Canon Annual Report 2015

Plain-text annual report

C A N O N A N N U A L R E P O R T 2 0 1 5 C A N O N A N N U A L R E P O R T 2 0 1 5 F i s c a l Y e a r E n d e d D e c e m b e r 3 1 , 2 0 1 5 TA B L E O F C O N T E N T S Strategy 2 To Our Shareholders 10 Growth Strategy Business Segment 12 At a Glance 14 Office Business Unit 16 Imaging System Business Unit 18 Industry and Others Business Unit Corporate Structure 20 Corporate Governance 24 Research & Development 26 Production 28 Sales & Marketing 30 Corporate Social Responsibility Financial Section 34 Financial Overview 48 Ten-Year Financial Summary 50 Consolidated Balance Sheets 51 Consolidated Statements of Income 51 Consolidated Statements of Comprehensive Income 52 Consolidated Statements of Equity 53 Consolidated Statements of Cash Flows 54 Notes to Consolidated Financial Statements 84 Schedule II Valuation and Qualifying Accounts 85 Management’s Report on Internal Control Over Financial Reporting 86 Reports of Independent Registered Public Accounting Firm Corporate Data 88 Transfer and Registrar’s Office 88 Shareholder Information 89 Major Consolidated Subsidiaries Cover Photo: Canon’s network cameras installed in British Library’s St. Pancras Reading Room Canon answers the call to protect cultural collections and the safety of visitors with the technological capabilities of its network cameras. F I N A N C I A L H I G H L I G H T S Millions of yen (except per share amounts) Thousands of U.S. dollars (except per share amounts) 2015 2014 Change (%) 2015 Net sales Operating profit Income before income taxes Net income attributable to Canon Inc. Net income attributable to Canon Inc. shareholders per share: —Basic —Diluted Total assets ¥ 3,800,271 ¥ 3,727,252 355,210 347,438 220,209 363,489 383,239 254,797 ¥ 201.65 ¥ 229.03 201.65 229.03 ¥ 4,427,773 ¥ 4,460,618 Canon Inc. shareholders’ equity ¥ 2,966,415 ¥ 2,978,184 +2.0 -2.3 -9.3 -13.6 -12.0 -12.0 -0.7 -0.4 $ 31,407,198 2,935,620 2,871,388 1,819, 909 $ 1.67 1.67 $ 36,593,165 $ 24,515,826 Notes: 1. Canon’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles. 2. U.S. dollar amounts are translated from yen at the rate of JPY121=U.S.$1, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 30, 2015, solely for the convenience of the reader. Net Sales (Billions of yen) Net Income Attributable to Canon Inc. (Billions of yen) 4,000 3,000 2,000 1,000 0 300 200 100 0 300 200 100 0 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 Net Income Attributable to Canon Inc. Shareholders per Share (Yen) ROE/ROA (%) 10.0 8.0 6.0 4.0 0 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 Basic Diluted ROE ROA CANON ANNUAL REPORT 2015 1 T O O U R S H A R E H O L D E R S 2 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon will embrace the challenge of new growth through a grand strategic transformation under Phase V of its Excellent Global Corporation Plan. Performance in 2015 Canon Group Axis, the global leader in network cameras. Looking at sales of our main products, digital cameras and inkjet printers continued to face harsh market con- ditions, mainly in China and emerging Asian countries, Despite expectations at the beginning of 2015 that the while color ofﬁ ce multifunction devices (MFDs) and color global economy would realize a modest recovery led by the light-production printing systems recorded sales growth. United States, the Chinese economy faced a slowdown in Semiconductor lithography equipment and ﬂ at panel dis- the second half of the year, which was followed by decelera- play (FPD) lithography equipment also achieved signiﬁ cant tion in emerging economies. As a result, the global economy year-on-year sales growth thanks to favorable market con- overall realized its lowest level of growth since the ﬁ nancial ditions. Consequently, beneﬁ ting from the boost provided crisis triggered by the 2008 collapse of Lehman Brothers. by the acquisition of Axis and the positive effects of favor- Faced with these circumstances, in 2015, the ﬁ nal year able currency exchange rates, consolidated net sales for of Phase IV of our Excellent Global Corporation Plan (2011– 2015 increased 2.0% year on year to ¥3,800.3 billion, and 2015), we actively tackled such key challenges as revital- the gross proﬁ t ratio rose 1.0 point year on year to 50.9%. izing existing businesses and expanding new and future Income before income taxes, however, declined 9.3% year businesses. In line with these efforts, we welcomed into the on year to ¥347.4 billion, mainly due to the impact of a 150 100 50 0 Cash Dividend (Yen) rise in investment in development aimed at reinforcing new businesses, higher expenses associated with consolidating Axis, and an increase in other deductions resulting from for- eign currency exchange losses. Among our accomplishments in 2015, we should high- light the fact that we recorded our highest-ever gross proﬁ t ratio despite the harsh business conditions we faced. This achievement, the result of ongoing cost-cutting activities and other efforts, is a testament to Canon’s unwavering manufacturing prowess, even under adverse circumstances. Furthermore, seeking to actively return proﬁ ts to sharehold- ers, we declared an annual cash dividend of ¥150.00 per share, which remains unchanged from the record-high divi- 2007 2008 2009 2010 2011 2012 2013 2014 2015 dend we paid in 2014. CANON ANNUAL REPORT 2015 3 Excellent Global Corporation Plan Phases I to IV (1996–2015) serious recessions. At the same time, we implemented two major measures to reorient our businesses with a view to the future. The ﬁ rst of these was ensuring new growth potential through the lateral expansion of existing businesses while the second was successfully acquiring new growth busi- Canon launched the Excellent Global Corporation Plan in nesses through active M&A activities. 1996 and, through four ﬁ ve-year phases of the Plan (Phases The ﬁ rst example of such lateral expansion of existing I through IV), we have reinforced our business foundation. businesses is the Cinema EOS System. Following its launch During Phase I, we stressed thorough cash-ﬂ ow manage- in 2012, the lineup has revolutionized the motion picture ment and signiﬁ cantly boosted productivity through the production industry and captured an overwhelming share of introduction of the cell production system and other mea- the market with further growth expected in the eras of 4K sures. In Phase II, we fully digitalized our copying machine and 8K. As for our Inkjet Product Operations, we launched and camera offerings and became an essentially debt-free a commercial photo printer and, through it, have developed company. During Phase III, we effectively expanded business a photo book service that encompasses editing, processing in the printing and medical equipment sectors while actively and bookbinding. Additional R&D achievements include the carrying out M&A activities. creation of businesses in such ﬁ elds as the machine vision And, in 2011, we embarked on Phase IV with the aim of and professional-use display segments, which have highly achieving sound growth. During this period, however, the promising futures. global economy faced a series of serious challenges, such As for M&A activity, we made successful acquisitions in as economic stagnation in Europe in the wake of Greece’s three new growth sectors, the ﬁ rst of which was commer- sovereign debt crisis and slowdowns in China and other cial printing. Océ was made a wholly owned subsidiary in emerging markets. In response, we altered our original pol- 2013, thus opening the door to a new world of commercial icy targeting scale expansion and focused instead on build- and package printing through high-speed printing systems. ing up a strong ﬁ nancial structure capable of withstanding The second was our entry into the network camera system The Excellent Global Corporation Plan Phase I 1996–2000 Phase II 2001–2005 Phase III 2006–2010 Phase IV 2011–2015 Strengthened our financial structure by thoroughly eliminat- ing wastefulness, with production reforms playing a major role, based on changing our mindset with a focus on total optimization and profitability. Recognized the need for digitalization and raised product competitiveness by enhancing our devel- opment infrastructure and reinforcing key components. Strove to achieve “Sound Growth,” seeking high growth levels by estab- lishing new businesses while raising the profit- ability of existing busi- nesses. With the global economy plunging into the global recession, shifted direction towards “improving the quality of management.” Tackled again the challenge of achieving “Sound Growth” through timely change in advance of changes in the times. Slogan: “Aiming for the Summit: Speed & Sound Growth” Next step Phase V 2016–2020 Continued on page 6 44 CANON ANNUAL REPORT 2015 segment. Canon leaped to the top of the industry by wel- 67.0% at the end of 2015, which enabled us to maintain coming Milestone Systems and Axis into the Canon Group. our top-ten ranking for this management indicator among The third was making Molecular Imprints a wholly owned FORTUNE Global 500 companies. subsidiary and accelerating the development of nanoimprint Based on the above, it is clear that Phase IV was an technology that will enable both the miniaturization of elec- important period during which Canon’s business structure tronic features and cost reductions. began undergoing signiﬁ cant changes as a result of efforts In these ways, Canon has initiated a shift from B2C to to cultivate new businesses and strengthen our manufactur- B2B, adding new business segments to such maturing core ing capabilities. businesses as cameras and ofﬁ ce equipment. As part of our effort to strengthen Canon’s manufac- turing capabilities, we have promoted production automa- tion. In the area of camera production in particular, we have 52 Gross Profit of Sales (%) made steady progress in expanding the scope and variety of automation, following the introduction of automated assembly systems for EF lens focus units with automated systems capable of handling basic assembly processes for single-lens reﬂ ex (SLR) camera bodies. These achievements are clearly reﬂ ected in our gross proﬁ t ratio, which marked a record high of 50.9% in 2015. As a result, net income remained at a high level, recording a ﬁ ve-year average of over ¥230.0 billion per year. Moreover, using this income as capital for M&A activities, we have laid the foundation for an engine of future growth. Through rigorous cash ﬂ ow 50 48 46 50.9 management, we achieved a shareholders’ equity ratio of 2011 2012 2013 2014 2015 The Cinema EOS System combines a compact, lightweight body with easy-to-use functions and an attractive low price is widely used in motion picture production. CEO Fujio Mitarai with the Board of Directors at Axis CANON ANNUAL REPORT 2015 5 5 Phase V (2016–2020) accelerating the product commoditization process, which is expected to result in competition becoming even more intense. It is amid this business environment that we have launched Phase V. During Phase V, under the basic policy “Embracing the challenge of new growth through a grand strategic transforma- 2016 marks the start of Phase V, our latest ﬁ ve-year initia- tion,” we seek to further expand the reforms that we promoted in tive within the Excellent Global Corporation Plan. As for the Phase IV. In 2020, the ﬁ nal year of Phase V, Canon aims to achieve economic conditions on which Phase V is based, while devel- net sales of ¥5 trillion, a cost-to-sales ratio of 45% or less, an oped countries are expected to perform generally well, due to operating proﬁ t ratio of 15% or more, a net income ratio of 10% the likelihood of a continued economic slowdown in China, or more, and a shareholders’ equity ratio of 70% or more. we anticipate only moderate growth overall. Meanwhile, we In accordance with this basic policy, we will pursue the follow- believe two new tides will bring about signiﬁ cant changes to ing ﬁ ve speciﬁ c strategies. the structure of industry, as well as to the economy and society. One of these is the Internet of Things (IoT) which, through the interconnectivity of all manner of “things” across the Internet, from appliances and automobiles to factory equip- ment, creates new value. Responding to this change means Strategy 1 Establish a new production system to achieve a cost-to-sales ratio of 45% that, even as a manufacturer, we must stop thinking in terms As a result of continuous production reforms, we were able of individual items and discard the notion that as long as we to improve our cost-to-sales ratio to 49.1% in 2015. During develop excellent products we will have no trouble selling them. Phase V, we aim to do even better, targeting a cost-to-sales Rather, we need to transform our business model to com- ratio of 45%. bine hardware, software and services, and consider the value A key initiative toward this goal will be promoting a higher offered by the system as a whole. ratio of production in Japan. This shift offers the advantage The other tide is the rise of emerging countries. With advances of integrating design, R&D and manufacturing functions, in the digitalization and modularization of products, many com- allowing us to put together a competitive cost structure from panies in emerging countries are entering the market and further the design stage, in addition to facilitating cost reductions Key Strategies 1 2 3 4 5 Establish a new production system to achieve a cost-to-sales ratio of 45% Reinforce and expand new businesses while creating future businesses Restructure global sales network in accordance with market changes Enhance R&D capabilities through open innovation Complete the Three Regional Headquarters management system capturing world dynamism 66 CANON ANNUAL REPORT 2015 2020 Management Targets Net sales ¥5 trillion *Cost-to-sales ratio 45% or less Operating proﬁ t ratio 15% or more Net income ratio 10% or more Shareholders’ equity ratio 70% or more (Based on exchange rates of US$1=¥125, €1=¥135) * Cost-to-sales ratio refers to the cost of goods sold as a ratio of consolidated sales. through the use of common parts and in-house production. our energies on strengthening and expanding the new growth Leveraging these advantages, we will position our produc- engines that we acquired through M&A activities in such areas tion bases in Japan as “mother factories” that mainly manu- as commercial printing and network camera systems. In the life facture high-end models and further adopt automation and sciences ﬁ eld, we seek to commercialize DNA diagnostic equip- other advanced production engineering technologies. In addi- ment. In this way, we are concentrating management resources tion to boosting productivity through automated produc- in promising growth areas and will supplement these with M&A tion systems and adopting such next-generation technologies activities aimed at accelerating business expansion. as the IoT and artiﬁ cial intelligence, we are establishing new production systems through the combination of such power- ful Canon manufacturing tools as Mixed Reality (MR) systems, 3D printers and machine vision. Meanwhile, our overseas production bases will be responsible for the mass produc- Strategy 3 Restructure global sales network in accordance with market changes tion of mid- and low-priced products, and we will review the We are working to expand sales in response to the major earnings structure of these bases and adapt accordingly to changes that distribution markets are undergoing in the cur- changes in such factors as labor costs, currency trends and rent age of IT. We plan to review existing sales organizations corporate taxes in pursuit of comprehensive cost reductions. and accelerate a shift to omni-channel marketing that uti- Strategy 2 Reinforce and expand new businesses while creating future businesses lizes the strengths of both online and brick-and-mortar sales routes while reinforcing direct communication with custom- ers. Furthermore, to get ahead in the IoT era, we are focused on strengthening and expanding solutions-driven businesses with the aim of solving issues faced by customers. At Canon, in order to achieve sustainable growth, we are shift- Meanwhile, with regard to regional expansion, we will ing our focus to ﬁ elds in which we can achieve greater growth. swiftly develop sales networks not only in China and India, As one of the initiatives we are undertaking toward this end, we but also in other areas with future growth potential, such as are creating and expanding new businesses by accelerating the ASEAN countries and Africa, while continuing our efforts to lateral expansion of existing businesses. We are also focusing cultivate markets in emerging countries. Automated processes for digital camera production have been adopted at Oita Canon Inc. (Japan) Digital printed packaging suitable for ﬂ exible, small-lot production runs of varied products with rapid turnaround times (Canon EXPO 2015 Tokyo exhibition) CANON ANNUAL REPORT 2015 77 Strategy 4 Enhance R&D capabilities through open innovation Japan, the United States and Europe. In terms of scale and volume, however, we still have a long way to go. We will therefore newly acquire multiple promising businesses via M&A activities focused on Japan, the United States and Europe while leveraging the distinctive features unique to The pace of technological advancement gets faster with each each region to accelerate diversiﬁ cation. In this way, we will passing day and, in the process, is becoming more sophis- complete the Three Regional Headquarters management ticated and complex. Additionally, we are seeing increased system under which Japan, the United States and Europe diversity in the needs of our customers, which has made it will each roll out businesses globally. necessary to integrate technologies from different ﬁ elds. We Additionally, we are working to establish a structure that are therefore building a more open R&D structure, harvest- will enable us to more effectively discover and cultivate com- ing information on state-of-the-art technologies from around petent human resources capable of managing and execut- the world and applying it with the aim of accelerating devel- opment processes and generating effective results. Also, ing their duties from a global perspective. We also aim to re-instill the entrepreneurial spirit and San-ji (Three Selfs)* particularly in the ﬁ eld of basic research, we are promoting col- Spirit that have been passed down since the Company’s laborative and sponsored research, forming a wide-reaching inception as a foundation for new growth. network through collaborations with universities, research insti- In these ways, we will work in Phase V to reform all tutions and business ventures in Japan and abroad. aspects of development, production and sales to boost prof- Strategy 5 Complete the Three Regional Headquarters management system capturing world dynamism During Phase IV, we made strides toward realizing the Three Regional Headquarters management system, which spans itability while further promoting diversiﬁ cation and the cul- tivation of new businesses. In doing so, we will overcome changes in the market environment and transform ourselves into an all-new Canon to realize new growth. * San-ji, or the Three Selfs, are: self-motivation (taking the initiative and being proactive in all things), self-management (conducting oneself with responsibility and accountability), and self-awareness (understanding one’s situation and role in all situations). New Canon ecommerce sites in Europe allow customers to purchase products and access services direct from Canon online. Research on ultra-miniature endoscopes at Healthcare Optics Research Lab. (Massachusetts, United States) 88 CANON ANNUAL REPORT 2015 Key Challenges for 2016 In Conclusion Under the theme “Taking a decisive ﬁ rst step toward trans- We live in a constantly changing world and will likely formation,” we will pursue six key challenges in 2016, the encounter unexpected events. At Canon, however, we are inaugural year of Phase V. already steadily laying the groundwork for our leading-edge The ﬁ rst of these is to draft and implement plans to industries. We will carry out Phase V of our Excellent Global revitalize existing businesses. We will again carry out Corporation Plan with ﬁ rm resolve, undaunted by the speed drastic cost-cutting while working to revitalize businesses, or power of any waves of change we may face, in order to swiftly launching future products that were exhibited at realize new growth for Canon as a global corporate group. Canon EXPO 2015.* We look forward to your continued understanding The second is to rapidly expand new businesses. In and support. the large-scale business segments on which Canon’s future will rely, such as commercial printing and network cameras, we will work to speed up their expansion and deployment. Our third challenge is to accelerate efforts aimed at reducing the cost-to-sales ratio. We will continue to investigate optimal locations for production bases tak- ing into account such various factors as currency exchange rates, taxation systems, workforce and logistics while work- ing to accelerate cost reductions at every step, including the product-development stage. The fourth is to boost sales productivity through mar- keting reforms. We will accelerate efforts to address global growth in e-commerce and work to reinforce our solutions business. The ﬁ fth is to improve R&D productivity through selection and concentration. Through a process of deci- sive selection and concentration applied to development themes, we will boost R&D productivity, particularly software development. Lastly, we will promote the cultivation of global human resources. Creating a structure that will enable us to discover talented individuals throughout the Canon Group, we will cultivate globally competent human resources capable of performing their duties while maintain- ing a global perspective. * A traveling private exhibition held in four countries once every five years that showcases Canon Group products and technologies. Fujio Mitarai Chairman & CEO Canon Inc. CANON ANNUAL REPORT 2015 99 G R O W T H S T R AT E G Y Canon network cameras play an important role in ensuring safety at the aircraft maintenance centers of airlines. (JAL Engineering Co., Ltd., Japan) New growth engines acquired through M&A activities are entering a full-scale growth phase with a focus on B2B businesses. Canon is working to nurture new businesses, along with revi- talizing existing ones. With a focus on B2B businesses, where market growth is highly anticipated and stable proﬁ ts can be expected, we have directed our efforts to new business ﬁ elds where we can make use of Canon’s optical and image pro- cessing technologies to maintain competitiveness after mar- ket entry, along with M&A activities. The drivers of Canon’s growth strategy are the commercial printing business, which has stepped up cooperation with Océ, and the network camera business, where Milestone and Axis have joined the Group. 10 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Commercial Printing Business In ofﬁ ce equipment, Canon aims for stable growth in the Network Camera Business Amid growing needs for security and safety globally, the net- medium term, having identiﬁ ed a shift to color models as a work camera market is undergoing a rapid shift from analog growth driver. Yet we also recognize a risk of market shrink- to digital in concert with advancement in digital technology age in the long term, and so we have worked to cultivate and the network environment. The market including solu- new businesses where Canon’s technologies can be used to tion is projected to grow at a rate of nearly 20% per year and full advantage. reach ¥3 trillion by 2018, propelled by the spread of cloud ser- Offset printing has traditionally dominated the commer- vices and advances in big data processing, along with expected cial printing market for publications such as books, newspa- expansion in software and solutions. Canon, with its strengths pers, catalogues, and posters. However, digital printing, with in optical, sensor, and image-processing technologies, has its advantages in terms of lead time and cost, is growing year set its sights on the network camera market, welcoming two by year amid an increasing trend toward ﬂ exible, low-vol- top ﬁ rms in this space to the Group through M&A activities. ume printing on varied materials. In addition, we can expect Milestone, the world’s foremost provider of video management demand for consumables to be generated by the enormous software, was the ﬁ rst, joining the Group in 2014. It was volume of printing. Canon therefore added Océ to the Group followed in 2015 by Axis, the market leader in network in 2010, an acquisition that brought with it Océ’s more than camera with outstanding communication technologies and 130 years of history as well as industry-leading technologies more than 80,000 business partners worldwide. Canon, Axis, including ultra-fast printing technology and software to keep and Milestone will work together to generate synergies and productivity high. Integration of Océ has enabled Canon to forge the market’s strongest lineup while working to create prepare a lineup ranging from copying machines, laser printers, products in new business segments. In addition, we will fully and inkjet printers to commercial printing equipment. harness the management resources of all three companies to Amid accelerating growth in digital commercial printing, accelerate business growth. Canon will take aggressive action in growth ﬁ elds through mea- sures such as enhancing its lineup of printers capable of han- dling a wide range of materials including plastic and metal. World Market for Video Surveillance (Millions of U.S. dollars) 20,000 15,000 10,000 5,000 0 A high-speed continuous feed printer at Océ Customer Experience Center. (Poing, Germany) 2014 2015 2016 2017 2018 Network Video Surveillance Analog Video Surveillance Source: IHS Technology CANON ANNUAL REPORT 2015 11 AT A G L A N C E Business Units Main Products OFFICE BUSINESS UNIT Office Multifunction Devices (MFDs) Digital Production Printing Systems Laser Multifunction Printers (MFPs) High Speed Continuous Feed Printers IMAGING SYSTEM BUSINESS UNIT Interchangeable Lens Digital Cameras Digital Cinema Cameras Inkjet Printers Multimedia Projectors INDUSTRY AND OTHERS BUSINESS UNIT Semiconductor Lithography Equipment Digital Radiography Systems Flat Panel Display (FPD) Lithography Equipment Network Cameras 12 CANON ANNUAL REPORT 2015 • Office Multifunction Devices (MFDs) • Laser Multifunction Printers (MFPs) • Laser Printers • Digital Production Printing Systems • High Speed Continuous Feed Printers • Wide-Format Printers • Document Solutions • Interchangeable Lens Digital Cameras • Digital Compact Cameras • Digital Camcorders • Digital Cinema Cameras • Interchangeable Lenses • Compact Photo Printers • Inkjet Printers • Large-Format Inkjet Printers • Commercial Photo Printers • Image Scanners • Multimedia Projectors • Broadcast Equipment • Calculators • Semiconductor Lithography Equipment • Flat Panel Display (FPD) Lithography Equipment • Digital Radiography Systems • Ophthalmic Equipment • Vacuum Thin-Film Deposition Equipment • Organic LED (OLED) Panel Manufacturing Equipment • Die Bonders • Micromotors • Network Cameras • Handy Terminals • Document Scanners STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Outline Composition of Sales (%) Net Sales (Billions of yen) In this segment, Canon offers a comprehen- sive range of multifunction devices (MFDs), printers, and other equipment featuring high image quality, high resolution, and high speed. Leveraging these products, Canon works in close collaboration with various Group com- panies and alliance partners to deliver opti- mal solutions tailored to match the customer’s business operations. These include various document solutions, such as ofﬁ ce document management and the output of records. At the same time, the Company provides top- quality services and support in a swift and reli- able manner. Canon’s offerings in this segment include digi- tal cameras, digital camcorders, digital cinema cameras, interchangeable lenses, inkjet print- ers, and calculators. Canon’s digital cameras, digital camcorders and digital cinema cameras, designed to deliver unparalleled image qual- ity, have earned particularly high acclaim world- wide, thanks to in-house developed lenses, CMOS image sensors, and image processors. Also widely popular are Canon’s inkjet printers, which are easy to use and produce beautiful pictures at high speeds. Applying optical technologies and image-pro- cessing technologies amassed over many years, Canon provides high-value-added products to a wide range of industries. The Company is already prominent globally as a manufacturer of semiconductor lithography equipment and ﬂ at panel display (FPD) lithography equipment. In addition, Canon is focusing on the medi- cal equipment ﬁ eld—one of its next generation core businesses. The Company is aggressively promoting sales of its cutting-edge digital radi- ography systems and ophthalmic equipment, which employ Canon’s highly regarded medical imaging technologies. 55.5% 33.3% 13.8% 2,500 2,000 1,500 1,000 500 0 1,500 1,000 500 0 600 500 400 300 200 100 0 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 Note: The percentage figures for the three business units presented in the pie charts above do not add up to 100% because “Eliminations,” recorded in consolidation accounting, were not included in calculation considerations. CANON ANNUAL REPORT 2015 13 O F F I C E B U S I N E S S U N I T Canon has expanded the functions of its ofﬁ ce multifunction devices, which realize enhanced coordination with IT systems and are compatible with various types of system application software, offering an optimal usage environment for all sorts of document-related tasks. Net Sales (Billions of yen) 2,500 2,000 1,500 1,000 500 0 2011 2012 2013 2014 2015 Digital production printing system imagePRESS C800/C700 14 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 2015 Review With regard to ofﬁ ce multifunction devices (MFDs), sales of for monochrome devices. These factors, combined with the positive effect of favorable monochrome models decreased in China and other regions, as currency exchange rates, resulted in consolidated sales for the busi- the recent ongoing shift in demand from monochrome to color ness unit totaling ¥2,110.8 billion, up 1.5% from the previous year. models progressed further. Meanwhile, in color models, Canon launched the compact-body imageRUNNER ADVANCE C3300 series, which features well-balanced image quality, user-friend- 2016 Initiatives While sales of ofﬁ ce MFDs are growing due to augmenta- liness, productivity, and cost-performance. The new models tion of its color model lineup amid the increasing shift to color saw steady sales growth around the world, especially in Japan, machines, Canon will also actively introduce strategic new prod- Europe, and the United States. Also in color models, sales of the ucts in its monochrome models in 2016. At the same time, we imageRUNNER ADVANCE C5200 series were steady, mainly in will focus on products for which demand for consumables is Europe and the United States. As a result, sales of ofﬁ ce MFDs, anticipated, such as high-speed MFDs that meet the need for an aggregate that combines monochrome and color models, high-volume output and printers that can provide high-speed were up slightly from 2014. business form output from core systems. Regarding solutions, In digital production printing systems, the imagePRESS C800/ we will roll out services we have built up in each region through C700 series sold well worldwide, signiﬁ cantly boosting Canon’s M&A activities to the rest of the world, thereby increasing sales share of unit sales in the light production market targeted by the for the entire business. series. In addition, in the high-end market, the Océ VarioPrint Canon will further strengthen its lineup of laser printers. For 6000 series performed steadily, particularly in Europe, and sales example, we will work to recover sales by enhancing our lineup of the Océ VarioPrint i300, Océ’s ﬁ rst high-speed, sheet-fed color of single-function printers (SFPs) aimed at emerging markets. inkjet press, got off to a favorable start. Overall sales for digital Continued growth is expected in the commercial printing production printing systems surpassed 2014 results. market. Canon will strive to expand sales of new products, as With regard to laser multifunction printers (MFPs) and laser well as traditional continuous-feed printers and wide-format printers, sales fell below 2014 levels, due to the impact of vari- printers, aiming for an increase in consumables generated by ous factors, including shrinking markets in emerging countries enormous printing volume. such as China and Russia, as well as a global decrease in demand Ofﬁ ce multifunction device imageRUNNER ADVANCE C3300 series Digital production printing system Océ VarioPrint i300 CANON ANNUAL REPORT 2015 15 I M A G I N G S Y S T E M B U S I N E S S U N I T The Cinema EOS System revolutionized the motion picture production industry and has a strong presence. Through high resolution and an expressive color gamut, Canon is developing 8K cameras and lenses that can create images so vivid they seem to come alive on screen. Net Sales (Billions of yen) 1,500 1,000 500 0 16 2011 2012 2013 2014 2015 Interchangeable lens digital camera EOS 5DS/5DS R CANON ANNUAL REPORT 2015STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 2015 Review Although overall unit sales of interchangeable lens digital cameras Unit sales of large-format inkjet printers remained at the same level as the previous year, and sales of consumables grew steadily declined due to the impact of the economic slowdowns in China with an increase in the number of units in operation. and Russia, signs of recovery began to appear in Japan and the As a result, consolidated sales in this business unit stood at United States. Amid such circumstances, Canon launched the EOS ¥1,263.8 billion, down 5.9% from the previous year. 5DS and EOS 5DS R digital SLR cameras, which boast the highest- ever resolution for EOS models, as well as the EOS M3 and EOS M10 non-reﬂ ex cameras, thereby maintaining the No. 1 share in 2016 Initiatives In interchangeable lens digital cameras, Canon will strengthen unit sales worldwide of interchangeable lens digital cameras. its high-end models through technological evolution beﬁ tting As for digital compact cameras, unit sales declined as the an Olympic year, in order to stimulate replacement demand market continued to contract amid the growing proliferation of among professionals and advanced amateurs. In digital com- smartphones. However, Canon raised its sales ratio for high-end pact cameras, we will concentrate on the high-end models that products such as the PowerShot G5 X. are performing well, in an effort to improve proﬁ tability. We will The Cinema EOS System of digital cinema cameras, which are also expand our business domains, not only in the consumer aimed at the motion picture production industry, sold well, partic- camera market, but also in the B2B ﬁ eld, as exempliﬁ ed by the ularly the new EOS C300 Mark II. Cinema EOS System. Sales of broadcasting equipment were solid, backed by con- In inkjet printers, we will expand sales by augmenting our tinuing demand for models designed for sports broadcasting and product lineup for emerging countries, such as the large-capacity for HDTV format equipment in China and other countries. The ink tank models launched at the end of last year, to meet the CN20x50 IAS H, a new zoom lens for 4K cameras equipped with diversiﬁ ed needs of emerging markets in Asia and elsewhere. large-format sensors, was also well received. In addition, we will bolster sales of business products such as As for inkjet printers, although Canon has been working to the MAXIFY series and large-format inkjet printers, as well as expand sales through its broad product lineup, which ranges from the imagePROGRAF PRO-1000, a new product aimed at pro- home-use printers to MAXIFY-series business models, unit sales fessional photographers that offers advanced image quality were lower than in 2014 due to shrinking markets, primarily in and high productivity. This will also lead to an increase in the Asia. In contrast, sales of consumables enjoyed solid demand. sales of consumables. Interchangeable EF lenses for Canon EOS-series Inkjet printer imagePROGRAF PRO-1000 CANON ANNUAL REPORT 2015 17 I N D U S T R Y A N D O T H E R S B U S I N E S S U N I T Canon has accelerated development of next-generation semiconductor lithography equipment using nanoimprint technology with sub-20-nanometer high-resolution processes. With the aim of a commercial launch soon, Canon seeks to solidify its position in the ﬁ eld of semiconductor lithography equipment. Net Sales (Billions of yen) 600 500 400 300 200 100 0 2011 2012 2013 2014 2015 Semiconductor lithography equipment FPA-5550iZ 18 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 2015 Review In the business of semiconductor lithography equipment, (OLED) panel manufacturing equipment made by Canon Tokki Corporation, and factory automation (FA) systems and semicon- sales were steady for the FPA-5550iZ i-line steppers and for ductor manufacturing equipment made by Canon Machinery Inc. FPA-6300ES6a KrF scanners, which feature high productiv- grew as a result of increased capital investments by customers. ity. This reﬂ ects strong capital investment for the manufactur- As a result of these factors, along with the impact of the ing of memory devices in response to growing demand for new consolidation of Axis, consolidated sales for this business mobile devices such as smartphones and for cloud servers. unit increased 31.6% year on year, to ¥524.7 billion. Furthermore, lithography equipment designed for manufac- turing power semiconductors and LEDs also saw considerable sales growth. As for ﬂ at panel display (FPD) lithography equip- 2016 Initiatives In the lithography equipment market, capital investment is ment, sales grew signiﬁ cantly for equipment used in the fabri- expected to remain strong. In semiconductor lithography equip- cation of large-sized panels such as the MPAsp-H800 series on ment, unit sales are expected to surpass those of the previous a boost from growth in capital investment for manufacturing year, backed by a continued high market share for i-line step- large-sized panels. pers and an expanded share for KrF scanners, which feature the In the medical equipment ﬁ eld, our digital radiography busi- industry’s highest levels of productivity and overlay accuracy. FPD ness faced price pressure by competition, but the release of lithography equipment sales are expected to grow sharply on high-value-added software bolstered its competitiveness, and further growth in unit sales of high-deﬁ nition mid- and small- new non-mydriatic fundus cameras supported ophthalmic size panels, and OLED panel manufacturing equipment sales are equipment sales. also expected to expand rapidly. Canon will continue to promote In network cameras, sales signiﬁ cantly increased compared the development of next-generation semiconductor lithogra- to 2014 as a result of major reinforcements to Canon’s product phy equipments employing nanoimprint technology, which was lineup in response to rising concerns about security and safety and acquired through M&A in 2014, targeted at the leading-edge diversiﬁ cation of use. The business was further strengthened by high-resolution patterning segment in semiconductors. the addition to the Group of Axis, the global leader in the network Growth is also expected to continue in the network camera camera market. Sales of document scanners manufactured by market. Through a fusion of Canon’s imaging technology, Axis’s Canon Electronics Inc. remained at the same level as the previous network technology, and Milestone’s video management soft- year overall, as sales growth in Europe and Asia offset a drop in ware, we aim at further business expansion by providing the the United States. Sales of semiconductor ﬁ lm deposition equip- most advanced network video solutions. ment manufactured by Canon ANELVA Corporation, organic LED Network cameras VB-R11, VB-M741LE, and VB-M641VE Organic LED (OLED) panel manufacturing equipment CANON ANNUAL REPORT 2015 19 C O R P O R AT E G O V E R N A N C E At a monthly meeting of all company executives, the CEO provides updates on earnings progress and important matters to implement in the future as a way to share crucial information. Canon maintains sound corporate governance as part of efforts to maximize its shareholders’ value and become a truly excellent global corporation. Basic Policy In order to establish a sound corporate governance structure and continuously raise corporate value, Canon believes that it is essential to improve management transparency and strengthen functions to supervise and monitor management. In this respect, a sense of ethics and mission held by each executive director and employee is very important for the Company. Representative Directors, Directors, and Board of Directors The Board of Directors makes decisions on matters prescribed in the Companies Act, including a policy for establishing sys- tems necessary to ensure the properness of operations (a basic 20 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA policy for an internal control system) and other important man- Chief Operating Ofﬁ cer (COO) manages the Group’s businesses agement matters. Furthermore, the Board receives reports on under the policies set by the CEO and serves as the president a regular basis and otherwise as necessary on the execution of of the Company. The Chief Financial Ofﬁ cer (CFO) oversees the operations by representative directors and executive ofﬁ cers Group’s ﬁ nancial matters, and the Chief Technical Ofﬁ cer (CTO) under the direction of the representative directors and it over- oversees technology and R&D. sees the execution of these operations. As of April 1, 2016, there will be 37 Executive Ofﬁ cers, As of ﬁ scal 2015, the Board of Directors consisted of 17 including two women and two with foreign citizenship. directors. However, it was resolved at the 115th Ordinary General Meeting of Shareholders held on March 30, 2016 to change to a structure with a total of six directors, compris- ing four directors from Canon career veterans and two outside directors who are independent directors*. Executive ofﬁ cers are responsible for the execution of oper- ations as a group executive or chief executive in charge of one or more of the Company’s main operations. Meanwhile, the Board of Directors consists of representative directors with years of experience at the Company who manage multiple divisions *Independent directors: Stock exchanges in Japan require listed com- panies to appoint outside directors and/or outside Audit & Supervisory Board members and to report their name. Outside directors and Audit & Supervisory Board members should have no possible conflict of inter- ests with regular shareholders. People related to the parent company or major business partners, consultants who receive large remunerations from the company, and their close relatives cannot be selected as inde- pendent directors. Corporate Strategy Committee, Risk Management Committee, and Disclosure Committee The Corporate Strategy Committee, consisting of and functions, along with independent outside directors who Representative Directors and some Executive Ofﬁ cers, functions have impartial perspectives on management that would differ as an advisory body to the CEO. Among items to be decided from those of Canon career veterans. With this compact Board, by the CEO, the Committee undertakes prior deliberations Canon aims to speed up its management via a rigorous system on important matters pertaining to Canon Group strategies. centered on decision-making from a high-level, all-around per- Outside directors and outside Audit & Supervisory Board mem- spective and oversight of execution of operations. bers attend the Corporate Strategy Committee meetings and The responsibilities of the four representative directors are proffer their opinions. divided as follows. The Chief Executive Ofﬁ cer (CEO) is responsi- Based on its policy on establishment of an internal control ble for overall management of the Group as a whole, while the system, the Company set up the Risk Management Committee, Directors and Audit & Supervisory Board Members (as of April 1, 2016) Representative Director Chairman & CEO Fujio Mitarai Representative Director President & COO Masaya Maeda Representative Director Executive Vice President & CFO Toshizo Tanaka Group Executive of Human Resources Management & Organization Headquarters Representative Director Senior Managing Director & CTO Shigeyuki Matsumoto Group Executive of R&D Headquarters Directors Kunitaro Saida (Outside) Attorney Haruhiko Kato (Outside) President & CEO of Japan Securities Depository Center, Incorporated Audit & Supervisory Board Members Makoto Araki Kazuto Ono Tadashi Ohe (Outside) Osami Yoshida (Outside) Kuniyoshi Kitamura (Outside) Note: Although this annual report is for FY2015, the above list of Directors and Audit & Supervisory Board members is as of April 1, 2016. CANON ANNUAL REPORT 2015 21 Governance Structure (as of March 30, 2016) General Meeting of Shareholders Elect/Dismiss Board of Directors 6 Members (Includes 2 Outside Members) Audit Elect/Dismiss Elect/Dismiss Audit & Supervisory Board 5 Members (Includes 3 Outside Members) Elect/Dismiss Approve/Supervise Report Audit Representative Directors CEO, COO, CFO, CTO Consult Corporate Strategy Committee Representative Directors and Executive Officers with direct control of an organizational division Cooperation Cooperation Accounting Auditor (Audit Firm) Report Instruct/Order Approve/Supervise Report Report Risk Management Committee Financial Risk Management Subcommittee Compliance Subcommittee Business Risk Management Subcommittee Report Disclosure Committee Report Cooperation Financial Audit Cooperation Corporate Audit Center Internal Audit Report Executive Officers and each General Manager Execution of the operations of the company which formulates policy and action proposals for improvement deliberations on information disclosure, including content and of the risk management system in the Canon Group under timing, to ensure timely and accurate disclosure of important decisions of the Board of Directors. The Risk Management company information. Committee consists of three entities: the Financial Risk Management Subcommittee, which improves systems on the credibility of ﬁ nancial reporting; the Compliance Subcommittee, Audit & Supervisory Board Canon is a “Company with an Audit & Supervisory Board.” The which ensures thorough implementation of corporate eth- Board consists of ﬁ ve members, three of which are independent ics and improves legal compliance systems; the Business Risk outside Audit & Supervisory Board members. In accordance Management Subcommittee, which improves systems prepared with auditing policies and plans decided at Audit & Supervisory for overall business risks, including insufﬁ cient product qual- Board meetings, members of the Audit & Supervisory Board ity and information leakage. The Risk Management Committee attend Board of Directors meetings, Corporate Strategy veriﬁ es the risk management system and reports the status to Committee meetings, and other relevant meetings, while the CEO and the Board of Directors. receiving verbal reports from directors, reviewing important In addition, the Disclosure Committee undertakes approval documents, and examining the business and ﬁ nancial 22 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA asset statuses of the Company and its subsidiaries. In these ways, the Audit & Supervisory Board meticulously checks direc- Compliance Shortly after its founding, Canon established the San-Ji or the tors’ and others’ execution of the company operations, includ- Three Selfs, are: self-motivation (taking the initiative and being ing establishment and operation of the internal control system, proactive in all things), self-management (conducting one- thus is fulﬁ lling a management oversight function. The Board self with responsibility and accountability), and self-aware- also works in close alliance with the Internal Audit Division and ness (understanding one’s situation and role in all situations), the accounting auditors to improve the efﬁ cacy of monitoring. or understanding one’s situation and role in it. In 2001, Canon Internal Audit Division The Corporate Audit Center, with about 70 members, is the Company’s internal auditing arm. It conducts audits and eval- uations and provides guidance on all operations and sectors without exception, including those of Group companies, from established the Canon Group Code of Conduct, inspired by the above Three Selfs, and each Group company makes efforts to enforce the Code. Countering Antisocial Forces Canon has a basic policy prohibiting relationships of any kind various perspectives, such as business efﬁ cacy and efﬁ ciency, with antisocial forces that represent a threat to social order and compliance, and information security. Audit results are reported security. To uphold this basic policy, Canon has established a to the CEO and Audit & Supervisory Board and complement department dedicated to activities aimed at countering such audits conducted by members of that board. parties while reinforcing cooperative ties with applicable pub- lic authorities. In addition, Canon’s Employment Regulations Accounting Auditor The Company has an auditing service contract with its indepen- include a clause prohibiting such relationships, and the Company continues to step up efforts to ensure strict dent auditor, Ernst & Young ShinNihon LLC, to audit its ﬁ nancial employee adherence. statements. To check the validity of the audits, the Company’s Audit & Supervisory Board members receive detailed explanations from the accounting auditors about the quality management sys- tem regarding audits. Risk Management As Canon expands its business on a global scale, business and other risks to which it may be exposed continue to diversify. In With the aim of monitoring the independence of the account- accordance with policies of its Risk Management Committee, ing auditors, the Company introduced a prior approval system by Canon calculates and investigates conceivable risks across the the Audit & Supervisory Board for contents of auditing and other entire Group. Canon also strives to prevent or minimize the service contracts and relevant fees. Based on “policies and pro- emergence of risk by formulating company regulations and cedures of the prior approval for both auditing and non-auditing other rules and conducting employee education. services,” each contract is closely reviewed for prior approval. San-ji, or the Three Selfs, are: self-motivation (taking the initiative and being proactive in all things), self-management (conducting oneself with responsibility and accountability), and self-awareness (understanding one’s situation and role in all situations). (calligraphy by Canon’s ﬁ rst president, Takeshi Mitarai) CANON ANNUAL REPORT 2015 23 R E S E A R C H & D E V E L O P M E N T Driving new dye ink R&D with a database of over 10,000 dye varieties, Canon pursues molecular structures that improve dye ink durability (light sta- bility) via original designs. Seeking to create a new Canon, the Company is reinforcing an R&D structure spanning Japan, the United States, and Europe under the Three Regional Headquarters management system. 24 CANON ANNUAL REPORT 2015 2015 Top Ten U.S. Patent Holders by Company 7,355 5,072 4,134 IBM* Samsung Electronics CANON Qualcomm Google Toshiba Sony 2,900 2,835 2,627 2,455 LG Electronics 2,242 Intel Microsoft 2,048 1,956 *IBM is an abbreviation for International Business Machines Corporation. Source: Preliminary data released by IFI CLAIMS Patent Services, a U.S. research company specialized in patent information STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Strengthening Our Global R&D Structure Pursuing globalized diversiﬁ cation of its operations in the Initiatives to Establish New Businesses Taking a long-term standpoint, Canon is concentrating on pre- competitive ﬁ elds where the seeds of new technologies for the ﬁ eld of R&D, Canon has established the foundation of the future are discovered. At the same time, the Company is continu- Three Regional Headquarters management system that leads ally bolstering R&D activities centered on key parts and key devices to new businesses emerging from Japan, the United States, in order to enhance the competitiveness of its products. With and Europe. regard to CMOS sensors employed in interchangeable lens digital For example, in the United States, Canon U.S. Life Sciences, cameras and digital cinema cameras, in 2015, a prototype camera Inc. is making steady progress in genetic testing systems, while equipped with a newly developed approximately 250-megapixel Healthcare Optics Research Laboratory is steadily advancing sensor succeeded in capturing images of the lettering printed on research on ultra-miniature endoscopes and medical robotics. the body of an aircraft ﬂ ying roughly 18 kilometers away. By rais- In Europe, we are reinforcing R&D in business ﬁ elds mainly in ing the performance levels of CMOS sensors to their fullest extent, printing solutions centered on Océ, as well as making further we are developing sensors applicable to functions in such areas as use of existing R&D centers to advance R&D in new ﬁ elds. astronomical and nature observation, medical research, aviation, and surveillance and security. We are also promoting businesses of R&D Expenses and Patents Canon is bolstering R&D activities to enable the ongoing devel- CMOS sensor components. In addition, by integrating Canon’s material appear- opment of innovative products and services. In the year under ance acquisition and image-processing technologies with review, R&D expenses amounted to ¥328.5 billion, up 6.3%, Océ’s elevated printing technology using UV-curable print- or ¥19.5 billion, from the previous year. The ratio of R&D ers, Canon is working on the development of technology to expenses to net sales was 8.6%. This focus on R&D activi- faithfully reproduce material appearance characteristics of ties has cemented Canon’s high status in the ﬁ eld of intellec- the original object, such as glossiness, surface contours, and tual property. In 2015, Canon was granted 4,134 patents in the transparency, with a printer. We will aim to expand its appli- United States, ranking it third in the world and the top ranked cation in such areas as wallpaper and other interior design Japanese company for an eleventh consecutive year. materials, and product packaging. A wide-view picture (left-hand side) taken with a 250-megapixel CMOS-sensor-equipped camera; a digitally magniﬁ ed close-up of a guide sign near an overpass in the high-resolution picture. CANON ANNUAL REPORT 2015 25 P R O D U C T I O N At Canon, employees with exceptional work skills are certiﬁ ed as a “Meister” (a multi-skilled worker). As participants in developing production equipment and reviewing designs, they are indispensible to advancing productivity improvement efforts in Japan. An S-grade Meister assembles a digital production system. (Toride Plant, Japan) In addition to establishing a Belief in “Internal Production” globally optimized production system, Canon seeks improved quality and productivity by putting a priority on conducting production operations itself to ensure the progress of its manufacturing expertise. Man-Machine Cell In-House Production Automation (cid:129) Production Efficiency Improvement (cid:129) Cost Reduction from Design Phase (cid:129) Lead Time Reduction (cid:129) Cost Reduction (cid:129) Product Differentiation (cid:129) Technology Protection (cid:129) Production Efficiency Improvement (cid:129) Localized Production (cid:129) Production Flexibility (cid:129) Lead Time Reduction (cid:129) Quality Improvement Internal Production 26 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Establishing a Globally Optimized Production System Canon aims to establish a globally optimized production system between Japan and Asia, allocating mass production of mid- range and low-priced products to our Asian production sites in China, Thailand, the Philippines and other countries. that identiﬁ es the most suitable locations for the production In the Americas and Europe, Canon is making use of auto- of individual products based on a comprehensive assessment mated production systems to implement localized production of various considerations. These factors include cost, taxation, mainly of consumables such as toner cartridges, with the aim of logistics, the ease of parts procurement, and the workforce in shortening distances to markets in order to deliver products in each country and region. a timely manner, while reducing transportation costs and inven- As one of its speciﬁ c efforts in that regard, Canon will make tory in transit. its Japanese production sites “mother plants” that produce mainly high-end models, harnessing the full-suite of strengths in Japan from R&D and procurement operations to production engineering technologies and manufacturing facilities. As we Environmental Friendly Manufacturing; Enhanced Product Quality Canon actively seeks to prioritize purchases of environmen- are bringing production back to Japan, the ratio of manufac- tally conscious parts and materials as well as shift to transpor- turing in Japan will increase to 60% over the next three years tation modes that have minimal environmental impact. We or so. At home, Canon will further improve productivity by also focus on manufacturing initiatives that are friendly to the enhancing its production engineering technology through ini- global environment. tiatives such as “man-machine