Lockheed Martin 2011 Annual Report Download - page 52

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 under the POC method requires judgment relative to assessing risks, estimating contract
revenues 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 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. For many of
our contracts, we are only able to estimate costs in ranges of amounts. Those ranges 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 revenue to be earned, a provision for the entire loss on the
contract is recorded in the period in which the loss is determined.
At the outset of each contract, we estimate the initial profit booking rate. The initial profit booking rate of each contract
is based on the initial estimated costs at completion considering risks surrounding the ability to achieve the technical
requirements (for example, a newly-developed product versus a mature product), schedule (for example, the number and type
of milestone events), and costs by contract requirements. Business segment personnel evaluate our contracts through periodic
reviews. Management personnel independent from the business segment performing work under the contract also perform
recurring evaluations of technical matters, scheduling, and contract costs. Profit booking rates may increase during the
performance of the contract if we successfully retire risks surrounding the technical, schedule, and costs aspects of the
contract. Likewise, the profit booking rate may decrease if we are not successful in retiring risks; and, as a result, our
estimated costs at completion increase. All of the estimates are subject to change during the performance of the contract and,
therefore, may affect the profit booking rate.
When adjustments in estimated contract revenues or estimated costs at completion are required, any changes from prior
estimates are recognized in the current period for the inception-to-date effect of the changes. For example, if we increase the
estimated profit booking rate on a cost-reimbursable contract, the increase in sales and operating profit for that contract will
reflect a higher return on sales in the current period due to the recognition of the higher profit booking rate on both current
period costs, as well as previously incurred costs. As examples of how changes in profit booking rates can affect our
financial statements, our net profit booking rate adjustments increased operating profit, net of state taxes, by approximately
$1.6 billion, $1.4 billion, and $1.6 billion for 2011, 2010, and 2009, as we were able to successfully retire risks across a
broad portfolio of contracts in those periods.
Services Method of Accounting
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. 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 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. Costs for all service contracts are expensed as incurred.
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, interest expense, and certain
advertising and public relations activities are unallowable and, therefore, not recoverable through sales. In addition, we may
enter into advance agreements with the U.S. Government that address the subjects of allowability and allocability of costs to
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