During the year, the audit committee conducted a competitive tender process for the role of statutory auditor and made a recommendation to the board in January 2020 that the incumbent auditor KPMG should be appointed for a further term.

Brian May

Chair of the audit committee

 


Quick facts

  • Brian May has chaired the committee since July 2013. He is a chartered accountant and is considered by the board to have recent and relevant financial experience, having served as finance director of a FTSE 100 company, from which he retired in February 2020.
  • All members of the committee are independent non-executive directors and the board is satisfied that the committee as a whole has competence relevant to the sector. Attendance at audit committee meetings is set out Attendance at board and committee meetings, and the relevant directors' biographies can be found Board of directors.
  • Other regular attendees at meetings at the invitation of the committee include the CEO, the CFO, the company secretary, the head of audit and risk, the group controller, and representatives from the statutory auditor, KPMG LLP (KPMG). None of these attendees are members of the committee.
  • The representatives from KPMG and the head of audit and risk each have time with the committee and the company secretary to raise freely any concerns they may have without management being present.
  • The committee is authorised to seek outside legal or other independent professional advice as it sees fit, but has not done so during the year.

Quick links

Audit committee members

Brian May (chair)

Stephen Carter

Paulette Rowe

Dear Shareholder

In my report this year I have sought to provide shareholders with an understanding of the work we have done as the audit committee to provide assurance on the integrity of the annual report and financial statements for the year ended 31 March 2020, coupled with insight into the outcome of the audit tender conducted during the year. Much of the work of the committee is necessarily targeted at the regulated activities of UUW, which represent over 98 per cent of group revenues and is a reflection of our commitment to safeguarding the interests of our stakeholders, particularly our shareholders and customers.

All directors have a duty to act in a way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and have regard to other stakeholders as set out in s172 of the Companies Act 2006. The directors' responsibility statement in respect of the 2019/20 annual report and financial statements can be found in the Statement of directors' responsibilities.

The particular role of the audit committee is to ensure that the interests of shareholders are properly protected in relation to the company's financial reporting and internal control arrangements, and to provide challenge to the decisions and approach made by the management team relating to the content and disclosures within the company's financial reports. As articulated in the Code, "the board should present a fair, balanced and understandable assessment of the company's position and prospects". The board asks the audit committee to advise on whether in fact "the annual report and accounts, taken as a whole, is fair balanced and understandable and provides the information necessary for shareholders to assess the company's position and performance, business model and strategy". The audit committee's role is to ensure that management's disclosures reflect the supporting detail or challenge them to explain and justify their interpretation and, if necessary, re-present the information. The committee reports its findings and makes recommendations to the board accordingly. The committee is supported in this role by using the expertise of the statutory auditor, who in the course of the audit, considers whether accounts have been prepared in accordance with IFRS and whether adequate accounting records have been kept. Furthermore, the company's own internal audit team also contributes to the assurance process by reviewing compliance with internal processes. The statutory auditor presents its findings to the shareholders as the owners of the business, and its report can be found in the Independent auditor's report.

 

During the year, the audit committee conducted a competitive tender process for the role of statutory auditor. KPMG were first appointed by shareholders on 22 July 2011; the 2019/20 audit has been their ninth consecutive year in office as auditor to the group. Last year's audit committee report indicated that we expected to conduct the tender process during 2020, with a view to the successful bidder providing statutory audit services for the year ending 31 March 2022. In light of the FRC's Revised Ethical Standard (2019) relating to auditor independence rules, applicable from March 2020, whereby a new statutory auditor cannot have provided internal audit services to public interest entities for 12 months prior to the start of the first period for which they are statutory auditor, the committee accelerated the timing of the tender process in order not to preclude any bidder on this basis. Three bids were received and 'challenger' firms were invited to participate. The committee concluded the tender process and made a recommendation to the board in January 2020, that the incumbent auditor KPMG should be appointed for a further term. There are no contractual obligations that restrict the committee's choice of auditor; the recommendation is free from third-party influence and no auditor liability agreement has been entered into. Further detail on the tender process can be found in the Statutory audit tender Process. The primary factor for the committee in making this recommendation was that KPMG offered a more compelling case for the provision of a high-quality audit.

As reported last year, KPMG implemented an audit quality transformation plan, following criticism by the FRC in their 2017/18 audit quality inspection report on the firm and other enhancements to improve audit quality as identified in their 2019 audit plan for the company (see How we assessed the effectiveness ). Furthermore, in KPMG's audit plan for the year ended 31 March 2020, they set out their proposals to address areas identified by the FRC for improvement in its 2018/19 audit quality inspection report.

Auditor independence is a key principle, and was an important factor considered during the tender process. As a general point, the auditor must be independent of the company and it is the committee's responsibility to ensure that the three-way relationship between the committee, the auditor and the company's management is appropriate and there is no undue influence by any of the parties on the other thereby ensuring the integrity of the audit process and the annual report and financial statements. Independence is a key focus for the auditor, whose staff must comply with their firm's own ethics and independence criteria which must be consistent with the FRC's Revised Ethical Standard (2019). Information on how the committee assesses the independence of the auditor can be found on How we assessed the independence of our statutory auditor.

The committee revised the group's policy on non-audit services to reflect the FRC's Revised Ethical Standard (2019) whereby the only non-audit services that a statutory auditor is permitted to provide to a public interest entity are those required by law or regulation, loan covenant reporting, other assurance services closely linked to the audit and/or reporting accountant services.

We continue to be committed to providing meaningful disclosure of the committee's activities. As chair of the audit committee, I am intent on ensuring that the committee's agenda is kept under review and keeps abreast of relevant developments, particularly in the area of audit reform following the recent reviews by Sir John Kingman, The Competition and Markets Authority, and Sir Donald Brydon, and we await further guidance from the FRC and BEIS in relation to the implementation of changes proposed in these reviews. The details of the annual evaluation process of the committee's performance can be found in Evaluation of the board and board committees.

I would like to extend my thanks to committee colleagues for their work and support during the year, particularly in relation to the audit tender process and extra focus at the year end to consider the matters in the financial statements impacted by COVID-19. As non-executive directors, my colleagues and I have no hesitation in seeking a full explanation from management or the auditor on any matter we feel necessary.

This report was approved by the committee at its meeting held on 19 May 2020.

Main responsibilities of the committee

  • Make a recommendation to the board for the appointment or reappointment of the auditor, and to be responsible for the tender of the audit from time to time and to agree the fees paid to the auditor.
  • Establish policies for the provision of any non-audit services by the auditor.
  • Review the scope and the results of the annual audit and report to the board on the effectiveness of the audit process and how the independence and objectivity of the auditor has been safeguarded.
  • Review the half-year and annual financial statements and any announcements relating to financial performance, including reporting to the board on the significant issues considered by the committee in relation to the financial statements and how these were addressed.
  • Review the scope, remit and effectiveness of the internal audit function and the group's internal control and risk management systems.
  • Review the group's procedures for reporting fraud and other inappropriate behaviour and to receive reports relating thereto.
  • Report to the board on how it has discharged its responsibilities.
  • Apply the principles of the Code and report against the provisions.

Brian May

Chairman of the audit committee

What has been on the committee's agenda during the year

The committee has an extensive agenda of items of business focusing on the audit, assurance and risk processes within the business which it deals with in conjunction with senior management, the auditor, the internal audit function and the financial reporting team. In doing so it ensures that high standards of financial governance, in line with the regulatory framework as well as market practice for audit committees going forward, are maintained. There were five scheduled meetings of the committee during the year, one of which was held specifically to consider the outcome of the audit tender process. Subsequent to the year end, the committee met on two further occasions to address matters in the financial statements impacted by COVID-19. Items of business considered by the committee during the year are set out in the table below.

