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 below.

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, 2018. Essity applies the historical cost method for measurement of assets and liabilities except for financial assets and liabilities, including derivative instruments, measured at fair value through profit or loss, which are measured at fair value either in profit or loss or in other comprehensive income.

New or amended accounting standards 2018

In this Annual Report, the Group and Parent Company apply the new and amended standards that came into effect from January 1, 2018.

IFRS 9 Financial Instruments

IFRS 9 replaces IFRS 39 and includes rules governing how financial instruments are to be classified and measured, introduces a new model for impairment of financial assets based on expected credit losses and provides clarification of the rules for hedge accounting. Information regarding the effects of the changed rules for Essity is provided in the Capital structure and financing section, in Note E1, E2, E3, E6 and in the Risks and risk management section. The effects of the transition to IFRS 9 are described in Note G5 Changes due to new accounting rules.

IFRS 15 Revenue from Contracts with Customers

IFRS 15 replaces 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 establishes a new regulatory framework for the manner in which a company should recognize revenue relating to commercial agreements (contracts) with customers in which the delivery of goods/services is divided up into separate identifiable performance obligations that are reported independently. Information regarding the effects of the changed rules for Essity is provided in Note B1 – Net sales – Revenue from contracts with customers. The effects of the transition to IFRS 15 are described in Note G5 Changes due to new accounting rules.

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 2018

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 16 Leases

In 2018, Essity continued it preparations for the transition to the new standard IFRS 16 Leases. Leases have been analyzed and evaluated, system support for managing leases has been implemented and the organization has received training in the new standard and the new system support. When the standard becomes effective on January 1, 2019, Essity will apply the modified retrospective approach, entailing an adjustment of the opening balance with the cumulative effect of initially applying the standard on the first date of initial application and that comparative years will not be restated.

The lease liability is measured at the present value of the outstanding lease payments and the right-of-use asset for all leases totals an amount corresponding to the lease liability, adjusted for any prepaid lease payments and accrued lease payments recognized on December 31, 2018. For onerous leases, Essity has chosen to adjust the value of the right-of-use asset downward in an amount that in the 2018 year-end accounts was recognized as non-current and current provision. Only marginal reclassifications of accrued and prepaid lease payments and adjustments of provisions have taken place. An incremental borrowing rate has been set by currency. The average incremental borrowing rate on January 1, 2019 was approximately 3%. The transition does not have any impact on equity.

Essity has decided to apply the exemption rules for short-term leases and leases where the underlying asset has a low value. These leases are not included in the right-of-use asset or the liability. In its application of the standard, Essity has determined that a time horizon of five years can generally be applied to leases of offices and distribution centers with no fixed end date even if the formal lease term is shorter.

The following preliminary adjustments are recognized in Essity’s balance sheet on January 1, 2019 when the standard became effective. The right-of-use assets largely comprise leases for offices and distribution centers:

Essity assesses that IFRS 16 will have a slightly positive impact on EBITA and a slightly negative impact on financial items. Total assets will increase as a result of an increase in non-current assets and net debt.

IFRIC 23 Uncertainty over Income Tax Treatments

In 2017, a new interpretation was issued regarding the recognition of taxes, IFRIC 23. The interpretation clarifies how the recognition and measurement of uncertain tax positions is to be conducted. The new interpretation will apply from January 1, 2019. A retrospective approach or a modified retrospective approach is permitted. Essity has chosen the modified retrospective approach, meaning that comparative figures are not restated. In conjunction with the 2018 annual accounts, the Group evaluated the effects of the interpretation and determined that no material changes are expected, with the exception of the reclassification of Essity’s current and non-current provisions to tax liabilities in an amount of SEK 713m in the opening balance for 2019.

Use of assessments KAA

The preparation of financial statements in conformity 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, B5 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 venture or joint operation. 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 during the period on the Group’s net assets are recognized in other comprehensive income in the translation reserve as a component of equity.

Exchange rate effects arising from financial instruments used to hedge foreign subsidiaries’ net assets are recognized in the same manner in other comprehensive income in the translation reserve as a component of equity. On divestment, the accumulated translation differences on the foreign subsidiary and accumulated 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 in foreign currency 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 borrowing and financial investments are recognized as other financial items.

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 in other comprehensive income.

If a financial instrument has been classified as financial assets measured at fair value through comprehensive income, 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.

Government grants

Government grants are measured at fair value when there is reasonable assurance 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.