Note 1: Summary of significant accounting policies

General information

Akzo Nobel N.V. is a company headquartered in the Netherlands. The address of our registered office is Christian Neefestraat 2, Amsterdam; the Chamber of Commerce number is 09007809. We have filed a list of subsidiaries, associated companies and joint ventures, drawn up in conformity with Article 379 and 414 of Book 2 of the Dutch Civil Code, with the Trade Registry of Amsterdam.

We have prepared the Consolidated financial statements of Akzo Nobel N.V. in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union. They also comply with the financial reporting requirements included in Title 9 of Book 2 of the Dutch Civil Code, as far as applicable. The Consolidated financial statements have been prepared on a going concern basis. The Management report within the meaning of Article 391 of Book 2 of the Dutch Civil Code consists of the following parts of the annual report:

The section How we created value in 2019 provides information on the developments during 2019 and the results. This section also provides information on cash flow and , capital expenditures, innovation activities and employees.

On February 11, 2020, the Board of Management authorized the financial statements for issue. The financial statements as presented in this report are subject to adoption by the Annual General Meeting of shareholders on April 23, 2020.

Consolidation

The Consolidated financial statements include the accounts of Akzo Nobel N.V. and its subsidiaries. Subsidiaries are companies over which Akzo Nobel N.V. has control, because it is exposed, or has rights, to variable returns from its involvement with the subsidiary and has the ability to affect returns through its power over the subsidiary. Non-controlling interests in equity and in results are presented separately.

Change in accounting policies and first time application

In 2019, the most significant change in accounting policies relates to adoption of the new standard IFRS 16 “Leases”.

IFRS 16 Leases

IFRS 16 replaces the previous standard on lessee accounting for leases. It requires lessees to bring most leases on balance sheet in a single lease accounting model, recognizing a right-of-use asset and a lease liability. Compared with the previous standard for operating leases, it also impacts the classification and timing of expenses and consequently the classification between net cash from operating activities and net cash from financing activities. AkzoNobel has adopted IFRS 16 as per January 1, 2019, applying the modified retrospective approach. All right-of-use assets are measured at the amount of the lease liability at transition, adjusted for any prepaid or accrued lease expenses. Short-term and low-value leases are exempted. AkzoNobel has not restated its 2018 comparative figures. The adoption did not have an impact on group equity. IFRS 16 requires the right-of-use asset and the lease liability to be recognized at discounted value and assumptions with regards to termination and renewal options have been taken into consideration.

Impact of adoption of IFRS 16 on the consolidated balance sheet

In € millions

As reported at December 31, 2018

Restatement due to adoption of IFRS 16

Restated opening balance at January 1, 2019

Intangible assets

3,458

(36)

3,422

Property, plant and equipment

1,748

(29)

1,719

Right-of-use assets

432

432

Deferred tax assets

559

559

Investments in associates and joint ventures

137

137

Financial non-current assets

1,269

1,269

Inventories

1,139

1,139

Current tax assets

74

74

Trade and other receivables

2,141

(4)

2,137

Short-term investments

5,460

5,460

Cash and cash equivalents

2,799

2,799

Total assets

18,784

363

19,147

Shareholder’s equity

11,834

11,834

Non-controlling interest

204

204

Post-retirement benefit provisions

603

603

Other provisions

296

296

Deferred tax liabilities

368

368

Long-term borrowings

1,799

270

2,069

Short-term borrowings

599

93

692

Current tax liabilities

225

225

Trade and other payables

2,645

2,645

Current portion of provisions

211

211

Total equity and liabilities

18,784

363

19,147

Impact of adoption of IFRS 9 and IFRS 15 and application of IAS 29

In € millions

2019 before IFRS 16

Impact

2019 Including IFRS 16

1

Adjusted operating income is operating income excluding identified items.

2

This identified item relates to a non-cash impairment of right-of-use assets following the implementation of our strategic portfolio review.

3

ROS% is calculated as adjusted operating income (operating income excluding identified items) as a percentage of group revenue.

4

OPI margin is operating income as percentage of revenue.

5

ROI% is calculated as adjusted operating income (operating income excluding identified items) of the last 12 months as a percentage of average invested capital of the last 12 months. Invested capital is calculated as total assets (excluding cash and cash equivalents, short-term investments, investments in associates, the receivable from pension funds in an asset position and assets held for sale) less current tax liabilities, deferred tax liabilities and trade and other payables.

