Northrop Grumman 2014 Annual Report Download - page 56

NORTHROP GRUMMAN CORPORATION
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These two types of inputs create the following fair value hierarchy:
Level 1 - Quoted prices for identical instruments in active markets.
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments
in markets that are not active; and model-derived valuations whose inputs are observable or whose
significant value drivers are observable.
Level 3 - Significant inputs to the valuation model are unobservable.
Marketable securities accounted for as trading and available-for-sale are recorded at fair value on a recurring basis.
For available-for-sale securities, any changes in unrealized gains and losses are reported as a component of other
comprehensive income. Changes in unrealized gains and losses on trading securities are included in other, net in the
consolidated statements of earnings and comprehensive (loss) income. In addition, investments in held-to-maturity
instruments with original maturities greater than three months are recorded at amortized cost.
Derivative financial instruments are recognized as assets or liabilities in the financial statements and measured at
fair value on a recurring basis. Changes in the fair value of derivative financial instruments that are designated as
fair value hedges are recorded in net earnings, while the effective portion of the changes in the fair value of
derivative financial instruments that are designated as cash flow hedges are recorded as a component of other
comprehensive income. For derivative financial instruments not designated as hedging instruments, gains or losses
resulting from changes in the fair value are reported in other, net in the consolidated statements of earnings and
comprehensive (loss) income.
The company may use derivative financial instruments to manage its exposure to interest rate risk for its fixed long-
term debt portfolio and foreign currency exchange risk related to receipts from customers and payments to suppliers
denominated in foreign currencies. The company does not use derivative financial instruments for trading or
speculative purposes, nor does it use leveraged financial instruments. Credit risk related to derivative financial
instruments is considered minimal and is managed through the use of multiple counterparties with high credit
standards and periodic settlements of positions, as well as by entering into master netting agreements with most of
our counterparties.
Income Taxes
Provisions for federal and foreign income taxes are calculated on reported earnings before income taxes based on
current tax law and include the cumulative effect of any changes in tax rates from those used previously in
determining deferred tax assets and liabilities. Such provisions differ from the amounts currently payable because
certain items of income and expense are recognized in different periods for financial reporting purposes than for
income tax purposes. The company recognizes federal and foreign interest accrued related to unrecognized tax
benefits in income tax expense. Federal penalties are recognized as a component of income tax expense. In
accordance with industry practice and regulations that govern the cost accounting requirements for government
contracts, state and local income and franchise taxes are considered allowable and allocable costs on government
contracts and are therefore recorded in operating costs and expenses. The company recognizes state interest accrued
related to unrecognized tax benefits in unallowable operating costs and expenses.
Uncertain tax positions reflect the company’s expected treatment of tax positions taken in a filed tax return, or
planned to be taken in a future tax return or claim, which have not been reflected in measuring income tax expense
for financial reporting purposes. Until these positions are sustained by the taxing authorities or the statute of
limitations concerning such issues lapses, the company does not recognize the tax benefits resulting from such
positions and reports the tax effects as a liability for uncertain tax positions in its consolidated statements of
financial position.
Cash and Cash Equivalents
Cash and cash equivalents are comprised of cash in banks and highly liquid instruments with original maturities of
three months or less, primarily consisting of bank time deposits and investments in institutional money market
funds. The company does not invest in high yield or high risk securities. Cash in bank accounts at times may exceed
federally insured limits.
Accounts Receivable and Inventoried Costs
Accounts receivable include amounts billed and currently due from customers, as well as amounts currently due but
unbilled (primarily related to costs incurred on contracts accounted for under the cost-to-cost method of percentage-
of-completion accounting). Accounts receivable also include certain estimated contract change amounts, claims or
requests for equitable adjustment in negotiation that are probable of recovery and amounts retained by the customer
pending contract completion.