I. Basic Principles

1. General information

MTU Aero Engines Holding AG and its subsidiary companies (hereinafter referred to as MTU Aero Engines Holding AG or the Company) is among the world’s leading makers of engine modules and components, and is the world’s leading independent provider of commercial aircraft engine services.

The business activities of the Group range through the entire lifecycle of an engine program – from development, construction, testing and production of new commercial and military engines and spare parts, to maintenance, repair and overhaul of commercial and military engines. The activities of MTU focus on two segments: Commercial and military engine business, and Commercial Maintenance, Repair and Overhaul business.

In the commercial and military engine business, the company develops and produces modules and components as well as spare parts for commercial engine programs and also handles their final assembly. Where military engines are concerned, MTU focuses on the development and production of modules and components for engines, production of spare parts and final assembly as well as maintenance services for these engines. The commercial maintenance, repair and overhaul business includes activities in the area of maintenance and logistical support for commercial engines.

MTU Aero Engines Holding AG (parent company) with its headquarters at Dachauer Str. 665, 80995 Munich, Germany, is registered under HRB 157 206 in the registration court’s commercial register at the local court of Munich.

The consolidated financial statements was approved for publication by the Supervisory Board of MTU Aero Engines Holding AG on March 22, 2006.

1.1 IFRS Accounting standards

The consolidated financial statements of MTU Aero Engines Holding AG of December 31, 2005, is compiled in accordance with Inter-national Financial Reporting Standards (IFRS) and the guidelines of the International Accounting Standards Board (IASB) of London. Standards applicable as of the balance sheet date were used. The designation “IFRS” also includes applicable International Accounting Standards (IAS). All interpretations of the International Financial Reporting Interpretations Committee (IFRIC), formerly the Standing Interpretations Committee (SIC), which are authoritative for the 2005 business year, have been applied.

The duty to prepare a consolidated financial statements is defined by Section 290 of the German Commercial Code (HGB). Pursuant to Article 4 of Regulation (EC) No. 1606/2002 of the European Parliament and the Council of July 19, 2002, the Group is obligated to apply the international accounting standards pursuant to Articles 2, 3 and 6 of the standards cited above. The consolidated financial statements exempt MTU Aero Engines GmbH, Munich pursuant to Section 264 Paragraph 3 No. 4, and is published through the commercial register of Munich (registered office of the company).

In order to improve clarity, various entries of the consolidated income statement and consolidated balance sheet are combined.

These entries are separately accounted for and explained in the appendix. The consolidated financial statements have been prepared in Euro. All amounts are disclosed in millions of Euro (in € million) unless otherwise stated.

The year-end financial statements of the consolidated companies are prepared as of the balance sheet date of December 31, 2005, of MTU Aero Engines Holding AG, Munich. The annual financial statements for Pratt & Whitney Canada Customer Service Centre Europe GmbH, Ludwigsfelde, which is valued at equity, are prepared as at November 30 of the calendar year. The statements are included in the consolidated financial statements at this balance sheet date.

Early adoption of modified standards

As part of the Improvement Project, the IASB has produced a series of amendments to existing IAS as well as issuing new IFRS, which as a rule are to be applied in the business year beginning January 1, 2005. The following standards were already applied by MTU Aero Engines Holding AG in its 2004 consolidated financial statements:

IFRS 1 “First-time adoption of International Financial Reporting Standards”

IFRS 3 “Business combinations”

Business combinations are stated in the financial year 2004 in accordance with IFRS 3. IFRS 3 is closely related to the revised standards by IAS 36 and IAS 38, which likewise have been applied early.

IAS 36 (revised 2004) “Impairment of assets”

The modifications to IAS 36 essentially relate to goodwill. This is no longer systematically amortized, but rather is now subjected to an annual “impairment-only” approach.

IAS 38 (revised 2004) “Intangible assets”

The primary modification of IAS 38 concerns the distinction of useful economic life into unlimited and limited lifetimes. Intangible assets with unlimited useful economic lifetimes are no longer amortized on a scheduled basis, but rather are now subjected to an annual “impairment-only” approach in accordance with IAS 36. Assets with a limited useful economic life continue to be amortized on a scheduled basis over their economic life.

