General Disclosures

(3) Discretionary decisions and sources of estimation uncertainty

Dealing with discretionary decisions and sources of estimation uncertainty

The preparation of the consolidated financial statements requires Merck to make discretionary decisions on the applicable accounting and measurement policies as well as estimates to a certain extent. The discretionary scope and estimation uncertainty are assessed on a company-specific basis. Discretion describes the need to make assumptions concerning recognition or measurement when applying accounting policies. Sources of estimation uncertainty affecting the selection of the valuation techniques to be applied relate in particular to the parameters used therein. The degree of estimation uncertainty may vary considerably depending on the availability and reliability of the input factors.

Increased uncertainty due to the macroeconomic situation

The continued dynamic development of the macroeconomic environment means that the degree of uncertainty in the preparation of the consolidated financial statements remains high. In particular, uncertainties included the sustained high level of inflation, the development of interest rates, geopolitical challenges, and efforts on the part of various nations to reduce international dependencies along with the related trade restrictions and sanctions. This applies in particular to the recoverability of non-financial assets. Based on the information currently available, there is no evidence of significant impairment losses to date. Furthermore, as in previous years, there are no grounds to suggest that the going concern assumption should not have been applied in preparing the consolidated financial statements.

Impact of inflation

The high rate of inflation slowed in fiscal 2023. Procurement costs for materials and energy in particular, which were mainly reflected in the increased cost of sales, remained above the level seen in previous years. As in the previous year, the cost of purchasing natural gas and electricity came to a low triple-digit million-euro amount for the Group in fiscal 2023. As in the previous year, Merck was able to offset these increased procurement costs by passing on price rises to the market. The assumptions concerning the long-term salary and pension trends applied in calculating pension obligations were reviewed again in fiscal 2023 to reflect the development of inflation, as they had been in the previous year. Compared with the previous year, however, this resulted in an adjustment and an increase in defined benefit obligations in connection with the measurement of defined benefit pension plans only in certain countries (see Note (33) “Provisions for employee benefits”).

Impact of higher interest rates

The sustained high level of interest rates in fiscal 2023 affected our customers’ refinancing costs, especially in the Life Science business sector, resulting in lower customer demand.

The higher interest rates also resulted in a rise in the discount rates applied in performing impairment testing and determining the fair values of financial and non-financial assets compared with the previous year (see Note (18) “Goodwill” and Note (43) “Information on fair value measurement” in particular).

Direct impact of armed conflicts

The war in Ukraine has not had any material effects on the Merck Group’s net assets, financial position, or results of operations owing to its limited business volume in Russia, Ukraine, Belarus, and the Republic of Moldova. In fiscal 2023 and 2022 alike, the total share of Group net sales generated in the aforementioned countries amounted to less than 1.5%. Furthermore, the conflict in the Middle East did not have a material impact on the Merck Group’s net assets, financial position, and results of operations in the reporting period. In fiscal 2023 and 2022 alike, the share of Group net sales generated with customers in Israel was less than 1%.

Impact of trade restrictions, sanctions, and supply chain bottlenecks

In the past, inventories were increased in order to limit the risks in connection with supply chain disruption. Accordingly, there is a heightened risk of subsequent write-downs if it is not possible to process or sell these inventories. Furthermore, the impact of the trade restrictions concerning semiconductor materials that were imposed between the United States of America and China in the fourth quarter of 2022 has been examined since fiscal 2022. No impairment losses have been recognized to date. However, there is considerable uncertainty with regard to future developments.

Increased uncertainty due to climate risks

As a globally active science and technology group, Merck is subject to transition-related and physical climate risks that could have a potentially negative impact on its net assets, financial position, and results of operations and lead to increased estimation uncertainty in accounting. To determine the potential impact of climate risks, a structured climate risk analysis is currently being conducted as part of a project aimed at implementing the recommendations of the “Task Force on Climate-Related Financial Disclosures” (TCFD) with the support of an external consulting firm and an insurance company.