6

Adjusted operating income, ROS%, OPI margin and ROI% are APM measures; a reconciilation of the alternative performance measures to the most directly comparable IFRS measures refer to Note 3.

Depreciation and amortization

(255)

(105)

(360)

Adjusted operating income1,6

983

8

991

Identified items2

(145)

(5)

(150)

Operating income

838

3

841

Financing income and expenses

(68)

(8)

(76)

Income tax

(232)

2

(230)

Profit for the period

580

(3)

577

Net cash from operating activities

75

108

33

Net cash from financing activities

(6,471)

(108)

(6,579)

ROS%3,6

10.6

0.1

10.7

OPI margin4,6

9.0

0.1

9.1

ROI%5,6

14.7

(0.6)

14.1

On transition to IFRS 16, we elected to apply the practical expedient to grandfather the prior assessment of which transactions are leases. We applied IFRS 16 only to contracts that were previously identified as leases. Contracts that were not identified as leases under IAS 17 and IFRIC 4 were not reassessed for whether there is a lease under IFRS 16. Therefore, the definition of a lease under IFRS 16 was applied only to contracts entered into or changed on or after January 1, 2019. We applied judgement at the initial application of IFRS 16 and also thereafter, when assessing whether payments to be made in optional periods should be included in the calculation of the right-of-use assets and lease liability. Such payments are included in the calculations when we deem it reasonably certain to exercise an option to extend the lease, or not to exercise an option to terminate the lease.

We used a number of practical expedients when applying IFRS 16 to leases previously classified as operating leases under IAS 17, in particular:

  • On a lease by lease basis we decided whether to recognize right-of-use assets and liabilities for leases for which the lease term ends within 12 months of the date of initial application
  • We did not recognize right-of-use assets and liabilities for leases of low-value assets (e.g. certain IT equipment)
  • We excluded initial direct costs from the measurement of the right-of-use asset at the date of initial application
  • We used hindsight when determining the lease terms

In respect of the implications of IFRS 16 for tax accounting, AkzoNobel has assessed that the right-of-use asset and the lease liability are to be considered together as a single transaction, because in the company’s view they are integrally linked. As a result, at inception of a lease and also at the IFRS 16 transition, the net lease asset or liability (without taking into account any advance payments) is nil, the tax base is nil and, therefore, the temporary difference is nil. Hence, no deferred taxes have to be accounted for at inception/IFRS 16 transition and going forward deferred tax is recognized when temporary differences arise after initial recognition, subject to the IAS 12 recognition principles.

The adoption of IFRS 16 as per January 1, 2019, has resulted in the recognition of right-of-use assets of €367 million, and additional lease liabilities of €363 million. In addition, assets with a book value of €65 million have been reclassified to right-of-use assets, including among others finance leases. In the Consolidated statement of income, the operating lease expenses (€113 million), previously recorded in operating income, are replaced by the depreciation charges on right-of-use assets (€105 million; remains recorded in operating income) and by Interest expenses for the lease liability (€8 million; recorded in net financing expenses). In addition, we recorded a non-cash impairment charge of right-of-use assets of €5 million. On a net basis, the adoption of IFRS 16 has led to an increase of operating income by €3 million and an increase of net financing expenses by €8 million; profit before tax was €5 million lower and profit for the period was €3 million lower. The payments for the operating leases (€108 million), previously included in the net cash from operating activities, are now included in the net cash from financing activities.

The blended incremental borrowing rate applied to the lease liabilities at January 1, 2019, was 2.2%. The following table reflects the reconciliation of the operating lease commitments as at December 31, 2018, and the lease liabilities recognized as at January 1, 2019.

Changes in lease accounting

In € millions

2019

Operating lease commitments as at December 31, 2018

420

Adjustments as a result of finalizing the lease portfolio assessment

(7)

Low-value and short-term leases recognized on a straight-line basis as expense

(10)

Total undiscounted lease commitments

403

Discounting of lease commitments

(40)

Lease liability recognized at January 1, 2019

363

Other changes in accounting policies

Accounting pronouncements, which became effective for 2019 (among others IFRIC 23 ‘‘Uncertainty over income tax treatments” and ‘‘Plan Amendment, Curtailment and Settlement” (Amendments to IAS 19)) had no material impact on our Consolidated financial statements as to a large extent we already complied with these pronouncements.

Discontinued operations (Note 2)

A discontinued operation is a component of our business that represents a separate major line of business or geographical area of operations that has been disposed of or is held for sale/held for distribution, or is a subsidiary acquired exclusively with a view to resale. Assets and liabilities are classified as held for sale if it is highly probable that the carrying value will be recovered through a sale transaction within one year rather than through continuing use. When reclassifying assets and liabilities as held for sale, we recognize the assets and liabilities at the lower of their carrying value or fair value less costs to sell. Assets held for sale are not depreciated and amortized but tested for impairment. In case of discontinued operations, the comparative figures in the Consolidated statement of income and Consolidated statement of cash flows are represented. The balance sheet comparative figures are not represented.

Alternative Performance Measures (Note 3)

Our Alternative Performance Measures (APM) are based on IFRS measures and exclude so-called identified items. Identified items are special charges and benefits, results on acquisitions and divestments, major restructuring and impairment charges, and charges and benefits related to major legal, anti-trust, environmental and tax cases, which are generated outside the normal course of business.

Use of estimates

The preparation of the financial statements in compliance with IFRS requires management to make judgments, estimates and assumptions that affect amounts reported in the financial statements. The estimates and assumptions are based on experience and various other factors that are believed to be reasonable under the circumstances and are used to judge the carrying values of assets and liabilities that are not readily apparent from other sources. The estimates and underlying assumptions are reviewed on an ongoing basis. The most critical accounting policies involving a higher degree of judgment and complexity in applying principles of valuation and for which changes in the assumptions and estimates could result in significantly different results than those recorded in the financial statements are the following:

  • Scope of consolidation (Note 2)
  • Discontinued operations and held for sale (Note 2)
  • Income tax and deferred tax assets, including uncertain tax positions (Note 8)
  • Impairment of intangible assets, property, plant and equipment and right-of-use assets (Note 10, 11, 12)
  • Post-retirement benefit provisions (Note 18)
  • Provisions and contingent liabilities (Note 19)

Statement of cash flows

We have used the indirect method to prepare the statement of cash flows. Cash flows in foreign currencies have been translated at transaction rates. Acquisitions or divestments of subsidiaries are presented net of cash and cash equivalents acquired or disposed of, respectively. Cash flows from derivatives are recognized in the statement of cash flows in the same category as those of the hedged items.

Operating segments

We determine and present operating segments based on the information that is provided to the Executive Committee, our chief operating decision-maker during 2019, to make decisions about resources to be allocated to the segments and assess their performance. Segment results reported to the Executive Committee include items directly attributable to a segment as well as those items that can be allocated on a reasonable basis. Unallocated items comprise mainly of corporate assets and corporate costs and are reported in “Corporate and other”.

Foreign currencies

Transactions in foreign currencies are translated into the functional currency using the foreign exchange rate at transaction date. Monetary assets and liabilities denominated in foreign currencies are translated into the functional currency using the exchange rates at the balance sheet date. Resulting foreign currency differences are included in the statement of income, whereby interest-related effects are included in financing income and expenses. Non-monetary assets and liabilities denominated in foreign currencies are translated into the functional currency at the exchange rate at acquisition date.

The assets and liabilities of entities with other functional currencies are translated into euros, the functional currency of the parent entity, using the exchange rates at the balance sheet date. The income and expenses of entities with other functional currencies are translated into the functional currency, using the exchange rates at transaction date.

When a subsidiary is operating in a hyperinflationary country, the financial statements of this entity are restated into the current purchasing power at the end of the reporting period. As of January 1, 2018, hyperinflation accounting is applied for Argentina.

Foreign exchange differences resulting from translation into the functional currency of investments in subsidiaries and of intercompany loans of a permanent nature with other functional currencies are recorded as a separate component (cumulative translation reserve) within Other . These cumulative translation adjustments are reclassified (either fully or partly) to the statement of income upon disposal (either fully or partly) or liquidation of the foreign subsidiary to which the investment or the intercompany loan with a permanent nature relates to. Foreign currency differences arising on the translation of a financial liability designated as an effective hedge of a net investment in a foreign operation are recognized in the cumulative translation reserve (in other comprehensive income).

Exchange rates of key currencies

The principal exchange rates against the euro used in preparing the balance sheet and the statement of income are:

 

Balance sheet

Statement of income

 

2018

2019

%

2018

2019

%

US dollar

1.143

1.121

2.0

1.182

1.120

5.5

Pound sterling

0.898

0.854

5.2

0.885

0.878

0.8

Swedish krona

10.245

10.473

(2.2)

10.257

10.589

(3.1)

Chinese yuan

7.863

7.808

0.7

7.812

7.742

0.9

Brazilian real

4.438

4.507

(1.5)

4.307

4.414

(2.4)

Revenue recognition (Note 4)

Sale of goods

AkzoNobel’s main business consists of straightforward selling of goods (paints and coatings) to customers at contractually determined prices and conditions without any additional services. Although the transfer of risks and rewards is not the only criterion to be considered to determine whether control over the goods has transferred, it is in most situations considered to be the main indicator of the customer’s ability to direct the use of and obtain the benefits from the asset and largely also coincides with the physical transfer of the goods and the obligation of the customer to pay.

Variable considerations, including among others rebates, bonuses, discounts and payments to customers, are accrued for as performance obligations are satisfied and revenue is recognized. Variable considerations are only recognized when it is highly probable that these are not subject to significant reversal. In case of expected returns, no revenue is recognized for such products, but a refund liability and an asset for the right to recover the to be returned products are recorded.

A provision for warranties is recognized when the underlying products or services are sold, generally based on historical warranty data.

Revenue is recognized net of rebates, discounts and similar allowances, and net of sales tax.

Equipment provided to customers

AkzoNobel regularly provides mixing machines, store interior and other assets to its customers at the start of a paint delivery contract. The delivery of such assets qualifies as a separate performance obligation. Revenue can only be recognized at the moment of transfer of such assets, when there is an agreed sales price or when there is a binding take-or-pay commitment for a minimum quantity of paint to be acquired by the customer.

Services

AkzoNobel provides certain training, technical or support services to customers as well as shipping and handling activities for its customers. Service revenue is recognized over time when the related services are being provided. When not separately invoiced, part of the sales price of paints or coatings is allocated to such services.

Post-retirement benefits (Note 6, 18)

Contributions to defined contribution plans are recognized in the statement of income as incurred.

Most of our defined benefit pension plans are funded with plan assets that have been segregated in a trust or foundation. We also provide post-retirement benefits other than pensions to certain employees, which are generally not funded. Valuations of both funded and unfunded plans are carried out by independent actuaries based on the projected unit credit method. Post-retirement costs primarily represent the increase in the actuarial present value of the obligation for projected benefits based on employee service during the year and interest on the net defined benefit liability/asset. When the calculation results in a benefit to AkzoNobel, 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. An economic benefit is available if it is realizable during the life of the plan, or on the settlement of the plan liabilities. The effect of these so-called asset ceiling restrictions and any changes therein is recognized in other comprehensive income. Remeasurement gains and losses, which arise in calculating our obligations, are recognized in other comprehensive income. When the benefits of a plan improve, the portion of the increased benefits related to past service by employees is recognized as an expense in the statement of income immediately. We recognize gains and losses on the curtailment or settlement of a defined benefit plan when the curtailment or settlement occurs.

Interest on the net defined benefit liability/asset is included in financing expenses related to post-retirement benefits. Other charges and benefits recognized are reported in operating income, unless recorded in other .

Other employee benefits (Note 6, 19)

Provisions for other long-term employee benefits are measured at present value, using actuarial assumptions and methods. Any actuarial gains and losses are recognized in the statement of income in the period in which they arise.

Share-based compensation (Note 6)

We have a performance-related and a restricted share plan as well as a share-matching plan, under which shares are conditionally granted to certain employees. The fair value is measured at grant date and amortized over the three-year period during which the employees normally become unconditionally entitled to the shares with a corresponding increase in shareholders’ equity. Amortization is accelerated in the event of earlier vesting or settlement. In case of a plan modification, the fair value is increased when the change is beneficial to the employee.

Income tax (Note 8)

Income tax expense comprises both current and deferred tax, including effects of changes in tax rates. In determining the amount of current and deferred tax we also take into account the impact of uncertain tax positions and whether additional taxes and interest may be due. Income tax is recognized in the statement of income, unless it relates to items recognized in other comprehensive income or equity.

Current tax includes the expected tax payable and receivable on the taxable income for the year, using tax rates enacted or substantially enacted at reporting date, as well as (any adjustments to) tax payables and receivables with respect to previous years.

Deferred tax is recognized using the liability method on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the Consolidated financial statements. We do not recognize deferred tax for the initial recognition of goodwill, the initial recognition of assets or liabilities that affect neither accounting nor taxable profit, and differences related to investments in subsidiaries to the extent that they will probably not reverse in the foreseeable future. Deferred tax assets are recognized for unused tax losses, tax credits and deductible temporary differences, to the extent that it is probable that future taxable profits will be available against which they can be utilized.

Measurement of deferred tax assets and liabilities is based upon the enacted or substantially enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be reversed. Income tax consequences are taken into account in the determination of deferred tax liabilities to the extent earnings are expected to be distributed by subsidiaries in the foreseeable future and AkzoNobel has control over dividend distribution. Deferred tax positions are not discounted.

Earnings per share (Note 9)

Basic is calculated by dividing the profit for the period attributable to shareholders of the company by the weighted average number of common shares outstanding during the year adjusted for any repurchased shares. Diluted earnings per share is calculated by adjusting the weighted average number of common shares outstanding during the year for the diluting effect of the shares of the performance-related share plan, the restricted share plan and the share-matching plan.

represents the basic earnings per share from continuing operations excluding identified items, after taxes.

Government grants

Government grants related to costs are deducted from the relevant costs to be compensated in the same period. Government grants to compensate for the cost of an asset are deducted from the cost of the related asset. Emission rights granted by the government are recorded at cost. A provision is recorded if the actual emission is higher than the emission rights granted.

Intangible assets (Note 10)

Intangible assets are valued at cost less accumulated amortization and impairment charges. Intangible assets with an indefinite useful life, such as goodwill and certain brands, are not amortized, but tested for impairment annually using the value in use method. Goodwill in a business combination represents the excess of the consideration paid over the net fair value of the acquired identifiable assets, liabilities and contingent liabilities. If the cost of an acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in the statement of income. The effects of all transactions with non-controlling interest shareholders are recorded in equity if there is no change in control.

Intangible assets with a finite useful life, such as licenses, know-how, brands, customer relationships, intellectual property rights, emission rights and capitalized development and software costs, are capitalized at historical cost and amortized on a straight-line basis over the estimated useful life of the assets, which generally ranges from five to 40 years for brands with finite useful lives, five to 25 years for customer lists and three to 15 years for other intangibles. Amortization methods, useful lives and residual values are reassessed annually. Research expenditures are recognized as an expense as incurred.

Property, plant and equipment (Note 11)

Property, plant and equipment are valued at cost less accumulated depreciation and impairment charges. Costs include expenditures that are directly attributable to the acquisition of the asset, including borrowing cost of capital investment projects under construction.

Depreciation is calculated using the straight-line method, based on the estimated useful life of the asset components. The useful life of plant equipment and machinery generally ranges from ten to 25 years, and for buildings ranges from 20 to 50 years. Land is not depreciated. In the majority of cases residual value is assumed to be not significant. Depreciation methods, useful lives and residual values are reassessed annually.

Costs of major maintenance activities are capitalized and depreciated over the estimated useful life. Maintenance costs which cannot be separately defined as a component of property, plant and equipment are expensed in the period in which they occur. We recognize conditional asset retirement obligations in the periods in which sufficient information becomes available to reasonably estimate the cash outflow.

Impairments (Note 10, 11, 12)

We assess the carrying value of intangible assets, property, plant and equipment and right-of-use assets whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In addition, for goodwill and other intangible assets with an indefinite useful life, the carrying value is reviewed at least annually or when circumstances indicate the carrying amount may be impaired. If the carrying value of an asset or its cash-generating unit exceeds its estimated recoverable amount, an impairment loss is recognized in the statement of income on the function level of the asset impaired. The assessment for impairment is performed at the lowest level of assets generating largely independent cash inflows. For goodwill and other intangible assets with an indefinite life, we have determined this to be at business unit level (one level below segment).

Except for goodwill, we reverse impairment losses in the statement of income if and to the extent we have identified a change in estimates used to determine the recoverable amount.

