1.2 – Changes in Accounting Principles

Accounting policies applied for the first time in 2018

IFRS 9 – Financial Instruments

IFRS 9 – Financial Instruments was endorsed by the European Union in the fourth quarter of 2016 and applied by BASF for the first time as of January 1, 2018.

IFRS 9 contains, in particular, new requirements for the classification and measurement of financial assets, fundamental changes regarding the accounting treatment of impairments of certain financial assets, and a revised approach to hedge accounting. IFRS 9 retains “amortized cost” and “fair value” as measurement bases for financial instruments and continues to differentiate between changes in fair value recognized through profit or loss and through other comprehensive income.

The classification and measurement of financial assets in accordance with IFRS 9 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.

Unlike in IAS 39, under IFRS 9 impairments of financial assets that are not measured at fair value through profit or loss are not just recognized when there is objective evidence of impairment. Rather, impairment allowances are also to be recognized for expected credit losses. These are 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 a simplified approach, impairments for receivables such as lease receivables and trade accounts receivable always cover the lifetime expected credit losses of the receivable concerned.

IFRS 9 also contains new requirements for the application of hedge accounting to better present an entity’s risk management activities, in particular with respect to the management of nonfinancial risks.

The first-time adoption of IFRS 9 at BASF follows the modified retrospective method, which means that prior-period information is not restated; this continues to be presented in accordance with IAS 39.

The introduction of the cash flow condition at BASF mainly resulted in the reclassification of securities that were allocated to the “available for sale” category under IAS 39 and subsequently measured at fair value in the balance sheet, with fair value changes recognized in other comprehensive income. Provided the contractual cash flows resulting from these securities are not solely payments of principal and interest, they continue to be measured at fair value in the balance sheet; however, fair value changes are recognized directly in income after taxes. The cash flow condition also leads to minor changes to the subsequent measurement of other receivables that were measured at amortized cost under IAS 39. These are now measured at fair value in the balance sheet, provided the resulting cash flows are not solely payments of principal and interest. Changes to the fair value of these other receivables are recognized in profit or loss as income after taxes.

At BASF, the definition of a business model for financial asset portfolios has implications for the accounting treatment of securities, which were allocated to the “available for sale” category under IAS 39 and, according to IFRS 9, do not have to be measured at fair value because of the cash flow condition. If these securities are managed with the intention of collecting the contractual cash flows, they are subsequently measured at amortized cost in line with the requirements of IFRS 9. If, however, these securities classified as “available for sale” are also managed with the intention of generating cash flows from their sale, they are subsequently measured at fair value; fair value changes are recognized in other comprehensive income.

At BASF, the recognition of impairments for expected credit losses mainly impacts the carrying amounts of trade accounts receivable. It also affects the carrying amounts of other receivables that represent financial instruments. The table below presents the effects of the transition from IAS 39 to IFRS 9 on the carrying amounts as of December 31, 2017, by category of financial instruments:

At BASF, the credit risk of a financial asset is assessed using both internal estimates, which are prepared as part of credit management, 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 credit risk is not reviewed for financial assets subject to the simplified approach.

BASF calculates the expected credit losses of a financial asset as the probability-weighted present value of each expected cash shortfall. As a general rule, three key parameters are used here: the probability of default of the counterparty, the loss ratio if the counterparty defaults, and the amount at risk. In the case of receivables from banks, the expected credit losses are primarily calculated on the basis of the probabilities of default derived from credit default swaps for the counterparty concerned.

The effects of the changes to the valuation allowance model on the impairments recognized in accordance with IAS 39 as of December 31, 2017, are presented in the table below. These mainly relate to valuation allowances for financial assets that were allocated to the “loans and receivables” category under IAS 39. Impairments were increased due to the recognition of expected credit losses. A countereffect arose from the fact that impairments to reflect transfer risks for certain countries and staggered impairments based on overdue status are no longer recognized under IFRS 9.

BASF exercises the option to apply the hedge accounting requirements of IFRS 9 only prospectively from January 1, 2018. This option cannot be applied to changes to the time value component of options if only its intrinsic value is designated as a hedging instrument in a hedge accounting relationship. In this case, IFRS 9 stipulates that changes to the fair value of the time value component during the term of the hedging relationship must be recognized in other comprehensive income, and that the amounts accumulated there must be released as an adjustment to the cost of the underlying item or directly in profit or loss. By contrast, under IAS 39, changes to the fair value of these time value components were recognized immediately in profit or loss.

Transition effects from the first-time adoption of IFRS 9 were recognized cumulatively in equity as of the date of initial application. Overall, after allowing for deferred taxes, the first-time adoption of IFRS 9 reduced equity by €30 million, primarily as a result of the increase in valuation allowances for trade accounts receivable. By contrast, the reclassification of components of income that were presented in other comprehensive income under IAS 39 to retained earnings did not have any effect on equity.

The table below shows the first-time adoption effects of IFRS 9 on retained earnings and other comprehensive income:

IFRS 15 – Revenues from Contracts with Customers

IFRS 15 – Revenues from Contracts with Customers was endorsed by the European Union in the third quarter of 2016 and applied by BASF for the first time as of January 1, 2018.

According to IFRS 15, sales revenue is measured at the amount the entity expects to recognize in exchange for goods and services when control of the agreed goods or services and the benefits obtainable from them are transferred to the customer. The standard provides the following five-step process for revenue recognition:

• Step 1: Identify contracts with customers
• Step 2: Identify performance obligations contained in the contracts
• Step 3: Determine the transaction price
• Step 4: Allocate the transaction price to the performance obligations
• Step 5: Recognize revenue when the performance obligation is satisfied

Control can be transferred at a certain point in time or over a period of time. The performance obligations arising from contracts with BASF’s customers are almost always satisfied at a point in time. In individual cases, in particular for licensing agreements, they are satisfied over a period of time.

BASF applied IFRS 15 as of January 1, 2018, using the modified retrospective method. As a result, comparative information for 2017 was not restated. In accordance with IFRS 15.C7, only contracts that had not yet been completed as of the date of initial application were transitioned to the new standard. Contract modifications arising before initial application (IFRS 15.C7 A(b)) did not have to be accounted for.

As part of the adoption of the new standard, the items “contract assets” and “contract liabilities” were added to the balance sheet. A contract liability is BASF’s obligation to transfer goods or services to a customer, for which BASF has already received consideration from the customer. There were no contract assets at any point in time during 2018.

The main effect of initial application of the new standard was a change in presentation within “other liabilities.” Deferred sales revenue of €204 million from licenses and long-term contracts with customers that was previously presented as deferred income was reclassified to contract liabilities. The adoption of the new standard did not lead to any changes in retained earnings.

Sales revenue of €62 million, that was included in contract liabilities as of January 1, 2018, was recognized in 2018.

Sales revenue for the 2018 fiscal year includes €135 million from performance obligations fulfilled in prior periods in connection with sales and usage-based licenses.

Annual Improvements to IFRSs (2014–2016)

In IAS 28, it was clarified that the option to measure an investment in an associated company or a joint venture held by an entity that is a venture capital organization or other qualifying entity, can be exercised on an investment-by-investment basis. The short-term exemptions in IFRS 1, Appendix E (IFRS 1.E3–E7) for first-time IFRS users were deleted. The amendments are not expected to have any material effect on BASF.

Amendments to IFRS 2 – Classification and Measurement of Share-Based Payment Transactions

The amendments address a number of individual issues pertaining to the accounting of cash-settled share-based payment transactions. The amendments relate to the calculation of fair value of obligations arising from share-based payment transactions. Other requirements concern the effects of withholding tax obligations on the classification of compensation programs, as well as the presentation of option rights with respect to the type of compensation to be received or granted (cash or equity settlement). The amendments are to be applied to compensation granted or changed in fiscal years beginning on or after January 1, 2018. The amendments have no effect on BASF.

Amendments to IFRIC 22 – Foreign Currency Transactions and Advance Consideration

IFRIC 22 addresses an application question for IAS 21 – The Effects of Changes in Foreign Exchange Rates. It clarifies the point in time for determining the exchange rate used to translate foreign currency transactions containing advance payments that have been made or received. The underlying asset, income or expense is translated using the relevant exchange rate on the date on which the asset or liability resulting from the prepayment was first recognized. The amendments have no material effect on BASF.

