Lockheed Martin 2004 Annual Report Download - page 26

We account for our pension plans using Statement of
Financial Accounting Standards (FAS) 87, Employers’
Accounting for Pensions. Those rules require that the
amounts we record, including the expense or income for the
plans, be computed using actuarial valuations. These valua-
tions include many assumptions, including assumptions we
make relating to financial market and other economic condi-
tions. Changes in key economic indicators can result in
changes in the assumptions we use. The key year-end
assumptions used to estimate pension expense or income for
the following fiscal year are the discount rate, the expected
long-term rate of return on plan assets and the rate of
increase in future compensation levels.
We use judgment in reassessing these assumptions each
year because we have to consider current market conditions
and, in the case of the expected long-term rate of return on plan
assets, past investment experience, judgments about future mar-
ket trends, changes in interest rates and equity market perform-
ance. We also have to consider factors like the timing and
amounts of expected contributions to the plans and benefit pay-
ments to plan participants.
An example of how changes in these assumptions can
affect our financial statements occurred in 2004. We reassess
the discount rate assumption at the end of each year. Based on
our review of interest rates at the end of the year, we lowered
our discount rate assumption to 5.75% at year-end 2004, com-
pared to 6.25% used at the end of 2003. This change, together
with other factors such as the effects of the actual return on
plan assets over the past few years, resulted in our projecting
that the amount of pension expense for 2005 will increase by
approximately 25% to 30% as compared to 2004 expense. The
change in the discount rate is the main factor causing this
result. The decrease of 50 basis points in the discount rate
increased the estimated 2005 pension expense by approxi-
mately $160 million. This annual review of our pension plan
assumptions also affects the pension liability recorded in our
balance sheet.
At the end of each of the last three years, we recorded a
noncash after-tax adjustment in the stockholders’ equity section
of our balance sheet to reflect a minimum pension liability for
most of our pension plans. These adjustments were calculated
on a plan-by-plan basis, and were determined by comparing the
accumulated benefit obligation (ABO) for each plan to the fair
value of that plan’s assets. The amount by which the ABO
exceeds the fair value of the plan assets, after adjusting for pre-
viously recorded accrued or prepaid pension cost for the plan,
must be recorded as a minimum pension liability, with a corre-
sponding increase in an intangible asset, if appropriate, and a
reduction to stockholders’ equity. In 2004, the adjustment we
recorded reduced stockholders’ equity by about $275 million,
mainly due to the change in the discount rate at December 31,
2004. This comes after stockholders’ equity increased by about
$300 million from the adjustment made in 2003, mainly due to
favorable asset returns for the year. At the end of 2002, the
adjustment reduced stockholders’ equity by $1.5 billion. These
minimum pension liability adjustments did not impact earn-
ings. The amount of the minimum pension liability is computed
at each year-end and could decrease or increase depending on
changes in interest rates and other factors.
U.S. Government Cost Accounting Standards (CAS) are a
major factor in determining our funding requirements and gov-
ern the extent to which our pension costs are allocable to and
recoverable under contracts with the U.S. Government. Funded
amounts are recovered over time through the pricing of our
products and services on U.S. Government contracts, and there-
fore are recognized in our net sales. The total funding require-
ment for pension plans under CAS in 2004 was $289 million.
For 2005, we expect our funding requirements under CAS to
increase. Also in 2005, funding in addition to the amount cal-
culated under CAS will likely be required under Internal
Revenue Code rules. Any additional amounts computed under
those rules are considered to be prepayments under the CAS
rules, and therefore are recorded on our balance sheet and
recovered in future periods. In 2004 and 2003, we made discre-
tionary prepayments of $485 million and $450 million, respec-
tively, to the pension trust, which reduced or will reduce our
cash funding requirements in the following year.
The FAS/CAS pension adjustment represents the differ-
ence between pension expense calculated in accordance with
FAS 87 and pension costs calculated and funded in accordance
with CAS. Since the CAS expense is recovered through the
pricing of our products and services on U.S. Government con-
tracts, and therefore recognized in a particular segment’s net
sales, the results of operations of our segments only include
pension expense as determined and funded in accordance with
CAS rules. Accordingly, the FAS/CAS adjustment is an amount
included in the reconciliation of total segment operating profit
to consolidated operating profit under GAAP. See the discus-
Lockheed Martin Corporation
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
December 31, 2004
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