Note 1.1 Corporate information

KGHM Polska Miedź S.A. (“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 Company’s principal activities include:

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

KGHM Polska Miedź S.A. carries out copper ore mining activities based on concessions given for specific mine deposits, and also based on mining usufruct agreements and mine operating plans.

Declaration by the Management Board on the accuracy of the prepared financial statements

The Management Board of KGHM Polska Miedź S.A. declares that according to its best judgement the annual financial statements for 2018 and the comparative data have been prepared in accordance with accounting principles currently in force, and give a true, fair and clear view of the financial position of KGHM Polska Miedź S.A. and the profit for the period of the Company.
The Management Board’s report on the activities of KGHM Polska Miedź S.A. and of the KGHM Polska Miedź S.A. Group in 2018 presents a true picture of the development and achievements, as well as the condition, of KGHM Polska Miedź S.A. and the KGHM Polska Miedź S.A. Group, including a description of the basic exposures and risks.

The financial statements were authorised for issue and signed by the Management Board of the Company on 13 March 2019.  

Note 1.2 Basis of preparation

These financial statements have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union.

The accounting policies described in this note and in individual notes were applied by the Company in a continuous manner for all presented periods, with the exception of accounting policies and measurement arising from the application of IFRS 9 and IFRS 15 from 1 January 2018.

The accounting policies and important estimates and judgements for significant items of the financial statements were presented in individual notes of these financial statements.

* Amounts include data on long-term and short-term loans, in the statement of financial position, short-term loans are recognised in the item “other financial assets".

** Amounts include data on non-current and current provisions for decommissioning costs of mines and other technological facilities, in the statement of financial position, current provisions for decommissioning costs of mines and other technological facilities are recognised in the item “provisions for liabilities and other charges”.

Note 1.3 Foreign currency transactions and the measurement of items denominated in foreign currencies

The financial statements are presented in Polish zloty (PLN), which is both the functional and presentation currency of the Company.

At the moment of initial recognition, foreign currency transactions are translated into the functional currency:

• at the actual exchange rate applied, i.e. at the buy or sell exchange rate applied by the bank in which the transaction occurs, in the case of the sale or purchase of currencies and the payment of receivables or liabilities;
• at the average exchange rate set for a given currency, prevailing on the date of the transaction for other transactions. The exchange rate prevailing on the date of the transaction is the average NBP rate announced on the last working day preceding the transaction date.

At the end of each reporting period, foreign currency monetary items are translated at the closing rate prevailing on that date.

Foreign exchange gains or losses on the settlement of foreign currency transactions, and on the measurement of foreign currency monetary assets and liabilities (other than derivatives), are recognised in profit or loss.

Foreign exchange gains or losses on the measurement of foreign currency derivatives are recognised in profit or loss as a fair value measurement, provided they do not represent a change in the fair value of the effective cash flow hedge. In such a case, in accordance with hedge accounting policies, they are recognised in other comprehensive income.

Note 1.4 Impact of new and amended standards and interpretations

The International Accounting Standards Board approved the following new standards for use from 1 January 2018:

• IFRS 9 “Financial Instruments”,
• IFRS 15 “Revenue from contracts with customers” and Amendments to IFRS 15, clarifying some of the standard’s requirements,
• Amendments to IFRS 2, clarifying the Classification and Measurement of Share-based Payment Transactions,
• Amendments to IFRS 4, clarifying the Application of IFRS 9 with IFRS 4,
• Amendments to IAS 40, clarifying when assets are transferred to, or from, investment properties,
• Annual Improvements to IFRS Standards, 2014-2016 Cycle, clarifying the scope of IAS 28 and IFRS 1, IFRIC 22, clarifying Foreign Currency Transactions and Advance Consideration.

Up to the date of publication of these financial statements, the aforementioned amendments to the standards were adopted for use by the European Union and with the exception of IFRS 9 and IFRS 15, they will not have an impact on the Company’s accounting policy or on the separate financial statements.

Impact of application of IFRS 9 and IFRS 15 on the Company’s accounting policy and on the Company’s financial statements.

IFRS 9 Financial Instruments

The Company did not make early implementation of IFRS 9 and applied the requirements of IFRS 9 retrospectively for periods beginning on or after 1 January 2018. In accordance with the possibility provided by the standard, the Company decided against the restatement of comparative data. Changes in the measurement of financial assets and financial liabilities, as at the date of initial application of the standard, were recognised in retained earnings. Implementation of IFRS 9 resulted in a change in accounting policy with respect to the recognition, classification and measurement of financial assets, the measurement of financial liabilities, impairment losses on financial assets and hedge accounting.

Selected accounting policy 

Measurement of financial assets and financial liabilities 

As at 1 January 2018, the Company classifies financial assets to the following categories:

-    financial assets measured at amortised cost,
-    financial assets measured at fair value through other comprehensive income,
-    financial assets measured at fair value through profit or loss, or
-    derivative hedging instruments.

Classification is made upon initial recognition of a given asset. Classification of debt financial assets depends on the business model for financial assets management and on the nature of the contractual cash flows (SPPI test) for a given financial asset.

The Company classifies the following assets to the category assets measured at amortised cost: trade receivables (except for sold receivables subject to factoring agreements and trade receivables priced upon M+ formula, i.e. for which the final price is set after the end of the reporting period), loans granted which pass the SPPI test, other receivables, deposits and cash and cash equivalents.
Financial assets measured at amortised cost are stated at amortised cost using the effective interest rate method, less allowance for impairment. Trade receivables with a maturity period of up to 12 months from the receivable origination date (i.e. with no financing element), and which are not subject to factoring, are not discounted and are measured at nominal value. In the case of purchased or originated credit-impaired (POCI) financial assets at the moment of initial recognition, such assets are measured at amortised cost using the effective interest rate adjusted for credit risk.

The following are classified to the category assets measured at fair value through other comprehensive income:

1. financial assets, if the following conditions are met: 

- they are held within a business model whose objective is to collect contractual cash flows due to holding and selling financial assets, and
- the contractual terms give the right to receive cash flows on specified dates that are solely payments of principal and interest on the principal amount outstanding (i.e. the SPPI test was passed),

The impact of changes in fair value is recognised in other comprehensive income up to the moment of derecognition of an asset from the statement of financial position, when the accumulated profit/loss is recognised in the statement of profit or loss.

2. equity instruments which at initial recognition were irrevocably selected to be classified to this category. The selection option of measurement at fair value through other comprehensive income is not available for instruments held for trading.
Gains and losses, on both measurement and realisation of these assets, are recognised in other comprehensive income, with the exception of income on dividends received, which is recognised in the statement of profit or loss.

All financial instruments that were not classified as measured at amortised cost or measured at fair value through other comprehensive income, as well as those that the Company decided to classify as such in order to eliminate an accounting mismatch, are classified to the category assets measured at fair value through profit or loss.
The Company classifies the following to this category: trade receivables subject to factoring arrangements, trade receivables priced upon M+ formula, loans granted which did not pass the contractual cash flows test and derivatives which were classified as assets on the condition that they were not designated as hedging instruments.
Gains and losses on financial assets which are classified as financial assets measured at fair value through profit or loss are recognised in profit or loss in the period in which they arise (including interest income and dividend income).

The following are classified to financial hedging instruments: financial assets and financial liabilities representing designated financial instruments and qualifying for hedge accounting, measured at fair value reflecting all market and credit risk components.

As at 1 January 2018, the Company classifies financial liabilities to the following categories:

-     financial liabilities measured at amortised cost,
-     financial liabilities measured at fair value through profit or loss, or  
-     financial hedging instruments.

Liabilities measured at amortised cost include liabilities other than those measured at fair value through profit or loss (such as trade payables and bank and other loans), with the exception of:

• financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition,
• financial guarantee agreements, measured at the higher of the following amounts:

-    the amount of loss allowance for expected credit losses determined in accordance with IFRS 9;
-   the amount initially recognised (i.e. at fair value increased by transaction costs that may be directly attributed to a financial liability) less cumulative revenue recognised according to IFRS 15 Revenue from contracts with customers.

Liabilities measured at fair value through profit or loss include financial liabilities held for trading and financial liabilities designated at their initial recognition to measurement at fair value through profit or loss.

Financial liabilities held for trading include derivatives which are not designated for hedge accounting purposes.

Note 1.5 Published standards and interpretations, which are not yet in force and were not applied earlier by the Company.

The Company did not decide for earlier application of published standards, interpretations or amendments to existing standards before their entry into force in these financial statements. With the exception of IFRS 16 presented below, other changes are not applicable to the Company’s activities and will not have any impact on the financial statements.

IFRS 16 „Leasing”

Basic information on the standard

Impact of IFRS 16 on the financial statements 

At the moment of preparation of these financial statements the Company had completed the work related to implementation of the new standard IFRS 16. The project to implement IFRS 16 (project), was executed in three stages:

- stage I – analysis of all executed agreements for the purchase of services, regardless of their classification, the goal of which was to identify agreements based on which the Company uses assets belonging to suppliers; in addition, this stage comprised the analysis of perpetual usufruct rights to land as well as land easements and transmission easements,

- stage II – the evaluation of each agreement identified in stage I in terms of its meeting the criteria to be recognised as a lease pursuant to IFRS 16,

- stage III - implementation of IFRS 16 based on the developed concept.

At the moment of preparation of these financial statements the Company had completed the work related to implementation of the new standard IFRS 16. The project to implement IFRS 16 (project), was executed in three stages:
- stage I – analysis of all executed agreements for the purchase of services, regardless of their classification, the goal of which was to identify agreements based on which the Company uses assets belonging to suppliers; in addition, this stage comprised the analysis of perpetual usufruct rights to land as well as land easements and transmission easements,
- stage II – the evaluation of each agreement identified in stage I in terms of its meeting the criteria to be recognised as a lease pursuant to IFRS 16,
- stage III - implementation of IFRS 16 based on the developed concept.
All agreements were subjected to analysis involving a finance lease, operating lease, rentals, leasing and perpetual usufruct rights to land as well as transmission easements and land easements. Also analysed were transactions involving purchased services (external service costs under operating activities) in terms of any occurrence of use of identified assets.
Under this project the Company carried out appropriate changes in accounting policy and operating procedures. Methods were developed and implemented for the proper identification of lease agreements and for gathering data needed in order to properly account for such transactions. The Company decided to apply the standard from 1 January 2019. In accordance with the transition rules described in IFRS 16.C5 (b), the new principles will be applied retrospectively, and the accumulated impact of initial application of the new standard will be recognised in equity as at 1 January 2019.
Consequently, comparable data for financial year 2018 will not be restated (the modified retrospective approach).
At the moment of transition, the Company applied the practical expedient pursuant to which the entity is not required to reassess whether previously classified agreements contain a lease. The project which was undertaken during the implementation indicated that the new definition of a lease per IFRS 16 will not significantly change the scope of agreements meeting the definition of a lease.

Following are the individual adjustments arising from the implementation of IFRS 16.

Description of adjustments

a) Recognition of lease liabilities

Following the adoption of IFRS 16, the Company will recognise lease liabilities related to agreements which were previously classified as "operating leases" in accordance with IAS 17 Leases. These liabilities will be measured at the present value of lease payments due to be paid as at the date of commencement of the application of IFRS 16. For purposes of implementation of IFRS 16 and disclosure with respect to the impact of implementation of IFRS 16, discounting was applied using the Company’s incremental borrowing rate as at 1 January 2019.
At their date of initial recognition, lease payments contained in the measurement of lease liabilities comprise the following types of payments for the right to use the underlying asset for the life of the lease:
- fixed lease payments less any lease incentives,
- variable lease payments which are dependent on market indices or market interest rates,
- amounts expected to be payable by the lessee under guaranteed residual value,
- the strike price of a purchase option, if it is reasonably certain that the option will be exercised, and
- payment of contractual penalties for terminating the lease, if the lease period reflects the lessee’s use of the option of terminating the lease.

For the purposes of calculating the discount rate under IFRS 16, the Company will apply an incremental borrowing rate reflecting the cost of financing which would be drawn to purchase the object of a given lease. To estimate the amount of the discount rate, the Company considered the following contractual parameters: the type and life of an agreement, the currency applied and the potential margin which would have to be paid to a financial institution to obtain financing.
As at 31 December 2018, the discount rates calculated by the Company was within the following ranges (depending on the life of the agreement):
- for PLN-denominated agreements: from 4.25% to 5.86%
- for EUR-denominated agreements: 2.10%
The Company makes use of expedients with respect to short-term leases (up to 12 months) as well as in the case of leases in respect of which the underlying asset has a low value (up to PLN 20 000) and for which agreements the Company will not recognise financial liabilities nor any respective right-to-use assets. These types of lease payments will be recognised as costs using the straight-line method during the life of the lease.

b) Recognition of right-to-use assets 

Right-to-use assets are measured at cost.
The initial cost of a right-to-use asset comprises:
- the amount of the initial measurement of lease liabilities,
- any lease payments paid at the commencement date or earlier, less any lease incentives received,
- initial direct costs incurred by the lessee as a result of entering into a lease agreement,
- estimates of costs which are to be incurred by the lessee as a result of an obligation to disassemble and remove an underlying asset or to carry out renovation.

