Canon Annual Report 2017

Plain-text annual report

CANON ANNUAL REPORT 2017 Fiscal Year Ended December 31, 2017 C A N O N A N N U A L R E P O R T 2 0 1 7 TABLE OF CONTENT S Strategy 1 Financial Highlights 2 To Our Shareholders 9 Growth Strategy Business Segment/ Corporate Structure 18 At a Glance 20 Research & Development 22 Production 24 Sales & Marketing 26 ESG 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: Axis network cameras installed at Malmö station in Sweden Network cameras that can monitor a wide area through their advanced zooming func- tion, watching over people’s safety. FINAN C IAL HIG HL IGHTS Millions of yen (except per share amounts) Thousands of U.S. dollars (except per share amounts) 2017 2016 Change (%) 2017 Net sales Operating profit Income before income taxes ¥ 4,080,015 ¥ 3,401,487 331,479 228,866 353,884 244,651 Net income attributable to Canon Inc. 241,923 150,650 Net income attributable to Canon Inc. shareholders per share: —Basic —Diluted Total assets ¥ 222.88 ¥ 137.95 222.88 137.95 ¥5,198,291 ¥5,138,529 Canon Inc. shareholders’ equity ¥ 2,870,630 ¥ 2,783,129 +19.9 +44.8 +44.6 +60.6 +61.6 +61.6 +1.2 +3.1 $ 36,106,327 2,933,442 3,131,717 2,140,912 $ 1.97 1.97 $ 46,002,575 $ 25,403,805 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 JPY113=U.S.$1, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 29, 2017, 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 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Net Income Attributable to Canon Inc. Shareholders per Share (Yen) ROE/ROA (%) 10 8 6 4 2 0 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Basic Diluted ROE ROA 1 CANON ANNUAL REPORT 2017 TO OUR SHARE HOL DERS FUJIO MITARAI Chairman & CEO Canon Inc. 2 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon will further promote a grand strategic transformation by accelerating reforms. Performance in 2017 enhanced product lineup. In the Imaging System Business Unit, although unit sales of interchangeable-lens digital cam- Looking back at the world in 2017, although politically it was eras declined slightly and sales of digital compact cameras an unstable year with unrelenting turmoil and tension, the were flat year on year, camera sales increased overall due to global economy as a whole continued to expand moderately growth in sales of high-value-added products. Sales of inkjet and stably. Against this backdrop, under our five-year man- printers maintained the same level as the previous year, as agement plan, Phase V (2016 - 2020) of the Excellent Global the trend toward market contraction came to a halt. In the Corporation Plan, the Canon Group strived to thoroughly Medical System Business Unit, sales of computed tomography strengthen the profitability of the existing businesses that (“CT”) systems and diagnostic ultrasound systems were support its business foundation by honing our capabilities on firm due to replacement demand for medical equipment in all fronts, including product competitiveness and sales capa- developed countries and growing medical needs in emerg- bilities. At the same time, we endeavored to strengthen and ing countries. In the Industry and Others Business Unit, sales expand our four new businesses: commercial printing, net- of FPD lithography equipment and Organic LED (“OLED”) work cameras, healthcare and industrial equipment. panel manufacturing equipment grew significantly, as de- Turning to an overview of each business unit, in the Office mand expanded due to active capital investment by panel Business Unit, sales of office multifunction devices (“MFDs”) manufacturers. Sales of network cameras were also robust, were strong, particularly for color devices, and laser printer with demand stemming from heightened crime prevention sales grew thanks to the expanding Chinese market and an concerns as well as the increasingly diverse application of net- Cash Dividend (Yen) work cameras in such fields as marketing support. Consequently, consolidated net sales for 2017 totaled ¥4.08 trillion (an increase of 19.9% year on year), and the gross profit ratio was 48.8%. Despite an increase in op- erating expenses of 15.0% year on year, operating profit amounted to ¥331.5 billion (an increase of 44.8% year on year), and net income attributable to Canon Inc. totaled ¥241.9 billion (an increase of 60.6% year on year). We distributed a record-high full-year dividend of ¥160.00 per share, comprising the interim dividend (¥75.00 per share) and the year-end dividend (¥85.00 per share, comprising an ordinary dividend of ¥75.00 plus a commemorative dividend of ¥10.00 to mark our 80th anniversary). 2009 2010 2011 2012 2013 2014 2015 2016 2017 3 160 120 80 40 0 CANON ANNUAL REPORT 2017Excellent 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 digitalize 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) to B2B. We subsequently reinforced and expanded our rap- idly growing network camera business by making Milestone Canon launched the Excellent Global Corporation Plan in Systems (“Milestone”) a subsidiary in 2014, followed by 1996, and has strengthened its management base through Axis Communications (“Axis”) in 2015. Additionally, Canon each of the plan’s five-year initiatives, from Phase I to Phase IV. Nanotechnologies, formerly Molecular Imprints, became a During Phase I, we stressed thorough cash-flow manage- subsidiary in 2014, and we are accelerating the development ment and significantly boosted productivity through the of next-generation semiconductor manufacturing equipment introduction of our cell production system, along with other that uses nanoimprint lithography, which will make it possible measures. In Phase II, we stepped up efforts to digitalize our to achieve both miniaturization and cost reductions for semi- copying machines and camera offerings, while building the conductor devices. foundation for a robust financial structure. During Phase III, As a manufacturer, Canon strives unceasingly to achieve we actively carried out M&A activities, and welcomed Océ to production reforms and thorough cost reductions. At the the Group in 2010, clearing the way for a move into the com- same time, we stay on top of opportunities to add excellent mercial printing market, which has shown growth potential. companies to the Group, in order to shift our focus towards As the markets for our core businesses—such as cameras changing growth markets, with the aim of unlocking new and office equipment—were maturing, during Phase IV, growth potential. which began in 2011, we promoted diversification via the lateral expansion of our existing businesses—such as the Cinema EOS System and commercial photo printers—while also accelerating our M&A strategy. In this manner, we set a clear direction for shifting our focus for growth from B2C 4 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Phase V (2016-2020) Strategy 1 Key Strategies Establish a new production system to achieve a cost-of-sales ratio of 45% 1 2 3 4 5 Establish a new production system to achieve a cost-of-sales ratio of 45% Reinforce and expand new businesses while creating future businesses Restructure the global sales network in accordance with market changes Enhance R&D capabilities through open innovation Complete the Three Regional Headquarters management system capturing world dynamism We are enhancing productivity via automated toner cartridge production. The year 2016 marked the start of Phase V, our latest five-year Canon’s foundation is made up of our existing businesses, initiative within the Excellent Global Corporation Plan. Under and we must continue to reinforce these businesses within the basic policy of “Embracing the challenge of new growth their maturing markets. We are taking a two-pronged ap- through a grand strategic transformation,” we aim to achieve proach to achieve this: developing and expanding the market net sales of ¥5 trillion, a cost-of-sales ratio of 45% or less, shares of “Dantotsu Products” and thoroughly reducing an operating profit ratio of 15% or more, a net income ratio manufacturing costs. of 10% or more, and a shareholders’ equity ratio of 70% or “Dantotsu Products” refers to products with extraordinary more (based on exchange rates of US$1 = ¥125 and €1 = ¥135) features that cannot be imitated by other companies. In order in 2020, the final year of Phase V. to strengthen our product capabilities, Canon will move for- In 2017, the year in which Canon marked the 80th anni- ward with development by steadily evolving the technologies versary of its founding, we worked to thoroughly bolster the we possess, while accelerating the shift from B2C to B2B in all profitability of existing businesses, while strengthening and areas from development to design, procurement, manufactur- expanding our four new businesses: commercial printing, net- ing, quality management, logistics, sales and services. work cameras, healthcare and industrial equipment. We are engaged in efforts to reduce manufacturing costs in Explanations regarding the progress of the key strategies of all processes, including development, design and procurement. Phase V, as well as our future course of action, are presented We are actively promoting such measures as the utilization of as follows. cutting-edge production and manufacturing technologies— including automation and robotics—in-house production, sharing knowhow between businesses and across the Group, and strengthening collaboration with external entities. 5 CANON ANNUAL REPORT 2017Strategy 2 Strategy 3 Reinforce and expand new businesses while creating future businesses Restructure the global sales network in accordance with market changes CEO Fujio Mitarai (middle) listening to the explanation from Canon Medical President Toshio Takiguchi (left) on the Ultra High-Resolution CT “Aquilion PrecisionTM” introduced at the International Technical Exhibition of Medical Imaging 2017 (Japan). Canon is focusing on e-commerce sites where customers can purchase products online anywhere at any time. With the aim of reinforcing and expanding our four new In order to adapt to our strengthening B2B shift, we are rein- businesses where greater growth is expected—commercial forcing our organization to ascertain customer needs from an printing, network cameras, healthcare and industrial equip- early stage and present optimal solutions by coordinating the ment, Canon has steadily achieved results by leveraging entire process from R&D to production, sales and logistics. As synergies between Group companies. In commercial printing, part of such efforts, we are training highly-skilled sales engi- we are raising our presence by combining the technologies neers who possess in-depth knowledge of both hardware and of Canon and Océ. In network cameras, we are collaborating software and can provide effective consulting. with Milestone and Axis to accelerate product development. We are also focusing on responding to the rapidly expand- We are expanding the breadth of solutions we offer by refin- ing e-commerce market. In China, where growth has been ing our image-analysis technologies in addition to camera especially rapid, we are steadily increasing the e-commerce performance. In healthcare, we are pursuing further growth ratio of Canon China’s consumer-oriented business. At Canon by combining the technologies possessed by Canon with U.S.A., we are concentrating on providing limited-edition and those of Canon Medical Systems (“Canon Medical”), which customized products and strengthening services and support changed its company name from Toshiba Medical Systems in order to significantly increase e-commerce sales. (“TMSC”) as of January 4, 2018. In industrial equipment, we are striving to achieve thorough cost reductions while estab- lishing an innovative manufacturing approach with regard to the manufacturing equipment handled by Canon Tokki, Canon ANELVA and Canon Machinery. 6 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Strategy 4 Strategy 5 Enhance R&D capabilities through open innovation Complete the Three Regional Headquarters management system capturing world dynamism Canon engages in medical research collaboration with Harvard-affiliated medical institutions (Healthcare Optics Research Lab, Canon U.S.A., United States) R&D on high-speed cut-sheet inkjet printers (Océ, Netherlands) With R&D representing a rising share of expenses in recent With global headquarters in Japan, the United States and years, Canon will promote the selection and concentration of Europe, Canon aims to establish a system that promotes research themes and carry out more efficient R&D investment. global development through diversification by leveraging the In preparation for the coming age of the Internet of Things unique features of each region. (“IoT”), we are pursuing open innovation that utilizes external Canon U.S.A.’s Healthcare Optics Research Laboratory is expertise and technology as necessary to accelerate the pace collaborating with Massachusetts General Hospital (“MGH”) of development. For example, Canon is a partner in a basic and Brigham and Women’s Hospital (“BWH”), both teaching research consortium organized by IBM in which we are col- affiliates of Harvard Medical School, on the development of laborating on cutting-edge technology programs in such areas an ultra-miniature endoscope that can make possible direct as artificial intelligence (“AI”), big data and sensing. Canon examination and diagnosis in anatomies that have previously researchers are dispatched to R&D centers in order to acceler- been inaccessible, as well as a guided needle insertion system ate the creation of practical applications. We are also engaged that assists with the insertion of needles in patients by guiding in joint development programs for photoacoustic tomogra- a needle to a precise position and depth. phy in cooperation with Kyoto University and Keio University In Europe, our collaboration with Océ has enabled us to ex- and we are continuing to pursue collaboration with industry, pand the scope of our commercial printing business to cover government and academic partners in order to accelerate a variety of fields. Furthermore, many new synergies are being technological innovation. created as Canon and Océ integrate our sales networks and Furthermore, as software becomes increasingly important in provide various products and services. bringing out the full potential of a product and for providing various services, we are training highly-skilled software engi- neers with a focus on trends in AI and IoT technologies. 7 CANON ANNUAL REPORT 2017Key Challenges for 2018 In Conclusion Our basic policy for 2018 is to “Pursue total optimization and Since launching Phase I of the Excellent Global Corporation profitability to complete our grand strategic transformation,” Plan in 1996, Canon has built a strong financial founda- as we work on the following six key challenges. tion and successfully weathered the 2008 financial crisis The first of these is to strengthen our research capabilities in and numerous other difficulties, including exchange rate the world’s leading-edge technologies. We aim to strengthen fluctuations, guided by our commitment to pursuing total our investigation and analysis abilities to accurately grasp optimization and profitability. Today, we are in the midst of a global trends that contribute to our strategic initiatives. digital revolution in which the dramatic development of IT has The second is to strengthen our product development ushered in the age of IoT, known as the fourth industrial revo- capability. We will accelerate the selection and concentration lution. We are now confronted with the question of how to of research themes as well as the pursuit of open innovation. respond to this profound transformation of society. In addition to implementing prototype-less design, product The global economy in 2018 is generally expected to con- design optimized for robotic assembly and standardized tinue a trend toward gradual recovery. In that environment, product platforms, we will also strengthen our software we will return to a policy of total optimization and profit- development capability. ability to take Canon to the next level as an excellent global The third challenge is to comprehensively reinforce our corporation. manufacturing abilities. In addition to building a glob- We look forward to your continued understanding ally optimized manufacturing system, we will promote our and support. mother plant concept that integrates development, produc- tion technology and manufacturing. We will also thoroughly implement cost reduction measures, including for new busi- nesses, through strengthening in-house production of key components, generic parts and production equipment. The fourth is to thoroughly strengthen our strategic pro- curement functions. In addition to accelerating a global procurement network, we will promote component sharing, adoption of generic parts and in-house production. The fifth is to reform our sales organization to reflect mar- ket changes. We will enhance the capabilities of our global sales engineers, bolster local service support systems and opti- mize such sales channels as e-commerce. Our sixth challenge is to establish human resource policies that evolve with changing times. We aim to create a person- nel system and human resources training system that will open up diverse career paths. 8 Fujio Mitarai Chairman & CEO Canon Inc. CANON ANNUAL REPORT 2017 G R O W T H S T R AT E G Y CANON ANNUAL REPORT 2017 9 COMME RCI AL PR INTING The Océ VarioPrint i300 sheet-fed inkjet color press, which is a high-speed commercial printer, uses Océ’s unique paper transport technology to achieve stable, high-speed output. Océ’s proven technologies enable printing on a range of media, including coated paper, to meet diverse needs in commercial printing. (Customer Experience Center Venlo, Netherlands) 10 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Aiming to become the world’s No. 1 printing company in a commercial printing market that is becoming increasingly digitized. The shift in demand towards digital printing is accelerating the continuous feed printer, Océ ProStream 1000, aiming for the growing graphic arts market, where items such as The commercial printing market, encompassing newspapers, catalogs demand high image quality. This digital system has magazines and books, promotional catalogs and flyers, and attracted attention for providing the same high level of image transaction printing such as statements and invoices, has quality and productivity as in offset printing. In April 2017, long been dominated by offset printing, which offers superb Canon opened the Customer Experience Center Tokyo at our quality, low cost, and high speed printing of large-volume Shimomaruko headquarters. This center, which is the fourth publications. However, the field of digital printing, which can large facility worldwide for equipment demonstrations and print straight from data without the use of plates, has contin- inspections, allows commercial printing businesses to experi- ued to expand since the 1990s. In particular, in recent years ence Canon’s leading digital printing solutions. the diversification and segmentation of commercial printing With a wide-ranging product lineup, Canon has been lay- needs, including production of a broader range of applica- ing the groundwork to become the world’s No. 1 printing tions requiring shorter turnaround times, has propelled the company since its entry into the commercial printing market. shift to digital printing. We will continue seeking business growth by further pursu- Digital printing needs are also growing in the industrial ing new possibilities in the digital printing market, which printing market, including printing on non-paper materials is expected to encompass various fields, including package such as ceramic, glass, and plastic, as well as 3D printing, printing and industrial printing, which involves printing on which involves applying hundreds of layers of ink. non-paper materials. To be the world’s No. 1 printing company Canon made a full-fledged entry into the commercial print- ing market in 2006, based on the core technologies it had accumulated in printer development since the development of the copy machine in the 1960s. In 2010, we welcomed the Dutch company, Océ into the Canon Group. Océ is a printer manufacturer with a history spanning 140 years. Its high- productivity printers are highly regarded for black-and-white printing jobs in the fields of invoices, direct mail, and pub- lishing. Océ’s high-speed continuous-feed printers make it a strong contender in the European and U.S. markets. Currently, we are generating new synergies for growth, including the introduction of Océ’s print controller into Canon’s printing systems. In February 2017, Océ announced At the Customer Experience Center Tokyo, customers can bring in their print data and have it verified. (Shimomaruko Headquarters, Canon Inc., Japan) 11 CANON ANNUAL REPORT 2017NETWORK CAMER AS Canon network cameras play a role in enabling optimal video stream at high resolution and definition 24 hours a day at an aircraft maintenance center. 12 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Responding to demand for network cameras used in all sorts of settings through rapidly expanding solutions business Rapid growth by expanding the scope of solutions multiple cameras are coordinated, requires video manage- ment software that provides centralized management of The network camera industry continues to expand due to high-resolution images. In 2014, Canon welcomed Milestone, rising security concerns worldwide. In the era of the IoT, the leading provider of video management software for video network cameras are evolving as a means of visualizing real- images captured by network cameras, into the Group. Canon time information based on higher performance cameras and and Milestone are striving to develop video analysis technolo- sophistication in image analysis technologies, along with AI gies. We are also proposing innovative solutions that combine technologies. As a result, the scope of solutions businesses Canon’s high-sensitivity, high-resolution differentiated cam- using network cameras is spreading in all sorts of settings, eras with image analysis software capable of counting people including stores and commercial facilities, factories, healthcare and identifying physical attributes. and nursing care, sports and other events, and transportation. Canon’s aim is to provide innovative network imaging Becoming an innovative network imaging solutions company solutions that integrate Axis’s network image processing tech- nology and Milestone’s video management technology with Canon’s proprietary imaging technology. Network cameras are Based on the camera and camcorder technologies Canon evolving for a growing range of applications that will support has cultivated since our foundation, we have been producing a safe and secure future. the cameras for the purpose of security and surveillance. We formally established our network camera business in 2013, and welcomed Axis into the Group in 2015. An outstanding range of network image processing technologies enables Axis to offer solutions to more than 90,000 partner companies in 180 countries and regions. Canon and Axis collaborate in the areas of product development, service, and support, while striving to improve efficiency, and in April 2017 we launched our first jointly developed product, the AXIS Q1659 inter- changeable-lens network camera. The AXIS Q1659 employs eight different interchangeable lenses for EOS-series cameras, ranging from wide-angle to telephoto, which can be used to satisfy a wide range of monitoring needs in environments such as airports and stadiums. Taking maximum advantage of network cameras, in which Axis network cameras protect the safety of people in Yokohama, one of the largest cities in Japan. 