Indepen­dent Auditor’s Report

To: Bayer Aktiengesellschaft, Leverkusen

Report on the audit of the consolidated financial statements and the combined management report

Audit opinions

We audited the consolidated financial statements of Bayer Aktiengesellschaft, Leverkusen, and its subsidiaries (the Group), which comprise the consolidated statements of financial position as at December 31, 2017, the consolidated income statement and consolidated statement of comprehensive income, the consolidated statement of changes in equity and the consolidated statements of cash flows for the fiscal year from January 1, 2017 through December 31, 2017 as well as the notes to the consolidated financial statements, including a summary of significant accounting policies. In addition, we audited the group management report of Bayer Aktiengesellschaft, Leverkusen, which is combined with the Company’s management report, for the fiscal year from January 1, 2017 through December 31, 2017. In conformity with German legal regulations, we have not audited the parts of the combined management report specified in the Chapter “Other information” of our independent auditor’s report with regard to their content.

In our opinion, based on our knowledge obtained during the audit,

  • the accompanying consolidated financial statements comply with International Financial Reporting Standards (IFRS) as adopted by the EU and the supplementary German legal regulations to be applied in accordance with Section 315e (1) German Commercial Code (HGB) in all material respects and give a true and fair view of the Group’s net assets and financial position as of December 31, 2017 as well as its results of operations for the fiscal year from January 1, 2017 through December 31, 2017 in accordance with these requirements and
  • the accompanying combined management report as a whole provides a suitable view of the Group’s position. In all material respects, this combined management report is consistent with the consolidated financial statements, complies with German legal requirements and suitably presents the opportunities and risks of future development. Our audit opinion on the combined management report does not extend to the content of the parts of the combined management report detailed in the Chapter “Other information” section.

Pursuant to Section 322 (3) Sentence 1 German Commercial Code (HGB), we state that our audit has not led to any reservations with respect to the propriety of the consolidated financial statements and the combined management report.

Basis for the audit opinions

We conducted our audit of the consolidated financial statements and the combined management report in accordance with Section 317 German Commercial Code (HGB) and the EU Audit Regulation (No. 537/2014; hereinafter referred to as “EU Audit Regulation”), and generally accepted German standards for the audit of financial statements promulgated by the Institute of Public Auditors in Germany [Institut der Wirtschaftsprüfer] (IDW). We conducted our audit of the consolidated financial statements also in accordance with International Standards on Auditing (ISA). Our responsibilities under these requirements, principles, and standards are further described in the Section “Auditor’s responsibility for the audit of the consolidated financial statements and the combined management report” of our report. We are independent of the group companies in accordance with European and German commercial law and rules of professional conduct and we have fulfilled our other ethical responsibilities applicable in Germany in accordance with these requirements. In addition, pursuant to Article 10 (2) lit. f EU Audit Regulation, we declare that we have not provided any prohibited non-audit services pursuant to Article 5 (1) EU Audit Regulation. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinions on the consolidated financial statements and combined management report.

Key audit matters in the audit of the consolidated financial statements

Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated financial statements for the fiscal year from January 1, 2017 through December 31, 2017. These matters were addressed in the context of our audit of the consolidated financial statements as a whole and in forming our opinion thereon but we do not provide a separate opinion on these issues.

In the following we present the key audit matters in our view:

Our presentation of these key audit matters is structured as follows:

  1. Description (including reference to corresponding information in the consolidated financial statements)
  2. Auditor’s response

1. Sales of shares in Covestro AG and deconsolidation of the Covestro Group

  1. Following the creation of the financial and legal autonomy of the MaterialScience segment in autumn 2015 and the subsequent IPO under the name of Covestro, at the end of 2016 the Bayer Group still held directly and indirectly via Bayer Pension Trust e. V. a total of 69.1% of the shares in Covestro AG (of which 64.2% were held directly). Due to three separate share sales transactions totaling 58.25 million or 28.7% of the shares in Covestro AG for EUR 3.7bn and the contribution of 8 million shares or 4% of the shares in Covestro AG worth EUR 0.5bn to Bayer Pension Trust e. V., the direct interest held by Bayer in Covestro AG fell to 31.5% and the directly and indirectly held interest to 40.4% by the beginning of September 2017. Since Bayer would still have held a majority at the Covestro AG Annual General Meeting at that time and was therefore able to exercise de facto control over the Covestro Group, these transfers of shares were accounted for as transactions between shareholders under IFRS 10 and the Covestro Group continued to be (fully) consolidated by Bayer. In all, the Bayer Group’s equity increased by EUR 4.2bn as a result of these transactions, of which EUR 1.5bn were attributable to non-controlling interests.

