Canon
Annual Report 2020

Plain-text annual report

CANON ANNUAL REPORT 2020 Fiscal Year Ended December 31, 2020 TABLE OF CONTENTS Strategy 1 Financial Highlights 2 To Our Shareholders 9 Business Strategy Business Segment/ Corporate Structure 18 At a Glance 20 Research & Development 22 Production 24 Sales & Marketing 26 ESG Financial Section 32 Financial Overview 46 Ten-Year Financial Summary 48 Consolidated Balance Sheets 49 Consolidated Statements of Income 49 Consolidated Statements of Comprehensive Income 50 Consolidated Statements of Equity 51 Consolidated Statements of Cash Flows 52 Notes to Consolidated Financial Statements 85 Schedule II Valuation and Qualifying Accounts 86 Management’s Report on Internal Control Over Financial Reporting 87 Report of Independent Registered Public Accounting Firm Corporate Data 93 Transfer and Registrar’s Office 93 Shareholder Information 93 Major Consolidated Subsidiaries Cover Photo: As an approach to deal with COVID-19, Canon Medical Systems Europe released a mobile CT solution that allows for diagnos- tic imaging that does not compromise on patient safety, workflow, or image quality. FINANCIAL HIGHLIGHTS Millions of yen (except per share amounts) Thousands of U.S. dollars (except per share amounts) 2020 2019 Change (%) 2020 Net sales Operating profit Income before income taxes Net income attributable to Canon Inc. Net income attributable to Canon Inc. shareholders per share: —Basic —Diluted Total assets ¥ 3,160,243 ¥ 3,593,299 110,547 130,280 83,318 174,420 195,493 124,964 ¥ 79.37 79.35 ¥ 116.79 116.77 ¥ 4,625,614 ¥ 4,771,918 Canon Inc. shareholders’ equity ¥ 2,575,031 ¥ 2,685,496 -12.1 -36.6 -33.4 -33.3 -32.0 -32.0 -3.1 -4.1 $ 30,386,952 1,062,952 1,252,692 801,135 $ 0.76 0.76 $ 44,477,058 $ 24,759,913 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 JPY104=U.S.$1, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 30, 2020, 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 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 Net Income Attributable to Canon Inc. Shareholders per Share (Yen) ROE/ROA (%) 300 200 100 0 10 8 6 4 2 0 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 Basic Diluted ROE ROA 1 CANON ANNUAL REPORT 2020 TO OUR SHAREHOLDERS Canon will further promote a grand strategic transformation by accelerating reforms. FUJIO MITARAI Chairman & CEO Canon Inc. 2 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Performance in 2020 In 2020, the spread of the COVID-19 pandemic and result- devices (MFDs) and laser printers experienced a decrease ing economic restrictions and stagnation led to a significant in demand for both machines and consumable supplies. global economic contraction. In the second half of the term, Furthermore, interchangeable-lens digital cameras contin- economic activities gradually resumed and the Chinese and ued to face severe market conditions amid ongoing market other major economies started to show signs of a recovery. contraction, although sales of new mirrorless cameras were However, the pandemic is far from over, as COVID-19 cases brisk. On the other hand, sales of inkjet printers were strong, have once again surged in Europe and have continued to supported by an increase in home-use demand. In medical spread in the U.S. Overall, economic conditions were chal- systems, amid the stagnation of capital investment by medical lenging throughout the year. Amid such an environment, in institutions in response to the COVID-19 pandemic, sales were this term, which is the final year of Phase V of our “Excellent kept at a slight decrease thanks to demand for COVID-19 Global Corporation Plan” series of five-year management related products. Semiconductor and OLED lithography equip- plans, the Canon Group worked to expand our four new busi- ment increased sales, but amid restrictions on overseas travel ness of commercial printing, network cameras, medical and and urban activity, sales of Flat Panel Display (FPD) lithography industrial equipment to achieve the Phase V key strategy of equipment were significantly impacted and decreased due to accelerating a grand strategic transformation of our business pandemic-related delayed installation. Furthermore, sales of portfolio. Meanwhile, in existing businesses such as office network cameras also grew. machines and cameras, the Canon Group worked to further As a result of the above, consolidated net sales for this improve product and service competitiveness by aiming to term was 3,160.2 billion yen (down 12.1% from the previ- acquire and maintain a high market share and securing a high ous term). Consolidated income before income taxes was profit margin. 130.3 billion yen (down 33.4% from the previous term). However, the COVID-19 pandemic had a significant impact Consolidated net income attributable to Canon Inc. was 83.3 on our business, and office products such as multifunction billion yen (down 33.3% from previous term). Trend in Y/Y Sales Growth (%) 20 0 -20 -40 1Q 2Q 3Q 4Q 3 CANON ANNUAL REPORT 2020Excellent Global Corporation Plan Phase I to Phase IV 1996–2015 printer manufacturer Canon Production Printing (formerly Canon launched the Excellent Global Corporation Plan in Océ) into the Group, firmly establishing our plan to enter the 1996, and has strengthened its management base through high-growth-potential industrial equipment and commercial each of the plan’s five-year initiatives, from Phase I through printing markets. Phase IV. As the markets for our core businesses—such as cameras During Phase I, we stressed thorough cash-flow manage- and office equipment—were maturing, during Phase IV that ment and significantly boosted productivity through the commenced in 2011 we promoted diversification via the lat- introduction of our cell production system, along with other eral expansion of our existing businesses, such as the Cinema measures. In Phase II, we stepped up efforts to digitalize our EOS System, while also accelerating our M&A strategy. In this copying machines and camera offerings, while building the manner, we set out a clear direction for shifting our focus for foundation for a robust financial structure. growth from B2C to B2B. We subsequently reinforced and In Phase III, we rode the globalization and digitization expanded our rapidly growing network camera business by wave to sharply increase sales and build income and profit. In making Milestone Systems (“Milestone”) a subsidiary in 2014, 2007, sales reached our highest ever levels of 4,481.3 billion followed by Axis Communications (“Axis”) in 2015. yen and net profit reached a remarkable 488.3 billion yen. Additionally, Canon Nanotechnologies, formerly Molecular That same year, we turned our attention to OLED for use as Imprints, became a subsidiary in 2014, and we are acceler- the read display for our digital cameras and welcomed OLED ating the development of next-generation semiconductor panel manufacturing equipment maker Canon Tokki (formerly manufacturing equipment that uses nanoimprint lithography, Tokki) into the Group. In 2010 we brought Netherlands-based which will make it possible to achieve both miniaturization Phase I 1996–2000 Phase II 2001–2005 Phase III 2006–2010 Phase IV 2011–2015 Phase V 2016–2020 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 re- form 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 busi- nesses 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 man- agement 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. Canon endeavored to reconsolidate its conven- tional core businesses, which include cameras and office equipment, and completed the first stage of its grand stra- tegic transformation by working to expand and strengthen the four new businesses that will un- derpin Canon’s future: commercial printing, network cameras, medical and industrial equipment. 4 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA and cost reductions for semiconductor devices. by working to expand and strengthen the four new businesses As a manufacturer, Canon strives unceasingly to implement that we believe will underpin Canon’s future: commercial production reforms and thorough cost reductions. At the printing, network cameras, medical and industrial equipment. same time, we stay on top of opportunities to add excellent Comparing results in 2015 with 2020, the percentage of companies to the Group, in order to shift our focus towards Canon’s total sales from new businesses increased sharply changing growth markets, with the aim of unlocking new from 9% to 28%—a sure sign that they are steadily be- growth potential. Phase V (2016–2020) achievements coming the foundation that will support the Canon Group. During these five years, amid a turbulent environment that included a worldwide economic downturn and the COVID- In Phase V of the Excellent Global Corporation Plan, the 19 pandemic, we accomplished the remarkable feat of what fifth five-year plan launched in 2016, Canon made progress can be regarded as the biggest portfolio transformation in toward a full-fledged entry into the medical field by welcom- Canon’s history. ing Canon Medical Systems Corporation (formerly Toshiba Despite this Group-wide portfolio transformation through Medical Systems) into the Group in 2016. Thus, we completed M&A, our financial health did not falter thanks to the solid our present business makeup, guided by the basic policy of financial foundation that we have built over the years. When “embracing the challenge of new growth through a grand we welcomed Canon Medical Systems into the Group, we strategic transformation.” While working to reconsolidate our borrowed 660 billion yen as operating capital. Since then, we core businesses, such as office equipment and cameras, we have been steadily paying off this debt, and as of the end of made a combined effort to reconstitute our business portfolio last year that balance had been reduced to roughly half. Key strategies 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 our 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 5 CANON ANNUAL REPORT 2020Phase VI basic policy and key strategies In 2021 we commenced a new five-year management plan— Phase VI of the Excellent Global Corporation Plan. Phase VI picks up where Phase V left off, under the basic policy “ac- Strategy 1 celerate our corporate portfolio transformation by improving Printing Group productivity and creating new businesses.” We also advance two key strategies: (1) enhance competitiveness through company-wide realignment into a new industry-oriented busi- ness group structure; and (2) improve group-wide productivity through extensive reinforcement of Canon’s global head- quarter functions. For 2025, the final year of Phase VI, we are targeting record sales of 4,500 billion yen. By executing the aforementioned strategies, we also aim for an operating profit ratio of 12% or greater, a net profit ratio of 8% or higher, and a shareholder equity of 60% or greater. Key strategies The continuous feed press ProStream 1000 The Printing Group consists of office multifunction devices, inkjet printers, laser printers and the commercial and in- dustrial printers of Canon Production Printing. This group aims to further expand and strengthen its product lineup based on electrophotography and inkjet technologies. In addition to expanding its digital commercial printing lineup, which has significant growth potential, the group plans to expand its industrial printing operations, which include label printing and package printing. Moreover, even though it is a maturing market, the office market remains Canon’s big- gest source of income and profit, the group will leverage the advantages of both electrophotography and Bubble Jet technologies in a way that puts together a uniquely Canon product lineup, while at the same time effectively respond- ing to digital transformation by offering a cloud-based on-demand printing environment. (1) Enhance competitiveness through company-wide realign- ment into a new industry-oriented business group structure Until now, Canon had a business division structure vertically aligned around individual products. These business divisions established competitiveness in their respective markets and acquired and developed the leading technology they needed to make better products. But new partners have joined the Group through M&A, and the Canon Group has now become a company possessing a truly diverse range of technologies. So that we can aim to create synergy among our businesses, boost new product development and manufacturing division pro- ductivity, capture changing market needs, further strengthen existing businesses and create new ones, we will be expand- ing and reorganizing our existing businesses operations and related companies into four business groups according to their affinity with each other: Printing, Optical Industry, Industrial Equipment, and Medical. Furthermore, the Frontier business operation that had been a new business has been upgraded to a business headquarters. Utilizing the wide range of technology cultivated over our long history, we will accelerate the materials business and the commercialization of its solutions for produc- tion technology and component sales to outside businesses. 6 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Optical Industry Group Industrial Equipment Group Network cameras at a Fukuoka City Subway station (Fukuoka, Japan) Nanoimprint semiconductor lithography equipment The Optical Industry Group includes cameras and lenses, broadcast equipment, industrial cameras, network cameras, vehicle on-board cameras. This group will leverage the opti- cal and sensor device technologies that Canon has cultivated over its long history, as well as video analytics technology, network technology, and cloud-based imaging AI technology, to expand beyond the conventional camera industry and into the broader field of the optical industry—the backbone of the digital society. More specifically, the group will not only aim to expand operations mainly in the vehicle on-board camera development business by utilizing its optical and network technologies, but also seek to expand the business domain of the network camera business into such areas of social infra- structure as smart cities and integrated resorts. Moreover, the camera business is Canon’s original business and the foundation of the Canon brand. For that reason, the group will strive to defend Canon’s top position in the camera industry by demonstrating its overwhelming competitive edge in the mirrorless segment. The Industrial Equipment Group comprises such equipment as semiconductor and flat panel display (FPD) lithography systems, Canon Tokki’s OLED panel manufacturing systems, Canon Anelva’s vacuum thin-film deposition equipment, Canon Machinery’s die bonders. For OLED panel manufactur- ing equipment, the group leverage its production technology in order to continuously reduce costs. The group will also aim to establish its position as the industry standard in fields where growth is expected. This includes large display panels that demand increasingly higher definition, as well as smart glass applications. Additionally, in the area of semiconduc- tor lithography systems, the group will work to maintain the dominant position of i-line systems by satisfying a diverse range of needs and develop new equipment with outstand- ing productivity for KrF systems with the goal of increasing Canon’s market share. The group will also utilize nanoimprint lithography technology to enter the leading-edge segment of semiconductor production. Currently, most of the techni- cal challenges related to nanoimprint lithography have been solved. Going forward, the group will work with a semicon- ductor device manufacturer to start mass production and will commence testing with the goal of expanding the usage of this technology. 7 CANON ANNUAL REPORT 2020Strategy 1 Medical Group Canon Medical’s Health Care IT Platform A reorganization is already underway in the Medical Group, which aims to expand the medical diagnostic equipment business and lower the base cost of the CT, MRI, diagnostic ultrasound systems and other core products. Regarding cost reductions, the group will take full advantage of the pro- duction technology cultivated through Canon’s production reform activities by developing product platforms and part unit systems. The group will also push manufacturing innova- tion through such advancements as automated assembly and in-house production. Looking ahead, in addition to improv- ing product performance, the group will work to boost the competitiveness of diagnostic solutions and image analysis applications that utilize AI to expand sales not only in Japan, but also in North America, Europe and emerging markets. Furthermore, in the field of in-vitro diagnostics, the group will utilize Canon’s core technologies used in products such as cameras and printers to collaborate with external medical institutions, venture firms, and major medical corporations in an effort to expand its business presence. 8 (2) Improve group-wide productivity through extensive rein- forcement of Canon’s global headquarter functions Canon will also focus on strengthening its head office setup to function effectively across these industry-aligned groups. First of all, we will look to reinforce thorough cash flow management— the basis of our Excellent Global Corporation Plan—and further strengthen our financial foundation in preparation for a major investment or the next economic crisis. While making every effort to establish a more dynamic and merit-based HR management system and improve the productivity of each and every employee, we will expand our in-house training system—which includes the Canon Institute of Software Technology (CIST), manufactur- ing training centers and other initiatives that provide personnel training aligned to our new business portfolio—and implement a personnel policy that assigns each employee in their most suitable role. We will also promote cost reduction efforts across the whole Group in order to further improve automation and in-house production capabilities by way of a combined effort by production technology, development, design, procurement and factories on a complete overhaul of product and device design. In conclusion As we proceed with Phase VI of our Excellent Global Corporation Plan, the five-year period through 2025 is a critically important one in Canon’s next big leap forward. Now, more than ever, we need to practice the Enterprising Spirit and the San-ji Spirit that have been part of Canon’s DNA since our founding and fear- lessly move forward, making every effort to further transform our business portfolio and build a resilient Canon Group that can overcome the challenges we face in any age. We look forward to your continued support and understanding. Fujio Mitarai Chairman & CEO Canon Inc. CANON ANNUAL REPORT 2020B U S I N E S S S T R AT E G Y EXISTING BUSINESS NEW BUSINESS 10 12 MEDICAL ............................................ 12 NETWORK CAMERAS ........................ 14 COMMERCIAL PRINTING ................... 16 INDUSTRIAL EQUIPMENT .................. 17 CANON ANNUAL REPORT 2020 9 EXISTING BUSINESS We seek to further expand market share and continually reinforce profitability A 10 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Multifunction Devices Inkjet Printers Sales of office multifunction devices (“MFDs”) have been Sales of inkjet printers increased as a result of capturing the brisk with the newly launched imageRUNNER ADVANCE DX, demand for working and learning from home in countries which features improved scanning and cloud functionality. such as Europe, the United States and China as well as the Up ahead, we are promoting efficiency in product develop- recovery in demand in some emerging countries. Going ment and reduction in production cost through the sharing forward, we will leverage our strength of having a balanced of product platforms, and aim to grow our market share lineup that includes both cartridge and refillable ink tank by combining durability, reliability, and other quality advan- models, as we work to capture printing demand from the tages—attributes rated highly by the market—with price home to office environments. competitiveness. Laser Printers Lithography Equipment In the semiconductor market the demand for data centers and Low-speed laser printer models met some of the expanding de- IoT devices has been growing as a result of the development mand resulting from working and learning from home. Going of 5G networks and advancements in autonomous vehicles. forward, under a strategy that places greater emphasis on prof- Canon expects its lithography equipment business to grow as itability, in order to achieve steady sales of consumables, we will well. And in the display panel market, large-screen televisions strengthen sales of medium- and high-speed models for the and smartphones are offering increasingly higher definition. office where we can expect higher print volume. We will work to expand flat panel display (FPD) business over Cameras the medium- to long-term. Amid travel restrictions caused by COVID-19, Canon aims For our range of interchangeable-lens digital cameras, we to establish a stable earnings structures with flexible manufac- launched three new mirrorless cameras and eight types of turing through accurate demand forecasting, cost reduction lenses. Sales of the EOS R5 and EOS R6 were particularly brisk. and strengthening predictive maintenance services. Also, the COVID-19 pandemic caused the creation of new demand for goods to be consumed inside the house. As one COVID-19 initiative in 2020, we released EOS Webcam Utility Beta software that enables the use of Canon interchange- able-lens cameras as web cameras. We will work to further strengthen our lineup of EOS R System cameras and RF lenses to facilitate our aim of expanding our market share among pro- fessional and advanced amateur users where demand is solid. A. The EOS R5 features a more advanced AF system using deep learning technology. It enables high-speed continuous shooting at up to 20 frames-per-second, 8K video recording, and handheld shooting with up to 8 stops of in-body image stabilizer. It expands creative possibili- ties of not only photos but movies. B. Our office multifunction devices, imageRUNNER ADVANCE models, are equipped with robust security features and make working with docu- ments a breeze. By connecting to the cloud service, they contribute to the improvement of productivity and the implementation of flexible working styles and also accelerate digital transformation. B 11 CANON ANNUAL REPORT 2020NEW BUSINESS—MEDICAL Reinforcing business operations and expanding business domains to achieve global growth A 12 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Business expansion centering on Response to COVID-19 Canon Medical Systems Given the spread of the COVID-19 pandemic, in 2020 Canon Medical institutions were beset by a challenging business developed and offered a suite of total solutions required for environment in 2020 mainly because the spread of COVID- diagnosing COVID-19 infections; for example, CT equipment, 19 infections meant fewer people were able to access usual diagnostic X-ray systems, diagnostic ultrasound systems, rapid medical care. Nevertheless, there was still strong demand for genetic testing for COVID-19, and rapid antigen testing. In sophisticated medical care and even though we were unable Japan, we partnered with Nagasaki University to develop and to undertake adequate sales activities because of restrictions launch a set of reagents for clinical COVID-19 RNA testing placed on face-to-face meetings, we still secured orders for that can quickly detect novel coronavirus genes. This test- mainly diagnostic imaging equipment. As such, sales decreased ing kit was used by the authorities to test the crew members only slightly year on year. Going forward, we will strengthen and passengers of a cruise ship docked in Nagasaki. Further, the competitiveness of our core products including CT, mag- we launched sales of a COVID-19 antigen test kit, devel- netic resonance imaging (MRI), and diagnostic ultrasound oped through joint research with Yokohama City University. systems, as well as diagnostic solutions and image analysis In the UK, the Bradford Royal Infirmary took delivery of a applications that make use of AI, to expand our medical diag- Relocatable CT Scanner equipped with a complete X-ray CT nostic equipment business. Furthermore, we will push ahead diagnostic system. This mobile CT solution makes possible with enhancing our sales and marketing activities in Europe, diagnostic imaging whenever and wherever needed, and North America, and emerging markets. We will also aim to contributes to reducing the risk of infection among healthcare boldly enter domains on the periphery of diagnostic equip- workers. With no end in sight to the global pandemic, Canon ment, such as test reagents and accelerate business growth will continue to contribute to safety and security in society by making the most of the comprehensive capabilities of the by lending its support to medical practitioners involved in the Canon Group. For CT, MRI, diagnostic ultrasound systems, and treatment of patients infected with COVID-19 and to all re- other mainstay products, in order to fully leverage Canon’s lated parties in other industries. superior production technology with the aim of further shoring up and expanding the medical business—one of the Group’s growth businesses—we will endeavor to implement produc- tion reform activities by developing product platforms and part unit systems. We will also push manufacturing innovation by means of automated assembly, in-house production, and so on, in an all-out effort to further reduce costs. A. Canon Medical’s MRI scanner maximizes high-resolution imaging performance while minimizing space requirements and energy consumption. B. Canon Medical’s diagnostic ultrasound systems harness a technology to send and receive detailed and uniform ultrasound beams at all depths and at high density. This technology delivers crystal-clear and high-definition images with little noise. B 13 CANON ANNUAL REPORT 2020NEW BUSINESS—NETWORK CAMERAS Solutions business that addresses demands in the smart city era A 14 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Network camera systems that combine all of the Canon Group’s extensive strengths and disaster monitoring tools. In Japan, Canon has started providing cloud-based video recording services using network As innovation accelerates at a rapid pace driven by IoT and cameras to facilitate remote operations such as in healthcare AI, network camera systems that can perform advanced video and at retail stores, as well as solutions that monitor and alert analytics, including face recognition and abnormality detec- of office congestion. tion, have become essential in the infrastructure for a safe With our strength, which originates from our large number and secure society that constitutes the basis of a smart city. of high quality products that excel in areas such as low-light Canon entered the network camera market with the sensitivity and image quality, and our large number of sales technology cultivated through camera development, and partners located around the world, we will firmly capture strengthened the business, welcoming Axis Communications market growth. Going forward, by combining the Groups (“Axis”), Milestone Systems (“Milestone”), and BriefCam Ltd. strengths in hardware and software, Canon will expand the (“BriefCam”) into the Group. These companies are leaders in breadth of our solutions and aim to expand business opera- the fields of network cameras, video management systems, tions with a view to providing social infrastructure, such as and video content analytics solutions respectively. smart cities and integrated resorts. While strengthening network camera hardware, Canon is also focused on developing video analytics technologies that make use of AI and fostering technological collaboration be- tween Group companies. Canon continues to deliver network camera systems that meet the needs of the times by combining the Group’s capabilities in the areas of network cameras, video management systems, and video content analytics software. Expanding and strengthening the solutions business Canon is stepping up efforts to develop new solution busi- nesses, combining the high-quality, high-resolution images captured by its network cameras with video content analytics software to analyze the movement of people. In 2020 during the COVID-19 pandemic, Canon strength- ened its sales activities based on diversified applications made possible by video analytics for such purposes as remote moni- toring and monitoring of crowded and confined areas, as well as conventional market needs including crime prevention A. Canon’s high resolution network cameras are installed at Showa Denko Budo Sports Center where sports games are held frequently. The cameras allow to check the site in detail if there is an incident. Canon contributes to creating environments where visitors can be en- thusiastic at sporting events while still feeling safe.