Raytheon 2009 Annual Report Download - page 48

CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are based on the application of U.S. Generally Accepted Accounting Principles
(GAAP), which require us to make estimates and assumptions about future events that affect the amounts reported in
our consolidated financial statements and the accompanying notes. Future events and their effects cannot be determined
with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ
from those estimates, and any such differences may be material to our consolidated financial statements. We believe the
estimates set forth below may involve a higher degree of judgment and complexity in their application than our other
accounting estimates and represent the critical accounting estimates used in the preparation of our consolidated financial
statements. We believe our judgments related to these accounting estimates are appropriate. However, if different
assumptions or conditions were to prevail, the results could be materially different from the amounts recorded.
Revenue Recognition
We determine the appropriate method by which we recognize revenue by analyzing the type, terms and conditions of
each contract or arrangement entered into with our customers. The significant estimates we consider in recognizing
revenue for the types of revenue-generating activities in which we are involved are described below. We classify contract
revenues as product or service according to the predominant attributes of the relevant underlying contracts unless the
contract can clearly be split between product and service. We define service revenue as revenue from activities which are
not associated with the design, development or production of tangible assets, the delivery of software code or a specific
capability. Our service sales are primarily related to our TS operating segment.
Percentage-of-Completion Accounting—We account for our long-term contracts associated with the design,
development, manufacture, or modification of complex aerospace or electronic equipment and related services, such as
certain cost-plus service contracts, using the percentage-of-completion accounting method. Under this method, revenue
is recognized based on the extent of progress towards completion of the long-term contract. The selection of the method
by which to measure such progress towards completion requires judgment and is based on the nature of the products or
services to be provided. Our analysis of these contracts also contemplates whether contracts should be combined or
segmented. The combination of two or more contracts requires significant judgment in determining whether the intent
of entering into the contracts was effectively to enter into a single project, which should be combined to reflect an overall
profit rate. Additionally, judgment is involved in determining whether a single contract or group of contracts may be
segmented based on how the contract was negotiated and the performance criteria. The decision to combine a group of
contracts or segment a contract could change the amount of revenue and gross profit recorded in a given period had
consideration not been given to these factors. We combine closely related contracts when all the applicable criteria under
GAAP are met. Similarly, we may segment a project, which may consist of a single contract or a group of contracts, with
varying rates of profitability, only if all the applicable criteria under GAAP are met.
We generally use the cost-to-cost measure of progress for all our long-term contracts unless we believe another method
more clearly measures progress towards completion of the contract. Under the cost-to-cost measure of progress, the
extent of progress towards completion is measured based on the ratio of costs incurred-to-date to the total estimated
costs at completion of the contract. Contract costs include material, labor and subcontracting costs, as well as an
allocation of indirect costs. Revenues, including estimated earned fees or profits, are recorded as costs are incurred. Due
to the nature of the work required to be performed on many of our contracts, the estimation of total revenue and cost at
completion is complex and subject to many variables. Management must make various assumptions and estimates related
to contract deliverables including design requirements, performance of subcontractors, cost and availability of materials,
productivity and manufacturing efficiency and labor availability. Incentive and award fees are generally awarded at the
discretion of the customer or upon achievement of certain program milestones or cost targets. Incentive and award fees,
as well as penalties related to contract performance, are considered in estimating profit rates. Estimates of award fees are
based on actual awards and anticipated performance, which may include the performance of subcontractor or partners
depending upon the individual contract requirements. Incentive provisions that increase or decrease earnings based
solely on a single significant event are generally not recognized until the event occurs. Such incentives and penalties are
recorded when there is sufficient information for us to assess anticipated performance. Our claims on contracts are
recorded only if it is probable the claim will result in additional contract revenue and the amounts can be reliably
estimated.
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