Lockheed Martin 2004 Annual Report Download - page 25

Most of our long-term contracts are denominated in U.S.
dollars, including contracts for sales of military products and
services to foreign governments conducted through the U.S.
Government (i.e., foreign military sales).
As a general rule, we recognize sales and profits earlier in
a production cycle when we use the cost-to-cost and milestone
methods of percentage of completion accounting than when we
use the units-of-delivery method. In addition, our profits and
margins may vary materially depending on the types of long-
term government contracts undertaken, the costs incurred in
their performance, the achievement of other performance
objectives, and the stage of performance at which the right to
receive fees, particularly under incentive and award fee con-
tracts, is finally determined. We have accounting policies in
place to address these as well as other contractual and business
arrangements in accounting for long-term contracts. For other
information on accounting policies we have in place for recog-
nizing sales and profits, see our discussion under “Sales and
earnings” in Note 1 to the financial statements.
Contract accounting requires judgment relative to assess-
ing risks, estimating contract revenues and costs, and making
assumptions for schedule and technical issues. Due to the size
and nature of many of our contracts, the estimation of total rev-
enue and cost at completion is complicated and subject to many
variables. Contract costs include material, labor and subcon-
tracting costs, as well as an allocation of indirect costs.
Assumptions have to be made regarding the length of time to
complete the contract because costs also include expected
increases in wages and prices for materials. For contract change
orders, claims or similar items, we apply judgment in estimat-
ing the amounts and assessing the potential for realization.
These amounts are only included in contract value when they
can be reliably estimated and realization is considered probable.
Incentives and award fees related to performance on contracts,
which are generally awarded at the discretion of the customer,
as well as penalties related to contract performance, are consid-
ered in estimating sales and profit rates. Incentives and penal-
ties are recorded when there is sufficient information for us to
assess anticipated performance. Award fees are recorded based
on actual awards and anticipated performance.
The majority of our sales are driven by pricing based on
costs incurred to produce products or perform services under
contracts with the U.S. Government, and therefore not neces-
sarily on market-based factors. Cost-based pricing is deter-
mined under the Federal Acquisition Regulations (FAR). The
FAR provides guidance on the types of costs that are allowable
in establishing prices for goods and services under U.S.
Government contracts. For example, costs such as those related
to charitable contributions, advertising, interest expense, and
public relations are unallowable, and therefore not recoverable
through sales. In addition, we may enter into agreements with
the U.S. Government that address the subjects of allowability
and allocability of costs to contracts for specific matters. For
example, some of the amounts we spend for groundwater treat-
ment and soil remediation related to discontinued operations
and sites operated in prior years are allocated to our current
operations as general and administrative costs under agree-
ments reached with the U.S. Government.
Products and services provided under long-term develop-
ment and production contracts make up a large portion of our
business. Therefore, the amounts we record in our financial
statements using contract accounting methods and cost
accounting standards are material. Because of the significance
of the judgments and estimation processes, it is likely that mate-
rially different amounts could be recorded if we used different
assumptions or if the underlying circumstances were to change.
When adjustments in estimated contract revenues or costs are
required, any changes from prior estimates are generally
included in earnings in the current period. We closely monitor
compliance with and the consistent application of our critical
accounting policies related to contract accounting. Business
segment personnel assess the status of contracts through peri-
odic contract status and performance reviews. Also, regular and
recurring evaluations of contract cost, scheduling and technical
matters are performed by management personnel separately
from the business segment performing work under the contract.
Costs incurred and allocated to contracts with the U.S.
Government are reviewed for compliance with regulatory stan-
dards by our personnel, and are subject to audit by the Defense
Contract Audit Agency.
Post-Retirement Benefit Plans
Most employees are covered by defined benefit pension plans
(pension plans), and we provide health care and life insurance
benefits to eligible retirees. Our earnings may be negatively or
positively impacted by the amount of expense or income we
record for our employee benefit plans. This is particularly true
with expense or income for pension plans because those calcu-
lations are sensitive to changes in several key economic assump-
tions and workforce demographics.
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Lockheed Martin Corporation