Northrop Grumman 2010 Annual Report Download - page 42

and subcontracting costs, and certain indirect costs including allowable general and administrative costs. Unless
otherwise specified in a contract, costs billed to contracts with the U.S. Government are determined under the
requirements of the Federal Acquisition Regulation (FAR) and CAS regulations as allowable and allocable costs.
Examples of costs incurred by us and not billed to the U.S. Government in accordance with the requirements of
the FAR and CAS regulations include, but are not limited to, certain legal costs, lobbying costs, charitable
donations, interest expense and advertising costs.
Our long-term contracts typically fall into one of two broad categories:
Flexibly Priced Contracts – Includes both cost-type and fixed-price incentive contracts. Cost-type contracts provide
for reimbursement of the contractor’s allowable costs incurred plus a fee that represents profit. Cost-type
contracts generally require that the contractor use its best efforts to accomplish the scope of the work within
some specified time and some stated dollar limitation. Fixed-price incentive contracts also provide for
reimbursement of the contractor’s allowable costs, but are subject to a cost-share limit which affects profitability.
Fixed-price incentive contracts effectively become firm fixed-price contracts once the cost-share limit is reached.
Firm Fixed-Price Contracts – A firm fixed-price contract is a contract in which the specified scope of work is
agreed to for a price that is a pre-determined, negotiated amount and not generally subject to adjustment
regardless of costs incurred by the contractor. Time-and-materials contracts are considered firm fixed-price
contracts as they specify a fixed hourly rate for each labor hour charged.
The following table summarizes 2010 revenue recognized by contract type and customer:
($ in millions)
U.S.
Government
Other
Customers Total
Percent
of Total
Flexibly priced $23,054 $ 198 $23,252 67%
Firm fixed-price 9,039 2,466 11,505 33%
Total $32,093 $2,664 $34,757 100%
Contract Fees – Negotiated contract fee structures, for both flexibly priced and fixed-price contracts include, but
are not limited to: fixed-fee amounts, cost sharing arrangements to reward or penalize for either under or over
cost target performance, positive award fees, and negative penalty arrangements. Profit margins may vary
materially depending on the negotiated contract fee arrangements, percentage-of-completion of the contract, the
achievement of performance objectives, and the stage of performance at which the right to receive fees,
particularly under incentive and award fee contracts, is finally determined.
Award Fees – Certain contracts contain provisions consisting of award fees based on performance criteria such as
cost, schedule, quality, and technical performance. Award fees are determined and earned based on an evaluation
by the customer of the company’s performance against such negotiated criteria. Fees that can be reasonably
assured and reasonably estimated are recorded over the performance period of the contract. Award fee contracts
are used in certain of our operating segments. Examples of significant long-term contracts with substantial
negotiated award fee amounts are the Broad Area Maritime Surveillance (BAMS) Unmanned Aircraft System and
the majority of satellite contracts.
Compliance and Monitoring – We monitor our policies and procedures with respect to our contracts on a regular
basis to ensure consistent application under similar terms and conditions as well as compliance with all applicable
government regulations. In addition, costs incurred and allocated to contracts with the U.S. Government are
routinely audited by the Defense Contract Audit Agency.
CRITICAL ACCOUNTING POLICIES, ESTIMATES, AND JUDGMENTS
Revenue Recognition
Overview – We derive the majority of our business from long-term contracts for the production of goods and
services provided to the federal government, which are accounted for in conformity with accounting principles
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NORTHROP GRUMMAN CORPORATION