Overview
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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 derivatives.
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 for impairment testing or purchase price allocations, 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
Profits and losses, sales revenues, and income and expenses arising from transactions among the consolidated companies, along with receivables and payables existing between them, 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 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 2008 or 2007.
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. Exchange rate differences from valuation of balances in foreign currencies are recognized in income. Derivatives are stated at fair value. The majority of consolidated companies autonomously carry out their activities financially, economically and organizationally 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 into euros at closing rates. All changes occurring during the year and all income and expense items and cash flows are translated into euros 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 | ||||
|---|---|---|---|---|---|
2007 | 2008 | 2007 | 2008 | ||
ARS | Argentina | 4.64 | 4.80 | 4.27 | 4.64 |
BRL | Brazil | 2.61 | 3.25 | 2.67 | 2.67 |
CAD | Canada | 1.44 | 1.70 | 1.47 | 1.56 |
CHF | Switzerland | 1.65 | 1.49 | 1.64 | 1.59 |
CNY | China | 10.75 | 9.50 | 10.42 | 10.23 |
GBP | U.K. | 0.73 | 0.95 | 0.68 | 0.80 |
JPY | Japan | 164.93 | 126.14 | 161.23 | 152.37 |
MXN | Mexico | 16.08 | 19.23 | 14.97 | 16.31 |
USD | United States | 1.47 | 1.39 | 1.37 | 1.47 |
Net sales and other operating income
Revenues from the sale of products and the rendering of services are recognized when 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 revenue 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 at the fair value of the consideration received or to be received. Sales deductions are estimated amounts for rebates, cash discounts 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 strategic business entity. 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. Adjustments to provisions for rebates, cash discounts or returns for sales made in prior periods were of secondary importance for income before income taxes in the years under report.
Provisions for rebates in 2008 amounted to 1.4% of total net sales, as in the previous year. In addition to rebates, Group companies offer cash discounts for prompt payment in some countries. Provisions for cash discounts as of December 31, 2008 and December 31, 2007 were less than 0.1% 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, 2008 were 0.2% of total net sales for the year (December 31, 2007: 0.3%). 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 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 accordingly. 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.
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 internally 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 generation. 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.”
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 recognized in 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.
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 infrastructure | 10 to 20 years |
Storage tanks and pipelines | 10 to 20 years |
Plant installations | 6 to 20 years |
Machinery and equipment | 6 to 12 years |
Furniture and fixtures | 4 to 10 years |
Vehicles | 4 to 8 years |
Computer equipment | 3 to 5 years |
Laboratory and research facilities | 3 to 5 years |
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 carrying amount of the assets is recognized as a gain or loss in other operating income or expenses, respectively.
Leasing
A lease is an agreement whereby the lessor assigns to the lessee the right to use an asset for an agreed period of time in return for a payment or series of payments. Leases are classified as either finance or operating leases. Leasing transactions that transfer substantially all the risks and rewards incidental to ownership of the leased asset to the lessee are classified as finance leases. All other leasing agreements are classified as operating leases.
Where the Bayer Group is the lessee in a finance lease, the leased asset is capitalized at the lower of the fair value or present value of the minimum lease payments at the beginning of the lease term and simultaneously recognized under financial liabilities. The minimum lease payments essentially comprise financing costs and the principal portion of the remaining obligation. The leased asset is depreciated by the straight-line method. If subsequent transfer of title to the leased asset is uncertain, it is depreciated over the shorter of its estimated useful life or the lease term. The lease payments to be made are divided into the principal portion and the interest expense using the effective-interest method.
Where the Bayer Group is the lessor in a finance lease, the net investment in the lease is reflected in sales and a leasing receivable is recognized. The lease payments received are divided into the principal portion and the interest income using the effective-interest method.
Where the Bayer Group is the lessee in an operating lease, the lease payments are expensed. Where it is the lessor, the lease payments received are recognized in income. The leased asset remains on the balance sheet of the lessor.
Financial Assets
Financial assets comprise loans and receivables, acquired equity and debt instruments, cash and cash equivalents, and derivatives 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 generally 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 according to IAS 39, with different measurement rules applying to each category:
Financial assets held at fair value through profit or loss comprise those financial assets that are held for trading. This category also comprises receivables from forward commodity contracts and receivables from other derivatives, 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 other 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 to maturity. 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. They mainly include equity instruments, such as shares, 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. Impairments are not recognized in income until the assets are sold, except where the fair value is substantially below the amortized cost and / or remains below the amortized cost for a prolonged period. 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 amortized cost. 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 expire or the financial assets are transferred together with all material risks and benefits.
Derivatives
The Bayer Group uses derivatives to mitigate the risk of changes in exchange rates, interest rates and commodity prices. Many transactions constitute economic hedges but do not qualify for hedge accounting under IAS 39 (Financial Instruments: Recognition and Measurement).
Contracts concluded in order to receive or deliver non-financial goods for the company’s own purposes are accounted for not as derivatives but as pending transactions. Where embedded derivatives are identified that are required to be separated from the pending transactions, they are accounted for separately. To take advantage of market opportunities or cover possible peak demand, non-material transactions may be entered into under which the possibility of immediate resale cannot be excluded. Such transactions are allocated to separate portfolios upon acquisition and accounted for as derivatives according to IAS 39. Changes in the fair values of these derivatives are recognized directly in the income statement.
Changes in the values of forward exchange contracts and currency options are reflected in exchange gains and losses, while changes in the values of interest-rate swaps and interest-rate options are recognized in interest income and expense. Changes in the fair values of commodity futures and commodity options and those arising from the hedging of forecasted transactions in foreign currencies are recognized in other operating income and expenses at the date of realization.
The fair values of derivatives are measured by the usual methods in light of the market data available at the measurement date. Currency and commodity contracts are measured individually at their forward rates or forward prices on the balance sheet date. These depend on spot rates or prices including time spreads. The fair values of interest-rate hedging instruments are determined by discounting future cash flows over the remaining terms of the instruments at market rates of interest. The present value of each interest-rate, currency or cross-currency interest-rate swap transaction is measured individually as of the balance sheet date. Interest income is recognized in the income statement at the date of payment or, in case of accrual, at the balance sheet date. Certain long-term commodity contracts to which fair values cannot be assigned are measured with the aid of valuation models based on internal fundamental data.
Changes in the fair values of derivatives designated as fair value hedges and the adjustments in the carrying amounts of the underlying transactions are recognized in the income statement. Changes in the fair values of the effective portion of derivatives designated as cash flow hedges are initially recognized not in the income statement, but in stockholders’ equity under other comprehensive income. They are released to the income statement when the underlying transaction is realized. If a derivative is sold or ceases to qualify for hedge accounting, the amount reflected in other comprehensive income continues to be recognized in this item until the forecasted transaction is realized. If the forecasted transaction is no longer probable, the amount previously recognized in other comprehensive income is released to the income statement.
The income and expense reflected in the non-operating result pertaining to the derivatives and the underlying transactions are shown separately. Income and expense are not offset.
Inventories
In accordance with IAS 2 (Inventories), inventories encompass assets held for sale in the ordinary course of business (finished goods and goods purchased for resale), 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 income taxes recognized are reflected 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, tax credits and tax loss carryforwards are recognized where 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.
Where gains or losses are recognized directly in stockholders’ equity, this also applies to the related deferred tax assets or liabilities.
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.
Deferred tax liabilities recognized on planned dividend payments by subsidiaries depend on the anticipated earnings situation of the subsidiaries concerned and on further assumptions regarding their future financing structure, for example. Such deferred taxes are subject to regular review with respect to the underlying assumptions. Changes in the assumptions or in circumstances may necessitate adjustments, possibly resulting in allocations to deferred taxes or reversals thereof.
Stockholders´ equity
Under the German Stock Corporations Act, the distributable dividend is based on the balance sheet profit recognized in the annual financial statements of Bayer AG, which are prepared in accordance with the German Commercial Code.
The proposed dividend is subject to approval by the company’s stockholders at the Annual Stockholders Meeting and has not been recognized as a liability in the consolidated fi nancial statements of the Bayer Group.
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, 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 operating result (EBIT). 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 reported net of taxes in the statement of recognized income and expense, without affecting the income statement, as well as being recognized in full in the respective provision. 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].
The expenses for the benefits expected to be payable after retirement are spread over each employee’s entire period of employment, also 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 discount rates used are calculated from the yields of high-quality corporate bond portfolios in specific currencies with cash flows approximately equivalent to the expected disbursements from the pension plans. The uniform discount rate that is used to discount pension and post-employment benefit obligations as part of the actuarial valuation is thus based on the yields, at the balance sheet date, of a portfolio of AA-rated corporate 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 or interest-rate swaps at the balance sheet date is used instead but was increased by about 0.5 to 1.0 percentage points in previous years since corporate bonds generally provide higher yields by virtue of their risk structure. In light of current developments on the financial markets and the associated higher yields on corporate bonds and lower yields on government bonds, a spread premium of 2.0 to 2.5 percentage points has been taken into account.
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 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. Higher or lower rates of employee fluctuation or longer or shorter life of participants may also affect the amount of pension income or expense recorded in the future.
Other provisions
Other provisions are recognized for present legal and constructive 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 obligations.
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 expected to occur after one year, the provision is recognized at the present value of the expected cash outflow. Claims for reimbursements 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 or 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% change in the probability of occurrence is examined in each case. This analysis has not shown other provisions to be materially sensitive.
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 for taxes, based on reasonable estimates, for liabilities to the tax authorities of the respective countries that are uncertain as to their amount and the probability of their occurrence. The amount of such provisions is based on various factors, such as experience with previous tax audits and differing legal interpretations by the taxable entity and the responsible tax authority.
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.
Provisions for restructuring only cover expenses that arise directly from restructuring measures, are necessary for restructuring and are not related to future business operations, such as costs for real estate no longer utilized or severance payments to employees.
Restructuring measures may include the sale or termination of business units, site closures, relocation of business activities, changes in management structure or a fundamental reorganization of departments or business units.
The respective provisions are established when a detailed restructuring plan has been drawn up, resolved upon by the responsible decision-making level of management and communicated to the employees or their representatives. Provisions for restructuring are established at the present value of future disbursements.
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.
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 more likely than not that a present 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.
Litigations 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. The outcome of currently pending and future proceedings therefore cannot be predicted. Upon resolution of any pending legal matter, the Bayer Group may be forced to incur charges in excess of presently established provisions and related insurance coverage. If courts find against Bayer in patent suits and this results in other manufacturers being permitted to market products developed by the Bayer Group or its legal predecessors, this could adversely impact the Group’s financial position or results of operations.
Personnel-related provisions are mainly those recorded for annual bonus payments, variable one-time payments, individual performance awards, long-service awards, surpluses on long-term accounts and other personnel costs. Obligations under stock-based compensation programs that provide for awards payable in cash are also included here.
Financial liabilities
Financial liabilities comprise primary financial liabilities and negative fair values of derivatives.
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, primary financial liabilities are measured at amortized cost using the effective-interest method.
Financial liabilities are derecognized when the contractual obligation is discharged or cancelled, 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 stockholders of Bayer AG or non-controlling interest are contractually entitled to terminate their participation and at the same time claim repayment of their 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 non-controlling 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 other 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 from third parties 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.
Noncurrent assets held for sale and discontinued operations, and liabilities directly related thereto
Assets held for sale comprise noncurrent assets and disposal groups (net of any related liabilities), the carrying amounts of which will be realized primarily by way of a highly probable divestment transaction within the next twelve months or an already executed divestment transaction, and not through continued use. Such assets are recognized at the lower of the carrying amount and the fair value less costs to sell.
Acquisition accounting
Acquired businesses are accounted for using the purchase method, 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 materially affect the Group’s future results of operations. In particular, the estimation of discounted cash flows from intangible assets under development and developed technologies is based on assumptions concerning, for example:
- the outcomes of research and development activities regarding compound efficacy, results of clinical trials etc.,
- the probability of obtaining regulatory approval in individual countries,
- long-term sales trends,
- possible selling price erosion due to generic competition in the market following patent
expirations, - the 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.
The effect of the revaluation of assets relating to acquisitions made in stages is recognized in equity in compliance with IFRS 3 (Business Combinations). If an enterprise is acquired in several stages, all assets and liabilities of the company have to be completely revalued on the date on which the acquiring company gains control and recognized at fair value. If the new fair value of the assets already held by the acquiring company exceeds their carrying amount, the carrying amount must be increased accordingly. This adjustment is recognized in a separate equity item (revaluation surplus) and thus has no effect on net income.
Procedure used in global impairment testing and its impact
In accordance with IFRS 3 (Business Combinations), in conjunction with 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 are allocated to a cash-generating unit, they must be tested for impairment annually, or more frequently if events or changes in circumstances indicate a possible impairment. This involves comparing the 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 or 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 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. Forecasts of future cash flows for the purpose of determining the recoverable amount are based on the current planning of the Bayer Group, generally for a planning horizon of three to five years, 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 0% to 2.0% (2007: 0% to 4.0%) for HealthCare, 1.7% to 6.4% (2007: 1.4% to 5.7%) for CropScience, and 0% to 1.0%, as in the previous year, 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 7.6% (2007: 8.1%) for HealthCare, 7.9% (2007: 8.1%) for CropScience and 7.0% (2007: 7.6%) for MaterialScience. The equivalent pre-tax interest rates are 7.9% (2007: 8.3%) for HealthCare, 8.3% (2007: 8.5%) for CropScience and 7.6% (2007: 8.0%) 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% decline in future cash flows and a 10% 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% lower than the anticipated present value, the carrying amount of goodwill in the Systems segment would have to be impaired by €78 million. If the weighted average cost of capital used for the impairment test were increased by 10%, assets of the Systems segment would have to be impaired by €81 million. In 2008 as in 2007, however, no impairment losses were recorded on the basis of the global annual impairment tests.
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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