ActionsOutcomesCross reference
Reviewed and discussed the reports from the financial reporting team on the financial statements, considered management's significant accounting judgements, and the policies being applied both at the full and half year and how the statutory audit contributed to the integrity of the year end financial reporting.Recommendations were made to the board, supporting the approval of the half and full-year accounts and financial statements.See Significant issues
Reviewed the regulatory reporting process relating to the annual performance report for UUW as required to be submitted to Ofwat and noted the differences between the regulatory and statutory accounts.Contribution to the assurance of the regulatory reporting to the UUW board.
Reviewed the company's approach to the adoption of International Financial Reporting Standards (IFRS) IFRS 16 Leases, first impacting the 31 March 2020 financial statements.Adoption of approach to new reporting standard IFRS 16.See Accounting policies
Reviewed the proposed audit strategy for the 2019/20 statutory audit, including the level of materiality applied by KPMG, audit reports from KPMG on the financial statements and the areas of particular focus for the 2019/20 audit, and tasked management to resolve any issues relating to internal controls and risk management systems.Monitoring progress made by statutory audit team against the agreed plan, and consideration of issues as they arise.See Independent auditor's report
Reviewed the basis of preparation of the financial statements as a going concern as set out in the accounting policies.Recommendation made to the board to support the going concern statement.See Accounting policies
Reviewed the long-term viability statement proposed by management.Recommendation made to the board to support the long-term viability statement.See Long-term viability statement
Reviewed the impact of COVID-19 on the financial statements.Approved accounting treatments and the impact of COVID-19 on the financial statements and in particular expected credit losses and carrying values in joint ventures.See Impact of COVID-19
Reviewed the results of the committee's assessment of the effectiveness of the 2018/19 audit.The committee concluded that the audit was effective and a recommendation was made to the board on the reappointment of KPMG as the auditor for the year ending 31 March 2021 at the forthcoming annual general meeting.See Statutory audit process
Reviewed whether the company's position and prospects as presented in the 31 March 2020 annual report and financial statements were considered to be a fair, balanced and understandable assessment of the company's position and prospects.Recommendation made to the board that the 31 March 2020 annual report and financial statements was a fair, balanced and understandable assessment of the company's position and prospects.See Audit committee
Reviewed the non-audit services and related fees provided by the auditor for 2019/20 and the policy on non-audit services provided by the auditor for 2020/21.Approved the non-audit services and related fees provided by KPMG for 2019/20 and approved an updated policy for non-audit services provided by the auditor.See How we assessed the independence of our statutory auditor
Negotiated and agreed the statutory audit fee for the year ended 31 March 2020.Statutory audit fee paid as agreed by the committee.See Statutory audit tender process
Conducted a competitive tender process for the role of statutory auditor.Recommendation made to the board to retain KPMG as statutory auditor for the year ending 31 March 2022.See Statutory audit tender process
Reviewed the effectiveness of the risk management and internal control systems.Recommendation made to the board that the risk management and internal control systems were effective.See Risk managment system
Review of the committee's terms of reference.Terms of reference were considered to be 2018 Code compliant.See Audit committee
Monitored fraud reporting.Reviewed the company's anti-fraud policies and processes and alleged incidents of fraud and the outcome of their investigation.See Anti-fraud and anti-bribery
Biannual oversight and monitoring of the group's compliance with the Bribery Act.Reviewed compliance with the company's ongoing anti-bribery programme.See Anti-fraud and anti-bribery
Approved the strategic internal audit planning approach and reviewed reports on the work of the internal audit function from the head of audit and risk.Monitored the implementation of the 2019/20 internal audit plan. Reviewed findings of specific internal audit and implementation of any resulting actions by management.See Assessing the effectiveness of the internal audit function
Considered the issues and findings brought to the committee's attention by the internal audit team.The committee was satisfied that management had resolved or was in the process of resolving any outstanding issues or concerns in relation to matters scrutinised by the internal audit team.See Internal audit function
Reviewed the quality and effectiveness of internal audit and the effectiveness of the current co-source arrangements.Concluded that the internal audit team, supported by the PwC co-source resource was effective.See Assessing the effectiveness of the internal audit function
Reviewed the internal audit plan for 2020/21.Approved the internal audit plan for 2020/21.See Internal audit function
Reviewed the conclusions of the committee's annual evaluation. The internally facilitated evaluation was undertaken as part of the overall board evaluation. The review explored: time management; the composition of the committee and the management of the meetings; the committee's processes and support; the agenda and work of the committee; and the priorities for change. All elements of the workings of the committee reviewed scored well.The board reviewed the results of evaluation of the committee and concluded that the committee continued to be effective.See Evaluation of the board and board committees

How we assessed whether "the annual report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the company's position and performance, business model and strategy"

The following section sets out the company's compliance with part of Code provision 27.

The directors' responsibility for preparing the annual report and financial statements is set out in the Statement of directors' responsibilities.

The board delegates to the committee the review of the annual report and financial statements with the intention of providing advice to the board on whether, as required by the Code, "the annual report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the company's position and performance, business model and strategy".

To make this assessment, the committee received copies of the annual report and financial statements to review during the drafting process to ensure that the key messages being followed in the annual report were aligned with the company's position, performance and strategy being pursued and that the narrative sections of the annual report were consistent with the financial statements. The significant issues considered by the committee in relation to the financial statements include those identified by the auditor in their report in the Independent auditor's report.

The committee received regular updates on the calculation of underlying operating profit measures as one of the principal alternative performance measures (APMs). A guide to APMs can be found on Our performance in 2019/20. APMs are used in accordance with the ESMA guidelines and management highlights any impact on APMs as a result of changes to accounting methods/transactions.

The key performance indicators included in the strategic report (see How we measure our performance) were, among others, those used by management and some of which reflect the regulatory measures to be monitored by either Ofwat, the DWI or the EA during the 2015–20 asset management period.

Additionally, the committee was satisfied that all the key events and issues which had been reported to the board in the executive team's monthly board reports during the year, both good and bad, had been adequately referenced or reflected within the annual report.

How we assessed the effectiveness of the statutory audit process

The committee, on behalf of the board, is responsible for the relationship with the auditor, and part of that role is to examine the effectiveness of the statutory audit process. Audit quality is regarded by the committee as the principal requirement of the annual audit process.

KPMG present the strategy and scope of the audit for the forthcoming financial year at the meeting of the committee held in September, highlighting any areas which would be given special consideration. KPMG report against this audit scope at subsequent committee meetings, providing an opportunity for the committee to monitor progress and raise any questions. Private meetings are also held at each committee meeting between the audit committee and representatives of the auditor without management being present in order to encourage open and transparent feedback by both parties. KPMG also meet with management at regular intervals during the annual audit process.

As reported in the 2019 audit committee report, KPMG had implemented an Audit Quality Transformation Plan (AQTP) addressing improvements identified by the FRC in its 2017/18 audit quality inspection report relating to the firm. KPMG's AQTP included: a more standardised audit approach; their intention to hold companies to account for the quality of the information provided to them in the audit process; their intention to provide more feedback to companies on the findings of their audit and provide additional senior level support to the KPMG audit teams during the audit. Furthermore, KPMG identified further audit quality improvements in the 2018/19 audit plan, presented in September 2018, including: delivering both a more standardised and structured audit programme; ensuring the KPMG audit team had an understanding of emerging issues; enhanced project management; greater use of technology as an 'enabler' to the audit process; more visibility of senior KPMG support to the audit team on site; greater challenge to management in general and increased scrutiny of pension scheme assets and liabilities.

