Kao Corp.
Annual Report 2017

Plain-text annual report

Financial Report 2017 For the year ended December 31, 2017 Management Discussion and Analysis Consolidated Financial Statements Notes to Consolidated Financial Statements Independent Auditor’s Report 1 14 19 64 Management Discussion and Analysis In the fiscal year ended December 31, 2017 (fiscal 2017), the The Kao Way is the corporate philosophy of the Kao Group. Kao Group adopted International Financial Reporting To implement the above policies, all members of the Kao Standards (IFRS) 15, “Revenue from Contracts with Group will share the Kao Way and put it into practice every Customers” and its amendments early in tandem with a day as the foundation of our approaches and actions. revision of its sales system for the Consumer Products Business in Japan. To facilitate comparison, growth adjusted Management Metric Used as a Target for the impact of these changes and excluding the effect of As its principal management metric, the Kao Group uses currency translation is presented as “like-for-like” below. economic value added (EVA®*), which measures true profit by Management Policies Management Policies of the Kao Group factoring in the cost of invested capital. This essentially takes the perspective of shareholders and other asset owners to deploy capital efficiently and generate profits. The Kao Group believes that continuously increasing EVA will lead to increases in corporate value and thus corresponds with long- The Kao Group’s mission is to strive for the wholehearted term benefits, not only for shareholders, but for all satisfaction and enrichment of the lives of people globally and stakeholders. The target of the Kao Group’s business activities to contribute to the sustainability of the world, with products is to increase EVA while expanding its business scale. The Kao and brands of excellent value that are created from the Group uses this metric to assess its businesses, to make consumer’s and customer’s perspective. Under this mission, evaluations on investment in facilities, acquisitions and other the Kao Group considers its response to the environment, items, and to develop performance targets for each fiscal year society and governance (ESG) – three elements that and for its compensation system. contribute to the formation of a sustainable society – to be an * EVA is a registered trademark of Stern Stewart & Co. EVA is defined as investment in the future and will achieve “profitable growth” by placing greater emphasis on this area. This commitment is embraced by all members of the Kao net operating profit after tax (NOPAT) less a charge for the cost of capital employed in the business. Group as we further promote efforts to fully utilize our assets and work together with passion to share joy with consumers Medium-to-long-term Management Strategies of the Kao Group and customers in our core domains of cleanliness, beauty, health and chemicals. The Kao Group aims to be a global company that is closest Long-term Management Strategy Long-term Targets to the consumers and customers in each market, earning the As its vision by 2030 based on the above management respect and trust of its shareholders and all other stakeholders. policies, the Kao Group aims to make Kao a company with a The Kao Group views corporate governance as the global presence by combining sustained “profitable growth,” cornerstone of management for supporting management’s and “contributions to the sustainability of the world” with intentions and ambitions from both “proactive” and proposals to resolve social issues and social contribution “protective” aspects and for continuously increasing its activities conducted through its business operations. To corporate value. For this purpose, the Kao Group works for achieve this vision, the Kao Group will promote the further ongoing “Innovation”* and further enhances its internal reinforcement of the existing businesses that are its strength controls for the execution of management that is swift, and the creation of new markets from a global perspective efficient and sound, as well as impartial and transparent, with utilizing the R&D capabilities that will create value for the the aim of being a company with a global presence. future, in addition to implementing basic measures to further * Innovation is one of the values of the Kao Way, the corporate philosophy of the Kao Group. raise the level of safety and reliability. 1 Kao Corporation Financial Report 2017 It is becoming difficult to predict the various changes that enhancing non-financial (ESG) activities. In addition, by taking will occur throughout the world in all aspects, such as speed, the full use of its assets to the next dimension, the Kao Group size and direction. To deal with this situation, the Kao Group will realize profitable growth at a high level of quality and aims to achieve the above vision by fully embracing the slogan create new assets to achieve the following goals. of “Transforming Ourselves to Drive Change.” The Kao Group has established “Kirei* – Making Life The Kao Group’s Vision by 2030 Make Kao a company with a global presence that • Has a distinctive corporate image Become a company that is always by the consumer’s side • Is a high-profit global consumer goods company that exceeds: Beautiful” as the key message for its ESG activities. The Kao Group aims to create unique experiences and touch the hearts of consumers through products filled with its passion. * Kirei is a Japanese word that represents the concept of cleanliness, beauty, health, purity, and fairness. K20 Goals – Three Commitments - ¥2.5 trillion in net sales (¥1.0 trillion outside Japan) • Commitment to fostering a distinctive corporate image - 17% operating margin - 20% ROE • Provides a high level of returns to stakeholders Mid-term Business Plan The Kao Group regards its mid-term business plan for the period to 2020 as an important milestone toward achieving its vision by 2030. To enhance corporate value, it established the • 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) * Excluding the effect of currency translation, change of sales system, etc. • Commitment to returns to stakeholders - Shareholders: Continuous cash dividend increases Kao Group Mid-term Plan K20 targeting the four years from (40% payout ratio target) fiscal 2017 to fiscal 2020 and announced it publicly on December 12, 2016. - Employees: Continuous improvement in compensation, benefits and health support The Kao Group will thoroughly instill the “Integrity” set - Customers: Maximization of win-win relationships forth in the Kao Way, the Kao Group’s corporate philosophy, by - Society: Advanced measures to address social issues sharing and practicing it among all employees while further Cash Dividends per Share (Yen) 120 100 80 60 40 20 0 Increases in dividends for 28 consecutive periods 50 52 54 56 57 58 60 62 64 110 94 80 70 7.1 8.87 9.09 10.0 10.5 11.5 12.5 14 7.1 15 16 20 24 26 38 30 32 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Note: Impact of share splits is reflected retroactively. Kao Corporation Financial Report 2017 2  The Kao Group must securely build this foundation under promote both profitable growth and contributions to the K20 to achieve its vision by 2030. This entails promoting the sustainability of society through “Yoki-Monozukuri”* that is a evolution of its post-deflation growth model of using proactive half-step ahead of these changes. To that end, it will address investments to generate earning power, thus achieving and deal appropriately with the following issues. profitable growth. Doing so will require drastically revising current procedures, approaches and concepts to maximize and make full use of Kao Group assets. While remaining * 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.” committed to thoroughly instilling “Integrity,” the Kao Group (1) To deal with changes in the risks entailed in its will put into practice the K20 slogan of “Transforming businesses, the Kao Group will define the serious Ourselves to Drive Change.” company-wide risks among its main risks as corporate risks and work to prevent damage to the corporate value of the Group as a whole by further enhancing its Issues for Management management system. (2) Regarding brightening products containing the With intensifying market competition, changing market ingredient Rhododenol sold by Kanebo Cosmetics, for structure and volatility in raw material market conditions and which a voluntary recall was announced on July 4, 2013, exchange rates, the operating environment remains uncertain. Kanebo Cosmetics has been responding earnestly with Changes in the attitudes of consumers regarding the environment, health and other matters and associated support for the recovery and compensation of people who have experienced vitiligo-like symptoms. In addition, changes in their purchasing attitudes, as well as the aging the entire Kao Group is making efforts with a view of society, hygiene and other social issues, are growing in the tasks before it as working to prevent recurrence significance. Moreover, amid the global expansion of business while striving to ensure greater safety and reliability. and the progress of structural changes in various fields, (3) During fiscal 2017, a portion of cosmetics production at companies must deal with changes in the risks entailed in Kao Corporation’s Odawara Factory near Tokyo, Japan their businesses. Under these conditions, the Kao Group will was found to be non-compliant with the Fire Service Net Sales / Gross Profit Ratio Operating Income / Operating Margin (Billions of yen) 1,500 1,315.2 1,401.7 1,471.8 1,474.6 1,457.6 1,489.4* (%) 100 1,000 500 0 56.5 54.9 55.3 55.3 56.3 44.0* 2013 2014 2015 2015 2016 2017 80 60 40 20 0 (Billions of yen) 250 200 150 100 50 0 204.8 13.7 185.6 12.7 164.4 11.2 167.3 11.3 124.7 133.3 9.5 9.5 2013 2014 2015 2015 2016 2017 (%) 20 15 10 5 0 Japanese GAAP IFRS Japanese GAAP IFRS Net Sales (Left) Gross Profit Ratio (Right) Operating Income (Left) Operating Margin (Right) * In FY2017, the Kao Group adopted IFRS 15 early in tandem with a revision of its sales system for the Consumer Products Business in Japan. As a result, certain items formerly treated as SG&A expenses are accounted for as reductions of net sales or cost of sales. 3 Kao Corporation Financial Report 2017 Management Discussion and Analysis Costs, Expenses and Income as Percentages of Net Sales Years ended December 31, 2017, 2016 and 2015 Cost of sales ........................................................................... 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 ................... 2017 56.0% 44.0 30.4 13.7 — 13.7 — 9.9 IFRS 2016 43.7% 56.3 43.5 12.7 — 12.6 — 8.7 2015 44.7% 55.3 43.6 11.3 — 11.3 — 7.1 Japanese GAAP 2015 44.7% 55.3 44.1 11.2 11.0 — 6.7 — Act. In addition to suspending that portion of production and improving the production system to comply with the Fire Service Act, Kao Corporation inspected the Basic Approach to Selection of Accounting Standards status of compliance with said Act at each of its Having decided that unifying accounting standards within the locations, and confirmed that they are operating lawfully. Kao Group will contribute to improving the quality of its Kao Corporation will strengthen its management system business management, the Kao Group has voluntarily adopted to prevent a recurrence and promote thorough compliance IFRS from the fiscal year ended December 31, 2016 (fiscal with laws and regulations. 2016). This will enable management based on standardized procedures and information for each Group company and business, and the Kao Group intends to reinforce its management foundation in order to increase its corporate value as a global company. The Kao Group also believes that Net Income Attributable to Owners of the Parent* / Return on Net Sales Basic Earnings per Share / ROE (Billions of yen) 150 100 50 0 98.9 6.7 105.2 7.1 79.6 5.7 64.8 4.9 147.0 9.9 126.6 8.7 (%) 15 10 5 0 (Yen) 300 200 126.03 100 10.7 156.46 12.4 298.30 (%) 30 253.43 19.8 18.6 209.82 197.19 16.1 14.8 20 10 0 2013 2014 2015 2015 2016 2017 0 2013 2014 2015 2015 2016 2017 Japanese GAAP IFRS Japanese GAAP IFRS Net Income Attributable to Owners of the Parent (Left) Return on Net Sales (Right) Basic Earnings per Share (Left) ROE (Right) * Net income attributable to owners of the parent was reported as net income under Japanese GAAP for the years ended December 31, 2013 to 2015. Kao Corporation Financial Report 2017 4 the application of IFRS will facilitate the international to changes in consumer needs based on its concept of “Yoki- comparability of its financial statements in capital markets. Monozukuri,” which emphasizes research and development geared to consumers and customers. The Kao Group also conducted cost reduction activities and other measures. Overview of Consolidated Results The Kao Group got off to a smooth start in fiscal 2017, the first Analysis of Income Statement fiscal year of the Kao Group Mid-term Plan K20 covering the four years from 2017 to 2020. Consolidated operating results Net sales increased 2.2% compared with the previous fiscal year met the forecast announced on October 30, 2017, and the Kao to ¥1,489.4 billion. On a like-for-like basis, net sales increased Group was able to increase operating income and net income 5.6%. In the Consumer Products Business, sales increased in for the eighth consecutive fiscal year and achieve record-high Japan due to factors including market growth, launches of new operating income for the fifth consecutive fiscal year. and improved products, and further enhancement of sales From January to December 2017, the markets for promotion activities. Outside Japan, sales in Asia and the household and personal care products and cosmetics in Americas increased. In the Chemical Business, sales increased Japan, which are key markets for the Kao Group, were in solid as the Kao Group worked to adjust selling prices in response to condition on a value basis according to retail sales and increased costs for natural fats and oils. consumer purchasing survey data. In particular, the As for profits, although costs for natural fats and oils and e-commerce channel grew substantially and inbound demand other raw materials increased, due to the effect of increased (demand from visitors to Japan) for cosmetics increased sales in the Consumer Products Business in Japan and Asia, significantly, mainly in the department store channel. Average among other factors, operating income was ¥204.8 billion, an unit prices for household and personal care products increase of ¥19.2 billion compared with the previous fiscal increased by one point. year, the operating margin was 13.7% and income before Under these circumstances, the Kao Group worked to income taxes was ¥204.3 billion, an increase of ¥20.9 billion. launch and nurture products with high added value in response Net income was ¥148.6 billion, an increase of ¥20.7 billion. Basic earnings per share were ¥298.30, an increase of ¥44.87, or 17.7%, from ¥253.43 in the previous fiscal year. Net Sales / Operating Income Consumer Products Business Information by Segment (Billions of yen) 1,400 (Billions of yen) 300 Consumer Products Business 1,091.9 1,154.5 1,222.8 1,225.6 1,219.8 1,216.0 Sales decreased 0.3% compared with the previous fiscal year to 134.2 137.4 155.1 103.0 111.3 200 172.3 172.3 172.3 ¥1,216.0 billion. On a like-for-like basis, sales increased 4.4%. In Japan, sales decreased 2.1% to ¥886.2 billion. On a like- 100 0 for-like basis, sales increased 2.6%. The Kao Group made efforts that included launching numerous high-value-added products and enhancing proposal-oriented sales activities, in addition to strengthening its response to the e-commerce channel. In Asia, sales increased 7.1% to ¥188.8 billion, with strong 2013 2014 2015 2015 2016 2017 Japanese GAAP IFRS growth centered on China, Indonesia and elsewhere. On a Note: In FY2017, the Kao Group adopted IFRS 15 early in tandem with a revision of its sales system for the Consumer Products Business in Japan. like-for-like basis, sales increased 16.8%. Net Sales (Left) Operating Income (Right) 5 Kao Corporation Financial Report 2017 1,200 1,000 800 600 400 200 0 Management Discussion and Analysis In the Americas, sales increased 5.5% to ¥77.3 billion. On Beauty Care Business a like-for-like basis, sales increased 3.5%. In Europe, sales Sales decreased 2.6% compared with the previous fiscal year decreased 1.5% to ¥63.8 billion. On a like-for-like basis, sales to ¥586.0 billion. On a like-for-like basis, sales increased 2.1%. decreased 4.1%. Sales of cosmetics decreased 4.8% to ¥242.7 billion. On a Operating income increased ¥17.2 billion compared with like-for-like basis, sales increased 2.1%. Outside Japan, the the previous fiscal year to ¥172.3 billion due to the effect of Kao Group was able to substantially expand sales, with strong increased sales in the Human Health Care Business. performance in Asia, mainly in China. However, sales in Japan 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. fell slightly short of the previous fiscal year on a like-for-like Net Sales / EBITDA / Operating Income / Capital Expenditure Beauty Care Business Human Health Care Business Fabric and Home Care Business Chemical Business (Billions of yen) 100 73.8 71.8 69.9 64.0 75.575.5 57.657.6 69.5 51.1 86.0 84.984.9 77.2 74.2 76.176.1 78.1 71.2 70.5 69.2 66.1 54.754.7 62.2 61.0 37.9 28.4 23.9 29.4 19.2 17.0 20.6 20.5 20.1 27.427.4 25.8 32.5 23.023.0 16.9 21.9 13.6 46.0 35.5 43.6 41.841.8 38.738.7 33.4 38.938.9 31.0 31.2 25.9 23.923.9 42.9 41.4 41.3 41.841.8 30.1 28.6 29.7 30.330.3 36.2 34.9 21.5 22.1 16.2 15.215.2 16.1 14.7 16.3 11.9 14.7 13.8 15.3 15.2 16.1 12.712.7 80 60 40 20 0 (Billions of yen) 700 600 500 400 300 200 100 0 589.9 607.7 608.6 601.6 586.0 570.3 280.7 280.7 281.7 281.7 273.1 273.1 294.3 240.1 240.1 210.6 311.0 324.5 334.4 335.3345.2 335.7 288.0 288.0 288.5 288.5 288.5 288.5 273.8 273.8 261.2 261.2 310.3 2013 2014 2015 2015 2016 2017 2013 2014 2015 2015 2016 2017 2013 2014 2015 2015 2016 2017 2013 2014 2015 2015 2016 2017 Japanese GAAP IFRS Japanese GAAP IFRS Japanese GAAP IFRS Japanese GAAP IFRS Notes: In FY2017, the Kao Group adopted IFRS 15 early in tandem with a revision of its sales system for the Consumer Products Business in Japan. Figures for the Consumer Products Business present sales to external customers and figures for the Chemical Business include sales to the Consumer Products Business in addition to external customers. Net Sales (Left) EBITDA (Right) Operating Income (Right) Capital Expenditure (Right) Kao Corporation Financial Report 2017 6 basis. In addition to a decline in inbound sales, which grew underway since fiscal 2016 and to increased shipments for significantly in 2016, mid-price skin care brands faced an uphill e-commerce. In Indonesia, sales of locally manufactured battle. On the other hand, major reforms of the cosmetics products targeting the middle-class consumer segment grew business are progressing steadily, and SOFINA iP base steadily. Sales of Laurier sanitary napkins increased. The