Audit Committee report

Martin Towers

Chairman

Director Number of meetings Out of possible
Martin Towers (Chairman) 3 3
Tony Illsley 3 3
Peter Smith 1 1

The membership and attendance at Committee meetings during the year is shown in the table above.

The Audit Committee is a sub-committee of the Board and is responsible for reviewing all aspects of the financial reporting of the Group and all aspects of internal control. In doing so, the Committee represents the interests of the shareholders of the Group in relation to the integrity of information and the effectiveness of the audit processes in place.

Composition

The Audit Committee during the year under review has consisted of two Non-Executive Directors up to 5 January 2015, at which point Peter Smith joined the Committee as a Non-Executive Director. From 7 April 2015, Liz Barber also joined the Committee upon her appointment as Non-Executive Director.

The Committee is chaired by Martin Towers, who has significant recent financial experience. He is a Fellow of the Institute of Chartered Accountants in England and Wales and has held a number of senior finance roles, including working as Group Finance Director at Kelda Group PLC until 2008. The Board considers therefore that he has the relevant financial experience to fulfil the role of Chairman of the Audit Committee.

Martin has indicated that it is his intention to retire from the Board at the AGM in July and at that point Liz Barber will become the Chairman of the Committee. Liz currently works as the Group Director of Finance, Regulation and Markets at Kelda Group PLC and was previously the Head of Audit for the North of England at Ernst & Young. She therefore brings a wealth of recent financial experience to the role.

Committee meetings are also attended by the Executive Directors, the Director of Group Finance Services, the Company Secretary and representatives from the internal and external auditors. The external auditors meet also with individual members of the Audit Committee during the year, without the other attendees present. The internal auditors also meet separately with the Chairman of the Audit Committee without the other attendees present.

Meetings

There were three meetings held in the year; in June, November and March. The June meeting was used to review the year end external audit and year end financial reporting, the November meeting to consider the half year review and financial reporting and the March meeting to consider the planning for the year end.

Each meeting included agenda items relating to internal audit, financial reporting and external audit. The areas discussed under each item are noted in the table below:

Area Discussion
Internal audit The internal audit agenda item focuses on the audits performed in the period, including any significant issues identified. A report setting out previous audit issues raised and the progress made to mitigate the issues is also discussed at each meeting. A review of the internal audit plan for the period to the next Audit Committee meeting also takes place.
Financial reporting The Director of Group Finance Services talks through the key judgement areas in relation to financial reporting and sets out the decisions made and the rationale behind these. These are covered in more detail in the Performance review.
External audit The representatives from PricewaterhouseCoopers LLP set out the audit approach, the key audit risks, an overview of internal controls and a view on the key audit and accounting matters, as well as how PricewaterhouseCoopers LLP ensures its continuing independence from the Group.

Each year the Audit Committee is also responsible for:

  • seeking the view of the external auditors on any accounting judgements made in the year;
  • considering the consistency and appropriateness of the accounting policies adopted;
  • reviewing the financial statements of the Group and the clarity of the disclosures made, although the ultimate responsibility for reviewing and approving the annual report and financial statements remains with the Board;
  • reviewing the adequacy of the whistleblowing procedures in place to enable employees and third parties to raise concerns in confidence, as well as the effectiveness and independence of any investigations undertaken as a result of such concerns being raised;
  • reviewing the procedures in place for the detection of fraud and the prevention of bribery across the business; and
  • overseeing the relationship with the external auditors.

The Committee’s Terms of Reference are in line with the recommendations in the UK Corporate Governance Code and the Institute of Chartered Secretaries and Administrators Guidance on Terms of Reference for Audit Committees. Copies of the Terms of Reference are available from the Company Secretary and are on our website at www.kcomplc.com.

Significant issues relating to the financial statements

The specific issues considered by the Audit Committee in the year under review, in relation to the financial statements, are shown in the table below.

Nature of the issue How the Committee was satisfied with the treatment adopted by management Any changes arising from discussion by the Committee
Pension accounting assumptions

Pension accounting is complex and there are a number of assumptions that have to be made, which can have a significant impact on the valuation of scheme liabilities.

This is a recurring matter.

The approach to the assumptions made was consistent with previous years and the Committee was satisfied that this was satisfactory given the reasonable nature of the previous assumptions and the fact that there had been no requirements for change identified.

The assumptions were debated by the Committee.

No changes were made as the Committee concluded that it agreed with the treatment adopted by management.

Capitalisation of intangible assets on internal projects

There is a significant internal project currently ongoing to implement a new back-office system. Costs relating to this are being capitalised in line with accounting standards but there have been judgements made in relation to the proportion of internal salaries that should be capitalised for this project and the recoverability of the carrying value of the asset.

This will be a recurring matter while there are significant internal projects ongoing.

The approach adopted by management in relation to the capitalisation of internal salaries was consistent with that previously adopted for other IT projects.

Management noted that the expected benefits of the project were still in line with the original business case, with the benefits to date exceeding those included in the business case. In addition, management remained committed to the delivery of the remainder of the project. There was therefore no trigger to indicate a potential impairment of the asset carrying value.

The Committee discussed at length the approach to the capitalisation and the proposed useful economic life and concluded that it was in agreement with the treatment adopted by management.

Valuation of goodwill and other intangible assets

Testing goodwill and other intangible assets for potential impairment is complex and requires a number of management estimates and sensitivities to be applied, which inevitably require judgement.

This is a recurring matter.

A full impairment assessment was performed at the year end and this was discussed in detail by the Committee, along with the assumptions made and the sensitivities in relation to the assumptions. It was concluded that an impairment of £33.9 million should be recognised in relation to the Kcom Cash Generating Unit. Further information on this can be found in Note 14 to the financial statements.

The Committee challenged the assumptions and sensitivities and concluded that no changes were required.

Exceptional costs

Management judgement around when costs should be treated as exceptional is always an area for review.

There is an established and well-defined policy in place in relation to the classification of costs as exceptional and this has not changed in the year. Management had followed this policy and therefore the Committee was satisfied with the treatment adopted by management.

No changes were made as the Committee was in agreement with the treatment adopted by management.

External audit

The Audit Committee is responsible for overseeing the relationship with the external auditors to ensure that the external auditors continue to be independent, objective and effective in their work, and also considers the re-appointment of the auditors each year.

PricewaterhouseCoopers LLP were appointed as auditors in 2006 following a comprehensive tender process. The current audit partner, Ian Morrison, was appointed to the audit in 2011 following a partner rotation. Each year the Committee considers the continued independence of the external auditors and the effectiveness of the external audit process, to determine whether to recommend to the Board that the current auditors be re-appointed, also taking into consideration the desire to comply with the requirement of the UK Corporate Governance Code to tender the external audit at least every 10 years and the transitional arrangements in place in relation to this.

There are no contractual obligations in place which would restrict the choice of external auditors by the Committee.

The Audit Committee has reviewed the effectiveness of the external audit process in the year through meetings, reviewing the reports from the external audit team and the close working of the internal audit team with the external auditors. The Committee has concluded that the external audit process was effective and is satisfied that the scope of the audit is appropriate and that significant judgements have been robustly challenged.

In addition PricewaterhouseCoopers LLP has formally confirmed its continued independence and the measures they have taken to ensure that they comply with best practice and professional and regulatory requirements in this area. The Committee believes that audit partner rotation is a significant factor in ensuring continued independence and objectivity by reducing the risk of familiarity while retaining the detailed understanding of the business which the external auditors have gained over time.

We have an Engagement of External Auditors policy which covers the selection of firms to perform non-audit work. This policy excludes the auditors from providing certain services, such as internal audit services, litigation support, remuneration advice and legal advice services. All other non-audit work is assessed separately and is awarded to the firm considered best suited to perform the work. Any such work with a fee greater than 25 per cent of the annual audit fee must be approved by the Chairman of the Audit Committee before the external auditors may be appointed.

During the year the fee for the external audit of the Group and its subsidiaries, along with other services pursuant to legislation, was £387,000 (2014: £245,000). In addition to this, the external auditors provided services to the value of £90,000 (2014: £111,000) relating to tax advisory services and Group structuring advice work. In these areas the auditors were considered the most appropriate firm to perform the work.

Risk management and internal control

The Audit Committee reviews the Group’s internal controls and risk management systems through the work performed by the internal and external auditors and reports to the Board on the effectiveness of such systems. The internal control and risk management systems have been improved during the year through the implementation of an SAP system resulting in an increase in the amount of automation in place across our Finance systems. The Committee is satisfied that any audit issues raised by either the internal or external auditors are being adequately followed up and closed down on a timely basis.

Internal audit

In November 2014, we took the decision to outsource our internal audit work and, following a selection process, Deloitte were appointed as our internal auditors. The decision to outsource was taken to enable the internal audit work performed to cover a broader scope and to give us access to subject matter experts, which we did not have with an in-house team. Up to November 2014, our internal audit team consisted of two qualified accountants, both with a ‘Big Four’ background. The team performed financial, operational and compliance audits and assessed each potential audit area according to the risk associated with it and the level of assurance already in place. This then enabled audits to be appropriately prioritised and built into the audit plan as necessary.

Going forward a similar approach is being adopted by Deloitte, of prioritising audits in relation to the risk associated with the audit area, as well as by looking specifically for ‘what must go right’ rather than simply the risk of something going wrong. The audit plan is brought to each Audit Committee meeting, where it is discussed and approved.

The internal auditors report to the Audit Committee at each meeting on the adequacy and effectiveness of the financial, operational and compliance controls in place across the Group. The Audit Committee is responsible for monitoring and reviewing the effectiveness of the internal audit work and does this through reviewing the internal audit reports presented to the Committee and through the Chairman of the Audit Committee meeting separately with the internal auditors outside of the Committee.

The Committee also reviews the adequacy of management responses to the audit issues raised and monitors the closure of issues on a timely basis through a regular report from the internal auditors.

The internal and external audit teams work closely together to ensure that all key risk areas are covered and that the work performed by one team feeds into the work of the other.