The Purpose and Function of the Audit Committee (the Committee)
The Committee's key role is to review and report to the Board on financial reporting and 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 Letter from the Audit Committee Chairman. Lisa Bright joined the Committee on her appointment to the Board in February 2019. All Committee members are Non-Executive Directors.
The Board considers that all members of the Committee are independent and have competences relevant to the sector in which the Company operates. Julian Heslop has recent and relevant financial experience as a result of his financial background and qualification. Ishbel Macpherson, Lawson Macartney and Lisa Bright 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 and Senior Executive Team.
The Company Secretary attends each meeting and acts as its secretary assisting the Chairman in ensuring that all papers are provided prior to each meeting in a timely manner and providing advice on all governance related matters. Other members of the Board normally attend each meeting together with the PricewaterhouseCoopers LLP (PwC) Lead Audit Partner, the Group Financial Controller and the Head of Internal Audit and Risk Assurance. In addition, the Committee Chairman meets with the Chief Financial Officer, the Head of Internal Audit and Risk Assurance and the Lead Audit Partner outside of the Committee meetings in order to understand fully the key topics to enable these subjects to be discussed meaningfully at the meetings.
The Committee meets with the external and internal auditors without management being present, after each scheduled meeting, to discuss their respective areas and any issues arising from their audits.
Neither the Company nor its Directors have any relationships that impair the external auditor's independence.
Effectiveness of the Committee
The Committee's performance was evaluated as part of the 2019 Board and Committee Internal Evaluation (further details of which can be found in the Corporate Governance Report). The Committee considered the results of the evaluation and it was agreed that the Committee remained effective. The structure and content of the papers and quality of discussions held gave the Committee further assurance of its effectiveness.
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's website at www.dechra.com. The Board reviewed the Committee's terms of reference at the November 2018 meeting and amended them to reflect the 2018 UK Corporate Governance Code requirements.
Major Activities of the Committee during the Year
The Committee met four times since the last Annual Report was issued. These meetings were scheduled meetings, and are generally timed to coincide with the financial reporting timetable of the Company. The Committee Chairman and the Company Secretary have developed an annual programme of business. This allows the Committee to consider standing items of business alongside any exceptional matters that may arise during the course of the year.
At each meeting the Committee reviews the following items routinely:
- status of statutory audits, global tax management and compliance support;
- non-audit fees (including actual and projected spend); and
- the internal audit progress and assurance report.
The table below shows the other key areas of the Committee activities:
|Purpose and Function|
- Review of the Committee's terms of reference
- Review of the implication of the 2018 Corporate Governance Code on the Committee's activities
- Review of the effectiveness of the Committee
|Financial and Narrative Reporting|
- Review and approval of Accounting Policy amendments due to the adoption of IFRS 9 and IFRS 15 from 1 July 2018
- Review of impact assessment and proposed adoption approach for IFRS 16 from 1 July 2019
- Review of year end accounting treatment for acquisitions, non-underlying items and new accounting standards
- Review and endorsement of key judgements made by management in determining half-year and full year results
- Review of the Group's Half-Yearly Report and supporting papers
- Consideration of the Half-Year Review Memorandum prepared by the external auditor
- Review of the dividend policy and interim and final dividend proposals
- Review of the Group's preliminary statement, draft Annual Report (including the Audit Committee Report) for the year ended 30 June 2019 and management presentation to investors
- 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 including impairment assessments undertaken
- commentary on the general control environment across the Group
- Review of viability statement process
- Review and commend the going concern and viability statements
- Fair, balanced and understandable recommendation of the Annual Report
|Internal Controls and Risk Management|
- Review of Anti-Bribery and Anti-Corruption and How to Raise a Concern Policies
- Anti-Bribery and Anti-Corruption and Sanction progress update
- Half-year and full year review of internal financial controls
- Review of tax strategy and policy framework
- Review of treasury policy and practice
- GDPR compliance update
- Review and approval of the internal control and risk management statements
- Review of Internal Audit Plan and effectiveness of Internal Audit
- Review of Internal Audit Charter
- Review and approval of PwC Half-Yearly review plan
- Review and approval of PwC full year external audit strategy (including timetable, scope and fees)
- Discussion in relation to the Company's expectations of the external auditor and audit process
- Review of the external audit effectiveness, external auditor's independence and level of non-audit fees
- Review of the non-audit fee policy
- Review of findings from the external audit
Financial and Narrative Reporting
All significant matters under consideration by the Committee during the year were supported by relevant justification papers and were fully discussed so 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.
