NOTES TO THE FINANCIAL STATEMENTS
4. Critical accounting judgements and estimates
The Group's principal accounting policies are set out in note 2. Management is required to exercise significant judgement and make use of estimates and assumptions in the application of these policies.
Areas which management believes require the most critical accounting judgements are:
Underlying business performance
Underlying business performance is presented to provide a more useful comparison of business trends and performance. The term underlying is not a defined term under IFRS, and may not be comparable with similarly-titled profit measurements reported by other companies. Reconciliations between underlying and reported measures are included in the Directors' Report; Financial performance and in note 11 for earnings per share.
Environmental and landfill restoration provisions
Restoration and aftercare provisions are recognised in the financial statements at the net present value of the estimated future expenditure required to settle the Group's restoration and aftercare obligations. A discount is applied to recognise the time value of money and is unwound over the life of the provision. This is included in the income statement as a financial item within finance costs.
As at 31 March 2010 the Group's environmental and landfill restoration provisions were £96.4m.
Where a provision gives access to future economic benefits, an asset is recognised and depreciated in accordance with the Group's depreciation policy.
Capitalisation of borrowing costs
The Group capitalises material borrowing costs directly attributable to the construction of qualifying assets (assets necessarily taking a substantial period of time to be prepared for their intended use). At the balance sheet date only the assets under construction in the joint ventures for the construction of Energy from Waste plants meet the criteria for capitalisation of related borrowing costs.
Retirement benefit obligations
The Group operates defined benefit pension schemes for which actuarial valuations are carried out as determined by the trustees at intervals of not more than three years.
The pension cost under IAS 19 is assessed in accordance with Directors' best estimates using the advice of an independent qualified actuary and assumptions in the latest actuarial valuation. The assumptions are based on information supplied to the actuary, supplemented by discussions between the actuary and management. The principal assumptions used to measure schemes' liabilities, sensitivities to changes in assumptions and future funding obligations are set out in note 29 of the financial statements.
Cash-generating units
For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows (cash-generating units). The waste management segment is considered to be a single cash-generating unit as it is an integrated business.
Areas which management believes require the most critical accounting estimations are:
Service concession arrangements
Consideration from public sector entities for the operation of waste management service concessions is treated as contract receivables, split between profit on the construction of assets, operation of the service and provision of finance recognised as interest receivable. Management's allocation between these three elements is assessed according to prevailing external market conditions according to the type of service provided.
Site development costs
The development of waste management sites for additional landfill capacity and new projects (such as Energy from Waste plants) are subject to obtaining planning permissions. Development costs are capitalised using management's assessment of the likelihood of a successful outcome for each project. To the extent that planning permission is not received any capitalised development costs would be expensed.
Landfill costs
The estimation of landfill reserves is of particular importance in assessing landfill costs, since the cost of a landfill site is depreciated over its estimated operational life taking into account the usage of void space and gas production at the site post closure. The estimates of landfill reserves are regularly reviewed and updated during the financial year for usage and other events (for example site extensions). Estimates are also subject to physical review by external advisors.
A number of factors impact on the depreciation of landfill reserves including the available landfill space, future capital expenditure and operating costs. The assumptions are revised as these factors change.
The estimate of gas production at landfill sites post-closure reduces the depreciation of landfill reserves. An assessment is undertaken for individual sites of the historic profile of gas production during landfilling activity and the projected generation post-closure according to the type of waste contained in the landfill and expected profile of gas production over time.
Carrying value of property, plant and equipment
The Group's accounting policy for property, plant and equipment assets is set out in note 2. The carrying value of property, plant and equipment as at 31 March 2010 was £2,822.7m. In the year ended 31 March 2010 additions totalled £190.2m and the depreciation charge was £136.5m. Estimated useful economic lives of property, plant and equipment are based on management's judgement and experience. When management identifies that actual useful lives differ materially from the estimates used to calculate depreciation, that charge is adjusted prospectively. Due to the significance of capital investment to the Group, variations between actual and estimated useful lives could impact operating results both positively and negatively. Asset lives and residual values are reviewed annually and historically changes to remaining estimates of useful lives have not been material.
Defined benefit pension schemes
Directors' best estimates are based upon an assessment, with advice from the schemes' actuaries, of key financial and demographic assumptions.
The rate used to discount schemes' liabilities reflects the market rate for long-term corporate bonds, adjusted for the projected duration of liabilities. Inflation is based upon the market rate observed at 31 March by reference to long-term index-linked bonds.
Mortality assumptions are set upon actuarial advice in accordance with published statistics using a “medium cohort” basis and scheme-specific experience.
A schedule showing the impact upon the schemes' liabilities of any change in the assumption made is included in note 29 to these financial statements.
Revenue recognition
The Group recognises revenue at the time of delivery of services. Payments received in advance of services delivered are recorded as a liability.
South West Water raises bills and recognises revenue in accordance with its entitlement to receive revenue in line with the limits established by the Periodic Review price-setting process. For water and waste water customers with water meters, revenue recognised is dependent upon the volume supplied including an estimate of the sales value of units supplied between the date of the last meter reading and the financial year-end. Estimated usage is based on historic data, judgement and assumptions; actual results could differ from these estimates which would result in operating revenue being adjusted in the period in which the revision of the estimates is determined.
Provision for doubtful debts
At each balance sheet date each subsidiary evaluates the collectability of trade receivables and records provisions for doubtful debts based on experience including comparisons of the relative age of accounts and consideration of actual write-off history.
The actual level of debt collected may differ from the estimated levels of recovery and could impact future operating results positively or negatively. As at 31 March 2010 the Group's current trade receivables were £174.5m, against which £50.6m was provided for impairment.
Impairment of intangible assets
The Group records all assets and liabilities acquired in business acquisitions, including goodwill, at fair value. Intangible assets which have an indefinite useful life, principally goodwill, are assessed at least annually for impairment.
The initial goodwill recorded and subsequent impairment analysis require management to make estimations of future cash flows, terminal values and an assessment of the long-term pre-tax discount rate to be applied to those cash flows which reflects an assessment of the cost of capital of the cash-generating unit.
Taxation
The Group corporation tax provision of £83.6m reflects management's estimation of the amount of tax payable for fiscal years with open tax computations where liabilities remain to be agreed with Her Majesty's Revenue and Customs.