UPM Annual Report 2016

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MATERIALITY Overall group materiality

KEY AUDIT MATTER IN THE AUDIT OF THE GROUP

HOW OUR AUDIT ADDRESSED THE KEY AUDIT MATTER

EUR 54 million (60 million).

Recoverability of deferred tax assets Refer to note 7.2 , in the consolidated financial statements for the related disclosures. The group has recognised deferred tax assets of EUR 226 million on net operating loss carry-forwards, of which most relates to German subsidiaries. In Germany the net operating loss carry-forwards do not expire. We focused on this area because the recognition of deferred tax assets relies on the significant application of judgement by the management in respect of assessing the probability and sufficiency of future taxable profits. Litigations Refer to note 9.2 , in the consolidated financial statements for the related disclosures. We focused on this area because the group is subject to challenge in respect of a number of legal matters, many of which are beyond its control. Consequently, management makes judgements about the incidence and quantum of such liabilities arising from litigation which are subject to the future outcome of legal processes. In particular the group has disclosed that it is participating in a project to construct a new nuclear power plant unit Olkiluoto 3 through its shareholdings in Pohjolan Voima Oy. The supplier AREVA-Siemens, which is constructing the power plant unit initiated arbitration proceedings in 2008 and submitted a claim concerning the delay of project and related costs. Responsibilities of the Board of Directors and the Managing Director for the Financial Statements The Board of Directors and the Managing Director 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 Managing Director 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 Managing Director 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 for 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

We assessed whether historical profitability in German subsidiaries support the recognition of the deferred tax asset. Despite recent history of profits for the German tax group we also assessed whether the management’s forecasts of future profitability support the recoverability of deferred tax assets.

How we determined it

5% of profit before tax.

Rationale for the materiality benchmark applied

We chose profit before taxes as the benchmark because, in our view, it is the benchmark against which the performance of the group is commonly measured by users, and is a generally accepted benchmark. We chose 5% which is within the range of acceptable quantitative materiality thresholds in auditing standards.

How we tailored our group audit scope We tailored the scope of our audit, taking into account the structure of the UPM group, the accounting processes and controls, and the industry in which the group operates.

auditors from other PwC network firms operating under our instruction. Audits were performed in group companies which were considered significant either because of their individual financial significance or due to their specific nature, covering the majority of revenue, assets and liabilities of the group. Selected specified procedures as well as analytical procedures were performed to cover the remaining group companies.

We evaluated the group’s assessment of the nature and status of litigations and claims and discussed them with group management including in-house counsel for signi cant cases. We examined the group’s conclusions with respect to the disclosures made for signi cant cases, both considering the correspondence between

We determined the type of work that needed to be performed at group companies by us, as the group engagement team, or by

the group and its external legal counsel and independently communicating with certain of those external legal counsel.

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. Valuation of forest assets Refer to note 4.2 , in the consolidated financial statements for the related disclosures. The group owns about one million hectares of forests and plantations in Finland, the United States and Uruguay valued at EUR 1,734 million at 31 December 2016. Forest assets are measured at fair value less cost to sell. The fair value is calculated on the basis of discounted future expected cash flows as there is a lack of a liquid market. Young saplings are valued at cost. Main factors used in the valuation are estimates for growth and wood harvested, stumpage prices and discount rates. We focused on this area as the amounts are material, the valuation process is complex and judgmental and is based on assumptions that are affected by expected future market or economic conditions. Valuation of energy shareholdings Refer to note 4.3 , in the consolidated financial statements for the related disclosures The energy shareholdings amounted to EUR 1,932 million at 31 December 2016. The energy shareholdings are unlisted equity investments in energy companies and are valued at fair value through other comprehensive income, net of tax if applicable. The fair value is determined on a discounted cash flow basis. The main factors impacting the future cash flows include future electricity prices, price trends, discount rates and the start-up schedule of the nuclear power plant unit Olkiluoto 3. We focused on this area as the amounts are material, the valuation process is complex and judgmental and is based on assumptions that are affected by expected future market or economic conditions. KEY AUDIT MATTER IN THE AUDIT OF THE GROUP

As set out in the nancial statements, the outcome of such cases is dependent on the future outcome of continuing legal processes and consequently the disclosures are subject to inherent uncertainty.

As in all of our audits, we also addressed the risk of management override of internal controls, including among other matters consideration of whether there was evidence of bias that represented a risk of material misstatement due to fraud.

We have no key audit matters to report with respect to our audit of the parent company financial statements.

HOW OUR AUDIT ADDRESSED THE KEY AUDIT MATTER

In testing the valuation of forest assets, in conjunction with our valuation specialists we:

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 financial statements. As part of an audit in accordance 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 collu- sion, 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 circum- stances, but not for the purpose of expressing an opinion on the effectiveness of the parent company’s or the group’s internal cont- rol. • 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 Managing Director’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 uncer- tainty 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 conclu-

• Assessed the methodologies adopted by management for the valua- tion; • Tested the mathematical accuracy of the model used for valuation;

• Assessed the discount rates applied in the valuation; • Assessed the other key valuation assumptions; and,

• Validated key inputs and data used in valuation model such as stum- page price, trend price forecast, tree growth assumptions, consumer price index and inflation.

We found the methodologies used and the assumptions applied to be appropriate.

In testing the valuation of the energy shareholdings, in conjunction with our valuation specialists we:

• Assessed the methodology adopted by management for the valua- tion; • Tested the mathematical accuracy of the model used for valuation; • Assessed the future electricity prices and price trends; • Assessed the discount rate applied in the valuation; • Validated the Olkiluoto 3 nuclear power plant unit start-up schedule against the most recent available information; • Validated key inputs and data used in valuation model such as pro- duction costs and volumes, UPM’s ownership percentages, inflation, tax rate and net debt.

We found the methodologies and the assumptions applied to be appropriate.

CONTENTS

ACCOUNTS

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UPM Annual Report 2016

UPM Annual Report 2016