au-dits. We are a public accounting firm and are re-quired to be independent with respect to the Group. We conducted our audits in accordance with Swiss law, Swiss Auditing Standards and the stan-dards of the Public Company Accounting Oversight Board (United States) (PCAOB). Those standards require that we plan and perform the audits to ob-tain reasonable assurance about whether the con-solidated financial statements are free from mate-rial misstatement, whether due to fraud or error.
An audit involves performing procedures to ob-tain audit evidence about the amounts and disclo-sures in the consolidated financial statements.
The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated fi-nancial statements, whether due to fraud or error.
In making those risk assessments, the auditor considers the internal control system relevant to the entity’s preparation of the consolidated finan-cial statements in order to design audit proce-dures that are appropriate in the circumstances.
An audit also includes evaluating the appropriate-ness of the accounting policies used and the reasonableness of accounting estimates made, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is suffi-cient and appropriate to provide a basis for our audit opinion.
Report on key audit matters based on the circular 1/2015 of the Federal Audit Oversight Authority
Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated financial
statements of the current period. These matters were addressed in the context of our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. For each matter below, our description of how our audit addressed the matter is provided in that context.
We have fulfilled the responsibilities described in the Auditor’s responsibility section of our report, including in relation to these matters. Accordingly, our audit included the performance of procedures designed to respond to our assessment of the risks of material misstatement of the
consolidated financial statements. The results of our audit procedures, including the procedures performed to address the matters below, provide the basis for our audit opinion on the
consolidated financial statements.
Report on the Audit of the
Consolidated Financial Statements
Revenue recognition on long-term projects Area of emphasis
The Company derives a significant portion of its revenues from long-term and fixed price projects.
Such contracts involve key project and financial milestones including the bid price, risk
contingencies, the execution, post-completion warranty obligations and ongoing uncertainties around expected costs to complete. Therefore, the revenue, cost and gross profit realization can vary substantially during the execution and reassessment of these projects against the contracted financial milestones.
The principal risks include:
• the potential manipulation of results to achieve performance targets through management’s use of estimates and judgments in relation to such projects;
• inappropriate or incorrect accounting for percentage of completion, variation orders, expected costs to complete, estimated project margin and risk contingencies; and
• unrecorded liabilities for warranties, contractual disputes or claims for liquidated damages.
We consider these the key judgmental areas impacting the recognition of revenue and margins in respect of long-term contracts.
See note 2 to these consolidated financial state-ments for ABB’s description of the accounting policy for Revenue Recognition.
Our audit response
We obtained an understanding of the process for how management determines the percentage of completion, evaluated the design of, and per-formed tests of controls in this area. We evaluated the judgments made by management regarding the expected costs to complete estimate, the tim-ing and recognition of variation orders, and the assumptions made in calculating warranty provi-sions with underlying data.
We evaluated management’s assessments around the potential for liquidated damages for projects behind contracted schedule and the contingency provisions to mitigate contract-specific financial risks. For those balances subject to claims, we made inquiries of external and internal legal counsel.
We also assessed whether management’s policies and processes for making these estimates con-tinue to be applied consistently to all contracts of a similar nature.
Legal and Compliance Area of emphasis
The illegal behavior by any employee or agent that has and may in the future violate the US Foreign Corrupt Practices Act of 1977, OECD (Organisation for Economic Co-operation and Development) legislation, anti-trust laws and other applicable laws and regulations may significantly impact the Company’s reputation, its ability to do business in certain jurisdictions and/or with certain counter-parties or may result in significant fines or civil claims.
Determining the impact and likely outcome of any litigation matter requires significant judgment.
Therefore, estimating litigation reserves and contingent liabilities can involve highly judgmental estimates.
The principal risks include:
• the judgments involved in determining the likely outcome of legal cases, disputes or
investigations results in a risk that those legal provisions may be incorrect; and
• failure to provide on a timely basis for claims due to lack of understanding or awareness of the claims.
See note 15 to these consolidated financial state-ments for ABB’s description of Contingencies – Regulatory, Compliance and Legal.
Our audit response
We assessed judgments and accounting conclusions made by management arising from violation of legislation, anti-trust laws and other regulatory risks.
Our procedures included an evaluation of management’s calculations and the related underlying assumptions to verify that the relevant risks are reflected in the provisions.
Our procedures included discussions with internal legal counsel, and we also obtained and
considered legal letters from external legal counsel and other supporting documentation.
Tax contingency reserves Area of emphasis
The Company operates in multiple jurisdictions and is therefore exposed to numerous tax laws around the world. Risk provisions are held where it is probable that a liability will materialize either in relation to previous planning strategies or a tax position taken in relation to submitted returns subject to tax audit. The amount of such a provision and whether it is probable that it will materialize are both considered to be significant judgmental areas.
is an area of complexity and judgment that is closely managed by ABB and certain provisions are recorded to reflect areas of uncertainty. These matters have come under renewed focus with the current Base Erosion and Profit Shifting rules of the OECD.
The principal risks include:
• significant judgments involved in determining the provision for tax liabilities that can result in misstatement of provisions; and
• there are ranges of possible transfer prices, therefore there is a risk of challenge by the tax authorities, particularly with the increased focus on tax and multinational businesses.
See note 16 to these consolidated financial state-ments for ABB’s description of Taxes.
Area of emphasis
We assessed tax exposures estimated by management and the risk analysis associated with these exposures along with claims or assessments made by tax authorities to date. We verified the components of the tax risk provision to ensure they reflect the tax risks in the business and evaluated the provisions.
We also reviewed documentation in relation to tax audits to ensure that any exposures the tax authorities are raising have been considered and provided for where necessary.
We reviewed, with the involvement of transfer pricing specialists, the significant transfer pricing policies applied by ABB including the related supporting documentation, and ensured that the tax risk provision considered such risks.
Goodwill impairment Area of emphasis
The Company reviews the carrying amount of its reporting units annually or more frequently if im-pairment indicators are present. The current year impairment assessment was performed using the qualitative assessment method to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. This annual impairment test was signifi-cant to our audit because the goodwill balance of USD 11,199 million as of December 31, 2017 is sig-nificant to the financial statements representing 26% of the total assets. In addition, we note that management’s assessment process is based on qualitative factors which are assumption based and highly judgmental.
units and subsequent allocation of goodwill used for impairment assessments; and
• inaccurate factors are used in the qualitative impairment assessment.
See note 11 to these consolidated financial state-ments for ABB’s description of Goodwill and other intangible assets.
Our audit response
Our procedures included a review of the qualitative factors used in the assessment prepared by management to verify that the relevant risks are addressed. We assessed management’s conclusion in regards to the factors used in the qualitative assessment method. We also performed audit procedures on the identification of the goodwill reporting units and performed an independent sensitivity analysis to assess the degree to which assumptions used in the last quantitative assessment performed in 2016 would need to change before an impairment could be triggered.
Illegal act in South Korea Area of emphasis
In February 2017, ABB uncovered criminal activity in its South Korean subsidiary that was an adjusting subsequent event for the consolidated financial statements as of December 31, 2016. The Company disclosed these irregularities and the initial results in a press release on February 22, 2017. The Company immediately launched an investigation in South Korea led by ABB and involving independent forensic and legal
specialists. The investigation by ABB was ongoing throughout 2017 and is now completed. The controls remediation is in progress.
See section “Other income (expense), net” in the Company’s analysis of results of operations within the Financial Review of ABB Group in the Company’s annual report.
Our audit response
Our audit procedures included, amongst others, understanding the nature of the criminal acts, the circumstances in which the acts occurred, and understanding of other relevant information to evaluate the impact on the consolidated financial statements. We shadowed the ABB investigation with the support of EY forensic specialists and discussed on a number of occasions the
investigation with management and the Finance, Audit and Compliance Committee (FACC) to evaluate the approach and the corresponding findings, financial and disclosure consequences and impact on internal controls. We monitored the
remediation process of the Company and performed remediation testing of the impacted controls as well as performed substantive audit procedures for significant accounts in South Korea.
Our audit procedures also included an evaluation of management’s process to ensure that similar control failures could not occur in other
jurisdictions. We performed our own procedures to verify the results of management’s
assessment.