13 CANON ANNUAL REPORT 2017HEALTHCAR E Canon Medical’s 320-row detector, Aquilion ONETM, which achieves wide-area, high-speed imaging with low radiation exposure and high image quality, is widely used for the diagnosis of cerebral aneurysms and cancer. (Fujita Health University Hospital, Japan) 14 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Expanding our healthcare business centered on Canon Medical Dramatically growing healthcare industry due to population growth and aging societies Canon Medical holds the top market share position in Japan and maintains high market share globally. In April 2017, The healthcare industry, which comprises the field of health, Canon Medical carried out the domestic launch of Aquilion including health promotion, disease prevention, and nursing PrecisionTM, a high-precision CT scanner that delivers substan- care, and the field of medicine, including testing, diagnosis, tially higher resolution than ever before. In the future, through treatment, and rehabilitation, represents a growing market synergies generated from the strengths of Canon and Canon driven by the growing global population and the aging of Medical in manufacturing technology and sales networks, we societies. This market is expected to expand dramatically, will aim to create new value in medical care. increasing from ¥16 trillion in 2013 to ¥37 trillion in 2030 The Healthcare Optics Research Lab at Canon U.S.A. has in Japan, and from ¥163 trillion to ¥525 trillion overseas. been steadily pursuing research on ultra-miniature endo- According to the Ministry of Economy, Trade and Industry, the scopes and medical robotics, including a needle guidance global market for medical equipment continues to grow at system, based on open innovation. a rate of 8% per year, and is expected to be worth approxi- Through synergies with Canon Medical and integrated mately $450 billion (roughly ¥50 trillion) in 2018. medical operations spanning from R&D to sales in the United States, we will continue to provide total solutions for the needs of today’s medical facilities and better healthcare for the future. Expanding the scope of our healthcare business Canon entered the healthcare business in 1940 with the devel- opment of Japan’s first indirect X-ray camera. Since that time, we have continued to support new areas of advanced medical care through the development of products such as digital radi- ography equipment and ophthalmic equipment, based on our proprietary optical and image processing technologies. In 2016, Canon welcomed TMSC, a leading manufacturer of medical equipment, into the Group, and in January 2018 changed the company’s name to Canon Medical. Canon Medical has a broad product portfolio that spans diagnostic X-ray systems, X-ray computed tomography (“CT”) systems, magnetic resonance imaging (“MRI”) systems, diagnostic ultrasound systems, diagnostic nuclear medicine systems, and medical sample testing systems. In the CT market, Research has been pursued on the needle guidance system, which assists physicians to insert a needle accurately into the targeted location of internal organ. (Healthcare Optics Research Lab, Canon U.S.A., United States) 15 CANON ANNUAL REPORT 2017INDU ST RI AL E QUIPMENT Canon Tokki produces OLED panel manufacturing equipment with unrivalled technology required for advanced manufacturing equipment, including vacuum evaporation equipment for depositing organic materials onto panel substrates and automated supply lines for glass substrates. Canon Tokki continues to be the industry leader. 16 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Seeking new growth with industrial equipment that support manufacturing and achieve innovation Industrial equipment enters a new era of growth in the fourth industrial revolution meet the needs of the times, based on its proprietary ultra- high vacuum technology and thin-film deposition technology. With the arrival of the fourth industrial revolution, the indus- Canon Machinery boasts the top domestic market share for trial equipment field has entered a new era of growth in areas its die bonders, a device which attaches dies (individual semi- such as semiconductor manufacturing equipment and organic conductor chips printed with circuits) to substrates. In 2017, LED (“OLED”) panel manufacturing equipment. In particular, Canon Machinery began expanding its Malaysia plant in order demand for OLED panels is growing rapidly for devices such to strengthen its production system by further enhancing as smartphones and TVs, due to advantages such as thinness, production capacity. Canon Machinery develops and produces light weight, low power consumption, and ability to produce customized automation and labor-saving equipment, such as vibrant colors. Expectations are high for OLED panels in terms automotive component assembly equipment and assembly of applications, including the capability to be bent, and in the equipment for secondary batteries for electric vehicles, which future, folded. are expected to see rapid growth in the future. Leading the industry in OLED panel manufacturing equipment Canon, together with Canon Tokki, Canon ANELVA, and Canon Machinery, will continue to aim for high growth in the industrial equipment field by leveraging group synergies Canon supports the growth of manufacturing and industry through collaboration in areas such as manufacturing by applying proprietary technologies that we have developed technology, procurement, and personnel support. over many years to the creation of industrial equipment. Canon Tokki, Canon ANELVA, and Canon Machinery play key roles in meeting the needs of a wide range of industries, from semiconductor manufacturing equipment to OLED panel manufacturing equipment. Canon Tokki’s OLED panel manufacturing equipment leads the industry, setting the standard worldwide. In 2017, we sig- nificantly increased production of OLED panel manufacturing equipment due to a rapid increase in demand for OLED panels used in smartphones. Orders were so strong we were nearly unable to keep up. This contributed significantly to substantial sales growth in industrial equipment in 2017. Canon ANELVA engages in the development, manufactur- ing, and sales of vacuum thin-film deposition equipment that In order to meet the needs of miniaturized semiconductor devices, Canon ANELVA is proceeding with the development of sputtering equipment based on thin-film deposition technologies. 17 CANON ANNUAL REPORT 2017OFFICE BUSINESS UNIT Composition of Sales (%) Office multifunction devices (MFDs) Laser multifunction printers (MFPs) 45.7% Main Products • Office multifunction devices (MFDs) • Laser multifunction printers (MFPs) • Laser printers • Digital production printing systems • High speed continuous feed printers • Wide-format printers • Document solutions Digital production printing systems High speed continuous feed printers IMAGING SYSTEM BUSINESS UNIT Composition of Sales (%) 27.8% Main Products • 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 Interchangeable-lens digital cameras —Digital SLR cameras Interchangeable-lens digital cameras —Compact-system cameras Inkjet printers Large format inkjet printers 18 CANON ANNUAL REPORT 2017AT A GLANCESTRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Composition of Sales (%) MEDICAL SYSTEM BUSINESS UNIT 10.7% Main Products • Diagnostic X-ray systems • Computed tomography • Magnetic resonance imaging • Diagnostic ultrasound systems • Clinical chemistry analyzers • Digital radiography systems • Ophthalmic equipment Composition of Sales (%) 17.9% Main Products • Semiconductor lithography equipment • FPD (Flat panel display) lithography equipment • Vacuum thin-film deposition equipment • Organic LED (OLED) panel manufacturing equipment • Die bonders • Micromotors • Network cameras • Handy terminals • Document scanners Computed tomography Magnetic resonance imaging Diagnostic ultrasound systems Digital radiography systems INDUSTRY AND OTHERS BUSINESS UNIT Semiconductor lithography equipment FPD (Flat panel display) lithography equipment Organic LED (OLED) panel manufacturing equipment Network cameras Note: The percentage figures for the four 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. 19 CANON ANNUAL REPORT 2017RE SE AR CH & D EV ELOPMEN T A B 2017 Top Ten U.S. Patent Holders by Company IBM* Samsung Electronics CANON Intel LG Electronics Qualcomm Google Microsoft Technology Licensing Taiwan Semiconductor Manufacturing Samsung Display 3,285 3,023 2,701 2,628 2,457 2,441 2,425 2,273 9,043 5,837 *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. Our photoacoustic tomography (“PAT”), which can capture 3-D images of blood vessels in a human hand, for example, is expected to be applied to diagnostic imaging. Clinical research for PAT technology is currently being carried out in collaboration with Kyoto University and Keio University. (Kyoto University, Japan) B. CE-SAT-I, a microsatellite developed by Canon Electronics, was loaded on a rocket launched by the Indian Space Research Organization (“ISRO”). (Satish Dhawan Space Center, India) 20 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon is engaged in efforts to discover new technologies that will help create future businesses R&D Expenses and Patents blood vessels using a pulse laser and ultrasonic sensors, with- Canon is bolstering R&D activities to enable the ongoing out the use of X-rays or contrast agents. In the healthcare field, development of innovative products and services. In the year where further growth is expected, TMSC was welcomed into under review, R&D expenses amounted to ¥330.1 billion, up the Canon Group in 2016. In addition to introducing Canon’s 9.2%, or ¥27.7 billion, from the previous year. The ratio of advanced production technologies, including precision design R&D expenses to net sales was 8.1%. and microfabrication technologies, to the new company, we This focus on R&D activities has cemented Canon’s high will use our original high-speed X-ray imaging sensors and status in the field of intellectual property. In 2017, Canon was new technologies such as PAT to develop highly innovative granted 3,285 patents in the United States, ranking it third in next-generation medical equipment. the world and the top ranked Japanese company for a thir- Free Viewpoint Video System teenth consecutive year. Canon is developing its Free Viewpoint Video System, a new visual solution that incorporates the optical and sensor Initiatives to Establish New Businesses technologies cultivated by the Company over many years. Canon has a long-term perspective as it concentrates its ef- The system comprises several high-resolution cameras set up forts on discovering new technologies for the future. around a stadium, which are connected to a network and CMOS Sensors controlled via software to capture a game from multiple view- Canon is conducting in-house development and production points. The video is rendered as high-resolution 3-D spatial of CMOS sensors, a key device in interchangeable-lens digital data. By achieving a new video experience that gives users a cameras. We are developing our proprietary ultra-high- sense that they are really at a sporting event, etc., Canon is resolution 250 megapixel CMOS sensors that make it possible expanding the boundaries of visual expression and contribut- to capture images of the lettering printed on the body of an air- ing to the development of video culture. plane roughly 18 kilometers away and ultra-high-sensitivity 35 Space Exploration mm full-frame CMOS sensors capable of capturing vivid images Canon is also conducting proprietary development in fields in color even in extreme low-light conditions. We anticipate related to space exploration. As a participant in the Thirty various applications for security, dashboard cameras, healthcare Meter Telescope (“TMT”) project to build an extremely large and space observation. We are also developing global shutter- telescope in Hawaii, Canon is involved in processing of the equipped CMOS sensor that can capture distortion-free images primary mirror, which demands an exceptional level of preci- even when shooting fast-moving objects. We are putting in sion. Meanwhile, Canon Electronics has used its technologies place a system for external sales to industrial fields. originally cultivated for cameras and printers to develop a Photoacoustic Tomography proprietary microsatellite, which was mounted on a rocket Canon participates in the Impulsing Paradigm Change through launched by the Indian Space Research Organization (“ISRO”) Disruptive Technologies (“ImPACT”) Program organized by the in 2017. Images captured by the camera attached to the micro- Cabinet Office of Japan. We are working on research in photo- satellite are expected to provide valuable information in a wide acoustic tomography (“PAT”) that can capture 3-D images of range of areas including agriculture and disaster response. 21 CANON ANNUAL REPORT 2017PR ODUC TION A B C A. In inkjet printer production, Canon seeks to raise the bar in high-quality product manufacturing while striving to improve production efficiency. (Canon Hi-Tech (Thailand), Thailand) B. With one of the largest semi-anechoic chambers in Japan, Canon conducts certification testing on large-scale products such as commercial printing systems using in-house facilities. (Tamagawa Office, Canon Inc., Japan) C. At Japan’s National Skills Competition in 2017, our technicians entered the Mechatronics category. Canon has won prizes in this technical contest for thirteen successive years since 2005. 22 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Canon aims to establish a new production system that achieves a cost-of-sales ratio of 45% through the evolution of our manufacturing capabilities Globally Optimized Production Human Resources for Manufacturing Canon has established a globally optimized production sys- Canon provides human resource training to nurture the tem in which we determine production locations based on a skills of employees at our production sites worldwide. Our comprehensive analysis of costs, taxes, logistics, procurement, programs teach manufacturing techniques and craftsman- labor and other factors. In Japan, we are promoting automa- ship—including hands-on practice—and educate employees tion technology in order to increase production. In the United with leadership potential in Canon management methods. States and Europe, we are accelerating the localized produc- To hone the technical skills of our employees in Japan, we tion of consumables. And in labor intensive manufacturing participate in Japan’s National Skills Competition. The spirit sites, we are boosting productivity by honing our employees’ of challenge that we cultivate through such activities can be skills. We aim to maximize the strengths of each region to found at Canon manufacturing sites around the world. produce high-quality products. To advance our manufacturing, Canon honors our most Automation and In-house Production nize employees who have contributed to Canon production Seeking to produce original products, Canon actively pro- through their skills and knowledge of assembly and com- motes in-house production of key devices and components ponent processing. These employees are awarded the title such as CMOS sensors, manufacturing equipment such as Meister. Employees who display transcendent skills earn the skilled technicians. At our factories worldwide, we recog- automated assembly machines and high-precision processing title Master Craftsman. machines, as well as molding dies. To produce high-quality products at efficient costs, we strive to maintain highly reliable automated production lines. We have been introducing fully Environmentally Friendly Manufacturing; Enhanced Product Quality automated production for toner cartridges. Now we are pur- From product design and development, to production, logistics, suing full automation for the manufacturing of our cameras, product use and recycling, throughout the product’s lifecycle in too. In 2016, we established the Techno Wing R&D facility at all areas of our business, Canon is engaged in manufacturing ini- Oita Canon, as a hub for pursuing superior manufacturing tiatives that are friendly to the global environment and minimize and product technologies. Our aim is to fully automate manu- environmental impact. facturing of digital cameras. Canon has established a quality management system that Furthermore, Miyazaki Canon has decided to establish a combines the requirements of ISO9001, an international quality new production site for digital cameras, which is scheduled management standard, with work mechanisms unique to Canon to begin operations in 2019. By applying the full-automation to ensure that our products are safe, can be enjoyed with peace technology developed at the Techno Wing to the new facility of mind, and provide satisfaction to our customers. In addition to in Miyazaki and other production sites, we aim to establish a thoroughly implementing operations in accordance with quality highly efficient manufacturing system. standards, certifications, and related laws and regulations of various countries around the world, we carry out strict evaluations using cutting-edge testing facilities that are at the forefront of the industry. 23 CANON ANNUAL REPORT 2017SALES & M ARKETING A B C A. The Océ Colorado 1640 printer, built on Canon UV gel technology, proved to be one of the star digital innovations of the FESPA 2017, pulling in large crowds to hourly demonstrations. B. The recently established “Professional Technology & Support Center” in Burbank provides comprehensive support services for video production equipment professionals. C. Activity exhibited at industry events with an eye to expand B2B business. Canon China displayed at a business exhibition for government institutions in Beijing. 24 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Accelerating growth in commercial printing, network cameras, healthcare and industrial equipment as key drivers of Canon’s next-generation business Japan printer for the signage and graphics industry. To further ex- Sales in Japan amounted to ¥884.8 billion, or 21.7% of con- pand operations in emerging markets, a new innovation centre solidated net sales. was opened in Dubai to help foster local talent and business. Performance was strong for products including hardware We continued structural reform efforts and also made a lot of such as MFPs, consumables, and IT solutions as capital invest- progress in furthering our customer-centric approach. ment by companies in Japan picked up. In the security business, sales of surveillance cameras, software and other products con- Asia and Oceania tinued to increase. In industrial equipment, sales and service of Sales in Asia and Oceania amounted to ¥1,059.3 billion, or equipment for semiconductor manufacturers were favorable, 26.0% of consolidated net sales. backed by brisk investment by customers. Regarding products As an Asia-wide initiative, we are promoting expansion of for consumers, while sales of mirrorless cameras were up, sales B2B business with the launch of a project aimed at strength- of inkjet printers declined due to a shrinking market. ening the sales and brand of copiers and commercial printers. The Americas Six of our sales companies in Asia marked anniversaries in 2017, including the 20th anniversary of Canon China and Sales in the Americas amounted to ¥1,107.5 billion, or 27.1% the 45th anniversary of Canon Hongkong. Commemorative of consolidated net sales. events and sales promotion activities were held in many areas. In the office equipment market, we reinforced our sales The efforts contributed to an increase in sales in the Asia network by developing a system that can better support and region. In Oceania, Harbour IT and Converga, which have manage our approximately 400 dealers across the Americas. recently joined the Canon Group, conducted cross-selling to We also brought together our comprehensive support and approach each other’s customers. services for professional video-production equipment at a strategic hub in Burbank, California, near Hollywood. We also began offering our “Next Day” repair services for professional Composition of Sales by Region photographers, the first initiative of its kind for the industry, and it was met with a favorable response. Europe (Europe, Middle East, Africa) Sales in Europe amounted to ¥1,028.4 billion, or 25.2% of consolidated net sales. Canon in EMEA maintained their leading position in Imaging System thanks to solid sales of interchangeable-lens cameras. Additionally, through strategic acquisitions, we strengthened the imaging ecosystem for consumers. In the B2B area, we enhanced business through the launch of a new wide-format Asia and Oceania 26.0% ¥1,059.3 billion Japan 21.7% ¥884.8 billion Net Sales ¥4,080.0 billion The Americas 27.1% ¥1,107.5 billion Europe 25.2% ¥1,028.4 billion 25 CANON ANNUAL REPORT 2017ESG ESG Environment Social E S G Governance In recent years, the ethical role of corporations has increased with the ideals laid out in the Sustainable Development Goals in importance amid wide-ranging societal expectations and (“SDGs”) adopted by the United Nations in 2015. As members responsibilities. Canon adopted kyosei as its corporate phi- of society, high expectations are being placed on corporations. losophy in 1988, and since then we have worked to fulfill our Accordingly, we will contribute to society by leveraging our responsibilities to society and build solid relationships not only technological capabilities to create new value, resolve social with our customers and business partners, but also with coun- issues, and engage in activities to preserve and protect the tries, communities, nature, and the global environment. The global environment, while continuing to be a company that approach we take with our corporate philosophy harmonizes always gives due consideration to people and society. Environment: Social: Governance: Canon’s Approach Canon’s Approach Canon’s Approach Based on the Canon Environmental Vision, Canon is working to reduce envi- ronmental burden throughout the entire product lifecycle, from procurement of raw materials and parts to collection and recycling of used products, in an effort to realize a society that promotes both enriched lifestyles and the global environment. Canon makes sincere efforts to engage in corporate social responsibilities, in- cluding product safety, human rights, labor management, and accountable procurement activities. In addition, as a good corporate citizen, we promote efforts such as disaster relief and sup- port for culture, and also work to resolve social issues through our technology and business activities. Canon maintains sound corporate gov- ernance as part of efforts to maximize its shareholders’ value and become a truly excellent global corporation. Key Activities Key Activities Key Activities • Contributing to a Low-Carbon Society • Promoting Diversity • Contributing to a Circular Economy • Addressing the Issue of Conflict • Eliminating Hazardous Substances and Minerals Preventing Pollution • Supporting Art and Culture • Board of Directors, Audit & Supervisory Board, Non-statutory Committees • Constructive Dialogue with Shareholders • Contributing to a Society in Harmony with Nature For details, please refer to the Canon Sustainability Report. http://global.canon/en/csr/report/index.html 26 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA ENVIRONMENT Canon is implementing the Canon Bird Branch Project, which examines the cycle of life by focusing on birds as a symbol of the ecosystem pyramid. The Shimomaruko Forest, a lush expanse of green space occupying about 30% of Canon’s headquarters site in Tokyo, plays host to bird watching parties, research studies, and ecosystem monitoring events as part of this project. Canon’s Toride Plant, Susono Plant, and Kawasaki Office, as well as Oita Canon’s Oita Plant and Canon Research Centre France are also engaged in these efforts, expanding the activities globally. Canon is working towards the goal of achieving a 3%-per- year improvement in lifecycle CO2 emissions per product. Eliminating Hazardous Substances and Preventing Pollution From 2008 to 2017, we have achieved an average improve- Canon strictly manages chemical substances in products in ment of around 5% per year. line with Canon Green Procurement Standards, as well as Contributing to a Low-Carbon Society proactive contributions to the establishment of international Canon has been promoting improvements in CO2 efficiency at frameworks for the appropriate management of chemical those used in manufacturing processes. Additionally, we make all stages of the product lifecycle: manufacture of raw materi- substances in the supply chain. als and parts, operational site activities, logistics and customer use of products. Contributing to a Society in Harmony with Nature Contributing to a Circular Economy Based on the Canon Biodiversity Policy, Canon is promoting In order to achieve more efficient use of resources, Canon conservation and protection activities around the world. One pursues advanced resource circulation through product- such activity is the Canon Bird Branch Project, which encour- to-product recycling, and is carrying out remanufacturing ages consideration of “the Cycle of Life” by focusing on birds of multifunction devices and closed-loop recycling of toner as a symbol of the top of the local ecosystem pyramid. cartridges. We are also actively promoting initiatives such as designing more compact products. 27 CANON ANNUAL REPORT 2017ESG SOCIAL The Tsuzuri Project has been creating high-resolution reproductions such as “Tatars Playing Polo and Hunting” attributed to Kano Soshu (photo, top) and “Landscape of the Four Seasons” by Shikibu Terutada. The two original pieces have been stored at the Asian Art Museum of San Francisco, and with the museum’s cooperation, the reproductions were finished and donated to the Kyoto National Museum in June 2017. The Project brings high-resolution facsimiles of Japanese cultural assets, that have been sent overseas, back to Japan and it donates reproductions to art museums, shrines, and temples, where they are displayed to the public, and at schools as living educational aids for teaching history. In such ways, the Project provides people with opportunities to experience Japan’s outstanding art and culture firsthand. Promoting Diversity on the Company’s website. Canon is a member of the Canon is committed to diversity of human resources. We wel- Responsible Minerals Initiative (“RMI”), an international come people of all types—irrespective of race, gender, age, program that plays a leading role in response to the issue of customs, and value perceptions—and deploy such differences conflict minerals, and continues to support industry activities. to foster our growth as an organization. Since 2012, we have engaged in in-house projects fostering diversity. In 2017, Supporting the Arts and Culture Canon held meetings with Group company presidents at 24 As a company that contributes to the development of visual Group companies in Japan organized by the VIVID diversity culture, Canon engages in activities to foster the richness of promotion program, where they promoted activities to enable human feelings and emotions. In 2007, Canon and the Kyoto more active roles for women in the workplace Group-wide. Culture Association (“NPO”) launched the Tsuzuri Project (of- Addressing the Issue of Conflict Minerals This initiative combines Canon’s latest digital technologies Seeking to ensure that customers can use Canon products with traditional Japanese craft techniques to create high-reso- with peace of mind, Canon conducts inquiries into conflict lution reproductions of Japanese cultural assets and use them minerals every year and discloses its findings to the U.S. effectively. As of March 2018, 35 works have been donated. ficially known as the Cultural Heritage Inheritance Project). Securities and Exchange Commission and publishes them 28 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA GOVERNANCE At a monthly company-wide meeting of executive officers, the CEO provides updates on earnings progress and important matters to implement in the future as a way to share crucial information. Fundamental Policy business fields, including office equipment, consumer products, In order to establish a sound corporate governance structure medical equipment, and industrial equipment, and aims to ag- and continuously raise corporate value, Canon believes that gressively expand into new business fields in the future. In order it is essential to improve management transparency and to make prompt decisions in each business field, and make strengthen management supervising functions. At the same important decisions for the entire Canon Group or matters that time, a sense of ethics and mission held by each executive and straddle several business fields from a company-wide perspec- employee of Canon is very important in order to achieve con- tive and at the same time secure appropriate decision making tinuous corporate growth and development. Details of Canon and execution of operation, the Company judges the corporate Inc.’s corporate governance structure are available on the governance structure below to be effective. Company’s official website under “an overview of Corporate Board of Directors Governance at Canon Inc.” While the focus of the organizational structure of the Board of (http://global.canon/en/ir/strategies/governance.html). Directors is on Representative Directors that oversee Company- Governance Structure Fundamental Policy wide business strategies or execution such as the CEO, COO, CFO, CTO, and Representative Directors or Executive Directors that oversee multiple business fields or headquarters functions, in The Company is globally expanding its businesses in various order to secure sound management, two or more Independent 29 CANON ANNUAL REPORT 2017ESG GOVERNANCE Outside Directors are appointed. The Board of Directors, in accor- Independent Outside Audit & Supervisory Board Members dance with laws and regulations, makes important decisions and that have extensive knowledge in specialized areas such as supervises the execution of duties by officers. law, finance and accounting. The Audit & Supervisory Board, Except for the above, the CEO and other Representative which is composed of these individuals, cooperates with the Directors are active in decision making and execution, and Company’s accounting auditors and internal audit division, under the command and supervision of the Representative oversees the status of duty execution of operations and cor- Directors, Executive Officers that are elected through resolu- porate assets to secure the soundness of management. tion of the Board of Directors make decisions and execute The Audit & Supervisory Board consists of five individuals, operations of each business field or function. three of which are Independent Outside Audit & Supervisory The Board of Directors consists of seven members, five Board Members. In accordance with auditing policies and Representative Directors from inside Canon and two Outside plans decided at Audit & Supervisory Board meetings, Directors that qualify as Independent Directors*. As of April the Audit & Supervisory Board Members attend Board of 1, 2018, there will be 36 Executive Officers, including two fe- Directors’ meetings, Corporate Strategy Committee meetings, males and one non-Japanese. etc., receive reports from directors and employees, review * Independent directors: Stock exchanges in Japan require listed companies to appoint out- side 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 busi- ness partners, consultants who receive large remunerations from the company, and their close relatives cannot be selected as independent directors. Audit & Supervisory Board documents related to important decisions, and conduct audits by investigating etc. the situation of businesses and property of the Company and its subsidiaries. In this way, the Audit & Supervisory Board conducts strict audits of directors’ ex- ecution of duty, including the status of development of the As a body which is in charge of the audit of operations, internal control system. under the principles of autonomy, which is independent Procedures in the Nomination of Directors etc. from the Board of Directors, the Company has full-time The Company established the “Nomination and Remuneration Audit & Supervisory Board Members that are familiar with Advisory Committee,” a non-statutory committee, which the Company’s businesses or its management structure, and consists of the CEO, two Independent Outside Directors, and Directors and Audit & Supervisory Board Members (as of April 1, 2018) Representative Director Chairman & CEO Fujio Mitarai Representative Director President & COO Masaya Maeda Representative Director Executive Vice President & CFO Toshizo Tanaka Group Executive of Finance & Accounting Headquarters Group Executive of Public Affairs Headquarters Group Executive of Facilities Management Headquarters 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 Headquarters Directors Kunitaro Saida (Outside) Attorney Haruhiko Kato (Outside) President & CEO of Japan Securities Depository Center, Incorporated Audit & Supervisory Board Members Kazuto Ono Masaaki Nakamura Tadashi Ohe (Outside) Hiroshi Yoshida (Outside) Koichi Kashimoto (Outside) Note: Although this annual report is for FY2017, the above list of Directors and Audit & Supervisory Board members is as of April 1, 2018. 30 CANON ANNUAL REPORT 2017STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA one Independent Outside Audit & Supervisory Board Member. Corporate Strategy Committee, Risk Management At the time Director and Audit & Supervisory Board Member Committee, and Disclosure Committee candidates are nominated and Executive Officers are selected The Company established the Corporate Strategy Committee, (includes the selection of the successor of chief executive of- consisting of Representative Directors and some Executive ficer), the CEO recommends candidates thereof from among Officers. Among items to be decided by the CEO, the individuals that have been recognized as having met the pre- Committee undertakes prior deliberations on important mat- scribed requirements, and the Committee checks the fairness ters pertaining to Canon Group strategies. Outside Directors and validity of such recommendation prior to submission to and Audit & Supervisory Board Members attend Corporate and deliberation by the Board of Directors. Additionally, as Strategy Committee meetings and are able to express their for Audit & Supervisory Board Member candidates, prior to own opinions. deliberation of the Board of Directors, consent of the Audit & Based on a resolution passed by the Board of Directors, Supervisory Board shall be acquired. Canon set up the Risk Management Committee, which 31 Governance Structure (as of March 29, 2018)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 divisionNomination and Remuneration Advisory Committee(CEO, two Independent Outside Directors, and one Independent Outside Audit & Supervisory Board Member)Financial Risk ManagementSubcommitteeCompliance SubcommitteeBusiness Risk ManagementSubcommitteeRisk Management CommitteeElect/DismissElect/DismissApprove/SuperviseInstruct/OrderApprove/SuperviseElect/DismissElect/DismissAuditCooperationFinancial AuditCooperationCooperationReportAuditReportReportReportReportReportInternal AuditConsultConsultReportCooperationReportCANON ANNUAL REPORT 2017ESG GOVERNANCE formulates policy and action proposals regarding improve- dialogue with shareholders through an ordinary general ment of the Canon Group risk management system. The meeting of shareholders, corporate strategy conferences, Risk Management Committee consists of three entities: the financial results conferences, and interviews with major insti- Financial Risk Management Subcommittee, which is tasked tutional investors. with improving systems to ensure reliability of financial re- The Structure to Promote Dialogue porting; the Compliance Subcommittee, which is tasked with Finance & accounting (Investor Relations (“IR”)), legal affairs, promoting corporate ethics and improving legal compliance corporate communications are responsible for working to- systems; and the Business Risk Management Subcommittee, gether and promoting dialogue. The Executive Vice President which is charged with improving systems to manage overall & CFO oversees the entire structure to promote dialogue. business risks, including risks related to product quality and For analysts and institutional investors, the CEO hosts a information leak. corporate strategy conference at the beginning of the year. The Risk Management Committee verifies the risk manage- Other than this, the CFO hosts quarterly financial results con- ment system’s improvement and implementation and reports ferences. For individual investors, conferences are held when the status to the CEO and the Board of Directors. appropriate and on Canon’s official website, specific pages In addition, the Disclosure Committee was established to containing information about corporate strategy, financial undertake deliberations pertaining to information disclosure, results, and financial data etc. have been set up using descrip- including content and timing, to ensure important corporate tions that are easy to understand. information will be disclosed in a timely and accurate manner. Additionally, Canon works for dialogue with domestic and Internal Audit Division overseas analysts and institutional investors, arranging inter- The Corporate Audit Center, the Company’s internal audit- view opportunities appropriately. For detail, see “an overview ing arm, as an independent and specialized organization and of Corporate Governance at Canon Inc.” in accordance with internal audit rules, conducts audits and As for the opinions or demands that are obtained through evaluations and provides guidance on such matters as compli- dialogue with shareholders, accordingly, the department in ance with laws and the internal control system. Furthermore, charge reports to the CFO and the CFO will report important the Corporate Audit Center is primarily responsible for audits ones to the CEO or the Board of Directors. covering such areas as quality, the environment, and informa- Controlling Insider Information tion security, and conducts them in collaboration with the Canon has set the “Rules on Prevention of Insider Trading,” divisions in charge. Additionally, based on senior executive which makes thorough control of undisclosed material informa- management policy, for all work processes, audits must be tion and provides the procedure of information disclosure. conducted from a specialized viewpoint and there are plans to increase the number of members from the current 70 to strengthen auditing functions. Constructive Dialogue with Shareholders Policy For sustainable growth and to help improve corporate value over a mid- to long-term perspective, Canon has constructive 32 CANON ANNUAL REPORT 2017FINANCIAL SECTION TABLE OF CO NTENTS 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 CANON ANNUAL REPORT 2017 33 FINANCIAL OVERVIEW GENERAL The following discussion and analysis provides information that management believes to be relevant to understanding Canon’s consolidated financial condition and results of opera- tions. References in this discussion to the “Company” are to Canon Inc. and, unless otherwise indicated, references to the financial condition or operating results of “Canon” refer to Canon Inc. and its consolidated subsidiaries. OVERVIEW Canon is one of the world’s leading manufacturers of plain paper copying machines, office multifunction devices (“MFDs”), laser printers, cameras, inkjet printers, medical equipment, semiconductor lithography equipment and FPD (Flat panel display) lithography equipment. Canon earns reve- nues primarily from the manufacture and sale of these products domestically and internationally. Canon’s basic management policy is to contribute to the prosperity and well-being of the world while endeavoring to become a truly excellent global corporate group targeting continued growth and development. Canon divides its businesses into four segments: the Office Business Unit, the Imaging System Business Unit, the Medical System Business Unit which was newly established in 2017 and the Industry and Others Business Unit. Economic environment Looking back at the global economy in 2017, the U.S. econ- omy continued to grow steadily as employment conditions and corporate earnings improved. In Europe, the economy remained stable as unemployment rates decreased and capi- tal investment increased due to strong exports. The Chinese economy rallied due to public investments while the econo- mies of emerging countries realized moderate recovery as the economies of Russia and Brazil bottomed out owing to the ris- ing price of natural resources. In Japan, corporate earnings improved and consumer spending showed signs of recovery. As a result, the global economy overall continued to recover more robustly than was expected at the beginning of the year. Market environment As for the markets in which Canon operates amid these con- ditions, demand for office multifunction devices (“MFDs”) and laser printers remained at around the same level as the previous year. While demand for cameras shrank moder- ately, demand for inkjet printers increased from the previous year with the economies recovering in emerging countries. Additionally, there was solid demand for medical equipment, mainly outside of Japan. Within the Industry and Others sec- tor, demand for FPD (Flat panel display) lithography equipment and manufacturing equipment for organic LED (“OLED”) pan- els enjoyed strong growth and the demand for network cam- era also enjoyed solid growth. The average value of the yen during the year was ¥112.13 against the U.S. dollar, a year-on-year depreciation of approx- imately ¥4, and ¥126.69 against the euro, a year-on-year depreciation of approximately ¥6. Summary of operations During 2017, unit sales of office MFDs increased compared with the previous year due to the expanded sales of color models. Additionally, unit sales of laser printers increased com- pared with the previous year, supported by the steady sales of newly launched models, as demand recovered in emerg- ing countries. While unit sales of interchangeable-lens digi- tal cameras decreased compared with the previous year, unit sales of digital compact cameras remained at around the same level amid the shrinking market, owing to increased sales of high-value-added models. Looking at inkjet printers, unit sales increased compared with the previous year, thanks to such factors as strong sales of newly launched home-use models and refillable ink tank models for emerging countries. Additionally, sales of semiconductor lithography equipment, FPD lithography equipment, and manufacturing equipment for OLED panels exceeded those of the previous year, thanks to favorable market conditions, and sales of network cameras increased steadily in response to the growing market. Under these conditions, along with the impact of acquiring TMSC, net sales for the year increased by 19.9% year on year to ¥4,080,015 million. Although the gross profit ratio decreased by 0.4 points to 48.8% due to the effect of the product mix, gross profit increased by 19.0% year on year to ¥1,992,691 million, thanks to such factors as the increase in sales and con- tinuous cost reduction efforts. Operating expenses increased by 15.0% year on year, mainly due to impairment loss on goodwill of commercial printing business in Office Business Unit and the impact of acquiring TMSC. As a result, operating profit increased by 44.8% to ¥331,479 million. Other income (deductions) increased by ¥6,620 million mainly due to gain on securities contributed to retirement benefit trust and for- eign currency exchange losses while income before income taxes increased by 44.6% year on year to ¥353,884 million and net income attributable to Canon Inc. increased by 60.6% to ¥241,923 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. Net sales and profit ratio As Canon pursues the goal to become a truly excellent global company, one indicator upon which Canon’s management places strong emphasis is revenue. The following are some of the KPIs related to revenue that management considers to be important. Net sales is one such KPI. Canon derives net sales primar- ily from the sale of products and, to a lesser extent, provision of services associated with its products. Sales vary depending on such factors as product demand, the number and size of transactions within the reporting period, market acceptance for new products, and changes in sales prices. Other factors 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 34 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA sales performance in various segments, taking into account recent market trends. Gross profit ratio (ratio of gross profit to net sales) is another KPI for Canon. Through its reforms of product devel- opment, Canon has been striving to shorten product develop- ment lead times in order to launch new, competitively priced products at a faster pace. Furthermore, Canon has further achieved cost reductions through enhancement of efficiency in its production. Canon believes that these achievements have contributed to improving Canon’s gross profit ratio, and will continue pursuing the curtailment of product development lead times and reductions of production costs. Operating profit ratio (ratio of operating profit to net sales) and R&D expense to net sales ratio are considered to be KPIs by Canon. Canon is focusing on two areas for improvement. Canon is striving to control and reduce its selling, general and administrative expenses as its first key point. Secondly, Canon’s R&D policy is designed to maintain adequate spending in core technology to sustain Canon’s leading position in its cur- rent business areas and to exploit opportunities in other mar- kets. Canon believes such investments will create the basis for future success in its business and operations. Cash flow management Canon also places significant emphasis on cash flow manage- ment. The following are the KPIs relating to cash flow man- agement that Canon’s management believes to be important. Inventory turnover measured in days is a KPI because it mea- sures the efficiency of supply chain management. Inventories have inherent risks of becoming obsolete, physically damaged or otherwise decreasing significantly in value, which may adversely affect Canon’s operating results. To mitigate these risks, management believes that it is crucial to continue reduc- ing work-in-process inventories by decreasing production lead times in order to promptly recover related product expenses, while balancing risks of supply chain disruptions by optimiz- ing finished goods inventories in order to avoid losing poten- tial 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 2017 2016 2015 2014 2013 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 4,080,015 48.8% 8.1% 8.1% 49 days 10.2% 55.2% 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% 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 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 accor- dance with U.S. generally accepted accounting principles (“U.S. GAAP”) and based on the selection and application of signifi- cant accounting policies which require management to make significant estimates and assumptions. These estimates and assumptions include future market conditions, net sales growth rate, gross margin and discount rate. Though Canon believes that the estimates and assumptions are reasonable, actual future results may differ from these estimates and assumptions. Canon believes that the following are the more critical judg- ment areas in the application of its accounting policies that cur- rently affect its financial condition and results of operations. Revenue recognition Canon generates revenue principally through the sale of office, imaging system and medical system products, equip- ment, supplies, and related services under separate contractual CANON ANNUAL REPORT 2017 35 FINANCIAL OVERVIEW 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 deter- minable, 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 contracts for most office products, for which the customer typi- cally pays a stated base service fee plus a variable amount based on usage. Revenue from these service maintenance contracts is measured at the stated amount of the contract and recognized as services are provided and variable amounts are earned. Revenue from the sale of equipment under sales-type leases is recognized at the inception of the lease. Income on sales- type leases and direct-financing leases is recognized over the life of each respective lease using the interest method. Leases not qualifying as sales-type leases or direct-financing leases are accounted for as operating leases and related revenue is rec- ognized ratably over the lease term. When equipment leases are bundled with product maintenance contracts, revenue is allocated based upon the estimated relative fair value of the lease and non-lease deliverables. Lease deliverables generally include equipment, financing and executory costs, while non- lease deliverables generally consist of product maintenance contracts and supplies. Revenue from sales of equipment that are sold with cus- tomer acceptance provisions related to their functionality including optical equipment such as semiconductor lithogra- phy equipment and FPD lithography equipment, and certain medical equipment such as computed tomography and mag- netic resonance imaging, is recognized when the equipment is installed at the customer site and the specific criteria of the equipment functionality are successfully tested. Service reve- nue is derived primarily from separately priced product main- tenance contracts on the equipment sold to customers and is measured at the stated amount of the contract and recog- nized as services are provided. For all other arrangements with multiple elements, Canon allocates revenue to each element based on its relative selling price if such element meets the criteria for treatment as a sep- arate unit of accounting. Otherwise, revenue is deferred until the undelivered elements are fulfilled and accounted for as a single unit of accounting. Canon records estimated reductions to sales at the time of sale for sales incentive programs including product discounts, customer promotions and volume-based rebates. Estimated reductions to sales are based upon historical trends and other known factors at the time of sale. 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, except 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 36 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA of accounting. The acquisition method of accounting requires the identification and measurement of all acquired tangible and intangible assets and assumed liabilities at their respective fair values, as of the acquisition date. The determination of the fair value of net assets acquired involves significant judgment and estimates, such as future cash flow projections, appro- priate discount and capitalization rates and other estimates based on available market information. Estimates of future cash flows are based on a number of factors including oper- ating results, known and anticipated trends, as well as market and economic conditions. Goodwill and other intangible assets Goodwill and other intangible assets with indefinite use- ful lives are not amortized, but are instead tested for impair- ment annually in the fourth quarter of each year, or more frequently if indicators of potential impairment exist. All good- will is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. If the carrying amount assigned to the reporting unit exceeds the fair value of the reporting unit, Canon recognizes an impair- ment charge in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. 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 2017 and recognized an impair- ment charge for the commercial printing business included in Office Business Unit for the amount by which the carrying amount exceeded the reporting unit’s fair value. For further information, please refer to Notes 8 and 20 of the Notes to Consolidated Financial Statements. The fair values of remain- ing reporting units exceeded its respective carrying amount, and thus no other impairment charges were recognized as a result of 2017 impairment test. However, since goodwill attributed to Medical System Business Unit and network cam- era business included in Industry and Others Business Unit were resulted from recent acquisitions, fair values in excess of reported carrying values as a percentage are relatively low. As a result, a future reduction more than expected in cash flows of the related business, could trigger an impairment. The goodwill related to these reporting units are ¥499,915 million and ¥235,172 million, respectively. Intangible assets with finite useful lives consist primarily of software, trademarks, patents and developed technology, license fees and customer relation- ships, which are amortized using the straight-line method. The estimated useful lives of software are from 3 years to 6 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 15 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 2017, Canon esti- mated a weighted-average discount rate used to determine benefit obligations of 0.6% 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 4.2% for foreign plans. In estimating the discount rate, Canon uses available information about rates of return on high-qual- ity fixed-income government and corporate bonds currently available and expected to be available during the period to the maturity of the pension benefits. Canon establishes the expected long-term rate of return on plan assets based on management’s expectations of the long-term return of the various plan asset categories in which it invests. Management develops expectations with respect to each plan asset category based on actual historical returns and its current expectations for future returns. CANON ANNUAL REPORT 2017 37 FINANCIAL OVERVIEW 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 2017, a decrease of 50 basis points in the discount rate increases the projected benefit obligation by approximately ¥101,964 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 2017, a change of 50 basis points in the expected long-term rate of return on plan assets would cause a change of approximately ¥4,948 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. Recently Issued Accounting Guidance Please refer to Note 1 of the Notes to Consolidated Financial Statements. 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 continued to recover more robustly than was expected at the beginning of the year. In such an environment, due to efforts to promote sales of newly launched models and high-value- added models, along with the impact of acquiring TMSC, Canon’s consolidated net sales in 2017 totaled ¥4,080,015 million, an increase of 19.9% from the previous year. Overseas operations are significant to Canon’s operating results and generated 78.3% of total net sales in 2017. 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 ¥112.13 against the U.S. dollar, a year-on-year depreciation of approx- imately ¥4, and ¥126.69 against the euro, a year-on-year depreciation of approximately ¥6. The effects of foreign exchange rate fluctuations positively affected net sales by approximately ¥96,224 million in 2017. This favorable impact consisted of approximately ¥42,467 million of favorable impact 38 CANON ANNUAL REPORT 2017 Millions of yen 2017 change 2016 change 2015 4,080,015 +19.9% 3,401,487 228,866 244,651 150,650 331,479 +44.8% 353,884 +44.6% 241,923 +60.6% -10.5% 3,800,271 355,210 -35.6% -29.6% 347,438 220,209 -31.6% for the U.S. dollar denominated sales and favorable impact of ¥42,950 million for the euro denominated sales, and ¥10,807 million for other foreign currency denominated sales. Cost of sales Cost of sales principally reflects the cost of raw materials, parts and labor used by Canon in the manufacture of its products. A portion of the raw materials used by Canon is imported or includes imported materials. Many of these raw materials are Return on Sales (%) 9 6 3 0 2013 2014 2015 2016 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 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 ratios of cost of sales to net sales for 2017 and 2016 were 51.2% and 50.8%, respectively. Gross profit Canon’s gross profit in 2017 increased by 19.0% to ¥1,992,691 million from 2016. The gross profit ratio also decreased by 0.4 points year on year to 48.8%. The decrease in the gross profit ratio is primarily due to the effect of product mix. Operating expenses The major components of operating expenses are payroll, R&D, advertising expenses and other marketing expenses. Operating expenses increased 15.0% year on year to ¥1,661,212 million owing to such factors as the increase in foreign-currency-denominated operating expenses after con- version into yen due to the depreciation of the yen, the impact of acquiring TMSC, and the impact of recognizing impairment losses on goodwill. Operating profit Operating profit in 2017 increased 44.8% from 2016 to a total of ¥331,479 million. The ratio of operating profit to net sales increased 1.4 points to 8.1% from 2016. Other income (deductions) Other income (deductions) for 2017 was ¥22,405 million, an increase of ¥6,620 million from 2016 mainly due to gain on securities contributed to retirement benefit trust which was partially offset by foreign currency exchange losses. Income before income taxes Income before income taxes in 2017 was ¥353,884 million, an increase of 44.6% from 2016, and constituted 8.7% of net sales. Income taxes Income taxes in 2017 increased by ¥15,343 million from 2016. The effective tax rate for 2017 was 27.7%, which was lower than the statutory tax rate in Japan. This was mainly due to the effect of reversal of deferred tax liabilities derived from US tax reform in 2017 and the tax credit for R&D expenses which were partially offset by the impact of impairment losses on goodwill. Net income attributable to Canon Inc. As a result, net income attributable to Canon Inc. in 2017 increased by 60.6% to ¥241,923 million, which represents 5.9% of net sales. Segment information Canon divides its businesses into four segments: the Office Business Unit, the Imaging System Business Unit, the Medical System Business Unit which was newly established in 2017, 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 Medical System Business Unit mainly includes Digital radiography systems / Diagnostic X-ray systems / Computed tomography / Magnetic resonance imaging / Diagnostic ultrasound systems / Clinical chemistry analyzers / Ophthalmic equipment The Industry and Others Business Unit mainly includes Semiconductor lithography equipment / FPD (Flat panel dis- play) lithography equipment / Vacuum thin-film deposition equipment / Organic LED (OLED) panel manufacturing equip- ment / Die bonders / Micromotors / Network cameras / Handy terminals / Document scanners Sales by Segment (Billions of yen) Sales by Geographic Area (Billions of yen) 5,000 4,000 3,000 2,000 1,000 0 Office Business Unit Imaging System Business Unit Medical System Business Unit Industry and Others Business Unit Eliminations 2013 2014 2015 2016 2017 5,000 4,000 3,000 2,000 1,000 0 Japan Americas Europe Asia and Oceania 2013 2014 2015 2016 2017 CANON ANNUAL REPORT 2017 39 FINANCIAL OVERVIEW Sales by segment Within the Office Business Unit, unit sales of office MFDs increased from the previous year and achieved higher growth than the market average, supported by steady sales of next- generation color models designed to strengthen the product lineup such as the newly launched color A3 (12”x18”) imag- eRUNNER ADVANCE C3500 series for small- and medium-size offices. Among high-speed continuous-feed printers, unit sales of the Océ-produced VarioPrint i300, a high-speed sheet-fed color inkjet press that offers superior low-running-cost perfor- mance, increased. As for laser printers, sales of both hardware and consumables increased from the previous year, supported by steady sales of new models that achieve low power con- sumption and compact body designs. These factors resulted in total sales for the business unit of ¥1,865,928 million, a year-on-year increase of 3.2%, while operating profit totaled ¥180,648 million, a year-on-year increase of 6.6%. Within the Imaging System Business Unit, while the pace of decline in demand for interchangeable-lens digital cam- eras is gradually decelerating, the sales of the advanced-ama- teur-models —including the EOS 6D Mark II—enjoyed solid demand, allowing Canon to maintain the top share, mainly in the United States, Europe, and Japan. As for compact-sys- tem cameras, the advanced-amateur-model EOS M6 and the entry-level EOS M100 enjoyed strong demand. As for digi- tal compact cameras, amid the shrinking market, unit sales remained at the same level as the previous year, supported by the increased sales of such high-value-added models as the newly launched G9 X Mark II—part of the high-image- quality PowerShot G-series lineup. As for inkjet printers, the newly designed home-use TS-series, refillable ink tank mod- els targeting emerging countries and the imagePROGRAF PRO series of large format inkjet printer targeting the professional photo and graphic art markets enjoyed strong demand, result- ing in unit sales increasing from the previous year. As a result, sales for the business unit increased by 3.7% year on year to ¥1,136,188 million, while operating profit totaled ¥175,913 million, a year-on-year increase of 21.8%. Within the Medical System Business Unit, TMSC’s com- puted tomography (“CT”) products increased the sales and maintained the top share in the Japanese market thanks to the solid sales of the newly launched Aquilion Precision CT scanner, which delivers the industry’s highest level of high-res- olution imaging. As for diagnostic ultrasound systems, sale of the Aplio i-series, which delivers proprietary high-resolution imaging technology, remained firm. As a result, sales for the business unit totaled ¥436,187 million, while operating profit totaled ¥22,505 million. In the Industry and Others Business Unit, unit sales of semi- conductor lithography equipment increased from the previ- ous year as a result of increasing demand for memory devices used in data centers. Additionally, sales of FPD lithography equipment and manufacturing equipment for OLED pan- els increased significantly in response to continued grow- ing demand for high-definition OLED displays used in mobile devices. As for network cameras, amid increasing market demand, Axis enjoyed solid sales, resulting in a considerable sales increase compared with the previous year. Consequently, sales for the business unit increased by 25.2% year on year to ¥731,704 million, while operating profit grew by ¥49,340 SALES BY SEGMENT Office Imaging System Medical System Industry and Others Eliminations Total SALES BY REGION Japan Americas Europe Asia and Oceania Total 2017 change 2016 change 2015 Millions of yen +3.2% +3.7% 1,865,928 1,136,188 436,187 731,704 +25.2% (89,992) — — 1,807,819 1,095,289 -14.4% -13.3% — — 584,660 +11.4% (86,281) — 2,110,816 1,263,835 — 524,651 (99,031) 4,080,015 +19.9% 3,401,487 -10.5% 3,800,271 Millions of yen 2017 change 2016 change 2015 884,828 +25.2% 1,107,515 +14.9% 1,028,415 +12.6% 1,059,257 +29.6% 706,979 963,544 913,523 817,441 -1.0% -15.8% -15.0% -5.7% 714,280 1,144,422 1,074,366 867,203 4,080,015 +19.9% 3,401,487 -10.5% 3,800,271 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 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA million from the previous year to ¥56,788 million. Intersegment sales of ¥89,992 million, representing 2.2% of total sales, are eliminated from total sales for the four seg- ments, and are described as “Eliminations”. Sales by geographic area Please refer to the table of sales by geographic area in Note 21 of the Notes to Consolidated Financial Statements. In Japan, net sales increased 25.2% from the previous year mainly due to the impact of acquiring TMSC. In the Americas, net sales increased 14.9% from the previ- ous year due to the impact of acquiring TMSC, solid sales of network cameras and the positive effects of favorable currency exchange rates. In Europe, net sales increased 12.6% from the previous year due to the impact of acquiring TMSC, solid sales of net- work cameras and the positive effects of favorable currency exchange rates. In Asia and Oceania, net sales increased by 29.6% from the previous year due to the impact of acquiring TMSC and strong sales of manufacturing equipment for OLED displays which is sold by Canon Tokki and manufacturing equipment for FPD (Flat panel display). 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 2017 increased by 6.6% from the previous year to ¥180,648 mil- lion, owing to the positive effects of favorable currency exchange rates. Operating profit for the Imaging System Business Unit in 2017 increased by 21.8% from the previous year to ¥175,913 million, owing to the improvement in profitability from the sales shift to high-added-value models in cameras, along with the positive effects of favorable currency exchange rates. Operating profit for the Medical System Business Unit, which was newly established from this year, was ¥22,505 mil- lion in 2017. Operating profit for the Industry and Others Business Unit in 2017 grew by ¥49,340 million to ¥56,788 million thanks to strong sales of manufacturing equipment for OLED displays and network cameras. FOREIGN OPERATIONS AND FOREIGN CURRENCY TRANSACTIONS Canon’s marketing activities are performed by subsidiaries in various regions in local currencies, while the cost of sales is generally in yen. Given Canon’s current operating structure, appreciation of the yen has a negative impact on net sales and the gross profit ratio. To reduce the financial risks from changes in foreign exchange rates, Canon utilizes derivative financial instruments, which consist principally of forward cur- rency exchange contracts. The operating profit on foreign operation sales is usually lower than that from domestic operations because foreign operations consist mainly of marketing activities. Marketing activities are generally less profitable than production activities, which are mainly conducted by the Company and its domestic subsidiaries. Please refer to the table of geographic information in Note 21 of the Notes to Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents increased by ¥91,621 million to ¥721,814 million in fiscal 2017 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 ¥90,274 million to ¥590,557 million in fiscal 2017 compared to the previous year thanks to the increase in net income. The major component of Canon’s cash inflow is cash received from customers, and the major components of Canon’s cash out- flow are payments for parts and materials, selling, general and administrative expenses, R&D expenses and income taxes. For fiscal 2017, cash inflow from cash received from custom- ers increased thanks to sales growth. There were no significant changes in Canon’s collection rates. Cash outflow for pay- ments for parts and materials, selling, general and administra- tive expenses and R&D expenses increased mainly due to sales growth. Cash outflow for payments for income taxes decreased thanks to a decrease in taxable income in fiscal 2016. Net cash used in investing activities decreased by ¥672,115 million to ¥165,010 million in fiscal 2017. This mainly reflects the acquisition of TMSC in fiscal 2016. Canon defines “free cash flow” as cash flows from operat- ing activities less cash flows from investing activities. For fiscal 2017, free cash flow increased by ¥762,389 million to positive ¥425,547 million as compared with negative ¥336,842 million for fiscal 2016. 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. 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 negative ¥340,464 million in fiscal 2017, mainly resulting from the div- idend payout of ¥162,887 million, the repayment for long- term loans of ¥126,578 million and the acquisition of own shares in ¥50,036 million. The Company paid dividends in fis- cal 2017 of ¥160.00 per share. CANON ANNUAL REPORT 2017 41 FINANCIAL OVERVIEW To the extent Canon relies on external funding for its liquid- ity and capital requirements, it generally has access to vari- ous funding sources, including the issuance of additional share capital, issuance of corporate bond or loans. While Canon has been able to obtain funding from its traditional financing sources and from the capital markets, and believes it will con- tinue to be able to do so in the future, there can be no assur- ance that adverse economic or other conditions will not affect Canon’s liquidity or long-term funding in the future. Short-term loans (including the current portion of long- term debt) increased to ¥39,328 million at December 31, 2017 compared with ¥1,850 million at December 31, 2016, which was mainly due to a new consolidation of subsidiary. Long-term debt (excluding the current portion) amounted to ¥493,238 million at December 31, 2017 compared with ¥611,289 million at December 31, 2016 thanks to the repay- ment for long-term loans. 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 9, 2018, 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. Reflecting the foregoing circumstances, Canon’s total inven- tory turnover ratios were 49, 59, and 47 days at the end of the fiscal years 2017, 2016, and 2015, 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. Increase in property, plant and equipment on an accrual basis in 2017 amounted to ¥147,542 million compared with ¥171,597 million in 2016 and ¥195,120 million in 2015. For 2018, Canon projects its increase in property, plant and equip- ment will be approximately ¥200,000 million. Employer contributions to Canon’s worldwide defined ben- efit pension plans were ¥50,628 million in 2017, ¥14,575 million in 2016 and ¥19,565 million in 2015. Employer con- tributions to Canon’s worldwide defined contribution pension plans were ¥18,979 million in 2017, ¥17,603 million in 2016, and ¥17,277 million in 2015. In addition, employer contribu- tions to the multiemployer pension plan of certain subsidiar- ies were ¥4,165 million in 2017, ¥3,482 million in 2016 and ¥3,864 million in 2015. Working capital in 2017 increased by ¥6,790 million to ¥1,123,169 million, compared with ¥1,116,379 million in 2016 and ¥1,241,850 million in 2015. 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 2017 was 2.01 compared to 2.14 for 2016 and to 2.52 for 2015. Return on assets (net income attributable to Canon Inc. divided by the average of total assets) was 4.7% in 2017, compared to 3.1% in 2016 and 5.0% in 2015. Return on Canon Inc. shareholders’ equity (net income attributable to Canon Inc. divided by the average of total Canon Inc. shareholders’ equity) was 8.6% in 2017 compared with 5.2% in 2016 and 7.4% in 2015. Increase in Property, Plant and Equipment (Billions of yen) Working Capital Ratio Return on Canon Inc. Shareholders’ Equity (%) 300 200 100 0 3.0 2.5 2.0 1.5 1.0 0.5 0 12 9 6 3 0 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 42 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA The debt to total assets ratios were 10.2%, 11.9% and 0.0% as of December 31, 2017, 2016 and 2015, respectively. Canon had short-term loans and long-term debt of ¥532,566 million as of December 31, 2017, ¥613,139 million as of December 31, 2016 and ¥1,569 million as of December 31, 2015. 