Regulatory accounting in the UK water industry by rt3463df

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									 Regulatory accounting
in the UK water industry
 ADERASA Regulatory Accounting
     Regional Working Group
Santiago de Chile August 5-6, 2004
AGENDA
• UK WATER INDUSTRY REGULATION
• THE INFORMATION FRAMEWORK
• REGULATORY ACCOUNTING, including
    – Design issues
    – Implementation issues
    – Learning points
• UK BIBLIOGRAPHY
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UK WATER INDUSTRY REGULATION

• The Office of Water Services (Ofwat) is the economic
  regulator for the water industry in England & Wales
• Ofwat regulates 22 companies (10 water & sewerage
  companies; 12 water only companies)
• Price cap, incentive regulation - control of:
    – Prices (RPI-X system)
    – Quality
    – Service levels
• Ofwat needs accurate, reliable, consistent & integrated
   information to regulate the companies – has developed a
   robust basis for the preparation of regulatory accounts

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UK WATER INDUSTRY FINANCIALS
    2002-03 outturn:                         US
                                            Dollars
    •Total operating expenditure            4,910m
    •Capital expenditure                    6,280m
    •Current cost operating profit          3,410m
    •Regulatory capital value               58,250m
    •Return on capital employed              5.9%
    2004-05 average household bills:         US
                                            Dollars
       •Average household bill - water        213
       •Average household bill - sewerage
Pareto Management Limited                     240
INFORMATION FRAMEWORK
• Relevant licence conditions, methods & guidelines are
    detailed & transparent – including regulatory accounting
    principles & Current Cost Accounting
•   Annual submissions + additional data for price reviews
•   Key annual submission is the “June return”:
    –   Key outputs
    –   Company performance
    –   Non-financial measures
    –   Regulatory accounts
    –   Financial measures
• Ofwat aims to publish as much information as possible:
    – Annual “Financial Performance & Expenditure” report
    – Public version of regulatory accounts for each company
    – Some data is collected on commercial-in-confidence basis
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REGULATORY ACCOUNTING

• The purpose of regulatory accounts
• What is required by Ofwat
• Regulatory accounting guidelines
• Regulatory accounting - design issues
• Implementation issues
• Learning points

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PURPOSE OF REGULATORY ACCOUNTS

• Monitor performance against the assumptions
    underlying the current price caps
•   Inform future price reviews
•   Allow yardstick competition with other
    companies in the UK water industry
•   Detect anti-competitive behaviour e.g. unfair
    cross-subsidisation & undue discrimination
•   Assist monitoring financial health / viability
•   Improve transparency in regulatory process
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WHAT IS REQUIRED BY OFWAT
• Company Licence imposes conditions to comply
    with accounts & accounting requirements
•   Ofwat requires 5 main items of information:
    – Regulatory Historical Cost accounts
    – Regulatory Current Cost accounts
    – Segmental information on costs, turnover & tangible
      fixed assets for each service
    – Details of transactions with associated companies
    – Certificate re financial & managerial resources
• All items are subject to audit scrutiny

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REGULATORY ACCOUNTING GUIDELINES

• Framework for the accounts is governed
  by detailed & transparent Regulatory
  Accounting Guidelines (RAGs)
• The Ofwat regulatory guidelines are a
  benchmark of good regulatory practice
• Mostly consistent with UK GAAP– RAGs
  take precedence where any conflicts
• There are 5 RAGs …..
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REGULATORY ACCOUNTING GUIDELINES

• RAG 1: Accounting for current costs
• RAG 2: Classification of expenditure
• RAG 3: Reporting requirements
• RAG 4: Analysis of operating costs &
  assets
• RAG 5: Transfer pricing

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DESIGN ISSUES (RAG 1)
• RAG 1 is the key framework guideline, which
    requires current cost accounts
•   A comparable measure of the real costs of
    supply, including the cost of capital, across
    companies
•   A realistic measures of asset values & the trends
    in the returns earned on these assets
•   Regulatory capital values (RCVs)

