Northrop Grumman 2011 Annual Report Download - page 42

NORTHROP GRUMMAN CORPORATION
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 the original estimate. A significant change in an estimate on one or more contracts could
have a material effect on our consolidated financial position, results of operations and/or cash flows.
Certain Service Contracts – We generally recognize revenue under contracts to provide services to non-federal
government customers when services are performed. Service contracts include operations and maintenance
contracts, and outsourcing-type arrangements, primarily in Technical Services and Information Systems. We
generally recognize revenue under such contracts 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. Operating profit related to such service contracts may
fluctuate from period to period, particularly in the earlier phases of the contract.
Contracts that include more than one type of product or service are accounted for under the relevant GAAP
guidance for revenue arrangements with multiple-elements. Accordingly, for applicable arrangements, revenue
recognition includes the proper identification of separate units of accounting and the allocation of revenue across
all elements based on relative fair values.
Cost Estimation – The cost estimation process is based upon the professional knowledge of our engineers, program
managers and financial professionals, and draws on their significant experience and judgment. Factors that are
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, results
of operations and/or cash flows. 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
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 initial 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 are determined based
upon the terms of the purchase or sales agreements and, in most cases, involve a significant degree of judgment.
We record these accruals based on our interpretation of the terms of the purchase or sale agreements, known facts,
and an estimation of probable future events based on our experience, which may cause final amounts to differ
materially from original estimates.
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