1. Defined benefit pension plan liabilities | |
Babcock International Group plc- Extract from Audit Report of Financial Statement 2016 | |
Area of focus | How our audit addressed the area of focus |
Refer to note 25 to the group financial statements. The Group operates a number of defined benefit pension plans, giving rise to net and gross pension liabilities of £203 million and £4,028 million respectively, which are significant in the context of the overall balance sheet of the Group. The valuation of pension liabilities requires judgement and technical expertise in choosing appropriate assumptions. Changes in a number of the key assumptions, including: – salary increases and inflation; All can have a material impact on the calculation of the liability. The Group uses external actuaries to assist in assessing these assumptions. |
We assessed, using our actuarial specialists, whether the assumptions used in calculating the pension plan liabilities, including salary increases, inflation, mortality rate and discount rate assumptions, were consistent with our internally developed benchmarks based on national and industry data. We were satisfied that the rates used fell within acceptable ranges. We also performed sample testing to agree underlying membership data to supporting human resources documentation and assessed the appropriateness of the closing liability based on known movements and assumptions. No issues were identified to raise concerns over the valuation of the pension liability. |
2. Goodwill impairment assessment | |
Babcock- Extract from Audit Report of Financial Statement 2016 | |
Risk Description | How the scope of our audit responded to the risk |
Refer to note 11 to the group financial statements. The goodwill balance of £2.5 billion, which principally relates to the acquisitions of the VT Group in 2010 and Avincis (now MCS) in 2015, is supported by an annual impairment review. No impairment charge has been recorded against these balances in the current financial year. The value in use assessment to support the continued carrying amount of goodwill involves the application of subjective judgement about future business performance. Certain assumptions made by management in the impairment review are considered by the engagement team to be key areas of judgement, notably the forecast cash flows, the overall growth rates and the discount rates applied. |
We evaluated management’s future cash flow forecasts and the process by which they were determined and approved, including checking that the forecasts were consistent with the latest Board approved budgets and confirming the mathematical accuracy of the underlying calculations. We also considered the accuracy of previous forecasts made by management. We obtained corroborating evidence regarding the carrying value of goodwill, and the related disclosures, through challenging:
We performed sensitivity analysis around these assumptions to ascertain the extent of change that individually, or in combination, would be required for the goodwill to be impaired. We have checked the related disclosures in note 11 including the sensitivities provided in relation to MCS. Based on our procedures, we agreed with the Directors that no impairment need be recognized at 31 March 2016. |
3. Contract accounting and revenue recognition | |
Babcock International Group PLC – Extract from Audit Report of Financial Statement 2016 | |
Area of focus | How our audit addressed the area of focus |
Refer to the critical accounting estimates and judgements section in note 1 to the group financial statements. The Group’s business involves entering into contractual relationships with customers to provide a range of services with a significant proportion of the Group’s revenues and profits derived from long term contracts. Due to the contracting nature of the business, revenue recognition involves a significant degree of judgement, with estimates being made to:
There is a range of acceptable outcomes resulting from these judgements that could lead to different profit and revenue being reported in the financial statements. |
We read the relevant clauses within all key contracts and discussed each with management to obtain a full understanding of the specific terms and risks, which informed our consideration of whether revenue for these contracts was appropriately recognized. We evaluated and tested the relevant IT systems and tested the operating effectiveness of internal controls over the accuracy and timing of revenue recognized in the financial statements, including controls relating to:
Our testing of the controls did not identify any matters that caused us to change our audit approach. For the more significant and judgmental contracts, in performing the following additional testing, we:
Our testing did not identify any factors that management had not taken into account in their estimates of the total contract costs, stage of completion and expected profit margin of each contract (including the expected losses on loss making contracts). |
4. Assessment of the carrying value of goodwill and other relevant assets | |
GKN PLC – Extract from Audit Report of Financial Statement 2016 | |
Risk Description | How the scope of our audit responded to the risk |
Refer to page 76 (Audit & Risk Committee report), note 1 (Accounting policies and presentation), note 11a and note 11c (Goodwill and other intangible assets) and note 12 (Property, plant and equipment). The Group holds goodwill of £0.6 billion, other intangible assets of £1.3 billion and tangible assets of £2.7 billion at 31 December 2016. The Group recognized impairment charges of £52 million in 2016. There are significant judgements attached to managements impairment review including forecast cash flows, pre-tax risk adjusted discount rates and long-term growth rates which together give rise to a risk that assets subject to impairment testing are not valued correctly. We identified four key risks as follows:
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We have obtained and understood the Directors’ impairment models for those CGUs including assets where the carrying value is subject to significant management judgement. We have challenged management’s key assumptions around the business drivers of the cash flow forecasts, discount rates and long-term growth rates. In evaluating the forecast cash flows presented we have:
We have directed our internal valuation specialists to derive an independent expectation of the discount rates specific to the assets and markets being tested for impairment. We also compared the long-term growth rates applied by the Directors to economic forecasts for regional productivity. In determining the identification of CGUs we have made enquiries of management and challenged the fact pattern, including considering the independence of cash inflows and the current level of interaction between plants. We have audited the disclosures within note 11 to determine whether material disclosures have been made in accordance with IAS 36. |
Key observations | |
From our work performed, we are satisfied with the carrying value of assets recognized. | |
5. Recoverability of material contract related assets | |
GKN PLC – Extract from Audit Report of Financial Statement 2016 | |
Risk Description | How the scope of our audit responded to the risk |
