Canon Annual Report 2016

Plain-text annual report

C A N O N A N N U A L R E P O R T 2 0 1 6 C A N O N A N N U A L R E P O R T 2 0 1 6 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 6 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 86 Schedule II Valuation and Qualifying Accounts 87 Management’s Report on Internal Control Over Financial Reporting 88 Reports of Independent Registered Public Accounting Firm Corporate Data 90 Transfer and Registrar’s Office 90 Shareholder Information 91 Major Consolidated Subsidiaries Cover Photo: The photographer in the cover photo (in the background on the left) is using an ultra-high-sensitivity Canon ME20F-SH multi-purpose camera to shoot this scene (see the thumbnail photo on the bottom left). The aurora borealis cover was photographed with a Canon EOS 5D Mark III. Multi-purpose cameras that feature Canon ultra-high-sensitivity sensors enable the capture of vivid colors even in direly lit scenes where it would be difficult to see with the naked eye. The still frame in the thumbnail photo was actu- ally pulled from video shot with the ME20F-SH. 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) 2016 2015 Change (%) 2016 Net sales Operating profit Income before income taxes ¥ 3,401,487 ¥ 3,800,271 228,866 355,210 244,651 347,438 Net income attributable to Canon Inc. 150,650 220,209 -10.5 -35.6 -29.6 -31.6 -31.6 -31.6 $ 29,323,164 1,972,983 2,109,060 1,298,707 $ 1.19 1.19 ¥ 137.95 ¥ 201.65 137.95 201.65 ¥5,138,529 ¥ 4,427,773 +16.1 $ 44,297,664 Net income attributable to Canon Inc. shareholders per share: —Basic —Diluted Total assets Canon Inc. shareholders’ equity ¥ 2,783,129 ¥ 2,966,415 -6.2 $ 23,992,491 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 JPY116=U.S.$1, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 30, 2016, 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 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 Net Income Attributable to Canon Inc. Shareholders per Share (Yen) ROE/ROA (%) 12.0 9.0 6.0 3.0 0 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 Basic Diluted ROE ROA 1 CANON ANNUAL REPORT 2016 T O O U R S H A R E H O L D E R S FUJIO MITARAI Chairman & CEO Canon Inc. 2 CANON ANNUAL REPORT 2016STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon will further promote a grand strategic transformation by accelerating reforms. Performance in 2016 to difficulties in procuring components caused by the 2016 Kumamoto Earthquake, along with an ongoing con- Looking back at the global economy in 2016, recovery in traction of the market. Meanwhile, sales of organic LED the United States and Europe slowed down, while growth (OLED) panel manufacturing equipment grew significantly in China continued to decelerate. As for the Japanese econ- against a backdrop of increasing OLED use, primarily in omy, the pickup in both corporate earnings and capital smartphones. investment showed signs of stalling. With regard to cur- Consequently, along with the negative impact of yen rency exchange rates, the yen appreciated considerably appreciation, consolidated net sales for 2016 decreased throughout the year, and conditions for Canon’s perfor- 10.5% year on year to ¥3,401.5 billion, and the gross profit mance were extremely challenging. ratio was 49.2%. Despite a reduction in operating expenses Looking at each of our main products, sales were strong of 8.5% year on year, which was partly due to Group-wide for color office multifunction devices and digital production efforts to reduce spending, operating profit decreased by printing systems, while sales of laser printers remained 35.6% to ¥228.9 billion, and net income attributable to low due to such factors as sluggish economic conditions Canon Inc. decreased by 31.6% to ¥150.7 billion. Seeking in emerging countries. New products for interchangeable to actively provide a stable return to shareholders, we lens digital cameras were well received in the market. As decided to distribute a full-year dividend of ¥150.00 per for digital compact cameras, sales volume declined due share, which is the same as the record-high dividend we 150 100 50 0 Cash Dividend (Yen) paid in the previous year. In 2016, we embarked on Phase V, our new five-year ini- tiative within the Excellent Global Corporation Plan, which is guided by the basic policy of “Embracing the challenge of new growth through a grand strategic transformation.” A significant event in the first year of Phase V was welcoming Toshiba Medical Systems Corporation (Toshiba Medical) into the Canon Group. Toshiba Medical has the broadest prod- uct portfolio in the diagnostic imaging equipment field and is the undisputed leader in Japan in sales of medical X-ray computed tomography (CT) systems. Furthermore, with the aim of achieving new growth, we have laid a foundation for our new businesses focused in the areas of commercial printing, network cameras, healthcare and industrial equip- 2008 2009 2010 2011 2012 2013 2014 2015 2016 ment, where future market expansion is expected. 3 CANON ANNUAL REPORT 2016 Excellent Global Corporation Plan Phase I 1996–2000 Phase II 2001–2005 Phase III 2006–2010 Phase IV 2011–2015 To strengthen its financial structure, Canon trans- formed its mindset to a focus on total optimiza- tion and profitability. The company introduced vari- ous business innovations, including the selection and consolidation of business areas, and reform activities in such areas as production and development. Aiming to become No. 1 in all major business areas, Canon focused on strengthening product competitiveness along with the changing times, stepping up efforts to digitize its products. The company also conducted structural reforms across all Canon Group compa- nies around the world. Canon moved ahead with such growth strategies as enhancing existing businesses and expanding into new areas while also thoroughly implementing supply chain management and IT reforms. Responding to weakness in the global economy, Canon revised its management policy from a strategy targeting expansion of scale to a strategy aimed at further strengthening its financial structure. While actively pursuing M&A activities, the company restructured its business at a founda- tional level to introduce new growth engines for future expansion. Phase V 2016–2020 From Phase I to Phase IV (1996–2015) Canon launched the Excellent Global Corporation Plan in to B2B. We subsequently reinforced and expanded our rap- idly growing network camera business by making Milestone 1996, and has strengthened its management base through Systems a subsidiary in 2014, followed by Axis in 2015. each of the plan’s five-year initiatives, from Phase I to Additionally, Canon Nanotechnologies, formally Molecular Phase IV. Imprints, became a subsidiary in 2014, and we are accelerat- During Phase I, we stressed thorough cash-flow man- ing the development of next-generation semiconductor man- agement and significantly boosted productivity through the ufacturing equipment that uses nanoimprint lithography, introduction of our cell production system, along with other which will make it possible to achieve both miniaturization measures. In Phase II, we stepped up efforts to digitalize our and cost reductions for semiconductor devices. copying machines and camera offerings, while building the As a manufacturer, Canon strives unceasingly to achieve foundation for a robust financial structure. During Phase III, production reforms and thorough cost reductions. At the we actively carried out M&A activities, and welcomed Océ same time, we stay on top of opportunities to add excellent to the Group in 2010, clearing the way for a move into the companies to the Group, in order to shift our focus towards high-growth-potential commercial printing market. changing growth markets, with the aim of unlocking new As the markets for our core businesses—such as cam- growth potential. eras and office equipment—were maturing, during Phase Finally, in the first year of Phase V, Toshiba Medical IV, which began in 2011, we promoted diversification via became a subsidiary. This completed our lineup of new busi- the lateral expansion of our existing businesses—such as the nesses—namely commercial printing, network cameras, Cinema EOS System and commercial photo printers—while healthcare and industrial equipment—that we have been also accelerating our M&A strategy. In this manner, we set establishing in preparation for future growth. These busi- a clear direction for shifting our focus for growth from B2C nesses are now beginning to produce results. 4 CANON ANNUAL REPORT 2016 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Phase V (2016–2020) Key Strategies 2020 Management Targets 1 2 3 4 5 Establish a new production system to achieve a cost-to-sales ratio of 45% Net sales Reinforce and expand new businesses while creating future businesses Restructure the global sales network in accordance with market changes *Cost-to-sales ratio Operating profit ratio Net income ratio Enhance R&D capabilities through open innovation Shareholders’ equity ratio ¥5 trillion 45% or less 15% or more 10% or more 70% or more Complete the Three Regional Headquarters management system capturing world dynamism (Based on exchange rates: US$1 = ¥125 and €1 = ¥135) * Cost-to-sales ratio refers to the cost of goods sold as a ratio of consoli- dated sales. The year 2016 marked the start of Phase V, our latest five- With advances in the digitalization and modularization of year initiative within the Excellent Global Corporation Plan. products, many companies in emerging countries are enter- As for the economic conditions on which Phase V is based, ing the market and further accelerating the product com- in 2016, the global economy experienced its lowest level of moditization process, which is expected to result in even overall growth since the financial crisis precipitated by the more intense competition. Lehman shock. Growth is expected to remain only moderate Amid forecasts of such changes in the business environ- in the coming fiscal year, even with the U.S. economy acting ment, Canon launched Phase V, guided by the basic pol- as a driving force. Meanwhile, we believe that two emerging icy of “Embracing the challenge of new growth through trends will bring about significant changes to future industry a grand strategic transformation.” During Phase V, we structure, the economy and society. are seeking to further expand the reforms that we pro- One of these trends is the Internet of Things (IoT), which moted in Phase IV, and aim to achieve net sales of ¥5 tril- creates new value through the interconnectedness of a lion, a cost-to-sales ratio of 45% or less, an operating profit diverse range of “things” via the Internet, from appliances ratio of 15% or more, a net income ratio of 10% or more, and automobiles to factory equipment. Responding to this and a shareholders’ equity ratio of 70% or more (based on change means that, even as a manufacturer, we must stop exchange rates of US$1 = ¥125 and €1 = ¥135) in 2020, the thinking in terms of individual items and discard the notion final year of Phase V. that we will have no troubles with sales as long as we Concrete explanations regarding the progress of these develop excellent products. Rather, we need to transform our strategies thus far, as well as our future course of action, are business model to combine hardware, software and services, presented as follows. and consider the value offered by the system as a whole. The other trend involves the rise of emerging economies. 5 CANON ANNUAL REPORT 2016Establish a new production system to achieve a cost-to-sales ratio of 45% Strategy 1 Strategy 2 Reinforce and expand new businesses while creating future businesses We are enhancing productivity via automated toner cartridge production. Canon network cameras are keeping children safe (Singapore International School, Hong Kong). The most important activity that will allow our grand trans- As a measure to shift our business focus to fields where formation to succeed is reinforcing existing businesses, and greater growth is anticipated, Canon has accelerated the the most important target towards achieving this is a cost- lateral expansion of existing businesses and developed a to-sales ratio of 45%. We see two aspects to achieving this: number of derivative businesses, including the Cinema EOS developing and expanding the market shares of “Dantotsu System, professional-use video and broadcast equipment Products” and thoroughly reducing manufacturing costs. for the age of 4K and 8K and the DreamLabo. We will con- “Dantotsu Products” refer to breakthrough products that tinue to reinforce and expand our four promising new busi- overturn conventional thinking. Through technological inno- nesses—commercial printing, network cameras, healthcare vation, we will create products, services and solutions that and industrial equipment. not only offer superior price, functionality and performance, In commercial printing, we are stepping up the develop- but that also cannot be imitated by other companies, thereby ment of products that combine the technologies of Canon securing high profitability. and Océ, with the aim of full-scale entry into the rapidly The Techno Wing at Oita Canon, a new R&D facility for growing markets of package printing (e.g., for product automation equipment, was completed in 2016 as an initia- packaging) and high-image-quality color commercial print- tive to reduce manufacturing costs. We will strengthen the ing for catalogues and other items. robot assembly processes even further in the future, as we In network cameras, Canon welcomed Milestone move toward complete automation. We will continue to pro- Systems to the Group in 2014, followed by Axis in 2015, duce our own key parts and components, and will proac- and in 2016, we released the first product jointly devel- tively increase in-house production of such manufacturing oped by Canon and Axis. Going forward, we will work equipment. We will also pursue productivity improvements to enhance image quality through 4K and 8K video, and by enhancing the functions of our mother plants in Japan strengthen camera intelligence by leveraging Canon’s while continuing production at optimal locations worldwide. image-processing and image-analysis technologies to 6 CANON ANNUAL REPORT 2016 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Restructure the global sales network in accordance with market changes Strategy 3 CEO Fujio Mitarai (right) and COO Masaya Maeda (left) visit Toshiba Medical Systems Corporation. Our e-commerce site where customers can purchase products online wherever they are at all hours has gained traction. develop market-specific solutions for such areas as urban Canon is currently executing a major shift to B2B and B2G, surveillance, airports, and stadiums. which targets governments and agencies. This requires the In healthcare, we will provide innovative products and ability to devise and implement solutions in response to cus- services worldwide, by combining the product lineup and tomer demands. To that end, we are strengthening our over- development capabilities of Toshiba Medical, which joined seas network functions, including connections with local the Group in 2016, with Canon’s medical and production governments, and enhancing coordination between com- technologies. Furthermore, we will also expand into new panies. We are concentrating our efforts to establish a fields, including healthcare IT and such biomedical fields as structure that is capable of detailed responses to customer genetic diagnostics. requests at any time—including after-sales maintenance and With regard to industrial equipment, strong growth is service—by training highly-skilled sales engineers who are expected to continue for Canon Tokki’s organic LED (OLED) fully equipped with technical knowledge of both hardware panel manufacturing equipment, thanks to a tailwind from and software. advances in IT equipment. Next-generation semiconductor Additionally, purchasing behavior is diversifying with the manufacturing equipment that uses nanoimprint lithogra- spread of the Internet and smartphones, and e-commerce phy is also expected to contribute to our business perfor- sales are expanding rapidly, especially in China and the mance, as our mass production system is almost in order. United States. In order to respond to these changes, we are In addition, we will work toward the growth of new busi- actively pursuing omni-channel marketing, which integrates nesses, mainly in the B2B domain, including machine vision, brick-and-mortar and online sales routes. industrial cameras, CMOS sensors and Canon Electronics’ aerospace business. 7 CANON ANNUAL REPORT 2016 Enhance R&D capabilities through open innovation Strategy 4 Strategy 5 Complete the Three Regional Headquarters management system capturing world dynamism Medical research collaboration with a Harvard-affiliated medical insti- tution (Healthcare Optics Research Lab., Canon U.S.A., United States). Canon Americas pursues genotyping systems R&D with the aim of commercialization (Canon BioMedical, United States). Research and development has always been a priority for In Phase IV, we made significant progress toward realizing Canon, resulting in a stream of excellent new products, our Three Regional Headquarters management system. In such as digital cameras, that have formed the foundation Phase V, we will further accelerate this diversification that of our growth. Recently, markets have undergone structural leverages the unique features of each region, with the aim changes in the industries in which Canon operates, includ- of completing a system capable of capturing the world dyna- ing cameras and office equipment. In this context, we will mism of businesses in Japan, the United States and Europe. promote the selection and concentration of future research To give an example of a specific initiative, we are carry- themes, and carry out well-modulated R&D investment, ing out R&D for genotyping solutions at Canon BioMedical, bearing in mind the urgency and gravity of the situation. At which we established in the United States in 2015. Canon the same time, as innovation continues to accelerate in a BioMedical launched the research-use-only Novallele geno- highly uncertain environment, we will actively promote R&D typing assays, which are being used in cancer and hereditary by making use of external expertise, when pursuing research disease research, and will continue to make further contri- themes that would require enormous amounts of time and butions to medical progress in the future. Additionally, the expense if developed independently. Healthcare Optics Research Laboratory is steadily advancing Furthermore, we will actively implement the training and research on ultra-miniature endoscopes and medical robot- development of software engineers, in light of the growing ics. In Europe, we are also reinforcing printing solutions demand for personnel in this area due to the advance of IoT research centered on Océ. and AI technologies. 8 CANON ANNUAL REPORT 2016 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Key Challenges for 2017 In Conclusion In 2017, the second year of our grand strategic transforma- 2016 was indeed a year befitting the inaugural year of this tion, we will take on the challenge of expanding our four five-year initiative that aims to achieve a grand transfor- new businesses of commercial printing, network cameras, mation of our business. While this grand transformation is healthcare and industrial equipment and produce results. So not something that can be accomplished overnight, all of our theme for 2017 is “Further promoting a grand strategic Canon’s divisions will make steady progress toward this goal. transformation by accelerating reforms,” as we work on the Moving forward, 2017 is a major milestone for Canon, following five key challenges. our 80th anniversary. While a moderate recovery is expected The first of these is to thoroughly bolster our existing busi- in the global economy, uncertainty is increasing and the eco- nesses with the aim of achieving a cost-to-sales ratio of 45% nomic situation does not allow for optimism. Nevertheless, by seeking even greater cost reductions and developing we will accelerate our growth by steadily executing the ini- “Dantotsu Products” that realize high profitability. tiatives laid out in Phase V to make this a fitting year for our The second is to strengthen and grow our new businesses 80th anniversary. and create future businesses. We will accelerate growth by We look forward to your continued understanding focusing on commercial printing, network cameras, health- and support. care and industrial equipment. Our third challenge is to restructure our global sales net- work. We will focus our efforts on establishing a structure to expand sales in new B2B businesses through such measures as training highly-skilled sales engineers. We will also formu- late global e-commerce strategies to make the most of the potential for development and expansion of e-commerce. The fourth is to strengthen R&D through open innovation. In addition to enhancing R&D efficiency for our existing busi- nesses and prioritizing investment in promising future fields, we will carry out strategic R&D by actively pursuing coopera- tion with external partners. The fifth is to cultivate global human resources and rein- vigorate the Canon spirit. To this end, we will work to re- instill Canon’s enterprising spirit and the San-ji (Three Selfs)* Spirit, while promoting the development of human resources that can exert leadership in a global setting. * San-ji, or the “Three Selfs,” refers to self-motivation (taking initia- tive 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). Fujio Mitarai Chairman & CEO Canon Inc. 9 CANON ANNUAL REPORT 2016 G R O W T H S T R AT E G Y G R O W T H S T R AT E G Y G R O W T H S T R AT E G Y A CB A. Toshiba Medical Systems Corporation’s computed tomography is highly regarded around the world for their high image quality and advanced technologies and have high market shares. B. The Customer Experience Center TOKYO (Canon Inc. Shimomaruko Headquarters, Japan), the first one built in Asia, is a facility for demo training and data verification using Canon products, in addition to displaying our large commer- cial printing equipment. C. Canon network cameras installed at a soccer practice field at the Jockey Club Kitchee Centre in Hong Kong. 10 CANON ANNUAL REPORT 2016STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Accelerating growth in commercial printing, network cameras, health care and industrial equipment as key drivers of Canon’s next-generation business. “Reinforcement and expansion of new businesses while cre- No. 1 provider in the market for network image solutions, we ating future businesses” is one of the strategies set out by are focusing development initiatives on high-performance net- Canon in Phase V of our Excellent Global Corporation Plan. work cameras and actively developing video analysis software. Here we explain our growth strategies in the following four new businesses: commercial printing, network cameras, the health care business, and the industrial equipment business. Health Care Major progress was seen in the health care field in 2016, when Toshiba Medical, a leader in the medical equipment Commercial Printing Canon welcomed Océ to the Group in 2010. We became the industry, became a Canon subsidiary. Toshiba Medical has a broad product portfolio that spans diagnostic X-ray systems, world’s top printing company both in name and substance computed tomography (CT), magnetic resonance imaging, with an extensive product lineup ranging from compact print- diagnostic ultrasound systems and diagnostic nuclear medi- ers to large commercial printing equipment. In recent years, cine systems. In CT systems, Toshiba Medical is the dominant the borders that had kept the printing market compartmen- market share leader in Japan and has been steadily increas- talized according to technologies and products have been ing its global market share. It also offers cutting-edge medical disappearing. In response to these changes in the business imaging solutions and in-vitro diagnostics. By maximizing the environment, we decided to make a full-fledged entry into the combined management resources of both companies, Canon fields of commercial and industrial printing where high growth aims to solidify its business foundation for health care that is anticipated. Particularly promising are the markets for pack- can contribute to the world. age printing, such as on folding carton, corrugated and labels as well as color printing with high image quality for catalogs and other items. Our plan is to nurture commercial printing as Industrial Equipment Sales of products such as semiconductor lithography equip- a major pillar of the next-generation printing business through ment and panel manufacturing equipment are growing, efforts including building an organization that will support our on the tailwind of growth of mobile devices such as smart- partnership with Océ, in order to establish a solid position in phones and increase of demand for IoT devices. In particular, these growth markets. organic LED (OLED) panel manufacturing equipment made by Canon Tokki is expected to continue showing strong growth. Network Cameras Axis, with its network camera development capabilities and Furthermore, with regard to semiconductor manufactur- ing equipment that uses nanoimprint lithography to achieve unrivalled sales network, Milestone, which holds the world’s top both miniaturization and cost reductions for next-genera- share in video management software, and Canon, with its pre- tion semiconductor devices, Molecular Imprints (now named cision optics and sensor technologies for cameras, are each har- Canon Nanotechnologies), which became a subsidiary in nessing their strengths in full. In 2016, Canon and Axis released 2014, is pushing ahead with technological development and is an interchangeable-lens network camera as our first jointly expected to contribute significantly to results. developed product. Furthermore, with the aim of becoming the 11 CANON ANNUAL REPORT 2016AT A G L A N C E Business Units Main Products Outline Composition of Sales (%) Net Sales (Billions of yen) 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 FPD (Flat panel display) Lithography Equipment Network Cameras 12 • 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 • FPD (Flat panel display) Lithography Equipment • Digital Radiography Systems • Diagnostic X-ray Systems • Computed Tomography • Magnetic Resonance Imaging • Diagnostic Ultrasound Systems • Clinical Chemistry Analyzers • Ophthalmic Equipment • Vacuum Thin-film Deposition Equipment • Organic LED (OLED) Panel Manufacturing Equipment • Die Bonders • Micromotors • Network Cameras • Handy Terminals • Document Scanners 53.1% 32.2% 17.2% 2,500 2,000 1,500 1,000 500 0 1,500 1,000 500 0 600 500 400 300 200 100 0 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 CANON ANNUAL REPORT 2016Business Units Main Products Outline Composition of Sales (%) Net Sales (Billions of yen) STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA In this segment, Canon offers an extensive range of products with high image quality, high resolution, and high speed, ranging from compact printers to large-scale commercial printing equipment. Leveraging these prod- ucts, Canon works in close collaboration with various Group companies and alliance partners to deliver optimal solutions tailored to match the customer’s business operations. These include various document solutions, such as office document management and the output of records. At the same time, the Company provides top quality services and support in a swift and reliable manner. Canon’s offerings in this segment include digi- tal cameras, digital camcorders, digital cinema cameras, interchangeable lenses, multimedia projectors, and inkjet printers. Canon’s digi- tal cameras, digital camcorders and digital cin- ema cameras, designed to deliver unparalleled image quality, have earned particularly high acclaim worldwide, thanks to in-house devel- oped lenses, CMOS image sensors, and image processors. Also widely popular are Canon’s inkjet printers, which are easy to use and pro- duce 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 FPD (flat panel display) lithography equipment. Moreover, working closely with Group com- panies, Canon is focusing on healthcare fields harnessing such products as computed tomog- raphy and network cameras. 53.1% 32.2% 17.2% 2,500 2,000 1,500 1,000 500 0 1,500 1,000 500 0 600 500 400 300 200 100 0 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 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. 13 2012 2013 2014 2015 2016 CANON ANNUAL REPORT 2016O F F I C E B U S I N E S S U N I T Widely used in commercial printing and central reprographic departments, Canon digital production printing systems are capable of handling diverse print content in a variety of paper types and sizes, and of providing quick turnaround of small-lot print jobs. 2016 Review Canon worked on increasing the profitability of office mul- Digital production printing systems saw a growth in sales of the imageRUNNER ADVANCE 8500 series, despite tifunction devices (MFDs) amid intensifying competition the shrinking monochrome market, and the imagePRESS by focusing on winning customers who can be expected C10000VP series of color models performed strongly. to produce high print volume. Sales of monochrome mod- In addition, laser multifunction printers (MFPs) and laser els remained weak, particularly in Japan, as demand contin- printers saw drops in both sales volume and revenue, due ued to shift toward color models. On the other hand, sales to a contraction of emerging markets mainly in Central and of the color models were relatively strong. Notably, the new South America, which led to a sharp decline especially in imageRUNNER ADVANCE C5500 series of A3 medium- to monochrome models. high-speed color machines featuring significantly improved The Océ VarioPrint i300 sheet-fed inkjet press, a high- operability, productivity and image quality was well received. speed commercial printer, posted healthy sales. The imageRUNNER ADVANCE C3300 series launched in the These factors, coupled with the negative effect of unfa- previous year also performed favorably, mainly in China. vorable currency exchange rates, resulted in consolidated net 14 CANON ANNUAL REPORT 2016 STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Net Sales (Billions of yen) 2,500 2,000 1,500 1,000 500 0 2012 2013 2014 2015 2016 Digital Production Printing System imagePRESS C10000VP Office Multifunction Device imageRUNNER ADVANCE C5560F Digital Production Printing System Océ VarioPrint i300 sales for the business unit of ¥1,807.8 billion, a year-on-year ing number of people are using color models and MFPs as decline of 14.4%. 2017 Initiatives Demand for color models in the office MFD market is shared printers, owing to the establishment of network envi- ronments, and the number of users is predicted to continue rising. On the other hand, we will rigorously prioritize the profitability of low-end models, rather than only pursuing expected to make up for lower demand for monochrome sales volume. models and remain in line with that of the previous year In the commercial printing market, steady demand for overall. In this context, Canon will pursue even greater sales small-lot printing and central reprographic departments is expansion by further enhancing its lineup of color models expected to continue. Canon will further increase sales of that realize high image quality with vivid color and improved light-production models and high-speed printers. expression, while also offering lower maintenance costs. We are also improving Océ’s high-speed sheet-fed inkjet The market for laser printers is also expected to remain at press to handle various types of paper, aiming for substantial the same level as that of the previous year. Even so, a grow- sales growth in this area. 15 CANON ANNUAL REPORT 2016 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 Delivering exceptional image quality and superior mobility, the Cinema EOS System is a prominent presence in the motion picture production industry. Through even higher resolution and more expressive color gamut, Canon is developing 8K cameras and lenses that can create images so vivid they seem to come alive on screen. Photo by LAUSCHSICHT, commissioned by Swiss International Air Lines for “The People behind SWISS” project. 2016 Review Sales volume for interchangeable lens digital cameras grew The Cinema EOS System, which is targeted at the motion picture production industry, bolstered its capacity to handle a after the rollout of new products, including the flagship SLR wide range of professional needs with the launch of the EOS model EOS-1D X Mark II, updated for the first time in four C700, its top-of-the-line digital cinema camera. years; the EOS 5D Mark IV full-size camera for advanced As for broadcasting equipment, demand was strong for amateurs; and the mirrorless model, the EOS M5, which fea- models for sports coverage and for HD lenses in China and tures a built-in EVF (electronic viewfinder). Strong sales of other countries. Inquiries picked up in Europe and Asia for these models contributed to the maintenance of Canon’s top zoom lenses for 4K broadcast cameras employing 2/3-inch share of the global market. sensors, and the COMPACT-SERVO lens for large-sensor cam- Sales volume of digital compact cameras declined due eras received favorable reviews worldwide. to difficulties in procuring components caused by the 2016 As for inkjet printers, sales in emerging countries, mainly Kumamoto Earthquake, along with an ongoing contraction in Asia, were strong for refillable ink tank models for high vol- of the market. ume printing. Newly designed models for home use also per- 16 CANON ANNUAL REPORT 2016STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Net Sales (Billions of yen) 1,500 1,000 500 0 2012 2013 2014 2015 2016 Interchangeable Lens Digital Camera EOS-1DX Mark II Inkjet Printer imagePROGRAF PRO-4000 Digital Cinema Camera EOS C700 formed well, mainly in Japan. However, overall sales volume capture a new user segment, using mirrorless cameras as a declined due to a shrinking market for consumer products. driver. We will also stimulate demand by further enhancing In large-format inkjet printers, the new imagePROGRAF AF and video functions aimed at advanced amateurs. PRO series models, which target the professional photo and Meanwhile, the digital compact camera market is graphic art market, saw robust sales. expected to take a while longer to bottom out. Canon As a result of these factors, along with the negative effect of will continue to focus on cost reductions and sales of high unfavorable currency exchange rates, consolidated sales for the added-value models with a view to improving profitability. business unit decreased 13.3% year on year to ¥1,095.3 billion. As for inkjet printers, we will concentrate on increasing 2017 Initiatives Although demand for interchangeable lens digital cameras sales in emerging countries of refillable ink tank models for high volume printing. As for the B2B field, we will conduct sales promotions for the MAXIFY series business models, and is waning, mainly in developed countries, the situation is the imagePROGRAF PRO series, which target the professional improving gradually. In these circumstances, Canon seeks to photo and graphic art market. 17 CANON ANNUAL REPORT 2016 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 equipment using nanoimprint lithography that delivers high-resolution processes at a lower cost. With the aim of a commercial launch soon, Canon seeks to solidify its position in the field of semiconductor lithography equipment. 2016 Review In semiconductor lithography equipment, Canon focused on Also, sales of OLED panel manufacturing equipment sold by Canon Tokki increased significantly due to brisk capital invest- sales of products such as the FPA-5550iZ i-line steppers, whose ment by panel manufacturers for smartphones. stable quality and operating rate have made them best sellers for Sales of network cameras also grew, owing to our efforts to a long period, and the FPA-6300ES6a KrF scanners that boast boost sales and broaden the product lineup to reflect increas- the industry’s highest overlay accuracy and high productivity. ing needs for enhancing marketing and efficiency at production However, unit sales decreased from the previous year amid the sites, in addition to disaster-monitoring and crime-prevention postponement of some capital investments by customers. functions. Moreover, we launched two software products lever- Meanwhile, in FPD (Flat panel display) Lithography Equipment, aging original Canon technology in video content analysis. unit sales of lithography systems employed in the fabrication With respect to medical equipment, sales of Canon’s mainstay of small-to-mid sized panels, such as the MPAsp-E810 series, digital radiography systems expanded for manufacturers of X-ray increased in response to growing demand for high-definition system equipment in China. However, global unit sales remained organic LED (OLED) displays used in mobile devices. flat year on year due to intensifying competition and other factors. 18 CANON ANNUAL REPORT 2016STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Net Sales (Billions of yen) 2012 2013 2014 2015 2016 FPD (Flat panel display) Lithography Equipment MPAsp-E810 600 500 400 300 200 100 0 Network Cameras VB-M50B Organic LED (OLED) Panel Manufacturing Equipment As a result of these factors, consolidated net sales for the equipment, which will sequentially allow it to significantly grow sales. business unit increased 11.4% year on year to ¥584.7 billion. In the area of network cameras, in addition to the launch of an 2017 Initiatives Unit sales of semiconductor lithography equipment are interchangeable-lens network camera suited for high-resolution surveillance that was jointly developed by Canon and Axis, Canon aims to reinforce its lineup by working to enhance its software expected to remain at the same level as the previous year, offering. Canon will also focus efforts on camera intelligence, lever- underpinned by IoT demand. Meanwhile, Canon plans to aging Canon’s image-processing and image-analysis technologies increase unit sales of FPD lithography equipment to at least to develop market-specific solutions. double the level of the previous year, as the stable quality of In medical equipment, Toshiba Medical became a subsidiary high-definition equipment for small-to-mid sized panels has of Canon at the end of last year. Based on a new growth strat- become recognized in the market. egy that centers on Toshiba Medical, Canon aims to exert the Canon, responding to strong demand, is also establishing a struc- Group’s comprehensive strengths to provide innovative prod- ture to expand production of Canon Tokki’s OLED panel production ucts and high-quality services. 19 CANON ANNUAL REPORT 2016 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. Directors and Audit & Supervisory Board Members (as of April 1, 2017) 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 HQ Group Executive of Facilities Management HQ Representative Director Executive Vice President In charge of Office Business Toshio Homma Chief Executive of Office Imaging Products Operations Representative Director Executive Vice President & CTO Shigeyuki Matsumoto Group Executive of R&D HQ 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) Hiroshi Yoshida (Outside) Kuniyoshi Kitamura (Outside) Note: Although this annual report is for FY2016, the above list of Directors and Audit & Supervisory Board members is as of April 1, 2017. 20 CANON ANNUAL REPORT 2016STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon maintains sound corporate governance as part of efforts to maximize its shareholders’ value and become a truly excellent global corporation. Fundamental Policy Concerning Corporate Governance In order to establish a sound corporate governance struc- Directors are active in decision making and execution, and under the command and supervision of the Representative Directors, Executive Officers that are elected through reso- ture and continuously raise corporate value, Canon believes lution of the Board of Directors make decisions and execute that it is essential to improve management transparency and operations of each business field or function. strengthen management supervising functions. At the same Currently, the Board of Directors consists of seven mem- time, a sense of ethics and mission held by each executive bers, five Representative Directors from inside Canon and and employee of Canon is very important in order to achieve two Outside Directors that qualify as Independent Directors*. continuous corporate growth and development. As of April 1, 2017, there will be 38 Executive Officers, Basic Guidelines on Corporate Governance The Company is globally expanding its businesses in vari- ous business fields, including office equipment, consumer products, and industrial equipment, and aims to aggressively expand new business fields in the future. In order to make including two females and two non-Japanese. * Independent directors: Stock exchanges in Japan require listed companies 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 interests with regular shareholders. People related to the parent company or major business partners, consul- tants who receive large remunerations from the company, and their close relatives cannot be selected as independent directors. prompt decisions in each business field, and make important decisions for the entire Canon Group or matters that straddle Audit & Supervisory Board As a body which is in charge of the audit of operations, several business fields from a company-wide perspective and under the principles of autonomy, which is independent at the same time secure appropriate decision making and from the Board of Directors, the Company has full-time execution of operation, the Company judges the corporate Audit & Supervisory Board Members that are familiar with governance structure below to be effective. the Company’s businesses or its management structure, and Board of Directors While the focus of the organizational structure of the Board of Independent Outside Audit & Supervisory Board Members that have extensive knowledge in specialized areas such as law, finance and accounting. The Audit & Supervisory Board, Directors is on Representative Directors that oversee company- which is composed of these individuals, cooperates with the wide business strategies or execution such as the CEO, COO, Company’s accounting auditors and internal audit division, CFO, CTO, and Representative Directors or Executive Directors oversees the status of duty execution of operations and cor- that oversee multiple business fields or headquarters functions, in porate assets to secure the soundness of management. order to secure sound management, two or more Independent Currently, the Audit & Supervisory Board consists of five Outside Directors are appointed. The Board of Directors, in accor- individuals, three of which are Independent Outside Audit dance with laws and regulations, makes important decisions and & Supervisory Board Members. In accordance with audit- supervises the execution of duties by officers. ing policies and plans decided at Audit & Supervisory Board Except for the above, the CEO and other Representative meetings, the Audit & Supervisory Board Members attend 21 CANON ANNUAL REPORT 2016Board of Directors’ meetings, Corporate Strategy Committee Directors, and one Independent Outside Audit & Supervisory meetings, etc., receive reports from directors and employ- Board Member. At the time Director and Audit & Supervisory ees, review documents related to important decisions, and Board Member candidates are nominated and Executive conducting audits by investigating etc. the situation of busi- Officers are selected (includes the selection of the successor nesses and property of the Company and its subsidiaries. In of chief executive officer), the CEO recommends candidates this way, the Audit & Supervisory Board plays a role in con- thereof from among individuals that have been recognized as ducting strict audits of directors’ execution of duty, including having met the prescribed requirements, and the Committee the status of development of the internal control system. checks the fairness and validity of such recommendation prior Procedures in the Nomination of Directors etc. The Company established the “Nomination and Remuneration Advisory Committee,” a non-statutory com- mittee, which consists of the CEO, two Independent Outside to submission to and deliberation by the Board of Directors. Additionally, as for the Audit & Supervisory Board Member candidate, prior to deliberation of the Board of Directors, consent of the Audit & Supervisory Board shall be acquired. 22 Governance Structure (as of March 30, 2017)Audit & Supervisory Board5 Members(Includes 3 Independent Members)General Meeting of ShareholdersBoard of Directors7 Members(Includes 2 Independent Members)Representative DirectorsCEO and othersAccounting Auditor(Audit Firm)Executive Officers, and each General ManagerCorporate Audit CenterDisclosure CommitteeCorporate Strategy CommitteeRepresentative Directors and Executive Officers with direct control of an organizational divisionElect/DismissElect/DismissApprove/SuperviseInstruct/OrderApprove/SuperviseElect/DismissElect/DismissAuditNomination and Remuneration Advisory Committee(CEO, two Independent Outside Directors, and one Independent Outside Audit & Supervisory Board Member)CooperationFinancial AuditCooperationCooperationReportAuditReportReportReportReportReportInternal AuditConsultConsultReportFinancial Risk ManagementSubcommitteeCompliance SubcommitteeBusiness Risk ManagementSubcommitteeRisk Management CommitteeCooperationReportCANON ANNUAL REPORT 2016STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Corporate Strategy Committee, Risk Management Committee, and Disclosure Committee The Company established the Corporate Strategy Committee, consisting of Representative Directors and some Executive Officers. Among items to be decided by the CEO, the Committee undertakes prior deliberations on impor- all work processes, audits must be conducted from a spe- cialized view point and there are plans to increase the num- ber of members from the current 70 to strengthen auditing functions. Accounting Auditor The Company has an auditing service contract with Ernst & tant matters pertaining to Canon Group strategies. Outside Young ShinNihon LLC to audit its financial statements. Directors and Audit & Supervisory Board members attend The names and other details of the certified public Corporate Strategy Committee meetings and are able to accountants that carried out accounting audit work for the express their own opinions. Company are listed below. Based on a resolution passed by the Board of Directors, Canon set up the Risk Management Committee, which for- Certified Public Accountant Accounting Firm mulates policy and action proposals regarding improve- ment of the Canon Group risk management system. The Risk Management Committee consists of three entities: the Financial Risk Subcommittee, which is tasked with improv- Designated Partner, Engagement Partner Yoshihiko Nakatani Ryo Kayama Kiyoto Tanaka Ernst & Young ShinNihon LLC ing systems to ensure reliability of financial reporting; the Notes: 1. Since all partners have fewer than seven years of consec- Compliance Sub-committee, which is tasked with promot- ing corporate ethics and improving legal compliance systems; and the Business Risk Management Sub-committee, which is charged with improving systems to management overall business risks, including risks related to product quality and information leak. The Risk Management Committee verifies the risk management system and reports the status to the utive audits, the number of years of consecutive audits has been omitted. 2. The above audit firm reinforces self-imposed regulations, employing more stringent rotation rules than those of various regulations stipulated by law etc., regarding audit engagements with respect to listed companies. Auditing assistants that carried out audit work for the Company: (Certified Public Accountants: 27; Others*: 53) *Note: Includes individuals that have passed the certified public CEO and the Board of Directors. In addition, the Disclosure accountant exam and persons in charge of auditing systems. Committee was established to undertake deliberations per- taining to information disclosure, including content and timing, to ensure important corporate information will be disclosed in a timely and accurate manner. Internal Audit Division The Corporate Audit Center, the Company’s internal audit- ing arm, as an independent and specialized organization and in accordance with internal audit rules, conducts audits of particular themes and evaluations and provides guidance on such matters as compliance with laws and the internal control system. Furthermore, audits such as quality, the envi- ronment, and information security, are conducted by the Corporate Audit Center in cooperation with each division in charge. Additionally, based on top management policy, for 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 first president, Takeshi Mitarai) 23 CANON ANNUAL REPORT 2016 R E S E A R C H & D E V E L O P M E N T A B 2016 Top Ten U.S. Patent Holders by Company IBM* Samsung Electronics CANON Qualcomm Google Intel LG Electronics Microsoft Taiwan Semiconductor Manufacturing Sony 2,897 2,835 2,784 2,428 2,398 2,288 2,181 8,088 5,518 3,665 *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. A. Canon continues clinical research at the Kyoto University Hospital to apply photoacoustic tomography to breast cancer screening and diagnosis. B. Canon’s ultra-high-resolution CMOS sensor captures images where the lettering on an aircraft fuselage about 18 kilometers away is legible. 24 CANON ANNUAL REPORT 2016STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon is engaged in efforts to discover new technologies that will help create future businesses. Strengthening Our Global R&D Structure Canon is pursuing globalized diversification of its operations Initiatives to Establish New Businesses Canon has a long-term perspective as it concentrates its efforts on discovering new technologies for the future. At in the field of R&D. The Company has established the foun- the same time, the Company is continually bolstering R&D dation of the Three Regional Headquarters management activities centered on key parts and key devices. With regard system that leads to new businesses emerging from Japan, to CMOS sensors employed in interchangeable lens digi- the United States, and Europe. We are leveraging the unique tal cameras and other devices, we are conducting in-house characteristics and capabilities of each region in activities development and production of ultra-high-resolution sen- that range from basic research to applied research. sors that make it possible to capture images of the letter- For example, in the United States, Canon BioMedical ing printed on the body of an aircraft roughly 18 kilometers is making steady progress in genotyping systems, while away and ultra-high-sensitivity sensors capable of captur- Healthcare Optics Research Laboratory is steadily advanc- ing vivid images in color even with minimal subject illumina- ing research on ultra-miniature endoscopes and medical tion, conditions under which subjects would be difficult to robotics. In Europe, we are reinforcing R&D in business fields discern with the naked eye. We will explore applications in mainly in printing solutions centered on Océ, as well as mak- such fields as astronomical and nature observation, medical ing further use of existing R&D centers to advance R&D in research, aviation, and surveillance and security. new fields. In the medical field, Canon participates in the Impulsing Paradigm Change through Disruptive Technologies (ImPACT) R&D Expenses and Patents Canon is bolstering R&D activities to enable the ongoing Program organized by the Cabinet Office of Japan. We are working on research in photoacoustic tomography that development of innovative products and services. In the year enables 3-D imaging of blood vessels using laser illumination under review, R&D expenses amounted to ¥302.4 billion, and ultrasonic sensors. down 8.0%, or ¥26.1 billion, from the previous year. The Moreover, Canon is combining its material appearance ratio of R&D expenses to net sales was 8.9%. This focus on image-processing technology with Océ’s elevated printing R&D activities has cemented Canon’s high status in the field technology of UV-curable printers. The aim is to use a printer of intellectual property. In 2016, Canon was granted 3,665 to faithfully reproduce material appearance characteristics of patents in the United States, ranking it third in the world the original object, such as glossiness, surface contours, and and the top ranked Japanese company for a twelfth consec- transparency. In line with these activities, we carried out ini- utive year. tiatives to create reproductions of rare manuscripts from the collection of the Vatican Apostolic Library in 2016. 25 CANON ANNUAL REPORT 2016 P R O D U C T I O N P R O D U C T I O N A CB A. Digital production printing system assembly: We are bolstering the functions of our domestic mother factories, raising the domestic production ratio of high-end models with high value added. (Toride Plant, Japan) B. We installed one of the largest semi-anechoic chambers in Japan in 2015, and now conduct verification testing in-house of large products. (Tamagawa Office, Japan) C. With the completion of Oita Canon’s Techno Wing R&D facility, an R&D base for production automation equipment, we aim to fully automate camera production. (Oita Canon, Japan) 26 CANON ANNUAL REPORT 2016STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon aims to establish a new production system capable of generating higher profits while seeking improved quality based on the manufacturing capabilities. Establishing a New Production System to Achieve a Cost-of-sales Ratio of 45% Canon has always endeavored to innovate production and Developing Human Resource for Manufacturing At Canon, we carry out global human resource training to development operations to maximize profitability. These prepare tomorrow’s leaders for success at production sites efforts include a thorough re-examination of production around the world. In Japan, honing the skills of employees processes at our factories worldwide. As a key initiative in has resulted in such achievements as the seven prizes in four this effort, we are bringing production back to Japan. We categories, including the Silver Award at Japan’s National are promoting a higher ratio of production in the country by Skills Competition in 2016. strengthening domestic mother factories through the inte- gration of design, procurement, production-engineering, and manufacturing-technology operations. Canon will further improve productivity by enhancing its Environmental Friendly Manufacturing; Enhanced Product Quality Canon actively seeks to prioritize purchases of environmen- production engineering technology through initiatives such tally conscious parts and materials as well as shift to trans- as in-house production, where Canon develops and pro- portation modes that have minimal environmental impact. duces its own parts and materials as well as manufactur- We also focus on manufacturing initiatives that are friendly ing equipment; and automation of product assembly using to the global environment. technologies such as the Canon-developed Super Machine The Quality Management Headquarters, which was pre- Vision. The Techno Wing R&D facility for automation equip- viously spread across multiple sites, was consolidated into ment was completed in Japan at Oita Canon in 2016. We the Tamagawa Office as a way to improve quality. We have aim to fully automate camera production by 2018. In addi- introduced cutting-edge facilities and facilities to handle tion to advanced automation technologies, we will make large products, and we have put into place a strong quality use of leading-edge technologies such as IoT, big data, and system that can swiftly respond to quality standards and cer- artificial intelligence. tifications of various countries around the world. Meanwhile, we are moving ahead with functional special- ization between Japan and Asia, allocating mass production of mid-range and low-priced products to our Asian produc- tion sites in China, Thailand, the Philippines and other coun- tries. In the Americas and Europe, Canon is making use of automated production systems to implement localized pro- duction mainly of consumables such as toner cartridges. Through these initiatives, Canon aims to achieve a cost- of-sales ratio of 45%, establishing a new production system capable of generating higher profits. 27 CANON ANNUAL REPORT 2016S A L E S & M A R K E T I N G A CB A. Canon EXPO 2016 Shanghai, a traveling exhibition that displays new products and future technologies under the concept of “Closer & Connect,” drew about 44,000 visitors in its tour of nineteen countries and regions across Asia. B. Canon BioMedical, founded in 2015 by Canon Americas, has launched its first products, genotyping tests, for genetic research*. *For research use only. Not for use in diagnostic procedures. C. Canon Europe attended a highly successful drupa 2016, where Canon’s end to end production print solutions were demonstrated and well received, and helped contribute to increased sales in this area. 28 CANON ANNUAL REPORT 2016STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon reinforces its sales and marketing capabilities by providing innovative products and advanced solutions tailored to meet the characteristics of each region. Japan Sales in Japan amounted to ¥707.0 billion, or 20.8% of con- were made to further strengthen our sales channels across EMEA and increase our solutions portfolio. To expand oper- solidated net sales. ations in emerging markets and be closer to our customers, The market for consumer products proved challenging new locations were established, including showrooms in due to a slump in personal consumption and the impact of Morocco and Qatar and an office in Nigeria. There was also the Kumamoto Earthquake, among other factors. Canon a focus on transformation across the organization, with saw a year-over-year decline in shipments of products for functional changes implemented to reflect a more consumers owing to the sluggish market. Although hard- customer-centric approach. ware sales stagnated in the B2B field, performance was strong in the consumables business. In addition, many com- panies increased their investments in security, resulting in an Asia and Oceania Sales in Asia and Oceania amounted to ¥817.4 billion, or increase in sales in this area for products such as software, 24.0% of consolidated net sales. peripherals and surveillance cameras. In China, Canon outlined its plan and vision at Canon EXPO 2016 Shanghai. Canon Singapore acquired three companies The Americas Sales in the Americas amounted to ¥963.5 billion, or 28.3% at the end of 2015, including Canon MailCom Malaysia. (for- merly Efficient Mailcom.), a leader of transaction printing ser- of consolidated net sales. vice provider in Malaysia, with the aim of expanding the B2B In activities for the office business market, we expanded business in the South Asia and Southeast Asian markets. In collaboration with our business solutions companies and com- Australia, IT solutions company Harbour IT and BPO business menced business negotiations for a large procurement with Converga, which have been added to the Canon Group, con- a major chain supplier for print-for-pay and business services. tributed to a significant increase in overall sales. The imaging system business unit received positive feedback for our technological knowhow and strong support from pho- tographers and broadcast industry professionals at sports fes- Composition of Sales by Region tivals hosted in Latin America. In the health care field, we aim Asia and Oceania for further growth in the wake of our equity investment of T2 Biosystems, a developer of medical diagnostic products. 24.0% ¥817.4 billion Europe (Europe, Middle East, Africa) Sales in Europe amounted to ¥913.5 billion, or 26.9% of consolidated net sales. Canon in EMEA saw encouraging growth in areas of the businesses including Pro Print and Solutions & Services and strong market share in DSLR. Strategic investments Japan 20.8% ¥707.0 billion Net Sales ¥3,401.5 billion The Americas 28.3% ¥963.5 billion Europe 26.9% ¥913.5 billion 29 CANON ANNUAL REPORT 2016 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 A B Lifecycle CO2 Emissions Improvement Index per Product 100 80 60 40 20 0 New York Yankees. All Rights Reserved *2008 results set as 100 2008 2009 2010 2011 2012 2013 2014 2015 2016 A. For the Tsuzuri Project, we donated high-resolution facsimiles of sliding door paintings completed over five years to Tenkyuin Temple, conclud- ing in 2016 the reproduction of 56 paintings in total. B. Canon U.S.A. donated $466,392 as support for the activities of the National Center for Missing & Exploited Children (NCMEC) on Canon Promotional Night, a social contribution event held at Yankee Stadium. 30 CANON ANNUAL REPORT 2016STRATEGY BUSINESS SEGMENT CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon is promoting CSR activities with the aim of becoming a truly excellent corporation that is admired and respected the world over. Canon’s Basic Approach to CSR Recognizing that its corporate activities are supported by the The Tsuzuri Project Canon and the non-profit organization Kyoto Culture development of society as a whole, Canon contributes to the Association jointly promote a project called the “Tsuzuri realization of a better society as a good corporate citizen, effec- Project” (Official title: Cultural Heritage Inheritance Project). tively leveraging its advanced technological strengths, global The aim of the project is to preserve original cultural assets business deployment, and diverse, specialized human resources. while making effective use of high-resolution facsimiles of Environmental Activities Reducing Lifecycle CO2 Emissions per Product cultural assets. These facsimiles are created by blending Canon’s latest digital technology and traditional Japanese crafts, such as gold leaf craftwork. As a result of the proj- Canon sets a target of reducing lifecycle CO2 emissions per ect, original cultural assets can be kept in the more favor- product by 3% per year to address the issue of climate change. able environment of museums while facsimiles can be used This effort falls under its environmental vision Action for Green, for educational purposes and public exhibits. Since the pro- established in 2008. Canon has been actively pursuing initia- gram began in 2007, the cumulative total of reproduced and tives to reduce CO2 emissions at all product life cycle stages, donated items has reached 34 (as of March 2017). from raw materials procurement to production, logistics, prod- uct use, and recycling. As a result, lifecycle CO2 emissions per Helping to Bring Home Missing Children in the U.S. product were reduced by more than 30% from 2008 to 2016, Since 1997, Canon U.S.A. has supported the activities of the or 5.5% per year. These efforts earned Canon inclusion on the National Center for Missing & Exploited Children (NCMEC), “Climate A List” in 2016 for the first time. The ranking is the a non-profit organization that works to prevent child kid- highest given by CDP, an international non-profit organization. napping and to quickly find and recover missing children. Social Contribution Activities Canon conducts wide-ranging social contribution activities in Canon U.S.A. has provided police and investigative agencies with over 2,200 pieces of equipment such as digital cam- eras, scanners, and printers that are essential for distributing various parts of the world to help create a better society. photographs and other information about missing children. Canon Foundation Announces Seventh Grant including contributions from Canon U.S.A. employees. Canon raised and donated $466,392 to NCMEC in 2016, Program Recipients The Canon Foundation aims to contribute to the ongoing Assistance for Typhoon-Stricken Areas in Vietnam prosperity and well-being of mankind. It has offered two Canon Vietnam and Canon Marketing Vietnam provided research grant programs, known as the Creation of Industrial assistance to areas hit by flooding as a result of Typhoon Infrastructure grant and Pursuit of Ideals grant. For the latter, Aere in October 2016. Volunteers from Canon Vietnam, the foundation sought proposals from the public on issues Canon Marketing Vietnam and other Japanese companies for research concerning food. In 2016, 17 projects were visited six communes of Ha Tinh Province and Quang Binh selected for the seventh research grant program. Province in Vietnam. They delivered supplies and financial aid 31 CANON ANNUAL REPORT 2016to 600 households. The Canon Group also donated a total found to have contributed to funding armed groups in con- of $13,298, including donations from employees, to the flict regions as defined by U.S. legislation. affected areas. Canon Inc., a U.S. listed company, files a report at the end of May every year regarding the Company’s status on this Creative Skills and Storytelling Development for issue with the U.S. Securities and Exchange Commission. Young People in EMEA For the reporting year 2015, an independent assurance Canon in EMEA offers programs for young people to spark report made by an independent auditor was included with their interest in creative and storytelling activities with a view the Company’s conflict minerals report, which confirmed to realizing a sustainable society. Canon Europe’s various pro- that the Canon Group’s activities were compliant with cer- grams include workshops and exhibitions aimed at empow- tain international standards. The report is also made available ering young people, nurturing their creativity and focusing on Canon’s website. Canon is a member of the Conflict- on areas such as photography, video and graphic art that are Free Sourcing Initiative (CFSI), that plays the leading role in closely related to Canon’s businesses. In 2016, we offered response to the conflict minerals. such programs in 12 countries, including Finland, Turkey and the UK. From 2017 Canon Europe will link the program to the UN Sustainable Development Goals. Addressing the Issue of Conflict Minerals Seeking to ensure that customers can use Canon products Cultivating Diverse Human Resources Canon is committed to diversity of human resources. We welcome people of all types—irrespective of race, gender, age, customs, and value perceptions—and deploy such dif- ferences to foster our growth as an organization. Since with peace of mind, the Canon Group addresses the issue of 2012, we have engaged in in-house projects fostering diver- conflict minerals. sity. In 2016, Canon held meetings with Group company Canon has been conducting full-scale inquiries targeting presidents at 23 Group companies in Japan organized by the products produced at manufacturing bases across the entire VIVID diversity promotion program, where they promoted Canon Group. As of February 2017, within the scope of the activities to enable more active roles for women in the work- responses collected, no specific parts or materials have been place Group-wide. C D C. As part of our young people program, a photography workshop for young people called “All ages are beautiful” was held at Canon Finland. D. Canon Vietnam and Canon Marketing Vietnam sent relief supplies and money to areas where Typhoon Aere in October 2016 caused flood- ing and damage. 32 CANON ANNUAL REPORT 2016F 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 86 Schedule II Valuation and Qualifying Accounts 87 Management’s Report on Internal Control Over Financial Reporting 88 Reports of Independent Registered Public Accounting Firm 33 CANON ANNUAL REPORT 2016FINANCIAL 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 2016, the trend of recovery in the U.S. economy became stronger as employment conditions and consumer spending progressively improved from the latter half of the year. In Europe, although the econ- omy grew moderately, centered on Germany, the outlook for the region’s economy has grown increasingly uncertain due to concerns over the UK’s decision to exit the EU and the politi- cal unrest in Syria. The Chinese economy continued its decel- eration trend while the economies of emerging countries such as Russia and Brazil remained stagnant. In Japan, the economy remained weak due to weak consumer spending. Looking at the global economy as a whole, although higher growth than the previous year was expected at the beginning of the year, the global economy overall experienced its lowest level of growth since the financial crisis precipitated by Lehman Brothers’ bankruptcy. Market environment As for the markets in which Canon operates amid these con- ditions, regarding the demand for office MFDs and laser print- ers, the demand for color models enjoyed strong growth due to the trend of shifting from monochrome to color machines, while the demand for monochrome shrunk due to the con- tinued economic slowdown in emerging countries. As for cameras, along with the ongoing contraction of the market, especially for digital compact cameras, the market suffered from a shortage of components arising from the earthquake in Kumamoto earlier in the year. Additionally, demand for inkjet printers continued to decline. Within the Industry and Other sector, demand for lithography equipment used in the pro- duction of flat panel displays (“FPDs”) and manufacturing equipment for organic LED (“OLED”) displays enjoyed strong growth thanks to active capital investment by panel manufacturers. The average value of the yen during the year was ¥108.58 against the U.S. dollar, a year-on-year appreciation of approx- imately ¥13, and ¥120.25 against the euro, a year-on-year appreciation of approximately ¥14. Summary of operations During 2016, color-model office MFDs achieved higher growth than the market average, making up for the contin- ued decline of monochrome models, which led to the same level of unit sales as the previous year overall. Although the unit sales of laser printers were below level compared with the same period of the previous year until the third quarter, due to the sluggish economic conditions in the emerging countries, signs of bottoming out started to appear in the fourth quar- ter. Looking at the interchangeable-lens digital cameras, sales volume for the year exceeded that of the previous year, sup- ported by sales of new products, while sales volume for dig- ital compact cameras declined compared with the previous year amid the ongoing contraction of the market. Sales vol- ume for inkjet printers declined for consumer products, while sales volume of wide format inkjet printers for business use exceeded the previous year. In contrast, sales of FPD lithog- raphy equipment and OLED panel manufacturing equipment increased, boosted by increased capital investment by panel manufacturers. Consequently, along with the negative impact of the appreciation of the yen, net sales for the year decreased 10.5% year on year to ¥3,401,487 million. The gross profit ratio decreased by 1.7 points year on year to 49.2% mainly due to the negative effect of yen’s appreciation. Despite a reduction in operating expenses of 8.5% year on year, partly due to Group-wide efforts to reduce spending, operating profit decreased by 35.6% to ¥228,866 million. Other income (deductions) increased by ¥23,557 million due to foreign cur- rency exchange gains while income before income taxes decreased by 29.6% year on year to ¥244,651 million and net income attributable to Canon Inc. decreased by 31.6% to ¥150,650 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. 