Introduction

Our Committee has continued to focus on the integrity of Bodycote's financial reporting, risk management and internal controls and on the quality of the external and internal audit processes. We will continue to keep our activities under review as the regulatory environment changes. This year I have given more emphasis to the work actually done by the Committee in addition to the other matters we report upon.

Membership

The members of the Audit Committee are J. A. Biles, Dr K. Rajagopal and E. Lindqvist, all of whom are independent Non-Executive Directors. Their biographical details are shown in the Board of Directors and their remuneration in the Board report on remuneration. The Company Secretary is the Secretary to the Audit Committee.

Mr Biles has been Chairman of the Audit Committee since 16 August 2007 when he was appointed a Director of the Company. The Board considers that Mr Biles has recent and relevant financial experience. He qualified as a Chartered Accountant with Price Waterhouse & Co, served as a plc Finance Director (FKI PLC 1998-2004 and Chubb Security PLC 1991-1997) and has chaired the Audit Committees of several other plcs.

Objective

The Committee's objective is to provide effective governance over the Group's financial reporting, including the adequacy of related disclosures, the management and oversight of the Group's systems of internal control, financial risks and the performance of internal audit and the external auditors.

Role and responsibilities

The Audit Committee is a sub-committee of the Board whose main role is to encourage and safeguard the highest standards of integrity, financial reporting, financial risk management and internal controls.

The responsibilities of the Audit Committee are set out in its Terms of Reference, which include all matters required by the Disclosure and Transparency Rules and the Code, and are available on the Company's website. These responsibilities include:

• reviewing the form and content of the interim and year end accounts and results announcements;
• reporting to the Board on the appropriateness of the Group's accounting policies and practices and significant areas of judgement;
• advising the Board on whether the Committee believes that 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 strategy, business model and performance;
• reviewing risk management and internal controls;
• overseeing the relationship with the external auditors; and
• assessing the performance and reviewing the scope, results and effectiveness of internal audit.

Committee meetings

The Audit Committee met four times during 2013 and in February 2014 and all members attended all meetings. The Committee Chairman also invited the Chairman, Chief Executive, Group Finance Director, Group Financial Controller and Group Head of Risk to attend all meetings. Other Executives from the Group were also invited, as appropriate, to attend certain meetings to provide a deeper level of insight into key issues. The Committee Chairman also invited the external auditors, Deloitte LLP, to every meeting.

Mr Biles also had preparatory meetings separately with Deloitte and the Group Head of Risk prior to most Committee meetings to review their reports and discuss issues in detail.

Main activities of the Committee during the year

As part of the process of working with the Board to carry out its responsibilities and to maximise effectiveness, meetings of the Committee generally take place just prior to Board Meetings.

At its meetings, the Committee focused on the following main areas:

Financial reporting

The primary role of the Committee in relation to financial reporting has been to review with management and the external auditors the appropriateness of the interim and annual financial statements concentrating on, amongst other matters:

• the quality and acceptability of accounting policies and practices;
• the application and impact of significant judgements or matters where there was significant discussion with the external auditors;
• the clarity of disclosures and compliance with Financial Reporting Standards;
• 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 Group's strategy, business model and performance; and
• correspondence with the Financial Reporting Council.

Reports from management were considered on significant matters, including in respect of litigation, treasury and tax matters and also reports from the external auditors on the outcome of their work. The committee challenged both management and Deloitte to ensure that the scope of the audit was appropriate and Deloitte had applied the necessary level of professional scepticism in their work.

Principal areas of judgement

The principal areas of judgement considered by us in relation to the 2013 accounts were as follows.

• Impairment of goodwill, intangible and tangible fixed assets. The Committee challenged the assumptions, particularly the discount rate and growth factors, used in the discounted cash flow calculations for each cash generating unit, the sensitivity analysis applied and the projected future cash flows used to support the carrying values of the goodwill and intangibles and tangible assets.
• Restructuring, reorganisation and environmental provisions. The Committee received reports and challenged the basis and completeness of the assumptions used to calculate the provisions. In particular the Committee considered the increase in the reorganisation provision, relating to the transfer of accounting to the Shared Service Centre in Prague. The Committee discussed with management the key judgements behind all provisions and agreed with their recommendations.
• Taxation. A number of judgements are involved in calculating tax provisions and the level of deferred tax assets to be recognised. The Committee reviewed the associated risks and challenged management's assessment concerning the Group's key tax risks and management's forecast of the future profitability of the relevant businesses.
• Going Concern. The Committee challenged the validity of the Going Concern assumption used in preparation of the Annual Report and Accounts, in particular considering the Group's forecast liquidity position, available borrowing facilities, covenant compliance and sensitivity analysis.
• Pension Liabilities. Management took external professional advice in determining pension liabilities. The Committee challenged the assumptions used, particularly in respect of inflation, the discount rate and life expectancy.

Risk management

The Group's risk assessment process and the way that significant financial risks are managed and mitigated is a key area of focus for the Committee at each meeting. The committee work on risk was guided by the Group's assessment of its principal risks and uncertainties. At each meeting the Committee reviewed a report from the Group Head of Risk who has primary responsibility for developing the Group's risk management framework. The Committee reviewed changes to significant risks and mitigating actions identified by management. The Committee also received quarterly reports on calls to the Open Door Line (whereby employees may report matters of concern) and assessed both how such calls are dealt with and whether there was any indication of material risk. The Committee also reviewed and challenged the effectiveness of management's business continuity and disaster recovery arrangements.

Internal control

At each meeting the committee reviewed the process by which the Group evaluated its internal control environment. In particular we considered and challenged reports from the internal auditors on effectiveness of internal controls and requested certain changes to those controls. During the year there has been a focus on controls to minimise the risk of fraud.

