Kao Corp.
Annual Report 2018

Plain-text annual report

Financial Report 2018 For the year ended December 31, 2018 Management Discussion and Analysis Consolidated Financial Statements Notes to Consolidated Financial Statements Independent Auditor’s Report 1 14 19 66 Management Discussion and Analysis Management Policies Among the various elements of ESG, the Kao Group views corporate governance as the cornerstone of management for Management Policies of the Kao Group supporting management’s intentions and ambitions from both The Kao Group’s mission is to strive for the wholehearted “proactive” and “protective” aspects and for continuously satisfaction and enrichment of the lives of people globally and increasing its corporate value. For this purpose, the Kao Group to contribute to the sustainability of the world, with products works for ongoing “Innovation”3 and will further enhance its and brands of excellent value that are created from the internal controls for the execution of management that is consumer’s and customer’s perspective. swift, efficient and sound, as well as impartial and transparent. The Kao Way, which is the corporate philosophy of the Kao 1. Research that pursues the essence of things for both humans and materials from a scientific standpoint. Group, serves as the foundation of all our activities. All 2. Kirei is a Japanese word that represents the concept of cleanliness, members of the Kao Group will share the Kao Way and put it beauty, health, purity, and fairness. 3. Innovation is one of the values of the Kao Way, the corporate philosophy into practice every day as the foundation of our approaches of the Kao Group. and actions. Moreover, this commitment is embraced by all members of the Kao Group as we further promote efforts to Management Metric Used as a Target fully utilize our assets and work together with passion to As its principal management metric, the Kao Group uses continue to share joy with consumers and customers in our economic value added (EVA®*), which measures true profit by core domains of cleanliness, beauty, health and chemicals. factoring in the cost of invested capital. This essentially takes Social conditions and the natural environment are changing the perspective of shareholders and other asset owners to dramatically. For the Kao Group to continue to grow deploy capital efficiently and generate profits. The Kao Group sustainably, we must transform ourselves to drive change. We believes that continuously increasing EVA will lead to will deepen our Essential Research1 to proactively offer innovations on a level that exerts an impact on society. increases in corporate value and thus corresponds with long- term benefits, not only for shareholders, but for all In addition, the Kao Group considers non-financial as well stakeholders. The target of the Kao Group’s business activities as financial strategies and initiatives to be a top management is to increase EVA while expanding its business scale. The Kao priority, and will conduct more substantive ESG activities Group uses this metric to assess its businesses, to make globally under the name “Kirei2 Action.” To help create the evaluations on investment in facilities, acquisitions and other future that people worldwide envision, we will take an items, and to develop performance targets for each fiscal year approach unique to the Kao Group in squarely confronting the and for its compensation system. social issues raised by the Sustainable Development Goals (SDGs) and addressing matters such as the strengthening of environmental laws and regulations and the ethical concerns of consumers. As we achieve profitable growth and a high level of returns to stakeholders, we will become a corporate group with a global presence by 2030. * EVA is a registered trademark of Stern Stewart & Co. EVA is defined as net operating profit after tax (NOPAT) less a charge for the cost of capital employed in the business. 1 Kao Corporation Financial Report 2018 Medium-to-long-term Management Strategies of the Kao Group Long-term Management Strategy Long-term Targets As its vision by 2030 based on the above management 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 policies, the Kao Group aims to make Kao a company with a exceeds: global presence by combining sustained “profitable growth,” - ¥2.5 trillion in net sales (¥1.0 trillion outside Japan) and “contributions to the sustainability of the world” with - 17% operating margin proposals to resolve social issues and social contribution - 20% ROE activities conducted through its business operations. To • Provides a high level of returns to stakeholders achieve this vision, the Kao Group will promote the further reinforcement of the existing businesses that are its strength and the creation of new markets from a global perspective utilizing the R&D capabilities that will create value for the future, in addition to implementing basic measures to further raise the level of safety and reliability. It is becoming difficult to predict the various changes that will occur throughout the world in all aspects, such as speed, size and direction. To deal with this situation, the Kao Group aims to achieve the above vision by fully embracing the slogan of “Transforming Ourselves to Drive Change.” Net Sales / Operating Margin ROE (Billions of yen) 1,600 1,401.7 1,471.8 1,474.6 1,457.6 1,489.4* 1,508.0 1,200 800 400 0 13.7 13.8 12.7 11.2 11.3 9.5 2014 2015 2015 2016 2017 2018 (%) 20 15 10 5 0 (%) 25 20 15 10 5 0 18.6 19.8 18.9 16.1 14.8 12.4 2014 2015 2015 2016 2017 2018 Japanese GAAP IFRS Japanese GAAP IFRS Net Sales (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. Kao Corporation Financial Report 2018 2 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 Kao Group Mid-term Plan 2020 “K20” targeting the four years from fiscal 2017 to fiscal 2020 and announced it publicly on December 12, 2016. K20 Goals – Three Commitments • Commitment to fostering a distinctive corporate image • 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% To further enhance its ESG activities, the Kao Group will - Three ¥100 billion brands (Merries baby diapers, thoroughly instill the Integrity set forth in the Kao Way, the Kao Group’s corporate philosophy, by sharing and practicing it Attack laundry detergents, Bioré skin care products) * Excluding the effect of currency translation, change of sales system, etc. among all employees while deepening Essential Research. In • Commitment to returns to stakeholders July 2018, we established a new ESG Division to set up a - Shareholders: Continuous cash dividend increases structure for promoting ESG activities globally. In addition, by (40% payout ratio target) utilizing artificial intelligence, the Internet of Things, robotics - Employees: Continuous improvement in and other cutting-edge technologies to take the full use of its assets to the next dimension, the Kao Group will realize profitable growth at a high level of quality and create new assets to achieve the following goals. compensation, benefits and health support - Customers: Maximization of win-win relationships - Society: Advanced measures to address social issues The Kao Group must securely build this foundation under K20 to achieve its vision by 2030. This entails promoting the evolution of its post-deflation growth model of using proactive investments to generate earning power, thus achieving profitable growth. Doing so will require drastically revising current procedures, approaches and concepts to maximize Cash Dividends per Share (Yen) 120 100 80 60 40 20 0 Increases in dividends for 29 consecutive periods 7.1 7.1 8.87 9.09 10.0 10.5 11.5 12.5 14 15 16 20 24 26 38 30 32 54 56 57 58 60 62 64 52 50 120 110 94 80 70 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 2018 Note: Impact of share splits is reflected retroactively. 3 Kao Corporation Financial Report 2018 Management Discussion and Analysis Costs, Expenses and Income as Percentages of Net Sales Years ended December 31, 2018, 2017 and 2016 Cost of sales ............................................................................................................ Gross profit .............................................................................................................. Selling, general and administrative expenses .......................................................... Operating income .................................................................................................... Income before income taxes ................................................................................... Net income attributable to owners of the parent .................................................... 2018 56.6% 43.4 29.5 13.8 13.7 10.2 IFRS 2017 56.0% 44.0 30.4 13.7 13.7 9.9 2016 43.7% 56.3 43.5 12.7 12.6 8.7 and make full use of Kao Group assets. While remaining significance. Moreover, amid the global expansion of business committed to thoroughly instilling Integrity, the Kao Group will and the progress of structural changes in various fields, put into practice the K20 slogan of “Transforming Ourselves companies must deal with changes in the risks entailed in to Drive Change.” their businesses. Under these conditions, the Kao Group will Issues for Management promote both profitable growth and contributions to the sustainability of society through Yoki-Monozukuri* that is a half-step ahead of these changes. To that end, it will address With intensifying market competition, changing market and deal appropriately with the following issues. structure and volatility in raw material market conditions and * The Kao Group defines Yoki-Monozukuri as a strong commitment by all exchange rates, the operating environment remains uncertain. Changes in the attitudes of consumers regarding the 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.” environment, health and other matters and associated (1) To deal with changes in the risks entailed in its changes in their purchasing attitudes, as well as the aging businesses, the Kao Group will define risks that have a society, hygiene and other social issues, are growing in particularly large impact on management and for which it Payout Ratio 44.7 40.6 (%) 50 40 30 20 10 0 must enhance its response as corporate risks and work to prevent damage to the corporate value of the Group as a whole by further enhancing its management system. (2) Given the current rapid progress of factors such as the diversification of values brought on by technology innovations and the accompanying changes in purchasing behavior and the structure of retailing, our 38.1 37.1 36.9 38.238.238.2 business model targeting the mass market, which could 2014 2015 2015 2016 2017 2018 Japanese GAAP IFRS formerly be conducted efficiently, must be reconsidered from all aspects, including research and development, production, logistics, sales and marketing. To resolve these issues, the Kao Group will proactively promote the enhancement of Essential Research and the use of artificial intelligence, the Internet of Things, robotics and other cutting-edge technologies. (3) To sustainably enhance its corporate value, the Kao Group must appropriately address social issues in the areas of environmental preservation and resource conservation such as problems with marine plastic and Kao Corporation Financial Report 2018 4 other kinds of trash, depletion of water resources, Overview of Consolidated Results sustainable and responsible procurement, as well as safety and human rights, among others. Therefore, the Conditions in the global economy are unclear due to factors Kao Group will globally roll out and accelerate the ESG- including trends in trade issues, the economic outlook for related initiatives it has been conducting, primarily China and other emerging countries in Asia and the impact of through the ESG Division, and enhance its management uncertainty about the policies of the Americas and Europe. system for conducting checks and administering these From January to December 2018, the markets for household initiatives. In October 2018, the Kao Group announced and personal care products and cosmetics in Japan, which are “Our Philosophy & Action on Plastic Packaging.” key markets for the Kao Group, were in solid condition according Basic Approach to Selection of Accounting Standards to retail sales and consumer purchasing survey data. In every product category, the share of the e-commerce channel increased further and average unit prices for household and personal care products increased by 1 percentage point compared with the same period a year earlier. Having decided that unifying accounting standards within the Under these circumstances, the Kao Group completed the Kao Group will contribute to improving the quality of its business management, the Kao Group has voluntarily adopted International Financial Reporting Standards (IFRS) from fiscal second fiscal year of the Kao Group Mid-term Plan “K20” covering the four years from 2017 to 2020. With technology innovations such as artificial intelligence and the Internet of 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 the application of IFRS will facilitate the international comparability of its financial statements in capital markets. Things, the structure of retailing and purchasing behavior and other factors are changing rapidly worldwide and consumer values are diversifying. The Kao Group invested proactively for the future and made efforts that included enhancing new and improved product launches, marketing and sales activities that address these changes. As a result, in its consolidated operating results the Kao Group increased operating income and net income Basic Earnings per Share Net Sales / Operating Margin (Yen) 400 300 200 100 0 Consumer Products Business (Billions of yen) 1,500 314.25 298.30 253.43 197.19 209.82 156.46 2014 2015 2015 2016 2017 2018 1,000 500 0 1,222.8 1,225.6 1,219.8 1,216.0 1,232.9 11.0 11.2 12.7 14.2 14.3 1,154.5 9.6 2014 2015 2015 2016 2017 2018 Japanese GAAP IFRS Japanese GAAP IFRS (%) 25 20 15 10 5 0 Net Sales (Left) Operating Margin (Right) 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. In FY 2018, due to the reorganization of the sales organization of the Consumer Products Business in Japan, operating income for the previous fiscal year has been restated. 5 Kao Corporation Financial Report 2018 Management Discussion and Analysis for the ninth consecutive fiscal year and achieved record-high 2. The Curél derma care brand, which formerly had been operating income for the sixth consecutive fiscal year. The Kao classified as skin care and hair care products, has been Group did not reach its forecast of consolidated operating results, included in the Cosmetics Business, and the Success men’s but the entire Group will continue to work to achieve “K20.” products brand, which formerly had been classified in the Analysis of Income Statement Human Health Care Business, has been included in the Skin Care and Hair Care Business. Net sales and operating income for the previous fiscal year have been restated accordingly. 3. Due to the reorganization of the sales organization of the Net sales increased 1.2% compared with the previous fiscal Consumer Products Business in Japan, operating income year to ¥1,508.0 billion. On a like-for-like basis, net sales for the previous fiscal year has been restated. increased 1.3%. In the Consumer Products Business in Japan, the Kao Group made efforts including launches of new and Consumer Products Business improved products and further enhancement of its sales Sales increased 1.4% compared with the previous fiscal year to promotion activities, but sales decreased slightly. Outside ¥1,232.9 billion. On a like-for-like basis, sales increased 1.6%. Japan, sales increased. The Chemical Business was impacted The Kao Group worked for more effective marketing and by factors including selling price adjustments associated with sales activities, including launching new and improved a drop in prices for natural fats and oils, but sales increased products that address the diversification of consumer values due to promotion of high-value-added products. and enhancing activities in the e-commerce channel in line As for profits, depreciation expenses and other costs with changes in purchasing behavior. increased, but due to more efficient deployment of marketing In Japan, sales decreased slightly by 0.3% to ¥883.9 billion. expenses and the effect of increased sales in the Consumer In Asia, sales were steady, increasing 5.3% to ¥198.7 Products Business in Asia, among other factors, operating billion. On a like-for-like basis, sales increased 6.3%. income was ¥207.7 billion, an increase of ¥2.9 billion In the Americas, sales increased 10.0% to ¥85.0 billion. On compared with the previous fiscal year, the operating margin a like-for-like basis, sales increased 12.1%. In Europe, sales was 13.8% and income before income taxes was ¥207.3 increased 2.3% to ¥65.2 billion. On a like-for-like basis, sales billion, an increase of ¥3.0 billion. Net income was ¥155.3 increased 0.1%. billion, an increase of ¥6.7 billion. Operating income increased ¥2.7 billion compared with the Basic earnings per share were ¥314.25, an increase of previous fiscal year to ¥175.7 billion. ¥15.95, or 5.3%, from ¥298.30 in the previous fiscal year. Note: The Kao Group’s Consumer Products Business consists of the To improve capital efficiency and further increase shareholder returns, Kao Corporation (the Company) resolved Cosmetics Business, the Skin Care and Hair Care Business, the Human Health Care Business, and the Fabric and Home Care Business. at a meeting of its Board of Directors held on April 27, 2018 to Cosmetics Business repurchase its own shares, and repurchased shares totaling Sales increased 5.0% compared with the previous fiscal year ¥50.0 billion. The Company retired 6.3 million treasury shares to ¥279.6 billion. On a like-for-like basis, sales increased 5.0%. on September 14, 2018. Information by Segment As of the fiscal year ended December 31, 2018, the following changes have been made. 1. The Beauty Care Business has been divided into the Cosmetics Business and the Skin Care and Hair Care Business, changing the four former reportable segments into five. The Kao Group announced a new growth strategy in May 2018, and was able to achieve some success from optimizing the brand portfolio, enhancing marketing and other measures. The Kao Group determined key strategic brands to promote selection and concentration, and enhanced digital marketing in response to changes in consumer purchasing behavior. Counseling cosmetics SUQQU and RMK, which are available in the department store channel, and in self-selection cosmetics, freeplus, which is hypoallergenic and contains Japanese and Chinese botanical extracts, and the Curél derma Kao Corporation Financial Report 2018 6 care brand sold strongly. SOFINA iP base essence was growing premium market and the impact of the shrinking improved in September 2018, and sales grew steadily as it mass market. In Europe, the John Frieda hair care brand was gained acceptance among an increasing number of affected by intense market competition. consumers. Sales increased substantially in the strongly In January 2018, U.S.