Chairman’s Letter
Notes
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Financial Statements
4. Basic principles, methods and
critical accounting policies
The financial statements of the consolidated companies are prepared according to uniform accounting and valuation principles.
The consolidated financial statements of the Group are based on the principle of the historical cost of acquisition, construction or production, with the exception of the items reflected at fair value, such as available-for-sale financial assets and derivative financial instruments.
The preparation of the financial statements for the Bayer Group requires the use of estimates and assumptions that affect the classification and measurement of assets, liabilities, income, expenses and contingent liabilities. Estimates and assumptions mainly relate to the useful life of noncurrent assets, the discounted cash flows used in impairment testing and the recognition of provisions, including those for litigation-related expenses, pensions and other benefits, taxes, environmental compliance and remediation costs, sales allowances, product liability and guarantees. Essential estimates and assumptions that may affect reporting in the various item categories of the financial statements are described in the following sections of this Note. Estimates are based on historical experience and other assumptions that are considered reasonable under given circumstances. They are continually reviewed but may vary from the actual values.
The consolidated financial statements of the Group are based on the principle of the historical cost of acquisition, construction or production, with the exception of the items reflected at fair value, such as available-for-sale financial assets and derivative financial instruments.
The preparation of the financial statements for the Bayer Group requires the use of estimates and assumptions that affect the classification and measurement of assets, liabilities, income, expenses and contingent liabilities. Estimates and assumptions mainly relate to the useful life of noncurrent assets, the discounted cash flows used in impairment testing and the recognition of provisions, including those for litigation-related expenses, pensions and other benefits, taxes, environmental compliance and remediation costs, sales allowances, product liability and guarantees. Essential estimates and assumptions that may affect reporting in the various item categories of the financial statements are described in the following sections of this Note. Estimates are based on historical experience and other assumptions that are considered reasonable under given circumstances. They are continually reviewed but may vary from the actual values.
Consolidation
Intragroup sales, profits, losses, income, expenses, receivables and payables are eliminated. Deferred income tax effects are reflected in consolidation.
Joint ventures are included by proportionate consolidation according to the same principles.
Capital consolidation is performed according to IAS 27 (Consolidated and Separate Financial Statements) by offsetting the net carrying amounts of subsidiaries in the balance sheet against their underlying equity. Equity of subsidiaries is valued at the respective acquisition dates, recognizing identifiable assets and liabilities (including contingent liabilities) at their fair values along with attributable deferred tax assets and liabilities. Any remaining difference to the purchase price is recognized as goodwill.
The cost of acquisition of a company included at equity in the consolidated financial statements is adjusted annually by a percentage of any change in its stockholders’ equity corresponding to Bayer’s percentage interest in the company. Differences arising upon first-time inclusion at equity are accounted for according to full-consolidation principles.Bayer’s share of changes in these companies’ stockholders’ equities that are recognized in their income statements – including write-downs of goodwill – are recognized in the non-operating result. Intercompany profits and losses for these companies were not material in either 2007 or 2006.
Joint ventures are included by proportionate consolidation according to the same principles.
Capital consolidation is performed according to IAS 27 (Consolidated and Separate Financial Statements) by offsetting the net carrying amounts of subsidiaries in the balance sheet against their underlying equity. Equity of subsidiaries is valued at the respective acquisition dates, recognizing identifiable assets and liabilities (including contingent liabilities) at their fair values along with attributable deferred tax assets and liabilities. Any remaining difference to the purchase price is recognized as goodwill.
The cost of acquisition of a company included at equity in the consolidated financial statements is adjusted annually by a percentage of any change in its stockholders’ equity corresponding to Bayer’s percentage interest in the company. Differences arising upon first-time inclusion at equity are accounted for according to full-consolidation principles.Bayer’s share of changes in these companies’ stockholders’ equities that are recognized in their income statements – including write-downs of goodwill – are recognized in the non-operating result. Intercompany profits and losses for these companies were not material in either 2007 or 2006.
Foreign currency translation
In the financial statements of the individual consolidated companies, all receivables and payables in currencies other than the respective functional currency are translated at closing rates, irrespective of whether they are exchange-hedged. Derivative financial instruments are stated at fair value. Exchange rate differences from valuation of balances in foreign currencies are recognized in income. The majority of consolidated companies are financially, economically and organizationally autonomous and their functional currencies are therefore the respective local currencies.
The assets and liabilities of foreign companies at the start and end of the year are translated at closing rates. All changes occurring during the year and all income and expense items are translated at average rates for the year. Components of stockholders’ equity are translated at the historical exchange rates prevailing at the respective dates of their first-time recognition in Group equity.
The differences between the resulting amounts and those obtained by translating at closing rates are reflected in other comprehensive income and stated separately in the tables in the Notes under “Exchange differences on translation of operations outside the euro zone” or “Exchange differences.” When a company is deconsolidated, exchange differences recognized in stockholders’ equity are removed from equity and recognized in the income statement.
The exchange rates for major currencies against the euro varied as follows:
The assets and liabilities of foreign companies at the start and end of the year are translated at closing rates. All changes occurring during the year and all income and expense items are translated at average rates for the year. Components of stockholders’ equity are translated at the historical exchange rates prevailing at the respective dates of their first-time recognition in Group equity.
The differences between the resulting amounts and those obtained by translating at closing rates are reflected in other comprehensive income and stated separately in the tables in the Notes under “Exchange differences on translation of operations outside the euro zone” or “Exchange differences.” When a company is deconsolidated, exchange differences recognized in stockholders’ equity are removed from equity and recognized in the income statement.
The exchange rates for major currencies against the euro varied as follows:
| Closing rate | Average rate | ||||
| €1 | 2006 | 2007 | 2006 | 2007 | |
| Argentina | ARS | 4.04 | 4.64 | 3.86 | 4.27 |
| Brazil | BRL | 2.82 | 2.61 | 2.73 | 2.67 |
| China | CNY | 10.28 | 10.75 | 10.01 | 10.42 |
| U.K. | GBP | 0.67 | 0.73 | 0.68 | 0.68 |
| Japan | JPY | 156.93 | 164.93 | 146.04 | 161.23 |
| Canada | CAD | 1.53 | 1.44 | 1.42 | 1.47 |
| Mexico | MXN | 14.27 | 16.08 | 13.69 | 14.97 |
| Switzerland | CHF | 1.61 | 1.65 | 1.57 | 1.64 |
| United States | USD | 1.32 | 1.47 | 1.26 | 1.37 |
Net sales and other operating income
Revenues from the sale of products and the rendering of services are recognized when
Sales are stated net of sales taxes, other taxes and sales deductions. The latter are estimated amounts for cash discounts, rebates and product returns. They are deducted at the time the sales are recognized, and appropriate provisions are recorded. Sales deductions are estimated primarily on the basis of historical experience, specific contractual terms and future expectations of sales development in each business segment. It is unlikely that estimation parameters other than these could affect sales deductions in a way that would be material to the Bayer Group’s business operations. The potential for variability in provisions for future sales deductions is not material in relation to the Group’s reported operating results. Adjustments to provisions for rebates, cash discounts or returns for sales made in prior periods were not significant in relation to income before income taxes in the years under report.
Provisions for rebates in 2007 amounted to 1.4 percent of total net sales (2006: 1.6 percent). In addition to rebates, Group companies offer cash discounts for prompt payment in some countries. Provisions for cash discounts as of December 31, 2007 and December 31, 2006 were less than 0.1 percent of total net sales for the respective year.
