6 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. This amount is recognized on a not netted basis 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 by the tenant to be the primary party responsible for providing the service. For all services that it does not perform itself, Vonovia also bears an inventory risk due to the settlement method (based on rentable area) as is standard practice in the real estate sector.

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) Income from Disposal of Properties (Development)

Income from disposal of properties (Development) is realized either over time or at a specific point in time as soon as the customer obtains control over the asset in question. No separate agreements are reached, in the contracts on the sale of apartments as part of the development business, on extraordinary rights of return or rescission, meaning that such rights are based on the relevant legal provisions. The same applies to warranty commitments, which are not to be treated as a separate contractual component within the meaning of IFRS 15 as a result. Existing warranty claims are always accounted for in line with the provisions of IAS 37.

In cases involving revenue recognition over time, the percentage of completion/progress made has to be assessed. Vonovia uses the cost-to-cost method, as an input-based procedure, for this purpose. The progress made is determined based on the ratio of the capitalized contract costs incurred up until the reporting date to the estimated total contract costs that can be capitalized.

c) Goodwill

Goodwill results from a business combination and is defined as the amount by which the acquisition costs for shares in a company or 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 fair value 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 loss testing of goodwill is performed at the level of cash-generating units (CGUs) 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 groups 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 CGU 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 segment (formerly “Value-add Business”). The third group of CGUs to which goodwill is allocated and for which goodwill is monitored for management purposes relates to the Development segment.

The group of CGUs to which goodwill has been allocated are tested for impairment on a regular basis. 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 segments and Development segments.

If goodwill has been allocated to a group of CGUs and its carrying amount exceeds the recoverable amount, the goodwill is to be written down in the amount of the difference in the first instance. Any need for impairment 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 that have been realized as part of the valuation of goodwill are not reversed in the following years.

d) Other Intangible Assets

Acquired other intangible assets are stated at amortized cost. Internally generated other intangible assets are stated at amortized cost provided that the requirements of IAS 38 for the capitalization of internally generated intangible assets are met. Acquired trademark rights that are identified have an indefinite useful life and are subject to regular impairment testing. All of Vonovia’s miscellaneous 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.

e) 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.

f) 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).

g) Investment Properties

When Vonovia acquires properties, whether through a business combination or as part of a separate transaction, 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 rental income 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 fair value 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 Chapter [23] 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.

h) Leases

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

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

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.

The lease payments under an operating lease in which Vonovia is the lessee are recognized as an expense on a straight-line basis over the lease term.

The lease payments under an operating lease in which Vonovia is the lessor are recognized as income on a straight-line basis over the lease term.

i) Financial Assets

Financial assets are recognized in the balance sheet when Vonovia becomes a contracting party of the financial instrument. A financial asset is derecognized when the contractual rights to the cash flows from a 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.

In accordance with IFRS 9, the classification of financial assets takes into account both the business model in which financial assets are held and the characteristics of the cash flows of the assets in question. These criteria determine whether the assets are measured at amortized cost using the effective interest method or at fair value.

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

With regard to the business model criterion, all financial investments at Vonovia are to be assigned to the “Hold” model pursuant to IFRS 9.4.1.2(a). Whenever financial investments are categorized as equity instruments, Vonovia has exercised the irrevocable option to state future changes to the fair value under other comprehensive income in equity. Gains and losses recognized in other comprehensive income are never reclassified from total equity to the income statement on their disposal.

Impairment losses on financial assets are determined based on the expected credit loss model. The guiding principle of the model is to reflect the general pattern of deterioration or improvement in the credit quality of financial instruments, taking losses that are already expected into account.

The IFRS 9 approach includes the following measurement levels:

• 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 (homogeneous debtor portfolios): which applies, when a significant increase in credit risk has occurred on an individual or 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 an assessment of the entire maturity of the financial instrument is decisive.

The simplified impairment approach is used with regard to trade receivables (e.g. rent receivables, receivables from ancillary costs, receivables from the sale of properties) and for contract assets pursuant to IFRS 15. This means that there is no need to track the changes in credit risk. Instead, Vonovia has to set up loan loss provisions in the amount of the lifetime expected credit losses both at the time of initial recognition and on each following reporting date.

Cash and cash equivalents are measured using the general impairment approach.

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 rating 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 (IAS 39)

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.

Equity Instruments at Fair Value Under Other Comprehensive Income

Equity instruments to be recognized at fair value under other comprehensive income 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 recognized in other comprehensive income.

The fair value of equity instruments to be recognized at fair value under other comprehensive income is based on quoted market prices as of the reporting date. If these equity instruments are derecognized, the cumulative gain or loss recognized in other comprehensive income is transferred to retained earnings, without affecting 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.

j) Inventories

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

k) 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.

l) Real Estate Inventories and Contract Assets

Real Estate Inventories

The development business intended for sale refers to subsidized or independently financed condominiums that are under construction or have already been completed. These properties are not held with the aim of generating rental income or achieving increases in value within the meaning of IAS 40, but rather are developed and constructed to be sold at a later date.

These development projects are recognized depending on whether there is a customer contract for the residential units that are intended for sale. If this is not the case, the valuation is performed, due to the intention to sell, according to IAS 2 at amortized cost or at net realizable value, whichever is lower, with a corresponding disclosure under real estate inventories.

Contract Assets

In cases involving development properties for which control, within the meaning of IFRS 15.35(c), already passes to the customer at the time at which the certified purchase agreement is concluded, revenue is to be recognized as of this point in time based on the degree of completion of the construction project. Disclosure of the contract assets that fall within the scope of IFRS 15 occurs on a net basis with the corresponding advance payments received under trade receivables.

The contract asset item also includes capitalized costs for the initiation of the contracts with customers. These relate, in particular, to brokerage commission, which is calculated differently in Germany and Austria. In Germany, the commission corresponds to 1.50% of the purchase price of the unit, while in Austria the percentage is 0.22%. The costs associated with the contract initiation process are amortized depending on how the goods or services to which the costs relate are transferred to the customer.

Contractual balances with an expected term of less than one year are not adjusted to reflect the time value of money.

m) 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 reporting 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.

n) Income and Expense Recognized Directly in Other Comprehensive Income

Other comprehensive income includes changes in total comprehensive income not affecting net income except that 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 equity instruments and derivative financial instruments that are designated as cash flow hedges. The item also includes actuarial gains and losses from defined benefit pension commitments, as well as certain currency translation differences.

o) 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 2017, the combined tax rate of corporate income tax and trade tax of 33.1% was used to calculate domestic deferred taxes for 2018. The corporate income tax rate for the companies based in Austria is 25.0%, while the rate for companies based in Sweden is 20.6%.

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.

p) 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.

q) 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 every 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 in the financial result. Interest expense is the increase during a period in the present value of a defined benefit obligation that generally 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.

r) 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.

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 for retrospective effectiveness testing and 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 as opposed to the provisions of IFRS 9. Vonovia will apply this accounting method to all hedge relationships.

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 regularly refer to the EURIBOR/STIBOR reference rates (3M and 6M EURIBOR/STIBOR). Discounting is based on market interest rate data as of the reporting date for comparable instruments (EURIBOR/STIBOR 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. The fair value is, in principle, determined by the value of the respective company; if a contractually agreed minimum purchase price is higher than this amount, this purchase price is recognized.

s) Financial Liabilities from Tenant Financing

Financial liabilities from tenant financing include tenant financing contributions. The financing contributions relate to the contributions collected from tenants in Austria for subsidized apartments. These are reimbursed upon the termination of the rental contract following the deduction of a depreciation amount. The amount refunded can be collected again relating to new tenants. As these are generally rental contracts that can be terminated at any time, these liabilities are reported as current liabilities.

Financial liabilities from tenant financing also include maintenance and improvement contributions deposited by tenants (EVB). These contributions are paid by tenants in Austria to finance the costs associated with modernization work. The payment depends on the age of the building and must be used up for modernization work within 20 years of their receipt. Otherwise, the contributions have to be refunded to the tenant.

First-time recognition is at fair value. Subsequent measurement is at amortized cost.

t) 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 [33] Provisions and [50] Share-based Payment).

u) Government Grants

The companies that belong to the Group 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 modernization measures, 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 2018 fiscal year, Vonovia was granted low-interest loans of € 171.1 million (2017: € 494.6 million).

v) 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, contingent liabilities are not generally recognized.

w) 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 completely available, however, Vonovia uses standard valuation techniques.

A detailed description of the discounted cash flow (DCF) method used can be found in note [23] 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 vacancy rates 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.

As part of the application of IFRS 15, the determination of the time at which a performance obligation is satisfied, the determination of the progress made in cases involving revenue recognition over time and the assumptions used to determine the amount of the capitalized contract initiation costs may involve discretionary judgment.

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.
• The need to include information concerning the future in the valuation of expected defaults results in discretionary decisions regarding the impact that changes in economic factors will have on the expected defaults.
• 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 of net assets transferred and, consequently, the resulting goodwill.

x) 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 2018 fiscal year.

The following new or amended standards and interpretations became mandatory for the first time in the 2018 fiscal year. The application of IFRS 9 “Financial Instruments” and IFRS 15 “Revenue from Contracts with Customers” is explained in the relevant sub-sections of the chapter on accounting policies. Neither of the new standards resulted in any adjustments being made to total equity at the time of the transition. The changes in classification pursuant to IFRS 9 are shown in the “Financial Assets” section of the chapter on accounting policies. None of the other new or amended standards listed below had a material impact.

• IAS 40: “Investment Properties”
• IFRS 2: “Share-based Payment”
• IFRS 4: “Insurance Contracts”
• IFRS 9 “Financial Instruments”
• IFRS 15 “Revenue from Contracts with Customers“
• IFRIC 22 “Foreign Currency Transactions and Advance Consideration”

y) New Standards and Interpretations not yet Applied

Application of the following standards, interpretations and amendments to existing standards was not yet mandatory for the 2018 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:

IFRS 16

In January 2016, the IASB published the new leasing standard IFRS 16 “Leases.” It was adopted by the European Union for application in Europe on November 9, 2017. IFRS 16 specifies how a company measures, presents and discloses leases according to IFRS and is to be applied for the first time, as a mandatory requirement, for fiscal years beginning on or after January 1, 2019.

In particular, IFRS 16 replaces the previous leasing standard, IAS 17 “Leases,” and introduces only one accounting model (right-of-use) for lessees, based on which all leases are to be recognized in the balance sheet as a matter of principle. There is an accounting option available for short-term leases and leases of low value assets. Vonovia will be making use of this option, meaning that such leases will not be recognized. The previous distinction between operating and finance leases will only remain in place for accounting at the level of the lessor.

As of January 1, 2019, all contracts that give the Vonovia Group the right to control the use of an asset over a certain period of time in return for consideration are considered leases within the meaning of IFRS 16.

In respect of those leases previously classified as operating leases, Vonovia will be recognizing lease liabilities as of January 1, 2019, equal to the present value of the future lease payments, discounted to reflect the term-specific incremental borrowing rate at the time of initial application. Right-of-use assets are recognized accordingly. The initial measurement of the right-of-use assets as of January 1, 2019, is based on the amount of the lease liabilities plus any advance payments that have already been made.

The right-of-use assets are generally recognized at amortized cost, taking amortization and write-downs into account. Right-of-use assets that meet the definition of investment properties (IAS 40) are already recognized at fair value as of the time of initial application in line with the recognition and measurement rules set out in IAS 40.

The lease liabilities are adjusted in line with financial principles. They are increased by the periodic interest expenses and reduced by the lease payments made.

Leases ending/expiring within the 2019 fiscal year are treated as short-term leases, meaning that they are not recognized. As far as rented IT equipment is concerned, portfolios have been set up for leases with similar terms and a single discount rate has been applied to these portfolios. As part of the transition to IFRS 16, Vonovia also takes scenarios pursuant to IAS 37 into account and adjusts the valuation of the right-of-use assets to reflect provisions for onerous contracts recognized on the reporting date.

The present value of the future lease obligations, pursuant to IAS 17, reported in the Notes to the consolidated financial statements as of December 31, 2018, deviates from the present value of the lease liabilities to be recognized as of January 1, 2019, pursuant to IFRS 16. This is due to leases that will expire in 2019 (short-term) and particularly due to those lease agreements that are not classified as leases under the control model within the meaning of IFRS 16.

Impact on the Consolidated Balance Sheet, Income Statement and Statement of Cash Flows

Vonovia is applying the new leasing standard for the first time as of January 1, 2019, based on the modified retrospective method provided for in the transitional provisions. Based on these provisions, the cumulative effect resulting from the initial application of IFRS 16 is recognized as an adjustment to the value of retained earnings in the opening balance sheet. Comparative information is not adjusted.

Vonovia expects the recognition of lease liabilities and right-of-use assets to increase its total assets by around € 311.4 million as of January 1, 2019, based on current calculations. This includes a reduction in retained earnings of around € 34.2 million resulting mainly from differences in the discounting of right-of-use assets and lease liabilities in connection with leasehold contracts. Due to the fair value measurement of the right-of-use assets under leasehold contracts, the right-of-use assets are calculated using property-specific discount rates. The lease liabilities from leasehold contracts, on the other hand, are calculated with the help of term-specific incremental borrowing rates. The equity ratio within the Group will fall accordingly. The weighted average incremental borrowing rate for all lease liabilities to be recognized amounts to 2.3% as of January 1, 2019.

In the consolidated income statement, leasing expenses from operating leases that were recognized on a straight-line basis in the past will be replaced, as of January 1, 2019, with amortization/earnings effects of the fair value measurement (for right-of-use assets relating to assets within the meaning of IAS 40) and interest expenses. This will result, all other things being equal, in an improvement in Adjusted EBITDA Total, EBITDA IFRS and an increase in the cash flow from operating activities. The cash flow from financing activities will be burdened due to the unwinding of discounting for the lease liabilities.

The application of IFRS 16 is not expected to have any impact on Vonovia’s ability to adhere to the financial covenants that are relevant to it.

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. As a result, no significant changes are expected for leases in which the Vonovia Group is the lessor. Rental income still falls within the scope of the accounting standard for leases (as of January 1, 2019: 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 contract 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 contract (IFRS 16.B33). This means that the income from land tax and buildings insurance, as types of ancillary costs, fall within the scope of IFRS 16 (previously: IAS 17), as the tenants do not receive any additional service in return.