Refer to page 77 (Audit & Risk Committee report), note 1 (Accounting policies and presentation) and note 11b (Goodwill and other intangible assets). There are material assets, including operating and non-operating intangible assets, recorded related to key aerospace contracts that require management judgement to assess recoverability. We have identified a key risk in relation to the recoverability (and therefore existence and valuation) of non-recurring cost (NRC) associated with significant Aerospace programmes. We have focused on this risk because the Directors’ assessment of the recoverability of these assets involves complex and subjective judgements and assumptions about the future results of these programmes, including future production rates and cost reductions. |
In response to the risk identified, we have challenged the underlying assumptions within management’s impairment assessment on material programmes including:
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Key observations | |
From our work performed, we are satisfied with the carrying value of assets recognised. | |
6. Revenue recognition | |
GKN PLC – Extract from Audit Report of Financial Statement 2016 | |
Risk Description | How the scope of our audit responded to the risk |
Refer to note 1 (Accounting policies and presentation) and note 2 (Segmental analysis). Sales are made worldwide on a number of different terms. Each division has some areas of complexity. However those that represent a key risk to the Group relate to the judgements taken within material risk and revenue sharing partnerships (RRSP) in the Aerospace division. These complexities and judgements arise where GKN is entitled to a set percentage of revenue per engine as contractually agreed with the programme partner. The Directors exercise judgement as to how much revenue to recognize, reflecting the quantum of products dispatched by the engine manufacturer and the difference in pricing of original engine manufacturer parts and spare parts. This risk specifically arises in Engine Systems, focusing on the timing at which risks and rewards are transferred and revenue recognized. We have also identified a key risk in the accuracy and occurrence of other material contract variations on existing contracts that have arisen in the year and material new contracts in the year. We note that contracts with customers sometimes contain multiple performance obligations and require the Directors to exercise judgement over the appropriateness of the accounting treatment for each individual part of the contract or arrangement. |
For each material RRSP contract, we have verified the amount of revenue recognised to check that it has been calculated in accordance with IAS 18 ‘Revenue’, the contractual agreement and the latest correspondence with the customer. In particular, we have:
In order to identify material new contracts or contract variations, we have performed enquiries with the Directors and others in the Group and a review of Board meeting minutes and contracts subject to senior approval under the delegation of authority. For material contracts identified, we have reviewed the contract terms and verified assumptions made in determining the revenue recognition in accordance with IAS 18, including consideration of discounts, performance penalties and other cost implications of the contract. |
Key observations | |
We are satisfied that the key assumptions made in determining the fair value of revenue recognized on RRSP contracts and new contracts in the year is appropriate. | |
7. Presentation and disclosure of non-trading items | |
GKN PLC – Extract from Audit Report of Financial Statement 2016 | |
Risk Description | How the scope of our audit responded to the risk |
Refer to page 77 (Audit & Risk Committee report), note 1 (Accounting policies and presentation) and note 3 (Adjusted performance measures). Trading profit, a non-statutory measure, is used by the Group to report the business performance to investors and wider stakeholders. We have identified a key audit risk in the presentation of the financial performance of the Group, including the separate identification of ‘non-trading’ items in arriving at the ‘trading profit’ measure, and the completeness of items separately identified. Non-trading items of £349 million were disclosed in 2016, which consisted of changes in value of derivatives and other financial instruments, losses related to changes in Group structure, amortization of non-operating intangible assets, acquisition related restructuring charges and impairment charges. |
We challenged and understood management’s rationale for including certain items outside trading profit to ensure appropriate disclosure in the financial statements. This was performed in the context of recent regulatory guidance, ensuring the purpose of using alternative performance measures was set out and that they were clearly defined, consistent over time and included appropriate reconciliations to statutory financial information. We assessed the completeness of items separately identified as non-trading items through an examination of costs recorded to determine whether they only related to those non-trading items defined above. We agreed the amounts recorded through to underlying financial records and other audit support to verify the amounts disclosed were complete and accurate. We focused our review of the Group financial statements on the financial statement and narrative presentation of items which may be considered to be non-recurring in nature to determine whether principles are being consistently applied and the resulting financial presentation is true and fair. We have checked that the narrative within the financial statements is balanced and that there are no items in trading profit which are outside of the ordinary course of business and materially distort the result. We tested, on a sample basis, restructuring costs recorded within trading profit and confirmed the validity of these costs by agreeing amounts to supporting contracts and payments. We performed a detailed assessment of the completeness and calculation of the restructuring provision held at 31 December 2016 to determine whether the provision recorded was consistent with the requirements of IAS 37 ‘Provisions, contingent liabilities and contingent assets’. |
Key observations | |
We are satisfied that the items excluded from trading profit and the related disclosure of these items in the financial statements is appropriate. | |
8. Assumptions made in determining pension liabilities | |
GKN PLC – Extract from Audit Report of Financial Statement 2016 | |
Risk Description | How the scope of our audit responded to the risk |
Refer to page 48 (Principal risks and uncertainties), page 77 (Audit & Risk Committee report), note 1 (Accounting policies and presentation) and note 24 (Post-employment obligations). The Group has a number of defined benefit obligation schemes with a gross liability of £4.6 billion, the majority of which relates to schemes in the UK, US and Germany. We have identified a key audit risk on the valuation of the pension scheme liabilities in the UK, US and Germany with specific focus on management judgements exercised in selecting the discount rates used to determine the pension liability in accordance with IAS 19. A relatively small change in assumptions could cause a material impact on the liability. |
We used our internal actuarial experts to assess the key assumptions for the UK, US and German schemes. Our assessment included reviewing available yield curves to recalculate a reasonable range for the key assumptions. We challenged management to understand the sensitivity of changes in key assumptions and quantify a range of reasonable rates that could be used in their calculation. Additionally, we benchmarked key assumptions against other listed companies to identify any outliers in the data used. |
Key observations | |
From the work performed, we are satisfied that the significant assumptions applied in respect of the valuation of the scheme liabilities are appropriate. |