Internal audit

The Group Head of Risk presented a report to the Committee at each meeting on the status of internal audit plans for the current year, points arising from audits completed and follow up action plans to address areas of weakness. We also received reports on actual or suspected frauds and thefts by third parties and employees. None had any material financial impact on the Group and where necessary, systems and procedures were altered to minimise the risk of recurrence. In December 2013 the plan for 2014 was presented to the Committee and accepted following discussion and challenge as to scope and areas of focus.

External audit

At the April and December meetings the external auditors presented their audit plans for the interim review and year end audit respectively. The Committee considered and challenged both the scope and materiality to be applied to the Group audit and its components. In particular the Committee considered carefully the scope in respect of smaller and more remote locations. As a consequence it decided that those few local audits that were not previously undertaken by Deloitte LLP would be for the 2013 audit.

Cyber risk

The members of the Committee completed the cyber risk questionnaire produced by the Department for Business Innovation and Skills and the Committee was further briefed on this important area by specialists from Deloitte LLP.

Training

Updates were presented to the Committee on any new accounting developments and any changes in corporate governance requirements that may affect the Group. Committee members also attended training briefings by accounting firms and other advisors.

Overview

The Committee reviewed the Annual Report and Accounts. Taken as a whole, in the light of their knowledge of the Group and its performance, the outcome of the activities described above and based on robust discussion with both management and the external auditors, the Committee has concluded that they are fair, balanced and understandable and provide the information necessary for shareholders to assess the Group's strategy, business model and performance, and reported to the Board accordingly.

External Audit

Appointment

The Committee considers the re-appointment of the external auditors each year and as part of this process considers the independence of the auditors and the effectiveness of the external audit process. Having reviewed the performance of Deloitte in 2013, the Committee has decided to recommend to the Board that Deloitte be reappointed for the 2014 audit and a resolution to this effect will be put to the 2014 AGM. The Committee reviewed and agreed the fee for 2013.

The external auditors are required to change the lead partner every five years and other partners periodically in order to protect independence and objectivity and provide fresh challenge to the Group. The current lead partner, Mrs N. Mitchell, has been in place for four years.

Deloitte has been the Company's auditor for 12 years and the Committee has decided, in accordance with the 2012 UK Corporate Governance Code, that the audit will be put out to tender in 2014 to coincide with the end of Mrs Mitchell's five year tenure.

Independence

The independence of the external auditors has been confirmed by Deloitte every half year and was last confirmed in February 2014. The Committee considered Deloitte's presentation and confirmed that it considered the auditors to be independent.

Effectiveness of the external audit process

We have adopted a formal framework for the review of the effectiveness of the external audit process and audit quality which includes the following aspects:

• assessment of the engagement partner, other partners and the audit team;
• audit approach and scope, including identification of risk areas;
• execution of the audit;
• interaction with management;
• communication with and support to the audit committee;
• insights, management letter points, added value and reports; and
• independence, objectivity and scepticism.

An assessment questionnaire has been completed by each member of the Committee, by the Group Finance Director and other senior finance Executives. The feedback from the process is considered by the Audit Committee and provided to external auditors and management. The full formal questionnaire is completed every three years with key areas being completed every year.

The committee assessed the effectiveness of management in the external audit process by considering timely identification and resolution of areas of accounting judgement, the quality and timeliness of papers analysing those judgements and other documents provided for review by the external auditors and the Committee.

We have considered the FRC Audit Quality Review Team report on Deloitte dated May 2013. If our audit is selected for quality review we have asked to see any resulting reports.

After considering the above matters the Committee felt that the external audit had been effective.

Non-audit services

The external auditor may be invited to provide services where their position as auditors renders them best placed to undertake the work. However, no contracts in excess of £20,000 can be awarded to the external auditor without prior approval from the Chairman of the Committee or, in his absence, another member of the Committee. Non-audit fees paid to the auditor are shown in note 3 and amounted to 11% of the audit fee.

Internal audit

The internal audit programme is managed by the Group Head of Risk and provides independent assurance over the key financial processes and controls in operation across the Group. The Group has engaged Ernst & Young LLP to provide additional and specialist resources. An annual internal audit plan is reviewed and approved by the Committee before the start of each financial year. This plan takes account of the Group's strategic objectives and risks and provides the degree of coverage deemed appropriate by the Committee. Accounting centres are visited at least every two years and plants every five years.

Internal audit reports include control weaknesses identified, recommendations for improvements and actions agreed with management to improve control. The status of these actions is monitored closely by the Committee until they are completed. The Committee noted that the 2013 programme was successfully completed and management actions were completed by agreed implementation dates.

Since the beginning of 2013, additional assurance has been obtained through control self-assessment. Internal auditors have received self-certification from every plant and accounting centre that internal controls have been complied with and noting any non-compliance. A summary of results is presented to the Committee. The accuracy of returns is monitored by Internal Audit by verification visits to a random sample of sites.

The effectiveness of internal audit is reviewed and discussed annually with the Group Head of Risk and the Ernst & Young engagement partner. In 2013 internal audit was assessed as effective.

Financial Reporting Council

In September 2013 a letter was received from the Financial Reporting Council (FRC) asking for additional information and clarification in connection with our 2012 Annual Report and Accounts. Management provided clarification and answered all questions, which after review by and approval of the Audit Committee Chairman, were provided to the FRC.

In October the FRC acknowledged that their enquiries had been satisfactorily concluded. The appropriate additional information has been included in this Annual Report and Accounts, where material and relevant.

Committee evaluation

The Committee's activities formed part of the review of Board effectiveness which was undertaken internally this year. Based on this and as a result of the work done during the year, the Committee has concluded that it has acted in accordance with its terms of reference and carried out its responsibilities effectively.

On behalf of the Audit Committee: