SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Johnson Controls, Inc. and its domestic and non-U.S. subsidiaries that are consolidated in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP). All significant intercompany transactions have been eliminated. Investments in partially-owned affiliates are accounted for by the equity method when the Company’s interest exceeds 20% and the Company does not have a controlling interest.
Under certain criteria as provided for in Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 810, “Consolidation,” the Company may consolidate a partially-owned affiliate. To determine whether to consolidate a partially-owned affiliate, the Company first determines if the entity is a variable interest entity (VIE). An entity is considered to be a VIE if it has one of the following characteristics: 1) the entity is thinly capitalized; 2) residual equity holders do not control the entity; 3) equity holders are shielded from economic losses or do not participate fully in the entity’s residual economics; or 4) the entity was established with non-substantive voting. If the entity meets one of these characteristics, the Company then determines if it is the primary beneficiary of the VIE. The party with the power to direct activities of the VIE that most significantly impact the VIE’s economic performance and the potential to absorb benefits or losses that could be significant to the VIE is considered the primary beneficiary and consolidates the VIE. If the entity is not considered a VIE, then the Company applies the voting interest model to determine whether or not the Company shall consolidate the partially-owned affiliate.
Consolidated VIEs
Based upon the criteria set forth in ASC 810, the Company has determined that it was the primary beneficiary in three VIEs for the reporting periods ended September 30, 2013 and 2012, as the Company absorbs significant economics of the entities and has the power to direct the activities that are considered most significant to the entities.
Two of the VIEs manufacture products in North America for the automotive industry. The Company funds the entities’ short-term liquidity needs through revolving credit facilities and has the power to direct the activities that are considered most significant to the entities through its key customer supply relationships.
During the three month period ended December 31, 2011, a pre-existing VIE accounted for under the equity method was reorganized into three separate investments as a result of the counterparty exercising its option to put its interest to the Company. The Company acquired additional interests in two of the reorganized group entities. The reorganized group entities are considered to be VIEs as the other owner party has been provided decision making rights but does not have equity at risk. The Company is considered the primary beneficiary of one of the entities due to the Company’s power pertaining to decisions over significant activities of the entity. As such, the VIE has been consolidated within the Company’s consolidated statements of financial position. The impact of the consolidation of the entity on the Company’s consolidated statements of income for the years ended September 30, 2013 and 2012 was not material. The VIE is named as a co-obligor under a third party debt agreement of $175 million, maturing in fiscal 2020, under which it could become subject to paying more than its allocated share of the third party debt in the event of bankruptcy of one or more of the other co-obligors. The other co-obligors, all related parties in which the Company is an equity investor, consist of the remaining group entities involved in the reorganization. As part of the overall reorganization transaction, the Company has also provided financial support to the group entities in the form of loans totaling $64 million, which are subordinate to the third party debt agreement. The Company is a significant customer of certain co-obligors, resulting in a remote possibility of loss. Additionally, the Company is subject to a floor guaranty expiring in fiscal 2022; in the event that the other owner party no longer owns any part of the group entities due to sale or transfer, the Company has guaranteed that the proceeds received from the sale or transfer will not be less than $25 million. The Company has partnered with the group entities to design and manufacture battery components for the Power Solutions business.
The carrying amounts and classification of assets (none of which are restricted) and liabilities included in the Company’s consolidated statements of financial position for the consolidated VIEs are as follows (in millions):
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| | | | | | | |
| September 30, |
| 2013 | | 2012 |
Current assets | $ | 273 |
| | $ | 199 |
|
Noncurrent assets | 139 |
| | 144 |
|
Total assets | $ | 412 |
| | $ | 343 |
|
| | | |
Current liabilities | $ | 212 |
| | $ | 172 |
|
Noncurrent liabilities | 39 |
| | 25 |
|
Total liabilities | $ | 251 |
| | $ | 197 |
|
The Company did not have a significant variable interest in any other consolidated VIEs for the presented reporting periods.
Nonconsolidated VIEs
The Company has a 40% interest in an equity method investee whereby the investee is a VIE. The investee produces and sells lead-acid batteries of which the Company will both purchase and supply certain batteries to complement each investment partners’ portfolio. The Company has a contractual right to purchase the remaining 60% equity interest in the investee between May 2014 and May 2016 (the “call option”). If the Company does not exercise the call option prior to its expiration in May 2016, for a period of six months thereafter the Company is subject to a contractual obligation at the counterparty’s option to sell the Company’s equity investment in the investee to the counterparty (the “repurchase option”). The purchase price is fixed under both the call option and the repurchase option. Based upon the criteria set forth in ASC 810, the Company has determined that the investee is a VIE as the equity holders, through their equity investments, may not participate fully in the entity’s residual economics. The Company is not the primary beneficiary as the Company does not have the power to make key operating decisions considered to be most significant to the VIE. Therefore, the investee is accounted for under the equity method of accounting as the Company’s interest exceeds 20% and the Company does not have a controlling interest. The investment balance included within investments in partially-owned affiliates in the consolidated statement of financial position at September 30, 2013 and 2012 was $56 million and $55 million, respectively, which represents the Company’s maximum exposure to loss. Current assets and liabilities related to the VIE are immaterial and represent normal course of business trade receivables and payables for all presented periods. In October 2013, the Company purchased an additional 50% equity interest in the investee to bring the Company's total interest in the investee to 90%. As a result this transaction, the fixed price call option and repurchase option no longer exist, and the Company will begin to consolidate the investee under the voting interest model in the first quarter of fiscal 2014.
As mentioned previously within the “Consolidated VIEs” section above, during the three month period ended December 31, 2011, a pre-existing VIE was reorganized into three separate investments as a result of the counterparty exercising its option to put its interest to the Company. The reorganized group entities are considered to be VIEs as the other owner party has been provided decision making rights but does not have equity at risk. The Company is not considered to be the primary beneficiary of two of the entities as the Company cannot make key operating decisions considered to be most significant to the VIEs. Therefore, the entities are accounted for under the equity method of accounting as the Company’s interest exceeds 20% and the Company does not have a controlling interest. The Company’s maximum exposure to loss includes the partially-owned affiliate investment balance of $57 million and $52 million at September 30, 2013 and 2012, respectively, as well as the subordinated loan from the Company, third party debt agreement and floor guaranty mentioned previously within the “Consolidated VIEs” section above. Current liabilities due to the VIEs are not material and represent normal course of business trade payables for all presented periods.
The Company did not have a significant variable interest in any other nonconsolidated VIEs for the presented reporting periods.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The fair values of cash and cash equivalents, accounts receivable, short-term debt and accounts payable approximate their carrying values. See Note 10, “Derivative Instruments and Hedging Activities,” and Note 11, “Fair Value Measurements,” of the notes to consolidated financial statements for fair value of financial instruments, including derivative instruments, hedging activities and long-term debt.
Assets and Liabilities Held for Sale
The Company classifies assets and liabilities (disposal groups) to be sold as held for sale in the period in which all of the following criteria are met: management, having the authority to approve the action, commits to a plan to sell the disposal group; the disposal group is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such disposal groups; an active program to locate a buyer and other actions required to complete the plan to sell the disposal group have been initiated; the sale of the disposal group is probable, and transfer of the disposal group is expected to qualify for recognition as a completed sale within one year, except if events or circumstances beyond the Company's control extend the period of time required to sell the disposal group beyond one year; the disposal group is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.
The Company initially measures a disposal group that is classified as held for sale at the lower of its carrying value or fair value less any costs to sell. Any loss resulting from this measurement is recognized in the period in which the held for sale criteria are met. Conversely, gains are not recognized on the sale of a disposal group until the date of sale. The Company assesses the fair value of a disposal group less any costs to sell each reporting period it remains classified as held for sale and reports any subsequent changes as an adjustment to the carrying value of the disposal group, as long as the new carrying value does not exceed the carrying value of the disposal group at the time it was initially classified as held for sale.
Upon determining that a disposal group meets the criteria to be classified as held for sale, the Company reports the assets and liabilities of the disposal group, if material, in the line items assets held for sale and liabilities held for sale, respectively, in the consolidated statement of financial position. Refer to Note 3, "Assets and Liabilities Held for Sale," of the notes to consolidated financial statements for further information.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
At September 30, 2013 and 2012, the Company held restricted cash of approximately $32 million and $29 million, respectively, within cash and cash equivalents. These amounts primarily were collected from customers for payment of maintenance costs under contract, and withdrawals are restricted for this purpose.
Receivables
Receivables consist of amounts billed and currently due from customers and unbilled costs and accrued profits related to revenues on long-term contracts that have been recognized for accounting purposes but not yet billed to customers. The Company extends credit to customers in the normal course of business and maintains an allowance for doubtful accounts resulting from the inability or unwillingness of customers to make required payments. The allowance for doubtful accounts is based on historical experience, existing economic conditions and any specific customer collection issues the Company has identified.
Inventories
Inventories are stated at the lower of cost or market. Finished goods and work-in-process inventories include material, labor and manufacturing overhead costs.
In the fourth quarter of fiscal 2013, the Company changed its method of inventory costing for certain inventory in its Power Solutions business to the first-in first-out (FIFO) method from the last-in first-out (LIFO) method. The Company's other businesses also determine costs using the FIFO method. Prior to the change, Power Solutions utilized two methods of inventory costing: LIFO for inventories in the U.S. and FIFO for inventories in other countries. The Company believes that the FIFO method is preferable as it better reflects the current value of inventory on the Company’s consolidated statement of financial position, provides better matching of revenues and expenses, results in uniformity across the Company’s global operations with respect to the method of inventory accounting and improves comparability with the Company’s peers. The change has been reported through retrospective application of the new accounting policy to all periods presented and resulted in a $5 million increase (less than $0.01 per diluted share), $16 million increase ($0.03 per diluted share) and $21 million decrease ($0.03 per diluted share) to net income attributable to Johnson Controls, Inc. for the quarters ended December 31, 2012, March 31, 2013 and June 30, 2013, respectively.
The impact of all adjustments made to the consolidated financial statements presented is summarized in the following table (in millions, except per share data):
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| | | | | | | | | | | |
| 2013 |
| Previous Method | | As Reported | | Effect of Change |
Consolidated Statement of Income | | | | | |
Cost of sales | | | | | |
Products and systems | $ | 29,207 |
| | $ | 29,196 |
| | $ | (11 | ) |
Gross profit | 6,767 |
| | 6,778 |
| | 11 |
|
Income before income taxes | 2,454 |
| | 2,465 |
| | 11 |
|
Provision for income taxes | 1,164 |
| | 1,168 |
| | 4 |
|
Net income | 1,290 |
| | 1,297 |
| | 7 |
|
Net income attributable to Johnson Controls, Inc. | 1,171 |
| | 1,178 |
| | 7 |
|
Earnings per share | | | | | |
Basic | 1.71 |
| | 1.72 |
| | 0.01 |
|
Diluted | 1.70 |
| | 1.71 |
| | 0.01 |
|
| | | | | |
Consolidated Statement of Comprehensive Income (Loss) | | | | | |
Net income | $ | 1,290 |
| | $ | 1,297 |
| | $ | 7 |
|
Total comprehensive income | 1,251 |
| | 1,258 |
| | 7 |
|
| | | | |
|
Consolidated Statement of Financial Position | | | | |
|
Inventories | $ | 2,198 |
| | $ | 2,325 |
| | $ | 127 |
|
Other current assets | 2,358 |
| | 2,308 |
| | (50 | ) |
Retained earnings | 9,251 |
| | 9,328 |
| | 77 |
|
| | | | |
|
Consolidated Statement of Cash Flows | | | | |
|
Cash provided by operating activities | | | | |
|
Net income attributable to Johnson Controls, Inc. | $ | 1,171 |
| | $ | 1,178 |
| | $ | 7 |
|
Net income | 1,290 |
| | 1,297 |
| | 7 |
|
Deferred income taxes | 269 |
| | 273 |
| | 4 |
|
Inventories | (86 | ) | | (97 | ) | | (11 | ) |
| | | | |
|
Consolidated Statement of Shareholders’ Equity Attributable to Johnson Controls, Inc. | | | | |
|
Retained earnings at September 30, 2012 | $ | 8,541 |
| | $ | 8,611 |
| | $ | 70 |
|
Retained earnings at September 30, 2013 | 9,251 |
| | 9,328 |
| | 77 |
|
|
| | | | | | | | | | | |
| 2012 |
| Previously Reported | | Revised | | Effect of Change |
Consolidated Statement of Income | | | | | |
Cost of sales | | | | | |
Products and systems | $ | 28,839 |
| | $ | 28,909 |
| | $ | 70 |
|
Gross profit | 6,218 |
| | 6,148 |
| | (70 | ) |
Income before income taxes | 1,590 |
| | 1,520 |
| | (70 | ) |
Provision for income taxes | 237 |
| | 209 |
| | (28 | ) |
Net income | 1,353 |
| | 1,311 |
| | (42 | ) |
Net income attributable to Johnson Controls, Inc. | 1,226 |
| | 1,184 |
| | (42 | ) |
Earnings per share | | | | |
|
Basic | 1.80 |
| | 1.74 |
| | (0.06 | ) |
Diluted | 1.78 |
| | 1.72 |
| | (0.06 | ) |
| | | | |
|
Consolidated Statement of Comprehensive Income (Loss) | | | | | |
Net income | $ | 1,353 |
| | $ | 1,311 |
| | $ | (42 | ) |
Total comprehensive income | 1,161 |
| | 1,119 |
| | (42 | ) |
| | | | | |
Consolidated Statement of Financial Position | | | | |
|
Inventories | $ | 2,227 |
| | $ | 2,343 |
| | $ | 116 |
|
Other current assets | 2,873 |
| | 2,827 |
| | (46 | ) |
Retained earnings | 8,541 |
| | 8,611 |
| | 70 |
|
| | | | |
|
Consolidated Statement of Cash Flows | | | | |
|
Cash provided by operating activities | | | | |
|
Net income attributable to Johnson Controls, Inc. | $ | 1,226 |
| | $ | 1,184 |
| | $ | (42 | ) |
Net income | 1,353 |
| | 1,311 |
| | (42 | ) |
Deferred income taxes | (206 | ) | | (234 | ) | | (28 | ) |
Inventories | 39 |
| | 109 |
| | 70 |
|
| | | | | |
Consolidated Statement of Shareholders’ Equity Attributable to Johnson Controls, Inc. | | | | |
|
Retained earnings at September 30, 2011 | $ | 7,838 |
| | $ | 7,950 |
| | $ | 112 |
|
Retained earnings at September 30, 2012 | 8,541 |
| | 8,611 |
| | 70 |
|
|
| | | | | | | | | | | |
| 2011 |
| Previously Reported | | Revised | | Effect of Change |
Consolidated Statement of Income | | | | | |
Cost of sales | | | | | |
Products and systems | $ | 27,675 |
| | $ | 27,674 |
| | $ | (1 | ) |
Gross profit | 6,058 |
| | 6,059 |
| | 1 |
|
Income before income taxes | 1,789 |
| | 1,790 |
| | 1 |
|
Provision for income taxes | 257 |
| | 258 |
| | 1 |
|
Net income | 1,532 |
| | 1,532 |
| | — |
|
Net income attributable to Johnson Controls, Inc. | 1,415 |
| | 1,415 |
| | — |
|
Earnings per share | | | | | |
Basic | 2.09 |
| | 2.09 |
| | — |
|
Diluted | 2.06 |
| | 2.06 |
| | — |
|
| | | | | |
Consolidated Statement of Comprehensive Income (Loss) | | | | | |
Net income | $ | 1,532 |
| | $ | 1,532 |
| | $ | — |
|
Total comprehensive income | 1,382 |
| | 1,382 |
| | — |
|
| | | | | |
Consolidated Statement of Cash Flows | | | | | |
Cash provided by operating activities | | | | | |
Net income attributable to Johnson Controls, Inc. | $ | 1,415 |
| | $ | 1,415 |
| | $ | — |
|
Net income | 1,532 |
| | 1,532 |
| | — |
|
Deferred income taxes | (257 | ) | | (256 | ) | | 1 |
|
Inventories | (387 | ) | | (388 | ) | | (1 | ) |
| | | | | |
Consolidated Statement of Shareholders’ Equity Attributable to Johnson Controls, Inc. | | | | | |
Retained earnings at September 30, 2010 | $ | 6,890 |
| | $ | 7,002 |
| | $ | 112 |
|
Retained earnings at September 30, 2011 | 7,838 |
| | 7,950 |
| | 112 |
|
Pre-Production Costs Related to Long-Term Supply Arrangements
The Company’s policy for engineering, research and development, and other design and development costs related to products that will be sold under long-term supply arrangements requires such costs to be expensed as incurred or capitalized if reimbursement from the customer is contractually assured. Income related to recovery of these costs is recorded within selling, general and administrative expense in the consolidated statements of income. At September 30, 2013 and 2012, the Company recorded within the consolidated statements of financial position approximately $259 million and $382 million, respectively, of engineering and research and development costs for which customer reimbursement is contractually assured. The reimbursable costs are recorded in other current assets if reimbursement will occur in less than one year and in other noncurrent assets if reimbursement will occur beyond one year.
Costs for molds, dies and other tools used to make products that will be sold under long-term supply arrangements are capitalized within property, plant and equipment if the Company has title to the assets or has the non-cancelable right to use the assets during the term of the supply arrangement. Capitalized items, if specifically designed for a supply arrangement, are amortized over the term of the arrangement; otherwise, amounts are amortized over the estimated useful lives of the assets. The carrying values of assets capitalized in accordance with the foregoing policy are periodically reviewed for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. At September 30, 2013 and 2012, approximately $99 million and $113 million, respectively, of costs for molds, dies and other tools were capitalized within property, plant and equipment which represented assets to which the Company had title. In addition, at September 30, 2013 and 2012, the Company recorded within the consolidated statements of financial position in other current assets approximately $297 million and $284 million, respectively, of costs for molds, dies and other tools for which customer reimbursement is contractually assured.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Depreciation is provided over the estimated useful lives of the respective assets using the straight-line method for financial reporting purposes and accelerated methods for income tax purposes. The estimated useful lives range from 3 to 40 years for buildings and improvements and from 3 to 15 years for machinery and equipment.
The Company capitalizes interest on borrowings during the active construction period of major capital projects. Capitalized interest is added to the cost of the underlying assets and is amortized over the useful lives of the assets.
Goodwill and Other Intangible Assets
Goodwill reflects the cost of an acquisition in excess of the fair values assigned to identifiable net assets acquired. The Company reviews goodwill for impairment during the fourth fiscal quarter or more frequently if events or changes in circumstances indicate the asset might be impaired. The Company performs impairment reviews for its reporting units, which have been determined to be the Company’s reportable segments or one level below the reportable segments in certain instances, using a fair value method based on management’s judgments and assumptions or third party valuations. The fair value of a reporting unit refers to the price that would be received to sell the unit as a whole in an orderly transaction between market participants at the measurement date. In estimating the fair value, the Company uses multiples of earnings based on the average of historical, published multiples of earnings of comparable entities with similar operations and economic characteristics. In certain instances, the Company uses discounted cash flow analyses or estimated sales price to further support the fair value estimates. The inputs utilized in the analyses are classified as Level 3 inputs within the fair value hierarchy as defined in ASC 820, “Fair Value Measurement.” The estimated fair value is then compared with the carrying amount of the reporting unit, including recorded goodwill. The Company is subject to financial statement risk to the extent that the carrying amount exceeds the estimated fair value. The impairment testing performed by the Company in the fourth quarter of fiscal year 2013 indicated that the estimated fair value of the Automotive Experience Interiors reporting unit did not exceed its corresponding carrying amount including recorded goodwill, and an impairment existed. No other reporting unit was determined to be at risk of failing step one of the goodwill impairment test as the impairment testing performed indicated that the estimated fair value of each reporting unit substantially exceeded its corresponding carrying amount including recorded goodwill at September 30, 2013. No impairments existed at September 30, 2012 and 2011.
Refer to Note 6, "Goodwill and Other Intangible Assets," of the notes to consolidated financial statements for further information regarding the goodwill impairment charge recorded in the fourth quarter of fiscal 2013.
Indefinite lived other intangible assets are also subject to at least annual impairment testing. Other intangible assets with definite lives continue to be amortized over their estimated useful lives and are subject to impairment testing if events or changes in circumstances indicate that the asset might be impaired. A considerable amount of management judgment and assumptions are required in performing the impairment tests. While the Company believes the judgments and assumptions used in the impairment tests are reasonable and no impairment existed at September 30, 2013, 2012 and 2011, different assumptions could change the estimated fair values and, therefore, impairment charges could be required, which could be material to the consolidated financial statements.
Impairment of Long-Lived Assets
The Company reviews long-lived assets, including property, plant and equipment and other intangible assets with definite lives, for impairment whenever events or changes in circumstances indicate that the asset’s carrying amount may not be recoverable. The Company conducts its long-lived asset impairment analyses in accordance with ASC 360-10-15, “Impairment or Disposal of Long-Lived Assets.” ASC 360-10-15 requires the Company to group assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities and evaluate the asset group against the sum of the undiscounted future cash flows. If the undiscounted cash flows do not indicate the carrying amount of the asset is recoverable, an impairment charge is measured as the amount by which the carrying amount of the asset group exceeds its fair value based on discounted cash flow analysis or appraisals. See Note 17, “Impairment of Long-Lived Assets,” of the notes to consolidated financial statements for disclosure of the impairment analyses performed by the Company during fiscal 2013, 2012 and 2011.
Percentage-of-Completion Contracts
The Building Efficiency business records certain long-term contracts under the percentage-of-completion method of accounting. Under this method, sales and gross profit are recognized as work is performed based on the relationship between actual costs incurred and total estimated costs at completion. The Company records costs and earnings in excess of billings on uncompleted contracts primarily within accounts receivable and billings in excess of costs and earnings on uncompleted contracts primarily within other current liabilities in the consolidated statements of financial position. Costs and earnings in excess of billings related to these contracts were $489 million and $531 million at September 30, 2013 and 2012, respectively. Billings in excess of costs and earnings related to these contracts were $263 million and $321 million at September 30, 2013 and 2012, respectively.
Revenue Recognition
The Company’s Building Efficiency business recognizes revenue from certain long-term contracts over the contractual period under the percentage-of-completion (POC) method of accounting. This method of accounting recognizes sales and gross profit as work is performed based on the relationship between actual costs incurred and total estimated costs at completion. Recognized revenues that will not be billed under the terms of the contract until a later date are recorded primarily in accounts receivable. Likewise, contracts where billings to date have exceeded recognized revenues are recorded primarily in other current liabilities. Changes to the original estimates may be required during the life of the contract and such estimates are reviewed monthly. Sales and gross profit are adjusted using the cumulative catch-up method for revisions in estimated total contract costs and contract values. Estimated losses are recorded when identified. Claims against customers are recognized as revenue upon settlement. The amount of accounts receivable due after one year is not significant. The use of the POC method of accounting involves considerable use of estimates in determining revenues, costs and profits and in assigning the amounts to accounting periods. The periodic reviews have not resulted in adjustments that were significant to the Company’s results of operations. The Company continually evaluates all of the assumptions, risks and uncertainties inherent with the application of the POC method of accounting.
The Building Efficiency business enters into extended warranties and long-term service and maintenance agreements with certain customers. For these arrangements, revenue is recognized on a straight-line basis over the respective contract term.
