Lockheed Martin 2003 Annual Report Download - page 24

over a longer period of time or to perform a substantial level of
development effort in comparison to the total value of the contract,
revenues are recorded when we achieve performance milestones or
using the cost-to-cost method to measure percentage of completion.
Under the cost-to-cost method of accounting, we recognize revenue
based on the ratio of costs incurred to our estimate of total costs at
completion. As examples, we use this methodology for our F/A-22
Raptor program and the AEGIS Weapons System program. In some
instances, long-term production programs may require a significant
level of development and/or a low level of initial production units in
their initial phases, but will ultimately require delivery of increased
quantities in full rate production stages. In those cases, the revenue
recognition methodology may change from the cost-to-cost method
to the units-of-delivery method after considering, among other fac-
tors, production stabilization. We record sales under cost-reim-
bursement-type contracts as we incur the costs. Examples of this
type of revenue recognition include the F-35 Joint Strike Fighter
system development and demonstration (SDD) program and the
THAAD missile defense program. The majority of our long-term
contracts are denominated in U.S. dollars, including contracts for
sales of military products and services to foreign governments con-
ducted 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 meth-
ods 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 per-
formance at which the right to receive fees, particularly under
incentive and award fee contracts, is finally determined. We have
accounting policies in place to address these as well as other con-
tractual and business arrangements in accounting for long-term
contracts. For other information on accounting policies we have in
place for recognizing sales and profits, see our discussion under
“Sales and earnings” in Note 1 to the financial statements.
Contract accounting requires judgment relative to assessing
risks, estimating contract revenues and costs, and making assump-
tions for schedule and technical issues. Due to the size and nature
of many of our contracts, the estimation of total revenue and cost 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. 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 estimating 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 considered in
estimating sales and profit rates. Incentives and penalties are
recorded when there is sufficient information for us to assess antic-
ipated performance. Award fees are estimated based on actual and
anticipated awards.
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 necessarily on market-
based factors. Cost-based pricing is determined 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, public rela-
tions, and stock-based compensation programs 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 mat-
ters. For example, some of the amounts we spend for groundwater
treatment and soil remediation related to discontinued operations
and sites operated in prior years are allocated to our current opera-
tions as general and administrative costs under agreements reached
with the U.S. Government.
Products and services provided under long-term development
and production contracts make up a large portion of our business,
and 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 esti-
mation processes, it is likely that materially different amounts could
be recorded if we used different assumptions or if the underlying cir-
cumstances 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 mon-
itor compliance with and the consistent application of our critical
accounting policies related to contract accounting. Business segment
personnel assess the status of contracts through periodic contract sta-
tus and performance reviews. Also, regular and recurring evaluations
of contract cost, scheduling and technical matters are performed by
Lockheed Martin Corporation
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
December 31, 2003
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