Kao Corp.
Annual Report 2020

Plain-text annual report

Financial Report 2020 For the year ended December 31, 2020 Management Discussion and Analysis Consolidated Financial Statements Notes to Consolidated Financial Statements Independent Auditor’s Report 1 16 21 67 Management Discussion and Analysis Management Policies beauty for oneself, and also for other people and for the natural world around us. At Kao, kirei is the value we want to bring to everyday life through our brands, products and services—now and in the future. Basic Management Policies of the Kao Group The Kao Group’s mission is to strive for the wholehearted satisfaction and enrichment of the lives of people globally and to contribute to the sustainability of the world, with products and brands of excellent value that are created from the consumer’s and customer’s perspective. Medium-to-long-term Management Strategies of the Kao Group and Management Metric Used as a Target All members of the Kao Group share the Kao Way, which is our corporate philosophy, and have been putting it into Long-term Management Strategy As its commitment to becoming the company it wants to be practice every day as the foundation of our approaches and by 2030, the Kao Group is taking a step forward from its actions to respond to changing times during our more than previous aim of “making Kao a company with a global 130 years of doing business, mainly in the domains of presence” by realizing sustained profitable growth while cleanliness, beauty and health. To continue our profitable contributing to the sustainability of the world to aiming to growth, in recent years we have created a post-deflation “make Kao a company with a global presence, valuable to growth model and have been implementing governance society.” Through ESG initiatives, we will become a valuable reforms aimed at achieving a compact, highly diverse Board of presence for people, society and the planet. Directors, among other measures, while also endeavoring to For the environment (E), we aim for zero waste and carbon contribute to consumers, customers and society by providing zero. For society (S), we will promote one and only products that facilitate clean, beautiful and healthy living, as personalization that is closely attuned to people in the hope of well as industrial-use products that contribute to the ending wasteful consumption. Then, while ensuring effective development of industry. governance (G), we will proceed as one team with “Integrity 2”, In 2009, we set forth our Environmental Statement to be a joined by like-minded parties. Following a management positive force for nature as well as for humankind, then went guideline of “Maximum with minimum”—generating the one step further with the aim of enriching lives in harmony maximum value with the minimum resources—we will with nature. In 2019, we announced our new ESG strategy, continue our growth to help create a better tomorrow. the “Kirei1 Lifestyle Plan (KLP),” and declared our commitment to shifting to ESG-driven management. Now, however, crises are impinging on human lives, which are the cornerstone for realizing the “enrichment of the lives of people” set forth in our mission. These threats are expected to continue jeopardizing the foundations of everyday lives. Under these circumstances, we will tackle this pressing social issue with an approach unique to Kao. With a strong determination to protect not only everyday lives and ecology, but also human lives, the Kao Group will become a company that saves future lives. Under our K25 basic principles toward 2030, “Kirei—Making Life Beautiful,” we will help to maintain the planet as a sustainable and clean place to live, to achieve a sustainable and prosperous society, and to protect people from hazards so they can enjoy their everyday lives. These efforts will lead to an ongoing cycle of positive financial results and returns to stakeholders. The Kao Group will continue working to enhance its corporate value at a higher level. 1. The Japanese word “kirei” describes something that is clean, well- ordered and beautiful, all at the same time. For Kao, this concept of kirei not only describes appearance, but also attitude—to seek to create Targets for 2030 Make Kao a company with a global presence, valuable to society • Become an essential company in a sustainable world • A highly profitable global company that also significantly contributes to society • Returns to stakeholders according to levels of growth Financial targets (as a result) - ¥2.5 trillion in net sales - ¥400 billion in operating income - 41 consecutive years of increases in cash dividends 2. Integrity is one of the values of the Kao Way, the corporate philosophy of the Kao Group. Mid-term Business Plan The five years from 2021 to 2025 are an important period for the Kao Group to establish the foundation for becoming the company it wants to be by 2030. To that end, the Kao Group Mid-term Plan 2025 “K25” establishes a vision of “Sustainability as the only 1 Kao Corporation Financial Report 2020 path” and sets forth three objectives. make high-level returns, according to the level of our growth, To become an essential company in a sustainable world, to our many stakeholders, including employees, consumers, we must actively promote KLP, the new ESG strategy we customers, business partners and shareholders. announced in 2019, and take leadership in a self-sufficient, While continuing to practice the “Integrity” set forth in the sustainable society that curtails the generation of waste to Kao Way, the Kao Group will achieve these objectives together the greatest extent possible. Moreover, we will ensure that with like-minded stakeholders, and in so doing create a better our investments for KLP are reflected in future earnings. tomorrow. By transforming to build robust business through investment, we will create “Another Kao.” For people facing compelling problems, we will fully utilize the technologies and expertise Kao Group Mid-term Plan 2025 “K25” we have cultivated as well as our digital transformation (DX) • Vision to create new businesses that “save future lives.” At the Sustainability as the only path same time, we will further reinforce our current business, which serves as the foundation of this new business, revitalizing it as “Reborn Kao.” Furthermore, to achieve these two objectives, the vitality of our employees is indispensable. Therefore, for our third • Concept Kirei—Making Life Beautiful • Policy (Objectives) Objective (1) Become an essential company in a objective—to maximize the power and potential of employees— sustainable world we will newly implement an Objectives and Key Results Goal (OKR) employee empowerment system in January 2021 so that all employees can give their utmost to achieving the substantial goals they set for themselves. We will also proactively open positions to talent from outside the Kao Group and promote external collaboration. Take leadership in a self-sufficient, sustainable society (ESG Investment = Reflection of future earnings) Key Results - Carbon recycling (Conversion of carbon dioxide into raw materials) - Positive recycling (Creation of new business through Achieving these three objectives will enable us to achieve re-use) our targets for record-high sales and profits (¥1.8 trillion in net - Stop pandemic (Eradicate the source of infectious sales, ¥250 billion in operating income and the 36th consecutive diseases) fiscal year of increases in cash dividends in 2025), and to Net Sales* / Operating Margin ROE (Billions of yen) 1,600 1,457.6 1,200 12.7 1,489.4 1,508.0 1,502.2 13.7 13.8 14.1 1,382.0 12.7 800 400 0 2016 2017 2018 2019 2020 (%) 20 15 10 5 0 (%) 25 20 15 10 5 0 Net Sales (Left) Operating Margin (Right) * In fiscal 2017, 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. In fiscal 2020, the Kao Group changed its method of recognizing sales for certain transactions from the gross amount to the net amount. 