Note 1.1 Corporate information

KGHM Polska Miedź S.A. (“the Parent Entity”, “the Company”) with its registered office in Lubin at 48 M.Skłodowskiej-Curie Street is a joint stock company registered at the Regional Court for Wrocław Fabryczna, Section IX (Economic) of the National Court Register, entry no. KRS  23302, on the territory of the Republic of Poland.

KGHM Polska Miedź S.A. has a multi-divisional organisational structure, comprised of a Head Office and 10 divisions: 3 mines (Lubin Mine Division, Polkowice-Sieroszowice Mine Division, Rudna Mine Division), 3 metallurgical plants (Głogów Smelter/Refinery, Legnica Smelter/Refinery, Cedynia Wire Rod Division), the Concentrator Division, the Tailings Division, the Mine-Smelter Emergency Rescue Division and the Data Center Division.

The shares of KGHM Polska Miedź S.A. are listed on the Warsaw Stock Exchange.       

The Parent Entity’s principal activities include:

• the mining of copper and non-ferrous metals ores; and
• the production of copper, precious and non-ferrous metals.

In addition, the KGHM Polska Miedź S.A. Group (“the Group”) conducts other activities, which are described in the Management Board’s report on the activities of KGHM Polska Miedź S.A. and of the KGHM Polska Miedź S.A. Group in 2017 (appendix 4).

The consolidated financial statements were prepared under the assumption that the Group’s companies will continue as a going concern during a period of at least 12 months from the end of the reporting period in an unaltered form and business scope, and there are no reasons to suspect any intentional or forced discontinuation or significant limitation of its current activities. As at the date of signing of the consolidated financial statements the Management Board of the Parent Entity is not aware of any facts or circumstances that may cast doubt about the going concern in the foreseeable future.

The KGHM Polska Miedź S.A. Group carries out exploration and the mining of copper, nickel and precious metals based on concessions given for the Polish deposits to KGHM Polska Miedź S.A., and also based on legal titles held by KGHM INTERNATIONAL LTD. and KGHM AJAX MINING INC. for the exploration for and mining of these resources in the USA, Canada, and Chile. Detailed information is presented in the Management Board’s report on the activities of KGHM Polska Miedź S.A  and of the KGHM Polska Miedź S.A. Group in 2017 (point 2.4).

In 2017, the Parent Entity of the Group consolidated 74 subsidiaries and used the equity method to account for the shares of three joint ventures (Sierra Gorda S.C.M., “Elektrownia Blachownia Nowa” sp. z o.o. in liquidation and NANO CARBON Sp. z o.o.).

The consolidated financial statements were authorised for issue and signed by the Management Board of the Parent Entity on 13 March 2018.

Note 1.2 Basis of preparation and presentation

These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union, on the historical cost basis, except for available-for-sale financial assets and derivatives measured at fair value.

Impact of a correction of a judgment on the functional currency of a subsidiary

As a result of reassessment of the currency of the basic economic environment in which the subsidiary Future 1 Sp. z o.o. (Future 1) functions, on 27 October 2017 the Management Board of the Parent Entity decided to alter its judgment on the functional currency of Future 1, by changing it from the Polish złoty (PLN) to the US dollar (USD) for purposes of the consolidated financial statements. The correction of the judgment was due to consideration of the following facts:

• - on 20 December 2016, the company Future 1 was combined with companies registered in Luxembourg (Fermat 1 S.a.r.l., Fermat 2 S.a.r.l. and Fermat 3 S.a.r.l.), as a result of which the main assets and liabilities of Future 1 are the loans granted to KGHM International Ltd. and the loans received from KGHM Polska Miedź S.A., denominated in USD,
• - the activities of Future 1 comprise the takeover of the companies registered in Luxembourg, whose functional currency was the USD.

Amendment of the judgment regarding the functional currency led to a correction of settled exchange rate differences from translation of the financial statements of subsidiaries whose functional currency was the USD, taken over under a trans-border combination by Future 1, as well as the recognition of exchange rate differences arising from the measurement of the assets and liabilities of Future 1 in other comprehensive income, even though prior to the amendment of the judgment, exchange rate differences were recognised in other operating income and costs.