essence, which also started a rollout in Asia, performed well. brand was hard pressed by fierce competition in Japan, while The global brand KANEBO started a rollout in Europe, in on the other hand, sales in Asia grew steadily. addition to Japan and Asia. Sales of SUQQU, a prestige brand Sales of personal health products increased. Sales of oral available in the department store channel, and est the lotion, care products increased with the launch of new products and which was launched in fall 2017, grew strongly. steady sales of high-performance products. Sales of Sales of skin care and hair care products decreased 1.0% MegRhythm Steam Eye Mask grew steadily as the Kao Group to ¥343.3 billion. On a like-for-like basis, sales increased 2.1%. cultivated new users in Japan, despite a decrease in inbound In skin care products, sales of Bioré grew steadily, with good demand compared with the previous fiscal year. performance in Japan, Asia and the Americas, and a rollout in Operating income increased ¥12.7 billion compared with Europe. In addition, sales of Curél derma care products grew the previous fiscal year to ¥38.7 billion, mainly due to the strongly in Japan and Asia, due in part to the launch of new effect of increased sales in Japan and Asia. products for the aging care market and progress in building a lineup in the cosmetics category. On the other hand, sales of Fabric and Home Care Business hair care products decreased in Japan due to the impact of Sales decreased 2.7% compared with the previous fiscal year the shrinking mass market. In Europe, sales of the John to ¥335.7 billion. On a like-for-like basis, sales increased 1.5%. Frieda hair care brand decreased, but sales of professional In Japan, sales of fabric care products increased on a like- hair care products were nearly on par with the previous for-like basis. Sales of laundry detergents were nearly flat in a fiscal year. severe market environment, despite the launch of improved In December 2017, the Kao Group announced the Attack Neo Antibacterial EX W Power amid rising consumer acquisition of Oribe Hair Care, LLC, which owns Oribe, a awareness of bacteria. Sales of fabric softeners were steady. super-premium-price brand in the United States for hair salons. Growth in sales of home care products was firm due to Operating income increased ¥6.5 billion compared with the consumer acceptance of high-value-added products. Sales of previous fiscal year to ¥57.6 billion. CuCute dishwashing detergent grew with the market Human Health Care Business penetration of a spray foam-type product. In Asia, although price competition in laundry detergents Sales increased 7.8% compared with the previous fiscal year to was severe in Thailand and Indonesia, sales were nearly on ¥294.3 billion. On a like-for-like basis, sales increased 13.0%. par with the previous fiscal year. Sales of food and beverage products faced an uphill battle Operating income decreased ¥2.0 billion compared with as the Kao Group was unable to sufficiently convey the value the previous fiscal year to ¥76.1 billion due to factors including of the functional drink Healthya, which has been approved as the effects of increased raw material costs. a Food for Specified Health Uses (FOSHU), due in part to launches in numerous different fields of FOSHU products and Chemical Business Foods with Functional Claims related to body fat. Sales increased 13.3% compared with the previous fiscal year Sales of sanitary products increased. Sales of Merries baby to ¥310.3 billion. On a like-for-like basis, sales increased 10.8%. diapers grew substantially. In Japan, amid fierce competition, Sales of oleo chemicals increased due to factors including sales increased in the domestic market and cross-border efforts to adjust selling prices globally in line with increased e-commerce for the Chinese market also grew substantially. raw material costs. Sales of performance chemicals In China, sales grew substantially, due in part to good increased, partly due to a market recovery trend in progress in reforms of the sales structure that have been infrastructure-related fields in Japan, in addition to an increase 7 Kao Corporation Financial Report 2017 Management Discussion and Analysis in automobile production volume in Japan, China and ¥10.0 billion decrease in deferred tax assets. elsewhere. Sales of specialty chemicals increased steadily Total liabilities decreased ¥38.8 billion from December with growth in demand for information material-related, hard 31, 2016 to ¥608.0 billion. The principal increase in disk-related and other products. To expedite the development liabilities was an ¥8.0 billion increase in trade and other of water-based pigment inkjet ink that contributes to the payables. The principal decrease in liabilities was a ¥30.1 mitigation of environmental impact and to accelerate the billion decrease in retirement benefit liabilities. global expansion of such business, the Kao Group acquired Total equity increased ¥127.9 billion from December companies in the United States and Europe and made them 31, 2016 to ¥819.4 billion. The principal increases in consolidated subsidiaries as of July 2016 for the company equity were net income totaling ¥148.6 billion and other in the United States and as of April 2017 for the company comprehensive income totaling ¥31.3 billion. The principal in Europe. decrease in equity was dividends totaling ¥50.6 billion. Operating income increased ¥0.6 billion compared with the As a result of the above factors, the ratio of equity previous fiscal year to ¥30.3 billion, despite the impact of attributable to owners of the parent to total assets was sharp fluctuations in raw material costs. 56.5% compared with 50.8% at December 31, 2016. In addition, Kao Corporation retired 9.0 million treasury shares on March 1, 2017. Financial Position Total assets increased ¥89.1 billion from December 31, 2016 Cash Flows to ¥1,427.4 billion. The principal increases in assets were a ¥40.0 billion increase in cash and cash equivalents, an ¥8.0 The balance of cash and cash equivalents at December 31, billion increase in trade and other receivables, an ¥18.7 billion 2017 increased ¥40.0 billion compared with December 31, increase in inventories and a ¥25.0 billion increase in property, 2016 to ¥343.1 billion, including the effect of exchange plant and equipment. The principal decrease in assets was a rate changes. Equity Attributable to Owners of the Parent1 / Financial Leverage2 (Billions of yen) 1,000 (Times) 4.0 806.4 800 600 400 200 0 628.7 658.2 675.6 681.0 679.8 1.8 1.8 1.9 1.9 2.0 1.8 2013 2014 2015 2015 2016 2017 3.0 2.0 1.0 0 Capital Expenditures (Billions of yen) 100 80 60 40 20 0 83.4 82.8 89.9 79.4 68.5 63.7 2013 2014 2015 2015 2016 2017 Japanese GAAP IFRS Japanese GAAP IFRS Equity Attributable to Owners of the Parent (Left) Financial Leverage (Right) 1. Equity attributable to owners of the parent is presented as net worth under Japanese GAAP as of December 31, 2013 to 2015. Net worth is equity, excluding minority interests and stock acquisition rights. 2. Financial Leverage = Total Assets ÷ Equity Attributable to Owners of the Parent Kao Corporation Financial Report 2017 8 Cash Flows from Operating Activities interests. The Kao Group repaid borrowings of ¥10.0 billion Net cash flows from operating activities totaled ¥185.8 in March 2017 and ¥20.0 billion in September 2017 and billion. The principal increases in net cash were income borrowed the same amounts, respectively, in order to before income taxes of ¥204.3 billion, depreciation and maintain an appropriate capital cost ratio and strengthen its amortization of ¥54.5 billion, increase in trade and other financial base for growth investments. payables of ¥14.6 billion, and other, which includes accrued expenses, of ¥14.5 billion. The principal decreases in net cash were increase in inventories of ¥15.3 billion, decrease in retirement benefit liabilities of ¥30.9 billion and income taxes Basic Policies Regarding Distribution of Profits and Dividends for the Period paid of ¥55.3 billion. Cash Flows from Investing Activities Net cash flows from investing activities totaled negative ¥96.1 billion. This primarily consisted of purchase of From the standpoint of EVA, the Kao Group makes effective use of its steadily generated operating cash flow for the following purposes toward further growth. property, plant and equipment of ¥83.7 billion and purchase • Investment for future growth (capital expenditures, of intangible assets of ¥6.3 billion. M&A, etc.) • Steady and continuous dividends (40% payout ratio Free cash flow, the sum of net cash flows from operating target) activities and net cash flows from investing activities, was • Share repurchases and early repayment of interest- ¥89.7 billion. bearing debt including borrowings Cash Flows from Financing Activities Net cash flows from financing activities totaled negative ¥53.2 billion. This primarily consisted of ¥50.7 billion for dividends paid to owners of the parent and non-controlling In accordance with this policy, the Company announced a year-end dividend for fiscal 2017 of ¥56.00 per share, an increase of ¥2.00 per share from the forecast announced on October 30, 2017 and an increase of ¥8.00 per share Free Cash Flows* (Billions of yen) 150 121.0 100 50 0 106.8 107.5 95.7 89.7 81.3 2013 2014 2015 2015 2016 2017 Japanese GAAP IFRS * Free cash flow is the sum of net cash flows from operating activities and net cash flows from investing activities. Total Dividend Payment / Share Repurchases* / Net Income Attributable to Owners of the Parent (Billions of yen) 150 147.0 100 50 0 105.2 126.6 98.9 50.0 46.8 54.3 40.2 40.2 50.0 79.6 35.5 64.8 30.0 32.8 2013 2014 2015 2015 2016 2017 Japanese GAAP IFRS Total Dividend Payment Share Repurchases Net Income Attributable to Owners of the Parent * Excludes repurchase of shares of less than one trading unit 9 Kao Corporation Financial Report 2017 Management Discussion and Analysis compared with the previous fiscal year. Consequently, cash were ¥79.4 billion. In the Consumer Products Business, the dividends for the fiscal year will increase ¥16.00 per share Kao Group carried out activities including facility expansion, compared with the previous fiscal year, resulting in a total of streamlining, maintenance and renewal in each of its ¥110.00 per share. The consolidated payout ratio was 36.9%. businesses. The Kao Group reinforced its supply system in the For fiscal 2018, the Company plans to pay total cash Human Health Care Business by expanding production dividends of ¥120.00 per share (38.9% payout ratio), an capacity at its factories for sanitary products inside and increase of ¥10.00 per share compared with the previous outside Japan, and completed the construction of a new fiscal year. This plan is in accordance with the Company’s production building in the Beauty Care Business to enhance basic policies regarding distribution of profits, and free cash production capacity in Taiwan. In the Chemical Business, the flow and other factors have also been taken into Kao Group expanded production capacity inside and outside consideration. As a result, the Company is aiming for its 29th Japan, in addition to conducting activities including consecutive fiscal year of increases in dividends. streamlining, maintaining and renewing facilities. The closing EVA and Related Activities for the acquisition of a hair salon business in the United States that was announced in December 2017 took place in January 2018. Research and development expenditures were ¥56.7 billion, which was the equivalent of 3.8% of net sales, EVA for fiscal 2017 was ¥90.4 billion, an increase of ¥17.0 billion remaining at a high level relative to net sales. compared with the previous fiscal year due to a substantial increase in net operating profit after tax (NOPAT), despite an Increasing Profit: Costs for raw materials such as natural fats increase in capital costs from the previous fiscal year. The Kao Group conducted the following EVA-related activities during the fiscal year. and oils increased during fiscal 2017. However, due to efforts to address this issue by working to adjust selling prices in the Chemical Business, as well as market growth, launches of new and improved products, stepped-up sales promotion Investing for Growth: During fiscal 2017, the Kao Group activities and other factors in the Consumer Products invested aggressively for future growth. Capital expenditures Business in Japan, the Kao Group continued to achieve double-digit growth in operating income compared with the previous fiscal year. Financial Improvement: For fiscal 2017, Kao Corporation paid annual dividends per share of ¥110.00, an increase of ¥2.00 per share from its initial forecast and a year-on-year increase of ¥16.00, or 17%. As a result, Kao Corporation has achieved 28 consecutive fiscal periods of dividend growth, the longest for a listed company in Japan. 90.490.490.4 70.6 58.6 73.4 50.8 53.3 55.1 54.8 56.4 59.1 Business Risks and Other Risks 2013 2014 2015 2015 2016 2017 Japanese GAAP IFRS Cost of Capital EVA Various risks arise in the course of a company’s business. The Kao Group manages risks appropriately by identifying and evaluating risks to formulate and implement necessary countermeasures, among other activities. In addition, in the event a risk manifests itself, the Kao Group sets up an Kao Corporation Financial Report 2017 10 EVA / Cost of Capital (Billions of yen) 150 47.6 39.8 100 50 0 emergency response organization and strives to minimize (2) Chemical Business damage and loss by responding promptly. However, in the The Kao Group’s Chemical Business is affected by factors event a major risk such as those described below manifests including trends in customer demand and fluctuations in raw itself, it may exert a significant impact on the Kao Group’s material prices. The Chemical Business promotes creation of business results and financial condition. The major risks high-value-added products that match customer needs, described below are not a comprehensive list of risks the Kao conducts research and development of products in Group faces. Other risks exist and may have an impact on consideration of the environment, and provides such products investment decisions. Any statements below concerning the while working to reduce costs and deal with product prices. future are judgments made by Kao Corporation as of the However, as a consequence of uncertainties in these submission of its securities report to the Ministry of Finance. business activities due to various factors, the Chemical Business may be unable to provide products that match (1) Consumer Products Business customer needs or respond to matters such as fluctuations in 1. Response to Changes in Consumer Needs raw material prices. This could have an impact on the Kao The Kao Group’s Consumer Products Business is affected by Group’s business results and financial condition. business cycles and changes in consumers’ values in the market of each country. The Consumer Products Business (3) Business Acquisitions, Business Alliances and Mergers maintains and improves brand value by understanding The Kao Group may implement business acquisitions, changes in consumer needs and using the comprehensive business alliances, mergers or other such measures. When strength of the Kao Group’s product development and implementing them, the Kao Group makes decisions after manufacturing in working to create high-value-added products thoroughly assessing economic value and its partner and provide services through approaches in areas including companies. However, due to various unforeseeable the environment, health, the aging society and hygiene. uncertainties in its business activities, the Kao Group may be However, as a consequence of uncertainties in these unable to produce the results it initially expected. This could business activities due to various factors, the Consumer have an impact on the Kao Group’s business results and Products Business may be unable to provide products and financial condition. services that respond to changes in consumer needs and brand value could decrease. This could have an impact on the (4) Overseas Business Expansion Kao Group’s business results and financial condition. As one of its growth strategies, the Kao Group is conducting operations in markets in Asia, the Americas, Europe and 2. Response to Changes in Retailing elsewhere, with a particular emphasis on strengthening its The Kao Group’s Consumer Products Business is affected by operations in countries where higher economic growth rates changes in the structure of retailing, including progress in the and market expansion are forecast. However, the Kao Group creation of new corporate groups through retail industry may be unable to strengthen its operations as a consequence mergers and integration in the market, and the emergence and of uncertainties due to various factors in the course of expansion of new retail channels. The Consumer Products business including the occurrence of a slowdown in economic Business conducts sales activities and makes new offerings growth or uncertain political or social conditions, intensifying that respond to these structural changes. However, as a competition, the inability to conduct sufficient cost consequence of uncertainties in these business activities due management or the emergence of problems in relationships to various factors, the Consumer Products Business may be with retail outlets, sales agents or other trading partners. This unable to conduct sales activities or make new offerings that could have an impact on the Kao Group’s business results and respond to these structural changes. This could have an impact financial condition. on the Kao Group’s business results and financial condition. 11 Kao Corporation Financial Report 2017 Management Discussion and Analysis (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 in raw material costs into product prices. In addition, the Kao explosion or fire at production facilities, information and control Group is conducting development of substitute raw materials system malfunction, problems at a supplier of raw materials, for natural fats and oils through research into advanced dysfunction of social infrastructures such as electric power effective utilization of non-edible raw materials. However, and water, environmental pollution from harmful substances, unexpected radical changes in market prices could have an the spread of infectious disease, terrorism, political change, impact on the Kao Group’s business results and financial riots and other incidents could hinder the supply of products condition. (6) Product Quality to the market. This could 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 desires of consumers through its consumer communication engage in derivative transactions for the purpose of centers. However, the unanticipated occurrence of a serious speculation. However, because items on the financial quality problem or concerns about product safety or reliability statements of overseas consolidated subsidiaries are resulting from new scientific knowledge would not only cause translated into Japanese yen, substantial variance in the difficulties for the relevant brand, but would also have a major exchange rate from the expected rate at the time of impact on the reputation of all of the Kao Group’s products. conversion will have an impact on the Kao Group’s business This could have an impact on the Kao Group’s business results and financial condition. results and financial condition. (9) Impact of Deferred Tax Assets and Impairment (7) Response to Natural Disasters, Accidents and Other The Kao Group records various tangible fixed assets and Incidents intangible assets and deferred tax assets including assets To deal with earthquakes and other natural disasters, the Kao used in the course of business and goodwill incurred in Group has formulated disaster countermeasures for its corporate acquisitions. The Kao Group may not generate the production facilities and primary offices and a business expected cash flow due to divergence from planned future continuity plan (BCP), and will continue to strengthen and business results, a decline in market value or other factors. reinforce them in the future. However, the occurrence and This could have an impact on the Kao Group’s business consequent damage of an earthquake on a scale exceeding results and financial condition. assumptions that hinder the supply of products to the market Kao Corporation Financial Report 2017 12 Management Discussion and Analysis (10) Securing Human Capital (12) Information Management The Kao Group strives to secure diverse, superior human The Kao Group possesses confidential information related to capital to achieve its business goals globally. Human capital matters including research and development, production, with advanced expertise in areas such as research and marketing and sales, as well as the personal information of development, production, marketing and sales is indispensable numerous customers used for product development, sales in aiming for the Yoki-Monozukuri (see note on page 3) that promotion and other purposes. The Kao Group conducts consumers support. However, an inability to secure the thorough information management using guidelines for necessary human capital due to changes in employment handling information and implements appropriate security conditions or other factors could have an impact on the Kao measures for its information systems, including both Group’s business results and financial condition. hardware and software. However, a leak of confidential or (11) Compliance with Laws and Regulations attack on its server, unlawful access, a computer virus or In the course of its business activities, the Kao Group must other factor that exceeds expectations could have an impact comply with a variety of laws and regulations concerning on the Kao Group’s reputation, business results and financial personal information held by the Kao Group resulting from an areas such as standards for product quality and safety, the condition. environment and chemical substances, as well as accounting standards, tax law and regulations related to labor and (13) Litigation transactions. The Kao Group has constructed a compliance The Kao Group conducts diverse businesses globally, and system and strives to comply with all related laws and various types of litigation may be brought against it. The result regulations. However, a serious legal violation by the Kao of such litigation could have an impact on the Kao Group’s Group or by a consignee or other party could have an impact business results and financial condition. 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 2017 Consolidated Statement of Financial Position Kao Corporation and Consolidated Subsidiaries As of December 31, 2017 Assets Current assets Cash and cash equivalents ................................................................................................ Trade and other receivables .............................................................................................. Inventories ........................................................................................................................ Other financial assets ....................................................................................................... Income tax receivables ..................................................................................................... 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 ....................................................................................................... Deferred tax assets ........................................................................................................... Other non-current assets .................................................................................................. Total non-current assets ............................................................................................. Notes 2017 2016 (Millions of yen) 8, 35 9, 35 10 35 11 12 13 14 14 15 35 16 11, 20 343,076 216,507 183,921 14,914 2,653 28,162 789,233 147 789,380 395,800 138,735 16,829 7,682 27,345 40,918 10,686 637,995 303,026 208,459 165,200 13,038 1,462 23,812 714,997 344 715,341 370,835 137,783 14,689 4,701 25,473 50,939 18,548 622,968 Total assets ............................................................................................................ 1,427,375 1,338,309 Liabilities and equity Liabilities Current liabilities Trade and other payables .................................................................................................. Bonds and borrowings ...................................................................................................... Other financial liabilities .................................................................................................... Income tax payables ......................................................................................................... Provisions .......................................................................................................................... Contract liabilities .............................................................................................................. Other current liabilities ...................................................................................................... Total current liabilities ................................................................................................ Non-current liabilities Bonds and borrowings ...................................................................................................... Other financial liabilities .................................................................................................... Retirement benefit liabilities ............................................................................................. Provisions .......................................................................................................................... Deferred tax liabilities ....................................................................................................... Other non-current liabilities ............................................................................................... Total non-current liabilities ......................................................................................... Notes 2017 2016 19, 35 17, 35 18, 35 21 26 22 17, 35 18, 35 20 21 16 224,893 25,262 7,739 34,255 4,822 17,296 107,404 421,671 95,322 10,091 64,694 10,617 435 5,181 186,340 216,893 30,289 8,164 32,621 11,370 — 131,112 430,449 90,357 11,666 94,773 13,809 528 5,264 216,397 Total liabilities ......................................................................................................... 608,011 646,846 Equity Share capital ..................................................................................................................... Capital surplus .................................................................................................................. Treasury shares ................................................................................................................. Other components of equity ............................................................................................. Retained earnings ............................................................................................................. Equity attributable to owners of the parent ................................................................... Non-controlling interests ................................................................................................... Total equity ............................................................................................................. 23 23 23 23 23 85,424 107,980 (9,593) (12,315) 634,885 806,381 12,983 819,364 85,424 107,648 (57,124) (21,821) 565,715 679,842 11,621 691,463 Total liabilities and equity ....................................................................................... 1,427,375 1,338,309 Kao Corporation Financial Report 2017 14 Consolidated Statement of Income Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2017 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 ......................................................................................... Operating income ...................................................................................................... 13,14,20,27 13,26,28 13,14,20,29 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 Attributable to: Owners of the parent ................................................................................................. Non-controlling interests ............................................................................................ Net income ................................................................................................................ 2017 1,489,421 (834,107) 655,314 (452,666) 14,909 (12,766) 204,791 1,452 (3,960) 2,007 (Millions of yen) 2016 1,457,610 (637,502) 820,108 (633,368) 13,677 (14,846) 185,571 1,389 (5,424) 1,894 204,290 183,430 (55,683) 148,607 (55,541) 127,889 147,010 1,597 148,607 126,551 1,338 127,889 Earnings per share Basic (Yen) .................................................................................................................. Diluted (Yen) ............................................................................................................... 31 31 298.30 298.09 253.43 253.18 15 Kao Corporation Financial Report 2017 Consolidated Statement of Comprehensive Income Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2017 Net income .......................................................................................................................... Other comprehensive income Items that will not be reclassified to profit or loss: Notes 2017 148,607 (Millions of yen) 2016 127,889 Net gain (loss) on revaluation of financial assets measured at fair value through other comprehensive income ..................................................... Remeasurements of defined benefit plans ................................................................... 32, 35 32 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 ............................................ 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 .......................... 32 32 32 Other comprehensive income, net of taxes ..................................................................... Comprehensive income ..................................................................................................... Attributable to: Owners of the parent ........................................................................................................ Non-controlling interests ................................................................................................... Comprehensive income .................................................................................................... 1,166 21,260 317 22,743 (906) (16,111) (72) (17,089) 8,541 (16,661) (1) 8,540 31,283 179,890 178,020 1,870 179,890 (10) (16,671) (33,760) 94,129 93,284 845 94,129 Kao Corporation Financial Report 2017 16 Consolidated Statement of Changes in Equity Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2017 Equity attributable to owners of the parent (Millions of yen) Notes Share Capital capital surplus 85,424 107,648 — — Treasury shares (57,124) — Subscription rights to shares 911 — Other components of equity Net gain (loss) on revaluation of financial assets measured at fair value through other compre hensive income 7,025 — Net gain (loss) on derivatives designated as cash flow hedges 4 — Exchange differences on translation of foreign operations (29,761) — Remeasurements of defined benefit plans — — Total (21,821) — Retained earnings 565,715 147,010 Total 679,842 147,010 Non- controlling interests 11,621 1,597 Total equity 691,463 148,607 1,472 1,472 21,317 21,317 31,010 31,010 — 147,010 31,010 178,020 273 1,870 31,283 179,890 January 1, 2017 ............... 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, 2017 ......... 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 ......... 23 23 34 25 23 23 34 25 — — — — — — — — — — — — — — — 8,221 8,221 — 49,373 (165) — (1,842) 332 — (0) — — — — — — — — — — — (15) — — — — — — — — — 332 85,424 107,980 47,531 (9,593) (180) 731 — (21,540) 85,424 108,659 — — (8,202) — 902 — — — (13,513) — (16,248) (16,248) 1,099 (189) — (50,021) — — — — — — — — — — — — (1,011) — — — — — — — — — — — — — — — — — — — (29,761) — 227 — — (29) — 9 911 — (1,011) 85,424 107,648 (48,922) (57,124) (0) (0) — — — — — — — — 4 (3) — 7 7 — — — — — — — — 4 — — — — — (7) — (7) 8,490 8,430 — (970) (970) — — — — — — (435) 7,025 (165) (48,914) 294 — (1,842) — — 294 (1,842) — (50,265) 332 (50,265) — (369) 332 (50,634) — (0) — — — — (0) — (139) (139) (21,317) (21,339) 21,339 — — — (21,317) — (21,504) (12,315) (77,840) 634,885 (51,481) 806,381 (508) 12,983 (51,989) 819,364 — — (4,184) — 499,299 126,551 680,996 126,551 10,991 1,338 691,987 127,889 (16,056) (16,056) (33,267) (33,267) — 126,551 (33,267) 93,284 (493) 845 (33,760) 94,129 — — — — — — — — — — — — — — — 227 — (189) (404) 506 — (50,021) — — 506 (50,021) — (44,139) 227 (44,139) — (955) 227 (45,094) — — (1,011) 1,007 (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 17 Kao Corporation Financial Report 2017 Consolidated Statement of Cash Flows Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2017 Notes 2017 2016 (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 and businesses ....................................................................... 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 8 204,290 54,508 (1,295) 1,339 (2,007) 3,111 (3,464) (15,349) 14,637 (30,886) 14,476 239,360 1,069 2,047 (1,329) (55,302) 185,845 (26,673) 25,349 (83,663) (6,273) (2,906) (1,980) (96,146) (59) 30,000 (30,090) (1,842) (50,299) (369) (585) (53,244) 36,455 303,026 3,595 343,076 183,430 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 Kao Corporation Financial Report 2017 18 Notes to Consolidated Financial Statements Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2017 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 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”) The Group’s consolidated financial statements have been prepared in accordance with IFRS issued by the International Accounting Standards Board, as 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. (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 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 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 19 Kao Corporation Financial Report 2017 (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”), and IFRS 15 “Revenue from Contracts with Customers” (issued in May 2014) and “Clarifications to IFRS 15” (issued in April 2016) (together, hereinafter “IFRS 15”) in preparing its consolidated financial statements. income of subsidiaries is attributed to owners of the parent 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. 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 the acquisition of the financial asset. Transaction costs of financial assets measured at fair value through profit or loss are recognized in profit or loss. (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 Kao Corporation Financial Report 2017 20 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 according to the classification of the financial asset as follows: (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. 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: (c) Equity instruments measured at fair value through • An unbiased and probability-weighted amount other comprehensive income The Group has made an irrevocable election to present subsequent changes in the 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 the fair value are included in other comprehensive income. If the Group disposes of an investment, or if the fair value of the investment declines significantly, the cumulative gain or loss recognized in other comprehensive income is reclassified from other components of equity to retained earnings. 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. 21 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements (iv) Derecognition of financial assets 4) Fair value of financial instruments 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 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. 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 2017 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: • Buildings and structures: 10 to 35 years • Machinery and vehicles: 7 to 14 years • 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. (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.” 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: • Trademarks: 10 years • 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.” 23 Kao Corporation Financial Report 2017 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. Kao Corporation Financial Report 2017 24 (12) Share-based Payments 1) Stock option plan with a customer, less discounts, rebates, returned products and other items. The Company has a stock option plan accounted for as an equity-settled share-based payment plan. Due to the introduction of a performance share plan from the fiscal year ended December 31, 2017, the stock option plan has been abolished except for the options already granted. 