TRANSITION TO INTERNATIONAL FINANCIAL REPORTING STANDARDS

TRANSITION TO INTERNATIONAL FINANCIAL REPORTING STANDARDS The European Union has approved the adoption of the International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board (IASB). EC regulation 1725/2003 published in the Official Journal of the European Communities on October 13, 2003 requires companies listed on a regulated stock exchange in one of the member states to present their consolidated accounts for financial years beginning on or after January 1, 2005 in conformity with IFRS. As Valeo is subject to this requirement, the Group set up a specific IFRS project to ensure smooth transition to the new accounting standards. 1 Summary of the project Based on a diagnostic review, the project team: identified the main differences between IFRS and Valeo s current accounting practices (French GAAP); analyzed the various accounting options; assessed the impact on organization and IT systems. Valeo subsequently: overhauled its procedures; adapted its accounting IT systems and the reporting system; trained the main operational staff concerned (some 650 people in 12 countries were given training sessions in 2004). These various action points enabled Valeo to prepare an IFRS opening balance sheet at the effective date of transition to the new standards which has been approved by the Group s Audit Committee and the external Auditors. As stated in the Management Report of June 30, 2004, Valeo has sought to provide its stockholders with quantitative information relating to the impact of switching to IFRS as of. In line with IFRS 1, First-time Adoption of International Financial Reporting Standards, the adjustments resulting from applying IFRS for the first time have been recorded in equity. 2 Impact of the transition to IFRS on opening equity In order to prepare its opening balance sheet at, Valeo has followed the first-time adoption guidelines set out in IFRS 1. The IFRSs that are operative have generally been applied retrospectively, as if Valeo had always applied these standards. IFRS 1 does, however, explicitly state a number of exemptions from retrospective application. These include: Mandatory exemptions. For example, IFRS 1 requires estimates under IFRSs at the date of transition to be consistent with estimates made for the same date under previous GAAP (i.e. it prohibits the use of hindsight to correct estimates made under previous GAAP). Also, IFRS 1 requires prospective application of hedge accounting as from the first period of application of IAS 39, Financial Instruments: Recognition and Measurement. Optional exemptions. Valeo has elected not to retrospectively restate the following: - business combinations which occurred before (IFRS 3); - pensions and other employee benefits (IAS 19), resulting in a full recognition at of all cumulative actuarial gains or losses previously unrecognised under French GAAP; - translation differences for all foreign operations (IAS 21): in accordance with the exemption provided for in IFRS 1, all cumulative translation gains and losses were reset to zero at (with no impact on total equity). In view of the European Union s late adoption in 2004 of IAS 32 and 39 relating to financial instruments, Valeo has elected not to apply these standards before January 1, 2005. The corresponding impact will be recorded in equity at January 1, 2005. 1

Retrospective application of IFRSs as of (apart from the exceptions described above) resulted in a 262 million decrease in opening stockholders equity. This decrease can be analyzed as follows: Stockholders equity including minority interests Comments Under French GAAP 2,112 (1) Pensions and other employee benefits (245) (a) Development expenditure 148 (b) Specific tooling (53) (c) Consolidation methods (35) (d) Currency translation (25) (e) Impairment of assets (19) (f) Zexel acquisition (16) (g) Other adjustments (14) (h) Deferred taxes (3) (i) Total impact of IFRS restatements (262) Under IFRS 1,850 (2) (1) including 132 million in minority interests (2) including 97 million in minority interests (a) Pensions and other employee benefits Valeo has carried out a comprehensive review of its obligations in relation to pensions and other employee benefits that fall within the scope of IAS 19. These obligations are as follows: Post-employment benefits which include statutory retirement bonuses, supplementary pension benefits and coverage of certain medical costs for retirees and early retirees; Other long-term benefits payable during employment, corresponding primarily to long-service bonuses. These benefits are broken down into: Defined contribution plans, under which the employer pays fixed contributions on a regular basis and has no legal or constructive obligation to pay further contributions; Defined benefit plans, under which the employer guarantees a future level of benefits. Valeo measured its obligation concerning these plans in accordance with IAS 19 and recorded a provision at to fully cover the related liability. The corresponding impact on equity included: primarily, fully recognizing (in accordance with IFRS 1) the actuarial gains and losses unrecognized at December 31, 2003 under French GAAP. These actuarial gains and losses usually arise due to changes in actuarial assumptions or experience adjustments (the effects of differences between the previous assumptions and what has actually occurred); the effect of changing the calculation method for certain obligations, as IAS 19 provides for only one valuation method (the Projected Unit Credit Method based on estimated final salary); and redefining certain actuarial assumptions, as these have to be determined more precisely under IFRS. For instance, discount rates must be determined by reference to market yields at the valuation date on high quality corporate bonds with a term consistent with that of the employee benefits concerned. In addition, in the 2004 consolidated financial statements prepared in accordance with French GAAP, Valeo applied CNC (Conseil National de la Comptabilité) recommendation 2003-R.01 which states that as from pensions and other employee benefits should be fully provided for, in accordance with the same methods as those prescribed in IAS 19. The impact (net of deferred taxes) resulting from the first-time application of this recommendation which primarily included full recognition of previously unrecognized actuarial gains and losses was recorded in opening equity, in accordance with the treatment used for changes in accounting method. 2

(b) Development expenditure In accordance with French GAAP as currently applied by Valeo, research and development costs are expensed when incurred. Under IAS 38, research costs are expensed and development costs are capitalized once the entity can demonstrate: its intention, and financial and technical capacity to complete the development project; the probability that the expected future economic benefits that are attributable to the development expenditure will flow to the entity; and that the cost of the intangible asset can be measured reliably. Based on these criteria, Valeo has capitalized development expenditure incurred between a) the date of receipt of nomination letters from customers (which demonstrates that Valeo has been chosen as a supplier for the serial production of a model and thus the existence of an active market) and b) the launch of production. The capitalized development expenditure is subsequently amortized over a period not exceeding four years as from the production launch date. In accordance with IFRS 1, this development expenditure has been capitalized retrospectively for all projects with a residual value other than zero at. The average level of capitalization of incurred development expenditure was, however, restricted due to the fact that certain historic data for the period concerned by this retrospective restatement (1998 to 2003) were unavailable. This situation should temporarily increase future operating results, as based on the assumption that development expenditure will remain stable, the amounts capitalized in the period concerned will exceed the amortization charge on development expenditure capitalized in prior years. Customer contributions to Valeo s development expenditure are recognized in the income statement over a maximum period of four years (irrespective of billing frequency), whereas they are recorded as profit according to billing frequency under French GAAP. The impact on equity in the IFRS opening balance sheet of restating development expenditure can be analyzed as follows: Impact on equity Development expenditure related to projects in serial production phase gross carrying amount 127 amortization and provisions for impairment in value (50) net carrying amount 77 Projects in development phase 104 Deferral of customer contributions (30) Restatement of goodwill (1) (3) Total 148 (1) Corresponds to the net book value (at the date of transition to IFRSs) of development expenditure arising on a past business combination which did not qualify for recognition as an asset under French GAAP. In accordance with IFRS 1, these costs have been capitalized and the carrying amount of goodwill has decreased accordingly. (c) Specific tooling The issue of specific tooling poses numerous practical difficulties, particularly concerning: identifying the owner of the tooling (the car manufacturer or the supplier); how the car manufacturer s contribution to the related costs are invoiced. Such invoicing may be: - separate; - included in the price of volume produced parts in the form of explicit amortization (either with or without a guarantee); or - taken into account in the sales price without any separation of the portion relating to specific tooling. Valeo therefore carried out an economic analysis of its contractual relations with car manufacturers to ascertain which party has control over the future economic benefits and risks relating to specific tooling over the latter s expected useful life. Based on this analysis, Valeo has defined two alternative ways of accounting for specific tooling in accordance with IFRS: If Valeo has control over the future economic benefits and risks relating to specific tooling, the latter is capitalized in accordance with IAS 16 and depreciated over a period not exceeding 4 years, with the car manufacturer s contribution deferred over the same period; If the car manufacturer has control over the future economic benefits and risks, specific tooling is recorded under inventories in accordance with IAS 2 until they are billed to the car manufacturer. Any loss arising on the tooling contract corresponding to the difference between the customer s contribution and the production cost of the tooling is provided for as soon it is identified. 3

The impact on the opening IFRS balance sheet of the restatement of specific tooling can therefore be summarized as follows: Impact on equity Derecognition of tooling where benefits and risks have been transferred (19) Provision for losses on future sales of tooling (34) Total (53) (d) Consolidation methods Under French GAAP, Valeo fully consolidates jointly-owned subsidiaries that are managed de facto by the Group. Under IFRS, control is assessed exclusively in relation to the power to govern the financial and operating policies of the entity under a statute or an agreement. As a result, those companies over which joint control is deemed to exist from a legal perspective are now proportionally consolidated. The impact of this change on equity at corresponding to the cancellation of minority interests represented 35 million. (e) Currency translation IAS 21 states that any goodwill arising on the acquisition of a foreign company must be treated as an asset of that company and therefore expressed in the currency of the company acquired and not that of the acquiring company. This treatment corresponds to the practice already applied by Valeo, except that within sub-groups no goodwill allocation is made at the level of each subsidiary. Applying this additional breakdown led to a 21 million decrease in equity. Valeo has also changed the reporting currency for certain of its entities as, according to IAS 21, a company s reporting currency must be the same as its functional currency which is defined as the currency of the primary economic environment in which a company operates. The impact of this change on equity in the opening balance sheet at was 4 million. (f) Impairment of assets In accordance with French GAAP, Valeo amortizes goodwill on a straight-line basis and exceptional amortization may be recorded where indicators of a lasting impairment in value have been identified. Under the revised IAS 36, it is no longer possible to amortize goodwill and it is compulsory to carry out systematic impairment tests. Valeo has therefore carried out systematic tests on its goodwill using the discounted cash flow method. The discount rate used based on the weighted average cost of capital (WACC) was 8% after tax (except for Japan for which a rate of 6.8% was applied to take into account the specific economic climate in that country and the nature of the businesses concerned). Further to these tests, goodwill was written down in an amount of 18 million, representing approximately 1% of the net book value of the total goodwill in Valeo s French GAAP balance sheet at December 31, 2003. Impairment tests were also carried out for property, plant and equipment where there was an indication of impairment. For the purposes of these tests, property, plant and equipment were allocated to Cash Generating Units (CGUs) as defined by IAS 36. The impact on equity identified as a result of this approach was not material ( 1million). (g) Zexel acquisition Valeo acquired a controlling interest in Zexel on December 1, 2003. In the 2003 financial statements, the Group provisionally determined the fair value of the assets and liabilities acquired. The final fair value determination was carried out for the 2004 French GAAP financial statements in accordance with the standard window period applicable under French accounting regulations. This amount was used for the Group s opening IFRS balance sheet with a view to disclosing a final valuation of goodwill at the date of transition to IFRS, rather than a provisional calculation. The corresponding impact on opening equity (including minority interests) amounted to 16 million. (h) Other adjustments This item reflects certain differences compared with Valeo s current practice whose individual impact is not material. (i) Deferred taxes This item corresponds to the tax impact of the above-mentioned IFRS restatements. This impact is not material since the IFRS restatements relate to countries where recognition of deferred taxes is limited. 4

The following standards did not have an impact on the opening balance sheet at, but they will have an impact on the financial statements for subsequent periods: IFRS 2 states that the fair value of employee benefits under stock option plans must be expensed during the vesting period. This restatement does not have any impact on the total amount of equity as its contra entry is recorded under Consolidated retained earnings ; Valeo has opted to apply IAS 32 and 39 concerning financial instruments as from January 1, 2005. These standards will have the following consequences: - The Group s 2003 OCEANE convertible/exchangeable bond issue will be broken down into a liability component and an equity component; - Derivatives will be recognized in the balance sheet at fair value; - Own-held shares will no longer be recorded under marketable securities but against equity. The presentation of the Group s financial information will also be amended, due to the application of IAS 1, Presentation of Financial Statements, IAS 7, Cash Flow Statements, IAS 14, Segment Reporting and IAS 34, Interim Financial Reporting. 3 - Next stages for the transition to IFRS Valeo will publish 2004 consolidated financial statements restated in accordance with IFRS together with its figures for the first quarter of 2005. The presentation of these 2004 consolidated financial statements will include an income statement, a balance sheet, a cash flow statement and a statement of changes in stockholders equity. For each of the main items in the financial statements, Valeo will also provide a French GAAP/IFRS reconciliation, along with explanatory notes. The impact on the Group s equity and net debt of the first-time adoption at January 1, 2005 of IAS 32 and 39 relating to financial statements will also be presented. Valeo will publish interim figures at March 31, 2005 and September 30, 2005 as well as interim financial statements at June 30, 2005, prepared in accordance with IFRS recognition and measurement principles. Prior-period comparative information restated in accordance with the same principles as those used in 2005 will also be provided for each of these closings (except in relation to IAS 32 and 39 concerning financial instruments). Finally, in February 2006, Valeo will publish full IFRS financial statements for the year ended December 31, 2005 with comparative information relating to the year ended December 31, 2004. 5