2 Summary of Significant Accounting Policies

2.1 BASIS OF AND CHANGES IN ACCOUNTING STANDARDS

2.1.1 BASIS OF APPLICATION

These consolidated financial statements were prepared in accordance with the International Financial Reporting Standards (IFRS) as published by the International Accounting Standards Board (IASB), London. The statements take into account the recommendations of the International Financial Reporting Standards Interpretations Committee (IFRS IC), as applicable in the European Union (EU) and also give consideration to the supplementary German commercial law provisions, applicable in accordance with Sec. 315a Para. 1 of the German Commercial Code (HGB).

These consolidated financial statements for the financial year ended December 31, 2016 comprise MorphoSys AG and its subsidiaries (collectively referred to as the “MorphoSys Group” or the “Group”).

In preparing the consolidated financial statements in accordance with IFRS, the Management Board is required to make certain estimates and assumptions, which have an effect on the amounts recognized in the consolidated financial statements and the accompanying notes. The actual results may differ from these estimates. The estimates and the underlying assumptions are subject to continuous review. Any changes in estimates are recognized in the period in which the changes are made and in all relevant future periods.

The consolidated financial statements were prepared in euro – the MorphoSys Group’s functional currency. Statements are prepared on the basis of historical cost, except for derivative financial instruments and available-for-sale financial assets, which are recognized at their respective fair value. All figures in this report are rounded to the nearest euro, thousand euros or million euros.

Unless stated otherwise, the accounting policies set out below have been applied consistently to all periods presented in these consolidated financial statements.

2.1.2 CHANGES IN ACCOUNTING POLICIES AND DISCLOSURES

The accounting principles applied generally correspond to the policies used in the prior year.

The following new and revised standards and interpretations were applied for the first time in the financial year.

Standard/Interpretation Mandatory application for financial years starting on Adopted by the European Union Impact on MorphoSys
IFRS 10/12 and IAS 28 (A) Investment Entities – Applying the Consolidation Exception 01/01/2016 yes none
IFRS 11 (A) Accounting for Acquisitions of Interests in Joint Operations 01/01/2016 yes none
IFRS 14 Regulatory Deferral Accounts 01/01/2016 no none
IAS 1 (A) Disclosure Initiative 01/01/2016 yes yes
IAS 16 and IAS 38 (A) Clarification of Acceptable Methods of Depreciation and Amortisation 01/01/2016 yes none
IAS 16 and IAS 41 (A) Bearer Plants 01/01/2016 yes none
IAS 19 (A) Benefit Plans: Employee Contributions 02/01/2015 yes none
IAS 27 (A) Equity Method in Separate Financial Statements 01/01/2016 yes none
       
Annual Improvements to IFRSs 2010–2012 Cycle 02/01/2015 yes none
Annual Improvements to IFRSs 2012–2014 Cycle 01/01/2016 yes none
       
(A) Amendments        

The following new and revised standards and interpretations, which were not yet mandatory for the financial year or were not yet adopted by the European Union, were not applied. Standards with the remark “yes” are likely to have an impact on the consolidated financial statements, and their impact is currently being assessed by the Group. Only material impacts will be described in more detail. Standards with the remark “none” are not likely to have a material impact on the consolidated financial statements.

Standard/Interpretation Mandatory application for financial years starting on Adopted by the European Union Possible Impact on MorphoSys
IFRS 9 Financial Instruments 01/01/2018 yes yes
IFRS 15 Revenue from Contracts with Customers 01/01/2018 yes yes
IFRS 16 Leases 01/01/2019 no yes
IFRS 2 (A) Classification and Measurement of Share-based Payment Transactions 01/01/2018 no yes
IFRS 4 (A) Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts 01/01/2018 no none
IFRS 15 (C) Revenue from Contracts with Customers 01/01/2018 no yes
IAS 7 (A) Disclosure Initiative 01/01/2017 no none
IAS 12 (A) Recognition of Deferred Tax Assets for Unrealised Losses 01/01/2017 no yes
IAS 40 (A) Transfers of Investmenty Property 01/01/2018 no none
IFRIC (I) 22 Foreign Currency Transactions and Advance Consideration 01/01/2018 no yes
       
Annual Improvements to IFRSs 2014–2016 Cycle 01/01/2017/01/01/2018 no none
       
(A) Amendments        
(C) Clarifications        
(I) Interpretation        

The new standard governing financial instruments, IFRS 9, may lead to changes in the classification and measurement of financial assets and finan­cial liabilities, as well as to additional disclosures in the Notes. The provisions on impairments of financial assets and the accounting of hedging relationships may also result in changes from the currently applied provisions under IAS 39. The Group is currently assessing the possible impact of the application of IFRS 9 on the consolidated financial statements.

The new IFRS 15 standard on revenue recognition was reviewed for its potential impact on the revenue recognition of existing contracts and future contracts with partners and/or licensees. The review for the existing contrac­tual arrangements revealed that no material quantitative effects on the consolidated financial statements compared to the regulations currently applied are to be expected. Qualitative adjustments of the required disclosures in the Notes under IFRS 15 are expected, however, not before the standard’s first-time application as of January 1, 2018.

The Group also reviewed the new IFRS 16 standard governing leases for its potential impact on existing lease contracts. Currently, all leases are accounted for as operating leases pursuant to IAS 17. As of January 1, 2019, right-of-use assets under existing lease contracts will be capitalized and lease liabilities will be recognized. Rental costs currently recognized in the statement of income will be replaced by depreciation on the respective assets and interest expenses. From today’s perspective, the implementation of IFRS 16 will have material quantitative effects on the consolidated balance sheet due to the rented premises at Semmelweisstraße 7, Planegg. The exact amount of assets and lease liabilities and the transitional pro­visions to be applied when switching from IAS 17 to IFRS 16 have not yet been determined.

2.2 CONSOLIDATION PRINCIPLES

Intercompany balances and transactions and any unrealized gains arising from intercompany transactions are eliminated when preparing consolidated financial statements pursuant to IFRS 10.B86. Unrealized losses are eliminated in the same manner as unrealized gains but are considered an indication of the transferred asset’s possible impairment. Accounting policies have been applied consistently for all subsidiaries.

For all contracts and business transactions between group entities, the arm’s length principle was applied.

