A) Water is moving from a point of bigger height to a point of a lower height, This changes the kinetic and potential energies of water. Some of the kinetic energy of water is transfered to a waterwheel. This causes water wheel to spin. Spining waterwheel has rotational energy. Also waterwheel is rotating around certain point. This causes friction and there is frictional energy.
B)To light LED we need electric energy. To create electric energy we need a generator. Generator consists of a rotor (a magnet) and a stator (copper wire). If we attach a magnet to waterwheel and a wire somewhere close to waterwheel the electric energy would be induced. This energy can be used to light LED.