Kao Corp.
Annual Report 2016

Plain-text annual report

Financial Report 2016 For the year ended December 31, 2016 Management Discussion and Analysis Consolidated Financial Statements Notes to Consolidated Financial Statements Independent Auditor’s Report 1 14 19 74 Management Discussion and Analysis The Kao Group has adopted International Financial Reporting increasing EVA. It also uses EVA to help shape long-term Standards (IFRS) from the fiscal year ended December 31, management strategies; to assess business performance; to 2016. In addition, financial figures for the previous fiscal year evaluate investments in facilities and acquisitions; and to have been restated using IFRS for comparative analysis. develop performance targets for each fiscal year. * EVA is a registered trademark of Stern Stewart & Co. EVA is defined as net operating profit after tax (NOPAT) less a charge for the cost of capital employed in the business. Management Policies Management Policies of the Kao Group The Kao Group’s mission is to strive for the wholehearted satisfaction and enrichment of the lives of people globally and to contribute to the sustainability of the world, with products and brands of excellent value that are created from Medium-to-long-term Management Strategies of the Kao Group Long-term Management Strategy Long-term Targets the consumer’s and customer’s perspective. This commitment As its vision by 2030 based on the above management policies, is embraced by all members of the Kao Group as we work the Kao Group aims to achieve its vision “make Kao a company together with passion to share joy with consumers and with a global presence” by combining sustained “profitable customers in our core domains of cleanliness, beauty, health growth,” and “contributions to the sustainability of the world” and chemicals. with proposals to resolve social issues and social contribution The Kao Group aims to be a global company that is closest activities conducted through its business operations. To achieve to the consumers and customers in each market, earning the this vision, the Kao Group will promote the further reinforcement respect and trust of its shareholders and all other stakeholders of the existing businesses that are its strength and the creation as it achieves “profitable growth.” of new markets from a global perspective utilizing the R&D In its corporate governance, the Kao Group works for capabilities that will create value for the future, in addition to ongoing innovation* and further enhances its internal control implementing basic measures to further raise the level of system to achieve management that is swift, efficient and safety and reliability. sound, as well as impartial and transparent, as it continuously It is becoming difficult to predict the various changes that increases its corporate value. * Innovation is one of the values of the Kao Way, the corporate philosophy of the Kao Group. The corporate philosophy that forms the basis of these activities is “the Kao Way,” which clearly expresses the Kao Group’s unique corporate culture and the essence of its corporate spirit, and is shared and practiced by all employees. Management Metric Used as a Target will occur throughout the world in all aspects, such as speed, size and direction. To deal with this situation, the Kao Group aims to achieve the above vision by fully embracing the slogan of “transforming ourselves to drive change.” The Kao Group’s Vision by 2030 Make Kao a company with a global presence that • Has a distinctive corporate image Economic value added (EVA®*), which measures true economic • Is a high-profit global consumer goods company that profit by factoring in the cost of invested capital, is the Kao exceeds: Group’s principal management metric. Growth in EVA is linked - ¥2.5 trillion in net sales (¥1.0 trillion outside Japan) to increased corporate value, which results in long-term benefits - 17% operating margin not only for shareholders but for all Kao Group stakeholders. - 20% ROE The Kao Group aims to conduct and invest in business • Provides a high level of returns to stakeholders activities that expand the scale of its business while also 1 Kao Corporation Financial Report 2016 Mid-term Business Plan The Kao Group has established Integrity, passed down The Kao Group regards its mid-term business plan for the from Kao’s founder, as one of the core Values of its corporate period to 2020 as an important milestone toward achieving its philosophy, the Kao Way. Under K20, this Integrity will continue vision by 2030. To enhance corporate value, it established the to be embraced in the Group’s daily business activities as it Kao Group Mid-term Plan 2020 “K20” targeting the four years maintains thorough quality control and information control, from fiscal 2017 to fiscal 2020 and announced it publicly on sincere consumer communications, strict compliance and December 12, 2016. effective crisis management. Through such endeavors, the Kao Group aims to reinforce its credibility in a global society. K20 Goals – Three Commitments • Commitment to fostering a distinctive corporate image Issues for Management - Become a company that is always by the consumer’s side • Commitment to profitable growth - Continue to set new record highs for profits - Aim for like-for-like* net sales CAGR of +5%, operating margin of 15% - Three ¥100 billion brands (Merries baby diapers, Attack laundry detergents, Bioré skin care products) With intensifying market competition, changing market structure and volatility in raw material market conditions and exchange rates, the operating environment remains uncertain. Changes in the attitudes of consumers regarding the environment, health and other matters and associated changes in their purchasing attitudes, as well as the aging society, hygiene and other social * Excluding the effect of currency translation, change of sales issues, are growing in significance. Moreover, amid the global system, etc. • Commitment to returns to stakeholders expansion of business and the progress of structural changes in various fields, companies must deal with changes in the risks - Shareholders: Continuous cash dividend increases entailed in their businesses. (40% payout ratio target) - Employees: Continuous improvement in compensation, benefits and health support - Customers: Maximization of win-win relationships - Society: Advanced measures to address social issues Under these conditions, the Kao Group will continuously increase corporate value by addressing and dealing appropriately with the following issues. (1) Regarding brightening products containing the ingredient Rhododenol sold by Kanebo Cosmetics, for which a Cash Dividends per Share (Yen) 100 80 60 40 20 0 Increases in dividends for 27 consecutive periods 56 57 58 60 62 64 52 54 50 94 80 70 7.1 8.87 9.09 10.0 10.5 11.5 12.5 14 7.1 38 30 32 24 26 20 15 16 Mar. 1988 Mar. 1990 Mar. 1992 Mar. 1994 Mar. 1996 Mar. 1998 Mar. 2000 Mar. 2002 Mar. 2004 Mar. 2006 Mar. 2008 Mar. 2010 Mar. 2012 Dec. 2014 Dec. 2016 Note: Impact of share splits is reflected retroactively. Kao Corporation Financial Report 2016 2 voluntary recall was announced on July 4, 2013, Kanebo in order to increase its corporate value as a global company. Cosmetics has been responding earnestly with support The Group also believes that the application of IFRS will facilitate for the recovery and compensation of people who have the international comparability of its financial statements in experienced vitiligo-like symptoms. In addition, the entire capital markets. Kao Group is making efforts with a view to preventing recurrence while striving to ensure greater safety and reliability. Overview of Consolidated Results (2) To deal with changes in the risks entailed in its businesses, the Kao Group will define the serious During the fiscal year ended December 31, 2016, the global company-wide risks among its main risks as corporate economy slowed in the first half due to factors including a risks and work to prevent damage to the corporate trend toward normalization of monetary policy in the United value  of the Group as a whole by further enhancing its States and Europe, sluggish economies in emerging nations management system. and elsewhere, and a drop in the price of crude oil, but turned Basic Approach to Selection of Accounting Standards toward recovery in the second half, centered on the United States. The Japanese economy continued on a moderate recovery track, although delays in improvement have become apparent in some sectors. Moreover, it was a volatile year in foreign exchange markets. The household and personal care Having decided that unifying accounting standards within products market in Japan, a key market for the Kao Group, the Kao Group will contribute to improving the quality of its grew by 2% on a value basis and consumer purchase prices business management, the Kao Group has voluntarily adopted remained nearly flat compared with the previous fiscal year. IFRS from the fiscal year ended December 31, 2016. This will The cosmetics market in Japan grew by 1%, excluding enable management based on standardized procedures and inbound demand (demand from visitors to Japan). information for each Group company and business, and the Under these circumstances, the Kao Group worked to launch Kao Group intends to reinforce its management foundation and nurture products with high added value in response to Net Sales / Gross Profit Ratio* Operating Income / Operating Income Ratio (Billions of yen) 1,500 1,220.4 1,401.7 1,315.2 1,471.8 1,474.6 1,457.6 1,000 500 0 56.5 54.9 55.3 55.3 56.3 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 (%) 100 80 60 40 20 0 (Billions of yen) 200 150 100 50 0 185.6 12.7 164.4 167.3 11.2 11.3 124.7 133.3 9.5 9.5 111.8 9.2 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 (%) 20 15 10 5 0 Japanese GAAP IFRS Japanese GAAP IFRS Net Sales (Left) Gross Profit Ratio (Right) * The gross profit ratio has not been disclosed for the year ended December 31, 2012 (Restated) Operating Income (Left) Operating Income Ratio (Right) 3 Kao Corporation Financial Report 2016 Management Discussion and Analysis Costs, Expenses and Income as Percentages of Net Sales IFRS Japanese GAAP Years ended December 31, 2016, 2015 and 2014 December 2016 December 2015 Cost of sales ........................................................................... 43.7% 44.7% Gross profit ............................................................................. Selling, general and administrative expenses ......................... Operating income ................................................................... Income before income taxes and minority interests .............. Income before income taxes .................................................. Net income ............................................................................. Net income attributable to owners of the parent ................... 56.3 43.5 12.7 — 12.6 — 8.7 55.3 43.6 11.3 — 11.3 — 7.1 December 2015 44.7% 55.3 44.1 11.2 11.0 — 6.7 — December 2014 45.1% 54.9 45.4 9.5 9.0 — 5.7 — changes in consumer needs based on its concept of “Yoki- Analysis of Income Statement Monozukuri,”* which emphasizes research and development geared to customers and consumers. The Kao Group also Net sales decreased 1.1% compared with the previous fiscal conducted cost reduction activities and other measures. year to ¥1,457.6 billion. Excluding the effect of currency * The Kao Group defines Yoki-Monozukuri as a strong commitment by all members to provide products and brands of excellent value for consumer satisfaction. In Japanese, Yoki literally means “good/excellent,” and Monozukuri means “development/manufacturing of products.” translation, net sales would have increased 3.2%. In the Consumer Products Business, sales increased in Japan due to factors including market growth, launches of new and To improve capital efficiency and increase shareholder improved products, and further enhancement of sales returns, Kao Corporation resolved at a meeting of its Board of promotion activities. Outside Japan, sales in Asia increased, Directors held on August 25, 2016 to repurchase its own shares, and repurchased shares totaling ¥50.0 billion. excluding the effect of currency translation. In the Chemical Business, sales increased compared with the previous fiscal year, excluding the effect of currency translation, as the Kao Net Income Attributable to Owners of the Parent* / Return on Sales Basic Earnings per Share (Billions of yen) 150 100 50 0 126.6 8.7 98.9 6.7 105.2 7.1 79.6 5.7 64.8 4.9 53.1 4.4 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 (%) 15 10 5 0 (Yen) 300 200 100 0 253.43 209.82 197.19 156.46 126.03 101.77 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 Japanese GAAP IFRS Japanese GAAP IFRS Net Income Attributable to Owners of the Parent (Left) Return on Sales (Right) * Net income attributable to owners of the parent was reported as net income under Japanese GAAP for the years ended December 31, 2012 (restated) to 2015. Kao Corporation Financial Report 2016 4 Group worked to adjust selling prices in response to rising In Japan, sales increased 2.1% to ¥943.0 billion. The Kao costs for natural fats and oils, although sales were impacted Group made efforts that included working to respond to by a decline in demand in some customer industries. the changing lifestyles and diversifying preferences of Net sales outside Japan were 33.8% of net sales compared consumers, and social issues such as the environment, with 35.2% for the previous year. Excluding the effect of health, the aging society and hygiene, by launching numerous currency translation, net sales outside Japan would have been high-value-added products and enhancing proposal-oriented 36.6% of net sales. sales activities. As for profits, due to the effect of increased sales in the In Asia, sales decreased 1.1% to ¥180.8 billion. Excluding Consumer Products Business in Japan and Asia, a decrease in the effect of currency translation, sales would have increased the cost of petrochemical raw materials and other factors, 13.0%. Growth continued as the Kao Group worked in areas operating income was ¥185.6 billion, an increase of ¥18.3 such as launching and nurturing products targeting the middle- billion compared with the previous fiscal year, the operating class consumer segment, collaborating with retailers, utilizing margin was 12.7% and income before income taxes was wholesale channels and expanding sales regions. ¥183.4 billion, an increase of ¥17.4 billion. Net income was In the Americas, sales decreased 10.7% to ¥80.1 billion. ¥127.9 billion, an increase of ¥21.9 billion. Excluding the effect of currency translation, sales would have Basic earnings per share were ¥253.43, an increase of decreased 0.5%. Although sales of skin care products and ¥43.61, or 20.8%, from ¥209.82 in the previous fiscal year. professional hair care products grew, sales of hair care products Information by Segment Consumer Products Business decreased compared with the previous fiscal year. In Europe, sales decreased 13.1% to ¥78.1 billion. Excluding the effect of currency translation, sales would have decreased 0.8%. Although sales of professional hair care products were nearly flat, sales of hair care products decreased compared Sales decreased 0.5% compared with the previous fiscal year with the previous fiscal year. to ¥1,219.8 billion. Excluding the effect of currency translation, Operating income increased ¥17.7 billion compared with sales would have increased 3.0%. the previous fiscal year to ¥155.1 billion due to factors Consumer Products Business Net Sales / Operating Income Beauty Care Business Net Sales / Operating Income (Billions of yen) 1,400 (Billions of yen) 200 (Billions of yen) 750 (Billions of yen) 80 1,200 1,000 800 600 400 200 0 1,091.9 1,154.5 1,019.4 1,222.8 1,225.6 1,219.8 155.1 134.2 137.4 93.4 103.0 111.3 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 150 100 50 0 500 250 0 570.3 589.9 537.8 607.7 608.6 601.6 51.1 37.9 23.9 20.1 28.4 29.4 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 60 40 20 0 Japanese GAAP IFRS Japanese GAAP IFRS Net Sales (Left) Operating Income (Right) Net Sales (Left) Operating Income (Right) 5 Kao Corporation Financial Report 2016 Management Discussion and Analysis including the effect of increased sales in the Fabric and Home increased due to growth in sales of Bioré facial cleanser and Care Business in Japan, increased sales in Asia, a decrease in UV care as well as Curél derma care products. Sales also the cost of raw materials and the completion of amortization grew in Asia and in the Americas as Bioré sold strongly. of trademarks. Note: The Kao Group’s Consumer Products Business consists of the Beauty Care Business, the Human Health Care Business, and the Fabric and Home Care Business. Beauty Care Business Sales of hair care products decreased. In Japan, the Kao Group conducted a complete renewal of Essential shampoos and conditioners and other measures, but sales were flat due to intensifying competition. The Kao Group also launched new easy-to-use, environmentally conscious refill products, which Sales decreased 1.1% compared with the previous fiscal year gained the support of consumers. Outside Japan, sales to ¥601.6 billion. Excluding the effect of currency translation, decreased as severe conditions continued. sales would have increased 2.9%. Operating income increased ¥13.2 billion compared with Sales of cosmetics were on a par with the previous fiscal the previous fiscal year to ¥51.1 billion, due to the effect of year at ¥255.0 billion. Excluding the effect of currency translation, increased sales in Japan, the completion of amortization of sales would have increased 2.8%. In Japan, sales increased trademarks related to Kanebo Cosmetics, and an impairment due to factors including good performance by new products loss and other items recorded in the previous fiscal year. launched in 2015 and enhanced in-store sales promotion activities. Major reforms in the cosmetics business started in Human Health Care Business September 2016 and sales of the SOFINA iP series, for which Sales decreased 3.1% compared with the previous fiscal year sales channels have expanded, and of the new global brand to ¥273.1 billion. Excluding the effect of currency translation, KANEBO were steady. In counseling cosmetics, the ALBLANC sales would have increased 1.3%. skin brightening brand and the RMK brand performed strongly, For food and beverage products, signs of recovery became and in self-selection cosmetics, sales of KATE and media apparent as the Kao Group strengthened its promotion of the makeup grew. Sales increased outside Japan, due in part to function of highly concentrated tea catechins in Healthya strong performance in China and Taiwan. Green Tea, a functional drink that enhances the body’s ability Sales of skin care products increased. In Japan, sales to metabolize fat and facilitates reduction of body fat, and Human Health Care Business Net Sales / Operating Income (Billions of yen) 300 250 200 189.6 280.7 281.7 (Billions of yen) 50 273.1 240.1 210.6 35.5 33.4 25.9 150 100 50 0 21.9 16.9 13.6 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 Japanese GAAP IFRS Net Sales (Left) Operating Income (Right) 40 30 20 10 0 worked to cultivate new users. Sales of sanitary products increased. Sales of the Laurier brand of sanitary napkins grew steadily. In Japan, a high- value-added scented version of Laurier Slim Guard, which offers both high absorbency and comfort, was launched and sales increased. In Asia, sales of high-value-added products increased strongly. Sales of Merries baby diapers were nearly flat excluding the effect of currency translation. In Japan, amid a decline in demand for purchasing with the purpose of resale in China compared with the previous fiscal year, the Kao Group began full-scale efforts for cross-border e-commerce for the Chinese market, but sales decreased. In addition, the Kao Group has mostly resolved prolonged shortages in stores, and resumed marketing activities. Market share is recovering, supported by the June 2016 launch of an improved product with even better breathability, among other factors. In China, where market growth continues, sales increased even as the Kao Group conducted a transformation of its sales structure. Kao Corporation Financial Report 2016 6 In Indonesia, sales of locally produced Merries targeting the with dishwashing detergent, the product created a new middle-class consumer segment were favorable. market with the entirely new concept of “spraying away Sales of personal health products increased. Sales of oral residue from places a sponge can’t reach.” Sales of Magiclean care products increased with good performance by Pure Oral household cleaners for the bath, toilet, kitchen and other toothpaste and mouthwash. Sales of bath additives increased. areas grew with value-added offerings such as deodorizing, Although sales of MegRhythm steam thermo sheets decreased disinfecting and anti-staining. In addition, sales of Resesh due to a decline in inbound demand, the product is on a recovery clothing, fabric and air refresher and Quickle household trend as a result of factors including enhanced in-store sales cleaning mop kit grew steadily. Sales grew in Asia as Magiclean, promotion activities and advertising. a high-value-added household cleaner that responds to lifestyles Operating income decreased ¥7.4 billion compared with in each country for use in various daily life settings, performed the previous fiscal year to ¥25.9 billion due to factors including strongly in Thailand and elsewhere. the effect of aggressive marketing expenditures, an increase Operating income increased ¥12.0 billion compared with in depreciation, the effect of exchange rate fluctuations and a the previous fiscal year to ¥78.1 billion due to factors including decrease in inbound demand. the effect of increased sales and a decrease in the cost of Fabric and Home Care Business Sales increased 2.9% compared with the previous fiscal year Chemical Business raw materials. to ¥345.2 billion. Excluding the effect of currency translation, Sales decreased 5.1% compared with the previous fiscal year sales would have increased 4.7%. to ¥273.8 billion. Excluding the effect of currency translation, Sales of fabric care products increased compared with the sales would have increased 2.5%. previous fiscal year. In Japan’s fiercely competitive market In Japan, sales were impacted by a trend toward a environment, both sales and market share increased from decrease in demand in some customer industry markets, responding to the larger-sized products category and the including construction materials. Outside Japan, excluding the contribution of new and improved products. Sales of laundry effect of currency translation, sales increased despite the detergents increased, centered on ultra-concentrated liquid negative effects from the decrease in demand among customer laundry detergent Ultra Attack Neo and the rest of the Neo series, as well as conventional-type Attack Antibacterial EX Super Clear Gel. For fabric softeners, as the market for high- value-added products expanded, the Kao Group launched a new Flair Fragrance product that features a new fragrance Fabric and Home Care Business Net Sales / Operating Income release function, and Flair Fragrance IROKA, a premium fabric softener, and sales increased. Humming Fine, which has a strong deodorizing effect, sold strongly. Sales also increased in Asia compared with the previous fiscal year. In particular, sales were strong for Attack Jaz1, a powder detergent for hand washing targeting the middle-class consumer segment in Indonesia. Sales of home care products increased. In Japan, for CuCute dishwashing detergent, the Kao Group launched CuCute CLEAR Foam Spray, a new foam spray type product. In response to the conventional notion that a sponge is used 7 Kao Corporation Financial Report 2016 (Billions of yen) 400 300 292.0 (Billions of yen) 100 311.0 324.5 334.4 335.3 345.2 78.1 59.6 62.2 61.0 69.2 66.1 200 100 0 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 Japanese GAAP IFRS Net Sales (Left) Operating Income (Right) 80 60 40 20 0 Management Discussion and Analysis industries, as the Kao Group worked to expand sales and Financial Structure adjust the selling prices of oleo chemicals. Sales of oleo chemicals continued to increase as the Kao Total assets increased ¥27.2 billion from December 31, 2015 Group worked to adjust selling prices in line with the continuing to ¥1,338.3 billion. The principal increases in assets were a rise of raw material prices. In performance chemicals, the Kao ¥13.9 billion increase in inventories and a ¥32.8 billion increase in Group worked to develop and expand sales of high-value- property, plant and equipment. The principal decreases in assets added products with a reduced environmental footprint, but were a ¥6.9 billion decrease in cash and cash equivalents and was impacted by worsening conditions in the construction a ¥14.2 billion decrease in other current assets. materials and other markets. Sales of specialty chemicals Total liabilities increased ¥27.8 billion from December 31, decreased due to ongoing sluggish demand and structural 2015 to ¥646.8 billion. The principal increases in liabilities changes in the personal computer market. were a ¥10.1 billion increase in trade and other payables, a Operating income increased ¥1.1 billion compared with the ¥5.7 billion increase in other current liabilities and a ¥19.1 previous fiscal year to ¥29.7 billion as the Kao Group promoted billion increase in retirement benefit liabilities. The principal high-value-added products, worked to adjust selling prices decrease in liabilities was a ¥9.3 billion decrease in provisions. and conducted other measures in response to rising costs for Total equity decreased ¥0.5 billion from December 31, 2015 natural fats and oils in a severe business environment. to ¥691.5 billion. The principal increase in equity was net income In June 2016, the Kao Group announced the acquisition of totaling ¥127.9 billion. The principal decreases in equity were ink companies in the United States and Europe to accelerate ¥50.0 billion due to purchase of treasury shares from the market, the development of its water-based pigment inkjet ink, which exchange differences on translation of foreign operations of contributes to reducing environmental footprint, and the ¥16.2 billion, remeasurements of defined benefit plans totaling global rollout of the business. The company in the United ¥16.1 billion and dividends totaling ¥45.1 billion. States became a consolidated subsidiary in July 2016. As a result of the above factors, the ratio of equity attributable to owners of the parent to total assets was 50.8% compared with 51.9% at December 31, 2015. Chemical Business Net Sales / Operating Income (Billions of yen) 300 261.2 236.5 (Billions of yen) 288.0 288.5 288.5 273.8 30.1 28.6 29.7 200 100 0 21.5 22.1 18.1 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 Japanese GAAP IFRS Net Sales (Left) Operating Income (Right) Note: Net sales include intersegment sales. 40 30 20 10 0 Total Assets / Equity Attributable to Owners of the Parent* (Billions of yen) 1,500 1,030.3 1,000 1,281.9 1,311.1 1,338.3 1,198.2 1,133.3 582.7 628.7 658.2 675.6 681.0 679.8 500 0 Dec. 2012 Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 Japanese GAAP IFRS Total Assets Equity Attributable to Owners of the Parent * Equity attributable to owners of the parent is presented as net worth under Japanese GAAP as of December 31, 2012 to 2015. Net worth is equity, excluding minority interests and stock acquisition rights. Kao Corporation Financial Report 2016 8 Cash Flows Cash Flows from Financing Activities Net cash flows from financing activities totaled negative The balance of cash and cash equivalents at December 31, ¥95.0 billion. This primarily consisted of ¥50.0 billion for 2016 decreased ¥6.9 billion compared with December 31, purchase of treasury shares and ¥45.1 billion for dividends 2015 to ¥303.0 billion, including the effect of exchange rate paid to owners of the parent and non-controlling interests. changes. Cash Flows from Operating Activities Net cash flows from operating activities totaled ¥184.3 billion. The principal increases in net cash were income before income Basic Policies Regarding Distribution of Profits and Dividends for the Period taxes of ¥183.4 billion, depreciation and amortization of ¥51.1 In order to achieve profitable growth, Kao Corporation (the billion and increase in retirement benefit liabilities of ¥20.0 Company) secures an internal reserve for capital investment billion. The principal decreases in net cash were increase in and acquisitions from a medium-to-long-term management inventories of ¥17.4 billion, other, which includes accrued perspective and places priority on providing shareholders with expenses, of ¥7.2 billion and income taxes paid of ¥48.7 billion. steady and continuous dividends. In addition, the Company flexibly considers share repurchase and retirement of treasury Cash Flows from Investing Activities shares from the standpoint of improving capital efficiency. Net cash flows from investing activities totaled negative ¥88.6 In accordance with these policies, the Company announced billion. This primarily consisted of payments into time deposits a year-end dividend for fiscal 2016 of ¥48.00 per share, an of ¥11.6 billion, purchase of property, plant and equipment of increase of ¥6.00 per share compared with the previous fiscal ¥74.6 billion and purchase of intangible assets of ¥5.1 billion. year. Consequently, cash dividends for the fiscal year increased Free cash flow, the sum of net cash flows from operating ¥14.00 per share compared with the previous fiscal year, activities and net cash flows from investing activities, was resulting in a total of ¥94.00 per share. The consolidated ¥95.7 billion. payout ratio was 37.1%. For fiscal 2017, the Company plans to pay total cash dividends Capital Expenditures (Billions of yen) 120 80 40 0 83.4 82.8 89.9 63.7 68.5 41.9 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 Free Cash Flows* (Billions of yen) 150 121.0 100 50 0 106.8 107.5 95.7 81.3 52.7 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2015 Dec. 2016 Japanese GAAP IFRS Japanese GAAP IFRS * Free cash flow is the sum of net cash flows from operating activities and net cash flows from investing activities. 9 Kao Corporation Financial Report 2016 Management Discussion and Analysis of ¥108.00 yen share, an increase of ¥14.00 per share compared and for consumer products in Indonesia. The Kao Group also with the previous fiscal year. Although the operating environment opened a new research facility in Japan, the Beauty Research & is challenging, this plan is in accordance with the Company’s Innovation Center, as one of the major reforms of its cosmetics basic policies regarding distribution of profits, and free cash flow business. Research and development expenditures were and other factors have also been taken into consideration. As a ¥54.6 billion, which was the equivalent of 3.7% of net sales, result, the Company is aiming for its 28th consecutive fiscal year remaining at a high level relative to net sales. of increases in dividends. EVA and Related Activities Increasing Profit: During the fiscal year ended December 31, 2016, the Kao Group invested in proactive research and development, marketing activities and major reforms of the cosmetics business. As a result, sales of the Consumer In conjunction with the introduction of IFRS from the fiscal year Products Business increased in Japan and continued to grow ended December 31, 2016, the Kao Group has begun disclosing by double digits in the rest of Asia, excluding the effect of the monetary amount of EVA, its principal management currency translation. Moreover, the Kao Group also benefitted metric. For the fiscal year ended December 31, 2016, EVA from a decline in petrochemical raw material prices in addition was ¥73.4 billion, an increase of ¥14.8 billion from the to its cost reduction activities, which covered the increase in previous fiscal year due to an increase in NOPAT. The Kao expenses and significantly improved NOPAT. Group conducted the following EVA-related activities during the fiscal year. Financial Improvement: In addition to achieving its 27th consecutive fiscal period of dividend growth with cash Investing for Growth: During the fiscal year ended December dividends of ¥94.00 per share, a 17.5% year-on-year increase 31, 2016, the Kao Group invested aggressively for future growth. that exceeded its initial forecast, Kao Corporation repurchased Capital expenditures were at a high level of ¥89.9 billion. ¥50.0 billion of its own shares. The main item was expansion of manufacturing facilities for sanitary products and fabric and home care products in Japan, Total Dividend Payment / Share Repurchases* EVA* (Billions of yen) 120 100 50 0 96.8 50.0 85.5 50.0 62.8 30.0 32.4 32.4 32.8 35.5 40.2 40.2 46.8 100 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 Dec. 2016 Mar. 2000 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Dec. 2015 (Billions of yen) 100 80 60 40 20 0 73.4 58.6 Dec. 2015 Dec. 2016 Total Dividend Payment Share Repurchases * Excludes repurchase of shares of less than one trading unit Japanese GAAP IFRS * EVA under Japanese GAAP is presented as an index with 100 representing the fiscal year ended March 31, 2000. Kao Corporation Financial Report 2016 10 Business Risks and Other Risks and expansion of new retail channels. The Consumer Products Business conducts sales activities and makes new offerings Various risks arise in the course of a company’s business. The that respond to these structural changes. However, as a Kao Group manages risks appropriately by identifying and consequence of uncertainties in these business activities due evaluating risks to formulate and implement necessary to various factors, the Consumer Products Business may be countermeasures, among other activities. In addition, in the unable to conduct sales activities or make new offerings that event a risk manifests itself, the Kao Group sets up an respond to these structural changes. This could have an impact emergency response organization and strives to minimize on the Kao Group’s business results and financial condition. damage and loss by responding promptly. However, in the event a major risk such as those described below manifests (2) Chemical Business itself, it may exert a significant impact on the Kao Group’s The Kao Group’s Chemical Business is affected by factors business results and financial condition. The major risks including trends in customer demand and fluctuations in raw described below are not a comprehensive list of risks the Kao material prices. The Chemical Business promotes creation of Group faces. Other risks exist and may have an impact on high-value-added products that match customer needs, investment decisions. Any statements below concerning the conducts research and development of products in future are judgments made by Kao Corporation as of the consideration of the environment, and provides such products submission of its securities report to the Ministry of Finance while working to reduce costs and deal with product prices. on March 21, 2017. However, as a consequence of uncertainties in these business activities due to various factors, the Chemical (1) Consumer Products Business Business may be unable to provide products that match 1. Response to Changes in Consumer Needs customer needs or respond to matters such as fluctuations in The Kao Group’s Consumer Products Business is affected by raw material prices. This could have an impact on the Kao business cycles and changes in consumers’ values in the Group’s business results and financial condition. market of each country. The Consumer Products Business maintains and improves brand value by understanding (3) Business Acquisitions, Business Alliances