2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Estimates and Assumptions

The preparation of the Annual Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the Annual Consolidated Financial Statements and accompanying notes, including allocations of costs during the reporting period. Management’s estimates are based on historical experience, facts and circumstances available at the time, and various other assumptions that are believed to be reasonable. Actual results could differ from those estimates.

Revenue Recognition

Revenue from product sales is recognized as risk and title to the product transfer to the customer, the sales price is fixed or determinable, and collectability is reasonably assured. Sales returns and allowances are generally not a business practice in the industry.

We use both the completed contract and percentage-of-completion methods to record revenue from equipment sale contracts. The completed contract method is used in circumstances in which financial position and results of operations are not materially different from those resulting from use of the percentage-of-completion method, e.g., certain short-term contracts. We use the percentage-of-completion method when we can make reasonably dependable estimates of progress toward completion and performance is expected.

Under the percentage-of-completion method, revenue from the sale of major equipment is recognized primarily based on costs incurred to date compared with total estimated costs. Under the completed contract method, revenue and cost is recognized when the equipment is completed and transferred to the customer. Changes to estimated labor hours under the percentage-of-completion method or anticipated losses under either method, if any, are recognized in the period determined.

Revenue from on-site services are generally fixed monthly fee arrangements for which we recognize revenue as the services are performed.

Amounts billed for shipping and handling fees are classified as sales in the consolidated income statements.

Amounts billed for sales and use taxes, value-added taxes, and certain excise and other specific transactional taxes imposed on revenue-producing transactions are presented on a net basis and excluded from sales in the consolidated income statements. We record a liability until remitted to the respective taxing authority.

Cost of Sales

Cost of sales predominantly represents the cost of tangible products sold. These costs include labor, raw materials, depreciation, production supplies, and materials packaging costs. Costs incurred for shipping and handling are also included in cost of sales.

Depreciation

Depreciation is recorded using the straight-line method, which deducts equal amounts of the cost of each asset from earnings every year over its expected economic useful life. The principal lives for major classes of plant and equipment are summarized in Note 8, Plant and Equipment, Net.

Selling and Administrative

The principal components of selling and administrative expenses are compensation, advertising, and promotional costs.

Research and Development

Research and development costs are expensed as incurred. Research and development expenses include employee costs, materials, contract services, research agreements, and other external spending related to the discovery and development of new products, enhancement of existing products and regulatory approval of new and existing products.

Post-employment Benefits

We provide termination benefits to employees as part of ongoing benefit arrangements and record a liability for termination benefits when probable and estimable. These criteria are met when management, with the appropriate level of authority, approves and commits to its plan of action for termination; the plan identifies the employees to be terminated and their related benefits; and the plan is to be completed within one year. We typically do not provide one-time benefit arrangements of significance.

Fair Value Measurements

We are required to measure certain assets and liabilities at fair value, either upon initial measurement or for subsequent accounting or reporting. For example, fair value is used in the initial measurement of net assets acquired in a business combination; on a recurring basis in the measurement of derivative financial instruments; and on a nonrecurring basis when long-lived assets are written down to fair value when held for sale or determined to be impaired. Refer to Note 13, “Fair Value”, for information on the methods and assumptions used in our fair value measurements.

Financial Instruments

We address certain financial exposures through a controlled program of risk management that includes the use of derivative financial instruments. If the circumstances qualify and we designate hedge accounting, the hedging relationship between the underlying financial exposures and the related hedging instrument would be documented on the date the derivative is entered into with the counterparty. We have not designated hedge accounting for any of the forward exchange contracts. Our program currently includes the use of forward exchange contracts to hedge intercompany loans denominated in a foreign currency

Foreign Currency

Since we do business in many foreign countries, fluctuations in currency exchange rates affect our financial position and results of operations.

In certain of our foreign operations, the local currency is considered the functional currency. These foreign subsidiaries translate their assets and liabilities into U.S. dollars at current exchange rates in effect at the end of the fiscal period. The gains or losses that result from this process are shown as translation adjustments in accumulated other comprehensive income (loss) in the stockholders’ equity section of the annual consolidated balance sheets. The revenue and expense accounts of these foreign subsidiaries are translated into U.S. dollars at the average exchange rates that prevail during the period. Therefore, the U.S. dollar value of these items on the income statement fluctuates from period to period, depending on the value of the dollar against foreign currencies. Some transactions are made in currencies different from an entity’s functional currency. Gains and losses from these foreign currency transactions are generally included in other income (expense), net on our consolidated income statements as they occur.

Litigation

Accruals for litigation are made when the information available indicates that it is probable that a liability has been incurred and the amount can be reasonably estimated. When only a range of possible loss can be established, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum amount in the range is accrued. The accrual for a litigation loss contingency includes estimates of potential damages and other directly related costs expected to be incurred. Litigation liabilities and expenditures included in the Annual Consolidated Financial Statements were not material for the periods presented.

Share-Based Compensation

Prior to the Separation, our employees participated in Air Products’ share-based compensation plans, which included stock options, deferred stock units, and restricted stock. Prior to the Separation, the Annual Consolidated Financial Statements included share-based compensation expense associated with our employees and Air Products’ costs that had been allocated to us based on awards and terms previously granted. In accordance with the Employee Matters Agreement entered into between Versum and Air Products on September 29, 2016 in connection with the Separation, all share-based compensation awards previously granted to Versum employees under Air Products’ Long-Term Incentive Plan that were outstanding on October 1, 2016, other than restricted stock, were adjusted and converted into Versum equity with substantially the same terms and conditions as the original Air Products awards.

The grant-date fair value of awards is expensed over the vesting period during which employees perform related services. Expense recognition is accelerated for retirement-eligible individuals who would meet the requirements for vesting of awards upon their retirement. The Black Scholes model is utilized to value new stock option awards. The grant date fair value of the deferred stock units tied to a market condition is estimated using a Monte Carlo simulation model for new awards.

Income Taxes

We account for income taxes under the liability method. Under this method, deferred tax assets and liabilities are recognized for the tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities measured using enacted tax rates. The cumulative impact of a change in tax rates or regulations is included in income tax expense in the period that includes the enactment date.

For the fiscal year ended September 30, 2016, certain of our operations included in our Annual Consolidated Financial Statements were divisions of legal entities included in Air Products consolidated U.S. federal and state income tax returns, or tax returns of non-U.S. subsidiaries of Air Products. The provision for income taxes has been prepared and presented in the Annual Consolidated Financial Statements based on a stand-alone basis separate from Air Products. Differences between our separate return income tax provision and cash flows attributable to income taxes for operations that were divisions of legal entities have been recognized as capital contributions from, or dividends to, Air Products, within Air Products’ net investment.

For the fiscal year ended September 30, 2016, the majority of the accrued U.S. federal, state, and foreign income tax balances were treated as settled with Air Products as of the end of the year. Therefore, this is included in Air Products’ net investment in the Annual Consolidated Financial Statements, for such periods.

Non-controlling Interests

We consolidate investments that we control but do not wholly own. The Annual Consolidated Financial Statements include all assets, liabilities, revenues, and expenses of our joint venture in Taiwan for which we have a 74% ownership interest during the periods presented in the Annual Consolidated Financial Statements. The ownership interests held by third party non-controlling partners are presented as non-controlling interests in our annual consolidated balance sheets. Any net income or loss attributed to the non-controlling partners is presented as such in the consolidated income statements. The activity for non-controlling interests for the years ended September 30, 2018, 2017 and 2016 is presented in the annual consolidated statements of stockholders’ equity.

Cash and Cash Items

Cash and cash items generally include cash, time deposits, and certificates of deposit acquired with an original maturity of three months or less for our foreign entities.

Trade Receivables, net

Trade receivables comprise amounts owed to us through our operating activities and are presented net of allowances for doubtful accounts. The allowances for doubtful accounts represent estimated uncollectible receivables associated with potential customer defaults on contractual obligations. A provision for customer defaults is made on a general formula basis when it is determined that the risk of some default is probable and estimable but cannot yet be associated with specific customers. The assessment of the likelihood of customer defaults is based on various factors, including the length of time the receivables are past due, historical experience, and existing economic conditions. The allowance also includes amounts for certain customers where a risk of default has been specifically identified, considering factors such as the financial condition of the customer and customer disputes over contractual terms and conditions. Allowance for doubtful accounts were $1.1 million and $1.0 million as of fiscal year end September 30, 2018 and 2017, respectively. Provisions to the allowance for doubtful accounts charged against income were not material in fiscal 2018, 2017, and 2016.

Inventories

Inventories are stated at the lower of cost or net realizable value. We write down our inventories for estimated obsolescence or unmarketable inventory based upon assumptions about future demand and market conditions.

Effective the fourth quarter of 2018, the company changed its method for inventory costing from the last-in, first-out (“LIFO”) cost method to the first-in, first-out (“FIFO”) cost method for inventory in the United States, which were the only operations that were using the LIFO cost method. All inventories outside the United States were already accounted for on the FIFO method. This change in accounting method was deemed preferable because the FIFO basis improves the matching of cost of sales with the related sales, causes inventory to be valued on a consistent basis throughout the entire company and valuation is on a more comparable basis with industry peer companies.

This change in accounting method was completed in accordance with US GAAP and all periods presented have been retrospectively adjusted to reflect the period-specific effects of applying the new accounting principle. The cumulative effect of this change in accounting principle, on periods prior to those presented, resulted in an increase in Air Products’ Net Investment of $11.0 million as of September 30, 2015, as presented in this Form 10-K.

