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Notes to the Consolidated Financial Statements

General

(1) Company information

The accompanying consolidated financial statements as of December 31, 2016 have been prepared with MERCK Kommandit­gesell­schaft auf Aktien (Merck KGaA), Frankfurter Strasse 250, 64293 Darmstadt as parent company. Merck KGaA, which manages the operations of the Merck Group, is registered under HRB 6164 with the Commercial Register of Darmstadt. 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), the ultimate parent company and general partner of Merck KGaA with an equity interest of 70.274% as of December 31, 2016. These consolidated financial statements include Merck KGaA 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 reporting 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.

In comparison with the previous year, there were no material changes to accounting and measurement principles. The accounting and measurement policies used in the consolidated financial statements are presented in Note (49) “Measurement policies” to  (65) “Share-based compensation programs”.

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 28 “Investments in Associates”
  • Amendment to IAS 38 “Intangible Assets”
  • Amendment to IAS 41 “Agriculture”
  • Amendment to IFRS 10 “Consolidated Financial Statements”
  • Amendment to IFRS 11 “Joint Arrangements”
  • Amendment to IFRS 12 “Disclosure of Interests in Other Entities”
  • Annual Improvements to IFRSs 2010 – 2012 Cycle
  • Annual Improvements to IFRSs 2012 – 2014 Cycle

 

The amendments had no material effects on the consolidated financial statements.

The following rules take effect as of fiscal 2018:

  • IFRS 9 “Financial Instruments”
  • IFRS 15 “Revenue from Contracts with Customers”
  • Amendment to IFRS15 Revenue from Contracts with Customers

In the course of introducing IFRS 9, the focus of the review is currently on analyzing the effects of the new impairment model on trade accounts receivable as well as the classification and measurement of equity instruments held by Merck. According to the present state of knowledge, the new rules will not have any material adjustment effects on Merck in terms of hedge accounting. The presentation of financial instruments in the consolidated balance sheet will change owing to the new classification and measurement rules. A final, reliable estimation of the other impacts of initial application of IFRS 9 is not yet available. Merck will make use of the possibility of modified initial application and record the cumulative adjustment from initial application as of January 1, 2018.

Since the beginning of 2015, a cross-functional project team has been analyzing the effects of the new rules on revenue recognition and is using quantitative and qualitative analyses, questionnaires and contract analyses to do so. Since Merck generates the vast majority of its sales revenues from simply structured sales of goods at a point in time and only provides longer-term services or conducts complex sales transactions with multiple performance obligations only to a small extent, from today’s perspective, the initial application of IFRS 15 is expected to have only immaterial impacts on the net assets, financial position and results of operations. According to the present state of knowledge, the new rules on variable consideration, on the costs of obtaining or fulfilling a contract, as well as on principal versus agent considerations will be of only minor relevance to Merck. Moreover, separate performance obligations from transportation or other logistics services that must be recognized separately exist only to a very minor extent. Only minor adjustment effects will probably result from the changes in connection with the timing of when control of an asset is transferred within the context of product sales, the accounting treatment of outlicensing intellectual property as well as the accounting treatment for rights of return. According to the present state of knowledge, based on the contracts existing as of the balance sheet date, the adjustment effect resulting from the change in presentation of multiple-element arrangements that include service components will be less than € 10 million when IFRS 15 is applied for the first time. The implementation of the new rules in the systems and processes of the Group companies commenced in 2016 and will be completed in the course of 2017. The necessary system adaptations relate in particular to the expanded sales revenue disclosure requirements in the Notes to the Consolidated Financial Statements. Merck will make use of the possibility of modified initial application and record the cumulative adjustment from initial application as of January 1, 2018.

As of the balance sheet date, the following standards were published by the International Accounting Standards Board and the IFRS Interpretations Committee, but not yet endorsed by the European Union:

  • IFRS 14 “Regulatory Deferral Accounts”
  • IFRS 16 “Leases”
  • IFRIC 22 “Foreign Currency Transactions and Advance Consideration”
  • Amendment to IAS 7 “Statement of Cash Flows”
  • Amendment to IAS 12 “Income Taxes”
  • Amendment to IAS 28 “Investments in Associates and Joint ­Ventures”
  • Amendment to IAS 40 “Investment Property”
  • Amendment to IFRS 2 “Share-based Payment”
  • Amendment to IFRS 4 “Insurance Contracts”
  • Amendment to IFRS 10 “Consolidated Financial Statements”
  • Amendment to IFRS15 Revenue from Contracts with Customers
  • Annual Improvements to IFRSs 2014 – 2016 Cycle

The impact of IFRS 16, which will become effective as of 2019 subject to a corresponding endorsement by the European Union, on the consolidated financial statements is currently being examined.

The implementation of IFRS 16 will mean that as a lessee, for all leases Merck will generally be required to recognize a liability and a corresponding right of use in its balance sheet. The possibility to classify a lease as an operating lease and to recognize the ­associated expenses in the period in which they are incurred will no longer exist. Merck will make use of the option under IFRS 16 to continue to refrain from recognizing utilization rights and the corresponding liabilities from leases of low-value assets in its ­balance sheet. At the time of initial application, Merck will make use of the transition relief provided by IFRS 16 to recognize the cumulative transition effect instead of adjusting the prior-year ­periods retroactively. In order to determine the impact of IFRS 16, around 7,000 leases have been identified and analyzed to date. According to the current status of the analysis, with the transition to IFRS 16, the increase in the balance sheet total will be less than 2%.

From today’s perspective, the other new rules are also 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, 2015 316
Additions Establishment 2
Acquisition 5
Materiality 8
Retirements Liquidation / Merger – 13
Divestment – 3
Immateriality
Loss of control – 2
Fully consolidated companies as of December 31, 2016 313
Non-consolidated subsidiaries as of December 31, 2015 63
Non-consolidated subsidiaries as of December 31, 2016 48

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 Merck 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 (see Note (18) “Financial Assets”).

The Venezuelan entities were deconsolidated effective February 29, 2016 since management came to the conclusion that due to the nearly complete absence of dividend payments and payments for Group-internal supplies of goods, the possibility of receiving and influencing variable returns from the involvement in the Venezuelan entities was no longer given (see Note (6) “Management judgments and sources of estimation uncertainty”). Accordingly, the deconsolidations were reported as disposals due to loss of control.

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 (see Note (66) “List of shareholdings”).

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

Acquisition of BioControl Systems, Inc., USA

On December 21, 2016, Merck acquired a 100% interest in ­BioControl Systems, Inc., Bellevue, USA (BioControl), a company that develops, manufactures and commercializes materials and systems to check food safety. BioControl was integrated into the Life Science business sector. The purchase price was US$ 167 million (€ 160 million after currency translation based on the closing rate on December 21, 2016). The purchase price allocation could not be completed by December 31, 2016. Consequently, the acquired assets and liabilities were reported on a preliminary basis at their carrying amounts.

Acquisition of Sigma-­Aldrich Corporation, St. Louis, USA,
in 2015

On November 18, 2015, Merck obtained control of the Sigma-­Aldrich Corporation, St. Louis, USA (Sigma-­Aldrich). The life science ­business of Sigma-­Aldrich was integrated into the Life Science business sector and the SAFC Hitech business was integrated into the Performance Materials business sector.

Since the acquisition date was November 18, 2015, the acquired Sigma-­Aldrich business only contributed to the results of the Merck Group in fiscal 2015 for this period. Consolidation as a member of the Group for fiscal 2016 led to significant effects, primarily on the consolidated income statement and the consolidated cash flow statement. The acquired inventories measured at fair values were recognized in cost of sales over a period of six months. Property, plant and equipment is depreciated over a period of up to 36 years. In fiscal 2016, this resulted in depreciation of € 135 million.

The intangible assets are being amortized over a period of up to 22 years. In 2016, amortization totaled € 335 million.

Purchase price allocation

The determination of fair values required extensive analyses and calculations, which were completed in November 2016. In comparison with the preliminary purchase price allocation, adjustments resulted for inventories, property, plant and equipment, intangible assets, non-current financial assets, current provisions as well as deferred tax liabilities.