-based Oribe Hair Care, LLC, which growing Asian region, led by China. The Kao Group will further owns Oribe, a super-premium-price brand for hair salons, develop the Cosmetics Business by executing its new growth became a consolidated subsidiary and its sales were strong. strategy as it steadily implements structural reforms. Operating income decreased ¥0.5 billion compared with Operating income was ¥27.7 billion, a substantial the previous fiscal year to ¥48.8 billion due to factors improvement of ¥14.7 billion from the previous fiscal year, including expenses incurred for structural reforms in the due to the effects of increased sales of strongly performing Americas and Europe, despite the effect of increased sales of brands and the Asia business, among other factors. skin care products in Japan and in Asia. Skin Care and Hair Care Business Human Health Care Business Sales increased 2.6% compared with the previous fiscal year Sales decreased 4.8% compared with the previous fiscal year to ¥341.4 billion. On a like-for-like basis, sales increased 2.7%. to ¥267.7 billion. On a like-for-like basis, sales decreased 4.4%. In skin care products, sales of the Bioré brand grew For Merries baby diapers, sales in Japan decreased. The steadily in Japan and Asia, but were impacted by stiff Kao Group gained greater consumer support in Japan by competition in the Americas. Jergens hand and body lotions conducting product improvements and enhancing sampling performed steadily in the Americas. and other sales promotion activities, but due to factors In hair care products in Japan, the Kao Group launched including the impact of the new e-commerce law in China, Rerise, an innovative next-generation brand for gray hair care, which came into effect as of January 2019, there was a and its performance was strong but sales of shampoos and substantial downturn in demand for the purpose of resale in conditioners decreased due to a delayed response to the China. Sales in China also decreased due to factors including Net Sales / Operating Margin Cosmetics Business Skin Care and Hair Care Business Human Health Care Business Fabric and Home Care Business Chemical Business (Billions of yen) 400 300 200 100 0 341.4 332.9 14.8 14.3 240.1 240.1 280.7 281.7 280.7 281.7 273.1 273.1 281.2 281.2 267.7 267.7 324.5 334.4 335.3 345.2 335.7 344.1 20.7 19.7 18.8 22.6 22.7 20.7 288.0 288.5 288.0 288.5 288.5 288.5 273.8 273.8 310.3 312.8 12.7 11.8 12.3 10.4 9.5 9.1 10.4 9.9 10.8 9.8 9.8 7.7 279.6 266.2 9.9 4.9 2017 2018 2017 2018 2014 2015 2015 2016 2017 2018 2014 2015 2015 2016 2017 2018 2014 2015 2015 2016 2017 2018 IFRS IFRS Japanese GAAP IFRS Japanese GAAP IFRS Japanese GAAP IFRS Net Sales (Left) Operating Margin (Right) (%) 40 30 20 10 0 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. In FY 2018, due to the reorganization of the sales organization of the Consumer Products Business in Japan, operating income for the previous fiscal year has been restated. The Beauty Care Business has been divided into the Cosmetics Business and the Skin Care and Hair Care Business, changing the four former reportable segments into five. The Curél derma care brand, which formerly had been classified as skin care and hair care products, has been included in the Cosmetics Business, and the Success men’s products brand, which formerly had been classified in the Human Health Care Business, has been included in the Skin Care and Hair Care Business. Net sales and operating income for the previous fiscal year have been restated accordingly. 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. 7 Kao Corporation Financial Report 2018 Management Discussion and Analysis intensifying price competition and aggressive activities by the impact of increased costs for petrochemicals and other local manufacturers. On the other hand, locally produced raw materials in a severe competitive environment. products targeting the middle-class consumer segment performed well in Indonesia and market share grew in Russia Chemical Business and neighboring countries as the products gained broad Sales increased 0.8% compared with the previous fiscal year acceptance among consumers. to ¥312.8 billion. On a like-for-like basis, sales increased 0.5%. For Laurier sanitary napkins, high-value-added products Sales of oleo chemicals decreased due to the impact of performed strongly in Japan, China and elsewhere, and selling price adjustments associated with a drop in prices for among adult incontinence products, sales grew steadily in natural fats and oils, although demand outside Japan was firm. Japan for a line of Relief ultra-thin pants-type diapers Sales of performance chemicals increased, due in part to the designed to be like regular underwear. contribution from growth in sales volume in infrastructure- Sales of personal health products were steady. In oral care related fields. In specialty chemicals, sales of hard disk-related and bath additives, high-performance products sold steadily. products were steady, despite the impact of a decrease in Sales of MegRhythm thermo products grew as the Kao Group customer demand for toner and toner binder. increased the number of loyal users through measures such Operating income increased ¥0.3 billion compared with the as launching improved items and enhancing digital marketing. previous fiscal year to a record high of ¥30.6 billion due to In food and beverage products, the Kao Group conducted growth in sales of oleo chemicals outside Japan and business reforms and the profit structure improved. promotion of high-value-added products. Operating income decreased ¥6.5 billion compared with the previous fiscal year to ¥27.9 billion, due to the decrease in sales of baby diapers, higher raw material costs, increased Financial Position depreciation expenses and other factors. Fabric and Home Care Business Total assets increased ¥33.6 billion from December 31, 2017 to ¥1,461.0 billion. The principal increases in assets were a Sales increased 2.5% compared with the previous fiscal year ¥13.7 billion increase in inventories, a ¥23.1 billion increase in to ¥344.1 billion. On a like-for-like basis, sales increased 2.6%. property, plant and equipment, a ¥41.6 billion increase in Sales of fabric care products were firm amid an goodwill and a ¥29.7 billion increase in intangible assets. The environment of severe competition in Japan. The Kao Group principal decrease in assets was a ¥77.1 billion decrease in worked to enhance communication of the value of Attack cash and cash equivalents. laundry detergent in “changing tap water for washing to Total liabilities increased ¥17.5 billion from December 31, antibacterial water” and increased the market share of fabric 2017 to ¥625.5 billion. The principal increase in liabilities was a softeners by improving Flair Fragrance amid the ongoing ¥19.9 billion increase in retirement benefit liabilities. expansion of the market for high-value-added products. Total equity increased ¥16.1 billion from December 31, Sales of home care products were firm. In Japan, the Kao 2017 to ¥835.5 billion. The principal increase in equity was net Group cultivated new users by improving foam spray-type income totaling ¥155.3 billion. The principal decreases in CuCute dishwashing detergent, and sales grew steadily. equity were purchase of treasury shares from the market Sales were firm in Asia as the Kao Group launched high-value- totaling ¥50.0 billion, dividends totaling ¥57.5 billion and other added products and enhanced in-store merchandising in Thailand comprehensive income totaling ¥32.1 billion. and other countries. In addition, to strengthen its commercial- As a result of the above factors, the ratio of equity use products business outside Japan, the Kao Group completed attributable to owners of the parent to total assets was 56.3% the acquisition of U.S.-based Washing Systems, LLC and made it compared with 56.5% at December 31, 2017. The Kao Group a consolidated subsidiary in August 2018. maintained return on equity at the high level of 18.9%. Operating income decreased ¥5.0 billion compared with In addition, the Company retired 6.3 million treasury shares the previous fiscal year to ¥71.2 billion due to factors including on September 14, 2018. Kao Corporation Financial Report 2018 8 Cash Flows activities and net cash flows from investing activities, was ¥37.7 billion. The balance of cash and cash equivalents at December 31, 2018 decreased ¥77.1 billion compared with December 31, 2017 to Cash Flows from Financing Activities ¥266.0 billion, including the effect of exchange rate changes. Net cash flows from financing activities totaled negative ¥108.6 billion. The Company emphasizes steady and continuous Cash Flows from Operating Activities dividends and flexibly repurchases and retires treasury shares to Net cash flows from operating activities totaled ¥195.6 billion. improve capital efficiency from the perspective of EVA. During The principal increases in net cash were income before income fiscal 2018, this primarily consisted of ¥57.6 billion for dividends taxes of ¥207.3 billion, depreciation and amortization of ¥60.7 paid to owners of the parent and non-controlling interests and billion and increase in retirement benefit liabilities of ¥20.7 ¥50.0 billion for purchase of treasury shares. In addition, to billion. The principal decreases in net cash were increase in trade reinforce its financial base in order to maintain an appropriate and other receivables of ¥12.6 billion, increase in inventories of capital cost rate and to invest for growth, the Kao Group issued ¥15.7 billion and income taxes paid of ¥51.7 billion. and redeemed corporate bonds, which resulted in ¥25.1 billion in proceeds from issuance of bonds and payments totaling ¥24.9 Cash Flows from Investing Activities billion for redemption of bonds. Net cash flows from investing activities totaled negative ¥157.9 billion. This primarily consisted of purchase of property, plant and equipment of ¥80.3 billion for capacity expansion at production bases in Japan and proactive capital investments in Asia, where growth is notable, and payments for business combinations of ¥73.9 billion for businesses for hair salons, commercial-use products and other purposes where synergies with existing Basic Policies regarding Distribution of Profits and Dividends for the Fiscal Years Ended December 31, 2018 and Ending December 31, 2019 business are expected. The Kao Group uses economic value added (EVA) as its Free cash flow, the sum of net cash flows from operating principal management metric and clearly sets the uses of its Net Cash Flows from Operating Activities / Capital Expenditures Free Cash Flows* 180.9 181.7 184.3 185.8 195.6 (Billions of yen) 150 (Billions of yen) 200 150 145.1 100 50 0 83.4 82.8 89.9 89.1 79.4 68.5 2014 2015 2015 2016 2017 2018 100 50 0 106.8 107.5 95.7 89.7 81.3 37.7 2014 2015 2015 2016 2017 2018 Japanese GAAP IFRS Japanese GAAP IFRS Net Cash Flows from Operating Activities Capital Expenditures * Free cash flow is the sum of net cash flows from operating activities and net cash flows from investing activities. 9 Kao Corporation Financial Report 2018 Management Discussion and Analysis steadily generated cash flow as shown below from that EVA and Related Activities viewpoint. Shareholder returns are one such use, and they are implemented after considering future demand for funds and EVA for fiscal 2018 was ¥93.5 billion, an increase of ¥3.1 the situation in financial markets. billion compared with the previous fiscal year due to growth in Use of cash flow: net operating profit after tax (NOPAT) that exceeded the increase in capital costs from the previous fiscal year. • Investment for future growth (capital expenditures, The Kao Group conducted the following EVA-related M&A, etc.) activities during the fiscal year. • Steady and continuous dividends (40% payout ratio target) • Share repurchases and early repayment of interest- Investing for Growth: During fiscal 2018, the Kao Group bearing debt including borrowings invested aggressively for future growth. Capital expenditures were ¥89.1 billion. In the Consumer Products Business, the In accordance with these policies, the Company plans to Kao Group carried out activities including facility expansion, pay a year-end dividend for fiscal 2018 of ¥60 per share, an streamlining, maintenance and renewal in each of its increase of ¥4 per share compared with the previous fiscal businesses. The Kao Group reinforced its supply system in the year. Consequently, annual cash dividends will increase ¥10 per Skin Care and Hair Care Business by constructing a new share compared with the previous fiscal year, resulting in a total building on the grounds of the Toyohashi Plant for efficient of ¥120 per share. The consolidated payout ratio will be 38.2%. production of premium products, and in the Human Health For fiscal 2019, the Company plans to pay total cash dividends Care Business by expanding production capacity at its factories of ¥130 per share (39.1% payout ratio), an increase of ¥10 per share for sanitary products inside and outside Japan. In the Chemical compared with the previous fiscal year. This plan is in accordance Business, the Kao Group expanded production capacity inside with the Company’s basic policies regarding distribution of and outside Japan and conducted activities including profits, and free cash flow and other factors have also been streamlining, maintaining and renewing facilities. Expenditures taken into consideration. As a result, the Company is aiming for business combinations with a hair salon business, a for its 30th consecutive fiscal year of increases in dividends. commercial-use products business and other businesses with Total Dividend Payment / Share Repurchases* / Net Income Attributable to Owners of the Parent Cost of Capital / EVA (Billions of yen) 150 153.7 147.0 (Billions of yen) 150 90.4 93.593.593.5 100 50 0 105.2 126.6 98.9 50.0 46.8 40.2 40.2 50.0 79.6 35.5 54.3 58.5 2014 2015 2015 2016 2017 2018 50.050.050.0 100 47.6 70.6 58.6 73.4 50 0 53.3 55.1 54.8 56.4 59.1 62.7 2014 2015 2015 2016 2017 2018 Japanese GAAP IFRS 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 Cost of Capital EVA Kao Corporation Financial Report 2018 10 the expectation of synergy with existing businesses totaled comprehensive list of risks the Kao Group faces. Other risks ¥73.9 billion. Research and development expenditures were exist and may have an impact on investment decisions. Any ¥57.7 billion, which was the equivalent of 3.8% of net sales, statements below concerning the future are judgments made remaining at a high level relative to net sales. by the Company as of the submission of its securities report to the Ministry of Finance. Increasing Profit: The Kao Group increased operating income in the Consumer Products Business by launching new and (1) Consumer Products Business improved products, further enhancing sales promotion 1. Response to Changes in Consumer Needs activities and promoting a shift to digital marketing in Japan. The Kao Group’s Consumer Products Business is affected by In the Chemical Business, the Kao Group achieved record-high business cycles and changes in consumers’ values in the operating income from growth in sales of oleo chemicals market of each country. The Consumer Products Business outside Japan and promotion of high-value-added products. maintains and improves brand value by understanding changes in consumer needs and using the comprehensive Financial Improvement: For fiscal 2018, the Company paid strength of the Kao Group’s product development and annual dividends per share of ¥120.00, a year-on-year increase manufacturing in working to create high-value-added products of ¥10.00, or 9%, as announced in its forecast at the and provide services through approaches in areas including beginning of the fiscal year. As a result, the Company has the environment, health, the aging society and hygiene. achieved 29 consecutive fiscal periods of dividend growth. In However, as a consequence of uncertainties in these addition, the Kao Group repurchased ¥50.0 billion of its own business activities due to various factors, the Consumer shares to improve capital efficiency. Products Business may be unable to provide products and R&D Expenses services that respond to changes in consumer needs and (Billions of yen) brand value could decrease. This could have an impact on the Cosmetics Business .......................................... Skin Care and Hair Care Business ................... Human Health Care Business ......................... Fabric and Home Care Business ..................... Chemical Business .......................................... 2018 10.5 16.0 11.3 9.8 10.2 Business Risks and Other Risks Kao Group’s business results and financial condition. 