Northrop Grumman 2010 Annual Report Download - page 78

Accounting Estimates – The company’s financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America (GAAP). The preparation thereof requires management to
make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of
contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses
during the reporting period. Estimates have been prepared on the basis of the most current and best available
information and actual results could differ materially from those estimates.
Revenue Recognition – The majority of the company’s business is derived from long-term contracts for production
of goods, and services provided to the federal government. In accounting for these contracts, the company
extensively utilizes the cost-to-cost and the units-of-delivery measures of the percentage-of-completion method
of accounting. Sales under cost-reimbursement contracts and construction-type contracts that provide for delivery
at a low volume per year or a small number of units after a lengthy period of time over which a significant
amount of costs have been incurred are accounted for using the cost-to-cost method. Under this method, sales,
including estimated earned fees or profits, are recorded as costs are incurred. For most contracts, sales are
calculated based on the percentage that total costs incurred bear to total estimated costs at completion. For
certain contracts with large up-front purchases of material, primarily in the Shipbuilding segment, sales are
calculated based on the percentage that direct labor costs incurred bear to total estimated direct labor costs. Sales
under construction-type contracts that provide for delivery at a high volume per year are accounted for using the
units-of-delivery method. Under this method, sales are recognized as deliveries are made to the customer
generally using unit sales values for delivered units in accordance with the contract terms. The company estimates
profit as the difference between total estimated revenue and total estimated cost of a contract and recognizes that
profit over the life of the contract based on deliveries or as computed on the basis of the estimated final average
unit costs plus profit. The company classifies contract revenues as product sales or service revenues depending
upon the predominant attributes of the relevant underlying contracts.
Certain contracts contain provisions for price redetermination or for cost and/or performance incentives. Such
redetermined amounts or incentives are included in sales when the amounts can reasonably be determined and
estimated. Amounts representing contract change orders, claims, requests for equitable adjustment, or limitations
in funding are included in sales only when they can be reliably estimated and realization is probable. In the
period in which it is determined that a loss will result from the performance of a contract, the entire amount of
the estimated ultimate loss is charged against income. Loss provisions are first offset against costs that are included
in unbilled accounts receivable or inventoried costs, with any remaining amount reflected in liabilities. Changes
in estimates of contract sales, costs, and profits are recognized using the cumulative catch-up method of
accounting. This method recognizes in the current period the cumulative effect of the changes on current and
prior periods. Hence, the effect of the changes on future periods of contract performance is recognized as if the
revised estimate had been used since contract inception. A significant change in an estimate on one or more
contracts could have a material effect on the company’s consolidated financial position or results of operations,
and where such changes occur, separate disclosure is made of the nature, underlying conditions and financial
impact of the change.
Revenue under contracts to provide services to non-federal government customers are generally recognized
when services are performed. Service contracts include operations and maintenance contracts, and outsourcing-
type arrangements, primarily in the Technical Services and Information Systems segments. Revenue under such
contracts is generally recognized on a straight-line basis over the period of contract performance, unless evidence
suggests that the revenue is earned or the obligations are fulfilled in a different pattern. Costs incurred under
these service contracts are expensed as incurred, except that direct and incremental set-up costs are capitalized
and amortized over the life of the agreement (see Outsourcing Contract Costs below). Operating profit related to
such service contracts may fluctuate from period to period, particularly in the earlier phases of the contract. For
contracts that include more than one type of product or service, revenue recognition includes the proper
identification of separate units of accounting and the allocation of revenue across all elements based on relative
fair values.
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NORTHROP GRUMMAN CORPORATION