Raytheon 2014 Annual Report Download - page 44

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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) 2014 2013 2012
Operating income $ 513 $ 557 $ 613
Income from continuing operations attributable to Raytheon Company 333 362 398
Diluted EPS from continuing operations attributable to Raytheon Company $ 1.07 $ 1.12 $ 1.19
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 under 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, 2014 and
December 31, 2013. 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. Additionally, royalty revenue is
recognized when earned.