Critical Audit Matters
Auditor Opinion Overview
| Filing | 2021 10-K | Company Page | AES CORP |
|---|---|---|---|
| Fiscal Year | 2021-12-31 | Signature Date | 2022-02-28 |
| Auditor | Ernst & Young LLP | Location | Tysons, VIRGINIA |
| Critical Audit Matters | |||
1: Goodwill
"Goodwill Impairment Evaluation of the AES Andes Reporting Unit
"
Description:
Description of the Matter At December 31, 2021, the Company’s goodwill balance was $1,177 million, of which $644 million relates to the AES Andes reporting unit. As disclosed in Note 1 to the consolidated financial statements, the Company’s goodwill is tested for impairment at least annually at the reporting unit level. The goodwill impairment test at the AES Andes reporting unit involves the use of significant unobservable inputs to determine the fair value of the reporting unit. This estimate of fair value is compared to the carrying value of the reporting unit to determine whether goodwill is impaired. Auditing the Company's measurement of the fair value of the AES Andes reporting unit involved a high degree of subjectivity given the lack of observable inputs to estimate the reporting unit’s fair value. Key inputs that had a significant impact on the valuation included the prospective financial information (including the estimated growth in renewable projects, forward electricity prices and developments in the Chilean capacity market) and the discount rate, which were forward-looking and based upon expectations about future economic and market conditions.
Description of the Matter At December 31, 2021, the Company’s goodwill balance was $1,177 million, of which $644 million relates to the AES Andes reporting unit. As disclosed in Note 1 to the consolidated financial statements, the Company’s goodwill is tested for impairment at least annually at the reporting unit level. The goodwill impairment test at the AES Andes reporting unit involves the use of significant unobservable inputs to determine the fair value of the reporting unit. This estimate of fair value is compared to the carrying value of the reporting unit to determine whether goodwill is impaired. Auditing the Company's measurement of the fair value of the AES Andes reporting unit involved a high degree of subjectivity given the lack of observable inputs to estimate the reporting unit’s fair value. Key inputs that had a significant impact on the valuation included the prospective financial information (including the estimated growth in renewable projects, forward electricity prices and developments in the Chilean capacity market) and the discount rate, which were forward-looking and based upon expectations about future economic and market conditions.
Response:
How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s goodwill impairment review process at the AES Andes reporting unit. For example, we tested controls over management’s review of the valuation model, the significant assumptions used to develop the estimates, and the completeness and accuracy of the data used in the valuations. To test the estimated fair value of the Company’s AES Andes reporting unit, we performed audit procedures that included, among others, assessing the methodologies used to develop the estimate of fair value, testing the significant assumptions discussed above, and testing the completeness and accuracy of the underlying data used by the Company in its analyses. We compared the significant assumptions used by management to current industry and economic trends as well as historical results. We assessed the historical accuracy of management’s estimates and performed sensitivity analyses of significant assumptions to evaluate the changes in the fair value of the reporting unit that would result from changes in the assumptions. We also involved valuation specialists to assist in our evaluation of the overall methodologies and the discount rate used in the fair value estimate.
How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s goodwill impairment review process at the AES Andes reporting unit. For example, we tested controls over management’s review of the valuation model, the significant assumptions used to develop the estimates, and the completeness and accuracy of the data used in the valuations. To test the estimated fair value of the Company’s AES Andes reporting unit, we performed audit procedures that included, among others, assessing the methodologies used to develop the estimate of fair value, testing the significant assumptions discussed above, and testing the completeness and accuracy of the underlying data used by the Company in its analyses. We compared the significant assumptions used by management to current industry and economic trends as well as historical results. We assessed the historical accuracy of management’s estimates and performed sensitivity analyses of significant assumptions to evaluate the changes in the fair value of the reporting unit that would result from changes in the assumptions. We also involved valuation specialists to assist in our evaluation of the overall methodologies and the discount rate used in the fair value estimate.
