MTU Aero Engines Holding AG and its subsidiary companies (hereinafter referred to as MTU Aero Engines Holding AG, MTU, or the MTU group) is among the world’s leading manufacturers of engine modules and components, and is the world’s largest independent provider of MRO services for commercial aero engines.

The business activities of the MTU group range through the entire lifecycle of an engine program, i.e. from development, construction, testing and production of new commercial and military engines and spare parts, through to maintenance, repair and overhaul of commercial and military engines. MTU’s activities focus on two segments: Commercial and military engine business (OEM business) and commercial maintenance business (MRO business).

MTU’s commercial and military engine business covers the development and production of modules, components and spare parts for engine programs, including final assembly. MTU’s military engine business additionally includes maintenance services for these engines. The commercial maintenance business segment covers activities in the areas of maintenance and logistical support for commercial engines.

MTU Aero Engines Holding AG (parent company), registered office Dachauer Str. 665, 80995 Munich, Germany, is registered under HRB 157 206 in the commercial registry at the district court of Munich.

The consolidated financial statements were approved for publication by the Board of Management of MTU Aero Engines Holding AG on February 19, 2009.

MTU’s consolidated financial statements have been drawn up in accordance with International Financial Reporting Standards (IFRSs), such as these apply in the European Union (EU), and the supplementary requirements of Section 315a (1) of the German Commercial Code (HGB). All IFRSs issued by the International Accounting Standards Board (IASB) which were effective at the time these consolidated financial statements were drawn up and were applied by MTU have been endorsed by the European Commission for use in the EU. MTU’s consolidated financial statements thus also comply with the IFRSs issued by the IASB. The term IFRS used in this document thus refers to both sets of standards.

The consolidated financial statements and group management report as at December 31, 2008 have been compiled in accordance with Section 315a (1) of the German Commercial Code (HGB) and published in the electronic version of the Federal Gazette (Bundesanzeiger).

The financial year is identical with the calendar year. Comparative data for the two preceding years are shown for significant items in the consolidated financial statements.

In the presentation of the balance sheet, a distinction is made between non-current and current assets and liabilities. A more detailed presentation of certain of these items in terms of their timing is provided in the notes to the consolidated financial statements. The income statement is laid out according to the cost-of-sales accounting format, in which revenues are balanced against the expenses incurred in order to generate these revenues, and the expenses are recorded in the appropriate line items by function: production, development, selling and general administration. The consolidated financial statements have been drawn up in euros. All amounts are stated in millions of euros (€ million), unless otherwise specified.

The financial statements prepared by MTU Aero Engines Holding AG and its subsidiaries are included in the group financial statements. Uniform methods of recognition and measurement are applied throughout the group.

The statements for the financial year 2008 were based on International Financial Reporting Standards (IFRSs) and recommendations of the International Financial Reporting Interpretations Committee (IFRIC) that are effective for annual periods beginning on or after January 1, 2008.

The following standards and interpretations – insofar as they are relevant to MTU’s business activities – were applied for the first time in the financial year 2008:

• Amendments to IAS 39 “Financial Instruments: Recognition and Measurement” and IFRS 7: “Financial Instruments: Disclosures”
• IFRIC 11 “IFRS 2: Group and Treasury Share Transactions”
• IFRIC 12 “Service Concession Arrangements”
• IFRIC 14 “IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction”

These standards and interpretations have been applied in compliance with the respective effective dates and recommendations for early adoption. Unless another form of presentation is explicitly required by individual standards or interpretations, their application is retrospective, i.e. the statements are presented as if the new accounting and measurement methods had always been applied in this way. Amounts stated in respect of previous periods are adjusted accordingly.

The application of the following standards and interpretations had an impact on MTU’s consolidated financial statements in respect of the relevant periods as described below:

On October 13, 2008, the IASB issued amendments to IAS 39 “Financial Instruments: Recognition and Measurement” and IFRS 7 “Financial Instruments: Disclosures”. These amendments to IAS 39 and IFRS 7 permit certain financial instruments to be reclassified out of the “available-for-sale” category into another category under “rare” circumstances. The financial crisis affecting the money and capital markets qualifies as one of these “rare” circumstances, and would justify the decision by entities to make use of this option. To this end, the requirements of IAS 39.50 have been modified and paragraphs 50B–50F and 103G have been added. Related changes have been made to IFRS 7, where section 7.12 has been modified and paragraphs 12A and 44E have been added. According to the published amendments to IAS 39 and IFRS 7, entities are permitted to reclassify certain financial instruments with effect from July 1, 2008.

In view of the financial crisis and the fact that certain financial instruments are no longer being traded or that the corresponding markets are no longer active or are in danger of closing, the IASB and the EU have voiced their opinion that the new amendments ought to be made effective as of October 15, 2008, enabling certain financial instruments to be reclassified retrospectively in Q3 financial statements for the quarter ending September 30, 2008. MTU has not made use of this option.

On November 27, 2008, the IASB published an update to the amendments to IAS 39 concerning the reclassification of financial instruments that had been published on October 13, 2008. In the slightly modified version of the amended IAS 39, the transitional provisions, which had led to some confusion in practice, were formulated more clearly. It was clarified that reclassifications made on or after November 1, 2008 become effective from the reclassification date, and that it is not permitted to apply them retrospectively. For reclassifications made prior to November 1, 2008, an earlier effective date can be chosen, but no earlier than July 1, 2008 and no later than October 31, 2008. Even though these modifications have not yet been adopted in European law, they should nevertheless be used as a reference if doubts should arise about the interpretation of the presently worded requirements concerning the effective date. The IASB published the meanwhile incorporated modifications almost immediately in the October issue of the IASB Update and, in any case, the modifications do not stipulate any new requirements but simply clarify the requirements already adopted in European law.

This interpretation addresses two issues: The first concerns the question of whether certain transactions should be accounted for as settled by means of equity instruments or as cash-settled share-based payments, under the requirements of IFRS 2. The second issue concerns share-based payment transactions involving two or more entities of the same group. This interpretation first became effective for annual periods beginning on or after March 1, 2007. The first-time application of this interpretation had no impact on the MTU consolidated financial statements, because MTU had already been using the accounting methods specified in IFRIC 11 before the interpretation became effective.

Service concession arrangements are arrangements in which a government or other public-sector body concludes contracts for the supply of public services, such as the construction of roads, airports or hospitals, with private operators. The public sector retains the rights to the constructed asset, while the operator has a contractual obligation to construct, operate, or maintain this asset. IFRIC 12 distinguishes between two types of service concession arrangement. In the first case, the operator receives a contractual right to receive cash or another financial asset from the government in return for supplying the public service. In this case, the service concession arrangement is accounted for as a financial asset. In the second case, the operator is granted the right to charge for use of the public service. In this case, it is accounted for as an intangible asset.

If the operator has both types of contractual right – to receive cash or another financial asset, and to charge for use of the public service – then a financial asset is recognized for the amount of the contractual right to receive cash or another financial asset, and an intangible asset is recognized for the expected usage charge payments. This interpretation is effective for annual periods beginning on or after January 1, 2008. In the absence of transactions of this nature, the interpretation in question did not have any impact on the MTU consolidated financial statements.

IFRIC 14 provides general guidelines prescribing how and to what extent a surplus arising from the measurement of pension provisions according to IAS 19 should be recognized as an asset.

IFRIC 14 furthermore addresses ways in which the accounting treatment of pension provisions (or a potential asset arising from a defined benefit plan) can be influenced by statutory or contractual minimum funding requirements. By issuing the interpretation IFRIC 14, the IFRIC aims to harmonize existing accounting practices and ensure that companies apply uniform rules when accounting for assets arising from the measurement of pension benefits. This interpretation is effective for annual periods beginning on or after January 1, 2008. This interpretation did not have any impact on the MTU consolidated financial statements.

The following IASB accounting standards, which have been issued but were not yet effective for the financial year 2008, have not been applied in advance of their effective date:

IFRS 8 was issued by the IASB in November 2006. This standard replaces IAS 14 and, in particular, prescribes the application of a “management approach” when reporting on the business performance of segments. An operating segment is a component of an entity whose operating results are reviewed regularly by a chief decision-maker to serve as a basis for decisions concerning the allocation of resources to the segment, and for which discrete financial information is available. Certain additional disclosures are required in the notes. The standard is effective for annual periods beginning on or after January 1, 2009. Earlier application is permitted. MTU expects the standard to have a negligible impact, with only minor additional disclosures required.

The main change in this standard is the removal of the option that permitted borrowing costs directly attributable to the acquisition, construction or production of a qualified asset to be immediately recognized as an expense. Entities are now required to capitalize borrowing costs that form part of the cost of the qualified asset. In this context, a qualified asset is defined as an asset that takes a substantial period of time to get ready for sale or its intended use. The revised standard does not require the borrowing costs to be capitalized for assets measured at fair value, or for inventories that are manufactured or produced in large quantities on a repetitive basis, even if they take a substantial period of time to get ready for use or sale.

The revised version of IAS 23 applies to borrowing costs relating to qualified assets for which the commencement date for capitalization is on or after January 1, 2009. For MTU, this will have an impact on the measurement of contract costs for production contracts according to IAS 11.18. The effect of including borrowing costs in the contract costs, as required from 2009 onward, will be to increase the contract costs and contract revenues of construction contracts accounted for using the zero-profit method, thus improving the financial result. EBIT will thereby remain unchanged and net profit will improve by the amount of the improvement in the financial result. In the case of construction contracts accounted for using the percentage-of-completion method, the financial result will be improved and EBIT reduced by an equivalent amount, resulting in an unchanged net profit. In view of MTU’s good financing structure and hence the secondary importance of borrowing costs in general, the company believes that the capitalization of borrowing costs will have an insignificant overall impact.

The revised IAS 1 “Presentation of Financial Statements” was issued by the IASB on September 6, 2007. The publication of the revised IAS 1 marks the completion of the first phase of the IASB’s joint project with the U.S. Financial Accounting Standards Board (FASB) to review and harmonize the presentation of financial statements, with the aim of narrowing down the differences between IFRS and US-GAAP requirements. One of the changes brought about by the revised IAS 1 is the introduction of a so-called “statement of comprehensive income” to replace or supplement the income statement in IFRS financial statements. The aim of this statement, which recognizes income and expenses directly in equity, is to enable readers to distinguish between changes in the company’s equity resulting from transactions with owners and non-owner changes. Companies are given the option of presenting items of income and expense and components of other comprehensive income either in a single statement of comprehensive income with subtotals or in two separate statements (an income statement and a separate statement of “other comprehensive income”). Other changes introduced by the revised IAS 1 include the renaming of certain constituent parts of the financial statements. The balance sheet will become a “statement of financial position” and the cash flow statement will become a “statement of cash flows”. The revised standard is effective for annual periods beginning on or after January 1, 2009. Earlier application is permitted. Application of the revised standard will lead to the inclusion of the above-mentioned presentation elements for the first time.

On January 10, 2008, the IASB concluded the second phase of its long-running, much-debated “Business Combinations” project and published two revised standards:

• IFRS 3 Business Combinations (rev. 2008)
• IAS 27 Consolidated and Separate Financial Statements (rev. 2008)

The revised standards contain substantial amendments concerning the accounting treatment of business combinations, transactions with companies in which the entity holds a non-controlling interest, and loss of control of a subsidiary. IFRS 3(2008) is a particularly lengthy document, which deals with many complex accounting issues.

The standards were jointly reviewed by the IASB and its U.S. counterpart, the FASB. The aim was to achieve a convergence between IFRS and US-GAAP requirements in this specific area. IFRS 3(2008) is the first major standard to have been drawn up in collaboration with the FASB. Despite these harmonization efforts, the two bodies were unable to concur on all issues. As a result, IFRS 3(2008) is not entirely identical with its American equivalent, the new SFAS 141 standard (revised 2007) issued on December 4, 2007. Significant differences still remain between the two revised standards, notably with respect to their scope, the definition of fair values, and the accounting treatment of contingent liabilities and employee benefit payments.

The most significant changes in the revised IFRS 3 concern the measurement of non-controlling interests, where entities now have two options, which can be exercised on a transaction-by-transaction basis. They can either apply the purchased goodwill method, which apportions identifiable net assets between the two parties in an acquisition, or apply the full goodwill method, in which the totality of the goodwill of the acquired entity, including those parts attributable to non-controlling interests, is recognized by the acquirer. IFRS 3(2008) is effective for annual periods beginning on or after July 1, 2009. The transitional provisions call for a prospective application of the revised standard. For entities whose financial year is the calendar year, this means that IFRS 3(2008) must be applied to all business combinations with an acquisition date of January 1, 2010 or later. Earlier application is permitted. Notwithstanding this ruling, entities whose financial year is the calendar year may not apply IFRS 3(2008) in respect of annual periods beginning prior to January 1, 2008. In each case, if an entity makes use of IFRS 3(2008) before the effective date, then IAS 27(2008) must be applied concurrently.

The amendments to IAS 27 primarily concern the accounting treatment of non-controlling interests. In future such investments must be fully accounted for in consolidated losses, and the profit or loss resulting from transactions leading to loss of control in a subsidiary must be accounted for in the income statement. By contrast, the profit or loss derived from the sale of investments in subsidiaries that does not involve loss of control must be recognized directly in equity. IAS 27 (2008) is effective for annual periods beginning on or after July 1, 2009. Whereas the transitional provisions require the retrospective application of the published amendments, they allow for prospective application in the above-mentioned case. Consequently, there is no change in the accounting treatment of assets and liabilities contracted in this way prior to the effective date of the amended standard.

The changes resulting from the first-time application of IFRS 3 and IAS 27 depend on the nature of the business transactions that might have been effectuated (e.g. the acquisition or sale of entities or parts of entities that previously formed part of the business combination). Since there is no way of planning or forecasting what transactions this might involve in the future, it is not possible to estimate the anticipated effect of applying this standard for the first time in respect of future transactions at the present juncture. Added to which, MTU has not yet reached a decision concerning utilization of the option allowing the application of the full goodwill method as defined in IFRS 3. What can be said is that the application of the full goodwill method, and its effect on the accounting treatment of any subsequent acquisitions, coupled with the requirement to account for consideration received at the time of acquisition, is likely to have led to a higher valuation of goodwill. The amendment of this standard has no impact on the MTU consolidated financial statements from the present point of view, since MTU has no plans for relevant transactions at the time of reporting.

On January 17, 2008, the IASB published final amendments to IFRS 2 “Share-based Payment”. These amendments are based on the exposure draft concerning vesting conditions and cancellations that was published in February 2006. The amended version of IFRS 2 clarifies the definition of “vesting conditions” and specifies the circumstances under which share-based payments may be cancelled by a party other than the entity. According to the amended IFRS 2, the only acceptable types of vesting conditions are service conditions, which require a given length of service before payment is granted, and performance conditions, which require given performance targets to be reached. Other features of a share-based payment are not vesting conditions.

In response to numerous queries, added material to help with the decision of whether or not a vesting condition exists has been inserted in the implementation guidance for IFRS 2 (including a decision tree and an overview chart of the conditions). A cancellation of the share-based payment by a party other than the entity, for instance by an employee, shareholder or other party, should receive the same accounting treatment as a cancellation by the entity. The amendment to IFRS 2 is effective for annual periods beginning on or after January 1, 2009. Earlier application is permitted. As things stand at present, the amendment to this standard does not affect the MTU consolidated financial statements, because the accounting methods used in the past already accorded with the clarifications in the new implementation guidance.

An amended version of IAS 32 “Financial Instruments: Presentation” was issued by the IASB on February 14, 2008. This standard is of central importance to drawing a distinction between equity capital and debt capital. By issuing this amendment, the IASB has responded to the objections raised by certain companies in Germany, among others, that the share capital of legal entities and partnerships ought to be classified as a liability in view of shareholders’ rights to withdraw this capital. The amended version of the standard allows puttable financial instruments to be classified as equity under certain defined conditions. These defined conditions have been substantially modified since the original exposure draft was published by the IASB in the summer of 2006, as a result of extensive consultation with the German Accounting Standards Committee DRSC. The amended standard will allow German legal entities and partnerships, as a general rule, to classify their share capital as equity capital in IFRS financial statements. The revised standard is effective from January 1, 2009. Voluntary early application is accepted. The amendment of this standard has no impact on the MTU consolidated financial statements at the present time, given that the MTU group does not currently hold any financial instruments of the type affected by the amendments to IAS 32.

On May 22, 2008, the International Accounting Standards Board (IASB) issued a standard entitled Improvements to International Financial Reporting Standards 2008 – a collection of amendments to various different IFRSs. These amendments are the result of the IASB’s first annual improvements process (AIP) project. The AIP project was launched by the IASB in July 2006 as a means of dealing with minor, non-urgent but necessary changes to existing standards, which are not covered by another, larger project. The IASB’s aim in this context is to reduce the workload for all concerned by issuing such amendments in a single, comprehensive document instead of repeatedly releasing individual amendments. The collection of amendments is divided into two parts:

Part I contains amendments to individual standards that result in accounting changes affecting the recognition, measurement or presentation of specific transactions. The amendments in Part II can be regarded as relatively immaterial, since they relate to terminological or editorial changes. In total, amendments were made to 19 standards. Four of these are found in both Part I and Part II (see chart below).

Unless otherwise specified in the standard, the amendments are effective for annual periods beginning on or after January 1, 2009. However, the amendments to IFRS 5 have an effective date of July 1, 2009. Early application of the amendments to the various standards is permitted. Given the large number of individual amendments involved, it is not really possible to make any definitive statement about any expected impact they might have. On the basis of the information we have on hand at the present time, we assume that the amendments concerning the following standards may have an impact on the consolidated financial statements:

An amendment in IAS 1 “Presentation of Financial Statements” (revised 2007) clarified the point that financial assets and liabilities classified as held-for-trading in accordance with IAS 39 “Financial Instruments: Recognition and Measurement” do not automatically lead to their presentation under current assets or liabilities (IAS 1.68 and 1.71). The existing wording had led to some confusion, especially in the case of stand-alone derivatives. The factor that determines whether a financial asset or liability is considered to be non-current or current is whether it is held by the company for more or less than 12 months. The classification as “held-for-trading” in accordance with IAS 39.9 thus only determines the measurement, and not the presentation of the financial instruments in question.

A change has been introduced in the accounting treatment of defined benefit plans with respect to past service costs. These arise when a company introduces a defined benefit plan for the first time under which benefits are granted for past periods of service, or when a company changes its retirement benefit plan. The new requirement added under the annual improvements process concerns the treatment of a negative past service cost. In the past, the IASB had rejected proposals to differentiate between negative past service cost and curtailments, estimating that it was improbable that such a differentiation would result in a significant material effect (IAS 19.BC62). This assumption has proven to be incorrect in practice. According to IAS 19.97, a negative past service cost is incurred when changes to a plan lead to a reduction in the present value of the defined benefit obligation (DBO). The newly added IAS 19.111A clarifies the point that, in cases where changes to a plan result in a reduction in benefits, only the effect of the reduction for future services should be treated as a curtailment according to IAS 19.109ff. All other effects are to be treated as (negative) past service cost, because they are related to the benefits for past service. This distinction has an impact on financial statements, because curtailments are recognized immediately in the income statement whereas past service cost is spread over the period up to the date on which it becomes non-forfeitable.

Prior to the amendment, IAS 20.37 stated that the benefit of a government loan with a below-market rate of interest should not be quantified on the basis of the calculated interest. This is inconsistent with IAS 39.43 “Financial Instruments: Recognition and Measurement”, which requires financial liabilities to be measured at fair value at first recognition, i.e. including the interest benefit of a below-market rate of interest. IAS 20 “Accounting for Government Grants and Disclosure of Government Assistance” has therefore been amended accordingly. Paragraph 37 has been deleted and replaced by a new paragraph 10A, which makes it mandatory to recognize and measure government loans with a below-market rate of interest according to the requirements of IAS 39. The difference between the proceeds received and the initial carrying amount of the loan must be accounted for as a loan benefit according to the requirements of IAS 20.

The amendment to IAS 23 “Borrowing Costs” involves the replacement of paragraphs 6(a)-(c) in the list of possible components of borrowing costs with a reference to the guidance in IAS 39 “Financial Instruments: Recognition and Measurement” on the calculation of interest expense using the effective interest method. This amendment averts the risk of possible inconsistencies between the methods applied when calculating borrowing costs according to IAS 23 and IAS 39 respectively. For more general information on the possible impact of amendments to IAS 23 on EBIT, financial result and net profit, please refer back to the earlier section on revisions to IAS 23.

The amendments to IAS 39 “Financial Instruments: Recognition and Measurement” concern exceptions to the basic principle specified in IAS 39.50 – relaxed slightly in October 2008 – that prohibits the reclassification of financial instruments out of the “at fair value through profit or loss” category into any other category for as long as they are held. It has now been clarified in IAS 39.50A that cases where a financial instrument classified in the FVTPL category is designated for the first time as a cash flow hedge derivative, or where it becomes necessary to end the cash flow hedging relationship because the purpose for which it was designated no longer applies, are not considered to be reclassifications for this purpose.

The amendment to IFRS 5 concerning non-current assets held for sale and discontinued operations relates to situations in which a company is committed to a planned sale of part of its interest in a subsidiary involving a loss of control while retaining a non-controlling interest. IFRS 5 now clearly states that, in such situations, all assets and liabilities of the subsidiary must be classified as “held for sale” if the planned sale meets the criteria set out in IFRS 5. The amendment is founded on the circumstance that the company will no longer have a controlling interest in the company after the planned sale. If, on the other hand, the planned sale does not involve a loss of control, the requirements of IFRS 5 do not apply. In this case, the assets and liabilities of the subsidiary representing the part of the company’s interest that it intends to sell should be recognized and measured in accordance with the relevant existing IFRSs.

To our current knowledge, the other amendments to IFRS 5 have no impact on the MTU consolidated financial statements, either because the issues addressed are not relevant or because MTU has already been employing the accounting treatment prescribed by the IASB.

On May 22, 2008, the International Accounting Standards Board (IASB) published revised versions of the standards IFRS 1 “First-time Adoption of International Financial Reporting Standards” and IAS 27 “Consolidated and Separate Financial Statements”. It thereby reached the end of a project launched in March 2006 to simplify the measurement of investments when drawing up a single set of financial statements according to IFRSs for the first time. The simplifications in the revised version of the standards particularly relate to the initial recognition at fair value of subsidiaries, joint ventures and associated companies, or alternatively the recognition of their carrying amounts derived from previous financial reporting. A further simplification has been achieved by removing the definition of the “at cost” accounting method from IAS 27. This eliminates the need for painstakingly dividing earnings into separate components for before and after the acquisition. IAS 27 now required dividends to be entirely recognized as income. Another modification relates to the restructuring of an existing business combination. The revised version of IAS 27 makes provision for the carrying amount at the acquisition date of an existing parent company by a newly created holding company to be taken as the acquisition cost. The changes to these standards have no impact on the MTU consolidated financial statements because the subject of IFRS 1 is of no relevance to MTU and the modifications to IAS 27 are not applicable to MTU either.

On July 31, 2008, the IASB issued an amendment to IAS 39 “Financial Instruments: Recognition and Measurement” entitled “Eligible hedged items”. The IASB’s amendments to this standard focus on guidance on basic hedge accounting issues. The amendments to IAS 39 firstly specify the exposures that qualify for hedge accounting, and secondly provide clarification of the cases in which an entity is permitted to designate a portion of the cash flows of financial instrument as a hedged item. The amendment does not involve any changes to the existing requirements, but merely adds new paragraphs in the application guidance to provide additional clarification. The amendments to IAS 39 are effective for annual periods beginning on or after July 1, 2009, with early adoption permitted. As things stand at present, the amendment to this standard does not affect the MTU consolidated financial statements, because the accounting methods used in the past already accorded with the clarifying guidance.

On November 27, 2008, the IASB published a restructured version of IFRS 1 “First-time Adoption of International Financial Reporting Standards”. The changes only affect the structure of IFRS 1 and not its substance, aiming to make the standard easier to read and understand and improve its design so that future changes can be better accommodated. No changes were made to the requirements concerning the first-time adoption of IFRSs set out in IFRS 1. The standard has absorbed numerous amendments and additions since it was first issued in 2003. As a result, its structure has become rather complex. Already in 2007, the IASB had proposed that the structure of IFRS 1 should be improved as part of its annual improvements project, but this proposal was then removed to a separate project. The restructured version of IFRS 1 is effective for annual periods beginning on or after January 1, 2009. Early adoption is permitted. Amendments to this standard have no impact on the MTU consolidated financial statements because the subject of IFRS 1 is of no relevance to MTU.

This interpretation provides guidance on the accounting treatment of customer loyalty programs. These marketing tools are designed to promote the customer’s loyalty to the company by awarding points or other forms of bonus to customers who purchase goods or services, which can be redeemed for free or discounted goods or services. Until now there were no specific IFRS requirements concerning the accounting treatment of customer loyalty programs, with the result that in practice such programs were accounted for in divergent ways. The consequent objective of IFRIC 13 was to provide uniform rules for the accounting treatment of customer loyalty programs. IFRIC 13 now requires that customer loyalty programs be accounted for in accordance with IAS 18.13, in other words as multicomponent transactions. This interpretation is effective for annual periods beginning on or after January 1, 2008. In the absence of transactions of this nature, the interpretation in question will not have any impact on the MTU consolidated financial statements.

IFRIC 15 “Agreements for the Construction of Real Estate” was published on July 3, 2008 and derives from the draft interpretation IFRIC D21 “Real Estate Sales” issued on July 5, 2007. IFRIC 15 is designed to provide guidance on the accounting treatment of real-estate sales in which revenue has to be recognized by the developer before construction has been completed (“off-plan” sales). IFRIC 15 provides interpretation guidance on how to determine whether an agreement for the construction of real estate lies within the scope of IAS 11 “Construction Contracts” or IAS 18 “Revenue” for accounting purposes and, accordingly, when revenue from the construction should be recognized. IFRIC 15 specifies that IAS 11 may only be applied in respect of agreements that meet the definition of a construction contract according to IAS 11.3. As further clarification, IFRIC 15.11 states that this definition only applies if the buyer is able to specify the major structural elements of the design of the real estate before construction begins, and/or specify major structural changes once construction is in progress, whether or not this ability is exercised. Agreements for the construction of real estate that do not fully provide this ability, e.g. merely allow the buyer to choose among predefined elements, must be accounted for according to IAS 18. IFRIC 15 is effective for annual periods beginning on or after January 1, 2009. Early adoption is permitted. MTU does not anticipate any impact from this interpretation on its consolidated financial statements, given its lack of relevance to the group’s business model.

