ANNUAL REPORT AND FINANCIAL STATEMENTS
FOR THE YEAR ENDED 31 MARCH 2010

The principal accounting policies adopted in the preparation of these financial statements are set out below.

a) Basis of preparation

The financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union (EU), including International Accounting Standards (IAS) and Interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC).

The financial statements have been prepared on the historical cost basis, except for the revaluation of financial instruments.

The preparation of financial statements, in conformity with generally accepted accounting principles (GAAP) under IFRS, requires management to make estimates and assumptions that affect the amounts of assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting periods presented. Although these estimates are based upon management’s best knowledge of the amount, event or actions, actual results ultimately may differ from these estimates.

The adoption of the following standards and interpretations, at 1 April 2009, has had no material impact on the group’s financial statements:

IFRIC 12  ‘Service Concession Arrangements’
The interpretation addresses accounting by private sector operators involved in the provision of public sector infrastructure assets and services. Relevant assets within its scope have been reclassified from property, plant and equipment to financial assets (where the operator has an unconditional right to receive a specified amount of cash or other financial asset over the life of the arrangement); or intangible assets (where the operator’s future cashflows are not specified); or a combination of both (where the operator’s return is provided partially by a financial asset and partially by an intangible asset). Its application is retrospective and hence requires the restatement of the comparative information presented for the years ended 31 March 2009 and 31 March 2008. Operating profit for the year ended 31 March 2009 has been reduced by £5.7 million, broadly offset by a corresponding increase in investment income of £5.2 million (see note 32).

IAS 23 (Revised 2007) ‘Borrowing Costs’
Borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset have been capitalised as part of the cost of that asset. Qualifying assets include property, plant and equipment, inventories and intangible assets developed in projects that take a significant period of time to complete. The standard has been adopted as a prospective change and borrowing costs have been capitalised on projects commencing from 1 April 2009. No changes have been made for borrowing costs incurred prior to this date that have been expensed. During the year ended 31 March 2010, borrowing costs of £0.5 million have been capitalised.

IAS 1 ‘Presentation of Financial Statements (September 2007)’
The application of this standard has resulted in the balance sheet and cashflow statements being renamed the ‘statement of financial position’ and the ‘statement of cashflows’ respectively. The shareholders’ equity note is presented as a primary statement and is renamed the ‘statement of changes in equity’. The statement of recognised income and expense is also presented as a primary statement and is renamed the ‘consolidated statement of comprehensive income’. Taxation on each item within the consolidated statement of comprehensive income is shown separately.

‘Improvements to IFRSs (2008)’
The amendments to IAS 1 clarify the classification of derivative financial instruments as current or non-current. Previously the group has categorised as current all derivative financial instruments classified as ‘held for trading’ under IAS 39 ‘Financial Instruments: Recognition and Measurement’. As a result of these amendments, ‘held for trading’ derivatives have now been categorised between current and non-current, based upon the contractual maturity date or, where applicable, the contractual early termination date (see note 32).

IFRS 2 ‘Share-based Payments (June 2009)’
The amendment to IFRS 2 is effective for periods commencing on or after 1 January 2010, was endorsed by the EU on 23 March 2010, and has been adopted early in these financial statements.

IFRS 7 ‘Financial Instruments: Disclosure - amendments’
The amendments to the standard require additional disclosures in respect of the financial instruments measured at fair value, based upon the nature of the inputs used in making such measurements (see note 19). The amendment to the standard does not require comparatives in the first year of adoption.

IFRS 8 ‘Operating Segments’
The application of this standard requires disclosure of information about the group’s operating segments on the same basis as that used for internal reporting, and replaces the requirement to determine the primary (business) and secondary (geographical) reporting segments. The group determined that its operating segments were the same as the business segments previously identified under IAS 14 ‘Segment Reporting’, except that the ‘other activities’ segment has been renamed ‘all other segments’. Additional disclosures about each of these segments are provided in note 2.

As a result of the adoption of these standards, the group has presented a restated statement of financial position for each of the years ended 31 March 2009 and 31 March 2008, together with notes for the relevant restated comparatives.

The consolidated income statement for the year ended 31 March 2009 has been re-presented to better reflect the nature of restructuring and reorganisation costs.

New statutory holding company

The company was incorporated and registered in England and Wales on 8 April 2008 under the Companies Act 1985 as a private company limited by shares with the name United Utilities Newco Limited and registered number 6559020. The company changed its name and re-registered as a public company on 28 April 2008 under the name United Utilities Group PLC. On 28 July 2008, the new statutory holding company structure became effective by way of a share exchange between the shareholders of United Utilities PLC (the previous holding company) and United Utilities Group PLC (the new holding company). This was accounted for as a reverse acquisition in the consolidated financial statements for the year ended 31 March 2009. The legal subsidiary, United Utilities PLC, was treated as the acquirer and the legal parent company, United Utilities Group PLC, was treated as the subsidiary. The transaction was, in substance, an acquisition of the assets of United Utilities Group PLC by United Utilities PLC.

