Note 1 – Accounting Principles

Lonza Group

Lonza Group Ltd and its subsidiaries (hereafter «the Group» or «Lonza») operate under the name Lonza. Lonza Group Ltd is a limited liability company incorporated and domiciled in Switzerland. The Group is headquartered in Basel, Switzerland. Lonza is one of the world’s leading and most-trusted suppliers to the pharmaceutical, biotech and specialty ingredients markets. It harnesses science and technology to create products that support safer and healthier living and enhance the overall quality of life. Following the 2017 Capsugel S.A. («Capsugel»)acquisition, Lonza offers products and services from the custom development and manufacture of active pharmaceutical ingredients through to innovative dosage forms for the pharma and consumer health and nutrition industries. Benefiting from its regulatory expertise, Lonza is able to transfer its know-how from pharma to hygiene and fast-moving consumer goods all the way to coatings and composites and the preservation and protection of agricultural goods and other natural resources.

Basis of Preparation

The consolidated financial statements for 2018 and 2017 are reported in Swiss francs (CHF), rounded to millions, and based on the annual accounts of Lonza Group Ltd (Company) and its subsidiaries at 31 December, which have been drawn up according to uniform Group accounting principles. The consolidated accounts are prepared in accordance with International Financial Reporting Standards (IFRS) and with Swiss law. They are prepared on the historical cost basis, except that derivative financial instruments and contingent considerations are stated at their fair values and the employee benefit liability is stated at the fair value of plan assets less the present value of the defined benefit obligation.

As a result of the acquisition of Capsugel in July 2017, the comparability of the consolidated income statements for 2018 and 2017 is limited.

Following the announcement on 1 November 2018 that Lonza had entered into a definitive agreement with Platinum Equity to sell Lonza’s Water Care business and operations, the results of the Water Care business are disclosed separately in the consolidated income statement as discontinued operations. Therefore, income statement related notes do not include the results from the Water Care business for 2018 and 2017, and comparative information was adjusted accordingly. Refer to the notes for further information.

Changes in Accounting Standards

There are new or amended standards that became applicable for the current reporting period. The Group has incorporated these standards and amendments into its accounting policies and had to make certain retrospective adjustments as a result of adopting the following standards:

  • IFRS 15 Revenue from Contracts with Customers
  • IFRS 9 Financial Instruments
  • Amendments to IFRS 2 – Classification and Measurement of Share-based Payment Transactions
  • IFRIC 22 – Foreign Currency Transactions and Advance Consideration
  • Annual Improvements to IFRS Standards 2014–2016 Cycle

Aside from IFRS 15, the adoption of the other standards had no significant impact on the Group’s financial statements.

IFRS 15 Revenue from contracts with customers amends revenue recognition requirements and establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Revenue is recognized when a customer obtains control of a good or service and thus has the ability to direct the use and obtain the benefits from the good or service. Based on the Group’s assessment the adoption of the new standard has primarily impacted its long-term contracts in the custom manufacturing business and resulted in recognition of contract assets for costs incurred during the pre-manufacturing phase as well as additional deferred income related to payments from customers before supply of goods.

The Group has implemented IFRS 15 retrospectively and comparative information for the 2017 financial year has been restated. In summary, the following adjustments were made to the amounts recognized in the balance sheet at the date of initial application (1 January 2018). These adjustments are reflected entirely in the operational segment Pharma & Biotech.

Changes in Accounting Standards

million CHF

 

31 December 2017

 

IFRS 15
Restatement
impacts

 

31 December 2017
restated

 

1 January 2017

 

IFRS 15
Restatement
impacts

 

1 January 2017
restated

 

 

 

 

 

 

 

 

 

 

 

 

 

Property, plant and equipment

 

3,198

 

0

 

3,198

 

2,412

 

0

 

2,412

Intangible assets

 

3,701

 

0

 

3,701

 

968

 

0

 

968

Goodwill

 

4,002

 

0

 

4,002

 

1,287

 

0

 

1,287

Other non-current assets

 

108

 

31

 

139

 

58

 

20

 

78

Non-current income tax receivables

 

15

 

0

 

15

 

0

 

0

 

0

Deferred tax assets

 

33

 

10

 

43

 

38

 

7

 

45

Total non-current assets

 

11,057

 

41

 

11,098

 

4,763

 

27

 

4,790

Inventories

 

1,177

 

0

 

1,177

 

897

 

0

 

897

Trade receivables

 

825

 

0

 

825

 

612

 

0

 

612

Current tax receivables

 

80

 

0

 

80

 

16

 

0

 

16

Other receivables, prepaid expenses and accrued income

 

172

 

0

 

172

 

175

 

0

 

175

Cash and cash equivalents

 

479

 

0

 

479

 

274

 

0

 

274

Assets held for sale

 

0

 

0

 

0

 

91

 

0

 

91

Total current assets

 

2,733

 

0

 

2,733

 

2,065

 

0

 

2,065

Total assets

 

13,790

 

41

 

13,831

 

6,828

 

27

 

6,855

 

 

 

 

 

 

 

 

 

 

 

 

 

Share capital

 

74

 

0

 

74

 

53

 

0

 

53

Share premium

 

3,314

 

0

 

3,314

 

311

 

0

 

311

Treasury shares

 

(59)

 

0

 

(59)

 

(10)

 

0

 

(10)

Retained earnings and reserves

 

2,876

 

(72)

 

2,804

 

2,001

 

(53)

 

1,948

Equity attributable to equity holders of the parent

 

6,205

 

(72)

 

6,133

 

2,355

 

(53)

 

2,302

Non-controlling interest

 

48

 

0

 

48

 

0

 

0

 

0

Total equity

 

6,253

 

(72)

 

6,181

 

2,355

 

(53)

 

2,302

Non-current provisions

 

101

 

0

 

101

 

90

 

0

 

