Lockheed Martin 2011 Annual Report Download - page 65

estimated profit as costs are incurred based on the proportion that the incurred costs bear to total estimated costs. For
contracts that require us to provide a substantial number of similar items without a significant level of development, we
record sales and an estimated profit on a POC basis using units-of-delivery as the basis to measure progress toward
completing the contract. For contracts to provide services to the U.S. Government, sales are generally recorded using the
cost-to-cost method.
Award fees and incentives, as well as penalties related to contract performance, are considered in estimating sales and
profit rates on contracts accounted for under the POC method. Estimates of award fees are based on past experience and
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 scope and nature of the work required to be performed on many of
our contracts, the estimation of total revenue and cost at completion is complicated and subject to many variables and,
accordingly, is subject to change. 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 such
changes. 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. 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, or may decrease
if we are not successful in retiring risks and, as a result, our estimated costs at completion increase.
Our net profit booking rate adjustments resulting from changes in estimates increased operating profit, net of state taxes,
by approximately $1.6 billion in 2011, $1.4 billion in 2010, and $1.6 billion in 2009. These adjustments increased net
earnings by approximately $1.0 billion ($3.00 per share) in 2011, $890 million ($2.40 per share) in 2010, and $1.0 billion
($2.60 per share) in 2009.
Services Method of Accounting – For cost-reimbursable contracts for services to non-U.S. Government customers, we
record net sales as services are performed, except for 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 fixed-price service
contracts, 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
with non-U.S. Government customers 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.
Change in Accounting Principle and Adoption of New Accounting Standard – On January 1, 2011, we changed the way
we account for our services contracts with the U.S. Government. We now recognize sales on those contracts using the POC
method (as described above). All prior period amounts have been adjusted to reflect the new method of accounting. The
effect of this change in accounting was not material to our consolidated results of operations or financial position for any
period, including 2011, and did not impact cash flows. At December 31, 2010, the cumulative effect of adopting the new
method was a reduction in retained earnings of $211 million, which reflects the inception-to-date timing differences between
the two methods. We believe the POC method is preferable to the service accounting method we previously used, as
consistent sales recognition for all contracts with the U.S. Government better reflects the underlying economics of those
contracts and aligns our financial reporting with other companies in our industry.
On January 1, 2011, we prospectively adopted a new accounting standard that revised accounting guidance related to
sales arrangements with multiple deliverables. This standard potentially applies to new or materially modified contracts that
are not accounted for under the POC method. The adoption did not have a material effect on our financial results in 2011,
and is not expected to have a material effect in future periods.
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