Lockheed Martin 2003 Annual Report Download - page 25

management personnel who are independent from the business seg-
ment performing work under the contract. Costs incurred and allo-
cated to contracts with the U.S. Government are reviewed for com-
pliance with regulatory standards by our personnel, and are subject
to audit by the Defense Contract Audit Agency.
Post-Retirement Benefit Plans
Most employees are covered by defined benefit pension plans, and
we provide health care and life insurance benefits to eligible
retirees. Our earnings may be positively or negatively impacted by
the amount of income or expense we record for our employee ben-
efit plans. This is particularly true with income or expense for qual-
ified defined benefit plans (pension plans) because those calcula-
tions are sensitive to changes in several key economic assumptions
and workforce demographics.
We account for our pension plans using Statement of Financial
Accounting Standards (FAS) No. 87, “Employers’ Accounting for
Pensions” (FAS 87). Those rules require that the amounts we record,
including the income or expense for the plans, be computed using
actuarial valuations. These valuations include many assumptions,
including assumptions we make relating to financial market and
other economic conditions. Changes in key economic indicators
can result in changes in the assumptions we use. The key year-end
assumptions used to estimate pension income or expense for the fol-
lowing fiscal year are the discount rate, the expected long-term rate
of return on plan assets and the rate of increase in future compen-
sation 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 market trends,
changes in interest rates and equity market performance. We also
have to consider factors like the timing and amounts of expected
contributions to the plans and benefit payments to plan participants.
An example of how changes in these assumptions can affect
our financial statements occurred in 2003. As required by FAS 87,
we reassessed the discount rate assumption at the end of 2003.
Based on our review of interest rates at the end of the year, we low-
ered our discount rate assumption to 6.25% at year-end 2003, ver-
sus 6.75% used for 2002 and 7.25% used for 2001. 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 2004 will approximately double as
compared to $484 million of expense recorded in 2003.
Also, at the end of 2002, we recorded a noncash after-tax
adjustment of $1.5 billion in the stockholders’ equity section of our
balance sheet to reflect a minimum pension liability for most of our
pension plans. The adjustment did not impact earnings, but reduced
our stockholders’ equity. This adjustment is calculated on a plan-by-
plan basis, and is determined by comparing the accumulated bene-
fit 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 previously recorded accrued or pre-
paid pension cost for the plan, must be recorded as a minimum pen-
sion liability, with a corresponding increase in an intangible asset, if
appropriate, and a reduction to stockholders’ equity, consistent with
FAS 87. In 2003, we reduced the adjustment recorded in stock-
holders’ equity in 2002 by about $300 million, mainly due to favor-
able asset returns for the year. Again, this minimum pension liabil-
ity adjustment did not impact 2003 earnings. The amount of the
minimum pension liability is computed at each year-end and could
potentially continue to reduce the amount recorded in 2002 in future
periods if financial markets improve and interest rates increase, or
could potentially increase if financial market performance and
interest rates decline.
U.S. Government Cost Accounting Standards (CAS) is a
major factor in determining our funding requirements and governs
the extent to which our pension costs are allocable to and recover-
able 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 therefore are recog-
nized in our net sales. The total funding requirement for our pen-
sion plans under CAS in 2003 was $184 million. For 2004, we
expect our funding requirements under CAS to increase. Also in
2004, funding in addition to the amount calculated under CAS will
likely be required under Internal Revenue Code rules. Any addi-
tional amounts computed under those rules are considered to be
prepayments under the CAS rules, and therefore will be recorded
on our balance sheet and recovered in future periods. In December
2003, we made a discretionary prepayment of $450 million to the
pension trust, the majority of which will reduce our cash funding
requirements for 2004. There is currently proposed legislation that
would change the measurement of the liabilities that are included
in the funding calculations for 2004. Our funding projections
assume that this proposed legislation will be passed and become
effective for 2004. We would expect our projected funding
requirements for 2004 to increase if the proposed legislation does
not become law.
Lockheed Martin Corporation
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