Below we present the condensed impact of the above change on the consolidated financial statements as at 31 December 2016:

•  an increase in accumulated other comprehensive income from PLN 855 million to PLN 2 216 million – a change by PLN 1 361 million,
•  a decrease in retained earnings (undistributed profit) from PLN 13 100 million to PLN 11 739 million – a change by PLN (1 361) million,
•  no impact on the financial result for 2016.

As a result of the correction of the judgment, on 27 October 2017 an amended periodic report for the first quarter of 2017 (QSr 1/2017) was published, while the amended periodic report for the first half of 2017 (PSr 2017), together with the auditor’s review report, was published by the Parent Entity on 9 November 2017.

Accounting policies

The accounting policies of the Group which apply to the consolidated financial statements as a whole, as well as significant estimates and their impact on amounts presented in the consolidated financial statements, are presented in the following note.

For a greater understanding of the data presented in the consolidated financial statements, important principles of measurement and accounting policies are presented in individual, detailed notes specified below:

* In the statement of financial position, current provisions for decommissioning costs of mines and other technological facilities are recognised in the item “other liabilities”.

The accounting policies described in this note and in individual notes were applied by the Group in a continuous manner to all presented periods.

Note 1.3 Impact of new and amended standards and interpretations

As at 1 January 2017 the following amendments to the standards are in force in the Group:

• Amendments to IAS 7 „Statement of Cash Flows” under the Disclosure Initiative,
• Amendments to IAS 12 „Income taxes” concerning the recognition of a deferred tax asset with respect to unrealised losses,
• Annual Improvements to IFRS Standards, 2014-2016 Cycle, clarifying the scope of IFRS 12 “Disclosure of Interests in Other Entities”.

The application of the amendments to the standards did not affect the Group’s accounting policy nor the following consolidated financial statements.

The above amendments to the standards were adopted by the European Union prior to the publication of these consolidated financial statements.

Note 1.4 Published standards and interpretations, which are not yet in force and were not applied earlier by the Group

In these consolidated financial statements, the Group did not decide for earlier application of the following published standards, interpretations or amendments to already existing standards prior to their effective date. Apart from the following new standards, other changes are not applicable to the Group’s activities nor will they impact the consolidated financial statements.

As at the moment of preparation of these financial statements, the Group has completed most of its work on implementing the new standard IFRS 9. Already in the fourth quarter of 2016 the Group had commenced a project to implement IFRS 9 (project), which was planned in two stages:

- stage I: gap analysis and preliminary impact assessment,

- stage II: implementation of IFRS 9 based on the concept developed.

Under this project, the Group made the appropriate changes to its accounting policy and operational procedures. Methods for evaluating business models and cash flow analysis were developed and implemented, including identifying assets, in respect of which following 1 January 2018 there will be a change in the valuation method from amortised costs to fair value. With respect to impairment, the Group developed and implemented methods for calculating expected credit losses on trade receivables (simplified approach) and other financial assets (general approach). With respect to hedge accounting, the Parent Entity updated the appropriate IT systems in order to modify the manner of recognising changes in the time value of options.

The Group decided to implement the standard as at 1 January 2018 without correcting comparative data, which means that data concerning 2017 presented in the financial statements for 2018 will not be comparable.

NOTE 1.4.1.3 IMPACT ON EQUITY

Note 1.4.1.4 Corrections

(a) changes in the classification of financial assets

(i)Debt instruments – trade receivables

The Group, based on factoring agreements, sells receivables which, under the evaluation of assets in terms of classification pursuant to IFRS 9, were classified to the assets sale model in order to recover contractual cash flows, which results in the measurement of these receivables to fair value. With respect to the balance of receivables in the amount of PLN 212 million, which as at 31 December 2017 were not yet transferred to factoring, fair value was set as the carrying amount of these receivables due to the short period between the balance sheet date and the receivables sale date.

Trade receivables applying the M+ pricing formula (the final price will be set after the balance sheet date), pursuant to IFRS 9, do not pass the SPPI (solely payments of principal and interest) test, due to the fact that cash flows which arise from these receivables do not solely represent the repayment of principal and interest, as their volatility arises from an embedded derivative instrument which represents the M+ pricing formula. Trade receivables as at 31 December 2017 applying the M+ pricing formula in the amount of PLN 660 million were measured to fair value as at 1 January 2018 in the amount of PLN 676 million, while the impact of measurement in the amount of PLN 16 million will be recognised in retained earnings.

