Accounting policies

Currency translation

Transactions in foreign currencies are translated into the functional currency of the reporting company at the exchange rate on the date on which they were carried out. As of the balance sheet date, monetary items are translated at the exchange rate on that date and non-monetary items are valued at the historical rate on the transaction date. Differences resulting from these conversions are, in principle, reported with an impact on the income statement.

The balance sheets of foreign subsidiaries not prepared in euros are translated into euros in accordance with the functional currency concept, based on the average exchange rates on the reporting date. The annual average euro exchange rate, calculated as the mean of all month-end exchange rates, is applied to the income statements of these subsidiaries.

Exceptions to this were the income statements of the prior year of the NOP World companies, which were translated into euros at a rate calculated as the average of month-end exchange rates from June to December, as NOP World was first consolidated as of June 1, 2005.

Differences arising from the translation of asset and liability items at the exchange rate on the reporting date compared with the translation on the prior reporting date, and differences arising from translation of the annual result in the balance sheet (reporting date rate) and the consolidated income statement (average rate) are reported in equity without impact on the income statement.

Exchange rate differences arising from capital consolidation are reported in income and expense recognized directly in equity.

The exchange rates against the euro of the key currencies for the GfK Group are indicated in the table below.

Recognition of sales

The method of recognizing sales is determined according to IAS 18 and depends on the nature of the underlying transaction:

For BUSINESS INVOLVING PANELS, the GfK Group recognizes its sales pro rata temporis according to the progress of the project. Thus, the sales for a project are distributed evenly over its duration. Each month during the term of a contract, the same sales are recognized in terms of amount.

AD HOC RESEARCH BUSINESS is valued by the percentage of completion method. Progress on the project is determined as the ratio of the actual costs incurred to the overall anticipated costs of the project. The estimate of total cost is continuously checked during the life of the project. Changes in the estimate of total cost flow into the calculation of recognizable sales at the time at which they can be anticipated. The costs to be included in this calculation comprise all direct personnel expenses and other cost of sales as well as pro rata indirect costs. Provisions are set up for anticipated losses on orders in progress when they can be anticipated.

In terms of determining sales, SYNDICATED BUSINESS is treated like panel business if it is comparable to panel business in nature because it involves repeated surveys where the cost behavior pattern is relatively evenly distributed over the term.

For other syndicated business, the method of recognizing sales depends on the empirical estimate of the profitability of the respective survey:

If a profit from the survey is probable, it is valued the same as an ad hoc research.

If it is not yet sufficiently certain that enough purchasers will be found for a survey, the sale is recognized corresponding to the accumulated costs. If the value of the actual incoming orders is below that of the costs incurred, recognizable sales are limited to the value of incoming orders. As soon as it is certain that the value of orders exceeds the costs, there is a switch to the above method of recognizing sales.

In all OTHER BUSINESS TRANSACTIONS, sales are only recognized once the work has been completed and invoiced.

Cost of sales, selling and general administrative expenses

In addition to personnel expenses, services rendered and scheduled depreciation/amortization of tangible and intangible assets, the cost of sales and selling and general administrative expenses comprise all other costs directly linked to the operational activity of the GfK Group.
They also include personnel expenses from the stock option program and the Long Term Incentive Plan as well as scheduled amortization on additional assets identified on acquisitions from purchase price allocation. Impairments of non-current assets are included under other operating expenses.

Research and development

Research and development costs are recorded as expenses at the time they are incurred and shown under cost of sales.

Development costs incurred within the GfK Group, particularly in setting up new panels, are shown under other intangible assets if the recognition criteria are met.

Internally generated intangible assets are only capitalized if they have resulted from the development phase and not the research phase and if further precisely defined preconditions have been cumulatively fulfilled. These include the technical viability of project completion, the scheduled completion and use and the usefulness to the company or saleability of the intangible asset. Future economic benefits and the availability of the necessary technical, financial and other resources to complete the project should also be reported. Reliable calculation of the costs associated with the intangible asset during its development phase is also a precondition for capitalization of internally generated intangible assets.

Operating income

Operating income in the GfK Group comprises gross income from sales, less cost of sales, selling and general administrative expenses, and net other income comprising other operating income and other operating expenses.

Financial income and expenses

Financial income and expenses include interest income and expenses and other financial income.

Interest is recorded as income or expense at the time it is incurred. At the GfK Group, interest expenses are not capitalized.

Tax on income

Tax on income from ongoing business activity comprises current and deferred taxes.

Current taxes are calculated by the companies within the GfK Group according to current tax law in their country of registration.

Deferred taxes are calculated according to the liability method whereby deferred tax assets and liabilities are entered on the balance sheet for temporary differences between the carrying amounts attributed in the consolidated financial statements and the tax basis of the assets and liabilities. Any effects on deferred taxes from changes in tax law are incorporated in the income statement from the date on which the tax law is passed.

Deferred tax assets are only entered on the balance sheet if it is probable that they can be recognized at a future date. This is generally the case where the relevant company is sufficiently likely to achieve enough taxable profit to use the tax benefit.

If deferred tax assets already recorded are not expected to be recognized within the foreseeable future as a result of new information, carrying values are adjusted.

Tax on items recognized directly in equity are not included in the income statement.

Earnings per share

The earnings per share (EPS) reported in the consolidated income statement show the proportion of consolidated total income attributable to equity holders of the parent which relates to the weighted average number of shares in the reporting period.

To calculate the diluted earnings per share, the average number of shares is adjusted by the options as yet not exercised and which are in the money as of the reporting date.

Stock options for employees and executives of the GfK Group

Up until 2005, selected executives of the GfK Group were entitled to convert part of their variable remuneration into stock options in GfK AG. The option term is five years; options cannot be exercised until two years after issue.

The GfK Group applies IFRS 2 for stock options issued after November 7, 2002. This remuneration, which is to be settled with equity instruments, is valued at the fair value on the grant date. The obligation is entered as expense in the income statement whilst the counter entry is made under capital reserve.

Long Term Incentive Plan for employees and executives of the GfK Group (5 Star Incentive Program)

In financial year 2006, selected executives of the GfK Group were entitled to convert part of their variable remuneration into virtual GfK shares. Virtual shares entitle the holders to cash payments at the end of the three-year performance period. GfK grants a corresponding volume of additional performance shares. The payment for the performance shares, which is also due at the end of the performance period depends on the achievement of two performance targets, the total shareholder return (TSR) on GfK shares compared with the TSR on shares of companies listed in the DJ Euro Stoxx Media Index, and on the increase in operating profit at GfK over a three-year period.

The amount payable at the end of the performance period is accumulated as provisions. The amount of the provisions is based on an actuarial opinion.

Intangible assets

Goodwill

This balance sheet item contains goodwill arising from the capital consolidation of subsidiaries and that transferred from subsidiaries’ financial statements into the consolidated financial statements.

In business combinations, goodwill represents the remaining difference in assets after the costs of acquisition of the participation are offset against the proportion of acquired revalued equity.

Goodwill from the acquisition of companies which do not report in euros is recorded in the reporting currency of the acquired subsidiary. The exchange rate at the time of first consolidation is used to calculate the goodwill at initial recognition. Subsequent measurements are based on the mean rate as of the reporting date.

The GfK Group checks the recoverability of its cash generating units, including goodwill, as part of an impairment test once a year or when triggering events or changed circumstances arise. For this purpose, goodwill is allocated to six cash generating units corresponding to the business divisions, matching the internal Group control. The cash generating units are Custom Research, Retail and Technology, Consumer Tracking, Media, HealthCare and Other.

Recoverability of goodwill is indicated when the recoverable amount is not less than the carrying amount of the cash generating unit.

The recoverable amount corresponds to the fair value less costs to sell or the value in use if higher. These are calculated by using the discounted cash flow procedure based on anticipated future cash flow from the relevant current five-year plan. The growth in cash flow after the five-year period is taken into account by reducing the discount rate by two percentage points.

The discount rate is determined by carrying out a weighted average capital cost calculation, taking into account the standard industry capital structure and standard industry financing costs.

The resulting discount rate is 6.87% (2005: 6.65%) on average. The discount rate takes into account the respective equity and country risks as well as tax advantages from the external financing of the cash generating unit concerned.

Other intangible assets

Other intangible assets are entered in the balance sheet at amortized cost and are subject to scheduled, straight line amortization. The useful life of software and other intangible assets is generally three to ten years.

Interest on borrowing is not capitalized. Intangible assets with an indefinite useful life are subject to an impairment test at least once a year.

Software

As a rule, software developed by companies in the GfK Group is used internally for analyzing and processing marketing research data. In some cases, it is destined for external users and was written specifically to meet user requirements.

Internal costs of software development are capitalized under non-current assets if the criteria according to IAS 38 are met. Amortization commences on completion of the software.

In addition to internally generated software, the item software also includes software acquired for internal use.

Other intangible assets

Miscellaneous intangible assets mainly include studies, customer relations, brands and panel set-up costs.

Panel set-up costs involve capitalized development costs for setting up new panels or extending an existing panel. Capitalized panel set-up costs include:

Spending on materials and services used in constructing panels

Wages and salaries and other employment expenses for staff directly involved in setting up panels.

Overheads necessarily incurred in panel set-up and which can reasonably and regularly be allocated to this based on cost accounting.

Costs from the preparation and application phases and maintenance costs for current panels cannot be capitalized. They are included in expenses.

The amortization period is measured by the contract term or the useful life.

Panel set-up costs are only subject to scheduled amortization if they are directly incurred in conjunction with a specific, fixed-term current client order. Other panel set-up costs and brands are not subject to any scheduled amortization; their useful life is indefinite. These intangible assets are subjected to an impairment test at least once a year.

Impairments on intangible assets are recorded if the recoverable amount falls below the amortized costs.

The recoverable amount is the higher of fair value less cost of sale and utility value, which at the GfK Group is based on the expected future cash flows over a minimum scheduled three-year period and which is discounted at a specific interest rate resulting from market conditions. The rate of growth of cash flow beyond the detailed planning period is usually taken into account as a deduction of one to two percentage points on the discount rate.

Tangible assets

Tangible assets are valued at cost less cumulative depreciation. Interest on borrowing is not capitalized. Cumulative depreciation includes scheduled straight line depreciation up to the balance sheet date and any impairments recorded. The depreciation period corresponds to the useful life. Assets in the course of set-up are not subject to scheduled depreciation.

The GfK Group normally applies the useful life periods shown in the following table:

Lease arrangements are entered on the balance sheet according to IAS 17 with either a finance or an operating lease depending on the type of contract.

Finance leases are characterized by the fact that risks and rewards of leased assets are generally transferred to the lessee. With a finance lease the leased item is capitalized by the lessee and a corresponding leasing liability is recorded. The leasing liability is equivalent to either the present value of the minimum lease payments or the fair value of the leased asset at the start of the lease arrangement if lower.

The leasing asset is subject to scheduled straight line depreciation. The depreciation period is the lease term or the economic useful life whichever is shorter. Subject to the fulfillment of the precon-ditions, an impairment is recorded.

The lease liability is amortized over the contractual period through lease payments. Discounts are written up by applying a constant interest rate to the remaining debt and recorded in interest expenses within other financial expenses.

With operating leases, the leased assets are entered on the balance sheet of the lessor. The lessee records the regular payments as rental expenses.

Financial instruments

Pursuant to IAS 32 and IAS 39, financial instruments are contracts which result in a financial asset with one company and a financial liability or an equity instrument with another. In the GfK Group, financial instruments are entered on the balance sheet as bought or sold on the trade date, i.e. on the date on which the obligation to buy or sell a financial instrument was entered into.

In the case of fixed-income financial instruments, interest rate changes may result in a change in fair value and in the case of variable rate financial instruments, in fluctuations in interest payments. In principle, short-term receivables and liabilities are not subject to interest rate risks.

Financial assets are taken off the books if the contractual rights to payments arising from the financial assets expire or if the financial assets are transferred with all material risks and opportunities. Financial liabilities are taken off the books if the contractual obligations have been settled, extinguished or have expired.

Borrowing costs are recorded as expenses in the period in which they were incurred.

Primary financial instruments

Loans issued, receivables and liabilities are valued at amortized costs where these are not linked to hedge transactions.

Shares in companies which do not qualify as subsidiaries or associated companies are also shown as primary financial instruments at cost.

The GfK Group only shows trading securities under short-term securities; all other securities are reported under other financial assets as available-for-sale securities. GfK does not hold any securities as “held to maturity”.

Derivative financial instruments, hedge accounting

The GfK Group concludes transactions throughout the world in various international currencies, which may involve currency risks. In addition, short-term investments, investment in securities and borrowing from banks take place in various currencies and can result in risks due to changes in exchange rates, rates of interest and market prices.

More detailed information on currency and interest rate risks is provided in the risk report, which is part of the management report.

The GfK Group uses currency forward transactions, combined interest rate and currency swaps as well as interest rate swaps to hedge against currency and interest rate risks. No derivative financial instruments are held for trading purposes.

Derivative financial instruments are reported at cost as asset or liability at the time of the transaction and subsequently valued at fair value.

Changes in the fair value of derivative financial instruments used in hedge accounting are recorded differently, depending on whether the instrument is a fair value hedge, cash flow hedge or net investment hedge.

If the derivative financial instrument is used to hedge against the risk of changes in the value of assets or liabilities, it represents a fair value hedge. In this case, changes in the fair value of both the hedged item and the derivative financial instrument are taken to the income statement.

With changes in the fair value of cash flow hedges used to hedge transactions against risks from fluctuations in future payment flows, the effective portions of the fair value fluctuations are initially reported under income and expense recognized directly in equity.

Once the hedged transaction affects the income statement, the profits and losses accumulated in the income and expense recognized directly in equity must be released with impact on the income statement.

Net investment hedges can be used to secure net investment in foreign subsidiaries. This may, for example, involve a foreign currency loan in the local currency of the acquired participation. Any exchange gains or losses resulting from the cut-off date valuation of the foreign currency loan are recorded in income and expense recognized directly in equity as is the case for cash flow hedges.

The prerequisite for using any hedge accounting is that the link between the hedged item and the hedging instrument must be accurately documented. It must also be recorded how the hedging instrument used compensates the risk relating to the hedged item highly effectively and which methods are used to substantiate the effectiveness.

If the hedge is considered highly effective, the exchange gains and losses from the hedging instrument are posted in the income and expense recognized directly in equity. The release with impact on the income statement of this item does not occur at the end of term of the hedging instrument but only upon sale or liquidation of the hedged item.

Generally, the part of the changes in fair value not covered by the hedged item is taken to the income statement.

If the prerequisites for reporting an item as a hedging instrument (hedge accounting) are not met as per the regulations in IAS 39, the changes in fair value of the derivatives are immediately charged to the income statement.

Fair values of forward currency transactions, combined interest rate and currency swaps and interest rate swaps are determined on the basis of market conditions as of the reporting date.

Inventories

Inventories are valued at the lower of cost and net realizable value.

Trade receivables

Trade receivables include both billed and unbilled receivables. They are stated at nominal value or, in the case of specific risks, at the lower attributable value taking into account a valuation allowance. Unbilled receivables can arise in the context of the valuation of sales.

Impairment

If an asset is impaired and is therefore depreciated, the cost of impairment is included in the income statement.

Liquid funds

The liquid funds contain cash on hand and in banks as well as liquid investments with a remaining term of less than three months.

Income and expense recognized directly in equity

Income and expense recognized directly in equity include changes in Group equity which have no impact on the income statement and which do not involve deposits by shareholders or distributions to shareholders.

