Lockheed Martin 2007 Annual Report Download - page 46

Products and services provided under long-term design, development and production contracts represent approximately
84% of our sales for 2007. 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 estimation processes, it is likely
that materially different amounts could be recorded if we used different assumptions or if our underlying circumstances were
to change. For example, if underlying assumptions were to change such that our estimated profit rate at completion for all
design, development and production contracts was higher or lower by one percentage point, our Net earnings would increase
or decrease by approximately $225 million. When adjustments in estimated contract revenues or estimated costs at
completion are required, any changes from prior estimates are recognized by recording adjustments in the current period for
the inception-to-date effect of the changes on current and prior periods.
Accounting for Services Contracts
Revenue under contracts for services other than those associated with design, development or production activities is
generally recognized either as services are performed or when a contractually required event has occurred, depending on the
contract. This methodology is mainly used by our IS&GS segment. Services contracts primarily include operations and
maintenance contracts, and outsourcing-type arrangements. Revenue under such contracts is generally recognized on a
straight-line basis over the period of contract performance, unless evidence suggests that the revenue is earned or the
obligations are fulfilled in a different pattern. Costs incurred under these services contracts are expensed as incurred, except
that initial “set-up” costs are capitalized and recognized ratably over the life of the agreement. Earnings related to such
services contracts may fluctuate from period to period, particularly in the earlier phases of the contract. Incentives and award
fees related to performance on services contracts are recognized when they are fixed and determinable, generally at the date
of award.
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, advertising, interest expense, and
public relations 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 matters. For
example, most 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 operations as general and administrative costs under FAR
provisions and supporting 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 assess the status of 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 with the U.S. Government are reviewed for compliance with regulatory standards by our personnel, and
are subject to audit by the Defense Contract Audit Agency. 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.
Postretirement Benefit Plans
Most of our employees are covered by defined benefit pension plans (pension plans), and we provide health care and
life insurance benefits to eligible retirees. Our earnings may be negatively or positively impacted by the amount of expense
or income we record for our employee benefit plans. This is particularly true with expense or income for pension plans
because those calculations are sensitive to changes in several key economic assumptions and workforce demographics.
Non-union represented employees hired after January 1, 2006 do not participate in our defined benefit pension plans, but are
eligible to participate in a defined contribution plan in addition to our other retirement savings plans. They also have the
ability to participate in our retiree medical plans, but we do not subsidize the cost of their participation.
We account for our pension plans using Statement of Financial Accounting Standards (FAS) 158, Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106
and 132(R) and FAS 87, Employers’ Accounting for Pensions. FAS 158, which we adopted as of December 31, 2006,
required us to recognize on a plan-by-plan basis the funded status of our postretirement benefit plans, with a corresponding
adjustment to Accumulated other comprehensive loss, net of tax, in Stockholders’ equity. Prior to the end of 2006,
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