The Purpose and Function of the Audit Committee (the Committee)

Purpose

The Committee's key role 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. Ishbel Macpherson and Lawson Macartney 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 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.

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.

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 at the November 2017 meeting and amended them to reflect the revised UK Corporate Governance Code and updated Financial Reporting Council (FRC) Guidance on Audit Committees.

Major Activities of the Committee during the Year

The Committee met seven times since the last Annual Report was issued. Four of the meetings were scheduled meetings, and these are generally timed to coincide with the financial reporting timetable of the Company. Three additional meetings were held to discuss the acquisition of AST Farma B.V. and Le Vet Beheeer B.V. (the Acquisition). The Committee 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.

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 provides an overview of the other matters discussed at the meetings:

Financial and Narrative Reporting

All significant matters under consideration by the Committee during the year 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-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:

Going Concern and Viability Statements

The Committee reviewed the Group's going concern and viability statements set out in the Corporate Governance Report. In considering the viability statement the Committee paid particular attention to the robustness of the stress testing scenarios. The external auditor reviewed management's assessment and discussed this review with the Committee.

During the year, the Committee reviewed the changes to Dechra's risk reporting and viability statement following recent guidance from the FRC. The statement was revised to distinguish clearly the assessment of long term prospects from the viability assessment, with a five year time frame for long term prospects and a three year time frame for viability.

Fair, Balanced and Understandable Assessment of the Annual Report

At the request of the Board, the Committee considered whether the 2018 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. In addition, the final draft document was reviewed by all members of the Senior Executive Team (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 2018 was fair, balanced and understandable, which can be found in the Independent Auditor's Report.

This assessment was carried out by the Committee on 28 August 2018, following which the Committee reported to the Board that it was satisfied that, taken as a whole, the Annual Report 2018 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 undertook the annual review of the Group Tax Policy and Strategy which had been amended to reference the Group's new policy on prevention of criminal facilitation of tax evasion. It also reviewed the Treasury Policy which has been amended to increase governance, monitoring and reporting on Treasury activities and compliance.

• Non-Audit Fees Policy

The Committee formalised the non-audit fees policy, further details of which can be found in the Audit Committee Report.

• Whistleblowing Policy (now referred to as How to Raise a Concern)

This policy was reviewed as part of the data privacy compliance work, the main changes included encouraging employees to raise an issue when it was a concern, an increase in the number of reporting channels, and an outline of how an investigation would be conducted and the reporting of the outcome.

Internal Audit

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 is supported by a co-sourcing arrangement with KPMG LLP (KPMG) 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, including the implementation of the Oracle ERP system. 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 2019 was approved by the Committee in May 2018.

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 concluded that Internal Audit continued to be effective.

External Auditor

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 Market Authority Order 2014 relating to audit tendering and the provision of non-audit services.

Audit Plan

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 and half-yearly review fees paid to the external auditor, which were 62.3% (2017: 8.5% 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 28 August 2018.

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.

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.

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.

Non-Audit Assignments

With respect to non-audit services 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.

For the first time in four years the level of non-audit fee paid to the external auditor exceeded 50%, which was wholly due to the engagement of PwC as the reporting accountant for the circular to shareholders to approve the Acquisition, which completed in February 2018. The time to complete this assignment was extremely short as a result of the vendor requirements which gave the Company a limited period of exclusivity. The Committee consequently considered the proposal by management to use PwC, who were best placed to meet the assignment timetable, and exceptionally gave their approval for the engagement. In giving their approval the Committee noted:

• the tight timescales;
• the fact that the audit team would not be compensated for work being assigned to PwC;
• consistency of the work to be done with the revised ethical standard issued by the FRC;
• that the proposed work had been internally approved by the PwC Ethics Partner; and
• PwC non-audit fees had been very low over the previous three years relative to the audit fee.

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. It is consequently expected, going forward, that the external auditor will continue to review the half-yearly accounts but will carry out little other work for the Company other than those situations where it is required to do so by legislation.

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. 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 and the audit work.

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 62.3% (2017: 8.5%) of the annual audit fee and half-yearly review fee. This fee is higher than in previous years, and is due to the external auditor providing the services of reporting accounting with respect to the Acquisition. The Committee fully considered this engagement and concluded that it did not consider that the performance of this non-audit work affected or impaired the external auditor's integrity for the reasons outlined above. The four year average of non-audit fees as a percentage of the audit fees to 30 June 2018 is 35.2%.

Role of the Committee in the Acquisition

The Committee had responsibility for the review and recommendation to the Board of:

• the Enlarged Group Working Capital for inclusion in the circular, which was reviewed by KPMG;
• the Financial Reporting Procedures Report, which was reviewed by KPMG; and
• Historical Financial Information included in the circular, which was audited by PwC.