3.2 Impairment of assets as at 31 December 2019

Due to the fact that the Parent Entity’s market capitalisation remained below the carrying amount of net assets in 2019, in accordance with IAS 36 the Management Board of KGHM Polska Miedź S.A. conducted an analysis to determine which areas of the Company’s activities may be impaired. As the result of the conducted analysis, it was determined that impairment testing of the investment in the KGHM INTERNATIONAL LTD. Group was necessary (held by Future 1 Sp. z o.o., a subsidiary of KGHM Polska Miedź S.A.). A description of the adopted assumptions and results of the test conducted on the investment in Future 1 Sp. z o.o. is presented below. The Management Board of KGHM Polska Miedź S.A. also analysed whether the Polish production assets of KGHM Polska Miedź S.A. might have been impaired. In the assessment in particular the following were analysed: past financial results of the Parent Entity, forecasts of the copper price adopted for subsequent years of KGHM Polska Miedź S.A.’s operations, USD/PLN exchange rate fluctuations and their impact on the level of results achieved by the Parent Entity, ore deposit availability, production technology, production costs, levels of market interest rates, level of debt and the share price of KGHM Polska Miedź S.A. versus other parameters such as the main stock exchange indices in Poland, and copper price and one-off events that did not have any connection with the fundamentals of the Parent Entity’s operations in Poland. As a result of the assessment, it was judged that there was no relation between the fall in the share price of KGHM Polska Miedź S.A. with the Polish activities of the Parent Entity, and as a result, it was decided that there was no risk of impairment of the Polish production assets of KGHM Polska Miedź S.A.

In the current period, as a result of the identification of indications of a possible change in the recoverable amounts of the international mining assets of the KGHM INTERNATIONAL LTD. Group, the Parent Entity’s Management Board performed impairment testing of these assets and took into account the results of these tests in the calculation of expected credit losses on loans granted to Sierra Gorda S.C.M. (these loans are not part of the net investment in the joint venture Sierra Gorda S.C.M., and an allowance for the impairment of loans measured at amortised cost is set pursuant to principles presented in note 6,2). The key indications to perform impairment testing were:

• a significant change to the market paths of commodities prices forecasts,
• a change in the assessed risk of individual projects and risk free rates which are the basis used to determine discount rates for testing purposes, and
• a change in the technical and economic parameters of the mining assets of the KGHM INTERNATIONAL LTD. Group and Sierra Gorda S.C.M. (a joint venture in the KGHM INTERNATIONAL LTD. Group) as respects production volumes, assumed operating costs and the level of capital expenditures during a mine’s life.

The key indications that the recoverable amount may be higher than the carrying amount, and therefore it may be justifiable to reverse previously recognised impairment losses, were:

• a change in risk free rates,
• a change in price paths for gold, palladium, silver and nickel,
• the assumed level of operating cost of the CGU Sierra Gorda,
• risk evaluation of the CGU Robinson, and
• extension of the Life of Mine of the CGU Robinson.

The key indications that the recoverable amount may be lower than the carrying amount, and therefore it may be necessary to recognise an additional impairment loss, were:

• a change in copper price paths,
• the level of capital expenditures during the life of mine of Sierra Gorda,
• the volume of production of the CGU Sierra Gorda,
• risk evaluation of the CGU Sierra Gorda.

The following CGUs have been selected for the purpose of assessment of ] the recoverable amount of the assets of the KGHM INTERNATIONAL LTD. Group:

• the Robinson mine,
• the Sudbury Basin, comprising the Morrison mine, the McCreedy mine and the pre-operational Victoria project,
• the Franke mine,
• the Carlota mine,
• involvement in the joint venture Sierra Gorda S.C.M., including loans granted, and
• the Ajax project.

To determine the recoverable amount of assets during the testing, their fair value (decreased by costs to sell) was calculated using the DCF method, i.e. the method of discounted cash flows for the CGU Sudbury and involvement in the joint venture Sierra Gorda S.C.M. and the value in use for the following CGUs: Franke, Robinson and Carlota.
As for the recoverable amount of the CGU KGHM Ajax, due to a lack of indications of changes in the recoverable amount, it was set at its carrying amount.

The fair value of the CGU Sudbury and the CGU Sierra Gorda S.C.M. were classified to level 3 of the fair value hierarchy.

Price paths were adopted on the basis of long-term forecasts available from financial and analytical institutions.
A specified forecast is being prepared for the period 2020-2024, while for the period 2025-2029 a technical adjustment of prices was applied between the last year of the specified forecast and 2030, from which a long-term metal price forecast is used, as follows:

• for copper – 6 614 USD/t (3.00 USD/lb);

• for gold – 1 500 USD/oz;

• or nickel – 8.00 USD/lb.

In its annual budgeting process, in order to determine its Reserves and Resources, the Group uses block models based on the price paths current at the moment of commencing work. Moreover, it takes into account information obtained, from the moment of preparation of the previous budget to the day the work commenced on the new budget, as a result of supplementary drilling (quality information, e.g. copper grade) and metallurgical drilling (e.g. copper recovery). Moreover, geotechnical and hydrogeological information is used.

The Victoria project’s deposit has copper-nickel ore with a significant percentage of precious metals. The identified mineralisation zone of the Victoria project was classified as “Inferred”. Exploration work commenced in 2008. Moreover, in the years 2015 – 2016 exploration work was performed on the deep part of the deposit, under the so-called Deep Drilling Program. In 2019, exploration work took place, aimed at deepening the knowledge of the project’s reserves and resources.

The mineralisation potential of the Pampa Lina deposit (CGU Sierra Gorda S.C.M deposit) was estimated based on the executed scope of exploration work, in particular on the basis of drilling performed, geophysical analyses and geological hypotheses. The estimation of Pampa Lina’s mineralisation potential is based on the work of specialist external companies and work executed by the company itself. Sierra Gorda S.C.M. has rights to the mineralisation of Pampa Lina.

In the current period, due to indications of the possibility of changes in the recoverable amount of the property, plant and equipment and intangible assets of the company Energetyka sp. z o.o., the Management Board of the Parent Entity performed impairment testing on these assets. The key indication to perform impairment testing in the current reporting period was a negative change in forecasted operating cash flows of Energetyka Sp. z o.o. The carrying amount of property, plant and equipment and intangible assets of Energetyka sp. z o.o. as at 31 December 2019 amounted to PLN 563 million. For the purpose of estimating the recoverable amount, in the conducted test the value in use of the cash generating unit, comprised of the property plant and equipment and intangible assets of the company, was measured using the DCF (discounted cash flows) method.

In the current period, due to indications of the possibility of changes in the recoverable amount of the property, plant and equipment and intangible assets of the company WPEC w Legnicy S.A., the Management Board of the Parent Entity performed impairment testing on these assets. The key indication to perform impairment testing in the current reporting period was a negative change in forecasted operating cash flows of WPEC w Legnicy S.A. The carrying amount of the property, plant and equipment and intangible assets of WPEC w Legnicy S.A. as at 31 December 2019 amounted to PLN 157 million. For the purpose of estimating the recoverable amount, in the conducted test the value in use
of the cash generating unit, comprised of the property, plant and equipment and intangible assets of the company, was measured using the DCF (discounted cash flows) method.

The market capitalisation of the subsidiary Interferie S.A. in 2019 was below the carrying amount of the company’s net assets, which in accordance with the adopted accounting policy was recognised by the company to be an indication to perform impairment testing of the company’s assets (the carrying amount of the tested assets was PLN 106 million). In order to assess the impairment, the Company identified the following CGUs: INTERFERIE in Ustronie Morskie – Leisure and Sanatorium Cechsztyn, INTERFERIE in Kołobrzeg Leisure and Sanatorium Chalkozyn, INTERFERIE in Dąbki Sanatorium Argentyt, INTERFERIE in Świeradów Zdrój – Hotel Malachit, INTERFERIE Hotel in Głogów and INTERFERIE Hotel Bornit in Szklarska Poręba. In order to assess the impairment, the fair value of the assets was estimated on the basis of the sum of future cash flows of individual CGUs discounted by the rate estimated on the basis of ratios used by the hotel industry, with the exception of CGU INTERFERIE Hotel in Głogów and CGU INTERFERIE Hotel Bornit in Szklarska Poręba, for which the fair value was determined on the basis of valuation reports.

The fair value was classified to level 3 of the fair value hierarchy.

In the current period, due to indications of the possibility of changes in the recoverable amount of the property, plant and equipment and intangible assets of the company POL MIEDŹ TRANS Sp. z o.o., the Management Board of the Parent Entity performed impairment testing on these assets. The key indication to perform impairment testing in the current reporting period was a loss for the period incurred by POL MIEDŹ TRANS Sp. z o.o. The carrying amount of property, plant and equipment and intangible assets of POL MIEDŹ TRANS Sp. z o.o. as at 31 December 2019 amounted to PLN 238 million. For the purpose of estimating the recoverable amount, in the conducted test the value
in use of property plant and equipment and intangible assets of the company was measured using the DCF (discounted cash flows) method.

In the Group, water rights in Chile are annually subjected to impairment testing by comparing their carrying amount to the recoverable amount, which is set as fair value decreased by costs to sell. The fair value of water rights is classified under level 2 of the fair value hierarchy, in which fair value measurements are based on significant observable input data, other than market prices.

For the year ended on 31 December 2019, the Group assessed the factors impacting the recoverable amount of the asset and concluded that there are no grounds for recognising an impairment loss, as the water price
and the estimated amount of water available for extraction did not change compared to the level of these factors adopted for measurement as at 31 December 2018. The carrying amount of water rights amounted to PLN 65 million as at 31 December 2019 (as at 31 December 2018: PLN 65 million).