The Company’s Building Efficiency business also sells certain heating, ventilating and air conditioning (HVAC) and refrigeration products and services in bundled arrangements, where multiple products and/or services are involved. In accordance with ASU No. 2009-13, “Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements - A Consensus of the FASB Emerging Issues Task Force,” the Company divides bundled arrangements into separate deliverables and revenue is allocated to each deliverable based on the relative selling price method. Significant deliverables within these arrangements include equipment, commissioning, service labor and extended warranties. In order to estimate relative selling price, market data and transfer price studies are utilized. Approximately four to twelve months separate the timing of the first deliverable until the last piece of equipment is delivered, and there may be extended warranty arrangements with duration of one to five years commencing upon the end of the standard warranty period.
In all other cases, the Company recognizes revenue at the time title passes to the customer or as services are performed.
Research and Development Costs
Expenditures for research activities relating to product development and improvement are charged against income as incurred and included within selling, general and administrative expenses in the consolidated statement of income. Such expenditures for the years ended September 30, 2013, 2012 and 2011 were $1,006 million, $1,025 million and $876 million, respectively.
A portion of the costs associated with these activities is reimbursed by customers and, for the fiscal years ended September 30, 2013, 2012 and 2011 were $448 million, $516 million and $366 million, respectively.
Earnings Per Share
The Company presents both basic and diluted earnings per share (EPS) amounts. Basic EPS is calculated by dividing net income attributable to Johnson Controls, Inc. by the weighted average number of common shares outstanding during the reporting period. Diluted EPS is calculated by dividing net income attributable to Johnson Controls, Inc. by the weighted average number of common shares and common equivalent shares outstanding during the reporting period that are calculated using the treasury stock method for stock options and unvested restricted stock. See Note 13, “Earnings per Share,” of the notes to consolidated financial statements for the calculation of earnings per share.
Foreign Currency Translation
Substantially all of the Company’s international operations use the respective local currency as the functional currency. Assets and liabilities of international entities have been translated at period-end exchange rates, and income and expenses have been translated using average exchange rates for the period. Monetary assets and liabilities denominated in non-functional currencies are adjusted to reflect period-end exchange rates. The aggregate transaction gains (losses), net of the impact of foreign currency hedges, included in net income for the years ended September 30, 2013, 2012 and 2011 were $(25) million, $12 million and $(22) million, respectively.
Derivative Financial Instruments
The Company has written policies and procedures that place all financial instruments under the direction of corporate treasury and restrict all derivative transactions to those intended for hedging purposes. The use of financial instruments for speculative purposes is strictly prohibited. The Company uses financial instruments to manage the market risk from changes in foreign exchange rates, commodity prices, stock-based compensation liabilities and interest rates.
The fair values of all derivatives are recorded in the consolidated statements of financial position. The change in a derivative’s fair value is recorded each period in current earnings or accumulated other comprehensive income, depending on whether the derivative is designated as part of a hedge transaction and if so, the type of hedge transaction. See Note 10, “Derivative Instruments and Hedging Activities,” and Note 11, “Fair Value Measurements,” of the notes to consolidated financial statements for disclosure of the Company’s derivative instruments and hedging activities.
Pension and Postretirement Benefits
The Company utilizes a mark-to-market approach for recognizing pension and postretirement benefit expenses, including measuring the market related value of plan assets at fair value and recognizing actuarial gains and losses in the fourth quarter of each fiscal year or at the date of a remeasurement event. Refer to Note 15, "Retirement Plans," of the notes to consolidated financial statements for disclosure of the Company's pension and postretirement benefit plans.
Retrospective Changes
In addition to the change in inventory costing method discussed in the "Inventories" section above, certain amounts in the prior years have been revised to conform to the current year’s presentation.
Effective October 1, 2012, the Company reorganized the reportable segments within its Automotive Experience business to align with its new management reporting structure and business activities. As a result of this change, Automotive Experience is comprised of three new reportable segments for financial reporting purposes: Seating, Interiors and Electronics. Historical information has been revised to reflect the new Automotive Experience reportable segment structure. Refer to Note 6, “Goodwill and Other Intangible Assets,” and Note 19, “Segment Information,” of the notes to consolidated financial statements for further information.