The 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) 5,808
Property, plant and equipment 838
Other non-current assets 124
6,770
Current assets
Cash and cash equivalents 1,235
Inventories 841
Receivables 452
Other current assets 36
Assets held for sale 124
2,688
Assets 9,458
 
Non-current liabilities
Non-current financial liabilities
Other non-current liabilities and provisions 150
Deferred tax liabilities 2,511
2,661
Current liabilities
Current financial liabilities 425
Other current liabilities and provisions 539
Liabilities directly related to assets held for sale
964
Liabilities 3,625
 
Acquired net assets 5,833
 
Purchase price for the acquisition of shares 14,594
Positive difference (goodwill) 8,761

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 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 € million Useful lives in years Valuation method for determining the fair values
Customer relationships 4,623 21 – 22 multi-period excess earnings method
Trademarks and brands 958 12 relief from royalty method
Technologies (patented and non-patented) 130 10 – 12 relief from royalty method, replacement cost method
Other 97
Total 5,808
 
Goodwill 8,761 indefinite
Total 14,569

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 have been € 468 million lower and the amortization period would have had 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. If the royalty rates were reduced by 0.25 percentage points, the fair value would have been € 57 million lower.

The positive difference of € 8,761 million was recognized as goodwill. This comprised anticipated synergies from the integration of Sigma-­Aldrich into the Merck Group as well as intangible assets that are not recognizable, such as the expertise of the transferred 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 to the two business sectors Life Science (€ 8,402 million) and Performance Materials (€ 359 million). It is not expected that goodwill will be deductible for tax purposes.

The development of goodwill between the two balance sheet dates was as follows:

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€ million
Development
of goodwill
Goodwill on December 31, 20151 8,541
Exchange rate effects 336
Goodwill on December 31, 2016 8,877
1
Previous year’s figure has been adjusted.

No material contingent liabilities were identified in the course of the purchase price allocation. The gross amounts of the acquired receivables on the acquisition date were € 457 million. The best possible estimate of irrecoverable receivables amounted to € 5 million.

Further acquisitions in 2015

In December 2015, Merck acquired the outstanding shares (89.7%) in Ormet Circuits, Inc., San Diego, USA (Ormet) to enhance its position as a semiconductor materials supplier. Ormet was integrated into the Performance Materials business sector. US$ 30 million (€ 28 million) was spent to acquire the outstanding interest. The purchase price for 100% of the shares would have been US$ 31 million (€ 28 million). An expense of € 1 million was recorded from the remeasurement of the interests in Ormet prior to the obtainment of control. In 2015, the preliminary difference from the purchase price allocation was fully reported as goodwill due to the fact that the acquisition was completed shortly before year-end. The purchase price allocation conducted in 2016 identified technology-related intangible assets amounting to € 26 million. Overall, deferred tax liabilities amounted to € 4 million. Goodwill thus amounted to € 3 million.

At the end of July 2015, Merck acquired the remaining 52.3% interest in the start-up Qlight Nanotech Ltd., Jerusalem, Israel (Qlight). Since then, Merck 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 (€ 3 million), milestone payments of up to US$ 4 million (€ 4 million) as well as license fees provided that certain preconditions are met. There were no adjustments to the preliminary purchase price allocation or to the measurement of the contingent consideration.

Adjustment of the consolidated balance sheet for 2015 due to the completion of the purchase price allocation in 2016

In 2016, the preliminary purchase price allocations as of December 31, 2015 for the Sigma-­Aldrich Corporation, USA, and Ormet Circuits, Inc., USA, were completed.

The values in the consolidated balance sheet as of December 31, 2015 were retroactively adjusted as follows:

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Previous year adjustment

Dec. 31, 2015
€ million Pre adjustment Sigma-Aldrich Corporation Ormet Circuits, Inc. Post adjustment
Non-current assets 30,657 80 30,737
of which:
Goodwill 14,370 148 – 26 14,492
Intangible assets (excluding goodwill) 10,969 – 65 26 10,930
Property, plant and equipment 4,009 – 2 1 4,008
Non-current financial assets 131 – 1 130
Unadjusted other non-current assets 1,178 1,178
 
Current assets 7,350 – 10 4 7,344
of which:
Inventories 2,620 – 10 2,610
Other current assets 496 4 500
Unadjusted other current assets 4,234 4,234
 
Total assets 38,007 70 4 38,081
 
Total equity 12,855 12,855
 
Non-current liabilities 15,769 69 4 15,842
of which:
Deferred tax liabilities 2,853 69 4 2,926
Unadjusted other non-current liabilities 12,916 12,916
 
Current liabilities 9,383 1 9,384
of which:
Current provisions 535 1 536
Unadjusted other current liabilities 8,848 8,848
 
Total equity and liabilities 38,007 70 4 38,081

Divestment of the rights to Kuvan® and Peg-Pal

On October 1, 2015, Merck 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 metabolic disorder, and the related business activities. These business activities, which were allocated to the Healthcare business sector, were reported as a disposal group in fiscal 2015 and included an intangible asset of € 24 million, allocable goodwill of € 22 million, as well as inventories to a limited extent.

Moreover, an agreement was also reached on October 1, 2015 under which Merck is obligated to 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, Merck received an upfront payment of € 340 million for the sale of the rights to Kuvan®. Moreover, Merck is entitled to milestone payments of up to € 185 million.

Divestment of Pakistani subsidiaries

On December 9, 2016, Merck divested its 75% shareholding in the Pakistani Merck (Private) Limited, its subsidiary Merck Pharmaceuticals (Private) Limited as well as its 100% shareholding in Merck Specialities (Private) Limited to Martin Dow Limited, Pakistan. The transaction involved the mutual transfer of trademarks and brands, making them accessible to the acquirer. The businesses of the Pakistani companies comprised allocated goodwill (€ 7 million), property, plant and equipment (€ 8 million), inventories (€ 16 million), cash (€ 15 million) and non-controlling interests (€ 10 million). The loss from the divestment of the three subsidiaries amounted to € 8 million and was recognized in other operating expenses.

Planned divestment of the Biosimilars business

Merck is in advanced stages of negotiations to divest its Biosimilars business. In this business, Merck develops similar subsequent ­versions of already registered biopharmaceuticals, primarily for the therapeutic areas of oncology and autoimmune diseases. The divestment is expected to be completed in 2017. The business activities allocable to the Healthcare business sector were reported as a disposal group as of December 31, 2016 and mainly consist of intangible assets amounting to € 2 million, the allocable goodwill of € 9 million as well as liabilities in connection with these activities.

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

On December 15, 2015, Merck sold to Honeywell Specialty Chemicals Seelze GmbH of Seelze, Germany, parts of the European solvents and inorganics business that had been acquired within the scope of the acquisition of the Sigma-­Aldrich Corporation, USA, in order to meet the antitrust conditions of the European Commission. In accordance with the agreement with the acquirer, during the reporting period Merck received a further payment of € 24 million, which had already been recognized as income in 2015.

(5) Collaborations of material ­significance

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

On November 17, 2014, Merck formed a global strategic alliance with Pfizer Inc., USA, (Pfizer) to co-develop and co-commercialize the anti-PD-L1 antibody avelumab. This antibody is currently being studied in multiple clinical trials as a potential treatment for various tumor types. The active ingredient is to be developed as a single agent as well as in various combinations with a broad portfolio of approved and investigational active ingredients. 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 to 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, Merck will realize the vast majority of sales from the commercialization of avelumab while Pfizer will realize the vast majority of sales from the commercialization of its anti-PD-1 antibody. At the same time, Merck and Pfizer will evenly 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.

Under the terms of the agreement, in 2014 Pfizer made an upfront cash payment of US$ 850 million (€ 678 million) to Merck after the closing. Pfizer also committed to make further payments of up to US$ 2 billion to Merck subject to the achievement of defined regulatory and commercial milestones. Based on the collaboration agreement, Merck additionally received the right to co-market for multiple years ­Xalkori® (crizotinib), a kinase inhibitor indicated for the treatment of patients with metastatic non-small cell lung cancer (NSCLC) whose tumors are anaplastic lymphoma kinase (ALK)-­positive. In the United States and the European Union, ­Xalkori®is also indicated for the treatment of metastatic NSCLC in patients whose tumors are ROS1-positive. During co-commercialization of ­Xalkori®, Merck receives from Pfizer a share of the profits, which are reported in net sales. In 2016, these amounted to € 64 million (2015: € 8 million). When it arose, the right was measured at fair value by an independent external expert using the multi-period excess earnings method. 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, 2016 was € 153 million (2015: € 262 million). More information on the impairment of € 71 million recognized on the intangible asset in 2016 can be found in Note (6) “Management judgments and sources of estimation uncertainty.”