2.2.1 CONSOLIDATED COMPANIES AND SCOPE OF CONSOLIDATION

MorphoSys AG as ultimate parent company of the Group is located in Planegg near Munich. MorphoSys AG has two wholly owned subsidiaries (collectively referred to as the “MorphoSys Group” or the “Group”): Sloning BioTechnology GmbH (Planegg) and Lanthio Pharma B.V. (Groningen, The Netherlands). Additionally, MorphoSys AG’s investment in Lanthio Pharma B.V. indirectly gives it 100 % ownership in LanthioPep B.V. (Groningen, The Netherlands).

The consolidated financial statements for the year ended December 31, 2016 were prepared and approved by the Management Board in its meeting on March 6, 2017 by means of a resolution. The Management Board members are Dr. Simon Moroney (Chief Executive Officer), Jens Holstein (Chief Financial Officer), Dr. Marlies Sproll (Chief Scientific Officer), and Dr. Malte Peters (Chief Development Officer). Dr. Arndt Schottelius has been Chief Development Officer until February 28, 2017. Dr. Malte Peters assumed the position on March 1, 2017.

The Supervisory Board is authorized to amend the financial statements after their approval by the Management Board. MorphoSys Group’s registered head office is located in Planegg (district of Munich) and the registered business address is Semmelweisstraße 7, 82152 Planegg, Germany. The company is registered in the Commercial Register, Section B, of the District Court of Munich under the number HRB 121023.

2.2.2 CONSOLIDATION METHODS

The following Group subsidiaries are included in the scope of consolidation as shown in the following table.

Company Established in/ Purchase of Shares Included in Basis of Consolidation since
Sloning BioTechnology GmbH October 2010 10/07/2010
Lanthio Pharma B.V. May 2015 05/07/2015
LanthioPep B.V. May 2015 05/07/2015

These subsidiaries are fully consolidated because they are either directly or indirectly wholly owned. MorphoSys controls these subsidiaries because it possesses full power over the investees. Additionally, MorphoSys is subject to risk exposure or has rights to variable returns from its involve­ment with the investees. MorphoSys also has unlimited capacity to exert power over the investees to influence their returns.

The Group does not have any entities consolidated as joint ventures by using the equity method as defined by IFRS 11 “Joint Arrangements” nor does it exercise a controlling influence as defined by IAS 28 “Investments in Associates and Joint Ventures”. Interests in such entities would be measured at fair value or historic cost in accordance with IAS 39.

Assets and liabilities of fully consolidated domestic and international entities are recognized using Group-wide uniform accounting and valuation methods. The consolidation methods applied have not changed from the previous year.

Receivables, liabilities, expenses and income among consolidated entities are eliminated in the consolidated financial statements.

2.2.3 BASIS OF FOREIGN CURRENCY TRANSLATION

IAS 21 “The Effects of Changes in Foreign Exchange Rates” governs the accounting for transactions and balances denominated in foreign currencies. Transactions denominated in foreign currencies are translated at the exchange rates prevailing on the date of the transaction. Any resulting translation differences are recognized in profit and loss. On the reporting date, assets and liabilities are translated at the closing rate, and income and expenses are translated at the average exchange rate for the financial year. Any foreign exchange rate differences derived from these trans­lations are recognized in the consolidated statement of income.

2.3 FINANCIAL INSTRUMENTS AND FINANCIAL RISK MANAGEMENT

2.3.1 CREDIT RISK AND LIQUIDITY RISK

Financial instruments that could subject the Group to a concentration of credit and liquidity risk include primarily cash and cash equivalents, market­able securities (consisting of available-for-sale financial assets and bonds), financial assets of the loans and receivables category, derivative financial instruments and receivables. The Group’s cash and cash equivalents are principally denominated in euros. Marketable securities and finan­cial assets of the loans and receivables category represent investments in high-quality securities. Cash, cash equivalents, marketable securi­ties and financial assets of the loans and receivables category are held at several renowned financial institutions in Germany. The Group continuously monitors its positions with financial institutions that are counterparts to its financial instruments and these institutions’ credit ratings and does not expect any risk of non-performance.

One of the Group’s policies requires all customers who wish to transact business on credit terms to undergo a credit assessment based on external ratings. Nevertheless, the Group’s revenues and accounts receivable are still subject to credit risk from customer concentration. The Group’s most significant single customer accounted for € 8.4 million of accounts receivables as of December 31, 2016 (December 31, 2015: € 8.3 million). This customer accounted for 66 % of the Group’s accounts receivable at the end of 2016. Three individual customers of the Group accounted for 85 %, 5 % and 5 %, respectively, of the total revenues in 2016. On December 31, 2015, one customer had accounted for 73 % of the Group’s accounts receivable and three customers had individually accounted for 56 %, 39 %, and 2 % of the Group’s revenues in 2015. Based on the Management Board’s assessment, no allowances were required in the financial years 2016 and 2015. The carrying amounts of financial assets represent the maximum credit risk.

The table below shows the credit risk of accounts receivables by region as of the reporting date.

in € 12/31/2016 12/31/2015
Europe and Asia 9,852,273 10,809,051
USA and Canada 2,744,382 633,008
Other 0 0
Total 12,596,655 11,442,059

The following table shows the term structure of trade receivables as of the reporting date.

in €; A/R are due since 12/31/2016 0 – 30 days 12/31/2016 30 – 60 days 12/31/2016 60+ days 12/31/2016 Total
Accounts Receivable 12,596,655 0 0 12,596,655
Write-off 0 0 0 0
Accounts Receivable, Net of Allowance for Impairment 12,596,655 0 0 12,596,655
in €; A/R are due since 12/31/2015 0 – 30 days 12/31/2015 30 – 60 days 12/31/2015 60+ days 12/31/2015 Total
Accounts Receivable 11,442,059 0 0 11,442,059
Write-off 0 0 0 0
Accounts Receivable, Net of Allowance for Impairment 11,442,059 0 0 11,442,059

As of December 31, 2016 and December 31, 2015, the Group was not exposed to a credit risk from derivative financial instruments. The maximum credit risk of financial guarantees (rent deposits) on the reporting date amounted to € 1.3 million (December 31, 2015: € 0.6 million).

The contractually agreed maturities and the corresponding cash outflows of accounts payable are within one year. Convertible bonds issued to related parties mature on March 31, 2020 (maximum cash outflow: € 0.2 million).

2.3.2 MARKET RISK

Market risk is the risk that changes in market prices, such as foreign exchange rates, interest rates and equity prices will affect the Group’s results of operations or the value of the financial instruments held. The Group is exposed to currency and interest rate risks.

CURRENCY RISK

The consolidated financial statements are prepared in euros. Whereas MorphoSys’s expenses are predominantly incurred in euros, a portion of the revenue is dependent on the prevailing exchange rate of the US dollar. Throughout the year, the Group monitors the need to hedge foreign exchange rates to minimize currency risk and addresses this risk by using derivative financial instruments.

The table below shows the Group’s exposure to foreign currency risk based on the items’ carrying amounts.

as of December 31, 2016; in € EUR USD Other Total
Cash and Cash Equivalents 73,456,907 471,754 0 73,928,661
Available-for-sale Financial Assets 63,361,727 0 0 63,361,727
Bonds, Available-for-sale 6,532,060 0 0 6,532,060
Financial Assets classified as Loans and Receivables 136,108,749 0 0 136,108,749
Financial Assets classified as Loans and Receivables, Net of Current Portion 79,521,181 0 0 79,521,181
Accounts Receivable 12,215,814 380,841 0 12,596,655
Accounts Payable and Accrued Expenses (31,794,114) (428,502) 0 (32,222,616)
Total 339,402,324 424,093 0 339,826,417
as of December 31, 2015; in € EUR USD Other Total
Cash and Cash Equivalents 90,206,933 720,740 0 90,927,673
Available-for-sale Financial Assets 64,292,830 0 0 64,292,830
Bonds, Available-for-sale 33,120,117 0 0 33,120,117
Financial Assets classified as Loans and Receivables 94,587,528 0 0 94,587,528
Financial Assets classified as Loans and Receivables, Net of Current Portion 15,510,989 0 0 15,510,989
Accounts Receivable 11,365,659 76,400 0 11,442,059
Accounts Payable and Accrued Expenses (22,308,082) (28,548) (5,033) (22,341,663)
Total 286,775,974 768,592 (5,033) 287,539,533

Various foreign exchange rates and their impact on assets and liabilities were simulated in an in-depth sensitivity analysis to determine the effects on income. A 10 % increase in the euro versus the US dollar as of December 31, 2016 would have reduced the Group’s income by less than € 0.1 million. A 10 % decline in the euro versus the US dollar would have increased the Group’s income by less than € 0.1 million.

A 10 % increase in the euro versus the US dollar as of December 31, 2015 would have reduced the Group’s income by € 0.1 million. A 10 % decline in the euro versus the US dollar would have increased the Group’s income by € 0.1 million.

If the foreign exchange rates for the US dollar versus the euro had remained at the prior year’s average rate, the Group’s revenues would have been less than € 0.1 million lower. In 2015, Group revenues would have been € 0.1 million lower.

INTEREST RATE RISK

The Group’s risk exposure to changes in interest rates mainly relates to available-for-sale securities. Changes in the general level of interest rates may lead to an increase or decrease in the fair value of these securities. The Group’s investment focus places the safety of an investment ahead of its return. Interest rate risk is limited because all securities can be liquidated within a maximum of two years.

The Group is not subject to significant interest rate risks from the liabilities currently reported in the balance sheet.

2.3.3 FAIR VALUE HIERARCHY AND MEASUREMENT PROCEDURES

The IFRS 13 “Fair Value Measurement” guidelines must always be applied when measurement at fair value is required or permitted or disclosures regarding measurement at fair value are required based on another IAS/IFRS guideline. The fair value is the price that would be achieved for the sale of an asset in an arm’s length transaction between independent market participants or the price to be paid for the transfer of a liability (disposal or exit price). Accordingly, the fair value of a liability reflects the default risk (i.e., own credit risk). Measurement at fair value requires that the sale of the asset or the transfer of the liability takes place on the principal market or, if no such principal market is available, on the most advantageous market. The principal market is the market a company has access to that has the highest volume and level of activity.

Fair value is measured by using the same assumptions and taking into account the same characteristics of the asset or liability as would an independent market participant. Fair value is a market-based, not an entity-specific measurement. The fair value of non-financial assets is based on the best use of the asset by a market participant. For financial instruments, the use of bid prices for assets and ask prices for liabilities is permitted but not required if those prices best reflect the fair value in the respective circumstances. For simplification, mean rates are also permitted. Thus, IFRS 13 not only applies to financial assets but all assets and liabilities.

MorphoSys uses the following hierarchy for determining and disclosing the fair value of financial instruments:

Level 1: Quoted (unadjusted) prices in active markets for identical assets or liabilities to which the Company has access.

Level 2: Inputs other than quoted prices included within Level 1 that are observable for the assets or liabilities, either directly (i.e., as prices) or indirectly (i.e., derived from prices).

Level 3: Inputs for the asset or liability that are not based on observable market data (that is, unobservable inputs).

The carrying amounts of financial assets and liabilities, such as cash and cash equivalents, marketable securities, financial assets of the loans and receivables category and accounts receivable and accounts payable approxi­mate their fair value because of their short-term maturities.

HIERARCHY LEVEL 1

The fair value of financial instruments traded in active markets is based on the quoted market prices on the reporting date. A market is considered active if quoted prices are available from an exchange, dealer, broker, indus­try group, pricing service or regulatory body that is easily and regularly accessible and prices reflect current and regularly occurring market transactions at arm’s length conditions. For assets held by the Group, the appropriate quoted market price is the buyer’s bid price. These instruments fall under Level 1 of the hierarchy (see also Item 5.2 of these Notes).

HIERARCHY LEVEL 2 AND 3

The fair value of financial instruments not traded in active markets can be determined using valuation methods. In this case, fair value is estimated using the results of a valuation method that makes maximum use of market data and relies as little as possible on entity-specific inputs. If all inputs required for measuring fair value are observable, the instrument is allocated to Level 2. If important inputs are not based on observable market data, the instrument is allocated to Level 3.

Hierarchy level 2 contains the forward exchange contracts used for currency hedging. Future cash flows for these forward exchange contracts are determined based on forward exchange rate curves. The fair value of these instruments corresponds to their discounted cash flows.

There were no financial assets or liabilities allocated to hierarchy level 3.

There were no transfers from one fair value hierarchy level to another in 2016 or 2015.

The table below shows the fair values of financial assets and liabilities and the carrying amounts presented in the consolidated balance sheet.

December 31, 2016 (in 000’ €) Note Hierarchy Level Loans and Receivables Available-for-sale Other Financial Liabilities Total Carrying Amount Fair value
Cash and Cash Equivalents 5.1 1 73,929 0 0 73,929 73,929
Financial Assets classified as Loans and Receivables 5.2 1 136,109 0 0 136,109 136,109
Accounts Receivable 5.3 1 12,597 0 0 12,597 1
Forward Exchange Contracts Used for Hedging 5.4 2 520 0 0 520 520
Other Receivables 5.4 1 137 0 0 137 137
Financial Assets classified as Loans and Receivables, Net of Current Portion 5.2 1 79,521 0 0 79,521 79,521
Available-for-sale Financial Assets 5.2 1 0 63,362 0 63,362 63,362
Bonds, Available-for-sale 5.2 1 0 6,532 0 6,532 6,532
Total 302,813 69,894 0 372,707 360,110
Convertible Bonds – Liability Component 7.1 1 0 0 (218) (218) (218)
Accounts Payable and Accrued Expenses 6.1 1 0 0 (32,223) (32,223) 1
Forward Exchange Contracts Used for Hedging 5.4 2 0 0 0 0 0
Total 0 0 (32,441) (32,441) (218)
1
Declaration waived in line with IFRS 7.29 (a).
December 31, 2015 (in 000’ €) Note Hierarchy Level Loans and Receivables Available-for-sale Other Financial Liabilities Total Carrying Amount Fair value
Cash and Cash Equivalents 5.1 1 90,928 0 0 90,928 90,928
Financial Assets classified as Loans and Receivables 5.2 1 94,588 0 0 94,588 94,588
Accounts Receivable 5.3 1 11,442 0 0 11,442 1
Forward Exchange Contracts Used for Hedging 5.3 2 750 0 0 750 750 2
Other Receivables 5.4 1 574 0 0 574 574
Financial Assets classified as Loans and Receivables, Net of Current Portion 5.2 1 15,511 0 0 15,511 15,511
Available-for-sale Financial Assets 5.2 1 0 64,293 0 64,293 64,293
Bonds, Available-for-sale 5.2 1 0 33,120 0 33,120 33,120
Total 213,793 97,413 0 311,206 299,764
Convertible Bonds – Liability Component 7.1 1 0 0 (225) (225) (225)
Accounts Payable and Accrued Expenses 6.1 1 0 0 (22,342) (22,342) 1
Forward Exchange Contracts Used for Hedging 5.4 2 0 0 (25) (25) (25)
Total 0 0 (22,592) (22,592) (250)
1
Declaration waived in line with IFRS 7.29 (a).
2
As of December 31, 2015, nil had been disclosed; the carrying amount equaled the fair value.

2.4 IMPAIRMENTS

2.4.1 NON-DERIVATIVE FINANCIAL INSTRUMENTS

A financial instrument not carried at fair value through profit or loss is assessed at each reporting date to determine if there is objective evidence for impairment. A financial instrument is impaired if objective evidence indicates that an event has occurred after the initial recognition of the asset that could result in a loss and whether that event could have a negative effect on the asset’s estimated future cash flows, which can be assessed reliably.

Objective evidence that financial instruments (including equity securities) are impaired can include the default or delinquency of a debtor, indications that a debtor or issuer will enter insolvency, adverse changes in the payment status of borrowers or issuers in the Group as well as economic conditions that correlate with defaults or the disappearance of an active market for a marketable security. A significant or prolonged decline in an equity security’s fair value below its acquisition cost is objective evidence of impairment.

2.4.2 RECEIVABLES

The Group considers evidence of the impairment of receivables on an individual level. All individually significant receivables are tested specifically for impairment.

For a financial instrument measured at amortized cost less impairment, impairment is calculated as the difference between its carrying amount and the present value of the estimated future cash flows. Cash flows are discounted at the asset’s initial effective interest rate. Losses are recognized in profit or loss and reflected in an allowance account against receivables. Interest on the impaired asset continues to be recognized. When a subsequent event (e.g., repayment by a debtor) causes the amount of impairment to decrease, the impairment is reversed through profit and loss.

2.4.3 AVAILABLE-FOR-SALE FINANCIAL ASSETS

In case of objective indications, impairment of available-for-sale financial assets is recognized by reclassifying the accumulated losses from the reva­luation reserve in equity to profit and loss. The amount of the accumulated loss to be reclassified from equity to profit and loss is the difference between the acquisition cost less amortization and any principal repayment and the current fair value less any impairment previously recognized in profit or loss. If in a subsequent period the fair value of an impaired available-for-sale financial asset increases and this increase can be objectively linked to an event occurring after the impairment was recognized in profit or loss, then the impairment loss is reversed, and the amount of the reversal is recognized in profit or loss. Any subsequent incre­ase in the fair value of an available-for-sale financial instrument is recognized in equity within other comprehensive income.

2.4.4 NON-FINANCIAL ASSETS

The carrying amounts of the Group’s non-financial assets, inventories and deferred tax assets are reviewed at each reporting date for any indication of impairment. The asset’s recoverable amount is estimated if such indication exists. For goodwill and intangible assets that have indefinite useful lives or are not yet available for use, the recoverable amount is estimated at the same time each year, or if required. Impairment is recognized if the carrying amount of an asset or the cash-generating unit (CGU) exceeds its estimated recoverable amount.

The recoverable amount of an asset or CGU is the greater of its value-in-use or its fair value less costs of disposal. In assessing value-in-use, the estimated future pre-tax cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset or CGU. For the purposes of impairment testing, assets that cannot be tested individually are grouped into the smallest group of assets that generates cash flows from ongoing use that are largely independent of the cash flows of other assets or CGUs. A ceiling test for the operating segment must be carried out for goodwill impairment testing. CGUs that have been allocated goodwill are aggregated so that the level at which impairment testing is performed reflects the lowest level at which goodwill is monitored for internal reporting purposes. Goodwill acquired in a business combination may be allocated to groups of CGUs that are expected to benefit from the combination’s synergies.

The Group’s corporate assets do not generate separate cash flows and are utilized by more than one CGU. Corporate assets are allocated to CGUs on a reasonable and consistent basis and are tested for impairment as part of the impairment testing of the CGU that was allocated the corporate asset.

Impairment losses are recognized in profit and loss. Goodwill impairment cannot be reversed. For all other assets, impairment recognized in prior periods is assessed on each reporting date for any indications that the losses decreased or no longer exist. Impairment is reversed when there has been a change in the estimates used to determine the recoverable amount. Impairment losses can only be reversed to the extent that the asset’s carrying amount does not exceed the carrying amount net of depreciation or amortization that would have been determined if an impair­ment had not been recognized.

2.5 ADDITIONAL INFORMATION

2.5.1 KEY ESTIMATES AND ASSUMPTIONS

Estimates and judgments are continually evaluated and based on historical experience and other factors that include expectations of future events that are believed to be realistic under the prevailing circumstances.

The Group makes estimates and assumptions concerning the future. The resulting accounting-related estimates will, by definition, seldom correspond to the actual results. The estimates and assumptions that carry a significant risk of causing material adjustments to the carrying amounts of assets and liabilities in the next financial year are addressed below.

GOODWILL

The Group performs a yearly test to determine whether goodwill is subject to impairment in accordance with the accounting policies discussed in Item 2.4.4. The recoverable amounts from cash-generating units have been determined using value-in-use calculations and are subjected to a sensitivity analysis. These calculations require the use of estimates (see also Item 5.7.5 in the Notes).

INCOME TAXES

The Group is subject to income taxes in a number of tax jurisdictions. Due to the increasing complexity of tax laws and the corresponding uncertainty regarding the legal interpretation by the fiscal authority, tax calculations are generally subject to an elevated amount of uncertainty. To the extent necessary, possible tax risks were taken into account in the form of provisions.

Deferred tax assets on tax loss carryforwards are recognized based on the expected business performance of the relevant Group entity. For details on tax loss carryforwards and any recognized deferred tax assets, please refer to Item 4.4 in the Notes.

2.5.2 CAPITAL MANAGEMENT

The Management Board’s policy for capital management is to preserve a strong and sustainable capital base in order to maintain the confidence of investors, business partners, and the capital market and to support future business development. The Group’s capital base was further enhanced by a capital increase amounting to € 115.4 million carried out in November 2016 (private placement with institutional investors). As of December 31, 2016, the equity ratio was 89.6 % (December 31, 2015: 90.7 %; see also the following overview). The Group does not currently have any financial debt.

Under the respective incentive plans resolved by the Annual General Meeting, the Management Board and employees may participate in the Group’s performance through long-term performance-related remuneration consisting of convertible bonds. MorphoSys also established long-term incentive programs (LTI plan) in 2012, 2013, 2014, 2015 and 2016. These programs are based on the performance-related issue of shares, or “performance shares”, which are granted when certain predefined success criteria have been achieved and the vesting period has expired (for more information, please refer to Item 7.2 in the Notes). There were no changes in the Group’s approach to capital management during the year.

in 000’ € 12/31/2016 12/31/2015
Stockholders’ Equity 415,460 362,736
In % of Total Capital 89.6 % 90.7 %
Debt 48,140 37,343
In % of Total Capital 10.4 % 9.3 %
Total Capital 463,600 400,079

2.6 USE OF INTEREST RATES FOR VALUATION

The Group uses interest rates to measure fair value. When calculating stock-based compensation, MorphoSys uses interest rates on German govern­ment bonds with maturities of five or seven years on the date they were granted to determine the fair value of convertible bonds.

2.7 ACCOUNTING POLICIES APPLIED TO LINE ITEMS OF THE h3NCOME STATEMENT

2.7.1 REVENUES AND REVENUE RECOGNITION

The Group’s revenue includes license fees, milestone payments, service fees and revenues from the sale of goods. Under IAS 18.9, revenues are measured at the fair value of the consideration received or receivable. In accordance with IAS 18.20b, revenues are recognized only to the extent that it is sufficiently probable that the Company will receive the economic benefits associated with the transaction.

LICENSE FEES AND MILESTONE Payments

Revenues related to non-refundable fees for providing access to tech­nologies, fees for the use of technologies and license fees are recognized on a straight-line basis over the period of the agreement unless a more appropriate method of revenue recognition is available. The period of the agreement usually corresponds to the contractually agreed term of the research project or, in the case of contracts without an agreed project term, the expected term of the collaboration. If all IAS 18.14 criteria are met, revenue is recognized immediately and in full. Revenues from milestone payments are recognized upon achievement of certain contractual criteria.

SERVICE FEES

Service fees from research and development collaborations are recognized in the period the services are provided.

Discounts that are likely to be granted and whose amount can be reliably determined are recognized as a reduction in revenue at the time of revenue recognition. The timing of the transfer of risks and rewards varies depend­ing on the terms of the sales contract. In accordance with IAS 18.21 and 18.25, revenue from multiple-component contracts is recognized by allocat­ing the total consideration to the separately identifiable components based on their respective fair values and by applying IAS 18.20. The applicable revenue recognition criteria are assessed separately for each component.

Deferred revenue consist of customer payments that were not yet recognized as revenue because the related services specified in the contract were not yet rendered.

2.7.2 OPERATING EXPENSES

PERSONNEL EXPENSES RESULTING FROM STOCK OPTIONS

The Group applies the provisions under IFRS 2 “Share-based Payment”, which require the Group to spread compensation expenses from the estimated fair values of share-based payments on the reporting date over the period in which the beneficiaries provide the services which triggered the granting of the share-based payments.

IFRS 2 “Share-based Payment” requires the consideration of the effectsof share-based payments if the Group acquires goods or services in exchange for shares or stock options (“settlement in equity instruments”) or other assets that represent the value of a specific number of shares or stock options (“cash settlement”). The key impact of IFRS 2 on the Group is the expense resulting from the use of an option pricing model in relation to share-based incentives for employees and the Management Board. Additional information can be found under Items 7.1 in the Notes.

RESEARCH AND DEVELOPMENT

Research costs are expensed in the period they occur. Development costs are generally expensed as incurred in accordance with IAS 38.5 and IAS 38.11 to 38.23. Development costs are recognized as an intangible asset when the criteria of IAS 38.21 (probability of expected future economic benefits, reliability of cost measurement) are met and if the Group can provide proof under IAS 38.57.

