1 – Basis of presentation

The Consolidated Financial Statements of the BASF Group for the year ending December 31, 2017, were prepared in accordance with the International Financial Reporting Standards (IFRS) in effect as of the balance sheet date. The Half-Year Financial Statements as of June 30, 2018, have been prepared – in line with the rules of International Accounting Standard 34 – in abbreviated form and largely continuing the same accounting policies.

IFRS 9 – Financial Instruments as of January 1, 2018

IFRS 9 – Financial Instruments was endorsed by the European Union on November 29, 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, it also depends on the business model for managing financial asset portfolios.

Impairments will also be recognized for expected credit losses on financial assets not measured at fair value through profit or loss based on the default risk of the respective counterparties and, in certain circumstances, changes to this default risk. The impairment approach generally provides for a three-stage model to calculate impairment losses. A simplified approach applies to certain financial instruments such as lease receivables and trade accounts receivable. This uses a two-stage model to assess impairment losses.

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. Comparative 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. 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.

At BASF, the creation 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 according to 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 loss allowances for expected 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:

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 the simplified approach referred to above, 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 rise in the counterparty’s credit risk is assumed if its rating is downgraded 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.

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 on the counterparty.

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 by the recognition of expected credit losses. A countereffect arose from the fact that valuation allowances to reflect transfer risks for certain countries and staggered valuation allowances 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 components of an option 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, 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

The IASB published the new standard on revenue recognition, IFRS 15, on May 28, 2014. The new standard was endorsed by the European Union in the third quarter of 2016 and is effective for reporting periods beginning on or after January 1, 2018.

According to IFRS 15, sales revenue is measured at the amount the entity expects to receive and 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. 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. In accordance with IFRS 15.C7A(b), only contracts that had not yet been performed as of the date of initial application were transitioned to the new standard.

The main effect of initial application of the new standard was a change in presentation within the balance sheet item “other liabilities.” Deferred sales revenue of €204 million from licenses and long-term contracts with customers that was previously presented as deferred income were reclassified to the new balance sheet item, contractual liabilities. This related to payments already received from customers for future deliveries of goods and services, which are recognized over a period of time. Contract liabilities amounted to €198 million as of June 30, 2018.

The adoption of the new standard did not lead to any changes in retained earnings.

The application of the following revisions to reporting standards requires endorsement by the European Union; the following standards were endorsed in the current fiscal year:

• Annual Improvements to IFRSs (2014–2016): The amendments were endorsed by the European Union on February 7, 2018. The clarification to IAS 28 entered into force on January 1, 2018. This clarifies 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 as of the same date. BASF was not affected by either amendment.
• Amendments to IFRS 2 – Classification and Measurement of Share-Based Payment Transactions: The amendments were endorsed by the European Union on February 26, 2018. They are to be applied to compensation granted or changed in fiscal years beginning on or after January 1, 2018. The amendments did not have any effect on BASF.
• Supplementary information on IFRIC 22 – Foreign Currency Transactions and Advance Consideration: The amendments were endorsed by the European Union on March 28, 2018. They address an application question for IAS 21 – The Effects of Changes in Foreign Exchange Rates and became effective on January 1, 2018. The amendments did not have any material effect on BASF.
• Amendments to IFRS 9 – Financial Assets with a Prepayment Feature with Negative Compensation: The amendments were endorsed by the European Union on March 22, 2018. The date of initial application is January 1, 2019.

The Half-Year Financial Statements and Half-Year Management’s Report have not been audited, nor have they undergone an auditor’s review.