The following table summarizes the effect of this accounting change on the company’s consolidated statements of income for each of the years ended September 30, 2017 and 2016:



	As Originally Reported under LIFO		As Adjusted under FIFO		Effect of Change
(In millions, except per share data)
Year ended September 30, 2016
Cost of sales	$	539.5	$	542.2	$	2.7
Net income	219.9		217.2		(2.7		)
Net income attributable to Versum	212.0		209.3		(2.7		)
Net income attributable to Versum per common share:
Basic	$	1.95	$	1.93	$	(0.02	)
Diluted	$	1.95	$	1.93	$	(0.02	)

Year ended September 30, 2017
Cost of sales	$	636.9	$	636.4	$	(0.5	)
Income tax provision	52.8		53.0		0.2
Net income	199.9		200.2		0.3
Net income attributable to Versum	193.0		193.3		0.3
Net income attributable to Versum per common share:
Basic	$	1.78	$	1.78	$	—
Diluted	$	1.76	$	1.77	$	0.01

As of September 30, 2017, the cumulative effect of the change increased inventories and deferred tax liabilities by $8.8 million and $3.2 million, respectively. This resulted in a net change to total stockholders’ equity of $5.6 million.

For 2018 there was a reduction of $0.2 million to costs of sales and a $0.1 million increase in the income tax provision. The net impact to net income attributable to Versum was an increase of $0.1 million. There was no impact on basic or diluted net income attributable to Versum per common share for 2018.

There was no impact on the cash provided by operating activities on the statement of cash flows as a result of the above changes.

Equity Investments

The equity method of accounting is used when we exercise significant influence but do not have operating control, generally assumed to be 20% to 50% ownership. Under the equity method, original investments are recorded at cost and adjusted by our share of undistributed earnings or losses of these companies. Equity investments are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the investment may not be recoverable. The Annual Consolidated Financial Statements include our investment in and proportionate share of the income from our 20% owned equity affiliate, Daido Air Products Electronics, Inc. During the first quarter of 2016, we sold our investment in this affiliate. Refer to Note 6, “Sale of Equity Affiliate”, for additional information.

Plant and Equipment

Plant and equipment is stated at cost less accumulated depreciation. Construction costs, labor, and applicable overhead related to installations are capitalized. Expenditures for additions and improvements that extend the lives or increase the capacity of plant assets are capitalized. The costs of maintenance and repairs of plant and equipment are charged to expense as incurred.

Fully depreciated assets are retained in the gross plant and equipment and accumulated depreciation accounts until they are removed from service. In the case of disposals, assets and related depreciation are removed from the accounts, and the net amounts, less proceeds from disposal, are included in income.

Impairment of Long-Lived Assets

Long-lived assets are grouped for impairment testing at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other assets and liabilities and are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. We assess recoverability by comparing the carrying amount of the asset group to estimated undiscounted future cash flows expected to be generated by the asset group. If an asset group is considered impaired, the impairment loss to be recognized is measured as the amount by which the asset group’s carrying amount exceeds its fair value. Long-lived assets held for sale are reported at the lower of carrying amount or fair value less cost to sell.

Goodwill

The purchase price is allocated to the assets acquired and liabilities assumed based on their estimated fair market values. Any excess purchase price over the fair market value of the net assets acquired, including identified intangibles, is recorded as goodwill. Preliminary purchase price allocations are made at the date of acquisition and finalized when information needed to affirm underlying estimates is obtained, within a maximum allocation period of one year.

Goodwill is subject to impairment testing at least annually. In addition, goodwill is tested more frequently if a change in circumstances or the occurrence of events indicates that potential impairment exists.

We conducted impairment tests during the fourth quarter of 2018 and determined that there was no goodwill impairment.

Intangible Assets

Intangible assets with determinable lives primarily consist of customer relationships and purchased patents and technology. The cost of intangible assets with determinable lives is amortized on a straight-line basis over the estimated period of economic benefit. Amortizable lives are adjusted whenever there is a change in the estimated period of economic benefit. No residual value is estimated for intangible assets.

Retirement Benefits

For periods prior to October 1, 2016, Air Products sponsored defined benefit pension plans, defined contribution plans, and other post-employment benefit plans that are shared amongst its businesses. Prior to the Separation on October 1, 2016, participation of our employees in these plans was reflected in the Annual Consolidated Financial Statements as though Versum participated in a multi-employer plan with Air Products. A proportionate share of cost was reflected in these Annual Consolidated Financial Statements, primarily within selling and administrative expenses.

In 2017, certain international pension plans were legally split from Air Products. Our plans provide certain international employees in Germany, Korea and Taiwan who previously participated in the Air Products plans the same defined benefit pension benefits that had previously been provided by Air Products. Versum assumed the defined benefit pension plan assets and liabilities of these plans.

Upon Separation from Air Products, our employees’ balances in the Air Products sponsored defined contribution plan was transferred to a Versum defined contribution plan.

Air Products’ Net Investment

Prior to the Separation, Air Products’ net investment in our business was presented as “Air Products’ net investment” in lieu of stockholders’ equity, as a stand-alone legal and capital structure did not exist for the historical periods presented.

Earnings Per Share

Prior to the Separation, Versum earnings per share for 2016 were calculated using the shares that were distributed to Air Products stockholders immediately following the Separation. For periods prior to the Separation it is assumed that there are no dilutive equity instruments as there were no equity awards in Versum outstanding prior to the Separation.