Sales are reduced for expected returns of defective goods or in respect of contractual arrangements to return saleable products on the date of sale or at the time when the amount of future returns can be reasonably estimated. Provisions for product returns as of December 31, 2007 were 0.3 percent of total net sales for the year (December 31, 2006: 0.1 percent). If future product returns cannot be reasonably estimated and are significant to the sale transaction, the revenues and the related cost of sales are deferred until an estimate may reasonably be made or when the right to return the goods has expired.
Some of the Bayer Group’s revenues are generated on the basis of licensing agreements under which third parties are granted rights to its products and technologies. Payments relating to the sale or outlicensing of technologies or technological expertise – once the respective agreements have become effective – are immediately recognized in income if all rights relating to the technologies and all obligations resulting from them have been relinquished under the contract terms and Bayer has no continuing obligation to perform under the agreement. However, if rights to the technologies continue to exist or obligations resulting from them have yet to be fulfilled, the payments received are recorded in line with the actual circumstances. Upfront payments and similar non-refundable payments received under these agreements are recorded as other liabilities and recognized in income over the estimated performance period stipulated in the agreement. Revenues such as license fees or rentals are recognized according to the same principles.
License or research and development collaboration agreements may consist of multiple elements and provide for varying consideration terms, such as upfront payments and milestone or similar payments. They therefore have to be assessed to determine whether separate delivery of the individual elements of such arrangements requires more than one unit of account. The delivered elements are separated if
If all three criteria are fulfilled, the appropriate revenue recognition rule is then applied to each separate accounting unit.
- the significant risks and rewards of ownership of the goods have been transferred to the customer,
- the company retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold,
- the amount of income and costs incurred or to be incurred can be measured reliably, and
- it is sufficiently probable that the economic benefits associated with the transaction will flow to the company.
Sales are stated net of sales taxes, other taxes and sales deductions. The latter are estimated amounts for cash discounts, rebates and product returns. They are deducted at the time the sales are recognized, and appropriate provisions are recorded. Sales deductions are estimated primarily on the basis of historical experience, specific contractual terms and future expectations of sales development in each business segment. It is unlikely that estimation parameters other than these could affect sales deductions in a way that would be material to the Bayer Group’s business operations. The potential for variability in provisions for future sales deductions is not material in relation to the Group’s reported operating results. Adjustments to provisions for rebates, cash discounts or returns for sales made in prior periods were not significant in relation to income before income taxes in the years under report.
Provisions for rebates in 2007 amounted to 1.4 percent of total net sales (2006: 1.6 percent). In addition to rebates, Group companies offer cash discounts for prompt payment in some countries. Provisions for cash discounts as of December 31, 2007 and December 31, 2006 were less than 0.1 percent of total net sales for the respective year.
Sales are reduced for expected returns of defective goods or in respect of contractual arrangements to return saleable products on the date of sale or at the time when the amount of future returns can be reasonably estimated. Provisions for product returns as of December 31, 2007 were 0.3 percent of total net sales for the year (December 31, 2006: 0.1 percent). If future product returns cannot be reasonably estimated and are significant to the sale transaction, the revenues and the related cost of sales are deferred until an estimate may reasonably be made or when the right to return the goods has expired.
Some of the Bayer Group’s revenues are generated on the basis of licensing agreements under which third parties are granted rights to its products and technologies. Payments relating to the sale or outlicensing of technologies or technological expertise – once the respective agreements have become effective – are immediately recognized in income if all rights relating to the technologies and all obligations resulting from them have been relinquished under the contract terms and Bayer has no continuing obligation to perform under the agreement. However, if rights to the technologies continue to exist or obligations resulting from them have yet to be fulfilled, the payments received are recorded in line with the actual circumstances. Upfront payments and similar non-refundable payments received under these agreements are recorded as other liabilities and recognized in income over the estimated performance period stipulated in the agreement. Revenues such as license fees or rentals are recognized according to the same principles.
License or research and development collaboration agreements may consist of multiple elements and provide for varying consideration terms, such as upfront payments and milestone or similar payments. They therefore have to be assessed to determine whether separate delivery of the individual elements of such arrangements requires more than one unit of account. The delivered elements are separated if
- they have value to the customer on a stand-alone basis,
- there is objective and reliable evidence of the fair value of the undelivered element(s) and
- the arrangement includes a general right of return relative to the delivered element(s) and delivery or performance of the as yet undelivered element(s) is probable and substantially within the control of the company.
If all three criteria are fulfilled, the appropriate revenue recognition rule is then applied to each separate accounting unit.
Research and development expenses
A substantial proportion of the Bayer Group’s financial resources is invested in research and development. In addition to in-house research and development activities, especially in the health care business, various research and development collaborations and alliances are maintained with third parties involving the provision of funding and/or payments for the achievement of performance milestones.
For accounting purposes, research expenses are defined as costs incurred for current or planned investigations undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Development expenses are defined as costs incurred for the application of research findings or specialist knowledge to production, production methods, services or goods prior to the commencement of commercial production or use.
According to IAS 38 (Intangible Assets), research costs cannot be capitalized; development costs must be capitalized if, and only if, specific, narrowly defined conditions are fulfilled. Development costs must be capitalized if it is sufficiently certain that the future economic benefits to the company will also cover the respective development costs. Since development projects are often subject to regulatory approval procedures and other uncertainties, the conditions for the capitalization of costs incurred before receipt of approvals are not normally satisfied.
The following costs in particular, by their very nature, constitute research and development expenses: the appropriate allocations of direct personnel and material costs and related overheads for application technology, engineering and other departments; costs for experimental and pilot facilities; costs for services purchased in connection with research and development activities; costs for clinical research; costs for the utilization of third parties’ patents for research and development purposes; other taxes related to research facilities; and fees for the filing and registration of self-generated patents that are not capitalized.
Under IAS 38 (Intangible Assets), milestone payments must initially be capitalized to the extent that they are related to the acquisition of the related technology rights, even if uncertainties exist as to whether the research and development will ultimately be successful in producing a saleable product. Where research and development collaborations are embedded in contracts for a strategic alliance, it is necessary to assess whether milestone or advance payments constitute funding of research and development work or consideration for the acquisition of assets. Factors considered in reaching this determination are the reason for the payment (for example, whether it is related to a regulatory approval, the attainment of a sales target or outsourced research and development activities), and the ratio of the fair value of the planned research and development activities to the total amount of the payment.
For accounting purposes, research expenses are defined as costs incurred for current or planned investigations undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Development expenses are defined as costs incurred for the application of research findings or specialist knowledge to production, production methods, services or goods prior to the commencement of commercial production or use.
According to IAS 38 (Intangible Assets), research costs cannot be capitalized; development costs must be capitalized if, and only if, specific, narrowly defined conditions are fulfilled. Development costs must be capitalized if it is sufficiently certain that the future economic benefits to the company will also cover the respective development costs. Since development projects are often subject to regulatory approval procedures and other uncertainties, the conditions for the capitalization of costs incurred before receipt of approvals are not normally satisfied.
The following costs in particular, by their very nature, constitute research and development expenses: the appropriate allocations of direct personnel and material costs and related overheads for application technology, engineering and other departments; costs for experimental and pilot facilities; costs for services purchased in connection with research and development activities; costs for clinical research; costs for the utilization of third parties’ patents for research and development purposes; other taxes related to research facilities; and fees for the filing and registration of self-generated patents that are not capitalized.
