Severn Trent Water Accounting Separation Methodology statement

Severn Trent Water Accounting Separation Methodology statement Contents Introduction 1. Systems in place and sources of information used to populate tables 2. Population of lines 3. Internal governance and consistency procedures 4. Capitalisation policy 5. Commentary Appendices i. ST1: Activity costing analysis Water Service ii. iii. iv. ST2: Activity costing analysis Retail Services ST3: Activity costing analysis Sewerage Service ST4-6: Analysis of fixed assets v. Capital Expenditure Accounting Policy 1

Introduction The purpose of this statement is to explain the systems, processes and allocation methods used to populate the Accounting Separation tables, historically 21a, 21b, 22a and 25a-c of the June Return. 1. Business structure and systems in place and sources of information used to populate tables Severn Trent Water is structured as follows: Water Services Waste Services Customer Relations Central functions (e.g. Information Technology) Information used to populate the tables originates from our SAP system, which was implemented during 2010. We believe that the allocations made within the accounting separation models are reasonable on the basis that: a. They are consistent with our stated methodology which was constructed based on a detailed review of the business; and b. The outputs are reviewed by our Performance Analysts and Performance General Managers for Water, Waste and Customer Relations, who bring a comprehensive view of their respective business areas. 1.1 Water service The table is populated from a matrix that records and analyses operating costs by cost centre. The cost centre data is sourced from the accounting system (SAP) and represents the transactions for the water services group of departments in their totality. The process is currently aligned to the existing reporting cost structure that is operational within the business. The majority of costs can be directly attributed to business units by specific identification of costs, whilst others are allocated based on a specific cost driver, leaving some costs based on management estimates. 1.2 Retail service As above, the table is populated from a matrix that records and analyses operating costs by cost centre. This data is sourced from SAP and represents the transactions for the customer relations department in its totality. 2

Whilst the majority of costs can be directly obtained from cost centres, certain costs require analysis using specific cost drivers, leaving a remainder of costs to be allocated based on management estimate. 1.3 Sewerage service The table is populated from a SAP Business Warehouse (BW) report that analyses operating costs by cost centre. Each operational cost centre in the Sewerage Service is either a location cost centre, a manager cost centre (i.e. contains costs that are not site specific), or a combination of manager activity and location. These cost centres are reviewed annually to capture changes in the organisational hierarchy. The majority of costs are directly attributable to the business units. However, apportionments are necessary for both direct Sewerage Service costs and general and support costs, based on specific cost drivers and some based upon management estimate. 1.4 Fixed assets The fixed assets tables (historically 25a, 25b and 25c of the June Return) consist of the assets capitalised to the SAP fixed asset register plus work in progress. The opening balances and current year transactions are analysed to the business units using the following approach: Fixed asset register Assets in the SAP asset register are allocated to cost centres which identify the operational business owner. Each asset also has an asset class which identifies the split between infrastructure, operational and other assets. This data is held as part of individual asset records on the SAP asset register. A direct link from cost centre to profit centre is included in the asset download from SAP. Profit centres are aligned to the accounting separation business units. A review is undertaken of categorisations of assets to business units to ensure they are appropriate. This targets areas where assets are more likely to require reclassifying. We identify any assets requiring reallocation based on specific asset detail in the asset register. Management and general assets have been allocated to business units based on set allocation rules. Each allocation is at cost centre level to provide the most appropriate allocation in line with the operating cost allocation rules. Retail asset costs have been allocated on the number of domestic or non domestic customers and, specifically for meters, on the number of domestic or non domestic metered customers. This is also used to analyse the depreciation charge and asset disposals by business unit and asset type. 3

Additions (Capital expenditure) Capital expenditure is analysed by business units and asset types based on the purpose code for each project. The expenditure value is adjusted to exclude infrastructure renewals expenditure and include sewer and pumping station adoptions. The purpose code for each project is obtained from a SAP Capital Project Expenditure BW report. 2. Population of lines In Appendices 1-4 we detail, on a line by line basis, the methodology employed to populate the accounting separation tables. Specifically, we provide details of the following (for lines that require a direct input): An explanation of how the data from the systems is processed to populate each line and any additional analysis or adjustments needed. An explanation of any assumptions made in the methodology, the basis of any assumptions and how we are satisfied that the basis is reasonable. An explanation of the allocation basis used for each line of the table, why these allocation bases are considered appropriate and how we are satisfied that they are reasonable. An explanation of any sampling used to populate the tables, justification for using sampling, the methodology applied and how we have ensured the results are reliable. Pensions For the activity costing analysis (historically tables 21a, 21b and 22a of the June Return) pension costs are allocated on the same basis as all other manpower costs since they are coded directly to cost centres from the payroll system. Any centrally held pension cost/credit is allocated pro rata to direct pension costs. Cost allocation principles Our approach to accounting separation applies the general principles set out in RAG 4 wherever possible. Ofwat has set out the following general principles which accounting separation systems are required to comply with. Transparency: the attribution methods applied within the accounting separation system need to be transparent. This requires that the costs and revenues apportioned to each service and business unit should be clearly identifiable. The cost and revenue drivers used within the system should also be clearly explained to enable a review of their appropriateness. 4

Costs apportioned to each business unit are identifiable and can be traced back to our SAP ledger. Our methodology statement and accounting separation models provide transparency. Causality: cost causality requires that costs (and revenues) are allocated to those activities and services that cause the cost (or revenue) to be incurred. This requires that the attribution of costs and revenues to activities and services should be performed at as granular a level as possible. Wherever possible, bases for costs are allocated to activities that cause the cost to be incurred. Some costs are more remote from the activities being allocated across than others (for example costs of regulation). The method applied to allocating such costs is described in the methodology statement. Non-discrimination: the attribution of costs and revenues should not favour any business unit within the regulated company and it should be possible to demonstrate that internal transfer charges are consistent with the prices charged to external third parties. Cost allocations bases are as objective as possible and are not designed to favour any business unit. Objectivity: the cost and revenue attribution criteria need to be objective and should not intend to benefit any business unit or service. Cost allocations bases are as objective as possible and are not designed to favour any business unit. Consistency: the cost and revenue attribution criteria should be consistent from year to year to enable meaningful comparison of information over time. Changes to the attribution methodology from year to year should be clearly justified and documented. We keep the methods of apportionment as consistent as possible. Where changes to the methods of apportionment are required, these are documented in the methodology statement (Section 5.6). 5

3. Internal governance and consistency procedures The activity costing analysis tables are prepared by the Lead Analyst for each of the three Services. A review is performed against expectations (using underlying management accounts) and against prior year. At the time of the exercise, regular update meetings are held between analysts responsible for populating the activity costing analysis tables for the respective business areas. A control totals spreadsheet which is centrally managed is used to ensure that costs are not doublecounted between business areas, and that the totals reconcile to total operating expenditure in the Regulatory Accounts. The spreadsheet takes initial operating expenditure figures from SAP and performs initial allocations into business areas before further allocation is performed. A top-down review of the final activity costing analysis tables is performed by the Water, Waste and Customer Relations Performance General Managers who bring a comprehensive view of their respective business areas. The analysis of fixed assets tables are prepared by the Senior Fixed Assets Associate and reviewed by the Capital Accounting Manager and the Financial Service Centre Controller. A reconciliation is performed between the additions in the regulatory accounts and the statutory accounts. The methodology statement is reviewed by the relevant Lead Analysts, the Capital Accounting Manager, Water, Waste and Customer Relations Performance General Managers, the Regulatory Accounting and Reporting Manager, and the Group Financial Controller on an annual basis. The regulatory accounts, which include the accounting separation tables, are approved by the Board. This methodology statement is approved by the Group Finance Director. 6

4. Capitalisation policy and process 4.1 Capital expenditure accounting policy The capital expenditure accounting policy applied by Severn Trent Water Limited is prepared in accordance with UK GAAP (FRS 15 Tangible Fixed Assets ) and the appropriate Regulatory Accounting Guidelines. The content of this document is the responsibility of the Group Financial Control and Regulatory Reporting department (Group Finance) who through their own research, and regular interaction with external auditors, keep abreast of changes in the accounting landscape that may impact the company s accounting policies. The capital expenditure accounting policy falls within the scope of this work and consequently is updated to reflect such changes as required. In recent years there have not been any significant changes in the UK accounting framework with regards to the treatment applied to tangible fixed assets. The company s capital expenditure accounting policy is structured to address both the requirements of the accounting standards and the needs of the business. Specifically, it addresses the following issues: The range of tangible fixed assets employed by Severn Trent Water; The accounting principles that determine which costs should be capitalised; The accounting treatment applied to infrastructure assets; Depreciation; and Disposals and assets taken out of commission. A copy of the policy is included in Appendix 6. 4.2 Capital expenditure accounting process The company s capital investment framework (CIF) process is well defined. Within the framework process, large capital programmes are managed, controlled and monitored. For each project the project manager is required to submit a business case template outlining the extent to which they believe the costs represent operating and capital expenditure. These proposals are submitted at approval bodies (such as programme boards) where project managers (typically engineers) discuss their projects with finance professionals from the Analyst teams. The Analyst team, in consultation with the CIF Governance Analyst, scrutinises these applications and assesses the accuracy around whether operating costs and capital expenditure have been allocated correctly. In the event that they disagree with the proposed accounting treatment the project manager is advised accordingly. However, in certain circumstances, the guidance issued by the Analyst team may be contested by the project team. In such cases the proposal is referred to Group Finance who after referring to the appropriate Financial Reporting Standard or Regulatory Accounting Guidance, provide a defining judgement on the issue. 7

Periodically, the Analyst team may request that Group Finance issue a guidance note to aid business users in the preparation of their capital investment proposals. This tends to occur for more complex areas where the applicable accounting principles, as defined in the capital expenditure accounting policy, are less easily understood by non-finance professionals. The objectives of these guidance notes is to provide an overview of the issue, describe the relevant accounting principle and recommend an appropriate course of action, in a manner that will benefit both finance and non-finance professionals in the future. 4.3 Labour, pensions and overhead absorption rates ( Burdening ) This is the mechanism in place to enable the recovery of costs from departments (primarily Support) whose activities are indirectly linked to the capital programme. We have a process that calculates these costs and allocates them to capital accordingly. The burden rate that is entered into the system, to be applied to all capital coded expenditure, is calculated as follows: Costs to recover as percentage of total capital programme = overhead rate. This information is refreshed at half year and then finalised at the year end. Information is downloaded from the ledger to ascertain gross costs and then there are two methods of calculating the figure to capitalise: Liaison with the business determines the appropriate allocations of both manpower and non-manpower costs e.g. Finance and Purchasing. A proportion of direct manpower recharges to gross manpower costs is applied to the remaining areas e.g. Human Resources and Property Services. 8

5. Commentary 5.1 Billing and collection Disclosure requirements for the methodology statement for 2013/14 include various details relating to billing and collection. Where the company outsources billing and collection, the risk of non-collection is not transferred. Any debt transferred to a collection agency for collection is already written down to nil. Collection agencies charged commission of 1.8m during 2013/14, which represents 0.1% of turnover. The company does not raise bills to the occupier. Where a customer leaves amounts unpaid, we do not raise credit notes to cancel amounts billed. The customer is pursued via trace and collect agents if the bill / charges are valid. If the amounts owed cannot be collected, these are written off as bad debts once all collection procedures have been exhausted. Credit notes to cancel charges are only raised when the bill / charges raised are invalid (issued to the wrong customer and / or wrong period). The company s approach to bad debt provisioning is set out in note 2d of the regulatory accounts. 5.2 Other direct costs Disclosure requirements for 2013-14 include a breakdown of the cost categories and values included within other direct costs. Other direct costs are included within other operating expenditure in the accounting separation tables. They are made up as follows: Category Water m Waste m Retail m Vehicle costs 3.3 3.0 - Compensation/insurance payments 2.5 0.6 0.2 Pump workshop recharges (Waste) - - Service improvement and monitoring - - 0.9 Miscellaneous expenses 0.8 0.4 Other 0.7 0.9 0.1 Total 7.3 4.9 1.2 9

5.3 Fixed assets and depreciation We maintain a current cost asset register in our SAP system. Individual Water and Waste assets are directly attributed to accounting separation business units based on the cost centre they are associated with. General and support assets are allocated across business units. Excluding general and support assets there is no significant depreciation charge relating to assets held in one business unit used by another. There are therefore no recharges made between business units for the use of shared assets. 5.4 General and support costs The table below sets out general and support costs in each service as a percentage of total operating expenditure (i.e. excluding capital maintenance). Water Services Waste Water Services Retail Household Retail Non Household 12% 10% 14% 10% Water Services Business Units Water resources Raw water distribution Water treatment Treated water distribution 9% 8% 11% 14% Waste Services Business Units Sewage Collection Sewage Treatment Sludge Treatment Sludge Disposal 13% 16% 12% 10% 5.5 Outsourced functions Disclosure requirements for 2013/14 include details of functions outsourced including agreements with other water companies and local authorities. Severn Trent Water outsources the following functions: Part of our customer relations back office processing (overseas) Meter installation Some secondary debt collection (once debt is written down to nil) Printing and issuing of customer bills Majority of maintenance of sewers Proportion of maintenance of treated water distribution network Leakage detection Sludge to land Design and build of capital projects (infrastructure and non infrastructure) 10

Managed IT hosting services Occupational health Payroll processing We have agreements with other water companies for cross-border billing and collection: Anglian Water South Staffordshire Water Thames Water Welsh Water Yorkshire Water We have agreements with local authorities (or related entities) for billing and collection: Chesterfield Borough Council Melton Borough Council North East Derby District Council Sheffield Homes Solihull Community Housing Rushcliffe Homes Major bulk import and/or export agreements with other Water Companies are as follows: Welsh Water Anglian Water South Staffordshire Water Yorkshire Water 11

5.6 Changes to methodology Bases of allocation generally remain unchanged, with the specific exceptions below. Customer side leaks Improved underlying processes mean we have been able to improve our methodology for allocating this cost between household and nonhousehold. We are now utilising categorisation of these jobs in our SAP system between domestic and commercial. Previously we based this allocation on the level of rebates paid to customers relating to leakage on their property. The Property Services cost centre in general and support contains the costs of centrally managed sites. The allocation of this cost centre was previously based upon analysis of FTE relating to each service based at facilities managed sites. Ofwat require that this allocation is based on floor space occupied for PR14. We have therefore adopted this method for 2014 accounting separation. This has no significant effect in the amount of cost allocated to each service. COSC We have updated our methodology which now allocates all of the Customer Services cost centre within COSC to Retail. This is to reflect specific Ofwat guidance relating to internally generated calls. This reduces the allocation of COSC costs to Water and Waste, with a corresponding increase in Household Retail and Non Household Retail. 12

5.7 Year on year variances We are required to explain significant year on year variances in the accounting separation tables. Explanations for significant variances are provided below. Water Resources Power 8.2m 2013/14 ( 7.2m 2012/13) +13.8% Increase is mainly due to inflation in power prices. Income treated as negative opex - 0.2m 2013/14 (- 0.3m 2012/13) -38.6% Decrease due to less self generation in current year Infrastructure renewals charge 1.0m 2013/14 ( 1.6m 2012/13) -37.5% Decrease in infrastructure renewals charge due to lower infrastructure renewals expenditure relating to Water Resources assets during the year. Raw Water Distribution Power 2.2m 2013/14 ( 1.9m 2012/13) +13.9% Increase is mainly due to inflation in power prices. Infrastructure renewals charge 2.4m 2013/14 ( 4.7m 2012/13) -48.9% Decrease in infrastructure renewals charge due to lower infrastructure renewals expenditure relating to Raw Water Distribution assets during the year. Water Treatment Power 24.8m 2013/14 ( 22.3m 2012/13) +11.1% Increase is mainly due to inflation in power prices. Bulk supply imports 3.8m 2013/14 ( 4.3m 2012/13) -12.4% Decrease in bulk supply imports is due to lower volume during the year. Third party current cost depreciation 0.5m 2013/14 ( 1.3m 2012/13) -61.5% Reduction in third party current cost depreciation due to write off of assets in prior year, resulting in no associated depreciation in the current year. 13

Amortisation of deferred credits - 0.8m 2013/14 (- 1.0m 2012/13) -20.0% Deferred credits are mapped inline with the assets they are associated with. Variances in the value and nature of capital expenditure therefore result in variances in the value of deferred credits. This also applies to the fall in deferred credits in Treated Water Distribution of 0.1m. Sewage Treatment Power 21.9m 2013/14 (26.5m 2012/13) -17.3% Income treated as negative opex - 5.3m 2013/14 (- 10.7m 2012/13) -50.4% Net Power 16.6m 2013/14 ( 15.8m 2012/13) +5.0% Increase in net power is mainly due to inflation in power prices. Power inflation has been offset to an extent by an increase in self supply. In the prior year we classified internally generated power credits as income treated as negative opex. This has been corrected in 2013/14 resulting in a reduction in power cost and a reduction in income treated as negative opex. This has no effect on the net power cost reported. Sludge Treatment Power - 0.8m 2013/14 ( 4.7m 2012/13) -116.9% Negative income - 5.3m 2013/14 (- 10.7m 2012/13) -50.4% Net Power - 6.1m 2013/14 (- 6.0m 2012/13) -1.7% Net power is consistent year on year. Power inflation has been offset by an increase in self supply. In the prior year we classified internally generated power credits as income treated as negative opex. This has been corrected resulting in a reduction in power cost and a reduction in income treated as negative opex. This has no effect on the net power cost reported. Other operating expenditure 40.4m 2013/14 ( 36.3m 2012/13) +11.3% The main factors making up the increase in other operating expenditure are o Correction of underlying materials mapping in SAP resulting in an increase of 1.3m (mapped out of Sewage Treatment). o Improved compliance resulting in higher manpower costs in Sludge Treatment ( 0.6m) o A digester incident at one of our sludge treatment works resulting in 0.8m of costs o Costs of improvement initiatives in the current year of 0.8m 14

Local authority rates 4.3m 2013/14 ( 3.6m 2012/13) +19.4% Local authority rates are posted to the Waste Service in the ledger. They are allocated between business units based on MEAV of assets across business units. Sludge Treatment assets represent a larger proportion of Waste assets in the current year than in the prior year. Additionally, rates have increased due to price inflation and lower level of refunds in the current year. Sludge Disposal Other operating expenditure 13.4m 2013/14 ( 9.0m 2012/13) +48.9% The main factors making up the increase in other operating expenditure are o A change in the underlying accounting treatment of sludge sales from negative opex to income (accounts for 1.6m of the variance). o Carry over of sludge to land activity from 2012/13 due to extreme wet weather in 2012/13 (accounts for 1.2m variance). o Additional tankering costs incurred due to sludge to land issues in the current year (accounting for 0.4m). o There were also increases in employment costs due to increased activity, and in general and support costs due to increased direct costs. Retail Household Debt management 9.1m 2013/14 ( 8.3m 2012/13) +9.4% Overall debt management costs have increased due to increased head count in order to improve collections, additional spend relating to communications, lower levels of litigation resulting in a lower level of court cost recoveries, and inflation. The allocation between household and non household is based on net debtors. The proportion of total net debtors represented by household net debtors has decreased, resulting in a lower allocation of debt management costs to Household Retail. Doubtful debts 26.9m 2013/14 ( 29.7m 2012/13) -9.5% The Severn Trent Water household doubtful debt provision is calculated based on the ageing of household debt and specific provisions identified. The provision against household debtors (after write offs) increased by a lower amount between 2012/13 and 2013/14 than it did between 2011/12 and 2012/13. This results in a lower charge in 2013/14 than that required in the prior year. No change in the accounting separation methodology has been made in relation to the doubtful debt charge. 15

Local authority rates 0.5m 2013/14 ( 0.3m 2012/13) +50.4% A higher level of credits relating to local authority rates was received in 2012/13 than in 2013/14. Credits relate to challenges made regarding the rateable value of properties. Additionally, there has been an inflationary increase in local authority rates. Allocation between household and non household is consistent with prior year. Current cost depreciation 15.1m 2013/14 ( 17.0m 2012/13) -11.2% A significant number of assets relating to the billing system (Target) reached the end of their useful economic life during the year, resulting in less than a full year s depreciation being charged. Current cost depreciation charge is therefore lower in 2013/14. Retail Non Household Debt management 1.9m 2013/14 ( 1.5m 2012/13) +29.4% Overall debt management costs have increased due to increased head count in order to improve collections, additional spend relating to communications, lower levels of litigation resulting in a lower level of court cost recoveries, and inflation. The allocation between household and non household is based on net debtors. The proportion of total net debtors represented by non household net debtors has increased, resulting in a higher allocation of debt management costs to Non Household Retail. Doubtful debts 7.1m 2013/14 ( 3.6m 2012/13) +96.5% The Severn Trent Water non household doubtful debt provision is calculated based on the ageing of non household debt and specific provisions identified. The provision against non household debtors (after write offs) increased by a greater amount between 2012/13 and 2013/14 than it did between 2011/12 and 2012/13. This increase mainly relates to specific provisions identified. This results in a higher charge in 2013/14 than that required in the prior year. No change in the accounting separation methodology has been made in relation to the doubtful debt charge. 16

Other operating expenditure 2.1m 2013/14 ( 3.6m 2012/13) -41.8% Improved underlying processes mean we have been able to improve our methodology for allocating the costs relating to customer side leaks between household and nonhousehold. We are now utilising categorisation of jobs in our SAP system between domestic and commercial. Previously we based the allocation of costs of customer side leaks on the level of rebates paid to customers relating to leakage on their property. This change is the main driver of the decrease in Non Household other operating expenditure. This is a change in accounting separation methodology and is included in section 5.6. Local authority rates 0.06m 2013/14 ( 0.02m 2012/13) +174.6% A higher level of credits relating to local authority rates was received in 2012/13 than in 2013/14. Credits relate to challenges made regarding the rateable value of properties. Additionally, there has been an inflationary increase in local authority rates. Fixed assets - Wholesale The main year on year variances in our wholesale fixed assets tables are due to the following factors: Reclassification adjustments these are lower in the year mainly due to the reclassification of customer meters into Treated Water Distribution in the prior year. This is also reflected in the Retail table. Disposals and write offs of assets were higher during the current year due to work undertaken by the Capital Accounting Team to cleanse the asset registers. This has no significant impact on net book value as the majority of these assets have been fully written down. The increase in non infrastructure Additions in Sewage Collection is mainly due to increased capital expenditure relating to the sewer network and increased adoptions of sewage pumping stations. Non infrastructure additions reduced in Sewage Treatment, mainly due to lower project spend at specific sewage treatment works. Non infrastructure additions in Sludge Treatment were mainly due to increased project spend notably at Minworth, Wanlip and Worksop and relating to a biosolids management project. Infrastructure additions in Raw Water Distribution were lower due to lower spend on raw water aqueducts during the current year. Infrastructure additions in Treated Water Distribution was higher due to increased spend on Stop Tap Renewals projects and specific resilience projects. 17

Fixed Assets - Retail Reclassification adjustments these are smaller in the year mainly due to the reclassification of customer meters into Treated Water Distribution in the prior year. RPI adjustment RPI adjustments are lower in 2013/14 than 2012/13 due to lower RPI in 2013/14. Disposals and write offs of assets were higher during the current year due to work undertaken by the Capital Accounting Team to cleanse the assets registers. This has no significant impact on net book value as the majority of these assets have been fully written down. Additions has increased due to increased capital expenditure on assets relating to Retail. Depreciation there have been no changes in the depreciation policy. Variances in depreciation are driven by variances in cost. 18

Appendix 1 ST1: Activity costing analysis Water Service A Operating expenditure 1. Power All energy costs, including the climate change levy which are directly attributable to each of the individually identified service business units: water resources, raw water distribution, water treatment, treated water distribution and water service total. Income from energy generation should be treated as negative operating expenditure. The largest element of power costs is the purchase of electricity. A download for Water Services is taken from the financial ledger. Added to this are centrally incurred Water Services costs which include Carbon Reduction Commitment payments and the negative operating expenditure associated with self generation. To apportion the Electricity cost across the four business units, a detailed site by site analysis is performed. The activities of many individual sites fall into multiple business units, so sub-site analysis is performed where necessary. The principles used are as follows: 1. Site wholly in one business unit then directly allocate. 2. Sites straddling business units apportioned based on average pumping head. 3. Where data not available in (2) above refer to Site Energy Management Plan if available. 4. Where data not available in (2) or (3) above management estimate. 2. Income treated as negative operating expenditure Income from energy generation should be treated as negative operating expenditure. Income from energy generation is allocated in line with power costs. Appendix 1 ST1: Activity costing analysis Water 19

3. Service Charges Total cost of service charges by the Environment Agency or BWB (British Waterways Board) for water abstraction which are directly attributable to individually identified service business units: water resources, raw water distribution, water treatment, treated water distribution and water service total. Services charges cost consists of Environment Agency Licences for abstraction and discharge of water. Abstraction charges are directly attributable to the Water Resources business unit. Discharge Consents are directly attributable to the Water Treatment business unit. All costs are directly attributed. 4. Bulk supply imports Total payments for imported bulk supplies that are directly attributable to individually identified service business units, water resources and water treatment. If a supply is a shared supply and is jointly owned, the costs associated with it should not be reported in the bulk supply imports line. The costs should be broken down and reported in lines 1 to 6 and 8 as appropriate. Where this has been done it should be stated in your commentary. Bulk Supplies include one Raw Water supply (Water Resources business unit) and numerous Treated Water supplies (Water Treatment business unit) so the costs can be directly attributed. All costs are directly attributed. Appendix 1 ST1: Activity costing analysis Water 20

5. Other operating expenditure a. Employment costs The sum of the total costs of non-manual and manual manpower which are directly attributable to each of the individually identified service business units: water resources, raw water distribution, water treatment, treated water distribution and water service total. To be included are the gross salaries and wages of all employees within the relevant business unit, including payments resulting from bonus and profit-related payment schemes, employer s National Insurance contributions, superannuation, pension liabilities, sick pay, sickness benefits, private health insurance, retirement awards, death in service benefits, paid leave, subsistence, travel, entertaining and conference expenses. Employment costs are captured in the SAP general ledger in the Water Services cost centre hierarchy. Some cost centres are directly attributable to one business unit. Others straddle a number and therefore costs related to these require allocation. A substantial number of employees carry out activities in multiple business units. The time recording system directly allocates costs to business units. Where this is not available, management estimate is required. Water Production department costs The majority of employees working in Water Production complete activities that straddle multiple business units. It is therefore necessary to allocate their costs based on time spent undertaking activities relating to each business unit. There are two methods used to allocate costs. 1. Jobs undertaken by maintainers and borehole operators are coded directly to one of the four business units, depending on the asset which has been worked on. Unbooked time (i.e. time recorded in the system but not booked against a specific asset) is allocated based on directly charged time. 2. Operators at large treatment works do not record their time in any system. It is therefore been necessary to use management estimate to allocate these costs. Third party costs are identified and moved in the table. Line population details can be found in the Third Party Services operating expenditure section. Water Production support costs are grouped and apportioned based on Water Production operational net operating expenditure. Appendix 1 ST1: Activity costing analysis Water 21

Distribution department costs The majority of the activities undertaken by employees in the Distribution department are within the Treated Water Distribution business unit, and so their costs are directly attributed. The exception to this is the Aqueducts team whose activities span the Raw Water and Treated Water Distribution business units. No time recording is undertaken in this team, so management estimate is used to apportion their costs between these two business units. Customer side leaks, disconnections and customer first visit costs are transferred to the Retail business unit. Line population details for these activities can be found in the Retail Services section of this document. Third party costs are identified and moved in the table. Line population details can be found in the Third Party Services section. COSC costs See separate section detailing allocation of COSC costs below. Asset Creation Water Production costs The majority of employees in this department work on capital projects and so have no impact on operating expenditure. The exception to this is the Reservoir Team, whose activities span the Water Resources business unit, the Treated Water Distribution business unit, and to a small extent, the Waste Water Service. No time recording is available so management estimate is used to apportion these costs. Any other specific operating expenditure in this department relates to Water Treatment. Asset Creation Distribution costs The majority of employees in this department work on capital projects and so have no impact on operating expenditure. The exception to this is the Mains Cleaning team which are directly attributable to the Treated Water Distribution business unit. Health and Safety department costs This department forms part of the Water Services support costs. Its costs are apportioned based on total direct costs in the four business units. Organisational Development Programme costs This department contains Water support activities. The Asset Data team manage the company s records of physical assets. The majority of this activity supports both the Water and Waste Services. This is split based on management estimate. Support activities are Appendix 1 ST1: Activity costing analysis Water 22

grouped together for all of Water Services and apportioned based on total direct costs in each business unit. Strategy department costs The Strategy Team contain costs of support activities, the Water Efficiency team, the Leakage Management team and the Always On team. The Water Efficiency Team costs are transferred to the Retail business unit. The Leakage management and Always On costs are directly allocated to Treated Water Distribution. Support activities are grouped together for all of Water Services and apportioned based on total direct costs in each business unit. b. Hired and contracted services All hired and contracted equipment and services including the hire of vehicles and plant, which are directly attributable to each of the individually identified service business units: water resources, raw water distribution, water treatment, and treated water distribution and water service total. Contracted services include all contracted labour; professional advice (such as lawyers and consultants); and computer software. Hired and contracted costs booked in WFM are coded directly to one of the four business units, depending upon the asset being worked on. Water Production department costs Hired and contracted costs within Water Production cover multiple business units and so cost allocations are required. With the exception of Chemical Analysis costs (Scientific Services) and Sludge Recycling (Water Treatment) all remaining hired and contracted costs are apportioned based on the direct manpower principles detailed above in the Employment Costs section. Third party costs are identified and moved in the table. Line population details can be found in the Third Party Services operating expenditure section. Distribution department costs The majority of hired and contracted costs in the Distribution department relate to activities which fall into the Treated Water Distribution business unit and so their costs are directly attributed. Appendix 1 ST1: Activity costing analysis Water 23

The exception to this is the Aqueducts team whose activities span the Raw Water and Treated Water Distribution business units. No time recording is undertaken in this team, so management estimate is used to apportion their costs between these two business units. Customer side leaks, disconnections and customer first visit costs are transferred to the Retail business unit. Line population details for these activities can be found in the Retail Services section of this document. Third party costs are identified and moved in the table. Line population details can be found in the Third Party Services section. COSC costs See separate section detailing allocation of COSC costs below. Asset Creation Water Production costs The majority of work carried out in this department is capitalised and so has no impact on operating expenditure. The exception to this is the Reservoir Team, whose activities span the Water Resources business unit, the Treated Water Distribution business unit, and to a small extent, the Waste Water Service. No time recording is available so management estimate is used to apportion these costs. Any other specific operating expenditure in this department relates to Water Treatment. Asset Creation Distribution costs The majority of work carried out in this department is capitalised and so has no impact on operating expenditure. The exception to this is the Mains Cleaning team which is directly attributable to the Treated Water Distribution business unit. Organisational Development Programme costs This department contains Water support activities. The Asset Data team manage the company s records of physical assets. The majority of this activity supports both the Water and Waste Services. This is split based on management estimate. Support activities are grouped together for all of Water Services and apportioned based on total direct costs in each business unit. Strategy department costs The Strategy Team contain support activities, the Water Efficiency team, the Leakage Management team and the Always On team. The Water Efficiency Team costs are Appendix 1 ST1: Activity costing analysis Water 24

transferred to the Retail business unit. The Leakage Management and Always On costs are directly allocated to Treated Water Distribution. Support activities are grouped together for all of Water Services and apportioned based on total direct costs in each business unit. c. Materials and consumables All materials and consumables that are not in hired and contracted services which are directly attributable to each of the individually identified service business units: water resources, raw water distribution, water treatment, treated water distribution and water service total. This category of cost includes equipment (such as small tools and clothing), provisions, tarmac and backfill materials, but excludes all items capitalised or included within infrastructure renewals expenditure. Most if not all stock items fall into this category. Water Production Materials and consumables costs booked in WFM are coded directly to one of the four business units, depending upon the asset being worked on. Chemical costs are directly attributable to the Water Treatment business unit. All other material costs cover multiple business units and have been allocated based on the direct manpower splits. All other departments As per Hired and Contracted detailed above. d. Other direct costs Any other direct operating costs, but excluding interest and taxation, on an aggregated basis, including costs associated with the provision of depots and offices, and insurance premiums, (where such costs exceed 5% of total water service operating costs, an analysis should be provided), also include fines and penalties (including network related GSS payments), and any bad debt costs associated with the sale of network services which can be directly attributable to individually identified service business units: water resources, raw water distribution, water treatment, treated water distribution and water service total. Appendix 1 ST1: Activity costing analysis Water 25

Water Production The largest element of Other direct costs relates to vehicles used by maintainers and operators. All costs have been allocated based on the direct manpower split between business units. All other departments As per Hired and Contracted costs. Costs included in Other direct costs are Vehicles; Map Licences; Service Standard Payments; Abortive Expenditure; and Miscellaneous Expenditure. e. COSC apportionment STW operates a Customer Operations Service Centre (COSC). Activities undertaken in COSC straddle all nine business units. It has therefore been necessary to use apportionment methods for all costs relating to COSC. The method used is based around the most appropriate cost driver for each cost centre/team. Cost drivers are as follows: Customer Service The costs of the Customer Service team, which receives calls from both customers and the business have been apportioned based on volumes of call-types. The total costs included in this cost centre have been allocated to Retail. The costs are then further split between household and non household based on customer numbers. The costs allocated to customer services include scheduling of jobs arising from customer calls and internally generated calls. Optimisation The costs of the Optimisation team have been apportioned based on the combined total of allocations in COSC. The team support all of the COSC functions with process improvement work, performance reporting and development of staff training. Operations Services The costs of the Operations Services team have been apportioned between Waste, Water and Retail based on Alarm Volumes (one half) and Job shifts (one half). Costs apportioned by Alarm volumes are then further analysed into business units Appendix 1 ST1: Activity costing analysis Water 26

based on a mixture of system data and management estimate. Costs apportioned by job shifts have been allocated to Sewage Collection in the Waste Service and Treated Water Distribution in the Water Service. TMA The TMA team costs have been split between Waste and Water based on the number of notices relating to each Service. The Water costs all relate to work undertaken in Treated Water Distribution and hence are all allocated to this business unit. The Waste costs all relate to work undertaken in Sewage Collection, which are similarly all allocated to this business unit. COSC Management Team The management team costs have been apportioned based on the combined total of allocations above. PDAS An element of COSC costs which relate to PDAS are transferred to PDAS cost centres for monitoring purposes on a monthly basis. For the purposes of Accounting Separation, these are reinstated to COSC. These costs represent customer contacts and so are allocated to Retail. f. Meter maintenance/installation non capex Operating costs associated with meter installations, maintenance, testing and removal installation, repair and exchange of customer meters, including planning and scheduling of work, pre installation survey, design of work and costing. Meter maintenance costs are allocated to treated water distribution. Meter maintenance costs are collected on a specific cost centre, 100% of which is allocated to meter maintenance. In addition, an allocation of the field management team is also made, based on total cost allocations of the Field Services cost centre. g. General and support expenditure General and support activities include all centrally provided services, except for any items specifically recorded in direct costs, scientific services or other business activities. The following services should be included where not already recorded in Direct costs: Human resources / personnel services; IT and data processing; Legal services; Management services; Appendix 1 ST1: Activity costing analysis Water 27

