Canon Annual Report 2010

Plain-text annual report

CANON ANNUAL REPORT 2010 Fiscal Year Ended December 31, 2010 FINANCIAL HIGHLIGHTS Net sales Operating proﬁ t Income before income taxes Net income attributable to Canon Inc. Net income attributable to Canon Inc. stockholders per share: –Basic –Diluted Total assets Millions of yen (except per share amounts) Thousands of U.S. dollars (except per share amounts) 2010 2009 Change (%) 2010 ¥3,706,901 ¥3,209,201 387,552 392,863 246,603 217,055 219,355 131,647 ¥ 199.71 ¥ 106.64 199.70 106.64 +15.5 +78.6 +79.1 +87.3 +87.3 +87.3 $45,764,210 4,784,593 4,850,160 3,044,481 $ 2.47 2.47 ¥3,983,820 ¥3,847,557 +3.5 $49,182,963 Canon Inc. stockholders’ equity ¥2,645,782 ¥2,688,109 -1.6 $32,663,975 Notes: 1. Canon’s consolidated ﬁ nancial 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 JPY81=U.S.$1, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 30, 2010, solely for the conve- nience of the reader. 4,481,346 4,156,759 4,094,161 3,706,901 3,209,201 Net Sales (Millions of yen) 5,000,000 4,000,000 3,000,000 2,000,000 1,000,000 0 Net Income Attributable to Canon Inc. (Millions of yen) 488,332 455,325 309,148 246,603 131,647 500,000 400,000 300,000 200,000 100,000 0 06 07 08 09 10 06 07 08 09 10 Net Income Attributable to Canon Inc. Stockholders per Share (Yen) Diluted Basic ROE/ROA (%) ROE ROA 377.59 377.53 341.95 341.84 246.21 246.20 199.71199.70 106.64 106.64 400.00 300.00 200.00 100.00 0.00 16.3 16.5 10.6 10.8 11.1 7.3 20.0 15.0 10.0 5.0 0 06 07 08 09 10 06 07 08 9.2 6.3 10 4.9 3.4 09 CANON ANNUAL REPORT 2010 1 CORPORATE PROFILE Canon develops, manufactures and markets a growing lineup of copying CONTENTS TO OUR STOCKHOLDERS machines, printers, cameras and industrial and other equipment. MESSAGE FROM THE PRESIDENT Through these products, the Company meets growing customer needs that are becoming increasingly diversiﬁ ed and sophisticated. Today, the CORPORATE GOVERNANCE Canon brand is recognized and trusted throughout the world. EXCELLENT GLOBAL CORPORATION PLAN: In 1996, Canon launched its Excellent Global Corporation Plan PHASE IV with the aim of becoming a company worthy of admiration and respect the world over. Currently, the Company is promoting a “cross-media imaging” strategy—wherein advanced synergies are realized between input and output devices. At the same time, Canon is strengthening its solutions business while nurturing its operations CORPORATE FUNCTIONS RESEARCH & DEVELOPMENT PRODUCTION SALES & MARKETING CORPORATE SOCIAL RESPONSIBILITY in the ﬁ elds of medical equipment and industrial equipment, the BUSINESS UNITS latter including intelligent robots, to establish new core businesses. Canon is working to fulﬁ ll its responsibilities to investors and society, emphasizing sound corporate governance and stepping up the OFFICE BUSINESS UNIT CONSUMER BUSINESS UNIT INDUSTRY AND OTHERS BUSINESS UNIT implementation of activities that contribute to environmental and FINANCIAL SECTION social sustainability. CORPORATE PHILOSOPHY: Kyosei TRANSFER AND REGISTRAR’S OFFICE STOCKHOLDER INFORMATION The corporate philosophy of Canon is kyosei. A concise deﬁ nition of MAJOR CONSOLIDATED SUBSIDIARIES 2 6 8 12 20 32 45 110 110 111 this word would be “Living and working together for the common good.” But Canon’s deﬁ nition is broader: kyosei is “All people, regard- less of race, religion or culture, harmoniously living and working together into the future.” Unfortunately, the presence of imbalances in the world in such areas as trade, income levels and the environ- ment 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 they need to address environmental issues worldwide. In addition, global companies must bear responsibility for the impact of their activities on society. For this reason, Canon’s goal is to contribute to global prosperity and to people’s well-being, which will lead to continuing growth and bring the world closer to achieving kyosei. CORPORATE GOAL Canon sees itself growing and prospering over the next 100, even 200, years. To realize this goal, the Company is implementing its Excellent Global Corporation Plan, and the year 2011 saw our launch of this plan’s Phase IV. Building on the ﬁ nancial strengths that it has continuously reinforced through the implementation of the plan, Canon aims to attain the status of being among the top 100 global Cover Photo: The advanced-amateur model, EOS 60D complemented Canon’s existing digital SLR lineup, contributing to increased sales volume and expanded market share. The EOS 60D offers such advanced features as the Vari-angle Clear View LCD monitor and full-HD companies in terms of key performance indicators. video capability. 2 CANON ANNUAL REPORT 2010 TO OUR STOCKHOLDERS Targeting Sound Growth Anew through Rapid Transformation Under a new slogan, “Aiming for the Summit—Speed & Sound Growth,” Canon will redouble its efforts to join the ranks of the world’s top 100 companies in terms of all key performance indi- cators during the ﬁ ve-year Phase IV of the Excellent Global Corporation Plan. Through the implementation of six key strategies over Phase IV, we aim to achieve consolidated net sales of more than ¥5 trillion by 2015. CANON ANNUAL REPORT 2010 3 4 CANON ANNUAL REPORT 2010 2010 Overview In 2010, we completed Phase III, further enhancing our The global economy continued on a path toward mild recovery corporate constitution. Achieving our goal of making 2010 in 2010, supported by growth in China, India and other emerg- the ﬁ rst year in a new era of growth for Canon, we were ing markets. The U.S. economy continued to recover gradually able to go on the offensive despite the lingering effects of while Europe showed signs of a turnaround. Although the the global recession. Japanese economy had been picking up gradually, the recovery came to a standstill due to deﬂ ation and the strong yen. Times are changing. Over the next ﬁ ve years of Phase IV, we will undergo a transformation, opening new gateways to the next generation of Canon. 2010 Performance Results on our performance, reducing net sales and operating proﬁ t In 2010, consolidated net sales increased 15.5% year on by ¥193.9 billion and ¥127.4 billion, respectively. year to ¥3,706.9 billion, and the gross proﬁ t ratio rose 3.6 Despite the yen’s sharp appreciation in the second half, points to 48.1%. Operating proﬁ t jumped 78.6% to ¥387.6 Canon aggressively introduced new products and contin- billion. By segment,* in the Ofﬁ ce Business Unit, sales grew ued to reduce costs while improving production turnover in 20.8% to ¥1,987.3 billion while operating proﬁ t surged line with increased production. These activities enabled us 27.9% to ¥293.3 billion. In the Consumer Business Unit, to expand our proﬁ ts substantially. Also, comprehensive sales edged up 6.9% to ¥1,391.3 billion while operating cash ﬂ ow management allowed us to enhance manage- proﬁ t climbed 29.7% to ¥238.1 billion. As for the Industry ment efﬁ ciency and accumulate ample cash on hand. and Others Business Unit, sales totaled ¥433.0 billion, up Canon continues its proactive approach to steadily 20.9% year on year, and operating loss totaled ¥9.8 billion, returning proﬁ ts to stockholders while taking into consider- an improvement of ¥66.1 billion. By geographic region, ation future investments, free cash ﬂ ow and consolidated sales in the Americas grew 14.4% to ¥1,023.3 billion; sales business performance. For 2010, Canon increased its full- in Europe increased 17.8% to ¥1,172.5 billion; in Japan, year dividend to ¥120 per share, up ¥10 from 2009. sales dipped 0.9% to ¥695.7 billion; and in Asia and Oceania * Segment sales results include intersegment sales. (excluding Japan), sales grew 32.0% to ¥815.4 billion. Selling, general and administrative expenses increased Achievements in Previous Phases 19.2% to ¥1,079.7 billion while R&D expenses rose 3.7% to In Phase I, which started in 1996, we worked to strengthen ¥315.8 billion. Net income attributable to Canon Inc. leapt the Company’s ﬁ nancial standing, making efforts to change 87.3% to ¥246.6 billion, while net income attributable to our mindset with a focus on total optimization and proﬁ t- Canon Inc. stockholders per share amounted to ¥199.71 and ability. In Phase II, which began in 2001, as the world was ¥199.70 in basic and diluted terms, respectively. overtaken by the wave of digitization, we reinforced Canon’s The average value of the yen during the year was ¥87.40 product competitiveness through a new R&D infrastructure against the U.S. dollar, a year-on-year appreciation of and the in-house production of key components. approximately ¥6.00, and ¥114.97 against the euro, a year- In Phase III, launched in 2006, we worked to expand on-year increase of approximately ¥15.00. The strong yen Canon’s scale with the aim of becoming a truly excellent against these and other currencies put downward pressure global company and achieving “sound growth.” We CANON ANNUAL REPORT 2010 5 improved the proﬁ tability of existing businesses and established new businesses through innova- tion, but, hit by the global recession in 2008, our record of eight consecutive years of sales and proﬁ t growth came to an end. To overcome this crisis, we temporarily revised our strategy, shifting our focus in 2010 to improv- ing management quality. We accelerated cost reductions, facilitated higher capital-investment efﬁ ciencies and promoted inventory reductions through the establishment of advanced supply chain management (SCM). These initiatives proved effective, enabling Canon to maintain a high stock- holders’ equity ratio and accumulate retained earn- ings and cash and cash equivalents. Furthermore, we joined the global top 100 companies in terms of market value. Future Business Environments 2. Developing new business through globalized diversiﬁ ca- Despite such uncertainties as high unemployment in the tion and establishing the Three Regional Headquarters United States, ﬁ nancial instability in Europe, and persistent management system deﬂ ation in Japan, advanced nations are expected to con- 3. Establishing a world-leading globally optimized produc- tinue moving toward gradual economic recovery. tion system Meanwhile, China, India and other emerging nations are 4. Comprehensively reinforcing global sales capabilities expected to sustain their steady economic growth. It is 5. Building the foundations of an environmentally advanced apparent that these emerging nations will drive the growth corporation of the global economy. Also, looking at social and industrial 6. Imparting a corporate culture, and cultivating human trends, the acceleration of information communication resources beﬁ tting a truly excellent global company technology (ICT) and increasing awareness of environmen- tal issues will play increasingly important roles. As corpora- In line with these strategies, we have set the following tions focus their energies on these growing ﬁ elds, global targets for 2015, the ﬁ nal year of Phase IV. competition in these areas is expected to further intensify. Strategies for Phase IV Net sales: Operating proﬁ t ratio: Under the new slogan “Aiming for the Summit—Speed & Net income ratio: Sound Growth,” Canon aims to realize rapid transformation Stockholders’ equity ratio: in anticipation of the changes of the times. Through this ¥5 trillion or more 20% or more 10% or more 75% or more transformation, we will again take on the challenge of By achieving these targets, Canon aims to renew itself joining the world’s top 100 companies in terms of all key and become a truly excellent global corporation. I would like performance indicators. To this end, we have formulated six to ask you all for your continued support and understanding. strategies, as follows: 1. Achieving the overwhelming No. 1 position in all core busi- nesses and expanding related and peripheral businesses Fujio Mitarai Chairman and CEO Canon Inc. 6 CANON ANNUAL REPORT 2010 MESSAGE FROM THE PRESIDENT Economies and industries worldwide are undergoing drastic changes. Aiming to achieve our targets for Phase IV of the Excellent Global Corporation Plan, we will take on new challenges, with the courage and conviction to change. 2011 marks the start of Phase IV of the Excellent Global In the Ofﬁ ce Business Unit, we aim to bolster our solu- Corporation Plan. In the course of working toward our targets tions business through such initiatives as forming alliances for 2015, we ﬁ rst aim to achieve in 2012 results that exceed our with HP and other IT powerhouses, promoting Canon’s record-high performance in 2007. To this end, we will take on proprietary Managed Print Services (MPS) and developing new challenges to reach a higher summit. application software that supports cloud services. Mean- while, by enhancing collaboration with Océ N.V., which Continuous Introduction of Innovative Products and Services became a consolidated subsidiary in 2010, we will expand Canon will continue to launch innovative products and our lineups of digital production printers and large-format services to attain the overwhelming No. 1 position in all inkjet printers while generating greater synergies in market- existing core businesses. To fulﬁ ll this goal, in all major prod- ing by accelerating our solutions business. uct categories, we will strengthen the solutions and serv- Turning to the Consumer Business Unit, we will continue ices we provide based on our powerful hardware portfolios to improve the video capabilities of our digital SLR cameras and thereby expand our business domains. while reinforcing our software offerings that facilitate the CANON ANNUAL REPORT 2010 7 effective use of the cameras in photo studios and other service. These IT reforms will have a substantial, positive settings. Also, in response to wide-ranging needs for image impact on Canon’s business management. output through electrophotographic and inkjet printers, we will enhance and strengthen our product lineups, from Continuous Enhancements of Product Quality personal-use to commercial-use models, by promoting a Product quality is the lifeline of all manufacturers. Even a total printing strategy. Under this strategy, we will target single minor product defect could potentially undermine imaging demand associated with the Internet and a wide the credibility—indeed, the very foundations—of a corpora- array of input devices. As a ﬁ rst step, anticipating further tion. Therefore, we must remain committed to maintaining growth in the retail photo-ﬁ nishing and commercial printing and improving the quality of our products across the Canon markets along with the spread of digital cameras, Canon Group. Canon has established a comprehensive quality- will enter the commercial photo printer market. information management system spanning all processes, from design to mass-production. Based on this system, and Aggressive Business Expansion in Emerging Markets by strengthening cooperation throughout the Company, we Emerging markets in China, India, ASEAN nations and other will continue to reinforce our structure to prevent critical regions are expected to realize further expansion. The product quality problems. Company is carrying out ﬁ ne-tuned initiatives designed to accommodate needs speciﬁ c to individual markets and cus- Toward Becoming a Truly Excellent Corporation tomers, from R&D to sales and service. For example, we will In the ﬁ rst year of Phase IV, we will work to further solidify launch products exclusively designed for speciﬁ c markets and our business foundation. Meanwhile, we will bolster efforts customers, executing sales strategies tailored to the character- to develop human resources to ensure that Canon employ- istics of each market. ees will be able to function as key players in the global market. We will train employees entrusted with the future Targeting Improved Productivity of Canon by making use of practical settings, including local We are working to establish an optimal global production sales and production operations worldwide, particularly in structure. Under this structure, we will manufacture prod- rapidly growing Asian markets. ucts worldwide at the most rational locations as deter- We will further expand our ﬁ eld of corporate activities. mined by such factors as cost, logistics, procurement, Accordingly, the need for us to fulﬁ ll our social responsibilities quality and workforce. Our focus on improving productivity will become more important than ever. Under our corporate through the promotion of automated and in-house produc- philosophy of kyosei, we will continue to promote activities to tion also plays an important role within our strategy to reduce the environmental burden of our corporate activities realize optimal global production. and products. At the same time, we aim to further bolster our We have signiﬁ cantly enhanced productivity for laser compliance and internal controls. printer toner cartridges through the automation of several Toward the achievement of our 2015 net sales target of hundred processes, from parts molding and assembly to more than ¥5 trillion, we are amassing our Groupwide inspection and packaging. We are now working to further strengths. Capitalizing on the sound ﬁ nancial constitution improve the reliability of these automated machines and that we have realized to date, with the courage and convic- realize complete automation, thereby reinforcing our prod- tion to change, we will continue to implement initiatives that uct competitiveness. will empower us to realize additional, sustainable growth. We Through our IT reforms targeting total optimization, we ask for your continued support and understanding. have carried out a range of initiatives, including the stan- dardization of 3D-CAD systems and the integration of 3D- CAD with our product data management (PDM) system. Such system integration has enabled us to share and use information throughout the entire product lifecycle, from procurement, development and production to sales and Tsuneji Uchida President and COO Canon Inc. 8 CANON ANNUAL REPORT 2010 CORPORATE GOVERNANCE Canon maintains sound corporate governance as part of efforts to maximize its stockholders’ value and become a truly excellent global corporation. Basic Policy and Corporate Governance Structure Canon recognizes that management supervision functions and management transparency are vital to strengthening its corpo- rate governance and further raising corporate value. Canon’s basic governance structure comprises the General Meeting of Shareholders, the Board of Directors and the Board of Corpo- rate Auditors. Furthermore, the Executive Committee and management committees are dedicated to addressing key issues. All of these bodies work together to ensure the appropriate management of the Group through an internal auditing structure underpinned by the independent Corporate Audit Center and an information disclosure system for management activities. Board of Directors Important business matters are discussed and ratiﬁ ed during meetings of the Board of Directors and Executive Committee. As of December 31, 2010, the board consisted of 17 directors. In order to facilitate more practical and efﬁ cient decision making, the board is entirely composed of internal directors who have well-developed knowledge of the Company’s affairs. Also, the board is supported by various management commit- tees that address important management issues in their speciﬁ c ﬁ elds. These committees complement the Company’s management system by business unit, facilitate efﬁ cient decision making and realize a mutual supervisory function for such matters as compliance and ethics. Executive Ofﬁ cer System Canon is endeavoring to realize more ﬂ exible and efﬁ cient management operations by maintaining an appropriately sized organization of directors and promoting capable human re- sources with accumulated executive knowledge across spe- ciﬁ c business areas. Executive ofﬁ cers are appointed and dismissed by the Board of Directors and have a term of ofﬁ ce of one year. The number of executive ofﬁ cers was 13 as of December 31, 2010. Auditing System Canon has ﬁ ve corporate auditors, including three outside corporate auditors who have no personal or business afﬁ lia- tions with the Company. Canon has notiﬁ ed the stock exchang- es in Tokyo, Osaka, Nagoya, Fukuoka and Sapporo of the designation of these outside corporate auditors as indepen- dent auditors, as provided under the regulations of the stock exchanges. Corporate auditors’ duties include attending meet- ings of the Board of Directors and of the Executive Committee, Directors & Corporate Auditors (as of December 31, 2010) Chairman & CEO Fujio Mitarai President & COO Tsuneji Uchida Executive Vice President & CFO Toshizo Tanaka Senior General Manager, External Relations Center Senior General Manager, Corporate Communications Center Vice Chairman, Supervisory Board of Océ N.V. Executive Vice President & CTO Toshiaki Ikoma Group Executive, Corporate R&D Headquarters Chief Executive, Optical Products Operations Senior Managing Directors Kunio Watanabe Group Executive, Corporate Planning Development Headquarters Yoroku Adachi President & CEO, Canon U.S.A., Inc. Toshio Homma Chief Executive, L Printer Products Operations Yasuo Mitsuhashi Chief Executive, Peripheral Products Operations Masaki Nakaoka Chief Executive, Ofﬁ ce Imaging Products Operations Managing Directors Tomonori Iwashita Group Executive, Environment Headquarters Group Executive, Quality Management Headquarters Masahiro Osawa Group Executive, Global Procurement Headquarters Group Executive, General Affairs Headquarters Shigeyuki Matsumoto Group Executive, Device Technology Development Headquarters Katsuichi Shimizu Chief Executive, Inkjet Products Operations Ryoichi Bamba President, Canon Europa N.V. President, Canon Europe Ltd. Haruhisa Honda Group Executive, Manufacturing Headquarters Hideki Ozawa President & CEO, Canon (China) Co., Ltd. Masaya Maeda Chief Executive, Image Communication Products Operations Corporate Auditors Keijiro Yamazaki Shunji Onda (Outside) Tadashi Ohe Kazunori Watanabe Kuniyoshi Kitamura CANON ANNUAL REPORT 2010 9 Governance Structure (as of December 31, 2010) Canon Inc. General Meeting of Shareholders Board of Directors Representative Directors Chairman & CEO President & COO Executive Vice President & CFO Subsidiaries & Subsidiaries & Affiliates Affiliates Executive Officers Board of Corporate Auditors Executive Committee Corporate Audit Center Management Strategy Committee New Business Development Committee Headquarters Administrative Divisions Corporate Ethics and Compliance Committee Internal Control Committee Disclosure Committee Office Business Unit Consumer Business Unit Industry and Others Business Unit Marketing Subsidiaries & Affiliates Manufacturing Subsidiaries & Affiliates R&D Subsidiaries & Affiliates listening to business reports from directors, carefully examin- ing 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 is in charge of monitoring the Company’s compliance, risk management and internal control systems in addition to providing assessments and recommen- dations as required. Internal Control Committee In response to the Sarbanes-Oxley Act, including Section 404, which came into force during 2006, Canon continues to reinforce internal control systems and implement appropriate measures. The Internal Control Committee is responsible for Groupwide internal controls, including those pertaining to ﬁ nancial reporting. In order to strengthen internal controls, Canon conducts comprehensive evaluations of internal controls across areas that include accounting, management oversight, legal compli- ance, IT systems and the promotion of corporate ethics. As of December 31, 2010, internal control over ﬁ nancial reporting has been assessed as effective by the management and an independent registered public accounting ﬁ rm. (Please refer to pages 107 and 109.) Compliance brieﬁ ng at Canon Hi-Tech (Thailand) Ltd. Compliance meeting at Canon Deutschland GmbH 10 CANON ANNUAL REPORT 2010 Other Corporate Governance Committees The Corporate Ethics and Compliance Committee, in addition to the Disclosure Committee, is the key body of Canon’s manage- ment committees. The Corporate Ethics and Compliance Com- mittee discusses and approves corporate ethics and compliance policies while monitoring the implementation of these policies. The Disclosure Committee works to ensure strict compliance with disclosure regulations as prescribed by stock exchanges. Compliance Shortly after its founding, Canon established 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-awareness,” or understanding one’s situation and role in it. These principles remain the basis for employee education and provide the platform for the Canon Group Code of Conduct. Recognizing the importance of safeguarding personal infor- mation, Canon does its utmost to protect this valuable form of information asset in the course of fulﬁ lling its social responsibili- ties. With the aim of keeping its employees informed and aware, the Company conducts e-learning sessions as part of its per- sonal information protection education programs every year. Disclosure Canon makes every effort to disclose information on its man- agement and business strategies as well as its performance results to all stakeholders in an accurate, fair and timely man- ner. To this end, Canon holds regular brieﬁ ngs and posts the latest information on its website together with a broad range of disclosure materials. Canon has formulated its own Disclosure Guidelines and established the Disclosure Committee, which makes decisions regarding information disclosure, including necessity, content and timing. The Disclosure Committee makes such decisions Signiﬁ cant 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 compa- nies listed on the NYSE must comply with certain corporate governance 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 practices 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 signiﬁ cant differences between the corporate governance 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 corpo- rate 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 sched- uled executive sessions without the presence of manage- ment. Unlike the NYSE Corporate Governance Rules, however, the Corporation Law does not require companies to imple- ment 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 compensation 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 stockholders 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 com- mittee and compensation committee, each composed en- tirely of independent directors, the Corporation Law does not require companies to have speciﬁ ed committees, including those that are responsible for director nomination, corporate governance and executive compensation. The Company’s Board of Directors nominates candidates for directorships and submits a proposal at the General Meeting of Shareholders for stockholder approval. Pursuant to the Corporation Law, the stockholders then vote to elect directors at the meeting. The Corporation Law requires that the total amount or calculation method of compensation for directors and corporate auditors be determined by a resolution CANON ANNUAL REPORT 2010 11 after receiving reports on information that might need to be disclosed from the person in charge of the disclosure working group at each headquarters. Countering Antisocial Forces Canon has formulated a basic policy stipulating that no Canon Group companies shall maintain relationships of any kind with antisocial forces that represent a threat to social order and security. To uphold this basic policy, Canon has established a department dedicated to activities aimed at countering such parties while reinforcing cooperative ties with applicable public authorities. In addition, Canon’s Employment Regulations include a clause prohibiting such relationships, and the Company con- tinues to step up efforts to ensure strict employee adherence. Risk Management As Canon pursues business expansion in various ﬁ elds on a global scale, the business and other risks to which it may be exposed continue to diversify. With the goal of eliminating such risks altogether, while honoring the trust placed in it by its stakeholders, Canon works diligently to avoid or minimize its exposure, to this end assigning speciﬁ cally designated man- agement committees to address key issues. In particular, the Executive Committee and various manage- ment committees engage in careful discussions regarding signiﬁ cant risk factors. The Corporate Audit Center preemp- tively identiﬁ es risk factors through audit activities. Also, Canon formulates in-house rules to guard against those risks and, in accordance with the policies formulated by the Internal Control Committee, strives to identify and assess relevant risks associ- ated with individual business processes. of the General Meeting 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 provide an amount or calculation meth- od, the amount of compensation for the directors and corpo- rate auditors of the Company is determined by a resolution of the General Meeting of Shareholders. The allotment of com- pensation for each director from the total amount of compen- sation is determined by the Company’s Board of Directors, and the allotment of compensation to each corporate auditor is determined by consultation among the Company’s corpo- rate auditors. 3. Audit Committee The Company avails 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 require- ments, subject to certain requirements which continue to be applicable under Rule 10A-3. Pursuant to the requirements of the Corporation Law, the stockholders elect the corporate auditors by resolution of a general meeting of shareholders. The Company currently has ﬁ ve 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 concern- ing the execution of the corporate auditor’s duties. The Board of Corporate Auditors prepares auditors’ reports and may veto a proposal for the nomination of corporate auditors, accounting auditors and the determination of the amount of compensation for the accounting auditors put forward by the Board of Directors. Under the Corporation Law, the half or more of a compa- ny’s corporate auditors must be “outside” corporate auditors. These are individuals who are prohibited to have ever been a director, executive ofﬁ cer, manager, or employee of the Company or its subsidiaries. The Company’s current corpo- rate auditor system meets these requirements. Among the ﬁ ve members on the Company’s Board of Corporate Auditors, three are outside corporate auditors. The qualiﬁ cations for an “outside” corporate auditor under the Corporation Law are different from the audit committee independence require- ment 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 stockholder approval regarding the stock options to be issued to directors and corporate auditors as part of remuneration of directors and corporate auditors. 12 CANON ANNUAL REPORT 2010 EXCELLENT GLOBAL CORPORATION PLAN: PHASE IV CANON ANNUAL REPORT 2010 13 CONTENTS Overview Six Key Strategies for Phase IV 14 15 Photo: Through the Canon-Kyoto University Joint Research Project (CK Project), Canon is advancing R&D for medical imaging systems—one of its next-generation core businesses. 14 CANON ANNUAL REPORT 2010 O VERVI EW In 2011, Canon launched Phase IV of its Excellent Global Corporation Plan, which will continue through 2015. Under the new slogan “Aiming for the Summit—Speed & Sound Growth,” Canon aims to rank among the world’s top 100 companies in terms of key performance indicators. Looking Back with a Focus on the Future Key Strategies for Phase IV The Excellent Global Corporation Plan comprises strategies Globalization and diversiﬁ cation—these are the two basic and initiatives consistent with Canon’s corporate philosophy management strategies that have guided Canon since the of kyosei. Under this plan, Canon has worked to become Company’s founding. In Phase IV, we will combine these a truly excellent company that contributes to society policies and embark upon “globalized diversiﬁ cation” based through technological advances—a company that is ad- on the following six key strategies. mired and respected worldwide. Although we faced various challenges over the three ﬁ ve-year phases up to 2010, implementing management reforms in each phase, we succeeded in becoming what we are today. During Phase IV of the Excellent Global Corporation Plan, Canon aims to post business results in 2012 that exceed the record performance it achieved in 2007. In addition, by 2015, the ﬁ nal year of Phase IV, Canon aims to realize net sales of more than ¥5 trillion, an operating proﬁ t ratio of more than 20% and a net income ratio of more than 10%. To meet these targets, we will develop our medical and industrial ﬁ elds into new business pillars. We will also con- tinue our efforts to improve such basic manufacturing functions as R&D, production, and sales and marketing in order to keep abreast of ever-accelerating technological advances. For R&D, in particular, we will build a Three Re- gional Headquarters management system with innovation centers based in Japan, the United States and Europe. Under this system, Canon will carry out development and manu- facturing activities in each region, and market the resulting products globally. 1. 2. 3. 4. 5. 6. Achieving the overwhelming No. 1 posi- tion in all core businesses and expand- ing related and peripheral businesses Developing new business through glo- balized diversiﬁ cation and establishing the Three Regional Headquarters man- agement system Establishing a world-leading globally optimized production system Comprehensively reinforcing global sales capabilities Building the foundations of an environ- mentally advanced corporation Imparting a corporate culture, and culti- vating human resources beﬁ tting a truly excellent global company External Rankings •Financial Times Global 500 (May 29/30, 2010 issue) Market value ranking: 93 (7th in the Technology Hardware & Equipment sector) •FORTUNE Global 500 (July 26, 2010 issue) Revenues ranking: 216 Proﬁ ts ranking: 202 FORTUNE Global 500 is a registered trademark of FORTUNE Magazine, a division of Time Inc. in the United States of America. S IX K EY STRATEGIES FOR PHA SE IV 1. Achieving the overwhelming No. 1 position in all core businesses and expanding related and peripheral businesses CANON ANNUAL REPORT 2010 15 imageRUNNER ADVANCE-based solutions contributing to Sodexo, France-based integrated food and facilities management service provider Canon’s current core businesses include digital cameras, aim for the No. 1 position in this ﬁ eld. In inkjet printers, we laser printers, ofﬁ ce network MFDs, inkjet printers and plan to improve our products’ compatibility with smart- semiconductor lithography equipment. In these segments, phones and other new information terminals as well as with Canon will continue to launch innovative products and new applications. In this way, we will work to meet ever- expand sales through strategic solutions and services, diversifying customer needs while continuing to enhance the thereby attaining the overwhelming No. 1 position world- operability of these printers. wide in all of them. At the same time, we will promote diversiﬁ cation to develop related and peripheral business ﬁ elds. In the Ofﬁ ce Business Unit, in addition to intro- ducing competitive products within our mainstay imageRUNNER ADVANCE-series lineup, we will strengthen our solutions, software and service offerings in each business area. In this way, we aim to transform this segment into a more comprehen- sive ofﬁ ce equipment business in response to the changing times towards the establishment of a greater revenue base. And in the course of these developments, M&A will deﬁ nitely be an option. Also, through closer collaboration with Océ, we will step up our technological cooperation, comple- menting each other’s product portfolios and sales channels to realize concrete synergies. As for the Consumer Business Unit, as the video capabilities of digital SLR cameras advance, we will PHOTOPRESSO online photo service in Japan, a digital camera-related business 16 CANON ANNUAL REPORT 2010 2. Developing new business through globalized diversiﬁ cation and establishing the Three Regional Headquarters management system Océ N.V., Canon’s new consolidated subsidiary, develops digital production printers. Canon will establish innovation centers not only in Japan but in radiation doses. Canon aims to become the industry leader the United States and Europe. We will develop fundamental in the digital radiography segment for both static and dy- technologies and region-speciﬁ c products and market these namic medical imaging. As for ophthalmic equipment, products through our global sales network. While acquiring leveraging synergies realized through the 2010 integration new technologies and businesses through M&A, we will accel- of OPTOPOL Technology S.A., we will expand our lineup of erate the establishment of our two next-generation business Optical Coherence Tomography (OCT) systems, essential for ﬁ elds—namely, medical equipment and industrial equipment. advanced medical examinations for lifestyle-related and We have continuously led the world of imaging, and we other diseases. Looking to new areas, through the promo- will reinforce our visualization technologies through our tion of the Canon-Kyoto University Joint Research Project innovative sensor and image-processing technologies, (CK Project), Canon is working to develop innovative medi- developing medical imaging into a new business pillar. For cal systems, including optical ultrasound diagnostic sys- example, looking at our existing digital radiography systems, tems that enable the early detection of cancer. we have applied our proprietary technologies to realize As for industrial equipment, we will bolster our existing high-resolution, high-speed dynamic imaging with reduced businesses Groupwide. Also, we will strengthen our R&D efforts for Artiﬁ cial Intelligence (AI) technologies that enable machines to better recognize human behavior and thinking. These technologies include Super Machine Vision—imaging technology surpassing the capabilities of human vision— and Mixed Reality (MR) technology. By integrating these technologies through the use of information communica- tion technology (ICT), we aim to develop a portfolio of comprehensive solutions for all manufacturing processes. In the long term, these technologies have the potential to help Canon make inroads into the security and safety ﬁ eld, Super Machine Vision goes beyond the capabilities of human vision. which includes risk prediction and nursing care. CANON ANNUAL REPORT 2010 17 3. Establishing a world-leading globally optimized production system With the launch of new plant operations at Canon Virginia, Inc., Canon has established a toner cartridge SCM cycle, from production to recycling, in the United States. By reviewing our global operations and comprehensively cycles similar to those operated by Canon Virginia. Further- assessing the status of every aspect of our business, in- more, we will promote “man-machine cell” production cluding costs, logistics, procurement, quality and workforce, systems and in-house production while continuing to we will reorganize our worldwide allocation of production improve the quality of our products. bases from a long-term perspective and work to achieve an optimal production structure. In January 2010, Canon Virginia, Inc. began the automated production of toner cartridges. With this, Canon has achieved toner cartridge supply chain management (SCM) in the United States, handling all the processes locally, from production and sales to collection and recycling. The establishment of a globally optimized production system is predicated on the promotion of automated processes and total automation. In toner cartridge production, we will further enhance the capabilities of our automated machines and accelerate their use for production in Eu- rope and Asia, which is expected to be- come an even bigger market. Regarding other products—particularly those that are generating, or will generate, signiﬁ cant demand and for which automated produc- tion is viable—we plan to develop SCM In-house production of a mold at Canon (Suzhou) Inc. 18 CANON ANNUAL REPORT 2010 4. Comprehensively reinforcing global sales capabilities Canon is diversifying service operations in China while expanding its after-sales service bases there through the establishment of Quick Service Stations. Economic growth centers are shifting from Europe and the work to expand sales in India, Indonesia and other ASEAN United States to Asia, South America, Africa and other nations, along with Brazil, Russia and African nations. In all emerging nations as well as to resource-producing nations. of our core businesses, we will enhance sales of our prod- Accurately capturing such trends, we will strive to boost ucts, giving due consideration to the characteristics and sales in these regions and nations. More speciﬁ cally, in Asia, actual conditions in each market. we will ﬁ rst sharpen our focus on building up our sales In advanced nations as well, we will further enhance our presence in China by bolstering our sales force. We will also sales capabilities. Starting with Europe, the United States and Japan, we will generate greater syner- gies through collaboration with Océ, taking full advantage of the company’s powerful global sales channels and product portfolio, including digital production printers and industrial-use printing systems. Regardless of the region or nation, we will work to accelerate the provision of solutions based on our ofﬁ ce equipment while expanding retail photo-ﬁ nishing services. Canon Ru LLC strengthening sales activities in Russia CANON ANNUAL REPORT 2010 19 5. Building the foundations of an environmentally advanced corporation Canon is working to reduce the lifecycle environmental burden of its products. Canon is bolstering the development of energy- and re- Canon will promote a localized production model, which source-saving technologies to achieve unparalleled envi- entails not only production and sales, but also the collection ronmental performance throughout the entire product and recycling of used lifecycle. For example, the application of on-demand ﬁ xing products in each region. technology has reduced power consumption during the This approach will toner ﬁ xing process on ofﬁ ce network MFDs. Also, by pro- contribute to reduced moting the remanufacturing and refurbishment of MFDs inventory and logis- and the recycling of toner cartridges enabled through our tics costs while also proprietary technologies, we are working to reduce our enabling us to reduce environmental burden. Ultimately, we aim to become a our environmental Exterior part of inkjet printer power supply unit global environmental leader. burden even further. made from recycled materials 6. Imparting a corporate culture, and cultivating human resources beﬁ tting a truly excellent global company Amid the dramatic changes of the times, Canon places high value on its San-ji, or “Three Selfs,” spirit—self-motivation, self-management and self-awareness—which provides the foundation of the Company’s guiding principles, and will boost its enterprising spirit. Further promoting a corporate culture that encourages the entire Group to embrace the courage to change, we will put in place systems that we will be sure to pass on to the next generation. To this end, we will hasten the development of human resources capable Seminar held in Tokyo for managerial staff of Group companies in China of shouldering truly global business responsibilities. 20 CANON ANNUAL REPORT 2010 CORPORATE FUNCTIONS CANON ANNUAL REPORT 2010 21 CONTENTS Research & Development Production Sales & Marketing Corporate Social Responsibility 22 24 26 28 Photo: In the Americas, Canon is leading the development of solutions- based business products with its imageRUNNER ADVANCE series. (Left: A FedEx Ofﬁ ce Print and Ship Center in the United States) 22 CANON ANNUAL REPORT 2010 R ESEARCH & DEVELOPM ENT While strengthening R&D in fundamental technologies necessary for enhancing product competitiveness, Canon is promoting a diversiﬁ cation strategy and nurturing new businesses in medical and other ﬁ elds. Canon is advancing materials R&D with the aim of eliminating hazardous substances from its products through the adoption of a voluntary standard stricter than laws and regulations. R&D Expenses and Patents Canon continues to bolster R&D activities to remain the leader in the imaging ﬁ eld. R&D expenses totaled ¥315.8 billion, up ¥11.2 billion, or 3.7%, from 2009. The ratio to net sales was 8.5%. By segment, ¥96.2 billion, or 30.4% of the total expenses, was allocated to the Ofﬁ ce Business Unit; ¥82.8 billion, or 26.2%, to the Consumer Business Unit; ¥21.1 billion, or 6.7%, to the Industry and Others Business Unit; and ¥115.8 billion, or 36.7%, to basic R&D, which cannot be classiﬁ ed by segment. During 2010, Canon was granted 2,543* patents in the United States. * Source: U.S. Patent and Trademark Ofﬁ ce. Calculated based upon publicly disclosed weekly totals Reinforcing Core Technologies Canon continues to strengthen R&D for key components and devices. In CMOS sensors—a key component of digital cam- eras—Canon successfully developed a sensor that delivers image resolution of approximately 120 megapixels. Canon also developed a large CMOS sensor with ultra-high sensitivity. With a chip size of 202 mm x 205 mm, this sensor provides greater light-gathering capability, with potential applications including the video recording of night skies and nocturnal animal behav- ior as well as nighttime surveillance cameras. Canon will advance its R&D efforts, undertaking projects even in pre- competitive ﬁ elds. CANON ANNUAL REPORT 2010 23 Nurturing New Businesses Canon aims to establish operations in medical and industrial equipment as its new business pillars. In the medical ﬁ eld, Canon is cooperating with Kyoto University in developing diagnostic imaging systems that enable the early detection of diseases, including an optical ultrasound mammography system that uses near-infrared rays instead of X-rays, eliminat- ing X-ray exposure, and an adaptive optics scanning laser ophthalmoscope (AO-SLO) for photoreceptor cell exams. Canon is also stepping up R&D for intelligent robots that can detect changes in surrounding conditions and make appropriate judgments, just as humans do. Looking to the future in hazard prediction and nursing care, Canon will strengthen related R&D activities. Moreover, Canon is promoting research on Mixed Reality (MR) technology—an imaging technology that seamlessly integrates the real and virtual worlds in real time—with poten- tial applications including design simulation and prototype-less development. R&D Globalization Canon is enhancing its global R&D approach. In the United States, we are undertaking genetic diagnostic technology research. In 2010, we delivered a prototype system to the University of Utah. Genetic diagnostic systems are expected to improve drug Development of 120-megapixel CMOS sensor administration based on genetic calculations. Meanwhile, Océ will play an important role in our R&D globalization. In line with its Three Regional Headquarters management system, Canon aims to expand its R&D bases in Japan, the United States and Europe to launch R&D projects in new business areas. Through the strengthening of its R&D structure, it will accelerate strategic R&D activities. Canon is advancing research on Mixed Reality (MR) technology—an imaging technology that integrates the real and virtual worlds. 24 CANON ANNUAL REPORT 2010 P RODU C TION While promoting in-house production, automated processes and total automation, Canon aims to establish an optimal global production structure. “Man-machine cell” production system has been introduced at Canon Hi-Tech (Thailand) Ltd. Establishing an Optimal Global Production Structure Canon is working to optimize its production structure and allocation on a global scale by comprehensively assessing such factors as costs, logistics, procurement, quality and workforce. An optimized structure will lead to additional productivity improvements for the entire Canon Group. In 2010, Canon Virginia, Inc. began the automated production of toner cartridges to serve customers in North America, which is still a major market. With the start of such production, Canon Virginia has created a toner cartridge business model that completes the entire process, from production and sales to collection and recycling, within the United States. Improving Productivity In addition to improving cell production efﬁ ciency, Canon has introduced a “man-machine cell” production system that integrates manual and automated processes. We are also actively expanding automated production for products other than toner cartridges. Aiming to strengthen technological expertise and reduce costs, Canon is promoting the in-house production of image sensors and other key components and devices. Canon plans to expand in-house production of materials and facilities, reducing costs and enhancing product competitiveness. CANON ANNUAL REPORT 2010 25 Meanwhile, Canon is implementing various IT reforms to eliminate redundancies in development, production and sales processes. As part of these reforms, Canon has established a centralized production management system, the introduction of which was completed as planned at 26 production bases in 2010. This system allows our production bases to share pur- chase-order information provided by sales companies in real time. Thus, materials and parts can be procured and products assembled to match the exact volume ordered, contributing to additional inventory reductions. Bolstering Production Capacity To prepare for an expected increase of global demand for its products, Canon is working to strengthen its production struc- ture worldwide by giving due consideration to optimal loca- tions and capacity. In 2010, Canon started the production of digital cameras at Nagasaki Canon Inc. In 2011, Canon Zhongshan Business Machines Co., Ltd., located in Guangdong, China plans to start operations of its new laser printer plant, and Canon High-Tech (Thailand), of its new inkjet printer plant. As the laser printer market heads toward full-ﬂ edged recov- ery, Canon anticipates that demand for toner cartridges will Automated toner cartridge production grow again. In response, Canon will construct a new plant at Hita Canon Materials Inc. in Oita Prefecture, Japan for the manufacture of toner cartridge parts and toners. The plant construction will start during 2011, and the plant is scheduled to begin operations in 2012. Digital camera production at Nagasaki Canon Inc. 26 CANON ANNUAL REPORT 2010 S ALES & MARKETING Canon continues to bolster its sales and marketing functions in all operations to better serve its customers through sophisticated products, advanced solutions and timely services. Canon Information Technology Services, Inc. efﬁ ciently responds to inquiries from end users throughout the United States. General Review ICT applications are spreading, and demand for advanced solu- tions and services is growing. Canon aims to expand sales by offering new solutions and services in all of its businesses. The consolidation of Océ N.V. has enabled Canon to provide a wider range of printing solutions worldwide. Meanwhile, through its 2009 alliance with HP, Canon is more capable than ever of helping ofﬁ ces throughout the world create optimal document input/output environments speciﬁ c to individual customer needs. Also, we are promoting Canon Managed Document Services (Canon MDS), a common global service designed to assist customers manage more effectively their document input/output environments and document process- es. Primarily targeting global corporations, we aim to expand our customer base for Canon MDS. In addition, Canon has entered the retail photo-ﬁ nishing market and begun photo-related solutions offerings. In the medical ﬁ eld, it has launched inte- grated services by linking diagnostic imaging systems with digi- tal production printers. The Americas Canon’s sales totaled ¥1,023.3 billion (27.6% of consolidated net sales). Markets in this region picked up gradually and showed robust trends in the second half. Canon renewed its IT systems to facilitate information sharing even with local distributors. These systems have enabled Canon to immediately gather inventory information and deliver products to customers in a more timely manner. Canon plans to establish a solutions business subsidiary in 2011. This subsidiary will develop and sell solutions combining digital cameras, printers, medical equipment and ofﬁ ce net- work MFDs. CANON ANNUAL REPORT 2010 27 Europe Sales in this segment, including Europe, the Middle East and Africa, amounted to ¥1,172.5 billion (31.6% of consolidated net sales). Canon renewed its entire lineups of laser printers, ofﬁ ce network MFDs and digital production printers. By linking these products with solutions, Canon effectively tapped into the market recovery in 2010. Also, Canon teamed up with Accenture and jointly launched Canon Consultancy Services. From 2011, Canon will work to attract clients from wide-ranging ﬁ elds. From 2009, Canon Europe headquarters assumed sales responsibility for large accounts, including electronics retail stores and Internet marketing operators, which had previously been handled by sales companies in individual countries. In 2010, the number of these accounts increased from 13 to 20, and total sales generated through these accounts grew to command more than half of the consumer product business in central and Western Europe. Asia and Oceania In Japan, sales totaled ¥695.7 billion (18.8% of consolidated net sales). In Asia and Oceania, excluding Japan, sales grew signiﬁ - cantly from 2009 to ¥815.4 billion (22.0% of consolidated net sales), reﬂ ecting brisk sales expansion in the Asian market, centered on China and India. Sales grew briskly in the Asian market, centered on China. In Japan, sales of ofﬁ ce network MFDs and laser printers were strong. Also, through the establishment of an intermediate holding company, Canon MJ IT Group Holdings Inc. (Canon MJ-ITHD), IT solution business companies of the Canon Marketing Japan Group have been included in the consolidation of Canon MJ-ITHD. Based “Showroom on Wheels”— Canon Image Express Campaign in India on this reorganization, and through a new data center under construction, Canon aims to accelerate its cloud services. Canon relocated its Chinese inkjet printer business head- quarters functions from Beijing to Shanghai. Meanwhile, we established new sales and service bases, such as eight new Quick Service Stations in China and four new Canon Image Squares in India to promote our consumer products. In 2010, inkjet printer sales in Indonesia ranked fourth among all the nations where Canon operates, following the United States, Japan and China. In Australia, despite severe operating conditions, Canon worked to improve sales and marketing efﬁ ciencies and ex- pand the markets for Canon products. On-site photo print service in Singapore 28 CANON ANNUAL REPORT 2010 C ORPORATE SOCIAL RESPON SIB I LITY Canon strives to fulﬁ ll its social responsibility through environmental measures and social and cultural activities to help bring the world closer to achieving kyosei. Through the Canon—Green Library for Kids initiative, Canon Singapore Pte. Ltd. has donated bookshelves and more than 40,000 children’s and other books to elementary schools across Vietnam through its Vietnam representative ofﬁ ce. Canon’s Basic Approach to CSR Canon is promoting CSR activities beﬁ tting a truly excellent global corporation that is admired and respected by people worldwide. We aspire to a society in which all people—regard- less of race, region or culture—live and work together for the common good into the future. Environmental Activities Canon announced “Action for Green,” the Canon Environmen- tal Vision, in 2009. In line with this vision, Canon is working to realize technological innovation and improve its management efﬁ ciency, thereby balancing the enhancement of product performance and functions and the minimization of the lifecycle environmental burden of its products. We are contributing to the establishment of a society in which people enjoy afﬂ uent lifestyles in a sound global environment. Meanwhile, along with global warming, the preservation of biodiversity has become an important issue shared by the entire world. Through its business and CSR activities, Canon is implementing various initiatives aimed at preserving wild fauna and ﬂ ora. 20th Anniversary of the Toner Cartridges Recycling Program 2010 marked the 20th anniversary of the Canon Toner Car- tridges Recycling Program. In 1990, Canon established a cartridge return framework—an unthinkable initiative in the electronic devices ﬁ eld at that time—and has achieved the recycling of used cartridges collected without using them for CANON ANNUAL REPORT 2010 29 landﬁ ll. The recycling program is now promoted in 24 nations worldwide and enabled Canon to reduce CO2 emissions by an aggregate total of approximately 400,000 tons in 2010. Promotion of Biomass Plastic Parts Plant-derived, biomass plastics, which curb increases in CO2, offer material properties that effectively reduce environmental burden. However, it had been difﬁ cult to achieve a sufﬁ cient level of moldability and ﬂ ame retardance required for the exterior parts of ofﬁ ce network MFDs and other products. In 2009, Canon and Toray Industries, Inc. successfully developed biomass plastic that boasts world-leading ﬂ ame retardance and that can be utilized for an exterior part of an ofﬁ ce net- work MFD. We have started using this material in imageRUN- NER ADVANCE models. Through additional joint R&D efforts, in 2010 we succeeded in developing a large exterior part using the same material. Canon began using the biomass plastic part on the imagePRESS C7010VP digital production printer in 2010. Support for Wildlife Preservation in Yellowstone National Park Canon U.S.A., Inc. has provided funding to world-famous Yellowstone National Park in Wyoming and supported innova- tive scientiﬁ c research aimed at protecting endangered spe- cies. Among various initiatives made possible by Canon fund- ing, Eyes on Yellowstone—an education and research program—uses Canon imaging products to conduct wildlife monitoring. In fact, distributed through the Internet, videos of wildlife observations are used for the education of children worldwide. Through these and other initiatives, Canon is helping younger generations understand environmental issues and the importance of nature conservation. imagePRESS C7010VP using a biomass plastic exterior part Disclosure Regarding Conﬂ ict Minerals The term conﬂ ict minerals refers to minerals such as tantalum, tin, gold and tungsten originating in the Democratic Republic of the Congo and adjoining countries in Africa that are alleged to be closely linked to conﬂ ict involving human rights violations in the eastern Democratic Republic of the Congo. In the United States, on July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, a statute target- ing ﬁ nancial reform, was enacted, and a provision relating to the disclosure of conﬂ ict minerals was included in the Act, requiring publicly listed companies in the United States to report and make public in the near future the use of so-called “conﬂ ict minerals” in their products. Toner cartridge Eyes on Yellowstone, an education and research program funded by Canon U.S.A. Inc. 30 CANON ANNUAL REPORT 2010 Participants of the Canon PhotoMarathon Asia 2010, held in Singapore, took photos to submit to a photo contest. Canon has begun investigations into whether or not the raw materials the Company purchases for use in its products include conﬂ ict minerals. Additionally, the Company will strive to act in accordance with the Dodd-Frank Act and related disclosure rules to be established by the U.S. Securities and Exchange Commission. Contributing to Society Canon conducts wide-ranging social contribution activities. The following are examples of these activities. Canon Foundation Decides the First Research Grant Recipients Canon established the Canon Foundation in 2008 to commem- orate its 70th anniversary. This foundation supports organizations and individuals engaged in research and education in various academic ﬁ elds, beginning with science and technology, as well as for cultural pursuits. In April 2010, the Canon Foundation decided on the recipients for its ﬁ rst research grants, which consisted of 13 grants in the Creation of Industrial Infrastructure category and three in the Pursuit of Ideals category. Canon—For a Green Vietnam Canon has undertaken an environmental protection project, Canon—For a Green Vietnam, since 2009 with the aim of promot- ing environmental awareness among the people in Vietnam. As part of this project, in 2010, Canon conducted the Canon—Green Library for Kids initiative to donate bookshelves and more than 40,000 children’s books and textbooks to pupils across the nation. These books were collected through the Canon—Environmental Bag Exchange program. Through such donations, Canon is contrib- uting to the development of school libraries in Vietnam. The Tsuzuri Project In cooperation with an NPO, the Kyoto Culture Association, Canon started a social contribution program called the Tsuzuri Project (ofﬁ cial title: Cultural Heritage Inheritance Project) in 2007, aiming to preserve important Japanese cultural heritage and promote the effective use of meticulously reproduced original-based works. Through this project, Canon creates high- precision reproductions of recognized Japanese cultural heri- tage by employing its advanced digital image input, processing and output technologies, together with gold-leaf and gold-paint CANON ANNUAL REPORT 2010 31 Three Tsuzuri Project works were exhibited at the Expo 2010 Shanghai China. treatments and other traditional techniques of skilled Japanese craftsmen. At the Expo 2010 Shanghai China, Canon displayed three works that were reproduced through the Tsuzuri Project to disseminate traditional Japanese art throughout the world. production base throughout the world. To nurture such human resources, Canon started intensive training of local managerial staff on a global scale in 2010 using highly qualiﬁ ed in-house trainers. Through localized training programs, Canon is bolster- ing its global production structure and workforce. Volunteer Day at Canon Nederland N.V. Based in the Netherlands, Canon Nederland established “Vol- unteer Days” in 2004—days on which its employees conduct various volunteer activities, such as serving as travel guides for the elderly and visiting welfare facilities to provide support. In 2010, for the sixth consecutive year, activities included visiting hospitalized children, taking and printing photos with them and presenting these photos to the children. Nurturing Diverse Human Resources Aiming to become a truly excellent global corporation, Canon effectively uses education to motivate each employee to continue growing as an “excellent person.” For Canon to achieve sustainable expansion of its global production structure in harmony with the development of the global community, it requires skilled and trained production personnel at each Volunteer Day at Canon Nederland N.V. 32 CANON ANNUAL REPORT 2010 BUSINESS UNITS CANON ANNUAL REPORT 2010 33 CONTENTS Ofﬁ ce Business Unit 34 (cid:129) Ofﬁ ce network digital multifunction devices (MFDs) (cid:129) Color network digital MFDs (cid:129) Ofﬁ ce copying machines (cid:129) Personal-use copying machines (cid:129) Full-color copying machines (cid:129) Laser printers (cid:129) Large format inkjet printers (cid:129) Digital production printers 53.6% Consumer Business Unit 38 (cid:129) Digital SLR cameras (cid:129) Compact digital cameras (cid:129) Interchangeable lenses (cid:129) Digital video camcorders (cid:129) Inkjet multifunction peripherals (cid:129) Single function inkjet printers (cid:129) Image scanners (cid:129) Broadcasting equipment 37.5% Industry and Others Business Unit 42 11.7% (cid:129) Semiconductor lithography equipment (cid:129) LCD lithography equipment (cid:129) Medical image recording equipment (cid:129) Ophthalmic products (cid:129) Magnetic heads (cid:129) Micromotors (cid:129) Computers (cid:129) Handy terminals (cid:129) Document scanners (cid:129) Calculators Note: The percentage ﬁ gures for the three business units presented in the pie charts above do not add up to 100% because “Eliminations,” used in consolidated accounting, were not included in calculation considerations. Photo: Canon is offering new imaging options through the advanced video capabilities of digital EOS, providing video professionals with high-quality motion-picture shooting possibilities enabled by digital SLR cameras. 34 CANON ANNUAL REPORT 2010 O FF IC E BUSINESS UNIT Photo: Thanks to its excellent ofﬁ ce network MFD performance and unparalleled user-friendliness, the imageRUNNER ADVANCE series has been introduced in an elementary school in Chicago, the United States. CANON ANNUAL REPORT 2010 35 “ Enhancing its lineups with imageRUNNER ADVANCE, Canon will accelerate the solutions business.” “ Canon will lead the large-format inkjet printer industry by continuing to launch market needs- oriented products.” Masaki Nakaoka Toshio Homma Chief Executive, Ofﬁ ce Imaging Products Operations Chief Executive, L Printer Products Operations In 2010, conditions in the ofﬁ ce imaging products market showed stronger recovery, particularly in Asia. In ofﬁ ce network MFDs, Canon strengthened its color and monochrome imag- eRUNNER ADVANCE lineups and solution-oriented sales activi- ties. Owing to our collaboration with HP and Océ N.V., MFD sales volume grew in the Americas. In digital production print- ers, the imageRUNNER ADVANCE C9000 PRO series performed robustly in the Americas. The sales amount and volume of MFPs for SOHO use grew in all markets, particularly in Europe and Asia. While promoting Canon MDS, we announced our plan to collaborate with Fujitsu Limited in offering cloud computing- based managed services for printing and other IT equipment. In 2011, the Ofﬁ ce Business Unit aims to outpace market growth. Thus we will continue to strengthen imageRUNNER ADVANCE lineups and sales activities for our cloud business while expanding our solutions business. In digital production printers, we will reinforce our product lineups and the synergy of working with Océ. We will also increase the sales volume of SOHO-use products by bolstering external collaboration in sales activities. Also, by enhancing our solutions menu based on imageRUNNER ADVANCE and im- proving our solutions provider presence, we aim to increase our market share. In 2010, the worldwide large-format inkjet printer market rebounded after two years of contraction. Reﬂ ecting this situation, global shipments grew slightly year on year. The use of large-format inkjet printers is spreading in the graphic arts ﬁ eld, including prepress color prooﬁ ng and digital photo and on-demand poster production. In response, Canon released new products incorporating a high-precision mechan- ical structure that enables high-accuracy printing and featuring the new LUCIA EX 12-color pigment ink system. These prod- ucts earned high acclaim, and their sales grew steadily, driving sales of Canon graphic arts printers. Reﬂ ecting the perfor- mance of these powerful products, Canon was able to record the largest shipments ever. We expanded sales in Europe and the United States and also reinforced our mutual sales struc- ture organized with Océ. From 2011, conditions in advanced nations are expected to improve. China and other emerging markets will likely maintain their growth trends. To prepare ourselves for expected market expansion, we will bolster R&D for core technologies and en- hance our optimal global production structure. In this way, we will further solidify our business, aggressively launching industry- leading, attractive products, and to meet ever-diversifying market needs, we will continue to reinforce our sales and R&D collaboration with Océ. Digital production printer, imagePRESS C7010VP Large-format inkjet printer, imagePROGRAF iPF8300 36 CANON ANNUAL REPORT 2010 2010 Review—OFFICE BUSINESS UNIT Sales Results (Millions of yen) 3,000,000 2,000,000 1,000,000 2,246,609 1,987,269 1,645,076 0 08 09 10 Net sales in the Ofﬁ ce Busi- ness Unit totaled ¥1,987.3 billion, increasing 20.8% year on year, despite the slow recovery in the production printing market. Global demand for ofﬁ ce network MFDs—color devices in particular—recovered com- pared with 2009, while the laser printer market also achieved signiﬁ cant recovery. In ofﬁ ce network MFDs, the Ofﬁ ce Business Unit realized double-digit growth in sales in Japan, the Americas, Europe, and Asia and Oceania. In China, sales of low-price models were robust. The sales volume and amount of color models, a mainstay imageRUNNER ADVANCE C5045 in this category, soared thanks to strong sales of the imag- eRUNNER ADVANCE C5000 series. Also, the monochrome imageRUNNER ADVANCE 6000 series with 50 to 70 ppm capability and the color imageRUNNER ADVANCE C2000 series with 20 to 30 ppm capability performed well, pushing up the overall shipment of ofﬁ ce network MFDs. In laser printers, Canon’s performance showed a signiﬁ - cant improvement in line with the market recovery. In Japan, color A4-models, such as the imageCLASS MF8050 Cn (i-SENSYS MF8050 in some areas) and the imageCLASS MF8350 Cdn (i-SENSYS MF8350 in some areas), underwent expanded sales. Overseas, shipment surged in India, Viet- nam and other Asian markets as well as in Europe and the United States. In emerging markets, the sales volume of monochrome SFPs and MFPs for individual use climbed signiﬁ cantly. This success reﬂ ected the enhanced competi- tiveness of these products owing to their faster printing speed and other functional enhancements. In digital production printers, Canon released the image- PRESS C7010VP series for the commercial printing market and the monochrome imageRUNNER ADVANCE 8000 series during the reporting term. The Company worked to expand sales of these new series. In addition, we reinforced our product lineups and the synergies of working with Océ. Meanwhile, Canon continued to enhance its solutions business. We expanded the applications of the Canon Multifunctional Embedded Application Platform (MEAP), which enables cloud service access via MFDs. Furthermore, Focus on Change—Accelerated Integration with Océ N.V. After Océ ofﬁ cially joined the Canon Group in March 2010, the two companies have promoted their integration and strengthened their cooperation steadily. In particular, mainly in Europe and the United States, Canon and Océ are striving to expand product portfolios and are in the process of expanding product sales and strengthening the servicing function by utilizing each other’s sales and service chan- nels effectively. In Japan, Canon has expanded the lines of Océ products it handles, and it is strategically meeting increased demand for commercial digital printers for production printing. We will con- tinue to complement each other in all business aspects, thereby targeting the leading position in the global printing industry. Digital production printer of Océ N.V. CANON ANNUAL REPORT 2010 37 imageRUNNER ADVANCE C5051 imagePROGRAF iPF6350 cooperation with Group companies has allowed Canon to acquire new solutions business accounts. The Asian market for large-format inkjet printers contin- ued to grow, contributing to a substantial increase in sales volume. In 2010, Canon introduced three new series— namely, the iPF6300, iPF6350 and iPF8300—for the graphic arts market. Featuring the new LUCIA EX 12-color pigment ink system, which realizes improvements in the color density of black as well as in color gradation and range, new models in these series provide superior productivity, exquisite photographic output and the capability to repro- duce ﬁ ne detail. These models have been received well in the market since their launch, contributing to segment sales. In the CAD market, Canon sustained robust sales of the iPF750, which enables high-speed printing on an A1- size sheet in approximately 28 seconds. During 2010, to effectively meet increased shipment needs, Canon established a new production base in China. Color imageCLASS MF8350Cdn (i-SENSYS MF8350Cdn in some areas) Focus on Change—imageRUNNER ADVANCE High-Speed Monochrome Lineup Completed Canon released three imageRUNNER ADVANCE 8000 PRO models in 2010 and completed its high-speed monochrome lineup. Thanks to their improved fuser unit performance, these printers require only one minute or less to warm up after powering on—the quickest of all A3 monochrome MFDs of 85 ppm or more.* In addition, they achieve industry-leading color scanning speed while supporting high-volume printing, with a maximum paper capacity of 7,700 sheets. Also, their footprint has been reduced by approximately 35% compared with their predecessor, the imageRUNNER 7105i.** The network of color and monochrome imageRUNNER ADVANCE models now enables a higher level of work efﬁ ciency in ofﬁ ces. * As of September 3, 2010. Based on a Canon study. ** The footprint of imageRUNNER 7105i: 2,021 mm (W) x 792 mm (D) imageRUNNER ADVANCE 8105 V2 (imageRUNNER ADVANCE 8105 PRO in some areas) 38 CANON ANNUAL REPORT 2010 C ONS UMER BU SINESS UN IT Photo: The EOS 60D is an advanced-amateur digital SLR camera that offers superior features, such as the Vari-angle Clear View LCD monitor, which provides enhanced monitor articulation, and excellent video capabilities, which have earned high acclaim from video professionals. Canon is reinforcing its lineup of digital SLR cameras packed with sophisticated functions. CANON ANNUAL REPORT 2010 39 “ Further reinforcing its brand power, Canon will bolster its overwhelming No. 1 position.” “ Canon will aggres- sively launch appealing inkjet products to achieve additional growth.” Masaya Maeda Katsuichi Shimizu Chief Executive, Image Communication Products Operations Chief Executive, Inkjet Products Operations The digital camera market grew steadily, and digital compact camera markets continued to thrive in emerging markets, while digital SLR camera markets remained strong worldwide, particularly in Asia. In digital compact cameras, Canon released many models featuring the HS SYSTEM. Incorporating a high-sensitivity image sensor with Canon’s proprietary DIGIC image processor, the HS SYSTEM enhances image quality in low-light conditions. The uniqueness and superiority of these cameras helped Canon secure its leading market position. In digital SLR cameras, Canon enhanced the mid-range and high-end products. Sales volume expanded in each market, increasing Canon’s share. The sales volume of Canon’s digital video camcorders also increased. In 2011, Canon will strengthen its optical technologies to create high-value-added products, thereby supporting higher image quality for still pictures and videos. It will also bolster its services to accommodate post-shooting needs, thereby pio- neering new possibilities for digital cameras. Meanwhile, Canon will solidify its sales capabilities in emerging markets. By offer- ing new products based on cutting-edge technologies, Canon is targeting its continuous growth. The inkjet printer market expanded worldwide, particularly in Asia. However, overall conditions have not returned to a level on par with the 2007 peak. Canon continues to expand inkjet sales even in a stagnant marketplace that has shrunk since the onset of the global recession in 2008. It managed to increase inkjet shipments in 2010 and will work to maintain this upward trend. Reviewing its 2010 strategies, Canon renewed PIXMA inkjet printer designs. While working to increase the series’ total sales volume by tapping into growing Asian markets, it strove to expand sales of high-value-added products with which cus- tomers are expected to perform high-volume printing. To that end, it aimed to expand sales of multifunction printers (MFPs) for home ofﬁ ce use and mid-range and high-end products in the United States and other advanced nations. Consequently, sales of these products rose as planned. In scanners, Canon increased sales volume amid market contraction, solidifying its leading position. From 2011, Canon will enhance its FINE technology, which enables the high-speed printing of high-quality images thanks to its proprietary high-precision print head technology. By launching new, user-friendly products that feature excellent design and boosted user value, Canon aims for additional sales volume. To meet expected sales growth, Canon plans to build a new plant in Thailand. Digital SLR camera, EOS Rebel T3i (EOS 600D in some areas) Inkjet printer, PIXMA MX880 series 40 CANON ANNUAL REPORT 2010 2010 Review—CONSUMER BUSINESS UNIT Sales Results (Millions of yen) 1,500,000 1,456,075 1,391,327 1,301,160 1,000,000 Net sales in the Consumer Business Unit grew 6.9% year on year to ¥1,391.3 billion. Sales steadily expanded for digital SLR cameras, digital compact cameras, inkjet printers and other consumer products. 0 09 08 500,000 In digital SLR cameras, Canon released the EOS Rebel T2i (EOS 550D in some areas)—an entry-level model with advanced full-HD video capabilities—and an ad- vanced-amateur model, EOS 60D, the ﬁ rst EOS equipped with the Vari-angle LCD monitor. EOS cameras received high acclaim in the market, allowing Canon to increase its market share of digital SLR cameras. In digital compact cameras, Canon launched as many as 14 new models in 2010, including the PowerShot SD1300 IS 10 PowerShot SD1300 IS DIGITAL ELPH (Digital IXUS 105 in some areas) DIGITAL ELPH (Digital IXUS 105 in some areas) featuring the HS SYSTEM. Other PowerShot models—speciﬁ cally, the SD3500 IS DIGITAL ELPH (Digital IXUS 210 in some areas) with a 3.5-inch, wide touch panel—added to segment sales. The sales volume continued to increase, particularly in emerging markets. In LCD projectors, the high-performance, high-resolution REALiS SX80 Mark II (XEED SX80 Mark II in some areas) with speciﬁ cations optimized for medical imaging and high- deﬁ nition photography contributed to segment sales. Canon introduced the HJ15ex8.5B KRSE-V portable HD zoom lens with a built-in Optical Image Stabilizer in the EOS Rebel T2i (EOS 550D in some areas) EF70-200mm F2.8L IS II USM Focus on Change—Full HD Video Capabilities on EOS Cameras Released in November 2008, the EOS 5D Mark II digital SLR camera continues to gain recognition among video professionals. Equipped with a full-frame CMOS sensor, this is the ﬁ rst EOS to offer full HD video capture, at 1,920 x 1,080 resolution. It has been widely used for TV program shooting as well as for the shooting of some Hollywood movies. In fact, its CMOS sensor is double the size of those in com- monly used broadcast cameras. It maximizes depth of ﬁ eld, or the aesthetic quality of blur—a shooting technique often used with SLR cameras—while providing compactness, portability and an extensive range of EF lenses. Featured on other EOS models, Canon’s full HD video capability is opening up new possibilities for digital SLR cameras. Video shooting using digital EOS in the United States CANON ANNUAL REPORT 2010 41 VIXIA HF M41 (LEGRIA HF M41 in some areas) Inkjet printer, PIXMA MG6100 series broadcasting lens. The HD image stability of this new prod- uct earned high acclaim among video professionals. In inkjet printers, supported by overall market recovery and by sales growth, particularly in Asia, sales volume expanded compared with 2009. In the United States, the PIXMA MX870 for home ofﬁ ce use and the PIXMA Pro9500 Mark II for professional and advanced amateur users were received well, pushing up segment sales. In China, while sustaining the high sales volume of the already-popular PIXMA iP1180, Canon achieved a brisk increase in sales of entry-model MFPs and MFPs for home ofﬁ ce use from 2009. REALiS SX80 Mark II (XEED SX80 Mark II in some areas) PIXMA MG8100 series Focus on Change—Renewal of PIXMA Inkjet Printer Series Canon renewed the PIXMA lineups, upgrading the design and usabil- ity. New PIXMA models were released in 2010, including the PIXMA MG6100 series. Featuring a stylish black exterior, these PIXMA print- ers provide sophisticated design. Also, the Intelligent Touch Sys- tem*—a light-guided, touch-sensitive button navigation system— enhances intuitive, effortless operations. Furthermore, the Full HD Movie Print function turns HD movie clips captured with compatible Canon digital cameras into beautiful photo prints. With these power- ful machines, Canon continues to lead the inkjet printer market. * Only available on the PIXMA MG8100 series and the PIXMA MG6100 series. Intelligent Touch System 42 CANON ANNUAL REPORT 2010 I NDU STRY AND OTHERS BU SIN ES S UN I T Photo: Canon’s LCD lithography equipment for eighth-generation mirror projection aligners provides not only excellent productivity, but also speedy installation, contributing to customers’ strategic LCD panel production. CANON ANNUAL REPORT 2010 43 “ Our market needs-oriented business model is gaining a strong foothold in the market and producing tangible results. In 2011, Canon will accelerate the development of technologies and products that enable it to capture demand in new businesses.” Shigeyuki Uzawa Chief Executive, Optical Products Operations (Effective January 1, 2011) In 2010, the markets of both semiconductor lithography and LCD lithography equipment enjoyed rapid recovery, each expanding briskly year on year in terms of shipment volume. Behind such market expansion was manufacturers’ strong drive for capital investment. Our semiconductor lithography equipment business in- creased sales volume signiﬁ cantly. Canon expects that market recovery will continue in 2011 in anticipation of semiconductor manufacturers’ spending on their facilities being either at the same level or higher compared with 2010. To capitalize on such positive conditions, Canon will facilitate closer collaboration among design and sales divisions and accurately grasp ever- diversifying customer needs while accelerating the develop- ment of products with unparalleled reliability and durability and upgrading its service quality. Through these activities, we will work to meet these needs ﬂ exibly. The LCD lithography equipment business also expanded sales substantially. Performance in South Korea, Taiwan and China was particularly robust. In fact, our shipment volume increased substantially year on year. In 2011, the LCD lithogra- phy equipment market in China is expected to grow further as an increasing number of LCD panel manufacturers are acceler- ating local production. In response, Canon will strengthen sales activities and systems to provide support and other services. The Company plans to launch LCD lithography equipment to capture opportunities arising in line with LCD panel manufac- turers’ investment in facilities for 7.5- and eighth-generation mirror projection aligners. Meanwhile, we will work to improve the reliability and durability of our products and enhance our capabilities for quick equipment installation. The development of optical products requires the latest in advanced technologies. This means that the outcome of R&D for optical products can be channeled into the development of other Canon products. In other words, R&D in this segment is the driver of technological advances achieved by the Canon Group. Bearing this signiﬁ cant responsibility, the Industry and Others Business Unit will continue to bolster the development of next-generation lithography, medical and other technologies. Semiconductor lithography systems Development of digital radiography system 44 CANON ANNUAL REPORT 2010 2010 Review—INDUSTRY AND OTHERS BUSINESS UNIT Sales Results (Millions of yen) 600,000 500,000 400,000 300,000 200,000 100,000 0 522,405 432,958 357,998 08 09 10 Net sales increased 20.9% year on year to ¥433.0 billion. In line with the recovery in capital investment by semicon- ductor and LCD panel manufacturers, Canon expanded sales volume. In semiconductor lithography equipment, sales were strong for products targeting manu- facturers of memory, sensor and imaging devices. In particular, products based on Canon’s FPA-5500 platform, which boasts excellent stability and reliability, were received well in the markets of Japan, Taiwan and South Korea. In LCD lithography equipment, our ability to install systems quickly helped customers promote their busi- ness strategies. Sales of the MPAsp-H700 series for eighth-generation mirror projection aligners were particularly robust. In digital radiography systems, the market for static X-ray imaging systems expanded, especially in China. Meanwhile, released in 2009, the CXDI-55C/55G ﬂ at panel detector saw increased sales in Japan, Europe and the United States. In ophthalmic equipment, sales of the CX-1 mydriatic/ non-mydriatic two- in-one digital retinal camera contributed to overall segment performance. Also, sales of Optical Coherence Tomog- raphy (OCT) sys- tems of Canon subsidiary OPTOPOL Technology S.A. grew, especially in Europe, pushing up segment sales. In other categories, the industrial systems of Group OPTOPOL’s ophthalmic equipment companies performed robustly, including Canon Machinery Inc.’s BESTEM series of die bonders and Canon ANELVA Corporation’s semiconductor ﬁ lm deposition equipment. BESTEM-D10Sp Focus on Change—CXDI-70C Wireless Digital Radiography System Since its release of the world’s ﬁ rst digital X-ray system, CXDI-11, in 1998, Canon has contributed to digital evolution in diagnostic imag- ing. As X-ray imaging equipment continues to go digital, Canon launched its ﬁ rst wireless digital radiography system, CXDI-70C Wireless, in October 2010. Capable of wireless image transmission, the lightweight CXDI-70C Wireless provides great portability and ﬂ exible usage. Its outer di- mension is the same as that of conventional ﬁ lm cassettes, allowing for an easy conversion of analog systems into digital. A new Canon- developed glass substrate with a pixel pitch of 125 microns achieves high-precision, high-resolution imaging. Also, the CXDI-70 Wireless is equipped with a highly sensitive cesium iodide (CsI) scintillator, which delivers high-quality images and reduces X-ray exposure to patients. CXDI-70C Wireless CANON ANNUAL REPORT 2010 45 FINANCIAL SECTION TABLE OF CONTENTS FINANCIAL OVERVIEW ...................................................................................... 46 TEN-YEAR FINANCIAL SUMMARY .................................................................... 62 CONSOLIDATED BALANCE SHEETS .................................................................. 64 CONSOLIDATED STATEMENTS OF INCOME ...................................................... 65 CONSOLIDATED STATEMENTS OF EQUITY ........................................................ 66 CONSOLIDATED STATEMENTS OF CASH FLOWS .............................................. 68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ...................................... 69 1 Basis of Presentation and Signiﬁ cant Accounting Policies 2 Basis of Financial Statement Translation .......................................... 73 3 Investments 4 Trade Receivables ............................................................................. 75 5 Inventories 6 Property, Plant and Equipment 7 Finance Receivables and Operating Leases ...................................... 76 8 Acquisitions ........................................................................................ 77 9 Goodwill and Other Intangible Assets .............................................. 78 10 Short-Term Loans and Long-Term Debt ............................................ 80 11 Trade Payables 12 Employee Retirement and Severance Beneﬁ ts ................................ 81 13 Income Taxes .................................................................................... 87 14 Common Stock .................................................................................. 90 15 Legal Reserve and Retained Earnings ............................................... 91 16 Other Comprehensive Income (Loss) 17 Stock-Based Compensation ................................................................ 93 18 Net Income Attributable to Canon Inc. Stockholders per Share ...... 95 19 Derivatives and Hedging Activities 20 Commitments and Contingent Liabilities ......................................... 97 21 Disclosures about the Fair Value of Financial Instruments and Concentrations of Credit Risk ........................................................... 99 22 Fair Value Measurements ............................................................... 100 23 Supplemental Cash Flow Information ............................................ 102 24 Segment Information 25 Subsequent Event ........................................................................... 106 MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING ........................................................................ 107 REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ......... 108 46 CANON ANNUAL REPORT 2010 FINANCIAL OVERVIEW GENERAL The following discussion and analysis provides information that management believes to be relevant to understanding Canon’s consolidated ﬁ nancial condition and results of operations. References in this discussion to the “Company” are to Canon Inc. and, unless otherwise indicated, references to the ﬁ nancial condition or operating results of “Canon” refer to Canon Inc. and its consolidated subsidiaries. OVERVIEW Canon is one of the world’s leading manufacturers of plain paper copying machines, digital multifunction devices (“MFDs”), laser printers, cameras, inkjet printers, semiconductor lithogra- phy equipment and liquid crystal display (“LCD”) lithography equipment. Canon earns revenues primarily from the manufac- ture and sale of these products domestically and international- ly. 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 con- tinued growth and development. Canon divides its businesses into three segments: the Ofﬁ ce Business Unit, the Consumer Business Unit, and the Industry and Others Business Unit. Economic environment Looking back at the global economy in 2010, economic condi- tions continued to improve broadly throughout the world, led by the economic growth of such emerging markets as China and India. In the United States, despite the unemployment rate remaining at a relatively high level and other concerns, eco- nomic conditions continued to recover gradually thanks in part to economic measures by the government. As for Europe, in spite of lingering ﬁ nancial and employment concerns along with the emergence of ﬁ nancial crises in some countries, the region overall managed to realize a recovery. China, which quickly recovered its growth pace through major economic stimulus measures, and the rest of Asia, along with other emerging nations, continued to achieve economic expansion. And in Japan, although signs began to appear indicating a turn- around, the recovery came to a standstill at the end of 2010 due to prolonged deﬂ ation and other factors. Market environment As for the markets in which Canon operates amid these condi- tions, within the ofﬁ ce equipment market, demand for network digital MFDs recovered, mainly for color models, while laser printers also realized a steady rebound compared with the pre- vious year. As for the consumer products market, demand for digital single-lens reﬂ ex (“SLR”) cameras maintained healthy growth across global markets. As for compact digital cameras, although sales were sluggish in developed countries, demand in emerging markets grew favorably resulting in a slight increase overall. With regard to inkjet printers, demand contin- ued on a track to recovery. In the industry and others market, demand for semiconductor lithography equipment and LCD lithography equipment grew steadily, owing to improved invest- ment by semiconductor device and LCD panel manufacturers. The average value of the yen during the year was ¥87.40 to the U.S. dollar, a year-on-year appreciation of approximately ¥6 or 6%, and ¥114.97 to the euro, a year-on-year appreciation of approximately ¥15 or 12%. Summary of operations Amid the impact of the sharp appreciation of the yen, net sales for the year totaled ¥3,706.9 billion (U.S.$45,764 million), an increase of 15.5% from the previous year, owing to a substan- tial recovery in sales of laser printers among ofﬁ ce products, continued robust sales of such consumer products as digital SLR cameras, the increase in sales within the Industry and Others Business Unit, and the effects of consolidation arising from corporate acquisitions, such as Océ N.V. Income before income taxes totaled ¥392.9 billion (U.S.$4,850 million), a year- on-year increase of 79.1%, while net income attributable to Canon Inc. also increased by 87.3% to ¥246.6 billion (U.S.$3,044 million). Key performance indicators The 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 47. Revenues As Canon pursues the goal to become a truly excellent global com- pany, one indicator upon which Canon’s management places strong emphasis is revenue. The following are some of the KPIs related to revenue 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, provi- sion of services associated with its products. Sales vary depending on such factors as product demand, the number and size of transactions within the reporting period, market acceptance for new products, and changes in sales prices. Other factors involved are market share and market environ- ment. In addition, management considers the evaluation of net sales by segment to be important for the purpose of assessing Canon’s sales performance in various segments, taking into account recent market trends. Gross proﬁ t ratio (ratio of gross proﬁ t to net sales) is another KPI for Canon. Through its reforms of product development, Canon has been striving to shorten product development lead times in order to launch new, competitively priced products at a faster pace. Furthermore, Canon has further achieved cost reductions through enhancement of efﬁ ciency in its production. Canon believes that these achievements have contributed to improving Canon’s gross proﬁ t ratio, and will continue pursuing the curtailment of product development lead times and reduc- tions in production costs. Operating proﬁ t ratio (ratio of operating proﬁ t to net sales) and research and development (“R&D”) expense to net sales ratio are considered to be KPIs by Canon. Canon is focusing on two areas for improvement. Canon is striving to control and reduce its selling, general and administrative expenses as its ﬁ rst key point. Secondly, Canon’s R&D policy is designed to maintain a certain level of spending in core technology to sus- tain Canon’s leading position in its current business areas and to seek possibilities in other markets. Canon believes such investments will create the basis for future success in its busi- ness and operations. CANON ANNUAL REPORT 2010 47 Cash ﬂ ow management Canon also places signiﬁ cant emphasis on cash ﬂ ow manage- ment. The following are the KPIs with regard to cash ﬂ ow man- agement that Canon’s management believes to be important. Inventory turnover measured in days is a KPI because it mea- sures the adequacy of supply chain management. Inventories have inherent risks of becoming obsolete, physically damaged or otherwise decreasing signiﬁ cantly in value, which may adversely affect Canon’s operating results. To mitigate these risks, management believes that it is crucial to continue reduc- ing inventories and decrease production lead times in order to promptly recover related product expenses by strengthening supply chain management. Canon’s management seeks to meet its liquidity and capital requirements primarily with cash ﬂ ow from operations. Management also seeks debt-free operations. For a manufac- turing company like Canon, it generally takes considerable time to realize proﬁ t from a business as the process of R&D, manu- facturing and sales has to be followed for success. Therefore, KEY PERFORMANCE INDICATORS management believes that it is important to have sufﬁ cient ﬁ nancial strength so that the Company does not have to rely on external funds. Canon has continued to reduce its dependency on external funds for capital investments in favor of generating the necessary funds from its own operations. Canon Inc. stockholders’ equity to total assets ratio is anoth- er KPI for Canon. Canon believes that its stockholders’ equity to total assets ratio measures its long-term sustainability. Canon also believes that achieving a high or rising stockholders’ equity ratio indicates that Canon has maintained a strong ﬁ nancial position or further improved its ability to fund debt obligations and other unexpected expenses. In the long-term, Canon will be able to maintain a high level of stable investments for its future operations and development. As Canon puts strong emphasis on its R&D activities, management believes that it is important to maintain a stable ﬁ nancial base and, accordingly, a high level of its stockholders’ equity to total assets ratio. 2010 2009 2008 2007 2006 Net sales (Millions of yen) Gross proﬁ t to net sales ratio R&D expense to net sales ratio Operating proﬁ t to net sales ratio Inventory turnover measured in days Debt to total assets ratio Canon Inc. stockholders’ equity to total assets ratio ¥3,706,901 48.1% 8.5% 10.5% 35 days 0.3% 66.4% ¥3,209,201 44.5% 9.5% 6.8% 39 days 0.3% 69.9% ¥4,094,161 47.3% 9.1% 12.1% 47 days 0.4% 67.0% ¥4,481,346 50.1% 8.2% 16.9% 44 days 0.6% 64.8% ¥4,156,759 49.6% 7.4% 17.0% 45 days 0.7% 66.0% Note: Inventory turnover measured in days; Inventory divided by net sales for the previous six months, multiplied by 182.5. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The consolidated ﬁ nancial statements are prepared in accor- dance with U.S. generally accepted accounting principles (“GAAP”) and based on the selection and application of signiﬁ - cant accounting policies which require management to make signiﬁ cant estimates and assumptions. Canon believes that the following are the more critical judgment areas in the applica- tion of its accounting policies that currently affect its ﬁ nancial condition and results of operations. Revenue recognition Canon generates revenue principally through the sale of con- sumer 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 or services have been rendered, the sales price is ﬁ xed or determinable, and collectibility is probable. Revenue from sales of ofﬁ ce products, such as ofﬁ ce net- work digital multifunction devices and laser printers, and con- sumer products, such as digital cameras and inkjet multifunction peripherals, 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 semicon- ductor lithography equipment and LCD lithography equipment that are sold with customer acceptance provisions related to their functionality, is recognized when the equipment is installed at the customer site and the speciﬁ c criteria of the equipment functionality are successfully tested and demon- strated by Canon. Service revenue is derived primarily from separately priced product maintenance contracts on equip- ment sold to customers and is measured at the stated amount of the contract and recognized as services are provided. Canon also offers separately priced product maintenance contracts for most ofﬁ ce imaging products, for which the cus- tomer typically pays a stated base service fee plus a variable amount based on usage. Revenue from these service mainte- nance contracts is measured at the stated amount of the con- tract and recognized as services are provided and variable amounts are earned. 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-ﬁ nancing leases is recognized over the life of each respective lease using the interest method. Leases not qualifying as sales-type leases or direct-ﬁ nancing leases are accounted for as operating leases and the related revenue is recognized ratably over the lease term. When equipment leas- es are bundled with product maintenance contracts, revenue is 48 CANON ANNUAL REPORT 2010 ﬁ rst allocated considering the relative fair value of the lease and non-lease deliverables based upon the estimated relative fair values of each element. Lease deliverables generally include equipment, ﬁ nancing and executory costs, while non- lease deliverables generally consist of product maintenance contracts and supplies. For all other arrangements with multiple elements, Canon allocates revenue to each element based on its relative fair value if such element meets the criteria for treatment as a sep- arate unit of accounting. Otherwise, revenue is deferred until the undelivered elements are fulﬁ lled and accounted for as a single unit of accounting. 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 are included in selling, general and administrative expenses. Estimates for accrued product war- ranty costs are based on historical experience, and are affected by ongoing product failure rates, speciﬁ c 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 ﬁ nancing receivables are not overstated due to uncollectibility. These fac- tors include the length of time receivables are past due, the credit quality of customers, macroeconomic conditions and historical experience. Also, Canon records speciﬁ c reserves for individual accounts when Canon becomes aware of a custom- er’s inability to meet its ﬁ nancial obligations to Canon, such as in the case of bankruptcy ﬁ lings or deterioration in the custom- er’s operating results or ﬁ nancial 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 by the average method for domestic inventories and principally the ﬁ rst-in, ﬁ rst-out method for overseas inven- tories. Market value is the estimated selling price in the ordi- nary course of business less the estimated costs of completion and the estimated costs necessary to make a sale. Canon rou- tinely reviews its inventories for their salability and for indica- tions of obsolescence to determine if inventories should be written-down to market value. Judgments and estimates must be made and used in connection with establishing such allow- ances 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. 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 indi- cate that the carrying amount of an asset may not be recover- able. If the carrying amount of the asset exceeds its estimated undiscounted future cash ﬂ ows, an impairment charge is rec- ognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Determining the fair value of the asset involves the use of estimates and assump- tions. These estimates and assumptions include future market conditions, net sales growth rate, gross margin and discount rate. Though Canon believes that the estimates and assump- tions are reasonable, actual future results may differ from these estimates and assumptions. 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. Goodwill and other intangible assets Goodwill and other intangible assets with indeﬁ nite useful lives are not amortized, but are instead tested for impairment annu- ally in the fourth quarter of each year, or more frequently if indi- cators of potential impairment exist. Canon performs its impairment test of goodwill using the two-step approach at the reporting unit level, which is one level below the operating seg- ment level. All goodwill is assigned to the reporting unit or units that beneﬁ t from the synergies arising from each business combination. If the carrying amount assigned to the reporting unit exceeds the fair value of the reporting unit, Canon per- forms the second step to measure an impairment charge in the amount by which the carrying amount of a reporting unit’s goodwill exceeds its implied fair value. Intangible assets with ﬁ nite useful lives consist primarily of software, license fees, pat- ented technologies and customer relationships. 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. Patented technologies are amortized using the straight-line method prin- cipally over the estimated useful life of 3 years. Customer rela- tionships are amortized principally using the declining- balance method over the estimated useful life of 5 years. Income taxes Canon considers many factors when evaluating and estimating income tax uncertainties. These factors include an evaluation of the technical merits of the tax positions as well as the amounts and probabilities of the outcomes that could be realized upon settlement. The actual resolutions of those uncertainties will inevitably differ from those estimates, and such differences may be material to the ﬁ nancial statements. CANON ANNUAL REPORT 2010 49 Valuation of deferred tax assets Canon currently has signiﬁ cant 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 proﬁ tability may change due to future market conditions, its ability to continue to successfully exe- cute its operating restructuring activities and other factors. Any changes in these factors may require possible recognition of signiﬁ cant valuation allowances to reduce the net carrying value of these deferred tax asset balances. When Canon deter- mines 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 beneﬁ t plans Canon has signiﬁ cant employee retirement and severance ben- eﬁ t obligations that are recognized based on actuarial valua- tions. Inherent in these valuations are key assumptions, including discount rates and expected return on plan assets. Management must consider current market conditions, includ- ing changes in interest rates, in selecting these assumptions. Other assumptions include assumed rate of increase in com- pensation levels, mortality rate, and withdrawal rate. Changes in these assumptions inherent in the valuation are reasonably likely to occur from period to period. 