Raytheon 2011 Annual Report Download - page 43

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Pension Costs
We have pension plans covering the majority of our employees, including certain employees in foreign countries. We must
calculate our pension costs under both CAS and FAS requirements under GAAP. The calculations under CAS and FAS require
judgment. CAS prescribes the allocation to and recovery of pension costs on U.S. Government contracts through the pricing
of products and services and the methodology to determine such costs. GAAP outlines the methodology used to determine
pension expense or income for financial reporting purposes. The CAS requirements for pension costs and its calculation
methodology differ from the FAS requirements and calculation methodology. As a result, while both CAS and FAS use long-
term assumptions in their calculation methodologies, each method results in different calculated amounts of pension cost. In
addition, the cash funding requirements for our pension plans are determined under the Employee Retirement Income Security
Act of 1974 (ERISA). ERISA funding requirements use a third and different method to determine funding requirements, which
is primarily based on the year’s expected service cost and amortization of other previously unfunded liabilities.
Effective January 1, 2011, we are subject to the funding requirements under the Pension Protection Act of 2006 (PPA), which
amended ERISA. Under the PPA, we are required to fully fund our pension plans over a rolling seven-year period as determined
annually based upon the funded status at the beginning of each year. Due to the foregoing differences in requirements and
calculation methodologies, our FAS pension expense or income is not indicative of the funding requirements or amount of
government recovery. Additionally, the recognition of pension costs for government contractors under the CAS rules is required
to be harmonized with the PPA.
On December 27, 2011, the CAS Pension Harmonization Rule (CAS Harmonization) was published in the Federal Register.
The new rule will impact pension costs on contracts beginning in 2013 and is effective for forward pricing purposes for
contracts negotiated on or after February 27, 2012. The new rule is intended to improve the alignment of the pension cost
recovered through contract pricing under CAS and the pension funding requirements under the PPA. The rule shortens the
CAS amortization period for gains and losses from 15 to 10 years and will result in the use of a discount rate based on high
quality corporate bonds to measure liabilities in determining the CAS pension expense. While the change in amortization
period is applicable in 2013, there is a transition period for the impact of the change in liability measurement method of 0%
in 2013, 25% in 2014, 50% in 2015, 75% in 2016 and 100% in 2017. CAS Harmonization is currently expected to increase
pension costs under CAS, primarily in 2014 and beyond due to the liability measurement transition period included in the
rule. The projected increase in our future pension costs under CAS increased our estimated cost to complete existing contracts
resulting in a reduction in revenue and profit in 2011, principally on our fixed price contracts in backlog. However, since the
pension cost increases occur primarily in 2014 and beyond, the impact on our current contracts was deminimus. Furthermore,
since CAS Harmonization is a mandatory change in cost accounting for government contractors, we may be entitled to an
equitable adjustment for some portion of the increase in costs on contracts. Because CAS Harmonization increases our future
CAS recovery, it is also expected to decrease our FAS/CAS expense in 2013 and beyond.
We record CAS expense in the results of our business segments. Due to the differences between FAS and CAS amounts, we
also present the difference between FAS and CAS expense, referred to as our FAS/CAS Pension Adjustment, which is a
component of our total FAS/CAS Adjustment disclosed as a separate line item in our segment results. This effectively increases
or decreases the amount of total pension expense in our results of operations so such amount is equal to the FAS expense
amount under GAAP. Due to the foregoing differences in requirements and calculation methodologies, our FAS pension
expense or income is not indicative of the funding requirements or amount of government recovery.
The assumptions in the calculations of our pension FAS expense and CAS expense, which involve significant judgment, are
described below.
FAS Expense—Our long-term return on plan assets (ROA) and discount rate assumptions are the key variables in determining
pension expense or income and the funded status of our pension plans under GAAP.
The long-term ROA represents the average rate of earnings expected over the long term on the assets invested to provide for
anticipated future benefit payment obligations. We employ a “building block” approach in determining the long-term ROA
assumption. Historical markets are studied and long-term relationships between equities and fixed income are assessed. Current
market factors such as inflation and interest rates are evaluated before long-term capital market assumptions are determined.
The long-term ROA assumption is also established giving consideration to investment diversification, rebalancing and active
management of the investment portfolio. Peer data and historical returns are reviewed periodically to assess reasonableness
and appropriateness.