(Oita, Japan) B. Canon provides Office Density Alert Solution to support safe and secure office environment management by enabling management de- partments to keep track of congestion levels in office areas in real time. B 15 CANON ANNUAL REPORT 2020NEW BUSINESS—COMMERCIAL PRINTING Consolidating the Canon brand and accelerating business expansion in response to trends in digitalization The continuous feed press ProStream 1000 can print on offset coated paper thanks to Canon’s newly developed ink and ColorGrip technology. Achieving unprecedented high-quality images in digital printing printing. Canon also launched a new high-speed cut-sheet inkjet printer and a new large-format printer for the graphic In the so-called commercial printing market, which includes arts market, which is especially expected to grow. And they the production of books, magazines, brochures, direct have garnered strong support from the market. In addition to mailings, and catalogs, demand is rapidly shifting from plate- this, for large-format printers, we will create a tailwind that based high-volume offset printing to short-run production for will support market share gain, enhancing our sales network broad range of applications quick-turnaround digital print- by adding new dealers that have extensive experience and ing. In 2010, Canon Production Printing (formerly Océ) was a broad customer base in graphic arts. Also, Canon plans to added to the Canon Group. Based in the Netherlands, this strengthen its presence in industrial printing such as label and company boasts a strong track record in the field of commer- other package printing fields expected to demonstrate strong cial printing. market growth. In 2020 Canon consolidated all products under the Canon brand, further strengthened brand unity across all areas of our printing business, and established a system for prod- ucts and services that meet the diversifying needs of digital 16 CANON ANNUAL REPORT 2020NEW BUSINESS—INDUSTRIAL EQUIPMENT Concentrating resources on high value-added businesses and sustaining advanced technological capabilities Canon Tokki produces OLED panel manufacturing equipment with high-level technologies, including vacuum evaporation technology for depositing organic materials onto panel substrates in a vacuum and automated supply lines for glass substrates. Focusing on development of next-generation manufacturing equipment with innovative technology equipment such as vacuum thin-film deposition equipment essential to the production of hard disk drives and LEDs, while the latter commands a large share of the market for die Canon Tokki is the first company to have produced OLED bonders, the equipment used to attach a semiconductor chip panel manufacturing equipment in the world, and our to a substrate. manufacturing capabilities in mainly vacuum evaporation On the other hand, in the semiconductor lithography technology establish us in a dominant position as the industry equipment business, which marks 50 years since entering the standard. OLEDs are rapidly being adopted for the next-gener- lithography equipment business on a full scale, we have devel- ation display panels in smartphones and televisions. oped nanoimprint lithography technology with a method that We have been establishing a solid profit foundation by is significantly different from conventional methods in order reducing costs and making its installation operation more to achieve circuit pattern miniaturization at low manufactur- efficient through close collaboration with not only Canon ing cost. In the future, we aim to expand the applications of Tokki, which has contributed to OLED panel mass produc- nanoimprint lithography equipment and to develop new fields tion, but other Group companies like Canon ANELVA and by utilizing the technologies cultivated in conventional expo- Canon Machinery. The former boasts strengths in sputtering sure equipment. 17 CANON ANNUAL REPORT 2020AT A GLANCE OFFICE BUSINESS UNIT Composition of Sales (%) Office multifunction devices (MFDs) Laser printer based MFDs 45.6% Main Products • Office multifunction devices (MFDs) • Laser printer based MFDs • Laser printers • Digital continuous feed presses • Digital sheet-fed presses • Wide-format printers • Document solutions Digital sheet-fed presses (Inkjet) Digital sheet-fed presses (Electrophotographic) IMAGING SYSTEM BUSINESS UNIT Composition of Sales (%) Interchangeable-lens digital cameras —Mirrorless cameras Interchangeable-lens digital cameras —Digital SLR cameras 22.5% Main Products • Interchangeable-lens digital cameras • Digital compact cameras • Interchangeable lenses • Compact photo printers • Inkjet printers • Large format inkjet printers • Commercial photo printers • Image scanners • Calculators Inkjet printers Large format inkjet printers 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 in- cluded in calculation considerations. 18 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Composition of Sales (%) MEDICAL SYSTEM BUSINESS UNIT 13.8% Main Products • Digital radiography systems • Diagnostic X-ray systems • Computed tomography (CT) systems • Magnetic resonance imaging (MRI) systems • Diagnostic ultrasound systems • Clinical chemistry analyzers • Ophthalmic equipment Computed tomography (CT) systems Diagnostic X-ray systems Diagnostic ultrasound systems Digital radiography systems Composition of Sales (%) INDUSTRY AND OTHERS BUSINESS UNIT 20.7% Main Products • Semiconductor lithography equipment • FPD (Flat panel display) lithography equipment • Vacuum thin-film deposition equipment • Organic LED (OLED) panel manufacturing equipment • Die bonders • Network cameras • Digital camcorders • Digital cinema cameras • Multimedia projectors • Broadcast equipment • Micromotors • Handy terminals • Document scanners Semiconductor lithography equipment FPD (Flat panel display) lithography equipment Organic LED (OLED) panel manufacturing equipment Network cameras 19 CANON ANNUAL REPORT 2020RESEARCH & DEVELOPMENT Canon is perpetually strengthening R&D as a company possessing a corporate DNA that places high importance on technology to differentiate itself from competitors. Canon’s crowd people counting technology utilizes AI to detect and count the number of heads, making it possible to count the number of people in a crowd in real time. 20 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA R&D Expenses and Patents mobile robots to move and transport items autonomously Canon focuses on R&D through strengthening fundamental even in such environments. Going forward, Canon will look to technologies and creating core competency technologies, in commercialize next-generation AGVs in partnership with Nidec- order to provide innovative products and services to society. Shimpo Corporation, a Nidec Group company. By providing our In 2020, R&D expenses amounted to ¥272.3 billion, and the Visual SLAM and other video analytic technologies to the AGV ratio of R&D expenses to net sales was 8.6%. This focus on and AMR, we intend to contribute to improved productivity and R&D has also cemented Canon’s leading position in the intel- accelerating automation in logistics operations. lectual property field. In 2020, Canon was granted 3,225 Canon opens Volumetric Video Studio - Kawasaki patents in the United States, the third highest among all Canon has opened the Volumetric Video Studio - Kawasaki, a companies. This also represents a first place ranking among studio supporting a full creative workflow—from capturing to Japanese companies for 16 consecutive years. editing for Free Viewpoint video and 3D content—located at the company’s Kawasaki Office, volumetric video is a technol- Initiatives to Establish New Businesses ogy involved in the reconstruction of a 3D space from captured Guided by a long-term perspective, Canon focuses on discov- images. Using this system, the images and the entire 3D space ering new technologies for the future. are digitized, allowing the creation of video from any position Canon develops world’s first 1-megapixel SPAD or angle. The system can generate high-detail video and 3D image sensor data almost simultaneously with capturing. The studio was first Canon has developed the world’s first* single photon ava- used in 2020 for a live streaming music event. Through video lanche diode (SPAD) image sensor with signal-amplifying capturing of mainly sports and entertainment events, Canon pixels capable of capturing 1-megapixel images. Featuring a will provide a whole new kind of visual experience. high time resolution of around 20-30 picoseconds (1 picosec- Improving the accuracy of facial recognition technology ond is 1 trillionth of a second), the sensor has the potential to Canon is focusing on developing powerful face authentication contribute to the analysis of various phenomena by capturing technology as image analysis technology to be applied to net- events that happen incredibly fast within an extremely short work cameras. The face authentication technology is capable time frame, like lightning strikes or chemical reactions that of authenticating network camera images captured from an cannot be observed with precision by the naked eye. It could obliquely upward angle, and it is strong against occlusions, also be useful for vehicle distance measurement for self-driv- for example by face masks, and it is also capable of handling ing automobiles and grasping 3D spatial information for xR poor-quality images. We will materialize high accurate face (including augmented reality, mixed reality, and virtual reality) authentication with the proper designing of deep-learning and similar devices. and the learning from a very large number of face images. * Among SPAD sensors. As of June 23, 2020. Based on Canon research. Development of video content analytic software for mobile robot navigation 2020 Top Ten U.S. Patent Holders by Company IBM*1 9,130 Canon has developed vision-based navigation technology, using Samsung Electronics 6,415 Visual SLAM, for next-generation automated guided vehicles (AGVs) and autonomous mobile robots (AMRs). The technology simultaneously estimates a position and orientation of a camera and 3D information of its surrounding environment based on video images. Although it is difficult to apply magnetic guid- ance method and 2D LiDAR-based SLAM to environments CANON Microsoft Intel TSMC*2 LG Electronics Apple Huawei 3,225 2,905 2,867 2,833 2,831 2,791 2,761 where layout changes often occur, our technology enables Qualcomm 2,276 *1 IBM is an abbreviation for International Business Machines Corporation. *2 TSMC is an abbreviation for Taiwan Semiconductor Manufacturing Co Ltd Source: Preliminary data released by IFI CLAIMS Patent Services, a U.S. research company specialized in patent information 21 CANON ANNUAL REPORT 2020 PRODUCTION Canon is a corporation that has constantly pursued ultimate perfection in manufacturing. While striving to further improve production-engineering technology such as automation of assembly lines, we also focus on developing human resources armed with outstanding technical skills. Oita Canon is pursuing in-house production of manufacturing automated assembly machines to maintain highly reliable automated production lines. (Oita, Japan) 22 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Globally Optimized Production improvement of Canon’s production technology and play a Canon employs a globally optimized production system role at the front line of production by passing on their skills to through which we comprehensively determine the most ratio- the next generation. nal locations to produce our products. This decision hinges on We are also endeavoring to develop technicians and en- changes in social and economic circumstances and takes into gineers as human resources for manufacturing for the next account country or region-specific factors such as costs, tax generation. At the 58th National Skills Competition held in systems, logistics, ease of procuring parts, and labor. In Japan 2020 Canon collected a gold medal in the instrument making we are endeavoring to reduce costs by establishing mother skills category. factories that integrate development, procurement, produc- tion, and manufacturing processes. Meanwhile, in emerging countries and regions we aim to boost productivity by further Initiatives for Environmentally Friendly Manufacturing and Enhanced Product Quality honing the skills of employees. Canon leverages regional From product design and development to production, dis- characteristics and manufactures products employing an agile tribution, use, and recycling, throughout the lifecycle of and flexible system that spans the globe. our products in all areas of our business, Canon is engaged in manufacturing initiatives that are friendly to the global Automation and In-house Production environment and minimize environmental impacts. In addi- Canon endeavors to create original products by actively pur- tion, guided by our mission to guarantee the high quality of suing the in-house production of not only CMOS sensors our products, “no claims, no trouble,” we have drawn up and other key devices and components, but also production our own quality standards that are even more stringent than equipment like automated assembly machines and high- ISO9001 or other international quality management stan- precision processing machines, as well as molding dies. To dards. This guarantees that our products are safe and provide produce high-quality products at low cost, we aim to establish satisfaction to our customers. We have devised our own highly reliable automated production lines with zero human unique quality management system to thoroughly comply intervention for toner cartridges and we seek to do the same with quality standards, authentication standards, and relevant for the manufacturing of cameras up ahead. laws in each country. We also carry out a severe evaluation In 2020 we pushed ahead with the development of produc- with the testing facilities corresponding to those standards. tion equipment needed to strengthen production-engineering technology and expand related businesses. Canon Production Printing (CPP) opened a new UVgel ink production facility in Venlo (the Netherlands) to meet growing demand for UVgel ink used in large-format printers for graphic arts market. Furthermore, Canon Mold has been consolidating its six sepa- rate plants in Kasama City in Ibaraki Prefecture with the aim of expanding its mold manufacturing business in the future. Development of Human Resources Canon is focused on nurturing its most skilled technicians, known as Master Craftsmen, and those who contribute to the advancement of manufacturing with their wide-ranging skills and knowledge of assembly and component process- ing, known as Meisters. These technicians contribute to the Production of components for inkjet printers. (Canon Hi-Tech (Thailand), Rachashima Factory) 23 CANON ANNUAL REPORT 2020SALES & MARKETING Accelerating growth in commercial printing, network cameras, medical and industrial equipment as key drivers of Canon’s next-generation business B to B products including commercial printers are displayed at the Customer Experience center in Switzerland. 24 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA Japan tutorials, knowledge sharing and inspiration through ‘Canon Sales in Japan amounted to ¥806.3 billion, or 25.5% of con- Connected’. The group also supported its partners and cus- solidated net sales. tomers by switching to online and virtual events, including the Sales of inkjet printers increased with more people tele- Future Book Forum. commuting or learning from home because of the impact of COVID-19. In addition, sales of mainly IT products and security Asia and Oceania services expanded on the back of greater demand among Sales in the Asia and Oceania region amounted to ¥705.9 bil- mostly small and medium-sized businesses to build telework- lion, or 22.3% of consolidated net sales. ing environments. At the same time, a considerable decline The Canon Asia Marketing Group oversees operations in in printing demand owing to fewer people commuting to the China, South Korea, South Asia, and Southeast Asia. In the office depressed sales of mainstay business equipment such as B to B domain, it developed and launched sales of IT solutions office MFPs and laser printers. Sales of interchangeable-lens that leverage facial recognition technology to manage room digital cameras decreased due to sharp market contraction entry/exiting, visitor reception, meeting room reservations, largely as a result of fewer opportunities for people to go out. and printing on MFDs. These solutions are currently used in The Americas many different settings, including offices and retail stores, because they can be flexibly customized to meet customer Sales in the Americas amounted to ¥852.5 billion, or 27.0% needs. In the B to C field, the Group has undertaken a num- of consolidated net sales. ber of new initiatives such as online product launch events in Canon U.S.A. handles marketing operations in North, which anybody can participate and a live streaming Central, and South America. In the commercial printing mar- e-commerce service enabling two-way communication. We ket, our high-quality service framework covering all U.S. states are strengthening brand appeal and boosting sales by creating has been rated highly by customers, which complements our more opportunities for interaction with customers. extensive product lineup of monochrome and color models and continuous-feed and cut-sheet printers. As a new ap- proach to deal with COVID-19, we were swift to develop and introduce software, which allowed compatible Canon EOS and other digital cameras to be used as high quality webcams to meet the demand for higher quality video for remote work- ing and online meetings. Europe (Europe, Middle East, Africa) Sales in Europe amounted to ¥ 795.6 billion, or 25.2% of consolidated net sales. Canon Europe oversees business in the EMEA region - Europe, the Middle East and Africa. Operating in approxi- mately 120 markets, Canon is proposing new products and solutions tailored to customer needs while strengthening its sales network. In 2020, Canon supported local communi- ties including the First Hugs campaign which documented people first interactions. Throughout the pandemic, they also provided photographers and videographers with Composition of Sales by Region Asia and Oceania 22.3% ¥705.9 billion Japan 25.5% ¥806.3 billion Net Sales ¥3,160.2 billion The Americas 27.0% ¥852.5 billion Europe 25.2% ¥795.6 billion 25 CANON ANNUAL REPORT 2020ESG Environment Social E S G Governance Canon adopted kyosei as its corporate philosophy in 1988 in launched its own consolidated earnings assessment system in an effort to clarify our stance on how we fulfill our responsi- 1997. During the period of more than 20 years since it was in- bilities to society and build solid relationships not only with troduced, it has served as a marker of improvement in each of our customers and business partners, but also with countries, our business divisions and Group companies. The assessment communities, nature, and the global environment. High expec- items, which are reviewed annually in accordance with our tations are placed on corporations as members of society and management policy and in line with current trends, include Canon therefore aims to be a company that not only gives due not only financial results for each department, such as sales consideration to people and society, but also contributes to so- and profit, but also environmental activity results. In 2019 we ciety by leveraging its technological capabilities to create new further strengthened the non-financial aspects of the system value, resolve social issues, and engage in activities to preserve with the addition of social contribution activity results. By hav- and protect the global environment. These activities contribute ing CSR-related departments evaluate business divisions and to the achievement of the Sustainable Development Goals Group companies, which in turn generates improvement, the (“SDGs”) adopted by the United Nations in 2015. system aims to contribute to the sustained development of In pursuing total optimization of management, Canon the Group as a whole, as well as society. Environment: Social: Governance: Canon’s Approach Canon’s Approach Canon’s Approach In order to leave the next generation with a natural environment that is still abundant and rich, Canon works together with its stakeholders to implement initiatives that help reduce environmental burdens with a focus on the entire product lifecycle. As a good corporate citizen, Canon works to resolve social issues with technology and through our business activities by respecting human rights, re- sponsible procurement activities, cultural support, etc. 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 • Contributing to a Circular Economy • Eliminating Hazardous Substances and Preventing Pollution • Contributing to a Society in Harmony with Nature • Promoting Diversity • Addressing the Issue of Responsible Minerals Sourcing • Supporting Art and Culture • Board of Directors, Audit & Supervisory Board, Non-statutory Committees • Constructive Dialogue with Shareholders For details, please refer to the Canon Sustainability Report. https://global.canon/en/csr/report/index.html 26 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA The Canon Eco Technology Park is a hub for the Canon Group’s environmental activities. (Ibaraki, Japan) Environment Contributing to a Low-Carbon Society in our Refreshed series of office multifunction devices. In addition to its own business activities, such as development, Eliminating Hazardous Substances and Preventing Pollution production, and sales, Canon monitors the environment impact Canon thoroughly manages chemical substances in products and CO2 emission at each stage of a product’s lifecycle, including and those used in manufacturing processes to prevent envi- those of suppliers and customers, and works to reduce them. ronmental pollution and adverse effects on people’s health. We are stepping up initiatives with the aim of achieving an With regard to chemical substances in products, in particular, average annual improvement of 3% in lifecycle CO2 emissions we have built a Group-wide environmental assurance system improvement index per product—an overall target we set in and established in-house standards that are in line with the 2008. As of 2020 we have achieved an average annual im- most stringent regulations in the world. provement of around 4.6%. Contributing to a Society in Harmony with Nature We will continue our efforts in view of Carbon Neutrality by Canon engages in various activities worldwide based on our 2050, which has been declared by over 100 countries. Biodiversity Policy. As part of these activities and in an effort to en- Contributing to a Circular Economy gage in the protection of biodiversity across the Canon Group, we To ensure more efficient use of limited resources and reduce globally run the Canon Bird Branch Project at our business sites. waste, Canon is making products smaller and lighter, and reusing and recycling materials as much as possible. In par- ticular, we are pursuing product-to-product recycling—in other words, recycling used products into new ones, including the remanufacturing of office multifunction devices and the closed-loop recycling of toner cartridges. Canon currently has five recycling centers in four global regions. The Canon Eco Technology Park, which opened in 2018, strives to realize state-of-the-art resource recycling as a front-runner in the creation of a circular economy. Lifecycle CO2 Emissions Improvement Index per Product Improvement index 100 41.3% Improvement 50 0 For example, we have achieved a parts reuse rate (mass ratio) 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 of about 93.8% for every imageRUNNER ADVANCE C3330F-RG *Indexed to 2008=100 27 CANON ANNUAL REPORT 2020Five high resolution facsimiles, including the important cultural properties “Kabuki Theater” (drawn by Hishikawa Moronobu), that were produced in Stage 13 of the Tsuzuri Project were donated to the National Institutes for Cultural Heritage. Social Diversity Promotion Commission. Canon has expanded due diligence of minerals Under our corporate philosophy of kyosei, Canon respects to whole world since 2020. global diversity and actively encourages the fair hiring and Social contributions promotion of employees, regardless of gender, age, or dis- Canon Inc. established The Canon Institute for Global Studies ability. In 2012, Canon established VIVID, a company-wide (CIGS) and The Canon Foundation in 2008 to commemorate horizontally integrated organization tasked with promoting Canon’s 70th anniversary. the advancement of female employees, supporting par- CIGS analyzes what kind of role Japan ought to play glob- ticipation in child rearing by male employees, and helping ally. With the goal of disseminating strategic proposals, CIGS employees skillfully balance work and nursing care. facilitates the exchange of knowledge between various re- In conjunction with International Women’s Day in 2020, Group searchers from industrial, government, and academic circles. companies in the Middle East and Africa launched the SHE Rise In addition, the Canon Foundation provides grants to assist a Program designed to support female empowerment in the work- broad range of science and technological research with the place. Canon Group companies are also taking steps to encourage goal of contributing to the advancement of science and tech- the active participation of sexual minorities, including those in nology. Since 2019, the foundation’s aim has been to create the LGBT community, as well as employees with disabilities. new value for society by supporting research that addresses Socially Responsible Procurement and Responsible cutting-edge fields of science and technology. Minerals Sourcing Furthermore, since 2007, as a company that contributes With the expansion of global supply chains, a number of to the development of visual culture, Canon has operated societal issues relating to human rights and environmental the Tsuzuri Project (officially named the Cultural Heritage protection have been prominent. Canon engages in socially Inheritance Project) to preserve original cultural assets and uti- responsible procurement in cooperation with business part- lize high-resolution facsimiles with Kyoto Culture Association. ners. Canon joined the Responsible Business Alliance (RBA) By combining Canon’s advanced digital technologies, rang- in 2019 and started introducing the RBA based assurance ing from input to image processing and output, with the program to 37 operational sites and their major suppliers in traditional craftsmanship of Kyoto, we have produced and 2020. Canon files an annual conflict minerals report attaching donated high-resolution facsimiles of important Japanese cul- a third-party assurance with the U.S. Securities and Exchange tural assets, such as folding screens, and handscrolls. 28 CANON ANNUAL REPORT 2020STRATEGY BUSINESS SEGMENT/ CORPORATE STRUCTURE FINANCIAL SECTION CORPORATE DATA For all company executive officers, the CEO provides updates on earnings progress and important matters to implement in the future as a way to share crucial information. Governance Fundamental Policy Additionally, there will be 40 Executive Officers, including In order to establish a sound corporate governance structure two females and one non-Japanese as of April 1, 2021. and continuously raise corporate value, the Company believes Audit & Supervisory Board that it is essential to improve management transparency and As a body which is in charge of the audit of operations, strengthen management supervising functions. under the principles of autonomy, which is independent Governance Structure Board of Directors from the Board of Directors, the Company has full-time Audit & Supervisory Board Members that are familiar with While the focus of the organizational structure of the Board the Company’s businesses or its management structure, and of Directors is on Representative Directors that oversee com- Independent Outside Audit & Supervisory Board Members pany-wide business strategies or execution such as the CEO, that have extensive knowledge in specialized areas such as COO, CFO, CTO, and Representative Directors or Executive law, finance and accounting, and internal control. The Audit Directors that oversee multiple business fields or headquarters & Supervisory Board, which is composed of these individu- functions, in order to secure sound management, an ad- als, cooperates with the Company’s accounting auditors and equate number of at least two or more Independent Outside internal audit division, oversees the status of duty execution Directors are appointed. The Board of Directors, in accordance of operations and corporate assets to secure the soundness with laws and regulations, makes important decisions and su- of management. pervises the execution of duties by officers. The Audit & Supervisory Board consists of five individuals, Except for the above, the CEO and other Representative three of which are Independent Outside Audit & Supervisory Directors are active in decision making and execution, and Board Members. under the command and supervision of the Representative Procedures in the Nomination of Directors etc. Directors, Executive Officers that are elected through resolu- The Company established the “Nomination and Remuneration tion of the Board of Directors make decisions and execute Advisory Committee,” a non-statutory committee, which con- operations of each business field or function. Currently, sists of the CEO, two Independent Outside Directors, and one the Board of Directors consists of five members, three Independent Outside Audit & Supervisory Board Member. At Representative Directors from inside the Company and two the time, Director and Audit & Supervisory Board Member can- Independent Outside Directors. didates are nominated and Executive Officers are appointed 29 CANON ANNUAL REPORT 2020Governance (includes the selection of a successor for the chief executive of- Internal Audit Division ficer position), the CEO recommends candidates thereof from The Corporate Audit Center, the Company’s internal audit- among individuals that have been recognized as having met ing arm, as an independent and specialized organization the prescribed requirements, and the Committee checks the and in accordance with internal audit rules, conducts audits fairness and validity of such recommendation prior to submis- and evaluations and provides guidance on such matters sion to and deliberation by the Board of Directors. as compliance with laws and the internal control system. Additionally, as for Audit & Supervisory Board Member Furthermore, audits of particular themes such as quality, the candidates, prior to deliberation of the Board of Directors, environment, and information security are conducted mainly consent of the Audit & Supervisory Board shall be acquired. by the Corporate Audit Center in cooperation with each Corporate Strategy Committee, Risk Management division in charge. Additionally, based on top management Committee, and Disclosure Committee policy, for all work processes, audits must be conducted from The Company established the Corporate Strategy Committee, specialized viewpoints and there are plans to increase the consisting of Representative Directors and some Executive number of its members from the current 70 to strengthen Officers. Among items to be decided by the CEO, the auditing functions by enabling audits from specialized view- Committee undertakes prior deliberations on important mat- points in each theme. ters pertaining to Canon Group strategies. Outside Directors and Audit & Supervisory Board members attend Corporate Strategy Committee meetings and are able to express their own opinions. Based on a resolution passed by the Board of Directors, Canon set up the Risk Management Committee, which formulates policy and action proposals regarding im- provement of the Canon Group risk management system. The Risk Management Committee consists of three entities: the Financial Risk Management Subcommittee, which is tasked with improving systems to ensure reliability of financial re- porting; the Compliance Subcommittee, which is tasked with promoting corporate ethics and improving legal compliance systems; and the Business Risk Management Subcommittee, which is charged with improving systems to manage overall business risks, including risks related to product quality and in- formation leak. The Risk Management Committee verifies the risk management system’s improvement and implementation and reports the status to the CEO and the Board of Directors. In addition, the Disclosure Committee was established to undertake deliberations pertaining to information disclosure, including content and timing, to ensure important corporate information will be disclosed in a timely and accurate manner. Details of Canon Inc.’s corporate governance structure are available on the Company’s website under “an overview of Corporate Governance at Canon Inc.” https://global.canon/en/ir/strategies/governance.html 30 CANON ANNUAL REPORT 2020F I N A N C I A L S E C T I O N TABLE OF CONTENTS Financial Overview ............................... 