As a consequence of applying reverse acquisition accounting, the consolidated results of United Utilities Group PLC (‘the group’) for the year ended 31 March 2009 comprised the results of United Utilities PLC for the year ended 31 March 2009 consolidated with those of United Utilities Group PLC from 28 July 2008. At 31 March 2008 for the statement of financial position, the comparative figures for the group are those of the group headed by United Utilities PLC.

Going concern

The directors have set out factors considered on concluding the appropriateness of the going concern basis of presentation in the financial reporting and going concern section of the corporate governance report.

Operating profit

Operating profit is stated after charging operating expenses but before investment income and finance expense.

b) Basis of consolidation

The group financial statements consolidate the financial statements of the company and entities controlled by the company (its subsidiaries), made up to 31 March each year, and incorporate the results of its share of jointly controlled entities using proportionate consolidation.

The results of subsidiaries and joint ventures acquired or disposed of during the year are included in the consolidated income statement from the date control is obtained or until the date that control ceases, as appropriate.

Where necessary, adjustments are made to the financial statements of subsidiaries to bring the accounting policies used under the relevant local GAAP into line with those used by the group.

Subsidiaries

Control is achieved where the company has the power to govern the financial and operating policies, generally accompanied by a shareholding of more than one-half of the voting rights of an investee entity so as to obtain benefits from its activities.

In the parent company accounts, investments are held at cost less provision for impairment.

On acquisition, the assets and liabilities and contingent liabilities of a subsidiary are measured at their fair values at the date of acquisition. Any excess of the cost of acquisition over the fair values of the identifiable net assets acquired is recognised as goodwill. Any deficiency of the cost of acquisition below the fair values of the identifiable net assets acquired is credited to the income statement in the period of acquisition. All intra-group transactions, balances, income and expenses are eliminated on consolidation.

Associates

An associate is an entity over which the group, either directly or indirectly, is in a position to exercise significant influence by participating in, but not controlling, the financial and operating policies of the entity. Associates are accounted for using the equity method. Losses of an associate in excess of the group’s interest in the associate are not recognised, except to the extent that the group has incurred obligations in respect of the associate. Unrealised profits and losses recognised by the group on transactions with an associate are eliminated to the extent of the group’s interest in the associate concerned.

Joint ventures

Joint ventures are entities in which the group holds an interest on a long-term basis and which are jointly controlled with one or more parties under a contractual arrangement. The group’s share of joint venture income, expenses, assets, liabilities and cashflows are included in the consolidated financial statements on a proportionate consolidation basis using the same accounting methods as adopted for subsidiaries.

c) Non-current assets held for sale

Non-current assets (and disposal groups comprising assets held for sale and the associated liabilities) classified as held for sale are measured at the lower of carrying amount and fair value less costs to sell.

Non-current assets (and disposal groups) are classified as held for sale if their carrying amount will be recovered through a sale transaction rather than through continuing use. This condition is regarded as met only when the sale is highly probable and the asset (or disposal group) is available for immediate sale in its present condition. Management must be committed to the sale which should be expected to qualify for recognition as a completed sale within one year from the date of classification.

d) Intangible assets

Goodwill

Goodwill arising on consolidation is recognised as an asset. Following initial recognition, goodwill is subject to impairment reviews, at least annually, and measured at initial value less accumulated impairment losses. Any impairment is recognised immediately in the income statement and is not subsequently reversed.

On disposal of a subsidiary, or jointly controlled entity, the attributable amount of goodwill is included in the determination of the gain or loss on disposal.

Goodwill written off to reserves under UK GAAP prior to 1998 has not been reinstated and is not included in determining any subsequent profit or loss on disposal.

Other intangible assets

Other intangible assets are measured initially at cost and are amortised on a straight-line basis over their estimated useful lives. The carrying amount is reduced by any provision for impairment where necessary.

On a business combination, as well as recording separable intangible assets already recognised in the statement of financial position of the acquired entity at their fair value, identifiable intangible assets that arise from contractual or other legal rights are also included in the acquisition statement of financial position at fair value.

Internal expenditure is capitalised as internally generated intangibles only if it meets the criteria of IAS 38 ‘Intangible Assets’.