    Finally, at the end of September 2017 Bayer sold a further 13.94 million or 6.9% of the shares in Covestro AG for EUR 1.0bn and entered into a relinquishment of control agreement with Covestro AG with effect from September 30, 2017. The consequence of this was the relinquishment of de facto control over the Covestro Group. Pursuant to IFRS 10, these two transactions were recognized economically as a single transaction. The Covestro Group was deconsolidated as of September 30, 2017 and has since been shown in the consolidated financial statements as a discontinued operation, in accordance with IFRS 5. Since Bayer currently directly holds 24.6% and indirectly holds 33.5% of the shares in Covestro AG and can continue to exercise significant influence over the Covestro Group, Covestro AG was included as of September 30, 2017 in the Bayer consolidated financial statements as an associated company with a carrying amount (fair value) of EUR 3.6bn according to the equity method. Bayer received income of EUR 3.1bn at Group level from the deconsolidation in 2017, in particular due to the recognition of the carrying amount at fair value. As of December 31, 2017, the equity value is virtually unchanged.

    In our opinion, this issue was of particular significance due to the complexity of the underlying contractual agreements and the numerous material effects on the consolidated financial statements.

    The Company’s disclosures on the discontinued operation, the deconsolidation, and the first-time inclusion of the Covestro Group as an associate are set out in Sections 6.3 and 19 of the Notes to the consolidated financial statements.

  2. We assessed whether Bayer had in fact continued to control the Covestro Group, despite the share sales up until the beginning of September, and thus ought to have continued to consolidate the Covestro Group. Moreover, by inspecting the relevant Board of Management resolutions and Board of Management and Supervisory Board minutes, we investigated whether the Board of Management had not already at the time of the individual share sales drawn up a plan that would have led to a loss of control over the Covestro Group, so that it would have been necessary, under IFRS 5, to report the Covestro Group as a discontinued operation even before September 30, 2017. We analyzed the sale of shares at the end of September 2017 and the conclusion of the relinquishment of control agreement to determine whether these can be treated as a single transaction under IFRS 10 and isolated from the earlier sales of shares up to mid-September.

    We also assessed the relinquishment of control agreement as to whether the agreement fulfilled the company and stock corporation law requirements for the loss of control and thus for the deconsolidation of the Covestro Group and whether Covestro should have been deconsolidated as of September 30, 2017. We also examined whether the first-time classification as a discontinued operation as of September 30, 2017 was appropriate and that the presentation in the income statement and statements of cash flows as a discontinued operation is in accordance with IFRS 5.

    Furthermore, we verified whether the deconsolidation was technically correct and whether the result of the deconsolidation was correctly determined and recognized in the accounts. We also performed audit procedures to ascertain whether the carrying amount of the investment in Covestro AG as an associated company and the provisional purchase price allocation made in this connection for the initial fair value measurement had been appropriately calculated.

2. Impairment of goodwill and brand rights

  1. In the consolidated financial statements, an amount of EUR 14,751m (20% of total Group assets) is reported under the balance sheet item “Goodwill”. In addition, brand rights of EUR 6,412m (9% of the Group’s total assets) are reported under “Other intangible assets”. The Company allocates goodwill to the strategic business units or groups of strategic business units within the Bayer Group. Regular impairment tests of goodwill and case-related impairment tests of brand rights compare the respective carrying amounts with their recoverable amounts. Fundamentally, the recoverable amount is determined on the basis of the fair value less costs to sell. The present value of future cash flows is used as a basis, since as a rule no market values are available for the individual strategic business units. The present value is determined using discounted cash flow models based on the Bayer Group’s three-year operating plan drawn up by the legal representatives and acknowledged by the Supervisory Board and perpetuated with assumptions about long-term growth rates. Discounting is based on the weighted average cost of capital of the reporting segments concerned. The result of this valuation depends to a large extent on the estimates by the legal representatives of the future cash flows of the strategic business unit concerned and the discount rate used and is therefore fraught with considerable uncertainty. In the light of this, and owing to the underlying complexity of the valuation models, this issue was of particular importance within the framework of our audit.

    The Company’s disclosures on goodwill and brand rights are contained in Section 4 and 17 of the Notes to the consolidated financial statements.

  2. In our audit, among other things we reconstructed the methodology used to perform the impairment tests and assessed the calculation of the weighted cost of capital. We convinced ourselves of the appropriateness of the future cash inflows used in the valuation among other things by recording and critically assessing the underlying planning process. We also compared this information with the current budget from the three-year plan drawn up by the legal representatives and noted by the Supervisory Board, and reconciled it with general and industry-specific market expectations. For this, we also convinced ourselves that the costs of the Group functions included in the Corporate Functions and Consolidation segment of segment reporting were appropriately taken into account in the impairment test of the strategic business unit concerned. We studied intensively the parameters used to determine the discount rate applied and assessed the completeness and correctness of the calculation scheme. Owing to the material significance of goodwill, we further performed additional sensitivity analyses of our own for the strategic business units (carrying amount in comparison to the recoverable amount).

3. Financial instruments – hedge accounting

  1. Bayer Group companies conclude a large number of different derivative financial instruments to hedge against currency, commodity price, and interest rate risks from ordinary business operations. The basis for this is the hedging policy prescribed by the legal representatives, which is documented in appropriate internal guidelines. The currency risk essentially results from sales revenues, sales and procurement transactions (in particular relating to raw materials), and financing transactions in foreign currencies. The aim of interest rate hedging is, on the one hand to achieve a reasonable relationship between variable and fixed interest rates and on the other to secure a low rate of interest for planned financing transactions. Derivative financial instruments are recognized at their fair value as of balance sheet date. The positive fair values of all derivative financial instruments used as hedges amounted to EUR 450m as of the closing date (i.e., 1% of total Group assets), the negative fair values amounted to EUR 533m (representing 1% of total Group assets). To the extent that the financial instruments used by the Bayer Group are effective hedges of future cash flows under hedge accounting in accordance with IAS 39, changes in fair value are recognized in equity until the due date of the hedged cash flow (effective portion) over the term of the hedge relationship. As of the balance sheet date, a cumulative amount of EUR -112m had been recognized outside profit or loss as expenses and income before taxes on income. In our view, these issues were of particular importance due to the high complexity and the great number of transactions, and the extensive accounting and reporting requirements of IAS 39 and IFRS 7.

    The disclosures on hedge accounting are contained in Sections 4 and 30 of the Notes to the consolidated financial statements. Risk reporting with regard to the use of financial instruments is provided in the combined management report in Section 3.2.2.

  2. Within the framework of our audit, and with the support of our internal specialists from the Financial Risk Solutions unit, we assessed the contractual and financial fundamentals of the financial instruments, among other things, and reconstructed the accounting including the effects on equity and earnings of the various hedging transactions. Jointly with our specialists, we also assessed the Company’s internal control system in the area of derivative financial instruments, including the internal monitoring of compliance with the hedging policy, and reviewed the controls with regard to design, implementation, and effectiveness. Furthermore, while auditing the fair value measurement of the financial instruments, we also checked, on the basis of market data and within the framework of our risk assessment, the calculation methods of representatively selected samples and reconstructed the correct implementation of the methods in the system. In order to audit the effectiveness of the hedging transactions, we analyzed the various methods (prospective critical term match method; retrospective regression method) and, in the framework of our risk assessment, reconstructed their correct implementation in the system. With regard to the expected cash flows, we essentially assessed the past hedging ratios in retrospect.

4. Depiction of risks arising from product-related legal disputes

  1. Bayer Group companies are involved in legal and out-of-court proceedings with public authorities, competitors, and other parties. These give rise to legal risks, in particular in the areas of product liability, competition and anti-trust law, patent law, tax law, and environmental protection.

    Against the background of pending and expected product liability lawsuits relating to the product Mirena™, the Bayer Group had been served in the United States with lawsuits from approximately 2,900 (previous year: 2,600) (women) users of Mirena™ by January 30, 2018. In addition, by January 30, 2018, the Bayer Group had been served in the United States with about 22,000 claims (prior year: 16,400) for damages and punitive damages from users of the product Xarelto™. Moreover, by January 30, 2018, the Bayer Group had been served in Canada with ten lawsuits relating to Xarelto™, in each of which the admission of a class action has been applied for. By January 30, 2018, the Bayer Group had been served with lawsuits in the United States by about 16,100 (prior year 3,700) (women) users of Essure™ and two lawsuits in Canada, in each of which the admission of a class action has been applied for.

    Whether a pending legal dispute makes the recognition of a provision to cover the risk necessary and, if so, to what extent, is determined to a large extent by estimates and assumptions by the legal representatives. Against this background, and in view of the amount of the claims asserted, the above-mentioned product-related disputes of the Bayer Group were of particular significance from our point of view.

