Northrop Grumman 2010 Annual Report Download - page 44

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considered in estimating the work to be completed and ultimate contract recovery include the availability,
productivity and cost of labor, the nature and complexity of the work to be performed, the effect of change orders,
the availability of materials, the effect of any delays in performance, the availability and timing of funding from the
customer, and the recoverability of any claims included in the estimates to complete. A significant change in an
estimate on one or more contracts could have a material effect on our consolidated financial position or results of
operations. We update our contract cost estimates at least annually and more frequently as determined by events or
circumstances. We generally review and reassess our cost and revenue estimates for each significant contract on a
quarterly basis.
We record a provision for the entire loss on the contract in the period the loss is determined when estimates of
total costs to be incurred on a contract exceed estimates of total revenue to be earned. We offset loss provisions
first against costs that are included in unbilled accounts receivable or inventoried assets, with any remaining
amount reflected in liabilities.
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. Adjustments to the fair value of purchased assets and liabilities after the measurement period are
recognized in net earnings.
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.
As a result of our announcement to wind down operations at Shipbuilding’s Avondale, Louisiana facility (see
Note 7 to the consolidated financial statements in Part II, Item 8), we performed an interim impairment test on
Shipbuilding’s goodwill as of June 30, 2010, and concluded that the estimated fair value of the Shipbuilding
reporting unit was substantially in excess of its carrying value.
The results of our annual goodwill impairment test as of November 30, 2010, indicated that the estimated fair
value of all reporting units were substantially in excess of their carrying values.
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.
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NORTHROP GRUMMAN CORPORATION