1.4 – Accounting Policies

Revenue recognition

Sales revenue from contracts with customers is recognized in the amount of the consideration BASF expects to receive in exchange for the goods or services when control of the goods or services is transferred to the customer.

BASF primarily generates income from the sale of goods. It is recognized as sales revenue at the point in time when control of the product is transferred from BASF to the customer; this is generally the case on delivery. If products are delivered to a consignment warehouse, BASF normally retains control. Revenue is recognized when the customer consumes the goods. Long-term supply agreements usually contain variable prices dependent on the development of raw materials prices and variable volumes.

Sales revenue from the sale or licensing of technologies or technical expertise are recognized according to the contractually agreed-upon transfer of the rights and obligations associated with these technologies. Recognition of revenue from granting licenses for technology and intellectual property depends on whether they are based on usage rights or access rights. Revenue from a usage-based rights is recognized at the point in time when the license is granted. Revenue from access-based rights is recognized over the term of the contract with the customer. Sales revenue from sales and usage-based licenses is recognized in accordance with the underlying settlement agreements.

Sales revenue from the sale of precious metals to industrial customers is recognized on delivery and the corresponding purchase prices are recorded as cost of sales. In the trading of precious metals and their derivatives with traders, where there is usually no physical delivery, revenues are netted against the associated costs.

Services rendered to customers are invoiced according to work completed and recognized as revenue accordingly.

If the consideration promised in a contract includes variable components, BASF estimates the amount of consideration to which it will be entitled in exchange for transferring the promised goods to the customer. Variable components are only recognized as revenue when it is highly unlikely that a reversal of sales revenue will occur. Expected rebates and other trade discounts are accrued in accordance with the principle of individual measurement to cover probable risks related to the return of goods, future warranty obligations and other claims.

BASF grants customers rebates if the goods purchased by the customer exceed a contractually defined threshold within the period specified. Rebates are usually deducted from the amounts payable by the customer. Depending on the terms of the underlying contract, BASF uses either the expected value or the most likely amount to estimate the variable consideration for expected future rebates. The method that is the best predictor of variable consideration is primarily determined by the number of volume thresholds contained in the contract. All available historical, current and forecast information is taken into account when calculating rebates.

Customers generally have a right of return if the supplied goods do not meet the agreed specifications. Furthermore, certain contracts grant the customer the right to return the goods within a defined period of time. BASF uses the expected value method to estimates the goods that will be returned, as this method is the best predictor of the amount of variable consideration to which BASF will be entitled.

BASF applies the practical expedient in IFRS 15, which means that it does not adjust the promised amount of consideration for the effects of a significant financing component if, at contract inception, it is expected that the period between the transfer of the promised goods or services to a customer and payment for these goods or services by the customer will be one year or less.

Pursuant to IFRS 15, no information on remaining performance obligations as of December 31, 2018 that have an expected original term of one year or less was reported.

Assets

Acquired intangible assets (excluding goodwill) with defined useful lives are generally measured at cost less straight-line amortization. The useful life is determined using the period of the underlying contract or the period of time over which the intangible asset can be expected to be used.

Impairments are recognized if the recoverable amount of the asset is lower than the carrying amount. The recoverable amount is the higher of either fair value less costs to sell or the value in use. The value in use is determined on the basis of future cash inflows and outflows, and the weighted average cost of capital after taxes, depending on tax rates and country-related risks. If the reasons for an impairment no longer exist, the write-downs are reversed up to the value of the asset had an impairment not been recognized. Depending on the type of intangible asset, amortization is reported under cost of sales, selling expenses, research and development expenses or other operating expenses.

Intangible assets with indefinite useful lives are trade names and trademarks that have been acquired as part of acquisitions. These are measured at cost and tested for impairment annually, or if there is an indication that their value has declined.

Internally generated intangible assets primarily comprise internally developed software. Such software and other internally generated intangible assets are measured at cost and amortized over their estimated useful lives. Impairments are recognized if the carrying amount of an asset exceeds the recoverable amount. In addition to those costs directly attributable to the asset, costs of internally generated intangible assets also include an appropriate portion of overhead costs.

