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

Purpose

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. Chris Richards resigned in April 2016 and the Committee is pleased to welcome Tony Rice as its most recent member. Tony will, subject to the appointment of an additional Non-Executive Director, resign from the Committee on his election as a Director and his subsequent appointment as Chairman of the Company at the forthcoming Annual General Meeting.

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 Tony Rice 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 Head of Internal Audit and Risk Assurance.

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 at the December meeting and no changes were made.

Major Activities of the Committee during the Year

The Committee met four times since the last Annual Report was issued. The meetings are 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 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
3 December 2015	Consideration of the proposed changes on risk management and internal controls Review and approval of the internal audit plan Review and approval of PricewaterhouseCoopers LLP (PwC) handover and Half-Yearly review plan Review of the Committee's terms of reference Anti-Bribery and Anti-Corruption and sanctions update Review of global tax management and compliance support Review of non-audit fees (including actual and projected spend)
17 February 2016	Review of the Group's Half-Yearly report Consideration of the Half-Year Review Memorandum prepared by the external auditor Half year review of internal financial controls Review of the internal audit report Review of the dividend policy Review of non-audit fees (including actual and projected spend) Review of reverse stress testing to support the viability statement Meeting with the external auditor without management present
5 May 2016	Review and approval of the 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 Intangible R&D Asset Capitalisation Policy Review of the internal audit work plan to the end of the 2016 financial year Review of non-audit fees (including actual and projected spend) Consideration of specific stress testing scenarios and relevant time period for the viability statement Discussion of the programme of business for the 2017 financial year
30 August 2016	Review of fair value accounting of acquisitions during the year Review of the Group's preliminary statement and draft Annual Report (including the Audit Committee Report) for the year ended 30 June 2016 and recommend the final dividend 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 the going concern and viability statements Review of the internal audit report Full year review of internal financial controls 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, PwC, in their reports to the Committee and in related discussions.

  The key matters reviewed are shown in the table below:

  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 £345.3 million, which represents 124.8% of Group net assets.	The Committee reviewed management's process for reviewing and testing goodwill and other intangible assets for potential impairment. It endorsed management's assessment that an impairment to acquired intangible assets of £3.9 million was required.
  Valuation of the intangible assets acquired during business combinations in the year, which total £179.4 million.	The Committee reviewed the calculations and assumptions provided by management and third party experts which support the valuation of these acquired intangible 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.
  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 14.0% (22.7% on underlying operations).	The Committee discussed the key risks in respect of corporate tax and reviewed that appropriate controls were in place to ensure that taxation calculations are not materially misstated. Areas where significant judgements such as uncertain tax positions have been applied are reviewed and challenged and external audit work and conclusions are 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 related 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 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 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 Report. In considering the viability statement the Committee paid particular attention to the time period to be used and the robustness of the stress testing scenarios. 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 2016 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) 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 2016 was fair, balanced and understandable, which can be found in the Independent Auditor's Report to the Members of Dechra Pharmaceuticals PLC.

  This assessment was carried out by the Committee on 30 August 2016, following which the Committee reported to the Board that it was satisfied that, taken as a whole, the Annual Report 2016 is fair, balanced and understandable.

• Review of Policies and Procedures

  During the year the Committee reviewed the following policies:

  • Accounting Policies

    The Committee reviewed the Intangible R&D Asset Capitalisation policy and the annual review of the tax policy.

  • Anti-Bribery and Anti-Corruption

    The Committee reviewed the revised third party due diligence procedures and code of conduct. The Company Secretary and the Head of Internal Audit and Risk Assurance ensure that the Committee is updated on a regular basis in respect of the training and monitoring of the policies across the Group. An online training solution (Delta) has been developed to assist with the ongoing training requirements of the Group.

  • Dividend

    The dividend policy was reviewed by the Committee and was recommended to the Board for approval.

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 changes made to the Group's risk management and internal control processes in order to meet the requirements of the Corporate Governance Code. These changes include the:

• identification of material internal controls and key monitoring processes;
• assessment of the effectiveness of these internal control processes by the SET;
• introduction of a rolling programme of risk and control reviews by the Board; and
• implementation of stress testing of the Group's cash flow forecasts to assess the impact of a number of downside risk scenarios in order to support the viability statement.

Following an independent review, the Group has completed the implementation of the recommendations made by Deloitte LLP (Deloitte) to strengthen the risk management and internal control processes. The Committee reviewed the assessment of the Group's internal financial controls at its meeting on 30 August 2016. It concluded that there was reasonable assurance that the controls operated effectively.

Further details in respect of the Group's risk management and internal control processes are provided in How the Business Manages Risk and the Board's statements on the effectiveness of these processes are provided in the Corporate Governance Report.

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 new geographies.

Internal Audit have developed a three year plan which seeks to provide balanced assurance coverage of the Group's material financial, operational and compliance control processes. The plan was approved by the Committee in December 2015. It sets out a rolling programme of core assurance activities together with a significant focus on the implementation of the Oracle ERP system.

Internal Audit recommendations are communicated to relevant business leaders and appropriate control improvements are agreed with them. Audit reports are provided to the Audit Committee together with regular progress reports on management's implementation of control improvements.

External Auditor

Following a competitive tender in 2015, PwC were appointed as the Company's external auditor for the 2016 audit, replacing KPMG who had been the Company's external auditor since its formation in 1997.

During the year the FRC'S Audit Quality Review team reviewed KMPG's audit of the Company's Financial Statements for the year ended 30 June 2015. The Committee discussed the results of this review.

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 3.8% (2015: 3.1% in relation to services rendered by KPMG).

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 30 August 2016.

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 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.

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.

Non-Audit Assignments

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 assurance in relation to the Oracle control framework. 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:

1. Deloitte undertake global tax compliance work;
2. KPMG support internal audit; and
3. during the course of the year Deloitte, Ernst & Young LLP, KPMG, Smith & Williamson LLP and Grant Thornton UK LLP have provided advice on global mobility matters, related tax advice, company reorganisation, acquisition valuation support 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 3.8% (2015: 3.1% in relation to services rendered by KPMG) of the annual audit fee and half-yearly review fee, and reflects the policy set out above.