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

(Continued)

Discussion and Analysis Critical Accounting Policies

(Continued)

Income Taxes—Altria Group, Inc. accounts for income taxes in accordance with Statement of Financial Accounting Standard (“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 accruals that are considered appropriate, 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.

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, 2003, 2002 and 2001, would have been recorded in net earnings.

Leasing—More than 75% of PMCC’s net revenues in 2003 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 consist 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 7. Finance Assets, net, PMCC leases a number of aircraft which were affected by developments in the airline industry during 2003 and 2002.

PMCC’s investment in leases is included in finance assets, net, on the consolidated balance sheets as of December 31, 2003 and 2002. At December 31, 2003, PMCC’s net finance receivable of $7.8 billion in leveraged leases, which is included in Altria Group, Inc.’s consolidated balance sheet as finance assets, net, consists of lease receivables ($28.6 billion) and the residual value of assets under lease ($2.2 billion), reduced by third-party nonrecourse debt ($19.4 billion) and unearned income ($3.6 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, within finance assets, net, in Altria Group, Inc.’s consolidated balance sheets. Finance assets, net, at December 31, 2003 also includes net finance receivables for direct finance leases of $0.9 billion and an allowance for losses ($0.4 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, including appraisals on certain assets, and activity in the relevant industry. If necessary, revisions to reduce the residual values are recorded. Such reviews have not resulted in adjustments to Altria Group, Inc.’s consolidated net revenues or operating results for any of the periods presented. To the extent that lease receivables due PMCC may be uncollectible, PMCC records an allowance for losses against its finance assets. During 2002, PMCC increased this allowance by $290 million for leases with the airline industry. PMCC’s investment in finance leases includes an aggregate of approximately $2.3 billion relating to the airline industry as of December 31, 2003. It is possible that further adverse developments in the airline industry may occur, which might require PMCC to record an additional allowance for losses in future periods.