90

Employee benefit liabilities

 

578

 

0

 

578

 

717

 

0

 

717

Other non-current liabilities

 

149

 

113

 

262

 

134

 

80

 

214

Non-current debt

 

3,730

 

0

 

3,730

 

1,571

 

0

 

1,571

Non-current income tax payables

 

46

 

0

 

46

 

0

 

0

 

0

Deferred tax liabilities

 

760

 

0

 

760

 

329

 

0

 

329

Total non-current liabilities

 

5,364

 

113

 

5,477

 

2,841

 

80

 

2,921

Current provisions

 

69

 

0

 

69

 

49

 

0

 

49

Other current liabilities

 

992

 

0

 

992

 

882

 

0

 

882

Trade payables

 

400

 

0

 

400

 

284

 

0

 

284

Current debt

 

516

 

0

 

516

 

289

 

0

 

289

Current tax payables

 

196

 

0

 

196

 

88

 

0

 

88

Liabilities held for sale

 

0

 

0

 

0

 

40

 

0

 

40

Total current liabilities

 

2,173

 

0

 

2,173

 

1,632

 

0

 

1,632

Total equity and liabilities

 

13,790

 

41

 

13,831

 

6,828

 

27

 

6,855

The following IFRS 15 restatement adjustments were made to the consolidated income statement for the year ended 31 December:

million CHF

 

2017
as reported for continuing operations

 

IFRS 15
Restatement
impacts

 

2017
restated for continuing operations

 

 

 

 

 

 

 

Sales

 

4,582

 

(34)

 

4,548

Cost of goods sold

 

(2,905)

 

12

 

(2,893)

Gross profit

 

1,677

 

(22)

 

1,655

Marketing and distribution

 

(277)

 

0

 

(277)

Research & development

 

(95)

 

0

 

(95)

Administration and general overheads

 

(609)

 

0

 

(609)

Other operating income

 

109

 

0

 

109

Other operating expenses

 

(110)

 

0

 

(110)

Result from operating activities (EBIT)

 

695

 

(22)

 

673

Financial income

 

30

 

0

 

30

Financial expenses

 

(169)

 

0

 

(169)

Net financing costs

 

(139)

 

0

 

(139)

Share of loss of associates / joint ventures

 

1

 

0

 

1

Profit before income taxes

 

557

 

(22)

 

535

Income taxes

 

128

 

3

 

131

Profit from continuing operations

 

685

 

(19)

 

666

The impact of IFRS 15 adoption on the Group’s retained earnings as at 1 January 2018 and 1 January 2017 is as follows:

million CHF

 

2018

 

2017

 

 

 

 

 

Retained earnings as reported

 

3,211

 

2,565

Recognition of capitalized contract costs

 

31

 

20

Recognition of deferred contractual revenues

 

(113)

 

(80)

Increase of deferred tax assets

 

10

 

7

Adjustment to retained earnings from changes in accounting policies

 

(72)

 

(53)

Restated retained earnings

 

3,139

 

2,512

The following IFRS 15 restatement adjustments were made to the consolidated cash flow statement for the year ended 31 December:

million CHF

 

2017 as reported

 

IFRS 15
Restatement
impacts

 

2017 restated

 

 

 

 

 

 

 

Profit for the period

 

728

 

(19)

 

709

Adjustment for non-cash items

 

475

 

(3)

 

472

Income tax and interest paid

 

(164)

 

0

 

(164)

Increase of net working capital

 

(41)

 

0

 

(41)

Use of provisions

 

(28)

 

0

 

(28)

Decrease of other payables, net

 

(107)

 

0

 

(107)

Net cash provided by operating activities

 

863

 

(22)

 

841

Purchase of property, plant & equipment and intangible assets

 

(451)

 

0

 

(451)

Acquisition of subsidiaries, net of cash acquired

 

(3,310)

 

0

 

(3,310)

Sale of assets held for sale

 

20

 

0

 

20

Net purchase of other assets and disposals

 

(9)

 

(12)

 

(21)

Interest and dividend received

 

14

 

0

 

14

Net cash used for investing activities

 

(3,736)

 

(12)

 

(3,748)

Increase of capital

 

3,024

 

0

 

3,024

Net increase in debt

 

346

 

0

 

346

Increase in other liabilities

 

23

 

34

 

57

Purchase of treasury shares

 

(71)

 

0

 

(71)

Sale of treasury shares

 

3

 

0

 

3

Dividends paid

 

(160)

 

0

 

(160)

Net cash provided by financing activities

 

3,165

 

34

 

3,199

Effect of currency translation on cash

 

(87)

 

0

 

(87)

Net increase in cash and cash equivalents

 

205

 

0

 

205

Cash and cash equivalents at 1 January

 

274

 

0

 

274

Cash and cash equivalents at 31 December

 

479

 

0

 

479

Accounting Standards Issued, but not yet Effective

The following new and revised standards have been issued, but are not yet effective. They have not been applied early in these consolidated financial statements. The current status of the expected effects is disclosed below.

*

 

No or no significant impact is expected on the consolidated financial statements

 

**

 

The Group’s assessment of the impact of adopting these standards is outlined below

 

Standard / Interpretation

 

 

 

Effective date

 

Planned application by Lonza

 

 

 

 

 

 

 

IFRS 16 – Leases

 

**

 

1 January 2019

 

Reporting year 2019

Long-term Interests in Associates and Joint Ventures – Amendments to IAS 28

 

*

 

1 January 2019

 

Reporting year 2019

IFRIC 23 – Uncertainty over Income Tax Treatments

 

*

 

1 January 2019

 

Reporting year 2019

Annual Improvements to IFRS® Standards 2015–2017 Cycle

 

*

 

1 January 2019

 

Reporting year 2019

Plan Amendment, Curtailment or Settlement – Amendments to IAS 19

 

*

 

1 January 2019

 

Reporting year 2019

Definition of a Business – Amendments to IFRS 3

 

*

 

1 January 2020

 

Reporting year 2020

IFRS 16 Leases was issued in January 2016 and will become effective for the financial period beginning on 1 January 2019. IFRS 16 will replace existing leases guidance, including IAS 17 Leases, and sets out the principles for recognition and measurement of leases. The new standard will also result in an increased volume of disclosure information in the Annual Financial Statements.

IFRS 16 Leases became effective for the financial period beginning on 1 January 2019. Implementation of IFRS 16 will result in almost all leases being recognized on the balance sheet, as the distinction between operating and finance leases is removed. The standard will affect primarily the Group’s accounting for operating leases.

As of 31 December 2018, the Group has non-cancellable operating lease commitments of CHF 249 million (2017: CHF 170 million), which are an appropriate indicator of the IFRS 16 implementation impact on the Group’s consolidated balance sheet. The Group will implement the new standard effective 1 January 2019 and will apply the modified retrospective approach for the transition, meaning that the comparative 2018 results will not be restated when the new standard is applied.

Principles of Consolidation

The consolidated financial statements represent the accounts for the year ended 31 December of Lonza Group Ltd and its subsidiaries. Subsidiaries are those entities controlled, directly or indirectly, by Lonza Group Ltd. Control is achieved when the Group is exposed, or has rights, to variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. Consolidation of a subsidiary begins when the Group obtains control over the subsidiary and ceases when the Group loses control of the subsidiary. Changes in ownership interests in subsidiaries are accounted for as equity transactions if they occur after control has already been obtained and if they do not result in a loss of control. The significant subsidiaries included in the consolidated financial statements are shown in note 33.

The full consolidation method is used, whereby the assets, liabilities, income and expenses are incorporated in full, irrespective of the extent of any non-controlling interest. Payables, receivables, income and expenses between Lonza consolidated companies are eliminated. Intercompany profits included in year-end inventories of goods produced within Lonza are eliminated, as well as unrealized gains on transactions between subsidiaries. Unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. 

The Group’s interests in equity-accounted investees comprise interests in associates and joint ventures, as disclosed in note 9. Associates are those entities in which the Group has significant influence, but not control or joint control, over the financial and operating policies. A joint venture is an arrangement in which the Group has joint control, whereby the Group has rights to the net assets of the arrangement, rather than rights to its assets and obligations for its liabilities. Associates and interests in joint ventures are accounted for in the consolidated financial statements using the equity method of accounting. They are recognized initially at cost, which includes transaction costs.

Subsequent to the initial recognition, the consolidated financial statements include the Group’s share of the profit and loss and other comprehensive income of equity-accounted investees, until the date on which significant influence or joint control ceases. Dividends paid during the year reduce the carrying value of the investments.

Segment Reporting

For the purpose of segment reporting, the Group’s Executive Committee (EC) is considered to be the Group’s Chief Operating Decision Maker. The determination of the Group’s operating segments is based on the organizational units for which information is reported to the EC on a regular basis. The information provided is used as the basis of the segment revenue and profit disclosures reported in note 2. Selected segment balance sheet information and performance measures are also routinely provided to the EC.

In 2018, the Group has two segments, Pharma & Biotech and Specialty Ingredients. Revenues are primarily generated from the sale of products. The Pharma & Biotech segment also derives revenues from rendering of services as well as the sale or licensing of products or technology to third parties. Residual operating activities from certain global activities are reported as «Corporate.» These include the EC and global group functions for communications, human resources, finance (including treasury and taxes), legal, environmental and safety services. Transfer prices between operating segments are set on an arm’s-length basis. Operating assets and liabilities consist of property, plant and equipment, goodwill and intangible assets, trade receivables/payables, inventories and other assets and liabilities, such as provisions, which can be reasonably attributed to the reported operating segments. Non-operating assets and liabilities mainly include current and deferred income tax balances, post-employment benefit assets/liabilities and financial assets/liabilities such as cash, investments and debt.

Revenue Recognition

Revenue is measured based on the consideration specified in the contract with a customer und excludes amounts collected on behalf of third parties. Revenues are recognized when a customer obtains control of a good or service and thus has the ability to direct the use and obtain the benefits from the good or service. In the custom manufacturing business, customer agreements may foresee payments at or near inception of contracts, which typically relate to setup efforts (e.g. system preparation, facility modification) for new customer-dedicated production facilities. Such setup efforts typically do not represent separate performance obligations, as no good or service is transferred to the customer. The payments for these setup efforts comprise part of the expected transaction price and are deferred as contract liabilities (non-current deferred income) until performance obligations are satisfied. Product sales are recognized when control of the products has been transferred, i.e. when the products are delivered to the customer, the customer has full discretion over the sales channel and pricing of the products, and there is no unfulfilled obligation that could affect the customer’s acceptance of the products. Delivery occurs when the products have been shipped to the specific location, the risks of obsolescence and loss have been transferred to the customer, and either the customer has accepted the products in accordance with the sales contract, the acceptance provisions have lapsed, or the Group has objective evidence that all criteria for acceptance have been satisfied. Contracts with customers may include volume discounts based on aggregate sales over a specified period. Revenues from these sales are recognized based on the price specified in the contract, net of the estimated volume discounts. Accumulated experience is used to estimate and provide for such discounts, using the expected value method, and revenues are only recognized to the extent that it is highly probable that no significant reversal will occur. A contract liability is recognized for expected volume discounts payable to customers in relation to sales made until the end of the reporting period. Revenues from providing services are recognized in the accounting period in which these services are rendered. For most services revenue recognition over time is appropriate. This is done with reference to output (i.e. analysis delivered) to measure the amount of revenue to be recognized. Revenue recognition over time is not applied for customer service contracts where the consideration depends on a defined outcome or result and its achievement cannot be estimated. In this case, revenues are only recognized at the point in time when the service has been completed and accepted by the customer.

Research & Development

Research & development costs are generally charged against income as incurred. Development costs are only capitalized when the related products meet the recognition criteria of an internally generated intangible asset, which mainly require the technical feasibility of completing the intangible asset, the probability of future economic benefits, the reliable measurement of costs and the ability and intention of the Group to use or sell the intangible asset. Fixed assets (buildings, machinery, plant, equipment) used for research purposes are valued similarly to other fixed assets. Such assets are capitalized and depreciated over their estimated useful lives.

Expenses for research & development include associated wages and salaries, material costs, depreciation on fixed assets, as well as overhead costs.

Other Operating Income and Other Operating Expenses

Other operating income and other operating expenses include items not assignable to other functions of the consolidated income statement. They mainly include gains and losses from the disposal of intangible assets, property, plant and equipment and other non-current assets, income and expenses from the release and recognition of provisions, income and expense related to restructuring, gains and losses from currency-related operating derivative instruments, as well as operating exchange rate gains and losses.

Net Financing Costs

Net financing costs comprise interest payable on borrowings calculated using the effective interest method, the interest expenses on the net defined-benefit liability, the finance charge for finance leases, dividend income, foreign exchange gains and losses arising on financial assets and liabilities, gains and losses on hedging instruments that are recognized in the income statement and gains/losses on sale of financial assets. Interest income/expense is recognized in the income statement as it accrues, taking into account the effective yield of the asset or liability or an applicable floating rate. Dividend income is recognized in the income statement on the date that the dividend is declared. Interest income and expense include the amortization of any discount or premium or other differences between the initial carrying amount of an interest-bearing instrument and its amount at maturity calculated on an effective interest rate basis.

Foreign Currencies

Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates («the functional currency»). The consolidated financial statements are presented in Swiss francs (CHF), which is the Group’s presentation currency. For consolidation purposes the balance sheet of foreign consolidated companies is translated to CHF with the exchange rate on the balance sheet date. Income, expenses and cash flows of the foreign consolidated companies are translated into CHF using the monthly average exchange rates during the year (unless this average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions). Exchange rate differences arising from the different exchange rates applied in balance sheets and income statements are recognized in other comprehensive income. In the individual company’s financial statements, transactions in foreign currencies are translated at the foreign exchange rate applicable at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the foreign exchange rate ruling at that date. All resulting foreign exchange gains and losses are recognized in the individual company’s profit or loss statement, except when they arise on monetary items that form a part of the Group’s net investment in a foreign entity. In such a case, the exchange gains and losses are recognized in other comprehensive income.

Hedge Accounting

The Group uses derivatives to manage its exposures to foreign currency, interest rate and commodity price risks. The instruments used may include interest rate swaps, commodity swaps, forward exchange contracts, FX swaps and options. The Group generally limits the use of hedge accounting to certain significant transactions. At inception of designated hedging relationships, the Group documents the risk management objective and strategy for undertaking the hedge. The Group also documents the economic relationship between the hedged item and the hedging instrument, including whether the changes in cash flows of the hedged item and hedging instrument are expected to offset each other.

Cash flow hedge This is a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with a recognized asset or liability or a highly probable forecast transaction and could affect profit or loss. The hedging instrument is recorded at fair value. The effective portion of the hedge is included in other comprehensive income and any ineffective portion is reported in cost of goods sold (instruments to manage the commodity price exposure), other operating income/expenses (instruments to manage the foreign currency exposure related to sales or purchases) or financial income/expenses (foreign currency exposure related to debt repayment or interest exposure on the Group’s debt). If the hedging relationship is the hedge of the foreign currency risk of a firm commitment or highly probable forecasted transaction that results in the recognition of a non-financial item, the cumulative changes in the fair value of the hedging instrument that have been recorded in other comprehensive income are included in the initial carrying value of the non-financial item at the date of recognition. For all other cash flow hedges, the cumulative changes in the fair value of the hedging instrument that have been recorded in other comprehensive income are included in cost of goods sold, other operational income/expenses or other financial income/expense (based on the principles explained above) when the forecasted transaction affects net income.

Fair value hedge This is a hedge of the exposure to changes in fair value of a recognized asset or liability, or an unrecognized firm commitment, or an identified portion of such an asset, liability or firm commitment, that is attributable to a particular risk and could affect profit or loss. The hedging instrument is recorded at fair value and the hedged item is recorded at its previous carrying value, adjusted for any changes in fair value that are attributable to the hedged risk. Changes in the fair values are reported in cost of goods sold (instruments to manage the commodity price exposure), other operating income/expenses (instruments to manage the foreign currency exposure related to sales or purchases) or financial income/expenses (foreign currency exposure related to debt repayment or interest exposure on the Group’s debt).

Capitalized Contract Cost

The Group recognizes contract assets mainly consisting of contract fulfillment costs that are incurred after a contract is obtained but before goods or services have been delivered to the customer. These costs arise from long-term contracts in the custom manufacturing business for customer specific production facility expansions or modifications on Lonza’s premises. They typically include costs for commissioning, qualification and startup, as well as for activities relating to process development and technology transfer.

Property, Plant and Equipment

Property, plant and equipment are stated at cost less accumulated depreciation and accumulated impairment losses. The assets are depreciated on a component basis over their estimated useful lives, which vary from 10 to 50 years for buildings and structures, and 5 to 16 years for production facilities, machinery, plant, equipment and vehicles. Fixed assets are depreciated using the straight-line method over their estimated useful lives. Subsequent expenditure incurred to replace a component of an item of property, plant and equipment that is accounted for separately, including major inspection and overhaul expenditure, is capitalized. Other subsequent expenditure is capitalized only when it increases the future economic benefits embodied in the item of property, plant and equipment. Borrowing costs incurred with respect to qualifying assets are capitalized and included in the carrying value of the assets.

All other expenditure is recognized in the income statement as an expense as incurred. The residual values and the useful life of items of property, plant and equipment are reviewed and adjusted, if appropriate, at each balance sheet date.

Leases

Financial leases, which effectively constitute assets purchased with long-term financing, are carried as fixed assets at their purchase price and are written off over their estimated useful lives if the leased assets are transferred to the lessee at the end of the lease term. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset is fully depreciated over the shorter of the lease term and its useful life. The corresponding liabilities are included in non-current and current debt. The finance lease gives rise to a depreciation expense for depreciable assets as well as a finance expense for each accounting period. For the purpose of classifying a lease of land and buildings, lease of the land and of the buildings is evaluated separately. Lease payments under an operating lease are recognized as an expense in the income statement on a straight-line basis over the lease term.

Intangible Assets

Purchased intangible assets with a finite useful life are stated at cost less accumulated amortization and accumulated impairment losses. Intangible assets acquired in a business combination are recognized at their fair value. Intangibles include software, licenses, patents, trademarks and similar rights granted by third parties, capitalized product development costs and capitalized computer software development costs. Costs associated with internally developed or maintained computer software programs are recognized as an expense as incurred. Costs that are directly associated with the production of identifiable and unique software products controlled by the Group, and that will probably generate future economic benefits exceeding costs beyond one year, are recognized as intangible assets. Those direct costs include the software development employee costs and an appropriate portion of relevant overheads. Intangible assets are amortized using the straight-line method over their estimated useful lives, which is the lower of the legal duration and the economic useful life. Useful lives vary from 3 to 5 years for software, 5 to 35 years for patents, trademarks and similar rights and 4 to 16 years for development costs. All intangible assets in Lonza have finite useful lives, except for the Capsugel trade name acquired in 2017 and the trademarks acquired in 2011 through the Arch Chemicals business combination and 2007 through the Cambrex business combination. The Group considers that these trademarks have an indefinite useful life as they are well established in the respective markets and have a history of strong performance. The Group intends and has the ability to maintain these trademarks for the foreseeable future.

Goodwill and Business Combinations

Business combinations are accounted for using the acquisition method. The consideration transferred in a business combination is measured at fair value at the date of acquisition and includes the cash paid plus the fair value at the date of exchange of assets, liabilities incurred or assumed and equity instruments issued by the Group. The fair value of the consideration transferred also includes contingent consideration arrangements at fair value. Directly attributable acquisition-related costs are expensed in the period the costs are incurred and the services are received and reported within administration and general overhead expenses. At the date of acquisition, the Group recognizes the identifiable assets acquired, the liabilities assumed and any non- controlling interest in the acquired business. The identifiable assets acquired and the liabilities assumed are initially recognized at fair value. Where the Group does not acquire 100% ownership of the acquired business, non-controlling interests are recorded as the proportion of the fair value of the acquired net assets attributable to the non-controlling interest. Goodwill is recorded as the surplus of the consideration transferred over the Group’s interest in the fair value of the acquired net assets. Any goodwill and fair value adjustments are recorded as assets/liabilities of the acquired business in the functional currency of that business.

When the initial accounting for a business combination is incomplete at the end of a reporting period, provisional amounts are recognized. During the measurement period, the provisional amounts are retrospectively adjusted and additional assets and liabilities may be recognized to reflect new information obtained about the facts and circumstances that existed at the acquisition date which, had they been known, would have affected the measurement of the amounts recognized at that date. The measurement period does not exceed 12 months from the date of acquisition. Goodwill is not amortized but is tested annually for impairment. Changes in ownership interests in subsidiaries are accounted for as equity transactions if they occur after control has already been obtained and if they do not result in a loss of control. Goodwill may also arise upon investments in associates and joint ventures, being the surplus of the cost of investment over the Group’s share of the fair value of the net identifiable assets. Such goodwill is recorded within investments in associates and joint ventures.

Inventories

Inventories are reported at the lower of cost (purchase price or production cost) or market value (net realizable value). In determining net realizable value, any costs of completion and selling costs are deducted from the realizable value. The cost of inventories is calculated using the weighted average method. Prorated production overheads are included in the valuation of inventories. Adjustments are made for inventories with a lower market value or which are slow moving. Unsalable inventory is fully written off. Costs include all expenditures related directly to specific projects and an allocation of fixed and variable overheads incurred in the Group’s contract activities based on normal operating capacity.

Receivables

Policy applicable from 1 January 2018

With the adoption of IFRS 9, receivables are carried at the original invoice amount less allowances made for doubtful accounts, volume rebates and similar allowances. A receivable represents a right to consideration that is unconditional and excludes contract assets. An allowance for doubtful accounts is recorded for expected credit losses over the term of the receivables. These estimates are based on specific indicators, such as the ageing of customer balances and specific credit circumstances. Expenses for doubtful trade receivables are recognized within the cost of goods sold. Volume rebates and similar allowances are recorded on an accrual basis consistent with the recognition of the related sales, using estimates based on existing contractual obligations, historical trends and the Group’s experience. Receivables are written off (either partly or in full) when there is no reasonable expectation of recovery.

For trade receivables, the Group applies the simplified approach prescribed by IFRS 9, which requires/permits the use of the lifetime expected loss provision from initial recognition of the receivables. The Group measures an allowance for doubtful accounts equal to the credit losses expected over the lifetime of the trade receivables.

Policy applicable before 1 January 2018

Trade receivables are recognized at the original invoice amount less allowances made for doubtful accounts. An allowance for doubtful accounts is recorded for the difference between the carrying value and the estimated recoverable amount where there is objective evidence that the Group will not be able to collect all amounts due. These estimates are based on specific indicators, such as the aging of customer balances, specific credit circumstances and the Group’s historical experience, also taking into account economic conditions. Expenses for doubtful trade receivables are recognized in the consolidated income statement within cost of goods sold. Long-term accounts receivable are discounted to take into account the time value of money, where material.

Financial Instruments

Policy applicable from 1 January 2018

Since 1 January 2018, with the adoption of IFRS 9 the Group has classified its financial assets in the following measurement categories, which are disclosed in note 29: amortized cost or fair value through profit or loss (including hedging instruments).

At initial recognition, the Group measures a financial asset at its fair value plus, in the case of a financial asset not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition of the financial asset. Transaction costs of financial assets carried at fair value through profit or loss are expensed in profit or loss.

Amortized cost Assets that are held for collection of contractual cash flows where those cash flows represent solely payments of principal and interest are measured at amortized cost, less provision for impairment. Interest income from these financial assets is included in other financial income using the effective interest rate method. The Group derecognizes a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers the rights to receive the contractual cash flows in a transaction in which substantially all the risk and rewards of ownership of the financial asset are transferred. Any interest in such transferred financial assets that is created or retained by the Group is recognized as a separate asset or liability. Assets at amortized cost are mainly comprised of accounts receivable, cash and cash equivalents and loans and advances.

Equity investments at fair value through profit or loss These are equity investments in non-quoted companies that are kept for strategic reason and in investment vehicles that invest in the Groups’ target markets. These assets are subsequently measured at fair value. Dividends are recognized as financial income in profit or loss unless the dividend clearly represents a recovery of part of the cost of the investment. Other net gains and losses are recognized as a financial income or a financial expense in the income statement.

Fair value through profit or loss These are primarily contingent consideration assets (and liabilities) that are initially recorded and subsequently carried at fair value with changes in fair value recorded as a financial income or a financial expense in the income statement.

Fair value through profit or loss – hedging instruments These are derivative financial instruments that are used to manage the exposures to foreign currency, interest rates and commodity prices. These instruments are initially recorded and subsequently carried at fair value. Apart from those derivatives designated as qualifying cash flow hedging instruments, all changes in fair value are recorded as cost of goods sold (instruments to manage the commodity price exposure), other operating income/expenses (instruments to manage the foreign currency exposure related to sales or purchases) or financial income/expenses (foreign currency exposure related to debt repayment or interest exposure on the Group’s debt).

The fair value of derivatives (forward exchange contract, FX swaps, commodity swaps and interest rate swaps) is estimated by discounting the difference between the contractual forward price and the current forward price for the residual maturity of the contract using a credit-adjusted risk-free rate. Current forward prices are provided by banks or other financial service providers.

Debt instruments These are initially recorded at cost, which is the proceeds received net of transaction costs. They are subsequently stated at amortized cost; any difference between the net proceeds and the redemption value is recognized in the income statement over the period of the debt instrument using the effective interest method.

Policy applicable before 1 January 2018

The Group has classified its financial assets in the following measurement categories: available for sale, loans and receivables, fair value – held for trading, fair value – designated and fair value – hedge accounting.

The measurement principles before 1 January 2018 were the same as described above, expect that investments in equity instruments that did not have a quoted price in an active market and whose fair value could not be reliably estimated were recorded at cost.

Cash and Cash Equivalents

Cash and cash equivalents include cash in hand, in postal and bank accounts, as well as short-term deposits and highly liquid funds that have an original maturity of less than three months.

Impairment

Assets that are subject to amortization and depreciation are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Goodwill and intangible assets with indefinite useful lives are tested for impairment annually, and whenever there is an indication that the assets may be impaired. An impairment loss is recognized for the amount by which the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less cost of disposal and value in use. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows (cash-generating units).

Calculation of recoverable amount – In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset.

Reversal of impairment – An impairment loss is reversed if the subsequent increase in recoverable amount can be related objectively to an event occurring after the impairment loss was recognized. An impairment loss in respect of goodwill is not reversed. In respect of other assets, an impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized.

Assets Held for Sale and Discontinued Operations

Disposal groups comprising assets and liabilities are classified as held-for-sale if it is highly probable that they will be recovered primarily through sale rather than through continuing use.

Such disposal groups are generally measured at the lower of their carrying amount and fair value less cost to sell. Any impairment loss on a disposal group is allocated first to goodwill and then to the remaining assets and liabilities on a pro rata bases, except that no loss is allocated to inventories, financial assets or deferred tax assets, which continue to be recognized in accordance with the Group’s other accounting policies. Impairment losses on initial classification as held-for-sale and subsequent gains and losses on remeasurement are recognized in profit or loss. Once classified as held-for-sale, intangible assets and property, plant and equipment are no longer amortized or depreciated. A discontinued operation is a component of the entity that has been disposed of or is classified as held for sale and that represents a separate major line of business or geographical area of operations or is part of a single coordinated plan to dispose of such a line of business or area of operations. Classification as a discontinued operation occurs at the earlier of disposal or when the operation meets the criteria to be classified as held-for-sale. The income statement activity of the discontinued operations is presented separately in the consolidated income statement. The comparative consolidated income statement and consolidated statement of comprehensive income have been restated to show the discontinued operation separately from continuing operations. Balance sheet and cash flow information related to discontinued operations are disclosed separately in the notes.

Deferred Taxes

Tax expense is calculated using the balance-sheet liability method. Additional deferred taxes are provided wherever temporary differences exist between the tax base of an asset or liability and its carrying amount in the consolidated accounts for the year.

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and, for deferred tax assets, operating loss and tax credit carry-forwards.

Deferred tax assets and liabilities are measured using enacted or substantially enacted tax rates in the respective jurisdictions in which Lonza operates that are expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. In assessing the recoverability of deferred tax assets, management considers whether it is probable that some portion or all of the deferred tax assets will not be realized. For transactions and other events recognized in other comprehensive income or directly in equity, any related tax effect is recognized in other comprehensive income or in equity. Liabilities for income taxes, mainly withholding taxes, which could arise on the remittance of retained earnings, principally relating to subsidiaries, are only recognized where it is probable that such earnings will be remitted in the foreseeable future.

