Annual Report 2014 Annual Report 2014
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Accounting policies

(6) Accounting and measurement principles

With the exception of the two changes described in the following, the accounting and measurement principles have remained unchanged in comparison with the previous year.

Effective January 1, 2014, two product groups, Neurobion® (a vitamin B-based analgesic) and Floratil® (a probiotic antidiarrheal), were transferred from the Merck Serono division to the Consumer Health division. A detailed presentation of the associated disclosure changes in Segment Reporting can be found in Note [52].

Amortization of intangible assets (excluding software), which was previously disclosed in a separate line in the income statement, was allocated to the corresponding functional costs in 2014. This has been done in particular to ensure improved comparability of the income statement of the Merck Group with other companies. The amortization relates mainly to intangible assets recognized within the scope of the purchase price allocations for the acquisitions of Serono SA, the Millipore Corporation as well as AZ Electronic Materials S.A. Amortization of software was already allocated to the functional costs in the past. The accounting policy change has led to an increase in marketing and selling expenses, cost of sales as well as research and development costs. The previous year’s figures have been adjusted accordingly and are presented in the following table:


Show table
2013
€ million reported adjustment adjusted
 
Sales 10,700.1 10,700.1
Royalty, license and commission income 395.0 395.0
Total revenues 11,095.1 11,095.1
 
Cost of sales – 2,992.5 – 49.2 – 3,041.7
Gross margin 8,102.6 – 49.2 8,053.4
 
Marketing and selling expenses – 2,326.5 – 762.0 – 3,088.5
Royalty, license and commission expenses – 567.0 – 567.0
Administration expenses – 562.4 – 562.4
Research and development costs – 1,504.3 – 2.3 – 1,506.6
Other operating expenses and income – 718.1 – 718.1
Amortization of intangible assets – 813.5 813.5
Operating result (EBIT) 1,610.8 1,610.8

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The main assets and liabilities disclosed in the consolidated balance sheet are measured as follows:


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Balance sheet items Measurement principle
 
ASSETS
Cash and cash equivalents Nominal value
Financial assets (current/non-current)
Held to maturity investments Amortized cost
Available-for-sale financial assets Fair value
Loans and receivables Amortized cost
Assets from derivatives (financial transactions) Fair value
Trade accounts receivable Amortized cost
Inventories Lower of cost and net realizable value
Other assets (current/non-current)
Assets from derivatives (operating business) Fair value
Receivables from non-income-related taxes Amortized cost
Other receivables Amortized cost
Income tax receivables Expected tax refunds based on tax rates that have been enacted or substantively enacted by the end of the reporting period
Assets held for sale Lower of carrying amount and fair value less costs to sell
Intangible assets
With finite useful lives Amortized cost
With indefinite useful lives Amortized cost (subsequent measurement impairment-only approach)
Property, plant and equipment Amortized cost
Deferred tax assets Undiscounted measurement based on tax rates that are expected to apply
to the period when the asset is realized or the liability is settled
EQUITY AND LIABILITIES
Financial liabilities (current/non-current)
Bonds Amortized cost
Liabilities to related parties Amortized cost
Bank loans and overdrafts Amortized cost
Liabilities from derivatives (financial transactions) Fair value
Finance lease liabilities Amortized cost
Trade accounts payable Amortized cost
Other liabilities (current/non-current)
Liabilities from derivatives (operating business) Fair value
Liabilities from non-income-related taxes Settlement amount
Other liabilities Settlement amount
Income tax liabilities Expected tax payments based on tax rates that have been enacted or substantively enacted by the end of the reporting period
Liabilities in connection with assets held for sale Fair value less costs to sell
Provisions (current/non-current) Present value of the expenditures expected to be required to settle the obligation
Provisions for pensions and other post-employment benefits Projected unit credit method
Deferred tax liabilities Undiscounted measurement based on tax rates that are expected to apply to the period when the asset is realized or the liability is settled

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(7) Management judgments and sources of estimation uncertainty

The preparation of the consolidated financial statements requires management to make judgments and assumptions as well as estimates to a certain extent. This affects the amount of assets and liabilities, disclosures on contingent assets and liabilities, as well as reported income and expenses. Actual values may differ from the estimates made and assumptions and judgments may subsequently prove inaccurate. This is of fundamental importance for the understanding of these consolidated financial statements and the assessment of the underlying risks. The relevant assumptions and estimates for the preparation of the consolidated financial statements are reviewed on an ongoing basis. Changes in estimates are considered in the period of the change and in subsequent periods if the change relates to both the reporting period and also future periods. Judgments, forward-looking assumptions and sources of estimation uncertainty with the greatest potential effects on these consolidated financial statements are presented below.

Recognition and measurement of assets, liabilities and contingent liabilities acquired in the context of business combinations

The measurement of assets, liabilities and contingent liabilities at fair value as part of purchase price allocations is subject to estimates which are prepared using the services of external valuation experts. The fair values of the assets and liabilities recognized as part of the purchase price allocation of AZ Electronic Materials S.A. and further information on this acquisition, which closed in the reporting period, can be found in Note [4].

Sales deductions

Merck grants its customers various kinds of rebates and discounts. In addition, expected product returns, state compulsory charges and rebates from health plans and programs are also deducted from sales.

The most significant portion of these deductions from sales is attributable to the Merck Serono division. The most complex and most substantial rebates in this division relate to government rebate programs in North America such as the U.S. Federal Medicare Program and the U.S. Medicaid Drug Rebate Program. Other significant sales deductions in the division result from compulsory government rebate programs in certain European countries.

Insofar as sales deductions were not already made on payments received, Merck determines the level of sales deductions on the basis of current experience and recognizes them as a liability. The sales deductions reduce gross sales revenues. Adjustments of liabilities can lead to increases or reductions of sales in later periods.

Impairment tests of goodwill and other intangible assets with indefinite useful lives

The goodwill (carrying amount as of December 31, 2014: € 5,693.9 million/2013: € 4,583.2 million) and other intangible assets with indefinite useful lives (carrying amount as of December 31, 2014: € 168.7 million/2013: € 214.9 million) reported in the consolidated financial statements are tested for impairment when a triggering event arises or at least once a year. Impairment losses for goodwill were not required to be recognized in the year under review. In contrast, impairment losses of other intangible assets with indefinite useful lives were recorded in the amount of € 84.8 million (2013: € 1.3 million); these were mainly attributable to the termination of development projects.

Goodwill and intangible assets with indefinite useful lives that do not generate any independent cash flows are allocated to cash-generating units within the scope of the impairment test. A cash-generating unit is a division as presented in the Segment Reporting.

When testing for potential impairments, Merck determines the recoverable amount by discounting expected cash flows and therefore uses the value-in-use method. Reference is made to the latest forecasts approved by the company management that cover a period of five years. Cash flows for periods in excess of this are included using an individualized long-term growth rate for the specific cash-generating unit.

The impairment tests include assumptions and estimates of the amount of future cash flows and the discount rate. Among other things, market observations, and – if available – market data, target-actual deviations, detailed plans as well as past experience form the basis for the estimates of future cash flows. Assumptions and estimates relate in particular to future customers, saleable quantities, achievable prices, corresponding cost developments, the long-term growth rate and the weighted average cost of capital (WACC) used for discounting. All of these assumptions are considered a source of estimation uncertainty due to their inherent uncertainty. The following long-term growth rates and discount rates were used to conduct the goodwill impairment tests of the cash-generating units:


Show table
€ million / %
2014
Goodwill as of
Dec. 31, 2014
Long-term
growth rate
Weighted average
cost of capital
after tax
Weighted average
cost of capital
before tax
 
Merck Serono 1,601.5 0.0 7.2 9.3
Consumer Health 243.1 2.0 6.9 8.4
Merck Millipore 2,911.1 2.0 6.8 7.8
Performance Materials 938.2 1.0 6.3 7.8

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Show table
€ million / %
2013
Goodwill as of
Dec. 31, 2013
Long-term
growth rate
Weighted average
cost of capital
after tax
Weighted average
cost of capital
before tax
 
Merck Serono 1,680.0 0.0 6.5 8.1
Consumer Health 164.1 2.5 7.2 8.8
Merck Millipore 2,730.9 2.8 7.6 8.8
Performance Materials 8.2 1.0 6.4 8.3

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The amount of the value in use is primarily affected by the terminal value, which is particularly sensitive to changes in the long-term growth rate and the discount rate. Even if the actual future cash flows were one percentage point lower than the expected cash flows, there would be no need to record impairment losses for goodwill. Likewise, there would be no need to record impairment losses if future cash flows were discounted by a weighted average cost of capital after tax that was one percentage point higher.

Determination of the level of amortization of intangible assets with finite useful lives

In addition to goodwill and other intangible assets with indefinite useful lives, Merck has a significant amount of intangible assets with finite useful lives (carrying amount as of December 31, 2014: € 5,496.1 million/2013: € 5,026.8 million). Substantial assumptions and estimates are required to determine the appropriate level of amortization of these intangible assets. This relates in particular to the determination of the underlying remaining useful life. The parameter is reviewed by Merck and adjusted if necessary at least at the end of every fiscal year. In these estimates, Merck considers factors including the typical product life cycles for each asset and publicly available information about the estimated useful lives of similar assets. Despite these analyses, the assumed useful lives can prove false at a later date because of the high degree of uncertainty.

If the amortization of intangible assets from market authorizations, patents, licenses and similar rights, capitalized brand names and trademarks had been 10 % higher, for example due to shortened remaining useful lives, profit before income tax would have been € 84.2 million lower in fiscal 2014 (2013: reduction of € 81.4 million). In fiscal 2014, a reduction of the useful lives of the intangible assets reported in connection with the drug Rebif® by one year would have lowered profit before income tax by € 73.6 million (2013: € 61.4 million).

Research and development collaborations as well as in- and out-licensing of intangible assets

Merck is regularly a partner of research and development collaborations with research institutions, biotechnology companies and other contract partners. These collaborations are aimed at developing marketable products. Merck also enters into in-licensing agreements regarding intellectual property of contract partners. Such agreements typically involve making upfront payments and payments for the achievement of certain milestones related to development and marketing progress. In this context, Merck has to judge to what extent up-front or milestone payments represent remuneration for services provided (ongoing research and development expense) or whether such payments result in an in-licensing of an intangible asset that has to be capitalized. This assessment is normally subject to judgment.

Merck also receives upfront and milestone payments as part of research and development collaborations or out-licensing agreements. In this context, income may only be recognized if Merck has transferred any material risks and rewards of an intangible asset to the acquirer, has no interest in the remaining business activities and has no other continuing commitment. If these criteria are not deemed to be met, the received payments are deferred and recognized over the period in which Merck is expected to fulfill its performance obligations. Both the assessment of the revenue recognition criteria and the determination of the appropriate period during which revenue is recognized are subject to judgment. If the upfront payment, which was agreed as part of the strategic alliance with Pfizer Inc., USA, entered into during the reporting period and which was received in cash and deferred as a liability, had been deferred and recognized in the income statement over a shorter period reduced by one year, profit before income tax for fiscal year 2014 would have increased by € 2.7 million.

Identification of impairment of non-financial assets

Judgments are required in the identification of existing indications of impairment of intangible assets and property, plant and equipment. As of December 31, 2014, the carrying amounts of these assets amounted to € 14,385.9 million (2013: € 12,514.4 million). Merck uses external and internal information to identify indications of impairment. For example, the approval of a competing product in the Merck Serono division or the closure of a location can be an indicator of impairment. Nevertheless, Merck’s analysis of indications of impairment can prove too optimistic, too pessimistic or incorrect in hindsight due to the high degree of uncertainty. This would result in impairment tests being carried out too late, too early or erroneously not carried out at all.

Impairment of financial assets

On every reporting date, Merck reviews whether there is any objective evidence that a financial asset is impaired and, if this is the case, carries out the impairment to the extent estimated as necessary. Particularly important in this context are impairment losses on trade receivables whose carrying amount was € 2,235.6 million in 2014 (2013: € 2,021.4).

Significant indicators for the identification of impaired receivables and the subsequent impairment tests are in particular payment default or delay in the payment of interest or principal, negative changes in economic or regional economic framework conditions as well as considerable financial difficulties of a debtor. These estimates are discretionary and can later prove to be incorrect.

Other provisions

As a global company for high-tech products in the pharmaceutical and chemical industries, Merck is exposed to a multitude of litigation risks. In particular, these include risks from product liability, competition and antitrust law, pharmaceutical law, patent law, tax law and environmental protection. Merck is engaged in legal proceedings and official investigations, the outcomes of which are uncertain. A detailed description of the most important legal matters as of the balance sheet date can be found in Note [48]. The provisions recognized for legal disputes mainly relate to the Merck Serono division and amounted to € 393.1 million as of the reporting date (2013: € 772.3 million). To assess the existence of a reporting obligation and to quantify pending outflows of resources, Merck draws on the knowledge of the legal department as well as any other outside counsel.

