Basic Principles, Methods and Critical Accounting Estimates The financial statements of the consolidated companies are prepared according to uniform accounting policies and measurement principles. The consolidated financial statements of the Group are based on the principle of the historical cost of acquisition, construction or production, with the exception of the items reflected at fair value, such as for example, financial assets held for trading or available for sale, derivatives, and liabilities for which Bayer has made use of the fair value option. In preparing the consolidated financial statements, the management has to make certain assumptions and estimates that may substantially impact the presentation of the Group’s financial position and / or results of operations. Such estimates, assumptions or the exercise of discretion mainly relate to the useful life of noncurrent assets, the discounted cash flows used for impairment testing and purchase price allocations, and the recognition of provisions, including those for litigation-related expenses, pensions and other benefits, taxes, environmental compliance and remediation costs, sales allowances, product liability and guarantees. Essential estimates and assumptions that may affect reporting in the various item categories of the financial statements are described in the following sections of this Note. Estimates are based on historical experience and other assumptions that are considered reasonable under given circumstances. They are continually reviewed but may vary from the actual values. Changes in accounting policies or measurement principles in light of new or revised standards are generally applied in line with the options permitted within the respective standard. Depending on the option that Bayer makes use of, the income statement for the previous year and the opening statement of financial position for that year are adjusted where necessary. For detailed information on standards to be applied for the first time from January 1, 2018, please see Note “Effects of new financial reporting standards”. Consolidation The consolidated financial statements include subsidiaries, joint operations, joint ventures and associates. Subsidiaries are companies over which Bayer AG is currently able to exercise power by virtue of existing rights. Power means the ability to direct the relevant activities that significantly affect a company’s profitability. Control is therefore only deemed to exist if Bayer AG is exposed, or has rights, to variable returns from its involvement with a company and has the ability to use its power over that company to affect the amount of that company’s returns. The ability to control another company generally derives from Bayer AG’s direct or indirect ownership of a majority of the voting rights. In the case of structured entities, however, control is based on contractual agreements. Inclusion of an entity’s accounts in the consolidated financial statements begins when the Bayer Group is able to exercise control over the entity and ceases when it is no longer able to do so. Joint operations and joint ventures are based on joint arrangements. A joint arrangement is deemed to exist if the Bayer Group through a contractual agreement jointly controls activities managed with a third party. Joint control is only deemed to exist if decisions regarding the relevant activities require the unanimous consent of the parties sharing control. A joint operation is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. The Bayer Group recognizes the share of assets, liabilities, revenues and expenses relating to its interest in a joint operation in accordance with its rights and obligations. A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. Joint ventures are accounted for using the equity method. Associates are companies over which Bayer AG exerts significant influence, generally through an ownership interest between 20% and 50%. They also are accounted for using the equity method. In addition, Bayer AG can generally exert significant influence on companies in which it holds an interest of below 20% when it has representation in that company’s supervisory body. The carrying amount of a company accounted for using the equity method is adjusted annually by the percentage of any change in its equity corresponding to Bayer’s percentage interest in the company. Differences arising upon first-time inclusion using the equity method are accounted for according to full-consolidation principles. Bayer’s share of changes – recognized in profit or loss – in these companies’ equities, impairment losses recognized on goodwill, and gains and losses from the sale of investments accounted for using the equity method, are reflected in equity-method income / loss. Interests in subsidiaries, joint ventures and associates that do not have a material impact on the Group’s financial position or results of operations, either individually or in aggregate, are accounted for at cost of acquisition less any impairment losses. Foreign currency translation The financial statements of the individual companies for inclusion in the consolidated financial statements are prepared in their respective functional currencies. A company’s functional currency is that of the economic environment in which it primarily generates and expends cash. The majority of consolidated companies carry out their activities autonomously from a financial, economic and organizational point of view, and their functional currencies are therefore the respective local currencies. In the consolidated financial statements, the assets and liabilities of companies that do not use the euro as their functional currency at the start and end of the year are translated into euros at closing rates. All changes occurring during the year and all income and expense items and cash flows are translated into euros at average monthly rates. Equity components are translated at the historical exchange rates prevailing at the respective dates of their first-time recognition in Group equity. The exchange differences arising between the resulting amounts and those obtained by translating at closing rates are recognized outside profit or loss as “Exchange differences