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 beneﬁ t costs in the future. In preparing its ﬁ nancial statements for ﬁ scal 2010, Canon estimated a weighted-average discount rate of 2.3% for Japanese plans and 4.9% for foreign plans and a weighted- average expected long-term rate of return on plan assets of 3.6% for Japanese plans and 6.1% for foreign plans. In estimat- ing the discount rate, Canon uses available information about CONSOLIDATED RESULTS OF OPERATIONS SUMMARY OF OPERATIONS rates of return on high-quality ﬁ xed-income governmental and corporate bonds currently available and expected to be avail- able during the period to the maturity of the pension beneﬁ ts. 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 beneﬁ t 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 beneﬁ t obligation by approximately 9%. The net effect of changes in the discount rate, as well as the net effect of other changes in actuarial assumptions and expe- rience, is deferred until subsequent periods. Decreases in expected returns on plan assets may increase net periodic beneﬁ t cost by decreasing the 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 ﬁ scal 2010, a change of 50 basis points in the expected long-term rate of return on plan assets would cause a change of approximately ¥3,290 million in net periodic beneﬁ t 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 expense. Canon defers rec- ognition of the difference between this expected return on plan assets and the actual return on plan assets. The net deferral affects future pension expense. Canon recognizes the funded status (i.e., the difference between the fair value of plan assets and the projected beneﬁ t obligations) of its pension plans in its consolidated balance sheets, with a corresponding adjustment to accumulated other comprehensive income (loss), net of tax. Net sales Operating proﬁ t Income before income taxes Net income attributable to Canon Inc. Millions of yen Thousands of U.S. dollars 2010 change 2009 change 2008 2010 ¥3,706,901 +15.5% ¥3,209,201 217,055 219,355 131,647 387,552 +78.6 392,863 +79.1 246,603 +87.3 –21.6% ¥4,094,161 $45,764,210 4,784,593 –56.2 4,850,160 –54.4 3,044,481 –57.4 496,074 481,147 309,148 50 CANON ANNUAL REPORT 2010 Sales Canon’s consolidated net sales in ﬁ scal 2010 totaled ¥3,706,901 million (U.S.$45,764 million), representing a 15.5% increase from the previous ﬁ scal year. This increase of sales was due to a sub- stantial recovery in sales of laser printers among ofﬁ ce prod- ucts, continued robust sales of such consumer products as digital SLR cameras, the increase in sales within the Industry and Other Business Unit, and the effects of consolidation aris- ing from corporate acquisitions, such as Océ N.V. (“Océ”). Canon made Océ into a consolidated subsidiary in March 2010 to strengthen the printing business. Océ is engaged in research and development, manufacture and sale of document manage- ment systems, printing systems for professionals and high- speed, wide-format digital printing systems. The amounts of net sales of Océ included in the Canon’s consolidated statement of income from the acquisition date to the year ended December 31, 2010 was ¥ 246,518 million (U.S.$3,043 million). Overseas operations are signiﬁ cant to Canon’s operating results and generated approximately 81% of total net sales in ﬁ scal 2010. Such sales are denominated in the applicable local currency and are subject to ﬂ uctuations in the value of the yen to those currencies. Despite efforts to reduce the impact of cur- rency ﬂ uctuations on operating results, including localization of manufacturing in some regions along with procuring parts and materials from overseas suppliers, Canon believes such ﬂ uctu- ations have had and will continue to have a signiﬁ cant effect on its results of operations. The average value of the yen in ﬁ scal 2010 was ¥87.40 to the U.S. dollar, and ¥114.97 to the euro, representing an apprecia- tion of about ¥6 or 6% to the U.S. dollar, and a signiﬁ cant appre- ciation of approximately ¥15 or 12% against the euro, compared with the previous year. The effects of foreign exchange rate ﬂ uc- tuations negatively affected net sales by approximately ¥193,900 million in 2010. This unfavorable impact consisted of approximately ¥86,700 million for U.S. dollar denominated sales, ¥101,100 million for euro denominated sales and ¥6,100 million for other foreign currency denominated sales. Cost of sales Cost of sales principally reﬂ ects 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. Many of these raw materials are subject to ﬂ uctuations in world market prices accompanied by ﬂ uctuations in exchange rates that may affect Canon’s cost of sales. Other com- ponents of cost of sales include depreciation expenses from plants, maintenance expenses, light and fuel expenses along with rent expenses. The ratio of cost of sales to net sales for ﬁ scal 2010 and 2009 was 51.9% and 55.5%, respectively. Gross proﬁ t Canon’s gross proﬁ t in ﬁ scal 2010 increased by 24.9% to ¥1,783,088 million (U.S.$22,013 million) from ﬁ scal 2009. The gross proﬁ t ratio rose by 3.6 points year on year to 48.1%. Despite the signiﬁ cant impact of the strong yen, this improve- ment was achieved due to the launch of new products and ongoing cost-reduction efforts, along with heightened produc- tion turnover accompanying ramped-up production. Operating expenses The major components of operating expenses are payroll, R&D, advertising expenses and other marketing expenses. Despite the negative impact of consolidation of ¥172,800 million (U.S.$2,133 million), continued Group-wide efforts to signiﬁ cant- ly reduce spending contributed to a decline in total operating expenses to sales ratio of 37.6% for ﬁ scal 2010, a 0.1 point improvement compared with ﬁ scal 2009. Operating proﬁ t Operating proﬁ t in ﬁ scal 2010 increased 78.6% to a total of ¥387,552 million (U.S.$4,785 million) from ﬁ scal 2009, constitut- ing 10.5% of net sales. Other income (deductions) Other income (deductions) for ﬁ scal 2010 improved by ¥3,011 million (U.S.$37 million), mainly due to earnings and losses on investments in afﬁ liated companies. Income before income taxes Income before income taxes in ﬁ scal 2010 was ¥392,863 million (U.S.$4,850 million), an increase of 79.1% from ﬁ scal 2009, and constituted 10.6% of net sales. Income taxes Provision for income taxes in ﬁ scal 2010 increased by ¥56,038 million (U.S.$692 million) from ﬁ scal 2009, primarily as a result of the increase in income before income taxes. The effective tax rate during ﬁ scal 2010 dropped by 2.6% compared with ﬁ s- cal 2009. This was due mainly to an increase in tax deduction for R&D expenses in ﬁ scal 2010. Return on Sales (%) 12 11.0 10.9 9 6 3 0 6.7 7.6 4.1 06 07 08 09 10 CANON ANNUAL REPORT 2010 51 Net income attributable to Canon Inc. As a result, net income attributable to Canon Inc. in ﬁ scal 2010 increased by 87.3% to ¥246,603 million (U.S.$3,044 million), which represents a 6.7% return on net sales. Segment information Canon divides its businesses into three segments: the Ofﬁ ce Business Unit, the Consumer Business Unit and the Industry and Others Business Unit. (cid:129) The Ofﬁ ce Business Unit mainly includes Ofﬁ ce network digital MFDs / Color network digital MFDs / Personal-use net- work digital MFDs / Ofﬁ ce copying machines /Full-color copying machines / Personal-use copying machines /Laser printers / Large format inkjet printers/ Digital production printers (cid:129) The Consumer Business Unit mainly includes Digital SLR cameras / Compact digital cameras / Interchangeable lenses / Digital video camcorders / Inkjet multifunction peripherals / Single function inkjet printers / Image scanners / Broadcast lenses (cid:129) The Industry and Others Business Unit mainly includes Semiconductor lithography equipment / LCD lithography equip- ment / Medical image recording equipment / Ophthalmic prod- ucts / Magnetic heads / Micromotors / Computers / Handy terminals / Document scanners / Calculators. Sales by segment Please refer to the table of sales by segment in Note 24 of the Notes to Consolidated Financial Statements. Canon’s sales by segment are summarized as follows: SALES BY SEGMENT Ofﬁ ce Consumer Industry and Others Eliminations Total Millions of yen Thousands of U.S. dollars 2010 change 2009 change 2008 2010 1,391,327 ¥1,987,269 +20.8% ¥1,645,076 –26.8% ¥2,246,609 1,456,075 1,301,160 +6.9 –10.6 522,405 –31.5 357,998 432,958 +20.9 (130,928) (95,033) — (104,653) — –21.6% ¥4,094,161 ¥3,706,901 +15.5% ¥3,209,201 $24,534,185 17,176,877 5,345,160 (1,292,012) $45,764,210 Sales by Segment (Millions of yen) Sales by Geographic Area (Millions of yen) Office Business Unit Consumer Business Unit Industry and Others Business Unit Eliminations Japan Americas Europe Asia and Oceania 4,481,346 4,156,759 4,094,161 3,706,901 3,209,201 5,000,000 4,000,000 3,000,000 2,000,000 1,000,000 0 4,481,346 4,156,759 4,094,161 3,706,901 3,209,201 5,000,000 4,000,000 3,000,000 2,000,000 1,000,000 0 06 07 08 09 10 06 07 08 09 10 52 CANON ANNUAL REPORT 2010 Sales of the Ofﬁ ce Business Unit constituting 53.6% of con- solidated net sales, increased by 20.8% to ¥1,987,269 million (U.S.$24,534 million) in ﬁ scal 2010. Sales volume of both color and monochrome network digital MFDs increased, boosted by the recovery in demand for ofﬁ ce equipment along with the introduction of new imageRUNNER ADVANCE-series products. Laser printers recorded a substantial increase in sales volume. The consolidation of Océ also contributed to the sales increase. Sales of the Consumer Business Unit constituting 37.5% of consolidated net sales, increased by 6.9% to ¥1,391,327 million (U.S.$17,177 million) in ﬁ scal 2010. Sales volumes increased sig- niﬁ cantly for such digital SLR cameras as EOS Digital Rebel T1i (EOS 500D) and new EOS Digital Rebel T2i (EOS 550D), the com- petitively priced model, along with the EOS 5D Mark II, EOS 7D and new 60D, the advanced-amateur models. As for compact digital cameras, the Company launched ﬁ ve new ELPH (IXUS)- series models and seven new PowerShot-series models, boost- ing sales volumes particularly in emerging markets. As for inkjet printers, sales volume increased from year-ago level particular- ly in Asia. Sales of the Industry and Others Business Unit increased by 20.9% in ﬁ scal 2010, to ¥432,958 million (U.S.$5,345 million). Within this segment, sales volume of LCD lithography equip- ment, semiconductor lithography and semiconductor-related independent business sales by Group subsidiaries increased. Sales of the Industry and Others Business Unit constituted 11.7% of consolidated net sales in ﬁ scal 2010. Intersegment sales of ¥104,653 million (U.S.$1,292 million), repre- senting 2.8% of total sales, are eliminated from the total sales of the three segments, and are described as “Eliminations”. Sales by geographic area Please refer to the table of sales by geographic area in Note 24 of the Notes to Consolidated Financial Statements. SALES BY GEOGRAPHIC AREA A geographical analysis indicates that net sales in ﬁ scal 2010 increased in the major geographic areas. In Japan, sales decreased by 0.9% in ﬁ scal 2010. In the Americas, net sales increased by 14.4% on yen basis in ﬁ scal 2010, due to an increase in sales volume of digital SLR cameras and laser printers. In Europe, net sales increased by 17.8% on yen basis in ﬁ scal 2010, mainly due to rebounded sales of laser printers. Sales in Asia and Oceania increased by 32.0% on a yen basis in ﬁ scal 2010, largely due to the increased sales of digital SLR cameras. A summary of net sales by geographic area is provided below. Operating proﬁ t by segment Please refer to the table of segment information in Note 24 of the Notes to Consolidated Financial Statements. Operating proﬁ t for the Ofﬁ ce Business Unit in ﬁ scal 2010 increased by ¥63,926 million (U.S.$789 million) to ¥293,322 mil- lion (U.S.$3,621 million). This increase resulted primarily from the increase in sales. Operating proﬁ t for the Consumer Business Unit in ﬁ scal 2010 increased by ¥54,573 million (U.S.$674 million) to ¥238,065 million (U.S.$2,939 million). This increase resulted primarily from the increase in sales. Operating proﬁ t for the Industry and Others Business Unit in ﬁ scal 2010 was a loss of ¥9,831 million (U.S.$121 million). Signiﬁ cant recovery of sales volume contributed to reduction of loss amount by ¥66,125 million (U.S.$816 million) . Japan Americas Europe Asia and Oceania Total Millions of yen 2010 change 2009 change 2008 ¥ 695,749 –0.9% ¥ 702,344 894,154 995,150 617,553 ¥3,706,901 +15.5% ¥3,209,201 1,023,299 +14.4 1,172,474 +17.8 815,379 +32.0 –19.1% ¥ 868,280 1,154,571 –22.6 1,341,400 –25.8 –15.4 729,910 –21.6% ¥4,094,161 Thousands of U.S. dollars 2010 $ 8,589,494 12,633,321 14,474,988 10,066,407 $45,764,210 Note: This summary of net sales by geographic area is determined by the location where the product is shipped to the customer. CANON ANNUAL REPORT 2010 53 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 proﬁ t ratio. To reduce the ﬁ nancial risks from changes in foreign exchange rates, Canon utilizes derivative ﬁ nancial instruments, which consist principally of forward currency exchange contracts. The operating proﬁ t on foreign operation sales is usually lower than that from domestic operations because foreign operations consist mainly of marketing activities. Marketing activities are generally less proﬁ table than production activities, which are mainly conducted by the Company and its domestic subsidiaries. Please refer to the table of geographic information in Note 24 of the Notes to Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents in ﬁ scal 2010 increased by ¥45,545 million (U.S.$562 million) to ¥840,579 million (U.S.$10,378 million), compared with ¥795,034 million in ﬁ scal 2009 and ¥679,196 million in ﬁ scal 2008. Canon’s cash and cash equiva- lents are typically denominated both in Japanese yen and in U.S. dollar, with the remainder denominated in foreign currencies. Net cash provided by operating activities in ﬁ scal 2010 increased by ¥133,178 million (U.S.$1,644 million) from the pre- vious year to ¥744,413 million (U.S.$9,190 million), as a result of signiﬁ cant increase of proﬁ t. Cash ﬂ ow from operating activities consisted of the following key components: the major compo- nent of Canon’s cash inﬂ ow is cash received from customers, and the major components of Canon’s cash outﬂ ow are pay- ments for parts and materials, selling, general and administra- tive expenses, and income taxes. For ﬁ scal 2010, cash inﬂ ow from cash received from custom- ers increased, due to the signiﬁ cant increase of sales. There were no signiﬁ cant changes in Canon’s collection rates. Cash outﬂ ow for payments for parts and materials also increased, as a result of an increase in net sales, however this increase remained within a range of net sales increase due to cost reductions activities. Cost reductions reﬂ ect 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 promot- ing efﬁ ciency in operations. Cash outﬂ ow for payments for sell- ing, general and administrative expenses increased, however, also remained within the range of sales increase due to cost- cutting efforts. Net cash used in investing activities in ﬁ scal 2010 was ¥342,133 million (U.S.$4,224 million), compared with ¥ 370,244 million in ﬁ scal 2009 and ¥472,480 million in ﬁ scal 2008, con- sisting primarily of purchases of ﬁ xed assets and acquisition of shares of Océ. The purchases of ﬁ xed assets, which totaled ¥199,152 million (U.S.$2,459 million) in ﬁ scal 2010, were focused on items relevant to raising production capacity and reducing production cost. Canon deﬁ nes “free cash ﬂ ow” by deducting the cash ﬂ ows from investing activities from the cash ﬂ ows from operating activities. For ﬁ scal 2010, free cash ﬂ ow totaled ¥402,280 million (U.S.$4,966 million) as compared with ¥240,991 million for ﬁ scal 2009. Canon’s management recognizes that constant and intensive investment in facilities and R&D is required to main- tain and strengthen the competitiveness of its products. Canon’s management seeks to meet its capital requirements with cash ﬂ ow principally earned from its operations, therefore, its capital resources are primarily sourced from internally gen- erated funds. Accordingly, Canon has included the information with regard to free cash ﬂ ow as its management frequently monitors this indicator, and believes that such indicator is ben- eﬁ cial to the understanding of investors. Furthermore, Canon’s management believes that this indicator is signiﬁ cant in under- standing Canon’s current liquidity and the alternatives of use in ﬁ nancing activities because it takes into consideration its oper- ating and investing activities. Canon refers to this indicator together with relevant U.S. GAAP ﬁ nancial measures shown in its consolidated statements of cash ﬂ ows and consolidated bal- ance sheets for cash availability analysis. Net cash used in ﬁ nancing activities totaled ¥279,897 million (U.S.$3,456 million) in ﬁ scal 2010, mainly resulting from the divi- dend payout of ¥136,103 million (U.S.$1,680 million), repurchase of treasury stock and repayment of borrowings of Océ N.V. The Company paid dividends in ﬁ scal 2010 of ¥110.00 (U.S.$1.36) per share. To the extent Canon relies on external funding for its liquidity and capital requirements, it generally has access to various funding sources, including the issuance of additional share cap- ital, long-term debt or short-term loans. While Canon has been able to obtain funding from its traditional ﬁ nancing sources and from the capital markets, and believes it will continue to be able to do so in the future, there can be no assurance that adverse economic or other conditions will not affect Canon’s liquidity or long-term funding in the future. Short-term loans (including the current portion of long-term debt) amounted to ¥7,200 million (U.S.$89 million) at December 31, 2010 compared with ¥4,869 million at December 31, 2009. Long-term debt (excluding the current portion) amounted to ¥4,131 million (U.S.$51 million) at December 31, 2010 compared with ¥4,912 million at December 31, 2009. Canon’s long-term debt (excluding the current portion) main- ly consists of lease obligations. 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 Ratings 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 March 15, 2011, Canon’s debt ratings are: Moody’s: Aa1 (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. Increase in property, plant and equipment on an accrual basis in ﬁ scal 2010 amounted to ¥158,976 million (U.S.$1,963 million) compared with ¥216,128 million in ﬁ scal 2009 and ¥361,988 million in ﬁ scal 2008. In ﬁ scal 2010, decrease in 54 CANON ANNUAL REPORT 2010 property, plant and equipment was due to limiting investment to necessary facilities. For ﬁ scal 2011, Canon projects its increase in property, plant and equipment will be approximate- ly ¥260,000 million (U.S.$3,210 million). Employer contributions to Canon’s worldwide deﬁ ned ben- eﬁ t pension plans were ¥21,435 million (U.S.$265 million) in ﬁ s- cal 2010, ¥18,232 million in ﬁ scal 2009, ¥23,033 million in ﬁ scal 2008. In addition, employer contributions to Canon’s world- wide deﬁ ned contribution pension plans were ¥11,780 million (U.S.$145 million) in ﬁ scal 2010, ¥9,148 million in ﬁ scal 2009, and ¥10,840 million in ﬁ scal 2008. Working capital in ﬁ scal 2010 decreased by ¥601 million (U.S.$7 million), to ¥1,233,488 million (U.S.$15,228 million), com- pared with ¥1,234,089 million in ﬁ scal 2009 and ¥1,120,848 mil- lion in ﬁ scal 2008. Canon believes its working capital will be sufﬁ cient 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 purchases of ﬁ xed assets and investments. The working capital ratio (ratio of current assets to current liabilities) for ﬁ scal 2010 was 2.38 compared to 2.57 for ﬁ scal 2009 and to 2.19 for ﬁ scal 2008. Return on assets (net income attributable to Canon Inc. divided by the average of total assets) was 6.3% in ﬁ scal 2010, compared to 3.4% in ﬁ scal 2009 and 7.3% in ﬁ scal 2008. Return on Canon Inc. stockholders’ equity (net income attributable to Canon Inc. divided by the average of total Canon Inc. stockholders’ equity) was 9.2% in ﬁ scal 2010 com- pared with 4.9% in ﬁ scal 2009 and 11.1% in ﬁ scal 2008. Debt to total assets ratio was 0.3%, 0.3% and 0.4% as of December 31, 2010, 2009 and 2008, respectively. Canon had short-term loans and long-term debt of ¥11,331 million (U.S.$140 million) as of December 31, 2010, ¥9,781 million as of December 31, 2009 and ¥13,963 million as of December 31, 2008. OFF-BALANCE SHEET ARRANGEMENTS As part of its ongoing business, Canon does not participate in transactions that generate relationships with unconsolidated entities or ﬁ nancial partnerships, such as entities often referred to as structured ﬁ nance 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 for bank loans of its employees, afﬁ liates 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 1 year to 10 years in the case of afﬁ liates and other companies. The maximum amount of undiscounted payments Canon would have had to make in the event of default by all borrowers was ¥16,746 million (U.S.$207 million) at December 31, 2010. The carrying amounts of the liabilities recognized for Canon’s obligations as a guaran- tor under those guarantees were insigniﬁ cant. Increase in Property, Plant and Equipment (Millions of yen) Working Capital Ratio Return on Canon Inc. Stockholders’ Equity (%) 2.57 2.38 2.39 2.19 2.08 500,000 428,549 400,000 379,657 361,988 300,000 200,000 100,000 0 216,128 158,976 3.0 2.5 2.0 1.5 1.0 0.5 0.0 16.3 16.5 20 15 10 5 0 11.1 9.2 4.9 06 07 08 09 10 06 07 08 09 10 06 07 08 09 10 CANON ANNUAL REPORT 2010 55 CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following summarizes Canon’s contractual obligations at December 31, 2010. Millions of yen 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 Other long-term liabilities: Total Less than 1 year 1-3 years 3-5 years More than 5 years Payments due by period ¥ 8,247 1,013 83,800 ¥ 4,268 861 23,413 ¥ 2,806 55 32,344 ¥ 1,105 50 13,941 ¥ 68 47 14,102 29,383 86,434 29,383 86,434 — — — — — — Contribution to deﬁ ned beneﬁ t pension plans Total 30,071 ¥238,948 30,071 ¥174,430 — ¥35,205 — ¥15,096 — ¥14,217 Note: The table does not include provisions for uncertain tax positions and related accrued interest and penalties, as the speciﬁ c timing of future payments related to these obligations cannot be projected with reasonable certainty. See Note 13, Income Taxes in the Notes to Consolidated Financial Statements for further details. Contribution to deﬁ ned beneﬁ t pension plans reﬂ ects the expected amount only for the next ﬁ scal year, since contributions beyond the next ﬁ scal year are not currently determinable due to uncertainties related to changes in actuarial assumptions, returns on plan assets and changes to plan membership. Thousands of U.S. dollars 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 Other long-term liabilities: Total Less than 1 year 1-3 years 3-5 years More than 5 years Payments due by period $ 101,815 12,506 1,034,568 $ 52,691 10,630 289,049 $ 34,642 679 399,309 $ 13,642 617 172,112 $ 840 580 174,098 362,753 1,067,086 362,753 1,067,086 — — — — — — Contribution to deﬁ ned beneﬁ t pension plans Total 371,247 $2,949,975 371,247 $2,153,456 — $434,630 — $186,371 — $175,518 56 CANON ANNUAL REPORT 2010 Canon provides warranties of 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 are recognized and are 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, speciﬁ c product class failures outside of the baseline experience, material usage and service delivery costs incurred in correcting a product failure. As of December 31, 2010, accrued product warranty costs amounted to ¥13,343 million (U.S.$165 million). At December 31, 2010, commitments outstanding for the purchase of property, plant and equipment were approximately ¥29,383 million (U.S.$363 million), and commitments outstand- ing for the purchase of parts and raw materials were approxi- mately ¥86,434 million (U.S.$1,067 million), both for use in the ordinary course of its business. Canon anticipates that funds needed to fulﬁ ll these commitments will be generated internally through operations. During ﬁ scal 2011, Canon expects to contribute ¥22,055 mil- lion (U.S.$272 million) to its Japanese deﬁ ned beneﬁ t pension plans and ¥8,016 million (U.S.$99 million) to its foreign deﬁ ned beneﬁ t pension plans. Canon’s management believes that current ﬁ nancial resourc- es, cash generated from operations and Canon’s potential capacity for additional debt and/or equity ﬁ nancing will be sufﬁ - cient to fund current and future capital requirements. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES Year 2010 marks the ﬁ nal year of the Excellent Global Corporation Plan, which started in 2006. The slogan of the third phase (“Phase III”) is “Innovation & Sound Growth” and there are four core strategies: (cid:129) Realize an overwhelming No.1 position worldwide in all current core businesses; (cid:129) Expand operations through diversiﬁ cation; (cid:129) Identify new business domains and accumulate neces- sary technological capabilities; and (cid:129) Establish new production system to sustain global com- petitiveness. Canon has been striving to implement the three R&D related strategies as follows: (cid:129) Realize an overwhelming No.1 position worldwide in all current core businesses: Pursue development of new products which enable “cross-media imaging” by sophis- ticated functional synergy among the variety of Canon’s image handling products, beneﬁ ting from the prolifera- tion of broad band communication environment. (cid:129) Expand operations through diversiﬁ cation: Focus on developing various types of display, including Organic Light-Emitting Diode displays (“OLED”). (cid:129) Identify new business domains and accumulate neces- sary technological capabilities: Accumulate technological capability to create innovative products and systems in the focused three domains of the medical imaging sector, intelligent robot industry and safety technology domain. Canon has developed and strengthened relationships with universities and other research institutes, such as Kyoto University, Tokyo Institute of Technology, Stanford University, The University of Arizona, the New Energy and Industrial Technology Development Organization and the National Institute of Advanced Industrial Science and Technology to assist with fun- damental research and to develop cutting-edge technologies. Canon has fully introduced 3D-CAD systems across the Canon group, boosting R&D efﬁ ciency to curtail product development times and costs. Moreover, Canon enhanced and evolved its simulation, measurement, and analysis technologies by estab- lishing leading-edge facilities, including one of Japan’s highest- performance cluster computers. As such, Canon has succeeded in further reducing the need for prototypes, dramatically lower- ing costs and shortening product development lead times. Canon has R&D centers worldwide. Each R&D center is col- laborating with other centers to achieve synergies, and is culti- vating closer ties in ﬁ elds ranging from basic research to product development. Canon’s consolidated R&D expenses were ¥315,817 million (U.S.$3,899 million) in ﬁ scal 2010, ¥304,600 million in ﬁ scal 2009 and ¥374,025 million in ﬁ scal 2008. The ratios of R&D expenses to the consolidated total net sales for ﬁ scal 2010, 2009 and 2008 were 8.5%, 9.5% and 9.1%, respectively. R&D Expenses (Millions of yen) 400,000 368,261 374,025 308,307 300,000 315,817 304,600 200,000 100,000 0 06 07 08 09 10 CANON ANNUAL REPORT 2010 57 Canon believes that new products protected by patents will not easily allow competitors to compete with it, and will give it an advantage in establishing standards in the market and industry. However, in the short term, the costs for recovery may occur along with the decrease of revenues, which may adversely affect on Canon to a certain degree. RECENT DEVELOPMENT On March 11, 2011, Japan experienced a massive earthquake and tsunami off the Paciﬁ c coast of Northeastern Japan. The earthquake caused damage to inventories and buildings at manufacturing facilities primarily in the Company’s Utsunomiya Plant, and Fukushima Canon Inc., a manufacturing subsidiary. In addition, certain distribution warehouses of the Company and Canon Marketing Japan Inc., a sales subsidiary, located in Northeastern Japan sustained damage to inventories. As a result, production operations have been suspended at certain plants of the Company and its manufacturing subsidiaries. The Company has organized a special taskforce, “Earthquake Disaster Recovery Task Force”, in order to rapidly respond to these events and is currently making effort to resume opera- tions immediately. Canon cannot estimate the effect of the earthquake on its consolidated results of operations and ﬁ nancial condition as of the issuance date of the consolidated ﬁ nancial statements. MARKET RISK EXPOSURE Canon is exposed to market risks, including changes in foreign currency exchange rates, interest rates and prices of market- able securities and investments. In order to hedge the risks of changes in foreign currency exchange rates, Canon uses deriv- ative ﬁ nancial instruments. Equity price risk Canon holds marketable securities included in current assets, which consist generally of highly-liquid and low-risk instru- ments. Investments included in noncurrent assets are held as long-term investments. Canon does not hold marketable secu- rities and investments for trading purposes. Maturities and fair values of such marketable securities and investments with original maturities of more than three months, all of which were classiﬁ ed as available-for-sale securi- ties, were as follows at December 31, 2010 and 2009. Available-for-sale securities Due within one year Due after one year through ﬁ ve years Due after ﬁ ve years through ten years Equity securities Millions of yen Thousands of U.S. dollars Cost ¥ 1,001 952 2,026 18,288 ¥22,267 Fair value ¥ 1,001 972 1,981 23,402 ¥27,356 Cost $ 12,358 11,753 25,012 225,778 $274,901 Fair value $ 12,358 12,000 24,456 288,914 $337,728 Foreign currency exchange rate and interest rate risk Canon operates internationally, exposing it to the risk of changes in foreign currency exchange rates. Derivative ﬁ nancial instru- ments are comprised principally of foreign currency exchange contracts utilized by the Company and certain of its subsidiaries to reduce the risk. Canon assesses foreign currency exchange rate risk by continually monitoring changes in the exposures and by evaluating hedging opportunities. Canon does not hold or issue derivative ﬁ nancial instruments for trading purposes. Canon is also exposed to credit-related losses in the event of non-performance by counterparties to derivative ﬁ nancial instru- ments, but it is not expected that any counterparties will fail to meet their obligations. Most of the counterparties are interna- tionally recognized ﬁ nancial institutions and selected by Canon taking into account their ﬁ nancial condition, and contracts are diversiﬁ ed across a number of major ﬁ nancial institutions. Canon’s international operations expose Canon to the risk of changes in foreign currency exchange rates. Canon uses for- eign exchange contracts to manage certain foreign currency exchange exposures principally from the exchange of U.S. dol- lars and euros 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 speciﬁ c portion of foreign currency exposure resulting from forecasted intercompany sales are hedged using foreign exchange contracts which principally mature within three months. 58 CANON ANNUAL REPORT 2010 The following table provides information about Canon’s major derivative ﬁ nancial instruments related to foreign curren- cy exchange transactions existing at December 31, 2010. All of the foreign exchange contracts described in the following table have a contractual maturity date in 2011. Millions of yen Forwards to sell foreign currencies: Contract amounts Estimated fair value Forwards to buy foreign currencies: Contract amounts Estimated fair value Thousands of U.S. dollars Forwards to sell foreign currencies: Contract amounts Estimated fair value Forwards to buy foreign currencies: Contract amounts Estimated fair value U.S.$ Euro Others Total ¥254,676 4,963 ¥178,962 6,134 ¥32,723 (282) ¥466,361 10,815 ¥ 21,944 (106) ¥ 24,414 (55) ¥ 2,328 383 ¥ 48,686 222 U.S.$ Euro Others Total $3,144,148 61,272 $2,209,407 75,728 $403,988 (3,481) $5,757,543 133,519 $ 270,914 (1,309) $ 301,407 (679) $ 28,741 4,728 $ 601,062 2,740 All of Canon’s long-term debt is ﬁ xed rate debt. Canon expects that fair value changes and cash ﬂ ows resulting from reasonable near-term changes in interest rates will be immate- rial. Accordingly, Canon believes interest rate risk is insigniﬁ - cant. See also Note 10 of the Notes to Consolidated Financial Statements. Changes in the fair value of derivative ﬁ nancial instruments designated as cash ﬂ ow hedges, including foreign exchange contracts associated with forecasted intercompany sales, are reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassiﬁ ed into earnings through other income (deductions) in the same period as the hedged items affect earnings. Substantially all such amounts recorded in accumulated other comprehensive income (loss) at year-end are expected to be recognized in earnings over the next 12 months. Canon excludes the time value component from the assessment of hedge effectiveness. Changes in the fair value of a foreign exchange contract for the period between the date that the forecasted intercompany sales occur and its maturity date are recognized in earnings and not considered hedge ineffectiveness. The amount of the hedging ineffectiveness was not material for the years ended December 31, 2010, 2009 and 2008. The amounts of net losses excluded from the assessment of hedge effectiveness (time value component) which was recorded in other income (deductions) was ¥302 million (U.S.$4 million), ¥462 million and ¥3,701 million for the years ended December 31, 2010, 2009 and 2008, respectively. Canon has entered into certain foreign currency exchange contracts to manage its foreign currency exposures. These for- eign currency exchange contracts have not been designated as hedges. Accordingly, the changes in fair values of these con- tracts are recorded in earnings immediately. CANON ANNUAL REPORT 2010 59 LOOKING FORWARD As for the global economy, in the U.S., despite the risk of a slowdown due to the ongoing credit crisis and high unemploy- ment, we expect the trend toward gradual recovery to contin- ue. In Europe, while concerns remain regarding ﬁ nancial instability, we believe the economy will make steady progress toward recovery. In Asia, the overall trend toward economic recovery is expected to continue, fueled by such factors as continued strong economic expansion in such countries as China and India. As for Japan, while the economy will likely con- tinue to realize a gradual economic rebound against the back- drop of a global economic recovery, we expect the current trend of economic deﬂ ation to continue due to weak domestic consumption. Amid this climate, Canon has launched its latest ﬁ ve-year plan: Phase IV of the Global Excellent Corporation Plan (2011- 2015). Our ultimate aim is to realize our goal of joining the ranks of the world’s top 100 companies in terms of all major manage- ment indicators. In order to achieve our targets, we aim to expand our scale and business operations, further strengthening our imaging- related businesses and working to expand business domains by cultivating such areas as medical and industrial equipment. At the same time, we will make efforts to transform our manu- facturing operations in keeping with the changing times through the reinforcement of such basic functions as research and development, production, and sales and marketing. Speciﬁ cally, we will strive to change to a situation where prod- ucts developed in each region are sold globally, accelerating transition to a three regional headquarters management sys- tem, which includes R&D centers in Japan, the U.S. and Europe, as we solicit the world’s great minds and innovative power. Targeting this kind of change and transformation, we will also make active use of M&As. For this, we set up a special organi- zation in charge of further promoting M&As, effective January 1, 2011. At the same time, we will work to solidify our foundation as a leading environmental company that aims for both growth and environmental conservation, by further raising the environmen- tal performance of our products and reducing the impact of all corporate activities on the environment. Ofﬁ ce Business Unit In 2010, Canon’s copying machine and MFD businesses rebounded substantially from the economic downturn, which had affected the entire industry in 2009. Emerging markets, such as in Asia, were particularly notable for their growth. The importance of providing added value in the form of net- working, integration, color printing, multifunction and solutions has grown in the ofﬁ ce imaging products business. Canon seeks to maintain its leading position in both the printing and in the ofﬁ ce products markets. Canon has matched its business strategy to market trends by strengthening its lineup of digital color network MFDs and print- on-demand machines. In 2010, Canon further expanded the imageRUNNER ADVANCE series with the introduction of a monochrome lineup and a low-end color device. We also launched the imagePRESS C7010VP series, designed to meet the needs of print professionals in commercial print shops with advanced function. To maintain and enhance its competitive edge and to meet increasingly sophisticated customer demands, Canon will continue reinforcing its hardware and software product lineups and solutions capability. Canon’s laser printer business has a strong market position. The market declined rapidly in the wake of the global economic downturn but slowly recovered in 2010. In the monochrome laser printer market, sales to the micro- ofﬁ ce/ home ofﬁ ce segment expanded. The color laser printer market is expected to grow over the long term, although demand slowed recently due to the eco- nomic downturn. Competition has intensiﬁ ed as competitors have pursued aggressive pricing strategies to establish market share. Canon is promoting technological development in order to provide competitive products in all segments with a focus on bringing new and improved offerings to market in a well-timed manner. The large format printer market shrank in 2009. However, the trend was toward recovery in 2010. Total business growth in 2010 increased slightly, with particularly strong growth in Asia. In 2010, we launched three new 12-color printer models (iPF6300/6350/8300), designed to meet the needs of the graph- ic art market (exceptional color reproduction, high print quality, and furthermore, high usability). We also released two new CAD models (iPF815/825), for a market that demands high productivity. These models have achieved a strong reputation, resulting in double-digit unit sales growth in 2010 as compared to 2009. Market share of our CAD models also increased steadily during 2010. 60 CANON ANNUAL REPORT 2010 Consumer Business Unit The digital SLR market continued to grow steadily in 2010. Additional manufacturers entered the market this year, expand- ing the market with mirrorless digital cameras, and solid growth in digital SLR cameras continued. These trends show that there is still a strong market need for high-quality digital photography. With respect to digital SLR cameras, the market shows demand for increased numbers of pixels. Higher sensitivity, miniaturization, reduced weight and video functions have become standard speciﬁ cations as well, including the support by each company of full HD image quality in this market. By offering new products based on cutting-edge technology, Canon seeks to continue its growth into the foreseeable future. In addition, sales volume in emerging markets appears ready to expand dramatically. For this reason, there is an urgent need to upgrade sales structures and other systems in order to han- dle this expansion. During ﬁ scal year 2010, the compact digital camera market was driven by growth in China, Russia, and other emerging economic regions. Although markets in some developed eco- nomic regions have expanded due to a reduction in average prices across the industry, overall, such regions have remained stable or have declined as compared to the previous year. Total global growth increased slightly, while Canon has maintained a high share at the same level as during the previous consolidat- ed ﬁ scal year. Developed markets are expected to remain stable in 2011, and emerging markets are expected to remain on a positive growth track, resulting in a projected slight increase worldwide as compared to consolidated ﬁ scal 2010. A ﬁ erce price war and the strong yen have been drastically squeezing proﬁ t margins in the digital camera market. Although the industry as a whole is relying more and more on electronic manufacturing service (“EMS”) companies and cost competi- tion is expected to intensify in the future, we plan to take advantage of our industry-leading economies of scale and its 100% internal manufacturing system in order to maintain and solidify our proﬁ tability. We expect continued growth in the interchangeable lens market due to the rapid spread of digital SLR cameras and mir- rorless digital cameras. Canon aims to continue expanding its sales and market share by introducing products with features that satisfy customer needs, such as lenses with image stabiliz- er functionality. The global digital video camcorder market has diversiﬁ ed due to the introduction of new recording media, such as ﬂ ash memory. During this consolidated ﬁ scal year, however, trends toward ﬂ ash memory and HD as the future mainstream medium became clear. Despite the worldwide economic downturn that started in the second half of 2008, the ﬂ ash memory and HD market segments have continued to grow year-on-year. The new, lowest-priced webcam product category (under $200) has proven strong, particularly in North America. Webcams appeal to a user segment that wants to enjoy convenient video capa- bilities, and they have been selling in increasing numbers. Canon is working to expand sales of its powerful lineup of products to meet a wide range of user needs with even greater added value and seeks to differentiate itself from the competi- tion based on its high-quality HD image technology concept. The business application projector market experienced the effects of the continuing economic downturn during this con- solidated ﬁ scal year as well, resulting in a slowdown as com- pared to previous forecasts. In particular, this downturn affected products with high added value. However, system inte- grators and other video professionals continue to require these high added value products, and therefore Canon plans to con- tinue working to maintain and expand sales. In 2010, although expansion in the market for network cam- eras used for surveillance video and monitoring applications softened somewhat, this market has been recording solid growth up until the present. We expect that the trends toward larger numbers of pixels, advancements in video analysis tech- nology and the industry standardization of operational com- mands will lead to future growth in this market. In order to avoid missing these trends, Canon is working to increase sales with an expanded competitive lineup. The broadcast television lens market experienced a tempo- rary decline in the wake of the economic downturn. However, the market has been on course for a gradual overall recovery during consolidated ﬁ scal year 2010, partially thanks to an expansion of the market in countries where the industry is still emerging. Nevertheless, due to the progressive reduction in prices caused by equipment downsizing as well as the inﬂ u- ence of the strong yen, while revenue growth was achieved, proﬁ ts declined. We expect this downsizing trend to continue, and starting next year, Canon will work to expand proﬁ ts by reinforcing its family of products aimed at responding to this change in the industry. In the medium term, we expect that this industry will be revitalized by increased demand for equipment upgrades due to the industry switch to digital broadcasting as well as demand from emerging markets. Canon already has a large market share worldwide, and plans to increase sales and expand its share further as the market recovers by releasing highly competitive products to the market in a timely fashion, further solidifying its position in the industry. The Inkjet printer market recovered in 2010. While emerging countries have contributed to the growth of market volume, in advanced countries there are increasing demands of small and home ofﬁ ce for high-value added products including MFPs with fax and ADF function and also wireless models. Along with basic performance, such as image quality and print speed, each vendor began to enhance the product design, ease of use and applications to increase user satisfaction. To manage these trends, Canon has introduced new models with variety of new features, such as an Intelligent Touch System, which provides light-guided direction, and Full HD Movie Print. Thereby strengthening its lineup from entry-level to high-end models, Canon intends further sales expansion. Industry and Others Business Unit In ﬁ scal 2010, the semiconductor device market recovered strongly from the economic downturn starting in the second half of ﬁ scal 2008. There were noteworthy improvements for semiconductor device market categories such as DRAM and NAND-ﬂ ash memory, CANON ANNUAL REPORT 2010 61 due to strong sales of PCs and smart phones, as well as the so- called “green” products such as LED and power devices. As a result, shipments of semiconductor lithography equip- ment in ﬁ scal 2010 recovered sharply over ﬁ scal 2009. By mar- ket, sales in Korea have been strong, thanks to increased investment by major memory manufacturers, while in Japan demand has been steadily improving for lithography equipment for sensors and image devices. The market for LCD lithography equipment in ﬁ scal 2010 grew dramatically from the previous year. Makers of LCD panels have signiﬁ cantly increased their equipment investment in order to capture growing demand in developing countries. Total equipment investment among the top LCD panel makers grew strongly in ﬁ scal 2010 from the previous year, topping the level recorded during the boom market of ﬁ scal 2008. Against this background, shipments of LCD lithography equipment markedly improved rapidly compared to ﬁ scal 2009. By region, shipments in Japan declined, but those to Korea, Taiwan and China improved signiﬁ cantly. Shipments of genera- tion-7.5 and 8 LCD lithography equipment for televisions improved noticeably. The medical equipment market in Europe and the United States was adversely inﬂ uenced by the economic downturn. However, the market for static digital X-ray equipment has been expanding, although competition has become more severe through the entry of computed radiography manufacturers into the market. The medical equipment market in Asia (mainly China) is expanding rapidly, and the static digital X-ray equip- ment market has followed this trend. Thin and lightweight CXDI-55C/55G portable digital radiogra- phy system, which was released in 2009, contributed to an increase of sales in Europe, the United States and Japan. In 2010, Canon’s overall sales increased steadily compared to the previous ﬁ scal year. We also focused on emerging markets and particularly, we set the low-end market in China, which is sup- ported by the Chinese government, as a main target. As a result, we have been successful in increasing sales to China, and orders from Central and South America have also contrib- uted to our U.S. sales ﬁ gures. During 2010, Canon released dynamic digital radiography CXDI-50RF in Europe and the United States, and Virtual Imaging, which Canon acquired in 2009, contributed to our increase in sales with its DR system. A strategic new product, the CXDI-70C Wireless, was launched in November 2010. The ophthalmic products market shrank in 2010, especially in Europe and the United States, due to the economic downturn. However, the optical coherence tomography (“OCT”) market expanded steadily compared to 2009. Therefore, many of Canon’s competitors released new strategic OCT products. In order to keep pace with these trends, Canon is striving to increase sales by expanding competitive lineup of products to gain the market acceptance. Canon acquired Optopol Technology in 2010 and plans to use Optopol Technology as a development and production center. In 2010, sales of Optopol’s OCT technology in Japan, Europe and the United States contributed to our net sales. Sales of hybrid retinal cameras, ﬁ rst released in 2009, contributed to sales in 2010, while sales of non-mydriatic retinal cameras declined slightly due to the economic downturn in Japan, Europe and the United States. Canon released the extremely compact non-mydriatic retinal camera CR2 in November 2010 and aims to increase sales in this market. Among the “imageFORMULA series” document scanners handled by Canon Electronics Inc., the high-durability, high- speed “DR-9050C/6050C,” compact “DR-2010C/2510C” and new “ScanFront 300P,” with network functionality, all met with strong market receptions, chalking up increases in units sold and reve- nues in every region where they are marketed. Sales have been particularly strong in China, India, and other parts of Asia, with signiﬁ cant increases in terms of both units and revenues. Meanwhile, in the Japanese market, strong sales of the extremely compact and portable document scanner “DR-150” have led a major increase in unit sales. Sales of the FA system-related devices handled by Canon Machinery Inc. ended the term with a year-on-year increase as solid ﬁ rst-half results outweighed sales declines in the second half. Die bonders had promising orders for the LED (light-emit- ting diode) compatible “BESTEM-D01 series,” helped in particu- lar by vigorous ﬁ rst-half capital investments by LED manufacturers. It enjoyed signiﬁ cantly higher sales for the term, despite lower orders in the second half. The magnetic disk manufacturing equipment handled by Canon ANELVA Corporation saw sales revenues more than double from the previous term as demand for hard disk drives to be used in servers and personal computers rose and cus- tomers increased capital investments. Sales of magnetic head manufacturing equipment and semiconductor ﬁ lm deposition equipment also rose signiﬁ cantly. Forward looking statements The foregoing discussion and other disclosure in this report contains forward-looking statements that reﬂ ect management’s current views with respect to certain future events and ﬁ nan- cial performance. Actual results may differ materially from those projected or implied in the forward-looking statements. Further, certain forward-looking statements are based upon assumptions of future events that may not prove to be accu- rate. The following important factors could cause actual results to differ materially from those projected or implied in any for- ward-looking statements: foreign currency exchange rate ﬂ uc- tuations; 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 ﬂ uctuations; uncer- tainty 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 relat- ed markets; uncertainty of recovery in demand for Canon’s semiconductor lithography equipment; Canon’s ability to con- tinue to develop products and to market products that incorpo- rate new technology on a timely basis, are competitively priced, and achieve market acceptance; the possibility of losses result- ing from foreign currency transactions designed to reduce ﬁ nancial risks from changes in foreign currency exchange rates; and inventory risk due to shifts in market demand. 62 CANON ANNUAL REPORT 2010 TEN-YEAR FINANCIAL SUMMARY Net sales: Domestic Overseas Total Percentage of previous year Net income attributable to Canon Inc. Percentage of sales Advertising Research and development expenses Depreciation of property, plant and equipment Increase in property, plant and equipment Long-term debt, excluding current installments Canon Inc. stockholders’ equity Total assets Per share data: Income before cumulative effect of change in accounting principle: Basic Diluted Net income attributable to Canon Inc. stockholders per share: Basic Diluted Dividends per share Stock price: High Low Millions of yen (except per share amounts) 2010 2009 2008 2007 ¥ 695,749 3,011,152 3,706,901 115.5% ¥ 702,344 2,506,857 3,209,201 78.4% ¥ 868,280 3,225,881 4,094,161 91.4% ¥ 947,587 3,533,759 4,481,346 107.8% 246,603 6.7% 94,794 315,817 232,327 158,976 131,647 4.1% 78,009 304,600 277,399 216,128 309,148 7.6% 112,810 374,025 304,622 361,988 488,332 10.9% 132,429 368,261 309,815 428,549 ¥ 4,131 2,645,782 3,983,820 ¥ 4,912 2,688,109 3,847,557 ¥ 8,423 2,659,792 3,969,934 ¥ 8,680 2,922,336 4,512,625 ¥ 199.71 199.70 ¥ 106.64 106.64 ¥ 246.21 246.20 ¥ 377.59 377.53 199.71 199.70 120.00 4,520 3,205 106.64 106.64 110.00 4,070 2,115 246.21 246.20 110.00 5,820 2,215 377.59 377.53 110.00 7,450 5,190 Average number of common shares in thousands Number of employees 1,234,818 197,386 1,234,482 168,879 1,255,626 166,980 1,293,296 131,352 Common Stock Price Range (Tokyo Stock Exchange) (Yen) 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 01 02 03 04 05 06 07 08 09 10 CANON ANNUAL REPORT 2010 63 2006 2005 2004 2003 2002 2001 Thousands of U.S. dollars (except per share amounts) 2010 ¥ 932,290 3,224,469 4,156,759 110.7% ¥ 856,205 2,897,986 3,754,191 108.3% ¥ 849,734 2,618,119 3,467,853 108.4% ¥ 801,400 2,396,672 3,198,072 108.8% ¥ 732,551 2,207,577 2,940,128 101.1% ¥ 827,288 2,080,285 2,907,573 107.8% $ 8,589,494 37,174,716 45,764,210 115.5% 455,325 11.0% 116,809 308,307 235,804 379,657 384,096 10.2% 106,250 286,476 205,727 383,784 343,344 9.9% 111,770 275,300 174,397 318,730 275,730 8.6% 100,278 259,140 168,636 210,038 190,737 6.5% 71,725 233,669 158,469 198,702 167,561 5.8% 66,837 218,616 147,286 207,674 3,044,481 6.7% 1,170,296 3,898,975 2,868,235 1,962,667 ¥ 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 ¥ 81,349 1,591,950 2,942,706 ¥ 95,526 1,458,476 2,844,756 $ 51,000 32,663,975 49,182,963 ¥ 341.95 341.84 ¥ 288.63 288.36 ¥ 258.53 257.85 ¥ 209.21 207.17 ¥ 145.04 143.20 ¥ 124.71 123.03 $ 341.95 341.84 83.33 6,780 4,567 288.63 288.36 66.67 4,780 3,460 258.53 257.85 43.33 3,880 3,273 209.21 207.17 33.33 4,140 2,607 145.04 143.20 20.00 3,500 2,413 127.53 125.80 16.67 3,553 2,100 1,331,542 118,499 1,330,761 115,583 1,328,048 108,257 1,317,974 102,567 1,315,074 97,802 1,313,940 93,620 2.47 2.47 2.47 2.47 1.48 55.80 39.57 Notes: 1. U.S. dollar amounts are translated from yen at the rate of U.S.$1 = JPY81, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 30, 2010. 2. The Company made a three-for-two stock split on July 1, 2006. The average number of common shares and the per share data for the periods prior to the stock split have been adjusted to reﬂ ect the stock split. 64 CANON ANNUAL REPORT 2010 CONSOLIDATED BALANCE SHEETS CANON INC. AND SUBSIDIARIES ASSETS Current assets: Cash and cash equivalents (Note 1) Short-term investments (Note 3) Trade receivables, net (Note 4) Inventories (Note 5) Prepaid expenses and other current assets (Notes 7,13 and 19) Total current assets Noncurrent receivables (Note 20) Investments (Note 3) Property, plant and equipment, net (Notes 6 and 7) Intangible assets, net (Note 9) Other assets (Notes 7, 9, 12 and 13) Total assets LIABILITIES AND EQUITY Current liabilities: Short-term loans and current portion of long-term debt (Note 10) Trade payables (Note 11) Accrued income taxes (Note 13) Accrued expenses (Notes 12 and 20) Other current liabilities (Notes 6, 13 and 19) Total current liabilities Long-term debt, excluding current installments (Note 10) Accrued pension and severance cost (Note 12) Other noncurrent liabilities (Note 13) Total liabilities Commitments and contingent liabilities (Note 20) Equity: Canon Inc. stockholders’ equity: Common stock Authorized 3,000,000,000 shares; issued 1,333,763,464 shares in 2010 and in 2009 (Note 14) Additional paid-in capital (Note 14) Legal reserve (Note 15) Retained earnings (Note 15) Accumulated other comprehensive income (loss) (Note 16) Treasury stock, at cost; 105,295,975 shares in 2010 and 99,288,001 shares in 2009 Total Canon Inc. stockholders’ equity Noncontrolling interests Total equity Total liabilities and equity See accompanying Notes to Consolidated Financial Statements. DECEMBER 31, 2010 AND 2009 Millions of yen 2010 2009 ¥ 840,579 96,815 557,504 384,777 250,754 2,130,429 16,771 81,529 1,201,968 153,021 400,102 ¥3,983,820 ¥ 7,200 383,251 72,482 299,710 134,298 896,941 4,131 197,609 75,502 1,174,183 ¥ 795,034 19,089 556,572 373,241 273,843 2,017,779 14,936 114,066 1,269,785 117,396 313,595 ¥3,847,557 ¥ 4,869 339,113 50,105 274,300 115,303 783,690 4,912 115,904 63,651 968,157 Thousands of U.S. dollars (Note 2) 2010 $10,377,519 1,195,247 6,882,765 4,750,333 3,095,729 26,301,593 207,049 1,006,531 14,839,111 1,889,148 4,939,531 $49,182,963 $ 88,889 4,731,494 894,840 3,700,123 1,658,000 11,073,346 51,000 2,439,617 932,123 14,496,086 174,762 400,425 57,930 2,965,237 (390,459) (562,113) 2,645,782 163,855 2,809,637 ¥3,983,820 174,762 404,293 54,687 2,871,437 (260,818) (556,252) 2,688,109 191,291 2,879,400 ¥3,847,557 2,157,556 4,943,518 715,185 36,607,864 (4,820,481) (6,939,667) 32,663,975 2,022,902 34,686,877 $49,182,963 CANON ANNUAL REPORT 2010 65 CONSOLIDATED STATEMENTS OF INCOME CANON INC. AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008 Net sales Cost of sales (Notes 6, 9, 12 and 20) Gross proﬁ t Operating expenses (Notes 1, 6 ,9, 12, 17 and 20): Selling, general and administrative expenses Research and development expenses Operating proﬁ t Other income (deductions): Interest and dividend income Interest expense Other, net (Notes 1, 3, 19 and 22) Income before income taxes Income taxes (Note 13) Consolidated net income 2010 ¥3,706,901 1,923,813 1,783,088 1,079,719 315,817 1,395,536 387,552 6,022 (1,931) 1,220 5,311 392,863 140,160 252,703 Millions of yen 2009 ¥3,209,201 1,781,808 1,427,393 905,738 304,600 1,210,338 217,055 5,202 (336) (2,566) 2,300 219,355 84,122 135,233 2008 ¥4,094,161 2,156,153 1,938,008 1,067,909 374,025 1,441,934 496,074 19,442 (837) (33,532) (14,927) 481,147 160,788 320,359 Thousands of U.S. dollars (Note 2) 2010 $45,764,210 23,750,778 22,013,432 13,329,864 3,898,975 17,228,839 4,784,593 74,346 (23,840) 15,061 65,567 4,850,160 1,730,370 3,119,790 Less: Net income attributable to noncontrolling interests Net income attributable to Canon Inc. 6,100 ¥ 246,603 3,586 ¥ 131,647 11,211 ¥ 309,148 75,309 $ 3,044,481 Yen U.S. dollars (Note 2) Net income attributable to Canon Inc. stockholders per share (Note 18): Basic Diluted Cash dividends per share See accompanying Notes to Consolidated Financial Statements. ¥ 199.71 199.70 120.00 ¥ 106.64 106.64 110.00 ¥ 246.21 246.20 110.00 $ 2.47 2.47 1.48 66 CANON ANNUAL REPORT 2010 CONSOLIDATED STATEMENTS OF EQUITY CANON INC. AND SUBSIDIARIES Common stock Additional paid-in capital Legal reserve Retained earnings Millions of yen Accumulated other comprehensive income (loss) Treasury stock Total Canon Inc. stockholders’ equity Noncontrolling interests Total equity Balance at December 31, 2007 ¥174,698 ¥402,991 ¥46,017 ¥2,720,146 ¥ 34,670 ¥(456,186) ¥2,922,336 ¥222,870 ¥3,145,206 Conversion of convertible debt Equity transactions with noncontrolling interests and other Dividends paid to Canon Inc. stockholders Dividends paid to noncontrolling interests Transfer to legal reserve Comprehensive income (loss): Net income Other comprehensive income (loss), net of tax (Note 16): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income (loss) Repurchase of treasury stock, net Balance at December 31, 2008 Equity transactions with noncontrolling interests and other Dividends paid to Canon Inc. stockholders Dividends paid to noncontrolling interests Transfer to legal reserve Comprehensive income: Net income Other comprehensive income (loss), net of tax (Note 16): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income Repurchase of treasury stock, net Balance at December 31, 2009 Acquisition of subsidiaries Equity transactions with noncontrolling interests and other Dividends paid to Canon Inc. stockholders Dividends paid to noncontrolling interests Transfer to legal reserve Comprehensive income (loss): Net income Other comprehensive income (loss), net of tax (Note 16): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income (loss) Repurchase of treasury stock, net 64 63 761 (145,024) 7,689 (7,689) 127 761 (26,218) (145,024) — (5,123) 127 (25,457) (145,024) (5,123) — 309,148 309,148 11,211 320,359 (258,764) (258,764) (1,911) (260,675) (5,152) 2,342 (65,916) (25) (5) 174,762 403,790 53,706 2,876,576 (292,820) (100,036) (556,222) 503 (135,793) 981 (981) (5,152) (690) (5,842) 2,342 (65,916) (18,342) (100,066) — (8,949) (339) 2,342 (74,865) (18,681) (100,066) 2,659,792 191,190 2,850,982 503 (1,376) (135,793) — (3,326) (873) (135,793) (3,326) — 131,647 131,647 3,586 135,233 33,340 2,150 (1,422) (2,066) (12) (30) 33,340 2,150 (1,422) (2,066) 163,649 (42) 174,762 404,293 54,687 2,871,437 (260,818) (556,252) 2,688,109 30 67 (1) 1,121 4,803 33,370 2,217 (1,423) (945) 168,452 (42) 191,291 19,168 2,879,400 19,168 (3,787) (13,453) (136,103) 3,243 (3,243) (680) 55,250 37,330 (43,214) (5,884) (136,103) (136,103) (2,827) (2,827) — — 246,603 246,603 6,100 252,703 (122,667) (122,667) (4,251) (126,918) (222) 833 (6,905) (222) 833 76 (66) (6,905) (2,422) (146) 767 (9,327) 117,642 (563) 117,079 (81) (4) (61,111) (61,196) (61,196) Balance at December 31, 2010 ¥174,762 ¥400,425 ¥57,930 ¥2,965,237 ¥ (390,459) ¥(562,113) ¥2,645,782 ¥163,855 ¥2,809,637 CANON ANNUAL REPORT 2010 67 Common stock Additional paid-in capital Legal reserve Retained earnings Accumulated other comprehensive income (loss) Treasury stock Total Canon Inc. stockholders’ equity Noncontrolling interests Total equity Thousands of U.S. dollars (Note 2) Balance at December 31, 2009 $2,157,556 $4,991,272 $675,148 $35,449,840 $ (3,219,975) $(6,867,310) $33,186,531 $2,361,617 $35,548,148 Acquisition of subsidiaries Equity transactions with noncontrolling interests and other Dividends paid to Canon Inc. stockholders Dividends paid to noncontrolling interests Transfer to legal reserve Comprehensive income (loss): Net income Other comprehensive income (loss), net of tax (Note 16): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income (loss) Repurchase of treasury stock, net 236,642 236,642 (46,754) (166,087) (8,395) 682,100 460,864 (533,506) (72,642) (1,680,284) (1,680,284) (1,680,284) 40,037 (40,037) (34,901) (34,901) — — 3,044,481 3,044,481 75,309 3,119,790 (1,514,407) (1,514,407) (52,481) (1,566,888) (2,741) 10,284 (85,247) (2,741) 938 (1,803) 10,284 (815) 9,469 (85,247) (29,901) (115,148) 1,452,370 (6,950) 1,445,420 (1,000) (49) (754,457) (755,506) (755,506) Balance at December 31, 2010 $2,157,556 $4,943,518 $715,185 $36,607,864 $(4,820,481) $(6,939,667) $32,663,975 $2,022,902 $34,686,877 See accompanying Notes to Consolidated Financial Statements. 68 68 CANON ANNUAL REPORT 2010 CANON ANNUAL REPORT 2010 CONSOLIDATED STATEMENTS OF CASH FLOWS CANON INC. AND SUBSIDIARIES Cash ﬂ ows from operating activities: Consolidated net income Adjustments to reconcile consolidated net income to net cash provided by operating activities: Depreciation and amortization Loss on disposal of property, plant and equipment Impairment loss of ﬁ xed assets (Note 6) Impairment loss of investments Equity in (earnings) losses of afﬁ liated companies Deferred income taxes (Increase) decrease in trade receivables (Increase) decrease in inventories Increase (decrease) in trade payables Increase (decrease) in accrued income taxes Increase (decrease) in accrued expenses Increase (decrease) in accrued (prepaid) pension and severance cost Other, net Net cash provided by operating activities Cash ﬂ ows from investing activities: Purchases of ﬁ xed assets (Note 6) Proceeds from sale of ﬁ xed assets (Note 6) Purchases of available-for-sale securities Proceeds from sale and maturity of available-for-sale securities Proceeds from maturity of held-to-maturity securities (Increase) decrease in time deposits, net Acquisitions of subsidiaries, net of cash acquired Purchases of other investments Other, net Net cash used in investing activities Cash ﬂ ows from ﬁ nancing activities: Proceeds from issuance of long-term debt Repayments of long-term debt Decrease in short-term loans, net Dividends paid Repurchases of treasury stock, net Other, net Net cash used in ﬁ nancing activities Effect of exchange rate changes on cash and cash equivalents Net change 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 ﬂ ow information (Note 23): Cash paid during the year for: Interest Income taxes See accompanying Notes to Consolidated Financial Statements. YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008 2010 Millions of yen 2009 2008 Thousands of U.S. dollars (Note 2) 2010 ¥252,703 ¥135,233 ¥320,359 $ 3,119,790 276,193 21,120 1,288 23,330 (10,471) 29,381 (6,671) (17,532) 115,726 25,228 77 4,147 29,894 744,413 (199,152) 3,303 (10,891) 3,910 — (80,904) (55,686) (1,955) (758) (342,133) 5,902 (5,739) (74,933) (136,103) (61,196) (7,828) (279,897) 315,393 8,215 15,466 2,398 12,649 20,712 48,244 143,580 (76,843) (21,023) (9,827) 4,765 12,273 611,235 (327,983) 8,893 (3,253) 2,460 — (11,345) (2,979) (37,981) 1,944 (370,244) 3,361 (6,282) (280) (135,793) (42) (3,343) (142,379) 341,337 11,811 13,503 10,568 20,047 (32,497) 83,521 49,547 (36,719) (77,340) (30,694) (12,128) (44,631) 616,684 (428,168) 7,453 (7,307) 4,320 10,000 2,892 (5,999) (45,473) (10,198) (472,480) 6,841 (15,397) (2,643) (145,024) (100,066) (21,276) (277,565) 3,409,790 260,741 15,901 288,025 (129,272) 362,728 (82,358) (216,444) 1,428,716 311,457 951 51,198 369,061 9,190,284 (2,458,667) 40,778 (134,457) 48,272 — (998,815) (687,481) (24,136) (9,358) (4,223,864) 72,864 (70,852) (925,099) (1,680,284) (755,506) (96,642) (3,455,519) (76,838) 45,545 795,034 ¥840,579 17,226 115,838 679,196 ¥795,034 (131,906) (265,267) 944,463 ¥679,196 (948,617) 562,284 9,815,235 $10,377,519 ¥ 1,924 80,212 ¥ 384 82,906 ¥ 901 263,392 $ 23,753 990,272 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CANON INC. AND SUBSIDIARIES CANON ANNUAL REPORT 2010 69 1. Basis of Presentation and Signiﬁ cant Accounting Policies (a) Description of Business Canon Inc. (the “Company”) and subsidiaries (collectively “Canon”) is one of the world’s leading manufacturers in such ﬁ elds as ofﬁ ce products, consumer products and industry and other products. Ofﬁ ce products consist mainly of network digi- tal multifunction devices (“MFDs”), copying machines, laser printers, large format inkjet printers and digital production printers. Consumer products consist mainly of digital single- lens reﬂ ex (“SLR”) cameras, compact digital cameras, inter- changeable lenses, digital video camcorders, inkjet multifunction peripherals, single function inkjet printers, image scanners and broadcasting equipment. Industry and other products consist mainly of semiconductor lithography equip- ment, lithography equipment for liquid crystal display (“LCD”) panels, and medical equipment. Canon’s consolidated net sales for the years ended December 31, 2010, 2009 and 2008 were distributed as follows: the Ofﬁ ce Business Unit 54%, 51% and 55%, the Consumer Business Unit 38%, 41% and 35%, the Industry and Others Business Unit 12%, 11% and 13%, and elimination between segments 4%, 3% and 3%, respectively. These percentages were computed by dividing segment net sales, including intersegment sales, by consolidated net sales, based on the segment operating results described in Note 24. Sales are made principally under the Canon brand name, almost entirely through sales subsidiaries. These subsidiaries are responsi- ble for marketing and distribution, and primarily sell to retail dealers in their geographic area. Approximately 81%, 78% and 79% of con- solidated net sales for the years ended December 31, 2010, 2009 and 2008 were generated outside Japan, with 28%, 28% and 28% in the Americas, 32%, 31% and 33% in Europe, and 21%, 19% and 18% in Asia and Oceania, respectively. Canon sells laser printers on an OEM basis to Hewlett- Packard Company; such sales constituted approximately 20%, 20% and 23% of consolidated net sales for the years ended December 31, 2010, 2009 and 2008, respectively, and are included in the Ofﬁ ce Business Unit. Canon’s manufacturing operations are conducted primarily at 26 plants in Japan and 19 overseas plants which are located in coun- tries or regions such as the United States, Germany, France, Netherlands, Taiwan, China, Malaysia, Thailand and Vietnam. (b) Basis of Presentation The Company and its domestic subsidiaries maintain their books of account in conformity with ﬁ nancial accounting stan- dards of Japan. Foreign subsidiaries maintain their books of account in conformity with ﬁ nancial accounting standards of the countries of their domicile. Certain adjustments and reclassiﬁ cations have been incorpo- rated in the accompanying consolidated ﬁ nancial statements to conform with U.S. generally accepted accounting principles (“GAAP”). These adjustments were not recorded in the statuto- ry books of account. interest entities where the Company or its consolidated subsid- iaries are the primary beneﬁ ciaries. All signiﬁ cant intercompany balances and transactions have been eliminated. (d) Use of Estimates The preparation of the consolidated ﬁ nancial statements in conformity with U.S. GAAP requires management to make esti- mates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated ﬁ nancial state- ments and the reported amounts of revenues and expenses during the period. Signiﬁ cant estimates and assumptions are reﬂ ected in valuation and disclosure of revenue recognition, allowance for doubtful receivables, valuation of inventories, impairment of long-lived assets, environmental liabilities, valua- tion of deferred tax assets, uncertain tax positions and employ- ee retirement and severance beneﬁ t obligations. Actual results could differ materially from those estimates. (e) Translation of Foreign Currencies Assets and liabilities of the Company’s subsidiaries located out- side 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 ﬁ nancial statements are excluded from earnings and are reported in other comprehensive income (loss). Gains and losses resulting from foreign currency transac- tions, including foreign exchange contracts, and translation of assets and liabilities denominated in foreign currencies are included in other income (deductions) in the consolidated statements of income. Foreign currency exchange gains and losses were net gains of ¥3,089 million ($38,136 thousand) and ¥1,842 million for the years ended December 31, 2010 and 2009, respectively, and was a net loss of ¥11,212 million for the year ended December 31, 2008. (f) Cash Equivalents All highly liquid investments acquired with original maturities of three months or less are considered to be cash equivalents. Certain debt securities with original maturities of less than three months classiﬁ ed as available-for-sale securities of ¥249,907 million ($3,085,272 thousand) and ¥184,856 million at December 31, 2010 and 2009, respectively, are included in cash and cash equivalents in the consolidated balance sheets. Additionally, certain debt securities with original maturities of less than three months classiﬁ ed as held-to-maturity securities of ¥1,000 million ($12,346 thousand) and ¥999 million at December 31, 2010 and 2009, respectively, are also included in cash and cash equivalents. Fair value for these securities approximates their cost. (c) Principles of Consolidation The consolidated ﬁ nancial statements include the accounts of the Company, its majority owned subsidiaries and those variable (g) Investments Investments consist primarily of time deposits with original maturities of more than three months, debt and marketable 70 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES equity securities, investments in afﬁ liated companies and non- marketable equity securities. Canon reports investments with maturities of less than one year as short-term investments. Canon classiﬁ es 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. Fair value is determined based on quoted market prices, projected discounted cash ﬂ ows or other valuation techniques as appro- priate. Unrealized holding gains and losses, net of the related tax effect, are reported as a separate component of other com- prehensive income (loss) until realized. Held-to-maturity securi- ties are recorded at amortized cost, adjusted for amortization of premiums and accretion of discounts. Available-for-sale and held-to-maturity securities are regular- ly reviewed for other-than-temporary declines in the carrying amount based on criteria that include the length of time and the extent to which the market value has been less than cost, the ﬁ nancial condition and near-term prospects of the issuer and Canon’s intent and ability to retain the investment for a period of time sufﬁ cient to allow for any anticipated recovery in market value. For debt securities for which the declines are deemed to be other-than-temporary and there is no intent to sell, impairments are separated into the amount related to credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other com- prehensive income (loss). For debt securities for which the declines are deemed to be other-than-temporary and there is an intent to sell, impairments in their entirety are recognized in earnings. For equity securities for which the declines are deemed to be other-than-temporary, impairments in their entirety are recognized in earnings. Canon recognizes an impairment loss to the extent by which the cost basis of the investment exceeds the fair value of the investment. Realized gains and losses are determined by the average cost method and reﬂ ected in earnings. Investments in afﬁ liated companies over which Canon has the ability to exercise signiﬁ cant inﬂ uence, but does not hold a controlling ﬁ nancial interest, are accounted for by the equity method. Non-marketable equity securities in companies over which Canon does not have the ability to exercise signiﬁ cant inﬂ uence are stated at cost and reviewed periodically for impairment. (h) Allowance for Doubtful Receivables Allowance for doubtful trade and ﬁ nance receivables is main- tained for all customers based on a combination of factors, including aging analysis, macroeconomic conditions and histor- ical experience. An additional reserve for individual accounts is recorded when Canon becomes aware of a customer’s inability to meet its ﬁ nancial obligations, such as in the case of bank- ruptcy ﬁ lings. If circumstances related to customers change, estimates of the recoverability of receivables would be further adjusted. When all collection options are exhausted including legal recourse, the accounts or portions thereof are deemed to be uncollectable and charged against the allowance. (i) Inventories Inventories are stated at the lower of cost or market value. Cost is determined by the average method for domestic inventories and principally by the ﬁ rst-in, ﬁ rst-out method for overseas inventories. (j) 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 indi- cate that the carrying amount of an asset may not be recover- able. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset and the estimated undiscounted future cash ﬂ ows expected to be gen- erated by the asset. If the carrying amount of the asset exceeds its estimated undiscounted future cash ﬂ ows, an impairment charge is recognized 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 carry- ing amount or fair value less costs to sell, and are no longer depreciated. (k) 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 1 year 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. (l) Goodwill and Other Intangible Assets Goodwill and other intangible assets with indeﬁ nite useful lives are not amortized, but are instead tested for impairment annu- ally in the fourth quarter of each year, or more frequently if indi- cators of potential impairment exist. Canon performs its impairment test of goodwill using the two-step approach at the reporting unit level, which is one level below the operating seg- ment level. All goodwill is assigned to the reporting unit or units that beneﬁ t from the synergies arising from each business combination. If the carrying amount assigned to the reporting unit exceeds the fair value of the reporting unit, Canon per- forms the second step to measure an impairment charge in the amount by which the carrying amount of a reporting unit’s goodwill exceeds its implied fair value. Intangible assets with ﬁ nite useful lives consist primarily of software, license fees, pat- ented technologies and customer relationships. 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. Patented technologies are amortized using the straight-line method prin- cipally over the estimated useful life of 3 years. Customer rela- tionships are amortized principally using the declining-balance method over the estimated useful life of 5 years. Certain costs CANON ANNUAL REPORT 2010 71 incurred in connection with developing or obtaining internal use software are capitalized. These costs consist primarily 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. (m) 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. (n) Income Taxes Deferred tax assets and liabilities are recognized for the esti- mated future tax consequences attributable to differences between the ﬁ nancial statement carrying amounts of existing assets and liabilities and their respective tax bases and operat- ing 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. Canon recognizes the ﬁ nancial statement effects of tax posi- tions when it is more likely than not, based on the technical merits, that the tax positions will be sustained upon examina- tion by the tax authorities. Beneﬁ ts from tax positions that meet the more-likely-than-not recognition threshold are measured at the largest amount of beneﬁ t that is greater than 50% likely of being realized upon settlement. Interest and penalties accrued related to unrecognized tax beneﬁ ts are included in income taxes in the consolidated statements of income. (o) Stock-Based Compensation Canon measures stock-based compensation cost at the grant date, based on the fair value of the award, and recognizes the cost on a straight-line basis over the requisite service period, which is the vesting period. (p) Net Income Attributable to Canon Inc. Stockholders per Share Basic net income attributable to Canon Inc. stockholders per share is computed by dividing net income attributable to Canon Inc. by the weighted-average number of common shares out- standing during each year. Diluted net income attributable to Canon Inc. stockholders per share includes the effect from potential issuances of common stock based on the assump- tions that all convertible debentures were converted into com- mon stock and all stock options were exercised. (q) Revenue Recognition Canon generates revenue principally through the sale of ofﬁ ce and consumer products, equipment, supplies, and related ser- vices under separate contractual arrangements. Canon recog- nizes revenue when persuasive evidence of an arrangement exists, delivery has occurred and title and risk of loss have been transferred to the customer or services have been ren- dered, the sales price is ﬁ xed or determinable, and collectibility is probable. Revenue from sales of ofﬁ ce products, such as ofﬁ ce net- work digital MFDs and laser printers, and consumer products, such as digital cameras and inkjet multifunction peripherals, 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 semicon- ductor lithography equipment and LCD lithography equipment that are sold with customer acceptance provisions related to their functionality, is recognized when the equipment is installed at the customer site and the speciﬁ c criteria of the equipment functionality are successfully tested and demon- strated by Canon. Service revenue is derived primarily from separately priced product maintenance contracts on equip- ment sold to customers and is measured at the stated amount of the contract and recognized as services are provided. Canon also offers separately priced product maintenance con- tracts for most ofﬁ ce products, for which the customer typically pays a stated base service fee plus a variable amount based on usage. Revenue from these service maintenance contracts is measured at the stated amount of the contract and recognized as services are provided and variable amounts are earned. 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-ﬁ nancing leases is recognized over the life of each respective lease using the interest method. Leases not qualifying as sales-type leases or direct-ﬁ nancing leases are accounted for as operating leases and related revenue is rec- ognized ratably over the lease term. When equipment leases are bundled with product maintenance contracts, revenue is ﬁ rst allocated considering the relative fair value of the lease and non-lease deliverables based upon the estimated relative fair values of each element. Lease deliverables generally include equipment, ﬁ nancing and executory costs, while non- lease deliverables generally consist of product maintenance contracts and supplies. For all other arrangements with multiple elements, Canon allocates revenue to each element based on its relative fair value if such element meets the criteria for treatment as a sep- arate unit of accounting. Otherwise, revenue is deferred until the undelivered elements are fulﬁ lled and accounted for as a single unit of accounting. 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 72 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES 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 are included in selling, general and administrative expenses in the consolidated statements of income. Estimates for accrued product warranty costs are based on historical experience, and are affected by ongoing product failure rates, speciﬁ c product class failures outside of the baseline experience, material usage and service delivery costs incurred in correcting a product failure. Taxes collected from customers and remitted to governmen- tal authorities are excluded from revenues in the consolidated statements of income. (r) Research and Development Costs Research and development costs are expensed as incurred. (s) Advertising Costs Advertising costs are expensed as incurred. Advertising expenses were ¥94,794 million ($1,170,296 thousand), ¥78,009 million and ¥112,810 million for the years ended December 31, 2010, 2009 and 2008, respectively. (t) Shipping and Handling Costs Shipping and handling costs totaled ¥56,306 million ($695,136 thousand), ¥45,966 million and ¥62,128 million for the years ended December 31, 2010, 2009 and 2008, respectively, and are included in selling, general and administrative expenses in the consolidated statements of income. (u) Derivative Financial Instruments All derivatives are recognized at fair value and are included in prepaid expenses and other current assets, or other current lia- bilities in the consolidated balance sheets. Canon uses and designates certain derivatives as a hedge of a forecasted transaction or the variability of cash ﬂ ows to be received or paid related to a recognized asset or liability (“cash ﬂ ow” hedge). Canon formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking vari- ous 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 cash ﬂ ows 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 qualiﬁ es as a cash ﬂ ow hedge are recorded in other comprehensive income (loss), until earnings are affected by the variability in cash ﬂ ows of the hedged item. Gains and losses from hedging ineffectiveness are included in other income (deductions). Gains and losses related to the components of hedging instru- ments excluded from the assessment of hedge effectiveness are included in other income (deductions). Canon also uses certain derivative ﬁ nancial instruments which are not designated as hedges. The changes in fair values of these derivative ﬁ nancial instruments are immediately recorded in earnings. Canon classiﬁ es cash ﬂ ows from derivatives as cash ﬂ ows from operating activities in the consolidated statements of cash ﬂ ows. (v) Guarantees Canon recognizes, at the inception of a guarantee, a liability for the fair value of the obligation it has undertaken in issuing guarantees. (w) Recently Issued Accounting Guidance In October 2009, the FASB issued new accounting guidance for revenue recognition under multiple-deliverable arrangements. This guidance modiﬁ es the criteria for separating consideration under multiple-deliverable arrangements and requires alloca- tion of the overall consideration to each deliverable using the estimated selling price in the absence of vendor-speciﬁ c objec- tive evidence or third-party evidence of selling price for deliver- ables. As a result, the residual method of allocating arrangement consideration will no longer be permitted. The guidance also requires additional disclosures about how a vendor allocates revenue in its arrangements and about the signiﬁ cant judg- ments made and their impact on revenue recognition. This guidance is effective for ﬁ scal years beginning on or after June 15, 2010 and is required to be adopted by Canon no later than the ﬁ rst quarter beginning January 1, 2011 (with early adoption permitted). The provisions are effective prospectively for reve- nue arrangements entered into or materially modiﬁ ed after the effective date, or retrospectively for all prior periods. Canon does not expect the adoption of this guidance to have a materi- al impact on Canon’s consolidated ﬁ nancial statements. In October 2009, the FASB issued new accounting guidance for software revenue recognition. This guidance modiﬁ es the scope of the software revenue recognition guidance to exclude from its requirements non-software components of tangible products and software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. This guidance is effective for ﬁ scal years beginning on or after June 15, 2010 and is required to be adopt- ed by Canon no later than the ﬁ rst quarter beginning January 1, 2011 (with early adoption permitted) using the same effective date and the same transition method used to adopt the guid- ance for revenue recognition under multiple-deliverable arrangements. Canon does not expect the adoption of this guidance to have a material impact on Canon’s consolidated ﬁ nancial statements. (x) Reclassiﬁ cations Certain reclassiﬁ cations have been made to the prior years’ consolidated statements of cash ﬂ ows to conform to the cur- rent year presentation. CANON ANNUAL REPORT 2010 73 2. Basis of Financial Statement Translation The consolidated ﬁ nancial 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 ¥81 = U.S.$1, the approximate exchange rate prevailing on the Tokyo Foreign Exchange Market on December 30, 2010. 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. Investments The cost, gross unrealized holding gains, gross unrealized holding losses and fair value for available-for-sale securities included in short-term investments and investments by major security type at December 31, 2010 and 2009 were as follows: December 31 Millions of yen 2010: Current: Government bonds Corporate bonds Noncurrent: Government bonds Corporate bonds Fund trusts Equity securities Millions of yen 2009: Current: Government bonds Noncurrent: Government bonds Corporate bonds Fund trusts Equity securities Gross unrealized holding gains Gross unrealized holding losses ¥ — — ¥ — ¥ — 42 20 5,768 ¥5,830 ¥ — — ¥ — ¥ 22 65 — 654 ¥741 Fair value ¥ 1 1,000 ¥ 1,001 ¥ 161 994 1,798 23,402 ¥26,355 Cost ¥ 1 1,000 ¥ 1,001 ¥ 183 1,017 1,778 18,288 ¥21,266 Gross unrealized holding gains Gross unrealized holding losses Cost Fair value ¥ 222 ¥ — ¥ — ¥ 222 ¥ 225 1,397 2,275 11,932 ¥15,829 ¥ — 27 300 7,295 ¥7,622 ¥ 21 55 7 1,501 ¥1,584 ¥ 204 1,369 2,568 17,726 ¥21,867 74 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES December 31 Thousands of U.S. dollars 2010: Current: Government bonds Corporate bonds Noncurrent: Government bonds Corporate bonds Fund trusts Equity securities Gross unrealized holding gains $ $ — — — $ — 519 246 71,210 $71,975 Gross unrealized holding losses $ — — $ — $ 272 802 — 8,074 $9,148 Fair value $ 12 12,346 $ 12,358 $ 1,987 12,272 22,197 288,914 $325,370 Cost $ 12 12,346 $ 12,358 $ 2,259 12,555 21,951 225,778 $262,543 Maturities of available-for-sale debt securities and fund trusts included in short-term investments and investments in the accom- panying consolidated balance sheets were as follows at December 31, 2010: Due within one year Due after one year through ﬁ ve years Due after ﬁ ve years through ten years Millions of yen Cost ¥1,001 952 2,026 ¥3,979 Fair value ¥1,001 972 1,981 ¥3,954 Thousands of U.S. dollars Cost $12,358 11,753 25,012 $49,123 Fair value $12,358 12,000 24,456 $48,814 Gross realized gains were ¥641 million ($7,914 thousand), ¥277 million and ¥116 million for the years ended December 31, 2010, 2009 and 2008, respectively. Gross realized losses, including write-downs for impairments that were other than temporary, were ¥1,961 million ($24,210 thousand), ¥2,482 mil- lion and ¥7,868 million for the years ended December 31, 2010, 2009 and 2008, respectively. At December 31, 2010, substantially all of the available-for- sale securities with unrealized losses had been in a continuous unrealized loss position for less than 12 months. Time deposits with original maturities of more than three months are ¥95,814 million ($1,182,889 thousand) and ¥18,852 million at December 31, 2010 and 2009, respectively, and are included in short-term investments in the accompanying con- solidated balance sheets. Aggregate cost of non-marketable equity securities account- ed for under the cost method totaled ¥26,475 million ($326,852 thousand) and ¥28,567 million at December 31, 2010 and 2009, respectively. Investments with an aggregate cost of ¥24,053 million ($296,951 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 signiﬁ cant adverse effects on the fair value of those investments. Investments in afﬁ liated companies accounted for by the equity method amounted to ¥26,817 million ($331,074 thou- sand) and ¥61,595 million at December 31, 2010 and 2009, respectively. Canon’s share of the net earnings (losses) in afﬁ li- ated companies accounted for by the equity method, included in other income (deductions), were earnings of ¥10,471 million ($129,272 thousand) for the year ended December 31, 2010, and losses of ¥12,649 million and ¥20,047 million for the years ended December 31, 2009 and 2008, respectively. 4. Trade Receivables Trade receivables are summarized as follows: December 31 Notes Accounts Less allowance for doubtful receivables 5. Inventories Inventories are summarized as follows: December 31 Finished goods Work in process Raw materials CANON ANNUAL REPORT 2010 75 Millions of yen 2010 ¥ 15,441 556,983 572,424 (14,920) ¥557,504 2009 ¥ 13,037 554,878 567,915 (11,343) ¥556,572 Thousands of U.S. dollars 2010 $ 190,630 6,876,333 7,066,963 (184,198) $6,882,765 Millions of yen 2010 ¥232,584 116,679 35,514 ¥384,777 2009 ¥228,161 129,824 15,256 ¥373,241 Thousands of U.S. dollars 2010 $2,871,407 1,440,482 438,444 $4,750,333 6. 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 2010 2009 ¥ 266,631 1,320,121 1,439,246 85,673 3,111,671 (1,909,703) ¥1,201,968 ¥ 258,824 1,299,154 1,422,076 105,713 3,085,767 (1,815,982) ¥1,269,785 Thousands of U.S. dollars 2010 $ 3,291,741 16,297,790 17,768,469 1,057,691 38,415,691 (23,576,580) $14,839,111 76 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Depreciation expense for the years ended December 31, 2010, 2009 and 2008 was ¥232,327 million ($2,868,235 thousand), ¥277,399 million and ¥304,622 million, respectively. Amounts due for purchases of property, plant and equipment were ¥23,306 million ($287,728 thousand) and ¥29,030 million at December 31, 2010 and 2009, respectively, and are included in other current liabilities in the accompanying consolidated balance sheets. Fixed assets presented in the consolidated statements of cash ﬂ ows include property, plant and equipment and intangible assets. As a result of continued sluggish demand in the semiconduc- tor manufacturing industry and diminished proﬁ tability of the semiconductor lithography equipment business, Canon recog- nized impairment losses related primarily to property, plant and equipment of its semiconductor lithography equipment busi- ness, which are included in the results of the Industry and Others Business Unit for the year ended December 31, 2009. Long-lived assets with a carrying amount of ¥15,390 million were written down to their fair value of zero, which was esti- mated using discounted future cash ﬂ ows expected to be gen- erated over their remaining useful life. The impairment losses were included in selling, general and administrative expenses in the consolidated statement of income. Canon also recognized impairment losses of ¥11,164 million related primarily to property, plant and equipment of its semi- conductor lithography equipment business, which are included in the results of the Industry and Others Business Unit for the year ended December 31, 2008, mainly as a result of declining demand in the semiconductor manufacturing industry. The impairment losses were estimated using discounted cash ﬂ ows and included in selling, general and administrative expenses in the consolidated statement of income. 7. Finance Receivables and Operating Leases Finance receivables represent ﬁ nancing leases which consist of sales-type leases and direct-ﬁ nancing leases resulting from the marketing of Canon’s and complementary third-party products primarily in foreign countries. These receivables typically have terms ranging from 1 year to 8 years. The components of the ﬁ nance receivables, which are included in prepaid expenses and other current assets, and other assets in the accompany- ing 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 current portion The activity in the allowance for credit losses is as follows: Year ended December 31, 2010 Balance at beginning of year Charge-offs Provision Other Balance at end of year Millions of yen 2010 ¥215,925 11,120 (2,063) (27,891) 197,091 (7,983) 189,108 (71,500) ¥117,608 2009 ¥206,267 14,630 (1,973) (26,994) 191,930 (9,023) 182,907 (65,146) ¥117,761 Millions of yen ¥9,023 (3,103) 1,995 68 ¥7,983 Thousands of U.S. dollars 2010 $2,665,741 137,284 (25,469) (344,333) 2,433,223 (98,556) 2,334,667 (882,716) $1,451,951 Thousands of U.S. dollars $111,395 (38,309) 24,630 840 $ 98,556 CANON ANNUAL REPORT 2010 77 Canon has policies in place to ensure that its products are sold to customers with an appropriate credit history, and continu- ously monitors its customers’ credit quality based on informa- tion including length of period in arrears, macroeconomic conditions, initiation of legal proceedings against customers and bankruptcy ﬁ lings. The allowance for credit losses of ﬁ nance receivables are evaluated collectively based on historical experience of credit losses. An additional reserve for individual accounts is recorded when Canon becomes aware of a cus- tomer’s inability to meet its ﬁ nancial obligations, such as in the case of bankruptcy ﬁ lings. Finance receivables which are past due or individually evaluated for impairment at December 31, 2010 are not signiﬁ cant. The cost of equipment leased to customers under operating leases included in property, plant and equipment, net at December 31, 2010 and 2009 was ¥63,239 million ($780,728 thousand) and ¥53,807 million, respectively. Accumulated depreciation on equipment under operating leases at December 31, 2010 and 2009 was ¥43,829 million ($541,099 thousand) and ¥39,992 million, respectively. The following is a schedule by year of the future minimum lease payments to be received under ﬁ nancing leases and non- cancelable operating leases at December 31, 2010. Year ending December 31: Millions of yen Thousands of U.S. dollars 2011 2012 2013 2014 2015 Thereafter Financing leases Operating leases Financing leases Operating leases ¥ 84,049 60,245 39,883 21,143 9,945 660 ¥215,925 ¥11,581 6,449 3,365 1,456 532 163 ¥23,546 $1,037,642 743,765 492,383 261,025 122,778 8,148 $2,665,741 $142,975 79,617 41,543 17,975 6,568 2,013 $290,691 8. Acquisitions In March 2010, Canon acquired 45.2% of the total outstanding shares of Océ N.V. (“Océ”), which is listed on NYSE Euronext Amsterdam, principally through a fully self-funded public cash tender offer for consideration of ¥50,374 million ($621,901 thousand), in addition to the 22.9% interest Canon held before the public cash tender offer. In addition, Canon acquired Océ’s convertible cumulative ﬁ nancing preference shares represent- ing 19.1% of the total outstanding shares of Océ for consider- ation of ¥8,027 million ($99,099 thousand). As a result, Canon’s aggregate interest represents 87.2% of the total outstanding shares of Océ. The fair value of the 12.8% noncontrolling inter- est in Océ of ¥18,245 million ($225,247 thousand) was mea- sured based on the quoted price of Océ’s common stock on the acquisition date. The acquisition was accounted for using the acquisition method. Prior to the March 2010 acquisition date, Canon accounted for its 22.9% interest in Océ using the equity meth- od. The acquisition-date fair value of the previous equity inter- est of ¥25,508 million ($314,914 thousand) was remeasured using the quoted price of Océ’s common stock on the acquisi- tion date and included in the measurement of the total acquisi- tion consideration. In connection with the acquisition, Canon repaid ¥55,378 million ($683,679 thousand) of Océ’s existing bank debt and ¥22,936 million ($283,160 thousand) of Océ’s existing United States Private Placement notes, which are included in decrease in short-term loans in the consolidated statement of cash ﬂ ows. Océ is engaged in research and development, manufacture and sale of document management systems, printing systems for professionals and high-speed, wide format digital printing systems. Canon and Océ have complementary technologies and products and would beneﬁ t from this strong business rela- tionship. Amid the increasingly competitive printing industry, Canon is further strengthening its business foundation in order to solidify its position as one of the global leaders. Canon aims to provide diversiﬁ ed solutions to its customers in the printing industry by making Océ a consolidated subsidiary. 78 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at acquisition date. Current assets Property, plant and equipment Intangible assets Goodwill Other noncurrent assets Non-current assets Total acquired assets Total assumed liabilities Net assets acquired Millions of yen ¥122,248 51,156 56,297 77,253 42,658 227,364 349,612 247,458 ¥102,154 Thousands of U.S. dollars $1,509,235 631,556 695,025 953,741 526,642 2,806,964 4,316,199 3,055,038 $1,261,161 Intangible assets acquired, which are subject to amortization, consist of customer relationships of ¥32,747 million ($404,284 thousand), patented technologies of ¥11,316 million ($139,704 thousand), and other intangible assets of ¥12,234 million ($151,037 thousand). Canon has estimated the amortization period for the customer relationships and patented technolo- gies to be 5 years and 3 years, respectively. The weighted aver- age amortization period for all intangible assets is approximately 4.4 years. Goodwill recognized, which is assigned to the Ofﬁ ce Business Unit for impairment testing, is attributable primarily to expected synergies from combining operations of Océ and Canon. None of the goodwill is expected to be deductible for income tax purposes. The amount of net sales of Océ included in Canon’s consoli- dated statement of income from the acquisition date for the year ended December 31, 2010 was ¥246,518 million ($3,043,432 thousand). The unaudited pro forma net sales as if Océ had been includ- ed in Canon’s consolidated statements of income from the beginning of the years ended December 31, 2010 and 2009 were ¥3,772,425 million ($46,573,148 thousand) and ¥3,554,316 million, respectively. Pro forma net income was not disclosed because the impact on Canon’s consolidated statements of income was not material. Canon acquired businesses other than those described above during the years ended December 31, 2010, 2009, and 2008 that were not material to its consolidated ﬁ nancial statements. 9. Goodwill and Other Intangible Assets Intangible assets developed or acquired during the year ended December 31, 2010 totaled ¥94,474 million ($1,166,346 thou- sand), which are subject to amortization and primarily consist of software of ¥34,441 million ($425,198 thousand), which is mainly for internal use, in addition to those recorded from acquired businesses. The weighted average amortization period for software and intangible assets in total is approximately 4 years and 4 years, respectively. The components of intangible assets subject to amortization at December 31, 2010 and 2009 were as follows: December 31 Millions of yen Software Customer relationships Patented technologies License fees Other 2010 2009 Gross carrying amount ¥200,245 37,637 25,425 22,108 16,686 ¥302,101 Accumulated amortization ¥109,200 12,107 9,377 14,436 4,641 ¥149,761 Gross carrying amount Accumulated amortization ¥198,276 8,585 11,648 23,889 10,377 ¥252,775 ¥114,410 2,245 2,878 13,546 3,135 ¥136,214 CANON ANNUAL REPORT 2010 79 Thousands of U.S. dollars Software Customer relationships Patented technologies License fees Other 2010 Gross carrying amount $2,472,161 464,654 313,889 272,938 206,000 $3,729,642 Accumulated amortization $1,348,148 149,469 115,765 178,222 57,297 $1,848,901 Aggregate amortization expense for the years ended December 31, 2010, 2009 and 2008 was ¥43,866 million ($541,555 thousand), ¥37,994 million and ¥36,715 million, respectively. Estimated amortization expense for intangible assets currently held for the next ﬁ ve years ending December 31 is ¥46,572 million ($574,963 thousand) in 2011, ¥36,765 mil- lion ($453,889 thousand) in 2012, ¥25,030 million ($309,012 thousand) in 2013, ¥16,559 million ($204,432 thousand) in 2014, and ¥7,190 million ($88,765 thousand) in 2015. Intangible assets not subject to amortization other than goodwill at December 31, 2010 and 2009 were not signiﬁ cant. For management reporting purposes, goodwill is not allocat- ed to the segments. Goodwill has been allocated to its respec- tive segment for impairment testing. The changes in the carrying amount of goodwill by segment, which is included in other assets in the consolidated balance sheets, for the years ended December 31, 2010 and 2009 were as follows: Years ended December 31 Millions of yen 2010: Balance at beginning of year Goodwill acquired during the year Translation adjustments and other Balance at end of year Millions of yen 2009: Balance at beginning of year Goodwill acquired during the year Translation adjustments and other Balance at end of year Thousands of U.S. dollars 2010: Balance at beginning of year Goodwill acquired during the year Translation adjustments and other Balance at end of year Ofﬁ ce ¥ 39,845 79,156 (11,700) ¥107,301 Consumer ¥13,303 — (917) ¥12,386 Ofﬁ ce ¥ 36,966 2,462 417 ¥ 39,845 Consumer ¥ 13,279 — 24 ¥ 13,303 Industry and Others ¥2,723 3,719 (940) ¥5,502 Industry and Others ¥ 509 2,343 (129) ¥ 2,723 Total ¥ 55,871 82,875 (13,557) ¥125,189 Total ¥ 50,754 4,805 312 ¥ 55,871 Ofﬁ ce Consumer $ 491,914 977,234 (144,444) $1,324,704 $164,235 — (11,321) $152,914 Industry and Others $33,616 45,914 (11,605) $67,925 Total $ 689,765 1,023,148 (167,370) $1,545,543 80 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES 10. Short-Term Loans and Long-Term Debt Short-term loans consisting of bank borrowings at December 31, 2010 were ¥2,071 million ($25,568 thousand). The weighted aver- age interest rate on short-term loans outstanding at December 31, 2010 was 1.46%. Long-term debt consisted of the following: December 31 Loans, principally from banks, maturing in installments through 2020; bearing weighted average interest of 1.83% and 0.30% at December 31, 2010 and 2009, respectively Capital lease obligations Less current portion Millions of yen 2010 2009 ¥1,013 8,247 9,260 (5,129) ¥4,131 ¥ 20 9,761 9,781 (4,869) ¥4,912 Thousands of U.S. dollars 2010 $ 12,506 101,815 114,321 (63,321) $ 51,000 The aggregate annual maturities of long-term debt outstanding at December 31, 2010 were as follows: Year ending December 31: 2011 2012 2013 2014 2015 Thereafter Millions of yen ¥5,129 1,799 1,062 833 322 115 ¥9,260 Thousands of U.S. dollars $ 63,321 22,210 13,111 10,284 3,975 1,420 $114,321 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. 11. Trade Payables Trade payables are summarized as follows: December 31 Notes Accounts Millions of yen 2010 ¥ 13,676 369,575 ¥383,251 2009 ¥ 7,608 331,505 ¥339,113 Thousands of U.S. dollars 2010 $ 168,840 4,562,654 $4,731,494 CANON ANNUAL REPORT 2010 81 12. Employee Retirement and Severance Beneﬁ ts The Company and certain of its subsidiaries have contributory and noncontributory deﬁ ned beneﬁ t pension plans covering substan- tially all of their employees. Beneﬁ ts payable under the plans are based on employee earnings and years of service. The Company and certain of its subsidiaries also have deﬁ ned contribution pen- sion plans covering substantially all of their employees. The amounts of cost recognized for the deﬁ ned contribution pension plans of the Company and certain of its subsidiaries for the years ended December 31, 2010, 2009 and 2008 were ¥11,780 million ($145,432 thousand), ¥9,148 million and ¥10,840 million, respectively. Obligations and funded status Reconciliations of beginning and ending balances of the beneﬁ t obligations and the fair value of the plan assets are as follows: Years ended December 31 Japanese plans Foreign plans Millions of yen Thousands of U.S. dollars Millions of yen Thousands of U.S. dollars 2010 2009 2010 2010 2009 2010 Change in beneﬁ t obligations: Beneﬁ t obligations at beginning of year Service cost Interest cost Plan participants’ contributions Amendments Actuarial (gain) loss Beneﬁ ts paid Acquisition Foreign currency exchange rate changes Beneﬁ t obligations at end of year ¥ 551,320 23,331 12,636 — (423) 22,290 (15,880) — — 593,274 Change in plan assets: Fair value of plan assets at beginning of year 457,208 Actual return on plan assets Employer contributions Plan participants’ contributions Beneﬁ ts paid Acquisition Foreign currency exchange rate changes Fair value of plan assets at end of year Funded status at end of year 4,533 13,283 — (14,934) — — 460,090 ¥(133,184) ¥521,985 21,759 12,535 — (674) 10,822 (15,107) — — 551,320 $ 6,806,420 288,037 156,000 — (5,223) 275,185 (196,049) — — 7,324,370 ¥ 94,170 5,660 11,792 2,460 (149) (5,946) (7,458) 198,754 (38,153) 261,130 ¥ 78,468 2,426 4,251 1,177 — 3,533 (1,784) — 6,099 94,170 $1,162,593 69,877 145,580 30,370 (1,840) (73,407) (92,074) 2,453,753 (471,025) 3,223,827 429,870 26,616 15,173 — (14,451) — — 457,208 ¥ (94,112) 5,644,543 55,963 163,988 — (184,371) — — 5,680,123 $(1,644,247) 75,058 19,307 8,152 2,460 (7,413) 128,043 (27,772) 197,835 ¥ (63,295) 62,996 4,844 3,059 1,177 (1,784) — 4,766 75,058 ¥(19,112) 926,642 238,358 100,642 30,370 (91,519) 1,580,778 (342,864) 2,442,407 $ (781,420) 82 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Amounts recognized in the consolidated balance sheets at December 31, 2010 and 2009 are as follows: December 31 Japanese plans Foreign plans Other assets Accrued expenses Accrued pension and severance cost Millions of yen Thousands of U.S. dollars Millions of yen Thousands of U.S. dollars 2010 2009 2010 2010 2009 2010 ¥ 345 — (133,529) ¥(133,184) ¥ 707 — (94,819) ¥(94,112) $ 4,259 — (1,648,506) $(1,644,247) ¥ 1,318 (533) (64,080) ¥(63,295) ¥ 2,069 (96) (21,085) ¥(19,112) $ 16,271 (6,580) (791,111) $(781,420) Amounts recognized in accumulated other comprehensive income (loss) at December 31, 2010 and 2009 before the effect of income taxes are as follows: December 31 Japanese plans Foreign plans Actuarial loss Prior service credit Net transition obligation Millions of yen Thousands of U.S. dollars Millions of yen Thousands of U.S. dollars 2010 2009 2010 2010 2009 2010 ¥257,625 (142,473) 722 ¥115,874 ¥237,822 (155,928) 1,444 ¥ 83,338 $3,180,555 (1,758,926) 8,914 $1,430,543 ¥3,538 (486) — ¥3,052 ¥19,411 (670) — ¥18,741 $43,679 (6,000) — $37,679 The accumulated beneﬁ t obligation for all deﬁ ned beneﬁ t plans was as follows: December 31 Japanese plans Foreign plans Accumulated beneﬁ t obligation ¥565,406 ¥522,582 $6,980,321 ¥216,239 ¥80,361 $2,669,617 Millions of yen Thousands of U.S. dollars Millions of yen Thousands of U.S. dollars 2010 2009 2010 2010 2009 2010 The projected beneﬁ t obligations and the fair value of plan assets for the pension plans with projected beneﬁ t obligations in excess of plan assets, and the accumulated beneﬁ t obligations and the fair value of plan assets for the pension plans with accumulated beneﬁ t obligations in excess of plan assets are as follows: December 31 Japanese plans Foreign plans Millions of yen Thousands of U.S. dollars Millions of yen Thousands of U.S. dollars 2010 2009 2010 2010 2009 2010 Plans with projected beneﬁ t obligations in excess of plan assets: Projected beneﬁ t obligations Fair value of plan assets Plans with accumulated beneﬁ t obligations in excess of plan assets: Accumulated beneﬁ t obligations Fair value of plan assets ¥589,391 455,862 ¥545,466 450,647 $7,276,432 5,627,926 ¥258,326 193,713 ¥94,123 72,942 $3,189,210 2,391,519 ¥559,468 453,342 ¥509,638 442,756 $6,907,012 5,596,815 ¥144,225 122,590 ¥80,314 72,942 $1,780,556 1,513,457 CANON ANNUAL REPORT 2010 83 Components of net periodic beneﬁ t cost and other amounts recognized in other comprehensive income (loss) Net periodic beneﬁ t cost for Canon’s employee retirement and severance deﬁ ned beneﬁ t plans for the years ended December 31, 2010, 2009 and 2008 consisted of the following components: Years ended December 31 Japanese plans Foreign plans Service cost Interest cost Expected return on plan assets Amortization of net transition obligation Amortization of prior service credit Amortization of actuarial loss Millions of yen Thousands of U.S. dollars Millions of yen Thousands of U.S. dollars 2010 2009 2008 2010 2010 2009 2008 2010 ¥23,331 12,636 (16,591) ¥21,759 12,535 (15,808) ¥20,786 12,253 (19,721) $288,037 156,000 (204,827) ¥ 5,660 11,792 (10,540) ¥2,426 4,251 (4,211) ¥3,141 4,991 (5,519) $ 69,877 145,580 (130,123) 722 722 722 8,914 — — — — (13,878) 14,545 ¥20,765 (13,650) 13,923 ¥19,481 (13,373) 7,068 ¥ 7,735 (171,334) 179,568 $256,358 (116) (98) 1,050 ¥ 7,846 1,014 ¥3,382 (271) 898 ¥3,240 (1,433) 12,963 $ 96,864 Other changes in plan assets and beneﬁ t obligations recognized in other comprehensive income (loss) for the years ended December 31, 2010 and 2009 are summarized as follows: Years ended December 31 Japanese plans Foreign plans Current year actuarial (gain) loss Amortization of actuarial loss Prior service credit due to amendments Amortization of prior service credit Amortization of net transition obligation Millions of yen Thousands of U.S. dollars Millions of yen 2010 2009 2010 2010 ¥34,348 (14,545) (423) 13,878 (722) ¥32,536 ¥ 14 (13,923) (674) 13,650 (722) ¥ (1,655) $424,049 (179,568) (5,223) 171,334 (8,914) $401,678 ¥(14,713) (1,050) (149) 116 — ¥(15,796) 2009 ¥2,900 (1,014) — 98 — ¥1,984 Thousands of U.S. dollars 2010 $(181,642) (12,963) (1,840) 1,433 — $(195,012) The estimated net transition obligation, prior service credit and actuarial loss for the deﬁ ned beneﬁ t pension plans that will be amortized from accumulated other comprehensive income (loss) into net periodic beneﬁ t cost over the next year are summarized as follows: Net transition obligation Prior service credit Actuarial loss Japanese plans Foreign plans Millions of yen ¥ 722 (13,574) 14,562 Thousands of U.S. dollars $ 8,914 (167,580) 179,778 Millions of yen ¥ — (132) 500 Thousands of U.S. dollars $ — (1,630) 6,173 Assumptions Weighted-average assumptions used to determine beneﬁ t obligations are as follows: December 31 Japanese plans Foreign plans Discount rate Assumed rate of increase in future compensation levels 2010 2.1% 3.0% 2009 2.3% 3.0% 2010 4.9% 2.9% 2009 5.2% 3.5% 84 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Weighted-average assumptions used to determine net periodic beneﬁ t cost are as follows: Years ended December 31 Japanese plans Foreign plans Discount rate Assumed rate of increase in future compensation levels Expected long-term rate of return on plan assets 2010 2.3% 3.0% 3.6% 2009 2.4% 3.0% 3.7% 2008 2.5% 2.9% 3.7% 2010 4.9% 2.8% 6.1% 2009 5.3% 3.1% 6.2% 2008 5.1% 3.1% 6.5% Canon determines the expected long-term rate of return based on the expected long-term return of the various asset catego- ries in which it invests. Canon considers the current expecta- tions for future returns and the actual historical returns of each plan asset category. Plan assets Canon’s investment policies are designed to ensure adequate plan assets are available to provide future payments of pension beneﬁ ts to eligible participants. Taking into account the expect- ed 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 expect- ed long-term rate of return on plan assets. Canon’s model portfolio for Japanese plans consists of three major components: approximately 30% is invested in equity securities, approximately 50% is invested in debt securities, and approximately 20% is invested in other investment vehicles, pri- marily consisting of investments in life insurance company gen- eral accounts. Outside Japan, investment policies vary by country, but the long-term investment objectives and strategies remain consis- tent. However, Canon’s model portfolio for foreign plans has been developed as follows: approximately 40% is invested in equity securities, approximately 55% is invested in debt securi- ties, and approximately 5% is invested in other investment vehi- cles, primarily consisting of investments in real estate assets. The equity securities are selected primarily from stocks that are listed on the securities exchanges. Prior to investing, Canon has investigated the business condition of the investee compa- nies, and appropriately diversiﬁ ed investments by type of industry and other relevant factors. The debt securities are selected primarily from government bonds, public debt instru- ments, and corporate bonds. Prior to investing, Canon has investigated the quality of the issue, including rating, interest rate, and repayment dates, and has appropriately diversiﬁ ed the investments. Pooled funds are selected using strategies consistent with the equity and debt securities described above. As for investments in life insurance company general accounts, the contracts with the insurance companies include a guaran- teed interest rate and return of capital. With respect to invest- ments in foreign investment vehicles, Canon has investigated the stability of the underlying governments and economies, the market characteristics such as settlement systems and the tax- ation systems. For each such investment, Canon has selected the appropriate investment country and currency. CANON ANNUAL REPORT 2010 85 The three levels of input used to measure fair value are more fully described in Note 22. The fair values of Canon’s pension plan assets at December 31, 2010 and 2009, by asset category, are as follows: December 31, 2010 Millions of yen Japanese plans Foreign plans Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Equity securities: Japanese companies (a) Foreign companies Pooled funds (b) Debt securities: Government bonds (c) Municipal bonds Corporate bonds Pooled funds (d) Mortgage backed securities (and other asset backed securities) Life insurance company general accounts Other assets ¥50,177 5,352 — ¥ — ¥ — ¥ 50,177 5,352 90,597 — 90,597 — — ¥ — ¥ — — 80,666 3,474 — ¥ — — — ¥ — 3,474 80,666 — 9,687 323 — 6,518 — — 194,286 9,687 — 323 — 6,518 — — 194,286 2,074 — — — — — — 104,650 — — — — 2,074 — — 104,650 — 1,980 — 1,980 — 232 — 232 — — ¥65,216 91,610 8,521 ¥393,835 — 1,039 ¥1,039 91,610 9,560 ¥460,090 — — ¥5,548 — 6,739 ¥192,287 — — ¥ — — 6,739 ¥197,835 December 31, 2009 Millions of yen Japanese plans Foreign plans Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Equity securities: Japanese companies (e) Foreign companies Pooled funds (f) Debt securities: Government bonds (g) Municipal bonds Corporate bonds Pooled funds (h) Mortgage backed securities (and other asset backed securities) Life insurance company general accounts Other assets ¥48,844 5,444 — ¥ — — 85,353 ¥ — ¥ 48,844 5,444 85,353 — — 14,803 — — — — 879 7,665 189,870 — — — — 14,803 879 7,665 189,870 ¥ — 3,898 — 1,581 — — — ¥ — — 47,290 ¥ — — — — — 6,673 9,343 — — — — ¥ — 3,898 47,290 1,581 — 6,673 9,343 — 943 — 943 — 256 — 256 — — ¥69,091 94,269 8,367 ¥387,346 — 771 ¥771 94,269 9,138 ¥457,208 — — ¥5,479 — 6,017 ¥69,579 — — ¥ — — 6,017 ¥75,058 86 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES December 31, 2010 Thousands of U.S. dollars Japanese plans Foreign plans Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Equity securities: Japanese companies (a) Foreign companies Pooled funds (b) Debt securities: Government bonds (c) Municipal bonds Corporate bonds Pooled funds (d) Mortgage backed securities (and other asset backed securities) Life insurance company general accounts Other assets $619,469 $ — $ — $ 619,469 — 66,074 — 1,118,481 — — 1,118,481 66,074 $ — $ — $ — $ — 42,889 995,877 — 995,877 42,889 — — — — 119,593 3,988 — — 80,469 — 2,398,593 119,593 — 3,988 — — 80,469 — 2,398,593 — 25,605 — — — — — 1,291,975 — 24,444 — 24,444 — 1,130,988 — 1,130,988 — — 2,864 — — — — — — — 25,605 — — 1,291,975 2,864 — — 105,197 118,024 $805,136 $4,862,160 $12,827 $5,680,123 12,827 — 83,197 $68,494 $2,373,913 — 83,197 $ — $2,442,407 (a) The plan’s equity securities include common stock of the Company and certain of its subsidiaries in the amounts of ¥1,044 million ($12,889 thousand) at December 31, 2010. (b) These funds invest in listed equity securities consisting of approximately 50% Japanese companies and 50% foreign companies for Japanese plans and mainly foreign compa- nies for foreign plans. (c) This class includes approximately 50% Japanese government bonds and 50% foreign government bonds. (d) These funds invest in approximately 60% Japanese govern- ment bonds, 20% foreign government bonds, 10% Japanese municipal bonds, and 10% corporate bonds for Japanese plans. These funds invest in approximately 40% foreign gov- ernment bonds and 60% corporate bonds for foreign plans. (e) The plan’s equity securities include common stock of the Company and certain of its subsidiaries in the amounts of ¥950 million at December 31, 2009. (f) These funds invest in listed equity securities consisting of approximately 50% Japanese companies and 50% foreign companies for Japanese plans, and mainly foreign compa- nies for foreign plans. (g) This class includes approximately 80% Japanese government bonds and 20% foreign government bonds. (h) These funds invest in approximately 55% Japanese govern- ment bonds, 25% foreign government bonds, 10% Japanese municipal bonds, and 10% corporate bonds. Each level into which assets are categorized is based on inputs used to measure the fair value of the assets, and does not necessarily indicate the risks or ratings of the assets. Level 1 assets are comprised principally of equity securities and government bonds, which are valued using unadjusted quoted market prices in active markets with sufﬁ cient volume and frequency of transactions. Level 2 assets are comprised principally of pooled funds that invest in equity and debt securi- ties, corporate bonds and investments in life insurance compa- ny general accounts. Pooled funds are valued at their net asset values that are calculated by the sponsor of the fund and have daily liquidity. Corporate bonds are valued using quoted prices for identical assets in markets that are not active. Investments in life insurance company general accounts are valued at con- version value. The fair value of Level 3 assets, consisting of hedge funds, was ¥1,039 million ($12,827 thousand) and ¥771 million at December 31, 2010 and 2009, respectively. Amounts of actual returns on, and purchases and sales of, these assets during the years ended December 31, 2010 and 2009 were not signiﬁ cant. CANON ANNUAL REPORT 2010 87 Contributions Canon expects to contribute ¥22,055 million ($272,284 thousand) to its Japanese deﬁ ned beneﬁ t pension plans and ¥8,016 million ($98,963 thousand) to its foreign deﬁ ned beneﬁ t pension plans for the year ending December 31, 2011. Estimated future beneﬁ t payments The following beneﬁ t payments, which reﬂ ect expected future service, as appropriate, are expected to be paid: Year ending December 31: Japanese plans Foreign plans 2011 2012 2013 2014 2015 2016–2020 Millions of yen ¥ 14,442 15,397 16,779 17,692 19,552 123,422 Thousands of U.S. dollars $ 178,296 190,086 207,148 218,420 241,383 1,523,728 Millions of yen ¥ 9,199 9,420 9,801 10,045 10,483 61,020 Thousands of U.S. dollars $113,568 116,296 121,000 124,012 129,420 753,333 13. Income Taxes Domestic and foreign components of income before income taxes and the current and deferred income tax expense (beneﬁ t) attributable to such income are summarized as follows: Years ended December 31 2010: Income before income taxes Income taxes: Current Deferred 2009: Income before income taxes Income taxes: Current Deferred 2008: Income before income taxes Income taxes: Current Deferred 2010: Income before income taxes Income taxes: Current Deferred Japanese ¥302,965 ¥ 78,359 35,496 ¥113,855 Millions of yen Foreign Total ¥89,898 ¥392,863 ¥32,420 (6,115) ¥26,305 ¥110,779 29,381 ¥140,160 ¥ 130,857 ¥ 88,498 ¥ 219,355 ¥ 45,079 15,415 ¥ 60,494 ¥ 18,331 5,297 ¥ 23,628 ¥ 63,410 20,712 ¥ 84,122 ¥ 382,299 ¥ 98,848 ¥ 481,147 ¥ 168,428 (34,073) ¥ 134,355 ¥ 24,857 1,576 ¥ 26,433 ¥ 193,285 (32,497) ¥ 160,788 Thousands of U.S. dollars Japanese Foreign Total $3,740,309 $1,109,851 $4,850,160 $ 967,395 438,222 $1,405,617 $ 400,247 (75,494) $ 324,753 $1,367,642 362,728 $1,730,370 88 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES 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, 2010, 2009 and 2008. A reconciliation of the Japanese statutory income tax rate and the effective income tax rate as a percentage of income before income taxes is as follows: Years ended December 31 Japanese statutory income tax rate Increase (reduction) in income taxes resulting from: Expenses not deductible for tax purposes Income of foreign subsidiaries taxed at lower than Japanese statutory tax rate Tax credit for research and development expenses Change in valuation allowance Other Effective income tax rate 2010 40.0% 0.8 (3.5) (5.1) 2.8 0.7 35.7% 2009 40.0% 0.9 (5.4) (2.8) 5.4 0.2 38.3% 2008 40.0% 0.5 (2.6) (4.6) 0.1 0.0 33.4% Net deferred income tax assets and liabilities are included in the accompanying consolidated balance sheets under the following captions: December 31 Prepaid expenses and other current assets Other assets Other current liabilities Other noncurrent liabilities Millions of yen 2010 ¥ 69,197 136,727 (2,149) (47,827) ¥155,948 2009 ¥ 94,798 117,263 (2,018) (36,278) ¥173,765 Thousands of U.S. dollars 2010 $ 854,284 1,687,988 (26,531) (590,457) $1,925,284 CANON ANNUAL REPORT 2010 89 The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at December 31, 2010 and 2009 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 Less valuation allowance Total deferred tax assets Deferred tax liabilities: Undistributed earnings of foreign subsidiaries Net unrealized gains on securities Tax deductible reserve Financing lease revenue Prepaid pension and severance cost Other Total deferred tax liabilities Net deferred tax assets Millions of yen 2010 2009 ¥ 23,836 6,200 78,552 14,740 41,737 35,823 28,373 52,869 282,130 (35,307) 246,823 (8,215) (2,119) (6,038) (37,353) (2,018) (35,132) (90,875) ¥155,948 ¥ 24,121 3,861 52,639 45,718 53,011 29,409 12,305 44,709 265,773 (22,188) 243,585 (8,023) (2,052) (7,797) (35,505) (314) (16,129) (69,820) ¥173,765 Thousands of U.S. dollars 2010 $ 294,272 76,543 969,778 181,975 515,272 442,259 350,284 652,704 3,483,087 (435,889) 3,047,198 (101,420) (26,160) (74,543) (461,148) (24,914) (433,729) (1,121,914) $1,925,284 The net changes in the total valuation allowance were increases of ¥13,119 million ($161,963 thousand), ¥11,371 mil- lion and ¥1,490 million for the years ended December 31, 2010, 2009 and 2008, respectively. Based upon the level of historical taxable income and projec- tions 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 beneﬁ ts of these deferred tax assets, net of the existing valuation allowance, at December 31, 2010. At December 31, 2010, Canon had net operating losses which can be carried forward for income tax purposes of ¥112,779 million ($1,392,333 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 twenty years as follows: Within one year After one year through ﬁ ve years After ﬁ ve years through ten years After ten years through twenty years Indeﬁ nite period Total Millions of yen ¥ 511 9,601 47,961 28,689 26,017 ¥112,779 Thousands of U.S. dollars $ 6,309 118,531 592,111 354,185 321,197 $1,392,333 90 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Income taxes have not been accrued on undistributed earn- ings 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 ¥26,406 million ($326,000 thousand) for a portion of undistributed earn- ings of foreign subsidiaries that arose for the year ended December 31, 2010 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, 2010, such undistributed earnings of these sub- sidiaries were ¥816,317 million ($10,077,988 thousand). A reconciliation of the beginning and ending amount of unrecognized tax beneﬁ ts is as follows: Years ended December 31 Balance at beginning of year Additions for tax positions of the current year Additions for tax positions of prior years Reductions for tax positions of prior years Settlements with tax authorities Additions from acquisitions Other Balance at end of year 2010 ¥13,235 73 805 (8,354) (2,471) 4,066 (1,319) ¥ 6,035 Millions of yen 2009 ¥12,689 — 1,442 (1,106) — — 210 ¥13,235 2008 ¥15,791 8,700 1,354 (8,512) (1,208) — (3,436) ¥12,689 Thousands of U.S. dollars 2010 $163,395 901 9,938 (103,136) (30,506) 50,198 (16,284) $ 74,506 The total amounts of unrecognized tax beneﬁ ts that would reduce the effective tax rate, if recognized, are ¥6,035 million ($74,506 thousand) and ¥4,746 million at December 31, 2010 and 2009, respectively. Although Canon believes its estimates and assumptions of unrecognized tax beneﬁ ts are reasonable, uncertainty regard- ing the ﬁ nal determination of tax audit settlements and any related litigation could affect the effective tax rate in the future period. Based on each of the items of which Canon is aware at December 31, 2010, no signiﬁ cant changes to the unrecognized tax beneﬁ ts are expected within the next twelve months. Canon recognizes interest and penalties accrued related to unrecognized tax beneﬁ ts in income taxes. Both interest and penalties accrued at December 31, 2010 and 2009, and interest and penalties included in income taxes for the years ended December 31, 2010, 2009 and 2008 are not material. Canon ﬁ les income tax returns in Japan and various foreign tax jurisdictions. In Japan, Canon is no longer subject to regular income tax examinations by the tax authority for years before 2006. While there has been no speciﬁ c indication by the tax authority that Canon will be subject to a transfer pricing exami- nation in the near future, the tax authority could conduct a transfer pricing examination for years after 2003. In other major foreign tax jurisdictions, including the United States and Netherlands, Canon is no longer subject to income tax exami- nations by tax authorities for years before 2004 with few exceptions. The tax authorities are currently conducting income tax examinations of Canon’s income tax returns for years after 2005 in Japan and for certain years after 2003 in major foreign tax jurisdictions. 14. Common Stock For the year ended December 31, 2008, the Company issued 127,254 shares of common stock in connection with the con- version 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 con- version price to the common stock account and the remainder to the additional paid-in capital account. CANON ANNUAL REPORT 2010 91 15. 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 Corporation Law of Japan also provides that additional paid-in capital 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, 2010, 2009 and 2008 represent dividends paid out during those years and the related appropriations to the legal reserve. Retained earnings at December 31, 2010 did not reﬂ ect current year-end dividends in the amount of ¥79,850 million ($985,802 thousand) which were approved by the stockholders in March 2011. 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 ﬁ nancial accounting standards of Japan. Such amount was ¥1,304,811 million ($16,108,778 thousand) at December 31, 2010. Retained earnings at December 31, 2010 included Canon’s equity in undistributed earnings of afﬁ liated companies account- ed for by the equity method in the amount of ¥15,133 million ($186,827 thousand). 16. Other Comprehensive Income (Loss) Changes in accumulated other comprehensive income (loss) are as follows: Years 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 Pension liability adjustments: Balance at beginning of year Adjustments for the year Balance at end of year Total accumulated other comprehensive income (loss): Balance at beginning of year Adjustments for the year Balance at end of year Millions of yen 2010 2009 2008 Thousands of U.S. dollars 2010 ¥(202,628) (122,984) (325,612) ¥(235,968) 33,340 (202,628) ¥ 22,796 (258,764) (235,968) $(2,501,580) (1,518,321) (4,019,901) 3,285 (265) 3,020 71 846 917 (61,546) (7,238) (68,784) 1,135 2,150 3,285 1,493 (1,422) 71 (59,480) (2,066) (61,546) 6,287 (5,152) 1,135 (849) 2,342 1,493 6,436 (65,916) (59,480) 40,556 (3,272) 37,284 876 10,445 11,321 (759,827) (89,358) (849,185) (260,818) (129,641) ¥(390,459) (292,820) 32,002 ¥(260,818) 34,670 (327,490) ¥(292,820) (3,219,975) (1,600,506) $(4,820,481) 92 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Tax effects allocated to each component of other comprehensive income (loss) and reclassiﬁ cation adjustments, including amounts attributable to noncontrolling interests, are as follows: Years ended December 31 2010: Foreign currency translation adjustments Net unrealized gains and losses on securities: Amount arising during the year Reclassiﬁ cation 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 Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Pension liability adjustments: Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Other comprehensive income (loss) 2009: Foreign currency translation adjustments Net unrealized gains and losses on securities: Amount arising during the year Reclassiﬁ cation 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 Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Pension liability adjustments: Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Other comprehensive income (loss) 2008: Foreign currency translation adjustments Net unrealized gains and losses on securities: Amount arising during the year Reclassiﬁ cation 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 Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Pension liability adjustments: Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Other comprehensive income (loss) Before-tax amount Millions of yen Tax (expense) or beneﬁ t Net-of-tax amount ¥(128,271) ¥ 1,353 ¥(126,918) (2,179) 1,320 (859) 8,409 (6,990) 1,419 (19,170) 2,323 (16,847) ¥(144,558) 671 42 713 (3,573) 2,921 (652) 8,314 (794) 7,520 ¥ 8,934 (1,508) 1,362 (146) 4,836 (4,069) 767 (10,856) 1,529 (9,327) ¥(135,624) ¥ 35,459 ¥ (2,089) ¥ 33,370 2,231 2,205 4,436 298 (2,670) (2,372) (1,333) (886) (2,219) (119) 1,068 949 898 1,319 2,217 179 (1,602) (1,423) (4,115) 1,911 (2,204) ¥ 35,319 1,891 (632) 1,259 ¥ (2,100) (2,224) 1,279 (945) ¥ 33,219 ¥ (266,568) ¥ 5,893 ¥ (260,675) (17,485) 7,752 (9,733) 23,121 (19,219) 3,902 6,992 (3,101) 3,891 (9,248) 7,688 (1,560) (10,493) 4,651 (5,842) 13,873 (11,531) 2,342 (111,215) (4,956) (116,171) ¥ (388,570) 39,233 2,073 41,306 ¥ 49,530 (71,982) (2,883) (74,865) ¥ (339,040) CANON ANNUAL REPORT 2010 93 2010: Foreign currency translation adjustments Net unrealized gains and losses on securities: Amount arising during the year Reclassiﬁ cation 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 Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Pension liability adjustments: Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Other comprehensive income (loss) Thousands of U.S. dollars Before-tax amount Tax (expense) or beneﬁ t Net-of-tax amount $(1,583,593) $ 16,705 $(1,566,888) (26,901) 16,296 (10,605) 103,815 (86,296) 17,519 8,284 518 8,802 (44,111) 36,061 (8,050) (18,617) 16,814 (1,803) 59,704 (50,235) 9,469 (236,666) 102,641 28,678 (207,988) (9,801) 92,840 (134,025) 18,877 (115,148) $(1,784,667) $110,297 $(1,674,370) 17. Stock-Based Compensation On May 1, 2010, based on the approval of the stockholders, the Company granted stock options to its directors, executive ofﬁ - cers and certain employees to acquire 890,000 shares of com- mon stock. These option awards vest after two years of continued service beginning on the grant date and have a four year contractual term. The grant-date fair value per share of the stock options granted during the year ended December 31, 2010 was ¥988 ($12.20). On May 1, 2009, based on the approval of the stockholders, the Company granted stock options to its directors, executive ofﬁ cers and certain employees to acquire 954,000 shares of common stock. These option awards vest after two years of continued service beginning on the grant date and have a four year contractual term. The grant-date fair value per share of the stock options granted during the year ended December 31, 2009 was ¥699. On May 1, 2008, based on the approval of the stockholders, the Company granted stock options to its directors, executive ofﬁ cers and certain employees to acquire 592,000 shares of common stock. These option awards vest after two years of continued service beginning on the grant date and have a four year contractual term. The grant-date fair value per share of the stock options granted during the year ended December 31, 2008 was ¥1,247. The compensation cost recognized for these stock options for the years ended December 31, 2010, 2009 and 2008 was ¥643 million ($7,938 thousand), ¥564 million and ¥246 million, respectively, and is included in selling, general and administra- tive expenses in the consolidated statements of income. The fair value of each option award was estimated on the date of grant using the Black-Scholes option pricing model that incorporates the assumptions presented below: Years ended December 31 2010 2009 2008 Expected term of option (in years) 4.0 Expected volatility Dividend yield Risk-free interest rate 4.0 38.00% 40.08% 37.39% 2.10% 0.95% 2.53% 3.51% 0.45% 0.64% 4.0 94 CANON ANNUAL REPORT 2010 A summary of option activity under the stock option plans as of and for the years ended December 31, 2010, 2009 and 2008 is presented below: Shares Weighted-average exercise price Weighted- average remaining contractual term Aggregate intrinsic value Yen U.S. dollars Year Millions of yen Thousands of U.S. dollars Outstanding at January 1, 2008 Granted Forfeited Outstanding at December 31, 2008 Granted Forfeited Outstanding at December 31, 2009 Granted Exercised Forfeited Outstanding at December 31, 2010 Exercisable at December 31, 2010 — 592,000 — 592,000 954,000 (34,000) 1,512,000 890,000 — (182,000) 2,220,000 558,000 ¥ — 5,502 — 5,502 3,287 4,851 4,119 4,573 — 3,479 ¥4,354 ¥5,502 3.3 3.0 2.5 1.3 ¥ — $ — 588 7,259 ¥722 ¥ — $8,914 $ — $50.85 56.46 — 42.95 $53.75 $67.93 At December 31, 2010, all outstanding option awards were vested or expected to be vested. A summary of the status of the Company’s nonvested shares at December 31, 2010, and changes during the year ended December 31, 2010, is presented below: Year ended December 31, 2010 Nonvested at January 1, 2010 Granted Vested Forfeited Nonvested at December 31, 2010 Shares Weighted-average grant-date fair value 1,512,000 890,000 (558,000) (182,000) 1,662,000 Yen ¥ 905 988 1,247 745 ¥ 852 U.S. dollars $11.17 12.20 15.40 9.20 $10.52 At December 31, 2010, there was ¥671 million ($8,284 thou- sand) of total unrecognized compensation cost related to non- vested stock options. That cost is expected to be recognized over a weighted-average period of 0.86 year. The total fair value of shares vested during the year ended December 31, 2010 was ¥696 million ($8,593 thousand). CANON ANNUAL REPORT 2010 95 18. Net Income Attributable to Canon Inc. Stockholders per Share A reconciliation of the numerators and denominators of basic and diluted net income attributable to Canon Inc. stockholders per share computations is as follows: Years ended December 31 Net income attributable to Canon Inc. Effect of dilutive securities: 1.30% Japanese yen convertible debentures, due 2008 Diluted net income attributable to Canon Inc. Average common shares outstanding Effect of dilutive securities: Stock options 1.30% Japanese yen convertible debentures, due 2008 Diluted common shares outstanding Net income attributable to Canon Inc. stockholders per share: Basic Diluted Millions of yen 2010 2009 ¥246,603 ¥131,647 2008 ¥309,148 Thousands of U.S. dollars 2010 $3,044,481 — ¥246,603 — ¥131,647 2 ¥309,150 — $3,044,481 Number of shares 1,234,817,511 1,234,481,836 1,255,626,490 50,603 — — — 1,234,868,114 1,234,481,836 — 79,929 1,255,706,419 Yen U.S. dollars ¥199.71 199.70 ¥106.64 106.64 ¥246.21 246.20 $2.47 2.47 The computation of diluted net income attributable to Canon Inc. stockholders per share for the years ended December 31, 2009 and 2008 excludes outstanding stock options because the effect would be anti-dilutive. The computation of diluted net income attributable to Canon Inc. stockholders per share for the year ended December 31, 2010 excludes certain outstand- ing stock options because the effect would be anti-dilutive. 19. Derivatives and Hedging Activities Risk management policy Canon operates internationally, exposing it to the risk of chang- es in foreign currency exchange rates. Derivative ﬁ nancial instruments are comprised principally of foreign exchange con- tracts utilized by the Company and certain of its subsidiaries to reduce the risk. Canon assesses foreign currency exchange rate risk by continually monitoring changes in the exposures and by evaluating hedging opportunities. Canon does not hold or issue derivative ﬁ nancial instruments for trading purposes. Canon is also exposed to credit-related losses in the event of non-perfor- mance by counterparties to derivative ﬁ nancial instruments, but it is not expected that any counterparties will fail to meet their obligations. Most of the counterparties are internationally recog- nized ﬁ nancial institutions and selected by Canon taking into account their ﬁ nancial condition, and contracts are diversiﬁ ed across a number of major ﬁ nancial 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 for- eign exchange contracts to manage certain foreign currency exchange exposures principally from the exchange of U.S. dol- lars and euros into Japanese yen. These contracts are primarily used to hedge the foreign currency exposure of forecasted intercompany sales and intercompany trade receivables that are denominated in foreign currencies. In accordance with Canon’s policy, a speciﬁ c portion of foreign currency exposure resulting from forecasted intercompany sales are hedged using foreign exchange contracts which principally mature within three months. 