The Boeing Company and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Dollars in millions)

(Unaudited)

Note 1 – Basis of Presentation

The condensed consolidated interim financial statements included in this report have been prepared by The Boeing Company and its subsidiaries. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation are reflected in the interim financial statements. The results of operations for the period ended June 30, 2005, are not necessarily indicative of the operating results for the full year. The interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our 2004 Annual Report on Form 10-K. Certain amounts in prior periods have been reclassified to conform to the current period’s presentation.

Our condensed consolidated financial statements and related footnote disclosures reflect the change in classification of the cash flow effects of customer financing transactions, as discussed in Note 17 and the change in classification of inventories to advances and billings in excess of related costs, as discussed in Note 5 and Note 9.

Note 2 – Standards Issued and Not Yet Implemented

In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 151, Inventory Costs – an amendment of ARB No. 43 . This Standard requires abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) to be recognized as current period charges. Additionally, it requires that fixed production overhead costs be allocated to inventory based on the normal capacity of the production facility. The provisions of this Standard apply prospectively and are effective for us for inventory costs incurred after January 1, 2006. While we believe this Standard will not have a material effect on our financial statements, the impact of adopting these new rules is dependent on events that could occur in future periods, and as such, an estimate of the impact cannot be determined until the event occurs in future periods.

In March 2005, the FASB issued Interpretation No. (FIN) 47, Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143 . This Interpretation clarifies the term conditional asset retirement obligation as used in SFAS No. 143 and requires a liability to be recorded if the fair value of the obligation can be reasonably estimated. The types of asset retirement obligations that are covered by this Interpretation are those for which an entity has a legal obligation to perform an asset retirement activity, however the timing and (or) method of settling the obligation are conditional on a future event that may or may not be within the control of the entity. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. This Interpretation is effective no later than December 31, 2005. We are currently evaluating the impact of FIN 47 on our financial statements.

In July 2005, the Emerging Issues Task Force (EITF) issued Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights . This EITF provides guidance as to when a general partner, or the general partners as a group, control a limited partnership or similar entity when the limited partners have certain rights. EITF No. 04-5 is effective as of June 29, 2005 for general partners of all new limited partnerships formed and for existing limited partnerships for which the partnership agreements are modified. EITF No. 04-5 is effective as of January 1, 2006 for all other limited partnerships. We are currently evaluating the impact of EITF No. 04-5 on our financial statements.

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In July 2005, the FASB issued Staff Position (FSP) No. APB 18-1, Accounting by an Investor for its Proportionate Share of Other Comprehensive Income of an Investee Accounted for under the Equity Method in Accordance with APB Opinion No. 18 upon a Loss of Significant Influence . This FSP provides guidance on how an investor should account for its proportionate share of an investee’s equity adjustments for other comprehensive income upon a loss of significant influence. FSP No. APB 18-1 is effective as of October 1, 2005. We are currently evaluating the impact of FSP No. APB 18-1 on our financial statements.

During the second quarter of 2004, we adopted EITF Issue No. 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings Per Share , which did not have a material effect on our earnings per share.

Basic earnings per share is calculated by the sum of (1) net income less dividends paid divided by the basic weighted average shares outstanding and (2) dividends paid divided by the weighted average shares outstanding. Basic weighted average shares outstanding is based on the weighted average number of shares outstanding as well as participating securities that reduce basic earnings per share and excludes treasury shares and the outstanding shares held by the ShareValue Trust not committed for distribution. Participating securities consist of vested stock units associated with our deferred compensation plans.

Diluted earnings per share is calculated by dividing net income by the diluted weighted average shares outstanding. Diluted weighted average shares outstanding is based on that same number of basic weighted shares outstanding plus dilutive potential common shares. Dilutive potential common shares may include shares distributable under stock option, stock unit, Performance Shares and ShareValue Trust plans. These potential common shares are included in the computation of diluted shares outstanding if they would reduce earnings per share.

The weighted average number of shares outstanding (in millions), included in the table below, is excluded from the computation of diluted earnings per share because the average market price did not exceed the exercise/threshold price. However, these shares may be dilutive potential common shares in the future.

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Note 4 – Income Taxes

The effective tax rate of 22.4% for the six months ended June 30, 2005 differed from the federal statutory rate of 35% due to Foreign Sales Corporation (FSC) and Extraterritorial Income (ETI) exclusion tax benefits, tax credits, state income taxes, a change in valuation allowances, and other provision adjustments. The effective income tax rate of 21.3% for the six months ended June 30, 2004 also differed from the federal statutory rate due to FSC and ETI exclusion tax benefits, tax credits, state income taxes, and tax benefits from a settlement with the Internal Revenue Service (IRS) for the years 1986-1997.

The effective tax rate of 29.9% for the three months ended June 30, 2005 differed from the federal statutory rate of 35% due to FSC and ETI exclusion tax benefits, tax credits, state income taxes, and other provision adjustments. The effective income tax rate of 6.2% for the three months ended June 30, 2004 also differed from the federal statutory rate due to FSC and ETI exclusion tax benefits, tax credits, state income taxes, and tax benefits from a settlement with the IRS of the years 1986-1997.