In spite of this, both the assessment of the existence of a present obligation and the estimate of the probability of a future outflow of resources are highly subject to uncertainty. Equally, the evaluation of a possible payment obligation is to be considered a major source of estimation uncertainty.

To a certain extent, Merck is obliged to take measures to protect the environment and reported provisions for environmental protection of € 123.7 million as of December 31, 2014 (2013: € 111.2 million). The underlying obligations were located mainly in Germany and the United States. Provisions were recognized primarily for obligations from soil remediation and groundwater protection in connection with the discontinued crop protection business.

The calculation of the present value of the future settlement amount requires, among other things, estimates of the future settlement date, the actual severity of the identified contamination, the applicable remediation methods and the associated future costs. The measurement is carried out regularly in consultation with independent experts. In spite of this, the determination of the future settlement amount of the provisions for environmental protection measures is subject to a considerable degree of uncertainty.

In the event of the discontinuation of clinical development projects, Merck is regularly required to bear unavoidable subsequent costs for a certain future period of time. The measurement of these provisions requires estimates regarding the length of time and the amount of the subsequent costs.

Provisions for pensions and other post-employment benefits

Merck maintains several defined benefit pension plans, particularly in Germany, Switzerland and the United Kingdom. The determination of the present value of the obligation from these defined benefit pension plans primarily requires estimates of the discount rate, future salary increases, future pension increases and future cost increases for medical care.

Detailed information on the existing pension obligations and a sensitivity analysis of the parameters named above are provided in Notes [22] and [49] . As of the reporting date, the amount recorded on the balance sheet for provisions for pensions and other post-employment benefits was € 1,820.1 million (2013: € 910.9 million). The present value of the defined benefit pension obligation was € 3,812.7 million as of December 31, 2014 (2013: € 2,736.8 million).

Income taxes

The calculation of the reported assets and liabilities from deferred and current income taxes requires extensive discretionary judgments, assumptions and estimates. Income tax liabilities were € 849.8 million as of December 31, 2014 (2013: € 465.1 million). The carrying amounts of deferred tax assets and liabilities amounted to € 992.9 million and € 818.4 million, respectively, as of the reporting date (2013: € 736.4 million and € 665.5 million, respectively).

The recognized income tax liabilities and provisions are partially based on estimates and interpretations of tax laws and ordinances in different jurisdictions.

With regard to deferred tax items, there is a high degree of uncertainty concerning the date on which an asset is realized or a liability settled and concerning the tax rate applicable on this date. This particularly relates to deferred tax liabilities recognized in the context of the acquisitions of Serono SA, the Millipore Corporation and AZ Electronic Materials S.A. The recognition of deferred tax assets from loss carryforwards requires an estimate of the probability of the future realizability of loss carryforwards. Factors considered in this estimate are results history, results planning and any tax planning strategy of the respective Group company.

Other judgments, assumptions and sources of estimation uncertainty

Merck makes other judgments, assumptions and estimates in the following areas:

  • Classification of financial assets and financial liabilities
  • Hedge accounting for cash flows from highly probable forecast transactions and firm purchase commitments
  • Determination of the fair value of financial instruments classified as available-for-sale and of derivative financial instruments
  • Determination of the fair value of the liability for share-based compensation
  • Determination of the fair value of plan assets

(8) Consolidation methods

The consolidated financial statements are based on the single-entity financial statements of the consolidated companies as of the balance sheet date, which were prepared applying consistent accounting policies in accordance with IFRS.

Acquisitions are accounted for using the purchase method in accordance with IFRS 3. Subsidiaries acquired and consolidated for the first time were measured at the carrying values at the time of acquisition on the basis of financial statements prepared for this purpose. Differences resulting in this connection are recognized as assets and liabilities to the extent that their fair values differ from the values actually carried in the financial statements. Any remaining – and usually positive – difference is recognized as goodwill within intangible assets, and is subjected to an impairment test if there are indications of impairment, or at least once a year.

In cases where a company was not acquired in full, non-controlling interests are measured using the fair value of the proportionate share of net assets. The option to measure non-controlling interests at fair value (full goodwill method) was not utilized.

When additional shares in a non-controlling interest are acquired, the purchase price amount that exceeds the carrying amount of this interest is recognized immediately in equity.