Financial services; Audit services; Planning liaison; Research and development; Administrative services; Property management services; Operational and technical support; Vehicles and plant; Electrical and mechanical maintenance; Land and property maintenance; Materials storage. Where an associated company provides such services, the relevant charge should be included. General and support costs are identified in the ledger by cost centre. These are apportioned between the Water Service, Retail Services and the Waste Service following the rules detailed in the table below. Where possible, specific cost drivers are used to allocate general and support costs. For example: manpower numbers by department; FTEs to apportion costs relating to HR & IS; or MEAV values to apportion rates. For some central functions the tasks being undertaken do not relate specifically to Water, Waste, or Retail (for example, Directors or Other Business Activities). One ninth of any such cost is allocated to each of the business units. This method of allocation mirrors Ofwat s approach to the Ofwat licence fee, which is required to be allocated on this basis. Some areas of apportionment require an annual refresh. For example: Internal vehicle and plant costs for transport have been allocated on the basis of vehicle and plant expenditure recharged to each of the business units; and Pension costs are allocated on the basis of actual pension costs attributed to each of the business units the data to apply this allocation is obtained through the SAP General Ledger. For summary level allocations between Water Service, Waste Service and Retail Services please refer to the Allocation of general and support expenditure between services below in this Appendix. Appendix 1 ST1: Activity costing analysis Water 28

Within the Water Table the following general and support costs have been allocated based on Manpower costs in each business unit: Information Systems Human Resources Financial Performance Financial Service Centre Property Services Business Improvement Sustainable Service Organisation Management charge The following G&S costs have been allocated based on total direct costs in each business unit: Legal and Professional Treasury and Tax Purchasing Miscellaneous Reporting Directors Group Reporting Communications and Public Affairs Assurance Small Companies credit Pension costs Transport has been allocated pro-rata on the basis of internal vehicles and plant charges. Appendix 1 ST1: Activity costing analysis Water 29

Allocation of general and support expenditure between services General and Support Cost Information Services Source of Information Total IS costs & manpower numbers downloaded from SAP. Basis of Allocation Allocated using manpower numbers. Transport Transport costs & vehicle & plant charges downloaded from SAP. Allocated to cost centres on the basis of vehicle & plant charges. Human Resources Total HR costs & manpower numbers downloaded from SAP. Allocated using manpower numbers. Property Services Legal Services Financial Performance Total property services costs downloaded from SAP. Legal Services costs downloaded from SAP. The total costs relating to Financial Performance have been downloaded from SAP. The FTEs, directly attributable to Water, Waste & Retail, have been downloaded from SAP. Allocated on basis of floor space and cost attributable to Water, Waste & Retail at facilities managed sites (See s5.6). Allocated on basis of non-manpower costs relating to Water, Waste and Retail. Allocated on FTEs directly attributable to Water, Waste & Retail. The remainder has been allocated 1/9th to each of the Business Units. Treasury & Tax Financial Services Centre The total costs relating to Treasury & Tax have been downloaded from SAP. The total costs relating to FSC have been downloaded from SAP. The FTEs, directly attributable to Water, Waste & Retail, have been downloaded from SAP. Total costs have been allocated 1/9th to each of the Business Units. Both Treasury & Tax are central support functions, hence there is no more suitable basis of allocating the costs between Water, Waste & Retail. Allocated on FTEs directly attributable to Water, Waste & Retail (Retail includes Income & Debt Team). The remainder has been allocated 1/9th to each of the Business Units. Appendix 1 ST1: Activity costing analysis Water 30

Purchasing The total costs relating to Purchasing & the non-manpower costs used as a basis of allocation have both been downloaded from SAP. Allocated on basis on Non-Manpower costs relating to Water, Waste & Retail (excluding bad debts). Misc Reporting (Includes Reservoir Lease Adj & Management Fee Charge) Total miscellaneous costs have been downloaded from SAP. Total costs have been allocated 1/9th to each of the Business Units. Miscellaneous costs are central costs, hence there is no more suitable basis of allocating the costs between Water, Waste & Retail. Group Reporting Group reporting costs have been downloaded from SAP. Total costs have been allocated 1/9th to each of the Business Units. Group reporting is a central support function, hence there is no more suitable basis of allocating the costs between Water, Waste & Retail. Directors Total director costs have been downloaded from SAP. The FTEs, directly attributable to Water, Waste & Retail, have been downloaded from SAP. Allocated on FTEs directly attributable to Water, Waste & Retail. The remainder has been allocated 1/9th to each of the Business Units. Pension Costs Pension Credit Costs Allocated on basis of actual pension costs for Waste, Water & Retail, downloaded from SAP. Communications and Public Affairs Costs downloaded from SAP Allocated on basis on Non-Manpower costs relating to Water, Waste & Retail (excluding bad debts). Management Charge Small Companies Management Charge downloaded form SAP Costs downloaded directly from SAP. Allocated on FTEs directly attributable to Water, Waste, Retail. Total costs have been allocated 1/9 th to each of the Business Units. Third party Costs downloaded directly from SAP. Allocated on basis of non-manpower costs relating to Water, Waste and Retail (excluding bad debts). Assurance Costs downloaded from SAP. Allocated on basis of non-manpower costs relating to Water, Waste and Retail. Appendix 1 ST1: Activity costing analysis Water 31

Business Improvement Sustained Support Organisation Costs downloaded from SAP. Costs downloaded from SAP. Allocated on basis of management estimate of time spent relating to each business unit. Allocated using manpower numbers. Energy team rates Costs downloaded from SAP. All costs allocated to Waste Service. Workplace improvement programme Other business change projects Costs downloaded from SAP. Costs downloaded from SAP. Allocated on basis of management estimate of time spent relating to each area. Allocated either on basis of manpower, management estimate or general and support costs, depending upon nature of project. h. Scientific Services Total costs directly associated with scientific services except for current cost depreciation and the infrastructure renewals charge. Include the costs of scientific and laboratory services, and of the monitoring of quality. The cost of such services purchased should be included but the costs of services provided for third parties excluded. For these purposes, the latter cost should be estimated, and adjustments made to the appropriate subjective lines (and compensating adjustments made under third party services). See activity definitions for further description of activities. Within Water Production are two teams that carry out Scientific Services, these are the Water Quality Compliance and Water Quality Performance teams. After excluding a small amount of operational costs relating to media replacement and tank cleaning, all costs are classified as Scientific Services. To split these costs down further, two methods are used: For Chemical analysis costs, a breakdown relating to the sample points is used to align with the nine business units. Management estimate for all other areas. Appendix 1 ST1: Activity costing analysis Water 32

The majority of costs in these teams relate to the Water Service, but a small amount of work related to Waste and so is transferred to the Waste Service table. i. Other business activities Total costs directly associated with other business activities except for current cost depreciation and the infrastructure renewals charge. This should include the cost of regulation, including all incremental managerial costs of regulation associated with a periodic review, licence fees payable to Ofwat and DEFRA in respect of regulation; certification fees associated with the Licence requirements; and staff and associated costs incurred in the preparation of submissions to, and liaison with, regulators. (Note: Environment Agency service charges are included under the operational activities). The costs relating to Other Business Activities includes the Cost of Regulation and licence fees. This figure is taken from a SAP download of costs within the Regulation cost centre group. The costs for Other Business Activities have been apportioned 1/9th to each of the Business Units i.e. 4/9ths to Water, 4/9ths to Sewerage and 1/9th to Retail on the assumption that this is a reflection of staff time spent on each Business Unit. Within each of the divisions i.e. Water, Waste and Retail, the costs relating to Other Business Activities have been further allocated on a direct costs basis to the individual Business Units. 6. Local authority rates The cost of local authority rates. This should include both Local Authority rates and cumulo rates (if appropriate). Rates cost has been identified in total and then allocated pro rata to the gross MEAV value of assets assigned to the business unit headings which are reported in the supplementary fixed assets table. Appendix 1 ST1: Activity costing analysis Water 33

The MEAV Values for Sewerage, Water and Retail have been taken from the fixed assets accounting separation. Additional rates costs have been assigned to Sewerage, Water and Retail from the General and Support costs. Rates relating to Office Buildings and the Energy Team are highlighted via SAP downloads and taken from the Property Services line on the G&S schedule. These costs are then allocated directly to the correct business units. 7. Exceptional items Exceptional items are defined in FRS3 Reporting Financial Performance. All costs which meet STW s criteria for reporting as exceptional are included in this line. Where possible, costs are directly allocated to individual business units. In some cases management estimate is applied. Any remaining costs that cannot be directly allocated are apportioned on a direct costs or general and support basis. B Capital Maintenance 1. Infrastructure renewals charge (excluding third party services) Infrastructure renewals charge, excluding any part which relates to infrastructure assets which are used for third party services. The infrastructure renewals charge is calculated for the Water Service and the Waste Service based upon actual/forecast infrastructure renewals expenditure over 15 years (AMP4, AMP5 and AMP6). This split is used to apportion the charge between the Services. The charge is then allocated to business units based on the proportion of infrastructure renewals expenditure in the year. Appendix 1 ST1: Activity costing analysis Water 34

2. Current cost depreciation The current cost depreciation charge on tangible fixed assets, for each of the individually identified service business units: water resources, raw water distribution, water treatment, treated water distribution and water service total. Note that this figure is not net of the amortisation of deferred credits and intangible assets, which are shown separately. The data is provided from the Analysis of Fixed assets table data adjusted for third party services. Allocation is completed in the Analysis of Fixed assets tables. 3. Amortisation of deferred credits The amortisation of deferred credits arising from third party contributions on noninfrastructure assets. These are amortised over the life of the related asset. The amortisation of deferred credit is analysed by profit centre which is linked to individual assets. This provides a direct link to the Water Services business units. The exception to this is management and general assets, which are allocated on an apportionment basis in line with the apportionment in the Analysis of Fixed Assets tables. 4. Amortisation of intangible assets Any amortisation or other reduction in the balance sheet valuation of intangible assets, such as goodwill. No data required. Appendix 1 ST1: Activity costing analysis Water 35

C Third party services 1. Third party services operating expenditure The operating costs of providing water services to third parties, to include amongst others: rechargeable works; water main diversions; supply of non potable water; bulk supply of raw or treated water to other companies; and repairs to fire hydrants. Third party costs are included as part of operating expenditure within the download taken from the SAP General Ledger. Such costs relate directly to Water Services and include such things as reservoir costs, fluoridation and Dams & Hydro, so costs have been removed from operating expenditure and included as part of Third Party Costs. Third Party Costs have been directly allocated to the Business Units where the costs have been incurred. Additional costs relating to third party sit within general and support costs. These costs are taken from a SAP download and stripped out of the G&S costs and allocated directly to Water Services. 2. Third party services infrastructure renewals charge Infrastructure renewals charge on infrastructure assets used only for third party services. 3. Third party services current cost depreciation Current cost depreciation on non-infrastructure assets used only for third party services. Third party current cost depreciation has been allocated on an individual asset basis. The main element being for fluoridation assets. Appendix 1 ST1: Activity costing analysis Water 36

Appendix 2 ST2: Activity costing analysis Retail Section 1: Allocation of Costs to Activities A Direct costs The direct costs of the Retail business comprise largely of the costs of the Customer Relations department, which deals with all household and non household customers. This is a distinct division of Severn Trent Water comprising of the following areas: CR Director Credit Management Field Services Transformation and Support Customer Services Business Services Control Tower and Support These areas are structured by cost centre and our activity costing analysis for retail is based around the analysis of these cost centres. Costs associated with the relevant cost centres are downloaded from the financial ledger and used as the starting point for the allocation of costs to activities. In addition, there are certain costs which are recorded outside of the Customer Relations division but which are included in the Retail business unit. These costs are identified and transferred from the relevant areas of the business. Customer Relations Costs CR Director This department comprises the Customer Relations Management Team. The cost of the team is apportioned between billing, debt management, payment handling, vulnerable customer scheme, non network enquiries, meter reading and other direct costs, based on the overall allocations of the other cost centres (excluding certain costs such as bad debts and charitable trust). Credit Management This department comprises a large number of teams which are predominately focused on debt management. In addition, the department also has some responsibilities for payment handling activity. Within Credit Management are also the costs of the doubtful debts provision, the charitable trust donations and the commission on Appendix 2 ST2: Activity costing analysis Retail 37

collection costs. The majority of the cost centres have been allocated 100% to debt management. The remaining costs are apportioned between activities as follows: An apportionment of the costs of the management team based on the consolidated total cost allocations of the other Credit Management cost centres. The Quality cost centre includes the payment services team which handles banking transactions and payment management contracts, and the quality and compliance teams, who monitor our debt management processes. The costs are therefore split between payment handling and debt management, based on an analysis of FTEs. The Commission on Collection costs sit within the Credit Manager cost centre and have been split between billing, payment handling, debt management, nonnetwork enquiries and meter reading based on a detailed analysis of the nature of the services being paid for. The doubtful debt provision sits within the Credit Manager cost centre and is allocated 100% to doubtful debts. Our charitable trust donations also sit within the Credit Manager cost centre and have been allocated directly to charitable trust donations. Charges associated with payment processing sit within the Quality cost centres and have been identified specifically and allocated directly to payment handling. Field This department comprises our field force and associated back office teams which are responsible for customer meter reading activity, billing and also assisting with non network enquiries and complaints. This department also manages the meter maintenance contract with Integra. The costs are allocated to the above categories as follows: An apportionment of the cost of the Field Management team and Compliance team, based on the total cost allocations of the other Field Services cost centres. An apportionment of the costs of the Connections team, which is responsible for amending the billing system for new properties and changes from the unmeasured to the measured tariff, based on FTE. The costs of the field force are allocated between metering and non network enquiries and complaints based on the number of FTEs involved in each of the activities. The costs of the associated planning teams are split between metering and non network enquiries and complaints based on the number of Field FTEs involved in each of the activities. The costs of the Contract Management team relate to the meter maintenance contract with Enterprise and the work of our own metering technicians. As such, the costs have been allocated 100% to Meter Maintenance. The New Connections team provide connection services for developers. The costs of the team are captured on seven individual cost centres in STW s accounting system. The majority of costs are then capitalised with the associated Appendix 2 ST2: Activity costing analysis Retail 38

new asset. The remaining balance of operating costs contained in these three cost centres gets allocated 100% to services to developers. Transformation and Support The Transformation Manager cost centre delivers process improvements across Customer Relations and produces MI for the CR management team. Any large projects are identified specifically and allocated directly to activities based on an analysis of FTE involvement. The remaining costs are allocated across activities based on the overall allocations of the other cost centres. Customer Services This department comprises our customer contact centres and associated back office teams which have responsibilities in respect of billing, payment handling, vulnerable customer scheme, non network enquires and complaints, services to developers and other direct costs. The cost centres are allocated as follows: The costs of our contact centres are apportioned between billing, non network enquiries and services to developers based on volumetric data. An allocation is also made to payment handling based on management estimate. The Income and Governance team provide back office customer services support. The costs are apportioned based on management estimate. The Proactive Income team seek to bill unbilled properties and manage the void properties file. Costs associated with this team are all allocated to Billing. The remaining cost centres (excluding vulnerable households allocation) are apportioned between billing, payment handling, services to developers, and non network enquires & complaints based on the consolidated cost allocations of the directly attributable cost centres. Within the Customer Services cost centres are the ex gratia payments made by Customer Relations in respect of poor customer service. These are identified and allocated 100% to other direct costs. The team that administers the vulnerable customer scheme sit within Customer Services. The costs are identified through an FTE analysis and allocated 100% to the vulnerable customer scheme activity. Business Services This department comprises the Business Services Manager cost centre and the Business Direct cost centre. The cost centres are allocated as follows: The Business Direct cost centre contains the teams responsible for billing and debt collection activity on commercial customers. This cost centre has therefore been apportioned based on FTEs to billing and debt management. The Business Services management team is apportioned based on the total cost allocations of the other Business Services cost centres. Appendix 2 ST2: Activity costing analysis Retail 39

The Relationship Manager cost centre contains a team responsible for managing relationships with large customers. These costs are allocated based on management estimate. Control Tower and Support The Continuous Improvement cost centre and the Customer Insight and Assurance cost centre help deliver the long term strategy of CR and ensure its ongoing effective performance. They have been allocated 100% to other direct costs. The Contracts costs are split between billing, debt management, payment handling and non network enquires, based on print and mail volumes. The costs associated with our Business Process Outsource team are apportioned between billing, debt management, payment handling, non-network enquiries and meter maintenance based on volumetric data. Other cost centres (e.g. Health and Safety) are allocated to activities based on the overall allocations of the other cost centres (excluding certain costs such as bad debts and charitable trust). Appendix 2 ST2: Activity costing analysis Retail 40

Transfers to/from Other Business Areas Reconciliation and Controls team This department, which resides in Financial Services, comprises a small team which is responsible for banking and maintenance of the cash book. The cost of the team has been identified by an analysis of FTEs associated with the activity. Costs of this team are apportioned based on FTE. Meter Maintenance The costs associated with maintaining our meter base sit within the Customer Relations department. As per revised OFWAT methodology, the costs associated with meter maintenance activity are now considered to be part of the wholesale business. As such, the meter maintenance costs are identified through our analysis of Customer Relations costs (as described above) and transferred to Water. COSC STW operates a Customer Operations Service Centre (COSC). Activities undertaken in COSC straddle all nine business units. The costs of the COSC team sit within Water. An analysis of these costs is performed by the Water team to allocate them to business units (see COSC section detailed in Appendix 1). The allocation received by Retail is allocated 100% to network customer enquiries. Distribution Services Technicians (DSTs) The costs associated with this type of work sit within the Water division, however the first time visits are considered a retail activity. The cost of initial inspections has been taken from time recording in SAP. Some of this cost relates to resolution of customer issues by the inspector, so this element is retained in Distribution and is based on management estimate. The remaining costs are transferred to Retail and allocated 100% to network enquiries. Costs of visiting the customer where no network issue is found are included in this activity. Water Efficiency Team Demand side water efficiency initiatives are performed by a team which has its own cost centre. The total expenditure of the Water Efficiency cost centre has therefore been transferred to Retail and allocated 100% to Demand side water efficiency initiatives. Customer Side Leaks The costs of customer side like are captured in the Water division. They are identifiable and are captured in Workforce Management. The associated costs are transferred to Retail and allocated 100% to Customer Side Leaks. Appendix 2 ST2: Activity costing analysis Retail 41

B Other operating expenditure General and support expenditure General and support costs are identified in the ledger by cost centre. These are apportioned between the Water Service, Retail Services and the Waste Service following the rules detailed in the table in Appendix 1 (Water Service general and support). Scientific services All scientific services costs are considered to be part of the wholesale business, so there has not been a cost allocation to Retail. Other business activities The costs relating to Other Business Activities includes the Cost of Regulation and licence fees. This figure is taken from a SAP download of costs within the Regulation cost centre group. The costs for Other Business Activities have been apportioned 1/9th to each of the Business Units i.e. 4/9ths to Water, 4/9ths to Sewerage and 1/9th to Retail on the assumption that this is a reflection of staff time spent on each Business Unit. Local authority rates Office building rates are identified in total and allocated on the basis of FTE directly attributable to Water, Waste and Retail. Exceptional items All costs which meet STW s criteria for reporting as exceptional are included in this line. Where costs can be directly allocated to the individual business units, these have been done so. All remaining costs that cannot be directly allocated have been apportioned on a direct costs basis to the individual Business Units. Third party services Retail does not incur any costs that fall within the definition of Third Party Services and hence no costs have been apportioned to Retail. C Capital maintenance Current cost depreciation The data is provided from the Analysis of Fixed Assets table data adjusted for third party services. Allocation is completed in that table. Amortisation of deferred credits The amortisation of deferred credit is analysed by profit centre which is linked to individual assets. This provides a direct link to the Water Services business units. The exception to this is management and general assets, which are allocated on an apportionment basis in line with the apportionment in the Analysis of Fixed Assets tables. Appendix 2 ST2: Activity costing analysis Retail 42

Section 2: Allocation to Household/Non-household The definition of household and non household is consistent with that used in the June Return. With the exception of the costs of our Business Direct team, which directly relates to Retail Non Household activity, and our External Relationships and Inbound/Outbound teams, which deal only with household debt, our organisational structure is such that our processes are not sub divided between household and non household activities. Therefore, to populate the Retail Household and Retail Non Household columns it has been necessary to apportion our total costs based on an appropriate allocation method. Billing Specific adjustments have been made for the costs of our Business Direct team, which directly relate to Retail Non Household activity. The remaining balance has been apportioned based on the number of household and non household customers. Payment handling, remittance and cash handling The cost of this activity is deemed to be driven by the number of receipts that are made in the year. The total number of individual receipts cannot be identified, so the allocation has been done based on relevant AQ volumes, which act as a proxy for the number of receipts. The volume of payment related AQs has been identified and apportioned between household and non-household, to give the allocation proportions used. Debt management A specific adjustment has been made for the apportioned costs of our Business Direct team, which relate to Retail Non Household activity and our External Relationships and Inbound/Outbound teams, which deal only with household debt. The remaining balance has been apportioned based on the household and non household debt split. Doubtful debts The bad debt charge is allocated to household and non household based on the calculated split of the bad debt charge between commercial and domestic customers. Charitable trust donations Total Charitable trust donations are allocated 100% to household. Vulnerable customer schemes The costs of administrating the Vulnerable Customer Scheme are allocated 100% to household. Appendix 2 ST2: Activity costing analysis Retail 43

Non network customer enquiries and complaints The costs associated with this activity are apportioned between household and non-household based on the number of household and non household customers. Meter reading Total Meter reading costs are allocated to household and non household based on the on the number of household and non household meters. Meter maintenance/ non installation non capex Meter maintenance is no longer considered a retail activity, so a household/non-household apportionment is no longer required. Network customer enquiries and complaints The costs associated with this activity are apportioned between household and non-household based on the number of household and non household customers. Disconnections Disconnections are no longer considered a retail activity, so a household/non-household apportionment is no longer required. Demand side water efficiency initiatives This activity is allocated on the basis of FTEs working on household or non-household initiatives. Services to developers The costs associated with this activity are allocated 100% to nonhousehold. Support for trade effluent compliance Support for trade effluence compliance is no longer considered a retail activity, so a household/non-household apportionment is no longer required. Customer side leaks Improved underlying processes mean we have been able to improve our methodology for allocating this cost between household and non-household. We are now utilising categorisation of these jobs in our SAP system between domestic and commercial. Previously we based this allocation on the level of rebates paid to customers relating to leakage on their property. Other direct costs With the exception of Fizzback costs (which are allocated 100% to household), the costs associated with this activity are apportioned between household and non-household based on the number of household and non household customers. General and support expenditure To allocate the majority of general and support costs, the total is first allocated to each activity (e.g. Billing) based upon the proportion of FTEs involved in undertaking the activity. The costs allocated to each activity are then Appendix 2 ST2: Activity costing analysis Retail 44

apportioned between household and non-household based on the same method used to allocate the direct costs of the specific activity e.g. billing would be allocated based on number of customers. The exceptions to this are Financial Performance, Financial Service Centre, and Treasury, which are allocated based on % of direct costs. Scientific services No scientific services have been allocated to Retail. Other business activities The costs relating to Other Business Activities have been allocated between the Retail Household and Retail Non Household columns based on the number of customers. Local Authority Rates The costs associated with this activity are apportioned between household and non-household based on the number of household and non household customers. Exceptional items Any costs associated with this activity are apportioned between household and non-household based on the number of household and non household customers. Third party services As Retail does not incur any of the costs that fall within the definition of Third Party Services, a household/non-household apportionment has not been calculated. Capital Maintenance The data is provided from the Analysis of Fixed Assets table data adjusted for third party services. Allocation is completed in that table. Appendix 2 ST2: Activity costing analysis Retail 45

Appendix 3 ST3: Activity costing analysis Sewerage Service A Operating expenditure 1. Power All energy costs, including sewerage agency power costs and the climate change levy, which are directly attributable to each of the individually identified service business units: sewage collection, sewage treatment, sludge treatment and sludge disposal. Power costs are coded by site and charged to the relevant cost centre. Where this relates to a specific Business Unit, no allocation is required. Where a site provides services to more than one Business Unit, and there is no sub metering on site, the electricity bill is allocated between Sewage and Sludge Treatment based on the Site Energy Management Plan (SEMP). 2. Income treated as negative operating expenditure Income from energy generation should be treated as negative operating expenditure. The credit associated with Combined Heat and Power (CHP) has been allocated 50/50 between Sewage Treatment and Sludge Treatment. 3. Service Charges Total costs of service charges by the Environment Agency, BWB (British Waterways Board) for discharge consents, which are directly attributable to individually identified service business units: sewage collection, sewage treatment, sludge treatment and sludge disposal. These costs are analysed and allocated directly to the appropriate business unit from the BWB and EA invoices received. Those costs relating to Water Services are transferred. Appendix 3 ST3: Activity costing analysis Sewerage Service 46

No apportionment between Business Unit is necessary 4. Other operating expenditure a. Employment costs The sum of the total costs of non-manual and manual manpower which are directly attributable to each of the individually identified service business units: sewage collection, sewage treatment, sludge treatment and sludge disposal. To be included are the gross salaries and wages of all employees within the relevant activity, including payments resulting from bonus and profit-related payment schemes, employer s National Insurance contributions, superannuation, pension liabilities, sick pay, sickness benefits, private health insurance, retirement awards, death in service benefits, private health insurance, retirement awards, paid leave, subsistence, travel, entertaining and conference expenses. Manpower costs are coded directly to Waste Water Services cost centres from the payroll system. The majority of employment costs within Waste Water Services are directly mapped to Sewerage Service business units via cost centres. Service Delivery Manpower cost centres Any balances on these cost centres are costs which have not settled via WFM to a specific asset. These are therefore allocated to the appropriate business units (Sewage Treatment, Sludge Treatment and Sewerage). These are allocated on the basis of manpower costs already mapped to the business unit. Service Delivery County manager cost centres County Manager cost centres hold costs relating to the Area Managers who report into the County Managers. Area managers cover all three business units (i.e. Sewage Collection, Sewage Treatment and Sludge Treatment). As such, it is necessary to allocate their costs. This is based on management estimate. Networks Managers are excluded from this allocation, and allocated to Sewage Collection. This is achieved by taking an average cost for a Network Manager and mapping it to Sewage Collection. Service Delivery General Manager cost centres General Manager cost centres hold costs of the County Managers that report into the General Managers. The allocation is based on management estimate. Appendix 3 ST3: Activity costing analysis Sewerage Service 47

Operational Support Service (OSS) cost centres Manpower costs of the Bio-Solids team are mapped to Sludge Disposal. The cost of the Shared Services team is allocated based on the cost of the contracts they manage. The remaining OSS costs are allocated based on management estimate. Support-type cost centres Support type cost centres include Performance and Planning and Standards departments. These costs are allocated based on management estimate of time spent on each business unit by these teams. An element of this is allocated to Water Service. Senior management Costs of Senior Managers are allocated evenly across the four Waste Service business units. COSC See Appendix 1. PDAS PDAS-related costs are calculated and transferred to a group of dedicated PDAS cost centres. The majority of PDAS costs are directly attributed to Sewage Collection. PDAS Costs associated with additional employees related to New Connections are identified and transferred to Retail. PDAS-related support-type costs are allocated on the basis of PDAS direct costs (therefore an element follows PDAS New Connections related costs to Retail). b. Hired and contracted services All hired and contracted equipment and services including the hire of vehicles and plant, which are directly attributable to each of the individually identified service business units: sewage collection, sewage treatment, sludge treatment and sludge disposal. Contracted services include all contracted labour; professional advice (such as lawyers and consultants); and computer software. (The provision of services by associated companies is dealt with in line 5). Hired and contracted services costs are coded directly to cost centres from purchase orders and other methods of procuring goods and services. e.g. purchasing cards. Appendix 3 ST3: Activity costing analysis Sewerage Service 48

The majority of hired and contracted costs are mapped directly to business units via asset cost centres. The remainder, which largely comprises centrally managed contracts are allocated based on an analysis of spend. An element of this is allocated to Water Service. This remainder also includes Energy Management costs associated with servicing and management of CHP assets. These costs have been allocated 50/50 between Sewage and Sludge Treatment. Any cost left unallocated is reviewed. As much as possible is allocated based on spend analysis (transactional review). Anything remaining is allocated based on direct hired and contracted costs. c. Materials and consumables All materials and consumables that are not in hired and contracted services which are directly attributable to each of the individually identified service business units: sewage collection, sewage treatment, sludge treatment and sludge disposal. This category of cost includes equipment (such as small tools and clothing), provisions, tarmac and backfill materials, but excludes all items capitalised or included within infrastructure renewals expenditure. Most if not all stock items fall into this category. Materials and consumables costs are coded directly to cost centres from purchase orders and other methods of procuring goods and services. e.g. purchasing cards. The majority of materials and consumables costs are mapped directly to business units via asset cost centres. The remainder, which largely comprises centrally managed contracts are allocated based on an analysis of spend. An allocation is made to Water Service. The remainder also includes Energy Management costs associated with servicing and management of CHP assets. These costs have been allocated 50/50 between Sewage and Sludge Treatment. Any cost left unallocated is reviewed. As much as possible is allocated based on spend analysis (transactional review). The remainder is allocated based on direct materials and consumables costs. Appendix 3 ST3: Activity costing analysis Sewerage Service 49

d. Other direct costs Any other direct operating costs, but excluding interest and taxation, on an aggregated basis, including costs associated with the provision of depots and offices, and insurance premiums where such costs exceed 5% of total sewerage service operating costs, an analysis should be provided, also include fines and penalties (including network related GSS payments), and any bad debt costs associated with the sale of network services which are directly attributable to individually identified service business units: sewage collection, sewage treatment, sludge treatment and sludge disposal. Other Direct Costs are coded directly to cost centres from purchase orders and other methods of procuring goods and services. e.g. purchasing cards. Insurance costs are stripped out and reclassified as general and support. A large element of Other Direct Costs relates to vehicles used by maintainers and operators. This is allocated using WFM data. Of the remaining costs as much as possible is allocated based on spend analysis (transactional review). The remainder is allocated based on directly attributed other direct costs. e. General and support expenditure General and support activities include all centrally provided services, except for any items specifically recorded in direct costs, scientific services or other business activities. The following services should be included where not already recorded in Direct costs: Human resources / personnel services; IT and data processing; Legal services; Management services; Financial services; Audit services; Planning liaison; Research and development; Administrative services; Property management services; Operational and technical support; Appendix 3 ST3: Activity costing analysis Sewerage Service 50

Vehicles and plant; Electrical and mechanical maintenance; Land and property maintenance; Materials storage. Where an associated company provides such services, the relevant charge should be included. Where possible, specific cost drivers are used to allocate general and support costs. For example: manpower numbers by department; FTEs to apportion costs relating to HR & IS; or MEAV values to apportion rates. For some central functions the tasks being undertaken do not relate specifically to Water, Waste, or Retail (for example, Directors or Other Business Activities). One ninth of any such cost is allocated to each of the business units. This method of allocation mirrors Ofwat s approach to the Ofwat licence fee, which is required to be allocated on this basis. Some areas of apportionment require an annual refresh. For example: Internal vehicle and plant costs for transport have been allocated on the basis of vehicle and plant expenditure recharged to each of the business units; and Pension costs are allocated on the basis of actual pension costs attributed to each of the business units the data to apply this allocation is obtained through the SAP General Ledger. For summary level allocations between Water Service, Waste Service and Retail Services please refer to the Allocation of general and support expenditure between services above Appendix 1. Within the Waste Services table the following general and support costs have been allocated based on Manpower costs in each business unit: Information Systems Human Resources Financial Performance Financial Service Centre Property Services Sustainable Support Organisation Pension costs Office rates Appendix 3 ST3: Activity costing analysis Sewerage Service 51

The following general and support costs have been allocated based on total direct costs in each business unit: Legal and Professional Treasury and Tax Purchasing Misc Reporting Directors Group Reporting Assurance Small Companies credit Communications and public affairs Business Improvement Management charge Transport has been allocated pro-rata on the basis of internal vehicles and plant charges. PDAS related general and support costs are allocated 100% to Sewage Collection. Energy team rates are allocated 100% to Sewage Treatment. f. Scientific Services Total costs directly associated with scientific services except for current cost depreciation and the infrastructure renewals charge. Include the costs of scientific and laboratory services, and of the monitoring of quality. The cost of such services purchases should be included, but the cost of services provided for third parties excluded. For these purposes, the latter costs should be estimated, and adjustments made to the appropriate subjective lines (and compensating adjustments made under third party services). See activity definitions for further description of activities. Scientific Service costs comprise of charges relating to chemical analysis sampling. The expenditure is charged to individual cost centres and consolidated for each business unit. It is necessary to apportion some remaining costs. This is on the basis of the direct chemical analysis costs. This is all allocated to the wholesale business. Appendix 3 ST3: Activity costing analysis Sewerage Service 52

g. Other business activities Total costs directly associated with other business activities except for current cost depreciation and the infrastructure renewals charge. This should include the cost of regulation, including all incremental managerial costs of regulation, licence fees payable to Ofwat and DEFRA in respect of regulation; certification fees associated with the Licence requirements and staff and associated costs incurred in the preparation of submissions to, and liaison with, regulators. (Note: Environment Agency service charges are included under the operational activities). The costs relating to Other Business Activities includes the Cost of Regulation and license fees. This figure is taken from a SAP download of costs within the Regulation cost centre group. The costs for Other Business Activities have been apportioned 1/9th to each of the Business Units i.e. 4/9ths to Water, 4/9ths to Sewerage and 1/9th to Retail on the assumption that this is a reflection of staff time spent under each Business Unit. Within each of the divisions i.e. Water, Waste and Retail, the costs relating to Other Business Activities have been further allocated on a direct costs basis to the individual Business Units. 5. Local authority rates The cost of local authority rates. This should include both Local Authority rates and sewerage site rates (where appropriate). The majority of Waste costs relate to Sewage Treatment and Sludge. These are allocated based on MEAV. The remainder (office rates etc) is allocated based on manpower. 6. Exceptional items Exceptional items are defined in FRS3 Reporting Financial Performance. Appendix 3 ST3: Activity costing analysis Sewerage Service 53

All costs which meet STW s criteria for reporting as exceptional are included in this line. Where costs can be directly allocated to the individual business units, these have been done so. All remaining costs that cannot be directly allocated have been apportioned on a direct costs basis to the individual Business Units. Within Waste the costs have been allocated based on direct costs. B Capital Maintenance 1. Infrastructure renewals charge (excluding third party services) Infrastructure renewals charge, excluding any part which relates to infrastructure assets which are used for third party services. The infrastructure renewals charge is calculated for the Water Service and the Waste Service based upon actual/forecast infrastructure renewals expenditure over 15 years (AMP4, AMP5 and AMP6). This split is used to apportion the charge between the Services. The charge is then allocated to business units based on the proportion of infrastructure renewals expenditure in the year. 2. Current cost depreciation The current cost depreciation charge on tangible fixed assets, for each of the individually identified service business units: sewage collection, sewage treatment, sludge treatment and sludge disposal. Note that this figure is not net of the amortisation of deferred credits and intangible assets, which are shown separately. The data is provided from the Analysis of Fixed Assets data adjusted for third party services. Allocation is completed in the Analysis of Fixed Assets tables. Appendix 3 ST3: Activity costing analysis Sewerage Service 54

3. Amortisation of deferred credits The amortisation of deferred credits arising from third party contributions on noninfrastructure assets. These are amortised over the life of the related asset. The amortisation of deferred credit is analysed by profit centre which is linked to individual assets. This provides a direct link to the water business units. Management and general assets are allocated on apportionment basis in line with the assets from the cost centre. Management and general assets are allocated on apportionment basis in line with the assets from the cost centre. 4. Amortisation of intangible assets Any amortisation or other reduction in the balance sheet valuation of intangible assets, such as goodwill. No data required. C Third party services 1. Third party services operating expenditure The operating costs of providing sewerage services to third parties, to include amongst others: rechargeable works; treatment and disposal of imported sewage and sludge; income from adoptions; sewer diversions; and emptying of septic waste tanks. Third party costs are included as part of operating expenditure within the download taken from the SAP General Ledger. Costs associated with the Farms activity and rechargeable Appendix 3 ST3: Activity costing analysis Sewerage Service 55

work indentified on statistical internal orders have been removed from direct costs and included as part of Third Party Costs. Third Party Costs have been directly allocated to the Business Units where the costs have been incurred. 2. Third party services infrastructure renewals charge Infrastructure renewals charge on infrastructure assets used only for third party services. No data required. 3. Third party services current cost depreciation Current cost depreciation on non-infrastructure assets used only for third party services. Third party current cost depreciation has been allocated on an individual asset basis, the main element being fluoridation assets. Appendix 3 ST3: Activity costing analysis Sewerage Service 56

Appendix 4 ST4-6: Analysis of fixed assets Allocation basis For operational assets each specific asset is allocated a cost centre within the current cost SAP asset register which identifies the operational business owner. There is a direct link from the cost centre to a profit centre, which is linked to one of the accounting separation business units. Each asset also has an asset class which identifies the split between infrastructure, operational and other assets. This data is held as part of individual asset records on the current cost SAP asset register. A reconciliation is performed between the additions in the regulatory accounts and the statutory accounts. Management and general assets are allocated across the accounting separation tables using the following bases: Business area Information systems Transport Property services Business Planning COSC Manager Basis of allocation Allocated using manpower numbers Allocation to cost centre on the basis of vehicle and plant charges Allocated on basis of floor space and cost attributable to Water, Waste & Retail at facilities managed sites (see s5.6). Allocation to waste, water and retail based on management view and allocation to business units within these areas on direct costs charged Allocation on direct cost to business unit Visitor sites Specific sites charged to relevant business unit. Non specific costs charges as property services Scientific Services Made up of direct costs attributable to Waste and Water. To allocate to each business unit for chemical analysis costs a cost breakdown relating to sample points is used. For all other costs a management estimate was used. Appendix 4 ST4-6: Analysis of fixed assets 57

Other Allocations The following allocations have also been included to allocate assets to appropriate business units: Raw water storage assets These have been split between water resources and raw water distribution based the business unit rules. Pumped raw water storage reservoirs have been included as raw water distribution assets. High level pumping at sites This has been included within water treatment when situated at the treatment works. CHP assets at sewage treatment works These have been allocated to the sludge treatment business unit. Retail assets These are allocated between Household and non-household based on customer/meter splits, depending upon the nature of the asset. Retail assets are made up as follows: Asset category Household Non Household Household Non Household Net book value Net book value Current cost depreciation Current cost depreciation m m m m Billing system 4.1 0.3 4.3 0.3 Other assets specifically allocated to retail 1.6 0.1 1.6 0.1 Shared assets allocated to retail 68.2 7.2 9.2 1.0 All shared assets are management and general assets; allocation bases for these are described above. Appendix 4 ST4-6: Analysis of fixed assets 58

Line population A Gross replacement cost 1. Gross replacement cost at 1 April This is the gross MEA brought forward from the previous year. The gross MEA value of an asset is what it would cost to replace an old asset with a technically up to date new asset with the same service capability. For definition of asset types and asset valuation see the guidance. The opening asset balance is the same as the closing gross replacement cost from the previous year. 2. AMP adjustment The adjustment to GMEA as a result of an MEA revaluation. This aligns the gross asset value brought forward, with the value of the MEA revaluation. The AMP adjustment is completed on an individual asset basis in the SAP asset register. A spreadsheet is then used to collate the download data at a summary level and include any adjustments and allocations to the correct business unit. Assets are attributed to business units on an individual asset basis or via an allocation rule for specific groups of assets. 3. Reclassification adjustment The adjustment to GMEA as a result of reclassifying assets between business units during the year. Reclassifications between business units arise due to one of the following Capital project expenditure is analysed by business units using purpose codes for inclusion in the Additions line. At the outset of a project, project managers Appendix 4 ST4-6: Analysis of fixed assets 59

determine the proportion of total project spend that will relate to each purpose code. As the project progresses/is capitalised, these proportions may change resulting in a reclassification between business units. Changes to management and general opening balances due to revised allocations between business units. A targeted review of asset to business unit mapping in the asset register is undertaken. This is necessary as the internal cost centre hierarchy is not entirely consistent with accounting separation definitions. For example, some sludge holding tanks are classified under Sewage Treatment internally, although they are classified as Sludge Treatment under accounting separation rules. Reclassifications of any such assets identified in the current year that were not reclassified previously, are reported in this line. Assets are attributed to business units on an individual asset basis or via an allocation rule for specific groups of assets. 4. RPI adjustment Adjustment for valuation from previous year to current year prices using year end RPI by asset type. The indexation for RPI is completed on an individual asset basis in the SAP asset register. A spreadsheet is then used to collate the download data at a summary level and includes any adjustments and allocations to the correct business unit. As reported above, assets are attributed to business units on an individual asset basis or via an allocation rule for specific groups of assets. This includes the transaction for revaluation of gross asset value. 5. Disposals The reduction in gross value of assets caused by disposal of assets, by type. An analysis of disposals by asset number and cost centre provides the gross asset disposal value by business unit. A spreadsheet is then used to collate the download data at a summary level and include any adjustments and allocations to the correct business unit. Appendix 4 ST4-6: Analysis of fixed assets 60

Assets are attributed to business units on an individual asset basis or via an allocation rule for specific groups of assets. 6. Additions Increase in gross value of assets by type caused by purchase. These comprise noninfrastructure expenditure on the base service, plus all enhancement expenditure. The additions line is the capital project expenditure for the year analysed by business unit. This is calculated by deducting infrastructure renewals expenditure from gross capital expenditure, and adding adoptions. The capital project expenditure is analysed using purpose codes. At the outset of a project, project managers determine the proportion of total project spend that will relate to each purpose code. These are reviewed and amended as the project progresses by the project managers. 7. Gross replacement cost at 31 March This is the total gross MEA at the end of the year. The gross MEA value of an asset is what it would cost to replace an old asset with a technically up to date new asset with the same service capability. The gross replacement cost of infrastructure assets relating to water and sewerage brought forward at the beginning of the financial year plus the AMP adjustment, plus the reclassification adjustment, plus the RPI adjustment, less disposals and plus additions. Calculated: sum of above. B Depreciation 8. Gross replacement cost at 31 March Accumulated depreciation brought forward on assets by type at the beginning of the year. Appendix 4 ST4-6: Analysis of fixed assets 61

The opening asset balance is the same as the closing balance from the previous financial year. Allocation basis is the same as the closing depreciation from the previous financial year. 9. AMP adjustment The adjustment to accumulated depreciation as a result of a MEA revaluation. For more details please see section Adjustment to accumulated depreciation lines below. 10. AMP adjustment gross MEA revaluation The proportion of the total adjustment in line 8 above that relates to an adjustment to gross replacement cost. The AMP adjustment is completed on an individual asset basis in the SAP register. A spreadsheet is then used to collate the download data at a summary level and include any adjustments and allocations to the correct business unit. Assets are attributed to business units on an individual asset basis or via an allocation rule for specific groups of assets. 11. AMP adjustment amendment to remaining useful economic lives The proportion of the total adjustment in line 8 above that relates to an amendment to remaining useful economic lives. No Amp adjustment has been made to the remaining useful economic life. 12. Reclassification adjustment The adjustment to accumulated depreciation as a result of reclassifying assets between business units during the year. Appendix 4 ST4-6: Analysis of fixed assets 62

Reclassifications between business units arise due to one of the following Capital project expenditure is analysed by business units using purpose codes for inclusion in the Additions line. At the outset of a project, project managers determine the proportion of total project spend that will relate to each purpose code. As the project progresses/is capitalised, these proportions may change resulting in a reclassification between business units. Changes to management and general opening balances due to revised allocations between business units. A targeted review of asset to business unit mapping in the asset register is undertaken. This is necessary as the internal cost centre hierarchy is not entirely consistent with accounting separation definitions. For example, some sludge holding tanks are classified under Sewage Treatment internally, although they are classified as Sludge Treatment under accounting separation rules. Reclassifications of any such assets identified in the current year that were not reclassified previously, are reported in this line. Assets are attributed to business units on an individual asset basis or via an allocation rule for specific groups of assets. 13. RPI adjustment The depreciation on the adjustment of valuation from previous year to current year (adjustment by year end RPI) by asset type. The indexation for RPI is completed on an individual asset basis in the SAP asset register. A spreadsheet is then used to collate the download data at a summary level and includes any adjustments and allocations to the correct business unit. Assets are attributed to business units on an individual asset via an allocation rule for specific groups of assets. This includes the transaction for revaluation of depreciation. 14. Disposals A negative number representing the reduction in depreciation caused by disposal of assets by type. Appendix 4 ST4-6: Analysis of fixed assets 63

An analysis of disposals by asset number and cost centre provides the depreciation asset disposal value by business unit. A spreadsheet is then used to collate the download data at a summary level and include any adjustments and allocations to the correct business unit. Assets are attributed to business units on an individual asset or project basis or via an allocation rule for specific groups of assets. This includes the transaction for depreciation disposed from the fixed asset register. 15. Charge for the year Depreciation charge on assets by type. For the definition of asset types see above. This figure is before the amortisation of deferred credits and intangible assets. The calculation of the depreciation charge for the year is completed on an individual asset basis in the SAP asset register. A spreadsheet is then used to collate the download data at a summary level and includes any adjustments and allocations to the correct business unit. As reported above assets are attributed to business units on an individual asset or project basis or via an allocation rule for specific groups of assets. This includes the transaction for the depreciation charge to the fixed asset register. 16. Depreciation at 31 March Accumulated depreciation carried forward by asset type at the end of the charging year. (Accumulated depreciation brought forward by asset type plus AMP adjustments, RPI adjustment, less disposals and the charge for the year for those assets). Calculated: sum of above. 17. Net book amount at 31 March Net book value by asset type at the year end. (Gross replacement cost by asset type at the year end less accumulated depreciation relating to those assets at the year end). Appendix 4 ST4-6: Analysis of fixed assets 64

Calculated: sum of closing cost less closing depreciation. 18. Net book amount at 1 April Net book value by asset type at the beginning of the year. (Gross replacement cost by asset type at the beginning of the year less accumulated depreciation relating to those assets at the beginning of the year). Calculated: sum opening cost less opening depreciation. Appendix 4 ST4-6: Analysis of fixed assets 65

Appendix 5 Capital expenditure accounting policy 1. Introduction 1.1 Objectives The objective of the Severn Trent Water Capital Expenditure accounting policy is to provide users with sufficient guidance to apply the correct accounting treatment to each stage of the investment life cycle. 1.2 of capital investment Capital investment provides a benefit over a period of years and normally involves the construction, provision, replacement, improvement or major renewal of an asset. 1.3 Severn Trent Water accounting policy The Company s accounting policy for capital investment is compatible with UK Generally Accepted Accounting Principles (UK GAAP). 2. What type of tangible fixed assets does Severn Trent Water employ? The fixed assets employed by the company fall into two broad categories: infrastructure assets and other assets. 2.1 Infrastructure assets In general terms infrastructure assets are those assets that form the fabric of the water network used by the Company in its day to day activities. The Regulatory Accounting Guidelines define infrastructure assets as comprising a network of systems being mains and sewers, impounding and pumped raw water storage reservoirs, dams and sludge pipelines. Further assets such as raw water aqueducts, river outflows and zonal investigation records also fall within this category. 2.2 Other assets Other assets include all assets not classed as infrastructure. These fall under the headings Freehold land Buildings Operational structures Fixed plant Vehicles, mobile plant and computers Appendix 5 Capital expenditure accounting policy 66

These assets are held on the fixed asset register at their cost less accumulated depreciation. 2.3 Assets held under finance leases This category includes assets financed by leasing arrangements which are treated as if they are owned by the Company. This is because a financing leasing arrangement transfers substantially all the risks and rewards of ownership from the lessor (the leasing company) to the lessee (Severn Trent). The assets are accounted for as if they had been purchased and the corresponding capital cost is shown as an obligation to the lessor through the creation of a finance lease creditor. At the inception of the lease the transaction should recorded as both a fixed asset and a finance leases creditor. This value should be the present value of future lease payments which is derived by discounting them at the interest rate implicit in the lease. Lease payments are treated as consisting of a capital element and a finance charge, the capital element reducing the obligation to the lessor and the finance charge being written off to the profit and loss account over the period of the lease in proportion to the capital amount outstanding. 2.4 Operating leases Under the terms of an operating lease the Company acquires the right to use an asset without obtaining the risk or rewards associated with that asset. The Company will be charged a fee for this service. Usually the Company does not have the obligation to repair the asset in the event of it breaking down. Consequently, assets held under operating leases are not included in the fixed assets register and the only accounting entries that should be made relate to the monthly rental charge. For further details on the treatment of finance and operating leases refer to the Finance and operating lease accounting policy. 3. Capitalising costs 3.1 Overview FRS 15 requires that tangible fixed assets should initially be measured at cost, which should include only those costs directly attributable to bringing the asset into working condition for its intended use. This concept is explained in further detail below. 3.2 Directly attributable costs Directly attributable costs include Production costs: the price of raw materials plus the direct costs of production; Appendix 5 Capital expenditure accounting policy 67

Labour costs of the Company s own employees arising in the construction or acquisition of the tangible fixed asset; Incremental costs incurred by the Company that would have been avoided only if the tangible asset had not been constructed or acquired; Costs of dismantling and removing an asset, and restoring the site. Specific examples: Only the directly attributable costs associated with bringing an asset into its intended use should be capitalised. Therefore Costs of renting alternative office space whilst construction of a new office takes place are expenses incurred in the normal course of business, and should not be capitalised; Migration costs associated with an IT project are not directly attributable to bringing the asset into its intended use, and should not be capitalised. Costs of construction of a diversion to enable overhaul of a water pump should not be capitalised as they represent work undertaken to enable the company to continue its day to day operations, rather than being directly attributable to bringing the asset into its intended use. Costs relating to staff training may only be capitalised where they relate to training materials, which can be retained to provide a future benefit to the company. Other costs incurred during the training of staff should not be capitalised as the company cannot control when employees leave the company, making their training redundant. 3.3 Treatment of specific costs Other specific costs are treated as follows: 3.3.1 Finance costs Company policy is not to capitalise finance costs that relate to bringing a tangible fixed asset into use. 3.3.2 Overheads Currently, costs incurred on a project comprise a raw cost (the invoice cost) and a burdening cost. The burdening cost relates to overheads which would not have been incurred in the absence of capital works. The capital burdening comprises two categories: Appendix 5 Capital expenditure accounting policy 68

Staff costs that cannot be directly attributed to specific projects. Typically this would include staff undertaking strategic or programme management activities across the entire programme; and Support function costs that would not be incurred if the capital programme did not exist. The burdening cost is the percentage that is applied to the raw cost of each transaction to reflect its element of overheads that are directly attributable to bringing the asset into its intended use. An overhead recovery rate is established at the beginning of each period to include an appropriate apportionment of these costs. At the end of the accounting period an exercise is performed to true-up the overhead absorption to reflect actual costs observed during the period. These tasks are performed by the Financial Performance department. 3.3.3 Labour costs Only those labour costs that relate to the time spent by employees on constructing or acquiring a specific asset should be capitalised. Therefore, if an engineer spends only 25% of their time on developing a particular asset then only 25% of their labour costs should be capitalised. 3.4 Subsequent expenditure The Company should only capitalise further expenditure on asset that has been brought into use under the following circumstances: It results in an improvement to the original performance of the asset beyond the previous estimate or extends the life of the asset; It replaces a component of an asset that has been treated separately for depreciation purposes and depreciated over its individual useful economic life; and It relates to a major overhaul of the asset and restores the economic benefits that have been used up by the Company that have already been reflected in the depreciation charge. 3.5 Start-up costs Costs associated with a start-up or commissioning period should be capitalised only where the asset is available for use but is incapable of operating at normal levels without such a start-up or commissioning period. A distinction should be drawn between those costs incurred because an asset is incapable of operating at normal levels, and those costs incurred because demand has not yet built up. In the latter of these cases the costs would be expensed. Appendix 5 Capital expenditure accounting policy 69

3.6 De minimis rule Where the total expenditure on a project is less than 3,000 it is Company policy that these costs will not be capitalised. Exceptions to this rule are as follows: When the asset is less than 3,000, and it relates to an initial equipping or a major equipping exercise where the total cost is in excess of 3,000, this may be treated as capital. Where a project is made up of a large number of jobs which can vary in size, e.g. housing mains, road works diversions, all jobs of that type should be charged to capital expenditure. Specialist attachments or additions to vehicles or items of mobile plant which are purchased some time after the vehicles are to be treated as capital expenditure if they are individually more than 3,000 or relate to an initial or major equipping exercise where the total cost is in excess of 3,000. Purchase of new office furniture as part of a major re-equipping exercise which in total costs more than 3,000 will be treated as capital expenditure. The occasional replacement of desks, cabinets etc. will be charged to revenue expenditure when purchased. 4. Accounting for infrastructure assets 4.1 Overview As per Regulatory Accounting Guideline 1, expenditure on infrastructure assets relating to increases in capacity or enhancements of the network is treated as an addition and included at cost after deducting grants and contributions. Capital and operating expenditure arising from each project in the investment programme must be identified based on the Regulatory Analysis categories defined in the SAP. The actual values ascribed to IRE and capital for each project are calculated automatically within SAP, as there is a one to one relationship between the Regulatory Analysis Codes and the Purpose Codes (which define the driver for the capital investment), ascribed to the project. The automatic calculation of the actual values ascribed to revenue and capital for each project are based on the promoted purpose codes There is a requirement for this data to be reviewed by Project Owners during the life of the project as defined in the Capital Investment Manual. Appendix 5 Capital expenditure accounting policy 70

4.2 Apportionment of costs Each project is apportioned between the categories below and a percentage is calculated for each category. Costs associated with all but the first of these categories should be capitalised. 4.2.1 Infrastructure Renewal This is expenditure necessary to maintain or restore the original operating capability of the system in terms of its original capacity, qualitative performance and condition; i.e. expenditure on the fabric of infrastructure assets which does not lead to an extension to or enhancement of the system. The infrastructure renewals charge is an annualised charge that is based on the expected expenditure required to maintain or restore the original operating capability of the system calculated over a five year rolling period. In the regulatory accounts the infrastructure renewals charge is calculated over a fifteen year rolling period. The annual charge is made to the profit and loss account and accrued in the balance sheet. Infrastructure renewals expenditure is then charged against this accrual. 4.2.2 Quality This category comprises expenditure which is to bring an infrastructure system capability up to a new quality standard imposed either internally or externally. 4.2.3 Level of service This includes cost incurred to bring an infrastructure systems capacity or capability up to a new level of service standard imposed either internally or externally. 4.2.4 Non-Infrastructure This is expenditure on the creation or renewal (resulting in an extension of asset life), of non-infrastructure assets. 4.2.5 Supply and Demand Balance These costs relate to growth from existing customers (determined by the difference between current and anticipated future consumption) and/or entirely new capacity for new customers. 4.2.6 Unfunded These are costs that are incurred on self financed projects that fall outside the scope of the Ofwat funding. Appendix 5 Capital expenditure accounting policy 71

5. Depreciation Freehold land is not depreciated. Other assets are depreciated over their estimated economic lives, which are principally as follows: Buildings 30-80 years Fixed plant and equipment 20-40 years Vehicles, mobile plant and computers 2-15 years Assets in the course of construction are not depreciated until commissioned. For more detailed information on depreciation refer to the Depreciation accounting policy. 6. Disposals and assets taken out of commission 6.1 Overview When an asset is disposed of, the book value of that asset should be written off. This is deducted from the net proceeds received to calculate the profit and loss on disposal. If there is insufficient detail available for the book value to be identified in the asset records (pre-vesting assets, assets acquired prior to 1974) then the net book value is estimated. Infrastructure assets that are taken out of commission should be removed from the fixed asset register at their original cost as no depreciation will have been charged against these assets. 6.2 Costs incurred at the end of an asset s life Before the asset is disposed of, additional costs may be incurred to bring the asset into a saleable condition or to meet a contractual or legislative requirement to dismantle the asset and/or restore the site to its original condition. 6.2.1 Dismantling an asset or restoring a site FRS 12 requires a provision for the liability for dismantling the asset and/or restoring the site to be recognised when the asset is capitalised (if there is a contractual or legal obligation). This is included in the cost of the asset. Costs are then booked against this provision as they are incurred prior to the disposal. The Company has a range of assets that were constructed prior to the implementation of FRS 15. Consequently, no provision was established at the point of inception for the future costs of dismantling or restoring the site. When this is the case the costs are recognised in the profit and loss account as they are incurred. Appendix 5 Capital expenditure accounting policy 72

6.2.2 Costs to bring the asset into a saleable condition If costs are incurred bringing the asset into a saleable condition and there is a reasonable expectation that the costs will be recovered from the sale of the asset then these costs may be capitalised. Costs are posted to the relevant disposal code on the balance sheet. If there is not a reasonable expectation that the costs will be recovered from the sale of the asset then these costs should be expensed through the profit and loss account. Activities that are undertaken bringing an asset into saleable condition often occur over an extensive period. A biannual review should be performed to determine whether the same level of certainty exists regarding the realisation of these costs. If either market or nonmarket conditions suggest that recovery of these costs is no longer probable the costs should be expensed to the profit and loss account immediately. These conditions can be applied to the following examples: A company incurs costs in obtaining planning permission for the site prior to sale (with a view to enhancing the value of the land). These costs should be capitalised if there is a reasonable expectation the property will be sold at a profit; If the company is unsuccessful in obtaining planning permission, and therefore a profit will not be made on sale, then the costs which had been previously capitalised should be written off. A company incurs marketing costs when disposing of an asset. Again these costs should again only be capitalised if there is a reasonable expectation that they will be recovered through the sale of the asset. If the company ceases to market the asset due to a change in market conditions but has the intention to use this information in future to recover costs through sale it is appropriate to continue to capitalise the costs. However, if it does not expect to recover the costs they should be written off. If the company then incurs further marketing costs in later periods then these are considered separately. 6.2.3 Abandonment A number of options may be evaluated before the company decides how a capital scheme will be delivered. Costs will be incurred in evaluating each option. These costs may only be capitalised if they are directly attributable to assets which are finally constructed. Appendix 5 Capital expenditure accounting policy 73

For example, if three options of delivering the same capital project are initially investigated, then the costs of determining which of these should be selected are all directly attributable to the final assets and should be capitalised. However, if there are three possible projects which are evaluated to resolve a particular issue then only the costs of investigating the project which is pursued can be capitalised. The costs of investigating the other projects should be recognised in the profit and loss account. An example of this would be where a number of sites are considered for construction. The costs of investigating the site which is finally developed are capitalised and the other costs are expense. Appendix 5 Capital expenditure accounting policy 74