2. PRESENTATION OF THE FINANCIAL STATEMENTS AND ACCOUNTING PRACTICES

2.1 Presentation of the financial statements

The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). These standards comprise (i) IFRS; (ii) the International Accounting Standard (IAS); and (iii) Interpretations originated by the International Financial Reporting Interpretations Committee (IFRIC), or its predecessor, the Standing Interpretations Committee (SIC). For the purposes of these consolidated financial statements presented in accordance with IFRS there are no differences in relation to the current accounting practices adopted in Brazil ("Brazilian GAAP") for the periods presented.

These are the first IFRS compliant financial statements prepared and presented by the Company. A summary of the main differences between the accounting practices previously adopted by the Company ("Prior Brazilian GAAP") and IFRS and the reconciliations between these comprehensive bodies of GAAP for shareholders' equity and comprehensive income, are presented in Note 5.

The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires Management to exercise its judgment in the process of applying the Company's accounting policies. The areas involving a higher degree of judgment or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements are disclosed in Note 3. The actual results may differ from these estimates.

These consolidated financial statements were prepared under the historical cost convention and adjusted to reflect financial assets and liabilities (including derivative instruments) measured at fair value through profit or loss.

2.2 Summary of significant accounting policies

a) Consolidation

The consolidated financial statements include the accounts of (i) the Company and all majority-owned subsidiaries in which the Company, directly or indirectly, has a majority of the equity of the subsidiary and has the power to direct the subsidiary's finance and operating policies; (ii) special purpose entities ("SPEs"), for which the Company has control, and (iii) exclusive investment funds, as follows:

ELEB – Equipamentos Ltda. – "ELEB" – subsidiary with 99.9% of its capital is held by Embraer, located in São José dos Campos – São Paulo, Brazil. ELEB produces and sells precision hydraulic and mechanical equipment for the aviation industry, mainly for Embraer aircraft. Its wholly-owned subsidiary, ELEB Aerospace, Inc., domiciled in Delaware, United States, with an operational base in the State of Kansas, United States, is currently closing down its operations.

Embraer Aircraft Holding Inc. – "EAH" – subsidiary with 99.9% of its capital is held by Embraer, located in São José dos Campos – São Paulo, Brazil. ELEB produces and sells precision hydraulic and mechanical equipment for the aviation industry, mainly for Embraer aircraft. Its wholly-owned subsidiary, ELEB Aerospace, Inc., domiciled in Delaware, United States, with an operational base in the State of Kansas, United States, is currently closing down its operations:

• Embraer Aircraft Customer Services, Inc. – "EACS" – sells spare parts, product support and customer training to customers in the United States, Canada and the Caribbean.
  
  
• Embraer Aircraft Maintenance Services Inc. – "EAMS" – provides maintenance services for aircraft and components.
  
  
• Embraer Training Services – "ETS" – located in Delaware, United States, responsible for corporate and institutional activities, and has a 51% subsidiary, Embraer CAE Training Services – "ECTS", also located in Delaware – United States, which provides training for pilots, mechanics and crew.
  
  
• Embraer Executive Jet Services, LLC – "EEJS" – located in Delaware – United States. EEJS provides after-sales support services and maintenance services for executive aircraft.
  
  
• Embraer Services Inc. – "ESI" – provides support in the United States for the defense and commercial market programs
  
  
• Embraer Executive Aircraft, Inc. – created in 2008, is located in Delaware and has its operational base in Melbourne, Florida. Its objective is the final assembly and delivery of the Phenom executive jet
  

Embraer Asia Pacific PTE. Ltd. – "EAP" – a wholly-owned subsidiary, located in Singapore, created in 2006 with the objective of providing after-sales support services in Asia.

Embraer Australia PTY Ltd. – "EAL" – a wholly-owned subsidiary, located in Melbourne, Australia, with the objective of providing after-sales support services to customers in the Australasian and Asian regions. The company is currently inactive.

Embraer Aviation Europe SAS – "EAE" – a wholly-owned subsidiary, located in Villepinte, France, responsible for corporate and institutional activities, and has the following subsidiaries:

• Embraer Aviation International SAS – "EAI" – located in Villepinte, France, sells parts and provides after-sales support services in Europe, Africa and the Middle East.
  
  
• Embraer Aviation International SAS – "EAI" – located in Villepinte, France, sells parts and provides after-sales support services in Europe, Africa and the Middle East.
  

Embraer Credit Ltd. – "ECL" – a wholly-owned subsidiary, located in Delaware, United States, provides support for sales operations.