18.6 19.8 18.9 17.6 14.2 2016 2017 2018 2019 2020 Kao Corporation Financial Report 2020 2  Objective (2) Transform to build robust business through investment Goal Create “Another Kao” and reinforce current Kao (Expand global business by focusing on saving lives) Key Results - New business: Launch digital and precision healthcare business (high-precision bioanalysis and homeostasis enhancement solution) - Current business: Invest in outstanding products and expand business shareholders and other asset owners to deploy capital efficiently and generate profits. The Kao Group believes that continuously increasing EVA will lead to increases in corporate value and thus corresponds with long-term benefits, not only for shareholders, but for all stakeholders. The target of the Kao Group’s business activities is to increase EVA while expanding its business scale. The Kao Group uses this metric to assess its businesses, to make evaluations on investment in facilities, acquisitions and other items, and to develop performance targets for each fiscal year and for its - Cosmetics business and sanitary business: Pursue compensation system. next innovation 3. EVA is a registered trademark of Stern Stewart & Co. Objective (3) Maximize the power and potential of employees Goal Double the productivity of our business activities (Make challenges visible and pursue open innovation) Key Results - Fair compensation according to challenge and contribution (implementation of OKR globally) Issues for Management Infectious diseases are spreading widely around the world and environmental issues in areas such as climate change, water and forest resources are becoming more serious. Moreover, the importance of efforts for human rights is - Active promotion of talent from outside Kao and growing, and market structure and consumer attitudes are doubling the results of collaboration - Reform to become “digital Kao” to be completed by 2023 Management Metric Used as a Target As its principal management metric, the Kao Group uses changing considerably together with growing social issues such as Japan’s aging society. In this significantly changing business environment, with doubts about the continuance of the sustainable society itself, the Kao Group considers sustainable corporate growth to be difficult using only its current business model. Reducing shortages as much as possible and avoiding lost EVA3, which measures true profit by factoring in the cost of opportunities during purchasing leads to stable business invested capital. This essentially takes the perspective of performance, but on the other hand, it is a cause of over- Cash Dividends per Share (Yen) 140 120 100 80 60 40 20 0 Increases in dividends for 31 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 50 52 54 56 57 58 60 62 64 140 130 120 110 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 2019 2020 Note: Impact of share splits is reflected retroactively. 3 Kao Corporation Financial Report 2020 Management Discussion and Analysis procurement and excess inventory. In addition, an excessive leading company that contributes to the businesses of focus on meeting customer needs for consumption makes a numerous other companies. company likely to opt for a wide-ranging lineup with short-term Achieving this goal will require a unique co-creation platform product revisions, discontinuances and other measures, causing in addition to new businesses. To that end, we believe that the some products to be discarded without ever being used. This extensive fundamental research that has supported our product outcome is a negative factor for environmental conservation. development research will serve as an engine for the Kao To lead to a resolution of this issue, we must urgently build Group. In particular, fundamental research into matters such as a consumption cycle model for achieving a sustainable society. the properties, variations, transmission, elimination and Through Yoki-Monozukuri 4 of products that can be regularly prevention of things that are harmful to people and the used as long as possible, we will establish a new business environment will surely significantly benefit society in the model that neither makes nor delivers useless items. future. Now, as the world faces a crisis, we are determined to Furthermore, we believe that we have not yet established focus on helping to resolve compelling social issues. the value of our existence for a sustainable society globally. The Kao Group Mid-term Plan 2025 “K25” is crucial for We must take on new challenges to realize the Kao Group’s building the business foundation that will be essential for Mission“ to strive for the wholehearted satisfaction and resolving these issues to become the company we want to be enrichment of the lives of people globally and to contribute to by 2030. The Kao Group will continue to take on the challenge the sustainability of the world.” We aim to lead the world in of helping to resolve major issues such as these. offering ESG-oriented products and services as we continue 4. The Kao Group defines Yoki-Monozukuri as a strong commitment by all to grow centered on these offerings, while also becoming a 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.” Costs, Expenses and Income as Percentages of Net Sales Years ended December 31, 2020, 2019 and 2018 Cost of sales ............................................................................................................ Gross profit .............................................................................................................. Selling, general and administrative expenses .......................................................... Operating income .................................................................................................... Income before income taxes ................................................................................... Net income attributable to owners of the parent .................................................... 2020 57.3% 42.7 30.1 12.7 12.6 9.1 2019 56.5% 43.5 29.5 14.1 14.0 9.9 2018 56.6% 43.4 29.5 13.8 13.7 10.2 Payout Ratio (%) 60 50 40 30 20 10 0 53.4 42.4 37.1 36.9 38.2 2016 2017 2018 2019 2020 Kao Corporation Financial Report 2020 4 Basic Approach to Selection of Accounting Standards Japan. On the other hand, sales and profits in the Cosmetics Business decreased substantially in Japan as inbound demand disappeared and the market contracted significantly, due in Having decided that unifying accounting standards within the part to the impact of people voluntarily refraining from going Kao Group will contribute to improving the quality of its outside. Outside Japan, the Kao Group was affected by business management, the Kao Group has voluntarily adopted mandated temporary store closures and restrictions on going International Financial Reporting Standards (IFRS) from fiscal outside all over the world except China, and also incurred 2016. This enables management based on standardized extra expenses to respond to the pandemic, resulting in an procedures and information for each Group company and overall decrease in consolidated financial results compared business, and the Kao Group intends to reinforce its with the previous fiscal year. management foundation in order to enhance its corporate In the Kao Group’s key markets, according to retail sales value as a global company. The Kao Group also believes that and consumer purchasing survey data, the cosmetics market the application of IFRS will facilitate the international in Japan shrank significantly from the previous year due to a comparability of its financial statements in capital markets. substantial decline in inbound demand and people’s voluntary Overview of Consolidated Results restraint in going outside. On the other hand, the household and personal care products market grew because of a substantial increase in demand for hygiene-related products, among other factors. In every product category, the share of In fiscal 2020, the novel coronavirus (COVID-19) pandemic had the e-commerce channel increased further and average unit a major impact on people’s lives and corporate activities prices for household and personal care products increased by worldwide. The Kao Group has been rallying its comprehensive 5 points compared with the previous fiscal year. strength in striving to provide products, services and information to contribute to the daily lives and safety of people around the world. Due to heightened awareness of hygiene, demand rose for hand soaps, hand sanitizers and home care products in general, resulting in growth in sales and profits compared with the previous fiscal year, mainly in Basic Earnings per Share Net Sales* / Operating Margin (Yen) 400 300 200 100 0 298.30 314.25 306.70 262.29 253.43 2016 2017 2018 2019 2020 5 Kao Corporation Financial Report 2020 Consumer Products Business (Billions of yen) 1,500 1,219.8 1,216.0 1,232.9 1,257.0 14.2 14.3 14.3 12.7 1,151.3 12.8 1,000 500 0 (%) 25 20 15 10 5 0 2016 2017 2018 2019 2020 Net Sales (Left) Operating Margin (Right) * In fiscal 2017, the Kao Group adopted IFRS 15 early in tandem with a revision of its sales system for the Consumer Products Business in Japan. In fiscal 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. In fiscal 2020, the Kao Group changed its method of recognizing sales for certain transactions from the gross amount to the net amount. Management Discussion and Analysis Analysis of Income Statement Cosmetics Business Sales decreased 22.4% compared with the previous fiscal Net sales decreased 8.0% compared with the previous fiscal year to ¥234.1 billion. On a like-for-like basis, sales decreased year to ¥1,382.0 billion. On a like-for-like basis, net sales 22.1%. decreased 5.2%. Operating income was ¥175.6 billion, a Cosmetics Business sales decreased substantially due to a decrease of ¥36.2 billion compared with the previous fiscal significant decline in inbound demand, as well as the impact of year, the operating margin was 12.7% and income before mandated temporary store closures and regulations and other income taxes was ¥174.0 billion, a decrease of ¥36.7 billion. restrictions on going outside enacted around the world. In Net income was ¥128.1 billion, a decrease of ¥22.3 billion. particular, sales of makeup products decreased, as wearing Basic earnings per share were ¥262.29, a decrease of masks became common practice. ¥44.41, or 14.5%, from ¥306.70 in the previous fiscal year. In Japan, in addition to the decrease in inbound demand, In addition, 2020 was the final year of the Kao Group Mid- there was an impact from people voluntarily refraining from term Plan “K20”, under which the Kao Group set and aimed to going outside and voluntary temporary retail store closures. achieve the following three goals. The Kao Group was able to Furthermore, the number of newly infected people began to achieve all of its targets other than “continue to set new rise again even after the declaration of a state of emergency record highs for profits” and “like-for-like net sales CAGR* of in April, delaying market recovery. In Europe, mandated +5% and operating margin of 15%” under “commitment to temporary store closures had a negative impact. In Asia, on profitable growth.” the other hand, the Kao Group enhanced its e-commerce and • Commitment to fostering a distinctive corporate image other initiatives in China, where sales were steady for • Commitment to profitable growth • Commitment to returns to stakeholders * CAGR: Compound annual growth rate freeplus, which is hypoallergenic and contains Japanese and Chinese botanical extracts, and Curél, a derma care brand. Operating income was ¥2.6 billion, a decrease of ¥38.8 billion from the previous fiscal year. Information by Segment Skin Care and Hair Care Business Sales decreased 9.3% compared with the previous fiscal year Consumer Products Business to ¥308.9 billion due to the change in the method of Sales decreased 8.4% compared with the previous fiscal year recognizing sales for certain transactions from the gross to ¥1,151.3 billion. On a like-for-like basis, sales decreased 5.3%. amount to the net amount, among other factors. On a like-for- During fiscal 2020, business activities worldwide were like basis, sales increased 1.4%. substantially impacted by the COVID-19 pandemic. In skin care products, sales of Bioré u hand soap, hand In Japan, sales increased as demand for hygiene-related sanitizer and other hygiene-related products increased due to the products grew, but Cosmetics Business sales decreased Kao Group’s efforts to concentrate all its capabilities on meeting substantially. With additional factors including a change in the increased demand in Japan resulting from the pandemic. method of recognizing certain transactions from the gross Sales of hair care products decreased as sales of hair coloring amount to the net amount, sales decreased 9.9% to ¥811.0 products grew in Japan with increased opportunities for hair care billion. On a like-for-like basis, sales decreased 6.3%. at home as people voluntarily refrained from going outside, but In Asia, sales decreased 2.9% to ¥200.3 billion. On a like- sales of the business for hair salons in the Americas and Europe for-like basis, sales decreased 