cell” production systems that The consolidation of the Quality Management Headquarters, integrate manual and automated processes; in-house produc- which had been split across ﬁ ve sites, in the Tamagawa Ofﬁ ce as tion, where Canon develops and produces its own parts and a way to improve quality was completed in 2015. With this, we materials as well as manufacturing equipment; and expansion have centralized the contact points dealing with consultations and of the ﬁ elds where automation technologies such as the Canon- requests related to quality, and this is expected to increase the pro- developed Super Machine Vision are employed. Such efforts will cessing speed of support for businesses. In conjunction with this, accelerate the return of production to Japan. we put into place an even stronger quality system by introducing Meanwhile, we are moving ahead with functional specialization cutting-edge facilities and facilities to handle large products. In-house production: Canon-developed ﬁ xing belts for copiers are produced in Japan. (Toride Plant) Semi-anechoic chamber: the new large-scale semi-anechoic cham- ber is for measuring electromagnetic waves emitted by products. (Tamagawa Ofﬁ ce, Japan) CANON ANNUAL REPORT 2015 27 S A L E S & M A R K E T I N G Canon EXPO exhibitions introducing the Group’s vision and values for the future were held in New York, Paris, and Tokyo in 2015. (Giant photo prints of Yankee Stadium were stitched together to recreate a baseball stadium backdrop for Canon EXPO 2015 New York.) Canon reinforces its sales and marketing capabilities by providing innovative products and advanced solutions tailored to meet the characteristics of each region. Composition of Sales by Region Asia and Oceania 22.8% ¥867.2 billion Net Sales ¥3,800.3 billion Japan 18.8% ¥714.3 billion The Americas 30.1% ¥1,144.4 billion Europe 28.3% ¥1,074.4 billion 28 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Japan Sales in Japan amounted to ¥714.3 billion, or 18.8% of consoli- slogan, “Canon See Impossible,” received high marks from many stakeholders. dated net sales. In the market for consumer products, challenging conditions carried over from the previous year amid a prolonged slump in Europe (Europe, Middle East, Africa) Sales in Europe amounted to ¥1,074.4 billion, or 28.3% of personal consumption. Nevertheless, Canon maintained top consolidated net sales. market shares in both camera products and inkjet printers, by Canon increased market share while focusing on develop- introducing various new products and implementing various ing new opportunities for growth, including entering the 3D sales promotion activities. printing market. Strategic acquisitions of Integra Document As for the B2B ﬁ eld, within the IT solutions segment, Canon’s Management in Italy and Lifecake in UK also drove growth main business of individual system development performed strongly in solutions and services for both businesses and consumers. amid strong investment, mainly among ﬁ nancial institutions. In Canon strengthened its sales and marketing through a very addition, growing demand for security led to greater investment successful Canon EXPO 2015 in Paris, launching new Canon by companies, resulting in an increase in sales in the ﬁ elds of ecommerce sites for consumer products and forming a new computer software and peripherals, and surveillance cameras. sales organization in Central and North Africa. The Americas Sales in the Americas amounted to ¥1,144.4 billion, or 30.1% Asia and Oceania Sales in Asia and Oceania amounted to ¥867.2 billion or 22.8% of consolidated net sales. of consolidated net sales. Canon Americas is making steady progress toward a regional In China, Canon added a Northwest branch and a Northeast headquarters with development, manufacturing, and sales branch, creating a six-branch system that is able to respond more functions under our Three Regional Headquarters management swiftly and precisely to market needs. In India, we opened a techni- system. In particular, Canon BioMedical, Inc., established in cal training center and worked to train and develop sales personnel 2015 as a crucial ﬁ rst step in that endeavor, is the ﬁ rst new in the production printing systems business. Furthermore, we hold business launched at Canon Americas since it assumed a unique photo contest called the Canon PhotoMarathon every headquarters functions. Canon BioMedical is responsible for year in the region, with the aim of promoting the culture of pho- development, manufacturing, and marketing of genetic tography and increasing the number of camera users. testing systems based on life science technologies cultivated in In Australia, Harbour IT Pty. Ltd., a leading IT managed services the United States. provider acquired by Canon in 2014, contributed to an increase in Canon EXPO 2015 in New York, featuring the common overall sales. Canon acquired Lifecake the U K company behind the popular Canon acquired Lifecake, the U.K. company behind the popular Lifecake photo-sharing app for families to store, organize, and share memories of their children. Canon PhotoMarathon Singapore 2015 welcomed 2,600 partici- pants, many of them photo enthusiasts in their twenties. CANON ANNUAL REPORT 2015 29 C O R P O R AT E S O C I A L R E S P O N S I B I L I T Y The “Silk Road Intangible Heritage Culture Protection Project” that Canon (China) Co., Ltd. has led since 2014 has striven to preserve that era’s cultural heritage using Canon imaging technologies. (A Buddhist priest prepares for spring amid falling snow at Da Xingshan Shrine, near the birthplace of Chinese Esoteric Buddhism.) Guided by its kyosei (“living Closed-loop Recycling and working together for the Used toner cartridges common good”) philosophy, Canon is promoting CSR activities with the aim of becoming a truly excellent corporation that is admired Use of toner cartridges and respected the world over. New toner cartridges Closed Loop Recycle Reuse for toner cartridges Materials recycling Collection of used toner cartridges Recycled at Canon Thermal recycling (reused as heat source) Canon recycling sites in the world Material recycling (reused as material for other applications) 30 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon’s Basic Approach to CSR Canon recognizes that its corporate activities are supported by porting Yellowstone National Park in 1995 and Acadia National Park in 2013. Canon imaging equipment is used to observe wild- the development of society as a whole, and contributes to the life, create video libraries and support communication activities. realization of a better society as a good corporate citizen, effec- tively leveraging its advanced technological strengths, global business deployment, and diverse, specialized human resources. Environmental Activities Renewed Automated Toner Cartridge Social Contribution Activities Canon conducts wide-ranging social contribution activities in various parts of the world to help create a better society. Canon Foundation Announces Sixth Grant Recycling System Starts Operations Program Recipients Canon has been promoting its toner cartridge recycling pro- The Canon Foundation aims to contribute to the ongo- gram since 1990, as it pursues ideal recycling for resource cir- ing prosperity and well-being of mankind. It has offered two culation. We also began the closed-loop recycling process* in research grant programs, known as the Creation of Industrial 1992, and new toner cartridges using recycled parts and plastics Infrastructure grant and Pursuit of Ideals grant. In 2015, 15 are being sold worldwide. Furthermore, our CARS-T** system projects were selected for the sixth research grant program. commenced operations in 2015 at Canon Ecology Industry Inc., our recycling hub in Japan, as a completely retooled system with The Tsuzuri Project an automated toner cartridge recycling process. Canon and the non-proﬁ t organization Kyoto Culture Association *Materials obtained from Canon products collected from the market are reused repeatedly in Canon products and parts with the same quality standards as new products. **CARS-T: Canon Automated Recycling System for Toner Cartridge jointly promote a project called the “Tsuzuri Project” (Ofﬁ cial title: Cultural Heritage Inheritance Project). The aim of the project is to preserve original cultural assets while maximizing the effective use of high-resolution facsimiles of cultural assets. These facsimi- Conservation Activities at National Parks in the les are created by blending Canon’s latest digital technology and United States traditional Japanese crafts, such as gold leaf craftwork. As a result Canon U.S.A. continues to provide support for environmental pro- of the project, original cultural assets can be kept in the more tection activities in U.S. national parks. The company began sup- favorable environment of museums while facsimiles can be used CARS-T realizes a much higher throughput in recycled plastic volumes and a higher degree of purity in recycled plastics. A high-resolution reproduction of the “Dragon and Clouds” (Unryu Zu) painting has been donated to Japan’s Tenryuji Temple; the orig- inal is housed in the collection at the Museum of Fine Arts, Boston. CANON ANNUAL REPORT 2015 31 for educational purposes and public exhibits. Since the program began in 2007, the cumulative total of reproduced and donated Addressing the Issue of Conﬂ ict Minerals Seeking to ensure that customers can use Canon products items has reached 33 (as of March 2016). with peace of mind, the Canon Group addresses the issue of conﬂ ict minerals. The Silk Road Intangible Heritage Culture Canon has been conducting full-scale investigations target- Protection Project ing products produced at manufacturing bases across the entire Cultural charity events in Gansu Province, China are the latest Canon Group. As of February 2016, no speciﬁ c parts or mate- stops in the “Silk Road Intangible Heritage Culture Protection rials have been found to have contributed to funding armed Project” organized by Canon China. Commencing in 2014 with groups in conﬂ ict regions as deﬁ ned by U.S. legislation. events in Shanxi and Henan provinces, the project aims to pro- Canon Inc., a U.S. listed company, ﬁ les a report at the end of tect intangible heritage culture along the Silk Road by harness- May every year regarding the Company’s status on this issue with ing Canon’s imaging technologies and promoting Chinese and the U.S. Securities and Exchange Commission. The Company plans foreign cultural exchanges and cooperation. It also collects to undergo independent private sector audits of the report begin- photos from the public. In 2015, one of the programs orga- ning in 2016. This report is also made available on Canon’s website. nized under the project photographed scenes from everyday In 2015 Canon joined the Conﬂ ict Free Sourcing Initiative (CFSI), life in the Gansu Province cities of Tianshui, Zhangye, Wuwei, an international program that plays the leading role in response to Jiayuguan, and Dunhuang. the conﬂ ict minerals, and continues to support industry activities. Beyond the Horizon Since 2014, Canon Middle East FZ-LLC has supported a pho- Cultivating Diverse Human Resources Canon is committed to diversity of human resources. We wel- tography project for young people. Sponsored by Mathare come people of all types—irrespective of race, gender, age, Foundation, a non-proﬁ t organization, the aim of the project is to customs, and value perceptions—and deploy such differences create an environment where the talents of economically under- to foster our growth as an organization. Since 2012, we have privileged children can be nurtured. The children attending the engaged in in-house projects with top priority on helping maxi- Beyond the Horizon workshops held in 2015 studied the basics of mize the potential of women in the workplace. In 2015, Akiko photography using cameras donated by Canon. Tanaka, President & CEO of Canon BioMedical became the ﬁ rst female Executive Ofﬁ cer at Canon. Canon Middle East sponsored “Beyond the Horizon,” a three-month photography project in Kenya that commenced in September 2015. Akiko Tanaka, president of Canon BioMedical is Canon’s ﬁ rst female executive ofﬁ cer. 32 CANON ANNUAL REPORT 2015 F I N A N C I A L S E C T I O N T A B L E O F C O N T E N T S 34 Financial Overview 48 Ten-Year Financial Summary 50 Consolidated Balance Sheets 51 Consolidated Statements of Income 51 Consolidated Statements of Comprehensive Income 52 Consolidated Statements of Equity 53 Consolidated Statements of Cash Flows 54 Notes to Consolidated Financial Statements 84 Schedule II Valuation and Qualifying Accounts 85 Management’s Report on Internal Control Over Financial Reporting 86 Reports of Independent Registered Public Accounting Firm CANON ANNUAL REPORT 2015 33 FINANCIAL OVERVIEW GENERAL The following discussion and analysis provides information that management believes to be relevant to understanding Canon’s consolidated financial condition and results of opera- tions. References in this discussion to the “Company” are to Canon Inc. and, unless otherwise indicated, references to the financial condition or operating results of “Canon” refer to Canon Inc. and its consolidated subsidiaries. OVERVIEW Canon is one of the world’s leading manufacturers of plain paper copying machines, office multifunction devices (“MFDs”), laser printers, cameras, inkjet printers, semiconduc- tor lithography equipment and FPD (Flat panel display) lithog- raphy equipment. Canon earns revenues primarily from the manufacture and sale of these products domestically and internationally. Canon’s basic management policy is to con- tribute to the prosperity and well-being of the world while endeavoring to become a truly excellent global corporate group targeting continued growth and development. Canon divides its businesses into three segments: the Office Business Unit, the Imaging System Business Unit, and the Industry and Others Business Unit. Economic environment Looking back at the global economy in 2015, the U.S. econ- omy continued to grow steadily as employment conditions and consumer spending progressively improved. In Europe, developed countries such as the U.K. led a moderate eco- nomic recovery. In contrast, the growth of China’s economy continued to decline, weighed down by excessive investments, and the economies of emerging countries, including those of Southeast Asia and India, slowed due to such factors as the recession in China and a decline in resource prices. As for the Japanese economy, improvements were seen in both corpo- rate earnings and employment conditions during the year. Despite expectations at the beginning of 2015 that the global economy would realize a modest recovery led by the U.S. economy, during the second half, as the slowdown in China’s economy became evident, emerging economies also grew weaker. As a result, the global economy overall experienced its lowest level of growth since the financial crisis precipitated by Lehman Brothers’ bankruptcy in 2008. equipment market, ongoing strong investment by manu- facturers led to healthy demand for semiconductor lithogra- phy systems for memory devices, image sensors and power semiconductor devices. Additionally, demand for lithogra- phy equipment used in the production of flat panel displays (“FPDs”) increased for large-size panels as device manufac- turers boost capital investment for larger-size LCD panels that offer higher levels of resolution. The average value of the yen during the year was ¥121.13 against the U.S. dollar, a year-on-year depreciation of approx- imately ¥15, and ¥134.20 against the euro, a year-on-year appreciation of approximately ¥6. Summary of operations Sales of digital cameras and inkjet printers declined in the face of continued harsh conditions, mainly in China and emerging Asian countries. By contrast, sales of color-model office MFDs and color-model light-production printing systems increased steadily. Sales of semiconductor lithography equipment and FPD lithography equipment also largely exceeded those for the previous year thanks to favorable market conditions. Consequently, benefitting from the boost provided by the acquisition of Axis and the positive effect of favorable currency exchange rates, net sales for the year increased 2.0% year on year to ¥3,800,271 million. The gross profit ratio for the year rose 1.0 point year on year to 50.9% thanks to ongoing cost- cutting activities and highly profitable new products. Operating expenses increased 5.4% year on year to ¥1,579,174 million owing to such factors as the increase in foreign-currency- denominated operating expenses after conversion into yen due to the depreciation of the yen, along with the impact of the acquisition of Axis and an increase in R&D expenses related to new products. As a result, operating profit decreased by 2.3% to ¥355,210 million. Other income (deductions) decreased by ¥27,522 million due to foreign currency exchange losses, lead- ing to a year-on-year decline in income before income taxes of 9.3% to ¥347,438 million, and a decrease in net income attrib- utable to Canon Inc. of 13.6% to ¥220,209 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 35. Market environment As for the markets in which Canon operates amid these condi- tions, demand for office MFDs remained firm, mainly for color models. As for cameras, the interchangeable-lens digital cam- era market continued to face harsh conditions owing to cur- rency depreciations in emerging countries and the slowing growth in China. Likewise, demand for digital compact cam- eras also declined amid the shrinking market. Additionally, demand for inkjet printers decreased in emerging countries, mainly in Asia, due to the depreciations of emerging coun- try currencies and the slowdown in China. In the industrial Revenues As Canon pursues the goal to become a truly excellent global company, 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 primar- ily from the sale of products and, to a lesser extent, provision 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 34 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA involved are market share and market environment. In addi- tion, 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 profit ratio (ratio of gross profit to net sales) is another KPI for Canon. Through its reforms of product devel- opment, Canon has been striving to shorten product develop- ment lead times in order to launch new, competitively priced products at a faster pace. Furthermore, Canon has further achieved cost reductions through enhancement of efficiency in its production. Canon believes that these achievements have contributed to improving Canon’s gross profit ratio, and will continue pursuing the curtailment of product development lead times and reductions of production costs. Operating profit ratio (ratio of operating profit to net sales) and 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 first key point. Secondly, Canon’s R&D policy is designed to maintain adequate spending in core technology to sustain Canon’s leading position in its cur- rent business areas and to exploit opportunities in other mar- kets. Canon believes such investments will create the basis for future success in its business and operations. Cash flow management Canon also places significant emphasis on cash flow manage- ment. The following are the KPIs relating to cash flow man- agement that Canon’s management believes to be important. Inventory turnover measured in days is a KPI because it mea- sures the efficiency of supply chain management. Inventories have inherent risks of becoming obsolete, physically KEY PERFORMANCE INDICATORS damaged or otherwise decreasing significantly in value, which may adversely affect Canon’s operating results. To mitigate these risks, management believes that it is crucial to continue reducing work-in-process inventories by decreasing produc- tion lead times in order to promptly recover related product expenses, while balancing risks of supply chain disruptions by optimizing finished goods inventories in order to avoid losing potential sales opportunities. Canon’s management seeks to meet its liquidity and cap- ital requirements primarily with cash flow from operations. Management also seeks debt-free operations. For a manufac- turing company like Canon, it generally takes considerable time to realize profit from a business due to lead times required for R&D, manufacturing and sales has to be followed for success. Therefore, management believes that it is important to have sufficient financial 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. shareholders’ equity to total assets ratio is another KPI for Canon. Canon believes that its shareholders’ equity to total assets ratio measures its long-term sustainabil- ity. Canon also believes that achieving a high or rising share- holders’ equity ratio indicates that Canon has maintained a strong financial position or further improved its ability to fund debt obligations and other unexpected expenses. In the long-term, Canon’s management believes a high sharehold- ers’ equity ratio will enable the company to maintain a high level of stable investments for its future operations and devel- opment. As Canon puts strong emphasis on its R&D activities, management believes that it is important to maintain a stable financial base and, accordingly, a high level of its shareholders’ equity to total assets ratio. 2015 2014 2013 2012 2011 Net sales (Millions of yen) Gross profit to net sales ratio R&D expense to net sales ratio Operating profit to net sales ratio Inventory turnover measured in days Debt to total assets ratio Canon Inc. shareholders’ equity to total assets ratio ¥3,800,271 ¥3,727,252 ¥3,731,380 ¥3,479,788 ¥3,557,433 48.8% 8.7% 10.6% 46 days 0.3% 64.9% 50.9% 8.6% 9.3% 47 days 0.0% 67.0% 47.4% 8.5% 9.3% 57 days 0.1% 65.7% 48.2% 8.2% 9.0% 52 days 0.1% 68.6% 49.9% 8.3% 9.8% 50 days 0.0% 66.8% Note: Inventory turnover measured in days is determined by: Inventory divided by net sales for the previous six months, multiplied by 182.5. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The consolidated financial statements are prepared in accor- dance with U.S. generally accepted accounting principles (“GAAP”) and based on the selection and application of sig- nificant accounting policies which require management to make significant estimates and assumptions. These estimates and assumptions include future market conditions, net sales growth rate, gross margin and discount rate. Though Canon believes that the estimates and assumptions are reasonable, actual future results may differ from these estimates and assumptions. Canon believes that the following are the more critical judgment areas in the application of its accounting policies that currently affect its financial condition and results of operations. CANON ANNUAL REPORT 2015 35 FINANCIAL OVERVIEW Revenue recognition Canon generates revenue principally through the sale of office and imaging system products, equipment, supplies, and related services under separate contractual arrangements. Canon recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred and title and risk of loss have been transferred to the customer or services have been rendered, the sales price is fixed or determinable, and collectibility is probable. Revenue from sales of office products, such as office MFDs and laser printers, and imaging system products, such as digi- tal cameras and inkjet printers, 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 FPD 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 specific 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 office products, for which the customer typi- cally 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-financing leases is recognized over the life of each respective lease using the interest method. Leases not qualifying as sales-type leases or direct-financing leases are accounted for as operating leases and the related revenue is recognized ratably over the lease term. When equipment leases are bundled with product maintenance contracts, rev- enue is first allocated considering the relative fair value of the lease and non-lease deliverables based upon the estimated rel- ative fair values of each element. Lease deliverables generally include equipment, financing 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 selling price if such element meets the criteria for treatment as a sep- arate unit of accounting. Otherwise, revenue is deferred until the undelivered elements are fulfilled 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 to 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 protec- tion 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, specific product class failures outside of the baseline experience, material usage and service delivery costs incurred in correcting a product failure. Allowance for doubtful receivables Allowance for doubtful receivables is determined using a com- bination of factors to ensure that Canon’s trade and financ- ing receivables are not overstated due to uncollectibility. These factors include the length of time receivables are past due, the credit quality of customers, macroeconomic conditions and historical experience. Also, Canon records specific reserves for individual accounts when Canon becomes aware of a custom- er’s inability to meet its financial obligations to Canon, due for example to bankruptcy filings or deterioration in the cus- tomer’s operating results or financial position. If circumstances related to customers change, estimates of the recoverability of receivables are 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 inven- tories and principally the first-in, first-out method for overseas inventories. Market value is the estimated selling price in the ordinary course of business less the estimated costs of comple- tion and the estimated costs necessary to make a sale. Canon routinely reviews its inventories for their salability and for indi- cations 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 flows, an impairment charge is recog- nized 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 assumptions. Property, plant and equipment Property, plant and equipment are stated at cost. Depreciation is calculated principally by the declining-balance method, 36 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 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 indefinite useful lives are not amortized, but are instead tested for impairment annually in the fourth quarter of each year, or more frequently if indicators of potential impairment exist. Canon performs its impairment test of goodwill using the two-step approach at the reporting unit level, which is one level below the oper- ating segment level. All goodwill is assigned to the report- ing unit or units that benefit 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 performs the second step to measure an impair- ment charge in the amount by which the carrying amount of a reporting unit’s goodwill exceeds its implied fair value. Fair value of a reporting unit is determined primarily based on the discounted cash flow analysis which involves estimates of projected future cash flows and discount rates. Estimates of projected future cash flows are primarily based on Canon’s forecast of future growth rates. Estimates of discount rates are determined based on the weighted average cost of capi- tal, which considers primarily market and industry data as well as specific risk factors. Canon has completed its impairment test in the fourth quarter of 2015 and determined that there were no reporting units that were at risk of failing the impair- ment test as the fair value of each reporting unit exceeded its respective carrying amount. Intangible assets with finite use- ful lives consist primarily of software, trademarks, patents and developed technology, license fees and customer relationships, which are amortized using the straight-line method. The esti- mated useful lives of software are from 3 years to 5 years, trademarks are 15 years, patents and developed technology are from 7 years to 16 years, license fees are 7 years, and cus- tomer relationships are from 8 years to 15 years, respectively. Income tax uncertainties 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 financial statements. Valuation of deferred tax assets Canon currently has significant deferred tax assets, which are subject to periodic recoverability assessments. Realization of Canon’s deferred tax assets is principally dependent upon its achievement of projected future taxable income. Canon’s judgments regarding future profitability may change due to future market conditions, its ability to continue to successfully execute its operating restructuring activities and other factors. Any changes in these factors may require possible recognition of significant 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 recover- able, the amounts, which may not be realized, are charged to income tax expense and will adversely affect net income. Employee retirement and severance benefit plans Canon has significant employee retirement and severance benefit obligations that are recognized based on actuarial val- uations. 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 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 benefit costs in the future. In preparing its financial statements for 2015, Canon esti- mated a weighted-average discount rate used to determine benefit obligations of 1.1% for Japanese plans and 3.0% for foreign plans and a weighted-average expected long- term rate of return on plan assets of 3.1% for Japanese plans and 5.6% for foreign plans. In estimating the discount rate, Canon uses available information about rates of return on high-quality fixed-income government and corporate bonds currently available and expected to be available during the period to the maturity of the pension benefits. Canon estab- lishes 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 cur- rent expectations for future returns. Decreases in discount rates lead to increases in actuarial pen- sion benefit obligations which, in turn, could lead to an increase in service cost and amortization cost through amortization of actuarial gain or loss, a decrease in interest cost, and vice versa. For 2015, a decrease of 50 basis points in the discount rate increases the projected benefit obligation by approximately ¥92,006 million. The net effect of changes in the discount rate, as well as the net effect of other changes in actuarial assump- tions and experience, is deferred until subsequent periods. Decreases in expected returns on plan assets may increase net periodic benefit 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 2015, a change of 50 basis points in the expected long-term rate of return on plan assets would cause a change of approximately ¥4,222 million in net periodic benefit cost. Canon multiplies CANON ANNUAL REPORT 2015 37 FINANCIAL OVERVIEW 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 recognition 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 ben- efit obligations) of its pension plans in its consolidated bal- ance sheets, with a corresponding adjustment to accumulated other comprehensive income (loss), net of tax. CONSOLIDATED RESULTS OF OPERATIONS SUMMARY OF OPERATIONS Net sales Operating profit Income before income taxes Net income attributable to Canon Inc. Sales The shrinking market for digital compact cameras and the slowing growth of China’s economy led to a major decline in net sales in Imaging System Business Unit. However, due to steady demand for color-model office MFDs and color-model light-production printing systems, benefitting from the boost provided by the acquisition of Axis and the positive effect of favorable currency exchange rates, Canon’s consolidated net sales in 2015 totaled ¥3,800,271 million, an increase of 2.0% from the previous year. Overseas operations are significant to Canon’s operating results and generated 81.2% of total net sales in 2015. Such sales are denominated in the applicable local currency and are subject to fluctuations in the value of the yen relative to those currencies. Despite efforts to reduce the impact of currency fluctuations on operating results, including localization of manufacturing in some regions along with procuring parts and materials from overseas suppliers, Canon believes such fluctu- ations have had and will continue to have a significant effect on its results of operations. The average value of the yen during the year was ¥121.13 against the U.S. dollar, a year-on-year depreciation of approx- imately ¥15, and ¥134.20 against the euro, a year-on-year appreciation of approximately ¥6. The effects of foreign exchange rate fluctuations positively affected net sales by approximately ¥146,800 million in 2015. This favorable impact consisted of approximately ¥44,800 million of unfavorable impact for the euro denominated sales and favorable impact of ¥170,500 million for the U.S. dollar denominated sales, and ¥21,100 million for other foreign currency denominated sales. Millions of yen 2015 change 2014 change 2013 ¥3,800,271 355,210 347,438 220,209 -0.1% ¥3,731,380 +2.0% ¥3,727,252 337,277 +7.8% 363,489 -2.3% 347,604 383,239 +10.3% -9.3% 230,483 254,797 +10.5% -13.6% Cost of sales Cost of sales principally reflects the cost of raw materials, parts and labor used by Canon in the manufacture of its products. A portion of the raw materials used by Canon is imported or includes imported materials. Many of these raw materials are subject to fluctuations in world market prices accompanied by fluctuations in foreign exchange rates that may affect Canon’s cost of sales. Other components of cost of sales include depreciation expenses, maintenance expenses, light and fuel expenses, and rent expenses. The ratio of cost of sales to net sales for 2015 and 2014 was 49.1% and 50.1%, respectively. Gross profit Canon’s gross profit in 2015 increased by 3.9% to ¥1,934,384 million from 2014. The gross profit ratio also increased by 1.0 points year on year to 50.9%. The increase in the gross profit ratio reflects ongoing cost-cutting activities and highly profit- able new products. Return on Sales (%) 9 6 3 0 2011 2012 2013 2014 2015 38 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Segment information Canon divides its businesses into three segments: the Office Business Unit, the Imaging System Business Unit and the Industry and Others Business Unit. The Office Business Unit mainly includes Office multifunc- tion devices (“MFDs”) / Laser multifunction printers (“MFPs”) / Laser printers / Digital production printing systems / High speed continuous feed printers / Wide-format printers / Document solutions The Imaging System Business Unit mainly includes Interchangeable lens digital cameras / Digital compact cameras / Digital camcorders / Digital cinema cameras / Interchangeable lenses / Compact photo printers / Inkjet printers / Large-format inkjet printers / Commercial photo printers / Image scanners / Multimedia projectors / Broadcast equipment / Calculators The Industry and Others Business Unit mainly includes Semiconductor lithography equipment / FPD (Flat panel dis- play) lithography equipment / Digital radiography systems / Ophthalmic equipment / Vacuum thin-film deposition equip- ment / Organic LED (“OLED”) panel manufacturing equipment / Die bonders / Micromotors / Network cameras / Handy termi- nals / Document scanners Operating expenses The major components of operating expenses are payroll, R&D, advertising expenses and other marketing expenses. Operating expenses increased 5.4% year on year to ¥1,579,174 million owing to such factors as the increase in foreign-currency- denominated operating expenses after conversion into yen due to the depreciation of the yen, additional operating expenses after the acquisition of Axis and an increase in R&D expenses related to new products. Operating profit Operating profit in 2015 decreased 2.3% from 2014 to a total of ¥355,210 million. The ratio of operating profit to net sales decreased 0.5% to 9.3% from 2014. Other income (deductions) Other income (deductions) for 2015 decreased ¥27,522 mil- lion, mainly due to foreign currency exchange losses. Income before income taxes Income before income taxes in 2015 was ¥347,438 million, a decrease of 9.3% from 2014, and constituted 9.1% of net sales. Income taxes Provision for income taxes in 2015 decreased by ¥1,895 mil- lion from 2014. The effective tax rate for 2015 was 33.4%, which was lower than the statutory tax rate in Japan. This was mainly due to the tax credit for R&D expenses. Net income attributable to Canon Inc. As a result, net income attributable to Canon Inc. in 2015 decreased by 13.6% to ¥220,209 million, which represents 5.8% of net sales. Sales by Segment (Billions of yen) Sales by Geographic Area (Billions of yen) 5,000 4,000 3,000 2,000 1,000 0 5,000 4,000 3,000 2,000 1,000 0 Office Business Unit Imaging System Business Unit Industry and Others Business Unit Eliminations Japan Americas Europe Asia and Oceania 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 CANON ANNUAL REPORT 2015 39 FINANCIAL OVERVIEW Sales by segment SALES BY SEGMENT Office Imaging System Industry and Others Eliminations Total 2015 change 2014 change 2013 Millions of yen ¥2,110,816 1,263,835 +1.5% ¥2,078,732 1,343,194 -5.9% 398,765 524,651 +31.6% (93,439) (99,031) — +3.9% ¥2,000,073 1,448,938 -7.3% 374,870 +6.4% (92,501) — ¥3,800,271 +2.0% ¥3,727,252 -0.1% ¥3,731,380 Within the Office Business Unit, as for office MFDs, thanks to strong sales of color models led by new small-office/home- office color A3 (12”x18”) imageRUNNER ADVANCE C3300- series models and imagePRESS C800/700-series color digital presses targeting the light production market, unit sales of color models increased compared with the previous year, as did unit sales for the segment overall, including monochrome models, which had been facing decreasing demand. Among high-speed continuous-feed printers, the new Océ-produced VarioPrint i300, Canon’s first high-speed sheet-fed color ink- jet press, gained favorable reviews. As for laser printers, total sales volume decreased due to declining demand in emerg- ing countries. Those factors, coupled with the positive effect of favorable currency exchange rates, resulted in sales for the business unit totaling ¥2,110,816 million, a year-on-year increase of 1.5%, while operating profit totaled ¥290,586 mil- lion, a year-on-year decrease of 0.5%. Within the Imaging System Business Unit, although total sales volume of interchangeable-lens digital cameras declined due to currency depreciations in emerging countries and the slow- down of China’s economy, there were positive signs of a recovery in sales in the U.S. and Japan. Additionally, sales have been strong for such models as the EOS 5DS and EOS 5DS R digital SLR cameras, which deliver the highest resolution of any model in the history of EOS cameras. As for digital com- pact cameras, while sales volume declined amid the ongoing contraction of the market, the ratio of more profitable high- added-value models increased owing to efforts to strengthen the lineup of PowerShot G-series models. As for inkjet print- ers, although Canon has been working to expand sales through the Company’s broad product lineup, ranging from home-use printers to MAXIFY-series business models, total sales volume declined due to the significant impact of shrink- ing markets, mainly in Asia. In contrast, sales of consumable supplies enjoyed solid demand. As a result, sales for the busi- ness unit totaled ¥1,263,835 million, a year-on-year decrease of 5.9%, while operating profit totaled ¥183,439 million, declining 5.7% year on year. In the Industry and Others Business Unit, within the semicon- ductor lithography equipment segment, unit sales increased owing to strong capital investment in response to grow- ing demand for memory devices used in mobile devices such as smartphones, and in cloud servers, along with increased demand for on-board automotive devices and for communi- cation devices supporting the development of the Internet of Things (“IoT”). Unit sales of FPD lithography equipment also increased, particularly systems used in the fabrication of large- size panels. Consequently, along with the impact of the acqui- sition of Axis, which was consolidated in the second quarter, sales for the business unit increased 31.6% year on year to ¥524,651 million. As for operating profit, although it improved by ¥8,722 million compared with the previous year, the busi- ness unit was in the red by ¥13,079 million due to upfront investment in next-generation technologies and new businesses. Intersegment sales of ¥99,031 million, representing 2.6% of total sales, are eliminated from total sales for the three seg- ments, and are described as “Eliminations.” Sales by geographic area Please refer to the table of sales by geographic area in Note 21 of the Notes to Consolidated Financial Statements. In Japan, net sales decreased 1.4% from the previous year due mainly to the rush in demand during the first quarter of the pre- vious year that preceded the country’s consumption tax increase. In the Americas, net sales increased 10.4% from the previous year owing to the positive effects of favorable currency exchange rates along with the consolidation of new businesses. In Europe, despite the solid demand for office MFDs and laser printers along with the consolidation of new businesses, sales decreased by 1.5% from the previous year due to the negative effect of the appreciation of the yen. In Asia and Oceania, despite the positive impact of deprecia- tion of the yen, net sales decreased by 1.0% from the previous year owing to the economic stagnation in China and Southeast Asian countries. 40 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA A summary of net sales by geographic area is provided below. SALES BY REGION Japan Americas Europe Asia and Oceania Total Millions of yen 2015 change 2014 change 2013 ¥ 714,280 -1.4% 1,144,422 +10.4% -1.5% 1,074,366 -1.0% 867,203 ¥ 724,317 +1.2% -2.2% -3.1% 875,951 +5.4% 1,036,500 1,090,484 ¥ 715,863 1,059,501 1,124,929 831,087 ¥3,800,271 +2.0% ¥3,727,252 -0.1% ¥3,731,380 Note: This summary of net sales by geographic area is determined by the location where the product is shipped to the customers. Operating profit by segment Please refer to the table of segment information in Note 21 of the Notes to Consolidated Financial Statements. Operating profit for the Office Business Unit in 2015 decreased by 0.5% to ¥290,586 million, owing to the increase in R&D and other expenses. Despite operating profit for the Imaging System Business Unit in 2015 decreased by 5.7% from the previous year to ¥183,439 million, in response to the sales decline, operating profit ratio remained at the same level year on year, owing to the improvement in profitability from the sales shift to high- added-value models in camera, along with the positive effects of favorable currency exchange rates. Operating profit for the Industry and Others Business Unit in 2015, despite an improvement from the previous year resulted from sales increase, recorded a loss of ¥13,079 mil- lion due to upfront investment in next-generation technolo- gies and new businesses. FOREIGN OPERATIONS AND FOREIGN CURRENCY TRANSACTIONS Canon’s marketing activities are performed by subsidiaries in various regions in local currencies, while the cost of sales is generally in yen. Given Canon’s current operating structure, appreciation of the yen has a negative impact on net sales and the gross profit ratio. To reduce the financial risks from changes in foreign exchange rates, Canon utilizes derivative financial instruments, which consist principally of forward cur- rency exchange contracts. The operating profit 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 profitable than production activities, which are mainly conducted by the Company and its domestic subsidiaries. Please refer to the table of geographic information in Note 21 of the Notes to Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents decreased by ¥210,967 million to ¥633,613 million in fiscal 2015 compared to the previous year primarily due to the acquisition of Axis. Canon’s cash and cash equivalents are primarily denominated in Japanese yen and in U.S. dollars, with the remainder denominated in other currencies. Net cash provided by operating activities decreased by ¥109,203 million to ¥474,724 million in fiscal 2015 com- pared to the previous year due to the decrease in profit along with the increase in working capital. The major component of Canon’s cash inflow is cash received from customers, and the major components of Canon’s cash outflow are payments for parts and materials, selling, general and administrative expenses, R&D expenses and income taxes. For fiscal 2015, cash inflow from cash received from cus- tomers increased thanks to sales growth. There were no sig- nificant changes in Canon’s collection rates. Cash outflow for payments for parts and materials decreased due to efforts to reduce inventory level. Cash outflow for payments for sell- ing, general and administrative expenses increased due to the translation effect on operating expenses denominated in for- eign currencies that resulted from the depreciation of the yen. The increase also reflects the acquisition of Axis and other companies. Cash outflow for income taxes increased due to an increase in taxable income. Net cash used in investing activities increased by ¥184,321 million to ¥453,619 million in fiscal 2015. This mainly reflects the acquisition of Axis to enhance Canon’s network camera business. Canon defines “free cash flow” as cash flows from operat- ing activities less cash flows from investing activities. For fis- cal 2015, free cash flow decreased by ¥293,524 million to ¥21,105 million as compared with ¥314,629 million for fis- cal 2014. Canon’s management recognizes that constant and intensive investment in facilities and R&D is required to maintain and strengthen the competitiveness of its prod- ucts. On March 17, 2016, the Board of Directors of the Company approved an acquisition of Toshiba Medical Systems Corporation (“TMSC”) from Toshiba Corporation (“Toshiba”) to make TMSC a subsidiary, and concurrently it has entered into a share transfer agreement with Toshiba. The Company CANON ANNUAL REPORT 2015 41 FINANCIAL OVERVIEW paid a total consideration of ¥665.5 billion for a right to acquire all the ordinary shares of TMSC, which is exercis- able upon the clearance of necessary competition regula- tory authorities. The Company borrowed the consideration through bank borrowing of ¥660 billion provisionally, which is due on September 30, 2016. The Company plans to make its final decision on whether to use own funds, borrowings or a combination of both, to fund the acquisition, by that time. Canon’s management seeks to meet its capital require- ments with generating cash flow principally from its operating activities. Therefore, its capital resources are primarily sourced from internally generated funds. Accordingly, Canon includes information with regard to free cash flow as management frequently monitors this indicator, and believes that such indi- cator is beneficial to an investor’s understanding. Furthermore, Canon’s management believes that this indicator is significant in understanding Canon’s current liquidity and the alternatives of use in financing activities because it takes into consider- ation its operating and investing activities. Canon refers to this indicator together with relevant U.S. GAAP financial measures shown in its consolidated statements of cash flows and con- solidated balance sheets for cash availability analysis. Net cash used in financing activities totaled ¥210,202 mil- lion in fiscal 2015, mainly resulting from the dividend pay- out of ¥174,711 million. The Company paid dividends in fiscal 2015 of ¥160.00 per share. To the extent Canon relies on external funding for its liquid- ity and capital requirements, it generally has access to vari- ous funding sources, including the issuance of additional share capital, long-term debt or short-term loans. While Canon has been able to obtain funding from its traditional financing sources and from the capital markets, and believes it will con- tinue to be able to do so in the future, there can be no assur- ance that adverse economic or other conditions will not affect Canon’s liquidity or long-term funding in the future. compared with ¥1,018 million at December 31, 2014. Long- term debt (excluding the current portion) amounted to ¥881 million at December 31, 2015 compared with ¥1,148 million at December 31, 2014. Canon’s long-term debt mainly 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 11, 2016, 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 down- grade 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. Canon’s management policy in recent periods to optimize inventory levels is intended to maintain an appropriate balance among relevant imperatives, including minimizing working capital, avoiding undue exposure to the risk of inventory obso- lescence, and maintaining the ability to sustain sales despite the occurrence of unexpected disasters. Reflecting the foregoing circumstances, Canon’s total inven- tory turnover ratios were 47, 50, and 52 days at the end of the fiscal years 2015, 2014, and 2013, respectively and the improvements over the last three years are in line with Canon’s expectations and its revised inventory management policy. Increase in property, plant and equipment on an accrual basis in 2015 amounted to ¥195,120 million compared with ¥182,343 million in 2014 and ¥188,826 million in 2013. For 2016, Canon projects its increase in property, plant and equip- ment will be approximately ¥230,000 million. Short-term loans (including the current portion of long- term debt) amounted to ¥688 million at December 31, 2015 Employer contributions to Canon’s worldwide defined ben- efit pension plans were ¥19,565 million in 2015, ¥22,146 Increase in Property, Plant and Equipment (Billions of yen) Working Capital Ratio Return on Canon Inc. Shareholders’ Equity (%) 300 200 100 0 3.0 2.5 2.0 1.5 1.0 0.5 0 12 9 6 3 0 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 42 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA million in 2014 and ¥48,515 million in 2013. Employer con- tributions to Canon’s worldwide defined contribution pension plans were ¥17,277 million in 2015, ¥15,077 million in 2014, and ¥14,383 million in 2013. In addition, employer contribu- tions to the multiemployer pension plan of certain subsidiaries were ¥3,864 million in 2015 and ¥2,815 million in 2014. Working capital in 2015 decreased by ¥228,704 million to ¥1,241,850 million, compared with ¥1,470,554 million in 2014 and ¥1,437,635 million in 2013. Canon believes its working capital will be sufficient for its requirements for the foreseeable future. Canon’s capital requirements are primar- ily dependent on management’s business plans regarding the levels and timing of purchases of fixed assets and investments. The working capital ratio (ratio of current assets to current lia- bilities) for 2015 was 2.52 compared to 2.60 for 2014 and to 2.69 for 2013. Return on assets (net income attributable to Canon Inc. divided by the average of total assets) was 5.0% in 2015, compared to 5.9% in 2014 and 5.6% in 2013. Return on Canon Inc. shareholders’ equity (net income attributable to Canon Inc. divided by the average of total Canon Inc. shareholders’ equity) was 7.4% in 2015 compared with 8.7% in 2014 and 8.4% in 2013. The debt to total assets ratio was 0.0%, 0.0% and 0.1% as of December 31, 2015, 2014 and 2013, respectively. Canon had short-term loans and long-term debt of ¥1,569 million as of December 31, 2015, ¥2,166 million as of December 31, 2014 and ¥2,747 million as of December 31, 2013. OFF-BALANCE SHEET ARRANGEMENTS As part of its ongoing business, Canon does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities 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 employ- ees, affiliates and other companies. Canon will have to per- form 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 5 years in the case of affiliates and other companies. The maximum amount of undiscounted payments Canon would have had to make in the event of default by all borrowers was ¥7,685 million at December 31, 2015. The carrying amounts of the liabilities recognized for Canon’s obligations as a guarantor under those guarantees at December 31, 2015 were insignificant. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following summarizes Canon’s contractual obligations at December 31, 2015. Millions of yen Contractual obiligations: 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 ¥ 1,470 73 87,592 ¥ 630 32 26,294 ¥ 705 28 34,183 ¥ 135 13 14,962 ¥ — — 12,153 43,059 75,439 43,059 75,439 — — — — — — — — — Contribution to defined benefit pension plans 20,721 20,721 Total ¥228,354 ¥166,175 ¥34,916 ¥15,110 ¥12,153 Note: The table does not include provisions for uncertain tax positions and related accrued interest and penalties, as the specific timing of future payments related to these obligations cannot be projected with reasonable certainty. See Note 12, Income Taxes in the Notes to Consolidated Financial Statements for further details. Contribution to defined benefit pension plans reflects the expected amount only for the next fiscal year, since contributions beyond the next fiscal year are not currently determinable due to uncertainties related to changes in actuarial assumptions, returns on plan assets and changes to plan membership. 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 costs are primar- ily based on historical experience, and are affected by ongo- ing product failure rates, specific product class failures outside CANON ANNUAL REPORT 2015 43 FINANCIAL OVERVIEW of the baseline experience, material usage and service delivery costs incurred in correcting a product failure. As of December 31, 2015, accrued product warranty costs amounted to ¥14,014 million. At December 31, 2015, commitments outstanding for the purchase of property, plant and equipment were approxi- mately ¥43,059 million, and commitments outstanding for the purchase of parts and raw materials were approximately ¥75,439 million, both for use in the ordinary course of its busi- ness. Canon anticipates that funds needed to fulfill these com- mitments will be generated internally through operations. During 2016, Canon expects to contribute ¥12,015 million to its Japanese defined benefit pension plans and ¥8,706 mil- lion to its foreign defined benefit pension plans. Canon’s management believes that current financial resources, cash generated from operations and Canon’s poten- tial capacity for additional debt and/or equity financing will be sufficient to fund current and future capital requirements. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES Year 2015 marks the last year of the Excellent Global Corporation Plan, Canon’s 5-year (2011-2015) management plan. The slogan of the fourth phase (“Phase IV”) is “Aiming for the Summit - Speed & Sound Growth” and there are three core strategies related to R&D: • Achieve the overwhelming No.1 position in all core busi- nesses and expand related and peripheral businesses; • Develop new business through globalized diversification and establish the Three Regional Headquarters manage- ment system; and • Build the foundations of an environmentally advanced corporation. Canon has been striving to implement the three R&D related strategies as follows: • Achieve the overwhelming No.1 position in all core busi- nesses and expand related and peripheral businesses: Continue to introduce competitive products through innovation and aim at gaining profit through solutions and services. • Develop new business through globalized diversification and establish the Three Regional Headquarters manage- ment system: Reinforce the businesses of medical imaging sector, industrial equipment sector and network camera sector to develop into Canon’s new pillars. Seek talents in Japan, US, and Europe to foster promising technologies and enhance R&D capabilities in global-scale dimensions by enabling product development in specialized area of each region, with actively utilizing M&A. • Build the foundations of an environmentally advanced cor- poration: Focus on energy-conserving, resource-saving, and recycling technologies to create products with the highest environmental performance. Canon is pursuing collaboration among government, industry and academia. Canon’s collaboration effort can be seen in various activities such as fundamental research and 44 CANON ANNUAL REPORT 2015 development of leading-edge technologies with top universi- ties and research institutes around the world, including Tokyo University, Kyoto University, Tokyo Institute of Technology, Tohoku University, Stanford University, and the University of Arizona, and also participation in the “ImPACT” (Impulsing Paradigm Change through Disruptive Technologies) program led by the Japanese government where Canon’s physically-noninvasive and -nondestructive imaging technol- ogy is selected as one of the R&D programs. Additionally, Canon is currently working on collaborative research with Massachusetts General Hospital (“MGH”) and Brigham and Women’s Hospital (“BWH”) to develop biomedical optical imaging and medical robotics technologies at the Healthcare Optics Research Laboratory in Cambridge, Massachusetts, founded in 2013. Canon has developed a comprehensive imaging simula- tion system covering all image formation processes includ- ing optics, mechanics, sensor, and image processing, ahead of its competitors. With the simulation system, Canon has suc- ceeded in further reducing the need for prototypes, lowering costs and shortening product development lead times. Canon’s consolidated R&D expenses were ¥328,500 million in 2015, ¥308,979 million in 2014 and ¥306,324 million in 2013. The ratios of R&D expenses to the consolidated total net sales for 2015, 2014 and 2013 were 8.6%, 8.3% and 8.2%, respectively. Canon believes that new products protected by the robust patents portfolio will not easily allow competitors to compete with them, and will give them an advantage in establishing standards in the market and industry. Canon obtained the third greatest number of private sector patents in 2015, according to the United States patent annual list, released by IFI CLAIMS® Patent Services. R&D Expenses (Billions of yen) 400 300 200 100 0 2011 2012 2013 2014 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA MARKET RISK EXPOSURES 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 financial 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 classified as available-for-sale securities, were as follows at December 31, 2015. Available-for-sale securities Debt securities Due after five years Fund trusts Equity securities Millions of yen Cost Fair value ¥ 304 63 20,461 ¥ 488 64 42,849 ¥20,828 ¥43,401 Foreign currency exchange rate and interest rate risk Canon operates internationally, exposing it to the risk of changes in foreign currency exchange rates. Derivative finan- cial instruments are comprised principally of foreign currency exchange contracts utilized by the Company and certain of its subsidiaries to reduce the risk. Canon assesses foreign cur- rency exchange rate risk by continually monitoring changes in the exposures and by evaluating hedging opportunities. Canon does not hold or issue derivative financial instruments for trading purposes. Canon is also exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments, but it is not expected that any counterparties will fail to meet their obligations. Most of the counterparties are internationally recognized financial institutions and selected by Canon taking into account their financial condition, and contracts are diversified across a num- ber of major financial institutions. Canon’s international operations expose Canon to the risk of changes in foreign currency exchange rates. Canon uses foreign exchange contracts to manage certain foreign currency exchange exposures principally from the exchange of U.S. dol- lars and euros into Japanese yen. These contracts are primar- ily used to hedge the foreign currency exposure of forecasted intercompany sales and intercompany trade receivables which are denominated in foreign currencies. In accordance with Canon’s policy, a specific portion of foreign currency exposure resulting from forecasted intercompany sales are hedged using foreign exchange contracts which principally mature within three months. The following table provides information about Canon’s major derivative financial instruments related to foreign currency exchange transactions existing at December 31, 2015. All of the foreign exchange contracts described in the following table have a contractual maturity date in 2016. Millions of yen 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 ¥120,227 (41) ¥90,865 226 ¥16,961 78 ¥228,053 263 ¥ 27,553 ¥ 9,623 ¥ 364 ¥ 37,540 318 265 15 598 All of Canon’s long-term debt is fixed rate debt. Canon expects that fair value changes and cash flows resulting from reasonable near-term changes in interest rates will be imma- terial. Accordingly, Canon believes interest rate risk is insignif- icant. See also Note 9 of the Notes to Consolidated Financial Statements. Changes in the fair value of derivative financial instruments designated as cash flow hedges, including foreign currency exchange contracts associated with forecasted intercom- pany sales, are reported in accumulated other comprehensive CANON ANNUAL REPORT 2015 45 FINANCIAL OVERVIEW income (loss). These amounts are subsequently reclassified into earnings through other income (deductions) in the same period as the hedged items affect earnings. Substantially all such amounts recorded in accumulated other comprehen- sive income (loss) at year-end are expected to be recognized in earnings over the next twelve months. Canon excludes the time value component from the assessment of hedge effectiveness. Changes in the fair value of a foreign cur- rency exchange contract for the period between the date that the forecasted intercompany sales occur and its matu- rity 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, 2015, 2014 and 2013. The amounts of net losses excluded from the assessment of hedge effectiveness (time value component) which was recorded in other income (deductions) was ¥131 million, ¥145 million and ¥111 million for the years ended December 31, 2015, 2014 and 2013, 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. LOOKING FORWARD As for the future of the global economy, although it is expected to be somewhat better than what it had been over the past five years, the situation remains unstable due to issues such as increased geopolitical risk in the Middle East and the economic slowdown in China. As such, global eco- nomic growth is expected to remain modest. From an indus- trial perspective, however, remarkable developments are being made in technologies in such areas as the IoT and artifi- cial intelligence, which are leading to major changes in indus- try structure. Advancements in digital technology have made it easier for startup companies to enter markets, thus fueling increased market competition. In the businesses in which Canon is involved, although demand for color office MFDs and production printers is expected to continue growing, a recovery in sales of products that are largely sold in emerging markets, such as entry-class cameras and single-function laser printers, is expected to take time. Within the market for semiconductor lithography equip- ment, capital investment is expected to remain strong while forecasts for the FPD lithography equipment market also point to further future expansion. Also expected to grow is the net- work camera market, a market in which Axis, which became a consolidated subsidiary in 2015, is a major player. Under these circumstances, the Canon Group embarked on a new five-year plan, Phase V of the “Excellent Global Corporation Plan.” During Phase V, under the basic policy of “Embracing the challenge of new growth through a grand strategic transformation,” reforms that were promoted in Phase IV will be further expanded upon. In 2020, the final year of Phase V, Canon aims to achieve net sales of 5 trillion yen, an operating profit ratio of 15% or more, a net income ratio of 10% or more, and a shareholders’ equity ratio of 70% or more. Toward this objective, Canon will undertake the follow- ing various measures. Establish a new production system to achieve a cost- of-sales ratio of 45% Strengthen domestic mother factories by further promot- ing the return of production to Japan and the integration of design, procurement, production engineering, and man- ufacturing technology operations. At the same time, pur- sue total cost reductions through the promotion of such advanced production engineering technologies as robotics and automation. Reinforce and expand new businesses while creating future businesses Create and expand new businesses by accelerating the hor- izontal expansion of existing business. Additionally, con- centrate management resources and make effective use of M&A to accelerate the expansion of promising business areas such as commercial printing, network cameras and life sciences. 46 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Forward looking statements The foregoing discussion and other disclosure in this report contains forward-looking statements that reflect manage- ment’s current views with respect to certain future events and financial performance. Actual results may differ materially from those projected or implied in the forward-looking state- ments. Further, certain forward-looking statements are based upon assumptions of future events that may not prove to be accurate. The following important factors could cause actual results to differ materially from those projected or implied in any forward-looking statements: foreign currency exchange rate fluctuations; the uncertainty of Canon’s ability to imple- ment its plans to localize production and other measures to reduce the impact of foreign currency exchange rate fluctua- tions; uncertainty as to economic conditions in Canon’s major markets; uncertainty of continued demand for Canon’s high- value-added products; Canon’s ability to continue to develop products and to market products that incorporate new tech- nology on a timely basis, are competitively priced, and achieve market acceptance; the possibility of losses resulting from for- eign currency transactions designed to reduce financial risks from changes in foreign currency exchange rates; and inven- tory risk due to shifts in market demand. Restructure the global sales network in accordance with market changes Review existing sales organizations and reinforce omni- channel marketing that integrates online and brick-and- mortar sales routes while strengthening and expanding solutions-driven businesses with the aim of solving issues faced by customers. Additionally, continue focusing energy on developing marketing in emerging countries. Enhance R&D capabilities through open innovation Discard the strict notion of self-sufficiency and construct an R&D system that proactively leverages external technologies and knowledge, promoting joint and contract research with various partners such as domestic and foreign universities and research institutes. Complete the Three Regional Headquarters management system capturing world dynamism Promote the acquisition of promising businesses through active M&A and complete the Three Regional Headquarter management system, under which Japan, the U.S. and Europe will each roll out businesses globally. Additionally, under the theme “Taking a decisive first step toward transformation,” the following key challenges will be pursued in 2016, the inaugural year of Phase V. Draft and implement plans to revitalize existing businesses Raise profitability through drastic cost-cutting and work to revitalize businesses, swiftly launching future products that were exhibited at Canon EXPO 2015. Rapidly expand new businesses Work to speed up the expansion and deployment of large- scale businesses such as commercial printing and network cameras. Accelerate efforts aimed at reducing the cost-of-sales ratio Continue to investigate optimal locations for production sites and work to accelerate cost reductions at all stages, including product development. Boost sales productivity through marketing reforms Accelerate efforts to address global growth in e-commerce and work to reinforce the solutions business. Improve R&D productivity through selection and con- centration Apply the selection and concentration process to develop- ment themes and boost R&D productivity. Promote the cultivation of global human resources Build a structure to discover talented individuals from within the entire Canon Group to cultivate global competent human resources capable of performing duties while maintaining an all-encompassing perspective of the world map. CANON ANNUAL REPORT 2015 47 TEN-YEAR FINANCIAL SUMMARY Millions of yen (except per share amounts) 2015 2014 2013 2012 Net sales: Domestic Overseas Total Percentage of previous year ¥ 714,280 3,085,991 3,800,271 102.0% ¥ 724,317 3,002,935 3,727,252 99.9% ¥ 715,863 3,015,517 3,731,380 107.2% ¥ 720,286 2,759,502 3,479,788 97.8% Net income attributable to Canon Inc. Percentage of sales 220,209 254,797 230,483 5.8% 6.8% 6.2% Advertising Research and development expenses Depreciation of property, plant and equipment Increase in property, plant and equipment 80,907 328,500 223,759 195,120 79,765 308,979 213,739 182,343 86,398 306,324 223,158 188,826 224,564 6.5% 83,134 296,464 211,973 270,457 Long-term debt, excluding current installments Canon Inc. shareholders’ equity Total assets ¥ 881 2,966,415 4,427,773 ¥ 1,148 2,978,184 4,460,618 ¥ 1,448 2,910,262 4,242,710 ¥ 2,117 2,598,026 3,955,503 Per share data: Net income attributable to Canon Inc. shareholders per share: Basic Diluted Dividend per share Stock price: High Low ¥ 201.65 201.65 150.00 4,539 3,402 ¥ 229.03 229.03 150.00 4,045 2,889 ¥ 200.78 200.78 130.00 4,115 2,913 ¥ 191.34 191.34 130.00 4,015 2,308 Average number of common shares in thousands Number of employees 1,092,018 189,571 1,112,510 191,889 1,147,934 194,151 1,173,648 196,968 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 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 48 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 2011 2010 2009 2008 2007 2006 2015 Thousands of U.S. dollars (except per share amounts) ¥ 694,450 2,862,983 3,557,433 ¥ 695,749 3,011,152 3,706,901 115.5% ¥ 702,344 2,506,857 3,209,201 ¥ 868,280 3,225,881 4,094,161 96.0% 78.4% 91.4% ¥ 947,587 3,533,759 4,481,346 107.8% ¥ 932,290 3,224,469 4,156,759 110.7% 248,630 246,603 131,647 309,148 488,332 7.0% 6.7% 4.1% 7.6% 10.9% 81,232 307,800 210,179 226,869 94,794 315,817 232,327 158,976 78,009 304,600 277,399 216,128 112,810 374,025 304,622 361,988 132,429 368,261 309,815 428,549 455,325 11.0% 116,809 308,307 235,804 379,657 $ 5,903,140 25,504,058 31,407,198 102.0% 1,819,909 5.8% 668,653 2,714,876 1,849,248 1,612,562 ¥ 3,368 2,551,132 3,930,727 ¥ 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 ¥ 15,789 2,986,606 4,521,915 $ 7,281 24,515,826 36,593,165 ¥ 204.49 204.48 120.00 4,280 3,220 ¥ 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 ¥ 341.95 341.84 83.33 6,780 4,567 $ 1.67 1.67 1.24 37.51 28.12 1,215,832 198,307 1,234,817 197,386 1,234,482 168,879 1,255,626 166,980 1,293,296 131,352 1,331,542 118,499 Notes: 1. U.S. dollar amounts are translated from yen at the rate of U.S.$1 = JPY121, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 30, 2015. 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 reflect the stock split. CANON ANNUAL REPORT 2015 49 CONSOLIDATED BALANCE SHEETS Canon Inc. and Subsidiaries December 31, 2015 and 2014 ASSETS Current assets: Cash and cash equivalents (Note 1) Short-term investments (Note 2) Trade receivables, net (Note 3) Inventories (Note 4) Prepaid expenses and other current assets (Notes 6, 12 and 17) Total current assets Noncurrent receivables (Note 18) Investments (Note 2) Property, plant and equipment, net (Notes 5 and 6) Intangible assets, net (Notes 7 and 8) Goodwill (Notes 7 and 8) Other assets (Notes 6, 11 and 12) Total assets LIABILITIES AND EQUITY Current liabilities: Short-term loans and current portion of long-term debt (Note 9) Trade payables (Note 10) Accrued income taxes (Note 12) Accrued expenses (Notes 11 and 18) Other current liabilities (Notes 5, 12 and 17) Total current liabilities Long-term debt, excluding current installments (Note 9) Accrued pension and severance cost (Note 11) Other noncurrent liabilities (Notes 7 and 12) Total liabilities Commitments and contingent liabilities (Note 18) Equity: Canon Inc. shareholders’ equity: Common stock Authorized 3,000,000,000 shares; issued 1,333,763,464 shares in 2015 and 2014 Additional paid-in capital Legal reserve (Note 13) Retained earnings (Note 13) Accumulated other comprehensive income (loss) (Note 14) Treasury stock, at cost; 241,690,840 shares in 2015 and 241,931,637 shares in 2014 Total Canon Inc. shareholders’ equity Noncontrolling interests Total equity Total liabilities and equity See accompanying Notes to Consolidated Financial Statements. 50 CANON ANNUAL REPORT 2015 Millions of yen 2015 2014 ¥ 633,613 20,651 588,001 501,895 313,019 ¥ 844,580 71,863 625,675 528,167 321,648 2,057,179 29,476 67,862 1,219,652 241,208 478,943 333,453 2,391,933 29,785 65,176 1,269,529 177,288 211,336 315,571 ¥ 4,427,773 ¥ 4,460,618 ¥ 688 278,255 47,431 317,653 171,302 ¥ 1,018 310,214 57,212 345,237 207,698 815,329 881 296,262 130,838 921,379 1,148 280,928 116,405 1,243,310 1,319,860 174,762 401,358 65,289 3,365,158 (29,742) (1,010,410) 2,966,415 218,048 174,762 401,563 64,599 3,320,392 28,286 (1,011,418) 2,978,184 162,574 3,184,463 3,140,758 ¥ 4,427,773 ¥ 4,460,618 CONSOLIDATED STATEMENTS OF INCOME Canon Inc. and Subsidiaries Years ended December 31, 2015, 2014 and 2013 Millions of yen 2015 2014 2013 Net sales Cost of sales (Notes 5, 8, 11 and 18) Gross profit Operating expenses (Notes 1, 5, 8, 11, 15 and 18): Selling, general and administrative expenses Research and development expenses Operating profit Other income (deductions): Interest and dividend income Interest expense Other, net (Notes 1, 2 and 17) Income before income taxes Income taxes (Note 12) Consolidated net income ¥ 3,800,271 ¥ 3,727,252 ¥ 3,731,380 1,932,959 1,798,421 1,865,887 1,934,384 1,865,780 1,861,472 1,250,674 328,500 1,189,004 308,979 1,154,820 306,324 1,579,174 1,497,983 1,461,144 355,210 363,489 337,277 5,501 (584) (12,689) 7,906 (500) 12,344 6,579 (550) 4,298 (7,772) 19,750 10,327 347,438 383,239 347,604 116,105 118,000 108,088 231,333 265,239 239,516 Less: Net income attributable to noncontrolling interests Net income attributable to Canon Inc. 11,124 10,442 9,033 ¥ 220,209 ¥ 254,797 ¥ 230,483 Net income attributable to Canon Inc. shareholders per share (Note 16): Basic Diluted Cash dividends per share See accompanying Notes to Consolidated Financial Statements. Yen ¥ 201.65 ¥ 229.03 ¥ 200.78 200.78 229.03 201.65 130.00 150.00 150.00 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Canon Inc. and Subsidiaries Years ended December 31, 2015, 2014 and 2013 Consolidated net income Other comprehensive income (loss), net of tax (Note 14): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Comprehensive income Less: Comprehensive income attributable to noncontrolling interests Millions of yen 2015 2014 2013 ¥ 231,333 ¥ 265,239 ¥ 239,516 (55,504) 2,010 2,785 (6,543) 143,834 2,524 (195) (37,985) 251,576 6,612 2,056 32,669 (57,252) 108,178 292,913 174,081 11,973 373,417 9,666 532,429 14,688 Comprehensive income attributable to Canon Inc. ¥ 162,108 ¥ 363,751 ¥ 517,741 See accompanying Notes to Consolidated Financial Statements. CANON ANNUAL REPORT 2015 51 CONSOLIDATED STATEMENTS OF EQUITY Canon Inc. and Subsidiaries Years ended December 31, 2015, 2014 and 2013 Common stock Additional paid-in capital Legal reserve Retained earnings Millions of yen Accumulated other comprehensive income (loss) Total Canon Inc. shareholders’ equity Treasury stock Noncontrolling interests Total equity Balance at December 31, 2012 ¥ 174,762 ¥ 401,547 ¥ 61,663 ¥ 3,138,976 ¥ (367,249) ¥ (811,673) ¥ 2,598,026 ¥ 156,276 ¥ 2,754,302 Equity transactions with noncontrolling interests and other Dividends to Canon Inc. shareholders Dividends to noncontrolling interests Transfer to legal reserve Comprehensive income: Net income Other comprehensive income, net of tax (Note 14): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income 489 295 (655) 129 (11,182) (155,627) 1,428 (1,428) (155,627) — (3,267) (11,053) (155,627) (3,267) — 230,483 230,483 9,033 239,516 249,791 6,097 2,056 29,314 249,791 1,785 251,576 6,097 515 6,612 2,056 29,314 — 3,355 2,056 32,669 517,741 14,688 532,429 Repurchases and reissuance of treasury stock (7) (7) (49,993) (50,007) (50,007) Balance at December 31, 2013 174,762 402,029 63,091 3,212,692 (80,646) (861,666) 2,910,262 156,515 3,066,777 Equity transactions with noncontrolling interests and other Dividends to Canon Inc. shareholders Dividends to noncontrolling interests Transfer to legal reserve Comprehensive income: Net income Other comprehensive income (loss), net of tax (Note 14): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income (420) 216 (22) (145,790) 1,508 (1,508) (226) (145,790) — (658) (2,949) (884) (145,790) (2,949) — 254,797 254,797 10,442 265,239 142,813 2,301 (195) (35,965) 142,813 1,021 143,834 2,301 223 2,524 (195) (35,965) — (2,020) (195) (37,985) 363,751 9,666 373,417 Repurchases and reissuance of treasury stock (46) (15) (149,752) (149,813) (149,813) Balance at December 31, 2014 174,762 401,563 64,599 3,320,392 28,286 (1,011,418) 2,978,184 162,574 3,140,758 Equity transactions with noncontrolling interests and other Dividends to Canon Inc. shareholders Dividends to noncontrolling interests Acquisition of subsidiaries Transfer to legal reserve Comprehensive income: Net income Other comprehensive income (loss), net of tax (Note 14): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income (29) 73 (174,711) 44 (174,711) 690 (690) — (29,627) (3,958) 77,086 (29,583) (174,711) (3,958) 77,086 — 220,209 220,209 11,124 231,333 (57,592) 1,509 2,785 (4,803) (57,592) 2,088 (55,504) 1,509 501 2,010 2,785 (4,803) — (1,740) 2,785 (6,543) 162,108 11,973 174,081 Repurchases and reissuance of treasury stock (176) (42) 1,008 790 790 Balance at December 31, 2015 ¥ 174,762 ¥ 401,358 ¥ 65,289 ¥ 3,365,158 ¥ (29,742) ¥ (1,010,410) ¥ 2,966,415 ¥ 218,048 ¥ 3,184,463 See accompanying Notes to Consolidated Financial Statements. 52 CANON ANNUAL REPORT 2015 CONSOLIDATED STATEMENTS OF CASH FLOWS Canon Inc. and Subsidiaries Years ended December 31, 2015, 2014 and 2013 Cash flows 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 fixed assets Equity in (earnings) losses of affiliated companies Deferred income taxes Decrease in trade receivables Decrease in inventories 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 Millions of yen 2015 2014 2013 ¥ 231,333 ¥ 265,239 ¥ 239,516 273,327 7,975 (447) 4,672 22,720 14,249 (17,288) (8,731) (25,529) 4,622 (32,179) 263,480 12,429 (478) 8,929 9,323 59,004 (24,620) 3,586 11,124 (6,305) (17,784) 275,173 10,638 664 16,791 45,040 85,577 (108,622) (9,432) (15,635) (15,568) (16,500) Net cash provided by operating activities 474,724 583,927 507,642 Cash flows from investing activities: Purchases of fixed assets (Note 5) Proceeds from sale of fixed assets (Note 5) Purchases of available-for-sale securities Proceeds from sale and maturity of available-for-sale securities (Increase) decrease in time deposits, net Acquisitions of businesses, net of cash acquired (Note 7) Purchases of other investments Other, net Net cash used in investing activities Cash flows from financing activities: Proceeds from issuance of long-term debt Repayments of long-term debt Decrease in short-term loans, net Purchases of noncontrolling interests Dividends paid Repurchases and reissuance of treasury stock Other, net Net cash used in financing activities (252,948) 3,824 (98) 804 47,665 (251,534) (1,220) (112) (218,362) 3,994 (311) 2,606 (14,223) (54,772) — 11,770 (233,175) 1,763 (5,771) 4,528 (12,483) (4,914) (296) 136 (453,619) (269,298) (250,212) 717 (1,350) — (29,570) (174,711) 790 (6,078) 1,377 (2,152) (54) — (145,790) (149,813) (4,454) 1,483 (2,334) (547) (2,616) (155,627) (50,007) (12,533) (210,202) (300,886) (222,181) Effect of exchange rate changes on cash and cash equivalents (21,870) 41,928 86,982 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 flow information: Cash paid during the year for: Interest Income taxes See accompanying Notes to Consolidated Financial Statements. (210,967) 55,671 122,231 844,580 788,909 666,678 ¥ 633,613 ¥ 844,580 ¥ 788,909 ¥ 653 117,643 ¥ 462 111,819 ¥ 500 108,950 CANON ANNUAL REPORT 2015 53 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Canon Inc. and Subsidiaries 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (a) Description of Business Canon Inc. (the “Company”) and subsidiaries (collectively “Canon”) is one of the world’s leading manufacturers in such fields as office products, imaging system products and indus- try and other products. Office products consist mainly of office multifunction devices (“MFDs”), laser multifunction printers (“MFPs”), laser printers, digital production printing systems, high speed continuous feed printers, wide-format printers and document solutions. Imaging system products consist mainly of interchangeable lens digital cameras, digital compact cameras, digital camcorders, digital cinema cameras, interchangeable lenses, compact photo printers, inkjet printers, large-format ink- jet printers, commercial photo printers, image scanners, multi- media projectors, broadcast equipment and calculators. Industry and other products consist mainly of semiconductor lithogra- phy equipment, FPD (Flat panel display) lithography equipment, digital radiography systems, ophthalmic equipment, vacuum thin-film deposition equipment, organic LED (“OLED”) panel manufacturing equipment, die bonders, micromotors, network cameras, handy terminals and document scanners. Canon’s consolidated net sales for the years ended December 31, 2015, 2014 and 2013 were distributed as follows: the Office Business Unit 55.5%, 55.8% and 53.6%, the Imaging System Business Unit 33.3%, 36.0% and 38.8%, the Industry and Others Business Unit 13.8%, 10.7% and 10.0%, and elimination between segments 2.6%, 2.5% and 2.4%, 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 21. Sales are made principally under the Canon brand name, almost entirely through sales subsidiaries. These subsidiaries are responsible for marketing and distribution, and primarily sell to retail dealers in their geographic area. 81.2%, 80.6% and 80.8% of consolidated net sales for the years ended December 31, 2015, 2014 and 2013 were generated outside Japan, with 30.1%, 27.8% and 28.4% in the Americas, 28.3%, 29.3% and 30.1% in Europe, and 22.8%, 23.5% and 22.3% in Asia and Oceania, respectively. Canon sells laser printers on an OEM basis to HP Inc.; such sales constituted 17.8%, 17.4% and 17.6% of consolidated net sales for the years ended December 31, 2015, 2014 and 2013, respectively, and are included in the Office Business Unit. Canon’s manufacturing operations are conducted primarily at 28 plants in Japan and 18 overseas plants which are located in countries or regions such as the United States, Germany, France, the Netherlands, Taiwan, China, Malaysia, Thailand, Vietnam and Philippines. (b) Basis of Presentation The Company and its domestic subsidiaries maintain their books of account in conformity with financial accounting stan- dards of Japan. Foreign subsidiaries maintain their books of account in conformity with financial accounting standards of the countries of their domicile. Certain adjustments and reclassifications have been incorporated in the accompanying consolidated financial statements to conform with U.S. generally accepted accounting principles (“GAAP”). These adjustments were not recorded in the statutory books of account. (c) Principles of Consolidation The consolidated financial statements include the accounts of the Company, its majority owned subsidiaries and those variable interest entities where the Company or its consolidated subsidiar- ies are the primary beneficiaries. All significant intercompany bal- ances and transactions have been eliminated. (d) Use of Estimates The preparation of the consolidated financial statements in con- formity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabili- ties at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Significant estimates and assumptions are reflected in valua- tion and disclosure of revenue recognition, allowance for doubt- ful receivables, inventories, long-lived assets, goodwill and other intangible assets with indefinite useful lives, environmental liabil- ities, deferred tax assets, uncertain tax positions and employee retirement and severance benefit obligations. Actual results could differ materially from those estimates. (e) Translation of Foreign Currencies Assets and liabilities of the Company’s subsidiaries located outside Japan with functional currencies other than Japanese yen are translated into Japanese yen at the rates of exchange in effect at the balance sheet date. Income and expense items are translated at the average exchange rates prevailing during the year. Gains and losses resulting from translation of finan- cial statements are excluded from earnings and are reported in other comprehensive income (loss). Gains and losses resulting from foreign currency trans- actions, including foreign exchange contracts, and transla- tion 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 a net loss of ¥22,149 million for the year ended December 31, 2015, a net gain of ¥2,628 million for the year ended December 31, 2014 and a net loss of ¥1,992 million for the year ended December 31, 2013, respectively. (f) Cash Equivalents All highly liquid investments acquired with original maturi- ties of three months or less are considered to be cash equiv- alents. Certain debt securities with original maturities of less than three months, classified as available-for-sale securities of ¥80,870 million and ¥139,240 million at December 31, 2015 and 2014, respectively, are included in cash and cash equiva- lents in the consolidated balance sheets. 54 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA (g) Investments Investments consist primarily of time deposits with original matur- ities of more than three months, debt and marketable equity securities, investments in affiliated companies and non- marketable equity securities. Canon reports investments with maturities of less than one year as short-term investments. Canon classifies investments in debt and marketable equity securities as available-for-sale or held-to-maturity securities. Canon does not hold any trading securities, which are bought and held primarily for the purpose of sale in the near term. Available-for-sale securities are recorded at fair value. Fair value is determined based on quoted market prices, projected dis- counted cash flows or other valuation techniques as appropriate. Unrealized holding gains and losses, net of the related tax effect, are reported as a separate component of accumulated other comprehensive income (loss) until realized. Held-to-maturity secu- rities are recorded at amortized cost, adjusted for amortization of premiums and accretion of discounts. Available-for-sale and held-to-maturity securities are regu- larly reviewed for other-than-temporary declines in the carry- ing amount based on criteria that include the length of time and the extent to which the market value has been less than cost, the financial condition and near-term prospects of the issuer and Canon’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in mar- ket value. For debt securities for which the declines are deemed to be other-than-temporary and there is no intent to sell, impair- ments are separated into the amount related to credit loss, which is recognized in earnings, and the amount related to all other fac- tors, which is recognized in other comprehensive 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, impair- ments in their entirety are recognized in earnings. Canon recog- nizes 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 reflected in earnings. Investments in affiliated companies over which Canon has the ability to exercise significant influence, but does not hold a con- trolling financial interest, are accounted for by the equity method. Non-marketable equity securities in companies over which Canon does not have the ability to exercise significant influence are stated at cost and reviewed periodically for impairment. (h) Allowance for Doubtful Receivables Allowance for doubtful trade and finance receivables is main- tained for all customers based on a combination of factors, including aging analysis, macroeconomic conditions and histor- ical experience. An additional reserve for individual accounts is recorded when Canon becomes aware of a customer’s inability to meet its financial obligations, such as in the case of bankruptcy filings. If 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 first-in, first-out method for overseas inventories. (j) Impairment of Long-Lived Assets Long-lived assets, such as property, plant and equipment, and acquired intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recov- erable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset and the esti- mated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of the asset exceeds its esti- mated undiscounted future cash flows, 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 carrying 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 lease term, generally from 2 years to 5 years. (l) Goodwill and Other Intangible Assets Goodwill and other intangible assets with indefinite useful lives are not amortized, but are instead tested for impairment annually in the fourth quarter of each year, or more frequently if indicators of potential impairment exist. Canon performs its impairment test of goodwill using the two-step approach at the reporting unit level, which is one level below the operating segment level. All good- will is assigned to the reporting unit or units that benefit 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 performs 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 finite useful lives consist primarily of software, trademarks, patents and developed technology, license fees and customer relationships, which are amortized using the straight-line method. The estimated useful lives of software are from 3 years to 5 years, trademarks are 15 years, patents and developed technology are from 7 years to 16 years, license fees are 7 years, and customer relationships are from 8 years to 15 years, respectively. Certain costs incurred CANON ANNUAL REPORT 2015 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS in connection with developing or obtaining internal-use soft- ware 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 connection 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 financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabili- ties 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 financial 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. Benefits from tax positions that meet the more-likely-than-not recognition threshold are measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. Interest and penalties accrued related to unrecognized tax benefits 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. Shareholders per Share Basic net income attributable to Canon Inc. shareholders per share is computed by dividing net income attributable to Canon Inc. by the weighted-average number of com- mon shares outstanding during each year. Diluted net income attributable to Canon Inc. shareholders per share includes the effect from potential issuances of common stock based on the assumptions that all stock options were exercised. (q) Revenue Recognition Canon generates revenue principally through the sale of office and imaging system products, equipment, supplies, and related services under separate contractual arrangements. Canon rec- ognizes 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 rendered, the sales price is fixed or determinable, and collectibility is probable. Revenue from sales of office products, such as office MFDs and laser printers, and imaging system products, such as digital cameras and inkjet printers, is recognized upon shipment or delivery, depend- ing upon when title and risk of loss transfer to the customer. Canon also offers separately priced product maintenance contracts for most office products, for which the customer typi- cally 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-financing leases is recognized over the life of each respective lease using the interest method. Leases not qualifying as sales-type leases or direct-financing leases are accounted for as operating leases and related revenue is rec- ognized ratably over the lease term. When equipment leases are bundled with product maintenance contracts, revenue is allocated based upon the estimated relative fair value of the lease and non-lease deliverables. Lease deliverables generally include equipment, financing and executory costs, while non- lease deliverables generally consist of product maintenance contracts and supplies. Revenue from sales of optical equipment, such as semicon- ductor lithography equipment and FPD 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 specific 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. For all other arrangements with multiple elements, Canon allocates revenue to each element based on its relative selling price if such element meets the criteria for treatment as a sep- arate unit of accounting. Otherwise, revenue is deferred until the undelivered elements are fulfilled 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 to sales are based upon historical trends and other known factors at the time of sale. Canon regularly adjusts its estimates each period in the ordinary course of establishing sales incentive program accruals based on current information. Canon also provides price protection to certain resellers of its products, and records reductions to sales for the estimated 56 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA impact of price protection obligations when announced. operating activities in the consolidated statements of cash flows. 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, specific 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 govern- mental authorities are excluded from revenues in the consoli- dated 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 ¥80,907 million, ¥79,765 million and ¥86,398 million for the years ended December 31, 2015, 2014 and 2013, respectively. (t) Shipping and Handling Costs Shipping and handling costs totaled ¥52,504 million, ¥49,576 mil- lion and ¥47,460 million for the years ended December 31, 2015, 2014 and 2013, 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 flows to be received or paid related to a recognized asset or liability (“cash flow” hedge). Canon formally documents all relation- ships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. Canon also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, Canon discontinues hedge accounting prospectively. Changes in the fair value of a derivative that is designated and quali- fies as a cash flow hedge are recorded in other comprehen- sive income (loss), until earnings are affected by the variability in cash flows of the hedged item. Gains and losses from hedg- ing 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 financial instruments which are not designated as hedges. The changes in fair values of these deriva- tive financial instruments are immediately recorded in earnings. Canon classifies cash flows from derivatives as cash flows from (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 September 2015, the Financial Accounting Standards Board (“FASB”) issued an amendment which requires an acquirer in a business combination to recognize the effect on earnings of any adjustments identified during the measurement period after an acquisition in the same period the adjustment is iden- tified, as opposed to the prior guidance which required mate- rial adjustments be retrospectively adjusted. Canon adopted this amended guidance from the quarter beginning October 1, 2015. This adoption did not have a material impact on its con- solidated results of operations and financial condition. In May 2014, the FASB issued a new accounting standard related to revenue from contracts with customers. This stan- dard requires an entity to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This stan- dard was originally planned to be effective for annual report- ing periods beginning after December 15, 2016, however, in August 2015, the FASB issued an accounting standard update for a one-year deferral of the effective date. Early adoption as of the original effective date is permitted. This standard may be applied retrospectively to each prior reporting period pre- sented or retrospectively with the cumulative effect of initially applying this standard recognized at the date of initial applica- tion. Canon has not selected a transition method and is cur- rently evaluating the adoption date and the effect that the adoption of this standard will have on its consolidated results of operations and financial condition. In July 2015, the FASB issued an amendment which requires an entity to measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably pre- dictable costs of completion, disposal, and transportation. This guidance is effective for annual reporting periods begin- ning after December 15, 2016, and early adoption is permit- ted. Canon is currently evaluating the adoption date and does not expect the adoption of this guidance to have a material impact on its consolidated results of operations and financial condition. In November 2015, the FASB issued an amendment which requires deferred tax assets and liabilities be classified as noncur- rent in the consolidated balance sheets. This guidance is effec- tive for annual reporting periods beginning after December 15, 2016, and early adoption is permitted. Canon will early adopt this amended guidance from the quarter beginning January 1, 2016, on a prospective basis, and prior periods were not ret- rospectively adjusted. The adoption of this guidance will have an impact on its consolidated balance sheets as our current deferred tax assets were ¥55,108 million and current deferred CANON ANNUAL REPORT 2015 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS tax liabilities were ¥2,682 million as of December 31, 2015. In January 2016, the FASB issued an amendment which addresses certain aspects of recognition, measurement, pre- sentation, and disclosure of financial instruments. This guid- ance includes the requirement that equity investments be measured at fair value with changes in the fair value recog- nized in net income. This guidance is effective for annual reporting periods beginning after December 15, 2017, and early adoption is permitted for certain provisions. Canon is currently evaluating the adoption date and the effect that the adoption of this guidance will have on its consolidated results of operations and financial condition. In February 2016, the FASB issued an amendment which requires lessees to recognize most leases on their balance sheets but recognize expenses on their income statements in a manner similar to current guidance. For lessors, the guidance modifies the classification criteria and the accounting for sales- type and direct financing leases. This guidance is effective for annual reporting periods beginning after December 15, 2018, and early adoption is permitted. Canon is currently evaluat- ing the adoption date and the effect that the adoption of this guidance will have on its consolidated results of operations and financial condition. 2. INVESTMENTS The cost, gross unrealized holding gains, gross unrealized holding losses and fair value for available-for-sale securities included in investments by major security type at December 31, 2015 and 2014 were as follows: December 31 Millions of yen 2015: Noncurrent: Government bonds Corporate bonds Fund trusts Equity securities Millions of yen 2014: Noncurrent: Government bonds Corporate bonds Fund trusts Equity securities Cost Gross unrealized holding gains Gross unrealized holding losses Fair value ¥ 298 6 63 20,461 ¥ 20,828 ¥ — 195 1 23,482 ¥ 23,678 ¥ 11 — — 1,094 ¥ 1,105 ¥ 287 201 64 42,849 ¥ 43,401 Cost Gross unrealized holding gains Gross unrealized holding losses Fair value ¥ 331 512 84 20,905 ¥ 21,832 ¥ — 153 — 19,765 ¥ 19,918 ¥ 6 29 — 17 ¥ 52 ¥ 325 636 84 40,653 ¥ 41,698 Maturities of available-for-sale debt securities included in investments in the accompanying consolidated balance sheets were as follows at December 31, 2015: Due after five years Millions of yen Cost ¥ 304 ¥ 304 Fair value ¥ 488 ¥ 488 Gross realized gains were ¥329 million, ¥2,540 million and ¥2,360 million for the years ended December 31, 2015, 2014 and 2013, respectively. Gross realized losses, including write- downs for impairments that were other-than-temporary, were ¥31 million, ¥31 million and ¥2 million for the years ended December 31, 2015, 2014 and 2013, respectively. At December 31, 2015, substantially all of the available-for-sale securities with unrealized losses had been in a continuous unreal- ized loss position for less than twelve months. Time deposits with original maturities of more than three months are ¥20,651 million and ¥71,863 million at December 31, 2015 and 2014, respectively, and are included in short-term 58 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA investments in the accompanying consolidated balance sheets. significant adverse effects on the fair value of those investments. Aggregate cost of non-marketable equity securities accounted for under the cost method totaled ¥2,570 million and ¥1,164 mil- lion at December 31, 2015 and 2014, respectively. These invest- ments were not evaluated for impairment at December 31, 2015 and 2014, respectively, because (a) Canon did not estimate the fair value of those investments as it was not practicable to esti- mate the fair value of the investments and (b) Canon did not iden- tify any events or changes in circumstances that might have had Investments in affiliated companies accounted for by the equity method amounted to ¥20,415 million and ¥20,863 million at December 31, 2015 and 2014, respectively. Canon’s share of the net earnings (losses) in affiliated companies accounted for by the equity method, included in other income (deductions), were earnings of ¥447 million and ¥478 million for the years ended December 31, 2015 and 2014, respectively, and losses of ¥664 million for the year ended December 31, 2013. 3. TRADE RECEIVABLES Trade receivables are summarized as follows: December 31 Notes Accounts Less allowance for doubtful receivables 4. INVENTORIES Inventories are summarized as follows: December 31 Finished goods Work in process Raw materials Millions of yen 2015 ¥ 17,614 582,464 600,078 (12,077) ¥ 588,001 2014 ¥ 18,476 619,321 637,797 (12,122) ¥ 625,675 Millions of yen 2015 ¥ 357,115 130,258 14,522 ¥ 501,895 2014 ¥ 363,685 144,394 20,088 ¥ 528,167 5. 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 2015 2014 ¥ 282,786 1,632,604 1,813,116 61,952 3,790,458 (2,570,806) ¥ 286,336 1,609,667 1,822,026 70,759 3,788,788 (2,519,259) ¥ 1,219,652 ¥ 1,269,529 Depreciation expenses for the years ended December 31, 2015, 2014 and 2013 were ¥223,759 million, ¥213,739 mil- lion and ¥223,158 million, respectively. Amounts due for purchases of property, plant and equip- ment were ¥30,789 million and ¥40,483 million at December 31, 2015 and 2014, respectively, and are included in other CANON ANNUAL REPORT 2015 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS current liabilities in the accompanying consolidated balance sheets. Fixed assets presented in the consolidated statements of cash flows include property, plant and equipment and intangible assets. 6. FINANCE RECEIVABLES AND OPERATING LEASES Finance receivables represent financing leases which consist of sales-type leases and direct-financing leases resulting from the sales of Canon’s and complementary third-party products primarily in foreign countries. These receivables typically have terms ranging from 1 year to 6 years. The components of the finance receivables, which are included in prepaid expenses and other current assets, and other assets in the accompanying consolidated balance sheets, are as follows: December 31 Millions of yen Total minimum lease payments receivable Unguaranteed residual values Executory costs Unearned income Less allowance for credit losses Less current portion 2015 ¥ 318,066 14,271 (888) (31,920) 299,529 (2,878) 296,651 (109,220) ¥ 187,431 2014 ¥ 308,733 13,924 (1,680) (31,919) 289,058 (6,276) 282,782 (102,920) ¥ 179,862 The activity in the allowance for credit losses is as follows: Years ended December 31 Millions of yen Balance at beginning of year Charge-offs Provision Translation adjustments and other Balance at end of year 2015 ¥ 6,276 (1,343) 55 (2,110) ¥ 2,878 2014 ¥ 7,323 (1,171) 154 (30) ¥ 6,276 Canon has policies in place to ensure that its products are sold to customers with an appropriate credit history, and continuously monitors its customers’ credit quality based on information includ- ing length of period in arrears, macroeconomic conditions, initia- tion of legal proceedings against customers and bankruptcy filings. The allowance for credit losses of finance receivables are evalu- ated collectively based on historical experience of credit losses. An additional reserve for individual accounts is recorded when Canon becomes aware of a customer’s inability to meet its financial obligations, such as in the case of bankruptcy filings. Finance receivables which are past due or individually evaluated for impair- ment at December 31, 2015 and 2014 are not significant. The cost of equipment leased to customers under operating leases included in property, plant and equipment, net at December 31, 2015 and 2014 was ¥108,746 million and ¥113,997 million, respectively. Accumulated depreciation on equipment under oper- ating leases at December 31, 2015 and 2014 was ¥82,916 million and ¥87,338 million, respectively. The following is a schedule by year of the future minimum lease payments to be received under financing leases and noncan- celable operating leases at December 31, 2015. Year ending December 31: 2016 2017 2018 2019 2020 Thereafter 60 CANON ANNUAL REPORT 2015 Millions of yen Financing leases Operating leases ¥ 127,714 90,137 57,828 30,501 11,165 721 ¥ 318,066 ¥ 8,709 5,307 3,308 1,786 490 206 ¥ 19,806 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 7. ACQUISITIONS On April 15, 2015, the Company acquired 76.1% of the issued shares of Axis AB (“Axis”), a Sweden-based company listed on Nasdaq Stockholm, a global leader in the network video solution industry, primarily through a public cash ten- der offer for consideration of ¥244,725 million. In addition, the Company acquired 9.0% of the issued shares of Axis from noncontrolling shareholders primarily through an additional public cash tender offer. As a result, the Company’s aggregate interest represents 85.1% of the issued shares of Axis. The fair value of the 23.9% noncontrolling interest in Axis of ¥77,086 million was measured based on Axis’s common stock price on the acquisition date. The acquisition was accounted for using the acquisi- tion method of accounting. Acquisition-related costs were expensed as incurred and were not material. The Company views its network surveillance camera busi- ness as a promising new business area for Canon. Canon aims to provide advanced and high-performance network solu- tions to its customers and improve its product competitiveness through the acquisition. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at acquisition date. Current assets Intangible assets Goodwill Other noncurrent assets Non-current assets Total assets acquired Total liabilities assumed Net assets acquired Millions of yen ¥ 31,365 60,992 259,863 2,053 322,908 354,273 32,462 ¥ 321,811 Intangible assets acquired, which are subject to amortization, consist of trademarks of ¥42,880 million, patents and developed technology of ¥17,823 million and software of ¥289 million. Canon has estimated the amortization period for the trademarks, patents and developed technology, and software to be 15 years, 7 years and 5 years, respectively. The weighted average amortiza- tion period for all intangible assets is approximately 13 years. Goodwill recorded is attributable primarily to expected syner- gies from combining operations of Axis and Canon. None of the goodwill is expected to be deductible for tax purposes. The good- will is assigned primarily to the Industry and Others Business Unit for impairment testing. The amounts of net sales of Axis since the acquisition date included in the Canon’s consolidated statement of income for the year ended December 31, 2015 were ¥72,602 million. The amounts of net income of Axis included in the Canon’s consoli- dated statement of income were not material. Pro forma results of operations were not disclosed because the effect on the Canon’s consolidated statement of income was not material. Canon acquired businesses other than that described above during the year ended December 31, 2015 that were not mate- rial to its consolidated financial statements. During the year ended December 31, 2014, Canon acquired several companies for a total cash consideration of ¥70,671 million, of which ¥30,696 million, ¥8,789 million, and ¥4,633 million was attributed to intangible assets, the related deferred tax liabilities, and other net assets acquired, respectively, and the residual amount of ¥44,131 million was recorded as goodwill. The goodwill recorded is attributable primarily to expected syn- ergies from the combined operations of the acquired companies and Canon. None of the goodwill is expected to be deductible for tax purposes. Total acquisition-related costs were expensed as incurred and were not significant. Intangible assets acquired, which are subject to amortization, consist of software of ¥13,290 million, customer relationships of ¥1,628 million and other intangible assets of ¥3,841 million. Canon has estimated the weighted average amortization period for the software and customer relationships to be 7 years and 6 years, respectively. The weighted average amortization period for all intangible assets is approximately 9 years. Intangible assets acquired, which are not subject to amortization, consist of in- process research and development of ¥11,937 million. The results of operations of the acquired companies were included in Canon’s consolidated financial statements from the respective acquisition dates and were not material. Pro forma results of operations have not been disclosed because the effects of these acquisitions were not material, individually and in the aggregate. CANON ANNUAL REPORT 2015 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. GOODWILL AND OTHER INTANGIBLE ASSETS Intangible assets subject to amortization acquired during the year ended December 31, 2015, including those recorded from busi- nesses acquired, totaled ¥113,216 million, which primarily consist of trademarks of ¥42,949 million, software of ¥39,817 million, and patents and developed technology of ¥18,083 million. The weighted average amortization periods for intangible assets in total acquired during the year ended December 31, 2015 are approximately 9 years. The weighted average amortization peri- ods for trademarks, software, and patents and developed tech- nology acquired during the year ended December 31, 2015 are approximately 15 years, 5 years and 7 years, respectively. Intangible assets subject to amortization acquired during the year ended December 31, 2014, including those recorded from businesses acquired, totaled ¥62,189 million, which primar- ily consist of software of ¥54,686 million. The weighted aver- age amortization periods for intangible assets in total acquired during the year ended December 31, 2014 are approximately 5 years. The weighted average amortization periods for soft- ware acquired during the year ended December 31, 2014 are approximately 4 years. The components of intangible assets subject to amortization at December 31, 2015 and 2014 were as follows: December 31 Millions of yen Software Trademarks Patents and developed technology Customer relationships License fees Other 2015 2014 Gross carrying amount ¥ 308,348 49,861 39,685 17,159 15,669 17,070 ¥ 447,792 Accumulated amortization ¥ 181,972 2,952 16,123 10,173 5,617 7,690 ¥ 224,527 Gross carrying amount ¥ 312,069 10,858 22,371 53,494 11,765 16,455 ¥ 427,012 Accumulated amortization ¥ 185,885 6,137 13,845 46,713 7,860 7,351 ¥ 267,791 Aggregate amortization expense for the years ended December 31, 2015, 2014 and 2013 was ¥49,568 million, ¥49,741 million and ¥52,015 million, respectively. Estimated amortization expense for intangible assets currently held for the next five years ending December 31 is ¥48,094 million in 2016, ¥38,852 million in 2017, ¥29,155 million in 2018, ¥20,589 million in 2019, and ¥15,736 million in 2020. Intangible assets not subject to amortization other than goodwill at December 31, 2015 and 2014 were ¥17,943 mil- lion and ¥18,067 million, respectively, which primarily consist of in-process research and development recorded from businesses acquired. For management reporting purposes, goodwill is not allo- cated to the segments. Goodwill has been allocated to its respective segment for impairment testing. The changes in the carrying amount of goodwill by segment for the years ended December 31, 2015 and 2014 were as follows: Years ended December 31 Millions of yen 2015: Balance at beginning of year Goodwill acquired during the year Translation adjustments and other Balance at end of year Millions of yen 2014: Balance at beginning of year Goodwill acquired during the year Translation adjustments and other Balance at end of year Office ¥ 145,335 10,373 (13,157) ¥ 142,551 Office ¥ 139,412 3,971 1,952 ¥ 145,335 Imaging System ¥ 21,780 31,367 327 ¥ 53,474 Imaging System ¥ 13,877 7,424 479 ¥ 21,780 Industry and Others ¥ 44,221 228,827 9,870 ¥ 282,918 Industry and Others ¥ 8,351 32,736 3,134 ¥ 44,221 Total ¥ 211,336 270,567 (2,960) ¥ 478,943 Total ¥ 161,640 44,131 5,565 ¥ 211,336 62 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 9. SHORT-TERM LOANS AND LONG-TERM DEBT Short-term loans consisting of bank borrowings at December 31, 2015 and 2014 were ¥26 million and ¥3 million, respectively. Long-term debt consisted of the following: December 31 Millions of yen 2015 2014 Loans, principally from banks, maturing in installments through 2020; bearing weighted average interest of 1.81% and 2.79% at December 31, 2015 and 2014, respectively Capital lease obligations Less current portion ¥ 73 1,470 1,543 (662) ¥ 881 The aggregate annual maturities of long-term debt outstanding at December 31, 2015 were as follows: Year ending December 31: 2016 2017 2018 2019 2020 Thereafter ¥ 145 2,018 2,163 (1,015) ¥ 1,148 Millions of yen ¥ 662 452 281 121 27 — ¥ 1,543 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. 10. TRADE PAYABLES Trade payables are summarized as follows: December 31 Notes Accounts Millions of yen 2015 2014 ¥ 16,706 261,549 ¥ 14,112 296,102 ¥ 278,255 ¥ 310,214 11. EMPLOYEE RETIREMENT AND SEVERANCE BENEFITS The Company and certain of its subsidiaries have contributory and noncontributory defined benefit pension plans covering substantially all of their employees. Benefits payable under the plans are based on employee earnings and years of service. The Company and certain of its subsidiaries also have defined contri- bution pension plans covering substantially all of their employees. Effective January 1, 2014, defined benefit pension plans of certain subsidiaries in the Netherlands were terminated, and the related plan assets and obligations were transferred to a multiemployer pension plan for the industry in which these subsidiaries operate. As a result, the Company recorded a gain on curtailments and settlements of ¥9,370 million in selling, general and administrative expenses in the consolidated state- ment of income for the year ended December 31, 2014. CANON ANNUAL REPORT 2015 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Obligations and funded status Reconciliations of beginning and ending balances of the projected benefit obligations and the fair value of the plan assets are as follows: December 31 Change in benefit obligations: Projected benefit obligations at beginning of year Service cost Interest cost Plan participants’ contributions Actuarial (gain) loss Benefits paid Plan amendments Curtailments and settlements Foreign currency exchange rate changes Japanese plans Millions of yen Foreign plans Millions of yen 2015 2014 2015 2014 26,445 10,772 — 59,496 (21,224) ¥ 760,331 ¥ 684,842 ¥ 364,662 ¥ 486,572 6,801 10,654 1,522 44,580 (7,352) — (191,179) 13,064 30,009 8,008 — 7,481 (24,479) — — — 7,760 10,572 1,830 (5,534) (6,795) (2,655) — (20,160) — — — Projected benefit obligations at end of year 781,350 760,331 349,680 364,662 Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Plan participants’ contributions Benefits paid Settlements Foreign currency exchange rate changes 622,121 17,541 8,701 — (21,788) — — 581,996 43,714 15,676 — (19,265) — — 221,421 21 10,864 1,830 (6,795) — (9,471) 360,527 17,851 6,470 1,522 (7,041) (165,640) 7,732 Fair value of plan assets at end of year 626,575 622,121 217,870 221,421 Funded status at end of year ¥ (154,775) ¥ (138,210) ¥ (131,810) ¥ (143,241) Amounts recognized in the consolidated balance sheets at December 31, 2015 and 2014 are as follows: December 31 Other assets Accrued expenses Accrued pension and severance cost Japanese plans Millions of yen Foreign plans Millions of yen 2015 2014 2015 2014 ¥ 814 ¥ — (155,589) (138,742) 532 ¥ 9,986 ¥ — (1,055) (140,673) (142,186) (1,123) — Amounts recognized in accumulated other comprehensive income (loss) at December 31, 2015 and 2014 before the effect of ¥ (154,775) ¥ (138,210) ¥ (131,810) ¥ (143,241) income taxes are as follows: December 31 Actuarial loss Prior service credit 64 CANON ANNUAL REPORT 2015 Japanese plans Millions of yen Foreign plans Millions of yen 2015 2014 2015 2014 ¥ 208,946 ¥ 209,829 ¥ 71,750 (2,567) (92,527) (79,935) ¥ 69,287 (57) ¥ 129,011 ¥ 117,302 ¥ 69,183 ¥ 69,230 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA The accumulated benefit obligation for all defined benefit plans was as follows: December 31 Japanese plans Millions of yen Foreign plans Millions of yen 2015 2014 2015 2014 Accumulated benefit obligation ¥ 740,545 ¥ 720,034 ¥ 338,160 ¥ 343,023 The projected benefit obligations and the fair value of plan assets for the pension plans with projected benefit obligations in excess of plan assets, and the accumulated benefit obligations and the fair value of plan assets for the pension plans with accu- mulated benefit obligations in excess of plan assets are as follows: December 31 Plans with projected benefit obligations in excess of plan assets: Projected benefit obligations Fair value of plan assets Plans with accumulated benefit obligations in excess of plan assets: Accumulated benefit obligations Fair value of plan assets Japanese plans Millions of yen Foreign plans Millions of yen 2015 2014 2015 2014 ¥ 777,458 621,869 ¥ 756,941 618,199 ¥ 346,749 204,953 ¥ 364,662 221,421 ¥ 731,537 615,963 ¥ 716,940 618,199 ¥ 331,351 200,891 ¥ 339,305 216,560 Components of net periodic benefit cost and other amounts recognized in other comprehensive income (loss) Net periodic benefit cost for Canon’s employee retirement and severance defined benefit plans for the years ended December 31, 2015, 2014 and 2013 consisted of the following components: Years ended December 31 Service cost Interest cost Expected return on plan assets Amortization of prior service credit Amortization of actuarial loss (Gain) loss on curtailments and settlements Japanese plans Millions of yen Foreign plans Millions of yen 2015 2014 2013 2015 2014 2013 ¥ 30,009 ¥ 26,445 ¥ 26,005 ¥ 7,760 ¥ 6,801 ¥ 9,448 8,008 10,772 11,655 10,572 10,654 14,299 (11,857) (10,637) (13,949) (19,579) (18,018) (15,273) (12,592) (12,800) (12,306) (143) 10,402 10,023 13,546 3,839 1,698 2,005 146 — — (9,370) (145) (61) — — Other changes in plan assets and benefit obligations recognized in other comprehensive income (loss) for the years ended December 31, 2015, 2014 and 2013 are summarized as follows: ¥ 16,248 ¥ 16,422 ¥ 23,627 ¥ 10,169 ¥ (915) ¥ 11,806 Years ended December 31 Current year actuarial (gain) loss Current year prior service credit Amortization of actuarial loss Amortization of prior service credit Curtailments and settlements Japanese plans Millions of yen Foreign plans Millions of yen 2015 2014 2013 2015 2014 2013 ¥ 9,519 ¥ 33,800 ¥ (54,150) — (10,402) 12,592 — — — (10,023) (13,546) 12,800 12,306 — — ¥ 6,302 ¥ 37,366 ¥ 2,290 — (2,005) 143 (358) (2,655) — (3,839) (1,698) 145 61 — (16,725) ¥ 11,709 ¥ 36,577 ¥ (55,390) ¥ (47) ¥ 19,004 ¥ 70 CANON ANNUAL REPORT 2015 65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The estimated prior service credit and actuarial loss for the defined benefit pension plans that will be amortized from accumu- lated other comprehensive income (loss) into net periodic benefit cost over the next year are summarized as follows: Prior service credit Actuarial loss Japanese plans Foreign plans Millions of yen Millions of yen ¥ (12,785) 10,830 ¥ (132) 3,213 Assumptions Weighted-average assumptions used to determine benefit obligations are as follows: December 31 Discount rate Assumed rate of increase in future compensation levels Japanese plans Foreign plans 2015 1.1% 3.0% 2014 1.1% 3.0% 2015 3.0% 2.0% 2014 2.9% 2.0% Weighted-average assumptions used to determine net periodic beneﬁ t cost are as follows: Years ended December 31 Discount rate Assumed rate of increase in future compensation levels Expected long-term rate of return on plan assets Japanese plans Foreign plans 2015 2014 2013 2015 2014 2013 1.1% 1.6% 1.8% 3.0% 3.0% 3.0% 3.1% 3.1% 3.1% 2.9% 3.9% 3.6% 2.0% 2.3% 2.2% 5.6% 4.9% 5.2% Canon determines the expected long-term rate of return based on the expected long-term return of the various asset categories in which it invests. Canon considers the current expectations for future returns and the actual historical returns of each plan asset category. Plan assets Canon’s investment policies are designed to ensure adequate plan assets are available to provide future payments of pen- sion benefits to eligible participants. Taking into account the expected long-term rate of return on plan assets, Canon for- mulates a “model” portfolio comprised of the optimal combi- nation of equity securities and debt securities. Plan assets are invested in individual equity and debt securities using the guide- lines 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 for- mulation of the “model” portfolio. Canon revises the “model” portfolio when and to the extent considered necessary to achieve the expected long-term rate of return on plan assets. Canon’s model portfolio for Japanese plans consists of three major components: approximately 20% is invested in equity securities, approximately 55% is invested in debt securities, and approximately 25% is invested in other investment vehi- cles, primarily consisting of investments in life insurance company general accounts. Outside Japan, investment policies vary by country, but the long-term investment objectives and strategies remain con- sistent. Canon’s model portfolio for foreign plans has been developed as follows: approximately 35% is invested in equity securities, approximately 35% is invested in debt securities, and approximately 30% 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 companies, and appropriately diversified 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 diversified 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 taxation systems. For each such investment, Canon has selected the appropriate investment country and currency. 66 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA The three levels of input used to measure fair value are more fully described in Note 20. The fair values of Canon’s pension plan assets at December 31, 2015 and 2014, by asset category, are as follows: December 31, 2015 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 ¥ 49,847 ¥ 3,287 — — — 125,850 ¥ — ¥ 49,847 ¥ — ¥ — 3,287 — 125,850 — — — 66,296 18,661 — 142,015 — 1,248 — 13,532 — 120,364 — 142,015 — 1,248 — 13,532 — 120,364 — 48 — 2,587 — 21,009 — 34,564 ¥ — ¥ — — 18,661 — 66,296 48 — — 2,587 — 21,009 — 34,564 — 10,462 — 10,462 — 137 — 137 — 125,759 — 33,432 — 125,759 779 34,211 — 6,190 — 68,378 — 6,190 — 68,378 ¥ 195,149 ¥ 430,647 ¥ 779 ¥ 626,575 ¥ 18,709 ¥ 199,161 ¥ — ¥ 217,870 December 31, 2014 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 Poole d funds (h) Mortgage backed securities (and other asset backed securities) Life insurance company general accounts Other assets ¥ 51,805 ¥ 10,233 — ¥ — ¥ 51,805 — 10,233 — — 124,388 — 124,388 ¥ — ¥ 31,963 — — — 74,744 ¥ — ¥ — — 31,963 — 74,744 — 143,431 573 — — 11,775 — 118,606 — 143,431 573 — — 11,775 — 118,606 — 7,899 3,221 — — 24,014 — 23,260 7,899 — 3,221 — — 24,014 — 23,260 — 12,310 — 12,310 — — — — — 123,575 — 23,825 — 123,575 1,600 25,425 — 7,049 — 49,271 — 7,049 — 49,271 ¥ 205,469 ¥ 415,052 ¥ 1,600 ¥ 622,121 ¥ 39,862 ¥ 181,559 ¥ — ¥ 221,421 (a) The plan’s equity securities include common stock of the Company and certain of its subsidiaries in the amounts of ¥325 million. (b) These funds invest in listed equity securities consisting of approximately 25% Japanese companies and 75% foreign companies for Japanese plans, and mainly foreign compa- nies for foreign plans. (c) This class includes approximately 85% Japanese government bonds and 15% foreign government bonds for Japanese plans, and mainly foreign government bonds for foreign plans. (d) These funds invest in approximately 25% Japanese govern- ment bonds, 50% foreign government bonds, 5% Japanese municipal bonds, and 20% corporate bonds for Japanese plans. These funds invest in approximately 75% foreign gov- ernment bonds and 25% 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 ¥197 million. (f) These funds invest in listed equity securities consisting of approximately 25% Japanese companies and 75% foreign companies for Japanese plans, and mainly foreign compa- nies for foreign plans. (g) This class includes approximately 85% Japanese government bonds and 15% foreign government bonds for Japanese plans, and mainly foreign government bonds for foreign plans. (h) These funds invest in approximately 25% Japanese government CANON ANNUAL REPORT 2015 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS bonds, 50% foreign government bonds, 5% Japanese munici- pal bonds, and 20% corporate bonds for Japanese plans. These funds invest in approximately 85% foreign government bonds and 15% corporate bonds for foreign plans. Each level into which assets are categorized is based on inputs used to measure the fair value of the assets, and does not neces- sarily 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 sufficient volume and fre- quency of transactions. Level 2 assets are comprised principally of pooled funds that invest in equity and debt securities, corporate bonds and investments in life insurance company general accounts. Pooled funds are valued at their net asset values that are calcu- lated 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 conversion value. The fair value of Level 3 assets, consisting of hedge funds, was ¥779 million and ¥1,600 million at December 31, 2015 and 2014, respectively. Amounts of actual returns on, and purchases and sales of, these assets during the years ended December 31, 2015 and 2014 were not significant. Contributions Canon expects to contribute ¥12,015 million to its Japanese defined benefit pension plans and ¥8,706 million to its foreign defined benefit pension plans for the year ending December 31, 2016. Estimated future benefit payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Year ending December 31: 2016 2017 2018 2019 2020 2021–2025 Japanese plans Foreign plans Millions of yen Millions of yen ¥ 20,023 21,351 23,280 23,359 27,886 170,161 ¥ 9,836 10,165 9,843 11,036 11,686 67,899 Multiemployer pension plans The amounts of cost recognized for the multiemployer pen- sion plans primarily in the Netherlands for the years ended December 31, 2015 and 2014 were ¥3,864 million and ¥2,815 million, respectively. The multiemployer pension plan in which the subsidiaries in the Netherlands participated was 102% funded as of December 31, 2014. The collective bar- gaining agreements have no expiration date. Canon is not liable for other participating employers’ obligations under the terms and conditions of the agreements. Defined contribution plans The amounts of cost recognized for the defined contribution pen- sion plans of the Company and certain of its subsidiaries for the years ended December 31, 2015, 2014 and 2013 were ¥17,277 million, ¥15,077 million and ¥14,383 million, respectively. 12. INCOME TAXES Domestic and foreign components of income before income taxes and the current and deferred income tax expense (benefit) attributable to such income are summarized as follows: Years ended December 31 2015: Income before income taxes Income taxes: Current Deferred Japanese ¥ 228,871 ¥ 80,020 3,414 ¥ 83,434 Millions of yen Foreign ¥ 118,567 ¥ 31,413 1,258 ¥ 32,671 Total ¥ 347,438 ¥ 111,433 4,672 ¥ 116,105 68 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Years ended December 31 2014: Income before income taxes Income taxes: Current Deferred Japanese ¥ 277,041 ¥ 83,221 6,796 ¥ 90,017 Millions of yen Foreign ¥ 106,198 ¥ 25,850 2,133 ¥ 27,983 Total ¥ 383,239 ¥ 109,071 8,929 ¥ 118,000 2013: Income before income taxes ¥ 251,351 ¥ 96,253 ¥ 347,604 Income taxes: Current Deferred ¥ 75,134 4,005 ¥ 79,139 ¥ 16,163 12,786 ¥ 28,949 ¥ 91,297 16,791 ¥ 108,088 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 35% for the year ended December 31, 2015 and approximately 38% for the years ended December 31, 2014 and 2013, respectively. Amendments to the Japanese tax regulations were enacted into law on March 31, 2015. As a result of these amendments, the statutory income tax rate will be reduced from approxi- mately 35% to 33% effective from the year beginning January 1, 2016, and to approximately 32% effective from the year beginning January 1, 2017 thereafter. Consequently, the stat- utory income tax rate utilized for deferred tax assets and lia- bilities expected to be settled or realized in the period from January 1, 2016 to December 31, 2016 is approximately 33% and for periods subsequent to December 31, 2016 the rate is approximately 32%. The adjustments of deferred tax assets and liabilities for this change in the tax rate amounted to ¥6,456 million and have been reflected in income taxes in the consolidated statement of income for the year ended December 31, 2015. 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 Effect of enacted changes in tax laws and rates on Japanese tax Other 2015 35.0% 2014 38.0% 2013 38.0% 0.8 (2.9) (4.8) (0.4) 1.9 3.8 0.7 (3.7) (5.0) (0.5) 0.8 0.5 0.9 (3.3) (5.4) 0.2 — 0.7 Effective income tax rate 33.4% 30.8% 31.1% Net deferred income tax assets and liabilities are included in the accompanying consolidated balance sheets under the follow- ing captions: December 31 Prepaid expenses and other current assets Other assets Other current liabilities Other noncurrent liabilities Millions of yen 2015 2014 ¥ 55,108 113,687 (2,682) (96,243) ¥ 61,943 117,636 (3,456) (80,459) ¥ 69,870 ¥ 95,664 CANON ANNUAL REPORT 2015 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at December 31, 2015 and 2014 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 Intangible assets Other Total deferred tax liabilities Net deferred tax assets Millions of yen 2015 2014 ¥ 15,298 3,293 77,420 6,906 24,281 39,881 33,526 33,808 234,413 (32,931) 201,482 (10,400) (7,354) (4,974) (54,280) (1,104) (21,106) (32,394) (131,612) ¥ 16,085 3,951 79,392 8,616 29,558 43,706 38,351 34,673 254,332 (37,498) 216,834 (10,368) (6,801) (5,696) (58,958) (1,671) (7,283) (30,393) (121,170) ¥ 69,870 ¥ 95,664 The net changes in the total valuation allowance were a decrease of ¥4,567 million for the year ended December 31, 2015, and increases of ¥2,443 million and ¥2,888 million for the years ended December 31, 2014 and 2013, respectively. Based upon the level of historical taxable income and projections for future taxable income over the periods which the net deductible temporary differences are expected to reverse, management believes it is more likely than not that Canon will realize the benefits of these deferred tax assets, net of the existing valuation allowance, at December 31, 2015. At December 31, 2015, Canon had net operating losses which can be carried forward for income tax purposes of ¥200,994 million to reduce future taxable income. Periods available to reduce future taxable income vary in each tax jurisdiction and gener- ally range from one year to an indefinite period as follows: Within one year After one year through five years After five years through ten years After ten years through twenty years Indefinite period Total Millions of yen ¥ 6,138 36,317 58,462 62,270 37,807 ¥ 200,994 Income taxes have not been accrued on undistributed earnings of domestic subsidiaries as the tax law provides a means by which the dividends from a domestic subsidiary can be received tax free. Canon has not recognized deferred tax liabilities of ¥28,500 million for a portion of undistributed earnings of foreign sub- sidiaries that arose for the year ended December 31, 2015 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 recog- nized when Canon expects that it will realize those undistrib- uted earnings in a taxable manner, such as through receipt of dividends or sale of the investments. At December 31, 2015, such undistributed earnings of these subsidiaries were ¥940,931 million. 70 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA A reconciliation of the beginning and ending amount of unrecognized tax benefits 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 Other Balance at end of year 2015 ¥ 6,431 2,174 165 (1,180) (505) (1,029) ¥ 6,056 Millions of yen 2014 ¥ 6,201 1,649 216 (114) (1,808) 287 ¥ 6,431 2013 ¥ 7,711 312 388 (3,141) (347) 1,278 ¥ 6,201 The total amounts of unrecognized tax benefits that would reduce the effective tax rate, if recognized, are ¥6,056 million and ¥6,431 million at December 31, 2015 and 2014, respectively. Although Canon believes its estimates and assumptions of unrecognized tax benefits are reasonable, uncertainty regarding the final determination of tax audit settlements and any related lit- igation could affect the effective tax rate in a future period. Based on each of the items of which Canon is aware at December 31, 2015, no significant changes to the unrecognized tax benefits are expected within the next twelve months. Canon recognizes interest and penalties accrued related to unrecognized tax benefits in income taxes. Both interest and pen- alties accrued at December 31, 2015 and 2014, and interest and penalties included in income taxes for the years ended December 31, 2015, 2014 and 2013 are not significant. Canon files income tax returns in Japan and various foreign tax jurisdictions. In Japan, Canon is no longer subject to regu- lar income tax examinations by the tax authority for years before 2015. Canon is also no longer subject to a transfer pricing exami- nation by the tax authority for years before 2015. In other major foreign tax jurisdictions, including the United States and the Netherlands, Canon is no longer subject to income tax examina- tions by tax authorities for years before 2007 with few exceptions. The tax authorities are currently conducting income tax examina- tions of Canon’s income tax returns for years after 2006 in major foreign tax jurisdictions. 13. 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 resolution of the shareholders. Certain foreign subsidiaries are also required to appropriate their earnings to legal reserves under the laws of their respective countries. Cash dividends and appropriations to the legal reserve charged to retained earnings for the years ended December 31, 2015, 2014 and 2013 represent dividends paid out during those years and the related appropriations to the legal reserve. Retained earnings at December 31, 2015 did not reflect cur- rent year-end dividends in the amount of ¥81,905 million which were approved by the shareholders in March 2016. The amount available for dividends under the Corporation Law of Japan is based on the amount recorded in the Company’s nonconsolidated books of account in accordance with financial accounting standards of Japan. Such amount was ¥970,771 million at December 31, 2015. Retained earnings at December 31, 2015 included Canon’s equity in undistributed earnings of affiliated compa- nies accounted for by the equity method in the amount of ¥17,129 million. CANON ANNUAL REPORT 2015 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. OTHER COMPREHENSIVE INCOME (LOSS) Changes in accumulated other comprehensive income (loss) for the years ended December 31, 2015, 2014 and 2013 are as follows: Millions of yen Balance at December 31, 2012 Equity transactions with noncontrolling interests and other Other comprehensive income (loss) before reclassifications Amounts reclassified from accumulated other comprehensive income (loss) Net change during the year Balance at December 31, 2013 Equity transactions with noncontrolling interests and other Other comprehensive income (loss) before reclassifications Amounts reclassified from accumulated other comprehensive income (loss) Net change during the year Balance at December 31, 2014 Equity transactions with noncontrolling interests and other Other comprehensive income (loss) before reclassifications Amounts reclassified from accumulated other comprehensive income (loss) Net change during the year Balance at December 31, 2015 Foreign currency translation adjustments Unrealized gains and losses on securities Gains and losses on derivative instruments Pension liability adjustments Total ¥ (247,734) ¥ 4,146 ¥ (4,462) ¥ (119,199) ¥ (367,249) (323) (1) (2) (329) (655) 249,791 7,449 (7,551) 27,153 276,842 — 249,468 1,734 (1,352) 6,096 10,242 9,607 2,054 (2,408) 2,161 28,985 (90,214) 10,416 286,603 (80,646) 10 3 — (35) (22) 142,813 3,933 (2,204) (47,840) 96,702 — 142,823 144,557 (1,632) 2,304 12,546 2,009 (195) (2,603) 11,875 (36,000) (126,214) 12,252 108,932 28,286 73 — — — 73 (57,592) 1,691 (256) (6,155) (62,312) — (57,519) ¥ 87,038 (182) 1,509 ¥ 14,055 3,041 2,785 ¥ 182 1,352 (4,803) ¥ (131,017) 4,211 (58,028) ¥ (29,742) Reclassifications out of accumulated other comprehensive income (loss) for the years ended December 31, 2015, 2014 and 2013 are as follows: Years ended December 31 Unrealized gains and losses on securities Gains and losses on derivative instruments Pension liability adjustments Amount reclassified from accumulated other comprehen- sive income (loss)*1 Millions of yen 2015 2014 2013 Affected line items in consolidated statements of income ¥ (298) 104 (194) ¥ (2,509) 879 (1,630) ¥ (2,358) Other, net 613 Income taxes (1,745) Consolidated net income 12 (182) 4,217 (1,180) 3,037 4 3,041 1,504 (175) 1,329 23 1,352 (2) 393 Net income attributable to noncontrolling interests (1,632) 3,260 (1,248) 2,012 (3) 2,009 15,585 (3,710) 11,875 — 11,875 (1,352) Net income attributable to Canon Inc. 15,387 Other, net (5,780) 9,607 Income taxes Consolidated net income Net income attributable to noncontrolling interests — 9,607 3,460 (1,037) 2,423 (262) Net income attributable to Canon Inc. See Note 11 Income taxes Consolidated net income Net income attributable to noncontrolling interests 2,161 Net income attributable to Canon Inc. Total amount reclassified, net of tax and noncontrolling interests ¥4,211 ¥ 12,252 ¥ 10,416 *1 Amounts in parentheses indicate gains in consolidated statements of income. 72 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Tax effects allocated to each component of other comprehensive income (loss) and reclassification adjustments, including amounts attributable to noncontrolling interests, are as follows: Years ended December 31 2015: Foreign currency translation adjustments Net unrealized gains and losses on securities: Amount arising during the year Reclassification adjustments for gains and losses realized in net income Net change during the year Net gains and losses on derivative instruments: Amount arising during the year Reclassification adjustments for gains and losses realized in net income Net change during the year Pension liability adjustments: Amount arising during the year Reclassification adjustments for gains and losses realized in net income Net change during the year Other comprehensive income (loss) 2014: Foreign currency translation adjustments Net unrealized gains and losses on securities: Amount arising during the year Reclassification adjustments for gains and losses realized in net income Net change during the year Net gains and losses on derivative instruments: Amount arising during the year Reclassification adjustments for gains and losses realized in net income Net change during the year Pension liability adjustments: Amount arising during the year Reclassification adjustments for gains and losses realized in net income Net change during the year Other comprehensive income (loss) 2013: Foreign currency translation adjustments Net unrealized gains and losses on securities: Amount arising during the year Reclassification adjustments for gains and losses realized in net income Net change during the year Net gains and losses on derivative instruments: Amount arising during the year Reclassification adjustments for gains and losses realized in net income Net change during the year Pension liability adjustments: Amount arising during the year Reclassification 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 benefit Net-of-tax amount ¥ (56,054) ¥ 550 ¥ (55,504) 3,249 (298) 2,951 52 4,217 4,269 (13,166) 1,504 (11,662) (1,045) 104 (941) (304) (1,180) (1,484) 5,294 (175) 5,119 2,204 (194) 2,010 (252) 3,037 2,785 (7,872) 1,329 (6,543) ¥ (60,496) ¥ 3,244 ¥ (57,252) ¥ 144,826 ¥ (992) ¥ 143,834 6,379 (2,509) 3,870 (3,309) 3,260 (49) (71,166) 15,585 (55,581) (2,225) 879 (1,346) 1,102 (1,248) (146) 21,306 (3,710) 17,596 4,154 (1,630) 2,524 (2,207) 2,012 (195) (49,860) 11,875 (37,985) ¥ 93,066 ¥ 15,112 ¥ 108,178 ¥ 253,707 ¥ (2,131) ¥ 251,576 12,669 (2,358) 10,311 (12,145) 15,387 3,242 51,860 3,460 55,320 (4,312) 613 (3,699) 4,594 (5,780) (1,186) (21,614) (1,037) (22,651) 8,357 (1,745) 6,612 (7,551) 9,607 2,056 30,246 2,423 32,669 ¥ 322,580 ¥ (29,667) ¥ 292,913 CANON ANNUAL REPORT 2015 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. STOCK-BASED COMPENSATION On May 1, 2011, based on the approval of the shareholders, the Company granted stock options to its directors, execu- tive officers and certain employees to acquire 912,000 shares of common stock. These option awards vest after two years of continued service beginning on the grant date and have a four year exercisable period. The grant-date fair value per share of the stock options granted during the year ended December 31, 2011 was ¥772. On May 1, 2010, based on the approval of the sharehold- ers, the Company granted stock options to its directors, execu- tive officers and certain employees to acquire 890,000 shares of common stock. These option awards vest after two years of continued service beginning on the grant date and have a four year exercisable period. The grant-date fair value per share of the stock options granted during the year ended December 31, 2010 was ¥988. On May 1, 2009, based on the approval of the sharehold- ers, the Company granted stock options to its directors, execu- tive officers 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 exercisable period. The grant-date fair value per share of the stock options granted during the year ended December 31, 2009 was ¥699. The compensation cost recognized for these stock options for the years ended December 31, 2015 and 2014 was nil and 2013 was ¥95 million, and is included in selling, general and adminis- trative expenses in the consolidated statements of income. A summary of option activity under the stock option plans as of and for the years ended December 31, 2015, 2014 and 2013 is presented below: Outstanding at January 1, 2013 Exercised Forfeited Outstanding at December 31, 2013 Exercised Forfeited/Expired Outstanding at December 31, 2014 Exercised Forfeited/Expired Outstanding at December 31, 2015 Exercisable at December 31, 2015 Shares Weighted- average exercise price Weighted-average remaining contractual term Aggregate intrinsic value Yen Year Millions of yen 2,726,400 ¥ 4,247 3,287 4,461 (8,600) (60,400) 2,657,400 (67,200) (728,400) 1,861,800 (249,600) (316,200) 4,245 3,287 4,869 4,036 3,311 3,678 1.6 ¥ 37 1.0 28 0.7 248 1,296,000 ¥ 4,263 1,296,000 ¥ 4,263 0.4 0.4 ¥ — ¥ — At December 31, 2015, all outstanding option awards were vested. The total fair value of shares vested during the years ended December 31, 2015 and 2014 was nil and 2013 was ¥570 mil- lion. Cash received from the exercise of stock options for the years ended December 31, 2015, 2014 and 2013 was ¥826 million, ¥221 million and ¥28 million, respectively. 74 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 16. NET INCOME ATTRIBUTABLE TO CANON INC. SHAREHOLDERS PER SHARE A reconciliation of the numerators and denominators of basic and diluted net income attributable to Canon Inc. shareholders per share computations is as follows: Years ended December 31 Millions of yen 2015 2014 2013 Net income attributable to Canon Inc. ¥ 220,209 ¥ 254,797 ¥ 230,483 Average common shares outstanding Effect of dilutive securities: Stock options Number of shares 1,092,017,955 1,112,509,931 1,147,933,835 34,931 4,393 8,466 Diluted common shares outstanding 1,092,052,886 1,112,514,324 1,147,942,301 Net income attributable to Canon Inc. shareholders per share: Basic Diluted ¥ 201.65 201.65 ¥ 229.03 229.03 ¥ 200.78 200.78 Yen The computation of diluted net income attributable to Canon Inc. shareholders per share for the years ended December 31, 2015, 2014 and 2013 excludes certain outstanding stock options because the effect would be anti-dilutive. 17. DERIVATIVES AND HEDGING ACTIVITIES Risk management policy Canon operates internationally, exposing it to the risk of changes in foreign currency exchange rates. Derivative financial 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 financial instruments for trading purposes. Canon is also exposed to credit-related losses in the event of non- performance by counterparties to derivative financial instru- ments, but it is not expected that any counterparties will fail to meet their obligations. Most of the counterparties are interna- tionally recognized financial institutions and selected by Canon taking into account their financial condition, and contracts are diversified across a number of major financial institutions. Foreign currency exchange rate risk management Canon’s international operations expose Canon to the risk of changes in foreign currency exchange rates. Canon uses foreign exchange contracts to manage certain foreign cur- rency exchange exposures principally from the exchange of U.S. dollars 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 specific portion of foreign currency exposure resulting from forecasted intercompany sales are hedged using foreign exchange contracts which principally mature within three months. Cash flow hedge Changes in the fair value of derivative financial instruments designated as cash flow hedges, including foreign exchange contracts associated with forecasted intercompany sales, are reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassified into earnings through other income (deductions) in the same period as the hedged items affect earnings. Substantially all amounts recorded in accumulated other comprehensive income (loss) at year-end are expected to be recognized in earnings over the next twelve months. Canon excludes the time value com- ponent 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. CANON ANNUAL REPORT 2015 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Derivatives not designated as hedges Canon has entered into certain foreign exchange contracts to primarily offset the earnings impact related to fluctuations 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 at December 31, 2015 and 2014 are set forth below: December 31 To sell foreign currencies To buy foreign currencies Millions of yen 2015 2014 ¥ 228,053 ¥ 358,862 37,540 21,365 Fair value of derivative instruments in the consolidated balance sheets The following tables present Canon’s derivative instruments measured at gross fair value as reflected in the consolidated balance sheets at December 31, 2015 and 2014. Derivatives designated as hedging instruments December 31 Balance sheet location 2015 2014 Fair value Millions of yen Assets: Foreign exchange contracts Liabilities: Foreign exchange contracts Prepaid expenses and other current assets ¥ 373 ¥ 8 Other current liabilities 534 1,597 Derivatives not designated as hedging instruments December 31 Balance sheet location 2015 2014 Fair value Millions of yen Assets: Foreign exchange contracts Liabilities: Foreign exchange contracts Prepaid expenses and other current assets ¥ 1,112 ¥ 257 Other current liabilities 90 9,570 76 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Effect of derivative instruments in the consolidated statements of income The following tables present the effect of Canon’s derivative instruments in the consolidated statements of income for the years ended December 31, 2015, 2014 and 2013. Derivatives in cash flow hedging relationships Years ended December 31 Gain (loss) recognized in OCI (effective portion) Gain (loss) reclassified 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 2015: Foreign exchange contracts 2014: Foreign exchange contracts 2013: Foreign exchange contracts ¥ 52 Other, net ¥ (4,217) Other, net ¥ (131) (3,309) Other, net (3,260) Other, net (12,145) Other, net (15,387) Other, net (145) (111) Derivatives not designated as hedging instruments Years ended December 31 Foreign exchange contracts Gain (loss) recognized in income on derivative Millions of yen Location Other, net 2015 ¥1,099 2014 2013 ¥(21,728) ¥(61,787) 18. COMMITMENTS AND CONTINGENT LIABILITIES Commitments At December 31, 2015, commitments outstanding for the pur- chase of property, plant and equipment approximated ¥43,059 million, and commitments outstanding for the purchase of parts and raw materials approximated ¥75,439 million. Canon occupies sales offices and other facilities under lease arrangements accounted for as operating leases. Deposits made under such arrangements aggregated ¥13,561 million and ¥13,847 million at December 31, 2015 and 2014, respec- tively, and are included in noncurrent receivables in the accom- panying consolidated balance sheets. Rental expenses under such operating lease arrangements amounted to ¥46,483 mil- lion, ¥43,215 million and ¥44,562 million for the years ended December 31, 2015, 2014 and 2013, respectively. Future minimum lease payments required under noncancelable operating leases that have initial or remaining lease terms in excess of one year at December 31, 2015 are as follows: Year ending December 31: 2016 2017 2018 2019 2020 Thereafter Total future minimum lease payments Millions of yen ¥ 26,294 20,328 13,855 8,847 6,115 12,153 ¥ 87,592 CANON ANNUAL REPORT 2015 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Guarantees Canon provides guarantees for bank loans of its employees, affiliates and other companies. The guarantees for the employ- ees are principally made for their housing loans. The guarantees of loans of its affiliates and other companies are made to ensure that those companies operate with less financial risk. For each guarantee provided, Canon would have to per- form 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 5 years, in the case of affiliates and other companies. The maximum amount of undiscounted payments Canon would have had to make in the event of default is ¥7,685 million at December 31, 2015. The carrying amounts of the liabilities recognized for Canon’s obligations as a guarantor under those guarantees at December 31, 2015 were not significant. Canon also issues contractual product warranties under which it generally guarantees the performance of products delivered and services rendered for a certain period or term. Changes in accrued product warranty costs for the years ended December 31, 2015 and 2014 are summarized as follows: Years ended December 31 Balance at beginning of year Additions Utilization Other Balance at end of year Millions of yen 2015 2014 ¥ 11,564 18,942 (12,404) (4,088) ¥ 14,014 ¥ 10,890 15,699 (12,039) (2,986) ¥ 11,564 Legal proceedings Canon is involved in various claims and legal actions arising in the ordinary course of business. Canon has recorded pro- visions for liabilities when it is probable that liabilities have been incurred and the amount of loss can be reasonably esti- mated. Canon reviews these provisions at least quarterly and adjusts these provisions to reflect the impact of the negotia- tions, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Based on its experience, although litigation is inherently unpre- dictable, Canon believes that any damage amounts claimed in outstanding matters are not a meaningful indicator of Canon’s potential liability. In the opinion of management, any reasonably possible range of losses from outstanding matters would not have a material adverse effect on Canon’s consoli- dated financial position, results of operations, or cash flows. 19. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK Fair value of financial instruments The estimated fair values of Canon’s financial instruments at December 31, 2015 and 2014 are set forth below. The following summary excludes cash and cash equivalents, trade receivables, finance receivables, noncurrent receivables, short-term loans, trade payables and accrued expenses for which fair values approximate their carrying amounts. The summary also excludes investments and derivative instruments which are disclosed in Note 2 and Note 17, respectively. December 31 Millions of yen 2015 2014 Carrying amount Estimated fair value Carrying amount Estimated fair value Long-term debt, including current installments ¥(1,543) ¥(1,507) ¥(2,163) ¥(2,146) 78 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA The following methods and assumptions are used to esti- mate the fair value in the above table. Long-term debt Canon’s long-term debt instruments are classified as Level 2 instruments and valued based on the present value of future cash flows associated with each instrument discounted using current market borrowing rates for similar debt instruments of comparable maturity. The levels are more fully described in Note 20. Limitations of fair value estimates Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instruments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Concentrations of credit risk At December 31, 2015 and 2014, one customer accounted for approximately 15% and 16% of consolidated trade receiv- ables, respectively. Although Canon does not expect that the customer will fail to meet its obligations, Canon is potentially exposed to concentrations of credit risk if the customer failed to perform according to the terms of the contracts. 20. 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 measure- ment 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 liabil- ities 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 significant inputs or value drivers are unobservable, which reflect 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, 2015 and 2014. December 31 Millions of yen 2015: Assets: Cash and cash equivalents 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 ¥ — ¥ 80,870 ¥ — ¥ 80,870 287 — 12 42,849 — — 201 52 — 1,485 ¥ 43,148 ¥ 82,608 ¥ — ¥ — ¥ 624 ¥ 624 — — — — — ¥ — ¥ — ¥ — 287 201 64 42,849 1,485 ¥ 125,756 ¥ ¥ 624 624 CANON ANNUAL REPORT 2015 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Millions of yen 2014: Assets: Cash and cash equivalents 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 ¥ — ¥ 139,240 ¥ — ¥ 139,240 325 — 12 40,653 — — 162 72 — 265 — 474 — — — 325 636 84 40,653 265 ¥ 40,990 ¥ 139,739 ¥ 474 ¥ 181,203 ¥ — ¥ — ¥ 11,167 ¥ 11,167 ¥ — ¥ — ¥ 11,167 ¥ 11,167 Level 1 investments are comprised principally of Japanese equity securities, which are valued using an unadjusted quoted market price in active markets with sufficient volume and fre- quency of transactions. Level 2 cash and cash equivalents are valued based on market approach, using quoted prices for iden- tical assets in markets that are not active. Level 3 investments are mainly comprised of corporate bonds, which are valued based on cost approach, using unobservable inputs as the market for the assets was not active at the measurement date. Derivative financial instruments are comprised of foreign exchange contracts. Level 2 derivatives are valued using quotes obtained from counterparties or third parties, which are peri- odically 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 corporate bonds, for the years ended December 31, 2015 and 2014. Years ended December 31 Millions of yen 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 2015 ¥ 474 — 22 (496) ¥ — 2014 ¥ 340 — (18) 152 ¥ 474 Assets and liabilities measured at fair value on a nonrecurring basis During the years ended December 31, 2015 and 2014, there were no circumstances that required any significant assets or liabilities to be measured at fair value on a nonrecurring basis. 21. SEGMENT INFORMATION Canon operates its business in three segments: the Office Business Unit, the Imaging System Business Unit, and the Industry and Others Business Unit, which are based on the organizational structure and information reviewed by Canon’s management to evaluate results and allocate resources. The primary products included in each segment are as follows: Office Business Unit: Office multifunction devices (MFDs) / Laser multifunction printers / Laser printers / Digital production printing systems / High speed continuous feed printers / Wide-format printers / Document solutions 80 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Imaging System Business Unit: Interchangeable lens digital cameras / Digital compact cameras / Digital camcorders / Digital cinema cameras / Interchangeable lenses / Compact photo printers / Inkjet printers / Large-format inkjet printers / Commercial photo printers / Image scanners / Multimedia projectors / Broadcast equipment / Calculators Industry and Others Business Unit: Semiconductor lithography equipment / FPD (Flat panel display) lithography equipment / Digital radiography sys- tems / Ophthalmic equipment / Vacuum thin-film deposi- tion equipment / Organic LED (OLED) panel manufacturing equipment / Die bonders / Micromotors / Network cameras / Handy terminals / Document scanners The accounting policies of the segments are substantially the same as those described in the significant accounting poli- cies in Note 1. Canon evaluates performance of, and allocates resources to, each segment based on operating profit. Information about operating results and assets for each segment as of and for the years ended December 31, 2015, 2014 and 2013 is as follows: Millions of yen 2015: Net sales: Office Imaging System Industry and Others Corporate and eliminations Consolidated External customers Intersegment ¥ 2,108,246 2,570 ¥ 1,262,667 1,168 Total Operating cost and expenses 2,110,816 1,820,230 1,263,835 1,080,396 ¥ 429,358 95,293 524,651 537,730 ¥ — ¥ 3,800,271 — (99,031) (99,031) 6,705 3,800,271 3,445,061 Operating profit ¥ 290,586 ¥ 183,439 ¥ (13,079) ¥ (105,736) ¥ 355,210 Total assets Depreciation and amortization Capital expenditures ¥ 1,020,758 86,206 73,819 ¥ 452,283 52,070 38,337 ¥ 332,252 45,064 24,241 ¥ 2,622,480 89,987 106,733 ¥ 4,427,773 273,327 243,130 2014: Net sales: External customers Intersegment ¥ 2,075,788 2,944 ¥ 1,342,501 693 Total Operating cost and expenses 2,078,732 1,786,675 1,343,194 1,148,593 ¥ 308,963 89,802 398,765 420,566 ¥ — ¥ 3,727,252 — (93,439) (93,439) 7,929 3,727,252 3,363,763 Operating profit ¥ 292,057 ¥ 194,601 ¥ (21,801) ¥ (101,368) ¥ 363,489 Total assets Depreciation and amortization Capital expenditures ¥ 1,025,499 87,058 69,704 ¥ 517,524 53,912 31,124 ¥ 342,695 37,544 15,976 ¥ 2,574,900 84,966 107,956 ¥ 4,460,618 263,480 224,760 2013: Net sales: External customers Intersegment ¥ 1,993,898 6,175 ¥ 1,448,186 752 Total Operating cost and expenses 2,000,073 1,733,165 1,448,938 1,245,144 ¥ 289,296 85,574 374,870 400,201 ¥ — ¥ 3,731,380 — (92,501) (92,501) 15,593 3,731,380 3,394,103 Operating profit ¥ 266,908 ¥ 203,794 ¥ (25,331) ¥ (108,094) ¥ 337,277 Total assets Depreciation and amortization Capital expenditures ¥ 954,803 88,344 54,644 ¥ 584,856 56,564 44,112 ¥ 328,202 37,072 27,040 ¥ 2,374,849 93,193 101,682 ¥ 4,242,710 275,173 227,478 CANON ANNUAL REPORT 2015 81 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Intersegment sales are recorded at the same prices used in transactions with third parties. Expenses not directly associated with specific segments are allocated based on the most rea- sonable measures applicable. Corporate expenses include cer- tain 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, investments, deferred tax assets, goodwill and corporate properties. Capital expenditures represent the addi- tions to property, plant and equipment and intangible assets measured on an accrual basis. Information about product sales to external customers by business unit for the years ended December 31, 2015, 2014 and 2013 is as follows: Years ended December 31 Office Monochrome copiers Color copiers Printers Others Total Imaging System Cameras Inkjet printers Others Total Industry and Others Lithography equipment Others Total Consolidated Millions of yen 2015 2014 2013 ¥ 328,061 421,209 857,369 501,607 ¥ 322,398 401,447 862,000 489,943 ¥ 312,973 381,848 841,436 457,641 2,108,246 2,075,788 1,993,898 782,623 362,663 117,381 861,196 366,946 114,359 973,517 363,070 111,599 1,262,667 1,342,501 1,448,186 123,887 305,471 90,395 218,568 62,116 227,180 429,358 308,963 289,296 ¥ 3,800,271 ¥ 3,727,252 ¥ 3,731,380 Information by major geographic area as of and for the years ended December 31, 2015, 2014 and 2013 is as follows: Millions of yen 2015 2014 2013 ¥ 714,280 1,144,422 1,074,366 867,203 ¥ 724,317 1,036,500 1,090,484 875,951 ¥ 715,863 1,059,501 1,124,929 831,087 ¥ 3,800,271 ¥ 3,727,252 ¥ 3,731,380 ¥ 937,716 150,105 183,451 189,588 ¥ 950,719 157,748 127,700 210,650 ¥ 984,231 131,660 111,609 196,305 ¥ 1,460,860 ¥ 1,446,817 ¥ 1,423,805 Net sales: Japan Americas Europe Asia and Oceania Total Long-lived assets: Japan Americas Europe Asia and Oceania Total 82 CANON ANNUAL REPORT 2015 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 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 busi- ness in any individual country in which its sales in that coun- try exceed 10% of consolidated net sales. Net sales in the United States were ¥1,047,838 million, ¥938,411 million and ¥960,213 million for the years ended December 31, 2015, 2014 and 2013, respectively. Long-lived assets represent property, plant and equipment and intangible assets for each geographic area. The following information is based on the location of the Company and its subsidiaries as of and for the years ended December 31, 2015, 2014 and 2013. In addition to the disclosure requirements under U.S. GAAP, Canon discloses this informa- tion in order to provide financial statements users with useful information. Millions of yen 2015: Net sales: External customers Intersegment Total Operating cost and expenses Operating profit Total assets 2014: Net sales: External customers Intersegment Total Operating cost and expenses Operating profit Total assets 2013: Net sales: External customers Intersegment Total Operating cost and expenses Japan Americas Europe Asia and Oceania Corporate and eliminations Consolidated ¥ 847,669 ¥ 1,138,830 ¥ 1,077,033 ¥ 736,739 ¥ 1,765,840 21,069 106,675 911,395 (2,804,979) — ¥ 3,800,271 — 2,613,509 2,285,780 1,159,899 1,130,099 1,183,708 1,165,218 1,648,134 1,582,113 (2,804,979) (2,718,149) 3,800,271 3,445,061 ¥ 327,729 ¥ 29,800 ¥ 18,490 ¥ 66,021 ¥ (86,830) ¥ 355,210 ¥ 969,805 ¥ 544,395 ¥ 409,357 ¥ 620,090 ¥ 1,884,126 ¥ 4,427,773 ¥ 836,801 ¥ 1,033,797 ¥ 1,088,293 ¥ 768,361 ¥ 1,752,378 8,738 59,493 821,600 (2,642,209) — ¥ 3,727,252 — 2,589,179 2,245,930 1,042,535 1,018,661 1,147,786 1,135,515 1,589,961 1,522,244 (2,642,209) (2,558,587) 3,727,252 3,363,763 ¥ 343,249 ¥ 23,874 ¥ 12,271 ¥ 67,717 ¥ (83,622) ¥ 363,489 ¥ 1,134,484 ¥ 531,122 ¥ 484,858 ¥ 674,672 ¥ 1,635,482 ¥ 4,460,618 ¥ 797,501 ¥ 1,056,096 ¥ 1,124,603 ¥ 753,180 ¥ 1,855,181 11,774 53,281 881,765 (2,802,001) — ¥ 3,731,380 — 2,652,682 2,326,351 1,067,870 1,043,487 1,177,884 1,171,357 1,634,945 1,574,125 (2,802,001) (2,721,217) 3,731,380 3,394,103 Operating profit ¥ 326,331 ¥ 24,383 ¥ 6,527 ¥ 60,820 ¥ (80,784) ¥ 337,277 Total assets ¥ 1,152,398 ¥ 447,039 ¥ 496,549 ¥ 631,827 ¥ 1,514,897 ¥ 4,242,710 22. SUBSEQUENT EVENT On March 17, 2016, the Board of Directors of the Company approved an acquisition of Toshiba Medical Systems Corporation (“TMSC”) from Toshiba Corporation (“Toshiba”) to make TMSC a subsidiary, and concurrently it has entered into a share transfer agreement with Toshiba. The Company paid a total consideration of ¥665.5 billion for a right to acquire all the ordinary shares of TMSC, which is exercisable upon the clearance of necessary com- petition regulatory authorities. The Company borrowed the con- sideration through bank borrowing of ¥660 billion provisionally, which is due on September 30, 2016. The Company plans to make its final decision on whether to use own funds, borrowings or a combination of both, to fund the acquisition, by that time. Until the clearance of necessary competition regulatory authorities is obtained, the Company does not expect to consol- idate TMSC since it does not currently hold power over TMSC including voting rights in the shareholders meeting of TMSC. Under Phase V of its Excellent Global Corporation Plan, a five- year initiative launched in 2016, the Company aims to embrace the challenge of new growth through a grand strategic trans- formation. With regard to reinforcing and expanding new busi- nesses in particular, which represents one of the important strategies to be carried out during this phase, the Company CANON ANNUAL REPORT 2015 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS / SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS intends to cultivate its health care business within the safety and security sector as a next-generation pillar of growth. TMSC is one of the leading global companies in the medical equipment industry. Within the field of medical X-ray computed tomography (CT) systems in particular, TMSC is the overwhelm- ing market share leader in Japan and has been steadily increasing its global market share. Through the agreement, TMSC, with its world-class technological capabilities and global platform, will be welcomed into the Canon Group. By maximizing the combina- tion of both companies’ management resources, the Company aims to solidify its business foundation for health care that can contribute to the world. SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS Years ended December 31 Millions of yen 2015: Allowance for doubtful receivables Trade receivables Finance receivables 2014: Allowance for doubtful receivables Trade receivables Finance receivables 2013: Allowance for doubtful receivables Trade receivables Finance receivables Balance at beginning of period Addition-charged to income Deduction bad debts written off Translation adjustments and other Balance at end of period ¥ 12,122 6,276 ¥ 12,730 7,323 ¥ 12,970 6,908 ¥ 2,180 55 ¥ 878 154 ¥ 1,235 212 ¥ (1,745) (1,343) ¥ (2,236) (1,171) ¥ (4,173) (1,278) ¥ (480) (2,110) ¥ 750 (30) ¥ 2,698 1,481 ¥ 12,077 2,878 ¥ 12,122 6,276 ¥ 12,730 7,323 84 CANON ANNUAL REPORT 2015 MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Canon is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934, as amended, as a process designed by, or under the supervision of, the company’s principal executive and principal financial officers and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with gener- ally accepted accounting principles and includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide rea- sonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, pro- jections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Canon’s management assessed the effectiveness of internal control over financial reporting as of December 31, 2015. In making this assessment, management used the criteria established in internal Control –Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the “COSO criteria”). Based on its assessment, management concluded that, as of December 31, 2015, Canon’s internal control over financial report- ing was effective based on the COSO criteria. Canon’s independent registered public accounting firm, Ernst & Young ShinNihon LLC, has issued an audit report on the effec- tiveness of Canon’s internal control over financial reporting. CANON ANNUAL REPORT 2015 85 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders of Canon Inc. We have audited the accompanying consolidated balance sheets of Canon Inc. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2015. Our audits also included the schedule of valuation and qualifying accounts (the “schedule”). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these finan- cial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Canon Inc. and subsidiaries at December 31, 2015 and 2014, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. 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 financial reporting as of December 31, 2015, based on criteria established in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 30, 2016 expressed an unqualified opinion thereon. March 30, 2016 86 CANON ANNUAL REPORT 2015 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders of Canon Inc. We have audited Canon Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria estab- lished in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Canon Inc. and subsidiaries’ management is responsible for maintaining effective internal con- trol over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accom- panying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over finan- cial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial 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 financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the main- tenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the com- pany; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding pre- vention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in con- ditions, 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 financial reporting as of December 31, 2015, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the con- solidated balance sheets of Canon Inc. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2015, and our report dated March 30, 2016 expressed an unqualified opinion thereon. March 30, 2016 CANON ANNUAL REPORT 2015 87 TRANSFER AND REGISTRAR’S OFFICE SHAREHOLDER INFORMATION Canon Inc. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan Stock Exchange Listings: Tokyo, Nagoya, Fukuoka, Sapporo and New York stock exchanges Manager of the Register of Shareholders 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, 2016, in Tokyo Further Information: For publications or information, please contact the Public Affairs Headquarters, Canon Inc., Tokyo, or access Canon’s Website at www.canon.com 88 CANON ANNUAL REPORT 2015 MAJOR CONSOLIDATED SUBSIDIARIES (As of December 31, 2015) Marketing & Other Canon Marketing Japan Inc. Canon System and Support Inc. Canon Software Inc. Canon IT Solutions Inc. Canon U.S.A., Inc. Canon Canada Inc. Canon Solutions America, Inc. Canon Financial Services, Inc. Canon Europa N.V. Canon Europe Ltd. Canon Ru LLC Canon (UK) Ltd. Canon Deutschland GmbH Canon (Schweiz) AG Canon Nederland N.V. Canon France S.A.S. Canon Middle East FZ-LLC Canon Italia S.p.A. Canon (China) Co., Ltd. Canon Hongkong Co., Ltd. Canon Singapore Pte. Ltd. Canon India Pvt. Ltd. Canon Australia Pty. Ltd. Manufacturing Canon Precision Inc. Fukushima Canon Inc. Canon Chemicals Inc. Canon Components, Inc. Canon Electronics Inc. Canon Finetech Inc. Nisca Corporation Canon Tokki Corporation Canon ANELVA Corporation Nagahama Canon Inc. Canon Machinery Inc. Oita Canon Materials Inc. Oita Canon Inc. Nagasaki Canon Inc. Canon Virginia, Inc. Canon Bretagne S.A.S. Axis Communications AB Océ-Technologies B.V. Océ Printing Systems G.m.b.H. Canon Dalian Business Machines, Inc. Canon (Suzhou) Inc. Canon Zhongshan Business Machines Co., Ltd. Canon Zhuhai, Inc. Canon Inc., Taiwan Canon Vietnam Co., Ltd. Canon Hi-Tech (Thailand) Ltd. Canon Prachinburi (Thailand) Ltd. Canon Business Machines (Philippines), Inc. Canon Opto (Malaysia) Sdn. Bhd. Research & Development Canon Research Centre France S.A.S. Canon Information Systems Research Australia Pty. Ltd. CANON ANNUAL REPORT 2015 89 C A N O N A N N U A L R E P O R T 2 0 1 5 CANON INC. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan ©Canon Inc. 2016 PUB.BEP025-02 0916

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