SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization. General Dynamics is organized into four business groups: Aerospace, which produces Gulfstream aircraft, provides aircraft services and performs aircraft completions for other original equipment manufacturers (OEMs); Combat Systems, which designs and manufactures combat vehicles, weapons systems and munitions; Marine Systems, which designs, constructs and repairs surface ships and submarines; and Information Systems and Technology, which provides communication and information technology systems and solutions. Our primary customer is the U.S. government. We also do significant business with non-U.S. governments and a diverse base of corporate and individual buyers of business aircraft.
Basis of Consolidation and Classification. The Consolidated Financial Statements include the accounts of General Dynamics Corporation and our wholly owned and majority-owned subsidiaries. We eliminate all inter-company balances and transactions in the Consolidated Financial Statements.
Consistent with defense industry practice, we classify assets and liabilities related to long-term production contracts as current, even though some of these amounts may not be realized within one year. In addition, some prior-year amounts have been reclassified among financial statement accounts to conform to the current-year presentation.
Use of Estimates. The nature of our business requires that we make a number of estimates and assumptions in accordance with U.S. generally accepted accounting principles (GAAP). These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and currently available information and on various other assumptions that we believe are reasonable under the circumstances. Actual results could differ from these estimates.
Revenue Recognition. We account for revenues and earnings using the percentage-of-completion method. Under this method, contract costs and revenues are recognized as the work progresses, either as the products are produced or as services are rendered. We estimate the profit on a contract as the difference between the total estimated revenue and costs to complete a contract and recognize that profit over the life of the contract. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the loss in the quarter it is identified.
We generally measure progress toward completion on contracts in our defense business based on the proportion of costs incurred to date relative to total estimated costs at completion. For our contracts for the manufacture of business-jet aircraft, we record revenue at two contractual milestones: when green aircraft are delivered to, and accepted by, the customer and when the customer accepts final delivery of the fully outfitted aircraft.
We review and update our contract estimates regularly. We recognize changes in estimated profit on contracts under the reallocation method. Under the reallocation method, the impact of a revision in estimate is recognized prospectively over the remaining contract term. The net increase in our operating earnings (and on a per-share basis) from the favorable impact of revisions in contract estimates totaled $356 ($0.63) in 2011, $180 ($0.33) in 2012 and $351 ($0.65) in 2013. No revisions on any one contract were material in 2013.
Discontinued Operations. In 2013, we recognized a $129 loss, net of taxes, from the settlement of the A-12 litigation with the U.S. Navy. The litigation was related to a terminated contract in the company’s former tactical military aircraft business. The $198 credit due the Navy under the terms of the settlement agreement is reported in other current and noncurrent liabilities on the Consolidated Balance Sheets and will be utilized over several years as the company renders services on the DDG-1000 program. This activity, including an estimated $57 expected in 2014, will be reported in net cash used by discontinued operations on the Consolidated Statements of Cash Flows. See Note N for further discussion of the A-12 settlement.
In 2011, we recognized losses of $26 from the settlement of an environmental matter associated with a former operation of the company and our estimate of legal costs associated with the A-12 litigation as a result of the U.S. Supreme Court’s decision in that year that extended the expected timeline associated with the litigation. Net cash used by discontinued operations in 2011 consists primarily of cash associated with the environmental settlement.
Research and Development Expenses. Company-sponsored research and development (R&D) expenses, including product development costs, were $372 in 2011, $374 in 2012 and $310 in 2013. R&D expenses are included in operating costs and expenses in the Consolidated Statements of Earnings (Loss) in the period in which they are incurred. Customer-sponsored R&D expenses are charged directly to the related contracts.
The Aerospace group has cost-sharing arrangements with some of its suppliers that enhance the group’s internal development capabilities and offset a portion of the financial cost associated with the group’s product development efforts. These arrangements explicitly state that supplier contributions are for reimbursements of costs we incur in the development of new aircraft models and technologies, and we retain substantial rights in the products developed under these arrangements. We record amounts received from these cost-sharing arrangements as a reduction of R&D expenses. We have no obligation to refund any amounts received under the agreement regardless of the outcome of the development effort. Under the terms of each agreement, payments received from suppliers for their share of the costs are based typically on milestones and are generally recognized as received.
Interest, Net. Net interest expense consisted of the following:
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| | | | | | | | | | | |
Year Ended December 31 | 2011 | | 2012 | | 2013 |
Interest expense | $ | 155 |
| | $ | 168 |
| | $ | 103 |
|
Interest income | (14 | ) | | (12 | ) | | (17 | ) |
Interest expense, net | $ | 141 |
| | $ | 156 |
| | $ | 86 |
|
Interest payments | $ | 133 |
| | $ | 186 |
| | $ | 94 |
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The decrease in interest expense from 2012 results from our debt refinancing completed in December 2012 that lowered the weighted-average interest rate on our outstanding debt from 3.9 percent to 2.2 percent. See Note J to the Consolidated Financial Statements for additional information regarding our debt obligations.
Cash and Equivalents and Investments in Debt and Equity Securities. We consider securities with a maturity of three months or less to be cash equivalents. We report our investments in available-for-sale securities at fair value. Changes in the fair value of available-for-sale securities are recognized as a component of other comprehensive income (loss) in the Consolidated Statements of Comprehensive Income (Loss). The interest income on these securities is a component of our net interest expense in the Consolidated Statements of Earnings (Loss). These investments are included in other current and noncurrent assets on the Consolidated Balance Sheets (see Note D). We had no trading or held-to-maturity securities on December 31, 2012 or 2013.
Long-lived Assets and Goodwill. We review long-lived assets, including intangible assets subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. We assess the recoverability of the carrying value of assets held for use based on a review of undiscounted projected cash flows. Impairment losses, where identified, are measured as the excess of the carrying value of the long-lived asset over its fair value as determined by discounted projected cash flows.
We review goodwill for impairment annually or when circumstances indicate that an impairment is more likely than not. Goodwill represents the purchase price paid in excess of the fair value of net tangible and intangible assets acquired. The test for goodwill impairment is a two-step process to first identify potential goodwill impairment for each reporting unit and then, if necessary, measure the amount of the impairment loss. Our reporting units are consistent with our business groups in Note Q. For a summary of our goodwill by reporting unit, see Note B.
Subsequent Events. In January 2014, we entered into an accelerated share repurchase (ASR) agreement with a financial institution. Under the ASR program, we repurchased 11.4 million shares of our common stock for $1.2 billion on January 24, 2014, funded by cash on hand. Our final cost will be determined based on the volume-weighted average daily market price of our stock during the term of the agreement, which expires later in 2014. On February 5, 2014, with shares from the prior authorization exhausted by the ASR program, the board of directors authorized management to repurchase 20 million additional shares of common stock on the open market, approximately 6 percent of our total shares outstanding as of December 31, 2013.
We have evaluated other material events and transactions that have occurred after December 31, 2013, and concluded that none have occurred that require adjustment to or disclosure in the Consolidated Financial Statements.