0.7%. In the Americas, sales decreased due to mandated temporary salon closures by decreased 5.9% to ¥83.6 billion. On a like-for-like basis, sales customers of the Kao Group, among other factors. decreased 3.7%. In Europe, sales decreased 9.3% to ¥56.4 Operating income increased ¥1.3 billion compared with the billion. On a like-for-like basis, sales decreased 8.8%. previous fiscal year to ¥50.8 billion. Operating income decreased ¥32.7 billion compared with the previous fiscal year to ¥147.2 billion. Human Health Care Business Note: The Kao Group’s Consumer Products Business consists of the Cosmetics Business, the Skin Care and Hair Care Business, the Human Health Care Business, and the Fabric and Home Care Business. Sales decreased 8.3% compared with the previous fiscal year to ¥234.0 billion. On a like-for-like basis, sales decreased 7.3%. Kao Corporation Financial Report 2020 6  Sales of Laurier sanitary napkins in Japan remained growing demand for hygiene-related products due to the basically unchanged from the previous fiscal year in a pandemic. Sales of hygiene-related products also grew in fluctuating market, with special demand but also fewer Asia. In addition, sales of commercial-use products grew as occasions for use because people voluntarily refrained from the Kao Group substantially ramped up its production capacity going outside. In Asia, sales grew substantially due to smooth for hand sanitizers to supply the food service industry progress of e-commerce initiatives in China. including restaurants, as well as lodging facilities, medical Sales of Merries baby diapers grew steadily in Indonesia institutions, nursing facilities and other locations where but decreased in both Japan and China. hygiene management is particularly necessary. Sales of personal health products decreased. Bath Operating income increased ¥9.1 billion compared with the additives performed strongly due to demand from people previous fiscal year to ¥80.9 billion. spending more time at home, among other factors, but sales of oral care products declined due to intense competition. Chemical Business Operating income decreased ¥4.3 billion compared with Sales decreased 5.8% compared with the previous fiscal year the previous fiscal year to ¥12.9 billion. to ¥269.2 billion. On a like-for-like basis, sales decreased 4.7%. Amid a decline in demand for oleo chemicals due to the Fabric and Home Care Business economic slowdown, sales of fat and oil derivative products Sales increased 4.1% compared with the previous fiscal year for disinfection and cleaning were firm. Sales of performance to ¥374.4 billion. On a like-for-like basis, sales increased 4.5%. chemicals decreased due to the ongoing impact of a decline In fabric care products in Japan, competition remained in demand in automobile-related and other fields. Specialty fierce in the markets for both laundry detergents and fabric chemicals were impacted by a slump in the market for toner softeners. Under these conditions, sales and market share of and toner binder. fabric care products held firm as the Kao Group launched new Operating income decreased ¥3.1 billion compared with and improved laundry detergent products. Sales of home care the previous fiscal year to ¥27.7 billion. products increased substantially as a result of enhanced promotion of antibacterial and anti-virus measures amid 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 0 332.9 341.4 340.8 308.9 14.8 14.3 14.5 16.5 301.5 279.6 266.2 234.1 13.7 9.9 4.9 1.1 273.1 281.2 267.7 255.2 234.0 12.3 10.4 9.5 6.7 5.5 345.2 335.7 344.1 374.4 359.5 22.6 22.7 20.7 20.0 21.6 310.3 312.8 273.8 273.8 285.9 269.2 10.8 9.8 9.8 10.8 10.3 (%) 40 30 20 10 0 2017 2018 2019 2020 2017 2018 2019 2020 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 Net Sales (Left) Operating Margin (Right) * 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. In fiscal 2017, the Kao Group adopted IFRS 15 early in tandem with a revision of its sales system for the Consumer Products Business in Japan. In fiscal 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. In fiscal 2020, the Kao Group changed its method of recognizing sales for certain transactions from the gross amount to the net amount. 7 Kao Corporation Financial Report 2020 Management Discussion and Analysis Financial Position assets totaling ¥10.5 billion. Adjusted free cash flow, the sum of net cash flows from Total assets increased ¥11.7 billion from December 31, 2019 operating activities and net cash flows from investing to ¥1,665.6 billion. The principal increase in assets was a activities less depreciation of right-of-use assets and other ¥63.5 billion increase in cash and cash equivalents. The expenses, was ¥131.2 billion. principal decreases in assets were a ¥15.3 billion decrease in right-of-use assets and an ¥8.8 billion decrease in trade and Cash Flows from Financing Activities other receivables. Net cash flows from financing activities totaled negative ¥87.1 Total liabilities decreased ¥55.1 billion from December 31, billion. The Company emphasizes steady and continuous 2019 to ¥727.4 billion. The principal decreases in liabilities dividends and flexibly repurchases and retires treasury shares were a ¥28.7 billion decrease in retirement benefit liabilities, a to improve capital efficiency from the perspective of EVA. ¥14.6 billion increase in lease liabilities and an ¥8.1 billion During fiscal 2020, this primarily consisted of ¥66.2 billion for decrease in income tax payables. dividends paid to owners of the parent and non-controlling Total equity increased ¥66.8 billion from December 31, interests and ¥20.9 billion in repayments of lease liabilities. To 2019 to ¥938.2 billion. The principal increases in equity were maintain an appropriate cost of capital ratio and to reinforce net income totaling ¥128.1 billion and remeasurements of its financial base for growth investments, the Company issues defined benefit plans totaling ¥16.4 billion. The principal and redeems corporate bonds, which consisted of ¥24.9 decreases in equity were dividends totaling ¥66.2 billion and billion in proceeds from issuance of bonds and ¥24.9 billion in exchange differences on translation of foreign operations redemption of bonds. totaling ¥9.9 billion. The ratio of equity attributable to owners of the parent to total assets was 55.5% compared with 51.9% at December 31, 2019. The Kao Group maintained return on equity at the high level of 14.2%. Cash Flows Basic Policies regarding Distribution of Profits and Dividends for the Fiscal Years Ended December 31, 2020 and Ending December 31, 2021 The Kao Group uses economic value added (EVA) as its principal management metric and clearly sets the uses of its The balance of cash and cash equivalents at December 31, 2020 steadily generated cash flow as shown below from that increased ¥63.5 billion compared with December 31, 2019 to viewpoint. Shareholder returns are one such use, and they are ¥353.2 billion, including the effect of exchange rate changes. implemented after considering future demand for funds and the situation in financial markets. Cash Flows from Operating Activities Net cash flows from operating activities totaled ¥214.7 billion. Use of cash flow: The principal increases in net cash were income before • Investment for future growth (capital expenditures, M&A, income taxes of ¥174.0 billion and depreciation and etc.) amortization of ¥86.1 billion. The principal decreases in net • Steady and continuous dividends (40% payout ratio cash were income taxes paid of ¥53.9 billion and a decrease target) in retirement benefit liabilities of ¥28.8 billion. • Share repurchases and early repayment of interest- bearing debt including borrowings Cash Flows from Investing Activities Net cash flows from investing activities totaled negative ¥61.9 In accordance with these policies, the Company plans to billion. This primarily consisted of purchase of property, plant pay a year-end dividend for fiscal 2020 of ¥70.00 per share, an and equipment of ¥59.4 billion for capacity expansion at increase of ¥5 per share compared with the previous fiscal production bases in Japan and proactive capital investments year. Consequently, annual cash dividends will increase ¥10 in Asia, where growth is notable, and purchase of intangible per share compared with the previous fiscal year, resulting in Kao Corporation Financial Report 2020 8 a total of ¥140 per share. The consolidated payout ratio will be streamlining, maintenance and renewal of facilities, and 53.4%. upgrading of distribution bases, in addition to expanding For fiscal 2021, the Company plans to pay total cash production capacity, mainly in Japan and Asia. In the Chemical dividends of ¥144 per share (53.9% payout ratio), an increase Business, the Kao Group also invested aggressively in of ¥4 per share compared with the previous fiscal year. This facilities to expand production capacity for fat and oil plan is in accordance with the Company’s basic policies derivatives and other products, inside and outside Japan. regarding distribution of profits, and free cash flow and other Research and development expenditures were ¥58.5 billion, factors have also been taken into consideration. As a result, equivalent to 4.2% of net sales, remaining at a high level the Company is aiming for its 32nd consecutive fiscal year of relative to net sales. increases in dividends. * Excluding right-of-use assets EVA and Related Activities Increasing Profit: In the Consumer Products Business, demand for hygiene-related products increased due to the EVA for fiscal 2020 was ¥62.3 billion, a decrease of ¥25.1 COVID-19 pandemic, but operating income decreased due to billion compared with the previous fiscal year, due to factors including a slump in the Cosmetics Business in Japan. decreases in operating income and net operating profit after In the Chemical Business, sales were firm for fat and oil tax (NOPAT) in addition to an increase in capital costs from derivative products for disinfection and cleaning, but operating the previous fiscal year. income decreased due to a slump in imaging materials and The Kao Group conducted the following EVA-related other products. activities during the fiscal year. Investing for Growth: During fiscal 2020, the Kao Group’s annual dividends per share of ¥140.00, a year-on-year increase capital expenditures* totaled ¥69.7 billion, centered on of ¥10.00, or 8%, as announced in its forecast at the investments for future growth. In the Consumer Products beginning of the fiscal year. As a result, the Company has Business, the Kao Group carried out activities including achieved 31 consecutive fiscal periods of dividend growth. Financial Improvement: For fiscal 2020, the Company paid investment in facilities to manufacture new products, Net Cash Flows from Operating Activities / Capital Expenditures* (Billions of yen) 250 244.5 214.7 200 150 100 50 0 184.3 185.8 195.6 89.9 79.4 89.1 90.2 69.7 2016 2017 2018 2019 2020 Net Cash Flows from Operating Activities Capital Expenditures * Excluding right-of-use assets from fiscal 2019 9 Kao Corporation Financial Report 2020 Free Cash Flows (Billions of yen) 150 100 95.7 89.7 50 0 128.5 131.2 37.7 2016 2017 2018 2019 2020 Note: Free cash flow is the sum of net cash flows from operating activities and net cash flows from investing activities. From fiscal 2019, cash flows from operating activities is adjusted for depreciation of right-of-use assets. Management Discussion and Analysis R&D Expenses Cosmetics Business .......................................... Skin Care and Hair Care Business ................... Human Health Care Business ......................... Fabric and Home Care Business ..................... Chemical Business .......................................... (Billions of yen) 2020 10.5 15.7 11.9 10.2 10.4 Business Risks and Other Risks pandemic has brought about changes in the attitudes of consumers regarding the environment, health, hygiene and other matters and associated changes in their purchasing attitudes. Moreover, amid the global expansion of business and the progress of structural changes in various fields, companies must respond promptly and appropriately to changes in the risks pertaining to their businesses. In this business environment, by placing ESG at the core of its management, further deepening its Essential Research and proactively proposing innovations on a level that impacts society, the Kao Group aims for profitable growth while contributing to people, society and the Earth. To do so, it manages the following risks The Kao Group’s mission is to strive for the wholehearted and crises. satisfaction and enrichment of the lives of people globally and The Kao Group defines a potential negative impact on its to contribute to the sustainability of the world, with products management targets and business activities as a “risk” and and brands of excellent value that are created from the the materialization of such risk as a “crisis.” The Risk and consumer’s and customer’s perspective. In addition, the Group Crisis Management Committee has established a system and is conducting initiatives under the Kao Group Mid-term Plan activity guideline for risk and crisis management based on 2025 “K25,” which establishes a Vision of “Sustainability as the the Kao Risk and Crisis Management Policy. Divisions, only path” and sets forth three objectives: (1) Become an subsidiaries and affiliates manage risks by identifying and essential company in a sustainable world; (2) Transform to build assessing risks, and formulating and implementing robust business through investment; and (3) Maximize the countermeasures based on this activity guideline. In a crisis, power and potential of employees. the Kao Group works to minimize harm to people and property However, with the global spread of COVID-19, intensifying by establishing an Emergency Response Team Organization market competition, a changing market structure and volatility that corresponds to the level of emergency and responding in raw material market conditions and exchange rates, the Kao promptly and appropriately. Group’s business environment remains