Under IAS 38 (Intangible Assets), milestone payments must initially be capitalized to the extent that they are related to the acquisition of the related technology rights, even if uncertainties exist as to whether the research and development will ultimately be successful in producing a saleable product. Where research and development collaborations are embedded in contracts for a strategic alliance, it is necessary to assess whether milestone or advance payments constitute funding of research and development work or consideration for the acquisition of assets. Factors considered in reaching this determination are the reason for the payment (for example, whether it is related to a regulatory approval, the attainment of a sales target or outsourced research and development activities), and the ratio of the fair value of the planned research and development activities to the total amount of the payment.
Goodwill and other intangible assets
Intangible assets are recognized at the cost of acquisition or creation. Those with a determinable useful life are amortized accordingly over a period of up to 30 years, except where their actual depletion demands a different amortization pattern. Determination of the expected useful lives of such assets and of amortization patterns is based on estimates of the period for which they will generate cash flows and the distribution of those cash flows over time.
Write-downs are made for impairment losses. Corresponding write-backs are made where the reasons for previous write-downs of intangible assets other than goodwill no longer apply, provided that the write-backs do not cause the carrying amount to exceed the amortized cost of acquisition.
Goodwill and other assets with an indefinite life are subject to annual impairment tests, which are explained under “Procedure used in global impairment testing and its impact.”
Costs of €27 million for in-house software development incurred in the application development phase were capitalized as of December 31, 2007 (2006: €49 million). These costs are amortized over the useful life of the software from the date it is placed in service.
Information on goodwill and other intangible assets existing at the balance sheet date is given in Note [17].
Write-downs are made for impairment losses. Corresponding write-backs are made where the reasons for previous write-downs of intangible assets other than goodwill no longer apply, provided that the write-backs do not cause the carrying amount to exceed the amortized cost of acquisition.
Goodwill and other assets with an indefinite life are subject to annual impairment tests, which are explained under “Procedure used in global impairment testing and its impact.”
Costs of €27 million for in-house software development incurred in the application development phase were capitalized as of December 31, 2007 (2006: €49 million). These costs are amortized over the useful life of the software from the date it is placed in service.
Information on goodwill and other intangible assets existing at the balance sheet date is given in Note [17].
Property, plant and equipment
Property, plant and equipment is carried at the cost of acquisition or construction depreciated over its estimated useful life. A write-down (impairment loss) is recognized in addition if an asset’s value falls below the depreciated cost of acquisition or construction.
The cost of acquisition comprises the acquisition price plus ancillary and subsequent acquisition costs, less any reduction received on the acquisition price. The cost of self-constructed property, plant and equipment comprises the direct cost of materials, direct manufacturing expenses and appropriate allocations of material and manufacturing overheads. Where an obligation exists to dismantle or remove an asset or restore a site to its former condition at the end of its useful life, the present value of the related future payments is capitalized along with the cost of acquisition or construction upon completion and a corresponding liability is recognized.
If the construction phase of property, plant or equipment extends over a long period, the interest incurred on borrowed capital up to the date of completion is capitalized as part of the cost of acquisition or construction in accordance with IAS 23 (Borrowing Costs).
Expenses for the repair of property, plant and equipment, such as ongoing maintenance costs, are normally charged to income. The cost of acquisition or construction is capitalized if a repair (such as a complete overhaul of technical equipment) will result in future economic benefits.
Property, plant and equipment is depreciated by the straight-line method, except where depreciation based on actual depletion is more appropriate.
Declines in value that go beyond regular depreciation and are expected to be permanent are accounted for by write-downs. Corresponding write-backs are made where the reasons for previous write-downs no longer apply, provided that the write-backs do not cause the carrying amount to exceed the cost of acquisition less accumulated depreciation.
When assets are sold, closed down or scrapped, the difference between the net proceeds and the net carrying amount of the assets is recognized as a gain or loss in other operating income or expenses, respectively.
The following depreciation periods, based on the estimated useful lives of the respective assets, are applied throughout the Group:
The cost of acquisition comprises the acquisition price plus ancillary and subsequent acquisition costs, less any reduction received on the acquisition price. The cost of self-constructed property, plant and equipment comprises the direct cost of materials, direct manufacturing expenses and appropriate allocations of material and manufacturing overheads. Where an obligation exists to dismantle or remove an asset or restore a site to its former condition at the end of its useful life, the present value of the related future payments is capitalized along with the cost of acquisition or construction upon completion and a corresponding liability is recognized.
If the construction phase of property, plant or equipment extends over a long period, the interest incurred on borrowed capital up to the date of completion is capitalized as part of the cost of acquisition or construction in accordance with IAS 23 (Borrowing Costs).
Expenses for the repair of property, plant and equipment, such as ongoing maintenance costs, are normally charged to income. The cost of acquisition or construction is capitalized if a repair (such as a complete overhaul of technical equipment) will result in future economic benefits.
Property, plant and equipment is depreciated by the straight-line method, except where depreciation based on actual depletion is more appropriate.
Declines in value that go beyond regular depreciation and are expected to be permanent are accounted for by write-downs. Corresponding write-backs are made where the reasons for previous write-downs no longer apply, provided that the write-backs do not cause the carrying amount to exceed the cost of acquisition less accumulated depreciation.
When assets are sold, closed down or scrapped, the difference between the net proceeds and the net carrying amount of the assets is recognized as a gain or loss in other operating income or expenses, respectively.
The following depreciation periods, based on the estimated useful lives of the respective assets, are applied throughout the Group:
| Buildings | 20 to 50 years |
| Outdoor infrastucture | 10 to 20 years |
| Plant installations | 6 to 20 years |
| Machinery and equipment | 6 to 12 years |
| Laboratory and research facilities | 3 to 5 years |
| Storage tank and pipelines | 10 to 20 years |
| Vehicles | 4 to 8 years |
| Computer equipment | 3 to 5 years |
| Furniture and fixtures | 4 to 10 years |
In accordance with IAS 17 (Leases), assets leased on terms economically equivalent to financing a purchase by a long-term loan (finance leases) are capitalized at the lower of their fair value or the present value of the minimum lease payments at the date of addition. The leased assets are depreciated over their estimated useful lives except where subsequent transfer of title is uncertain, in which case they are depreciated over their estimated useful lives or the respective lease terms, whichever are shorter.
Financial assets
Financial assets comprise issued loans and receivables, acquired equity and debt instruments, cash and cash equivalents, and derivative financial instruments with positive fair values.
They are recognized and measured in accordance with IAS 39 (Financial Instruments: Recognition and Measurement). Accordingly, financial assets are recognized in the consolidated financial statements if the Bayer Group has a contractual right to receive cash or other financial assets from another entity. Regular way purchases and sales of financial assets are posted on the settlement date. Financial assets are initially recognized at fair value plus transaction costs. The transaction costs incurred for the purchase of financial assets held at fair value through profit or loss are expensed immediately. Interest-free or low-interest receivables are initially reflected at the present value of the expected future cash flows. For purposes of subsequent measurement, financial assets are allocated to the following categories:
If there are substantial, objective indications that loans and receivables, held-to-maturity financial assets or available-for-sale financial assets are impaired, their carrying amount is compared to the present value of the expected future cash flows, discounted by the current market rate of return on a comparable financial asset. If an impairment is confirmed, they are written down by the difference between the two amounts. Indications of impairment include the fact that a company has been making an operating loss for several years, a reduction in market value, a significant deterioration in credit standing, a material breach of contract, a high probability of insolvency or other financial restructuring of the debtor, or the disappearance of an active market for the asset.
Corresponding write-backs are made where the reasons for previous write-downs no longer apply, provided that the write-backs do not cause the carrying amount to exceed the cost of acquisition. No write-backs are made for available-for-sale equity instruments.