On completion of the annual audit process, all members of the committee, as well as key members of the senior management team and those who regularly provide input into the audit committee or have regular contact with the auditor, completed a feedback questionnaire seeking their views on how well KPMG performed the audit. The questionnaire was issued in July 2019. Views were sought from respondents, and it was confirmed in the responses, that KPMG had delivered the audit quality improvements as identified in its 2018/19 audit plan.

Views of the respondents were sought in terms of:

  • The robustness of the external audit process and degree of challenge to matters of significant audit risk and areas of management subjectivity;
  • Whether the scope of the audit and the planning process were appropriate for the delivery of an effective and efficient audit;
  • The quality of the delivery of the audit and whether planned quality improvements had been delivered;
  • The expertise of the audit team conducting the audit;
  • That the degree of professional scepticism applied by the auditor was appropriate;
  • The appropriateness of the communication between the committee and the auditor in terms of technical issues;
  • The quality of the service provided by the auditor;
  • Their views on the quality of the interaction between the audit engagement partner, the audit senior manager and the company; and
  • Whether the statutory audit contributed to the integrity of the group's financial reporting.

The feedback was collated and presented to the committee's meeting in September 2019, at which the conclusions were discussed and any opportunities for improvement brought to the attention of the auditor. As part of a process of continual improvement the committee requested that management and KPMG collaborate to enhance performance in certain limited areas.

In summary, the committee noted KPMG's delivery of improvements to its policies and processes most importantly impacting audit quality, and in relation to the additional oversight provided by senior KPMG personnel during the 2018/19 audit, it was agreed that the statutory audit process and services provided by KPMG were satisfactory and effective.

How we assessed the independence of our statutory auditor

The following section sets out the company's compliance with part of Code provision 26.

There are two aspects to auditor independence that the committee monitors to ensure that the auditor remains independent of the company.

Firstly, in assessing the independence of the auditor from the company, the committee takes into account the information and assurances provided by the auditor confirming that all its partners and staff involved with the audit are independent of any links to United Utilities. KPMG confirmed that all its partners and staff complied with their ethics and independence policies and procedures which are fully consistent with the FRC's Ethical Standard including that none of its employees working on our audit hold any shares in United Utilities Group PLC. KPMG is also required to provide written disclosure, an independence confirmation letter, at the planning stage of the audit disclosing matters relating to KPMG's independence and objectivity, including any relationships that may reasonably be thought to have an impact on its independence and the integrity and objectivity of the audit engagement partner and the audit staff. The audit engagement partner must change every five years and other senior audit staff rotate at regular intervals.

Secondly, the committee develops and recommends to the board the company's policy on non-audit services and associated fees that are paid to KPMG. In accordance with the FRC's Revised Ethical Standard (2019), an auditor is only permitted to provide certain non-audit services to public interest entities (i.e. United Utilities Group PLC) that are closely linked to the audit itself or that are required by law or regulation, as such services could impede their independence. Permitted non-audit services fees paid to the statutory auditor are subject to a fee cap of no more than 70 per cent of the average annual statutory audit fee for the three consecutive financial periods preceding the financial period in which the cap will apply.

The cap will first apply for the group in the year ending 31 March 2021 and, as such, our year ended 31 March 2020 will be the third year of the initial three-year rolling period over which the annual statutory audit fee will be measured for this purpose. The committee revised the non-audit services policy incorporating the 70 per cent fee cap as described above with effect from 1 April 2017. During the year, the company's policy was amended to reflect the FRC's Revised Ethical Standard (2019), so that permitted services (which remain subject to the 70 per cent cap, apart from the regulatory audit) can be approved by the CFO subject to a cap of £10,000 applied for individual items. Individual items in excess of £10,000 require the approval of the committee. Auditor provided permitted services include the non-audit fees paid to the statutory auditor for: the interim review; the regulatory audit; agreed upon procedures for regulatory reporting and the Euro Medium Term Note Programme and Law Debenture Trust compliance work.

Fees for non-audit services are shown in the bar chart below (2020: £77,000) and represent 16.4 per cent of the total audit fees (2019: £65,000; 2018: £80,000). Fees paid to KPMG include the cost of the UUW regulatory assurance work they undertake, which is separate to the regulatory audit. While this work could be performed by a different firm, the information is in fact more granular breakdowns of data that form part of the statutory audit, and by KPMG undertaking the work it reduces duplication and saves considerable cost.

Work undertaken by KPMG in auditing management's methodology and processes in the implementation of new international financial reporting standards and related disclosures and judgements is included in the statutory audit fee.

Taking into account our findings in relation to the effectiveness of the audit process and in relation to the independence of KPMG, the committee was satisfied that KPMG continue to be independent, and free from any conflicting interest with the group.

Statutory audit tender process

During the year, the committee led and supervised a formal tender process for external audit services. Prior to this, a formal tender was last undertaken in 2011 when KPMG were appointed, commencing their appointment as auditor and presented their first report to shareholders for the year ended 31 March 2012. As previously reported, the committee undertook an audit tender review in September 2015, which concluded that KPMG as incumbent, would remain in office and the committee would next undertake a competitive tender for external audit services for the year ended 31 March 2022, most probably during 2020. The company, as a public interest entity, is required to conduct a competitive tender process every 10 years, and rotate auditors after 20 years at most.

The FRC's Revised Ethical Standard (2019) introduced the requirement that an auditor must not have provided certain non-audit services in the financial year immediately preceding the first year on which they will perform a statutory audit. It was therefore decided to conduct the audit tender process prior to the end of the 2019/20 financial year so that any selected firm would be in a position to take on the statutory audit for 2021/22.

Summary of the statutory audit tender process

The committee's primary objective throughout the tender process, and in making its recommendation to the board, was to review the audit approach and ensure best practice in the delivery of the group's audit. Maximising value to the group and its stakeholders in terms of: audit quality; reliability of assurance; the identification of potential improvements to business and accounting processes and the reporting thereof.

A timeline of the process is set out opposite. In conducting the tender and making an appointment ahead of 1 April 2020 for the audit for the year ending 31 March 2022, sufficient time would be available for a firm to cease to provide non-audit services, as set out in the FRC's Revised Ethical Standard (2019) prior to commencing their tenure, including those services for which a 'cooling in' period may apply and to allow a new auditor to shadow the incumbent during the audit for the year ending 31 March 2021, if applicable.

A selection panel was established consisting of: the chairman of the audit committee; a member of the committee; the Chairman; the CFO and the group controller, thereby ensuring a wide range of views were taken into account and a considerable amount of financial expertise supported the committee in the decision-making process. The audit committee as a whole was kept fully appraised of the progress of the tender by the chairman of the committee. The group controller and his team were responsible for leading on the logistics of the tender process. Ahead of the request for proposal (RFP) being issued, two 'challenger' firms confirmed that they did not wish to participate in the tender and a third 'Big 4' firm was conflicted from participating. Industry sector expertise was an important factor in the selection of the firms invited to tender, given the regulatory complexities of the business. All three of the firms that participated demonstrated considerable experience of the utility sector and/or water sector and the industry experience of the key members of the audit teams demonstrated the same.

Each firms' proposal consisted of a written tender document and face-to-face presentations. Their responses were evaluated by the selection panel against the following criteria and weightings, as had been set out in the RFP:

  • Quality assurance and independence 35 per cent;
  • Audit team and credentials 25 per cent;
  • Service approach 25 per cent; and
  • Pricing 15 per cent.

 

Audit tender timeline

23 September 2019

Meeting of the audit committee to confirm the acceleration of the timescale of tender process and providing an update on firms who had expressed an interest in bidding.

October 2019

Individual meetings were held between the representatives of the interested firms and the chairman of the audit committee and the CFO.

1 November 2019

Issue of RFP to firms and provision of information via a data portal.

7 November 2019

Meetings held for bidding firms to meet United Utilities personnel including members of the financial control team and the regulatory reporting team.

13 November 2019

Meeting of the audit committee to discuss progress with the tender process.

28 January 2020

Board meeting which considered and approved the audit committee's recommendation to appoint its preferred candidate, KPMG, as auditor in respect of the year ending 31 March 2022.

28 January 2020

Meeting of the audit committee to consider and discuss the findings of the selection panel and to make a recommendation to the board on the preferred and second choice candidates.

9 January 2020

Presentations by bidding firms to the selection panel.

20 December 2019

RFP submissions and summary briefing papers circulated to the selection panel.

29 November 2019

Deadline for receipt of bids.

 

Outcome of statutory audit tender process

Following the selection panel process, the audit committee met on 28 January 2020 to review and discuss the bidders' proposals and how these proposals met the assessment criteria, following which the committee made its recommendation that KPMG (the incumbent) was its preferred candidate, with Deloitte being identified as the committee's second choice candidate. The recommendation was made to the board at its meeting held later in the day on 28 January 2020. The board accepted the committee's recommendation that KPMG would be reappointed as statutory auditor for the year ending 31 March 2022. There are no contractual obligations that restrict the committee's choice of auditor; the recommendation is free from third-party influence and no auditor liability agreement has been entered into.

KPMG were identified as the preferred candidate due to: the strength and experience of its team in relation to regulation; KPMG's quality transformation journey in recent years provided a bedrock for further quality enhancements going forward; the proposed audit engagement partner demonstrated a genuine enthusiasm for driving further audit quality; and its targeted approach to the use of data analytics. Furthermore, in reaching the assessment, the committee considered the ranking of the firms both including and excluding the pricing criteria. In both scenarios KPMG proved to be preferred candidate. Ian Griffiths will be appointed as KPMG's audit engagement partner for the year ending 31 March 2021, having shadowed Bill Meredith during the 2019/20 audit process.

 

Statutory auditor reappointment for the year ending 31 March 2021

The following section sets out the company's compliance with part of Code provision 26.

The 2019/20 year-end audit has been KPMG's ninth consecutive year in office as auditor. Bill Meredith, audit engagement partner, who has considerable audit experience of other FTSE 100 utility companies, is in his fourth year in the role. The audit engagement partner changes at least every five years. United Utilities has complied fully with the provisions of The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014 for the year ended 31 March 2020.

At its meeting on 19 May 2020, the committee recommended to the board that KPMG be proposed for reappointment, for the year ending 31 March 2021 at the forthcoming AGM in July 2020. There are no contractual obligations that restrict the committee's choice of auditor; the recommendation is free from third-party influence and no auditor liability agreement has been entered into.

Going concern and long-term viability

The committee challenged and scrutinised management's detailed assessment of the group's long-term viability and its ability to continue as a going concern. In doing this the committee took into account the risks facing the business, and its ability to withstand a number of severe but reasonable scenarios including the impact of a potential 'long peak' COVID-19 scenario (see Corporate governance report). Having considered management's assessment the committee approved the long-term viability statement set out in the Corporate governance report.

Significant issues considered by the committee in relation to the financial statements and how these were addressed

The following section sets out the company's compliance with part of Code provision 26.

In relation to the group's financial statements, the committee reviewed the following principal areas of judgement (as noted in the accounting policies where applicable):

Impact of COVID-19

The impact of the COVID-19 pandemic has resulted in higher levels of estimation uncertainty and considerably more judgements having been required than in most years. The impacts of the pandemic on the issues considered are outlined below, where applicable.

Capitalisation of fixed assets

Fixed assets (see Notes to the financial statements) represents a subjective area, particularly in relation to costs permitted for capitalisation and depreciation policy.

  • In considering the work performed by KPMG during the year in this area, the committee assessed the reasonableness of the group's capitalisation policy and the basis on which expenditure is determined to relate to the enhancement or maintenance of assets. These were both deemed to be appropriate; and
  • The committee also reviewed the recovery of the capital overhead rate which management has applied during the year and which the committee had approved in the year ended 31 March 2015 for the five year regulatory period ending 31 March 2020. The committee concluded that the rate still remained appropriate.

Write down of bioresources assets

During the year the group undertook a strategic review of its bioresources operations, considering a range of alternative processes to some of those that have been employed historically.

  • The committee considered the outcome of this review and the implications this had for the future use of certain assets, including those involving incineration. On the basis that lower cost and more environmentally friendly routes are considered more likely to be used, the committee concurred with the directors' judgment that the likelihood of future economic benefit being derived from the identified assets is now considered to be remote. Accordingly, the committee agreed that it was appropriate to accelerate the depreciation of these assets in the current year, bringing their net book value down to nil. Read more about our Operating profit

Revenue recognition and allowance for doubtful receivables

Due to the nature of the group's business, the extent to which revenue is recognised and doubtful customer debts are provided against is an area of considerable judgement and estimation. This is particularly the case in the current year, where the economic impacts of COVID-19 are highly uncertain but are expected to have an adverse effect on the ability of certain customer groups to pay their bills.

  • The committee reviewed the current underlying levels of doubtful debt and credit note provisioning (see Trade and other receivables for more detail). The committee challenged management over the appropriateness of the overall levels of provisioning following these reviews and were satisfied that the resulting net debtor balance was appropriate;
  • The committee also reviewed the COVID-19 overlay and considered the assumptions applied to the various segments of the customer base in arriving at an expected credit loss assessment. The committee was satisfied that while highly judgemental and uncertain, the assumptions used and the methodology applied were appropriate in light of the COVID-19 pandemic.

Retirement benefits

The group’s defined benefit retirement schemes are an area of considerable judgement, the performance and position of which is sensitive to the assumptions made. In addition, as a result of high levels of market volatility resulting from the COVID-19 pandemic, the valuation of certain defined benefit pension scheme assets required significant levels of judgment compared with more stable economic circumstances.

    • The committee sought from management an understanding as to the factors which led to the increase in the IAS19 net retirement benefit surplus during the period and noted that the scheme specific funding basis had not been impacted by this volatility. In line with previous years, Read more about our Retirement benefits in order to communicate most effectively what is a complex area for the benefit of the group’s stakeholders. The committee was satisfied with the explanations provided by management and approved their inclusion in the financial statements;
    • The committee reviewed the methodology and assumptions used in calculating the defined benefit scheme surplus (Read more about our Retirement benefits here). The group employs the services of an external actuary to perform these calculations and determine the appropriate assumptions to make. After considering the above, the committee concluded that the approach taken and assumptions made – including changes to the basis on which mortality assumptions are set – were appropriate and fairly balanced in determining the net retirement benefit surplus; and
    • The committee also reviewed the assumptions underlying management’s valuation of ‘level 3’ defined benefit pension scheme assets, which requires considerable judgement. These assumptions include the market proxies used as a reference in deriving a view of the assets’ fair values and adjustments required to take account of movements in these resulting from the COVID-19 pandemic. Having considered these together with the audit work KPMG performed in relation to the asset valuations, the committee concluded that the approach taken was appropriate and in accordance with the requirements of IFRS 13 ‘Fair Value Measurement’.

Carrying value of loans to and investments in the Water Plus joint venture

The group has interests relating to its Water Plus joint venture in the form of an investment in the company's ordinary share capital (see Investment in joint ventures) and loans receivable (see Notes to the financial statements – appendices), the recoverability of which are considered with reference to the estimated future cash flows of the joint venture. The COVID-19 pandemic has particularly impacted businesses, forcing many to close temporarily, which has in turn impacted Water Plus as a non-household retailer. This has resulted in significant losses being recognised by Water Plus, which have caused the company to fall into a net liabilities position at 31 March 2020. Consequently, the group's equity investment in Water Plus, together with zero coupon loan notes extended to the joint venture, have been reduced to nil.

      • The committee has reviewed management's assessment of the nature of the group's financial interests in Water Plus. Having sought to understand management's assessment, the committee concurred with the view that zero coupon loan notes extended to Water Plus represent part of the group's long-term interest against which losses in excess of the group's equity interest should be allocated.
      • The committee also reviewed and challenged the assumptions and judgements underpinning management's expected credit loss assessment in respect of loans extended to Water Plus, and concurred with the approach taken and judgements made. Following robust discussion on this issue, the committee confirmed that it was satisfied that the carrying values of these interests at the reporting date are appropriate.

Derivative financial instruments

The group has a significant value of swap instruments, the valuation of which is based upon models which require certain judgements and assumptions to be made (see ). Management perform periodic checks to ensure that the model-derived valuations agree back to third-party valuations and KPMG check a sample against their own valuation models. It was confirmed to the committee that such testing had been undertaken during the year and there were no significant issues identified.

Taxation

The committee considered the tax risks that the group faces and the key judgements made by management underpinning the provisions for potential tax liabilities and deferred tax assets. In addition, the committee took account of KPMG's assessment of these provisions. Based upon the above, the committee was satisfied with the judgements made by management.

Underlying profit adjustment

During the year the committee considered and challenged management's treatment of items as adjustments to underlying profit measures and satisfied itself that those items being reported as adjustments met the requirements of the group's policy (see Financial performance). In doing this the committee specifically scrutinised and satisfied itself over the appropriateness of management's decision to include the write down of certain bioresources assets and costs associated with the COVID-19 pandemic during the year as an adjusting item when calculating underlying profit measures. In addition the committee satisfied itself of the appropriateness of a now adjustment in relation to deferred tax when calculating underlying profit measures (see Financial performance).

In reading the above significant issues considered by the committee, shareholders might also wish to examine the auditor's report and their assessment of risks of material misstatement in the Independent auditor's report.

 

The main features of the group's internal controls and risk management systems are summarised below:

Internal audit function

The internal audit function is a key element of the group's corporate governance framework. Its role is to provide independent and objective assurance, advice and insight on governance, risk management and internal control to the audit committee, the board and to senior management. It supports the organisation's vision and objectives by evaluating and assessing the effectiveness of risk management systems, business policies and processes, systems and key internal controls. In addition to reviewing the effectiveness of these areas and reporting on aspects of the group's compliance with them, internal audit makes recommendations to address any key issues and improve processes and, as such, provides an indication of the behaviours being exhibited by employees in the areas under review. Once any recommendations are agreed with management, the internal audit monitors their implementation and reports to the committee on progress made at every meeting.

A five-year strategic audit planning approach is applied. This facilitates an efficient deployment of internal audit resource in providing assurance coverage over time across the whole business, as well as greater variation in the nature, depth and breadth of audit activities. This strategic approach supports the annual audit plan, which is then endorsed by management, and which the committee also approves. The plan focuses the team's work on those areas of greatest risk to the business. Building on the strategic planning approach, the development of the plan considers risk assessments, issues raised by management, areas of business and regulatory change, prior audit findings and the cyclical review programme. The purpose, scope and authority of internal audit is defined within its charter which is approved annually by the audit committee.

Internal audit, led by the head of audit and risk, covers the group's principal activities and reports to the committee and functionally to the CFO. The head of audit and risk attends all scheduled meetings of the audit committee, and has the opportunity to raise any matters with the members of the committee at these meetings without the presence of management. He is also in regular contact with the chair of the committee outside of committee meetings.

The in-house team is expanded as and when required with additional resource and skills co-sourced from external providers – primarily PwC at present. The committee keeps the relationship with PwC under review to ensure the independence of the internal audit function is maintained and there is a documented process to manage possible conflicts of interest with the co-sourced resource. Ensuring that PwC remain independent in the course of its work is crucial to the integrity of its work.

The internal audit function also liaises with the statutory auditor, discussing relevant aspects of their respective activities which ultimately supports the assurance provided to the audit committee and board. During the year, the committee reviewed the current operating model, in particular the balance of in-house versus co-sourced resource, and concluded that, while minor improvements were identified, the current approach was satisfactory.

Assessing the effectiveness of the internal audit function

The effectiveness of the internal audit function's work is continually monitored using a variety of inputs including the ongoing audit reports received, the audit committee's interaction with the head of audit and risk, an annual review of the department's internal quality assurance report, a quarterly summary dashboard providing a snapshot of the progress against the internal audit plan tabled at each committee meeting as well as any other periodic quality reporting requested.

An annual stakeholder survey in the form of a feedback questionnaire is circulated to committee members, senior management and other managers who have regular contact with the internal audit function, including representatives from the auditor KPMG and the co-source audit provider PwC. The responses were anonymous to encourage open and honest feedback, and were consistently favourable, as were previous surveys.

Periodically, the quality and effectiveness of the internal audit function is also assessed externally, with the most recent review being undertaken in early 2019. Taking all these elements into account, the committee concluded that the internal audit function was an effective provider of assurance over the organisation's risks and controls and appropriate resources were available as required.

Risk management systems

The committee receives updates and reports from the head of audit and risk on key activities relating to the company's risk management systems and processes at every meeting. These are then reported to the board, as appropriate. The group designs its risk management activities in order to manage rather than eliminate the risk of failure to achieve its strategic objectives.

The CFO has executive responsibility for risk management and is supported in this role by the head of audit and risk and the corporate risk manager and his team. The group audit and risk board (GARB) is a sub-committee of the executive team. The GARB meets quarterly and reviews the governance processes and the effectiveness and performance of these processes along with the identification of emerging trends and themes within and across the business. The work of the GARB then feeds into the information and assurance processes of the audit committee and into the board's assessment of risk exposures and the strategies to manage these risks.

Supplementing the more detailed ongoing risk management activities within each business area, the biannual business unit risk assessment process (BURA) seeks to identify how well risk management is embedded across the different teams in the business. The BURA involves a high-level review of the effectiveness of the controls that each business unit has in place to mitigate risks relating to activities in their business area, while also identifying new and emerging risks and generally to facilitate improvements in the way risks are managed. The outcome of the BURA process is communicated to the executive team and the board. This then forms the basis of the determination of the most significant risks that the company faces which are then reviewed by the board. The group utilises risk management software to underpin the company's risk management process. The maturity of the risk management framework and its application across the business is assessed on an annual basis against a defined maturity model. This assessment provides an objective appraisal of the degree of maturity in how the risk management system is being applied and the quality of each risk in terms of quantification and management. The results of the maturity assessment are reported to the GARB, and actions agreed with business units.

An external assessment of the risk management process last took place in 2017/18.

Internal controls

The committee reviews the group's internal control systems and receives updates on the findings of internal audit's investigations at every meeting, prior to reporting any significant matters to the board. Internal control systems are part of our 'business as usual' activities and are documented in the company's internal control manual which covers financial, operational and compliance controls and processes. Internal control systems are the responsibility of the CFO, with the support of the GARB, the financial control team and the internal audit team, although the head of audit and risk and his team are directly accountable to the audit committee.

Confirmation that the controls and processes are being adhered to throughout the business is the responsibility of managers, but is continually tested by the work of the internal audit team as part of its annual plan of work which the committee approves each year as well as aspects being tested by other internal assurance providers. Compliance with the internal control system is monitored annually by the completion of a self-assessment checklist by senior managers in consultation with their teams. The results are then reviewed and audited on a sample basis by the internal audit team and reported to the committee.

Anti-fraud and anti-bribery

The audit committee is responsible for reviewing the group's procedures for detecting fraud, and the systems and controls for preventing other inappropriate behaviour. In the first instance of an incident being reported, a summary of the allegations is passed to the fraud and whistleblowing committee (consisting of the company secretary, customer services and people director, commercial director and head of internal audit and risk) to decide on the appropriate course of action and investigation and by whom.

During the year, the audit committee was kept fully appraised in regular updates on the progress and findings of investigations of cases of alleged fraud and any remedial actions taken. A number of employees have been selected and received specialist training in order to conduct investigations of cases of alleged fraud.

The company has an anti-bribery policy to prevent bribery being committed on its behalf, which all employees must follow, and processes in place to monitor compliance with the policy. As part of the anti-bribery programme, employees are also required to comply with the group's hospitality policy. The hospitality policy permits employees to accept proportionate and reasonable hospitality for legitimate business purposes only. Our employees and representatives of our suppliers must also comply with the group's sustainable supply chain charter which explains that we will not tolerate corruption, bribery and anti-competitive actions and we expect our suppliers to comply with applicable laws and regulations, and in particular never to offer or accept any undue payment or other consideration, directly or indirectly, for the purposes of inducing any person or entity to act contrary to their prescribed duties.

As part of the internal control self-assessment checklist (part of the group's internal control processes), senior managers in consultation with their teams are required to confirm, among other things, that they have complied with the group's anti-bribery and hospitality policies. The anti-bribery programme is monitored and reviewed biannually by the committee. Our sustainable supply chain policy also sets out that we do not tolerate corruption, bribery and unfair anti-competitive actions by our own behalf or that of our suppliers.