Employee Benefits

Employee-benefit liabilities as stated in the consolidated balance sheet include obligations from defined-benefit pension plans, other post-employment benefits (medical plans) as well as other long-term employee-related liabilities, such as long-term vacation accounts.

Defined-Benefit Plans (Pension and Medical Plans)

Most of Lonza’s subsidiaries operate their own pension plans. Generally, they are funded by employees’ and employers’ contributions. In addition, the Group operates three medical plans in the United States. The Group’s net obligation in respect of defined-benefit plans is calculated separately for each plan by estimating the amount of future benefit that employees have earned in the current and prior periods, discounting that amount and deducting the fair value of any plan assets. The calculation of defined-benefit obligations is performed annually by a qualified external actuary using the projected unit credit method. When the calculation results in a potential asset for the Group, the recognized asset is limited to the present value of economic benefits available in the form of any future refunds from the plan or reductions in future contributions to the plan. To calculate the present value of economic benefits, consideration is given to any applicable minimum funding requirements. Remeasurements of the defined-benefit liability, which comprise actuarial gains and losses and the return on plan assets (excluding interest) and the effect of the asset ceiling (if any, excluding interest), are recognized immediately in other comprehensive income.

The Group determines the net interest expense on the net defined-benefit liabilities for the period by applying the discount rate used to measure the defined-benefit obligation at the beginning of the annual period to the net defined-benefit liability, taking into account any changes in the net defined-benefit liability during the period as a result of contributions and benefit payments. Net interest expense and other expenses related to defined-benefit plans are recognized in profit or loss. While the net interest expense is disclosed within financial expenses, the other expenses related to defined-benefit plans are allocated to the different functions of the operating activities. When the benefits of a plan are changed or when a plan is curtailed, the resulting change in benefit that related to past service or the gain or loss on curtailment is recognized immediately in profit or loss. The Group recognizes gains and losses on the settlement of a defined-benefit plan when the settlement occurs.

Provisions

A provision is recognized in the balance sheet when (i) the Group has a legal or constructive obligation as a result of a past event, (ii) it is probable that an outflow of economic benefits will be required to settle the obligation, and (iii) a reliable estimate of the amount of the obligation can be made. If the effect is material, provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. A provision for restructuring is recognized when the Group has approved a detailed and formal restructuring plan, and the restructuring has either commenced or been announced publicly. Future operating costs are not provided for.

Provisions for environmental liabilities are made when there is a legal or constructive obligation for the Group that will result in an outflow of economic resources. Provisions are made for remedial work where there is an obligation to remedy environmental damage, as well as for containment work where required by environmental regulations.

Share Capital

Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds. Where any Group company purchases Lonza Group Ltd’s equity share capital (treasury shares), the consideration paid, including any directly attributable incremental costs (net of income taxes), is deducted from equity attributable to the Group’s equity holders until the shares are cancelled, reissued or disposed of.

Dividend

Dividend distribution to Lonza’s shareholders is recognized as a liability in the Group’s financial statements in the period in which the dividends are approved by the Lonza shareholders.

Share-Based Compensation

The Group operates various equity-settled, share-based compensation plans. The fair value of the employee services received in exchange for the grant of shares and other share-based compensations is recognized as an expense. The total amount to be expensed over the vesting period is determined by reference to the fair value of the shares granted. At each balance sheet date, the entity revises its estimates of the number of shares that are expected to become vested. It recognizes the impact of the revision of original estimates, if any, in the income statement, and a corresponding adjustment to equity over the remaining vesting period.

Significant Accounting Estimates and Judgments

Key assumptions and sources of estimation uncertainty

Use of Estimates The preparation of the financial statements and related disclosures in conformity with International Financial Reporting Standards requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Actual results could differ from those estimates. Estimates are used in impairment tests, accounting for allowances for doubtful receivables, inventory obsolescence, depreciation, employee benefits, taxes, restructuring provisions and contingencies. 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. The key assumptions about the future key sources of estimation uncertainty that entail a significant risk of causing a material adjustment to the carrying value of assets and liabilities within the next financial year are described below.

Impairment Test of Property, Plant and Equipment, Intangible Assets and Goodwill The Group has carrying values with regard to property, plant and equipment of CHF 3,152 million (2017: CHF 3,198 million), goodwill of CHF 3,748 million (2017: CHF 4,002 million) and intangible assets of CHF 3,312 million (2017: CHF 3,701 million) (see notes 6 and 7). The intangible assets include trademarks acquired through business combinations with a carrying value of CHF 363 million (2017: CHF 630 million), which have an indefinite useful life and are not systematically amortized. Goodwill and intangible assets with indefinite useful lives are reviewed annually for impairment. To assess if any impairment exists, estimates are made of the future cash flows expected to result from the use of the asset and its possible disposal. Actual outcomes could vary significantly from such estimates of discounted future cash flows. Factors such as changes in the planned use of buildings, machinery or equipment, or closure of facilities, the presence or absence of competition, technical obsolescence or lower-than-anticipated sales of products with capitalized rights could result in shortened useful lives or impairment. The impairment analysis as explained in note 6 is most sensitive to the discount rate used for the discounted cash flow model, as well as the expected future cash-inflows and the growth rate used for calculation purposes. The key assumptions used to determine the recoverable amount for the different cash-generating units are further explained in note 6.2.

