Canon Annual Report 2006

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FY2006 Annual Report · Canon

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CANON ANNUAL REPORT 2006

Fiscal Year Ended December 31, 2006

CANON INC. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan

CORPORATE PROFILE

Canon develops, manufactures and sells a wide lineup of copying machines,
printers, cameras, optical products, industrial equipment and other products to
meet a diverse range of customer needs. The Company has developed its
business activities on a global scale. Canon is a registered trademark in over
180 countries and regions around the world.

Canon first began implementing its Excellent Global Corporation Plan in
1996, and has since delivered a series of strong performances. In fiscal 2006,
the inaugural year of Phase III of the Plan, Canon achieved record earnings and
marked its seventh consecutive year of growth in both sales and net income.
With the spread of globalization and broadband networks, Canon stands

poised to lead a new era in digital imaging and highly effective
communication. In addition to strengthening business results for enhanced
corporate value, the Company engages in a number of environmental and
social contribution activities and focuses on fulfilling its duties to investors and
society by stressing good corporate governance.

CORPORATE PHILOSOPHY: Kyosei

The corporate philosophy of Canon is kyosei. A concise definition of this
word would be “Living and working together for the common good,” but
our definition is broader: “All people, regardless of race, religion or culture,
harmoniously living and working together into the future.” Unfortunately,
the presence of imbalances in our world in such areas as trade, income
levels and the environment hinders the achievement of kyosei.

Addressing these imbalances is an ongoing mission, and Canon is doing
its part by actively pursuing kyosei. True global companies must foster good
relations, not only with their customers and the communities in which they
operate, but also with nations and the environment. They must also bear
the responsibility for the impact of their activities on society. For this reason,
Canon’s goal is to contribute to global prosperity and people’s well-being,
which will lead to continuing growth and bring the world closer to
achieving kyosei.

CORPORATE GOAL

In fiscal 2007, Canon’s 70th year in business, the Company aims to
strengthen existing businesses and identify next-generation business domains
to assure sustained growth beyond 2010, while maintaining a high profit
margin structure. Canon will make every effort to join the ranks of the global
top 100 companies by 2010 in terms of key performance indicators. The
Company’s goals for 2010 include net sales of ¥5.5 trillion and a return on
net sales ratio of 10% or higher.

CONTENTS

FINANCIAL HIGHLIGHTS ............................ 1

TO OUR STOCKHOLDERS ...........................

EXCELLENT GLOBAL CORPORATION

PLAN—PHASE III ......................................... 4

CORPORATE GOVERNANCE ....................... 10

CORPORATE FUNCTIONS ........................... 15

RESEARCH & DEVELOPMENT

PRODUCTION

SALES & MARKETING

CORPORATE SOCIAL RESPONSIBILITY

PRODUCT GROUPS ..................................... 27

OFFICE IMAGING PRODUCTS

COMPUTER PERIPHERALS

CAMERAS

OPTICAL AND OTHER PRODUCTS

MAJOR CONSOLIDATED SUBSIDIARIES .... 36

FINANCIAL SECTION ................................... 37
TRANSFER AND REGISTRAR’S OFFICE ....... 92
STOCKHOLDER INFORMATION ................. 92

Cover Photos:
Aiming to expand its business areas to achieve sound
growth in Phase III, Canon has entered the print-on-
demand market and strengthened its large-format
printer business. The Company will leverage its
exceptional imaging technologies to increase its
presence in these markets.

This publication was printed on 100% recycled paper by an
ISO 14001-accredited printer. The inks used, containing
neither VOCs (volatile organic compounds) nor mineral oils,
excel in decomposition and de-inking.

PUB. BEP016 0704SZ 19.3 Printed in Japan

FINANCIAL HIGHLIGHTS

Net sales

Operating profit

Income before income taxes

and minority interests

Net income

Net income per share:

-Basic

-Diluted

Total assets

Millions of yen
(except per share amounts)

Thousands of U.S. dollars
(except per share amounts)

2006

2005 Change (%)

2006

¥4,156,759

3,754,191

707,033

719,143

583,043

612,004

+10.7

+21.3

+17.5

$34,930,748

5,941,454

6,043,218

455,325

384,096

+18.5

3,826,261

341.95

341.84

288.63

288.36

+18.5

2.87

¥4,521,915

4,043,553

+11.8

$37,999,286

Stockholders’ equity

¥2,986,606

2,604,682

+14.7

$25,097,529

Notes:
1. Canon’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles.
2. U.S. dollar amounts are translated from yen at the rate of JPY119=U.S.$1, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 29, 2006, solely for the convenience of the reader.
3. Canon has made a three-for-two stock split on July 1, 2006. All per share information has been adjusted to reflect the stock split.

Net Sales
(Millions of yen)

Net Income
(Millions of yen)

Net Income per Share
(Yen)

ROE / ROA
(%)

Basic
Diluted

ROE
ROA

5,000,000

500,000

400

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02 03 04 05 06

TO OUR STOCKHOLDERS

Continuing Our
Upward Journey with
Innovation and
Sound Growth

Overview of Fiscal 2006
Canon hit the ground running in fiscal 2006, the inaugural year
of Phase III of its Excellent Global Corporation Plan aimed at
attaining sound growth. The Company achieved record earn-
ings and posted its seventh consecutive year of sales and profit
growth, as well as increased sales across all major product
categories and all operating regions.

The global economy continued on a steady course in 2006

in spite of concerns over sharp rises in raw material and fuel
costs, along with tense geopolitical conditions. Personal
consumption and capital investment increased in the United
States while the European economy recovered steadily. The
Asian economy continued to hum along, driven by China and
ASEAN countries, and the economy in Japan saw moderate
but stable growth.

Canon again enjoyed strong results in digital cameras, color
network multifunction devices (MFDs) and laser beam printers
(LBPs). Consolidated net sales in fiscal 2006 grew 10.7% to
¥4,156.8 billion (US$34,931 million), income before income
taxes and minority interests jumped 17.5% to ¥719.1 billion
(US$6,043 million), and net income rose 18.5% to ¥455.3
billion (US$3,826 million). The gross profit ratio improved 1.1
percentage points to 49.6%, owing to major cost reductions.

Return to Stockholders
With the goal of expanding its base of individual investors,
Canon executed a three-for-two stock split in July 2006. The
Company will continue taking an active approach to stockholder
returns in the future, primarily in the form of dividends, after
careful consideration of investment plans and cash flows in the
context of consolidated performance results. Over the mid to
long term, the Company intends to raise its stockholder return
ratio to a level of approximately 30% on a consolidated basis.
For the fiscal year ended December 31, 2006, Canon set its full-
year dividend per share at ¥100, which would equal ¥125 on a
pre-stock-split basis, marking a real increase of ¥25 over the
previous fiscal year.

Toward the Achievement of Phase III Targets
In Phase III of our Excellent Global Corporation Plan, we will
strengthen existing businesses and cultivate new businesses
while maintaining a high profit structure. In addition, we will
work toward further accelerating innovation across all busi-
ness activities.

Through reforms carried out in Phase I and Phase II, Canon

made major improvements in productivity and solidified its
financial foundation to enhance corporate value. Moreover,
aggressive investments in infrastructure over the past 10 years
have led to expanded sales and enabled us to focus on cultivat-
ing new businesses over the mid-term.

We view the five years of Phase III as an expansion period and,

with the aim of joining the ranks of the global top 100 compa-
nies, have set consolidated performance targets of ¥5.5 trillion in
net sales and a return on net sales of 10% or higher in 2010.

A Truly Excellent Global Corporation
In 2007, as we celebrate the 70th anniversary of Canon’s
founding, I envision the Company continuing on a long journey
of 100 or even 200 years of sustained development and
prosperity. As we take up fresh challenges in our drive to
increase the level of admiration and respect the Company earns
worldwide, we will continue to follow our philosophy of kyosei
and act as a responsible corporate citizen to protect the natural
environment and make positive contributions to society.
In May 2006, I was appointed Chairman of Nippon
Keidanren (Japan Business Federation), and will work in this
capacity to contribute to the development of Japanese society,
in addition to my responsibilities at Canon. I have assumed the
post of Chairman and CEO, while Mr. Tsuneji Uchida has been
appointed President and COO. Under this new management
framework, we will press ahead toward our primary goal of
accomplishing our Phase III objectives.

Fujio Mitarai
Chairman and CEO
Canon Inc.

EXCELLENT GLOBAL CORPORATION PLAN—PHASE III

Steady Advances for Sound Growth

Under Phase III, Canon aims to enter the ranks of the global top 100
companies by 2010 in terms of key performance indicators. The
Company has set targets for 2010 of ¥5.5 trillion in consolidated net
sales and a net income to sales ratio of 10% or higher.

At GRAPH EXPO 2006 in Chicago, U.S.A., Canon exhibited the “imagePRESS” brand production printer to bolster its presence in the
field of commercial printing

Canon has its sights firmly set on achieving the 2010 targets
established for Phase III of its Excellent Global Corporation
Plan. When the Company embarked on Phase I of the Plan in
1996, its initial aim was to strengthen its financial health.
Indicators that testify to Canon’s success include the stock-
holder equity ratio, which climbed from 35.1% in 1995 to
66.0% at the end of 2006, and retained earnings, which
expanded nearly 5.5 times from ¥433.5 billion to ¥2,368.0
billion over the same period.

In Phase II, launched in 2001, the Company set the ambi-

tious goal of becoming No. 1 in the world in all of its major
areas of business, with an emphasis on product competitive-
ness. Building on this goal, Canon kicked off Phase III in fiscal
2006 under the theme of “Innovation and Sound Growth.”
Capitalizing on global trends, specifically the diffusion of broad-
band networks and the continued advance of globalization as

External Ratings

• Financial Times Global 500 (June 10, 2006 issue)

Market value ranking: 102

(9th in the Technology Hardware and Equipment category)

• FORTUNE Global 500 (July 24, 2006 issue)

Revenues ranking: 170

(6th in the Computers, Office Equipment category)

Profits ranking: 114

(3rd in the Computers, Office Equipment category)

• BusinessWeek “Best Global Brands” of 2006 (August 7, 2006 issue)

Ranking: 35

(4th among all Japanese companies)

FORTUNE Global 500 is a registered trademark of FORTUNE Magazine,
a division of Time Inc. in the United States of America.

economic development spreads to more nations around the
world led by the BRIC economies (Brazil, Russia, India, and
China), Canon is taking steps to fortify its existing businesses
while creating new business domains.

I will do everything in my
power to steer Canon toward
the achievement of new
innovation and boldly push
forward with measures to
realize our Phase III objectives.

Tsuneji Uchida
President and COO
Canon Inc.

EXCELLENT GLOBAL CORPORATION PLAN—PHASE III

Achieve the overwhelming No. 1 position in existing core
businesses and develop three new display businesses

Canon has achieved global No. 1 market
positions for such core products as
copying machines, LBPs and digital
cameras, and will strive not only to
maintain these positions but also to
further its market leadership.

Furthermore, Canon is generally already

among the top three in other sectors and
has given the highest priority to attaining
the top position for all of its core businesses.
For example, in line with growing demand
for color output in the office, Canon is
applying proprietary technology to copying
machines and LBPs to actively launch
competitive new products that are differen-
tiated by their performance capabilities. The
Company aims to get a jump on the com-
petition with the development of a new-
concept multifunction office system that
maximizes the functionality of each device
connected to a network. By leveraging its

Canon plans to equip digital cameras and
camcorders with OLED displays (prototype)

Canon displayed a full-HD SED 55-inch panel prototype at CEATEC JAPAN 2006

©Hitomi-za Otome Bunraku

strengths in digital cameras and photo
printers, Canon aspires to become No. 1 in
home photo printing. In semiconductor-
production equipment, the Company is
aiming to raise competitiveness by develop-
ing state-of-the-art exposure equipment
that employs leading-edge technology such
as liquid immersion lithography. In today’s
environment where production volume has
dramatically increased, Canon recognizes
quality as an extremely important issue.
Quality problems have the potential to
severely impact the brand image that has
been carefully cultivated through decades

of effort. Therefore, Canon will review and
reinforce its quality-control systems.

Canon’s three new display businesses

are surface-conduction electron-emitter
displays (SEDs), organic light-emitting diode
(OLED) displays, and rear projection displays.
The Company is speeding up the develop-
ment of these businesses and reinforcing
their support systems. Canon is forging
ahead with measures to realize commer-
cial opportunities in SEDs, and has also
intensified development of OLED displays,
which Canon plans to use for monitors in
digital cameras.

2 Establish new production systems to maintain

international competitiveness

Canon will continue to promote production
innovation initiatives

For Canon to compete with the world’s
top companies, it must raise production
efficiency to even higher levels. Therefore,
the Company has set a Phase III perfor-
mance target for the cost-to-sales ratio of
45% in 2010. To attain this goal, Canon is
implementing Companywide initiatives
targeting in-house production, automation
and procurement reforms.

In-house production of key devices

and components is one of the most
important aspects of efforts to increase
product competitiveness and reduce
costs. Canon is also strengthening
in-house production of parts and
production equipment.

The Company has introduced auto-
mated production lines using automated
assembly systems and robots in order to
meet growing demand for Canon products,
as well as to reinforce competitiveness on

a global scale and to boost production. In
Japan, the Company is promoting the
automated production of such products
as toner and ink cartridges, for which
there is a sharp increase in demand.
Canon will take active steps to realize a
“three-in-one” foundation for manufac-
turing that integrates development,
production technology, and manufacturing
know-how. As a step in this direction, the
Company is planning the construction of
a new production-engineering center in
Japan to accelerate the strengthening of
production technology capabilities. Also,

Canon Machinery Inc., a company with
expertise in automated machinery that
was added to the Group in 2005, will
construct a new plant for production of
automated machinery for toner and ink
cartridge assembly.

In the field of procurement reforms,

Canon works to secure more reliable
parts and components with a focus
on environment, quality, cost and
delivery (EQCD). At the same time,
the Company is making significant
progress in reducing costs by raising
efficiency in procurement operations.

Canon is now establishing fully automated toner cartridge production

EXCELLENT GLOBAL CORPORATION PLAN—PHASE III

3 Expand operations through diversification and

strengthen the Three Regional Headquarters system

seventh product operations segment in
2007. Canon also entered the growing
print-on-demand (POD) market with the
introduction of the imagePRESS series of
production color printing systems for such
commercial printing needs as the creation
of catalogs and brochures.

In an aim to increase revenues from
independent business, Group companies are
being encouraged to pursue business activi-
ties outside of Canon’s established fields.

Canon is focusing on strengthening its

Three Regional Headquarters system.
Canon U.S.A., Inc., Canon Europe Ltd.,
and Canon Europa N.V. have made steady
progress in implementing structural
reforms and new businesses. These com-
panies will be encouraged to apply their
human and capital resources in order to
expand their areas of business and become
companies that provide exports to the rest
of the world.

Canon is strengthening its large-format printer business, expanding the potential of inkjet printers

Canon recognizes that new business is
crucial to succeed in reaching the 2010 net
sales target of ¥5.5 trillion and increasing
corporate value.

Regarding business diversification, the

Company is expanding its large-format
printer business for graphic arts and a
range of corporate uses. The L Printer
division, for which the Company holds
high expectations, became Canon’s

4 Identify next-generation business domains and obtain

necessary technological capabilities

Canon works tirelessly to stay ahead of
changing trends in order to launch next-
generation products. To this end, the
Company established the New Business
Domain Committee, which explores new

fields to ensure significant growth from
2010. Canon aims to establish a core
business in medical-related fields in the
future by cultivating and expanding applica-
tions in its imaging technologies. To com-

pile and develop the technologies required
for this area, the Company launched a joint
project with Kyoto University in Japan
during 2006 and began joint research with
Stanford University in the United States in

the field of medical imaging.

In addition, efforts are underway to

strengthen collaboration between
academia and industry through joint
research with other world-renowned
universities and research institutes.
For example, Canon strengthened its ties
with the Tokyo Institute of Technology in
2006 through continued joint research in
the areas of advanced materials and
imaging technologies.

To meet the future needs of society,
the Company aims to develop platform
technologies in the areas of intelligent
robots and safety. Aiming to create
breakthrough technologies for next-
generation businesses, Canon will bolster
research capabilities across the Group.

Canon is conducting collaborative research with leading research institutions such as the Massachusetts
Institute of Technology

5 Nurture truly autonomous individuals

Canon’s guiding principles are epitomized
in its “San-Ji” spirit: self-motivation,
self-management and self-awareness.
The Company believes that putting the
San-Ji spirit into practice on a daily basis
cultivates individual autonomy and an
internalized sense of duty and ethics,
which provides a basis for thorough
compliance and internal controls.

In an era of intense shifts in the
business environment, it is becoming
ever more important to anticipate
changes early on and to continue to

innovate proactively. It will be the
truly autonomous individuals who will
carry the responsibility of achieving
further innovation.

To cultivate a new generation of
employees who display a strong San-Ji
spirit, the Company opened the Canon
Global Management Institute in Tokyo in
May 2006. It will function as a develop-
ment center for future leaders and
executives of the Group worldwide.

Canon aims to become a company

that produces human resources that

play supporting roles in the world of
business and industry as well as the
global economy.

Sales staff training at the Suzhou Training
Academy of Canon (China) Co., Ltd.

CORPORATE GOVERNANCE

For 70 years Canon has nurtured a vibrant compliance culture based on the guiding
principles of the San-Ji spirit.

Governance Structure (as of December 31, 2006)

Canon Inc.
Canon Inc.

General Meeting of Stockholders

Board of Directors

Chairman and CEO
President and COO

Subsidiaries &
Subsidiaries &
Affiliates
Affiliates

Executive Committee

Corporate Audit Center

Headquarters Administrative Divisions

Product Group Operations

Marketing Subsidiaries & Affiliates

Manufacturing Subsidiaries & Affiliates

R&D Subsidiaries & Affiliates

Board of Corporate Auditors

Management Strategy Committee

New Business Development Committee

Corporate Ethics and Compliance Committee

Internal Control Committee

Disclosure Committee

Global Legal Affairs Coordination Committee

Boards of Directors & Corporate Auditors (as of December 31, 2006)

Chairman & CEO

Fujio Mitarai

President & COO

Tsuneji Uchida

Senior Managing Directors

Toshizo Tanaka
Group Executive, Finance & Accounting Headquarters;
in charge of Internal Control Committee and Disclosure
Committee

Nobuyoshi Tanaka
Group Executive, Corporate Intellectual Property &
Legal Headquarters; in charge of Global Legal Affairs
Coordination Committee

Junji Ichikawa
Chief Executive, Optical Products Operations

Hajime Tsuruoka
President, Canon Europa N.V.; President & CEO,
Canon Europe Ltd.

Managing Directors

Akiyoshi Moroe
Group Executive, General Affairs Headquarters;
Group Executive, External Relations Headquarters;
in charge of Corporate Ethics and Compliance Committee

Kunio Watanabe
Group Executive, Corporate Planning Development
Headquarters; in charge of Management Strategy
Committee and New Business Development Committee

Hironori Yamamoto
Group Executive, Global Environment Promotion
Headquarters; Group Executive, Production Engineering
Headquarters

Yoroku Adachi
President & CEO, Canon U.S.A., Inc.

Yasuo Mitsuhashi
Chief Executive, Peripheral Products Operations

Directors

Katsuichi Shimizu
Chief Executive, Inkjet Products Operations

Ryoichi Bamba
Executive Vice President, Canon U.S.A., Inc.

Tomonori Iwashita
Chief Executive, Image Communication Products
Operations

Toshio Homma
Group Executive, L Printer Business Promotion Headquarters

Shigeru Imaiida
Senior Managing Director, Canon ANELVA Corporation

Masahiro Osawa
Group Executive, Global Procurement Headquarters

Keijiro Yamazaki
Group Executive, Human Resources Management &
Organization Headquarters

Shunichi Uzawa
Group Executive, Core Technology Development
Headquarters

Masaki Nakaoka
Chief Executive, Office Imaging Products Operations

Toshiyuki Komatsu
Group Executive, Leading-Edge Technology Research
Headquarters

Shigeyuki Matsumoto
Group Executive, Device Technology
Development Headquarters

Haruhisa Honda
Chief Executive, Chemical Products Operations

Tetsuro Tahara
Group Executive, Global Manufacturing & Logistics
Headquarters

Seijiro Sekine
Group Executive, Information & Communication
Systems Headquarters; Deputy Group Executive, Global
Manufacturing & Logistics Headquarters

Shunji Onda
Deputy Group Executive, Finance & Accounting
Headquarters

Corporate Auditors

Teruomi Takahashi
Kunihiro Nagata
Tadashi Ohe
Yoshinobu Shimizu
Minoru Shishikura

Basic Policy and Corporate Governance Structure
Canon recognizes that strengthening management supervision
functions and maintaining management transparency are vital to
improving its corporate governance structure and raising corpo-
rate value. Canon’s basic governance structure comprises the
General Meeting of Stockholders, the Board of Directors and the
Board of Corporate Auditors. Furthermore, the Executive
Committee and management committees are dedicated to key
issues. All of these bodies work together to ensure appropriate
management of the Group through an independent internal
auditing structure centered on the Corporate Audit Center, and
an information disclosure system for management activities.

Board of Directors
Important business matters are discussed and ratified during
meetings of the Board of Directors and Executive Committee,
which are attended, in principle, by all directors. As of
December 31, 2006, the Board consisted of 26 directors. In
order to realize a more streamlined and efficient management
decision-making process, Canon has not adopted an outside
director system. The main reason why directors are chosen from
among Canon personnel is that they have followed these same
codes of behavior and have been subject to close scrutiny within
the Group over many years.

Auditing System
Canon is working to bolster its auditing framework. In 2006,
Canon increased the membership of its Board of Corporate
Auditors to five, including three external auditors who have no
personal, capital or business affiliations with Canon. Auditor
duties include attending meetings of the Board of Directors,
Executive Committee and various management committees,
listening to business reports from directors, carefully examining
documents related to important decisions, and conducting strict

audits of the Group’s business and assets. Corporate auditors also
work closely with accounting auditors and the Corporate Audit
Center, which monitors compliance, risk management and
internal control systems, and provides assessments and recom-
mendations. Relevant administrative divisions collaborate with the
Center to oversee such areas as quality, environmental issues,
export control management and information security.

Internal Control Committee
The Internal Control Committee, established in 2004, ensures the
reliability of financial reporting. It also conducts reviews of the
Group’s internal controls in order to gauge the true efficiency of
business operations, supports compliance with all related laws
and internal regulations, and implements sound internal controls.
In response to the Sarbanes-Oxley Act, including Article 404 that
came into force during 2006, Canon continues to reinforce
internal control systems and implement all appropriate measures.
In order to strengthen internal controls, Canon is document-
ing and assessing material business processes at all related divi-
sions throughout the Group, and proceeding with reform
initiatives. Canon has formed working groups to conduct com-
prehensive evaluations of internal controls across areas including
accounting, management oversight, legal compliance, IT systems,
and promotion of corporate ethics.

Internal controls over financial reporting as of December 31,
2006, have been assessed as effective by the management and
the independent registered public accounting firm. (Please refer
to p.89 and p.91)

Other Corporate Governance Committees
Canon’s management committees are integral to its overall
governance system. Key among these are the Corporate Ethics
and Compliance Committee, which discusses and approves
compliance and corporate ethics policies; the Global Legal Affairs

CORPORATE GOVERNANCE

Coordination Committee, which analyzes trends in legal develop-
ments and works to raise the level of employee awareness
regarding important legal issues facing the Group; and the
Disclosure Committee, which is dedicated to ensuring the
dissemination of accurate and thorough information.

Compliance
Since its founding, employee education has been based on the
guiding principles of the San-Ji, or “Three Selfs” spirit, namely
“self-motivation,” or taking the initiative and being proactive in
all things; “self-management,” or conducting oneself responsibly
and being accountable for all one’s actions; and “self-aware-
ness,” or understanding one’s situation and role in it. Based upon
these principles, the Canon Group Code of Conduct was estab-
lished as a standard for executives and employees.

Canon holds a Compliance Week twice per year to give
employees a chance to discuss issues related to compliance and
corporate ethics that may arise in actual operations, and to recog-
nize the importance of their individual actions in the workplace.

Disclosure
Canon makes every effort to disclose information on its manage-
ment and business strategies as well as its performance results to
stockholders, investors and all other stakeholders in an accurate,
fair and timely manner. To this end, Canon holds regular briefings
and posts the latest information on its Website together with a
broad range of disclosure materials. Canon has established its
own Disclosure Guidelines, in addition to a Disclosure Committee
that serves to ensure strict compliance with disclosure regulations
prescribed by stock exchanges.

With 46.9% of Canon’s shares owned by non-Japanese
investors as of December 31, 2006, the Group goes to great
lengths to promote close relations with non-Japanese institutional
investors, maintaining IR bases in Europe and the United States
and working to ensure that investors inside and outside of Japan
have access to the same information. Recognizing the growing
influence of individual investors in capital markets, Canon has also
initiated IR briefings at which the Chairman and CEO or a Group
executive from the Finance & Accounting Headquarters presents
the Group’s strategies and answers questions that arise. Canon
will continue to promote transparency and understanding of its
activities by practicing thoroughgoing disclosure.

Significant Differences in Corporate Governance Practices
between Canon and U.S. Companies Listed on the NYSE

Section 303A of the New York Stock Exchange (the “NYSE”)
Listed Company Manual (the “Manual”) provides that companies
listed on the NYSE must comply with certain corporate gover-
nance standards. However, foreign private issuers whose shares
have been listed on the NYSE, such as Canon Inc. (the
“Company”), are permitted, with certain exceptions, to follow
the laws and practice of their home country in place of the
corporate governance practices stipulated under the Manual. In
such circumstances, the foreign private issuer is required to
disclose the significant differences between the corporate gover-
nance practices under Section 303A of the Manual and those
required in Japan. A summary of these differences as they apply
to the Company is provided below.

1. Directors
Currently, the Company’s board of directors does not have any
director who could be regarded as an “independent director”
under the NYSE Corporate Governance Rules for U.S. listed
companies. Unlike the NYSE Corporate Governance Rules, the
Corporation Law of Japan (the “Corporation Law”) does not
require Japanese companies with a board of corporate auditors
such as the Company, to appoint independent directors as
members of the board of directors. The NYSE Corporate
Governance Rules require non-management directors of U.S.
listed companies to meet at regularly scheduled executive ses-
sions without the presence of management. Unlike the NYSE
Corporate Governance Rules, however, the Corporation Law
does not require companies to implement an internal corporate
organ or committee comprised solely of independent directors.
Thus, the Company’s board of directors currently does not
include any non-management directors.

2. Committees
Under the Corporation Law, the Company may choose to:
(i) have an audit committee, nomination committee and compen-
sation committee and abolish the post of corporate auditors; or
(ii) have a board of corporate auditors.

The Company has elected, to have a board of corporate auditors,
whose duties include monitoring and reviewing the management
and reporting the results of these activities to the shareholders or
board of directors of the Company. While the NYSE Corporate
Governance Rules provide that U.S. listed companies must have
an audit committee, nominating committee and compensation
committee, each composed entirely of independent directors, the
Corporation Law does not require companies to have specified
committees, including those that are responsible for director
nomination, corporate governance and executive compensation.
The Company’s board of directors nominates the candidate
for directorship and submits a proposal at the general meeting of
shareholders for shareholder approval. Pursuant to the
Corporation Law, the shareholders then vote to elect directors at
the meeting. The Corporation Law requires that the total amount
or calculation method of compensation for directors and corpo-
rate auditors be determined by a resolution of the general meet-
ing of shareholders respectively, unless the amount or calculation
method is provided under the Articles of Incorporation. As the
Articles of Incorporation of the Company do not stipulate the
requirements as expressed under the Corporation Law, the
amount of compensation for the directors and corporate auditors
of the Company is determined by a resolution of the general
meeting of shareholders. The allotment of compensation for each
director from the total amount of compensation is determined by
the Company’s board of directors, and the allotment of compen-
sation to each corporate auditor is determined by consultation
among the Company’s corporate auditors.

3. Audit Committee
The Company plans to avail itself of paragraph (c)(3) of Rule 10A-3
of the Security Exchange Act, which provides that a foreign private
issuer which has established a board of corporate auditors shall be
exempt from the audit committee requirements, subject to certain
requirements which continue to be applicable under Rule 10A-3.
Pursuant to the requirements of the Corporation Law, the

shareholders elect the corporate auditors by resolution of a
general meeting of shareholders. The Company currently has five
corporate auditors, although the minimum number of corporate
auditors required pursuant to the Corporation Law is three.

Unlike the NYSE Corporate Governance Rules, Japanese laws

and regulations, including the Corporation Law, do not require
corporate auditors to be experts in accounting or to have any
other area of expertise. Under the Corporation Law, a board of
corporate auditors may determine the auditing policies and
methods for investigating the business and assets of a Company,
and may resolve other matters concerning the execution of the
corporate auditor’s duties. The board of corporate auditors pre-
pares auditors’ reports and may veto a proposal for the nomina-
tion of corporate auditors and accounting auditors put forward by
the board of directors.

Under the Corporation Law, more than half of a company’s
corporate auditors must be “outside” corporate auditors. These
are individuals who are prohibited to have ever been a director,
executive officer, manager, or employee of the Company or its
subsidiaries. There are five members on the Company’s board of
auditors, three of whom are outside corporate auditors. The
Company’s current corporate auditor system meets these require-
ments. The qualifications for an “outside” corporate auditor under
the Corporation Law are different from the audit committee
independence requirement under the NYSE Corporate
Governance Rules.

