Northrop Grumman 2012 Annual Report Download - page 37

NORTHROP GRUMMAN CORPORATION
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Operating Costs and Expenses
Operating costs and expenses are primarily comprised of labor, material, subcontractor, and overhead costs, and are
generally allocated to contracts as they are incurred. In accordance with industry practice and the regulations that
govern cost accounting requirements for government contracts, most general management and corporate expenses
incurred at the segment and corporate locations are considered allowable and allocable costs. These general and
administrative costs are generally allocated on a systematic basis to contracts in progress.
Operating costs and expenses consist of the following:
Year Ended December 31
$ in millions 2012 2011 2010
Product and service costs $19,638 $20,786 $22,849
General and administrative 2,450 2,350 2,467
Operating costs and expenses $22,088 $23,136 $25,316
2012 – Product and service costs for 2012 decreased $1.1 billion, or 6 percent, as compared to 2011. The primary
driver of the reduction in product and service costs was reduced volume at Electronic Systems, Information Systems
and Technical Services. General and administrative expenses as a percentage of total sales increased to 9.7 percent
in 2012, from 8.9 percent in 2011; the increase includes the impact of lower sales, higher indirect costs related to
compensation accruals and cost classification changes to standardize cost accounting practices at one of our
segments, as well as higher bid and proposal expenses.
2011 – Product and service costs for 2011 decreased $2.1 billion, or 9 percent, as compared to 2010. The primary
driver of the reduction in product and service costs is reduced volume at all four of our segments, with Aerospace
Systems, Information Systems and Technical Services driving the majority of the decrease. General and
administrative expenses as a percentage of total sales was comparable at 8.9 percent.
For the product and service costs detail, see the Product and Service Analysis section that follows.
Operating Income
We define operating income as sales less operating costs and expenses, which includes general and administrative
expenses. Changes in estimated sales, operating costs and expenses, and the resulting operating income related to
our contracts accounted for using the percentage-of-completion method are recorded using the cumulative catch-up
method of accounting. The aggregate effects of these favorable and unfavorable changes in our estimated costs at
completion, across our portfolio of contracts, can have a significant effect upon our reported sales and operating
income in each of our reporting periods. Cumulative catch-up operating income adjustments are presented in the
table below:
Year Ended December 31
$ in millions 2012 2011 2010
Favorable adjustments $1,270 $1,123 $945
Unfavorable adjustments (285)(385)(270)
Net operating income adjustments $ 985 $ 738 $675
Cost reduction initiatives to increase our competitiveness contributed to the net favorable operating income
adjustments. Our cost management activities have led to overall improved contract performance, reflected in both
increased favorable adjustments and lower unfavorable adjustments.
Segment Operating Income
Segment operating income is defined as operating income less certain corporate-level expenses that are not
considered allowable or allocable under applicable CAS and FAR and the net FAS/CAS pension difference.