IFRS 11, which has been applicable since 2014, is applied for joint arrangements. A joint arrangement exists when, on the basis of a contractual arrangement, Merck and third parties jointly control business activities. Joint control means that decisions about the relevant activities require unanimous consent. Joint arrangements are either joint operations or joint ventures. Revenues and expenses as well as assets and liabilities from joint operations are included in the consolidated financial statements on a pro rata basis in accordance with Merck’s rights and obligations. By contrast, interests in joint ventures as well as in material associates over which Merck has significant influence are included in accordance with IAS 28 using the equity method of accounting.

Intragroup sales, expenses and income, as well as all receivables and payables between the consolidated companies, were eliminated. The effects of intragroup deliveries reported under non-current assets and inventories were adjusted by eliminating any intragroup profits. In accordance with IAS 12, deferred taxes are applied to these consolidation measures.

(9) Currency translation

The functional currency concept applies to the translation of financial statements of consolidated companies prepared in foreign currencies. The subsidiaries of the Merck Group generally conduct their operations independently. The functional currency of these companies is normally the respective local currency. Assets and liabilities are measured at the closing rate, and income and expenses are measured at weighted average annual rates in euros, the reporting currency. Any currency translation differences arising during consolidation of Group companies are taken directly to equity. If Group companies are deconsolidated, existing currency differences are reversed and reclassified to profit or loss. The local currency is not the functional currency at only a few subsidiaries.

When the financial statements of consolidated companies are prepared, business transactions that are conducted in currencies other than the functional currency are recorded using the current exchange rate on the date of the transaction. Foreign currency monetary items (cash and cash equivalents, receivables and payables) in the year-end financial statements of the consolidated companies prepared in the functional currency are translated at the respective closing rates. Exchange differences from the translation of monetary items are recognized in the income statement with the exception of net investments in a foreign operation. Hedged items are likewise carried at the closing rate. The resulting gains or losses are eliminated in the income statement against offsetting amounts from the fair value measurement of derivatives.

Currency translation was based on the following key exchange rates:


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Average annual rate Closing rate
€ 1 = 2014 2013 Dec. 31, 2014 Dec. 31, 2013
 
British pound (GBP) 0.805 0.848 0.781 0.834
Chinese renminbi (CNY) 8.167 8.178 7.534 8.345
Japanese yen (JPY) 140.594 129.016 145.392 144.729
Swiss franc (CHF) 1.214 1.228 1.203 1.227
Taiwan dollar (TWD) 40.172 39.471 38.448 41.128
U.S. dollar (USD) 1.325 1.330 1.215 1.379

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(10) Recognition of sales and revenues

Sales are recognized net of sales-related taxes as well as sales deductions. They are recognized once the goods have been delivered or the services have been rendered, the significant risks and rewards of ownership have been transferred to the purchaser, the amount of revenue can be measured reliably, and it is probable that the economic benefits will flow to the entity. When sales are recognized, estimated amounts are taken into account for expected sales deductions, for example rebates, discounts and returns.

In addition to revenue from the sale of goods, sales also include revenue from services, but the volume involved is insignificant. Long-term, customer-specific manufacturing contracts do not exist.

Depending on the substance of the relevant agreements, royalty, license and commission income is recognized either immediately or is recognized when the contractual obligation is fulfilled.

Dividend income is recognized when the shareholders’ right to receive the dividend is established. This is normally the date of the dividend resolution. Interest income is recognized in the period in which it is earned.

(11) Research and development costs

Research and development costs comprise the costs of research departments and process development, the expenses incurred as a result of research and development collaborations as well as the costs of clinical trials (both before and after approval is granted).

The costs of research cannot be capitalized and are expensed in full in the period in which they are incurred. As internally generated intangible assets, it is necessary to capitalize development expenses if the cost of the internally generated intangible asset can be reliably determined and the asset can be expected to lead to future economic benefits. The condition for this is that the necessary resources are available for the development of the asset, technical feasibility of the asset is given, its completion and use are intended, and marketability is given. Owing to the high risks up to the time that pharmaceutical products are approved, these criteria are not met in the pharmaceutical business. Costs incurred after regulatory approval are usually insignificant and are therefore not recognized as intangible assets. Owing to the risks existing up until market launch, development expenses in the Performance Materials and Merck Millipore divisions can likewise not be capitalized.

Reimbursements for R&D are offset against research and development costs.

(12) Financial instruments: principles

A financial instrument is any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. A distinction is made between non-derivative and derivative financial instruments.

Derivatives can be embedded in other financial instruments or in non-financial instruments. Under IFRS, an embedded derivative must be separated from the host contract and accounted for separately at fair value if the economic characteristics of the embedded derivative are not closely related to the economic characteristics of the host contract. Issued compound financial instruments with both an equity and a liability component must be recognized separately depending on their characteristics. Merck was not a party to hybrid or compound financial instruments during the fiscal year.