The estimated useful lives and amortization methods of intangible assets are based on historical values, plans and estimates. The weighted average amortization periods of intangible assets were as follows:

Emission rights: Emission rights certificates, which are granted free of charge by the German Emissions Trading Authority (Deutsche Emissionshandelsstelle) or a similar authority in other countries, are recognized in the balance sheet with a value of zero. Certificates purchased on the market are capitalized at cost as intangible assets. Emissions generated create an obligation to surrender the emission certificates. Emission certificates purchased on the market are subsequently measured at fair value, up to a maximum of the amount of the acquisition costs. If the fair value is lower than the carrying amount on the balance sheet date, the emission rights are impaired.

Goodwill is only written down in the case of an impairment. Impairment testing is performed once a year and whenever there is an indication of impairment. Goodwill impairments are not reversed.

Property, plant and equipment are measured at cost less depreciation and impairment over their useful lives. The revaluation method is not applied. Low-value assets are fully expensed in the year of acquisition.

The cost of self-constructed plants includes direct costs, appropriate allocations of material and production overhead costs, and a share of the general administrative costs of the divisions involved in the construction of the plants.

Expenditures related to the scheduled maintenance of large-scale plants are capitalized separately and depreciated using the straight-line method over the period until the next planned turnaround. Costs for the replacement of components are recognized as assets if an additional future benefit is expected. The carrying amount of the replaced components is derecognized. Costs for maintenance and repair as part of normal business operations are recognized as an expense.

Both movable and immovable fixed assets were, for the most part, depreciated using the straight-line method, with the exception of production licenses and plants in the oil and gas business, which has been classified as a discontinued operation since the end of September 2018. Until then, these were primarily depreciated based on use in accordance with the unit of production method. The estimated useful lives and depreciation methods of property, plant and equipment are based on historical values, plans and estimates. The depreciation methods, useful lives and residual values are reviewed at each balance sheet date. The weighted average depreciation periods of continuing operations were as follows:

Impairments are recognized if the recoverable amount of the asset is lower than the carrying amount. The measurement is based on fair value less costs to sell or the value in use. The value in use is determined on the basis of future cash inflows and outflows, and the weighted average cost of capital after taxes, depending on tax rates and country-related risks. An impairment is recognized for the difference between the carrying amount and the recoverable amount. If the reasons for an impairment no longer exist, the write-downs are reversed up to the value of the asset had an impairment not been recognized.

Investment properties held to realize capital gains or rental income are immaterial. They are valued at the lower of fair value or acquisition cost less depreciation.

Leases: A lease is an agreement whereby the lessor conveys to the lessee the right to use an asset for an agreed period of time in return for a payment or series of payments. Lease contracts are classified as either finance or operating leases.

Assets subject to operating leases are not capitalized. Lease payments are recognized in the income statement in the period they are incurred.

A lease is classified as a finance lease if it transfers all material risks and rewards related to the leased asset. Assets subject to a finance lease are capitalized at the lower of the fair value of the leased assets or the present value of the minimum lease payments. A lease liability is recorded in the same amount. The periodic lease payments must be divided into principal and interest components. The principal component reduces the liability, while the interest component represents an interest expense. Depreciation is recognized over the shorter of the useful life of the asset or the period of the lease.

Leases can be embedded within other contracts. If separation is required under IFRS, the embedded lease is recorded separately from its host contract and each component of the contract is carried and measured in accordance with the applicable regulations.

Borrowing costs: Borrowing costs directly incurred as part of the acquisition, construction or production of a qualifying asset are capitalized as part of the acquisition or production cost of that asset. A qualifying asset is an asset for which the time period necessary to make it ready for its intended use or sale is longer than one year. Borrowing costs are capitalized up to the date the asset is ready for its intended use. The borrowing costs were calculated based on a rate of 1.5% (previous year: 2.0%) and adjusted on a country-specific basis, if necessary. All other borrowing costs are recognized as an expense in the period in which they are incurred.

Government grants: Government grants related to the acquisition or construction of property, plant and equipment reduce the acquisition or construction cost of the respective assets. Other government grants or government assistance are recognized immediately as other operating income or treated as deferred income and released over the underlying period.

Investments accounted for using the equity method: The carrying amounts of these companies are adjusted annually based on the pro rata share of net income, dividends and other changes in equity. Should there be indications of a reduction in the value of an investment, an impairment is recognized in the income statement.

