Note 1 – Material accounting policies

The financial statements of Zealand Pharma A/S for 2013 has been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the EU and in accordance with additional Danish disclosure requirements for annual reports of listed companies.

The amounts in the annual report are denominated in Danish kroner (DKK ´000).

As at 1. January 2013 Zealand Pharma A/S merged with its subsidiary BetaCure Holding A/S, consequently consolidated financial statements are no longer presented. 
Changes to accounting policies, including presentation and implementation of accounting standards Zealand Pharma A/S has implemented the accounting standards adopted by the IASB and the EU as well as related amendments and interpretations effective for the financial year 2013. 

  • Amendment to IAS 1 – The amendment implies requirements of presentation of elements in other comprehensive income which will be recycled to the income statement separate from elements which are not. 
  • IAS 32/IFRS 7 – The amendment provides further guidance as regards offsetting and related disclosures.
  •  IFRS 13 – General standard on fair value measurement.
  • The annual improvements comprise: 
    • IAS 1, clarification of comparable disclosures when presenting statement of financial positions for three years
    • IAS 16, spare parts and servicing equipment for land, buildings and equipment are to be classified as property,plant andequipment rather than inventory when they qualify as such. 
    • IAS 32, clarification of tax in the income statement and equity, respectively. 
    • IAS 34, segment disclosures in interim financial statements.

The implementation of standards, amendments and interpretations has not had any significant effect to Zealand Pharma A/S.

The accounting policies applied by Zealand Pharma A/S, remain unchanged compared to the previous year.

Most recently adopted accounting standards (IFRS) and interpretations (IFRIC)
At the end of January 2014, IASB published the following new accounting standards and interpretations which are assessed to be relevant to Zealand Pharma A/S. 

•     IFRS 9 – The number of classification criteria is reduced to two; amortised cost or fair value. 
The standards and interpretations published by the IASB which are presently considered as irrelevant to Zealand Pharma A/S comprise, IFRS 10, IFRS 11, IFRS 12, amendments to IAS 27 and IAS 28 and IFRIC 20. The mentioned standards and interpretations have been adopted by the EU, except for IFRS 9 and the annual minor improvements to applicable IFRSs.

Zealand Pharma A/S expects to implement the new standards and interpretations when the application becomes mandatory.

Translation policies
Transactions denominated in foreign currencies are translated at the exchange rates at the dates of transaction.

Exchange differences arising between the rate on the date of transaction and the rate on the payment day are recognized in the income statement as financial income or financial expenses.

Where foreign exchange exposures are considered cash flow hedges, value adjustments are recognized directly in equity.

Receivables, payables and other monetary items denominated in foreign currencies that have not been settled at the balance sheet date are translated by applying the exchange rates at the balance sheet date. Differences arising between the rate at balance sheet date and the rate at the date of the arising of the receivable or payable are recognized in the income statement under financial income and expenses.

Fixed assets purchased in foreign currencies are measured at the rate of the date of transaction.

The income statement

The income statement is classified by function.

Revenue comprises royalties, milestone payments and other income from collaboration agreements. Revenue is recognized when it is probable that future economic benefits will flow to the company and these economic benefits can be measured reliably.
Royalty income from licenses is based on third-party sales of licensed products and is recognized in accordance with contract terms when third-party results are available and are deemed to be reliable. 

The income from agreements with multiple components and where the individual components cannot be separated is recognized over the period of the agreement. In addition, recognition requires that all material risks and benefits related to the ownership of the goods and services included in the transaction are transferred to the purchaser.

If all risks and benefits have not been transferred, the revenue is recognized as deferred income until all components in the transaction have been completed. 

Royalty expenses
Royalty expenses comprise royalty paid to third parties on certain milestone payments and royalty income from collaboration agreements. 

Research and development expenses
Research expenses comprise salaries, contributions to pension schemes and other expenses, including patent expenses, as well as depreciation and amortization attributable to the company’s research activities. Research expenses are recognized in the income statement as incurred.

Development expenses comprise salaries, contributions to pension schemes and other expenses, including depreciation and amortization, attributable to the company’s development activities.

Capitalization assumes that the development of the technology or the product in the company’s opinion has been completed, that all necessary public registrations and marketing approvals have been received, and that expenses can be reliably measured. Furthermore, it has to be established that the technology or the product can be commercialized and that the future income from the product can cover, not only the production, selling and administrative expenses, but also development expenses.

Overhead expenses have been allocated to research and development based on the number of employees in research and development. 

Administrative expenses
Administrative expenses include expenses for administrative personnel, expenses related to company premises, operating leases, investor relation, etc. Overhead expenses have been allocated to administration based on the number of employees in administration. 

Other operating income
Other operating income includes income of a secondary nature, including grants related to research and development projects. It also includes funding received from Boehringer Ingelheim International GmbH related to their research collaboration with Zealand Pharma A/S and also development expenses for ZP2929 that are funded by Boehringer Ingelheim International GmbH.

Public Grants
Public grants are recognized when a final and firm right to the grant has been obtained. Public grants are included in other operating income as the grants are considered to be cost refunds. Grants related to investments are set off against the purchase price. Possible future conditional return obligations regarding the received grants will be disclosed in a note to the financial statements as a contingent liability.

Net financials
Financial income and financial expenses are recognized in the income statement with the amounts related to the financial year. Financial income and financial expenses include interest receivable and payable, as well as realized and unrealized exchange rate adjustments and realized and unrealized gains and losses on marketable securities (designated as fair value through the income statement).

Tax on results for the year
Tax on results for the year which comprises current tax and changes in deferred tax is recognized in the income statement with the portion of taxes related to the taxable income for the year whereas the portion attributable to entries on equity is recognized directly in equity.

Segment reporting
The company is managed by a management team reporting to the chief executive officer. No separate business areas or separate business units have been identified in connection with product candidates or geographical markets. As a consequence of this, no segment reporting is made concerning business areas or geographical areas.

Statement of financial position

Property, plant and equipment
Plant and machinery, other fixtures and fittings, tools and equipment and leasehold improvements are measured at cost less accumulated depreciation.

Cost comprises acquisition price and costs directly related to acquisition until the time when the company starts using the asset.

The basis for depreciation is cost less estimated residual value after the end of useful life. Assets are depreciated under the straight-line method over the expected useful lives of the assets. The depreciation periods are as follows:

•    Leasehold improvements 5 years
•     Plant and machinery 5 years
•     Other fixtures and fittings, tools and equipment 3–5 years.

Profits and losses arising from disposal of plant and equipment are stated as the difference between the selling price less the selling costs and the carrying amount of the asset at the time of the disposal. Profits and losses are recognized in the income statement under research and development expenses and administrative expenses.

Investments in subsidiaries
The parent company’s shares in subsidiaries are measured at fair value. 

Fair value adjustments of subsidiaries are recognized in the income statement under “Financial income”. 

Investments in subsidiaries are measured in Statement of financial position under “Investments in subsidiaries”.

Impairment of non-current assets
The carrying amount of intangible assets, property, plant and equipment as well as non-current asset investments is reviewed for impairment when events or changed conditions indicate that the carrying amount may not be recoverable. If there is such an indication, an impairment test is made. An impairment loss is recognized in the amount with which the carrying amount exceeds the recoverable amount of the asset, which is the higher of the net present value and the net selling price. In order to assess the impairment, the assets are grouped on the least identifiable group of assets that generates cash flows (cash flow generating units). Impairments are recognized in the income statement under the same items as the related depreciation and amortization.

Financial assets
Financial assets include receivables, securities and cash. Financial assets can be divided into the following categories: loans and receivables, financial assets at fair value through the income statement, available-for-sale financial assets and held-to maturity investments. Financial assets are assigned to the different categories by management on initial recognition, depending on the purpose for which the investments were acquired. The designation of financial assets is re-evaluated at every reporting date at which a choice of classification or accounting treatment is available. All financial assets are recognized on their settlement date. All financial assets that are not classified as fair value through the income statement are initially recognized at fair value, plus transaction costs.

Trade receivables are provided against when objective evidence is received that the company will not be able to collect all amounts due to it in accordance with the original terms of the receivables. The amount of the write-down is determined as the difference between the assets’ carrying amount and the present value of estimated future cash flows.

Lease agreements are classified as either financial or operating leases based on the criteria in IAS 17. Lease payments under operating leases and other rental agreements are recognized in the income statement over the term of the agreements. The company’s total obligation related to operating leases and rental agreements is stated under contingent assets and liabilities etc.

Own shares
Purchase and sales prices as well as dividend from own shares are recognized directly under retained earnings under equity. Capital reductions by cancellation of own shares reduce the share capital by an amount equaling the nominal values of the shares.
Profit from sale of own shares, respectively issue of shares in connection with exercise of warrants is entered directly on equity.

Prepaid expenses
Prepaid expenses comprise incurred expenses related to the following financial year.

Tax payable and deferred tax
Current tax liabilities and current tax receivables are recognized in the statement of financial position as tax calculated on the taxable income for the year adjusted for tax on previous years’ taxable income and taxes paid on account/prepaid. Deferred tax is measured according to statement of financial position liability method in respect of temporary differences between the carrying amount and the tax base of assets and liabilities. Deferred tax assets including the tax value of tax losses carry forward, are measured at the expected realizable value, either by elimination in tax on future earnings or by set-off against deferred tax liabilities within the same legal tax entity and jurisdiction.

Deferred tax is measured on the basis of the tax rules and tax rates in force at the balance sheet date when the deferred tax is expected to crystallize as current tax. Any changes in deferred tax as a consequence of amendments to tax rates are recognized in the income statement. 

Prepayments from customers
Prepayments from customers comprise not yet consumed prepayments relating to the research collaboration with Boehringer Ingelheim International GmbH.

Other liabilities
Financial liabilities are recognized initially at fair value. In subsequent periods, financial liabilities are measured at amortized cost corresponding to the capitalized value using the effective interest method; consequently the difference between the proceeds and the nominal value is recognized in the income statement over the maturity period of the loan.

Other payables are measured at amortized cost corresponding to nominal value.

Employee incentive programs (warrant programs)
Share based incentive programs have been established, which have to be settled in cash or in the enterprise’s equity instruments, and are offered to a number of employees and the Executive Management. Incentive programs were offered in 2005, 2007 and 2009-2013.

The value of services received as consideration for granted warrants is measured at the fair value of the warrant. The fair value is determined at the grant date and is recognized in the income statement as staff costs over the period in which the final right to the warrant is obtained. The contra entry to this is recognized under equity. In connection with the initial recognition of the warrants, an estimate is made of the number of warrants that the employees are expected to obtain rights to. Subsequently, an adjustment is made for changes in the estimate of the number of shares that the employees have obtained rights to so the total recognition is based on the actual number of shares that the employees have obtained rights to. The fair value of the granted options is estimated by application of the Black and Scholes pricing model.

Statement of cash flows

The statement of cash flows shows the cash flow for the year together with the cash and cash equivalents at the beginning and end of the year.

Cash flow from operating activities
Cash flow from operating activities is presented indirectly and is calculated as the net result adjusted for non-cash operating items, changes in the net working capital, financial and extraordinary items paid and income taxes paid.

Cash flow from investment activities
Cash flow from investment activities includes payments associated with the purchase and sale of fixed assets and investments.

Cash flow from financing activities
Cash flow from financing activities comprises new equity, loan financing and repayment of interest bearing debt.

Cash and cash equivalents
Cash and cash equivalents comprise cash and bank balances.
Accounting estimates and assessments
In the statement of the carrying amounts of certain assets and liabilities estimates are required on how future events will affect the carrying amounts of these assets and liabilities at the balance sheet date.

The used estimates are based on assumptions assessed reasonable by management, however, estimates are inherently
uncertain and unpredictable. The assumptions can be incomplete or inaccurate and unexpected events or circumstances might occur. Furthermore, the company is subject to risks and uncertainties that might result in deviations in actual results compared to estimates.

Evaluating the criteria for revenue recognition with respect to the company’s research and development and collaboration agreements requires management’s judgment to ensure that all criteria have been fulfilled prior to recognizing any amount of revenue. In particular, such judgments are made with respect to determination of the nature of transactions, whether simultaneous transactions shall be considered as one or more revenue-generating transactions, allocation of the contractual price (upfront and milestone payments subscribed in connection with a collaboration agreement) to several elements included in an agreement, and the determination of whether the significant risks and rewards have been transferred to the buyer. Collaboration agreements are reviewed carefully to understand the nature of risks and rewards of the arrangement. All the company’s revenue-generating transactions, including those with Sanofi S.A., Helsinn Healthcare S.A., Boehringer Ingelheim International GmbH and Abbvie Inc. have been subject to such evaluation by management

Employee incentive programs
In accordance with IFRS 2 “Share-based Payment”, the fair value of the warrants at grant date is recognized as an expense in the income statement over the vesting period, the period of delivery of work. Subsequently, the fair value is not re-measured. The fair value of each warrant granted during the year is calculated using the Black Scholes pricing model. This pricing model requires the input of subjective assumptions such as:

The expected stock price volatility, which is based upon the historical volatility of Zealand Pharma A/S’s stock price;

The risk-free interest rate, which is determined as the interest rate on Danish government bonds (bullet issues) with a maturity of five years;
The expected life of warrants, which is based on vesting terms, expected rate of exercise and life terms in current warrant program.

These assumptions can vary over time and can change the fair value of future warrants granted.

Deferred tax
Zealand Pharma A/S recognizes deferred tax assets, including the tax base of tax loss carry-forwards, if management assesses that these tax assets can be offset against positive taxable income within a foreseeable future.

This judgment is made on an ongoing basis and is based on budgets and business plans for the coming years, including planned commercial initiatives. The creation and development of therapeutic products within the biotechnology and pharmaceutical industry is subject to considerable risks and uncertainties. Zealand Pharma A/S has so far reported significant losses, and as a consequence, has unused tax losses. Management has concluded, that deferred tax assets should not be recognized as of December 31, 2013, and a 100 % valuation allowance of the deferred tax asset is recognized in accordance with IAS 12, “Income Taxes.” The tax assets are currently not deemed to meet the criteria for recognition as management is not able to provide any convincing positive evidence that deferred tax assets should be recognized.

Research and Development
According to the IAS 38, “Intangible Assets,” intangible assets arising from development projects should be recognized in the statement of financial position. The criteria that must be met for capitalization are that:

•    the development project is clearly defined and identifiable and the attributable costs can be measured reliably during the development period; 
•    the technological feasibility, adequate resources to complete and a market for the product or an internal use of the product can be documented; and 
•    management has the intent to produce and market the product or to use it internally.

Such an intangible asset should be recognized if sufficient certainty can be documented that the future income from the development project will exceed the aggregate cost of production, development and the sale and administration of the product. A development project involves a single product candidate undergoing a high number of tests to illustrate its safety profile and the effect on human beings prior to obtaining the necessary final approval of the product from the appropriate authorities. The future economic benefits associated with the individual development projects are dependent on obtaining such approval. Considering the significant risk and duration of the development period related to the development of biological products, management has concluded that the future economic benefits associated with the individual projects cannot be estimated with sufficient certainty until the project has been finalized and the necessary regulatory final approval of the product has been obtained. Accordingly, Zealand Pharma A/S has not recognized such assets at this time and therefore all research and development costs are recognized in the income statement when incurred. The total research and development costs related to the continuing operations amounted to DKK 164 million in 2014 compared to DKK 183 million in 2013.







