Overview page 3. Information Sources page 6. Changes to cost allocations page 7. Cost Allocation Model page 8. Cost allocations page 9

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2 CONTENTS Accounting Separation Methodology Overview page 3 Information Sources page 6 Changes to cost allocations page 7 Cost Allocation Model page 8 Cost allocations page 9 Wholesale Direct Cost Allocations Table 2B page 10 Allocation of Business Unit costs to Service level Tables 4D & 4E page 15 Retail cost allocations Table 2C page 17 Retail household cost allocations Table 4F page 20 Corporate support costs page 21 Recharges between business units page 22 Capital Expenditure - Tables 2B, 2D, 4D and 4E page 23 Capital maintenance Charges Table 4F page 28 Appendices Appendix A: Business unit, services, activities and sub- activities summary page 29 Appendix B: General ledger reporting structure page 30 Appendix C: Retail household / non- household allocation page 31 Appendix D: Corporate and support allocation basis page 32 Appendix E: Apportionment basis of M&G assets page 34 Appendix F: IFRS Fixed Asset Statements from Non Statutory Accounts 2015/16 page 35 Appendix G: 2014/15 UKGAAP Regulatory Accounts Capex Expenditure Schedule page 37 2

3 OVERVIEW Accounting Separation Methodology 1.1. The purpose of this report is to explain the procedure undertaken to produce the 31 March 2016 Regulatory Accounting Separation tables Operating cost analysis, capital expenditure and Fixed Asset analysis for wholesale and retail business units A commentary on the key cost movements is available at Bournemouthwater.co.uk 1.3. The tables have been prepared in accordance with Regulatory Accounting Guidelines ( RAG s ) 4.05 issued in October 2015 effective for the financial year ended 31 March In addition, the tables meet the requirements set out by Ofwat following their targeted review undertaken during early The Regulatory Accounts report Bournemouth Water s appointed activities analysed between certain Retail and Clean Water Service business units in respect of specific activities and cost categories 1 between the following areas: Operating costs, Capital expenditure Fixed asset values Whilst these business units are not treated as organisationally separate businesses or separate companies by Bournemouth Water, due to more efficient and effective structures being in place to support the management and accountability of the business, there are certain activities which are solely carried out by specific areas of the business The data hierarchies used Bournemouth Water s financial systems primarily support the management structure of the Company to support accountability and to most effectively analyse performance against budgets, targets or prior periods. However, the coding used to record financial transactions is designed to also record activity based information to support regulatory accounting, particularly in relation to direct costs Bournemouth Water does not have a formal activity based costing system, but it does have existing and established processes to allocate operating costs, capital maintenance costs and fixed assets to the separate service areas used to populate the accounting separation tables As the business units and services identified in the accounting separation tables are not organisationally separated in Bournemouth Water they do not have their own separate management and support functions and they do not trade with one another. To represent them as distinct cost centres and asset centres requires the allocation of costs and assets to them. Where no direct allocation is possible, some subjective judgment is required. The resulting costs reported for these business units do not necessarily represent what the costs would be if they were operated as separate business units For direct retail costs, a large proportion of costs are directly identifiable from the finance system. Allocations are primarily required between retail activities. 1 Appendix A shows a summary of business units, services and activity examples. 3

4 1.10. The analysis of direct costs for the wholesale business is essentially obtained from the expense type of the underlying cost (for example employment costs, power, and service charges). These costs are directly identifiable from the way costs are coded in the general ledger. The direct cost analysis for retail contains further division of cost by activity (for example customer service, debt management, meter reading) with the cost being dominated by employment costs for staff who may work across a number of different activities The company has extracted the necessary fixed asset information from its existing fixed asset records and has performed validation and analysis where there has been opportunities within these data sources to improve the quality of the information entered onto the tables The responsibility for the compilation of the accounting separation tables and methodologies lies with the Finance and Asset Management functions of Bournemouth Water Final review of the tables is undertaken by the Finance Director to ensure that there is clear understanding of the year on year movements In preparing the information required for the accounting separation tables the company has developed a cost allocation model as well as adapting, and extending, where necessary, the existing and well- established processes to allocate operating costs, capital expenditure costs and fixed assets to separate service areas The company has a well- defined basis for allocating directly related general and support costs, for example accommodation which is allocated by floor area. Where there are elements of business support and corporate costs which have no obvious connection to operational activities (and which do not increase or reduce in line with the level of operational activities) judgement has been used to select the most appropriate method of allocation The allocation of operating costs within Bournemouth Water to specific service areas within the appointed and non- appointed business is based on activity analysis and principles which result in both direct and support costs being apportioned where not directly attributed. Activity levels between individual services between appointed and non- appointed segments are ascertained by reference to time allocations by individual employees along with other allocation basis in accordance to the underlying nature of resource utilisation Where such a detailed approach is not applicable, costs are apportioned pro rata to either relevant elements of direct cost or FTE s for each principal service The internal charging rates for operating costs adopted by the company are updated annually Costs are charged directly to sub- services wherever possible. For activities where this is not practical, for example, business support and corporate overheads, costs are either allocated pro rata to direct costs, total costs within the prime service, subject to management assessment of the effect of direct costs such as doubtful debt charge, power and EA charges which do not generate the same level of support or apportioned based on FTE s In developing a methodology to complete the accounting separation tables the company s cost allocation model (first used in 2012/13 and subsequently modified) has been used for 4

