The preparation of the consolidated financial statements requires management to make judgments and assumptions as well as estimates to a certain extent. This affects the amount of assets and liabilities, disclosures on contingent assets and liabilities, as well as reported income and expenses. Actual values may differ from the estimates made and assumptions and judgments may subsequently prove inaccurate. This is of fundamental importance for the understanding of these consolidated financial statements and the assessment of the underlying risks. The relevant assumptions and estimates for the preparation of the consolidated financial statements are reviewed on an ongoing basis. Changes in estimates are considered in the period of the change and in subsequent periods if the change relates to both the reporting period and also future periods. Judgments, forward-looking assumptions and sources of estimation uncertainty with the greatest potential effects on these consolidated financial statements are presented below.
Sales deductions
Merck grants its customers various kinds of rebates and discounts. In addition, expected product 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 Merck Serono division. The most complex and most substantial rebates in this division 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 division result from compulsory government rebate programs in certain European countries.
Insofar as sales deductions were not already made on payments received, Merck determines the level of required sales deductions on the basis of current experience and recognizes them as a liability or provision. The sales deductions reduce gross sales revenues. Adjustments of liabilities and provisions can lead to increases or reductions of sales in later periods.
Impairment tests of goodwill and other intangible assets with indefinite useful lives
The goodwill (carrying amount as of December 31, 2013: € 4,583.2 million/2012: € 4,695.7 million) and other intangible assets with indefinite useful lives (carrying amount as of December 31, 2013: € 214.9 million/2012: € 156.6 million) reported in the consolidated financial statements are tested for impairment when a triggering event arises or at least once a year.
The impairment tests include assumptions and estimates of the amount of future cash flows and the discount rate. Here, to be mentioned in particular are assumptions and estimates regarding future customers, saleable quantities, achievable prices, corresponding cost developments, the long-term growth rate and the weighted average cost of capital (WACC) used for discounting. All of these assumptions are considered a source of estimation uncertainty due to their inherent uncertainty. Changes in the long-term growth rate and the discount rate especially have an influence on the determination of value in use. Information on the sensitivity of these two factors can be found in Note [41].
Especially due to the acquisition of Serono SA and the Millipore Corporation, the goodwill reported in the consolidated financial statements represents a significant factor. Although Merck expects no materially significant impairment of the goodwill in the near future, such impairment cannot be ruled out for the future in the event of unfavorable developments in the earnings situations of the relevant cash-generating units.
Determination of the level of amortization of intangible assets with finite useful lives
In addition to goodwill and other intangible assets with indefinite useful lives, Merck has a significant amount of intangible assets with finite useful lives (carrying amount as of December 31, 2013: € 5,026.8 million/2012: € 6,056.8 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 by Merck and adjusted if necessary at least at the end of every fiscal year. In these estimates, Merck considers factors including the typical product life cycles for each asset and publicly available information about the estimated useful lives of similar assets. Despite these analyses, the assumed useful lives can prove false at a later date because of the high degree of uncertainty.
If the amortization of intangible assets from market authorizations, patents, licenses and similar rights, capitalized brand names and trademarks had been 10% higher, for example due to shortened remaining useful lives, profit before income tax would have been € 81.4 million lower in fiscal 2013 (2012: reduction of € 87.2 million). In fiscal 2013, a reduction of the useful lives of the intangible assets reported in connection with the drug Rebif® by one year would have lowered profit before income tax by € 61.4 million (2012: € 52.6 million).
In- and out-licensing of intangible assets
Merck regularly acquires intellectual property from research institutions, biotechnology companies and other contract partners. Such acquisitions typically involve the agreement of up-front payments and payments for the achievement of certain milestones. In this context, Merck has to judge to what extent up-front or milestone payments represent compensation for assets to be capitalized or how far these payments represent remuneration for purchased services (ongoing research and development expense).
Merck also acts as the seller of intellectual property in out-licensing agreements and usually receives up-front and milestone payments on this basis. In this context, it must be assessed to what extent all significant risks and rewards of the intangible asset in question are transferred to the acquirer and consequently whether revenue is required to be recognized.
Identification of impairment of non-financial assets
Judgments by company management are required in the identification of existing indications of impairment of intangible assets and property, plant and equipment. As of December 31, 2013, the carrying amounts of these assets amounted to € 12,514.4 million (2012: € 13,898.1 million). Merck uses external and internal information to identify indications of impairment. For example, the approval of a competing pharmaceutical product or the closure of a location can be an indicator of impairment. Nevertheless, Merck’s analysis of indications of impairment can prove too optimistic, too pessimistic or incorrect in hindsight due to the high degree of uncertainty. This would result in impairment tests being carried out too late, too early or erroneously not carried out at all.
Impairment of financial assets
On every reporting date, Merck 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 receivables whose carrying amount was € 2,021.4 million in 2013 (2012: € 2,114.6). Of these trade receivables, € 209.1 million related to receivables in Italy, Spain, Greece and Portugal (2012: € 258.1 million), which are a particular focus as part of the management of operating counterparty risks.
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 and can later prove to be incorrect.
Other provisions
As a global pharmaceutical and chemical group, 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 detailed description of the most important legal matters as of the balance sheet date can be found in Note [48]. The provisions recognized for legal disputes mainly relate to the Merck Serono division and amounted to € 772.3 million as of the reporting date (2012: € 678.9 million). To assess the existence of a reporting obligation 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 evaluation of a possible payment obligation 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 € 111.2 million as of December 31, 2013 (2012: € 106.7 million). The underlying obligations were located mainly in Germany 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 and the associated future costs. 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.
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, 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 Notes [21] and [49]. As of the reporting date, the amount recorded on the balance sheet for provisions for pensions and other post-employment benefits was € 910.9 million (2012: € 1,211.7 million). The present value of the defined benefit pension obligation was € 2,736.8 million as of December 31, 2013 (2012: € 2,830.1 million).
Income taxes
The calculation of the reported assets and liabilities from deferred and current income taxes requires extensive discretionary judgments, assumptions and estimates. The tax liabilities and the provisions for tax obligations resulted in total income tax liabilities of € 465.1 million as of December 31, 2013 (2012: € 401.4 million). The carrying amounts of deferred tax assets and liabilities amounted to € 736.4 million and € 665.5 million, respectively, as of the reporting date (2012: € 946.6 and € 1,192.0 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 Serono SA and the Millipore Corporation. 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.
Other judgments, assumptions and sources of estimation uncertainty
Merck makes other judgments, assumptions and estimates in the following areas:
- Identification, recognition and measurement of assets, liabilities and contingent liabilities in the context of business combinations
- Classification of financial assets and financial liabilities
- 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
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