(ii) Debt instruments – loans granted

The Group has loans granted to a jointly-controlled entity (details regarding loans may be found in Note 6.2). Pursuant to IAS 39, these loans were measured at amortised cost (carrying amount per IAS 39 – PLN 3 889 million). Pursuant to IFRS 9, these loans were classified to impaired financial assets due to the credit risk at the moment of initial recognition. Moreover, the Group granted a loan to other entity in the net amount of PLN 17 million as at 31 December 2017, which as at 1 January 2018 will be classified in the same amount to loans measured at fair value.

(iii) Equity instruments – share in other entities

In accordance with the requirements of the new standard, equity instruments will have to be measured at fair value, though the Group will be able to classify them to financial assets measured at fair value through profit or loss or make an irrevocable choice to measure them at fair value through other comprehensive income. The Group classified all of the  equity instruments it holds as being measured at fair value through other comprehensive income and, consequently, the result from measurement to fair value will be recognised in other comprehensive income, the impairment loss will not be recognised in the statement of profit or loss, and in the case of sale of a given instrument, gains/loss will not be reclassified to the statement of profit or loss. The Group has shares of listed companies (carrying amount per IAS 39 – PLN 617 million) and of unlisted companies. Shares of unlisted companies, pursuant to IAS 39, are classified to „available-for-sale financial assets” and are measured at cost (carrying amount PLN 56 million). Pursuant to IFRS 9, shares of other unlisted companies were measured to fair value, and as at 1 January 2018 (as an opening balance sheet for 2018), their carrying amount was PLN 93 million. The difference in the amount of PLN 37 million will be recognised in other comprehensive income. As to the owned shares of listed companies, impairment losses recognised up to 31 December 2017 in retained earnings in the amount of PLN 691 million will be transferred to other comprehensive income.

 (b) measurement to fair value - measurement hierarchy 

Information on assets measured to fair value per their hierarchy:

(c) Methodology of evaluating impairment allowances using the expected losses method

Pursuant to IAS 39, in recognising impairment allowances the Group was obliged to assess whether there were indications of impairment and, if determined, to estimate the impairment allowance. IFRS 9 introduces a new approach to estimating losses with respect to financial assets measured at amortised cost. This approach is based on identifying expected losses, regardless of whether or not indications occurred. The standard requires the classification of financial assets in terms of their impairment in three stages:

Stage 1 – the balances for which there was no substantial increase in credit risk from the moment of initial recognition and for which the expected impairment is set based on the probability of insolvency within the next 12 months,

Stage 2 – the balances for which there was a substantial increase in credit risk from the moment of initial recognition and for which the expected impairment is set based on the probability of insolvency within the entire period of credit,

Stage 3 – the impaired balances.

 (i) Impairment allowance on trade receivables (simplified approach)

For trade receivables measured at amortised cost, in terms of determining expected impairment, the Group will apply the simplified model and will estimate expected impairment throughout the entire period of life, applying payment provision matrices based on historical data, reflecting the rules of the standard with respect to current and forecasted economic conditions. The impact of the new principles regarding impairment on the measurement of trade receivables measured at amortised cost was estimated in the amount of PLN (16) million.

(d) Hedge accounting - changes in the time value of options 

Pursuant to IFRS 9, on the date that IFRS 9 is implemented, the Parent Entity may make the decision, representing an element of the accounting policy, to continue to apply hedge accounting rules pursuant to IAS 39, thereby refraining from the implementation of hedge accounting rules arising from IFRS 9.

However, the Parent Entity decided that it will apply the hedge accounting rules set forth in IFRS 9 for hedging relationships opened as at 1 January 2018 and for relationships which will be established after 1 January 2018.
In particular this means a modification of the manner of recognition of changes in the time value of options comprising hedging instruments subject to hedge accounting rules. Until now, changes in the time value of options pursuant to IAS 39 were excluded from measurement of effectiveness and were recognised on an on-going basis in the statement of profit or loss. Pursuant to the new rules of IFRS 9 (par. 6.5.15) changes in the time value of options will be recognised during the life of the hedge relationship in a separate item under equity and reclassified to the statement of profit or loss during the period when the hedged item is realised. IFRS 9 requires that the Parent Entity carry out a retrospective recognition of the time value of options pursuant to the new rules for all hedge relationships continued after 31 December 2017. As a result of the above change, the Parent Entity will reclassify the change in the time value of options in the amount of PLN 233 million (a loss) from retained earnings to other reserves from measurement of financial instruments.

(e) Corporate financial guarantees 

As part of the analysis of the impact of IFRS 9 on the consolidated financial statements, the Group determined that it is necessary to recognise the financial guarantees granted to Sierra Gorda, to secure its obligations arising from lease agreements and short-term bank loans, in the accounting books as per paragraph 4.2.1 point c of
IFRS 9.

Pursuant to the new regulations, as at 1 January 2018 the Group will recognise receivables, in an amount equal to the present value of future payments due to the guarantees, against the corresponding liabilities, and then it will correct the receivables by the unwinding of the discount effect and will recognise the expected impairment for the full amount of receivables, calculated in accordance with IFRS 9. The impact of the aforementioned change on the consolidated financial statements will be immaterial.

Note 1.4.2.1 Basic information about the standard

Note 1.4.2.2 Impact of IFRS 15 on the financial statements of the Group

The Group analysed the impact of applying IFRS 15  on recognising revenues from contracts concluded by the Group. The first phase of work concerned the analysis of differences between IFRS 15 and current principles governing the recognition of revenues. In the next step, the Group aggregated contracts concluded with its customers in 2017 by bundling them and adopting, as the primary criteria of bundling them, the moment of transferring control over promised goods or services to a customer. The KGHM Polska Miedź S.A. Group mainly concludes sales contracts for produced copper, precious metals and other by-products of copper production, which constitutes approx. 98% of its total revenues from sales. These contracts make use of International Commercial Terms (“INCOTERMS”) to determine the terms of delivery. Therefore, the moment of transferring control to the client was determined by analysing these terms.

The bundles created from aggregated contracts were analysed in order to identify the performance obligations towards the clients in these contracts, and to identify all goods or services (or a bundle of goods or services) or a bundle of  distinct goods or services, the transfer of which to the customer has identical characteristics. Based on the aforementioned analyses and taking into account the fact that the moment of transferring control over the promised goods and services to a client is precisely described in the delivery conditions, it was determined that:

• in the case of most contracts, control is transferred to the customer after delivery of the goods. In these cases, pursuant to IFRS 15, all goods and services promised in the contract (e.g. transport, customs clearance) should be considered to be a single performance obligation and recognise revenues once, in a given moment,
• in the case of other contracts, control over goods is transferred to the customer before the delivery is made, i.e. transport services, and the Group is obliged to organise the completion of this service. In such a case, the obligation to sell goods and the obligation to provide a transport service should be considered to be different services promised in the contract, while the transaction price arising from the contract should be properly allocated to them and their revenues separately recognised. Pursuant to IFRS 15, revenues from sales of goods should be recognised once at a specified moment, while revenues from services rendered should be deferred, proportionally to the progress towards complete satisfaction of that performance obligation. However, due to the negligible share of transport services’ costs and services associated with them, as compared to the revenues from sales of the goods and the time of delivery of such shipments, which does not exceed 7 weeks, in the Group’s opinion  the impact on the current method of recognising revenues will be immaterial, and it does not plan to make any corrections as at 1 January 2018 due to the implementation of IFRS 15.

While analysing the impact of IFRS 15 on the consolidated financial statements of the KGHM Polska Miedź S.A. Group, a so-called streaming arrangement agreement was identified containing a significant financing component as understood by IFRS 15. Streaming arrangements are one of the sources of financing available to companies operating in the mining sector.

The agreement (signed in 2008 between Quadra FNX Mining Ltd. and Franco Nevada) concerns the sale of half of the production of gold, platinum and palladium contained in the ore extracted during the lives of the following mines: Morrison, McCreedy West and Podolsky (CGU Sudbury). Pursuant to the agreement, Quadra FNX Mining Ltd. received a prepayment in the amount of CAD 400 million. Moreover, pursuant to the agreement, the selling price for one ounce of gold equivalent is the lower of these two amounts: (a) USD 400, increased by 1% in each year beginning from 2011, or (b) the market price of gold. The received prepayment covers the difference between the market price of ore sold and its fixed selling price.

The effects of financing arising from the agreement with Franco Nevada, pursuant to IFRS 15, will be presented as at 1 January 2018 in an item other than revenues from contracts with clients, in the consolidated statement of comprehensive income. As at 1 January 2018, due to transitioning to IFRS 15, the KGHM Group will recognise the following adjustments:

• a decrease in deferred income by PLN 70 million,
• an increase in deferred tax liabilities by PLN 21 million,
• an increase in retained earnings by PLN 49 million.

In the reporting periods after 1 January 2018, the KGHM Group will recognise interest costs arising from the Franco Nevada agreement. In addition, pursuant to IFRS 15, the Group will modify the current scope of disclosures on judgments with respect to planned ore extraction by the mines specified in the Franco Nevada agreement, and as a result the amounts of raw materials sold, and will amend the transaction price.

Note 1.4.3 IFRS 16 “Leases”

Note 1.4.3.1 Basic information about the standard

Note 1.4.3.2 Impact of IFRS 16 on the consolidated financial statements

In 2017, the Group commenced an analysis of all realised agreements involving the purchase of services, regardless of their existing classification. The goal of this analysis was to identify those agreements based on which the Group utilises assets belonging to suppliers, and subsequently to make a preliminary assessment of each such agreement as to whether it meets the criteria to be recognised as a lease pursuant to IFRS 16.

As a result of this analysis it was determined that the following assets belonging to suppliers met the condition of right to use:

• technical equipment,
• railroad cars and tankers, cars and other means of transport,
• offices and premises,
• various types of land.  

Pursuant to IFRS 16, an agreement is a lease if a customer designed an asset in a way that determines from the start in what manner and for what purpose the asset will be utilised throughout its life. As a result, in the Group’s opinion, pursuant to IFRS 16 the scope of agreements meeting the criteria of containing a lease will be broader than heretofore, in particular with respect to production infrastructure.

Continuing its work on implementing IFRS 16, in 2018 the Group plans to:

• expand its preliminary analysis of the control of utilisation of a given asset, i.e. whether the Group’s companies have the right to utilise substantially all of the economic benefits deriving from the use of an identified asset as well as the right to direct the use of the identified asset,
• estimate the lease periods for agreements in which the lease period is not definitely indicated in the terms of the agreement,
• calculate the interest rates for discounting lease payments,
• separate lease payments from agreements containing servicing elements,
• evaluate the possibilities of applying exclusions for short-term leases and whose base asset value is low,
• determine the manner of presenting leases in the statement of financial position,
• introduce necessary changes to the IT systems employed, and
• select the transitional rules of IFRS 16 to be applied as at 1 January 2019.

According to preliminary analysis, the application of IFRS 16 will lead to the recognition in the Group’s statement of financial position of assets and corresponding financial liabilities from agreements treated at present as operating leases and services, as well as rights to perpetual usufruct of land which are not currently recognised in the statement of financial position.

Other standards and interpretations published but not yet in force are not applicable to the Group’s activities nor will they have an impact on them. These are as follows:

• Amendments to IFRS 10 and IAS 28 with respect to the sale or contribution of assets between an investor and its associate or joint venture,
• Amendments to IFRS 2 in relation to the classification and measurement of share-based payment transactions,
• Amendments to IFRS 4 with respect to applying IFRS 9 with IFRS 4,
• Amendments to IAS 40 regarding transfers of investment property,
• IFRIC 22 interpretation on foreign currency transactions and advance consideration,
• IFRIC 23 interpretation on uncertainty over income tax treatments,
• IFRS 17 Insurance contracts,
• Amendments to IFRS 9 on debt financial assets with early repayment options, which could lead to the arising of a so-called negative compensation,
• Amendments to IAS 28 on long-term interests that form part of the net investments in associates and joint ventures,
• Annual improvements to IFRS Standards, 2014-2016 cycle, clarifying the scope of IAS 28 and IFRS 1,
• Annual improvements to IFRS Standards, 2015-2017 cycle,
• Amendments to IAS 19 on amendments, curtailments or settlements of plans of specified benefits.

The aforementioned standards, with the exception of amendments to IFRS 4, IFRS 2 and annual improvements to IFRS Standards, 2014-2016 Cycle, are awaiting adoption by the European Union. The Company aims to apply all of the amendments at their effective dates