Management's Discussion and Analysis of Financial Condition and Results of Operations

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Discussion and Analysis > Critical Accounting Policies and Estimates

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Income Taxes—Altria Group, Inc. accounts for income taxes in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” Under SFAS No. 109, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. The provision for income taxes is based on domestic and international statutory income tax rates and tax planning opportunities available in the jurisdictions in which Altria Group, Inc. operates. Significant judgment is required in determining income tax provisions and in evaluating tax positions. ALG and its subsidiaries establish additional provisions for income taxes when, despite the belief that their tax positions are fully supportable, there remain certain positions that are likely to be challenged and that may not be sustained on review by tax authorities. ALG and its subsidiaries adjust these additional accruals in light of changing facts and circumstances. The consolidated tax provision includes the impact of changes to these accruals, as well as the related net interest. If ALG’s and its subsidiaries’ filing positions are ultimately upheld under audits by respective taxing authorities, it is possible that the provision for income taxes in future years may reflect significant favorable adjustments. The tax provision in 2004 includes the reversal of $355 million of tax accruals that are no longer required due to foreign tax events that were resolved during the first quarter of 2004 at Kraft ($35 million) and the second quarter of 2004 at PMI ($320 million). The tax provision also reflects an $81 million favorable resolution of an outstanding tax item at Kraft, the majority of which occurred in the third quarter.

On October 22, 2004, the American Jobs Creation Act (“the Jobs Act”) was signed into law. The Jobs Act provides for a deduction of 85% of certain foreign earnings that are repatriated. Altria Group, Inc. may elect to apply this provision to qualifying earnings repatriations in 2005 and is conducting analyses of its effects. The U.S. Treasury Department recently provided additional clarifying language on key elements of the provision, which is under consideration as part of Altria Group, Inc.’s evaluation. Altria Group, Inc. expects to complete its evaluation of the effects of the repatriation provision within a reasonable period of time. The amount of dividends Altria Group, Inc. can repatriate under this provision is up to $7.1 billion. Since Altria Group, Inc. has provided deferred taxes on a portion of its unrepatriated earnings, there is a potential financial statement income tax benefit upon repatriations under the Jobs Act. Assuming certain expected technical amendments to the Jobs Act are enacted and the entire $7.1 billion were repatriated, the income tax benefit would be approximately $80 million.

The Jobs Act also provides tax relief to U.S. domestic manufacturers by providing a tax deduction of up to 9% of the lesser of “qualified production activities income” or taxable income. In December 2004, the FASB issued FASB Staff Position 109-1, “Application of FASB Statement No. 109, ‘Accounting for Income Taxes,’ to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (“FSP 109-1”). FSP 109-1 requires companies to account for this deduction as a “special deduction” rather than a rate reduction, in accordance with SFAS No. 109, and therefore, Altria Group, Inc. will recognize these benefits in the year earned.

Hedging—As discussed below in “Market Risk,” Altria Group, Inc. uses derivative financial instruments principally to reduce exposures to fluctuations in foreign exchange rates and commodity prices. Altria Group, Inc. conforms with the requirements of U.S. GAAP in order to account for a substantial portion of its derivative financial instruments as hedges. As a result, gains and losses on these derivatives are deferred in accumulated other comprehensive earnings (losses) and recognized in the consolidated statement of earnings in the periods when the related hedged transaction is also recognized in operating results. If Altria Group, Inc. had elected not to use and comply with the hedge accounting provisions permitted under U.S. GAAP, gains (losses) deferred as of December 31, 2004, 2003 and 2002, would have been recorded in net earnings.



Impairment of Long-Lived Assets—Altria Group, Inc. reviews long-lived assets, including amortizable intangible assets, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. Altria Group, Inc. performs undiscounted operating cash flow analyses to determine if an impairment exists. For purposes of recognition and measurement of an impairment for assets held for use, Altria Group, Inc. groups assets and liabilities at the lowest level for which cash flows are separately identifiable. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.

Leasing—More than 85% of PMCC’s net revenues in 2004 related to leveraged leases. Income relating to leveraged leases is recorded initially as unearned income, which is included in finance assets, net, on Altria Group, Inc.’s consolidated balance sheets, and is subsequently recorded as net revenues over the life of the related leases at a constant after-tax rate of return. The remainder of PMCC’s net revenues consists primarily of amounts related to direct finance leases, with income initially recorded as unearned and subsequently recognized in net revenues over the life of the leases at a constant pre-tax rate of return. As discussed further in Note 8. Finance Assets, net, PMCC leases a number of aircraft which were affected by developments in the airline industry during 2004, 2003 and 2002.

PMCC’s investment in leases is included in finance assets, net, on the consolidated balance sheets as of December 31, 2004 and 2003. At December 31, 2004, PMCC’s net finance receivable of $7.6 billion in leveraged leases consists of lease receivables ($27.0 billion) and the residual value of assets under lease ($2.1 billion), reduced by third-party nonrecourse debt ($18.3 billion) and unearned income ($3.2 billion). The payment of the nonrecourse debt is collateralized only by lease payments receivable and the leased property, and is nonrecourse to all other assets of PMCC. As required by U.S. GAAP, the third-party nonrecourse debt has been offset against the related rentals receivable and has been presented on a net basis. Finance assets, net, at December 31, 2004, also includes net finance receivables for direct finance leases of $0.7 billion and an allowance for losses ($0.5 billion).

Estimated residual values represent PMCC’s estimate at lease inception as to the fair value of assets under lease at the end of the lease term. The estimated residual values are reviewed annually by PMCC’s management based on a number of factors and activity in the relevant industry. If necessary, revisions to reduce the residual values are recorded. Such reviews resulted in a decrease of $25 million to PMCC’s net revenues and operating results in 2004. There were no adjustments in 2003 and 2002. To the extent that lease receivables due PMCC may be uncollectible, PMCC records an allowance for losses against its finance assets. During 2004 and 2002, PMCC increased this allowance by $140 million and $290 million, respectively, in consideration of the continuing downturn in the airline industry. PMCC’s aggregate finance asset balance related to aircraft was approximately $2.2 billion at December 31, 2004. It is possible that further adverse developments in the airline industry may require PMCC to increase its allowance for losses in future periods.