Lockheed Martin 2015 Annual Report Download - page 65

The percentage-of-completion method for product contracts depends on the nature of the products provided under the
contract. For example, for contracts that require us to perform a significant level of development effort in comparison to the
total value of the contract and/or to deliver minimal quantities, sales are recorded using the cost-to-cost method to measure
progress toward completion. Under the cost-to-cost method, we recognize sales and an 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
percentage-of-completion 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 and incentive fees, as well as penalties related to contract performance, are considered in estimating sales and
profit rates on contracts accounted for under the percentage-of-completion 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 using the percentage-of-completion method requires judgment relative to assessing risks,
estimating contract sales 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 sales and
costs at completion is complicated and subject to many variables and, accordingly, is subject to change. When adjustments in
estimated total contract sales or estimated total costs are required, any changes from prior estimates are recognized in the
current period for the inception-to-date effect of such changes.
Our estimates of costs at completion of the contract 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 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, overhead and the estimated costs to fulfill our
industrial cooperation agreements, sometimes referred to as offset agreements, required under certain contracts with
international customers). 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 total costs to complete the contract. 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 which decreases the estimated total costs to complete the contract. Conversely, our profit booking
rates may decrease if the estimated total 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 segment sales, operating profit and operating margins may be impacted favorably or
unfavorably 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
estimated total costs that reflect improved conditions on a particular contract. Conversely, conditions on a particular contract
may deteriorate resulting in an increase in the estimated total costs to complete and a reduction in 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 margins may also be impacted favorably or unfavorably by other items.
Favorable items may include the positive resolution of contractual matters, cost recoveries on restructuring charges,
insurance recoveries and gains on sales of assets. Unfavorable items may include the adverse resolution of contractual
matters; restructuring charges, except for significant severance actions as mentioned above which are excluded from segment
operating results; reserves for disputes; asset impairments; and losses on sales of assets. Segment operating profit and items
such as risk retirements, reductions of profit booking rates or other matters are presented net of state income taxes.
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