Inventories are measured at acquisition cost or cost of conversion based on the weighted average method. If the market price or the fair value of the sales products, which are based on the net realizable values, is lower, then the sales products are written down to this lower value. The net realizable value is the estimated price in the ordinary course of business less the estimated costs of completion and the estimated selling costs.

In addition to direct costs, cost of conversion includes an appropriate allocation of production overhead costs based on normal utilization rates of the production plants, provided that they are related to the production process. Pensions, social services and voluntary social benefits are also included, as well as allocations for administrative costs, provided they relate to the production. Borrowing costs are not included in cost of conversion.

Inventories may be written down if the prices for the sales products decline, or in cases of a high rate of days sales of inventory (DSI). Write-downs on inventories are reversed if the reasons for them no longer apply.

The exception made by IAS 2 for traders is applied to the measurement of precious metal inventories. Accordingly, inventories held exclusively for trading purposes are to be measured at fair value less costs to sell. All changes in value are recognized in the statement of income.

Deferred taxes: Deferred taxes are recorded for temporary differences between the carrying amount of assets and liabilities in the financial statements and the carrying amounts for tax purposes as well as for tax loss carryforwards and unused tax credits. This also comprises temporary differences arising from business combinations, with the exception of goodwill. Deferred tax assets and liabilities are calculated using the respective country-specific tax rates applicable for the period in which the asset or liability is realized or settled. Tax rate changes enacted or substantively enacted on or before the balance sheet date are taken into consideration.

Deferred tax assets are offset against deferred tax liabilities provided they are related to the same taxation authority and have the same maturities. Surpluses of deferred tax assets are only recognized provided that the tax benefits are likely to be realized. The valuation of deferred tax assets is based on the probability of a reversal of the differences and the assessment of the ability to utilize tax loss carryforwards and unused tax credits. This depends on whether future taxable profits will exist during the period in which temporary differences are reversed and in which tax loss carryforwards and unused tax credits can be claimed. The valuation of deferred tax assets is based on internal projections of the future earnings of the particular Group company.

Changes in deferred taxes in the balance sheet are recorded as deferred tax expense or income if the underlying transaction is not to be recognized directly in equity or in income and expenses recognized in equity. For those effects which have been recognized in equity, changes to deferred tax assets and tax liabilities are also recognized directly in equity.

Deferred tax liabilities are recognized for differences between the proportional IFRS equity and the tax base of the investment in a consolidated subsidiary if a reversal of these differences is expected in the foreseeable future. Deferred tax liabilities are recognized for dividend distributions planned for the following year if these distributions lead to a reversal of temporary differences.

Financial instruments

Financial assets and financial liabilities are recognized in the consolidated balance sheet when the BASF Group becomes a party to a financial instrument. Financial assets are derecognized when BASF no longer has a contractual right to the cash flows from the financial asset or when the financial asset is transferred together with all material risks and rewards of ownership and BASF does not have control of the financial asset after it has been transferred. For example, receivables are derecognized when they are definitively found to be uncollectible. Financial liabilities are derecognized when the contractual obligations expire, are discharged or cancelled. Regular-way purchases and sales of financial instruments are accounted for using the settlement date; in precious metals trading, the day of trading is used.

The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. If pricing on an active market is available, for example in the form of share prices, these are used as the basis for the measurement. Otherwise, the measurement is based on internal measurement models using current market parameters or external measurements, for example, from banks. These internal measurements predominantly use the net present value method and option pricing models.

BASF began applying IFRS 9 as of January 1, 2018. Except for financial assets measured at fair value through profit or loss, this requires the recognition of impairments for expected credit losses, independent of the existence of any actual default events and individual valuation allowances if evidence of a permanent need for impairment exists. If this evidence no longer exists, the impairment is reversed in the statement of income up to the carrying amount of the asset had the default event not occurred. Valuation allowances are generally recognized in separate accounts.

