Raytheon 2012 Annual Report Download - page 43

35
to date to the total estimated costs at completion of the contract. Contract costs include labor, material and subcontracting
costs, as well as an allocation of indirect costs. Revenues, including estimated 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 (the process for which we describe below in more detail) is complex and subject to many variables. Incentive and
award fees generally are 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
subcontractors or partners depending on the individual contract requirements. Incentive provisions that increase or decrease
earnings based solely on a single significant event generally are 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 that the claim will result in additional contract revenue and the amounts can be reliably
estimated.
We have a Company-wide standard and disciplined quarterly Estimate at Completion (EAC) process in which management
reviews the progress and performance of our contracts. As part of this process, management reviews information including,
but not limited to, any outstanding key contract matters, progress towards completion and the related program schedule,
identified risks and opportunities, and the related changes in estimates of revenues and costs. The risks and opportunities
include management's judgment about the ability and cost to achieve the schedule (e.g., the number and type of milestone
events), technical requirements (e.g., a newly-developed product versus a mature product), and other contract requirements.
Management must make assumptions and estimates regarding labor productivity and availability, the complexity of the work
to be performed, the availability of materials, the length of time to complete the contract (to estimate increases in wages and
prices for materials and related support cost allocations), performance by our subcontractors, the availability and timing of
funding from our customer, and overhead cost rates, among other variables. These estimates also include the estimated cost
of satisfying our industrial cooperation agreements, sometimes referred to as offset obligations required under certain contracts.
Based on this analysis, any quarterly adjustments to net sales, cost of sales, and the related impact to operating income are
recorded as necessary in the period they become known. These adjustments may result from positive program performance,
and may result in an increase in operating income during the performance of individual contracts, if we determine we will be
successful in mitigating risks surrounding the technical, schedule, and cost aspects of those contracts or realizing related
opportunities. Likewise, these adjustments may result in a decrease in operating income if we determine we will not be
successful in mitigating these risks or realizing related opportunities. Changes in estimates of net sales, cost of sales, and the
related impact to operating income are recognized quarterly on a cumulative catch-up basis, which recognizes in the current
period the cumulative effect of the changes on current and prior periods based on a contract's percentage of completion. A
significant change in one or more of these estimates could affect the profitability of one or more of our contracts. When
estimates of total costs to be incurred on a contract exceed total estimates of revenue to be earned, a provision for the entire
loss on the contract is recorded in the period the loss is determined.
Our operating income included net EAC adjustments resulting from changes in estimates of approximately $613 million, $548
million and $158 million for the years ended December 31, 2012, 2011 and 2010, respectively. These adjustments increased
our income from continuing operations attributable to Raytheon Company common stockholders by approximately $398
million ($1.19 per diluted share), $348 million ($0.98 per diluted share), and $75 million ($0.20 per diluted share) for the
years ended December 31, 2012, 2011 and 2010, respectively.
Other Revenue Methods—To a much lesser extent, we enter into other types of contracts such as service, commercial, or
software and licensing arrangements. Revenue under fixed-price service contracts not associated with the design, development,
manufacture, or modification of complex aerospace or electronic equipment and commercial contracts generally is recognized
upon delivery or as services are rendered once persuasive evidence of an arrangement exists, our price is fixed or determinable,
and collectability is reasonably assured. Costs on fixed-price service contracts are expensed as incurred, unless they otherwise
qualify for deferral. There were no costs deferred on fixed price service contracts at December 31, 2012 and December 31,
2011. We recognize revenue on contracts to sell software when evidence of an arrangement exists, the software has been
delivered and accepted by the customer, the fee is fixed or determinable, and collection is probable. For software arrangements
that include multiple elements, including perpetual software licenses and undelivered items (e.g., maintenance and/or services;
subscriptions/term licenses), we allocate and defer revenue for the undelivered items based on vendor specific objective
evidence (VSOE) of the fair value of the undelivered elements, and recognize revenue on the perpetual license using the
residual method. We base VSOE of each element on the price for which the undelivered element is sold separately. We
determine fair value of the undelivered elements based on historical evidence of our stand-alone sales of these elements to