A1. General accounting principles, new accounting rules and basis of preparation

Reading instructions

General accounting principles AP and new accounting rules are presented below. Other accounting principles considered material by Essity are presented in conjunction with the respective notes. The same principles are usually applied in both the Parent Company and the Group. In some cases, the Parent Company applies principles other than those used by the Group and, in such cases, these principles are specified under the respective note in the section about the Parent Company.

Key assessments and assumptions KAA are presented under the respective notes; see application of assessments.

Amounts that are reconcilable to the balance sheet, income statement, cash flow statement and the operating cash flow statement are marked with the following symbols:

BS Balance sheet

IS Income statement

CF Cash flow statement

OCF Operating cash flow statement

Tx:x Reference to table in note

Basis for preparation

Essity’s financial statements are prepared in accordance with the Annual Accounts Act and International Financial Reporting Standards (IFRS)/International Accounting Standards (IAS), as adopted within the EU, and the Swedish Financial Reporting Board, Recommendation RFR 1 Supplementary Accounting Rules for Groups. The Parent Company’s financial statements are prepared in accordance with the Swedish Financial Reporting Board’s recommendation RFR 2, Reporting by Legal Entities, and the Annual Accounts Act. The accounts for both the Group and the Parent Company relate to the fiscal year that ended on December 31, 2017. Essity applies the historical cost method for measurement of assets and liabilities except for available-for-sale financial assets and financial assets and liabilities, including derivative instruments, measured at fair value through profit or loss, which are measured at fair value either through profit or loss or other comprehensive income.

New presentation format for the income statement

Essity has modified the presentation format for the income statement and the 2016 and 2015 comparative years have been restated. According to the table below, amortization of acquisition-related intangible assets has been separated from “Cost of goods sold” and “Sales, general and administration” and recognized below on a new line, “Operating profit before amortization of acquisition-related intangible assets (EBITA)”. In a corresponding manner, depreciation/amortization and impairment of acquisition-related intangible assets included in items affecting comparability has been recognized separately. The reason for the reclassification is to clarify earnings before the effects of amortization of acquisition-related intangible assets.

New or amended accounting standards 2017

In this Annual Report, the Group and Parent Company apply the new and amended standards that came into effect from January 1, 2017.

IAS 7 Statement of Cash Flows (amendment)

IAS 7 has been amended and entails expanded disclosure requirements relating to changes arising from financing activities. The Group provides information in the section concerning the Group’s cash flow statement.

IAS 12 Income Taxes (amendment)

The amendment clarifies the recognition of deferred tax assets for holdings of debt instruments measured at fair value.

The above amendments did not have any material impact on the Group’s or Parent Company’s results or financial position.

New or amended accounting standards after 2017

A number of new and amended IFRS have not yet come into effect and have not been applied in advance in preparing the Group’s and the Parent Company’s financial statements. The IFRS that may affect the financial statements of the Group or the Parent Company are described below. Other new or amended standards or interpretations published by IASB are not expected to have any impact on the Group’s or the Parent Company’s financial statements.

IFRS 9 Financial Instruments

IFRS 9 Financial Instruments was issued in July 2014 and is a new standard that replaces IAS 39. The standard is divided into three areas: classification and measurement of financial assets and liabilities, impairment and hedging.

The company’s business model for managing the asset and the nature of the asset’s contractual cash flows comprise the basis for classification and measurement, in which the financial assets are classified in one of the following three categories: 1) financial assets measured at amortized cost 2) financial assets measured at fair value through other comprehensive income and 3) financial assets measured at fair value through profit or loss. The new standard entails essentially unchanged recognition of financial liabilities.

The standard introduces a new model for impairment of financial assets based on expected losses and not as previously under IAS 39 until the loss event has already occurred. Under the model, provisions are established for credit losses that may arise within the next 12 months for assets with low credit risk. In other cases where the credit risk has increased significantly since initial recognition and where the credit risk is not low, provisions are established for credit losses that are expected to occur during the full lifetime of the asset.

A simplified model has been developed for trade receivables and lease receivables, whereby anticipated losses are recognized over the estimated remaining term of the receivable. Upon review of the Group’s financial assets, it was concluded that the effects primarily relate to expected losses on trade receivables. In the first quarter of 2018, Essity intends to report a non-recurring effect of SEK 7m in equity due to a changed calculation model for expected credit losses on trade receivables.

The new standard focuses to a great extent on reflecting an entity’s risk management strategies in hedge accounting and allowing more hedging strategies to qualify for hedge accounting.

Essity has evaluated the new rules for hedge accounting and has concluded that these may provide Essity with greater scope to apply hedge accounting.

IFRS 15 Revenue from Contracts with Customers

IFRS 15 Revenue from Contracts with Customers establishes a new regulatory framework for the manner in which a company should recognize revenue. The new standard will replace IAS 11 Construction Contracts, IAS 18 Revenue, IFRIC (International Financial Reporting Interpretations Committee) 13 Customer Loyalty Programmes, IFRIC 15 Agreements for the Construction of Real Estate, IFRIC 18 Transfers of Assets from Customers and SIC (Standing Interpretation Committee of the IASC, predecessor to the IFRIC) 31 Revenue – Barter Transactions Involving Advertising Services. The standard will apply from January 1, 2018. During the year, IFRS 15 Clarification was issued, providing further guidance on when goods or services are to be recognized separately or jointly with other goods and services.

The standard regulates commercial agreements (contracts) with customers in which delivery of goods/services is divided into separately identifiable performance obligations that are recognized independently. In certain cases, the good/service can be integrated with other obligations in the contract, whereby a package of goods/services comprises a joint obligation. The standard establishes rules for calculating the transaction price for delivery of goods and services and the manner in which this can be allocated among the various performance obligations. Revenue is recognized when control has passed to the customer by the customer being able to use or benefit from the good/service, at which point it is deemed to have been transferred. Control may be passed at a given point in time, which is usually the case for sales. In other cases, a performance obligation may be satisfied over time, which is common for services. Three different criteria have been established for determining whether a performance obligation is satisfied over time. Either the customer receives and consumes all of the benefits as the obligation is performed; the company’s performance enhances an asset that the customer controls; or the company’s performance does not create an asset with an alternative use to the company and the company has an enforceable right to payment for performance completed to date. IFRS 15 aims to create more comparable and transparent financial reporting, which will be achieved by separating customer contracts as specified above and by providing significantly expanded disclosure regarding how and when revenue is generated. Disclosures encompass both quantitative and qualitative information to help the users of financial statements to understand the company’s business. Disclosures include information regarding contracts with customers, separation of revenue into geographical regions, categories or similar with reconciliation against the recognized segment, information regarding balance sheet items and information concerning significant assessments.

In 2016, Essity initiated a project to evaluate the consequences of implementing IFRS 15. Via a questionnaire, the project group identified the various types of contracts that exist within Essity and provided training to various parts of the Group in what is entailed by the transition to IFRS 15.

The conclusion can be drawn that Essity’s sales mainly comprise sales of products and, to a limited extent, services, but to ensure separate accounting of sales and services, separate accounts have been created for this.

The new reporting standard has transitioned from a risk and reward concept to focusing more on when control has been transferred to the customer. The project group has created awareness regarding and controls for avoiding material deviations between the point in time for revenue recognition and the point in time when control of the sold goods has been transferred to the buyer. Based on the above, this means that the new standard did not have any material impact on Essity’s revenue recognition.

IFRS 16 Leases

In January 2016, the IASB published a new leases standard that will replace IAS 17 Leases and associated interpretations IFRIC 4, SIC-15 and SIC-27. The standard requires that all assets and liabilities attributable to all leases with a few exceptions, are recognized in the balance sheet. This type of recognition is based on the approach that the lessee is entitled to use an asset over a specific period and simultaneously has an obligation to pay for this entitlement. The only exceptions are leases with a term of less than 12 months or assets with a low value, such as leases of computers and office furniture. Recognition for the lessor will remain unchanged. The standard is applicable to fiscal years beginning on January 1, 2019 or later. Prospective application is permitted. Essity has formed a project team that will prepare the Group to adapt its reporting to the new standard. The project team is currently identifying the leases within the Group and assessing which measures are necessary to adapt its reporting to the new standard. The cost of operational leases for the fiscal year 2017 amounted to SEK 776m. As of December 31, 2017, the undiscounted amount relating to payment commitments for operational lease agreements totaled approximately SEK 2,500m. However, the application of IFRS 16 would entail that a lower amount would be recognized as a liability and asset given that components of the lease agreements may refer to service and, moreover, the future payment commitments are also to be discounted. For more information about the company’s lease commitments, including the maturity structure, refer to Note G2 Leases.

Use of assessments KAA

The preparation of financial statements in accordance with IFRS and generally accepted Swedish accounting principles requires assessments and assumptions to be made that affect recognized asset and liability items and income and expense items, respectively, as well as other information disclosed.

These assumptions and estimates are often based on historical experience, but also on other factors, including expectations of future events. With other assumptions and estimates, the result may be different and the actual result will seldom fully concur with the estimated result.

In Essity’s opinion, the areas that are impacted the most by assumptions and estimates are:

Goodwill, D1 Intangible assets
Pensions, C5 Remuneration after employment
Taxes, B4 Income taxes
Provisions, D6 Other provisions

Essity’s assessments and assumptions are presented in the respective notes.

Principles of consolidation

Group companies are consolidated from the date the Group exercises control or influence over the company according to the definitions provided under the respective category of Group company below. Divested Group companies are included in the consolidated accounts until the date the Group ceases to control or exercise influence over the companies. Intra-Group transactions have been eliminated.

Parent Company

The Parent Company recognizes all holdings in Group companies at cost after deduction for any accumulated impairment losses.

Subsidiaries

All companies over which Essity Aktiebolag (publ) has control are included as subsidiaries. The definition of control is that Essity has the ability to control the subsidiary, is entitled to a return and has the power to influence the activities that impact this return. The consolidated financial statements are prepared in accordance with the purchase method.

Joint arrangements

Essity classifies its joint arrangements as joint ventures or joint operations. A joint venture entitles the joint owners to the net assets of the investment and is therefore recognized according to the equity method. In joint operations, parties to the agreement have rights to the assets and obligations for the liabilities associated with the investment, meaning that the operator must account for its share of the assets, liabilities, revenues and costs according to the proportional method.

Associates

Associates are companies in which the Group exercises a significant influence without the partly owned company being a subsidiary or a joint arrangement. Normally, this means that the Group owns between 20% and 50% of the votes. Accounting for associates is carried out according to the equity method and they are initially measured at cost.

For further information, see Note F3 Joint ventures and associates.

Translation of foreign currency

Functional currency and translation of foreign Group companies to the presentation currency

Essity’s Parent Company has Swedish kronor (SEK) as its functional currency. The functional currency of each Essity Group company is determined on the basis of the primary economic environment in which the respective company is active which, with a few exceptions, is the country in which the individual company operates. The financial statements of Group companies are translated to the Group’s presentation currency, which is SEK in the case of Essity. Assets and liabilities are translated at the closing rate, while income and expenses are translated at the average rate for the respective period. Translation differences on net assets are recognized as translation differences in other comprehensive income, which is a component of equity (translation reserve).

Exchange rate effects arising from financial instruments used to hedge foreign subsidiaries’ net assets are recognized in the same manner in other comprehensive income, which is a component of equity (translation reserve). On divestment, the translation difference on the foreign subsidiary and exchange rate effects on the financial instrument used to currency hedge the net assets in the company are recognized as part of the gain or loss on disposal.

Goodwill and fair value adjustments arising in connection with the acquisition of a foreign subsidiary are to be translated, in a manner corresponding to the net assets in the company, from their functional currency to the presentation currency.

Transactions and balance sheet items in foreign currency

Transactions in foreign currency are translated to a functional currency using the rate prevailing on the transaction date. At the balance sheet date, monetary assets and liabilities are translated at the closing rate and any exchange rate effects are recognized in profit or loss. In cases where the exchange rate effect is related to the operations, the effect is recognized net in operating profit. Exchange rate effects pertaining to borrowings and financial investments are recognized as other financial items. Non-monetary assets and liabilities recognized at historical cost are translated at the exchange rate prevailing on the transaction date.

If hedge accounting has been applied, for example, for cash flow hedges or hedging of net investments, the exchange rate effect is recognized in total equity under other comprehensive income.

If a financial instrument has been classified as available-for-sale financial assets, the portion of the value change pertaining to currency is recognized in profit or loss, while any other unrealized change is recognized in equity under other comprehensive income.

Revenue recognition

Sales revenue, which is synonymous with net sales, refers to the fair value of consideration received or receivable for goods and services sold within Essity’s ordinary activities. Revenue is recognized when delivery to the customer has taken place according to the terms of the sale. Other revenue includes compensation for sales that are not included in Essity’s ordinary activities and includes rental revenue, which is recognized in the period covered by the rental contract, royalties and similar items, which are recognized in accordance with the implied financial effect of the contract. Interest income is recognized in accordance with the effective interest method. Dividends received are recognized when the right to receive a dividend has been established.

Government grants

Government grants are measured at fair value when there is reasonable assurance that the grants will be received and that Essity will comply with the conditions attached to them. Government grants related to acquisition of assets are recognized in the balance sheet by the grant reducing the carrying amount of the asset. Government grants received as compensation for costs are accrued and recognized in profit or loss during the same period as the costs. If the government grant or assistance is neither related to the acquisition of assets nor to compensation for costs, the grant is recognized as other income.