96 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Cash ﬂ ow hedge Changes in the fair value of derivative ﬁ nancial instruments designated as cash ﬂ ow hedges, including foreign exchange contracts associated with forecasted intercompany sales, are reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassiﬁ ed into earnings through other income (deductions) in the same period as the hedged items affect earnings. Substantially all amounts record- ed in accumulated other comprehensive income (loss) at year- end are expected to be recognized in earnings over the next 12 months. Canon excludes the time value component from the assessment of hedge effectiveness. Changes in the fair value of a foreign exchange contract for the period between the date that the forecasted intercompany sales occur and its maturity date are recognized in earnings and not considered hedge inef- fectiveness. Derivatives not designated as hedges Canon has entered into certain foreign exchange contracts to primarily offset the earnings impact related to ﬂ uctuations in foreign currency exchange rates associated with certain assets denominated in foreign currencies. Although these foreign exchange contracts have not been designated as hedges as required in order to apply hedge accounting, the contracts are effective from an economic perspective. The changes in the fair value of these contracts are recorded in earnings immediately. Contract amounts of foreign exchange contracts as of December 31, 2010 and 2009 are set forth below: December 31 To sell foreign currencies To buy foreign currencies Millions of yen 2010 ¥466,361 48,686 2009 ¥494,314 30,978 Thousands of U.S. dollars 2010 $5,757,543 601,062 Fair value of derivative instruments in the consolidated balance sheets The following tables present Canon’s derivative instruments measured at gross fair value as reﬂ ected in the consolidated balance sheets as of December 31, 2010 and 2009. Derivatives designated as hedging instruments December 31 Fair value Millions of yen Balance sheet location 2010 2009 Assets: Foreign exchange contracts Liabilities: Foreign exchange contracts Prepaid expenses and other current assets ¥2,487 Other current liabilities 426 Derivatives not designated as hedging instruments December 31 ¥ — 644 Fair value Balance sheet location 2010 2009 Millions of yen Assets: Foreign exchange contracts Liabilities: Foreign exchange contracts Prepaid expenses and other current assets ¥9,463 Other current liabilities 487 ¥ 752 6,566 Thousands of U.S. dollars 2010 $ 30,704 5,259 Thousands of U.S. dollars 2010 $116,827 6,013 CANON ANNUAL REPORT 2010 97 Effect of derivative instruments on the consolidated statements of income The following tables present the effect of Canon’s derivative instruments on the consolidated statements of income for the years ended December 31, 2010 and 2009. Derivatives in cash ﬂ ow hedging relationships Years ended December 31 Gain (loss) recognized in OCI (effective portion) Gain (loss) reclassiﬁ ed from accumulated OCI into income (effective portion) Gain (loss) recognized in income (ineffective portion and amount excluded from effectiveness testing) Millions of yen Amount Location Amount Location Amount 2010: 2009: Foreign exchange contracts Foreign exchange contracts Thousands of U.S. dollars 2010: Foreign exchange contracts ¥ 1,419 Other, net ¥ 6,990 Other, net ¥ (302) ¥ (2,372) Other, net ¥ 2,670 Other, net ¥ (462) $17,519 Other, net $86,296 Other, net $(3,728) The amount of the hedging ineffectiveness was not material for the year ended December 31, 2008. 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 ¥3,701 million for the year ended December 31, 2008. Derivatives not designated as hedging instruments Years ended December 31 Gain (loss) recognized in income on derivative Foreign exchange contracts Location Other, net Millions of yen 2010 ¥50,794 2009 ¥(8,638) Thousands of U.S. dollars 2010 $627,086 20. Commitments and Contingent Liabilities Commitments At December 31, 2010, commitments outstanding for the pur- chase of property, plant and equipment approximated ¥29,383 million ($362,753 thousand), and commitments outstanding for the purchase of parts and raw materials approximated ¥86,434 million ($1,067,086 thousand). Canon occupies sales ofﬁ ces and other facilities under lease arrangements accounted for as operating leases. Deposits made under such arrangements aggregated ¥13,686 million ($168,963 thousand) and ¥14,210 million at December 31, 2010 and 2009, respectively, and are included in noncurrent receiv- ables in the accompanying consolidated balance sheets. Rental expenses under such operating lease arrangements amounted to ¥40,396 million ($498,716 thousand), ¥36,474 mil- lion and ¥41,169 million for the years ended December 31, 2010, 2009 and 2008, respectively. 98 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Future minimum lease payments required under noncancelable operating leases that have initial or remaining lease terms in excess of one year at December 31, 2010 are as follows: Year ending December 31: 2011 2012 2013 2014 2015 Thereafter Total future minimum lease payments Millions of yen ¥23,413 22,054 10,290 8,359 5,582 14,102 ¥83,800 Thousands of U.S. dollars $ 289,049 272,272 127,037 103,198 68,914 174,098 $1,034,568 Guarantees Canon provides guarantees for bank loans of its employees, afﬁ liates and other companies. The guarantees for the employ- ees are principally made for their housing loans. The guaran- tees of loans of its afﬁ liates and other companies are made to ensure that those companies operate with less ﬁ nancial 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 afﬁ liates and other companies. The maximum amount of undiscounted payments Canon would have had to make in the event of default is ¥16,746 million ($206,741 thousand) at December 31, 2010. The carrying amounts of the liabilities rec- ognized for Canon’s obligations as a guarantor under those guarantees at December 31, 2010 were not signiﬁ cant. 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, 2010 and 2009 are summarized as follows: Years ended December 31 Balance at beginning of year Addition Utilization Other Balance at end of year Millions of yen 2010 ¥13,944 17,605 (14,713) (3,493) ¥13,343 2009 ¥17,372 21,670 (22,050) (3,048) ¥13,944 Thousands of U.S. dollars 2010 $172,148 217,346 (181,642) (43,124) $164,728 Legal proceedings In October 2003, a lawsuit was ﬁ led 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 ($566,321 thousand) as reasonable remuneration 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 ($12,346 thousand) and interest thereon. On January 30, 2007, the Tokyo District Court of Japan ordered the Company to pay the former employee approximately ¥33.5 mil- lion ($414 thousand) and interest thereon. On the same day, the Company appealed the decision. On February 26, 2009, the Intellectual Property High Court of Japan issued a judgment in the appellate court review and ordered the Company to pay the former employee approximately ¥69.6 million ($859 thousand), consisting of reasonable remuneration of approximately ¥56.3 million ($695 thousand) and interest thereon. On March 12, 2009, the Company appealed the decision to the Supreme Court. On October 19, 2010, the Supreme Court, by an order, dismissed the Company’s appeal without prejudice, and the judgment made by the Intellectual Property High Court became ﬁ nal and binding. In Germany, Verwertungsgesellschaft Wort (“VG Wort”), a col- lecting society representing certain copyright holders, has ﬁ led 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 compa- nies importing and distributing these digital products. VG Wort ﬁ led a lawsuit in January 2006 against Canon seeking payment of copyright levies on single-function printers, and the court of ﬁ rst 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 before the court of appeals in Düsseldorf. Following a decision by the same court of appeals in Düsseldorf on January 23, 2007 in relation to a similar court case seeking copyright levies on single-function printers of Epson Deutschland GmbH, Xerox GmbH and Kyocera Mita Deutschland GmbH, whereby the court rejected such alleged levies, in its judgment of November 13, 2007, the court of appeals rejected VG Wort’s claim against Canon. VG Wort appealed further against said decision of the court of appeals before the Federal Supreme Court. In December 2007, for a similar Hewlett-Packard GmbH case relating to single-function CANON ANNUAL REPORT 2010 99 printers, the Federal Supreme Court delivered its judgment in favor of Hewlett-Packard GmbH and dismissed VG Wort’s claim. VG Wort has already ﬁ led a constitutional complaint with the Federal Constitutional Court against said judgment of the Federal Supreme Court. Likewise, after rejection by the Federal Supreme Court of an appeal by VG Wort in relation to Canon’s single-function printers case in September 2008, VG Wort lodged a claim before the Federal Constitutional Court. The Federal Constitutional Court gave its decision in September 2010 for Hewlett-Packard GmbH case where the court has reverted the case back to the Federal Supreme Court, admitting VG Wort’s claim for lack of ‘due process’ (i.e., request for European Court of Justice’s preliminary ruling). It is not clear at this stage what the implication of said decision for Hewlett- Packard GmbH case would be on Canon’s case. In 2007, an amendment of German copyright law was carried out, and a new law has been effective from January 1, 2008 for both multi- function printers and single-function printers. The new law sets forth that the scope and tariff of copyright levies will be agreed between industry and the collecting society. Industry and the collecting society, based on the requirement under the new law, reached an agreement in December 2008. This agreement is applicable retroactively from January 1, 2008 and will remain effective through end of 2011. However, in Canon’s assessment, the ﬁ nal outcome of the court case regarding the single-function printers sold in Germany before January 1, 2008 remains uncertain. Canon is involved in various claims and legal actions, includ- ing those noted above, arising in the ordinary course of busi- ness. 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 provi- sions at least quarterly and adjusts these provisions to reﬂ ect 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 speciﬁ c matters discussed above and other outstanding matters are not a meaningful indi- cator of Canon’s potential liability. In the opinion of manage- ment, the ultimate disposition of outstanding matters would not have a material adverse effect on Canon’s consolidated ﬁ nancial position, results of operations, or cash ﬂ ows. 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 ﬁ nancial posi- tion, results of operations, or cash ﬂ ows could be materially affected in any particular period by the unfavorable resolution of one or more of these matters. 21. Disclosures about the Fair Value of Financial Instruments and Concentrations of Credit Risk Fair value of ﬁ nancial instruments The estimated fair values of Canon’s ﬁ nancial instruments at December 31, 2010 and 2009 are set forth below. The following summary excludes cash and cash equivalents, trade receivables, ﬁ nance receivables, noncurrent receivables, short-term loans, trade payables and accrued expenses for which fair values approximate their carrying amounts. The summary also excludes investments which are disclosed in Note 3. December 31 Millions of yen Thousand of U.S. dollars Long-term debt, including current installments Foreign exchange contracts: Assets Liabilities 2010 2009 2010 Carrying amount Estimated fair value Carrying amount ¥ (9,260) ¥ (9,245) ¥(9,781) Estimated fair value ¥(9,777) Carrying amount Estimated fair value $(114,321) $(114,136) 11,950 (913) 11,950 (913) 752 (7,210) 752 (7,210) 147,531 (11,272) 147,531 (11,272) 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 present value of future cash ﬂ ows associated with each instrument discounted using current market borrow- ing rates for similar debt instruments of comparable maturity. Foreign exchange contracts The fair values of foreign exchange contracts are measured based on the market price obtained from ﬁ nancial institutions. Limitations Fair value estimates are made at a speciﬁ c point in time, based on relevant market information and information about the ﬁ nancial instruments. These estimates are subjective in nature and involve uncertainties and matters of signiﬁ cant judgment and therefore cannot be determined with precision. Changes in assumptions could signiﬁ cantly affect the estimates. Concentrations of credit risk At December 31, 2010 and 2009, one customer accounted for approximately 21% and 22% of consolidated trade receivables, respectively. Although Canon does not expect that the custom- er 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. 100 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES 22. Fair Value Measurements Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. A three-level fair value hierarchy that prioritizes the inputs used to measure fair value is as follows: Level 1 — Inputs are quoted prices in active markets for identi- cal assets or liabilities. Level 2 — Inputs are quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs that are derived principally from or corroborated by observable market data by correlation or other means. Level 3 — Inputs are derived from valuation techniques in which one or more signiﬁ cant inputs or value drivers are unobservable, which reﬂ ect the reporting entity’s own assumptions about the assumptions that mar- ket participants would use in establishing a price. Assets and liabilities measured at fair value on a recurring basis The following tables present Canon’s assets and liabilities that are measured at fair value on a recurring basis consistent with the fair value hierarchy at December 31, 2010 and 2009. December 31 Millions of yen 2010: Assets: Cash and cash equivalents Available-for-sale (current): Government bonds Corporate bonds Available-for-sale (noncurrent): Government bonds Corporate bonds Fund trusts Equity securities Derivatives Total assets Liabilities: Derivatives Total liabilities Millions of yen 2009: Assets: Cash and cash equivalents Available-for-sale (current): Government bonds Available-for-sale (noncurrent): Government bonds Corporate bonds Fund trusts Equity securities Derivatives Total assets Liabilities: Derivatives Total liabilities Level 1 Level 2 Level 3 Total ¥ — ¥249,907 ¥ — ¥249,907 1 — 161 — 10 23,402 — — — — 44 1,788 — 11,950 — 1,000 — 950 — — — 1 1,000 161 994 1,798 23,402 11,950 ¥23,574 ¥263,689 ¥1,950 ¥289,213 ¥ — ¥ — ¥ ¥ 913 913 ¥ — ¥ — ¥ ¥ 913 913 Level 1 Level 2 Level 3 Total ¥ — ¥ 184,856 ¥ — ¥ 184,856 222 204 — 1,589 17,726 — — — 29 979 — 752 — — 1,340 — — — 222 204 1,369 2,568 17,726 752 ¥ 19,741 ¥ 186,616 ¥ 1,340 ¥ 207,697 ¥ ¥ — — ¥ ¥ 7,210 7,210 ¥ — ¥ — ¥ ¥ 7,210 7,210 CANON ANNUAL REPORT 2010 101 Thousands of U.S. dollars 2010: Assets: Cash and cash equivalents Available-for-sale (current): Government bonds Corporate bonds Available-for-sale (noncurrent): Government bonds Corporate bonds Fund trusts Equity securities Derivatives Total assets Liabilities: Derivatives Total liabilities Level 1 Level 2 Level 3 Total $ — $3,085,272 $ — $3,085,272 12 — 1,987 — 123 288,914 — — — 544 22,074 — — 147,531 — 12,346 — 11,728 — — — 12 12,346 1,987 12,272 22,197 288,914 147,531 $291,036 $3,255,421 $24,074 $3,570,531 $ — $ — $ $ 11,272 11,272 $ — $ — $ $ 11,272 11,272 Level 1 investments are comprised principally of Japanese equity securities, which are valued using an unadjusted quoted market price in active markets with sufﬁ cient volume and fre- quency of transactions. Level 2 cash and cash equivalents are valued based on market approach, using quoted prices for identical assets in markets that are not active. Level 3 invest- ments are mainly comprised of corporate bonds, which are val- ued based on cost approach, using unobservable inputs as the market for the assets was not active at the measurement date. Derivative ﬁ nancial instruments are comprised of foreign exchange contracts. Level 2 derivatives are valued using quotes obtained from counterparties or third parties, which are period- ically validated by pricing models using observable market inputs, such as foreign currency exchange rates and interest rates, based on market approach. The following table presents the changes in Level 3 assets measured on a recurring basis, consisting primarily of corpo- rate bonds, for the years ended December 31, 2010 and 2009. Years ended December 31 Balance at beginning of year Total gains or losses (realized or unrealized): Included in earnings Included in other comprehensive income (loss) Purchases, issuances, and settlements Balance at end of year Millions of yen 2010 ¥1,340 (79) (7) 696 ¥1,950 2009 ¥1,516 (221) (1) 46 ¥1,340 Thousands of U.S. dollars 2010 $16,543 (975) (86) 8,592 $24,074 Gains and losses included in earnings are mainly related to cor- porate bonds still held at December 31, 2010 and 2009, and are reported in “Other, net” in the consolidated statements of income. Assets and liabilities measured at fair value on a nonrecurring basis During the year ended December 31, 2010, non-marketable equity securities with a carrying amount of ¥5,000 million ($61,728 thousand) were written down to their fair value of ¥2,422 million ($29,901 thousand) and equity securities accounted for by the equity method with a carrying amount of ¥33,984 million ($419,556 thousand) were written down to their fair value of ¥15,164 million ($187,210 thousand), resulting in an other-than-temporary impairment charge totaling ¥21,398 mil- lion ($264,173 thousand), which was included in earnings. The non-marketable equity securities were classiﬁ ed as Level 2 instruments and valued based on a market approach using observable inputs such as unadjusted quoted prices for similar instruments in active markets at the measurement date. Equity securities accounted for by the equity method were classiﬁ ed as Level 3 instruments and valued based on a combination of income approach and market approach using both unobserv- able and observable inputs including the use of inputs such as ﬁ nancial metrics, ratios and projected income of the investees and appropriate comparable public companies. 102 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES During the year ended December 31, 2009, long-lived assets held and used with a carrying amount of ¥15,390 million were written down to their fair value of zero, resulting in an impair- ment charge of ¥15,390 million, and non-marketable equity securities with a carrying amount of ¥1,468 million were written down to their fair value of ¥480 million, resulting in an other-than-temporary impairment charge of ¥988 million, which was included in earnings. Both the long-lived assets and the non-marketable equity securities were classiﬁ ed as Level 3 instruments and valued based on an income approach using unobservable inputs such as estimate of future cash ﬂ ows. 23. Supplemental Cash Flow Information During the year ended December 31, 2010, the Company executed three separate share exchanges under which the Company made its three listed subsidiaries, Canon Finetech Inc., Canon Machinery Inc. and Tokki Corporation, its wholly owned subsidiaries. The Company issued no new shares, as it issued 10,000,853 shares of treasury stock for these transactions in total. As a result of the share exchanges, the carrying amount of the Company’s noncontrolling interest in Canon Finetech Inc., Canon Machinery Inc. and Tokki Corporation was decreased from ¥38,644 million to zero. 24. Segment Information Canon operates its business in three segments: the Ofﬁ ce Business Unit, the Consumer Business Unit, and the Industry and Others Business Unit, which are based on the organization- al structure and information reviewed by Canon’s management to evaluate results and allocate resources. Consumer Business Unit: Digital SLR cameras / Compact digital cameras / Interchangeable lenses / Digital video camcorders / Inkjet multifunction peripherals / Single function inkjet printers / Image scanners / Broadcasting equipment The primary products included in each segment are as follows: Industry and Others Business Unit: Ofﬁ ce Business Unit: Ofﬁ ce network digital MFDs / Color network digital MFDs / Personal-use network digital MFDs / Ofﬁ ce copying machines / Full-color copying machines / Personal-use copying machines / Laser printers / Large format inkjet printers / Digital production printers Semiconductor lithography equipment / LCD lithography equipment / Medical image recording equipment / Ophthalmic products / Magnetic heads / Micromotors / Computers / Handy terminals / Document scanners / Calculators The accounting policies of the segments are substantially the same as those described in the signiﬁ cant accounting policies in Note 1. Canon evaluates performance of, and allocates resources to, each segment based on operating proﬁ t. CANON ANNUAL REPORT 2010 103 Information about operating results and assets for each segment as of and for the years ended December 31, 2010, 2009 and 2008 is as follows: Millions of yen 2010: Net sales: External customers Intersegment Total Operating cost and expenses Operating proﬁ t (loss) Total assets Depreciation and amortization Capital expenditures 2009: Net sales: External customers Intersegment Total Operating cost and expenses Operating proﬁ t (loss) Total assets Depreciation and amortization Capital expenditures 2008: Net sales: External customers Intersegment Total Operating cost and expenses Operating proﬁ t (loss) Total assets Depreciation and amortization Capital expenditures Thousands of U.S. dollars 2010: Net sales: External customers Intersegment Total Operating cost and expenses Operating proﬁ t (loss) Total assets Depreciation and amortization Capital expenditures Ofﬁ ce Consumer Industry and Others Corporate and eliminations Consolidated ¥1,978,945 8,324 1,987,269 1,693,947 ¥ 293,322 ¥ 855,893 103,548 53,115 ¥1,389,622 1,705 1,391,327 1,153,262 ¥ 238,065 ¥ 414,022 41,665 36,266 ¥338,334 94,624 432,958 442,789 ¥ (9,831) ¥307,029 37,387 27,105 (104,653) (104,653) 29,351 ¥ — ¥3,706,901 — 3,706,901 3,319,349 ¥ (134,004) ¥ 387,552 ¥3,983,820 ¥2,406,876 276,193 93,593 193,547 77,061 ¥ 1,635,056 10,020 1,645,076 1,415,680 229,396 745,646 90,878 96,718 ¥ ¥ ¥ 1,299,194 1,966 1,301,160 1,117,668 183,492 437,160 48,701 27,503 ¥ ¥ ¥ 2,223,253 23,356 2,246,609 1,789,263 457,346 822,660 99,962 139,046 ¥ ¥ ¥ 1,453,647 2,428 1,456,075 1,232,951 223,124 502,927 58,082 52,641 ¥ ¥ ¥ 274,951 83,047 357,998 433,954 ¥ (75,956) ¥ 359,635 60,770 25,644 ¥ 417,261 105,144 522,405 570,281 ¥ (47,876) ¥ 453,581 71,557 31,445 ¥ (95,033) (95,033) 24,844 (119,877) ¥ — ¥ 3,209,201 — 3,209,201 2,992,146 217,055 ¥ 3,847,557 315,393 258,252 ¥ ¥ 2,305,116 115,044 108,387 ¥ (130,928) (130,928) 5,592 (136,520) ¥ — ¥ 4,094,161 — 4,094,161 3,598,087 496,074 ¥ 3,969,934 341,337 403,400 ¥ ¥ 2,190,766 111,736 180,268 Ofﬁ ce Consumer Industry and Others Corporate and eliminations Consolidated 102,765 24,534,185 20,912,926 21,050 17,176,877 14,237,803 $24,431,420 $17,155,827 $4,176,963 $ — $45,764,210 — 1,168,197 (1,292,012) (1,292,012) 45,764,210 5,345,160 40,979,617 5,466,530 $ 3,621,259 $ 2,939,074 $ (121,370) $ (1,654,370) $ 4,784,593 $10,566,580 $ 5,111,383 $3,790,481 $29,714,519 $49,182,963 3,409,790 2,389,469 1,278,370 655,741 1,155,469 951,370 461,568 334,630 514,383 447,728 362,358 104 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Intersegment sales are recorded at the same prices used in transactions with third parties. Expenses not directly associat- ed with speciﬁ c segments are allocated based on the most rea- sonable measures applicable. Corporate expenses include certain corporate research and development expenses. Segment assets are based on those directly associated with each segment. Corporate assets primarily consist of cash and cash equivalents, ﬁ nance receivables, investments, deferred tax assets, goodwill and corporate properties. Capital expendi- tures represent the additions to property, plant and equipment and intangible assets measured on an accrual basis. Information by major geographic area as of and for the years ended December 31, 2010, 2009 and 2008 is as follows: Net sales: Japan Americas Europe Asia and Oceania Total Long-lived assets: Japan Americas Europe Asia and Oceania Total 2010 ¥ 695,749 1,023,299 1,172,474 815,379 ¥3,706,901 ¥1,104,949 69,034 108,160 72,846 ¥1,354,989 Millions of yen 2009 ¥ 702,344 894,154 995,150 617,553 ¥3,209,201 ¥1,205,887 59,273 44,875 77,146 ¥1,387,181 2008 ¥ 868,280 1,154,571 1,341,400 729,910 ¥4,094,161 ¥1,314,092 43,435 47,392 71,407 ¥1,476,326 Thousands of U.S. dollars 2010 $ 8,589,494 12,633,321 14,474,988 10,066,407 $45,764,210 $13,641,346 852,272 1,335,308 899,333 $16,728,259 Net sales are attributed to areas based on the location where the product is shipped to the customers. Other than in Japan and the United States, Canon does not conduct business in any individual country in which its sales in that country exceed 10% of consolidated net sales. Net sales in the United States are ¥836,645 million ($10,328,951 thousand), ¥793,428 million and ¥1,043,333 million for the years ended December 31, 2010, 2009 and 2008, respectively. Long-lived assets represent property, plant and equipment and intangible assets for each geographic area. CANON ANNUAL REPORT 2010 105 The following information is based on the location of the Company and its subsidiaries as of and for the years ended December 31, 2010, 2009 and 2008. In addition to the disclosure requirements under U.S. GAAP, Canon discloses this information as supplemental information based on the disclosure require- ments of the Japanese Financial Instruments and Exchange Law. Millions of yen 2010: Net sales: External customers Intersegment Total Operating cost and expenses Operating proﬁ t Total assets 2009: Net sales: Japan Americas Europe Asia and Oceania Corporate and eliminations Consolidated 1,974,591 2,828,799 2,398,439 ¥ 854,208 ¥1,008,200 ¥1,163,452 ¥ 681,041 723,423 1,404,464 1,357,663 ¥ 430,360 ¥ 46,801 ¥1,321,572 ¥ 251,587 ¥ 472,785 ¥ 421,250 7,975 1,016,175 993,310 3,489 1,166,941 1,126,521 22,865 ¥ 40,420 ¥ ¥ — ¥3,706,901 (2,709,478) — 3,706,901 (2,709,478) 3,319,349 (2,556,584) ¥ (152,894) ¥ 387,552 ¥3,983,820 ¥1,516,626 External customers Intersegment Total Operating cost and expenses Operating proﬁ t Total assets ¥ 827,762 1,714,375 2,542,137 2,288,471 ¥ 253,666 ¥ 1,386,511 ¥ ¥ ¥ 871,633 1,263 872,896 860,863 12,033 198,094 ¥ ¥ ¥ 991,336 919 992,255 964,606 27,649 378,477 2008: Net sales: External customers Intersegment Total Operating cost and expenses Operating proﬁ t Total assets ¥ 998,676 2,318,521 3,317,197 2,812,645 ¥ 504,552 ¥ 1,607,653 ¥ 1,141,560 3,758 1,145,318 1,136,288 ¥ 9,030 203,255 ¥ ¥ 1,337,147 4,329 1,341,476 1,314,942 26,534 417,562 ¥ ¥ ¥ ¥ ¥ ¥ ¥ ¥ 518,470 534,147 1,052,617 1,019,208 33,409 384,795 ¥ — ¥ 3,209,201 — 3,209,201 2,992,146 ¥ 217,055 ¥ 3,847,557 (2,250,704) (2,250,704) (2,141,002) ¥ (109,702) ¥ 1,499,680 616,778 670,678 1,287,456 1,247,156 40,300 344,638 ¥ — ¥ 4,094,161 — 4,094,161 3,598,087 ¥ 496,074 ¥ 3,969,934 (2,997,286) (2,997,286) (2,912,944) ¥ (84,342) ¥ 1,396,826 Thousands of U.S. dollars 2010: Net sales: External customers Intersegment Total Operating cost and expenses Operating proﬁ t Total assets Japan Americas Europe Asia and Oceania Corporate and eliminations Consolidated 98,456 $10,545,778 $12,446,914 $14,363,605 $ 8,407,913 $ — $45,764,210 24,377,666 — 34,923,444 12,545,370 14,406,679 17,339,062 (33,450,345) 45,764,210 29,610,358 12,263,086 13,907,667 16,761,272 (31,562,766) 40,979,617 $ 5,313,086 $ 577,790 $ (1,887,579) $ 4,784,593 $16,315,704 $ 3,106,012 $ 5,836,852 $ 5,200,617 $18,723,778 $49,182,963 8,931,149 (33,450,345) 282,284 $ 499,012 $ 43,074 106 CANON ANNUAL REPORT 2010 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES 25. Subsequent Event On March 11, 2011, Japan experienced a massive earthquake and tsunami off the Paciﬁ c coast of Northeastern Japan. The earthquake caused damage to inventories and buildings at manufacturing facilities primarily in the Company’s Utsunomiya Plant, and Fukushima Canon Inc., a manufacturing subsidiary. In addition, certain distribution warehouses of the Company and Canon Marketing Japan Inc., a sales subsidiary, located in Northeastern Japan sustained damage to inventories. Production operations have been suspended at certain plants of the Company and its manufacturing subsidiaries and Canon is cur- rently taking action to resume operations. Canon cannot esti- mate the effect of the earthquake on its consolidated results of operations and ﬁ nancial condition as of the issuance date of the consolidated ﬁ nancial statements. CANON ANNUAL REPORT 2010 107 MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Canon is responsible for establishing and maintaining adequate internal control over ﬁ nancial reporting. Internal control over ﬁ nancial reporting is deﬁ ned in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934, as amended, as a process designed by, or under the supervision of, the company’s principal executive and principal ﬁ nancial ofﬁ cers and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of ﬁ nancial reporting and the preparation of ﬁ nancial 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 reﬂ ect the transactions and dispositions of the assets of the company; (2) provide reason- able assurance that transactions are recorded as necessary to permit preparation of ﬁ nancial statements in accordance with gen- erally 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 ﬁ nancial statements. Because of its inherent limitations, internal control over ﬁ nancial reporting may not prevent or detect misstatements. Also, projec- tions 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 ﬁ nancial reporting as of December 31, 2010. 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, 2010, Canon’s internal control over ﬁ nancial reporting was effective based on the COSO criteria. Canon’s independent registered public accounting ﬁ rm, Ernst & Young ShinNihon LLC, has issued an audit report on the effective- ness of our internal control over ﬁ nancial reporting. 108 CANON ANNUAL REPORT 2010 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Ernst & Young ShinNihon LLC Hibiya Kokusai Bldg. 2-2-3 Uchisaiwai-cho Chiyoda-ku, Tokyo, Japan 100-0011 Tel : +81 3 3503 1191 Fax: +81 3 3503 1277 The Board of Directors and Stockholders of Canon Inc. We have audited the accompanying consolidated balance sheets of Canon Inc. and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of income, equity, and cash ﬂ ows for each of the three years in the period ended December 31, 2010, all expressed in Japanese yen. These ﬁ nancial statements are the responsibility of the Company’s manage- ment. Our responsibility is to express an opinion on these ﬁ nancial 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 ﬁ nancial state- ments are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and dis- closures in the ﬁ nancial statements. An audit also includes assessing the accounting principles used and signiﬁ cant estimates made by management, as well as evaluating the overall ﬁ nancial statement presentation. We believe that our audits provide a rea- sonable basis for our opinion. In our opinion, the ﬁ nancial statements referred to above present fairly, in all material respects, the consolidated ﬁ nancial position of Canon Inc. and subsidiaries at December 31, 2010 and 2009, and the consolidated results of their operations and their cash ﬂ ows for each of the three years in the period ended December 31, 2010, 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), Canon Inc. and subsidiaries’ internal control over ﬁ nancial reporting as of December 31, 2010, 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 30, 2011 expressed an unqualiﬁ ed opinion thereon. We have also recomputed the translation of the consolidated ﬁ nancial statements as of and for the year ended December 31, 2010 into United States dollars. In our opinion, the consolidated ﬁ nancial statements expressed in Japanese yen have been translated into United States dollars on the basis described in Note 2. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM CANON ANNUAL REPORT 2010 109 Ernst & Young ShinNihon LLC Hibiya Kokusai Bldg. 2-2-3 Uchisaiwai-cho Chiyoda-ku, Tokyo, Japan 100-0011 Tel : +81 3 3503 1191 Fax: +81 3 3503 1277 The Board of Directors and Stockholders of Canon Inc. We have audited Canon Inc. and subsidiaries’ internal control over ﬁ nancial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Canon Inc. and subsidiaries’ management is responsible for maintaining effective internal control over ﬁ nancial reporting, and for its assessment of the effectiveness of internal control over ﬁ nancial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over ﬁ nancial 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 con- trol over ﬁ nancial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal con- trol over ﬁ nancial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, 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 ﬁ nancial reporting is a process designed to provide reasonable assurance regarding the reliabili- ty of ﬁ nancial reporting and the preparation of ﬁ nancial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over ﬁ nancial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reﬂ ect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁ nancial 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 ﬁ nancial statements. Because of its inherent limitations, internal control over ﬁ nancial reporting may not prevent or detect misstatements. Also, projec- tions 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. In our opinion, Canon Inc. and subsidiaries maintained, in all material respects, effective internal control over ﬁ nancial reporting as of December 31, 2010, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Canon Inc. and subsidiaries as of December 31, 2010 and 2009, and the related consolidated state- ments of income, equity, and cash ﬂ ows for each of the three years in the period ended December 31, 2010, all expressed in Japanese yen, and our report dated March 30, 2011 expressed an unqualiﬁ ed opinion thereon. 110 CANON ANNUAL REPORT 2010 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 and New York 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, N.A. 1 Chase Manhattan Plaza, Floor 58, New York, N.Y. 10005-1401, U.S.A. American Depositary Receipts are traded on the New York Stock Exchange (CAJ). Ordinary General Meeting of Shareholders: March 30, 2011, 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 MAJOR CONSOLIDATED SUBSIDIARIES 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. Nagasaki 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 Tokki Corporation Canon Imaging Systems Inc. Canon Virginia, Inc. Canon Giessen GmbH Canon Bretagne S.A.S. OPTOPOL Technology S.A. 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 Engineering (Thailand) Ltd. Canon Vietnam Co., Ltd. Canon Electronic Business Machines (H.K.) Co., Ltd. RESEARCH & DEVELOPMENT 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. Canon i-tech Inc. CANON ANNUAL REPORT 2010 111 (As of December 31, 2010) MARKETING & OTHER Canon Marketing Japan Inc. Canon System and Support Inc. Canon IT Solutions Inc. Canon Software Inc. e-System Corporation ASPAC 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. Virtual Imaging, Inc. Canon Business Solutions, 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 Austria GmbH Canon Svenska AB Canon Oy Canon North-East Oy Canon Norge A.S. Canon Ru LLC Canon CEE GmbH Canon Eurasia A.S. Canon Portugal S.A. Océ N.V. Canon Middle East FZ-LIC Canon South Africa Pty. Ltd. Canon Australia Pty. Ltd. Canon New Zealand Ltd. Canon Finance Australia 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 India Pvt. Ltd. Canon Korea Consumer Imaging Inc. Canon Semiconductor Engineering Korea Inc. Canon Semiconductor Equipment Taiwan Inc. Canon Engineering Hong Kong Co., Ltd. Canon Optical Industrial Equipment (Shanghai) Inc. Canon Optical Industrial Equipment Service (Shanghai) Inc. CANON INC. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan PUB. BEP020 0411N9.6 Printed in Japan

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