32 Ten-Year Financial Summary ................. 46 Consolidated Balance Sheets ................ 48 Consolidated Statements of Income ..... 49 Consolidated Statements of Comprehensive Income ........................ 49 Consolidated Statements of Equity ....... 50 Consolidated Statements of Cash Flows .......................................... 51 Notes to Consolidated Financial Statements ............................ 52 Schedule II Valuation and Qualifying Accounts ............................. 85 Management’s Report on Internal Control Over Financial Reporting .......... 86 Report of Independent Registered Public Accounting Firm ....... 87 31 CANON ANNUAL REPORT 2020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 office multifunction devices (“MFDs”), plain paper copying machines, laser printers, cameras, inkjet printers, medical equipment, semiconductor lithography equipment and flat- panel-display (“FPD”) lithography equipment. Canon earns revenues 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 and the Industry and Others Business Unit. Economic environment Looking back at 2020, the global economy fell significantly with no signs of controlling the spread of infections, although the balanced measures to curb infections and expand eco- nomic activities were implemented around the world amid the global coronavirus (“COVID-19”) pandemic. In the U.S., despite a record decline in consumption caused by move- ment restrictions implemented in the first half of the year, the economy gradually recovered in the second half of the year while repeating deregulation and tighter regulations of economic activities. In Europe, the consumption headed toward a recovery phase resulting from the easing of large- scale lockdowns and night curfews that were enacted in each country from March. The European economy, however, con- tinued to slow down due to restrictions on economic activities being reinstated due to a resurgence of infections. In China, economic recovery has accelerated mainly through domestic demand and exports resulting from a rapid resumption of economic activities. Even in other emerging markets, despite restrictions on movement and economic activities in some countries, economies showed signs of recovery resulting from gradual resumption of economic activities amid the COVID-19 pandemic. In Japan, the recovery trend continued due to the resumption of economic activities and the easing of volun- tary restrictions after the lifting of the State of Emergency, although infections began to rise again in November. Market environment Amid these conditions, the markets in which Canon operates were greatly affected by the spread of COVID-19. For office MFDs and laser printers, demand for both monochrome and color models declined due to insufficient recovery of corporate activities in the spread of COVID-19. For cameras, despite a significant decline in demand due to the impact of COVID- 19, demand headed toward an improvement phase due to a recovery in consumption in the second half of the year. For inkjet printers, the pace of recovery gradually increased in some emerging countries in the second half of the year, in addition to developed countries and China, where demand for products were solid due to a rise in remote working and education. For medical equipment, although restrictions on sales activities to medical institutions in the first half of the year due to the impact of COVID-19 were eased in the second half of the year, sales activities were nonetheless affected by the prolonged impact of COVID-19. For industrial equipment, demand for both FPD lithography equipment and semiconduc- tor lithography equipment remained solid. The average value of the yen for the year was ¥106.68 against the U.S. dollar, a year-on-year appreciation of approxi- mately ¥2, and ¥122.07 against the euro, the same level as the previous year. Summary of operations In 2020, sales of MFDs for the office and production print- ing market both decreased, although they showed signs of recovery since the second half of the year. Unit sales of laser printers, both monochrome and color models, were below those of the previous year. Sales of services and consumables also declined resulting from the moderate recovery in cus- tomers’ print volumes after cancellation of office closures in response to the spread of COVID-19 and the resumption of corporate activities. For interchangeable-lens digital cameras, although unit sales were below those of the previous year, sales were better than expected in the second half of the year due to strong sales of the EOS R5 and EOS R6 full-frame mirrorless cameras. As for inkjet printers, unit sales, includ- ing refillable ink tank models, were significantly above those of the previous year due to the recovery in demand in some emerging countries on top of demand for remote working and education in developed countries and China. In medi- cal equipment, amid the postponement of installation and restrictions on sales activities, sales were slightly below those of the previous year, as a result of capturing demand for equipment supplies to medical institutions supported by the government of each country in the second half of the year. For industrial equipment, despite solid demand for semiconductor lithography equipment for memory devices, and for organic LED (”OLED”) panel manufacturing equipment, sales for FPD lithography equipment decreased compared with those of the previous year as a result of postponement of installation due to the impact of COVID-19. As for network cameras, which are being used in a growing range of applications and where the market is growing, sales increased slightly from those of the previous year due to a moderate recovery in sales activi- ties. Under these conditions, net sales for the year decreased 32 CANON ANNUAL REPORT 2020by 12.1% year-on-year to ¥3,160,243 million. Gross profit as a percentage of net sales decreased by 1.3 points to 43.5%. Gross profit for the year decreased by 14.5% year-on-year to ¥1,375,868 million. Operating expenses decreased by 11.9% year-on-year to ¥1,265,321 million, due to the further promo- tion of efficiency for expenses throughout the entire Group. As a result, although operating profit decreased by 36.6% year-on-year to ¥110,547 million, it exceeded the prediction which had been revised upward in the most recent forecast. Other income (deductions) decreased by ¥1,340 million to ¥19,733 million, mainly due to decrease of interest and divi- dend income, while income before income taxes decreased by 33.4% year on year to ¥130,280 million and net income attributable to Canon Inc. decreased by 33.3% year on year to ¥83,318 million. Total assets decreased by ¥146,304 million to ¥4,625,614 million at December 31, 2020, compared with the end of previous year, mainly due to a decrease of fixed and intangible assets, and accounts receivables. Total liabilities decreased by ¥46,365 million to ¥1,841,573 million at December 31, 2020, compared with the end of previous year, mainly due to a decrease of accrued pension liabilities and accrued expenses. Total equity decreased by ¥99,939 million to ¥2,784,041 mil- lion at December 31, 2020, compared with the end of previ- ous year, mainly due to the dividend payout, the repurchasing of treasury stock and an increase of accumulated other com- prehensive loss resulting from the appreciation of the yen. 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 below. Net sales and profit ratio As Canon pursues the goal to become a truly excellent global corporation, 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 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 pursued cost reductions through enhancement of efficiency in its production. Canon believes that these approaches will improve Canon’s gross profit ratio, and so will continue pursu- ing the curtailment of product development lead times and reductions of production costs. Operating profit ratio (ratio of operating profit to net sales), income before income taxes ratio (ratio of income before income taxes 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 current business areas and to exploit opportunities in other markets. Canon believes such invest- ments 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 optimizing finished goods inventories in order to avoid losing potential sales opportunities. The debt to total assets ratio is also one of the KPIs. For a manufacturing company like Canon, it generally takes consid- erable time to realize profit from a business due to lead times required for R&D, manufacturing and sales. Therefore, man- agement believes that it is important to have sufficient finan- cial 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 sustain- ability. Canon also believes that achieving a high or rising shareholders’ 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 Canon to maintain a high level of stable investments for its future operations and development. As Canon puts strong emphasis on its R&D activities, manage- ment believes that it is important to maintain a stable financial base and, accordingly, a high level of its shareholders’ equity to total assets ratio. 33 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020FINANCIAL OVERVIEW KEY PERFORMANCE INDICATORS 2017 4,080,015 Net sales (Millions of yen) 48.8% Gross profit to net sales ratio 8.2% R&D expense to net sales ratio 7.9% Operating profit to net sales ratio 8.7% Income before income taxes to net sales ratio 49 days Inventory turnover measured in days 10.2% Debt to total assets ratio 55.1% Canon Inc. shareholders' equity to total assets ratio Notes: 1. Inventory turnover measured in days is determined by: Inventory divided by net sales for the previous six months, multiplied by 182.5. 2019 3,593,299 44.8% 8.3% 4.9% 5.4% 59 days 10.8% 56.3% 2018 3,951,937 46.4% 8.0% 8.7% 9.2% 56 days 8.2% 57.5% 2020 3,160,243 43.5% 8.6% 3.5% 4.1% 60 days 10.9% 55.7% 2016 3,401,487 49.2% 9.0% 6.4% 7.2% 59 days 11.9% 54.0% 2. The increase of the debt to total assets ratio in 2019 was primarily due to adopting new accounting standard ASU No. 2016-02, Leases (Topic 842) Section A. The company includes current operating lease liability and noncurrent operating lease liability as the debt since 2019. If this factor were excluded, the debt to total assets ratio in 2019 is 8.6%. 3. The decrease of the Canon Inc. shareholders’ equity to total assets ratio in 2019 was primarily due to adopting new accounting standard ASU No. 2016- 02, Leases (Topic 842) Section A. The company includes operating lease right-of-use assets in total assets since 2019. If this factor were excluded, Canon Inc. shareholders’ equity to total assets ratio is 57.9%. 4. Canon adopted ASU No. 2017-07 from the quarter beginning January 1, 2018. The adoption of the new presentation requirement of the service cost component and the other components of net benefit cost resulted in reclassification from cost of sales, and selling, general and administrative expenses, and research and development expenses into other income (deductions) for the years ended December 31, 2017 and 2016 respectively. 5. Certain figures for the fiscal years ended December 31, 2019, 2018, 2017 and 2016 presented in the table above have been revised from the versions previously disclosed. The effect on the consolidated financial statements was immaterial, respectively. For further details regarding the circumstances of the revision, please refer to Note 1 (y) of the Notes to Consolidated Financial Statements. 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 significant 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. In addition, new waves of COVID-19 infections are being seen in some regions, and it is still difficult to predict when COVID-19 will be brought under control. However, each country and region continues to pursue both the infection control and economic activities. Although the global economy is expected to recover in 2021, it is expected that some regions would continue to be affected by COVID-19. Canon believes that the following are the more critical judgment areas in the application of its accounting policies that currently affect its financial condition and results of operations. Revenue recognition Canon generates revenue principally through the sale of office, imaging system and medical system products, industrial equip- ment, supplies and related services under separate contractual arrangements. Revenue is recognized when, or as, control of promised goods or services transfers to customers in an amount that reflects the consideration to which Canon expects to be entitled in exchange for transferring these goods or services. Revenue from sales of office products, such as office MFDs and laser printers, and imaging system products, such as digital cameras and inkjet printers, is recognized upon ship- ment or delivery, depending upon when the customer obtains controls of these products. Revenue from sales of equipment that are sold with customer acceptance provisions related to their functionality including optical equipment such as semiconductor lithography equip- ment and FPD lithography equipment, and certain medical equipment such as CT systems and MRI systems, is recognized when the equipment is installed at the customer site and the agreed-upon specifications are objectively satisfied. Most of Canon’s service revenue is generated from mainte- nance service in the office and medical system products which is recognized over time. For the service contracts of office products, the customer typically pays a variable amount based on usage, a stated fixed fee or a stated base fee plus a vari- able amount which frequently include the provision of con- sumables as well as break fix activities. The majority portion of service revenue from the office products is recognized as billed since the invoiced amount directly correlates with the value to the customer of the underlying performance obligation to date. For the service contracts of medical system products, the customer typically pays a stated fixed fee for the stand ready maintenance service and revenue is recognized ratably over the contract period. The majority of service arrangements for office products are executed in combination with related products. Transaction prices for products and services need to be allocated to each performance obligation on a relative standalone selling price basis where judgements are required. Canon estimates the standalone selling price using a range of prices that would meet the allocation objective based on all the information that is reasonably available including market conditions and other observable inputs. If transaction prices of the product or service contracts are not within the acceptable range then the revenue is subject to allocation based on the estimated stand- alone selling prices. Canon recognizes the incremental costs of obtaining a contract as an expense when related office 34 CANON ANNUAL REPORT 2020 products are sold. Revenue from sales of certain industrial equipment which do not have alternative use and for which Canon has enforce- able right to payment to the customers for the performance completed to date is recognized over time with progress towards completion measured using the cost based input method as the basis to recognize revenue and an estimated margin. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses become evident. Changes in job performance, job conditions, esti- mated margin and final contract settlements may result in revi- sions to projected costs and revenue and are recognized in the period in which the revisions to estimates are identified and the amounts can be reasonably estimated. Factors that may affect future project costs and margins include, production efficiencies, availability and costs of labor and materials. These factors can impact the accuracy of our estimates and materi- ally impact future reported revenue and cost of sales. The transaction prices that Canon is entitled to receive in exchange for transferring goods or services to the customer include certain forms of variable consideration, including product discounts, customer promotions and volume-based rebates mainly for imaging system products, which are sold predominantly through distributors and retailers. Canon includes estimated amounts in the transaction price only to the extent it is probable that a significant reversal of cumula- tive revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Variable considerations are estimated based upon historical trends and other known factors at the time of sale, and are subsequently adjusted in each period based on current information. In addi- tion, Canon may provide a right of return on our products for a short time period after a sale. These rights are accounted for as variable consideration when determining the transaction price, and accordingly Canon recognizes revenue based on the estimated amount to which Canon expects to be entitled after considering expected returns. Taxes collected from customers and remitted to governmen- tal authorities are excluded from revenues in the consolidated statements of income. Allowance for credit losses Allowance for credit losses is determined using a combination of factors to ensure that Canon’s trade and financing receiv- ables are not overstated due to uncollectibility. These factors include the length of time receivables are past due, the credit quality of customers, macroeconomic conditions, historical experiences and future prospects based on a current expected credit loss model (Please refer to Note 1 (x) of the Notes to Consolidated Financial Statement). Also, Canon records specific reserves for individual accounts when Canon becomes aware of a customer’s inability to meet its financial obligations to Canon, due for example to bankruptcy filings or deteriora- tion in the customer’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 necessary 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. Lease As for lessor accounting, Canon provides leasing arrange- ment to its customers primarily for the sale of office products. Revenue from the sale of these products under sales-type leases is recognized at the inception of the lease. Interest income on sales-type leases and direct-financing leases is recognized over the life of each respective lease using the interest method. Leases not qualifying as sales-type leases or direct-financing leases are accounted for as operating leases and related revenue is recognized ratably over the lease term. When product leases are bundled with maintenance contracts, revenue is allocated based upon the estimated standalone selling prices of the lease and non-lease components. Lease components generally include product and financing while non-lease components generally consist of maintenance contracts and supplies. Some of the contracts include options to extend or to terminate the lease. Canon takes such options into account to determine the lease term when it is reasonably certain that it will exercise these options. The majority of Canon’s lease contracts do not contain bargain purchase options for their customers. As for lessee accounting, Canon has operating and finance leases for various assets including office buildings, ware- houses, employees’ accommodations, and vehicles. Canon 35 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020FINANCIAL OVERVIEW determines if an arrangement is a lease at the inception of each contract. Some of the contracts include options to extend or to terminate the lease. Canon takes such options into accounts to determine the lease term when it is reason- ably certain that it will exercise these options. Canon’s lease arrangements do not contain material residual value guar- antees or material restrictive covenants. As a rate implicit in most of Canon’s leases cannot be determined, Canon uses incremental borrowing rate based on the information available at commencement to determine the present values of lease payments. Canon has lease contracts with lease and non-lease components, which are accounted for separately. Canon allo- cates the consideration in the lease contract to the lease and non-lease components based upon the estimated standalone prices. Costs associated with operating lease assets are recog- nized on a straight-line basis over the term of the lease. Business combinations Acquisitions are accounted for using the acquisition method of accounting. The acquisition method of accounting requires the identification and measurement of all acquired tangible and intangible assets and assumed liabilities at their respective fair val- ues, as of the acquisition date. The determination of the fair value of net assets acquired involves significant judgment and esti- mates, such as future cash flow projections, appropriate 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 operating results, known and anticipated trends, as well as market and economic conditions. Goodwill and other intangible assets Goodwill and other intangible assets with indefinite useful lives are not amortized, but are instead tested for impairment annu- ally 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 carrying 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. Fair value of a report- ing 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 capital, which considers primarily market and industry data as well as specific risk factors. Canon has completed its impairment test in the fourth quarter of 2020 and determined that there were no reporting units that were at risk of failing the impairment test as the fair value of each reporting unit substantially exceeded its respective carrying amount. However, with regard to goodwill attributed to the Medical System Business Unit, fair values in excess of reported carrying values as a percentage is lower than other reporting units. As a result, a future reduction in cash flows of the related business, could trigger an impairment. The goodwill related to this reporting unit as of December 31, 2020 is ¥506,513 mil- lion. 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 8 years, trademarks are 15 years, patents and developed technology are from 5 years to 18 years, license fees are 8 years, and customer relationships are 15 years, respectively. Income tax uncertainties Canon considers many factors when evaluating and estimat- ing income tax uncertainties. These factors include an evalu- ation of the technical merits of the tax positions as well as the amounts and probabilities of the outcomes that could be realized upon settlement. The actual resolutions of those uncertainties will inevitably differ from those estimates, and such differences may be material to the financial statements. Valuation of deferred tax assets Canon currently has significant deferred tax assets, which are subject to periodic recoverability assessments. Realization of Canon’s deferred tax assets is principally dependent upon its achievement of projected future taxable income. Canon’s judgments regarding future profitability may change due to future market conditions, its ability to continue to successfully execute its operating 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 determines that cer- tain deferred tax assets may not be recoverable, the amounts, which may not be realized, are charged to income tax expense and will adversely affect net income. Employee retirement and severance benefit plans Canon has significant employee retirement and severance benefit obligations that are recognized based on actuarial valuations. Inherent in these valuations are key assumptions, including discount rates and expected return on plan assets. Management must consider current market conditions, 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 2020, Canon esti- mated a weighted-average discount rate used to determine benefit obligations of 0.5% for Japanese plans and 1.5% for foreign plans and a weighted-average expected long-term rate of return on plan assets of 3.0% for Japanese plans and 4.8% 36 CANON ANNUAL REPORT 2020for foreign plans. In estimating the discount rate, Canon uses available information about rates of return on high-quality fixed-income government and corporate bonds currently available and expected to be available during the period to the maturity of the pension benefits. Canon establishes the expected long-term rate of return on plan assets based on management’s expectations of the long-term return of the various plan asset categories in which it invests. Management develops expectations with respect to each plan asset category based on actual historical returns and its current expectations for future returns. Decreases in discount rates lead to increases in actuarial pension benefit obligations which, in turn, could lead to an increase in service cost and amortization cost through amor- tization of actuarial gain or loss, a decrease in interest cost, and vice versa. For 2020, a decrease of 50 basis points in the discount rate increases the projected benefit obligation by approximately ¥97,818 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 2020, a change of 50 basis points in the expected long-term rate of return on plan assets would cause a change of approximately ¥5,229 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 recognition of the difference between this expected return on plan assets and the actual return on plan assets. The net deferred amount affects future pension expense. Canon recognizes the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligations) of its pension plans in its consolidated balance sheets, with a corresponding adjustment to an 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 Products and Equipment Services Operating profit Income before income taxes Net income attributable to Canon Inc. Note: See note to KEY PERFORMANCE INDICATORS Sales In the current business term, on a global basis, the economic slowdown continued. In such an environment, although each of Canon Group’s businesses endeavored to expand sales particularly with respect to new products, Canon’s consoli- dated net sales in 2020 totaled ¥3,160,243 million, a decrease of 12.1% from the previous year largely due to adverse effect of a shrinking market as well as unfavorable currency effects of foreign exchange rate fluctuation. Net sales of products and equipment totaled ¥2,489,829 million, a year- on-year decrease of 12.2%, while net sales of services totaled ¥670,414 million, a year-on-year decrease of 11.5%. Overseas operations are significant to Canon’s operating results and generated 74.5% of total net sales in 2020. 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 cur- rency fluctuations on operating results, including localization of manufacturing in some regions along with procuring parts and materials from overseas suppliers, Canon believes such 2020 3,160,243 2,489,829 670,414 110,547 130,280 83,318 Millions of yen 2019 change -12.1% 3,593,299 -12.2% 2,835,428 757,871 -11.5% 174,420 -36.6% 195,493 -33.4% 124,964 -33.3% 2018 change -9.1% 3,951,937 -11.2% 3,194,724 757,213 +0.1% 342,452 -49.1% 362,392 -46.1% 252,441 -50.5% fluctuations 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 ¥106.68 against the U.S. dollar, a year-on-year appreciation of approxi- mately ¥2, and ¥122.07 against the euro, the same level as the previous year. The effects of foreign exchange rate fluctuations 9 6 3 0 300 200 100 0 400 300 200 100 0 Return on Sales (%) Sales by Segment (Billions of yen) Sales by Geographic Area (Billions of yen) 5,000 4,000 3,000 2,000 1,000 0 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 37 Increase in Property, Plant and Equipment (Billions of yen) Working Capital Ratio Return on Canon Inc. Shareholders’ Equity (%) Office Business Unit Imaging System Business Unit Medical System Business Unit Industry and Others Business Unit Eliminations Japan Americas Europe Asia and Oceania 5,000 4,000 3,000 2,000 1,000 0 12 9 6 3 0 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 R&D Expenses (Billions of yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) 2016 2017 2018 2019 2020 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 3.0 2.5 2.0 1.5 1.0 0.5 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020FINANCIAL OVERVIEW negatively affected net sales by approximately ¥27,159 million in 2020. This unfavorable impact consisted of approximately ¥22,416 million of unfavorable impact for the U.S. dollar denominated sales and favorable impact of ¥1,999 million for the euro denominated sales, and unfavorable impact of ¥6,742 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 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 2020 and 2019 were 56.5% and 55.2%, respectively. Gross profit Canon’s gross profit in 2020 decreased by 14.5% to ¥1,375,868 million from 2019. The gross profit ratio also dropped by 1.3 points to 43.5%. The decrease in the gross profit and gross profit ratio were mainly due to a decrease in sales, the effect of product mix and the negative effect of appreciation of the yen against other foreign currencies such as U.S. dollar. Operating expenses The major components of operating expenses are payroll, R&D, advertising expenses and other marketing expenses. Operating expenses decreased by 11.9% year on year to ¥1,265,321 mil- lion, thanks to the pursuit of cost efficiencies in Canon as well as positive effects of currency exchange fluctuation. Operating profit Operating profit in 2020 decreased by 36.6% from 2019 to a total of ¥110,547 million. The ratio of operating profit to net sales decreased by 1.4 points to 3.5% from 2019. Other income (deductions) Other income (deductions) for 2020 was ¥19,733 million, a decrease of ¥1,340 million from 2019 mainly due to a decrease in interest income. Income before income taxes Income before income taxes in 2020 was ¥130,280 million, a decrease of 33.4% from 2019, and constituted 4.1% of net sales. Income taxes Income taxes in 2020 decreased by ¥21,809 million from 2019. The effective tax rate for 2020 was 26.4%, which was lower than the statutory tax rate in Japan. This was mainly due to income of foreign subsidies taxed at lower than Japanese statutory tax rate. Net income attributable to Canon Inc. As a result, net income attributable to Canon Inc. in 2020 decreased by 33.3% to ¥83,318 million, which represents 2.6% of net sales. Segment information Canon operates four segments: the Office Business Unit, the Imaging System Business Unit, the Medical System Business Unit and the Industry and Others Business Unit. • The Office Business Unit mainly includes Office MFDs / Laser MFPs / Laser printers / Digital continuous feed presses / Digital sheet-fed presses / Wide-format printers / Document solutions • The Imaging System Business Unit mainly includes Interchangeable-lens digital cameras / Digital compact cameras / Interchangeable lenses / Compact photo printers / Inkjet printers / Large format inkjet printers / Commercial photo printers / Image scanners / Calculators • The Medical System Business Unit mainly includes Digital radiography systems / Diagnostic X-ray systems / CT systems / MRI systems / Diagnostic ultrasound systems / Clinical chemistry analyzers / Ophthalmic equipment • The Industry and Others Business Unit mainly includes Semiconductor lithography equipment / FPD (Flat panel display) lithography equipment / Vacuum thin-film deposition equipment / Organic LED (OLED) panel manufacturing equipment / Die bonders / Return on Sales (%) Return on Sales (%) Sales by Segment (Billions of yen) Sales by Segment (Billions of yen) Sales by Geographic Area (Billions of yen) Sales by Geographic Area (Billions of yen) 2020 Office Business Unit Imaging System Business Unit Medical System Business Unit Industry and Others Business Unit Eliminations Office Business Unit Imaging System Business Unit Medical System Business Unit Industry and Others Business Unit Eliminations Japan Americas Europe Asia and Oceania Japan Americas Europe Asia and Oceania 2018 2016 2019 2017 2020 2018 2019 2020 5,000 5,000 4,000 4,000 3,000 3,000 2,000 2,000 1,000 1,000 0 0 2017 2016 9 6 3 0 9 6 3 0 9 6 3 0 400 300 200 100 0 9 6 3 0 400 300 200 100 0 200 200 100 100 0 0 5,000 5,000 4,000 4,000 3,000 3,000 2,000 2,000 1,000 1,000 0 0 2016 2017 2018 2016 2019 2017 2020 2018 2019 2020 2016 2017 2016 2018 2017 2019 2018 2020 2019 38 3.0 2.5 2.0 1.5 1.0 0.5 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 3.0 2.5 2.0 1.5 1.0 0.5 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Increase in Property, Increase in Property, Plant and Equipment (Billions of yen) Plant and Equipment (Billions of yen) 300 300 Working Capital Ratio Working Capital Ratio Return on Canon Inc. Return on Canon Inc. Shareholders’ Equity (%) Shareholders’ Equity (%) 12 12 2016 2017 2018 2016 2019 2017 2020 2018 2019 2020 2016 2017 2018 2016 2019 2017 2020 2018 2019 2020 2016 2017 2018 2016 2019 2017 2020 2018 2019 2020 R&D Expenses (Billions of yen) R&D Expenses (Billions of yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) 2016 2017 2018 2016 2019 2017 2020 2018 2019 2020 2011 2012 2011 2013 2012 2014 2013 2015 2014 2016 2015 2017 2016 2018 2017 2019 2018 2020 2019 2020 CANON ANNUAL REPORT 2020Network cameras / Digital camcorders / Digital cinema cameras / Multimedia projectors / Broadcast equipment / Micromotors / Handy terminals / Document scanners Sales by segment Please refer to the table of sales by segment in Note 22 of the Notes to Consolidated Financial Statements. Within the Office Business Unit, although sales of the new imageRUNNER ADVANCE DX series were strong, unit sales of MFDs for the office and the production printing market were below those of the previous year reflecting such factors as the moderate recovery in business negotiations following the resumption of in-office work. As for laser printers, unit sales of both monochrome and color models were below those of the previous year resulting from the continued economic slowdown caused by the COVID-19 pandemic. Sales of ser- vices and consumables also declined as a result of a moderate recovery in customers’ print volumes after the resumption of corporate activities. These factors resulted in total sales for the business unit of ¥1,440,212 million, a year-on-year decrease of 17.8%, while income before income taxes decreased by 49.3% year-on-year to ¥86,483 million. As for the Imaging System Business Unit, although unit sales of interchangeable-lens digital cameras were below those of the previous year as the market continued to shrink and, the decline of the demand caused by COVID-19, the shift to mirrorless models accelerated, particularly for full-frame mirrorless models, due to the introduction of the new EOS R5 and EOS R6. As for inkjet printers, sales of printers and consumables increased significantly from the previous year as a result of capturing the recovered demand in some emerging countries as well as the demand for remote working and education in developed countries and China. These factors resulted in total sales for the business unit of ¥712,238 million, a year-on-year decrease of 11.8%, while income before income taxes increased by 43.1% year-on-year to ¥71,070 million thanks to improvements in profitability due to the effect of new products. Within the Medical System Business Unit, although COVID- 19 caused delay of installation of the large equipment and business negotiation, the demand of CT systems for the diagnosis of pneumonia and Diagnostic X-ray systems was captured with the support to emergency medical system maintenance and financial support for medical institutions from governments of each country. These factors resulted in total sales for the business unit of ¥436,074 million, a year- on-year decrease of 0.6%, while income before income taxes decreased by 6.4% year-on-year to ¥25,544 million. As for the Industry & Others Business Unit, regarding semiconductor lithography equipment, demand for memory devices remained solid. As a result, unit sales were significantly above those of the previous year. In OLED panel manufac- turing equipment, sales increased due to the resumption of installation work after the easing of COVID-19 travel restric- tions. In FPD lithography equipment, although the installa- tion work after the gradual easing of travel restrictions were resumed, unit sales were below those of the previous year. Despite reflecting the negative impact of COVID-19, sales for network cameras slightly increased as a result of strengthened sales activities based on diversified applications made possible by video analysis for such purposes as remote monitoring and monitoring of crowded and confined, as well as conventional market needs including crime prevention and disaster monitor- ing tools. These factors resulted in total sales for the business unit of ¥654,813 million, a year-on-year decrease of 4.9%, while income before income taxes totaled ¥14,315million, a year-on-year decrease of 26.3%. Intersegment sales of ¥83,094 million are eliminated from total sales for the four segments, and are described as “Eliminations”. SALES BY SEGMENT Office Imaging System Medical System Industry and Others Eliminations Total 2020 1,440,212 712,238 436,074 654,813 (83,094) 3,160,243 change -17.8% -11.8% -0.6% -4.9% — -12.1% Millions of yen 2019 1,752,107 807,414 438,525 688,433 (93,180) 3,593,299 change 2018 -16.8% +0.2% -12.0% — -6.2% 1,868,355 970,435 437,578 781,887 (106,318) -9.1% 3,951,937 Note: From the beginning of the first quarter of 2020, Canon has reclassified certain businesses from Industry and Others Business Unit to Office Business Unit. Sales amounts for the years ended 2019 and 2018 also have been reclassified. SALES BY GEOGRAPHIC AREA Japan Americas Europe Asia and Oceania Total change 2020 -7.6% 806,305 852,451 -17.2% 795,616 -9.8% 705,871 -12.8% 3,160,243 -12.1% Millions of yen 2019 872,534 1,029,078 882,480 809,207 3,593,299 change +0.3% -4.4% -13.1% -18.3% -9.1% 2018 869,577 1,076,402 1,015,428 990,530 3,951,937 Note: This summary of net sales by geographic area is determined by the location where the product is shipped to the customers. 39 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020FINANCIAL OVERVIEW Sales by geographic area Please refer to the table of sales by geographic area in Note 22 of the Notes to Consolidated Financial Statements. In Japan, net sales decreased by 7.5% from the previous year mainly owing to a decline in sales of interchangeable-lens digital cameras and office MFDs mainly due to the decline of the demand caused by COVID-19 pandemic. In the Americas, net sales decreased by 17.2% from the previous year mainly owing to a decline in sales of inter- changeable-lens digital cameras and office MFDs mainly due to the decline of the demand caused by COVID-19 pandemic. In Europe, net sales decreased by 9.8% from the previous year mainly owing to a decline in sales of interchangeable-lens digital cameras and office MFDs mainly due to the decline of the demand caused by COVID-19 pandemic. In Asia and Oceania, net sales decreased by 12.8% from the previous year mainly owing to a decline in sales of inter- changeable-lens digital cameras and office MFDs mainly due to the decline of the demand caused by COVID-19 pandemic. Income before income taxes by segment Please refer to the table of segment information in Note 22 of the Notes to Consolidated Financial Statements. Income before income taxes for the Office Business Unit in 2020 decreased by 49.3% from the previous year to ¥86,483 million, mainly due to a decline in sales of office MFDs and laser printers and declines in sales of services and consumables. Income before income taxes for the Imaging System Business Unit in 2020 increased by 43.1% from the previous year to ¥71,070 million, thanks to improvements in profitabil- ity due to the effect of new products. Income before income taxes for the Medical System Business Unit in 2020 decreased by 6.4% from the previous year to ¥25,544 million, mainly due to COVID-19 caused delay of installation of the large equipment and business negotiation. Income before income taxes for the Industry and Others Business Unit in 2020 decreased by 26.3% from the previous year to ¥14,315 million, mainly due to COVID-19 caused delay of installation of the FPD lithography equipment. 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 22 of the Notes to Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents decreased by ¥5,130 million to ¥407,684 million in fiscal 2020 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 decreased by ¥24,656 million to ¥333,805 million in fiscal 2020 compared to the previous year due to a decrease in profit, despite improving working capital mainly through inventory reduction. The major component of Canon’s cash inflow is cash received from customers, and the major components of Canon’s cash outflow are payments for parts and materials, selling, general and administrative expenses, R&D expenses and income taxes. For fiscal 2020, cash inflow from cash received from cus- tomers decreased due to sales deterioration. There were no significant changes in Canon’s collection rates. Cash outflow for payments for parts and materials decreased due to a decrease of inventory compared with the inventory in fiscal 2019. Cash outflow for payments for income taxes decreased due to a decrease in taxable income in fiscal 2019. Net cash used in investing activities decreased by ¥73,129 million to ¥155,439 million in fiscal 2020 mainly due to a decrease in payment for purchases of fixed assets. Canon defines “free cash flow” as cash flows from operating activities less cash flows from investing activities. For fiscal 2020, free cash flow increased by ¥48,473 million to ¥178,366 million as compared with ¥129,893 million for fiscal 2019. Note: “Free cash flow” is a non-GAAP measure. Refer to the “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 alternatives of use in financing activities because it takes into consideration its operating and investing activities and believes that such indi- cator is beneficial to an investor’s understanding. 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 availability analysis. Net cash used in financing activities totaled ¥183,449 mil- lion in fiscal 2020, mainly resulting from the dividend payout of ¥126,938 million, the repurchases and reissuance of trea- sury stock of ¥50,008 million. The Company paid dividends in fiscal 2020 of ¥120.00 per share. To the extent Canon relies on external funding for its liquid- ity and capital requirements, it generally has access to various 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 financ- ing sources and from the capital markets, and believes it will continue to be able to do so in the future, there can be no 40 CANON ANNUAL REPORT 2020assurance that adverse economic or other conditions will not affect Canon’s liquidity or long-term funding in the future. Canon transferred 344,000 million yen which is loans with a repayment date of December, 2021, from long-term debt to the current portion of long term debt because the repay- ment date was within one year. As a result, short-term loans (including the current portion of long-term debt) increased by ¥350,201 million to ¥392,235 million at December 31, 2020 compared with ¥42,034 million at December 31, 2019. Long-term debt (excluding the current portion) decreased by ¥352,506 million to ¥4,834 million at December 31, 2020 compared with ¥357,340 million at December 31, 2019. Canon’s long-term debt mainly consists of bank borrowings and finance 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 9 agency in Japan, for access to the Japanese capital market. Sales by Segment (Billions of yen) Return on Sales (%) 5,000 5,000 Sales by Segment (Billions of yen) 5,000 basis in 2020 amounted to ¥132,302 million compared with ¥178,088 million in 2019 and ¥159,316 million in 2018. For 2021, Canon projects its increase in property, plant and equip- ment will be approximately ¥160,000 million. Employer contributions to Canon’s worldwide defined benefit pension plans were ¥26,965 million in 2020, ¥30,383 million in 2019 and ¥35,044 million in 2018. Employer contributions to Canon’s worldwide defined contribution pension plans were ¥16,334 million in 2020, ¥17,414 million in 2019, and ¥19,570 million in 2018. In addition, employer contributions to the mul- tiemployer pension plan of certain subsidiaries were ¥4,224 mil- lion in 2020, ¥4,321 million in 2019 and ¥4,452 million in 2018. Sales by Segment (Billions of yen) Working capital in 2020 decreased by ¥411,008 million to ¥462,954 million, compared with ¥873,962 million in 2019 and ¥1,009,269 million in 2018. Canon believes its working capital will be sufficient for its requirements for the foreseeable Sales by Geographic Area (Billions of yen) future. Canon’s capital requirements are primarily 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 liabilities) for 2020 was 1.35 compared to 1.90 for 2019 and to 1.97 for 2018. 3,000 5,000 5,000 4,000 3,000 3,000 4,000 4,000 As of March 15, 2021, Canon’s debt ratings are: Moody’s: Baa1 (long-term); S&P: A (long-term), A-1 (short-term); and R&I: AA (long-term). Canon does not have any rating down- 6 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. 2,000 Office Business Unit Office Business Unit Canon’s management policy in recent periods to optimize 3 Imaging System Imaging System Business Unit Business Unit inventory levels is intended to maintain an appropriate balance 1,000 Medical System Medical System among relevant imperatives, including minimizing working Return on Canon Inc. shareholders’ equity (net income Business Unit Business Unit capital, avoiding undue exposure to the risk of inventory obso- attributable to Canon Inc. divided by the average of total Industry and Others Industry and Others 0 Business Unit Business Unit 0 lescence, and maintaining the ability to sustain sales despite Canon Inc. shareholders’ equity) was 3.2% in 2020 compared Eliminations Eliminations 2020 2018 2016 2018 2018 2019 2016 2018 the occurrence of unexpected disasters. with 4.5% in 2019 and 8.9% in 2018. Return on assets (net income attributable to Canon Inc. divided by the average of total assets) was 1.8% in 2020, 2,000 compared to 2.6% in 2019 and 5.0% in 2018. Office Business Unit Imaging System Business Unit 1,000 Medical System Business Unit Industry and Others Business Unit Eliminations 0 2019 0 2019 2017 2019 2020 2020 2016 2019 2020 2020 2016 2017 2016 2017 2018 2016 2019 2017 2020 2017 3,000 4,000 1,000 3,000 2,000 4,000 1,000 2,000 2,000 1,000 0 0 Canon’s total inventory turnover measured in days were 60, 59, and 56 days at the end of the fiscal years 2020, 2019, and 2018, respectively. While sales declined significantly, inventory decreased by ¥21,949 million in fiscal 2020 compared to the previous year. As a result, inventory turnover measured in days was the same level as the previous year. Increase in property, plant and equipment on an accrual The debt to total assets ratios were 10.9%, 10.8% and 8.2% as of December 31, 2020, 2019 and 2018, respectively. Canon had short-term loans, current operating lease liabilities, long-term debt, and noncurrent operating lease liabilities of ¥506,172 million as of December 31, 2020, ¥514,946 mil- lion as of December 31, 2019 and ¥400,489 million as of December 31, 2018. Sales by Geographic Area (Billions of yen) 1,000 Japan Americas Europe Asia and Oceania 0 Japan Americas Europe Japan Americas Europe Asia and Oceania Asia and Oceania 2017 2018 2019 2020 2016 2017 2018 2019 2020 Sales by Geographic Area (Billions of yen) 5,000 4,000 3,000 2,000 12 9 6 3 0 Increase in Property, Plant and Equipment (Billions of yen) Increase in Property, Plant and Equipment (Billions of yen) 3.0 Working Capital Ratio Working Capital Ratio Working Capital Ratio Return on Canon Inc. Shareholders’ Equity (%) Return on Canon Inc. Shareholders’ Equity (%) Return on Canon Inc. Shareholders’ Equity (%) 300 200 100 2.5 2.0 1.5 1.0 0.5 3.0 2.5 2.0 1.5 1.0 0.5 0 3.0 2.5 2.0 1.5 1.0 0.5 12 9 6 3 12 9 6 3 0 2019 2020 2016 2017 0 2018 2019 2016 2020 2017 2018 0 2019 2020 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 41 2016 2017 2018 2019 2020 2016 2017 2018 0 2019 2020 2016 2017 0 2018 2019 2016 2020 2017 2018 2019 2020 2016 2017 2018 Return on Sales (%) Return on Sales (%) 2016 2017 2018 2019 2020 2016 2017 2018 Increase in Property, Plant and Equipment (Billions of yen) 9 6 3 0 300 200 100 0 400 300 200 100 0 9 6 3 0 300 200 100 0 400 300 200 100 0 R&D Expenses (Billions of yen) R&D Expenses (Billions of yen) R&D Expenses (Billions of yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) 400 300 200 100 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 2011 2012 2013 2014 2011 2015 2012 2016 2013 2017 2014 2011 2018 2015 2012 2019 2016 2013 2020 2017 2014 2018 2015 2019 2016 2020 2017 2018 2019 2020 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020FINANCIAL OVERVIEW Non-GAAP Financial Measures We have reported our financial results in accordance with U.S. GAAP. In addition, we have discussed our results using the combination of two GAAP cash flow measures, Net cash provided by operating activities and Net cash used for invest- ing activities, which we refer to as “Free Cash Flow” which is a non-GAAP measure. We believe this measure is beneficial to an investor’s understanding of Canon’s current liquidity and the alternatives of uses of financing activities because it takes into consideration its operating and investing activities. A reconciliation of this non-GAAP financial measure and the most directly comparable measure calculated and presented in accordance with GAAP is 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 2020 333,805 (155,439) 178,366 2019 358,461 (228,568) 129,893 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 principally made for their housing loans. The guarantees for affiliates and other companies are made for their lease obliga- tions and bank loans to ensure that those companies operate with less financial risk. Canon would have to perform under a guarantee if the borrower defaults on a payment within the contract terms. The contract terms are 1 year to 15 years in case of employ- ees with housing loans, and 1 year to 5 years in case of affili- ates 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 ¥2,568 million at December 31, 2020. The carrying amounts of the liabilities recognized for Canon’s obligations as a guar- antor under those guarantees at December 31, 2020 were not significant. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following summarizes Canon’s contractual obligations at December 31, 2020. 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: Contribution to defined benefit pension plans Total Total Less than 1 year 1-3 years 3-5 years More than 5 years Payments due by period 344,000 6,608 115,813 42,434 121,031 30,846 660,732 344,000 1,774 35,769 42,434 121,031 30,846 575,854 — 1,570 43,545 — — — 665 20,970 — — — 2,599 15,529 — — — 45,115 — 21,635 — 18,128 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 11, Income Taxes in the Notes to Consolidated Financial Statements for further details. Contribution to defined benefit pension plans reflects the expected amount only for the next fiscal year, since contributions beyond the next fiscal year are not currently determinable due to uncertainties related to changes in actuarial assumptions, returns on plan assets and changes to plan membership. Canon provides warranties of generally less than one year against defects in materials and workmanship on most of its consumer products. Estimated product warranty related costs are recorded at the time revenue is recognized and are included in selling, general and administrative expenses. Estimates for accrued product warranty costs are primarily based on historical experience, and are affected by ongoing product failure rates, specific product class failures outside of the baseline experience, material usage and service delivery costs incurred in correcting a product failure. As of December 42 CANON ANNUAL REPORT 202031, 2020 accrued product warranty costs are included in accrued expenses and amounted to ¥14,300 million. At December 31, 2020, commitments outstanding for the purchase of property, plant and equipment were approxi- mately ¥42,434 million, and commitments outstanding for the purchase of parts and raw materials were approximately ¥121,031 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 2021, Canon expects to contribute ¥14,414 million to its Japanese defined benefit pension plans and ¥16,432 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 Since its founding, Canon has diversified its business by devel- oping and diversifying core competence management that comprises various core competence technologies (“core tech- nologies”) to create industry-leading core products and basic component technologies that form the basis of technology accumulation. In addition, Canon incorporates technology and expertise that support the Canon brand accumulated during the company’s growth, that is, technology that supports qual- ity, cost and delivery, into core competence management as basic technologies for value creation. Canon’s key R&D strate- gies are as follows: • Reinforce basic component technologies and basic tech- nologies for value creation • Create future businesses based on strong core technolo- gies and basic component technologies • Enhance innovation-type R&D in response to the demands of the current age Canon strives to implement the above R&D strategies as follows: • Reinforce basic component technologies and basic tech- nologies for value creation: Contribute to higher efficiency of existing businesses by further evolving basic technologies for value creation. Alongside this, extract the essence of a wide range of core technologies possessed by each business group, deepen basic component technologies and inject them into core technologies of new businesses. In doing so, Canon will promote core competence management for strengthening existing businesses and growing new business groups. • Create future businesses based on strong core technolo- gies and basic component technologies: Promote development of new business areas through technology diversification. For example, Canon will develop devices that utilize functional materials tech- nology –the foundation of ink and toner materials- as well as materials with unique properties, and work on Return on Sales (%) Sales by Segment (Billions of yen) Sales by Geographic Area (Billions of yen) 3 9 6 • Enhance innovation-type R&D in response to the demands development of next-generation technologies that lead to business creation. 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 Japan Americas Europe Asia and Oceania 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 0 2020 2019 2016 2017 of the current age: Build upon trends such as Digital transformation (“DX”) and carbon neutrality, promote R&D that leads to cor- 2018 porate value improvement. In particular, focus on cyber- physical systems that closely integrate cyberspace, which enables the combination of various services, with physical (real world) space, the point of contact with people. Develop cyber-physical technologies that stay one step ahead by incorporating advanced cyber technology and utilize business alliances to develop world-class core tech- nologies in the physical field. 5,000 4,000 3,000 2,000 1,000 0 12 9 6 3 0 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 3.0 2.5 2.0 1.5 1.0 0.5 0 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 R&D expenses were ¥272,312 million in fiscal 2020 and ¥298,503 million in fiscal 2019. The R&D expenses to net sales ratios were 8.6% in fiscal 2020 and 8.3% in fiscal 2019. Increase in Property, Canon believes that new products protected by a robust Plant and Equipment (Billions of yen) patent portfolio will not easily allow competitors to surpass them, and will give the company an advantage in establishing standards in the market and industry. 300 Canon obtained the third greatest number of patents in the United States in 2020, according to the annual ranking list, released by IFI CLAIMS® Patent Services. 200 Working Capital Ratio Return on Canon Inc. Shareholders’ Equity (%) 100 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 risk of changes in foreign currency exchange rates, Canon uses derivative financial instruments. 0 2016 2017 2018 2019 2020 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 securities and investments for trading purposes. R&D Expenses (Billions of yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) 400 300 200 100 0 2016 2017 2018 2019 2020 43 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020FINANCIAL OVERVIEW Maturities and fair values of such marketable securities and investments with original maturities of more than three months were as follows at December 31, 2020. Fund trusts Equity securities Millions of yen Fair value 532 18,683 19,215 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 primarily used to hedge the foreign currency exposure of forecasted intercompany sales and intercompany trade receivables which are denominated in foreign currencies. In accordance with Canon’s policy, a specific portion of foreign currency exposure resulting from forecasted intercompany sales are hedged using foreign exchange contracts which principally mature within three months. The following table provides information about Canon’s major derivative financial instruments related to foreign currency exchange transactions existing at December 31, 2020. All of the foreign exchange contracts described in the following table have a contractual maturity date in 2021. 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 50,258 686 17,302 (216) 75,689 (992) 2,712 (4) 11,774 (133) 137,721 (439) 7,206 (33) 27,220 (253) Canon expects that fair value changes and cash flows result- The amount of the hedging ineffectiveness was not material ing from reasonable near-term changes in interest rates will be immaterial. Accordingly, Canon believes interest rate risk is insignificant. See also Note 8 of the Notes to Consolidated Financial Statements. Changes in the fair value of derivative financial instruments designated as cash flow hedges, including foreign exchange contracts associated with forecasted intercompany sales, are reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassified into earnings in the same period as the hedged items affect earnings. Substantially all amounts recorded in accumulated other comprehensive income (loss) as of December 31, 2020 are expected to be recognized in net sales over the next twelve months. 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. for the years ended December 31, 2018. The amounts of net losses excluded from the assessment of hedge effectiveness (time value component) which was recorded in other income (deductions) were ¥682 million for the years ended December 31, 2018. Canon has entered into certain foreign currency exchange contracts to manage its foreign currency exposures. These foreign currency exchange contracts have not been designated as hedges. Accordingly, the changes in fair values of these contracts are recorded in earnings immediately. LOOKING FORWARD Under the corporate philosophy of kyosei—living and working together for the common good—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 44 CANON ANNUAL REPORT 2020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. The global economy in 2021 is expected to recover moder- ately with the various economic measures and fiscal policies in each country and region over the long term. In the markets in which Canon operates, for office MFDs, demand for the imageRUNNER ADVANCE DX series with advanced scan functions and cloud functionality is expected to increase and print volumes are expected to recover. For laser printers, demand is also expected to increase due to signs of recovery of operating conditions in office. As for interchangeable-lens digital cameras, although the overall market is expected to continue to shrink, sales promotion efforts will be strengthened amid the shift to mirrorless and the product mix will be improved. As for inkjet printers, demand is expected not to decrease significantly given the increase of print volumes while remote working and education needs remain stable due to the ongoing pandemic. As for the medical equipment market, demand is expected to remain at around the same level as the previous year due to the risk of additional COVID-19 infections. For semiconductor lithography equipment, while demand for memory devices is expected to remain firm, demand for image sensors and automotive devices is expected to continue to increase. For FPD lithogra- phy equipment and OLED panel manufacturing equipment, demand will remain solid as panel manufacturers are expected to increase capital investments. As for network cameras, the market is also expected to trend towards expansion due to increasing demand for high-resolution cameras and the video analysis solutions that require them. In 2021, Under a new five-year management plan, Phase VI of the “Excellent Global Corporation Plan,” which begins in 2021, we will implement the following measures under the basic policy of group-wide productivity improvement and the enhancement of new businesses. (1) Printing group While expanding commercial printing business includ- ing catalog printing, the Printing Group will also firmly establish itself in the industrial printing field including label printing, package printing and the like. In the office mar- ket, Canon will expand and strengthen the product lineup by exploiting the advantages of both electrophotographic technology and inkjet technology. In addition, Canon will effectively respond to DX. (2) Optical Industry Group Canon will enter in-car camera business by leveraging the optical and network technology that Canon has refined over its long history and will aim to expand its business domains focusing on social infrastructure, such as observa- tion camera systems to support the realization of smart city. (3) Industrial Equipment Group Canon will further expand the competitiveness of OLED manufacturing equipment through innovation and cost reduction. In addition, Canon will strive to increase our share in semiconductor lithography equipment and FPD lithography equipment. (4) Medical Group Canon will strengthen the competitiveness of our core products including CT, magnetic resonance imaging (MRI), and ultrasound diagnostic systems, as well as diagnostic solutions and image analysis applications that make use of AI, to expand medical diagnostic equipment business. Canon will also aim to boldly enter domains on the periph- ery of diagnostic equipment, such as test reagents, and accelerate the growth of its business. 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 foreign currency transactions designed to reduce financial risks from changes in foreign currency exchange rates; and inventory risk due to shifts in market demand. In addition, new waves of COVID-19 infections are being seen in some regions, and it is still difficult to predict when COVID-19 will be brought under control. However, each country and region continues to pursue both the infection control and economic activities. Although the global economy is expected to recover in 2021, it is expected that some regions would continue to be affected by COVID-19. 45 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 20209 6 3 0 300 200 100 0 400 300 200 100 0 2016 2017 2018 2019 2020 Increase in Property, Plant and Equipment (Billions of yen) 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 Return on Sales (%) Sales by Segment (Billions of yen) Sales by Geographic Area (Billions of yen) 5,000 4,000 3,000 2,000 1,000 0 TEN-YEAR FINANCIAL SUMMARY Office Business Unit Imaging System Business Unit Medical System Business Unit Industry and Others Business Unit Eliminations 2018 2019 2020 Net sales: 2017 2016 Domestic Overseas Total Percentage of previous year Net income attributable to Canon Inc. Percentage of sales Advertising Research and development expenses Depreciation of property, plant and equipment Increase in property, plant and equipment Working Capital Ratio 3.0 2.5 2.0 Long-term debt, excluding current installments Canon Inc. shareholders' equity Total assets 1.5 Per share data: 1.0 Net income attributable to Canon Inc. shareholders per share: 0.5 2018 2019 2020 0 Basic Diluted 2016 Dividend per share Stock price: 2017 High Low 5,000 4,000 3,000 2,000 0 12 9 6 3 0 806,305 2,353,938 3,160,243 87.9% 83,318 2.6% 31,273 272,312 162,733 132,302 4,834 2,575,031 4,625,614 79.37 79.35 80.00 3,099 1,627 1,000 Millions of yen (except per share amounts) 2020 2019 2018 2017 2016 872,534 2,720,765 3,593,299 90.9% 2018 2020 2019 869,577 3,082,360 3,951,937 96.9% 124,964 3.5% 252,441 6.4% Return on Canon Inc. Shareholders’ Equity (%) 46,665 298,503 170,418 178,088 58,729 315,842 175,771 159,316 Japan Americas Europe 2017 Asia and Oceania 884,828 3,195,187 4,080,015 119.9% 242,081 5.9% 61,207 333,371 189,712 147,542 2016 2015 2014 2013 2012 2011 2020 Thousands of U.S. dollars (except per share amounts) 706,979 2,694,508 3,401,487 89.5% 150,334 4.4% 58,707 306,537 199,133 171,597 714,280 3,085,991 3,800,271 102.0% 219,943 5.8% 80,907 332,678 223,759 195,120 724,317 3,002,935 3,727,252 99.9% 254,627 6.8% 79,765 311,896 213,739 182,343 715,863 3,015,517 3,731,380 107.2% 229,829 6.2% 86,398 307,500 223,158 188,826 720,286 2,759,502 3,479,788 97.8% 224,854 6.5% 83,134 296,281 211,973 270,457 694,450 2,862,983 3,557,433 96.0% 248,214 7.0% 81,232 308,900 210,179 226,869 $ 7,752,933 22,634,019 30,386,952 87.9% 801,135 2.6% 300,702 2,618,385 1,564,740 1,272,135 357,340 2,685,496 4,771,918 361,962 2,820,644 4,902,955 493,238 2,863,986 5,201,626 611,289 2,776,327 5,142,279 881 2,959,929 4,431,720 1,148 2,971,963 4,464,854 1,448 2,904,212 4,246,796 2,117 2,592,630 3,959,542 3,368 $ 46,481 2,545,447 3,934,992 24,759,913 44,477,058 116.79 116.77 160.00 2016 2017 233.80 233.78 160.00 2018 2019 2020 3,338 2,688 4,395 2,877 223.03 223.03 160.00 4,472 3,218 137.66 137.66 150.00 3,656 2,780 201.41 201.40 150.00 4,539 3,402 228.88 228.88 150.00 4,045 2,889 200.21 200.21 130.00 4,115 2,913 191.59 191.58 130.00 4,015 2,308 204.15 204.14 120.00 4,280 3,220 $ 0.76 0.76 0.77 29.80 15.64 Average number of common shares in thousands Number of employees 1,049,802 181,897 1,069,957 187,041 1,079,753 195,056 1,085,439 197,776 1,092,071 197,673 1,092,018 189,571 1,112,510 191,889 1,147,934 194,151 1,173,648 196,968 1,215,832 198,307 R&D Expenses (Billions of yen) Common Stock Price Range (Tokyo Stock Exchange) (Yen) 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 46 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 CANON ANNUAL REPORT 2020Millions of yen (except per share amounts) 806,305 2,353,938 3,160,243 87.9% 83,318 2.6% 31,273 272,312 162,733 132,302 872,534 2,720,765 3,593,299 90.9% 124,964 3.5% 46,665 298,503 170,418 178,088 869,577 3,082,360 3,951,937 96.9% 252,441 6.4% 58,729 315,842 175,771 159,316 884,828 3,195,187 4,080,015 119.9% 242,081 5.9% 61,207 333,371 189,712 147,542 Net sales: Domestic Overseas Total Percentage of previous year Net income attributable to Canon Inc. Percentage of sales Advertising Research and development expenses Depreciation of property, plant and equipment Increase in property, plant and equipment Long-term debt, excluding current installments Canon Inc. shareholders' equity Total assets Per share data: Net income attributable to Canon Inc. shareholders per share: Dividend per share Stock price: Basic Diluted High Low 2020 2019 2018 2017 2016 2015 2014 2013 2012 2011 2020 Thousands of U.S. dollars (except per share amounts) 706,979 2,694,508 3,401,487 89.5% 150,334 4.4% 58,707 306,537 199,133 171,597 714,280 3,085,991 3,800,271 102.0% 219,943 5.8% 80,907 332,678 223,759 195,120 724,317 3,002,935 3,727,252 99.9% 254,627 6.8% 79,765 311,896 213,739 182,343 715,863 3,015,517 3,731,380 107.2% 229,829 6.2% 86,398 307,500 223,158 188,826 720,286 2,759,502 3,479,788 97.8% 224,854 6.5% 83,134 296,281 211,973 270,457 694,450 2,862,983 3,557,433 96.0% 248,214 7.0% 81,232 308,900 210,179 226,869 $ 7,752,933 22,634,019 30,386,952 87.9% 801,135 2.6% 300,702 2,618,385 1,564,740 1,272,135 4,834 2,575,031 4,625,614 357,340 2,685,496 4,771,918 361,962 2,820,644 4,902,955 493,238 2,863,986 5,201,626 611,289 2,776,327 5,142,279 881 2,959,929 4,431,720 1,148 2,971,963 4,464,854 1,448 2,904,212 4,246,796 2,117 2,592,630 3,959,542 3,368 2,545,447 3,934,992 $ 46,481 24,759,913 44,477,058 79.37 79.35 80.00 3,099 1,627 116.79 116.77 160.00 3,338 2,688 233.80 233.78 160.00 4,395 2,877 223.03 223.03 160.00 4,472 3,218 137.66 137.66 150.00 3,656 2,780 201.41 201.40 150.00 4,539 3,402 228.88 228.88 150.00 4,045 2,889 200.21 200.21 130.00 4,115 2,913 191.59 191.58 130.00 4,015 2,308 204.15 204.14 120.00 4,280 3,220 $ 0.76 0.76 0.77 29.80 15.64 Average number of common shares in thousands Number of employees 1,049,802 181,897 1,069,957 187,041 1,079,753 195,056 1,085,439 197,776 1,092,071 197,673 1,092,018 189,571 1,112,510 191,889 1,147,934 194,151 1,173,648 196,968 1,215,832 198,307 Notes: 1. U.S. dollar amounts are translated from yen at the rate of U.S.$1 = JPY104, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 30, 2020. 2. Canon adopted ASU No. 2017-07 from the quarter beginning January 1, 2018. The adoption of the new presentation requirement of the service cost component and the other components of net benefit cost resulted in reclassification from cost of sales, and selling, general and administrative expenses, and research and development expenses into other income (deductions) for the years ended December 31 from 2017 to 2011 respectively. 3. Certain figures prior to the fiscal year ended December 31, 2019 presented in the table above have been revised from the versions previously disclosed. The effect on the consolidated financial statements was immaterial, respectively. For further details regarding the circumstances of the revision, please refer to Note 1 (y) of the Notes to Consolidated Financial Statements. 47 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020 CONSOLIDATED BALANCE SHEETS Canon Inc. and Subsidiaries December 31, 2020 and 2019 ASSETS Current assets: Cash and cash equivalents (Note 1) Short-term investments (Note 2) Trade receivables, net of allowance for credit losses of ¥11,645 and ¥10,359 (Note 3) Inventories (Note 4) Prepaid expenses and other current assets, net of allowance for credit losses of ¥1,101 and ¥994 (Notes 6, 14 and 17) Total current assets Noncurrent receivables (Note 19) Investments (Notes 2 and 21) Property, plant and equipment, net (Notes 5 and 6) Operating lease right-of-use assets (Note 18) Intangible assets, net (Note 7) Goodwill (Note 7) Other assets, net of allowance for credit losses of ¥1,967 and ¥1,633 (Notes 6, 10 and 11) Total assets LIABILITIES AND EQUITY Current liabilities: Short-term loans and current portion of long-term debt (Note 8) Trade payables (Note 9) Accrued income taxes (Note 11) Accrued expenses (Notes 10 and 19) Current operating lease liabilities (Note 18) Other current liabilities (Notes 5, 14 and 17) Total current liabilities Long-term debt, excluding current installments (Notes 8 and 20) Accrued pension and severance cost (Note 10) Noncurrent operating lease liabilities (Note 18) Other noncurrent liabilities (Note 11) Total liabilities Commitments and contingent liabilities (Note 19) Equity: Canon Inc. shareholders’ equity: Common stock Millions of yen 2020 2019 407,684 71 535,126 562,807 283,455 412,814 1,767 559,836 584,756 286,792 1,789,143 1,845,965 17,276 49,994 17,135 48,361 1,037,680 1,089,671 107,361 318,497 915,564 390,099 114,418 347,921 898,661 409,786 4,625,614 4,771,918 392,235 303,809 18,761 317,716 32,307 261,361 1,326,189 4,834 345,897 76,796 87,857 42,034 305,312 18,801 336,396 31,884 237,576 972,003 357,340 368,507 83,688 106,400 1,841,573 1,887,938 Authorized 3,000,000,000 shares; issued 1,333,763,464 shares in 2020 and 2019 Additional paid-in capital Legal reserve (Note 12) Retained earnings (Note 12) Accumulated other comprehensive income (loss) (Note 13) 174,762 404,620 69,436 3,409,371 (324,789) 174,762 405,017 67,572 3,455,083 (308,442) Treasury stock, at cost; 287,989,819 shares in 2020 and 269,928,993 shares in 2019 (1,158,369) (1,108,496) Total Canon Inc. shareholders’ equity Noncontrolling interests Total equity Total liabilities and equity See accompanying Notes to Consolidated Financial Statements. 48 2,575,031 209,010 2,784,041 4,625,614 2,685,496 198,484 2,883,980 4,771,918 CANON ANNUAL REPORT 2020CONSOLIDATED STATEMENTS OF INCOME Canon Inc. and Subsidiaries Years ended December 31, 2020, 2019 and 2018 Net sales (Notes 6, 14 and 17) Products and Equipment Services Cost of sales (Notes 5, 7, 10 and 18) Products and Equipment Services Gross profit Operating expenses (Notes 1, 5, 7, 10, 15, 18 and 19): Selling, general and administrative expenses Research and development expenses Operating profit Other income (deductions): Interest and dividend income Interest expense Other, net (Notes 1, 2, 10, 13 and 17) Income before income taxes Income taxes (Note 11) 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 See accompanying Notes to Consolidated Financial Statements. Millions of yen 2020 2019 2018 2,489,829 670,414 3,160,243 2,835,428 757,871 3,593,299 3,194,724 757,213 3,951,937 1,463,637 320,738 1,784,375 1,375,868 993,009 272,312 1,265,321 110,547 1,627,858 355,408 1,983,266 1,610,033 1,137,110 298,503 1,435,613 174,420 1,762,171 354,212 2,116,383 1,835,554 1,177,260 315,842 1,493,102 342,452 2,923 (854) 17,664 19,733 130,280 34,337 95,943 12,625 83,318 79.37 79.35 5,526 (1,038) 16,585 21,073 195,493 56,146 139,347 14,383 124,964 Yen 116.79 116.77 6,604 (797) 14,133 19,940 362,392 95,995 266,397 13,956 252,441 233.80 233.78 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Canon Inc. and Subsidiaries Years ended December 31, 2020, 2019 and 2018 Consolidated net income Other comprehensive income (loss), net of tax (Note 13): 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. 2020 95,943 (17,354) — 970 1,382 (15,002) 80,941 13,961 66,980 Millions of yen 2019 139,347 (32,157) — (1,068) (3,630) (36,855) 102,492 16,353 86,139 2018 266,397 (93,146) (141) 488 (30,570) (123,369) 143,028 6,887 136,141 49 CANON ANNUAL REPORT 2020CONSOLIDATED STATEMENTS OF EQUITY Canon Inc. and Subsidiaries Years ended December 31, 2020, 2019 and 2018 Balance at December 31, 2017 Cumulative effects of accounting standard update—adoption of ASU No.2014-09 Cumulative effects of accounting standard update—adoption of ASU No. 2016-01 Equity transactions with noncontrolling interests and other Dividends to Canon Inc. shareholders (165.00 yen per share)* Dividends to noncontrolling interests Transfers to legal reserve Comprehensive income: Net income Other comprehensive income (loss), net of tax (Note 13): 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 Balance at December 31, 2018 Cumulative effects of accounting standard update—adoption of ASU No. 2017-12 Equity transactions with noncontrolling interests and other Dividends to Canon Inc. shareholders (160.00 yen per share)* Dividends to noncontrolling interests Transfers to legal reserve Comprehensive income: Net income Other comprehensive income (loss), net of tax (Note 13): Foreign currency translation adjustments Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income (loss) Repurchases of treasury stock Reissuance of treasury stock Balance at December 31, 2019 Cumulative effects of accounting standard update—adoption of ASU No. 2016-13 Equity transactions with noncontrolling interests and other Dividends to Canon Inc. shareholders (120.00 yen per share)* Dividends to noncontrolling interests Transfers to legal reserve Comprehensive income: Net income Other comprehensive income (loss), net of tax (Note 13): Foreign currency translation adjustments Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income (loss) Repurchases of treasury stock Reissuance of treasury stock Balance at December 31, 2020 Millions of yen Common stock 174,762 Additional paid-in capital 401,386 Legal reserve 66,879 Other retained earnings 3,422,668 Total retained earnings 3,489,547 Accumulated other comprehensive income (loss) (143,228) Total Canon Inc. shareholders’ equity Treasury stock (1,058,481) 2,863,986 Non- controlling interests 224,766 Total equity 3,088,752 (106) (106) 5,343 5,343 (5,343) (106) — (76) — (182) — 3,003 (4,200) (1,197) (36,518) (37,715) (178,159) (178,159) 237 (237) — (178,159) — (5,558) (178,159) (5,558) — 252,441 252,441 252,441 13,956 266,397 (89,823) (141) 488 (26,824) 174,762 404,389 67,116 3,501,950 3,569,066 (269,071) 641 122 122 (122) (424) (171,487) (171,487) 456 (456) — (89,823) (3,323) (93,146) (141) — (141) 488 (26,824) 136,141 (25) 4 (1,058,502) 2,820,644 (25) 4 — (3,746) 6,887 189,501 488 (30,570) 143,028 (25) 4 3,010,145 — — — 217 (1,813) (1,596) (171,487) — (5,557) (171,487) (5,557) — 124,964 124,964 124,964 14,383 139,347 (32,043) (1,073) (5,709) 174,762 (13) 405,017 (10) 3,455,083 (10) 3,522,655 67,572 (308,442) (32,043) (114) (32,157) (1,073) (5,709) 86,139 (50,015) (2) (1,108,496) 2,685,496 (50,015) 21 5 2,079 16,353 198,484 (1,068) (3,630) 102,492 (50,015) (2) 2,883,980 (159) (159) (159) — (159) (316) (9) (15) (340) 1,091 751 (126,938) (126,938) 1,864 (1,864) — (126,938) — (4,526) (126,938) (4,526) — 83,318 83,318 83,318 12,625 95,943 (17,355) (17,355) 1 (17,354) 174,762 (81) 404,620 (69) 3,409,371 (69) 3,478,807 69,436 987 30 987 30 66,980 (50,008) 0 (324,789) (1,158,369) 2,575,031 (50,008) 150 (17) 1,352 13,961 209,010 970 1,382 80,941 (50,008) 0 2,784,041 *Canon changed the presentation of cash dividends per share which were previously presented in the consolidated statements of income. See accompanying Notes to Consolidated Financial Statements. 50 CANON ANNUAL REPORT 2020CONSOLIDATED STATEMENTS OF CASH FLOWS Canon Inc. and Subsidiaries Years ended December 31, 2020, 2019 and 2018 Cash flows from operating activities: Consolidated net income Adjustments to reconcile consolidated net income to net cash provided by operating activities: Depreciation and amortization Loss on disposal of fixed assets Equity in earnings of affiliated companies Deferred income taxes Decrease (increase) in trade receivables Decrease (increase) in inventories Decrease in trade payables Increase (decrease) in accrued income taxes (Decrease) increase in accrued expenses Decrease in accrued (prepaid) pension and severance cost Other, net (Note 6) Net cash provided by operating activities Cash flows from investing activities: Purchases of fixed assets (Note 5) Proceeds from sale of fixed assets (Note 5) Purchases of securities Proceeds from sale and maturity of securities Decrease (increase) in time deposits, net Acquisitions of businesses, net of cash acquired Other, net Net cash used in investing activities Cash flows from financing activities: Proceeds from issuance of long-term debt (Note 8) Repayments of long-term debt (Note 8) Increase in short-term loans, net (Note 8) Transaction with noncontrolling interests Dividends paid Repurchases and reissuance of treasury stock Other, net Millions of yen 2020 2019 2018 95,943 139,347 266,397 227,825 4,326 994 (15,542) 15,120 16,075 (4,636) 43 (16,413) (16,601) 26,671 333,805 (164,719) 7,815 (592) 558 1,652 (127) (26) 237,327 5,991 311 (6,523) 43,504 19,895 (35,509) (22,279) 9,738 (13,722) (19,619) 358,461 (215,671) 885 (4,907) 828 (1,511) (8,880) 688 251,554 5,726 (1,414) (12,004) (17,724) (61,755) (31,212) (35,284) 3,041 (17,738) 15,706 365,293 (191,399) 9,634 (2,311) 1,615 401 (13,346) (209) (155,439) (228,568) (195,615) 2,100 (11,095) 5,642 1,376 (126,938) (50,008) (4,526) — (8,678) 4,913 (1,769) (171,487) (50,012) (5,557) 439 (136,094) 2,501 (37,942) (178,159) (21) (5,554) Net cash used in financing activities (183,449) (232,590) (354,830) Effect of exchange rate changes on cash and cash equivalents (47) (5,134) (16,017) 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. (5,130) (107,831) (201,169) 412,814 407,684 520,645 721,814 412,814 520,645 1,028 45,471 888 77,654 749 131,616 51 CANON ANNUAL REPORT 2020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 products consist mainly of office multifunction devices (“MFDs”), laser multifunction printers (“MFPs”), laser print- ers, digital continuous feed presses, digital sheet-fed presses, wide-format printers and document solutions. Imaging system products consist mainly of interchangeable-lens digital cam- eras, digital compact cameras, interchangeable lenses, com- pact photo printers, inkjet printers, large format inkjet printers, commercial photo printers, image scanners and calculators. Medical system products consist mainly of digital radiography systems, diagnostic X-ray systems, computed tomography (“CT”) systems, magnetic resonance imaging (“MRI”) systems, diagnostic ultrasound systems, clinical chemistry analyzers and ophthalmic equipment. Industry and other products consist mainly of semiconductor lithography equipment, FPD (Flat panel display) lithography equipment, vacuum thin-film depo- sition equipment, organic LED (“OLED”) panel manufacturing equipment, die bonders, network cameras, digital camcord- ers, digital cinema cameras, multimedia projectors, broadcast equipment, micromotors, handy terminals and document scanners. Sales are made principally under the Canon brand name, almost entirely through sales subsidiaries. These sub- sidiaries are responsible for marketing and distribution, and primarily sell to retail dealers in their geographic area. Further segment information is described in Note 22. Canon sells laser printers on an OEM basis to HP Inc.; such sales constituted 11.4%, 13.0% and 13.6% of consolidated net sales for the years ended December 31, 2020, 2019 and 2018, respectively, and are included in the Office Business Unit. Canon’s manufacturing operations are conducted primarily at 29 plants in Japan and 14 overseas plants which are located in countries and 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 standards of Japan. Foreign subsidiaries maintain their books of account in conformity with financial accounting standards of the countries of their domicile. Certain adjustments and reclassifications have been incorpo- rated in the accompanying consolidated financial statements to conform with U.S. generally accepted accounting principles (“U.S. GAAP”). These adjustments were not recorded in the statutory books of account. (c) Principles of Consolidation The consolidated financial statements include the accounts of the Company, its majority owned subsidiaries and those vari- able interest entities where the Company or its consolidated subsidiaries are the primary beneficiaries. All significant inter- company balances and transactions have been eliminated. (d) Use of Estimates The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial state- ments and the reported amounts of revenues and expenses during the period. Significant estimates and assumptions are reflected in valuation and disclosure of accounts including: revenue recognition, allowance for credit losses, inventories, long-lived assets, leases, 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 dif- fer materially from those estimates. In addition, new waves of COVID-19 infections are being seen in some regions, and it is still difficult to predict when COVID-19 will be brought under control. However, each country and region continues to pursue both the infection control and economic activities. Although the global economy is expected to recover in 2021, it is expected that some regions would continue to be affected by COVID-19. (e) Translation of Foreign Currencies Assets and liabilities of the Company’s subsidiaries located outside Japan with functional currencies other than Japanese yen are translated into Japanese yen at the rates of exchange in effect at the balance sheet date. Income and expense items are translated at the average exchange rates prevailing during the year. Gains and losses resulting from translation of finan- cial statements are excluded from earnings and are reported in other comprehensive income (loss). Gains and losses resulting from foreign currency transac- tions and translation of assets and liabilities denominated in foreign currencies are included in other income (deductions) in the consolidated statements of income. Foreign currency exchange gains and losses were net losses of ¥4,451 mil- lion, ¥4,236 million and ¥6,044 million for the years ended December 31, 2020, 2019 and 2018, respectively. (f) Cash Equivalents All highly liquid investments acquired with original maturities of three months or less are considered to be cash equivalents. Certain debt securities with original maturities of less than three months, classified as available-for-sale securities of ¥500 million and ¥506 million at December 31, 2020 and 2019, respectively, are included in cash and cash equivalents in the consolidated balance sheets. 52 CANON ANNUAL REPORT 2020(g) Investments Investments consist primarily of time deposits with original maturities of more than three months, debt and equity securi- ties and investments in affiliated companies. Canon classifies investments in debt securities as available- for-sale securities. Canon does not hold any trading securities which are bought and held primarily for the purpose of sale in the near term, or any held-to-maturity securities. Canon reports investments with maturities of less than one year as short-term investments. Available-for-sale debt securities and equity securities with readily determinable fair value that are not accounted for under the equity method are recorded at fair value which is determined based on quoted market prices, projected dis- counted cash flows or other valuation techniques as appropri- ate. The changes in fair value for equity securities are included in other, net in the consolidated statements of income. The changes in fair value for available-for-sale debt securities are included in net unrealized gains and losses on securities in the consolidated statements of comprehensive income. Available-for-sale debt securities are regularly reviewed for other-than-temporary declines in the carrying amount based on criteria that include the length of time and the extent to which the market value has been less than cost, the financial condition and near-term prospects of the issuer and Canon’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. For available-for-sale securities for which the declines are deemed to be other-than-temporary and there is no intent to sell, the impairment is separated into the amount related to credit loss, which is recognized in earnings and the amount related to all other factors is recognized in other compre- hensive income (loss). For available-for-sale securities for which the declines are deemed to be other-than-temporary and there is an intent to sell, the impairment in its entirety is recognized in earnings. Canon recognizes an impairment loss to the extent the cost basis of the investment exceeds the fair value of the investment. Canon measures non-marketable equity securities without readily determinable fair value at cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for an identical or a similar investment of the same issuer. 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 controlling financial interest, are accounted for by the equity method. (h) Allowance for credit losses Allowance for credit losses for trade and finance receivables is maintained for all customers based on a current expected credit loss model (Please refer to Note 1 (x) Recently adopted accounting guidance), considering various factors, including aging analysis, macroeconomic conditions and historical experience. An additional reserve for individual accounts is recorded when Canon becomes aware of a customer’s inability to meet its financial obligations, such as in the case of bank- ruptcy filings. If circumstances related to customers change, estimates of the recoverability of receivables would be further adjusted. When all collection options are exhausted including legal recourse, the accounts or portions thereof are deemed to be uncollectable and charged against the allowance. (i) Inventories Inventories are stated at the lower of cost or 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 circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset 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. (l) Leases As for lessor accounting, Canon provides leasing arrange- ments to its customers primarily for the sale of office products. Revenue from the sale of these products under sales-type leases is recognized at the inception of the lease. Interest income on sales-type leases and direct-financing leases is recognized over the life of each respective lease using the interest method. Leases not qualifying as sales-type leases or direct-financing leases are accounted for as operating leases and related revenue is recognized ratably over the lease term. When product leases are bundled with maintenance contracts, revenue is allocated based upon the estimated standalone sell- ing prices of the lease and non-lease components. Lease com- ponents generally include product and financing while non- lease components generally consist of maintenance contracts 53 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and supplies. Some of the contracts include options to extend or to terminate the lease. Canon takes such options into account to determine the lease term when it is reasonably cer- tain that it will exercise these options. The majority of Canon’s lease contracts do not contain bargain purchase options for their customers. Assets leased to others under operating leases are stated at cost and depreciated to the estimated residual value of the assets by the straight-line method over the lease term, generally from 2 years to 50 years. As for lessee accounting, Canon has operating and finance leases for various assets including office buildings, warehouses, employees’ accommodations, and vehicles. Canon determines if an arrangement is a lease at the inception of each contract. Some of the contracts include options to extend or to ter- minate the lease. Canon takes such options into account to determine the lease term when it is reasonably certain that it will exercise these options. Canon’s lease arrangements do not contain material residual value guarantees or material restric- tive covenants. As a rate implicit in most of Canon’s leases cannot be determined, Canon uses incremental borrowing rates based on the information available at commencement to determine the present values of lease payments. Canon has lease contracts with lease and non-lease components, which are accounted for separately. Canon allocates the consideration in the lease contract to the lease and non-lease components based upon the estimated standalone prices. Costs associated with operating lease assets are recognized on a straight-line basis over the term of the lease. (m) Goodwill and other intangible assets Goodwill and other intangible assets with indefinite useful lives are not amortized, but are instead tested for impairment annually in the fourth quarter of each year, or more frequently if indicators of potential impairment exist. 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 8 years, trademarks are 15 years, patents and developed technology are from 5 years to 18 years, license fees are 8 years, and customer relationships are 15 years, respectively. Certain costs incurred in connection with developing or obtaining internal-use software are capital- ized. These costs consist primarily of payments made to third parties and the salaries of employees working on such soft- ware development. Costs incurred in connection with devel- oping internal-use software are capitalized at the application development stage. In addition, Canon develops or obtains certain software to be sold where related costs are capitalized after establishment of technological feasibility. (n) Environmental Liabilities Liabilities for environmental remediation and other environ- mental costs are accrued when environmental assessments or remedial efforts are probable and the costs can be reasonably estimated, and are included in other noncurrent liabilities in the consolidated balance sheets. Such liabilities are adjusted as further information develops or circumstances change. Costs of future obligations are not discounted to their present values. (o) Income Taxes Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and 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 examina- tion by the tax authorities. Benefits from tax positions that meet the more-likely-than-not recognition threshold are measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. Interest and penalties accrued related to unrecognized tax benefits are included in income taxes in the consolidated statements of income. (p) 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. (q) 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 common 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. (r) Revenue Recognition Canon generates revenue principally through the sale of office, imaging system and medical system products, indus- trial equipment, supplies and related services under separate 54 CANON ANNUAL REPORT 2020contractual arrangements. Revenue is recognized when, or as, control of promised goods or services transfers to customers in an amount that reflects the consideration to which Canon expects to be entitled in exchange for transferring these goods or services. For further information, please refer to Note 14. (w) 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. (s) Research and Development Costs Research and development costs are expensed as incurred. (t) Advertising Costs Advertising costs are expensed as incurred. Advertising expenses were ¥31,273 million, ¥46,665 million and ¥58,729 million for the years ended December 31, 2020, 2019 and 2018, respectively. (u) Shipping and Handling Costs Shipping and handling costs totaled ¥47,721 million, ¥51,718 million and ¥54,844 million for the years ended December 31, 2020, 2019 and 2018, respectively, and are included in selling, general and administrative expenses in the consolidated state- ments of income. (v) Derivative Financial Instruments All derivatives are recognized at fair value and are included in prepaid expenses and other current assets, or other current liabilities in the consolidated balance sheets. Canon uses and designates certain derivatives as a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge). Canon formally documents all relation- ships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. Canon also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, Canon discontinues hedge accounting prospectively. Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge are recorded in other comprehensive income (loss), until earnings are affected by the variability in cash flows of the hedged item, and reclassified in the same income statement line item in which the earnings effect of the hedged item is reported. 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. (x) Recent Accounting Guidance Recently adopted accounting guidance In June 2016, the Financial Accounting Standards Board issued ASU No. 2016-13, Financial Instruments – Credit Losses – (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires entities to use a current expected credit loss model to measure impairments of certain financial assets. Using this model results in earlier recognition of losses than under the incurred loss approach, which requires waiting to recognize a loss until it is probable of being incurred. Canon adopted the guidance from the quarter beginning January 1, 2020 with the modified retrospective basis through a cumula- tive effect adjustment directly to retained earnings as of the beginning of the period. The adoption of this guidance did not have a material impact on its consolidated results of operation and financial condition. Under the adoption of ASU No. 2016- 13, Canon changed the presentation related to the allowance for credit losses in the consolidated balance sheets, from “ trade receivables, net” to “trade receivables, net of allowance for credit losses”, “prepaid expenses and other current assets” to “prepaid expenses and other current assets, net of allow- ance for credit losses” and other assets” to “other assets, net of allowance for credit losses”. (y) Correction of an Immaterial Error During the year ended December 31, 2020, Canon corrected an error in its previously issued consolidated financial state- ments related to accounting for the Company and domestic subsidiaries’ compensated absence carryforward in accordance with ASC 710 “Compensation.” In evaluating whether the previously issued consolidated financial statements were mate- rially misstated for the annual periods prior to December 31, 2020, Canon applied the guidance of ASC 250, “Accounting Changes and Error Corrections,” SEC Staff Accounting Bulletin (“SAB”) Topic 1.M “Assessing Materiality” and SAB Topic 1.N “Considering the Effects of Prior Period Misstatements when Quantifying Misstatements in Current Year Financial Statements,” and concluded that the effect of the error on prior period financial statements was immaterial; however, the cumulative effect of correcting the prior period misstatements in the current year would be material to the current year con- solidated financial statements. As a result, Canon revised its consolidated financial statements as follows: 55 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Consolidated balance sheet As of December 31 Other assets Accrued expenses Retained earnings Noncontrolling interests Consolidated statements of income Year ended December 31 Millions of yen 2019 As revised As previously reported 409,786 336,396 3,455,083 198,484 406,219 324,891 3,462,182 199,323 Millions of yen 2019 2018 As revised As previously reported As revised As previously reported Selling, general and administrative expenses 1,137,110 1,136,863 1,177,260 1,176,760 Operating profit Income before income taxes Income taxes 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: Basic Diluted 174,420 195,493 56,146 139,347 14,383 124,964 174,667 195,740 56,223 139,517 14,412 125,105 Yen 342,452 362,392 95,995 266,397 13,956 252,441 342,952 362,892 96,150 266,742 13,987 252,755 116.79 116.77 116.93 116.91 233.80 233.78 234.09 234.08 Consolidated statements of comprehensive income Year ended December 31 Millions of yen 2019 2018 As revised As previously reported As revised As previously reported Consolidated net income 139,347 139,517 266,397 266,742 Less: Comprehensive income attributable to noncontrolling interests Comprehensive income (loss) attributable to Canon Inc. Consolidated statements of cash flows Year ended December 31 Consolidated net income Increase in accrued expenses Deferred income taxes 16,353 16,382 6,887 6,918 86,139 86,280 136,141 136,455 Millions of yen 2019 2018 As revised As previously reported As revised As previously reported 139,347 139,517 9,738 (6,523) 9,491 (6,446) 266,397 3,041 (12,004) 266,742 2,541 (11,849) The consolidated statements of equity have been revised, accordingly. 56 CANON ANNUAL REPORT 20202. INVESTMENTS The unrealized and realized gains and losses related to equity securities for the year ended December 31, 2020, 2019 and 2018 are as follows: Years ended December 31 Net gains and (losses) recognized during the period on equity securities Less: Net gains and (losses) recognized during the period on equity securities sold during the period Unrealized gains and (losses) recognized during the period on equity securities still held at December 31 2020 1,959 477 1,482 Millions of yen 2019 2,148 2018 (6,092) (76) 675 2,224 (6,767) The carrying amount of non-marketable equity securities without readily determinable fair value totaled ¥8,559 mil- lion and ¥8,448 million at December 31, 2020 and 2019, respectively. The impairment or other adjustments resulting from observable price changes recorded during the year ended December 31, 2020 and 2019 were not significant. There were no available-for-sale debt securities included in short-term investments and investments at December 31, 2020 and 2019, respectively. The unrealized and realized gains and losses related to debt securities were not significant for the years ended December 31, 2020, 2019 and 2018, respectively. Time deposits with original maturities of more than three months are ¥71 million and ¥1,767 million at December 31, 2020 and 2019, respectively, and are included in short-term investments in the accompanying consolidated balance sheets. Investments in affiliated companies accounted for by the equity method amounted to ¥19,634 million and ¥19,988 million at December 31, 2020 and 2019, respectively. Canon’s share of the net earnings in affiliated companies accounted for by the equity method, included in other income (deductions), were losses of ¥994 million and ¥311 million for the year ended December 31, 2020 and 2019 respectively, and earnings of ¥1,414 million for the years ended December 31, 2018. 3. TRADE RECEIVABLES Trade receivables are summarized as follows: December 31 Notes Accounts Less allowance for credit losses 4. INVENTORIES Inventories are summarized as follows: December 31 Finished goods Work in process Raw materials Millions of yen 2020 34,922 511,849 (11,645) 535,126 2019 32,952 537,243 (10,359) 559,836 Millions of yen 2020 352,513 160,696 49,598 562,807 2019 367,332 165,399 52,025 584,756 57 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 Finance lease right-of-use assets Less accumulated depreciation Millions of yen 2020 270,308 1,687,921 1,806,185 37,324 6,048 3,807,786 (2,770,106) 1,037,680 2019 273,014 1,658,270 1,802,624 77,953 4,999 3,816,860 (2,727,189) 1,089,671 Depreciation expenses for the years ended December 31, 2020, 2019 and 2018 were ¥162,733 million, ¥170,418 mil- lion and ¥175,771 million, respectively. Amounts due for purchases of property, plant and equip- ment were ¥27,688 million and ¥30,601 million at December 31, 2020 and 2019, 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. LESSOR ACCOUNTING Lease income is included in Products and Equipment sales in the accompanying consolidated statements of income. Supplemental income statement information is as follows: Years ended December 31 Lease income - sales-type and direct financing leases Revenue at lease commencement Interest income on lease receivables Lease income – operating leases Variable lease income Millions of yen 2020 2019 92,133 18,594 110,727 23,878 5,343 139,948 114,312 20,382 134,694 25,403 6,216 166,313 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 7 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 58 2020 337,265 11,459 — (29,541) 319,183 (3,068) 316,115 (108,837) 207,278 2019 360,146 13,070 — (33,338) 339,878 (2,627) 337,251 (113,892) 223,359 CANON ANNUAL REPORT 2020Allowance for Credit Losses The activities in the allowance for credit losses are 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 2020 2,627 (2,199) 2,351 289 3,068 2019 2,675 (1,653) 1,495 110 2,627 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 customers and bankruptcy filings. The allowance for credit losses of finance receivables is evaluated collectively based on historical experiences of credit losses, and reasonable and support- able forecasts. An additional reserve for individual accounts is recorded when Canon becomes aware of a customer’s inability to meet its financial obligations, such as in the case of bank- ruptcy filings. Finance receivables which are past due or are individually evaluated for impairment at December 31, 2020 and December 31, 2019 are not significant. Equipment leased to customers The cost of equipment leased to customers under operat- ing leases included in property, plant and equipment, net at December 31, 2020 and 2019 was ¥132,763 million and ¥116,681 million, respectively. Accumulated depreciation on equipment under operating leases at December 31, 2020 and 2019 was ¥81,345 million and ¥82,633 million, respectively. Maturity Analysis The following is a schedule by year of the future minimum lease payments to be received under finance leases and non-cancellable operating leases at December 31, 2020. Year ending December 31: 2021 2022 2023 2024 2025 Thereafter Millions of yen Financing leases Operating leases 121,577 91,568 62,913 36,652 16,868 7,687 9,273 5,156 3,154 1,450 617 129 337,265 19,779 Information about transferring finance receivables Canon has syndication arrangements to sell its entire interests in finance receivables to the third-party financial institutions. The transactions under the arrangements are accounted for as sales in accordance with ASC 860 “Transfers and Servicing.” The sales of finance receivables were ¥19,185 million, ¥11,710 million and ¥21,909 million for the year ended December 31, 2020, 2019 and 2018. The amounts remaining uncollected were ¥36,339 million, ¥28,616 million and ¥22,956 million at December 31, 2020, 2019 and 2018, respectively. Cash proceeds from the transactions are included in other, net under the cash flow from operating activities in the consolidated state- ments of cash flows. Canon continues to provide collection and administrative services for the financial institutions. The amount associated with the servicing liability measured at fair value was not material at December 31, 2020, 2019 and 2018, respec- tively. Canon also retains limited recourse obligations which cover credit defaults. The recourse obligation was not material at December 31, 2020, 2019 and 2018, respectively. 59 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. GOODWILL AND OTHER INTANGIBLE ASSETS Intangible assets subject to amortization acquired during the year ended December 31, 2020, including those recorded from businesses acquired, totaled ¥31,413 million, which primarily consist of software of ¥29,137 million. The weighted average amortization periods for intangible assets in total acquired during the year ended December 31, 2020 are approximately 6 years. The weighted average amortization period for software acquired during the year ended December 31, 2020 is approximately 5 years. Intangible assets subject to amortization acquired during the year ended December 31, 2019, including those recorded from businesses acquired, totaled ¥34,259 million, which primarily consist of software of ¥32,334 million. The weighted average amortization periods for intangible assets in total acquired during the year ended December 31, 2019 are approximately 5 years. The weighted average amortization period for software acquired during the year ended December 31, 2019 is approximately 5 years. The components of intangible assets subject to amortization at December 31, 2020 and 2019 were as follows: December 31 Millions of yen Software Customer relationships Patents and developed technology Trademarks License fees Other 2020 Gross carrying amount 379,504 155,648 124,315 44,914 13,651 17,163 Accumulated amortization 279,372 46,613 59,328 17,800 6,065 9,235 2019 Gross carrying amount 370,178 153,708 123,609 41,688 15,944 18,972 Accumulated amortization 262,405 35,276 46,263 13,582 8,482 11,846 735,195 418,413 724,099 377,854 Aggregate amortization expense for the years ended December 31, 2020, 2019 and 2018 was ¥65,092 million, ¥66,909 million and ¥75,783 million, respectively. Estimated amortization expense for intangible assets currently held for the next five years ending December 31 is ¥58,160 million in 2021, ¥46,939 million in 2022, ¥39,001 million in 2023, ¥31,291 million in 2024, and ¥27,405 million in 2025. Intangible assets not subject to amortization other than goodwill at December 31, 2020 and 2019 were not significant. For management reporting purposes, goodwill is not allo- cated to the reporting unit. Goodwill has been allocated to its respective reporting unit for impairment testing. The changes in the carrying amount of goodwill by segment for the years ended December 31, 2020 and 2019 were as follows: Year ended December 31 Millions of yen 2020: Goodwill -gross Accumulated impairment losses Balance at beginning of year Goodwill acquired during the year Translation adjustments and other Goodwill - gross Accumulated impairment losses Balance at end of year Office 135,862 (31,290) 104,572 — 1,997 138,985 (32,416) 106,569 Imaging System 46,953 — Medical System Industry and Others 508,907 238,229 — — 46,953 508,907 238,229 — 2,398 49,351 — — (2,394) 506,513 — — 14,902 253,131 — 49,351 506,513 253,131 Total 929,951 (31,290) 898,661 — 16,903 947,980 (32,416) 915,564 60 CANON ANNUAL REPORT 2020Year ended December 31 Millions of yen 2019: Goodwill -gross Accumulated impairment losses* Balance at beginning of year Goodwill acquired during the year Translation adjustments and other Goodwill - gross Accumulated impairment losses* Balance at end of year Office 139,518 (32,428) 107,090 — (2,518) 135,862 (31,290) 104,572 Imaging System 48,670 — Medical System Industry and Others 500,896 251,855 — — 48,670 500,896 251,855 — (1,717) 46,953 — 8,330 (319) 508,907 — — (13,626) 238,229 — 46,953 508,907 238,229 Total 940,939 (32,428) 908,511 8,330 (18,180) 929,951 (31,290) 898,661 * Based on the realignment of Canon’s internal reporting and management structure, from the beginning of the first quarter of 2020, Canon has reclassified cer- tain businesses from the Industry and Others Business Unit to the Office Business Unit. Prior period amounts also have been reclassified. 8. SHORT-TERM LOANS AND LONG-TERM DEBT Short-term loans consisting of bank borrowings at December 31, 2020 and 2019 were ¥46,461 million and ¥40,800 mil- lion, respectively. The weighted average interest rate on short-term borrowings outstanding at December 31, 2020 and 2019 were 0.26% and 0.21%, respectively. Unused overdraft facilities at December 31, 2020 were ¥750,000 million. The overdraft facilities bear interest at a rate equal to a base rate plus a spread. Long-term debt consisted of the following: December 31 Loan from banks; bearing interest of 0.09% at December 31, 2020 and 0.08% at December 31, 2019*1 Other debt*2 Less current portion Millions of yen 2020 2019 344,000 6,608 350,608 (345,774) 4,834 354,000 4,574 358,574 (1,234) 357,340 *1 Canon has unsecured revolving credit facility contracts expiring in December 2021. Canon prepaid ¥10,000 million of the loan with cash flows generated dur- ing the year ended December 31, 2020. The outstanding loans under the credit facilities are ¥344,000 million at a floating interest of 0.09% and Canon has no unused credit facilities as of December 31, 2020. *2 The other debt consisted of term-loans and finance lease obligations as of December 31, 2020 and 2019. The aggregate annual maturities of long-term debt outstanding at December 31, 2020 were as follows: Year ending December 31: 2021 2022 2023 2024 2025 Thereafter Millions of yen 345,774 868 702 434 231 2,599 350,608 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. 61 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. TRADE PAYABLES Trade payables are summarized as follows: December 31 Notes Accounts Millions of yen 2020 83,468 220,341 303,809 2019 56,865 248,447 305,312 10. 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 contribution pension plans covering substantially all of their employees. Canon Medical Systems Corporation (“CMSC”) temporarily participated in Toshiba Corporate Pension Funds (“Toshiba Funds”) after CMSC was acquired by Canon in 2016. In April 2018, CMSC established a new pension provi- sion which provides participants an equivalent level of benefits as compared to the Toshiba Funds. As of December 31, 2018, a majority of plan participants had been transferred from the Toshiba Funds into the new pension provision. Canon calcu- lated the projected benefit obligations for the remaining par- ticipants within the Toshiba Funds based on the benefit level of the Toshiba Funds and included the proportional share of the plan assets to which CMSC had a legal right in the follow- ing tables for the remaining participants as of December 31, 2018. In March 2019, CMSC settled the pension obligations attributed to the remaining participants within the Toshiba Funds. The loss recognized due to the settlement in the con- solidated statement of income for the year ended December 31, 2019 was not significant. Obligations and funded status Reconciliations of beginning and ending balances of the projected benefit obligations and the fair value of the plan assets are as follows: December 31 Change in benefit obligations: Projected benefit obligations at beginning of year Service cost Interest cost Plan participants’ contributions Actuarial (gain) loss Benefits paid Plan amendments Curtailments and settlements Foreign currency exchange rate changes 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 Settlements Foreign currency exchange rate changes Fair value of plan assets at end of year Funded status at end of year 62 Japanese plans Millions of yen Foreign plans Millions of yen 2020 2019 2020 2019 925,390 30,604 4,064 — (11,432) (36,646) (859) — — 911,121 704,169 36,060 13,360 — (29,550) — — 724,039 (187,082) 927,006 30,903 5,074 — 15,289 (35,372) — (17,510) — 925,390 682,695 54,170 12,367 — (28,549) (16,514) — 704,169 (221,221) 439,624 5,303 6,087 860 43,202 (12,351) (1,463) (6,004) 2,079 477,337 294,829 23,912 13,605 860 (12,351) (805) 1,663 321,713 (155,624) 385,949 6,264 8,643 1,432 52,261 (10,863) 362 (3,608) (816) 439,624 248,642 35,298 18,016 1,432 (10,863) — 2,304 294,829 (144,795) CANON ANNUAL REPORT 2020Amounts recognized in the consolidated balance sheets at December 31, 2020 and 2019 are as follows: December 31 Other assets Accrued expenses Accrued pension and severance cost Japanese plans Millions of yen Foreign plans Millions of yen 2020 2019 2020 2019 2,684 (791) 1,904 (818) 2,236 (938) 2,342 (937) (188,975) (222,307) (156,922) (146,200) (187,082) (221,221) (155,624) (144,795) Amounts recognized in accumulated other comprehensive income (loss) at December 31, 2020 and 2019 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 2020 2019 2020 2019 192,931 231,811 142,455 118,247 (28,633) (36,506) (520) 268 164,298 195,305 141,935 118,515 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 2020 2019 2020 2019 879,136 892,154 460,536 421,460 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 2020 2019 2020 2019 897,669 707,708 916,562 693,437 475,137 318,079 437,780 290,643 874,327 707,708 887,138 688,754 453,120 312,748 414,729 285,341 63 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 2020, 2019 and 2018 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 Japanese plans Millions of yen Foreign plans Millions of yen 2020 2019 2018 2020 2019 2018 30,604 30,903 31,241 4,064 5,074 5,419 5,303 6,087 6,264 8,643 7,982 8,691 (21,013) (19,553) (21,983) (12,006) (11,919) (12,601) (8,732) (11,877) (13,001) (675) (133) (217) 12,401 15,247 11,900 6,122 4,345 5,108 (Gain) loss on curtailments and settlements — (36) — 236 (2,197) — 17,324 19,758 13,576 5,067 5,003 8,963 Service cost component of net periodic benefit cost for Canon’s employee retirement and severance defined benefit plans is included in cost of sales and operating expenses in the consolidated statements of income. The components other than the service cost component are included in other, net of other income (deductions) in the consolidated statements of income. Other changes in plan assets and benefit obligations recognized in other comprehensive income (loss) for the years ended December 31, 2020, 2019 and 2018 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 2020 2019 2018 2020 2019 2018 (26,479) (19,328) 58,149 31,296 28,882 (5,654) (859) — (3,963) (1,463) 362 3,257 (12,401) (15,247) (11,900) (6,122) (4,345) (5,108) 8,732 11,877 13,001 675 133 — (960) — (966) (1,411) 217 (63) (31,007) (23,658) 55,287 23,420 23,621 (7,351) Assumptions Weighted-average assumptions used to determine benefit obligations are as follows: December 31 Discount rate Assumed rate of increase in future compensation levels Interest crediting rate for cash balance plans Japanese plans Foreign plans 2020 0.5% 2.6% 1.9% 2019 0.5% 2.6% 1.9% 2020 1.5% 0.9% 1.0% 2019 1.6% 1.0% 1.0% Weighted-average assumptions used to determine net periodic benefit cost are as follows: Years ended December 31 Japanese plans Foreign plans Discount rate Assumed rate of increase in future compensation levels Expected long-term rate of return on plan assets Interest crediting rate for cash balance plans 2020 0.5% 2.6% 3.0% 1.9% 2019 0.6% 2.6% 3.0% 1.9% 2018 0.6% 2.6% 2.9% 1.9% 2020 1.6% 1.0% 4.8% 1.0% 2019 2.4% 1.9% 5.2% 1.0% 2018 2.2% 1.8% 4.4% 1.0% 64 CANON ANNUAL REPORT 2020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 securi- ties, and approximately 25% is invested in other investment vehicles, primarily consisting of investments in life insurance company general accounts. Outside Japan, investment policies vary by country, but the long-term investment objectives and strategies remain con- sistent. Canon’s model portfolio for foreign plans has been developed as follows: approximately 25% is invested in equity securities, approximately 25% is invested in debt securities, and approximately 50% is invested in other investment vehi- cles, such as investments in real estate assets. The equity securities are selected primarily from stocks that are listed on securities exchanges. Prior to investing, Canon investigates the business condition of the investee companies, and appropriately diversifies investments by type of industry and other relevant factors. The debt securities are selected primarily from government bonds, public debt instruments, and corporate bonds. Prior to investing, Canon investigates the quality of the issue, including rating, interest rate, and repayment dates, and appropriately diversifies the invest- ments. Pooled funds are selected using strategies consistent with the equity and debt securities described above. As for investments in life insurance company general accounts, the contracts with the insurance companies include a guaranteed interest rate and return of capital. With respect to investments in foreign investment vehicles, Canon investigates the stability of the underlying governments and economies, the market characteristics such as settlement systems and the taxation sys- tems. For each such investment, Canon selects the appropriate investment country and currency. The three levels of input used to measure fair value are more fully described in Note 21. The fair values of Canon’s pension plan assets at December 31, 2020 and 2019, by asset category, are as follows: December 31, 2020 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: 80,201 9,807 — — — 80,201 — — 9,807 10,267 — — — 168,745 — 168,745 37,538 Government bonds (c) 136,771 — Municipal bonds Corporate bonds Pooled funds (d) — 1,126 — 15,617 — 140,825 — 136,771 — 1,126 — 15,617 — 140,825 — — — — 2,324 6,375 — — — 10,267 37,538 — — — — 2,324 6,375 — 108,499 — 108,499 Mortgage backed securities (and other asset backed securities) Life insurance company general accounts Other assets — 8,308 — 117,762 — 8,308 — 117,762 — 28,731 1,356 30,087 Investment measured at net asset value — — — 14,790 — 2,696 — 27,953 — 102,159 — — 226,779 481,114 1,356 724,039 10,267 287,544 — 2,696 — 27,953 — 102,159 — 23,902 — 321,713 65 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2019 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: 77,484 5,164 — — — 77,484 — — 5,164 10,298 — — — 164,662 — 164,662 63,557 Government bonds (g) 130,180 — Municipal bonds Corporate bonds Pooled funds (h) — 1,202 — 11,711 — 136,655 — 130,180 — 1,202 — 11,711 — 136,655 — — — — 2,302 6,472 — — — 10,298 63,557 — — — — 2,302 6,472 — 64,259 — 64,259 Mortgage backed securities (and other asset backed securities) Life insurance company general accounts Other assets — 12,090 — 121,573 — 12,090 — 121,573 — 26,979 218 27,197 Investment measured at net asset value — — — 16,251 — — 2,511 9,676 — 115,102 — — 212,828 474,872 218 704,169 10,298 263,879 — — 2,511 9,676 — 115,102 — 20,652 — 294,829 (a) The plan’s equity securities include common stock of the Company and certain of its subsidiaries in the amounts of ¥282 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 85% Japanese govern- ment bonds and 15% foreign government bonds for Japanese plans, and mainly foreign government bonds for foreign plans. (d) These funds invest in approximately 25% Japanese gov- ernment bonds, 55% foreign government bonds, 5% Japanese municipal bonds, and 15% corporate bonds for Japanese plans. These funds invest in approximately 60% foreign government bonds and 40% 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 ¥118 million. (f) 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. (h) These funds invest in approximately 25% Japanese gov- ernment bonds, 55% foreign government bonds, 5% Japanese municipal bonds, and 15% corporate bonds for Japanese plans. These funds invest in approximately 75% foreign government bonds and 25% corporate bonds for foreign plans. Each level into which assets are categorized is based on inputs used to measure the fair value of the assets, and does not 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. The fair values of Level 3 asset, consisting of hedge funds, (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. were ¥1,356 million and ¥218 million at December 31, 2020 and 2019, respectively. Amounts of actual returns on, purchases and sales of these assets during the years ended December 31, 2020 and 2019 were not significant. Contributions Canon expects to contribute ¥14,414 million to its Japanese defined benefit pension plans and ¥16,432 million to its foreign defined benefit pension plans for the year ending December 31, 2021. 66 CANON ANNUAL REPORT 2020Estimated future benefit payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Year ending December 31: 2021 2022 2023 2024 2025 2026 – 2030 Japanese plans Foreign plans Millions of yen Millions of yen 39,523 41,562 43,080 43,251 44,391 224,816 13,273 14,055 14,862 15,783 16,609 99,803 Multiemployer pension plans The amounts of cost recognized for the multiemployer pen- sion plans primarily in the Netherlands for the years ended December 31, 2020, 2019 and 2018 were ¥4,224 million, ¥4,321 million and ¥4,452 million, respectively. The mul- tiemployer pension plan in which the subsidiaries in the Netherlands participated was 99% funded as of December 31, 2019. The collective bargaining agreements have no expiration date. Canon is not liable for other participating employers’ obligations under the terms and conditions of the agreements. Defined contribution plans The amounts of cost recognized for the defined contribution pension plans of the Company and certain of its subsidiar- ies for the years ended December 31, 2020, 2019 and 2018 were ¥16,334 million, ¥17,414 million and ¥19,570 million, respectively. 11. 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 2020: Income before income taxes Income taxes: Current Deferred Japanese 48,186 24,063 (6,007) 18,056 Millions of yen Foreign 82,094 25,816 (9,535) 16,281 Total 130,280 49,879 (15,542) 34,337 2019: Income before income taxes 107,082 88,411 195,493 Income taxes: Current Deferred 39,483 (4,276) 35,207 23,186 (2,247) 20,939 62,669 (6,523) 56,146 2018: Income before income taxes 240,974 121,418 362,392 Income taxes: Current Deferred 75,556 (6,707) 68,849 32,443 (5,297) 27,146 107,999 (12,004) 95,995 The Company and its domestic subsidiaries are subject to a number of income taxes, which, in the aggregate, represent a statutory income tax rate of approximately 31% for the years ended December 31, 2020, 2019 and 2018. 67 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 Deferred tax liabilities on undistributed earnings of foreign subsidiaries Tax credit at foreign subsidiaries Effect of enacted changes in tax laws Other Effective income tax rate 2020 31.0% 2.3 (5.8) (1.7) 2.4 2.6 (1.3) (1.5) (1.6) 26.4% 2019 31.0% 1.7 (2.9) (2.3) (1.6) 2.4 (1.1) (0.2) 1.7 28.7% 2018 31.0% 0.6 (2.6) (3.4) 0.4 0.9 (0.7) (0.1) 0.4 26.5% 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 2020 154,226 (48,247) 105,979 2019 157,515 (59,888) 97,627 The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at December 31, 2020 and 2019 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 Operating lease liabilities Accrued expenses Net operating losses carried forward Other Less valuation allowance Total deferred tax assets Deferred tax liabilities: Undistributed earnings of foreign subsidiaries Tax deductible reserve Financing lease revenue Operating lease right-of-use assets Intangible assets Other Total deferred tax liabilities Net deferred tax assets 68 Millions of yen 2020 2019 10,551 1,629 95,386 4,989 34,923 20,163 28,243 29,591 42,741 268,216 (30,752) 237,464 (9,147) (4,040) (15,041) (19,425) (54,948) (28,884) (131,485) 105,979 10,225 1,282 107,463 4,751 32,040 25,646 29,412 21,294 41,759 273,872 (27,678) 246,194 (8,769) (4,050) (19,029) (25,249) (59,350) (32,120) (148,567) 97,627 CANON ANNUAL REPORT 2020The net changes in the total valuation allowance were an increase of ¥3,074 million, a decrease of ¥3,056 million and a decrease of ¥49 million for the years ended December 31, 2020, 2019 and 2018, 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, 2020. At December 31, 2020, Canon had net operating losses which can be carried forward for income tax purposes of ¥176,489 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 Millions of yen 981 12,332 48,181 11,321 103,674 176,489 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 ¥24,236 subsidiaries of ¥1,008,414 million as of December 31, 2020 because Canon intends to permanently reinvest such undis- tributed earnings of foreign subsidiaries. Deferred tax liabilities will be recognized when such undistributed earnings are no longer permanently reinvested. million for a portion of undistributed earnings of foreign A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Years ended December 31 Millions of yen 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* 2020 8,120 — 208 (49) — 293 2019 8,649 — 204 (44) (402) (287) 8,572 8,120 2018 10,282 45 178 (17) (1,286) (553) 8,649 * The unrecognized tax benefits were offset by deferred tax assets in the amount of ¥1,412 million, ¥933 million and ¥2,043 million as of December 31, 2020, 2019 and 2018, respectively, and reported under “other noncurrent liabilities” on the consolidated balance sheets. The total amounts of unrecognized tax benefits that would reduce the effective tax rate, if recognized, were ¥8,572 million and ¥8,120 million at December 31, 2020 and 2019, 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, 2020, no significant changes to the unrecognized tax benefits are expected within the next twelve months. Canon recognizes interest and penalties accrued related to unrecognized tax benefits in income taxes. Both interest and penalties accrued at December 31, 2020 and 2019, and inter- est and penalties included in income taxes for the years ended December 31, 2020, 2019 and 2018 were not significant. Canon files income tax returns in Japan and various for- eign tax jurisdictions. In Japan, Canon is no longer subject to regular income tax examinations by the tax authority for years before 2017. Canon is also no longer subject to a transfer pricing examination by the tax authority for years before 2017. 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 2009 with few exceptions. 69 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. 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, 2020, 2019 and 2018 represent dividends paid out during 13. OTHER COMPREHENSIVE INCOME (LOSS) those years and the related appropriations to the legal reserve. Retained earnings at December 31, 2020 did not reflect current year-end dividends in the amount of ¥41,831 million which were approved by the shareholders in March 2021. 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 ¥719,353 million at December 31, 2020. Retained earnings at December 31, 2020 included Canon’s equity in undistributed earnings of affiliated companies accounted for by the equity method in the amount of ¥16,597 million. Changes in accumulated other comprehensive income (loss) for the years ended December 31, 2020, 2019 and 2018 are as follows: Millions of yen Foreign currency translation adjustments Unrealized gains and losses on securities Gains and losses on derivative instruments Pension liability adjustments Total Balance at December 31, 2017 30,208 5,484 (180) (178,740) (143,228) Cumulative effects of accounting standard update—adoption of ASU No. 2016-01 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, 2018 Cumulative effects of accounting standard update—adoption of ASU No. 2017-12 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, 2019 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, 2020 — (5,343) (4,200) (89,823) — (94,023) (63,815) — (424) (31,889) (154) (32,467) (96,282) (9) (17,355) — (17,364) (113,646) — — (141) (141) — — — — — — — — — — — — — — — — (5,343) (4,200) (457) (29,909) (120,189) 945 488 308 (122) — 3,085 (26,824) (205,564) — — 3,889 (120,500) (269,071) (122) (424) (1,723) (12,763) (46,375) 650 (1,073) (887) 7,054 (5,709) (211,273) 7,550 (39,249) (308,442) — — (9) (1,199) (7,530) (26,084) 2,186 987 100 7,560 30 (211,243) 9,746 (16,347) (324,789) 70 CANON ANNUAL REPORT 2020Reclassifications out of accumulated other comprehensive income (loss) for the years ended December 31, 2020, 2019 and 2018 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 comprehensive income (loss)* Millions of yen 2020 2019 2018 Affected line items in consolidated statements of income — — — — — — — — — — 3,034 (775) 2,259 (73) 2,186 10,082 (2,484) 7,598 (38) 7,560 (154) — (154) — (154) — — — — — 661 (2) 659 (9) 650 9,953 (2,523) 7,430 (376) 7,054 — Other, net — Income taxes — Consolidated net income Net income attributable to noncontrolling interests — — Net income attributable to Canon Inc. (178) Other, net 37 Income taxes (141) Consolidated net income Net income attributable to noncontrolling interests — (141) Net income attributable to Canon Inc. 1,341 Net Sales (392) Income taxes 949 Consolidated net income Net income attributable to noncontrolling interests (4) 945 Net income attributable to Canon Inc. 3,853 Other, net (699) Income taxes 3,154 Consolidated net income Net income attributable to noncontrolling interests (69) 3,085 Net income attributable to Canon Inc. Total amount reclassified, net of tax and noncontrolling interests 9,746 7,550 3,889 * Amounts in parentheses indicate gains in consolidated statements of income. 71 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Tax effects allocated to each component of other comprehensive income (loss) and reclassification adjustments, including amounts attributable to noncontrolling interests, are as follows: Years ended December 31 Before-tax amount Millions of yen Tax (expense) or benefit Net-of-tax amount 2020: 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 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) 2019: 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) 2018: 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) (17,583) — (17,583) (1,731) 3,034 1,303 (2,495) 10,082 7,587 (8,693) (32,396) (154) (32,550) — — — (2,180) 661 (1,519) (9,916) 9,953 37 (34,032) (93,955) — (93,955) — (178) (178) (586) 1,341 755 229 — 229 442 (775) (333) (3,721) (2,484) (6,205) (6,309) 393 — 393 — — — 453 (2) 451 (1,144) (2,523) (3,667) (2,823) 809 — 809 — 37 37 125 (392) (267) (17,354) — (17,354) (1,289) 2,259 970 (6,216) 7,598 1,382 (15,002) (32,003) (154) (32,157) — — — (1,727) 659 (1,068) (11,060) 7,430 (3,630) (36,855) (93,146) — (93,146) — (141) (141) (461) 949 488 (51,789) 3,853 (47,936) (141,314) 18,065 (699) 17,366 17,945 (33,724) 3,154 (30,570) (123,369) 72 CANON ANNUAL REPORT 202014. REVENUE Revenue from sales of office products, such as office MFDs and laser printers, and imaging system products, such as digital cameras and inkjet printers, is recognized upon ship- ment or delivery, depending upon when the customer obtains controls of these products. Revenue from sales of equipment that are sold with cus- tomer acceptance provisions related to their functionality including optical equipment such as semiconductor lithography equipment and FPD lithography equipment, and certain medi- cal equipment such as CT systems and MRI systems, is recog- nized when the equipment is installed at the customer site and the agreed-upon specifications are objectively satisfied. Most of Canon’s service revenue is generated from mainte- nance service in the office and medical system products which is recognized over time. For the service contracts of office products, the customer typically pays a variable amount based on usage, a stated fixed fee or a stated base fee plus a vari- able amount which frequently include the provision of con- sumables as well as break fix activities. The majority portion of service revenue from the office products is recognized as billed since the invoiced amount directly correlates with the value to the customer of the underlying performance obligation to date. For the service contracts of medical system products, the customer typically pays a stated fixed fee for the stand ready maintenance service and revenue is recognized ratably over the contract period. The majority of service arrangements for office products are executed in combination with related products. Transaction prices for products and services need to be allocated to each performance obligation on a relative standalone selling price basis where judgements are required. Canon estimates the standalone selling price using a range of prices that would meet the allocation objective based on all the information that is reasonably available including market conditions and other observable inputs. If transaction prices of the product or service contracts are not within the acceptable range then the revenue is subject to allocation based on the estimated stand- alone selling prices. Canon recognizes the incremental costs of obtaining a contract as an expense when related office prod- ucts are sold. Revenue from sales of certain industrial equipment which do not have alternative use and for which Canon has enforce- able right to payment to the customers for the performance completed to date is recognized over time with progress towards completion measured using the cost based input method as the basis to recognize revenue and an estimated margin. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses become evident. Changes in job performance, job conditions, esti- mated margin and final contract settlements may result in revi- sions to projected costs and revenue and are recognized in the period in which the revisions to estimates are identified and the amounts can be reasonably estimated. Factors that may affect future project costs and margins include, production efficiencies, availability and costs of labor and materials. These factors can impact the accuracy of our estimates and materi- ally impact future reported revenue and cost of sales. The transaction prices that Canon is entitled to receive in exchange for transferring goods or services to the customer include certain forms of variable consideration, including product discounts, customer promotions and volume-based rebates mainly for imaging system products, which are sold predominantly through distributors and retailers. Canon includes estimated amounts in the transaction price only to the extent it is probable that a significant reversal of cumula- tive revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Variable considerations are estimated based upon historical trends and other known factors at the time of sale, and are subsequently adjusted in each period based on current information. In addi- tion, Canon may provide a right of return on our products for a short time period after a sale. These rights are accounted for as variable consideration when determining the transaction price, and accordingly Canon recognizes revenue based on the estimated amount to which Canon expects to be entitled after considering expected returns. 73 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Disaggregated revenue by timing is as follows. Disaggregated revenue by business unit, product and geographic area are described in Note 22. 2020: Revenue recognized at a point in time Revenue recognized over time Total 2019: Revenue recognized at a point in time Revenue recognized over time Total 2018: Revenue recognized at a point in time Revenue recognized over time Total Office Imaging System Medical System Industry and Others Corporate and eliminations Consolidated Millions of yen 958,698 481,514 1,440,212 1,187,284 564,823 1,752,107 1,286,079 582,276 1,868,355 701,658 10,580 712,238 793,832 13,582 807,414 957,518 12,917 970,435 287,849 148,225 436,074 290,702 147,823 438,525 305,457 132,121 437,578 527,120 127,693 654,813 582,178 106,255 688,433 635,929 145,958 781,887 (83,094) — (83,094) 2,392,231 768,012 3,160,243 (93,180) — (93,180) 2,760,816 832,483 3,593,299 (106,318) — (106,318) 3,078,665 873,272 3,951,937 Revenue recognized over time includes primarily revenue from maintenance service in the office and medical system products and sales of certain industrial equipment which do not have alternative use and for which Canon has enforceable right to payment to the customers for the performance com- pleted to date. Canon recognizes contract assets primarily for unbilled receivables mainly arising from services contracts for office products. Contract assets at December 31, 2020 and 2019 were ¥42,752 million and ¥43,783 million, respectively, and are included in prepaid expenses and other current assets in the consolidated balance sheets. Canon typically bills to the customer when the performance obligation is satisfied and collects the payment in relatively short term except for certain maintenance service of office and medical products and certain industrial equipment for which Canon occasionally receives the payment in advance from cus- tomers. The amount received in excess of revenue recognized is recognized as deferred revenue until the performance obli- gation for distinct goods or services are satisfied. Deferred rev- enue at December 31, 2020 and 2019 were ¥135,455 million and ¥113,030 million, respectively, and are included in other current liabilities in the accompanying consolidated balance sheets. Revenue recognized for the year ended December 31, 2020, which had been included in the deferred revenue bal- ance at December 31, 2019, was ¥79,042 million. Remaining performance obligations for products and equip- ment at December 31, 2020 primarily arise from the sales of certain industrial equipment, amounting to ¥235,825 million, 89% of which is expected to be recognized as revenue within one year and remaining 11% is within two years. Disclosure of remaining performance obligations is not required for the majority of services since the related revenue is recognized on an as billed basis applying the right to invoice practical expedi- ent or is generated from the contracts with original expected duration of less than one year. The portion of fixed mainte- nance service contract for office and medical products with original expected duration of more than one year is approxi- mately 12% of total service revenue and the average remain- ing period for these fixed contracts as of December 31, 2020 is about two years. Taxes collected from customers and remitted to governmen- tal authorities are excluded from revenues in the consolidated statements of income. 74 CANON ANNUAL REPORT 202015. STOCK-BASED COMPENSATION On May 1, 2020, based on the board of the directors, the Company granted stock options to its directors and executive officers to acquire 88,600 shares of common stock. Those to whom stock acquisition rights are granted (the “Holder(s)”) shall be entitled to exercise all the stock acquisition rights together within 10 days (in case the last day is not a business day, the following business day) from after the date when they cease to hold any position as a director or an executive officer of the Company. These option awards have a 30 year exercisable period. The grant-date fair value per share of the stock options granted during the year ended December 31, 2020 was ¥1,459. On March 25, 2020, based on the board of the directors, the Company granted stock options to its executive officer to acquire 10,300 shares of common stock. The Holder shall be entitled to exercise all the stock acquisition rights together within 10 days (in case the last day is not a business day, the following business day) from after the date when they cease to hold any position as a director or an executive officer of the Company. These option awards have a 30 year exercisable period. The grant-date fair value per share of the stock options granted during the year ended December 31, 2020 was ¥1,703. On April 26, 2019, based on the board of the directors, the Company granted stock options to its directors and execu- tive officers to acquire 116,300 shares of common stock. The Holders shall be entitled to exercise all the stock acquisition rights together within 10 days (in case the last day is not a business day, the following business day) from after the date when they cease to hold any position as a director or an executive officer of the Company. These option awards have a 30 year exercisable period. The grant-date fair value per share of the stock options granted during the year ended December 31, 2019 was ¥2,281. The compensation cost recognized for these stock options for the years ended December 31, 2020 was ¥147 million and 2019 was ¥265 million and 2018 was ¥218 million, and it is included in selling, general and administrative expenses in the consolidated statements of income. The fair value of the option award was estimated on the date of grant using the Black-Sholes option pricing model that incor- porates the assumptions presented below: Years ended December 31 Expected term of option (in years) Expected volatility Dividend yield Risk-free interest rate 2020 Granted on March 25, 2020 Granted on May 1, 2020 6.0 20.32% 6.25% (0.12%) 6.0 20.92% 6.97% (0.17%) 2019 6.0 19.97% 5.05% (0.16%) A summary of option activity under the stock option plans as of and for the years ended December 31, 2020, 2019 and 2018 is presented below: Outstanding at January 1, 2018 Granted Outstanding at December 31, 2018 Granted Exercised Outstanding at December 31, 2019 Granted Exercised Outstanding at December 31, 2020 Exercisable at December 31, 2020 Weighted- average exercise price Weighted-average remaining contractual term Aggregate intrinsic value Yen Year Millions of yen — 1 1 1 1 1 1 1 1 1 — 222 29.3 29.0 555 28.4 28.4 324 324 Shares — 74,000 74,000 116,300 (4,500) 185,800 98,900 (37,100) 247,600 247,600 The total fair values of shares vested during the years ended December 31, 2020 and 2019 were ¥147 million and ¥265 million, respectively, and 2018 was ¥218 million. Cash received from the exercise of stock options for the year ended December 31, 2020 and 2019 were not significant, and for the years ended December 31, 2018 was nil. 75 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. NET INCOME ATTRIBUTABLE TO CANON INC. SHAREHOLDERS PER SHARE A reconciliation of the numerators and denominators of basic and diluted net income attributable to Canon Inc. shareholders per share computations is as follows: Years ended December 31 Basic net income attributable to Canon Inc. Diluted net income attributable to Canon Inc. 2020 83,318 83,315 Millions of yen 2019 124,964 124,962 Number of shares 2018 252,441 252,441 Average common shares outstanding 1,049,802,197 1,069,956,767 1,079,753,008 Effect of dilutive securities: Stock options 229,691 158,173 49,319 Diluted common shares outstanding 1,050,031,888 1,070,114,940 1,079,802,327 Net income attributable to Canon Inc. shareholders per share: Basic Diluted Yen 116.79 116.77 79.37 79.35 233.80 233.78 17. DERIVATIVES AND HEDGING ACTIVITIES Risk management policy Canon operates internationally, exposing it to the risk of changes in foreign currency exchange rates. Derivative financial instruments are comprised principally of foreign exchange contracts utilized by the Company and certain of its subsidiaries to reduce the risk. Canon assesses foreign cur- rency exchange rate risk by continually monitoring changes in the exposures and by evaluating hedging opportunities. Canon does not hold or issue derivative financial instruments for trading purposes. Canon is also exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments, but it is not expected that any counterparties will fail to meet their obligations. Most of the counterparties are internationally recognized financial institu- tions and selected by Canon taking into account their financial condition, and contracts are diversified across a number of major financial institutions. Foreign currency exchange rate risk management Canon’s international operations expose Canon to the risk of changes in foreign currency exchange rates. Canon uses foreign exchange contracts to manage certain foreign cur- rency exchange exposures principally from the exchange of U.S. dollars and euros into Japanese yen. These contracts are primarily used to hedge the foreign currency exposure of fore- casted intercompany sales and intercompany trade receivables that are denominated in foreign currencies. In accordance with Canon’s policy, a specific portion of foreign currency exposure resulting from forecasted intercompany sales are hedged using foreign exchange contracts which principally mature within three months. Cash flow hedge Changes in the fair value of derivative financial instruments designated as cash flow hedges, including foreign exchange contracts associated with forecasted intercompany sales, are reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassified into earn- ings in the same period as the hedged items affect earnings. Substantially all amounts recorded in accumulated other comprehensive income (loss) as of December 31, 2020 are expected to be recognized in net sales over the next twelve months. 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. 76 CANON ANNUAL REPORT 2020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, 2020 and 2019 are set forth below: December 31 To sell foreign currencies To buy foreign currencies Millions of yen 2020 137,721 27,220 2019 180,242 32,618 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, 2020 and 2019. Derivatives designated as hedging instruments December 31 Assets: Balance sheet location 2020 2019 Fair value Millions of yen Foreign exchange contracts Prepaid expenses and other current assets Liabilities: Foreign exchange contracts Other current liabilities Derivatives not designated as hedging instruments 426 416 34 828 Fair value Millions of yen Balance sheet location 2020 2019 December 31 Assets: Foreign exchange contracts Prepaid expenses and other current assets Liabilities: Foreign exchange contracts Other current liabilities 107 809 317 1,745 77 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Effect of derivative instruments in the consolidated statements of income The following tables present the effect of Canon’s derivative instruments in the consolidated statements of income for the years ended December 31, 2020, 2019 and 2018. Derivatives in cash flow hedging relationships Years ended December 31 Gain (loss) recognized in OCI Gain (loss) reclassified from accumulated OCI into income Millions of yen Amount 2020: Foreign exchange contracts (1,731) 2019: Foreign exchange contracts (2,180) Location Net sales Net sales Amount (3,034) (661) Year 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 2018: Foreign exchange contracts Amount (586) Location Other, net Amount (1,341) Location Other, net Amount (682) Derivatives not designated as hedging instruments Years ended December 31 Gain (loss) recognized in income on derivative Foreign exchange contracts 18. LESSEE ACCOUNTING Location Other, net 2020 104 Millions of yen 2019 805 2018 5,284 Lease costs are included in cost of goods sold or selling general and administrative expense in accompanying consolidated state- ments of income. Supplemental income statement information is as follows: Years ended December 31 Operating lease cost Short-term lease cost Other lease cost Operating lease cash flow Supplemental cash flow information is as follows: Years ended December 31 Millions of yen 2020 40,053 14,245 120 54,418 2019 43,236 14,374 168 57,778 Millions of yen 2020 2019 Cash paid for amount included in the measurement of lease liabilities Operating cash flows from operating leases 36,733 41,368 Noncash activity - Rights of use assets obtained in exchange for lease liabilities Operating leases 30,700 33,939 78 CANON ANNUAL REPORT 2020Maturity Analysis The following is a schedule by year of the future minimum lease payments under operating leases at December 31, 2020. Years ending December 31: 2021 2022 2023 2024 2025 Thereafter Total future minimum lease payments Less Imputed Interest Millions of yen 35,769 26,492 17,053 12,403 8,567 15,529 115,813 (6,709) 109,104 Remaining lease term and discount rate The following is remaining lease term and discount rate under operating leases at December 31, 2020 and 2019. December 31 Weighted-average remaining lease term Weighted-average discount rate 2020 2019 56 months 62 months 2.1% 2.2% 19. COMMITMENTS AND CONTINGENT LIABILITIES Commitments At December 31, 2020, commitments outstanding for the pur- chase of property, plant and equipment approximated ¥42,434 million, and commitments outstanding for the purchase of parts and raw materials approximated ¥121,031 million. Guarantees Canon occupies sales offices and other facilities under lease arrangements accounted for as operating leases. Deposits mainly for restoration made under such arrangements aggre- gated ¥10,962 million and ¥11,778 million at December 31, 2020 and 2019, respectively, and are included in noncurrent receivables in the accompanying consolidated balance sheets. Canon provides guarantees for its employees, affiliates and other companies. The guarantees for the employees are principally made for their housing loans. The guarantees for affiliates and other companies are made for their lease obliga- tions and bank loans to ensure that those companies operate with less financial risk. Canon would have to perform under a guarantee if the borrower defaults on a payment within the contract terms. The contract terms are 1 year to 15 years in case of employ- ees with housing loans, and 1 year to 5 years in case of affili- ates 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 ¥2,568 million at December 31, 2020. The carrying amounts of the liabilities recognized for Canon’s obligations as a guar- antor under those guarantees at December 31, 2020 were not significant. 79 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Canon also offers assurance-type warranties under which it generally guarantees the performance of products delivered and services rendered for a certain period or term. Estimated product warranty costs are recorded at the time revenue is recognized and are included in selling, general and administrative expenses in the accompanying consolidated statements of income. Estimates for accrued product warranty costs are based on historical experience. Accrued product warranty costs are included in accrued expenses in the accompanying consolidated balance sheets and the changes for the years ended December 31, 2020 and 2019 are summarized as follows: Years ended December 31 Balance at beginning of year Additions Utilization Other Balance at end of year Millions of yen 2020 15,846 11,355 (10,657) (2,244) 14,300 2019 17,318 15,945 (14,488) (2,929) 15,846 Legal proceedings Canon is involved in various claims and legal actions arising in the ordinary course of business. Canon has recorded provi- sions 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, and cash flows. 20. 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, 2020 and 2019 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, and the fair values of these instruments approximate their carrying amounts. The summary also excludes investments and derivative instruments which are disclosed in Note 2 and Note 21, and Note 17, respectively. December 31 Millions of yen 2020 2019 Carrying amount Estimated fair value Carrying amount Estimated fair value Long-term debt, including current installments (346,317) (346,275) (354,444) (354,444) 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 21. 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, 2020 and 2019, one customer accounted for approximately 8% and 10% 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. 80 CANON ANNUAL REPORT 202021. FAIR VALUE MEASUREMENTS Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. A three-level fair value hierarchy that prioritizes the inputs used to measure fair value is as follows: Level 1 – Inputs are quoted prices in active markets for identi- cal assets or liabilities. from or corroborated by observable market data by correlation or other means. Level 2 – Inputs are quoted prices for similar assets or liabili- Level 3 – Inputs are derived from valuation techniques in ties 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 which one or more significant inputs or value drivers are unobservable, which reflect the reporting entity’s own assumptions about the assumptions that mar- ket participants would use in establishing a price. Assets and liabilities measured at fair value on a recurring basis The following tables present Canon’s assets and liabilities that are measured at fair value on a recurring basis consistent with the fair value hierarchy at December 31, 2020 and 2019. December 31 Millions of yen 2020: Assets: Cash and cash equivalents Investments: Fund trusts and others Equity securities Prepaid expenses and other current assets: Derivatives Total assets Liabilities: Other current liabilities: Derivatives Total liabilities Millions of yen 2019: Assets: Cash and cash equivalents Investments: Fund trusts and others Equity securities Prepaid expenses and other current assets: Derivatives Total assets Liabilities: Other current liabilities: Derivatives Total liabilities Level 1 Level 2 Level 3 Total — 284 18,683 — 18,967 — — 500 248 — 533 1,281 1,225 1,225 — — — — — — — 500 532 18,683 533 20,248 1,225 1,225 Level 1 Level 2 Level 3 Total — 489 16,740 — 17,229 — — 506 241 — 351 1,098 2,573 2,573 — — — — — — — 506 730 16,740 351 18,327 2,573 2,573 81 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 frequency 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 foreign 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 There were no significant assets or liabilities to be measured at fair value on a nonrecurring basis during the year ended December 31, 2020 and 2019. 22. 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, from the beginning of the first quarter of 2020, Canon has reclassified certain businesses from the Industry and Others Business Unit to the Office Business Unit. Prior period amounts also have been reclassified. The primary products included in each segment are as follows: Office Business Unit: Office multifunction devices (MFDs) / Laser multifunction printers (MFPs) / Laser printers / Digital continuous feed presses / Digital sheet-fed presses / Wide-format printers / Document solutions Imaging System Business Unit: Interchangeable-lens digital cameras / Digital compact cameras / Interchangeable lenses / Compact photo printers /Inkjet printers / Large format inkjet printers / Commercial photo printers / Image scanners / Calculators Medical System Business Unit: Digital radiography systems / Diagnostic X-ray systems / Computed tomography (CT) systems / Magnetic resonance imaging (MRI) systems / Diagnostic ultrasound systems / Clinical chemistry analyzers / Ophthalmic equipment Industry and Others Business Unit: Semiconductor lithography equipment / FPD (Flat panel display) lithography equipment/ Vacuum thin-film deposition equipment / Organic LED (OLED) panel manufacturing equipment / Die bonders / Network cameras / Digital camcorders / Digital cinema cameras / Multimedia projectors / Broadcast equipment / Micromotors / Handy terminals / Document scanners The accounting policies of the segments are substantially the same as those described in the significant accounting policies in Note 1. Canon evaluate results and allocate resources for each segment based on income before income taxes. 82 CANON ANNUAL REPORT 2020Information about operating results and assets for each segment as of and for the years ended December 31, 2020, 2019 and 2018 is as follows: Millions of yen 2020: Net sales: External customers Intersegment Total Operating cost and expenses Operating profit Other income (deductions) Income before income taxes Total assets Depreciation and amortization Capital expenditures 2019: Net sales: External customers Intersegment Total Operating cost and expenses* Operating profit Other income (deductions) Income before income taxes Total assets Depreciation and amortization Capital expenditures 2018: Net sales: External customers Intersegment Total Operating cost and expenses Operating profit Other income (deductions) Income before income taxes Total assets Depreciation and amortization Capital expenditures Office Imaging System Medical System Industry and Others Corporate and eliminations Consolidated 1,437,188 3,024 1,440,212 1,358,843 81,369 5,114 86,483 812,553 56,814 46,536 1,749,165 2,942 1,752,107 1,587,111 164,996 5,439 170,435 878,705 59,061 51,680 1,865,056 3,299 1,868,355 1,651,272 217,083 8,280 225,363 937,607 66,107 48,415 711,317 921 712,238 640,433 71,805 (735) 71,070 242,923 30,381 19,814 806,425 989 807,414 759,247 48,167 1,499 49,666 313,141 35,805 24,016 969,660 775 970,435 843,599 126,836 4,179 131,015 371,944 38,054 25,712 435,368 706 436,074 410,830 25,244 300 25,544 286,749 11,781 7,244 437,456 1,069 438,525 411,781 26,744 539 27,283 273,525 11,760 7,074 437,305 273 437,578 408,739 28,839 640 29,479 247,282 9,365 7,454 577,130 77,683 654,813 641,588 13,225 1,090 14,315 446,674 40,406 24,079 598,653 89,780 688,433 669,041 19,392 33 19,425 409,587 40,732 33,458 679,916 101,971 781,887 722,501 59,386 2,284 61,670 390,282 39,926 23,887 (760) (82,334) (83,094) (1,998) (81,096) 13,964 (67,132) 2,836,715 88,443 64,054 1,600 (94,780) (93,180) (8,301) (84,879) 13,563 (71,316) 2,896,960 89,969 95,000 — (106,318) (106,318) (16,626) (89,692) 4,557 (85,135) 2,955,840 98,102 95,036 3,160,243 — 3,160,243 3,049,696 110,547 19,733 130,280 4,625,614 227,825 161,727 3,593,299 — 3,593,299 3,418,879 174,420 21,073 195,493 4,771,918 237,327 211,228 3,951,937 — 3,951,937 3,609,485 342,452 19,940 362,392 4,902,955 251,554 200,504 * During 2019, the Company implemented a restructuring plan centered in Europe with the goal of reorganizing sales structure and improving profitability mainly in the Office Business Unit. The employee severance charges in the Office Business Unit under the plan for the year ended December 31, 2019 were ¥15,621 million and most of the charges are included in selling, general and administrative expenses in the consolidated statements of income. The balance of the related employee severance liability as of December 31, 2019 is ¥10,225 million. The restructuring charges for the years ended December 31, 2020 and 2018 were not significant. 83 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Intersegment sales are recorded at the same prices used in transactions with third parties. Expenses not directly associ- ated 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 CMSC are also included in corporate expenses. Segment assets are based on those directly associated with each segment. Corporate assets primarily consist of cash and cash equivalents, investments, deferred tax assets, goodwill, 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. Information about sales by product and service to external customers for each segment for the years ended December 31, 2020, 2019 and 2018 is as follows: Millions of yen 2020 2019 2018 204,574 304,689 502,156 425,769 261,964 382,845 624,601 479,755 280,035 403,522 702,378 479,121 1,437,188 1,749,165 1,865,056 347,240 317,371 46,706 711,317 466,306 285,821 54,298 806,425 594,567 318,382 56,711 969,660 435,368 437,456 437,305 142,516 434,614 577,130 (760) 157,160 441,493 598,653 1,600 199,722 480,194 679,916 — 3,160,243 3,593,299 3,951,937 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 Corporate Consolidated 84 CANON ANNUAL REPORT 2020Information by major geographic area as of and for the years ended December 31, 2020, 2019 and 2018 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 2020 2019 2018 806,305 852,451 795,616 705,871 3,160,243 1,011,109 133,648 175,516 143,265 1,463,538 872,534 1,029,078 882,480 809,207 3,593,299 1,053,074 148,669 191,050 159,217 1,552,010 869,577 1,076,402 1,015,428 990,530 3,951,937 1,046,065 129,989 169,357 136,602 1,482,013 Net sales are attributed to areas based on the location where the product is shipped and the service is performed to the customers. Other than in Japan and the United States, Canon does not conduct business in any individual country in which its sales in that country exceed 10% of consolidated net sales. Net sales in the United States were ¥801,376 million, ¥958,442 million and ¥995,245 million for the years ended December 31, 2020, 2019 and 2018, respectively. Long-lived assets represent property, plant and equipment, intangible assets, and operating lease right-of-use assets for each geographic area. 23. SUBSEQUENT EVENT On January 19, 2021, Canon borrowed ¥20,000 million under its existing overdraft facilities with Mizuho Bank, Ltd. and MUFG Bank, Ltd. for required operating funds. The overdraft facilities bear interest at a rate equal to a base rate plus a spread. SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS Years ended December 31 Millions of yen 2020: Allowance for credit losses Trade receivables Finance receivables 2019: Allowance for credit losses Trade receivables Finance receivables 2018: Allowance for credit losses 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 10,359 2,627 11,477 2,675 13,378 2,681 3,419 2,351 1,840 1,495 1,347 938 (1,983) (2,199) (2,189) (1,653) (2,789) (1,284) (150) 289 (769) 110 (459) 340 11,645 3,068 10,359 2,627 11,477 2,675 85 STRATEGYBUSINESS SEGMENT/CORPORATE STRUCTUREFINANCIAL SECTIONCORPORATE DATACANON ANNUAL REPORT 2020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-l5(f) promulgated under the Exchange Act, 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 U.S. generally accepted account- ing principles and includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. An effective internal control system, no matter how well designed, has inherent limitations, including the possibility of human error or overriding of controls, and therefore can provide only reasonable assurance with respect to reliable financial reporting. 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 and concluded that Canon’s inter- nal control over financial reporting was not effective as of December 31, 2020 due to identified material weaknesses. In mak- ing this assessment, management used the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that a reasonable possibility exists that a material misstatement of the annual or interim financial statements would not be prevented or detected on a timely basis. Canon’s management identified deficiencies in the risk assessment and control activities principles associated with the COSO framework, which, either individually or in the aggregate, constitute material weaknesses relating to (i) identifying and analyzing significant changes that could impact the system of internal control and control activities, and (ii) integrating control activities to ensure that responses to risks are performed in a timely manner. Factors contributing to the material weaknesses described above included the failure to generate or maintain sufficient evidence supporting Canon’s consideration of the significant changes and the impact on its internal controls over financial reporting. Canon’s independent registered public accounting firm, Deloitte Touche Tohmatsu LLC, has issued an audit report on the effec- tiveness of Canon’s internal control over financial reporting. This report appears in Item 18. Remediation Efforts to Address the Material Weakness Canon’s management plans to improve the agility in identifying and analyzing the significant changes that could impact the system of internal control and control activities through frequent and open communications within the organization, and to improve the process to generate and maintain sufficient evidence for significant changes. 86 CANON ANNUAL REPORT 2020REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte Touche Tohmatsu LLC Marunouchi Nijubashi Building 3-2-3 Marunouchi, Chiyoda-ku Tokyo 100-8360 Japan Tel: +81 (3) 6213 1000 Fax: +81 (3) 6213 1005 www.deloitte.com/jp/en To the Shareholders and the Board of Directors of Canon Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheet of Canon Inc. and subsidiaries (the “Company”) as of December 31, 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for the year ended December 31, 2020, and the related notes and the schedule listed in the Index at Item 18 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020, and the results of its operations and its cash flows for the year ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. We have also 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, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 30, 2021, expressed an adverse opinion on the Company’s internal control over financial reporting because of material weaknesses. 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 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 the financial statements are free of material misstatement, whether due to error or fraud. Our audit 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 regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provide a reasonable basis for our opinion. 87 CANON ANNUAL REPORT 2020REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Critical Audit Matters The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Goodwill—Medical System Reporting Unit—Refer to Notes 1 and 7 to the Financial Statements Critical Audit Matter Description The Company tests goodwill for impairment annually in the fourth quarter of each year, or more frequently if indicators of potential impairment exist. 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 the Company’s forecast of future growth rates. The Company’s total consolidated goodwill was ¥915,564 million as of December 31, 2020, of which ¥506,513 million was allocated to the Medical System reporting unit. With regard to the goodwill attributed to the Medical System reporting unit, fair value in excess of reported carrying value as a percentage is lower than other reporting units. As a result, a future reduction in cash flows of the Medical System reporting unit could trigger an impairment. Given the significant judgements made by management to estimate the fair value of the Medical System reporting unit, performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions related to the projected future cash flows and selection of the discount rate required a high degree of auditor judgment and an increased extent of effort, including the need to involve fair value specialists. How the Critical Audit Matter Was Addressed in the Audit Our audit procedures related to the projected future cash flows and selection of the discount rate used by management to estimate the fair value of the Medical System reporting unit included the following, among others: • We evaluated management’s ability to accurately project future cash flows by comparing actual results to management’s historical projections. • We evaluated the reasonableness of management’s projected future cash flows by comparing the projections to: —Historical cash flows —Internal communications to management and the Board of Directors — Projected information included in Company press releases as well as in analyst and industry reports for the Company and certain of its peer companies • With the assistance of our fair value specialists, we evaluated the reasonableness of the (1) valuation methodology and (2) discount rate by: — Testing whether the methodology, assumptions, and models used were consistent with existing valuation practices that are both generally accepted in practice and recognized as appropriate in similar circumstances and testing the use and weighting of valuation techniques — Testing the source information underlying the determination of the discount rate and the mathematical accuracy of the calculation — Developing a range of independent estimates and comparing those to the discount rate selected by management 88 CANON ANNUAL REPORT 2020Revenue—Long-Term Contracts—Industry and Others Segment—Refer to Note 14 to the Financial Statements Critical Audit Matter Description The Company recognized revenue on long-term contracts of certain industrial equipment in the Industry and Others segment totaling ¥127,693 million for the year ended December 31, 2020. The Company recognized revenue over the contract term (“over time”) for long-term contracts of certain industrial equipment for which there is no alternative use and for which the Company has an enforceable right to payment from customers for performance completed to date. The Company considers costs incurred and future project costs in accordance with the input method to determine progress, and as such, revenue is recognized over time based on costs incurred to date plus the estimate of margins at completion. Changes in job performance, job conditions, estimated margin and final contract settlements may result in revisions to projected costs and revenue and are recognized in the period in which the revisions to estimates are identified and the amounts can be reasonably estimated. Factors that may affect future project costs and margins include production efficiencies and availability and costs of labor and materials. Given the complexity of certain of the Company’s long-term contracts of certain industrial equipment in the Industry and Others segment and the judgments necessary to estimate future project costs and the margins at completion for these long-term contracts, auditing these estimates for certain contracts required extensive audit effort and a high degree of auditor judgment, including the need to involve our legal specialists in evaluating the legal framework for determining the impact of changes in final contract settlements. How the Critical Audit Matter Was Addressed in the Audit Our audit procedures related to the estimates of future costs and the margins at completion for certain long-term contracts of industrial equipment in the Industry and Others segment included the following, among others: • We evaluated management’s ability to estimate future costs and margins at completion accurately by comparing actual costs and margins at completion for similar contracts that were previously completed to management’s historical estimates for such contracts. • We evaluated the reasonableness of management’s estimates of future costs and margins at completion by comparing the estimates to management’s work plans, engineering specifications, meeting minutes and fee proposals, and by performing corroborating inquiries with management, project managers, and engineers. • We selected samples from actual costs incurred subsequent to December 31, 2020 and traced them to the future costs estimate schedule to test whether the selected cost was properly included in the future costs. • With the assistance of our legal specialists, we evaluated the legal framework for the transaction price when it had a variable nature. March 30, 2021 We have served as the Company’s auditor since 2020. 89 CANON ANNUAL REPORT 2020REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte Touche Tohmatsu LLC Marunouchi Nijubashi Building 3-2-3 Marunouchi, Chiyoda-ku Tokyo 100-8360 Japan Tel: +81 (3) 6213 1000 Fax: +81 (3) 6213 1005 www.deloitte.com/jp/en To the Shareholders and the Board of Directors of Canon Inc. Opinion on Internal Control over Financial Reporting We have audited the internal control over financial reporting of Canon Inc. and subsidiaries (the “Company”) as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, because of the effect of the material weaknesses identified below on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by COSO. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2020, of the Company and our report dated March 30, 2021, expressed an unqualified opinion on those financial statements. 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. 90 CANON ANNUAL REPORT 2020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 generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Material Weaknesses A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in Management’s Report on Internal Control over Financial Reporting: The Company identified deficiencies in the risk assessment and control activities principles associated with the COSO framework, which, either individually or in the aggregate, constitute material weaknesses relating to (i) identifying and analyzing significant changes that could impact the system of internal control and control activities, and (ii) integrating control activities to ensure that responses to risks are performed in a timely manner. Factors contributing to the material weaknesses described above included the failure to generate or maintain sufficient evidence supporting the Company’s consideration of the significant changes and the impact on its internal controls over financial reporting. These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated financial statements as of and for the year ended December 31, 2020, of the Company, and this report does not affect our report on such financial statements. March 30, 2021 91 CANON ANNUAL REPORT 2020REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Ernst & Young ShinNihon LLC Hibiya Mitsui Tower, Tokyo Midtown Hibiya, 1-1-2 Yurakucho, Chiyoda-ku, Tokyo, Japan 100-0006 Tel: +81 3 3503 1100 www.eyjapan.jp To the Shareholders and the Board of Directors of Canon Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheet of Canon Inc. and subsidiaries (the Company) as of December 31, 2019, the related consolidated statements of income, comprehensive income, equity and cash flows for each of the two years in the period ended December 31, 2019, and the related notes and financial statement schedule listed in the Index at Item 18 (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, 2019, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles. 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 regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant 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 served as the Company’s auditor for SEC reporting purposes from 2004, and as its Japanese statutory auditor from 1978, to 2020. Tokyo, Japan March 27, 2020, except for the effects on the consolidated financial statement of the correction of an error as described in Note 1(y) and the realignment of segments described in Note 22, as to which the date is March 30, 2021 92 CANON ANNUAL REPORT 2020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. 383 Madison Avenue, Floor 11, New York, NY 10179, USA American Depositary Receipts are traded on the New York Stock Exchange (CAJ). Ordinary General Meeting of Shareholders: March of each year Further Information: For publications or information, please contact the Public Affairs Headquarters, Canon Inc., Tokyo, or access Canon’s Website at global.canon/en MAJOR CONSOLIDATED SUBSIDIARIES (As of December 31, 2020) Manufacturing Canon Precision Inc. Canon Tokki Corporation Fukushima Canon Inc. Canon Medical Systems Corporation Canon Electron Tubes & Devices Co., Ltd. Canon Components, Inc. Canon Semiconductor Equipment Inc. Canon Chemicals Inc. Canon Electronics Inc. Canon Finetech Nisca Inc. 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. Canon Production Printing Netherlands B.V. Canon Production Printing Germany GmbH & Co.KG Axis Communications AB 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. Canon Medical Systems Manufacturing Asia Sdn. Bhd. Research & Development Canon Research Centre France S.A.S. Marketing & Other Canon Marketing Japan Inc. Canon System and Support Inc. Canon IT Solutions Inc. Canon Medical Finance Co., Ltd. Canon U.S.A., Inc. Canon Canada Inc. Canon Solutions America, Inc. Canon Financial Services, Inc. Canon Medical Systems USA, 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. Canon Medical Systems Europe B.V. Milestone Systems A/S Canon (China) Co., Ltd. Canon Hongkong Co., Ltd. Canon Semiconductor Equipment Taiwan, Inc. Canon Singapore Pte. Ltd. Canon India Pvt. Ltd. Canon Australia Pty. Ltd. 93 CANON ANNUAL REPORT 2020CANON INC. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan ©Canon Inc. 2021 PUB.BEP030 0321 

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