IAS 32 and 39 (revised 2004) “Financial instruments”

Early application of IAS 32 and IAS 39 (revised 2004) results in new classification of financial assets. Depending on the classified category, changes in fair value are recognized in the income statement or directly in equity until disposition of the financial asset. Receivables and liabilities are valued at amortized cost. Transitional guidelines pursuant to IAS 39 No. 105 ff were applied accordingly.

Newly issued accounting regulations

The following standards, which were revised as part of IASB’s improvement projects, were applied for the first time in 2005:

• IAS 1 (Presentation of financial Statements)
• IAS 8 (Accounting Policies. Changes in Accounting Estimates and Errors)
• IAS 16 (Property, plant, and equipment)
• IAS 24 (Related party disclosures)

In addition, IASB has issued new or revised and amended standards in 2004, which are being followed. These are, in particular:

• IFRS 2 (Share-based Payments)
• IFRS 5 (Non-current assets held for sale and discontinued operations)

1.2. Changes in corporate law

1.2.1. Merger agreements

MTU Aero Engines Verwaltungs GmbH was merged into MTU Aero Engines Investment GmbH through a resolution of the shareholders’ meeting on March 15, 2005. With the merger agreement of March 15, 2005 (UR No. S 0455/2005), the merger was carried out by absorption through transferral of assets as a whole. With regard to the law of obligations and to taxes, the merger was internal and effective as of January 1, 2005.

MTU Aero Engines Dritte Participation GmbH was merged into MTU Aero Engines Investment GmbH through a resolution of the shareholders’ meeting on March 15, 2005. With the merger agreement of March 15, 2005 (UR No. S 0459/2005), the merger was carried out by absorption through transferral of assets as a whole. With regard to the law of obligations and to taxes, the merger was internal and effective as of January 1, 2005.

MTU Aero Engines Zweite Verwaltungs GmbH was merged into MTU Aero Engines Dritte Holding GmbH through a resolution of the shareholders’ meeting on March 15, 2005. With the merger agreement of March 15, 2005 (UR No. S 0467/2005), the merger was carried out by absorption through transferral of assets as a whole. With regard to the law of obligations and to taxes, the merger was internal and effective as of January 1, 2005.

MTU Aero Engines Zweite Participation GmbH was merged into MTU Aero Engines Dritte Holding GmbH through a resolution of the shareholders’ meeting on March 15, 2005. With the merger agreement of March 15, 2005 (UR No. S 0463/2005), the merger was carried out by absorption through transferral of assets as a whole. With regard to the law of obligations and to taxes, the merger was internal and effective as of January 1, 2005.

MTU Aero Engines Dritte Holding GmbH was merged into MTU Aero Engines Zweite Holding GmbH through a resolution of the shareholders’ meeting on April 27, 2005. With the merger agreement of April 27, 2005 (UR No. S 0771/2005), the merger was carried out by absorption through transferral of assets as a whole. With regard to the law of obligations and to taxes, the merger was internal and effective as of January 1, 2005.

MTU Aero Engines Zweite Holding GmbH was merged into MTU Aero Engines Erste Holding GmbH through a resolution of the shareholders’ meeting on April 27, 2005. With the merger agreement of April 27, 2005 (UR No. S 0775/2005), the merger was carried out by absorption through transferral of assets as a whole. With regard to the law of obligations and to taxes, the merger was internal and effective as of January 1, 2005.

1.2.2. Change of legal form

MTU Aero Engines Erste Holding GmbH (HRB 151 251), was transformed into an Aktiengesellschaft (German public limited company) by way of a transformation resolution passed in May 2, 2005 within the scope of the Umwandlungsgesetz (German Corporate Transformation Act) via a change of legal form. This transformation was entered in the commercial register on May 19, 2005, under number HRB 157 206. Also by way of a shareholders’ resolution passed in May 2, 2005, the share capital of MTU Aero Engines Erste Holding GmbH was increased by €37.8 million according to the rules for a capital increase from company funds from €2.2 million to €40.0 million prior to the change of legal form. For this purpose, an amount of €37.8 million was withdrawn from the capital reserves and transformed to become ordinary share capital. No new shares were issued. The capital increase took effect when it was entered in the commercial register on May 19, 2005.

In the General Meeting on May 30, 2005, a resolution was passed to increase the company’s share capital against capital contributions by €15.0 million from €40.0 million to €55.0 million by issuing 15.0 million new no-par value bearer shares. The new shares, which carry dividend rights from the start of the current fiscal year, were issued with a nominal amount of €1.00. The capital increase took effect when it was entered in the commercial register on June 3, 2005. The purpose of the capital increase was to place the shares as part of the company’s initial public offering.

Conditional capital

Conditional capital of €19.25 million was also created by way of a resolution of the General Meeting on May 30, 2005. This capital is to be used to grant shares to the holders of convertible bonds or bonds with warrants.

Authorized capital

According to a resolution by the General Meeting on May 30, 2005, the Board of Management is authorized, subject to approval, to increase the share capital on or before May 29, 2010, against cash contributions on one or several occasions by a total of up to €5.5 million, whereby it is possible to exclude shareholders’ subscription rights (Authorized capital I).

In addition, according to a resolution by the General Meeting on May 30, 2005, the Board of Management is authorized, subject to approval, to increase the share capital on or before May 29, 2010, against cash and/or non-cash contributions on one or several occasions by a total of up to €19.25 million, whereby it is possible to exclude shareholders’ subscription rights (Authorized capital II).

The Company’s Board of Management was further authorized to issue, with the consent of the supervisory board, bearer or registered convertible bonds, warrant bonds, profit participation rights, or profit-linked bonds (or combinations of such instruments), on one or more occasions, through May 29, 2010. Such Bonds are to be with or without fixed maturity, up to an aggregate nominal amount of €750.0 million, and to grant the holders of convertible and/or warrant bonds conversion or option rights for up to an aggregate of €29.25 million in the registered share capital of the company, in accordance with the detailed terms and conditions of such convertible bonds and/or warrant bonds.

1.2.3. The Initial public offering (IPO)

The new shares of the company were issued on June 6,2005 on the Frankfurt Stock Exchange, Amtlicher Markt, using book-building and with a subscription period from May 25, 2005 to June 3, 2005. After the subscription offers had been received within the bookbuilding window at prices of between €19.00 and €22.00 per share, the issue price was set at €21.00 per share. Initial listing on the first day of trading was at €21.89. A placement volume of 31 million shares plus a green shoe option of 4.65 million shares resulted in a placement volume of €748.65 million. Of these proceeds, a total of €294.7 million accrued to MTU Aero Engines Holding AG after the deduction of costs from the capital increase of 15 million shares. This amount was mostly used to repay debt. The remaining proceeds from the issue accrued to the company’s former main shareholder, Blade Lux Holding Two S.a.r.l., Luxembourg.

Shareholding structure as of December 31, 2005

The following synopsis shows the shareholders and their participation in the capital following the IPO.

1.2.4. Changes in consolidated entities With an agreement dated May 17, 2005, ATENA Engineering GmbH, Munich with its shares ATENA INDIA PRIVATE LIMITED and EUROAER GmbH, were sold effective June 30, 2005. ATENA Engineering GmbH was then no longer consolidated. As the sale had an overall insignificant effect on the portrayal of the Group’s net worth, the financial statements does not include a separate presentation of assets and liabilities pursuant to IFRS 5. The profit from the sale is referred to in the explanation under text item 10 (Other operating income and expenses). The principal groups of assets and liabilities that were classified under the “Commercial and Military engine business” market segment up to the time of the sale are classified as follows up to June 30, 2005:

2.4. Consolidated as well as non-consolidated companies included:

The complete statement of Group share ownership is reported in the commercial registry of the local court of Munich (HRB 157 206). 3. Consolidation principles Business combinations are accounted for using the purchase method as defined in IFRS 3. Under the purchase method identifiable assets and liabilities acquired are measured initially at their fair value. The excess of the group’s interest in the net fair value of the identifiable assets and liabilities acquired over cost is recognized as goodwill. Goodwill is subject to regular review for possible impairment. If the fair value of the assets and liabilities exceed the acquisition cost, the remaining difference is immediately recorded in the income statement. The effects of inter-company transactions have been eliminated. Accounts receivable and accounts payable as well as expenses and income between the consolidated companies are netted. Internal deliveries are recorded on the basis of market prices. Interim results are eliminated in the financial year. In accordance with IAS 12, deferred taxes arising from timing differences are recognized as a result of the elimination of profits and losses due to transactions within the Group. Shares in associated companies and equity participations in joint ventures are accounted for using the equity method from the point of acquisition, and are initially recognized at cost. Any difference between the acquisition costs and the fair values of the identified assets, liabilities and contingent liabilities which arise at the point of the acquisition are recognized as goodwill. The company’s share of an investee’s profits or losses is recorded in the income statement. Program investment companies are associated companies. With regard to the special accounting treatment of these investments, please refer to text item 5.8.2. All other equity participations (non-consolidated subsidiaries and other shares) are carried at fair value. If the fair value cannot be reliably determined, they are stated at cost (see explanation to text item 5.8.1., 5.8.3. and 5.8.4.). 4. Currency translation The financial statements of consolidated companies whose functional currency is not Euro are translated into Euro in accordance with IAS 21 using the functional currency concept. The functional currency is the currency in which a foreign company generates most of its funds and makes its payments. Because the functional currency at all group companies is the corresponding local currency, the assets and liabilities are translated using the exchange rate applicable on the balance sheet date, and expenses and income are translated every month using the rate applicable at the end of the month. The effect of the exchange rate movements is included in a separate component of accumulated other equity, and does not have any impact on the net profit/loss for the year. Foreign currency receivables and liabilities are translated using the exchange rate applicable on the balance sheet date. The following rates have been used for currency translation:

5. Accounting principles and policies The financial statements of MTU Aero Engines Holding AG as well as of the domestic and foreign subsidiaries are prepared using standard accounting and valuation methods in accordance with IAS 27. 5.1. Revenues Revenues from the sale of goods are recognized when the significant risks and rewards of ownership are transferred to the buyer, and the seller retains neither management involvement in, nor control over the goods. Further recognition criteria are the probability that economic benefits associated with the transaction will flow to the seller and the revenues and costs can be measured reliably. The company’s customers are trading partners from risk-and-revenue-sharing programs, original equipment manufacturers (‘‘OEMs’’), joint sale companies, national governments, airlines and other third parties. Revenues from contractual maintenance services (time and material contracts, fly-byhour contracts, Power by hour-contracts) in the maintenance, repair and overhaul (‘‘MRO’’) business as well as construction contracts in the military business, are based on the percentage of completion method, in accordance with IAS 11 and IAS 18. If the final profit cannot be reliably estimated, IFRS requires the use of the zero-profit method, which recognizes revenues only to the extent of costs incurred that are expected to be recovered. Revenues are recognized less discounts for customers, price reductions and other rebates. The consolidated companies’ foreign exchange contracts to hedge the potential volatility in future cashflows have been accounted for as cashflow hedges under IFRS. These financial investment instruments are measured at fair values, with the effective gains and losses on the hedging instrument, where they are effective, initially deferred in accumulated other equity. They are subsequently released to revenues, concurrent with the earnings recognition pattern of the hedged item. 5.2 Cost of sales Cost of sales comprises the productionrelated manufacturing costs of the sold products, development services paid, and the costs of products purchased for resale. In addition to the direct cost of material and production, they also comprise the indirectly allocatable overheads, including depreciation of the production installations, productionrelated other intangible assets, depreciation on inventories and commensurate productionrelated administration overheads. In addition to expenses charged by OEMs, cost of sales includes calculated costs for marketing new engines in the scope of risk-and-revenuesharing programs for customer acquisition costs. 5.3. Research and development costs The research costs are expensed as incurred. Development costs are capitalized when the recognition criteria of IAS 38 are satisfied. The development costs for engine programs in the series and spare part phase were capitalized at fair value as part of the program assets resulting from purchase price allocation (intangible assets). Development costs comprise all costs that can be allocated directly to the development process as well as reasonable amounts of development- related overheads. Financing costs are not capitalized. The program assets are amortized using scheduled amortization over the expected product life cycle (maximum of 30 years.) Development costs which do not qualify for capitalization are expensed as incurred. 5.4. Public sector grants and assistance Public sector grants and assistance are recognized in accordance with IAS 20 (accounting for government grants and disclosure of government assistance) only if there is adequate certainty that the related conditions are satisfied and that the grants and assistance will indeed be received. Revenue-based grants are deferred in the balance sheet and released to the income statement to offset the related expenditure that they are intended to reimburse. The grants and assistance are accordingly stated in the balance sheet when the book value of the assets is established. 5.5. Intangible assets Purchased intangible assets and internally generated intangible assets are capitalized in accordance with IAS 38 (Intangible Assets). IAS 38 requires capitalization if it is probable that a future economic benefit attributable to the asset exists and the costs of the asset can be measured reliably. Intangible assets with a limited useful life are carried at cost of purchase or production and amortized on a straight-line basis over their useful life. If there are indications that an intangible asset’s carrying amount may be extraordinary, the asset is subject to an impairment test. The recoverable amount is calculated as the higher of the fair value less cost to sell and the value in use of an asset. An impairment loss is recognized immediately in the income statement if the carrying amount of an asset exceeds its recoverable amount. If the reason for an impairment in previous reporting periods is no longer applicable, a reversal is taken to the income statement, whereby the amortized costs of production or purchase must not be exceeded. Scheduled amortization, with the exception of goodwill, technology assets, and program assets, is normally applied over three years. Program assets are amortized over a period of maximally 30 years, whereas technology assets are amortized over a period of ten years and customer relations between 4 and 18 years. Goodwill with an unlimited life in accordance with IFRS 3 is subject to an impairment test at least once a year. As for other reporting, the “Commercial and military engine business” and “Commercial Maintenance Repair and Overhaul business are viewed as cash generating units. The goodwill as of January 1, 2004, is allocated to both segments. The present value of the future net cashflows of each cash generating unit is compared with its carrying amount. If the present value is lower than the carrying amount, the goodwill is impaired. If the amount estimated for an impairment loss is greater than the goodwill, the difference is proportionately allocated to the other assets of the cash generating unit. A test is conducted for each balance sheet date to determine whether grounds for the non-scheduled depreciation of the previous period still exist. If the recoverable amount of an asset has increased the impairment must be reversed, irrespective of the declared goodwill. The recoverable amount is the higher amount from the present value less the cost to sell and the anticipated value in use. The upper limit of the impairment loss reversal is determined by the acquisition cost less the cumulative scheduled depreciation that would have resulted if no non-scheduled depreciation had been recorded. The reversal of impairment loss is recorded in the income statement in the corresponding function areas. An impairment loss recognized for goodwill shall not be reversed in a subsequent period. 5.6. Property, plant, and equipment Property, plant and equipment are subject to wear and tear and are carried at cost of purchase or production less scheduled depreciation. Depreciation is applied using the straight-line method to reflect wear and tear. If there are any indications of impairment, the property, plant, and equipment is subject to an impairment test. An impairment loss is recognized immediately in the income statement if the carrying amount of an asset exceeds its recoverable amount. The recoverable value is calculated as the higher of fair value less the cost to sell and the value in use of the asset. If the reason for impairment in previous reporting periods is no longer applicable, the value is written up to an amount not exceeding the amortized costs. Minor value assets (worth less than €410) are expensed immediately in the year in which they are acquired. Scheduled depreciation is based on the following useful life:

The depreciation applicable for machines used in multiple-shift operation is increased accordingly by way of shift mark-ups.

The costs of production of installations produced in-house comprise all costs that can be directly allocated to the production process as well as reasonable amounts of productionrelated overheads. These comprise productionrelated depreciation, pro rata administrative expenses and pro rata social costs. Financing costs are not considered as part of production costs or purchase.

If all opportunities and risks associated with ownership of a group company leased asset are primarily transferred attributable to the lessee, the leased asset is capitalized under property, plant and equipment, and an equivalent value is recognized under liabilities from finance lease (finance lease arrangements). The amount capitalized at the start of the basic lease period is the lower of fair value or present value of minimum lease payments. The capitalized leased asset is depreciated over its useful life, whereas interest is added in instalments to the leasing liability.

If all risks and opportunities associated with ownership of a leased asset are not attributable to the lessee, the lease payments are expensed as incurred (operating lease arrangements).

5.7. Financial assets

Financial assets are recognized at the settlement date, the date on which the asset is delivered. When the financial assets are initially recognized, they are stated at fair value.

After the initial recognition, ‘‘available for sale financial assets’’ as well as assets in the category ‘‘fair value through profit and loss’’ are recorded at fair value. In general, the fair value corresponds to the market value. If a market price does not exist, the market value of the available for sale financial assets as well as market value of assets in the category ‘‘fair value through profit and loss” are determined using suitable valuation methods, e.g. discounted cashflow method, taking into account market data available at the balance sheet date.

Financial investments in equity instruments for which there is no active market price and for which no fair value can reliably be determined, are valued at acquisition cost.

Changes in the fair value of assets in the category “fair value through profit and loss” are recognized with an impact on profits via the income statement, whereas changes in “fair value of available for sale” assets are recognized in accumulated other equity without having impacts on profits. Interest rate swaps that do not meet the strict criteria of IAS 39 for hedge accounting are classified as ‘‘held for trading’’ in the category ‘‘fair value through profit and loss’’.

Loans extended by the company which are not held for trading purposes (originated loans and receivables) as well as all financial assets which do not have a quoted market price in an active market and whose fair value cannot be reliably measured are carried at amortized cost, if they have a fixed maturity. In the case of current receivables, the amortized costs are equivalent to the nominal amount or the repayment amount.

In accordance with IAS 39 (Financial Instruments: recognition and measurement) regular checks are carried out to establish whether there are any objective sustantial indications of an impairment of a financial asset or portfolio. If such indications exist, the impairment loss is recognized in the income statement. Profits and losses from an available for sale financial asset are recorded directly in accumulated other equity until the financial asset is disposed, or until an impairment has been established. In the event of an impairment, the cumulative loss is withdrawn from shareholders’ equity and transferred to the income statement.

5.8. Financial investments

Profits or losses attributable to joint venture companies accounted for under the equity method are allocated on a pro rata basis to the profit/loss and the corresponding book value of the investment. In the income statements, the allocated profit/loss is disclosed separately under the item ‘‘share of income /loss of joint venture accounted for using the equity method’’.

5.8.1. Shares in non-consolidated subsidiaries

The shares in non-consolidated subsidiaries recognized under financial assets are carried at fair value. If a quoted market price in an active market is not available and if a fair value cannot be reliably measured, the shares are carried at cost.

5.8.2. Shares in associated companies

Shares in associated companies that are not accounted for under the equity method in accordance with IAS 28 are carried at fair value in accordance with IAS 39. If this value is not available, or if it cannot be reliably measured, the shares in associated companies are carried at cost.

5.8.3. Equity participations in joint ventures

Equity participations in joint ventures that are not accounted for under the equity method are carried at fair value in accordance with IAS 39. They are carried at cost if a quoted market price in an active market cannot be reliably measured.

5.8.4. Other shares

Other shares are carried at fair value in accordance with IAS 39. If a quoted market price in an active market is not available and if a fair value cannot be reliably measured, the shares are carried at cost.

5.8.5. Impairment of financial assets

If there are indications that investments in non-consolidated subsidiaries, non-consolidated associated companies, in non-consolidated joint ventures and non-consolidated other equity participations might be impaired, IAS 39 is applied.

5.9. Financial assets – loans receivable

Loans receivable are carried at amortized costs based on their classification as financial assets. This item does not include any financial assets held for trading.

5.10. Inventories

5.10.1. Raw materials and supplies

Raw materials and supplies are recognized at the lower of average costs of purchase or net realizable values. Costs of purchase comprise all direct purchasing expenses as well as other costs incurred bringing them to the current location and condition. The net realizable value is the estimated selling price generated as part of normal business transactions less costs of completion and less any selling expenses.

5.10.2. Unfinished products

Unfinished products are recognized at the lower of cost of production or net realizable value. Cost of production comprises all expenses that can be directly allocated to the production process as well as reasonable amounts of production-related overheads. These include production-related depreciation, pro rata administrative expenses and pro rata social expenses.

5.10.3. Financing costs of inventories

Financing costs are not considered as part of costs of production or purchase.

5.11. Receivables and other assets

Receivables and other assets, except for derivative financial instruments, are loans and accounts receivable, which are recognized at amortized cost. Interest-free or low-interest receivables due in more than one year are discounted. Allowances are established all for estimated bad debts.

5.12. Derivative financial instruments

At the company derivative financial instruments are used for hedging purposes in order to reduce currency and interest rate risks.

According to IAS 39, all derivative financial instruments, such as interest rate swaps, currency swaps, combined interest rate and currency swaps, and foreign exchange forward contracts are recognized at market value, irrespective of the purpose or intention for which they were acquired. Unrealized changes in market value of the derivative financial instruments treated as a hedge are recognized in accumulated other equity. Changes in other financial instruments are immediately recorded in earnings.

The consolidated companies are exposed to risks due to interest rate changes and currency risks based on securing the US Dollar cashflows from operational business as well as from financing. Accordingly, derivative financial instruments are used to manage these risks (cross currency swaps).

Hedge accounting

The company meets the requirements of hedge accounting for its foreign exchange forward contracts as cashflow hedges. Changes in the market value of foreign exchange forward contracts which are used for compensating for future cashflow risks from existing underlying transactions or planned transactions are initially recognized in accumulated other equity without any impact on profits. As a result, profit (loss) is recorded to the income statement at the same time at which the hedged underlying transaction has an impact on profits. Ineffective portions of the risk management instrument are immediately recorded in results for the period.

For swap transactions, the requirements of hedge accounting are not met. Changes in fair values are recognized in the income statement under financial result with an impact on profits.

Financing of the company has been provided in the currency ‘‘Euro’’ and is provided primarily in the form of loans, an issued bond and bank borrowings (Revolving Credit Facility). Current liquidity surpluses are invested on the money market securities.The consolidated companies are exposed to risks associated with changes in interest rates only as far as amounts are drawn from revolving credit. This does not include credit guarantees for which commissions but not interest are to be paid. Revolving credit has a term of 5 years, serves as a preventative liquidity provision and is only used for very current requirements; from this vantage point, no risk arises from changes in interest rates.

The following financial instruments were used during the financial year:

1. Forward foreign exchange transactions:

The purpose of forward foreign exchange transactions is to hedge US Dollar cashflows arising from operational transactions. At the end of the year, there were currency forward foreign exchange transactions of US $560.0 million, which have expiration dates till October 2007, with a fair value of €416.8 million.

The change in market price value of the derivative financial instruments totaled €27.2 million during the past business year. Proceeds from hedging activities from the accumulated other equity amounting to €8.3 million were recorded in the revenues.

As of December 31, 2005, after deduction of deferred taxes, the change in fair value of the cashflow hedges transactions of €-15.0 million (prior year: €12.2 million) was recorded in accumulated other equity without any impact on profits.

There are no transactions for which hedge accounting had previously been used but that are no longer expected to occur. 2. Swaps Cross currency swaps The goal is to protect against fluctuations in exchange rates and interest rates, using US Dollar income surpluses. With this financial instrument, fixed Euro interest obligations have been swapped for fixed US Dollar interest obligations. Due to exchange rate fluctuations, a negative market price of €7.7 million resulted on the balance sheet date (versus a positive €5.2 million for the previous year). 5.13. Cash and cash equivalents Cash and cash equivalents comprise foreign currency holdings of €8.2 million and are valued using the exchange rate applicable at the reference date. 5.14. Deferred taxes Deferred tax assets and deferred tax liabilities are recognized for all temporary differences between the values reported in the tax balance sheets and the consolidated balance sheet (‘‘balance sheet liability method’’). The deferred tax assets and deferred tax liabilities were calculated using the tax rate applicable at the point at which the temporary differences are expected to reverse. Deferred tax assets and deferred tax liabilities are offset if the tax creditor and tax debtor is the same person and if maturities are congruent. 5.15. Pension provisions Pension provisions are established based on the projected unit credit method in accordance with IAS 19 (Employee Benefits). This method recognizes not only the pensions and acquired entitlements known on the balance sheet date but also estimated increases in pensions and salaries expected in future, with a conservative assessment of the relevant parameters. The calculation is based on actuarial reports. Actuarial profits and losses are only offset against the pension expense if they fall outside a range of 10% (target range) of the estimated obligation. In this case, they are spread over the future average remaining service time of the workforce. The expenses attributable to cumulative interest for pension obligations are recognized with financial results in the income statement. All other expenses attributable to pension obligations are included with the costs of the affected function areas. 5.16. Other provisions Other provisions are recorded if an obligation exists to third parties, it is probable that the provision will be utilized and, if probable, if the provision can be reliably estimated. For measuring the value of provisions with, for example, warranties and missing costs – consideration is given to all cost components including those in inventories. Non-current provisions due in more than one year are recognized with a settlement amount discounted to the balance sheet´s date. Provisions for part-time work for elderly people and anniver-saries are evaluated in accordance with statistical appraisals under IAS 19. 5.17. Financial obligations Financial obligations are initially recognized at cost of purchase equivalent to the fair value of the service rendered in return. Financial obligations that are valued at fair value are considered in the totals pursuant to transition regulations in accordance with IAS 39.105 ff. Non-current liabilities due in more than one year are recognized with their present value. Liabilities, except for derivative financial instruments, are carried at fair value. 5.18. Other comments The claims of shareholders to dividend payments are recorded as a liability in the period in which the corresponding resolution is passed. 5.19. Assumptions and estimates The process of preparing consolidated financial statements in accordance with the requirements of IASB involves making assumptions and estimates which have an impact on the extent and disclosure of the reported assets and liabilities, income and expenditure as well as contingent liabilities. The assumptions and estimates primarily refer to the determination of estimated useful lives within the group, the statement and valuation of provisions and the extent to which future tax relief will be realized. The actual amounts may differ from the assumptions and estimates. Changes are reflected in the income statement at the point at which appropriate knowledge is gained. The company assesses the value of its goodwill at least once a year (see ‘‘Accounting principles and policies’’). For this purpose, the goodwill is allocated to cash generating units. The recoverable amount of the cash generating units is established on the basis of the value in use. This requires the use of estimates. 5.20. Sensitivity analysis The group makes estimates and assumptions relating to the future. Those estimates may not correspond precisely to subsequent circumstances. The estimates and assumptions involving a significant risk in the form of a major adjustment to the book values of assets and liabilities during the next financial year are discussed in the following. 5.20.1. Goodwill In line with its accounting policies, the consolidated companies assesses every year whether an impairment of goodwill is required. The utility value is determined by calculating the recoverable amount of the cash generating units. This requires the use of estimates. If the actual gross profit on December 31, 2006, is 10% lower than management’s estimate of gross profit on December 31, 2005, this would not indicate an impairment of goodwill or any other assets. Assuming a 10% increase in the discount rate before taxes which was applied for calculating the enterprise value using the discounted cashflow method (DCF), the company’s goodwill and property, plant, and equipment would still not be impaired. 5.20.2. Income taxes The group bases the extent of provisions for expected tax audits on estimates with regard to whether, and if so to what extent, additional taxes will be payable. If the definitive taxation in relation to these business transactions differs from the initially assumed taxation, this will have an impact on the actual and deferred taxes in the period in which the taxation is definitively established.