    The disclosures about and explanations of the legal disputes mentioned are contained in Section 32 of the notes to the consolidated financial statements.

  2. Within the framework of our audit, we assessed, among other things, the process established by the Company to ensure the recognition, the estimate of the outcome of the proceedings, and the accounting presentation of a legal dispute. Furthermore, we held regular discussions with the Company’s internal legal department in order to be informed about current developments and the reasons that led to the corresponding estimates. The development of material legal disputes, including the estimates by the legal representatives with regard to the possible outcome of proceedings, was made available to us in writing by Bayer AG’s internal legal department. As of the closing date, we furthermore obtained external attorney’s certificates, which we compared with the risk assessment made by the legal representatives about the product-related disputes named in the “Description of the facts” section.

5. Adjustments to EBITDA for special items

  1. For management and analysis purposes, the Bayer Group adduces EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization, and also impairment losses and reversals), adjusted for special items (by their nature or amount special effects). Adjustments to EBITDA amounting to EUR 725m are presented in Bayer AG’s consolidated financial statements in continuing operations. Adjusted EBITDA from continuing operations are used by Bayer as a key financial performance indicator in its capital market communications. They are furthermore adduced as a degree of target achievement for the annual performance-based compensation of the employees of the Bayer Group. The adjustments to EBITDA were of particular significance within the framework of our audit, as they are made on the basis of the Bayer Group’s internal accounting guideline and there is a risk that the legal representatives may exercise their discretionary powers one-sidedly.

    The company’s disclosures on the adjustments to EBITDA and the calculation thereof are presented in Section 5 of the notes to the consolidated financial statements and in Section 2.2 of the combined management report.

  2. We reconstructed the calculation of adjusted EBITDA and critically examined the identification of the Group companies’ special items taken into account by the legal representatives. For this we analyzed the composition of the adjustments in terms of the extent to which the individual components correspond to the corresponding guidelines for special items and were correctly excluded from adjusted EBITDA. At the same time, we examined, on the basis of the findings of our audit and the information provided by the legal representatives, whether the adjustments made were carried out in accordance with the definition and procedure presented in the explanations in the combined management report and in the segment reporting.

Other information

The legal representatives are responsible for the other information. The other information comprises:

  • the Group’s statement on business management pursuant to Section 289f and Section 315d HGB specified in Chapter 4.1 of the combined management report,
  • the “Compliance” section of the Corporate Governance Report contained in Chapter 4.2 of the combined management report pursuant to No. 3.10 of the German Corporate Governance Code,
  • all online annexes referred to in the combined management report and contained in the augmented online version of the Annual Report,
  • assurance pursuant to Section 297 (2) Sentence 4 German Commercial Code (HGB) to the consolidated financial statements and assurance pursuant to Section 315 (1) Sentence 5 German Commercial Code (HGB) to the combined management report, and
  • the remaining components of the annual report, with the exception of the audited consolidated financial statements and the combined management report and our Auditor’s Report.

Our audit opinions on the consolidated financial statements and the combined management report do not extend to cover the other information, and accordingly we do not issue an audit opinion or any other form of assurance conclusion thereon.

In connection with our audit, our responsibility is to read the other information and, in doing so, to consider whether the other information

  • is materially inconsistent with the consolidated financial statements, the combined man-agement report or our knowledge obtained in the audit, or
  • otherwise appears to be substantially misstated.

If, based on the work we have performed, we conclude that there is a material misstatement of this information, we are required to report on that fact. We have nothing to report in this regard.

Responsibilities of the legal representatives and the Supervisory Board for the consolidated financial statements and the combined management report

The legal representatives are responsible for the preparation of the consolidated financial statements which comply with IFRS as adopted by the EU and the supplementary requirements of the German legal regulations pursuant to Section 315e (1) German Commercial Code (HGB) in all material respects, so that the consolidated financial statements give a true and fair view of the net assets, financial position, and results of operations of the Group in accordance with these requirements. In addition, the legal representatives are responsible for the internal controls they have identified as necessary in order to enable the preparation of consolidated financial statements that are free from material misstatements, whether intentional or unintentional.

In preparing the consolidated financial statements, the legal representatives are responsible for assessing the Group’s ability to continue as a going concern. Furthermore, they have the responsibility to disclose matters relating to the Group’s ability to continue as a going concern, if relevant. In addition, they are responsible for using the going concern basis of accounting, unless the intention is to liquidate the Group or to cease operations, or there is no realistic alternative but to do so.

In addition, the legal representatives are responsible for the preparation of the combined management report, which as a whole provides a suitable view of the Group’s position, is consistent with the consolidated financial statements in all material respects, complies with German legal regulations and suitably presents the opportunities and risks of future development. Furthermore, the legal representatives are responsible for such arrangements and measures (systems) which they have deemed necessary in order to enable the preparation of a combined management report in accordance with the applicable German legal regulations and to furnish sufficient and appropriate evidence for the statements in the combined management report.

The Supervisory Board is responsible for overseeing the Group’s financial reporting process for the preparation of the consolidated financial statements and the combined management report.

Auditor’s responsibilities for the audit of the consolidated financial statements and the combined management report

Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatements, whether due to fraud or error, and whether the combined management report as a whole provides an appropriate view of the Group’s position and, in all material respects, is consistent with the findings of the audit, is in accordance with the German legal regulations, and appropriately presents the opportunities and risks of future development, as well as to issue an auditor’s report that includes our audit opinions on the consolidated financial statements and the combined management report.

Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Section 317 German Commercial Code (HGB) and the EU Audit Regulation and generally accepted German standards for the audit of financial statements promulgated by the Institute of Public Auditors in Germany (IDW), and subject to supplementary compliance with ISA, will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements and this combined management report.

As part of an audit, we exercise professional judgement and maintain professional skepticism. We also

  • identify and assess the risks of material misstatements in the consolidated financial statements and in the combined management report, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our audit opinions. The risk of not detecting a material misstatement resulting from fraud is higher than one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the overriding of internal controls.
  • obtain an understanding of internal controls relevant to the audit of the consolidated financial statements and the arrangements and measures relevant to the audit of the combined management report in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of these systems.
  • evaluate the appropriateness of the accounting policies used by the legal representatives and the reasonableness of accounting estimates and related disclosures made by the legal representatives.
  • form a conclusion on the appropriateness of the legal representatives’ use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists relating to events or conditions that may cast significant doubt on the Group’s ability to continue as a going concern. If we conclude that there is a material uncertainty, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated financial statements and combined management report, or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Group to cease to continue as a going concern.
  • evaluate the overall presentation, structure, and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner such that the consolidated financial statements give a true and fair view of the net assets and financial position as well as the results of operations of the Group in accordance with IFRS as adopted by the EU and the supplementary requirements of German law pursuant to Section 315e (1) German Commercial Code (HGB).
  • obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group to express opinions on the consolidated financial statements and the combined management report. We are responsible for the direction, supervision, and performance of the group audit. We remain solely responsible for our audit opinions.
  • evaluate the consistency of the combined management report with the consolidated financial statements, its legal consistency, and the view provided of the Group’s position.
  • perform audit procedures on the forward-looking information presented by the legal representatives in the combined management report. On the basis of sufficient appropriate audit evidence, we particularly evaluate the significant assumptions underlying the forward-looking information by the legal representatives and evaluate the correct derivation of forward-looking information from these assumptions. We do not issue an independent opinion on the forward-looking information or on the underlying assumptions. There is a significant unavoidable risk that future events will differ materially from the forward-looking information.

We communicate with those charged with governance among other matters, on the planned scope and timing of the audit and significant audit findings, including any deficiencies in internal control, which we identify during our audit.

We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.

From the matters communicated with those charged with governance we determine those matters that were of most significance in the audit of the consolidated financial statements of the current reporting period and are therefore the key audit matters. We describe these matters in our auditor’s report on the consolidated financial statements unless law or regulation precludes public disclosure about the matter.

Other legal and regulatory requirements

Other information pursuant to Article 10 EU Audit Regulation

We were appointed by the Annual General Meeting on April 28, 2017 to audit the consolidated financial statements. We were engaged by the Supervisory Board on June 1/28, 2017. We have been engaged continuously as the auditors of the consolidated financial statements of Bayer Aktiengesellschaft, Leverkusen, since the fiscal year 2017.

We confirm that the audit opinions contained in this auditor’s report are consistent with the additional report to the audit committee pursuant to Article 11 EU Audit Regulation (“Prüfungsbericht”).

Responsible auditor

The auditor responsible for the audit is Prof. Dr. Frank Beine.

Munich, February 21, 2018

Deloitte GmbH

Wirtschaftsprüfungsgesellschaft

Heiner Kompenhans
German Public Auditor

Prof. Dr. Frank Beine
German Public Auditor

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