Payoffs to staff made redundant by the merger of Scotland's three water authorities into a single body cost �86.6m, a new report says.

Scotland's Auditor General Robert Black found that "financial control was maintained" in the run-up to the creation of Scottish Water in April this year.

The merger saw the demise of regional water authorities in the East, West and North of Scotland.

But the financial watchdog's report warned the new quango to address continuing problems with unpaid bills.

Scottish Water needs to ensure that sound governance arrangements are established

Auditor General Robert Black

It said that the level of debt increased from �79m two years ago to �95m by last year, under the three former water authorities.

The report into the final year of operation by the three authorities said all had met their financial targets, while their audits had been completed on time.

The authorities' accounts for the two years up to the merger recorded exceptional costs of �86.6m.

These were attributed mainly to redundancy and early retirement pension payments under voluntary severance schemes set up to reduce costs in preparation for the creation of the new quango.

Efficiency savings

"Scottish Water needs to ensure that sound governance arrangements are established and that financial and management systems inherited from the three previous water authorities are harmonised in a controlled and cost-effective way," Mr Black said.

He said merger costs would continue, but insisted annual efficiency savings of �165m by 2005/06 were expected by the Water Industry Commissioner, who would be monitoring Scottish Water's performance.

"The non-payment of water and sewerage charges is a significant issue in Scotland and warrants early attention by Scottish Water," he added.

"Progress has been made in this important area will remain under review."