5 the year ended 31 March 2016 to aid reporting and analysis of data. This forms the backbone to producing the regulatory accounts and enables the separate business unit and subsequent service analysis to be more easily obtained Cost and asset allocations have been made in a transparent, objective and non- discriminatory manor, ensuring the underlying causality of the cost is reflected. Allocations are made on a consistent basis, subject to improvements made to allocation methodologies and underlying data sources. Operating costs have been allocated by specific general ledger line and assets by individual asset reflecting the highest possible level of granularity. These attributes along with clear and well documented procedure / methodology significantly aid management review and assessment of cost and asset allocations to ensue all allocations to services and business units are reasonable A more detailed description of the general ledger ( GL ) coding system is detailed in Appendix B. 5

6 INFORMATION SOURCES Accounting Separation Methodology 2.1 Cost Information is derived from the company s finance system SAP which is run on an IFRS GAAP basis. Our SAP system has a shadow ledger that enables us to make all the allocations and journal adjustments required for Accounting Separation within the finance system, and to produce the operating cost data for the regulatory tables direct from the main Finance system. These numbers are then adjusted for any GAAP differences, as shown within the Regulatory accounts. 2.2 Information regarding staff activity is collected using a number of operational systems, including job management, billing and telephone logging systems. We also maintain an information management function which allows reliable timesheet information regarding staff activity to be collected. 2.3 An integrated SAP fixed assets register is used to record the detail of fixed assets and related depreciation charges for the historical cost regulatory accounts. These assets are coded to specific business units, and this provides the information for asset values and depreciation. 2.4 Fixed asset current cost accounts information is also held within SAP. SAP contains an integrated mirrored current cost asset register, linked to the main Historic Cost Register. This is updated for RPI increases. 6

7 CHANGES TO COST ALLOCATIONS / The basis for allocating costs between business units has largely remained unchanged during 2015/16. The exceptions to this are as follows: 1.2. Following a review we have changed how we allocate management overhead costs. These costs are now allocated in the same manner as staff costs, whereas previously we used GMEA values to allocate these costs. This change more closely aligns our overhead cost allocation with allocation methods used for the recent Price Review, although we are using estimated activity drivers rather than FTE numbers to base allocations on. The impact of this change on the allocation of central overhead is shown in the table below: Impact of changing allocation method for management overheads Sector Business Unit m Wholesale Water resources Raw Water Distribution Water Treatment Treated Water Distribution Retail Household Non- Household Non- Regulated Non- Regulated As can be seen, the effect has been to reduce Wholesale costs and increase Retail and Non- regulated costs. 7

8 COST ALLOCATION MODEL 2.1. The methodology for allocating costs to business unit level is set out below Our Finance system has the Ofwat business units built into the general ledger coding. As such costs are largely directly posted to the correct business unit 2.3. Regulated numbers are prepared within a Special Purpose Ledger (SPL). This ledger mirrors the Company s main general ledger, but allows for Regulatory specific changes to be made whilst leaving the statutory records untouched Where income and costs, such as those associated with meter commission, need to be transferred to non- regulated business we post journals within the SPL Cost allocations are made using allocation cycles within the SPL. This process allows us to allocate costs from a specific general ledger code to many other codes, using defined percentages These percentages are based upon relevant activity drivers such as job hours, water samples collected, IT calls and floor space occupied We run the current year allocation cycles to allocate the costs between the Business Units. We then run reports over the SPL which are designed to allow us to populate the operational cost tables within the Regulatory Accounts. The reports created within the SPL are exported to an excel spreadsheet where we summarise the data into the OFWAT table layout These tables are reconciled to the main SAP general ledger and to the Company management accounts to ensure completeness and accuracy Further metrics are then applied to business unit costs to provide an allocation to service level (within business units) as explained later in section 6 of this document. 8

9 COST ALLOCATIONS Accounting Separation Methodology 3.1. The revised general ledger balances are initially allocated between the following areas based on the business unit element of the GL code. For example customer services costs centres are allocated to retail, water costs are allocated to wholesale water and HR cost centres to corporate support. Wholesale Retail Corporate support (separately allocated between retail, wholesale and non- appointed) Non- appointed (these cost are identified for exclusion from the regulatory accounting separation tables) Where costs are not wholly attributed to a specific business unit, costs are allocated between service areas based on an underlying assessment of the costs and their respective drivers by management. The approach being consistent with the basis of allocation within each service area. 9

10 WHOLESALE COST ALLOCATIONS TABLE 2B 4.1. Wholesale costs are initially allocated to the following four business units: Water resources Raw Water transport Water Treatment Treated Water Distribution Subsequently, the business unit costs are further analysed so that the costs are allocated against the following services: Water Resources Raw Water Transport Water Treatment Treated Water Distribution Abstraction Licences Raw Water Abstraction Raw Water Transport Raw Water Storage Water Treatment Treated Water Distribution 4.2. The RAG definitions for wholesale activities were reviewed and checked against the codes used in the SAP general ledger. The general ledger is used to identify and apply direct cost allocations to specific business units for costs 4.3. In some cases, costs, which are readily identified from the SAP general ledger, need to be allocated over several business units or services. Where this is the case, the most appropriate form of apportionment or allocation is identified, by the appropriate Management team, and applied to the cost centre The table below lists the operating expenditure lines included within total wholesale operating expenditure and outlines the sources of the cost contained within each line and where apportionments have been used. Ref Operating Expenditure heading Costs included and method of allocation A7.1 Power All energy costs including the climate change levy. A7.2 Income treated as a negative expense Power costs are allocated to individual sites which are in turn allocated to specific business units. At combined sites an allocation of the power costs is determined based on an assessment of the power usage of individual items of equipment. The regulated business does not have such income, which usually refers to income received from energy generation. 10

11 Ref Operating Expenditure heading Accounting Separation Methodology Costs included and method of allocation A7.3 Service charges Total cost of service charges by the Environment Agency or British Waterways for water abstraction and discharge consents. A7.4 Bulk supply imports A7.5 Other operating expenditure A7.6 Local authority rates Service charges are identified as abstraction charges and discharge consents. Allocation to business unit is then made through reference to the individual cost centres. Service charges are identified from the general ledger and allocated to business unit through reference to the specific cost centre posting. Total payments for bulk imports. Bournemouth Water does not rely on bulk imports (although there is a small cross border link with Wessex for emergencies) and normally sources all water from resources within the region. All other operating costs. Allocated to business unit based on the underlying cost driver of the specific cost. Where possible other operating expenditure is allocated directly to business unit. Where direct allocation is not possible management assessment is used to allocate the costs. Corporate and support costs are allocated to business unit using the most appropriate underlying cost driver. Where costs cannot be specifically allocated costs are apportioned pro- rata to direct or total cost. The cost of local authority rates (including local authority rates, cumulo rates). Water Cumulo are allocated on basis of MEAV. Local authority rates for support buildings are apportioned between functions by floor area. A7.7 Exceptional items Exceptional items as defined by UK GAAP. No exceptional items have been reported. A7.16 Third Party Services Operating Expenditure Operating expenditure relating to providing third party services. Allocated to business unit based on the underlying cost driver of the specific cost. Where possible third party services costs are allocated directly to a business unit. Where direct allocation is not possible management assessment is used to allocate the costs Wholesale direct cost allocations are initiated by a combination of the cost and expense elements of SAP s eighteen digit general ledger code. Cost centre This consists of 3 elements, the Ofwat business unit, the site, together with function or activity and the department. 11

12 Initial allocation of the business unit is based on the nature of the site or activity. For example a cost centre associated with abstraction would be coded with a business unit of Raw Water Abstraction. The site/function or activity element of the code differentiates parts of a site that may be used for multiple purposes, for example treatment and treated water distribution. Activity refers to the different types of Treated Water activities. Expense element The accounting separation tables require the wholesale costs to be disclosed by the following expense types: o o o o o o o Power Income treated as a negative expense Service charges Bulk supply imports Other operating expenditure Local authority rates Exceptional items The general ledger holds expenses in more detail than this, for example power includes electricity supplied via the National Grid and the costs of electricity supplied by on site generators. These detailed expenses are summarised up into the categories required by Ofwat Where cost allocations span the boundary between business units management assessment is required to allocate the cost. Scientific Services 4.7. The entire total cost of scientific services has been allocated to the wholesale business units, covering the cost of sampling including sampling at customer taps, quality monitoring, testing, performance monitoring etc The allocation of costs across the business units is based on the number of samples taken for each area. 12

13 Wholesale Adjustments See section 5 Accounting Separation Methodology 4.9. Due to the current data hierarchies used Bournemouth Water being primarily in place to support the management structures of the Company certain costs allocated by cost centre and expense element require adjustment in order to allocate the costs to the appropriate, Ofwat defined, business unit The adjustments are processed within SAP as detailed above The table below lists the manual adjustments made and outlines the source of information and methodology behind each adjustment. No. Adjustment Information source and methodology 1 Re- allocation of control room costs 2 Re- allocation of general company costs 3 Re- allocation of Raw Water power 4 Re- allocation of Inspectorate costs We maintain two control rooms and costs are allocated to these directly. However the control rooms effectively share costs, as staff move between them and each location provides back- up support for the other. As a result we have combined the control room costs and then allocated the combined costs over the Bus based on the number of telemetry hits by the site that generated the hit. (Telemetry refers to automated reporting and control systems, and includes telephony costs). A variety of cost drivers are used to allocate general and support (G&S) expenditure. This expenditure covers Finance, IT, HR, Regulation and general management. Each department uses a driver best suited to itself. See appendix D for further details. Raw water power costs are originally charged to one cost centre. This number is then allocated between raw water transport and raw water storage based on information provided by sub meters on the site. The inspectorate covers a number of operational functions across both wholesale and retail BUs. Costs are allocated based on the number of inspector hours recorded in the job management system. 5 Re- allocation of vehicle costs Commercial vehicle workshop costs are directly allocated to the non- regulated business. Core vehicle workshop costs, including depreciation, are charged on the basis of vehicle type and the number of vehicles assigned to each BU. The vehicles used by the non- regulated business have been excluded from this calculation as charges to these vehicles already include an overhead element. Charging costs based on vehicle usage is considered the most appropriate method of apportionment. Fuel costs are mostly directly allocated to sites within a BU. 13

14 No. Adjustment Information source and methodology Where costs are not directly allocated we use a range of appropriate cost drivers to allocate costs, such as job hours. 6 Re- allocation of general maintenance costs 7 Re- allocation of scientific services 8 Re- allocation of engineering department costs 9 Re- allocation of operational offices 10 Re- allocation of business rates Most maintenance costs are allocated directly to sites which fall within a single BU. Maintenance costs which are not directly allocated, such as supervision, are apportioned amongst the BU s based on the ratio of the number of jobs performed in each BU Scientific service costs relate entirely to wholesale. These costs are allocated based on the number of samples taken by each BU. Most engineering costs are allocated directly using our time management system. Any unallocated costs are allocated using the ratio of hours recorded to sites. The offices and site infrastructure at Knapp Mill support sites across the business. The costs associated with Knapp Mill have been allocated on the basis of Gross Modern Equivalent Asset (GMEA) costs of the regulated business, on the basis that these costs relate to the assets used by the company. Business rates are billed on a cumulo basis. Local authority rates are allocated using the GMEA of the regulated business. Rates are levied in relation to the Company turnover. Therefore allocating the costs based on the GMEA reflects the capital employed in producing the turnover. 14

15 ALLOCATION OF BUSINESS UNIT COSTS TO SERVICE LEVEL TABLE 4D & 4E 5.1. Allocation of Water Business Units to Services The Water Business Units break down into 6 Services as shown below Water Resources Abstraction Licences Raw Water Abstraction Raw Water Transport Raw Water Transport Raw Water Storage Water Treatment Water Treatment Treated Water Distribution Treated Water Distribution 5.2. Water Resources The Water Resources Business Unit consists of two Services, Abstraction Licences and Raw Water Abstraction 5.3. Abstraction Licenses The costs of abstraction licences are separately identifiable within the Water Resources business unit as Service Charges. The costs of the abstraction licences are allocated to the abstraction licence service 5.4. Raw Water Abstraction Following the allocation of costs to the abstraction licence service the balance of the Water Resources Business Unit cost is allocated to the raw water abstraction service Raw Water Distribution The Raw Water Distribution Business Unit consists of two Services, Raw Water Transport and Raw Water Abstraction Raw Water Storage The geography and topography of the Bournemouth Water region results in relatively short distances between water resources and water treatment works. Raw water can be transported directly from abstraction point to water treatment works. As a result there is a very limited requirement to store raw water. Bournemouth Water has one storage facility (Longham Lakes) The cost of Raw Water Storage is the maintenance cost of the Longham Lakes operational site, plus a proportion of G&S costs. 15

16 5.7. Raw Water Transport These costs are primarily power, with a share of general and support costs and any related maintenance Water treatment The Water Treatment Business Unit contains only one service. All costs identified as being part of the Water Treatment Business Unit by the Accounting Separation Methodology are allocated to this Service 5.9. Treated water distribution The Treated Water Distribution Business Unit contains only one service. All costs identified as being part of the Treated Water Distribution Business Unit by the Accounting Separation Methodology are allocated to this Service 16

17 RETAIL COST ALLOCATIONS TABLE 2C 6.1. The RAG definitions for retail activities were reviewed and used to identify and apply direct cost allocations to costs that are separately identifiable from the SAP general ledger coding system e.g. customer services, meter reading costs, bad debt expense, etc In other cases, whilst costs are readily identified from the SAP general ledger, they are not directly attributable to one particular activity line within the retail unit. Where this is the case, the most appropriate form of apportionment or allocation is identified, by the appropriate Management team, and applied to the cost centre. This applies particularly to allocating costs between Household and Non Household The table below lists the retail activities included within retail total operating expenditure and outlines the sources of the cost contained within each line and where apportionments have been used. Line Operating Expenditure Activity A8.1 Customer Services Costs included and method of allocation, where applicable This represents the costs associated with Billing, Payment Handling, remittance and cash handling, Charitable Trust donations, Vulnerable customer schemes, Non- Network customer enquiries and complaints, Network Customer enquiries and complaints. A8.2 Debt Management Includes all costs relating to the management of debt recovery, including monitoring debt, issuing reminders and undertaking follow up calls, managing external debt collection and notification of disconnection to non- households. Debt management is a separate, specific cost centre within the general ledger, which facilitates collecting costs associated with this activity. A8.3 Doubtful debts Relates to the charge for bad and doubtful debts. The total charges are identified from the general ledger and specifically attributed between households and non- households from a report run over the billing system which specifically identifying household and non- household debt. A8.4 Meter Reading Includes all costs associated with meter reading including supervising and managing meter readers. The cost of meter readers are specifically identified from the general ledger. The cost of service deliver managers in managing meter reading activities is allocated from specific cost centres in the general ledger based on a time assessment. 17

18 Line Operating Expenditure Activity A8.5 Services to Developers A8.6 Other operating expenditure Accounting Separation Methodology Costs included and method of allocation, where applicable Represents the cost of providing developer services including: - Providing developer information, dealing with questions from developers where physical aspects of infrastructure are required to change. Investigating and advising on implications and; - Administration of new connections Cost are specifically identified from the general ledger and wholly attributed to retail non- households. Other operating expenditure, excluding interest and tax, includes: - Decision and administration of disconnections and reconnections - Demand- side water efficiency initiatives - Customer side leaks - Other direct costs - General & support costs - Other business activities Cost centres relating to the above activities are either directly identified and allocated from the general ledger or apportioned based on a specific time assessment or the most appropriate underlying cost driver. Other direct costs principally comprise customer policy and relations costs. A8.7 Rates This represents a share of the cumulo rates, based on a GMEA approach to allocation. A8.8 Exceptional items A8.10 Third Party Services Exceptional items as defined by UK GAAP. No exceptional items have been reported. Comprises the cost of providing retail services to third parties. The cost has been allocated based on a time assessment and directly attributed to non- households. A8.19 Debt written- off Represents debt written- off, net of collections previously written- off. Cost has been directly attributed Where a customer has vacated a property leaving amounts unpaid full provision is made against the outstanding debt, no credit notes are issued to cancel all or part of the outstanding debt The doubtful debt charge represents the movement in the doubtful debt provision, which reflects the company s assessment of the risk of non- recoverability of debt. The provision is calculated by providing in full against all doubtful debt categories such as those customers who have left our area of supply or whom the company is taking legal action against. Doubtful debt provisioning is reviewed annually to reflect the latest collection performance data from the company s billing system Corporate and support costs separately identify directly attributable costs that can be allocated to specific retail activity for example the costs of the Gentrack billing system have 18

19 been allocated directly to the billing activity within the retail business unit. Other corporate and support expenditure which cannot be directly allocated to a specific retail activity or specific disclosure line are included within other operating expenditure Retail costs are directly attributed to either households or non- households wherever possible. Costs which are not directly attributed are allocated between household and non- household based on an assessment of the most appropriate underlying cost driver (i.e. bill numbers, customer contacts etc). 1 1 See Appendix C for metrics used in the allocation of retail costs between household and nonhousehold. 19

20 RETAIL HOUSEHOLD ANALYSIS TABLE 4F 7.1. The retail household costs obtained from table 2C are analysed between measured and unmeasured customers To populate this table, the total household costs have been allocated to the appropriate category based on the number of customers receiving the service as a proportion of the overall customer numbers, as reported in table 2F Demand side efficiency and customer- side leak repairs represent the apportionment of costs from a number of Retail cost centres, based on management assessment: 20

21 CORPORATE SUPPORT COSTS 8.1. The allocation of corporate support costs within Bournemouth Water to specific business areas within the appointed and non- appointed business is based upon an assessment of underlying cost drivers according to the nature of resource utilisation Information Services (IS) costs wherever possible are allocated directly to business units. For all common costs which cannot be directly allocated these have been apportioned based on the calls log and the time spent resolving calls, as this is considered a more precise measure of consumption of costs than number of PC s Where there are elements of business support and corporate costs which have no obvious connection to operational activities (and which do not necessarily increase or decrease in line with the level of operational activities) management has assessed the time spent by staff in the departments on the different business units and used this to allocate departmental costs. Such allocations are reviewed against the previous year to identify and investigate any significant movements Where applicable corporate and support costs have been allocated to specific retail activities where they are considered to be directly attributable (for example the costs of the Gentrack billing system have been allocated directly to the billing sub- activity within the customer services activity within the retail business unit). Likewise specific expense items which require separate disclosure e.g. rates are identified and recorded directly against the appropriate expense category. All other corporate and support expenditure, which cannot be directly allocated to a specific activity or expense category, are included within other operating expenditure. 21

