Lockheed Martin 2013 Annual Report Download - page 57

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 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 contracts for specific matters. For
example, most of the environmental costs we incur for environmental remediation related to sites operated in prior years are
allocated to our current operations as general and administrative costs under FAR provisions and supporting advance
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. Costs incurred and allocated to contracts are reviewed for compliance with U.S. Government regulations
by our personnel, and are subject to audit by the Defense Contract Audit Agency.
Postretirement Benefit Plans
Overview
Many of our employees are covered by defined benefit pension plans, and we provide certain health care and life
insurance benefits to eligible retirees (collectively, postretirement benefit plans – see Note 10). In recent years, we have
taken certain actions to mitigate the effect of our defined benefit pension plans on our financial results, including no longer
offering a defined benefit pension plan to non-union represented employees hired after December 2005. Over the last few
years, we have negotiated similar changes with various labor organizations such that new union represented employees do
not participate in our defined benefit pension plans. We have also made substantial cash contributions over the years to our
defined benefit pension plans including $2.25 billion in 2013, $3.6 billion in 2012, and $2.3 billion in 2011. Notwithstanding
these actions, the impact of these plans and benefits on our earnings may be volatile in that the amount of expense we record
and the funded status for our postretirement benefit plans may materially change from year to year because those calculations
are sensitive to funding levels as well as changes in several key economic assumptions, including interest rates, rates of
return on plan assets, and other actuarial assumptions including participant mortality estimates, expected rates of increase in
future compensation levels, and employee turnover, as well as the timing of cash funding.
We recognize on a plan-by-plan basis the funded status of our postretirement benefit plans under GAAP as either an
asset or a liability on our Balance Sheets. There is a corresponding non-cash adjustment to accumulated other comprehensive
loss, net of tax benefits recorded as deferred tax assets, in stockholders’ equity. The GAAP funded status is measured as the
difference between the fair value of the plan’s assets and the benefit obligation of the plan. The GAAP benefit obligation
represents the present value of the future benefits to be paid to plan participants based on past service. The present value is
calculated using a discount rate that is determined at the end of each year. Historically low interest rates over the last few
years have significantly increased our benefit obligation. This has contributed to a lower funded status of our defined benefit
pension plans as determined by GAAP but has been partially mitigated by a rise in interest rates during 2013.
The funding of our pension plans is determined in accordance with the Employee Retirement Income Security Act of
1974 (ERISA), as amended by the Pension Protection Act of 2006 (PPA). Our goal has been to fund the pension plans to a
level of at least 80%, as determined by the PPA. This ERISA funded status is calculated on a different basis than under
GAAP. The ERISA liability does not reflect anticipated future pay increases for plan participants as required under GAAP
and is currently measured using a higher discount rate than for GAAP, primarily due to The Moving Ahead for Progress in
the 21st Century Act of 2012 (MAP-21) which provides temporary funding relief due to the historically low interest rate
environment. By way of contrast, under ERISA our plans are about 90% funded at December 31, 2013 and 2012, while for
GAAP our defined benefit pension plans are about 78% and 67% funded at December 31, 2013 and 2012. CAS govern the
extent to which our pension costs are allocable to and recoverable under contracts with the U.S. Government, including FMS.
Actuarial Assumptions
GAAP requires that the amounts we record related to our plans be computed using actuarial valuations. The primary
year-end assumptions used to determine the funded status and estimate postretirement benefit plan expense for the following
calendar year are the discount rate, the expected long-term rate of return on plan assets, employee turnover, and participant
mortality estimates for all postretirement benefit plans; the expected rates of increase in future compensation levels for the
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