uncertain. The COVID-19 Total Dividend Payment / Share Repurchases* / Net Income Attributable to Owners of the Parent (Billions of yen) 150 147.0 153.7 148.2 126.1 50.0 50.0 Cost of Capital / EVA (Billions of yen) 150 73.4 100 90.4 93.5 87.4 62.3 54.3 58.5 62.6 67.4 50 56.4 59.1 62.7 63.8 66.5 126.6 50.0 46.8 100 50 0 2016 2017 2018 2019 2020 0 2016 2017 2018 2019 2020 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 2020 10  After deliberation by the Risk and Crisis Management Management Committee selects risk themes and the Committee and the Management Committee, the Kao Group individuals (executive officers) in charge of handling each has selected the following 14 particularly significant risks as theme, while the Risk and Crisis Management Committee the main risks that have a negative impact on its sustained manages progress. (* Main corporate risk themes and profitable growth and contribution to the sustainability of the countermeasures are presented in “Main Initiatives.”) world through its business activities. Among these main risks, These are the main risks that might materialize within five the Kao Group designates risks that would have a major years as recognized as of the fiscal year ended December 31, impact on management and require an enhanced response as 2020. In addition, there are risks other than the listed risks “corporate risks,” and once a year, based on internal and that may affect investors’ decisions. external risk surveys and interviews with management, the Details of Main Risks Main Initiatives Risks related to the Novel Coronavirus Pandemic The global spread of COVID-19 is having a significant impact on the global economy, including delays in raw material procurement, manufacturing, distribution and other areas, immigration restrictions imposed in each country and region, restrictions on going outside and mandated temporary store closures. The COVID-19 pandemic has been recurring, with second and third waves in many countries and regions. The uncertain business environment is expected to continue, with years required for the impact of COVID-19 to be reduced through the introduction of vaccines and other measures, and for the global economy to recover. Under these circumstances, in Japan, which is the Kao Group's main market, the cosmetics market shrank significantly from the previous year due to the impact of factors including a substantial decline in inbound demand and people’s voluntary restraint in going outside, while the household and personal care products market has grown due to increased demand for hygiene-related products. The COVID-19 pandemic has caused changes in people’s awareness of hygiene, and changes in values regarding makeup and related products as people have voluntarily refrained from going outside and wearing masks has become common practice. It has caused changes in consumer behavior including a rapid increase in the use of e-commerce. Risks associated with the COVID-19 pandemic and related changes in people’s behavior are as follows. Inability to take appropriate measures could cause net sales and profits to deviate significantly from targets. ∙ Temporary suspension of operations or obstacles to providing In response to COVID-19, the Kao Group held a meeting of the Emergency Response Team Headquarters headed by the President and CEO to decide on Group-wide policies regarding (1) ensuring the safety of employees and their families, (2) continuity of business activities, and (3) contributions to society, and took the following actions. In addition, these actions have been reported to the Board of Directors. (1) Ensuring the safety of employees and their families ∙ As crisis management measures, followed national and local government policies, and implemented work systems and styles compatible with the status of infection in each country and region (promotion of remote work/teleworking, restrictions on business trips, restrictions on training/events/tours, etc.) ∙ Identified the status of infected employees and family members or those who have been in close contact with infected persons, and implemented care as applicable, and measures to prevent the occurrence of clusters ∙ Launched the Infectious Disease Risk Assessment Project to reinforce infection prevention measures in the workplace and at home (2) Continuity of business activities ∙ To maintain the supply chain, implemented higher-level infection control measures at production sites and rolled them out to subcontractors and other related parties, in addition to conducting relevant activities for raw material procurement ∙ Enhanced information systems for remote work and promoted digitalization of operations ∙ Reviewed Group systems for new work styles ∙ Formulated and implemented a business strategy for dealing with products and services due to multiple infections (clusters) at the Kao Group’s bases or in its supply chains COVID-19 (main response initiatives related to the Cosmetics Business are presented in “Risks related to Changes in the Retailing Environment”) ∙ Delays in product development and launch plans due to a resurgence or prolongation of infections, because of work that cannot be performed remotely ∙ Delays in the recovery of the Cosmetics Business or other (3) Contributions to society ∙ Provided a continuous supply of hygiene-related products for cleanliness and worry-free daily life businesses due to a resurgence or prolongation of infections ∙ Increased production of alcohol disinfectants to 20 times the previous ∙ Inadequate response to changes in people’s awareness and values, and changes in consumer behavior level and supplied them on a priority basis to medical institutions, nursing facilities and other locations with urgent needs ∙ Through its website, provided information on hygiene in daily life, based on the knowledge of experts and its own know-how. Also, for hygiene researchers, medical professionals, public health nurses working at educational institutions and other professionals, provided a wide range of information, including expert knowledge on measures for preventing the spread of infection based on academic papers ∙ Contributed to the development of therapies and diagnostic tools for COVID-19, including the discovery of VHH antibodies that can be expected to inhibit infection • Main Corporate Risk Themes and Countermeasures Pandemics: The Kao Group implemented the above measures by applying to COVID-19 the guidelines and action plans it had been considering for responding to global pandemics of new strains of influenza and other diseases. 