Estimates and judgements are frequently evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. The Group makes estimates and assumptions concerning the future. The resulting accounting estimates will, by definition, seldom equal the related actual results. The estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below.
Fair value of derivatives and other financial instruments
The fair value of financial instruments that are not traded in an active market (for example, electricity price hedges) is determined by using valuation techniques. The Group uses its judgement to select methods and make assumptions that are mainly based on market conditions existing at the end of each reporting period. The Group has used discounted cash flow analysis for various electricity price hedges that are not traded in an active market. The forward curve is derived from a combination of market quoted prices and management's best estimates. The discount rate is assumed as the counterparty's cost of funds for the period of the instrument.
Electricity gross margin
Three key estimates are made when determining electricity gross margin. The accrual for all three factors is based on an estimate of unbilled units.
• Revenue recognition
An accrual is estimated for units sold but not billed at the end of the reporting period for non-half hourly metered customers. This estimate is based on units bought from the wholesale electricity market as well as historical factors. Significant judgement is required in making this determination.
• Line cost recognition
Some electricity lines companies bill the Group based on the units and days that the Group has billed its customers while the remaining electricity lines companies bill the Group based on estimated total units and days. For the companies that base their bill on the Group's customer billing, an accrual, similar to the revenue recognition accrual, is estimated for line charges incurred but not billed at the end of the reporting period.
• Energy cost recognition
An accrual is estimated for units that the Group believes it has consumed but has not yet been billed for by Energy Clearing House Limited. Significant judgement is required in making this determination.
If the estimated unbilled units had been 10% higher/lower, operating profit for the year would have increased/(decreased) by $411,000/$(411,000) (2010: increased/(decreased) by $74,000/$(85,000)).
Generation property, plant and equipment
The Group's generation property, plant and equipment is stated at fair value as established by an independent valuation undertaken at least every three years. This valuation is reviewed annually and if it is considered that there has been a material change then a new independent valuation is undertaken. The basis of the valuation is a discounted cash flow analysis of the future earnings of the assets. The major inputs that are used in the valuation model that require management judgement include the forward price path of electricity, sales volume forecasts, projected operational and capital expenditure profiles, discount rates and life assumptions for each generation station. The following table outlines the key assumptions used by Deloitte Corporate Finance in preparing the most recent valuation as at 31 March 2009. In all cases there is an element of judgement required. The table shows the range of reasonably possible alternative assumption values considered. The valuation is based on a combination of values that are generally in the midpoint of the range.