General Dynamics 2015 Annual Report Download - page 36

the products are produced or as services are rendered. We determine
progress using either input measures (e.g., costs incurred) or output
measures (e.g., contract milestones or units delivered), as appropriate
to the circumstances. An input measure is used in most cases unless
an output measure is identified that is reliably determinable and
representative of progress toward completion. We estimate the profit
on a contract as the difference between the total estimated revenue
and expected costs to complete a contract and recognize that profit
over the life of the contract. If at any time the estimate of contract
profitability indicates an anticipated loss on the contract, we recognize
the loss in the quarter it is identified.
We generally measure progress toward completion on contracts in
our defense business based on the proportion of costs incurred to date
relative to total estimated costs at completion (input measure). For our
contracts for the manufacture of business-jet aircraft, we record
revenue at two contractual milestones: when green aircraft are
delivered to and accepted by the customer and when the customer
accepts final delivery of the fully outfitted aircraft (output measure). We
do not recognize revenue at green delivery unless (1) a contract has
been executed with the customer and (2) the customer can be
expected to satisfy its obligations under the contract, as evidenced by
the receipt of significant deposits from the customer and other factors.
Accounting for long-term contracts and programs involves the use
of various techniques to estimate total contract revenue and costs.
Contract estimates are based on various assumptions to project the
outcome of future events that often span several years. These
assumptions include labor productivity and availability; the complexity
of the work to be performed; the cost and availability of materials; the
performance of subcontractors; and the availability and timing of
funding from the customer. We include in our contract estimates
additional revenue for submitted contract modifications or claims
against the customer when the amount can be estimated reliably and
its realization is probable. In evaluating these criteria, we consider the
contractual/legal basis for the claim, the cause of any additional costs
incurred, the reasonableness of those costs and the objective evidence
available to support the claim. We include award or incentive fees in
the estimated contract value when there is a basis to reasonably
estimate the amount of the fee. Estimates of award or incentive fees
are based on historical award experience and anticipated performance.
These estimates are based on our best judgment at the time. As a
significant change in one or more of these estimates could affect the
profitability of our contracts, we review our performance monthly and
update our contract-related estimates at least annually and often
quarterly, as well as when required by specific events and
circumstances.
We recognize changes in the estimated profit on contracts under the
reallocation method. Under the reallocation method, the impact of a
revision in estimate is recognized prospectively over the remaining
contract term. We use this method because we believe the majority of
factors that typically result in changes in estimates on our long-term
contracts affect the period in which the change is identified and future
periods. These changes generally reflect our current expectations as to
future performance and, therefore, the reallocation method is the method
that best matches our profits to the periods in which they are earned.
Most government contractors recognize the impact of a change in
estimated profit immediately under the cumulative catch-up method. The
impact on operating earnings in the period the change is identified is
generally lower under the reallocation method as compared to the
cumulative catch-up method.
The net impact of revisions in contract estimates on our operating
earnings (and on a diluted per-share basis) totaled favorable changes of
$222 ($0.44) in 2015, $184 ($0.35) in 2014 and $351 ($0.65) in 2013.
No revisions on any one contract were material to our Consolidated
Financial Statements in 2015, 2014 or 2013.
Consistent with defense industry practice, we classify assets and
liabilities related to long-term contracts as current, even though some of
these amounts may not be realized within one year. All contracts are
reported on the Consolidated Balance Sheets in a net asset (contracts in
process) or liability (customer advances and deposits) position on a
contract-by-contract basis at the end of each reporting period. Our U.S.
government customer generally asserts title to, or a security interest in,
inventoried costs related to such contracts as a result of advances and
progress payments. We reflect these advances and progress payments
as an offset to the related inventoried costs.
In the second quarter of 2014, the Financial Accounting Standards
Board (FASB) issued Accounting Standards Update (ASU) 2014-09,
Revenue from Contracts with Customers. ASU 2014-09 prescribes a
single, common revenue standard that replaces most existing revenue
recognition guidance in GAAP. The standard outlines a five-step model,
whereby revenue is recognized as performance obligations within a
contract are satisfied. The standard also requires new, expanded
disclosures regarding revenue recognition. Several updates have been
proposed since the issuance of ASU 2014-09. These updates are
intended to allow for a more consistent interpretation and application of
the principles outlined in the standard. Once these updates are issued by
the FASB in 2016, the standard will be final.
ASU 2014-09 is effective in the first quarter of 2018 for public
companies. However, entities can elect to adopt one year earlier in the
first quarter of 2017. The standard permits the use of either the
retrospective or cumulative effect transition method.
We are utilizing a bottom-up approach to analyze the standard’s
impact on our contract portfolio, taking a fresh look at historical
accounting policies and practices and identifying potential differences
from applying the requirements of the new standard to our contracts.
32 General Dynamics Annual Report 2015