on translation of operations outside the eurozone” (in other comprehensive income) or presented as “Exchange differences” in the tables in the Notes. When a company is deconsolidated or the net investment in a foreign operation is reduced, such exchange differences are reclassified from equity to profit or loss. The exchange rates for major currencies against the euro varied as follows: (XLS:) Download Exchange Rates for Major Currencies Closing rate Average rate 1 € / 2016 2017 2016 2017 BRL Brazil 3.43 3.98 3.84 3.59 CAD Canada 1.42 1.51 1.47 1.46 CHF Switzerland 1.07 1.17 1.09 1.11 CNY China 7.35 7.81 7.36 7.61 GBP United Kingdom 0.86 0.89 0.82 0.88 JPY Japan 123.36 135.01 120.06 126.39 MXN Mexico 21.78 23.66 20.62 21.28 RUB Russia 64.30 69.41 73.79 65.71 USD United States 1.05 1.20 1.11 1.13 In 2017, as in prior years, the rules of IAS 29 (Financial Reporting in Hyperinflationary Economies) were relevant for Bayer S.A., Venezuela. Gains and losses incurred upon adjusting the carrying amounts of nonmonetary assets and liabilities and of items in the income statement for inflation are recognized in other operating income and expenses. Starting in January 2016, foreign currency translation and valuation were switched to the “hyperinflation-adjusted” SIMADI exchange rate. This is determined internally because reliable exchange rates are not available externally. It was initially based on the official SIMADI rate and has subsequently been adjusted in line with published inflation rates. The exchange rate thus calculated was VEF 74,258 to the U.S. dollar at the end of December 2017 (2016: VEF 2,737 to the U.S. dollar). The resulting U.S. dollar amounts were then translated at the dollar / euro closing-date rate. Receivables from the Venezuelan exchange control authority relating to the allocation of U.S. dollars at a preferential exchange rate are impaired to zero as soon as they are posted. Foreign currency measurement In the separate financial statements of the individual consolidated companies, monetary items, such as receivables and liabilities, that are denominated in currencies other than the respective functional currency are measured at closing rates. Related exchange differences are recognized in profit or loss as exchange gains or losses under other financial income or expenses. Net sales and other operating income All revenues derived from the selling of products or rendering of services or from licensing agreements are recognized as sales. Other operational revenues are recognized as other operating income. Sales are recognized in profit or loss when the significant risks and rewards of ownership of the goods have been transferred to the customer, the company retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold, the amount of revenue and costs incurred or to be incurred can be measured reliably, and it is sufficiently probable that the economic benefits associated with the transaction will flow to the company. Sales are stated net of sales taxes, other taxes and sales deductions at the fair value of the consideration received or to be received. Sales deductions are estimated amounts for rebates, cash discounts and product returns. They are deducted at the time the sales are recognized, and appropriate provisions are recorded. Sales deductions are estimated primarily on the basis of historical experience, specific contractual terms and future expectations of sales development. It is unlikely that factors other than these could materially affect sales deductions in the Bayer Group. Provisions for rebates in 2017 amounted to 6.1% of total net sales (2016: 5.5%). In addition to rebates, Group companies offer cash discounts for prompt payment in some countries. Provisions for cash discounts as of December 31, 2017, and December 31, 2016, were less than 0.1% of total net sales for the respective year. Sales are reduced by the amount of the provisions for expected returns of defective goods or of saleable products that may be returned under contractual arrangements. The net sales are reduced on the date of sale or on the date when the amount of future product returns can be reasonably estimated. Provisions for product returns in 2017 amounted to 0.6% of total net sales (2016: 0.6%). If future product returns cannot be reasonably estimated and are significant to a sales transaction, the revenues and the related cost of sales are deferred until a reasonable estimate can be made or the right to return the goods has expired. Some of the Bayer Group’s revenues are generated on the basis of licensing agreements under which third parties have been granted rights to products and technologies. Payments received, or expected to be received, that relate to the sale or out-licensing of technologies or technological expertise are recognized in profit or loss as of the effective date of the respective agreement if all rights relating to the technologies and all obligations resulting from them have been relinquished under the contract terms. However, if rights to the technologies continue to exist or obligations resulting from them have yet to be fulfilled, the payments received are deferred accordingly. Upfront payments and similar nonrefundable payments received under these agreements are recorded as other liabilities and recognized in profit or loss according to the degree of performance over the estimated performance period stipulated in the agreement. License agreements and research and development collaboration agreements may be multiple-deliverable arrangements with varying consideration terms, such as upfront, milestone or similar payments. Such agreements therefore have to be assessed to determine whether the revenues allocated to individual deliverables must be recognized at different points in time and therefore form separate units of account. To qualify as a separate unit of account for revenue recognition purposes, a deliverable must have value to the licensee on a standalone basis. If this is not the case, the agreement as a whole or a combination of individual deliverables that has value on a standalone basis forms a unit of account. If necessary goods have yet to be delivered or necessary services provided for a unit of account and such delivery or provision is probable, nonrefundable (royalty) payments already received are recognized through profit or loss over the periods in which these goods are delivered or these services are provided. Income may also arise from the exchange of intangible assets. The amount recognized is generally based on the fair value of the asset received plus (less) any cash received (dispersed). Research and development expenses For accounting purposes, research expenses are defined as costs incurred for current or planned investigations undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Development expenses are defined as costs incurred for the application of research findings or specialist knowledge to plans or designs for the production, provision or development of new or substantially improved products, services or processes, respectively, prior to the commencement of commercial production or use. Research and development expenses are incurred in the Bayer Group for in-house research and development activities as well as numerous research and development collaborations and alliances with third parties. Research and development expenses mainly comprise the costs for active ingredient discovery, clinical studies, research and development activities in the areas of application technology and engineering, field trials, regulatory approvals and approval extensions. Research costs cannot be capitalized. The conditions for capitalization of development costs are closely defined: a key precondition for recognition of an intangible asset is that it is sufficiently certain that the development activity will generate future cash flows that will cover the associated development costs. Since our own development projects are often subject to regulatory approval procedures and other uncertainties, the conditions for the capitalization of costs incurred before receipt of approvals are not normally satisfied. In the case of research and development collaborations, a distinction is generally made between payments on contract signature, upfront payments, milestone payments and cost reimbursements for work performed. If an intangible asset (such as the right to the use of an active ingredient) is acquired in connection with any of these payment obligations, the respective payment is capitalized even if it is uncertain whether further development work will ultimately lead to the production of a saleable product. Reimbursements of the cost of research or development work are recognized in profit or loss, except where they are required to be capitalized. Income taxes Income taxes comprise the taxes levied on taxable income in the individual countries along with changes in deferred tax assets and liabilities that are recognized in profit or loss. The income taxes recognized are reflected at the amounts likely to be payable under the statutory regulations in force, or already enacted in relation to future periods, at the end of the reporting period. Complex tax regulations may give rise to uncertainties with respect to their interpretation and the amounts and timing of future taxable income. Given the wide range of international business relationships and the long-term nature and complexity of existing contractual agreements, differences arising between the actual results and the assumptions made, or future changes to such assumptions, could necessitate adjustments to tax income and expense in future periods. The Group establishes provisions for taxes, based on reasonable estimates, for liabilities to the tax authorities of the respective countries that are uncertain as to their amount and the probability of their occurrence. The amount of such provisions is based on various factors, such as experience with previous tax audits and differing legal interpretations by the taxable entity and the responsible tax authority. In compliance with IAS 12 (Income Taxes), deferred taxes are recognized for temporary differences between the carrying amounts of assets and liabilities in the statement of financial position prepared according to IFRS and their tax bases. Deferred taxes are also recognized for consolidation measures and for loss carryforwards, interest carryforwards and tax credits that are likely to be usable. Deferred tax assets relating to deductible temporary differences, tax credits, loss carryforwards and interest carryforwards are recognized where it is sufficiently probable that taxable income will be available in the future to enable them to be used. Deferred tax liabilities are recognized on temporary differences taxable in the future. Deferred taxes are calculated at the rates which – on the basis of the statutory regulations in force, or already enacted in relation to future periods, as of the closing date – are expected to apply in the individual countries at the time of realization. Deferred tax assets and deferred tax liabilities are offset if they relate to income taxes levied by the same taxation authority and Bayer has a legal right to settle on a net basis. Material effects of changes in tax rates or tax law on deferred tax assets and liabilities are generally accounted for in the period in which the changes are enacted. Such effects are recognized in profit or loss except where they relate to deferred taxes that were recognized outside profit or loss, in which case they are recognized in other comprehensive income or directly in equity. Deferred and current taxes are recognized in profit or loss unless they relate to items recognized outside profit or loss, in which case they, too, are recognized in other comprehensive income or directly in equity. The probability that deferred tax assets resulting from temporary differences, loss carryforwards or interest carryforwards can be used in the future is the subject of forecasts by the individual consolidated companies regarding their future earnings situation and other parameters. Deferred tax liabilities are recognized on planned dividend payments by subsidiaries. Where no dividend payment is planned for the foreseeable future, no deferred tax liability is recognized on the difference between the proportionate net assets according to IFRS and the tax base of the investment in the subsidiary. Goodwill In a business combination, goodwill is capitalized at the acquisition date. It is measured at its cost of acquisition, which is the excess of the acquisition price for shares in a company over the acquired net assets. The net assets are the balance of the fair values of the acquired identifiable assets and the assumed liabilities and contingent liabilities. Goodwill is not amortized, but tested annually for impairment. Details of the annual impairment tests are given under “Procedure used in global impairment testing and its impact.” Once an impairment loss has been recognized on goodwill, it is not reversed in subsequent periods. Other intangible assets An “other intangible asset” is an identifiable nonmonetary asset without physical substance, other than goodwill (such as a patent, a trademark or a marketing right). It is capitalized if the future economic benefits attributable to the asset will probably flow to the company and the cost of acquisition or generation of the asset can be reliably measured. Other intangible assets are recognized at the cost of acquisition or generation. Those with a determinable useful life are amortized accordingly on a straight-line basis over a period of up to 30 years, except where their actual depletion demands a different amortization pattern. Determination of the expected useful lives of such assets and the amortization patterns is based on estimates of the period for which they will generate cash flows. An impairment test is performed if there is an indication of possible impairment. Other intangible assets with an indefinite life (such as the Bayer Cross trademark) and intangible assets not yet available for use (such as research and development projects) are not amortized, but tested annually for impairment. Property, plant and equipment Property, plant and equipment is depreciated by the straight-line method over an asset’s useful life, except where depreciation based on actual depletion is more appropriate. The following depreciation periods are applied throughout the Group: (XLS:) Download Useful Life of Property, Plant and Equipment Buildings 20 to 50 years Outdoor infrastructure 10 to 20 years Storage tanks and pipelines 10 to 20 years Plant installations 6 to 20 years Machinery and equipment 6 to 12 years Furniture and fixtures 4 to 10 years Vehicles 5 to 8 years Computer equipment 3 to 5 years Laboratory and research facilities 3 to 5 years When assets are sold, closed down or scrapped, the difference between the net proceeds and the net carrying amount of the assets is recognized as a gain or loss in other operating income or expenses, respectively. Investment property comprises land and buildings not being used for operational or administrative purposes. It is measured using the cost model. The fair value of the investment property reported in the Notes is determined using the discounted cash flow method, comparisons with the current market values of similar properties, or reports from external experts. Financial assets Financial assets comprise loans and receivables, acquired equity and debt instruments, cash and cash equivalents, and derivatives with positive fair values. Regular-way purchases and sales of financial assets are generally posted on the settlement date. Financial assets are initially recognized at fair value plus transaction costs. The transaction costs incurred for the purchase of financial assets held at fair value through profit or loss are expensed immediately. If there are substantial and objective indications of a decline in the value of loans and receivables, held-to-maturity financial assets or available-for-sale financial assets, an impairment test is performed. Indications of possible impairment include a high probability of insolvency, a significant deterioration in credit standing, a material breach of contract, operating losses reported by a company over several years, a reduction in market value, the financial restructuring of the debtor, or the disappearance of an active market for the asset. Impairment losses are generally recorded on receivables in the event of insolvency or similar proceedings being launched, financial restructuring at business partners, or the initiation of enforcement measures. Payment history and past-due receivables are also analyzed, with customer-specific facts assessed in each case. Financial assets are derecognized when contractual rights to receive cash flows from the financial assets expire or the financial assets are transferred together with all material risks and benefits. Inventories In accordance with IAS 2 (Inventories), inventories encompass assets consumed in production or in the rendering of services (raw materials and supplies), assets in the production process for sale (work in process), goods held for sale in the ordinary course of business (finished goods and goods purchased for resale), and advance payments on inventories. Inventories are recognized at their cost of acquisition or production (production-related full costs) – calculated by the weighted-average method – or at their net realizable value, whichever is lower. The net realizable value is the estimated selling price in the ordinary course of business less estimated cost to complete and selling expenses. Cash and cash equivalents Cash and cash equivalents comprise cash, checks received and balances with banks and companies. Cash equivalents are highly liquid short-term financial investments that are subject to an insignificant risk of changes in value, are easily convertible into a known amount of cash and have a maturity of three months or less from the date of acquisition or investment. Provisions for pensions and other post-employment benefits Within the Bayer Group, post-employment benefits are provided under defined contribution and / or defined benefit plans. In the case of defined contribution plans, the company pays contributions to publicly or privately administered pension plans on a mandatory, contractual or voluntary basis. Once the contributions have been paid, the company has no further payment obligations. The regular contributions constitute expenses for the year in which they are due and as such are included in the functional cost