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 compa- rable 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 2017 2016 590,557 500,283 (165,010) (837,125) 425,547 (336,842) 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 its employees, affiliates and other companies. The guarantees for the employees are prin- cipally made for their housing loans. The guarantees for affili- ates and other companies are made for their lease obligations and bank loans to ensure that those companies operate with less financial risk. Canon would have to perform under a guarantee if the bor- rower defaults on a payment within the contract terms. The contract terms are 1 year to 30 years in case of employees with housing loans, and 1 year to 7 years in case of affiliates and other companies with lease obligations and bank loans. The maximum amount of undiscounted payments Canon would have had to make in the event of default is ¥6,059 mil- lion at December 31, 2017. The carrying amounts of the liabil- ities recognized for Canon’s obligations as a guarantor under those guarantees at December 31, 2017 were not significant. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following summarizes Canon’s contractual obligations at December 31, 2017. Millions of yen Contractual obiligations: Long-term debt: Loan from the banks Other debt Operating lease obligations Purchase commitments for: Property, plant and equipment Parts and raw materials Other long-term liabilities: Total Less than 1 year 1-3 years 3-5 years More than 5 years Payments due by period 490,000 9,168 111,502 — 5,930 28,414 — 2,776 37,622 490,000 390 22,495 — 72 22,971 36,199 135,649 36,199 135,649 — — — — — — — — — Contribution to defined benefit pension plans 36,750 36,750 Total 819,268 242,942 40,398 512,885 23,043 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 ANNUAL REPORT 2017 43 FINANCIAL OVERVIEW 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, 2017 accrued product warranty costs amounted to ¥17,452 million. At December 31, 2017, commitments outstanding for the purchase of property, plant and equipment were approxi- mately ¥36,199 million, and commitments outstanding for the purchase of parts and raw materials were approximately ¥135,649 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 2018, Canon expects to contribute ¥14,447 million to its Japanese defined benefit pension plans and ¥22,303 mil- lion to its foreign defined benefit pension plans. Canon's management believes that current financial resources, cash generated from operations and Canon's poten- tial capacity for additional debt and/or equity financing will be sufficient to fund current and future capital requirements. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES 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: (cid:129) Establish a new production system to achieve a cost-of- sales ratio of 45%; (cid:129) Reinforce and expand new businesses while creating future businesses; and (cid:129) Enhance R&D capabilities through open innovation. Canon has been striving to implement the three R&D related strategies as follows: (cid:129) Establish a new production system to achieve a cost-of- 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. (cid:129) Reinforce and expand new businesses while creating 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 44 CANON ANNUAL REPORT 2017 while actively taking advantage of M&A to accelerate the early expansion of these businesses. (cid:129) Enhance R&D capabilities through open innovation: Construct a more open R&D system that proactively lever- ages external technologies and knowledge to accelerate and improve efficiency of the R&D. Especially in our fundamen- tal research and development, Canon is promoting joint and contract research with various partners including universi- ties, research institutes, and startups around the world. 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. Also, TMSC and the University of Bordeaux has started a joint research on ultra- high-resolution MRI technologies. Canon has developed simulation systems covering compre- hensive image processing including optical design, mechanical noise analysis, and thermal air flow analysis. With these simu- lation systems, Canon has succeeded in further reducing the need for prototypes, lowering costs and shortening product development lead times. Canon’s consolidated R&D expenses were ¥330,053 mil- lion in 2017, ¥302,376 million in 2016 and ¥328,500 million in 2015. The ratios of R&D expenses to the consolidated total net sales for 2017, 2016 and 2015 were 8.1%, 8.9% and 8.6%, respectively. 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 R&D Expenses (Billions of yen) 400 300 200 100 0 2013 2014 2015 2016 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA standards in the market and industry. Canon obtained the third greatest number of private sector patents in 2017, according to the United States patent annual list, released by IFI CLAIMS® Patent Services. MARKET RISK EXPOSURES Canon is exposed to market risks, including changes in foreign currency exchange rates, interest rates and prices of market- able securities and investments. In order to hedge the risks of changes in foreign currency exchange rates, Canon uses deriv- ative financial instruments. Equity price risk Canon holds marketable securities included in current assets, which consist generally of highly-liquid and low-risk instru- ments. Investments included in noncurrent assets are held as long-term investments. Canon does not hold marketable secu- rities and investments for trading purposes. Maturities and fair values of such marketable securities and investments with original maturities of more than three months, all of which were classified as available-for-sale securities, were as follows at December 31, 2017. Available-for-sale securities Debt securities Due within one year Due after one year through five years Due after five years Fund trusts Equity securities Millions of yen Cost Fair value 1,222 605 340 122 10,965 13,254 1,222 605 506 124 20,901 23,358 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. CANON ANNUAL REPORT 2017 45 FINANCIAL OVERVIEW The following table provides information about Canon’s major derivative financial instruments related to foreign currency exchange transactions existing at December 31, 2017. All of the foreign exchange contracts described in the following table have a contractual maturity date in 2018. 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 119,128 61 127,449 (1,720) 25,986 (426) 272,563 (2,085) 38,775 (448) 2,399 (187) 4,994 5 46,168 (630) Canon expects that fair value changes and cash flows result- ing from reasonable near-term changes in interest rates will be immaterial. 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 designated as cash flow hedges, including foreign currency exchange contracts associated with forecasted intercom- pany sales, are reported in accumulated other comprehen- sive income (loss). These amounts are subsequently reclassified into earnings through other income (deductions) in the same period as the hedged items affect earnings. Substantially all such amounts recorded in accumulated other comprehen- sive income (loss) at year-end are expected to be recognized in earnings over the next twelve months. Canon excludes the time value component from the assessment of hedge effectiveness. Changes in the fair value of a foreign cur- rency exchange contract for the period between the date that the forecasted intercompany sales occur and its matu- rity date are recognized in earnings and not considered hedge ineffectiveness. The amount of the hedging ineffectiveness was not material for the years ended December 31, 2017, 2016 and 2015. The amounts of net losses excluded from the assessment of hedge effectiveness (time value component) which was recorded in other income (deductions) were ¥332 million, ¥311 million and ¥131 million for the years ended December 31, 2017, 2016 and 2015, respectively. Canon has entered into certain foreign currency exchange contracts to manage its foreign currency exposures. These for- eign currency exchange contracts have not been designated as hedges. Accordingly, the changes in fair values of these con- tracts are recorded in earnings immediately. LOOKING FORWARD Under the corporate philosophy of kyosei—living and work- ing together for the common good—Canon’s basic manage- ment policy is to contribute to the prosperity and well-being of the world while endeavoring to become a truly excellent global corporation targeting continued growth and development. Based on this basic management policy, Canon launched the Excellent Global Corporation Plan in 1996 and, from Phase I through to Phase IV, has worked to strengthen its manage- ment base and improve corporate value. In 2016, under the slogan “Embracing the challenge of new growth through a grand strategic transformation,” Canon embarked on a new five-year initiative: Phase V of the Excellent Global Corporation Plan. Under this plan, Canon aims to facilitate growth through structural transformation by reinforcing existing businesses and taking steps to cultivate and strengthen new businesses. Despite the growing concerns about geopolitical risks, the world economy is expected to continue achieving moderate growth in 2018. In the businesses in which Canon is involved, for office MFDs, demand for color models is expected to grow mod- erately and make up for the contraction of the market for monochrome models, leading to the same level of demand overall compared with the previous year. Looking at the laser printer market, although the demand in developed countries is expected to decrease, demand in emerging countries con- tinues to recover, resulting in overall demand remaining at the same level as the previous year. For interchangeable-lens digital cameras, demand is expected to decrease moderately. Projections for digital compact cameras indicate continued market contraction, centered mainly on low-priced mod- els, despite solid demand for high-value-added models. With regard to inkjet printers, demand is expected to continue to exceed that of the previous year. As for the medical equip- ment market, demand is expected to remain firm in response to replacement demand for medical equipment in developed countries, increasing medical needs associated with popula- tion growth in emerging countries and changes in the prev- alence of diseases. Looking at industrial equipment, within the semiconductor lithography equipment segment, the mar- ket is expected to enjoy healthy growth due to the increase in demand for memory devices used in data centers and mobile devices. The outlook for FPD lithography equipment and OLED panel manufacturing equipment points to continued active capital investment by panel manufacturers, which is expected to increase demand. The network camera market is also expected to grow in response to the increasing use of network cameras for diverse applications in such areas as marketing support in addition to disaster monitoring and crime preven- tion applications. 46 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Reform sales organizations to correspond to market changes Cultivate global sales engineers essential for B2B busi- nesses such as commercial printing and network camera, and while striving to enhance the capabilities of these sales engineers, work to strengthen local service support systems with a focus on sales companies. Carry out the optimiza- tion of sales channels to correspond to changes in product and market landscapes, such as adapting to e-commerce. Establish a human resource management system that adapts to the changing times Build a human resource development system, a personnel system that enables a wide range of career paths that are in step with changes in the business environment and times. Forward looking statements The foregoing discussion and other disclosure in this report contains forward-looking statements that reflect manage- ment’s current views with respect to certain future events and financial performance. Actual results may differ materially from those projected or implied in the forward-looking state- ments. Further, certain forward-looking statements are based upon assumptions of future events that may not prove to be accurate. The following important factors could cause actual results to differ materially from those projected or implied in any forward-looking statements: foreign currency exchange rate fluctuations; the uncertainty of Canon’s ability to imple- ment its plans to localize production and other measures to reduce the impact of foreign currency exchange rate fluctua- tions; uncertainty as to economic conditions in Canon’s major markets; uncertainty of continued demand for Canon’s high- value-added products; Canon’s ability to continue to develop products and to market products that incorporate new tech- nology on a timely basis, are competitively priced, and achieve market acceptance; the possibility of losses resulting from for- eign currency transactions designed to reduce financial risks from changes in foreign currency exchange rates; and inven- tory risk due to shifts in market demand. Amid these conditions, 2018 marks the year of accelerated progress toward the target “to achieve net sales of 5.0 tril- lion yen” under Phase V (2016 - 2020) of “Excellent Global Corporation Plan” with the new business portfolio includ- ing the four new business areas (commercial printing, net- work cameras, healthcare, and industrial equipment), and will work to address the following key challenges under the theme of “Pursue total optimization and prioritize profits to com- plete our grand strategic transformation.” Canon will once again return to the slogans of “total optimization” and “focus on profit,” which Canon have upheld since 1996, and review everything from scratch based on them aiming to raise the level of the overall management one step higher. Strengthen capability to research leading-edge technology Strengthen research and analysis functions that contrib- ute to the expansion of strategic initiatives that response to changing times and rapid and constant innovation. Comprehensively strengthen capability to research not only global leading-edge technology, but also political, eco- nomic, industrial, social and other areas. Strengthen product development capability Focus resources in areas that hold future promise, promot- ing even more strictly the selection and concentration of development themes. Efficiently accelerate technological development through collaboration and the use of exter- nal research institutes, and start-up enterprises. Further improve quality, cost, and delivery, promoting such initia- tives as elimination of prototypes by improving simulation technology, optimal designs for robot assembly, and the sharing of product platforms. Enhance software develop- ment capability and work to obtain the optimal balance between outsourcing and in-house production. Comprehensively strengthen manufacturing prowess Accelerate reduction in the production cost ratio of new businesses. Establish an advanced and efficient produc- tion system that brings together, development, produc- tion engineering, and manufacturing, and strongly promote the expansion of this via the “mother factory” concept. Thoroughly pursue cost reduction, expanding the in-house production of production equipment and parts that are shared among various products in addition to key compo- nents. Construct a globally optimized manufacturing sys- tem, which enables monitoring of costs in real time by country and region. Eradicate waste in product develop- ment stage, having product development and quality orga- nizations work in unison. Comprehensively strengthen strategic procurement function Further strengthen and accelerate cooperation with world- wide suppliers in the global procurement network developed so far. Promote in-house production of parts and materials and realize cost reduction by promoting standardization of parts and adoption of general-purpose components. CANON ANNUAL REPORT 2017 47 TEN-YEAR FINANCIAL SUMMARY Net sales: Domestic Overseas Total Percentage of previous year Millions of yen (except per share amounts) 2017 2016 2015 2014 884,828 3,195,187 4,080,015 119.9% 706,979 2,694,508 3,401,487 89.5% 714,280 3,085,991 3,800,271 102.0% 724,317 3,002,935 3,727,252 99.9% Net income attributable to Canon Inc. Percentage of sales 241,923 150,650 220,209 5.9% 4.4% 5.8% 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 Total assets Per share data: Net income attributable to Canon Inc. shareholders per share: Basic Diluted Dividend per share Stock price High Low 61,207 330,053 189,712 147,542 493,238 2,870,630 5,198,291 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 4,427,773 254,797 6.8% 79,765 308,979 213,739 182,343 1,148 2,978,184 4,460,618 222.88 222.88 160.00 4,472 3,218 137.95 137.95 150.00 3,656 2,780 201.65 201.65 150.00 4,539 3,402 229.03 229.03 150.00 4,045 2,889 Average number of common shares in thousands Number of employees 1,085,439 197,776 1,092,071 197,673 1,092,018 189,571 1,112,510 191,889 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 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 48 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 2013 2012 2011 2010 2009 2008 2017 Thousands of U.S. dollars (except per share amounts) 715,863 3,015,517 3,731,380 107.2% 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 78.4% 230,483 224,564 248,630 246,603 131,647 6.2% 6.5% 7.0% 6.7% 4.1% 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 3,847,557 868,280 3,225,881 4,094,161 91.4% 309,148 7.6% 112,810 374,025 304,622 361,988 $ 7,830,336 28,275,991 36,106,327 119.9% 2,140,912 5.9% 541,655 2,920,823 1,678,867 1,305,681 8,423 2,659,792 3,969,934 $ 4,364,938 25,403,805 46,002,575 200.78 200.78 130.00 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 2,115 246.21 246.20 110.00 5,820 2,215 $ 1.97 1.97 1.42 39.58 28.48 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 Notes: U.S. dollar amounts are translated from yen at the rate of U.S.$1 = JPY113, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 29, 2017. CANON ANNUAL REPORT 2017 49 CONSOLIDATED BALANCE SHEETS Canon Inc. and Subsidiaries December 31, 2017 and 2016 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 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, 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 (Note 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 2017 and 2016 Additional paid-in capital Legal reserve (Note 13) Retained earnings (Note 13) Accumulated other comprehensive income (loss) (Note 14) Treasury stock, at cost; 254,007,681shares in 2017 and 241,695,310 shares in 2016 Total Canon Inc. shareholders’ equity Noncontrolling interests Total equity Total liabilities and equity See accompanying Notes to Consolidated Financial Statements. 50 CANON ANNUAL REPORT 2017 Millions of yen 2017 2016 721,814 1,965 650,872 570,033 287,965 2,232,649 35,444 48,320 1,126,620 420,972 936,722 397,564 630,193 3,206 641,458 560,736 264,155 2,099,748 29,297 73,680 1,194,976 446,268 936,424 358,136 5,198,291 5,138,529 39,328 380,654 77,501 330,188 281,809 1,109,480 493,238 365,582 133,816 1,850 372,269 30,514 304,901 273,835 983,369 611,289 407,200 142,049 2,102,116 2,143,907 174,762 401,386 66,879 3,429,312 (143,228) (1,058,481) 2,870,630 225,545 174,762 401,385 66,558 3,350,728 (199,881) (1,010,423) 2,783,129 211,493 3,096,175 2,994,622 5,198,291 5,138,529 CONSOLIDATED STATEMENTS OF INCOME Canon Inc. and Subsidiaries Years ended December 31, 2017, 2016 and 2015 Net sales Cost of sales (Notes 5, 8, 11 and 18) Gross profit Operating expenses (Notes 1, 5, 8, 11, 18 and 20): Selling, general and administrative expenses Research and development expenses Impairment losses on goodwill 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 2017 2016 2015 4,080,015 2,087,324 1,992,691 3,401,487 1,727,654 1,673,833 3,800,271 1,865,887 1,934,384 1,297,247 330,053 33,912 1,142,591 302,376 — 1,250,674 328,500 — 1,661,212 1,444,967 1,579,174 331,479 228,866 355,210 6,012 (818) 17,211 4,762 (1,061) 12,084 5,501 (584) (12,689) 22,405 15,785 (7,772) 353,884 244,651 347,438 98,024 82,681 116,105 255,860 161,970 231,333 13,937 11,320 11,124 241,923 150,650 220,209 Yen 222.88 222.88 160.00 137.95 137.95 150.00 201.65 201.65 150.00 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Canon Inc. and Subsidiaries Years ended December 31, 2017, 2016 and 2015 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 2017 2016 2015 255,860 161,970 231,333 47,090 (9,362) 2,588 21,207 (107,666) 997 (2,948) (70,355) (55,504) 2,010 2,785 (6,543) 61,523 (179,972) (57,252) 317,383 18,807 (18,002) 1,745 174,081 11,973 298,576 (19,747) 162,108 CANON ANNUAL REPORT 2017 51 CONSOLIDATED STATEMENTS OF EQUITY Canon Inc. and Subsidiaries Years ended December 31, 2017, 2016 and 2015 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, 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 44 (29,627) (174,711) (174,711) 690 (690) — (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 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 (loss) Repurchases of treasury stock Reissuance of treasury stock 1 (162,887) 1 (162,887) 321 (321) — (1) — (162,887) (4,814) 60 — (4,814) 60 241,923 241,923 13,937 255,860 44,168 (9,767) 2,562 19,690 44,168 2,922 47,090 (9,767) 405 (9,362) 2,562 19,690 26 1,517 2,588 21,207 298,576 18,807 317,383 (50,036) (50,036) (131) 1,978 1,847 (50,036) 1,847 Balance at December 31, 2017 174,762 401,386 66,879 3,429,312 (143,228) (1,058,481) 2,870,630 225,545 3,096,175 See accompanying Notes to Consolidated Financial Statements. 52 CANON ANNUAL REPORT 2017 CONSOLIDATED STATEMENTS OF CASH FLOWS Canon Inc. and Subsidiaries Years ended December 31, 2017, 2016 and 2015 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 Impairment losses on goodwill (Notes 8 and 20) Gain on securities contributed to retirement benefit trust (Note 2) 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 in accrued (prepaid) pension and severance cost Other, net Millions of yen 2017 2016 2015 255,860 161,970 231,333 261,881 6,935 (1,196) 33,912 (17,836) (17,603) 3,563 2,967 4,951 46,296 18,503 522 (8,198) 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) Net cash provided by operating activities 590,557 500,283 474,724 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 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) Increase (decrease) in short-term loans, net (Note 9) Purchases of noncontrolling interests Dividends paid Repurchases and reissuance of treasury stock Other, net (189,484) 26,444 (2,220) 970 3,373 (6,557) (928) 3,392 (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) (165,010) (837,125) (453,619) 1,570 (126,578) 5,628 — (162,887) (50,034) (8,163) 610,552 (856) (80,580) (4,993) (163,810) (14) (4,607) 717 (1,350) — (29,570) (174,711) 790 (6,078) Net cash provided by (used in) financing activities (340,464) 355,692 (210,202) Effect of exchange rate changes on cash and cash equivalents 6,538 (22,270) (21,870) 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. 91,621 (3,420) (210,967) 630,193 633,613 844,580 721,814 630,193 633,613 1,026 71,473 738 76,714 653 117,643 CANON ANNUAL REPORT 2017 53 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Canon Inc. and Subsidiaries 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (a) Description of Business Canon Inc. (the “Company”) and subsidiaries (collectively “Canon”) is one of the world’s leading manufacturers in such fields as office products, imaging system products, medical system products and industry and other products. Office prod- ucts consist mainly of office multifunction devices (“MFDs”), laser multifunction printers (“MFPs”), laser printers, digital pro- duction printing systems, high speed continuous feed print- ers, wide-format printers and document solutions. Imaging system products consist mainly of interchangeable-lens digi- tal cameras, digital compact cameras, digital camcorders, dig- ital cinema cameras, interchangeable lenses, compact photo printers, inkjet printers, large format inkjet printers, commer- cial photo printers, image scanners, multimedia projectors, broadcast equipment and calculators. Medical system prod- ucts consist mainly of digital radiography systems, diagnos- tic X-ray systems, computed tomography, magnetic resonance imaging, diagnostic ultrasound systems, clinical chemistry ana- lyzers and ophthalmic equipment. Industry and other prod- ucts consist mainly of semiconductor lithography equipment, FPD (Flat panel display) lithography equipment, vacuum thin- film deposition equipment, organic LED (“OLED”) panel man- ufacturing equipment, die bonders, micromotors, network cameras, handy terminals and document scanners. 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 deal- ers in their geographic area. Further segment information is described in Note 21. Canon sells laser printers on an OEM basis to HP Inc.; such sales constituted 13.1%, 14.8% and 17.8% of consolidated net sales for the years ended December 31, 2017, 2016 and 2015, 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. (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 variable interest entities where the Company or its consoli- dated subsidiaries are the primary beneficiaries. All significant intercompany balances and transactions have been eliminated. (d) Use of Estimates The preparation of the consolidated financial statements in conformity with U.S. 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 accounts including: rev- enue recognition, allowance for doubtful receivables, inven- tories, long-lived assets, goodwill and other intangible assets with indefinite useful lives, environmental liabilities, deferred tax assets, uncertain tax positions and employee retirement and severance benefit obligations. Actual results could differ materially from those estimates. (e) Translation of Foreign Currencies Assets and liabilities of the Company’s subsidiaries located outside Japan with functional currencies other than Japanese yen are translated into Japanese yen at the rates of exchange in effect at the balance sheet date. Income and expense items are translated at the average exchange rates prevailing during the year. Gains and losses resulting from translation of finan- cial statements are excluded from earnings and are reported in other comprehensive income (loss). Gains and losses resulting from foreign currency trans- actions, including foreign exchange contracts, and transla- tion of assets and liabilities denominated in foreign currencies are included in other income (deductions) in the consoli- dated statements of income. Foreign currency exchange gains and losses were net losses of ¥9,775 million, ¥2 million and ¥22,149 million for the years ended December 31, 2017, 2016 and 2015, respectively. (f) Cash Equivalents All highly liquid investments acquired with original maturi- ties of three months or less are considered to be cash equiv- alents. Certain debt securities with original maturities of less than three months, classified as available-for-sale securities of ¥70,500 million and ¥30,500 million at December 31, 2017 and 2016, 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 54 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA securities as available-for-sale securities. Canon does not hold any trading securities which are bought and held primarily for the pur- pose of sale in the near term, or any held-to-maturity securities. 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. 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. All goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. If the car- rying amount assigned to the reporting unit exceeds the fair value of the reporting unit, Canon recognizes an impairment charge in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. 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 6 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 15 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. CANON ANNUAL REPORT 2017 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (m) Environmental Liabilities Liabilities for environmental remediation and other environ- mental costs are accrued when environmental assessments or remedial efforts are probable and the costs can be reasonably estimated. Such liabilities are adjusted as further information develops or circumstances change. Costs of future obligations are not discounted to their present values. (n) Income Taxes Deferred tax assets and liabilities are recognized for the esti- mated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and oper- ating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those tem- porary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Canon records a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not realizable. Canon recognizes the financial statement effects of tax posi- tions when it is more likely than not, based on the technical merits, that the tax positions will be sustained upon exami- nation by the tax authorities. Benefits from tax positions that meet the more-likely-than-not recognition threshold are mea- sured 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, imaging system and medical system products, equip- ment, 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 collectability 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 contracts for most office products, for which the customer typi- cally pays a stated base service fee plus a variable amount based on usage. Revenue from these service maintenance contracts is measured at the stated amount of the contract and recognized as services are provided and variable amounts are earned. Revenue from the sale of equipment under sales-type leases is recognized at the inception of the lease. Income on sales- type leases and direct-financing leases is recognized over the life of each respective lease using the interest method. Leases not qualifying as sales-type leases or direct-financing leases are accounted for as operating leases and related revenue is rec- ognized ratably over the lease term. When equipment leases are bundled with product maintenance contracts, revenue is allocated based upon the estimated relative fair value of the lease and non-lease deliverables. Lease deliverables generally include equipment, financing and executory costs, while non- lease deliverables generally consist of product maintenance contracts and supplies. Revenue from sales of equipment that are sold with cus- tomer acceptance provisions related to their functionality including optical equipment such as semiconductor lithogra- phy equipment and FPD lithography equipment, and certain medical equipment such as computed tomography and mag- netic resonance imaging, is recognized when the equipment is installed at the customer site and the specific criteria of the equipment functionality are successfully tested. Service reve- nue is derived primarily from separately priced product main- tenance contracts on the equipment sold to customers and is measured at the stated amount of the contract and recog- nized 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 ¥125,965 million and ¥102,298 mil- lion at December 31, 2017 and 2016, 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 56 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 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 ¥61,207 million, ¥58,707 million and ¥80,907 million for the years ended December 31, 2017, 2016 and 2015, respectively. (t) Shipping and Handling Costs Shipping and handling costs totaled ¥52,953 million, ¥44,296 million and ¥52,504 million for the years ended December 31, 2017, 2016 and 2015, 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 effec- tive as a hedge or that it has ceased to be a highly effective hedge, Canon discontinues hedge accounting prospectively. Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge are recorded in other compre- hensive income (loss), until earnings are affected by the vari- ability in cash flows of the hedged item. Gains and losses from hedging ineffectiveness are included in other income (deduc- tions). Gains and losses related to the components of hedging instruments excluded from the assessment of hedge effective- ness 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 issu- ing guarantees. (w) Recently Issued Accounting Guidance In January 2017, the Financial Accounting Standards Board (“FASB”) issued an amendment which eliminates the second step from the impairment test of goodwill. This amendment requires the entity to recognize an impairment charge for the amount by which the carrying amount exceeds the fair value of reporting unit; however, the impairment charge is limited to the amount of goodwill allocated to that reporting unit. Canon early adopted this amended guidance from the impairment test performed after January 1, 2017. In May 2014, the FASB issued a new accounting standard related to revenue from contracts with customers, as amended. 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 is effective for Canon from the quarter begin- ning January 1, 2018. Canon will apply the modified retrospec- tive method of adoption to contracts that are not completed as of the adoption. While Canon currently does not expect the adoption of this standard to have a material impact on revenue recognition pattern of each performance obligation, the adop- tion of this standard is expected to result in changes in alloca- tion of transaction prices between goods and services primarily in Office Business Unit. Canon is in the process of finalizing the assessment of the effect from the adoption and related adjust- ments. Also, in the course of the adoption of the guidance, Canon has reconsidered the scope of performance obligations related to services, and as a result, Canon will separately dis- close revenues and costs of services from those of products and equipment from the quarter beginning January 1, 2018. In this context, certain costs related to service will be also reclassified from operating expenses to cost of sales. 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 that do not result in consolidation and are not accounted for under the equity method be measured at fair value with changes in the fair value recognized in net income. This guidance is effective for Canon from the first quarter beginning January 1, 2018, and Canon will recognize a cumulative-effect adjustment to CANON ANNUAL REPORT 2017 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS retained earnings of ¥5,343 million as of January 1, 2018 for the after-tax unrealized gains of available-for-sale equity secu- rities previously recognized in accumulated other comprehen- sive income. 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 man- ner similar to current guidance. For lessors, the guidance modi- fies the classification criteria and the accounting for sales-type and direct financing leases. The new guidance is required to be applied with a modified retrospective approach. The guidance is effective for annual reporting periods beginning after December 15, 2018, and early adoption is permitted. Canon currently plans to adopt the guidance from the quarter beginning after January 1, 2019. The adoption of the guidance is expected to have an impact on its consolidated balance sheet by recognizing right-of-use assets and lease liabilities for non-cancelable oper- ating leases. Canon is currently evaluating the effect that the adoption of the 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 guid- ance eliminate the exception for an intra-entity transfer of an asset other than inventory. Two common examples of assets included in the scope of this guidance are intellectual property and property, plant, and equipment. The amendments in this guidance should be applied on a modified retrospective basis through a cumulative effect adjustment directly to retained earnings as of the beginning of the period of adoption. This guidance is effective for Canon from the quarter beginning January 1, 2018. Canon does not expect the adoption of this guidance to have a material impact on its consolidated results of operation and financial condition. In March 2017, the FASB issued an amendment which requires an entity to disaggregate the service cost component from the other components of net benefit cost and report the service cost component in the same line item or items as other compensation costs arising from services rendered by the per- tinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component, such as in other income (deductions). The amendments also allow only the service cost component to be eligible for capitalization (for example, as a cost of internally manufactured inventory). The amendments in this guidance should be applied retro- spectively for the presentation of the service cost component and the other components of net benefit cost, and prospec- tively for the capitalization of the service cost component of net benefit cost. This guidance is effective for Canon from the quarter beginning January 1, 2018 and the adoption of this standard will result in the decrease in operating profit and the increase in other income of ¥9,874 million, ¥12,441 million and ¥11,352 million for the years ended December 31, 2017, 2016 and 2015, respectively. In August 2017, the FASB issued an amendment which amends existing guidance to simplify the application of the hedge accounting in certain situations and enable an entity to better portray the economic results of an entity’s risk manage- ment activities in its financial statements. This guidance elimi- nates the requirement to separately measure and report hedge ineffectiveness, and requires an entity to present the earnings effect of the hedging instrument in the same income state- ment line item which the earnings effect of the hedged item is reported. This guidance is effective for annual reporting periods beginning after December 15, 2018, and early adoption is per- mitted. Canon is currently evaluating the adoption date and the effect that the adoption of this guidance will have on its consol- idated results of operations and financial condition. 2. INVESTMENTS The cost, gross unrealized holding gains, gross unrealized holding losses and fair value for available-for-sale securities included in short-term investments and investments by major security type at December 31, 2017 and 2016 are as follows: December 31 Millions of yen 2017: Current: Corporate bonds Noncurrent: Government bonds Corporate bonds Fund trusts Equity securities 58 CANON ANNUAL REPORT 2017 Cost 1,222 1,222 305 640 122 10,965 12,032 Gross unrealized holding gains Gross unrealized holding losses — — — 182 2 11,612 11,796 — — 16 — — 1,676 1,692 Fair value 1,222 1,222 289 822 124 20,901 22,136 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Millions of yen 2016: Noncurrent: Government bonds Corporate bonds Fund trusts Equity securities Cost 277 43 85 19,026 19,431 Gross unrealized holding gains Gross unrealized holding losses — 188 1 23,439 23,628 8 2 — 21 31 Fair value 269 229 86 42,444 43,028 Maturities of available-for-sale debt securities included in short-term investments and investments in the accompanying consol- idated balance sheets are as follows at December 31, 2017: Due within one year Due after one year through five years Due after five years Millions of yen Cost 1,222 605 340 2,167 Fair value 1,222 605 506 2,333 During the year ended December 31, 2017, Canon con- tributed certain marketable equity securities, not including those of its subsidiaries and affiliated companies, to an estab- lished employee retirement benefit trust, with no cash pro- ceeds there on. The fair value of those securities at the time of contribution was ¥30,473 million. Upon contribution of those available-for-sale securities, the unrealized gains amounting to ¥17,836 million were realized and were included in “Other, net” in the consolidated statements of income. Gross realized gains were ¥18,514 million, ¥750 million and ¥329 million for the years ended December 31, 2017, 2016 and 2015, respectively. Gross realized losses, including write-downs for impairments that were other-than-temporary, were ¥42 million, ¥1,032 million and ¥31 million for the years ended December 31, 2017, 2016 and 2015, respectively. At December 31, 2017, 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 ¥743 million and ¥3,206 million at December 31, 2017 and 2016, 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 ¥3,760 million and ¥7,800 million at December 31, 2017 and 2016, respec- tively. These investments were not evaluated for impairment at December 31, 2017 and 2016, 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 ¥20,496 million and ¥21,514 million at December 31, 2017 and 2016, respectively. Canon’s share of the net earnings in affiliated companies accounted for by the equity method, included in other income (deduc- tions), were earnings of ¥1,196 million, ¥890 million and ¥447 million for the years ended December 31, 2017, 2016 and 2015 respectively. 3. TRADE RECEIVABLES Trade receivables are summarized as follows: December 31 Notes Accounts Less allowance for doubtful receivables Millions of yen 2017 37,077 627,173 664,250 (13,378) 650,872 2016 28,811 623,722 652,533 (11,075) 641,458 CANON ANNUAL REPORT 2017 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. INVENTORIES Inventories are summarized as follows: December 31 Finished goods Work in process Raw materials Millions of yen 2017 377,632 144,251 48,150 570,033 2016 373,337 143,298 44,101 560,736 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 2017 274,551 1,638,202 1,804,982 46,940 3,764,675 (2,638,055) 1,126,620 2016 283,893 1,656,087 1,778,552 54,786 3,773,318 (2,578,342) 1,194,976 Depreciation expenses for the years ended December 31, 2017, 2016 and 2015 were ¥189,712 million, ¥199,133 mil- lion and ¥223,759 million, respectively. Amounts due for purchases of property, plant and equip- ment were ¥23,432 million and ¥31,318 million at December 31, 2017 and 2016, 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. 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. 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 60 CANON ANNUAL REPORT 2017 2017 361,686 15,055 (2,216) (32,286) 342,239 (2,681) 339,558 (120,186) 219,372 2016 306,766 14,776 (34) (30,288) 291,220 (2,325) 288,895 (105,308) 183,587 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 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 2017 2,325 (1,523) 1,436 443 2,681 2016 2,878 (978) 398 27 2,325 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, 2017 and 2016 are not significant. The cost of equipment leased to customers under oper- ating leases included in property, plant and equipment, net at December 31, 2017 and 2016 was ¥103,078 million and ¥97,890 million, respectively. Accumulated depreciation on equipment under operating leases at December 31, 2017 and 2016 was ¥78,307 million and ¥75,997 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, 2017. Year ending December 31: 2018 2019 2020 2021 2022 Thereafter 7. ACQUISITIONS Millions of yen Financing leases 134,020 102,203 69,180 38,264 14,819 3,200 361,686 Operating leases 8,580 4,446 2,636 1,347 401 34 17,444 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 strategic 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 med- ical equipment industry. Within the field of medical X-ray computed tomography systems in particular, TMSC is the over- whelming market share leader in Japan and has been steadily increasing its global market share. By maximizing the com- bination of both companies’ management resources, Canon aims to solidify its business foundation for health care that can contribute to the world. The purchase price allocation was based on estimated fair values of the assets acquired and liabilities assumed at acqui- sition date. Since the acquisition date of TMSC was near the balance sheet date in 2016, and TMSC is composed of vari- ous entities located around the world, the purchase price allo- cation was preliminary at December 31, 2016. The purchase price allocation was finalized in the fourth quarter of 2017. The certain underlying inputs for inventories and intangible assets have been updated during the measurement period. CANON ANNUAL REPORT 2017 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at acquisition date. Millions of yen 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 Preliminary 25,301 169,545 227,500 42,975 465,321 199,223 92,231 291,454 1,047 172,820 492,678 665,498 Measurement Period Adjustment — (1,962) 627 — (1,335) (877) (1,049) (1,926) — 591 (591) — Final 25,301 167,583 228,127 42,975 463,986 198,346 91,182 289,528 1,047 173,411 492,087 665,498 Intangible assets acquired, which are subject to amortiza- tion, mainly consist of customer relationships of ¥143,600 mil- lion, and patents and developed technology of ¥73,000 million. Canon has estimated the amortization period for the customer relationships, and patents and developed technology to be 15 years and 10 years, respectively. The weighted average amorti- zation period for all intangible assets is approximately 13 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 capabil- ities. 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. 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 statement 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 years ended December 31, 2017 and 2016 that were not material to its consolidated financial statements. 8. GOODWILL AND OTHER INTANGIBLE ASSETS Intangible assets subject to amortization acquired during the year ended December 31, 2017, including those recorded from businesses acquired, totaled ¥35,112 million, which pri- marily consist of software of ¥33,437 million and customer relationships of ¥1,203 million. The weighted average amorti- zation periods for intangible assets in total acquired during the year ended December 31, 2017 are approximately 5 years. The weighted average amortization periods for software and cus- tomer relationships acquired during the year ended December 31, 2017 are approximately 5 years and 8 years, respectively. Intangible assets subject to amortization acquired during the year ended December 31, 2016, including those recorded from businesses acquired, totaled ¥266,325 million, which pri- marily consist of customer relationships of ¥155,997 million, patents and developed technology of ¥73,451 million and software of ¥36,054 million. The weighted average amortiza- tion periods for intangible assets in total acquired during the year ended December 31, 2016 are approximately 14 years. The weighted average amortization periods for customer relationships, patents and developed technology and soft- ware acquired during the year ended December 31, 2016 are approximately 15 - 20 years, 10 years and 5 years, respectively. 