Pensions Many of the Group’s employees participate in post-employment plans. The calculations of the recognized assets and liabilities from such plans are based upon statistical and actuarial calculations. In particular, the present value of the defined-benefit obligation is influenced 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’s independent external actuaries use statistically based assumptions, covering areas such as future withdrawals of participants from the plan and estimates of life expectancy. At 31 December 2018, the present value of the Group’s defined-benefit obligation was CHF 3,132 million (2017: CHF 3,264 million). The plan assets at fair value amounted to CHF 2,664 million (2017: CHF 2,730 million), resulting, compared with the present value of the pension obligation, in a funded status deficit of CHF 468 million (2017: CHF 534 million) (see note 24.1). The actuarial assumptions used may differ materially from actual results due to changes in market and economic conditions, higher or lower withdrawal rates or longer or shorter lifespans of participants and other changes in the factors being assessed.

These differences could affect the fair value of assets or liabilities recognized in the balance sheet in future periods.

Business Combinations Where the Group acquires control of another business, the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquired business shall be recognized, separately from goodwill. The process of assessing fair values requires in particular management involvement and judgment in the recognition and measurement of the following items:

  • Intellectual property, such as patents, licenses, trademarks, customer relations, technologies and similar rights
  • Contingencies, such as legal and environmental matters
  • Contingent consideration arrangements
  • The recoverability of any accumulated tax losses previously incurred by the acquired company

In all cases, management makes an assessment based on the underlying economic substance of the items in order to fairly present these items.

Environmental Provisions Lonza is exposed to environmental liabilities and risks relating to its operations, principally in respect of provisions for remediation costs, which at 31 December 2018 amounted to CHF 139 million (2017: CHF 113 million), as disclosed in note 14. Provisions for non-recurring remediation costs are made when there is a legal or constructive obligation and the cost can be reliably estimated. It is difficult to estimate any future action required by Lonza to correct the effects on the environment of prior disposal or release of chemical substances by Lonza or other parties, and the associated costs, pursuant to environmental laws and regulations. The material components of the environmental provisions consist of costs to clean and refurbish contaminated sites and to treat and contain contamination at sites. The Group’s future remediation expenses are affected by a number of uncertainties that include, but are not limited to, the method and extent of remediation and the responsibility attributable to Lonza at the remediation sites, relative to that attributable to other parties. The Group permanently monitors the various sites identified as at risk for environmental exposures. Lonza believes that its provisions are adequate, based upon currently available information; however, given the inherent difficulties in estimating liabilities in this area, there is no guarantee that additional costs will not be incurred beyond the amounts provided. Due to the uncertainty both of the amount and timing of future expenses, the provisions provided for environmental remediation costs could be affected in future periods.

Income Taxes At 31 December 2018, deferred tax assets of CHF 29 million (2017: CHF 43 million), non-current tax receivables of CHF 13 million (2018: CHF 15 million), current tax receivables of CHF 31 million (2017: CHF 80 million), deferred tax liabilities of CHF 711 million (2017: CHF 760 million), non-current tax payables of CHF 0 million (2017: 46 million) and current tax payables of CHF 150 million (2017: CHF 196 million) are included in the consolidated balance sheet. Significant estimates are required in determining the current and deferred assets and liabilities for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. Management believes that the estimates are reasonable and that the recognized liabilities for income tax-related uncertainties are adequate. Various internal and external factors may have favorable or unfavorable effects on the actual amounts of estimated income tax assets and liabilities. These factors include, but are not limited to, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations and changes in overall levels of pre-tax earnings. Such changes that arise could affect the assets and liabilities recognized in the balance sheet in future periods. The enactment of the United States Tax Cuts and Jobs Act in December 2017 and certain internal tax restructuring initiatives required significant estimates to determine the adjustments of the Group’s current tax payables and its deferred tax assets and liabilities. These significant estimates are disclosed in note 22.

Critical Accounting Judgments in Applying the Group’s Accounting Policies

In the process of applying the Group’s accounting policies, management has made the following judgments that have the most significant effect on the amounts recognized in the financial statements (apart from those involving estimations, which are dealt with above).

Revenue Recognition The Group has recognized revenues for sales of goods during 2018 to customers who have the right to rescind the sale if the goods do not meet the agreed quality. The Group believes that, based on past experience with similar transactions, the quality delivered will be accepted. Therefore, it is appropriate to recognize revenue on these transactions during 2018.

Revenues are recognized only when, according to management’s judgment, performance obligations are satisfied, control over the assets have been transferred to the customer and no future performance obligation exists. For certain transactions, recognition of revenues is based on the performance of the conditions agreed in particular contracts, the verification of which requires evaluation and judgments by management.

The Group is required to determine the transaction price in respect of each of its contracts with customers. In making such judgment the Group assesses the impact of any variable consideration in the contract, due to potential refunds, contractual price changes, batch success fees, estimated breakage, discounts or penalties, additional commission paid by distributors, profit sharing and the existence of any significant financing components. In determining the impact of variable consideration the Group uses accumulated experience to estimate the impact of variable consideration.

The Group has various contractual agreements that contain several components promised to the customer. As these contracts may include multiple performance obligations, the transaction price must be allocated to the performance obligations on a relative stand-alone selling price basis. Management estimates the stand-alone selling price at contract inception based on observable prices of the type of product likely to be provided and the services rendered in similar circumstances to similar customers. If a discount is granted, it is allocated to both performance obligations based on their relative stand-alone selling prices. Contractually agreed upfront or other one-time payments are allocated to the performance obligation to which they relate.

Intangible Assets The Group considers the Capsugel trade name acquired through the business combination in 2017 as well as the trademarks acquired in 2011 through the Arch Chemicals business combination and in 2007 through the Cambrex business combination to have an indefinite useful life, as they are well established in the respective markets and have a history of strong performance. The Group intends and has the ability to maintain these trademarks for the foreseeable future. The assumption of an indefinite useful life is reassessed whenever there is an indication that a trademark may have a definite useful life. In addition, intangible assets with indefinite useful lives are tested for impairment on an annual basis (see note 6).