IFRIC 16 “Hedges of a Net Investment in a Foreign Operation” was published on July 3, 2008 and derives from the draft interpretation IFRIC D22 issued on July 19, 2007. IFRIC 16 clarifies the following accounting issues:

• To which exposures may an entity apply hedge accounting and how should the hedged items be designated: Transaction risk arising from foreign currency exposure to the functional currency of the foreign operation, or currency risk arising from translation differences between the functional currency of the foreign operation and the presentation currency of the parent entity’s consolidated financial statements?
• Which entity within a group can hold the hedging instrument?
• How are the amounts to be reclassified from equity to profit or loss when the entity disposes of the investment?

The IFRIC 16 interpretation is as follows:

• Translation into the presentation currency does not constitute an exposure to which an entity may apply hedge accounting. Hedge accounting may only be applied to transaction risks.
• The hedging instrument may be held by any entity in the group.
• Concerning the reclassification and measurement on disposal of the investment, IAS 39 must be applied in respect of the hedging instrument and IAS 21 in respect of the hedged item.

IFRIC 16 is effective for annual periods beginning on or after October 1, 2008. Voluntary early application is permitted. The interpretation must be applied prospectively, i.e. IAS 8 is not applicable. MTU does not anticipate any impact of this interpretation on its consolidated financial statements, given that hedging strategies of this nature have not been implemented up to now.

The International Financial Reporting Interpretations Committee (IFRIC) issued IFRIC 17 “Distribution of Non-cash Assets to Owners” on November 27, 2008. IFRIC 17 is derived from the draft interpretation IFRIC D23 issued on January 17, 2008 and applies to the distribution of dividends in the form of non-cash assets. Until now, there were no defined IFRS requirements determining how an entity should account for dividends paid to shareholders in another form than cash or cash equivalents. In practice, such payments are therefore accounted for in widely divergent ways. In some cases the carrying amount is used to recognize the distributed non-cash assets, and in other cases the fair value. By way of clarification, IFRIC 17 concludes that:

• a dividend payable should be recognized when the dividend is appropriately authorized and is no longer at the discretion of the entity (which, depending on relevant national legislation, may be the resolution date or the notification date of the proposed dividend payment);
• the entity should measure the dividend payable at the fair value of the net assets to be distributed to owners (shareholders);
• the difference between the fair value and the carrying amount of the net assets distributed to shareholders as a dividend should be recognized in profit and loss;
• additional disclosures must be provided if the net assets to be distributed to owners meet the definition of a discontinued operation, and thus qualify for classification as “held-for-sale”.

IFRIC 17 applies to pro rata distributions of non-cash assets but does not apply to common control transactions. IFRIC 17 is to be applied prospectively and is effective for annual periods beginning on or after July 1, 2009. Early adoption is permitted. MTU does not anticipate any impact of this interpretation on its consolidated financial statements, given that the company has no current plans to distribute dividends in the form of non-cash assets.

The International Financial Reporting Interpretations Committee (IFRIC) issued IFRIC 18 “Transfers of Assets from Customers” on January 29, 2009. IFRIC 18 provides supplementary guidance on the accounting treatment of transfers of assets from customers and is above all relevant to the energy sector. The interpretation clarifies the requirements of IFRSs for agreements in which an entity receives an item of property, plant and equipment from a customer that the entity must then use either to connect the customer to a network or provide the customer with ongoing access to a supply of goods or services. This interpretation must be applied prospectively and is effective for annual periods beginning on or after July 1, 2009. Limited provision is nevertheless made for retrospective application in specific cases. MTU does not anticipate that this interpretation will have any impact on its consolidated financial statements.

MTU does not intend to apply any of these standards and interpretations in advance of their effective date.

MTU Aero Engines GmbH, Munich, which is a consolidated affiliated company of MTU Aero Engines Holding AG, Munich, and for which the consolidated financial statements of MTU Aero Engines Holding AG, Munich constitute the exempting consolidated financial statements, has invoked the provision of Section 264 (3) of the German Commercial Code (HGB) exempting the company from the obligation to prepare disclosure notes and a management report. The official notice of the company’s invocation of the exemption has been published in the electronic version of the Federal Gazette (Bundesanzeiger) in the name of MTU Aero Engines GmbH, Munich.

The following table presents the evolution of the shareholder structure and the corresponding equity investments:

• Starting in the financial year 2007, the disclosures relating to Supervisory Board compensation pursuant to Section 315a (1) in conjunction with Section 314 (1) no. 6 of the German Commercial Code (HGB) are individually presented in the management compensation report.
   
• From the financial year 2008 onward, in the interests of greater clarity, particularly with respect to the application of IAS 12, actual tax obligations and tax refund claims have been removed from the items “Other provisions” and “Other assets” respectively and included in the items “Income tax claims” and “Income tax liabilities”.
   
• For greater clarity, receivables from derivative financial instruments have been removed from the item “Other assets” and transferred to the item “Financial assets”. By contrast, derivative financial liabilities are still included in “Financial liabilities”.
   
• In the interests of providing a more transparent overview, the reporting statements relating to the primary and secondary business segments have been placed immediately in front of the notes to the consolidated financial statements. This enables to segment information to be compared more easily with the consolidated income statement by way of the reconciliation tables.
   
• From the financial year 2008 onward, a separate reporting line has been presented in the notes to the consolidated financial statements for the fund-financed plan assets of MTU Maintenance Canada Ltd., Canada, amounting to € 13.7 million (2007: € 19.0 million). These plan assets were measured at fair value and reported on the face on the balance sheet under a separate item to pensions and similar obligations (DBO). Consequently, additional items for the expected return on plan assets, effective losses arising from fund-financed plan assets, employer and employee contributions and retirement benefit payments out of plan assets were added to the changes in the group’s plan assets. Additionally, Note 31. provides explanatory comments on pension obligations supplemented by a breakdown of fund-financed plan assets by asset category and an estimate of the plan asset yield expected in the current financial year.
   
• To provide a more accurate picture of their economic importance, contract production receivables and payables have been removed from the formerly combined item “Trade and contract production receivables” and the item “Other liabilities” and are now presented in separate items for “Contract production receivables” and “Contract production payables”. Prepayments are included as an offset in “Contract production payables”. Prepayments that can be directly attributed to contract production receivables are transferred from “Contract production payables” (Note 36.) to “Contract production receivables” (Note 24.).
   
• Any adjustments or modifications applied in the financial year 2008 have been applied similarly to the comparative data for previous years.

MTU Aero Engines Polska Sp. z.o.o., Rzeszów, Poland, which was created with effect of July 20, 2007, was included as a fully consolidated company in the financial statements for the first time in 2008. It was not included in 2007 because its impact was not material. As a result of its consolidation, the amount of cash and cash equivalents at January 1, 2008 increased by € 5.3 million.

The consolidated financial statements of MTU Aero Engines Holding AG include all significant companies in which MTU Aero Engines Holding AG holds a controlling interest by virtue of holding the majority of voting rights in those subsidiaries. Entities are con-solidated as from the date on which control arises and are deconsolidated when control comes to an end.

Associated companies are companies in which MTU has a significant influence and which are neither subsidiaries nor joint ventures. Entities corresponding to this definition over whose financial and operating policies MTU directly or indirectly has significant influence are accounted for using the equity method or – if non-significant – at cost. Significant influence is assumed to exist if MTU Aero Engines Holding AG, directly or indirectly, owns 20 % or more of the voting stock of an entity.

Joint ventures are companies over which MTU exercises joint control together with another entity. Holdings in joint ventures with a significant impact on the group financial statements are either consolidated proportionately or accounted for using the equity method in these statements.

Non-significant investments are shares in companies and stakes in engine programs whose overall impact on the group’s net assets, financial situation and operating results is not material. These equity investments are accounted for at cost in the consolidated financial statements.

As in 2007, equity investments in five joint ventures, five associated companies and one other entity are included in the consolidated financial statements. Of these, one joint venture is accounted for using the equity method and one joint venture is proportionately consolidated at 50 %. The equity investments in the remaining joint ventures and associated companies and the one other entity are measured at amortized cost owing to their insignificant value to the group, as are the equity investments in two subsidiaries.

The following additional assets, liabilities, expenses and income are recognized in the consolidated accounts as a result of the 50 % proportionate consolidation of the joint venture MTU Maintenance Zhuhai Co. Ltd., Zhuhai, China:

MTU Maintenance Zhuhai Co. Ltd., Zhuhai, China, at December 31, 2008 employed a staff of 487 employees (2007: 413).

All business combinations are accounted for using the acquisition method as defined in IFRS 3. Under the acquisition method, the acquired identifiable assets, liabilities, and contingent liabilities are measured initially by the acquirer at their fair values at the acquisition date and recognized separately. In accordance with IAS 36, goodwill is tested for impairment at least annually, or at shorter intervals if there is an indication that the asset might be impaired. If the group’s interest in the net fair value of the acquired identifiable net assets exceeds the cost of the business combination, that excess (negative goodwill) is immediately recognized in the income statement – after remeasurement as required by IFRS 3.56.

The effects of intragroup transactions are eliminated. Accounts receivable and accounts payable as well as expenses and income between the consolidated companies are netted. Internal sales are recorded on the basis of market prices and intragroup profits and losses are eliminated.