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 Merck 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 (6) “Management judgments and sources of estimation uncertainty.”

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

In March 2013, Merck established an agreement with Bristol-Myers Squibb Company, USA, (BMS) for the co-commercialization of the anti­diabetic agent Glucophage® (active ingredient: metformin hydrochloride) for the treatment of type 2 diabetes in China. In 2016, Merck recorded commission income of € 104 million from co-­commercialization (2015: € 84 million). As of 2017, Merck will book net sales instead of commission income from the distribution of Glucophage® in China and in return make license payments to BMS.

Agreement with Intrexon Corporation, USA, on the ­co-­development and co-commercialization of CAR-T
cancer therapies

In March 2015, Merck and Intrexon Corporation, USA, entered into an exclusive strategic collaboration and license agreement to develop and commercialize Chimeric Antigen Receptor T-cell ­(CAR-T) cancer therapies. The agreement provided Merck exclusive access to Intrexon’s proprietary and complementary suite of technologies to engineer T-cells with optimized and inducible gene expression. Intrexon will be responsible for all platform and product developments until the investigational new drug application is submitted for regulatory approval. Merck will select targets of interest for which CAR-T products will be developed. Merck will also lead the regulatory submission process and pre-submission interactions with the regulatory authorities, as well as clinical development and commercialization. Intrexon received an upfront payment of US$ 115 million. This amount was recognized as part of intangible assets not yet available for use (carrying amount as of December 31, 2016: € 104 million / 2015: € 104 million). For the first two targets of interest selected by Merck, Intrexon will receive research funding and is eligible to receive up to US$826 million development, regulatory and commercial milestones, as well as tiered royalties on product sales. In addition, Intrexon is also eligible to receive further payments upon achievement of certain technology development milestones.

(6) Management judgments and ­sources of estimation uncertainty

The preparation of the consolidated financial statements requires Merck 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 normally obtained here. The fair values of the assets and liabilities recognized as part of the purchase price allocation of the Sigma-­Aldrich Corporation, a sensitivity analysis in relation to the acquired customer lists, and trademarks and brands, as well as further information on this acquisition, which closed in 2015, can be found in Note (4) “Acquisitions, assets held for sale and disposal groups”.

Sales deductions

Merck 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.

Insofar as sales deductions were not already made on payments received, Merck determines the level of sales deductions on the basis of current experience and recognizes them as a liability (carrying amount on December 31, 2016: € 443 million / 2015: € 421 million). The sales deductions reduce gross sales revenues. Adjustments of liabilities can lead to increases or reductions in net sales in later periods.

Impairment tests of goodwill and intangible assets not yet available for use

The goodwill (carrying amount as of December 31, 2016: € 15,064 million / 2015: € 14,492 million) and other intangible assets not yet available for use (carrying amount as of December 31, 2016: € 181 million / 2015: € 184 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, 2016
as of
Dec. 31, 2015
Biopharma 1,560 1,580
Consumer Health 251 243
Life Science1 11,801 11,272
Performance Materials1 1,452 1,397
Total 15,064 14,492
1
Previous year’s figures have been adjusted, see “Acquisitions, assets held for sale and disposal groups”.

The identified cash-generating units or groups of cash-generating units represent the lowest level at which goodwill is monitored by management.

As in 2015, 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 2016 impairment losses of other intangible assets not yet available for use were recorded in the amount of € 12 million (2015: € 109 million).

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 Biosimilars1)
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
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 government bonds
    Beta factor: Derived from the 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 the respective peer group
1
Biosimilars was not yet reported as a disposal group when the impairment test was performed.

The long-term growth rates and weighted average costs 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
2016 2015 2016 2015 2016 2015
Biopharma 0.00% 0.00% 6.1% 6.2% 8.1% 8.0%
Consumer Health 2.00% 2.00% 5.9% 6.2% 7.2% 7.6%
Life Science1 1.75% 1.75% 6.1% 6.1% 7.5% 7.5%
Performance Materials1 0.50% 0.50% 6.1% 6.6% 7.9% 8.6%
1
The disclosures for 2015 relate to the impairment test performed as of October 31, 2015 before the closing of the acquisition of the Sigma-­Aldrich Corporation, USA.

For the impairment test, net cash flows were discounted using cost of capital after tax. The aforementioned cost of capital before tax was subsequently derived iteratively. 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, the planning data used were checked for plausibility against externally available forecasts and the recoverable amounts determined were validated using valuation multiples based on peer group information. In addition, sensitivity analyses of the key assumptions were performed as part of the impairment tests. Overall, no change of a significant assumption deemed possible by management would have resulted in an impairment. The following table presents the amount by which key assumptions would have to change before an impairment would need to be recognized as a result of the impairment tests:

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Decrease in long-term ­
growth rate
Increase in cost
of capital after tax
Decrease in
net cash flows
2016 2015 2016 2015 2016 2015
in percentage points in percentage points in %
Biopharma > 2.0 > 2.0 > 2.0 > 2.0 > 5% > 5%
Consumer Health > 2.0 > 2.0 > 2.0 > 2.0 > 5% > 5%
Life Science1 > 2.0 > 2.0 > 1.5 > 2.0 > 5% > 5%
Performance Materials1 > 2.0 > 2.0 > 2.0 > 2.0 > 5% > 5%
1
The disclosures for 2015 relate to the impairment test performed as of October 31, 2015 before the closing of the acquisition of the Sigma-­Aldrich Corporation, USA.

Determination of the amortization of intangible assets with finite useful lives

In addition to goodwill and intangible assets not yet available for use, Merck has a significant amount of intangible assets with finite useful lives (carrying amount as of December 31, 2016: € 9,556 million / December 31, 2015: € 10,636 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, which Merck reviews regularly and adjusts if necessary. Merck 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, marketing authorizations, patents, licenses and similar rights, brands and trademarks had been 10% higher, for example due to shortened remaining useful lives, profit before tax would have been € 122 million lower in fiscal 2016 (2015: € 95 million lower).

In fiscal 2016, a reduction of the useful life of the intangible asset reported in connection with the drug Rebif®by one year would have lowered profit before tax by € 123 million (2015: € 92 million). An extension of the useful life by one year would have increased profit before tax by € 74 million (2015: € 61 million).

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

Merck is regularly a partner of research and development collaborations with research institutions, biotechnology companies or other contract parties. These collaborations are aimed at developing marketable products. Merck 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 commercialization. In this context, Merck 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.

Merck 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 Merck 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 Merck is expected to fulfill its performance obligations. Both the assessment of the revenue recognition criteria and the determination of the appropriate period during which income is recognized are subject to judgment.

If the consideration that 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 2016 this would have increased other operating income and thus profit before tax would have increased by € 64 million (2015: € 48 million). Recognition over a period extended by one year would have lowered other operating income and profit before tax by € 38 million (2015: € 32 million).

Identification of impairment of non-financial assets

Discretionary decisions are required in the identification of objective evidence of impairment of intangible assets and property, plant and equipment. As of December 31, 2016, the carrying amounts of these assets totaled € 29,219 million (2015: € 29,430 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 site can be an indicator of impairment.

In the second quarter of 2016, the intangible asset in connection with the co-commercialization right for ­Xalkori® (crizotinib), a medicine to treat patients with ALK-positive metastatic non-small cell lung cancer, was subjected to an impairment test owing to negative developments in the market environment. This test led to an impairment loss of € 71 million on the intangible asset, which was reported under other operating expenses. Within the scope of the impairment test, the recoverable amount was determined using a discount rate before tax of 7.9%. This included an asset-specific risk premium.

Impairment of financial assets

On every balance sheet date, Merck reviews whether there is any objective evidence that a financial asset is impaired and, if this is the case, recognizes allowances to the extent estimated as necessary. Particularly important in this context are allowances on trade accounts receivable, whose carrying amount was € 2,889 million as of December 31, 2016 (2015: € 2,738 million).