Embraer GPX Ltda – "GPX" – subsidiary with 99,9% of its capital is held by Embraer, created in 2006 and located in Gavião Peixoto, State of São Paulo, Brazil to provide specialized aircraft maintenance services, started operations in October 2009.

Embraer Overseas Limited – "EOS" – a wholly-owned subsidiary, located in the Cayman Islands, B.W.I., created in September 2006 with the sole objective of carrying out financial transactions, including rising and investing funds, intercompany loans for Embraer companies.

Embraer Representation LLC – "ERL" – a wholly-owned subsidiary, located in Delaware, United States, provides commercial and institutional representation for the Company.

Embraer Spain Holding Co. SL – "ESH" – a wholly-owned subsidiary, located in Spain. Its objective is to coordinate investments in subsidiaries abroad, including those focused on activities that support the sale of aircraft and Management of assets derived from these operations. ESH's operations are carried out by its subsidiaries, as follows:

• Airholding SGPS, S.A. – is located in Portugal and 70% of its capital is held by ESH. Its main activity is its 65% participation in the voting capital of OGMA – Indústria Aeronáutica de Portugal S.A., a Portuguese aviation maintenance and production company. The remaining 35% of the voting capital is held by Empresa Portuguesa de Defesa – EMPORDEF.
  


• ECC Investment Switzerland AG – located in Switzerland, holds 100% of the capital of the subsidiaries ECC Insurance & Financial Co. Ltd. and Embraer Finance Ltd. – EFL.
  
  
• ECC Insurance & Financial Co. Ltd. – located in the Cayman Islands, is an in-house insurance company providing cover for the financial guarantees offered to customers and/or financing agents involved in structuring the sales of Embraer aircraft.
  


• Embraer Finance Ltd. – "EFL" – located in the Cayman Islands, assists customers in obtaining third-party financing, as well as providing support for some of the Company's purchase and sale transactions.
  


• ECC Leasing Co. Ltd. – located in Ireland, its objective is the lease and sale of used aircraft.
  


• Harbin Embraer Aircraft Industry Company Ltd. – "HEAI" – based in Harbin, in China, its purpose is to manufacture aircraft in order to meet the air transportation market demand in China.
  


• Embraer CAE Training Services (UK) Ltd. – "ECUK" – created in 2009, is located in London, United Kingdom, and provides training for pilots, mechanics and crew. EMBRAER holds 51% of its capital.
  


• Embraer Portugal – SGPS S.A. – a wholly-owned subsidiary created in 2008, is located in Ever, Portugal, and its objective is to coordinate investments and economic activity in its subsidiaries in Portugal.
  


• Embraer-Portugal Estruturas Metálicas S.A. – created in 2008 and located in Portugal, in the city of Évora, its objective is the manufacture, assembly, maintenance and sale of parts, components and metal sets and carrying out other technical, industrial, commercial and service activities related to the metal products industry.
  


• Embraer-Portugal Estruturas em Compósitos S.A. – constituída em 2008, está domiciliada em Portugal, na cidade de Évora, tem como objeto social a fabricação, montagem e comercialização de estruturas a partir de peças e conjuntos em materiais compostos e a execução de outras atividades tecnológicas, industriais, comerciais e de serviços relacionados à indústria de produtos fabricados com materiais compostos e não metálicos.
  


• Embraer (China) Aircraft Techinical Services Co., Ltd – "ECA" – based in Beijing, its objective is to provide after-sales support services, maintenance services and sell parts to customers in China.
  

ECC do Brasil Cia. de Seguros – "ECC" – a wholly-owned subsidiary, located in Rio de Janeiro, State of Rio de Janeiro, Brazil, was created in 2004 and approved by the Private Insurance Agency – SUSEP. Its objective is to operate solely with export credit insurance. On December 7, 2007, Embraer's Board of Directors approved the proposal to sell all of its shares in ECC do Brasil Cia. de Seguros, and on April 7, 2009, Embraer signed a contract to this effect, subject to approval by the Private Insurance Agency – SUSEP, which has not yet been granted.

Indústria Aeronáutica Neiva Ltda. – "Neiva" – subsidiary with 99,9% of its capital is held by Embraer, located in Botucatu, State of São Paulo, Brazil, which currently sells agricultural aircraft and parts and components for this model of aircraft.

Special Purpose Companies – "SPEs" – the Company organizes some of its aircraft sale financing transactions through SPEs, in which the Company has no direct or indirect interest. Although it has no equity interests, the Company controls their operations or takes a majority share of their risks and rewards, and the SPEs are therefore consolidated in the financial statements of the parent company. The consolidated SPEs are: Table Inc., PM Limited, Refine Inc., RS Limited, River One Ltd. and Port One Ltd. Other SPEs in which Embraer has not control and has no continuous involvement were not consolidated, based on technical analyses made by Management.

Exclusive Investment Funds – in connection with its business strategies, the Company has investments in exclusive funds, which are consolidated in the financial statements. The balances of marketable securities and investments maintained through these Funds are recorded in the Cash and cash equivalents or Financial assets accounts, taking into consideration the original maturities of the securities and the fund investment strategies, which provide for negotiation of these securities in periods that reflect the immediate liquidity of the amounts (Note 7 and 8).

All intercompany accounts and transactions arising from consolidated entities have been eliminated.

• Currency that mainly influences sales prices of goods and services;
  
  
• Currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services;
  
  
• Currency that mainly influences labor, materials and other costs of providing goods or services;
  
  
• Currency in which the funds for financial operations are largely obtained; and
  
  
• Currency in which revenue from operations is usually received.
  

Items included in the financial statements of each of the Company's entities are measured using the currency of the primary economic environment in which the entity operates ('the functional currency'). The consolidated financial statements are presented in U.S. dollars, which is the Company's presentation currency.

• Land – mainly comprise areas on which the industrial, engineering and administrative buildings are located.
  
  
• Buildings and land improvements – buildings are mainly plants, engineering departments and offices, and land improvements include parking lots, road systems and water and sewage networks.
  
  
• Facilities – comprise auxiliary industrial facilities that directly or indirectly support the Company's industrial operations, as well as facilities of the engineering and administrative departments.
  
  
• Machinery and equipment – comprise the machinery and other equipment directly or indirectly used in the manufacturing process.


• Furniture and fixtures – comprise furniture and fixtures used in the production, engineering and administrative departments.


• Vehicles – comprise mainly industrial vehicles and automobiles.
  
  
• Aircraft – comprise mainly aircraft leased to airlines, and those used by the parent company to assist in testing new projects.


• Computers and peripherals – comprise technology equipment used mainly in the production process, engineering and administration.


• Property, plant and equipment in progress – comprise construction works to expand the manufacturing plants and aircraft maintenance centers.
  
  
• Spare parts pool – comprises a spare parts pool for the exclusive use of customers who are included in the Exchange Pool Program. This program allows these customers to exchange a damaged component for one in working condition, as defined in the Program. These items are depreciated based on estimated useful lives of seven to ten years and an average residual value of 35%, which the Company believes to be the approximate utilization time and realizable amount, respectively.

s) Leases

The classification of a lease depends on whether an agreement is or contains a lease, is based on the essence of the agreement and includes a determination as to if (i) the fulfillment of the agreement depends on the use of one or more specific assets; and (ii) the agreement assigns the right to use the asset

(i) Aircraft leases

Aircraft classified as operating leases are reported in the Company's balance sheet as property, plant and equipment, and depreciated over their estimated useful lives. The rental income (net of any subsidy granted to the lessee) is recorded by the straight-line method over the lease period. Aircraft classified as finance leases are not recorded in the Company's assets after the lease commences; the income and respective cost of sales are recorded on the date of the leasing transaction.

(ii) Other leases

Leases in which the Company holds substantially all the risks and benefits of ownership are classified as finance leases. Finance leases are recorded as a financed purchase, initially by recording a property, plant and equipment asset and a financial liability (lease). Property, plant and equipment assets purchased classified as finance leases are depreciated at the rates in Note 16.

Leases in which a significant part of the risks and benefits of ownership are assumed by the lessor are classified as operating leases. Payments made for operating leases are appropriated to the statement of income on the straight-line method over the contract period.

t) Borrowing costs

Borrowing costs attributable to acquisitions, buildings, or production of qualifying assets that need a substantial period of time to be ready for use or sale are capitalized as part of the cost of the asset. The additional borrowing costs are recognized as expenses in the period when they occur. Borrowing costs include interest and other costs that the Company incurs in connection with funds raising.

w) Employee benefits

(i) Defined contribution

The Company and its subsidiaries provide defined contribution pension plans for their employees. For the companies headquartered in Brazil, the administration of the plan was transferred from Banco do Brasil S.A. – BB Previdência to EMBRAER PREV – Sociedade de Previdência Complementar in 2010.

(ii) Post-retirement healthcare benefits

The Company provides healthcare benefits including medical treatment, reimbursement of costs of medications, dental treatment and other benefits for certain retirees who retired in the past and for certain retirees who will retire in the future.

The planned costs of offering post-retirement healthcare benefits and coverage for dependents are recorded as a provision during the period of employment.

The Company accounts for such benefits recognizing in its balance sheet the over or underfunded status of its defined benefit post-retirement plans, measured as the difference between the fair value of the plan assets and the benefit obligation. The Company also recognizes changes in the funded status of defined benefit post-retirement plans within other comprehensive income, net of tax, to the extent such changes are not recognized in earnings as components of periodic net benefit cost.

The funded status of the defined benefit pension and post-retirement medical benefit plans are recorded by the Company based on the funded status of each plan as of the balance sheet dates. The net periodic cost of the Company's post-retirement medical benefit plan and the terminated defined benefit pension was determined using the projected unit credit method and several actuarial assumptions, the most significant of which are the discount rate, the long-term rate of return on plan assets and the medical cost trend rate.

x) Earnings per share

Basic earnings per common share was computed by dividing net income attributable to owners of Embraer available to common shareholders by the weighted average number of common shares outstanding during the period.

Undistributed net income attributable to owners of Embraer is computed by deducting total dividends from net income attributable to owners of Embraer.

Diluted earnings per share is computed similarly to basic earnings per share except that the outstanding shares are increased to include the number of additional shares that would have been outstanding had the potentially dilutive shares attributable to stock options been issued during the respective periods, utilizing the treasury stock method.

y) Share-based payment

The Company operates an equity-settled, share-based compensation plan, under which the entity receives services from employees as consideration for equity instruments (options) of the Company. The fair value of the employee services received in exchange for the grant of the options is recognized as an expense. The total amount to be expensed is determined by reference to the fair value of the options granted.

The total expense is recognized over the vesting period, which is the period over which all of the specified vesting conditions are to be satisfied. At the end of each reporting period, the Company revises its estimates of the number of options that are expected to vest. It recognizes the impact of revisions to original estimates, if any, in the statement of income, with a corresponding adjustment to equity.

z) Employee profit-sharing plan
The employee profit-sharing program is linked to the Company's net income and to performance targets. Provisions are recorded monthly for the amounts determined proportionally to the salaries payable. The policies established for company profit-sharing are set forth in Note 31.

aa) Dividends and interest on own capital

Proposed distribution of dividends to shareholders is recorded as a liability in the Company's financial statements at the end of the tax year, based on the corporate bylaws. Any amount over and above the minimum mandatory dividends according to Brazilian Law is only provisioned when declared by the shareholders' meeting.

Interest on own capital, paid out or registered as a provision, is recorded in the accounts as a financial expense for tax purposes. However, for purposes of these financial statements, the amount is disclosed as a part of the net income for the year, and reclassified to shareholders' equity; the tax benefits arising from the distributions are included the net income for the year.

bb) Income tax and social contribution

Tax expenses for the period comprise current and deferred income tax. Tax is recorded in the statement of income, except to the extent that it relates to items recognized in Other comprehensive income or directly in Shareholders' equity. In this case, the tax is also recognized in Shareholders' equity.

The current income tax charge is calculated at the nominal rates applicable in each country, which on a composite, in the case of the Brazilian operations, approximate 34%, comprising income tax of 25% and social contribution on net income of 9%.

Deferred income tax is recognized using the liability method on temporary differences arising between the tax bases of assets and liabilities and their accounting values in the consolidated financial statements.

Deferred tax assets are recorded on income tax and social contribution losses, and on temporary differences between the book and tax bases of assets and liabilities, when it is probable that future taxable income will be sufficient to recover these tax credits. This assessment is based on projections of future results of operations prepared and supported by internal assumptions and on future economic scenarios and are, accordingly, subject to change.

There is no prescriptive period of the tax losses carryforwards from the Brazilian operations; however, their compensation is limited in future years to 30% of the tax payable in each year.

ff) Other current and non current liabilities

These are stated at known or estimated amounts including, when applicable, accrued charges and foreign exchange differences.

gg) Revenue recognition

Revenue comprises the fair value of the remuneration received or to be received for the sale of products and services in the normal course of business. Revenue is presented net of taxes, returns, reductions and discounts, and in the consolidated financial statements, after eliminating intercompany sales.

(i) Revenue from aircrafts and spare parts

Revenues from sales of commercial, executive and other aircraft, spare parts and services are generally recognized at the time of delivery or shipment, when the risks and benefits are transferred to the customer.

(ii) Revenue from after-sales support

Revenue from aircraft sales contracts involving the supply of spare parts, training and technical representation is recognized when effectively realized;

(iii) Revenue from Exchange Pool Program

Revenue from the spare parts pool programs is recognized during the period of the contract and consists of a fixed charge and a variable charge directly related to the hours effectively flown by the aircraft covered by this program;

(iv) Revenue from construction contracts

In the Defense and security business, includes long-term contracts the revenue from which is recognized according to the percentage-of-completion method, considering the percentage of costs incurred in relation to the estimated total costs. Some contracts contain clauses for price increases based on pre-established price indices which are recognized on an accrual basis. Adjustments of recognition of revenues from sales contracts in the Defense and security business sector are recorded when there is evidence that they will occur, based on Management's best estimates;

(v) Revenue from operating leases

The Company also recognizes the revenue from aircraft rental as operating leases, proportional to the lease period, and records such revenues as income under the "Other related businesses" line item of our segment reporting;

(vi) Sales deductions

Sales deductions comprise indirect sales taxes and contractual concessions. The Company may offer contractual concessions that provide customers with a reduction in the amount paid for the aircraft. The concessions are recorded as sales deductions, because the concessions represent a reduction of the sales price.

hh) Cost of sales and services

Cost of sales and services consist of the cost of the aircraft, spare parts and services rendered, comprising:

(i) Material – substantially all material cost are covered by contracts with suppliers. Prices under these contracts are generally adjusted based on escalation formula which reflect, in part, inflation in the United States;

(ii) Labor – these costs are primarily Real-denominated;

(iii) Depreciation – property, plant and equipment is depreciated over the useful lives, on a straight-line basis. Depreciation of aircraft classified as operating leases and exchange pool programs is recorded in Cost of sales and services, from the beginning of the lease term using the straight-line method over the estimated useful life and considering a residual value at the end of the lease term;

(iv) Amortization – Internally generated intangible assets are amortized in accordance with the estimated sales of the series of aircraft and intangible assets acquired from third parties are amortized on straight-line bases over the estimated useful lives of the assets.

The Company accrues a liability for obligations associated with product warranties at the aircraft delivery date estimated based on historical experience and recorded in Cost of sales and services, pursuant to the accounting standard for contingencies.

The Company enters into transactions that represent multiple-element arrangements, such as training, technical assistance, spare parts and others concessions. These costs are recognized when the product or service is provided to the customer.

ii) Operating expenses and other income

Operating expenses are basically made up of sales and marketing, administration, research and other operating expenses.

jj) Government grants

Refers to investment subsidies received from FINEP (Research and Projects Financing Agency) for joint development of technologically innovative projects, in accordance with Law No. 10,973/04, relating to subsidies for technological research and development. These amounts are recorded in the statement of income to the extent that the recourses are invested and the contractual milestones are met.

Government grants received for investments in research that is in accordance with pre determined conditions are recorded in the statement of income as a reduction of research expenses.

kk) Financial income and expenses

Financial income and expenses primarily comprise earnings on short-term investments, financial charges on loans, interest on contested taxes and contingencies (Note 34), as well as foreign exchange differences on assets and liabilities expressed in currencies other than the functional currency (U.S. dollars). Financial income and expenses exclude borrowing costs attributable to acquisitions, buildings or production of qualifying assets that need a substantial period of time to be ready for use or sale which are capitalized as part of the cost of the asset.

ll) Transitional tax regime

The transitional tax regime (Regime Tributário de Transição – RTT) will be in force until a law regulating the tax effects of the new accounting methods comes into effect, while seeking to maintain tax neutrality.

The regime was optional for tax-years 2008 and 2009 and is mandatory for 2010, as follows:

(i) Application to the two-year period 2008-2009, and not only to a single year; and
(ii) Declaration of the election in the corporate income tax return (DIPJ).

The Company decided to adopt the RTT in 2008. Accordingly, for purposes of determining income tax and social contribution for the years ended December 31, 2010 and 2009, the Company adopted the prerogatives set forth in the RTT.

mm) Statement of Cash Flows

The statement of cash flows was prepared on the indirect method in accordance with IAS 7 – Statement of Cash Flows.

nn) Segment reporting

Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker. The chief operating decision-maker, who is responsible for allocating resources and assessing performance of the operating segments and making strategic decisions, is the Chief Executive Officer.