items, and thus in EBIT. All other post-employment benefit systems are defined benefit plans, which may be either unfunded, i.e. financed by provisions, or funded, i.e. financed through pension funds. The present value of provisions for defined benefit plans and the resulting expense are calculated in accordance with IAS 19 (Employee Benefits) by the projected unit credit method. The future benefit obligations are valued by actuarial methods and spread over the entire employment period on the basis of specific assumptions regarding beneficiary structure and the economic environment. These relate mainly to the discount rate, future salary and pension increases, variations in health care costs, and mortality rates. The discount rates used are calculated from the yields of high-quality corporate bond portfolios in specific currencies with cash flows approximately equivalent to the expected disbursements from the pension plans. The uniform discount rate derived from this interest-rate structure is thus based on the yields, at the closing date, of a portfolio of AA-rated corporate bonds whose weighted residual maturities approximately correspond to the duration necessary to cover the entire benefit obligation. The fair value of plan assets is deducted from the present value of the defined benefit obligation for pensions and other post-employment benefits to determine the net defined benefit liability. The obligations and plan assets are valued at regular intervals of not more than three years. Comprehensive actuarial valuations for all major plans are performed annually as of December 31. Plan assets in excess of the benefit obligation are reflected in other receivables, subject to the asset ceiling specified in IAS 19 (Employee Benefits). The balance of all income and expenses relating to defined benefit plans, except the net interest on the net liability, is recognized in EBIT. The net interest is reflected in the financial result under other financial income and expenses. The effects of remeasurements of the net defined benefit liability are reflected in the statement of comprehensive income as other comprehensive income. They consist of actuarial gains and losses, the return on plan assets and changes in the effects of the asset ceiling, less the respective amounts included in net interest. Deferred taxes relating to the effects of remeasurements are also recognized in other comprehensive income. Other provisions Other provisions are recognized for present legal and constructive obligations arising from past events that will probably give rise to a future outflow of resources, provided that a reliable estimate can be made of the amount of the obligations. If the projected obligation declines as a result of a change in the estimate, the provision is reversed by the corresponding amount and the resulting income recognized in the operating expense item(s) in which the original charge was recognized. To enhance the information content of the estimates, certain provisions that could have a material effect on the financial position or results of operations of the Group are tested for their sensitivity to changes in the underlying parameters. To reflect uncertainty about the likelihood of the assumed events actually occurring, the impact of a five-percentage-point change in the probability of occurrence is examined in each case. This analysis has not shown other provisions to be materially sensitive. Provisions for environmental protection are recorded if future cash outflows are likely to be necessary to ensure compliance with environmental regulations or to carry out remediation work, such costs can be reliably estimated and no future benefits are expected from such measures. Provisions for environmental protection mainly relate to the rehabilitation of contaminated land, recultivation of landfills, and redevelopment and water protection measures. Estimating the future costs of environmental protection and remediation involves many uncertainties, particularly with regard to the status of laws, regulations and the information available about conditions in the various countries and at the individual sites. Significant factors in estimating the costs include previous experiences in similar cases, conclusions drawn from expert opinions obtained regarding the Group’s environmental programs, current costs and new developments affecting costs, management’s interpretation of current environmental laws and regulations, the number and financial position of third parties that may become obligated to participate in any remediation costs on the basis of joint liability, and the remediation methods likely to be deployed. Changes in these assumptions could impact future reported results of the Group. Taking into consideration experience gained to date regarding environmental matters of a similar nature, provisions are believed to be adequate based upon currently available information. Given the difficulties inherent in estimating environmental liabilities in the businesses in which the Group operates, especially those for which the risk of environmental damage is greater in relative terms (Crop Science), it remains possible that material additional costs will be incurred beyond the amounts accrued. It may transpire during remediation work that additional expenditures are necessary over an extended period and that these exceed existing provisions and cannot be reasonably estimated. Provisions for restructuring only cover expenses that arise directly from restructuring measures, are necessary for restructuring and are not related to future business operations. Such expenses include severance payments to employees and compensation payments in respect of rented property that can no longer be used. Restructuring measures may include the sale or termination of business units, site closures, relocations of business activities or fundamental reorganizations of business units. Trade-related provisions are recorded mainly for the granting of rebates or discounts, product returns, obligations in respect of services already received but not yet invoiced, and impending losses or onerous contracts. As a global enterprise with a diverse business portfolio, the Bayer Group is exposed