4. Shareholder Approval of Equity Compensation Plans
The NYSE Corporate Governance Rules require that shareholders
be given the opportunity to vote on all equity compensation plans
and any material revisions of such plans, with certain limited
exceptions. Under the Corporation Law, a Company is required to
obtain shareholder approval regarding the detail of an equity-
compensation plan. Stock acquisition rights to be issued to direc-
tors and corporate auditors are recognized as part of
remuneration of directors and corporate auditors, and the
issuance of stock acquisition rights must be approved by share-
holders as part of their approval regarding remuneration of direc-
tors and corporate auditors. The Company currently has not
adopted any stock option compensation plans.

CORPORATE FUNCTIONS

RESEARCH & DEVELOPMENT ......................... 16

PRODUCTION ................................................... 18

SALES & MARKETING ...................................... 20

CORPORATE SOCIAL RESPONSIBILITY ........... 22

Photo:
To celebrate the 100th anniversary of the Beijing Zoo,
Canon cosponsored a photography and essay
competition entitled “The Beijing Zoo and me,” focusing
on the themes of protecting wildlife and bringing
harmony between people and nature.

RESEARCH & DEVELOPMENT

Canon’s engineers around the world are improving upon existing capabilities and
pursuing next-generation technologies to drive business growth.

Next-Generation Business Domains
Canon is pursuing the development of innovative
technologies that will support its push into new busi-
ness domains. The Company is working to leverage its
expertise in imaging to pioneer advances in such fields
as healthcare. Canon researchers and engineers are
actively engaged in joint research with leading insti-
tutes and universities. For example, in 2006 the
Company teamed up with several departments from
Kyoto University, Japan, to conduct studies in medical
imaging, aiming to revolutionize diagnostic imaging in
order to enable the early detection of illnesses.

Canon conducts research in nanotechnology, the

science and control of matter and light on the
nanometer scale, including research into nanostructural
material, to develop key components and core devices.
In life sciences, Canon has applied inkjet technology to
fabricate reliable DNA chips able to detect genetic muta-
tions that cause cancer and other maladies, and to realize
treatments optimized for each individual patient by accu-
rately identifying types of diseases and stages of progress.
Moreover, Canon is working to develop a new device for
administering medication through a mist sprayed into the
mouth, providing an alternative to injections.

Bolstering Product Competitiveness
Canon strives to be No. 1 in the world in each of its
core business areas by boosting product competitive-
ness. Toward this end, the Company cultivates the

Canon is conducting joint
research with the Tokyo
Institute of Technology
aimed at developing
thin-film transistors

R&D Expenditure and Patents
Canon is dedicated to maintaining its competitive
edge through a strong emphasis on cutting-edge
research and development, which is reflected in the
high percentage of net sales that Canon allots to such
activities. In 2006, R&D expenses increased ¥21.8
billion from the previous fiscal year to ¥308.3 billion,
accounting for 7.4% of net sales. Looking at spend-
ing by segment, ¥113.8 billion, or 36.9%, went to
business machines, and ¥41.1 billion, or 13.3%, to
cameras. Investment in optical and other products
was ¥29.9 billion, or 9.7% of the total, and basic R&D
that does not belong to any one business segment
was ¥123.5 billion, or 40.1%.

Canon’s extensive and highly advanced R&D
activities have produced a wealth of intellectual
property. In 2006, the Company newly acquired 2,385
patents in the United States, third* among all corpora-
tions, marking the 15th consecutive year Canon has
placed among the top three. The Company will
continue to pursue R&D themes targeting sustainable
growth and endeavor to strengthen its R&D capabili-
ties that lead to the gain of major and basic patents.

*Source: U.S. Patent and Trademark Office; Calculated based upon
announcements of weekly totals.

New HD CMOS sensor incorporated in Canon HD camcorders
produces full high-definition video

following five “imaging engines,” a group of technolo-
gies that support Canon product businesses.

1. Image Capturing Engines
2. Electrophotographic Engines
3. Inkjet Engines
4. Photolithographic Engines
5. Display Engines

These engines support product performance and

are the source of Canon’s competitive advantage.
Canon continues to cultivate these engines and explore
the fusion of various technologies, which in turn leads
to the development of key devices and innovative
product features.

An example of an Image Capturing Engine is the
DIGIC imaging processor. In 2006, DIGIC III was intro-
duced with advanced Face Detection Technology that
properly adjusts focus and exposure based on the
detection of people’s faces. Canon has also developed
a new HD CMOS sensor for video camcorders that
enables the high-speed reading of images in full HD
(1,920 x 1,080 pixels).

Canon believes that shared-platform technolo-
gies are vital for accelerating and reinforcing product

Canon’s color management
technology allows for
consistent color
reproduction in both input
and output devices

development. The Company has established its
unique color management technology that unifies
color reproduction for Canon input and output
products. In addition, Canon is proceeding further
with its advanced color management system, called
“Kyuanos.” Part of this technology has been incor-
porated into Windows Vista™*.

In addition to reinforcing its measuring, analysis
and simulation technologies, Canon uses 3D-CAD
systems to shorten product-development times and to
reduce trial times and costs.

*Windows Vista is a trademark of Microsoft Corporation.

3D-CAD design systems have enabled fewer prototypes, shorter
development times and effective information sharing

PRODUCTION

As a further step toward production reform, Canon is aiming to reduce its
cost-to-sales ratio to 45% in 2010.

competitiveness and reduce costs. As an example of
the Company’s endeavors, Canon made Igari Mold
Co., Ltd. a wholly owned subsidiary in 2004 to
increase in-house mold production. Mold-making
operations across the entire Group were consolidated
into this manufacturer of precision plastic molds, which
was renamed Canon Mold Co., Ltd. in January 2007.
In the area of procurement innovations, Canon is
carrying out sweeping structural reforms of its current
system while consolidating suppliers. In addition, the
Company is improving collaboration between procure-
ment and development divisions in order to reduce the
cost of parts, beginning at the development stage.

Building Integrated Production Systems and
Increasing Production Capacity
In order to further reduce lead times, Canon is building a
production system for fully integrating the manufacture
of materials and key components, as well as assembly
and logistics operations. For example, construction of a
new lens plant at Oita Canon Inc. has been completed
and operations will begin in spring 2007, enabling the
integration of interchangeable SLR camera lens produc-
tion with camera manufacturing operations.

At the same time, the Company is stepping up

production capacity in order to meet growing
demand. Oita Canon Materials Inc. completed
construction of a new toner and toner cartridge
facility in 2006, and has begun construction of

Manufacturing high-precision molds at Canon Mold Co., Ltd. to
bolster in-house production and product competitiveness

Producing color LBPs
and copying machines
through the cell production
system at Canon (Suzhou)
Inc. in China

Toward the Establishment of New
Production Methods
The introduction of the cell production system, which
replaced conveyor belt lines with small teams of
workers, or “cells,” who assemble products from start
to finish, marked a major step forward in production
reforms at Canon. With ingenuity, effort, and the
experience-based knowledge of each individual worker
as driving forces, cell production is employed at all of
Canon’s production bases worldwide. Cell production
supports just-in-time production—the manufacture of
products only when and in the amounts needed—
while also enabling highly accurate supply chain
management (SCM) in response to market demands.
As a next step to further production reform, the
Company is boosting in-house production, establishing
automated production systems and reforming its
procurement operations. Canon has targeted a cost-
to-sales ratio of 45% for 2010.

In-House Production and Procurement
Innovations
The in-house production of key parts and components
as well as production equipment represents one of
Canon’s most important efforts to increase

another new facility for the manufacture of print
heads and ink cartridges for inkjet printers.

Canon is building a second inkjet printer factory in
Hanoi, Vietnam, in order to expand production capaci-
ty by approximately 50%. Scheduled for completion in
spring 2007, the new facility will integrate aspects of
production from parts processing to assembly. The
Company also commenced production of LBPs at its
facility in Que Vo, Hanoi, Vietnam, during 2006.

Efforts toward Full Automation
Canon aims to achieve fully automated manufactur-
ing as a means of boosting productivity and enhanc-
ing its competitive position in global markets, while
responding to increasing demand for Canon prod-
ucts. To bolster this effort, the Company will
establish automated production systems through
“three-in-one” foundation integrating development,
production technology and manufacturing know-
how. Canon is working to realize round-the-clock,
unmanned manufacturing in its toner cartridge
operations, and is also promoting the automated
assembly of inkjet cartridges.

Oita Canon Inc. is
constructing a wholly
integrated system for
production of digital
cameras and lenses

IT Revolution for Optimal SCM
Canon seeks to construct a highly advanced integrat-
ed IT system to achieve optimal SCM across develop-
ment, procurement, production, logistics, sales and
service processes. The Company has already intro-
duced 3D-CAD systems across the organization for
product development and, as a next step, intends to
standardize 3D-CAD systems throughout the Group
to create a comprehensive system that integrates all
business processes through 3D data. The system will
link the production data system, used to coordinate
sales and production, with the sales data system.

Canon is promoting automated production of inkjet cartridges
at Fukushima Canon Inc. in Japan

SALES & MARKETING

Canon is implementing a number of region-specific strategies to reinforce its leading
position in global markets.

being enhanced, with careful analysis of economic
trends and consideration of potential risk, in order to
expand sales and secure profits.

Canon U.S.A. plans to make its full-fledged
entry into such new markets as POD, and bolster its
large-format printer business. Furthermore, by
reinforcing the supply chain to ensure the timely
and accurate delivery of products to customers, the
Company aims to significantly reduce inventory
management-related costs.

Europe
In Europe, sales reached ¥1,314.3 billion in 2006, up
11.3% from the previous year, representing 31.6%
of consolidated net sales. This strong performance
was made possible through structural reform efforts
to lower fixed costs and boost productivity.

Buoyed by the introduction of new products in

autumn 2006, the business products segment
enjoyed improved conditions and sales. In an effort to
foster closer ties with end-users, the consumer imag-
ing products segment is developing a Web-based
communication system to promote healthy dialogue.
Canon has been working to standardize and unify its
IT system infrastructure across Europe by mid-2007,
enabling all Group sales companies in Europe to
access Group data online. The Company is strength-
ening its sales networks in areas with strong growth
potential such as Russia, Eastern Europe, the Middle

Based upon their high performance, Canon HD broadcasting
lenses are in use at the studios of ABC, Inc. in the United States

Canon Concerto held in
Moscow in 2006—Canon
will expand its presence
in Russia

Greater Global Diversification
In today’s world of constantly evolving information
networks, Canon sales and marketing companies
around the world work tirelessly to provide tailor-
made solutions to satisfy a diverse range of unique
customer needs, and to advance Canon’s reputation
as a highly trusted brand. Regional marketing
headquarters oversee operations in each area:
Canon U.S.A., Inc. in North and South America;
Canon Europe Ltd. and Canon Europa N.V. in
Europe, Russia, Africa and the Middle East; Canon
(China) Co., Ltd. in Asia outside Japan; Canon
Australia Pty. Ltd. in Oceania; and Canon Marketing
Japan Inc. in Japan.

The Americas
In the Americas, Canon continues to turn out strong
performances, with sales in 2006 increasing 12.0%
to ¥1,283.6 billion, representing 30.9% of Canon’s
consolidated net sales.

Aiming to spur more dynamic business expansion

in North America, Canon U.S.A. is strengthening
collaboration in sales and marketing with Canon
Canada, Inc. and Canon Mexicana, S. de R.L. de C.V.
In Latin America, the quality of business operations is

East and Africa. Canon aims to increase year-on-year
sales and profits in Europe for 2007 to mark its 50th
anniversary in Europe.

Japan, Asia and Oceania
Sales in Japan reached a record ¥932.3 billion, up
8.9% year on year, marking the fourth consecutive
year of sales and profit growth. Sales in Japan
accounted for 22.4% of consolidated net sales.

Canon Sales Co., Inc. changed its name to Canon

Marketing Japan, Inc. in April 2006 to reflect the
company’s strengthened focus on providing value-
creating information services that meet customer
needs. Canon Marketing Japan is bolstering its pres-
ence in the solutions and services business, and con-
tinues to strengthen its customer-focused operations.
Sales in China, Oceania and Asian countries
excluding Japan increased 9.8% year on year to
¥626.5 billion, representing 15.1% of consolidated
net sales. The Company recorded outstanding sales
increases of more than 30% in the high-growth
markets of China, India, Vietnam, and Thailand, with
growth in China in particular topping 36%.

Using a security card,
Canon’s MFD solutions
made it possible for
Interpolis, a Dutch
insurance company, to
realize their flexible
“Crystal Clear” concept
with no IT boundaries

Canon is working actively to attain greater
customer satisfaction in Asian markets by improving
education among its staff in sales, services and call
center operations. Canon is also promoting the
expansion of its solutions business and high-value-
added products for professionals, such as large-
format printers and digital SLR cameras. Moreover,
the Company is implementing region-specific strate-
gies to raise awareness and enhance the image of
the Canon brand throughout Asia.

Canon opened a showroom in Beijing to enhance communication
with customers and provide personalized service

CORPORATE SOCIAL RESPONSIBILITY

Canon’s corporate philosophy of kyosei embodies the very essence of CSR
and demonstrates the Company’s commitment to creating a better world.

which targets the doubling of resource efficiency across
all of the Group’s business operations by 2010, using
2000 as the baseline date. The “Factor” is calculated as
the ratio of net sales to life cycle CO2 emissions (CO2
emissions throughout the entire life cycle of all Canon
Group Products).

Production Stage
Working on a collaborative basis, Canon and its
suppliers have adopted the Canon Green Procurement
Standards, which favor materials and products that
reduce environmental impact.

In the design stage, Canon’s use of 3D-CAD
systems has reduced the amount of waste generated
from the creation of prototypes. The Company makes
every effort to develop and manufacture lighter and
smaller products that use less material and thereby
consume fewer resources. Canon was among the first
companies to develop alternative technologies for
regulated hazardous substances in anticipation of the
European Union’s RoHS Directive. Furthermore, the
Company promotes energy conservation in its produc-
tion activities through such measures as the installation
of energy efficient technologies and facilities, and the
purification and reuse of water used in manufacturing
processes. Canon has also achieved zero landfill waste
at all manufacturing sites. In the area of distribution, the
Company is actively implementing a worldwide modal
shift, switching from trucks to ships and railway

Lenses are cleaned at Oita Canon with purified and reused
wastewater from the plant

As part of its policy of
Green Procurement, Canon
conducts on-site
verification at a hexavalent
chromium-free plating
factory in Shanghai

Canon’s Basic Approach to CSR
Canon’s corporate philosophy is kyosei, which can be
defined as “Living and working together for the
common good.” In addition to the basic principle of
returning a portion of profits to society, Canon believes
that involvement in environmental conservation and
social contribution activities is the natural responsibility
of an Excellent Global Corporation. Aiming to become a
company worthy of admiration and respect worldwide,
Canon is engaged in such activities on many fronts.

Environmental Activities

Life Cycle Assessment
Canon conducts its environmental activities from the
standpoint of life cycle assessment (LCA) to ensure that
products are environmentally friendly at every stage,
from procurement and production to use and recycling.
The Company promotes energy and resource conserva-
tion as well as the elimination of hazardous substances
in all of its business operations.

Factor 2
Canon’s mid-to long-term environment-management
plan, known as Vision 2010, centers on “Factor 2,”

The PIXMA MP600 cuts
power consumption by
nearly 90% compared to
earlier models thanks to
energy-saving technologies

transport to reduce burden on the environment. Canon
has also instituted a number of measures to lessen the
environmental impact of packaging materials, including
cutting down on the number of materials used as a
means of reducing CO2 emissions.

Usage Stage
When considered in terms of product life cycle, the
burden on the environment from copying machines and
inkjet printers is at its highest during the usage stage.
Canon’s on-demand fixing technology and improved
copying machine controller have made it possible for the

imageRUNNER C3380 (iR C3380 in some areas) MFD to
achieve an 80% reduction in power consumption
compared with previous models. Although energy
consumption during camera use is comparatively low,
the CMOS sensor and DIGIC image processor enable
Canon cameras to not only achieve higher image quality,
but also help lower power consumption.

Recycling Stage
Canon is active in recycling and remanufacturing its
products. For instance, the Company pioneered the
recycling of toner cartridges from copying machines and

Fixing film

Paper

Fixing

Ceramic
heater

Image surface

Toner

Pressure roller

Fixing film enables toner fixing with localized warming to
eliminate warm-up times and save energy

Reusable parts and recycled plastics are employed in Canon
copying machines, MFDs and printers

The Other Side of Fashion
In 2006, Canon launched a photography campaign
entitled The Other Side of Fashion, putting Canon
cameras in the hands of 100 of the world’s most
influential style icons for them to capture images
reflecting their relationship with the world of fashion.
The collection was exhibited across Europe and
published as a magazine. All proceeds from the sales
of the magazine and charity auctions of the prints
went to Red Cross youth projects across Europe.

Eyes on Yellowstone
An educational and research program made possible by
Canon, Eyes on Yellowstone (a national park in the United
States) assists with scientific research and breaks new
ground in conservation, endangered species protection
and the application of cutting-edge technology essential
to managing park wildlife and ecosystems.

Canon Envirothon
The Canon Envirothon is North America’s largest high
school environmental education competition. More
than 500,000 teenagers are involved in a year-long
learning process that combines in-class curriculum with
hands-on field experiences.

Canon Cup Junior Soccer
Canon has been supporting Canon Cup Junior Soccer,
a competition for primary school boys and girls in Japan,

Canon supports the Heritage and Research Center at
Yellowstone National Park in digitizing its priceless archives

Charity auction for The
Other Side of Fashion. All
proceeds go to Red Cross
youth projects across
Europe

LBPs in 1990, and has been remanufacturing copying
machines on a global scale since 1992. In 2007, Canon
released its first remanufactured color MFD in Japan.
While maintaining the same level of reliability and
performance as a new machine, the remanufactured
MFDs employ reused components accounting for up to
83% of their weight. Moreover, CO2 emissions during
the production stage are reduced by upwards of 76%
in comparison to new products.

Material Flow Cost Accounting
Canon introduced material flow cost accounting in 2001,
and plans to implement it at all major manufacturing sites
by the end of fiscal 2007. Material flow cost accounting
involves calculating and managing quantity and cost data
from losses incurred in the manufacturing process. Using
this method, Canon has successfully reduced the amount
of resources used, waste generated, and costs incurred.
Canon achieved resource savings of 1,200 tons in 2006.

Contributing to Society
In line with its corporate philosophy, kyosei, Canon
makes social contributions around the world. The
following are just a few of the Company’s many
ongoing activities.

©WWF-Canon / Martin HARVEY

since 2001. The aim is to provide boys and girls with an
opportunity to experience the excitement of sports and
international exchange through various programs.

Training and Nurturing Employees
Striving to achieve the objectives of its Excellent Global
Corporation Plan, Canon has redoubled its efforts in
educating personnel and offering specialized training at all
levels, including management and administrative levels.

Since the Company’s founding, employee educa-
tion has been based on the guiding principles of the
San-Ji, or “Three Selfs” spirit. Future innovation at
Canon depends on the strength and autonomy of
each and every employee. They express their commit-
ment to the Three Selfs principle through excellence
in their day-to-day responsibilities.

Canon employs a merit-based pay system that fairly

rewards employees who work hard to expand their
skills and reach their performance targets. Canon
supports recognition and award programs to honor
employees for their outstanding achievements. Under
the Canon Expert System, employees involved in cell
production are evaluated and recognized based on such

Canon has been supporting
the WWF, the global
wildlife conservation
organization, as a
Conservation Partner in
Europe, the Middle East
and Africa since 1998

factors as the number of processes handled by a single
worker, specialized knowledge, and skills. Similarly,
Canon’s Master Craftsman System recognizes employ-
ees for their superlative manufacturing skills in areas
including lens polishing and high-precision processing,
as well as for passing on their know-how to the next
generation. Canon also certifies researchers and engi-
neers who are experts in particular technologies as
Members of the Canon Academy of Technology.
Academy members enhance technical research, mentor
younger engineers, and bring Canon’s technological
superiority to the global forefront.

Canon Compliance Cards defining the San-Ji spirit are provided
to Group employees

PRODUCT GROUPS

Business Machines
OFFICE IMAGING PRODUCTS .................... 28-29
• Office network digital multifunction devices (MFDs)
• Color network digital MFDs
• Office copying machines
• Personal-use copying machines
• Full-color copying machines, etc.

28.5%

Business Machines
COMPUTER PERIPHERALS .......................... 30-31
• Laser beam printers (LBPs)
• Single-function inkjet printers
• Inkjet multifunction peripherals
• Image scanners, etc.

28.5%
28.5%

28.5%

33.6%

33.6%
Business Machines
33.6%
BUSINESS INFORMATION PRODUCTS
33.6%
• Computer information systems
• Document scanners
• Personal information products, etc.

2.6%

2.6%
2.6%

2.6%

CAMERAS ................................................... 32-33
• Single lens reflex (SLR) cameras
• Compact cameras
• Digital cameras
• Digital video camcorders, etc.

25.1%

25.1%
25.1%

25.1%

OPTICAL AND OTHER PRODUCTS ............. 34-35
• Semiconductor-production equipment
• Mirror projection mask aligners

10.2%

for LCD panels

• Broadcasting equipment
• Medical equipment
• Components, etc.

10.2%
10.2%

10.2%

Share of Consolidated Sales

Photo:
Canon solutions using MEAP technology made it
possible for the Omni Hotel Business Center in Atlanta
to enhance their operational efficiency and provide
an around-the-clock self copying service by credit card
payment for customer convenience.

OFFICE
IMAGING
PRODUCTS
Canon is strengthening
its solutions business
and working to boost
sales of color products.

Masaki Nakaoka

Chief Executive, Office Imaging Products
Operations

The market for office imaging products is
seeing an overall shift toward color
models. While color models have largely
become the norm in offices in Japan,
there remains ample room for greater
expansion in Europe and the United
States. In response, Canon plans to
introduce high-value-added color prod-
ucts to reinforce competitiveness. At the
same time, demand is on the rise for
multifunction devices (MFDs) in the
SOHO markets of Europe and Asia, and
Canon expects significant growth still to
come. The Company is steadily expand-
ing sales of high-performance, low-end
MFDs to SOHO markets. By introducing
competitively priced models to high-
growth emerging markets, we aim to
expand underlying demand and increase
market share. In the Asian market for
office machines, led by China, Canon is
working to establish its service and
maintenance systems.

Canon is forging ahead with efforts to

strengthen its proposal-style solutions
business in order to bring greater efficiency
to customers’ businesses and contribute to
enhancing their performance. While
leveraging our Multifunctional Embedded

Office network color multifunction device

Application Platform (MEAP) technology,
which enables the customization of net-
work digital MFDs, we are improving the
training of solutions and sales staff to
provide optimal solutions that reduce total
costs in offices. Canon will actively extend
its solutions business worldwide.

Holding high expectations for its
imagePRESS digital color printing systems,
Canon is entering the POD market with a
view toward expanding its office imaging
business. The imagePRESS addresses the
needs of customers to create outstanding
color catalogs, brochures and all kinds of
documents. We foresee significant poten-
tial for this business in 2007 and beyond,
and will continue to expand our product
lineup to increase market share in the
commercial printing industry.

The year 2007 marks the 30th anniver-
sary of Canon color copying machines and
20th anniversary of digital color models,
demonstrating the instrumental role
Canon has played in opening new
frontiers for color copying machines.
Expecting growth of the market for color
models to continue, we will work vigor-
ously to boost sales of our color products
and make 2007 a truly memorable year.

Sales Results:
Office Imaging Products
(Millions of yen)

1,200‚000

5
9
9
1
8
0
1

1
3
1
3
2
0
1

5
2
9
5
8
1
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02 03 04 05 06

Fiscal 2006 Review

Sales in the Office Imaging
Products business during fiscal
2006 amounted to ¥1,185.9
billion, up 2.8% over the previ-
ous fiscal year. Strong sales in the
fourth quarter of the year miti-
gated the impact of a slight drop
in unit sales, leading to an overall
sales increase for the year.

Sales of color MFDs rose

sharply, owing to the launch of new models including the
mid- to high-speed Color imageRUNNER C5180 series
(iR C5180 series in some areas) and the energy-saving Color
imageRUNNER C3380 series (iR C3380 series in some areas).
Among monochrome network digital MFDs, the unveiling of
the high-speed imageRUNNER iR 7105 (iR 7105 in some
areas) helped to maintain year-on-year sales levels in the
United States. However, sales of monochrome models
decreased in other markets as users revealed preferences for
color models. Low-end models targeting the SOHO market
proved popular and contributed to overall sales growth.
Sales in all regions were up compared to the previous
fiscal year. Sales in the U.S. market rose on a unit basis and in
monetary value, while Canon
posted record unit sales in
Latin America. In Europe,
expanded sales of color
models offset a drop in
sales of monochrome
models resulting from the
impact of geopolitical ten-
sions in the Middle East. In Asia,
although price declines spurred
by increasing competition grew
more severe, Canon recorded
increased unit sales of low-end
models in emerging economies.
In Japan, the introduction of
new color models during the
second half of the year led to
strong fourth-quarter sales and
an increase for the full year.

Color imageRUNNER C5180
(iR C5180 in some areas)

Color imageRUNNER C3380
(iR C3380 in some areas)

(cid:47)(cid:48)(cid:46)(cid:46)(cid:46)(cid:46)(cid:46)
1200000

(cid:47)(cid:46)(cid:46)(cid:46)(cid:46)(cid:46)(cid:46)
1000000

(cid:54)(cid:46)(cid:46)(cid:46)(cid:46)(cid:46)
800000

(cid:52)(cid:46)(cid:46)(cid:46)(cid:46)(cid:46)
600000

(cid:50)(cid:46)(cid:46)(cid:46)(cid:46)(cid:46)
400000

(cid:48)(cid:46)(cid:46)(cid:46)(cid:46)(cid:46)
200000

(cid:46)

Innovative Technology
Twin Belt Fixing

In response to increasing demands for higher speed output of
color documents in office environments, Canon continuously
seeks to enhance the speed and consistency of its MFDs for
greater productivity. One such example is Canon’s Twin Belt
Fixing (TBF) technology. In electrophotographic printing, toner is
transferred to paper by heat and fused to the paper by adding
pressure. Canon’s TBF technology uses a fixing belt and a
pressure belt to replace the two rollers conventionally used for
adding heat and pressure. The fixing belt is heated by a highly
efficient induction-heating (IH) coil similar to those used in
cooking devices, and the pressure belt adds pressure from the
backside of the paper. Using belts instead of the rollers found in
conventional machines allows the toner to be fixed over a wide
contact area. This enables faster, more consistent printing even
for color documents that utilize large amounts of toner.

Utilizing materials with low thermal capacity for the fixing
belt also improves heat efficiency by 20% in comparison with
conventional models.

The new TBF technology has been incorporated into
Canon’s new iR C5180 and Color imageRUNNER iR C4580
(iR C4580 in some areas) MFDs, which have been received
favorably by customers for their reduced warm-up time and
consistent image reproduction.

IH coil

Fixing belt

Pressure belt

Twin Belt Fixing
TBF employs a fixing belt and a pressure belt for
fast, consistent image reproduction, and an IH
coil for a significant reduction in warm-up time.

COMPUTER
PERIPHERALS
Canon will expand the
market for home photo
printing by cultivating its
FINE technology and
providing enhanced
functions.

Katsuichi Shimizu

Chief Executive, Inkjet Products
Operations

Canon maintains an unwavering commit-
ment to producing photo-quality inkjet
printers. FINE (Full-photolithography Inkjet
Nozzle Engineering) is Canon’s key inkjet
printing technology for precise ejection of
ultra-fine ink droplets up to one-picoliter*,
resulting in images of high resolution.
Incorporated into all of the Company’s
inkjet printers, FINE technology supports
the photo-quality printing abilities that
have given Canon printers a solid brand
reputation around the globe. It is this
commitment to photo quality that contin-
ues to drive sales growth in inkjet printers.
The volume market continues to shift
from single-function printers (SFPs) toward
multifunction printers (MFPs) capable of
printing, copying, scanning and faxing.
While the overall market for inkjet printers
showed signs of leveling off in 2006,
Canon recorded a steady year-on-year
sales increase. In the year under review,
we introduced a new, popular operation
method for our MFPs in the form of an
Easy-Scroll Wheel, which enables users to
select functions with greater simplicity for
improved operability. Canon also devel-
oped Dual Color Gamut Processing

Inkjet multifunction printer

Technology to control the hue and bright-
ness of an MFP’s copy function for faithful
reproduction of original photos and
documents. In addition, we are continuing
to pursue improvements in printer design.
While continually cultivating FINE and

other key technologies for superior
images, Canon will actively move to
expand the market for home photo
printing by improving user-friendliness
and promoting the cost merits of home
printing. In addition, we will equip our
printers with greater network functions
to enhance compatibility with TV-based
home networks.

We are also bolstering our lineup of

inkjet printers for professional and
advanced amateur photographers. Key
strategies in this area include launching
products with refined monotone printing
capabilities that appeal to professionals.

*One picoliter = one trillionth of a liter

PIXMA iP4300

1500000

1200000

900000

600000

300000

Innovative Technology
For Professional Photo Quality

With the dramatic advances in image quality and speed in
recent years, demand for inkjet printers is on the rise among
professional and advanced amateur photographers who use
digital SLR cameras.

To follow the PIXMA Pro9000 that was released in 2006,
Canon is preparing to launch the PIXMA Pro9500 professional-
quality inkjet printer. The Pro9500 features a 10-color pigment-
ink system to meet the most demanding commercial photo-
graphic requirements and deliver high-resolution prints with
exceptional color stability for exhibitions, art sales, quality
samples and other commercial uses.

In addition to generating outstanding color prints, the ink

system includes gray, black and matte black ink tanks that
create monochrome photographs of incomparable quality. The
printer also supports a wide range of fine art papers, and is
equipped with a flat paper path to enable such papers to be fed
straight into the printer without the risk of bending or curling.
Intended for use in professional studio environments,
PIXMA Pro series printers provide faster and simpler results
when used with digital SLR cameras. The printers are compati-
ble with features of Canon’s EOS-series of digital SLR cameras.
With the increasing popularity of digital SLR cameras, Canon
aims to contribute to the further evolution of photo culture and
reinforce its leading position in the professional market.

Sales Results:
Computer Peripherals
(Millions of yen)

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Fiscal 2006 Review

1,500‚000

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Sales in the Computer
Peripherals business during
fiscal 2006 amounted to
¥1,398.4 billion, a year-on-year
increase of 12.3%, resulting
from the aggressive introduc-
tion of new models.

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Amidst increasingly severe
price competition, the world-
wide printer market saw growth
in demand for laser beam printers (LBPs), while demand for
inkjet printers shifted rapidly from single-function to multi-
function models.

Canon saw record sales of LBPs, with results of color
models in terms of units sold rising more than 50% over the
previous year, and monochrome models achieving unit
growth of more than 10%. Through color on-demand fixing,
the color LBP5000 realizes zero warm-up time and was well
received in the Asian market.

Canon also posted sales increases for inkjet printers. Among
the Company’s leading new products were the PIXMA MP600,
a high-speed MFP featuring outstanding ease of use, and the
PIXMA iP4300, an SFP that gained popularity in North America,
Europe and Asia. In addition to
raising the appeal of its product
design, Canon also equipped
new inkjet models with the
Easy-Scroll Wheel for enhanced
user convenience.

PIXMA MP600

Despite shrinking overall
demand for flatbed scanners,
Canon scanner sales declined
only slightly in comparison with
the overall market owing to
superior product features. Sales
remained strong in the United
States, Russia, China, Japan,
Canada and Australia. In
addition to low-end models,
the mid-range CanoScan LiDE
600F is seeing increased sales
in Japan and the United States.

PIXMA Pro 9500
The PIXMA Pro9500 allows for seamless
connectivity to EOS digital SLR cameras, and
improved workflow from image capturing and
processing to editing and printing.

LBP5300

CanoScan LiDE 600F

CAMERAS
We will leverage our 70
years of accumulated
know-how to expand
the camera market and
lead the creation of a
more abundant imaging
culture.

Tomonori Iwashita

Chief Executive, Image Communication
Products Operations

In fiscal 2006, Canon further reinforced
its overwhelming No. 1 position in the
global market for compact digital cam-
eras and digital single lens reflex (SLR)
cameras. Total sales volume of the
Company’s digital still cameras surpassed
20 million units in 2006.

Canon shipped a record 2.5 million

digital SLR cameras in 2006 and can
boast the largest share of a market that
continues to expand. In compact cam-
eras, 2006 was a year that saw further
evolution of our photography culture,
with Canon not only offering such
conventional improvements as increased
pixel counts and boosted optical zoom
performance, but also focusing on
enhancements that allow anyone to
easily shoot winning photos for greater
enjoyment of the picture-taking experi-
ence. In video camcorders, the Company
released the high-definition HV10, lever-
aging Canon’s imaging strengths.

As we move into the high-definition
television (HDTV) age, Canon will continue
to pursue the ultimate in image quality,
from still images to movies for both input
and output devices. Specifically, Canon
will forge ahead with the independent

Digital SLR camera

development of all key components for
digital SLR cameras, including lenses,
imaging sensors, and image processors.
We will utilize this strength to spur tech-
nological innovation in the basic capabili-
ties of cameras and create value-added
products. Canon will raise productivity and
cost competitiveness through in-house
production and the utilization of IT net-
works. To increase the sales volume of
digital cameras, we will expand our push
into the BRIC and other emerging
economies to complement existing opera-
tions in Japan, Western Europe and the
United States. In addition, Canon intends
to boost sales and profits in such new
business areas as compact photo printers,
LCD projectors and network cameras.
Images will always have a major
influence in shaping our culture and are
constantly changing. Marking our 70th
anniversary in 2007, we will draw from
the know-how accumulated over our
history to contribute to the further expan-
sion of the camera market and to take a
leading role in creating a more abundant
imaging culture. We will work tirelessly to
be the overwhelming No. 1 brand in all of
our existing camera products.

Fiscal 2006 Review

1,100‚000

Sales in the Camera segment
increased 18.5 % year on year to
¥1,041.9 billion.

Supported by rapid growth in

Sales Results:
Cameras
(Millions of yen)

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emerging markets, compact
digital camera unit sales climbed
over 20% to 18.6 million units in
2006. Canon has further
strengthened its competitive
advantage by releasing models
such as the PowerShot SD800 IS DIGITAL ELPH (DIGITAL IXUS
850 IS in some areas), equipped with the DIGIC III imaging
processor featuring Face Detection Technology.

02 03 04 05 06

Canon’s worldwide sales of digital SLR cameras on a unit
basis were extremely impressive, jumping approximately 30%
over the previous year. Canon, with its formidable lineup, main-
tained its commanding lead in the market. This lineup includes
the EOS Digital Rebel XTi (EOS 400D in some areas) entry-level
model, the EOS 5D for advanced amateurs, and the EOS-1Ds
Mark II and the EOS-1D Mark II N for professional photogra-
phers. In line with the sales growth for digital SLR cameras, the
Company also achieved record sales of interchangeable lenses.
Canon launched the high-definition HV10 digital video
camcorder in 2006. With a full HD CMOS sensor for moving
images and a DIGIC DV II imaging processor built into a compact
body, this camcorder realizes vivid high-definition images that
are tops in the industry.

1100000

880000

660000

440000

220000

Innovative Technology
Face Detection Technology

Canon developed Face Detection Technology to facilitate
clearer pictures of people’s faces. Face Detection Technology
is able to detect faces and then optimize focus and exposure
accordingly. Face Detection AF finds faces within the frame
and sets the optimal focus. For group shots, the AF system
can detect up to nine faces in the frame and sets the most
suitable focus accordingly. Canon’s AE system automatically
adjusts the exposure and flash to ensure proper illumination
of both the faces and the overall scene, eliminating the
common problem of darkened or overexposed faces. This
leading-edge technology
enhances user-friendliness and
the pleasure of picture taking.
The evolution of the DIGIC
imaging processor has enabled
the addition of this new func-
tion to Canon digital cameras.

DIGIC III

l Not applied

l Applied

Canon expanded its SELPHY series
of compact digital photo printers with
the release of the SELPHY ES1, featur-
ing an integrated ink and paper cas-
sette. With the built-in DIGIC imaging
processor for simple operation and
high-quality photo prints, this model has
generated robust sales growth.

Canon reinforced its lineup of LCD
projectors with the introduction of such
models as the SX6 and SX60, both of
which are equipped with a liquid crystal
on silicon (LCOS) panel and Canon’s
exclusive Aspectual Illumination System
(AISYS) optical system.

PowerShot SD800 IS DIGITAL ELPH
(DIGITAL IXUS 850 IS in some areas)

Face Detection Technology
Canon’s Face Detection technology helps
camera users to capture crisp, clear shots of
human subjects to eliminate blurred or over-
exposed faces.

HV10

REALiS SX6
(XEED SX6 in some areas)

OPTICAL
AND
OTHER
PRODUCTS
Canon provides highly
advanced LCD-paneI and
semiconductor-
production equipment
that rapidly contributes to
customers’ profitability.

Junji Ichikawa

Chief Executive, Optical Products
Operations

Major products in Canon’s Optical and
Other Products segment include
semiconductor-production equipment and
LCD-panel production equipment. Major
factors affecting the return on investment
for customers that purchase such equipment
include productivity and installation time.
By enhancing the quality of our products
from the design stage, we are working to
boost throughput to contribute to greater
productivity of customers’ operations,
while aiming to reduce the installation time
required for equipment.

Canon concentrated on sales of
MPA-8800 mirror projection aligners for
seventh- and eighth-generation panels
during 2006. Though demand for LCD
exposure equipment dipped in 2006
owing to previous robust investment by
panel manufacturers, the trend toward
larger glass substrates for production of
larger LCD televisions has fueled demand
for exposure equipment in recent years.
Accordingly, Canon will launch
new-concept LCD exposure equipment
during 2007 for the production of
next-generation panels.

As for semiconductor exposure equip-

ment in 2007, Canon will commence

Semiconductor exposure equipment

shipments of new ArF excimer laser dry-
type and immersion lithography-type
scanning steppers. This will give us a full
lineup of products to provide memory
manufacturers with a combination of
steppers best suited to their fabrication
systems. Another key concept in Canon
semiconductor equipment is “upward
compatibility,” which stresses the impor-
tance of delivering platform products, or
“base machines,” that can be used for
several product generations. Investing in
completely new systems with each succes-
sive innovation in the industry requires a
tremendous amount of time and
resources. We are working to create base
machines that only require new key
components to be developed in order to
meet the latest market needs.

Canon will work closely with customers

to provide highly advanced LCD-panel
and semiconductor-production equipment
that matches their needs and rapidly
contributes to their profitability. With an
emphasis on quality and low-cost
production methods, including in-house
production, Canon will make every effort
to bolster sales and earnings results in
this segment.

Sales Results:
Optical and Other Products
(Millions of yen)

Fiscal 2006 Review

500‚000

Sales in the Optical and Other
Products segment in fiscal 2006
totaled ¥423.8 billion, up 13.7%
from the previous fiscal year.

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02 03 04 05 06

In the LCD market, oversupply
in the first half of 2006 triggered
a steep decrease in prices, and
earnings at panel manufacturers
dropped accordingly. This led to a
slowdown in demand for exposure
equipment that impacted overall segment sales. In contrast,
unit sales of semiconductor-production equipment increased
steadily. Canon enhanced the competitiveness of its
FPA-6000ES5a and other KrF excimer laser systems, as well
as its FPA-5500iZa and i-line series lineup, by improving
product performance and quality. In addition, the Company
shortened lead-times to successfully deliver products in line
with customer time demands. These factors contributed to
significant growth in revenues that exceeded forecasts at the
beginning of 2006.

In X-ray digital radiography, competition grew more severe

between CR-, CCD- and FPD-based still-image X-ray digital
cameras. Led by the CXDI-50G, overall year-on-year sales
increased significantly. Against a backdrop of greater use of
digital images in patient diagnosis, sales of non-mydriatic
retinal cameras decreased.
However, sales of
CF-60DSi digital mydriatic
retinal cameras and TX-F
non-contact tonometers
offset the decrease. As a
result, overall sales of
ophthalmic equipment remained
largely unchanged from the
previous year.

MPA-8800

Spurred by strong growth of
HDTV lenses for studios and live
broadcasts, as well as profes-
sional ENG lenses, Canon
posted record sales of broad-
cast lenses on double-digit
percentage growth.

CXDI-50G

DIGISUPER 100AF

500000

400000

300000

200000

100000

Innovative Technology
Immersion Lithography Technology

Making narrower circuit linewidths on a semiconductor chip
enables a greater number of transistors or other components
per chip. To achieve increasingly narrow circuit linewidths,
Canon is pursuing advances in immersion lithography tech-
nology utilizing ArF excimer lasers as a light source. The
technology involves filling the space between the projection
lens and the wafer with ultrapure water, which has a higher
refractive index than air, to increase the numerical aperture
(NA) of the lens for greater precision. As a light source, ArF
excimer lasers offer the shortest wavelength—193 nanometers
(nm)—used in current lens optics. Using an ArF excimer laser
light source, the limit for circuit linewidths was previously
thought to be 65nm. Applying immersion lithography technol-
ogy, however, enables circuit linewidths to be reduced down
to 45nm. Immersion lithography enables customers to shrink
circuit linewidths using current equipment, potentially leading
to a significant reduction in investment costs.

In 2007, Canon will introduce the FPA-7000AS7 immersion

lithography scanning stepper incorporating this immersion
lithography technology. Canon will continue exploring further
possibilities and applications for immersion technology by
searching for liquids with high refractive indexes to increase
numerical apertures.

Ultrapure
water
recovery

Projection lens

Ultrapure
water

Semiconductor
wafer

Wafer stage

Liquid Film Immersion Method Using
Ultrapure Water
Immersion lithography involves replacing the
air normally found between the projection
lens and wafer with ultrapure water, enabling
circuit linewidths down to 45nm.

MAJOR CONSOLIDATED SUBSIDIARIES

(As of December 31, 2006)

MANUFACTURING
Canon Electronics Inc.
Canon Finetech Inc.
Nisca Corporation
Canon Semiconductor Equipment Inc.
Canon Ecology Industry Inc.
Canon Chemicals Inc.
Canon Components, Inc.
Canon Precision Inc.
Oita Canon Inc.
Nagahama Canon Inc.
Oita Canon Materials Inc.
Ueno Canon Materials Inc.
Fukushima Canon Inc.
Canon Optron, Inc.
Canon Mold Co., Ltd.
Canon Machinery Inc.
Canon ANELVA Corporation
SED Inc.
Canon Virginia, Inc.
Custom Integrated Technology, Inc.
Industrial Resource Technologies, Inc.
Canon Giessen GmbH
Canon Bretagne S.A.S.
Canon Inc., Taiwan
Canon Dalian Business Machines, Inc.
Canon Zhuhai, Inc.
Canon Zhongshan Business Machines Co., Ltd.
Tianjin Canon Co., Ltd.
Canon (Suzhou) Inc.
Canon Opto (Malaysia) Sdn. Bhd.
Canon Hi-Tech (Thailand) Ltd.
Canon Ayutthaya (Thailand) Ltd.
Canon Engineering (Thailand) Ltd.
Canon Vietnam Co., Ltd.
Canon Electronic Business Machines (H.K.) Co., Ltd.
Canon Engineering Singapore Pte. Ltd.
Canon Engineering Hong Kong Co., Ltd.

RESEARCH & DEVELOPMENT
Canon Development Americas, Inc.
Canon Technology Europe Ltd.
Canon Research Centre France S.A.S.
Canon Information Systems Research Australia Pty. Ltd.
Canon Information Technology (Beijing) Co., Ltd.
Canon (Suzhou) System Software Inc.

MARKETING & OTHER
Canon Marketing Japan Inc.
Canon System and Support Inc.
Canon System Solutions Inc.
Canon Software Inc.
Canon U.S.A., Inc.
Canon Canada, Inc.
Canon Mexicana, S. de R.L. de C.V.
Canon Latin America, Inc.
Canon do Brasil Industria e Comercio Limitada
Canon Chile, S.A.
Canon Panama, S.A.
Canon Argentina, S.A.
Canon Business Solutions-Central, Inc.
Canon Business Solutions-West, Inc.
Canon Business Solutions-East, Inc.
Canon Financial Services, Inc.
Canon Information Technology Services, Inc.
Canon Europa N.V.
Canon Europe Ltd.
Canon (UK) Ltd.
Canon Deutschland GmbH
Canon France S.A.S.
Canon Italia S.p.A.
Canon España S.A.
Canon Nederland N.V.
Canon Danmark A/S
Canon Belgium N.V./S.A.
Canon (Schweiz) AG
Canon Gesellschaft m.b.H.
Canon Svenska AB
Canon Oy
Canon North-East Oy
Canon Norge A.S.
Canon CEE GmbH
Canon Middle East FZ-LIC
Canon South Africa Pty. Ltd.
Canon Australia Pty. Ltd.
Canon New Zealand Ltd.
Canon Finance Australia Ltd.
Canon Finance New Zealand Ltd.
Canon (China) Co., Ltd.
Canon Singapore Pte. Ltd.
Canon Hongkong Co., Ltd.
Canon Marketing (Malaysia) Sdn. Bhd.
Canon Marketing (Philippines), Inc.
Canon Marketing (Thailand) Co., Ltd.
Canon Marketing (Taiwan) Co., Ltd.
Canon India Pte. Ltd.
Canon Semiconductor Engineering Korea Inc.
Canon Semiconductor Equipment Taiwan Inc.

FINANCIAL SECTION

TABLE OF CONTENTS

FINANCIAL OVERVIEW ........................................................................................ 38

TEN-YEAR FINANCIAL SUMMARY ..................................................................... 56

CONSOLIDATED BALANCE SHEETS .................................................................... 58

CONSOLIDATED STATEMENTS OF INCOME ...................................................... 59

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY .......................... 60

CONSOLIDATED STATEMENTS OF CASH FLOWS .............................................. 61

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ...................................... 62

(1) Basis of Presentation and Significant Accounting Policies

(2) Basis of Financial Statement Translation ........................................... 66

(3)

Foreign Operations

(4) Marketable Securities and Investments ............................................. 67

(5) Trade Receivables ................................................................................ 69

(6)

Inventories

(7) Property, Plant and Equipment .......................................................... 70

(8)

Finance Receivables and Operating Leases

(9) Acquisitions .......................................................................................... 71

(10) Goodwill and Other Intangible Assets

(11) Short-Term Loans and Long-Term Debt ............................................ 72

(12) Trade Payables ..................................................................................... 73

(13) Employee Retirement and Severance Benefits .................................. 74

(14) Income Taxes ........................................................................................ 79

(15) Common Stock ..................................................................................... 81

(16) Legal Reserve and Retained Earnings ................................................ 82

(17) Other Comprehensive Income (Loss)

(18) Net Income per Share .......................................................................... 84

(19) Derivatives and Hedging Activities .................................................... 85

(20) Commitments and Contingent Liabilities .......................................... 86

(21) Disclosures about the Fair Value of Financial Instruments and

Concentrations of Credit Risk ............................................................. 88

(22) Supplemental Cash Flow Information

(23) Subsequent Event

MANAGEMENT’S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING ............................................................................ 89

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ............. 90

FINANCIAL OVERVIEW

GENERAL
The following discussion and analysis provides information
that management believes to be relevant to understanding
Canon’s consolidated financial condition and results of operations.
References in this discussion to the “Company” are to Canon
Inc. and, unless otherwise indicated, references to the financial
condition or operating results of “Canon” refer to Canon Inc.
and its consolidated subsidiaries.

aligners, which are used to produce liquid crystal display (LCD)
panels, declined due to restrained investment by LCD manu-
facturers, demand for steppers, used in the production of
semiconductors, was strong, supported by increased investment
by manufacturers. The average value of the yen for the year
was ¥116.43 to the U.S. dollar and ¥146.51 to the euro,
representing year-on-year decreases of about 5% against the
U.S. dollar, and 7% against the euro.

OVERVIEW
Canon is one of the world’s leading manufacturers of copying
machines, laser beam printers, inkjet printers, cameras, steppers
and aligners. Canon earns revenues primarily from the manu-
facture and sale of these products domestically and interna-
tionally. Canon’s basic management policy is to contribute to
the prosperity and well-being of the world while endeavoring
to become a truly excellent global corporate group targeting
continued growth and development.

Canon divides its businesses into three product groups:
business machines, cameras, and optical and other products.
The business machines product group has three sub-groups:
office imaging products, computer peripherals and business
information products.

Economic Environment
Looking back at the global economy in 2006, in the United
States, despite a decrease in housing investment, the economy
continued to display growth with healthy employment condi-
tions and continued growth in consumer spending, along with
an increase in corporate capital investment. In Europe, while
exports appeared somewhat sluggish due to the appreciation
of the euro, the region indicated a trend toward moderate
recovery as domestic demand expanded in major European
countries, boosted by such factors as increased consumer
spending owing to improvements in the employment environ-
ment. Within Asia, the Chinese economy maintained a high
growth rate while other economies in the region also enjoyed
generally favorable conditions. In Japan, although consumer
spending has yet to fully regain its strength, the economy
maintained a trend toward recovery amid increased capital
spending fueled by strong corporate performances.

Market Environment
With respect to the markets in which the Canon Group operates,
within the camera segment demand for digital single-lens reflex
(SLR) cameras and compact digital cameras continued to realize
healthy growth during the term. Within the office imaging
product market, demand for network digital multifunction
devices (MFDs) remained solid as the office market moved
toward color and multifunctionality. As for computer peripherals,
including printers, although demand grew for color as well as
monochrome laser beam printers, and shifted rapidly within
the inkjet printer market from single-function to multifunction
models, the segment suffered amid severe price competition. In
the optical equipment segment, although demand for projection

Summary of Operations
In 2006, the first year of a new five-year management plan—
Phase III of Canon’s Excellent Global Corporation Plan—Canon
achieved record highs in both consolidated net sales and net
income, and a seventh consecutive year of sales and profit
growth, mainly due to a solid rise in sales of digital cameras
and color network digital MFDs, and laser beam printers, along
with the positive effects of the depreciation of the yen. In fiscal
2006, Canon achieved 10.7% growth in net sales, to ¥4,156,759
million (U.S.$34,931 million), and an 18.5% increase in net
income, to ¥455,325 million (U.S.$3,826 million). Canon’s
gross profit increased by 13.3%, to ¥2,060,480 million
(U.S.$17,315 million).

Key Performance Indicators
Following are the key performance indicators (KPIs) that Canon
uses in managing its business. The changes from year to year in
these KPIs are set forth in the table shown on page 39.

Revenues
As Canon seeks to become a truly excellent global company,
one indicator upon which Canon’s management places strong
emphasis is revenue. Following are some of the KPIs relating to
revenues that management considers to be important.

Net sales is one such KPI. Canon derives net sales primarily
from the sale of products, and to a much lesser extent, the provi-
sion of services relating to its products. Sales vary based on
such factors as product demand, the number and size of trans-
actions within the reporting period, product reputation for new
products, and changes in sales prices. Other factors involved
are market share and market environment. In addition, man-
agement considers an evaluation of net sales by product group
important to assessing Canon’s performance in sales in various
product groups in light of market trends.

Gross profit ratio (ratio of gross profit to net sales) is

another KPIs for Canon. Through its reforms in product develop-
ment, Canon has been striving to shorten product development
lead times in order to launch new, competitively priced products
at a faster pace. In addition, Canon has achieved cost reductions
through efficiency enhancements in production. Canon believes
that these achievements have contributed to improving Canon’s
gross profit ratio, and Canon intends to continue to pursue
further shortening of product development lead times and
reductions in production costs.

Operating profit ratio (ratio of operating profit to net sales)

and research and development (“R&D”) expense to net sales

ratio are considered by Canon to be KPIs. Canon is focusing on
two areas for improvement. On one hand, Canon strives to
control and reduce its selling, general and administrative
expenses. On the other hand, Canon’s R&D policy is designed
to maintain a high level of spending in core technology in order
to sustain Canon’s leading position in its current fields of
business, and to explore possibilities in other markets. Canon
believes such investments will be the basis for future success
in its business and operations.

Cash Flow Management
Canon also places significant emphasis on cash flow
management. The following are the KPI relating to cash flow
management that management believes to be important.

Inventory turnover within days is a KPI because it is a mea-
sure of supply-chain management efficiency. Inventories have
inherent risks of becoming obsolete, deteriorating or other-
wise decreasing in value significantly, which may adversely
affect Canon’s operating results. To mitigate these risks,
management believes that it is important to continue reducing
inventories and shortening production lead times in order to
achieve early recovery of related product expenses by
strengthening supply-chain management.

Canon’s management seeks to meet its liquidity and
capital requirements primarily with cash flow from operations.
Management also seeks debt-free operations. For a manufac-
turing company such as Canon, the process for realizing profit
on any endeavor can be lengthy, involving as it does R&D,
manufacturing, and sales activities. Management, therefore,
believes that it is important to have sufficient financial strength
so that it does not have to rely on external funding. Canon has
continued to reduce its reliance on external funding for capital
investments in favor of generating the necessary funds from its
own operations.

Stockholders’ equity to total assets ratio (ratio of total
stockholder’s equity to total assets) is another KPI for Canon.
Canon believes that the stockholders’ equity to total asset ratio
measures its long-term viability. Canon believes that high or
increasing stockholders’ equity ratio usually indicates that
Canon has a good, or improving ability to fund debt obligations
and other unexpected expenses, which means in the long-term
that Canon is better able to maintain a high level of stable
investments for its future operations and development. As
Canon puts a strong emphasis on its research and development
activities, management believes that it is important to maintain
a stable financial base and, accordingly, a high level of
stockholders’ equity to total assets ratio.

KEY PERFORMANCE INDICATORS
Net sales (Millions of yen)
Gross profit to net sales ratio
R&D expense to net sales ratio
Operating profit to net sales ratio
Inventory turnover within days
Debt to total assets ratio
Stockholders’ equity to total assets ratio

2006
¥4,156,759
49.6%
7.4%
17.0%
45 days
0.7%
66.0%

2005
3,754,191
48.5%
7.6%
15.5%
47 days
0.8%
64.4%

2004
3,467,853
49.4%
7.9%
15.7%
49 days
1.1%
61.6%

2003
3,198,072
50.3%
8.1%
14.2%
49 days
3.1%
58.6%

2002
2,940,128
47.6%
7.9%
11.8%
51 days
5.0%
54.1%

Note: Inventory turnover within days; Inventory divided by net sales for the previous six months, multiplied by 182.5.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The consolidated financial statements are prepared in accor-
dance with U.S. generally accepted accounting principles, and
based on the selection and application of significant accounting
policies which require management to make significant estimates
and assumptions. Canon believes that the following are the
more critical judgment areas in the application of its accounting
policies that currently affect its financial condition and results
of operations.

Revenue Recognition
Canon generates revenue principally through the sale of
consumer products, equipment, supplies, and related services
under separate contractual arrangements. Canon recognizes
revenue when persuasive evidence of an arrangement exists,
delivery has occurred and title and risk of loss have been
transferred to the customer, the sales price is fixed or
determinable, and collectibility is probable.

For arrangements with multiple elements, which may

include any combination of equipment, installation and mainte-
nance, Canon allocates revenue to each element based on its
relative fair value if such element meets the criteria for treatment
as a separate unit of accounting as prescribed in the Emerging
Issues Task Force Issue 00-21 (“EITF 00-21”), “Revenue
Arrangements with Multiple Deliverables.” Otherwise, revenue
is deferred until the undelivered elements are fulfilled as a
single unit of accounting.

Revenue from sales of consumer products including
office imaging products, computer peripherals, business infor-
mation products and cameras is recognized upon shipment or
delivery, depending upon when title and risk of loss transfer to
the customer.

Revenue from sales of optical equipment such as steppers
and aligners sold with customer acceptance provisions related
to their functionality is recognized when the equipment is
installed at the customer site and the specific criteria of the
equipment functionality are successfully tested and demonstrated

by Canon. Service revenue is derived primarily from maintenance
contracts on equipment sold to customers and is recognized
over the term of the contract.

Canon offers service maintenance contracts for most office
imaging products for which the customer typically pays a base
service fee plus a variable amount based on usage. Revenue
from these service maintenance contracts is recognized as
services are provided.

Revenue from the sale of equipment under sales-type
leases is recognized at the inception of the lease. Income on
sales-type leases and direct-financing leases is recognized over
the life of each respective lease using the interest method.
Leases not qualifying as sales-type leases or direct-financing
leases are accounted for as operating leases and related revenue
is recognized over the lease term.

Canon records estimated reductions to sales at the time of
sale for sales incentive programs including product discounts,
customer promotions and volume-based rebates. Estimated
reductions in sales are based upon historical trends and other
known factors at the time of sale. In addition, Canon provides
price protection to certain resellers of its products, and records
reductions to sales for the estimated impact of price protection
obligations when announced.

Estimated product warranty costs are recorded at the time

revenue is recognized and is included in selling, general and
administrative expenses. Estimates for accrued product warranty
costs are based on historical experience, and are affected by
ongoing product failure rates, specific product class failures
outside of the baseline experience, material usage and service
delivery costs incurred in correcting a product failure.

Allowance for Doubtful Receivables
Allowance for doubtful receivables is determined using a com-
bination of factors to ensure that Canon’s trade and financing
receivables are not overstated due to uncollectibility. Canon
maintains an allowance for doubtful receivables for all customers
based on a variety of factors, including the length of time
receivables are past due, trends in overall weighted average risk
rating of the total portfolio, macroeconomic conditions, signifi-
cant one-time events and historical experience. Also, Canon
records specific reserves for individual accounts when Canon
becomes aware of a customer’s inability to meet its financial
obligations to Canon, such as in the case of bankruptcy filings
or deterioration in the customer’s operating results or financial
position. If circumstances related to customers change, estimates
of the recoverability of receivables would be further adjusted.

Valuation of Inventories
Inventories are stated at the lower of cost or market value.
Cost is determined principally by the average method for
domestic inventories and the first-in, first-out method for
overseas inventories. Market value is the estimated selling price
in the ordinary course of business less the estimated costs of
completion and the estimated costs necessary to make a sale.
Canon routinely reviews its inventories for their salability and

for indications of obsolescence to determine if inventories
should be written-down to market value. Judgments and esti-
mates must be made and used in connection with establishing
such allowances in any accounting period. In estimating the
market value of its inventories, Canon considers the age of the
inventories and the likelihood of spoilage or changes in market
demand for its inventories.

Environmental Liabilities
Canon is subject to liability for the investigation and clean-up
of environmental contamination at each of the properties that
Canon owns or operates, as well as at certain properties Canon
formerly owned or operated. Canon employs extensive internal
environmental protection programs that focus on preventive
measures. Canon conducts environmental assessments for a
number of its locations and operating facilities. If Canon was to
be held responsible for damages in any future litigation or pro-
ceedings, such costs may not be covered by insurance and may
be material. The liability for environmental remediation and
other environmental costs is accrued when it is considered
probable and costs can be reasonably estimated.

Valuation of Deferred Tax Assets
Canon currently has significant deferred tax assets, which are
subject to periodic recoverability assessments. Realization of
Canon’s deferred tax assets is principally dependent upon its
achievement of projected future taxable income. Canon’s judg-
ments regarding future profitability may change due to future
market conditions, its ability to continue to successfully execute
its operating restructuring activities and other factors. Any
changes in any of these factors may require possible recogni-
tion of significant valuation allowances to these deferred tax
asset balances. When Canon determines that certain deferred
tax assets may not be recoverable, the amounts which may
not be realized are charged to income tax expense and will
adversely affect net income.

Employee Retirement and Severance Benefit Plans
Canon has significant employee retirement and severance
benefit obligations which are recognized based on actuarial
valuations. Inherent in these valuations are key assumptions,
including discount rates and expected return on plan assets.
Management must consider current market conditions,
including changes in interest rates, in selecting these assump-
tions. Other assumptions include assumed rate of increase in
compensation levels, mortality rate, and withdrawal rate.
Changes in these assumptions inherent in the valuation are
reasonably likely to occur from period to period. These changes
in assumptions may lead to changes in related employee
retirement and severance benefit costs in the future.

Actual results that differ from the assumptions are
accumulated and amortized over future periods and, therefore,
generally affect future pension expenses. While management
believes that the assumptions used are appropriate, the
differences may affect employee retirement and severance
benefit costs in the future.

In preparing its financial statements for fiscal 2006, Canon
estimated a discount rate of 2.7% and an expected long-term
rate of return on plan assets of 4.8%. In estimating the discount
rate, Canon uses available information about rates of return on
high-quality fixed-income governmental and corporate bonds
currently available and expected to be available during the
period to the maturity of the pension benefits. Canon establishes
the expected long-term rate of return on plan assets based on
management’s expectations of the long-term return of the
various plan asset categories in which it invests. Management
develops expectations with respect to each plan asset category
based on actual historical returns and its current expectations
for future returns.

Decreases in discount rates lead to increases in actuarial
pension benefit obligations which, in turn, could lead to an
increase in service cost and amortization cost through amorti-
zation of actuarial gain or loss, a decrease in interest cost, and
vice versa. A decrease of 50 basis points in the discount rate
increases the projected benefit obligation by approximately
11%. The net effect of changes in the discount rate, as well as
the net effect of other changes in actuarial assumptions and
experience, are deferred until subsequent periods, as permitted
by the Statement of Financial Accounting Standards (“SFAS”)
No. 87, “Employers’ Accounting for Pensions.”

Decrease in expected return on plan assets may increase

net periodic benefit cost by decreasing expected return
amounts, while differences between expected value and actual
fair value of those assets could affect pension expense in the
following years, and vice versa. For fiscal 2007, if a change of

50 basis points in the expected long-term rate of return on plan
assets is to occur, that may cause a change of approximately
¥3,040 million in net periodic benefit cost. Canon multiplies
management’s expected long-term rate of return on plan
assets by the value of its plan assets, to arrive at the expected
return on plan assets that is included in pension income
(expense). Canon defers recognition of the difference between
this expected return on plan assets and the actual return on
plan assets. The net deferral affects the value of plan assets in
future fiscal years and, ultimately, future pension income
(expense).

On December 31, 2006, Canon adopted the recognition

Effective January 1, 2007, Canon and certain of its domes-

tic subsidiaries have amended their defined benefit pension
plans, and the projected benefit obligation has decreased by
¥101,620 million (U.S.$853,950 thousand). This decrease will
be amortized as a reduction of net periodic benefit cost over
the employees’ average remaining service period. The amount
will be approximately ¥5,834 million (U.S.$49,025 thousand)
per year. In conjunction therewith, Canon and certain of its
domestic subsidiaries have implemented a defined contribution
pension plan for certain future pension benefits attributable to
employees’ future services.

CONSOLIDATED RESULTS OF OPERATIONS

SUMMARY OF OPERATIONS

Net sales
Operating profit
Income before income taxes and minority interests
Net income

Millions of yen
2006

2004
Change
2005
Change
+8.3% 3,467,853
¥4,156,759 +10.7% 3,754,191
543,793
+7.2
583,043
552,116
612,004 +10.8
343,344
384,096 +11.9

707,033 +21.3
719,143 +17.5
455,325 +18.5

Thousands of
U.S. dollars
2006
$ 34,930,748
5,941,454
6,043,218
3,826,261

Sales
Canon’s consolidated net sales in fiscal 2006 totaled
¥4,156,759 million (U.S.$34,931 million). This represents a
10.7% increase from the previous fiscal year, reflecting solid
rises in sales of digital cameras and color network digital MFDs,
and laser beam printers, along with the positive effects of the
depreciation of the yen.

Overseas operations are significant to Canon’s operating
results and generated approximately 75% of total net sales in
fiscal 2006. Such sales are denominated in the applicable local
currency and are subject to fluctuations in the value of the yen
in relation to such other currencies. Despite efforts to reduce
the impact of currency fluctuations on operating results,
including localizing some manufacturing and procuring parts

and materials from overseas suppliers, Canon believes such
fluctuations have had and will continue to have a significant
effect on results of operations.

The average value of the yen in fiscal 2006 was ¥116.43 to
the U.S. dollar, and ¥146.51 to the euro, representing depreci-
ation of about 5% against the U.S. dollar, and 7% against the
euro, compared with the previous year. The effects of foreign
exchange rate fluctuations favorably impacted net sales by
approximately ¥138,700 million. This favorable impact was
comprised of approximately ¥67,800 million for U.S. dollar
denominated sales, ¥65,900 million for euro-denominated
sales and ¥5,000 million for other foreign currency-denomi-
nated sales.

Cost of Sales
Cost of sales principally reflects the cost of raw materials, parts
and labor used by Canon in the manufacture of its products.
A portion of the raw materials used by Canon is imported or
includes imported materials. Such raw materials are subject to
fluctuations in world market prices and exchange rates that
may affect Canon’s cost of sales. Other components of cost of
sales include depreciation expenses from plants, maintenance
expenses, light and fuel expenses and rent expenses. The ratio
of cost of sales to net sales for fiscal 2006, 2005 and 2004
was 50.4%, 51.5% and 50.6%, respectively.

Gross Profit
Canon’s gross profit in fiscal 2006 increased by 13.3% to
¥2,060,480 million (U.S.$17,315 million) from fiscal 2005. The
gross profit ratio improved 1.1 points year on year to reach
49.6%. The improved gross profit ratio was mainly the result of
such factors as the introduction of automated production lines,
and the in-house manufacturing of key components and key
devices, in addition to cost-reduction efforts realized through
ongoing production-reform and procurement-reform activities,
which absorbed the negative effects of severe price competition
in the consumer product market.

Operating Expenses
The major components of operating expenses are payroll, R&D,
advertising expenses and other marketing expenses. Although
R&D expenditures grew 7.6% in fiscal 2006 from the previous
year to ¥308,307 million (U.S.$2,591 million), the operating
expenses to net sales ratio improved 0.4 points. This was
achieved by limiting growth in selling, general and administra-
tive expenses, with the exception of a temporary increase in
expenses related to the relocation of operation bases, below
the growth rate for net sales. In general, Canon maintains a
high level of R&D expenditure to strengthen its R&D capabilities.
R&D expenditures grew in fiscal 2006 from the previous year,
resulting from increased R&D activities.

Operating Profit
Operating profit in fiscal 2006 increased by 21.3% to ¥707,033
million (U.S.$5,941 million) from fiscal 2005. Operating profit
in fiscal 2006 was 17.0% of net sales, compared with 15.5%
in fiscal 2005.

Other Income (Deductions)
Other income (deductions) declined ¥16,851 million (U.S.$142
million), attributable to an increase of currency exchange losses
and a decrease in gains on sales of securities, although interest
income grew in line with the rise in the interest rate.

Income Before Income Taxes and
Minority Interests
Income before income taxes and minority interests in fiscal
2006 was ¥719,143 million (U.S.$6,043 million), a 17.5%
increase from fiscal 2005, and constituted 17.3% of net sales.

Income Taxes
Provision for income taxes increased by ¥35,448 million
(U.S.$298 million) from fiscal 2005, primarily as a result of the
increase in income before income taxes and minority interests.
The effective tax rate during fiscal 2006 declined by 0.3%
compared with fiscal 2005.

Net Income
As a result of the factors offerings above, net income in fiscal
2006 increased by 18.5% to ¥455,325 million (U.S.$3,826
million), which exceeds the growth rate of income before
income taxes and minority interests. This represents an 11.0%
return on net sales.

Product Information
Canon divides its businesses into three product groups: business
machines, cameras and optical and other products.
• The business machines product group includes office
imaging products, computer peripherals and business
information products.
Office imaging products include office network digital MFDs,
color network digital MFDs, office copying machines, personal-
use copying machines and full-color copying machines.
Computer peripherals include laser beam printers, inkjet
printers, inkjet multifunction peripherals and image scanners.
Business information products include micrographic
equipment, personal computers and calculators.

• The cameras product group includes single lens reflex
(“SLR”) cameras, compact cameras, digital cameras and
digital video camcorders.

• The optical and other products product group includes

steppers for semiconductor chip production, mirror projection
mask aligners used in the production of LCDs, television
broadcasting lenses and medical equipment.

Sales by Product
Canon’s sales by product group are summarized as follows:

SALES BY PRODUCT

Business machines:

Office imaging products
Computer peripherals
Business information products

Cameras
Optical and other products

Total

Millions of yen
2006

¥1,185,925

Change

2005

Change

2004

1,398,408 +12.3
+2.4
106,754
+7.5
2,691,087
1,041,865 +18.5
423,807 +13.7
¥4,156,759 +10.7

+2.8% 1,153,240
1,244,906

2,502,401

+2.9% 1,120,972
1,149,914
+8.3
117,067
104,255 –10.9
2,387,953
+4.8
763,079
879,186 +15.2
316,821
372,604 +17.6
3,467,853
+8.3

3,754,191

Thousands of
U.S.dollars
2006

$ 9,965,756
11,751,328
897,092
22,614,176
8,755,168
3,561,404
$ 34,930,748

Sales of business machines, constituting 64.7% of consoli-
dated net sales, increased 7.5%, to ¥2,691,087 million
(U.S.$22,614 million) in fiscal 2006.

Sales of office imaging products increased 2.8% in fiscal
2006, to ¥1,185,925 million (U.S.$9,966 million). In the business
machine segment, sales of color network digital MFDs, which
are grouped in the office imaging products sub-segment,
recorded significant growth with the launch of such new
models as the mid to high-speed office-use iR C5180 series,
the low-power-consumption iR C3380 series, and the high-
image-quality imagePRESS C1 for commercial printing. Among
monochrome network digital MFDs, while sales increased in the
Asian market, sales of monochrome models declined in other
markets as demand shifted toward color models. Color office
imaging products accounted for 31% and 28% and
monochrome office imaging products accounted for 52% and

56% of office imaging products sales in fiscal 2006 and 2005,
respectively. Sales of facsimiles and information system busi-
ness accounted for 17% and 16% of sales of office imaging
products in both fiscal 2006 and 2005, respectively.

Sales of computer peripherals increased 12.3% in fiscal
2006 to ¥1,398,408 million (U.S.$11,751 million). Laser beam
printers enjoyed a year-on-year increase in unit sales, with color
models growing more than 50% and monochrome machines,
particularly low-end models, also recording healthy growth of
over 10%. Sales in value terms also rose significantly. As for
inkjet printers, despite a decline in demand for single-function
models and severe price competition in the market, sales in
value terms increased along with unit sales. Sales performance
was boosted by the introduction of 24 new models—13 single-
function models and 11 multifunction models-including the
high-speed user-friendly PIXMA MP600 and overseas entry-

Return on Sales
(%)

Sales by Product
(Millions of yen)

Business Machines
Office imaging products
Computer peripherals
Business information products
Cameras
Optical and other products

Sales by Region
(Millions of yen)

Japan
Americas
Europe
Other areas

10.2

9.9

8.6

6.5

11.0

4,500,000

4,156,759

4,500,000

4,156,759

3,754,191

3,467,853

3,198,072

2,940,128

3,754,191

3,467,853

3,198,072

2,940,128

level-model PIXMA MP160 all-in-ones, which contributed to a
stronger product lineup while also supporting favorable sales
growth for consumables.

Sales of business information products increased 2.4%, to
¥106,754 million (U.S.$897 million) in fiscal 2006, mainly due
to the growth in the demand for document scanner.

Sales of cameras continued to achieve significant sales
growth of 18.5% in fiscal 2006, totaling ¥1,041,865 million
(U.S.$8,755 million). The continued strong demand for digital
SLR cameras has fueled continued growth with particularly
strong sales for the advanced-amateur-model EOS 30D,
launched in the first half of 2006, and the EOS DIGITAL REBEL
XTi, launched in the second half. This, in turn, led to expanded
sales of interchangeable lenses for SLR cameras. Sales of com-
pact digital cameras also continued to expand steadily with the
introduction of 16 new models in 2006, including six stylish
ELPH-series models and 10 PowerShot-series models that cater
to a diverse range of shooting styles. As a result, unit sales of
digital cameras grew by more than 20% compared with the
previous year. Digital cameras accounted for 75% and 72%
and conventional film cameras accounted for 15% and 16% of
camera sales in fiscal 2006 and 2005, respectively. In the field
of digital video camcorders, the launch of consumer-market HDV
models equipped with Canon HD CMOS sensors contributed to
expanded sales, filling out the company’s digital camcorder
lineup along with MiniDV and DVD models. Video camcorders
accounted for the remaining 10% and 12% of camera sales in
fiscal 2006 and 2005, respectively. Sales of cameras constituted
25.1% of consolidated net sales in fiscal 2006.

Sales of optical and other products increased 13.7% in
fiscal 2006, to ¥423,807 million (U.S.$3,561 million). In the
optical and other products segment, while steppers, used in
the production of semiconductors, enjoyed steady demand

due to a significant increase in investment by manufacturers,
sales of optical products decreased amid declining demand
for aligners, used to produce LCD panels, due to restrained
investment by LCD manufacturers. As for the other products
included in the segment, the newly consolidated subsidiaries
last year contributed to significant sales growth. Sales of optical
and other products constituted 10.2% of consolidated net
sales in fiscal 2006.

Sales by Region
A geographical analysis indicates that net sales in fiscal 2006
increased in every region.

In Japan, net sales increased by 8.9% in fiscal 2006 from
fiscal 2005. The results were mainly attributable to increased
sales of digital cameras and steppers, used in the production of
semiconductors and the significant sales growth of the newly
consolidated subsidiaries acquired last year.

In the Americas, net sales increased by 6.6% on a local
currency basis, mainly due to increased sales of digital cameras
and laser beam printers. Sales of digital cameras experienced
continued strong demand and benefited from the effect of
newly-launched products such as the EOS 30D, advanced-
amateur-model, and the EOS DIGITAL REBEL XTi. On a yen
basis, after accounting for the depreciation of the yen against
the U.S. dollar, net sales in the Americas increased by 12.0%.
In Europe, net sales increased by 4.3% on a local currency
basis mainly due to increased sales of digital cameras and laser
beam printers. On a yen basis, after accounting for the depre-
ciation of the yen against the euro, net sales in Europe grew
11.3% in fiscal 2006.

Sales in other areas increased by 9.8% on a yen basis in
fiscal 2006, reflecting overall sales growth, particularly in digital
cameras.

A summary of net sales by region is provided below:

SALES BY REGION

Japan
Americas
Europe
Other areas
Total

Millions of yen
2006
¥ 932,290

Change
2005
+8.9% 856,205
1,145,950
1,181,258

Change
2004
+0.8% 849,734
1,059,425
+8.2
1,093,295
+8.0
465,399
570,778 +22.6
3,467,853
+8.3

3,754,191

1,283,646 +12.0
1,314,305 +11.3
+9.8
¥4,156,759 +10.7

626,518

Thousands of
U.S.dollars
2006
$ 7,834,370
10,786,941
11,044,580
5,264,857
$ 34,930,748

Note: This summary of net sales by region of destination is determined by the location of the customer.

SEGMENT INFORMATION BY PRODUCT

Millions of yen
2006: Net sales:

Unaffiliated customers
Intersegment

Total

Operating cost and expenses
Operating profit
Assets
Depreciation and amortization
Capital expenditure

2005: Net sales:

Unaffiliated customers
Intersegment

Total

Operating cost and expenses
Operating profit
Assets
Depreciation and amortization
Capital expenditure

2004: Net sales:

Unaffiliated customers
Intersegment

Total

Operating cost and expenses
Operating profit
Assets
Depreciation and amortization
Capital expenditure

Thousands of U.S.dollars
2006: Net sales:

Unaffiliated customers
Intersegment

Total

Operating cost and expenses
Operating profit
Assets
Depreciation and amortization
Capital expenditure

Business
Machines

Cameras

Optical and
Other Products

Corporate and
Eliminations

¥2,691,087 1,041,865

—

2,691,087 1,041,865
773,127
2,091,858
268,738
¥ 599,229
542,866
¥1,617,198
28,756
127,873
31,517
154,259

—
423,807
(190,687)
— 190,687
(190,687)
614,494
11,722
573,019
41,475
(202,409)
501,008 1,860,843
68,647
37,018
157,609
36,272

¥2,502,401
—
2,502,401
1,960,373
¥ 542,028
¥1,427,277
123,037
201,887

¥2,387,953
—
2,387,953
1,866,869
¥ 521,084
¥1,338,817
115,830
134,128

879,186

—
372,604
(158,114)
— 158,114
(158,114)
530,718
13,397
491,898
(171,511)
38,820
517,527 1,617,792
47,231
28,011
108,264
15,955

879,186
705,480
173,706
480,957
27,662
57,678

763,079

316,821
— 138,419
455,240
426,408
28,832

—
(138,419)
(138,419)
(1,498)
(136,921)
418,418 1,430,579
30,087
92,555

24,895
52,264

763,079
632,281
130,798
399,207
21,880
39,783

Consolidated

4,156,759
—
4,156,759
3,449,726
707,033
4,521,915
262,294
379,657

3,754,191
—
3,754,191
3,171,148
583,043
4,043,553
225,941
383,784

3,467,853
—
3,467,853
2,924,060
543,793
3,587,021
192,692
318,730

Business
Machines

Cameras

Optical and
Other Products

Corporate and
Eliminations

Consolidated

$22,614,176 8,755,168
—

22,614,176 8,755,168
17,578,638 6,496,865
$ 5,035,538 2,258,303
$13,589,899 4,561,899
241,647
264,849

1,074,563
1,296,294

3,561,404

— 1,602,411 (1,602,411)
5,163,815 (1,602,411)
98,505
4,815,286
348,529 (1,700,916)
4,210,151 15,637,337
311,076
576,865
304,807 1,324,445

— 34,930,748
—
34,930,748
28,989,294
5,941,454
37,999,286
2,204,151
3,190,395

Notes:
1. General corporate expenses of ¥202,328 million (U.S.$1,700 million), ¥171,522 million and ¥136,929 million in the years ended December 31, 2006, 2005 and
2004, respectively, are included in “Corporate and Eliminations.” For the fiscal year ended December 31, 2004, a gain of ¥17,141 million is also included, which
relates to the Transfer to the Japanese Government of the Substitutional Portion of Employee Pension Fund Liabilities.

2. Corporate assets of ¥1,860,933 million (U.S.$15,638 million), ¥1,239,255 million and ¥1,430,599 million as of December 31, 2006, 2005 and 2004, respectively,
which mainly consist of cash and cash equivalents, marketable securities, investments and corporate properties, are included in “Corporate and Eliminations.”

3. The segments are defined under Japanese GAAP. In grouping of segment information by product, Japanese GAAP requires that consideration be given to

similarities of product types and characteristics, manufacturing methods, sales markets, and other factors that are similar.

SEGMENT INFORMATION BY GEOGRAPHIC AREA

Millions of yen
2006: Net sales:

Japan

Americas

Europe

Others

Corporate and
Eliminations

Consolidated

Unaffiliated customers
Intersegment

Total

Operating cost and expenses
Operating profit
Assets

¥1,037,657
2,311,482
3,349,139
2,558,685
¥ 790,454
¥2,644,116

1,277,867
4,764
1,282,631
1,236,138
46,493
432,001

1,313,919
3,586
1,317,505
1,272,463
45,042
682,381

2005: Net sales:

Unaffiliated customers
Intersegment

Total

Operating cost and expenses
Operating profit
Assets

¥ 979,748
2,046,173
3,025,921
2,362,019
¥ 663,902
¥2,419,012

1,139,784
7,424
1,147,208
1,110,415
36,793
406,101

1,178,672
2,206
1,180,878
1,147,658
33,220
569,750

2004: Net sales:

527,316
792,018 (3,111,850)

— 4,156,759
—
1,319,334 (3,111,850) 4,156,759
1,275,817 (2,893,377) 3,449,726
707,033
(218,473)
4,521,915
424,103

43,517
339,314

455,987
646,530 (2,702,333)

— 3,754,191
—
1,102,517 (2,702,333) 3,754,191
1,071,155 (2,520,099) 3,171,148
583,043
(182,234)
4,043,553
336,218

31,362
312,472

Unaffiliated customers
Intersegment

Total

Operating cost and expenses
Operating profit
Assets

¥ 919,153
1,882,973
2,802,126
2,206,141
¥ 595,985
¥1,793,679

1,057,066
8,863
1,065,929
1,025,628
40,301
341,616

1,090,712
4,161
1,094,873
1,071,552
23,321
533,865

— 3,467,853
400,922
—
591,677 (2,487,674)
992,599 (2,487,674) 3,467,853
965,080 (2,344,341) 2,924,060
543,793
(143,333)
27,519
3,587,021
646,295
271,566

Thousands of U.S.dollars
2006: Net sales:

Unaffiliated customers
Intersegment

Total

Operating cost and expenses
Operating profit
Assets

Japan

Americas

Europe

Others

Corporate and
Eliminations

Consolidated

40,034

$ 8,719,807 10,738,378 11,041,336
30,135

— 34,930,748
19,424,218
—
28,144,025 10,778,412 11,071,471 11,086,840 (26,150,000) 34,930,748
21,501,554 10,387,715 10,692,967 10,721,151 (24,314,093) 28,989,294
365,689 (1,835,907) 5,941,454
3,563,891 37,999,286

4,431,227
6,655,613 (26,150,000)

$ 6,642,471
$ 22,219,462

378,504
5,734,294

390,697
3,630,261

2,851,378

3. Segment information by geographic area is determined by the location of the Company or its relevant subsidiary making the sale. The segments are defined

under Japanese GAAP. In grouping of segment information by geographic area, Japanese GAAP requires that consideration be given to geographic proximity,
as well as similarities of economic activities, interrelationships of business activities and other similar factors.

Operating Profit by Product
Operating profit for business machines in fiscal 2006
increased ¥57,201 million (U.S.$481 million) to ¥599,229 million
(U.S.$5,036 million). The gross profit ratio improved compared
to the previous year, due to cost reduction efforts, and the
sales-to-expense ratio declined, contributing to an increase in
operating profit.

Operating profit for cameras increased ¥95,032 million
(U.S.$799 million) to ¥268,738 million (U.S.$2,258 million).
The gross profit ratio for the camera segment improved, due
to such factors as increased sales of new products and cost
reduction efforts.

Operating profit for optical and other products in fiscal
2006 increased ¥2,655 million (U.S.$22 million) to ¥41,475
million (U.S.$349 million). The gross profit ratio increased
compared to the previous year, due to an increase in sales
of steppers.

FOREIGN OPERATIONS AND FOREIGN CURRENCY
TRANSACTIONS
Canon’s marketing activities are performed by subsidiaries in
various regions in local currencies, while the cost of sales is
generally in yen. Given Canon’s current operating structure,
appreciation of the yen has a negative impact on net sales and
the gross profit ratio. To reduce the financial risks from changes
in foreign exchange rates, Canon utilizes derivative financial
instruments, which are comprised principally of forward
currency exchange contracts.

The return on foreign operation sales is usually lower than
that from domestic operations because foreign operations con-
sist mainly of marketing activities. Return on foreign operation
sales is calculated by dividing net income of foreign subsidiaries,
after factoring in consolidation adjustments between foreign
subsidiaries, by net sales of foreign subsidiaries. Marketing
activities are generally less profitable than production activities,
which are mainly conducted by the Company and its domestic
subsidiaries. The returns on foreign operation sales in fiscal
2006, 2005 and 2004 were 3.7%, 3.0% and 2.8%, respectively.
This compares with returns of 11.0%, 10.2% and 9.9% on
total operations for the respective years.

LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents in fiscal 2006 increased
¥150,673 million (U.S.$1,266 million) to ¥1,155,626 million
(U.S.$9,711 million), compared with ¥1,004,953 million in
fiscal 2005 and ¥887,774 million in fiscal 2004. Canon’s cash
and cash equivalents are typically denominated in Japanese
yen, with the remainder denominated in foreign currencies
such as the U.S. dollar.

Net cash provided by operating activities in fiscal 2006
increased by ¥89,563 million (U.S.$753 million) from the
previous year to ¥695,241 million (U.S.$5,842 million), reflecting
the substantial growth in sales and increased cash proceeds
from sales, combined with a substantial increase in net income.
Cash flow from operating activities consisted of the following
components: the major component of Canon’s cash inflow is
cash received from customers, while the major components of
Canon’s cash outflow are payments for parts and materials,
selling, general and administrative expenses, and income taxes.
For fiscal 2006, cash inflow from cash received from cus-
tomers increased, due to the increase in net sales. This increase
in cash inflow was within the range of the increase in net sales,
as there were no significant changes in Canon’s collection
rates. Cash outflow for payments for parts and materials also
increased, as a result of an increase in net sales. However, this
increase was less than the increase in net sales, due to the
effects of cost reduction. Cost reduction reflects a decline in
unit prices of parts and raw materials, as well as a streamlining
of the process of using these parts and materials through
promoting efficiency in operations. Cash outflow for payroll
payments increased, due to the increase in the number of
employees. The employees in the Asian region increased, due
to the expansion of production in the regions. Cash outflow for
payments for selling, general and administrative expenses
increased, but the increase was within the range of the
increase in net sales, due to cost-cutting efforts. Cash outflow
for payments of income taxes increased, due to the increase in
taxable income.

Net cash used in investing activities in fiscal 2006 was
¥460,805 million (U.S.$3,872 million), compared with ¥401,141
million in fiscal 2005 and ¥252,967 million in fiscal 2004,
consisting primarily of capital expenditures. Capital expenditures
in fiscal 2006 totaled ¥424,862 million (U.S.$3,570 million),
which was used mainly to expand production capabilities in
Japan and overseas regions and to strengthen the Company’s
R&D-related infrastructure. As a result, free cash flow, or cash
flow from operating activities minus cash flow from investing
activities, totaled ¥234,436 million (U.S.$1,970 million) for
fiscal 2006 as compared to ¥204,537 million for fiscal 2005.

Net cash used in financing activities totaled ¥107,487
million (U.S.$903 million) in fiscal 2006, mainly resulting from
a decrease in loan repayments accompanying the company’s
strengthened financial position despite a large increase in the
dividend payout. The Company paid dividends in fiscal 2006 of
¥83.33 (U.S.$0.70) per share, which was an increase of ¥16.66
(U.S.$0.14) per share over the prior year (after adjusting for the
effect of 3 for 2 stock split in 2006).

Canon seeks to meet its liquidity and capital requirements
principally with cash flow from operations. Consistent with this
objective, Canon continued to reduce its reliance on external
funding for capital investments in favor of relying upon inter-
nally generated cash flows. This approach is supplemented
with group-wide treasury and cash management activities
undertaken at the parent company level. Canon believes that
its working capital is sufficient for its present requirements.

To the extent Canon relies on external funding for its
liquidity and capital requirements, it generally has access to
various funding sources, including issuance of additional share
capital, long-term debt or short-term loans. While Canon has
been able to obtain funding from its traditional financing
sources and from the capital markets, and believes it will con-
tinue to be able to do so in the future, there can be no assur-
ance that adverse economic or other conditions will not affect
Canon’s liquidity or long-term funding in the future.

Short-term loans (including current portion of long-term

debt) amounted to ¥15,362 million (U.S.$129 million) at
December 31, 2006 compared to ¥5,059 million at December
31, 2005. Long-term debt (excluding current portion) amounted
to ¥15,789 million (U.S.$133 million) at December 31, 2006
compared to ¥27,082 million at December 31, 2005.

Canon’s long-term debt generally consists of lease obliga-

tions, as well as fixed-rate notes and convertible debentures
which Canon has issued in the domestic market with original
maturities of ten to fifteen years.

In order to facilitate access to global capital markets, Canon

obtains credit ratings from two rating agencies, Moody’s
Investors Services, Inc. (“Moody’s”) and Standard and Poor’s
Rating Services (“S&P”). In addition, Canon maintains a rating
from Rating and Investment Information, Inc. (“R&I”), a rating
agency in Japan, for access to the Japanese capital market.

As of February 28, 2007, Canon’s debt ratings are:
Moody’s: Aa2 (long-term); S&P: AA (long-term), A-1+ (short-
term); and R&I: AA+ (long-term). Canon does not have any
rating downgrade triggers that would accelerate the maturity
of a material amount of its debt. A downgrade in Canon’s
credit ratings or outlook could, however, increase the cost of
its borrowings.

Capital expenditure in fiscal 2006 amounted to ¥379,657
million (U.S.$3,190 million) compared with ¥383,784 million in
fiscal 2005 and ¥318,730 million in fiscal 2004. In fiscal 2005,
capital expenditures were mainly used to expand production
capabilities in both domestic and overseas regions, and to
bolster the Company’s R&D-related infrastructure. In addition,
Canon has been continually investing in tools and dies for
business machines, in which the amount invested is generally
the same each year. For fiscal 2007, Canon projects its capital
expenditures will be approximately ¥480,000 million (U.S.$4,034
million). The capital expenditures include investments in new
production plants and new facilities of Canon.

Employer contributions to Canon’s worldwide defined
benefit pension plans were ¥44,981 million (U.S.$378 million)
in fiscal 2006, ¥40,059 million in fiscal 2005, ¥31,018 million
in fiscal 2004. During fiscal 2007, Canon expects to make cash
contributions of approximately ¥17,369 million (U.S.$146
million) to its defined benefit pension plans.

Capital Expenditure
(Millions of yen)

400,000

383,784 379,657

318,730

210,038

198,702

Working capital in fiscal 2006 increased ¥239,101 million
(U.S.$2,009 million), to ¥1,619,042 million (U.S.$13,605 mil-
lion), compared with ¥1,379,941 million in fiscal 2005 and
¥1,248,987 million in fiscal 2004. This increase was primarily a
result of an increase in cash and cash equivalents. Canon
believes its working capital will be sufficient for its requirements
for the foreseeable future. Canon’s capital requirements are
primarily dependent on management’s business plans regarding
the levels and timing of capital expenditures and investments.
The working capital ratio (ratio of current assets to current
liabilities) for fiscal 2006 was 2.39 compared to 2.28 for fiscal
2005 and 2.27 for fiscal 2004.

Return on assets (Net income divided by the average of total
assets as of December 31, 2006, 2005 and 2004) recorded
10.6% in fiscal 2006, compared to 10.1% in fiscal 2005 and
10.1% in fiscal 2004.

Return on stockholders’ equity was 16.3% in fiscal 2006
compared with 16.0% in fiscal 2005 and 16.8% in fiscal 2004.

Debt to total assets ratio was 0.7%, 0.8% and 1.1% as of
December 31, 2006, 2005 and 2004, respectively. Canon had
short-term loans and long-term debt of ¥31,151 million as of
December 31, 2006, ¥32,141 million as of December 31, 2005
and ¥38,530 million as of December 31, 2004.

OFF-BALANCE SHEET ARRANGEMENTS
As part of its ongoing business, Canon does not participate in
transactions that generate relationships with unconsolidated
entities or financial partnerships, such as entities often referred
to as structured finance or special purpose entities, which
would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow
or limited purposes.

Canon provides guarantees to third parties of bank loans
of its employees, affiliates and other companies. Canon would
have to perform under a guarantee, if the borrower defaults on
a payment within the contract periods of 1 year to 30 years in
the case of employees with housing loans, and of 1 year to 10
years in the case of affiliates and other companies. The maxi-
mum amount of undiscounted payments Canon would have had
to make in the event of default by all borrowers was ¥30,051
million (U.S.$253 million) at December 31, 2006. The carrying
amounts of the liabilities recognized for Canon’s obligations as
a guarantor under those guarantees are insignificant.

Working Capital Ratio

Return on Stockholders’ Equity
(%)

2.5

2.13

2.33

2.27

2.28

2.39

16.8

15.9

16.0

16.3

12.5

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following summarizes Canon’s contractual obligations at December 31, 2006.

Contractual obligations:

Long-term debt

Capital lease obligations
Other long-term debt
Operating lease obligations
Purchase commitments for

Property plant and equipment
Parts and raw materials
Total

Contractual obligations:

Long-term debt

Capital lease obligations
Other long-term debt
Operating lease obligations
Purchase commitments for

Property plant and equipment
Parts and raw materials
Total

Total

Less than 1 year

1–3 years

3–5 years More than 5 years

Payments Due By Period

Millions of yen

¥ 10,585
20,467
60,378

107,685
85,403
¥284,518

5,263
10,000
16,025

107,685
85,403
224,376

4,850
10,432
22,565

—
—
37,847

465
22
10,532

—
—
11,019

7
13
11,256

—
—
11,276

Total

Less than 1 year

1–3 years

3–5 years More than 5 years

Payments Due By Period

Thousands of U.S.dollars

88,950
171,991
507,378

44,226
84,034
134,664

904,916
717,672
$2,390,907

904,916
717,672
1,885,512

40,756
87,664
189,622

—
—
318,042

3,908
185
88,504

—
—
92,597

60
108
94,588

—
—
94,756

Canon provides warranties generally less than one year
against defects in materials and workmanship on most of its
consumer products. Estimated product warranty related costs
are established at the time revenue is recognized and is
included in selling, general and administrative expenses.
Estimates for accrued product warranty cost are primarily
based on historical experience, and are affected by ongoing
product failure rates, specific product class failures outside of
the baseline experience, material usage and service delivery
costs incurred in correcting a product failure. As of December
31, 2006, accrued product warranty costs amounted to
¥18,144 million (U.S.$152 million).

At December 31, 2006, commitments outstanding for the

purchase of property, plant and equipment approximated
¥107,685 million (U.S.$905 million), and commitments out-
standing for the purchase of parts and raw materials approxi-
mated ¥85,403 million (U.S.$718 million), both for use in the
ordinary course of its business. Canon anticipates that funds
needed to fulfill these commitments will be generated internally
through operations.

Canon’s management believes that current financial

resources, cash generated from operations and Canon’s poten-
tial capacity for additional debt and/or equity financing will be
sufficient to fund current and future capital requirements.

RESEARCH AND DEVELOPMENT, PATENTS
AND LICENSES
Canon kicked off the year 2006, the first year of Phase III
(2006–2010) of the Excellent Global Corporation Plan, with an
objective to realize “Sound Growth” toward “Joining the
World’s Top 100 Companies.”

Canon has established the following as key strategies:
• Realize the overwhelming No.1 position worldwide in all

current core businesses,

• Expand operations through diversification and
• Identify new business domains and accumulate necessary

technological capabilities

Canon is striving to achieve these strategies as follows:
• Realize the No.1 position worldwide in all current core

businesses: Product R&D divisions will work together with
the corporate R&D headquarters to bolster product

competitiveness through development of superior next-
generation products.

• Expand operations through diversification: Canon is

studying existing technologies to expand business oppor-
tunities and develop required technologies for new SED
businesses to make SEDs the windows for images and
information in living rooms.

• Identify new business domains and accumulate necessary
technological capabilities: Canon has established a Strategic
Committee for New Businesses. In addition, Canon devel-
oping and strengthening relationships with universities
and other research institutes to carry on fundamental
research and develop cutting-edge technologies. Canon
has signed a comprehensive partnership agreement with
Tokyo Institute of Technology in 2005 regarding joint
research on advanced materials and imaging technologies.
Canon has also tied up with Kyoto University to develop
next-generation medical-image processing technologies.
Canon has utilized 3D-CAD systems for some time to boost

R&D efficiency by curtailing product development times and
costs. Moreover, Canon enhanced and evolved its simulation,
measurement, and analysis technologies by introducing leading-
edge facilities, including one of Japan’s highest-performance
cluster computers in 2005. As a result, Canon has succeeded in
further reducing the need for prototypes, dramatically lowering
costs and shortening development lead times.

Canon has R&D centers worldwide, including the USA. Each

of our R&D centers, with its expertise, is collaborating with
other centers to achieve synergies, and cultivating closer ties in
fields ranging from basic research to product development.
The Company’s R&D activities are conducted in the

following four organizations:

• Core Technology Development Headquarters, where

component engineering and base technology R&D, such
as optics technology and nanotechnology, is conducted

R&D Expenditure
(Millions of yen)

350,000

308,307

286,476

275,300

259,140

233,669

• Leading-Edge Technology Development Headquarters,

where most advanced technology R&D, aiming to create
new technological capabilities, is conducted

• Platform Technology Development Headquarters, where
platform technology R&D, such as system Large-Scale
Integration (LSI) chips, network technology and visual
information technology, is conducted

• Device Technology Development Headquarters, where
key device R&D, such as for semiconductor devices, is
conducted

Canon’s consolidated R&D expenditures were ¥308,307
million (U.S.$2,591 million) in fiscal 2006, ¥286,476 million in
fiscal 2005 and ¥275,300 million in fiscal 2004. The ratios of
R&D expenditure to consolidated total net sales for fiscal 2006,
2005, and 2004 were 7.4 %, 7.6% , and 7.9%, respectively.
Canon believes that new products protected by seminal
patents will not easily allow competitors to catch up with it,
and provide Canon with advantages in establishing standards
in the market and industry. According to the United States
patent annual list, which IFI CLAIMS® Patent Services released,
Canon obtained the 3rd-greatest number of private sector
patents in 2006. This achievement marks Canon’s fifteenth
consecutive year as one of the top three patent-receiving
private-sector organizations.

RECENT DEVELOPMENTS
Canon has decided to purchase from Toshiba Corporation
(“Toshiba”) all of Toshiba’s outstanding shares of SED Inc., a
Canon subsidiary. On completion of the purchase, SED Inc.
became a wholly owned subsidiary of Canon, effective Jan-
uary 29, 2007. In accordance with this decision, which was
based on the assumption of prolonged litigation pending
against Canon in the United States with respect to SED tech-
nology, Canon will carry out the SED panel business indepen-
dently in order to facilitate the earliest possible launch of a
commercial SED television business. Canon, with the necessary
cooperation from Toshiba, will make every effort for the smooth
launch of its television business based on the high image quality
achieved by SED technology.

Canon Electronics Inc. acquired the shares of e-System Cor-
poration (listed on the Hercules Section of the Osaka Securities
Exchange) through a third-party distribution and made it into a
subsidiary as of December 27, 2006. By making e-System Cor-
poration a subsidiary, Canon Electronics Inc. aims to make fur-
ther advances in its group’s information-related business and
develop it into a core business.

MARKET RISK EXPOSURE
Canon is exposed to market risks, including changes in foreign
currency exchange rates, interest rates and prices of marketable
securities and investments. In order to hedge the risks of
changes in foreign currency exchange rates and interest rates,
Canon uses derivative financial instruments.

Equity Price Risk
Canon holds marketable securities included in current assets as
short-term investments, which consists generally of highly-liquid
and low-risk instruments. Investments included in noncurrent

assets are held as long-term investments. Canon does not hold
marketable securities and investments for trading purposes.

Maturities and fair values of such marketable securities and

investments were as follows at December 31, 2006.

Available-for-sale securities

Due within one year
Due after one year through five years
Due after five years
Equity securities

Held-to-maturity securities

Due within one year
Due after one year through five years

Millions of yen

Thousands of U.S. dollars

Cost
295
5,606
2,891
12,648
¥21,440

Fair Value
294
7,104
2,947
29,852
40,197

Cost
2,478
47,109
24,294
106,286
$180,167

Fair Value
2,470
59,697
24,765
250,857
337,789

Millions of yen

Thousands of U.S. dollars

Cost
¥10,151
10,311
¥20,462

Fair Value
10,151
10,311
20,462

Cost
$ 85,303
86,647
$171,950

Fair Value
85,303
86,647
171,950

Foreign Currency Exchange Rate and Interest
Rate Risk
Canon operates internationally, exposing it to the risk of changes
in foreign currency exchange rates and interest rates. Derivative
financial instruments are comprised principally of foreign cur-
rency exchange contracts and interest rate swaps utilized by the
Company and certain of its subsidiaries to reduce these risks.
Canon assesses foreign currency exchange rate risk and interest
rate risk by continually monitoring changes in these exposures
and by evaluating hedging opportunities. Canon does not hold
or issue derivative financial instruments for trading purposes.
Canon is also exposed to credit-related losses in the event of
non-performance by counterparties to derivative financial
instruments, but it is not expected that any counterparties will
fail to meet their obligations, because most of the counterparties
are internationally recognized financial institutions and contracts
are diversified across a number of major financial institutions.

Canon’s international operations expose Canon to the risk of
changes in foreign currency exchange rates. Canon uses foreign
exchange contracts to manage certain foreign currency exchange
exposures principally from the exchange of U.S. dollar and euro
into Japanese yen. These contracts are primarily used to hedge
the foreign currency exposure of forecasted intercompany sales
and intercompany trade receivables which are denominated in
foreign currencies. In accordance with Canon’s policy, a specific
portion of foreign currency exposure resulting from forecasted
intercompany sales are hedged using foreign exchange contracts
which principally mature within three months.

The following table provides information about Canon’s
major derivative financial instruments related to foreign currency
exchange transactions existing at December 31, 2006. All of
the foreign exchange contracts described in the following table
have a contractual maturity date in 2007.

Forwards to sell foreign currencies:

Contract amounts
Estimated fair value

Forwards to buy foreign currencies:

Contract amounts
Estimated fair value

Forwards to sell foreign currencies:

Contract amounts
Estimated fair value

Forwards to buy foreign currencies:

Contract amounts
Estimated fair value

U.S.$

euro

¥392,402
(6,692)

286,148
(8,671)

¥ 34,004
(310)

3,204
(111)

Others

38,586
(392)

13,981
(1,051)

Millions of yen

Total

717,136
(15,755)

51,189
(1,472)

Thousands of U.S. dollars

U.S.$

euro

Others

Total

$3,297,496
(56,235)

2,404,605
(72,866)

324,252
(3,294)

6,026,353
(132,395)

$ 285,748
(2,605)

26,924
(933)

117,488
(8,832)

430,160
(12,370)

Canon’s exposure to the risk of changes in interest rates
relates primarily to its debt obligations. The variable-rate debt
obligations expose Canon to variability in their cash flows due
to change in interest rates. To manage the variability in cash
flows caused by interest rate changes, Canon enters into interest
rate swaps when it is determined to be appropriate based on

market conditions. The interest rate swaps change variable-rate
debt obligations to fixed-rate debt obligations by primarily
entering into pay-fixed, receive-variable interest rate swaps.
For debt obligations, the table below presents principal
cash flows by expected maturity dates and related weighted
average interest rates, as of December 31, 2006.

LONG-TERM DEBT (including due within one year)

Japanese yen notes
Japanese yen convertible
debentures
Other long-term debt

Total

Weighted Average
Interest Rates

2.61%

1.30%
1.34%

Expected Maturity Date

Total
¥ 20,000

2007

2008
10,000 10,000

2009
—

318
10,734
¥ 31,052

318
—
5,263
3,132
15,263 13,450

—
1,832
1,832

2010
—

—
418
418

LONG-TERM DEBT (including due within one year)

Japanese yen notes
Japanese yen convertible
debentures
Other long-term debt

Total

Weighted Average
Interest Rates

Total
2.61% $168,068

Expected maturity date

2007

2008
84,034 84,034

2009
—

2010
—

1.30%
1.34%

— 2,672

2,672
90,201

—
44,226 26,319 15,395
$260,941 128,260 113,025 15,395

—
3,513
3,513

Millions of yen

2011
—

Thereafter

Estimated
Fair Value
— 20,319

—
69
69

2011
—

—
580
580

—
20
20

1,819
10,657
32,795

Thousands of U.S. dollars

Thereafter

Estimated
Fair Value
— 170,748

— 15,286
89,554
275,588

168
168

Note: All long-term debt is fixed rate.

Derivative financial instruments designated as fair value
hedges principally relate to interest rate swaps associated with
fixed-rate debt obligations. Changes in fair values of the
hedged debt obligations and derivative instruments designated
as fair value hedges of these debt obligations are recognized in
other income (deductions). There is no hedging ineffectiveness
or net gains or losses excluded from the assessment of hedge
effectiveness for fiscal 2004 as the critical terms of the interest
rate swaps match the terms of the hedged debt obligations.
Canon had no fair value hedges in 2006 or 2005.

Changes in the fair value of derivative financial instruments

designated as cash flow hedges, including foreign exchange
contracts associated with forecasted intercompany sales and
interest rate swaps associated with variable rate debt obligations,
are reported in accumulated other comprehensive income (loss).
These amounts are subsequently reclassified into earnings
through other income (deductions) in the same period as the
hedged items affect earnings. Substantially all amounts
recorded in accumulated other comprehensive income (loss) at
year-end is expected to be recognized in earnings over the next
twelve months. Canon excludes the time value component
from the assessment of hedge effectiveness.

The amounts of the hedging ineffectiveness are not mate-
rial for the years ended December 31, 2006, 2005 and 2004.
The amounts of net gains or losses excluded from the assess-
ment of hedge effectiveness which are recorded in other

income (deductions) are net losses of ¥5,917 million (U.S.$50
million), ¥3,725 million and ¥2,096 million for the years ended
December 31, 2006, 2005 and 2004, respectively.

Canon has entered into certain foreign currency exchange

contracts to manage its foreign currency exposures. These
foreign currency exchange contracts have not been designated
as hedges. Accordingly, the changes in fair values of the
contracts are recorded in earnings immediately.

LOOKING FORWARD
The global economy is generally expected to maintain a pro-
longed economic growth this year, despite predictions of
slightly lower growth rate in major areas of Japan, the U.S.,
and Europe. Business competition in general, however, is
expected to further intensify and the business conditions
surrounding the Canon Group will likely remain difficult.

Under these circumstances, the Canon Group has posi-
tioned 2007, the second year of Phase III (2006 to 2010) of its
“Excellent Global Corporation Plan,” as a year for fundamental
strengthening to achieve 2010 objectives and will accelerate
our growth.

For this year, the 70th anniversary of our founding, key
objectives toward that end include, first of all, introducing even
more competitive new products to boost our competitiveness
against other companies with the aim of achieving the over-
whelming No.1 position worldwide in all of our current core

businesses. Secondly, we aim to achieve steady cost reductions
and further reduce our cost ratio through continuous measures
to improve productivity, such as promoting production
automation by introducing high-speed automation equipment;
bringing the in-house production of more key parts, taking
procurement innovation activities to an even higher level; and
building an IT system that centralizes business information for
everything from planning and development to production,
sales, procurement, and logistics.

Renewing our awareness that companies’ mission is to
maintain product quality, we will build or enhance our systems
for quality management, safety management and crisis man-
agement, including measures to heighten awareness, to help
ensure that our quality fits for an excellent global corporation.

We will also reform our research and development activities
from the new perspective to secure robust patents, which are a
critical lifeline for a manufacturer and the very source of com-
petitiveness for a high-value-added manufacturing business.
Lastly, toward the objective of becoming a truly excellent global
corporation, we will bring to bear the resource of the entire
Canon Group to ensure that our compliance activities are
thoroughly implemented, that our internal controls are strictly
enforced, and that our management excels in transparency.

Business Machines Segment
Office imaging products
In the office imaging products segment, it has become more
important to provide added value in the form of networking,
integration, color printing, and multifunction models. Also, in
addition to the mid-segment products for the office market
which is enjoying steady growth, Canon expects that the
market for higher-end models and low-end multifunction
models will expand as well. The market for color digital devices
continued to grow rapidly, and sales of monochrome digital
MFDs were stable, reflecting the market trend shifting from
single-function to multifunction. Recently, there has been a
new, printer-based MFP market created by other printer
vendors as they seek to enter the copier and MFD market.

To maintain and enhance a competitive edge and to meet
more sophisticated customer demands, Canon is strengthening
its marketing capabilities by reinforcing its hardware and soft-
ware product lineups and by improving functionality. In 2006,
Canon strengthened the product lineups of its color digital
devices in addition to its existing full line of monochrome
machines and maintained its market share by executing
business strategies in line with current market trends.
Computer peripheral products
In the Inkjet printer market, Canon expects a continuation of
declines in market prices, slowdown in market growth, and a
shift from single-function printers (“SFP”) to MFPs. To manage
in line with these trends, Canon launched new lineups of SFP
and MFP from flagship to entry models in order to expand its
printer sales.

Canon’s laser beam printer business holds a strong position

in the market. In the monochrome laser beam printer market,

Canon expects that the transition to a low price segment will
expand sales in the micro-business/home office market and in
the emerging markets. In the color laser beam printer market,
Canon expects continued strong growth in demand. In general,
competition will become more intense as competitors implement
aggressive price strategies in order to establish themselves as
market leaders. Canon seeks to remain competitive by develop-
ing technologies that can be deployed in a timely fashion to
produce innovative products in all segments. Canon is also
working to lower costs by automating production of consum-
ables and to secure procurement of essential parts through
internal sourcing.

Although Canon expects that the size of the scanner market

will continue to contract, the stylish and compact CanoScan
LiDE series and hyper CCD models with ultrahigh-resolution
were both introduced in fiscal 2005 in order to increase
Canon’s share of this market.

The size of the worldwide facsimile market has remained
stable, as expansion in Asia, mainly China, has offset declines
in other regions. Due to price declines for inkjet MFPs with
facsimile function, prices are also declining for stand-alone
machines.
Business information products
The market for business-use document scanners has further
expanded as demand for document scanners has accelerated
due to the evolving office IT environment and the need to
comply with various laws related to the management of infor-
mation. Under these conditions, in the “DR Scanner series” ,
Canon has introduced the “DR-2050C II” as a new product for
the segment of affordable machines with the most significantly
expanding demand and worked to expand sales of this product
and the “DR-1210C” introduced in the first half of 2006. As a
result, sales steadily increased.

With regard to servers and personal computers, demand
from corporate clients in the Japanese market held steady in
fiscal 2006, but a decline in sales was caused by Canon’s
change in marketing strategy from selling single products to a
solutions business involving the proposal of unique combina-
tions of various products. This trend is expected to continue in
fiscal 2007.

Cameras Segment
The entire digital camera market continues to expand. While
the growth rate has slowed in Japan and the United States,
emerging markets, especially China and Eastern Europe, have
experienced strong growth. In addition, the emergence of
digital imaging systems has contributed to this growth as well,
such as PC-free direct printing systems, by expanding the
digital imaging functionality through network connectivity,
along with the improvement of the user-friendly image
processing interfaces and software.

The digital camera industry is seeing growth on various
fronts. As with most other digital consumer electronics, the
digital camera market is now confronted with a fierce price
war and intensified technological competition in terms of

picture quality and functions. Profit margins have been
shrinking for the overall industry, but Canon has been able to
maintain higher margins through reforms of its production
and procurement systems.

Canon expects the market for compact digital cameras to
expand in the intermediate term. However, profit margins for
the overall industry are moving lower as prices fall and compe-
tition increases. Therefore, Canon seeks to continue cutting
production costs while expanding sales volumes.

There are signs of rapid growth in the market for compact
photo printers, which present a new business opportunity. By
creating a strong product line over the mid-term, Canon
believes that it will be able to take a significant role in this
market and turn the compact photo printer business into a
new earnings source for Canon.

Canon played a major role in the continued expansion of
the digital SLR market in fiscal 2006. This market is expected to
continue growing for the time being. However, Canon expects
the growth rate to decline over-time .

The market for film cameras is contracting as a result of the

rapid shift to digital cameras. Canon anticipates this trend to
continue, both for film single lens reflex cameras and for film
compact cameras.

Canon expects the interchangeable lens market to grow as
a result of the rapid market penetration of digital SLR cameras.
Canon aims to expand its sales and market share by introducing
the most suitable products for the digital SLR camera market,
which is expected to continue growing.

For video camcorders, analog camcorder sales have been

further replaced by sales of digital camcorders even in the
United States and Europe, where this transition had been
comparatively slow. Now almost the entire world has made the
switch over to digital. Against this background two new trends
have emerged in the market. First, the introduction of video
cameras using DVDs, HDDs, SD cards and other new forms of
media has resulted in a trend in which convenience offered by
the products is increasingly emphasized. Second, the trend
towards higher picture quality has evolved, provided by products
using high-resolution recording methods such as HDV and AVC
HD. Canon believes that these two trends are stimulating the
market by responding to more diverse user needs, and will likely
contribute to further growth for the overall digital video market.
Canon will seek continued sales growth with a stronger
product line while investing in research and development in
order to better respond to new market trends.

Canon expects that the market for business-use liquid
crystal projectors will continue to grow by about 20% per year
on a unit basis, while market prices will continue to decline,
resulting in almost no growth in monetary terms. In addition to
our independently developed SX50 high-resolution projector
released at the end of 2004, Canon has also introduced the
SX6, 60 and X600 models late in the second half of 2006.
The high picture quality and resolution offered by these
models have won high praise from system integrators, allowing
Canon to capture a large share of the market for high-resolution

projectors. Canon expects to continue to develop distinctive,
value-added products by further improving picture quality,
resolution and brightness.

Optical and Other Products Segment
In the semiconductor-production equipment industry,
equipment manufacturers must provide high quality products
corresponding to rapid technology progress.

Canon will continue to focus on developing new products

which adopt leading-edge technologies, such as immersion
exposure technology and ultra precision processing and
measurement technology.

In the LCD production mask aligner market, Canon will
seek to strengthen its technical capabilities to meet the recent
trend toward larger glass-substrates due to the increasing
demand for larger LCD televisions.

In addition, Canon will continue to make distinctive products

enabling high resolution and high productivity.

In the TV lens market, demand for HDTV, which has grown

in the United States and Japan, is now growing as well in
Europe. In particular, there has been increased demand for
lenses used for broadcasting sporting events and for producing
dramas and documentaries. Canon also expects to see new
demand in China and other Asian markets thanks to greater
progress in digitalization. At the same time, there have been
signs of expanded HDTV applications by the press in Japan and
the United States while Canon already has a major market
share worldwide for this class of lens, it intends to continue to
strengthen its position in this market.

Forward Looking Statements
The foregoing discussion and other disclosure in this report
contains forward-looking statements that reflect management’s
current views with respect to certain future events and financial
performance. Actual results may differ materially from those
projected or implied in the forward-looking statements. Further,
certain forward-looking statements are based upon assump-
tions of future events that may not prove to be accurate. The
following important factors could cause actual results to differ
materially from those projected or implied in any forward-
looking statements: foreign currency exchange rate fluctua-
tions; the uncertainty of Canon’s ability to implement its plans
to localize production and other measures to reduce the impact
of foreign currency exchange rate fluctuations; uncertainty as
to economic conditions, in Canon’s major markets; uncertainty
of continued demand for Canon’s high-value-added products;
uncertainty as to the recovery of computer and related mar-
kets; uncertainty of recovery in demand for Canon’s semicon-
ductor production equipment; Canon’s ability to continue to
develop products and to market products that incorporate new
technology on a timely basis, are competitively priced and
achieve market acceptance; the possibility of losses resulting
from foreign currency transactions designed to reduce finan-
cial risks from changes in foreign currency exchange rate; and
inventory risk due to shifts in market demand.

TEN-YEAR FINANCIAL SUMMARY

Millions of yen except per share amounts

Net sales:

Domestic
Overseas
Total

Percentage of previous year

Net income

Percentage of sales

Advertising
Research and development
Depreciation of property, plant and equipment
Capital expenditure

Long-term debt, excluding current installments
Stockholders’ equity
Total assets

Per share data:

Income before cumulative effect of change
in accounting principles:
Basic
Diluted
Net income:

Basic
Diluted

Cash dividends declared
Stock price:
High
Low

2006

2005

2004

2003

¥ 932,290
3,224,469
4,156,759
110.7%

455,325
11.0%

116,809
308,307
235,804
379,657

856,205
2,897,986
3,754,191
108.3

384,096
10.2

106,250
286,476
205,727
383,784

849,734
2,618,119
3,467,853
108.4

343,344
9.9

111,770
275,300
174,397
318,730

801,400
2,396,672
3,198,072
108.8

275,730
8.6

100,278
259,140
168,636
210,038

15,789
2,986,606
4,521,915

27,082
2,604,682
4,043,553

28,651
2,209,896
3,587,021

59,260
1,865,545
3,182,148

341.95
341.84

341.95
341.84
83.33

6,780
4,567

288.63
288.36

288.63
288.36
66.67

4,780
3,460

258.53
257.85

258.53
257.85
43.33

3,880
3,273

209.21
207.17

209.21
207.17
33.33

4,140
2,607

Average number of common shares in thousands
Number of employees

1,331,542
118,499

1,330,761
115,583

1,328,048
108,257

1,317,974
102,567

Common Stock Price Range (Tokyo Stock Exchange)
(Yen)

7,000

6,000

5,000

4,000

3,000

2,000

1,000

2002

2001

2000

1999

1998

1997

732,551
2,207,577
2,940,128
101.1

190,737
6.5

71,725
233,669
158,469
198,702

827,288
2,080,285
2,907,573
107.8

167,561
5.8

66,837
218,616
147,286
207,674

779,366
1,917,054
2,696,420
106.5

134,088
5.0

67,840
194,552
144,043
170,986

718,513
1,812,383
2,530,896
92.5

70,234
2.8

67,544
177,922
155,682
200,386

725,063
2,011,021
2,736,084
102.5

109,569
4.0

76,911
176,967
159,888
221,401

811,455
1,858,079
2,669,534
108.0

118,813
4.5

75,800
170,793
137,777
219,779

81,349
1,591,950
2,942,706

95,526
1,458,476
2,844,756

142,925
1,298,914
2,832,125

165,277
1,202,003
2,587,532

180,320
1,155,520
2,728,329

226,889
1,109,511
2,872,779

Thousands of U.S. dollars
except per share amounts
2006

$ 7,834,370
27,096,378
34,930,748
110.7%

3,826,261
11.0%

981,588
2,590,815
1,981,546
3,190,395

132,681
25,097,529
37,999,286

145.04
143.20

145.04
143.20
20.00

3,500
2,413

124.71
123.03

127.53
125.80
16.67

3,553
2,100

102.44
101.01

102.44
101.01
14.00

3,747
2,267

53.77
53.00

53.77
53.00
11.33

2,800
1,447

84.07
82.62

84.07
82.62
11.33

2,267
1,287

91.82
89.73

91.82
89.73
11.33

2,547
1,520

2.87
2.87

2.87
2.87
0.70

56.97
38.38

1,315,074
97,802

1,313,940
93,620

1,308,909
86,673

1,306,049
81,009

1,303,374
79,799

1,293,996
78,767

Notes: 1. U.S. dollar amounts are translated from yen at the rate of U.S.$1 = ¥119, the approximate exchange rate on the Tokyo Foreign Exchange Market as of

December 29, 2006.

2. Canon has made a three-for-two stock split on July 1, 2006. All per share information has been adjusted to reflect the stock split.

CONSOLIDATED BALANCE SHEETS
CANON INC. AND SUBSIDIARIES

ASSETS
Current assets:

Cash and cash equivalents
Marketable securities (notes 4 and 11)
Trade receivables, net (note 5)
Inventories (note 6)
Prepaid expenses and other current assets (notes 1, 8 and 14)

Total current assets

Noncurrent receivables (note 20)
Investments (notes 4 and 11)
Property, plant and equipment, net (notes 7 and 8)
Other assets (notes 8, 9, 10, 13 and 14)

Total assets

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:

Short-term loans and current portion of long-term debt (note 11)
Trade payables (note 12)
Income taxes (note 14)
Accrued expenses (note 20)
Other current liabilities (notes 7 and 14)

Total current liabilities

Long-term debt, excluding current installments (note 11)
Accrued pension and severance cost (note 13)
Other noncurrent liabilities (note 14)

Total liabilities
Minority interests
Commitments and contingent liabilities (note 20)
Stockholders’ equity:
Common stock

Authorized 3,000,000,000 shares;
issued 1,333,445,830 shares in 2006
and 1,333,114,169 shares in 2005 (note 15)

Additional paid-in capital (note 15)
Legal reserve (note 16)
Retained earnings (note 16)
Accumulated other comprehensive income (loss) (note 17)
Treasury stock, at cost 1,794,390 shares in 2006 and
1,718,523 shares in 2005
Total stockholders’ equity
Total liabilities and stockholders’ equity

See accompanying notes to consolidated financial statements.

December 31, 2006 and 2005

Millions of yen

Thousands of
U.S. dollars (note 2)

2006

2005

2006

¥1,155,626
10,445
761,947
539,057
315,274
2,782,349
14,335
110,418
1,266,425
348,388
¥4,521,915

1,004,953
172
689,427
510,195
253,822
2,458,569
14,122
104,486
1,148,821
317,555
4,043,553

15,362
493,058
133,745
303,353
217,789
1,163,307
15,789
83,876
55,536
1,318,508
216,801

5,059
505,126
110,844
248,205
209,394
1,078,628
27,082
80,430
52,395
1,238,535
200,336

$ 9,711,143
87,773
6,402,916
4,529,891
2,649,361
23,381,084
120,462
927,882
10,642,227
2,927,631
$ 37,999,286

129,092
4,143,345
1,123,908
2,549,185
1,830,159
9,775,689
132,681
704,840
466,689
11,079,899
1,821,858

174,603
403,510
43,600
2,368,047
2,718

174,438
403,246
42,331
2,018,289
(28,212)

1,467,252
3,390,840
366,386
19,899,555
22,840

(5,872)
2,986,606
¥4,521,915

(5,410)
2,604,682
4,043,553

(49,344)
25,097,529
$ 37,999,286

CONSOLIDATED STATEMENTS OF INCOME
CANON INC. AND SUBSIDIARIES

Year ended December 31 2006, 2005 and 2004

Net sales
Cost of sales (notes 10, 13 and 20)

Gross profit

Operating expenses:

Selling, general and administrative expenses
(notes 1, 10, 13 and 20)
Research and development expenses

Operating profit

Other income (deductions):

Interest and dividend income
Interest expense
Other, net (notes 1, 4 and 19)

Income before income taxes and minority interests

Income taxes (note 14)

Income before minority interests

Minority interests

Net income

Net income per share (note 18):

Basic
Diluted

Cash dividends per share

See accompanying notes to consolidated financial statements.

2006
¥4,156,759
2,096,279
2,060,480

Millions of yen

2005
3,754,191
1,935,148
1,819,043

2004
3,467,853
1,754,510
1,713,343

1,045,140
308,307
1,353,447
707,033

949,524
286,476
1,236,000
583,043

894,250
275,300
1,169,550
543,793

27,153
(2,190)
(12,853)
12,110
719,143

248,233
470,910

15,585
¥ 455,325

7,118
(2,756)
3,961
8,323
552,116

194,014
358,102

14,758
343,344

14,252
(1,741)
16,450
28,961
612,004

212,785
399,219

15,123
384,096

Yen

Thousands of
U.S. dollars (note 2)

2006
$34,930,748
17,615,790
17,314,958

8,782,689
2,590,815
11,373,504
5,941,454

228,176
(18,403)
(108,009)
101,764
6,043,218

2,085,991
3,957,227

130,966
$ 3,826,261

U.S. dollars (note 2)

341.95
341.84
83.33

288.63
288.36
66.67

258.53
257.85
43.33

2.87
2.87
0.70

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
CANON INC. AND SUBSIDIARIES

Total
stockholders’
equity

1,865,545
9,938
2,805
(246)
(52,950)
—

343,344

4,050
686
(396)
37,623
385,307
(503)
2,209,896
1,148
899
(64,310)
—

384,096

53,979
(1,397)
(481)
20,999
457,196
(147)
2,604,682
429
(104,298)
—

455,325

48,630
1,992
(489)
(3,575)
501,883
(15,628)
(462)
2,986,606

Millions of yen

Legal
reserve

Retained
earnings

Accumulated
other
comprehensive
income (loss)

Treasury
stock

39,998

1,410,442 (143,275)

(7,451)

2,691

Common
Stock

¥ 168,892
4,972

Additional
paid-in
capital

396,939
4,966
114
(246)

1,202

(52,950)
(1,202)

343,344

4,050
686
(396)
37,623

41,200

1,699,634 (101,312)

(503)
(5,263)

¥ 173,864
574

401,773
574
899

1,131

(64,310)
(1,131)

384,096

53,979
(1,397)
(481)
20,999

¥ 174,438
165

403,246
264

42,331

2,018,289

(28,212)

(147)
(5,410)

1,269

(104,298)
(1,269)

455,325

48,630
1,992
(489)
(3,575)

(15,628)

¥ 174,603

403,510

43,600

2,368,047

2,718

Thousands of U.S. dollars (note 2)

$1,465,865 3,388,622 355,722 16,960,412 (237,075)

1,387

2,218

10,664

(876,454)
(10,664)

3,826,261

(462)
(5,872)

(45,462) 21,888,084
3,605
(876,454)
—

3,826,261

408,655
16,739
(4,109)
(30,042)

408,655
16,739
(4,109)
(30,042)
4,217,504
(131,328)
(3,882)
(3,882)
22,840 (49,344) 25,097,529

(131,328)

$1,467,252 3,390,840 366,386 19,899,555

Balance at December 31, 2003
Conversion of convertible debt and other
Stock exchanged under exchange offering
Capital transaction by consolidated subsidiaries and affiliated companies
Cash dividends
Transfers to legal reserve
Comprehensive income:

Net income
Other comprehensive income (loss), net of tax (note 17)

Foreign currency translation adjustments
Net unrealized gains and losses on securities
Net gains and losses on derivative instruments
Minimum pension liability adjustments

Total comprehensive income
Repurchase of treasury stock, net
Balance at December 31, 2004
Conversion of convertible debt and other
Capital transaction by consolidated subsidiaries and affiliated companies
Cash dividends
Transfers to legal reserve
Comprehensive income:

Net income
Other comprehensive income (loss), net of tax (note 17)

Foreign currency translation adjustments
Net unrealized gains and losses on securities
Net gains and losses on derivative instruments
Minimum pension liability adjustments

Total comprehensive income
Repurchase of treasury stock, net
Balance at December 31, 2005
Conversion of convertible debt and other
Cash dividends
Transfers to legal reserve
Comprehensive income:

Net income
Other comprehensive income (loss), net of tax (note 17)

Foreign currency translation adjustments
Net unrealized gains and losses on securities
Net gains and losses on derivative instruments
Minimum pension liability adjustments

Total comprehensive income

Adjustment to initially apply SFAS 158, net of tax (note 13)
Repurchase of treasury stock, net
Balance at December 31, 2006

Balance at December 31, 2005
Conversion of convertible debt and other
Cash dividends
Transfers to legal reserve
Comprehensive income:

Net income
Other comprehensive income (loss), net of tax (note 17)

Foreign currency translation adjustments
Net unrealized gains and losses on securities
Net gains and losses on derivative instruments
Minimum pension liability adjustments

Total comprehensive income

Adjustment to initially apply SFAS 158, net of tax (note 13)
Repurchase of treasury stock, net
Balance at December 31, 2006

See accompanying notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS
CANON INC. AND SUBSIDIARIES

Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash

provided by operating activities:
Depreciation and amortization
Loss on disposal of property, plant and equipment
Deferred income taxes
Increase in trade receivables
(Increase) decrease in inventories
(Decrease) increase in trade payables
Increase in income taxes
Increase in accrued expenses
Decrease in accrued pension and severance cost
Other, net

Net cash provided by operating activities

Cash flows from investing activities:

Purchases of fixed assets
Proceeds from sale of fixed assets
Purchases of available-for-sale securities
Purchases of held-to-maturity securities
Proceeds from sale of available-for-sale securities
Increase in time deposits
Acquisitions of subsidiaries, net of cash acquired
Proceeds from sale of subsidiary common stock
Purchases of other investments
Other, net

Net cash used in investing activities

Cash flows from financing activities:

Proceeds from issuance of long-term debt
Repayments of long-term debt
Decrease in short-term loans
Dividends paid
Purchases of treasury stock, net
Other, net

Net cash used in financing activities
Effect of exchange rate changes on cash and
cash equivalents
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year

Supplemental disclosure for cash flow information
(note 22):

Cash paid during the year for:

Interest
Income taxes

See accompanying notes to consolidated financial statements.

Year ended December 31 2006, 2005 and 2004

Millions of yen

Thousands of
U.S. dollars (note 2)

2006

2005

2004

2006

¥ 455,325

384,096

343,344

$ 3,826,261

262,294
16,182
(6,945)
(40,969)
(5,542)
(2,313)
22,657
36,165
(20,309)
(21,304)
695,241

(424,862)
12,507
(7,768)
—
4,047
(35,863)
(2,485)
—
(8,911)
2,530
(460,805)

1,053
(5,861)
(828)
(104,298)
(462)
2,909
(107,487)

225,941
13,784
(766)
(48,391)
27,558
16,018
1,998
31,241
(16,221)
(29,580)
605,678

(395,055)
14,827
(5,680)
—
12,337
(6,090)
(17,657)
—
(19,531)
15,708
(401,141)

1,716
(15,187)
(12,011)
(64,310)
(147)
(4,000)
(93,939)

23,724
150,673
1,004,953
¥1,155,626

6,581
117,179
887,774
1,004,953

192,692
24,597
9,060
(53,595)
(40,050)
65,873
21,689
8,196
(16,924)
6,647
561,529

(256,714)
7,431
(388)
(21,544)
9,735
—
—
9,731
(8,628)
7,410
(252,967)

2,115
(43,175)
(3,046)
(52,950)
(494)
(4,718)
(102,268)

(8,818)
197,476
690,298
887,774

2,204,151
135,983
(58,361)
(344,277)
(46,571)
(19,437)
190,395
303,908
(170,664)
(179,027)
5,842,361

(3,570,269)
105,101
(65,277)
—
34,008
(301,370)
(20,882)
—
(74,882)
21,260
(3,872,311)

8,849
(49,252)
(6,958)
(876,454)
(3,882)
24,445
(903,252)

199,362
1,266,160
8,444,983
$ 9,711,143

2,146
244,236

1,919
211,540

2,981
164,450

18,034
2,052,403

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CANON INC. AND SUBSIDIARIES

(1) Basis of Presentation and Significant Accounting Policies
(a) Description of Business
Canon Inc. (the “Company”) and subsidiaries (collectively
“Canon”) is one of the world’s leading manufacturers in such
fields as office imaging products, computer peripherals, business
information products, cameras, and optical related products.
Office imaging products consist mainly of copying machines
and digital multifunction devices. Computer peripherals consist
mainly of laser beam and inkjet printers. Business information
products consist mainly of computer information systems,
micrographics and calculators. Cameras consist mainly of single
lens reflex (“SLR”) cameras, compact cameras, digital cameras
and video camcorders. Optical related products include steppers
and aligners used in semiconductor chip production, projection
aligners used in the production of liquid crystal displays (“LCDs”),
broadcasting lenses and medical equipment. Canon’s consoli-
dated net sales for the years ended December 31, 2006, 2005
and 2004 were distributed as follows: office imaging products
28%, 31% and 33%, computer peripherals 34%, 33% and
33%, business information products 3%, 3% and 3%, cameras
25%, 23% and 22%, and optical and other products 10%,
10% and 9%, respectively.

Sales are made principally under the Canon brand name,
almost entirely through sales subsidiaries. These subsidiaries
are responsible for marketing and distribution, and primarily
sell to retail dealers in their geographical area. Approximately
75%, 74% and 73% of consolidated net sales for the years
ended December 31, 2006, 2005 and 2004 were generated
outside Japan, with 31%, 30% and 30% in the Americas,
31%, 32% and 31% in Europe, and 13%, 12% and 12% in
other areas, respectively.

Canon sells laser beam printers on an OEM basis to

Hewlett-Packard Company; such sales constituted approximately
22%, 21% and 21% of consolidated net sales for the years
ended December 31, 2006, 2005 and 2004, respectively.

Canon’s manufacturing operations are conducted primarily
at 23 plants in Japan and 17 overseas plants which are located
in countries or regions such as the United States, Germany,
France, Taiwan, China, Malaysia, Thailand and Vietnam.

(b) Basis of Presentation
The Company and its domestic subsidiaries maintain their books
of account in conformity with financial accounting standards of
Japan. Foreign subsidiaries maintain their books of account in
conformity with financial accounting standards of the countries
of their domicile.

Certain adjustments and reclassifications have been incor-
porated in the accompanying consolidated financial statements
to conform with U.S. generally accepted accounting principles.
These adjustments were not recorded in the statutory books
of account.

(c) Principles of Consolidation
The consolidated financial statements include the accounts of
the Company, its majority owned subsidiaries and those variable
interest entities where the Company or its consolidated sub-
sidiaries are the primary beneficiaries under Financial Account-
ing Standards Board (“FASB”) Interpretation No. 46 (revised
December 2003) (“FIN 46R”), “Consolidation of Variable
Interest Entities.” All significant intercompany balances and
transactions have been eliminated.

(d) Use of Estimates
The preparation of the consolidated financial statements in
conformity with U.S. generally accepted accounting principles
requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the
consolidated financial statements and the reported amounts of
revenues and expenses during the period. Significant estimates
and assumptions are reflected in valuation and disclosure of
revenue recognition, allowance for doubtful receivables,
valuation of inventories, environmental liabilities, valuation of
deferred tax assets and employee retirement and severance
benefit plans. Actual results could differ materially from
those estimates.

(e) Cash Equivalents and Time Deposits
All highly liquid investments acquired with an original maturity
of three months or less are considered to be cash equivalents.
Time deposits with an original maturity of more than three
months are ¥41,953 million ($352,546 thousand) and ¥6,090
million at December 31, 2006 and 2005, respectively, and are
included in prepaid expenses and other current assets in the
accompanying consolidated balance sheets.

(f) Translation of Foreign Currencies
Assets and liabilities of the Company’s subsidiaries located
outside Japan with functional currencies other than Japanese
yen are translated into Japanese yen at the rates of exchange in
effect at the balance sheet date. Income and expense items are
translated at the average exchange rates prevailing during the
year. Gains and losses resulting from translation of financial
statements are excluded from earnings and are reported in
other comprehensive income (loss).

Gains and losses resulting from foreign currency transactions,
including foreign exchange contracts, and translation of assets
and liabilities denominated in foreign currencies are included in
other income (deductions). Foreign currency exchange losses,
net were ¥25,804 million ($216,840 thousand), ¥3,710 million
and ¥17,800 million for the years ended December 31, 2006,
2005 and 2004, respectively.

(g) Marketable Securities and Investments
Canon classifies investments in debt and marketable equity
securities as available-for-sale, or held-to-maturity securities.
Canon does not hold any trading securities which are bought
and held primarily for the purpose of sale in the near term.
Available-for-sale securities are recorded at fair value. Unrealized
holding gains and losses, net of the related tax effect, are
reported as a separate component of other comprehensive
income (loss) until realized. Held-to-maturity securities are
recorded at amortized cost, adjusted for the amortization or
accretion of premiums or discounts.

Available-for-sale and held-to-maturity securities are regu-

larly reviewed for other-than-temporary declines in carrying
value based on criteria that include the length of time and the
extent to which the market value has been less than cost, the
financial condition and near-term prospects of the issuer and
Canon’s intent and ability to retain the investment for a period
of time sufficient to allow for any anticipated recovery in market
value. When such a decline exists, Canon recognizes an impair-
ment loss to the extent by which the cost basis of the investment
exceeds the fair value of the investment. Fair value is determined
based on quoted market prices, projected discounted cash
flows or other valuation techniques as appropriate.

Realized gains and losses are determined on the average

cost method and reflected in earnings.

Other securities are stated at cost and reviewed periodically

for impairment.

(h) Allowance for Doubtful Receivables
Allowance for doubtful trade and finance receivables is main-
tained for all customers based on a combination of factors,
including aging analysis, macroeconomic conditions, significant
one-time events, and historical experience. An additional
reserve for individual accounts is recorded when Canon
becomes aware of a customer’s inability to meet its financial
obligations, such as in the case of bankruptcy filings. If circum-
stances related to customers change, estimates of the recover-
ability of receivables would be further adjusted. When all
collection options are exhausted including legal recourse, the
accounts or portions thereof are deemed to be uncollectible
and charged against the allowance.

(i) Inventories
Inventories are stated at the lower of cost or market value.
Cost is determined principally by the average method for
domestic inventories and the first-in, first-out method for
overseas inventories.

(j) Investments in Affiliated Companies
Investments in affiliated companies over which Canon has
the ability to exercise significant influence, but does not hold
a controlling financial interest, are accounted for by the
equity method.

(k) Impairment of Long-Lived Assets
Long-lived assets, such as property, plant and equipment, and
acquired intangibles subject to amortization, are reviewed for
impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of the asset to estimated
undiscounted future cash flows expected to be generated by the
asset. If the carrying amount of the asset exceeds its estimated
undiscounted future cash flows, an impairment charge is rec-
ognized in the amount by which the carrying amount of the
asset exceeds the fair value of the asset. Assets to be disposed
of by sale are reported at the lower of the carrying amount or
fair value less costs to sell, and are no longer depreciated.

(l) Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation
is calculated principally by the declining-balance method, except
for certain assets which are depreciated by the straight-line
method over the estimated useful lives of the assets. The
depreciation period ranges from 3 years to 60 years for buildings
and 2 years to 20 years for machinery and equipment.

Assets leased to others under operating leases are stated at

cost and depreciated to the estimated residual value of the
assets by the straight-line method over the period ranging from
2 years to 5 years.

(m) Goodwill and Other Intangible Assets
Goodwill and other intangible assets with indefinite useful
lives are not amortized, but are instead tested for impairment
annually in the fourth quarter of each year, or more frequently
if indicators of potential impairment exist. Intangible assets
with finite useful lives, consisting primarily of software and
license fees, are amortized using the straight-line method over
the estimated useful lives, which range from 3 years to 5 years
for software and 5 years to 10 years for license fees. Certain
costs incurred in connection with developing or obtaining
internal use software are capitalized. These costs consist of
payments made to third parties and the salaries of employees
working on such software development. Costs incurred in con-
nection with developing internal use software are capitalized at
the application development stage. In addition, Canon develops
or obtains certain software to be sold where related costs are
capitalized after establishment of technological feasibility.

(n) Environmental Liabilities
Liabilities for environmental remediation and other environ-
mental costs are accrued when environmental assessments or
remedial efforts are probable and the costs can be reasonably
estimated. Such liabilities are adjusted as further information
develops or circumstances change. Costs of future obligations
are not discounted to their present values.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

(o) Income Taxes
Deferred tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and
tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.

Canon records a valuation allowance to reduce the deferred
tax assets to the amount that is more likely than not realizable.

(p) Issuance of Stock by Subsidiaries and Equity Investees
The change in the Company’s proportionate share of a sub-
sidiary’s or equity investee’s equity resulting from the issuance
of stock by the subsidiary or equity investee is accounted for as
an equity transaction.

(q) Net Income per Share
Basic net income per share is computed by dividing net income
by the weighted-average number of common shares outstanding
during each year. Diluted net income per share includes the
effect from potential issuance of common stock based on the
assumption that all convertible debentures were converted into
common stock.

(r) Revenue Recognition
Canon generates revenue principally through the sale of
consumer products, equipment, supplies, and related services
under separate contractual arrangements. Canon recognizes
revenue when persuasive evidence of an arrangement exists,
delivery has occurred and title and risk of loss have been trans-
ferred to the customer, the sales price is fixed or determinable,
and collectibility is probable.

For arrangements with multiple elements, which may include

any combination of equipment, installation and maintenance,
Canon allocates revenue to each element based on its relative
fair value if such element meets the criteria for treatment as a
separate unit of accounting as prescribed in the Emerging
Issues Task Force (“EITF”) Issue No. 00-21, “Revenue Arrange-
ments with Multiple Deliverables.” Otherwise, revenue is
deferred until the undelivered elements are fulfilled as a single
unit of accounting.

Revenue from sales of consumer products including office
imaging products, computer peripherals, business information
products and cameras is recognized upon shipment or delivery,
depending upon when title and risk of loss transfer to the
customer.

Revenue from sales of optical equipment such as steppers
and aligners sold with customer acceptance provisions related to
their functionality is recognized when the equipment is installed
at the customer site and the specific criteria of the equipment

functionality are successfully tested and demonstrated by
Canon. Service revenue is derived primarily from maintenance
contracts on equipment sold to customers and is recognized as
services are provided.

Canon offers service maintenance contracts for most office
imaging products, for which the customer typically pays a base
service fee plus a variable amount based on usage. Revenue
from these service maintenance contracts is recognized as
services are provided.

Estimated product warranty costs are recorded at the time
revenue is recognized and are included in selling, general and
administrative expenses. Estimates for accrued product warranty
costs are based on historical experience, and are affected by
ongoing product failure rates, specific product class failures
outside of the baseline experience, material usage and service
delivery costs incurred in correcting a product failure.

(s) Research and Development Costs
Research and development costs are expensed as incurred.

(t) Advertising Costs
Advertising costs are expensed as incurred. Advertising
expenses were ¥116,809 million ($981,588 thousand),
¥106,250 million and ¥111,770 million for the years ended
December 31, 2006, 2005 and 2004, respectively.

(u) Shipping and Handling Costs
Shipping and handling costs totaled ¥62,626 million ($526,269
thousand), ¥50,052 million and ¥46,953 million for the years
ended December 31, 2006, 2005 and 2004, respectively, and
are included in selling, general and administrative expenses in
the consolidated statements of income.

(v) Derivative Financial Instruments
All derivatives are recognized at fair value and are included in
prepaid expenses and other current assets, or other current
liabilities in the consolidated balance sheets. On the date the
derivative contract is entered into, Canon designates the
derivative as either a hedge of the fair value of a recognized

asset or liability or of an unrecognized firm commitment (“fair
value” hedge), or a hedge of a forecasted transaction or the
variability of cash flows to be received or paid related to a rec-
ognized asset or liability (“cash flow” hedge). Canon formally
documents all relationships between hedging instruments and
hedged items, as well as its risk-management objective and
strategy for undertaking various hedge transactions. Canon
also formally assesses, both at the hedge’s inception and on an
ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair
values or cash flows of hedged items. When it is determined
that a derivative is not highly effective as a hedge or that it has
ceased to be a highly effective hedge, Canon discontinues
hedge accounting prospectively.

Changes in the fair value of a derivative that is designated
and qualifies as a fair-value hedge, along with the loss or gain
on the hedged asset or liability or unrecognized firm commitment
of the hedged item that is attributable to the hedged risk, are
recorded in earnings. Changes in the fair value of a derivative
that is designated and qualifies as a cash-flow hedge are
recorded in other comprehensive income (loss), until earnings
are affected by the variability in cash flows of the hedged item.
Gains and losses from hedging ineffectiveness are included in
other income (deductions). Gains and losses excluded from the
assessment of hedge effectiveness (time value component) are
included in other income (deductions).

Canon also uses certain derivative financial instruments
which are not designated as hedges. Canon records these
derivative financial instruments in the consolidated balance
sheets at fair value. The changes in fair values are immediately
recorded in earnings.

(w) Guarantees
Canon recognizes, at the inception of a guarantee, a liability
for the fair value of the obligation it has undertaken in issuing
guarantees.

(x) New Accounting Standards
In June 2006, the FASB ratified the EITF consensus on EITF Issue
No. 06-2, “Accounting for Sabbatical Leave and Other Similar
Benefits Pursuant to FASB Statement No. 43” (“EITF 06-2”).
EITF 06-2 provides guidance for an accrual of compensated
absences that require a minimum service period but have no
increase in the benefit even with additional years of service.
EITF 06-2 is effective for fiscal years beginning after December
15, 2006, and is required to be adopted by Canon in the first
quarter beginning January 1, 2007. The adoption of EITF 06-2
will not have a material impact on Canon’s consolidated results
of operations and financial condition.

In June 2006, the FASB issued FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes, an interpretation
of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the
accounting for uncertainty in income taxes by prescribing the
recognition threshold a tax position is required to meet before

being recognized in the financial statements. It also provides
guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition. FIN 48
is effective for fiscal years beginning after December 15, 2006
and is required to be adopted by Canon in the first quarter
beginning January 1, 2007. The adoption of FIN 48 will not
have a material impact on Canon’s consolidated results of
operations and financial condition.

In September 2006, the FASB issued Statement of

Financial Accounting Standards (“SFAS”) No. 157, “Fair Value
Measurements” (“SFAS 157”). SFAS 157 defines fair value,
establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. SFAS 157 is effec-
tive for fiscal years beginning after November 15, 2007 and is
required to be adopted by Canon in the first quarter beginning
January 1, 2008. Canon is currently evaluating the effect that
the adoption of SFAS 157 will have on its consolidated results
of operations and financial condition but does not expect
SFAS 157 to have a material impact.

In September 2006, the FASB issued SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other
Postretirement Plans, an amendment of FASB Statements No.
87, 88, 106, and 132(R)” (“SFAS 158”). SFAS 158 requires
plan sponsors of defined benefit pension and other postretire-
ment benefit plans (collectively, “postretirement benefit plans”)
to recognize the funded status of their postretirement benefit
plans in the consolidated balance sheet, measure the fair value
of plan assets and benefit obligations as of the date of the
fiscal year-end consolidated balance sheet, and provide addi-
tional disclosures. On December 31, 2006, Canon adopted the
recognition and disclosure provisions of SFAS 158. The effect
of adopting SFAS 158 on Canon’s financial condition at
December 31, 2006 has been included in the accompanying
consolidated financial statements. SFAS 158 did not have an
effect on Canon’s consolidated financial condition at December
31, 2005. SFAS 158’s provisions regarding the change in the
measurement date of postretirement benefit plans will not
have a material impact on Canon’s consolidated results of
operations and financial condition as Canon already uses a
measurement date of December 31 for the majority of its
plans. See Note 13 for further discussion of the effect of adopt-
ing SFAS 158 on Canon’s consolidated financial statements.

In September 2006, the Securities and Exchange Commission

(“SEC”) staff published Staff Accounting Bulletin No. 108,
“Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial State-
ments” (“SAB 108”). SAB 108 provides guidance on the con-
sideration of the effects of prior year misstatements in
quantifying current year misstatements for the purpose of a
materiality assessment. SAB 108 requires quantification of the
effects of financial statement errors on each of the balance
sheets and statements of income and the related financial
statement disclosures. SAB 108 was adopted by Canon in the
year ended December 31, 2006. The adoption of SAB 108 did

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

not have a material impact on Canon’s consolidated results of
operations and financial condition.

In February 2007, the FASB issued SFAS No. 159, “The Fair

Value Option for Financial Assets and Financial Liabilities—
Including an amendment of FASB Statement No. 115”
(“SFAS 159”). SFAS 159 provides companies with an option
to report selected financial assets and liabilities at fair value.
Unrealized gains and losses on items for which the fair value
option has been elected will be recognized in earnings. SFAS
159 is effective for fiscal years beginning after November 15,

2007 and is required to be adopted by Canon in the first quarter
beginning January 1, 2008. Canon is currently evaluating the
effect that the adoption of SFAS 159 will have on its consoli-
dated results of operations and financial condition but does not
expect SFAS 159 to have a material impact.

(y) Reclassification
Certain reclassifications have been made to the prior years’ con-
solidated financial statements to conform with the presentation
used for the year ended December 31, 2006.

(2) Basis of Financial Statement Translation
The consolidated financial statements presented herein are
expressed in Japanese yen and, solely for the convenience of
the reader, have been translated into United States dollars at
the rate of ¥119= U.S.$1, the approximate exchange rate

prevailing on the Tokyo Foreign Exchange Market on December
29, 2006. This translation should not be construed as a repre-
sentation that the amounts shown could be converted into
United States dollars at such rate.

