Lockheed Martin 2013 Annual Report Download - page 70

estimated contract sales 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 sales to be earned, a provision for the entire loss on the contract is recorded in the period in which
the loss is determined.
Many of our contracts span several years and include highly complex technical requirements. At the outset of a contract,
we identify and monitor risks to the achievement of the technical, schedule, and cost aspects of the contract, and assess the
effects of those risks on our estimates of total costs to complete the contract. The estimates consider the technical
requirements (e.g., a newly-developed product versus a mature product), the schedule and associated tasks (e.g., the number
and type of milestone events), and costs (e.g., material, labor, subcontractor and overhead). The initial profit booking rate of
each contract considers risks surrounding the ability to achieve the technical requirements, schedule, and costs in the initial
estimated costs at completion. Profit booking rates may increase during the performance of the contract if we successfully
retire risks surrounding the technical, schedule and cost aspects of the contract. Conversely, our profit booking rates may
decrease if the estimated costs to complete the contract increase. All of the estimates are subject to change during the
performance of the contract and may affect the profit booking rate.
In addition, comparability of our sales, segment operating profit, and segment operating margins may be impacted by
changes in profit booking rates on our contracts accounted for using the percentage-of-completion method of accounting.
Increases in the profit booking rates, typically referred to as risk retirements, usually relate to revisions in the total estimated
costs at completion that reflect improved conditions on a particular contract. Conversely, conditions on a particular contract
may deteriorate resulting in an increase in the estimated costs at completion and a reduction of the profit booking rate.
Increases or decreases in profit booking rates are recognized in the current period and reflect the inception-to-date effect of
such changes. Segment operating profit and segment operating margins may also be impacted, favorably or unfavorably, by
other matters such as the resolution of contractual matters; restructuring charges, except for significant severance actions as
mentioned below; cost recoveries on all restructuring charges; reserves for disputes; asset impairments; and insurance
recoveries; among others. Segment operating profit and items such as risk retirements, reductions of profit booking rates, or
other matters are presented net of state income taxes.
Our consolidated net adjustments not related to volume, including net profit booking rate adjustments and other matters,
increased segment operating profit, net of state income taxes, by approximately $2.1 billion in 2013, $1.9 billion in 2012, and
$1.6 billion in 2011. These adjustments increased net earnings by approximately $1.3 billion ($4.09 per share) in 2013,
$1.2 billion ($3.70 per share) in 2012, and $1.0 billion ($3.00 per share) in 2011.
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.
Research and development and similar costs – Except for certain arrangements described below, we account for
independent research and development costs as part of the general and administrative costs that are allocated among all of
our contracts and programs in progress under U.S. Government contractual arrangements and charged to cost of sales. Under
certain arrangements in which a customer shares in product development costs, our portion of unreimbursed costs is
expensed as incurred in cost of sales. Independent research and development costs charged to cost of sales totaled
$697 million in 2013, $616 million in 2012, and $585 million in 2011. Costs we incur under customer-sponsored research
and development programs pursuant to contracts are included in net sales and cost of sales.
Stock-based compensation – Compensation cost related to all share-based payments is measured at the grant date based
on the estimated fair value of the award. We generally recognize the compensation cost ratably over a three-year vesting
period.
Income taxes – We calculate our provision for income taxes using the asset and liability method, under which deferred
tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences that exist
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