5 Accounting Policies

a) Recognition of Income and Expenses

Income from property management includes income from the rental of investment properties and assets held for sale which is recognized, net of discounts, over the duration of the contracts when the remuneration is contractually fixed or can be reliably determined and collection of the related receivable is probable.

In Vonovia’s financial statements, the corresponding income for all the services for ancillary costs performed by the end of the year is also recognized in the year in which the service is performed.

Income from real estate sales is recognized as soon as the material risks and rewards of ownership have been transferred to the buyer and Vonovia has no substantial further obligations. As far as any remaining obligations are concerned, a provision is recognized for the probable risk.

Expenses are recognized when they arise or at the time they are incurred. Interest is recognized as income or expense in the period in which it is incurred using the effective interest method.

b) Goodwill

Goodwill results from a business combination and is defined as the amount by which the acquisition costs for shares in a company or a group of companies exceed the pro rata net assets acquired. The net assets are the total of the identifiable assets acquired that are valued at in accordance with IFRS 3 as well as the assumed liabilities and contingent liabilities.

Goodwill is not subject to amortization, but rather is subjected to impairment testing on an annual basis. It is also tested for impairment whenever events or circumstances indicating an impairment arise.

The impairment testing of goodwill is performed at the level of a (CGU) or a group of cash-generating units. A cash-generating unit is the smallest group of assets which generates cash inflows that are largely independent of the cash inflows generated by other assets or other groups of assets. Goodwill purchased as part of a business combination is allocated to the CGUs or a group of CGUs that are expected to produce benefits resulting from the synergy effects of the combination. At Vonovia, each property meets the requirements for classification as a as a general rule. As part of operational management, these properties are grouped first of all to form geographically structured business units and then to form regional business areas. Since the regional business areas are the lowest level within the company at which goodwill is monitored for internal management purposes, the impairment test is performed at business area level and, as a result, in accordance with IAS 36.80 for a group of CGUs. The acquired assets are allocated to the business areas based on the geographical location of the properties. A further group of CGUs for which goodwill is monitored for internal management purposes relates to the Value-add Business segment. The Value-add Business segment combines all of the business activities relating to the expansion of the core business to include customer-oriented services, e. g., services that are closely related to and/or influence the rental business. The Value-add Business segment also includes the activities performed by the craftsmen’s and residential environment organization, new construction, the condominium administration business and insurance.

The group of CGUs to which goodwill has been allocated are tested for impairment.

This involves comparing the recoverable amount with the carrying amount of the group of CGUs. The recoverable amount of the group of CGUs is either its value in use or fair value less costs of sale, whichever is higher. When calculating the value in use, the estimated future cash flows are discounted to their cash value. Discount rates before tax are used that reflect the current market assessment of the interest rate effect and the specific risks associated with the business areas/the Value-add Business segment.

If goodwill has been allocated to a group of CGUs and its carrying amount exceeds the recoverable amount in the future, the goodwill is to be amortized in the amount of the difference in the first instance. Any need for amortization in excess of this amount is distributed among the other assets in the group of CGUs in proportion to their carrying amount. The individual fair value less costs to sell must not be undercut in this regard.

Impairment losses relating to the valuation of goodwill are not reversed.

c) Other Intangible Assets

Acquired other intangible assets are capitalized at amortized cost and internally generated intangible assets at amortized cost provided that the requirements of IAS 38 for the capitalization of internally generated intangible assets are met. All of Vonovia’s other intangible assets have definite useful lives and are amortized on a straight-line basis over their estimated useful lives. Software and licenses are amortized on the basis of a useful life of three years.

d) Property, Plant and Equipment

Items of property, plant and equipment are carried at amortized cost less accumulated depreciation and are depreciated over their respective estimated useful lives on a straight-line basis.

Subsequent costs of replacing part of an item of property, plant and equipment are capitalized provided it is probable that future economic benefits associated with the item will flow to Vonovia and the cost can be estimated reliably.

Real estate used by the company itself (owner-occupied properties) is depreciated over 50 years; equipment, fixtures, furniture and office equipment are depreciated over periods of between three and thirteen years.

e) Impairment of Other Intangible Assets and Property, Plant and Equipment

In accordance with IAS 36 “Impairment of Assets,” other intangible assets as well as property, plant and equipment are tested for impairment whenever there is an indication of an impairment. Impairment testing is performed at least once a year. An impairment loss is recognized when an asset’s recoverable amount is less than its carrying amount. If the recoverable amount cannot be determined for the individual asset, the impairment test is conducted on the CGU to which the asset belongs. Impairment losses are recognized as expenses in the income statement with effect on net income.

An impairment loss recognized for prior periods is reversed if there has been a change in the estimates used to determine the asset’s (or the CGU’s) recoverable amount since the last impairment loss was recognized. The carrying amount of the asset (or the CGU) is increased to the newly estimated recoverable amount. The carrying amount is limited to the amount that would have been determined if no impairment loss had been recognized in prior years for the asset (or the CGU).

f) Investment Properties

When Vonovia acquires properties, whether through a business combination or separately, the intended use determines whether such properties are classified as investment properties or as owner-occupied properties.

Investment properties are properties that are held for the purpose of earning or for capital appreciation or both and are not owner-occupied or held for sale in the ordinary course of business. Investment properties include undeveloped land, land and land rights including buildings and land with inheritable building rights of third parties. Properties that are capitalized under a finance lease in accordance with IAS 17 “Leases” and covered by the definition of investment properties are also classified as investment properties.

Investment properties are initially measured at cost. Related transaction costs, such as fees for legal services or real estate transfer taxes, are included in the initial measurement. If properties are purchased as part of a business combination and if the transaction relates to a “business,” then IFRS 3 applies as far as recognition is concerned. Transaction costs are recognized as an expense. Property held under a finance lease is recognized at the lower of the of the property and the present value of the minimum lease payments upon initial recognition.

Following initial recognition, investment properties are measured at fair value. Any change therein is recognized as affecting net income in the income statement.

For a description of the determination of the fair values of investment properties, see note [21] Investment Properties.

Investment properties are transferred to property, plant and equipment when there is a change in use evidenced by the commencement of owner-occupation. The properties’ deemed cost for subsequent measurement corresponds to the fair value at the date of reclassification.

g) Leases

Finance Leases

Leases where all material risks and rewards associated with ownership are transferred to the lessee are accounted for as finance leases.

Vonovia as a Lessee under a Finance Lease

The leased asset and corresponding liability are recognized at an amount equal to the lower of the fair value of the leased asset and the present value of the minimum lease payments. Subsequently, the leased asset is accounted for in accordance with the standards applicable to that asset. The minimum lease payments are apportioned between the finance charge and the reduction of the outstanding liability.

Operating Leases

All leases where not all material risks and rewards associated with ownership are transferred are accounted for as operating leases.

Vonovia as a Lessor under an Operating Lease

Lease payments are recognized as income on a straight-line basis over the lease term.

Vonovia as a Lessee under an Operating Lease

Lease payments are recognized as an expense on a straight-line basis over the lease term.

h) Non-derivative Financial Assets

Loans and Receivables

Loans and receivables are first recognized as incurred, other non-derivative financial assets as of the day of trading. The day of trading is the date on which Vonovia becomes a contracting party of the financial instrument. All financial instruments are initially measured at fair value, taking account of transaction costs. A financial asset is derecognized when the contractual rights to the cash flows from the financial asset expire, or the financial asset is transferred and Vonovia neither retains control nor retains material risks and rewards associated with ownership of the financial asset.

Loans and receivables are stated at amortized cost using the effective interest method.

Vonovia determines whether there is an objective indication of an impairment at the level of individual financial instruments if they are material, and, for financial instruments for which no impairments have been identified at the level of the individual financial instruments or such impairments are immaterial, grouped according to risk profile. Impairments are identified for individual financial instruments when the counterparty has defaulted or breached a contract or there are indications of risks of impairments due to a downgrade and general information (loss event). For groups of financial instruments with similar risks, historical default probabilities in relation to the time overdue are drawn upon (loss event). An impairment is calculated after the occurrence of a loss event as the difference between the carrying amount and the value of the discounted estimated future cash flow. The original effective interest rate is taken as the discount rate. Impairment losses are recognized with effect on net income and offset directly with the carrying amount of the financial instrument. Any interest income on impaired financial instruments is still recognized. If there are indications that the amount of the impairment loss will be smaller, this reduction is credited to the financial instrument affecting net income to the extent that the sum does not exceed the amortized cost that would have been recognized if the impairment had not occurred.

Available-for-Sale Financial Assets

Available-for-sale financial assets are initially stated at their fair value, plus the directly attributable transaction costs. Subsequent measurement is at fair value as a general rule. Changes in the fair value are, if not an impairment loss, recognized in other comprehensive income. Impairments are reclassified from other comprehensive income to the income statement. Reversals of impairments are recognized in accordance with IAS 39.67f.

The fair value of available-for-sale financial assets is based on quoted market prices as of the reporting date. When an available-for-sale financial asset is derecognized, the cumulative gain or loss recognized in other comprehensive income is transferred to the income statement with an impact on net income. Interest on interest-bearing financial instruments of this category is calculated using the effective interest method. Dividends on equity instruments in this category are shown in the income statement.

i) Inventories

Inventories are valued at cost or at their net realizable value, whichever is lower.

j) Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, checks and deposits at banking institutions as well as marketable securities with an original term of up to three months.

k) Assets Held for Sale

To be classified as held for sale, the assets must be available for immediate sale in their present condition subject only to terms that are usual and customary for sales of such assets, and it must be highly probable that a sale will take place. A sale is deemed to be highly probable if there is a commitment to a plan to sell the asset, an active program to locate a buyer and complete the plan has been initiated, the asset is being actively marketed for sale at a reasonable price, and a sale is expected to be completed within one year of the date on which the asset is classified as held for sale.

Vonovia accounts for investment properties as assets held for sale when notarized purchase contracts have been signed or a declaration of intent to purchase has been signed by both parties as of the reporting date but transfer of title will, under the contract, not take place until the subsequent period. Initially they are recognized at the contractually agreed selling price and subsequently at fair value following deductions for costs to sell, if the latter is lower.

l) Income and Expense Recognized Directly in Other Comprehensive Income

This equity line item includes changes in other comprehensive income not affecting net income except those resulting from capital transactions with equity holders (e. g., capital increases or dividend distributions). Vonovia includes under this item unrealized gains and losses from the fair value measurement of available-for-sale financial assets and derivative financial instruments that are designated as cash flow hedges as well as actuarial gains and losses from defined benefit pension commitments.

m) Tax

Current Income Taxes

Income taxes for the current and prior fiscal years are recognized as current income tax liabilities to the extent that they have not yet been paid.

A dividend payment to the shareholders does not trigger any tax obligation at Vonovia SE.

Deferred Taxes

Deferred tax assets and liabilities are recognized using the liability method under the temporary concept, providing for all temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. Deferred tax assets are only recognized for temporary differences and on loss carryforwards to the extent that there are deferred tax liabilities that can be offset against them – regarding deferred tax assets on loss carryforwards taking the minimum taxation into account – or, based on the predictable profits in the foreseeable future, it can be verified that they will be realized.

Deferred tax assets and liabilities are not recognized where the temporary difference arises from initial recognition of goodwill in connection with a business combination or the initial recognition (other than a business combination) of other assets and liabilities in a transaction that neither affects taxable income nor net income.

The carrying amount of a deferred tax asset is reviewed at each reporting date. If necessary, the carrying amount of the deferred tax asset is reduced to the extent that it is no longer probable that sufficient taxable profit will be available in the future.

Deferred taxes are measured at the tax rates that apply, or are expected to apply, to the period when the tax asset is realized or the liability is settled based on the current legislation in the countries in question. As in 2016, the combined tax rate of corporate income tax and trade tax of 33.1% was used to calculate domestic deferred taxes for 2017. The corporate income tax rate for the companies based in Austria is 25.0%.

Deferred tax assets and liabilities are offset against each other only if Vonovia has a legally enforceable right to set off the recognized amounts, when the same tax authority is involved and when the realization period is the same. In accordance with the regulations of IAS 12 “Income Taxes,” deferred tax assets and liabilities are not discounted.

n) Earnings Per Share

The basic earnings per share are calculated by dividing the profit for the period attributable to the shareholders by the weighted average number of ordinary shares in circulation during the reporting period. The diluted earnings per share are obtained by adjusting the profit for the period and the number of outstanding shares on the basis of the assumption that convertible instruments will be converted, options or warrants will be exercised or ordinary shares will be issued under certain conditions. Potential ordinary shares will only be included in the calculation if the conversion into ordinary shares would reduce the earnings per share.

o) Provisions

Provisions for Pensions and Similar Obligations

When valuing the provisions for pensions, the company pension obligations are determined using the projected unit credit method pursuant to IAS 19 “Employee Benefits,” whereby current pensions and vested pension rights as of the reporting date as well as expected future increases in salaries and pensions, are included in the valuation. An actuarial valuation is performed at each reporting date.

The amount shown in the balance sheet is the total present value of the defined benefit obligations (DBO) after offsetting against the fair value of the plan assets.

Actuarial gains and losses are accounted for in full in the period in which they occur and recognized in retained earnings as a component of other comprehensive income and not in profit or loss. The actuarial gains and losses are also no longer recognized with effect on net income in subsequent periods.

Service cost is shown in personnel expenses. The service cost is the increase in the present value of a defined benefit obligation resulting from employee service in the reporting period.

The interest expense is recognized as an increase in the present value in the financial result. Interest expense is the increase during a period in the present value of a defined benefit obligation that arises due to the fact that the benefit obligation is one period closer to being discharged.

Reinsurance contracts that qualify as plan assets have been taken out to cover the pension obligations toward particular individuals. Where the value of those reinsurance contracts exceeds the related pension obligations, the excess is recognized as an asset and shown under other assets.

Obligations from joint defined benefit multi-employer plans at Versorgungsanstalt des Bundes und der Länder (VBL), a pension scheme operated by the German federal government and the German states, are stated, in line with IAS 19.34, in the same way as obligations from defined contribution plans, insofar as the information required for the statement of defined benefit plans is not available. The obligations are based on the amounts to be paid for the current period.

Other Provisions

Other provisions are recognized when there is a present obligation, either legal or constructive, vis-à-vis third parties as a result of a past event, if it is probable that a claim will be asserted and the probable amount of the required provision can be reliably estimated. Provisions are discounted if the resulting effect is material. The carrying amount of discounted provisions increases in each period to reflect the passage of time and the unwinding of the discount is recognized within interest expense. The discount rate is a pre-tax rate that reflects current market assessments.

Provisions for restructuring expenses are recognized when the Group has set up and communicated a detailed formal plan for restructuring and has no realistic possibility of withdrawing from these obligations.

Provisions for onerous contracts are recognized when the expected benefits from a contract are lower than the unavoidable cost of meeting the obligations under the contract. The provision is stated at the lower of the present value of the fulfillment obligation and the cost of terminating the contract, i. e., a possible indemnity or fine for breach or non-fulfillment of contract.

Provisions are reviewed regularly and adjusted to reflect new information or changed circumstances.

The provisions for pre-retirement part-time work arrangements are basically to be classified as other long-term employee benefits that are to be accrued over the employees’ service periods.

The assets of the insolvency policy to secure fulfillment shortfalls arising from pre-retirement part-time work arrangements are offset against the amounts for fulfillment shortfalls contained in the provisions for pre-retirement part-time work arrangements.

p) Financial Liabilities

Vonovia recognizes non-derivative financial liabilities, which mainly include liabilities to banks and to investors, at their fair value on the day of trading, less the directly attributable transaction costs (this generally corresponds to the acquisition cost). These liabilities are subsequently measured at amortized cost using the effective interest method. Financial liabilities are derecognized when Vonovia’s obligations specified in the contract expire or are discharged or canceled.

Liabilities bearing no interest or interest below market rates in return for occupancy rights at rents below the prevailing market rates are recorded at present value.

Derivative financial instruments are stated at their fair value on the day of trading when they are recognized for the first time. The fair values of the derivative financial instruments are calculated using standard market valuation methods for such instruments on the basis of the market data available on the valuation date.

With derivatives that are not designated as a hedging instrument in the balance sheet, changes in the fair value are recognized in profit or loss with effect on net income.

With derivatives designated as hedging instruments, the recognition of changes in the fair value depends on the type of hedge:

With a fair value hedge, the changes in the fair value of the derivative financial instruments and of the underlying hedged items attributable to the hedged risk are recognized affecting net income.

With a cash flow hedge, the unrealized gains and losses are initially recognized in other comprehensive income to the extent that the hedge is effective. Amounts accumulated in other comprehensive income are reclassified to the income statement at the same time the underlying hedged item affects net income. To the extent that the hedge is ineffective, the change in fair value is immediately recognized in net interest.

Embedded derivative financial instruments that are combined with a non-derivative financial instrument (host contract) to form a hybrid financial instrument are to be separated from the underlying contract pursuant to IAS 39 as a general rule and accounted for separately if (i) its economic risks and characteristics are not closely related to those of the host contract, (ii) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative, and (iii) the hybrid instrument is not measured at fair value affecting net income with changes in fair value recognized in the income statement. As soon as the derivative is to be separated from its host contract, the individual components of the hybrid financial instrument are to be accounted for based on the provisions that apply to the individual financial instruments.

In order to measure interest rate swaps, future cash flows are calculated and then discounted. The calculated cash flows result from the contract conditions. The contract conditions refer to the EURIBOR reference rates (3M and 6M EURIBOR). Discounting is based on market interest rate data as of the reporting date for comparable instruments (EURIBOR rate of the same tenor). The fair value contains the credit risk of the interest rate swaps and therefore allows for adjustments for the company’s own credit risk or for the counterparty credit risk.

To measure the cross currency swaps, future cash flows are calculated and then discounted. The calculated cash flows result from the contract conditions and the USD forward rates (development of exchange rates expected by the market). Discounting is based on market interest rate data as of the reporting date for comparable instruments (EURIBOR rate of the same tenor). The fair value contains the credit risk of the cross currency swaps and therefore allows for adjustments for the company’s own credit risk or for the counterparty credit risk.

Liabilities from finance leases are initially recognized at the fair value of the leased object or the lower present value of the minimum lease payments. For the purposes of subsequent measurement, the leased asset is accounted for in accordance with the standards applicable to that asset. The minimum lease payments are split into an interest and a principal repayment component in respect of the residual debt.

Liabilities to non-controlling interests, which include obligations from the guaranteed dividend agreements, in particular, are stated at fair value when they are recognized for the first time. They are subsequently measured at amortized cost using the effective interest method.

q) Share-based Payment

The obligations arising from share-based payments are calculated using standard valuation methods based on option pricing models.

Equity-settled share-based payments are recognized at the grant date at the fair value of the equity instruments vested by that date. The fair value of the obligation is therefore recognized as personnel expenses proportionally over the vesting period and is offset directly against the capital reserves.

The cash-settled share-based payments are shown under other provisions and remeasured at fair value at each reporting date. The expenses are also recognized as personnel expenses over the vesting period (see notes [30] Provisions and [46] Share-Based Payment).

r) Government Grants

Vonovia companies receive grants from public authorities in the form of construction subsidies, expenses subsidies, expenses loans and low-interest loans.

Government grants are recognized when there is reasonable assurance that the relevant conditions will be fulfilled and that the grants will be awarded.

Government grants that do not relate to investments are regularly recognized as income in the periods in which the relevant expenses are incurred.

Expenses subsidies granted in the form of rent, interest and other expenses subsidies are recorded as income in the periods in which the expenses are incurred and shown within other income from property management.

The low-interest loans are grants from public authorities that – insofar as the company received them as part of a business combination – are recorded at present value. The difference between face value and present value is recognized with an effect on net income over the maturity term of the corresponding loans.

New expenses loans or low-interest loans are initially recognized at their present value within the non-derivative financial liabilities on the basis of the market interest rate at the time the loans are taken out. The difference between the face value and the present value of the loan is recognized as deferred income. Reversal occurs, in principle, with an effect on net income in line with the length of the fixed-interest-rate period of the relevant loans. In cases where the low-interest loans are issued as part of capitalized , the difference between the face value and the present value of the loan is deducted from the capitalized acquisition cost. In subsequent measurements, the loans are measured at amortized cost. In the 2017 fiscal year, Vonovia was granted low-interest loans of € 494.6 million (2016: € 75.0 million).

s) Contingent Liabilities

A contingent liability is a possible obligation towards third parties that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events or a present obligation that arises from past events for which an outflow of resources is not probable or the amount of which cannot be estimated with sufficient reliability. According to IAS 37 “Provisions, Contingent Liabilities and Contingent Assets,” contingent liabilities are not generally recognized.

t) Estimates, Assumptions, Options and Management Judgment

Estimates and Assumptions

To a certain extent, the preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the reporting date, as well as reported amounts of income and expenses during the reporting year. The actual amounts may differ from the estimates as the business environment may develop differently than assumed. In this case, the assumptions and, where necessary, the carrying amounts of the assets or liabilities affected are prospectively adjusted accordingly.

Assumptions and estimates are reviewed on an ongoing basis and are based on experience and other factors, including expectations regarding future events that appear reasonable under the given circumstances.

The estimates and assumptions that may have a material risk of causing an adjustment to the carrying amounts of assets and liabilities mainly relate to the determination of the fair value of investment properties.

The best evidence of fair value of investment properties is current prices in an active market for comparable properties. As such information is not available, however, Vonovia uses standard valuation techniques.

A detailed description of the discounted cash flow (DCF) method used can be found in note [21] Investment Properties.

In accordance with IAS 40 in conjunction with IFRS 13, the respective market values of the investment properties owned by Vonovia are determined for accounting purposes. Changes in certain market conditions such as prevailing rent levels and may affect the valuation of investment properties. Any changes in the fair value of the investment portfolio are recognized as part of the profit for the period in the Group’s income statement and can thus substantially affect Vonovia’s results of operations.

The statement of financial liabilities at amortized cost using the effective interest method takes the expected contractual cash flows into account. In some cases, the agreements do not have any fixed maturity terms. As a result, the cash flows included in the valuation are subject to management assumptions in terms of amount and term.

As explained in the accounting policies, Vonovia checks for goodwill impairments on an annual basis, or if there is any reason to suspect such impairments. The next step involves estimating the recoverable amount of the group of cash-generating units (CGU). This corresponds to either the fair value less costs of sale or the value in use, whichever is higher. Determining the value in use includes adjustments and estimates regarding the forecast and discounting of the future cash flow. Although the management believes that the assumptions used to determine the recoverable amount are appropriate, any unforeseeable changes in these assumptions could result in impairment losses, with a detrimental impact on the net assets, financial position and results of operations.

When determining the volume of current and deferred taxes, the Group takes into account the effects of uncertain tax items and whether additional taxes and interest may be due. This assessment is made on the basis of estimates and assumptions and may contain a number of judgments about future events. New information may become available that causes the Group to change its judgments regarding the appropriateness of existing tax liabilities; such changes to tax liabilities will affect the tax expense in the period in which such a change is made.

Deferred tax assets are recognized to the extent that it can be demonstrated that it is probable that future taxable profits will be available against which the temporary difference can be utilized. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that there will be sufficient future taxable profits to realize the tax benefit in the future.

Additional estimates and assumptions mainly relate to the uniform definition of useful lives, the assumptions made on the value of land and buildings, the recognition and measurement of provisions, as well as the realization of future tax benefits.

Options and Judgments

Options exercised and judgments made by Vonovia’s management in the process of applying the entity’s accounting policies that may have a significant effect on the amounts recognized in the consolidated financial statements include the following:

  • Determining whether the acquisition of investment properties as part of a business combination constitutes the acquisition of a “business” or the acquisition of an individual asset or group of assets can involve discretionary judgments.
  • Vonovia measures investment properties at fair value. If management had opted to use the cost model as permitted under IAS 40, the carrying amounts of the investment properties, as well as the corresponding income and expense items in the income statement, would differ significantly.
  • The criteria for assessing in which category a financial asset is to be classified may involve discretionary judgments.
  • Vonovia accounts for ancillary costs using the principal method, since Vonovia, as the landlord, bears responsibility for performing the service as well as the credit risk. With the principal method, income and expenses are not netted.
  • The decision on how to define a group of cash-generating units to which goodwill is allocated may involve discretionary judgments.
  • Allocating the goodwill to the group of individual cash-generating units may also involve discretionary judgments.
  • The parameters used in the impairment test, such as the determination of undiscounted cash flows, the weighted average cost of capital and the growth rate, may also involve discretionary judgments.
  • Due to a lack of any detailed definition of the term “operation” (IAS 36.86), the disposal of goodwill within the context of real estate sales may involve discretionary decisions.
  • Due to a lack of any detailed definition of the term “a separate major line of business or geographical area of operations” (IFRS 5), a disposal group within the context of real estate sales may involve discretionary decisions.
  • At the moment, there are no definitive provisions on how to reflect a mandatory acquisition of non-controlling interests following the acquisition of control as part of a voluntary public takeover offer. In general, the acquisition of shares as part of a public offer during the second offer period is based on exactly the same conditions as those that applied in the first offer period, and the two acquisitions are closely related in terms of content and timing. This means that, even if it is executed in two offer periods, the acquisition constitutes one and the same transaction (linked transaction). Following the completion of the later acquisition, the original purchase price allocation is to be adjusted with retroactive effect from the acquisition date, resulting in a change in the consideration transferred, the fair value net assets transferred and, consequently, the resulting goodwill.

u) Changes in Accounting Policies Due to New Standards and Interpretations

The application of numerous new standards, interpretations and amendments to existing standards became mandatory for the 2017 fiscal year.

The following new or amended standards and interpretations became mandatory for the first time in the 2017 fiscal year and have no material effects on Vonovia’s consolidated financial statements:

  • Improvements and supplements to a selection of IFRS 2014–2016
  • IAS 7 “Statement of Cash Flows”
  • IAS 12 “Income Taxes”

v) New Standards and Interpretations Not Yet Applied

Application of the following standards, interpretations and amendments to existing standards was not yet mandatory for the 2017 fiscal year. Vonovia also did not choose to apply them in advance. Their application will be mandatory for the fiscal years following the dates stated in the following table:

Relevant New Standards, Interpretations and Amendments to Existing Standards and Interpretations

 

Effective date for Vonovia

*

not yet endorsed

 

 

 

 

 

Improvements and supplements to a selection of IFRS 2014–2016

 

Jan 1, 2018*

Improvements and supplements to a selection of IFRS 2015–2017

 

Jan 1, 2019*

Amendments to Standards

 

 

IAS 28

 

"Investments in Associates and Joint Ventures"

 

Jan 1, 2019*

IAS 40

 

"Investment Property"

 

Jan 1, 2018*

IFRS 2

 

"Share-Based Payment"

 

Jan 1, 2018*

IFRS 4

 

"Insurance Contracts"

 

Jan 1, 2018

IFRS 9

 

"Financial Instruments: Classification and Measurement"

 

Jan 1, 2019*

IFRS 15

 

"Revenue Recognition"

 

Jan 1, 2018

IFRS 17

 

"Insurance Contracts"

 

Jan 1, 2021*

New Standards

 

 

IFRS 9

 

"Financial Instruments: Classification and Measurement"

 

Jan 1, 2018

IFRS 15

 

"Revenue Recognition"

 

Jan 1, 2018

IFRS 16

 

"Leases"

 

Jan 1, 2019

IFRS 17

 

"Insurance Contracts"

 

Jan 1, 2021*

IFRIC 22

 

"Foreign Currency Transactions and Advance Consideration"

 

Jan 1, 2018*

IFRIC 23

 

"Uncertainty over Income Tax Treatments"

 

Jan 1, 2019*

IFRS 9

The main impact of IFRS 9 “Financial Instruments” is shown below:

Classification and Measurement

In particular, IFRS 9 contains a new approach to the classification and measurement of financial assets that reflects both the business model in which the assets are held and the characteristics of their cash flows. The criteria determine whether the instrument in the subsequent measurement is to be measured at cost or fair value. Whenever financial investments are categorized as equity instruments, Vonovia will exercise an irrevocable option to state future changes to the fair value under other comprehensive income in equity. Gains or losses recognized in other comprehensive income are never reclassified from equity to the income statement when disposed of. In general, the new classification requirements will not have any material impact.

The following table shows the quantitative impact of classification in accordance with IFRS 9 compared with IAS 39:

Measurement category as of Dec. 31, 2017
in € million

 

IAS 39

 

IFRS 9

 

 

 

 

 

At amortized cost

 

14,766.4

 

14,766.4

At fair value through profit and loss

 

4.2

 

4.2

At fair value recognized directly in equity under other comprehensive income (OCI) with reclassification to the income statement

 

648.3

 

 

At fair value recognized directly in equity under other comprehensive income (OCI) without reclassification to the income statement

 

 

 

648.3

As far as the classification of financial liabilities is concerned, IFRS 9 continues to apply the existing requirements set out in IAS 39.

Impairment Losses

The main difference compared with IAS 39 relates to the newly developed expected loss model. The guiding principle of the expected credit loss model is to reflect the general pattern of deterioration or improvement in the credit quality of financial instruments. Under the old standard, impairments tended only to be recognized when the counterparty triggered such an event (incurred loss model). Based on the new standard, expected losses are already to be reflected in an impairment loss.

The need to include information concerning the future in the valuation of expected defaults means that the application of the standard will involve discretionary decisions regarding the impact that changes in economic factors will have on the expected defaults.

General Impairment Approach

According to the general approach, there are three levels of measurement:

  • Level 1: Twelve-month expected credit losses (ECLs), which applies to all items (from initial recognition) as long as there is no significant deterioration in credit quality,
  • Level 2: Lifetime ECLs (regarding homogenous debtor portfolios), which applies when a significant increase in credit risk has occurred on an individual financial instrument or a collective basis of financial instruments.
  • Level 3: Lifetime ECLs (based on an individual assessment): If an individual assessment of assets produces objective indications of a need for impairment, then Vonovia calculates the ECLs as it calculates the specific provisions (SP) at present.

Cash and cash equivalents, other non-current loans and other financial assets are measured as part of the general impairment approach.

Simplified Impairment Approach

With regard to trade receivables (e. g. rent receivables, receivables from ancillary costs, receivables from the sale of properties) or contract assets, the “simplified approach” is used and the entire term is taken as a basis.

The simplified approach means that the company does not need to track the changes in credit risk. Instead, loan loss provisions are set up in the amount of the lifetime expected credit losses both at the time of initial recognition and on each following reporting date.

The application of IFRS 9 will result in a considerable change in the calculation processes for the risk clustering of receivables from property letting, for updates to historical credit losses and for calculating the need for impairments taking forward-looking information into account. Nevertheless, Vonovia does not currently expect any major impact in terms of amount (less than € 5 million) within the scope of the impairment model according IFRS 9.

Hedge Accounting

The changes to IFRS 9 relating to hedge accounting include, among other things, an expanded range of eligible hedged items, changes regarding the posting approach for certain undesignated value components of hedging instruments, the abolition of the fixed effectiveness ranges and retrospective effectiveness testing as well as the first-time introduction of “recalibration.” The less restrictive provisions compared with IAS 39 make it easier to reflect economic risk management in the balance sheet, which can, in turn, reduce artificial volatility in the income statement.

In general, the new provisions set out above will not have any impact on the Vonovia Group.

At the time of initial application of IFRS 9, Vonovia will opt to continue to apply the hedge accounting provisions set out in IAS 39 instead of the provisions of IFRS 9. Vonovia will apply this accounting method to all hedge relationships.

Transition

Changes to accounting methods based on the application of IFRS 9 will be applied with retroactive effect as a general rule. There is, however, the option of making use of the exemption clause under which comparative information for prior periods does not have to be adjusted to reflect the changes in classification and measurement (including impairment). Vonovia will make use of the exemption clause. Differences between the carrying amounts of financial assets and financial liabilities due to the application of IFRS 9 will generally be recognized in retained earnings and other reserves as of January 1, 2018. At present, the application of IFRS 9 is not expected to have any material impact over and above the minor effects set out in quantitative terms above.

The initial application of IFRS 9 will result in changes to the information provided in the Notes. In Vonovia’s case, these changes will relate primarily to the presentation of impairment losses. In detail, the disclosures will start by explaining how the risk categories were set up, before calculating an expected loss rate based on the historical losses observed and indicators as to credit risks in the future that are already foreseeable (forward-looking information). The disclosures on the impairment accounts will provide transparent information on the individual developments in the fiscal year.

IFRS 15

The new accounting standard IFRS 15 – “Revenue from Contracts with Customers” establishes a comprehensive framework for determining whether and when to recognize revenue and how much revenue to recognize.

The aim of the new standard is to consolidate the wide range of provisions previously contained in various standards and interpretations. The new standard contains a single, comprehensive model on how companies are to recognize revenue from contracts with customers. The core principle of this model is that companies should recognize revenue in an amount that reflects the consideration to which they expect to be entitled in exchange for the performance obligations they have assumed. The standard contains much more extensive application guidelines and provisions on disclosures in the notes to the financial statements than the previous provisions, and also includes a new concept for defining whether an entity is a principal or an agent. The assessment of Vonovia’s position as the principal or the agent involves discretionary decisions, e. g., with regard to the weighting of the criteria set out in IFRS 15.B37.

IFRS 15 is to be applied to all contracts with customers, with the exception, inter alia, of leases covered by IAS 17 “Leases.”

The main types of revenue within the Vonovia Group are:

  • Income from property letting (rental income and ancillary costs),
  • Income from disposal of investment properties and
  • Other income from property management.

Within income from property letting, rental income does not fall under IFRS 15, but rather is covered by IAS 17 and as of January 1, 2019 by IFRS 16. As part of the implementation projects for IFRS 15 and IFRS 16, all ancillary cost components were analyzed in detail. IFRS 16 distinguishes not only between separate lease components, but also between other services (non-lease components, covered by IFRS 15) and components of the continuing obligation that do not result in the lessor providing a service (IFRS 16 B33).

In connection with this, an analysis of ancillary costs showed that the individual components will not be accounted for together, rather they will be recognized separately and that, in future, those parts of the continuing obligation that result in Vonovia being obliged to perform a service (other ancillary costs – covered by IFRS 15) will be distinguished from those that do not result in the tenant receiving a separate service, but for which the tenant has to reimburse Vonovia as part of the ancillary costs bill (land tax and buildings insurance – not covered by IFRS 15, but by IFRS 16 as of 2019). Before the application of IFRS 16, all components of a contract that are not leasing components pursuant to IAS 17 must, in accordance with IAS 17 in conjunction with IFRIC 4.12, be accounted for in accordance with other standards, meaning that they fall under IFRS 15.

The other ancillary costs will continue to be accounted for using the principal method, in particular due to Vonovia’s business model, which provides for a large proportion of services relevant to ancillary costs being performed by Vonovia itself as Vonovia is considered the primary party responsible for providing the service. For all services that it does not perform itself, Vonovia also bears an inventory risk, in particular due to the settlement method (based on rentable area), which corresponds to Section 565a of the German Civil Code (BGB) and is standard practice in the real estate sector. A particular weighting is to be assigned to this inventory risk at Vonovia due to the structure of the stock, as the settlement of ancillary costs based on individual consumption is usually not possible due to a current lack of meters at unit level.

Ultimately, the expenses relating to ancillary costs and the corresponding income are still not netted in the income statement under IFRS 15, which results in consistency of presentation and the clear reporting of net rent excluding ancillary expenses and rent including ancillary expenses. As there are no changes regarding the period-based recognition of income from ancillary costs, the application of IFRS 15 does not have any impact in terms of amount.

Otherwise, the new standard will not have any impact on the income from disposal of investment properties and other income from property management.

The standard is to be applied, for the first time, in the first reporting period in a fiscal year beginning on or after January 1, 2018. As the new standard does not have any impact in terms of amount, there is no need to select a transitional approach.

IFRS 16

The European Union adopted IFRS 16 “Leases” for application in Europe on November 9, 2017. IFRS 16 specifies how a company measures, presents and discloses leases according to IFRS.

The standard provides a single lessee accounting model. This model requires lessees to recognize all assets and liabilities for leases in the balance sheet unless the lease term is 12 months or less or the underlying asset has a low value (option in each case). Under IFRS 16, the lessee recognizes a lease liability equal to the present value of the future lease payments, plus directly attributable costs, and at the same time capitalizes a corresponding right of use to the underlying asset, for all leases in the balance sheet. During the term of a lease, the lease liability is adjusted in line with actuarial principles in a manner similar to that set out in the provisions of the previous IAS 17 for finance leases. Rights of use to assets that are not investment properties pursuant to IAS 40 are subject to scheduled amortization. Rights of use to investment properties that are measured at fair value in accordance with IAS 40 are measured in line with the standard recognition and measurement rules set out in IAS 40.

At the time of initial application, Vonovia expects to see an increase in its total assets due to the recognition of lease liabilities as well as a similarly marked increase in assets due to the rights of use to be capitalized. The equity ratio will fall accordingly. The main effect results from the capitalization of rights of use in connection with leasehold agreements.

The type of expenses associated with these leases will change in the income statement. The linear expenses for operating leases will be replaced by interest expenses for lease liabilities and, depending on the right-of-use asset, either by amortization expense for the right of use or by the earnings effect of the fair value measurement of investment properties. This will result in an improvement in and an increase in the cash flow from operating activities.

As far as lessors are concerned, the accounting model that IFRS 16 provides for does not differ significantly from the requirements set out in IAS 17. For Vonovia as a lessor, the still falls within the scope of IFRS 16. IFRS 16 distinguishes not only between separate lease components but also between other services (non-lease components, covered by IFRS 15) and other components of the continuing obligation that do not result in the lessor providing a service. The condition for identifying a separate non-lease component is the lessor’s obligation to provide a service pursuant to the continuing obligation (IFRS 16.B33). This means that the income from the ancillary costs, land tax and buildings insurance fall within the scope of IFRS 16, as the tenants do not receive any additional service in return.

The Group will apply IFRS 16 for the first time as of January 1, 2019. At present, Vonovia is considering applying the modified retrospective approach as a transitional approach.

The financial statements for the previous year already contain a description of the other new and amended standards and interpretations and their possible impact on Vonovia’s consolidated financial statements.

Fair Value
Valuation pursuant to IAS 40 in conjunction with IFRS 13. The estimated value of an asset. The fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.
Cash-Generating Unit (CGU)
The cash-generating unit refers, in connection with the impairment testing of goodwill, to the smallest group of assets that generates cash inflows and outflows independently of the use of other assets or other cash-generating units (CGUs).
Cash-Generating Unit (CGU)
The cash-generating unit refers, in connection with the impairment testing of goodwill, to the smallest group of assets that generates cash inflows and outflows independently of the use of other assets or other cash-generating units (CGUs).
Rental Income
Rental income refers to the current gross income for rented units as agreed in the corresponding rent agreements before the deduction of non-transferable ancillary costs.
Fair Value
Valuation pursuant to IAS 40 in conjunction with IFRS 13. The estimated value of an asset. The fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.
Rating
Classification of debtors or securities with regard to their creditworthiness or credit quality according to credit ratings. The classification is generally performed by rating agencies.
Modernization Measures
Modernization measures are long-term and sustainable value-enhancing investments in housing and building stocks. Energy-efficient refurbishments generally involve improvements to the building shell and communal areas as well as the heat and electricity supply systems. Typical examples are the installation of heating systems, the renovation of balconies and the retrofitting of prefabricated balconies as well as the implementation of energy-saving projects, such as the installation of double-glazed windows and heat insulation, e. g., facade insulation, insulation of the top story ceilings and basement ceilings. In addition to modernization of the apartment electrics, the refurbishment work upgrades the apartments, typically through the installation of modern and/or accessible bathrooms, the installation of new doors and the laying of high-quality and non-slip flooring. Where required, the floor plans are altered to meet changed housing needs.
Vacancy Rate
The vacancy rate is the number of empty units as a percentage of the total units owned by the company. The vacant units are counted at the end of each month.
Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization)
Adjusted EBITDA is the result before interest, taxes, depreciation and amortization (including income from other operational investments) adjusted for effects that do not relate to the period, recur irregularly or that are atypical for business operation, and for net income from fair value adjustments to investment properties. These non-recurring items include the development of new fields of business and business processes, acquisition projects, expenses for refinancing and equity increases (where not treated as capital procurement costs), IPO preparation costs and expenses for pre-retirement part-time work arrangements and severance payments.
Rental Income
Rental income refers to the current gross income for rented units as agreed in the corresponding rent agreements before the deduction of non-transferable ancillary costs.