Accounting Methodology Statement Section 1: Overview Section 2: Reporting Principles Section 3: Allocation Principles Section 4: Capital Expenditure

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2 Accounting Methodology Statement Section 1: Overview Section 2: Reporting Principles Section 3: Allocation Principles Section 4: Capital Expenditure Section 5: Cash Expenditure Section 6: Tables 4D and 4E Section 7:Improvement Plan Appendix 1: Summary of Support Cost Allocations Appendix 2: Water Operations Boundary Points

3 1 Section 1: Overview Structure and processes 1 The purpose of this document is to set out the Anglian Water Services (AWS) approach to the allocation of totex costs between price controls (table 2B, wholesale water and wastewater and 2C, retail) and the more detailed upstream services included in our 2017 Annual Performance Report (table 4D wholesale water, 4E wholesale wastewater and 4F household retail) 2 The contents of this document are aimed at helping stakeholders to understand our systems, processes and methodology used to complete the published tables. 3 AWS does not organise or manage it's business on the same basis as reported in the regulatory accounts tables and therefore, some costs are not directly attributable to either a price control or service. Where no direct allocation is possible, the guidance contained in the regulatory accounting guidelines has been followed. 4 AWS uses SAP as its integrated financial and business management system. The financial system is configured to reflect the way in which we manage our business by business unit, by location and by cost driver. 5 Our business is divided into 13 business units. In terms of the allocation of cost to price controls, the four primary business units are water services, water recycling services, customer services and Anglian Water Business (AWB) with nine support service business units. 6 The water services business unit is split into three geographic regions: East, North and South. Each region is divided into a number of management areas, and within these, costs are charged directly at a site level or an aggregation of smaller sites. Maintenance and repair work on our water network is primarily undertaken by outsourced external contractors. 7 The water recycling services business unit is split into four regions (Lincolnshire, Norfolk & Suffolk, Essex and Ruthamford) and separate maintenance, collection and support departments. Each treatment region, maintenance department and collection department are divided into smaller geographic areas or patches. Within these regions, costs are charged directly at a site level for our sewage treatment works and grouped for pumping stations and network costs by manger. 8 Customer services consists of six individual units: resource & planning, billing, customer care, debt collection, contract & process change and customer experience. Customer services costs make up 79% of total household retail costs. Within customer services, we have off-shored a large part of our back office function. This off-shore service is not customer facing and is primarily responsible for dealing with transactions arising from customer contact and correspondence. 9 Anglian Water Business (AWB) was established in as a separate business unit managing non-household customers ahead of full market opening in Costs allocated directly to AWB account for 74% of total non-household retail costs. A further 17% of total non-household costs reflect the recharge from customer services for billing, collection, debt management and meter reading. 10 The costs within the nine support services business units are charged directly to those business units, and are managed by budget holders within the business units. 11 We use SAP as our corporate financial system and costs are coded to a large number of individual cost codes which are then amalgamated into cost element groups. These groups form our key cost drivers and are the basis of our internal reporting. Key cost element groups are: Employment costs Power Rates Chemicals

4 2 Accounting Methodology Statement Tools & materials Hired and contracted services Customer debt 12 The vast majority of our costs are coded at source. This includes payroll costs, purchase requisitions and works orders. The number of costs not coded at source is small and is generally from month end transactions which by their nature are temporary pending a system generated allocation (for example, the coding used when a purchase order is first raised). 13 In order to produce regulatory accounts, and in addition to the accounting structure used for internal management reporting, we have created a separate operational cost centre and account code hierarchy in SAP. This means that directly coded water and wastewater operational costs can largely be assigned to the appropriate regulatory service and cost heading. Further reallocation of costs to service type is required in order to comply with reporting guidelines. Where costs are not directly coded to a specific service, management have assessed the appropriate allocation. 14 The allocation of support costs into the water and sewerage tables is carried out using a central consolidation model. Each support business unit provides a summary of its costs by cost driver in line with RAG 2.06 and RAG 4.06 definitions. Where possible, support costs are directly allocated to service and where costs are not directly allocated, an appropriate cost driver or management estimate determines the allocation of costs between services. Allocation assumptions are reviewed annually to ensure that the basis of allocation is still appropriate. Appendix 1 summarises the support cost allocation methodology. 15 The reporting structure of our customer services and AWB business units within SAP are closely aligned to the cost drivers on the retail analysis return, table 2C. The vast majority of costs reported in customer services, AWB and therefore retail are coded at source with the allocation of remaining costs between household and non-household following an appropriate cost driver. Further details on our assumptions can be found in the table in paragraph We allocate a share of all support overheads to the retail functions (for example Human Resources, IT and Finance). Where not directly attributable, these costs are allocated on the most appropriate basis decided by management review. Details of our allocation methodology are in appendix 1. Scope 17 The tables have been prepared in accordance with the current Regulatory Accounting Guidelines (RAGs) which provide guidance on the allocation of costs between the four price controls; water, wastewater, household retail and non-household retail. 18 The RAGs referred to in the preparation of our annual return are: Accounting Methodology Statement 2017 anglianwater.co.uk RAG principles and guidelines for regulatory reporting under the 'new UK GAAP' regime RAG guideline for classification of costs across the price controls RAG guideline for the format and disclosures for the annual performance report RAG guideline for the table definitions in the annual performance report RAG guideline for transfer pricing in the water and sewerage sectors 19 Our return has also been informed by Information Notice 16/09 (regulatory accounting guidelines ), Information Notice 17/03 (expectations for monopoly company annual performance reporting ), and the company specific recommendations arising from the CEPA targeted review of sludge and water resources which have been implemented.