ASCG Interpretation 4 (IFRS) – Accounting for Interest and Penalties Related to Income Taxes under IFRSs

The interpretation addresses the accounting for interest and penalties related to taxes within the meaning of section 3(4) of the Fiscal Code of Germany (AO) that relate to current income taxes within the meaning of IAS 12.5 in financial statements presented in accordance to IFRS as recognized by the European Union. It prescribes the application of IAS 37 to interest and penalties related to taxes within the meaning of section 3(4) AO and the implications for the recognition, measurement and presentation of interest and penalties related to taxes. At BASF, interest income/expense related to income taxes in accordance with IAS 12.5 and tax penalties were therefore no longer reported under tax income/ expense for the first time in 2018; rather, these were shown under other financial result or other operating expenses. The change in presentation represents a change in accounting policy within the meaning of IAS 8. As the effects were not material, the prior-year figures were not restated in accordance with IAS 8. The interpretation is effective for the first time for reporting periods beginning on or after January 1, 2018.

IFRSs and IFRICs not yet to be considered but already endorsed by the E.U.

The effects on the BASF Group financial statements of the IFRSs and IFRICs not yet in force but already endorsed by the European Union in 2018 were reviewed and are explained below.

IFRS 16 – Leases

The IASB published the new standard on leases, IFRS 16, on January 13, 2016. The rules and definitions of IFRS 16 will supersede the content of IAS 17, IFRIC 4, SIC-15 and SIC-27. The standard requires an accounting model for a lessee that recognizes all right-of-use assets and liabilities from lease agreements in the balance sheet, unless the term is twelve months or less or the underlying asset is of low value. As for the lessor, the new standard substantially carries forward the accounting requirements of IAS 17 – Leases. This means that lessors will continue to classify leases as either finance or operating leases. The European Union endorsed the new standard on October 31, 2017. IFRS 16 must be applied for reporting periods beginning on or after January 1, 2019.

BASF has largely completed its analysis of the effects on the Consolidated Financial Statements and intends to exercise the exemption for lease agreements with a term of up to 12 months and low-value assets. Lease agreements that are already in place as of December 31, 2018, will not be re-assessed.

BASF will generally apply a threshold of €5,000 when identifying leases to be capitalized. However, in the future, a significant number of lease agreements that today represent operating leases will be reported in the balance sheet as right-of-use assets with the corresponding lease liabilities. As of the date of initial application of the new standard (January 1, 2019), BASF will measure – in accordance with the modified retrospective method – lease liabilities arising from operating leases with a remaining term of more than 12 months at the present value of the remaining lease payments, taking into account current incremental borrowing rates. The right-of-use asset will be recognized at the same amount as the lease liability. Existing finance leases will not be affected.

BASF introduced a new software program to manage and measure leases, in which the relevant leases were documented. The following statements on the effects of IFRS 16 are based on a simulation conducted on December 31, 2018, using the data available.

As well as increasing BASF’s total assets by around €1.1 billion, the presentation of expenses associated with operating leases will change. For 2019, BASF anticipates a depreciation charge for right-of-use assets of around €250 million and interest expenses on lease liabilities of around €20 million. Moreover, the additional liability items are expected to reduce BASF’s equity ratio by 0.5%.

BASF will present the interest component in lease payments in cash flows from operating activities and the repayment portion in cash flows from financing activities. Lease payments under short-term agreements, agreements with low-value assets or variable payments will be presented in cash flows from operating activities.

Amendments to IFRS 9 – Financial Assets with a Prepayment Feature with Negative Compensation

The amendments pertain to the relevant criteria for the classification of financial assets. Financial assets with a prepayment feature with negative compensation may be recognized under certain conditions at amortized cost or at fair value through other comprehensive income instead of at fair value through profit and loss. The amendments are effective as of January 1, 2019. They are not expected to have any material effect on BASF.

IFRIC 23 – Uncertainty over Income Tax Treatments

IFRIC 23 expands on the requirements in IAS 12 on how to account for uncertainties surrounding the income tax treatment of circumstances and transactions with respect to both actual and deferred taxes. The interpretation is effective for reporting periods beginning on or after January 1, 2019. The amendments have no material effect on BASF.