62 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA The components of intangible assets subject to amortization at December 31, 2017 and 2016 were as follows: December 31 Millions of yen Software Customer relationships Patents and developed technology Trademarks License fees Other 2017 2016 Gross carrying amount 342,322 162,832 121,886 48,823 13,565 18,592 708,020 Accumulated amortization 217,654 22,463 27,085 9,890 6,375 8,136 291,603 Gross carrying amount 313,599 172,234 106,250 44,704 15,561 17,713 670,061 Accumulated amortization 193,785 11,146 16,272 5,610 6,756 8,250 241,819 Aggregate amortization expense for the years ended December 31, 2017, 2016 and 2015 was ¥72,169 million, ¥50,963 million and ¥49,568 million, respectively. Estimated amortization expense for intangible assets currently held for the next five years ending December 31 is ¥67,791 million in 2018, ¥57,214 million in 2019, ¥45,435 million in 2020, ¥37,265 million in 2021, and ¥30,805 million in 2022. Intangible assets not subject to amortization other than goodwill at December 31, 2017 were not significant. Intangible assets not subject to amortization other than good- will at December 31, 2016 were ¥18,026 million, which primarily consist of in-process research and development recorded from businesses acquired. For management reporting purposes, goodwill is not allo- cated to the segments. Goodwill has been allocated to its respective segment for impairment testing. The changes in the carrying amount of goodwill by segment for the years ended December 31, 2017 and 2016 were as follows: Years ended December 31 Millions of yen 2017: Balance at beginning of year Goodwill acquired during the year Transfer*1 Impairment loss*2 Translation adjustments and other Balance at end of year Years ended December 31 Millions of yen 2016: Balance at beginning of Office Imaging System Medical System Industry and Others Unallocated*1 Total 136,256 49,034 — 258,456 492,678 936,424 857 — (33,912) 236 — — — 499,855 — 2,394 (7,177) — — (492,678) — 3,487 — (33,912) 9,855 113,056 3,291 52,561 60 499,915 17,517 271,190 — — 30,723 936,722 Office Imaging System Medical System Industry and Others Unallocated*1 Total year 142,551 53,474 — 282,918 — 478,943 Goodwill acquired during the year Translation adjustments and other Balance at end of year 863 — (7,158) 136,256 (4,440) 49,034 — — — 4,589 492,678 498,130 (29,051) 258,456 — 492,678 (40,649) 936,424 *1 Canon did not complete the allocation of goodwill to the segments for impairment testing which was attributable to the acquisition of TMSC as of December 31, 2016. Based on the realignment of Canon’s internal reporting and management structure, Canon newly established Medical System Business Unit effec- tive at the beginning of the second quarter of 2017. Goodwill related to TMSC as well as goodwill related to certain medical business which was previously included in Industry and Others Business Unit have been transferred to Medical System Business Unit. *2 After entering the commercial printing business through the acquisition of Océ N.V. in 2010, the market environment surrounding this business has become significantly competitive and rapid technological changes have required increasing investments into R&D. These factors resulted in lower operating margin than expected, which led to the decline in the estimated fair value of this business which was determined based on the income approach. As the result of the annual goodwill impairment test as of October 1, 2017, it was determined that the estimated fair value of commercial printing business was less than its carry- ing value of the reporting unit. Based on the accounting policy described in Note 1, Canon recognized an impairment charge of ¥33,912 million representing the excess of the carrying amount over the reporting unit’s fair value. CANON ANNUAL REPORT 2017 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. SHORT-TERM LOANS AND LONG-TERM DEBT Short-term loans consisting of bank borrowings at December 31, 2017 and 2016 were ¥33,398 million and ¥601 million, respec- tively. The weighted average interest rate on short-term borrowings outstanding at December 31, 2017 was 0.52%. Long-term debt consisted of the following: December 31 Loan from the banks; bearing interest of 0.06% at December 31, 2017 and 0.13% at December 31, 2016*1 Other debt*2 Less current portion Millions of yen 2017 2016 490,000 9,168 499,168 (5,930) 610,000 2,538 612,538 (1,249) 493,238 611,289 *1 On January 31, 2017, Canon entered into the unsecured revolving credit facility contracts expiring in December 2021 in order to refinance the bank term loan which was due in 2017. Canon prepaid ¥120,000 million of the loan with cash flows generated during the year. The outstanding loans under the credit facili- ties are ¥490,000 million at a floating interest of 0.06% and Canon has no unused credit facilities as of December 31, 2017. *2 The other debt consisted of term-loans and capital lease obligations as of December 31, 2017 and 2016. The aggregate annual maturities of long-term debt outstanding at December 31, 2017 were as follows: Year ending December 31: 2018 2019 2020 2021 2022 Thereafter Millions of yen 5,930 2,372 404 490,342 48 72 499,168 Both short-term and long-term bank loans are primarily made under general agreements which provide that security and guarantees for present and future indebtedness will be given upon request of the bank, and that the bank shall have the right to offset cash deposits against obligations that have become due or, in the event of default, against all obligations due to the bank. 10. TRADE PAYABLES Trade payables are summarized as follows: December 31 Notes Accounts 64 CANON ANNUAL REPORT 2017 Millions of yen 2017 2016 81,002 299,652 38,073 334,196 380,654 372,269 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 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. TMSC temporarily participates in Toshiba Corporate Pension Fund. However, it is not allowed to permanently continue to participate in the fund as a result of the acquisition by Canon. In addition, Canon is required to maintain an equivalent level of pension benefit and therefore plans to establish a new pension plan in 2018. Canon calculated the projected bene- fit obligations based on the benefit level of Toshiba Corporate Pension Fund at December 31, 2017 and 2016, and included proportional share of the plan assets of TMSC to which they have legal right in the following tables. These obligations 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 Curtailments and settlements 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 Settlements 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 2017 2016 2017 2016 906,007 30,889 5,689 — 11,112 (29,020) 4,239 1,149 (435) — 929,630 781,350 29,367 8,238 — 45,778 (25,032) 71,040 (4,734) — — 906,007 392,086 6,962 8,691 1,644 (1,760) (7,884) — (1,069) — 24,909 423,579 349,680 6,816 8,792 1,594 55,629 (6,268) 21,285 — — (45,442) 392,086 667,436 47,376 43,468 — (23,967) 1,223 (23) — 735,513 (194,117) 626,575 12,145 7,304 — (21,782) 43,194 — — 667,436 (238,571) 224,939 14,262 7,160 1,644 (7,884) — — 13,899 254,020 (169,559) 217,870 18,276 7,271 1,594 (6,268) 14,972 — (28,776) 224,939 (167,147) Employer contributions for the year ended December 31, 2017 include contribution of equity securities to a retirement benefit trust. The fair value of those securities at the time of contribution was ¥30,473 million. Amounts recognized in the consolidated balance sheets at December 31, 2017 and 2016 are as follows: December 31 Other assets Accrued expenses Accrued pension and severance cost Japanese plans Millions of yen Foreign plans Millions of yen 2017 2016 2017 2016 1,695 — (195,812) (239,547) (194,117) (238,571) 976 — 1,215 (1,004) 1,346 (840) (169,770) (167,653) (169,559) (167,147) CANON ANNUAL REPORT 2017 65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts recognized in accumulated other comprehensive income (loss) at December 31, 2017 and 2016 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 2017 2016 2017 2016 221,106 (57,430) 251,078 (71,439) 105,883 (3,638) 116,930 (2,652) 163,676 179,639 102,245 114,278 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 2017 2016 2017 2016 894,329 869,355 402,390 377,004 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 2017 2016 2017 2016 924,536 728,724 905,975 666,428 420,383 249,609 390,942 222,449 889,652 728,724 867,706 664,586 394,840 245,247 375,860 222,449 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, 2017, 2016 and 2015 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 66 CANON ANNUAL REPORT 2017 Japanese plans Millions of yen Foreign plans Millions of yen 2017 2016 2015 2017 2016 2015 30,889 29,367 30,009 6,962 6,816 7,760 5,689 8,238 8,008 8,691 8,792 10,572 (10,722) (10,012) (11,857) (20,493) (19,443) (19,579) (12,860) (13,230) (12,592) (145) 14,220 10,944 10,402 5,747 2,185 3,839 — — (83) (63) 85 — — — 17,382 15,876 16,248 10,595 7,866 10,169 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Other changes in plan assets and benefit obligations recognized in other comprehensive income (loss) for the years ended December 31, 2017, 2016 and 2015 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 2017 2016 2015 2017 2016 2015 (15,771) 53,076 9,519 (5,300) 47,365 6,302 1,149 (4,734) — (2,655) (5,747) (2,185) (3,839) (14,220) (10,944) (10,402) 12,860 13,230 12,592 145 — — — (1,069) (85) — 83 — 19 — 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: (15,963) 50,628 11,709 (12,033) 45,095 (47) Prior service credit Actuarial loss Japanese plans Foreign plans Millions of yen Millions of yen (12,727) 11,821 (52) 4,466 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 2017 0.6% 2.6% 2016 0.7% 2.6% 2017 2.2% 1.8% 2016 2.2% 2.1% 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 2017 2016 2015 2017 2016 2015 0.7% 1.1% 1.1% 2.6% 3.0% 3.0% 3.1% 3.1% 3.1% 2.2% 3.0% 2.9% 2.1% 2.0% 2.0% 4.2% 4.4% 5.6% Canon determines the expected long-term rate of return based on the expected long-term return of the various asset categories in which it invests. Canon considers the current expectations for future returns and the actual historical returns of each plan asset category. Plan assets Canon’s investment policies are designed to ensure adequate plan assets are available to provide future payments of pen- sion benefits to eligible participants. Taking into account the expected long-term rate of return on plan assets, Canon for- mulates a “model” portfolio comprised of the optimal com- bination 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 25% is invested in equity securities, approximately 50% 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. CANON ANNUAL REPORT 2017 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 25% is invested in debt securities, and approximately 35% 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 investi- gated the quality of the issue, including rating, interest rate, and repayment dates, and has appropriately diversified the investments. Pooled funds are selected using strategies con- sistent with the equity and debt securities described above. As for investments in life insurance company general accounts, the contracts with the insurance companies include a guaran- teed interest rate and return of capital. With respect to invest- ments in foreign investment vehicles, Canon has investigated the stability of the underlying governments and economies, the market characteristics such as settlement systems and the taxa- tion 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, 2017 and 2016, by asset category, are as follows: December 31, 2017 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 83,765 8,261 — — — 164,946 — 83,765 — 8,261 — 164,946 — 32,240 — — — 73,968 — — — 32,240 — 73,968 — 138,092 — 1,166 — 15,246 — 130,507 — 138,092 — 1,166 — 15,246 — 130,507 — 9,343 — 2,901 — 22,045 — 25,821 9,343 — — 2,901 — 22,045 — 25,821 (and other asset backed securities) Life insurance company general accounts Other assets Investment measured at net asset value — 8,076 — 8,076 — 3 — 3 — 126,985 — 126,985 — 8,683 — 8,683 — 43,070 — — — 43,070 — 15,399 — 73,320 — — — 73,320 5,696 — 230,118 489,996 — 735,513 41,583 206,741 — 254,020 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 (e) Foreign companies Pooled funds (f) Debt securities: Government bonds (g) Municipal bonds Corporate bonds Pooled funds (h) Mortgage backed securities 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 (and other asset backed securities) Life insurance company general accounts Other assets Investment measured at net asset value — 13,612 — 13,612 — — — — — 128,220 — 128,220 — 6,898 — 6,898 — 90,637 — — — 90,637 — 11,574 — 71,358 — — 24 71,382 4,918 — 68 CANON ANNUAL REPORT 2017 153,689 502,173 — 667,436 34,238 185,759 24 224,939 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA (a) The plan’s equity securities include common stock of the Company and certain of its subsidiaries in the amounts of ¥381 million. (b) These funds invest in listed equity securities consisting of approximately 30% Japanese companies and 70% foreign companies for Japanese plans, and mainly foreign compa- nies for foreign plans. (c) This class includes approximately 90% Japanese govern- ment bonds and 10% foreign government bonds for Japanese plans, and mainly foreign government bonds for foreign plans. (d) These funds invest in approximately 30% Japanese govern- ment bonds, 45% foreign government bonds, 5% Japanese municipal bonds, and 20% corporate bonds for Japanese plans. These funds invest in approximately 70% foreign gov- ernment 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 ¥187 million. (f) These funds invest in listed equity securities consisting of approximately 25% Japanese companies and 75% foreign companies for Japanese plans, and mainly foreign compa- nies for foreign plans. (g) This class includes approximately 85% Japanese govern- ment 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 municipal bonds, and 20% corporate bonds for Japanese plans. These funds invest in approximately 70% foreign government bonds and 30% 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 necessarily indicate the risks or ratings of the assets. Level 1 assets are comprised principally of equity securities and government bonds, which are valued using unadjusted quoted market prices in active markets with sufficient volume and frequency of transactions. Level 2 assets are comprised principally of pooled funds that invest in equity and debt secu- rities, corporate bonds, investments in life insurance company general accounts and other assets. Pooled funds are valued at their net asset values that are calculated by the sponsor of the fund and have daily liquidity. Corporate bonds are valued using quoted prices for identical assets in markets that are not active. Investments in life insurance company general accounts are valued at conversion value. Other assets are comprised principally of interest bearing cash and hedge funds. Amounts of actual returns on, and purchases and sales of, Level 3 assets during the years ended December 31, 2017 and 2016 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 ¥14,447 million to its Japanese defined benefit pension plans and ¥22,303 million to its foreign defined benefit pension plans for the year ending December 31, 2018. Estimated future benefit payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Year ending December 31: 2018 2019 2020 2021 2022 2023–2027 Japanese plans Foreign plans Millions of yen Millions of yen 33,137 34,534 36,631 38,470 41,900 218,317 10,599 10,743 11,250 11,986 12,666 71,944 Multiemployer pension plans The amounts of cost recognized for the multiemployer pen- sion plans primarily in the Netherlands for the years ended December 31, 2017, 2016 and 2015 were ¥4,165 million, ¥3,482 million and ¥3,864 million, respectively. The mul- tiemployer pension plan in which the subsidiaries in the Netherlands participated was 96% funded as of December 31, 2016. 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 contribu- tion pension plans of the Company and certain of its sub- sidiaries for the years ended December 31, 2017, 2016 and 2015 were ¥18,979 million, ¥17,603 million and ¥17,277 million, respectively. CANON ANNUAL REPORT 2017 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 2017: Income before income taxes Income taxes: Current Deferred Japanese 276,149 80,225 (7,453) 72,772 Millions of yen Foreign 77,735 35,402 (10,150) 25,252 Total 353,884 115,627 (17,603) 98,024 2016: Income before income taxes 135,131 109,520 244,651 Income taxes: Current Deferred 47,687 4,126 51,813 27,806 3,062 30,868 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 The Company and its domestic subsidiaries are subject to a number of income taxes, which, in the aggregate, repre- sent a statutory income tax rate of approximately 31%, 33% and 35% for the years ended December 31, 2017, 2016 and 2015, 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. The Tax Cuts and Jobs Act of 2017 (the “Act”) was enacted in the U.S. on December 22, 2017. Due to the Act, the fed- eral corporate income tax rate in the U.S. is reduced from 35% to 21% from the fiscal year commencing on January 1, 2018. The adjustment to deferred tax assets and liabilities for the tax rate change was tax benefit of ¥14,563 million for the year ended December 31, 2017. The impacts related to other changes from the Act are not material. 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 Effect of enacted changes in U.S. tax laws Other 2017 31.0% 2016 33.0% 2015 35.0% 3.7 (2.1) (4.8) 1.7 — (3.6) 1.8 0.8 (3.0) (3.0) (0.8) 1.4 — 5.4 0.8 (2.9) (4.8) (0.4) 1.9 — 3.8 Effective income tax rate 27.7% 33.8% 33.4% * Expenses not deductible for tax purposes for the year ended December 31, 2017 primarily consist of impairment losses on goodwill. 70 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Net deferred income tax assets and liabilities are included in the accompanying consolidated balance sheets under the follow- ing captions: December 31 Other assets Other noncurrent liabilities Millions of yen 2017 150,854 (90,010) 2016 149,866 (108,429) 60,844 41,437 The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at December 31, 2017 and 2016 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 Intangible assets Other Total deferred tax liabilities Net deferred tax assets Millions of yen 2017 2016 11,921 4,705 98,114 5,383 33,488 30,126 29,006 38,526 251,269 (30,783) 220,486 (9,859) (1,815) (4,396) (38,287) (74,377) (30,908) (159,642) 60,844 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 The net changes in the total valuation allowance were an increase of ¥4,096 million for the year ended December, 2017 and a decrease of ¥6,244 million and ¥4,567 million for the years ended December 31, 2016 and 2015, respectively. Based on 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 valuation allowance, at December 31, 2017. At December 31, 2017, Canon had net operating losses which can be carried forward for income tax purposes of ¥185,637 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 654 38,641 39,278 52,250 54,814 185,637 CANON ANNUAL REPORT 2017 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Income taxes have not been accrued on undistributed earn- ings of domestic subsidiaries as the tax law provides a means by which the dividends from a domestic subsidiary can be received tax free. Canon has not recognized deferred tax liabilities of ¥27,361 million for a portion of undistributed earnings of foreign subsidiaries of ¥961,735 million as of December 31, 2017 because Canon currently does not expect to have such amounts distributed or paid as dividends to the Company in the foreseeable future. Deferred tax liabilities will be recog- nized when Canon expects that it will realize those undistrib- uted earnings in a taxable manner, such as through receipt of dividends or sale of the investments. 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 2017 7,318 2,956 250 (915) — 673 10,282 Millions of yen 2016 6,056 2,741 — (665) (370) (444) 7,318 2015 6,431 2,174 165 (1,180) (505) (1,029) 6,056 The total amounts of unrecognized tax benefits that would reduce the effective tax rate, if recognized, were ¥10,282 million and ¥7,318 million at December 31, 2017 and 2016, respectively. Although Canon believes its estimates and assumptions of unrecognized tax benefits are reasonable, uncertainty regard- ing the final determination of tax examination settlements and any related litigation could affect the effective tax rate in a future period. Based on each of the items of which Canon is aware at December 31, 2017, 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 inter- est and penalties accrued at December 31, 2017 and 2016, and interest and penalties included in income taxes for the years ended December 31, 2017, 2016 and 2015 were not significant. Canon files income tax returns in Japan and various foreign tax jurisdictions. In Japan, Canon is no longer subject to reg- ular income tax examinations by the tax authority for years before 2017 with few exceptions. Canon is also no longer subject to a transfer pricing examination by the tax author- ity for years before 2017 with few exceptions. In other major foreign tax jurisdictions, including the United States and the Netherlands, Canon is no longer subject to income tax examinations by tax authorities for years before 2007 with few exceptions. The tax authorities are currently conducting income tax examinations of Canon’s income tax returns for years after 2006 in major foreign tax jurisdictions. 72 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 13. LEGAL RESERVE AND RETAINED EARNINGS The Corporation Law of Japan provides that an amount equal to 10% of distributions from retained earnings paid by the Company and its Japanese subsidiaries be appropriated as a legal reserve. No further appropriations are required when the total amount of the additional paid-in capital and the legal reserve equals 25% of their respective stated capital. The Corporation Law of Japan also provides that additional paid- in capital and legal reserve are available for appropriations by resolution of the shareholders. Certain foreign subsidiaries are also required to appropriate their earnings to legal reserves under the laws of their respective countries. Cash dividends and appropriations to the legal reserve charged to retained earnings for the years ended December 31, 2017, 2016 and 2015 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, 2017 did not reflect cur- rent year-end dividends in the amount of ¥91,779 million which were approved by the shareholders in March 2018. 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 ¥953,952 million at December 31, 2017. Retained earnings at December 31, 2017 included Canon’s equity in undistributed earnings of affiliated compa- nies accounted for by the equity method in the amount of ¥17,139 million. Changes in accumulated other comprehensive income (loss) for the years ended December 31, 2017, 2016 and 2015 are as follows: Millions of yen 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 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, 2017 Foreign currency translation adjustments Unrealized gains and losses on securities Gains and losses on derivative instruments Pension liability adjustments Total 144,557 12,546 (2,603) (126,214) 28,286 73 — — — 73 (57,592) — (57,519) 87,038 1,691 (182) 1,509 14,055 (256) (6,155) (62,312) 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) — — — — — 44,184 2,813 (1,452) 14,785 60,330 (16) (12,580) 44,168 30,208 (9,767) 5,484 4,014 2,562 (180) 4,905 19,690 (178,740) (3,677) 56,653 (143,228) CANON ANNUAL REPORT 2017 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Reclassifications out of accumulated other comprehensive income (loss) for the years ended December 31, 2017, 2016 and 2015 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 2017 2016 2015 Affected line items in consolidated statements of income (39) 12 (27) 11 (16) (18,472) 5,727 (12,745) 165 (12,580) 5,772 (1,732) 4,040 (26) 4,014 7,005 (1,832) 5,173 (268) 4,905 139 (46) 93 — 93 282 (94) 188 194 382 (5,890) 2,049 (3,841) (21) (3,862) (16) 164 148 (49) 99 — Other, net — Income taxes — Consolidated net income — Net income attributable to noncontrolling interests — Net income attributable to Canon Inc. (298) Other, net 104 Income taxes (194) Consolidated net income Net income attributable to noncontrolling interests 12 (182) Net income attributable to Canon Inc. 4,217 Other, net (1,180) 3,037 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 4 3,041 1,504 (175) 1,329 23 1,352 Net income attributable to Canon Inc. Total amount reclassified, net of tax and noncontrolling interests (3,677) (3,288) 4,211 *1 Amounts in parentheses indicate gains in consolidated statements of income. 74 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Tax effects allocated to each component of other comprehensive income (loss) and reclassification adjustments, including amounts attributable to noncontrolling interests, are as follows: Years ended December 31 2017: 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) 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) Before-tax amount 47,825 (39) 47,786 5,100 (18,472) (13,372) (2,080) 5,772 3,692 20,991 7,005 27,996 66,102 (108,280) 139 (108,141) 1,184 282 1,466 1,619 (5,890) (4,271) Millions of yen Tax (expense) or benefit (708) 12 (696) (1,717) 5,727 4,010 628 (1,732) (1,104) (4,957) (1,832) (6,789) (4,579) 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 47,117 (27) 47,090 3,383 (12,745) (9,362) (1,452) 4,040 2,588 16,034 5,173 21,207 61,523 (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) CANON ANNUAL REPORT 2017 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. STOCK-BASED COMPENSATION On May 1, 2011, based on the approval of the shareholders, the Company granted stock options to its directors, execu- tive officers and certain employees to acquire 912,000 shares of common stock. These option awards vest after two years of continued service beginning on the grant date and have a four year exercisable period. The grant-date fair value per share of the stock options granted during the year ended December 31, 2011 was ¥772. 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, 2017, 2016 and 2015 was nil. A summary of option activity under the stock option plans as of and for the years ended December 31, 2017, 2016 and 2015 is presented below: Outstanding at January 1, 2015 Exercised Forfeited/Expired Outstanding at December 31, 2015 Exercised Forfeited/Expired Outstanding at December 31, 2016 Exercised Forfeited/Expired Outstanding at December 31, 2017 Exercisable at December 31, 2017 Weighted- average exercise price Weighted-average remaining contractual term Aggregate intrinsic value Shares 1,861,800 (249,600) (316,200) 1,296,000 — (693,000) 603,000 — (603,000) Yen 4,036 3,311 3,678 4,263 — 4,500 3,990 — 3,990 Year Millions of yen 0.7 248 0.4 — 0.2 — — — — — — — Cash received from the exercise of stock options for the years ended December 31, 2017 and 2016 were nil, and 2015 was ¥826 million, respectively. 76 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 16. NET INCOME ATTRIBUTABLE TO CANON INC. SHAREHOLDERS PER SHARE A reconciliation of the numerators and denominators of basic and diluted net income attributable to Canon Inc. shareholders per share computations is as follows: Years ended December 31 Millions of yen 2017 2016 2015 Net income attributable to Canon Inc. 241,923 150,650 220,209 Average common shares outstanding Effect of dilutive securities: Stock options Number of shares 1,085,439,370 1,092,070,680 1,092,017,955 — — 34,931 Diluted common shares outstanding 1,085,439,370 1,092,070,680 1,092,052,886 Net income attributable to Canon Inc. shareholders per share: Basic Diluted 222.88 222.88 Yen 137.95 137.95 201.65 201.65 The computation of diluted net income attributable to Canon Inc. shareholders per share for the years ended December 31, 2017 and 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 year ended December 31, 2015 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 finan- cial instruments are comprised principally of foreign exchange contracts utilized by the Company and certain of its subsid- iaries to reduce the risk. Canon assesses foreign currency exchange rate risk by continually monitoring changes in the exposures and by evaluating hedging opportunities. Canon does not hold or issue derivative financial instruments for trad- ing 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 counter- parties will fail to meet their obligations. Most of the counter- parties are internationally recognized financial institutions and selected by Canon taking into account their financial condi- tion, 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 for- eign exchange contracts to manage certain foreign currency exchange exposures principally from the exchange of U.S. dol- lars and euros into Japanese yen. These contracts are primar- ily 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. CANON ANNUAL REPORT 2017 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 earn- ings 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, 2017 and 2016 are set forth below: December 31 To sell foreign currencies To buy foreign currencies Millions of yen 2017 2016 272,563 371,644 46,168 46,741 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, 2017 and 2016. Derivatives designated as hedging instruments December 31 Balance sheet location 2017 2016 Fair value Millions of yen Assets: Foreign exchange contracts Liabilities: Foreign exchange contracts Prepaid expenses and other current assets 255 19 Other current liabilities 367 1,913 Derivatives not designated as hedging instruments December 31 Balance sheet location 2017 2016 Fair value Millions of yen Assets: Foreign exchange contracts Liabilities: Foreign exchange contracts Prepaid expenses and other current assets 289 567 Other current liabilities 2,892 7,479 78 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Effect of derivative instruments in the consolidated statements of income The following tables present the effect of Canon’s derivative instruments in the consolidated statements of income for the years ended December 31, 2017, 2016 and 2015. 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 2017: Foreign exchange contracts 2016: Foreign exchange contracts 2015: Foreign exchange contracts (2,080) Other, net (5,772) Other, net (332) 1,619 Other, net 5,890 Other, net 52 Other, net (4,217) Other, net (311) (131) Derivatives not designated as hedging instruments Years ended December 31 Gain (loss) recognized in income on derivative Foreign exchange contracts Location 2017 Other, net (7,932) Millions of yen 2016 7,018 2015 1,099 18. COMMITMENTS AND CONTINGENT LIABILITIES Commitments At December 31, 2017, commitments outstanding for the pur- chase of property, plant and equipment approximated ¥36,199 million, and commitments outstanding for the purchase of parts and raw materials approximated ¥135,649 million. Canon occupies sales offices and other facilities under lease arrangements accounted for as operating leases. Deposits made under such arrangements aggregated ¥13,740 million and ¥13,128 million at December 31, 2017 and 2016, respec- tively, and are included in noncurrent receivables in the accom- panying consolidated balance sheets. Rental expenses of cancelable and noncancelable operating leases amounted to ¥47,619 million, ¥42,714 million and ¥46,483 million for the years ended December 31, 2017, 2016 and 2015, 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, 2017 are as follows: Year ending December 31: 2018 2019 2020 2021 2022 Thereafter Total future minimum lease payments Millions of yen 28,414 21,437 16,185 12,721 9,774 22,971 111,502 CANON ANNUAL REPORT 2017 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Guarantees Canon provides guarantees for its employees, affiliates and other companies. The guarantees for the employees are prin- cipally made for their housing loans. The guarantees for affili- ates and other companies are made for their lease obligations and bank loans to ensure that those companies operate with less financial risk. Canon would have to perform under a guarantee if the bor- rower defaults on a payment within the contract terms. The contract terms are 1 year to 30 years in case of employees with housing loans, and 1 year to 7 years in case of affiliates and other companies with lease obligations and bank loans. The maximum amount of undiscounted payments Canon would have had to make in the event of default is ¥6,059 mil- lion at December 31, 2017. The carrying amounts of the liabil- ities recognized for Canon’s obligations as a guarantor under those guarantees at December 31, 2017 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, 2017 and 2016 are summarized as follows: Years ended December 31 Millions of yen Balance at beginning of year Additions Utilization Other Balance at end of year 2017 13,168 18,893 (12,957) (1,652) 17,452 2016 14,014 15,403 (12,759) (3,490) 13,168 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 unpredict- able, 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 reason- ably possible range of losses from outstanding matters would not have a material adverse effect on Canon’s consolidated financial position, results of operations, or cash flows. 80 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA 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, 2017 and 2016 are set forth below. The following summary excludes cash and cash equivalents, trade receivables, finance receivables, noncurrent receivables, short-term loans, trade payables and accrued expenses for which fair values approximate their carrying amounts. The summary also excludes investments and derivative instruments which are disclosed in Note 2 and Note 17, respectively. December 31 Millions of yen 2017 2016 Carrying amount Estimated fair value Carrying amount Estimated fair value Long-term debt, including current installments (499,168) (499,126) (612,538) (612,668) 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, 2017 and 2016, one customer accounted for approximately 8% and 12% 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. CANON ANNUAL REPORT 2017 81 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 2017 and 2016. December 31 Millions of yen 2017: Assets: Cash and cash equivalents Available-for-sale (current): Corporate bonds Available-for-sale (noncurrent): Government bonds Corporate bonds Fund trusts Equity securities Derivatives Total assets Liabilities: Derivatives Total liabilities 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 — 70,500 1,222 — 289 605 13 20,901 — 23,030 — — — 217 111 — 544 71,372 3,259 3,259 — — — — — — — — — — 70,500 1,222 289 822 124 20,901 544 94,402 3,259 3,259 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 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. Derivative financial instruments are comprised of for- eign exchange contracts. Level 2 derivatives are valued using quotes obtained from counterparties or third parties, which are periodically validated by pricing models using observable market inputs, such as foreign currency exchange rates and interest rates, based on market approach. Assets and liabilities measured at fair value on a nonrecurring basis The following table presents the Canon’s asset that was measured at fair value on a nonrecurring basis consistent with the fair value hierarchy and related impairment charge recognized during the year ended December 31, 2017. There were no assets or liabilities to be measured at fair value on a nonrecurring basis during the year ended December 31, 2016. Year ended December 31, 2017 Millions of yen 2017: Asset: Goodwill 82 CANON ANNUAL REPORT 2017 Total loss Level 1 Level 2 Level 3 Total (33,912) — — 29,370 29,370 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Goodwill was classified as Level 3 items and valued based on an income approach using unobservable inputs. Canon performed the annual goodwill impairment test as of October 1, 2017, which indicated that the fair value of the reporting unit was less than its carrying value. Canon recog- nized the impairment charge for the amount representing the excess of the carrying amount over the reporting unit’s fair value. The fair value for the reporting unit was mea- sured based on the discounted cash flow method with 6.0% of weighted average cost of capital and estimated future cash flows. Future cash flows are based on management’s estimates of projected revenues, gross profits, operating expenses, a long-term growth rate, taking into consideration industry trends and market conditions. 21. SEGMENT INFORMATION Canon operates its business in four segments: the Office Business Unit, the Imaging System Business Unit, the Medical 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. Based on the realignment of Canon’s internal reporting and management structure, Canon newly established Medical System Business Unit effective at the beginning of the second quarter of 2017, and certain businesses included in Industry and Others Business Unit have been reclassified. Operating results for the year ended December 31, 2017 have been reclassified and for the years ended December 31, 2016 and 2015 were not restated since they were not material. Total assets for the year ended December 31, 2016 have been restated and for the year ended December 31, 2015 were not restated since they were not material. The primary products included in each segment are as follows: Office Business Unit: Office multifunction devices (MFDs) / Laser multifunction print- ers (MFPs) / Laser printers / Digital production printing systems / High speed continuous feed printers / Wide-format printers / Document solutions 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 Medical System Business Unit: Digital radiography systems / Diagnostic X-ray systems / Computed tomography / Magnetic resonance imaging / Diagnostic ultrasound systems / Clinical chemistry analyzers / Ophthalmic equipment Industry and Others Business Unit: Semiconductor lithography equipment / FPD (Flat panel dis- play) lithography equipment / Vacuum thin-film deposition equipment / Organic LED (OLED) panel manufacturing equip- ment / 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. CANON ANNUAL REPORT 2017 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Information about operating results and assets for each segment as of and for the years ended December 31, 2017, 2016 and 2015 is as follows: Millions of yen 2017: Net sales: Office Imaging System Medical System Industry and Others Corporate and eliminations Consolidated External customers Intersegment Total Operating cost and expenses 1,863,688 2,240 1,865,928 1,685,280 1,135,584 604 1,136,188 960,275 434,985 1,202 436,187 413,682 645,758 85,946 731,704 674,916 — (89,992) (89,992) 14,383 4,080,015 — 4,080,015 3,748,536 Operating profit 180,648 175,913 22,505 56,788 (104,375) 331,479 Total assets Depreciation and amortization Impairment losses on goodwill Capital expenditures 962,006 74,377 33,912 47,653 387,088 41,695 — 28,508 238,824 5,212 — 8,963 360,271 37,705 — 15,736 3,250,102 102,892 — 80,529 5,198,291 261,881 33,912 181,389 2016: Net sales: External customers Intersegment Total Operating cost and expenses Operating profit 1,804,862 2,957 1,807,819 1,638,333 1,094,291 998 1,095,289 950,876 169,486 144,413 — — — — — 502,334 82,326 584,660 577,212 — (86,281) (86,281) 6,200 3,401,487 — 3,401,487 3,172,621 7,448 (92,481) 228,866 Total assets Depreciation and amortization Capital expenditures 961,749 78,319 72,189 391,661 47,386 25,564 204,755 — — 340,455 41,053 29,346 3,239,909 83,338 81,280 5,138,529 250,096 208,379 2015: Net sales: External customers Intersegment Total Operating cost and expenses Operating profit Total assets Depreciation and amortization Capital expenditures 2,108,246 2,570 2,110,816 1,820,230 1,262,667 1,168 1,263,835 1,080,396 290,586 183,439 1,020,758 86,206 73,819 452,283 52,070 38,337 — — — — — — — — 429,358 95,293 524,651 537,730 — (99,031) (99,031) 6,705 3,800,271 — 3,800,271 3,445,061 (13,079) (105,736) 355,210 332,252 45,064 24,241 2,622,480 89,987 106,733 4,427,773 273,327 243,130 Intersegment sales are recorded at the same prices used in transactions with third parties. Expenses not directly asso- ciated with specific segments are allocated based on the most reasonable measures applicable. Corporate expenses include certain corporate research and development expenses. Amortization costs of identified intangible assets resulting from the purchase price allocation of TMSC are also included in corporate expenses. Segment assets are based on those directly associated with each segment. Corporate assets pri- marily consist of cash and cash equivalents, investments, deferred tax assets, goodwill, identified intangible assets from acquisitions and corporate properties. Capital expenditures represent the additions to property, plant and equipment and intangible assets measured on an accrual basis. 84 CANON ANNUAL REPORT 2017 STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Information about product sales to external customers by business unit for the years ended December 31, 2017, 2016 and 2015 is as follows: Years ended December 31 Office Monochrome copiers Color copiers Printers Others Total Imaging System Cameras Inkjet printers Others Total Medical System Diagnostic equipment Industry and Others Lithography equipment Others Total Consolidated Millions of yen 2017 2016 2015 287,823 405,576 702,491 467,798 289,532 386,193 664,846 464,291 328,061 421,209 857,369 501,607 1,863,688 1,804,862 2,108,246 702,598 333,721 99,265 666,868 329,066 98,357 782,623 362,663 117,381 1,135,584 1,094,291 1,262,667 434,985 — — 193,113 452,645 121,090 381,244 123,887 305,471 645,758 502,334 429,358 4,080,015 3,401,487 3,800,271 Information by major geographic area as of and for the years ended December 31, 2017, 2016 and 2015 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 2017 2016 2015 884,828 1,107,515 1,028,415 1,059,257 706,979 963,544 913,523 817,441 714,280 1,144,422 1,074,366 867,203 4,080,015 3,401,487 3,800,271 1,081,522 141,937 174,889 149,244 1,163,374 147,129 166,734 164,007 937,716 150,105 183,451 189,588 1,547,592 1,641,244 1,460,860 Net sales are attributed to areas based on the location where the product is shipped to the customers. Other than in Japan and the United States, Canon does not conduct busi- ness in any individual country in which its sales in that coun- try exceed 10% of consolidated net sales. Net sales in the United States were ¥1,022,305 million, ¥884,083 million and ¥1,047,838 million for the years ended December 31, 2017, 2016 and 2015, respectively. Long-lived assets represent property, plant and equipment and intangible assets for each geographic area. CANON ANNUAL REPORT 2017 85 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS Years ended December 31 Millions of yen 2017: Allowance for doubtful receivables Trade receivables Finance receivables 2016: Allowance for doubtful receivables Trade receivables Finance receivables 2015: 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 11,075 2,325 12,077 2,878 12,122 6,276 3,574 1,436 1,460 398 2,180 55 (1,787) (1,523) (1,824) (978) (1,745) (1,343) 516 443 (638) 27 (480) (2,110) 13,378 2,681 11,075 2,325 12,077 2,878 86 CANON ANNUAL REPORT 2017 MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Canon is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934, as amended, as a process designed by, or under the supervision of, the company’s principal executive and principal financial officers and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with gener- ally accepted accounting principles and includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide rea- sonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, pro- jections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Canon’s management assessed the effectiveness of internal control over financial reporting as of December 31, 2017. 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, 2017, 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. This report appears in Item 18. During 2017, Toshiba Medical Systems Corporation (“TMSC”) (Canon Medical Systems Corporation as of January 4, 2018) which Canon acquired in 2016 was integrated into the Canon’s internal control over financial reporting. Canon assessed the effective- ness of internal control over financial reporting of TMSC as of December 31, 2017. There are no other changes in Canon’s inter- nal control over financial reporting that occurred during the period covered by this Annual Report that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting. CANON ANNUAL REPORT 2017 87 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and the Board of Directors of Canon Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Canon Inc. and subsidiaries (the Company) as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and schedule of valuation and qualifying accounts (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, 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 29, 2018 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regard- ing the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and sig- nificant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. We have served as the Company’s auditor for SEC reporting purposes since 2004, and as its Japanese statutory auditor since 1978. March 29, 2018 88 CANON ANNUAL REPORT 2017 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and the Board of Directors of Canon Inc. Opinion on Internal Control over Financial Reporting We have audited Canon Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2017, 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). In our opinion, Canon Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and schedule of valuation and qualifying accounts and our report dated March 29, 2018 expressed an unqualified opinion thereon. Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, 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. Definition and Limitations of Internal Control Over Financial Reporting 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. March 29, 2018 CANON ANNUAL REPORT 2017 89 TRANSFER AND REGISTRAR’S OFFICE SHAREHOLDER INFORMATION Canon Inc. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan Stock Exchange Listings: Tokyo, Nagoya, Fukuoka, Sapporo and New York stock exchanges Manager of the Register of Shareholders Mizuho Trust & Banking Co., Ltd. 2-1, Yaesu 1-chome, Chuo-ku, Tokyo 103-8670, Japan Depositary and Agent with Respect to American Depositary Receipts for Common Shares JPMorgan Chase Bank, N.A. 4 New York Plaza Floor 12, New York, NY 10004, USA American Depositary Receipts are traded on the New York Stock Exchange (CAJ). Ordinary General Meeting of Shareholders: March 29, 2018, 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 2017 MAJOR CONSOLIDATED SUBSIDIARIES (As of December 31, 2017) Manufacturing Canon Precision Inc. Fukushima Canon Inc. Toshiba Medical Systems Corporation Marketing & Other Canon Marketing Japan Inc. Canon System and Support Inc. Canon IT Solutions Inc. Toshiba Electron Tubes & Devices Co., Ltd. Toshiba Medical Finance Co., Ltd. Canon Chemicals Inc. Canon Components, Inc. Canon Electronics Inc. Canon Finetech Nisca Inc. Canon Tokki Corporation Canon ANELVA Corporation Nagahama Canon Inc. Canon Machinery Inc. Oita Canon Materials Inc. Oita Canon Inc. Nagasaki Canon Inc. Miyazaki Canon Inc. Canon Virginia, Inc. Canon Bretagne S.A.S. Axis Communications AB Océ-Technologies B.V. Canon U.S.A., Inc. Canon Canada Inc. Canon Solutions America, Inc. Canon Financial Services, Inc. Toshiba America Medical Systems, Inc. Axis AB 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. Océ Printing Systems G.m.b.H. & Co. KG Toshiba Medical Systems Europe B.V. Canon (China) Co., Ltd. Canon Hongkong Co., Ltd. Canon Singapore Pte. Ltd. Canon India Pvt. Ltd. Canon Australia Pty. Ltd. 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. Toshiba Medical Systems Manufacturing Asia Sdn. Bhd. Research & Development Canon Research Centre France S.A.S. Canon Information Systems Research Australia Pty. Ltd. 91 CANON ANNUAL REPORT 2017C A N O N A N N U A L R E P O R T 2 0 1 7 CANON INC. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan ©Canon Inc. 2018 PUB.BEP027-01 0418

Continue reading text version or see original annual report in PDF format above