As a rule, Merck accounts for regular way purchases or sales of financial instruments at the settlement date and of derivatives at the trade date.

Financial assets and financial liabilities are generally measured at fair value on initial recognition, if necessary including transaction costs.

Financial assets are derecognized in part or in full if the contractual rights to the cash flows from the financial asset have expired or if control and substantially all the risks and rewards of ownership of the financial asset have been transferred to a third party. Financial liabilities are derecognized if the contractual obligations have been discharged, cancelled, or expired. Cash and cash equivalents are carried at nominal value.

(13) Financial instruments: Categories and classes of financial instruments

Financial assets and liabilities are classified into the following IAS 39 measurement categories and IFRS 7 classes. The classes required to be disclosed in accordance with IFRS 7 consist of the measurement categories set out here. Additionally, cash and cash equivalents with an original maturity of up to 90 days, finance lease liabilities, and derivatives designated as hedging instruments are also classes in accordance with IFRS 7. There were no reclassifications between the aforementioned measurement categories during the fiscal year.

Financial assets and financial liabilities at fair value through profit or loss

“Financial assets and financial liabilities at fair value through profit or loss” can be both non-derivative and derivative financial instruments. Financial instruments in this category are subsequently measured at fair value. Gains and losses on financial instruments in this measurement category are recognized directly in the income statement. This measurement category includes an option to designate non-derivative financial instruments as “at fair value through profit or loss” on initial recognition (fair value option) or as “financial instruments held for trading”. The fair value option was not applied during the fiscal year. Merck only assigns derivatives to the “held for trading” measurement category. Special accounting rules apply to derivatives that are designated as hedging instruments in a hedging relationship.

Held to maturity investments

“Held to maturity investments” are non-derivative financial assets with fixed or determinable payments and a fixed maturity that are quoted in an active market. To be able to assign a financial asset to this measurement category, the entity must have the positive intention and ability to hold it to maturity. These investments are subsequently measured at amortized cost. If there is objective evidence that such an asset is impaired, an impairment loss is recognized in profit or loss. Subsequent reversals of impairment losses are also recognized in profit or loss up to the amount of the original cost of the asset. At Merck, this measurement category is used for current and non-current financial assets.

Loans and receivables

“Loans and receivables” are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They are subsequently measured at amortized cost. If there is objective evidence that such assets are impaired, an impairment loss is recognized in profit or loss. Subsequent reversals of impairment losses are also recognized in profit or loss up to the amount of the original cost of the asset. Long-term non-interest-bearing and low-interest receivables are measured at their present value. Merck primarily assigns trade receivables, loans, and miscellaneous other current and non-current receivables to this measurement category. Merck always uses a separate allowance account for impairment losses on trade and other receivables. Amounts from the allowance account are recognized in the carrying amount of the corresponding receivable as soon as this is settled or derecognized due to irrecoverability.

Available-for-sale financial assets

“Available-for-sale financial assets” are those non-derivative financial assets that are not assigned to the measurement categories “financial assets and financial liabilities at fair value through profit or loss”, “held-to-maturity investments” or “loans and receivables”. Financial assets in this category are subsequently measured at fair value. Changes in fair value are recognized immediately in equity and are only transferred to the income statement when the financial asset is derecognized. If there is objective evidence that such an asset is impaired, an impairment loss is recognized immediately in the income statement, including any amounts already recognized in equity. Reversals of impairment losses on previously impaired equity instruments are recognized immediately in equity. Reversals of impairment losses on previously impaired debt instruments are recognized in profit or loss up to the amount of the impairment loss. Any amount in excess of this is recognized directly in equity. At Merck, this measurement category is used in particular for securities and financial assets, as well as interests in subsidiaries that are not consolidated due to secondary importance (affiliates). Financial assets in this category for which no fair value is available or fair value cannot be reliably determined are measured at cost less any cumulative impairment losses. Impairment losses on financial assets carried at cost may not be reversed.

Other liabilities

Other liabilities are non-derivative financial liabilities that are subsequently measured at amortized cost. Differences between the amount received and the amount to be repaid are amortized to profit or loss over the maturity of the instrument. Merck primarily assigns financial liabilities, trade payables, and miscellaneous other non-derivative current and non-current liabilities to this category.

