The preparation of the financial statements in conformity with IFRS as adopted for use by the European Union requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.
Management bases its estimates on historical experience and various other assumptions that are reasonable under the circumstances, the results of which form the basis for making the reported amounts of revenue and expenses that may not be readily apparent from other sources. Actual results will by definition not equal those estimates. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the financial statements in the period they are determined to be necessary.
4.2.1 Sales allowances
The Group has accruals for expected sales returns, chargebacks and other rebates, including the U.S. Medicaid Drug Rebate program and the U.S. Federal Medicare program, and similar rebates in other countries. Such estimates are based on analyses of existing contractual obligations or legislation, historical trends and the Group experience. After assessment of the Management, the total accruals for these items are adequate, based upon currently available information and interpretation of relevant regulations. As these deductions are based on management estimates, the actual deductions might differ from these estimates.
Such differences could impact the accruals recognized in the statement of financial position in future periods and consequently the level of sales recognized in the income statement in future periods, as there is often a time lag of several months between the recording of the estimate and the final accounting of the sales allowances. In general, the discounts, rebates and other deductions shown on the invoice are accounted for as an immediate deduction from gross sales in the income statement. The sales returns, chargebacks, rebates and discounts that are not mentioned on the invoice are estimated, deducted from sales and presented on the statement of financial position in the appropriate accrual account and deducted from sales.
All sales allowances are considered as being part of the variable consideration included in the transaction price. The amount of variable consideration included in the transaction price is determined so that the total transaction price is the price estimated by management as not being constrained.
4.2.2 Intangible assets and goodwill
The Group has intangible assets with a carrying amount of € 2 973 million (Note 20 ) and goodwill with a carrying amount of € 4 964 million (Note 21) . Intangible assets are amortized over their useful lives on a straight-line basis as from the moment they are available for use (i.e. when related products are launched for sale).
Management estimates that the useful life for acquired in-progress R&D compounds equates to the period these compounds benefit from patent protection or data exclusivity. For the intangible assets acquired through a business combination and which comprises compounds that are marketed but for which no patent protection or data exclusivity exists, management estimates that the useful life equates to the period in which these compounds will realize substantially all the cash contributions.
These intangible assets and goodwill are regularly reviewed for impairment and whenever there is an indication that an impairment might exist. The intangible assets that are not yet available for use and goodwill are subject to at least annual impairment testing.
To assess if there is any impairment, estimates are made of the future cash flows expected to result from the use of these assets and their eventual disposal. These estimated cash flows are then adjusted to the present value using an appropriate discount rate that reflects the risks and uncertainties associated with the forecasted cash flows.
Actual outcomes could vary significantly from such estimates of discounted future cash flows. Factors such as the entrance or absence of competition, technical obsolescence or lower than expected rights could result in shortened useful lives and impairments.
The Group applied the following key assumptions for the “value in use” calculations required for the impairment testing of intangible assets and goodwill at year-end:
Growth rate for terminal value: 2.0%
Discount rate in respect of goodwill and Intangibles related to marketed products: 5.93%
Discount rate in respect of Intangibles related to pipeline products: 12.5%
Since the cash flows also take into account tax expenses, a post-tax discount rate is used in the impairment testing.
Management estimates that the use of the post-tax discount rate approximates the results of using a pre-tax rate applied to pre-tax cash flows.
4.2.3 Environmental provisions
The Group has provisions for environmental remediation costs, which are disclosed in Note 34 . The most significant elements of the environmental provisions consist of costs to fully clean and refurbish contaminated sites and to treat contamination at certain other sites, mainly related to the discontinued chemical and films activities of the Group.
Future remediation expenses are affected by a number of uncertainties that include, amongst others, the detection of previously unknown contaminated sites, the method and extent of remediation, the percentage of waste attributable to the Group, and the financial capabilities of the other potentially responsible parties. Given the inherent difficulties in estimating the liabilities in this area, it cannot be guaranteed that additional costs will not be incurred beyond the amounts currently accrued. The effect of resolution of environmental matters on results of operations cannot be predicted due to uncertainty concerning both the a mount and timing of future expenditures and the results of future operations. Such changes that arise could impact the provisions recognized in the statement of financial position in the future.
4.2.4 Employee benefits
The Group currently has many defined benefit plans, which are disclosed in Note 33 . The calculation of the assets or liabilities related to these plans is based upon statistical and actuarial assumptions. This is in particular the case for the present value of the defined benefit obligation which is impacted by assumptions on discount rates used to arrive at the present value of future pension liabilities, and assumptions on future increases in salaries and benefits.
Furthermore, the Group uses statistically-based assumptions covering areas such as future withdrawals of participants from the plans and estimates of life expectancy. The actuarial assumptions used might differ materially from actual results due to changes in market and economic conditions, higher or lower employee turnover, longer or shorter life spans of participants, and other changes in the factors being assessed.
These differences could impact the assets or liabilities recognized in the statement of financial position in future periods.
4.2.5 Tax positions
The Group operates in multiple jurisdictions with often complex legal and tax regulatory environments. The Group engages constructively with the tax authorities. Where appropriate, we engage advisors and legal counsel to obtain opinions on tax legislation and principles. The income tax positions taken are considered by the Group to be supportable and are intended to withstand challenge from tax authorities. However, it is acknowledged that some of the positions are uncertain and include interpretations of complex tax laws as well as transfer pricing considerations which could be disputed by tax authorities. The Group judges these positions on their technical merits and this on a regular basis using all the information available (legislation, case law, regulations, established practice, authoritative doctrine as well as the current state of discussions with tax authorities, where appropriate).
A liability is recorded for each item that is not probable of being sustained on examination by the tax authorities and after using all legal remedies of defending the position before Court, based on all relevant information. The liability is calculated taking into account the most likely outcome for corporate income tax related matters or the expected value for corporate income tax and transfer pricing matters, depending on which is thought to give a better prediction of the resolution of each uncertain tax position in view of reflecting the likelihood of an adjustment being recognized upon examination. These estimates are based on facts and circumstances existing at the end of the reporting period. The tax liability and income tax expense include expected penalties and late payment interests arising from tax disputes.
An asset for tax audit adjustments is recorded when the Group considers it probable, based on the technical merits of the tax case, that a Mutual Agreement or Arbitration Procedure may provide for relief in one or more jurisdictions. The asset is calculated as the expected value (as relating to transfer pricing matters) of the recoverability in corporate income taxes in the concerning jurisdiction upon completion of the Mutual Agreement or Arbitration procedure.
The Group has recognized net deferred tax assets of € 437 million (Note 32 ). The recognition of deferred tax assets is based upon whether it is probable that sufficient taxable profits will be available in the future against which the reversal of temporary differences can be used. Where the temporary differences relate to losses or carry-forward tax attributes (such as innovation income deduction), the availability of sufficient forecasted taxable profits to offset against the tax attributes is also considered.
Significant items on which management has exercised judgement include recognition on the statement of financial position of deferred tax assets relating to losses in jurisdictions where losses have been made in prior periods but where profits now arise or are forecast to do so for the foreseeable future. Management has used its best estimate of the correct value of asset to recognize in such cases, which includes a judgment on the length of the future time period to use in such assessments. These judgments are made on a case-by-case basis taking into account the origin and nature of the expected revenues, based on the functional profiles of the concerning entities and on an entity-by-entity basis, but this time period in most cases does not exceed five years. Differences in forecasted taxable profits and actual profitability or a downgrade in future forecasted taxable profits could impact the deferred tax assets recognized in future periods.
No material deferred tax assets are recognized for entities that are currently still lossmaking or not using their tax attributes.
4.2.6 Valuation of intangibles and related deferred taxes acquired in business combination
Assets that have been identified as a result of a business combination are valued incorporating the concept of highest and best use in accordance with IFRS 13, Fair Value Measurement and IFRS 3, Business Combinations from the viewpoint of a market participant.
In order to value the existing In-Process Research & Development (IPR&D) assets as of the effective date of the business combination, the multi-period excess earnings method is used which is a variation of the income approach that estimates an intangible asset’s value based on the present value of the incremental after-tax cash flows (or “excess earnings”) attributable only to the intangible asset. As a basis for this valuation, management-prepared prospective financial information is used for the prospective earnings associated with the IPR&D. Specifically, this prospective financial information relates to revenues, cost of goods sold, R&D expenses, distribution, sales and marketing expenses, general and administrative costs and Probability of Technical and Regulatory Success (PTRS) specific to the IPR&D assets. The determination of these PTRS is based on benchmarks and internal analysis.
Other assumptions relate to income tax rate and tax amortization benefit, useful life and discount rate. The fair value of the IPR&D assets is considered amortizable for income tax purposes from the viewpoint of a market participant. The present value of the tax benefit from amortization of the assets is added to the present value of the incremental after-tax cash flows to arrive at the indicated value of the IPR&D assets. The magnitude of the discount rate applied to the projected cash flows is related to the perceived risk the investment and current capital costs. The discount rate utilized represents an estimate of the Weighted Average Cost of Capital.
All prospective financial information, PTRS and other assumptions are assessed on a case-by-case basis taking into account all specific circumstances.
Actual outcomes could vary significantly from such assumptions and could impact the value of the intangibles and related deferred taxes in future periods. An impairment test is performed at least once a year and whenever there is an indication that an impairment might exists. See also Note 4.2.2 Intangible assets and goodwill.
4.2.7 Assessment of control over an investment in case more than 50% of the shares are held by non-controlling interests
In order to assess whether or not UCB has control over an investment in case more than 50% of the shares are held by non-controlling interests, any contractual arrangement between UCB and the investment is considered as well as the design and the purpose of investment, the power to direct the relevant activities of the investment, the contractual sharing of risk as well as the power of UCB compared to the non-controlling interests to affect the returns of the investment.