In January 2013, the Company’s shareholders approved a restatement of the Company’s articles of incorporation that included the simplification of the par value of the Company’s common stock by changing the par value from $0.01 7/18 per share to $1.00 per share. This change resulted in an increase to common stock and corresponding reduction in capital in excess of par value in the consolidated statements of financial position and is reported through retrospective application of the new par value for all periods presented.
The net gains related to business divestitures are now included in the gain on business divestitures - net line within the consolidated statements of income. In the prior year, net gains related to business divestitures were included in the selling, general and administrative expenses line.
New Accounting Pronouncements
In July 2013, the FASB issued Accounting Standards Update (ASU) No. 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a similar Tax Loss, or a Tax Credit Carryforward Exists." ASU No. 2013-11 clarifies that companies should present an unrecognized tax benefit as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward. ASU No. 2013-11 will be effective prospectively for the Company for the quarter ending December 31, 2014, with early adoption permitted. The Company is currently assessing the impact on its consolidated statement of financial position; however, the adoption of this guidance will have no impact on the Company's consolidated results of operations.
In March 2013, the FASB issued ASU No. 2013-05, "Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity." ASU No. 2013-05 clarifies when companies should release the cumulative translation adjustment (CTA) into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets within a foreign entity. Additionally, ASU No. 2013-05 states that CTA should be released into net income upon an acquirer obtaining control of an acquiree in which it held an equity interest immediately before the acquisition date (step acquisition). ASU No. 2013-05 will be effective prospectively for the Company for the quarter ending December 31, 2014, with early adoption permitted. The significance of this guidance for the Company is dependent on any future derecognition events involving the Company's foreign entities.
In February 2013, the FASB issued ASU No. 2013-02, "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." ASU No. 2013-02 requires companies to provide information about the amounts reclassified out of accumulated other comprehensive income by component. Additionally, companies are required to disclose these reclassifications by each respective line item on the statements of income. ASU No. 2013-02 is effective for the Company for the quarter ended December 31, 2013, though the Company has early adopted as permitted. The adoption of this guidance had no impact on the Company's consolidated financial condition or results of operations. Refer to Note 14, "Equity and Noncontrolling Interests," of the notes to consolidated financial statements for disclosures regarding other comprehensive income.
In July 2012, the FASB issued ASU No. 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” ASU No. 2012-02 provides companies an option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, as a result of the qualitative assessment, it is determined that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the Company is not required to take further action. ASU No. 2012-02 is effective for the Company for impairment tests of indefinite-lived intangible assets performed in the current fiscal year. The adoption of this guidance had no impact on the Company’s consolidated financial condition or results of operations.
In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.” ASU No. 2011-11 requires additional quantitative and qualitative disclosures of gross and net information regarding financial instruments and derivative instruments that are offset or eligible for offset in the consolidated statement of financial position. ASU No. 2011-11 will be effective for the Company for the quarter ending December 31, 2013. The adoption of this guidance will have no impact on the Company’s consolidated financial condition or results of operations.
In September 2011, the FASB issued ASU No. 2011-08, “Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” ASU No. 2011-08 provides companies an option to perform a qualitative assessment to determine whether further goodwill impairment testing is necessary. If, as a result of the qualitative assessment, it is determined that it is more likely than not that a reporting unit’s fair value is less than its carrying amount, the two-step quantitative impairment test is required. Otherwise, no further testing is required. ASU No. 2011-08 is effective for the Company for goodwill impairment tests performed in the current fiscal year. The adoption of this guidance had no impact on the Company’s consolidated financial condition or results of operations.
In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” ASU No. 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of shareholders’ equity. All non-owner changes in shareholders’ equity instead must be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU No. 2011-05 was effective for the Company for the quarter ended December 31, 2012. The adoption of this guidance had no impact on the Company’s consolidated financial condition or results of operations. Refer to the consolidated statements of comprehensive income (loss) and Note 14, “Equity and Noncontrolling Interests,” of the notes to consolidated financial statements for disclosures regarding other comprehensive income.
