NOTES TO THE FINANCIAL STATEMENTS - NOTE 3


 

3. Critical accounting estimates and judgements
  Estimates and judgements are evaluated continually 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 judgements, 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. Revisions to accounting estimates are recognised in the period in which they are revised and future periods they affect.

(a) Embedded derivatives
  Eskom has entered into a number of agreements to supply electricity to electricity-intensive businesses where the revenue from these contracts is linked to commodity prices and foreign currency rates or foreign production price indices that give rise to embedded derivatives.

The embedded derivatives have been divided into three categories:

commodity and/or foreign currency derivatives
foreign currency or interest rate derivatives
United States production price and foreign currency derivatives

Valuation

The fair value of embedded derivatives is determined by using a forward electricity price curve to value the host contract and the derivative contract is valued by using market forecasts of future commodity prices, foreign currencies rand exchange rate, interest rate differential, future sales volumes, production price and liquidity, model risk and other economic factors.

The forecast cash flow is determined and then discounted at the relevant interest rate curve. The net present value of the cash flows is then converted at the rand/foreign currency spot rate to the reporting currency. The fair value of the embedded derivative is adjusted, where applicable, to take into account the inherent uncertainty relating to the future cash flows of embedded derivatives such as liquidity, model risk and other economic factors. The important assumptions are obtained either with reference to the contractual provisions of the relevant contracts or from independent market sources where appropriate. These assumptions are:

spot and forward commodity prices
spot and forward foreign currency exchange rates
spot and forward interest rates
forecasted sales volumes
spot and foreign production price indices
liquidity, model risk and other economic factors

Embedded derivatives that are not separated are effectively accounted for as part of the hybrid instrument. Non-option based derivatives are separated on terms that result in a fair value at the date of inception of zero. Option-based derivatives are separated on the terms stated in the contracts and will not necessarily have a fair value equal to zero at the initial recognition of the embedded derivative resulting in day-one gains or losses. These day-one gains or losses are recognised over the period of the agreement. The fair value will depend on the strike price at inception.

The only significant unobservable input is the United States producer price index (PPI).

Valuation assumptions

The forward electricity curve used to value the embedded derivatives at 31 March 2014 is based on the current MYPD 3 approved tariff increase of 8% for 2014/15 to 2017/18, whereafter a forecasted return on the regulatory asset base is used until maturity.

The contracted electricity price used to value embedded derivatives is based on a combination of the factors in the table below over the contracted period.

Forecast sales volumes are based on the most likely future sales volumes based on past trends and taking into account future production plans in consultation with industry specific experts and key customer executives.

The fair value of embedded derivatives takes into account the inherent uncertainty relating to the future cash flows of embedded derivatives, such as liquidity, model risk and other economic factors.

The following valuation assumptions for the future electricity price curve discussed above for the valuation of embedded derivatives were used and are regarded as the best estimates by the board:

    Year ended 31 March  
Input Unit 20141 20151 20161 20171 20181 20191  
Aluminium USD per ton 1 716 1 865 1 939 2 005 2 068 2 127  
Volatility Year-on-year (ratio) 0.22 0.22 0.22 0.22 0.22 0.22  
Rand interest rates Continuous actual/365 days (%) 5.57 6.74 6.84 7.28 7.55 7.79  
Dollar interest rates Annual actual/365 days (%) 0.09 0.52 0.57 1.03 1.48 1.87  
United States PPI Year-on-year (%) 3.27 2.20 2.33 2.20 2.41 2.32  
Rand/ USD USD per rand 0.09 0.09 0.08 0.08 0.07 0.07  
2013   Year ended 31 March  
Input Unit 20131 20141 20151 20161 20171 20181  
Aluminium USD per ton 1 886 1 962 2 045 2 128 2 213 2 288  
Volatility Year-on-year (ratio) 0.25 0.25 0.25 0.25 0.25 0.25  
Rand interest rates Continuous actual/365 days (%) 5.10 5.66 5.42 5.71 6.00 6.32  
Dollar interest rates Annual actual/365 days (%) 0.24 0.93 0.41 0.53 0.71 0.96  
United States PPI Year-on-year (%) 1.14 1.49 2.21 2.47 2.42 2.38  
Rand/USD USD per rand 0.11 0.10 0.10 0.09 0.09 0.08  
1. Forward curve based on financial years.

Sensitivity analysis

The approximate change in the value of embedded derivatives if one of the inputs is changed is disclosed in note 4.2 Financial risk management – market risk under currency risk (note 4.2.1), commodity risk (note 4.2.2), interest rate risk (note 4.2.3) and other price risk (note 4.2.5).

The carrying amount of the embedded derivative liabilities for the group is R9 332 million (2013: R11 481 million) and R9 331 million (2013: R11 480 million) for the company. Refer to note 25.

(b) Post-employment medical benefits
  The group recognises a liability for post-employment medical benefits to qualifying retirees. The post-employment medical benefits plan is unfunded.

Valuation

The estimated present value of the anticipated expenditure for both in-service and retired members is actuarially valued using the projected unit method. This method treats the accrued service liability separately from the current cost liability. The accrued service liability (on the valuation assumptions) is based on the completed service to the valuation date. The current cost is the cost of providing the benefit over the next year.

Valuation assumptions

The principal actuarial assumptions used were:

  Group and company  
  2014   2013  
Discount rate (%) 9.7   8.8  
Medical aid inflation (%) 8.4   8.0  
Mortality table Adjusted PA (90) tables rated down by
two years
  Adjusted PA (90) tables rated down by
two years
 

Assumptions regarding future mortality have been based on published statistics and mortality tables. The current longevities underlying the values of the defined benefit obligation at the reporting date were:

  Group and company  
  2014
Male
  2014
Female
  2013
Male
  2013
Female
 
Longevities (years) 14.42   20.82   14.42   20.77  

The weighted average duration of the defined benefit obligation for the group was 20.8 years (2013: 21.3 years) and for the company was 20.9 years (2013: 21.4 years).

Sensitivity analysis

The effect of an increase or decrease in the assumptions are:

      Group   Company  
  Change in
assumption
  2014
increase
Rm
2014
decrease
Rm
  2013
increase
Rm
2013
decrease
Rm
  2014
increase
Rm
2014
decrease
Rm
  2013
increase
Rm
2013
decrease
Rm
 
Effect on aggregate current service cost and finance cost                            
Discount rate 1%   (154) 199   (106) 134   (152) 196   (105) 132  
Medical aid inflation 1%   318 (242)   234 (182)   312 (238)   230 (179)  
Future mortality 1 year   40 (40)   30 (30)   39 (39)   29 (29)  
Effect on post-employment medical benefit obligation                            
Discount rate 1%   (1 432) 1 834   (1 461) 1 887   (1 398) 1 792   (1 433) 1 853  
Medical aid inflation 1%   1 809 (1 436)   1 848 (1 456)   1 767 (1 402)   1 819 (1 432)  
Future mortality 1 year   285 (284)   290 (288)   278 (277)   284 (282)  

The carrying amount of the post-employment medical benefits liability for the group is R10 234 million (2013: R9 993 million) and R9 981 million (2013: R9 788 million) for the company.

The above sensitivity analyses are based on a change in an assumption while all other assumptions remain constant. In practice, this is unlikely to occur, and changes in some of the assumptions may be correlated. When calculating the sensitivity of the defined benefit obligation to significant actuarial assumptions the present value of the defined benefit obligation is calculated with the projected unit credit method at the end of the reporting period which is recognised within the statement of financial position.

The methods and types of assumptions used in preparing the sensitivity analysis did not change compared to the previous period.

(c) Occasional and service leave
  The group recognises a liability for occasional and service leave.

Valuation

An actuarial valuation is done on an annual basis for occasional and service leave. The accrued liability is determined by valuing all future leave expected to be taken and payments to be made in respect of benefits up to the valuation date. The present value of the benefits is determined by using the yield of long-dated corporate bonds (or government bonds where high quality corporate bonds are not available).

Valuation assumptions

The principal actuarial assumptions used were:

  Group and company  
  2014
%
  2013
%
 
Discount rate 9.7   8.8  
General price inflation 6.4   6.0  
Salary increases 7.9   7.5  
Leave usage 4.0   4.0  

The assumptions made in respect of resignation, death and retirement rates are the same as for the post-employment medical benefit liability. Refer to note 3(b).

Sensitivity analysis

Based on current experience, only 4% (2013: 4%) of the leave is utilised. If the rate at which leave is taken is 8% (2013: 8%), then the liability will increase by R60 million (2013: R53 million).

The carrying amount of the occasional and service leave liability for the group is R1 195 million (2013: R1 086 million) and R1 138 million (2013: R1 037 million) for the company.

(d) Decommissioning, mine closure and rehabilitation
  Provision is made for the estimated decommissioning cost of nuclear and other generation plant and for the management of nuclear fuel assemblies and radioactive waste. Provision is made for the estimated mine-related closure, pollution control and rehabilitation costs at the end of the life of the mines, where a constructive and contractual obligation exists to pay coal suppliers.

Valuation

These provisions are determined by discounting the estimated future decommissioning and rehabilitation costs.

Valuation assumptions

The discount rate used for these provisions was 5.0% (2013: 4.6%) for the group and company.

Estimated payment dates

The estimated payment dates of the costs are:

  Group and company  
  2014   2013  
Nuclear plant 2026 - 2041   2026 - 2040  
Coal and pumped storage plants1 2018 - 2074   2018 - 2113  
Spent nuclear fuel 2016 - 2105   2015 - 2105  
Mine-related closure, pollution control and rehabilitation 2014 - 2073   2014 - 2073  
1. The timing of cash flows relating to water treatment and ground water monitoring have been re-estimated based on the latest studies.

Sensitivity analysis

The carrying amount of the decommissioning, mine closure and rehabilitation provision would be an estimated R3 465 million (2013: R3 379 million) lower had the real discount rate used in the calculation of the provision increased by 1% and R4 527 million (2013: R4 511 million) higher had the real discount rate decreased by 1%.

(e) Subordinated loan from shareholder
  The government loan was provided in tranches where each tranche has a 30-year term with an early redemption option after 10 years. Interest on the facility is only payable for those financial years where the financial results at the end of the reporting period reflect a leverage ratio of better than 12.5% and where if, after paying interest on the facility, the interest multiple remains above 2.5 times. A loan remeasurement occurs when the carrying amount of the loan is adjusted where the cash flows (interest and capital repayment) are revised for a given tranche, based on the tranche’s original effective rate to reflect the actual and revised estimated cash flows.

The value of the equity portion of the loan from the shareholder is the difference between the amount advanced and the calculated loan value on the day the tranches were drawn down. The loan value was calculated using Eskom’s long-term financial plan to forecast the leverage ratio and the interest cover to determine in which years interest will be payable over the period of the loan. These expected interest flows and the capital redemptions are discounted at the effective rate which was calculated at the inception of each tranche received to determine the loan amounts. Once the equity portion of a tranche is recorded it does not change. Refer to the statement of changes in equity.

The interest payments and cash flows are determined based on Eskom’s long-term forecasts of the leverage ratio and the interest multiple, adjusted to include the potential interest on the government loan. The future cash flows are discounted using a zero curve constructed from money market and swap rates that reflect the credit worthiness of Eskom.