Leases (Note 12, 20)

We applied IFRS 16 using the modified retrospective approach and therefore the comparative information for 2018 has not been restated and continues to be reported under IAS 17 and IFRIC 4. The details of accounting policies under IAS 17 and IFRIC 4 are disclosed separately.

Policy applicable from January 1, 2019

We assess whether a contract is, or contains, a lease at inception. A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for a consideration.

This policy is applied to contracts entered into, on or after January 1, 2019.

As a lessee

At commencement or on modification of a contract that contains a lease component, we allocate the consideration in the contract to each lease component on the basis of its relative stand-alone prices. However, for the leases of cars we have elected not to separate non-lease components and account for the lease and non-lease components as a single lease component.

We recognize a right-of-use asset and a lease liability at the lease commencement date. The right-of-use asset is initially measured at the present value of the lease liability. The right-of-use asset value contains lease prepayments, lease incentives received, the initial direct costs and an estimate of restoration, removal and dismantling costs.

The right-of-use assets are subsequently depreciated using the straight-line method from the commencement date to the end of the lease term or shorter economic life. In addition, the right-of-use assets is reduced by impairment losses, if any, and adjusted for certain remeasurements of the lease liability.

The net present value of the lease liability is measured at the discounted value of the lease payments. The liability includes payments to be made in optional periods if the lessee is reasonably certain to exercise an option to extend the lease, or not to exercise an option to terminate the lease. The lease payments comprise the following:

  • Fixed payments (including in substance fixed payments), less any lease incentives
  • Variable lease payments that depend on an index or a rate
  • The exercise price of a purchase option if it is reasonably certain that the option will be exercised
  • Payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease; and
  • Amounts expected to be payable under residual value guarantees.

These lease payments are discounted using the interest rate implicit in the lease if that rate can be readily determined. If that rate cannot be readily determined, the incremental borrowing rate is used. We determine our incremental borrowing rates by obtaining interest rates from various external financing sources and make certain adjustments to reflect the term of the lease and type of the asset leased.

At the lease commencement dates, we assess whether it is reasonably certain to exercise the extension options. We reassess whether it is reasonably certain to exercise the options if there is a significant event or significant change in circumstances within our control.

At the commencement date, we assess whether it is reasonably certain that:

  • An option to extend is exercised; or
  • An option to purchase is exercised; or
  • An option to terminate the lease is not exercised

In making these assessments, all relevant facts and circumstances that create an economic incentive for us to exercise, or not to exercise, the option, including any expected changes in facts and circumstances from the commencement date until the exercise date of the option are considered.

Short-term leases and leases of low-value assets

We elected not to recognize on the balance sheet right-of-use assets and lease liabilities for leases of low-value assets and short-term leases. We recognize the lease payments associated with these leases as an expense on a straight-line basis over the lease term.

Policy applicable before January 1, 2019

Lease contracts in which we have substantially all the risks and rewards of ownership are classified as financial leases. Upon initial recognition, the leased asset is measured at the lower of its fair value and the present value of minimum lease payments. Subsequent to initial recognition, the asset is depreciated using a straight-line method, based on the lower of the estimated useful life or the lease term. The interest expenses are recognized as other financing expenses over the lease term.

Payments made under operational leases are recognized in the statement of income on a straight-line basis over the term of the lease.

Associates and joint ventures (Note 13)

Associates and joint ventures are accounted for using the equity method and are initially recognized at cost. The Consolidated financial statements include our share of the income and expenses of the associates and joint ventures, whereby the result is determined using our accounting principles. When the share of losses exceeds the interest in the investee, the carrying amount is reduced to nil and recognition of further losses is discontinued, unless we have incurred legal or constructive obligations on behalf of the investee.

Inventories (Note 15)

Inventories are measured at the lower of cost and net realizable value. Costs of inventories comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to the present location and condition. The costs of inventories are determined using weighted average cost.

Provisions (Note 19)

We recognize provisions when a present legal or constructive obligation as a result of a past event exists, it is probable that an outflow of economic benefits is required to settle the obligation and the amount can be reliably estimated. Provisions are measured at net present value. The increase of provisions as a result of the passage of time is recognized in the statement of income under Financing income and expenses.

Provisions for restructuring of activities are recognized when a detailed and formal restructuring plan has been approved, and the restructuring has either commenced or has been announced publicly. We do not provide for future operating costs.

Financial instruments

Classification

All assets are measured at amortized cost, fair value through profit or loss or fair value through other comprehensive income. Financial assets are classified according to a model based on:

  • A contractual cash flow characteristics test
  • A business model dictating how the reporting entity manages its financial assets in order to generate cash flows as either:
    1. Hold to collect contractual cash flows.
    2. Collect contractual cash flows and sell.
    3. Neither 1 or 2.
  • Election of the fair value option in some specific cases in order to eliminate an accounting mismatch

The classification of a financial asset is determined at initial recognition, but if certain conditions are met, an asset might be subject to reclassification.

Valuation and impairment

Financial assets are assessed for impairment either according to the general approach or a simplified approach.

The calculation of impairment under the general approach uses the following stages:

  • 12-month expected credit losses; taking in account possible default events within one year
  • Lifetime expected credit losses in case of an increase in credit risk; through recognition of expected credit losses over the remaining life of the exposure
  • Lifetime expected credit losses, where interest is calculated on the net amount of the receivables less impairment loss

In all above stages, the impairment calculation used at AkzoNobel is based on external credit ratings of involved parties or default rates published by well-known credit risk agencies.

The financial assets included in the general impairment approach are long-term loans and other long-term receivables.

The calculation of impairment under the simplified approach requires recognition of lifetime expected credit loss (no tracking of changes in credit risk). The financial assets included in the simplified impairment approach are trade receivables and the remaining financial assets.

Measurement

Regular purchases and sales of financial assets and liabilities are recognized on trade date. The initial measurement of all financial instruments is at fair value. Except for derivatives and cash and cash equivalents, the initial measurement of financial instruments is adjusted for directly attributable transaction costs.

Derivative financial instruments (Note 26)

Derivative financial instruments are recognized at fair value on the balance sheet. Fair values are derived from market prices and quotes from dealers and brokers or are estimated using observable market inputs. When determining fair values, credit risk for our contract party, as well as for AkzoNobel, is taken into account.

Changes in the fair value are recognized in the statement of income, unless cash flow hedge accounting or net investment hedge accounting is applied. In those cases, the effective part of the fair value changes is deferred in other comprehensive income and released to the related specific lines in the statement of income or balance sheet at the same time as the hedged item.

Financial non-current assets (Note 14) and Trade and other receivables (Note 16)

Loans and receivables are measured at amortized cost, using the effective interest method, less any impairment losses.

Cash and cash equivalents and Short-term investments (Note 20)

Cash and cash equivalents and short-term investments are measured at fair value. Cash and cash equivalents include all cash balances and other investments that are directly convertible into known amounts of cash. Changes in fair values are included in financing income and expenses.

Long-term and Short-term borrowings (Note 20, 26) and Trade and other payables (Note 21)

Long-term and short-term borrowings, as well as trade and other payables, are measured at amortized cost, using the effective interest rate method. The interest expense on borrowings is included in financing income and expenses. The fair value of borrowings, used for disclosure purposes, is determined based on listed market price, if available. If a listed market price is not available, the fair value is calculated based on the present value of principal and interest cash flows, discounted at the interest rate at the reporting date, considering AkzoNobel’s credit risk.

New IFRS accounting standards

IFRS standards and interpretations thereof not yet in force which may apply to our Consolidated financial statements for 2020 and beyond have been assessed for their potential impact.

These include among others amendments to IFRS 3 ‘‘Definition of a Business”, amendments to IAS 1 and IAS 8 “Definition of Material”, ‘‘Amendments to References to the Conceptual Framework in IFRS Standards” and IFRS 17 ‘‘Insurance Contracts’’, all effective on or after January 1, 2020. These changes are not expected to have a material effect on AkzoNobel’s Consolidated financial statements.

Operating income

This is income excluding net financing expenses, results from associates and joint ventures, income tax and profit from discontinued operations. Operating income includes the share of non-controlling interests. Operating income includes identified items to the extent these relate to lines included in operating income.

Net debt

Defined as long-term borrowings plus short-term borrowings less cash and cash equivalents and short-term investments.

Comprehensive income

The change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with shareholders in their capacity as shareholders.

Comprehensive income

The change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with shareholders in their capacity as shareholders.

Earnings per share

Net income attributable to shareholders divided by the weighted average number of common shares outstanding during the year.

Adjusted earnings per share

Adjusted earnings per share are the basic earnings per share from operations, excluding identified items and taxes thereon.