Amendments to IAS 28 – Long-Term Interests in Associates and Joint Ventures

On October 12, 2017, the IASB published amendments to IAS 28 on long-term interests in associated companies and joint ventures. These amendments clarify that IFRS 9 is to be applied to long-term interests in associated companies or joint ventures that are not accounted for using the equity method. The amendments were adopted as E.U. legislation in the first quarter of 2019 and must be applied as of January 1, 2019. The effects are explained under IFRS 9 – Financial Instruments in this Note.

IFRSs and IFRICs not yet to be considered and not yet endorsed by the E.U.

The IASB issued further amendments to standards and interpretations whose application is not yet mandatory and is still subject to E.U. endorsement. These amendments are unlikely to have a material impact on the reporting of BASF. BASF does not plan on early adoption of these amendments.

Amendments to IFRS 10 and IAS 28 – Sale or Contribution of Assets between an Investor and an associated company or Joint Venture

The IASB issued amendments to IFRS 10 and IAS 28 on September 11, 2014. The amendments address a known inconsistency between the requirements of IFRS 10 and IAS 28 (2011) in the case of the sale of an asset to an associated company or a joint venture or the contribution of an asset to an associated company or a joint venture.

IASB has postponed the effective date of the changes indefinitely.

Annual Improvements to IFRSs (2015–2017)

Four IFRSs were amended in the Annual Improvements to IFRSs (2015–2017).

In IFRS 3, it was clarified that when a party to a joint arrangement obtains control of a business that is a joint operation and had rights to the assets and obligations for the liabilities relating to that joint operation immediately before the acquisition date, the transaction is a business combination achieved in stages. The acquirer shall therefore apply the requirements for a business combination achieved in stages, including remeasuring its previously held interest in the joint operation.

In IFRS 11, it was clarified that when an entity obtains joint control of a business that is a joint operation and had rights to the assets and obligations for the liabilities relating to that joint operation immediately before the acquisition date, the previously held interest in that business is not to be remeasured.

IAS 12 was amended to the extent that all income tax effects of dividend payments must be considered in the same way as the income on which the dividends are based.

Finally, in IAS 23, it was determined that when entities borrow funds in general for the acquisition of qualifying assets that those costs for borrowed capital specifically for the acquisition of qualifying assets should not be considered in the determination of the financing rate until their completion.

The amendments are – subject to E.U. endorsement – to be applied for the first time in the reporting period beginning on or after January 1, 2019.

Improvements to IAS 19 – Plan Amendment, Curtailment or Settlement

The amendments relate to the measurement of pension obligations based on updated assumptions if plan amendment, curtailment or settlement occurs. After such an event, the past service cost as well as any gains or losses on the basis of current actuarial assumptions and a comparison of the resulting pension benefits must be calculated before and after the change. The periods before and after the plan amendment, curtailment or settlement are treated separately in subsequent measurement. The amendments are – subject to E.U. endorsement – to be applied for the first time in the reporting period beginning on or after January 1, 2019.

Conceptual Framework

The revised Conceptual Framework issued on March 29, 2018, replaces the previous Conceptual Framework from 2010. The main changes primarily relate to the definition, recognition and measurement of assets and liabilities, as well as the differentiation between income and expense and other comprehensive income. Subject to adoption by E.U. legislation, amendments are effective as of January 1, 2020.

Amendments to References to the Conceptual Framework in IFRS Standards

The amendments update references to and quotes from the Conceptual Framework. The amendments are – subject to E.U. endorsement – to be applied for the first time in the reporting period beginning on or after January 1, 2020.

Amendments to IFRS 3 – Business Combinations

The amendments issued on October 22, 2018, clarify that a business is a set of activities and assets with at least one input and one substantive process that together significantly contribute to the ability to create outputs. Outputs are defined as the provision of goods and services to customers. The reference to cost reduction was removed. In addition, the new provisions also contain an optional concentration test designed to simplify identification of a business. Subject to adoption by E.U. legislation, the modified definition is to be applied to business combinations with an acquisition date on or after January 1, 2020.

Amendments to IAS 1 Financial Statement Presentation and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

The amendments issued on October 31, 2018, provide a uniform and more precise definition of the materiality of information provided in the financial statements, together with accompanying examples. In this connection, the definitions in the Conceptual Framework, IAS 1, IAS 8 and the IFRS Practice Statement 2 (Making Materiality Judgements) were harmonized. Subject to adoption by E.U. legislation, the amendments are effective as of January 1, 2020.