(25) Derivative Financial Instruments
We use derivative financial instruments in order to reduce risks resulting from fluctuations in foreign-currency exchange rates, risks resulting from future cash flows associated with Stock Appreciation Rights (STARs) granted to employees and risks resulting from potential future variability interest payments. The carrying amounts of our derivative financial instruments were as follows:
| € millions | 2007 | 2006 |
| Assets: | ||
| Derivatives without a hedging relationship | 60 | 15 |
| – thereof forward exchange contracts | 59 | 15 |
| – thereof interest rate swaps | 1 | 0 |
| Derivatives with a hedging relationship (hedge accounting) |
87 | 189 |
| – thereof forward exchange contracts | 29 | 18 |
| – thereof call options (STAR hedge) | 58 | 171 |
| Liabilities: | ||
| Derivatives without a hedging relationship | – 30 | – 10 |
| – thereof forward exchange contracts | – 30 | – 10 |
| Derivatives with a hedging relationship (hedge accounting) |
– 1 | – 2 |
| – thereof forward exchange contracts | – 1 | – 2 |
Foreign Exchange Forward Contracts
As a globally active enterprise, we are subject to risks associated with fluctuations in foreign currencies in our ordinary operations. This includes foreign currency-denominated receivables, payables, debt, and other balance sheet positions as well as future cash flows resulting from anticipated transactions including intragroup transactions.
We manage our balance sheet exposure on a Group-wide basis primarily using foreign exchange forward contracts. The derivative financial instruments we use are usually not designated as accounting hedges.
We are also exposed to risks associated with anticipated
intercompany cash flows in foreign currencies resulting
from intercompany royalty payments. Most of SAP AG’s
subsidiaries have entered into license agreements with
SAP AG pursuant to which each subsidiary has acquired
the right to sublicense SAP AG software products to customers
within a specific territory. Under these license
agreements, the subsidiaries are generally required to pay SAP AG a royalty equivalent to a percentage of the software
and support services fees charged by them to their
customers within 30 days following the end of the month
in which the subsidiary recognizes the revenue. These
intercompany royalties payable to SAP AG are mostly denominated
in the respective subsidiaries’ local currency.
This leads to a centralization of the foreign currency risk
with SAP AG in Germany as the royalties are to be paid in
subsidiary’s local currency while the functional currency
of SAP AG is the euro.
We enter into derivative instruments, primarily foreign exchange forward contracts, to hedge all significant anticipated cash flows in foreign currencies from foreign subsidiaries. Specifically, these foreign exchange forward contracts offset anticipated cash flows and existing intercompany receivables relating to countries with significant operations, including the United States, the United Kingdom, Japan, Switzerland, Canada, and Australia. We use foreign exchange derivatives that have maturities of 15 months or less, which may be rolled over to provide continuing coverage until the applicable royalties are received.
We believe that the use of foreign currency derivative financial instruments reduces the aforementioned risks that arise from doing business in international markets. We hold such instruments for purposes other than trading.
Foreign exchange derivatives are recorded at fair value in our Consolidated Balance Sheets. The fair value of foreign exchange derivatives is the value we would receive or have to pay if the derivatives were discontinued at the reporting date. It is calculated on the basis of the contracting parties’ relevant exchange rates, the relevant current exchange rates and the respective interest rates. Gains or losses on derivatives designated and qualifying as cash flow hedges are recognized directly in equity less the component of the financial instrument’s gain or loss that was excluded from the assessment of hedge effectiveness, net of tax, and removed from equity to profit and loss when the underlying transaction affects earnings. When intercompany accounts receivable resulting from royalties related to software and software-related services related royalties are recorded, the applicable gain or loss on the respective derivative is reclassified from Other comprehensive income to Other non-operating income/expense, net.
Going forward, any additional gains or losses relating to
that derivative are posted to Other non-operating income/
expense, net until the position is closed or the derivative
expires.
For the years ending December 31, 2007 and 2006, no gains or losses were reclassified from Accumulated other comprehensive income as a result of the discontinuance of foreign currency cash flow hedges resulting from a determination that it was probable that the original forecasted transaction would not occur. We did not record any ineffectiveness for these hedges for the fiscal years 2007 and 2006. However, we excluded differences between spot and forward rates from the assessment of hedge effectiveness and included this component of financial instruments’ gain or loss in Other non-operating income/expenses, net. It is estimated that €21 million of the net gains recognized directly in equity on December 31, 2007 will be reclassified into earnings during fiscal year 2008. All foreign exchange derivatives held as at December 31, 2007 have maturities of 15 months or less.
Foreign exchange derivatives entered into by us to offset exposure to anticipated cash flows that do not meet the requirements for applying hedge accounting are marked to market at each reporting period with unrealized gains and losses recognized in earnings.
