III. Notes to the Consolidated Balance Sheet
18. ANALYSIS OF CHANGES IN INTANGIBLE ASSETS, PROPERTY, PLANT AND EQUIPMENT, AND FINANCIAL ASSETS 2010
ANALYSIS OF CHANGES IN INTANGIBLE ASSETS, PROPERTY, PLANT AND EQUIPMENT, AND FINANCIAL ASSETS 2009
19. INTANGIBLE ASSETS
Intangible assets mainly comprise program assets capitalized by purchase price allocation (PPA), program-independent technologies and software (the latter mostly for engineering applications), and acquired goodwill.
The depreciation/amortization expense on intangible assets is included in the presentation of the following line items: cost of sales € 45.3 million (2009: € 44.0 million), research and development expenses € 3.0 million (2009: € 2.5 million), selling expenses € 1.4 million (2009: € 1.7 million), and general administrative expenses € 1.2 million (2009: € 1.4 million).
The additions to development costs of € 19.1 million (2009: € 17.4 million) mainly comprised company-funded development expenditure for General Electric’s GEnx commercial engine program and General Electric’s GE38 military engine program. The additions to rights and licenses amounting to € 5.5 million (2009: € 4.0 million) were acquired in exchange for payment.
DEVELOPMENT COSTS
MTU acquired a 6.65% stake in the GEnx engine program for the Boeing 787 and 747-8 through a cooperation agreement between the General Electric Company and MTU Aero Engines GmbH, Munich. In the financial year 2010, internally generated development costs amounting to € 7.1 million (2009: € 4.3 million) were capitalized for this engine program.
In 2008, MTU was conferred full development responsibility for a module of a U.S. military engine program, the General Electric GE38 helicopter engine. Further internally generated development costs amounting to € 6.9 million (2009: € 8.3 million) were capitalized in 2010.
The commercial MRO business has developed special repair processes capable of increasing the efficiency of engine maintenance, allowing intangible assets totaling € 5.1 million (2009: € 4.8 million) to be recognized.
20. PROPERTY, PLANT AND EQUIPMENT
Through its capital expenditure on property, plant and equipment for the OEM business, MTU aims to consolidate and extend its position as a leading engine manufacturer, improve efficiency, and modernize equipment and machinery to state-of-the-art standards.
The depreciation/amortization expense on property, plant and equipment is included in the presentation of the following line items: cost of sales € 71.3 million (2009: € 69.2 million), research and development expenses € 5.3 million (2009: € 4.2 million), selling expenses € 0.9 million (2009: € 2.0 million) and general administrative expenses € 2.5 million (2009: € 1.4 million).
LAND, LEASEHOLD RIGHTS AND BUILDINGS, INCLUDING BUILDINGS ON NON-OWNED LAND
Land and buildings leased by MTU Maintenance Hannover from Silkan Gewerbepark Nord Hannover-Langenhagen GmbH & Co. KG, Munich, have been capitalized because an attractive purchase option has been granted to the company at the end of the leasing period.
TECHNICAL EQUIPMENT, PLANT AND MACHINERY
The capital expenditure on technical equipment, plant and machinery totaling € 24.1 million (2009: € 21.9 million) relates mainly to the purchase of CNC lathes and grinding/milling machines.
OTHER EQUIPMENT, OPERATIONAL AND OFFICE EQUIPMENT
The capital expenditure on other equipment, operational and office equipment, which mainly comprises special operating equipment, fixtures and tools for new and ongoing programs, was within normal limits in the year under review.
ADVANCE PAYMENTS AND CONSTRUCTION IN PROGRESS
Additions to this item in the financial year 2010 totaling € 28.8 million (2009: € 46.4 million) relate to work in progress on technical equipment, plant and machinery for new engine programs and the modernization of a test rig in Munich.
Capitalized assets under finance lease agreements are based on the following components:
The following carrying amounts resulted from the capitalized assets under finance lease agreements at the balance sheet date. The change in the future minimum lease payments is due to fact that, on December 22, 2010, a purchase option was agreed with Silkan Gewerbepark Nord Hannover-Langenhagen GmbH & Co. KG for land and buildings previously leased and capitalized. This option can be exercised on December 31, 2011.
21. FINANCIAL ASSETS
The following table shows the carrying amounts of financial assets included in the consolidated financial statements:
At the balance sheet date, unrealized losses on available-for-sale financial assets totaling € -0.2 million were recognized in other comprehensive income, net of related tax effects. The carrying amounts also include accrued interest of € 0.5 million.
The derivative financial assets can be broken down as follows:
The following amounts have been recognized in respect of the assets, liabilities, income and expenses of joint ventures and associated companies, with the exception of MTU Maintenance Zhuhai Co. Ltd., Zhuhai, China:
22. INVENTORIES
Inventories comprise the following components:
The change in inventories attributable to write-downs on raw materials and supplies and work in progress is as follows:
In line with the group’s business model, the write-down method represents the best possible means of estimating the net realizable value of inventories held by MTU.
23. TRADE RECEIVABLES
Transactions with related companies are presented in more detail in Note 43.1.1. (Business with related companies).
The valuation allowances on trade receivables changed as follows:
The expenses for bad debts on trade receivables written off as uncollectable offset against income from bad debts recovered amounted to € -0.8 million (2009: € -2.3 million).
All expense and income amounts arising from valuation allowances and the write-off of uncollectable bad debts on trade receivables are recognized as selling expenses.
24. CONSTRUCTION CONTRACT RECEIVABLE
Interest-free advance payments received for construction contracts directly attributable to an engine project are offset against the corresponding receivables. If the amount of the directly attributable advance payments received exceeds the amount of the receivables, the balance is recognized under construction contract payables.
Revenues from construction contracts in the financial year 2010 amounted to € 75.7 million (2009: € 59.9 million). Contract-related costs to be offset against these revenues amounted to € 97.7 million (2009: € 64.8 million). The amount of € 424.3 million for construction contract receivables at December 31, 2010 (2009: € 339.0 million) includes advance payments received amounting to € 286.1 million (2009: € 240.6 million). No amounts were retained for partial settlement of construction contract receivables.
For disclosures relating to construction contract receivables that have been offset against directly attributable advance payments received, please refer to Note 35. (Construction contract payables).
The following table shows the carrying amounts and a breakdown of the past due dates of unimpaired trade and construction contract receivables at the balance sheet date:
25. OTHER ASSETS
Other assets comprise the following items:
The other taxes totaling € 16.0 million (2009: € 14.8 million) comprise an amount of € 15.6 million (2009: € 14.4 million) relating to input taxes and an amount of € 0.4 million (2009: € 0.4 million) relating to receivables of foreign group companies due to transaction taxes.
The sundry other assets totaling € 9.1 million (2009: € 14.2 million) groups together a variety of different assets. These include the surplus amount of the plan assets of MTU Maintenance Canada Ltd., Richmond, Canada amounting to € 3.5 million (2009: € 2.4 million). Please refer to Note 30. (Pension provisions) for further information on the calculation of the surplus plan assets.
The table below shows the carrying amounts and a breakdown of the past due dates of the unimpaired loans and receivables stated in other assets at the balance sheet date:
26. CASH AND CASH EQUIVALENTS
The cash and cash equivalents of € 111.9 million (2009: € 120.8 million) comprise cash in hand and bank deposits with an original maturity of three months or less. This item also includes foreign currency holdings amounting to € 73.2 million (2009: € 52.4 million).