to numerous legal risks for which provisions for litigations must be established under certain conditions – particularly in the areas of product liability, competition and antitrust law, patent disputes, tax law and environmental protection. Litigations and other judicial proceedings often raise complex issues and are subject to many uncertainties and complexities including, but not limited to, the facts and circumstances of each particular case, the jurisdiction in which each suit is brought and differences in applicable law. The outcomes of currently pending and future proceedings generally cannot be predicted. It is particularly difficult to assess the likely outcomes of class actions for damages or mass compensation claims in the United States, which may give rise to significant financial risks for the Bayer Group. As a result of a judgment in court proceedings, regulatory decisions or the conclusion of a settlement, the Bayer Group may incur charges for which no accounting measures have yet been taken for lack of reasonable estimability or which exceed presently established provisions and the insurance coverage. The Bayer Group considers the need for accounting measures in respect of pending or future litigations, and the extent of any such measures, on the basis of the information available to its legal department and in close consultation with legal counsel acting for the Bayer Group. Where it is more likely than not that such a litigation will result in an outflow of resources that is already reasonably estimable, a provision for litigation is recorded in the amount of the present value of the expected cash outflows. Such provisions cover the estimated payments to the plaintiffs, court and procedural costs, attorney costs and the cost of potential settlements. It is frequently impossible to reliably determine the existence of a present obligation or reasonably estimate the probability that a potential outflow of resources will result from a pending or future litigation. The status of the material “legal risks” is described in Note “Legal risks”. Due to the special nature of these litigations, provisions generally are not established until initial settlements allow an estimate of potential amounts or judgments have been issued. Provisions for legal defense costs are established if it is probable that material costs will have to be incurred for external legal counsel to defend the company’s legal position. Internal and external legal counsel evaluate the current status of the Bayer Group’s material legal risks at the end of each reporting period. The need to establish or adjust a provision and the amount of the provision or adjustment are determined on this basis. Adjusting events are reflected up to the date of preparation of the consolidated financial statements. The measurement of provisions in the case of class actions or mass compensation claims is mainly based on any settlements reached during the past year and on pending or anticipated future claims. Provisions for personnel commitments mainly include those for variable one-time payments under short-term incentive programs and for stock-based compensation. Also reflected here are commitments for service awards, early retirements and pre-retirement part-time working arrangements. Provisions for severance payments resulting from restructuring are reflected in provisions for restructuring. Miscellaneous provisions include those for other liabilities, contingent liabilities from business combinations, and asset retirement obligations (other than those included in provisions for environmental protection). Financial liabilities Financial liabilities comprise financial liabilities, trade accounts payable and other liabilities that are settled in cash and cash equivalents or other financial instruments, as well as negative fair values of derivatives. Financial liabilities are measured at amortized cost unless they are carried at fair value. Examples include derivatives with negative fair values or liabilities for which the fair value option has been used. Liabilities for contingent consideration arising from business combinations are measured at fair value. Changes in fair value are recognized through profit or loss as of the respective closing date. Financial liabilities are derecognized when the contractual obligation is discharged or canceled, or has expired. Mandatory convertible notes are assessed to determine whether they should be accounted for entirely as debt or split into an equity component and a debt component. This involves examining whether Bayer’s early conversion rights have economic substance. These rights may have economic substance with respect to maintaining the current credit rating if early conversion can prevent a rating downgrade. In this event, future savings of credit interest would more than offset the cost of early conversion by Bayer. If the right to early conversion is deemed to have economic substance, components of the mandatory convertible notes are classified as equity. The mandatory convertible notes issued are accounted for as a hybrid financial instrument. The directly attributable costs along with the debt component, which corresponds to the present value of the future interest payments, are deducted from the proceeds of the issue. The debt component is included in financial liabilities. The remaining amount is the equity component, which is reflected in capital reserves. The fair value option under IAS 39.11A may be used if a bond represents a hybrid financial instrument, i.e. if the nonderivative host contract constitutes a debt instrument, multiple derivatives are embedded in the bond and at least one of the derivatives has to be separated from the host contract and significantly modifies the contractual cash flows. Such a bond is designated in its entirety as a financial liability at fair value through profit or loss. Changes in its fair value are recognized in other financial income and expenses. Use was made of this fair value option for the first time for the debt instruments issued in June 2017 (exchangeable bond 2017 / 2020), which are exchangeable into Covestro shares. Other receivables and liabilities Accrued items and other nonfinancial