Northrop Grumman 2014 Annual Report Download - page 55

NORTHROP GRUMMAN CORPORATION
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entitled to recover any of our costs on partially completed work and may be liable to the government for re-
procurement costs of acquiring similar products or services from another contractor, and for certain other damages.
Termination of a contract for the convenience of the government may occur when the government concludes it is in
the best interests of the government that the contract be terminated. Under a termination for convenience, the
contractor is typically entitled to be paid in accordance with the contract’s terms for costs incurred prior to the
effective date of termination, plus a reasonable profit and settlement expenses. At December 31, 2014, the company
does not have any contract terminations in process that we anticipate would have a material effect on our
consolidated financial position, annual results of operations and/or cash flows.
We recognize changes in estimated contract sales, costs or profits 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; sales and profit in future periods of contract performance are recognized as if the revised estimates had been
used since contract inception. If it is determined that a loss will result from the performance of a contract, the entire
amount of the estimable future loss is charged against income in the period the loss is identified. Loss provisions are
first offset against any costs that are included in unbilled accounts receivable or inventoried costs, and any
remaining amount is reflected in liabilities.
Significant changes in estimates on a single contract could have a material effect on the company's consolidated
financial position or annual results of operations. Where such changes occur, we generally disclose the nature,
underlying conditions and financial impact of the change. Aggregate net changes in contract estimates recognized
using the cumulative catch-up method of accounting increased operating margin by $664 million, $753 million and
$985 million ($2.04, $2.09 and $2.53 per diluted share based on statutory tax rates) in 2014, 2013 and 2012,
respectively. No discrete event or adjustments to an individual contract were material to the consolidated statements
of earnings and comprehensive (loss) income for any of these periods.
General and Administrative Expenses
In accordance with industry practice and regulations that govern the cost accounting requirements for government
contracts, most general and administrative expenses incurred at the segments and corporate office are considered
allowable and allocable costs on government contracts. These costs are allocated to contracts in progress on a
systematic basis and are included as a component of total estimated contract costs, including any provision for loss
contracts.
Research and Development
Company-sponsored research and development activities primarily include independent research and development
(IR&D) efforts related to government programs. Company-sponsored IR&D expenses are included in general and
administrative expenses in the consolidated statements of earnings and comprehensive (loss) income and are
generally allocated to government contracts. Company-sponsored IR&D expenses totaled $569 million, $507
million and $520 million, in 2014, 2013 and 2012, respectively. Expenses for research and development funded by
the customer are charged directly to the related contracts.
Environmental Costs
Environmental liabilities are accrued when the company determines that, based on the facts and circumstances
known to the company, it is probable the company will incur costs to address environmental impacts and the costs
are reasonably estimable. When only a range of amounts is established and no amount within the range is more
probable than another, the low end of the range is recorded. The company typically projects environmental costs for
up to 30 years, records environmental liabilities on an undiscounted basis, and excludes legal costs or asset
retirement obligations. At sites involving multiple parties, the company accrues environmental liabilities based upon
our expected share of liability, taking into account the financial viability of other jointly liable parties.
Environmental expenditures are capitalized or expensed, as appropriate. As a portion of environmental remediation
costs is expected to be recoverable through overhead charges on government contracts, such amounts are deferred in
inventoried costs (current portion) and other non-current assets. The portion of environmental expenditures not
expected to be recoverable is expensed.
Fair Value of Financial Instruments
The company utilizes fair value measurement guidance prescribed by GAAP to value its financial instruments. The
guidance includes a definition of fair value, prescribes methods for measuring fair value, establishes a fair value
hierarchy based on the inputs used to measure fair value and expands disclosures about the use of fair value
measurements.
The valuation techniques utilized are based upon observable and unobservable inputs. Observable inputs reflect
market data obtained from independent sources, while unobservable inputs reflect internal market assumptions.