Lockheed Martin 2010 Annual Report Download - page 48

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Services Contracts
For cost-reimbursable contracts for services that provide for award and incentive fees, we record net sales as services are
performed, except for award and incentive fees. Award and incentive fees are recorded when they are fixed or determinable, generally
at the date the amount is communicated to us by the customer. This approach results in the recognition of such fees at contractual
intervals (typically every six months) throughout the contract and is dependent on the customer’s processes for notification of awards
and issuance of formal notifications. Under a fixed-price service contract, we are paid a predetermined fixed amount for a specified
scope of work and generally have full responsibility for the costs associated with the contract and the resulting profit or loss. We
record net sales under fixed-price service contracts on a straight-line basis over the period of contract performance, unless evidence
suggests that net sales are earned or the obligations are fulfilled in a different pattern. Costs for all service contracts are expensed as
incurred. The majority of our service contracts are in our IS&GS segment.
2011 Change in Revenue Recognition on Service Contracts with the U.S. Government
Effective January 1, 2011, we changed our methodology for recognizing net sales for service contracts with the
U.S. Government. We will recognize sales on those contracts using the POC method similar to our DD&P contracts as described
above. As such, we expect that over 95% of our consolidated net sales will be recognized using the POC method. We believe the POC
method is preferable, as consistent revenue recognition application across all contracts with the U.S. Government better reflects the
underlying economics of those contracts and aligns our financial reporting with others in our industry. Beginning with our first quarter
2011 financial statements, all prior periods presented will be retrospectively adjusted to apply the new method of accounting. The
effect of this change is expected to be less than one percent of net sales and segment operating profit in 2011, and was not material to
prior periods.
Other Contract Accounting Considerations
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. Cost-based pricing is determined under the Federal Acquisition Regulation (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, interest expense, and certain advertising and public relations activities
are unallowable, and therefore not recoverable through sales. In addition, we may enter into advance agreements with the U.S.
Government that address the subjects of allowability and allocability of costs to contracts for specific matters. For example, most of
the environmental costs we incur for groundwater treatment and soil remediation related to sites operated in prior years are allocated
to our current operations as general and administrative costs under FAR provisions and supporting advance agreements reached with
the U.S. Government.
We closely monitor compliance with, and the consistent application of, our critical accounting policies related to contract
accounting. Business segment personnel evaluate our contracts through periodic contract status and performance reviews. Also,
regular and recurring evaluations of contract cost, scheduling, and technical matters are performed by management personnel
independent from the business segment performing work under the contract. Costs incurred and allocated to contracts are reviewed for
compliance with U.S. Government regulations by our personnel, and are subject to audit by the Defense Contract Audit Agency.
Postretirement Benefit Plans
Most of our employees are covered by defined benefit pension plans, and we provide certain health care and life insurance
benefits to eligible retirees (collectively, postretirement benefit plans – see Note 11). The impact of these plans and benefits on our
earnings may be volatile in that the amount of expense we record for our postretirement benefit plans may materially change from
year to year because those calculations are sensitive to changes in several key economic assumptions and workforce demographics.
We recognize on a plan-by-plan basis the funded status of our postretirement benefit plans under GAAP as either an asset or liability
on our Balance Sheets, with a corresponding adjustment to accumulated other comprehensive income (loss), net of tax, in
stockholders’ equity. The funded status is measured as the difference between the fair value of the plan’s assets and the benefit
obligation of the plan as determined under GAAP.
Actuarial Assumptions
GAAP requires that the amounts we record related to our plans be computed using actuarial valuations. The primary year-end
assumptions used to estimate postretirement benefit plan expense for the following calendar year are the discount rate and the
expected long-term rate of return on plan assets for all postretirement benefit plans; the rates of increase in future compensation levels
for the participants in our defined benefit pension plans; and the health care cost trend rates for our retiree medical plans. The discount
rate we select impacts both the calculation of the benefit obligation at the end of the year and the calculation of net postretirement
benefit plan cost in the subsequent year. The difference between the long-term rate of return on plan assets assumption we select and
the actual return on plan assets in any given year affects both the funded status of our benefit plans and the calculation of net