Warrants may be exercised in the periods mentioned above, four times a year during a 4-week period starting from the time of the publication of Zealand Pharma’s annual report or quarterly or semi-annual reports.                 
The 2010 Employee incentive program                
The program was established in 2010 for the Board of Directors, Executive Management, employees and consultants of Zealand Pharma.                
The Board of Directors is authorized to issue up to 2,750,000 warrants.                 
By December 31, 2013 2,059,136 warrants have been granted.                 
Effect on income statement                
In 2013 the fair value of warrants recognized in the income statement amounts to DKK 8.8 million (13.2) of which DKK 1.5 million (1.8)relates to the Board of Directors and DKK 1.7 million (5.1) relates to the Executive Management.        


Exchange rate risk                    
Zealand Pharma A/S does not engage in any exchange rate risk.                    

Most of Zealand Pharma A/S’s financial transactions are made in DKK, USD and EUR.                    

The EUR/DKK exchange rate has politically been fixed within very narrow limits and Zealand Pharma A/S has evaluated that there are no transaction exposure or exchange rate risk regarding transactions in EUR.                    

Zealand Pharma A/S’s milestone payments have been agreed in foreign currency, USD and EUR. However, as milestone payments are speculative the payments are not included in the basic exchange risk evaluation.                     

However, as Zealand Pharma A/S conduct toxicology studies and clinical trials in the US, Zealand Pharma A/S will be exposed to the exchange rate fluctuation and risks associated with transactions in USD. Zealand Pharma A/S’s policy has up until now been to manage the transaction and translation risk associated with the USD passively, placing the revenues received from milestone payments in USD on an USD account for future payment of Zealand Pharma A/S’s expenses denominated in USD, covering payments for the next 12 – 24 months, hereby matching Zealand Pharma A/S’s assets with its liabilities.

Interest rate risk:                        
Zealand Pharma A/S has the policy to avoid any financial instrument which exposes the company to any unwanted financial risk. Zealand Pharma A/S does not speculate in the underlying trends in the basic economy.                    

Zealand Pharma A/S invests its free cash in fixed rate, time defined bank deposits.                            

Credit risks
Zealand  Pharma is exposed to credit risks in respect of receivables and bank balances. The maximum credit risk corresponds to the carrying amount.                             

Zealand Pharma A/S invest in AA+ (Standard&Poors) rated RealKredit bonds with < 24 months maturity.                
Cash is not deemed to be subject to any credit risks, as the counterparts are banks with investment grade ratings. (i.e BBB- or higher by Standard&Poors).                            

Cash management                            
The purpose of Zealand Pharma A/S’s cash management is to ensure that the company at all times has sufficient and flexible financial resources at its disposal.                             

Zealand Pharma A/S’s short-term liquidity situation is matched with Zealand Pharma A/S’s quarterly budget revisions to balance the demand for liquidity and maximize Zealand Pharma A/S’s interest income by matching Zealand Pharma A/S’s free cash in fixed rate, time defined bank deposits with Zealand Pharma A/S’s expected future cash burn.                             
Capital structure                            
It is Zealand Pharma A/S’s aim to have an adequate capital structure in relation to the underlying operating results and R&D projects, so that it is always possible to provide sufficient capital to support operations and its long term growth targets.

The Board of Directors finds that the current capital and share structure is appropriate to the shareholders and to the company.    


Fair value measurement of financial instruments
Financial instruments carried at fair value can be divided into three levels:

Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2 Inputs other than quoted prices included within level 1 that are observable for the assets or liability, either directly (i.e. as prices or indirectly (i.e. derived from prices).

Level 3 Inputs for the asset or liability that are not based on observable market data.