(3) Foreign Operations
Amounts included in the consolidated financial statements
relating to subsidiaries operating in foreign countries are
summarized as follows:

December 31:
Total assets
Net assets

Year ended December 31:

Net sales
Net income

Millions of yen

2006

2005

2004

¥1,995,927
907,845

1,751,011
767,711

1,500,197
632,657

¥3,119,102
114,916

2,774,443
81,916

2,548,700
70,227

Thousands of
U.S. dollars

2006

$16,772,496
7,628,950

$26,210,941
965,681

(4) Marketable Securities and Investments
The cost, gross unrealized holding gains, gross unrealized
holding losses and fair value for available-for-sale securities and

held-to-maturity securities by major security type at December
31, 2006 and 2005 were as follows:

December 31

Millions of yen
2006: Current:

Available-for-sale:

Government bonds
Bank debt securities

Held-to-maturity:

Corporate debt securities

Noncurrent:

Available-for-sale:

Government bonds
Corporate debt securities
Fund trusts
Equity securities

Held-to-maturity:

Corporate debt securities

Millions of yen
2005: Current:

Available-for-sale:

Bank debt securities
Equity securities

Noncurrent:

Available-for-sale:

Government bonds
Corporate debt securities
Fund trusts
Equity securities

Held-to-maturity:

Corporate debt securities

Gross
Unrealized
Holding
Gains

Gross
Unrealized
Holding
Losses

—
—
—

—
—

—
35
1,536
17,479
19,050

—
19,050

Gross
Unrealized
Holding
Gains

—
—
—

7
3
1,446
15,086
16,542

—
16,542

—
1
1

—
1

15
1
1
275
292

—
292

Gross
Unrealized
Holding
Losses

—
—
—

—
—
—
10
10

—
10

Cost

224
71
295

10,151
¥ 10,446

335
4,090
4,072
12,648
21,145

10,311
¥ 31,456

Cost

71
101
172

525
85
4,553
11,373
16,536

20,961
¥ 37,497

Fair Value

224
70
294

10,151
10,445

320
4,124
5,607
29,852
39,903

10,311
50,214

Fair Value

71
101
172

532
88
5,999
26,449
33,068

20,961
54,029

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

Thousands of U.S. dollars
2006: Current:

Available-for-sale:

Government bonds
Bank debt securities

Held-to-maturity:

Corporate debt securities

Noncurrent:

Available-for-sale:

Government bonds
Corporate debt securities
Fund trusts
Equity securities

Held-to-maturity:

Corporate debt securities

Maturities of debt securities and fund trusts classified as

available-for-sale and held-to-maturity were as follows at
December 31, 2006:

Available-for-sale securities

Due within one year
Due after one year through five years
Due after five years

Held-to-maturity securities

Due within one year
Due after one year through five years

Gross
Unrealized
Holding
Gains

Gross
Unrealized
Holding
Losses

Cost

1,882
596
2,478

85,303
$ 87,781

2,815
34,370
34,218
106,286
177,689

86,647
$264,336

—
—
—

—
—

—
293
12,908
146,882
160,083

—
160,083

—
8
8

—
8

126
8
8
2,311
2,453

—
2,453

Fair Value

1,882
588
2,470

85,303
87,773

2,689
34,655
47,118
250,857
335,319

86,647
421,966

Millions of yen
Cost
¥ 295
5,606
2,891
¥8,792

Fair Value
294
7,104
2,947
10,345

Millions of yen
Cost
¥ 10,151
10,311
¥ 20,462

Fair Value
10,151
10,311
20,462

Thousands of
U.S. dollars
Cost
$ 2,478
47,109
24,294
$73,881

Fair Value
2,470
59,697
24,765
86,932

Thousands of
U.S. dollars
Cost
$ 85,303
86,647
$171,950

Fair Value
85,303
86,647
171,950

The gross realized gains for the years ended December 31,

2006, 2005 and 2004 were ¥674 million ($5,664 thousand),
¥11,049 million and ¥3,867 million, respectively. The gross
realized losses for the years ended December 31, 2006, 2005
and 2004 were not significant.

At December 31, 2006, substantially all of the available-
for-sale and held-to-maturity securities with unrealized losses
had been in a continuous unrealized loss position for less than
12 months.

Aggregate cost of non-marketable equity securities

accounted for under the cost method totaled ¥18,462 million
($155,143 thousand) and ¥16,714 million at December 31,
2006 and 2005, respectively. Investments with an aggregate
cost of ¥18,429 million ($154,866 thousand) were not

evaluated for impairment because (a) Canon did not estimate
the fair value of those investments as it was not practicable to
estimate the fair value of the investments and (b) Canon did
not identify any events or changes in circumstances that might
have had significant adverse effects on the fair value of those
investments.

Investments in affiliated companies accounted for by the
equity method amounted to ¥40,143 million ($337,336 thou-
sand) and ¥31,418 million at December 31, 2006 and 2005,
respectively. Canon’s share of the net earnings (losses) in affili-
ated companies accounted for by the equity method, included
in other income (deductions), are earnings of ¥4,237 million
($35,605 thousand), ¥1,646 million and ¥1,921 million for the
years ended December 31, 2006, 2005 and 2004, respectively.

(5) Trade Receivables
Trade receivables are summarized as follows:

December 31

Notes
Accounts

Less allowance for doubtful receivables

(6) Inventories
Inventories are summarized as follows:

December 31

Finished goods
Work in process
Raw materials

Millions of yen

2006
¥ 24,241
751,555
775,796
(13,849)
¥ 761,947

2005
27,328
673,827
701,155
(11,728)
689,427

Thousands of
U.S. dollars

2006
$ 203,706
6,315,588
6,519,294
(116,378)
$6,402,916

Millions of yen

2006
¥ 359,471
160,231
19,355
¥ 539,057

2005
359,934
132,520
17,741
510,195

Thousands of
U.S. dollars

2006
$3,020,765
1,346,479
162,647
$4,529,891

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

(7) Property, Plant and Equipment
Property, plant and equipment are stated at cost less
accumulated depreciation and are summarized as follows:

December 31

Land
Buildings
Machinery and equipment
Construction in progress

Less accumulated depreciation

Millions of yen

2006
231,026
1,077,585
1,261,176
79,582
2,649,369
(1,382,944)
¥ 1,266,425

2005
199,595
997,351
1,164,480
59,558
2,420,984
(1,272,163)
1,148,821

Thousands of
U.S. dollars

2006
$ 1,941,395
9,055,336
10,598,118
668,756
22,263,605
(11,621,378)
$ 10,642,227

Amounts due for purchases of property, plant and
equipment were ¥122,081 million ($1,025,891 thousand) and
¥116,716 million at December 31, 2006 and 2005, respec-

tively, and are included in other current liabilities in the
accompanying consolidated balance sheets.

(8) Finance Receivables and Operating Leases
Finance receivables represent financing leases which consist of
sales-type leases and direct-financing leases resulting from the
marketing of Canon’s and complementary third-party products.
These receivables typically have terms ranging from 1 to 6 years.

The components of the finance receivables, which are included
in prepaid expenses and other current assets, and other assets
in the accompanying consolidated balance sheets, are as follows:

December 31

Total minimum lease payments receivable
Unguaranteed residual values
Executory costs
Unearned income

Less allowance for doubtful receivables

Less amount due within one year

Millions of yen

2006
¥ 216,697
14,377
(2,923)
(24,930)
203,221
(7,871)
195,350
(72,808)
¥ 122,542

2005
204,774
13,849
(2,785)
(23,632)
192,206
(8,372)
183,834
(69,211)
114,623

Thousands of
U.S. dollars

2006
$1,820,983
120,815
(24,563)
(209,496)
1,707,739
(66,143)
1,641,596
(611,831)
$1,029,765

The cost of equipment leased to customers under operating

leases included in property, plant and equipment, net at
December 31, 2006 and 2005 was ¥62,357 million ($524,008
thousand) and ¥60,839 million, respectively. Accumulated

depreciation on equipment under operating leases at Decem-
ber 31, 2006 and 2005 was ¥46,092 million ($387,328 thou-
sand) and ¥45,285 million, respectively.

The following is a schedule by year of the future minimum
lease payments to be received under financing leases and non-
cancelable operating leases at December 31, 2006.

Year ending December 31

Millions of yen

Thousands of U.S. dollars

2007
2008
2009
2010
2011
Thereafter

Financing Leases Operating Leases
5,689
2,996
1,699
770
70
24
11,248

¥ 86,961
64,107
41,212
18,368
5,518
531
¥216,697

Financing Leases Operating Leases
47,807
$ 730,765
25,176
538,714
14,277
346,319
6,471
154,353
588
46,370
202
4,462
94,521
$1,820,983

(9) Acquisitions
In 2005, the Company acquired two companies for a total cost
of ¥20,205 million, which was paid in cash. Those companies
are engaged in the development, manufacturing and sales of
semiconductor manufacturing equipment, factory automation
equipment and vacuum equipment for production of electronic
parts, including semiconductors, flat panel displays, magnetic
heads and hard disc drives. In connection with those transactions,
the Company recognized goodwill of ¥4,885 million and intan-
gible assets of ¥16,382 million, which were classified as other
assets in the accompanying consolidated financial statements.
Intangible assets consist primarily of developed technology, and
are subject to a weighted average amortization period of
approximately 9 years.

In 2004, the Company acquired all of the outstanding
common shares of a precision plastic mold manufacturer, in an
exchange offering for 866,880 shares of the Company’s
common stock. The aggregate value of the shares exchanged
was approximately ¥2,805 million. In connection with this
transaction, the Company recognized goodwill of ¥1,585 mil-
lion, which was classified as other assets in the accompanying
consolidated financial statements.

Canon has included the results of operations of these trans-
actions prospectively from the respective dates of transactions.
Canon has not presented the pro forma results of operations of
the acquired businesses because the results are not material to
its consolidated results of operations on either an individual or
an aggregate basis.

(10) Goodwill and Other Intangible Assets
Intangible assets acquired during the year ended December 31,
2006 totaled ¥46,791 million ($393,202 thousand), which are
subject to amortization, and primarily consist of internal use
software of ¥33,996 million ($285,681 thousand) and license
fees of ¥5,898 million ($49,563 thousand). The weighted aver-

December 31

Millions of yen
Software
License fees
Other

Thousands of U.S. dollars

Software
License fees
Other

age amortization period for internal use software and license
fees is approximately 4 years and 8 years, respectively.

The components of acquired intangible assets subject to
amortization included in other assets at December 31, 2006
and 2005 were as follows:

2006

2005

Gross Carrying
Amount
¥140,756
23,681
24,899
¥189,336

2006

Gross Carrying
Amount
$1,182,824
199,000
209,235
$1,591,059

Accumulated
Amortization
76,120
11,257
4,919
92,296

Accumulated
Amortization
639,664
94,597
41,336
775,597

Gross Carrying
Amount
¥121,729
20,567
23,291
¥165,587

Accumulated
Amortization
70,535
11,329
4,997
86,861

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

Aggregate amortization expense for the years ended
December 31, 2006, 2005 and 2004 was ¥26,490 million
($222,605 thousand), ¥20,214 million and ¥18,295 million,
respectively. Estimated amortization expense for intangible
assets currently held for the next five years ending December
31 is ¥29,979 million ($251,924 thousand) in 2007, ¥23,033
million ($193,555 thousand) in 2008, ¥14,374 million

($120,790 thousand) in 2009, ¥8,127 million ($68,294 thou-
sand) in 2010, and ¥5,355 million ($45,000 thousand) in 2011.
Intangible assets not subject to amortization other than
goodwill at December 31, 2006 and 2005 were not significant.
The changes in the carrying amount of goodwill for the
years ended December 31, 2006 and 2005 were as follows:

Year ended December 31

Balance at beginning of year
Goodwill acquired during the year
Recognition of acquired company’s tax benefits
Translation adjustments and other
Balance at end of year

Millions of yen

2006
¥ 40,161
2,297
(1,038)
(619)
¥ 40,801

2005
24,233
15,391
—
537
40,161

Thousands of
U.S. dollars

2006
$337,487
19,303
(8,723)
(5,201)
$342,866

During the year ended December 31, 2006, Canon recog-
nized ¥1,038 million ($8,723 thousand) of deferred tax bene-
fits relating to preexisting net operating tax losses of a

company acquired in 2005. In connection therewith, Canon
reduced the related goodwill by the same amount.

(11) Short-Term Loans and Long-Term Debt
Short-term loans consisting of bank borrowings at December
31, 2006 and 2005 were ¥99 million ($832 thousand) and ¥67
million, respectively. The weighted average interest rate on

short-term loans outstanding at December 31, 2006 and 2005
were 4.91% and 2.14%, respectively.

Long-term debt consisted of the following:

December 31

Loans, principally from banks, maturing in installments through 2018;
bearing weighted average interest of 1.34% and 1.40%
at December 31, 2006 and 2005, respectively,
partially secured by mortgage of property, plant and equipment
2.95% Japanese yen notes, due 2007
2.27% Japanese yen notes, due 2008
1.30% Japanese yen convertible debentures, due 2008
Capital lease obligations

Less amount due within one year

Millions of yen

2006

2005

Thousands of
U.S. dollars

2006

149
10,000
10,000
318
10,585
31,052
(15,263)
¥ 15,789

2,641
10,000
10,000
649
8,784
32,074
(4,992)
27,082

1,251
84,034
84,034
2,672
88,950
260,941
(128,260)
$ 132,681

The aggregate annual maturities of long-term debt out-

standing at December 31, 2006 were as follows:

Year ending December 31

2007
2008
2009
2010
2011
Thereafter

Millions of yen
¥15,263
13,450
1,832
418
69
20
¥31,052

Thousands of
U.S. dollars
$128,260
113,025
15,395
3,513
580
168
$260,941

Canon entered into an agreement whereby certain assets
were deposited into an irrevocable trust to meet the debt service
requirements of the: 2.95% Japanese yen notes; and 2.27%
Japanese yen notes in the aggregate amount of ¥20,000 million
($168,068 thousand). The assets contributed by Canon were

debt securities with carrying amounts of ¥20,462 million
($171,950 thousand) at December 31, 2006. Cash flows from
such investments will be used solely to satisfy the principal and
interest obligations for the debts. Accordingly, the debt securities
are included in the consolidated balance sheets under the cap-
tions of marketable securities and investments.

Both short-term and long-term bank loans are made under
general agreements which provide that security and guarantees
for present and future indebtedness will be given upon request
of the bank, and that the bank shall have the right to offset
cash deposits against obligations that have become due or, in
the event of default, against all obligations due to the bank.

The 1.30% Japanese yen convertible debentures due 2008
are convertible into approximately 319,000 shares of common
stock at a conversion price of ¥998.00 ($8.39) per share at
December 31, 2006. The debentures are redeemable at the
option of the Company between January 1, 2007 and Decem-
ber 31, 2007 at premiums of 1%, and at par thereafter.

(12) Trade Payables
Trade payables are summarized as follows:

December 31

Notes
Accounts

Millions of yen

2006
¥ 15,902
477,156
¥ 493,058

2005
17,567
487,559
505,126

Thousands of
U.S. dollars

2006
$ 133,630
4,009,715
$4,143,345

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

(13) Employee Retirement and Severance Benefits
The Company and certain of its subsidiaries have contributory
and noncontributory defined benefit plans covering substan-
tially all employees after one year of service. Other subsidiaries
sponsor unfunded retirement and severance plans. Benefits
payable under the plans are based on employee earnings and
years of service.

The contributory plans in Japan mainly represented the
Employees’ Pension Fund plans (“EPFs”), composed of the
substitutional portions based on the pay-related part of the old
age pension benefits prescribed by the Welfare Pension Insurance
Law and the corporate portions based on contributory defined
benefit pension arrangements established at the discretion of
the Company and its subsidiaries. The substitutional portions
of the EPFs represented welfare pension plans carried on behalf
of the Japanese government. These contributory and noncon-
tributory plans were funded in conformity with the funding
requirements of applicable Japanese governmental regulations.
In January 2003, the EITF reached a final consensus on EITF

Issue No. 03-2, “Accounting for the Transfer to the Japanese
Government of the Substitutional Portion of Employee Pension
Fund Liabilities” (“EITF 03-2”), which addresses accounting for
a transfer to the Japanese government of a substitutional por-
tion of an EPF. During the year ended December 31, 2003, the
Company and certain of its domestic subsidiaries received
approval from the government for an exemption from the obli-
gation to pay benefits for future employee service related to the
substitutional portion. During the year ended December 31,
2004, the Company and certain of its domestic subsidiaries
received approval to separate the remaining substitutional
portion related to past service by their employees. During the
year ended December 31, 2004, the Company and certain of
its domestic subsidiaries also completed the transfer of the
substitutional portion of the benefit obligation and the related
government-specified portion of the plan assets which were
computed by the government, and were relieved of all related
obligations. Canon accounted for the entire process at the
completion of the transfer to the government of the substitu-
tional portion of the benefit obligation and the related plan
assets as a single settlement transaction in accordance with
EITF 03-2. As a result, Canon recognized a settlement loss of
¥69,651 million for the year ended December 31, 2004, which
was determined based on the proportion of the projected ben-
efit obligation settled to the total projected benefit obligation
immediately prior to the separation. Canon also recognized a
subsidy from the government of ¥86,792 million, which was
calculated as the difference between the obligation settled and
the assets transferred to the government. The net gain of

¥17,141 million was included in selling, general and administra-
tive expenses for the year ended December 31, 2004.

Effective January 1, 2007, Canon and certain of its domestic
subsidiaries have amended their defined benefit pension plans,
and the projected benefit obligation has decreased by ¥101,620
million ($853,950 thousand). In conjunction therewith, Canon
and certain of its domestic subsidiaries also have implemented a
defined contribution pension plan for certain future pension
benefits attributable to employees’ future services.

Canon uses a measurement date of December 31 for the

majority of its plans.

On December 31, 2006, Canon adopted the recognition

and disclosure provisions of SFAS 158. SFAS 158 required
Canon to recognize the funded status (i.e., the difference
between the fair value of plan assets and the projected benefit
obligations) of its pension plans in the December 31, 2006
consolidated balance sheet, with a corresponding adjustment
to accumulated other comprehensive income (loss), net of tax.
The adjustment to accumulated other comprehensive income
(loss) at adoption represents the unrecognized actuarial loss,
unrecognized prior service cost, and unrecognized net transi-
tion obligation, all of which were previously netted against the
plans' funded status in the consolidated balance sheet pur-
suant to the provisions of SFAS 87. These amounts will be
subsequently recognized as net periodic benefit cost pursuant
to Canon’s historical accounting policy for amortizing such
amounts. Further, actuarial gains and losses that arise in sub-
sequent periods and are not recognized as net periodic benefit
cost in the same periods will be recognized as a component of
other comprehensive income (loss). Those amounts will be
subsequently recognized as a component of net periodic ben-
efit cost on the same basis as the amounts recognized in accu-
mulated other comprehensive income (loss) at adoption of
SFAS 158.

The incremental effects of adopting the provisions of SFAS

158 on the accompanying consolidated balance sheet at
December 31, 2006 are presented in the following table. The
adoption of SFAS 158 had no effect on the consolidated state-
ment of income for the years ended December 31, 2006, or for
any prior period presented, and it will not effect Canon’s oper-
ating results in future periods. Had Canon not been required to
adopt SFAS 158 at December 31, 2006, it would have recog-
nized an additional minimum liability pursuant to the provisions
of SFAS 87. The effect of recognizing the additional minimum
liability is included in the table below in the column labeled
“Before application of SFAS 158.”

Other assets
Accrued expenses
Accrued pension and severance cost
Deferred income taxes
Minority interests
Accumulated other comprehensive income (loss)

Obligations and funded status
Reconciliations of beginning and ending balances of the benefit
obligations and the fair value of the plan assets are as follows:

December 31

Change in benefit obligations:

Benefit obligations at beginning of year
Service cost
Interest cost
Plan participants’ contributions
Amendments
Actuarial gain
Benefits paid
Acquisition
Foreign currency exchange rate changes
Other
Benefit obligations at end of year

Change in plan assets:

Fair value of plan assets at beginning of year
Actual return on plan assets
Employer contributions
Plan participants’ contributions
Benefits paid
Acquisition
Foreign currency exchange rate changes
Fair value of plan assets at end of year

Funded status at end of year

Before
Application of
SFAS 158
¥ 5,230
—
(57,031)
6,408
1,517
10,914

Millions of yen

Adjustments
(2,206)
(90)
(26,845)
9,516
3,997
15,628

Thousands of U.S. dollars

Before
Application of
SFAS 158
$ 43,949
—
(479,252)
53,849
12,748
91,714

Adjustments
(18,537)
(757)
(225,588)
79,966
33,588
131,328

After
Application of
SFAS 158
¥ 3,024
(90)
(83,876)
15,924
5,514
26,542

After
Application of
SFAS 158
$ 25,412
(757)
(704,840)
133,815
46,336
223,042

Millions of yen

2006

2005

¥620,493
27,399
17,309
1,412
(954)
23,586
(13,064)
714
11,696
—
688,591

545,518
18,858
44,981
1,412
(13,064)
320
9,624
607,649
¥ (80,942)

582,212
25,801
16,172
1,161
(6,212)
3,340
(12,239)
10,106
167
(15)
620,493

418,798
93,844
40,059
1,161
(12,239)
3,486
409
545,518
(74,975)

Thousands of
U.S. dollars

2006

$5,214,227
230,244
145,454
11,865
(8,017)
198,202
(109,782)
6,000
98,286
—
5,786,479

4,584,185
158,471
377,992
11,865
(109,782)
2,689
80,874
5,106,294
$ (680,185)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

Amounts recognized in the consolidated balance sheet at

December 31, 2006 consist of:

Other assets
Accrued expenses
Accrued pension and severance cost

Amounts recognized in accumulated other comprehensive

income (loss) at December 31, 2006 consist of:

Actuarial loss
Prior service cost
Net transition obligation

The funded status at December 31, 2005, reconciled to the

net amount recognized in the consolidated balance sheet at
that date, is summarized as follows:

Funded status
Unrecognized actuarial loss
Unrecognized prior service cost
Unrecognized net transition obligation
Net amount recognized

Amounts recognized in the consolidated balance sheet at

December 31, 2005 consist of:

Other assets
Accrued pension and severance cost
Accumulated other comprehensive income (loss)
Net amount recognized

Millions of yen
3,024
¥
(90)
(83,876)
¥ (80,942)

Thousands of
U.S. dollars

25,412
(757)
(704,840)
$ (680,185)

Millions of yen
¥ 139,305
(94,935)
3,610
¥ 47,980

Thousands of
U.S. dollars
$1,170,630
(797,773)
30,336
$ 403,193

Millions of yen
¥ (74,975)
110,424
(101,552)
3,955
¥ (62,148)

Millions of yen
3,089
¥
(80,430)
15,193
¥ (62,148)

The accumulated benefit obligation for all defined benefit

plans was as follows:

December 31

Accumulated benefit obligation

Millions of yen

2006
¥ 641,199

2005
578,627

Thousands of
U.S. dollars

2006
$5,388,227

The projected benefit obligations and the fair value of plan
assets for the pension plans with projected benefit obligations
in excess of plan assets, and the accumulated benefit obligations

and the fair value of plan assets for the pension plans with
accumulated benefit obligations in excess of plan assets are
as follows:

December 31

Plans with projected benefit obligations in excess of plan assets:

Projected benefit obligations
Fair value of plan assets

Plans with accumulated benefit obligations in excess of plan assets:

Accumulated benefit obligations
Fair value of plan assets

Millions of yen

2006

2005

¥ 656,722
572,756

608,812
568,615

587,162
510,287

545,375
506,634

Thousands of
U.S. dollars

2006

$5,518,673
4,813,076

5,116,067
4,778,277

Components of Net Periodic Benefit Cost
Net periodic benefit cost for Canon’s employee retirement and

severance defined benefit plans for the years ended December
31, 2006, 2005 and 2004 consisted of the following components:

Year ended December 31

Service cost
Interest cost
Expected return on plan assets
Amortization of net transition obligation
Amortization of prior service cost
Recognized actuarial loss
Settlement loss resulting from plan termination
Settlement loss resulting from transfer of
substitutional portion of EPFs to the Japanese government

The estimated net transition obligation, prior service cost
and actuarial loss for the defined benefit pension plans that
will be amortized from accumulated other comprehensive
income (loss) into net periodic benefit cost over the next year
are summarized as follows.

Net transition obligation
Prior service cost
Actuarial loss

Millions of yen
345
(13,491)
6,100

Thousands of
U.S. dollars
$

2,899
(113,370)
51,261

2006
¥ 27,399
17,309
(26,199)
345
(7,549)
3,779
—

—
¥ 15,084

Millions of yen

2005
25,801
16,172
(19,651)
345
(8,007)
10,542
—

—
25,202

2004
26,571
19,108
(17,054)
344
(6,814)
12,505
2,784

69,651
107,095

Thousands of
U.S. dollars

2006
$ 230,244
145,454
(220,160)
2,899
(63,437)
31,756
—

—
$ 126,756

The above prior service cost that will be amortized over the

next year includes amortization amounting to ¥5,834 million
($49,025 thousand) of prior service cost resulting from the plan
amendment effective January 1, 2007.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

Assumptions
Weighted-average assumptions used to determine benefit
obligations are as follows:

December 31
Discount rate
Assumed rate of increase in
future compensation levels

2006

2005
2.8% 2.7%

3.4% 3.3%

Weighted-average assumptions used to determine net

periodic benefit cost are as follows:

Year ended December 31
Discount rate
Assumed rate of increase in
future compensation levels
Expected long-term rate of
return on plan assets

2006

2005
2004
2.7% 2.7% 2.7%

3.3% 3.0% 2.0%

4.8% 4.6% 3.6%

Canon determines the expected long-term rate of return
based on the expected long-term return of the various asset
categories in which it invests. Canon considers the current
expectations for future returns and the actual historical returns
of each plan asset category.

Plan assets
The weighted-average asset allocations of Canon’s benefit plans
at December 31, 2006 and 2005 and target asset allocation by
asset category are as follows:

December 31

Asset category:

Equity securities
Debt securities
Cash
Life insurance company
general accounts
Other

2006

Target
2005 Allocation

40.5% 50.8% 37.5%
40.5% 34.6% 44.5%
0.4% 0.7% 0.1%

15.9% 13.5% 15.7%
2.7% 0.4% 2.2%
100.0% 100.0% 100.0%

Canon’s investment policies are designed to ensure adequate
plan assets are available to provide future payments of pension
benefits to eligible participants. Taking into account the expected
long-term rate of return on plan assets, Canon formulates a
“model” portfolio comprised of the optimal combination of
equity securities and debt securities. Plan assets are invested in
individual equity and debt securities using the guidelines of the
“model” portfolio in order to produce a total return that will
match the expected return on a mid-term to long-term basis.
Canon evaluates the gap between expected return and actual
return of invested plan assets on an annual basis to determine
if such differences necessitate a revision in the formulation of
the “model” portfolio. Canon revises the “model” portfolio
when and to the extent considered necessary to achieve the
expected long-term rate of return on plan assets.

The plan’s equity securities include common stock of the

Company and certain of its subsidiaries in the amounts of
¥1,797 million ($15,101 thousand) and ¥1,311 million at
December 31, 2006 and 2005, respectively.

Contributions
Canon expects to contribute ¥17,369 million ($145,958 thou-
sand) to its defined benefit plans for the year ending December
31, 2007.

Estimated future benefit payments
The following benefit payments, which reflect expected future
service, as appropriate, are expected to be paid:

Year ending December 31

2007
2008
2009
2010
2011
2012—2016

Millions of yen
¥ 10,709
12,514
13,914
15,216
16,800
109,869

Thousands of
U.S. dollars
$ 89,992
105,160
116,924
127,866
141,176
923,269

(14) Income Taxes
Domestic and foreign components of income before income
taxes and minority interests, and the current and deferred

Year ended December 31

2006: Income before income taxes and minority interests

Income taxes:
Current
Deferred

income tax expense (benefit) attributable to such income are
summarized as follows:

Japanese
¥556,759

¥201,022
(73)
¥200,949

Millions of yen

Foreign
162,384

54,156
(6,872)
47,284

Total
719,143

255,178
(6,945)
248,233

2005: Income before income taxes and minority interests

¥492,709

119,295

612,004

Income taxes:
Current
Deferred

¥172,595
3,441
¥176,036

40,956
(4,207)
36,749

213,551
(766)
212,785

2004: Income before income taxes and minority interests

¥447,864

104,252

552,116

Income taxes:
Current
Deferred

2006: Income before income taxes and minority interests

Income taxes:
Current
Deferred

¥162,679
(1,065)
¥161,614

22,275
10,125
32,400

184,954
9,060
194,014

Thousands of U.S. dollars

Japanese
$4,678,647

Foreign
1,364,571

Total
6,043,218

$1,689,260
(613)
$1,688,647

455,092
(57,748)
397,344

2,144,352
(58,361)
2,085,991

The Company and its domestic subsidiaries are subject to a
number of income taxes, which, in the aggregate, represent a
statutory income tax rate of approximately 40% for the years
ended December 31, 2006 and 2005, and 42% for the year
ended December 31, 2004.

Amendments to the Japanese tax regulations were enacted

on March 24, 2003. As a result of these amendments, the
statutory income tax rate was reduced from approximately

42% to 40% effective from the year beginning January 1,
2005. Consequently, the statutory tax rate utilized for deferred
tax assets and liabilities expected to be settled or realized
subsequent to January 1, 2005 is approximately 40%.

A reconciliation of the Japanese statutory income tax rate
and the effective income tax rate as a percentage of income
before income taxes and minority interests is as follows:

Year ended December 31
Japanese statutory income tax rate
Increase (reduction) in income taxes resulting from:

Expenses not deductible for tax purposes
Tax benefits not recognized on operating losses of subsidiaries
Income of foreign subsidiaries taxed at lower than Japanese statutory tax rate
Tax credit for research and development expenses
Other
Effective income tax rate

2006
40.0%

0.3
—
(2.1)
(4.1)
0.4
34.5%

2005
40.0%

0.3
—
(1.9)
(3.9)
0.3
34.8%

2004
42.0%

0.4
0.1
(2.1)
(4.0)
(1.3)
35.1%

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

Net deferred income tax assets and liabilities are included in

the accompanying consolidated balance sheets under the fol-
lowing captions:

December 31

Prepaid expenses and other current assets
Other assets
Other current liabilities
Other noncurrent liabilities

The tax effects of temporary differences that give rise to
the deferred tax assets and deferred tax liabilities at December
31, 2006 and 2005 are presented below:

December 31

Deferred tax assets:

Inventories
Accrued business tax
Accrued pension and severance cost
Research and development—costs capitalized for tax purposes
Property, plant and equipment
Accrued expenses
Net operating losses carried forward
Other

Total gross deferred tax assets
Less valuation allowance
Net deferred tax assets

Deferred tax liabilities:

Undistributed earnings of foreign subsidiaries
Net unrealized gains on securities
Tax deductible reserve
Financing lease revenue
Other

Total gross deferred tax liabilities
Net deferred tax assets

Millions of yen

2006
¥ 66,839
67,568
(4,133)
(39,299)
¥ 90,975

2005
52,116
61,325
(3,500)
(36,329)
73,612

Millions of yen

2006

2005

¥ 20,077
10,654
33,633
31,068
26,577
21,277
1,767
28,061
173,114
(6,500)
166,614

(9,138)
(7,521)
(11,955)
(35,990)
(11,035)
(75,639)
¥ 90,975

13,459
8,599
34,257
23,629
21,839
20,132
1,388
24,362
147,665
(3,345)
144,320

(6,806)
(6,480)
(14,307)
(35,395)
(7,720)
(70,708)
73,612

Thousands of
U.S. dollars

2006
$ 561,672
567,798
(34,731)
(330,243)
$ 764,496

Thousands of
U.S. dollars

2006

$ 168,714
89,530
282,630
261,076
223,336
178,798
14,849
235,807
1,454,740
(54,622)
1,400,118

(76,790)
(63,202)
(100,462)
(302,437)
(92,731)
(635,622)
$ 764,496

The net changes in the total valuation allowance were an

increase of ¥3,155 million ($26,513 thousand) for the year
ended December 31, 2006, and decreases of ¥150 million and
¥4,906 million for the years ended December 31, 2005 and
2004, respectively.

Based upon the level of historical taxable income and
projections for future taxable income over the periods which
the net deductible temporary differences are expected to
reverse, management believes it is more likely than not that

Canon will realize the benefits of these deferred tax assets, net
of the existing valuation allowance at December 31, 2006.
At December 31, 2006, Canon had net operating losses

which can be carried forward for income tax purposes of
¥5,567 million ($46,782 thousand) to reduce future taxable
income. Periods available to reduce future taxable income vary
in each tax jurisdiction and generally range from one year to
ten years as follows:

Within one year
After one year through five years
After five years through ten years
Indefinite period

Total

Millions of yen

¥ 2,979
967
101
1,520
¥ 5,567

Thousands of
U.S. dollars

$ 25,034
8,126
849
12,773
$ 46,782

Income taxes have not been accrued on undistributed
earnings of domestic subsidiaries as the tax law provides a
means by which the dividends from a domestic subsidiary can
be received tax free.

Canon has not recognized deferred tax liabilities of ¥36,568

million ($307,294 thousand) for a portion of undistributed
earnings of foreign subsidiaries that arose for the year ended
December 31, 2006 and prior years because Canon currently

does not expect to have such amounts distributed or paid as
dividends to the Company in the foreseeable future. Deferred
tax liabilities will be recognized when Canon expects that it will
realize those undistributed earnings in a taxable manner, such
as through receipt of dividends or sale of the investments. At
December 31, 2006, such undistributed earnings of these
subsidiaries were ¥597,969 million ($5,024,950 thousand).

(15) Common Stock
Based on the resolution of Board of Directors on May 11, 2006,
the Company made a three-for-two stock split on July 1, 2006,
for stockholders recorded in the stockholders’ register as of June
30, 2006. All share and per share information has been adjusted
to reflect the implementation of the stock split.

For the years ended December 31, 2006, 2005 and 2004,

the Company issued 331,661 shares, 1,148,292 shares and

9,957,909 shares of common stock, respectively, in connection
with the conversion of convertible debt. In accordance with the
Corporation Law of Japan, conversion into common stock of
convertible debt is accounted for by crediting one-half or more
of the conversion price to the common stock account and the
remainder to the additional paid-in capital account.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

(16) Legal Reserve and Retained Earnings
The Corporation Law of Japan provides that an amount equal
to 10% of distributions from retained earnings paid by the
Company and its Japanese subsidiaries be appropriated as a
legal reserve. No further appropriations are required when the
total amount of the additional paid-in capital and the legal
reserve equals 25% of their respective stated capital. The Cor-
poration Law of Japan also provides that additional paid-in cap-
ital and legal reserve are available for appropriations by the
resolution of the stockholders. Certain foreign subsidiaries are
also required to appropriate their earnings to legal reserves
under the laws of the respective countries.

Cash dividends and appropriations to the legal reserve
charged to retained earnings for the years ended December
31, 2006, 2005 and 2004 represent dividends paid out during
those years and the related appropriations to the legal

reserve. Retained earnings at December 31, 2006 do not reflect
current year-end dividends in the amount of ¥66,583 million
($559,521 thousand) which will be payable in March 2007
upon approval by the stockholders.

The amount available for dividends under the Corporation

Law of Japan is based on the amount recorded in the
Company’s nonconsolidated books of account in accordance
with financial accounting standards of Japan. Such amount
was ¥1,494,372 million ($12,557,748 thousand) at December
31, 2006.

Retained earnings at December 31, 2006 included Canon’s

equity in undistributed earnings of affiliated companies
accounted for by the equity method in the amount of ¥13,493
million ($113,387 thousand).

(17) Other Comprehensive Income (Loss)
Changes in accumulated other comprehensive income (loss)
are as follows:

Year ended December 31

Foreign currency translation adjustments:

Balance at beginning of year
Adjustments for the year
Balance at end of year

Net unrealized gains and losses on securities:

Balance at beginning of year
Adjustments for the year
Balance at end of year

Net gains and losses on derivative instruments:

Balance at beginning of year
Adjustments for the year
Balance at end of year

Minimum pension liability adjustments:

Balance at beginning of year
Adjustments for the year
Adjustment to initially apply SFAS 158
Balance at end of year
Pension liability adjustments:

Adjustment to initially apply SFAS 158
Balance at end of year

Millions of yen

2006

2005

2004

¥ (25,772)
48,630
22,858

(79,751)
53,979
(25,772)

(83,801)
4,050
(79,751)

6,073
1,992
8,065

(1,174)
(489)
(1,663)

(7,339)
(3,575)
10,914
—

(26,542)
(26,542)

7,470
(1,397)
6,073

(693)
(481)
(1,174)

(28,338)
20,999
—
(7,339)

—
—

6,784
686
7,470

(297)
(396)
(693)

(65,961)
37,623
—
(28,338)

—
—

Total accumulated other comprehensive income (loss):

Balance at beginning of year
Adjustments for the year
Adjustment to initially apply SFAS 158
Balance at end of year

(28,212)
46,558
(15,628)
2,718

(101,312)
73,100
—
(28,212)

(143,275)
41,963
—
(101,312)

Thousands of
U.S. dollars

2006

$(216,571)
408,655
192,084

51,034
16,739
67,773

(9,866)
(4,109)
(13,975)

(61,672)
(30,042)
91,714
—

(223,042)
(223,042)

(237,075)
391,243
(131,328)
$ 22,840

Tax effects allocated to each component of other com-
prehensive income (loss) and reclassification adjustments are
as follows:

Year ended December 31

2006:

Foreign currency translation adjustments
Net unrealized gains and losses on securities:

Amount arising during the year
Reclassification adjustments for gains and losses realized in net income
Net change during the year

Net gains and losses on derivative instruments:

Amount arising during the year
Reclassification adjustments for gains and losses realized in net income
Net change during the year

Minimum pension liability adjustments
Other comprehensive income (loss)

2005:

Foreign currency translation adjustments
Net unrealized gains and losses on securities:

Amount arising during the year
Reclassification adjustments for gains and losses realized in net income
Net change during the year

Net gains and losses on derivative instruments:

Amount arising during the year
Reclassification adjustments for gains and losses realized in net income
Net change during the year

Minimum pension liability adjustments
Other comprehensive income (loss)

2004:

Foreign currency translation adjustments
Net unrealized gains and losses on securities:

Amount arising during the year
Reclassification adjustments for gains and losses realized in net income
Net change during the year

Net gains and losses on derivative instruments:

Amount arising during the year
Reclassification adjustments for gains and losses realized in net income
Net change during the year

Minimum pension liability adjustments
Other comprehensive income (loss)

Before-Tax
Amount

Millions of yen

Tax (Expense)
or Benefit

Net-of-Tax
Amount

¥ 49,518

(888)

48,630

3,708
(388)
3,320

(7,126)
6,309
(817)
(4,391)
¥ 47,630

(1,502)
174
(1,328)

2,858
(2,530)
328
816
(1,072)

2,206
(214)
1,992

(4,268)
3,779
(489)
(3,575)
46,558

¥ 55,345

(1,366)

53,979

9,005
(10,793)
(1,788)

(9,137)
8,333
(804)
40,364
¥ 93,117

(3,892)
4,283
391

3,658
(3,335)
323
(19,365)
(20,017)

5,113
(6,510)
(1,397)

(5,479)
4,998
(481)
20,999
73,100

¥ 4,400

(350)

4,050

5,022
(3,698)
1,324

(1,673)
929
(744)
78,179
¥ 83,159

(2,202)
1,564
(638)

708
(360)
348
(40,556)
(41,196)

2,820
(2,134)
686

(965)
569
(396)
37,623
41,963

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

Year ended December 31

2006:

Foreign currency translation adjustments
Net unrealized gains and losses on securities:

Amount arising during the year
Reclassification adjustments for gains and losses realized in net income
Net change during the year

Net gains and losses on derivative instruments:

Amount arising during the year
Reclassification adjustments for gains and losses realized in net income
Net change during the year

Minimum pension liability adjustments
Other comprehensive income (loss)

Thousands of U.S. dollars

Before-Tax
Amount

Tax (Expense)
or Benefit

Net-of-Tax
Amount

$ 416,117

(7,462)

408,655

31,160
(3,261)
27,899

(59,883)
53,017
(6,866)
(36,899)
$ 400,251

(12,622)
1,462
(11,160)

24,017
(21,260)
2,757
6,857
(9,008)

18,538
(1,799)
16,739

(35,866)
31,757
(4,109)
(30,042)
391,243

(18) Net Income per Share
The basic and diluted net income per share as well as the
number of shares has been calculated to reflect the three-for-
two stock split that was completed on July 1, 2006.

A reconciliation of the numerators and denominators of basic

and diluted net income per share computations is as follows:

Year ended December 31

Net income
Effect of dilutive securities:

1.20% Japanese yen convertible debentures,
due 2005
1.30% Japanese yen convertible debentures,
due 2008
Diluted net income

Average common shares outstanding
Effect of dilutive securities:

1.20% Japanese yen convertible debentures,
due 2005
1.30% Japanese yen convertible debentures,
due 2008

Diluted common shares outstanding

2006
¥ 455,325

Millions of yen

2005
384,096

2004
343,344

Thousands of
U.S. dollars

2006
$3,826,261

—

8
¥ 455,333

18
384,119

72
343,440

67
$3,826,328

Number of shares
1,331,542,074 1,330,760,715 1,328,047,686

—

185,755

694,235

474,796

3,187,917
1,332,016,870 1,332,065,401 1,331,929,838

1,118,931

Net income per share:

Basic
Diluted

Yen

U.S. dollars

¥ 341.95
341.84

288.63
288.36

258.53
257.85

$2.87
2.87

(19) Derivatives and Hedging Activities
Risk management policy
Canon operates internationally, exposing it to the risk of
changes in foreign currency exchange rates and interest rates.
Derivative financial instruments are comprised principally of
foreign exchange contracts and interest rate swaps utilized by
the Company and certain of its subsidiaries to reduce these risks.
Canon assesses foreign currency exchange rate risk and interest
rate risk by continually monitoring changes in these exposures
and by evaluating hedging opportunities. Canon does not hold
or issue derivative financial instruments for trading purposes.
Canon is also exposed to credit-related losses in the event of
non-performance by counterparties to derivative financial
instruments, but it is not expected that any counterparties will
fail to meet their obligations, because most of the counterparties
are internationally recognized financial institutions and contracts
are diversified across a number of major financial institutions.

Foreign currency exchange rate risk management
Canon’s international operations expose Canon to the risk of
changes in foreign currency exchange rates. Canon uses
foreign exchange contracts to manage certain foreign currency
exchange exposures principally from the exchange of U.S.
dollar and euro into Japanese yen. These contracts are primarily
used to hedge the foreign currency exposure of forecasted
intercompany sales and intercompany trade receivables which
are denominated in foreign currencies. In accordance with
Canon’s policy, a specific portion of foreign currency exposure
resulting from forecasted intercompany sales are hedged using
foreign exchange contracts which principally mature within
three months.

Interest rate risk management
Canon’s exposure to the risk of changes in interest rates relates
primarily to its debt obligations. The variable-rate debt obliga-
tions expose Canon to variability in their cash flows due to
change in interest rates. To manage the variability in cash flows
caused by interest rate changes, Canon enters into interest rate
swaps when it is determined to be appropriate based on
market conditions. The interest rate swaps change variable-rate
debt obligations to fixed-rate debt obligations by primarily
entering into pay-fixed, receive-variable interest rate swaps.

December 31

To sell foreign currencies
To buy foreign currencies

Fair value hedge
Derivative financial instruments designated as fair value hedges
principally relate to interest rate swaps associated with fixed
rate debt obligations. Changes in fair values of the hedged
debt obligations and derivative financial instruments designated
as fair value hedges of these debt obligations are recognized in
other income (deductions). There is no hedging ineffectiveness
or net gains or losses excluded from the assessment of hedge
effectiveness for the year ended December 31, 2004 as the
critical terms of the interest rate swaps match the terms of the
hedged debt obligations.

Cash flow hedge
Changes in the fair value of derivative financial instruments
designated as cash flow hedges, including foreign exchange
contracts associated with forecasted intercompany sales and
interest rate swaps associated with variable rate debt obligations,
are reported in accumulated other comprehensive income (loss).
These amounts are subsequently reclassified into earnings
through other income (deductions) in the same period as the
hedged items affect earnings. Substantially all amounts
recorded in accumulated other comprehensive income (loss) at
year-end are expected to be recognized in earnings over the
next twelve months. Canon excludes the time value component
from the assessment of hedge effectiveness.

The amount of the hedging ineffectiveness was not material

for the years ended December 31, 2006, 2005 and 2004. The
amount of net gains or losses excluded from the assessment of
hedge effectiveness (time value component) which was recorded
in other income (deductions) was net losses of ¥5,917 million
($49,723 thousand), ¥3,725 million and ¥2,096 million for the
years ended December 31, 2006, 2005 and 2004, respectively.

Derivatives not designated as hedges
Canon has entered into certain foreign exchange contracts to
manage its foreign currency exposures. These foreign exchange
contracts have not been designated as hedges. Accordingly,
the changes in fair value of the contracts are recorded in
earnings immediately.

Contract amounts of foreign exchange contracts at

December 31, 2006 and 2005 are set forth below:

Millions of yen

2006
¥ 717,136
51,189

2005
645,188
46,424

Thousands of
U.S. dollars

2006
$6,026,353
430,160

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

(20) Commitments and Contingent Liabilities
Commitments
At December 31, 2006, commitments outstanding for the
purchase of property, plant and equipment approximated
¥107,685 million ($904,916 thousand), and commitments
outstanding for the purchase of parts and raw materials
approximated ¥85,403 million ($717,672 thousand).

Canon occupies sales offices and other facilities under lease

arrangements accounted for as operating leases. Deposits
made under such arrangements aggregated ¥13,648 million
($114,689 thousand) and ¥13,790 million at December 31,

2006 and 2005, respectively, and are included in noncurrent
receivables in the accompanying consolidated balance sheets.
Rental expenses under the operating lease arrangements
amounted to ¥36,157 million ($303,840 thousand), ¥38,297
million and ¥41,381 million for the years ended December 31,
2006, 2005 and 2004, respectively.

Future minimum lease payments required under noncance-
lable operating leases that have initial or remaining lease terms
in excess of one year at December 31, 2006 are as follows:

Year ending December 31

2007
2008
2009
2010
2011
Thereafter

Total future minimum lease payments

Millions of yen

¥ 16,025
12,975
9,590
5,962
4,570
11,256
¥ 60,378

Thousands of
U.S. dollars
$134,664
109,034
80,588
50,101
38,403
94,588
$507,378

Guarantees
Canon provides guarantees for bank loans of its employees,
affiliates and other companies. The guarantees for the employ-
ees are principally made for their housing loans. The guarantees
of loans of its affiliates and other companies are made to
ensure that those companies operate with less financial risk.

For each guarantee provided, Canon would have to perform

under a guarantee if the borrower defaults on a payment
within the contract periods of 1 year to 30 years, in the case of
employees with housing loans, and of 1 year to 10 years, in the
case of affiliates and other companies. The maximum amount

of undiscounted payments Canon would have had to make in
the event of default is ¥30,051 million ($252,529 thousand) at
December 31, 2006. The carrying amounts of the liabilities
recognized for Canon’s obligations as a guarantor under those
guarantees at December 31, 2006 were not significant.

Canon also issues contractual product warranties under
which it generally guarantees the performance of products
delivered and services rendered for a certain period or term.
Changes in accrued product warranty cost for the years ended
December 31, 2006 and 2005 are summarized as follows:

Year ended December 31

Balance at beginning of year
Addition
Utilization
Other
Balance at end of year

Millions of yen

2006
¥ 16,746
15,213
(14,266)
451
¥ 18,144

2005
14,264
18,510
(15,580)
(448)
16,746

Thousands of
U.S. dollars

2006
$ 140,723
127,840
(119,882)
3,790
$ 152,471

Legal proceedings
In February 2003, a lawsuit was filed by St. Clair Intellectual
Property Consultants, Inc. (“St. Clair”) against the Company
and one of its subsidiaries in the United States District Court of
Delaware, which accused the Company of infringement of
patents related to certain technology. In connection with this
case, in October 2004, a jury preliminarily found damages
against the Company of approximately ¥4,000 million
($33,613 thousand) based on a percentage of certain product
sales in the United States through 2003. Subsequent to this jury
finding, St. Clair also made a motion to the court for damages
relating to certain 2004 sales, using the same royalty rate
awarded by the jury. In March 2006, the Company and St. Clair
entered into a settlement agreement, pursuant to which the
lawsuit was withdrawn in July 2006.

In October 2003, a lawsuit was filed by a former employee

against the Company at the Tokyo District Court in Japan.
The lawsuit alleges that the former employee is entitled to
¥45,872 million ($385,479 thousand) as compensation for an
invention related to certain technology used by the Company,
and the former employee has sued for a partial payment of
¥1,000 million ($8,403 thousand) and interest thereon. On Jan-
uary 30, 2007, the Tokyo District Court in Japan ordered the
Company to pay the former employee approximately ¥33.5
million ($282 thousand) and interest thereon. On the same
day, the Company appealed the decision.

In Germany, Verwertungsgesellschaft Wort (“VG Wort”),
a collecting agency representing certain copyright holders, has
filed a series of lawsuits seeking to impose copyright levies
upon digital products such as PCs and printers, that allegedly
enable the reproduction of copyrighted materials, against the
companies importing and distributing these digital products. In
May 2004, VG Wort filed a civil lawsuit against Hewlett-Packard
GmbH seeking levies on multi-function printers. This is an
industry test case under which Hewlett-Packard GmbH represents
other companies sharing common interests, and Canon has
undertaken to be bound by the final decision of this court case.
The court of first instance and the court of appeals held that
the multi-function printers were subject to a levy. In particular,
the court of appeals ordered Hewlett-Packard GmbH to pay
the amount equivalent to the levies imposed on photocopiers
(EUR 38.35 to EUR 613.56 per unit, depending on printing
speed and color printing capability). This lawsuit is currently
under appeal before the German Federal Supreme Court. With
regard to single-function printers, VG Wort filed a separate
lawsuit in January 2006 against Canon seeking payment of
copyright levies, and the court of first instance in Düsseldorf
ruled in favor of the claim by VG Wort in November 2006.
Canon lodged an appeal against such decision in December
2006. In a similar court case, which does not include Canon,
seeking copyright levies on single-function printers of Epson
Deutschland GmbH, Xerox GmbH and Kyocera Mita Deutsch-
land GmbH, the court of appeals in Düsseldorf rejected such
alleged levies on January 23, 2007. Canon, other companies

and the industry associations have expressed opposition to
such extension of the levy scope and the final conclusion of
these court cases including the amount of levies to be imposed,
remains uncertain.

In April 2005, a lawsuit was filed by Nano-Proprietary Inc.

(“NPI”) against the Company and Canon U.S.A. Inc. in the
United States District Court of Texas alleging that SED Inc., a
joint venture company established by the Company and
Toshiba Corporation, is not regarded as a “Subsidiary” under
the Patent License Agreement between the Company and NPI
(the “Agreement”) and that the extension of the license to SED
Inc. constitutes a breach of the Agreement. NPI also alleges
that there was fraudulent conduct by the Company in execut-
ing the Agreement, and requests rescission of the Agreement
and compensatory damages. This case is still pending and the
final outcome, including any liability to the Company, is not yet
determined, but in November 2006, the Court denied the
Company’s Motion for a summary judgment that SED Inc. is a
Subsidiary of the Company. In January 2007, the Company
purchased all the shares of SED Inc. owned by Toshiba Corpo-
ration, making SED Inc. a 100% owned subsidiary of the Com-
pany. However, on February 22, 2007, the court issued a
summary judgment stating that SED Inc. (before the above
stock purchase) was not a Subsidiary of the Company, and that
the Agreement has been terminated due to a material breach
of the Agreement by the Company. The remaining pending
issues at the district court are whether the Company was
engaged in fraudulent conduct and whether compensatory
damages should be granted. The Company will appeal to the
appellate court immediately after the current proceeding at the
district court has been concluded regardless of any judgments
rendered by the district court.

Canon is involved in various claims and legal actions,
including those noted above, arising in the ordinary course of
business. In accordance with SFAS No. 5, “Accounting for
Contingencies,” Canon has recorded provisions for liabilities
when it is probable that liabilities have been incurred and the
amount of loss can be reasonably estimated. Canon reviews
these provisions at least quarterly and adjusts these provisions
to reflect the impact of the negotiations, settlements, rulings,
advice of legal counsel and other information and events
pertaining to a particular case. Based on its experience, Canon
believes that any damage amounts claimed in the specific
matters discussed above are not a meaningful indicator of
Canon’s potential liability. In the opinion of management, the
ultimate disposition of the above mentioned matters will not
have a material adverse effect on Canon’s consolidated financial
position, results of operations, or cash flows. However, litigation
is inherently unpredictable. While Canon believes that it has
valid defenses with respect to legal matters pending against it,
it is possible that Canon’s consolidated financial position,
results of operations, or cash flows could be materially affected
in any particular period by the unfavorable resolution of one or
more of these matters.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES

(21) Disclosures about the Fair Value of Financial Instruments and Concentrations of Credit Risk
Fair value of financial instruments
The estimated fair values of Canon’s financial instruments at
December 31, 2006 and 2005 are set forth below. The following
summary excludes cash and cash equivalents, trade receivables,
finance receivables, noncurrent receivables, short-term loans,

trade payables, accrued expenses for which fair values
approximate their carrying amounts. The summary also
excludes marketable securities and investments which are
disclosed in Note 4.

December 31

Long-term debt, including current installments
Foreign exchange contracts:

Assets
Liabilities

Millions of yen

2006

2005

Thousands of U.S. dollars
2006

Carrying
Amount
¥(31,052)

Estimated
Fair Value
(32,795)

Carrying
Amount
(32,074)

Estimated
Fair Value
(35,194)

Carrying
Amount
$ (260,941)

Estimated
Fair Value
(275,588)

307
(17,534)

2,250
(10,062)

2,580
(147,345)

The following methods and assumptions are used to

estimate the fair value in the above table.

Long-term debt
The fair values of Canon’s long-term debt instruments are
based on the quoted price in the most active market or the
present value of future cash flows associated with each instru-
ment discounted using Canon’s current borrowing rate for
similar debt instruments of comparable maturity.

Foreign exchange contracts
The fair values of foreign exchange contracts, all of which are
used for purposes other than trading, are estimated by obtaining
quotes from brokers.

Limitations
Fair value estimates are made at a specific point in time, based
on relevant market information and information about the
financial instruments. These estimates are subjective in nature
and involve uncertainties and matters of significant judgment
and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates.

Concentrations of credit risk
At December 31, 2006 and 2005, one customer accounted for
approximately 14% and 12% of consolidated trade receivables,
respectively. Although Canon does not expect that the customer
will fail to meet its obligations, Canon is potentially exposed to
concentrations of credit risk if the customer failed to perform
according to the terms of the contracts.

(22) Supplemental Cash Flow Information
For the years ended December 31, 2006, 2005 and 2004,
aggregate common stock and additional paid-in capital
arising from conversion of convertible debt amounted to

¥331 million ($2,782 thousand), ¥1,147 million and ¥9,938
million, respectively.

(23) Subsequent Event
On February 15, 2007, the Board of Directors of the Company
approved a plan to repurchase up to 17 million shares of the
Company’s common stock at a cost of up to ¥100,000 million
($840,336 thousand) for the period from February 16, 2007 to
March 16, 2007. Such repurchases are intended to improve
capital efficiency and ensure flexible capital strategy. Common
stock repurchased in the Tokyo Stock Exchange between
February 16, 2007 and March 6, 2007 under the aforemen-

tioned plan was 15,423,300 shares at a cost of ¥100,000 mil-
lion ($840,336 thousand).

On March 8, 2007, the Board of Directors of the Company

approved an additional plan to repurchase up to 17 million
shares of the Company’s common stock at a cost of up to
¥100,000 million ($840,336 thousand) for the period from
March 9, 2007 to April 9, 2007.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Canon is responsible for establishing and maintaining adequate internal control over financial reporting.
Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934 as a
process designed by, or under the supervision of, the company’s principal executive and principal financial officers and effected by
the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles and includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable
detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Canon’s management assessed the effectiveness of internal control over financial reporting as of December 31, 2006. In making
this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission in Internal Control-Integrated Framework (the COSO criteria).

Based on its assessment, management concluded that, as of December 31, 2006, Canon’s internal control over financial reporting
was effective based on the COSO criteria.

Canon’s independent registered public accounting firm, Ernst & Young ShinNihon has issued an audit report on our assessment of
internal control over financial reporting.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of
Canon Inc.

We have audited the accompanying consolidated balance sheets of Canon Inc. and subsidiaries (the “Company”) as of December
31, 2006 and 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three
years in the period ended December 31, 2006, all expressed in Japanese yen. These financial statements are the responsibility of
the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

The Company’s consolidated financial statements do not disclose segment information required by Statement of Financial
Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information.” In our opinion, disclosure
of segment information is required by U.S. generally accepted accounting principles.

In our opinion, except for the omission of segment information as discussed in the preceding paragraph, the financial statements
referred to above present fairly, in all material respects, the consolidated financial position of Canon Inc. and subsidiaries at
December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in
the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
effectiveness of Canon Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2006, based on criteria
established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 16, 2007 expressed an unqualified opinion thereon.

We have also recomputed the translation of the consolidated financial statements as of and for the year ended December 31,
2006 into United States dollars. In our opinion, the consolidated financial statements expressed in Japanese yen have been
translated into United States dollars on the basis described in Note 2.

March 16, 2007

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of
Canon Inc.

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over
Financial Reporting, that Canon Inc. and subsidiaries (the “Company”) maintained effective internal control over financial
reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is
responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the
effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal
control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets
of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial statements.

In our opinion, management’s assessment that Canon Inc. and subsidiaries maintained effective internal control over financial
reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion,
Canon Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December
31, 2006, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
accompanying consolidated balance sheets of Canon Inc. and subsidiaries as of December 31, 2006 and 2005, and the related
consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December
31, 2006, all expressed in Japanese yen, and our report thereon dated March 16, 2007 stated that, except for the omission of
segment information required by Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an
Enterprise and Related Information,” the financial statements referred to above present fairly, in all material respects, the
consolidated financial position of Canon Inc. and subsidiaries at December 31, 2006 and 2005, and the consolidated results of
their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S.
generally accepted accounting principles.

March 16, 2007

TRANSFER AND REGISTRAR’S OFFICE

STOCKHOLDER INFORMATION

Canon Inc.

30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan

Stock Exchange Listings:
Tokyo, Osaka, Nagoya, Fukuoka, Sapporo, New York and
Frankfurt am Main stock exchanges

Manager of the Register of Stockholders
Mizuho Trust & Banking Co., Ltd.

2-1, Yaesu 1-chome, Chuo-ku, Tokyo 103-8670, Japan

Depositary and Agent with Respect to American Depositary

Receipts for Common Shares

JPMORGAN Chase Bank

4 New York Plaza, New York, N.Y. 10004, U.S.A.

Depositaries and Agents with Respect to Global Bearer

Certificates for Common Shares

Clearstream Banking AG

Neue Börsenstraße 1, 60487 Frankfurt am Main, Germany

Deutsche Bank AG

Taunusanlage 12, 60325 Frankfurt am Main, Germany

American Depositary Receipts are traded on the New York Stock
Exchange (CAJ).

Stockholders’ Annual General Meeting:
March 29, 2007, in Tokyo

Further Information:
For publications or information, please contact the
Corporate Communications Center, Canon Inc., Tokyo,
or access Canon’s Website at
www.canon.com/

CORPORATE PROFILE

CORPORATE PHILOSOPHY: Kyosei

CORPORATE GOAL

CONTENTS

FINANCIAL HIGHLIGHTS ............................ 1

TO OUR STOCKHOLDERS ...........................

EXCELLENT GLOBAL CORPORATION

PLAN—PHASE III ......................................... 4

CORPORATE GOVERNANCE ....................... 10

CORPORATE FUNCTIONS ........................... 15

RESEARCH & DEVELOPMENT

PRODUCTION

SALES & MARKETING

CORPORATE SOCIAL RESPONSIBILITY

PRODUCT GROUPS ..................................... 27

OFFICE IMAGING PRODUCTS

COMPUTER PERIPHERALS

CAMERAS

OPTICAL AND OTHER PRODUCTS

MAJOR CONSOLIDATED SUBSIDIARIES .... 36

FINANCIAL SECTION ................................... 37
TRANSFER AND REGISTRAR’S OFFICE ....... 92
STOCKHOLDER INFORMATION ................. 92

PUB. BEP016 0704SZ 19.3 Printed in Japan

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CANON ANNUAL REPORT 2006

Fiscal Year Ended December 31, 2006

CANON INC. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan