Audit committee report
LETTER FROM THE CHAIRMAN
OF THE COMMITTEE
I am pleased to introduce our audit committee report for 2015/16. The committee’s key responsibilities include monitoring the integrity of the group’s financial reporting, internal controls and risk management procedures, overseeing the internal and external audit processes and a range of other corporate governance activities.
During the year the committee devoted particular attention to the following key areas: the year-end financial statements and interim report and associated audit matters, with particular focus on the accounting treatment of certain matters arising as a result of the acquisition of Spirit Pub Company; the relationship with the external auditor, including audit tender and audit partner rotation review; and risk management processes and internal controls. In particular the committee reviewed the viability statement in the Risks and uncertainties section before it was recommended to the board.
I will be retiring from the board at the AGM in September and therefore, during 2016/17, under the stewardship of Rob Rowley, the committee will continue its focus on the financial statements, on governance matters and on risk management, whilst at the same time ensuring that the new Ernst & Young audit partner, as explained below, has a full and detailed understanding of the issues facing the business and is able to deliver a robust and detailed audit of the group’s financial statements.
Chairman of the audit committee
The audit committee was chaired during the year by Ian Durant. The other members of the committee were Mike Coupe and Rob Rowley. All members are considered by the board to be independent. The board is satisfied that Ian Durant has recent and relevant financial experience, as the former finance director of Liberty International plc, since renamed as Intu Properties PLC, and the current audit committee chairman at Home Retail Group plc. Looking forward Rob Rowley, who is the former finance director of Reuters Group plc, will take over as chairman of the committee following Ian Durant’s retirement from the board at the AGM in September.
A key responsibility for the audit committee is reviewing the financial reporting, controls and risk management processes across the group. The committee assesses the external audit conclusions on both the full year and interim results, in each case prior to their submission to the board. Whilst the board retains responsibility for undertaking the required assessment that the annual report is fair, balanced and understandable, the audit committee this year, at the request of the board, has undertaken a review of this prior to submission of the annual report to the board, as detailed below.
The committee also reviews the company’s internal control systems, advises the board on the appointment of external auditor, oversees the relationship with the external auditors, and reviews the quality and effectiveness of both the internal and the external audit. In addition, the committee is responsible for considering the company’s whistle blowing procedures and reviewing their effectiveness in practice.
In relation to risk matters, the committee reviews the group’s risk management policies and procedures prior to submission to the board and receives detailed reports on the risk management processes within the business units and key functional areas. The committee receives regular updates on regulatory, accounting and reporting developments and their application to the company.
Operation of the committee
The committee held three half-day meetings during the year. Attendance at these meetings by the committee members is shown in the Corporate governance statement. On each occasion the external auditors, chief financial officer and senior members of the finance function attended, as well as the company secretary, head of risk and members of the internal audit function. By rotation, operational managers and functional heads present risk reports at audit committee meetings.
There is an opportunity at each meeting for the committee to discuss matters privately with the internal and external auditors without management present. Outside of scheduled meeting times, the chairman of the committee is in regular contact with the external audit partner to discuss matters relevant to the company.
The committee’s terms of reference are available on the company’s website and these are reviewed annually and updated to reflect changes in the responsibility and regulation of the committee. In addition, the committee conducts a review of its own performance on an annual basis, taking input from the members of the committee, the external auditor and senior members of the finance function. As a result of the review the audit committee has assisted the board in its fair, balanced and understandable review of the annual report, as explained below.
Financial statements and audit
The committee reviewed and provided input into the audit scope and audit plan presented by the external auditor, ensuring there was adequate focus on the fair value issues arising from the acquisition of Spirit. In considering the financial statements the committee reviewed the group’s accounting policies to ensure consistency on a year-to-year basis, and that appropriate accounting policies were adopted for new issues such as brand valuations associated with the acquisition of Spirit. Significant issues that the committee addressed in relation to the financial statements are set out in the table below. The committee also reviewed management’s attestation paper setting out the information that had been provided to the auditor to enable it to form its opinion on the group’s financial statements and demonstrating that it was appropriate for the directors to make the representations set out in the letter of representation.
Significant issues considered by the audit committee in relation to the financial statements for 2015/16
The committee reviewed the proposed fair value accounting treatment of assets and liabilities acquired as a result of the Spirit acquisition and the changes proposed to the interim adjustments applied by management at the half year. In particular, it considered key judgmental areas including off-market leases, brand valuations and property and lease valuations and the treatment of goodwill, ensuring an appropriately rigorous process had been applied to determine fair values based on reasonable assumptions. In particular, the committee noted the assessments of independent advisers appointed to undertake property valuations of the Spirit estate and to consider the valuation of brands and other intangible assets. Following discussions with the external auditors, the committee concluded that the proposed accounting treatment of the Spirit assets and liabilities was reasonable and confirmed that the fair values set out in note 7 to the financial statements were appropriate.
The committee undertook a detailed review of uncertain tax positions which have not yet been agreed or are in dispute with HMRC. Whilst many of the uncertain tax provisions have been resolved with HMRC, the largest of these, an internal funding arrangement undertaken in 2003/4, known as Sussex, remains outstanding. The committee satisfied itself that an appropriate provision was in place in respect of this uncertain tax position following discussion with the external auditor.
Management prepared a detailed report for consideration by the committee concerning the methodology used to determine the extent of any impairment required. The committee considered the methodology used, reviewed management’s proposals and considered the expected timetable for the disposal of non-core sites. The committee assessed the proposed changes to both the underlying growth rates and the discount rate used and determined them to be appropriate. The committee agreed that the growth rates were appropriate at this stage even in light of possible consumer uncertainty following the referendum vote to leave the European Union. The external auditors were asked for their input and the committee took into account their views on the questions raised. Following the review and discussions the committee concluded that an impairment of £32.2m was appropriate in relation to property, plant and equipment.
The committee reviewed the group’s funding headroom and covenants in conjunction with the review of the use of the going concern assumption and, in particular, the viability statement in the Risks and uncertainties section. The committee considered the time period proposed for the viability statement, challenged management’s projections, assumptions and stress testing (which included material reductions in planned growth rates), as well as the extent to which mitigating actions would achieve the desired outcomes, and took into account the external auditor’s comments on its own work on this issue.
The committee reviewed the group’s accounting for supplier income, including listing fees, performance fees and volume rebates, noting that such income is not recognised until it can be reliably estimated. The auditor’s review of both supplier income and customer rebates was considered. During 2015/16 the annual value of supplier fees and rebates amounted to approximately £27m, whilst customer rebates amounted to £22m in the year. The committee was satisfied that the current controls in place provided reasonable assurance that the risks associated with these areas were being appropriately managed.
The committee reviewed the changes to the deferred tax provision for rolled over gains and property revaluations, which led to a £26.8m deferred tax credit. The auditor’s review of the capital gains model and HMRC’s review as part of the dispute resolution process were considered. The committee was satisfied that the revised deferred tax provision for capital gains was appropriate.
Fair balanced and understandable annual report
One of the key governance requirements in relation to the annual report is that it should be fair, balanced and understandable. At the request of the board this year, the audit committee undertook a review of management’s processes in this regard (including the clear guidance given to contributors and the review process adopted by management) and also considered in detail the draft annual report to ensure that it was fair, balanced and understandable in their view. The committee then recommended to the board that it could make the required disclosure as set out in the Directors' responsibilities statements.
Effectiveness of the external audit
After the 2014/15 audit was completed a review of the effectiveness of the auditor and of the audit service was undertaken, supported by a questionnaire completed by the audit committee chairman, the chief financial officer, and a number of key members of the finance team involved in the preparation of the statutory accounts. The overall quality of the service, the audit partner and the audit team were all reviewed and matters such as the management of the audit team, the quality of its challenge, insight and communications and the cost-effectiveness of the audit were considered. Taking into account the internal review the committee was satisfied that the quality of the audit service provided by Ernst & Young LLP was appropriate. The feedback from the review was also provided to Ernst & Young LLP. The committee also took into account the quality of the audit firm procedures as published by the Financial Reporting Council.
Ensuring external auditor independence
The audit committee is cognisant of the importance of auditor independence and objectivity and has a policy in relation to the use of the auditor for non-audit work. The company will award non-audit work to the firm which provides the best commercial solution for the work in question, taking into account the skills and experience of the firm; and (if the audit firm is being considered) the nature of the services involved, the level of fees relative to the audit fee and whether there are safeguards in place to mitigate to an acceptable level any threat to objectivity and independence in the conduct of the audit resulting from such services.
Work estimated to cost in excess of £25,000 is put out to tender unless agreed otherwise by the chairman of the audit committee. The chief financial officer may approve specific engagements up to £50,000 (in aggregate up to £100,000 p.a.), and the chairman of the audit committee may approve engagements up to £100,000 (in aggregate up to £200,000 p.a.), with fees in excess of those limits being subject to approval of the full committee. This policy was complied with during the year.
The audit committee has considered a revised policy for non-audit services in line with the recent guidance issued by the FRC which will have effect for the group’s 2017/18 financial year. Now that the guidance is finalised, the audit committee will confirm its policy and implement it before the 2017/18 financial year. The revised policy will be more restrictive than that which currently exists.
The committee also has a policy in relation to the appointment of former partners or employees of the auditor by the group, which provides that audit partners will not be offered employment by Greene King or any of its subsidiary undertakings within two years of undertaking any role on the audit. Other key team members will not be offered employment by Greene King within six months of undertaking any role on the audit. Other audit team members who accept employment by Greene King must cease activity on the audit as soon as they tender their resignation to the audit firm. No members of the audit team have joined Greene King in the period.
During the year the company made limited use of specialist teams within Ernst & Young LLP for non-audit work, including acting as auditors to the Belhaven pension scheme and in relation to the restated FRS 101 accounts for Greene King Finance plc, required in relation to the secured financing completed in May 2016. The total fees paid to Ernst & Young LLP during the year amounted to £0.65m of which £12k related to prior year expenses, and £0.04m (6%) related to non-audit work. Further detail is in note 4 to the financial statements.
In considering the independence and objectivity of the external auditor, and the further safeguards in place to protect it, the committee noted the annual review undertaken by the external auditor identifying all services provided to the group and determined that carrying out such work did not, and will not going forward, impair the independence of the external auditor.
External auditor – tendering and re-appointment
The company last tendered the external audit contract in 1997 and Ernst & Young have been the auditor since then, with an annual rolling contract and subject to an annual shareholder vote at the AGM. Ernst & Young LLP are required to rotate the audit partner responsible for the group every five years and the current audit partner’s term ends with completion of this annual report.
In accordance with The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Processes and Audit Committee Responsibilities) Order 2014 (the Order) and in the light of the transitional provisions on audit matters thereunder which allow a period until April 2024 before an audit tender and change is required, and given the change of audit committee chairman which will take place immediately after the signing of this annual report, the committee recommended to the board, and the board accepted the recommendation, that Ernst & Young LLP should be retained as the group’s auditors for the time being. A new audit partner will be in place for the 2016/17 financial year audit, and the committee will give consideration to undertaking a full audit tender, in which Ernst & Young LLP will not be permitted to partake, within the next five years. The company was in compliance with the Order during the year.
The committee therefore recommended to the board that Ernst & Young LLP should be reappointed as the company’s auditor for the forthcoming year. This resolution will be put to shareholders at the AGM.
The company’s internal audit function is responsible for reviewing the effectiveness and efficiency of the systems of internal control in place to safeguard the assets of the company. Under the terms of reference for the function, the internal audit team has direct access to the audit committee chairman to enable it to raise any significant issues and to maintain independence. Members of the internal audit team also attend the audit committee meetings to report on the progress and actions taken by the function. During the year, as well as full reviews of relevant areas, the internal audit function had also carried out a number of key financial control reviews, all of which were reported to management and the committee. The committee also reviewed the resources available to the internal audit function both in the short term following the acquisition of Spirit and on a longer term basis, noting that resources have been increased during the year.
Other matters considered during the year
The committee considered the group’s policy in relation to the valuation of its property assets, in the light of the fact that Spirit operated with an annual revaluation policy, whereas Greene King has historically adopted a policy whereby property plant and equipment are valued at cost or deemed cost on transition to IFRS. The committee considered the advantages and disadvantages of each approach and recommended to the board no change to Greene King’s policy in this regard.
The committee reviewed, as it does on an annual basis, the group’s whistle blowing policy and its application across the business. All whistle blowing reports were investigated and resolved satisfactorily, with no significant issues emerging.
The committee has continued to review the subject of cyber security and receives regular reports from management on the issue and how it is managing external threats in this area. At the request of the committee, management undertook further testing (including by external consultants) of the company’s defences against a cyber security attack, implemented a number of additional security measures as a result and addressed the content of regular committee reporting on this topic.
The terms of reference of the committee were also reviewed during the year and an exercise was undertaken to assess the effectiveness of the audit committee itself.
Internal control and risk management
As disclosed in the Risks and uncertainties section of this report, there is an on-going process for identifying, evaluating and managing the principal risks faced by the company. The board has overall responsibility for the group’s risk management framework and systems of internal control and for reviewing their effectiveness, whilst the audit committee monitors and reviews those internal controls and risks on a regular basis, and reports to the board on its findings. During the course of the year the committee continued to review reports from a number of business units and functional areas on their respective risk management processes and key risks and on the key financial internal controls and to challenge representatives of the relevant business unit or functional area who attended those meetings to present the relevant reports. The risk management framework and internal control systems are designed to manage to an acceptable level, and not to eliminate, the risk of failure to achieve business objectives. They can provide reasonable, but not absolute, assurance that the group’s assets are safeguarded and that the financial information used within the business and for external reporting is reliable.
The company has in place procedures to assess the key risks to which it is exposed and has formalised the control environment needed to address these and other issues. There are processes in place which accord with the Financial Reporting Council’s Guidance on Risk Management, Internal Control and Related Financial and Business Reporting, and these remained in place up to the date of this report. The board is satisfied that there are no significant weaknesses in these systems and that the group’s internal controls are operating effectively.
The key elements of the internal control framework, in addition to the risk management processes outlined in the risks and uncertainties section of this report, are:
- the schedule of matters reserved for the board;
- the group’s defined management structure with suitable authority limits and responsibilities, staffed by appropriate personnel;
- regular updates for the board on strategy;
- a comprehensive planning and financial reporting procedure including annual budgets and a three-year strategic plan, both of which are reviewed and approved by the board;
- ongoing monitoring by both the board and senior management of performance against budgets, through the periodic reporting of detailed management accounts and key performance indicators;
- ongoing monitoring by the board of compliance with financial covenants;
- a centralised financial reporting system and close process, with controls and reconciliation procedures designed to facilitate the production of the consolidated accounts;
- clearly defined evaluation and approval processes for acquisitions and disposals, capital expenditure and project control, with escalating levels of authority (including board approval for major acquisitions and disposals), detailed appraisal and review procedures and post-completion reviews;
- review of retail operational compliance by the retail internal audit team responsible and other analytical and control procedures facilitated by the EPOS till system;
- audits conducted by the group internal audit function of business and functional control environments; and
- documented policies to cover bribery and whistle-blowing and regular updates on any incidents.