The Purpose and Function of the Audit Committee (the Committee)
The Committee's key aim is to review and report to the Board on financial reporting, internal financial control effectiveness and to oversee the relationship with the external auditor. The main responsibilities are summarised in the Corporate Governance Report.
Membership, Meetings and Attendance
The membership of the Committee, together with appointment dates and attendance at meetings, are detailed in the Corporate Governance Report.
The Board considers that all members of the Committee are independent. Julian Heslop has recent and relevant financial experience as a result of his financial background and qualification. Dr Chris Richards and Ishbel Macpherson provide different but relevant skills and experience which support the Committee in meeting its objectives. The biographies of all Committee members are detailed in the Board of Directors.
The Company Secretary attends each meeting and acts as its secretary assisting the Chairman in ensuring that all Committee papers are provided prior to each meeting in a timely manner and providing advice to the Committee on all governance related matters.
Other members of the Board normally attend each meeting together with the lead audit partner and the newly appointed Head of Internal Audit and Risk Management.
The Committee has discussions at least twice a year with the external auditor without management being present including the meeting which reviews and endorses the annual results.
Neither the Company nor its Directors have any relationships that impair the external auditor's independence.
Role and Responsibilities
The main role and responsibilities of the Committee are set out in the written terms of reference which are available on the Company website at www.dechra.com. The Board reviewed the Committee's terms of reference during the year and amended them to reflect the establishment and remit of the internal audit and risk management function.
Major Activities of the Committee during the Year
The Committee met five times since the last Annual Report was issued. The meetings are timed to coincide with the financial reporting timetable of the Company. The Chairman and the Company Secretary have developed an annual programme of business. This allows the Committee to ensure that standing items of business are appropriately considered alongside any exceptional matters that may arise during the course of the year. The table below provides an overview of the main matters discussed at the meetings:
|Meeting Date||Main Activities|
|4 December 2014|
- Consideration of the internal controls project, recruitment of the internal audit and risk manager and progress on the external audit tender
- Review of the anti-bribery and anti-corruption and whistleblowing policies
- Review of non-audit fees
|9 January 2015|
- Completion of the external audit tender process and recommendation to the Board
|16 February 2015|
- Review of the Group's half-yearly report
- Consideration of the Half-Year Review Memorandum prepared by the external auditor
- Review of the Committee's terms of reference
- Review of non-audit fees (including actual and projected spend)
- Consideration of the progress of the internal controls project
- Review of the dividend policy
- Meeting with the external auditor without management present
|5 May 2015|
- Review of the audit strategy for the year ending 30 June 2015 (including timetable, scope and fees)
- Discussion in relation to the Company's expectations of the external auditor and audit process
- Review of the internal financial control environment
- Review of the internal audit work plan to the end of 2015 financial year
- Review of non-audit fees
- Discussion of the programme of business for 2016 financial year
|1 September 2015|
- Review of the Group's preliminary statement and draft Annual Report (including the Audit Committee Report) for the year ended 30 June 2015
- Consideration of the Audit Memorandum prepared by the external auditor, including
- review of accounting treatment of non-underlying items
- assessment of acquired intangible assets and goodwill
- commentary on the general control environment across the Group
- Review and approval of going concern statement
- Report from the internal auditor
- Review of the external audit effectiveness, external auditor's independence and level of non-audit fees
- Meeting with the external auditor without management present
- Fair, balanced and understandable recommendation of the Annual Report
All significant matters under consideration were supported by relevant justification papers and fully discussed in order to ensure that due and appropriate consideration was given before any decision was approved. Further detail in relation to a number of the matters is provided below:
- Financial Judgements
The Committee reviewed both the half-yearly and the annual financial statements. This process included an analysis by management of key judgements made in determining the results over matters such as the carrying value of intangible assets. The Committee reviewed this in detail and endorsed management's judgements.
The Committee gave particular attention to significant matters where judgement was involved which were complex in nature or where adjusted numbers were provided to enhance investors' understanding of the underlying performance. These matters were well supported by briefing papers provided by management and were specifically reviewed and agreed by the external auditor, KPMG, in their reports to the Committee and in related discussions.
The key matters reviewed were as follows:
|Significant risk considered by the Committee in relation to the financial statements||Corresponding actions taken by the Committee to address the issues|
|Review of the carrying value of acquired intangible assets and goodwill of £155.5 million which represents 80.0% of Group net assets.||The Committee reviewed the analysis provided by management which supported the underlying carrying values. The value of Food producing Animal Products assets, given their recent sales decline, was given particular attention; a combination of 30.0% amortisation of these assets since acquisition together with a realistic assessment of their value on acquisition, given expected market declines at the time, meant that their carrying values were supported by anticipated future cash flows and no impairment was required. In reviewing the valuations, special attention was paid to the assumptions relating to future growth rates in the context of current underlying performance including the impact of and calculation of terminal values. The impact of sensitivity analysis was also considered where relevant. In addition, the Committee reviewed the expected longevity of the intangible assets. It also reviewed the discount rates used.|
|Significant judgements considered by the Committee in relation to the financial statements||Corresponding actions taken by the Committee to address the issues|
|Review of the corporate tax rate for the year of 24.6%.||The Committee discussed the key risks in respect of corporate tax and considered KPMG's audit work and conclusions.|
|In order to assist investors with a better understanding of the underlying performance of the business, management present within the financial statements figures for underlying profit and earnings. This is reconciled to the figures provided in the financial statements and excludes matters such as intangible amortisation, profit on business disposal and acquisition related restructuring costs.|
The Committee reviewed the basis for calculating the underlying figures and its consistency with previous year's figures. It also sought confirmation from the external auditor, KPMG, that they were satisfied with the accuracy and consistency of these figures.
The Committee also reviewed material one-off income and costs within the underlying results, if any, and ensured these are clearly disclosed within the financial statements and notes.
- Going Concern
The Committee reviewed management's 2016 and 2017 budgets for profit, cash flow and net debt and the committed financing facilities available to the Group. Based on this, it concluded that it is appropriate to use the going concern principle for Group reporting. Further detail in relation to this is provided in the Corporate Governance Report.
- Fair, Balanced and Understandable Assessment of the Annual Report
At the request of the Board, the Committee considered whether the 2015 Annual Report was fair, balanced and understandable and whether it provided the necessary information for shareholders to assess the Company's performance, business model and strategy.
The Committee based its assessment on a review of the processes and controls put in place by management. This included the relevant senior management providing information on their own business units and their confirmation that it was fair, balanced and understandable. In addition, the final draft document was reviewed by all members of the Senior Executive Team (SET) which included the Chief Executive Officer and Chief Financial Officer who also concluded that it met the fair, balanced and understandable test.
An integral part of the process was the Committee's final review; other Board members and the external auditor were invited to comment so that issues could be debated and a final assessment made. The external auditor also confirmed that in their opinion the Annual Report 2015 was fair, balanced and understandable.
This assessment was carried out by the Committee on 1 September 2015, following which the Committee reported to the Board that it was satisfied that, taken as a whole, the Annual Report 2015 is fair, balanced and understandable.
Internal Controls and Risk Management
The Board retains overall responsibility for establishing the systems of internal control and monitoring their effectiveness and also for the identification and management of risk. The Committee monitors and reviews the effectiveness of the Group's internal financial control activities. Further details in respect of the internal controls are provided within the Strategic Report.
The Committee is currently developing its approach to meeting the 2014 Code standards, which are operative for accounting periods commencing from 1 October 2014. They require the monitoring of internal control and risk management as an ongoing process as well as assessing the robustness of risk management processes, reporting on significant control failings, together with a formal assessment of the viability of the Company over a period significantly longer than 12 months. The Company is planning to comply with the revised terms of the Code for the 2016 financial year.
The Group has made further progress during the year in implementing the recommendations made by Deloitte to strengthen the risk management process and internal controls. The application of key financial controls was tested by Internal Audit for the year ended 30 June 2015. The Committee reviews progress on a regular basis and reviewed the overall assessment of the Group's internal financial controls at its meeting on 1 September 2015. It concluded that there was reasonable assurance that internal financial controls operated effectively as referred to in the Strategic Report.
Appointment of Internal Auditor
The Committee appointed a Head of Internal Audit and Risk Management in April 2015. He is accountable to and delivers regular reports to the Committee. The Committee defines the scope of his work which broadly comprises provision of independent assurance that major business risks are being managed appropriately, and that the internal control framework is robust and operating effectively.
KPMG agreed their audit plan with the Committee which included their audit scope, key audit risk areas and materiality. The Committee discussed the audit plan with KPMG and approved it together with the fees proposed.
Independence, Effectiveness and Objectivity of the Audit Process
The Committee conducted a review of the external auditor's independence, effectiveness and objectivity based on:
- its own assessment of the quality of the audit plan, the rigour of the audit findings and conclusions and the extent to which the Lead Audit Partner understands and constructively challenges management;
- the results of a questionnaire on external auditor effectiveness and efficiency (further detail on which is provided below);
- a report prepared by KPMG setting out its processes to ensure independence and its confirmation of compliance with them; and
- the level of non-audit fees as a percentage of the audit and half-yearly fees paid to the external auditor, which were 3.1% (2014: 52.4%).
Responses to the questionnaire have been received from all finance directors across the Group who provided information and assistance to the external auditor. The questionnaire covered a number of areas, including:
- quality of the audit team;
- knowledge and understanding of the Group;
- appropriateness of the areas of audit focus;
- interaction with audit specialists; and
- timeliness and adequacy of communication by the external auditor.
The results of the questionnaire were reported to the Committee at the meeting on 1 September 2015.
Based on the review set out above the Committee remains satisfied with the external auditor's independence, effectiveness and objectivity.
Appointment of External Auditor
KPMG will be retiring as the Company's external auditor at the conclusion of the forthcoming Annual General Meeting. The reports of KPMG on the Company's financial statements for past financial years did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles. In connection with the audits of the Company's financial statements for each of the two previous financial years, and in the subsequent half-yearly period to 31 December 2014, there were no disagreements with KPMG on any matters of accounting principles or practices, financial statement disclosure, or auditing scope and procedures which, if not resolved to the satisfaction of KPMG, would have caused KPMG to make reference to the matter in their report.
At the forthcoming Annual General Meeting, a resolution to appoint PricewaterhouseCoopers LLP (PwC) as the external auditor and to authorise the Directors to set their remuneration will be proposed.
There are no contractual obligations that restrict the Committee's capacity to recommend a particular firm as external auditor and the Company does not provide an indemnity to the external auditor.
PwC have been invited to observe the year end close process and they have agreed plans to assure a smooth transition.
External Audit Engagement Director Rotation
In line with the ethical standards of the Audit Practices Board the Lead Audit Partner will be rotated every five years.
External Audit Firm Tendering
KPMG (as KPMG Audit Plc and latterly as KPMG LLP) has been appointed as the external auditor since the Company's formation in 1997 and their performance has been reviewed annually by the Committee since that time. The Committee has remained consistently satisfied with the level of independence of the external auditor and the integrity of the external audit process. As reported in the 2014 Annual Report the Committee was aware of the recommendations in the Code in relation to the expectation that the external audit is put out to tender every ten years, and therefore decided to undertake a tender process to coincide with the rotation of the Lead Audit Partner of KPMG.
Given the size, complexity, and geographical spread of the Company, the Committee decided to invite PwC, Ernst & Young LLP (Ernst & Young) and KPMG to take part in a tender for carrying out the external audit. Deloitte was excluded from the process as they provide significant global tax management and compliance support to the Group that would be disruptive to change. Each firm was invited to make a presentation to the Committee ensuring that each firm had equivalent access to management. Written tenders covered pre-determined areas of focus including risk identification, audit approach to risk and audit scope together with fee proposals.
The Committee was mindful throughout the process that the independence of the external auditor be preserved and required disclosure of existing relationships.
The Committee selected PwC, subject to shareholder approval, because the Committee believed that they best met the objectives it had set including demonstrating an understanding of our business and associated risks and an ability to work constructively and challengingly with management and provide the Committee with the assurances needed in order to carry out its function.
With respect to non-audit assignments undertaken by the external auditor, the Company has a policy of ensuring that the provision of such services does not impair their independence or objectivity.
Prior approval of the Committee is required before the external auditor is appointed to carry out non-audit work and the rationale for doing so is provided to the Committee, who assess the qualification, expertise, independence and objectivity of the external auditor prior to granting approval. As such, non-audit fee spend is a standing item on the agenda for every Committee meeting.
The Committee firmly believes that there are certain non-audit services where it is appropriate for the Group to engage the external auditor. In such cases safeguards are in place to ensure continued external auditor independence including the use of separate teams to undertake the non-audit work separately from the audit work. During the year, the external auditor provided assistance with tax compliance correspondence, completing an engagement agreed in the prior year. The Committee did not consider that the performance of this non-audit work would affect or impair the external auditor's integrity. This is consistent with the ethical standard published by the Accounting Practices Board.
The results of this policy are that:
- Deloitte undertake global tax compliance work in substitution for the external auditor; and
- during the course of the year Deloitte, Ernst & Young, Grant Thornton and PwC have been appointed to provide advice on an employment matter, related tax advice, company reorganisation and due diligence.
A summary of audit and non-audit fees in relation to the year is provided in note 6 to the Group's financial statements. This shows that non-audit work carried out by the external auditor represented 3.1% (2014: 52.4%) of the annual audit fee and half-yearly review fee, and reflects the policy set out above.
Audit Committee Chairman
7 September 2015