5 3 Section 2: Reporting Principles 20 RAG 2.06 sets out the the principles to be used when allocating costs. We have set out those principles below with commentary on how AWS has applied those principles. 21 Transparency - the cost attribution and allocation methods applied to allocate costs within the Annual Performance Report need to be transparent. This requires that the costs and revenues apportioned to each service or segment should be clearly identifiable. The cost and revenue drivers used within the system should also be clearly explained to enable robust assurance against this guidance Costs are coded at source to each of our 13 business units The proportion of costs directly attributable to each price control are: sewerage 77%, water 74%, household retail 79% and non-household retail 74% RAG guidance is followed in the allocation of costs and revenues to price controls 22 Causality - cost causality requires that costs (and revenues) are attributed or allocated to those activities and services that cause the cost (or revenue) to be incurred. This requires that the attribution or allocation of costs and revenues to activities and services should be performed at as granular level as possible. Allocating costs in relation to the way resources are consumed provides a means of building up service and product costs. This approach views a business as a series of activities, each of which consumes resources and, therefore, generates costs. An activity based approach should result in the majority of the total costs being attributed or allocated on a meaningful basis. All operating and capital costs must ultimately be attributed or allocated. Anglian Water uses SAP as its integrated financial and business management system. The financial system is configured to reflect the way in which we manage our business by business unit, by location and by cost driver. The majority of our water and wastewater sites are individually costed Where possible, costs are allocated directly to service in our regulatory accounts. If this is not possible, the allocation guidelines contained in the RAGs have been followed. Where the option to use more than one cost driver is available, we use the one that most closely reflects the cost burden Anglian Water Services operates strict internal control processes, including budgetary control that ensure costs are allocated at the most granular level possible 23 Non-discrimination - Companies should ensure that no undue preference or discrimination is shown by water undertakers in relation to the provision of services by themselves or other service providers. Therefore, the attribution or allocation of costs and revenues should not favour any price control unit or appointed/non-appointed business and it should be possible to demonstrate that internal transfer charges are consistent with the prices charged to external third parties. AWS aim to allocate costs in a way that reflects as fully as possible the cost burden on any given service and price control, and we are committed to improving the disaggregation of costs further. 24 No cross subsidy between price controls - following the introduction of separate binding price controls at the 2014 price review, companies cannot transfer costs between the price control units in setting prices and preparing the APR. The revenue allowance for each price control is determined by the costs specific to that particular price control. Therefore, companies should also ensure that there is no cross subsidy between price control units. In accordance with RAG 5, transfer prices for transactions between price control units should be based on market price unless no market exists, in which case transfer prices should be based on cost. There will also be instances where the transfer price for some internal services and activities should be based on cost, even though a market may exist, for example activities such as treasury, legal or payroll etc. Provided the service or activity is company specific and is being provided internally to all of the price control units, or being provided solely to both the appointed and non-appointed business, then the transfer price should be based on cost.

6 4 Accounting Methodology Statement As for non-discrimination, we aim to allocate costs in a way that reflects as fully as possible the cost burden on any given service and price control. The services provided internally are company specific, and therefore charging to price controls is based on actual cost. 25 Objectivity - the cost and revenue attribution criteria need to be objective and should not intend to benefit any price control unit or appointed/non-appointed business. Cost allocation must be fair, reasonable and consistent. We want to allocate costs in the most accurate way possible, and accordingly, where costs cannot be allocated directly, fair an consistent cost drivers are used. Where there is a choice over the cost driver used to apportion costs, we ensure that we use the one we believe most accurately reflects the burden of costs. 26 Consistency - Costs should be allocated consistently by each company from year to year to ensure: Meaningful comparison of information across the sector and over time That regulatory incentives from comparative analysis apply fairly across companies To enable monitoring of companies' performance against price control assumptions Costs are allocated on a consistent basis from one year to the next. Any changes to our methodology would result from changes in the RAGs or other instruction from Ofwat, or where we have refined our methodology with the result that cost allocation has become more accurate. Any change in approach is highlighted in this document. 27 Principle use - where possible, capital expenditures and associated depreciation should be directly attributed to one of the price control units. Where this is not possible as the asset is used by more than one service, it should be reported in the service of principle use with recharges made to the other services that use the asset reflecting the proportion of the asset used by the other service. Both capital expenditure and depreciation are allocated to price controls and business units based on and internal business investment category (BIC) code, and are therefore, by default, allocated to the business unit of principle use The exceptions to this will be for management and general expenditure, where an assessment of principle use is made. Further, some allocation is required at the upstream service level as the BIC code does not always go to this level. 28 This document also addresses the reporting requirements set out in RAG 3.09 for the disclosures to be included in companies' accounting methodology statements, specifically: Accounting Methodology Statement 2017 anglianwater.co.uk High level overview including systems for producing disaggregated cost and asset data (1-19) Confirmation that the principles of RAG4 have been followed (18, 29-48) Description of the method or cost driver used to calculate allocations between price control units (where specific guidance has not been prescribed) (29-48, appendices 1&2) Any change in methodology compared to the previous year with reasons for the change and the impact quantified (39) A description of significant changes in reported costs at the price control unit level compared to the previous year (54-58) Reasons for any significant movement in a particular cost type between the price control units (54-58) For 'power' and other 'operating expenditure', quantify the percentage split between directly coded and allocated costs (40) A description of how power costs are disaggregated when it is consumed at sites that cover more than one price control unit (37)

7 5 The percentage split of M&G costs across the price control units (78) Any planned improvements for future years ( ) Section 3: Allocation Principles Wholesale operating expenditure cost allocation, table 2B Direct costs 29 For the purpose of this commentary, we define direct costs as those charged directly to our water and wastewater operational business units. 30 The majority of direct costs are coded at source with 74% of water service total operating expenditure and 77% of sewerage operating expenditure reported in table 2B, row 9 directly allocated. 31 The new format of table 2B compared to has necessarily resulted in some direct costs having to be apportioned between activities within the water and sewerage price controls. 32 Some costs are clearly identifiable as either water resources or water network+ or wastewater network+ and sludge. Where they are not, our allocation methodology is set out in the table below. 33 In the absence of directly derived financial information, we believe that this methodology represents a reasonable assessment of the split of costs between these activities. 34 The boundary points used for the allocation of costs between water operations are in line with Ofwat guidance in RAG 4.06, but for clarity, we use the diagrams shown in Appendix 2 to ensure our assessment of water boundary points is made consistently. 35 Bulk supply imports make up only 0.4% of reported water totex costs and given the materiality of these costs and the fact that the majority of costs incurred are through a joint venture arrangement rather than supplied by an appointed entity, we continue to treat the cost of bulk supply imports wholly as a water treatment cost. We will be reviewing this reporting treatment for 2018 reporting to ensure alignment with PR19 guidance. 36 Recharges are made between services and business units to reflect the cost burden of activities undertaken.

8 6 Accounting Methodology Statement 37 The table below sets out how wholesale services direct costs are allocated in table 2B. Allocation Basis of direct operating costs Table Line Water resources Water service Water Network+ Wastewater network+ Sewerage service Sludge Power Directly coded to all water sites. Where a site spans more than one service, then costs are split based either on a pumping head calculation or management assessment Directly coded to all sewerage sites. Where a site spans more than one service, then costs are split based either telemetry data, energy audits or management assessment Income treated as negative expenditure Share of demand/supply response benefits, pro-rated to power costs Demand/supply response benefits CHP and ROCS exports, farm sales income Service Charges/discharge consents Abstraction licence costs directly charged Actual charge from the EA allocated to water treatment Direct discharge consent fees directly charged to network+ Bulk supply/bulk discharge Actual charge Other operating expenditure Majority of costs can be allocated to service. Where not, costs are allocated by an appropriate cost driver including management assessment. Majority of costs can be allocated to service. Where this is not possible, costs are allocated by an appropriate cost driver including FTE, direct costs and management assessment. Local authority rates Allocated based on historic GMEAV at a service level Third party services Indirect Costs Special agreements share of abstraction Includes all non-potable water, rechargeable work, special agreement costs Detailed cost assessment of third party treatment costs 38 The methodology for the allocation of indirect and support costs, where they cannot be directly attributed, is set out in appendix 1 and follows the guidelines set out in RAG Accounting Methodology Statement 2017 anglianwater.co.uk