(14) Financial instruments: Derivatives and hedge accounting

Merck uses derivatives solely to economically hedge recognized assets or liabilities and forecast transactions. The hedge accounting rules in accordance with IFRS are applied to some of these hedges. A distinction is made between fair value hedge accounting and cash flow hedge accounting. Designation of a hedging relationship requires a hedged item and a hedging instrument. At Merck, all hedges relate to recognized or highly probable hedged items. Merck currently only uses derivatives as hedging instruments.

The hedging relationship must be effective at all times, i.e. the change in fair value of the hedging instrument fully offsets changes in the fair value of the hedged item. Merck uses the dollar offset method as well as regression analyses to measure hedge effectiveness. Derivatives that do not or no longer meet the documentation or effectiveness requirements for hedge accounting, whose hedged item no longer exists, or for which hedge accounting rules are not applied are reported as “financial assets and liabilities at fair value through profit or loss”. Changes in fair value are then recognized in profit or loss.

As a rule, the purpose of a fair value hedge is to offset the exposure to changes in the fair value of recognized hedged items (financial assets or financial liabilities) through offsetting changes in the fair value of a hedging instrument. Gains and losses on the hedging instrument resulting from changes in fair value are recognized in profit or loss, net of deferred taxes. Offsetting gains and losses on the hedged item that are attributable to the hedged risk are also recognized in profit or loss, irrespective of the item’s allocation to a measurement category.

At Merck, cash flow hedges normally relate to highly probable forecast transactions in foreign currency and to future interest payments. In cash flow hedges, the effective portion of the gains and losses on the hedging instrument is recognized in equity until the hedged expected cash flows affect profit or loss. This is also the case if the hedging instrument expires, is sold, or is terminated before the hedged transaction occurs and the occurrence of the hedged item remains likely. The ineffective portion of a cash flow hedge is recognized directly in profit or loss.

(15) Other non-financial assets and liabilities

Other non-financial assets are carried at amortized cost. Allowances are recognized for any credit risks. Long-term non-interest-bearing and low-interest receivables are carried at their present value. Other non-financial liabilities are carried at the amount to be repaid.

(16) Inventories

Inventories are carried at the lower of cost or net realizable value. When determining cost, the “first-in, first-out” (FIFO) and weighted average cost formulas are used. In addition to directly attributable unit costs, manufacturing costs also include overheads attributable to the production process, which are determined on the basis of normal capacity utilization of the production facilities.

Inventories are written down if the net realizable value is lower than the acquisition or manufacturing cost carried in the balance sheet.

Since the products are not manufactured within the scope of long-term production processes, the manufacturing cost does not include any borrowing cost.

Inventory prepayments are recorded under other current assets.

(17) Intangible assets

Acquired intangible assets are recognized at cost and are classified as assets with finite and indefinite useful lives. Self-developed intangible assets are only capitalized if the requirements specified by IAS 38 have been met. Intangible assets acquired in the course of business combinations are recognized at fair value on the acquisition date.

Intangible assets with indefinite useful lives

Intangible assets with indefinite useful lives are not amortized; however they are tested for impairment when a triggering event arises or at least once a year. Here, the respective carrying amounts are compared with the recoverable amount of the cash-generating unit and impairments are recognized as required. Impairment losses recognized on indefinite-life intangible assets other than goodwill are reversed if the original reasons for impairment no longer apply.

Goodwill is allocated to cash-generating units and tested for impairment either annually or if there are indications of impairment. A cash-generating unit is a division as presented in the Segment Reporting. The carrying amounts of the cash-generating units are compared with their recoverable amounts and impairment losses are recognized where the recoverable amount is lower than the carrying amount. The recoverable amount of a cash-generating unit is determined as the higher of fair value less costs to sell and value in use estimated using the discounted cash flow method. When testing for potential goodwill impairments, Merck determines the recoverable amount by discounting expected cash flows and therefore uses the value-in-use method.

Intangible assets with finite useful lives

Intangible assets with a finite useful life are amortized using the straight-line method. The useful lives of marketing authorizations, acquired patents, licenses and similar rights, brand names, trademarks and software are between 3 and 19 years. Amortization of intangible assets and software is allocated to the functional costs in the income statement. An impairment test is performed if there are indications of impairment. Impairment losses are determined using the same methodology as for indefinite-life intangible assets. Impairment losses are reversed if the original reasons for impairment no longer apply.