assets and liabilities are carried at amortized cost. They are amortized to income by the straight-line method or according to performance of the underlying transaction. Grants and subsidies from third parties that serve to promote investment are reflected in the statement of financial position under other liabilities and amortized to income over the useful lives of the respective investments or in line with the terms of the grant or subsidy. Derivatives The Bayer Group uses derivatives to mitigate the risk of changes in exchange rates, interest rates or prices and to hedge stock-based compensation programs. The instruments used include forward exchange contracts, interest-rate swaps and stock options. Derivatives are recognized at the trade date. Contracts concluded in order to receive or deliver nonfinancial items for the company’s own purposes are not accounted for as derivatives but treated as pending transactions. Where embedded derivatives are identified that are required to be separated from the pending transactions, they are accounted for separately. To take advantage of market opportunities or cover possible peak demand, a nonmaterial volume of transactions may be entered into for which the possibility of immediate resale cannot be excluded. Such transactions are allocated to separate portfolios upon acquisition and accounted for as derivatives according to IAS 39. Derivatives are carried at fair value. Positive fair values at the end of the reporting period are reflected in financial assets, negative fair values in financial liabilities. Changes in the fair values of these derivatives are recognized directly in profit or loss except where hedge accounting is used. Changes in the fair values of the effective portion of derivatives designated as cash flow hedges are initially recognized outside profit or loss in accumulated other comprehensive income. They are reclassified to profit or loss when the underlying transaction is realized. If such a derivative is sold or ceases to qualify for hedge accounting, the change in its value continues to be recognized in accumulated other comprehensive income until the forecasted transaction is realized. If the forecasted transaction is no longer expected to occur, the amount previously recognized in accumulated other comprehensive income is reclassified to profit or loss. The ineffective portion of gains or losses on derivatives designated as cash flow hedges is recognized either in other operating income or expenses or in the financial result, depending on the type of underlying transaction. Changes in the fair values of derivatives designated as fair-value hedges and the adjustments in the carrying amounts of the underlying transactions are recognized in profit or loss. Changes in the fair values of forward exchange contracts and currency options serving as hedges of items in the statement of financial position are reflected in other financial income and expenses as exchange gains or losses, while changes in the values of interest-rate swaps and interest-rate options are recognized in interest income or expense. Changes in the fair values of commodity futures and options, and of forward exchange contracts used to hedge forecasted sales transactions in foreign currencies, are recognized in other operating income or expenses. Changes in the fair values of stock options or forward stock transactions used to hedge stock-based employee compensation are initially recognized outside profit or loss and subsequently reclassified to profit or loss in the functional costs over the periods of the Aspire programs. The income and expense reflected in the financial result pertaining to the derivatives and the underlying transactions are shown separately. Income and expense are not offset. Acquisition accounting Acquired businesses are accounted for using the acquisition method, which requires that the assets acquired and liabilities assumed be recorded at their respective fair values on the date Bayer obtains control. Ancillary acquisition costs are recognized as expenses in the periods in which they occur. The application of the acquisition method requires certain estimates and assumptions to be made, especially concerning the fair values of the acquired intangible assets, property, plant and equipment and the liabilities assumed at the acquisition date, and the useful lives of the acquired intangible assets, property, plant and equipment. Measurement is based to a large extent on anticipated cash flows. If actual cash flows vary from those used in calculating fair values, this may materially affect the Group’s future results of operations. In particular, the estimation of discounted cash flows from intangible assets under development, patented and nonpatented technologies and brands is based on assumptions concerning, for example: The outcomes of research and development activities regarding the efficacy of a crop protection or seed product, compound, results of clinical trials The probability of obtaining regulatory approvals in individual countries Long-term sales projections Possible selling price erosion due to offerings of unpatented products following patent expirations The behavior of competitors (launch of competing products, marketing initiatives, etc.) For significant acquisitions, the purchase price allocation schließen Purchase price allocation (PPA) describes the process of allocating the purchase price into various assets and liabilities when a company is acquired. is carried out with assistance from independent third-party valuation specialists. The valuations are based on the information available at the acquisition date. In step acquisitions, the fair values of the acquired entity’s assets and liabilities are measured in accordance with IFRS 3 (Business Combinations) at the date on which control is obtained. Any resulting adjustments to the fair value of the existing interest are recognized in profit or loss. The carrying amount of the assets and liabilities already recognized in the statement of financial position is then adjusted accordingly. Divestment accounting Divestments of shares in subsidiaries that result in a loss of control are generally accounted for in profit or loss. When shares