22 RECHARGES BETWEEN BUSINESS UNITS TABLE 2A 9.1. Where possible assets have been allocated directly to the business unit to which they relate. Assets which are utilised by more than one business unit have been allocated on the following basis (as detailed in Information Notice IN13/01 published in February 2013): Asset Direct assets utilised by one business unit Direct assets used by more than one wholesale business unit Direct assets used by both wholesale and retail business units Allocation Asset recorded in business unit Asset is allocated between the wholesale assets that used the asset based on usage Asset is recorded in the business unit of principal use with recharges made by the other General and support assets where part of the asset can be directly identified as being a primarily retail (or wholesale asset) with the asset also used in part by wholesale (or retail) General and support assets Where part of a general and support asset is separately identifiable as being used primarily in a particular business unit the asset is recorded in the business unit of principal use and recharges made by the other Where a general and support asset is used to support the entire business the asset is allocated across the business units 9.2. For the year ended 31 March 2016 no assets are considered to give rise for the need to record and disclose recharges between the retail and wholesale business units in line with the guidance contained within IN 13/01 as Bournemouth Water does not have any direct assets that straddle the boundary between the retail and wholesale areas of business. All assets that do straddle the retail and wholesale areas of business are considered to be general and support assets and have been apportioned based on the most appropriate metric Depreciation for M&G assets is now allocated in the same proportions as M&G opex. This change enhances consistency. Previously this depreciation was allocated equally across all BU. This change has increased depreciation re- charged to retail by 0.1m. 22

23 Capital Expenditure - Tables 2B, 2D, 4D and 4E Purpose The purpose of this report is to explain the methodology behind populating the capital expenditure lines within the Regulatory tables listed above, whilst showing reconciliations back to the statutory accounts. Where appropriate comparisons to prior year reporting have also been included Background The PR14 business plan submitted to Ofwat in December 2014 specified, through tables S and W3, the areas in which Bournemouth Water would invest capital expenditure during AMP6. Capital expenditure is broken down into projects, and these projects are further broken down into jobs. The internal structure of capex reporting allows for effective reporting over these jobs whilst also facilitating the day to day management of programmes of work. The capital programme is monitored on a monthly and quarterly basis to ensure key programmes of work are bring delivered within the funding restrictions placed upon the company. The planning and timing of delivery of each key project is managed by the Asset Management team and, in the main, delivered by our Engineering department In addition AMP6 has seen the introduction of Outcome Delivery Incentives (ODI s) which are measured deliverables that BW will be monitored against during this 5 year period. Delivery of these measures impact both capex and opex expenditure and due to the complexity and detail within this area they are reported upon within their own table (3A), and therefore do not feature in this commentary directly. Each month the performance of BW as measured against the performance commitments is reviewed as part of the board review Processes, Cost Allocations and Quality Controls Capex additions appear in various forms in tables 2B, 2D and 4D. The methodology for the cost allocation is consistent within each of the tables. The details below explain how allocations have been made at Business Unit level (Covering tables 2B and 2D) and then at upstream service level (Covering table 4D). The wording below also details how quality control has been maintained during the allocation process. 23

24 Project Allocations Accounting Separation Methodology All assets within the asset register hold the business unit to which they are attached as part of a mandatory field. This field defines whether an asset is: (1) Water Resources (2) Raw Water Distribution (3) Water Treatment (4) Treated Water Distribution (5) Retail Household (6) Retail Non- Household (7) M&G (8) Non Regulated Business This structure allows the allocation of projects to Business Units from the outset. This code is defined by the project engineers and reviewed once it has been set up in SAP as part of the reporting process by the Asset Manager. Capital expenditure is extracted from SAP in to an excel spread sheet, where the asset manager allocates a QBEG driver. This gives the split of expenditure over the 4 mains areas of spend in the tables: Maintaining the long term capability of the assets infra Maintaining the long term capability of the assets - non- infra Other capital expenditure infra Other capital expenditure - non- infra Non Regulated A check is made to ensure that the total is consistent with the regulatory accounts and any adjustments have been accounted for. Although the capital infrastructure renewals expenditure (IRE) is recorded in the SAP general ledger it is not included in the asset register. As the Regulatory Accounts are now completed on an IFRS basis the capital element of the IRE is added to the capital expenditure analysis. The combined fixed asset totals and analysis are agreed to the general ledger, which is in IFRS GAAP. Management of the Capital Programme Costs relating to the management of the capital programme are directly allocated to each job. M&G costs Internal labour rates charged to capital projects includes an element to recover relevant overheads, such as supervision. Allocations to upstream service The table below shows the allocations of fixed assets within upstream services: 24

25 Water resourc es Raw water distribution Abstraction licences Raw water abstraction Raw water transport Raw water storage Water treatment Treated water distribution No Costs allocated as licenses are an opex cost All Water resource additions are allocated to this service All Raw water distribution assets that are not Raw Any expenditure on pumped water storage are allocated storage reservoirs are included to this service in this category No allocations required No Allocations required Retail Household As the primary user all non specific retail additions are allocated to Household Non Household Any specific non household expenditure is allocated here Quality Control Reconciliation to Statutory Accounts The starting point for populating the tables was to ensure the total additions were reconciled to the figures provided in the statutory accounts. As the Regulatory Accounts are now completed on an IFRS basis the reconciliation is simplified, a copy of the IFRS asset additions statements are included in Appendix F: Item Description m Non Statutory Account Additions: Plant Non Statutory Account Additions: Intangibles Less Capitalised Interest Regulatory Accounts Less Retail additions Table 4D Total gross Capital Expenditure Capitalised Interest Following our purchase by the Pennon Group Plc on 15 th April 2016, we have adopted their policy for the capitalisation of interest. Interest is now capitalised on any project with a total cost of over 1m and a construction period of more than 1 year, at the group average interest rate. As per RAG 1.06 section 1.6 Capitalised Interest has been excluded from the regulatory accounts in both the additions and depreciation figures. 2. There were no non regulated additions in the year. Other checks The following quality checks have been performed on the data prior to audit: 25

26 Reconciliation of the total expenditure to the General Ledger Reconciliation of the total expenditure and the expenditure by each area at each stage of the analysis of the data Checks that the split adds to 100% Second person check of the formulas and analysis of the data within the spreadsheet Completion of the supporting schedules provides a final sense check of the numbers within each line. Through identifying the components of each line, any material costs misclassified will be identified. Reconciliation to prior year reporting The 2014/15 regulatory accounts were completed on a UKGAAP basis but it is still possible to complete a reconciliation between the old table 4C (see Appendix G) and the current tables 4D and 4E on a gross basis when the retail capex expenditure is added into the numbers for 2015/16. The first step to compare year on year is to convert table 4C to IFRS and to add in adopted assets to create a comparable figure, as noted above the gross figure submitted in the 2014/15 accounts can be seen in Appendix G: Capital Expenditure 2014/15 UKGAAP Opex tfrs Change in IFRS Acct Policy m m m m Infrastructure Renewals Expenditure (IRE) Maintenance Non- infrastructure (MNI) Infrastructure enhancements Non- infrastructure enhancements Total gross Capital Expenditure 2014/ The second step is to add back retail capital expenditure to the totals from table 4D: 26

27 Description Wholesale Retail IFRS (Table 4D) m m m Maintenance Infrastructure Maintenance Non- infrastructure (MNI) Infrastructure enhancements Non- infrastructure enhancements Total gross Capital Expenditure 2015/ The two figures are then directly comparable and a list of movements Year on Year are supplied below: Description 2014/ /16 Movement m m m Maintenance Infrastructure Maintenance Non- infrastructure (MNI) Infrastructure enhancements Non- infrastructure enhancements Total gross Capital Expenditure In total there has been a reduction of 2.4m of regulatory IFRS expenditure from 2014/15, an analysis of movements is given below: Maintenance Infrastructure - 0.6m increase including: Increase in mains renewals length Increase in communication pipe renewals Maintenance Non Infrastructure - 3.1m reduction arising from: Major projects in 2014/15 largely completed and no new major projects started in 2015/16. Infrastructure Enhancement - 0.3m reduction arising from: Completion of infrastructure work on the Wessex resilience main, which was a unique project for BW. Non- Infrastructure Enhancement - 0.4m increase arising from: Non- Infrastructure expenditure on the Wessex resilience main. Increased metering 27

28 Capital maintenance Charges Table 4F Capital maintenance charges comprise current cost depreciation (CCD) and an infrastructure renewals charge (IRC). The CCD charge comes directly from our current cost asset register. As IRC is no longer calculated we have used the same IRC charge as last year A full Modern Equivalent Asset ( MEA ) revaluation was carried out as at 31 March 2008 for PR09 and loaded into the CC asset register, which is an integrated module within SAP. Additions and disposals since 31 March 2008 are automatically updated to the CC asset register Within the CCA Register indexation is applied annually on the opening Gross, Depreciation and Net Values with the depreciation charges being calculated as updated cost over asset life As with the historic cost register, each asset holds a code which specifies to which BU the asset belongs. This code is used for reporting by BU and enables us to identify depreciation belonging to wholesale assets. Management and General ( M&G ) M&G assets are allocated either across business units, depending on the nature of the project The split of costs and depreciation between household and non- household has been allocated based on the number of properties equating to a 92:8 split. Infrastructure assets Infrastructure assets are depreciated by the IRC. 28

