Raytheon 2012 Annual Report Download - page 93

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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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.
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. 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
third parties or from the stated renewal rate for the undelivered elements. When VSOE does not exist for undelivered items,
we recognize the entire arrangement fee ratably over the applicable performance period. Revenue from non-software license
fees is recognized over the expected life of the continued involvement with the customer. Royalty revenue is recognized when
earned.
We apply the separation guidance under GAAP for contracts with multiple deliverables. We analyze revenue arrangements
with multiple deliverables to determine if the deliverables should be divided into more than one unit of accounting. For
contracts with more than one unit of accounting, we allocate the consideration we receive among the separate units of accounting
based on their relative selling prices, which we determine based on prices of the deliverables as sold on a stand-alone basis,
or if not sold on a stand-alone basis, the prices we would charge if sold on a stand-alone basis, and we recognize revenue for
each deliverable based on the revenue recognition policies described above.
Research and Development Expenses—Expenditures for Company-sponsored research and development projects and bid
and proposal costs are expensed as incurred. Customer-sponsored research and development projects performed under
contracts are accounted for as contract costs as the work is performed and included in contracts in process, net in our consolidated
balance sheets. Bid and proposal costs were between 40% and 50% of total research and development expenses in 2012, 2011
and 2010.
Federal, Foreign and State Income Taxes—The Company and its domestic subsidiaries provide for federal income taxes
on pretax accounting income at rates in effect under existing tax law. Foreign subsidiaries record provisions for income taxes
at applicable foreign tax rates in a similar manner. Such provisions differ from the amounts currently payable because certain
items of income and expense are recognized in different time periods for financial reporting purposes than for income tax
purposes. The payments made for state income taxes are included in administrative and selling expenses as these costs can