Summary of significant accounting policies

Basis of presentation
In fiscal 2004, Software AG’s consolidated financial statements were for the first time prepared in accordance with the International Financial Reporting Standards (“IFRS”) as promulgated by the International Accounting Standards Board (IASB). The IFRS/IAS applicable as of December 31, 2004, were observed, as were the corresponding interpretations of the International Financial Reporting Interpretations Committee (IFRIC, formerly SIC). In addition, the following standards have been adopted, despite the fact that their application is not yet mandatory: IAS 1, (revised 2003), IAS 36, (revised 2004), IAS 38, (revised 2004), IFRS 3 and IAS 19 (revised in December 2004), and IFRS 2.

Significant differences between IFRS and German accounting in accordance with the provisions of the German Commercial Code (“HGB”) include the measurement of goodwill, provisions, and provisions for employee benefits, as well as the classification of leases, recognition of income from long-term service contracts according to percentage of completion, and accounting for deferred tax assets and liabilities.

Software AG is a publicly quoted corporation established under German law registered in Darmstadt. The Company is active worldwide in the fields of software development, software licensing, software maintenance and IT services.

The consolidated financial statements of Software AG are expressed in thousands of euro unless otherwise stated.

Scope of consolidation
The consolidated financial statements include Software AG and all companies it controls. Control is generally considered to exist, if Software AG directly or indirectly controls the majority of voting rights of a company’s share capital and/or is in a position to determine the financial and operating policies of a company.

The following affiliated companies belong to the Software AG Group, of which the latter is the parent.

a) Domestic companies (Table)
b) Foreign companies (Table)

The scope of consolidation has changed in comparison to December 31, 2003, due to the initial consolidation of the company Software AG España, Systemhaus S.L., Unipersonal, Madrid, Spain. We established this company on May 13, 2004, with subscribed capital of €60,000 and consolidated it at the same point in time. There were no further changes in the scope of consolidation compared to December 31, 2003.

With the approval of the respective shareholders’ meetings, consolidated Group companies SAG Systemhaus GmbH, Darmstadt, SAG East GmbH, Darmstadt, and SQL Datenbanksysteme GmbH, Berlin, exercised the option provided in Section 264, paragraph 3, no. 4 of the HGB and are thus exempt from the duty to prepare and publish additional financial statements in accordance with HGB accounting.

Principles of consolidation
The separate financial statements of the companies included in the consolidated financial statements were prepared according to uniform accounting policies in accordance with IFRS as of the balance sheet date of the consolidated financial statements (December 31, 2004). All annual financial statements of subsidiaries have been audited by independent auditors and in each case have been granted an unqualified audit opinion.

In the consolidation of equity, subsidiaries established by Software AG are consolidated at the date they were established. The date of first inclusion in the consolidated financial statements is taken as the date of consolidation for the companies SAG-E, SAG-P, SAG-CH, SIH, SQL, SAG-IRL and the Asian subsidiaries, which were initially consolidated in 1994. In the case of all other companies included in the consolidated financial statements, the acquisition date is selected as the consolidation date.

The initial consolidation of companies consolidated prior to December 31, 2002 followed the book value method in accordance with section 301, paragraph 1 no. 1 of the HGB. Accordingly, the acquisition and start-up costs were offset against the Group’s investment in shareholders’ equity. Initial consolidation after the transition to IFRS on January 1, 2003 followed the regulations set out in IFRS 3. Subsequent consolidations were based on the initial consolidation.

Goodwill arising from the consolidation of equity was offset against retained earnings for acquisitions prior to January 31, 2001 in accordance with section 309 paragraph 1 HGB. Goodwill araising after that date was capitalized in accordance with HGB accounting and amortized over 10 years unsing the straight-line method. In accordance with the option set out in IFRS 1.14, the Company continues to account for business combinations and the goodwill arising thereof on the date of transition to IFRS in accordance with HGB.

Goodwill previously capitalized in line with HGB accounting was measured in accordance with IAS 36 for fiscal 2003 and 2004. It was frozen at the carrying amount stated on the date of transition to IFRS on January 1, 2003, and only written down in case of actual impairments. Goodwill is annually tested for impairment.

Revenue, expenses and income, receivables and payables arising between consolidated companies have been eliminated. Inter-company earnings from services provided within the Group were also eliminated where these were not realized from services to third parties. Consolidated equity and net income allocable to minority interests are reported separately from consolidated equity and net income allocable to the parent company.

Currency translation
Financial statements of foreign subsidiaries are translated according to the functional currency concept using the modified closing rate as set out in IAS 21. Since the subsidiaries operate independently from an organizational, financial and business standpoint, the local currency is identical with the functional currency.

Income and expenses are translated at monthly average rates, assets and liabilities at closing rates and equity in subsidiaries at historical rates. Currency translation differences arising from the consolidation of equity are excluded from income and reported in a separate column in the statement of changes in equity.

When eliminating receivables and liabilities, currency translation differences are recognized under other operating income and expenses on the income statement.

In the statement of fixed assets movements, the balances at the beginning and end of the fiscal year are converted at the applicable closing rates and other items at average rates. Any difference arising from exchange rate changes is displayed in a separate column under both costs and accumulated depreciation/amortization as an exchange difference.

Foreign currency payables and receivables are translated at the closing rate in the financial statements of consolidated companies. Exchange gains and losses not yet recognized on the balance sheet date are included in net income for the period except for translation differences from longterm, inter-company monetary items that are part of a net investment in a foreign company. These differences are excluded from income and recorded as other reserves in shareholders’ equity.

The exchange rates of key currencies used for currency translation have changed against the euro as shown below:

Use of estimates
In the preparation of the consolidated financial statements, estimates and assumptions are made for certain items impacting the recognition and measurement of assets, liabilities and contingent liabilities as well as income and expenses reported. Actual amounts may differ from these estimates.