These changes result from exchange rate differences, unrecognized profits and losses from available-for-sale securities, actuarial gains and losses from provisions for pensions and unrecognized income and expenses from derivative financial instruments.

Provisions

In principle, provisions are set up when an obligation to a third party will probably result in an outflow of funds. In addition, the level of the obligation needs to be estimated reliably. Long-term provisions are discounted if they are interest-free or low-interest.

Provisions for pensions are valued in accordance with the projected unit credit method, in which future compensation increases are taken into account. The amount shown on the balance sheet represents the present value of the obligation adjusted by the unrecognized past-service costs after offsetting the fair value of the plan assets. The discount rate is based on the interest rate for prior-ranking fixed-income corporate bonds.

Payments for defined contribution plans are stated as expenses when they occur.

Actuarial gains and losses on defined benefit plans are recorded directly in income and expense recognized directly in equity in exercise of the option in IAS 19.

Financial liabilities

Financial liabilities include interest-bearing liabilities relating to financing, particularly loans from banks and other lenders, liabilities under financial leases and other interest-bearing liabilities. They are stated at the present value if they are interest-free or low-interest. Further valuation is carried out at amortized cost using the effective interest rate method.

The GfK Group reports rights to make delivery (put options or obligations) held by minority shareholders as purchase price elements contingent on future events in similar application to the regulations on business combinations in accordance with IFRS 3.

The minority interests affected by this are no longer reported as minority interests but are stated under non-current or current liabilities. These obligations are valued at fair value.

Earnings distributed to minority interests and the interest added to payment obligations are reported as interest expenses.

Trade payables, other liabilities

Trade payables and other liabilities are stated at repayment value.

Interest-free or low-interest non-current liabilities are discounted and stated at present value.

Liabilities on orders in progress

Liabilities on orders in progress comprise payments on account and accrued amounts from the recognition of sales. Within this item, sales are accrued which have arisen from contractually agreed invoices for prepayments or payments on account, but cannot yet be recognized as sales according to the above described sales recognition methods.

Consolidated cash flow statement

The cash flow statement shows the changes to the balance sheet item Liquid funds resulting from cash flows from operating activity, investing activity and financing activity.

The cash flow from operating activity is derived indirectly from changes to balance sheet entries. These are adjusted for the effects of currency translation and changes in the scope of consolidation. As a consequence, only a limited reconciliation is possible between the changes in the balance sheet items according to the consolidated cash flow statement and the arithmetical changes in the consolidated financial statements, the schedule of movements in non-current assets and other information in the notes to the financial statements.

Estimates

To a certain extent, estimates and assumptions cannot be avoided in the consolidated financial statements. They may affect assets and liabilities as well as contingencies on the balance sheet date and the income and expenses for the financial year. These estimates were made by the management, taking into account all known facts to the best of their knowledge. Nevertheless, the actual amounts may deviate from such estimates.

The key estimates on future development of the GfK Group and its economic environment are shown in the “Outlook” section of the management report.

As regards reporting on the business combination due to the acquisition of NOP World as of June 1, 2005, the consolidated financial statements as of December 31, 2005 were based on preliminary figures. The required adjustment to these preliminary figures within a 12 month period as stipulated by IFRS 3 were based on the date of acquisition of June 1, 2005. The following changes resulted with regard to the consolidated financial statements as of December 31, 2005:

Liabilities (current income tax liabilities, trade payables and other short-term liabilities and deferred items) were reduced by EUR 9,693 thousand and receivables (trade receivables and current income tax assets) decreased by EUR 326 thousand. Deferred tax assets were reduced by EUR 331 thousand, deferred tax liabilities rose by EUR 2,955 thousand. These changes resulted in goodwill being EUR 6,197 thousand below the preliminary figure. Currency reserves under income and expense recognized directly in equity were down by EUR 116 thousand. The relevant prior year figures have been adjusted in the notes to the con-solidated accounts.

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GfK Annual Report 2006

GfK 2006 Financial Statements