As Chairman of the Audit Committee, I am pleased to present the report of the Audit Committee for the 52 weeks ended 2 December 2018.
In this report, we aim to share some of the Committee's discussions from the year, providing insight regarding the role of the Committee, the Committee's essential function in ensuring the integrity of the Company's financial reporting, and in reviewing the effectiveness of the Group's assurance framework and internal controls.
This report details the significant accounting matters and issues in relation to the Group's financial statements that the Committee has assessed during the year and in this report we explain why the issues were considered significant, which provides context for understanding the Group's accounting policies and financial statements for the period.
In April, I will be stepping down as Chairman of the Audit Committee and I am pleased to hand responsibility to Julie Southern.
I will be available at the AGM to answer any questions about our work.
Audit Committee Chairman
5 February 2019
This report aims to share some of the Committee's discussions from the year, providing insight regarding the role of the Committee, the Committee's essential function in ensuring the integrity of the Company's financial reporting, and the effectiveness of the assurance framework and internal controls.
Audit Committee Chairman
Membership and Meetings
The membership and attendance of the Audit Committee, together with the appointment dates, are set out below:
Audit Committee member since 9 March 2010
Relevant sector experience: Retail
Audit Committee member since 1 March 2016
Relevant sector experience: Retail, Technology
Audit Committee member since 1 September 2018
Relevant sector experience: Retail
Actual meetings attended
Possible meetings the Director could have attended
At least two members of the Audit Committee (Ruth Anderson and Julie Southern) are considered by the Board to have competence in accounting and all members have recent and relevant financial experience. Ruth Anderson and Julie Southern are chartered accountants with the Institute of Chartered Accountants in England and Wales. In line with the UK Corporate Governance Code 2016, the Audit Committee as a whole has competence relevant to the sectors in which the Company operates, notably the retail and technology sectors. Details of each Audit Committee member's relevant sector experience can be found in the diagram above. The biography of each member of the Audit Committee is set out in the Directors' Report section.
As required under the Terms of Reference, the Audit Committee members are independent Non-Executive Directors and the Audit Committee has held three meetings during the year. During the year, composition of the Audit Committee changed as a result of the retirement from the Board and Audit Committee of Alex Mahon in December 2017 and the appointment of Julie Southern. Julie Southern became a member of the Audit Committee on her appointment to the Board on 1 September 2018. With effect from 1 April 2019, Julie Southern will succeed Ruth Anderson as Chairman of the Audit Committee.
The timing of meetings coincide with key intervals in the reporting and audit cycle for the Group. The Chairman of the Audit Committee reports at each Board meeting on the business conducted at the previous Audit Committee meeting, any recommendations made by the Audit Committee and the discharge of its responsibilities as set out in this report.
Regular attendees at the Audit Committee meetings include the Chief Financial Officer, the Group General Counsel and Company Secretary, the Finance and Risk Director, the Head of Internal Audit and the external auditor. Other attendees who attend as required include the Chief Executive Officer, the Chairman, a number of senior members of the finance department, other members of senior management and operational teams and other advisers to the Company. The Deputy Company Secretary is the secretary to the Audit Committee.
Key Areas of Focus for the Audit Committee
The responsibilities of the Audit Committee are set out in its Terms of Reference. The Audit Committee has an annual work plan, developed from its Terms of Reference, with standing items that the Audit Committee considers at each meeting, in addition to areas of risk identified for detailed review and any matters that arise during the year. The main matters that the Audit Committee considered during the year are described below.
Financial Statements and Reporting: The Audit Committee monitored the financial reporting processes for the Group, which included reviewing reports from, and discussing these with, the external auditor. As part of the year end reporting process the Audit Committee reviewed this Annual Report, a management report on accounting estimates and judgements, the external auditor's reports on internal controls, accounting and reporting matters, and management representation letters concerning accounting and reporting matters.
Monitoring the integrity of the financial statements of the Company, the financial reporting process and reviewing the significant accounting issues are key roles of the Audit Committee. The Board ensures this Annual Report, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company's position, performance, business model and strategy and the Audit Committee plays an important role in assisting the Board in reaching those conclusions. For information concerning the process followed by the Company in preparing this Annual Report see the Corporate Governance Statement. The Audit Committee also monitors the financial reporting processes for the Group's half year report, which is a similar role to the one it carries out for full year reporting.
Accounting judgements and key sources of estimation uncertainty: The Audit Committee reviewed and discussed reports from management on accounting policies, current accounting issues and the key judgements and estimates in relation to this Annual Report. It assessed whether suitable accounting policies had been adopted and the reasonableness of the judgements and estimates that had been made by management. This section outlines those significant issues which received particular focus from the Audit Committee in relation to the financial statements for the period and how these issues were addressed.
Accounting for revenue: The Audit Committee reviewed the impact of the new accounting standard, International Financial Reporting Standard (IFRS) 15 "Revenue from Contracts with Customers", on the accounting for revenue received from the Group’s customers, which includes contracts signed with new Ocado Solutions partners at the end of 2017 and during 2018, the existing Morrisons contracts and the customers of the retail business segment.
The Audit Committee considered and agreed with management’s proposal to adopt early the new accounting standard because several Ocado Solutions contracts were signed in the period, which would in any case result in additional reporting disclosures and restated comparable numbers. The Audit Committee reviewed the effect of the standard on the restatement of results included in this Annual Report and the related disclosure in the notes to the financial statements concerning the significant changes to the Group’s accounting policies in respect of revenue recognition.
The timing of revenue recognition requires management judgement. The Audit Committee considered reports from management on its detailed review of the Ocado Solutions contracts, the judgements made in particular with regards to contract life, the amount and timing of revenue recognition (both commencement date and time period for recognition) for the relevant performance obligations and the evidence used to support those judgements. The Audit Committee also received reports from the auditors with regards to their audit procedures, including their review of the Ocado Solutions contracts and accounting treatment applied by management. Adoption of the new standard has meant that revenue recognised is restated in respect of the 2017 financial year and resulted in a reduction in revenue recognised for that period of £9.3 million and has resulted in a reduction in net assets and retained earnings of £23.1 million. The overall impact also means that less revenue will be recognised in the period than otherwise would have been the case under the old accounting standard. See notes 1.4, 1.5, 2.1 and 2.4 to the consolidated financial statements.
|Area||Issue and Nature of Judgement or Estimate||Factors and Reasons Considered and Conclusion||Impact on Financial Information and Disclosure in Financial Statements|
|Accounting for Ocado Solutions contracts – balance sheet restatement under IFRS 15||The adoption of IFRS 15 has led to significant changes in the revenue recognition policies for Ocado Solutions contracts and significant restatement of prior period balance sheets and income statements.||The Audit Committee reviewed the management proposal for the restatement of the balance sheet included in this Annual Report and approved the proposed restatement of the Balance Sheet.||The Group restated the 2017 results for the adoption of IFRS 15. The Group's accounting policy for revenue has been rewritten to reflect the adoption of IFRS 15. This new policy is included in full in note 2.1 to the consolidated statements. The new policy also includes disclosure of significant judgements and estimates in relation to the application of these accounting policies.|
|Accounting for Ocado Solutions contracts – revenue recognition under IFRS 15||Management judgement is required for recognition of revenue due to the evolving nature of the business and new services that are being provided. The accounting for new Ocado Solutions contracts with a range of deliverables and fees is complex. They require management judgement, including with regards to the timing of recognition, estimated contract life, expected customer life and classification of income under the accounting standard.||The Audit Committee reviewed the appropriateness of management's proposed accounting treatment of existing and new revenue streams in light of IFRS 15.|
The Audit Committee approved the new accounting policies associated with the revenue recognition standard and taking into account the views of the external auditor.
|The accounting treatment is included in the Consolidated Income Statement.|
|IAS 37 - Provisions, Contingent Liabilities and Contingent Assets||The implementation of OSP for each Solutions customer is a complex project. A typical Solutions contract includes a number of key milestones during the project implementation phase. Failure to achieve these key events can be subject to contractual financial penalties. Management judgement is required to review the progress of ongoing projects and determine whether there is a risk that Ocado will not meet the agreed key milestones and thus incur a financial penalty.||The Audit Committee considered the management report concerning the progress of all current Solutions projects. It was concluded that there were no material risks to key milestones and hence there were no contingent liabilities to disclose.||There is no impact to the financial statements and no additional disclosures required.|
|IAS 38 - (Intangible Assets) – Capitalisation of Internal Development Time and Costs||The capitalisation of internal development costs is material and involves management judgements as to whether the costs incurred meet the criteria in accounting standards for capitalisation, including the technical feasibility of the project and the likelihood of the project delivering sufficient future economic benefits, and the risk of impairment when new technology supersedes previously capitalised projects.||Details of material technology projects which are being capitalised along with the rationale for capitalisation were reviewed by the Audit Committee. The criteria for identification of projects which may be treated as intangible assets, the process to capture costs of these technology projects and any potential impairments were discussed by the Audit Committee. The audit procedures carried out on the management controls by the auditors were considered.||The amount of £51.5 million of internal development costs has been capitalised and an impairment charge of £0.4 million has been recognised within intangible non-current assets, as set out in Note 3.1 to the consolidated financial statements.|
|Recognition of deferred tax asset||The estimates used to support the future business profitability and recognised deferred tax asset which requires management estimate.||The basis of management estimates of future taxable profits of the Group and the process used to calculate the deferred tax asset recognised were reviewed by the Audit Committee. The review included the recent changes in UK tax legislation on the treatment of losses and the impact of international expansion on the Ocado business model. The Audit Committee supported the reasonableness of the assumptions underlying the Group's future profit forecasts including the impact of the new Solutions contracts.||The amount of £16.6 million was recognised in the Consolidated Balance Sheet for the period. Details of the deferred tax asset are set out in Note 2.9 to the consolidated financial statements.|
The Audit Committee reviewed an update on the impact of the new international accounting standard relating to leases (IFRS 16) on the Group’s financial statements. The Group has not adopted this standard early. IFRS 16 is expected to have a material impact on the Group’s financial results and financial position for future periods (when adopted), including requiring the Group to bring large operating lease commitments onto the balance sheet and the impact on the Group’s EBITDAA , depreciation, debt and operating profit (as well as other measures). Given their significance, management updated the quantitative analysis of the estimated impacts of IFRS 16 for recent developments. The Audit Committee reviewed the disclosure contained in this Annual Report regarding the anticipated impact of the standards on the Group’s financial results and position (see note 1.2 to the consolidated financial statements). Our review of IFRS 16 indicates that the financial impact will result in an increase in finance leased assets of approximately £278 million, and a corresponding increase in financial liabilities of £297 million, on the consolidated balance sheet of the Group’s financial statements.
The table above is not a complete list of all the Group’s accounting issues, estimates and policies, but highlights the most significant ones for the period in the opinion of the Audit Committee. Accounting for the judgemental nature surrounding commercial income for the retail business, accounting for share based payments and exceptional itemsA are recurring issues for the Group, but did not require a significant change in the basis of the estimate or judgement during the period, unlike some previous periods. The accounting treatment of all significant issues and judgements was subject to review by the external auditor. For a discussion of the areas of particular audit focus by the external auditor, refer to the Independent Auditor’s Report. The Audit Committee considers that the Company has adopted appropriate accounting policies and made appropriate estimates and judgements.
Going Concern and Viability Assessments: The Audit Committee and the Board reviewed the Group's going concern and viability statements and the assessment reports prepared by management in support of such statements. The report on the viability statement included updated downside scenarios in light of the agreements signed by Ocado with Solutions partners during the period. The Audit Committee gave careful consideration to the period of assessment used for the viability statement. It took into account a wide range of factors and concluded the time period of three years remained appropriate. The external auditor discussed the statements with management and approved of the conclusions reached by management regarding concern and viability.
Tax Review: The Board reviewed and approved the Group’s tax strategy and related statement, which was published during the year.
Risk Review:The Board has ultimate responsibility for effective management of risk for the Group including determining its risk appetite, identifying key strategic and emerging risks, and reviewing the risk management framework. The Audit Committee, in supporting the Board to assess the effectiveness of risk management and internal control processes, relies on a number of different sources to carry out its work including an assessment report provided by Governance, Risk and Compliance, a regular finance controls self-assessment report by management, Internal Audit assurance reports and the assurance provided by the external auditor and other third parties in specific risk areas.
The Audit Committee has reviewed and the Board has agreed the continued effectiveness of the Group's system of internal control, including risk management. The Board confirms that no significant failings or weaknesses were identified during the year and up to the date of this Annual Report. Where areas for improvement have been identified, plans have been proposed to ensure that necessary action is taken and that progress is monitored.
The Board discussed and reviewed the Group's risk appetite when reviewing the principal risks and the strategy for the Group. Regular review of the risk appetite ensures that the Company's risk exposure remains appropriate and acceptable in enabling the Group to achieve its strategic objectives. The Audit Committee also reviews risk appetite and principal risks when considering the effectiveness of the risk management system. Every year the Audit Committee focuses on particular risk areas identified in the Group risk register. During the period, management reported on the Group's information security controls and assurance plans for the existing systems, the programme for complying with the new General Data Protection Regulation and the programme for the new Ocado Solutions platform security and privacy internal control systems. The Audit Committee will continue to receive reports on these areas in future years. Further details of the risk review and the Group's risk management and internal control systems, including financial controls, are set out in the "How We Manage Our Risks" section.
Internal Audit: Part of the assurance provided to the Audit Committee when reviewing the effectiveness of the Group's systems of internal control comes from Internal Audit. The Audit Committee reviewed the Internal Audit plan in January 2018 and considered it appropriate to the Group having regard to the principal risks of the business.
The Internal Audit plan, which is risk-based, sets out a number of activities for the period and the 2019 Financial Year, including key assurance programmes, most notably the work on the Ocado Solutions platform security and privacy internal control system. The programme also included operational audits for key operational risk areas such as physical site security, supplier payments and the Group's business continuity and disaster recovery plans. The Audit Committee reviews the planned Internal Audit activities, and its resourcing and prioritisation. Internal Audit reports to each Audit Committee meeting. Management actions are tracked and the status of these actions is reported alongside progress against the Internal Audit plan. These reports enable the Audit Committee to monitor progress, and to discuss key findings and the plans to address them.
The Audit Committee is satisfied that the Internal Audit plan provides appropriate assurance on the controls in place to manage the principal risks facing the Group.
Internal Audit Effectiveness Review: A review of the effectiveness of the Internal Audit function was carried out during the period by way of a questionnaire completed by members of management and business operations, the Audit Committee members and the external auditor, as well as a self-assessment by the Head of Internal Audit. The assessment questionnaire asked questions to assess performance in a range of areas including planning and work programme, communication, reporting and performance. Having considered the results of this review and informal feedback from management and the external auditor provided during the period, the Audit Committee concluded that the Internal Audit function was effective. During the period, the Audit Committee met with the Head of Internal Audit, without management present.
Annual Review: In addition to its annual performance evaluation, discussed in the Corporate Governance Statement, the Audit Committee carried out a review of its terms of reference. The review resulted in changes to the terms of reference to reflect the new 2018 Code. The Audit Committee's terms of reference can be found on www.ocadogroup.com.
Assessing the Effectiveness of the External Audit Process and the External Auditor
The Audit Committee places great importance on ensuring that there are high standards of quality and effectiveness in the external audit. Given Deloitte transitioned into the external auditor role during the prior period, the Audit Committee assessment covers the first full period of Deloitte as the Company's external auditor. The Audit Committee reviewed and approved the annual audit plan to ensure that it is consistent with the scope of the audit engagement. In reviewing the audit plan, the Audit Committee discussed the significant and elevated risk areas identified by Deloitte most likely to give rise to a material financial reporting error or those that are perceived to be of higher risk and requiring additional audit emphasis (including those set out in the Independent Auditor's Report). The Audit Committee also considered the audit scope and materiality threshold. The Audit Committee met with Deloitte at various stages during the period, including without management present, to discuss their remit and any issues arising from the work of the auditor.
At the end of the period, the Audit Committee reviewed the performance of Deloitte based on a questionnaire that contained various criteria for judging their effectiveness and on feedback from management. The criteria for assessing the effectiveness of the audit included the robustness of the audit, the quality of the audit delivery and the quality of the people and service. The questionnaire was completed by members of the Audit Committee, members of the finance department and senior members of management. The results of the questionnaire were reviewed by the Audit Committee. The Audit Committee also met with management, including without Deloitte present, to hear their views on the effectiveness of the external auditor.
The Audit Committee concluded that Deloitte had remained effective in their role.
Independence and Objectivity: The Audit Committee considered the safeguards in place to protect the external auditor's independence. Deloitte reported to the Audit Committee that it had considered its independence in relation to the audit and confirmed to the Audit Committee that it complies with UK regulatory and professional requirements and that its objectivity is not compromised. The Audit Committee took this into account when considering the external auditor's independence and concluded that Deloitte remained independent and objective in relation to the audit.
Non-Audit Work Carried Out by the External Auditor: To help protect auditor objectivity and independence, the provision of any non-audit services provided by the external auditor requires prior approval, as set out in the table below. These thresholds are unchanged.
|Approval Thresholds for Non-Audit Work||Approver|
|Over £10,000 and up to £30,000 per engagement||Chief Financial Officer|
|Over £30,000 and up to £100,000 per engagement||Chief Financial Officer and Audit Committee Chairman|
|Greater than £100,000 per engagement, or if the value of non-audit fees to audit fees reaches a ratio of 1:2 as a result of a new engagement, regardless of value||Audit Committee|
An additional protection is provided by way of a non-audit services fee cap. The Audit Committee (or the Company) may not approve an engagement of the external auditor if annual non-audit services fees would exceed 70% of the average audit fees (not including fees for audit-related services) charged in the previous three years. Certain types of non-audit service are of sufficiently low risk so as not to require the prior approval of the Audit Committee, such as "audit-related services" including the review of interim financial information. "Prohibited services" are those that have the potential to conflict directly with the auditor's role, such as the preparation of the Company's financial statements.
Non-audit Work Undertaken During the Period: The total of non-audit fees, audit fees and audit-related services fees paid to the external auditor during the period is set out in Note 2.6 to the consolidated financial statements. The non-audit service fees of £39,000 (2017: £311,000) paid to Deloitte during the period related to audit-related assurance services for an interim review. All non-audit work engagements were approved by the Chief Financial Officer and Audit Committee Chairman as the fees concerned were within the approval thresholds set under the policy.
The Audit Committee received a regular report from management regarding the extent of non-audit services performed by the external auditor. Deloitte provided a report to the Audit Committee on the specific safeguards put in place for each piece of non-audit work confirming that it was satisfied that neither the extent of the non-audit services provided nor the size of the fees (being 13% of the audit fees) charged had any impact on its independence as statutory auditor. It was concluded that appropriate safeguards were in place to prevent a compromise of auditor independence. The Audit Committee was satisfied this was the case and so concluded that the auditor's independence from the Group was not compromised.
Audit Fees: The Audit Committee was satisfied that the level of audit fees payable in respect of the audit services provided (excluding audit-related services) (being £456,000 (2017: £345,000)) was appropriate and that an effective audit could be conducted for such a fee. The existing authority for the Audit Committee to determine the current remuneration of the external auditor is derived from the shareholder approval granted at the Company's annual general meeting in 2018. At the annual general meeting in 2018, 99.92% of votes cast by shareholders were in favour of granting the Directors this authority.
Statement of Compliance with the Competition and Markets Authority (CMA) Order
The Company confirms that it has complied with The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Processes and Audit Committee Responsibilities) Order 2014 (Article 7.1), including with respect to the Audit Committee's responsibilities for agreeing the audit scope and fees and authorising non-audit services.
See Alternative Performance Measures