In accordance with IAS 12, deferred taxes are recognized on temporary differences arising from the elimination of intragroup profits and losses.

Investments in joint ventures – with the exception of MTU Maintenance Zhuhai Co. Ltd., China – are accounted for using the equity method from the date of acquisition and are recognized initially at cost. Any difference arising at the acquisition date between the acquisition cost and fair values of the identified assets, liabilities and contingent liabilities is recognized as goodwill. MTU Aero Engines Holding AG’s share of an investee’s profits or losses is recorded in the income statement.

MTU’s 50% share in the jointly controlled entity MTU Maintenance Zhuhai Co. Ltd., China, is proportionately consolidated in the group financial statements. Consequently, an equivalent proportion of the jointly controlled assets and liabilities, income and expenses attributable to MTU Maintenance Zhuhai Co. Ltd., China, is included in the consolidated financial statements. The figures in the table presented under Note 2.6. include the corresponding portion of the joint venture’s assets, liabilities, expenses and income.

Program management and coordination companies are associated companies, and consequently accounted for at cost. With regard to the special accounting treatment of these investments, please refer to Note 5.7.2.

All other equity investments (non-consolidated subsidiaries and other equity investments) are measured at their fair value. If the fair value cannot be reliably determined, these investments are stated at cost (see explanatory comments in Notes 5.7.1., 5.7.3. and 5.7.4.).

Transactions in foreign currencies are translated to the functional currency using the exchange rate prevailing on the date of the transaction. At the balance sheet date, monetary items are translated using the exchange rate prevailing at that date, whereas non-monetary items are translated using the exchange rate prevailing on the transaction date. Translation differences are recognized in the income statement. The assets and liabilities of group companies whose functional currency is not the euro are translated from the corresponding local currency to the euro using the closing exchange rate at the balance sheet date. In the income statements of foreign group companies whose functional currency is not the euro, income and expense items are translated each month using the exchange rate applicable at the end of the month; from these can be derived the average exchange rate for the year. The translation differences arising in this way are recognized in equity and do not have any impact on the net profit/loss for the year.

The financial statements of MTU Aero Engines Holding AG and of its German and foreign subsidiaries are drawn up using uniform accounting policies in accordance with IAS 27.

Revenues from the sale of goods are recognized when goods are delivered to the customer and accepted by the latter, in other words when the significant risks and rewards of ownership of the goods have been transferred by the seller. 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), cooperation entities, public-sector contractors, airlines and other third parties.

Revenues from contractual maintenance (time and material, Fly-by-Hour, Power-by-the-Hour contracts) in the commercial MRO business are recognized when the maintenance service has been performed and the criteria for recognizing revenues on overhauled engines have been met. In the case of long-term commercial maintenance agreements and military development and production contracts, revenues are recognized by reference to the percentage of completion in accordance with IAS 11 and IAS 18. If the outcome of a contract cannot be estimated reliably, the zero-profit method is applied, whereby revenues are only recognized to the extent that contract costs have been incurred and it is probable that those costs will be recovered. Contracts are recognized in the balance sheet under “contract production receivables” (Note 24.) or under “contract production payables” (Note 36.). Further explanation of the measurement of percentage of completion is given in work in progress (Note 5.8.).

Revenues are reported net of trade discounts and concessions and customer loyalty awards.

The group’s forward currency contracts satisfy the conditions for applying hedge accounting according to IAS 39. The instruments used to hedge cash flows are measured at their fair value, with gains and losses recognized initially in equity (under other comprehensive income). They are subsequently recorded as revenues when the hedged item is recognized.

Cost of sales comprises the production-related manufacturing cost of products sold, development services paid, and the cost of products purchased for resale. In addition to the direct material cost and production costs, it also comprises systematically allocated overheads, including depreciation of the production installations, productionrelated other intangible assets, write-downs on inventories and an appropriate portion of production-related administrative overheads. Cost of sales also includes expenses charged by OEMs for marketing new engines in conjunction with risk- and revenue-sharing programs.

Expenditure in connection with research activities (research costs) is charged to expense in the period in which it is incurred.

In the case of development costs, a distinction is drawn between purchased (“externally acquired”) development assets and self-created (“internally generated”) development assets. Project costs attributable to externally acquired development assets are generally allocated to contract production receivables on the basis of percentage of completion. Any surplus expense or income remaining after the end of a development project is amortized proportionately over the subsequent production phase.

Development costs generated in the context of company-funded R&D projects are capitalized at the construction cost to the extent that they can be attributed directly to the product and on condition that the product’s technical and commercial feasibility have been proved. There must also be reasonable probability that the development activity will generate future economic benefits. The capitalized development costs comprise all costs directly attributable to the development process. Government grants are deducted from the capitalized development costs. Capitalized development costs are amortized on a scheduled basis over the expected product life cycle from the start of production onwards.

The development costs for engine programs that had reached the production and spare-parts phase at the date of January 1, 2004, when the company was acquired by Kohlberg Kravis Roberts & Co. (KKR) from the then Daimler-Chrysler AG, were allocated to the individual engine programs and recognized at their fair value as part of the identification of assets and the subsequent purchase price allocation. The development costs comprise all costs directly attributable to the development process. Borrowing costs are not capitalized. Program assets are amortized on a scheduled basis over the expected product life cycle (maximum of 30 years).

Both capitalized development costs, as well as previously capitalized development projects that have not been completed by the end of the financial year, are subjected once a year to an impairment test. An impairment charge is only then recognized when the carrying amount of the capitalized asset exceeds the recoverable amount.

Externally acquired and internally generated intangible assets are recognized in accordance with IAS 38 if it is probable that a future economic benefit attributable to the asset will flow to the entity and the cost of the asset can be measured reliably.

Intangible assets with a finite useful life are carried at cost and amortized on a straight-line basis over their useful lives.

With the exception of goodwill, technology assets, customer relations and capitalized program assets, intangible assets are generally amortized over a period of 3 years. Program assets are amortized over their useful lives of up to 30 years, technology assets over 10 years, and customer relations over periods of between 4 and 26 years.

In accordance with IFRS 3, goodwill with an indefinite useful life is subjected to an impairment test at least once a year. Consistent with the distinction made for segment reporting purposes, the commercial and military engine business (OEM) and the commercial MRO business are viewed as cash-generating units (CGUs). Goodwill was attributed to each of the two segments as of January 1, 2004. The present value of each cash-generating unit’s future net cash flows (recoverable amount) is compared with the carrying amount of the corresponding assets (including goodwill). If the recoverable amount is lower than the carrying amount of the respective cash-generating unit, an impairment loss is recognized initially on goodwill. If the amount estimated for an impairment loss is greater than the goodwill, the remaining difference is allocated pro rata to the remaining assets of the respective cashgenerating unit.

A test is conducted at each balance sheet date to determine whether the reasons for impairment losses recognized in prior periods still exist. There is a requirement to reverse an impairment loss if the recoverable amount of the asset (other than goodwill) has increased. The recoverable amount is the higher amount of the present value less costs to sell and the expected value in use. The upper limit of the impairment loss reversal is determined by the acquisition cost less the accumulated scheduled depreciation that would have been recorded if no impairment loss had been recognized. The reversal of an impairment loss is recorded in the appropriate income statement line items by function. By contrast, an impairment loss recognized on goodwill is not reversed in a subsequent period. No reasons for recognition of impairment loss on good-will existed in the financial year 2008, nor in previous periods. For impairment losses recognized on other assets in the financial year 2007, please refer to Note 7.

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 reasonable assurance that the conditions attached to them will be complied with and that the grants will be received. Grants are recognized as income over the periods necessary to match them with the related costs which they are intended to compensate. In the case of capital expenditure on property, plant and equipment and on intangible assets, the amount of the public sector grant awarded for this purpose is deducted from the carrying amount of the asset. The grants are then recognized as income using reduced depreciation/amortization amounts over the lifetime of the depreciable asset.

Property, plant and equipment are subject to wear and tear and are carried at their acquisition or construction cost less scheduled depreciation. Such assets are depreciated using the straight-line method in line with the pattern of usage. If there are any indications of impairment, property, plant and equipment is subjected 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 amount is calculated as the higher of an asset’s fair value less costs to sell and its value in use.

If the reason for recognizing an impairment loss in prior periods no longer exists, the impairment loss is reversed with income statement effect up to an amount not exceeding the asset’s amortized cost. So-called low-value business assets (individually costing less than € 150) are expensed in the year of acquisition. On the other hand, assets with a purchase price exceeding € 150 but less than € 1,000 are amortized on a straight-line basis over a period of five years, in accordance with German taxation rules (pool measurement).

Scheduled depreciation is based on the following useful lives:

The depreciation of machines used in multi-shift operation is accelerated by using a higher shift coefficient to take account of additional usage.

The cost of items of self-constructed plant and equipment comprises all costs directly attributable to the production process and an appropriate proportion of production-related overheads, including depreciation and pro rata administrative and social security costs. Borrowing costs are not recognized as a component of acquisition or construction cost.

The beneficial ownership of leased assets is attributed to the contracting party in the lease arrangement that bears the substantial risks and rewards incidental to the ownership of that asset. If the lessor retains the substantial risks and rewards (operating lease), the leased asset is recognized in the lessor’s income statement, and is measured according to the accounting requirements applicable to that asset. The lessee in an operating lease arrangement recognizes lease payments as an expense throughout the duration of the lease arrangement.

If the substantial risks and rewards incidental to the ownership of the leased asset are transferred to the lessee (finance lease), the leased asset is recognized in the lessee’s balance sheet. The leased object is measured at its fair value at the date of acquisition, or at the present value of future minimum lease payments if lower, and depreciated over its estimated useful life, or the contract duration if shorter. The depreciation expense is recognized in the income statement. The lessee immediately recognizes a finance lease liability corresponding to the carrying amount of the leased asset. The effective interest rate method is employed to reduce and amortize the lease liability.

Impairment losses on intangible assets and on property, plant and equipment are calculated by comparing the carrying amount with the recoverable amount. If it is not possible to attribute separate future cash flows to discrete assets that have been generated independently of other assets, then an impairment test must be carried out on the basis of the cash-generating unit ultimately responsible for the asset. At each balance sheet date, the asset must be tested for indications of impairment. If impairment is indicated, the recoverable amount of the asset or of the cash-generating unit is remeasured. If the reasons for impairment losses recognized in a prior period no longer exist, the impairment on these assets is reversed.

The recoverable amount of a cash-generating unit is usually determined using a discounted cash flow (DCF) technique. This involves making forecasts of the cash flow that can be generated over the estimated useful life of the asset or cash-generating unit, applying a discount rate that takes into account the risks associated with the asset or cash-generating unit. The forecast cash flows reflect certain assumptions on the part of management which are validated by reference to external sources of information.

Available-for-sale financial assets are classified as such if their carrying amount can only be realized by sale and not through continued use. Assets corresponding to this description are measured at the lower of their carrying amount or their fair value less costs to sell, and are classified as available-for-sale financial assets. Such assets are not recognized at amortized cost. Impairment losses are not recognized for this category of asset unless their fair value less costs to sell is lower than the carrying amount.

If the fair value less costs to sell should increase in a later period, the previously recognized impairment loss is reversed. This reversal is limited to the amount of the impairment loss previously recognized for the asset in question. If measures or marketing activities in connection with non-current assets are introduced after the balance sheet date but before the financial statements are published, disclosures relating to the available-for-sale financial assets are included in the notes to the financial statements. The assets are not classified as available-for-sale in the consolidated financial statements for the financial year in question, and their scheduled depreciation/amortization is continued.

The group’s share of profits or losses of joint venture companies accounted for using the equity method are allocated on a pro rata basis to profit/loss and the corresponding carrying amount of the investment. This profit/loss is reported in the financial result on a separate line item for “profit/loss of companies accounted for using the equity method”.

All investments in non-consolidated subsidiaries reported as non-current financial assets are measured at their fair value. If a quoted market price in an active market is not available and if a fair value cannot be reliably measured, investments in non-consolidated subsidiaries are carried at cost – with appropriate adjustments for impairment loss where necessary.

Investments in associated companies that are not accounted for using the equity method in accordance with IAS 28 are measured at their fair value in accordance with IAS 39. If a fair value is not available or cannot be reliably measured, investments in associated companies are carried at cost – with appropriate adjustments for impairment loss where necessary.

Equity investments in joint ventures that are not accounted for using the equity method are measured at their fair value or proportionately consolidated in accordance with IAS 39. They are carried at cost – with appropriate adjustments for impairment loss where necessary – if a quoted market price in an active market cannot be reliably measured.

Other equity investments are measured 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, these investments are carried at cost – with appropriate adjustments for impairment loss where necessary.

Asset-based loans based on financial assets are classified as loans and receivables, and hence carried at amortized cost – with appropriate adjustments for impairment loss where necessary.

Raw materials and supplies are measured at the lower of average acquisition cost and net realizable value. Trade discounts and concessions and customer loyalty awards are taken into account when determining acquisition costs. Advance payments for inventories are capitalized. Acquisition cost comprises all direct costs of purchasing and other costs incurred in bringing the inventories to their present location and condition. Net realizable value is the estimated selling price generated in the ordinary course of business for the finished product in question, less estimated costs necessary to make the sale (costs to complete and selling costs).

Work in progress is measured at the lower of manufacturing cost and net realizable value. Manufacturing cost comprises all costs directly attributable to the production process as well as an appropriate proportion of productionrelated overheads, including depreciation on production-related assets and production-related administrative costs.

Borrowing costs of inventories are not included in the cost of inventories.

The group uses the percentage-of-completion (PoC) method to recognize all production contracts. If the outcome of a specific production contract can be estimated reliably, revenues and income are recognized in proportion to the percentage of completion. The percentage of completion is determined as the ratio of contract costs incurred to total contract costs (cost-to-cost method). If the outcome of a contract cannot be estimated reliably, the zeroprofit method is applied, whereby revenues are only recognized to the extent that contract costs have been incurred, resulting in a balance of zero. If settlement has not yet been received for a production contract, the construction costs determined using the PoC method, taking profit sharing into account where relevant, are recognized as future contract receivables in the balance sheet and as revenues arising from production contracts in the income statement. These items are defined as the difference between the sum of contract costs incurred and measured up to the balance sheet date and recorded profits less losses incurred and partial settlements.

Receivables from production contracts are recognized separately from trade receivables in the balance sheet under the item “contract production receivables”. If advance payments received from customers are lower than the amount of receivables, the difference is deducted from the amount of contract production receivables and accounted for as an asset. If the advance payments received are higher than the contract production receivables, the negative balance of the production contracts is recognized under contract production payables. Projects with an assets surplus are not offset against other projects with a liabilities surplus.

Long-term production contracts carried as assets or as liabilities are discounted at the appropriate market rate. In the case of programs carried as assets, the discounted revenues arising from long-term production contracts are recognized in the income statement under revenues. When the product is delivered, this interest component is derecognized via the financial result. If, on the other hand, the long-term production contract is financed by means of long-term advance payments received, the economic benefit arising from the present value received up to delivery of the engine is recognized under other liabilities. The accrued interest receivable is transferred to revenues at the delivery date of the engine.

A financial instrument is a contract that simultaneously gives rise to a financial asset in one company and to a financial liability or equity instrument in another company. Financial assets include, in particular, cash and cash equivalents, trade receivables, loans and other receivables, financial investments held to maturity, and nonderivative and derivative financial assets held for trading. Financial liabilities often entitle the holder to return the instrument to the issuer in return for cash or another financial asset. These include, in particular, bonds and other debts evidenced by certificates, trade payables, liabilities to banks, finance lease liabilities, borrowers’ note loans and derivative financial liabilities. Financial instruments are always recognized as soon as MTU becomes a party to the contractual provisions of the instrument. In the case of regular way purchases or sales (purchases or sales under contractual terms that provide for delivery of the asset within a certain period, which is normally determined by regulations or conventions in the respective market), however, the trade date – the date on which the asset is delivered to or by MTU – is of importance to the asset’s initial recognition and derecognition.

Financial assets are measured in accordance with their classification according to IAS 39. MTU makes a distinction between these financial assets on the basis of their intended purpose as follows: “fair value through profit or loss”, “held to maturity”, “loans and receivables” and “available for sale”. The assignment of an asset to a category, which moreover has implications for measurement subsequent to initial recognition, is performed at the time of acquisition and is primarily determined by the purpose for which the financial asset is held.

At initial recognition, financial assets are measured at their fair value. This includes transaction costs directly attributable to the acquisition in the case of assets not to be subsequently measured at fair value through profit or loss. As a rule, the fair value recognized in the balance sheet corresponds to the financial asset’s quoted market price. The measurement of a financial asset subsequent to initial recognition depends on the category to which it was assigned at the time of acquisition. The accounting treatment of each category is described in greater detail below:

FVtPL financial instruments are measured at fair value through profit or loss. This category has two subcategories: “held for trading” and “designated at fair value through profit or loss”. To date, MTU has not made any use of the option allowing financial instruments to be designated at fair value through profit or loss. The subcategory “held for trading” primarily includes derivative financial instruments that do not form part of an effective hedging relationship as defined in IAS 39 and which hence are required to be classified as “held for trading”. Any profit or loss resulting from remeasurement is recognized in the income statement. The measured value of FVtPL financial instruments at the balance sheet date may lie above the original acquisition costs. Changes in fair value are recognized in the income statement for the current reporting period. This also applies to interest and dividends paid on the asset.

There are certain financial investments where it is both intended and can be reasonably expected on the basis of economic assessment that they will be held to maturity. This category of financial assets is measured at amortized cost using the effective interest method. To date, the group has not made any investments that can be classified as “held to maturity”.

Financial assets classified as “loans and receivables” are measured at amortized cost less impairment, using the effective interest rate where appropriate. The impairment losses, which are recognized as specific allowances, are adequately matched to the expected credit risk. When actual credit losses are incurred, the corresponding receivables are written off. Financial assets that are individually assessed and for which impairment is potentially indicated are grouped with other financial assets with similar credit risk characteristics and collectively assessed for impairment. If deemed necessary, impairment loss is also recognized for the other assets (as a flat-rate general allowance).

When determining the expected future cash flows for a portfolio in this context, past experience with credit losses is taken into account along with the contractually agreed payment flow. Impairment loss on trade receivables is sometimes accounted for by means of valuation allowances. The decision whether to account for credit risk by means of an allowance account or by directly recording an impairment loss on receivables depends on the degree of certainty with which the risk situation can be assessed.

Other non-derivative financial assets are classified as “available for sale”. These are always measured at fair value. Gains or losses resulting from the measurement of fair value are recognized directly in equity. This does not apply in the case of significant or long-lasting impairment to the fair value of an equity instrument carried at below its acquisition cost, or in the case of fair value changes in debt instruments due to foreign exchange gains or losses. These impairments are recognized in the income statement. The cumulative gain or loss that was recognized in equity in connection with the measurement of fair value is not recognized as profit or loss in the income statement until the financial asset is derecognized. If it is not possible to reliably measure the fair value of an equity instrument that is not quoted in an active market, the investment is measured at acquisition cost (less impairment where appropriate).

At each balance sheet date, the carrying amounts of financial assets that are not measured at fair value through profit or loss are assessed to determine whether there is any substantial objective evidence of impairment (such as significant financial difficulties on the part of the debtor, a high probability that insolvency proceedings will be brought against the debtor, the closure of an active market for the financial asset, significant negative changes in technological, economic, legal or market conditions affecting the issuer, a persistent decline in the fair value of the financial asset below its amortized cost). The amount of the impairment loss, which is indicated if its fair value is lower than its carrying amount, is recognized in the income statement. Any impairment losses relating to the fair value of available-for-sale financial assets previously recognized in equity are recycled from equity to the income statement to the amount of the assessed impairment loss.

If, in a subsequent period, there is objective evidence that the fair value has increased due to an event occurring after the impairment was originally recognized, the appropriate amount of the previously recognized impairment loss is reversed through profit and loss. Impairment losses affecting available-for-sale equity instruments (or equity instruments not quoted in an active market that are accounted for at cost) are not allowed to be reversed. When testing for impairment, the estimated fair value of held-to-maturity investments, and the fair value of loans and receivables measured at amortized cost, is approximated to the present value of future estimated cash flows discounted at the financial asset’s original effective interest rate. The fair value of equity instruments measured at cost and not quoted in an active market is calculated on the basis of the future estimated cash flows discounted at the current rate consistent with the specific risks to which the investment is exposed.

Cash and cash equivalents, which include current accounts and short-term bank deposits, are due within three months and are measured at amortized cost.

Financial liabilities are measured at their fair value at the time of acquisition, which is normally equivalent to the acquisition cost. Transaction costs directly attributable to the acquisition have the effect of reducing the acquisition cost of all financial liabilities that are not measured at fair value subsequent to initial recognition. If a financial liability is interest-free or bears interest at below the market rate, it is recognized at an amount below the settlement price or nominal value. The financial liability initially recognized at fair value is amortized subsequent to initial recognition using the effective interest method.

To date, MTU has not made any use of the option allowing financial liabilities to be designated at fair value through profit or loss at initial recognition.

Subsequent to initial recognition, all financial liabilities – with the exception of derivative financial instruments – are measured at amortized cost using the effective interest method (“financial liabilities measured at amortized cost; FLAC”).

MTU uses derivative financial instruments as a hedge against currency, interest rate and price risks arising out of its operating activities and financing transactions.

At initial recognition, derivative financial instruments are measured at their fair value. The fair value is also of importance to subsequent measurement. The fair value of traded derivative financial instruments is equivalent to the market price, which can be positive or negative. If no quoted market price is available, the fair value is calculated using recognized actuarial models. The fair value of derivative financial instruments is represented by the amount that MTU would receive or would have to pay at the balance sheet date when the financial instrument is terminated. It is calculated on the basis of the relevant exchange rates, interest rates and credit standing of the contractual partners at the balance sheet date.

When measuring derivative financial instruments, it must be determined whether or not a hedging relationship exists between the underlying transaction and the hedged item. Derivative financial instruments that do not form part of an effective hedging relationship as defined in IAS 39 must be classified as “held for trading” and are therefore recognized in the balance sheet at their fair value. If the fair value is negative, they are recognized under financial liabilities (“financial liabilities held for trading; FLHfT”).

Changes in fair value in the context of hedge accounting are recorded either as profit or loss in the income statement or directly in equity, depending on whether or not the derivative financial instrument forms part of an effective hedging relationship as defined in IAS 39. If a derivative financial instrument does not qualify as a cash flow hedge, changes in the fair value must be recognized in the income statement immediately (see “held for trading” instruments, above). If, on the other hand, an effective hedging relationship as defined in IAS 39 does exist, it is permitted to account for the economic hedging relationship as such in an appropriate way.

MTU applies the requirements relating to hedging instruments in accordance with IAS 39 (cash flow hedge accounting) to hedge future payment cash flows. This reduces volatility in cash flows that could affect profit and loss. In doing so, MTU complies with the strict requirements of IAS 39 concerning hedge accounting. When a hedge is undertaken, the relationship between the financial instrument designated as the hedging instrument and the underlying transaction is documented, as are the risk management objective and strategy for undertaking the hedge. This includes assigning specific hedging instruments to the corresponding future transactions and assessing the effectiveness of the designated hedging instrument. Existing cash flow hedges are monitored for effectiveness on a regular basis.

Cash flow hedges are used to hedge the exposure of future cash flows arising from underlying transactions to fluctuations in foreign currency exchange rates. When a cash flow hedge is in place, the effective portion of the change in value of the hedging instrument is recognized directly in equity (as a hedge reserve under other comprehensive income), including deferred taxes, until such time as the outcome of the hedged transaction has been recorded.

The effective hedge is recycled to the income statement as soon as the hedged transaction affects profit or loss. The ineffective portion of the change in value of the hedging instrument is recognized immediately in the financial result. If, contrary to standard practice at MTU, an instrument does not qualify for hedge accounting, then the change in fair value of the hedging transaction is recognized in the income statement.

Deferred tax assets and liabilities are recognized on temporary differences between the tax bases of assets and liabilities and their carrying amount in the balance sheet (“balance sheet liability method”), and for losses carried forward. Deferred tax assets are recognized to the extent of the probability that taxable income will be available against which the deductible temporary difference can be applied together with losses that are permitted to be carried forward for tax purposes and tax refunds. Deferred tax assets and liabilities are measured on the basis of the tax rates expected to be applicable on the date when the temporary differences are reversed. The taxation rules in force or officially announced at the balance sheet date are applied when measuring deferred tax assets and liabilities. Deferred tax assets and liabilities are offset, insofar as this meets the requirements of IAS 12.74.

Pension provisions are accounted for using the projected unit credit method in accordance with IAS 19 (Employee Benefits). This method takes account not only of pension and other vested benefits known at the balance sheet date, but also of estimated future increases in pensions and salaries, applying a conservative assessment of the relevant parameters. Measurement is based on actuarial reports. Actuarial gains and losses are recognized using the socalled corridor method. This means that they are not recognized in profit or loss until they fall outside a range of 10% (target corridor) of the defined benefit obligation. In this case, they are recognized over the average remaining working lives of the employees participating in the relevant plans. The expense attributable to unwinding the interest on pension obligations is included in the financial result. All other expenses attributable to pension obligations are recorded in the appropriate income statement line items by function.

Provisions are accrued to cover the cost of legal disputes and claims for damages if the group incurs a current obligation arising from a lawsuit, government investigation or other claims which derive from past events and are pending, or if it is possible that such proceedings could be initiated against the group or be enforced at a future date, and if it is probable that an outflow of economic resources will be necessary to fulfill the obligation, and it is possible to reliably estimate the amount of the obligation. For the purposes of measuring provisions involving services to be performed by the group, especially in connection with warranties and costs to complete, all cost components included in inventories are taken into account. Non-current provisions due in more than one year are measured on the basis of their settlement amount, discounted to the balance sheet date. Provisions for part-time early retirement working arrangements and long-service awards are measured on the basis of actuarial reports prepared in accordance with IAS 19.

Contingencies (contingent liabilities and assets) are potential obligations or assets arising from past events whose existence depends on the occurrence or non-occurrence of one or more uncertain future events that are not wholly within the control of MTU.

Contingent liabilities are also present obligations resulting from past events for which there is unlikely to be an outflow of economic resources, or where the amount of the obligation cannot be reliably estimated. Obligations arising from contingent liabilities assumed and identified in connection with an acquisition are recognized if it is possible to reliably measure their fair value. Subsequent to initial recognition, contingent liabilities are recognized at the higher of the two values: (a) the amount that would have been recognized as a provision according to IAS 37, (b) the originally recognized amount amortized by the actual cash flows. Negative values of engine programs resulting from purchase price allocation are accounted for as contingent liabilities.

Contingent assets are not recognized. Disclosure of contingent liabilities is provided in the notes to the consolidated financial statements if an outflow of economic benefits is not improbable. The same applies to contingent assets if an inflow is probable.

Share options (share-based payment transactions settled by the issuance of equity instruments) are measured at fair value at the grant date. The fair value of the obligation is recognized during the vesting period as a personnel expense and in equity. Exercise conditions that are not tied to market conditions are included in the assumptions concerning the number of options that are expected to be exercised. If there are modifications during the vesting period, the incremental amount of the fair value corresponding to the services received from the modification date to the date on which the modified equity instrument becomes exercisable is recognized in addition to the amount based on the fair value of the original equity instrument at the grant date, which is recognized throughout the remaining part of the original vesting period. The expenses are recognized over the vesting period. The fair value is obtained using the internationally recognized Black-Scholes pricing model.

The claims of shareholders to dividend payments and profit distribution are recognized as a liability in the period in which the corresponding resolution is passed.

The drawing-up of consolidated financial statements in accordance with IFRSs requires a certain measure of discretionary decision-making. All discretionary choices are reviewed at frequent intervals and are based on past experience and expected future events which, under the given circumstances, would appear to be appropriate. This is especially the case in the following circumstances:

• Certain contractual obligations require that a decision be made to classify them as contingent liabilities or as financial liabilities.
• Financial assets have to be classified in one of the categories “held-to-maturity investments”, “loans and receivables”, “available-for-sale financial assets” or “financial assets at fair value through profit or loss”.
• When measuring pension provisions and similar obligations, different methods can be applied to determine actuarial gains and losses. The method used by MTU is the so-called corridor method (applying a corridor of 10%).

The presentation of the group’s net assets, financial situation and operating results in the consolidated financial statements depends on the use of recognition and measurement methods and of assumptions and estimations. Actual amounts may deviate from those estimated. The estimations and corresponding assumptions detailed below are crucial to an understanding of the underlying risks of financial reporting and the effects that these estimations, assumptions and uncertainties might have on the consolidated financial statements. Actual values may occasionally deviate from the assumed and estimated values. Adjustments may be made to carrying amounts at the time that better knowledge comes to light.

The measurement of property, plant and equipment, intangible assets and financial assets comprising a carrying amount at the end of the financial year of € 1,808.4 million (2007: € 1,689.4 million) involves the use of estimations to determine the fair value at the acquisition date. Estimations are also employed to determine the expected useful life of assets. Judgments by management form the basis for determining the fair value of assets and liabilities and the useful life of assets.

In the process of determining the impairment loss on property, plant and equipment, intangible assets and financial assets, estimations are made concerning such parameters as the source, timing and amount of the impairment loss. Many different factors can give rise to an impairment loss. Factors always considered are changes in the present competitive situation, expectations concerning the growth of aviation and the aircraft industry, changes in the cost of capital, changes in the future availability of financing funds, aging and obsolescence of technologies, the suspension of services, present replacement costs, purchase prices paid in comparable transactions, and other general changes providing evidence of impairment.

As a rule, recoverable amounts and fair values are determined using the discounted cash flow method, which includes reasonable assumptions derived from other market players (peer group). The identification of indications of impairment, the estimation of future cash flows and the determination of the fair value of an asset (or a group of assets) require a variety of judgments that management has to make with respect to the identification and verification of signs of impairment, anticipated cash flows, the appropriate discount rate, the relevant useful life, and residual values. In particular, the estimation of cash flows on which the fair values of new engine programs in both the commercial and military engine business are based depends on the assumption that it will be possible to raise funds on a continuous basis, but also that it will be necessary to make continuous investments in order to generate sustainable growth.

If the demand for engines is slower than expected, this could reduce earnings and cash flows and possibly lead to the recognition of an impairment loss to reflect the investment’s fair value. This could in turn have negative repercussions on operating results.

The determination of the recoverable amount for the commercial and military engine business, amounting to € 1,660.0 million (2007: € 1,440.0 million), and commercial MRO, amounting to € 786.0 million (2007: € 907.0 million) involves estimations on the part of management. The recoverable amount is determined using the discounted cash flow method. One of the key sets of assumptions on which management bases its estimation of the recoverable amount thus concerns the cash flows of the cash-generating units. These estimations, including the method used to obtain them, may have a significant impact on the determined recoverable amount and ultimately on the amount of the impairment loss recognized on goodwill.

Management creates allowances for doubtful accounts in order to account for estimated losses arising from the insolvency of customers. Management bases its judgment of the appropriateness of allowances for doubtful accounts on the repayment structure of the balance of settlements and past experience with the writing-off of debts, the customer’s credit standing, and changes in the conditions of payment. At December 31, 2008, impairment losses of € 10.4 million (2007: € 8.4 million) were recognized in respect of trade receivables. If the customer’s financial situation should deteriorate, the volume of the allowances that actually have to be created may exceed the expected volume.

Revenues in the military engine business and in the commercial maintenance business are recognized in progressive stages as the work advances, using the percentage-of-completion method. The percentage of completion is determined on the basis of the total contract costs. Management regularly reviews all estimates made in connection with these production contracts, making adjustments where necessary. Revenues from the sale of engine components in the month of December are partially estimated for bookkeeping purposes. These estimates are derived principally from preliminary data supplied by the consortium leader and from material flow data. This information provides an adequately reliable basis on which to estimate the corresponding revenues.

Income taxes have to be estimated for each tax jurisdiction in which the group operates. The current income taxes have to be calculated for each taxable subject, and temporary differences arising from the different treatment of certain balance sheet items in the IFRS consolidated financial statements and the tax statements need to be determined. All identified temporary differences lead to the recognition of deferred tax assets and liabilities in the consolidated financial statements. Management judgments come into play in the calculation of current taxes and deferred taxes.

A total of € 1.4 million (2007: € 0.7 million) in deferred tax assets were accounted for at December 31, 2008. The utilization of deferred tax assets depends on the possibility of generating sufficient taxable income in a particular tax category and tax jurisdiction, taking into account where appropriate any statutory restrictions relating to the maximum periods over which losses may be carried forward. A variety of factors are used to assess the probability that it will be possible to utilize deferred tax assets, including past operating results, operating business plans, the period over which losses can be carried forward, and tax planning strategies. If the actual results deviate from these estimations, or if these estimations have to be adjusted in a future period, this may have detrimental effects on the group’s net asset position, financial situation and operating results. If there is a change in the value assessment of deferred tax assets, the recognized deferred tax assets must be written down. Temporary differences which were not recognized as deferred tax assets totaled € 12.3 million for the financial year 2008 (2007: € 11.6 million).

The discount rate is an important factor when determining what provisions must be allocated for pensions and similar obligations. An increase or decrease of one percentage point in the discount rate can lower or raise the amount of pension obligations by approximately € 40 million. Given that actuarial gains and losses are only recognized if they exceed the higher of the amount of total obligations or the fair value of plan assets by 10 %, changes in the discount rate usually have no impact, or only an insignificant impact, on the recognized expense or carrying amount of the provisions for the following year in respect of the retirement benefit plans in place within the MTU group.

Pension obligations for employee benefits that are classified and accounted for as defined benefit plans are not covered by any other plan assets except for the plan assets of MTU Maintenance Canada Ltd., Canada and MTU München Unterstützungskasse GmbH. The existing plan assets are offset against the pension obligations. If the respective plan assets should exceed the corresponding pension obligations, the surplus amount of the plan assets is capitalized according to IAS 19.58A.

The total value of pension obligations and therefore the expenses in connection with employees’ retirement benefits are determined using actuarial methods based on assumptions concerning interest rates and life expectancy. If it should become necessary to modify these assumptions, this could have a significant effect on the future amount of pension provisions or the expense from pension obligations.

The recognition and measurement of other provisions amounting to € 479.4 million (2007: € 498.5 million) and net contingent liabilities amounting to € 140.3 million (2007: € 112.6 million) in connection with pending legal disputes or other pending claims arising from conciliation or arbitration proceedings, joint committee procedures, government lawsuits or other types of contingent liability (particularly those arising from risk- and revenue-sharing partnerships) involve substantial estimations on the part of MTU. For instance, the assessment of the probability that a pending case will be won or that an obligation will arise, or the quantification of the probable payment, all depend on an accurate evaluation of the prevailing situation. Provisions are accrued when a present legal or de facto obligation arises from a past event, it is probable that an outflow of economic resources will be required to fulfill this obligation and it is possible to reliably estimate the amount of the obligation. Due to the uncertainties attached to this assessment, the actual losses may deviate from those originally estimated, and hence from the amount of the provision. Furthermore, the calculation of certain specific provisions (for example to cover tax obligations, environmental obligations and legal risks) also involves considerable use of estimations. These estimations may change in the light of new information.

All assumptions and estimates are based on the prevailing conditions and judgements made at the balance sheet date. Estimations of future business developments also take into account the economic environment of the industry and the regions in which MTU is active, such as are deemed realistic at that time. In order to obtain new information, MTU mainly relies on the services of internal experts and external consultants such as actuaries and legal counsels. Changes to the estimations of these obligations can have a significant impact on future operating results.