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 nine months ended September 24, 2017 (unaudited; in millions, except per share data):



	Quarter Ended
				Adjustments for
	Historical			ASC 606			ASU 2017-07			Adjusted
Net sales
Products	$	10,496		$	132		$	—		$	10,628
Services	1,673			40			—			1,713
Total net sales	12,169			172			—			12,341
Cost of sales
Products	(9,481		)	(63		)	—			(9,544		)
Services	(1,513		)	(71		)	—			(1,584		)
Other unallocated, net	176			—			211			387
Total cost of sales	(10,818		)	(134		)	211			(10,741		)
Gross profit	1,351			38			211			1,600
Other income, net	77			—			—			77
Operating profit	1,428			38			211			1,677
Interest expense	(162		)	—			—			(162		)
Other non-operating expense, net	(7		)	—			(211		)	(218		)
Earnings before income taxes	1,259			38			—			1,297
Income tax expense	(320		)	(14		)	—			(334		)
Net earnings	$	939		$	24		$	—		$	963

Earnings per common share
Basic	$	3.27		$	0.08		$	—		$	3.35
Diluted	$	3.24		$	0.08		$	—		$	3.32
Cash dividends paid per common share	$	1.82		$	—		$	—		$	1.82



	Nine Months Ended
				Adjustments for
	Historical			ASC 606			ASU 2017-07			Adjusted
Net sales
Products	$	30,837		$	26		$	—		$	30,863
Services	5,074			179			—			5,253
Total net sales	35,911			205			—			36,116
Cost of sales
Products	(27,919		)	69			—			(27,850		)
Services	(4,547		)	(177		)	—			(4,724		)
Other unallocated, net	484			—			636			1,120
Total cost of sales	(31,982		)	(108		)	636			(31,454		)
Gross profit	3,929			97			636			4,662
Other income, net	133			—			—			133
Operating profit	4,062			97			636			4,795
Interest expense	(477		)	—			—			(477		)
Other non-operating expense, net	(8		)	—			(636		)	(644		)
Earnings before income taxes	3,577			97			—			3,674
Income tax expense	(933		)	(34		)	—			(967		)
Net earnings	$	2,644		$	63		$	—		$	2,707

Earnings per common share
Basic	$	9.16		$	0.22		$	—		$	9.38
Diluted	$	9.08		$	0.21		$	—		$	9.29
Cash dividends paid per common share	$	5.46		$	—		$	—		$	5.46

As a result of the increase in net earnings, our comprehensive income for the quarter and nine months ended September 24, 2017 increased by $24 million to $1.2 billion and increased by $63 million to $3.4 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 nine months ended September 24, 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	$	2,644			$	63		$	2,707
Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization	880				—			880
Stock-based compensation	133				—			133
Changes in assets and liabilities
Receivables, net	(819		)		(15		)	(834		)
Contract assets	—				(228		)	(228		)
Inventories	(133		)		67			(66		)
Accounts payable	1,229				—			1,229
Contract liabilities ^(a)	(581		)		89			(492		)
Postretirement benefit plans	1,012				—			1,012
Income taxes	(202		)		—			(202		)
Other, net	801				24			825
Net cash provided by operating activities	$	4,964			$	—		$	4,964


^(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 the Tax Act 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 reclassified the impact of the income tax effects of the Tax Act from AOCL in the period in which they occurred.

Recent Accounting Pronouncements Not Yet Adopted

In August 2018, the FASB issued ASU 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General (Topic 715-20): Disclosure Framework—Changes to the Disclosure Requirements For Defined Benefit Plans. The new standard modifies the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans by removing and adding certain disclosures for these plans. The effective date is our fiscal year ending December 31, 2020 with early adoption permitted and requires application on a retrospective basis. The adoption will not have a material effect on the Company’s consolidated financial statements.

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 and required application on a retrospective basis. 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), as amended, 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 fiscal years beginning after December 15, 2018, which makes the new standard effective for us on January 1, 2019. We may apply the transition provisions of ASU 2016-02, as amended, either at the beginning of the earliest period presented in our fiscal year 2019 Form 10-K, which would be January 1, 2017, or on the effective date of adoption, which would be January 1, 2019. Among other requirements, the transition provisions require the lessee to recognize a right-of-use asset and liability for most existing lease arrangements on the date the transition provisions are applied. We have elected to apply the transition provisions of this new standard on January 1, 2019. Therefore, periods prior to the effective date of adoption will continue to be reported using current GAAP (ASC 840).

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. We have successfully identified and classified our lease population and we continued to perform under the project plan through the end of the third 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. Based on the net present value of leases outstanding at September 30, 2018, we expect to record a right-of-use asset and lease liability of approximately $1.1 billion each, on our balance sheet upon adoption of the new standard on January 1, 2019. We do not anticipate that adoption of the new standard will have a significant impact on our net earnings or cash flows.