and Mergers changes in consumer needs and using the comprehensive The Kao Group may implement business acquisitions, strength of the Kao Group’s product development and business alliances, mergers or other such measures. When manufacturing in working to create high-value-added products implementing them, the Kao Group makes decisions after and provide services through approaches in areas including thoroughly assessing economic value and its partner the environment, health, the aging society and hygiene. companies. However, due to various unforeseeable However, as a consequence of uncertainties in these uncertainties in its business activities, the Kao Group may be business activities due to various factors, the Consumer unable to produce the results it initially expected. This could Products Business may be unable to provide products and have an impact on the Kao Group’s business results and services that respond to changes in consumer needs and financial condition. brand value could decrease. This could have an impact on the Kao Group’s business results and financial condition. (4) Overseas Business Expansion As one of its growth strategies, the Kao Group is conducting 2. Response to Changes in Retailing operations in markets in Asia, the Americas, Europe and The Kao Group’s Consumer Products Business is affected by elsewhere, with a particular emphasis on strengthening its changes in the structure of retailing, including progress in the operations in countries where higher economic growth rates creation of new corporate groups through retail industry and market expansion are forecast. However, the Kao Group mergers and integration in the market, and the emergence may be unable to strengthen its operations as a consequence 11 Kao Corporation Financial Report 2016 Management Discussion and Analysis of uncertainties due to various factors in the course of (7) Response to Natural Disasters, Accidents and Other business including the occurrence of a slowdown in economic Incidents growth or uncertain political or social conditions, intensifying To deal with earthquakes and other natural disasters, the Kao competition, the inability to conduct sufficient cost Group has formulated disaster countermeasures for its management or the emergence of problems in relationships production facilities and primary offices and a business with retail outlets, sales agents or other trading partners. This continuity plan (BCP), and will continue to strengthen and could have an impact on the Kao Group’s business results and reinforce them in the future. However, the occurrence and financial condition. consequent damage of an earthquake on a scale exceeding assumptions that hinder the supply of products to the market (5) Procurement of Raw Materials due to problems in areas such as securing raw materials and Market prices for natural fats and oils and petroleum-related maintaining production, among other impediments, could materials used as raw materials for products of the Kao Group have a serious impact on the Kao Group’s business results are affected by factors including geopolitical risks, the balance and financial condition. In addition, the emergence of major between supply and demand, abnormal weather and changes in demand trends due to a worsening economic exchange rate fluctuations. The Kao Group has moved to environment associated with the earthquake could have a reduce the effect of increases in raw material prices through serious impact on the Kao Group’s business results and measures including cost reductions and passing on increases financial condition. Furthermore, the occurrence of an explosion in raw material costs into product prices. In addition, the Kao or fire at production facilities, information system malfunction, Group is conducting development of substitute raw materials problems at a supplier of raw materials, dysfunction of social for natural fats and oils through research into advanced infrastructures such as electric power and water, environmental effective utilization of non-edible raw materials. However, pollution from harmful substances, the spread of infectious unexpected radical changes in market conditions and pricing disease, terrorism, political change, riots and other incidents could have an impact on the Kao Group’s business results and could hinder the supply of products to the market. This could financial condition. (6) Product Quality have a serious impact on the Kao Group’s reputation, business results and financial condition. The Kao Group designs and manufactures products from the (8) Currency Exchange Rate Fluctuations viewpoint of consumers, in compliance with related laws and Foreign currency-denominated transactions are affected by regulations and voluntary standards. In the development changes in currency exchange rates. The Kao Group hedges stage prior to market launch, the Kao Group conducts foreign exchange risk through various measures such as thorough safety testing and survey research to confirm the settlement of transactions through foreign currency accounts, safety of products. After market launch, the Kao Group works foreign exchange contracts, and currency swaps to mitigate to further improve quality by incorporating the opinions and the effect on business results. The Kao Group does not engage desires of consumers through its consumer communication in derivative transactions for the purpose of speculation. centers. However, the unanticipated occurrence of a serious However, because items on the financial statements of quality problem or concerns about product safety or reliability overseas consolidated subsidiaries are translated into resulting from new scientific knowledge would not only cause Japanese yen, substantial variance in the exchange rate from difficulties for the relevant brand, but would also have a major the expected rate at the time of conversion will have an impact impact on the reputation of all of the Kao Group’s products. on the Kao Group’s business results and financial condition. This could have an impact on the Kao Group’s business results and financial condition. Kao Corporation Financial Report 2016 12 Management Discussion and Analysis (9) Impact of Deferred Tax Assets and Impairment (12) Information Management The Kao Group records various tangible fixed assets and The Kao Group possesses confidential information related to intangible assets and deferred tax assets including assets matters including research and development, production, used in the course of business and goodwill incurred in marketing and sales, as well as the personal information of corporate acquisitions. The Kao Group may not generate the numerous customers used for product development, sales expected cash flow due to divergence from planned future promotion and other purposes. The Kao Group conducts business results, a decline in market value or other factors. thorough information management using guidelines for handling This could have an impact on the Kao Group’s business information and implements appropriate security measures results and financial condition. for its information systems, including both hardware and (10) Securing Human Capital held by the Kao Group resulting from an attack on its server, The Kao Group strives to secure diverse, superior human unlawful access, a computer virus or other factor that exceeds capital to achieve its business goals globally. Human capital expectations could have an impact on the Kao Group’s with advanced expertise in areas such as research and reputation, business results and financial condition. software. However, a leak of confidential or personal information development, production technologies, marketing and sales activities are indispensable in aiming for the Yoki-Monozukuri (13) Litigation (see note on page 4) that consumers support. However, The Kao Group conducts diverse businesses globally, and an inability to secure the necessary human capital due to various types of litigation may be brought against it. The result changes in employment conditions or other factors could of such litigation could have an impact on the Kao Group’s have an impact on the Kao Group’s business results and business results and financial condition. financial condition. (11) Compliance with Laws and Regulations In the course of its business activities, the Kao Group must comply with a variety of laws and regulations concerning areas such as standards for product quality and safety, the environment and chemical substances, as well as accounting standards, tax law and regulations related to labor and transactions. The Kao Group has constructed a compliance system and strives to comply with all related laws and regulations. However, a serious legal violation by the Kao Group or by a consignee or other party could have an impact on the Kao Group’s reputation, business results and financial condition. Moreover, a change in current laws and regulations, or new laws and regulations could restrict the Kao Group’s business activities, require investment for compliance, or otherwise affect the Kao Group. This could have an impact on the Kao Group’s business results and financial condition. 13 Kao Corporation Financial Report 2016 Consolidated Statement of Financial Position Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2016 and 2015, and at the transition date Assets Current assets Cash and cash equivalents ................................................................ Trade and other receivables ............................................................... Inventories .......................................................................................... Income tax receivables ...................................................................... Other financial assets ........................................................................ Other current assets .......................................................................... Subtotal ........................................................................................... Non-current assets held for sale ......................................................... Total current assets ...................................................................... Non-current assets Property, plant and equipment .......................................................... Goodwill.............................................................................................. Intangible assets ................................................................................ Investments accounted for using the equity method ...................... Other financial assets ........................................................................ Other non-current assets ................................................................... Deferred tax assets ............................................................................ Total non-current assets ............................................................. Notes 2016 2015 Transition date (Millions of yen) 8,34 9,34 10 34 11 12 13 14 14 15 34 11,20 16 303,026 208,459 165,200 1,462 13,038 23,812 714,997 344 715,341 370,835 137,783 14,689 4,701 25,473 18,548 50,939 622,968 309,922 210,707 151,271 2,077 5,065 38,005 717,047 1,330 718,377 337,997 138,251 15,705 4,209 29,339 17,732 49,454 592,687 228,967 212,742 151,876 1,261 4,034 47,299 646,179 — 646,179 319,282 138,751 23,626 3,544 26,088 7,966 61,194 580,451 Total assets .............................................................................. 1,338,309 1,311,064 1,226,630 Liabilities and equity Liabilities Current liabilities Trade and other payables ................................................................... Bonds and borrowings ....................................................................... Income tax payables .......................................................................... Other financial liabilities ..................................................................... Provisions ........................................................................................... Other current liabilities ...................................................................... Total current liabilities ................................................................. Non-current liabilities Bonds and borrowings ....................................................................... Retirement benefit liabilities .............................................................. Other financial liabilities ..................................................................... Provisions ........................................................................................... Other non-current liabilities ............................................................... Deferred tax liabilities ........................................................................ Total non-current liabilities .......................................................... Notes 2016 2015 Transition date 19,34 17,34 18,34 21 22 17,34 20 18,34 21 16 216,893 30,289 32,621 8,164 11,370 131,112 430,449 90,357 94,773 11,666 13,809 5,264 528 216,397 206,760 339 32,184 6,929 16,772 125,422 388,406 120,207 75,706 11,817 17,704 4,919 318 230,671 193,460 21,422 28,283 5,765 33,360 123,916 406,206 80,188 77,895 12,813 5,296 5,411 433 182,036 Total liabilities ........................................................................... 646,846 619,077 588,242 Equity Share capital .................................................................................. Capital surplus ............................................................................... Treasury shares.............................................................................. Other components of equity .......................................................... Retained earnings .......................................................................... 23 23 23 23 23 Equity attributable to owners of the parent ................................ Non-controlling interests ................................................................ Total equity .......................................................................... 85,424 107,648 (57,124) (21,821) 565,715 679,842 11,621 691,463 85,424 108,659 (8,202) (4,184) 499,299 680,996 10,991 691,987 85,424 109,561 (9,719) 7,601 431,975 624,842 13,546 638,388 Total liabilities and equity ........................................................ 1,338,309 1,311,064 1,226,630 Kao Corporation Financial Report 2016 14 Consolidated Statement of Income Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2016 and 2015 Net sales ............................................................................................................. Cost of sales ........................................................................................................ Gross profit .......................................................................................................... Notes 6,26 10,13,14,20 Selling, general and administrative expenses ....................................................... Other operating income ....................................................................................... Other operating expenses.................................................................................... 12,13,14,20,29 Operating income ................................................................................................. 13,14,20,27 13,28 6 Financial income .................................................................................................. Financial expenses ............................................................................................... Share of profit in investments accounted for using the equity method ................ Income before income taxes .............................................................................. Income taxes ...................................................................................................... Net income .......................................................................................................... 6,20,30 6,20,30 6,15 6 16 2016 1,457,610 (637,502) 820,108 (633,368) 13,677 (14,846) 185,571 1,389 (5,424) 1,894 183,430 (55,541) 127,889 (Millions of yen) 2015 1,474,550 (658,865) 815,685 (642,729) 14,099 (19,737) 167,318 1,416 (4,213) 1,517 166,038 (60,086) 105,952 Attributable to: Owners of the parent........................................................................................... Non-controlling interests ...................................................................................... Net income .......................................................................................................... 126,551 1,338 127,889 105,196 756 105,952 Earnings per share Basic (Yen) ........................................................................................................... Diluted (Yen) ......................................................................................................... 31 31 253.43 253.18 209.82 209.53 15 Kao Corporation Financial Report 2016 Consolidated Statement of Comprehensive Income Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2016 and 2015 Net income ................................................................................................................. Other comprehensive income Items that will not be reclassified to profit or loss: Net gain (loss) on revaluation of financial assets measured at fair value through other comprehensive income .............................................. Remeasurements of defined benefit plans ............................................................ Share of other comprehensive income of investments accounted for using the equity method ............................................................... Total of items that will not be reclassified to profit or loss ..................................... Items that may be reclassified subsequently to profit or loss: Exchange differences on translation of foreign operations ..................................... Net gain (loss) on derivatives designated as cash flow hedges ............................. Share of other comprehensive income of investments accounted for using the equity method ............................................................... Total of items that may be reclassified subsequently to profit or loss ................... Other comprehensive income, net of taxes .............................................................. Comprehensive income .............................................................................................. Attributable to: Owners of the parent................................................................................................ Non-controlling interests ........................................................................................... Comprehensive income ............................................................................................. Notes 2016 127,889 (Millions of yen) 2015 105,952 32,34 32 32 32 32 32 (906) (16,111) (72) (17,089) (16,661) — (10) (16,671) (33,760) 94,129 93,284 845 94,129 1,795 (770) 245 1,270 (15,064) 12 (19) (15,071) (13,801) 92,151 93,011 (860) 92,151 Kao Corporation Financial Report 2016 16 Consolidated Statement of Changes in Equity Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2016 and 2015 Equity attributable to owners of the parent (Millions of yen) Notes Share Capital capital surplus 85,424 108,659 — — Treasury shares (8,202) — Subscription rights to shares 902 — Exchange differences on translation of foreign operations (13,513) — Other components of equity Net gain (loss) on revaluation of financial assets measured at fair value through other compre- hensive income 8,430 — Net gain (loss) on derivatives designated as cash flow hedges (3) — Remeasure- ments of defined benefit plans — — Total (4,184) — Retained earnings 499,299 126,551 Total 680,996 126,551 Non- controlling interests 10,991 1,338 Total equity 691,987 127,889 — — — — (16,248) (16,248) (970) (970) (16,056) (16,056) (33,267) (33,267) — 126,551 (33,267) 93,284 (493) 845 (33,760) 94,129 23 23 33 25 23 23 33 25 January 1, 2016 ............... Net income .................... Other comprehensive income ....................... Comprehensive income .... Disposal of treasury shares ......................... Purchase of treasury shares ......................... Share-based payment transactions ................ Dividends ...................... Changes in the ownership interest in subsidiaries ................ Transfer from other components of equity to retained earnings ... Other increase (decrease) ................... Total transactions with the owners ................. December 31, 2016 ......... January 1, 2015 ............... Net income .................... Other comprehensive income ....................... Comprehensive income .... Disposal of treasury shares ......................... Purchase of treasury shares ......................... Share-based payment transactions ................ Dividends ...................... Changes in the ownership interest in a subsidiary ................... Transfer from other components of equity to retained earnings ... Other increase (decrease) ................... Total transactions with the owners ................. December 31, 2015 ......... — — — — — — — — — 1,099 (189) — (50,021) — — — — — 227 — (29) — 9 911 980 — — — — — — — — — — (1,011) 85,424 107,648 (48,922) (57,124) 85,424 109,561 — — (9,719) — — — — — — — — — — — — — — — 1,571 (231) (54) — — — 225 — — (902) — — — — — — — — — (902) 85,424 108,659 1,517 (8,202) (72) — (78) 902 — — — — — — — — (29,761) — — (13,513) (13,513) — — — — — — — — (13,513) 7 7 — — — — — — — — 4 (4) — 1 1 — — — — — — — — (3) (189) (404) 506 — 506 — 227 — — (50,021) — (50,021) — (44,139) 227 (44,139) — (955) 227 (45,094) — — — — — — — — — — (4) — — — (435) 16,056 15,592 (15,592) — — — — (267) (267) 16,056 — 15,630 (21,821) (60,135) 565,715 (94,438) 679,842 (215) 11,621 (94,653) 691,463 — — (714) (714) — — — — — 714 — 714 — 7,601 — 431,975 105,196 624,842 105,196 13,546 756 638,388 105,952 (12,185) (12,185) — 105,196 (12,185) 93,011 (1,616) (860) (13,801) 92,151 (231) (375) 965 (54) — — 965 (54) — — (37,091) 225 (37,091) — (1,248) 225 (38,339) — 225 — — — (902) (334) (1,236) 406 (406) — — — — — — (113) (113) 400 (4,184) (37,872) 499,299 (36,857) 680,996 (1,695) 10,991 (38,552) 691,987 — (435) 7,025 6,625 — 2,041 2,041 — — — — — (236) — (236) 8,430 — (1,011) — — — — (1,011) 1,007 17 Kao Corporation Financial Report 2016 Consolidated Statement of Cash Flows Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2016 and 2015 Notes 2016 2015 (Millions of yen) Cash flows from operating activities Income before income taxes .......................................................................................... Depreciation and amortization ........................................................................................ Interest and dividend income .......................................................................................... Interest expense ............................................................................................................. Share of profit in investments accounted for using the equity method .......................... (Gains) losses on sale and disposal of property, plant and equipment, and intangible assets ................................................................................ (Increase) decrease in trade and other receivables .......................................................... (Increase) decrease in inventories .................................................................................. Increase (decrease) in trade and other payables ............................................................. Increase (decrease) in retirement benefit liabilities ........................................................ Other ............................................................................................................................... Subtotal ....................................................................................................................... Interest received ............................................................................................................. Dividends received .......................................................................................................... Interest paid .................................................................................................................... Income taxes paid ........................................................................................................... Net cash flows from operating activities ................................................................. Cash flows from investing activities Payments into time deposits .......................................................................................... Proceeds from withdrawal of time deposits .................................................................. Purchase of property, plant and equipment .................................................................... Purchase of intangible assets ......................................................................................... Acquisition of subsidiaries .............................................................................................. Other ............................................................................................................................... Net cash flows from investing activities .................................................................. Cash flows from financing activities Increase (decrease) in short-term borrowings ................................................................ Proceeds from long-term borrowings ............................................................................. Repayments of long-term borrowings ............................................................................ Purchase of treasury shares ........................................................................................... Dividends paid to owners of the parent .......................................................................... Dividends paid to non-controlling interests ..................................................................... Other .............................................................................................................................. Net cash flows from financing activities .................................................................. Net increase (decrease) in cash and cash equivalents .................................................. Cash and cash equivalents at the beginning of the year .............................................. Effect of exchange rate changes on cash and cash equivalents ................................... Cash and cash equivalents at the end of the year ......................................................... 8 8 183,430 51,116 (1,247) 1,484 (1,894) 3,466 (4,049) (17,450) 4,388 19,967 (7,175) 232,036 1,003 1,479 (1,503) (48,708) 184,307 (11,570) 3,703 (74,637) (5,060) (3,659) 2,584 (88,639) (44) 200 (317) (50,021) (44,188) (955) 282 (95,043) 625 309,922 (7,521) 303,026 166,038 57,423 (1,266) 1,528 (1,517) 3,497 (4,882) (3,964) 9,707 (997) 2,321 227,888 1,004 1,315 (1,462) (47,073) 181,672 (2,669) 1,355 (69,023) (5,598) — 1,811 (74,124) (1,128) 40,080 (20,068) (55) (37,137) (1,248) (1,217) (20,773) 86,775 228,967 (5,820) 309,922 Kao Corporation Financial Report 2016 18 Notes to Consolidated Financial Statements Kao Corporation and Consolidated Subsidiaries Fiscal year ended December 31, 2016 1 Reporting Entity Kao Corporation (hereinafter the “Company”) is a corporation established pursuant to the Companies Act of Japan (hereinafter the “Companies Act”) with its headquarters in Chuo-ku, Tokyo. The consolidated financial statements of the Company and its subsidiaries (hereinafter the “Group”) have a closing date as of December 31 and comprise the financial statements of the Group and the interests in associates of the Company. The Group manufactures consumer products including cosmetics, skin care products, hair care products, sanitary products, fabric care products, and chemical products including fatty alcohols and surfactants. The Group delivers its products to customers through its sales companies and distributors in Japan and other countries. Details of these principal business activities of the Group are presented in Note 6 “Segment Information.” 2 Basis of Preparation (1) Compliance with International Financial Reporting Standards (hereinafter “IFRS”) and Matters Concerning Its First-time Adoption The Group’s consolidated financial statements have been prepared in accordance with IFRS issued by the International Accounting Standards Board, permitted by the provision of Article 93 of the Ordinance on Terminology, Forms, and Preparation Methods of Consolidated Financial Statements (Ordinance of the Ministry of Finance of Japan No. 28 of 1976), as they satisfy the requirements for an “IFRS Specified Company” in Article 1-2 of the same ordinance. The Group adopted IFRS for the fiscal year ended December 31, 2016. The Group made the transition to IFRS on January 1, 2015 (hereinafter the “transition date”), and applied IFRS 1 “First- time Adoption of International Financial Reporting Standards” (hereinafter “IFRS 1”). Note 39 “First-time Adoption of IFRS” presents the effect of the transition to IFRS on amounts at the transition date and comparative information for financial position, operating results and cash flows for the fiscal year ended December 31, 2015. The Group’s accounting policies are in compliance with IFRS effective as of December 31, 2016, excluding the IFRS provisions 3 Significant Accounting Policies (1) Basis of Consolidation 1) Subsidiaries Subsidiaries refer to all business entities controlled by the Company. The Company controls an entity when it has exposure, or rights, to variable returns from involvement with an investee and has the ability to affect those returns through its power over the investee. The financial statements of subsidiaries are included in the consolidated financial statements of the Group from the date the Company gains control until the date it loses control of the subsidiary. All intergroup balances, transactions, income and expenses and unrealized gains and losses arising from intergroup transactions are eliminated in preparing the consolidated financial statements. A change in the Company’s ownership interest in a subsidiary, without a loss of control, is accounted for as an equity transaction. Any difference between the amount by 19 Kao Corporation Financial Report 2016 that have not been early adopted and the exemptions available in IFRS 1. (2) Basis of Measurement The Group’s consolidated financial statements have been prepared on the historical cost basis, except for certain assets and liabilities including financial instruments measured at fair value as presented in Note 3 “Significant Accounting Policies.” (3) Functional Currency and Presentation Currency The Group’s consolidated financial statements are presented in Japanese yen, which is the Company’s functional currency. All financial information presented in Japanese yen is rounded to the nearest million yen. (4) Early Adoption of New or Revised Standards and Interpretations The Group has early adopted IFRS 9 “Financial Instruments” (issued in November 2009, revised in July 2014) (hereinafter “IFRS 9”) in preparing its consolidated financial statements. which the non-controlling interests are adjusted and the fair value of the consideration paid or received is recognized directly in equity attributable to the Group. Non-controlling interests in subsidiaries are identified separately from the Group’s equity therein. Comprehensive income of subsidiaries is attributed to owners of the parent company and to the non-controlling interests even if this results in the non-controlling interests having a deficit balance. All subsidiaries have the same closing date as the Company. 2) Associates An associate is defined as an entity over which the Company has significant influence on financial and operating policy decisions but does not have control over the entity. The Company is presumed to have significant influence over another entity when it directly or indirectly holds at least 20%, but no more than 50% of the voting rights of that entity. Entities over which the Company is able to exercise significant influence on financial and operating policy decisions are also included in associates, even if it holds less than 20% of the voting rights. Investments in associates are initially recognized at cost, and are accounted for by the equity method from the date the Company gains significant influence until the date it loses that influence. Goodwill recognized on acquisition of associates (less any accumulated impairment losses) is included in investments in associates. The closing dates of some associates differ from that of the Company. Associates with different closing dates prepare additional financial closing as of the closing date of the Company. (2) Business Combinations Business combinations are accounted for using the acquisition method. The consideration of an acquisition is measured as the aggregate of the acquisition-date fair value of the assets transferred, liabilities assumed and equity securities issued by the Company to the former owners of the acquiree in exchange for control of the acquiree. Identifiable assets and liabilities of the acquiree in business combinations are measured at their acquisition-date fair value, with the following exceptions: • Deferred tax assets or liabilities and assets or liabilities related to employee benefit arrangements are recognized and measured in accordance with IAS 12 “Income Taxes” and IAS 19 “Employee Benefits”, respectively. • Non-current assets and disposal groups that are classified as held for sale in accordance with IFRS 5 “Non-current Assets Held for Sale and Discontinued Operations” are measured in accordance with that Standard. • Liabilities or equity instruments related to share-based payment transactions of the acquiree or share-based payment transactions of the Company entered into to replace such transactions of the acquiree are measured in accordance with IFRS 2 “Share-based Payment.” Any excess of the consideration over the net fair value of identifiable assets acquired and liabilities assumed at the acquisition date is recognized as goodwill in the consolidated statement of financial position. Conversely, any deficit is immediately recognized as income in the consolidated statement of income. Costs associated with business combinations, such as advisory fees, attorney fees and due diligence costs, are expensed as incurred. The additional acquisition of non-controlling interests is accounted for as an equity transaction, and therefore no goodwill is recognized with respect to such a transaction. Business combinations under common control are business combinations in which all of the combining entities or combining businesses are ultimately controlled by the same party or parties both before and after the business combination, and that control is not transitory. These business combinations are accounted for based on the carrying amounts. (3) Foreign Currency Translation 1) Functional currency and presentation currency The presentation currency used in the Group’s consolidated financial statements is Japanese yen, which is the Company’s functional currency. Subsidiaries and associates in the Group determine their own functional currencies and each entity’s transactions are measured in its functional currency. 