RECENT ACCOUNTING PRONOUNCEMENTS

Recent Accounting Pronouncements Adopted

Effective January 1, 2018, we adopted ASC 606, which replaces existing revenue recognition guidance and outlines a single set of comprehensive principles for recognizing revenue under GAAP. Among other things, ASC 606 requires entities to assess the products or services promised in contracts with customers at contract inception to determine the appropriate unit at which to record revenues, which is referred to as a performance obligation. Revenue is recognized when control of the promised products or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those products or services. Prior to the adoption of ASC 606, we recognized the majority of our revenues using the percentage-of-completion method of accounting. Based on the nature of products provided or services performed, revenue was recorded as costs were incurred (the percentage-of-completion cost-to-cost method) or as units were delivered (the percentage-of-completion units-of-delivery method). For most of our contracts, the customer obtains control or receives benefits as we perform on the contract. As a result, under ASC 606 revenue is recognized over a period of time utilizing the percentage-of-completion cost-to-cost method. This change generally results in an acceleration of revenue for contracts that were historically accounted for using the percentage-of-completion units-of-delivery method as revenues are now recognized earlier in the performance period as we incur costs. For more information on our policy for recognizing revenue under ASC 606, see “Note 2 – Significant Accounting Policy Updates.” Significant programs impacted by these changes include the C-130J and C-5 programs in our Aeronautics business segment; tactical missile programs (Hellfire and Joint Air-to-Surface Standoff Missile (JASSM)), Patriot Advanced Capability-3 (PAC-3), and fire control programs (LANTIRN^® and SNIPER^®) in our MFC business segment; the Black Hawk and Seahawk helicopter programs in our RMS business segment; and commercial satellite programs in our Space business segment.

We adopted ASC 606 using the full retrospective method, which means we applied the new standard to each prior year presented in our financial statements going back to January 1, 2016, with a cumulative effect adjustment to retained earnings as of January 1, 2016 for contracts that were in process at that point in time. Accordingly, the amounts for all periods presented in this Form 10-Q have been adjusted to reflect the impacts of ASC 606.

Effective January 1, 2018, we also adopted ASU 2017-07, which changed the income statement presentation of certain components of net periodic benefit cost related to defined benefit pension and other postretirement benefit plans. ASU 2017-07 requires entities to record only the service cost component of FAS pension and other postretirement benefit plan expense in operating profit and the non-service cost components of FAS pension and other postretirement benefit plan expense (i.e., interest cost, expected return on plan assets, net actuarial gains or losses, and amortization of prior service cost or credits) as part of non-operating expense. Previously, we recorded all components of net periodic benefit cost in operating profit as part of cost of sales. We adopted ASU 2017-07 using the retrospective method, which means we applied the new standard to each prior period presented in our financial statements going back to January 1, 2016.

The following tables summarize the effects of adopting ASC 606 and ASU 2017-07 on our consolidated statement of earnings for the quarter and six months ended June 25, 2017 (unaudited; in millions, except per share data):



	Quarter Ended
				Adjustments for
	Historical			ASC 606			ASU 2017-07			Adjusted
Net sales
Products	$	10,828		$	(206	)	$	—		$	10,622
Services	1,857			84			—			1,941
Total net sales	12,685			(122		)	—			12,563
Cost of sales
Products	(9,751		)	189			—			(9,562		)
Services	(1,658		)	(48		)	—			(1,706		)
Other unallocated, net	149			—			212			361
Total cost of sales	(11,260		)	141			212			(10,907		)
Gross profit	1,425			19			212			1,656
Other income, net	60			—			—			60
Operating profit	1,485			19			212			1,716
Interest expense	(160		)	—			—			(160		)
Other non-operating expense, net	(2		)	—			(212		)	(214		)
Earnings before income taxes	1,323			19			—			1,342
Income tax expense	(381		)	(6		)	—			(387		)
Net earnings	$	942		$	13		$	—		$	955

Earnings per common share
Basic	$	3.27		$	0.04		$	—		$	3.31
Diluted	$	3.23		$	0.05		$	—		$	3.28
Cash dividends paid per common share	$	1.82		$	—		$	—		$	1.82



