Lockheed Martin 2013 Annual Report Download - page 56

Award and incentive fees, as well as penalties related to contract performance, are considered in estimating sales and
profit rates on contracts accounted for under the percentage-of-completion method. Estimates of award fees are based on past
experience and anticipated performance. We record incentives or penalties when there is sufficient information to assess
anticipated contract performance. Incentive provisions that increase or decrease earnings based solely on a single significant
event are not recognized until the event occurs.
Accounting for contracts using the percentage-of-completion method requires judgment relative to assessing risks,
estimating contract sales and costs (including estimating award and incentive fees and penalties related to performance), and
making assumptions for schedule and technical issues. Due to the number of years it may take to complete many of our
contracts and the scope and nature of the work required to be performed on those contracts, the estimation of total sales and
costs at completion is complicated and subject to many variables.
Contract costs include material, labor, and subcontracting costs, as well as an allocation of indirect costs. Our estimates
of costs at completion of the contract are based on assumptions we make for variables such as labor productivity and
availability, the complexity of the work to be performed, the availability of materials, the length of time to complete the
contract (to estimate increases in wages and prices for materials), performance by our subcontractors, and the availability and
timing of funding from our customer, among other variables. When estimates of total costs to be incurred on a contract
exceed total estimates of sales to be earned, a provision for the entire loss on the contract is recorded in the period in which
the loss is determined.
Many of our contracts span several years and include highly complex technical requirements. At the outset of a contract,
we identify and monitor risks to the achievement of the technical, schedule, and cost aspects of the contract, and assess the
effects of those risks on our estimates of total costs to complete the contract. The estimates consider the technical
requirements (e.g., a newly-developed product versus a mature product), the schedule and associated tasks (e.g., the number
and type of milestone events), and costs (e.g., material, labor, subcontractor and overhead). The initial profit booking rate of
each contract considers risks surrounding the ability to achieve the technical requirements, schedule, and costs in the initial
estimated costs at completion. Profit booking rates may increase during the performance of the contract if we successfully
retire risks surrounding the technical, schedule and cost aspects of the contract. Conversely, our profit booking rates may
decrease if the estimated costs to complete the contract increase. All of the estimates are subject to change during the
performance of the contract and may affect the profit booking rate.
In addition, comparability of our sales, segment operating profit, and segment operating margins may be impacted by
changes in profit booking rates on our contracts accounted for using the percentage-of-completion method of accounting.
Increases in the profit booking rates, typically referred to as risk retirements, usually relate to revisions in the total estimated
costs at completion that reflect improved conditions on a particular contract. Conversely, conditions on a particular contract
may deteriorate resulting in an increase in the estimated costs at completion and a reduction of the profit booking rate.
Increases or decreases in profit booking rates are recognized in the current period and reflect the inception-to-date effect of
such changes. Segment operating profit and segment operating margins may also be impacted, favorably or unfavorably, by
other matters such as the resolution of contractual matters; restructuring charges, except for significant severance actions as
mentioned above; cost recoveries on all restructuring charges; reserves for disputes; asset impairments; and insurance
recoveries; among others. Segment operating profit and items such as risk retirements, reductions of profit booking rates, or
other matters are presented net of state income taxes.
Services Method of Accounting
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 to non-U.S. Government customers 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.
For cost-reimbursable contracts for services to non-U.S. Government customers that provide for award and incentive fees, we
record net sales as services are performed, exclusive of 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. Costs for all service
contracts are expensed as incurred.
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