Construction and Long-Term Contract Accounting

Introduction

In 2025, Lockheed Martin recorded a $950 million loss on a classified program in its Aeronautics segment, $570 million on a Canadian maritime helicopter program and smaller charges on other contracts. Yet its net profit adjustments across all its contracts that year were positive, adding about $75 million to operating profit, because favorable revisions on other programs more than offset the losses. A year earlier, net adjustments had cut profit by $180 million; in 2023 they had added $1.6 billion. Those swings, disclosed in its 2025 annual report, are the defining feature of accounting for long-term contracts.

Contractors, from builders of offices and power plants to shipyards and defense primes, work on projects that last years. They recognize revenue as the work progresses, based on estimates of how far along each contract is and what it will cost in total. Every revision of those estimates flows straight into earnings. The general mechanics of revenue over time are covered in revenue recognition on long-term contracts; for a contractor, their consequences run through margins, the balance sheet and cash flow.

Under Accounting Standards Codification (ASC) 606, most construction and defense contracts transfer control to the customer as the work is performed, so revenue is recognized over time, typically in proportion to the costs incurred against the total costs expected. For US government contracts, the contract itself supports this: its clauses give the government ownership of the work in process and let it terminate for convenience while paying the costs incurred plus a reasonable profit. Profit on a contract is the difference between its estimated revenue and its estimated total cost, recognized at a profit booking rate as work progresses. When estimates change, the contractor applies the new rate to all work done to date, recognizing the cumulative effect at once, a catch-up adjustment.

Reach-forward loss

The loss a contractor expects on a contract when its estimate of total costs exceeds the total revenue it expects to receive. Under ASC 605-35, which covers construction- and production-type contracts, the entire expected loss is recognized in the period in which it becomes evident, rather than as the remaining work is performed. The term is used particularly in the defense industry.

Measuring Progress

Most contractors measure progress by costs incurred as a share of total expected costs, the cost-to-cost method, an input method that works well when costs track the work. Some use outputs instead, such as units delivered or milestones reached, and contracts for standard products built in volume may recognize revenue only at delivery: Boeing, for example, recognizes revenue on commercial aircraft when each airplane is completed and accepted by the customer, while recognizing its defense development contracts over time. The method matters, because it decides how quickly a large contract's profit reaches the income statement and how exposed earnings are to revisions of the estimated total cost.

Lockheed's disclosure shows the effect of those revisions by segment:

The swings illustrate why contractors' margins are hard to forecast. A single program can move a segment's profit by hundreds of millions in a quarter, and the losses tend to be concentrated in fixed-price development contracts, where the contractor bears the cost of overruns on technology that does not yet exist.

The type of contract decides who bears cost overruns. Under a cost-reimbursable contract, the customer pays the contractor's allowable costs plus a fee, so the contractor's risk is largely limited to its fee. Under a firm fixed-price contract, the contractor receives an agreed price whatever its costs, so overruns reduce profit or create losses; fixed-price incentive contracts share overruns up to a ceiling. Defense contractors disclose the split of their sales by contract type, and a shift toward fixed-price development work raises risk even if reported margins look unchanged, as the industrials guide's article on defense contract types explains.

Commercial construction has the same structure under different names: lump-sum contracts resemble fixed-price ones, while cost-plus and guaranteed maximum price contracts share risk with the owner. Changes in scope add a further judgment. Change orders whose price has not yet been agreed, and claims against customers for delays or disputed work, are variable consideration under ASC 606: the contractor includes them in its estimate of revenue only to the extent that it is probable that a significant reversal of the revenue recognized will not occur, which requires evidence such as the customer's approval of the scope and a history of recovering similar amounts.

Because billing follows contract milestones rather than the work itself, a contractor's balance sheet carries the timing differences. Revenue recognized ahead of billing becomes a contract asset, often called unbilled receivables; billings and advances received ahead of the work become contract liabilities. Lockheed carried $13.0 billion of contract assets and $11.4 billion of contract liabilities at the end of 2025, both large relative to its annual earnings, the balances explained in contract liabilities and contract assets.

These balances drive cash flow. A contractor whose customers pay in advance can run with negative working capital and generate cash ahead of profit; one that funds the work and bills later consumes cash as it grows. Contract assets rising faster than revenue can mean billing milestones are being missed or that revenue is being recognized optimistically, the same signal as receivables outgrowing sales. Reach-forward losses are non-cash when recorded, as Lockheed's cash flow statement shows by adding back $1.6 billion of them in 2025, but the cash costs follow as the loss-making work is performed.

Joint Ventures

Large construction projects are often carried out through joint ventures among several contractors. US generally accepted accounting principles (GAAP) allow investors in unincorporated construction joint ventures to use proportionate consolidation (ASC 810-10-45-14), recording their share of each asset, liability, revenue and cost, rather than the equity method. Engineering firms such as Jacobs apply this exception to their construction-related joint ventures, so their reported revenue includes their share of joint venture work, a presentation that differs from the equity method treatment described in joint ventures and joint operations.

Bankers covering contractors start with backlog, the value of contracted work not yet performed. Lockheed's backlog was $193.6 billion at the end of 2025, up from $176.0 billion, of which it expected to recognize about 37% as revenue within twelve months. The ratio of new orders to revenue, book-to-bill, shows whether backlog is growing, and the mix of backlog by contract type and margin shows its quality; the industrials guide's article on backlog and book-to-bill covers both. Backlog definitions vary: Lockheed counts both funded and unfunded firm orders (funded backlog alone was $120.2 billion) but excludes unexercised options, and other contractors draw the line differently, so comparisons need care.

Valuation and deal work add their own questions. Cash conversion matters as much as margins, because advances and milestone billing can make a contractor's free cash flow very different from its earnings. In acquisitions, the buyer must assess the target's estimates contract by contract, because losses not yet recognized become the buyer's problem, and purchase accounting values the backlog as an intangible asset and may record liabilities for contracts with below-market terms.

Pension Costs for Government Contractors

Government contractors carry one further industry-specific item. Pension costs they can recover through contract prices are calculated under the government's Cost Accounting Standards (CAS), which differ from GAAP pension accounting, so Lockheed and its peers report segment results with pension costs on the CAS basis and show the difference from the GAAP basis (which Lockheed calls FAS, for Financial Accounting Standards) outside the segments as the FAS/CAS pension adjustment. Analysts track it separately, because it can move reported operating profit by large amounts with no change in the contracts (the operating portion of Lockheed's adjustment added $1.5 billion to 2025 operating profit), a link back to the mechanics in pension accounting. Across all of these items, contractors reward the same discipline as insurers: the estimates behind the figures matter more than the figures themselves.