2. Response to Changes in Retailing The Kao Group’s Consumer Products Business is affected by changes in the structure of retailing, including progress in the creation of new corporate groups through retail industry mergers and integration in the market, and the emergence and expansion of new retail channels. The Consumer Products Business conducts sales activities and makes new offerings that respond to these structural changes. However, as a Various risks arise in the course of a company’s business. The consequence of uncertainties in these business activities due Kao Group manages risks appropriately by identifying and to various factors, the Consumer Products Business may be evaluating risks to formulate and implement necessary unable to conduct sales activities or make new offerings that countermeasures, among other activities. In addition, in the respond to these structural changes. This could have an impact event a risk manifests itself, the Kao Group sets up an on the Kao Group’s business results and financial condition. emergency response organization and strives to keep the extent of injury and damage as small as possible by (2) Chemical Business responding promptly. However, in the event a major risk such The Kao Group’s Chemical Business is affected by factors as those described below manifests itself, it may exert a including trends in customer demand and fluctuations in raw significant impact on the Kao Group’s business results and material prices. The Chemical Business promotes creation of financial condition. The major risks described below are not a high-value-added products that match customer needs, 11 Kao Corporation Financial Report 2018 Management Discussion and Analysis conducts research and development of products in material costs into product prices. In addition, the Kao Group consideration of the environment, and provides such products is conducting development of substitute raw materials for while working to reduce costs and deal with product prices. natural fats and oils through research into advanced effective However, as a consequence of uncertainties in these utilization of non-edible raw materials. However, unexpected business activities due to various factors, the Chemical radical changes in market prices could have an impact on the Business may be unable to provide products that match Kao Group’s business results and financial condition. customer needs or respond to matters such as fluctuations in raw material prices. This could have an impact on the Kao (6) Product Quality Group’s business results and financial condition. The Kao Group designs and manufactures products from the viewpoint of consumers, in compliance with related laws and (3) Business Acquisitions, Business Alliances and Mergers regulations and voluntary standards. In the development The Kao Group may implement business acquisitions, business stage prior to market launch, the Kao Group conducts alliances, mergers or other such measures. When implementing thorough safety testing and survey research to confirm the them, the Kao Group makes decisions after thoroughly safety of products. After market launch, the Kao Group works assessing economic value and its partner companies. However, to further improve quality by incorporating the opinions and due to various unforeseeable uncertainties in its business desires of consumers through its consumer communication activities, the Kao Group may be unable to produce the results it centers. However, the unanticipated occurrence of a serious initially expected. This could have an impact on the Kao Group’s quality problem or concerns about product safety or reliability business results and financial condition. resulting from new scientific knowledge would not only cause difficulties for the relevant brand, but would also have a major (4) Overseas Business Expansion impact on the reputation of all of the Kao Group’s products. As one of its growth strategies, the Kao Group is conducting This could have an impact on the Kao Group’s business operations in markets in Asia, the Americas, Europe and results and financial condition. elsewhere, with a particular emphasis on strengthening its operations in countries where higher economic growth rates (7) Response to Natural Disasters Associated with Events and market expansion are forecast. However, the Kao Group Such as Large-scale Earthquakes or Climate Change, may be unable to strengthen its operations as a consequence Accidents and Other Incidents of uncertainties due to various factors in the course of business To deal with earthquakes and other natural disasters, the Kao including the occurrence of a slowdown in economic growth or Group has formulated disaster countermeasures for its uncertain political or social conditions, intensifying competition, production facilities and primary offices and a business the inability to conduct sufficient cost management or the continuity plan (BCP), and will continue to strengthen and emergence of problems in relationships with retail outlets, sales reinforce them in the future. However, natural disasters agents or other trading partners. This could have an impact on associated with events such as a large-scale earthquake or the Kao Group’s business results and financial condition. climate change that hinder the supply of products to the market due to problems in areas such as securing raw materials and (5) Procurement of Raw Materials maintaining production, among other impediments, could have Market prices for natural fats and oils and petroleum-related a serious impact on the Kao Group’s business results and materials used as raw materials for products of the Kao Group financial condition. In addition, the emergence of major changes are affected by factors including geopolitical risks, the balance in demand trends due to a worsening economic environment between supply and demand, abnormal weather and exchange associated with the earthquake could have a serious impact on rate fluctuations. The Kao Group has moved to reduce the the Kao Group’s business results and financial condition. effect of increases in raw material prices through measures Furthermore, the occurrence of an explosion or fire at production including cost reductions and passing on increases in raw facilities, information or control system malfunction, problems at Kao Corporation Financial Report 2018 12 Management Discussion and Analysis a supplier of raw materials, dysfunction of social infrastructure (11) Compliance with and Response to Laws and such as electric power and water, environmental pollution from Regulations, Etc. harmful substances, the spread of infectious disease, terrorism, In the course of its business activities, the Kao Group must political change, riots and other incidents could hinder the supply comply with a variety of laws and regulations concerning of products to the market. This could have a serious impact on the areas such as standards for product quality and safety, the Kao Group’s reputation, business results and financial condition. environment and chemical substances, as well as accounting standards, tax law and regulations related to labor and (8) Currency Exchange Rate Fluctuations transactions. It will also be required to respond to policies and Foreign currency-denominated transactions are affected by tightening of legal and regulatory systems in various countries changes in currency exchange rates. The Kao Group hedges for mitigating climate change. The Kao Group has constructed foreign exchange risk through various measures such as a compliance system, among other measures, and strives to settlement of transactions through foreign currency accounts, comply with and respond to all related laws, regulations, foreign exchange contracts, and currency swaps to mitigate policies and systems. However, a serious legal violation by the the effect on business results. The Kao Group does not Kao Group or by a consignee or other party could have an engage in derivative transactions for the purpose of impact on the Kao Group’s reputation, business results and speculation. However, because items on the financial financial condition. Moreover, a change in current laws and statements of overseas consolidated subsidiaries are regulations, or new laws and regulations could restrict the translated into Japanese yen, substantial variance in the Kao Group’s business activities, require investment for exchange rate from the expected rate at the time of compliance, or otherwise affect the Kao Group. This could conversion will have an impact on the Kao Group’s business have an impact on the Kao Group’s business results and results and financial condition. financial condition. (9) Impact of Deferred Tax Assets and Impairment (12) Information Management The Kao Group records various tangible fixed assets and The Kao Group possesses confidential information related to intangible assets and deferred tax assets including assets matters including research and development, production, used in the course of business and goodwill incurred in marketing and sales, as well as the personal information of corporate acquisitions. The Kao Group may not generate the numerous customers used for product development, sales expected cash flow due to divergence from planned future promotion and other purposes. The Kao Group conducts business results, a decline in market value or other factors. thorough information management using guidelines for This could have an impact on the Kao Group’s business handling information and implements appropriate security results and financial condition. measures for its information systems, including both hardware and software. However, a leak of confidential or personal (10) Securing Human Capital information held by the Kao Group resulting from an attack on The Kao Group strives to secure diverse, superior human its server, unlawful access, a computer virus or other factor capital to achieve its business goals globally. Human capital that exceeds expectations could have an impact on the Kao with advanced expertise in areas such as research and Group’s reputation, business results and financial condition. development, production, marketing and sales is indispensable in aiming for the Yoki-Monozukuri (see note on (13) Litigation page 4) that consumers support. However, an inability to The Kao Group conducts diverse businesses globally, and secure the necessary human capital due to changes in various types of litigation may be brought against it. The result employment conditions or other factors could have an impact of such litigation could have an impact on the Kao Group’s on the Kao Group’s business results and financial condition. business results and financial condition. 13 Kao Corporation Financial Report 2018 Consolidated Statement of Financial Position Kao Corporation and Consolidated Subsidiaries As of December 31, 2018 Assets Current assets Notes 2018 2017 (Millions of yen) 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 ......................................................................................... 8, 35 9, 35 10 35 11 12 13 14 14 15 35 16 11, 20 265,978 223,102 197,571 15,146 2,066 22,449 726,312 — 726,312 418,935 180,286 46,549 7,931 23,540 49,158 8,275 734,674 343,076 216,507 183,921 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 Total assets ......................................................................................................... 1,460,986 1,427,375 Liabilities and equity Liabilities Current liabilities Notes 2018 2017 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 ...................................................................................... 19, 35 17, 35 18, 35 21 26 22 17, 35 18, 35 20 21 16 225,560 40,488 6,880 34,198 2,873 18,387 102,452 430,838 80,339 9,506 84,552 12,175 2,864 5,203 194,639 224,893 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 Total liabilities...................................................................................................... 625,477 608,011 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 85,424 108,245 (11,282) (30,029) 670,002 822,360 13,149 835,509 85,424 107,980 (9,593) (12,315) 634,885 806,381 12,983 819,364 Total liabilities and equity .................................................................................... 1,460,986 1,427,375 Kao Corporation Financial Report 2018 14 Consolidated Statement of Income Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2018 Net sales .................................................................................................................... Cost of sales .............................................................................................................. 10, 13, 14, 20 Gross profit ................................................................................................................ 6, 26 Notes Selling, general and administrative expenses ............................................................ 13, 14, 20, 27 Other operating income ............................................................................................. Other operating expenses ......................................................................................... 13, 14, 20, 29 Operating income ...................................................................................................... 13, 26, 28 6 Financial income ........................................................................................................ Financial expenses ..................................................................................................... Share of profit in investments accounted for using the equity method ..................... Income before income taxes ..................................................................................... Income taxes ............................................................................................................. Net income ................................................................................................................ 6, 20, 30 6, 20, 30 6, 15 6 16 Attributable to: Owners of the parent ................................................................................................. Non-controlling interests ............................................................................................ Net income ................................................................................................................ 2018 1,508,007 (853,989) 654,018 (444,845) 14,288 (15,758) 207,703 1,717 (4,251) 2,082 (Millions of yen) 2017 1,489,421 (834,107) 655,314 (452,666) 14,909 (12,766) 204,791 1,452 (3,960) 2,007 207,251 204,290 (51,920) 155,331 (55,683) 148,607 153,698 1,633 155,331 147,010 1,597 148,607 Earnings per share Basic (Yen) .................................................................................................................. Diluted (Yen) ............................................................................................................... 31 31 314.25 314.12 298.30 298.09 15 Kao Corporation Financial Report 2018 Consolidated Statement of Comprehensive Income Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2018 Net income .......................................................................................................................... Other comprehensive income Items that will not be reclassified to profit or loss: Net gain (loss) on revaluation of financial assets measured at fair value through other comprehensive income ................................................... Remeasurements of defined benefit plans ................................................................... Share of other comprehensive income of investments accounted for using the equity method ..................................................................... Total of items that will not be reclassified to profit or loss ............................................ Items that may be reclassified subsequently to profit or loss: Exchange differences on translation of foreign operations ............................................ Share of other comprehensive income of investments accounted for using the equity method ..................................................................... Total of items that may be reclassified subsequently to profit or loss .......................... Other comprehensive income, net of taxes ..................................................................... Comprehensive income ..................................................................................................... Attributable to: Owners of the parent ........................................................................................................ Non-controlling interests ................................................................................................... Comprehensive income .................................................................................................... Notes 2018 155,331 (Millions of yen) 2017 148,607 32, 35 32 32 32 32 (2) (15,524) (345) (15,871) 1,166 21,260 317 22,743 (16,140) 8,541 (73) (16,213) (32,084) 123,247 (1) 8,540 31,283 179,890 122,324 923 123,247 178,020 1,870 179,890 Kao Corporation Financial Report 2018 16 Consolidated Statement of Changes in Equity Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2018 Equity attributable to owners of the parent (Millions of yen) Other components of equity Net gain (loss) on revaluation of financial assets measured at fair value through other compre hensive income 8,490 — Net gain (loss) on derivatives designated as cash flow hedges 4 — Exchange differences on translation of foreign operations (21,540) — Subscription rights to shares 731 — Notes Share Capital capital surplus 85,424 107,980 — — Treasury shares (9,593) — Remeasurements of defined benefit plans — — Total (12,315) — Retained earnings 634,885 153,698 Total 806,381 153,698 Non- controlling interests 12,983 1,633 Total equity 819,364 155,331 — — — — — — (15,492) (15,492) (338) (338) (15,539) (15,539) (31,374) (31,374) — (31,374) 122,324 153,698 (710) 923 (32,084) 123,247 23 23 34 25 23 23 34 25 January 1, 2018 ............... Net income .................... Other comprehensive income ....................... Comprehensive income .... Disposal of treasury shares ........................ Purchase of treasury shares ........................ Share-based payment transactions.............. Dividends ...................... Transfer from other components of equity to retained earnings ... Other increase (decrease) .................. Total transactions with the owners ................. December 31, 2018 ......... 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 ......... — — — — — — — — — — — — — — — — — — — 265 85,424 108,245 (1,689) (11,282) 85,424 107,648 — — (57,124) — (99) 48,345 (167) — (50,034) 364 — — — — — — — — — — — — (1,842) 332 — (0) — — — — — — — — — — (18) — (185) 546 911 — — — — — — — (15) — (180) 731 — 49,373 (165) — — — — — — — (37,032) (29,761) — 8,221 8,221 — — — — — — — — (21,540) (5) (5) — — — — — — — (1) 4 — (0) (0) — — — — — — — — 4 — — — — — — — — — — — — — — — (167) (47,961) 118 — (50,034) — — 118 (50,034) — (56,793) 364 (56,793) — (746) 364 (57,539) (1,694) 15,539 13,827 (13,827) — — — — — — (11) — (11) — (1,694) 6,458 7,025 — 1,472 1,472 — — — — — (7) — 15,539 — 13,660 (30,029) (118,581) 670,002 (106,345) 822,360 (757) 13,149 (107,102) 835,509 — — (21,821) — 565,715 147,010 679,842 147,010 11,621 1,597 691,463 148,607 21,317 21,317 31,010 31,010 — 147,010 31,010 178,020 273 1,870 31,283 179,890 (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 — — — — — — — — 332 47,531 (9,593) 85,424 107,980 (7) 8,490 (21,317) — (21,504) (12,315) (77,840) 634,885 (51,481) 806,381 (508) 12,983 (51,989) 819,364 17 Kao Corporation Financial Report 2018 Consolidated Statement of Cash Flows Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2018 Notes 2018 2017 (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 ........................................................................................... Payments for business combinations ............................................................................... Other ................................................................................................................................. Net cash flows from investing activities .................................................................... 33 Cash flows from financing activities Increase (decrease) in short-term borrowings .................................................................. Proceeds from long-term borrowings ............................................................................... Repayments of long-term borrowings .............................................................................. Proceeds from issuance of bonds .................................................................................... Redemption of bonds ....................................................................................................... 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 8 207,251 60,662 (1,578) 1,256 (2,082) 4,531 (12,591) (15,677) 3,951 20,740 (21,437) 245,026 1,273 2,312 (1,293) (51,708) 195,610 (26,768) 26,987 (80,295) (7,703) (73,915) 3,799 (157,895) 230 — (67) 25,060 (24,939) (50,035) (56,838) (745) (1,245) (108,579) (70,864) 343,076 (6,234) 265,978 204,290 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 Kao Corporation Financial Report 2018 18 Notes to Consolidated Financial Statements Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2018 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 2018 (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) Changes in Presentation (Consolidated Statement of Cash Flows) “Acquisition of subsidiaries and businesses,” which was presented in cash flows from investing activities for the fiscal year ended December 31, 2017, has been presented as “Payments for business combinations” to appropriately reflect the substance of the transactions for the fiscal year ended December 31, 2018. 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 closings 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. 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 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. (3) Foreign Currency Translation 1) Functional currency and presentation currency (ii) Classification and subsequent measurement 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. The Group classifies the financial assets it holds as (a) financial assets measured at amortized cost; (b) debt instruments measured at fair value through other comprehensive income; (c) equity instruments measured at fair value through other comprehensive income; or (d) financial assets measured at fair value through profit or Kao Corporation Financial Report 2018 20 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. (c) Equity instruments measured at fair value through 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. Dividends from equity instruments measured at fair value through other comprehensive income are recognized as financial income in profit or loss. (d) Financial assets measured at fair value through profit or loss Financial assets that are not classified as financial assets measured at amortized cost, debt instruments measured at fair value through other comprehensive income, or equity instruments measured at fair value through other comprehensive income are classified as financial assets measured at fair value through profit or loss. The Group’s financial assets that are measured at fair value through profit or loss include certain short- term investments and derivative assets. The Group has not irrevocably designated any financial assets as measured at fair value through profit or loss. These financial assets are measured at fair value after initial recognition, and changes in their fair value are recognized in profit or loss. Gains and losses on financial assets measured at fair value through profit or loss are recognized in profit or loss. (iii) Impairment of financial assets With respect to impairment of financial assets measured at amortized cost, the Group recognizes a loss allowance for expected credit losses on such financial assets. At each reporting date, the Group assesses whether the credit risks on the financial assets have increased significantly since initial recognition. If credit risk on a financial instrument has not increased significantly since initial recognition, the loss allowance for that financial instrument is measured at an amount equal to the 12-month expected credit losses. If credit risk on a financial instrument has increased significantly since initial recognition, the loss allowance is measured in an amount equal to the lifetime expected credit losses. However, the loss allowance on trade receivables and others is always measured in an amount equal to the lifetime expected credit losses. The expected credit losses of financial assets are estimated in a way that reflects the following: • An unbiased and probability-weighted amount determined by evaluating a range of possible outcomes • The time value of money • Reasonable and supportable information about past events, current conditions and forecasts of economic conditions that is available without undue cost or effort at the reporting date The amounts of these measurements are recognized in profit or loss. If an event that reduces an impairment loss occurs after the impairment loss has been recognized, the impairment loss will be reversed to the extent of the decrease and credited to profit or loss. 21 Kao Corporation Financial Report 2018 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. 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: 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. 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. The Group does not use cash flow hedges, fair value hedges or net investment hedges in foreign operations. (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 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. Kao Corporation Financial Report 2018 22 (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 material intangible assets with indefinite useful lives. The estimated useful lives of major intangible assets are as follows: • Trademarks: 20 years • Customer relationships: 15 or 20 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.” (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 23 Kao Corporation Financial Report 2018 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). Notes to Consolidated Financial Statements 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 the defined contribution plan are recognized as expenses when employees have rendered services entitling them to the contributions. 2) Other employee benefits Short-term employee benefit obligations are measured on an undiscounted basis, and are recognized as an expense when the related services are rendered. For bonuses, when there is a present legal or constructive obligation to make payments of bonuses, and a reliable estimate of the obligation can be made, the estimated amount to be paid is accounted for as a liability. For the paid absence expenses, when there is a legal or constructive obligation with respect to accumulating paid absence systems and a reliable estimate of the obligation can be made, the estimated amount to be paid based on those systems is accounted for as a liability. (12) Share-based Payments 1) Stock option plan 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, the stock option plan has been abolished except for the options already granted. 2) Performance share plan The Company introduced a performance share plan accounted for as an equity-settled share-based payment plan. The performance share plan measures services received at the fair value of the Company’s shares on the date of grant, recognizing them 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. Kao Corporation Financial Report 2018 24 (14) Revenue 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 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 obligations in the contract recognition of goodwill Step 5: Recognize revenue when the entity satisfies a • Temporary differences arising from initial recognition of 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. (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. assets and liabilities from transactions that are not business combinations and affect neither accounting income nor taxable income • Taxable temporary differences on investments in subsidiaries and associates, when the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future • Deductible temporary differences on investments in subsidiaries and associates, when it is probable that the temporary differences will not reverse in the foreseeable future Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the period when the assets are realized or the liabilities are settled, based on the tax rates and tax laws enacted or substantively enacted by the end of the reporting period. Deferred tax assets and liabilities are offset if the Group has a legally enforceable right to set off current tax assets against current tax liabilities and income taxes are levied by the same taxation authority on the same taxable entity. The Company and some of its subsidiaries have adopted the consolidated tax system. (16) Earnings per Share Basic earnings per share are calculated by dividing net income attributable to owners of the parent by the weighted average number of ordinary shares outstanding during the period, adjusted for treasury shares held. Diluted earnings per share are calculated by adjusting the effects of all dilutive potential ordinary shares. (17) Non-current Assets Held for Sale A non-current asset or disposal group whose carrying amount is expected to be recovered principally through a sale transaction rather than through continuing use is classified as a non-current asset or disposal group held for sale if it is highly probable that the asset or disposal group will be sold within one year and is available for immediate sale in its present condition, and the Group’s management is committed to a plan to sell. Non-current assets are not depreciated or amortized while they are classified as held for sale or are part of a disposal group classified as held for sale. Non-current assets or disposal groups classified as held for sale are measured at the lower of the carrying amount and fair value less costs to sell. 25 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements (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. 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. Kao Corporation Financial Report 2018 26 (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 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, 2018 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 IFRS 16 “Leases” replaces IAS 17 “Leases” and others. As a result of this adoption, due to its single lessee accounting model, right-of-use assets representing the right to use an underlying asset and lease liabilities representing the obligation to make lease payments are required to be recognized for all leases, in principle, on the consolidated statement of financial position. After recognition of right-of-use assets and lease liabilities, depreciation of the right-of-use assets and interest on the lease liabilities are recognized on the consolidated statement of income. The main impact of this adoption on the Group’s consolidated financial statements is expected to be increases of approximately 160 billion yen in right-of-use assets and lease liabilities on the consolidated statement of financial position at the beginning of the fiscal year ending December 31, 2019. Cash flows from operating activities on the consolidated statement of cash flows are expected to increase by approximately 20 billion yen and cash flows from financing activities are expected to decrease by the same amount. The impact on the consolidated statement of income will be immaterial. 27 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements 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 organized on the basis of five businesses: the four business areas that constitute the Consumer Products Business (the Cosmetics Business, the Skin Care and Hair Care Business, the Human Health Care Business, and the Fabric and Home Care Business) and the Chemical Business. In each business, the Group plans comprehensive business strategies and carries out business activities on a global basis. Accordingly, the Group has five reportable segments: the Cosmetics Business, the Skin Care and Hair Care Business, the Human Health Care Business, the Fabric and Home Care Business and the Chemical Business. Due to a change in organization as of January 1, 2018, in the fiscal year ended December 31, 2018 the Group reclassified its four former reportable segments (the Beauty Care Business, the Human Health Care Business, the Fabric and Home Care Business and the Chemical Business) into five (the Cosmetics Business, the Skin Care and Hair Care Business, the Human Health Care Business, the Fabric and Home Care Business and the Chemical Business). Segment information for the fiscal year ended December 31, 2017 has been restated to reflect the reclassification. Information about major customers has been omitted as the revenue from each customer is less than 10% of the Group’s net sales. Reportable segments Major products Consumer Products Business Cosmetics Business Skin Care and Hair Care Business Human Health Care Business Fabric and Home Care Business Chemical Business Performance chemicals Cosmetics Counseling cosmetics, self-selection cosmetics Skin care products Soaps, facial cleansers, body cleansers Hair care products Food and beverage products Shampoos, conditioners, hair styling agents, hair coloring agents, men’s products Beverages Sanitary products Sanitary napkins, baby diapers Personal health products Bath additives, oral care 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 Specialty chemicals Toner and toner binder for copiers and printers, ink and colorants for inkjet printers, fragrances and aroma chemicals Kao Corporation Financial Report 2018 28 (2) Sales and Results of Reportable Segments Fiscal year ended December 31, 2018 (Millions of yen) Reportable segments Consumer Products Business Cosmetics Business Skin Care and Hair Care Business Human Health Care Business Fabric and Home Care Business Subtotal Chemical Business Total Reconciliation1 Consolidated Net sales Sales to customers ............... 279,635 Intersegment sales and transfers2 ............................. — Total net sales ........................... 279,635 Operating income ..................... 27,710 Financial income ................... Financial expenses ................ Share of profit in investments accounted for using the equity method ...................... Income before income taxes ..... 341,419 267,702 344,105 1,232,861 275,146 1,508,007 — 1,508,007 — 341,419 48,827 — 267,702 27,907 — — 37,661 344,105 1,232,861 312,807 30,631 175,693 71,249 37,661 1,545,668 206,324 (37,661) (37,661) 1,379 — 1,508,007 207,703 1,717 (4,251) 2,082 207,251 Other items Depreciation and amortization3 ....................... Capital expenditures4 ............ 10,908 11,597 9,593 17,021 17,602 19,259 10,299 18,107 48,402 65,984 12,000 23,032 60,402 89,016 260 81 60,662 89,097 Notes: 1. The operating income reconciliation of 1,379 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. Fiscal year ended December 31, 2017 (Millions of yen) Reportable segments Consumer Products Business Cosmetics Business Skin Care and Hair Care Business Human Health Care Business Fabric and Home Care Business Subtotal Chemical Business Total Reconciliation1 Consolidated Net sales Sales to customers ............... 266,214 Intersegment sales and transfers2 ............................. — Total net sales ........................... 266,214 Operating income ..................... 12,989 Financial income ................... Financial expenses ................ Share of profit in investments accounted for using the equity method ...................... Income before income taxes ..... 332,872 281,201 335,709 1,215,996 273,425 1,489,421 — 1,489,421 — 332,872 49,329 — 281,201 34,453 — — 36,860 36,860 335,709 1,215,996 310,285 1,526,281 203,317 173,018 30,299 76,247 (36,860) (36,860) 1,474 — 1,489,421 204,791 1,452 (3,960) 2,007 204,290 Other items Depreciation and amortization3 ....................... Capital expenditures4 ............ 10,333 11,267 7,730 16,450 15,822 23,596 8,884 12,676 42,769 11,479 63,989 15,245 54,248 79,234 260 121 54,508 79,355 Notes: 1. The operating income reconciliation of 1,474 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 2018 Notes to Consolidated Financial Statements (3) Geographical Information Sales to customers and non-current assets (excluding financial assets, deferred tax assets and retirement benefit assets) by region consist of the following: Sales to Customers Japan ......................................................................................................................................................... Asia ........................................................................................................................................................... China ...................................................................................................................................................... Americas .................................................................................................................................................... United States ......................................................................................................................................... Europe ....................................................................................................................................................... Total ................................................................................................................................................... Note: Sales are classified by country or region based on the location of customers. 2018 939,463 295,714 135,629 140,637 110,783 (Millions of yen) 2017 938,074 288,087 134,751 134,219 102,763 132,193 1,508,007 129,041 1,489,421 Non-current Assets (excluding Financial Assets, Deferred Tax Assets and Retirement Benefit Assets) (Millions of yen) Japan ......................................................................................................................................................... Asia ............................................................................................................................................................ Americas .................................................................................................................................................... Europe ....................................................................................................................................................... Total .................................................................................................................................................... 2018 448,357 88,843 96,426 27,184 660,810 2017 431,673 85,290 22,610 28,935 568,508 7 Business Combinations (1) Acquisition of Oribe Hair Care, LLC in the U.S. 1) Outline of Business Combination Name of the acquired business and 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 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. 3) Acquisition Cost of Acquired Business and Acquiree and Its Components Acquisition cost of acquired business and acquiree: 45,633 million yen Components of acquisition cost: Cash 45,633 million yen Kao Corporation Financial Report 2018 30 4) Fair Value of Assets Acquired and Liabilities Assumed at the Acquisition Date Current assets ................................................................ 4,074 million yen Trademarks ..................................................................... 14,232 million yen Other non-current assets ................................................ 4,151 million yen Total assets.................................................................. 22,457 million yen Current liabilities ............................................................. 1,090 million yen Total liabilities .............................................................. 1,090 million yen 5) Goodwill Goodwill recognized: Components of goodwill: 24,266 million yen Goodwill recognized for this business combination reflects excess earning powers in future from using newly acquired brands, products and sales networks from Oribe Hair Care, LLC. Goodwill recognized is expected to be 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, 2018 are not presented because the impacts on the consolidated statement of income are immaterial. (2) Acquisition of Washing Systems Intermediate Holdings, Inc. in the U.S. 1) Outline of Business Combination Name of the acquiree: Washing Systems Intermediate Holdings, Inc. (hereinafter “Washing Systems”) Business outline: Acquisition date: Acquisition method: Development and sales of detergents and other products and provision of consulting and other services to the commercial laundry market August 9, 2018 Cash consideration to acquire shares Percentage of voting rights acquired: 100% 2) Primary Reason for Business Combination Washing Systems has earned substantial market support by developing and selling industry-leading cleaning agents and by providing integrated supply systems for cleaning agents and best-in-class customer service to commercial laundry companies, mainly in North America. The Group develops professional-use products, primarily in Japan, through Kao Professional Services Company, Ltd. (hereinafter “KPS”) The mission of KPS is to maintain people’s safety, security, and comfort through support for cleaning applications, hygiene management and other measures in a variety of fields including food service, food processing, hospitals and cleaning. With this acquisition, the Company will promote global development of its professional-use products. 3) Acquisition Cost of Acquired Business and Acquiree and Its Components Acquisition cost of acquired business and acquiree: Components of acquisition cost: 30,706 million yen Cash 30,706 million yen 4) Fair Value of Assets Acquired and Liabilities Assumed at the Acquisition Date Current assets ................................................................ 2,609 million yen Customer relationships ................................................... 9,291 million yen Other non-current assets ................................................ 4,630 million yen Total assets ................................................................. 16,530 million yen Current liabilities ............................................................ 1,672 million yen Non-current liabilities ..................................................... 2,752 million yen Total liabilities .............................................................. 4,424 million yen 31 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements 5) Goodwill Goodwill recognized: Components of goodwill: 18,600 million yen Goodwill recognized for this business combination reflects excess earning powers in future from using newly acquired products and sales networks from Washing Systems. A portion of goodwill recognized is expected to be 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, 2018 are not presented because the impacts on the consolidated statement of income are immaterial. 8 Cash and Cash Equivalents Cash and cash equivalents consist of the following: Cash and deposits ..................................................................................................................................... Short-term investments ............................................................................................................................. Total .................................................................................................................................................... 2018 206,078 59,900 265,978 (Millions of yen) 2017 260,176 82,900 343,076 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 .................................................................................................................................................... 2018 217,594 7,073 (1,565) 223,102 (Millions of yen) 2017 211,990 5,915 (1,398) 216,507 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 2018 32 10 Inventories Inventories consist of the following: Merchandise and finished goods ............................................................................................................... Work in progress ....................................................................................................................................... Materials and supplies .............................................................................................................................. Total .................................................................................................................................................... 2018 146,684 14,875 36,012 197,571 (Millions of yen) 2017 136,795 12,723 34,403 183,921 The amount of inventories recognized as expenses and included in cost of sales for the fiscal years ended December 31, 2018 and 2017 were 733,108 million yen and 714,981 million yen, respectively. Write-downs of inventories recognized as expenses for the fiscal years ended December 31, 2018 and 2017 were 5,044 million yen and 5,093 million yen, respectively. 11 Other Assets Other assets consist of the following: Other current assets (Millions of yen) 2018 2017 Insurance receivable .............................................................................................................................. Prepaid expenses ................................................................................................................................... Other ...................................................................................................................................................... Total .................................................................................................................................................... Other non-current assets Insurance receivable .............................................................................................................................. Long-term prepaid lease payments ....................................................................................................... Long-term prepaid expenses ................................................................................................................. Retirement benefit assets ..................................................................................................................... Other ...................................................................................................................................................... Total .................................................................................................................................................... 2,886 9,538 10,025 22,449 2,109 4,060 435 1,166 505 8,275 8,120 9,566 10,476 28,162 2,654 4,508 1,624 1,224 676 10,686 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 pursuant to the decision to sell these assets. These assets were sold in the fiscal year ended December 31, 2018. 33 Kao Corporation Financial Report 2018 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 January 1, 2017 ............................................................ Additions .................................................................. Acquisitions through business combinations .......... Sales and disposals .................................................. Reclassification ........................................................ Exchange differences on translation of foreign operations .................................................. Other ........................................................................ Buildings and structures 408,899 Machinery and vehicles 716,797 566 697 (5,468) 18,605 2,766 60 230 100 (27,952) 36,152 4,327 281 Tools, furniture and fixtures 119,612 4,762 48 (13,424) 7,464 1,197 (315) December 31, 2017 ..................................................... 426,125 729,935 119,344 Additions .................................................................. Acquisitions through business combinations .......... 327 46 331 1,649 Sales and disposals .................................................. (6,808) (26,497) Reclassification ........................................................ 20,519 41,311 1,433 181 (8,457) 10,773 Construction in progress 24,488 67,471 — (3) (62,591) 359 172 29,896 76,545 129 — Land 73,018 13 83 (443) 370 274 (0) 73,315 2,749 — (226) 34 (72,637) (Millions of yen) Total 1,342,814 73,042 928 (47,290) — 8,923 198 1,378,615 81,385 2,005 (41,988) — Exchange differences on translation of foreign operations .................................................. (4,207) (8,474) (1,389) (189) (538) (14,797) Other ........................................................................ December 31, 2018 ..................................................... (231) 435,771 162 738,417 (334) 121,551 0 75,683 1,148 34,543 745 1,405,965 Accumulated Depreciation and Accumulated Impairment Losses Buildings and structures 285,460 January 1, 2017 ............................................................ Machinery and vehicles 583,202 Depreciation1 ............................................................ 13,036 25,133 Impairment losses2 .................................................. Impairment losses reversed2 ................................... — (0) 18 — Tools, furniture and fixtures 92,901 11,323 1 (1) Sales and disposals .................................................. (5,132) (27,219) (13,185) Exchange differences on translation of foreign operations .................................................. Other ........................................................................ 1,888 69 4,091 272 December 31, 2017 ..................................................... 295,321 585,497 Depreciation1 ............................................................ 13,739 28,209 929 (291) 91,677 11,683 Sales and disposals .................................................. (6,315) (25,663) (8,270) Exchange differences on translation of foreign operations .................................................. (2,199) (5,737) Other ........................................................................ December 31, 2018 ..................................................... (113) 300,433 132 582,438 (1,042) (209) 93,839 Land 10,416 — — — (96) — — 10,320 — — — — 10,320 Construction in progress — — — — — — — — — — — — — (Millions of yen) Total 971,979 49,492 19 (1) (45,632) 6,908 50 982,815 53,631 (40,248) (8,978) (190) 987,030 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 2018 34 Carrying Amount January 1, 2017 ............................................................ Buildings and structures 123,439 Machinery and vehicles 133,595 December 31, 2017 ..................................................... 130,804 144,438 December 31, 2018 ..................................................... 135,338 155,979 (Millions of yen) Tools, furniture and fixtures 26,711 27,667 27,712 Construction in progress 24,488 29,896 34,543 Land 62,602 62,995 65,363 Total 370,835 395,800 418,935 (2) Leased Assets The carrying amount of leased assets from finance leases included in property, plant and equipment is as follows: January 1, 2017 ............................................................ December 31, 2017 ..................................................... December 31, 2018 ..................................................... (Millions of yen) Buildings and structures 4,060 3,195 2,419 Other 54 58 45 Total 4,114 3,253 2,464 (4) Commitments Note 38 “Commitments” presents information on commitments to acquire property, plant and equipment. (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. 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 (Millions of yen) January 1, 2017 ............................................................ Additions .................................................................. Acquisitions through business combinations .......... Sales and disposals .................................................. Reclassification ........................................................ Exchange differences on translation of foreign operations .................................................. Other ........................................................................ Goodwill 137,783 Software 27,284 — 495 — — 457 — 84 11 (5,502) 5,194 134 (9) December 31, 2017 ..................................................... 138,735 27,196 Additions .................................................................. — Acquisitions through business combinations .......... 42,866 Sales and disposals .................................................. Reclassification ........................................................ — — 110 5 (5,640) 7,495 Exchange differences on translation of foreign operations .................................................. (1,315) (127) (68) Other ........................................................................ December 31, 2018 ..................................................... — 180,286 281 29,320 — 14,710 Note: 1. Software in progress is included in other in intangible assets. 35 Kao Corporation Financial Report 2018 Intangible assets Customer relationships Trademarks — — 2 (2) — — — — — — — 768 (63) — 72 — 777 — 14,778 13,115 — — — — (153) — 13,739 Other1 5,163 6,229 12 (807) (5,188) (55) (11) 5,343 7,602 1,525 (143) (7,495) (72) (25) 6,735 Total 32,447 6,313 793 (6,374) 6 151 (20) 33,316 7,712 29,423 (5,783) — (420) 256 64,504 Notes to Consolidated Financial Statements Accumulated Amortization and Accumulated Impairment Losses (Millions of yen) January 1, 2017 ............................................................ Amortization1 ............................................................ Sales and disposals .................................................. Exchange differences on translation of foreign operations .................................................. Other ........................................................................ December 31, 2017 ..................................................... Amortization1 ............................................................ Sales and disposals .................................................. Exchange differences on translation of foreign operations .................................................. Other ........................................................................ December 31, 2018 ..................................................... Goodwill — — — — — — — — — — — Software 14,915 4,839 (5,486) 117 (10) 14,375 5,397 (5,500) (105) 228 14,395 Intangible assets Customer relationships — Trademarks — — — — — — 737 — (1) — 736 120 (63) 1 — 58 619 — (11) — 666 Other 2,843 57 (794) (52) — 2,054 278 (135) (52) 13 2,158 Total 17,758 5,016 (6,343) 66 (10) 16,487 7,031 (5,635) (169) 241 17,955 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, 2017 ............................................................ Goodwill 137,783 December 31, 2017 ..................................................... 138,735 December 31, 2018 ..................................................... 180,286 (Millions of yen) Intangible assets Customer relationships Trademarks — — — 719 13,974 13,073 Software 12,369 12,821 14,925 Other 2,320 3,289 4,577 Total 14,689 16,829 46,549 (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 Cosmetics Business, the Skin Care and Hair Care Business, the Fabric and Home Care Business and the Chemical Business. The goodwill primarily relates to the acquisition of the Kanebo Cosmetics Group. Cosmetics Business .................................................................................................................................. Kanebo Cosmetics Group ...................................................................................................................... Molton Brown Group ............................................................................................................................. Skin Care and Hair Care Business ............................................................................................................. Oribe Hair Care and other ...................................................................................................................... Other ...................................................................................................................................................... Fabric and Home Care Business .............................................................................................................. Chemical Business .................................................................................................................................... Total .................................................................................................................................................... 2018 130,455 119,400 11,055 28,831 24,908 3,923 18,423 2,577 180,286 (Millions of yen) 2017 131,283 119,400 11,883 4,792 779 4,013 — 2,660 138,735 (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 two-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 two-year forecasts approved by management were calculated using an annual growth rate of 0% and were discounted to present value Kao Corporation Financial Report 2018 36 using a weighted average cost of capital (WACC) of 8.2% for the fiscal year ended December 31, 2018 and 7.1% for the fiscal year ended December 31, 2017. For the fiscal year ended December 31, 2018, 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. While the value in use exceeded carrying amount at December 31, 2017, increasing the discount rate by 2.9% would result in impairment. (4) Intangible Assets with Indefinite Useful Lives The intangible assets above include no material intangible assets with indefinite useful lives. (5) Commitments Note 38 “Commitments” presents information on commitments associated with the acquisition of intangible assets. 15 Investments Accounted for Using the Equity Method Investments in associates are accounted for using the equity method in the Group’s consolidated financial statements. The carrying amount of investments in associates that are not individually material is as follows: Investments accounted for using the equity method ................................................................................ 2018 7,931 (Millions of yen) 2017 7,682 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 ........................................................................................... 2018 2,082 (418) 1,664 (Millions of yen) 2017 2,007 316 2,323 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, 2018 (Millions of yen) January 1, 2018 Recognized in profit or loss Recognized in other comprehensive income Other December 31, 2018 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 .......................................... 18,735 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 2018 559 589 (998) (1,065) 2,593 1,678 776 — 426 52 1,254 424 — 7,011 — — — 7,011 — 121 — — 121 6,890 (77) (244) 13 366 (45) 13 2,309 (756) — (37) 1,516 (1,503) 19,217 24,093 10,446 1,400 15,866 71,022 10,188 2,635 11,161 744 24,728 46,294 Notes to Consolidated Financial Statements 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 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 ............................................................................................................................ 2018 49,158 2,864 46,294 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 ......................................................................................................................................................... 2018 2,664 11,981 14,645 2018 210 353 472 297 1,332 2,664 18,735 16,737 11,431 2,099 13,318 62,320 7,103 3,270 10,735 729 21,837 40,483 (Millions of yen) 2017 40,918 435 40,483 (Millions of yen) 2017 17,656 19,967 37,623 (Millions of yen) 2017 507 3,426 7,007 5,336 1,380 17,656 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, 2018 and 2017 were 11,512 million yen and 15,835 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 2018 38 (2) Income Taxes Income taxes consist of the following: Current taxes ............................................................................................................................................. Deferred taxes1 .......................................................................................................................................... Total ....................................................................................................................................................... 2018 52,344 (424) 51,920 (Millions of yen) 2017 55,769 (86) 55,683 Note: 1. Deferred taxes include 385 million yen and 160 million yen for the fiscal years ended December 31, 2018 and 2017, 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 .............................................................................................................................. 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 ............................................................................................. 2018 430 40,046 30,299 12 50,040 120,827 2017 201 67 70,347 24,994 24,975 120,584 Current liabilities Bonds and borrowings .................................................................... 40,488 25,262 Non-current liabilities Bonds and borrowings .................................................................... Total ............................................................................................. 80,339 120,827 95,322 120,584 2018 30.86 (3.80) (1.64) (0.30) 0.19 (0.26) 25.05 (%) 2017 30.86 (2.68) (0.92) 0.48 0.08 (0.56) 27.26 Average interest rate1 (%) 1.18 0.13 0.11 — — (Millions of yen) Maturity — — 2021-2023 — — Notes: 1. The average interest rate is the weighted average interest rate on the balance of borrowings as of December 31, 2018. 2. Details of bonds issued are as follows: Issuer Bond name Issue date 2018 2017 Interest rate (%) Collateral Maturity date The Company 3rd unsecured bonds June 14, 2013 — 24,994 The Company 4th unsecured bonds June 14, 2013 24,985 24,975 The Company 5th unsecured bonds June 19, 2018 24,947 Subsidiaries Other bonds — 120 — — Total ................................................................................. 50,052 49,969 0.39 0.62 0.08 — None June 20, 2018 None June 19, 2020 None June 20, 2023 — — (Millions of yen) 39 Kao Corporation Financial Report 2018 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 2017 2018 789 689 1,769 25 2,483 (64) 2,419 2,337 149 3,275 (97) 3,178 (Millions of yen) Present value of minimum lease payments 2018 663 1,731 25 2,419 — 2,419 2017 755 2,276 147 3,178 — 3,178 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 ....................................................................................................................................................... 2018 8,622 15,539 6,381 30,542 (Millions of yen) 2017 8,414 16,347 6,917 31,678 The total of minimum lease payments under operating lease contracts recognized as expenses is as follows: Total of minimum lease payments ............................................................................................................. 19 Trade and Other Payables Trade and other payables consist of the following: Trade payables ........................................................................................................................................... Non-trade payables .................................................................................................................................... Total ...................................................................................................................................................... 2018 9,829 (Millions of yen) 2017 10,080 2018 145,603 79,957 225,560 (Millions of yen) 2017 143,944 80,949 224,893 Kao Corporation Financial Report 2018 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 defined benefit liabilities ............................................................................................................. Amounts recognized in consolidated statement of fi nancial position Retirement benefit liabilities .................................................................................................................. Retirement benefit assets ..................................................................................................................... Net defined benefit liabilities ............................................................................................................. 2) Defined benefit obligations Changes in the present value of defined benefit obligations are as follows: The present value of the defi ned benefi t 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 defi ned benefi t obligations at end of year .......................................................... 2018 342,130 (258,744) 83,386 84,552 (1,166) 83,386 2018 333,614 9,376 2,569 6,755 1,376 1,748 107 (11,865) — (1,550) 342,130 (Millions of yen) 2017 333,614 (270,144) 63,470 64,694 (1,224) 63,470 (Millions of yen) 2017 355,579 9,839 2,672 (31) (20,245) 2,242 (407) (12,015) (4,738) 718 333,614 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 cost of sales and general and administrative expenses in the consolidated statement of income. 4. The weighted average duration of the defined benefit obligations in Japan was mainly 17.4 years at December 31, 2018 and 16.6 years at December 31, 2017. 41 Kao Corporation Financial Report 2018 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 ............................................................................................... 2018 270,144 1,927 (12,656) 10,292 (10,249) — (714) 258,744 (Millions of yen) 2017 261,857 1,882 12,850 8,941 (10,624) (4,738) (24) 270,144 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 13,661 million yen to the defined benefit plan for the fiscal year ending December 31, 2019. Plan assets consist of the following: Equity securities Japan ...................................... Overseas ................................. Debt securities ........................... Japan ...................................... Overseas ................................. Other .......................................... Total ..................................... 2018 Market price in an active market Quoted 8,830 — 8,830 6,640 — 6,640 352 15,822 Unquoted 43,962 21,502 22,460 188,425 126,940 61,485 10,535 242,922 Total 52,792 21,502 31,290 195,065 126,940 68,125 10,887 258,744 (Millions of yen) 2017 Market price in an active market 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 Quoted 9,207 — 9,207 7,518 — 7,518 257 16,982 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% 2018 2017 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) 2018 2017 (25,292) 26,314 (23,414) 24,311 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 2018 42 5) Defined contribution plans Expenses related to the defined contribution plan recognized in profit or loss were 4,176 million yen and 3,873 million yen for the fiscal years ended December 31, 2018 and 2017, 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, 2018 and 2017 were 272,234 million yen and 268,034 million yen, respectively. 21 Provisions Components of and changes in provisions consist of the following: January 1, 2018 .................................................................................... Provision for loss related to cosmetics 8,763 Provision for asset retirement obligations 4,339 Other provisions 2,337 Increase ............................................................................................ 2,732 Interest expense on discounted provision ......................................... 7 Decrease (provision used) ................................................................ (3,334) Decrease (provision reversed) .......................................................... Exchange differences on translation of foreign operations ........................................................................... — — December 31, 2018 .............................................................................. 8,168 174 62 (139) — (22) 4,414 1,383 — (1,002) (181) (71) 2,466 (Millions of yen) Total 15,439 4,289 69 (4,475) (181) (93) 15,048 (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 2,521 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 subsidiaries in Europe and the Americas 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 ......................................................................................................................................................... 2018 77,530 8,808 7,865 8,249 (Millions of yen) 2017 81,515 9,741 7,558 8,590 Total ....................................................................................................................................................... 102,452 107,404 43 Kao Corporation Financial Report 2018 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) 2018 1,000,000,000 2017 1,000,000,000 Beginning balance .................................................................................................................................. 495,000,000 504,000,000 Change during the year2 ......................................................................................................................... (6,300,000) (9,000,000) Ending balance ....................................................................................................................................... 488,700,000 495,000,000 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, 2018 and 2017 decreased by 6,300,000 shares and 9,000,000 shares respectively 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 .................................................................................................................................... Increase2 ................................................................................................................................................ (Shares) 2018 2,225,561 6,237,461 2017 11,137,654 263,176 Decrease3 ............................................................................................................................................... (6,419,750) (9,175,269) Ending balance4 ......................................................................................................................................... 2,043,272 2,225,561 Notes: 1. 556,492 shares of treasury shares held by associates were included at December 31, 2018 and 2017. 257,300 shares held by the Board Incentive Plan Trust (hereinafter “BIP Trust”) were included at December 31, 2018. 2. The increase of 6,237,461 shares of treasury shares during the fiscal year ended December 31, 2018 resulted from the acquisition of 6,233,200 shares by resolution of the Board of Directors and the purchase of 4,261 fractional shares. 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 BIP Trust and the purchase of 5,876 fractional shares. 3. The decrease of 6,419,750 shares of treasury shares during the fiscal year ended December 31, 2018 resulted from the retirement of 6,300,000 shares by resolution of the Board of Directors, a decrease of 105,000 shares due to the exercise of stock options, a decrease of 14,625 shares due to the grant to the Board of Directors by the BIP trust and the sale of 125 fractional shares. 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. 4. 556,492 shares of treasury shares held by associates were included at December 31, 2018 and 2017. In addition, 242,675 shares and 257,300 shares held by the BIP Trust were included at December 31, 2018 and 2017, respectively. (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, 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 Associates hedge their 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 2018 44 5) Remeasurements of defined benefit plans Remeasurements of defined benefit plans include 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. 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. Guided by EVA management, which places importance on both continuous enhancements in corporate value and long-term profits for all stakeholders, the Group develops its business strategy and business plan. 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 maintain high credit ratings which will allow it to procure capital for large-scale investments. The Group is not subject to significant (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. 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, 2018, EVA increased 3.1 billion yen compared with the previous fiscal year to 93.5 billion yen due to an 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, 2018 Date of resolution 112th Annual General Meeting of Shareholders held on March 23, 2018 Board of Directors meeting held on July 26, 2018 Total dividends¹ (Millions of yen) Dividends per share (Yen) Record date Effective date 27,595 29,197 56 60 December 31, 2017 March 26, 2018 June 30, 2018 September 3, 2018 Note: 1. Total dividends are reduced by dividends on treasury shares held by associates accounted for using the equity method and dividends on shares of the Company held by the BIP Trust. The dividend resolved at the 112th Annual General Meeting of Shareholders held on March 23, 2018 was 27,641 million yen before the deduction. The dividend resolved at the meeting of the Board of Directors held on July 26, 2018 was 29,245 million yen before the deduction. 45 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements 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 on shares of the Company 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. Dividends with an effective date after the fiscal year end are as follows: Fiscal year ended December 31, 2018 Date of Resolution 113th Annual General Meeting of Shareholders held on March 26, 2019 Fiscal year ended December 31, 2017 Date of Resolution 112th Annual General Meeting of Shareholders held on March 23, 2018 Total dividends (Millions of yen) Dividends per share (Yen) Record date Effective date 29,247 60 December 31, 2018 March 27, 2019 Total dividends (Millions of yen) Dividends per share (Yen) Record date Effective date 27,641 56 December 31, 2017 March 26, 2018 26 Revenue (1) Disaggregation of Revenue The Group is organized on the basis of five businesses: the four business areas that constitute the Consumer Products Business (the Cosmetics Business, the Skin Care and Hair Care Business, the Human Health Care Business, and the Fabric and Home Care Business), and the Chemical Business. Revenues of these five 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 five main businesses. The Group disaggregates revenue from contracts with customers by separating the Consumer Products Business into the Cosmetics Business and non-Cosmetics Businesses 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: Due to a change in organization as of January 1, 2018, in the fiscal year ended December 31, 2018 the Group reclassified its reportable segments and disaggregation of revenue for the fiscal year ended December 31, 2017 has been restated to reflect the reclassification. Changes in segment classification are presented in Note 6 “Segment Information (1) Summary of Reportable Segments.” Kao Corporation Financial Report 2018 46 Fiscal year ended December 31, 2018 Cosmetics Business Skin Care and Hair Care Business Human Health Care Business Fabric and Home Care Business Consumer Products Business Chemical Business Elimination of intersegment transactions Consolidated Revenue of logistics services to third parties included in other operating income Japan 217,726 195,821 171,633 298,712 883,892 126,550 (32,864) 977,578 Asia 34,667 28,513 95,971 39,558 198,709 67,480 (3,088) 263,101 Americas 6,397 72,804 98 5,723 85,022 51,846 (87) Europe 20,845 44,281 — 112 65,238 66,931 (1,622) (Millions of yen) Total 279,635 341,419 267,702 344,105 1,232,861 312,807 (37,661) 136,781 130,547 1,508,007 8,548 — — — 8,548 Total revenue from contracts with customers 986,126 263,101 136,781 130,547 1,516,555 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. Fiscal year ended December 31, 2017 Cosmetics Business Skin Care and Hair Care Business Human Health Care Business Fabric and Home Care Business Consumer Products Business Chemical Business Elimination of intersegment transactions Consolidated Revenue of logistics services to third parties included in other operating income Japan 215,035 191,853 184,453 294,838 886,179 123,886 (31,833) 978,232 Asia 25,356 27,942 96,701 38,786 188,785 69,572 (3,352) 255,005 Americas 6,276 68,866 47 2,085 77,274 52,625 (99) Europe 19,547 44,211 — — 63,758 64,202 (1,576) (Millions of yen) Total 266,214 332,872 281,201 335,709 1,215,996 310,285 (36,860) 129,800 126,384 1,489,421 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. 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- 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 47 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements 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. January 1, 2018 December 31, 2018 (Millions of yen) 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) Liabilities from Contracts with Customers Liabilities from contracts with customers are as follows: Fiscal year ended December 31, 2018 Contract liabilities Advances ........................................................................................................................... Refund liabilities ................................................................................................................. Total ................................................................................................................................ 392 16,904 17,296 181 18,206 18,387 Fiscal year ended December 31, 2017 Contract liabilities January 1, 2017 December 31, 2017 (Millions of yen) Advances ........................................................................................................................... Refund liabilities ................................................................................................................. Total ................................................................................................................................ 2,501 14,046 16,547 392 16,904 17,296 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. The balances of advances as of January 1, 2018 and 2017 were recognized as revenue during the fiscal years ended December 31, 2018 and 2017, respectively. The amount of revenue recognized during the fiscal year ended December 31, 2018 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. (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, 2018 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. Kao Corporation Financial Report 2018 48 27 Selling, General and Administrative Expenses Selling, general and administrative expenses consist of the following: Advertising ................................................................................................................................................. Sales promotion ......................................................................................................................................... 2018 80,274 55,308 (Millions of yen) 2017 89,935 58,940 Employee benefi ts ..................................................................................................................................... 148,220 147,007 Depreciation .............................................................................................................................................. Amortization .............................................................................................................................................. Research and development ....................................................................................................................... Other ......................................................................................................................................................... 9,186 6,860 57,673 87,324 8,870 4,784 56,703 86,427 Total ....................................................................................................................................................... 444,845 452,666 28 Other Operating Income Other operating income consists of the following: Revenue of logistics services to third parties ............................................................................................ Royalty income .......................................................................................................................................... Other ......................................................................................................................................................... 2018 8,548 1,039 4,701 (Millions of yen) 2017 8,619 1,112 5,178 Total ....................................................................................................................................................... 14,288 14,909 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 subsidiaries in Europe and the Americas ................................. Other1 ........................................................................................................................................................ 2018 7,667 4,769 1,516 1,806 Total ....................................................................................................................................................... 15,758 Note: 1. Note 13 “Property, Plant and Equipment” presents impairment losses included in other. (Millions of yen) 2017 7,688 3,729 27 1,322 12,766 49 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements 30 Financial Income and Financial Expenses Financial income consists of the following: (Millions of yen) 2018 2017 Interest income Financial assets measured at amortized cost ........................................................................................ Retirement benefi t assets ..................................................................................................................... 1,320 30 1,059 38 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 ......................................................................................................................................................... 78 171 8 110 0 224 12 119 Total ................................................................................................................................................ 1,717 1,452 Financial expenses consist of the following: Foreign exchange loss1 .............................................................................................................................. Interest expenses2 Financial liabilities measured at amortized cost ..................................................................................... Retirement benefi t liabilities .................................................................................................................. Other ............................................................................................................................................... Total ................................................................................................................................................ 2018 2,304 1,256 672 19 4,251 (Millions of yen) 2017 1,765 1,339 828 28 3,960 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. 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) 2018 153,698 — 2017 147,010 — Net income used to calculate basic earnings per share ............................................................................ 153,698 147,010 Weighted average number of ordinary shares (Thousands of shares) .................................................. 489,089 492,832 Basic earnings per share (Yen) ................................................................................................................... 314.25 298.30 Kao Corporation Financial Report 2018 50 (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) 2018 153,698 — 2017 147,010 — Net income used to calculate diluted earnings per share .......................................................................... 153,698 147,010 Weighted average number of ordinary shares (Thousands of shares) ...................................................... 489,089 492,832 Increase in ordinary shares Subscription rights to shares (Thousands of shares) .................................................................... 199 Weighted average number of ordinary shares after dilution (Thousands of shares) .......................... 489,289 337 493,170 Diluted earnings per share (Yen) ...................................................................................................... 314.12 298.09 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, 2018 Items that will not be reclassifi ed to profi t or loss Gains (losses) arising for the year Tax effect After tax effect (Millions of yen) Net gain (loss) on revaluation of fi nancial assets measured at fair value through other comprehensive income ................................................................................... 119 (121) (2) Remeasurements of defi ned benefi t plans ................................................................. (22,535) 7,011 (15,524) Share of other comprehensive income of investments accounted for using the equity method ........................................................................................... (497) Total of items that will not be reclassifi ed to profi t or loss ...................................... (22,913) 152 7,042 (345) (15,871) Items that may be reclassified subsequently to profit or loss Exchange differences on translation of foreign operations ......................................... (16,140) Share of other comprehensive income of investments accounted for using the equity method ........................................................................................... (75) Total of items that may be reclassifi ed subsequently to profi t or loss .................... (16,215) — 2 2 (16,140) (73) (16,213) Total ..................................................................................................................... (39,128) 7,044 (32,084) 51 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements 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 fi nancial assets measured at fair value through other comprehensive income ................................................................................... Remeasurements of defi ned benefi t plans ................................................................. Share of other comprehensive income of investments accounted for using the equity method ........................................................................................... Total of items that will not be reclassifi ed to profi t or loss ...................................... 1,675 30,884 457 33,016 Items that may be reclassifi ed subsequently to profi t 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 reclassifi ed subsequently to profi t 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 33 Cash Flow Information (1) Payments for Business Combinations Payments for business combinations consist of the following: Cash and cash equivalents paid for acquisition ......................................................................................... Cash and cash equivalents held by the acquiree at the time of acquisition .............................................. Payments for business combinations ........................................................................................................ (Millions of yen) 2018 76,387 (2,472) 73,915 (2) Changes in Liabilities Arising from Financing Activities The major changes in liabilities arising from financing activities are changes from financing cash flows and there are no significant non- cash changes. Kao Corporation Financial Report 2018 52 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, 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. 2) Number of stock options and weighted average exercise price • 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 Beginning balance of outstanding ................................. Granted ...................................................................... Exercised ................................................................... Expired at maturity ..................................................... Ending balance of outstanding ...................................... Ending balance of exercisable ....................................... 2018 2017 Number of shares (Shares) 313,000 — (105,000) (83,000) 125,000 125,000 Weighted average exercise price (Yen) 973 — 1,117 2,254 1 1 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 Notes: 1. The weighted average share price on the date of exercise for the fiscal years ended December 31, 2018 and 2017 was 7,877 yen and 6,254 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: Exercise price (Yen) 1 — Total 2018 Number of shares (Shares) 125,000 — 125,000 Weighted average remaining contractual life (Years) Exercise price (Yen) 2.8 — 2.8 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 53 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements (2) Performance Share Plan 1) Outline of performance share plan 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 or paid following completion of settlement procedures by the designated beneficiary, after the end of the eligibility period in the case of performance- linked points, or 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: Number of points granted during the period ................... Achievement-linked points 37,625 Weighted average fair value (Yen) ................................... 6,821 Fixed points 16,125 6,659 Achievement-linked points 34,125 6,821 Fixed points 14,625 6,767 2018 2017 (3) Share-based Payment Expenses Share-based payment expenses recognized in the consolidated statement of income for the fiscal years ended December 31, 2018 and 2017 were 364 million yen and 332 million yen, respectively. Kao Corporation Financial Report 2018 54 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) 2018 2017 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 fi nancial assets ............................................................................................................................ Subtotal .............................................................................................................................................. Non-current assets Other fi nancial assets ............................................................................................................................ Total ................................................................................................................................................ 236,078 223,102 23,495 29,900 1,068 2,983 11,140 527,766 265,978 223,102 15,146 504,226 23,540 527,766 313,176 216,507 24,639 29,900 602 2,926 14,092 601,842 343,076 216,507 14,914 574,497 27,345 601,842 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, 2018 Company name Seven & i Holdings Co., Ltd. ..................................................................................................................... Saiwai Trading Co., Ltd. ............................................................................................................................. Livedo Corporation .................................................................................................................................... Aeon Co., Ltd. ........................................................................................................................................... Tokio Marine Holdings, Inc. ...................................................................................................................... Japan Alcohol Trading Co., Ltd. ................................................................................................................. Izumi Co., Ltd. .......................................................................................................................................... Keytrading Co., Ltd. .................................................................................................................................. The Yamagata Bank, Ltd. .......................................................................................................................... Inageya Co., Ltd. ....................................................................................................................................... (Millions of yen) Fair value 3,076 1,191 1,122 905 889 622 511 389 237 225 55 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements 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. .................................................................................................................. 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 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 values 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) .......................................................................................................................... 2018 3,077 2,451 (Millions of yen) 2017 24 10 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, 2018 and 2017, were 1,694 million yen and 7 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) 2018 2017 Trade and other payables (Note 19) ........................................................................................................ Bonds and borrowings (Note 17) ........................................................................................................... Other ...................................................................................................................................................... 225,560 120,827 16,178 Financial liabilities measured at fair value through profi t or loss Derivatives ............................................................................................................................................. 208 Total ................................................................................................................................................ 362,773 Current liabilities Trade and other payables ....................................................................................................................... 225,560 Bonds and borrowings ........................................................................................................................... Other fi nancial liabilities ......................................................................................................................... 40,488 6,880 Subtotal .............................................................................................................................................. 272,928 Non-current liabilities Bonds and borrowings ........................................................................................................................... Other fi nancial liabilities ......................................................................................................................... Subtotal .............................................................................................................................................. 80,339 9,506 89,845 Total ................................................................................................................................................ 362,773 224,893 120,584 16,804 1,026 363,307 224,893 25,262 7,739 257,894 95,322 10,091 105,413 363,307 There are no significant assets pledged for the above financial liabilities. The Group held deposits received, which are interest-bearing liabilities in other financial liabilities, at December 31, 2018 and 2017 totaling 12,380 million yen and 12,599 million yen, respectively. The average interest rate on deposits received as of December 31, 2018 was 0.13%. Kao Corporation Financial Report 2018 56 (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 currencies 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 2018 Contract amount over 1 year Contract amount Carrying amount (fair value)¹ Contract amount (Millions of yen) 2017 Contract amount over 1 year Carrying amount (fair value)1 U.S. dollar ........................................................... Euro .................................................................... 14,583 — Buying Euro .................................................................... Chinese yuan ...................................................... Currency swaps: Receiving Japanese yen, paying U.S. dollar .......... Receiving Japanese yen, paying Chinese yuan ..... — 212 7,343 — — — — — 7,343 — 116 — — (1) (15) — 13,800 70 120 725 8,004 1,987 7,280 — — — 2,339 — 135 1 (2) (98) (53) (325) 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, 2018 Net exposure .................................................................................................................. As of December 31, 2017 Net exposure .................................................................................................................. U.S. dollar 2,801 U.S. dollar 8,713 Euro 1,930 Euro 161 (Millions of yen) Chinese yuan 10,766 (Millions of yen) Chinese yuan 8,458 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. 57 Kao Corporation Financial Report 2018 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 ........................................................................................................................................................... 2018 (280) (193) Chinese yuan ............................................................................................................................................. (1,077) (Millions of yen) 2017 (871) (16) (846) (ii) Interest rate fluctuation risk (ii) Short-term investments 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 that 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 6,640 million yen and 10,165 million yen at December 31, 2018 and 2017, 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 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 Kao Corporation Financial Report 2018 58 following situations that would adversely affect future cash flows, however, the Group measures expected credit losses individually by treating each receivable as a credit-impaired financial asset: • Where the customer has serious financial difficulties • Where the customer defaults or becomes delinquent in accounts receivable payments despite repeated demands for payment • Where it is more likely that the customer will go into bankruptcy or face a situation that forces it to reconstruct its business The Group directly writes down 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 6,782 million yen and 6,463 million yen at December 31, 2018 and 2017, respectively. The carrying amount of trade receivables and changes in the related allowance for doubtful receivables are as follows: Fiscal year ended December 31, 2018 (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, 2018 ..................................................................... 211,441 Change during the year (Recognition and derecognition) ................................... Transfer to credit-impaired fi nancial assets ........................ Other changes ................................................................... December 31, 2018 ............................................................ 10,605 (84) (4,944) 217,018 549 (16) 84 (41) 576 Allowance for doubtful receivables January 1, 2018 ..................................................................... Increase during the year .................................................... Decrease during the year (charge-offs) .............................. Decrease during the year (other) ....................................... Transfer to credit-impaired fi nancial assets ........................ Other changes ................................................................... December 31, 2018............................................................... 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 915 238 (78) (86) (4) (28) 957 459 98 (19) (0) 4 (51) 491 Total 211,990 10,589 — (4,985) 217,594 (Millions of yen) Total 1,374 336 (97) (86) — (79) 1,448 59 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements 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 fi nancial 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 fi nancial 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 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, 2018 Trade receivables ....................................................... Allowance for doubtful receivables ........................... Expected credit loss (%) ............................................ As of December 31, 2017 Trade receivables ....................................................... Allowance for doubtful receivables ........................... Expected credit loss (%) ............................................ (Millions of yen unless otherwise noted) Days past due Not due 204,308 164 0.1 Less than 30 days 7,453 Over 30 days 2,021 129 1.7 37 1.8 Over 60 days 1,197 53 4.4 Over 90 days 2,615 1,065 40.7 Total 217,594 1,448 0.7 (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 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. Kao Corporation Financial Report 2018 60  Financial liabilities including derivative instruments by maturity date consist of the following: As of December 31, 2018 (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 ........... 225,560 225,560 225,560 — — Bonds and borrowings ............... 120,827 120,895 40,488 25,050 30,247 Lease obligations........................ Long-term deposits payable ....... 2,419 6,782 2,483 6,782 Derivative financial liabilities Currency related ......................... 208 208 689 — 50 666 — 54 494 — — Total ........................................ 355,796 355,928 266,787 25,770 30,741 — 32 485 — 104 621 — 25,018 124 — — 25,142 — 60 25 6,782 — 6,867 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 (3) Fair Value of Financial Instruments 1) Fair value hierarchy levels and money held in trust, and are measured with a financial model using observable inputs such as interest rates. 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 (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. 61 Kao Corporation Financial Report 2018 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, 2018 or 2017. As of December 31, 2018 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 ....................................................................................... Financial liabilities Financial liabilities measured at fair value through profi t or loss Derivative liabilities ................................................................... Total ....................................................................................... — — — 6,640 6,640 — — 29,900 1,068 2,983 — 33,951 208 208 — — — 4,500 4,500 — — 29,900 1,068 2,983 11,140 45,091 208 208 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 Changes in financial instruments categorized within Level 3 are as follows: Beginning balance ..................................................................................................................................... Gains (losses)¹ ....................................................................................................................................... Sales ...................................................................................................................................................... Other changes ....................................................................................................................................... — — — 3,927 3,927 — — 2018 3,927 574 (0) (1) Ending balance .......................................................................................................................................... 4,500 29,900 602 2,926 14,092 47,520 1,026 1,026 (Millions of yen) 2017 3,472 454 — 1 3,927 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 2018 62 3) Financial instruments measured at amortized cost (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 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. The carrying amount and fair value hierarchy of financial instruments measured at amortized cost are as follows: As of December 31, 2018 Carrying amount Level 1 Level 2 Level 3 Total Fair value (Millions of yen) Financial liabilities Financial liabilities measured at amortized cost Bonds ............................................................ Borrowings .................................................... 50,052 70,775 — — 50,338 70,985 — — 50,338 70,985 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 63 Kao Corporation Financial Report 2018 Notes to Consolidated Financial Statements 36 Principal Subsidiaries Principal subsidiaries consist of the following. Voting rights at December 31, 2018 did not significantly change from a year earlier. Company name Kao Group Customer Marketing Co., Ltd. Country Japan Kanebo Cosmetics Inc. Kao Transport & Logistics Co., Ltd. Kao (China) Holding Co., Ltd. Kao Corporation Shanghai Kao (Hefei) Co., Ltd. Kao Commercial (Shanghai) Co., Ltd. Japan Japan China China China China Kanebo Cosmetics (China) Co., Ltd. Kao (Shanghai) Chemical Industries Co., Ltd. Kao (Taiwan) Corporation China China Taiwan Pilipinas Kao, Inc. Kao Industrial (Thailand) Co., Ltd. Philippines Thailand Kao Commercial (Thailand) Co., Ltd. Thailand Fatty Chemical (Malaysia) Sdn. Bhd. PT Kao Indonesia Malaysia Indonesia Kao USA Inc. Oribe Hair Care, LLC Washing Systems, LLC 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. U.S.A. U.S.A. U.S.A. U.S.A. U.S.A. Germany Germany Germany U.K. Spain Spain Principal businesses Control of sales companies and other subsidiaries in Japan Cosmetics Skin Care and Hair Care Human Health Care Fabric and Home Care Cosmetics Logistics and related services in Japan Control of subsidiaries in China Cosmetics Cosmetics Skin Care and Hair Care Human Health Care Fabric and Home Care Human Health Care Cosmetics Skin Care and Hair Care Human Health Care Fabric and Home Care Cosmetics Chemical Cosmetics Skin Care and Hair Care Human Health Care Fabric and Home Care Chemical Chemical Skin Care and Hair Care Human Health Care Fabric and Home Care Chemical Cosmetics Skin Care and Hair Care Human Health Care Fabric and Home Care Chemical Skin Care and Hair Care Human Health Care Fabric and Home Care Cosmetics Skin Care and Hair Care Skin Care and Hair Care Fabric and Home Care Corporate service to subsidiaries in the U.S. Holding company for Chemical Business in the U.S. Chemical Cosmetics Skin Care and Hair Care Skin Care and Hair Care Chemical Cosmetics Control of subsidiaries in Chemical Business in Europe, etc. Chemical Voting rights (%) 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 72.2 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Kao Corporation Financial Report 2018 64 Notes to Consolidated Financial Statements 37 Related Parties (1) Transactions with Related Parties Disclosure is omitted because there are no material related party transactions. (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 ....................................................................................................................................................... 2018 1,161 28 364 1,553 (Millions of yen) 2017 1,315 30 332 1,677 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 ....................................................................................................................................................... 2018 30,751 1,188 31,939 (Millions of yen) 2017 37,906 1,237 39,143 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 25, 2019. 65 Kao Corporation Financial Report 2018 Independent Auditor’s Report Kao Corporation Financial Report 2018 66 14-10, Nihonbashi Kayabacho 1-chome Chuo-ku, Tokyo 103-8210, Japan https://www.kao.com/global/en/ Investor Relations E-mail: ir@kao.co.jp Website: https://www.kao.com/global/en/investor-relations/ 

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