11 Kao Corporation Financial Report 2020 Management Discussion and Analysis Details of Main Risks Main Initiatives Risks related to Response to Social Issues The Kao Group’s Consumer Products Business and Chemical Business are affected by economic cycles and changes in the needs of consumers and customers. The marine plastic waste problem, climate change, depletion of water resources, and environmental and human rights issues in raw material procurement, as well as growing social issues such as the aging society and hygiene have increased consumer awareness about the environment, health and other matters, leading to the trend of ethical consumption and customers’ increasing needs for sustainability. Moreover, the global spread of COVID-19 is further heightening these trends. Inability to provide appropriate products and services in response to changes in consumer awareness and customer needs relating to these social issues may reduce competitiveness, making targets for net sales and market share unattainable. In addition, if efforts to address social issues are deemed inadequate, corporate value could decline. Risks related to Changes in the Retailing Environment The retailing environment in which the Kao Group operates is changing significantly. The growth of E-commerce is accelerating due to the COVID-19 situation, and brick-and-mortar retailers are also responding to this changing environment based on discrete strategies such as combinations of offline and online retailing and mergers or integrations across business formats. If appropriate sales activities cannot be developed in response to these changes in the retailing environment and their accelerating pace, targets for net sales, market share and profits may be unattainable. Changes in the market environment due to COVID-19 have also had a significant impact on the retail industry. If response to the disappearance of inbound demand and the shrinking cosmetics market is inadequate, targets for net sales, market share and profits may be unattainable. Risks related to Business outside Japan Under the “Kirei Lifestyle Plan” (KLP), an ESG strategy that integrates an ESG perspective with business strategy, the Kao Group aims to contribute to the sustainability of the world through technology innovations at every stage from raw material procurement to production, point of use and product disposal, and KLP promotion activities to ensure all Kao Group members correctly understand the purpose and content of KLP so they can fulfill their respective roles and responsibilities. In addition, while steadily conducting initiatives, the Kao Group is working proactively to disclose these initiatives to stakeholders in order to demonstrate their results at an early stage. In the Consumer Products Business, the Kao Group clarifies social issues to be addressed through its brand, which is a point of contact with consumers, and considers social and environmental issues from the product design stage. The Kao Group strives to contribute to better lives for consumers and the sustainability of society by maximizing the Group’s assets. In the Chemical Business, the Kao Group helps to resolve social issues through innovations in chemical technologies to respond to changes in customer needs and advances in technology. By strengthening the development of natural fat and oil derivatives and other sustainable and distinctive products, the information materials and performance materials businesses are developing innovative products that offer greater customization, with the aim of further reducing environmental impact. The Kao Group is proactively addressing E-commerce by rolling out products and services favored by E-commerce users and promoting the evolution of its digital marketing activities. Going forward, the Kao Group will further promote digital transformation (DX) and new initiatives such as D2C.* The Kao Group will also promote co-creation initiatives with retailers to meet cosmetics needs through non-contact methods such as online counseling and live commerce, and to respond to growing hygiene- related demand. * D2C (Direct to Consumer) A business model for selling directly to consumers through a company’s own E-commerce site As one of its growth strategies, the Kao Group is rolling out its businesses outside Japan, with a particular emphasis on strengthening its operations in Asia and other regions where the economic growth rate is high and market expansion is forecast. However, in each country or region, in addition to the impact of COVID-19, in the course of business there is the possibility of events arising including a slowdown in economic growth, political or social instability, problems at retail outlets, agents or other business partners, sudden changes in laws, regulations or tax systems, a spate of counterfeit products, or reputation risk.* If there is a substantial delay in the implementation of business plans due to the impact of these events, targets for net sales and profits may be unattainable. The Kao Group routinely collects information on the laws and regulations of each country relating to its business, in addition to the economic, political and social conditions of the countries in which it produces or sells products, and takes necessary measures in response. The Kao Group pays particularly close attention to tightening regulations in each country relating to the environment, product safety and quality, and the impact of changes in import and export regulations on the Group. With regard to intellectual property rights infringements such as counterfeit products, the Kao Group is focusing on countermeasures against counterfeit products, especially in the Asian region, in an effort to ensure that consumers and customers can use its products with peace of mind. * See “Risks related to Reputation” • Main Corporate Risk Themes and Countermeasures Risks related to environmental laws and regulations outside Japan: Among changes in laws and regulations outside Japan, the Kao Group pays particular attention to the risk of inability to adapt to changes in environmental laws and regulations that lead to the suspension of business and operations. In this regard, the Kao Group strengthened its monitoring and response system in China using an external specialist organization to address the impact of a sudden change in environmental laws and regulations on its local plants and major suppliers. Kao Corporation Financial Report 2020 12 Details of Main Risks Risks related to Business Investment The Kao Group conducts proactive capital investment and M&A for business growth based on investment decisions using EVA, which is highly correlated with corporate value. The Kao Group will continue to make these investments for growth while striving to enhance corporate value through ongoing improvements in EVA. However, if the market and business environments deteriorate at levels not anticipated at the time investment decisions were made and the expected cash flows cannot be generated due to a deviation from business performance plans or other factors, impairment of property, plant and equipment recorded due to capital expenditures or impairment of goodwill and intangible assets recorded due to M&A could have an impact on financial condition and business results. Risks related to Product Quality The basis of the Kao Group’s product quality management activities is Yoki-Monozukuri with a consumer/customer-oriented perspective, as set forth in the Kao Way. At every stage from raw materials to research and development, production, transportation and