in a subsidiary are gradually divested in several tranches, a reduction in the majority shareholding without the loss of control is reflected outside profit or loss and results in an increase in the equity attributable to noncontrolling stockholders. After the loss of control, the interest remaining at the time of the loss of control is carried at fair value. If Bayer AG still retains significant influence after divesting shares, the remaining interest is recognized as an interest in an associate and is accounted for using the equity method. If Bayer can no longer exert significant influence on the company, the remaining interest is immediately classified as an available-for-sale financial asset and recognized at fair value outside profit or loss. Procedure used in global impairment testing and its impact Impairment tests are performed not only on individual items of intangible assets, property, plant and equipment, but also at the level of cash-generating units or groups of cash-generating units. A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. The Bayer Group regards its strategic business entities or groups of strategic business entities, as well as certain product families, as cash-generating units and subjects them to global impairment testing. The strategic business entities constitute the second financial reporting level below the segments. Cash-generating units and unit groups are globally tested if there is an indication of possible impairment. Those to which goodwill is allocated are tested at least annually. Impairment testing involves comparing the carrying amount of each cash-generating unit, unit group or item of intangible assets, property, plant or equipment to the recoverable amount, which is the higher of its fair value less costs of disposal or value in use. If the carrying amount exceeds the recoverable amount, an impairment loss must be recognized for the difference. In this case an impairment loss is first recognized on any goodwill allocated to the cash-generating unit or unit group. Any remaining part of the impairment loss is then allocated among the other noncurrent nonfinancial assets of the cash-generating unit or unit group in proportion to their carrying amounts. The resulting expense is reflected in the functional item of the income statement in which the depreciation or amortization of the respective assets is recognized. The same applies to income from impairment loss reversals. The recoverable amount is generally determined on the basis of the fair value less costs of disposal, taking into account the present value of the future net cash flows as market prices for the individual units are not normally available. These are forecasted on the basis of the Bayer Group’s current planning, the planning horizon normally being three to five years. Forecasting involves making assumptions, especially regarding future selling prices, sales volumes, costs, market growth rates, economic cycles and exchange rates. These assumptions are based on internal estimates along with external market studies. Where the recoverable amount is the fair value less costs of disposal, the cash-generating unit or unit group is measured from the viewpoint of an independent market participant. Where the recoverable amount is the value in use, the cash-generating unit, unit group or individual asset is measured as currently used. In either case, net cash flows beyond the planning period are determined on the basis of long-term business expectations using the respective individual growth rates derived from market information. The fair value less costs of disposal is determined on the basis of unobservable inputs (Level 3). The net cash inflows are discounted at a rate equivalent to the weighted average cost of equity and debt capital. To allow for the different risk and return profiles of the Bayer Group’s principal businesses, the after-tax cost of capital is calculated separately for each reporting segment, and a segment-specific capital structure is defined by benchmarking against comparable companies in the same industry sector. The cost of equity corresponds to the return expected by stockholders, while the cost of debt is based on the conditions on which comparable companies can obtain long-term financing. Both components are derived from capital market information. The growth rates applied for impairment testing in 2017 and 2016 and the capital cost factors used to discount the expected cash flows are shown in the following table: (XLS:) Download Impairment Testing Parameters Growth rate After-tax cost of capital 2016 2017 2016 2017 % % % % Pharmaceuticals 0.0 0.0 5.5 5.6 Consumer Health 0.0 1.0 5.2 4.8 Crop Protection 2.1 2.0 5.3 5.4 Seeds 1.7 2.0 5.3 5.4 Environmental Science 2.4 2.0 5.3 5.4 Animal Health 0.0 1.0 5.3 5.0 No impairment losses were recognized on goodwill on the basis of the global annual impairment testing of the cash-generating units and unit groups in 2017 or 2016. Impairment losses on intangible assets, property, plant and equipment – net of €13 million (2016: €1 million) in impairment loss reversals – totaled €506 million (2016: €711 million). Details are provided in Notes “Goodwill and other intangible assets” and “Property, plant and equipment”. Although the estimates of the useful lives of certain assets, assumptions concerning the macroeconomic environment and developments in the industries in which the Bayer Group operates, and estimates of the discounted future cash flows are believed to be appropriate, changes in assumptions or circumstances could require changes in the analysis. This could lead to the recognition of additional impairment losses in the future or – except in the case of goodwill – to reversals of previously recognized impairment losses if developments are contrary to expectations. The sensitivity analysis for cash-generating units and unit groups to which goodwill is allocated was based on a 10% reduction in future cash flows, a 10% increase in the weighted average cost of capital or a one-percentage-point reduction in the long-term growth rate. Bayer concluded that no impairment loss would need to be recognized on goodwill in any cash-generating unit or unit group under these conditions.