Amortisation periods for categories of intangible assets are:

• Computer software 3 to 10 years;
• Other intangible assets 2 to 20 years; and
• Service concessions 20 to 30 years (see note r).

e) Property, plant and equipment

Property, plant and equipment comprises infrastructure assets (water mains, sewers, impounding and pumped raw water storage reservoirs, dams, sludge pipelines and sea outfalls) and other assets (including properties and overground plant and equipment).

Water and wastewater infrastructure assets

Infrastructure assets comprise a network of water and wastewater systems. Expenditure on the infrastructure assets, including borrowing costs where applicable, relating to increases in capacity or enhancements of the network is treated as additions. Amounts incurred in maintaining the operating capability of the network in accordance with defined standards of service are expensed in the year in which the expenditure is incurred. Infrastructure assets are depreciated by writing off their deemed cost, less the estimated residual value, evenly over their useful lives, which range from 15 to 300 years.

Employee costs incurred in implementing the capital schemes of the group are capitalised within infrastructure assets.

Other assets

All other property, plant and equipment is stated at historical cost less accumulated depreciation.

Historical cost includes expenditure that is directly attributable to the acquisition of the items, including relevant borrowing costs, where applicable, for qualifying assets. Subsequent costs are included in the asset’s carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the group and the cost of the item can be measured reliably. All other repairs and maintenance costs are charged to the income statement during the financial period in which they are incurred.

Freehold land and assets in the course of construction are not depreciated. Other assets are depreciated by writing off their cost, less their estimated residual value, evenly over their estimated useful lives, based upon management’s judgement and experience, which are principally as follows:

• Buildings 10 to 60 years;
• Operational assets 5 to 80 years; and
• Fixtures, fittings, tools and equipment 3 to 40 years.

Depreciation methods, residual values and useful lives are reassessed annually and, if necessary, changes are accounted for prospectively.

The gain or loss arising on the disposal or retirement of an asset is determined as the difference between the sales proceeds and the carrying amount of the asset and is recognised in income.

f) Impairment of tangible and intangible assets excluding goodwill

Intangible assets with definite useful lives and property, plant and equipment are reviewed for impairment at each reporting date to determine whether there is any indication that those assets may have suffered an impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss, if any. Where the asset does not generate cashflows that are independent from other assets, the group estimates the recoverable amount of the cash generating unit to which the asset belongs.

The recoverable amount is the higher of fair value less costs to sell, and value in use. Value in use represents the net present value of expected future cashflows, discounted on a pre-tax basis, using a rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the estimates of future cashflows have not been adjusted.

If the recoverable amount of an asset (or cash generating unit) is estimated to be less than its carrying amount, the carrying amount of the asset (or cash generating unit) is reduced to its recoverable amount. Impairment losses in respect of non-current assets are recognised in the income statement within operating costs.

Where an impairment loss subsequently reverses, the reversal is recognised in the income statement and the carrying amount of the asset is increased to the revised estimate of its recoverable amount, but not so as to exceed the carrying amount that would have been determined had no impairment loss been recognised in prior years.

g) Financial instruments

Financial assets and financial liabilities are recognised and derecognised on the group’s statement of financial position on the trade date when the group becomes a party to the contractual provisions of the instrument.

Cash and short-term deposits

Cash and short-term deposits include cash at bank and in hand, deposits and other short-term highly liquid investments which are readily convertible into known amounts of cash, have a maturity of three months or less from the date of acquisition and which are subject to an insignificant risk of change in value. In the consolidated statement of cashflows and related notes, cash and cash equivalents include cash and short-term deposits, net of bank overdrafts.

Financial investments

Investments (other than interests in associates, subsidiaries, joint ventures and fixed deposits) are initially measured at fair value, including transaction costs. Investments classified as available for sale in accordance with IAS 39 ‘Financial Instruments: Recognition and Measurement’ are measured at subsequent reporting dates at fair value. Gains and losses arising from changes in fair value are recognised directly in equity, until the security is disposed of or is determined to be impaired, at which time the cumulative gain or loss previously recognised in equity is included in the net profit or loss for the period. Investments classified as loans and receivables in accordance with IAS 39 ‘Financial Instruments: Recognition and Measurement’ are measured at amortised cost.

Service concession financial assets

See note r.

Trade receivables

Trade receivables are initially measured at fair value, and are subsequently measured at amortised cost, less any impairment for irrecoverable amounts. Estimated irrecoverable amounts are based upon historical experience of the receivables balance.

Trade payables

Trade payables are initially measured at fair value and are subsequently measured at amortised cost.

Financial liabilities and equity

Financial liabilities and equity instruments are classified according to the substance of the contractual arrangements entered into. An equity instrument is any contract that evidences a residual interest in the assets of the group after deducting all of its liabilities.

Equity instruments

Equity instruments issued by the group are recorded at the proceeds received, net of direct issue costs.

