KOGENERACJA S.A. - Annual report 2019 | Report of the independent auditor

To the General Meeting and the Supervisory Board of Zespół Elektrociepłowni Wrocławskich KOGENERACJA S.A

Report on the audit of the annual consolidated financial statement

Opinion

We have audited the annual consolidated financial statements of the Group ("the Group"), in Zespół Elektrociepłowni Wrocławskich KOGENERACJA S.A. is the parent company. ("Parent Company"), which comprise the consolidated statement of financial position as of 31 December 2019 and the consolidated statement of comprehensive income, the consolidated statement of changes in equity, the consolidated statement of cash flows for the year then ended and notes, comprising a description of the adopted accounting policies and other explanatory information ("the consolidated financial statements").

In our opinion, the consolidated financial statement:

gives a true and fair view of the Group's financial position as of 31 December 2019 and its financial performance and its financial flows for the year then ended, in accordance with applicable International Financial Reporting Standards as adopted by the European Union and with adopted accounting policies;
is consistent in form and content with the Group's legal regulations and the Parent's Articles of Association.

This opinion is consistent with the additional report to the Audit Committee that we issued on 9 March 2020.

We conducted our audit in accordance with International Standards on Auditing as adopted as National Standards on Auditing by the National Board of Statutory Auditors ("KSB") and in accordance with the Act on Statutory Auditors, Audit Firms and Public Supervision of 11 May 2017 ("Act on Auditors" - The EU Regulation of 2019, item 1421 as amended) and the EU Regulation No. 537/2014 of 16 April 2014 on detailed requirements concerning statutory audits of public-interest entities ("EU Regulation" - EU Official Journal L158). Our responsibility in accordance with these standards is further described in the section of our report Auditor's responsibility for auditing the consolidated financial statements.

We are independent of the Group's companies in accordance with the Code of Ethics for Professional Accountants of the International Federation of Accountants ("IFAC Code") adopted by a resolution of the National Council of Statutory Auditors and with other ethical requirements that apply to the audit of financial statements in Poland. We have fulfilled our other ethical obligations in accordance with these requirements and the IFAC Code. During the course of the audit, the key statutory auditor and the audit firm remained independent of the Group companies in accordance with the independence requirements set out in the Act on Statutory Auditors and in the EU Regulation.

We believe that the research evidence we have obtained is sufficient and appropriate to support our opinion.

We would like to draw your attention to note 42 to the condensed interim consolidated financial statements, which describes the effects of an error concerning the calculation of an asset on deferred tax. Our report is not modified with respect to this matter.

The Group's consolidated financial statements for the year ended 31 December 2018 were audited by an auditor acting on behalf of another auditing firm, who expressed an unqualified opinion on these statements on 11 March 2019.

The key matters of the audit are those which, in our professional judgment, were most significant during the audit of the consolidated financial statements for the current financial year. They include the most significant assessed risks of material misstatement, including assessed risks of material misstatement caused by fraud. We have addressed these matters in the context of our audit of the consolidated financial statements as a whole and in forming our opinion and summarized our response to these risks and, where we considered it appropriate, made key observations related to these risks. We do not express a separate opinion on these matters.

Key issue of the audit	How did our investigation relate to this case
Impairment of fixed assets The net value of property, plant and equipment of Wrocław Heat and Power Plants Group KOGENERACJA S.A. Group presented in the consolidated financial statements as at 31 December 2019 amounted to PLN 1,607 million and goodwill to PLN 42 million. As at 31 December 2019 The Management Board of the Parent identified indications of impairment of assets, including changes in energy prices, greenhouse gas emission allowances and raw material prices. As a result, the Management Board of the Parent Company carried out impairment tests with respect to funds generating units. The impairment tests were prepared on the basis of estimates adopted by the Management Board of the Parent Company, prepared on the basis of, among others, forecasts of electricity, hard coal and greenhouse gas emission allowances, taking into account other key assumptions concerning operational parameters, including the impact of the introduction of the power market in Poland, as well as the Polish energy strategy. Impairment of property, plant and equipment was considered a key issue of the audit due to the value of fixed assets disclosed in the consolidated financial statements, as well as due to significant and complex estimates included in the prepared impairment test. The Group's disclosures regarding the impairment testing of assets are included in note 9 "Intangible assets" and 13 "Asset impairment testing". Disclosures concerning material estimates are presented in note 39 "Accounting estimates and assumptions".	As part of the audit, we documented our understanding of the process and identified control mechanisms for the identification of evidence of impairment and the process of impairment testing, and assessed how to identify funds-generating units. We have designed and carried out test procedures in relation to the conducted impairment tests. These procedures included, among others, assessment of the impairment model and its assumptions, with the support of valuation specialists, including: evaluation of financial forecasts adopted by the Management Board by comparing the current results with previous forecasts; comparison of assumptions in the model (including future revenues, costs and margins achieved) with market data presented by the Company's Management Board; comparison of the applied discount rates with market data; analysis of the arithmetic correctness of the discounted cash flow model and reconciliation of source data to financial forecasts presented by the Management Board; assessing the adequacy of disclosures for impairment testing.
Compensation for the termination of long-term power and electricity sale agreements (PPAs) Subsidiary of Heat and Power Plant "Zielona Góra" S.A. ("EC Zielona Góra") participates in the cost coverage system regulated by the Act of 29 June 2007 on the principles of covering costs incurred by the generators in connection with the early termination of long-term agreements for the sale of power and electricity ("stranded costs"; "Stranded Costs Act"). Based on the provisions of the Act, HPP Zielona Góra receives stranded costs compensation for the termination of long-term power and electricity sale agreements (PPAs) in the form of quarterly advances, adjusted by appropriate annual adjustments. A final adjustment is made at the end of the full period for which the PPAs were concluded. The amounts related to compensation for PPAs of HPP Zielona Góra included in the Group's consolidated statement of comprehensive income for the year ended 31 December 2019 amounted to PLN 7 million. The value of revenue from annual adjustments and the expected final adjustment is quantified on the basis of a comprehensive financial model prepared by the Management Board of HPP Zielona Góra based on the estimation of the relation between the operating results of HPP Zielona Góra in the period of participation in the stranded costs coverage system, i.e. until 2025. The issue of compensation for the termination of long-term contracts has been identified as a key issue for the audit due to the scale of the transaction and the fact that it is an area of significant estimation by the Management Board. Disclosures concerning the costs of LTC compensation are contained in Note 2 "Compensation for stranded costs of HPP Zielona Góra S.A. subsidiary. - Notes to the consolidated financial statements. Disclosures concerning material estimates are presented in Note 39 "Accounting estimates and assumptions”.	As part of the audit, we analyzed and evaluated the accounting policy for recognition of revenues from compensation and the methodology implemented by the Management Board for determining and recognizing such revenues. In addition, we documented an understanding of the process and related control mechanisms for the accounting treatment of compensation, including annual compensation, final adjustment and reimbursement of compensation made in previous years. Our procedures also included, among others: assessment of assumptions made for the preparation of the financial model used to calculate the final adjustment; evaluation of the arithmetic correctness of the model indicated above; assessing the adequacy of disclosures of compensation income in the consolidated financial statements.
Audit of consolidated financial statements for the first time The Group's financial statements for the financial year ended 31 December 2019 were the first consolidated financial statements to be audited. Due to the size and scope of the Group's operations, it was important to understand the Group's organizational structure and its impact on the processes in the Group. In the course of the study we conducted a number of additional procedures in order to understand and acquire the necessary knowledge about the subject: the Group's business profile and the processes that accompany it, specific risks associated with the business zaimplementowanych przez Grupę mechanizmów kontrolnych oraz przyjętych politykach mających wpływ na sprawozdawczość finansową Grupy. These procedures have allowed us to assess the risk of testing, identify the risk of material misstatement, including inherent testing and control risks, determine the level of materiality, as well as the scope of testing procedures. Additionally, as part of the first annual audit of the consolidated financial statements, the purpose of our additional procedures was to determine whether the initial states contain potential significant distortions affecting the consolidated financial statements for the current period and whether the accounting principles (policy) applied to the initial states were applied continuously when preparing the consolidated financial statements for the current period, or whether the changes that were made to them were correctly accounted for and presented in accordance with the applicable financial reporting assumptions.	Our examination procedures included in particular: conducting an initiation meeting with key personnel responsible for financial reporting of the Group; familiarization with the control mechanisms implemented in the Group and testing of selected controls in relation to particular processes; understanding of the Group's accounting policy and significant values included in the consolidated financial statements based on professional judgement and estimates; communication with the key auditor acting on behalf of the former audit firm, including discussion of key issues in the Group's audit; an assessment of the main audit issues from the previous reporting period and their impact on the Group's financial statements for the current financial year and the initial financial statements; assessing the adequacy of disclosures, in accordance with International Accounting Standard 8 Accounting Policies, Changes in Accounting Estimates and Errors, in the Group's financial statements. The results of our procedures were communicated to the Group's Management Board and the Audit Committee.

Key issue of the audit

How did our investigation relate to this case

Impairment of fixed assets

The net value of property, plant and equipment of Wrocław Heat and Power Plants Group KOGENERACJA S.A. Group presented in the consolidated financial statements as at 31 December 2019 amounted to PLN 1,607 million and goodwill to PLN 42 million.

As at 31 December 2019 The Management Board of the Parent identified indications of impairment of assets, including changes in energy prices, greenhouse gas emission allowances and raw material prices. As a result, the Management Board of the Parent Company carried out impairment tests with respect to funds generating units. The impairment tests were prepared on the basis of estimates adopted by the Management Board of the Parent Company, prepared on the basis of, among others, forecasts of electricity, hard coal and greenhouse gas emission allowances, taking into account other key assumptions concerning operational parameters, including the impact of the introduction of the power market in Poland, as well as the Polish energy strategy. Impairment of property, plant and equipment was considered a key issue of the audit due to the value of fixed assets disclosed in the consolidated financial statements, as well as due to significant and complex estimates included in the prepared impairment test.

The Group's disclosures regarding the impairment testing of assets are included in note 9 "Intangible assets" and 13 "Asset impairment testing". Disclosures concerning material estimates are presented in note 39 "Accounting estimates and assumptions".

As part of the audit, we documented our understanding of the process and identified control mechanisms for the identification of evidence of impairment and the process of impairment testing, and assessed how to identify funds-generating units. We have designed and carried out test procedures in relation to the conducted impairment tests. These procedures included, among others, assessment of the impairment model and its assumptions, with the support of valuation specialists, including:

evaluation of financial forecasts adopted by the Management Board by comparing the current results with previous forecasts;
comparison of assumptions in the model (including future revenues, costs and margins achieved) with market data presented by the Company's Management Board;
comparison of the applied discount rates with market data;
analysis of the arithmetic correctness of the discounted cash flow model and reconciliation of source data to financial forecasts presented by the Management Board;
assessing the adequacy of disclosures for impairment testing.

Compensation for the termination of long-term power and electricity sale agreements (PPAs)

Subsidiary of Heat and Power Plant "Zielona Góra" S.A. ("EC Zielona Góra") participates in the cost coverage system regulated by the Act of 29 June 2007 on the principles of covering costs incurred by the generators in connection with the early termination of long-term agreements for the sale of power and electricity ("stranded costs"; "Stranded Costs Act"). Based on the provisions of the Act, HPP Zielona Góra receives stranded costs compensation for the termination of long-term power and electricity sale agreements (PPAs) in the form of quarterly advances, adjusted by appropriate annual adjustments. A final adjustment is made at the end of the full period for which the PPAs were concluded. The amounts related to compensation for PPAs of HPP Zielona Góra included in the Group's consolidated statement of comprehensive income for the year ended 31 December 2019 amounted to PLN 7 million.

The value of revenue from annual adjustments and the expected final adjustment is quantified on the basis of a comprehensive financial model prepared by the Management Board of HPP Zielona Góra based on the estimation of the relation between the operating results of HPP Zielona Góra in the period of participation in the stranded costs coverage system, i.e. until 2025. The issue of compensation for the termination of long-term contracts has been identified as a key issue for the audit due to the scale of the transaction and the fact that it is an area of significant estimation by the Management Board.

Disclosures concerning the costs of LTC compensation are contained in Note 2 "Compensation for stranded costs of HPP Zielona Góra S.A. subsidiary. - Notes to the consolidated financial statements. Disclosures concerning material estimates are presented in Note 39 "Accounting estimates and assumptions”.

As part of the audit, we analyzed and evaluated the accounting policy for recognition of revenues from compensation and the methodology implemented by the Management Board for determining and recognizing such revenues. In addition, we documented an understanding of the process and related control mechanisms for the accounting treatment of compensation, including annual compensation, final adjustment and reimbursement of compensation made in previous years.

Our procedures also included, among others:

assessment of assumptions made for the preparation of the financial model used to calculate the final adjustment;
evaluation of the arithmetic correctness of the model indicated above;
assessing the adequacy of disclosures of compensation income in the consolidated financial statements.

Audit of consolidated financial statements for the first time

The Group's financial statements for the financial year ended 31 December 2019 were the first consolidated financial statements to be audited. Due to the size and scope of the Group's operations, it was important to understand the Group's organizational structure and its impact on the processes in the Group.