GENERAL AND ADMINISTRATIVE

This line item contains personnel expenses, consumables, operating costs, amortization of intangible assets, expenses for external services, infrastructure costs and depreciation.

OPERATING LEASE PAYMENTS

Payments made under operating leases are recognized in the income statement on a straight-line basis over the term of the lease. According to SIC-15, all incentive agreements in the context of operating leases are recogn­ized as an integral part of the net consideration agreed for the use of the leased asset. The total amount of income from incentives is recognized as a reduction in lease expenses on a straight-line basis over the term of the lease.

All of the Group’s lease agreements are classified exclusively as operating leases. The Group did not engage in any finance lease arrangements in which the Group, as lessee, capitalized the assets at the start of the lease at the lower of fair value or the net present value of the minimum-lease payments and then depreciated the assets on a straight-line basis over their economic life.

2.7.3 OTHER INCOME

GOVERNMENT GRANTS

Grants received from government agencies to fund specific research and development projects are recognized in the income statement in the separate line item “other income” to the extent that the related expenses have already occurred. Under the terms of the grants, government agencies generally have the right to audit the use of the funds granted to the Group.

Basically, government grants are cost subsidies, and their recognition through profit and loss is limited to the corresponding costs.

When the repayment of cost subsidies depends on the success of the development project, these cost subsidies are recognized as other liabilities until success has been achieved. If the condition for repayment is not met, then the grant is recognized under “other income”.

No payments were granted in the 2016 financial year that are required to be classified as investment subsidies.

2.7.4 OTHER EXPENSES

The line item “other expenses” consists mainly of currency losses from the operating business.

2.7.5 FINANCE INCOME

Interest income is recognized in the income statement as it occurs and takes into account the asset’s effective interest rate.

2.7.6 FINANCE EXPENSES

Finance expenses are expensed in the income statement in the period they occur.

2.7.7 INCOME TAX EXPENSES/INCOME

Income taxes consist of current and deferred taxes and are recognized in the income statement unless they relate to items recognized directly in equity.

Current taxes are the taxes expected to be payable on the year’s taxable income based on prevailing tax rates on the reporting date and any adjustments to taxes payable in previous years.

The calculation of deferred taxes is based on the balance sheet liability method that refers to the temporary differences between the carrying amounts of assets and liabilities and the amounts used for taxation purposes. The method of calculating deferred taxes depends on how the asset’s carrying amount is expected to be realized and how the liabilities will be repaid. The calculation is based on the prevailing tax rates or those adopted on the reporting date.

Deferred tax assets and liabilities are offset when there is a legally enforce­able right to offset current tax liabilities and assets and when they relate to income taxes imposed on the same taxable entity by the same tax authority or on different tax entities that intend to settle the balance of current tax assets and liabilities on a net basis or when the tax assets and liabilities are to be realized simultaneously.

Deferred tax assets are recognized only to the extent that it is likely that there will be future taxable income to offset. Deferred tax assets are reduced by the amount that the related tax benefit is no longer expected to be realized.

2.7.8 EARNINGS PER SHARE

The Group reports basic and diluted earnings per share. Basic earnings per share is computed by dividing the net profit or loss attributable to parent company shareholders by the weighted-average number of ordinary shares outstanding during the reporting period. Diluted earnings per share is calculated in the same manner with the exception that the net profit or loss attributable to parent company shareholders and the weighted average number of ordinary shares outstanding are adjusted for any dilutive effects resulting from convertible bonds granted to the Management Board and employees.

2.8 ACCOUNTING POLICIES APPLIED TO THE ASSETS OF THE BALANCE SHEET

2.8.1 LIQUIDITY

Cash and cash equivalents

The Group regards all cash at banks and on hand and all short-term deposits with a maturity of three months or less as cash and cash equivalents. The Group invests most of its cash and cash equivalents at several major ­financial institutions: Commerzbank, UniCredit, Bayern LB, LBBW, BNP Paribas, Deutsche Bank, Sparkasse and Rabobank.

Cash and cash equivalents are recognized at nominal value. Marketable securities are recognized and measured at fair value. Any fluctuations in the fair value of marketable securities are directly recognized in equity. Permanent impairment is recognized in profit and loss.

NON-DERIVATIVE FINANCIAL INSTRUMENTs

Depending on how they are classified, existing financial instruments are either measured at amortized cost (category “loans and receivables”) or fair value (category “available-for-sale financial assets”). The amortized cost of current receivables and current liabilities generally corresponds to either the nominal amount or repayment amount.

All non-derivative financial instruments are initially recognized at fair value, which is defined as the fair value of the consideration provided net of transaction costs.

The Group applies IAS 39 for financial instruments in the form of debt and equity instruments. At the time of purchase, the Management Board deter­mines the financial instrument’s classification and reviews this classification at each reporting date. The classification depends on the purpose of acquiring the financial instrument. As of December 31, 2016 and December 31, 2015, some financial instruments held by the Group were classified as “available-for-sale”. These financial instruments are recognized or derecognized as of the date on which the Group commits to the financial instrument’s purchase or sale. Following their initial recognition, available-for-sale financial assets are measured at fair value, and any resulting gain or loss is reported directly in the revaluation reserve within equity until the financial instruments are sold, redeemed, otherwise disposed of or considered impaired, at which time the accumulated loss is reported in profit and loss.

Guarantees granted for rent deposits and obligations from convertible bonds issued to employees are recorded under other assets as restricted cash since they are not available for use in the Group’s operations.

DERIVATIVE FINANCIAL INSTRUMENTS

The Group uses derivative financial instruments to hedge its foreign exchange rate risk and cash flows. In accordance with IAS 39.9, stand-alone derivative financial instruments are predominantly held for trading and are initially recognized at fair value. After their initial recognition, derivative financial instruments are measured at fair value, which is defined as their quoted market price on the reporting date. Any resulting gain or loss from derivatives is recognized in profit and loss, unless the derivatives are effective and designated as hedging instruments under a hedging relationship (hedge accounting). According to the Group’s foreign currency hedging policy, the Group only hedges highly probable future cash flows and clearly identifiable receivables that can be collected within a 12-month period.

The use of derivative financial instruments is subject to a Group policy that is a written guideline approved by the Management Board for dealing with derivative financial instruments. Any changes in the fair value of derivative financial instruments are documented.

Hedge Accounting

The Group has designated hedging instruments to hedge cash flows (cash flow hedges).

At the beginning of the hedge accounting, the hedging relationship between the underlying and the hedge transaction are documented, includ­ing the risk management objectives and corporate strategy underlying the hedging relationship. Additionally, when concluding the hedge and also during the term of the hedge, the Group regularly provides documentation if the hedging instrument designated for the hedging relationship is highly effective in terms of the hedged risk to compensate for any changes of the underlying transaction’s cash flows.

For information on the fair value of derivatives used for hedging, please refer to Item 5.4 in the Notes.

Cashflow Hedges

The effective portion of the change in fair value of derivatives that are suitable for cash flow hedges and designated as such is recognized within other comprehensive income. The gain/loss attributable to the ineffective portion is immediately recognized in profit and loss with “other operating income/expenses”.

Amounts recognized within other comprehensive income are reclassified to the consolidated statement of income in the period in which the underlying transaction is recognized in profit and loss. The gain/loss is recorded in the same line item of the consolidated statement of income as the underlying transaction.

The hedging relationship is no longer accounted for if the Group dissolves the hedging relationship, the hedging instrument expires, is sold, terminated or exercised or no longer is suitable for hedging purposes. The full gain/loss recognized in other comprehensive income and accrued within equity remains in equity when the hedge accounting ends and is only recognized in profit and loss once the expected transaction is also recognized in profit and loss. If the transaction is no longer expected to materialize, the full gain/loss recognized in equity is immediately reclassified into the consolidated statement of income.

2.8.2 ACCOUNTS RECEIVABLE, INCOME TAX RECEIVABLES AND OTHER RECEIVABLES

Accounts receivable are measured at amortized cost less any impairment; for example, allowances for doubtful accounts (see Items 2.4.2 and 5.3 in the Notes).

Income tax receivables mainly include receivables due from tax authorities in the context of capital gain taxes withheld.

Other non-derivative financial instruments are measured at amortized cost using the effective interest method less any impairment.

2.8.3 INVENTORIES

Inventories are measured at the lower value of production or acquisition cost and net realizable value under the FIFO method. Acquisition costs comprise all costs of purchase and those incurred in bringing the inventories into operating condition while taking into account purchase price reductions, such as bonuses and discounts. Net realizable value is the estimated selling price less the estimated expenses necessary for completion and sale. Inventories are divided into the categories of raw materials and supplies.

2.8.4 PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses include expenses resulting from an outflow of liquid assets prior to the reporting date that are only recognized as expenses in the subsequent financial year. Such expenses usually involve maintenance contracts, sublicenses and prepayments for external laboratory services not yet performed. Other current assets primarily consist of receivables from tax authorities resulting from value-added taxes and restricted cash, such as rent deposits. This item is recognized at nominal value.

2.8.5 PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment is recorded at historical cost less accumulated depreciation (see also Item 5.6 in the Notes) and any impairment (see Item 2.4.4 in the Notes). Historical cost includes expenditures directly related to the purchase at the time of the acquisition. Replacements purchases, building alterations and improvements are capitalized while repair and maintenance expenses are charged as expenses as they are incurred. Property, plant and equipment is depreciated on a straight-line basis over its useful life (see table below). Leasehold improvements are depreciated on a straight-line basis over the asset’s estimated useful life.

Asset Class Useful Life Depreciation Rates
Computer Hardware 3 years 33 %
Low-value Laboratory and ffice Equipment below € 410 Immediately 100 %
Permanent Improvements to Property/Buildings 10 years 10 %
Office Equipment 8 years 13 %
Laboratory Equipment 4 years 25 %

Asset’s residual values and useful lives are reviewed at the end of each reporting period and adjusted if appropriate.

Borrowing costs that can be directly attributed to the acquisition, construction or production of a qualifying asset are not included in the acquisition or production costs because the Group finances the entire operating business with equity.

2.8.6 INTANGIBLE ASSETS

Purchased intangible assets are capitalized at acquisition cost and exclusively amortized on a straight-line basis over their useful lives. Internally generated intangible assets are recognized to the degree the recognition criteria set out in IAS 38 are met.

Development costs are capitalized as intangible assets when the capitalization criteria described in IAS 38 have been met, namely, clear specifi­cation of the product or procedure, technical feasibility, intention of completion, use, commercialization, coverage of development costs through future free cash flows, reliable determination of these free cash flows and availability of sufficient resources for completion of development and sale. Amortization is recorded in research and development expenses.

Expenses to be classified as research expenses are allocated to research and development expenses as defined by IAS 38.

Subsequent expenditures for capitalized intangible assets are capitalized only when they substantially increase the future economic benefits of the specific asset to which they relate. All other expenditures are expensed as incurred.

Patents

Patents obtained by the Group are recorded at acquisition cost less accumulated amortization (see below) and any impairment (see Item 2.4.4 in the Notes). Patent costs are amortized on a straight-line basis over the lower of the estimated useful life of the patent (ten years) or the remaining patent term. Amortization starts when the patent is issued. Technology identified in the purchase price allocation for the acquisition of Sloning BioTechnology GmbH is recorded at the fair value at the time of acquisition, less accumulated amortization (useful life of ten years).

LICENSE RIGHTS

The Group has acquired license rights from third parties by making upfront license payments, paying annual fees to maintain the license and paying fees for sublicenses. The Group amortizes upfront license payments on a straight-line basis over the estimated useful life of the acquired license (eight to ten years). The amortization period and method are reviewed at the end of each financial year under IAS 38.104. Annual fees to maintain a license are amortized over the term of each annual agreement. Sublicense fees are amortized on a straight-line basis over the term of the contract or the estimated useful life of the collaboration for contracts without a set duration.

IN-PROCESS R&D PROGRAMS

This line item contains capitalized upfront payments from the in-licensing of two compounds for the Proprietary Development segment as well as a milestone payment for one of these compounds which was paid at a later time. Additionally, the line item also includes two compounds resulting from an acquisition. The assets are recorded at acquisition cost and are not yet available for use and therefore not subject to scheduled amortization. The assets were tested for impairment on the reporting date as required by IAS 36.

Software

Software is recorded at acquisition cost less accumulated amortization (see below) and any impairment (see Item 2.4.4 in the Notes). Amorti­zation is recognized in profit and loss on a straight-line basis over the estim­ated useful life of three to five years. Software is amortized from the date the software is operational.

GOODWILL

Goodwill is recognized for expected synergies from business combinations and the skills of the acquired workforce. Goodwill is tested annually for impairment as required by IAS 36 (see also Item 5.7.5 in the Notes).

Intangible Asset Class Useful Life Amortisation Rates
Patents 10 years 10 %
License Rights 8 (10) years 13 % – 10 %
In-process R&D Programs Not yet amortized
Software 3 (5) years 33 % – 20 %
Goodwill Impairment Only

2.8.7 PREPAID EXPENSES AND OTHER ASSETS, NET OF CURRENT PORTION

The non-current portion of expenses that occurred prior to the reporting date but to be recognized in subsequent financial years is also recorded under prepaid expenses. This line item contains maintenance contracts and sublicenses.

This line item also includes other non-current assets, which are recognized at fair value. Other non-current assets consist mainly of restricted cash, such as rent deposits.

2.9 ACCOUNTING POLICIES APPLIED TO EQUITY AND LIABILITY ITEMS OF THE BALANCE SHEET

2.9.1 ACCOUNTS PAYABLE, OTHER LIABILITIES AND OTHER PROVISIONS

Trade payables and other liabilities are recognized at amortized cost. Liabili­ties with a term of more than one year are discounted to their net present value. Liabilities with uncertain timing or amount are recorded as provisions.

IAS 37 requires the recognition of provisions for obligations to third parties arising from past events. Furthermore, provisions are only recognized for legal or factual obligations to third parties if the event’s occurrence is more likely than not. Provisions are recognized at the amount required to settle the respective obligation and discounted to the reporting date if the interest effect is material. The amount required to meet the obligation also includes expected price and cost increases. The interest portion of the added provisions is recorded in the finance result. The measurement of provisions is based on past experience and considers the circumstances in existence on the reporting date.

2.9.2 TAX PROVISIONS

Tax liabilities are recognized and measured at their nominal value. Tax liabilities contain obligations from current taxes, excluding deferred taxes. Provisions for trade taxes, corporate taxes and similar taxes on inco­me are determined based on the taxable income of the consolidated entities less any prepayments made.

2.9.3 CURRENT PORTION OF DEFERRED REVENUE

Upfront payments from customers for services to be rendered by the Group are recognized as deferred revenue in accordance with IAS 18.13 and measured at the lower of fair value or nominal value. The corresponding rendering of services and revenue recognition occurs within a twelve-month period after the reporting date.

2.9.4 DEFERRED REVENUE

This line item includes the non-current portion of deferred upfront payments from customers in accordance with IAS 18.13, which are measured at the lower of fair value or nominal value. Due to its low materiality in the financial year, this line item was not discounted to its present value despite its long-term maturity.

2.9.5 CONVERTIBLE BONDS DUE TO RELATED PARTIES

The Group issued convertible bonds to the Group’s Management Board and employees. In accordance with IAS 32.28, the equity component of a convertible bond must be recorded separately under additional paid-in capital. The equity component is determined by deducting the separately determined amount of the liability component from the fair value of the convertible bond. The effect of the equity component is recognized in profit and loss in personnel expenses from share-based payments, whereas the effect on profit and loss from the liability component is recognized as interest expense. The Group applies the provisions of IFRS 2 “Share-based Payments” for all convertible bonds granted to the Management Board and the Group’s employees.

2.9.6 DEFERRED TAXES

The recognition and measurement of deferred taxes are based on the provisions of IAS 12. Deferred tax assets and liabilities are calculated using the liability method, which is common practice internationally. Under this method, taxes expected to be paid or recovered in subsequent financial years are based on the applicable tax rate at the time of recognition.

Deferred tax assets and liabilities are recorded separately in the balance sheet. Deferred tax liabilities take into account the future tax effects of temporary differences between the value of assets and liabilities in the balance sheet and tax loss carryforwards.

Deferred tax assets are offset against deferred tax liabilities if the taxes are levied by the same taxation authority and have matching terms. Pursuant to IAS 12, deferred tax assets and liabilities may not be discounted.

2.9.7 OTHER LIABILITIES

Other liabilities for rent-free periods and their corresponding release over the minimum rent period are calculated based on the effective interest method. Other liabilities are discounted due to their long-term maturities.

2.9.8 STOCKHOLDERS’ EQUITY

COMMON STOCK

Ordinary shares are classified as stockholders’ equity. Incremental costs directly attributable to the issue of ordinary shares and stock options are recognized as a deduction from stockholders’ equity.

TREASURY STOCK

Repurchases of the Company’s own shares at prices quoted on an exchange or at market value are recorded in this line item as a deduction from common stock.

When common stock that was recorded as stockholders’ equity is repurchased, the amount of consideration paid, including directly attributable costs, is recognized as a deduction from stockholders’ equity net of taxes and is classified as treasury shares. When treasury shares are subsequently sold or reissued, the proceeds are recognized as an increase in stockholders’ equity, and any difference between the proceeds from the transaction and the initial acquisition costs is recognized in additional paid-in capital.

The allocation of treasury shares to beneficiaries (in this case: performance shares) under long-term incentive programs is reflected in this line item based on the set number of shares to be allocated after the expiration of the four-year vesting period (quantity structure) multiplied by the weighted-average purchase price of the treasury shares (value structure). The adjustment is carried out directly in equity by reducing the treasury stock line item, which is a deduction from common stock, while simulta­neously reducing the amount of additional paid-in capital.

ADDITIONAL PAID-IN CAPITAL

Additional paid-in capital mainly consists of personnel expenses resulting from the grant of convertible bonds and performance shares and the proceeds from newly created shares in excess of their nominal value.

REVALUATION RESERVE

The revaluation reserve mainly consists of unrealized gains and losses on available-for-sale securities and bonds that are measured directly in equity until they are sold as well as cash flow hedges.

ACCUMULATED INCOME/LOSS

The “accumulated income/loss” line item consists of the Group’s accumulated consolidated net profits/losses. A separate measurement of this item is not made.

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