Northrop Grumman 2012 Annual Report Download - page 59

NORTHROP GRUMMAN CORPORATION
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damages. Termination of a contract for the convenience of the government may occur when the government
concludes it is in the best interests of the government that the contract be terminated. Under a termination for
convenience, the contractor is typically entitled to be paid in accordance with the contract’s terms for costs incurred
prior to the effective date of termination, plus a reasonable profit and settlement expenses. The company does not
have any contract terminations in process that would have a material effect on our consolidated financial position or
annual results of operations at December 31, 2012.
Changes in estimates of contract sales, costs, or profits are recognized using the cumulative catch-up method of
accounting. This method recognizes, in the current period, the cumulative effect of the changes on current and prior
periods, and revenue and profit on future periods of contract performance are recognized as if the revised estimate
had been used since contract inception. If it is determined that a loss will result from the performance of a contract,
the entire amount of the estimable future loss is charged against income in the period the loss is identifiable. Loss
provisions are first offset against costs that are included in unbilled accounts receivable or inventoried costs, and any
remaining amount is reflected in liabilities.
Changes in contract estimates occur for a variety of reasons, including changes in contract scope, other changes in
estimated revenue and changes in contract cost estimates. These changes are often driven by events such as changes
in estimated incentive fees, unanticipated risks affecting contract costs, the resolution of risk at lower or higher cost
than anticipated, and changes in indirect cost allocations, such as overhead and general and administrative expenses.
We employ an extensive contract management process involving several functional organizations and numerous
personnel who are skilled at managing contract activities. Changes in estimates are frequent; the company performs
on a broad portfolio of long-term contracts, many of which include complex and customized aerospace and
electronic equipment and software. These contracts often include technology that is at the forefront of science.
Significant changes in estimates on a single contract could have a material effect on the company's consolidated
financial position or annual results of operations, and where such changes occur, separate disclosure is made of the
nature, underlying conditions and financial impact of the change. Aggregate net changes in contract estimates
recognized using the cumulative catch-up method of accounting increased operating income by $985 million ($2.53
per diluted share) in 2012, $738 million ($1.70 per diluted share) in 2011, and $675 million ($1.46 per diluted share)
in 2010. No discrete event or adjustments to an individual contract within the aggregate net changes in contract
estimates for 2012, 2011, or 2010 was material to the consolidated statements of earnings and comprehensive
income for such annual period.
General and Administrative Expenses
In accordance with industry practice and the regulations that govern the cost accounting requirements for
government contracts, most general and administrative expenses incurred at both the segment and corporate
locations are considered allowable and allocable costs on government contracts. These costs are allocated to
contracts in progress on a systematic basis and are included as a component of total contract costs, including any
provision for loss contracts.
Research and Development
Company-sponsored research and development activities primarily include independent research and development
(IR&D) efforts related to government programs. Company-sponsored IR&D expenses are included in general and
administrative expenses in the consolidated statements of earnings and comprehensive income and are generally
allocated to government contracts. Company-sponsored IR&D expenses totaled $520 million, $543 million, and
$580 million, in 2012, 2011, and 2010, respectively. Expenses for research and development sponsored by the
customer are charged directly to the related contracts.
Environmental Costs
Environmental liabilities are accrued when the company determines that, based on the facts and circumstances
known to the company, such amounts are reasonably estimable and it is probable that a liability will be found to
have been incurred. When only a range of amounts is established and no amount within the range is more probable
than another, the minimum amount in the range is recorded. Environmental liabilities are recorded on an
undiscounted basis and do not include legal costs or asset retirement obligations. At sites involving multiple parties,
the company accrues environmental liabilities based upon its expected share of liability, taking into account the
financial viability of other jointly liable parties. A portion of the environmental remediation costs is expected to be
recoverable through overhead charges on government contracts and accordingly, such amounts are deferred in
inventoried costs (current portion) and other non-current assets. Environmental expenditures are expensed or
capitalized as appropriate. Capitalized expenditures relate to long-lived improvements in currently operating
facilities. The company does not record insurance recoveries before collection is probable. At December 31, 2012
and 2011, the company did not have any accrued receivables related to insurance reimbursements.