Reduction targets for greenhouse gas emissions

Merck has set itself the goal of reducing its direct (Scope 1) and indirect (Scope 2) greenhouse gas emissions by 50% in comparison with the 2020 base year in the period from 2020 to 2030. By 2030, 80% of its purchased electricity will come from renewable sources. Merck also plans to reduce the indirect emissions along the entire value chain (Scope 3) in terms of metric kilotons of CO₂ equivalents per euro of gross profit by 52 % by 2030 and to achieve climate-neutral business operations along the entire value chain (Scope 1-3) by 2040. In 2022, the Science Based Targets Initiative confirmed that the targets for 2030 and the necessary measures support its ambition and that of the Paris Agreement to limit global warming to 1.5°C.

The goals described above are to be achieved through the following measures in particular:

• reduction in process-related emissions,
• increased purchase of electricity from renewable sources,
• energy efficiency measures,
• reduced emissions in the supply chain (e.g., switching to sea transportation), and
• recognition of a shadow price for the CO₂ emissions of major projects.

Transition-related climate risks

Transition-related climate risks describe the consequences for companies as a result of the transition to a more sustainable economic system.

The most significant transition-related climate risks to the net assets, financial position, and results of operations are in the Electronics business sector, which is responsible for well in excess of half of the Group’s direct (Scope 1) and indirect (Scope 2) greenhouse gas emissions. The majority of these greenhouse gas emissions take the form of process-related emissions resulting from the production of specialty gases for the semiconductor and electronics industries. In order to achieve the climate goals it has adopted, the Group intends to reduce the emissions in its business with these specialty gases by making technological improvements to the production process in particular. The recoverability of the assets recognized in connection with these products depends on the successful implementation of the technological improvements in production, as they could largely prevent the risk of long-term price rises due to the increased pricing of greenhouse gas emissions. Furthermore, based on the information currently available, the implementation of Merck’s sustainability strategy is not expected to result in a significant decline in net sales in this business. There have been no indications of impairment of the assets concerned to date, nor has it been necessary to adjust their remaining useful lives. There is significant estimation uncertainty due to the long-term nature of the underlying analyses and the high degree of uncertainty concerning future development.

Merck has concluded several virtual purchase agreements for the purchase of electricity from renewable energy sources as an additional measure to mitigate climate risks, and it also intends to increasingly purchase such electricity physically. After signing two virtual power purchase agreements in 2022, renewable energy sources will account for 90 % of the electricity consumed by Merck in the United States and 55 % of its global electricity consumption in the future. A further three virtual power purchase agreements were concluded in Spain in 2023 (see the disclosures in Note (42) “Management of financial risks” in addition to the existing virtual power purchase agreements that are in place with wind and solar farm project developers in the United States and Spain). This will further increase the proportion of energy consumption covered by renewable energy sources.

Merck participates in EU emissions trading and purchases emission certificates where the certificates allocated by the public authorities are not sufficient to cover Merck’s greenhouse gas emissions. The impact of this EU emissions trading is currently immaterial to Merck’s net assets, financial position, and results of operations.

Physical climate risks

Physical climate risks describe the risks that could result from longer-term changes in the general climatic conditions. For example, physical climate risks can have an accounting impact in the form of the necessary shortening of the economic life of items of property, plant, and equipment (“stranded assets”); the risk of operational disruption; or increased future expenses due to necessary adaptations to safeguard sites. In determining physical climate risks as part of the current TCFD project, the long-term impact of climate change was simulated for 100 site clusters of the Merck Group using two global warming scenarios for 2030 and 2050 that took account of risks due to flood, fire, wind, extreme heat, precipitation, drought, extreme cold, thunderstorms, and hail. All in all, the identified physical climate risks have not led to any material direct accounting impact. However, there is significant estimation uncertainty due to the long-term nature of the underlying analyses and the high degree of uncertainty concerning future development.

Overview of significant discretionary decisions and sources of estimation uncertainty

The accounting matters with the most significant discretionary decisions as well as the most comprehensive assumptions relating to the future and sources of estimation uncertainty are described below: