Note  1 -- Summary of Significant Accounting Policies Note  2 -- Accounting Changes Note  3 -- Special Charges Note  4 -- Segment Information Note  5 -- Leases Note  6 -- Supplementary Income Statement Information Note  7 -- Provision for Income Taxes Note  8 -- Earnings Per Share Note  9 -- Supplementary Balance Sheet Information Note 10 -- Property, Plant and Equipment - Net Note 11 -- Deferred Income Taxes Note 12 -- Goodwill Note 13 -- Other Intangible Assets Note 14 -- Debt Note 15 -- Financial Instruments Note 16 -- Shareholder's Equity Note 17 -- Preferred Stock Note 18 -- Incentive Plans and Stock Options Note 19 -- Retirement Programs Note 20 -- Commitments and Contingencies Note 21 -- Quarterly Data (Unaudited)
 

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Operations — Praxair, Inc. (Praxair or company) is one of the largest industrial gases companies worldwide and the largest in North and South America. Praxair produces, sells and distributes atmospheric, process and specialty gases, and high-performance surface coatings to a diverse group of industries including aerospace, chemicals, electronics, energy, food and beverage, healthcare, manufacturing and metals.

Principles of Consolidation — The consolidated financial statements include the accounts of all significant subsidiaries where control exists and, in limited situations, variable interest entities where the company is the primary beneficiary. Equity investments generally consist of 20-50% owned operations where the company exercises significant influence. Operations less than 20% owned, where the company does not exercise significant influence, are generally carried at cost. Pre-tax income from equity investments that are partnerships or limited liability corporations (LLC) is included in other income (expenses) — net with related taxes included in income taxes and remaining equity earnings are reported as income from equity investments, net of income taxes. Partnership and LLC net assets are reported as equity investments in the balance sheet. Significant intercompany transactions are eliminated and any significant related party transactions have been disclosed.

Use of Estimates — The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and to disclose contingent assets and liabilities at the date of the financial statements during the reporting period. While actual results could differ, management believes such estimates to be reasonable.

Revenue Recognition — Revenue is recognized when: a firm sales agreement exists; product is shipped or services are provided to customers; and collectibility of the fixed or determinable sales price is reasonably assured. A small portion of the company’s revenues relate to long-term construction contracts and are recognized using the percentage-of-completion method. Under this method, revenues from sales of major equipment, such as large air separation facilities, are recognized primarily based on cost incurred to date compared with total estimated cost. Changes to total estimated cost and anticipated losses, if any, are recognized in the period determined. For contracts that contain multiple products and/or services, amounts assigned to each component are based on its objectively determined fair value, such as the sales price for the component when it is sold separately or competitor prices for similar components. Sales returns and allowances are not a normal practice in the industry and are de minimis.

Amounts billed for shipping and handling fees are recorded as sales, generally on FOB destination terms, and costs incurred for shipping and handling are recorded as cost of sales.

Cash Equivalents — Cash equivalents are considered to be highly liquid securities with original maturities of three months or less.

Inventories — Inventories are stated at the lower of cost or market. Cost is determined using the last-in, first-out (LIFO) method for certain U.S. operations and the average cost method for most other operations.

Property, Plant and Equipment – Net — Property, plant and equipment are carried at cost, net of accumulated depreciation. The company capitalizes interest as part of the cost of constructing major facilities (see Note 6). Depreciation is calculated on the straight-line method based on the estimated useful lives of the assets, which range from 3 to 40 years (see Note 10). Praxair uses accelerated depreciation methods for tax purposes where appropriate.

The company performs a test for impairment whenever circumstances and events indicate that the carrying amount of an individual asset or grouping of assets may not be recoverable. Should projected undiscounted cash flows be less than the carrying amount of the asset, an impairment charge reducing the carrying amount to fair value is required. Fair value is determined based on the most appropriate valuation technique, including discounted cash flows.

Foreign Currency Translation — For international subsidiaries where the local currency is the functional currency, translation gains and losses are reported as part of the accumulated other comprehensive income (loss) component of shareholders’ equity as a cumulative translation adjustment (see Note 9). For international subsidiaries operating in hyperinflationary economies, the U.S. dollar is the functional currency and translation gains and losses are included in income.

Financial Instruments — Praxair enters into various derivative financial instruments to manage its exposure to fluctuating interest and currency exchange rates and energy costs. Such instruments primarily include interest rate swap agreements; currency swap, forward contracts; and commodity swap agreements. These instruments are not entered into for trading purposes. Praxair only uses commonly traded and non-leveraged instruments.

Effective January 1, 2001, Praxair adopted Statement of Financial Accounting Standards (SFAS) 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS 137, 138 and 149. SFAS 133 requires all derivatives to be recorded on the balance sheet at fair value. There are two types of derivatives the company enters into: hedges of fair value exposures and hedges of cash flow exposures. Fair value exposures relate to recognized assets or liabilities, and firm commitments; while cash flow exposures relate to the variability of future cash flows associated with recognized assets or liabilities, or forecasted transactions.

When a derivative is executed and hedge accounting is appropriate, it is designated as either a fair value hedge or a cash flow hedge. Currently, Praxair designates all interest rate and commodity swap agreements as hedges; however, currency contracts are generally not designated as hedges for accounting purposes. All derivatives are linked to an appropriate underlying exposure. On an ongoing basis, the company assesses the hedge effectiveness of all derivatives designated as hedges to determine if they continue to be highly effective in offsetting changes in fair values or cash flows of the underlying hedged items. If it is determined that the hedge is not highly effective, then hedge accounting will be discontinued prospectively.

Changes in the fair value of derivatives designated as fair value hedges are recognized in earnings as an offset to the change in the fair values of the exposures being hedged. The changes in fair value of derivatives that are designated as cash flow hedges are deferred in accumulated other comprehensive income (loss) and are recognized in earnings as the underlying hedged transaction occurs. Any ineffectiveness is recognized in earnings immediately. Derivatives that are entered into for risk management purposes and are not designated as hedges (primarily related to projected net income and currency derivatives other than for firm commitments) are recorded at their fair market values and recognized in current earnings.

Praxair records hedging activity related to debt instruments in interest expense and hedging related to lease obligations and commodity contracts in operating profit. The company recognizes the changes in the fair value associated with currency contracts as follows: hedges of balance sheet exposures, firm commitments and anticipated future net income are recognized in other income (expense) — net and generally offset the underlying hedged items; hedges of net investments in foreign subsidiaries are recognized in the cumulative translation adjustment component of accumulated other comprehensive income (loss) on the consolidated balance sheet to offset translation gains and losses associated with the hedged net investment.

Praxair uses the following methods and assumptions to estimate the fair value of each class of financial instrument. The fair value of interest rate swaps and currency exchange contracts is estimated based on market prices obtained from independent dealer or market quotes. The fair value of long-term debt is estimated based on the quoted market prices for the same or similar issues. Due to their nature, the carrying value of cash, short-term investments and short-term debt, receivables and payables approximates fair value.

Goodwill — When a business is acquired, the excess of the purchase price over the fair value of the assets and liabilities acquired is recorded as goodwill (see Note 12). In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS 142, “Goodwill and Other Intangible Assets,” which eliminated the amortization of goodwill effective January 1, 2002. Goodwill is reviewed annually in April and when circumstances or other events indicate that impairment may have occurred. Also, in accordance with SFAS 141, “Business Combinations,” goodwill related to acquisitions after June 30, 2001 has not been amortized.

Prior to SFAS 142, previous accounting standards required goodwill to be amortized over the estimated period of benefit up to 40 years.

Other Intangible Assets — Patents are recorded at historical cost and are amortized over their remaining useful lives. Trademarks and other intangibles are amortized over the estimated period of benefit. Praxair periodically evaluates the recoverability of patents, trademarks and other intangibles by assessing whether the unamortized balance can be recovered over its remaining life through cash flows generated by the related assets. When expected undiscounted cash flows are less than the carrying value of the intangible asset, an impairment loss will be recognized.

Income Taxes — Deferred income taxes are recorded for the temporary differences between the financial statement and tax bases of assets and liabilities using current tax rates. Valuation allowances are established against deferred tax assets whenever circumstances indicate that it is more likely than not that such assets will not be realized in future periods. The provision for income taxes includes probable exposures for tax matters.

Pension and Other Retirement Programs — Most Praxair employees worldwide are covered by various pension plans. The cost of pension benefits under these plans is determined using the “projected unit credit” actuarial cost method. Funding of pension plans varies and is in accordance with local laws and practices.

Praxair accrues the cost of retiree life and health insurance benefits during the employees’ service period when such benefits are earned.

Post-employment Benefits — Praxair recognizes the estimated cost of future benefits provided to former and inactive employees after employment but before retirement on the accrual basis.

Stock Split — On October 28, 2003, Praxair’s board of directors declared a two-for-one split of the company’s common stock. The stock split was effected in the form of a stock dividend of one additional share for each share owned by stockholders of record on December 5, 2003, and each share held in treasury as of the record date. The additional shares were distributed to such holders on December 15, 2003. Information pertaining to shares, earnings per share and dividends per share has been restated in the accompanying financial statements, except for the statement of shareholders’ equity, and related footnotes to reflect this split.

Stock-based Compensation — Praxair accounts for incentive plans and stock options using the provisions of Accounting Principles Board Opinion 25, “Accounting for Stock Issued to Employees.” Pro forma information required by SFAS 123, “Accounting for Stock-Based Compensation,” as amended by SFAS 148, requires Praxair to disclose pro forma net income and pro forma earnings per share amounts as if compensation expense was recognized based on fair values for options granted after 1994. Pro forma net income and the related basic and diluted earnings per share amounts would be as follows:

(Dollar amounts in millions, except per share data)
YEAR ENDED DECEMBER 31,	2003	2002	2001
NET INCOME
As reported	$ 585	$ 409	$ 430
Less: total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	(27)	(25)	(32)
Pro forma net income	$ 558	$ 384	$ 398
BASIC EARNINGS PER SHARE
As reported	$1.79	$1.26	$1.33
Pro forma	$1.71	$1.18	$1.23
DILUTED EARNINGS PER SHARE
As reported	$1.77	$1.24	$1.31
Pro forma	$1.69	$1.17	$1.21

The weighted average fair value of options granted during 2003 was $18.47 ($21.37 in 2002 and $16.15 in 2001). These values, which were used as a basis for the pro forma disclosures, were estimated using the Black-Scholes Options-Pricing Model with the following weighted average assumptions used for grants in 2003, 2002, and 2001:

YEAR ENDED DECEMBER 31,	2003		2002		2001
Dividend yield	1.3	%	1.2	%	1.2	%
Volatility	36.5	%	35.8	%	35.6	%
Risk-free interest rate	2.9	%	4.5	%	4.7	%
Expected term–years	6		6		5

These pro forma disclosures may not be representative of the effects for future years as options vest over several years and additional awards generally are made each year.

Recently Issued Accounting Standards – In 2003, the FASB added stock-based compensation to its technical agenda and may require all companies to expense the fair value of employee stock options as earned starting in 2005. Until a new statement is issued, the provisions of SFAS 123 (as amended by SFAS 148), which permit the continued use of the intrinsic value method, remain in effect.

In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities,” and substantially revised the statement throughout 2003 which is effective December 31, 2003 for Praxair. The implementation of this standard and its subsequent revisions did not have a material impact on Praxair’s financial condition or results of operations.

In May 2003, the Emerging Issues Task Force (EITF) of the FASB reached a consensus on Issue 01-8, “Determining Whether an Arrangement Contains a Lease” (EITF 01-8), that outlines specific criteria for determining when a supply arrangement or portion thereof should be accounted for as a lease. EITF 01-8 became effective for Praxair for certain on-site supply arrangements entered into or modified after June 30, 2003 that are dependent upon specific assets used to supply primarily one customer. An arrangement may be considered in part a lease if, among other things, no other asset can be effectively substituted to supply the customer and if there are no other customers using more than a minor amount of the asset in question. Praxair believes that certain of its product supply arrangements may be considered leases under EITF 01-8, however, any resulting prospective change in accounting treatment has not had a material impact on Praxair’s financial condition or results of operations.

In May 2003, the EITF finalized Issue 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables” (EITF 00-21). During December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) 104, “Revenue Recognition,” which incorporated EITF 00-21. The impact of adopting EITF 00-21 and SAB 104 was not material to Praxair’s financial condition or results of operations.

In December 2003, the FASB issued a revision to SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits” and requires new annual disclosures about the types of plan assets, investment strategy, measurement date, plan obligations, and cash flows as well as the components of the net periodic benefit cost recognized in interim periods. This statement is effective December 31, 2003 for Praxair except for the requirements to disclose future benefit payments and international plan asset information, which will be effective December 31, 2004. Accordingly, Praxair has expanded its pension disclosures (see Note 19).

In January 2004, the FASB issued FASB Staff Position (FSP) 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” which permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to defer accounting for the effects of the Act until the impact can be determined. Accordingly, as of and for the year ended December 31, 2003, the consolidated financial statements and accompanying notes do not reflect the effects of the Act on the Plan. Specific authoritative guidance on the accounting for the federal subsidy is pending and Praxair will implement the appropriate accounting when the standard is finalized.

Reclassifications — Certain prior years’ amounts have been reclassified to conform to the current year’s presentation.