Reference:
Note 1
Note 1
2: Property, plant and equipment
"Identification and Valuation of Long-Lived Asset Impairments and Re-evaluation of Useful Lives"
Description:
Description of the Matter At December 31, 2021, the Company's property, plant and equipment had an aggregate net carrying value of approximately $19,906 million. As disclosed in Note 1 to the consolidated financial statements, when circumstances indicate the carrying amount of long-lived assets in a held-for-use asset group may not be recoverable, the Company evaluates the assets for potential impairment and re-evaluates the remaining useful life. These circumstances may include, but are not limited to, changes in the regulatory environment, demand, power prices or fuel costs, technological advancements, physical deterioration, or an expectation it is more likely than not that the asset will be disposed of before the end of its useful life. In 2021, as disclosed in Footnote 22 to the consolidated financial statements, the Company recognized a total asset impairment expense of $1,575 million, primarily related to the Company’s Puerto Rico, Ventanas 3 & 4 and Angamos asset groups. Auditing the Company's identification and evaluation of impairment indicators involved significant auditor judgment considering the many geographic, regulatory, and economic environments in which the Company operates. Similarly, auditing the Company’s re-evaluation of useful lives required a high degree of subjectivity, particularly as it related to the Company’s coal generation assets given the Company’s decarbonization initiatives and the potential risks associated with climate change that have led to increased regulation and other actions. These audit procedures required an evaluation of a wide variety of circumstances for potential changes in useful lives or impairment indicators. In addition, auditing the Company’s valuation of long-lived asset impairments involved significant judgment related to the estimation of the asset groups’ fair value. There was a high degree of subjectivity given the lack of observable inputs to estimate the fair value. Key inputs that had a significant impact on the valuation included the prospective financial information (including the expected retirement dates of the plants and the probabilities assigned to the different scenarios) and the discount rate, which were forward-looking and based upon expectations about future economic and market conditions.
Description of the Matter At December 31, 2021, the Company's property, plant and equipment had an aggregate net carrying value of approximately $19,906 million. As disclosed in Note 1 to the consolidated financial statements, when circumstances indicate the carrying amount of long-lived assets in a held-for-use asset group may not be recoverable, the Company evaluates the assets for potential impairment and re-evaluates the remaining useful life. These circumstances may include, but are not limited to, changes in the regulatory environment, demand, power prices or fuel costs, technological advancements, physical deterioration, or an expectation it is more likely than not that the asset will be disposed of before the end of its useful life. In 2021, as disclosed in Footnote 22 to the consolidated financial statements, the Company recognized a total asset impairment expense of $1,575 million, primarily related to the Company’s Puerto Rico, Ventanas 3 & 4 and Angamos asset groups. Auditing the Company's identification and evaluation of impairment indicators involved significant auditor judgment considering the many geographic, regulatory, and economic environments in which the Company operates. Similarly, auditing the Company’s re-evaluation of useful lives required a high degree of subjectivity, particularly as it related to the Company’s coal generation assets given the Company’s decarbonization initiatives and the potential risks associated with climate change that have led to increased regulation and other actions. These audit procedures required an evaluation of a wide variety of circumstances for potential changes in useful lives or impairment indicators. In addition, auditing the Company’s valuation of long-lived asset impairments involved significant judgment related to the estimation of the asset groups’ fair value. There was a high degree of subjectivity given the lack of observable inputs to estimate the fair value. Key inputs that had a significant impact on the valuation included the prospective financial information (including the expected retirement dates of the plants and the probabilities assigned to the different scenarios) and the discount rate, which were forward-looking and based upon expectations about future economic and market conditions.
Response:
How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of the Company’s controls over the identification of impairment indicators, estimation of useful lives (including any changes if necessary) and valuation of the long-lived asset impairments. For example, we tested management’s monitoring controls over businesses that have had been affected or are expected to be affected by the circumstances above. Our testing also included management’s review controls of the valuation model, the significant assumptions used to develop the estimates, and the completeness and accuracy of the data used in the valuations. Our audit procedures included, among others, making inquiries of management (including personnel in operations) to understand changes in the businesses, reading industry journals and publications to independently identify changes in the regulatory environments or the geographic areas and evaluating whether management has considered identified changes, if any. We considered businesses for which current power prices are significantly less than contractual prices within Power Purchase Agreements (PPAs) that are also near expiration. We also considered the Company’s ability to re-contract certain of its coal generation assets upon the expiration of a PPA, given the most recent legislative or regulatory changes. We evaluated the Company’s analysis of the useful lives of its coal generation assets, considering the existing PPAs and the Company’s ability to use the assets subsequent to the expiration of a PPA, based on any regulatory or market changes. For projects that were still under construction, we compared the Company's actual progress to their budgets, inspected engineering reports when considered appropriate, and considered project overruns. We reviewed disaggregated financial results for deterioration in earnings performance compared to prior periods, negative cash flows from operations, and working capital deficiencies and assessed whether these would represent impairment indicators, when applicable. We also considered and assessed conditions and trends in the industry and the underlying economies and evaluated sale or disposition activities. When testing the impairment analyses for AES Puerto Rico, Ventanas and Angamos, our audit procedures included, among others, obtaining an understanding of management’s strategic view of the plants given the regulatory changes, evaluating management’s assessment of the lowest level of identifiable cash flows, assessing the appropriateness of methodologies, testing the significant assumptions discussed above and testing the completeness and accuracy of the underlying data used by the Company in its analyses. We compared the significant assumptions used by management to current industry and economic trends, latest regulations as well as historical results. We assessed the historical accuracy of management’s estimates and performed sensitivity analyses of significant assumptions to evaluate the changes in the fair value of the asset groups that would result from changes in the assumptions. We also involved valuation specialists to assist in our evaluation of the overall methodology and the discount rate used in the fair value estimate.
How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of the Company’s controls over the identification of impairment indicators, estimation of useful lives (including any changes if necessary) and valuation of the long-lived asset impairments. For example, we tested management’s monitoring controls over businesses that have had been affected or are expected to be affected by the circumstances above. Our testing also included management’s review controls of the valuation model, the significant assumptions used to develop the estimates, and the completeness and accuracy of the data used in the valuations. Our audit procedures included, among others, making inquiries of management (including personnel in operations) to understand changes in the businesses, reading industry journals and publications to independently identify changes in the regulatory environments or the geographic areas and evaluating whether management has considered identified changes, if any. We considered businesses for which current power prices are significantly less than contractual prices within Power Purchase Agreements (PPAs) that are also near expiration. We also considered the Company’s ability to re-contract certain of its coal generation assets upon the expiration of a PPA, given the most recent legislative or regulatory changes. We evaluated the Company’s analysis of the useful lives of its coal generation assets, considering the existing PPAs and the Company’s ability to use the assets subsequent to the expiration of a PPA, based on any regulatory or market changes. For projects that were still under construction, we compared the Company's actual progress to their budgets, inspected engineering reports when considered appropriate, and considered project overruns. We reviewed disaggregated financial results for deterioration in earnings performance compared to prior periods, negative cash flows from operations, and working capital deficiencies and assessed whether these would represent impairment indicators, when applicable. We also considered and assessed conditions and trends in the industry and the underlying economies and evaluated sale or disposition activities. When testing the impairment analyses for AES Puerto Rico, Ventanas and Angamos, our audit procedures included, among others, obtaining an understanding of management’s strategic view of the plants given the regulatory changes, evaluating management’s assessment of the lowest level of identifiable cash flows, assessing the appropriateness of methodologies, testing the significant assumptions discussed above and testing the completeness and accuracy of the underlying data used by the Company in its analyses. We compared the significant assumptions used by management to current industry and economic trends, latest regulations as well as historical results. We assessed the historical accuracy of management’s estimates and performed sensitivity analyses of significant assumptions to evaluate the changes in the fair value of the asset groups that would result from changes in the assumptions. We also involved valuation specialists to assist in our evaluation of the overall methodology and the discount rate used in the fair value estimate.
Reference:
Note 1
Note 1
3: Business combinations
"Accounting for the Merger of sPower and Distributed Energy Development Platforms
"
Description:
Description of the Matter As disclosed in Footnote 25 to the consolidated financial statements, the Company completed the merger of the sPower and AES Renewable Holdings development platforms to form AES Clean Energy Development in 2021. As part of the transaction, AES acquired an additional 25% ownership interest in the sPower development platform in exchange for a 25% ownership interest in specifically identified development entities of AES Renewable Holdings, certain future exit rights in the new partnership, and $7 million of cash. The acquisition of the sPower development platform was accounted for as a step acquisition as a result of the Company’s previously held interest. The sPower development assets were remeasured at their acquisition-date fair values resulting in a $214 million gain. The Company also recorded goodwill of $45 million representing the difference between the fair value of the consideration transferred and the fair value of the identifiable assets acquired and liabilities assumed. Auditing the Company’s accounting for the merger was complex due to the significant estimation in management’s determination of the fair value of the non-cash consideration transferred as well as the acquired assets. Specifically, the fair value of the sPower development pipeline and the intangible assets associated with the contracted and uncontracted projects acquired from sPower involved significant estimation uncertainty. The estimation uncertainty was primarily related to underlying assumptions about the future performance of the development projects or other unobservable inputs. The Company used a discounted cash flow model to measure the fair value of the development pipeline and acquired intangible assets. The significant assumptions used included discount rates and certain assumptions that form the basis of the forecasted results (e.g., pipeline capacity, developer profit, probability of project completion and expected timing of completion). These significant assumptions were forward looking and could be affected by future economic and market conditions.
Description of the Matter As disclosed in Footnote 25 to the consolidated financial statements, the Company completed the merger of the sPower and AES Renewable Holdings development platforms to form AES Clean Energy Development in 2021. As part of the transaction, AES acquired an additional 25% ownership interest in the sPower development platform in exchange for a 25% ownership interest in specifically identified development entities of AES Renewable Holdings, certain future exit rights in the new partnership, and $7 million of cash. The acquisition of the sPower development platform was accounted for as a step acquisition as a result of the Company’s previously held interest. The sPower development assets were remeasured at their acquisition-date fair values resulting in a $214 million gain. The Company also recorded goodwill of $45 million representing the difference between the fair value of the consideration transferred and the fair value of the identifiable assets acquired and liabilities assumed. Auditing the Company’s accounting for the merger was complex due to the significant estimation in management’s determination of the fair value of the non-cash consideration transferred as well as the acquired assets. Specifically, the fair value of the sPower development pipeline and the intangible assets associated with the contracted and uncontracted projects acquired from sPower involved significant estimation uncertainty. The estimation uncertainty was primarily related to underlying assumptions about the future performance of the development projects or other unobservable inputs. The Company used a discounted cash flow model to measure the fair value of the development pipeline and acquired intangible assets. The significant assumptions used included discount rates and certain assumptions that form the basis of the forecasted results (e.g., pipeline capacity, developer profit, probability of project completion and expected timing of completion). These significant assumptions were forward looking and could be affected by future economic and market conditions.
Response:
How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s accounting for the step acquisition. For example, we tested controls over the recognition and measurement of the consideration transferred and intangible assets acquired, including management’s review of the valuation models, the significant assumptions used to develop the estimates, and the completeness and accuracy of the data used in the valuations. To test the estimated fair value of the development pipeline and intangible assets, we performed audit procedures that included, among others, evaluating the Company's selection of the valuation methodology, evaluating the methods and significant assumptions used by the Company's valuation specialist, and evaluating the completeness and accuracy of the underlying data supporting the significant assumptions and estimates. For example, we compared the significant assumptions used by management to third-party industry data, the Company’s budgets and forecasts as well as historical results. We also involved valuation specialists to assist in our evaluation of the overall methodology and the discount rates used in the fair value estimate.
How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s accounting for the step acquisition. For example, we tested controls over the recognition and measurement of the consideration transferred and intangible assets acquired, including management’s review of the valuation models, the significant assumptions used to develop the estimates, and the completeness and accuracy of the data used in the valuations. To test the estimated fair value of the development pipeline and intangible assets, we performed audit procedures that included, among others, evaluating the Company's selection of the valuation methodology, evaluating the methods and significant assumptions used by the Company's valuation specialist, and evaluating the completeness and accuracy of the underlying data supporting the significant assumptions and estimates. For example, we compared the significant assumptions used by management to third-party industry data, the Company’s budgets and forecasts as well as historical results. We also involved valuation specialists to assist in our evaluation of the overall methodology and the discount rates used in the fair value estimate.
Reference:
Footnote 25
Footnote 25