In the course of the study we conducted a number of additional procedures in order to understand and acquire the necessary knowledge about the subject:

the Group's business profile and the processes that accompany it,
specific risks associated with the business
zaimplementowanych przez Grupę mechanizmów kontrolnych oraz przyjętych politykach mających wpływ na sprawozdawczość finansową Grupy.

These procedures have allowed us to assess the risk of testing, identify the risk of material misstatement, including inherent testing and control risks, determine the level of materiality, as well as the scope of testing procedures.

Additionally, as part of the first annual audit of the consolidated financial statements, the purpose of our additional procedures was to determine whether the initial states contain potential significant distortions affecting the consolidated financial statements for the current period and whether the accounting principles (policy) applied to the initial states were applied continuously when preparing the consolidated financial statements for the current period, or whether the changes that were made to them were correctly accounted for and presented in accordance with the applicable financial reporting assumptions.

Our examination procedures included in particular:

conducting an initiation meeting with key personnel responsible for financial reporting of the Group;
familiarization with the control mechanisms implemented in the Group and testing of selected controls in relation to particular processes;
understanding of the Group's accounting policy and significant values included in the consolidated financial statements based on professional judgement and estimates;
communication with the key auditor acting on behalf of the former audit firm, including discussion of key issues in the Group's audit;
an assessment of the main audit issues from the previous reporting period and their impact on the Group's financial statements for the current financial year and the initial financial statements;
assessing the adequacy of disclosures, in accordance with International Accounting Standard 8 Accounting Policies, Changes in Accounting Estimates and Errors, in the Group's financial statements.

The results of our procedures were communicated to the Group's Management Board and the Audit Committee.

The Management Board of the Parent Company is responsible for the preparation of consolidated financial statements that give a true and fair view of the financial position and financial performance of the Group in accordance with applicable International Financial Reporting Standards as adopted by the European Union, the accounting principles (policy) adopted and the laws and regulations applicable to the Group and the Group's Articles of Association, and for such internal control as the Management Board of the Parent Company deems necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

When preparing the consolidated financial statements, the Management Board of the Parent Company is responsible for assessing the Group's ability to continue as a going concern, disclosing, if applicable, matters related to the going concern and adopting the going concern principle as the basis of accounting, except when the Management Board of the Parent Company either intends to liquidate the Group or to discontinue operations, or has no realistic alternative to do so.

The Management Board of the Parent Company and members of the Supervisory Board of the Parent Company are obliged to ensure that the consolidated financial statements meet the requirements provided for in the Accounting Act of 29 September 1994 ("the Accounting Act" - Journal of Laws of 2019, item 351, as amended). Members of the Supervisory Board of the parent company are responsible for supervising the financial reporting process.

Our objectives are to obtain reasonable assurance that the consolidated financial statements as a whole do not contain any material misstatement due to fraud or error and to issue an audit report containing our opinion. Rational certainty is a high level of certainty, but does not guarantee that a KSB test always detects an existing significant distortion. Distortions may arise from fraud or error and are considered material if it can be reasonably expected that, either individually or in combination, they would influence the economic decisions of users taken on the basis of these consolidated financial statements.

The scope of the audit does not include assurance as to the future profitability of the Group or the efficiency or effectiveness of the management of its affairs by the Management Board of the Parent Company at present or in the future.

During the examination in accordance with KSB we apply professional judgment and maintain professional skepticism, as well:

we identify and assess risks of material misstatement of the consolidated financial statements due to fraud or error, design and perform audit procedures appropriate to those risks, and obtain audit evidence that is sufficient and appropriate to support our opinion. The risk of failure to detect material misstatement due to fraud is greater than that due to error because fraud may involve collusion, misrepresentation, intentional omissions, introduction of misrepresentation or circumvention of internal control;
we obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not to express an opinion on the effectiveness of the Group's internal control;
we assess the appropriateness of the accounting policies used and the reasonableness of the accounting estimates and related disclosures made by the Management Board of the parent company;
we conclude that the Management Board of the Parent Company has applied the going concern principle as the basis of accounting and, based on the audit evidence obtained, whether there is any material uncertainty related to events or conditions that could cast significant doubt on the Group's ability to continue operations. If we conclude that there is a material uncertainty, we are required to draw attention in our audit report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on audit evidence obtained up to the date of our auditor's report, however, future events or conditions may cause the Group to discontinue its operations;
we evaluate the overall presentation, structure and content of the consolidated financial statements, including disclosures, and whether the consolidated financial statements present the underlying transactions and events in a manner that ensures a fair presentation;
we obtain sufficient appropriate audit evidence about the financial information of the entities or intra-group operations to express an opinion on the consolidated financial statements. We are responsible for directing, supervising and conducting the Group audit and remain solely responsible for our audit opinion.

We provide the Supervisory Board of the Parent Company with information on, i.a., the planned scope and time of the audit and significant findings of the audit, including any significant weaknesses in internal control that we identify during the audit.

We submit a statement to the Supervisory Board of the Parent Company that we have complied with the relevant ethical requirements for independence and that we will inform it of all relationships and other matters that could reasonably be considered a threat to our independence, and, where applicable, we will inform it of the safeguards applied.

Of the matters submitted to the Supervisory Board of the Parent Company, we identified those matters which were most significant during the audit of the consolidated financial statements for the current financial year and therefore we considered them to be the key matters of the audit. We shall describe these matters in our auditor's report unless laws or regulations prohibit their public disclosure or where, in exceptional circumstances, we determine that an issue should not be presented in our report because the negative consequences could reasonably be expected to outweigh the public interest benefits of such information.

Other information includes the Group's report on its operations for the financial year ended 31 December 2019. ("Report on operations") together with a statement on the application of corporate governance and a statement on non-financial information referred to in Article 49b(1) of the Accounting Act, which are separate parts of this Report (together "Other information").

Responsibility of the Management Board and Supervisory Board

The Management Board of the Parent Company is responsible for the preparation of Other information in accordance with legal regulations.

The Management Board of the Parent Company and members of the Supervisory Board of the Parent Company are obliged to ensure that the Report on operations together with the separated parts meet the requirements provided for in the Accounting Act.

Auditor's responsibility

Our audit opinion on the consolidated financial statements does not include any other information. In connection with the audit of the consolidated financial statements, it is our responsibility to review the Other Information, and in doing so, to consider whether the Other Information is not materially inconsistent with the consolidated financial statements or with our audit knowledge or otherwise appears to be materially distorted. If, based on the work performed, we become aware of material misstatements in Other Information, we are required to disclose them in our audit report. As required under the Act on Auditors, we are also required to issue an opinion on whether the Report on the Company's activities are in compliance with the regulations and whether they are consistent with the consolidated financial statements. In addition, we are required to state whether the Group has prepared a statement of non-financial information and to issue an opinion on whether the Group has included the required information in its corporate governance statement.

Based on the work carried out in the course of the audit, in our opinion, the Activity Report:

has been prepared in accordance with Article 49 of the Accounting Act and paragraph 71 of the Regulation of the Minister of Finance of 29 March 2018 on current and periodic information to be published by issuers of securities and conditions for recognizing as equivalent information required by the laws of a non-member state ("Regulation on current information" - Journal of Laws of 2018, item 757),

is consistent with the information contained in the consolidated financial statements.

Furthermore, in the light of our knowledge of the Group and its environment during our audit, we declare that we have not found any material misstatements in the Business Report.

In our opinion, in its statement on the application of corporate governance, the Group included the information specified in paragraph 70.6.5 of the Regulation on current information. In addition, in our opinion, the information specified in paragraph 70.6(5)(c-f), (h) and that Regulation contained in the corporate governance statement is consistent with the applicable regulations and information contained in the consolidated financial statements.

In accordance with the requirements of the Act on Statutory Auditors, we confirm that the Group has prepared a statement on non-financial information referred to in Article 49b(1) of the Accounting Act as a separate part of the Report on operations.

We have not performed any attestation work on the non-financial information statement and do not express any assurance about it.

To the best of our knowledge and belief, we declare that the non-audit services we have provided to the Parent Company and its subsidiaries are in accordance with the laws and regulations in force in Poland and that we have not provided non-audit services which are prohibited under Article 5(1) of the EU Regulation and Article 136 of the Act on Auditors. The services not constituting an audit of the financial statements that we provided to the Parent Company and its subsidiaries during the audited period are listed in section "Agreement concluded with an entity authorized to audit financial statements" of the Report on operations.

We were appointed to audit the Group's consolidated financial statements by virtue of Resolution No. 1/700/2019 of the Parent Company's Supervisory Board of 22 January 2019. We are auditing the consolidated financial statements of the Group for the first time.

Adrian Karaś is the key auditor responsible for the audit, the result of which is this independent auditor's report.

Acting on behalf of Deloitte Audyt limited liability company Sp. k. with its registered office in Warsaw, entered on the list of audit firms under number 73, on behalf of which the key statutory auditor audited the financial statemen:

ADRIAN KARAŚ
No. in the register: 12194

Warsaw, 9 march 2020

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