Northrop Grumman 2009 Annual Report Download - page 43

Purchase Accounting and Goodwill
Overview – We allocate the purchase price of an acquired business to the underlying tangible and intangible assets
acquired and liabilities assumed based upon their respective fair market values, with the excess recorded as goodwill.
Such fair market value assessments require judgments and estimates that can be affected by contract performance
and other factors over time, which may cause final amounts to differ materially from original estimates. For
acquisitions completed through December 31, 2008, we recorded adjustments to fair value assessments to goodwill
over the purchase price allocation period (typically not exceeding twelve months), and adjusted goodwill for the
resolution of income tax uncertainties which extended beyond the purchase price allocation period.
In 2009, we implemented new GAAP accounting guidance related to business combinations that impacts how
we record adjustments to fair values included in the purchase price allocation and the resolution of income tax
uncertainties. For acquisitions completed after January 1, 2009, any adjustments to the fair value of purchased
assets and subsequent resolution of uncertain tax positions are recognized in net earnings, rather than as
adjustments to goodwill.
Acquisition Accruals – We establish certain accruals in connection with indemnities and other contingencies from
our acquisitions and divestitures. We have recorded these accruals and subsequent adjustments during the
purchase price allocation period for acquisitions and as events occur for divestitures. The accruals were
determined based upon the terms of the purchase or sales agreements and, in most cases, involve a significant
degree of judgment. We recorded these accruals in accordance with our interpretation of the terms of the
purchase or sale agreements, known facts, and an estimation of probable future events based on our experience.
Tests for Impairment – We perform impairment tests for goodwill as of November 30th of each year, or when
evidence of potential impairment exists. We record a charge to operations when we determine that an
impairment has occurred. In order to test for potential impairment, we use a discounted cash flow analysis,
corroborated by comparative market multiples where appropriate.
The principal factors used in the discounted cash flow analysis requiring judgment are the projected results of
operations, weighted average cost of capital (WACC), and terminal value assumptions. The WACC takes into
account the relative weights of each component of our consolidated capital structure (equity and debt) and
represents the expected cost of new capital adjusted as appropriate to consider lower risk profiles associated with
longer term contracts and barriers to market entry. The terminal value assumptions are applied to the final year
of the discounted cash flow model.
Due to the many variables inherent in the estimation of a business’s fair value and the relative size of our recorded
goodwill, differences in assumptions may have a material effect on the results of our impairment analysis.
Litigation, Commitments, and Contingencies
Overview – We are subject to a range of claims, lawsuits, environmental and income tax matters, and
administrative proceedings that arise in the ordinary course of business. Estimating liabilities and costs associated
with these matters requires judgment and assessment based upon professional knowledge and experience of
management and our internal and external legal counsel. In accordance with our practices relating to accounting
for contingencies, we record amounts as charges to earnings after taking into consideration the facts and
circumstances of each matter, including any settlement offers, and determine that it is probable that a liability has
been incurred and the amount of the loss can be reasonably estimated. The ultimate resolution of any such
exposure to us may vary from earlier estimates as further facts and circumstances become known.
Environmental Accruals – We are subject to the environmental laws and regulations of the jurisdictions in which we
conduct operations. We record a liability for the costs of expected environmental remediation obligations when
we determine that it is probable we will incur such costs, and the amount of the liability can be reasonably
estimated. When a range of costs is possible and no amount within that range is a better estimate than another,
we record the minimum amount of the range.
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NORTHROP GRUMMAN CORPORATION
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