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Notes to the Group accounts

General

(1) Company information

The accompanying consolidated financial statements as of December 31, 2015 have been prepared with MERCK Kommanditgesellschaft auf Aktien (Merck KGaA), Frankfurter Strasse 250, 64293 Darmstadt, Germany, which manages the operations of the Group, as parent company. In accordance with the provisions of the German financial reporting disclosure law (Publizitätsgesetz), consolidated financial statements are also prepared for E. Merck Kommanditgesellschaft (E. Merck KG), Darmstadt, Germany, the ultimate parent company and general partner of Merck KGaA, Darmstadt, Germany, with an equity interest of 70.274% as of December 31, 2015. These consolidated financial statements include Merck KGaA, Darmstadt, Germany, and its subsidiaries. The authoritative German versions of these financial statements are filed with the German Federal Gazette (Bundesanzeiger) and can be accessed at www.bundesanzeiger.de.

(2) Reporting principles

These consolidated financial statements have been prepared in accordance with the International Financial Reporting Standards in force on the balance sheet date and adopted by the European Union as issued by the International Accounting Standards Board and the IFRS Interpretations Committee (IFRS and IAS, as well as IFRIC and SIC) as well as the additionally applicable provisions of section 315a of the German Commercial Code (HGB). The fiscal year corresponds to the calendar year. These financial statements have been prepared in euros, the reporting currency. The figures reported in the consolidated financial statements have been rounded, which may lead to individual values not adding up to the totals presented.

The following rules took effect as of fiscal 2015:

  • Annual Improvements to IFRSs 2011 – 2013 Cycle
  • IFRIC 21 “Levies”

These new rules did not have any material effects on the consolidated financial statements.

The following rules take effect as of fiscal 2016:

  • Amendment to IAS 1 “Presentation of Financial Statements”
  • Amendments to IAS 16 “Property, Plant and Equipment”
  • Amendment to IAS 19 “Employee Benefits”
  • Amendment to IAS 27 “Separate Financial Statements”
  • Amendment to IAS 38 “Intangible Assets”
  • Amendment to IAS 41 “Agriculture”
  • Amendment to IFRS 11 “Joint Arrangements”
  • Annual Improvements to IFRSs 2010 – 2012 Cycle
  • Annual Improvements to IFRSs 2012 – 2014 Cycle

The Group currently does not expect the new rules to have any material effects on the consolidated financial statements.

As of the balance sheet date, the following standards were published by the International Accounting Standards Board, but not yet adopted by the European Union:

  • IFRS 9 “Financial Instruments”
  • IFRS 14 “Regulatory Deferral Accounts”
  • IFRS 15 “Revenue from Contracts with Customers”
  • Amendments to IAS 28 “Investments in Associates and Joint Ventures”
  • Amendments to IFRS 10 “Consolidated Financial Statements”
  • Amendment to IFRS 12 “Disclosure of Interests in Other Entities”
  • Amendment to IFRS 15 “Revenue from Contracts with Customers”

The impact of IFRS 9 and IFRS 15, which will become effective as of 2018 (subject to a corresponding endorsement by the European Union), on the consolidated financial statements is currently being examined. Based on the results of a preliminary study, the Group currently does not expect that the first-time application of IFRS 15 will have any significant effects on the amount and timing of revenue recognition. According to the present state of knowledge, certain changes will result with respect to outlicensing as well as to a smaller extent with respect to the multiple-element arrangements within the Life Science business sector. From today’s perspective, the other new rules are not expected to have any material effects on the consolidated financial statements.

(3) Changes in the scope of consolidation

The scope of consolidation changed as follows in the reporting period:


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Fully consolidated companies as of December 31, 2014 218
Additions Establishment 2
Acquisitions 102
Materiality 4
Retirements Liquidations / Mergers – 7
Divestments 0
Immateriality – 3
Fully consolidated companies as of December 31, 2015 316
Non-consolidated subsidiaries as of December 31, 2014 28
Non-consolidated subsidiaries as of December 31, 2015 63

Due to the acquisition of the Sigma-Aldrich Corporation, USA, and its subsidiaries, the number of fully consolidated companies of the Group increased by 100; the number of companies not consolidated due to immateriality increased by 40.

Overall, the impact of subsidiaries not consolidated due to immateriality on sales, profit after tax, assets and equity was less than 1% relative to the entire Group. The interests in subsidiaries not consolidated due to immateriality were classified as available-for-sale financial assets and presented under non-current financial assets. The list of shareholdings presents all of the companies included in the consolidated financial statements as well as all of the shareholdings of Merck KGaA, Darmstadt, Germany, (see Note [67] “List of shareholdings”).

(4) Acquisitions, assets held for sale and disposal groups

Acquisition of Sigma-Aldrich Corporation, USA

On November 18, 2015, the Group obtained control of the Sigma-Aldrich Corporation, a life science enterprise headquartered in St. Louis, USA (Sigma-Aldrich). Prior to that, on September 22, 2014, the Group and Sigma-Aldrich entered into an agreement under which the Group would acquire Sigma-Aldrich for US$ 140 per share in cash. Afterwards, the Group received the approval of Sigma-Aldrich shareholders as well as clearance from various antitrust authorities regarding the acquisition. Due to the commitments imposed by the European antitrust authorities, the Group and Sigma-Aldrich had agreed to sell parts of Sigma-Aldrich’s solvents and inorganics business in Europe. This business was reported under “assets held for sale” in the overview of fair values as of the acquisition date. Further information can be found in the section entitled “Business activities of Sigma-Aldrich acquired with a view to resale”.

The purchase price as well as the payments for the acquisitions of 100% of the shares in Sigma-Aldrich were as follows:


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€ million
Purchase price for 100% of shares (US$ 17,015 million) at the closing rate on November 18, 2015 15,973.8
Reclassification of hedging gains from other comprehensive income to assets – 1,380.3
Purchase price according to IFRS 3 14,593.5
Acquired cash and cash equivalents 1,235.1
Payments for 100% of the interests less acquired cash and cash equivalents 13,358.4

The vast majority of the currency risk stemming from the purchase price payment for Sigma-Aldrich in U.S. dollars was hedged within the scope of a rolling hedging strategy using derivatives (forward exchange transactions and currency options) in line with the requirements for cash flow hedge accounting. The resulting income amounting to € 1,380.3 million was taken into consideration during the determination of the purchase price in accordance with IFRS 3.

Acquisition financing

The purchase price was financed through cash on the Group's balance sheet, bank loans and bonds. Following the issuance of a hybrid bond (€ 1.5 billion) in December 2014, the Group issued a further bond with a volume of US$ 4 billion in the United States on March 17, 2015. On August 27, 2015, the Group issued a euro bond amounting to € 2.1 billion. The bond issues comprised various tranches along with various maturities and interest rates. An overview of the outstanding bonds can be found in Note [28] “Financial liabilities / Capital management”.

Business activities as well as sales and earnings contribution of Sigma-Aldrich

Sigma-Aldrich manufactures and distributes more than 250,000 chemicals, biochemicals and other essential products to customers in research and applied labs as well as in industrial and commercial markets. Sigma-Aldrich operates in 37 countries, has approximately 9,300 employees and, under U.S. Generally Accepted Accounting Principles (U.S. GAAP), generated sales of US$ 2,785 million (€ 2,102 million) and net income of US$ 500 million (€ 377 million) in 2014. In 2013, the corresponding values under U.S. GAAP were US$ 2,704 million (€ 2,033 million) for sales and US$ 491 million (€ 369 million) for net income.

Following the transaction closing, the Group started to integrate the life science business of Sigma-Aldrich into the Life Science business sector and the SAFC Hitech business into the Performance Materials business sector. The aim of the acquisition is to offer customers a wider range of products, greater geographic reach and a broad combination of industry-leading capabilities.

The impact of the consolidation of Sigma-Aldrich on sales between November 18, 2015 and December 31, 2015 as well as net income after taxes amounted to € 289.5 million and € – 5.8 million, respectively. This result also includes higher cost of sales due to the step-up of the acquired inventories to preliminary fair values as well as the amortization of assets identified and remeasured during the purchase price allocation.

Assuming the first-time consolidation of Sigma-Aldrich had already taken place as of January 1, 2015, sales of the Group for the period from January 1 to December 31, 2015 would have amounted to € 14,926.8 million (compared with reported sales of € 12,844.7 million) and net income after taxes would have been € 1,150.3 million (compared with reported net income of € 1,124.1 million. The determination of these figures assumed that the adjustments of the book values as a result of the purchase price allocation would have been identical.

Purchase price allocation

Since the obtainment of control over Sigma-Aldrich did not take place until November 18, 2015, and material information for the purchase price allocation was only obtained after that date for legal reasons, the purchase price allocation for all assets and liabilities as of December 31, 2015 has not yet been completed. The preliminary fair values as of the acquisition date were as follows:


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€ million Fair values on the acquisition date
Non-current assets
Intangible assets (excluding goodwill) 5,872.6
Property, plant and equipment 840.3
Other non-current assets 124.7
6,837.6
Current assets
Cash and cash equivalents 1,235.1
Inventories 851.9
Receivables 451.5
Other current assets 36.0
Assets held for sale 123.8
2,698.3
Assets 9,535.9
 
Non-current liabilities
Non-current financial liabilities 0.2
Other non-current liabilities and provisions 150.1
Deferred tax liabilities 2,441.8
2,592.1
Current liabilities
Current financial liabilities 425.1
Other current liabilities and provisions 538.6
Liabilities directly related to assets held for sale
963.7
Liabilities 3,555.8
 
Acquired net assets 5,980.1
 
Purchase price for the acquisition of shares 14,593.5
Positive difference (goodwill) 8,613.4

The most significant impact of the purchase price allocation resulted from the remeasurement of intangible assets, property, plant and equipment as well as finished and unfinished goods within inventories at fair value, and from the recognition of deferred taxes. The intangible assets identified during the preliminary purchase price allocation and recognized on the date of first-time consolidation as well as the measurement methods applied are presented in the following overview:


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Fair values on the acquisition date (preliminary)
€ million
Useful lives in years (preliminary) Valuation method for determining the fair values
Customer relationships 4,675.5 22 – 24 multi-period excess earnings method
Trademarks and brands 963.6 12 relief from royalty method
Technologies (patented and non-patented) 129.5 10 – 15 relief from royalty method, reproduction cost method
Other 104.0
Total 5,872.6
 
Goodwill 8,613.4 indefinite
Total 14,486.0

A major factor for the measurement of customer relationships was the assumption regarding long-term customer retention. If the annual loss of customers was one percentage point higher, the fair value of customer relationships would be € 529.2 million lower and the amortization period would have to be reduced by two years. The most significant assumption for the measurement of trademarks and brands concerned the underlying royalty rates. These were derived from available market information. In case of a reduction of the royalty rates by 0.5 percentage points, the fair value would have been € 113.6 million lower.

The preliminary positive difference of € 8,613.4 million was recognized as goodwill. This comprised anticipated synergies from the integration of Sigma-Aldrich into the Group as well as intangible assets that are not recognizable, such as the expertise of the workforce. Synergies are primarily expected in the areas of administration, production and purchasing. Apart from these cost synergies, earnings synergies are expected particularly through the use of the e-commerce platform of Sigma-Aldrich for products from the legacy life science business. The goodwill was allocated on a preliminary basis to the two business sectors Life Science (€ 8,260.2 million) and Performance Materials (€ 353.2 million). Goodwill is not expected to be deductible for tax purposes.

Within the scope of the acquisition, no contingent consideration was agreed upon which the Group would possibly have to pay in the future. The selling shareholders did not contractually indemnify the Group for the outcome of a contingency or uncertainty related to the acquired assets or liabilities. Costs of € 76.6 million related to the acquisition of the company were recorded under other operating expenses in 2015 (€ 60.0 million) and in 2014 (€ 16.6 million).

The development of goodwill, which is carried in U.S. dollars, during the period from first-time recognition and December 31, 2015 was as follows:


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€ million
Development of goodwill
Goodwill on November 18, 2015 8,613.4
Exchange rate effects – 219.9
Goodwill on December 31, 2015 8,393.5

No material contingent liabilities were identified in the course of the preliminary purchase price allocation. The gross amounts of the acquired receivables on the acquisition date were € 456.5 million. The best possible estimate of the irrecoverable receivables amounted to € 5.0 million.

Further acquisitions in 2015

At the end of July 2015, the Group acquired the remaining 52.3% interest in the start-up Qlight Nanotech Ltd., Israel (Qlight). Since then, the Group has held 100% of the company. Qlight conducts research in the field of quantum materials and was integrated into the Performance Materials business sector. The purchase price comprised fixed consideration amounting to US$ 3 million (€ 2.7 million), conditional purchase price components of up to US$ 4 million (€ 3.6 million) as well as further license remuneration provided that certain preconditions are met. Expenses of € 0.5 million were recorded from the remeasurement of the interests in Qlight prior to the obtainment of control. The intangible assets identified were attributable to technology-related assets amounting to € 6.1 million. Deferred tax liabilities amounting to € 1.6 million and goodwill of € 1.1 million were recognized. The purchase price allocation had not yet been completed on December 31, 2015.

In December 2015, the Group acquired the outstanding shares (89.7%) in Ormet Circuits, Inc., USA (Ormet) to enhance its position as a semiconductor materials supplier. Ormet will be integrated into the Performance Materials business sector. The purchase price for 100% of the shares amounts to US$ 32.0 million (€ 29.2 million). Income of € 0.6 million was recorded from the remeasurement of the interests in Ormet prior to the obtainment of control. The purchase price allocation had not been completed by December 31, 2015; therefore, the preliminary difference was fully reported as goodwill.

Acquisition of AZ Electronic Materials S.A. in 2014

Within the scope of a public takeover offer, on May 2, 2014 the Group had received valid acceptances of the offer in respect of 81.3% of the share capital and thus obtained control of the publicly listed company AZ Electronic Materials S.A., Luxembourg (AZ). By June 27, 2014, the Group had increased its shareholding in AZ to 99.8% and was then able to initiate a squeeze-out, which was completed on July 2, 2014 with the acquisition of the remaining shareholding of 0.2%.

AZ is a manufacturer of ultrapure specialty chemicals and materials for use in integrated circuits (semiconductors) and equipment, in flat-panel displays, and for photolithographic printing.

Within the scope of the acquisition, no conditional consideration was agreed upon which the Group would possibly have to pay in the future. The purchase price allocation was completed on December 31, 2014.

The development of goodwill recognized within the framework of the acquisition and carried in U.S. dollars was as follows:


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€ million
Development of goodwill
Goodwill on December 31, 2014 930.0
Exchange rate effects 104.1
Goodwill on December 31, 2015 1,034.1

Divestment of the rights to Kuvan® and Peg-Pal

On October 1, 2015, the Group entered into an agreement with BioMarin Pharmaceutical Inc., USA (BioMarin), to return the rights to Kuvan® (sapropterin dihydrochloride), a drug used to treat phenylketonuria (PKU), a rare metabolism disorder, and the related business activities. These business activities, which were allocated to the Healthcare business sector, were reported as a disposal group and include an intangible asset of € 23.9 million, allocable goodwill of € 21.6 million, as well as an immaterial amount of inventories.

In addition, an agreement was also reached on October 1, 2015 under which the Group will return its option to develop and commercialize Peg-Pal to BioMarin. Peg-Pal is an investigational drug that is also designed for the treatment of PKU.

Both agreements became effective at the beginning of January 2016. Based on the agreements, in January 2016 the Group received an upfront payment of € 340 million for the sale of the rights to Kuvan®. Moreover, the Group is entitled to up to € 185 million for the achievement of certain milestones.

Business activities of Sigma-Aldrich acquired with a view to resale

On June 15, 2015, before control of Sigma-Aldrich Corporation, USA, was obtained, the Group received conditional antitrust approval from the European Commission for the acquisition of Sigma-Aldrich. As a consequence of the EU commitments, the Group and Sigma-Aldrich had agreed to sell parts of Sigma-Aldrich’s solvents and inorganics business in Europe.

This includes Sigma-Aldrich Laborchemikalien GmbH, Seelze, where most of the solvents and inorganics sold by Sigma-Aldrich in Europe were manufactured. The agreement further concerns those solvents and inorganics sold by Sigma-Aldrich in Europe under the Sigma-Aldrich brand and globally under the Fluka® brand, as well as the global rights to the Hydranal® and Chromasolv® trademarks. A corresponding agreement on the sale of these businesses was entered into with Honeywell Specialty Chemicals Seelze GmbH, Seelze, on October 19 / 20, 2015. Since the obtainment of control, the provisions of IFRS 5 in relation to discontinued operations have applied to the corresponding assets and liabilities, which are thus disclosed as “assets held for sale” in the overview of fair values as of the Sigma-Aldrich acquisition date. The transaction with Honeywell closed on December 15, 2015. Consequently, as of year-end, the corresponding assets and liabilities were no longer reported in the consolidated balance sheet of the Group. Profit after tax of € 5.6 million was recorded in the income statement, based on net sales of € 13.1 million and expenses of € – 7.5 million.