Borrowings

Bonds, bank loans and overdrafts are usually recorded at the proceeds received, net of direct issue costs. Finance charges, including premiums payable on settlement or redemption and direct issue costs, are accounted for on an amortised cost basis to the income statement using the effective interest method and are added to the carrying amount of the instrument to the extent that they are not settled in the period in which they arise. In some cases, borrowings are designated at fair value through profit or loss, or in a fair value hedge.

Financial liabilities designated at fair value through profit or loss

Borrowings are designated at fair value through profit or loss at inception where the complexity of the related swaps means that they are disallowed from being allocated in a hedge relationship despite there being significant fair value offset between the hedged item and the derivative. The otherwise inconsistent accounting treatment that would have resulted allows the group to satisfy the criteria for this designation. Financial liabilities at fair value through profit or loss are stated at fair value, with any resultant gain or loss recognised in profit or loss. The net gain or loss recognised incorporates any interest paid on the financial liability. The treatment of financial liabilities designated at fair value through profit or loss is consistent with the group’s documented risk management strategy.

Derivative financial instruments and hedge accounting

Interest rate swap agreements are used to manage interest rate exposure, while the group enters into cross-currency swaps to manage its exposure to fluctuations in foreign exchange rates. The group does not use derivative financial instruments for speculative purposes.

All financial derivatives are recognised in the statement of financial position at fair value. Changes in the fair value of all derivative financial instruments are recognised in the income statement within finance expense as they arise, except for derivatives that are designated as, and effective in terms of, cashflow hedging relationships, in which case the gains and losses are deferred in equity.

Fair value hedges

For an effective hedge of an exposure to changes in the fair value, the hedged item is adjusted for changes in fair value attributable to the risk being hedged with the corresponding entry in the income statement. Gains or losses from remeasuring the derivative are recognised in the income statement.

Where changes in the fair value of a derivative differ from changes in the fair value of the hedged item attributable to the risks being hedged, the hedge ineffectiveness is recorded in the income statement within finance expense.

Hedge accounting is discontinued prospectively when the hedging instrument is sold, terminated or exercised, where the hedge relationship no longer meets the criteria for hedge accounting in accordance with IAS 39, or where the hedge designation is revoked. The cumulative fair value adjustment on the hedged instrument is frozen at the date of ineffectiveness, or the date the designation is revoked and is amortised to the income statement based upon a recalculated effective interest rate through to maturity.

Cashflow hedges

Changes in the fair value of derivative financial instruments that are designated and effective as hedges of future cashflows are recognised directly in equity and the ineffective portion is recognised immediately in the income statement.

Hedge accounting is discontinued when the hedging instrument is sold, terminated or exercised, where the hedge relationship no longer meets the criteria for hedge accounting in accordance with IAS 39, or where the hedge designation is revoked. At that time, any cumulative gain or loss on the hedging instrument recognised in equity is retained in equity until the forecast transaction occurs. If a hedged transaction is no longer expected to occur, the net cumulative gain or loss recognised in equity is transferred to net profit or loss for the period.

Net investment hedges

Exchange differences arising from the translation of net investments in foreign operations are recognised directly in equity. Gains and losses on those hedging instruments (which include foreign currency forward contracts) designated as hedges of net investments in foreign operations are recognised in equity to the extent that the hedging relationships are effective. These amounts are included in foreign exchange adjustments within the statement of comprehensive income. Gains and losses relating to hedge ineffectiveness are recognised immediately in the income statement for the period. Gains and losses accumulated in the exchange reserve are included in the income statement when the foreign operations are disposed of.

h) Foreign currency translation

Transactions and balances

Transactions in foreign currencies are recorded at the exchange rates applicable on the dates of the transactions. At each reporting date, monetary assets and liabilities denominated in foreign currencies are translated into sterling at the relevant rates of exchange applicable on that date. Gains and losses arising on retranslation are included in net profit or loss for the period. Exchange differences arising on investments in equity instruments classified as available for sale are included in the gains or losses arising from changes in fair value which are recognised directly in equity.

In order to hedge its exposure to certain foreign exchange risks, the group enters into forward contracts, options and other derivative instruments (see derivative financial instruments and hedge accounting in note g).

Group companies

On consolidation, the statements of financial position of overseas subsidiaries and joint ventures (none of which has the currency of a hyperinflationary economy) are translated into sterling at exchange rates applicable at each reporting date. The income statements are translated into sterling using the average rate unless exchange rates fluctuate significantly in which case the exchange rate at the date the transaction occurred is used. Exchange differences resulting from the translation of such statements of financial position at rates ruling at the beginning and end of the period, together with the differences between income statements translated at average rates and rates ruling at the period end, are dealt with as movements on the group’s cumulative exchange reserve, a separate component of equity. Such translation differences are recognised as income or expense in the period in which the operation is disposed of.

Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing rate. The group has elected to treat goodwill and fair value adjustments arising on acquisitions before the date of implementation of IFRS 3 ‘Business Combinations’ (1 April 1999) as sterling denominated assets and liabilities.

i) Borrowing costs and finance income

Except as noted below, all borrowing costs and finance income are recognised in the income statement in the period in which they are accrued.

Transaction costs that are directly attributable to the acquisition or issue of a financial asset or financial liability are included in the initial fair value of that instrument.

Where borrowing costs are attributable to the acquisition, construction or production of a qualifying asset, such costs are capitalised as part of the specific asset.

j) Long-term contract accounting

Where the outcome of a long-term contract can be estimated reliably, revenue and costs are recognised by reference to the stage of completion of the contract activity at each reporting date, as measured by the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs. Variations in contract work, claims and incentive payments are included to the extent that they have been agreed with the customer.

Where the outcome of a long-term contract cannot be estimated reliably, contract revenue is recognised to the extent of contract costs incurred that it is probable will be recoverable. Contract costs are recognised as expenses in the period in which they are incurred.

When it is probable that total contract costs will exceed total contract revenue, the expected loss is recognised as an expense immediately.

k) Taxation

The taxation expense represents the sum of current taxation and deferred taxation.

Current taxation

Current taxation, including UK corporation tax and foreign tax, is based upon the taxable profit for the period and is provided at amounts expected to be paid or recovered using the tax rates and laws that have been enacted or substantively enacted at each reporting date. Taxable profit differs from the net profit as reported in the income statement because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible.

Deferred taxation

Deferred taxation is the tax expected to be payable or recoverable on differences between the carrying amounts of assets and liabilities in the financial statements and the corresponding tax bases used in the computation of taxable profit. Deferred taxation liabilities are provided, using the liability method, on all taxable temporary differences at each reporting date. Such assets and liabilities are not recognised if the temporary difference arises from goodwill or from the initial recognition (other than in a business combination) of other assets and liabilities in a transaction that affects neither the taxable profit nor the accounting profit.

Deferred taxation liabilities are recognised for taxable temporary differences arising on investments in subsidiaries and interests in joint ventures, except where the group is able to control the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future.

Deferred taxation is measured at the average tax rates that are expected to apply in the periods in which the temporary timing differences are expected to reverse based upon tax rates and laws that have been enacted or substantively enacted at each reporting date.

The carrying amount of deferred taxation assets is reviewed at each reporting date and reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered.

Deferred taxation is charged or credited in the income statement, except when it relates to items charged or credited to equity, in which case the deferred taxation is also dealt with in equity.

l) Employee benefits

Retirement benefit obligations

The group operates a number of defined benefit pension schemes, which are independent of the group’s finances, for the majority of its employees. Actuarial valuations of the schemes are carried out as determined by the pension scheme trustees using the projected unit credit method at intervals of not more than three years, the rates of contribution payable and the pension cost being determined on the advice of the actuaries, having regard to the results of these valuations. In any intervening years, the actuaries review the continuing appropriateness of the contribution rates.

Defined benefit assets are measured at fair value while liabilities are measured at present value. The difference between the two amounts is recognised as a surplus or obligation in the statement of financial position.

The cost of providing pension benefits to employees relating to the current year’s service is included within the income statement within employee costs. The difference between the expected return on scheme assets and interest on scheme liabilities is included within the income statement within investment income or finance expense.

All actuarial gains and losses, excluding curtailment gains and losses, are recognised outside the income statement in retained earnings and presented in the statement of comprehensive income.

In addition, the group also operates defined contribution pension schemes. Payments are charged as employee costs as they fall due. The group has no further payment obligations once the contributions have been paid.

Share-based compensation arrangements

The group operates equity-settled, share-based compensation plans. In accordance with the transitional provisions, IFRS 2 ‘Share-based Payments’ has been applied to all grants of equity instruments after 7 November 2002 that were unvested as of 1 April 2004.

The group issues equity-settled share-based payments to certain employees. Equity-settled share-based payments are measured at fair value at the date of grant. The fair value determined at the grant date is expensed on a straight-line basis over the vesting period, based upon estimates of the number of options that are expected to vest. Fair value is based upon both simulation and binomial models, according to the relevant measures of performance. The group has the option to settle some of these equity-settled share-based payments on a net basis in cash.

At each reporting date, the group revises its estimate of the number of options that are expected to become exercisable with the impact of any revision being recognised in the income statement, and a corresponding adjustment to equity over the remaining vesting period. The proceeds received net of any directly attributable transaction costs are credited to share capital (nominal value) and share premium when the options are exercised.

m) Provisions

Provisions are recognised when the group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the obligation, and the amount can be reliably estimated.

Expenditure that relates to an existing condition caused by past operations that does not contribute to current or future earnings is expensed. Liabilities for environmental remediation and decommissioning costs are recognised, and capitalised in accordance with IAS 37 as appropriate, when there is a legal or constructive obligation, environmental assessments indicate that clean-up is probable, and the associated costs can be reliably estimated.

n) Revenue recognition

Revenue represents the fair value of the income receivable in the ordinary course of business for goods and services provided. Where relevant, this includes an estimate of the sales value of units supplied to customers between the date of the last meter reading and the period end, exclusive of value added tax and foreign sales tax.

The group recognises revenue generally at the time of delivery and when collection of the resulting receivable is reasonably assured. Should the group consider that the criteria for revenue recognition are not met for a transaction, revenue recognition would be delayed until such time as the transaction becomes fully earned or collectability is reasonably assured. Payments received in advance of revenue recognition are recorded as deferred income.

o) Grants and contributions

Grants and contributions receivable in respect of property, plant and equipment are treated as deferred income, which is credited to the income statement over the estimated economic lives of the related assets.

p) Leases

Leases are classified according to the substance of the transaction. A lease that transfers substantially all the risks and rewards of ownership to the lessee is classified as a finance lease. All other leases are classified as operating leases.

Operating leases

Operating lease rentals are charged to the income statement on a straight-line basis over the period of the lease.

q) Inventories

Inventories are stated at cost less any provision necessary to recognise damage and obsolescence. Finished goods and goods for resale are stated at the lower of cost (comprising, where applicable, direct materials, direct labour costs and appropriate overheads incurred in bringing them to their present location and condition) and net realisable value.

Properties held for resale are included at the lower of cost and net realisable value. Cost includes the cost of acquiring and developing the sites, including borrowing costs where applicable.

Net realisable value represents the estimated selling price less all estimated costs of completion and costs to be incurred in marketing, selling and distribution.

r) Service concessions

IFRIC 12 addresses accounting by private sector operators involved in the provision of public sector infrastructure assets and services. Relevant assets within its scope are classified as financial assets (where the operator has an unconditional right to receive a specified amount of cash or other financial asset over the life of the arrangement); or intangible assets (where the operator’s future cashflows are not specified); or a combination of both (where the operator’s return is provided partially by a financial asset and partially by an intangible asset).

The group has service concession arrangements in Scotland, Australia and Bulgaria, where it has been engaged to finance, design, construct and operate water and wastewater assets on behalf of local government authorities or other utility providers for periods of 20 to 30 years. At the end of the contracts, the constructed assets will be transferred to the grantors of the respective service concessions at market price or written down asset value, depending upon the contract.

The group bears demand risk on revenues arising from its service concession arrangements in Scotland and Bulgaria. In accordance with IFRIC 12, the related assets have therefore been classified as intangible assets (see note 13). The service concession arrangements in Australia have a mix of revenue streams; some are fixed, while others vary depending upon demand levels. The related assets have therefore been classified as financial asset loan receivables or intangible assets as appropriate (see notes 16 and 13).

s) Critical accounting judgements and key sources of estimation uncertainty

In the process of applying its accounting policies, the group is required to make certain estimates, judgements and assumptions that it believes are reasonable based upon the information available. These estimates and assumptions affect the amounts of assets and liabilities at the date of the financial statements and the amounts of revenues and expenses recognised during the reporting periods presented.

On an ongoing basis, the group evaluates its estimates using historical experience, consultation with experts and other methods considered reasonable in the particular circumstances. Actual results may differ significantly from the estimates, the effect of which is recognised in the period in which the facts that give rise to the revision become known.

The following paragraphs detail the estimates and judgements the group believes to have the most significant impact on the annual results under IFRS.

Carrying value of property, plant and equipment

The estimated useful economic lives of property, plant and equipment (PPE) are based upon management’s judgement and experience. When management identifies that actual useful lives differ materially from the estimates used to calculate depreciation, that charge is adjusted prospectively. Due to the significance of PPE investment to the group, variations between actual and estimated useful lives could impact operating results both positively and negatively, although historically few changes to estimated useful lives have been required.

The group is required to evaluate the carrying values of PPE for impairment whenever circumstances indicate, in management’s judgement, that the carrying value of such assets may not be recoverable. An impairment review requires management to make subjective judgements concerning the cashflows, growth rates and discount rates of the cash generating units under review.

Revenue recognition

The group recognises revenue generally at the time of delivery and when collection of the resulting receivable is reasonably assured. When the group considers that the criteria for revenue recognition are not met for a transaction, revenue recognition is delayed until such time as the transaction becomes fully earned or collectability is reasonably assured. Payments received in advance of revenue recognition are recorded as deferred income.

United Utilities Water PLC raises bills in accordance with its entitlement to receive revenue in line with the limits established by the periodic regulatory price review processes. For water and wastewater customers with water meters, the receivable billed is dependent upon the volume supplied including the sales value of an estimate of the units supplied between the date of the last meter reading and the billing date. Meters are read on a cyclical basis and the group recognises revenue for unbilled amounts based upon estimated usage from the last billing through to each reporting date. The estimated usage is based upon historical data, judgement and assumptions; actual results could differ from these estimates, which would result in operating revenues being adjusted in the period that the revision to the estimates is determined. For customers who do not have a meter, the receivable billed is dependent upon the rateable value of the property, as assessed by an independent rating officer.

For the group’s other businesses, revenue is recognised in line with activity and performance, normally using amounts specified in contractual obligations and when recoverability is reasonably assured. In general:

• variable revenues, for example, revenues dependent upon customer volumes in the period, are recognised only when those variable activities are performed;
• performance incentives are recognised in revenue only to the extent that it is probable that the related economic benefits will flow to the group; and
• revenue invoiced or received in advance of performance is recognised as deferred income. When performance occurs, the deferred income is released and reported as revenue.

A breakdown of revenues by segment is contained in note 2 to the financial statements.

Provision for doubtful receivables

At each reporting date, the company and each of its subsidiaries evaluate the recoverability of trade receivables and record provisions for doubtful receivables based upon experience. These provisions are based upon, amongst other things, customer category and consideration of actual collection history. The actual level of receivables collected may differ from the estimated levels of recovery, which could impact operating results positively or negatively.

Accounting for provisions and contingencies

The group is subject to a number of claims incidental to the normal conduct of its business, relating to and including commercial, contractual and employment matters, which are handled and defended in the ordinary course of business. The group routinely assesses the likelihood of any adverse judgements or outcomes to these matters as well as ranges of probable and reasonably estimated losses. Reasonable estimates involve judgements made by management after considering information including notifications, settlements, estimates performed by independent parties and legal counsel, available facts, identification of other potentially responsible parties and their ability to contribute, and prior experience. A provision is recognised when it is probable that an obligation exists for which a reliable estimate can be made after careful analysis of the individual matter. The required provision may change in the future due to new developments and as additional information becomes available. Matters that either are possible obligations or do not meet the recognition criteria for a provision are disclosed in note 30, unless the possibility of transferring economic benefits is remote.

Retirement benefits

The group operates a number of defined benefit schemes, two of which have a defined contribution section, which are independent of the group’s finances. Actuarial valuations of the schemes are carried out as determined by the trustees at intervals of not more than three years. The pension cost under IAS 19 ‘Employee Benefits’ is assessed in accordance with the advice of a firm of actuaries based upon the latest actuarial valuation and assumptions determined by the actuary. The assumptions are based upon information supplied to the actuary by the company, supplemented by discussions between the actuary and management. The assumptions are disclosed in note 20. Profit before taxation and net assets are affected by the actuarial assumptions used. These assumptions include investment returns on the schemes’ assets, discount rates, pay growth and increases to pensions in payment and deferred pensions and may differ from actual results due to changing market and economic conditions and longer or shorter lives of participants.

Derivatives and borrowings

The group’s default treatment is for borrowings to be carried at amortised cost, whilst derivatives are recognised separately in the statement of financial position at fair value with movements in those fair values recognised in the income statement. This has the potential to introduce considerable volatility to both the income statement and statement of financial position.

Therefore, where feasible, the group has taken advantage of the various provisions under IAS 39 to designate borrowings at fair value through the income statement or equity to reduce this volatility and better represent the economic hedges that exist between the group’s borrowings and related derivative contracts.

In order to apply hedge accounting, it must be demonstrated that the derivative has been, and will continue to be, an effective hedge of the hedged risk within the debt item. Changes in the fair value of all derivatives are recognised in the income statement, except for derivatives that are designated as, and effective in terms of, cashflow hedging relationships, in which case the gains and losses are deferred in equity. The group applies the fair value through profit or loss option where the complexity of the swaps means that they are disallowed from being accounted for in a hedge relationship despite there being significant fair value offset between the hedged item and the derivative itself. This area is considered to be of significance due to the magnitude of the group’s level of borrowings.

