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Auditor's report

This document is an English translation of the Finnish auditor’s report. Only the Finnish version of the report is legally binding.

To the Annual General Meeting of Wärtsilä Corporation

Report on the Audit of the Financial Statements

Opinion

We have audited the financial statements of Wärtsilä Corporation (business identity code 0128631-1) for the year ended 31 December, 2016. The financial statements comprise the consolidated balance sheet, income statement, statement of comprehensive income, statement of changes in equity, statement of cash flows and notes, including a summary of significant accounting policies, as well as the parent company’s balance sheet, income statement, statement of cash flows and notes.

In our opinion

  • the consolidated financial statements give a true and fair view of the group’s financial performance and financial position in accordance with International Financial Reporting Standards (IFRS) as adopted by the EU
  • the financial statements give a true and fair view of the parent company’s financial performance and financial position in accordance with the laws and regulations governing the preparation of financial statements in Finland and comply with statutory requirements.
Basis for Opinion

We conducted our audit in accordance with good auditing practice in Finland. Our responsibilities under good auditing practice are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report.

We are independent of the parent company and of the group companies in accordance with the ethical requirements that are applicable in Finland and are relevant to our audit, and we have fulfilled our other ethical responsibilities in accordance with these requirements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Materiality

The scope of our audit was influenced by our application of materiality. The materiality is determined based on our professional judgement and is used to determine the nature, timing and extent of our audit procedures and to evaluate the effect of identified misstatements on the financial statements as a whole. The level of materiality we set is based on our assessment of the magnitude of misstatements that, individually or in aggregate, could reasonably be expected to have influence on the economic decisions of the users of the financial statements. We have also taken into account misstatements and/or possible misstatements that in our opinion are material for qualitative reasons for the users of the financial statements.

Key Audit Matters

Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial statements of the current period. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters.

We have also addressed the risk of management override of internal controls. This includes consideration of whether there was evidence of management bias that represented a risk of material misstatement due to fraud.

Valuation of goodwill (EUR 1,112 million) and acquisition related intangible assets (EUR 209 million) - refer to accounting principles for the consolidated financial statements and notes 2 and 13 of the consolidated financial statements
Key audit matter Our response
  • In recent years the group has expanded its operations through acquisitions. At year-end, the group had EUR 1,112 million in goodwill and EUR 209 million in acquisition related intangible assets being, 25% of total assets and 57% of total equity. In 2016, these assets increased by EUR 56 million and EUR 16 million, respectively, as a result of the acquisitions of American Hydro and Eniram.
  • Irrespective of whether there is any indication of impairment, goodwill acquired through a business combination is required to be tested for impairment annually. An impairment arises when the recoverable amount is less than the carrying value of the investment.
  • In Wärtsilä, acquisition related intangible assets have a definitive useful life, however, the useful lives and related amortization periods are assessed annually.
  • The assumptions used to support the valuation of goodwill (e.g. discount rates and growth rates) are judgmental.
  • We have assessed the impairment tests prepared by management and related supporting third party evidence.
  • We have challenged the assumptions used in respect of the forecasted growth rates and involved KPMG valuation specialists to assess the appropriateness of the discount rates used. This included comparison to economic and industry forecasts, where appropriate, as well as assessment over the technical appropriateness of the calculations.
  • We have applied professional judgment when evaluating the forecasts by stress testing key assumptions and assessing the impact on the sensitivity analysis.
  • In addition, we have assessed the adequacy and appropriateness of the notes in the financial statements on goodwill and impairment testing.
  • For acquisition related intangible assets, we have challenged management's assumptions regarding the remaining useful life of identified intangible assets based on our own expectations and on our knowledge of the client and experience of the industry in which it operates as well as external data sources.

 

Business combinations:  Purchase price allocation on acquisitions - refer to accounting principles for the consolidated financial statements note 2 of the consolidated financial statements
Key audit matter Our response
  • In 2016, Wärtsilä acquired American Hydro and Eniram for a total of EUR 87 million. Acquisition accounting requires the fair value of the acquired assets and liabilities at the acquisition date to be determined. This involved complex valuation considerations and required the use of specialists. Goodwill arising from acquisitions was EUR 56 million and EUR 16 million was allocated to separately identified intangible assets.
  • There is a risk of inappropriate judgment in determining the fair value of assets acquire and use of inaccurate forecasted financial and operational data in the valuations. There is also a risk that costs are provided for before there is an obligation and accounting policy differences arising from the acquisitions are not identified.
  • The purchase price allocation includes significant judgments in assessing the fair values of the assets and liabilities acquired. The fair values are based on the anticipated future performance of the acquired entities. With the involvement of KPMG valuation specialists, we have challenged and evaluated key assumptions made by management and their advisors. This include the challenge of the key assumptions made by management, such as the discount rates, royalty rates applied, and the projected financial information.
  • We have performed audit procedures on the acquired opening balances
  • We have evaluated the adequacy of disclosures in the group's financial statements.

 

Revenue recognition of long-term contracts - refer to accounting principles for the consolidated financial statements and notes 1, 4, 19, 24, 26 and 30 of the consolidated financial statements
Key audit matter Our response
  • Revenue and costs of long-term projects, long-term operations and maintenance agreements, which are recognised according to their percentage of completion, are highlighted as requiring management judgment and estimates in Wärtsilä's accounting policies.
  • There is risk of inappropriate percentage of completion accounting as this involves judgement over cost forecasts, estimated profits and/ or contingencies.
  • We have performed audit procedures over the controls in place to assess whether the percentage of completion for each significant long-term contract has been appropriately applied
  • Our audit procedures included testing the recoverability of unbilled receivable balances and the adequacy of cost accruals within the contracts.

 

Adequacy of contract related provisions, including warranty provisions - refer to accounting principles for the consolidated financial statements and notes 24 and 26 to the consolidated financial statements
Key audit matter Our response
  • Contract related provisions comprise obligations and disputes with customer and other contractual obligations.
  • Accounting for warranty provisions and the associated judgments over costs to manage the warranty claims is highlighted as a key estimate in Wärtsilä's accounting principles
  • There is a risk of unrecorded liabilities for contractual obligations and disputes and warranty accounting is based on inaccurate data and assumptions.
  • For those exposures where provision is made, the use of estimates within those provisions gives rise to inherent subjectivity in the amounts recorded in the financial statements.
  • For those exposures where no provision has been made, the obligation to disclose the nature and estimate of its financial impact gives rise to further judgement in the disclosure within the financial statements.
 
  • We have challenged management in respect of the reasonableness of judgments made regarding the cost to complete and contingency provisions to mitigate contract specific risks based historical and project specific information.
  • We have also assessed whether management's policies and processes for making these estimates continue to be appropriate in the light of previous performance and are applied consistently to all contracts of a similar nature.

 

Responsibilities of the Board of Directors and the President and CEO for the Financial Statements

The Board of Directors and the President and CEO are responsible for the preparation of consolidated financial statements that give a true and fair view in accordance with International Financial Reporting Standards (IFRS) as adopted by the EU, and of financial statements that give a true and fair view in accordance with the laws and regulations governing the preparation of financial statements in Finland and comply with statutory requirements. The Board of Directors and the President and CEO are also responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the financial statements, the Board of Directors and the President and CEO are responsible for assessing the parent company’s and the group’s ability to continue as going concern, disclosing, as applicable, matters relating to going concern and using the going concern basis of accounting. The financial statements are prepared using the going concern basis of accounting unless there is an intention to liquidate the parent company or the group or cease operations, or there is no realistic alternative but to do so.

Auditor’s Responsibilities in the Audit of the Financial Statements

Our objectives are to obtain reasonable assurance on whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with good auditing practice will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements.

As part of an audit in accordance with good auditing practice, we exercise professional judgment and maintain professional skepticism throughout the audit. We also:

  • Identify and assess the risks of material misstatement of the financial statements, 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 opinion. 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 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 the parent company’s or the group’s internal control.
  • Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.
  • Conclude on the appropriateness of the Board of Directors’ and the President and CEO’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 parent company’s or the group’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. 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 parent company or the group to cease to continue as a going concern.
  • Evaluate the overall presentation, structure and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events so that the financial statements give a true and fair view.
  • Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the group to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion.

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 relevant ethical requirements regarding independence, and communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, 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 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 or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication.

Other Reporting Requirements

Other information

The Board of Directors and the President and CEO are responsible for the other information. The other information comprises information included in the report of the Board of Directors and in the Annual Report, but does not include the financial statements and our auditor’s report thereon.

Our opinion on the financial statements does not cover the other information.

In connection with our audit of the financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. With respect to the report of the Board of Directors, our responsibility also includes considering whether the report of the Board of Directors has been prepared in accordance with the applicable laws and regulations.

In our opinion, the information in the report of the Board of Directors is consistent with the information in the financial statements and the report of the Board of Directors has been prepared in accordance with the applicable laws and regulations.

If, based on the work we have performed on the report of the Board of Directors and the Annual Report, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard.

Other opinions

We support the adoption of the financial statements. The proposal by the Board of Directors regarding the treatment of distributable funds is in compliance with the Limited Liability Companies Act. We support that the Board of Directors of the parent company and the President and CEO be discharged from liability for the financial period audited by us.

Helsinki January 26, 2017

KPMG OY AB

Virpi Halonen
Authorised Public Accountant, KHT

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