The classification and measurement of financial assets is based on the one hand on the cash flow condition (the “solely payments of principle and interest” criterion), that is, the contractual cash flow characteristics of an individual financial asset. On the other hand, it also depends on the business model used for managing financial asset portfolios. Based on these two criteria, BASF uses the following measurement categories for financial assets:

• Financial assets recognized at fair value through profit or loss include all financial assets whose cash flows are not solely payments of principal and interest in accordance with the cash flow condition established in IFRS 9. At BASF, derivatives are allocated to this measurement category, for example. BASF does not generally exercise the fair value option in IFRS 9, which permits the allocation of financial instruments not to be measured at fair value through profit or loss on the basis of the cash flow condition or the business model criterion to the above category under certain circumstances.
• Financial assets measured at amortized cost include all assets with contractual terms that give rise to cash flows on specific dates, provided that these cash flows are solely payments of principal and interest on the principal amount outstanding in accordance with the cash flow condition in IFRS 9, to the extent that the asset is held with the intention of collecting the expected contractual cash flows over its term. At BASF, this measurement category includes trade accounts receivable, as well as receivables reported under other receivables and miscellaneous assets and certain securities.
  
  Initial measurement of these assets is generally at fair value, which usually corresponds to the transaction price at the time of acquisition. Subsequent measurement effects are recognized in income using the effective interest method.
  
  Impairments are recognized for expected credit losses in both initial and subsequent measurement, even before the occurrence of any default event. If the counterparty is considered as having defaulted, an individual valuation allowance is generally recognized for the financial assets measured at amortized cost. In addition, a valuation allowance must be recognized when the contractual conditions that form the basis for the receivable are changed through renegotiation in such a way that the present value of the future cash flows decreases.
  
  The extent of expected credit losses is determined based on the credit risk of a financial asset, as well as any changes to this credit risk: If the credit risk of a financial asset has increased significantly since initial recognition, expected credit losses are generally recognized over the lifetime of the asset. If, however, the credit risk has not increased significantly in this period, impairments are generally only recognized for the 12-month expected credit losses. By contrast, under the simplified approach for determining expected credit losses permitted by IFRS 9, impairments for receivables such as lease receivables and trade accounts receivable always cover the lifetime expected credit losses of the receivable concerned.
  
  At BASF, the credit risk of a financial asset is assessed using both internal information and external rating information on the respective counterparty. A significant increase in the counterparty’s credit risk is assumed if its rating is lowered by a certain number of notches. The significance of the increase in the credit risk is not reviewed for trade accounts receivable or lease receivables. Furthermore, it is generally assumed that the credit risk for a counterparty with a high credit rating will not have increased significantly.
  
  Regional and, in certain circumstances, industry-specific factors and expectations are taken into account when assessing the need for a valuation allowance as part of the calculation of expected credit losses and individual valuation allowances. In addition, BASF uses internal and external ratings and the assessments of debt collection agencies and credit insurers, when available. Individual valuation allowances are also based on experience relating to customer solvency and customer-specific risks. Factors such as credit insurance, which covers a portion of receivables measured at amortized cost, are likewise considered when calculating valuation allowances. Bank guarantees and letters of credit are used to an immaterial extent. Expected credit losses and individual valuation allowances are only calculated for those receivables that are not covered by insurance or other collateral. The valuation allowances for receivables whose insurance includes a deductible are not recognized in excess of the amount of the deductible.
  
  A decrease in valuation allowances due, for example, to a reduction in the credit risk of a counterparty or an objective event occurring after the valuation allowance is recorded in profit or loss. Reversals of valuation allowances may not exceed amortized cost, less any expected future credit losses.
• Financial assets measured at fair value through other comprehensive income include all assets with contractual terms that give rise to cash flows on specified dates, which are solely payments of principal and interest on the principal amount outstanding in accordance with the cash flow condition in IFRS 9, to the extent that the asset is not just held with the intention of collecting the expected contractual cash flows over its term, but also generating cash flows from its sale. At BASF, certain securities that are classified as debt instruments are allocated to this category. BASF does not exercise the option to subsequently measure equity instruments through other comprehensive income.
  
  Assets measured at fair value through other comprehensive income are initially measured at fair value, which usually corresponds to the nominal value of the securities allocated to this category at the time of acquisition. Subsequent measurement is likewise at fair value. Changes in the time value are recognized in other comprehensive income and reclassified to the statement of income when the asset is disposed of.
  
  Impairments on financial assets measured at fair value through other comprehensive income are calculated in the same way as impairments on financial assets measured at amortized cost and recognized in profit or loss. The following measurement categories are used for financial liabilities:
• Financial liabilities that are measured at amortized cost generally include all financial liabilities, provided these do not represent derivatives. They are generally measured at fair value at the time of initial recognition, which usually corresponds to the value of the consideration received. Subsequent measurement is recognized in profit or loss at amortized cost using the effective interest method. At BASF, for example, bonds and liabilities to banks reported under financial indebtedness are measured at amortized cost.
• Financial liabilities recognized at fair value through profit or loss contain derivative financial liabilities. These are likewise measured at the value of the consideration received as the fair value of the liability on the date of initial recognition. The latter also represents the measurement basis for these liabilities in subsequent measurement. The option to subsequently measure financial liabilities at fair value is not exercised.
  
  Derivative financial instruments can be embedded within other contracts, creating a hybrid financial instrument. If IFRS requires separation, the embedded derivative is accounted for separately from its host contract and measured at fair value. If IFRS 9 does not provide for separation, the hybrid instrument is accounted for at fair value in its entirety.

Financial guarantees of the BASF Group are contracts that require compensation payments to be made to the guarantee holder if a debtor fails to make payment when due under the terms of a transaction entered into with the holder of the guarantee. Financial guarantees issued by BASF are measured at fair value upon initial recognition. In subsequent periods, these financial guarantees are carried at the higher of amortized cost or the best estimate of the present obligation as of the reporting date.

In cash flow hedges, future cash flows and the related income and expenses are hedged against the risk of changes in fair value. To this end, future underlying transactions and the corresponding hedging instruments are designated and the cost of hedging are a cash flow hedge accounting relationship for accounting purposes. The effective portion of the change in fair value of the hedging instrument, which often meets the definition of a derivative, and the cost of hedging are recognized directly in equity under other comprehensive income over the term of the hedge, taking deferred taxes into account. The ineffective portion is recognized immediately in the income statement. In the case of future transactions that lead to recognition of a nonfinancial asset or a nonfinancial liability, the cumulative fair value changes of the hedge in equity are generally charged against the acquisition costs of the hedged item on its initial recognition. For hedges based on financial assets, financial liabilities or future transactions, cumulative fair value changes of the hedges are transferred from equity to the income statement in the reporting period in which the hedged item is recognized in the income statement. The maturity of the hedging instrument is determined based on the effective date of the future transaction.

When fair value hedge accounting is used, the asset or liability recognized is hedged against the risk of a change in fair value. The hedging instruments used, which often take the form of a derivative, are measured at fair value and changes in fair value are recognized in the statement of income. The carrying amounts of the assets or liabilities designated as the underlying transaction are also measured at fair value through the statement of income.

BASF applied IAS 39 in 2017. It required recognition of an impairment loss if there was evidence of a permanent impairment of a financial instrument not measured at fair value through profit or loss. If the reason for the impairment of loans and receivables as well as held-to-maturity financial instruments ceased to exist, the impairment was reversed up to the amortized cost and recognized in the income statement. Impairments on financial instruments were recognized in separate accounts.

Financial assets and liabilities were divided into the following measurement categories:

• Financial assets and liabilities at fair value recognized in the income statement consisted of derivatives and other trading instruments. At BASF, this measurement category included derivatives only. Derivatives were reported in other receivables and miscellaneous assets or other liabilities. BASF did not make use of the fair value option under IAS 39. The calculation of fair values was based on market parameters or measurement models based on such parameters. In some exceptional cases, the fair value was calculated using parameters that are not observable on the market.
• Loans and receivables comprised financial assets with fixed or determinable payments, which were not quoted on an active market and were not derivatives or classified as available-for-sale. This measurement category included trade accounts receivable as well as other receivables and loans reported under other receivables and miscellaneous assets. Initial measurement was at fair value, which generally corresponded to the nominal value of the receivable or loan. Interest-free and low-interest long-term loans and receivables were recorded at present value. Subsequent measurement recognized in income was generally at amortized cost using the effective interest method. If there was objective evidence for an impairment of a receivable or loan, an individual valuation allowance was made. When assessing the need for a valuation allowance, regional and sector-specific conditions were considered. In addition, BASF used internal and external ratings, as well as the assessments of debt collection agencies and credit insurers, when available. A portion of receivables was covered by credit insurance. Bank guarantees and letters of credit were used to an immaterial extent. Valuation allowances were only recognized for those receivables not covered by insurance or other collateral. The valuation allowances for receivables whose insurance included a deductible were not recognized in excess of the amount of the deductible. Write-downs were based on historical values relating to customer solvency and the age, period overdue, insurance policies and customer-specific risks. In addition, a valuation allowance had to be recognized when the contractual conditions forming the basis for the receivable were changed through renegotiation in such a way that the present value of the future cash flows decreased. Furthermore, valuation allowances were recognized for receivables based on transfer risks for certain countries. If, in a subsequent period, the amount of the impairment decreased, and the decrease could be objectively attributed to an event occurring after the valuation allowance was made, it was reversed in the income statement. Reversals of valuation allowances did not exceed amortized cost. Loans and receivables were derecognized when they were definitively found to be uncollectible.
• Held-to-maturity financial assets consisted of nonderivative financial assets with fixed or determinable payments and a fixed term, for which there was the intent and ability to hold until maturity, and which did not fall under other valuation categories. They were initially recognized at fair value, which corresponded to the nominal value in most cases. Subsequent measurement was at amortized cost using the effective interest method. BASF did not have any material financial assets that fell under this category.
• Available-for-sale financial assets comprised financial assets that were not derivatives and did not fall under any of the above valuation categories. This measurement category comprised shareholdings reported under the item other financial assets, which were not accounted for using the equity method, as well as short and long-term securities. Measurement was at fair value. Changes in fair value were recognized directly in equity (other comprehensive income) and were only recognized in the income statement when the assets had been disposed of or impaired. Subsequent reversals were recognized directly in equity (other comprehensive income). In the case of debt instruments only, reversals were recognized in the income statement up to the amount of the original impairment; reversals above this amount were recognized directly in equity. If the fair value of available-for-sale financial assets fell below acquisition costs, the assets were impaired if the decline in value was material and was considered permanent. The fair values were determined using market prices. Shareholdings whose fair value could not be reliably determined were carried at cost and written down in the case of impairment. Cost represented the best estimate of the fair value of these shareholdings. This category included investments in other shareholdings, provided that these shares were not publicly traded. There were no plans to sell significant shares in these shareholdings.
• Financial liabilities that were not derivatives were initially measured at fair value. This usually corresponded to the amount received. Subsequent measurement was at amortized cost using the effective interest method.
• Cash and cash equivalents consisted primarily of cash on hand and bank balances with maturities of less than three months.

Derivative financial instruments could be embedded within other contracts. If IAS 39 required separation, the embedded derivative was accounted for separately from its host contract and measured at fair value.

Other comprehensive income

The expenses and income shown in other comprehensive income are divided into two categories: Items that will be recognized in the income statement in the future (known as “recycling”) and items that will not be reclassified to the income statement in the future. The first category includes translation adjustments, the measurement of securities at fair value, and changes in the fair value of derivatives held to hedge future cash flows and net investments in foreign operations. Items in other comprehensive income that will not be reclassified to the income statement at a future date include effects from the remeasurement of defined benefit plans.

Liabilities

Provisions for pensions and similar obligations: Provisions for pensions are calculated on an actuarial basis in accordance with the projected unit credit method using assumptions relating to the following valuation parameters, among others: future developments in compensation, pensions and inflation, employee turnover and the life expectancy of beneficiaries. Obligations are discounted based on the market yields on high-quality corporate fixed-rate bonds rated between “AA–” to “AA+” by at least one of the following rating agencies: Fitch, Moody’s or Standard & Poor’s.

Similar obligations, especially those arising from commitments by North American Group companies to pay the healthcare costs and life insurance premiums of retired staff and their dependents, are reported under provisions for similar obligations.

Actuarial reports are used to calculate the amount of pension provisions.

Actuarial gains and losses from changes in estimates relating to the actuarial assumptions used to calculate defined benefit obligations, the difference between standardized and actual returns on plan assets, as well as the effects of the asset ceiling are recognized directly in equity as other comprehensive income.

Other provisions: Other provisions are recognized when there is a present obligation as a result of a past event and when there is a probable outflow of resources whose amount can be reliably estimated. Provisions are recognized at the probable settlement value.

Provisions for German trade income tax, German corporate income tax and similar income taxes are calculated and recognized based on the expected taxable income of the consolidated companies less any prepayments that have been made. Provisions are set up for interest accrued. Other taxes to be assessed are considered accordingly.

Provisions are established for certain environmental protection measures and risks if there is a present legal or constructive obligation arising from a past event, and the expected cash outflow can be estimated with sufficient reliability.

In addition, other provisions also cover expected costs for dismantling existing plants and buildings, rehabilitating contaminated sites, recultivating landfills, removal of environmental contamination from existing production or storage sites and similar measures. If BASF is the only responsible party that can be identified, the provision covers the entire expected claim. At sites operated together with one or more partners, the provision generally covers only BASF’s share of the expected claim. The determination of the amount of the provision is based on the available technical information on the site, the technology used, legal regulations, and official obligations.

Provisions are recognized for expected severance payments or similar personnel expenses as well as for demolition expenses and other charges related to restructuring measures that have been planned and publicly announced by management.

Provisions for long-service and anniversary bonuses are predominantly calculated based on actuarial principles. For contracts signed under phased retirement programs, approved supplemental payments are accrued in installments until the end of the exemption phase at the latest. Accounting and measurement follow the German Accounting Standards Committee’s Implementation Guidance 1 (IFRS) dated December 2012.

Other provisions also cover risks resulting from legal disputes and proceedings, provided the criteria for recognizing a provision are fulfilled. In order to determine the amount of the provisions, the company takes into consideration the facts related to each case, the size of the claim, claims awarded in similar cases and independent expert advice as well as assumptions regarding the probability of a successful claim and the range of possible claims. Actual costs can deviate from these estimates.

The probable amount required to settle noncurrent provisions is discounted if the effect of discounting is material. In this case, the provision is recognized at present value. Assumptions must be made in determining the discount rate (2018: 1.5%; 2017: 2.0%) used for calculating noncurrent provisions. Financing costs related to unwinding the discount of provisions in subsequent periods are shown in other financial result.

Other accounting policies

Business combinations: In business combinations, the acquired assets and liabilities are recognized at fair value on the date the acquirer effectively obtains control. The fair value of acquired assets and assumed liabilities at the date of acquisition, as well as the useful lives of the acquired assets, are determined on the basis of assumptions. Measurement is largely based on projected cash flows. Actual cash flows can deviate significantly from those. Independent external appraisals are used for the purchase price allocation of material business combinations. Valuations in the course of business combinations are based on existing information as of the acquisition date.

Groups of assets and liabilities held for sale (disposal groups): These comprise those assets and directly associated liabilities shown separately on the balance sheet whose sale in the context of a single transaction is highly probable. A transaction is assumed to be highly probable if there are no significant risks of completion of the transaction, which usually requires the conclusion of binding contracts. The assets and liabilities of disposal groups are recognized at the lower of the sum of their carrying amounts or fair value less costs to sell; this does not apply to assets that do not fall under the valuation principles of IFRS 5. Depreciation of noncurrent assets and the use of the equity method are suspended.

Discontinued operations: These are classified as held for sale and are presented as discontinued operations in BASF’s Consolidated Financial Statements in accordance with IFRS 5. Until closing, the income after taxes of discontinued operations will be shown in income after taxes of the BASF Group as a separate item (income after taxes from discontinued operations). The BASF Group’s sales and earnings were retroactively adjusted for the consolidated figures for discontinued operations as of the beginning of the fiscal year. The prior-year figures were restated. In addition, the assets and liabilities of the discontinued operations were reclassified to a disposal group (assets or liabilities of disposal groups). Depreciation of noncurrent assets and the use of the equity method are suspended as of the date when the disposal group is initially presented. The statement of cash flows was not restated. The activities of discontinued operations are not allocated to any reportable segment in financial reporting.

Exploration and development expenditures in the discontinued oil and gas business are accounted for using the successful efforts method. Under this method, costs of successful exploratory drilling as well as successful and dry development wells are capitalized.

The unit of production method at the field or reservoir level was used to depreciate assets from oil and gas production. Depreciation is generally calculated on the basis of production in the period in relation to the proven, developed reserves.

The intangible asset from the marketing contract for natural gas from the Yuzhno Russkoye natural gas field is amortized based on BASF’s share of the produced and distributed volumes.

Intangible assets in the discontinued oil and gas business relate primarily to exploration and production rights. During the exploration phase, these are not subject to amortization but are tested for impairment annually. When economic success is determined, the rights are amortized in accordance with the unit of production method.

Amortization and depreciation of intangible assets and property, plant and equipment of the discontinued oil and gas business were included in the earnings of the BASF Group through September 2018.

Provisions for restoration obligations concern the filling of wells and the removal of production facilities upon the termination of production. When the obligation arises, the provision is measured at the present value of the future restoration costs. An asset of the same amount is capitalized as part of the carrying amount of the plant concerned and is depreciated along with the plant. The discount on the provision is unwound annually until the time of the planned restoration.

The assumptions regarding the long-term development of oil and gas prices are significant for impairment tests in the discontinued oil and gas business. The internal company projections are based on an empirical analysis of global oil and gas supply and demand. Short-term estimates up to three years also consider the current prices on active markets or forward transactions. In long-term estimates, assumptions were made regarding factors such as inflation, production quantities and costs as well as energy efficiency and the substitution of energy sources. Using external sources and reports, the oil and gas price estimates were regularly checked for plausibility.

A valuation model based on a field-related valuation approach is used for the Exploration & Production unit in the discontinued oil and gas business. This takes into account the expected cash flows as well as the tax payments in the individual countries. The period under consideration includes the planned license terms and the production profiles of the included oil and gas fields. Furthermore, instead of using a single weighted average cost of capital rate, the country risk and the specific tax rate is considered in each case; this leads to a more precise calculation of the recoverable amount. Allowing for these parameters, the cost of capital rate after taxes varied from 6.56% to 10.63% (2017: from 7.92% to 12.85%) and before taxes from 9.62% to 30.37% (2017: from 11.32% to 36.99%).

Use of estimates and assumptions in preparing the Consoli- dated Financial Statements

The carrying amount of assets, liabilities and provisions, contingent liabilities and other financial obligations reported in the Consolidated Financial Statements depends on the use of estimates, assumptions and use of discretionary scope. Specific estimates or assumptions used in individual accounting or valuation methods are disclosed in their respective sections. They are based on the circumstances and estimates on the balance sheet date and thus affect the amounts of income and expenses shown for the reporting periods presented. These assumptions primarily relate to the determination of discounted cash flows in the context of impairment tests and purchase price allocations; the useful lives of property, plant and equipment and intangible assets; the carrying amount of shareholdings; and the measurement of provisions for items such as employee benefits, warranties, trade discounts, environmental protection and taxes. Although uncertainty is appropriately incorporated in the valuation factors, actual results can differ from these estimates.

For planning purposes in 2019, BASF assumes an oil price of $70/bbl (Brent) and for gas of approximately €19/MWh (roughly $7/mmBtu).

Impairment tests on assets are carried out whenever certain triggering events indicate potential impairment. External triggering events include, for example, changes in customer industries, technologies used and economic downturns. Internal triggering events for an impairment test include lower product profitability, planned restructuring measures or physical damage to assets. Impairment tests are based on a comparison of the carrying amount and the recoverable amount. The recoverable amount is the higher of fair value less costs to sell and the value in use. As a rule, value in use is determined using the discounted cash flow method. The estimation of cash flows and the assumptions used consider all information available on the respective balance sheet date on the future development of the operating business. Actual future developments may vary. Impairment testing relies upon the cash-generating unit’s long-term earnings forecasts, which are based on macroeconomic trends. The weighted average cost of capital (WACC) based on the capital asset pricing model plays an important role in impairment testing. It comprises a risk-free rate, the market risk premium and the spread for the credit risk. Additional important assumptions are the forecasts for the detailed planning period and the terminal growth rates used.

An impairment is recognized if the recoverable amount of the asset is lower than the carrying amount. The impaired asset (excluding goodwill) is written down by the amount of the difference between these amounts.

The goodwill impairment test is based on cash-generating units. At BASF, these largely correspond to the business units, or in individual cases the divisions. If there is a need for a valuation allowance, the existing goodwill is, if necessary, completely written off as a first step. If there is further need for a valuation allowance, this is allocated to the remaining assets of the cash-generating unit. Goodwill impairments are reported under other operating expenses.