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2018 Annual Report

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2018 Annual Report

Continental Corporation - 2018 Annual Report
 

Independent Auditor’s Report

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To Continental Aktiengesellschaft, Hanover

Report on the Audit of the Consolidated Financial Statements and the Corporate Management Report

Opinions
We have audited the consolidated financial statements of Continental Aktiengesellschaft and its subsidiaries (the corporation), which comprise the Consolidated Statement of Financial Position as at December 31, 2018, and the Consolidated Statement of Income, Consolidated Comprehensive Income, the Consolidated Statement of Changes in Equity, and the Consolidated Statement of Cash Flows for the financial year from January 1, 2018, to December 31, 2018, and Notes to the Consolidated Financial Statements, including a summary of significant accounting policies. In addition, we have audited the Corporate Management Report of Continental Aktiengesellschaft for the financial year from January 1, 2018, to December 31, 2018. In line with the German legal regulations, we have not audited the content of the combined corporate non-financial statement, which is included in the corresponding section of the management report.

In our opinion, on the basis of the knowledge obtained in the audit,

  • the accompanying consolidated financial statements comply, in all material respects, with IFRS as adopted by the EU and the additional requirements of German commercial law pursuant to Section 315e (1) of the German Commercial Code (Handelsgesetzbuch – HGB) and, in compliance with these requirements, give a true and fair view of the assets, liabilities and financial position of the corporation as at December 31, 2018, and of its financial performance for the financial year from January 1, 2018, to December 31, 2018, and
  • the accompanying Corporate Management Report as a whole provides an appropriate view of the corporation’s position. In all material respects, this Corporate Management Report is consistent with the consolidated financial statements, complies with German legal requirements and appropriately presents the opportunities and risks of future development.

Pursuant to Section 322 (3) sentence 1 HGB, we declare that our audit has not led to any reservations relating to the legal compliance of the consolidated financial statements and of the Corporate Management Report.

Basis for the opinions
We conducted our audit of the consolidated financial statements and of the Corporate Management Report in accordance with Section 317 HGB and the EU Audit Regulation No. 537/2014 (referred to subsequently as “EU Audit Regulation”) and in compliance with German Generally Accepted Standards for Financial Statement Audits promulgated by the Institut der Wirtschaftsprüfer (Institute of Public Auditors in Germany, IDW). Our responsibilities under those requirements and principles are further described in the “Auditor’s responsibilities for the audit of the consolidated financial statements and of the Corporate Management Report” section of our auditor’s report. We are independent of the corporation’s entities in accordance with the requirements of European law and German commercial and professional law, and we have fulfilled our other German professional responsibilities in accordance with these requirements. In addition, in accordance with Art. 10 (2) point (f) of the EU Audit Regulation, we declare that we have not provided non-audit services prohibited under Art. 5 (1) of the EU Audit Regulation. We believe that the evidence we have obtained is sufficient and appropriate to provide a basis for our opinions on the consolidated financial statements and on the Corporate Management Report.

Key audit matters in the audit of the consolidated financial statements
Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated financial statements for the financial year from January 1, 2018, to December 31, 2018. These matters were addressed in the context of our audit of the consolidated financial statements as a whole and in forming our opinion thereon. We do not provide a separate opinion on these matters.

Recoverability of the carrying amount of goodwill
The accounting policies as well as the assumptions made are disclosed in Note 2 of the Notes to the Consolidated Financial Statements. Disclosure of the amount of goodwill is provided in the Notes to the Consolidated Financial Statements in Note 13.

THE FINANCIAL STATEMENT RISK
As at December 31, 2018, goodwill totaled €7,233 million, thus comprising a substantial portion of net assets at approximately 18%.

Goodwill is tested for impairment annually at the level of the cashgenerating units. The carrying amount is thereby compared with the recoverable amount of the respective cash-generating unit. If the carrying amount exceeds the recoverable amount, an impairment is recorded. The recoverable amount is the higher of the fair value less costs to sell and value in use of the cash-generating unit. The impairment test was carried out as at November 30, 2018.

The goodwill impairment test is complex and is based on a number of judgmental assumptions. These include, among others, the expected business and earnings development of the cash-generating units for the upcoming five years, the assumed long-term growth rates and the discount rate used.

On the basis of the impairment test carried out, the company has not identified any need to record an impairment. The company’s sensitivity analysis has shown that reasonably possible changes in the discount rate, in the long-term growth rate or in the sales in perpetuity would not lead to an impairment to the recoverable amount.

There is a risk for the financial statements that existing impairment as at the reporting date may not have been identified. In addition, there is a risk that the disclosures in the notes associated herewith may not be appropriate.

OUR AUDIT APPROACH
With the support of our valuation specialists, we assessed, among other things, the appropriateness of the significant assumptions as well as the company’s valuation model. This included a discussion of the expected development of the business and results as well as of the assumed underlying long-term growth rates with those responsible for the planning process. Furthermore, reconciliations were made with the annual planning prepared by the Executive Board which was approved by the Supervisory Board and the long-term planning of which the Supervisory Board took note. We also assessed the consistency of the assumptions with external market expectations.

We also assessed the company’s planning accuracy by comparing projections for previous financial years with the actual results realized and analyzing deviations. Since small changes in the discount rate can have a substantial impact on the results of the impairment test, we compared the assumptions and parameters underlying the discount rate – the risk-free rate, the market risk premium and the beta factor – with own assumptions and publicly available information.

To ensure the calculative correctness of the valuation model utilized, we verified the company’s calculations on the basis of elements selected in a risk-oriented manner.

To reflect the existing uncertainty with respect to forecasts as well as the earlier valuation date for the impairment test, we assessed reasonably possible changes of the sales, the discount rate respectively EBIT margin on the recoverable amount (sensitivity analysis) by calculating alternative scenarios and comparing these with the company’s valuation results. The risk-oriented focal point of our analysis was on four cash-generating units, for which we performed detailed analyses.

Finally, we assessed whether the disclosures in the notes with respect to the recoverability of the carrying amount of the goodwill are appropriate.

OUR OBSERVATIONS
The underlying valuation model used in the impairment test of goodwill is appropriate and consistent with the applicable accounting principles.

The company’s assumptions and parameters underlying the valuation are within an acceptable bandwidth and are, on the whole, balanced.

The disclosures in the notes associated herewith are appropriate.

Accrual of sales by period in accordance with IFRS 15
The accounting policies as well as the assumptions made are disclosed in the Notes to the Consolidated Financial Statements in Notes 2 and 6.

THE FINANCIAL STATEMENT RISK
Corporate sales amounted to €44,404 million in the 2018 fiscal year.

Sales revenue is recognized when the entity satisfies a performance obligation by transferring a promised good or service to a customer. An asset is transferred when (or as) the customer obtains control of that asset. Based on the transfer of control, sales revenue shall be recognized either at a point in time or over time at the amount at which there is expected to be a claim.

Based on the identification of the following criteria, it was determined that the performance obligation will now be satisfied over time – rather than at a point in time according to IAS 18 – for portions of the sales revenue and that recognition of sales revenue will therefore be related to a time period:

  • The customer simultaneously receives and consumes the benefits provided by the corporation’s performance as the corporation performs.
  • The corporation’s performance does not create an asset with alternative use to the corporation and the corporation has an enforceable right to payment for performance completed to date, including an appropriate margin.

The transition effect resulting from the change to sales revenue recognition of €22 million as at January 1, 2018, including deferred taxes, was recognized in revenue reserves.

Due to the variety of different complex contractual agreements for the global corporation companies and the existing discretion when it comes to judging the criteria for assessing the timing of the transfer of control within the scope of the introduction of IFRS 15, there is a financial statement risk that sales revenue may be incorrectly accrued as at the reporting date.

OUR AUDIT APPROACH
Given the introduction of IFRS 15, we made the assessment of the legal representatives’ interpretation of criteria for sales revenue recognition based on IFRS 15 a priority of our audit. We acknowledged the corresponding structure of the corporate-wide accounting policies based on our knowledge of the transactions.

We assessed the appropriateness of significant judgments, such as the identification of distinct performance obligations, the existence of alternative use of the asset to the corporation, the existence of a legally enforceable right to payment including an appropriate margin for services completed to date, the determination of the degree of progress and the assessment of the degree of performance progress achieved, based on agreements selected in a risk-oriented manner.

OUR OBSERVATIONS
The approach to accruing sales revenue based on IFRS 15 is appropriate. The assumptions underlying the accounting are appropriate.

Measurement of the investment in OSRAM CONTINENTAL GmbH
The accounting policies as well as the assumptions made are disclosed in Note 2 of the Notes to the Consolidated Financial Statements.

THE FINANCIAL STATEMENT RISK
As part of the set-up of a new business partnership with OSRAM, parts of a business unit were transferred in capital reserves to the associate OSRAM CONTINENTAL GmbH on July 2, 2018, and a cash payment made. In addition, further parts of the same business unit were sold to the company and subsidiaries of OSRAM CONTINENTAL GmbH. A total carrying amount of €189 million and a positive earnings effect of €184 million was reported on the acquisition date after intercompany profits were eliminated on a pro rata basis.

The cost of acquisition of the investment in the associate is based on the cash payment and the fair value of the parts of the business unit that were transferred. The sales price for the other parts of the business unit is also measured based on the fair value of these sold parts of the business unit. Continental enlisted an external assessor to assess the transferred and sold parts of the business unit and to determine and measure the identifiable assets acquired on a pro rata basis to continue the investment based on the equity method and the measurement of OSRAM CONTINENTAL GmbH.

The measurement of the investment in the associate is complex and based on discretionary assumptions by the Executive Board. The significant assumptions relate to sales planning and margin development for the business and costs of capital.

There is a risk for the consolidated financial statements that the measurement of the associate may be incorrect. In addition, there is a risk that the disclosures in the Notes to the Consolidated Financial Statements may not be appropriate.

OUR AUDIT APPROACH
With the support of our own measurement specialists, we assessed, among other things, the appropriateness of the significant assumptions as well as the assessment and measurement methods. To do this, we initially obtained an understanding of the transaction on the basis of employee inquiries and an appraisal of the relevant agreements.

We assessed the expertise, capabilities and objectivity of the independent assessors engaged by Continental AG. We also acknowledged the process used to determine the assets acquired on a pro rata basis based on our knowledge of the OSRAM CONTINENTAL GmbH business model. We evaluated the measurement methods used to check that they were consistent with the accounting policies.

We discussed the expected sales and margin development with those responsible for the planning process. We also assessed the consistency of the assumptions with external market expectations. We compared the assumptions and parameters underlying the cost of capital – in particular the risk-free interest rate, the market risk premium and the beta factor – with own assumptions and data that is publicly available.

To assess calculative correctness, we verified selected calculations in a risk-oriented manner. We also assessed whether the disclosures in the notes are appropriate.

OUR OBSERVATIONS
The underlying method used to measure the associate is appropriate and consistent with the applicable accounting policies. The presentation in the notes to the consolidated financial statements is appropriate.

Other information
The Executive Board is responsible for the other information. The other information comprises:

  • the combined corporate non-financial statement and
  • the remaining parts of the annual report, with the exception of the audited consolidated financial statements and Corporate Management Report and our auditor’s report.

Our opinions on the consolidated financial statements and on the Corporate Management Report do not cover the other information, and consequently we do not express an opinion or any other form of assurance conclusion thereon.

In connection with our audit, our responsibility is to read the other information and, in so doing, to consider whether the other information

  • is materially inconsistent with the consolidated financial statements, the Corporate Management Report or our knowledge obtained in the audit, or
  • otherwise appears to be materially misstated.

In accordance with our engagement, we performed a separate operational audit of the combined corporate non-financial statement. The type, scope and results of this operational audit are disclosed in our unqualified audit opinion dated February 20, 2019.

Responsibilities of the Executive Board and the Supervisory Board for the consolidated financial statements and the Corporate Management Report
The Executive Board is responsible for the preparation of the consolidated financial statements that comply, in all material respects, with IFRS as adopted by the EU and the additional requirements of German commercial law pursuant to Section 315e (1) HGB and that the consolidated financial statements, in compliance with these requirements, give a true and fair view of the assets, liabilities, financial position and financial performance of the corporation. In addition, the Executive Board is responsible for internal controls that it deems necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the consolidated financial statements, the Executive Board is responsible for assessing the corporation’s ability to continue as a going concern. It also is responsible for disclosing, as applicable, matters related to the going concern. In addition, the Executive Board is responsible for financial reporting based on the going concern basis of accounting unless there is an intention to liquidate the corporation or to cease operations, or there is no realistic alternative but to do so.

Furthermore, the Executive Board is responsible for the preparation of the Corporate Management Report that, as a whole, provides an appropriate view of the corporation’s position and is, in all material respects, consistent with the consolidated financial statements, complies with German legal requirements and appropriately presents the opportunities and risks of future development. In addition, the Executive Board is responsible for arrangements and measures (systems) that it considers necessary to enable the preparation of the Corporate Management Report that is in accordance with the applicable German legal requirements and to be able to provide sufficient appropriate evidence for the assertions in the Corporate Management Report.

The Supervisory Board is responsible for overseeing the corporation’s financial reporting process for the preparation of the consolidated financial statements and of the Corporate Management Report.

Auditor’s responsibilities for the audit of the consolidated financial statements and of the Corporate Management Report
Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and whether the Corporate Management Report as a whole provides an appropriate view of the corporation’s position and, in all material respects, is consistent with the consolidated financial statements and the knowledge obtained in the audit, complies with the German legal requirements, and appropriately presents the opportunities and risks of future development, as well as to issue an auditor’s report that includes our opinions on the consolidated financial statements and on the Corporate Management Report.

Reasonable assurance is a high level of assurance, but it is not a guarantee that an audit conducted in accordance with Section 317 HGB and the EU Audit Regulation and in compliance with German Generally Accepted Standards for Financial Statement Audits promulgated by the Institut der Wirtschaftsprüfer (IDW) will always detect a material misstatement. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements and this Corporate Management Report.

We exercise professional judgment and maintain professional skepticism throughout the audit. We also:

  • Identify and assess the risks of material misstatement of the consolidated financial statements and of the Corporate Management Report, whether due to fraud or error; design and perform audit procedures responsive to those risks; and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinions. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations or the override of internal control.
  • Obtain an understanding of internal control relevant to the audit of the consolidated financial statements and of arrangements and measures (systems) relevant to the audit of the Corporate Management Report in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of these systems.
  • Evaluate the appropriateness of accounting policies used by the Executive Board and the reasonableness of estimates made by the Executive Board and related disclosures.
  • Conclude on the appropriateness of the Executive Board’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the corporation’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in the auditor’s report to the related disclosures in the consolidated financial statements and in the Corporate Management Report or, if such disclosures are inadequate, to modify our respective opinions. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the corporation to cease to be able to continue as a going concern.
  • Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements present the underlying transactions and events in such a manner that the consolidated financial statements give a true and fair view of the assets, liabilities, financial position and financial performance of the corporation in compliance with IFRS as adopted by the EU and the additional requirements of German commercial law pursuant to Section 315e (1) HGB.
  • Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the corporation to express opinions on the consolidated financial statements and on the Corporate Management Report. We are responsible for the direction, supervision and performance of the corporate audit. We remain solely responsible for our opinions.
  • Evaluate the consistency of the Corporate Management Report with the consolidated financial statements, its conformity with German law and the view of the corporation’s position it provides.
  • Perform audit procedures on the prospective information presented by the Executive Board in the Corporate Management Report. On the basis of sufficient appropriate audit evidence we evaluate, in particular, the significant assumptions used by the Executive Board as a basis for the prospective information, and evaluate the proper derivation of the prospective information from these assumptions. We do not express a separate opinion on the prospective information and on the assumptions used as a basis. There is a substantial unavoidable risk that future events will differ materially from the prospective information.

We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

We also provide those charged with governance with a statement that we have complied with the relevant independence requirements, and communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, the related safeguards.

From the matters communicated with those charged with governance, we determine those matters that were of most significance in the audit of the consolidated financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about the matter.

Other Legal and Regulatory Requirements

Further information pursuant to Art. 10 of the EU Audit Regulation
We were elected as corporate auditor by the Annual Shareholders’ Meeting on April 27, 2018. We were engaged by the Supervisory Board on December 27, 2018. We have been the corporate auditor of Continental Aktiengesellschaft without interruption for more than 30 years.

We declare that the opinions expressed in this auditor’s report are consistent with the additional report to the audit committee pursuant to Art. 11 of the EU Audit Regulation (long-form audit report).

We have provided to the corporation’s entities the following services that are not disclosed in the consolidated financial statements or the Corporate Management Report:

In addition to the audit of the consolidated and annual financial statements as well as the review of the half-year financial statements of Continental Aktiengesellschaft, we conducted various audits of financial statements as well as reviews of half-year financial statements of subsidiaries. Audit-related IT services, audits of various IT systems and IT processes as well as migration tests were carried out. We have also provided other attestation services, such as the granting of a comfort letter, and legal or contractual attestation services, such as audits according to the EEG, EMIR audits in accordance with Section 20 WpHG, the audit of the combined corporate non-financial statement and performance indicators regarding sustainability, the audit of transfer prices, the audit of the treasury management process, and audits of the use of funds. We have issued confirmations of compliance with contractual arrangements. Related to the first-time adoption of new accounting standards, such as IFRS 9, IFRS 15 and IFRS 16, we supported the implementation of regulatory requirements in a quality-assured manner. Furthermore, workshops on accounting-related issues and tax issues were conducted. Tax advisory services provided by us also include support services in the preparation of tax returns and in tax audits, as well as income tax and sales tax advice on individual matters.

German public auditor responsible for the engagement
The German public auditor responsible for the engagement is Dirk Papenberg.

Hanover, March 5, 2019

KPMG AG
Wirtschaftsprüfungsgesellschaft

Ufer
Wirtschaftsprüfer

Papenberg
Wirtschaftsprüfer

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