2) Foreign currency transactions Foreign currency transactions are translated into the functional currency at the spot exchange rate at the date of the transaction, or an exchange rate that approximates the spot rate. At the end of each reporting period, foreign currency monetary items are translated into the functional currency using the rates at the end of each reporting period. Non-monetary items that are measured in terms of historical cost in foreign currencies are translated using the exchange rates at the date of acquisition. Non-monetary items that are measured at fair value in foreign currencies are translated into the functional currency using the exchange rates at the date when the fair value was measured. Exchange differences arising from such translations and settlements are recognized in profit or loss. However, exchange differences arising from equity instruments measured at fair value through other comprehensive income and cash flow hedges are recognized in other comprehensive income. 3) Financial statements of foreign operations Assets and liabilities of foreign operations are translated at the rates at the end of each reporting period. Income and expenses are translated at the average exchange rates for the period, provided that there were no significant fluctuations in the exchange rates during the period. Exchange differences arising from translation of the financial statements of foreign operations are recognized in other comprehensive income. On the disposal of a foreign operation, the cumulative amount of exchange differences relating to that foreign operation is reclassified from equity to profit or loss when the gain or loss on disposal is recognized. (4) Financial Instruments The Group has early adopted IFRS 9 effective from the transition date. 1) Financial assets (i) Initial recognition and measurement The Group initially recognizes trade and other receivables at the date they are originated. Other financial assets are initially recognized at the transaction date when the Group becomes a party to the contractual provisions of the financial instrument. At initial recognition, all financial assets are measured at fair value, but those that are not classified as financial assets measured at fair value through profit or loss are measured at fair value plus transaction costs directly attributable to acquisition of the financial asset. Transaction costs of financial assets measured at fair value through profit or loss are recognized in profit or loss. Kao Corporation Financial Report 2016 20 (ii) Classification and subsequent measurement The Group classifies the financial assets it holds as (a) financial assets measured at amortized cost; (b) debt instruments measured at fair value through other comprehensive income; (c) equity instruments measured at fair value through other comprehensive income; or (d) financial assets measured at fair value through profit or loss. This classification is determined at initial recognition, and measurement of financial assets after initial recognition is performed as follows according to the classification of the financial asset. (a) Financial assets measured at amortized cost Financial assets held by the Group are measured at amortized cost if both of the following conditions are met: • The financial asset is held in a business model whose objective is to hold financial assets in order to collect contractual cash flows; and • The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. After initial recognition, the carrying amounts of financial assets measured at amortized cost are recognized using the effective interest method less impairment loss, if any. Amortization using the effective interest method and gains and losses on derecognition are recognized in profit or loss for the period. (b) Debt instruments measured at fair value through other comprehensive income Financial assets held by the Group are classified as debt instruments measured at fair value through other comprehensive income if both of the following conditions are met: • The financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling the financial asset; and • The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. (c) Equity instruments measured at fair value through other comprehensive income The Group has made an irrevocable election to present subsequent changes in fair value of certain equity instruments in other comprehensive income, and classifies them in equity instruments measured at fair value through other comprehensive income. These financial assets are measured at fair value after initial recognition, and changes in fair value are included in other comprehensive income. If the Group disposes of an investment, or if the fair value of the 21 Kao Corporation Financial Report 2016 investment declines significantly, the cumulative gain or loss recognized in other comprehensive income is reclassified from other components of equity to retained earnings. Dividends from equity instruments measured at fair value through other comprehensive income are recognized as financial income in profit or loss. (d) Financial assets measured at fair value through profit or loss Financial assets that are not classified as financial assets measured at amortized cost, debt instruments measured at fair value through other comprehensive income, or equity instruments measured at fair value through other comprehensive income are classified as financial assets measured at fair value through profit or loss. The Group’s financial assets that are measured at fair value through profit or loss include certain short- term investments and derivative assets. The Group has not irrevocably designated any financial assets as measured at fair value through profit or loss. These financial assets are measured at fair value after initial recognition, and changes in their fair value are recognized in profit or loss. Gains and losses on financial assets measured at fair value through profit or loss are recognized in profit or loss. (iii) Impairment of financial assets With respect to impairment of financial assets measured at amortized cost, the Group recognizes a loss allowance for expected credit losses on such financial assets. At each reporting date, the Group assesses whether the credit risks on the financial assets have increased significantly since initial recognition. If credit risk on a financial instrument has not increased significantly since initial recognition, the loss allowance for that financial instrument is measured at an amount equal to the 12-month expected credit losses. If credit risk on a financial instrument has increased significantly since initial recognition, the loss allowance is measured in an amount equal to the lifetime expected credit losses. However, the loss allowance on trade receivables and others is always measured in an amount equal to the lifetime expected credit losses. The expected credit losses of financial assets are estimated in a way that reflects the following: • An unbiased and probability-weighted amount determined by evaluating a range of possible outcomes • The time value of money • Reasonable and supportable information about past events, current conditions and forecasts of economic conditions that is available without undue cost or effort at the reporting date The amounts of these measurements are recognized in profit or loss. If an event that reduces an impairment loss occurs after the impairment loss has been recognized, the impairment loss will be reversed to the extent of the decrease and credited to profit or loss. (iv) Derecognition of financial assets The Group derecognizes financial assets only when the contractual rights to the cash flows from the financial assets expire, or when the Group transfers financial assets and substantially all the risks and rewards of ownership of the financial assets. 2) Financial liabilities (i) Initial recognition and measurement The Group initially recognizes bonds and borrowings at the date they are issued, and other financial liabilities at the transaction date. Upon initial recognition, all financial liabilities are measured at fair value. However, financial liabilities measured at amortized cost are measured in the full amount after deducting directly attributable transaction costs from the fair value. Transaction costs of financial liabilities measured at fair value through profit or loss are recognized in profit or loss. (ii) Classification and subsequent measurement The Group classifies financial liabilities as either financial liabilities measured at fair value through profit or loss, or financial liabilities measured at amortized cost. This classification is determined at initial recognition. Measurement of financial liabilities after initial recognition is performed as follows, according to the classification of the financial liability. The Group’s financial liabilities measured at fair value through profit or loss are derivative liabilities. The Group has not irrevocably designated any financial liabilities as measured at fair value through profit or loss at initial recognition. Financial liabilities measured at fair value through profit or loss are measured at fair value after initial recognition, and any changes in their fair value are recognized in profit or loss for the period. Financial liabilities measured at amortized cost are subsequently measured at amortized cost using the effective interest method. Amortization using the effective interest method and gains and losses on derecognition are recognized in profit or loss for the period. (iii) Derecognition of financial liabilities The Group derecognizes financial liabilities when they are extinguished (i.e., when the obligation specified in the contract is discharged or cancelled or expires). 3) Offsetting of financial assets and financial liabilities Financial assets and financial liabilities are offset and the net amount is presented in the consolidated statement of financial position only when the Group currently has a Notes to Consolidated Financial Statements legally enforceable right to set off the recognized amount and intends either to settle on a net basis or realize the assets and settle the liabilities simultaneously. 4) Fair value of financial instruments The Group recognizes the fair value of financial instruments using various valuation methodologies and inputs. The fair values recognized based on the observability of inputs into the valuation methodologies are grouped into the following three levels: Level 1: Fair value measured with quoted prices in active markets for identical assets or liabilities Level 2: Fair value measured with inputs other than quoted prices categorized within Level 1 that are observable for the asset or liability, either directly or indirectly Level 3: Fair value measured with unobservable inputs for the asset or liability 5) Hedge accounting The Group uses interest rate swaps and other derivatives to hedge interest rate risk. At the inception of a hedging relationship, the Group formally designates and documents the hedging relationship and the interest rate risk management objective and strategy for undertaking the hedge. The documentation includes identification of the hedging instrument, the hedged item, the nature of the risk being hedged, and the methods of assessing whether the hedging relationship meets the hedge effectiveness requirements. In addition, the Group assesses whether the hedging relationship meets the hedge effectiveness requirements, both at the inception and on an ongoing basis. Ongoing assessments are conducted either at each reporting date or upon a significant change in the circumstances affecting the hedge effectiveness requirements, whichever comes first. In accordance with the Group’s risk management policy, derivatives that meet the criteria for hedge accounting with respect to interest rate risk are designated as cash flow hedges and accounted for as follows. Derivatives designated as hedging instruments in cash flow hedges are interest rate swaps to convert floating-rate financial liabilities to fixed-rate financial liabilities. The effective portion of changes in the fair values of derivatives designated as cash flow hedges is recognized in other components of equity until the associated hedged transactions are executed and profit or loss is recognized. Gains or losses on derivatives recognized in other components of equity are reclassified into profit or loss at the time when the associated hedged transactions are recognized in profit or loss. However, any ineffective portion of the change in fair value of the derivatives is recognized immediately in profit or loss. Hedge accounting is discontinued prospectively only when the hedging relationship ceases to meet the qualifying criteria. This includes instances when the hedging instrument expires or is sold, terminated or exercised. The Group does not use fair value hedges or net investment hedges in foreign operations. Kao Corporation Financial Report 2016 22 (5) Cash and Cash Equivalents Cash and cash equivalents consist of cash on hand, demand deposits and short-term investments that are highly liquid and readily convertible to known amounts of cash subject to an insignificant risk of changes in value, and that mature or become due within three months from the date of acquisition. Cash and cash equivalents include certificates of deposit, time deposits, commercial paper, public and corporate bonds in investment trusts, and money in trust. (6) Inventories Inventories are measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. The cost of inventories includes all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition, and are determined principally by the weighted average method. (7) Property, Plant and Equipment Property, plant and equipment are measured using the cost model and carried at cost less any accumulated depreciation and any accumulated impairment losses. The cost of an item of property, plant and equipment comprises any costs directly attributable to acquisition of the asset and the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located. Depreciation of assets other than land and construction in progress is calculated on a straight-line basis over the estimated useful lives of the assets. The estimated useful lives of major asset items are as follows: (cid:119)(cid:1)Buildings and structures: 10 to 35 years (cid:119)(cid:1)Machinery and vehicles: 7 to 14 years (cid:119)(cid:1)Tools, furniture and fixtures: 3 to 10 years The estimated useful lives, residual values and depreciation method are reviewed at each fiscal year end, and any revisions are applied prospectively as changes in accounting estimates. The Group changed estimated useful lives from the fiscal year ended December 31, 2016. The details are presented in Note 4 “Significant Accounting Estimates and Judgments (3) Useful Lives of Property, Plant and Equipment.” (8) Goodwill and Intangible Assets 1) Goodwill Goodwill arising from a business combination is not amortized, and is carried at cost, determined at the acquisition date, less any accumulated impairment losses. In addition, goodwill is allocated to the cash generating unit or group of cash-generating units that is expected to benefit from the synergies of the business combination, and is tested for impairment at least once a year by each fiscal year end or if there are indications of impairment. Impairment loss on goodwill is recognized in profit or loss and is not reversed in subsequent periods. Goodwill measurements at initial recognition are presented in Note 3 “Significant Accounting Policies (2) Business Combinations.” 23 Kao Corporation Financial Report 2016 2) Intangible assets Intangible assets are measured using the cost model and carried at cost less any accumulated amortization and any accumulated impairment losses. The costs of separately acquired intangible assets comprise any costs directly attributable to acquisition of the assets. The costs of intangible assets acquired in business combinations are measured at fair value at the acquisition date. Expenditures related to internally generated intangible assets are recognized as expenses when incurred, with the exception of development expenses that meet the criteria for capitalization. Software development expense only meets the criteria for capitalization. After initial recognition, with the exception of intangible assets with indefinite useful lives, intangible assets are amortized on a straight-line basis over their estimated useful lives. The Group has no intangible assets with indefinite useful lives. The estimated useful lives of major intangible assets are as follows: (cid:119)(cid:1)Trademarks: 10 years (cid:119)(cid:1)Software: 5 years The estimated useful lives, residual values and amortization method are reviewed at each fiscal year end, and any revisions are applied prospectively as changes in accounting estimates. 3) Research and development expenses Research expenditures are expensed as incurred. Development expenditures are capitalized only if they can be measured reliably, future economic benefits are probable, and the Group intends to, and has sufficient resources to, complete development and to use or sell the asset. If research expenditures and development expenditures cannot be clearly distinguished, they are expensed as incurred as research expenditures. (9) Leases The Group classifies a lease that transfers substantially all the risks and rewards incidental to ownership of an asset as a finance lease and a lease other than a finance lease as an operating lease. In finance lease transactions, leased assets and lease obligations are initially recognized at the lower of the fair value of leased property and the present value of the minimum lease payments, each determined at the inception of the lease. Leased assets are depreciated on a straight-line basis over the shorter of their estimated useful lives and lease terms. Lease payments are apportioned between the finance charges and the reduction of the outstanding liability using the interest method. Lease payments under operating leases are recognized as an expense on a straight-line basis over the lease term. Determination of whether an arrangement is, or contains, a lease is based on the substance of the arrangement, in accordance with IFRIC Interpretation 4 “Determining Whether an Arrangement Contains a Lease.” Notes to Consolidated Financial Statements (10) Impairment of Non-financial Assets Non-financial assets, excluding inventories, deferred tax assets, non-current assets classified as held for sale and assets arising from employee benefits, are assessed at the end of each reporting period to determine whether there is any indication of impairment. If there is an indication of impairment, the recoverable amount of the asset is estimated. For goodwill, the recoverable amount is estimated at least once a year by each fiscal year end, irrespective of whether there is any indication of impairment. The recoverable amount of an asset or a cash-generating unit is the higher of its value in use and fair value less cost of disposal. The discount rate used in calculating the asset’s value in use is a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the asset, for which the future cash flow estimates have not been adjusted. If it is not possible to estimate the recoverable amount of an individual asset, the recoverable amount of the cash-generating unit to which the asset belongs is measured. Goodwill acquired in business combinations is allocated to each of the cash-generating units or groups of cash-generating units of the Group that is expected to benefit from synergies of the business combinations after the acquisition date, and is tested for impairment. Because corporate assets do not generate separate cash inflows, the recoverable amount of individual corporate assets cannot be measured unless management has decided to dispose of the asset. If there is an indication that a corporate asset may be impaired, the recoverable amount of the cash-generating unit or group of cash-generating units to which the asset belongs is measured and compared with the carrying amount. Impairment losses are recognized in profit or loss whenever the recoverable amount is less than the carrying amount. Such impairment losses of the cash-generating unit or group of cash- generating units are recognized by first reducing the carrying amount of any goodwill allocated to the cash-generating unit or group of cash-generating units, and then allocating the rest of the losses to other assets of the unit pro rata on the basis of the carrying amount of each asset in the unit. The Group reviews assets other than goodwill at each fiscal year end to determine whether there is any indication that previously recognized impairment losses may no longer exist or may have decreased. If there are any such indications, the Group estimates the recoverable amount of the asset. Impairment losses on assets other than goodwill that were recognized in prior fiscal years are reversed only when there have been changes in the estimates used to determine the recoverable amount of the asset since the last impairment loss was recognized. In this case, the carrying amount of the asset is increased as a reversal of impairment loss to the recoverable amount. Impairment losses are reversed up to the carrying amount, net of amortization or depreciation, that would have been determined had no impairment loss for the asset been recognized in prior fiscal years. (11) Employee Benefits 1) Post-employment benefits The Group sponsors a defined benefit plan and a defined contribution plan as post-employment benefit plans for employees. (i) Defined benefit plan For the defined benefit plan, the projected unit credit method is used to individually determine the present value of defined benefit obligations, related current service costs and past service costs of each plan. The discount rate is determined by referring to market yields at the end of the fiscal year on high quality corporate bonds corresponding to the period until the expected date of future benefit payment. The net amount of the present value of defined benefit obligations and the fair value of plan assets is accounted for as a liability or asset. However, if the defined benefit plan has surplus, the net defined benefit asset is limited to the present value of any economic benefits available in the form of refunds from the plan or reductions in the future contributions to the plan. Net interest on the net defined benefit liability (asset) is recognized in profit or loss as financial expenses (income). Remeasurements of the net defined benefit liability (asset) are recognized in other comprehensive income and immediately reclassified to retained earnings in the period in which they occur. Past service costs are recognized in profit or loss for the period in which they are incurred. (ii) Defined contribution plan Payments to defined contribution plan are recognized as expenses when employees have rendered services entitling them to the contributions. 2) Other employee benefits Short-term employee benefit obligations are measured on an undiscounted basis, and are recognized as an expense when the related services are rendered. For bonuses, when there is a present legal or constructive obligation to make payments of bonuses, and a reliable estimate of the obligation can be made, the estimated amount to be paid is accounted for as a liability. For the paid absence expenses, when there is a legal or constructive obligation with respect to accumulating paid absence systems and a reliable estimate of the obligation can be made, the estimated amount to be paid based on those systems is accounted for as a liability. (12) Share-based Payments The Company has a stock option plan accounted for as an equity- settled share-based payment plan. Stock options are estimated using their fair value at the grant date and recognized in profit or loss as expenses over the vesting periods with corresponding increases to equity and taking into account the estimated number of options to be finally vested. The fair value of options granted is measured using the Black-Scholes model based on the terms and conditions of the options. The terms and conditions are periodically reviewed and the estimated number of options vested is revised as necessary. Kao Corporation Financial Report 2016 24 (13) Provisions Provisions are recognized when the Group has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. The amounts recognized as provisions are the best estimates of necessary expenditures to settle the present obligation at the end of the reporting period, taking into account the risks and uncertainties associated with the obligation. When the effect of the time value of money is material, the amount of provision is measured at the present value of the expenditures expected to be required to settle the obligation. (14) Revenue The Group is engaged in the sale of consumer products, including cosmetics, skin care products, hair care products, sanitary products and fabric care products, as well as chemical products, including fatty alcohols and surfactants. Revenue from the sale of these goods is recognized when the Group has transferred the significant risks and rewards of ownership of the goods to the buyer; the Group retains neither continuing managerial involvement nor effective control over the goods sold; it is probable that economic benefits related to the transaction will flow to the Group; and these benefits and corresponding costs can be measured reliably. Therefore, revenue is usually recognized at the time of delivery of goods to customers. Revenue is measured at the fair value of the consideration received or receivable less any discounts, rebates, consumption taxes and other taxes. (15) Income Taxes Income taxes consist of current income taxes and deferred income taxes. Income taxes are recognized as income or expenses and included in profit or loss, except for taxes related to business combinations and taxes related to items that are recognized directly in equity or in other comprehensive income. 1) Current income taxes Current income taxes are recognized in the amount of the expected taxes payable to or receivable from the taxation authorities. Calculation of the amount of tax is based on the tax rates and tax laws enacted or substantively enacted by the end of the reporting period in countries where the Group conducts business and earns taxable income. 2) Deferred income taxes Deferred tax assets and liabilities are recognized for temporary differences between the carrying amounts of assets or liabilities at the end of the reporting period and its tax base, and for tax loss carryforwards and tax credits. Deferred tax assets are recognized for deductible temporary differences, the carryforwards of unused tax losses and the carryforwards of unused tax credits to the extent that it is probable that future taxable income will be available against such deferred tax assets. Deferred tax liabilities are recognized, in principle, for all taxable temporary differences. The carrying amount of deferred tax assets is reviewed each period and reduced to the extent that it is no longer probable 25 Kao Corporation Financial Report 2016 that sufficient future taxable income will be available to realize benefits from all or part of the assets. Unrecognized deferred tax assets are reassessed each period and are recognized to the extent that it has become probable that future taxable income will allow the deferred tax assets to be recovered. Deferred tax assets and liabilities are not recognized for the following temporary differences: • Taxable temporary differences arising from initial recognition of goodwill • Temporary differences arising from initial recognition of assets and liabilities from transactions that are not business combinations and affect neither accounting income nor taxable income • Taxable temporary differences on investments in subsidiaries and associates, when the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future • Deductible temporary differences on investments in subsidiaries and associates, when it is probable that the temporary differences will not reverse in the foreseeable future Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the period when the assets are realized or the liabilities are settled, based on the tax rates and tax laws enacted or substantively enacted by the end of the reporting period. Deferred tax assets and liabilities are offset if the Group has a legally enforceable right to set off current tax assets against current tax liabilities and income taxes are levied by the same taxation authority on the same taxable entity. The Company and some of its subsidiaries have adopted the consolidated tax system. (16) Earnings per Share Basic earnings per share are calculated by dividing net income attributable to owners of the parent by the weighted- average number of ordinary shares outstanding during the period, adjusted for treasury shares held. Diluted earnings per share are calculated by adjusting the effects of all dilutive potential ordinary shares. (17) Non-current Assets Held for Sale A non-current asset or disposal group whose carrying amount is expected to be recovered principally through a sale transaction rather than through continuing use is classified as a non-current asset or disposal group held for sale if it is highly probable that the asset or disposal group will be sold within one year and is available for immediate sale in its present condition, and the Group’s management is committed to a plan to sell. Non-current assets are not depreciated or amortized while they are classified as held for sale or are part of a disposal group classified as held for sale. Non-current assets or disposal groups classified as held for sale are measured at the lower of the carrying amount and fair value less costs to sell. Notes to Consolidated Financial Statements (19) Dividends Dividend distributions to shareholders of the Company are recognized as liabilities in the period in which year-end dividends are resolved upon by the General Meeting of Shareholders and interim dividends are resolved upon by the Board of Directors. (18) Equity and Other Capital 1) Ordinary shares Ordinary shares are recognized in share capital and capital surplus at their issue price. Share issuance costs are deducted from the issue price. 2) Treasury shares Treasury shares are recognized at cost and deducted from equity. No gain or loss is recognized on the purchase, sale or retirement of the Company’s treasury shares. Any difference between the carrying amount and consideration received on the sale of treasury shares is recognized directly in equity. 4 Significant Accounting Estimates and Judgments The Group’s consolidated financial statements include estimates and assumptions made by the management regarding income and expenses, measurement of the carrying amounts of assets and liabilities, and disclosure of contingencies and others at the end of the reporting period. These estimates and assumptions are based on management’s best judgment at the end of the reporting period, and take into account historical experience and various other factors that can be considered as reasonable. However, due to their nature, actual results may differ from these estimates and assumptions. The estimates and their underlying assumptions are reviewed by management on an ongoing basis. The effects of revisions to accounting estimates and assumptions are recognized in the period when the estimates are revised and in future periods. Estimates and assumptions that significantly affect the amounts recognized in the Group’s consolidated financial statements are as follows. (1) Impairment of Property, Plant and Equipment, Goodwill and Intangible Assets The Group conducts impairment tests for property, plant and equipment, goodwill and intangible assets when there is an indication that the recoverable amount of the asset or cash- generating unit is less than the carrying amount. Triggering events for impairment testing include, for example, significant changes with adverse effects on past or projected business performance, significant changes in the use of acquired assets, or changes in overall business strategy. Furthermore, goodwill is tested for impairment at least once a year by each fiscal year end, irrespective of indication of impairment, to verify that the recoverable amount of the cash-generating unit to which goodwill is allocated exceeds the carrying amount. Impairment tests are performed by comparing the carrying amount and the recoverable amount of the asset or cash- generating unit. If the recoverable amount is less than the carrying amount, the carrying amount is reduced to the recoverable amount and the reduction is recognized as an impairment loss. The recoverable amount is the higher of the value in use and the fair value less cost of disposal of the asset or cash-generating unit. In calculating the value in use, the Group makes certain assumptions about the remaining useful life and future cash flows of the asset, discount rate, growth rate and other factors. These assumptions are based on management’s best estimates and judgments, but may be affected by changes in future business plans, economic conditions or other factors. If revisions to the assumptions become necessary, such revisions could have a material effect on the amounts recognized in the consolidated financial statements in future periods. Note 13 “Property, Plant and Equipment” and Note 14 “Goodwill and Intangible Assets” present the method for calculating the recoverable amount. Note 14 “Goodwill and Intangible Assets” presents sensitivity associated with goodwill. (2) Post-employment Benefits The Group provides a variety of post-retirement benefit plans that include a defined benefit plan. The present value of defined benefit obligations and related service costs are determined based on actuarial assumptions. Actuarial assumptions are based on management’s best estimates and judgments, but may be affected by the revision of inputs including discount rate and mortality rate due to changes in economic conditions. If revisions to the assumptions become necessary, such revisions could have a material effect on the amounts recognized in the consolidated financial statements in future periods. Note 20 “Employee Benefits” presents actuarial assumptions and related sensitivity. (3) Useful Lives of Property, Plant and Equipment The Group focuses on machinery and equipment in making proactive capital investments, and prioritizes management issues such as global analysis to optimize production bases and enable manufacturing cost comparisons. Consequently, the Group globally unified its property, plant and equipment systems in January 2016. The Group decided to take advantage of this change to make the estimated useful lives of machinery and equipment consistent (generally 9 or 10 years depending on the type of equipment) from the fiscal year ended December 31, 2016 to better reflect the actual use of machinery and equipment in global production. The effect of this change in accounting estimates on the consolidated financial statements is immaterial. Kao Corporation Financial Report 2016 26 (4) Provisions The Group has recognized a provision for loss related to cosmetics, a provision for sales returns, a provision for asset retirement obligations and other provisions in the consolidated statement of financial position. The amounts recognized are the best estimates of the expenditures required to settle the present obligations, taking into account historical experience and other factors at the end of the reporting period. The provision for loss related to cosmetics may be affected by changes in compensation-related and other expenses. The provision for sales returns may be affected by factors such as plans to discontinue production and sales of products. The provision for asset retirement obligations and other provisions may be affected by factors such as changes in future business plans. (6) Fair Value The Group uses various inputs, including unobservable inputs, and valuation methodologies to estimate the fair value of specific assets and liabilities. When measuring fair value, the Group maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs, and management’s best estimates and judgments are required in that process. The fair value of these assets and liabilities is based on management’s best estimates and judgments, but could be affected by factors including changes in inputs due to changes in economic conditions. Any revisions that become necessary could have a material effect on the amounts recognized in the consolidated financial statements in future periods. Note 34 “Financial Instruments” presents fair value measurement methods and amounts for major financial assets and liabilities measured at fair value. If the actual amounts paid differ from the estimates, such In its first-time adoption of IFRS, the Group applies the exemption differences could have a material effect on the amounts recognized in the consolidated financial statements in future periods. Note 21 “Provisions” presents the nature and amounts of these provisions. under IFRS 1 and uses the deemed cost as the acquisition cost for certain property, plant and equipment. Note 39 “First-time Adoption of IFRS” presents fair value measurement methods and amounts for these assets. (7) Contingencies Contingencies are disclosed when there are items that could have a material effect on future business after considering the probability of occurrence and the amount of financial impact, taking into account all available evidence at the end of the reporting period. (5) Income Taxes The Group recognizes and measures income tax payables and income taxes based on reasonable estimates of the amounts to be paid to the taxation authorities in each country. Such estimates are made using the tax rates and tax laws enacted or substantively enacted by the end of the reporting period. Calculating income tax payables and income taxes requires estimates and judgments of various factors, including interpretations of tax regulations by the Group and the taxation authorities and the experience of past tax audits. Therefore, if the final tax outcome is different from the amount initially recognized, the difference is recognized in the period when the tax outcome is finalized. Deferred tax assets are recognized for deductible temporary differences, the carryforwards of unused tax losses and the carryforwards of unused tax credits to the extent that it is probable that future taxable income will be available. The realizability of deferred tax assets is assessed using the tax rates that are expected to apply to the period when the asset is realized, based on tax rates and tax laws enacted or substantively enacted by the end of the reporting period. Recognition and measurement of deferred tax assets are based on management’s best estimates and judgments, but may be affected by future changes in business plans or other conditions, or by the amendment or promulgation of related laws. Any revisions that become necessary could have a material effect on the amounts recognized in the consolidated financial statements in future periods. Note 16 “Income Taxes” presents income taxes and amounts. 27 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements 5 New Standards and Interpretations Not Yet Adopted New or revised major Standards and Interpretations that were issued by the date of approval presented in Note 40 “Approval of the Consolidated Financial Statements,” but were not yet adopted by the Group as of December 31, 2016 are as follows. IFRS Title Revenue from Contracts with Customers IFRS 15 Mandatory adoption (From the fiscal year beginning) January 1, 2018 IFRS 16 Leases January 1, 2019 Adoption by the Group Early adoption being planned in fiscal year ending December 31, 2017 Overview of new or revised Standards and Interpretations Revised accounting treatment for revenue recognition and disclosure Fiscal year ending December 31, 2019 Revised lease definition, accounting treatment and disclosure The main impact resulting from the early adoption of IFRS 15 “Revenue from Contracts with Customers” is the accounting treatment of consideration payable to customers. Some of the consideration payable to customers previously recognized as selling, general and administrative expenses will be accounted for as reductions of net sales or as cost of sales. The expected major impact on the Group’s consolidated financial statements for the fiscal year ending December 31, 2017 is a decrease of approximately 40 billion yen in net sales in the consolidated statement of income. The impact on operating income will be immaterial. The Group is currently evaluating the possible impacts on the consolidated financial statements resulting from the adoption of IFRS 16 “Leases” and the estimates are currently not available. 6 Segment Information (1) Summary of Reportable Segments The Group’s reportable segments are the components of the Group for which discrete financial information is available and which are regularly reviewed by the Board of Directors in deciding how to allocate resources and in assessing their performance. Net sales and operating income are the key measures used by the Board of Directors to evaluate the performance of each segment. The Group is an organization comprising four main business units - the Beauty Care Business, the Human Health Care Business, the Fabric and Home Care Business (collectively, the “Consumer Products Business”) and the Chemical Business. In each business unit, the Group plans comprehensive business strategies and carries out business activities on a global basis. Accordingly, the Group has four reportable segments: the Beauty Care Business, the Human Health Care Business, the Fabric and Home Care Business and the Chemical Business. Information about major customers has been omitted as the revenue from each customer is less than 10% of the Group’s net sales. Reportable segments Major products Beauty Care Business Consumer Products Business Human Health Care Business Cosmetics Skin care products Hair care products Food and beverage products Sanitary products Counseling cosmetics, self-selection cosmetics Soaps, facial cleansers, body cleansers Shampoos, conditioners, hair styling agents, hair coloring agents Beverages Sanitary napkins, baby diapers Personal health products Bath additives, oral care products, men’s products Fabric care products Laundry detergents, fabric treatments Fabric and Home Care Business Home care products Oleo chemicals Chemical Business Performance chemicals Specialty chemicals Kitchen cleaning products, house cleaning products, paper cleaning products, commercial-use products Fatty alcohols, fatty amines, fatty acids, glycerin, commercial-use edible fats and oils Surfactants, plastics additives, superplasticizers for concrete admixtures Toner and toner binder for copiers and printers, ink and colorants for inkjet printers, fragrances and aroma chemicals Kao Corporation Financial Report 2016 28 (2) Sales and Results of Reportable Segments Fiscal year ended December 31, 2016 (Millions of yen) Reportable segments Consumer Products Business Beauty Care Business Human Health Care Business Fabric and Home Care Business Subtotal Chemical Business Total Reconciliation1 Consolidated 601,620 273,067 345,163 1,219,850 237,760 1,457,610 — 1,457,610 — 601,620 51,086 — 273,067 25,948 — 345,163 78,099 — 36,025 273,785 29,683 1,219,850 155,133 36,025 1,493,635 184,816 (36,025) (36,025) 755 — 1,457,610 185,571 1,389 (5,424) 1,894 183,430 18,399 43 20,135 12,930 26 41,752 7,876 40 16,050 39,205 109 77,937 11,650 — 11,877 50,855 109 89,814 261 — 86 51,116 109 89,900 Net sales Sales to customers ............... Intersegment sales and transfers2 ............................ Total net sales ........................... Operating income ..................... Financial income ................... Financial expenses ................ Share of profit in investments accounted for using the equity method ..................... Income before income taxes ..... Other items Depreciation and amortization3 ....................... Impairment losses3 .............. Capital expenditures4 ............ Notes: 1. The operating income reconciliation of 755 million yen includes corporate expenses not allocated to reportable segments, as well as elimination of intersegment inventory transactions. 2. Intersegment sales and transfers are mainly calculated based on market price and manufacturing cost. 3. Note 13 “Property, Plant and Equipment” and Note 14 “Goodwill and Intangible Assets” present the details of depreciation, amortization and impairment losses. 4. Capital expenditures include investments in property, plant and equipment, intangible assets and other non-current assets. Fiscal year ended December 31, 2015 (Millions of yen) Reportable segments Consumer Products Business Beauty Care Business Human Health Care Business Fabric and Home Care Business Subtotal Chemical Business Total Reconciliation1 Consolidated 608,617 281,672 335,308 1,225,597 248,953 1,474,550 — 1,474,550 — — 608,617 37,929 281,672 33,368 — 335,308 66,124 — 39,517 39,517 (39,517) — 1,225,597 137,421 288,470 28,593 1,514,067 166,014 (39,517) 1,304 1,474,550 167,318 1,416 (4,213) 1,517 166,038 26,028 2,476 20,458 10,236 510 30,962 8,072 657 15,150 44,336 3,643 66,570 12,804 388 16,244 57,140 4,031 82,814 283 — 34 57,423 4,031 82,848 Net sales Sales to customers ............... Intersegment sales and transfers2 ............................ Total net sales ........................... Operating income ..................... Financial income ................... Financial expenses ................ Share of profit in investments accounted for using the equity method ..................... Income before income taxes ..... Other items Depreciation and amortization3 ....................... Impairment losses3 .............. Capital expenditures4 ............ Notes: 1. The operating income reconciliation of 1,304 million yen includes corporate expenses not allocated to reportable segments, as well as elimination of intersegment inventory transactions. 2. Intersegment sales and transfers are mainly calculated based on market price and manufacturing cost. 3. Note 12 “Non-current Assets Held for Sale,” Note 13 “Property, Plant and Equipment,” and Note 14 “Goodwill and Intangible Assets” present the details of depreciation, amortization and impairment losses. 4. Capital expenditures include investments in property, plant and equipment, intangible assets and other non-current assets. 29 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements (3) Geographical Information Sales to customers and non-current assets (excluding financial assets, deferred tax assets and retirement benefit assets) by region consist of the following. Sales to Customers Japan .............................................................................................................................. Asia ................................................................................................................................. China ........................................................................................................................... Americas ......................................................................................................................... United States .............................................................................................................. Europe ............................................................................................................................ Total ......................................................................................................................... Note: Sales are classified by country or region based on the location of customers. 2016 964,904 251,284 103,346 120,782 93,148 (Millions of yen) 2015 956,033 249,335 96,565 134,080 102,865 120,640 1,457,610 135,102 1,474,550 Non-current Assets (excluding Financial Assets, Deferred Tax Assets and Retirement Benefit Assets) Japan .............................................................................................................................. Asia ................................................................................................................................. Americas ......................................................................................................................... Europe ............................................................................................................................ Total ......................................................................................................................... 2016 415,993 81,927 22,854 24,731 545,505 2015 375,831 86,362 21,535 29,126 512,854 (Millions of yen) Transition date 357,162 81,980 20,738 32,238 492,118 7 Business Combinations (1) Outline of Business Combination Name of the acquiree: Collins Inkjet Corporation and SAMGAM, LLC, which owns and manages its real estate and other assets used by Collins Inkjet Corporation (collectively, “Collins”) Business outline: Acquisition date: Development, manufacturing and sales of inkjet ink July 1, 2016 Acquisition method: Cash consideration to acquire shares Percentage of voting rights acquired: 100% By taking advantage of newly acquired technologies, manufacturing facilities and sales networks from Collins in addition to its own technologies, the Group aims to provide global customers with innovative products and services that can contribute to the mitigation of environmental impact. (2) Primary Reason for Business Combination Collins, based in the U.S., is engaged in development, manufacturing and sales of inkjet ink. Collins was an early entrant into the rapidly growing inkjet ink market for industrial printing. With its advanced ink designing technologies responding to a wide variety of inkjet heads and its reliability, Collins has built a wide customer network. Collins continues to focus on ink development to broaden the application range and expand business globally. (3) Acquisition Cost of Acquiree and Its Components Acquisition cost of acquiree: 3,715 million yen Components of acquisition cost: Cash 3,715 million yen Kao Corporation Financial Report 2016 30 (4) Fair Value of Assets Acquired and Liabilities Assumed at the Acquisition Date Current assets .................................................................. 1,496 million yen Non-current assets ........................................................... 913 million yen Total assets ................................................................... 2,409 million yen Current liabilities ............................................................... 377 million yen Non-current liabilities ........................................................ 232 million yen Total liabilities ................................................................ 609 million yen (5) Goodwill Goodwill recognized .................................................................. 1,915 million yen Components of goodwill: Goodwill recognized for this business combination reflects excess earning power in future from using newly acquired technologies, manufacturing systems and sales networks from Collins in addition to the Group’s technologies. Certain goodwill is deductible for tax purposes. (6) Net Sales and Income of Acquired Business Information on income associated with this business combination after the acquisition date and information on income assuming that the business combination took place on the date of January 1, 2016 are not presented because the impacts on the consolidated statement of income are immaterial. 8 Cash and Cash Equivalents Cash and cash equivalents consist of the following. Cash and deposits .......................................................................................................... Short-term investments .................................................................................................. Total ......................................................................................................................... 2016 186,226 116,800 303,026 2015 121,371 188,551 309,922 (Millions of yen) Transition date 105,328 123,639 228,967 Cash and deposits include time deposits that mature or become due within three months from the date of acquisition. In addition, the balance of cash and cash equivalents presented in the consolidated statement of financial position is equal to the balance of cash and cash equivalents presented in the consolidated statement of cash flows. 9 Trade and Other Receivables Trade and other receivables consist of the following. Trade receivables ............................................................................................................ Other receivables ........................................................................................................... Allowance for doubtful receivables ................................................................................. Total ......................................................................................................................... 2016 205,099 4,546 (1,186) 208,459 2015 206,966 5,049 (1,308) 210,707 (Millions of yen) Transition date 205,674 8,372 (1,304) 212,742 31 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements 10 Inventories Inventories consist of the following. Merchandise and finished goods .................................................................................... Work in progress ............................................................................................................ Materials and supplies .................................................................................................... Total ......................................................................................................................... 2016 122,479 12,253 30,468 165,200 2015 112,087 12,356 26,828 151,271 (Millions of yen) Transition date 111,998 12,910 26,968 151,876 The amount of inventories recognized as expenses and included in cost of sales for the fiscal years ended December 31, 2016 and 2015 were 636,969 million yen and 658,325 million yen, respectively. Write-downs of inventories recognized as expenses for the fiscal years ended December 31, 2016 and 2015 were 4,534 million yen and 4,982 million yen, respectively. 11 Other Assets Other assets consist of the following. 2016 2015 Transition date (Millions of yen) Other current assets Insurance receivable ................................................................................................... Prepaid expenses ........................................................................................................ Other ........................................................................................................................... Total ......................................................................................................................... Other non-current assets Insurance receivable ................................................................................................... Long-term prepaid lease payments ............................................................................ Long-term prepaid expenses ...................................................................................... Other ........................................................................................................................... Total ......................................................................................................................... 6,330 9,410 8,072 23,812 11,095 5,337 881 1,235 18,548 20,219 8,487 9,299 38,005 9,919 5,818 754 1,241 17,732 30,357 8,426 8,516 47,299 — 5,175 1,563 1,228 7,966 12 Non-current Assets Held for Sale Certain assets including the land for a training center and the buildings and land for sales offices were classified as non-current assets held for sale in the fiscal year ended December 31, 2015 pursuant to the decision to sell these assets. Impairment loss of 694 million yen was recognized upon classification of these assets as non-current assets held for sale and included in other operating expenses in the consolidated statement of income for the fiscal year ended December 31, 2015. The sale of these assets was largely completed in the fiscal year ended December 31, 2016. Certain assets including the buildings and land for sales offices were classified as non-current assets held for sale in the fiscal year ended December 31, 2016 pursuant to the decision to sell these assets. The fair value of these assets was based on third-party appraisal values using sales comparison and other approaches and sales prices determined with reference to sales contracts, and was categorized within Level 3 of the fair value hierarchy. Kao Corporation Financial Report 2016 32 13 Property, Plant and Equipment (1) Changes in Property, Plant and Equipment The following tables present changes in acquisition costs, accumulated depreciation and accumulated impairment losses, and carrying amounts of property, plant and equipment. Acquisition Cost January 1, 2015............................................................ Additions .................................................................. Sales and disposals .................................................. Reclassification ........................................................ Reclassification to assets held for sale .................... Exchange differences on translation of foreign operations ................................................ Other ........................................................................ December 31, 2015 ..................................................... Additions .................................................................. Acquisitions through business combinations .......... Sales and disposals .................................................. Reclassification ........................................................ Reclassification to assets held for sale .................... Exchange differences on translation of foreign operations ................................................ Other ........................................................................ December 31, 2016 ..................................................... Buildings and structures 379,857 270 (5,464) 25,689 (486) Machinery and vehicles 701,384 556 (21,628) 46,784 — Tools, furniture and fixtures 113,312 6,033 (7,449) 5,126 (1) Land 77,934 1 (1,228) 345 (3,710) (Millions of yen) Construction in progress 27,247 70,328 (24) (77,944) — Total 1,299,734 77,188 (35,793) — (4,197) (5,502) (11,298) (1,500) (362) (409) (19,071) (370) 393,994 313 272 (5,355) 24,591 (585) (185) 715,613 245 175 (29,108) 39,877 (22) 118 115,639 4,490 31 (7,642) 9,055 (7) — 72,980 36 126 (97) 384 (216) (464) 18,734 79,781 14 (13) (73,907) — (901) 1,316,960 84,865 618 (42,215) — (830) (4,410) (10,069) (1,860) (194) (64) (16,597) 79 408,899 86 716,797 (94) 119,612 (1) 73,018 (57) 24,488 13 1,342,814 Accumulated Depreciation and Accumulated Impairment Losses (Millions of yen) January 1, 2015............................................................ Depreciation1 ............................................................ Impairment losses 2 ................................................. Impairment losses reversed2 ................................... Sales and disposals .................................................. Reclassification to assets held for sale .................... Exchange differences on translation of foreign operations ................................................ Other ........................................................................ December 31, 2015 Depreciation1 ............................................................ Impairment losses2 ................................................. Impairment losses reversed2 .................................. Sales and disposals .................................................. Reclassification to assets held for sale .................... Exchange differences on translation of foreign operations ................................................ Other ........................................................................ December 31, 2016 ..................................................... Buildings and structures 277,771 11,765 154 (196) (4,841) (336) Machinery and vehicles 604,104 21,393 117 — (20,677) — Tools, furniture and fixtures 89,346 10,074 27 — (7,200) (1) Land 9,231 — 3,039 — (96) (1,853) (2,978) (8,458) (1,216) — (96) 281,243 11,934 13 (0) (4,990) (497) (198) 596,281 22,448 — — (28,415) (22) 88 91,118 10,396 — (1) (7,264) (7) — 10,321 — 96 — (1) — (2,220) (7,024) (1,392) — (23) 285,460 (66) 583,202 51 92,901 — 10,416 Construction in progress — — — — — — — — — — — — — — — — — Total 980,452 43,232 3,337 (196) (32,814) (2,190) (12,652) (206) 978,963 44,778 109 (1) (40,670) (526) (10,636) (38) 971,979 Notes: 1. Depreciation of property, plant and equipment is included in cost of sales, selling, general and administrative expenses and other operating expenses in the consolidated statement of income. 2. Impairment losses on property, plant and equipment are included in other operating expenses and impairment losses reversed are recognized in other operating income in the consolidated statement of income. 33 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements Carrying Amount January 1, 2015............................................................ Buildings and structures 102,086 December 31, 2015 ..................................................... 112,751 December 31, 2016 ..................................................... 123,439 (Millions of yen) Machinery and vehicles 97,280 119,332 133,595 Tools, furniture and fixtures 23,966 24,521 26,711 Land 68,703 62,659 62,602 Construction in progress 27,247 18,734 24,488 Total 319,282 337,997 370,835 (2) Leased Assets The carrying amount of leased assets from finance leases included in property, plant and equipment is as follows: January 1, 2015............................................................ December 31, 2015 ..................................................... December 31, 2016 ..................................................... (Millions of yen) Buildings and structures 6,472 5,441 4,060 Other 125 83 54 Total 6,597 5,524 4,114 (3) Impairment Losses The Group allocates property, plant and equipment into cash- generating units based on the smallest identifiable group of assets that generates cash inflows that are largely independent. For idle assets, the Group considers whether to recognize impairment losses for individual properties. Impairment losses recognized for the fiscal years ended December 31, 2016 and 2015 were 109 million yen and 3,337 million yen, respectively. Impairment losses of 3,337 million yen for the fiscal year ended December 31, 2015 consisted mainly of impairment losses of 3,039 million yen recognized for idle land owned by the Company and Kanebo Cosmetics Inc. Based on the projection that the Group would no longer use these assets as a result of organizational restructuring, the Group separated these assets from the cash-generating units, reduced carrying amounts to fair value less costs of disposal as independent assets, and consequently recognized impairment losses. Fair value less costs of disposal was based on third-party appraisals using a sales comparison approach, and was categorized within Level 3 of the fair value hierarchy. The assets held by the Company belong to the segments of the Beauty Care Business, the Human Health Care Business and the Fabric and Home Care Business. The assets held by Kanebo Cosmetics Inc. belong to the Beauty Care Business. (4) Commitments Note 37 “Commitments” presents information on commitments to acquire property, plant and equipment. Kao Corporation Financial Report 2016 34 14 Goodwill and Intangible Assets (1) Changes in Goodwill and Intangible Assets The following tables present changes in acquisition costs, accumulated amortization and accumulated impairment losses, and carrying amounts of goodwill and intangible assets. Acquisition Cost January 1, 2015.................................................................................. Additions ........................................................................................ Sales and disposals ........................................................................ Reclassification .............................................................................. Exchange differences on translation of foreign operations ............ Other .............................................................................................. December 31, 2015 ........................................................................... Additions ........................................................................................ Acquisitions through business combinations ................................ Sales and disposals ........................................................................ Reclassification .............................................................................. Exchange differences on translation of foreign operations ............ Other .............................................................................................. December 31, 2016 ........................................................................... Note: 1. Software in progress is included in other in intangible assets. Intangible assets (Millions of yen) Goodwill 138,751 — — — (500) — 138,251 — 1,915 — — (2,383) — 137,783 Software 24,031 199 (4,736) 5,666 (316) (20) 24,824 85 4 (2,629) 5,122 (246) 124 27,284 Trademarks 133,526 — (3) — — — 133,523 — — (133,523) — — — — Other1 5,317 5,432 (23) (5,046) (104) (15) 5,561 4,948 316 (361) (5,115) (164) (22) 5,163 Total 162,874 5,631 (4,762) 620 (420) (35) 163,908 5,033 320 (136,513) 7 (410) 102 32,447 Accumulated Amortization and Accumulated Impairment Losses (Millions of yen) January 1, 2015.................................................................................. Amortization1 ................................................................................. Sales and disposals ........................................................................ Exchange differences on translation of foreign operations ............ Other .............................................................................................. December 31, 2015 ........................................................................... Amortization1 .................................................................................. Sales and disposals ........................................................................ Exchange differences on translation of foreign operations ............ Other .............................................................................................. December 31, 2016 ........................................................................... Goodwill — — — — — — — — — — — Intangible assets Software 14,037 4,143 (4,732) (359) (44) 13,045 4,650 (2,626) (225) 71 14,915 Trademarks 122,222 9,977 (3) — — 132,196 1,327 (133,523) — — — Other1 2,989 71 — (98) — 2,962 361 (346) (135) 1 2,843 Total 139,248 14,191 (4,735) (457) (44) 148,203 6,338 (136,495) (360) 72 17,758 Note: 1. Amortization of intangible assets is included in cost of sales, selling, general and administrative expenses and other operating expenses in the consolidated statement of income. Carrying Amount January 1, 2015................................................................................... December 31, 2015 ............................................................................ December 31, 2016 ............................................................................ Intangible assets (Millions of yen) Goodwill 138,751 138,251 137,783 Software 9,994 11,779 12,369 Trademarks 11,304 1,327 — Other 2,328 2,599 2,320 Total 23,626 15,705 14,689 35 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements (2) Goodwill The following table presents the carrying amount of goodwill recognized in the Group’s consolidated statement of financial position. Goodwill arising from business combinations is allocated at the acquisition date to cash-generating units benefiting from the business combination, and the goodwill belongs to the Beauty Care Business and the Chemical Business. The goodwill primarily relates to the acquisition of the Kanebo Cosmetics Group. Beauty Care Business .................................................................................................... Kanebo Cosmetics Group ........................................................................................... Molton Brown Group .................................................................................................. Other ........................................................................................................................... Chemical Business ......................................................................................................... Total ......................................................................................................................... 2016 135,618 119,400 11,327 4,891 2,165 137,783 2015 138,251 119,400 13,771 5,080 — 138,251 (Millions of yen) Transition date 138,751 119,400 14,270 5,081 — 138,751 (3) Impairment Test for Goodwill The Group tests goodwill for impairment each period or at least once a year by each fiscal year end, irrespective of indication of impairment. The recoverable amount on the impairment test is calculated based on value in use. The Group primarily recognizes goodwill associated with the Kanebo Cosmetics Group. For the goodwill associated with the Kanebo Cosmetics Group, cash flow projections that are the basis for value in use are estimated using four-year medium-term plans that reflect past year’s performance. The key assumptions used in formulating these estimates include sales growth rates and discount rates and the sales growth rates are consistent with the growth rate projections of the markets in which cash-generating units operate. Estimated cash flows in years beyond the four-year forecasts approved by management were calculated using an annual growth rate of 0% and were discounted to present value using a weighted average cost of capital (WACC) of 7.4% for the fiscal year ended December 31, 2016 (8.7% and 8.9% for the fiscal year ended December 31, 2015 and at the transition date, respectively). Management assumes the probability that material impairment will occur in this cash-generating unit is low even in cases where the key assumptions used for the impairment test change within the reasonably possible ranges for the fiscal year ended December 31, 2016. While value in use exceeded carrying amount at the transition date and at December 31, 2015, increasing the discount rate by 1.8% at the transition date or 2.8% at December 31, 2015 would result in impairment. (4) Intangible Assets with Indefinite Useful Lives The intangible assets above include no intangible assets with indefinite useful lives. (5) Commitments Note 37 “Commitments” presents information on commitments associated with the acquisition of intangible assets. 15 Investments Accounted for Using the Equity Method Investments in associates are accounted for using the equity method in the Group’s consolidated financial statements. The carrying amount of investments in associates that are not individually material is as follows: Investments accounted for using the equity method ..................................................... 2016 4,701 2015 4,209 (Millions of yen) Transition date 3,544 Changes in the Group’s share of net income and other comprehensive income of associates that are not individually material are as follows: The Group’s share of net income .................................................................................. The Group’s share of other comprehensive income ....................................................... The Group’s share of comprehensive income ................................................................ 2016 1,894 (82) 1,812 (Millions of yen) 2015 1,517 226 1,743 Kao Corporation Financial Report 2016 36 16 Income Taxes (1) Deferred Tax Assets and Liabilities Details of major causes of occurrence and changes in deferred tax assets and liabilities consist of the following. Fiscal year ended December 31, 2016 (Millions of yen) January 1, 2016 Recognized in profit or loss Recognized in other comprehensive income Other December 31, 2016 Deferred tax assets Property, plant and equipment and intangible assets ................................................ Retirement benefit liabilities .................................. Accrued expenses ................................................. Unused tax losses ................................................. Other ...................................................................... Total deferred tax assets ........................................... Deferred tax liabilities Property, plant and equipment and intangible assets ................................................ Retirement benefit assets ..................................... Financial assets ...................................................... Undistributed foreign earnings .............................. Other ...................................................................... Total deferred tax liabilities ........................................ Deferred tax assets, net ............................................ 19,570 22,708 13,040 1,385 17,739 74,442 7,959 (1) 3,649 12,390 1,309 25,306 49,136 (1,292) (1,024) (889) (135) (1,696) (5,036) 92 1 — 340 45 478 (5,514) — 6,298 — — — 6,298 — — (663) — — (663) 6,961 38 (135) (224) (10) (202) (533) (106) — (222) — (33) (361) (172) 18,316 27,847 11,927 1,240 15,841 75,171 7,945 — 2,764 12,730 1,321 24,760 50,411 Fiscal year ended December 31, 2015 (Millions of yen) January 1, 2015 Recognized in profit or loss Recognized in other comprehensive income Other December 31, 2015 Deferred tax assets Property, plant and equipment and intangible assets ................................................ Retirement benefit liabilities .................................. Accrued expenses ................................................. Unused tax losses ................................................. Other ...................................................................... Total deferred tax assets ........................................... Deferred tax liabilities Property, plant and equipment and intangible assets ................................................ Retirement benefit assets ..................................... Financial assets ...................................................... Undistributed foreign earnings .............................. Other ...................................................................... Total deferred tax liabilities ........................................ Deferred tax assets, net ............................................ 21,459 26,424 14,089 4,990 20,428 87,390 7,758 1,676 3,381 12,500 1,314 26,629 60,761 (1,582) (3,212) (725) (3,562) (3,053) (12,134) (203) (1,703) — 96 (115) (1,925) (10,209) — (482) — — (6) (488) — — 405 — — 405 (893) (307) (22) (324) (43) 370 (326) 404 26 (137) (206) 110 197 (523) 19,570 22,708 13,040 1,385 17,739 74,442 7,959 (1) 3,649 12,390 1,309 25,306 49,136 37 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements Deferred tax assets and liabilities recognized in the consolidated statement of financial position are as follows: Deferred tax assets ......................................................................................................... Deferred tax liabilities ...................................................................................................... Deferred tax assets, net .................................................................................................. 2016 50,939 528 50,411 2015 49,454 318 49,136 Deductible temporary differences and unused tax losses for which no deferred tax asset is recognized are as follows: Unused tax losses ........................................................................................................... Deductible temporary differences ................................................................................... Total ............................................................................................................................. Unused tax losses for which no deferred tax asset is recognized will expire as follows: Not later than 1 year ........................................................................................................ Later than 1 year and not later than 2 years .................................................................... Later than 2 years and not later than 3 years .................................................................. Later than 3 years and not later than 4 years .................................................................. Later than 4 years ............................................................................................................ Total ............................................................................................................................. 2016 35,274 21,091 56,365 2016 10,974 4,132 5,551 7,320 7,297 35,274 2015 39,784 22,049 61,833 2015 3,902 10,370 4,630 6,400 14,482 39,784 (Millions of yen) Transition date 61,194 433 60,761 (Millions of yen) Transition date 46,367 12,904 59,271 (Millions of yen) Transition date 5,968 8,025 7,353 5,198 19,823 46,367 The aggregate amount of taxable temporary differences associated with investments in subsidiaries and associates for which deferred tax liabilities were not recognized at December 31, 2016 and 2015, and the transition date were 12,385 million yen, 14,496 million yen and 25,767 million yen, respectively. The Group did not recognize deferred tax liabilities for these temporary differences because it was able to control the timing of the reversal of these temporary differences, and it was probable that the temporary difference will not reverse in the foreseeable future. (2) Income Taxes Income taxes consist of the following. Current taxes ............................................................................................................. Deferred taxes1 ........................................................................................................... Total ........................................................................................................................ 2016 50,027 5,514 55,541 (Millions of yen) 2015 49,877 10,209 60,086 Note: 1. Deferred taxes include 2,698 million yen and 3,838 million yen for the fiscal years ended December 31, 2016 and 2015, respectively, due to tax rate changes. Kao Corporation Financial Report 2016 38 (3) Reconciliation of Effective Tax Rate The details of difference between the statutory income tax rate and the Group’s average actual tax rate consist of the following. Effective statutory tax rate ........................................................................................ Tax credit for experimental research costs and other ............................................. Different tax rates applied to subsidiaries ............................................................... Reassessment of recoverability of unused tax losses and deferred tax assets ..... Change in tax rates ................................................................................................. Other ....................................................................................................................... Average actual tax rate ............................................................................................... 2016 33.06 (3.00) (2.06) 0.32 1.47 0.49 30.28 (%) 2015 35.64 (2.68) (2.44) 1.94 2.31 1.42 36.19 Note: Fiscal year ended December 31, 2016 The “Act for Partial Revision of the Income Tax Act, etc.” (Act. No. 15 of 2016) and the “Act for Partial Revision of the Local Tax Act, etc.” (Act No. 13 of 2016) enacted in Japan on March 29, 2016 reduced the income tax rate for fiscal years beginning on or after April 1, 2016. Accordingly, the effective statutory tax rate used to measure deferred tax assets and deferred tax liabilities has changed from 32.26% to 30.86% for temporary differences expected to be reversed in the fiscal years beginning January 1, 2017 and January 1, 2018, and to 30.62% for temporary differences expected to be reversed in or after the fiscal year beginning January 1, 2019. Fiscal year ended December 31, 2015 The “Act for Partial Revision of the Income Tax Act, etc.” (Act. No. 9 of 2015) and the “Act for Partial Revision of the Local Tax Act, etc.” (Act No. 2 of 2015) enacted in Japan on March 31, 2015 reduced the income tax rate for fiscal years beginning on or after April 1, 2015. Accordingly, the effective statutory tax rate used to measure deferred tax assets and deferred tax liabilities has changed from 35.64% to 33.06% for temporary differences expected to be reversed in the fiscal year beginning January 1, 2016, and to 32.26% for temporary differences expected to be reversed in or after the fiscal year beginning January 1, 2017. 17 Bonds and Borrowings Bonds and borrowings consist of the following. Short-term borrowings .............................................. Current portion of long-term borrowings ................... Long-term borrowings ............................................... Bonds2 ....................................................................... Total .................................................................... Current liabilities Bonds and borrowings ........................................... Non-current liabilities Bonds and borrowings ........................................... Total .................................................................... 2016 220 30,069 40,410 49,947 120,646 2015 267 72 70,282 49,925 120,546 Transition date 1,357 20,065 30,285 49,903 101,610 30,289 339 21,422 90,357 120,646 120,207 120,546 80,188 101,610 (Millions of yen) Average interest rate1 (%) 0.95 0.29 0.13 — Maturity — — 2019-2023 — Notes: 1. The average interest rate is the weighted-average interest rate on the balance of borrowings as of December 31, 2016. 2. Details of bonds issued are as follows: Issue date 2016 2015 Transition date Interest rate (%) Collateral Maturity date (Millions of yen) 24,958 24,945 49,903 0.39 0.62 None June 20, 2018 None June 19, 2020 Issuer The Company The Company Bond name 3rd unsecured bonds 2018 4th unsecured bonds 2020 June 14, 2013 24,982 24,970 June 14, 2013 24,965 24,955 Total(cid:1)..................................................... 49,947 49,925 39 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements 18 Leases (1) Finance Lease Payables As a lessee, the Group leases assets including buildings. Some lease contracts include renewal options. The Group has no lease contracts with covenants such as restrictions on additional borrowings or additional leases. The total of future minimum lease payments and the present value under finance lease contracts consist of the following. Not later than 1 year ................................... Later than 1 year and not later than 5 years .................................... Later than 5 years ....................................... Total ........................................................ Financial charges ........................................ Present value of minimum lease payments ................................... Minimum lease payments 2015 968 Transition date 1,050 2016 884 Present value of minimum lease payments 2015 2016 917 842 Transition date 989 (Millions of yen) 2,622 634 4,140 (140) 4,000 3,008 1,125 5,101 (190) 4,911 3,306 1,786 6,142 (252) 5,890 2,532 626 4,000 — 4,000 2,888 1,106 4,911 — 4,911 3,153 1,748 5,890 — 5,890 (2) Non-cancellable Operating Leases As a lessee, the Group leases assets including land. The total of future minimum lease payments under non-cancellable operating lease contracts consists of the following. Not later than 1 year ................................................................................................................ Later than 1 year and not later than 5 years ............................................................................ Later than 5 years .................................................................................................................... Total ..................................................................................................................................... 2016 8,808 16,660 7,627 33,095 2015 8,649 16,889 8,815 34,353 (Millions of yen) Transition date 10,291 18,030 10,156 38,477 The total of minimum lease payments under operating lease contracts recognized as expenses is as follows: Total of minimum lease payments ........................................................................................... 2016 9,858 (Millions of yen) 2015 11,590 19 Trade and Other Payables Trade and other payables consist of the following. Trade payables ......................................................................................................................... Non-trade payables .................................................................................................................. Total ..................................................................................................................................... 2016 130,348 86,545 216,893 2015 134,278 72,482 206,760 (Millions of yen) Transition date 130,264 63,196 193,460 Kao Corporation Financial Report 2016 40 20 Employee Benefits (1) Post-employment Benefits The Company and most of its domestic subsidiaries have a cash balance plan as a defined benefit plan and a defined contribution plan as post-employment benefits (The cash balance plan is linked to market interest rates). Defined benefit plan obligations held in Japan account for a large proportion of the Group’s defined benefit plan obligations. Cash balance plan benefits are calculated using points acquired during the enrollment period and a multiplier based on the enrollment period. The Group may also pay an early retirement bonus allowance to employees who retire earlier than retirement age. In accordance with laws and regulations, the defined benefit plan is operated as a pension fund that is legally separated from the Group. The pension fund is managed by a Board of Representatives composed of representatives elected by the participating companies and the representatives of participating employees. Pension fund management institutions manage the pension fund’s assets in accordance with management policies specified by the Board of Representatives. The Board of Representatives and the pension fund management institutions are legally required to act in the best interests of plan participants in executing their responsibilities for managing plan assets. Certain foreign subsidiaries have defined benefit plans and/or defined contribution plans as post-employment benefits. The defined benefit plan is exposed to the actuarial risk and to the risk of fluctuation in the fair value of plan assets. Actuarial risk primarily involves interest rate risk. Interest rate risk involves the potential for an increase in defined benefit plan obligations if the discount rate used to calculate their present value decreases, because this discount rate is based on market yields on instruments including high-quality corporate bonds. The risk of fluctuation in the fair value of plan assets involves underfunding if actual interest rates are lower than the interest rate criteria for managing plan assets. 1) Defined benefit liabilities recognized in the consolidated statement of financial position Net defined benefit liabilities and assets recognized in the consolidated statement of financial position, defined benefit obligations and plan assets are as follows: Present value of defined benefit obligations ................................................................... Fair value of plan assets .................................................................................................. Funded status .............................................................................................................. Effect of asset ceiling ...................................................................................................... Net defined benefit liabilities ....................................................................................... Amounts recognized in consolidated statement of financial position Retirement benefit liabilities ........................................................................................ Retirement benefit assets1 .......................................................................................... Net defined benefit liabilities ....................................................................................... 2016 355,579 (261,857) 93,722 — 93,722 94,773 (1,051) 93,722 2015 331,494 (256,828) 74,666 — 74,666 75,706 (1,040) 74,666 (Millions of yen) Transition date 332,385 (255,541) 76,844 0 76,844 77,895 (1,051) 76,844 Note: 1. Retirement benefit assets are included in other non-current assets in the consolidated statement of financial position. 2) Defined benefit obligations Changes in the present value of defined benefit obligations are as follows: The present value of the defined benefit obligations at beginning of year ................................................ Current service cost1 ............................................................................................................................. Interest expense2 .................................................................................................................................. Remeasurements Actuarial (gains) losses arising from changes in demographic assumptions ...................................... Actuarial (gains) losses arising from changes in financial assumptions ............................................. Actuarial (gains) losses arising from experience adjustments............................................................ Benefits paid3 ......................................................................................................................................... Exchange differences on translation of foreign operations and other .................................................... The present value of the defined benefit obligations at end of year ......................................................... 2016 331,494 8,784 3,619 (2,374) 28,545 (1,245) (10,964) (2,280) 355,579 (Millions of yen) 2015 332,385 9,110 3,679 4,614 (5,013) (468) (11,148) (1,665) 331,494 Notes: 1. Current service cost is recognized in profit or loss and included in cost of sales, selling, general and administrative expenses and other operating expenses in the consolidated statement of income. 2. Interest expense or interest income associated with the net of the present value of the defined benefit obligations and the fair value of plan assets is recognized in profit or loss and included in financial expenses or financial income in the consolidated statement of income. 3. The weighted-average duration of the defined benefit obligations in Japan was mainly 17.3 years at December 31, 2016, 16.1 years at December 31, 2015 and 15.7 years at the transition date. 41 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements 3) Plan assets Changes in the fair value of plan assets are as follows: The fair value of plan assets at beginning of year ...................................................................................... Interest income ..................................................................................................................................... Remeasurements Return on plan assets (excluding amounts included in interest income) ........................................... Contributions to the plan by the employer1 ............................................................................................ Payments from the plan ......................................................................................................................... Exchange differences on translation of foreign operations and other .................................................... The fair value of plan assets at end of year ............................................................................................... 2016 256,828 2,692 2,517 10,768 (9,752) (1,196) 261,857 (Millions of yen) 2015 255,541 2,665 (1,155) 10,483 (10,140) (566) 256,828 Note: 1. Pursuant to laws and regulations, the Group and the pension fund review the financial condition of the pension plan regularly and recalculate contributions for allocating future benefits and maintaining the balance of pension financing when the plan is underfunded. The Group plans to contribute 8,972 million yen to the defined benefit plan for the fiscal year ending December 31, 2017. Plan assets consist of the following. Equity securities .............. Japan ........................... Overseas ...................... Debt securities Japan ........................... Overseas ...................... Other ............................... Total .......................... 2016 Market price in an active market Quoted 7,723 — 7,723 7,489 — 7,489 237 15,449 Unquoted 51,195 24,704 26,491 180,216 116,734 63,482 14,997 246,408 Total 58,918 24,704 34,214 187,705 116,734 70,971 15,234 261,857 2015 Market price in an active market Total Unquoted 54,049 46,838 23,801 23,801 30,248 23,037 186,851 181,072 122,107 122,107 64,744 58,965 15,928 13,680 256,828 241,590 Quoted 7,211 — 7,211 5,779 — 5,779 2,248 15,238 (Millions of yen) Transition date Market price in an active market Total Unquoted 43,569 35,793 22,118 22,118 21,451 13,675 196,075 189,992 169,917 169,917 26,158 20,075 15,897 13,733 255,541 239,518 Quoted 7,776 — 7,776 6,083 — 6,083 2,164 16,023 Note: Plan assets invested in pooled funds of trust banks are classified without a quoted market prices in active markets. Pension assets in Japan account for a large proportion of the Group’s plan assets. The objective in managing plan assets is to raise total returns to the greatest extent possible in order to ensure stable benefits and lump-sum payments for plan participants in the future and beneficiaries with a long-term view under acceptable risks. Specifically, the Group considers factors including expected rate of return on investments in appropriate assets, risks of each asset, and asset combinations to set an asset mix policy for an appropriate basic portfolio in future years as the basis for maintaining asset allocation. The Group reviews the basic portfolio annually and realigns it as necessary if the asset allocation conditions have changed since the asset mix was set. 4) Significant actuarial assumptions and related sensitivity analysis Significant actuarial assumptions are as follows: Discount rate ................................................................................................................. Mainly 0.8% Mainly 1.3% Mainly 1.2% 2016 2015 Transition date Note: The above table presents the discount rate used by the Company and major domestic subsidiaries. Sensitivity analysis of the effect of changes in the present value of the defined benefit obligations of the Company and major domestic subsidiaries given changes in the discount rate used as a significant actuarial assumption is as follows: 2016 2015 Transition date (Millions of yen) The impact on defined benefit obligations 0.5% increase in discount rate .................................................................................. 0.5% decrease in discount rate ................................................................................. (25,807) 26,774 (21,946) 23,706 (21,944) 23,306 Note: This sensitivity analysis estimates the effect on the defined benefit obligations at the end of each reporting period from changes in the discount rate while all of the other assumptions remain constant. Kao Corporation Financial Report 2016 42 5) Defined contribution plans Expenses related to the defined contribution plan recognized in profit or loss were 3,551 million yen and 3,707 million yen for the fiscal years ended December 31, 2016 and 2015, respectively and included in cost of sales, selling, general and administrative expenses and other operating expenses in the consolidated statement of income. (2) Other Employee Benefit Expenses Other employee benefit expenses recognized in cost of sales, selling, general and administrative expenses, and other operating expenses in the consolidated statement of income for the fiscal years ended December 31, 2016 and 2015 were 258,225 million yen and 254,287 million yen, respectively. 21 Provisions Components of and changes in provisions consist of the following. January 1, 2016.......................................................... Increase ................................................................. Interest expense on discounted provision ................ Decrease (Provision used) ..................................... Decrease (Provision reversed) ............................... Exchange differences on translation of foreign operations ............................................... December 31, 2016 ................................................... Provision for loss related to cosmetics 23,447 — 8 (9,601) (144) Provision for asset retirement obligations 4,022 260 68 (87) — Provision for sales returns 2,083 4,749 — (2,751) (9) — 13,710 (21) 4,242 (107) 3,965 Other provisions 4,924 2,030 — (3,210) (452) (30) 3,262 (Millions of yen) Total 34,476 7,039 76 (15,649) (605) (158) 25,179 (1) Provision for Loss Related to Cosmetics The Group has recognized estimated compensation and other expenses related to cosmetics for brightening products of Kanebo Cosmetics containing the ingredient Rhododenol, for which a voluntary recall was announced on July 4, 2013. The Group expects insurance to cover 9,143 million yen of the estimated expenses. (2) Provision for Asset Retirement Obligations The Group recognizes asset retirement obligations principally based on or pursuant to reasonably estimated future expenditures using historical experience and other factors when the Group has a legal or contractual obligation associated with the retirement of property, plant and equipment and leased assets held for use. These expenditures are generally expected to take place after a year or more, but are affected by factors including future business plans. (3) Provision for Sales Returns The Group recognizes expected losses from product returns based on reasonable estimates using historical experience and other factors when the Group expects that customers will return products that the Group has sold, primarily when the Group terminates the production and sale of products. These expenditures are generally expected to take place after a year or more, but are affected by factors including future business plans. (4) Other Provisions Estimated expenses for business transformation at European subsidiaries and other expenses are included. 22 Other Current Liabilities Other current liabilities consist of the following. Accrued expenses ........................................................................................................... Consumption tax payables .............................................................................................. Obligation for unused paid absences .............................................................................. Other ............................................................................................................................. Total ............................................................................................................................. 2016 104,425 8,655 6,199 11,833 131,112 2015 100,651 10,249 5,974 8,548 125,422 (Millions of yen) Transition date 96,227 13,077 5,775 8,837 123,916 43 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements 23 Equity and Other Equity Items (1) Share Capital The numbers of shares authorized and issued are as follows: Authorized................................................................................................................... Issued1 Beginning balance ................................................................................................... Change during the year ........................................................................................... Ending balance ........................................................................................................ (Shares) 2016 1,000,000,000 2015 1,000,000,000 504,000,000 — 504,000,000 504,000,000 — 504,000,000 Note: 1. All of the issued shares of the Company are ordinary shares that have no par value and no limitations on rights. Issued shares are fully paid. (2) Capital Surplus Capital surplus consists of capital reserve and other capital surplus. The Companies Act stipulates that over half of the capital contributed from the issue of shares must be included in share capital and that the remainder must be included in capital reserve. Moreover, capital reserve may be included in share capital by resolution of the General Meeting of Shareholders. (3) Treasury Shares The changes in treasury shares are as follows: Beginning balance1 ..................................................................................................... Increase2 ................................................................................................................. Decrease3 ............................................................................................................... Ending balance1 ......................................................................................................... 2016 2,541,816 8,862,432 (266,594) 11,137,654 (Shares) 2015 2,921,992 9,340 (389,516) 2,541,816 Notes: 1. 556,492 shares of treasury shares held by associates were included at December 31, 2016 and 2015, and the transition date. 2. The increase of 8,862,432 shares of treasury shares during the fiscal year ended December 31, 2016 resulted from the acquisition of 8,858,700 shares by resolution of the Board of Directors and the purchase of 3,732 fractional shares. The increase of 9,340 shares of treasury shares during the fiscal year ended December 31, 2015 resulted from the purchase of fractional shares. 3. The decrease of 266,594 shares of treasury shares during the fiscal year ended December 31, 2016 resulted from a decrease of 266,000 shares due to the exercise of stock options, and the sale of 594 fractional shares. The decrease of 389,516 shares of treasury shares during the fiscal year ended December 31, 2015 resulted from a decrease of 389,000 shares due to the exercise of stock options, and the sale of 516 fractional shares. (4) Other Components of Equity 1) Subscription rights to shares The Company employs a stock option system and issues subscription rights to shares in accordance with the Companies Act. Note 33 “Share-based Payments” presents information including terms and conditions and amounts. 2) Exchange differences on translation of foreign operations Foreign currency translation differences arise from the translation of financial statements of foreign operations prepared in foreign currencies. 3) Net gain (loss) on derivatives designated as cash flow hedges The Group hedges its exposure to the risk of variability in future cash flows. The effective portion of changes in the fair value of cash flow hedges is the portion of the change in the fair value of the hedging instrument recognized as effective under hedge accounting. 4) Net gain (loss) on revaluation of financial assets measured at fair value through other comprehensive income This is the accumulated amount of changes in the fair value of financial assets measured at fair value through other comprehensive income. The Group reclassifies net gain (loss) on revaluation of financial assets from other components of equity to retained earnings when it disposes of an investment or when fair value declines significantly. 5) Remeasurements of defined benefit plans Remeasurements of defined benefit plans includes the effect of variance between actuarial assumptions at the beginning of the year and actual results, the effects of changes in actuarial assumptions, actual return on plan assets and interest income on plan assets (excluding amounts included in net interest on the net defined benefit liability (asset)), and any change in the effect of the asset ceiling (excluding amounts included in net interest on the net defined benefit liability (asset)). Remeasurements of defined benefit plans are recognized in other comprehensive income and Kao Corporation Financial Report 2016 44 immediately reclassified from other components of equity to retained earnings in the period when they occur. (5) Retained Earnings Retained earnings consist of legal reserve and other retained earnings. The Companies Act requires that an amount equal to one-tenth of dividends must be appropriated as capital reserve or as legal reserve until the total of aggregate amount of capital reserve and legal reserve equals a quarter of share capital. Legal reserve may be appropriated to reduce a deficit, and also may be reversed by resolution of the General Meeting of Shareholders. 24 Basic Strategy for Capital Policy The Group’s capital policy follows a basic strategy of securing a sound financial structure to make investments for sustainable growth and tolerate the related risks, and to make stable, continuous returns to shareholders. To realize this policy, the Group uses Economic Value Added (hereinafter “EVA®1”), a management indicator that takes capital cost into account, as its main indicator and works to enhance its corporate value by improving EVA. The Group manages all equity and interest-bearing liabilities as subject of capital cost and intends to optimize capital cost from the viewpoint of safety and capital efficiency. For equity, the Group aims for a streamlined and sound structure from a medium- to long-term perspective with efficiency in mind and, while maintaining interest-bearing liabilities at a moderate level, aims to obtain high credit ratings which will allow it to procure capital for large-scale investments. The Group is not subject to significant capital regulations except for general requirements under the Companies Act and others. Although the Group emphasizes shareholder returns, it realizes that investment for growth will meet the expectations of its stakeholders, and therefore prioritizes such investment. In addition to providing stable dividends, the Group aims to continuously increase dividends to reflect improvement in business results. The Group also uses surplus funds to flexibly conduct share repurchases. In addition to making returns to shareholders, the Group retains the capital necessary to conduct investments for growth in a timely fashion and to ensure sufficient soundness to deal with situations that exceed assumptions while improving EVA. For the fiscal year ended December 31, 2016, EVA increased 14.8 billion yen compared with the previous fiscal year to 73.4 billion yen, due in part to an increase in net operating profit after tax (hereinafter “NOPAT”) and efforts to reduce capital invested including the implementation of shareholder returns through a share repurchase. Note: 1. EVA is a monetary metric defined as NOPAT less capital cost. EVA is a registered trademark of Stern Stewart & Co. 25 Dividends Dividends paid are as follows: Fiscal year ended December 31, 2016 Date of resolution 110th Annual General Meeting of Shareholders held on March 25, 2016 Board of Directors held on July 28, 2016 Total dividends1 (Millions of yen) Dividends per share (Yen) Record date Effective date 21,061 23,077 42 46 December 31, 2015 March 28, 2016 June 30, 2016 September 1, 2016 Note: 1. Dividends on treasury shares held by associates accounted for using the equity method are reduced by an amount corresponding to the Group’s equity in these associates. The dividend resolved at the 110th Annual General Meeting of Shareholders held on March 25, 2016 was 21,085 million yen before the reduction. The dividend resolved at the meeting of the Board of Directors held on July 28, 2016 was 23,103 million yen before the reduction. Fiscal year ended December 31, 2015 Date of resolution 109th Annual General Meeting of Shareholders held on March 25, 2015 Board of Directors held on July 28, 2015 Total dividends1 (Millions of yen) Dividends per share (Yen) Record date Effective date 18,039 19,052 36 38 December 31, 2014 March 26, 2015 June 30, 2015 September 1, 2015 Note: 1. Dividends on treasury shares held by associates accounted for using the equity method are reduced by an amount corresponding to the Group’s equity in these associates. The dividend resolved at the 109th Annual General Meeting of Shareholders held on March 25, 2015 was 18,059 million yen before the reduction. The dividend resolved at the meeting of the Board of Directors held on July 28, 2015 was 19,073 million yen before the reduction. 45 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements Dividends with an effective date after the fiscal year end are as follows: Total dividends (Millions of yen) Dividends per share (Yen) Record date Effective date 23,684 48 December 31, 2016 March 22, 2017 Total dividends (Millions of yen) Dividends per share (Yen) Record date Effective date 21,085 42 December 31, 2015 March 28, 2016 Fiscal year ended December 31, 2016 Date of Resolution 111th Annual General Meeting of Shareholders held on March 21, 2017 Fiscal year ended December 31, 2015 Date of Resolution 110th Annual General Meeting of Shareholders held on March 25, 2016 26 Net Sales Net sales consist of the following. Sale of goods ............................................................................................................................................. Rendering of services ................................................................................................................................ Total ....................................................................................................................................................... 2016 1,456,950 660 1,457,610 (Millions of yen) 2015 1,473,956 594 1,474,550 27 Selling, General and Administrative Expenses Selling, general and administrative expenses consist of the following. Freight/warehouse ..................................................................................................................................... Advertising ................................................................................................................................................. Sales promotion ......................................................................................................................................... Employee benefits ..................................................................................................................................... Depreciation .............................................................................................................................................. Amortization .............................................................................................................................................. Research and development ....................................................................................................................... Other ....................................................................................................................................................... Total ....................................................................................................................................................... 28 Other Operating Income Other operating income consists of the following. Revenue of logistics services to third party ............................................................................................... Royalty income .......................................................................................................................................... Other ....................................................................................................................................................... Total ....................................................................................................................................................... 2016 58,168 97,437 83,161 191,122 11,236 6,173 54,567 131,504 633,368 (Millions of yen) 2015 60,737 94,745 79,910 191,392 11,695 13,957 52,699 137,594 642,729 2016 8,300 1,022 4,355 13,677 (Millions of yen) 2015 8,885 829 4,385 14,099 Kao Corporation Financial Report 2016 46 29 Other Operating Expenses Other operating expenses consist of the following. Expenses of logistics services to third party ............................................................................................. Losses on sale and disposal of property, plant and equipment ................................................................. Impairment losses1 .................................................................................................................................... Loss related to cosmetics ......................................................................................................................... Expenses for business transformation at European subsidiaries .............................................................. Other ....................................................................................................................................................... Total ....................................................................................................................................................... 2016 7,454 3,817 109 — 1,776 1,690 14,846 (Millions of yen) 2015 8,159 3,910 4,031 1,961 — 1,676 19,737 Note: 1. Note 12 “Non-current Assets Held for Sale” and Note 13 “Property, Plant and Equipment” present impairment losses. 30 Financial Income and Financial Expenses Financial income consists of the following. Interest income Financial assets measured at amortized cost ........................................................................................ Retirement benefit assets ..................................................................................................................... Dividend income Financial assets measured at fair value through other comprehensive income Financial assets derecognized during the year .................................................................................. Financial assets held at year end ....................................................................................................... Financial assets measured at fair value through profit or loss ............................................................... Other ....................................................................................................................................................... Total ............................................................................................................................................... Financial expenses consist of the following. Foreign exchange loss1 ............................................................................................................................. Interest expenses2 Financial liabilities measured at amortized cost ................................................................................... Retirement benefit liabilities ................................................................................................................. Other ....................................................................................................................................................... Total ................................................................................................................................................ 2016 1,012 26 9 205 21 116 1,389 2016 2,859 1,484 953 128 5,424 (Millions of yen) 2015 1,048 21 46 135 37 129 1,416 (Millions of yen) 2015 1,633 1,528 1,035 17 4,213 Notes: 1. Valuation gains or losses on currency derivatives that are not designated as hedges are included in foreign exchange loss. 2. Valuation gains or losses on interest rate derivatives that are not designated as hedges are included in interest expenses. 47 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements 31 Earnings per Share (1) The Basis for Calculating Basic Earnings per Share Net income attributable to owners of the parent ........................................................................................ Amounts not attributable to ordinary shareholders of the parent ................................................................ Net income used to calculate basic earnings per share .............................................................................. (Millions of yen, unless otherwise noted) 2016 126,551 — 126,551 2015 105,196 — 105,196 Weighted average number of ordinary shares (Thousands of shares) ........................................................ 499,355 501,352 Basic earnings per share (Yen) .................................................................................................................... 253.43 209.82 (2) The Basis for Calculating Diluted Earnings per Share Net income used to calculate basic earnings per share ............................................................................... Adjustments to net income .......................................................................................................................... Net income used to calculate diluted earnings per share ............................................................................. (Millions of yen, unless otherwise noted) 2016 126,551 — 126,551 2015 105,196 — 105,196 Weighted average number of ordinary shares (Thousands of shares) ......................................................... Increase in ordinary shares Subscription rights to shares (Thousands of shares) ................................................................................ Weighted average number of ordinary shares after dilution (Thousands of shares) .................................... 499,355 501,352 483 499,838 701 502,053 Diluted earnings per share (Yen) .................................................................................................................. 253.18 209.53 Summary of potential ordinary shares not included in the calculation of diluted earnings per share because they have no dilutive effect ........................................................................................................ — — 32 Other Comprehensive Income Amount arising during the fiscal year, reclassification adjustments to profit or loss and tax effects for each component of other comprehensive income are as follows: Fiscal year ended December 31, 2016 (Millions of yen) Gains (losses) arising for the year Reclassification adjustments Before tax effect Tax effect After tax effect Other comprehensive income that will not be reclassified to profit or loss Gains (losses) on financial assets measured at fair value through other comprehensive income ...... Remeasurements of defined benefit pension plans ...... Share of other comprehensive income of associates accounted for by the equity method ....... Total of other comprehensive income that will (1,569) (22,409) (128) not be reclassified to profit or loss .................... (24,106) Other comprehensive income that can be reclassified to profit or loss Exchange differences on translation of foreign operations ................................................................. (16,661) Share of other comprehensive income of associates accounted for by the equity method ....... Total of other comprehensive income that can (7) be reclassified to profit or loss .......................... (16,668) Total ............................................................... (40,774) — — — — — — — — (1,569) (22,409) (128) 663 6,298 56 (906) (16,111) (72) (24,106) 7,017 (17,089) (16,661) (7) (16,668) — (3) (3) (16,661) (10) (16,671) (40,774) 7,014 (33,760) Kao Corporation Financial Report 2016 48 Fiscal year ended December 31, 2015 (Millions of yen) Gains (losses) arising for the year Reclassification adjustments Before tax effect Tax effect After tax effect Other comprehensive income that will not be reclassified to profit or loss Gains (losses) on financial assets measured at fair value through other comprehensive income ...... Remeasurements of defined benefit pension plans ...... Share of other comprehensive income of associates accounted for by the equity method ....... Total of other comprehensive income that will 2,200 (288) 332 not be reclassified to profit or loss .................... 2,244 Other comprehensive income that can be reclassified to profit or loss Exchange differences on translation of — — — — 2,200 (288) 332 2,244 foreign operations ..................................................... (14,236) (828) (15,064) Effective portion of changes in the fair value of cash flow hedges ...................................................... Share of other comprehensive income of associates accounted for by the equity method ....... Total of other comprehensive income that can 18 (26) — 1 18 (25) be reclassified to profit or loss .......................... (14,244) (827) (15,071) (405) (482) (87) (974) — (6) 6 — 1,795 (770) 245 1,270 (15,064) 12 (19) (15,071) Total ............................................................... (12,000) (827) (12,827) (974) (13,801) 33 Share-based Payments (1) Share-based Payment System The Company issues the following two types of stock options to directors, executive officers and employees of the Group. 1) Stock options for share-based payment Stock options for share-based payment are granted as compensation for directors and executive officers who do not concurrently serve as directors. These stock options are intended to motivate and inspire recipients to enhance the Company’s results and value of shares and to further enhance corporate value by aligning the interests of recipients with those of shareholders by further increasing the linkage among the compensation of recipients, the Company’s results and value of shares. • Vesting conditions: Set on date of grant • Settlement: Shares settled (2) Number of Stock Options and Weighted Average Exercise Price • Exercise period: Five years from July 1 of two years after the subscription rights to shares are granted 2) Conventional stock options Conventional stock options were granted to the employees of the Company and the directors and employees of its subsidiaries and associates as incentives. These stock options were intended to further enhance corporate value by aligning the interests of recipients with those of shareholders. The Group has ceased granting these stock options since the fiscal year ended December 31, 2012 after reviewing its system of compensation and incentives for managers. • Vesting conditions: Set on date of grant • Settlement: Shares settled • Exercise period: Five years from September 1 of two years after the subscription rights to shares are granted 2016 2015 Number of shares (Shares) Weighted average exercise price (Yen) Number of shares (Shares) Weighted average exercise price (Yen) Beginning balance of outstanding ...................................... Granted ........................................................................... Exercised ........................................................................ Expired at maturity .......................................................... Ending balance of outstanding ........................................... Ending balance of exercisable ............................................ 846,000 40,000 (266,000) (71,000) 549,000 469,000 1,654 1 1,886 2,355 1,331 1,558 1,343,000 40,000 (389,000) (148,000) 846,000 766,000 2,100 1 2,473 3,100 1,654 1,827 Notes: 1. The weighted average share price on the date of exercise for the fiscal years ended December 31, 2016 and 2015 was 5,821 yen and 5,443 yen, respectively. 49 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements 2. The exercise price and the weighted average remaining contractual life for stock options outstanding at the end of the period are as follows: Range of exercise price (Yen) 1 2,190 - 2,254 Total 2016 Number of shares (Shares) 222,000 327,000 549,000 Weighted average remaining contractual life (Years) 4.0 1.4 2.4 Range of exercise price (Yen) 1 2,190 - 2,355 Total 2015 Number of shares (Shares) 231,000 615,000 846,000 Weighted average remaining contractual life (Years) 4.1 1.8 2.4 (3) Fair Value of and Assumptions for Stock Options Issued during the Fiscal Year The weighted average fair value of stock options issued was estimated using the Black-Scholes model with the following assumptions. Fair value at date of grant ............................................................................................................... Share price at date of grant ............................................................................................................ Exercise price ................................................................................................................................. Expected volatility ........................................................................................................................... Expected remaining life .................................................................................................................. Expected dividend yield .................................................................................................................. Risk-free interest rate ..................................................................................................................... Expected volatility is calculated using actual recent share prices for the expected remaining life. Stock option 2016 5,681 yen 5,956 yen 1 yen 25.723% 3.5 years 1.343% (0.235)% Stock option 2015 5,630 yen 5,871 yen 1 yen 21.458% 3.5 years 1.192% 0.018% (4) Share-based Payment Expenses Share-based payment expenses recognized in the consolidated statement of income for the fiscal years ended December 31, 2016 and 2015 were 227 million yen and 225 million yen, respectively. 34 Financial Instruments (1) Classification of Financial Instruments The amounts of each classification of financial assets are as follows: Financial assets 2016 2015 Transition date (Millions of yen) Financial assets measured at amortized cost Cash and cash equivalents (Note 8) .............................................................................. Trade and other receivables (Note 9) ............................................................................ Other ............................................................................................................................. Financial assets measured at fair value through profit or loss Cash and cash equivalents (Note 8) .............................................................................. Derivatives .................................................................................................................... Other ............................................................................................................................. Financial assets measured at fair value through other comprehensive income Equity securities ........................................................................................................... Total ...................................................................................................................... Current assets Cash and cash equivalents ........................................................................................... Trade and other receivables .......................................................................................... Other financial assets ................................................................................................... Subtotal ...................................................................................................................... Non-current assets Other financial assets ................................................................................................... Total ...................................................................................................................... 268,126 208,459 22,404 34,900 791 2,888 12,428 549,996 303,026 208,459 13,038 524,523 25,473 549,996 240,363 210,707 14,319 69,559 2,240 2,858 14,987 555,033 309,922 210,707 5,065 525,694 29,339 555,033 181,323 212,742 13,140 47,644 656 2,853 13,473 471,831 228,967 212,742 4,034 445,743 26,088 471,831 Kao Corporation Financial Report 2016 50  Equity securities held by the Group are mainly issued by the entities that maintain business relationships with the Group and held for the long-term without speculative purposes. The Group has designated such equity securities as financial assets measured at fair value through other comprehensive income. Names of major equity securities and their fair values are as follows: As of December 31, 2016 Company name Seven & i Holdings Co., Ltd. ......................................................................................... Seven Bank, Ltd. .......................................................................................................... Tokio Marine Holdings, Inc. .......................................................................................... Saiwai Trading Co., Ltd. ................................................................................................ Livedo Corporation ....................................................................................................... Aeon Co., Ltd. ............................................................................................................... Settsu Oil Mill, Inc. ....................................................................................................... Izumi Co., Ltd. .............................................................................................................. Japan Alcohol Trading Co., Ltd. .................................................................................... Keytrading Co., Ltd. ...................................................................................................... As of December 31, 2015 Company name Seven & i Holdings Co., Ltd. .......................................................................................... Seven Bank, Ltd. ........................................................................................................... Tokio Marine Holdings, Inc. ........................................................................................... Livedo Corporation ........................................................................................................ Saiwai Trading Co., Ltd. ................................................................................................. Aeon Co., Ltd. ................................................................................................................ Settsu Oil Mill, Inc. ........................................................................................................ Izumi Co., Ltd. ............................................................................................................... Japan Alcohol Trading Co., Ltd. ..................................................................................... Keytrading Co., Ltd. ....................................................................................................... (Millions of yen) Fair value 2,863 1,675 913 863 835 687 533 502 462 359 (Millions of yen) Fair value 3,568 2,665 1,000 831 766 728 621 468 418 353 As of the transition date Company name Seven & i Holdings Co., Ltd. .......................................................................................... Seven Bank, Ltd. ........................................................................................................... Tokio Marine Holdings, Inc. ........................................................................................... Livedo Corporation ........................................................................................................ Saiwai Trading Co., Ltd. ................................................................................................. Aeon Co., Ltd. ................................................................................................................ Settsu Oil Mill, Inc. ........................................................................................................ Izumi Co., Ltd. ............................................................................................................... Japan Alcohol Trading Co., Ltd. ..................................................................................... Keytrading Co., Ltd. ....................................................................................................... (Millions of yen) Fair value 2,801 2,540 1,043 784 571 491 473 422 386 364 The Group derecognizes some financial assets measured at fair value through other comprehensive income by sale for reasons including asset efficiency and changes in business relationships. The total amounts of the fair value of such financial assets at the time of sale and the cumulative gains or losses on sales are as follows: Fair value .................................................................................................................... Cumulative gains (losses) ........................................................................................... 2016 1,036 658 (Millions of yen) 2015 690 367 The Group transfers to retained earnings the cumulative gains or losses arising from changes in the fair value of financial assets measured at fair value through other comprehensive income recognized as other components of equity when it disposes of an investment or when fair value declines significantly. Cumulative gains or losses of other comprehensive income, net of taxes, that were transferred to retained earnings for the fiscal years ended December 31, 2016 and 2015 were 435 million yen and 236 million yen, respectively. 51 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements The amounts of each classification of financial liabilities are as follows. Financial liabilities 2016 2015 Transition date (Millions of yen) Financial liabilities measured at amortized cost Trade and other payables (Note 19) ............................................................................ Bonds and borrowings (Note 17) ................................................................................ Other ........................................................................................................................... Financial liabilities measured at fair value through profit or loss Derivatives .................................................................................................................. Total .................................................................................................................... Current liabilities Trade and other payables ............................................................................................ Bonds and borrowings ................................................................................................ Other financial liabilities .............................................................................................. Subtotal ................................................................................................................... Non-current liabilities Bonds and borrowings ................................................................................................ Other financial liabilities .............................................................................................. Subtotal ................................................................................................................... Total .................................................................................................................... 216,893 120,646 19,057 773 357,369 216,893 30,289 8,164 255,346 90,357 11,666 102,023 357,369 206,760 120,546 17,919 827 346,052 206,760 339 6,929 214,028 120,207 11,817 132,024 346,052 193,460 101,610 17,492 1,086 313,648 193,460 21,422 5,765 220,647 80,188 12,813 93,001 313,648 There are no significant assets pledged for the above financial liabilities. Deposits received, which is interest-bearing liability in other financial liabilities at December 31, 2016 and 2015, and the transition date, was 13,275 million yen, 11,986 million yen and 10,561 million yen, respectively. The average interest rate on deposits received as of December 31, 2016 is 0.14%. (2) Risk Management on Financial Instruments The Group manages financial instrument risk based on the following policies to avoid and mitigate market risk, credit risk and liquidity risk. mitigation needs, and does not use derivatives for trading or speculative purposes. Therefore, as a rule, changes in the fair value of derivative instruments that the Group holds effectively offset changes in the fair value or cash flow. 1) Market risk management (i) Exchange rate risk The Group is exposed to the risk of market variability such as fluctuations in exchange rates, interest rates and share prices. The Group appropriately manages market risk to mitigate risk. In addition, the Group uses derivatives mainly consisting of foreign exchange forward contracts, currency swaps and interest rate swaps with the objective of appropriately managing market risk. The Group executes and manages derivatives in accordance with internal policies that define objective, position limit, scope, organizational structure and others. The Group limits the use of derivatives to actual risk The Group also operates outside Japan, and therefore is exposed to the risks of exchange rate fluctuations associated with transactions conducted in foreign currencies and with net investments in foreign operations. The Group minimizes the effect of exchange rate fluctuations on operating results by settling transactions denominated in foreign currency through foreign currency accounts, and by hedging the risk of exchange rate fluctuations using derivative instruments such as foreign exchange forward and currency swaps. Kao Corporation Financial Report 2016 52  Details of foreign exchange forward contracts and currency swaps between the Japanese yen, which is the Group’s functional currency, and its main foreign currencies including the U.S. dollar, the euro and the Chinese yuan are as follows: The Group did not apply hedge accounting for these derivative transactions, but determined that these transactions effectively offset the impact of fluctuations in exchange rates. (Millions of yen) 2016 Contract amount over 1 year Carrying amount (fair value)1 Contract amount 2015 Contract amount over 1 year Carrying amount (fair value)1 Contract amount Derivatives transactions Foreign exchange forward contracts: Selling Transition date Contract amount over 1 year Carrying amount (fair value)1 Contract amount U.S. dollar ................................. Euro .......................................... Chinese yuan ........................... 16,308 74 1,065 Buying Euro .......................................... Chinese yuan ........................... 151 701 7,280 — — — 701 60 3 (1) (6) (52) 16,824 76 4,578 43 778 9,729 — 3,379 — 778 (83) (0) 110 1 (100) — 54 3,053 55 808 — — 3,053 — 808 — 1 (67) (1) (114) Currency swaps: Receiving Japanese yen, paying Chinese yuan ........................... 2,279 2,279 (158) 2,279 2,279 (417) 2,279 2,279 (602) Note: 1. Note 34 “Financial Instruments (4) Fair Value of Financial Instruments” presents the method of measuring the fair value of the above derivatives. The above assets or liabilities related to derivative transactions are included in other financial assets or other financial liabilities in the consolidated statement of financial position. Net exposure to exchange rate risk consists of the following. Amounts hedged against exchange rate fluctuation risk with derivatives are excluded. As of December 31, 2016 Net exposure As of December 31, 2015 Net exposure U.S. dollar 2,210 U.S. dollar 1,598 Euro 707 Euro 1,354 (Millions of yen) Chinese yuan 5,342 (Millions of yen) Chinese yuan 4,183 The following table illustrates the impact on income before income taxes in the consolidated statement of income from foreign currency-denominated financial instruments held by the Group at the end of each fiscal year if the Japanese yen appreciated by 10% against the U.S. dollar, the euro and the Chinese yuan. The effects of translating financial instruments denominated in the Group’s functional currency, and the assets, liabilities, income and expenses of foreign operations are not included in the analysis. The analysis also assumes that currencies other than those used in the calculation remain constant. U.S. dollar ............................................................................................................................................... Euro ........................................................................................................................................................ Chinese yuan .......................................................................................................................................... 2016 (221) (71) (534) (Millions of yen) 2015 (160) (135) (418) (ii) Interest rate fluctuation risk The Group finances through long-term borrowings and bonds for maintaining an appropriate cost of capital and strengthening its financial base for investment for growth. The Group considers interest rate market movements and the balance between floating and fixed interest rates in making decisions about long-term funding. The Group’s short-term borrowings generally have floating interest rates. The Group hedges interest rate risk as necessary using derivative instruments such as interest rate swaps, and therefore estimates its exposure to interest rate fluctuation risk is limited. (iii) Share price fluctuation risk The Group held marketable equity securities, primarily those of companies with which the Group has business relationships, totaled at 8,956 million yen, 11,775 million yen and 10,476 million yen at December 31, 2016 and 2015, 53 Kao Corporation Financial Report 2016 and the transition date, respectively. These equity securities are exposed to share price fluctuation risk. However, the Group annually evaluates the rationale and reviews ongoing advisability and position size of these holdings. Fluctuations in their prices do not affect net profit or loss because all of these equity securities are designated as financial assets measured at fair value through other comprehensive income. 