1.4 – 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 typically 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 is 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 are retroactively adjusted for the consolidated figures for discontinued operations as of the beginning of the fiscal year. The prior-year figures are restated. In addition, the assets and liabilities of the discontinued operations are 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 is not restated. The activities of discontinued operations are not allocated to any reportable segment in financial reporting.

Exploration and development expenditures in the oil and gas business, now accounted for using the equity method, 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.

Use of estimates and assumptions in preparing the Consolidated 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 discretionary scope. Specific estimates or assumptions used in individual accounting or valuation methods are disclosed in their respective sections of the Notes to the Consolidated Financial Statements. 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.

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 interest rate, the market risk premium and the industry-specific spread for the credit risk. Additional important assumptions are the forecasts for the detailed planning period and the terminal growth rates used. Fair value less costs to sell must be determined for the impairment test of the disposal groups; specific assumptions relating to the respective transaction must be made for this determination.

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 impairment, the existing goodwill is, if necessary, completely written off as a first step. If there is further need for impairment, this is allocated to the remaining assets of the cash-generating unit. Goodwill impairments are reported under other operating expenses.

The assumptions regarding the long-term development of oil and gas prices were significant for impairment tests in the discontinued oil and gas business in 2018. Internal company projections were based on an empirical analysis of global oil and gas supply and demand. Short-term estimates up to three years also considered 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 was used for the impairment test for the Exploration & Production unit in the discontinued oil and gas business when the disposal group was set up in 2018. It took into account the expected cash flows as well as the tax payments in the individual countries. The period under consideration included 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 were considered in each case; this led to a more precise calculation of the recoverable amount. Allowing for these parameters, the cost of capital rate after taxes in 2018 varied from 6.56% to 10.63% and before taxes from 9.62% to 30.37%.

The determination of fair value for the initial recognition of Wintershall Dea GmbH, which is accounted for using the equity method, was based on assumptions, particularly for production profiles of oil and gas fields, oil and/or gas prices, and discount factors.

For planning purposes, BASF assumes an oil price of $60/bbl (Brent) and for gas of approximately €18/MWh (roughly $6/mmBtu) in 2020.

Further accounting policies are included in the respective notes to the balance sheet and to the statement of income.