For the six months ended June 30, 2005 and 2004, net income tax (payments)/refunds were ($31) and $149.

During the six months ended June 30, 2005, we received federal income tax refunds totaling $95 (of which $43 represents interest). $41 of the interest was previously accrued in the Condensed Consolidated Statement of Operations and $2 has been accrued in the second quarter. These refunds related to the settlement of federal income tax audits for the 1987 through 1990 tax years. Also, an additional $17 of interest income has been accrued this quarter in the Condensed Consolidated Statement of Operations relating to the 1988 tax year.

IRS Audit Overview

We are currently under examination by the IRS for the years 1998-2001 and are in the final stages of the exam. An IRS audit report was received in June 2005 and is at the Joint Committee of Taxation for review. We expect the outcome of the exam to be at or below the accrued position. IRS examinations have been completed through 1997 and income taxes have been settled with the IRS for all years through 1996 and for McDonnell Douglas Corporation for all years through 1992. We have filed appeals with the IRS for 1993 through 1997 for McDonnell Douglas Corporation. We believe adequate provisions for all outstanding issues have been made for all open years.

Contingencies

We are subject to income taxes in the U.S. and numerous foreign jurisdictions.

Amounts accrued for potential tax assessments recorded in current tax liabilities total $1,641 and $1,678 at June 30, 2005 and December 31, 2004, respectively. Accruals relate to tax issues for U.S. federal, domestic state, and taxation of foreign earnings as follows:

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Legislative Update

The American Jobs Creation Act of 2004 (the Act) provides for a special deduction for qualified domestic production activities and a two-year phase-out of the existing ETI exclusion tax benefit for foreign sales which the World Trade Organization (WTO) ruled was an illegal export subsidy. These new provisions are not expected to have a material impact on the 2005 income tax rate.

The European Union believes that the Act fails to adequately repeal the illegal export subsidies because of the transitional provisions and has asked the WTO to review whether these provisions are in compliance with their prior ruling. It is not possible to predict what impact this issue will have on future earnings, cash flows and/or financial position pending the final resolution of this matter.

On December 21, 2004, FSP No. FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004, was issued. FSP No. FAS 109-2 provides companies with additional time, beyond the financial reporting period during which the Act took effect, to evaluate the Act’s impact on a company’s plan for reinvestment or repatriation of certain foreign earnings for purposes of applying SFAS No. 109. FSP No. FAS 109-2 was effective upon issuance. As of June 30, 2005, we have not decided on whether and to what extent we might repatriate foreign earnings under the Act, and accordingly, the financial statements do not reflect any provisions for taxes on unremitted foreign earnings. Based on our analysis, although not yet finalized, it is possible that under the repatriation provision of the Act we may repatriate some amount of earnings between $0 and $350 with the respective tax liability ranging from $0 to $26. We expect to be in a position to finalize our assessment by September 30, 2005.

Note 5 – Inventories

Inventories consisted of the following:

As of December 31, 2004, we reclassified ($3,044) of long-term contracts in progress and $783 of advances and progress billings to Advances and billings in excess of related costs on our Condensed Consolidated Statements of Financial Position. (See Note 9.)

As a normal course of our Commercial Airplanes segment production process, our inventory may include a small quantity of airplanes that are completed but unsold. As of June 30, 2005 and December 31, 2004, the value of completed but unsold aircraft in inventory was insignificant. Inventory balances included $234 subject to claims or other uncertainties primarily relating to the A-12 program as of June 30, 2005 and December 31, 2004.

Included in commercial aircraft program inventory and directly related to the sales contracts for the production of aircraft are amounts paid or credited in cash or other consideration, to airline customers totaling $769 and $665 as of June 30, 2005 and December 31, 2004. These amounts are referred to as early issue sales consideration. Early issue sales consideration is recognized as a reduction to

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revenue when the delivery of the aircraft under contract occurs. In the unlikely situation that an airline customer was not able to perform and take delivery of the contracted aircraft we believe that we would have the ability to recover amounts paid through retaining amounts secured by advances. However to the extent early issue sales consideration exceeds advances these amounts may not be recoverable and would be recognized as a current period expense. As of June 30, 2005 and December 31, 2004, the amount of early issue sales consideration net of advance deposits included in commercial aircraft program inventory amounted to $158 and $123, which related to one customer.

Commercial aircraft 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 of our 2004 Annual Report on Form 10-K, represent deferred production costs. As of June 30, 2005 and December 31, 2004, there were no significant excess deferred production costs or unamortized tooling costs not recoverable from existing firm orders. The deferred production costs and unamortized tooling included in the 777 program’s inventory are summarized in the following table:

As of June 30, 2005 and December 31, 2004, the balance of deferred production costs and unamortized tooling related to all other commercial aircraft programs was insignificant relative to the programs’ balance-to-go cost estimates.

During the six months ended June 30, 2005 and the year ended December 31, 2004, we purchased $61 and $298 of used aircraft. Used aircraft in inventories totaled $201 and $162 as of June 30, 2005 and December 31, 2004. When our Commercial Airplane segment is unable to immediately sell used aircraft, we may place the aircraft on operating leases or we may finance the sale of new aircraft with a short-term note receivable. The carrying amount of aircraft recorded as operating leases, or sales financed under a note receivable, totaled $727 and $958 as of June 30, 2005 and December 31, 2004.

As of June 30, 2005, there were no material additional expenses related to the 767 United States Air Force (USAF) Tanker program.

Note 6 – Divestitures

On February 28, 2005 we completed the stock sale of Electron Dynamic Devices Inc. (EDD) to L-3 Communications. EDD was a separate legal entity wholly owned by us. The corresponding net assets of the entity were $46 and a gain of $25 was recorded in the Launch and Orbital Systems (L&OS) segment of Integrated Defense Systems (IDS) from the sale of the net assets. In addition, there was a related pre-tax loss of $68 recorded in the Condensed Consolidated Statement of Operations in Accounting differences/eliminations for net pension and other postretirement benefit curtailments and settlements. (See Note 14 for discussion of our environmental indemnification agreement with L-3.)

On February 22, 2005, we announced the sale of the Rocketdyne Propulsion and Power (Rocketdyne) business for cash proceeds of approximately $700 to United Technologies Corporation under an asset purchase agreement. This divestiture includes assets and sites in California, Alabama, Mississippi, and Florida. The Rocketdyne business primarily develops and builds rocket engines and provides booster engines for the space shuttle and the Delta family as well as propulsion systems for missile defense systems. The assets and liabilities as of June 30, 2005 that were subject to the transaction were $221 and $35. See breakout below for major classes of assets and liabilities. The Federal Trade Commission (FTC) requested additional information with respect to the sale in March 2005 and the

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transaction was under review as of June 30, 2005. Accordingly these assets were classified as held for use as of March 31, 2005 and June 30, 2005. On July 26, 2005, the FTC cleared the transaction, and the sale is now expected to close in August 2005. We expect to record a net pre-tax gain of approximately $575, predominantly in the L&OS segment, from the sale of the net assets in the third quarter of 2005. In addition, we expect to record a related pre-tax loss of $218 for estimated pension and postretirement curtailments and settlements in the fourth quarter of 2005 as Accounting differences/eliminations. (See Note 11 for the pension and postretirement effects.)

In addition to the assets and liabilities noted above, this transaction will reduce our prepaid pension expense in the amount of $253, our accrued pension plan liability by $2 and our accrued retiree health care liability by $33 as a result of the pension and other postretirement benefit curtailments and settlements. These amounts are included in the expected losses noted above.

On February 22, 2005, we announced the sale of substantially all of the assets at our Commercial Airplanes facilities in Wichita, Kansas and Tulsa and McAlester, Oklahoma to Onex Partners LP (Mid-Western Aircraft Systems, Inc. “Mid-Western”) under an asset purchase agreement. Mid-Western’s obligation to complete the purchase was subject to several significant conditions, including successful negotiation of collective bargaining agreements and Mid-Western receiving the proceeds of its debt financing in substantially the amount and form described in its financing commitments, therefore, as of March 31, 2005, the assets and liabilities of the business were classified as held for use. Mid-Western decided to proceed with the transaction without all collective bargaining agreements in place and the transaction closed June 16, 2005. Transaction consideration given to us includes cash of approximately $900, together with the transfer of certain liabilities and long-term supply agreements that provide us with ongoing cost savings. The assets and liabilities as of June 16, 2005 that were subject to the transaction were $1,037 and $97. See breakout below for major classes of assets and liabilities. We expect to record a total pre-tax loss of approximately $348 on the transaction, including pension and postretirement impacts. (See Note 11 for pension and postretirement effects). We recorded a pre-tax loss of $110 in the second quarter of 2005, which was recorded in the Condensed Consolidated Statements of Operations as Gain/(loss) on dispositions, net, of which $75 was recognized by the Commercial Airplanes segment and $35 was recognized as Accounting differences/eliminations and Unallocated expense. The remaining loss of $238 relates to estimated pension and postretirement curtailments and settlements and is expected to be recorded as Accounting differences/eliminations in the third quarter of 2005.

Except for $37 in net assets which related to other segments, the above assets and liabilities were part of the Commercial Airplanes segment.

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In addition to the assets and liabilities noted above, this transaction will reduce our prepaid pension expense in the amount of $309, our accrued pension plan liability by $1 and our accrued retiree health care liability by $70 as a result of the pension and other postretirement benefit curtailments and settlements. These amounts are included in the expected losses noted above.

We have agreed to indemnify Mid-Western for certain environmental contamination that existed on or prior to the June 16, 2005 closing date. At this time, we cannot estimate the maximum amount of future payments under this guarantee. (See Note 14 for further discussion of this indemnification).

Note 7 – Discontinued Operations – Commercial Financial Services

On May 2, 2004, our Board of Directors approved a plan to sell all of the assets and business operations of Boeing Capital Corporation’s (BCC) Commercial Financial Services (CFS) business. This plan was approved by BCC’s Board of Directors on May 21, 2004. On May 24, 2004, BCC entered into a purchase and sale agreement with General Electric Capital Corporation (GECC) to sell substantially all of the assets related to its CFS business and the final asset sale closed on December 27, 2004. As of June 30, 2005, approximately $57 of assets had not been sold and continue to be marketed for sale. As of June 30, 2005, these assets are held for sale or re-lease and are included in Customer financing, net in our Condensed Consolidated Statement of Financial Position.

For the six and three months ended June 30, 2004, our condensed consolidated financial statements reflect the CFS business as discontinued operations with Income from discontinued operations of $25 ($16 net of taxes) and $11 ($7 net of taxes). For the same periods of 2004, the Net gain on disposal of discontinued operations was $21 ($14 net of taxes).

As part of the purchase and sale agreement with GECC, BCC agreed to a sharing arrangement for losses that may be incurred at the end of the initial financing terms of the transferred portfolio assets, or, in some instances, prior to the end of the financing term, such as certain events of default and repossession. The loss sharing arrangement provides that cumulative net losses (if any) are to be shared between BCC and GECC in accordance with the following formula: (i) with respect to the first $150 of cumulative net losses, BCC will be liable to GECC for 80% of the amount thereof (in such event GECC will bear 20% of such losses); (ii) with respect to cumulative net losses between $150 and $275, BCC will be liable to GECC for 100% of such additional cumulative net losses; and (iii) if cumulative losses exceed $275, GECC will bear 100% of the loss risk above $275. These provisions effectively limit BCC’s exposure to any losses as referred to herein at $245. In the event there are cumulative net gains on the portfolio, GECC is required to make an earn-out payment to BCC in an amount equal to 80% of such cumulative net gain. Gains and losses on the portfolio are to be measured on a cumulative basis over the remaining life of the portfolio assets. The amount of the gain or loss on any particular portfolio asset is the difference between the fair market value of the equipment asset securing the portfolio asset and the carrying value of the portfolio asset. BCC has the right in certain circumstances to participate in a refinancing or other redeployment of a portfolio asset for the purpose of minimizing any loss on such asset. BCC has provided a liability of $109 for its estimated losses under this sharing arrangement as follows:

During the six months ended June 30, 2005, BCC recorded a charge of $19 associated with its exposure to GECC under the loss arrangement for matters reported to it during the second quarter of 2005.

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Note 8 – Investments

Joint ventures and other investments

As of June 30, 2005 and December 31, 2004, Investments included $99 and $67 primarily attributable to investments in joint ventures. Investments also included non-marketable securities of $26 and $73 at June 30, 2005 and December 31, 2004.

On May 5, 2005, we entered into an agreement with Lockheed Martin Corporation (Lockheed) to create a 50/50 joint venture named United Launch Alliance (ULA), which will be accounted for as an equity investment. ULA will combine the production, engineering, test and launch operations associated with U.S. government launches of Boeing Delta and Lockheed Martin Atlas rockets. It is expected that ULA will reduce the cost of meeting the critical national security and NASA expendable launch vehicle needs of the United States. Closing is contingent upon approval by governmental agencies, which is expected to occur later in 2005. ULA will be reported in the L&OS segment of IDS. We do not expect this agreement to have a material impact to our earnings, cash flows and/or financial position.

On March 31, 2005, we executed a Purchase and Sale Agreement to sell certain investments in technology related funds and partnerships of $63 and related capital commitment obligations for a purchase price of $24. As a result of our decision to dispose of these assets, the investments were classified as held for sale. Therefore, during the six months ended June 30, 2005, we recorded an asset impairment charge of $42 as a result of this agreement, which is included in Other income, net on the Condensed Consolidated Statements of Operations. We have closed the sale on investments of $10 during the three months ended June 30, 2005 and expect the final closings to be consummated during the third quarter of 2005.

Investments in debt and equity securities

Short-term investments and Investments included the following:

During 2004, we invested $3,000 of cash in an externally managed portfolio of investment grade fixed income instruments. The portfolio is diversified and highly liquid and primarily consists of U.S. dollar debt obligations of the United States Treasury, other government agencies, corporations, mortgage-backed and asset-backed securities. The portfolio has an average duration of 1.5 years. As of June 30, 2005 and December 31, 2004, amounts invested with a fair value of $2,773 and $2,718 were classified as available-for-sale Investments on the Condensed Consolidated Statements of Financial Position. We do not intend to hold these investments to maturity, nor do we intend to actively and frequently buy and sell these securities with the objective of generating profits on short-term differences in price. In addition, amounts totaling $71 and $108 were classified as Cash and cash equivalents and $207 and $173 were classified as available-for-sale Short-term investments as of June 30, 2005 and December 31, 2004. Gross unrealized losses on these investments, which are included in Investments and Short- term investments, primarily due to rising interest rates, were $22 and $12 as of June 30, 2005 and

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December 31, 2004, none of which have been in a continuous unrealized loss position for 12 months or longer. During the six months ended June 30, 2005 and 2004, gross realized gains and losses on these investments were not material.

On March 4, 2005, we completed the previously disclosed exchange transaction with Delta Air Lines, Inc. (Delta) in which we exchanged our investment in a D tranche Delta Enhanced Equipment Trust Certificate (EETC) with a carrying value of $145 and a face value of $176 for two C tranche Delta EETCs with face values totaling $176. During the six months ended June 30, 2005, the assets we received were recorded at their fair values of $143, and we recorded an asset impairment charge of $2. As of June 30, 2005, the unrealized loss on the two C tranche Delta EETCs was $30. At December 31, 2004, there was no unrealized loss on the Delta investment.

On an ongoing basis, we perform impairment tests on our investment securities to determine if the fair value decline of a security is other-than-temporary. If the impairment is other-than-temporary, we adjust the cost basis for the impaired security and record the charge in the Condensed Consolidated Statements of Operations.

As of June 30, 2005, our available-for-sale investments included subordinated debt investments in several Equipment Trust Certificates (ETC) and EETCs with estimated fair values totaling $250, which includes our Delta EETCs. Approximately $127 of these amounts relate to investments that were acquired in 2002. Due to the commercial aviation market downturn, with the exception of the Delta EETCs, these securities have been in a continuous unrealized loss position for 12 months or longer. Despite the unrealized loss position of these securities, we have concluded that these EETCs are not other-than-temporarily impaired. This assessment was based on the value of the underlying collateral to the securities, our ability to hold the investment until it recovers its fair value, the term of the securities, and both internal and third-party credit reviews and analyses of the counterparties, principally major domestic airlines. Accordingly, we have concluded that it is probable that we will be able to collect all amounts due according to the contractual terms of these debt securities.

Maturities of available-for-sale debt securities at June 30, 2005, were as follows:

Note 9 – Advances and billings in excess of related costs

We receive advance payments, performance based payments and progress payments from our commercial and government customers. Historically we have recorded advance payments in excess of cost incurred in Advances in excess of related costs. Performance based payments and progress payments have historically been recorded as Inventories, net of advances and progress billings. In 2005, we began classifying performance based payments and progress payments in excess of inventoriable cost in Advances and billings in excess of related costs on the Condensed Consolidated Statements of Financial Position and reclassified prior years to conform with our new presentation. As of December 31, 2004, we reclassified $2,261 of performance based payments and progress payments in excess of inventoriable costs to Advances and billings in excess of related costs. See Note 16 for reclassified asset and liability balances as of December 31, 2004 for our IDS segment.

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Note 10 – Deferred Lease Income

During 2003, we delivered four 767 aircraft to a joint venture named TRM Aircraft Leasing Co. Ltd (TRM) and one 767 aircraft in 2004. TRM was established in the second quarter of 2003 in order to provide financing and arrange for a total of five 767 aircraft to be leased to Japan Airlines. The leases were accounted for as operating leases each with a term of seven years. We provided financing of approximately $42 related to the five aircraft, which in combination with an expense sharing arrangement with TRM, caused us to retain substantial risk of ownership in the aircraft. As a result, we were recognizing rental income over the term of the lease. As of December 31, 2004, the present value of the remaining deferred lease income was $379, discounted at a rate of 5.0%.

During April 2005, we received full repayment for the financing arrangement from TRM. Additionally, we signed an agreement to eliminate any ongoing obligations for TRM’s expenses effective April 28, 2005. As a result, during the six and three months ended June 30, 2005, we were able to recognize the remaining deferred lease income of $369 and repayment for the financing arrangement of $42 as Revenue and charged the remaining net asset value to Cost of services. This transaction resulted in earnings before income taxes of $63 in our Condensed Consolidated Statements of Operations for the six and three months ended June 30, 2005.

Note 11 – Postretirement Plans

We have various pension plans covering substantially all employees. We also have postretirement benefits other than pensions which consist principally of health care coverage for eligible retirees and qualifying dependents, and to a lesser extent, life insurance to certain groups of retirees.

The components of net periodic benefit cost were as follows:

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We previously disclosed in our 2004 Annual Report on Form 10-K that we did not expect our required pension contributions under Employee Retirement Income Security Act (ERISA) regulations to be material in 2005. During the six months ended June 30, 2005 and 2004, we made discretionary pension contributions of $450 (pre-tax) and $2,000 (pre-tax). Subsequent to quarter-end, on July 14, 2005, we contributed an additional $550 (pre-tax) on a discretionary basis to our pension plans. We continue to evaluate additional discretionary pension and postretirement contributions and expect to contribute approximately $550 later this year to pension plans. During the six months ended June 30, 2005 and 2004, we made contributions to our other postretirement benefit plans of $8 and $8. We expect to contribute $13 to our other postretirement benefit plans in 2005.

As a result of our Wichita and Tulsa sale, we have an estimated pension and other postretirement benefit net loss of $238 comprised of a $308 loss on pension curtailment/settlement and other postretirement benefit curtailment gain of $70 which will be recognized in the third quarter of 2005. Additionally, the Wichita and Tulsa sale triggered a re-measurement of the affected pension and other postretirement benefit plans as of June 16, 2005. As a result of the low interest rate environment, the effective discount rate as of the re-measurement date for these plans was 5.25% for all but one of the pension plans and 5.0% for the remaining pension plan and all the other postretirement benefit plans, down from 5.75%, resulting in increased pension expense of $72 which will be recognized in the third and fourth quarters of 2005. This re-measurement also reduced other comprehensive income by $2,131 after-tax, which will also be recorded in the second half of 2005.

As a result of our Rocketdyne divestiture we have possible pension and postretirement net curtailment/settlement loss of $218 comprised of a $251 pension curtailment/settlement loss and other postretirement benefit curtailment gain of $33. These figures are estimates subject to re-measurement on the settlement date. In addition, there would be an impact to other comprehensive income, which could be material.

On February 28, 2005 we completed our stock sale of EDD Operations to L-3 Communications. The EDD sale generated pension settlement/curtailment loss of $69 and other postretirement benefit curtailment gain of $1.

Note 12 – Share-Based Compensation

In December 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123R), Share-Based Payment. We early adopted the provisions of SFAS No. 123R as of January 1, 2005 using the modified prospective method. SFAS No. 123R primarily resulted in a change in our method of measuring and recognizing the fair value of our Performance Shares and estimating forfeitures for all unvested awards. Additionally, prior to the adoption of SFAS No. 123R, we used the nominal vesting period approach for retirement eligible employees. Using this approach, we recognize compensation cost for share-based awards granted prior to 2005 over the stated vesting period for retirement eligible employees and, if an employee retires before the end of the vesting period, we recognize any remaining unrecognized compensation cost at the date of retirement. As a result of adopting SFAS No. 123R, we have changed our approach for recognizing compensation expense for new share-based awards granted to retirement eligible employees. For all share-based awards granted during 2005 and thereafter, SFAS No. 123R requires that we use the non-substantive vesting period approach to recognize compensation cost for retirement eligible employees over the period from the date of grant to the date retirement eligibility is achieved or one year of service (whichever is greater), if that is expected to occur during the nominal vesting period. Had we also applied the non-substantive vesting period approach to awards granted prior to 2005, compensation expense would have been $288 lower for the six months ended June 30, 2005 and $8 higher for the six months ended June 30, 2004. For the three months ended June 30, 2005, compensation expense would have been reduced by $135 under the non-substantive vesting period approach for awards granted before 2005; there would have been a reduction of $9 for the three months ended June 30, 2004.

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With the adoption of SFAS No. 123R, we recorded an increase in net earnings as a cumulative effect of accounting change based on SFAS No. 123R’s requirement to apply an estimated forfeiture rate to unvested awards. Previously, we recorded forfeitures as incurred. For the six months ended June 30, 2005, the amount of cumulative effect of accounting change for share forfeitures was $21, net of taxes of $12, and the net effect on basic and diluted earnings per share was $0.02 and $0.03, respectively. There was no impact for the three months ended June 30, 2005.

Our primary types of share-based compensation consist of Performance Shares, ShareValue Trust distributions and stock options and other stock unit awards, which are described below. The total number of shares authorized to be granted under all share-based plans is 94,000,000, excluding ShareValue Trust. Shares issued as a result of stock option exercise or conversion of stock unit awards will be funded out of treasury shares except to the extent there are insufficient treasury shares in which case new shares will be issued. We believe we currently have adequate treasury shares to meet any requirements to issue shares during 2005.

Share-based plans expense was previously presented as a separate line item on the Condensed Consolidated Statements of Operations. In accordance with Staff Accounting Bulletin No. 107 issued in March 2005, share-based plans expense has been included in general and administrative expense since it is incentive compensation issued primarily to our executives. Share-based plans expense consisted of the following:

During the first quarter of 2005, we recorded a $64 charge to share-based plans expense for the acceleration of compensation expense related to retired employees. The net income tax benefit recognized in the income statement for share-based plans was $168 and $103 for the six months ended June 30, 2005 and 2004 and $76 and $60 for the three months ended June 30, 2005 and 2004. Certain other deferred stock compensation plans are also reflected in general and administrative expense. We had issued 12,926,112 and 10,343,380 stock units as of June 30, 2005 and December 31, 2004 that are convertible to either stock or a cash equivalent, of which 11,839,212 and 9,549,837 are vested as of June 30, 2005 and December 31, 2004, and the remainder generally vest with employee service through retirement. These stock units principally represent a method of deferring employee compensation by which a liability is established based upon the current stock price. An expense or reduction to expense is recognized associated with the change in the liability balance which reflects stock price changes, earned dividends and amortization on stock units that can be settled in cash or stock. For the six months ended June 30, 2005 and 2004, general and administrative expense related to deferred stock compensation was $163 and $75. For the three months ended June 30, 2005 and 2004, general and administrative expense related to deferred stock compensation was $76 and $86.

Performance Shares

Performance Shares are stock units that are convertible to common stock, on a one-to-one basis, contingent upon stock price performance. If, at any time up to five years after award, the stock price reaches and maintains for twenty consecutive days a price equal to stated price growth targets, a stated percentage (up to 125%) of the Performance Shares awarded are convertible to common stock.

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For pre-2003 grants, if market conditions are not met during the five-year period, the Compensation Committee of the Board of Directors may, at its discretion, allow vesting of up to 100% of the target Performance Shares if our total shareholder return (stock price appreciation plus dividends) during the five-year period exceeds the average total shareholder return of the S&P 500 over the same period. For 2003 and 2004 grants, if less than 125% of the award has not vested at the end of the five-year period, up to 125% of the award may vest based on an award formula using the total shareholder return performance relative to the S&P 500. For 2005 grants, at the end of the five-year period, the Compensation Committee may, at its discretion, allow vesting of up to 125% of the award based on the total shareholder return performance relative to the S&P 100 and the five-year Treasury Bill rate. Performance Shares not converted to common stock due to not achieving market conditions expire five years after the date of the award. Dividends are accrued as additional Performance Shares and are converted to common stock at the same time as the related Performance Shares and in the same proportion as the originally granted Performance Shares. Dividends are not accrued on Performance Shares vesting percentages over 100%. In the event a participant has a termination of employment due to retirement, layoff, disability, or death, the participant (or beneficiary) continues to participate in outstanding performance cycles for Performance Shares that have been outstanding for at least one year. Payment of such awards will be made at the same time as payment would have been made had the participant not had a termination of employment. Unless otherwise provided by the Compensation Committee, Performance Shares that have been outstanding for less than one year as of the date of the participant’s termination of employment due to retirement, layoff, disability, or death and any accrued dividend equivalents will be canceled or forfeited. Except as provided above, participants must be employed by us on the date such awards become vested in order to receive payment for such awards. In the event of any termination of employment other than those described above, all outstanding Performance Shares and any accrued dividend equivalents will be canceled or forfeited as of the termination date. The Compensation Committee may, in its discretion, choose to allow a participant to continue to participate in an outstanding performance cycle upon such terms as it deems appropriate.

During the six months ended June 30, 2005, our stock price, on four occasions, met the cumulative growth rate levels above the grant price for Performance Shares granted in 2003. Accordingly, pursuant to the plan’s terms, an additional 50% of the 2003 Performance Shares awarded were converted to 2,448,988 shares of common stock with a total market value of $147 and 1,953,496 shares awarded were deferred as stock or cash at the employees election and therefore, are reported within Accounts payable and other liabilities within the Condensed Consolidated Statements of Financial Position. Additionally, during the six months ended June 30, 2005, our stock price, on one occasion, met the cumulative growth rate level above the grant price for Performance Shares granted in 2004. Accordingly, pursuant to the plan’s terms, 15% of the 2004 Performance Shares awarded were converted to 981,148 shares of common stock with a total market value of $62 and 626,464 shares awarded were deferred as stock or cash at the employees’ election and therefore, are reported within Accounts payable and other liabilities within the Condensed Consolidated Statements of Financial Position. For the six months ended June 30, 2005 and 2004, we recorded an additional $96 and $25 of compensation expense to reflect the cumulative expense for those Performance Shares converted to common stock. For the three months ended June 30, 2005 and 2004, we recorded an additional $41 and $25 of compensation expense to reflect the cumulative expense for those Performance Shares converted to common stock. For the six months ended June 30, 2005 and 2004, we used $4 and $2 in cash to settle the non-U.S. based payroll award conversions. For the three months ended June 30, 2005 and 2004, we used $2 and $1 in cash to settle the non-U.S. based payroll award conversions.

For Performance Shares granted prior to 2005, share-based expense was determined based on the market price of our stock at the time of the award applied to the maximum number of shares contingently issuable (up to 125%), and was amortized over a five-year period. For Performance

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Shares granted in 2005, the fair value of each award was estimated on the date of grant using a Monte Carlo simulation model instead of the grant date market price used for previous awards. We changed our valuation technique based on further clarification provided in SFAS No. 123R and the fact that our Performance Shares contain a market condition, which should be reflected in the grant date fair value of an award. The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying each market condition stipulated in the award grant and calculates the fair market value for each Performance Share granted. The valuation model used the following assumptions:

Weighted average expected volatility is based on recent volatility levels implied by actively traded option contracts on our common stock and the historical volatility levels on our common stock. Expected dividend yield is based on historical dividend payments. Risk free interest rate reflects the yield on the 5-year zero coupon U.S. Treasury, based on the Performance Shares’ contractual term. Stock beta is a measure of how our stock price moves relative to the market as a whole. Stock beta and market volatility are acquired from a third-party source. The fair value of the 2005 Performance Shares is amortized over the expected term of each award. The expected term of 1 to 4 years for each award granted is derived from the output of the valuation model and represents the median time required to satisfy the conditions of the award, adjusted for the effect of retiree eligible participants. Each price growth target has a different expected term, resulting in the range of values provided.

The following tables summarize information about Performance Shares outstanding at June 30, 2005.

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At June 30, 2005, there was $786 of total unrecognized compensation cost related to the Performance Share plan which is expected to be recognized over a weighted average period of 3.5 years.

ShareValue Trust

The ShareValue Trust, established effective July 1, 1996, is a 14-year irrevocable trust that holds our common stock, receives dividends and distributes to employees the appreciation in value above a 3% per annum threshold rate of return. The Trust was split between two funds, “fund 1” and “fund 2”, upon its initial funding. Each fund consists of investment periods which result in overlapping periods as follows:

An initial investment value is established for each subsequent investment period based on the lesser of the threshold amount or the fair market value of the immediately preceding investment period for that fund. This amount is then compounded by the 3% per annum to determine the threshold amount that must be met for that investment period. At the end of the investment period, participants will receive a distribution to the extent the market value of that investment period has increased above the threshold amount. A distribution is proportionally distributed among all the participants of an investment period in the ratio each participant’s number of months of participation relates to the total number of months earned by all participants in the investment period. At June 30, 2005, the Trust held 39,301,252 shares of our common stock in the two funds. The ShareValue Trust’s total compensation expense to be recognized over the life of the trust was determined using a binomial option-pricing model.

On June 30, 2004, the market value of fund 2 exceeded $913 (the threshold representing a 3% per annum rate of return). Based on the average stock price of $50.825 as of June 30, 2004, the market value of fund 2 exceeded the threshold by $143 resulting in a distribution to participants. The distribution was paid in Boeing common stock, except for partial shares, distributions to foreign employees and beneficiaries of deceased participants, which were paid in cash. After employee withholding taxes, approximately 1.7 million shares of common stock were distributed to participants. These transactions were recorded as a deduction from additional paid-in capital.

If on June 30, 2006, the market value of fund 1 exceeds $1,004, the amount in excess of the threshold will be distributed to employees in shares of common stock. Similarly, if on June 30, 2008, the market value of fund 2 exceeds $1,028, the amount in excess of the threshold will be distributed to employees in shares of common stock.

The ShareValue Trust is accounted for as a contra-equity account and stated at market value. Market value adjustments are offset to additional paid-in capital. At June 30, 2005, there was $359 of total unrecognized compensation cost related to the ShareValue Trust which is expected to be recognized over a period of 5.0 years.

Stock options

Our 1997 Incentive Stock Plan (1997 Plan) permits the grant of stock options, stock appreciation rights (SARs) and restricted stock awards (denominated in stock or stock units) to any employee of ours or

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our subsidiaries and contract employees. Under the terms of the plan, 64 million shares are authorized for issuance upon exercise of options, as payment of SARs and as restricted stock awards, of which no more than an aggregate of 6,000,000 shares are available for issuance as restricted stock awards and no more than an aggregate of 3,000,000 shares are available for issuance as restricted stock that is subject to restrictions based on continuous employment for less than three years. This authorization for issuance under the 1997 Plan will terminate on April 30, 2007. The 1993 Incentive Stock Plan permitted the grant of options, SARs and stock to employees of ours or our subsidiaries. The 1988 and 1984 stock option plans permitted the grant of options or SARs to officers or other key employees of ours or our subsidiaries. No further grants may be awarded under these three plans. As of June 30, 2005, no SARs have been granted under these plans.

On April 28, 2003, the shareholders approved The Boeing Company 2003 Incentive Stock Plan (2003 Plan). The 2003 Plan permitted awards of incentive stock options, nonqualified stock options, restricted stock, stock units, Performance Shares, performance units and other incentives. The aggregate number of shares of our stock available for issuance under the 2003 Plan will not exceed 30 million and no participant may receive more than 2,000,000 shares in any one calendar year. Under the terms of the 2003 Plan, no more than an aggregate of 6,000,000 shares are available for issuance as restricted stock awards and no more than an aggregate of 1,500,000 shares are available for issuance as restricted stock that is subject to restrictions based on continuous employment for less than three years. A summary of the principal features is provided in our 2004 Proxy Statement.

Options have been granted with an exercise price equal to the fair market value of our stock on the date of grant and expire ten years after the date of grant. Vesting is generally over a five-year service period with portions of a grant becoming exercisable at one year, three years and five years after the date of grant.

Information concerning stock options issued to directors, officers and other employees is presented in the following table: