Raytheon 2013 Annual Report Download - page 44

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whether contracts should be combined or segmented in accordance with the applicable criteria under GAAP. We combine
closely related contracts when all the applicable criteria under GAAP are met. The combination of two or more contracts
requires 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. Similarly, we may segment a project, which may consist of a single
contract or group of contracts, with varying rates of profitability, only if the applicable criteria under GAAP are met. Judgment
also is involved in determining whether a single contract or group of contracts may be segmented based on how the arrangement
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.
The selection of the method by which to measure progress towards completion of a contract also requires judgment and is
based on the nature of the products or services to be provided. We generally use the cost-to-cost measure of progress for 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 labor, materials and
subcontractors 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 (e.g. 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
recognized 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 recognized in the period the loss is determined.
Net EAC adjustments had the following impact on our operating results:
(In millions, except per share amounts) 2013 2012 2011
Operating income $ 557 $ 613 $ 548
Income from continuing operations attributable to Raytheon Company 362 398 348
Diluted EPS from continuing operations attributable to Raytheon Company $ 1.12 $ 1.19 $ 0.98