2) Performance share plan In the fiscal year ended December 31, 2017, the Company introduced a performance share plan accounted for as an equity-settled share-based payment plan. The performance share plan measures service received at the fair value of the Company’s shares on the date of grant, recognizing it as an expense from the date of grant through the vesting period and recognizing the same amount as an increase in capital surplus. The fair value of the Company’s shares on the date of grant is determined by adjusting the market price of the shares taking expected dividends into account. (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 has early adopted IFRS 15 effective from the fiscal year ended December 31, 2017. The Group recognizes revenue based on the following five-step model: Step 1: Identify the contract with a customer Step 2: Identify the performance obligations in the contract Step 3: Determine the transaction price Step 4: Allocate the transaction price to the performance obligations in the contract Step 5: Recognize revenue when the entity satisfies a performance obligation The Group sells 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. For sales of such products, because the customer obtains control over the products upon delivery, the performance obligation is judged to have been satisfied and revenue is therefore recognized upon delivery of the products. Revenue is measured at the consideration promised in a contract (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 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 25 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements 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. (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. (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. (20) Changes in Significant Accounting Policies (Revenue) The Group has early adopted IFRS 15 from the fiscal year ended December 31, 2017. As a transitional measure upon the early adoption of IFRS 15, the Group applies this Standard retrospectively with the cumulative effect of initially applying this Standard recognized at the date of initial application. In accordance with the adoption of IFRS 15, revenue is recognized based on the following five-step model: Step 1: Identify the contract with a customer Step 2: Identify the performance obligations in the contract Step 3: Determine the transaction price Step 4: Allocate the transaction price to the performance obligations in the contract Step 5: Recognize revenue when the entity satisfies a performance obligation The Group sells 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. For sales of such products, because the customer obtains control over the products upon delivery, the performance obligation is judged to have been satisfied and revenue is therefore recognized upon delivery of the products. Revenue is measured at the consideration promised in a contract with a customer, less discounts, rebates, returned products and other items. Based on the above five-step model, as a result of identification of performance obligations under contracts with customers, the portion of sales promotion and other expenses that is consideration paid by the Group to customers, which had previously been accounted for as selling, general and administrative expenses, is accounted for as reductions of net sales from the fiscal year ended December 31, 2017. In addition, freight/warehouse expenses, employee benefits and other expenses necessary for satisfying performance obligations that had previously been accounted for as selling, general and administrative expenses are accounted for as cost of sales from the fiscal year ended December 31, 2017. As a result, compared with the application of the former accounting standard, net sales decreased by 45,742 million yen, selling, general and administrative expenses decreased by 174,999 million yen, and cost of sales increased by 129,257 million yen in the consolidated statement of income for the fiscal year ended December 31, 2017. These changes had no effect on operating income or net income. In addition, with the application of IFRS 15, refund liabilities for rebates and other payments, which were previously included in trade and other payables under current liabilities, liabilities for returned products, which were previously included in provisions, and refund liabilities for rebates and other payments and advances received from customers, which were previously included in other current liabilities, are presented as contract liabilities. As a result, compared with the application of the former accounting standard, as of the end of the fiscal year ended December 31, 2017, trade and other payables under current liabilities decreased by 2,279 million yen and as of the beginning and end of the fiscal year ended December 31, 2017, provisions under current liabilities decreased by 3,965 million yen and 3,049 million yen, respectively, and other current liabilities decreased by 12,582 million yen and 11,968 million yen, respectively, in the consolidated statement of financial position. Kao Corporation Financial Report 2017 26 4 Significant Accounting Estimates and Judgments The Group’s consolidated financial statements include estimates and assumptions made by 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 14 “Goodwill and Intangible Assets” presents the method for measuring the recoverable amount and 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 the 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) Provisions The Group has recognized a provision for loss related to cosmetics, 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 asset retirement obligations and other provisions may be affected by factors such as changes in future business plans. If the actual amounts paid differ from the estimates, such 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. (4) 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 27 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements 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. (5) 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 35 “Financial Instruments” presents fair value measurement methods and amounts for major financial assets and liabilities measured at fair value. (6) 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 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 early adopted by the Group as of December 31, 2017 are as follows: IFRS Title Mandatory adoption (From the fiscal year beginning) IFRS 16 Leases January 1, 2019 Adoption by the Group Fiscal year ending December 31, 2019 Overview of new or revised Standards and Interpretations Revised lease definition, accounting treatment and disclosure 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. Kao Corporation Financial Report 2017 28 Reportable segments Major products Beauty Care Business Consumer Products Business Human Health Care Business Fabric and Home Care Business Cosmetics Counseling cosmetics, self-selection cosmetics Skin care products Hair care products Food and beverage products Soaps, facial cleansers, body cleansers Shampoos, conditioners, hair styling agents, hair coloring agents Beverages Sanitary products Sanitary napkins, baby diapers Personal health products Bath additives, oral care products, men’s products, thermo products Fabric care products Laundry detergents, fabric treatments Home care products Oleo 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 Chemical Business Performance chemicals Specialty chemicals Toner and toner binder for copiers and printers, ink and colorants for inkjet printers, fragrances and aroma chemicals (2) Sales and Results of Reportable Segments Fiscal year ended December 31, 2017 (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 585,995 294,292 335,709 1,215,996 273,425 1,489,421 — 1,489,421 — 585,995 57,596 — 294,292 38,661 — 335,709 76,057 — 36,860 310,285 30,299 1,215,996 172,314 36,860 1,526,281 202,613 (36,860) (36,860) 2,178 — 1,489,421 204,791 1,452 (3,960) 2,007 204,290 17,855 27,422 16,031 23,892 8,883 12,675 42,769 63,989 11,479 15,245 54,248 79,234 260 121 54,508 79,355 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 ....................... Capital expenditures4 ............ Notes: 1. The operating income reconciliation of 2,178 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 and amortization. 4. Capital expenditures include investments in property, plant and equipment and intangible assets. 29 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements 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 — 1,219,850 155,133 36,025 273,785 29,683 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 20,135 12,930 41,752 7,876 16,050 39,205 77,937 11,650 11,877 50,855 89,814 261 86 51,116 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 ...................... 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 and amortization. 4. Capital expenditures include investments in property, plant and equipment, intangible assets and other non-current assets. (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. 2017 938,074 288,087 134,751 134,219 102,763 (Millions of yen) 2016 964,904 251,284 103,346 120,782 93,148 129,041 1,489,421 120,640 1,457,610 Non-current Assets (excluding Financial Assets, Deferred Tax Assets and Retirement Benefit Assets) (Millions of yen) Japan ......................................................................................................................................................... Asia ............................................................................................................................................................ Americas .................................................................................................................................................... Europe ....................................................................................................................................................... Total .................................................................................................................................................... 2017 431,673 85,290 22,610 28,935 568,508 2016 415,993 81,927 22,854 24,731 545,505 Kao Corporation Financial Report 2017 30 7 Business Combinations (1) Acquisition of Ink Business of Chimigraf Holding, S.L. in Europe 1) Outline of Business Combination Name of the acquired business and the acquiree: Business outline: Acquisition date: Acquisition method: Business-related assets of Chimigraf Ibérica, S.L.U., the subsidiary of Chimigraf Holding, S.L.; and Chimigraf France, S.A.S. and Chimigraf Italy, S.R.L.,the subsidiaries of Chimigraf Holding, S.L. (collectively, “Chimigraf”) Development, manufacturing and sales of flexographic ink and inkjet ink April 1, 2017 Cash consideration to acquire assets and equity interests Percentage of voting rights acquired: 100% 2) Primary Reason for Business Combination Chimigraf is engaged in development, manufacturing and sales of flexographic ink and inkjet ink for package printing. With a wide range of product lineups and diverse ink designing technologies, Chimigraf has developed its business centered in Europe, and is expanding its sales network globally. In particular, Chimigraf is focusing on developing inkjet ink effective for various types of printing. By taking advantage of newly acquired technologies, manufacturing facilities and sales networks from Chimigraf in addition to the Group’s technologies, the Group aims to provide global customers with innovative products and services that can contribute to the mitigation of environmental impact. 3) Acquisition Cost of Acquired Business and Acquiree and Its Components Acquisition cost of acquired business and acquiree: 2,979 million yen Components of acquisition cost: Cash 2,979 million yen 4) Fair Value of Assets Acquired and Liabilities Assumed at the Acquisition Date Current assets ................................................................ 1,182 million yen Non-current assets ......................................................... 1,692 million yen Total assets ................................................................. 2,874 million yen Current liabilities ............................................................. 387 million yen Non-current liabilities ...................................................... 3 million yen Total liabilities .............................................................. 390 million yen 5) Goodwill Goodwill recognized: Components of goodwill: 495 million yen Goodwill recognized for this business combination reflects excess earning powers in future from using newly acquired technologies, manufacturing facilities and sales networks from Chimigraf in addition to the Group’s technologies. There is an immaterial amount of goodwill that 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, 2017 are not presented because the impacts on the consolidated statement of income are immaterial. 31 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements (2) Acquisition of Oribe Hair Care, LLC in the U.S. 1) Outline of Business Combination On January 17, 2018, the Company completed the acquisition of Oribe Hair Care, LLC (location: New York State, U.S.A.) pursuant to an acquisition agreement concluded through the Company’s U.S. subsidiary on December 19, 2017. Because initial accounting for this business combination is incomplete at this time, detailed information on accounting is not presented. Name of the acquiree: Oribe Hair Care, LLC Business outline: Acquisition date: Acquisition method: Development, manufacturing and sales of hair care products for hair salons January 17, 2018 Cash consideration to acquire equity interests Percentage of voting rights acquired: 100% 2) Primary Reason for Business Combination 3) Fair Value of Assets Acquired, Liabilities Assumed and The “Oribe,” a super-premium price brand for hair salons, which is owned by Oribe Hair Care, LLC, has a substantial presence in the top-class hair salon industry and among major specialty retailers in the United States. By utilizing the brand and products obtained through this acquisition, the Group aims to expand its brand portfolio for hair salons and to expand its customer base. Goodwill Recognized at the Acquisition Date Because the fair value of the assets acquired and liabilities assumed at the acquisition date is being determined, it has not been finalized at this time. 8 Cash and Cash Equivalents Cash and cash equivalents consist of the following: Cash and deposits ..................................................................................................................................... Short-term investments ............................................................................................................................. Total .................................................................................................................................................... 2017 260,176 82,900 343,076 (Millions of yen) 2016 186,226 116,800 303,026 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 .................................................................................................................................................... 2017 211,990 5,915 (1,398) 216,507 (Millions of yen) 2016 205,099 4,546 (1,186) 208,459 Trade receivables are recognized when the Group’s products are delivered because the Group’s right to consideration is unconditional except for the passage of time from that point. Moreover, the Group receives payment within a short period of time after satisfying its performance obligation under separately determined payment terms. Because the period from satisfaction of the performance obligation to receipt of consideration is usually within one year or less, as a practical expedient, the Group does not adjust the promised amount of consideration for the effects of a significant financing component for such receivables. Kao Corporation Financial Report 2017 32 10 Inventories Inventories consist of the following: Merchandise and finished goods ............................................................................................................... Work in progress ....................................................................................................................................... Materials and supplies ............................................................................................................................... Total .................................................................................................................................................... 2017 136,795 12,723 34,403 183,921 (Millions of yen) 2016 122,479 12,253 30,468 165,200 The amount of inventories recognized as expenses and included in cost of sales for the fiscal years ended December 31, 2017 and 2016 were 714,981 million yen and 636,969 million yen, respectively. Write-downs of inventories recognized as expenses for the fiscal years ended December 31, 2017 and 2016 were 5,093 million yen and 4,534 million yen, respectively. 11 Other Assets Other assets consist of the following: Other current assets (Millions of yen) 2017 2016 Insurance receivable .............................................................................................................................. Prepaid expenses ................................................................................................................................... Other ...................................................................................................................................................... Total .................................................................................................................................................... Other non-current assets Insurance receivable .............................................................................................................................. Long-term prepaid lease payments ....................................................................................................... Long-term prepaid expenses ................................................................................................................. Other ...................................................................................................................................................... Total .................................................................................................................................................... 8,120 9,566 10,476 28,162 2,654 4,508 1,624 1,900 10,686 6,330 9,410 8,072 23,812 11,095 5,337 881 1,235 18,548 12 Non-current Assets Held for Sale 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, 2017 and 2016 pursuant to the decision in the fiscal year ended December 31, 2016 to sell these assets. These assets were partially sold in the fiscal year ended December 31, 2017. 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. 33 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements 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 (Millions of yen) Buildings and structures 393,994 Machinery and vehicles 715,613 Tools, furniture and fixtures 115,639 Land 72,980 January 1, 2016............................................................ Additions .................................................................. Acquisitions through business combinations .......... Sales and disposals .................................................. Reclassification ........................................................ Reclassification to assets held for sale .................... Exchange differences on translation of foreign operations .................................................. 313 272 (5,355) 24,591 (585) 245 175 (29,108) 39,877 (22) (4,410) (10,069) 4,490 31 (7,642) 9,055 (7) (1,860) (94) 36 126 (97) 384 (216) (194) (1) Other ........................................................................ 79 86 December 31, 2016 ..................................................... 408,899 716,797 119,612 73,018 Additions .................................................................. Acquisitions through business combinations .......... Sales and disposals .................................................. Reclassification ........................................................ 566 697 (5,468) 18,605 230 100 4,762 48 (27,952) (13,424) 36,152 7,464 13 83 (443) 370 Exchange differences on translation of foreign operations .................................................. Other ........................................................................ December 31, 2017 ..................................................... 2,766 60 426,125 4,327 281 729,935 1,197 (315) 119,344 274 (0) 73,315 Accumulated Depreciation and Accumulated Impairment Losses Buildings and structures 281,243 January 1, 2016............................................................ Machinery and vehicles 596,281 Depreciation1 ............................................................ 11,934 22,448 Impairment losses2 .................................................. Impairment losses reversed2 .................................. Sales and disposals .................................................. Reclassification to assets held for sale .................... 13 (0) (4,990) (497) Tools, furniture and fixtures 91,118 10,396 — (1) — — (28,415) (7,264) (22) (7) Exchange differences on translation of foreign operations .................................................. (2,220) (7,024) (1,392) Other ........................................................................ (23) (66) December 31, 2016 ..................................................... 285,460 Depreciation1 ............................................................ 13,036 Impairment losses2 .................................................. Impairment losses reversed2 ................................... — (0) 583,202 25,133 18 — 51 92,901 11,323 1 (1) Sales and disposals .................................................. (5,132) (27,219) (13,185) Exchange differences on translation of foreign operations .................................................. 1,888 4,091 929 Land 10,321 — 96 — (1) — — — 10,416 — — — (96) — Other ........................................................................ December 31, 2017 ..................................................... 69 295,321 272 585,497 (291) 91,677 — 10,320 Construction in progress 18,734 79,781 14 (13) (73,907) — (64) (57) 24,488 67,471 — (3) (62,591) 359 172 29,896 Construction in progress — — — — — — — — — — — — — — — — Total 1,316,960 84,865 618 (42,215) — (830) (16,597) 13 1,342,814 73,042 928 (47,290) — 8,923 198 1,378,615 (Millions of yen) Total 978,963 44,778 109 (1) (40,670) (526) (10,636) (38) 971,979 49,492 19 (1) (45,632) 6,908 50 982,815 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. Kao Corporation Financial Report 2017 34 Carrying Amount January 1, 2016............................................................ Buildings and structures 112,751 December 31, 2016 ..................................................... 123,439 December 31, 2017 ..................................................... 130,804 (Millions of yen) Machinery and vehicles 119,332 133,595 144,438 Tools, furniture and fixtures 24,521 26,711 27,667 Land 62,659 62,602 62,995 Construction in progress 18,734 24,488 29,896 Total 337,997 370,835 395,800 (2) Leased Assets The carrying amount of leased assets from finance leases included in property, plant and equipment is as follows: January 1, 2016............................................................ December 31, 2016 ..................................................... December 31, 2017 ..................................................... (Millions of yen) Buildings and structures 5,441 4,060 3,195 Other 83 54 58 Total 5,524 4,114 3,253 (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 evaluates whether to recognize impairment losses for individual properties based on impairment tests performed. Impairment losses recognized for the fiscal years ended December 31, 2017 and 2016 were 19 million yen and 109 million yen, respectively. (4) Commitments Note 38 “Commitments” presents information on commitments to acquire property, plant and equipment. 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 Intangible assets (Millions of yen) Goodwill 138,251 Software 24,824 Trademarks 133,523 January 1, 2016.................................................................................. Additions ........................................................................................ Acquisitions through business combinations ................................ Sales and disposals ........................................................................ Reclassification .............................................................................. — 1,915 — — Exchange differences on translation of foreign operations ............ (2,383) Other .............................................................................................. — 85 4 (2,629) 5,122 (246) 124 December 31, 2016 ........................................................................... 137,783 27,284 Additions ........................................................................................ Acquisitions through business combinations ................................ Sales and disposals ........................................................................ Reclassification .............................................................................. Exchange differences on translation of foreign operations ............ — 495 — — 457 Other .............................................................................................. December 31, 2017 ........................................................................... — 138,735 84 11 (5,502) 5,194 134 (9) 27,196 Note: 1. Software in progress is included in other in intangible assets. 35 Kao Corporation Financial Report 2017 Other1 5,561 4,948 316 (361) (5,115) (164) (22) 5,163 6,229 780 (870) (5,188) 17 (11) 6,120 Total 163,908 5,033 320 (136,513) 7 (410) 102 32,447 6,313 793 (6,374) 6 151 (20) 33,316 — — (133,523) — — — — — 2 (2) — — — — Notes to Consolidated Financial Statements Accumulated Amortization and Accumulated Impairment Losses January 1, 2016.................................................................................. Amortization1 .................................................................................. Sales and disposals ........................................................................ Exchange differences on translation of foreign operations ............ Other .............................................................................................. December 31, 2016 ........................................................................... Amortization1 .................................................................................. Sales and disposals ........................................................................ Exchange differences on translation of foreign operations ............ Other .............................................................................................. December 31, 2017 ........................................................................... Intangible assets (Millions of yen) Goodwill — Software 13,045 Trademarks 132,196 — — — — — — — — — — 4,650 (2,626) (225) 71 14,915 4,839 (5,486) 117 (10) 14,375 1,327 (133,523) — — — — — — — — Other 2,962 361 (346) (135) 1 2,843 177 (857) (51) — 2,112 Total 148,203 6,338 (136,495) (360) 72 17,758 5,016 (6,343) 66 (10) 16,487 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, 2016................................................................................. December 31, 2016 .......................................................................... December 31, 2017 .......................................................................... Intangible assets (Millions of yen) Goodwill 138,251 137,783 138,735 Software 11,779 12,369 12,821 Trademarks 1,327 — — Other 2,599 2,320 4,008 Total 15,705 14,689 16,829 (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 .................................................................................................................................................... 2017 136,075 119,400 11,883 4,792 2,660 138,735 (Millions of yen) 2016 135,618 119,400 11,327 4,891 2,165 137,783 (3) Impairment Test for Goodwill The Group tests goodwill for impairment at least once a year by each fiscal year end or if there are indications of impairment. The recoverable amount on the impairment test is measured based on value in use. The majority of goodwill recognized at the Group relates to the Kanebo Cosmetics Group. For the goodwill associated with the Kanebo Cosmetics Group, cash flow projections that are the basis for the value in use are estimated using three-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 the cash-generating units operate. Estimated cash flows in years beyond the three-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 7.1% for the fiscal year ended December 31, 2017 and 7.4% for the fiscal year ended December 31, 2016. While the value in use exceeded carrying amount at December 31, 2017, increasing the discount rate by 2.9% would result in impairment. For the fiscal year ended December 31, 2016, management assumed the probability that material impairment would occur in this cash-generating unit was low even in cases where the key assumptions used for the impairment test changed within the reasonably possible ranges. (4) Intangible Assets with Indefinite Useful Lives The intangible assets above include no intangible assets with indefinite useful lives. (5) Commitments Note 38 “Commitments” presents information on commitments associated with the acquisition of intangible assets. Kao Corporation Financial Report 2017 36 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 ................................................................................ 2017 7,682 (Millions of yen) 2016 4,701 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 ........................................................................................... 2017 2,007 316 2,323 (Millions of yen) 2016 1,894 (82) 1,812 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, 2017 (Millions of yen) January 1, 2017 Recognized in profit or loss Recognized in other comprehensive income Other December 31, 2017 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 ................................................ Financial assets .................................................... Undistributed foreign earnings ............................ Other .................................................................... Total deferred tax liabilities ...................................... Deferred tax assets, net .......................................... 18,316 27,847 11,927 1,240 15,841 75,171 7,945 2,764 12,730 1,321 24,760 50,411 384 (1,536) (561) 866 (2,439) (3,286) (766) — (1,995) (611) (3,372) 86 — (9,624) — — — (9,624) — 509 — — 509 (10,133) 35 50 65 (7) (84) 59 (76) (3) — 19 (60) 119 18,735 16,737 11,431 2,099 13,318 62,320 7,103 3,270 10,735 729 21,837 40,483 37 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements 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 benefi t liabilities ................................ Accrued expenses ............................................... Unused tax losses ............................................... Other .................................................................... Total deferred tax assets ......................................... Deferred tax liabilities Property, plant and equipment and intangible assets ................................................ Retirement benefi t 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) 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 .............................................................................................................................. 2017 40,918 435 40,483 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 ......................................................................................................................................................... 2017 17,656 27,748 45,404 2017 507 3,426 7,007 5,336 1,380 17,656 18,316 27,847 11,927 1,240 15,841 75,171 7,945 — 2,764 12,730 1,321 24,760 50,411 (Millions of yen) 2016 50,939 528 50,411 (Millions of yen) 2016 35,274 21,091 56,365 (Millions of yen) 2016 10,974 4,132 5,551 7,320 7,297 35,274 The aggregate amounts of taxable temporary differences associated with investments in subsidiaries and associates for which deferred tax liabilities were not recognized at December 31, 2017 and 2016 were 15,835 million yen and 12,385 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. Kao Corporation Financial Report 2017 38 (2) Income Taxes Income taxes consist of the following: Current taxes ............................................................................................................................................. Deferred taxes1 .......................................................................................................................................... Total ....................................................................................................................................................... 2017 55,769 (86) 55,683 (Millions of yen) 2016 50,027 5,514 55,541 Note: 1. Deferred taxes include 160 million yen and 2,698 million yen for the fiscal years ended December 31, 2017 and 2016, respectively, due to tax rate changes. (3) Reconciliation of Effective Tax Rate The details of difference between the effective statutory 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 .............................................................................................................................. 2017 30.86 (2.68) (0.92) 0.48 0.08 (0.56) 27.26 (%) 2016 33.06 (3.00) (2.06) 0.32 1.47 0.49 30.28 Note: 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 in the fiscal year ended December 31, 2016 reduced the income tax rate for fiscal years beginning on or after April 1, 2016. Accordingly, the effective statutory tax rate has changed from 33.06% to 30.86%. 17 Bonds and Borrowings Bonds and borrowings consist of the following: Short-term borrowings ....................................................................... Current portion of long-term borrowings ............................................ Long-term borrowings ........................................................................ Current portion of bonds2 .................................................................. Bonds2 ................................................................................................ Total ............................................................................................. 2017 201 67 70,347 24,994 24,975 120,584 2016 220 30,069 40,410 — 49,947 120,646 Current liabilities Bonds and borrowings .................................................................... 25,262 30,289 Non-current liabilities Bonds and borrowings .................................................................... Total ............................................................................................. 95,322 120,584 90,357 120,646 Average interest rate1 (%) 0.95 1.02 0.12 — — (Millions of yen) Maturity — — 2019-2023 — — Notes: 1. The average interest rate is the weighted average interest rate on the balance of borrowings as of December 31, 2017. 2. Details of bonds issued are as follows: Issuer Bond name Issue date 2017 2016 Interest rate (%) Collateral Maturity date The Company 3rd unsecured bonds June 14, 2013 24,994 24,982 The Company 4th unsecured bonds June 14, 2013 24,975 24,965 Total ..................................................................... 49,969 49,947 0.39 0.62 None June 20, 2018 None June 19, 2020 (Millions of yen) 39 Kao Corporation Financial Report 2017 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 ................................. (2) Non-cancellable Operating Leases As a lessee, the Group leases assets including land. Minimum lease payments 2016 2017 884 789 2,337 149 3,275 (97) 3,178 2,622 634 4,140 (140) 4,000 (Millions of yen) Present value of minimum lease payments 2017 755 2,276 147 3,178 — 3,178 2016 842 2,532 626 4,000 — 4,000 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 ...................................................................................................................................................... 2017 8,414 16,347 6,917 31,678 (Millions of yen) 2016 8,808 16,660 7,627 33,095 The total of minimum lease payments under operating lease contracts recognized as expenses is as follows: Total of minimum lease payments ............................................................................................................. (Millions of yen) 2017 10,080 2016 9,858 19 Trade and Other Payables Trade and other payables consist of the following: Trade payables .......................................................................................................................................... Non-trade payables ................................................................................................................................... Total ...................................................................................................................................................... 2017 143,944 80,949 224,893 (Millions of yen) 2016 130,348 86,545 216,893 Kao Corporation Financial Report 2017 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). The defined benefit obligations held in Japan account for a large proportion of the Group’s defined benefit obligations. Cash balance plan benefits are determined 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 the 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 the 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 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 determine 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 the 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 ............................................................................................................................ Net defi ned benefi t liabilities .............................................................................................................. Amounts recognized in consolidated statement of fi nancial position Retirement benefi t liabilities .................................................................................................................. Retirement benefi t assets1 .................................................................................................................... Net defi ned benefi t liabilities .............................................................................................................. 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 ........................................................... Past service cost and (gains) losses arising from settlements3 ............................................................. Benefits paid4 ......................................................................................................................................... Changes due to termination (curtailment and settlement) of defined benefit plans ........................ Exchange differences on translation of foreign operations and other .................................................... The present value of the defined benefit obligations at end of year ......................................................... 2017 333,614 (270,144) 63,470 64,694 (1,224) 63,470 2017 355,579 9,839 2,672 (31) (20,245) 2,242 (407) (12,015) (4,738) 718 333,614 (Millions of yen) 2016 355,579 (261,857) 93,722 94,773 (1,051) 93,722 (Millions of yen) 2016 331,494 8,784 3,619 (2,374) 28,545 (1,245) (33) (10,964) — (2,247) 355,579 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. Past service cost and (gains) losses arising from settlements are recognized in profit or loss and included in general and administrative expenses in the consolidated statement of income. 4. The weighted average duration of the defined benefit obligations in Japan was mainly 16.6 years at December 31, 2017 and 17.3 years at December 31, 2016. 41 Kao Corporation Financial Report 2017 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 ......................................................................................................................... Changes due to termination (curtailment and settlement) of defined benefit plans ........................ Exchange differences on translation of foreign operations and other .................................................... The fair value of plan assets at end of year ............................................................................................... 2017 261,857 1,882 12,850 8,941 (10,624) (4,738) (24) 270,144 (Millions of yen) 2016 256,828 2,692 2,517 10,768 (9,752) — (1,196) 261,857 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 8,808 million yen to the defined benefit plan for the fiscal year ending December 31, 2018. Plan assets consist of the following: Equity securities .......................... Japan ....................................... Overseas .................................. Debt securities ............................ Japan ....................................... Overseas .................................. Other ........................................... Total ...................................... 2017 Market price in an active market Quoted 9,207 — 9,207 7,518 — 7,518 257 16,982 Unquoted 50,055 25,010 25,045 192,628 128,279 64,349 10,479 253,162 Total 59,262 25,010 34,252 200,146 128,279 71,867 10,736 270,144 (Millions of yen) 2016 Market price in an active market 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 Quoted 7,723 — 7,723 7,489 — 7,489 237 15,449 Note: Plan assets invested in pooled funds of trust banks are classified without 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 the 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 0.8% 2017 2016 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: The impact on defined benefit obligations 0.5% increase in discount rate ........................................................................................................... 0.5% decrease in discount rate .......................................................................................................... (Millions of yen) 2017 2016 (23,414) 24,311 (25,807) 26,774 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 2017 42 5) Defined contribution plans Expenses related to the defined contribution plan recognized in profit or loss were 3,873 million yen and 3,551 million yen for the fiscal years ended December 31, 2017 and 2016, 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, 2017 and 2016 were 268,034 million yen and 258,225 million yen, respectively. 21 Provisions Components of and changes in provisions consist of the following: January 1, 2017 ..................................................................................... Provision for loss related to cosmetics 13,710 Provision for asset retirement obligations 4,242 Other provisions 3,262 Increase ............................................................................................ Interest expense on discounted provision ......................................... — 21 Decrease (provision used) ................................................................ (4,968) Decrease (provision reversed) .......................................................... Exchange differences on translation of foreign operations ......................................................................... — — December 31, 2017 .............................................................................. 8,763 89 67 (89) — 30 4,339 108 — (415) (668) 50 2,337 (Millions of yen) Total 21,214 197 88 (5,472) (668) 80 15,439 The effect of the adoption of IFRS 15 on provisions is presented in Note 3 “Significant Accounting Policies (20) Changes in Significant Accounting Policies.” As a result of this adoption, liabilities for returned products, which had previously been presented as provision for sales returns, are presented as contract liabilities. (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 its insurance policy to cover 4,663 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) Other Provisions Other provisions consist of estimated expenses for business transformation at European subsidiaries and other expenses. 22 Other Current Liabilities Other current liabilities consist of the following: Accrued expenses ..................................................................................................................................... Consumption tax payables ........................................................................................................................ Obligation for unused paid absences ........................................................................................................ Other ....................................................................................................................................................... 2017 81,515 9,741 7,558 8,590 Total ....................................................................................................................................................... 107,404 (Millions of yen) 2016 104,425 8,655 6,199 11,833 131,112 43 Kao Corporation Financial Report 2017 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 ....................................................................................................................................................... (Shares) 2017 1,000,000,000 2016 1,000,000,000 Beginning balance .................................................................................................................................. 504,000,000 504,000,000 Change during the year2 ......................................................................................................................... (9,000,000) — Ending balance ....................................................................................................................................... 495,000,000 504,000,000 Notes: 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. The number of issued shares during the fiscal year ended December 31, 2017 decreased by 9,000,000 shares due to the retirement of treasury shares pursuant to the resolution of the Board of Directors. (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 .................................................................................................................................... 2017 11,137,654 Increase² ................................................................................................................................................ 263,176 (Shares) 2016 2,541,816 8,862,432 Decrease³ .............................................................................................................................................. (9,175,269) (266,594) Ending balance4 ......................................................................................................................................... 2,225,561 11,137,654 Notes: 1. 556,492 shares of treasury shares held by associates were included at December 31, 2017 and 2016. 2. The increase of 263,176 shares of treasury shares during the fiscal year ended December 31, 2017 resulted from the acquisition of 257,300 shares by the Board Incentive Plan Trust (hereinafter “BIP Trust”) and the purchase of 5,876 fractional shares. 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. 3. The decrease of 9,175,269 shares of treasury shares during the fiscal year ended December 31, 2017 resulted from the retirement of 9,000,000 shares by resolution of the Board of Directors, a decrease of 175,000 shares due to the exercise of stock options and the sale of 269 fractional shares. 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. 4. 556,492 shares of treasury shares held by associates were included at December 31, 2017 and 2016. In addition, 257,300 shares held by the BIP Trust were included at December 31, 2017. (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; however, due to the introduction of a performance share plan from the fiscal year ended December 31, 2017, the stock option plan has been abolished except for the options already granted. Note 34 “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. Net gain (loss) on derivatives designated as cash flow hedges is the portion of the change in the fair value of the hedging instrument that meets the hedge effectiveness requirements 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. Kao Corporation Financial Report 2017 44 5) Remeasurements of defined benefit plans Remeasurements of defined benefit plans includes the effect of any variances 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 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 the 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 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 investments for growth will meet the expectations of its stakeholders, and therefore prioritizes such investments. In addition to providing stable dividends, the Group aims to continuously increase dividends to reflect improvements 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 the appropriate resources to deal with situations that exceed assumptions while improving EVA. For the fiscal year ended December 31, 2017, EVA increased 17.0 billion yen compared with the previous fiscal year to 90.4 billion yen due to a substantial increase in net operating profit after tax (hereinafter “NOPAT”). 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, 2017 Date of resolution 111th Annual General Meeting of Shareholders held on March 21, 2017 Board of Directors meeting held on July 27, 2017 Total dividends¹ (Millions of yen) Dividends per share (Yen) Record date Effective date 23,657 26,608 48 54 December 31, 2016 March 22, 2017 June 30, 2017 September 1, 2017 Note: 1. Dividends on treasury shares held by associates accounted for using the equity method are deducted by an amount corresponding to the Group’s equity in these associates. In addition, total dividends pursuant to the resolution of the Board of Directors held on July 27, 2017 are deducted by the amount of dividends held by the BIP Trust. The dividend resolved at the 111th Annual General Meeting of Shareholders held on March 21, 2017 was 23,684 million yen before the deduction. The dividend resolved at the meeting of the Board of Directors held on July 27, 2017 was 26,652 million yen before the deduction. 45 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements Fiscal year ended December 31, 2016 Date of resolution 110th Annual General Meeting of Shareholders held on March 25, 2016 Board of Directors meeting 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 deducted 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 deduction. The dividend resolved at the meeting of the Board of Directors held on July 28, 2016 was 23,103 million yen before the deduction. Dividends with an effective date after the fiscal year end are as follows: Fiscal year ended December 31, 2017 Date of Resolution 112th Annual General Meeting of Shareholders held on March 23, 2018 Fiscal year ended December 31, 2016 Date of Resolution 111th Annual General Meeting of Shareholders held on March 21, 2017 Total dividends (Millions of yen) Dividends per share (Yen) Record date Effective date 27,641 56 December 31, 2017 March 26, 2018 Total dividends (Millions of yen) Dividends per share (Yen) Record date Effective date 23,684 48 December 31, 2016 March 22, 2017 26 Revenue (1) Disaggregation of Revenue 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 and the Chemical Business. Revenues of these four businesses are presented as net sales. The Board of Directors of the Company reviews them regularly to determine allocation of resources and to assess their performance. Revenue of logistics services to third parties is included in other operating income because it is not a part of the abovementioned four main businesses. The Group disaggregates revenue from contracts with customers by separating the Consumer Products Business into cosmetics and non-cosmetics based on contracts with customers, with the Chemical Business as a separate division. Revenue by geographic region is disaggregated based on the location of revenue recognized. The relationship between disaggregated revenue and net sales by segment is as follows: Fiscal year ended December 31, 2017 Cosmetics Skin care/hair care products Beauty Care Business Human Health Care Business Fabric and Home Care Business Consumer Products Business Chemical Business Elimination of intersegment Consolidated Japan 197,905 195,929 393,834 197,507 294,838 886,179 123,886 (31,833) 978,232 Asia 22,416 30,845 53,261 96,738 38,786 188,785 69,572 (3,352) 255,005 Americas Europe 2,825 72,317 75,142 47 2,085 77,274 52,625 (99) 19,547 44,211 63,758 — — 63,758 64,202 (1,576) (Millions of yen) Total 242,693 343,302 585,995 294,292 335,709 1,215,996 310,285 (36,860) 129,800 126,384 1,489,421 Revenue of logistics services to third parties included in other operating income 8,619 — — — 8,619 Total revenue from contracts with customers 986,851 255,005 129,800 126,384 1,498,040 Note: Figures for the Consumer Products Business present sales to external customers and figures for the Chemical Business include sales to the Consumer Products Business in addition to external customers. Kao Corporation Financial Report 2017 46 1) Consumer Products Business The Consumer Products Business sells consumer products including cosmetics, skin care products, hair care products, sanitary products and fabric care products. Its customers are mainly retailers in Japan and retailers and wholesalers outside Japan. Revenue from such sales is recognized when control of a product is transferred to a customer, i.e., at the point in time a product is delivered and handed over at the place designated by a customer because legal title to the product, physical possession and the significant risks and rewards of ownership of the product are transferred to the customer and the customer has the right to decide the method of sale and selling price of the product. In the Consumer Products Business, products may be sold with a rebate conditional upon achievement of certain targets such as the quantity or amount of sales (hereinafter “Achievement Rebate”) or other payments. In such cases, the transaction price is determined in an amount deducting the estimated amount of the Achievement Rebate or other payments from the consideration promised in the contract with the customer. Estimates of Achievement Rebate or other payment amounts use the most likely outcome method based on historical experience and other factors, and revenue is recognized only to the extent that it is highly probable that a significant reversal will not occur. In addition, in the event that the Group makes payments to customers such as funding for sales promotions, if the consideration paid to customers is payment for separate goods or services from the customer and fair value cannot be reasonably estimated, revenue is measured by deducting the consideration from the transaction price. Among the products in the Consumer Products Business, cosmetics are composed of counseling cosmetics and self- (2) Liabilities from Contracts with Customers Liabilities from contracts with customers are as follows: selection cosmetics. The Group may provide support to customers when they sell counseling cosmetics through counseling to final consumers. In addition, when selling cosmetics, a certain level of product returns from customers associated with the termination of products is expected to occur. Because the Group has an obligation to refund the consideration for a product if a customer returns it, the Group recognizes a liability for sales returns as a deduction from revenue for projected refunds to customers. To estimate liabilities related to such sales returns, the Group uses the most likely outcome method based on historical experience and other factors, and revenue is recognized only to the extent that it is highly probable that a significant reversal will not occur. When customers return products, the Group has the right to collect the products from the customers, but because returned goods are primarily the result of a product termination, the products returned have no asset value and therefore such assets are not recognized. 2) Chemical Business The Chemical Business sells chemical products such as fatty alcohols and surfactants. Its customers are mainly the users and distributors of the products. Revenue from such sales is recognized when control of a product is transferred to a customer, i.e., at the point in time a product is delivered and handed over at the place designated by a customer because legal title to the product, physical possession and the significant risks and rewards of ownership of the product are transferred to the customer and the customer has the right to decide the method of sale and selling price of the product. Revenue from sales of products in the Chemical Business is measured at transaction prices for contracts with customers. Contract liabilities Advances ........................................................................................................................... Refund liabilities ................................................................................................................. Total ................................................................................................................................ 2,501 14,046 16,547 392 16,904 17,296 January 1, 2017 December 31, 2017 (Millions of yen) Among liabilities from contracts with customers, estimates of Achievement Rebates or other payment amounts expected to be paid to customers related to sales by the end of the reporting period and liabilities for returned products are recognized as refund liabilities. As of the beginning and end of the fiscal year ended December 31, 2017, 3,965 million yen and 3,049 million yen, respectively, of liabilities for returned products previously included in provisions as provision for sales returns were included in the refund liabilities. The balance of advances as of January 1, 2017 was fully recognized as revenue during the fiscal year ended December 31, 2017. The amount of revenue recognized during the fiscal year ended December 31, 2017 from performance obligations satisfied in previous periods was not material. (3) Transaction Price Allocated to the Remaining Performance Obligations The Group uses the practical expedient of omitting the disclosure of information on the remaining performance obligations because it has no significant transactions with individual expected contractual terms exceeding one year. In addition, there are no significant amounts in consideration from contracts with customers that are not included in transaction prices. 47 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements (4) Assets Recognized from the Costs of Obtaining or Fulfilling Contracts with Customers The amount of assets recognized from the costs of obtaining or fulfilling contracts with customers during the fiscal year ended December 31, 2017 was not material. In addition, if the amortization period of the assets that the Group otherwise would have recognized is one year or less, the Group uses the practical expedient of recognizing the incremental costs of obtaining the contract as an expense when incurred. 27 Selling, General and Administrative Expenses Selling, general and administrative expenses consist of the following: Freight/warehouse ..................................................................................................................................... Advertising ................................................................................................................................................. Sales promotion ......................................................................................................................................... 2017 55 89,935 58,940 (Millions of yen) 2016 58,168 97,437 83,161 Employee benefi ts ..................................................................................................................................... 147,007 191,122 Depreciation .............................................................................................................................................. Amortization .............................................................................................................................................. Research and development ....................................................................................................................... Other ......................................................................................................................................................... 8,870 4,784 56,703 86,372 Total ....................................................................................................................................................... 452,666 11,236 6,173 54,567 131,504 633,368 Note 3 “Significant Accounting Policies (20) Changes in Accounting Policies” presents the impact on selling, general and administrative expenses resulting from the adoption of IFRS 15. As a transitional measure upon the adoption of IFRS 15, the Group applies this Standard retrospectively with the cumulative effect of initially applying this Standard recognized at the date of initial application and thus has not adjusted the amounts for the comparative period. Expenses of 17,703 million yen, 1,344 million yen, 24,653 million yen and 2,042 million yen previously included in freight/ warehouse, advertising, sales promotion and other, respectively, were accounted for as reductions of net sales. Expenses of 44,887 million yen, 3,106 million yen, 52,725 million yen, 2,874 million yen, 96 million yen and 25,569 million yen previously included in freight/warehouse, sales promotion, employee benefits, depreciation, amortization and other, respectively, were accounted for as cost of sales. As a result, compared with the application of the former accounting standard, selling, general and administrative expenses decreased by 174,999 million yen. Furthermore, as an additional item other than the adoption of IFRS 15 impacting selling, general and administrative expenses, the Group revised its sales system for the Consumer Products Business in Japan in the fiscal year ended December 31, 2017. Expenses of 1,735 million yen and 21,672 million yen previously included in sales promotion and other, respectively, were accounted for as reductions of net sales. As a result, selling, general and administrative expenses decreased by 23,407 million yen. 28 Other Operating Income Other operating income consists of the following: Revenue of logistics services to third parties ............................................................................................ Royalty income .......................................................................................................................................... Other ......................................................................................................................................................... 2017 8,619 1,112 5,178 Total ....................................................................................................................................................... 14,909 (Millions of yen) 2016 8,300 1,022 4,355 13,677 Kao Corporation Financial Report 2017 48 29 Other Operating Expenses Other operating expenses consist of the following: Expenses of logistics services to third parties .......................................................................................... Losses on sale and disposal of property, plant and equipment ................................................................. Expenses for business transformation at European subsidiaries .............................................................. Other¹ ....................................................................................................................................................... Total ....................................................................................................................................................... Note: 1. Note 13 “Property, Plant and Equipment” presents impairment losses included in other. 30 Financial Income and Financial Expenses Financial income consists of the following: 2017 7,688 3,729 — 1,349 12,766 (Millions of yen) 2016 7,454 3,817 1,776 1,799 14,846 (Millions of yen) 2017 2016 Interest income Financial assets measured at amortized cost ........................................................................................ Retirement benefit assets ................................................................................................................... 1,059 38 1,012 26 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 profi t or loss ............................................................... Other ....................................................................................................................................................... 0 224 12 119 9 205 21 116 Total ............................................................................................................................................... 1,452 1,389 Financial expenses consist of the following: Foreign exchange loss¹ .............................................................................................................................. Interest expenses² Financial liabilities measured at amortized cost ..................................................................................... Retirement benefi t liabilities .................................................................................................................. Other ....................................................................................................................................................... Total ................................................................................................................................................ 2017 1,765 1,339 828 28 3,960 (Millions of yen) 2016 2,859 1,484 953 128 5,424 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. 49 Kao Corporation Financial Report 2017 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 .............................................................. (Millions of yen, unless otherwise noted) 2017 147,010 — 2016 126,551 — Net income used to calculate basic earnings per share ............................................................................ 147,010 126,551 Weighted average number of ordinary shares (Thousands of shares) .................................................. 492,832 499,355 Basic earnings per share (Yen) ................................................................................................................... 298.30 253.43 (2) The Basis for Calculating Diluted Earnings per Share Net income used to calculate basic earnings per share ............................................................................ Adjustments to net income ....................................................................................................................... (Millions of yen, unless otherwise noted) 2017 147,010 — 2016 126,551 — Net income used to calculate diluted earnings per share .......................................................................... 147,010 126,551 Weighted average number of ordinary shares (Thousands of shares) ...................................................... 492,832 499,355 Increase in ordinary shares Subscription rights to shares (Thousands of shares).......................................................................... 337 Weighted average number of ordinary shares after dilution (Thousands of shares) ............................ 493,170 483 499,838 Diluted earnings per share (Yen) .............................................................................................................. 298.09 253.18 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 and tax effects for each component of other comprehensive income are as follows: Fiscal year ended December 31, 2017 Gains (losses) arising for the year Tax effect After tax effect (Millions of yen) Items that will not be reclassifi ed to profi t or loss Net gain (loss) on revaluation of financial assets measured at fair value through other comprehensive income ................................................................................... 1,675 Remeasurements of defined benefit plans ................................................................ 30,884 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 ................................. 457 33,016 Items that may be reclassified subsequently to profit or loss Exchange differences on translation of foreign operations ..................................... 8,541 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 ............... (1) 8,540 (509) (9,624) (140) (10,273) — 0 0 1,166 21,260 317 22,743 8,541 (1) 8,540 Total ..................................................................................................................... 41,556 (10,273) 31,283 Kao Corporation Financial Report 2017 50 Fiscal year ended December 31, 2016 Gains (losses) arising for the year Tax effect After tax effect (Millions of yen) Items that will not be reclassifi ed to profi t 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 ........................................................................................... (1,569) (22,409) (128) Total of items that will not be reclassified to profit or loss ..................................... (24,106) Items that may be reclassified subsequently to profit or loss Exchange differences on translation of foreign operations ......................................... (16,661) Share of other comprehensive income of investments accounted for using the equity method ........................................................................................... (7) Total of items that may be reclassified subsequently to profit or loss .................... (16,668) 663 6,298 56 7,017 — (3) (3) (906) (16,111) (72) (17,089) (16,661) (10) (16,671) Total ..................................................................................................................... (40,774) 7,014 (33,760) 33 Cash Flow Information The major changes in liabilities arising from financing activities are changes from financing cash flows and there are no significant non- cash changes. 34 Share-based Payments (1) Stock Options 1) Outline of stock options The Company issued the following two types of stock options to directors, executive officers and employees of the Group. Due to the introduction of a performance share plan from the fiscal year ended December 31, 2017, the stock option plan has been abolished except for the options already granted. (i) Stock options for share-based payment Stock options for share-based payment were granted as compensation for directors and executive officers who do not concurrently serve as directors. These stock options were 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 • Exercise period: Five years from July 1 of two years after the date the stock options were granted (ii) 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. • Vesting conditions: Set on date of grant • Settlement: Shares settled • Exercise period: Five years from September 1 of two years after the date the stock options were granted 51 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements 2) Number of stock options and weighted average exercise price Beginning balance of outstanding ................................. Granted ...................................................................... Exercised ................................................................... Expired at maturity ..................................................... Ending balance of outstanding ...................................... Ending balance of exercisable ....................................... 2017 2016 Number of shares (Shares) 549,000 — (175,000) (61,000) 313,000 273,000 Weighted average exercise price (Yen) 1,331 — 1,672 2,190 973 1,115 Number of shares (Shares) 846,000 40,000 (266,000) (71,000) 549,000 469,000 Weighted average exercise price (Yen) 1,654 1 1,886 2,355 1,331 1,558 Notes: 1. The weighted average share price on the date of exercise for the fiscal years ended December 31, 2017 and 2016 was 6,254 yen and 5,821 yen, respectively. 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 2,254 Total 2017 Number of shares (Shares) 178,000 135,000 313,000 Weighted average remaining contractual life (Years) 3.3 0.7 2.2 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 (2) Performance Share Plan 1) Outline of performance share plan In the fiscal year ended on December 31, 2017, the Company introduced a performance share plan (hereinafter the “Plan”) for the members of the Board of Directors (excluding Outside Directors) and Executive Officers (collectively, “Directors, etc.”) as a highly transparent and objective compensation system that is closely linked to company performance. The purpose of the Plan is to improve the Company’s mid- and long-term performance as well as increase the awareness of contributions to increasing corporate value. The Company has introduced the Plan using a structure called a BIP Trust. A BIP Trust is designed as an executive incentive plan based on the performance share plans and restricted stock plans in the U.S. wherein the Company’s shares that are acquired through the BIP Trust and the amount equivalent to the converted value of such shares will be vested or paid to Directors, etc. depending on their executive positions and level of achievement of performance targets in the mid-term plan and other factors. The shares held by the BIP Trust are accounted for as treasury shares. The Plan grants specified points (1 point = 1 share) to Directors, etc. each year depending on their executive positions and other factors on the condition that the requirements of a designated beneficiary, such as holding the office of Director, etc. on the last day of each fiscal year during the eligibility period, have been satisfied. The Company’s shares and cash in the amount of the converted value of such Company’s shares equivalent to the number of such points may be granted and paid following completion of settlement procedures by the designated beneficiary, after the end of the eligibility period in the case of performance-linked points, and for a specified period each year during the eligibility period in the case of fixed points. The Plan is accounted for as an equity-settled share-based payment transaction. 2) Number of points granted during the period and weighted average fair value of points The fair value of the points on the date of grant is determined by adjusting the market price of the Company’s shares taking expected dividends into account. The number of points granted during the period and the weighted average fair value of the points are as follows: 2017 Number of points granted during the period .................................................................................. Achievement-linked points 34,125 Weighted average fair value (Yen) .................................................................................................. 6,821 Fixed points 14,625 6,767 (3) Share-based Payment Expenses Share-based payment expenses recognized in the consolidated statement of income for the fiscal years ended December 31, 2017 and 2016 were 332 million yen and 227 million yen, respectively. Kao Corporation Financial Report 2017 52 35 Financial Instruments (1) Classification of Financial Instruments The amounts of each classification of financial assets are as follows: Financial assets measured at amortized cost Financial assets (Millions of yen) 2017 2016 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 ................................................................................................................................................ 313,176 216,507 24,639 29,900 602 2,926 14,092 601,842 343,076 216,507 14,914 574,497 27,345 601,842 268,126 208,459 22,404 34,900 791 2,888 12,428 549,996 303,026 208,459 13,038 524,523 25,473 549,996 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, 2017 Company name Seven & i Holdings Co., Ltd. ...................................................................................................................... (Millions of yen) Fair value 3,011 Seven Bank, Ltd. ........................................................................................................................................ 