Notes to the Annual Financial Statements<br>of Volkswagen AG

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Financial statements in accordance with the German Commercial Code

The annual financial statements of Volkswagen AG have been prepared in accordance with the provisions of the Handelsgesetzbuch (HGB – German Commercial Code) and comply with the provisions of the Aktiengesetz (AktG – German Stock Corporation Act).

To enhance the clarity of presentation, we have combined individual items of the balance sheet and the income statement. These items are disclosed separately in the notes. The income statement uses the cost of sales (function of expense) format to enable better international comparability.

Volkswagen AG is a vertically integrated energy company within the meaning of section 3 no. 38 of the Energiewirtschaftsgesetz (EnWG – German Energy Industry Act) and is therefore subject to the provisions of the EnWG. In the electricity sector, both Volkswagen AG and a subsidiary carry out the functions of generation and sales as well as electricity distribution. To prevent discrimination and cross-subsidies, separate accounts must as a rule be maintained for these functions in accordance with section 10(3) of the EnWG. In addition, a balance sheet and income statement that comply with the provisions contained in section 10(1) of the EnWG must be prepared for each area of activity. (Unbundling requirement in internal accounting systems). As Volkswagen AG’s electricity distribution activities (site network) do not serve the purpose of general provision and are also extremely insignificant, Volkswagen AG has not reported these activities separately and has limited itself to preparing a separate presentation of its other activities within the electricity sector in accordance with the purpose of the EnWG to prevent discrimination and cross-subsidies.

The list of all shareholdings can be downloaded from the electronic companies register at www.unternehmensregister.de and from www.volkswagenag.com/ir under the heading “Mandatory Publications” and the menu item “Annual Reports”.

Declaration on the German Corporate Governance Code in accordance with section 161 of the AktG/section 285 no. 16 of the HGB

The Board of Management and Supervisory Board of Volkswagen AG issued the declaration of conformity in accordance with section 161 of the AktG on December 20, 2007.

The declaration of conformity has been made permanently available at www.volkswagenag.com/ir.

Significant events in the fiscal year

As part of the continued realignment of our foreign equity investments, we contributed the shares in the subsidiaries Škoda and VW Group Rus at their fair values amounting to a total of €924 million to our intermediate holding company in the Netherlands. This generated a book gain of €69 million, which was reported in other income from investments.
 
In the course of the restructuring of our equity investments in Brazil, the Truck & Bus division was spun off from VW do Brasil and contributed at its fair value of €496 million to the newly formed VW Caminhões e Ônibus. The attributable gross book value and the write-down recognized in previous years were recorded as disposals.

In addition, the financial services activities in Brazil were restructured and bundled together in VW Financial Services.

Our equity investment in the Belgian company VW Group Services was increased by €1,150 million.

A further €840 million was invested in long-term investments.

Accounting policies

In most cases, the accounting policies applied in the previous year were retained. Any changes in specific instances are individually addressed in the following.

Intangible assets are carried at cost and amortized over three to five years using the straight-line method. Grants paid for third-party assets are capitalized as purchased rights to use and amortized over five years.

Tangible assets are carried at cost and reduced by depreciation. Investment grants are deducted from cost.

Production costs are recognized on the basis of directly attributable material and labor costs, as well as proportionate indirect material and labor costs, including depreciation and amortization. Administrative cost components are not included.

Depreciation is based primarily on the following useful lives derived from the official tax depreciation tables:

To the extent allowed by tax law, depreciation of movable items of tangible assets is initially charged using the declining balance method, and subsequently using the straight-line method, and also reflects the use of assets in multi-shift operation.

Additions of movable assets are depreciated ratably in the year of acquisition.

Low-value assets are written off in full in the year of acquisition and derecognized. In addition, certain items of operating and office equipment with individual purchase costs of up to €1,500 are treated as disposals when their standard useful life has expired.
 
The differences between the carrying amounts required by the HGB and the lower carrying amounts allowed under tax law are recorded in the special tax-allowable reserves presented between equity and liabilities in the balance sheet.

Shares in affiliated companies and other equity investments are carried at the lower of cost and net realizable value.

Long-term investments are carried at cost.

Non- or low-interest-bearing loans are carried at their present value; other loans are carried at their principal amount.

Raw materials, consumables and supplies, and merchandise, carried in inventories are measured at the lower of average cost and replacement cost.

In addition to direct materials and direct labor costs, the carrying amount of work in progress also includes proportionate indirect materials and labor costs, including depreciation in the amount required under tax law.

Adequate valuation allowances take account of all identifiable storage and inventory risks.

Receivables and other assets are carried at their principal amounts. Valuation allowances are recognized for identifiable specific risks.

Receivables due after more than one year are carried at their present value at the balance sheet date by applying an interest rate to match the maturity.

Receivables denominated in foreign currencies are translated at the exchange rate prevailing at the date of initial recognition. A lower exchange rate at the balance sheet date results in the remeasurement of the receivable at a lower carrying amount, with the difference recognized in the income statement; higher exchange rates at the balance sheet date (remeasurement gains) are not recognized. Hedged receivables are not remeasured at the closing rate.

Purchased foreign currency and interest rate options are carried at the lower of cost or fair value until maturity.

Securities classified as current assets are carried at the lower of cost or fair value.

Adequate provisions are recognized for identifiable risks and uncertain obligations on the basis of prudent business judgment. Provisions cover all identifiable risks of future settlement.

Provisions for pensions and similar obligations are carried at the actuarial present value computed using the German entry age normal method and reflect current mortality tables. A discount rate of 5.5% was used for the first time in 2007. The previous discount rate was 6%. This change in the discount rate, which reflects current market developments, reduced earnings by €495 million in the fiscal year.
 
Since fiscal year 2001, pension obligations relating to employees covered by collective wage agreements have been linked to a pension fund model.

Provisions for jubilee payments are discounted at 5.5% per annum, reflecting tax recognition and measurement provisions.

Provisions for obligations under partial retirement arrangements are discounted to the present value at a real discount rate of 3.2%.

Provisions for warranty obligations are recognized on the basis of the historical or estimated probability of claims affecting vehicles delivered.

Currency forwards are measured by comparing the agreed rate with the forward rate for the same maturity at the balance sheet date. A provision is recognized for any resulting unrealized loss. Any positive gains (remeasurement gains) are not recognized. Gains and losses are not offset. Measurement gains or losses are discounted to the present value.

Liabilities are carried at their redemption or settlement amount.

Liabilities denominated in foreign currencies are translated at the exchange rate prevailing at the date of initial recognition. A higher exchange rate at the balance sheet date results in the remeasurement of the receivable at a higher carrying amount, with the difference recognized in the income statement. Lower exchange rates at the balance sheet date (remeasurement gains) are not recognized.

The amount of contingent liabilities disclosed corresponds to the liable amount.

In the income statement, the allocation of expenses to the cost of sales, selling and general and administrative functions is based on cost accounting principles.

Cost of sales contains all expenses relating to the purchase of materials and the production function, the costs of merchandise, the cost of research and development, and warranties and product liability expenses.

Selling expenses include personnel and non-personnel operating costs of our sales and marketing activities, as well as shipping, advertising, sales promotion, market research and customer service costs.

General and administrative expenses include personnel and non-personnel operating costs of the administrative functions.

Other taxes are allocated to the consuming functions.

Foreign currency translation

Transactions denominated in foreign currencies are translated at the exchange rates prevailing at the transaction dates or at agreed exchange rates. Expected exchange rate losses at the balance sheet date are reflected in the measurement of the items. Equity investments are translated at the rate prevailing at the date of acquisition.

To hedge future cash flows – primarily from expected future sales, purchases of materials and credit transactions – against currency and interest rate fluctuations, Volkswagen AG uses derivatives such as currency forwards and options, including structured options, as well as interest-rate hedges, such as caps. Such transactions are measured in accordance with the imparity principle (under which expected or unrealized losses must be recognized, but the recognition of unrealized gains is prohibited). Assets or liabilities hedged by cross-currency swaps and currency forwards are translated at the contractually agreed rates at the time of initial recognition.

Balance Sheet Disclosures

(1) FIXED ASSETS

The classification of the assets combined in the balance sheet and their changes during the year are presented in the chart above. The carrying amount of fixed assets is €27,072 million at the balance sheet date. Fixed assets are composed of intangible assets, tangible assets and long-term financial assets.

Capital expenditures amounted to:

Depreciation, amortization and write-downs were charged on:

As well as the above-mentioned restructuring measures, the additions to shares in affiliated companies and other equity investments primarily relate to capital contributions at VW Group Services S.A., VW Financial Services AG, AUDI AG and VW of America, the purchase of shares in MAN AG and Scania AB as well as newly formed companies in India and Russia.

Most of the disposals of shares in affiliated companies result from the contribution of companies to the Dutch intermediate holding company and from the restructuring in Brazil.

Volkswagen AG invested a further €840 million in long-term investments in 2007.

Long-term investments also include bonds issued by an affiliated company in the amount of €1 million. They also include the shares in securities investment funds held by Volkswagen Pension Trust e. V. in trust for Volkswagen AG amounting to €1,865 million. These represent the values of employee Time Assets transferred to the Pension Trust and the contribution of the annual benefit expense to the pension fund.

Reversals of write-downs of long-term financial assets relate almost exclusively to the carrying amount of the investment in VW do Brasil.

STATEMENT OF CHANGES IN FIXED ASSETS OF VOLKSWAGEN AG

(2) INVENTORIES

(3) RECEIVABLES AND OTHER ASSETS

In addition to trade receivables, receivables from affiliated companies are composed primarily of receivables relating to profit distributions, including income tax allocations, and short- and medium-term loans.

Other assets primarily include tax and cost reimbursements that are not yet due (€1,480 million and €210 million respectively), rights from foreign currency option transactions entered into (€93 million) and deferred interest receivables (€20 million).

(4) SECURITIES

(5) SUBSCRIBED CAPITAL

The subscribed capital of Volkswagen AG is composed of no-par value bearer shares with a notional value of €2.56 each.

Because of the capital increase implemented in fiscal year 2007 due to the exercise of conversion rights from the fourth, fifth, sixth and seventh tranches of the stock option plan, the subscribed capital increased by a total of €11 million to €1,015 million.

The subscribed capital is composed of 291,337,267 no-par value ordinary shares and 105,238,280 preferred shares.

The Annual General Meeting on May 3, 2006 resolved to create authorized capital of up to €90 million, expiring on May 2, 2011, to issue new no-par value ordinary bearer shares. According to the resolution adopted by the Annual General Meeting on April 22, 2004, further authorized capital of up to €400 million has been created that expires on April 21, 2009.

There is also contingent capital of €100 million to issue up to 39,062,500 ordinary and/or preferred shares. This contingent capital will only be implemented to the extent that the holders of convertible bonds issued up to April 21, 2009 exercise their conversion rights.

Stock option plan

The Board of Management, with the consent of the Supervisory Board, exercised the authorization given by the Annual General Meeting on April 16, 2002 to implement a stock option plan. Contingent capital of €16.5 million was created for this purpose. The contingent capital increase will only be implemented to the extent that the holders of convertible bonds issued on the basis of the authorization by the Annual General Meeting to establish a stock option plan exercise their conversion rights.

The stock option plan entitles the optionees - the Board of Management, Group senior executives and management, as well as employees of Volkswagen AG covered by collective pay agreements - to purchase options on shares of Volkswagen AG by subscribing for convertible bonds at a price of €2.56 each. Each bond is convertible into ten ordinary shares.

The stock options are not accounted for until the exercise date. The conversion price then received for the new shares is credited to subscribed capital or capital reserves.

The conversion prices and periods following expiration of the first three tranches are shown in the following table. The information on the fourth tranche is presented as data for fiscal year 2007, although this tranche has now also expired.

The total value at December 31, 2007 of the convertible bonds issued at €2.56 per convertible bond was €964,648.96 (= 376,816 bonds), conveying the right to purchase 3,768,160 ordinary shares. The liabilities from convertible bonds are recognized under other liabilities. In fiscal year 2007, 11,503 convertible bonds with a value of €29,447.68 were returned by employees who have since left the Company. 435,720 conversion rights from the fourth, fifth, six and seventh tranches with a nominal value of €1,115,443.20 have been exercised. 4,357,200 shares with a notional value of €11,154,432.00 were thus issued.

Changes in the rights to stock options granted (fifth to eighth tranches) are shown in the following table:

(6) CAPITAL RESERVES

The capital reserves comprise the share premium of a total of €4,816 million from the capital increases, the share premium of €219 million from the issue of bonds with warrants, and an amount of €107 million appropriated on the basis of the capital reduction implemented in the previous fiscal year. The share premium from the capital increase resulting from the exercise of conversion rights from the stock option plan increased the capital reserves by €200 million in fiscal year 2007. No amounts were withdrawn from the capital reserves.

(7) REVENUE RESERVES

In accordance with section 58(2) of the AktG, a total of €720 million was appropriated from net income for the year to other revenue reserves.

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