The Committee reviewed both the half-year and the annual financial statements. This process included an analysis by management of key judgements made in determining the results. 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 alternative performance measures (APMs) were provided to enhance investors' understanding of the underlying performance. The Group uses various non-GAAP APMs within internal management reporting, the Half-Yearly Report and the Annual Report. The objective of these APMs is to isolate the impact of exceptional, one-off or non-trading related items to allow the Board and investors to understand better the underlying performance of the business. The Group also uses constant exchange rate growth percentages to eliminate the impact of exchange rate fluctuations and show the underlying business growth. These matters were well supported by briefing papers provided by management and were specifically reviewed and agreed by the external auditor in their reports to the Committee and in related discussions.
The key matters reviewed are shown in the table below:
|Significant risks 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 intangible assets and goodwill of £687.0 million, which represents 65.5% of total Group assets.
The Committee reviewed management's process for reviewing and testing goodwill and other intangible assets for potential impairment. In respect of assets not subject to amortisation, it reviewed the papers provided by management and noted the headroom between the value in use and the carrying value of goodwill. In addition, it considered the ongoing viability of capitalised R&D projects compared to their carrying value. Finally it reviewed the process adopted by management to review amortised assets for impairment. It endorsed management's conclusion that no impairment of these assets had taken place. The Committee considered PwC's report on these matters.
Review of the remeasurement of the intangibles and associated contingent consideration for the licensing transactions which were remeasured during the year.
The Committee reviewed the accounting basis of the adjustments which supported the remeasurement and considered the appropriateness of the accounting treatment.
Valuation of the acquired intangible assets and goodwill acquired during business combinations in the year, which total £37.5 million.
Valuation and accounting for the acquired commercial licensing agreement intangibles of £7.9 million together with the related deferred consideration.
The Committee reviewed the calculations and assumptions provided by management and third party experts which support the valuation of these acquired assets and these valuations were assessed for completeness. The Committee reviewed the useful economic lives of the identifiable intangible assets and the future growth rate assumptions applied in the valuations.
Review of the corporate tax rate for the year being a credit of 11.2% (21.2% on underlying operations).
The Committee discussed the key risks in respect of corporate tax and reviewed that appropriate controls were in place to confirm that taxation calculations were not materially misstated. Areas where significant judgements, such as uncertain tax positions, had been applied were reviewed and challenged and external audit work and conclusions were considered.
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 impairment and amortisation of acquired intangible assets and related deferred consideration, acquisition costs, manufacturing rationalisation restructuring costs, and the fair value uplift on inventory acquired through business combinations.
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, PwC, that they were satisfied that the application of the accounting policy was appropriate.
The Committee also reviewed any material one-off income and costs within the underlying results, and ensured these were clearly disclosed within the financial statements and notes.
Going Concern and Viability Statements
The Committee reviewed the Group's going concern and viability statements set out in the Corporate Governance of the Corporate Governance Report. In considering the viability statement the Committee paid particular attention to the robustness of the stress testing scenarios, the cash flows forecast by the business and the committed bank facilities available to the Group. The external auditor reviewed management's assessment and discussed this review with the Committee.
Fair, Balanced and Understandable Assessment of the Annual Report
At the request of the Board, the Committee considered whether the 2019 Annual Report was fair, balanced and understandable and whether it provided the necessary information for shareholders to assess the Group'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; and
- the Executive Directors and Company Secretary providing confirmation that each section of the report has been subject to a rigorous review process built around four tiers:
- ongoing internal review by members of the Annual Report project team;
- Board review of a full printed draft copy of the Annual Report with all comments received being considered by the owners of the respective reports;
- external review by advisers including the external auditor; and
- a final review by all members of the Senior Executive Team (SET).
The above is an integral part of the process and each tier is invited to comment so that issues could be debated and a final assessment made. The Annual Report project team concluded that the Annual Report 2019 met the fair, balanced and understandable test. In addition, the final draft document was reviewed by all members of the SET 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 confirmed that in their opinion the Annual Report 2019 was fair, balanced and understandable, which can be found in the Independent Auditior's Report.
This assessment was carried out by the Committee on 27 August 2019, following which the Committee reported to the Board that it was satisfied that, taken as a whole, the Annual Report 2019 is fair, balanced and understandable.
Internal Controls and Risk Management
The Board retains overall responsibility for the management of the Group's risk management and internal control framework. The Committee monitors and reviews the effectiveness of the Group's internal financial controls.
The Committee has also reviewed the effectiveness of the Group's risk management and internal control processes. This includes:
- confirmation that the rolling programme of risk and control reviews by the Board has been completed;
- a review of the SET's assessment of material internal control effectiveness;
- a review of the going concern and viability statements together with the financial stress testing conducted to support these statements; and
- a review of baseline financial controls and management representations on their effectiveness across the Group.
Further details in respect of the Group's risk management and internal control processes are provided in How the Business Manages Risk of the Strategic Report and the Board's statements on the effectiveness of these processes are provided in the Corporate Governance Report.
Review of Policies and Procedures
During the year the Committee reviewed the following policies:
- Finance Policies
The Committee endorsed amendments to three Accounting Policies (Receivables, Intercompany and Revenue) which had been impacted by the adoption of IFRS 9 and IFRS 15. In addition, the Committee undertook the annual review of the Group Tax Policy and Strategy and Treasury Policy.
- Anti-Bribery and Anti-Corruption Policy
This policy was amended to give further information and guidance to the policy audience on the relevance of this area of law to them, and included the newly developed Third Party Risk Identification Questionnaire and guidance.
The Head of Internal Audit and Risk Assurance provides objective assurance and advice on the management of the Group's risks and its systems of internal control. Internal Audit operates a resourcing arrangement with KPMG LLP (KPMG) with a mix of seconded and specialist resources to provide a flexible resource model and access to specialist expertise and language skills in worldwide geographies.
Internal Audit operates a three year assurance plan which seeks to provide balanced coverage of the Group's material financial, operational and compliance control processes. It consists of a rolling programme of core assurance activities together with initial controls reviews on new acquisitions and reviews of major business process and systems changes. The annual delivery plan, which defines the specific assurance projects to be delivered each calendar year, is developed from the three year plan. The annual plan for the year to June 2020 was approved by the Committee in May 2019.
The acquisition of Laboratorios Vencofarma do Brasil Ltda (Venco) in December 2018 has been a key focus area for this year given the higher risk inherent in doing business in Brazil. A compliance and financial controls improvement plan to implement Dechra's global standards in the Brazilian business has been designed by Internal Audit, who are also monitoring its implementation by the Venco management team. This plan includes:
- implementation of Dechra's standard financial control framework;
- communication and training on the Group's compliance policies with a significant focus on the Anti-Bribery and Anti-Corruption (ABC) Policy;
- implementation of Dechra's ABC third party compliance programme to complete a risk assessment of Venco's customer and suppliers, communicate Dechra's Third Party Code of Conduct to higher risk parties and conduct due diligence on these higher risk relationships; and
- a review and assessment of the internal controls in the recently implemented ERP system.
Internal Audit recommendations are communicated to relevant business leaders, appropriate control improvements agreed with them, and implementation of agreed actions is monitored monthly. Audit reports are provided to the Committee together with regular progress reports on management's implementation of control improvements.
During the year the Committee reviewed and approved an Internal Audit Charter and, based on an assessment of its work, concluded that Internal Audit continued to be effective.
Following a competitive tender in 2015, PwC were appointed as the Company's external auditor effective from the 2016 audit. The Company complies with the Competition and Markets Authority Order 2014 relating to audit tendering and the provision of non-audit services.