(18) Property, plant and equipment

Property, plant and equipment is measured at cost less depreciation and impairments plus reversals of impairments. The component approach is applied here in accordance with IAS 16. Subsequent costs are only capitalized if it is probable that future economic benefits will arise for the Group and the cost of the asset can be measured reliably. The cost of self-constructed property, plant and equipment is calculated on the basis of the directly attributable unit costs and an appropriate share of overheads. If the construction of property, plant and equipment takes a substantial period of time, the directly attributable borrowing costs incurred up until completion are capitalized as part of the costs. In accordance with IAS 20, costs are reduced by the amount of government grants in those cases where government grants or subsidies have been paid for the acquisition or manufacture of assets (grants related to assets). Grants related to expenses which no longer offset future expenses are recognized in profit or loss. Property, plant and equipment is depreciated by the straight-line method over the useful life of the asset concerned. Depreciation of property, plant and equipment is based on the following useful lives:

Useful life of property, plant and equipment

Show table
Useful life
 
Production buildings maximum of 33 years
Administration buildings maximum of 40 years
Plant and machinery 6 to 25 years
Operating and office equipment; other facilities 3 to 10 years

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The useful lives of the assets are reviewed regularly and adjusted if necessary. If indications of a decline in value exist, an impairment test is performed. The determination of the possible need to recognize impairments proceeds in the same way as for intangible assets. If the reasons for an impairment loss no longer exist, a reversal of the impairment loss recognized in prior periods is recorded.

(19) Leasing

Where non-current assets are leased and economic ownership lies with Merck (finance lease), the asset is recognized at the present value of the minimum lease payments or the lower fair value in accordance with IAS 17 and depreciated over their useful life. The corresponding payment obligations from future lease payments are recorded as liabilities. If an operating lease is concerned, the associated expenses are recognized in the period in which they are incurred.

(20) Deferred taxes

Deferred tax assets and liabilities result from temporary differences between the carrying amount of an asset or liability in the IFRS and tax balance sheets of consolidated companies as well as from consolidation activities, insofar as the reversal of these differences will occur in the future. In addition, deferred tax assets are recorded in particular for tax loss carryforwards if and insofar as their utilization is probable in the foreseeable future. In accordance with the liability method, the tax rates enacted and published as of the balance sheet date are used.

Deferred tax assets and liabilities are only offset on the balance sheet date if they meet the requirements of IAS 12.

(21) Provisions

Provisions are recognized in the balance sheet if it is more likely than not that a cash outflow will be required to settle the obligation and the amount of the obligation can be measured reliably. The carrying amount of provisions takes into account the amounts required to cover future payment obligations, recognizable risks and uncertain obligations of the Merck Group to third parties.

Measurement is based on the settlement amount with the highest probability or, if the probabilities are equivalent and a high number of similar cases exist, it is based on the expected value of the settlement amounts. Long-term provisions are discounted and carried at their present value as of the balance sheet date. To the extent that reimbursement claims exist as defined in IAS 37, they are recognized separately as an asset if their realization is virtually certain and the asset recognition criteria has been met.

(22) Provisions for pensions and other post-employment benefits

Provisions for pensions and other post-employment benefits are recorded in the balance sheet in accordance with IAS 19. The obligations under defined benefit plans are measured using the projected unit credit method. Under the projected unit credit method, dynamic parameters are taken into account in calculating the expected benefit payments after an insured event occurs; these payments are spread over the entire period of service of the participating employees. Annual actuarial opinions are prepared for this purpose. The actuarial assumptions for discount rates, salary and pension trends, staff turnover as well as health care cost increases, which were used to calculate the benefit obligation, were determined on a country-by-country basis in line with the economic conditions prevailing in each country; the latest country-specific actuarial mortality table was used in each case. The respective discount rates are generally determined on the basis of the returns on high-quality corporate bonds issued with adequate maturities and currencies. For euro-denominated obligations, bonds with ratings of at least “AA” from one of the three major rating agencies (Standard & Poor’s, Moody’s or Fitch), and a euro swap rate of adequate duration served as the basis for the data. Actuarial gains and losses resulting from changes in actuarial assumptions and/or experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred) are recognized immediately in equity as soon as they are incurred, taking deferred taxes into account. Consequently, the balance sheet discloses – after deduction of the plan assets – the full scope of the obligations while avoiding the fluctuations in expenses that can result especially when the calculation parameters change. The actuarial gains and losses recorded in the respective reporting period are presented separately in the Statement of Comprehensive Income.

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