Notes to Consolidated Financial Statements

Years ended December 31, 1998, 1997 and 1996
(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 majority-owned subsidiaries. Investments in joint ventures in which the Company does not have control, but has the ability to exercise significant influence over the operating and financial policies, are accounted for under the equity method. Accordingly, the Company’s share of net earnings and losses from these ventures is included in the consolidated statements of operations. 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 fixed-price-type contracts are generally recognized as deliveries are made or at the completion of contractual billing milestones. 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. Commercial aircraft sales are recorded as deliveries are made unless transfer of risk and rewards of ownership is not sufficient. Income associated with customer financing activities is included in sales and other operating revenues.

Contract and program accounting
In the Military Aircraft and Missiles segment and Space and Communications segment, operations principally consist of performing work under contract, predominantly for the U.S. Government and foreign governments. Cost of sales for such contracts is determined based on the estimated average total contract cost and revenue.

Commercial aircraft 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 the 737, 747, 757, 767 and 777 commercial aircraft programs is determined under the program method of accounting based on estimated average total cost and revenue for the current 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 aircraft programs normally have lower operating profit margins than established programs. The initial program quantities for the 777 program and the 737-600/700/800/900 (Next-Generation 737) programs had been established at 400 units, the same initial program quantity as used for the 747, 757 and 767 programs. Deliveries for the 777 program began in 1995, and deliveries for the Next-Generation 737 program began in 1997. The estimated program average costs and revenues are reviewed and reassessed quarterly, and changes in estimates are recognized over current and future deliveries constituting the program quantity. Cost of sales for the MD-80, MD-90 and MD-11 aircraft programs is determined on a specific-unit cost method.

To the extent that inventoriable costs are expected to exceed the total estimated sales price, charges are made to current earnings to reduce inventoried costs to estimated realizable value.

Inventories
Inventoried costs on commercial aircraft programs and long-term contracts include direct engineering, production and tooling costs, and applicable overhead, 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.

Share-based plans
In 1998 the Company adopted the expense recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. The Company values stock options issued based upon an option-pricing model and recognizes this value as an expense over the period in which the options vest. Potential distribution from the ShareValue Trust, described in Note 16, have been valued based upon an option-pricing model, with the related expense recognized over the life of the trust. Share-based expense associated with Performance Shares described in Note 16 is determined based on the market value of the Company’s stock at the time of the award applied to the maximum number of shares contingently issuable based on stock price, and is amortized over a five-year award period. Performance Shares were first issued in 1998. Prior to 1998, the Company recognized no expense for stock options, and ShareValue Trust expense was determined based on the change in the distributable market value of the trust. Share-based plans expenses for stock options, the ShareValue Trust, Performance Shares and other share-based awards are offset by a credit to additional paid-in capital.

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.

Income taxes
Federal, state and foreign income taxes are computed at current tax rates, less tax credits. Taxes are adjusted both for items that do not have tax consequences and for the cumulative effect of any changes in tax rates from those previously used to determine deferred tax assets or liabilities. Tax provisions include amounts that are currently payable, plus changes in deferred tax assets and liabilities that arise because of temporary differences between the time when items of income and expense are recognized for financial reporting and income tax purposes.

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 age at retirement, the employee’s annual earnings indexed at the U.S. Treasury 30-year bond rate, and years of service. 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, consisting principally of U.S. Government Treasury obligations, are classified as trading securities with unrealized gains and losses reflected in other income.

Property, plant and equipment
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; and machinery and equipment, from 3 to 13 years. The principal methods of depreciation are as follows: buildings and land improvements, 150% declining balance; and machinery and equipment, sum-of-the-years’ digits.

Goodwill
Goodwill, representing the excess of acquisition costs over the fair value of net assets of businesses purchased, is being amortized by the straight-line method over 30 years. Recoverability of the unamortized goodwill balance is based upon assessment of related operational cash flows.

Note 2
Mergers and Acquisitions

Merger with McDonnell Douglas Corporation
On August 1, 1997, McDonnell Douglas Corporation merged with the Company through a stock-for-stock exchange in which 1.3 shares of Company stock were issued for each share of McDonnell Douglas stock outstanding. The Company issued 277.3 million shares in connection with the merger. The merger is accounted for as a pooling of interests. Accordingly, except for adjustments to reflect conformed accounting policies, the historical results of operations of the two companies have been combined, and no acquisition revaluation or goodwill was recorded.

The merger was subject to approval by the United States Federal Trade Commission and the European Commission. Future requirements or obligations associated with obtaining these approvals are not expected to have a material impact on future operations or liquidity of the Company.

Acquisition of Rockwell aerospace and defense business
On December 6, 1996, the Company acquired Rockwell’s aerospace and defense business by issuing 9.2 million shares of common stock valued at $875 and assuming debt valued at $2,180. This transaction has been accounted for under the purchase method. The assets and liabilities have been recorded at fair value with excess purchase price recorded as goodwill.

Note 3
Special Charges - Douglas Products
Valuation Adjustment

In the fourth quarter of 1997, the Company completed an assessment of the financial impact of its post-merger strategy decisions related to its McDonnell Douglas Corporation commercial aircraft product lines and recorded a special charge of $1,400 relative to these decisions. The charge principally represents an inventory valuation adjustment based on post-merger assessments of the market conditions and related program decisions and commitments. Also included in the charge were valuation adjustments in connection with customer financing assets. The applicable programs currently in production are the MD-11 trijet and the MD-80 and MD-90 twinjets. Additionally, the MD-95 twinjet, now referred to as the 717 model program, is currently in development, with first delivery scheduled for 1999. The MD-80 and MD-90 twinjets and the MD-11 trijet will continue to be produced through 2000.

Note 4
Earnings from Joint Ventures

Operating costs and expenses in the Consolidated Statements of Operations include costs of $127, $102 and $53 for the years ending December 31, 1998, 1997 and 1996, respectively, representing the Company’s share of losses from joint venture arrangements in the developmental stages accounted for under the equity method. The Company’s principal joint venture arrangement in the developmental stages is a 40% partnership in the Sea Launch program, a commercial satellite launch venture with Norwegian, Russian and Ukrainian partners.

Additionally, the Company recognized income of $60, $59 and $2 for the years ending December 31, 1998, 1997 and 1996, respectively, attributable to non-developmental joint venture arrangements. The Company’s 50% partnership with Lockheed Martin in United Space Alliance is the principal non-developmental joint venture arrangement. United Space Alliance is responsible for all ground processing of the Space Shuttle fleet and for space-related operations with the U.S. Air Force.

Note 5
Earnings per Share

The weighted average number of shares outstanding (in millions) used to compute basic earnings per share were 966.9, 970.1 and 968.7 for the years ended December 31, 1998, 1997 and 1996, respectively. The weighted average number of shares outstanding (in millions) used to compute diluted earnings per share were 976.7, 970.1 and 981.9 for the same respective years. Basic earnings per share are calculated based on the weighted average number of shares outstanding, excluding treasury shares and the outstanding shares held by the ShareValue Trust. Diluted earnings per share are calculated based on that same number of shares plus additional dilutive shares representing stock distributable under stock option plans computed using the treasury stock method plus contingently issuable shares from other share-based plans. Because 1997 results reflected a net loss from continuing operations, both basic and diluted earnings per share were calculated based on the same weighted average number of shares for that year.

Note 6
Accounts Recievable

Accounts receivable at December 31 consisted of the following:

Accounts receivable included the following as of December 31, 1998 and 1997, respectively: amounts not currently billable of $381 and $587 relating primarily to sales values recorded upon attainment of performance milestones that differ from contractual billing milestones and withholds on U.S. Government contracts ($109 and $161 not expected to be collected within one year); $93 and $341 relating to claims and other amounts on U.S. Government contracts subject to future settlement ($66 and $333 not expected to be collected within one year); and $48 and $62 of other receivables not expected to be collected within one year.

Note 7
Inventory

Inventories at December 31 consisted of the following:

As of December 31, 1998, there were no significant excess deferred production costs (inventory 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) or unamortized tooling costs not recoverable from existing firm orders for commercial programs other than the 777 and the Next-Generation 737 programs. The program quantity for the 777 and the Next-Generation 737 programs for determining cost of sales based on estimated average total cost (including inventory production costs and tooling) and revenue was initially established at 400 units. In 1998 the accounting quantity for the Next-Generation 737 program was extended beyond the initial program quantity. The current accounting quantity for the Next-Generation 737 program is 1,200 units.

Inventory costs at December 31, 1998, included unamortized tooling of $2,022 and $760 relating to the 777 and Next-Generation 737 programs, and excess deferred production costs of $1,654 and $329 relating to the 777 and Next-Generation 737 programs. Inventory costs at December 31, 1997, included unamortized tooling of $2,678 and $809 relating to the 777 and Next-Generation 737 programs, and excess deferred production costs of $2,384 relating to the 777 program. Firm backlog for both the 777 and Next-Generation 737 programs is sufficient to recover all significant amounts of excess deferred production costs as of December 31, 1998; however, such deferred costs are recognized over the current program accounting quantity in effect at the date of reporting.

Interest capitalized as construction-period tooling costs amounted to $20, $33 and $30 in 1998, 1997 and 1996, respectively.

As of December 31, 1998 and 1997, inventory balances included $231 subject to claims or other uncertainties primarily relating to the A-12 program. See Note 21.

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 22.

The Boeing Company and Subsidiaries

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