MTU is not free to dispose of cash and cash equivalents in the amount of € 15.9 million (2009: € 9.7 million) held by MTU Maintenance Zhuhai Co. Ltd.
27. INCOME TAX CLAIMS
The company had no current tax assets in 2010. In 2009, current tax assets amounted to € 1.2 million.
28. PREPAYMENTS
The prepayments of € 6.0 million (2009: € 7.2 million) consist primarily of prepayments for insurance premiums and rents.
29. EQUITY
Changes in group equity are set out in the consolidated statement of changes in equity.
29.1. SUBSCRIBED CAPITAL
The company’s subscribed capital (capital stock) is unchanged and amounts to € 52.0 million, divided into 52,000,000 registered non-par-value shares.
29.2. AUTHORIZED CAPITAL
AUTHORIZED CAPITAL I
The Board of Management is authorized until April 21, 2015 to increase the company’s capital stock by up to € 5.2 million, with the prior approval of the Supervisory Board, by issuing, either in a single step or in several steps, new registered non-par-value shares in return for cash contributions (Authorized capital I 2010).
29.3. CONDITIONAL CAPITAL
CONVERTIBLE BONDS AND BONDS WITH WARRANTS
At the Annual General Meeting on April 22, 2010, the Board of Management was authorized until April 21, 2015 to carry out conditional capital increases with the prior approval of the Supervisory Board:
- The company’s capital stock may be conditionally increased by up to € 3.64 million through the issue of up to 3,640,000 new registered non-par-value shares. The purpose of this conditional capital increase is to issue shares to owners or creditors of convertible bonds and/or bonds with warrants in accordance with the authorization granted to the company’s Board of Management under a resolution passed by the Annual General Meeting on May 30, 2005. Shares may be issued at a conversion price or warrant exercise price determined on the basis of the conditions laid down in the relevant authorization.
- The company’s capital stock may be increased by up to € 22.36 million through the issue of up to 22,360,000 new registered non-par-value shares, each corresponding to a proportional amount (one euro) of the company’s total capital stock (conditional capital). The purpose of this conditional capital increase is to issue shares to owners or creditors of convertible bonds and/or bonds with warrants in accordance with the authorization granted to the company’s Board of Management under a resolution passed by the Annual General Meeting on April 22, 2010. Shares may be issued at a conversion price or warrant exercise price determined on the basis of the conditions laid down in the relevant authorization.
- The Board of Management is authorized until April 21, 2015 to issue, in a single step or in several steps and with the prior approval of the Supervisory Board, bearer convertible bonds and/or bonds with warrants (collectively referred to as ‘securities’), with or without maturity date, with a total nominal value of up to € 500 million, and to grant the owners of convertible bonds and/or bonds with warrants the right, obligation or option to convert them into registered non-par-value shares of the company representing a share in the capital stock of up to € 22.36 million under the conditions established for the issue of convertible bonds or bonds with warrants. The securities may be issued in return for cash contributions only. They may be issued in euros or – to an equivalent value – in any other legal currency, for instance that of an OECD country. They may also be issued by an affiliated company in which MTU holds a controlling interest (group company). In such cases, and subject to the prior approval of the Supervisory Board, the Board of Management is authorized to act as guarantor for the securities, and to grant the owners of the securities the right, obligation or option to convert them into new registered non-par-value shares in MTU.
29.4. CAPITAL RESERVES
Capital reserves include premiums from the issue of shares, the equity component (net of taxes) and proportional transaction costs of the issued convertible bond, the fair value of shares granted under the Matching Stock Program (MSP) and the Share Matching Plan, and an amount of € 0.2 million (2009: € 3.4 million) representing the excess over the sale proceeds from the shares sold under the MAP employee stock option program. For information on the equity component of the convertible bond and the associated deferred tax assets/liabilities, transaction costs, and income tax reductions, please read the explanatory comments under Note 33. (Financial liabilities).
MATCHING STOCK PROGRAM (MSP)
To strengthen the motivation to meet business targets, the group has set up the MSP, an incentive and risk-sharing instrument allowing management-level employees to participate in its share capital. The MSP authorizes the subscription of phantom stocks. On the date of subscription to the MSP, participants must have an existing employment contract with MTU Aero Engines Holding AG, Munich, or a German company in the MTU group.
When the program was launched on June 6, 2005, the group granted a defined quantity of phantom stocks to the participants for the duration of five years, for allocation in equal tranches over this period. In order to be granted phantom stock, it was a condition at the start of the program that MSP participants should hold their own investment in the company’s share capital. Each MSP share acquired from the program authorizes the holder to subscribe for six phantom stocks per allocated tranche. MSP shares are not subject to any restraints on disposal and entitle the holder to participate in dividend and subscription rights.
Each tranche of allocated phantom stock is subject to a vesting period of two years and can be converted to taxable compensation upon achievement of the average exercise price. It is a mandatory condition that this compensation must be used to purchase shares in MTU. The shares are purchased at the market price on the strike date (exercise date). They must be held for two years after the strike date.
EXERCISE CONDITIONS
A tranche of phantom stock allocated under the Matching Stock Program can be exercised when the average, non-weighted closing price of the shares in Xetra trading on the Frankfurt Stock Exchange exceeds the basis price by 10% for a period of 60 trading days prior to the exercise date of the phantom stocks.
ACCOUNTING POLICY
The fair value of the phantom stock is carried as a personnel expense on a pro rata basis and simultaneously recognized in equity (capital reserves) up to the stock’s exercise date.
When the program was launched in June 2005, the expected volatility was determined from the average volatility of shares in comparable listed companies with similar business models, given that MTU did not yet have any capital market history of its own at that time.
Changes in valuations for non-market-related exercise thresholds (such as significant fluctuations in personnel) are considered in the assumptions relating to the expected number of exercisable shares of phantom stock. The fair value is thus based on the estimated number of ultimately exercisable equity instruments. The impact of any changes to original estimates is taken into account in the income statement and via a corresponding adjustment to equity for the remaining period until they become non-forfeitable.
Changes in market conditions such as variations in share price performance and price volatility, on the other hand, do not lead to any subsequent adjustment of the fair value.
The table shows the changes in granted equity instruments and the number of phantom stocks that were not exercisable at December 31, 2010 because the vesting period had not yet expired.
EXPLANATORY COMMENTS CONCERNING CHANGES DURING THE YEAR:
- The number of phantom stocks granted relates to phantom stocks granted by MTU under the agreed terms of the program at the time the five tranches were allocated for the period from 2005 to 2009.
- The number of phantom stocks forfeited relates to stocks held by employees whose employment contract was terminated prior to the exercise date for the tranche in question.
- The number of phantom stocks exercised relates to phantom stocks converted into MTU shares after reaching the exercise threshold (tranche 4); the weighted average share price on the exercise date amounted to € 34.92.
- The number of phantom stocks lapsed relates to phantom stocks that failed to reach the exercise threshold (tranches 2 and 3).
The 367,782 phantom stocks not yet exercisable at the end of the financial year 2010 (2009: 772,032 phantom stocks) relate to the fifth tranche allocated in the financial year 2009.
In the financial year 2010, the average fair value of a phantom stock was € 3.57 (2009: € 3.43) and was calculated using the Black-Scholes pricing method.
At December 31, 2010, the weighted average remaining duration of contracts under the Matching Stock Program was 0.5 years (2009: 0.9 years).
EXPECTED EXERCISE PRICE FOR THE FIFTH MSP TRANCHE
Assuming a dividend payment for the financial year 2010 of € 1.10 per share, which the Board of Management and the Supervisory Board intends to propose to the Annual General Meeting, the exercise price for the fifth tranche allocated in June 2009 will be € 22.59.
The total expense for share-based payments under the MSP in the financial year 2010 was € 0.3 million (2009: € 1.4 million).
SHARE MATCHING PLAN (SMP)
For a description of the SMP we refer you to the management compensation report, which forms part of the Corporate Governance Report. The members of the Board of Management are entitled to use the amount disbursed under the Performance Share Plan (PSP) to purchase MTU Aero Engines Holding AG shares, which must then be held for a further three years. At the end of the vesting period, these shares are matched on the basis of a Share Matching Plan (SMP), with each Board of Management member being awarded one additional free share for every three MTU shares acquired in this way. The entitlement to additional free shares is deemed to have expired once the corresponding number of such shares has been transferred to the member of the Board of Management. The total value of the matching shares available for allocation at the end of the vesting period is limited to three times the initial purchase price.
The number of future matching shares depends on the amount paid out under the PSP. For an explanation of the PSP we refer you to the corresponding section of Note 32. (Other provisions). In order to determine the fair value, a combined Monte Carlo simulation and Black-Scholes pricing model was used. The expected payout was determined on the basis of exactly the same assumptions used to value the Long Term Incentive Plan (PSP). The payout calculated serves as a basis for valuing the SMP in accordance with the Black-Scholes pricing model. The fair value of this forward option estimated at the grant date is recognized in the balance sheet taking into account the vesting conditions. The vesting period of the forward option is 52 months.
The fair value per performance share of the SMP, which was calculated by an independent expert in accordance with the recommendations of IFRS 2, amounted to € 3.72 at January 1, 2010 and € 4.23 at July 1, 2010, taking into account a fluctuation rate of 4%. The accounting methods used to calculate these figures are documented in the fairness opinion established at the grant date. Rounded to the nearest thousand, the total expense of the 40,727 performance shares granted under the share matching program in the financial year 2010 was € 158,000, of which € 31,000 was recognized in the financial year 2010.
In the financial year 2010, the following numbers of performance shares were granted to the members of the MTU Board of Management under the first tranche of the PSP:
The method of calculation is documented in the fairness opinion established at the grant date.
The fair values of the options granted in the financial year 2010 and effective January 1, 2010 were calculated on the basis of the following parameters:
The fair value per performance share calculated in this manner amounted to € 4.44 or, taking into account a fluctuation rate of 4%, € 3.72.
The fair values of the options granted in the financial year 2010 and effective July 1, 2010 were calculated on the basis of the following parameters:
The fair value per performance share calculated in this manner amounted to € 5.05 or, taking into account a fluctuation rate of 4%, € 4.23.
MAP EMPLOYEE STOCK OPTION PROGRAM
In the financial year 2008 and each succeeding year, the Board of Management of MTU Aero Engines Holding AG, Munich, has invited group employees to purchase shares under the MAP employee stock option program, which runs for a period of two years in each case. Under this program, MTU offers to match each participant’s investment at the end of a two-year vesting period with a taxable cash payment of an amount corresponding to 50? of the amount invested by the employee in MTU shares at the beginning of the program.
The number of shares sold to group employees under the terms of the MAP employee stock option program since the financial year 2008 is as follows:
The purchase price for the third tranche of MTU shares distributed in the financial year 2010 was based on the lowest share price on April 16, 2010 (purchase date) and amounted to € 42.58 per share. The issued shares, valued at the average acquisition cost, were removed from the equity item ‘treasury shares’. The difference between the proceeds of the sale and the original acquisition cost amounted to a total of € 0.2 million (2009: € 3.4 million) and was deducted from capital reserves.
The total expense for the matching exercise in connection with the MAP in the financial year 2010 amounted to € 1.7 million (2009: € 2.0 million) and was recognized in the income statement on a pro rata basis over the duration of the respective tranche. At December 31, 2010, the liability amounted to € 2.0 million (2009: € 2.8 million).
29.5. REVENUE RESERVES
Revenue reserves comprise the post-acquisition and non-distributed earnings of consolidated group companies.
29.6. TREASURY SHARES
PURCHASE OF TREASURY SHARES IN ACCORDANCE WITH THE AUTHORIZATIONS GRANTED BY THE ANNUAL GENERAL MEETING ON APRIL 22, 2010
The Board of Management of MTU Aero Engines Holding AG, Munich, has been authorized by resolution of the Annual General Meeting to buy back shares. These shares may be purchased on the stock market or by means of a public offering addressed to all shareholders. The purchase price paid in consideration of these shares must not exceed or undercut the market value by more than 10%, net of any supplementary transaction fees.
The authorization to buy back shares granted to the company by resolution of the Annual General Meeting on May 26, 2009 expired on November 26, 2010 and was replaced by a new authorization. Pursuant to Section 71(1) item 8 of the German Stock Corporation Act (AktG) as amended by the German Act of July 30, 2009 implementing the EU’s Shareholders’ Rights Directive (ARUG), the authorization may now be granted for a period of up to five years. The Board of Management of MTU was authorized to purchase treasury shares with an aggregate nominal value not exceeding 10% of the company’s issued capital stock, as applicable on the date of the resolution, during the period from April 23, 2010 through April 22, 2015, pursuant to Section 71(1) item 8 of the German Stock Corporation Act (AktG). At no point in time may the value of the acquired shares, together with other treasury shares in the company’s possession or which are assigned to it pursuant to Section 71a et seq. of the German Stock Corporation Act (AktG), exceed 10% of the company’s capital stock.
PURCHASE OF SHARES
In the financial year 2010, the company purchased 300,000 shares (2009: 0 shares) for a total price of € 13.6 million. The average acquisition cost for the shares purchased was € 45.55 per share. The shares were purchased in order to meet contractual obligations attached to the convertible bond issue, to issue shares to group employees under the Matching Stock Program (MSP) and the MAP employee stock option program, and to honor the company’s commitments under the Share Matching Plan (SMP) in the financial year 2010. The following table shows the development and average acquisition costs of all the shares acquired since the start of share buybacks.
RECONCILIATION OF AVERAGE WEIGHTED NUMBER OF OUTSTANDING SHARES
At December 31, 2010, MTU held 3,247,593 treasury shares (2009: 3,078,192 shares). This represents 6.2% of the company’s capital stock (2009: 5.9%).
As a result of the share buyback exercise, the weighted average number of outstanding shares in 2010 amounted to 48,868,149 shares (2009: 48,858,948 shares). At December 31, 2010, a total of 48.752.407 shares in MTU (2009: 48,921,808 shares), each with a par value of one euro, were in issue and entitled to receive a dividend.
ISSUE OF SHARES TO EMPLOYEES UNDER EMPLOYEE STOCK OPTION SCHEMES
In the financial year 2010, a total of 68,086 treasury shares (2009: 0 shares) were issued to the Board of Management and other executive managers under the fourth tranche of the Matching Stock Program.
A total of 59,096 shares (2009: 150,863 shares) were sold to group employees in June 2010 under the MAP employee stock option program.
29.7. OTHER COMPREHENSIVE INCOME (OCI)
In 2010, other comprehensive income increased by a total of € 5.1 million to € 2.7 million (2009: decreased by € 2.4 million), principally as a result of gains arising from translating the financial statements of foreign subsidiaries and of fair value losses on derivative financial instruments.
The table below shows the income and expenses arising from valuation changes recognized in other comprehensive income, together with the related tax effects:
29.8. DISCLOSURES RELATING TO CAPITAL MANAGEMENT
MTU strives to maintain a strong financial profile in the interests of carrying out the company’s business within a flexible financing framework and in order to generate confidence on the part of its shareholders.
Consequently, the group’s capital management activities are focused on optimizing the ratio between equity and net financial debt, and on improving the equity ratio.
30. PENSION PROVISIONS
Defined benefit and defined contribution plans are in place for MTU employees. In the case of defined contribution plans, the company has no further obligations beyond the payment of fixed contributionsto the plan. In the case of defined benefit plans, the company has an obligation to fulfill commitments to current and former employees. For group companies in Germany, these benefits are financed primarily by provisions recognized in the financial statements, which are largely not covered by plan assets. In contrast, MTU Maintenance Canada Ltd., Richmond, Canada, has a fund-financed retirement benefit plan.
In some cases, it is difficult to differentiate between defined contribution and defined benefit plans. In Germany, for example, a minimum level of benefits is guaranteed for defined contribution plans, such that, even when the plan is organized via an external fund or insurance company, it is still the employer that remains liable. The so-called ‘ultimate liability of employer’ is governed by Section 1 (1) sentence 3 of the German Law on Retirement Pensions (BetrAVG). For financial reporting purposes, the term ‘defined benefit plans’ is required to be interpreted on the basis of the underlying economic substance of the arrangements. Insofar as the MTU group has no further obligations beyond its so-called ultimate liability once the contributions have been paid to state and private retirement funds, these plans are classified as defined contribution plans. Current contributions are recognized as expenses in the period in which payments are made.
30.1. DEFINED CONTRIBUTION PLANS
Since January 1, 2007, no new pension benefits have been granted to new employees in Germany. Instead MTU pays contributions to a company-sponsored external fund for employees who joined the company after that date. Other plans that exist within the MTU group are direct insurance contracts funded by employee contributions.
Employer’s contributions to the state pension scheme in the financial year 2010 totaled € 34.1 million (2009: € 33.1 million). In addition, contributions of € 0.1 million (2009: € 0.1 million) were made to the company-sponsored external fund.
30.2. DEFINED BENEFIT PLANS
The pension obligations of MTU are measured using the projected unit credit method in accordance with IAS 19, taking account of future salary and pension increases and other adjustments expected to be made to benefits and pension plans, such as stock-flow adjustments. The provision for defined benefit plans recognized in the balance sheet corresponds to the fair value of the benefits payable for current and past service (the defined benefit obligation) of beneficiaries less the fair value of plan assets at the balance sheet date and adjusted for cumulative unrecognized actuarial gains and losses. Extensive actuarial reviews and computations are carried out annually for each pension plan by independent actuaries.
Actuarial gains or losses can result from increases or decreases either in the present value of the defined benefit obligations or in the fair value of the plan assets. Causes of actuarial gains or losses include the effect of changes in the measurement parameters, changes in the assessment of risks on pension obligations and differences between the actual and expected return on plan assets. The interest rates used to calculate present values are usually determined by reference to high-quality corporate bonds with similar maturities.
Present value and funding status of the defined benefit obligation:
In the financial year 2010, the defined benefit obligation (DBO) increased as a result of a reduction of 0.75 percentage points in the discount rate both for the pension plans in Germany and abroad. The negative impact from the reduction of the discount rate was partially offset by a reduction of 0.5 percentage points in salary trends.
Of the total amount of pension obligations of € 533.9 million (2009: € 473.3 million), an amount of € 510.9 million (2009: € 454.7 million) relates to group companies in Germany; this represents 95.7% (2009: 96.1%) of the total amount.
The following weighted parameters were applied to measure the pension obligations at December 31 of the respective year and to measure the pension plan expense in the respective year under review:
The market yields on high-quality corporate bonds have fallen compared to the previous year. For this reason, obligations for pensions and long-service awards in Germany were discounted at December 31, 2010 using a discount rate of 4.50% (2009: 5.25%). The biometric tables issued by Prof. Dr. Heubeck (RT 2005G) were used for the purpose of measuring the obligations of pension plans in Germany. In the case of foreign group companies, up-to-date biometric assumptions for each relevant country were applied. The expected salary trend refers to the expected rate of salary increase, which is estimated depending on inflation and the length of service of employees within the group.
Employee turnover, mortality and disability rates were estimated on the basis of statistical data. For the effects of the experience adjustments, reference is made to the table showing the funding status and the experience adjustments at the end of the financial year presented near the end of this note.
Based on constant assumptions otherwise, a change of 25 basis points in the discount rate would have had the following effects on the pension obligations at the end of 2010:
In the following table, the defined benefit obligation and plan assets are reconciled to the recognized pension provision:
FAIR VALUE OF PLAN ASSETS
The total amount of the defined benefit obligation (measured using the projected unit credit method) is reduced by the fair value of the plan assets of one fund-financed and one loan-financed pension plan totaling € 28.9 million (2009: € 26.5 million). On account of the more favorable exchange rate parities between the euro and the Canadian dollar at December 31, 2010 compared with the prior year and due to the return on the plan assets of MTU Maintenance Canada Ltd., Richmond, Canada, the fair value of the plan assets at December 31, 2010 increased year on year by a total of € 2.4 million (2009: increased by € 1.4 million).
CUMULATIVE UNRECOGNIZED ACTUARIAL LOSSES
At December 31, 2010, cumulative unrecognized actuarial losses on pension obligations increased to € 75.3 million (2009: € 37.6 million) primarily as a result of the reduction of 0.75 percentage points in interest rates in addition to experience adjustments and effects from changes in estimates. In accordance with IAS 19.92, these losses were not recognized in the income statement. An actuarial loss of € 0.1 million (2009: actuarial gain of € 1.0 million) resulted for the plan assets in the financial year 2010. The actuarial losses on pension obligations in the financial year 2010 amounted to € 37.6 million (2009: € 17.8 million).
The defined benefit obligation developed as follows:
The fair value of plan assets developed as follows:
In the financial year 2010, pension benefit payments totaling € 2.6 million (2009: € 2.6 million) were granted out of the plan assets. Payments of € 1.3 million (2009: € 1.3 million) were made by MTU München Unterstützungskasse and of € 1.3 million (2009: € 1.3 million) by MTU Maintenance Canada. The actual return on plan assets totaled € 1.4 million in the financial year 2010 (2009: € 2.7 million).
The expense from defined benefit plans and similar obligations comprises the following components:
FUND-FINANCED PLAN ASSETS
The fund-financed plan assets relate to MTU Maintenance Canada Ltd. and do not include any securities pertaining to MTU group entities or any assets used by the MTU group.
The composition of plan assets to cover pension obligations is as follows at the respective balance sheet dates:
The expected return determined for each category of assets took account of generally available information concerning capital market forecasts. The expected return on fixed-income securities is based on the maturities of securities held and on the past record of average yields achieved for these investment classes with maturities between 10 and 20 years. The expected return on equity investments reflects the long-term expectation of yields on the stock markets. An expected return of 7.0% (2009: 7.25%) was applied to measure the fair value of fund-financed plan assets. A return of 6.5% is assumed for the financial year 2011.
LOAN-FINANCED PLAN ASSETS
Loan-financed plan assets relate to a loan issued by MTU München Unterstützung-skasse, Munich, to MTU Aero Engines München GmbH, Munich, representing a receivable amount of € 7.8 million at December 31, 2010 (2009: € 9.0 million). The loan is subject to interest at the three-month Euribor rate plus 50 basis points.
FUNDING STATUS AND EXPERIENCE ADJUSTMENTS
The actuarial gains and losses arising in the financial year relate on the one hand to experience adjustments which are attributable to the fact that the assumptions made at the beginning of a financial year for variables such as mortality, disability and employee turnover develop differently to forecasts. On the other hand, changes to actuarial as-sumptions also have an effect, for example the change of 0.75 percentage points in the interest rate for discounting pension obligations and the reduction of 0.5 percentage points in salary trends.
To calculate the experience adjustments and the effects of changes to actuarial assumptions, the DBO was determined at the current balance sheet date based on the assumptions made at the beginning of the financial year. As a result, the experience adjustments correspond to the difference between the expected DBO and the DBO – with changes that had actually occurred at the balance sheet date – calculated based on the actuarial assumptions at the beginning of the year.
Unrecognized actuarial gains and losses resulted in the following experience adjustments to pension obligations and plan assets:
EXPECTED FUTURE PENSION BENEFIT PAYMENTS
In addition to the employer’s contributions to plan assets, the company is expecting the following pension benefit payments in the coming years:
Employer’s contributions to fund-financed plan assets for the financial years 2011 - 2012 are expected to amount to between € 0.8 million and € 1.0 million.
As a result of switching to the new ‘MTU kapitalPlus 2006’ pension plan, in place since the financial year 2006, a life-long pension to group employees was converted into an immediate cash payment. In individual cases and after consultation with the company, it is also possible to grant a ten-year payment by installments or continue to make pension payments indexed by 1% each year. The group’s expectations regarding the annual spread of pension benefit payments under the new pension plan are based on the assumption that an immediate cash payment will be made as soon as the end of the contribution period is reached.
31. INCOME TAX PAYABLE
The income tax payable amounting to € 71.2 million (2009: € 12.5 million) comprises corporation and municipal trade tax amounting to € 70.7 million (2009: € 12.4 million) and taxes on the income of foreign group companies amounting to € 0.5 million (2009: € 0.1 million).
The income tax liabilities are due for payment within one year.
32. OTHER PROVISIONS
At the balance sheet date, other provisions comprised the following items:
WARRANTY OBLIGATIONS AND RISKS FROM PENDING LOSSES ON ONEROUS CONTRACTS
Risks from pending losses on onerous contracts primarily contain provisions for pending losses on onerous contracts, legal disputes and relate to current obligations in respect of probable third-party claims for which the likely expense can be reliably estimated. Provisions for warranties mainly consist of obligations in connection with product entry into service, products that have been sold and for which accounts have been settled, and a variety of other services.
In the commercial maintenance business, MTU has identified onerous contracts for the maintenance of engines for which the unavoidable costs of fulfilling contractual obligations are higher than the expected economic benefits. Expenses exceeding the economic benefits were set aside as expense and are included in the warranty obligations and risks from pending losses on onerous contracts. It was not necessary to recognize impairment losses on assets relating to the contracts in 2010 or 2009 or they were already recognized in previous financial years.
RISKS AND UNCERTAINTIES LINKED TO THE TP400-D6 ENGINE PROGRAM
The basic premises underlying the measurement of construction contract receivables for the TP400-D6 military engine program had to be entirely reviewed in the financial year 2009 due to the uncertainties arising from delayed deliveries at the end of the 2009 financial year and the uncertain technical status on the one hand, and the general uncertainty surrounding the future of the program on the other. As a result of the reassessment of the time schedule undertaken by MTU at the end of 2009, taking into account all recalculated premises, the carrying amount of construction contract receivables for the TP400-D6 engine program was written down in 2009 and a valuation allowance for receivables recognized in the income statement. In addition, a provision of € 45.3 million was recognized in the income statement. The measurement of the valuation allowance and allocated provision at December 31, 2009 also included a proportional share of contract penalties that – according to MTU’s estimates at the time – the company would have been required to pay in the event of the program being discontinued.
Following the signing of an agreement in principle – the ‘A400M Understanding’ – in March 2010, the customer nations (represented by the procurement agency OCCAR) and Airbus Military subsequently agreed the details of the changes to the A400M contract. Although the agreements envisage that the overall economics will remain unchanged, there is nevertheless one major change that must be taken into consideration, namely Germany’s decision to reduce its order from 60 to 53 aircraft and the United Kingdom’s decision to trim its order from 25 to 22 aircraft. The ‘A400M Understanding’ was followed by appropriate agreements between Airbus Military and the military engine consortium Europrop International GmbH, Munich (EPI). This saw the total number of firm orders for the A400M project decrease to 170 and the number of Europrop TP400-D6 engines fall to approximately 680. The first aircraft are now expected to be delivered in early 2013.
Based on this generally satisfactory solution for the overall project, the review of the TP400-D6 engine program at December 31, 2010, took into consideration the absence of the contractual penalties for possible program discontinuation or non-performance penalties taken into account in 2009 and also took into consideration postponements of deliveries, cancellations of previous orders by customer nations, reworking of the software for engine control and price escalations.
The TP400-D6 engine program was subjected to detailed analysis and evaluation at December 31, 2010, on the basis of the agreements made in December 2010. This led to the provisions being reversed. The gain of € 45.3 million is included in cost of sales in the income statement.
PERSONNEL OBLIGATIONS
The personnel obligations comprise provisions allocated for profit-sharing and performance-related bonuses amounting to € 31.0 million (2009: € 28.3 million), provisions to cover unfunded pension liabilities in connection with pre-retirement part-time working arrangements amounting to € 3.0 million (2009: € 1.2 million), provisions for long-service awards amounting to € 5.8 million (2009: € 5.8 million) and provisions for restructuring measures following the introduction of single-status pay agreements (ERA) amounting to € 2.8 million (2009: € 8.6 million).
TV FlexÜ, a collective agreement on flexible transition into retirement, came into effect in the respective German collective bargaining regions at the beginning of the financial year 2010. In addition, the MTU group companies in Germany entered into an agreement with the Works Council, effective until December 31, 2016, which replaces the collective bargaining agreement. For each of the group companies in Germany, upper limits were agreed for the maximum number of employees covered by collective bargaining agreements who can assert a claim to a pre-retirement part-time employment contract. These upper limits are 450 contracts in Munich, 130 in Hannover and 30 in Ludwigsfelde. Implementation of these contracts will be spread over the period to 2016. On the basis of the agreements made with group employees, provisions to cover the unfunded pension liabilities amounting to € 3.0 million (2009: € 1.2 million) were recognized in the financial year 2010.
For more detailed explanatory comments concerning the annual performance bonus (APB), please refer to the management compensation report in the Corporate Governance section of this Annual Report. One half of the annual performance bonus is paid in the calendar year following the financial year in which it was earned. The withheld portion of the annual performance bonus (the remaining 50%) is paid in two equal portions in the two subsequent years.
The deferred components of the 2010 annual performance bonus (APB Deferral 1 and 2) were agreed for the first time effective January 1, 2010. The ultimate amount to be paid depends on the goal achievement level attained in respect of the two key performance indicators at group level and on the discretionary factor applied in the financial years 2011 and 2012.
Additionally, as of the financial year 2010, the long-term compensation awarded to members of the MTU Board of Management will include “annual tranches” granted within the framework of a Long Term Incentive Performance Share Plan (PSP). For more detailed explanatory comments concerning the annual performance bonus (APB), please refer to the management compensation report in the Corporate Governance section of this Annual Report.
Share-based compensation gave rise to the following expenses in the financial year 2010:
CONTINGENT LIABILITIES ARISING FROM BUSINESS COMBINATIONS
The obligations arising under engine programs absorbed in the purchase price allocation relate to the amortized measurement of contingent liabilities for engine programs identified and measured in connection with the acquisition of the company by Kohlberg Kravis Roberts & Co. from the then DaimlerChrysler AG. The contingent liabilities are measured according to IFRS 3.56. Reference is made to further comments in Note 5.22. (Discretionary scope, measurement uncertainties and sensitivity) for sensitivity assumptions and other estimating parameters in respect of the measurement of contingent liabilities.
LOSSES ARISING FROM THE SETTLEMENT OF ACCOUNTS
Losses arising from the settlement of accounts relate to retrospective price adjustments or special conditions agreed with end customers by the consortium leader, expected cancellations by end customers leading to loss of revenues, and disputed amounts from contracts already invoiced between the consortium leaders and end customers, as well as potential reimbursement claims asserted by public-sector customers.
OTHER OBLIGATIONS
Provisions for other obligations cover a multitude of identifiable individual risks and contingent liabilities.
OTHER TAX OBLIGATIONS
Tax obligations relate to probable obligations in respect of trade taxes and other taxes on business operations, for which provisions have been allocated to cover payments due for 2010 and previous financial years.
Non-current other provisions developed as follows:
The following cash outflows are expected from the carrying amounts of non-current other provisions:
MTU expects that the stated personnel obligations will become due within the next one to five years.
Current other provisions developed as follows:
The cash outflows resulting from the carrying amounts of current other provisions are expected to be realized in the next calendar year following the reporting period.
33. FINANCIAL LIABILITIES
BONDS
On January 23, 2007, MTU Aero Engines Finance B.V., Amsterdam, Netherlands, issued a convertible bond with a par value of € 180.0 million and an effective date of February 1, 2007, guaranteed by MTU Aero Engines Holding AG, Munich. The convertible bond is divided into 1,800 units each with a par value of € 100,000 and its term to maturity runs until February 1, 2012.
The bond is convertible into registered non-par-value common shares of MTU Aero Engines Holding AG, Munich. Bondholders are entitled to exercise the conversion right at any time between March 13, 2007 and January 18, 2012 in accordance with the ‘bond features’ at a conversion price fixed at the issue date of € 49.50. The coupon rate is 2.75% p.a., payable yearly on February 1 starting on February 1, 2008. Depending on changes in the share price, the bond features authorize MTU to proceed with the repayment of the convertible bond on or after February 15, 2010.
MTU is furthermore authorized to call all remaining outstanding units of the convertible bond for early repayment in the event that the total par value of the outstanding units of the convertible bond should at any time fall below the threshold of 10% of the total par value of the originally issued bond.
The convertible bond was split according to its substance into liability and equity components for the purpose of initial recognition, in accordance with the definitions of IAS 32.11. The liability component was measured at fair value, whereby transaction costs directly attributable to the bond issue were included in the calculation. The present value of all future cash flows arising from the contractual obligation was determined by applying a discount at the market interest rate of 5.425% p.a., which corresponds to the rate that MTU would have had to pay at the bond issue date for a non-convertible bond.
In subsequent periods, the liability component was measured at amortized cost using the effective interest method, so that the expense over the life of the convertible bond agreement represents the reversal of the discounting at the applied rate.
The original equity component of the convertible bond issue was recognized directly in equity, taking deferred taxes into account. The proportionate amount of transaction costs allocated to the equity component, less the corresponding income tax reductions, was deducted from the equity component.
In the financial year 2008, MTU repurchased units of its own convertible bond on the market with a total nominal volume of € 27.2 million. The total value of these securities at that time amounted to € 21.9 million. In addition, one bondholder exercised his conversion right on June 23, 2010, at which stage partial convertible bonds with a nominal value of € 100,000 were exchanged – based on their amortized cost at the conversion date – for 2,020 shares.
Following the repurchase of units of the convertible bond in 2008 and the conversion in 2010, the associated conversion rights theoretically corresponded at the end of the financial year 2010 to approximately 3.1 million (2009: 3.1 million) non-par-value shares of conditional capital. If these conversion rights had been exercised in the financial year 2010, earnings per share would have been reduced to € 0.07 (2009: € 0.08).
More detailed explanatory comments concerning the conditional capital increase are provided in Note 29.3. (Conditional capital). Information on the dilutive effect of the potential issue of shares through the exercise of conversion rights is provided in Note 16. (Earnings per share). Additional information regarding the retrospective change in presentation of the convertible bond as a non-current financial liability is provided in Note 1.3. (Notes relating to changes in the reporting of the consolidated financial statements).
LIABILITIES TO BANKS
PROMISSORY NOTES
On June 3, 2009 MTU placed four promissory notes for a total nominal note amount of € 65.0 million. Through these promissory notes, consisting of four tranches with fixed maturity dates as listed below, the group aims to further diversify its sources of financing:
The promissory notes were recognized at their fair value on the date of acquisition, which corresponds to the nominal note amount, less transaction costs amounting to € 0.4 million. The promissory notes are measured at amortized cost.
REVOLVING CREDIT FACILITY
MTU meets its financing requirements in its functional currency, the euro, principally through the uptake of loans, the issuance of a convertible bond, and credit arrangements with banks (revolving credit facility). On August 3, 2009, the existing revolving credit facility for an amount of € 250.0 million was replaced by a new line of credit with a contractual term of 3 years. As a result, the group now has access to overdraft facilities amounting to € 100.0 million made available by two banks. On December 1, 2010 MTU renegotiated the existing revolving credit facility, extending its term by 5 years.
Of this line of credit, a total of € 29.0 million had been drawn down as bank guarantees in favor of third parties at December 31, 2010 (December 31, 2009: € 27.7 million).
Any credit actually utilized is subject to interest at market index average rates plus an additional margin. Unused credit facilities are subject to a loan commitment fee.
FINANCIAL COVENANTS
MTU has undertaken the obligation to ensure that certain financial indicators remain within defined boundaries throughout the contractual period of the promissory notes and until all final amounts payable in connection with the promissory notes have been settled in full, as well as for the overdraft facilities, as follows: MTU’s debt-equity ratio at the end of each quarter during the contractual period of each promissory note shall not exceed 2.5; the times interest earned ratio at the end of each quarter during the contractual period of each promissory note shall not lie below 4.0.
The financial indicators are calculated according to the following formulae:
- Times interest earned ratio = EBITDA adjusted/consolidated net interest expense
- Debt-equity ratio = Consolidated net financial debt/EBITDA adjusted(earnings before interest, tax, depreciation and amortization)
The financial indicators that MTU has undertaken to observe at the end of each quarter are obtained from the quarterly interim financial reports.
In the financial year 2010 and in the previous year, MTU and its affiliates met all loan repayment and other obligations arising from financing arrangements.
OTHER LIABILITIES TO BANKS
The other liabilities to banks amounting to € 34.4 million (2009: € 14.6 million) relate to third-party loans provided to subsidiaries.
OTHER FINANCIAL LIABILITIES
Finance lease liabilities represent obligations under finance lease arrangements that are capitalized and amortized using the effective interest method; see Note 20.
The loan from the province of British Columbia to MTU Maintenance Canada Ltd., Richmond, Canada, was repaid in full at the end of 2010.
DERIVATIVE FINANCIAL LIABILITIES
Derivative financial liabilities amounting to € 24.9 million (2009: € 12.2 million) relate principally to changes in the fair value of forward foreign exchange contracts and currency option transactions.
34. TRADE PAYABLES
The total amount of trade payables is due within one year.
35. CONSTRUCTION CONTRACT PAYABLES
Liabilities arising from construction contracts primarily concern advance payments for construction contracts for specific engine programs.
Advance payments received which exceed the amount of accounts receivable due in more than 12 months are measured at fair value by application of a discount rate.
36. OTHER LIABILITIES
LIABILITIES TO EMPLOYEES
Amounts due for social security principally comprise contributions to social insurance against occupational accidents amounting to € 1.5 million (2009: € 1.5 million) and amounts due to health insurers totaling € 0.6 million (2009: € 0.5 million).
TV FlexÜ, a collective agreement on flexible transition into retirement, came into effect in the German collective bargaining regions at the beginning of the financial year 2010. In addition, each of the MTU group companies in Germany entered into an agreement with the Works Council, effective until December 31, 2016, which supersedes the collective bargaining agreement. For each of the group companies in Germany, upper limits were agreed for the maximum number of employees covered by collective bargaining agreements who can assert a claim to a pre-retirement part-time employment contract. These upper limits are 450 contracts in Munich, 130 in Hannover and 30 in Ludwigsfelde. Implementation of these contracts will be spread over the period to 2016. Within the scope of the agreed terms for part-time early retirement working arrangements, agreements on top-up and severance payments amounting to € 20.5 million (2009: € 1.6 million) were concluded with group employees.
Other liabilities to employees are composed of unclaimed vacation entitlements, flexitime credits, obligations arising from pre-retirement part-time working arrangements and obligations arising from efficiency-improvement programs in prior periods. This item also includes liabilities to group employeesunder the MAP employee stock option program amounting to € 2.0 million (2009: € 2.8 million). Additional information concerning the MAP employee stock option program is provided in Note 29.4. (Capital reserves).
ACCRUED INTEREST EXPENSE
Long-term advance payments received for construction contracts are discounted at the prevailing market rate over the duration of financing and recognized under ‘other liabilities’ until the engine is delivered to the customer. The interest expenses relate to advance payments received for long-term military construction contracts amounting to € 18.7 million (2009: € 16.6 million) and to advance payments of € 4.8 million received in 2009 for long-term engine programs in the commercial engine business. Further explanations are given in Note 5.10. (Inventories).
OUTSTANDING MAINTENANCE WORK ON RETURNED OPERATE-LEASE ENGINES
These non-current liabilities relate to outstanding maintenance work on the present fleet of 12 operate-lease engines.
REPAYMENT OF GRANTS TOWARD DEVELOPMENT COSTS
In the financial years from 1976 to 1991, MTU received grants toward the internally generated costs of developing the PW2000 engine from the German Federal Ministry of Economics and Technology which were recognized in the income statement. Once the contractually agreed sales figures of PW2000 production engines have been reached for the Boeing 757 and C-17, MTU is obliged to pay back the grants (government subsidy of development costs) within a timeframe of 10 years. Due to a significant increase in the probability of repayment during the course of 2010 as a result of strong demand for engines in the C-17 military application, a liability of € 57.3 million (2009: € 0.0 million) was recognized at fair value as an expense in cost of sales in the financial year 2010. The first installment of the repayment is expected to become due in early 2012.
SUNDRY OTHER LIABILITIES
Sundry other liabilities cover a multitude of minor individual obligations.
OTHER TAXES
The tax liabilities amounting to € 8.6 million (2009: € 8.4 million) concern payable wage and church taxes, solidarity surcharges and transactional taxes.
CASH OUTFLOWS OF FINANCIAL LIABILITIES
The following tables list the contractually agreed undiscounted payments of interest and principle on the non-derivative financial liabilities and derivative financial instruments measured at fair value through profit or loss held by MTU:
The statement includes all instruments in the portfolio at December 31, 2010 for which payment terms had been contractually agreed. It does not include planned estimates for future new liabilities. Amounts denominated in a foreign currency are translated at the exchange rate prevailing on the respective balance sheet date. The variable-rate interest payments on the financial instruments are based on the most recent interest rate fixed prior to December 31, 2010. Financial liabilities with no fixed repayment date and contingent liabilities are always assigned to cash flows on the basis of the earliest likely repayment dates. For further information concerning the stated carrying amounts, please refer to Note 42. (Contingent liabilities and other financial obligations).
37. ADDITIONAL DISCLOSURES RELATING TO FINANCIAL INSTRUMENTS
CARRYING AMOUNTS, MEASUREMENT/RECOGNITION METHODS AND FAIR VALUES AGGREGATED BY CATEGORY
In the following tables, the carrying amounts of financial instruments are aggregated by category, regardless of how they are recognized and irrespective of whether or not the instruments fall within the scope of IFRS 7 or IAS 39. The presented information also includes separate amounts for each category as a function of the measurement/recognition method applied. Finally, the carrying amounts are set opposite the fair values for comparison. Note 5.12. (Financial instruments) provides explanatory material on the categories of financial instruments as defined in the International Financial Reporting Standards and the accounting policies applied.
Financial instruments not within the scope of either IFRS 7 or IAS 39 mainly comprise pension provisions or plan assets and other liabilities arising from employee benefits accounted for in accordance with IAS 19.
The table below provides comparative information on the carrying amounts, measurement/recognition methods and fair values aggregated by category for the financial year 2009.
Cash and cash equivalents, trade receivables and construction contract receivables are generally due within a relatively short time. For this reason, their carrying amounts at the balance sheet date are approximated to the fair value.
As a rule, trade payables and construction contract payables are due within a relatively short time; the amounts carried in the balance sheet are approximated to the fair value.
