The experience over the past two years has resulted in a range of plus or minus 0.5% for the combined gross margin of all contracts in the Military Aircraft and Missile Systems and the Space and Communications segments. If combined gross margin for all contracts in the Military Aircraft and Missile Systems and the Space and Communications segments for all of 2002 had been estimated to be higher or lower by 0.5% it would have increased or decreased income for the year by approximately $125 million.

Program accounting The Company uses program accounting for its 7-series commercial airplane programs. Program accounting is a method of accounting for the costs of certain products manufactured for delivery under production type contracts where profitability is realized over multiple contracts and years. Under program accounting, inventoriable production costs (including overhead), program tooling costs and warranty costs are accumulated and charged to revenue by program instead of by individual units or contracts. A program consists of the estimated number of units (accounting quantity) of a product to be produced in a continuing, long-term production effort for delivery under existing and anticipated contracts. To establish the relationship of revenue to cost of sales, program accounting requires estimates of (a) the number of units to be produced and sold in a program, (b) the period over which the units can reasonably be expected to be produced, and (c) their expected selling prices, production costs, program tooling, and warranty costs for the total program.

The reliance on estimates in the use of program accounting requires the demonstrated ability to reliably estimate the cost-revenue relationship for the defined program accounting quantity. The factors that must be estimated include selling price, labor and employee benefit costs, material costs, procured parts and major component costs, and overhead costs. To meet this requirement the Company employs a rigorous estimating process that is reviewed and updated on a quarterly basis. Changes in estimate are recognized on a prospective basis.

Underlying all estimates used for program accounting is the assumed market and the corresponding production rates. The program accounting quantity is established based upon the assumed market. The total program revenue is determined by estimating the model mix and sales price for all unsold units within the accounting quantity added together with the revenue for all undelivered units under contract. The sales prices for all undelivered units within the accounting quantity include an escalation adjustment that is based on projected escalation rates. Cost estimates are based in a large part on historical performance trends, business base and other economic projections, and information provided by suppliers. Factors that influence these estimates include production rates, internal and subcontractor performance trends, asset utilization, anticipated labor agreements, and inflationary trends.

The Company recognizes revenue for commercial airplanes when a unit is completed and accepted by the customer. The revenue recognized is the price negotiated with the customer including special features adjusted by an escalation formula. The amount reported as cost of sales is determined by applying the estimated cost of sales percentage for the total remaining program to the amount of revenue recognized for the quarter. Because of the higher unit production costs experienced at the beginning of a new airplane program (known as the learning curve effect), the actual costs incurred for production of the early units in the program will exceed the amount reported as cost of sales for those units. This difference known as deferred production costs is included in inventory along with unamortized tooling costs.

The experience of the last two years, with all programs being relatively mature, has been that estimate changes due to model mix, escalation, cost performance, and accounting quantity increases have resulted in a range of plus or minus 0.5% for the combined gross margin of all commercial airplane programs. If combined gross margin for all commercial airplane programs for all of 2002 had been estimated to be higher or lower by 0.5% it would have increased or decreased income for the year by approximately $122 million.

Aircraft valuation

Used aircraft under trade-in agreements The Company enters into certain trade-in agreements to purchase used aircraft from customers at a specific price at a future point in time when those customers purchase new aircraft from the Company. In the event the Company accepts an aircraft under a trade-in agreement, the aircraft purchased by the Company serves as collateral to offset amounts paid by the Company to the customer.

Obligations recorded from trade-in aircraft agreements are measured as the difference between gross amounts payable to customers and the estimated fair value of the collateral. The fair value of collateral is determined using a process based on the net present value of expected future cash flows from the trade-in aircraft, assuming the most likely market placement of the aircraft. The first step in this process uses the Company’s assessment of the market for each trade-in aircraft, which in most instances begins years before the return of the aircraft. There are several possible markets to which the Company continually pursues opportunities to place used aircraft. These markets include, but are not limited to, (1) the resale market, which could potentially include the cost of long-term storage, (2) the leasing market, with the potential for refurbishment costs to meet the leasing customer’s requirements, or (3) the scrap market. Collateral valuation varies significantly depending on which market the Company determines is most likely for each aircraft. On a quarterly basis, the Company updates its valuation analysis based on the actual activities associated with placing each aircraft into a market. This quarterly collateral valuation process yields results that are typically lower than residual value estimates by independent sources and tends to more accurately reflect results upon the actual placement of the aircraft.

Based on the best market information available at the time, the Company deemed it probable that it would be obligated to perform on trade-in agreements with gross amounts payable to customers totaling $1,370 million and $1,340 million as of December 31, 2002 and 2001, respectively. Accounts payable and other liabilities included $156 million and $189 million as of December 31, 2002 and 2001, respectively, which represents the trade-in aircraft exposure related to these trade-in agreements.