9 7 Material changes in methodology from and increase/(decrease) in operating costs 39 The table below sets out the material changes in cost allocation resulting from a change in our allocation methodology Impact of change in methodology between and on operating costs Change Water Service Sewerage Service Water Resources Water Network + Wastewater Network + Sludge Improved calculation for the treatment of water sludge by wastewater ( 1.5m) ( 0.2m) 1.7m We have introduced a charge for water consumed by sewage works ( 0.9m) 0.3m 0.6m De-watering assets have moved from sludge treatment to sewage treatment in line with RAG m ( 1.6m) Improved calculation of grit and screening disposal 2.1m ( 2.1m) Improved methodology for the allocation of scientific services costs ( 1.6m) 1.6m Total impact on reported numbers (favourable)/adverse ( 1.6m) ( 0.8m) 3.8m ( 1.4m) Percentage of power and other operating expenditure directly coded 40 The table below sets out the percentage of power and other operating expenditure that is directly coded to service. Percentage of power and other operating expenditure directly coded Table line Water Service Sewerage Service Water Resources Water Network + Wastewater Network + Sludge Power 45% 73% 66% 99% Other Operating Expenditure 6% 34% 45% 70% Retail operating expenditure cost allocation, table 2C 41 Our total retail costs reported in table 2C are substantially the sum of the customer services, AWB and doubtful debts costs reported internally. 42 Additional specific costs accounted for internally in the wholesale business are transferred to retail in accordance with RAG 4.05 reporting requirements. 43 An appropriate share of general support costs are also allocated to the retail business. 44 The retail business therefore consists of:

10 8 Accounting Methodology Statement Direct internal customer services costs Doubtful debts A relevant share of IT, data processing, systems support and maintenance A relevant share of Financial, legal, management, administrative Property costs and utilities Certain costs that are currently accounted for internally in wholesale such as customer side leaks. 45 The majority of retail costs incurred are coded at source. The cost drivers listed have been used for those costs not coded directly at source. 46 Costs coded to wholesale and then re-allocated to retail are customer side leaks and network enquiries and complaints: Customer side leaks are directly costed to water services and are transferred in their entirety to retail The value of network enquiries and complaints is assessed by reference to jobs undertaken in water and sewerage operations where they are assessed as a customer related job. 47 Indirect costs are allocated on the basis set out in appendix The table below sets out how customer services direct costs are allocated between household and non-household in table 2C. Cost drivers and assumptions used to derive the household/non-household allocations Operating Expenditure Activity Driver Rationale for cost driver Customer Services Billing Number of bills raised Rag 2.06 guidance Payment handling, remittance and cash Number of payments received Rag 2.06 guidance Charitable trust donations All household Rag 2.06 guidance Vulnerable customer schemes All household Rag 2.06 guidance Non-network customer queries and complaints Time spent on calls RAG we have developed reports using our telephony system that log the time spent on a call by customer type. Network customer queries and complaints Time spent on calls RAG we have developed reports using our telephony system that log the time spent on a call by customer type. Accounting Methodology Statement 2017 anglianwater.co.uk Debt Management Doubtful Debts Meter reading Services to developers Other operating expenditure Disconnections Demand side water efficiency initiatives Debt outstanding > 30 days. Direct allocation Number of meter reads All non household Number of disconnections - costs are directly attributable to non HH only All household RAG 2.06 Actual charge can be calculated by customer category. Reflective of the cost burden. Rag 2.06 guidance RAG 2.06 guidance Programme of work is all in household.

11 9 Operating Expenditure Activity Driver Rationale for cost driver Customer side leaks Directly allocated Actual costs are directly allocated to HH and non-hh. Other direct costs Various - either number of bills raised, number The most appropriate driver has been taken. of customers or direct allocation General & support - IT General & support - vehicles General & support - Finance, HR payroll General & support - Exec directors Number of customers Number of customers Number of customers Number of customers Due to our structures and nature of shared support services between HH and non HH activities, a meaningful FTE split cannot be established between the two retail services. Customer numbers adequately reflect the burden of cost between the two retail services, as they can be taken as a proxy for time spent and the consumption of resource General & support - Non-execs Number of customers General & support - Facilities Number of customers General & support - insurance Number of customers Other general and support Number of customers Other business activities - regulation Number of customers Local authority rates Number of customers Third party services - Direct allocation Dependent on service provided. Depreciation - Actual use of asset RAG 2.06 Billing and collection 49 We have billing arrangements in place with a number of other water companies and local authorities that bill on our behalf where we provide the sewerage service in that area. These billing arrangements accounted for 6.5% of our total revenue in We do not issue bills addressed to 'the occupier'. We only issue a bill when we have a customer name. 51 Where a customer has vacated a property, a provision is made against any debt at an appropriate rate depending on the age of the debt. For the purposes of provisioning, we do not differentiate between vacated and other classes of debt. The debt balance is retained on the account until such time as a write off of the debt is approved. Should the customer re-appear in our region but at a different address, the outstanding debt will be pursued. We do not issue credit notes to cancel debt, but a customer may be entitled to a credit towards outstanding debt via our assistance fund. 52 Our general provisioning policy is unchanged from the previous year. We provide by age of debt, with debt over 4 years old attracting our highest provision rate of100%. We apply different provision rates to household and non-household debt. With the exception of debt where a charging order is in place, we do not distinguish between classes or types of customer in our provisioning policy.

12 10 Accounting Methodology Statement 53 As a result of the opening of the non-household retail market from the beginning of April, some vacated and court case non-household debt will be retained by the wholesale business and not transferred to the new, non-household retail entity. This has attracted amended provisioning rates to reflect the likely difficulty in collection, which increased the non-household retail bad debt charge by 0.2m. Significant changes in operating costs since Wholesale table 2B Movement in wholesale operating costs to Water m Sewerage m Total m reported expenditure % operating costs indexed to prices reported operating costs Change to operating costs from (favourable)/adverse (5.3) (7.7) (13.0) Key variances in operating costs (real terms) Water 54 The reduction in operating costs in the year is almost entirely as a result of lower power costs. Power fell by fell by 3.9million due to a non-repeating IAS39 charge in the prior year of 2.2million, hedged power costs increasing by less than the rate of inflation and a small write-back of previously assumed costs. Sewerage Accounting Methodology Statement 2017 anglianwater.co.uk 55 The majority of the reduction in operating costs in the year is as a result of lower power costs. Power fell by fell by 4million due to a non-repeating IAS39 charge in the prior year of 2.6million, hedged power costs increasing by less than the rate of inflation and the write-back of previously assumed costs not materialising. 56 Local authority rates fell by 1.2m in the year due to the write back of previously assumed costs relating to the valuation that did not materialise.

13 11 Retail table 2C Movement in retail operating costs to Retail HH m Retail Non-HH m Total m reported operating costs % costs indexed to prices reported operating costs Change to operating costs from (favourable)/adverse (3.2) 1.8 (1.4) Key variances in operating costs (in real terms) Household 57 The main change in costs was in the bad debt charge which was down by 3.8million. Collection performance in the year was particularly strong, leading to the reduced charge. Non-Household 58 The key movement on non-household costs is also on the bad debt charge which increased by 1.0million ( 0.9million in real terms). This is due to a combination of one off benefits from the prior year not repeating and also a significant amount of cleansing of old debt in readiness for market opening that was not fully provided for. Debt written off 59 Total debt written off was 40.4m, an increase of 9.0million over the prior year. Our write off policy has not changed, but after a number of years where our bad debt charge has exceeded in year write offs, we are focusing on utilising our provision where debt is un-collectable. The increase in the level of write-offs is also attributable to the lead up to the separation of non-household retail from the appointed business. Section 4: Capital Expenditure Capitalisation policy 60 AWS capitalises expenditure which is incurred to acquire, to materially extend the useful life of, or to enhance the capability of its assets. 61 The cost of assets includes the purchase price and any costs directly attributable to bringing it into use.

14 12 Accounting Methodology Statement 62 Directly attributable costs are the costs of own employees arising from the construction or acquisition of the asset and incremental costs which would have been avoided if the asset had not been constructed or acquired. 63 Borrowing costs attributable to the acquisition, construction or production of assets are capitalised in accordance with IAS 23, and added to the total asset cost. The interest rate used is the gross cost of debt as advised by our Treasury section, and is revised each half year. Finance costs are reported separately to acquisition, construction and production costs. This principle is applied to the company s statutory reporting, however for regulatory reporting Ofwat require capitalised interest costs to be backed out in the regulatory accounts. 64 AWS does not revalue assets for statutory reporting on a regular basis, the exception being on initial adoption of reporting under IFRS (2014/15) when infrastructure and operational assets were revalued based on regulated capital value. 65 Expenditure is only capitalised where the resultant asset has an economic life of at least three years. 66 AWS has a de minimus limit of 2,000 on capital expenditure. New or replacement single assets with a total cost below 2,000 are charged to opex unless they are part of a collective programme of related work approved in advance. 67 Own costs capitalised are only those costs which can be shown to be incremental to the business due to the AWS capital programme i.e. costs which would be avoided in the event of the capital programme being removed. 68 Controls are in place to ensure methods used to recover own costs capitalised do not result in over recovery. Infrastructure Renewals Charge 69 The infrastructure renewals charge (IRC) is only applicable for reporting under old UKGAAP. Since the adoption of IFRS, an IRC is no longer applicable for statutory accounting as all infrastructure assets are depreciated. 70 For APR table 4G Wholesale current cost financial performance, a notional IRC is required as part of line 3 Capital maintenance charges. As the original method of calculation is no longer valid due to certain activities now being expensed instead of capitalised, we have taken an average of the AMP6 Final Business Plan projection in accordance with RAG This results in the notional IRC being 49.5m for , instead of the originally assessed value of 93.5m. The difference of 44m in IRC is the comparative to 54m previously capitalised, now expensed as infrastructure renewals. Wholesale totex analysis Tables 2B, 2C, 4D and 4E Accounting Methodology Statement 2017 anglianwater.co.uk 71 All additions and disposals are allocated directly to business units. This is achieved through mapping our Business Investment Category (BIC) coding for asset additions and through reviewing each asset disposal and allocating to business unit for disposals. We currently use about 500 individual BIC codes. Individual projects can have up to five separate codes but are usually proportionally allocated to no more than two or three different categories, and in many cases will be single purpose. 72 Management and General (M&G) additions and disposals during the report year are allocated wherever possible direct to business unit; where this is not possible, they are allocated according to the following hierarchy (in order of preference): 1. To a specific group of business units 2. To a specific service (water / wastewater) 3. To the combined water / wastewater operational service (non retail) 4. To all business units.