2) Credit risk management The Group is exposed to credit risk such as a counterparty’s default on its contractual obligations resulting in financial losses to the Group. (i) Trade and other receivables Notes and accounts receivable are trade receivables that expose the Group to customer credit risk. The Group manages that risk with an internal process for investigating and approving customer credit on initial transactions, and by obtaining deposits, collateral or other guaranties as necessary. The Group also manages due dates and outstanding balances by customer, and periodically reconfirms creditworthiness of major customers. Non-trade receivables expose the Group to business partner credit risk, but these receivables are almost entirely settled in the short-term. (ii) Short-term investments Short-term investments are recognized in cash and cash equivalents and other financial assets. They are highly safe and liquid financial instruments that include commercial paper issued by entities with high bond ratings, bond investment trusts, and money held in trust. (iii) Loan receivables Loan receivables expose the Group to borrower credit risk. The Group manages this risk with an internal process for investigating and approving borrower credit on initial lending transactions, and by obtaining deposits, collateral or other guaranties as necessary. The Group also periodically reconfirms creditworthiness of borrowers. (iv) Derivatives The Group executes and manages derivatives in accordance with internal policies that define objective, position limit, scope and organizational structure. The Group limits the use of derivatives to actual risk mitigation needs, and does not use derivatives for trading or speculative purposes, and reduces credit risk by limiting transactions to highly creditworthy financial institutions. Notes to Consolidated Financial Statements The carrying amount after impairment of financial assets in the consolidated financial statements of financial position represents the Group’s maximum exposure to the credit risk of financial assets. The Group is not exposed to excessive credit risk associated with a particular customer that requires exceptional management. The Group recognizes an allowance for doubtful receivables for trade receivables and other financial assets measured at amortized cost by estimating future credit losses in consideration of recoverability and significant increases in credit risk. The Group determines if credit risk has increased significantly by evaluating changes in default risk with reference to factors including downgrading of internal credit ratings, the decline of counterparty results, and delinquency information. Trade receivables are particularly important financial assets for the Group. The Group collectively measures expected credit losses of the financial assets for the entire period to recognize the allowance for doubtful receivables. In the following situations that would adversely affect future cash flows, however, the Group measures expected credit losses individually by treating each receivable as a credit-impaired financial asset. • Where the customer has serious financial difficulties • Where the customer defaults or becomes delinquent in accounts receivable payments despite repeated demands for payment • Where it is more likely that the customer will go into bankruptcy or face a situation that forces it to reconstruct its business The Group directly writes down carrying amount if it does not reasonably expect to recover all or part of the trade receivables, following an internal process of investigation and approval. The Group held security deposits for credit enhancement totaling 6,413 million yen, 6,271 million yen, and 6,105 million yen at December 31, 2016 and 2015, and the transition date, respectively. Kao Corporation Financial Report 2016 54  The carrying amount of trade receivables and changes in the related allowance for doubtful receivables are as follows: Fiscal year ended December 31, 2016 (Millions of yen) Trade receivables January 1, 2016 ..................................................................... Change during the year (Recognition and derecognition) .................................... Transfer to credit-impaired financial assets ....................... Other changes ................................................................... December 31, 2016 ............................................................... Allowance for doubtful receivables January 1, 2016 ..................................................................... Increase during the year .................................................... Decrease during the year (charge-offs) .............................. Decrease during the year (other) ....................................... Transfer to credit-impaired financial assets ....................... Other changes ................................................................... December 31, 2016 ............................................................... Financial assets for which loss allowances are always measured at an amount equal to expected credit losses for the entire period 206,494 2,472 28 (4,258) 204,736 Credit-impaired financial assets 472 (36) (28) (45) 363 Financial assets for which loss allowances are always measured at an amount equal to expected credit losses for the entire period Credit-impaired financial assets 803 217 (85) (72) (6) (76) 781 465 18 (28) (36) 6 (43) 382 Total 206,966 2,436 — (4,303) 205,099 (Millions of yen) Total 1,268 235 (113) (108) — (119) 1,163 Fiscal year ended December 31, 2015 (Millions of yen) Trade receivables January 1, 2015 ..................................................................... Change during the year (Recognition and derecognition) .................................... Transfer to credit-impaired financial assets ....................... Other changes ................................................................... December 31, 2015 ............................................................... Allowance for doubtful receivables January 1, 2015 ..................................................................... Increase during the year .................................................... Decrease during the year (charge-offs) .............................. Decrease during the year (other) ....................................... Transfer to credit-impaired financial assets ....................... Other changes ................................................................... December 31, 2015 ............................................................... Financial assets for which loss allowances are always measured at an amount equal to expected credit losses for the entire period 205,186 5,749 (146) (4,295) 206,494 Credit-impaired financial assets 488 (104) 146 (58) 472 Financial assets for which loss allowances are always measured at an amount equal to expected credit losses for the entire period Credit-impaired financial assets 775 236 (115) (46) (7) (40) 803 475 126 (35) (49) 7 (59) 465 Total 205,674 5,645 — (4,353) 206,966 (Millions of yen) Total 1,250 362 (150) (95) — (99) 1,268 55 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements The following tables present an analysis of the carrying amount of trade receivables and the allowance for doubtful receivables by days past due. As of December 31, 2016 Trade receivables ....................................................... Allowance for doubtful receivables ........................... Expected credit loss (%) ............................................ As of December 31, 2015 Trade receivables ....................................................... Allowance for doubtful receivables ........................... Expected credit loss (%) ............................................ As of the transition date Trade receivables ....................................................... Allowance for doubtful receivables ........................... Expected credit loss (%) ............................................ (Millions of yen unless otherwise noted) Days past due Not due 197,543 256 0.1 Less than 30 days 4,315 82 1.9 Over 30 days 1,248 30 2.4 Over 60 days 553 60 10.9 Over 90 days 1,440 735 51.0 Total 205,099 1,163 0.6 (Millions of yen unless otherwise noted) Days past due Not due 196,783 245 0.1 Less than 30 days 6,795 89 1.3 Over 30 days 1,414 28 2.0 Over 60 days 504 34 6.6 Over 90 days 1,470 872 59.3 Total 206,966 1,268 0.6 (Millions of yen unless otherwise noted) Days past due Not due 197,825 356 0.2 Less than 30 days 4,853 26 0.5 Over 30 days 1,142 43 3.8 Over 60 days 511 39 7.6 Over 90 days 1,343 786 58.6 Total 205,674 1,250 0.6 3) Liquidity Risk Management Liquidity risk is the risk that the Group may not be able to fulfill its obligation to pay financial liabilities that come due. The Group uses methods such as scheduled medium- and long-term financing plans to understand its liquidity and consistently ensure the availability of sufficient funding. The Group has also implemented the Global Cash Management System to reduce liquidity risk through the focused and efficient management of the Group’s capital in Japan and overseas. Financial liabilities including derivative instruments by maturity date consist of the following. As of December 31, 2016 (Millions of yen) Carrying amount Contract amount Not later than 1 year Later than 1 year but not later than 2 years Later than 2 years but not later than 3 years Later than 3 years but not later than 4 years Later than 4 years but not later than 5 years Later than 5 years Non-derivative financial liabilities Trade and other receivables .......... Bonds and borrowings .................. Lease obligations .......................... Long-term deposits payable ......... Derivative financial liabilities Currency related ........................... Interest rate related ...................... Total .......................................... 216,893 120,646 4,000 6,413 216,893 120,699 4,140 6,413 758 15 348,725 758 15 348,918 216,869 30,289 884 — 337 7 248,386 24 25,066 779 — 159 8 26,036 — 40,045 684 — — — 40,729 — 25,038 667 — — — 25,705 — 235 492 — 262 — 989 — 26 634 6,413 — — 7,073 Kao Corporation Financial Report 2016 56 As of December 31, 2015 Non-derivative financial liabilities Trade and other receivables .......... Bonds and borrowings .................. Lease obligations .......................... Long-term deposits payable ......... Derivative financial liabilities Currency related ........................... Interest rate related ...................... Total .......................................... As of the transition date Carrying amount Contract amount Not later than 1 year 206,760 120,546 4,911 6,271 206,760 120,621 5,101 6,271 790 37 339,315 790 37 339,580 206,732 339 968 — 54 — 208,093 Later than 1 year but not later than 2 years Later than 2 years but not later than 3 years Later than 3 years but not later than 4 years Later than 4 years but not later than 5 years Later than 5 years (Millions of yen) 28 30,070 882 — 54 25 31,059 — 25,067 782 — 515 12 26,376 — 40,046 683 — 58 — 40,787 — 25,038 661 — 109 — 25,808 — 61 1,125 6,271 — — 7,457 Non-derivative financial liabilities Trade and other receivables .......... Bonds and borrowings .................. Lease obligations .......................... Long-term deposits payable ......... Derivative financial liabilities Currency related ........................... Interest rate related ...................... Total .......................................... Carrying amount Contract amount Not later than 1 year 193,460 101,610 5,890 6,105 193,460 101,707 6,142 6,105 1,007 79 308,151 1,007 79 308,500 193,460 21,422 1,050 — 338 79 216,349 Later than 1 year but not later than 2 years Later than 2 years but not later than 3 years Later than 3 years but not later than 4 years Later than 4 years but not later than 5 years Later than 5 years (Millions of yen) — 63 967 — — — 1,030 — 30,061 880 — — — 30,941 — 25,058 780 — 669 — 26,507 — 37 679 — — — 716 — 25,066 1,786 6,105 — — 32,957 (3) Hedge Accounting As described in Note 34 “Financial Instruments (2) Risk Management on Financial Instruments”, the Group designates interest rate swaps as cash flow hedges to hedge interest rate fluctuation risk for floating-rate liabilities. When applying hedge accounting, the Group periodically evaluates whether the hedged item and the hedging instrument meets key criteria and is closely matched in order to confirm an offsetting economic relationship between fluctuations in the cash flow of the hedged item attributable to the risk being hedged and fluctuations in the cash flow of the hedging instrument. The Group also assesses hedge effectiveness by quantitatively evaluating whether changes in the cash flows of the hedged item and the hedging instrument have an offsetting relationship due to the same risk. In addition, the Group sets hedge ratios that are appropriate in light of the economic relationship between the hedging instrument and the hedged item and the Group’s risk management strategy. The Group’s hedges generally do not have a significant ineffective hedge portion because the Group only applies the hedge accounting when the hedged item and the hedging instrument meet key criteria. The effective portion of changes in the fair value of derivatives designated as cash flow hedges is recognized in other comprehensive income. Gains or losses on derivatives recognized in other components of equity are transferred to profit or loss when changes in the future cash flows associated with hedged items are recognized in profit or loss. Any ineffective portion is recognized in profit or loss. The Group discontinues hedge accounting for a hedging relationship if the risk management objective has changed. The carrying amount (fair value) of derivatives designated as cash flow hedges consists of the following. There was no hedging relationship for which the Group discontinued hedge accounting. Consolidated statement of financial position line item Other financial liabilities in current liabilities Hedging instrument Interest rate swap (pay fixed / receive variable)1 Type of risk Interest Rate Risk 2016 Contract amount later than 1 year Nominal amount Carrying amount (fair value) Nominal amount 2015 Contract amount later than 1 year (Millions of yen) Transition date Carrying amount (fair value) Nominal amount Contract amount later than 1 year Carrying amount (fair value) — — — — — — 20,000 — (18) Note: 1. The details of this swap contract are: pay fixed 0.53%, receive variable TIBOR+0.05%. 57 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements Derivatives designated as cash flow hedges that the Group recognized in other components of equity and in profit and loss (before tax effect) consist of the following. As of December 31, 2016 None applicable. As of December 31, 2015 Type of risk Interest rate risk Beginning of year: Effective portion of changes in the fair value of cash flow hedge (18) Hedge profit or loss recognized in other comprehensive income 18 Amount reclassified to other components of equity — (Millions of yen) End of year: Effective portion of changes in the fair value of cash flow hedge — (4) Fair Value of Financial Instruments 1) Fair value hierarchy levels For financial instruments measured at fair value, the fair values developed based on the observability of inputs into the valuation techniques used in measurement are categorized within the following three levels. Level 1: Fair value measured with quoted prices in active markets for identical assets or liabilities Level 2: Fair value measured with inputs other than quoted (ii) Derivative assets and derivative liabilities Derivative assets and derivative liabilities are included in other financial assets and other financial liabilities, and are designated as financial assets and financial liabilities measured at fair value through profit or loss. Consisting of instruments including foreign exchange forward contracts, currency swaps and interest rate swaps, derivative assets and derivative liabilities are primarily measured with a model using observable inputs such as exchange rates and interest rates. prices categorized within Level 1 that are observable for the asset or liability, either directly or indirectly (iii) Equity securities Level 3: Fair value measured with inputs not based on observable market data for the asset or liability 2) Financial instruments measured at fair value The measurement methods for the main financial instruments measured at fair value are as follows. (i) Short-term investments (excluding short-term investments measured at amortized cost) Short-term investments are included in cash and cash equivalents, and are designated as financial assets measured at fair value through profit or loss. Short-term investments primarily consist of bond investment trusts and money held in trust, and are measured with a model using observable inputs such as interest rates. Equity securities are included in other financial assets, and are designated as financial assets measured at fair value through other comprehensive income. Equity securities that are categorized within Level 1 are publicly listed and traded in active markets, and are measured using market prices on exchanges. Equity securities that are categorized within Level 3 are unlisted, and are primarily measured using a net asset valuation model, which measures corporate value based on the net asset of the issuing company with adjustments based on fair value. Kao Corporation Financial Report 2016 58  The fair value hierarchy of financial instruments measured at fair value is as follows. The Group recognizes transfers of financial instruments between levels of the fair value hierarchy at the end of each fiscal year. No financial instruments were transferred between levels of the fair value hierarchy for the fiscal years ended December 31, 2016 or 2015. As of December 31, 2016 Level 1 Level 2 Level 3 Total (Millions of yen) Financial assets Financial assets measured at fair value through profit or loss Short-term investments ............................................................ Derivative assets ....................................................................... Other ......................................................................................... Financial assets measured at fair value through other comprehensive income Equity securities ........................................................................ Total ...................................................................................... Financial liabilities Financial liabilities measured at fair value through profit or loss Derivative liabilities ................................................................... Total ...................................................................................... — — — 8,956 8,956 — — 34,900 791 2,888 — 38,579 773 773 — — — 3,472 3,472 — — 34,900 791 2,888 12,428 51,007 773 773 As of December 31, 2015 Level 1 Level 2 Level 3 Total (Millions of yen) Financial assets Financial assets measured at fair value through profit or loss Short-term investments ............................................................ Derivative assets ....................................................................... Other ......................................................................................... Financial assets measured at fair value through other comprehensive income Equity securities ........................................................................ Total ...................................................................................... Financial liabilities Financial liabilities measured at fair value through profit or loss ... Derivative liabilities ................................................................... Total ...................................................................................... — — — 11,775 11,775 — — 69,559 2,240 2,858 — 74,657 827 827 — — — 3,212 3,212 — — 69,559 2,240 2,858 14,987 89,644 827 827 As of the transition date Level 1 Level 2 Level 3 Total (Millions of yen) Financial assets Financial assets measured at fair value through profit or loss Short-term investments ............................................................ Derivative assets ....................................................................... Other ......................................................................................... Financial assets measured at fair value through other — — — comprehensive income Equity securities ........................................................................ Total ...................................................................................... 10,476 10,476 Financial liabilities Financial liabilities measured at fair value through profit or loss Derivative liabilities ................................................................... Total ...................................................................................... — — 47,644 656 2,853 — 51,153 1,086 1,086 — — — 2,997 2,997 — — 47,644 656 2,853 13,473 64,626 1,086 1,086 59 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements Changes in financial instruments categorized within Level 3 are as follows: Beginning balance ..................................................................................................................................... Gains (Losses)1 ...................................................................................................................................... Purchases .............................................................................................................................................. Sales ...................................................................................................................................................... Other changes ....................................................................................................................................... Ending balance .......................................................................................................................................... 2016 3,212 231 30 — (1) 3,472 (Millions of yen) 2015 2,997 290 — (73) (2) 3,212 Note: 1. All gains and losses are associated with financial assets measured at fair value through other comprehensive income at the end of each reporting period. These gains and losses are recognized in net gain (loss) on revaluation of financial assets measured at fair value through other comprehensive income in the consolidated statement of comprehensive income. Financial instruments categorized within Level 3 are primarily unlisted equity securities. Each responsible department of the Group refers to the Group accounting policies in measuring the fair value of unlisted equity securities each quarter using recently available data, and reports any changes in fair value and the reasons to the department manager, and to senior management as necessary. 3) Financial instruments measured at amortized cost The following tables present the measurement techniques for measuring the fair value of major financial instruments measured at amortized cost. Financial instruments for which carrying amounts are a reasonable approximation of fair value or financial instruments that are not material are not included in the tables. (i) Cash and cash equivalents (excluding short-term investments measured at fair value), trade and other receivables, and trade and other payables Carrying amounts approximate fair value because these are settled in the short-term. (ii) Bonds and borrowings The fair value of bonds is based on market prices. The fair value of borrowings is the present value of remaining principal and interest discounted using a deemed interest rate on equivalent new borrowings. The carrying amount and fair value hierarchy of financial instruments measured at amortized cost are as follows: As of December 31, 2016 Carrying amount Level 1 Level 2 Level 3 Total Fair value (Millions of yen) Financial liabilities Financial liabilities measured at amortized cost Bonds ............................................................. Borrowings ..................................................... As of December 31, 2015 Financial liabilities Financial liabilities measured at amortized cost Bonds ............................................................ Borrowings .................................................... As of the transition date Financial liabilities Financial liabilities measured at amortized cost Bonds ............................................................ Borrowings .................................................... 49,947 70,699 — — 50,548 71,084 — — 50,548 71,084 Carrying amount Level 1 Level 2 Level 3 Total Fair value (Millions of yen) 49,925 70,621 — — 50,650 70,933 — — 50,650 70,933 Carrying amount Level 1 Level 2 Level 3 Total Fair value (Millions of yen) 49,903 51,707 — — 50,910 51,935 — — 50,910 51,935 Kao Corporation Financial Report 2016 60 35 Principal Subsidiaries Principal subsidiaries consist of the following. Voting rights at December 31, 2016 did not significantly change from a year earlier. Company name Country Principal businesses Voting rights (%) Kao Group Customer Marketing Co., Ltd. Japan Control of sales companies and other subsidiaries in Japan Kao Customer Marketing Co., Ltd. Kanebo Cosmetics Inc. Kanebo Cosmetics Sales Inc. Kao Transport & Logistics Co., Ltd. Kao (China) Holding Co., Ltd. Kao Corporation Shanghai Kao (Hefei) Co., Ltd. Kao Commercial (Shanghai) Co., Ltd. Kanebo Cosmetics (China) Co., Ltd. Kao (Shanghai) Chemical Industries Co., Ltd. Kao (Taiwan) Corporation Pilipinas Kao, Inc. Beauty Care Human Health Care Fabric and Home Care Beauty Care Beauty Care Logistics and related services in Japan Control of subsidiaries in China Beauty Care Beauty Care Human Health Care Fabric and Home Care Human Health Care Beauty Care Human Health Care Fabric and Home Care Beauty Care Chemical Beauty Care Human Health Care Fabric and Home Care Chemical Japan Japan Japan Japan China China China China China China Taiwan Philippines Chemical Kao Industrial (Thailand) Co., Ltd. Thailand Beauty Care Human Health Care Fabric and Home Care Chemical Beauty Care Human Health Care Fabric and Home Care Chemical Beauty Care Human Health Care Fabric and Home Care Thailand Malaysia Indonesia U.S.A. Beauty Care U.S.A. U.S.A. Germany Germany Germany Corporate service to subsidiaries in U.S. Holding company for Chemical Business in the U.S. Chemical Beauty Care Beauty Care Chemical U.K. Beauty Care Spain Spain Control of subsidiaries in Chemical Business in Europe, etc. Chemical 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 92.2 100.0 100.0 100.0 70.0 72.2 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Kao Commercial (Thailand) Co., Ltd. Fatty Chemical (Malaysia) Sdn. Bhd. PT Kao Indonesia Kao USA Inc. Kao America Inc. Kao Specialties Americas LLC Kao Germany GmbH Kao Manufacturing Germany GmbH Kao Chemicals GmbH Molton Brown Limited Kao Chemicals Europe, S.L. Kao Corporation S.A. 61 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements 36 Related Parties (1) Transactions with Related Parties Disclosure is omitted because there is no material related party transaction. (2) Primary Executive Management Compensation Primary executive management compensation consists of the following. The Group’s primary executive management includes members of the Board of Directors and executive officers of the Company for each fiscal year. Short-term benefits ................................................................................................................................... Post-retirement benefits ............................................................................................................................ Share-based payment ................................................................................................................................ Total ....................................................................................................................................................... 2016 1,131 39 227 1,397 (Millions of yen) 2015 951 50 225 1,226 37 Commitments Commitments to acquire property, plant and equipment and intangible assets after the end of each reporting period are as follows: Acquisition of property, plant and equipment ............................................................. Acquisition of intangible assets .................................................................................. Total ........................................................................................................................ 2016 27,100 1,306 28,406 2015 23,130 689 23,819 (Millions of yen) Transition date 19,958 625 20,583 38 Significant Subsequent Events The Board of Directors, at the meeting of the Board of Directors held on February 2, 2017, resolved to retire treasury shares in accordance with Article 178 of the Companies Act and the Company retired treasury shares of the Company. The number of shares retired corresponds to the number of shares of the Company’s shares purchased from the market during the fiscal year ended December 31, 2016. • Shares retired: Ordinary shares of the Company • Number of shares retired: 9,000,000 shares • Total amount of shares retired: 48,429 million yen • Retirement date: March 1, 2017 Kao Corporation Financial Report 2016 62 39 First-time Adoption of IFRS The Group presents consolidated financial statements that comply with IFRS from the fiscal year ended December 31, 2016. The most recent consolidated financial statements prepared in accordance with generally accepted accounting principles in Japan (hereinafter “Japanese GAAP”) were for the fiscal year ended December 31, 2015, and the transition date is January 1, 2015. The first-time adopter shall, in principle, apply the standards required under IFRS retrospectively. However, an entity may elect to use the exemptions contained in IFRS 1 and shall apply the exceptions prohibiting retrospective application of some aspects of other IFRS. The Group mainly applies the following exemptions. IFRS 1 Exemptions (1) Business Combinations Under IFRS 1, an entity may elect to apply IFRS 3 “Business Combinations” (hereinafter “IFRS 3”) either retrospectively or prospectively. The Group has elected not to apply IFRS 3 retrospectively to past business combinations that occurred before the transition date. As a result, the Group has applied the accounting treatment under Japanese GAAP to the business combinations that occurred before the transition date, which were not restated. With respect to goodwill arising in business combinations, the Group has kept the Japanese GAAP carrying amounts that had been applied before the transition to IFRS, in principle, and has translated all goodwill denominated in a foreign currency at the closing rate for the retrospective application of IAS 21 “The Effects of Changes in Foreign Exchange Rates.” Goodwill is tested for impairment at the transition date, regardless of any indications of impairment. (2) Deemed Cost Under IFRS 1, an entity may elect to measure property, plant and equipment at its fair value at the transition date and use the fair value as its deemed cost at the transition date. The Group used fair value at the transition date as the deemed cost for certain property, plant and equipment. (3) Cumulative Translation Differences for Foreign Operations Under IFRS 1, the cumulative translation differences for all foreign operations are deemed to be zero at the transition date, or recalculated retrospectively up until the date the subsidiary or associate was established or acquired. The Group elected to reset the cumulative translation differences to zero at the transition date. (4) Designation of Previously Recognized Financial Instruments Under IFRS 1, an entity may designate financial instruments recognized before the transition date in accordance with IFRS 9 on the basis of the facts and circumstances that exist at the transition date. The Group designated financial instruments in accordance with IFRS 9 on the basis of the facts and circumstances that existed at the transition date. Mandatory Exceptions of IFRS 1 IFRS 1 prohibits retrospective application of IFRS for estimates, derecognition of financial assets and financial liabilities, hedge accounting, non-controlling interests, classification and measurement of financial assets, and impairment of financial assets. The Group has prospectively applied IFRS for these items from the transition date. 63 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements The table below presents reconciliations required in first-time adoption of IFRS. In the table, items that do not affect retained earnings and comprehensive income are included in the “Reclassification” column, differences from Japanese GAAP resulting from a review of the scope of consolidation under IFRS are included in the “Consolidation scope differences” column, and items that affect retained earnings and comprehensive income are included in the “Recognition and measurement differences” column. Reconciliations of Equity as of the Transition Date (January 1, 2015) Japanese GAAP Reclassifi- cation Consolidation scope differences Recognition and measurement differences IFRS Notes Accounts under IFRS (Millions of yen) 107,412 121,251 304 — 228,967 (13), (14) 204,060 110,639 157,787 6,832 20,232 — — 36,420 7,279 (110,639) (2,892) (6,832) (20,232) 1,023 4,130 10,428 (1,648) 641,734 1,648 5,164 1,290 — 1,161 — — 238 (96) (33) — 2,864 113 — (4,180) — — — — 484 — (3,583) 212,742 — 151,876 — — 1,261 4,034 47,299 — 646,179 Assets Current assets Cash and cash equivalents Trade and other receivables (14) (13) (1), (14) Inventories (13) (14) (13), (14) (13), (14) Income tax receivables Other financial assets Other current assets Total current assets Non-current assets Property, plant and 307,615 10,432 2,119 (884) 319,282 (2), (13), (14) equipment Accounts under Japanese GAAP Assets Current assets Cash and time deposits ............ Notes and accounts receivable - trade .................... Short-term investments ............ Inventories ................................ Prepaid expenses ...................... Deferred tax assets ................... Other ......................................... Allowance for doubtful receivables ............................. Total current assets .................. Fixed assets Property, plant and equipment..... Intangible assets .......................... Goodwill .................................... Trademarks ............................... Other ......................................... 139,941 15,145 12,844 — — (15,145) (12,844) 27,965 Investments and other assets Investment securities ............... 20,984 (20,984) Long-term loans ........................ Long-term prepaid expenses ..... Asset for retirement benefits .... Other ......................................... Deferred tax assets ................... Allowance for doubtful — 1,432 17,281 9,692 — 11,612 20,630 receivables ............................. Total fixed assets ...................... Total assets .................................... (677) 556,499 1,198,233 9,264 (1,432) (17,281) (9,692) 23,916 4,982 20,232 677 20,090 25,254 — — — 7 — (5,505) — — — 424 44 1,189 — (1,722) 1,142 (1,190) — — (4,346) 138,751 — — 23,626 — — (215) — — — 1,748 (8,672) 19,143 — 5,584 2,001 3,544 — — — 26,088 7,966 61,194 — 580,451 1,226,630 (3) Goodwill (4), (14) Intangible assets Investments accounted for using the equity method (14) (13) (5), (13), (14) (9), (14) (6), (13), (14) Other financial assets Other non-current assets Deferred tax assets Total non-current assets Total assets Kao Corporation Financial Report 2016 64 Japanese GAAP Reclassifi- cation Consolidation scope differences Recognition and measurement differences (Millions of yen) IFRS Notes Accounts under IFRS Liabilities Current liabilities Accounts under Japanese GAAP Liabilities Current liabilities Notes and accounts payable - trade ........................ Short-term loans ....................... Current portion of long- term loans ............................... Accounts payable - other .......... Accrued expenses .................... Income taxes payable ............... Liability for loss related to cosmetics ............................... Other ......................................... Total current liabilities ............... Long-term liabilities Bonds ........................................ Long-term loans ........................ Liability for retirement benefits ................................... Other ......................................... 129,711 1,137 20,013 — 66,230 94,666 28,108 8,220 — — 32,451 380,536 50,000 30,083 — 42,414 — — 22,807 — 65,491 (1,137) (20,013) 21,150 (66,230) (94,666) 112 (8,220) 10,122 35,962 81,754 24,325 (50,000) (30,083) 80,083 798 11,877 4,447 (19,614) 3,421 929 25,254 Total long-term liabilities ........... Total liabilities ............................ 145,304 525,840 Net assets Common stock .......................... Capital surplus ........................... Treasury stock, at cost .............. Unrealized gain on available-for- sale securities......................... Deferred gain (loss) on derivatives under hedge accounting .............................. Foreign currency translation 85,424 109,561 (9,719) — — — 5,507 (5,507) 8 (8) adjustments............................ (4,853) 4,853 Remeasurements of defined benefit plans ........................... Stock acquisition rights ............. Retained earnings ..................... 3,619 944 — 468,684 (3,619) (944) 5,225 — (14) Trade and other payables (14) Bonds and borrowings (14) (13) (13), (14) (7), (13), (14) (8), (13), (14) Income tax payables Other financial liabilities Provisions Other current liabilities Total current liabilities Non-current liabilities (14) (9), (14) (13), (14) (13), (14) Bonds and borrowings Retirement benefit liabilities Other financial liabilities Provisions Other non-current (10), (13), (14) liabilities (6), (13) Deferred tax liabilities Total non-current liabilities Total liabilities Equity Share capital Capital surplus Treasury shares (1,742) — — 272 — — 63 — (4,375) (2) 4,210 (1,574) — — 202 763 936 370 108 — 2,379 805 — — — — — — — — — — — — — — — — 18 (2,600) 5,501 2,919 — — (97) 33,920 — 479 2,110 (2,988) 33,424 36,343 — — — — — — — — 193,460 — — 21,422 — — 28,283 — 5,765 33,360 123,916 406,206 — — 80,188 77,895 12,813 5,296 5,411 433 182,036 588,242 85,424 109,561 (9,719) — — — — — (302) 151 2,678 (36,860) 7,601 431,975 (11), (14) (12), (14) Other components of equity Retained earnings Equity attributable to owners of the parent Non-controlling interests Total equity Total liabilities and equity Minority interests ...................... Total net assets ......................... Total liabilities and net assets ......... 13,218 672,393 1,198,233 — — 25,254 488 337 1,142 (160) (34,342) 2,001 624,842 13,546 638,388 1,226,630 (14) 65 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements Notes on Reconciliations of Equity as of the Transition Date (January 1, 2015) (1) Adjustment to Inventories Mainly, goods for sales promotion recognized in supplies under Japanese GAAP are recognized in an adjustment to retained earnings as they do not meet the definition of assets under IFRS. (2) Adjustment to Property, Plant and Equipment Property, plant and equipment is adjusted mainly by applying deemed cost as follows. The Group used fair value as the deemed cost at the transition date for certain items of property, plant and equipment. At the transition date, the carrying amount of property, plant and equipment to which deemed cost was applied was 1,851 million yen under Japanese GAAP, and the fair value was 848 million yen. As a result of the above, property, plant and equipment at the transition date decreased by 1,003 million yen, and the adjustment was recognized in retained earnings. Fair value is based on valuation by independent appraisers with appropriate qualifications and other methods, and is categorized within Level 3. (3) Adjustment to Goodwill Under Japanese GAAP, certain foreign currency-denominated goodwill was translated at the exchange rate at the acquisition date, whereas under IFRS all foreign currency-denominated goodwill is translated at the closing rate and recognized in adjustments to retained earnings. (4) Adjustment to Intangible Assets Certain intangible assets recognized under Japanese GAAP are recognized in adjustments to retained earnings as they do not meet the definition of assets under IFRS. (5) Adjustment to Other Financial Assets (Non-current Assets) Under Japanese GAAP, non-marketable equity instruments were carried at the acquisition cost, and impairment loss was recognized as required depending on the financial condition of the issuing company. Under IFRS, these equity instruments are designated as financial assets measured at fair value through other comprehensive income, and are measured at fair value, irrespective of the existence of market activity, with the change recognized as other comprehensive income and reclassified to retained earnings in case of derecognition or a significant decrease in fair value. (6) Adjustments to Deferred Tax Assets and Deferred Tax Liabilities The amounts of deferred tax assets and deferred tax liabilities are adjusted mainly due to taxable temporary differences arising as a result of adjustments from Japanese GAAP to IFRS. (7) Adjustment to Provisions (Current Liabilities) Under Japanese GAAP, future expenses that fulfilled the required conditions were recognized as provisions, but are recognized in an adjustment to retained earnings as they do not meet the conditions for recognition of provisions under IFRS. (8) Adjustment to Other Current Liabilities Mainly, obligation for unused paid absences that was not recognized as a liability under Japanese GAAP is recognized as a liability under IFRS and recognized in an adjustment to retained earnings. (9) Adjustments to Retirement Benefit Liabilities and Other Non-current Assets Under Japanese GAAP, actuarial gains and losses were recognized in other comprehensive income as incurred, and were recognized in profit or loss from the fiscal year when incurred, amortized on a straight-line basis over a certain number of years no longer than the average remaining service period of employees. Under IFRS, these actuarial gains and losses are recognized in other comprehensive income as incurred, and immediately reclassified to retained earnings. Moreover, under Japanese GAAP, past service costs were recognized in other comprehensive income as incurred, and were recognized in profit or loss from the fiscal year when incurred, amortized on a straight-line basis over a certain number of years no longer than the average remaining service period of employees whereas under IFRS they are recognized in profit or loss as incurred. Under Japanese GAAP, the Company adopted the “Accounting Standard for Retirement Benefits” of the Accounting Standards Board of Japan (hereinafter “ASBJ”) (ASBJ Statement No. 26 issued on May 17, 2012, hereinafter “Retirement Benefits Accounting Standard”), and the “Guidance on Accounting Standard for Retirement Benefits” (ASBJ Guidance No. 25 issued on March 26, 2015, hereinafter “Retirement Benefits Guidance”) from the fiscal year ended December 31, 2015, revising the methods for calculating retirement benefit obligations and service costs and changing the method for calculating projected retirement benefits from the straight-line basis to the benefit formula basis. In addition, determination of the discount rate changed from a method based on the number of years for the underlying obligations approximating the average remaining years of service of the eligible employees to a method using several discount rates set for each expected retirement benefit payment period. In accordance with the transitional handling set forth in Article 37 of the Retirement Benefits Accounting Standard, the effect associated with the change in the method of calculating retirement benefit obligations and service costs was recognized by adjusting retained earnings at the beginning of the fiscal year ended December 31, 2015. Consequently, as the changes due to the revisions of the Retirement Benefits Accounting Standard and the Retirement Benefits Guidance were not recognized in the consolidated balance sheet under Japanese GAAP, which was already disclosed as of the transition date, the differences with the consolidated statement of financial position are recognized in retained earnings under IFRS. (10) Adjustment to Other Non-current Liabilities Special paid leave and bonuses granted conditional on a certain number of years of employment, which were not recognized as liabilities under Japanese GAAP, are recognized as liabilities under IFRS and recognized in adjustments to retained earnings. Kao Corporation Financial Report 2016 66 (11) Adjustment to Other Components of Equity 1) As an exemption elected under IFRS 1, the cumulative translation differences for all foreign operations were reclassified to retained earnings as of January 1, 2015, the transition date. As a result, other components of equity increased by 4,853 million yen. 2) Based on the fair value of non-marketable equity instruments stated in (5) above, other components of equity increased by 1,120 million yen. 3) Due to the impact of adjustment to retirement benefit liabilities stated in (9) above, other components of equity decreased by 3,318 million yen. (12) Adjustments to Retained Earnings Adjustment to inventories ................................................................................................ Adjustment to property, plant and equipment ............................................................... Adjustment to goodwill ..................................................................................................... Adjustment to intangible assets ...................................................................................... Adjustment to provisions (current liabilities) .................................................................. Adjustment to other current liabilities ............................................................................. Adjustment to retirement benefit liabilities .................................................................... Adjustment to other non-current liabilities ..................................................................... Adjustment to exchange differences on translation of foreign operations ................ Other adjustments ............................................................................................................. Subtotal ....................................................................................................................... Adjustment for tax effects ................................................................................................ Adjustment for non-controlling interests ........................................................................ Total ......................................................................................................................... (Millions of yen) Transition date January 1, 2015 (4,180) (884) (1,190) (4,346) 2,600 (5,501) (36,366) (2,110) (4,853) 402 (56,428) 19,414 154 (36,860) (13) Reclassifications Reclassifications are made to comply with the provisions of IFRS. The main reclassifications are as follows: 1) Time deposits with deposit terms of more than three months in “Cash and time deposits” under Japanese GAAP are classified as “Other financial assets” in current assets under IFRS. Among “Short-term investments” and “Other (current assets)” under Japanese GAAP, short-term investments redeemable within three months from the date of acquisition are classified as “Cash and cash equivalents” under IFRS. 2) “Deferred tax assets” and “Deferred tax liabilities” classified as current items under Japanese GAAP are classified as non-current items under IFRS. 3) Store fixtures for cosmetics were classified as “Long-term prepaid expenses” under Japanese GAAP, but are classified as “Property, plant and equipment” under IFRS. 4) Financial assets and financial liabilities are disclosed separately based on the requirements of IFRS. 5) The provision for sales returns and asset retirement obligations, which were included in “Other (current liabilities)” and “Other (non-current liabilities)” and the gross amount of liability for loss related to cosmetics under Japanese GAAP, are classified as “Provisions” under IFRS. (14) Differences in Scope of Consolidation Certain subsidiaries of minor importance were not included in the scope of consolidation under Japanese GAAP and the equity method was applied, but all subsidiaries are included in the scope of consolidation under IFRS. 67 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements Reconciliations of Equity as of December 31, 2015 Japanese GAAP Reclassifi- cation Consolidation scope differences Recognition and measurement differences IFRS Notes Accounts under IFRS (Millions of yen) Cash and time deposits ............ 125,159 184,279 484 — 309,922 (11), (12) 205,603 158,651 158,134 7,048 20,763 — — 59,501 (1,626) 733,233 — 733,233 3,921 (158,651) (2,953) (7,048) (20,763) 1,899 5,301 (21,971) 1,626 (14,360) 1,330 (13,030) 1,147 — 814 — — 178 (236) 15 — 2,402 — 2,402 36 — (4,724) — — — — 460 — (4,228) — (4,228) 210,707 — 151,271 — — 2,077 5,065 38,005 — 717,047 1,330 718,377 Assets Current assets Cash and cash equivalents Trade and other receivables (12) (11) (1), (12) Inventories (11) (12) (11), (12) (11), (12) Income tax receivables Other financial assets Other current assets Subtotal Non-current assets held (11) for sale Total current assets Non-current assets Property, plant and 327,730 9,299 1,865 (897) 337,997 (2), (11), (12) equipment Accounts under Japanese GAAP Assets Current assets Notes and accounts receivable - trade .................... Short-term investments ............ Inventories ................................ Prepaid expenses ...................... Deferred tax assets ................... Other ......................................... Allowance for doubtful receivables ............................. Total current assets .................. Fixed assets Property, plant and equipment .. Intangible assets ....................... Goodwill ................................. Trademarks............................. Other ...................................... 127,099 1,791 14,832 — — (1,791) (14,832) 16,602 Investments and other assets Investment securities ............... 22,331 (22,331) Long-term loans ........................ — 1,171 9,384 (1,171) (4,956) — Long-term prepaid expenses .... 17,583 (17,583) Asset for retirement benefits .... Other ......................................... Deferred tax assets ................... Allowance for doubtful 1,027 — 11,860 23,896 receivables ............................. Total fixed assets ...................... Total assets .................................... (684) 548,636 1,281,869 (1,027) 26,862 5,846 20,763 684 30,705 17,675 — — — 2 — 11,152 — — (899) 138,251 — — 15,705 — — (3) Goodwill (4), (12) Intangible assets Investments accounted for using the equity method 4,209 — (12) — (11) — 29,339 17,732 49,454 (5), (11), (12) (12) (6), (11), (12) Other financial assets Other non-current assets Deferred tax assets (219) — — — 2,037 (35) 3,800 — — 440 61 995 — (1,593) 809 — 14,939 10,711 — 592,687 1,311,064 Total non-current assets Total assets Kao Corporation Financial Report 2016 68 Japanese GAAP Reclassifi- cation Consolidation scope differences Recognition and measurement differences (Millions of yen) IFRS Notes Accounts under IFRS Liabilities Current liabilities Accounts under Japanese GAAP Liabilities Current liabilities Notes and accounts payable - trade ........................ Short-term loans ....................... Current portion of long-term loans ....................................... Accounts payable - other .......... Accrued expenses .................... Income taxes payable ............... Liability for loss related to cosmetics ............................... Other ......................................... Total current liabilities ............... Long-term liabilities Bonds ........................................ Long-term loans ........................ 133,728 47 15 — 76,078 99,033 32,073 2,891 — — 33,628 377,493 74,741 (47) (15) 62 (76,078) (99,033) — (2,891) 11,335 16,712 82,225 7,011 50,000 70,060 — (50,000) (70,060) 120,060 Liability for retirement benefits .................................. 74,178 804 Liability for loss related to cosmetics ............................... Other ......................................... Total long-term liabilities ........... Total liabilities .............................. Net assets Common stock .......................... Capital surplus ........................... Treasury stock, at cost .............. Unrealized gain on available-for- sale securities......................... Deferred gain (loss) on derivatives under hedge accounting ......... Foreign currency translation 2,474 — — 20,531 — 217,243 594,736 85,424 108,659 (8,202) (2,474) 11,093 16,880 (17,790) 2,151 10,664 17,675 — — — 7,063 (7,063) (3) 3 adjustments............................ (19,315) 19,315 Remeasurements of defined benefit plans ........................... Stock acquisition rights ............. (152) 889 152 (889) (12) Trade and other payables (12) Bonds and borrowings (12) (11) (11), (12) (11) (7), (11), (12) Income tax payables Other financial liabilities Provisions Other current liabilities Total current liabilities Non-current liabilities (12) (12) (11) (11), (12) (11), (12) Bonds and borrowings Retirement benefit liabilities Other financial liabilities Provisions Other non-current (8), (11), (12) liabilities (6), (11) Deferred tax liabilities Total non-current liabilities Total liabilities Equity Share capital Capital surplus Treasury shares (1,709) — — 277 — — 111 — (4,406) — 3,920 (1,807) — — 222 724 — 724 365 83 — 2,118 311 — — — — — — — — — — — — — — — — — 60 5,649 5,709 206,760 — — 339 — — 32,184 — 6,929 16,772 125,422 388,406 — — (75) — — 120,207 — 75,706 — — 459 2,095 (1,833) 646 6,355 — — — — — — — — — 11,817 17,704 4,919 318 230,671 619,077 85,424 108,659 (8,202) — — — — — Retained earnings ........................ — 502,134 (11,518) — (218) 246 7,552 (3,081) (4,184) 499,299 (9), (12) (10), (12) Minority interests ......................... Total net assets ........................... Total liabilities and net assets ......... 10,636 687,133 1,281,869 — — 17,675 470 498 809 (115) 4,356 10,711 680,996 10,991 691,987 1,311,064 (12) Other components of equity Retained earnings Equity attributable to owners of the parent Non-controlling interests Total equity Total liabilities and equity 69 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements Notes on Reconciliations of Equity as of December 31, 2015 (1) Adjustment to Inventories Mainly, goods for sales promotion recognized in supplies under Japanese GAAP are recognized in an adjustment to retained earnings as they do not meet the definition of assets under IFRS. (2) Adjustment to Property, Plant and Equipment Property, plant and equipment is adjusted mainly by applying deemed cost as follows. The Group used fair value as the deemed cost at the transition date for certain items of property, plant and equipment. As a result, property, plant and equipment at the transition date decreased by 1,003 million yen, and the adjustment was recognized in retained earnings. At the transition date, the carrying amount of property, plant and equipment to which deemed cost was applied was 1,851 million yen under Japanese GAAP, and the fair value was 848 million yen. Fair value is based on valuation by independent appraisers with appropriate qualifications and other methods, and is categorized within Level 3. (3) Adjustment to Goodwill 1) Under Japanese GAAP, the amortization period of goodwill was effectively estimated and goodwill was amortized over the amortization period, but under IFRS amortization of goodwill has been discontinued since the transition date. 2) Under Japanese GAAP, certain foreign currency-denominated goodwill was translated at the exchange rate at the acquisition date, whereas under IFRS all foreign currency-denominated goodwill is translated at the closing rate and recognized in adjustments to other components of equity. (4) Adjustment to Intangible Assets Certain intangible assets that were recognized under Japanese GAAP are recognized in adjustments to retained earnings as they do not meet the definition of assets under IFRS. (10) Adjustments to Retained Earnings (5) Adjustment to Other Financial Assets (Non-current Assets) Under Japanese GAAP, non-marketable equity instruments were carried at the acquisition cost, and impairment loss was recognized as required depending on the financial condition of the issuing company. Under IFRS, these equity instruments are designated as financial assets measured at fair value through other comprehensive income, and are measured at fair value, irrespective of the existence of market activity, with the change recognized as other comprehensive income and reclassified to retained earnings in case of derecognition or a significant decrease in fair value. (6) Adjustments to Deferred Tax Assets and Deferred Tax Liabilities The amounts of deferred tax assets and deferred tax liabilities are adjusted mainly due to temporary differences arising as a result of adjustments from Japanese GAAP to IFRS. (7) Adjustment to Other Current Liabilities Mainly, obligation for unused paid absences that was not recognized as a liability under Japanese GAAP is recognized as a liability under IFRS and recognized in adjustments to retained earnings. (8) Adjustment to Other Non-current Liabilities Special paid leave and bonuses granted conditional on a certain number of years of employment, which were not recognized as liabilities under Japanese GAAP, are recognized as liabilities under IFRS and recognized in adjustments to retained earnings. (9) Adjustment to Other Components of Equity 1) As an exemption elected under the provisions of IFRS 1, the cumulative translation differences for all foreign operations were reclassified to retained earnings as of January 1, 2015, the transition date. In addition, under IFRS, the cumulative translation differences associated with the liquidation of foreign operations during the fiscal year were reclassified to retained earnings. As a result, other components of equity increased by 6,070 million yen. 2) Based on the fair value of non-marketable equity instruments stated in (5) above, other components of equity increased by 1,368 million yen. Adjustment to inventories ................................................................................................ Adjustment to property, plant and equipment ............................................................... Adjustment to goodwill ..................................................................................................... Adjustment to intangible assets ...................................................................................... Adjustment to other current liabilities ............................................................................. Adjustment to retirement benefit liabilities .................................................................... Adjustment to other non-current liabilities ..................................................................... Adjustment to exchange differences on translation of foreign operations ................ Other adjustments ............................................................................................................. Subtotal ....................................................................................................................... Adjustment for tax effects ................................................................................................ Adjustment for non-controlling interests ........................................................................ Total ......................................................................................................................... (Millions of yen) December 31, 2015 (4,724) (897) 11,687 (899) (5,649) (220) (2,095) (6,070) (33) (8,900) 5,755 64 (3,081) Kao Corporation Financial Report 2016 70 (11) Reclassifications Reclassifications are made to comply with the provisions of IFRS. The main reclassifications are as follows: 1) Time deposits with deposit terms of more than three months in “Cash and time deposits” under Japanese GAAP are classified as “Other financial assets” in current assets under IFRS. Among “Short-term investments” and “Other (current assets)” under Japanese GAAP, short-term investments redeemable within three months from the date of acquisition are classified as “Cash and cash equivalents” under IFRS. 2) “Deferred tax assets” and “Deferred tax liabilities” classified as current items under Japanese GAAP are classified as non-current items under IFRS. 3) Store fixtures for cosmetics were classified as “Long-term prepaid expenses” under Japanese GAAP, but are classified as “Property, plant and equipment” under IFRS. 4) Financial assets, financial liabilities and non-current assets held for sale are disclosed separately based on the requirements of IFRS. 5) The provision for losses on returned products and asset retirement obligations, which were included in “Other (current liabilities)” and “Other (non-current liabilities)” and the gross amount of liability for loss related to cosmetics under Japanese GAAP, are classified as “Provisions” under IFRS. (12) Differences in Scope of Consolidation Certain subsidiaries of minor importance were not included in the scope of consolidation under Japanese GAAP and the equity method was applied, but all subsidiaries are included in the scope of consolidation under IFRS. Reconciliations of Profit or Loss and Comprehensive Income for the Fiscal Year Ended December 31, 2015 (January 1 to December 31, 2015) Japanese GAAP 1,471,791 (658,221) 813,570 Reclassifi- cation — (647) (647) Consolidation scope differences 2,759 198 2,957 Recognition and measurement differences IFRS — 1,474,550 (658,865) 815,685 (195) (195) Notes (6) (2), (6) Accounts under IFRS Net sales Cost of sales Gross profit (Millions of yen) (2,234) 9,758 (8,824) 1,657 3 (85) (1,113) — — — — 462 (596) (134) (182) 48 — 12,577 (62) (1,286) 11,034 (375) (6,636) (26) — — — — 1,517 — — — — 3,997 2,609 6,606 166,038 (60,086) 105,952 6,516 90 — 105,196 756 — (642,729) 14,099 (19,737) 167,318 Selling, general and (1), (2), (6) administrative expenses (4), (6) (4), (6) Other operating income Other operating expenses Operating income 1,416 (4,213) (4), (6) Financial income (1), (2), (4), (6) Financial expenses (4), (6) (4) (4) (4) (4) (3), (6) Share of profit in investments accounted for using the equity method Income before income taxes Income taxes Net income Attributable to: Owners of the parent Non-controlling interests Accounts under Japanese GAAP Net sales ......................................... Cost of sales ................................... Gross profit ..................................... Selling, general and administrative expenses ..................................... Operating income ........................... Non-operating income .................... Non-operating expenses ................. Extraordinary gain ........................... Extraordinary loss ........................... Income before income taxes and minority interests ......................... Total income taxes ......................... Income before minority interests ... (649,190) — — 164,380 — — — 7,600 (2,707) 1,561 (9,255) 161,579 (62,099) 99,480 (3,882) 4,403 (9,627) (9,753) 1,788 2,508 2,656 (7,600) 2,707 (1,561) 9,255 — — — Minority interests ........................... Net income ..................................... — 618 98,862 98,862 — (98,862) 71 Kao Corporation Financial Report 2016 Notes to Consolidated Financial Statements Accounts under Japanese GAAP Income before minority interests ... Japanese GAAP 99,480 Reclassifi- cation — Consolidation scope differences (134) Recognition and measurement differences 6,606 IFRS 105,952 Notes Accounts under IFRS Net income (Millions of yen) Other comprehensive income Unrealized gain (loss) on available- for-sale securities ...................... Remeasurements of defined 1,310 benefit plans ............................. (3,712) — — 0 6 Other comprehensive income Items that will not be reclassified to profit or loss: Net gain (loss) on revaluation of financial assets measured at fair value through other comprehensive income Remeasurements of 485 1,795 (6) 2,936 (770) (5), (6) defined benefit plans — 167 78 — 245 (6) 1,270 Foreign currency translation adjustments .............................. (15,793) — — — (213) 942 (15,064) (6) — 12 12 Share in other comprehensive income of associates applied for equity method ........................... (9) (167) 150 7 (19) (6) Other comprehensive income ..... Comprehensive income .................. (18,204) 81,276 — — 21 (113) 4,382 10,988 (13,801) 92,151 (15,071) Share of other comprehensive income of investments accounted for using the equity method Total of items that will not be reclassified to profit or loss Items that may be reclassified subsequently to profit or loss: Exchange differences on translation of foreign operations Net gain (loss) on derivatives designated as cash flow hedges Share of other comprehensive income of investments accounted for using the equity method Total of items that may be reclassified subsequently to profit or loss Other comprehensive income, net of taxes Comprehensive income Notes on Reconciliations of Profit or Loss and Comprehensive Income for the Year Ended December 31, 2015 (January 1 to December 31, 2015) (1) Adjustment to Selling, General and Administrative Expenses 1) Under Japanese GAAP, expected return on plan assets and interest expenses relating to retirement benefits were included in cost of sales and selling, general and administrative expenses as retirement benefit expenses, but net interest relating to retirement benefits is classified as financial expenses under IFRS. As a result, negative 3,863 million yen was reclassified from selling, general and administrative expenses to financial expenses. 2) Under Japanese GAAP, actuarial gains and losses relating to retirement benefits were recognized in other comprehensive income as incurred, and were recognized in profit or loss from the fiscal year when incurred, amortized on a straight-line basis over a certain number of years no longer than the average remaining service period of employees. Under IFRS, these actuarial gains and losses are recognized in other comprehensive income as incurred, and immediately reclassified to retained earnings. Moreover, under Japanese GAAP, past service costs were recognized in other comprehensive income as incurred, and were recognized in profit or loss from the fiscal year when incurred, amortized on a straight-line basis over a certain number Kao Corporation Financial Report 2016 72 Notes to Consolidated Financial Statements of years no longer than the average remaining service period of employees, whereas under IFRS, they are recognized in profit or loss as incurred. As a result, defined benefit cost increased by 1,152 million yen compared with Japanese GAAP. 3) Under Japanese GAAP, the amortization period of goodwill was effectively estimated and goodwill was amortized over the amortization period, but amortization of goodwill is discontinued under IFRS. As a result, amortization of goodwill decreased by 12,879 million yen compared with Japanese GAAP. 4) The intangible assets recognized under Japanese GAAP that do not meet the definition of assets under IFRS are not recognized as assets. As a result, amortization of intangible assets decreased by 3,329 million yen compared with Japanese GAAP. 5) Under Japanese GAAP, future expenses that fulfilled the required conditions were recognized as provisions, but are recognized in an adjustment to retained earnings as they do not meet the conditions for recognition of provisions under IFRS. As a result, selling, general and administrative expenses increased by 1,710 million yen compared with Japanese GAAP. (2) Adjustment to Financial Expenses 1) Under Japanese GAAP, expected return on plan assets and interest expenses relating to retirement benefits were recognized in cost of sales and selling, general and administrative expenses as retirement benefit expenses, but net interest relating to retirement benefits is classified as financial expenses under IFRS. As a result, 4,529 million yen was reclassified from cost of sales and selling, general and administrative expenses to financial expenses. 2) Under Japanese GAAP, interest expenses, determined by multiplying the discount rate by retirement benefit obligations, and expected return on plan assets, determined by multiplying the expected rate of return on plan assets by plan assets, respectively, were recognized as retirement benefit expenses, but under IFRS the net interest amount determined by multiplying the net amount of retirement benefit obligations and the plan assets by the discount rate is recognized as retirement benefit expenses. As a result, financial expenses increased by 5,558 million yen. 3) As an exemption elected under the provisions of IFRS 1, the cumulative translation differences for all foreign operations were reclassified to retained earnings as of January 1, 2015, the transition date. As a result, foreign exchange losses associated with the liquidation of foreign operations during the fiscal year increased by 1,064 million yen compared with Japanese GAAP. (3) Adjustment to Income Taxes The amount of income taxes is adjusted due to temporary differences that arise as a result of adjustment from Japanese GAAP to IFRS. (4) Other Reclassifications In addition to the above, reclassifications are made to comply with the provisions of IFRS. The main reclassifications are as follows. Among items that were classified as non-operating income, non- operating expenses, extraordinary gain and extraordinary loss under Japanese GAAP, finance-related items and foreign exchange gain or loss are classified as financial income or financial expenses under IFRS and other items are classified as other operating income, other operating expenses or share of profit in investments accounted for using the equity method. (5) Adjustment to Remeasurements of Defined Benefit Plans Under Japanese GAAP, actuarial gains and losses were recognized in other comprehensive income as incurred, and were recognized in profit or loss from the fiscal year when incurred, amortized on a straight-line basis over a certain number of years no longer than the average remaining service period of employees. Under IFRS, these actuarial gains and losses are recognized in other comprehensive income as incurred, and immediately reclassified to retained earnings. Moreover, under Japanese GAAP, past service costs were recognized in other comprehensive income as incurred, and were recognized in profit or loss from the fiscal year when incurred, amortized on a straight-line basis over a certain number of years no longer than the average remaining service period of employees, whereas under IFRS, they are recognized in profit or loss as incurred. (6) Differences in Scope of Consolidation Certain subsidiaries of minor importance were not included in the scope of consolidation under Japanese GAAP and the equity method was applied, but all subsidiaries are included in the scope of consolidation under IFRS. Reconciliations of Cash Flows for the Fiscal Year Ended December 31, 2015 (January 1 to December 31, 2015) There are no significant differences between the disclosed consolidated statement of cash flows under Japanese GAAP and the disclosed consolidated statement of cash flows under IFRS. 40 Approval of the Consolidated Financial Statements The Consolidated Financial Statements were approved by Michitaka Sawada, President and Chief Executive Officer, and by Kenichi Yamauchi, Executive Officer, Senior Vice President, Accounting and Finance, on March 14, 2017. 73 Kao Corporation Financial Report 2016 Independent Auditor’s Report Kao Corporation Financial Report 2016 74 14-10, Nihonbashi Kayabacho 1-chome Chuo-ku, Tokyo 103-8210, Japan Investor Relations Telephone: 81-3-3660-7101 Facsimile: 81-3-3660-8978 E-mail: ir@kao.co.jp Website: http://www.kao.com/jp/en/corp_ir/investors.html 

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