Key indicators for the identification of impaired receivables and the subsequent recoverability tests are, in particular, payment default or delay in the payment of interest or principal, negative changes in 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, Merck 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. Merck is engaged in legal proceedings and official investigations, the outcomes of which are uncertain. A description of the most important legal matters as of the balance sheet date can be found in Note (26) “Other provisions” and  Note (38) “Contingent liabilities”. The provisions recognized for legal disputes mainly relate to the Healthcare and Performance Materials business sectors and amounted to € 483 million as of the balance sheet date (2015: € 492 million).

To assess the existence of a reporting obligation in relation to provisions and to quantify pending outflows of resources, Merck 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 measurement of provisions is to be considered a major source of estimation uncertainty.

To a certain extent, Merck is obliged to take measures to protect the environment and reported provisions for environmental protection of € 142 million as of December 31, 2016 (2015: € 127 million). The underlying obligations were located mainly in Germany and Latin America. 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. 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, Merck 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 follow-on 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 remote, are subject to estimation uncertainties similarly to the date on which a potential obligation arises.

Provisions for pensions and other post-employment benefits

Merck 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, and future pension increases.

As of the balance sheet date, the amount recorded in the consolidated balance sheet for provisions for pensions and other post-­employment benefits was € 2,313 million (2015: € 1,836 million). The present value of the defined benefit pension obligation was € 4,698 million as of December 31, 2016 (2015: € 4,153 million). The following overview shows how the present value of all defined benefit obligations would have been impacted by changes to relevant actuarial assumptions.

29.5 KB EXCEL
€ million Dec. 31, 2016 Dec. 31, 2015
Change in present value of all defined benefit obligations if
the discount rate were 50 basis points higher – 441 – 373
the discount rate were 50 basis points lower 518 444
the expected rate of future salary increases were 50 basis points higher 160 126
the expected rate of future salary increases were 50 basis points lower – 138 – 112
the expected rate of future pension increases were 50 basis points higher 280 234
the expected rate of future pension increases were 50 basis points lower – 209 – 176

To determine the sensitivities, in principle each of the observed parameters was varied while keeping the measurement assumptions otherwise constant. The amounts for social security vary in line with the salary trend. Further information on the existing pension obligations is provided in Note (25) “Provisions for pensions and other post-employment benefits” and under “Accounting and measurement principles” in Note (63) “Provisions for pensions and other post-employment benefits”.

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 € 883 million as of December 31, 2016 (2015: € 1,011 million). The carrying amounts of deferred tax assets and liabilities amounted to € 1,013 million and € 2,720 million respectively, as of the balance sheet date (2015: € 1,050 million and € 2,926 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 are degrees 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.

Deconsolidation of the Venezuelan entities

In the past, the Merck Group imported products in Venezuela and marketed these via its local subsidiaries. Due to the nearly complete absence of dividend payments and payments for Group-­internal supplies of goods, management came to the conclusion that the possibility of receiving and influencing variable returns from the involvement in the Venezuelan entities can no longer be deemed given. Owing to the lack of control, the Venezuelan subsidiaries were therefore deconsolidated effective February 29, 2016. This estimate is discretionary. Merck continues to closely monitor the development of the situation in Venezuela.

Up until deconsolidation on February 29, 2016, in Venezuela Merck generated net sales of € 1 million in fiscal 2016. In 2015, net sales amounted to € 175 million. Of this amount, sales of € 168 million were attributable to the first half of 2015 (using the CENCOEX exchange rate) and sales of € 7 million were attributable to the second half of 2015 (using the SIMADI exchange rate). Cash and cash equivalents in Venezuela amounted to € 8 million as of December 31, 2015. They were classified as restricted. The deconsolidation gain recognized in 2016 amounted to € 50 million and was reported under other operating income. This figure included the currency result of the Venezuelan entities that was previously reported in equity and subsequently reclassified to the consolidated income statement.

Other judgments, assumptions and sources of estimation uncertainty

Merck 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 contingent consideration
  • Determination of the fair value of the liability for share-based compensation
  • Determination of the fair value of plan assets.