	Six Months Ended
				Adjustments for
	Historical			ASC 606			ASU 2017-07			Adjusted
Net sales
Products	$	20,341		$	(106	)	$	—		$	20,235
Services	3,401			139			—			3,540
Total net sales	23,742			33			—			23,775
Cost of sales
Products	(18,438		)	132			—			(18,306		)
Services	(3,034		)	(106		)	—			(3,140		)
Other unallocated, net	308			—			425			733
Total cost of sales	(21,164		)	26			425			(20,713		)
Gross profit	2,578			59			425			3,062
Other expense, net	56			—			—			56
Operating profit	2,634			59			425			3,118
Interest expense	(315		)	—			—			(315		)
Other non-operating expense, net	(1		)	—			(425		)	(426		)
Earnings before income taxes	2,318			59			—			2,377
Income tax expense	(613		)	(20		)	—			(633		)
Net earnings	$	1,705		$	39		$	—		$	1,744

Earnings per common share
Basic	$	5.90		$	0.13		$	—		$	6.03
Diluted	$	5.84		$	0.13		$	—		$	5.97
Cash dividends paid per common share	$	3.64		$	—		$	—		$	3.64

As a result of the increase in net earnings, our comprehensive income for the quarter and six months ended June 25, 2017 increased by $13 million to $1.2 billion and increased by $39 million to $2.2 billion.

The following table summarizes the effects of adopting ASC 606 on our consolidated balance sheet as of December 31, 2017 (ASU 2017-07 had no impact on our consolidated balance sheet) (unaudited; in millions, except par value):



				Adjustments for
	Historical				ASC 606			Adjusted
Assets
Current assets
Cash and cash equivalents	$	2,861			$	—		$	2,861
Receivables, net	8,603				(6,338		)	2,265
Contract assets	—				7,992			7,992
Inventories	4,487				(1,609		)	2,878
Other current assets	1,510				(1		)	1,509
Total current assets	17,461				44			17,505
Property, plant and equipment, net	5,775				—			5,775
Goodwill	10,807				—			10,807
Intangible assets, net	3,797				—			3,797
Deferred income taxes	3,111				45			3,156
Other noncurrent assets	5,570				10			5,580
Total assets	$	46,521			$	99		$	46,620
Liabilities and equity
Current liabilities
Accounts payable	$	1,467			$	—		$	1,467
Contract liabilities ^(a)	6,752				276			7,028
Salaries, benefits and payroll taxes	1,785				—			1,785
Current maturities of long-term debt	750				—			750
Other current liabilities	1,883				—			1,883
Total current liabilities	12,637				276			12,913
Long-term debt, net	13,513				—			13,513
Accrued pension liabilities	15,703				—			15,703
Other postretirement benefit liabilities	719				—			719
Other noncurrent liabilities	4,558				(10		)	4,548
Total liabilities	47,130				266			47,396
Stockholders’ equity
Common stock, $1 par value per share	284				—			284
Additional paid-in capital	—				—			—
Retained earnings	11,573				(168		)	11,405
Accumulated other comprehensive loss	(12,540		)		1			(12,539		)
Total stockholders’ deficit	(683		)		(167		)	(850		)
Noncontrolling interests in subsidiary	74				—			74
Total deficit	(609		)		(167		)	(776		)
Total liabilities and equity	$	46,521			$	99		$	46,620


^(a)	Formerly referred to as customer advances and amounts in excess of costs incurred.

The following table summarizes the effects of adopting ASC 606 on certain components within our net cash provided by operating activities for the six months ended June 25, 2017 (ASC 606 had no impact on total operating cash flows or cash flows from investing and financing activities) (unaudited; in millions):



				Adjustments for
	Historical				ASC 606			Adjusted
Operating activities
Net earnings	$	1,705			$	39		$	1,744
Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization	581				—			581
Stock-based compensation	101				—			101
Changes in assets and liabilities
Receivables, net	(560		)		(59		)	(619		)
Contract assets	—				(170		)	(170		)
Inventories	(271		)		233			(38		)
Accounts payable	940				—			940
Contract liabilities ^(a)	(316		)		(72		)	(388		)
Postretirement benefit plans	685				—			685
Income taxes	3				—			3
Other, net	342				29			371
Net cash provided by operating activities	$	3,210			$	—		$	3,210


^(a)	Formerly referred to as customer advances and amounts in excess of costs incurred.

Effective January 1, 2018, we also adopted ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which provides entities an option to reclassify certain tax effects as a result of the Tax Act from accumulated other comprehensive income or loss to retained earnings. The adoption of ASU 2018-02 increased our AOCL at January 1, 2018 by $2.4 billion with a corresponding increase to retained earnings by the same amount with zero impact to total equity. The reclassification was primarily related to the impact of U.S. tax reform on deferred tax assets associated with net actuarial losses (and prior service credits) resulting from our defined benefit pension and other postretirement benefit plans that were originally recorded in AOCL within equity. Those amounts were originally recorded net of deferred tax benefits based on the federal statutory income tax rate in effect at the time they were recorded. GAAP requires entities to remeasure deferred tax assets and liabilities as a result of a change in tax laws or rates, with the impacts reflected in earnings. Accordingly, in the fourth quarter of 2017, we remeasured the deferred tax assets associated with our AOCL using the lower U.S. corporate income tax rate under the Tax Act, with the impacts of the remeasurement recorded as a one-time charge to earnings. Prior to ASU 2018-02, GAAP required the original deferred tax amount recorded in accumulated other comprehensive income or loss, to remain at the old tax rate despite the fact that its related deferred tax asset or liability was remeasured as a result of the Tax Act. ASU 2018-02 allows entities to record a one-time reclassification of these tax effects between accumulated other comprehensive income or loss and retained earnings. We reclassify the impact of the income tax effects of tax reform from AOCL in the period in which they occur.

Recent Accounting Pronouncements Not Yet Adopted

In August 2017, the Financial Accounting Standards Board (FASB) issued ASU 2017-12, Derivatives and Hedging (Topic 815), which eliminates the requirement to separately measure and report hedge ineffectiveness. The guidance is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. We do not expect a significant impact to our consolidated assets and liabilities, net earnings, or cash flows as a result of adopting this new standard. We plan to adopt the new standard effective January 1, 2019.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires lessees to recognize a right-of-use asset and lease liability on the balance sheet for most lease arrangements and expands disclosures about leasing arrangements for both lessees and lessors, among other items. The new standard is effective for public companies for fiscal years beginning after December 15, 2018, with early adoption permitted, and must be adopted using a modified retrospective transition method. Currently, the new standard requires companies to apply the new lease requirements as of the beginning of the earliest period presented in the financial statements, which would be January 1, 2017 in our December 31, 2019 Form 10-K. However, the FASB has proposed a change that would allow companies to elect an optional transition method whereby companies could continue to apply existing lease guidance during the comparative periods and apply the new lease requirements through a cumulative-effect adjustment in the period of adoption rather than in the earliest period presented, which would result in an adjustment, if any, to our January 1, 2019 retained earnings balance in our December 31, 2019 Form 10-K without adjusting our historical financial statements for 2017 or 2018. We plan to adopt the new standard on January 1, 2019 and will evaluate the transition method if and when the FASB issues new guidance that permits the optional transition method.

We commenced our evaluation of the impact of the new lease accounting standard in late 2016 by evaluating its impact on selected contracts. With this baseline understanding, we developed a project plan to evaluate numerous contracts across our corporation, develop processes and tools to implement the new standard and identify and design changes to internal controls by January 1, 2019, which we continued to perform under this plan through the end of the second quarter of 2018. The majority of our existing lease arrangements are classified as operating leases, which we expect will continue to be classified as operating under the new standard. Upon adoption of the new standard, we will record a right-of-use asset and lease liability on our balance sheet for all of our lease arrangements. Based on our progress to date, we anticipate being able to estimate the impacts of adopting the new standard in our third quarter of 2018.