Financial assets are derecognized when contractual rights to receive cash flows from the financial assets no longer exist or the financial assets are transferred together with all material risks and benefits.
The management of financial and commodity price risks and, in particular, the accounting treatment of derivative financial instruments and hedging relationships involving such instruments are explained in more detail in Note [30].
They are recognized and measured in accordance with IAS 39 (Financial Instruments: Recognition and Measurement). Accordingly, financial assets are recognized in the consolidated financial statements if the Bayer Group has a contractual right to receive cash or other financial assets from another entity. Regular way purchases and sales of financial assets are posted on the settlement date. Financial assets are initially recognized at fair value plus transaction costs. The transaction costs incurred for the purchase of financial assets held at fair value through profit or loss are expensed immediately. Interest-free or low-interest receivables are initially reflected at the present value of the expected future cash flows. For purposes of subsequent measurement, financial assets are allocated to the following categories:
- Financial assets held at fair value through profit or loss comprise those financial assets that are held for trading. This category comprises receivables from forward commodity contracts and receivables from other derivative financial instruments, which are included in other financial assets, except where hedge accounting is used. Changes in the fair value of financial assets in this category are recognized in the income statement when the increase or decrease in value occurs.
- Loans and receivables are non-derivative financial assets that are not quoted in an active market. They are carried at amortized cost. This category comprises trade accounts receivable, the financial receivables and loans included in other financial assets, the additional financial receivables and loans reflected in miscellaneous receivables, and cash and cash equivalents. Interest income from items assigned to this category is determined using the effective interest method, insofar as such items are not classified as current receivables and the effect of discounting interest is not material.
- Held-to-maturity financial assets are non-derivative financial assets, with fixed or determinable payments, that are to be held for a fixed period of time. They are accounted for at amortized cost by the effective-interest method. Held-to-maturity financial investments are recognized in other financial assets.
- Available-for-sale financial assets are those non-derivative financial assets that are not assigned to any of the above categories. In particular, they comprise equity instruments recognized at fair value and debt instruments not to be held to maturity, which are included in other financial assets. Changes in the fair value of available-for-sale financial assets are recognized in stockholders’ equity and not released to the income statement until the assets are sold or impaired. Where possible, a fair value for equity and debt securities is derived from market data. Financial assets for which no market price is available and whose fair value cannot be reliably estimated are carried at cost less impairment charges.
If there are substantial, objective indications that loans and receivables, held-to-maturity financial assets or available-for-sale financial assets are impaired, their carrying amount is compared to the present value of the expected future cash flows, discounted by the current market rate of return on a comparable financial asset. If an impairment is confirmed, they are written down by the difference between the two amounts. Indications of impairment include the fact that a company has been making an operating loss for several years, a reduction in market value, a significant deterioration in credit standing, a material breach of contract, a high probability of insolvency or other financial restructuring of the debtor, or the disappearance of an active market for the asset.
Corresponding write-backs are made where the reasons for previous write-downs no longer apply, provided that the write-backs do not cause the carrying amount to exceed the cost of acquisition. No write-backs are made for available-for-sale equity instruments.
Financial assets are derecognized when contractual rights to receive cash flows from the financial assets no longer exist or the financial assets are transferred together with all material risks and benefits.
The management of financial and commodity price risks and, in particular, the accounting treatment of derivative financial instruments and hedging relationships involving such instruments are explained in more detail in Note [30].
Inventories
In accordance with IAS 2 (Inventories), inventories encompass assets (finished goods and goods purchased for resale) held for sale in the ordinary course of business, in the process of production for such sale (work in process) or in the form of materials or supplies to be consumed in the production process or in the rendering of services (raw materials and supplies). Inventories are recognized at the lower of acquisition or production cost – calculated by the weighted-average method – and net realizable value which is the realizable sale proceeds under normal business conditions less estimated cost to complete and selling expenses.
Taxes
Income taxes comprise the taxes levied on taxable income in the individual countries and the changes in deferred tax assets and liabilities. The actual income taxes are recognized at the amounts likely to be payable under the statutory regulations in force, or already enacted in relation to future periods, as of the closing date.
The remaining taxes, such as property, electricity and other energy taxes, are included in the functional cost items.
In compliance with IAS 12 (Income Taxes), deferred taxes are calculated for temporary differences between the carrying amounts of assets and liabilities in the IFRS balance sheet and the balance sheet drawn up for tax purposes, for consolidation measures, and for tax loss carryforwards likely to be realizable.
Deferred tax assets relating to deductible temporary differences and tax loss carryforwards are recognized to the extent that it is sufficiently probable that taxable income will be available in the future to enable the tax loss carryforwards to be utilized. Deferred tax liabilities are recognized on temporary differences taxable in the future. Deferred taxes are calculated at the rates which – on the basis of the statutory regulations in force, or already enacted in relation to future periods, as of the closing date – are expected to apply in the individual countries at the time of realization. Deferred tax assets and deferred tax liabilities are offset if they relate to income taxes levied by the same taxation authority. Changes in deferred tax assets and liabilities due to changes in tax rates are recognized in income. This also applies to the related deferred tax assets or liabilities where gains or losses are recognized directly in stockholders’ equity. The probability that deferred tax assets resulting from temporary differences or loss carryforwards can be utilized in the future is the subject of forecasts by the individual consolidated companies regarding their future earnings situation and other parameters.
Uncertainties exist with respect to the interpretation of complex tax regulations and the amount and timing of future taxable income. Given the wide range of international business relationships and the long-term nature and complexity of existing contractual agreements, differences arising between the actual results and the assumptions made, or future changes to such assumptions, could necessitate adjustments to tax income and expense in future periods. The Group establishes provisions, based on reasonable estimates, for possible consequences of audits by the tax authorities of the respective countries. The amount of such provisions is based on various factors, such as experience with previous tax audits and differing interpretations of tax regulations by the taxable entity and the responsible tax authority. Such differences of interpretation may arise on a wide variety of issues depending on the conditions prevailing in the respective Group company’s domicile.
Further information on income taxes is provided in Note [14].
The remaining taxes, such as property, electricity and other energy taxes, are included in the functional cost items.
In compliance with IAS 12 (Income Taxes), deferred taxes are calculated for temporary differences between the carrying amounts of assets and liabilities in the IFRS balance sheet and the balance sheet drawn up for tax purposes, for consolidation measures, and for tax loss carryforwards likely to be realizable.
Deferred tax assets relating to deductible temporary differences and tax loss carryforwards are recognized to the extent that it is sufficiently probable that taxable income will be available in the future to enable the tax loss carryforwards to be utilized. Deferred tax liabilities are recognized on temporary differences taxable in the future. Deferred taxes are calculated at the rates which – on the basis of the statutory regulations in force, or already enacted in relation to future periods, as of the closing date – are expected to apply in the individual countries at the time of realization. Deferred tax assets and deferred tax liabilities are offset if they relate to income taxes levied by the same taxation authority. Changes in deferred tax assets and liabilities due to changes in tax rates are recognized in income. This also applies to the related deferred tax assets or liabilities where gains or losses are recognized directly in stockholders’ equity. The probability that deferred tax assets resulting from temporary differences or loss carryforwards can be utilized in the future is the subject of forecasts by the individual consolidated companies regarding their future earnings situation and other parameters.
Uncertainties exist with respect to the interpretation of complex tax regulations and the amount and timing of future taxable income. Given the wide range of international business relationships and the long-term nature and complexity of existing contractual agreements, differences arising between the actual results and the assumptions made, or future changes to such assumptions, could necessitate adjustments to tax income and expense in future periods. The Group establishes provisions, based on reasonable estimates, for possible consequences of audits by the tax authorities of the respective countries. The amount of such provisions is based on various factors, such as experience with previous tax audits and differing interpretations of tax regulations by the taxable entity and the responsible tax authority. Such differences of interpretation may arise on a wide variety of issues depending on the conditions prevailing in the respective Group company’s domicile.
Further information on income taxes is provided in Note [14].
Provisions for pensions and other post-employment benefits
Group companies provide retirement benefits for most of their employees, either directly or by contributing to privately or publicly administered funds. The way these benefits are provided varies according to the legal, fiscal and economic conditions of each country, the benefits generally being based on the employees’ remuneration and years of service. The obligations relate both to existing retirees’ pensions and to pension entitlements of future retirees.
Group companies provide retirement benefits under defined contribution and/or defined benefit plans. In the case of defined contribution plans, the company pays contributions to publicly or privately administered pension schemes on a mandatory, contractual or voluntary basis. Once the contributions have been paid, the company has no further payment obligations. The regular contributions constitute expenses for the year in which they are due and as such are included in the functional cost items, and thus in the operating result (EBIT). All other retirement benefit systems are defined benefit plans, which may be either unfunded, i.e. financed by provisions (accruals), or funded, i.e. financed through pension funds. All income and expenses relating to defined benefit plans other than from interest cost and the expected return on plan assets are recognized in the Group operating result. Interest cost and the expected return on plan assets are reflected in the non-operating result under other non-operating income and expense. Actuarial gains and losses from defined benefit plans and deductions in connection with asset limitation are recognized entirely in the respective provision via the statement of changes in stockholders’ equity and shown in a separate statement of recognized income and expense, so they have no impact on profit or loss. Early retirement and certain other benefits to retirees are also included in the provisions for pensions, since these obligations are similar in character to pension obligations.
The present value of provisions for defined benefit plans is calculated in accordance with IAS 19 (Employee Benefits) by the projected unit credit method. The future benefit obligations are valued by actuarial methods. This involves assumptions regarding life expectancy, staff fluctuation, and other parameters that depend partly on the economic situation in the respective country. The other main factors on which these calculations are based are assumptions regarding discount rate, expected return on plan assets, the rate of future compensation increases and variations in health care costs. Statistical information such as attrition and mortality rates is also used in estimating the expenses and liabilities under the plans. The effects of changes in important parameters are explained in Note [25].
Benefits expected to be payable after retirement are spread over each employee’s entire period of employment, allowing for future changes in remuneration.
The fair value of plan assets is deducted from the present value of the defined benefit obligation for pensions and other post-employment benefits. The obligations and plan assets are valued at regular intervals of not more than three years. For all major plans, comprehensive actuarial valuations are performed annually as of December 31. The difference between the defined benefit obligation – after deducting the fair value of plan assets – and the net liability recognized in the balance sheet is attributable to unrecognized past service cost. Plan assets in excess of the benefit obligation are reflected in other receivables, subject to the asset limitation specified in IAS 19 (Employee Benefits).
The expected future cash outflows are discounted in order to recognize obligations for pensions and other post-employment benefits at their present value as of the reporting date. The interest rate used to discount post-employment benefit obligations to present value is derived from the yields of senior, high-quality corporate bonds in the respective country at the balance sheet date. These generally include AA-rated securities. The discount rate is based on the yield of a portfolio of bonds whose weighted residual maturities approximately correspond to the duration necessary to cover the entire benefit obligation. If AA-rated corporate bonds of equal duration are not available, a discount rate equivalent to the effective interest rate for government bonds at the balance sheet date is used instead but increased by about 0.5 to 1.0 percentage point since corporate bonds generally provide higher yields by virtue of their risk structure.
Determination of the discount rate is also based on a bond portfolio corresponding to the expected cash outflows from the pension plans. The average return on this bond portfolio serves as the benchmark when determining the discount rate. The expected long-term return on plan assets, determined on the basis of published and internal capital market reports and forecasts for each asset class, is applied to the fair market value of plan assets at each year end.
Because of changing market and economic conditions, the expenses and the obligations actually arising under the plans in the future may differ materially from the estimates made on the basis of these actuarial assumptions. The plan assets are mainly comprised of equity and fixed-income instruments. Therefore, declining returns on equity markets and markets for fixed-income instruments could necessitate additional contributions to the plans in order to cover future pension obligations. Also, higher or lower withdrawal rates or longer or shorter life of participants may have an impact on the amount of pension income or expense recorded in the future.
Group companies provide retirement benefits under defined contribution and/or defined benefit plans. In the case of defined contribution plans, the company pays contributions to publicly or privately administered pension schemes on a mandatory, contractual or voluntary basis. Once the contributions have been paid, the company has no further payment obligations. The regular contributions constitute expenses for the year in which they are due and as such are included in the functional cost items, and thus in the operating result (EBIT). All other retirement benefit systems are defined benefit plans, which may be either unfunded, i.e. financed by provisions (accruals), or funded, i.e. financed through pension funds. All income and expenses relating to defined benefit plans other than from interest cost and the expected return on plan assets are recognized in the Group operating result. Interest cost and the expected return on plan assets are reflected in the non-operating result under other non-operating income and expense. Actuarial gains and losses from defined benefit plans and deductions in connection with asset limitation are recognized entirely in the respective provision via the statement of changes in stockholders’ equity and shown in a separate statement of recognized income and expense, so they have no impact on profit or loss. Early retirement and certain other benefits to retirees are also included in the provisions for pensions, since these obligations are similar in character to pension obligations.
The present value of provisions for defined benefit plans is calculated in accordance with IAS 19 (Employee Benefits) by the projected unit credit method. The future benefit obligations are valued by actuarial methods. This involves assumptions regarding life expectancy, staff fluctuation, and other parameters that depend partly on the economic situation in the respective country. The other main factors on which these calculations are based are assumptions regarding discount rate, expected return on plan assets, the rate of future compensation increases and variations in health care costs. Statistical information such as attrition and mortality rates is also used in estimating the expenses and liabilities under the plans. The effects of changes in important parameters are explained in Note [25].
Benefits expected to be payable after retirement are spread over each employee’s entire period of employment, allowing for future changes in remuneration.
The fair value of plan assets is deducted from the present value of the defined benefit obligation for pensions and other post-employment benefits. The obligations and plan assets are valued at regular intervals of not more than three years. For all major plans, comprehensive actuarial valuations are performed annually as of December 31. The difference between the defined benefit obligation – after deducting the fair value of plan assets – and the net liability recognized in the balance sheet is attributable to unrecognized past service cost. Plan assets in excess of the benefit obligation are reflected in other receivables, subject to the asset limitation specified in IAS 19 (Employee Benefits).
The expected future cash outflows are discounted in order to recognize obligations for pensions and other post-employment benefits at their present value as of the reporting date. The interest rate used to discount post-employment benefit obligations to present value is derived from the yields of senior, high-quality corporate bonds in the respective country at the balance sheet date. These generally include AA-rated securities. The discount rate is based on the yield of a portfolio of bonds whose weighted residual maturities approximately correspond to the duration necessary to cover the entire benefit obligation. If AA-rated corporate bonds of equal duration are not available, a discount rate equivalent to the effective interest rate for government bonds at the balance sheet date is used instead but increased by about 0.5 to 1.0 percentage point since corporate bonds generally provide higher yields by virtue of their risk structure.
Determination of the discount rate is also based on a bond portfolio corresponding to the expected cash outflows from the pension plans. The average return on this bond portfolio serves as the benchmark when determining the discount rate. The expected long-term return on plan assets, determined on the basis of published and internal capital market reports and forecasts for each asset class, is applied to the fair market value of plan assets at each year end.
Because of changing market and economic conditions, the expenses and the obligations actually arising under the plans in the future may differ materially from the estimates made on the basis of these actuarial assumptions. The plan assets are mainly comprised of equity and fixed-income instruments. Therefore, declining returns on equity markets and markets for fixed-income instruments could necessitate additional contributions to the plans in order to cover future pension obligations. Also, higher or lower withdrawal rates or longer or shorter life of participants may have an impact on the amount of pension income or expense recorded in the future.
Other provisions
Other provisions are recognized for currently existing obligations arising from past events that will probably give rise to a future outflow of resources, provided that a reliable estimate can be made of the amount of the obligation.
Other provisions are measured in accordance with IAS 37 (Provisions, Contingent Liabilities and Contingent Assets) or, where applicable, IAS 19 (Employee Benefits). Where the cash outflow to settle an obligation is not expected to occur until after one year, the provision is recognized at the present value of the expected cash outflow. Reimbursements receivable from third parties are capitalized separately if their realization is virtually certain.
If the projected obligation declines as a result of a change in the estimate, the provision is reversed by the corresponding amount and the resulting income recognized in the operating expense item(s) in which the original charge was recognized.
To enhance the information content of the estimates, certain provisions that could have a material effect on the financial position and results of operations of the Group are selected and tested for their sensitivity to changes in the underlying parameters. To reflect uncertainty about the likelihood of the assumed events actually occurring, the impact of a 5 percent change in the probability of occurrence is examined in each case. For noncurrent interest-bearing provisions, the impact of a 1-percentage-point change in the interest rate used is analyzed. Analysis has not shown other provisions to be materially sensitive.
Personnel-related provisions are mainly those recorded for annual bonus payments, long-service awards, surpluses on long-term accounts and other personnel costs. Reimbursements to be received from the German authorities under the senior part-time work program are recorded as receivables and recognized in income as soon as the criteria for such reimbursements are fulfilled.
Trade-related provisions are recorded mainly for the granting of rebates or discounts, the acceptance of product returns, or obligations in respect of services already received but not yet invoiced.
Provisions for environmental protection are recorded if future cash outflows are likely to be necessary to ensure compliance with environmental regulations or to carry out remediation work, such costs can be reliably estimated and no future benefits are expected from such measures.
Estimating the future costs of environmental protection and remediation involves many uncertainties, particularly with regard to the status of laws, regulations and the information available about conditions in the various countries and at the individual sites. Significant factors in estimating the costs include previous experiences in similar cases, the conclusions in expert opinions obtained regarding the Group’s environmental programs, current costs and new developments affecting costs, management’s interpretation of current environmental laws and regulations, the number and financial position of third parties that may become obligated to participate in any remediation costs on the basis of joint liability, and the remediation methods which are likely to be deployed. Changes in these assumptions could impact future reported results.
Taking into consideration experience gained to date regarding environmental matters of a similar nature, provisions are believed to be adequate based upon currently available information. There were no significant changes in assumptions or estimates that would have impacted the income statement in prior years. However, given the inherent difficulties in estimating liabilities in the businesses in which the Group operates, especially those for which the risk of environmental damage is relatively greater (CropScience and MaterialScience), it remains possible that material additional costs will be incurred beyond the amounts accrued. It may transpire during remediation work that additional expenditures are necessary over an extended period of time that exceed existing provisions and cannot be reasonably estimated. Management nevertheless believes that such additional amounts, if any, would not have a material adverse effect on the Group’s financial position or results of operations. Further information on environmental provisions in the Bayer Group can be found in Note [26.3].
As a global company with a diverse business portfolio, the Bayer Group is exposed to numerous legal risks, particularly in the areas of product liability, competition and antitrust law, patent disputes, tax assessments and environmental matters.
Provisions for litigations are recorded in the balance sheet in respect of pending or future litigation, subject to a case-by-case examination. Such legal proceedings are evaluated on the basis of the available information, including that from legal counsel acting for the Group, to assess potential outcomes. Where it is reasonably likely that a future obligation arising out of legal proceedings will result in an outflow of resources, a provision is recorded in the amount of the present value of the expected cash outflows if these are considered to be reliably measurable. These provisions cover the estimated payments to plaintiffs, court fees, attorney costs and the cost of potential settlements. The evaluation is based on the current status of litigation as of each reporting date and includes an assessment of whether the criteria for recording a provision are met and, if so, the amount of the provision to be recorded.
The outcome of currently pending and future proceedings cannot be predicted. Thus, an adverse decision in a lawsuit could result in additional costs that are not covered, either wholly or partially, under insurance policies and that could significantly impact the business and results of operations of the Bayer Group. If the Bayer Group loses a case in which it seeks to enforce its patent rights, a decrease in future earnings could result as other manufacturers could be permitted to begin to market products that the Bayer Group or its predecessors had developed.
Litigation and other judicial proceedings generally raise complex issues and are subject to many uncertainties and complexities including, but not limited to, the facts and circumstances of each particular case, issues regarding the jurisdiction in which each suit is brought and differences in applicable law. Upon resolution of any pending legal matter, the Bayer Group may be forced to incur charges in excess of the presently established provisions and related insurance coverage. It is possible that the financial position, results of operations or cash flows of the Bayer Group could ultimately be materially affected by the unfavorable outcome of litigation.
Further information on legal risks and the related provisions is contained in Notes [26.6] and [32].
Other provisions are measured in accordance with IAS 37 (Provisions, Contingent Liabilities and Contingent Assets) or, where applicable, IAS 19 (Employee Benefits). Where the cash outflow to settle an obligation is not expected to occur until after one year, the provision is recognized at the present value of the expected cash outflow. Reimbursements receivable from third parties are capitalized separately if their realization is virtually certain.
If the projected obligation declines as a result of a change in the estimate, the provision is reversed by the corresponding amount and the resulting income recognized in the operating expense item(s) in which the original charge was recognized.
To enhance the information content of the estimates, certain provisions that could have a material effect on the financial position and results of operations of the Group are selected and tested for their sensitivity to changes in the underlying parameters. To reflect uncertainty about the likelihood of the assumed events actually occurring, the impact of a 5 percent change in the probability of occurrence is examined in each case. For noncurrent interest-bearing provisions, the impact of a 1-percentage-point change in the interest rate used is analyzed. Analysis has not shown other provisions to be materially sensitive.
Personnel-related provisions are mainly those recorded for annual bonus payments, long-service awards, surpluses on long-term accounts and other personnel costs. Reimbursements to be received from the German authorities under the senior part-time work program are recorded as receivables and recognized in income as soon as the criteria for such reimbursements are fulfilled.
Trade-related provisions are recorded mainly for the granting of rebates or discounts, the acceptance of product returns, or obligations in respect of services already received but not yet invoiced.
Provisions for environmental protection are recorded if future cash outflows are likely to be necessary to ensure compliance with environmental regulations or to carry out remediation work, such costs can be reliably estimated and no future benefits are expected from such measures.
Estimating the future costs of environmental protection and remediation involves many uncertainties, particularly with regard to the status of laws, regulations and the information available about conditions in the various countries and at the individual sites. Significant factors in estimating the costs include previous experiences in similar cases, the conclusions in expert opinions obtained regarding the Group’s environmental programs, current costs and new developments affecting costs, management’s interpretation of current environmental laws and regulations, the number and financial position of third parties that may become obligated to participate in any remediation costs on the basis of joint liability, and the remediation methods which are likely to be deployed. Changes in these assumptions could impact future reported results.
Taking into consideration experience gained to date regarding environmental matters of a similar nature, provisions are believed to be adequate based upon currently available information. There were no significant changes in assumptions or estimates that would have impacted the income statement in prior years. However, given the inherent difficulties in estimating liabilities in the businesses in which the Group operates, especially those for which the risk of environmental damage is relatively greater (CropScience and MaterialScience), it remains possible that material additional costs will be incurred beyond the amounts accrued. It may transpire during remediation work that additional expenditures are necessary over an extended period of time that exceed existing provisions and cannot be reasonably estimated. Management nevertheless believes that such additional amounts, if any, would not have a material adverse effect on the Group’s financial position or results of operations. Further information on environmental provisions in the Bayer Group can be found in Note [26.3].
As a global company with a diverse business portfolio, the Bayer Group is exposed to numerous legal risks, particularly in the areas of product liability, competition and antitrust law, patent disputes, tax assessments and environmental matters.
Provisions for litigations are recorded in the balance sheet in respect of pending or future litigation, subject to a case-by-case examination. Such legal proceedings are evaluated on the basis of the available information, including that from legal counsel acting for the Group, to assess potential outcomes. Where it is reasonably likely that a future obligation arising out of legal proceedings will result in an outflow of resources, a provision is recorded in the amount of the present value of the expected cash outflows if these are considered to be reliably measurable. These provisions cover the estimated payments to plaintiffs, court fees, attorney costs and the cost of potential settlements. The evaluation is based on the current status of litigation as of each reporting date and includes an assessment of whether the criteria for recording a provision are met and, if so, the amount of the provision to be recorded.
The outcome of currently pending and future proceedings cannot be predicted. Thus, an adverse decision in a lawsuit could result in additional costs that are not covered, either wholly or partially, under insurance policies and that could significantly impact the business and results of operations of the Bayer Group. If the Bayer Group loses a case in which it seeks to enforce its patent rights, a decrease in future earnings could result as other manufacturers could be permitted to begin to market products that the Bayer Group or its predecessors had developed.
Litigation and other judicial proceedings generally raise complex issues and are subject to many uncertainties and complexities including, but not limited to, the facts and circumstances of each particular case, issues regarding the jurisdiction in which each suit is brought and differences in applicable law. Upon resolution of any pending legal matter, the Bayer Group may be forced to incur charges in excess of the presently established provisions and related insurance coverage. It is possible that the financial position, results of operations or cash flows of the Bayer Group could ultimately be materially affected by the unfavorable outcome of litigation.
Further information on legal risks and the related provisions is contained in Notes [26.6] and [32].
Financial liabilities
Financial liabilities comprise primary financial liabilities and negative fair values of derivative financial instruments.
Primary financial liabilities are recognized in the balance sheet if the Bayer Group has a contractual obligation to transfer cash or other financial assets to another party. Such liabilities are initially recognized at the fair value of the consideration received or the value of payments received less any transaction costs. In subsequent periods, they are measured at amortized cost using the effective-interest method. Liabilities relating to finance leases are carried at the present value of the minimum future lease payments.
Derivative financial instruments are carried at fair value through profit or loss unless hedge accounting is used. Negative fair values of derivative financial instruments are included in financial liabilities or other liabilities. The accounting treatment of derivative financial instruments and hedging relationships involving such instruments are explained in more detail in Note [30].
Financial liabilities are derecognized when the contractual obligation is discharged or canceled, or has expired.
Under IAS 32 (Financial Instruments: Presentation), financial instruments are only classified as equity if no contractual obligation exists to repay the capital or deliver other financial assets to the issuer. Where a third party holding a (minority) interest in a consolidated subsidiary is contractually entitled to terminate its participation and at the same time claim repayment of its capital contribution, such capital is recognized as a liability in the Group statements even if it is classified as equity in the respective jurisdiction. The redeemable capital of a minority stockholder is recognized at the amount of such stockholder’s pro-rated share of the subsidiary’s net assets.
Primary financial liabilities are recognized in the balance sheet if the Bayer Group has a contractual obligation to transfer cash or other financial assets to another party. Such liabilities are initially recognized at the fair value of the consideration received or the value of payments received less any transaction costs. In subsequent periods, they are measured at amortized cost using the effective-interest method. Liabilities relating to finance leases are carried at the present value of the minimum future lease payments.
Derivative financial instruments are carried at fair value through profit or loss unless hedge accounting is used. Negative fair values of derivative financial instruments are included in financial liabilities or other liabilities. The accounting treatment of derivative financial instruments and hedging relationships involving such instruments are explained in more detail in Note [30].
Financial liabilities are derecognized when the contractual obligation is discharged or canceled, or has expired.
Under IAS 32 (Financial Instruments: Presentation), financial instruments are only classified as equity if no contractual obligation exists to repay the capital or deliver other financial assets to the issuer. Where a third party holding a (minority) interest in a consolidated subsidiary is contractually entitled to terminate its participation and at the same time claim repayment of its capital contribution, such capital is recognized as a liability in the Group statements even if it is classified as equity in the respective jurisdiction. The redeemable capital of a minority stockholder is recognized at the amount of such stockholder’s pro-rated share of the subsidiary’s net assets.
Other receivables and liabilities
Accrued items, advance payments and non-financial assets and liabilities are carried at amortized cost. They are amortized to income by the straight-line method or according to performance of the underlying transaction.
In accordance with IAS 20 (Accounting for Government Grants and Disclosure of Government Assistance), grants and subsidies that serve to promote investment are reflected in the balance sheet under other liabilities and amortized to income over the useful lives of the respective assets.
In accordance with IAS 20 (Accounting for Government Grants and Disclosure of Government Assistance), grants and subsidies that serve to promote investment are reflected in the balance sheet under other liabilities and amortized to income over the useful lives of the respective assets.
Acquisition accounting
Acquired businesses are accounted for using the purchase method of accounting, which requires that the assets acquired and liabilities assumed be recorded at their respective fair values on the date Bayer gains control.
The application of the purchase method requires certain estimates and assumptions especially concerning the determination of the fair values of the acquired intangible assets and property, plant and equipment as well as the liabilities assumed at the date of the acquisition. Moreover, the useful lives of the acquired intangible assets, property, plant and equipment have to be determined.
Measurement is based to a large extent on anticipated cash flows. If actual cash flows vary from those used in calculating fair values, this may significantly affect the Group’s future results of operations. In particular, the estimation of discounted cash flows of intangible assets under development and developed technologies is subject to assumptions closely related to the nature of the acquired business. Factors that may affect the assumptions regarding future cash flows include
For significant acquisitions, the purchase price allocation is carried out with assistance from independent third-party valuation specialists. The valuations are based on information available at the acquisition date.
The application of the purchase method requires certain estimates and assumptions especially concerning the determination of the fair values of the acquired intangible assets and property, plant and equipment as well as the liabilities assumed at the date of the acquisition. Moreover, the useful lives of the acquired intangible assets, property, plant and equipment have to be determined.
Measurement is based to a large extent on anticipated cash flows. If actual cash flows vary from those used in calculating fair values, this may significantly affect the Group’s future results of operations. In particular, the estimation of discounted cash flows of intangible assets under development and developed technologies is subject to assumptions closely related to the nature of the acquired business. Factors that may affect the assumptions regarding future cash flows include
- outcomes of research and development activities regarding compound efficacy, results of clinical trials etc.,
- probability of obtaining regulatory approval in individual countries,
- long-term sales forecasts,
- anticipation of selling price erosion after the end of patent protection due to generic competition in the market,
- behavior of competitors (launch of competing products, marketing initiatives etc.).
For significant acquisitions, the purchase price allocation is carried out with assistance from independent third-party valuation specialists. The valuations are based on information available at the acquisition date.
Procedure used in global impairment testing and its impact
In accordance with IFRS 3 (Business Combinations) and the related revised versions of IAS 36 (Impairment of Assets) and IAS 38 (Intangible Assets), goodwill and other intangible assets with indefinite useful lives are tested regularly for impairment.
Where goodwill or other indefinite-lived intangible assets allocated to a cash-generating unit are not likely to generate identifiable future economic benefits independently of other assets, they must be tested for impairment annually, or more frequently if events or changes in circumstances indicate a possible impairment. This involves comparing the net carrying amount of each cash-generating unit to the recoverable amount, which is the higher of the cash-generating unit’s fair value less costs to sell and its value in use. In the Bayer Group, the strategic business entities – the financial reporting levels below the segments – are defined as the cash-generating units.
Where the carrying amount of a cash-generating unit exceeds the recoverable amount, an impairment loss is recognized for the difference. First, the goodwill of the relevant strategic business entity is written down accordingly. Any remaining impairment loss is allocated among the other assets of the strategic business entity in proportion to their net carrying amounts. This value adjustment is recognized in the income statement under other operating expenses.
The recoverable amount is determined from the present value of future cash flows, based on continuing use of the asset by the strategic business entity and its retirement at the end of its useful life. The cash flow forecasts are derived from the current long-term planning for the Bayer Group, generally for a five-year planning horizon, which involves assumptions, especially regarding future selling prices, sales volumes and costs. Cash flows beyond this planning period are extrapolated using individual growth rates derived from the respective market information. The assumed growth rates, depending on the businesses valued, are zero to 4.0 percent for HealthCare, 1.4 to 5.7 percent for CropScience, and zero to 1.0 percent for MaterialScience.
Bayer calculates the cost of capital on the basis of the debt/equity ratio. The underlying capital structure of each subgroup is determined by benchmarking against comparable companies in the same industry sector. The cost of equity corresponds to the return expected by stockholders, while the cost of debt is based on the conditions on which the company can obtain long-term financing. Both components are derived from capital market information.
To allow for the different risk and return profiles of the Bayer Group’s principal businesses, the after-tax cost of capital is calculated separately for each subgroup. The discount rates used are 8.1 percent (2006: 7.6 percent) for HealthCare, 8.1 percent (2006: 7.9 percent) for CropScience and 7.6 percent (2006: 7.3 percent) for MaterialScience. The equivalent pre-tax interest rates are 8.3 percent (2006: 7.8 percent) for HealthCare, 8.5 percent (2006: 8.3 percent) for CropScience and 8.0 percent (2006: 7.8 percent) for MaterialScience. These rates are based on assumptions and estimates relating to business-specific costs of capital, which in turn depend on country risks, credit risks, and additional risks resulting from the volatility of certain businesses. The risk adjustment for each subgroup is determined by benchmarking against comparable companies in the same industry sector.
Sensitivity analysis is based on a 10 percent decline in future cash flows and a 10 percent increase in the weighted average cost of capital because changes up to this magnitude are reasonably possible. Based on the Group’s experience, greater changes than this are unlikely. If the actual present value of future cash flows were 10 percent lower than the anticipated present value, the net carrying amount of goodwill in the Systems segment would have to be impaired by €31 million. If the weighted average cost of capital used for the impairment test were increased by 10 percent, assets of the Systems segment would have to be impaired by €36 million.
In 2007 and 2006 the following write-downs were made as a result of specific events (such as restructuring) or changes in circumstances. In 2007 as in 2006, however, no impairment losses were recorded on the basis of the global annual impairment tests.
Where goodwill or other indefinite-lived intangible assets allocated to a cash-generating unit are not likely to generate identifiable future economic benefits independently of other assets, they must be tested for impairment annually, or more frequently if events or changes in circumstances indicate a possible impairment. This involves comparing the net carrying amount of each cash-generating unit to the recoverable amount, which is the higher of the cash-generating unit’s fair value less costs to sell and its value in use. In the Bayer Group, the strategic business entities – the financial reporting levels below the segments – are defined as the cash-generating units.
Where the carrying amount of a cash-generating unit exceeds the recoverable amount, an impairment loss is recognized for the difference. First, the goodwill of the relevant strategic business entity is written down accordingly. Any remaining impairment loss is allocated among the other assets of the strategic business entity in proportion to their net carrying amounts. This value adjustment is recognized in the income statement under other operating expenses.
The recoverable amount is determined from the present value of future cash flows, based on continuing use of the asset by the strategic business entity and its retirement at the end of its useful life. The cash flow forecasts are derived from the current long-term planning for the Bayer Group, generally for a five-year planning horizon, which involves assumptions, especially regarding future selling prices, sales volumes and costs. Cash flows beyond this planning period are extrapolated using individual growth rates derived from the respective market information. The assumed growth rates, depending on the businesses valued, are zero to 4.0 percent for HealthCare, 1.4 to 5.7 percent for CropScience, and zero to 1.0 percent for MaterialScience.
Bayer calculates the cost of capital on the basis of the debt/equity ratio. The underlying capital structure of each subgroup is determined by benchmarking against comparable companies in the same industry sector. The cost of equity corresponds to the return expected by stockholders, while the cost of debt is based on the conditions on which the company can obtain long-term financing. Both components are derived from capital market information.
To allow for the different risk and return profiles of the Bayer Group’s principal businesses, the after-tax cost of capital is calculated separately for each subgroup. The discount rates used are 8.1 percent (2006: 7.6 percent) for HealthCare, 8.1 percent (2006: 7.9 percent) for CropScience and 7.6 percent (2006: 7.3 percent) for MaterialScience. The equivalent pre-tax interest rates are 8.3 percent (2006: 7.8 percent) for HealthCare, 8.5 percent (2006: 8.3 percent) for CropScience and 8.0 percent (2006: 7.8 percent) for MaterialScience. These rates are based on assumptions and estimates relating to business-specific costs of capital, which in turn depend on country risks, credit risks, and additional risks resulting from the volatility of certain businesses. The risk adjustment for each subgroup is determined by benchmarking against comparable companies in the same industry sector.
Sensitivity analysis is based on a 10 percent decline in future cash flows and a 10 percent increase in the weighted average cost of capital because changes up to this magnitude are reasonably possible. Based on the Group’s experience, greater changes than this are unlikely. If the actual present value of future cash flows were 10 percent lower than the anticipated present value, the net carrying amount of goodwill in the Systems segment would have to be impaired by €31 million. If the weighted average cost of capital used for the impairment test were increased by 10 percent, assets of the Systems segment would have to be impaired by €36 million.
In 2007 and 2006 the following write-downs were made as a result of specific events (such as restructuring) or changes in circumstances. In 2007 as in 2006, however, no impairment losses were recorded on the basis of the global annual impairment tests.
| 2006 | 2007 | |
| € million | ||
| Impairment charges (continuing operations) | 172 | 286 |
| Impairment charges (discontinued operations) | 18 | - |
| Total impairment charges | 190 | 286 |
Although the estimates of the useful lives of certain assets, assumptions concerning the macroeconomic environment and developments in the industries in which the Bayer Group operates and estimates of the discounted future cash flows are believed to be appropriate, changes in assumptions or circumstances could require changes in the analysis. This could lead to additional impairment charges in the future or – except in the case of goodwill – to valuation write-backs should the expected trends reverse.
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