(5) Joint arrangements of material significance

Strategic alliance with Pfizer Inc., USA, to co-develop and co-commercialize active ingredients in immunooncology

On November 17, 2014 the Group formed a global strategic alliance with Pfizer Inc., USA, (Pfizer) to co-develop and co-commercialize the anti-PD-L1 antibody avelumab (also known as MSB 0010718C). This antibody is currently being studied in multiple clinical trials as a potential treatment for further tumor types. The active ingredient is to be developed as a single agent as well as in various combinations with Pfizer’s and the Group's broad portfolio of approved and investigational pipeline candidates. As part of the strategic alliance, the two companies will combine resources and expertise to also co-develop and co-market Pfizer’s anti-PD-1 antibody. The overriding objective of the strategic alliance is share the risks of development and to accelerate the two companies’ presence in immuno-oncology.

According to the collaboration agreement, during the development period each partner will bear one-half of the development expenses. In a potentially later commercialization phase, the Group will realize the vast majority of sales from the commercialization of avelumab while the Group and Pfizer will split defined income and expense components.

The execution of the collaboration agreement is not being structured through a separate vehicle. This means that the assets and liabilities attributable to the contractual arrangement are owned by the two contract partners. Decisions about the relevant activities require unanimous consent in accordance with the collaboration agreement. Therefore, the accounting rules governing joint operations pursuant to IFRS 11 are applied and the Group records the assets, liabilities, revenues and expenses attributable to the collaboration in accordance with the respectively valid IFRS.

Under the terms of the agreement, in 2014 Pfizer made an upfront cash payment of US$ 850 million (€ 678.3 million) to the Group after the closing. Pfizer also committed to make further payments of up to US$ 2 billion to the Group subject to the achievement of defined regulatory and commercial mile stones. Based on the collaboration agreement, the Group additionally received the right to co-market for multiple years Xalkori® (crizotinib), a drug for the treatment of non-small-cell lung cancer, in the United States and certain other major markets. During co-commercialization of the product, the Group will receive from Pfizer compensation for marketing activities and a share of the profits. The fair value of the right was determined by an independent external expert using the multi-period excess earnings method. The entitlement to the right was capitalized when it was granted and will be amortized over the term of the agreement. The residual book value of these assets as of December 31, 2015 was € 261.7 million (2014: € 294.4 million).

On the date of the closing of the collaboration agreement, both the upfront payment received and the value of the right to co-market Xalkori® were recognized in the balance sheet as deferred revenues under other liabilities. Both amounts are being recognized over the expected period during which the Group is to meet certain obligations and will be disclosed under other operating income. More information on the exercise of management judgments and estimation uncertainties in this regard can be found in Note [7] “Management judgments and sources of estimation uncertainty.”

Agreement with Threshold Pharmaceuticals, Inc., USA, to co-develop and co-market evofosfamide

In February 2012, the Healthcare bussines sector entered into a global agreement with Threshold Pharmaceuticals, Inc., USA (Threshold), to co-develop and co-commercialize evofosfamide (also known as TH-302), a chemical molecule for use in cancer treatment. Under the terms of the agreement, the Group received co-development rights as well as exclusive global commercialization rights. Threshold had the option to co-commercialize the therapeutic in the United States.

On December 7, 2015, the Group announced that it will not submit evofosfamide for approval in locally advanced inoperable or metastatic soft-tissue sarcoma as well as advanced pancreatic cancer after two Phase III studies had failed to meet their primary endpoints in these indications. Consequently, the upfront and milestone payments that had been capitalized as intangible assets with indefinite useful lives as well as capitalized borrowing costs amounting to € 84.4 million were impaired in full in December 2015.

Agreement with Eli Lilly and Company, USA and Bristol-Myers Squibb Company, USA for the co-commercialization of Erbitux® in Japan

Until its termination, which took effect on May 1, 2015, an agreement was in place between the Healthcare business sector, ImClone Systems Inc., USA (which has now merged into Eli Lilly and Company, USA) and Bristol-Myers Squibb Company, USA, for the co-development and co-commercialization of Erbitux® (cetuximab), a drug indicated for the treatment of metastatic colorectal cancer, as well as for other cancers, in Japan. Since the collaboration ended, the Group has been marketing the aforementioned activities itself in Japan, bearing exclusive overall responsibility.

Up until the end of the agreement, the Group recorded sales of € 36.7 million from the commercialization of Erbitux® in Japan (2014 in full: € 113.2 million).

Agreement with Bristol-Myers Squibb Company, USA, for the co-commercialization of Glucophage® in China

In March 2013, the Healthcare bussines sector established an agreement with Bristol-Myers Squibb Company, USA, for the co-commercialization of the antidiabetic agent Glucophage® (active ingredient: met formin hydrochloride) for the treatment of type 2 diabetes in China. In 2015, the Group recorded sales of € 84.3 million from co-commercialization (2014: € 59.3 million).

(6) Changes to accounting and measurement principles and disclosure changes

In comparison with the previous year, there were no material changes to accounting and measurement principles. Only the disclosure changes described in the following were made in order to ensure improved comparability of the income statement and the balance sheet of the Group with other companies.

Consolidated Income Statement


New composition of net sales

Since January 1, 2015, royalty, license and commission income has no longer been disclosed in a separate line in the consolidated income statement. While commission income is now recorded as part of net sales, royalty and license income is included under other operating income.

Functional allocation of royalty, license and commission expenses

Effective January 1, 2015, royalty, license and commission expenses, which were previously disclosed in a separate line, were allocated to the corresponding functional costs.

The previous year’s figures in the consolidated income statement have been adjusted accordingly and are presented in the following table:


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GROUP

Adjustment
€ million 2014 old structure 2014 adjustment 2014 adjusted
Net sales 11,291.5 71.3 11,362.8
Royalty, license and commission income 209.3 – 209.3
Total revenues 11,500.8
Cost of sales – 3,526.4 – 3,526.4
(of which: amortization of intangible assets)1 (– 94.0) (–) (– 94.0)
Gross profit 7,974.4 – 138.0 7,836.4
Marketing and selling expenses – 3,104.9 – 484.2 – 3,589.1
(of which: amortization of intangible assets)1 (– 719.0) (–) (– 719.0)
Royalty, license and commission expenses – 537.5 537.5
Administration expenses – 608.6 – 608.6
Research and development costs – 1,703.7 – 1,703.7
(of which: amortization of intangible assets)1 (– 3.8) (–) (– 3.8)
Other operating income 426.4 138.0 564.4
Other operating expenses – 684.1 – 53.3 – 737.4
Operating result (EBIT) 1,762.0 1,762.0
Margin (% of net sales) 15.6 – 0.1 15.5
EBITDA 3,122.9 3,122.9
Margin (% of net sales) 27.7 – 0.2 27.5
EBITDA pre exceptionals 3,387.7 3,387.7
Margin (% of net sales) 30.0 – 0.2 29.8
1
Excluding amortization of internally generated or separately acquired software.

Consolidated Balance Sheet


Balance sheet structure

Since January 1, 2015, the consolidated balance sheet of the Group has been structured in descending order of maturity. The previous year’s figures have been adjusted accordingly.

Disclosure of receivables from royalties and licenses

As a result of the disclosure of royalty and license income under other operating income, in the consolidated balance sheet dated December 31, 2014, receivables from royalties and licenses, which amounted to € 16.1 million and were previously included under trade accounts receivable, were reclassified to other current assets.

Segment Reporting

On January 1, 2015, the Group changed its segment reporting structure to report on the three segments Healthcare, Life Science and Performance Materials. The Healthcare business sector comprises the businesses that were reported separately as the Biopharma business and Consumer Health segments in the previous year. The Life Science business sector comprises the Life Science business as well as the acquired life science business of the Sigma-Aldrich Corporation, USA. The Performance Materials business sector corresponds to the segment of the same name in the previous year as well as the acquired SAFC Hitech business of Sigma-Aldrich. More information on the new segmentation as well as reconciliation of the previous year’s figures by business sector can be found in Note [33] “Information on segment reporting”.

As regards segment reporting by country and region, the composition of regions was adjusted and the corresponding comparative year-earlier figures are presented. The regional reporting structure now comprises five regions: Europe, North America, Asia-Pacific, Latin America as well as Middle East and Africa.

(7) Management judgments and sources of estimation uncertainty

The preparation of the consolidated financial statements requires management to make discretionary decisions and assumptions as well as estimates to a certain extent. The discretionary decisions, assumptions relating to the future and sources of estimation uncertainty described below are associated with the greatest potential effects on these consolidated financial statements.

Recognition and measurement of assets, liabilities and contingent liabilities acquired in the context of business combinations

The recognition and measurement of assets, liabilities and contingent liabilities at fair value during purchase price allocations involve the use of estimates. The expertise of external valuation experts is obtained here. The fair values of the assets and liabilities recognized as part of the purchase price allocation of the Sigma-Aldrich Corporation and further information on this acquisition, which closed in the reporting period, can be found in Note [4] “Acquisitions, assets held for sale and disposal groups”.

Sales deductions

The Group grants its customers various kinds of rebates and discounts. In addition, expected returns, state compulsory charges and rebates from health plans and programs are also deducted from sales.

The most significant portion of these deductions from sales is attributable to the Healthcare business sector. The most substantial sales deductions in this business sector relate to government rebate programs in North America such as the “U.S. Federal Medicare Program” and the “U.S. Medicaid Drug Rebate Program”. Other significant sales deductions in the business sector result from compulsory government rebate programs in individual European countries.

Insofar as sales deductions were not already made on payments received, the Group determines the level of sales deductions on the basis of current experience and recognizes them as a liability. The sales deductions reduce gross sales revenues. Adjustments of liabilities can lead to increases or reductions of income in later periods.

Impairment tests of goodwill and other intangible assets with indefinite useful lives

The goodwill (carrying amount as of December 31, 2015: € 14,370.1 million / 2014: € 5,693.9 million) and other intangible assets with indefinite useful lives (carrying amount as of December 31, 2015: € 183.6 million / 2014: €  168.7 million) reported in the consolidated financial statements are tested for impairment at least once a year or when a triggering event arises. The carrying amounts of goodwill are allocated to the following cash-generating units or groups of cash-generating units on which level the impairment tests were performed:


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Goodwill
€ million as of Dec. 31, 2015 as of Dec. 31, 2014
Biopharma 1,579.8 1,601.5
Consumer Health 243.1 243.1
Life Science 11,130.4 2,911.1
Performance Materials 1,416.8 938.2
Total 14,370.1 5,693.9

The internal reorganization and changes to the reporting structure of the Group on January 1, 2015 did not result in any changes to the level at which the impairment tests are conducted. Subsequent to the reorganization, the cash-generating units or groups of cash-generating units continue to represent the lowest level at which goodwill is monitored for internal purposes by management.

As in 2014, no impairment losses for goodwill were recorded in the year under review. Owing to the termination of development projects in the Healthcare business sector, in 2015 impairment losses of other intangible assets with indefinite useful lives were recorded in the amount of € 108.5 million (2014: € 84.8 million).

Owing to a change in the planning process, the detailed planning period was shortened by one year to four years, and the date of the goodwill impairment test was changed, complying with the one-year time period stipulated by IAS 36.

When conducting the impairment tests the following parameters were used:


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Measurement basis Value in use
Impairment test level Biopharma (including Allergopharma and Biosimilars)
Consumer Health
Life Science
Performance Materials
Planning basis Most recent financial medium-term planning approved by the Executive Board and used for internal purposes
Detailed planning period 4 years (2014: 5 years)
Key assumptions Net cash flows Long-term growth rate after the detailed planning period Discount rate after tax (Weighted average cost of capital after tax – WACC)
Determination of the value of the key assumptions Net cash flows
  • Sales growth Based on internal planning, taking into consideration internal and external market information and market estimations, i.e. regarding market shares, excluding approvals of new compounds from the development pipeline and other expansion investments
  • Profit margins Based on past experiences, adjusted for expected changes
Long-term growth rate after the detailed planning period Based on long-term inflation expectations and expected long-term sector growth
Discount rate after tax (Weighted average cost of capital after tax – WACC)
  • Cost of equity Risk-free interest rate: Derived from the returns of long-term German government bonds

    Beta factor: Derived from respective peer group

    Market risk premium: Range as recommended by the Technical Committee for Business Valuation and Commerce of the Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer e.V. – IDW)
  • Cost of debt and capital structure Derived from respective peer group

The long-term growth rates and weighted average cost of capital (WACC) used to conduct the goodwill impairment tests were as follows:


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Long-term growth rate Cost of capital after tax Cost of capital before tax
in % 2015 2014 2015 2014 2015 2014
Biopharma 0.00 0.00 6.2 7.2 8.0 9.3
Consumer Health 2.00 2.00 6.2 6.9 7.6 8.4
Life Science1 1.75 2.00 6.1 6.8 7.5 7.8
Performance Materials1 0.50 1.00 6.6 6.3 8.6 7.8
1
The disclosures for 2015 relate to the impairment test performed before the acquisition of the Sigma-Aldrich Corporation, USA.

The cost of capital before tax is iteratively calculated based on the discounted cash flows determined using cost of capital after tax.

All of the aforementioned assumptions are considered a source of estimation uncertainty due to their inherent uncertainty.

In all the impairment tests performed, the recoverable amount was more than 10% higher than the carrying amount of the respective cash-generating unit or group of cash-generating units. Irrespective of this, sensitivity analyses of the key assumptions were performed as part of the impairment tests. Overall, no change of a significant assumption deemed possible by the management would have resulted in an impairment. The following table presents the amount by which the key assumptions would have to change before an impairment would need to be recognized within the scope of an impairment test:


Show table
22 KB EXCEL
Decrease in long-term
growth rate
Increase in cost
of capital after tax
Decrease in
net cash flow
2015 2014 2015 2014 2015 2014
percentage points percentage points %
Biopharma > 2 > 2 > 2 > 2 > 5 > 5
Consumer Health > 2 > 2 > 2 > 2 > 5 > 5
Life Science1 > 2 > 2 > 2 > 2 > 5 > 5
Performance Materials1 > 2 > 2 > 2 > 2 > 5 > 5
1
The disclosures for 2015 relate to the impairment test performed before the acquisition of the Sigma-Aldrich Corporation, USA.

Based on the preliminary purchase price allocation for the acquisition of the Sigma-Aldrich Corporation, USA, which was completed in November 2015, goodwill amounting to € 8,613.4 million was attributable to this acquisition. Based on a preliminary determination, € 8,260.2 million of this goodwill would have been allocated to Life Science and € 353.2 million to Performance Materials. Since the purchase price allocation had not yet been completed on the balance sheet date, a final allocation was not yet possible. An indicative test of the related goodwill as of November 30, 2015, on the basis of the preliminary planning used in the context of the purchase price allocation did not lead to an impairment requirement, neither with respect to the value in use nor the fair value less costs of disposal (based on non-observable input factors). The difference between the recoverable amount and the carrying amount for Life Science decreased due to the allocation of significant intangible assets and goodwill, however the difference was still more than 10%. Within the scope of these indicative impairment tests, costs of capital after tax of 6.1% (Life Science) and 6.5% (Performance Materials) were used. The assumption regarding long-term growth rates is identical to the assumption shown above. Based on the indicative test, a reduction of the long-term growth rate by around one percentage point in the Life Science business sector would have resulted in a situation where the recoverable amount would have been identical with the carrying amount. The recoverable amount would have also been identical with the carrying amount in the Life Science business sector if the cost of capital after tax (WACC) had been increased by around one percentage point. In the Performance Materials business sector, no change of a significant assumption deemed possible by the management would have resulted in an impairment.

Determination of the amortization of intangible assets with finite useful lives

In addition to goodwill and other intangible assets with indefinite useful lives, the Group has a significant amount of intangible assets with finite useful lives (carrying amount as of December 31, 2015: € 10,674.9 million / December 31, 2014: € 5,496.1 million). Substantial assumptions and estimates are required to determine the appropriate level of amortization of these intangible assets. This relates in particular to the determination of the underlying remaining useful life. The parameter is reviewed regularly by the Group and adjusted if necessary. The Group considers factors including the typical product life cycles for each asset and publicly available information about the estimated useful lives of similar assets.

If the amortization of intangible assets from customer relationships, market authorizations, patents, licensed and similar rights, capitalized brand names and trademarks had been 10% higher, for example due to shortened remaining useful lives, earnings before taxes would have been € 94.8 million lower in fiscal 2015 (2014: reduction of € 84.2 million). In fiscal 2015, a reduction of the useful lives of the intangible asset reported in connection with the drug Rebif® by one year would have lowered earnings before taxes by € 92.0 million (2014: € 73.6 million).

Research and development collaborations as well as in- and out-licensing of intangible assets

The Group is regularly a partner of research and development collaborations with research institutions, biotechnology companies and other contract parties. These collaborations are aimed at developing marketable products. The Group also enters into in-licensing agreements regarding intellectual property of contract partners. Such agreements typically involve making upfront payments and payments for the achievement of certain milestones related to development and marketing progress. In this context, the Group has to judge to what extent upfront or milestone payments represent remuneration for services received (research and development expense) or whether such payments result in an in-licensing of an intangible asset that has to be capitalized. This assessment is normally subject to judgment.

The Group regularly receives upfront and milestone payments as part of research and development collaborations or out-licensing agreements. In this context, income may only be recognized if the Group has transferred all material risks and rewards of an intangible asset to the acquirer, has no interest in the remaining business activities and has no material continuing commitment. If these criteria are not deemed to be met, the received payments are deferred and recognized over the period in which the Group is expected to fulfill its performance obligations. Both the assessment of the revenue recognition criteria and the determination of the appropriate period during which revenue is recognized are subject to judgment.

If the consideration, which was received as part of the strategic alliance with Pfizer Inc., USA, in November 2014 and deferred as a liability, had been recognized in the income statement over a shorter period reduced by one year, in 2015 this would have increased other operating income and thus profit before income tax would have increased by € 47.8 million (2014: € 3.9 million). Recognition over a period extended by one year would have lowered other operating income and profit before tax by € 31.9 million (2014: € 2.6 million).

Identification of impairment of non-financial assets

Discretionary decisions are required in the identification of existing indications of impairment of intangible assets and property, plant and equipment. As of December 31, 2015, the carrying amounts of these assets totaled € 29,348.1 million (December 31, 2014: € 14,385.9 million). External and internal information is used to identify indications of impairment. For example, the approval of a competing product in the Healthcare business sector or the closure of a location can be an indicator of impairment. Nevertheless, the Group's analysis of indications of impairment can prove too optimistic or too pessimistic in hindsight due to the high degree of uncertainty.

In October 2015, the Group relaunched its branding and fun damentally revamped its visual appearance. In the future, the Group will operate uniformly under its corporate brand worldwide, expect for the US and Canada, where it operates as EMD Serono in the Biopharma business, as MilliporeSigma in the Life Science business and as EMD Performance Materials in the materials business. Owing to this, the “Millipore” brand, which is recognized as an intangible asset in the balance sheet, was subjected to an impairment test. As a result of this impairment test, a need to record an impairment loss was not identified since the value added from the continued use of the brand for the Group's filtration products and as part of the name the Life Science business operates under in the U.S. and Canadian markets exceeded the residual book value of the brand. The intangible assets for the “Serono” brand recognized within the scope of the purchase price allocation for Serono SA had already been fully amortized when the new branding was launched.

Impairment of financial assets

On every balance sheet date, the Group reviews whether there is any objective evidence that a financial asset is impaired and, if this is the case, carries out the impairment to the extent estimated as necessary. Particularly important in this context are impairment losses on trade accounts receivable whose carrying amount was € 2,738.3 million as of December 31, 2015 (2014: € 2,219.5 million).

Significant indicators for the identification of impaired receivables and the subsequent impairment tests are, in particular, payment default or delay in the payment of interest or principal, negative changes in economic or regional economic framework conditions as well as considerable financial difficulties of a debtor. These estimates are discretionary.

Other provisions and contingent liabilities

As a global company for high-tech products, the Group is exposed to a multitude of litigation risks. In particular, these include risks from product liability, competition and antitrust law, pharmaceutical law, patent law, tax law and environmental protection. The Group is engaged in legal proceedings and official investigations, the outcomes of which are uncertain. A detailed description of the most important legal matters as of the balance sheet date can be found in Notes [27] “Provisions” and [39] “Contingent liabilities”. The provisions recognized for legal disputes mainly relate to the Healthcare business sector and amounted to € 490.6 million as of the balance sheet date (2014: € 393.1 million).

To assess the existence of a reporting obligation in relation to provisions and to quantify pending outflows of resources, the Group draws on the knowledge of the legal department as well as any other outside counsel. In spite of this, both the assessment of the existence of a present obligation and the estimate of the probability of a future outflow of resources are highly subject to uncertainty. Equally, the evaluation of a possible payment obligation is to be considered a major source of estimation uncertainty. Accordingly, the date of utilization may be determined reliably not earlier than after an out-of-court settlement is reached or upon the termination of judicial proceedings.

To a certain extent, the Group is obliged to take measures to protect the environment and reported provisions for environmental protection of € 126.9 million as of December 31, 2015 (2014: € 123.7 million). The underlying obligations were located mainly in Germany, Latin America and the United States. Provisions were recognized primarily for obligations from soil remediation and groundwater protection in connection with the discontinued crop protection business.

The calculation of the present value of the future settlement amount requires, among other things, estimates of the future settlement date, the actual severity of the identified contamination, the applicable remediation methods, the associated future costs, and the discount rate. The measurement is carried out regularly in consultation with independent experts. In spite of this, the determination of the future settlement amount of the provisions for environmental protection measures is subject to a considerable degree of uncertainty.

In the event of the discontinuation of clinical development projects, the Group is regularly required to bear unavoidable subsequent costs for a certain future period of time. The measurement of these provisions requires estimates regarding the length of time and the amount of the subsequent costs.

Apart from provisions, contingent liabilities are also subject to estimation uncertainties and discretionary judgment. Accordingly, contingent liabilities from legal and tax disputes are subject to the same estimation uncertainties and discretionary judgment as provisions for litigation. Therefore, the existence and the amount of the outflow of resources, which is not unlikely, is subject to estimation uncertainties similarly to the date on which a potential obligation arises.

Provisions for pensions and other post-employment benefits

The Group maintains several defined benefit pension plans, particularly in Germany, Switzerland and the United Kingdom. The determination of the present value of the obligation from these defined benefit pension plans primarily requires estimates of the discount rate, future salary increases, future pension increases and future cost increases for medical care.

Detailed information on the existing pension obligations and a sensitivity analysis of the parameters named above are provided in Note [26] “Provisions for pensions and other post-employment benefits” and under “Accounting and measurement principles” in Note [64] “Provisions for pensions and other post-employment benefits”. As of the balance sheet date, the amount recorded in the consolidated balance sheet for provisions for pensions and other post-employment benefits was € 1,836.1 million (2014: € 1,820.1 million). The present value of the defined benefit pension obligation was € 4,152.7 million as of December 31, 2015 (2014: € 3,812.7 million).

Income taxes

The calculation of the reported assets and liabilities from current and deferred income taxes requires extensive discretionary judgments, assumptions and estimates. Income tax liabilities were € 1,011.3 million as of December 31, 2015 (2014: € 849.8 million). The carrying amounts of deferred tax assets and liabilities amounted to € 1,049.6 million and € 2,852.7 million, respectively, as of the balance sheet date (2014: € 992.9 million and € 818.4 million, respectively).

The recognized income tax liabilities and provisions are partially based on estimates and interpretations of tax laws and ordinances in different jurisdictions.

With regard to deferred tax items, there is a high degree of uncertainty concerning the date on which an asset is realized or a liability settled and concerning the tax rate applicable on this date. This particularly relates to deferred tax liabilities recognized in the context of the acquisitions of the Sigma-Aldrich Corporation, the Millipore Corporation, Serono SA, and AZ Electronic Materials S.A. The recognition of deferred tax assets from loss carryforwards requires an estimate of the probability of the future realizability of loss carryforwards.Factors considered in this estimate are results history, results planning and any tax planning strategy of the respective Group company.

Assets held for sale, disposal groups and discontinued operations

The assessment as to when a non-current asset, disposal group or discontinued operation meets the prerequisites for a classification as “held for sale” is subject to significant discretionary judgment. Even in the case of an existing management decision to review a disposal, an assessment subject to uncertainties has to be made as to the probability that a corresponding disposal will occur during the year or not.

Applicable foreign exchange mechanism in Venezuela

Through subsidiaries, the Group imports and distributes products in Venezuela. The translation of the local financial statements from Venezuelan bolivars as the functional currency to euros as the reporting currency must proceed in analogous application of IAS 21.26 using the exchange rate at which the future cash flows represented by the transaction or balance could have been settled if those cash flows had occurred at the measurement date.

The Venezuelan bolivar is not a freely convertible currency, meaning that its exchange into other currencies requires authorization and must take place at official exchange rates set by the government. As of December 31, 2015, the three following exchange rate mechanisms were in place:

  • “CENCOEX” (6.3 bolivars per U.S. dollar): Official privileged exchange rate mechanism allowed only for imports of high-priority essential goods such as food and medicines;
  • “SICAD” (13.5 bolivars per U.S. dollar): Official exchange rate mechanism whereby exchange rates are set based on the conducted auctions.
  • “SIMADI” (Marginal Currency System) (198.7 bolivars per U.S. dollar): Official exchange rate mechanism that permits individuals and entities to buy and sell foreign currency with fewer restrictions than other exchange rate mechanisms in Venezuela.

In the past, the Group applied the privileged exchange rate mechanism CENCOEX for the translation of local financial statements prepared in Venezuelan bolivars, the functional currency, into euros, the reporting currency. In 2015, the Venezuelan authorities have been increasingly limiting authorizations to pay for imports using the privileged exchange rate. Against this background and owing to the development of payments received as well as the growing uncertainty since the last balance sheet date regarding the extent to which the privileged CENCOEX exchange rate mechanism will be available in the future, the Executive Board of Merck KGaA, Darmstadt, Germany, came to the conclusion that for the translation as of July 1, 2015 of local financial statements reported in Venezuelan bolivars, the functional currency, into euros as the reporting currency, it will be necessary to apply the SIMADI exchange rate mechanism.

This estimate is discretionary. The Group continues to closely monitor the development of payments received and the exchange rate mechanism. Should the payment rates improve or if it can no longer be assumed that the SIMADI exchange rate is the relevant exchange rate for the translation from local currency into the reporting currency, euros, this could lead to an amended estimate, which in turn could trigger an amended currency translation.

On this basis, in fiscal 2015 the Group generated sales of € 175.1 million, € 168.3 million of which was attributable to the first half of 2015. Net sales using the CENCOEX exchange rate amounted to € 221.1 million in 2014. Cash and cash equivalents in Venezuela, translated using the SIMADI exchange rate as of December 31, 2015, amounted to € 8.2 million. They were classified as restricted.

Other judgments, assumptions and sources of estimation uncertainty

The Group makes other judgments, assumptions and estimates in the following areas:

  • Classification of financial assets and financial liabilities
  • Cash flow hedging for highly probable forecast transactions
  • Determination of the fair value of financial instruments classified as available-for-sale and of derivative financial instruments
  • Determination of the fair value of the liability for share-based compensation
  • Determination of the fair value of plan assets