15 13 73 Assets in item 4 above are allocated to retail (15%) and the remainder (85%) to item 3 (non retail assets). This is based on the ratio of the proportion of AWS employees in Retail to the total AWS employees as at 31 March Assets in item 3 (non retail assets) are allocated to item 2 split 40% water and 60% wastewater. This is our policy split for M&G assets between the water and wastewater services (based on population served) and is consistent with our approach elsewhere in previous June Returns, Regulated Accounts and PR Assets in item 2 (specific service assets) are allocated to business units pro rata to direct employment costs in each business unit. 76 Retail assets (consisting of M&G assets), additions and disposals are allocated to either the retail household business unit or the retail non household business unit, by individual examination. 77 In accordance with Ofwat requirements for table 2A, we allocate all M&G depreciation to wholesale wastewater, being the highest percentage allocation. We recharge depreciation from wastewater to the other business units for the use of fixed assets. 78 For , M&G capital expenditure is allocated as follows: wastewater 53%, water 36%, household retail 5% and non-household retail 6%. 79 Anglian Water does not maintain a CCA register. For table 4G line 3 Capital Maintenance charges, we follow the methodology outlined in RAG We include CCD for the previous year inflated by RPI, and adjust for the depreciation for additions accounted for as described in our methodology above. We add the IRC as outlined above. Change in capital expenditure from Total capital expenditure is up by approximately 108m compared to This reflects the increased level of work undertaken in the second year of the AMP, but its not possible to comment on specific variances as the expenditure in a given year is largely unrelated to the expenditure in another. Recharges from and to other segments 82 We have followed the guidance set out in RAG 4.06 whereby depreciation is recorded in a single price control unit which then makes recharges. 83 Where assets are used by more than one business unit, a management assessment has been made of the level of use, which is then used to establish the appropriate level of recharge. This is reviewed annually. 84 Recharges made from the appointed business to the non-appointed business include a charge for the use of assets where relevant. 85 We do not include any financing costs in our recharges to and from other segments as table 2A does not report finance costs at a business unit level and therefore inclusion would distort the reported operating profit. Section 5: Cash Expenditure 86 The only cash expenditure incurred is for pension deficit recovery payments. The allocation of cash payments is in line with our final determination and is based on the number of employees in our defined benefit pension scheme.

16 14 Accounting Methodology Statement Section 6: Tables 4D and 4E Overview 87 The purpose of the publication of upstream service costs is to understand the approaches and methodologies that companies take to allocate costs to services and also to prepare for price setting at PR Our allocation to upstream services mirrors the process undertaken to complete table 2B and therefore, our allocation methodology is as described in paragraphs in this document. 89 The allocation of indirect support costs is set out in appendix 2. Water Services - total operating expenditure Abstraction licence 90 Total costs charged by the EA less any recharges made through bulk supply agreements. The cost of licences is readily identifiable and allocated directly to service Raw water abstraction 91 Total water resources operating expenditure less abstraction licence costs. Raw water transport 92 The total of raw water distribution operating expenditure. Raw water storage 93 We do not operate a raw water storage system, although some very limited elements of our network may fall into the definition provided. The cost associated with this part of our operation is negligible and therefore is included in raw water transport. Water treatment 94 Direct operating expenditure can be identified by service with an allocation of support costs. As bulk supply imports make up only 0.4% of reported water totex costs and given the materiality of these costs and the fact that the majority of costs incurred are through a joint venture arrangement rather than supplied by an appointed entity, we continue to treat the cost of bulk supply imports wholly as a water treatment cost. We will be reviewing this reporting treatment for 2018 reporting to ensure alignment with PR19 guidance. Treated water distribution Accounting Methodology Statement 2017 anglianwater.co.uk 95 Direct operating expenditure can be identified by service, as we separately identify this function in our internal management reporting. High lift pumps at the end of the treatment process (on site) have been reported as network + in treated water distribution as we believe that this activity belongs in water distribution as an activity. This treatment aligns with Ofwat's proposed changes to regulatory accounting guidelines. Water Services - capital expenditure 96 We use our business investment code (BIC) code allocations for each capital project, and these can be used to accurately reflect a direct cost allocation. Water Services - cash expenditure 97 Pension deficit costs are allocated in line with our final determination.

17 15 Sewerage Services - total operating expenditure Foul, surface water and highways drainage 98 We have developed a hydraulic model which, whilst still at a relatively early stage of development, uses population, paved area, roof area and highways area to model collection volumes by the upstream service split. This will develop further over the next couple of years, but we have derived a split of 57%, 32% and 11% respectively based on initial findings. Sewage treatment and disposal 99 Total cost for sewage treatment less the calculated costs of imported sludge liquor treatment. Imported sludge liquor treatment 100 Liquor treatment occurs at our sewage treatment works where we also have sludge treatment processes and no stand-alone dedicated liquor treatment plant. To calculate the costs associated with liquor treatment, a population equivalent is assigned to the return liquors on sludge treatment sites. We have then apportioned costs based on a population equivalent between sewage treatment and liquor treatment. Sludge transport 101 Costs of our internal and contracted liquid sludge transport service and internal contact centre used to manage routine liquid haulage work. Costs are separately identifiable with minimal estimates required in cost allocation. Sludge treatment 102 Total sludge costs less liquid sludge transport and sludge disposal costs. Includes raw cake haulage and local de-watering centres where thickening exists to >10% dry solids. Sludge disposal 103 Sludge disposal costs are already separately identified, captured and reported in the business and are generally directly allocated to this activity via our accounting system. Sewerage Services - Capital expenditure Foul, surface water and highway drainage 104 Capital expenditure at a sewage collection level is directly coded. Costs are then allocated using our hydraulic model as described in paragraph 98.above Network+ sewage treatment and sludge 105 We use our business investment code (BIC) code allocations for each capital project, and these can be used to accurately reflect a direct cost allocation. Sludge disposal 106 Total capex cost as reported in the regulatory accounts. Sewerage Services - cash expenditure 107 Pension deficit costs are allocated in line with our final determination.

18 16 Accounting Methodology Statement Variances between and Table 4D 108 The reduction in operating costs in the year is almost entirely as a result of lower power costs. Power fell by fell by 3.9m due to a non-repeating IAS39 charge in the prior year of 2.1m, hedged power costs increasing by less than the rate of inflation and a small write-back of previously over-provided costs. The reported reduction in the year is pro-rata to the reported costs. 109 Other operating expenditure reduced in raw water abstraction due to a refinement in the way scientific services costs are allocated which reduced the charge by c. 1.6m. Table 4E 110 The majority of the reduction in operating costs in the year is as a result of lower power costs, which can be seen across each business unit with a reported power cost. Power fell by 4.0m due to a non-repeating IAS39 charge in the prior year of 2.3m, hedged power costs increasing by less than the rate of inflation and the write-back of previously over-provided costs. The reported reduction in the year is pro-rata to the reported costs. 111 The allocation of costs to each service in network+ sewage collection has been impacted by the change in methodology outlined in paragraph 88 whereby the cost apportionment is now 57%, 32% and 11%. Changes to unit costs Table 4D 112 The key change to unit costs has been on network+ sewage collection due to our re-assessment of both the total volume of collection volumes and the apportionment between business units. These outputs have been derived from our hydraulic model as described in paragraph 98. Unit costs - derivation of quantities 113 The majority of the quantities used in tables 4D and 4E are reported in our internal Yearbook, and as such are included in our internal assurance and sign off processes. Water 114 Licenced volume available from rivers, reservoirs and boreholes for input into the public water supply 115 Volume abstracted from rivers, reservoirs and boreholes excluding transfer licence volumes. Accounting Methodology Statement 2017 anglianwater.co.uk 116 Volume transported from satellite sources and transferred internally 117 Average volume stored is immaterial and we report no costs in relation to raw water storage 118 Distribution input volumes for water treatment and treated water distribution are the same measure and are the volume of water put into supply as defined in JR Population is the sum of our water only and water & sewerage customers. It is based on internal data, but we are developing Local Super Output Area (LSOA) reporting to inform reporting next year. Sewerage 120 We have developed a hydraulic model which, whilst still at a relatively early stage of development, uses population, paved area, roof area and highways area to model collection volumes by the upstream service split.

19 BOD sewage sewage treatment and disposal is the total load received by sewage treatment works 122 BOD sludge liquor treatment is estimated to be 10% of sewage treatment and disposal volume. This is the amount assumed at the design stage for a treatment centre. 123 Sludge volume transported is calculated from a job database within our internal haulage business. The total volume includes liquid sludge and raw cake haulage. 124 Sludge treatment - dried solid mass treated captured and reported internally 125 Population is the sum of our sewerage only and water & sewerage customers. It is based on internal data, but we are developing Local Super Output Area (LSOA) reporting to inform reporting next year. Section 7:Improvement Plan Improvement Plan 126 Our continued involvement in the Regulatory Accounts Working Group will help us to identify more efficient and consistent ways in capturing and reporting accounting separation information. 127 A new cost capture and reporting system is under development, to be delivered in Sitting outside of SAP, this will enable greater flexibility on in-year analysis of costs and our ability to improve cost driver principles. 128 Development of our hydraulic model will continue, enabling a more granular analysis of sewage collection volumes and associated costs.

20 18 Accounting Methodology Statement Accounting Methodology Statement 2017 anglianwater.co.uk Appendix 1: Summary of Support Cost Allocations Summary of support cost allocations wher direct allocation is not possible Business Unit Narrative Basis of allocation to Table 2B and 2C (water / sewerage / retail) Asset Management Asset data management centre AM remainder ADMC oncost credit proportions G&S / total cost percentages Asset Planning Asset Planning Imp percentages Facilities (retail occupied) Floorspace Innovation team Based on project Network contract re-let SCM expenditure Risk & Value G&S / total cost percentages SCM excluding FM G&S / total cost percentages UKWIR subs Equal Water Resources 100% water Customer Services Customer Services Doubtful debts Direct cost to retail Direct cost to retail Debt management Direct cost to retail Meter reading Direct cost to retail Services to developers (1) Activity Acct Mgt and admin - direct cost non-hh retail (2) Activity Water Regulation split between W / Sewerage using number of billed customers Disconnection (1) Decision and administration activity - direct cost retail (2) Physical disconnection - direct cost water Basis of allocation to service in 2B, 4D and 4E (water / sewerage) Direct (1) (2) (1) (2) 100% to treated water distribution Basis of allocation to household / non-household in 2C (retail) Customer numbers, more appropriate driver than previously used generic CS split. See retail appendix See retail appendix See retail appendix See retail appendix (1) See retail appendix (2) (1) See retail appendix (2)

21 19 Business Unit Wholesale services Information Services Regulation CEO Narrative Demand side water efficiency initiatives / Other direct costs / General and support expenditure Meter maintenance / installation - non capex CAM team costs Asset maintenance and information Asset delivery Business resilience Tactical operations Wholesale market services Networks support Operational contact centre IT costs Business Strategy Director Income & Tariffs Economic Regulation Change CEO Basis of allocation to Table 2B and 2C (water / sewerage / retail) Direct cost to retail Direct costs to wholesale Activity on rota for OMC and fields ops staff so split between W /sewerage using direct costs All wholesale All wholesale All wholesale All wholesale All wholesale All wholesale All wholesale (1) Costs of application support, software, licences, support & maintenance contract directly attributable to the BU (2) For the rest of the costs split between W / WR / retail based on FTE or users One ninth to each service One ninth to each service One ninth to each service One ninth to each service Retail - Managerial estimate (5%) FTE Basis of allocation to service in 2B, 4D and 4E (water / sewerage) 100% to treated water distribution Management assessment Management assessment Management assessment Management assessment Management assessment Management assessment Management assessment (1) Operational direct salary costs (2) Operational direct salary costs One ninth to each service One ninth to each service One ninth to each service One ninth to each service Basis of allocation to household / non-household in 2C (retail) See retail appendix Customer numbers, more appropriate driver than previously used generic CS FTE split.

22 20 Accounting Methodology Statement Accounting Methodology Statement 2017 anglianwater.co.uk Business Unit Narrative Legal Health & Safety Corporate Affairs Corporate Affairs Finance Finance Central Insurance claims Insurance premium Carbon reduction commitment Bonus, pensions charge, welfare scheme, employee savings, class 1A and PSA Corporate overhead recovery to capex Basis of allocation to Table 2B and 2C (water / sewerage / retail) Retail allocation on management assessment Retail 100% of OHS Business Partner for CS. FTE FTE Claims split for W / WR split. Management judgement for Retail Direct, FTEs, vehicle numbers Pro-rated to water and wastewater power costs for retail. FTE's for W / WR Capital salaries Basis of allocation to service in 2B, 4D and 4E (water / sewerage) Operational direct salary costs Direct or management estimate Direct or management estimate Power costs Operational direct salary costs Direct employee costs Basis of allocation to household / non-household in 2C (retail)

23 Appendix 2: Water Operations Boundary Points 21

24 22 Accounting Methodology Statement Accounting Methodology Statement 2017 anglianwater.co.uk

25 23