On the day of initial application, in the case of leases previously classified as operating leases under IAS 17, right-to-use assets were measured by the Company at the amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments related to that lease, recognised in the statement of financial position directly preceding the date of the initial application of IFRS 16.
Following initial recognition, right-to use assets are depreciated under IAS 16 and are subjected to impairment testing pursuant to IAS 36.

c) Application of estimates

The implementation of IFRS 16 requires the making of certain estimates and calculations which effect the measurement of lease liabilities and of right-to-use assets. These include among others:
- determining which agreements are subject to IFRS 16,
- determining the remaining life of leases for agreements entered into before 1 January 2019 (including for agreements with unspecified lives or which may be prolonged),
- determining the marginal interest rates applied for the purpose of discounting future cash flows, and
- determining useful lives and depreciation rates of right-to-use assets, recognised as at 1 January 2019.

d) Application of practical expedients 

In applying IFRS 16 for the first time, the Company will apply the following practical expedients permitted by the standard:
- application of a single discount rate to a portfolio of leases with similar characteristics,
- assessment as to whether leases are onerous as defined by IAS 37 at the moment of implementation of the standard as an alternative to performing impairment testing of a leased asset,
- the treatment of operating lease agreements for which the remaining lease term is less than 12 months as at 1 January 2019 as short-term leases, and
- the use of hindsight (i.e. knowledge gained after the fact) in determining the lease period if the agreement contains options to prolong or terminate the lease.

e) Information on the financial impact of IFRS 16 on the financial statements in the period in which the Standard will be applied for the first time

As at 31 December 2018, the Company had non-cancellable, off-balance sheet operating lease liabilities in respect of the following agreements: perpetual usufruct of land, lease of land, lease of machines and equipment and other leases. As at 31 December 2018, their notional amount was PLN 957 million (detailed information is presented in note 12.5 and in note 12.7), of which the amount of PLN 955 million concerns lease agreements and in accordance with IFRS 16 excludes short-term leases and the lease of low value assets.

For the aforementioned agreements, the Company measured the present value of assets used under these agreements and recognised, as at 1 January 2019, right-to-use assets in the amount of PLN 390 million and a corresponding lease liability in the same amount.

Off-balance sheet lease liabilities in the amount of PLN 955 million will be written-off.

In the case of agreements in which the Company is a lessor, application of IFRS 16 will not necessitate the recognition of adjustments as at 1 January 2019

Summary of the financial impact of the implementation of IFRS 16 (this only concerns lease agreements entered into or amended before 1 January 2019):

It is estimated that the annual cost of short-term lease agreements and the annual cost of lease agreements for low-value assets is immaterial.

Impact on financial ratios

Given the fact that the Company recognises nearly all of its lease agreements in its statement of financial position, the implementation of IFRS 16 by the Company will affect its balance sheet ratios, including the debt to equity ratio. Moreover, as a result of the implementation of IFRS 16 there may be a change in profit ratios (such as operating profit, EBITDA), as well as in cash flow from operating activities. The Company has analysed the impact of all of these changes in terms of compliance with covenants contained in credit agreements to which the Company is a party, and did not identify any risk of breaches in these covenants.

Other standards and interpretations published but not yet in force are not applicable to the Company’s activities nor will they have an impact. 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,
• 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, 2015-2017 cycle,
• Amendments to IAS 19 on amendments, curtailments or settlements of plans of specified benefits,
• Revision of IFRS Conceptual Framework,
• Amendments to IFRS 3 on  the Definition of a Business,
• Amendments to IAS 1 and IAS 8 on the Definition of Material.

The aforementioned standards, with the exception of IFRIC 23, amendments to IFRS 9 and amendments to IAS 28 are awaiting adoption by the European Union. The Company aims to apply all of the amendments at their effective dates.