PwC 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 PwC 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:
- the Committee's own assessment of the quality of the audit plan, the rigour of the audit findings and conclusions, the extent to which the Lead Audit Partner understands the business and constructively challenges management and the quality and clarity of the technical and governance advice provided;
- the results of a questionnaire on external auditor effectiveness and efficiency (further detail on which is provided below);
- a report prepared by PwC 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 fees paid to the external auditor, which were 6.7% (2018: 70.0% in relation to services rendered by PwC).
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 27 August 2019.
Based on the review set out above, the Committee is satisfied with the external auditor's independence, effectiveness and objectivity.
Re-Appointment of External Auditor
At the forthcoming Annual General Meeting, a resolution to re-appoint PwC as the external auditor and to authorise the Committee to set their remuneration will be proposed.
In recommending the re-appointment of the external auditor at the Annual General Meeting, the Committee also takes into account EU guidance and the Competition and Markets Authority (CMA) Order on mandatory audit tendering. Dechra will be required to retender its audit no later than for 2026 financial year and we also note that the next regular PwC partner rotation will take place after the 2020 audit. The Committee has therefore started to consider the factors that would be taken into account during the tender process to enable access to an appropriate pool of external auditors for consideration.
External Audit Engagement Partner Rotation
In line with the ethical standards of the Audit Practices Board, the Lead Audit Partner will be rotated every five years. The current Lead Audit Partner was appointed during the 2016 financial year and consequently will stand down at the latest after the completion of the audit of the 2020 financial year.
With respect to non-audit services undertaken by the external auditor, the Company's policy is that the provision of such services does not impair their independence or objectivity.
The 2018 fee was higher than in previous years, and was due to the external auditor providing the services of reporting accountant with respect to the acquisition of AST Farma B.V. and Le Vet Beheer B.V. in February 2018. The Committee fully considered this engagement and concluded that the performance of this non-audit work did not affect or impair the external auditor's integrity for the reasons outlined in the 2018 Audit Committee Report.
As previously disclosed, in May 2018 the Committee amended its policy for the use of the auditors, PwC, for non-audit work, by agreeing a cap of 30% for the ratio of non-audit fees to the audit fee and reconfirmed the underlying principle that the external auditor should never be used where another professional firm can provide the same or similar service. This principle is stricter than the FRC guidance as it is expected that non-audit work performed by the external auditor will be limited to the review of the half-year accounts and any other work required to be carried out by the auditor in accordance with legislation. The annual review of the policy was undertaken in May 2019 with no major changes being made.
The approval of the Committee must be obtained before the external auditor is engaged to provide any permitted non-audit services. Should another professional firm be unable to provide the same or similar service the Committee will continue to approve in advance any non-audit work carried out by the external auditor. In all instances the Committee will assess the qualification, expertise, independence and objectivity of the external auditor prior to granting approval. Safeguards are in place to provide for continued external auditor independence, including the use of separate teams to undertake the non-audit work and the audit work. As such, non-audit fee spend is a standing item on the agenda for every Committee meeting.
A summary of audit and non-audit fees in relation to the year is provided in note 7 to the Group's financial statements. This shows that non-audit work carried out by the external auditor represented 6.7% (2018: 70.0%) of the annual audit fee. The 2019 non-audit fees relate to the engagement of PwC to provide an annual attestation to NOMA (the regulator in Norway), an attestation in respect of the Mexican Social Security Institute filings and an expert's opinion in relation to the capital reduction of the Group's Irish subsidiary, as such the services were permitted under the non-audit fee policy.
|Audit fees including related assurance services (£m)||0.89||0.80||0.57||0.50|
|Non-audit fees (£m):|
|Review of Half-Yearly Report||0.04||0.04||0.04||0.04|
|Ratio of non-audit fees to audit fees||6.7%||70.0%||15.8%||12.0%|
* The 2018 Audit Committee Report sets out the reasons for the engagement of PwC.
Audit Committee Chairman
2 September 2019