Designated borrowings and derivatives recorded at fair value are valued using a discounted cashflow valuation model. This model calculates the zero coupon curves for the applicable currency as at each reporting date and uses these to determine future floating cashflows. Future fixed and floating cashflows are discounted using discount factors derived from the same zero coupon curves adjusted for credit risk where appropriate. Cashflows denominated in foreign currencies are converted into sterling at the spot exchange rate at each reporting date.

The valuation of debt designated as being within a fair value hedged relationship is calculated based upon the risk being hedged in line with IAS 39. The group looks to hedge cashflows which represents its floating rate exposure, and it is this portion which is used in the valuation model.

The valuation of debt designated at fair value through the profit or loss incorporates an assumed credit spread in the discount factor. Credit spreads are determined based upon indicative pricing data.

Taxation

Assessing the outcome of uncertain tax positions requires judgements to be made regarding the result of negotiations with, and enquiries from, tax authorities in a number of jurisdictions.

t) Recently issued accounting pronouncements

International Financial Reporting Standards

At the date of authorisation of these financial statements, the following relevant standards and interpretations were in issue but not yet effective. The directors anticipate that the group will adopt these standards and interpretations on their effective dates.

The directors anticipate that the adoption of the following standards and interpretations may have a material impact on the group’s financial statements:

• IFRS 3 ‘Business Combinations - revised standard’, issued in January 2008, is effective for periods commencing on or after 1 July 2009 and was endorsed by the EU on 12 June 2009. This will have a material impact on the group’s financial statements only if it enters into any relevant transactions in the future; and
• IFRIC 18 ‘Transfers of Assets from Customers’, issued in January 2009, is effective for transfers from customers received on or after 1 July 2009, for periods commencing on or after 31 October 2009 and was endorsed by the EU on 27 November 2009. This interpretation will therefore be adopted by the group in the year ending 31 March 2011. The adoption of IFRIC 18 is expected to change the group’s policy for the valuation of assets transferred from customers and may lead to an increase in revenue, the value of assets capitalised and future depreciation costs.

The directors anticipate that the adoption of the following standards and interpretations will have no material impact on the group’s financial statements:

• ‘Annual improvements 2009’, issued in April 2009, is effective for periods commencing on or after 1 January 2010 and was endorsed by the EU on 23 March 2010;
• IFRIC 16 ‘Hedges of a Net Investment in a Foreign Operation’, issued in July 2008, is effective for periods commencing on or after 1 July 2009 and was endorsed by the EU on 4 June 2009; and
• IFRS 9 ‘Financial Instruments’, issued in November 2009, is effective for periods commencing on or after 1 January 2013 but has not yet been endorsed by the EU.

Standards and interpretations in issue but not considered relevant to the activities of the group are as follows:

• IAS 24 ‘Related Party Disclosures - amendment’, issued in November 2009, is effective for periods commencing on or after 1 January 2011 but has not yet been endorsed by the EU;
• IAS 27 ‘Consolidated and Separate Financial Statements - revised standard’, issued in January 2008, is effective for periods commencing on or after 1 July 2009 and was endorsed by the EU on 12 June 2009;
• IAS 32 ‘Financial Instruments - amendment’, issued in October 2009,  is effective for periods commencing on or after 1 February 2010 and was endorsed by the EU on 23 December 2009;
• IAS 39 ‘Financial Instruments: Recognition and Measurement -  amendment’, issued in July 2008, is effective for periods commencing on or after 1 July 2009 and was endorsed by the EU on 16 September  2009;
• ‘IFRS for Small and Medium-sized Entities’, issued in July 2009, is effective immediately;
• IFRS 1 ‘First-time Adoption - revised standard’, issued in November 2008, is effective for periods commencing on or after 1 July 2010 and was endorsed by the EU on 25 November 2009;
• IFRS 1 ‘First-time Adoption - amendment’, issued in July 2009, is  effective for periods commencing on or after 1 January 2010 but has  not yet been endorsed by the EU;
• IFRS 1 ‘First-time Adoption - amendment’, issued in January 2010, is effective for periods commencing on or after 1 July 2010 but has not yet been endorsed by the EU;
• IFRIC 14 ‘Prepayments of a Minimum Funding Requirement - amendment’, issued in November 2009, is effective for periods commencing on or after 1 January 2011 but has not yet been endorsed by the EU;
• IFRIC 17 ‘Distribution of Non-cash Assets to Owners’, issued in November 2008, is effective for periods commencing on or after 1 July 2009 and was endorsed by the EU on 26 November 2009; and
• IFRIC 19 ‘Extinguishing Financial Liabilities with Equity Instruments’, issued in November 2009, is effective for periods commencing on or after 1 July 2010 but has not yet been endorsed by the EU.

The impact of all other IFRSs and IFRICs issued but not yet adopted is not considered relevant to the group.