Notes to Consolidated Financial Statements

Financial Report 1995

Notes to Consolidated Financial Statements

Years ended December 31, 1995, 1994 and 1993
(Dollars in millions except per share data)

Note 1
Summary of Significant Accounting Policies

Principles of consolidation
The consolidated financial statements include the accounts of all subsidiaries. Intercompany profits, transactions and balances have been eliminated in consolidation.

Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make assumptions and estimates that directly affect the amounts reported in the consolidated financial statements. Significant estimates for which changes in the near term are considered reasonably possible and that may have a material impact on the financial statements are addressed in these notes to the consolidated financial statements.

Sales and other operating revenues
Sales under commercial programs and U.S. Government and foreign military fixed-price contracts are generally recorded as deliveries are made. For certain fixed-price contracts that require substantial performance over an extended period before deliveries begin, sales are recorded based upon attainment of scheduled performance milestones. Sales under cost-reimbursement contracts are recorded as costs are incurred. Certain U.S. Government contracts contain profit incentives based upon performance relative to predetermined targets. Incentives based on cost performance are recorded currently, and other incentives and fee awards are recorded when the amounts can be reasonably estimated or are awarded. Income associated with customer financing activities is included in sales and other operating revenues.

Contract and program accounting
Defense and space segment operations principally consistof performing work under U.S. Government and foreign military contracts. Cost of sales for such contracts is determined based on the estimated average total contract cost and revenue. To the extent the total of such costs is expected to exceed the total estimated sales price, charges are made to current earnings to reduce inventoried costs to estimated realizable value.

Commercial jet transport programs are planned, committed and facilitized based on long-term delivery forecasts, normally for quantities in excess of contractually firm orders. Cost of sales for all commercial jet transport programs is determined based on estimated average total cost and revenue for the current program commitment quantity. For new commercial jet transport programs, the program quantity is initially based on an established number of units representing what is believed to be a conservative market projection. Program commitment quantities generally represent deliveries for the next three to five years, although the initial program quantity for new programs will normally include orders and deliveries over periods up to ten years. The initial program quantity for the new 777 program has been established at 400 units, the same initial program quantity as for the 747 program in 1969 and for the 767 and 757 programs in 1982. The commercial program method of accounting, an industry-developed practice adopted by the Company in the 1960s and applied to all commercial jet transport programs since that time, requires the demonstrated ability to reliably estimate and manage the cost-revenue relationship for the defined program quantity. The program method of accounting effectively amortizes or averages tooling and special equipment costs, as well as unit production costs, over the program quantity. Because of the higher unit production costs experienced at the beginning of a new program and the substantial investment required for initial tooling and special equipment, new commercial jet transport programs normally have lower operating profit margins than established programs. The estimated program average costs and revenues are reviewed and reassessed quarterly, and changes in estimates are recognized over current and future deliveries comprising the program quantity.

Inventories
Inventoried costs on long-term commercial jet transport programs and U.S. Government and foreign military contracts include direct engineering, production and tooling costs, and applicable overhead. In addition, for U.S. Government fixed-price-incentive contracts, inventoried costs include research and development and general and administrative expenses estimated to be recoverable. Inventoried costs associated with commercial jet transport programs and long-term contracts, less estimated average cost of sales, are not in excess of estimated realizable value. In accordance with industry practice, inventoried costs include amounts relating to programs and contracts with long production cycles, a portion of which is not expected to be realized within one year. Commercial spare parts and general stock materials are stated at average cost not in excess of realizable value.

Research and development, general and administrative expenses
Research and development and general and administrative expenses are charged directly to earnings as incurred except to the extent estimated to be directly recoverable under U.S. Government flexibly priced contracts.

Interest expense
Interest and debt expense is presented net of amounts capitalized. Interest expense is subject to capitalization as a construction-period cost of property, plant and equipment and of commercial program tooling.

Postretirement benefits
The Company’s funding policy for pension plans is to contribute, at a minimum, the statutorily required amount to an irrevocable trust. Benefits under the plans are generally based on years of credited service, age at retirement and average of last five years’ earnings. The actuarial cost method used in determining the net periodic pension cost is the projected unit credit method.

Cash and cash equivalents
Cash and cash equivalents consist of highly liquid instruments, such as certificates of deposit, time deposits, treasury notes and other money market instruments, which generally have maturities of less than three months.

Short-term investments
Short-term investments principally consist of U.S. Government Treasury obligations, with unrealized gains and losses reflected in other income.

Capital assets
Property, plant and equipment are recorded at cost, including applicable construction-period interest, and depreciated principally over the following estimated useful lives: new buildings and land improvements, from 20 to 45 years; machinery and equipment, from 3 to 10 years. The principal methods of depreciation are as follows: building and land improvements, 150% declining balance; machinery and equipment, sum-of-the-years’ digits.

Per share data
Net earnings per share are computed based on the weighted average number of shares outstanding of 342,159,741; 340,574,779; and 339,736,640 for the years ended December 31, 1995, 1994 and 1993, respectively. There is no material dilutive effect on net earnings per share due to common stock equivalents.

Note 2
Accounts Receivable

Accounts receivable at December 31 consisted of the following:

Accounts receivable included the following as of December 31, 1995 and 1994, respectively: amounts not currently billable of $119 and $137 relating primarily to sales values recorded upon attainment of performance milestones that differ from contractual billing milestones and withholds on U.S. Government contracts ($65 and $109 not expected to be collected within one year); $162 and $212 relating to claims and other amounts on U.S. Government contracts subject to future settlement ($19 and $212 not expected to be collected within one year); and $46 and $41 of other receivables not expected to be collected within one year.

Note 3
Inventories

Inventories as of December 31, 1995 and 1994, consisted of $13,107 and $10,352 relating to long-term commercial programs and U.S. Government and foreign military contracts, and $894 and $917 relating to commercial spare parts, general stock materials and other inventories. General and administrative and research and development expenses included in inventories represented less than 1% of total inventories. Interest capitalized as construction-period tooling costs amounted to $33, $36 and $50 in 1995, 1994 and 1993, respectively.

As of December 31, 1995, there were no significant deferred production costs in excess of estimated average cost of deliveries or unamortized tooling costs not recoverable from existing firm orders for commercial programs other than the 777 and 737-600/700/800 programs. The program quantity for the 777 program for determining deferred production costs in excess of aggregate estimated average cost and over which total tooling costs will be amortized and absorbed in cost of sales has been established at 400 units. Inventory costs relating to the 777 program included unamortized tooling of $3,241 and $3,089 at December 31, 1995 and 1994, and $1,440 at December 31, 1995 of deferred production costs incurred on in-process and delivered units in excess of the estimated average cost of such units determined as described in Note 1. It is estimated that $2,285 of such amounts will be recovered from firm orders received after December 31, 1995. As of December 31, 1995, 183 777s were under firm contract and 13 777s had been delivered. The program quantity for the 737-600/700/800 program for determining the deferred production costs in excess of aggregate estimated average cost and over which total tooling costs will be amortized will be established when deliveries commence in 1997. Inventory costs relating to the 737-600/700/800 program included tooling of $274 at December 31, 1995.

As of December 31, 1995, 212 737-600/700/800s were under firm contract. As of December 31, 1995 and 1994, inventory balances included $324 and $318 subject to claims or other uncertainties related to U.S. Government contracts, principally for the Peace Shield program. (See Note 17.)

The estimates underlying the average costs of deliveries reflected in the inventory valuations may differ materially from amounts eventually realized for the reasons outlined in Note 18.

Note 4
Customer Financing

Long-term customer financing, less current portion, at December 31 consisted of the following:

Financing for aircraft is collateralized by security in the related asset, and historically, the Company has not experienced a problem in accessing such collateral. The operating lease aircraft category includes new and used jet and commuter aircraft, spare engines and spare parts.

Scheduled principal payments from notes receivable and sales-type leases for the next five years are as follows:

The Company has entered into interest rate swaps with third-party investors whereby the interest rate terms differ from the terms in the original receivable. These interest rate swaps related to $67 of customer financing receivables as of December 31, 1995.

Interest rates on fixed-rate notes ranged from 7.87% to 13.215%, and effective interest rates on variable-rate notes ranged from the London Interbank Offered Rate (LIBOR) to 4.05% above LIBOR.

Sales and other operating revenues included interest income associated with notes receivable and sales-type leases of $160, $183 and $153 for 1995, 1994 and 1993, respectively.

The valuation allowance is subject to change depending on estimates of collectability and realizability of the customer financing balances.

Note 5
Property, Plant and Equipment

Property, plant and equipment at December 31 consisted of the following:

Interest capitalized as construction-period property, plant and equipment costs amounted to $32, $51 and $100 in 1995, 1994 and 1993, respectively.

Note 6
Taxes on Income

The provision for federal taxes on income consisted of the following:

State taxes on income, which are relatively minor in amount, are included in general and administrative expense. The provisions for federal taxes on income were less than those which result from application of the statutory corporate tax rates due to the following:

The deferred tax assets, net of deferred tax liabilities, resulted from an alternative minimum tax credit carry-forward and from temporary tax differences associated with the following:

The alternative minimum tax credit carryforward produces a future tax benefit that may be carried forward indefinitely.

The temporary tax differences associated with inventory and long-term contract methods of income recognition encompass related costing differences, including timing and depreciation differences.

Valuation allowances were not required due to the nature of and circumstances associated with the temporary tax differences.

In response to an Internal Revenue Service clarification of a transition rule relating to the repeal of investment tax credit under the Tax Reform Act of 1986, the Company is conducting a comprehensive study regarding prior years’ investments that may qualify for additional investment tax credit. The study will likely result in recognition of additional prior years’ investment tax credit benefits. Income taxes have been settled with the Internal Revenue Service for all years through 1978, and Internal Revenue Service field examinations have been completed through 1987. The Company believes adequate provision has been made for all open years. Favorable resolution of certain claims by the Company could potentially result in reductions in future tax provisions. Federal income tax payments (refunds) and transfers were $(91), $401 and $908 in 1995, 1994 and 1993, respectively.

Note 7
Other Assets

Other assets at December 31 consisted of the following:

Note 8
Accounts Payable and Other Liabilities

Accounts payable and other liabilities at December 31 consisted of the following:

Note 9
Long-Term Debt

Long-term debt at December 31 consisted of the following:

The $300 debentures due August 15, 2024, are redeemable at the holder’s option on August 15, 2012. All other debentures and notes are not redeemable prior to maturity. The $100 notes due August 15, 2042, with a stated rate of 7.50% were issued to a private investor in connection with an interest rate swap arrangement that resulted in an effective synthetic rate of 7.865%.

Maturities of long-term debt for the next five years are as follows:

Interest payments were $210, $210 and $175 in 1995, 1994 and 1993, respectively.

The Company has $2,000 currently available under credit-line agreements with a group of commercial banks. Under these agreements, revised as of September 29, 1995, $1,000 is available until September 27, 1996, and $1,000 is available until September 30, 2002. There are compensating balance arrangements, and retained earnings totaling $1,458 are free from dividend restrictions. The Company has complied with restrictive covenants contained in the various debt agreements.

Note 10
Postretirement Plans

Pensions
The Company has various noncontributory plans covering substantially all employees. All major plans are funded and have plan assets that exceed accumulated benefit obligations. The following table reconciles the plans’ funded status to the prepaid expense balance at December 31.

The actuarial present value of the projected benefit obligation at December 31, 1995, 1994 and 1993, respectively, was determined using a weighted average discount rate of 7.0%, 8.5% and 7.25%, and a rate of increase in future compensation levels of 5.0%, 5.75% and 5.0%. The expected long-term rate of return on plan assets at December 31, 1995, 1994 and 1993, respectively, was 8.0%, 8.0% and 8.5%.

The pension plans provide that, in the event there is a change in control of the Company which is not approved by the Board of Directors and the plans are terminated within five years thereafter, the assets in the plans first will be used to provide the level of retirement benefits required by the Employee Retirement Income Security Act, and then any surplus will be used to fund a trust to continue present and future payments under the postretirement medical and life insurance benefits in the Company’s group insurance programs.

The Company has an agreement with the Government with respect to certain of the Company pension plans. Under the agreement, should the Company terminate any of the plans (although the Company has no intention of doing so) under conditions in which the plan’s assets exceed that plan’s obligations, the Government will be entitled to a fair allocation of any of the plan’s assets based on plan contributions that were reimbursed under Government contracts. Also, the Revenue Reconciliation Act of 1990 imposes a 20% nondeductible excise tax on the gross assets reverted if the Company establishes a qualified replacement plan or amends the terminating plan to provide for benefit increases; otherwise, a 50% tax is applied. Any net amount retained by the Company is treated as taxable income.

A special retirement program was offered during the first half of 1995 to encourage early retirements, resulting in a pretax charge of $600. The special retirement program will be funded over a minimum of ten years through the Company’s retirement plan. The projected benefit obligation at June 30, 1995, the date at which the special retirement program expense was recognized, was determined using a weighted average discount rate of 7.75%.

The Company has certain unfunded and partially funded plans with a projected benefit obligation of $233 and $132; plan assets of $38 and $5; and unrecognized prior service costs and actuarial losses of $85 and $39 as of December 31, 1995 and 1994, respectively, based on actuarial assumptions consistent with the funded plans. The net provision for the unfunded plans was $27 and $23 for 1995 and 1994.

The principal defined contribution plans are the Company-sponsored 401(k) plans and a funded plan for unused sick leave. Under the terms of the Company-sponsored 401(k) plans, eligible employees were allowed to contribute up to 12% of their base pay (15% beginning in 1996). The Company contributes amounts equal to 50% of the employee’s contribution to a maximum of 4% of the employee’s pay, subject to statutory limitations. The provision for these defined contribution plans in 1995, 1994 and 1993 was $190, $206 and $213, respectively.

Other postretirement benefits
The Company’s postretirement benefits other than pensions consist of health care coverage for eligible retirees and qualifying dependents. Except for employees covered by the United Auto Workers bargaining agreement for whom lifetime benefits are provided, retiree health care is provided principally until age 65.

The retiree health care cost provision was $246, $218 and $230 for 1995, 1994 and 1993, respectively. The components of expense were as follows:

Benefit costs were calculated based on assumed cost growth for retiree health care costs of an 8.9% annual rate for 1996, decreasing to a 5.0% annual growth rate by the year 2008. A 1% increase or decrease in the assumed annual trend rates would increase or decrease the accumulated retiree health care obligation by $271, $231 and $218 as of December 31, 1995, 1994 and 1993, respectively, with a corresponding effect on the retiree health care expense of $41, $37 and $39. The accumulated retiree health care obligation at December 31, 1995, 1994 and 1993 was determined using a weighted average discount rate of 7.0%, 8.5% and 7.25%, respectively.

The accumulated retiree health care obligation at December 31 consisted of the following components:

The special retirement program offered during the first half of 1995 did not result in an additional retiree health care cost due to offsetting unrecognized actuarial gains.

Note 11
Research and Development, General and Administrative Expenses

Expenses charged directly to earnings as incurred included the following: