Notes to the Financial Statements

Note 1 – Description of Business

Nature of Operations

The United States Postal Service provides mail service to the public, offering a variety of classes of mail services without undue discrimination among our many customers. This means that within each class of mail our price does not unreasonably vary by customer for the levels of service we provide. This fulfills our legal mandate to offer universal service at a fair price. We conduct our operations primarily in the domestic market, with international operations representing less than 3% of our total revenue.

Our primary lines of service are First-Class Mail, Priority Mail, Express Mail, Periodicals Mail, Standard Mail, Package Services and International Mail. The principal markets for these services are the communications, distribution, delivery, advertising and retail markets. Our services (products) are sold and distributed through almost 37,000 Post Offices, stations, branches, contract postal units, a large network of consignees, more than 600 processing facilities and almost 1,000 administrative and support facilities.

Our labor force is primarily represented by the American Postal Workers Union, National Association of Letter Carriers, National Postal Mail Handlers Union and National Rural Letter Carriers Association. More than 85% of our career employees are covered by collective bargaining agreements. The agreements with the major unions expire November 20, 2006. Information on labor agreements can be found on our website www.USPS.com.

By law, we also consult with management organizations representing most of the employees not covered by collective bargaining agreements. These consultations provide an opportunity to participate directly in the planning, development, and implementation of programs and policies affecting the managerial employees in the field. The management organizations include the National Association of Postal Supervisors, National League of Postmasters and National Association of Postmasters of the United States.

Postal Reorganization

We commenced operations on July 1, 1971, in accordance with the provisions of the Postal Reorganization Act (the Act). We are an "independent establishment" of the executive branch of the U.S. government. Governing decisions are made by a Board of Governors appointed by the President with the advice and consent of the Senate.

The equity that the U.S. government held in the former Post Office Department became our initial capital. We valued the assets of the former Post Office Department at original cost less accumulated depreciation. The initial transfer of assets, including property, equipment and cash, totaled $1.7 billion. Subsequent cash contributions and transfers of assets

between 1972 and 1982 totaled approximately $1.3 billion, resulting in total government contributions of $3.034 billion. The U.S. government remains responsible for all the liabilities attributable to operations of the former Post Office Department, however, under the Balanced Budget Act of 1997, the liability for Post Office Department workers' compensation costs was transferred to us.

We enter into significant transactions with other government agencies, as disclosed throughout these financial statements.

Price Setting Process

Since 1971, the Act has required us to establish prices that cover the costs of operating the postal system. The ratemaking process provides for the recovery of financial losses through future rate increases.

The Act established the independent Postal Rate Commission (PRC) with oversight responsibility for recommending fair and equitable rates of postage and fees, subject to approval by the Governors of the Postal Service.


Note 2 – Summary of Significant Accounting Policies

Basis of Accounting and Use of Estimates

We conform to accounting principles generally accepted in the United States. We maintain our accounting records and prepare our financial statements on the accrual basis of accounting. Following these principles, we make estimates and assumptions that affect the amounts we report in the financial statements and notes. Actual results may differ from our estimates.

Segment Information

We operate in one segment throughout the United States, it possessions, territories and internationally.

Reclassifications

Certain comparative prior year amounts in the financial statements and accompanying notes have been reclassified to conform to the current year presentation. These reclassifications had no effect on previously reported operating income and net income.

We currently recognize checks outstanding as a reduction of cash. We previously recognized checks outstanding as a current liability until presented for payment. Due to this 2006 change in accounting policy we have reclassified our balance sheets and statements of cash flow as required by Generally Accepted Accounting Principles (GAAP). This reclassification had no effect on our previously reported net income.

Cash and Cash Equivalents

We consider securities that mature within 90 days or less from the date we buy them as cash equivalents.