The consolidated financial statements comprise the financial statements of the parent entity, Royal DSM N.V., and its subsidiaries as well as the proportion of DSM’s ownership of joint ventures (together ‘DSM’ or ‘Group’). A subsidiary is an entity over which DSM has control. Control is the power to govern the financial and operating policies of the entity so as to obtain benefits from its activities. The financial data of subsidiaries are fully consolidated. Minority interests in the Group’s equity and income are stated separately. A joint venture is an entity in which DSM holds an interest and which is jointly controlled by DSM and one or more other venturers under a contractual arrangement. The financial data of joint ventures are included in the consolidated financial statements according to the method of proportionate consolidation. Subsidiaries and joint ventures are consolidated from the acquisition date and de-consolidated from the date on which DSM ceases to have control or joint control, respectively. On consolidation all intra-group balances and transactions and unrealized gains and losses from intra-group transactions are eliminated. Unrealized losses are not eliminated if these losses indicate an impairment of the asset transferred. In such cases a value adjustment for impairment of the asset is made.

Segment information is presented in respect of the Group’s business and geographical segments. The primary format, business segments, reflects the Group’s management structure. Prices for transaction between segments are determined on an arm’s length basis. Segment results, assets and liabilities include items directly attributable to a segment as well as those that can be allocated on a reasonable basis.

The presentation currency of the Group is the euro. Each entity of the Group records transactions and balance sheet items in its functional currency. Commercial transactions denominated in another currency than the functional currency are recorded at the spot exchange rates prevailing at the date of the transactions. Monetary assets and liabilities denominated in a currency other than the functional currency of the entity are translated at the closing rates at the balance sheet date. Exchange differences resulting from the settlement of these transactions and from the translation of monetary items are recognized in income.

On consolidation, the balance sheets of subsidiaries and joint ventures whose functional currency is not the euro are translated into euro at the closing rate. The income statements of these entities are translated into euro at the average rates for the relevant period. Goodwill paid on acquisition is recorded in the functional currency of the acquired entity. Exchange differences arising from the translation of the net investment in entities with another functional currency than the euro are recorded in equity (Translation reserve). The same applies to exchange differences arising from borrowings and other financial instruments in so far as they hedge the currency exchange risk related to the net investment.

On disposal of an entity with a functional currency other than the euro the cumulative exchange difference relating to the translation of net investment is recognized in income. DSM has made use of the exemption in IFRS 1, according to which the cumulative translation differences at the date of transition to IFRS (1 January 2004) are deemed to be zero.

An asset (liability) is classified as current when it is expected to be realized (settled) within 12 months after the balance sheet date.

DSM is subject to legislation to encourage reductions of greenhouse gas emission and has been awarded emission rights in a number of jurisdictions, principally to cover emission of CO₂. Emission rights are reserved for meeting delivery obligations and are not recognized. Revenue is recognized when surplus emission rights are sold to third parties. When actual emissions exceed the emission rights available to DSM a provision is recognized for the expenditure required to obtain the additional rights.

Goodwill represents the excess of the cost of an acquisition over DSM’s share in the net fair value of the identifiable assets, liabilities and contingent liabilities of an acquired subsidiary, joint venture or associate. Goodwill paid on acquisition of subsidiaries and joint ventures is included in intangible assets. Goodwill paid on acquisition of associates is included in the carrying amount of these associates. Goodwill is tested for impairment annually and when there are indications that the carrying value may not be recoverable. Any impairment is recognized in income. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold.

It was DSM’s policy up to and including 1999 to charge goodwill paid immediately against equity. In accordance with IFRS 1 this goodwill is not recognized in the opening balance sheet but remains a deduction from equity. From 2000 up to and including 2003, goodwill was capitalized and amortized over its estimated useful life. DSM has made use of the exemption of IFRS 1 that permits entities to elect not to apply IFRS 3, Business Combinations, retrospectively. The carrying amount of the goodwill on 31 December 2003 according to ‘NL GAAP’ is used as the deemed cost of the goodwill as at the date of transition to IFRS (1 January 2004).

Acquired licenses, patents and application software are carried at cost less straight-line depreciation and less any impairment losses. The expected useful lives vary from 4 to 10 years. Costs of software maintenance and new releases are expensed when incurred. Capital expenditure that is directly related to the development of application software is recognized as intangible asset and amortized over its estimated useful life (5-8 years).

Research costs are expensed when incurred. Where the recognition criteria are met, development expenditure is capitalized and amortized over its useful life from the moment the product is launched commercially. The carrying amount of an intangible asset from development is reviewed for impairment at each balance sheet date or earlier upon indication of impairment. Any impairment losses are recorded in income.

Property, plant and equipment is carried at cost less depreciation calculated on a straight-line basis and less any impairment losses. Interest during construction is capitalized. Expenditures relating to major scheduled turnarounds are capitalized and depreciated over the period up to the next turnaround.

The items of property, plant and equipment are systematically depreciated over their estimated useful lives. Reviews are made annually of the estimated remaining lives of the most important individual productive assets, taking account of commercial and technological obsolescence as well as normal wear and tear. The initially assumed expected useful lives are in principle: for buildings 10-50 years; for plant and machinery: 5-15 years; for other equipment 4-10 years. Land is not depreciated.

An item of property, plant and equipment is derecognized upon disposal or when no future economic benefits are expected to arise from continued use or the sale of the asset. Any gain or loss arising on derecognition of the asset is included in income.

An associate is an entity over which DSM has significant influence but no control, usually supported by a shareholding that entitles DSM to between 20% and 50% of the voting rights. Investments in associates are accounted for by the equity method of accounting, which involves recognition in income of DSM’s share of the associate’s profit or loss for the year. DSM’s interest in an associate is carried in the balance sheet at its share in the net assets of the associate together with goodwill paid on acquisition, less any impairment loss.

When DSM’s share in the loss of an associate exceeds the carrying amount of the associate, including any other receivables, the carrying amount is reduced to nil. No further losses are recognized, unless DSM incurs obligations of the associate which it has guaranteed or is otherwise committed to. Unrealized profits and losses from transactions with associates are eliminated according to DSM’s percentage ownership of these entities.

Securities comprise of interests in entities in which DSM has no significant influence that are accounted for as available-for-sale securities. These securities are measured against fair value with changes in fair value being recognized in equity (Fair value reserve). In case a reliable fair value can not be established the securities are held at cost. Available-for sale securities are tested for impairment with other than temporary declines in value being charged to income. On disposal the cumulative fair value adjustments of the related securities are released from equity and included in income. Proceeds from other securities held at cost are recognized in income on disposal (Net finance costs).

Loans and long-term receivables are measured at amortized cost, if necessary with deduction of a value adjustment for bad debts. The proceeds are recognized in income (Net finance costs).

When there are indications that the carrying amount of a non-current asset (an item of intangible assets, property, plant and equipment, or financial assets) may exceed the estimated recoverable amount (the higher of its value in use and fair value less costs to sell), the possible existence of an impairment loss is investigated. In case an asset does not generate largely independent cash inflows, the recoverable amount is determined for the cash-generating unit to which the asset belongs. In assessing the value in use, the estimated future 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.

When the recoverable amount of an asset is less than its carrying amount, the carrying amount is impaired to its recoverable amount. An impairment loss is reversed when there has been a change in estimate that is relevant for the determination of the asset’s recoverable amount since the last impairment loss was recognized. Impairment losses for goodwill will never be reversed.

Inventories are stated at the lower of cost and net realizable value. The first-in, first-out (FIFO) method of valuation is used. The cost of finished goods and intermediates includes directly attributable costs and related production overhead expenses. Net realizable value is determined as the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale. Products whose manufacturing cost cannot be calculated because of joint cost components are stated at net realizable price after deduction of a margin.

Current receivables are stated at face value less an allowance for bad debts.

Deposits held at call with banks with a remaining maturity of more than 3 months and less than 12 months are classified as current investments. They are measured at amortized cost. Proceeds from these deposits are recognized in income (Net finance costs).

Non-current assets or assets and liabilities related to a disposal group are separately disclosed as assets and/or liabilities held for sale when such assets are available for immediate sale and when the sale is highly probable. These conditions are usually met as from the date a first draft of an agreement to sell is ready for discussion. Assets and liabilities classified as held for sale are measured at the lower of carrying amount and fair value less costs to sell. For non-current assets classified as held for sale depreciation is terminated.

DSM’s ordinary shares and cumulative preference shares are classified as equity. The consideration paid for repurchased DSM shares (treasury shares) is deducted from Shareholders’ equity until the shares are withdrawn or reissued. Dividend to be distributed to holders cumulative preference shares is recognized as a liability in the period in which the Supervisory Board of Directors approves the proposal for profit distribution. Dividend to be distributed to holders of ordinary shares is recognized as a liability in the period in which the Annual General Meeting of Shareholders approves the proposal for dividend.

Borrowings are initially recognized at cost, being the fair value of the proceeds received, net of transaction costs. Subsequently, borrowings are stated at amortized cost using the effective interest method. Amortized cost is calculated by taking into account any discount or premium. Interest expenses are accrued for and recorded in income for each period. Where the interest rate risk relating to a long-term borrowing is hedged, and the hedge is regarded as effective, the carrying amount of the long-term loan is adjusted for changes in fair value of the interest component of the loan.

Provisions are recognized when all of the following conditions are met:

• There is a present legal or constructive obligation as a result of past events
• It is probable that a transfer of economic benefits will settle the obligation
• A reliable estimate can be made of the amount of the obligation.

If the effect of the time value of money is material, provisions are determined by discounting the expected cash flows at a pre-tax rate. Where discounting is used, the increase in the provision due to the passage of time is recognized as borrowing cost. However, the interest costs relating to pension obligations are included in pension costs. Any provision for costs that will arise from future site restoration is made when the investment project concerned is taken into operation. These are included in Property, plant and equipment, along with the historic cost of the relating asset, and depreciated over the useful life of the asset.

Income tax is accounted for using the balance sheet liability method. Income tax expense is recognized in the income statement except to the extent it relates to an item recognized directly within shareholders’ equity.

Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted at the balance sheet date, and any adjustment to tax payable in respect to previous years. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the bases of assets and liabilities and their reported amounts. Deferred tax assets and liabilities are measured at the tax rates and under the tax laws that have been enacted or substantially enacted at the balance sheet date and are expected to apply when the related deferred tax assets are realized or the deferred tax liabilities are settled. Deferred tax assets are recognized to the extent that it is probable that future taxable profits will be available against which the deductible temporary differences and unused tax losses can be utilized. If necessary a value adjustment is deducted. Deferred tax assets and liabilities are stated at face value. Deferred tax liabilities relating to withholding taxes are included only if and to the extent that DSM intends to distribute the profits made by subsidiaries in the form of dividend in the near future.

The Group operates a number of defined benefit plans and defined contribution plans throughout the world, the assets of which are generally held in separately administered funds. The pension plans are generally funded by payments from employees and by the relevant Group companies. The Group also provides certain additional post-employment healthcare benefits to retired employees in the United States. These benefits are unfunded.

For defined benefit plans, pension costs are determined using the projected unit credit method. Actuarial gains and losses are recognized in income, spread over the average remaining service lives of employees, using the corridor approach. Prepaid pension costs relating to defined benefit plans are capitalized only if they lead to refunds to the employer or to reductions in future contributions to the plan by the employer. Payments to defined contribution plans are charged as an expense as they fall due.

The costs of option plans are measured by reference to the fair value of the options at the date at which the options are granted. The fair value is determined using the Black-Scholes option pricing model, taking into account market conditions linked to the price of the DSM share. The costs of these options are recognized in income (Employee benefits), together with a corresponding increase in equity (Reserve for share-based compensation) during the vesting period in the case of share-settled options. In the case of cash-settled options (share appreciation rights) the contra-account is Other liabilities. No expense is recognized for options that do not ultimately vest, except for options where vesting is conditional upon a market condition, which are treated as vesting, irrespective of whether or not the market condition is satisfied, provided that all other performance conditions are satisfied.

Finance leases, which transfer to the Group substantially all the risks and benefits incidental to ownership of the leased item, are capitalized at the inception of the lease at the fair value of the leased property or, if lower, at the present value of the minimum lease payments. All other leases are operating leases.
Lease payments for finance leases are apportioned to finance charges and reduction of the lease liability so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income. Capitalized leased assets are depreciated over the shorter of the estimated useful life of the asset or the lease term. Operating lease payments are recognized as an expense on a straight-line basis over the lease term.

Revenue from the sale of goods is recognized when the significant risks and rewards of ownership are transferred to the buyer. Net sales represent the invoice value less estimated rebates and cash discounts, and was excluding value-added taxes.

Royalty income is recognized (Other operating revenue) on an accruals basis in accordance with the substance of the relevant agreements. Interest income is recognized on a time-proportion basis using the effective interest method. Dividend income is recognized when the right to receive payment is established.

Government grants are recognized at their fair value where there is reasonable assurance that the grant will be received and all related conditions will be complied with. When the grant relates to an expense item, it is recognized as income over the periods necessary to match the grant on a systematic basis to the costs that it is intended to compensate. Where the grant relates to an asset, the fair value is initially recognized as deferred income (Other non-current liabilities) and then released to income over the expected useful life of the relevant asset by equal annual amounts.

Research expenditure is charged to income in the period in which it is incurred. Internal development expenditure is charged to income in the period in which it is incurred unless it meets the recognition criteria for intangible assets.

The Group uses derivative financial instruments (‘derivatives’) such as foreign currency contracts and interest rate swaps to hedge risks associated with foreign currency and interest rate fluctuations.

Financial derivatives are initially recognized in the balance sheet at cost and subsequently measured at their fair value on each balance sheet date. The method of recognizing the resulting gains or losses is dependent on the nature of the item being hedged. When derivative contracts are entered into, the Group designates them as either: hedges of the fair value of recognized assets or liabilities; hedges of firm commitments or forecast transactions or as hedges of net investments in entities with a functional currency other than the euro.

Changes in the fair value of derivatives designated and qualifying as fair value hedges are immediately recognized in income, together with any changes in the fair value of the hedged assets or liabilities attributable to the hedged risk.

Changes in the fair value of derivatives designated and qualifying as cash flow hedges are recognized in equity (Hedging reserve). Upon recognition of the related asset or liability the cumulative gain or loss is transferred from the Hedging reserve and included in the carrying amount or in income.

Changes in the fair value of derivatives designated and qualifying as net investment hedges are recognized in equity (Translation reserve). Gains and losses accumulated in the Translation reserve are included in income when the net investment is disposed of.

Gains or losses relating to the ineffective portion of fair value hedges, cash flow hedges and net investment hedges are immediately recognized in income.

Exceptional items relate to material non-recurring items of income and expense arising from circumstances such as:

• Write-downs of inventories to net realizable value or of property, plant and equipment to recoverable amount, as well as reversals of such write-downs
• Restructurings of the activities of an entity and reversals of any provisions for the cost of restructurings
• Disposals of property, plant and equipment
• Disposals of investments
• Discontinued operations
• Litigation settlements
• Other reversals of provisions
• Exceptional items are reported separately to give a better understanding of the underlying results of the period.

Deposits held at call with banks with a remaining maturity of more than 3 months and less than 12 months are classified as current investments. They are measured at amortized cost. Proceeds from these deposits are recognized in income (Net finance costs).