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Note 38: Critical Accounting Estimates and Judgements

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. See note 39 for sensitivity analysis.

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.
Sensitivity analysis

If the estimated unbilled units had been 10% higher/lower, operating profit for the year would have (decreased)/increased by $(54,000)/$54,000 (2012: increased/(decreased) by $695,000/$(695,000)).

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 2012. 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.

       
Assumption Low High Valuation Impact
New Zealand Assets
Forward electricity price path Decreasing in real terms from $98/MWh to $85/MWh by 2015 then constant. Decreasing in real terms from $98/MWh to $85/MWh by 2015 then increasing to $95/MWh by 2020. Thereafter held constant. -/+ $98,000,000
Generation volume 2,167 GWh 2,649 GWh -/+ $245,000,000
Operating costs $29,600,000 p.a. $32,600,000 p.a. +/- $38,000,000
Weighted average cost of capital 7.84% 8.34% +$82,000,000 / -$75,000,000
Australian Assets AUD
Forward electricity price path (Stated in AUD) Until 2018 constant at $82 in real terms. After 2018 increasing to $105 by 2030 in real terms. (Stated in AUD) Until 2018 constant at $82 in real terms. After 2018 increasing to $115 with gradual increases to $125 by 2030 in real terms. -$11,000,000/ +$33,000,000
Generation volume 350 GWh 428 GWh -/+ $30,000,000
Weighted average cost of capital 7.74% 8.24% +$6,000,000 / -$5,000,000
       
The valuation impact is calculated as the movement in the fair value as a result of the change in the assumption and keeping all other valuation inputs constant.

Depreciation expense

A significant amount of management judgement is used when determining the useful lives of the Group's generation assets for depreciation purposes. This is especially so for the Group's longer lived assets.

Sensitivity analysis

If the estimated useful lives of generation assets were 10% higher/lower, operating profit for the year would have increased/(decreased) by $5,278,000/$(6,451,000) (2012: $4,804,000/$(5,872,000)).

Amortisation expense

Management judgement is used when determining the useful lives of the Group's intangible assets for amortisation purposes.

Sensitivity analysis

If the estimated useful lives of intangible assets were 10% higher/lower, operating profit for the year would have increased/decreased by $721,000/$(881,000) (2012: $478,000/$(584,000)).

Income tax expense

The Group is subject to income taxes in New Zealand and Australia. Significant judgement is required in determining the provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain. The Group recognises liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the current and deferred income tax assets and liabilities in the period in which such determination is made.

Provision against advances to subsidiaries

For subsidiaries involved in generation development, the Parent fully provides for advances made until such time as a viable project is identified and construction commences. This provision is the result of significant uncertainty that economic projects will be completed and that the advances will be recoverable.

Changes to accounting estimates

Apart from the change in metering asset useful lives (refer note 2.6), there have been no changes to accounting estimates in the year.