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DESIGN ISSUES (RAG 2)
• Classification of capital expenditure
• Infrastructure renewals accounting for below ground
    network of assets = unique to water industry
•   Broad categories:
                            Base                Enhancements
                            Service
                                      Quality   Supply /   Service
                                                Demand     levels
    Infrastructure
    Non
    Infrastructure

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DESIGN ISSUES (RAG 3)
• Detailed format & disclosure requirements for regulatory
   statements, including pro forma accounts
    – Profit & loss accounts & balance sheets (both historical cost &
      current cost basis)
    – Cash flow statement
    – Revenue from measured & unmeasured supplies of water &
      sewerage services & other sources
    – Values & types of fixed assets
    – Movements in working capital & reserve
    – Analysis of net debt
    – Regulatory capital value
    – Disaggregated activities

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DESIGN ISSUES (RAG 4)
• Classification of operating costs & assets
  by both purpose & function
• Designed to assist:
    – Comparisons of costs incurred in fulfilling
      functions
    – Explanations of cost variations & trends
• A particularly useful model for other
   regulators

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ANALYSIS OF COSTS & ASSETS (RAG 4)

ANALYSIS OF INDIVIDUAL ACTIVITIES        SUBJECTIVE ANALYSIS
•Service activities - water supply       •Direct costs
     –Water resources & treatment             –Employment costs
                                              –Power
     –Distribution of treated water           –etc
•Service activities - sewerage service   •General & support expenditure
     –Sewerage                           •Capital costs
     –Sewage treatment                        –Depreciation & amortisation
     –Sludge treatment & disposal             –Infrastructure renewals expenditure
                                              –etc
•Business activities                     •Service costs
     –Customer services                       –Local authority rates
     –Scientific services                     –Charges for bad & doubtful debts
     –Cost of regulation                      –etc
•Services provided for third parties     •Capital costs of business activities



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DESIGN ISSUES (RAG 5)
• Transfer pricing is a significant issue for the UK
    water industry
•   Transactions with associated companies
•   Designed to ensure no cross-subsidy between
    regulated business & associated companies
•   Market prices should be market tested
•   Developing this guideline took up a lot of
    resources – far more than any of the others

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IMPLEMENTATION ISSUES
• Linkages with price reviews:
    – Measurement of the capital base i.e. Regulatory Capital Value
    – Accounting for out-performance
•   Role of auditors & reporters
•   Commentary & explanation of trends
•   Disaggregating costs
•   Accuracy, reliability & consistency of data
•   Interaction with UK Generally Accepted Accounting
    Practice & International Accounting Standards
•   A common set of key reported numbers for all utilities

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LEARNING POINTS (1)
• Main considerations governing the choice of
   basis of preparation of regulatory accounts:
    –   Transparency & openness
    –   The method used to set price caps
    –   How the regulatory asset value is determined
    –   Consistency within the industry
    –   Consistency with statutory accounts
    –   Views of consumers
    –   Nature of the industry
    –   Extent of competition within the industry
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LEARNING POINTS (2)
• Cost allocation & recharging principles:
    –   Cost causality
    –   Objectivity
    –   Consistency
    –   Transparency
• Publication issues
• Detailed specification of reporting requirements is a key
    task – to ensure accurate & reliable data collection
•   Regulator needs to work closely with the industry to
    secure improvements in consistency & reliability


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UK BIBLIOGRAPHY
• Company licence conditions
• Regulatory Accounting Guidelines:
    –   RAG 1:   Accounting for current costs
    –   RAG 2:   Classification of expenditure
    –   RAG 3:   Reporting requirements
    –   RAG 4:   Analysis of operating costs & assets
    –   RAG 5:   Transfer pricing
•   “June return” reporting requirements & definitions manual
•   Business Plan reporting requirements & definitions manual
•   Letters from Ofwat to Managing Directors & Regulatory Directors
•   Ofwat annual reports e.g. “Financial Performance & expenditure”
•   Individual companies’ regulatory accounts

Ofwat website: http://www.ofwat.gov.uk


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