1,930 Livedo Corporation .................................................................................................................................... Tokio Marine Holdings, Inc. ....................................................................................................................... The Nisshin OilliO Group, Ltd.¹ .................................................................................................................. Saiwai Trading Co., Ltd. .............................................................................................................................. Aeon Co., Ltd. ............................................................................................................................................ Izumi Co., Ltd. ........................................................................................................................................... Japan Alcohol Trading Co., Ltd. .................................................................................................................. Keytrading Co., Ltd. ................................................................................................................................... 981 978 962 956 799 700 552 373 Note: 1. The Settsu Oil Mill, Inc.’s shares were exchanged to the Nisshin OilliO Group, Ltd.’s shares through a share exchange on May 1, 2017. 53 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements As of December 31, 2016 Company name Seven & i Holdings Co., Ltd. ...................................................................................................................... (Millions of yen) Fair value 2,863 Seven Bank, Ltd. ........................................................................................................................................ 1,675 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. ................................................................................................................................... 913 863 835 687 533 502 462 359 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) .......................................................................................................................... 2017 24 10 (Millions of yen) 2016 1,036 658 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, 2017 and 2016, were 7 million yen and 435 million yen, respectively. The amounts of each classification of financial liabilities are as follows: Financial liabilities measured at amortized cost Financial liabilities (Millions of yen) 2017 2016 Trade and other payables (Note 19) ........................................................................................................ Bonds and borrowings (Note 17) ........................................................................................................... Other ...................................................................................................................................................... Financial liabilities measured at fair value through profi t or loss Derivatives ............................................................................................................................................. Total ................................................................................................................................................ 224,893 120,584 16,804 1,026 363,307 Current liabilities Trade and other payables ....................................................................................................................... 224,893 Bonds and borrowings ........................................................................................................................... Other fi nancial liabilities ........................................................................................................................ 25,262 7,739 Subtotal ............................................................................................................................................. 257,894 Non-current liabilities Bonds and borrowings ........................................................................................................................... Other financial liabilities ......................................................................................................................... Subtotal .............................................................................................................................................. Total ................................................................................................................................................ 95,322 10,091 105,413 363,307 216,893 120,646 19,057 773 357,369 216,893 30,289 8,164 255,346 90,357 11,666 102,023 357,369 There are no significant assets pledged for the above financial liabilities. The Group held deposits received, which is interest-bearing liability in other financial liabilities, at December 31, 2017 and 2016 totaling 12,599 million yen and 13,275 million yen, respectively. The average interest rate on deposits received as of December 31, 2017 was 0.12%. Kao Corporation Financial Report 2017 54 (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. 1) Market risk management 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 the internal policies that define the objectives, position limit, scope, organizational structure and others. The Group limits the use of derivatives to actual 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 flows. (i) Exchange rate 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. 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. Derivatives transactions Foreign exchange forward contracts: Selling U.S. dollar ........................................................... Euro .................................................................... Chinese yuan ...................................................... Buying Euro .................................................................... Chinese yuan ...................................................... Currency swaps: Receiving Japanese yen, paying U.S. dollar .......... Receiving Japanese yen, paying Chinese yuan ..... Contract amount 13,800 70 — 120 725 8,004 1,987 2017 Contract amount over 1 year Carrying amount (fair value)¹ Contract amount (Millions of yen) 2016 Contract amount over 1 year Carrying amount (fair value)1 7,280 — — — — 2,339 — 135 1 — (2) (98) (53) (325) 16,308 74 1,065 151 701 — 2,279 7,280 — — — 701 — 2,279 60 3 (1) (6) (52) — (158) Note: 1. Note 35 “Financial Instruments (3) 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, 2017 Net exposure .................................................................................................................. As of December 31, 2016 Net exposure .................................................................................................................. U.S. dollar 8,713 U.S. dollar 2,210 Euro 161 Euro 707 (Millions of yen) Chinese yuan 8,458 (Millions of yen) Chinese yuan 5,342 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. 55 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements 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 ............................................................................................................................................. (ii) Interest rate fluctuation risk (ii) Short-term investments 2017 (871) (16) (846) (Millions of yen) 2016 (221) (71) (534) The Group obtains 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, totaling 10,165 million yen and 8,956 million yen at December 31, 2017 and 2016, 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 the 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. 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 the creditworthiness of borrowers. (iv) Derivatives The Group executes and manages derivatives in accordance with the internal policies that define the objectives, 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. The carrying amount after impairment of financial assets in the consolidated statement 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 Kao Corporation Financial Report 2017 56 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 the 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 6,463 million yen and 6,413 million yen at December 31, 2017 and 2016, respectively. The carrying amount of trade receivables and changes in the related allowance for doubtful receivables are as follows: Fiscal year ended December 31, 2017 (Millions of yen) Trade receivables 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 January 1, 2017 ...................................................................... 204,736 Change during the year (Recognition and derecognition) ..................................... Transfer to credit-impaired financial assets ...................... Other changes ................................................................... 3,914 (99) 2,890 December 31, 2017 ............................................................... 211,441 363 45 99 42 549 Allowance for doubtful receivables January 1, 2017 ...................................................................... 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, 2017 ............................................................... 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 781 237 (69) (77) — 43 915 382 84 (34) (10) — 37 459 Total 205,099 3,959 — 2,932 211,990 (Millions of yen) Total 1,163 321 (103) (87) — 80 1,374 Fiscal year ended December 31, 2016 (Millions of yen) Trade receivables 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 January 1, 2016...................................................................... 206,494 Change during the year (Recognition and derecognition) ..................................... Transfer to credit-impaired fi nancial assets ........................ Other changes ................................................................... 2,472 28 (4,258) December 31, 2016 ............................................................... 204,736 472 (36) (28) (45) 363 Total 206,966 2,436 — (4,303) 205,099 57 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements 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 Credit-impaired financial assets 803 217 (85) (72) (6) (76) 781 465 18 (28) (36) 6 (43) 382 (Millions of yen) Total 1,268 235 (113) (108) — (119) 1,163 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, 2017 Trade receivables ....................................................... Allowance for doubtful receivables ........................... Expected credit loss (%) ............................................ As of December 31, 2016 Trade receivables ....................................................... Allowance for doubtful receivables ........................... Expected credit loss (%) ............................................ (Millions of yen unless otherwise noted) Days past due Not due 200,841 195 0.1 Less than 30 days 7,033 Over 30 days 1,441 135 1.9 55 3.8 Over 60 days 680 44 6.5 Over 90 days 1,995 945 47.4 Total 211,990 1,374 0.6 (Millions of yen unless otherwise noted) Days past due Not due 197,543 256 0.1 Less than 30 days 4,315 Over 30 days 1,248 82 1.9 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 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, 2017 (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 payables ............ 224,893 224,893 224,892 1 — — Bonds and borrowings ............... 120,584 120,614 25,268 40,046 25,038 30,235 Lease obligations........................ Long-term deposits payable ....... 3,178 6,463 3,275 6,463 Derivative financial liabilities Currency related ......................... 1,022 1,022 Interest rate related .................... 4 4 789 — 635 3 690 — — — 666 — 296 — 495 — — — Total ........................................ 356,144 356,271 251,587 40,737 26,000 30,730 — 21 486 — 91 1 599 — 6 149 6,463 — — 6,618 Kao Corporation Financial Report 2017 58 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 payables ........... 216,893 216,893 216,869 24 — — Bonds and borrowings ............... 120,646 120,699 30,289 25,066 40,045 25,038 Lease obligations........................ Long-term deposits payable ....... 4,000 6,413 4,140 6,413 Derivative financial liabilities Currency related ......................... Interest rate related .................... 758 15 758 15 884 — 337 7 779 — 159 8 684 — — — 667 — — — Total ........................................ 348,725 348,918 248,386 26,036 40,729 25,705 — 235 492 — 262 — 989 — 26 634 6,413 — — 7,073 (3) 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 prices categorized within Level 1 that are observable for the asset or liability, either directly or indirectly 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 financial model using observable inputs such as interest rates. (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 financial model using observable inputs such as exchange rates and interest rates. (iii) Equity securities 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. 59 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements The fair value hierarchy of financial instruments measured at fair value is shown below. 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, 2017 or 2016. As of December 31, 2017 Financial assets Level 1 Level 2 Level 3 Total (Millions of yen) Financial assets measured at fair value through profi t or loss Short-term investments ........................................................... Derivative assets ...................................................................... Other ......................................................................................... Financial assets measured at fair value through other comprehensive income — — — Equity securities ........................................................................ Total ....................................................................................... 10,165 10,165 Financial liabilities Financial liabilities measured at fair value through profi t or loss Derivative liabilities ................................................................... Total ....................................................................................... — — 29,900 602 2,926 — 33,428 1,026 1,026 — — — 3,927 3,927 — — 29,900 602 2,926 14,092 47,520 1,026 1,026 As of December 31, 2016 Financial assets Level 1 Level 2 Level 3 Total (Millions of yen) 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 Changes in financial instruments categorized within Level 3 are as follows: Beginning balance ..................................................................................................................................... Gains (losses)¹ ....................................................................................................................................... Purchases .............................................................................................................................................. Other changes ....................................................................................................................................... — — — 3,472 3,472 — — 2017 3,472 454 — 1 34,900 791 2,888 12,428 51,007 773 773 (Millions of yen) 2016 3,212 231 30 (1) Ending balance .......................................................................................................................................... 3,927 3,472 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. Kao Corporation Financial Report 2017 60 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, 2017 Carrying amount Level 1 Level 2 Level 3 Total Fair value (Millions of yen) Financial liabilities Financial liabilities measured at amortized cost Bonds ............................................................ Borrowings .................................................... 49,969 70,615 — — 50,345 70,946 — — 50,345 70,946 As of December 31, 2016 Financial liabilities Financial liabilities measured at amortized cost Carrying amount Level 1 Level 2 Level 3 Total Fair value (Millions of yen) Bonds ............................................................ Borrowings .................................................... 49,947 70,699 — — 50,548 71,084 — — 50,548 71,084 61 Kao Corporation Financial Report 2017 Notes to Consolidated Financial Statements 36 Principal Subsidiaries Principal subsidiaries consist of the following. Voting rights at December 31, 2017 did not significantly change from a year earlier. Company name Country Principal businesses Voting rights (%) Kao Group Customer Marketing Co., Ltd. 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. Japan Japan Japan Japan China China China China China China Kao (Taiwan) Corporation Pilipinas Kao, Inc. Taiwan Philippines Kao Industrial (Thailand) Co., Ltd. Thailand 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. Thailand Malaysia Indonesia U.S.A. U.S.A. U.S.A. Germany Germany Germany Control of sales companies and other subsidiaries in Japan 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 Chemical 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 Beauty Care Corporate service to subsidiaries in the 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 Corporation Financial Report 2017 62 Notes to Consolidated Financial Statements 37 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 benefi ts.................................................................................................................................... Post-retirement benefi ts ............................................................................................................................ Share-based payments .............................................................................................................................. Total ....................................................................................................................................................... 2017 1,315 30 332 1,677 (Millions of yen) 2016 1,131 39 227 1,397 38 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 ....................................................................................................................................................... 2017 37,906 1,237 39,143 (Millions of yen) 2016 27,100 1,306 28,406 39 Significant Subsequent Events There were no significant subsequent events to present. 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 20, 2018. 63 Kao Corporation Financial Report 2017 Independent Auditor’s Report Kao Corporation Financial Report 2017 64 14-10, Nihonbashi Kayabacho 1-chome Chuo-ku, Tokyo 103-8210, Japan http://www.kao.com/global/en/ Investor Relations E-mail: ir@kao.co.jp Website: http://www.kao.com/global/en/investor-relations/ 

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