The fair value of the convertible bond, amounting to € 173.3 million (2009: € 155.4 million), is obtained by multiplying the par value of exercisable convertible bonds, totaling € 152.7 million (2009: € 152.8 million), by the factor of 113,49% (2008: 101,73%), representing the quoted share price at the balance sheet date. Based on prevailing market assumptions on the balance sheet date relating to risk-free interest rates for the remaining term of the convertible bond, conversion price, share price, expected dividend payments and volatility of the MTU share, a proportional value of € 7.00 (2009: € 6.67) was calculated per exercised conversion option.
The equity component of the convertible bond amounts to € 21.6 million (2009: € 20.6 million), based on a total of 3,084,849 (2009: 3,086,869) exercisable conversion options.
Accordingly, the fair value of the equity component amounted to € 151.7 million (2009: € 134.8 million) at the balance sheet date. Taking into account the separately recognized interest of € 3.8 million (2009: € 3.9 million) accrued over the eleven months up to December 31, 2010, the fair value inclusive of interest amounts to € 155.5 million (2009: € 138.7 million). The carrying amount inclusive of accrued interest over eleven months amounts to € 152.4 million (2009: € 148.9 million).
CLASSIFICATION OF FAIR VALUE MEASUREMENTS OF FINANCIAL ASSETS AND LIABILITIES ACCORDING TO THE FAIR VALUE HIERARCHY
In order to evaluate the significance of the factors used as input when measuring financial assets and liabilities at their fair value, MTU assigns these assets and liabilities to three levels of a fair value hierarchy.
The three levels of the fair value hierarchy are described below, together with their utilization when measuring financial assets and liabilities:
| Level 1: | Quoted prices in active markets for identical assets or liabilities (unadjusted input) |
| Level 2 | Directly observable market inputs other than Level 1 inputs, i.e. input factors that can be related directly (price) or indirectly (derived from price) to the financial assets or liabilities |
| Level 3: | Input factors used to measure assets and liabilities that are not based on observable market data (unobservable input factors) |
In the following table, financial assets and liabilities measured at fair value are allocated to the three levels of the fair value hierarchy:
The result of applying the fair value hierarchy to the fair value measurement of financial assets and liabilities in the prior year is shown in the following tables:
EXPLANATORY COMMENTS RELATING TO NET GAIN/LOSS ON FINANCIAL INSTRUMENTS BY CATEGORY
The table below shows the gains/losses arising from transactions involving financial instruments, aggregated by category. Interest income and expense in connection with financial assets and liabilities, which are recognized in the income statement at fair value, are not included here:
The interest component of financial instruments is recognized under net interest expense (see Note 12. Interest result). Other components of net income or loss are recorded in MTU’s financial statements in the financial result on other items (Note 14. Financial result on other items), with the exception of the expense for allowances on trade receivables, which comes under the category of loans and receivables and is recognized under selling expenses, and gains/losses arising from translation differences on trade receivables and payables, which are recognized under revenues or cost of sales respectively. The loss of € 2.1 million (2009: loss of € 1.5 million) generated by the joint venture Pratt & Whitney Canada Customer Service Centre Europe GmbH, Ludwigsfelde, which is accounted for using the equity method, is recognized under ‘profit/loss of companies accounted for using the equity method’ (Note 13. Profit/loss of companies accounted for using the equity method).
EXPLANATORY COMMENTS RELATING TO NET INTEREST EXPENSE
The net interest expense on financial liabilities classified as financial liabilities measured at amortized cost (an expense of € 19.9 million) mainly comprises interest expenses attributable to the convertible bond, finance lease liabilities and credit agreements with banks.
EXPLANATORY COMMENTS RELATING TO EQUITY INVESTMENTS
The column headed ‘from investments’ includes the profit/loss of companies accounted for using the equity method (Note 13. Profit/loss of companies accounted for using the equity method) in addition to profit/loss of other related companies accounted for at cost (Note 14. Financial result on other items).
EXPLANATORY COMMENTS RELATING TO MEASUREMENT SUBSEQUENT TO INITIAL RECOGNITION
Measurement of fair value
Financial instruments measured at fair value mainly comprise securities transactions, exchange rate gains and losses on ineffective currency hedging transactions, and losses arising from the measurement of interest rate derivatives.
Currency translation
Losses from the currency translation of financial instruments classified as loans and receivables amounting to € 5.6 million (2009: gain of € 0.5 million) are mainly attributable to exchange rate gains and losses arising from the measurement of trade receivables.
The following table provides comparative information on the effect of transactions involving financial instruments, aggregated by category.
38. DEFERRED TAXES
Deferred tax assets and liabilities were created for assets and liabilities and for measurement differences on the equity component of the convertible bond, for available-for-sale assets that are not measured at fair value through profit or loss, and for derivative financial instruments. Income tax assets were also recognized for tax credits and losses available for carry-forward.
Reference is made to Note 15. (Income taxes) for further information relating to current and deferred tax assets and liabilities resulting from the balance sheet and other items listed above and to the reconciliation between expected and actual tax expense.
Deferred tax assets and liabilities are only offset if the balances relate to income taxes levied by the same taxation authority and with similar maturities.
Deferred tax assets were recognized for deferred tax losses/credits available for carry-forward in the case of the following group companies:
The tax credits of € 10.3 million relate to the production site of MTU Aero Engines Polska. These credits are available to the Polish company to promote business investments due to the fact that the production site is located in a free trade zone. The actual utilization of the tax credits depends on the level of investment and actual taxable profits through to the financial year 2017.
In the United States, tax losses can be carried forward for 20 years. The same ruling has applied to tax losses in Canada since the financial year 2006. In relation to the disposal of a group of assets and associated liabilities of MTU Aero Engines North America Inc., Newington, USA in the financial year 2009, a large proportion of that company’s already fully impaired tax loss carry-forwards were viewed as no longer being recoverable in 2010 due to the low remaining volume of business and were written off. Losses available for carry-forward and valuation allowances for MTU Aero Engines North America Inc., Newington, USA therefore decreased compared with 2009.
In Germany, tax losses can be carried forward indefinitely. The tax losses of group companies in Germany were fully utilized by the end of the financial year 2008.
Temporary differences for which no deferred tax assets were recognized totaled € 3.5 million in the financial year 2010 (2009: € 3.5 million) and related to MTU Aero Engines North America. The resulting potential tax impact of € 1.6 million (2009: € 1.6 million) was therefore not taken into account in the computation of income tax expense.
Applying the same accounting treatment of deferred taxes as when the convertible bond was issued, the deferred tax liabilities of € 5.1 million (2009: liabilities of € 5.1 million) relating to the equity component of the convertible bond are presented in capital reserves. Deferred taxes on cash flow hedges and securities are presented in other comprehensive income.
DEFERRED TAX LIABILITIES FOR TAXABLE TEMPORARY DIFFERENCES ARISING FROM INVESTMENTS IN SUBSIDIARIES AND JOINT VENTURES
In accordance with IAS 12, deferred tax liabilities were not recognized for temporary differences amounting to € 237.5 million (2009: € 205.9 million) that arose in connection with investments in subsidiaries and joint ventures. If these differences were to lead to the creation of deferred tax liabilities, they would result in a tax liability amounting to € 3.9 million (2009: € 3.4 million), based on the current provisions of Section 8b of the German Corporate Income Tax Act (KStG).