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2019 Annual Report

 

TRANSFORMATION

2019 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, 2019, the Consolidated Statement of Income, the Consolidated Statement of Comprehensive Income, the Consolidated Statement of Changes in Equity and the Consolidated Statement of Cash Flows for the fiscal year from January 1, 2019, to December 31, 2019, and the 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 fiscal year from January 1, 2019, to December 31, 2019. In line with the German legal regulations, we have not audited the content of the parts of the corporate management report mentioned in the “Other information” section of our auditor’s 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 E.U. 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, 2019, and of its financial performance for the fiscal year from January 1, 2019, to December 31, 2019, 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. Our opinion on the corporate management report does not cover the content of the parts of the corporate management report mentioned in the “Other information” section.

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 E.U. Audit Regulation No. 537/2014 (referred to subsequently as “E.U. 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 E.U. Audit Regulation, we declare that we have not provided non-audit services prohibited under Art. 5 (1) of the E.U. 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 fiscal year from January 1, 2019, to December 31, 2019. 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, 2019, goodwill totaled €5,114 million, thus comprising a substantial portion of net assets at 12%.

Goodwill is tested for impairment annually at the level of the cash-generating 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, which must take place once a year, was carried out on November 30, 2019. Continental AG also carried out an adhoc impairment test on September 30, 2019.

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.

Within the context of the annual planning process, the company did not expect global production of passenger cars and light commercial vehicles to increase substantially in the coming years (2020–2024). The reduction in expected future cash flows resulted, on the basis of the ad-hoc impairment test carried out on September 30, 2019, in goodwill impairment of €2,291.2 million. If financial performance is worse than expected or the discount rate on which the impairment test was based increases, further impairment will be required.

On the basis of the annual impairment test carried out on November 30, 2019, no additional need for impairment was identified. The company’s sensitivity analysis has shown that reasonably possible changes not only in the discount rate and in the long-term growth rate in perpetuity but also in sales would lead to additional impairment.

There is a risk for the consolidated financial statements that the impairment recorded in the financial statements may not have been appropriately accounted for. In addition, there is a risk that the disclosures in the notes associated with the subsequent measurement of goodwill 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 fiscal 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 in sales, the discount rate and the 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 seven 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.

Recoverability of the carrying amount of deferred tax assets
The accounting policies as well as the assumptions made are disclosed in Notes 2 and 19 of the notes to the consolidated financial statements.

THE FINANCIAL STATEMENT RISK
As at December 31, 2019, deferred tax assets of €2,174 million – €389 million of which resulted from loss carryforwards and limitation of interest deduction – were reported in the consolidated financial statements of Continental AG.

For the recognition of deferred tax assets, it is necessary to estimate the extent to which the existing deferred tax assets can be used in the following reporting periods. The realization of these assets is subject to the condition that sufficient taxable income is generated in the future. If there are any doubts about the future usability of the deferred tax assets calculated, deferred tax assets may not be recognized or – if they have already been recognized – must be derecognized.

The measurement of deferred tax assets is highly dependent on the estimates and assumptions made by the Executive Board in relation to the operating performance of the country units and tax planning for the corporation, and is therefore subject to significant uncertainties. Realization is also dependent on the respective tax environment.

The global production of passenger cars and light commercial vehicles declined in fiscal 2019. This will have a negative effect on future business and earnings prospects. In Continental’s opinion, it can be assumed, in spite of market developments, that existing deferred tax assets can be used, so that deferred tax assets can continue to be capitalized.

There is a risk for the consolidated financial statements that Continental AG’s opinion may not be appropriate and that the recognized deferred tax assets may not be recoverable.

OUR AUDIT APPROACH
To assess tax matters, we involved our tax specialists in the audit. To begin with, we took a critical look at the temporary differences between the IFRS carrying amounts and the respective tax base carrying amounts for the corporation’s entities. We also reconciled the losses carried forward to tax assessments and tax calculations for the current fiscal year and acknowledged off-balance-sheet corrections.

We assessed the recoverability of the carrying amount of deferred tax assets on the basis of internal projections issued for the corporation’s entities on future taxable income, and critically examined the underlying assumptions. In this regard, we reconciled in particular the planning of future taxable income with the planning issued by the Executive Board, and reviewed the consistency of the underlying parameters. We also assessed the planning accuracy of the corporation’s entities by comparing projections for previous fiscal years with the actual results realized and analyzing deviations.

Continental AG’s opinion on the financial performance of the corporation’s entities with an existing history of losses was presented to us by the Executive Board. If deferred tax assets are reported for these entities, we are convinced of the sustainability of the taxable income.

OUR OBSERVATIONS
The assumptions underlying the measurement of deferred tax assets are appropriate overall.

Recognition and measurement of restructuring provisions
The accounting policies as well as the assumptions made are disclosed in Notes 2 and 28 of the notes to the consolidated financial statements.

THE FINANCIAL STATEMENT RISK
As at December 31, 2019, restructuring provisions of €599 million were reported in the consolidated financial statements of Continental AG.

For restructuring measures, where there are general or illustrative recognition criteria for the relevant conditions, corresponding provisions must be drawn up. The measurement of significant restructuring provisions is highly dependent on the estimates and assumptions made by the Executive Board, particularly in relation to the arrangement of social schemes, compensation amounts, staff cuts and site closure costs.

There is a risk for the consolidated financial statements that the conditions for recognition of the restructuring provisions may not be met or may not be measured appropriately.

OUR AUDIT APPROACH
We initially assessed, within the scope of our engagement, whether the recognition criteria had been met in each case as at December 31, 2019. In this regard, we assessed in particular whether or not there was a detailed, formal restructuring plan in each case and whether the key elements of the restructuring measures had been communicated to the employees affected or implementation of the restructuring measures had begun.

The assumptions underlying the measurement of the restructuring provisions were then presented to us. We assessed the consistency of the assumptions with the detailed, formal restructuring plans. We also critically examined contracts and agreements that had already been concluded as at the end of the reporting period.

OUR OBSERVATIONS
The assumptions made by the Executive Board are appropriate.

Other information
The Executive Board and the Supervisory Board are responsible for the other information. The other information comprises the following parts of the management report. The content of these parts has not been audited:

  • the combined corporate non-financial statement, which is in the “Sustainability and Combined Corporate Non-Financial Statement” section of the management report, and
  • the corporate governance declaration, which is referred to in the section of the same name of the corporate management report.

The other information also comprises the remaining parts of the annual report.

The other information does not comprise the consolidated financial statements, the disclosures in the corporate management report audited with respect to content, 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 disclosures in the corporate management report audited with respect to content 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 March 3, 2020.

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 E.U. and the additional requirements of German commercial law pursuant to Section 315e (1) HGB and for ensuring 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 E.U. 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 E.U. 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 26, 2019. We were engaged by the Supervisory Board on November 13, 2019. 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 E.U. 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. Project-related IT audits, audits of various IT systems and IT processes as well as migration audits 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, the audit of transfer prices, 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 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 income tax and sales tax advice on individual matters, as well as project-related support for the implementation of a tax compliance management system.

German public auditor
The German public auditor responsible for the engagement is Andreas Modder.

Hanover, March 3, 2020

KPMG AG
Wirtschaftsprüfungsgesellschaft

Dr. Tonne
Wirtschaftsprüfer

Modder
Wirtschaftsprüfer