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 34 CANON ANNUAL REPORT 2016for new products, and changes in sales prices. Other factors 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 measures the efficiency of supply chain management. Inventories have inherent risks of becoming obsolete, physi- cally damaged or otherwise decreasing significantly in value, which may adversely affect Canon’s operating results. To mit- igate these risks, management believes that it is crucial to continue reducing work-in-process inventories by decreas- ing production lead times in order to promptly recover related product expenses, while balancing risks of supply chain dis- ruptions by optimizing finished goods inventories in order to avoid losing potential sales opportunities. The debt to total assets ratio is also one of the KPIs. For a man- ufacturing 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 suc- cess. Therefore, management believes that it is important to have sufficient financial strength. Canon will continue 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. KEY PERFORMANCE INDICATORS 2016 2015 2014 2013 2012 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 3,401,487 49.2% 8.9% 6.7% 59 days 11.9% 54.2% 3,800,271 50.9% 8.6% 9.3% 47 days 0.0% 67.0% 3,727,252 49.9% 8.3% 9.8% 50 days 0.0% 66.8% 3,731,380 48.2% 8.2% 9.0% 52 days 0.1% 68.6% 3,479,788 47.4% 8.5% 9.3% 57 days 0.1% 65.7% Note: Inventory turnover measured in days is determined by: Inventory divided by net sales for the previous six months, multiplied by 182.5. The increase of inventory turnover in 2016 was primarily due to the acquisition of Toshiba Medical Systems Corporation (“TMSC”) on December 19, 2016. If this factor were excluded, the inventory turnover would show 50 days. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and based on the selection and application of significant account- ing 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 cur- rently affect its financial condition and results of operations. 35 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016FINANCIAL 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 typically pays a stated base service fee plus a variable amount based on usage. Revenue from these service maintenance contracts is mea- sured at the stated amount of the contract and recognized as ser- vices 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 net realizable value. Cost is determined by the average method for domes- tic inventories and principally the first-in, first-out method for overseas inventories. Net realizable value is the estimated selling price in the ordinary course of business less the esti- mated costs of completion and the estimated costs neces- sary to make a sale. Canon routinely reviews its inventories for their salability and for indications of obsolescence to deter- mine if inventories should be written-down to market value. Judgments and estimates must be made and used in con- nection with establishing such allowances in any accounting period. In estimating the net realizable 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 2016except for certain assets which are depreciated by the straight- line method over the estimated useful lives of the assets. Business combinations The acquisition is accounted for using the acquisition method of accounting. The acquisition method of accounting requires the identification and measurement of all acquired tangible and intangible assets and assumed liabilities at their respec- tive fair values, as of the acquisition date. The determina- tion of the fair value of net assets acquired involves significant judgment and estimates, such as future cash flow projections, appropriate discount and capitalization rates and other esti- mates based on available market information. Estimates of future cash flows are based on a number of factors includ- ing operating results, known and anticipated trends, as well as market and economic conditions. With regard to acquisition of Toshiba Medical Systems Corporation (“TMSC”), the iden- tification and measurement of acquired tangible and intangi- ble assets are still preliminary and subject to change within the measurement period. For further information, please refer to Note 7 of the Notes to Consolidated Financial Statements. 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 2016 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 17 years, license fees are 7 years, and cus- tomer relationships are from 11 years to 20 years, respectively. Income tax uncertainties Canon considers many factors when evaluating and estimat- ing income tax uncertainties. These factors include an evalua- tion of the technical merits of the tax positions as well as the amounts and probabilities of the outcomes that could be real- ized upon settlement. The actual resolutions of those uncer- tainties 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 2016, Canon esti- mated a weighted-average discount rate used to determine benefit obligations of 0.7% for Japanese plans and 2.2% for foreign plans and a weighted-average expected long- term rate of return on plan assets of 3.1% for Japanese plans and 4.4% for foreign plans. In estimating the dis- count rate, Canon uses available information about rates of return on high-quality fixed-income government and cor- porate bonds currently available and expected to be avail- able during the period to the maturity of the pension benefits. Canon establishes the expected long-term rate of return on plan assets based on management’s expectations of the long- term return of the various plan asset categories in which it invests. Management develops expectations with respect to each plan asset category based on actual historical returns and 37 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016FINANCIAL OVERVIEW its current expectations for future returns. Decreases in discount rates lead to increases in actuarial pension benefit obligations which, in turn, could lead to an increase in service cost and amortization cost through amor- tization of actuarial gain or loss, a decrease in interest cost, and vice versa. For 2016, a decrease of 50 basis points in the discount rate increases the projected benefit obligation by approximately ¥99,379 million. The net effect of changes in the discount rate, as well as the net effect of other changes in actuarial assumptions and experience, is deferred until subse- quent 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 2016, a change of 50 basis points in the expected long-term rate of return on plan assets would cause a change of approximately ¥4,462 million in net periodic benefit cost. Canon multiplies manage- ment’s expected long-term rate of return on plan assets by the value of its plan assets to arrive at the expected return on plan assets that is included in pension expense. Canon defers rec- ognition of the difference between this expected return on plan assets and the actual return on plan assets. The net defer- ral affects future pension expense. Canon recognizes the funded status (i.e., the difference between the fair value of plan assets and the projected bene- fit obligations) of its pension plans in its consolidated balance 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 In the current business term, the world economy as a whole experienced only a moderate recovery due to, among others, the slowdown in emerging economies. In such an environment, despite efforts to promote sales of highly-competitive products, due to the effect of significant appreciation of the yen, Canon’s consolidated net sales in 2016 totaled ¥3,401,487 million, a decrease of 10.5% from the previous year. Overseas operations are significant to Canon’s operating results and generated 79.2% of total net sales in 2016. 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 ¥108.58 against the U.S. dollar, a year-on-year appreciation of approxi- mately ¥13, and ¥120.25 against the euro, a year-on-year appre- ciation of approximately ¥14. The effects of foreign exchange rate fluctuations negatively affected net sales by approximately ¥280,434 million in 2016. This unfavorable impact consisted of approximately ¥144,206 million of unfavorable impact for the U.S. dollar denominated sales and unfavorable impact of ¥90,308 million for the euro denominated sales, and ¥45,920 million for other foreign currency denominated sales. 38 Millions of yen 2016 change 2015 change 2014 3,401,487 228,866 244,651 150,650 -10.5% 3,800,271 355,210 -35.6% 347,438 -29.6% 220,209 -31.6% +2.0% 3,727,252 363,489 -2.3% 383,239 -9.3% 254,797 -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 2016 and 2015 was 50.8% and 49.1%, respectively. 9 6 3 0 300 200 100 0 400 300 200 100 0 Return on Sales (%) Sales by Segment (Billions of yen) Sales by Geographic Area (Billions of yen) 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 Office Business Unit Imaging System Business Unit Industry and Others Business Unit Eliminations Japan Americas Europe Asia and Oceania Increase in Property, Plant and Equipment (Billions of yen) Working Capital Ratio Return on Canon Inc. Shareholders’ Equity (%) 5,000 4,000 3,000 2,000 1,000 0 12 9 6 3 0 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 R&D Expenses (Billions of yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) 2012 2013 2014 2015 2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 5,000 4,000 3,000 2,000 1,000 0 3.0 2.5 2.0 1.5 1.0 0.5 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 CANON ANNUAL REPORT 2016Net income attributable to Canon Inc. As a result, net income attributable to Canon Inc. in 2016 decreased by 31.6% to ¥150,650 million, which represents 4.4% of net sales. 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 / Diagnostic X-ray systems / Computed tomography / Magnetic resonance imaging / Diagnostic ultrasound systems / Clinical chemistry analyzers / Ophthalmic equipment / Vacuum thin- film deposition equipment / Organic LED (“OLED”) panel man- ufacturing equipment / Die bonders / Micromotors / Network cameras / Handy terminals / Document scanners Gross profit Canon’s gross profit in 2016 decreased by 13.5% to ¥1,673,833 million from 2015. The gross profit ratio also decreased by 1.7 points year on year to 49.2%. The decrease in the gross profit ratio primarily reflects the negative effect of appreciation of the yen against other foreign currencies such as the U.S. dollar and the euro. Operating expenses The major components of operating expenses are payroll, R&D, advertising expenses and other marketing expenses. Operating expenses decreased 8.5% year on year to ¥1,444,967 million owing to such factors as the decrease in foreign-currency-denominated operating expenses after con- version into yen due to the appreciation of the yen, and a decrease in advertising and other marketing expenses and R&D expenses. Operating profit Operating profit in 2016 decreased 35.6% from 2015 to a total of ¥228,866 million. The ratio of operating profit to net sales decreased 2.6 points to 6.7% from 2015. Other income (deductions) Other income (deductions) for 2016 was ¥15,785 million, an increase of ¥23,557 million from 2015 mainly due to a decrease in foreign currency exchange loss. Income before income taxes Income before income taxes in 2016 was ¥244,651 million, a decrease of 29.6% from 2015, and constituted 7.2% of net sales. Income taxes Provision for income taxes in 2016 decreased by ¥33,424 mil- lion from 2015. The effective tax rate for 2016 was 33.8%, which was higher than the statutory tax rate in Japan. This was mainly due to the effect of reversal of deferred tax assets derived from changes in tax laws and Japanese tax rates that took effect in 2016. Return on Sales (%) Return on Sales (%) Sales by Segment (Billions of yen) Sales by Segment (Billions of yen) Sales by Geographic Area (Billions of yen) Sales by Geographic Area (Billions of yen) 9 6 3 0 400 300 200 100 0 9 6 3 0 400 300 200 100 0 200 200 100 100 0 0 5,000 5,000 4,000 4,000 3,000 3,000 2,000 2,000 1,000 1,000 0 0 Office Business Unit Imaging System Business Unit Industry and Others Business Unit Eliminations Office Business Unit Imaging System Business Unit Industry and Others Business Unit Eliminations 2012 2013 2014 2012 2015 2013 2016 2014 2015 2016 2012 2013 2014 2012 2015 2013 2016 2014 2015 2016 Japan Americas Europe Asia and Oceania Japan Americas Europe Asia and Oceania 2012 2014 2013 2015 2014 2016 2015 2016 39 5,000 5,000 4,000 4,000 3,000 3,000 2,000 2,000 1,000 1,000 0 0 2013 2012 9 6 3 0 9 6 3 0 Increase in Property, Increase in Property, Plant and Equipment (Billions of yen) Plant and Equipment (Billions of yen) 300 300 Working Capital Ratio Working Capital Ratio Return on Canon Inc. Return on Canon Inc. Shareholders’ Equity (%) Shareholders’ Equity (%) 12 12 2012 2013 2014 2012 2015 2013 2016 2014 2015 2016 2012 2013 2014 2012 2015 2013 2016 2014 2015 2016 2012 2013 2014 2012 2015 2013 2016 2014 2015 2016 R&D Expenses (Billions of yen) R&D Expenses (Billions of yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) 2012 2013 2014 2012 2015 2013 2016 2014 2015 2016 2007 2008 2007 2009 2008 2010 2009 2011 2010 2012 2011 2013 2012 2014 2013 2015 2014 2016 2015 2016 3.0 2.5 2.0 1.5 1.0 0.5 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 3.0 2.5 2.0 1.5 1.0 0.5 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016FINANCIAL OVERVIEW Sales by segment Within the Office Business Unit, unit sales of office MFDs increased overall from the previous year thanks to strong sales of color mod- els, even with the continued decrease in sales of monochrome models. This growth was supported by steady sales of the color A3 (12”x18”) imageRUNNER ADVANCE C5500-series models, which were released this year, and the small-office/home-office color A3 (12”x18”) imageRUNNER C3300-series models, which were launched in the previous year, along with expanded sales of imagePRESS C10000VP-series models, which target the production printing market. Among high-speed continuous-feed printers, unit sales of the Océ-produced VarioPrint i300, a high-speed sheet-fed color inkjet press, increased year on year. Although the unit sales of laser printers had been below level against the same period of the previous year until the third quarter, due to the sluggish economic conditions in the emerging countries, unit sales exceeded the same period of the year at fourth quarter along with a smooth transition to new models as planned. These factors, coupled with the negative effect of unfavorable currency exchange rates, resulted in total sales for the business unit of ¥1,807,819 million, a year-on-year decline of 14.4%, while operating profit totaled ¥169,486 million, a year-on- year decline of 41.7%. Within the Imaging System Business Unit, sales volume for inter- changeable-lens digital cameras grew compared with the previ- ous year owing to healthy demand for the EOS-1D X mark II and the EOS 5D mark IV, which were launched this year, and the launch of a new addition to the Company’s strengthening compact- system camera lineup, the EOS M5, which features a built-in EVF. As for digital compact cameras, along with the ongoing con- traction of the market, sales volume declined amid difficulties in procuring components due to the earthquake in Kumamoto ear- lier in the year, with much of the profitability generated by sales SALES BY SEGMENT of high-added-value models that deliver high image quality and zoom capabilities. As for inkjet printers, although sales volume declined compared with the previous year due to a shrinking mar- ket for consumer products, sales of models equipped with large- capacity ink tanks that were launched in the fourth quarter of 2015 experienced healthy demand mainly in emerging countries, while demand was high mainly in Japan for newly designed mod- els for home use that were launched in 2016. Additionally, wide format inkjet printers, new imagePROGRAF PRO-series models, which target the professional photo and graphic art market, saw an increase in unit sales. As a result of these factors, along with the negative effect of unfavorable currency exchange rates, sales for the business unit decreased by 13.3% to ¥1,095,289 million while operating profit totaled ¥144,413 million, a year-on-year decline of 21.3%. In the Industry and Others Business Unit, unit sales of semiconductor lithography equipment decreased from the previous year amid the postponement of some capital investments by customers. As for FPD lithography equipment, unit sales of lithography systems employed in the fabrication of mid- and small-size panels increased in response to growing demand for high-definition OLED displays used in mobile devices. Also, sales of manufacturing equipment for OLED displays, which is sold by Canon Tokki, increased amid brisk capital invest- ment by panel manufacturers. In addition, sales of network cam- eras increased compared with the previous year thanks to efforts to strengthen the product lineup. Consequently, sales for the business unit increased 11.4% year-on-year to ¥584,660 million while operat- ing profit grew by ¥20,527 million to ¥7,448 million. Intersegment sales of ¥86,281 million, representing 2.5% of total sales, are eliminated from total sales for the three seg- ments, and are described as “Eliminations.” 2016 change 2015 change 2014 Millions of yen Office Imaging System Industry and Others Eliminations Total SALES BY REGION Japan Americas Europe Asia and Oceania Total 1,807,819 1,095,289 -14.4% -13.3% 584,660 +11.4% (86,281) — 2,110,816 1,263,835 +1.5% -5.9% 524,651 +31.6% (99,031) — 2,078,732 1,343,194 398,765 (93,439) 3,401,487 -10.5% 3,800,271 +2.0% 3,727,252 Millions of yen 2016 change 2015 change 2014 706,979 963,544 913,523 817,441 -1.0% -15.8% -15.0% -5.7% 714,280 -1.4% 1,144,422 +10.4% -1.5% 1,074,366 -1.0% 867,203 724,317 1,036,500 1,090,484 875,951 3,401,487 -10.5% 3,800,271 +2.0% 3,727,252 Note: This summary of net sales by geographic area is determined by the location where the product is shipped to the customers. 40 CANON ANNUAL REPORT 2016Sales 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 1.0% from the previous year due to the ongoing contraction of the digital camera market, especially for digital compact cameras, which reflected a slow recovery in consumer spending. In the Americas, net sales decreased 15.8% from the previous year owing to the negative effect of the yen’s appreciation and the decline in sales of laser printers, interchangeable-lens digital cameras and digital compact cameras. In Europe, net sales decreased 15.0% from the previous year owing to the negative effect of the yen’s appreciation and the decline in sales of laser printers. In Asia and Oceania, despite strong sales of manufacturing equipment for OLED displays which is sold by Canon Tokki, net sales decreased by 5.7% from the previous year mainly due to the negative effect of the yen’s appreciation. 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 activ- ities, 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. 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 2016 decreased by 41.7% from the previous year to ¥169,486 mil- lion, owing to the negative effect of the yen’s appreciation along with the decrease in sales of laser printers. Operating profit for the Imaging System Business Unit in 2016 decreased by 21.3% from the previous year to ¥144,413 mil- lion, owing to the negative effect of the yen’s appreciation along with the decrease in sales of compact digital cameras. Operating profit for the Industry and Others Business Unit in 2016 grew by ¥20,527 million to ¥7,448 million thanks to strong sales of manufacturing equipment for OLED displays and network cameras, despite the negative impact of the yen’s appreciation. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents decreased by ¥3,420 million to ¥630,193 million in fiscal 2016 compared to the previous year. Canon’s cash and cash equivalents are primarily denomi- nated in Japanese yen and in U.S. dollars, with the remainder denominated in other currencies. Net cash provided by operating activities increased by ¥25,559 million to ¥500,283 million in fiscal 2016 compared to the previous year thanks to the decrease 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 2016, cash inflow from cash received from cus- tomers decreased due to sales deterioration. There were no significant 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 decreased thanks to Group-wide efforts to reduce spending those expenses. Net cash used in investing activities increased by ¥383,506 million to ¥837,125 million in fiscal 2016. This mainly reflects the acquisition of Toshiba Medical Systems Corporation (“TMSC”) to solidify Canon’s business foundation for its health care business within the realm of “safety and security.” Canon defines “free cash flow” as cash flows from operat- ing activities less cash flows from investing activities. For fiscal 2016, free cash flow decreased by ¥357,947 million to nega- tive ¥336,842 million as compared with ¥21,105 million for fiscal 2015. Note: “Free cash flow” is non-GAAP measure. Refer to “Non- GAAP Financial Measures” section for the explanation and the reconciliation to the reported GAAP measure. 41 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016FINANCIAL OVERVIEW Canon’s management places importance on cash flow man- agement and frequently monitors this indicator. Furthermore, Canon’s management believes that this indicator is significant in understanding Canon’s current liquidity and the alterna- tives of use in financing activities because it takes into con- sideration its operating and investing activities and believes that such indicator is beneficial to an investor’s understand- ing. Canon refers to this indicator together with relevant U.S. GAAP financial measures shown in its consolidated statements of cash flows and consolidated balance sheets for cash avail- ability analysis. Net cash provided in financing activities totaled ¥355,692 million in fiscal 2016, mainly resulting from the long-term bank borrowing of ¥610,000 million related to the acquisition of TMSC, the dividend payout and the repayment for short- term loans. The Company paid dividends in fiscal 2016 of ¥150.00 per share. Return on Sales (%) Return on Sales (%) 2012 2013 2014 2015 2016 2012 2013 2014 To the extent Canon relies on external funding for its liquid- Return on Sales (%) Sales by Segment (Billions of yen) Sales by Segment (Billions of yen) 5,000 4,000 5,000 4,000 3,000 5,000 4,000 ity and capital requirements, it generally has access to vari- 9 ous funding sources, including the issuance of additional share capital, issuance of corporate bond or loans. While Canon has been able to obtain funding from its traditional financing 6 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. 3 2,000 Office Business Unit Imaging System Short-term loans (including the current portion of long- Business Unit 1,000 term debt) amounted to ¥1,850 million at December 31, Industry and Others Business Unit 2016 compared with ¥688 million at December 31, 2015. Eliminations Long-term debt (excluding the current portion) amounted to 0 ¥611,289 million at December 31, 2016 compared with ¥881 2014 2014 2016 2015 million at December 31, 2015. 2014 2013 2012 2015 2015 2016 2016 2012 2013 2012 2013 2015 3,000 1,000 2,000 3,000 2,000 1,000 0 0 Canon’s long-term debt mainly consists of bank borrowings and 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 10, 2017, Canon’s debt ratings are: Moody’s: Aa3 (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. Sales by Segment (Billions of yen) Sales by Geographic Area (Billions of yen) Reflecting the foregoing circumstances, Canon’s total inven- 5,000 5,000 tory turnover ratios were 59, 47, and 50 days at the end of the fiscal years 2016, 2015, and 2014, respectively. The increase of inventory turnover in 2016 was primarily due to the acquisition of TMSC on December 19, 2016. If this factor were excluded, the inventory turnover would show 50 days. 3,000 3,000 4,000 4,000 2,000 Increase in property, plant and equipment on an accrual basis in 2016 amounted to ¥171,597 million compared with ¥195,120 million in 2015 and ¥182,343 million in 2014. For 2017, Canon projects its increase in property, plant and equip- 0 ment will be approximately ¥195,000 million. Office Business Unit Imaging System Business Unit Industry and Others Business Unit Eliminations Office Business Unit Imaging System Business Unit Industry and Others Business Unit Eliminations 1,000 1,000 2,000 0 2015 0 2015 Sales by Geographic Area (Billions of yen) 2016 2012 2013 2014 2016 2012 2013 2014 2016 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 1,000 Japan Americas Europe Asia and Oceania 0 Japan Americas Europe Japan Americas Europe Asia and Oceania Asia and Oceania Increase in Property, Plant and Equipment (Billions of yen) Increase in Property, Plant and Equipment (Billions of yen) 3.0 Working Capital Ratio 300 200 100 2.5 2.0 1.5 1.0 0.5 Working Capital Ratio Working Capital Ratio Return on Canon Inc. Shareholders’ Equity (%) Return on Canon Inc. Shareholders’ Equity (%) Return on Canon Inc. Shareholders’ Equity (%) 3.0 2.5 2.0 1.5 1.0 0.5 3.0 2.5 2.0 1.5 1.0 0.5 12 9 6 3 12 9 6 3 2012 2013 2014 2015 2016 2012 2013 2014 0 2015 2016 2012 2013 0 2014 2015 2012 2016 2013 2014 0 2015 2016 2012 2013 2014 0 2015 2016 2012 2013 0 2014 2012 2015 2013 2016 2014 0 2015 2016 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 R&D Expenses (Billions of yen) R&D Expenses (Billions of yen) R&D Expenses (Billions of yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) 42 400 300 200 100 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 2007 2008 2009 2010 2007 2011 2008 2012 2009 2013 2010 2007 2014 2011 2008 2015 2012 2009 2016 2013 2010 2014 2011 2015 2012 2016 2013 2014 2015 2016 Increase in Property, Plant and Equipment (Billions of yen) 9 6 3 0 300 200 100 0 400 300 200 100 0 9 6 3 0 300 200 100 0 400 300 200 100 0 Sales by Geographic Area (Billions of yen) 5,000 4,000 3,000 2,000 12 9 6 3 0 CANON ANNUAL REPORT 2016Employer contributions to Canon’s worldwide defined ben- efit pension plans were ¥14,575 million in 2016, ¥19,565 million in 2015 and ¥22,146 million in 2014. Employer con- tributions to Canon’s worldwide defined contribution pension plans were ¥17,603 million in 2016, ¥17,277 million in 2015, and ¥15,077 million in 2014. In addition, employer contribu- tions to the multiemployer pension plan of certain subsidiar- ies were ¥3,482 million in 2016, ¥3,864 million in 2015 and ¥2,815 million in 2014. Working capital in 2016 decreased by ¥125,471 million to ¥1,116,379 million, compared with ¥1,241,850 million in 2015 and ¥1,470,554 million in 2014. 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 2016 was 2.14 compared to 2.52 for 2015 and to 2.60 for 2014. Return on assets (net income attributable to Canon Inc. divided by the average of total assets) was 3.1% in 2016, compared to 5.0% in 2015 and 5.9% in 2014. Return on Canon Inc. shareholders’ equity (net income attributable to Canon Inc. divided by the average of total Canon Inc. shareholders’ equity) was 5.2% in 2016 compared with 7.4% in 2015 and 8.7% in 2014. The debt to total assets ratio was 11.9%, 0.0% and 0.0% as of December 31, 2016, 2015 and 2014, respectively. Canon had short-term loans and long-term debt of ¥613,139 million as of December 31, 2016, ¥1,569 million as of December 31, 2015 and ¥2,166 million as of December 31, 2014. Non-GAAP Financial Measures We have reported our financial results in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). In addition, we have discussed our results using the combination of two GAAP cash flow measures, Net cash provided by oper- ating activities and Net cash used for investing activities, which we refer to as “Free Cash Flow” which is non-GAAP measure. We believe this measure is beneficial to an investor’s under- standing on Canon’s current liquidity and the alternatives of use in financing activities because it takes into consideration its operating and investing activities. A reconciliation of these non-GAAP financial measures and the most directly comparable measures calculated and presented in accordance with GAAP are set forth on the following table. FREE CASH FLOW Net cash provided by operating activities Net cash used in investing activities Free cash flow Millions of yen 2016 2015 500,283 (837,125) 474,724 (453,619) (336,842) 21,105 43 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 FINANCIAL OVERVIEW 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 employees, affiliates and other companies. Canon will have to perform under a guarantee if the borrower defaults on a payment within the contract periods of 1 year to 30 years in the case of employees with housing loans, and 1 year to 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 ¥6,056 million at December 31, 2016. The carrying amounts of the liabilities recognized for Canon’s obligations as a guarantor under those guarantees at December 31, 2016 were insignificant. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following summarizes Canon’s contractual obligations at December 31, 2016. Millions of yen Contractual obiligations: Long-term debt: Loan from a bank Capital lease obligations and others 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 610,000 2,538 84,945 — 1,249 26,380 — 1,141 31,816 610,000 148 14,955 — — 11,794 36,578 119,395 36,578 119,395 — — — — — — — — — Contribution to defined benefit pension plans 22,382 22,382 Total 875,838 205,984 32,957 625,103 11,794 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 of the baseline experience, material usage and service delivery costs incurred in correcting a product failure. As of December 31, 2016, accrued product warranty costs amounted to ¥13,168 million. At December 31, 2016, commitments outstanding for the purchase of property, plant and equipment were approxi- mately ¥36,578 million, and commitments outstanding for the purchase of parts and raw materials were approximately ¥119,395 million, both for use in the ordinary course of its business. Canon anticipates that funds needed to fulfill these commitments will be generated internally through operations. During 2017, Canon expects to contribute ¥14,179 million to its Japanese defined benefit pension plans and ¥8,203 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. 44 CANON ANNUAL REPORT 2016 Japan Americas Europe Asia and Oceania 2012 2013 2014 2015 2016 5,000 4,000 3,000 2,000 1,000 0 12 9 6 3 0 Return on Canon Inc. Shareholders’ Equity (%) 2012 2013 2014 2015 2016 Return on Sales (%) Sales by Segment (Billions of yen) Sales by Geographic Area (Billions of yen) 9 6 5,000 4,000 3,000 3 RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES Canon has started its 5-year management plan, the Excellent Global Corporation Plan Phase V (“Phase V”) from the year 2016. In Phase V, our slogan is “Embrace the challenge of new growth through a grand strategic transformation” and there are three key strategies related to R&D: 2014 2015 2012 2013 2016 0 • Establish a new production system to achieve a cost-of-sales ratio of 45%; • Reinforce and expand new businesses while creating future businesses; and • Enhance R&D capabilities through open innovation. Canon has been striving to implement the three R&D related strategies as follows: • Establish a new production system to achieve a cost-of- Increase in Property, Plant and Equipment (Billions of yen) sales ratio of 45%: Strengthen domestic mother factories by integrating design, procurement, production engi- neering and manufacturing technology operations while pursuing total cost reduction by advancing production engineering capabilities with more sophisticated robots and next-generation technologies such as the IoT, big data and artificial intelligence. 300 • Reinforce and expand new businesses while creating 200 100 future businesses: Create and expand new businesses by accelerating the horizontal expansion of existing busi- ness with the exploration of new application possibility of Canon’s technologies into new fields. Also, invest inten- sively on the R&D of promising businesses areas such as commercial printing, network cameras and life sciences while actively taking advantage of M&A to accelerate the early expansion of these businesses. 2014 2015 2012 2013 2016 0 Office Business Unit Imaging System Business Unit Industry and Others Business Unit Eliminations 2,000 0 1,000 In the “ImPACT” (Impulsing Paradigm Change through Disruptive Technologies) program led by the Japanese gov- ernment, Canon’s “Innovative Visualization Technology to Lead to Creation of a New Growth Industry” was selected as one of the R&D programs in the year 2014, and we are aiming to develop medical inspection equipment with the physically-noninvasive and -nondestructive imaging technol- ogy. Additionally, Canon is currently working on collabora- tive research with Massachusetts General Hospital (“MGH”) and Brigham and Women’s Hospital (“BWH”) to develop bio- medical optical imaging and medical robotics technologies at the Healthcare Optics Research Laboratory in Cambridge, Massachusetts, founded in 2013. 2014 2013 2016 2015 2012 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. Working Capital Ratio 3.0 Canon’s consolidated R&D expenses were ¥302,376 million 2.5 in 2016, ¥328,500 million in 2015 and ¥308,979 million in 2014. The ratios of R&D expenses to the consolidated total net sales for 2016, 2015 and 2014 were 8.9%, 8.6% and 8.3%, respectively. 2.0 1.5 0.5 Canon believes that new products protected by the robust patent portfolio will not easily allow competitors to compete with them, and will give them an advantage in establishing standards in the market and industry. 1.0 Canon obtained the third greatest number of private sector patents in 2016, according to the United States patent annual 0 list, released by IFI CLAIMS® Patent Services. 2014 2016 2012 2013 2015 • Enhance R&D capabilities through open innovation: Construct a more open R&D system that proactively leverages external technologies and knowledge to accel- erate and improve efficiency of the R&D. Especially in our fundamental research and development, Canon is pro- moting joint and contract research with various partners including universities, research institutes, and startups around the world. 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. R&D Expenses (Billions of yen) 400 300 200 100 0 2012 2013 2014 2015 2016 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. 8,000 7,000 Common Stock Price Range (Tokyo Stock Exchange) (Yen) 6,000 5,000 4,000 3,000 2,000 1,000 0 2007 2008 2009 2010 2011 2012 45 2013 2014 2015 2016 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016FINANCIAL OVERVIEW 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, 2016. Available-for-sale securities Debt securities Due after five years Fund trusts Equity securities Millions of yen Cost Fair value 320 85 19,026 19,431 498 86 42,444 43,028 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, 2016. All of the foreign exchange contracts described in the following table have a contractual maturity date in 2017. 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 213,018 (4,599) 131,440 (3,803) 27,186 (1,074) 371,644 (9,476) 38,392 612 979 (16) 7,370 74 46,741 670 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 insignificant. See also Note 9 of the Notes to Consolidated Financial Statements. Changes in the fair value of derivative financial instruments des- ignated as cash flow hedges, including foreign currency 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 such amounts recorded in accumulated other comprehensive income (loss) at year-end are expected to be recognized in earnings over the next twelve months. Canon excludes the time value component from the assessment of hedge effectiveness. Changes in the fair value of a foreign currency exchange contract for the period between the date that the fore- casted intercompany sales occur and its maturity date are recog- nized in earnings and not considered hedge ineffectiveness. The amount of the hedging ineffectiveness was not material for the years ended December 31, 2016, 2015 and 2014. The amounts of net losses excluded from the assessment of hedge effectiveness (time value component) which was recorded in other income (deductions) was ¥311 million, ¥131 million and ¥145 million for the years ended December 31, 2016, 2015 and 2014, 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. 46 CANON ANNUAL REPORT 2016LOOKING FORWARD Although the IMF is projecting a modest pickup in the global economy in 2017, political and economic circumstances are expected to remain highly uncertain. In the businesses in which Canon is involved, among office MFDs, demand for color models makes up for the market con- traction of monochrome models and demand is expected to remain in line with that of the previous year overall. Although demand for laser printers is expected to remain at the same level as that for the previous year, demand for color models and laser multifunction models with high potential consum- able sales is expected to increase. As for interchangeable-lens digital cameras, although demand is waning mainly in devel- oped countries, the sluggish demand condition is improving gradually, which is expected to bottom out. Projections for dig- ital compact cameras indicate continued market contraction, centered mainly on low-priced models. With regard to inkjet printers, demand is expected to continue declining mainly for consumer models. Looking at industrial equipment, within the semiconductor lithography equipment segment, the market is expected to remain at the same level as the previous year while the outlook for FPD lithography equipment and OLED display manufacturing equipment points to continued active capital investment by panel manufacturers. The network camera mar- ket is also expected to grow in response to increasing market- ing and production site efficiency-enhancing needs, in addition to disaster monitoring and crime prevention functions. Amid these conditions, 2017 marks not only the second year of Phase V of the Excellent Global Corporation Plan, but also Canon’s 80th anniversary. To ensure that 2017 is a year befitting this milestone, Canon is addressing the following key challenges under the theme “Further promoting grand strate- gic transformation by accelerating reforms.” at its disposal in order to create market-specific solutions. As for healthcare, Canon will formulate new growth strat- egies, built around TMSC, and will exert the Group’s com- prehensive strength to provide innovative products and high-quality services on a global scale. For industrial equip- ment, such as IC lithography equipment that utilizes nano- imprint lithography, Canon will formulate new business strategies to pioneer a “fourth industrial revolution” driven by artificial intelligence and IoT. Restructure the global sales network In the B2B sphere, success or failure is determined by the capacity to devise and implement solutions. In addition to training highly skilled sales engineers with a breadth of techni- cal knowledge spanning both hardware and software, Canon will establish a sales structure with networks that expand to corporations and governments. Additionally, Canon will for- mulate global sales strategies that take full advantage of the expansion and development of e-commerce. Strengthen R&D through open innovation Canon will enhance R&D efficiency in existing business fields and be selective in investment in promising new fields. On top of this, aiming to establish and expand ser- vice businesses, Canon will train software engineers, develop systems and accelerate the establishment of an external cooperation system. Cultivate global human resources and reinvigorate the Canon spirit An enterprising spirit and the San-ji (Three Selfs) Spirit of self-motivation, self-management, and self-awareness, have been basic components of Canon’s corporate DNA since its foundation. Canon is now working to re-instill these values as we promote the development of human resources that are able to exert leadership in a global environment. Thoroughly bolster existing business In order to successfully transform its business structure, Canon will work to improve profitability by reinforcing the existing businesses that will support this transforma- tion. Specifically, Canon will accelerate the development of “Dantotsu Products,” which are products with unique appeal and strengths that realize high profitability thanks to their dif- ficulty to imitate. At the same time, Canon will advance such initiatives as automation, in-house production, and procure- ment reform, in order to achieve a cost-of-sales ratio of 45%. Additionally, Canon will expand its business domains, develop- ing new business models in response to the internet of things (“IoT”) and cloud environments. Strengthen and grow new businesses and create future businesses For commercial printing, with the aim of becoming a com- prehensive printing company, Canon will accelerate prod- uct development in order to make a full-scale entry into the fast-growing package printing market. Regarding network cameras, Canon will work to strengthen camera intelli- gence, by not only improving image quality, but leverag- ing the image-processing and image-analytics technologies Forward looking statements The foregoing discussion and other disclosure in this report con- tains forward-looking statements that reflect management’s cur- rent views with respect to certain future events and financial performance. Actual results may differ materially from those pro- jected or implied in the forward-looking statements. Further, cer- tain forward-looking statements are based upon assumptions of future events that may not prove to be accurate. The follow- ing important factors could cause actual results to differ mate- rially from those projected or implied in any forward-looking statements: foreign currency exchange rate fluctuations; the uncertainty of Canon’s ability to implement its plans to localize production and other measures to reduce the impact of foreign currency exchange rate fluctuations; uncertainty as to economic conditions in Canon’s major markets; uncertainty of continued demand for Canon’s high-value-added products; Canon’s abil- ity to continue to develop products and to market products that incorporate new technology on a timely basis, are competitively priced, and achieve market acceptance; the possibility of losses resulting from foreign currency transactions designed to reduce financial risks from changes in foreign currency exchange rates; and inventory risk due to shifts in market demand. 47 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 9 6 3 0 300 200 100 0 400 300 200 100 0 2012 2013 2014 2015 2016 Increase in Property, Plant and Equipment (Billions of yen) 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 Return on 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 TEN-YEAR FINANCIAL SUMMARY Office Business Unit Imaging System Business Unit Industry and Others Business Unit Eliminations 5,000 4,000 3,000 2,000 1,000 Millions of yen (except per share amounts) 2016 2015 2014 2014 2015 2016 2012 Net sales: 2013 Domestic Overseas Total Percentage of previous year 0 706,979 2,694,508 3,401,487 89.5% 2014 2012 2013 714,280 3,085,991 3,800,271 102.0% 2016 2015 724,317 3,002,935 3,727,252 99.9% Net income attributable to Canon Inc. Percentage of sales 150,650 220,209 254,797 4.4% 5.8% 6.8% Japan Americas 2013 Europe Asia and Oceania 715,863 3,015,517 3,731,380 107.2% 230,483 6.2% 86,398 306,324 223,158 188,826 1,448 2,910,262 4,242,710 2012 2011 2010 2009 2008 2007 2016 Thousands of U.S. dollars (except per share amounts) 720,286 2,759,502 3,479,788 694,450 2,862,983 3,557,433 695,749 3,011,152 3,706,901 702,344 2,506,857 3,209,201 868,280 3,225,881 4,094,161 947,587 3,533,759 4,481,346 97.8% 96.0% 115.5% 78.4% 91.4% 107.8% $ 6,094,647 23,228,517 29,323,164 89.5% 224,564 248,630 246,603 131,647 309,148 488,332 1,298,707 6.5% 7.0% 6.7% 4.1% 7.6% 10.9% 4.4% 83,134 296,464 211,973 270,457 2,117 2,598,026 3,955,503 81,232 307,800 210,179 226,869 3,368 2,551,132 3,930,727 94,794 315,817 232,327 158,976 4,131 2,645,782 3,983,820 78,009 304,600 277,399 216,128 4,912 2,688,109 3,847,557 112,810 374,025 304,622 361,988 8,423 2,659,792 3,969,934 246.21 246.20 110.00 5,820 2,215 132,429 368,261 309,815 428,549 506,095 2,606,690 1,716,664 1,479,284 8,680 $ 5,269,733 2,922,336 4,512,625 23,992,491 44,297,664 377.59 377.53 110.00 7,450 5,190 $ 1.19 1.19 1.29 31.52 23.97 201.65 201.65 2013 150.00 2012 2014 229.03 229.03 2016 150.00 2015 4,539 3,402 4,045 2,889 200.78 200.78 130.00 4,115 2,913 191.34 191.34 130.00 4,015 2,308 204.49 204.48 120.00 4,280 3,220 199.71 199.70 120.00 4,520 3,205 106.64 106.64 110.00 4,070 2,115 80,907 328,500 223,759 195,120 Return on Canon Inc. Shareholders’ Equity (%) 79,765 308,979 213,739 182,343 881 2,966,415 4,427,773 1,148 2,978,184 4,460,618 Advertising Research and development expenses Depreciation of property, plant and equipment Increase in property, plant and equipment Working Capital Ratio 3.0 2.5 2.0 Long-term debt, excluding current installments Canon Inc. shareholders’ equity Total assets 1.5 Per share data: Net income attributable to Canon Inc. 1.0 shareholders per share: 0.5 Basic 0 Diluted 2012 Dividend per share Stock price: 2014 2013 High Low 2015 2016 12 9 6 3 0 58,707 302,376 199,133 171,597 611,289 2,783,129 5,138,529 137.95 137.95 150.00 3,656 2,780 Average number of common shares in thousands Number of employees 1,092,071 197,673 1,092,018 189,571 1,112,510 191,889 1,147,934 194,151 1,173,648 196,968 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 R&D Expenses (Billions of yen) 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 48 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 CANON ANNUAL REPORT 2016 Millions of yen (except per share amounts) Thousands of U.S. dollars (except per share amounts) 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2016 Net sales: Domestic Overseas Total Percentage of previous year Advertising Research and development expenses Depreciation of property, plant and equipment Increase in property, plant and equipment Long-term debt, excluding current installments Canon Inc. shareholders’ equity Net income attributable to Canon Inc. shareholders per share: Total assets Per share data: Dividend per share Stock price: Basic Diluted High Low 706,979 2,694,508 3,401,487 714,280 3,085,991 3,800,271 724,317 3,002,935 3,727,252 715,863 3,015,517 3,731,380 89.5% 102.0% 99.9% 107.2% 720,286 2,759,502 3,479,788 694,450 2,862,983 3,557,433 97.8% 96.0% 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 78.4% 91.4% Net income attributable to Canon Inc. 150,650 220,209 254,797 230,483 224,564 248,630 246,603 131,647 309,148 Percentage of sales 4.4% 5.8% 6.8% 6.2% 6.5% 7.0% 6.7% 4.1% 7.6% 58,707 302,376 199,133 171,597 611,289 2,783,129 5,138,529 80,907 328,500 223,759 195,120 881 2,966,415 4,427,773 79,765 308,979 213,739 182,343 1,148 2,978,184 4,460,618 86,398 306,324 223,158 188,826 1,448 2,910,262 4,242,710 83,134 296,464 211,973 270,457 2,117 2,598,026 3,955,503 81,232 307,800 210,179 226,869 3,368 2,551,132 3,930,727 94,794 315,817 232,327 158,976 4,131 2,645,782 3,983,820 78,009 304,600 277,399 216,128 4,912 2,688,109 3,847,557 137.95 137.95 150.00 3,656 2,780 201.65 201.65 150.00 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 2,308 204.49 204.48 120.00 4,280 3,220 199.71 199.70 120.00 4,520 3,205 106.64 106.64 110.00 4,070 2,115 112,810 374,025 304,622 361,988 8,423 2,659,792 3,969,934 246.21 246.20 110.00 5,820 2,215 947,587 3,533,759 4,481,346 107.8% 488,332 10.9% 132,429 368,261 309,815 428,549 $ 6,094,647 23,228,517 29,323,164 89.5% 1,298,707 4.4% 506,095 2,606,690 1,716,664 1,479,284 8,680 2,922,336 4,512,625 $ 5,269,733 23,992,491 44,297,664 377.59 377.53 110.00 7,450 5,190 $ 1.19 1.19 1.29 31.52 23.97 Average number of common shares in thousands Number of employees 1,092,071 197,673 1,092,018 189,571 1,112,510 191,889 1,147,934 194,151 1,173,648 196,968 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 Note: U.S. dollar amounts are translated from yen at the rate of U.S.$1 = JPY116, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 30, 2016. 49 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 CONSOLIDATED BALANCE SHEETS Canon Inc. and Subsidiaries December 31, 2016 and 2015 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 1, 5, 12 and 17) Total current liabilities Long-term debt, excluding current installments (Notes 9 and 19) 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 2016 and 2015 Additional paid-in capital Legal reserve (Note 13) Retained earnings (Note 13) Accumulated other comprehensive income (loss) (Note 14) Treasury stock, at cost; 241,695,310 shares in 2016 and 241,690,840 shares in 2015 Total Canon Inc. shareholders’ equity Noncontrolling interests Total equity Total liabilities and equity See accompanying Notes to Consolidated Financial Statements. 50 Millions of yen 2016 2015 630,193 3,206 641,458 560,736 264,155 2,099,748 29,297 73,680 1,194,976 446,268 936,424 358,136 633,613 20,651 588,001 501,895 313,019 2,057,179 29,476 67,862 1,219,652 241,208 478,943 333,453 5,138,529 4,427,773 1,850 372,269 30,514 304,901 273,835 983,369 611,289 407,200 142,049 688 278,255 47,431 317,653 171,302 815,329 881 296,262 130,838 2,143,907 1,243,310 174,762 401,385 66,558 3,350,728 (199,881) (1,010,423) 2,783,129 211,493 174,762 401,358 65,289 3,365,158 (29,742) (1,010,410) 2,966,415 218,048 2,994,622 3,184,463 5,138,529 4,427,773 CANON ANNUAL REPORT 2016 CONSOLIDATED STATEMENTS OF INCOME Canon Inc. and Subsidiaries Years ended December 31, 2016, 2015 and 2014 Net sales Cost of sales (Notes 5, 8, 11 and 18) Gross profit Operating expenses (Notes 1, 5, 8, 11 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 Less: Net income attributable to noncontrolling interests Net income attributable to Canon Inc. Net income attributable to Canon Inc. shareholders per share (Note 16): Basic Diluted Cash dividends per share See accompanying Notes to Consolidated Financial Statements. Millions of yen 2016 2015 2014 3,401,487 1,727,654 1,673,833 3,800,271 1,865,887 1,934,384 3,727,252 1,865,780 1,861,472 1,142,591 302,376 1,250,674 328,500 1,189,004 308,979 1,444,967 1,579,174 1,497,983 228,866 355,210 363,489 4,762 (1,061) 12,084 15,785 5,501 (584) (12,689) 7,906 (500) 12,344 (7,772) 19,750 244,651 347,438 383,239 82,681 116,105 118,000 161,970 231,333 265,239 11,320 11,124 10,442 150,650 220,209 254,797 Yen 137.95 137.95 150.00 201.65 201.65 150.00 229.03 229.03 150.00 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Canon Inc. and Subsidiaries Years ended December 31, 2016, 2015 and 2014 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 (loss) Less: Comprehensive income attributable to noncontrolling interests Comprehensive income (loss) attributable to Canon Inc. See accompanying Notes to Consolidated Financial Statements. Millions of yen 2016 2015 2014 161,970 231,333 265,239 (107,666) 997 (2,948) (70,355) (55,504) 2,010 2,785 (6,543) 143,834 2,524 (195) (37,985) (179,972) (57,252) 108,178 (18,002) 1,745 174,081 11,973 373,417 9,666 (19,747) 162,108 363,751 51 CANON ANNUAL REPORT 2016 CONSOLIDATED STATEMENTS OF EQUITY Canon Inc. and Subsidiaries Years ended December 31, 2016, 2015 and 2014 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, 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) (226) (658) (145,790) 1,508 (1,508) (145,790) — (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 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): 27 258 (163,810) 285 (163,810) 1,269 (1,269) — (5,270) (4,077) 1,047 (4,985) (163,810) (4,077) 1,047 — 150,650 150,650 11,320 161,970 Foreign currency translation adjustments (101,257) (101,257) (6,409) (107,666) Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income (loss) Repurchases and reissuance of treasury stock 1,196 (2,924) (67,412) 1,196 (199) 997 (2,924) (67,412) (24) (2,943) (2,948) (70,355) (19,747) 1,745 (18,002) (1) (13) (14) (14) Balance at December 31, 2016 174,762 401,385 66,558 3,350,728 (199,881) (1,010,423) 2,783,129 211,493 2,994,622 See accompanying Notes to Consolidated Financial Statements. 52 CANON ANNUAL REPORT 2016 CONSOLIDATED STATEMENTS OF CASH FLOWS Canon Inc. and Subsidiaries Years ended December 31, 2016, 2015 and 2014 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 of affiliated companies Deferred income taxes (Increase) decrease in trade receivables Decrease in inventories Increase (decrease) in trade payables Increase (decrease) in accrued income taxes Increase (decrease) in accrued expenses Increase (decrease) in accrued (prepaid) pension and severance cost Other, net Millions of yen 2016 2015 2014 161,970 231,333 265,239 250,096 5,203 (890) 7,188 (4,155) 6,156 56,844 (16,456) (5,256) 5,489 34,094 273,327 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) Net cash provided by operating activities 500,283 474,724 583,927 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 (Note 9) Repayments of long-term debt (Note 9) Decrease in short-term loans, net (Note 9) Purchases of noncontrolling interests Dividends paid Repurchases and reissuance of treasury stock Other, net (206,971) 6,177 (84) 1,181 15,414 (649,570) (4,460) 1,188 (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 (837,125) (453,619) (269,298) 610,552 (856) (80,580) (4,993) (163,810) (14) (4,607) 717 (1,350) — (29,570) (174,711) 790 (6,078) 1,377 (2,152) (54) — (145,790) (149,813) (4,454) Net cash provided by (used in) financing activities 355,692 (210,202) (300,886) Effect of exchange rate changes on cash and cash equivalents (22,270) (21,870) 41,928 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. (3,420) (210,967) 55,671 633,613 844,580 788,909 630,193 633,613 844,580 738 76,714 653 117,643 462 111,819 53 CANON ANNUAL REPORT 2016 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 cam- eras, 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, diagnostic X-ray systems, computed tomography, magnetic resonance imaging, diagnostic ultrasound systems, clinical chemistry analyzers, ophthalmic equipment, vacuum thin-film deposition equipment, organic LED (“OLED”) panel manufacturing equipment, die bonders, micromotors, net- work cameras, handy terminals and document scanners. Canon’s consolidated net sales for the years ended December 31, 2016, 2015 and 2014 were distributed as follows: the Office Business Unit 53.1%, 55.5% and 55.8%, the Imaging System Business Unit 32.2%, 33.3% and 36.0%, the Industry and Others Business Unit 17.2%, 13.8% and 10.7%, and elimination between segments 2.5%, 2.6% and 2.5%, 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. 79.2%, 81.2% and 80.6% of consolidated net sales for the years ended December 31, 2016, 2015 and 2014 were generated out- side Japan, with 28.3%, 30.1% and 27.8% in the Americas, 26.9%, 28.3% and 29.3% in Europe, and 24.0%, 22.8% and 23.5% in Asia and Oceania, respectively. Canon sells laser printers on an OEM basis to HP Inc.; such sales constituted 14.8%, 17.8% and 17.4% of consolidated net sales for the years ended December 31, 2016, 2015 and 2014, respectively, and are included in the Office Business Unit. Canon’s manufacturing operations are conducted primarily at 30 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. On December 19, 2016, Canon acquired all the ordinary shares of Toshiba Medical Systems Corporation (“TMSC”), one of the leading global companies in the medical equip- ment industry, and consolidated TMSC. Further information is described in Note 7. (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 incorpo- rated in the accompanying consolidated financial statements to conform with U.S. generally accepted accounting principles (“U.S. 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 vari- able interest entities where the Company or its consolidated subsidiaries are the primary beneficiaries. All significant inter- company balances and transactions have been eliminated. (d) Use of Estimates The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial state- ments and the reported amounts of revenues and expenses during the period. Significant estimates and assumptions are reflected in valuation and disclosure of revenue recognition, allowance for doubtful receivables, inventories, long-lived assets, goodwill and other intangible assets with indefi- nite useful lives, environmental liabilities, deferred tax assets, uncertain tax positions and employee retirement and sever- ance 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 transac- tions, including foreign exchange contracts, and translation of assets and liabilities denominated in foreign currencies are included in other income (deductions) in the consolidated statements of income. Foreign currency exchange gains and losses were net losses of ¥2 million and ¥22,149 million for the years ended December 31, 2016 and 2015, respectively, and a net gain of ¥2,628 million for the year ended December 31, 2014. 54 CANON ANNUAL REPORT 2016(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 ¥30,500 million and ¥80,870 million at December 31, 2016 and 2015, respectively, are included in cash and cash equiva- lents in the consolidated balance sheets. (g) Investments Investments consist primarily of time deposits with original maturities 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 securities. Canon does not hold any trading securities which are bought and held primarily for the purpose of sale in the near term. Available-for-sale securities are recorded at fair value. Fair value is determined based on quoted market prices, projected discounted cash flows or other valuation techniques as appro- priate. Unrealized holding gains and losses, net of the related tax effect, are reported as a separate component of accumu- lated other comprehensive income (loss) until realized. Canon does not hold any held-to-maturity securities. Available-for-sale securities are regularly reviewed for other- than-temporary declines in the carrying amount based on cri- teria that include the length of time and the extent to which the market value has been less than cost, the financial condi- tion and near-term prospects of the issuer and Canon’s intent and ability to retain the investment for a period of time suf- ficient to allow for any anticipated recovery in market value. For debt securities for which the declines are deemed to be other-than-temporary and there is no intent to sell, impair- ments are separated into the amount related to credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other 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, impairments in their entirety are recog- nized in earnings. Canon recognizes an impairment loss to the extent by which the cost basis of the investment exceeds the fair value of the investment. Realized gains and losses are determined by the average cost method and 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 fac- tors, including aging analysis, macroeconomic conditions and historical experience. An additional reserve for individual accounts is recorded when Canon becomes aware of a cus- tomer’s inability to meet its financial obligations, such as in the case of bankruptcy filings. If circumstances related to cus- tomers 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 net realizable 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 cir- cumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset and the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated undiscounted future cash flows, an impairment charge is 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, gener- ally 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 55 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. 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 17 years, license fees are 7 years, and customer relationships are from 11 years to 20 years, respectively. Certain costs incurred 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 estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and lia- bilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to tax- able 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 mer- its, that the tax positions will be sustained upon examination 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 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. Canon also offers separately priced product maintenance con- tracts for most office products, for which the customer typically pays a stated base service fee plus a variable amount based on usage. Revenue from these service maintenance contracts is mea- sured at the stated amount of the contract and recognized as ser- vices 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 function- ality are successfully tested and demonstrated by Canon. Service 56 CANON ANNUAL REPORT 2016 revenue is derived primarily from separately priced product main- tenance contracts on equipment sold to customers and is mea- sured 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 amounts received in advance from custom- ers in excess of revenue recognized primarily for sales of opti- cal equipment and product maintenance contracts as deferred revenue until the revenue recognition criteria are satisfied. Deferred revenue were ¥102,298 million and ¥51,390 mil- lion at December 31, 2016 and 2015, respectively, and are included in other current liabilities in the accompanying con- solidated balance sheets. 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 impact of price protection obligations when announced. Estimated product warranty costs are recorded at the time revenue is recognized and are included in selling, general and administrative expenses in the consolidated statements of income. Estimates for accrued product warranty costs are based on historical experience, and are affected by ongoing product failure rates, 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 governmen- tal authorities are excluded from revenues in the consolidated statements of income. (r) Research and Development Costs Research and development costs are expensed as incurred. (s) Advertising Costs Advertising costs are expensed as incurred. Advertising expenses were ¥58,707 million, ¥80,907 million and ¥79,765 million for the years ended December 31, 2016, 2015 and 2014, respectively. (t) Shipping and Handling Costs Shipping and handling costs totaled ¥44,296 million, ¥52,504 million and ¥49,576 million for the years ended December 31, 2016, 2015 and 2014, respectively, and are included in selling, general and administrative expenses in the consolidated state- ments 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 val- ues of these derivative financial instruments are immediately recorded in earnings. Canon classifies cash flows from derivatives as cash flows from operating activities in the consolidated statements of cash flows. (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 November 2015, the Financial Accounting Standards Board (“FASB”) issued an amendment which requires deferred tax assets and liabilities be classified as noncurrent in the con- solidated balance sheets. Canon early adopted this amended guidance from the quarter beginning January 1, 2016, on a prospective basis, and prior periods were not retrospectively adjusted. Canon’s current deferred tax assets were ¥55,108 million and current deferred tax liabilities were ¥2,682 million as of December 31, 2015. In July 2015, the FASB issued an amendment which requires an entity to measure inventory at the lower of cost and net real- izable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Canon early adopted this amended guidance from the quarter beginning April 1, 2016. This adoption did not have a material impact on its consolidated results of operations and financial condition. 57 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In May 2014, the FASB issued a new accounting standard related to revenue from contracts with customers. This standard 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 standard was origi- nally planned to be effective for annual reporting periods begin- ning after December 15, 2016, however, in August 2015, the FASB issued an accounting standard update for a one-year defer- ral 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 presented or retrospectively with the cumulative effect of initially applying this standard recognized at the date of initial application. In March 2016, the FASB issued an accounting standard update which clarifies the implementa- tion guidance for principal versus agent considerations. In April 2016, the FASB issued an accounting standard update which clarifies guidance related to identifying performance obligations and licensing implementation guidance. In May 2016, the FASB issued an accounting standard update which amends guidance in the new standard on transition, collectibility, noncash consid- eration and the presentation of sales and other similar taxes. In December 2016, the FASB issued an accounting standard update which amends guidance in the new standard on disclosure of performance obligations, provisions for losses on certain types of contracts, scoping, and other areas. These standard updates have the same effective date as the original standard. Canon cur- rently plans to apply the modified retrospective method of adop- tion from the quarter beginning January 1, 2018. While Canon currently does not expect the adoption of this standard to have a material impact on the timing of revenue recognition, the adop- tion of this standard is expected to result in change in allocation of revenue between goods and services in Office Business Unit and Industry and Others Business Unit on its consolidated state- ments of income. From consolidated balance sheets perspective, the reclassification between receivable and refund liability for vari- able consideration in Office Business Unit and Imaging System Business Unit may results in the increase of total assets and total liabilities. However, evaluation is still ongoing and it could result in additional impacts on its consolidated results of operations and financial condition. 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. In October 2016, the FASB issued an amendment which requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Consequently, the amendments in this guidance eliminate the exception for an intra-entity trans- fer of an asset other than inventory. Two common examples of assets included in the scope of this guidance are intellec- tual property and property, plant, and equipment. This guid- ance is effective for annual reporting periods beginning after December 15, 2017, and early adoption is permitted. The amendments in this guidance should be applied on a modi- fied retrospective basis through a cumulative effect adjustment directly to retained earnings as of the beginning of the period of adoption. 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. 58 CANON ANNUAL REPORT 20162. 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, 2016 and 2015 are as follows: December 31 Millions of yen 2016: Noncurrent: Government bonds Corporate bonds Fund trusts Equity securities Millions of yen 2015: Noncurrent: Government bonds Corporate bonds Fund trusts Equity securities Cost 277 43 85 19,026 19,431 Cost 298 6 63 20,461 20,828 Gross unrealized holding gains Gross unrealized holding losses Fair value — 188 1 23,439 23,628 8 2 — 21 31 269 229 86 42,444 43,028 Gross unrealized holding gains Gross unrealized holding losses Fair value — 195 1 23,482 23,678 11 — — 1,094 1,105 287 201 64 42,849 43,401 Maturities of available-for-sale debt securities included in investments in the accompanying consolidated balance sheets are as follows at December 31, 2016: Due after five years Millions of yen Cost 320 320 Fair value 498 498 Gross realized gains were ¥750 million, ¥329 million and ¥2,540 million for the years ended December 31, 2016, 2015 and 2014, respectively. Gross realized losses, including write- downs for impairments that were other-than-temporary, were ¥1,032 million, ¥31 million and ¥31 million for the years ended December 31, 2016, 2015 and 2014, respectively. At December 31, 2016, substantially all of the available-for- sale securities with unrealized losses had been in a continuous unrealized loss position for less than twelve months. Time deposits with original maturities of more than three months were ¥3,206 million and ¥20,651 million at December 31, 2016 and 2015, respectively, and were included in short-term investments in the accompanying consolidated balance sheets. Aggregate cost of non-marketable equity securities accounted for under the cost method totaled ¥7,800 million and ¥2,570 million at December 31, 2016 and 2015, respec- tively. These investments were not evaluated for impairment at December 31, 2016 and 2015, respectively, because (a) Canon did not estimate the fair value of those investments as it was not practicable to estimate the fair value of the investments and (b) Canon did not identify any events or changes in cir- cumstances that might have had significant adverse effects on the fair value of those investments. Investments in affiliated companies accounted for by the equity method amounted to ¥21,514 million and ¥20,415 million at December 31, 2016 and 2015, respectively. Canon’s share of the net earnings in affiliated companies accounted for by the equity method, included in other income (deductions), were earnings of ¥890 million, ¥447 million and ¥478 million for the years ended December 31, 2016, 2015 and 2014 respectively. 59 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 2016 28,811 623,722 652,533 (11,075) 641,458 2015 17,614 582,464 600,078 (12,077) 588,001 Millions of yen 2016 373,337 143,298 44,101 560,736 2015 357,115 130,258 14,522 501,895 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 2016 2015 283,893 1,656,087 1,778,552 54,786 3,773,318 (2,578,342) 282,786 1,632,604 1,813,116 61,952 3,790,458 (2,570,806) 1,194,976 1,219,652 Depreciation expenses for the years ended December 31, 2016, 2015 and 2014 were ¥199,133 million, ¥223,759 mil- lion and ¥213,739 million, respectively. Amounts due for purchases of property, plant and equip- ment were ¥31,318 million and ¥30,789 million at December 31, 2016 and 2015, respectively, and are included in other 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. 60 CANON ANNUAL REPORT 2016 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 2016 306,766 14,776 (34) (30,288) 291,220 (2,325) 288,895 (105,308) 183,587 2015 318,066 14,271 (888) (31,920) 299,529 (2,878) 296,651 (109,220) 187,431 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 2016 2,878 (978) 398 27 2,325 2015 6,276 (1,343) 55 (2,110) 2,878 Canon has policies in place to ensure that its products are sold to customers with an appropriate credit history, and con- tinuously monitors its customers’ credit quality based on infor- mation including length of period in arrears, macroeconomic conditions, initiation of legal proceedings against custom- ers and bankruptcy filings. The allowance for credit losses of finance receivables are evaluated collectively based on histori- cal experience of credit losses. An additional reserve for indi- vidual 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 impairment at December 31, 2016 and 2015 are not significant. The cost of equipment leased to customers under oper- ating leases included in property, plant and equipment, net at December 31, 2016 and 2015 was ¥97,890 million and ¥108,746 million, respectively. Accumulated depreciation on equipment under operating leases at December 31, 2016 and 2015 was ¥75,997 million and ¥82,916 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, 2016. Year ending December 31: 2017 2018 2019 2020 2021 Thereafter Millions of yen Financing leases Operating leases 117,728 87,627 58,364 31,422 10,986 639 306,766 7,226 3,894 2,185 994 409 41 14,749 61 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. ACQUISITIONS On March 17, 2016, Canon entered into a Shares and Other Securities Transfer Agreement with Toshiba Corporation and acquired the share options for consideration of cash to acquire all the ordinary shares of Toshiba Medical Systems Corporation (“TMSC”), which is exercisable upon the clearances of nec- essary competition regulatory authorities. As such clear- ances were obtained, Canon exercised the share options and acquired all the ordinary shares of TMSC on December 19, 2016. The acquisition date was December 19, 2016 and the purchase price was ¥665,498 million, which approximates the fair value at that date. The acquisition was accounted for using the acquisi- tion method of accounting. Acquisition-related costs were expensed as incurred and were not material. Under Phase V of the Excellent Global Corporation Plan, a five- year initiative that Canon has been implementing since 2016, “embracing the challenge of new growth through a grand strate- gic transformation” has been set as a basic policy. With regard to “strengthening and growing new businesses, and creating future businesses,” a particularly important strategy, Canon intends to develop a health care business within the realm of “safety and security,” 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 com- puted tomography (“CT”) systems in particular, TMSC is the overwhelming market share leader in Japan and has been steadily increasing its global market share. By maximizing the combination of both companies’ management resources, Canon aims to solidify its business foundation for health care that can contribute to the world. The following table summarizes the preliminary purchase price allocation which was based on estimated fair values of the assets acquired and liabilities assumed at acquisition date. Since the acquisition date of TMSC was near the balance sheet date, and TMSC is composed of various entities located around the world, the purchase price allocation is still prelimi- nary. The estimates and assumptions are subject to change as Canon obtains additional information for the estimates within the measurement period. The primary areas of the preliminary allocation of the fair value of consideration transferred that are not yet finalized relate to the fair values of certain tangi- ble and intangible assets acquired and the residual goodwill. Specifically, certain underlying analyses for customer relation- ships, and patents and developed technology were based on overall estimates rather than detail information for each of the individual operations. Cash and cash equivalents Other current assets Intangible assets Other noncurrent assets Total assets acquired Current liabilities Noncurrent liabilities Total liabilities assumed Noncontrolling interest Net identifiable assets acquired Goodwill Net assets acquired Millions of yen 25,301 169,545 227,500 42,975 465,321 199,223 92,231 291,454 1,047 172,820 492,678 665,498 Intangible assets acquired, which are subject to amortization, consist of customer relationships of ¥155,200 million, and pat- ents and developed technology of ¥72,300 million. Canon has preliminarily estimated the amortization period for the customer relationships, and patents and developed technology to be 15 - 20 years and 10 years, respectively. The weighted average amortiza- tion period for all intangible assets is approximately 15 years. Goodwill recorded is attributable primarily to expected syn- ergies from combining operations of TMSC and Canon, such as accelerating entry into new fields, further improvement in quality through shared production technology and expanding business domains through the enhancement of R&D capabili- ties. None of the goodwill is expected to be deductible for tax purposes. The amounts of net sales of TMSC since the acquisition date included in the Canon’s consolidated statement of income for the year ended December 31, 2016 were ¥13,582 million. The amounts of net income of TMSC included in the Canon’s con- solidated statement of income were not material. 62 CANON ANNUAL REPORT 2016 The unaudited pro forma net sales for the years ended December 31, 2016 and 2015 as if TMSC had been included in Canon’s consolidated statements of income from the begin- ning of the year ended December 31, 2015 were ¥3,806,667 million and ¥4,224,181 million, respectively. Pro forma net income was not disclosed because the impact on Canon’s con- solidated statements of income was not material. Canon acquired businesses other than that described above during the year ended December 31, 2016 that were not material to its consolidated financial statements. 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 amortiza- tion, 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 amortization period for all intangible assets is approximately 13 years. Goodwill recorded is attributable primarily to expected syn- ergies from combining operations of Axis and Canon. None of the goodwill is expected to be deductible for tax purposes. The goodwill 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 consol- idated 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 material to its consolidated financial statements. 63 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. GOODWILL AND OTHER INTANGIBLE ASSETS Intangible assets subject to amortization acquired during the year ended December 31, 2016, including those recorded from busi- nesses acquired, totaled ¥266,325 million, which primarily consist of customer relationships of ¥155,997 million, patents and devel- oped technology of ¥73,451 million and software of ¥36,054 million. The weighted average amortization periods for intangi- ble assets in total acquired during the year ended December 31, 2016 are approximately 14 years. The weighted average amor- tization periods for customer relationships, patents and devel- oped technology and software acquired during the year ended December 31, 2016 are approximately 15 - 20 years, 10 years and 5 years, respectively. Intangible assets subject to amortization acquired during the year ended December 31, 2015, including those recorded from businesses 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 mil- lion. The weighted average amortization periods for intangi- ble assets in total acquired during the year ended December 31, 2015 are approximately 9 years. The weighted average amortiza- tion periods for trademarks, software, and patents and developed technology acquired during the year ended December 31, 2015 are approximately 15 years, 5 years and 7 years, respectively. The components of intangible assets subject to amortization at December 31, 2016 and 2015 were as follows: December 31 Millions of yen Software Customer relationships Patents and developed technology Trademarks License fees Other 2016 2015 Gross carrying amount Accumulated amortization Gross carrying amount Accumulated amortization 313,599 172,234 106,250 44,704 15,561 17,713 670,061 193,785 11,146 16,272 5,610 6,756 8,250 241,819 308,348 17,159 39,685 49,861 15,669 17,070 447,792 181,972 10,173 16,123 2,952 5,617 7,690 224,527 Aggregate amortization expense for the years ended December 31, 2016, 2015 and 2014 was ¥50,963 million, ¥49,568 million and ¥49,741 million, respectively. Estimated amortization expense for intangible assets currently held for the next five years ending December 31 is ¥60,474 million in 2017, ¥53,031 million in 2018, ¥42,624 million in 2019, ¥34,079 million in 2020, and ¥28,817 million in 2021. Intangible assets not subject to amortization other than goodwill at December 31, 2016 and 2015 were ¥18,026 mil- lion and ¥17,943 million, respectively, which primarily consist of in-process research and development recorded from busi- nesses 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, 2016 and 2015 were as follows: Years ended December 31 Millions of yen 2016: Balance at beginning of year Goodwill acquired during the year Translation adjustments and other Office 142,551 863 (7,158) Imaging System Industry and Others Unallocated*1 Total 53,474 — 282,918 4,589 (4,440) (29,051) — 492,678 — 478,943 498,130 (40,649) Balance at end of year 136,256 49,034 258,456 492,678 936,424 Millions of yen 2015: Balance at beginning of year Goodwill acquired during the year Translation adjustments and other Office 145,335 10,373 (13,157) Imaging System Industry and Others Unallocated Total 21,780 31,367 327 44,221 228,827 9,870 — — — 211,336 270,567 (2,960) Balance at end of year 142,551 53,474 282,918 — 478,943 *1 Canon has not completed the allocation of goodwill to the segments for impairment testing which is attributable to the acquisition of TMSC as of December 31, 2016. 64 CANON ANNUAL REPORT 2016 9. SHORT-TERM LOANS AND LONG-TERM DEBT Short-term loans consisting of bank borrowings at December 31, 2016 and 2015 were ¥601 million and ¥26 million, respectively. Long-term debt consisted of the following: December 31 Millions of yen Loan from a bank; bearing interest of 0.13% at December 31, 2016*1 Capital lease obligations and others Less current portion 2016 610,000 2,538 612,538 (1,249) 611,289 2015 — 1,543 1,543 (662) 881 *1 On March 15, 2016, Canon entered into a provisional borrowing agreement with a bank which matures in 2017 for acquiring TMSC. On January 31, 2017, Canon refinanced this borrowing to the unsecured loans by credit facilities expiring in December 2021. The loans under the credit facilities are ¥610,000 million at a floating interest (0.04% as of January 31, 2017). As a result, this borrowing was classified as long-term debt in the accompanying Consolidated Balance Sheet as of December 31, 2016. The aggregate annual maturities of long-term debt outstanding at December 31, 2016 were as follows: Year ending December 31: 2017 2018 2019 2020 2021 Thereafter Millions of yen 1,249 736 405 125 610,023 — 612,538 Both short-term and long-term bank loans are primarily made under general agreements which provide that security and guar- antees for present and future indebtedness will be given upon request of the bank, and that the bank shall have the right to off- set 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 2016 2015 38,073 334,196 16,706 261,549 372,269 278,255 65 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 multiem- ployer pension plan for the industry in which these subsidiaries operate. As a result, the Company recorded a gain on curtail- ments and settlements of ¥9,370 million in selling, general and administrative expenses in the consolidated statement of income for the year ended December 31, 2014. The following tables include the provisional financial impact related to the acquisition of TMSC, which was acquired during the year ended December 31, 2016. TMSC participates in Toshiba Corporate Pension Fund and the establishment of the new pen- sion plan is currently in progress. The Company calculated the projected benefit obligations based on the current benefit level of Toshiba Corporate Pension Fund and included proportional share of the plan assets of TMSC in the following tables. These obliga- tions and plan assets are expected to be reasonable estimates of the impact of creating the new plan. 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 Acquisition Plan amendments Foreign currency exchange rate changes Projected benefit obligations at end of year Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Plan participants’ contributions Benefits paid Acquisition Foreign currency exchange rate changes Fair value of plan assets at end of year Funded status at end of year Japanese plans Millions of yen Foreign plans Millions of yen 2016 2015 2016 2015 781,350 29,367 8,238 — 45,778 (25,032) 71,040 (4,734) — 906,007 760,331 30,009 8,008 — 7,481 (24,479) — — — 781,350 349,680 6,816 8,792 1,594 55,629 (6,268) 21,285 — (45,442) 392,086 364,662 7,760 10,572 1,830 (5,534) (6,795) — (2,655) (20,160) 349,680 626,575 12,145 7,304 — (21,782) 43,194 — 667,436 (238,571) 622,121 17,541 8,701 — (21,788) — — 626,575 (154,775) 217,870 18,276 7,271 1,594 (6,268) 14,972 (28,776) 224,939 (167,147) 221,421 21 10,864 1,830 (6,795) — (9,471) 217,870 (131,810) Amounts recognized in the consolidated balance sheets at December 31, 2016 and 2015 are as follows: December 31 Other assets Accrued expenses Accrued pension and severance cost 66 Japanese plans Millions of yen Foreign plans Millions of yen 2016 2015 2016 2015 976 — (239,547) (155,589) (238,571) (154,775) 814 — 1,346 (840) 9,986 (1,123) (167,653) (140,673) (167,147) (131,810) CANON ANNUAL REPORT 2016 Amounts recognized in accumulated other comprehensive income (loss) at December 31, 2016 and 2015 before the effect of income taxes are as follows: December 31 Actuarial loss Prior service credit Japanese plans Millions of yen Foreign plans Millions of yen 2016 2015 2016 2015 251,078 (71,439) 208,946 (79,935) 116,930 (2,652) 71,750 (2,567) 179,639 129,011 114,278 69,183 The accumulated benefit obligation for all defined benefit plans was as follows: December 31 Accumulated benefit obligation Japanese plans Millions of yen Foreign plans Millions of yen 2016 2015 2016 2015 869,355 740,545 377,004 338,160 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 2016 2015 2016 2015 905,975 666,428 777,458 621,869 390,942 222,449 346,749 204,953 867,706 664,586 731,537 615,963 375,860 222,449 331,351 200,891 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, 2016, 2015 and 2014 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 2016 2015 2014 2016 2015 2014 29,367 30,009 26,445 6,816 7,760 6,801 8,238 8,008 10,772 8,792 10,572 10,654 (10,012) (11,857) (10,637) (19,443) (19,579) (18,018) (13,230) (12,592) (12,800) (61) 10,944 10,402 10,023 2,185 3,839 1,698 — (9,370) — (145) 85 — — — 15,876 16,248 16,422 7,866 10,169 (915) 67 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Other changes in plan assets and benefit obligations recognized in other comprehensive income (loss) for the years ended December 31, 2016, 2015 and 2014 are summarized as follows: 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 2016 2015 2014 2016 2015 2014 53,076 (4,734) (10,944) 13,230 — 9,519 — (10,402) 12,592 — 33,800 — (10,023) 12,800 — 47,365 — (2,185) (85) — 6,302 (2,655) (3,839) 145 — 37,366 — (1,698) 61 (16,725) 50,628 11,709 36,577 45,095 (47) 19,004 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 (13,163) 13,852 43 5,765 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 2016 0.7% 2.6% 2015 1.1% 3.0% 2016 2.2% 2.1% 2015 3.0% 2.0% Weighted-average assumptions used to determine net periodic benefit 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 2016 2015 2014 2016 2015 2014 1.1% 1.1% 1.6% 3.0% 3.0% 3.0% 3.1% 3.1% 3.1% 3.0% 2.9% 3.9% 2.0% 2.0% 2.3% 4.4% 5.6% 4.9% 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 formu- lates a “model” portfolio comprised of the optimal combination of equity securities and debt securities. Plan assets are invested in individual equity and debt securities using the guidelines of the “model” portfolio in order to produce a total return that will match the expected return on a mid-term to long-term basis. Canon evaluates the gap between expected return and actual return of invested plan assets on an annual basis to determine if such differences necessitate a revision in the formulation of the “model” portfolio. Canon revises the “model” portfolio when and to the extent considered necessary to achieve the expected long-term rate of return on plan assets. 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 com- pany general accounts. 68 CANON ANNUAL REPORT 2016 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 40% is invested in equity securities, approximately 30% 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 compa- nies, and appropriately diversified investments by type of indus- try and other relevant factors. The debt securities are selected primarily from government bonds, public debt instruments, and corporate bonds. Prior to investing, Canon has investigated the quality of the issue, including rating, interest rate, and repay- ment 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 guaranteed interest rate and return of capital. With respect to investments in foreign invest- ment vehicles, Canon has investigated the stability of the under- lying 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. 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, 2016 and 2015, by asset category, are as follows: December 31, 2016 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 46,630 7,902 — — — 133,023 — 46,630 — 7,902 — 133,023 — 22,680 — — — 62,641 — — — 22,680 — 62,641 — 99,157 — 1,317 — 14,298 — 121,066 — 99,157 — 1,317 — 14,298 — 121,066 — 11,558 — 2,577 — 19,989 — 22,296 — 11,558 — 2,577 — 19,989 — 22,296 — 13,612 — 13,612 — — — — — 128,220 — 128,220 — 6,898 — 6,898 — 102,127 84 102,211 — 76,276 24 76,300 153,689 513,663 84 667,436 34,238 190,677 24 224,939 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 (e) Foreign companies Pooled funds (f) Debt securities: Government bonds (g) Municipal bonds Corporate bonds Pooled funds (h) Mortgage backed securities (and other asset backed securities) Life insurance company general accounts Other assets 49,847 3,287 — — — 125,850 — 49,847 — 3,287 — 125,850 — 18,661 — — — 66,296 — — — 18,661 — 66,296 — 142,015 — 1,248 — 13,532 — 120,364 — 142,015 — 1,248 — 13,532 — 120,364 — 48 — 2,587 — 21,009 — 34,564 48 — — 2,587 — 21,009 — 34,564 — 10,462 — 10,462 — 137 — 137 — 125,759 — 125,759 — 6,190 — 6,190 — 33,432 779 34,211 — 68,378 — 68,378 195,149 430,647 779 626,575 18,709 199,161 — 217,870 69 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (a) The plan’s equity securities include common stock of the Company and certain of its subsidiaries in the amounts of ¥187 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 companies 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 government bonds, 50% foreign government bonds, 5% Japanese munici- pal bonds, and 20% corporate bonds for Japanese plans. These funds invest in approximately 70% foreign government bonds and 30% 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 ¥325 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 companies 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 bonds, 50% foreign government bonds, 5% Japanese munici- pal bonds, and 20% corporate bonds for Japanese plans. These funds invest in approximately 75% foreign government bonds and 25% 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, investments in life insurance company general accounts and other assets. Pooled funds are valued at their net asset val- ues that are calculated by the sponsor of the fund and have daily liquidity. Corporate bonds are valued using quoted prices for iden- tical assets in markets that are not active. Investments in life insur- ance company general accounts are valued at conversion value. Other assets are comprised principally of interest bearing cash and hedge funds. The fair value of Level 3 assets, consisting of hedge funds, was ¥108 million and ¥779 million at December 31, 2016 and 2015, respectively. Amounts of actual returns on, and purchases and sales of, these assets during the years ended December 31, 2016 and 2015 were not significant. The fair values of plan assets by each asset category of TMSC are calculated based on a pro-rata basis of total plan assets of Toshiba Corporate Pension Fund. Contributions Canon expects to contribute ¥14,179 million to its Japanese defined benefit pension plans and ¥8,203 million to its foreign defined benefit pension plans for the year ending December 31, 2017. Estimated future benefit payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Year ending December 31: 2017 2018 2019 2020 2021 2022–2026 Japanese plans Foreign plans Millions of yen Millions of yen 30,021 32,431 33,936 34,833 36,715 203,010 9,549 9,920 10,070 10,460 10,905 61,681 Multiemployer pension plans The amounts of cost recognized for the multiemployer pen- sion plans primarily in the Netherlands for the years ended December 31, 2016, 2015 and 2014 were ¥3,482 million, ¥3,864 million and ¥2,815 million, respectively. The mul- tiemployer pension plan in which the subsidiaries in the Netherlands participated was 96% funded as of December 31, 2015. The collective bargaining 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, 2016, 2015 and 2014 were ¥17,603 million, ¥17,277 million and ¥15,077 million, respectively. 70 CANON ANNUAL REPORT 2016 12. INCOME TAXES Domestic and foreign components of income before income taxes and the current and deferred income tax expense attributable to such income are summarized as follows: Years ended December 31 2016: Income before income taxes Income taxes: Current Deferred Japanese 135,131 47,687 4,126 51,813 Millions of yen Foreign 109,520 27,806 3,062 30,868 Total 244,651 75,493 7,188 82,681 2015: Income before income taxes 228,871 118,567 347,438 Income taxes: Current Deferred 80,020 3,414 83,434 31,413 1,258 32,671 111,433 4,672 116,105 2014: Income before income taxes 277,041 106,198 383,239 Income taxes: Current Deferred 83,221 6,796 90,017 25,850 2,133 27,983 109,071 8,929 118,000 The Company and its domestic subsidiaries are subject to a number of income taxes, which, in the aggregate, rep- resent a statutory income tax rate of approximately 33%, 35% and 38% for the years ended December 31, 2016, 2015 and 2014, respectively. The statutory income tax rate utilized for deferred tax assets and liabilities which are expected to be settled or realized in the periods from January 1, 2017 is approximately 31%. The adjustments of deferred tax assets and liabilities for amend- ments to the Japanese tax regulations which have been reflected in income taxes in the consolidated statements of income for the years ended December 31, 2016 and 2015 were ¥3,498 million and ¥6,456 million, respectively. 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 2016 33.0% 2015 35.0% 2014 38.0% 0.8 (3.0) (3.0) (0.8) 1.4 5.4 0.8 (2.9) (4.8) (0.4) 1.9 3.8 0.7 (3.7) (5.0) (0.5) 0.8 0.5 Effective income tax rate 33.8% 33.4% 30.8% 71 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 2016 — 149,866 — (108,429) 41,437 2015 55,108 113,687 (2,682) (96,243) 69,870 The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at December 31, 2016 and 2015 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 2016 2015 15,387 1,835 108,781 5,998 26,519 31,316 29,167 33,782 252,785 (26,687) 226,098 (9,450) (7,321) (4,449) (47,802) — (85,888) (29,751) (184,661) 41,437 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) 69,870 The net changes in the total valuation allowance were a decrease of ¥6,244 million and ¥4,567 million for the years ended December 31, 2016 and 2015, respectively, and an increase of ¥2,443 million for the year ended December 31, 2014. 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, 2016. 72 CANON ANNUAL REPORT 2016 At December 31, 2016, Canon had net operating losses which can be carried forward for income tax purposes of ¥175,404 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 2,150 22,314 57,302 56,547 37,091 175,404 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 ¥26,474 million for a portion of undistributed earnings of foreign sub- sidiaries that arose for the year ended December 31, 2016 and prior years because Canon currently does not expect to have such amounts distributed or paid as dividends to the Company in the foreseeable future. Deferred tax liabilities will be recognized when Canon expects that it will realize those undistributed earnings in a taxable manner, such as through receipt of dividends or sale of the investments. At December 31, 2016, such undistributed earn- ings of these subsidiaries were ¥935,913 million. 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 2016 6,056 2,741 — (665) (370) (444) 7,318 Millions of yen 2015 6,431 2,174 165 (1,180) (505) (1,029) 6,056 2014 6,201 1,649 216 (114) (1,808) 287 6,431 The total amounts of unrecognized tax benefits that would reduce the effective tax rate, if recognized, were ¥7,318 million and ¥6,056 million at December 31, 2016 and 2015, 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, 2016, 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, 2016 and 2015, and interest and penalties included in income taxes for the years ended December 31, 2016, 2015 and 2014 were 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. 73 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 reso- lution 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, 2016, 2015 and 2014 represent dividends paid out during 14. OTHER COMPREHENSIVE INCOME (LOSS) those years and the related appropriations to the legal reserve. Retained earnings at December 31, 2016 did not reflect cur- rent year-end dividends in the amount of ¥81,905 million which were approved by the shareholders in March 2017. 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 ¥940,000 million at December 31, 2016. Retained earnings at December 31, 2016 included Canon’s equity in undistributed earnings of affiliated compa- nies accounted for by the equity method in the amount of ¥17,804 million. Changes in accumulated other comprehensive income (loss) for the years ended December 31, 2016, 2015 and 2014 are as follows: Millions of yen 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 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, 2016 Foreign currency translation adjustments Unrealized gains and losses on securities Gains and losses on derivative instruments Pension liability adjustments Total 1,734 10 142,813 — 142,823 144,557 10,242 (2,408) (90,214) (80,646) 3 — (35) (22) 3,933 (1,632) 2,304 12,546 (2,204) (47,840) 96,702 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) 259 — — (1) 258 (101,350) 93 (100,998) (13,960) 814 382 1,196 15,251 938 (67,511) (167,109) (3,862) (2,924) (2,742) 99 (67,413) (198,430) (3,288) (170,139) (199,881) 74 CANON ANNUAL REPORT 2016 Reclassifications out of accumulated other comprehensive income (loss) for the years ended December 31, 2016, 2015 and 2014 are as follows: Years ended December 31 Foreign currency translation adjustments 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 2016 2015 2014 Affected line items in consolidated statements of income 139 (46) 93 — 93 282 (94) 188 194 382 (5,890) 2,049 (3,841) (21) (3,862) (16) 164 148 (49) 99 — — — — — (298) 104 (194) 12 (182) 4,217 (1,180) 3,037 4 3,041 1,504 (175) 1,329 — Other, net — Income taxes — Consolidated net income — Net income attributable to noncontrolling interests — Net income attributable to Canon Inc. (2,509) Other, net 879 Income taxes (1,630) Consolidated net income Net income attributable to noncontrolling interests (2) (1,632) Net income attributable to Canon Inc. 3,260 Other, net (1,248) 2,012 Income taxes Consolidated net income Net income attributable to noncontrolling interests Net income attributable to Canon Inc. See Note 11 Income taxes Consolidated net income Net income attributable to noncontrolling interests (3) 2,009 15,585 (3,710) 11,875 23 — 1,352 11,875 Net income attributable to Canon Inc. Total amount reclassified, net of tax and noncontrolling interests (3,288) 4,211 12,252 *1 Amounts in parentheses indicate gains in consolidated statements of income. 75 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 2016: Foreign currency translation adjustments: Amount arising during the year Reclassification adjustments for gains and losses realized in net income Net change during the year 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) 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) 76 Before-tax amount (108,280) 139 (108,141) 1,184 282 1,466 1,619 (5,890) (4,271) Millions of yen Tax (expense) or benefit 521 (46) 475 (375) (94) (469) (726) 2,049 1,323 (95,707) (16) (95,723) (206,669) 25,204 164 25,368 26,697 Net-of-tax amount (107,759) 93 (107,666) 809 188 997 893 (3,841) (2,948) (70,503) 148 (70,355) (179,972) (56,054) 550 (55,504) 3,249 (298) 2,951 52 4,217 4,269 (13,166) 1,504 (11,662) (60,496) (1,045) 104 (941) (304) (1,180) (1,484) 5,294 (175) 5,119 3,244 2,204 (194) 2,010 (252) 3,037 2,785 (7,872) 1,329 (6,543) (57,252) 144,826 (992) 143,834 6,379 (2,509) 3,870 (3,309) 3,260 (49) (2,225) 879 (1,346) 1,102 (1,248) (146) 4,154 (1,630) 2,524 (2,207) 2,012 (195) (71,166) 15,585 (55,581) 93,066 21,306 (3,710) 17,596 15,112 (49,860) 11,875 (37,985) 108,178 CANON ANNUAL REPORT 2016 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. 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. The compensation cost recognized for these stock options for On May 1, 2010, based on the approval of the shareholders, the years ended December 31, 2016, 2015 and 2014 was nil. A summary of option activity under the stock option plans as of and for the years ended December 31, 2016, 2015 and 2014 is presented below: Outstanding at January 1, 2014 Exercised Forfeited/Expired Outstanding at December 31, 2014 Exercised Forfeited/Expired Outstanding at December 31, 2015 Exercised Forfeited/Expired Outstanding at December 31, 2016 Exercisable at December 31, 2016 Weighted- average exercise price Weighted-average remaining contractual term Aggregate intrinsic value Shares 2,657,400 (67,200) (728,400) 1,861,800 (249,600) (316,200) 1,296,000 — (693,000) Yen 4,245 3,287 4,869 4,036 3,311 3,678 4,263 — 4,500 Year Millions of yen 1.0 28 0.7 248 0.4 — 603,000 3,990 603,000 3,990 0.2 0.2 — — At December 31, 2016, all outstanding option awards were vested. The total fair value of shares vested during the years ended December 31, 2016, 2015 and 2014 was nil. Cash received from the exercise of stock options for the years ended December 31, 2016, 2015 and 2014 was nil, ¥826 million and ¥221 million, respectively. 77 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 2016 2015 2014 Net income attributable to Canon Inc. 150,650 220,209 254,797 Average common shares outstanding Effect of dilutive securities: Stock options Number of shares 1,092,070,680 1,092,017,955 1,112,509,931 — 34,931 4,393 Diluted common shares outstanding 1,092,070,680 1,092,052,886 1,112,514,324 Net income attributable to Canon Inc. shareholders per share: Basic Diluted 137.95 137.95 Yen 201.65 201.65 229.03 229.03 The computation of diluted net income attributable to Canon Inc. shareholders per share for the year ended December 31, 2016 excludes outstanding stock options because the effect would be anti-dilutive. The computation of diluted net income attributable to Canon Inc. shareholders per share for the years ended December 31, 2015 and 2014 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 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 institu- tions and selected by Canon taking into account their finan- cial 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. 78 CANON ANNUAL REPORT 2016 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. 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, 2016 and 2015 are set forth below: December 31 To sell foreign currencies To buy foreign currencies Millions of yen 2016 2015 371,644 228,053 46,741 37,540 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, 2016 and 2015. Derivatives designated as hedging instruments December 31 Balance sheet location 2016 2015 Fair value Millions of yen Assets: Foreign exchange contracts Liabilities: Foreign exchange contracts Prepaid expenses and other current assets 19 373 Other current liabilities 1,913 534 Derivatives not designated as hedging instruments December 31 Balance sheet location 2016 2015 Fair value Millions of yen Assets: Foreign exchange contracts Liabilities: Foreign exchange contracts Prepaid expenses and other current assets 567 1,112 Other current liabilities 7,479 90 79 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 2016, 2015 and 2014. 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 2016: Foreign exchange contracts 2015: Foreign exchange contracts 2014: Foreign exchange contracts 1,619 Other, net 5,890 Other, net (311) 52 Other, net (4,217) Other, net (3,309) Other, net (3,260) Other, net (131) (145) Derivatives not designated as hedging instruments Years ended December 31 Gain (loss) recognized in income on derivative Foreign exchange contracts Location Other, net 2016 7,018 Millions of yen 2015 1,099 2014 (21,728) 18. COMMITMENTS AND CONTINGENT LIABILITIES Commitments At December 31, 2016, commitments outstanding for the pur- chase of property, plant and equipment approximated ¥36,578 million, and commitments outstanding for the purchase of parts and raw materials approximated ¥119,395 million. Canon occupies sales offices and other facilities under lease arrangements accounted for as operating leases. Deposits made under such arrangements aggregated ¥13,128 million and ¥13,561 million at December 31, 2016 and 2015, respec- tively, and are included in noncurrent receivables in the accom- panying consolidated balance sheets. Rental expenses under such operating lease arrangements amounted to ¥42,714 mil- lion, ¥46,483 million and ¥43,215 million for the years ended December 31, 2016, 2015 and 2014, 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, 2016 are as follows: Year ending December 31: 2017 2018 2019 2020 2021 Thereafter Total future minimum lease payments 80 Millions of yen 26,380 18,273 13,543 8,544 6,411 11,794 84,945 CANON ANNUAL REPORT 2016 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 ¥6,056 million at December 31, 2016. The carrying amounts of the liabilities recognized for Canon’s obligations as a guarantor under those guarantees at December 31, 2016 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, 2016 and 2015 are summarized as follows: Years ended December 31 Millions of yen Balance at beginning of year Additions Utilization Other Balance at end of year 2016 14,014 15,403 (12,759) (3,490) 13,168 2015 11,564 18,942 (12,404) (4,088) 14,014 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, 2016 and 2015 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 Long-term debt, including current installments Millions of yen 2016 2015 Carrying amount Estimated fair value Carrying amount (612,538) (612,668) (1,543) Estimated fair value (1,507) 81 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 2016 and 2015, one customer accounted for approximately 12% and 15% 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, 2016 and 2015. December 31 Millions of yen 2016: 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 — 30,500 269 — 12 42,444 — 42,725 — — — 229 74 — 586 31,389 9,392 9,392 — — — — — — — — — 30,500 269 229 86 42,444 586 74,114 9,392 9,392 82 CANON ANNUAL REPORT 2016 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 — 80,870 287 — 12 42,849 — 43,148 — — — 201 52 — 1,485 82,608 624 624 — — — — — — — — — 80,870 287 201 64 42,849 1,485 125,756 624 624 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 identical assets in markets that are not active. Level 3 invest- ments are mainly comprised of corporate bonds, which are val- ued based on cost approach, using unobservable inputs as the market for the assets was not active at the measurement date. Derivative 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 year ended December 31, 2015. There are no changes in Level 3 assets measured on a recurring basis for the year ended December 31, 2016. Years ended December 31 Balance at beginning of year Total gains or losses (realized or unrealized): Included in earnings Included in other comprehensive income (loss) Purchases, issuances, and settlements Balance at end of year Millions of yen 2015 474 — 22 (496) — Assets and liabilities measured at fair value on a nonrecurring basis During the years ended December 31, 2016 and 2015, 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 (MFPs) / Laser printers / Digital production printing systems / High speed continuous feed printers / Wide-format printers / Document solutions 83 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 dis- play) lithography equipment / Digital radiography systems / Diagnostic X-ray Systems / Computed Tomography / Magnetic Resonance Imaging / Diagnostic Ultrasound Systems / Clinical Chemistry Analyzers / Ophthalmic equipment / Vacuum thin- film deposition equipment / Organic LED (OLED) panel manu- facturing 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, 2016, 2015 and 2014 is as follows: Millions of yen 2016: Net sales: External customers Intersegment Total Operating cost and expenses Operating profit Total assets Depreciation and amortization Capital expenditures 2015: Net sales: External customers Intersegment Total Operating cost and expenses Operating profit Total assets Depreciation and amortization Capital expenditures 2014: Net sales: External customers Intersegment Total Operating cost and expenses Operating profit Total assets Depreciation and amortization Capital expenditures Office 1,804,862 2,957 1,807,819 1,638,333 169,486 961,749 78,319 72,189 2,108,246 2,570 2,110,816 1,820,230 290,586 1,020,758 86,206 73,819 2,075,788 2,944 2,078,732 1,786,675 292,057 1,025,499 87,058 69,704 Imaging System Industry and Others Corporate and eliminations 1,094,291 998 1,095,289 950,876 144,413 391,661 47,386 25,564 1,262,667 1,168 1,263,835 1,080,396 183,439 452,283 52,070 38,337 1,342,501 693 1,343,194 1,148,593 194,601 517,524 53,912 31,124 502,334 82,326 584,660 577,212 7,448 545,210 41,053 29,346 429,358 95,293 524,651 537,730 (13,079) 332,252 45,064 24,241 308,963 89,802 398,765 420,566 (21,801) 342,695 37,544 15,976 — (86,281) (86,281) 6,200 (92,481) 3,239,909 83,338 81,280 — (99,031) (99,031) 6,705 (105,736) 2,622,480 89,987 106,733 — (93,439) (93,439) 7,929 (101,368) 2,574,900 84,966 107,956 Consolidated 3,401,487 — 3,401,487 3,172,621 228,866 5,138,529 250,096 208,379 3,800,271 — 3,800,271 3,445,061 355,210 4,427,773 273,327 243,130 3,727,252 — 3,727,252 3,363,763 363,489 4,460,618 263,480 224,760 84 CANON ANNUAL REPORT 2016 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 seg- ment. 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. Operating results of TMSC for the year ended December 31, 2016 and assets of TMSC other than corporate assets at December 31, 2016 are included in Industry and Others Business Unit based on preliminary assessment. Information about product sales to external customers by business unit for the years ended December 31, 2016, 2015 and 2014 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 2016 2015 2014 289,532 386,193 664,846 464,291 328,061 421,209 857,369 501,607 322,398 401,447 862,000 489,943 1,804,862 2,108,246 2,075,788 666,868 329,066 98,357 782,623 362,663 117,381 861,196 366,946 114,359 1,094,291 1,262,667 1,342,501 121,090 381,244 123,887 305,471 90,395 218,568 502,334 429,358 308,963 3,401,487 3,800,271 3,727,252 Information by major geographic area as of and for the years ended December 31, 2016, 2015 and 2014 is as follows: Net sales: Japan Americas Europe Asia and Oceania Total Long-lived assets: Japan Americas Europe Asia and Oceania Total Millions of yen 2016 2015 2014 706,979 963,544 913,523 817,441 714,280 1,144,422 1,074,366 867,203 724,317 1,036,500 1,090,484 875,951 3,401,487 3,800,271 3,727,252 1,163,374 147,129 166,734 164,007 937,716 150,105 183,451 189,588 950,719 157,748 127,700 210,650 1,641,244 1,460,860 1,446,817 85 STRATEGYBUSINESS SEGMENTCORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS / SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS 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 ¥884,083 million, ¥1,047,838 million and ¥938,411 million for the years ended December 31, 2016, 2015 and 2014, respectively. Long-lived assets represent property, plant and equipment and intangible assets for each geographic area. In addition to the disclosure requirements under Topic 280, Canon has disclosed the segment information based on the location of Canon Inc. and its subsidiaries. Results from a sur- vey of a representative sample of financial statement users, however, indicated that they consider the latter to be less use- ful than sales information based on the location where the product is shipped to customers, which is disclosed separately. For this reason, Canon decided to discontinue the disclosure of geographical segment information based on the location of Canon Inc. and its subsidiaries from this year, in order to avoid the risk of confusing users due to disclosing two similar types of geographical information and make disclosure more concise and transparent. SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS Years ended December 31 Millions of yen 2016: Allowance for doubtful receivables Trade receivables Finance receivables 2015: Allowance for doubtful receivables Trade receivables Finance receivables 2014: 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 12,077 2,878 12,122 6,276 12,730 7,323 1,460 398 2,180 55 878 154 (1,824) (978) (1,745) (1,343) (2,236) (1,171) (638) 27 (480) (2,110) 750 (30) 11,075 2,325 12,077 2,878 12,122 6,276 86 CANON ANNUAL REPORT 2016 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 excluded from its assessment of the effectiveness of Canon’s internal control over financial reporting as of December 31, 2016, an assessment of internal control over financial reporting of Toshiba Medical Systems Corporation (“TMSC”), which became a wholly-owned subsidiary of Canon on December 19, 2016. TMSC had total assets of 251.4 bil- lion yen and net sales of 13.6 billion yen for the period from December 19, 2016 to December 31, 2016 that were reflected in Canon’s consolidated financial statements as of and for the fiscal year ended December 31, 2016. Canon’s management assessed the effectiveness of internal control over financial reporting as of December 31, 2016. 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, 2016, 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. 87 CANON ANNUAL REPORT 2016REPORT 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, 2016 and 2015, 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, 2016. 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, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, 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, 2016, 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, 2017 expressed an unqualified opinion thereon. March 30, 2017 88 CANON ANNUAL REPORT 2016REPORT 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, 2016, 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 maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with gener- ally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authori- zations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in con- ditions, or that the degree of compliance with the policies or procedures may deteriorate. As indicated in the accompanying Management’s Report on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Toshiba Medical Systems Corporation, which is included in the 2016 consolidated financial statements of Canon Inc. and subsidiaries and constituted 251.4 billion yen of total assets as of December 31, 2016 and 13.6 billion yen of net sales for the year then ended. Our audit of inter- nal control over financial reporting of Canon Inc. and subsidiaries also did not include an evaluation of the internal control over financial reporting of Toshiba Medical Systems Corporation. In our opinion, Canon Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, 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, 2016 and 2015, 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, 2016, and our report dated March 30, 2017 expressed an unqualified opinion thereon. March 30, 2017 89 CANON ANNUAL REPORT 2016TRANSFER 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, 2017, in Tokyo Further Information: For publications or information, please contact the Public Affairs Headquarters, Canon Inc., Tokyo, or access Canon’s Website at global.canon/en 90 CANON ANNUAL REPORT 2016MAJOR CONSOLIDATED SUBSIDIARIES (As of December 31, 2016) Marketing & Other Canon Marketing Japan Inc. Canon System and Support Inc. Canon Software Inc. Canon IT Solutions Inc. TOSHIBA AMERICA MEDICAL SYSTEMS, INC. Canon U.S.A., Inc. Canon Canada Inc. Canon Solutions America, Inc. Canon Financial Services, Inc. TOSHIBA MEDICAL SYSTEMS EUROPE B.V. 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. TOSHIBA MEDICAL SYSTEMS CORPORATION TOSHIBA ELECTRON TUBES & DEVICES CO., LTD. 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. 91 CANON ANNUAL REPORT 2016C A N O N A N N U A L R E P O R T 2 0 1 6 CANON INC. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan ©Canon Inc. 2017 PUB.BEP026-02 0417

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