounts & Business Affairs on 0121 625 3616 or by e-mail at robert.lee@ofwat.gsi.gov.uk
Keith Mason
Director of Regulatory Finance & Competition
- RAG 1: Guideline for accounting for current costs and regulatory capital values [version 1.04]
(PDF - 218Kb) - RAG 3: Guideline for the contents of regulatory accounts [version 3.06]
(PDF - 267Kb) - RAG 4: Guideline for the analysis of operating costs and assets [version 4.03]
(PDF - 205Kb)
ANNEX 1
RESPONSES TO RD 14/06
THE REVIEW OF THE REGULATORY ACCOUNTING GUIDELINES 1, 3 & 4
| Anglian Water Services Ltd | (Word - 34Kb) |
| AquaVitae UK Ltd | (PDF - 81Kb) |
| Bournemouth and West Hampshire Water plc | (Word - 37Kb) |
| Bristol Water plc | (PDF - 300Kb) |
| Folkestone & Dover Water Services Ltd | (PDF - 62Kb) |
| Mid Kent Water Ltd | (Word - 253Kb) |
| Northumbrian Water Ltd | (Word - 38Kb) |
| Portsmouth Water Ltd | (PDF - 57Kb) |
| PricewaterhouseCoopers LLP | (PDF - 2.1Mb) |
| Severn Trent Water Ltd | (PDF - 15Kb) |
| South East Water Ltd | (PDF - 1.4Mb) |
| South Staffordshire Water plc | (PDF - 90Kb) |
| Thames Water Utilities Ltd | (Word - 58Kb) |
| Tendring Hundred Water Services Ltd | (Word - 38Kb) |
| Three Valleys Water plc | (PDF - 79Kb) |
| United Utilities plc | (PDF - 38Kb) |
| United Utilities plc - Appendix | (PDF - 64Kb) |
| Yorkshire Water Services Ltd | (PDF - 176Kb) |