29 APPENDIX A: BUSINESS UNIT, SERVICES, ACTIVITIES AND SUB- ACTIVITIES SUMMARY Sector Business Unit Services Activities examples Retail Household Non- Household All customer facing costs of water services Billing, payment handling, meter reading Wholesale Drinking Water Water Resources Abstraction licence and water abstraction Abstraction Licences/charges, Water abstraction/catchment management, testing Raw Water Distribution Raw water storage and transport Pumping, leakage detection, power generation Water Treatment Water treatment Managing water treatment, testing, power generation Treated Water Distribution Trunk and local water transport and distribution Pumping, leakage detection, network modelling 29

30 APPENDIX B: GENERAL LEDGER REPORTING STRUCTURE Bournemouth Water has separate reporting structures used for P&L and Balance sheet enabling income and costs to be collected in a defined format. Profit and Loss Profit and loss general ledger coding structure comprises of 10 alpha or numeric digits split into 4 segments (as detailed below) and was specifically developed to support reporting by business area and activity. An expense code is then added separately Ofwat Business Unit Site/Activity Example GL Code: GBK2 PA 1Z RB Company/Country Department/Activity Ofwat Business Unit This is used to assign costs directly to the relevant business unit when preparing regulatory tables. SAP contains 8 business units. Site/Activity Code This segment is generally used to distinguish between direct operational activities, maintenance activities and corporate and support activities. Sap contains 1742 site codes. Department /Activity This section is used primarily to differentiate retail and support costs, and to provide management information Expense element This is an additional code and specifies costs by type of expenditure. i.e power, direct salaries, overhead salaries, software, power etc. SAP contains 231 expense lines. The P&L structure is arranged in a hierarchical way so that costs relating to a particular service or support function are grouped together enabling reports to be produced for that area of the business. This is also known as the subjective analysis. Capital Expenditure Capital expenditure is coded in detail to jobs within the internal order module of SAP. This module feeds the costs directly into the historic cost and current cost asset registers used by Bournemouth Water. Each job uses the same GL code structure detailed above, and this detail is carried over into the asset registers. This enables assets to be easily categorised into Ofwat s business units for reporting. 30

31 APPENDIX C: RETAIL HOUSEHOLD / NON- HOUSEHOLD ALLOCATION The table below details the method of allocation of the retail costs between household and non- household. 2C.1 Customer Services Manage customer data Number of bills issued Manage property Number of bills issued data Billing General Number of bills issued Payment Handling General Number of payments Donations to charitable All household trusts Administering vulnerable groups All household scheme Investigate billing and payment enquiries & complaints Non-Network No. of Contacts Investigate metering queries & Non-Network No. of Contacts complaints Non network customer enquiries and complaints General Non-Network No. of Contacts Network customer enquiries and complaints General 2C.2 Debt Management Debt Management General 2C.3 Doubtful debts Doubtful debt charge 2C.4 Meter Reading Meter Reading General Network No. of Contacts Debt >30 days Actual provision Number of meter by reads customer type 2C.5 Services to developers Services to developers General All Non-Household 2C.6 Other operating expenditure Administration of disconnections and reconnections Number of connections by customer type Demand side water efficiency initiatives General Number of customers Customer side leaks General Number of customers Other direct costs Number of customers General Retail - General and Number of customers Support Retail - Scientific Services Number of customers Retail - Other business Number of customers 2C.8 Third party activities Retail - Third Party services Services Rates Retail - Share of Cumulo Rates GMEA Exceptional Items Retail - Exceptional Items as defined by IFRS Not Applicable 31

32 APPENDIX D: CORPORATE AND SUPPORT ALLOCATION BASIS The table below details the method of allocation for corporate and support costs. Management assessment of where to allocate costs is carried out on a department basis, with each department making its own assessment of how it has spent it s time in the year. 32

33 Function Cost Allocation Basis Health Safety and Support Services Health & Safety Security & Emergency Planning Property Accommodation and related costs Property Team Insurance Terrorism Employers Liabillity - SWW Property Public & Products Liability Motor Liability GMEA Value of sites insured GMEA value of sites insured Allocated within Vehicle recharge HR & Employee Development Personnel & Payroll Child Care Vouchers Smart Water Training Employee Development Organisational Development IS Infra & Telecom - Retail (Customer Services) Infra & Telecom - Telephones (non specific) Infra & Telecom - Data Lines Applications Development & Support - Software (Billing & Customer services) Applications Development & Support - Software (non specific) Applications Development & Support Other Information Management Strategy Specifically allocated to Retail IS Support Time IS support time (where not specifically attributable) Specifically allocated to Retail IS Support Time IS Support Time IS Support Time Bournemouth Board Pennon Group Corporate Charges Pennon Group Corporate Charges Pennon Group Corporate Charges Company Expenses Bonus Other employee costs Consultancy Audit fee Water UK membership Bank charges (Retail element relates to payment handling within Customers Services) Other Specifically attributable Finance Financial Accounting & Reporting Payables Regulation Licence Fee Regulatory Reporting Split equally between 5 business units Split equally between 5 business units Procurement Procurement costs Other Insurance Claims Specifically Attributable 33