sales, the Kao Group pursues a high level of product safety and strives to constantly improve quality from a thoroughgoing consumer/customer perspective. However, the occurrence of serious product incidents or concerns about product safety and environmental issues could lead to a decline in credibility, not only with regard to the problems with the brand concerned, but for the entire Kao Group. The proliferation of incorrect methods of use of hygiene-related products during the COVID-19 pandemic and the risk of product incidents involving the elderly are increasing. In addition, there are changes in laws and regulations in each country as well as growing requirements for contribution to the resolution of safety and environmental issues and transparency in relation to product ingredients, safety and other matters. Furthermore, product retailing at an international level is increasing due to globalization, and product quality management activities and response to consumers may become inadequate. Risks related to Large-scale Earthquakes, Other Natural Disasters and Accidents For companies with large-scale plants, process safety needs have increasingly heightened in the context of accidents at chemical plants and the many natural disasters that have occurred recently. A major obstruction to the supply of products to the market due to injury to employees or damage to facilities or supply chains resulting from a large-scale earthquake or other natural disaster such as a large-scale typhoon or flood brought on by climate change could have a significant impact on business results. In addition, the occurrence of substantial injury to employees or damage to the surrounding area due to events such as a fire or explosion at a plant of the Kao Group could have a significant impact on business results, with a resultant loss of social credibility. Main Initiatives For major investments, the Kao Group checks performance at the time quarterly results are calculated to ensure that there is no significant deviation from the initial plan, and the results are reported at the Management Committee meeting. As necessary, relevant departments consider future direction and measures to improve business performance. The Kao Group designs and manufactures products in compliance with product-related laws and regulations and in conformance with strict standards it has set voluntarily. At the development stage prior to launch, the Kao Group thoroughly carries out testing, studies and research to confirm safety. After launch, the Kao Group strives to further improve quality by collecting feedback, requests and other information regarding products through the Customer Communication Center. In addition, to respond to changes in risks relating to product quality management, the Kao Group is enhancing its communication of information through product FAQs and other methods to disseminate correct methods of use; improving product satisfaction for diverse customers by promoting universal design and by providing multilingual information; ensuring competitiveness by developing alternative technologies that anticipate new requirements in relation to laws and regulations in each country, and to safety and environmental issues; increasing reliability by promoting visualization of product quality management activities and by engaging in communication with all stakeholders; and building a system capable of promptly confirming compliance with the laws and regulations of each country, introducing a mechanism for centralized collection of consumer feedback across countries and regions and implementing other measures to enhance quality management activities on a global scale. • Main Corporate Risk Themes and Countermeasures Risk of occurrence of serious product quality issues: The Kao Group is strengthening its Group-wide response in the event serious damage occurs due to product quality issues and is enhancing awareness within the Group to prevent the occurrence of such issues. The Kao Group prevents fires, explosions and chemical spills while maintaining safe and stable operations, and prepares for emergency situations by conducting measures for facilities and periodic training premised on a natural disaster. The Kao Group has built a framework to keep track of accidents or disasters worldwide when they occur through its emergency reporting network. In addition, the Kao Group is strengthening its response to disasters so that it can execute a plan for countermeasures that place top priority on the safeguarding of human life and a business continuity plan (BCP). To achieve this, the Group has established organizational units for disaster response in both Eastern Japan and Western Japan premised on damage to the Kao Head Office from an earthquake in the greater Tokyo metropolitan area and is establishing an Emergency Response Team Organization headed by the President and CEO. • Main Corporate Risk Themes and Countermeasures Large-scale earthquakes and other natural disasters: In response to recent large-scale typhoons, floods and other natural disasters brought on by climate change, the Kao Group conducted flood risk surveys at each site, stepped up countermeasures in both physical and intangible terms and carried out disaster prevention education for employees regarding hazard maps and evacuation. In addition, the Kao Group has strengthened its disaster response capabilities by implementing emergency response training and BCP training to address the possibility of large-scale earthquakes. 13 Kao Corporation Financial Report 2020 Details of Main Risks Risks related to Information Security The Kao Group uses IT to promote efficient business and operations and conducts business using data. The Kao Group possesses confidential information (trade secrets) relating to research and development, production, marketing, sales and other matters, and retains the personal information of many customers and consumers for sales promotion activities, member site management and E-commerce. The Kao Group is working to strengthen information security in order to protect information assets including trade secrets and personal information, as well as IT hardware, software and many kinds of data records, in accordance with Kao’s Information Security Policy. However, a leak of confidential information or personal information outside the Kao Group could occur due to an error or to intentional actions including a cyberattack. In addition, the supply chain and other business activities may be temporarily suspended as a result of such actions. If such an incident occurs, credibility could decline and targets for net sales and profits may be unattainable. Risks related to Reputation The rapid penetration of social networking services (SNS) on a global scale has enabled a wide range of interactive communication among consumers or between consumers and companies. In addition, while leading lives of voluntarily refraining from going outside due to the COVID-19 pandemic, a wide range of people, regardless of age or gender, have come to use SNS in search of extensive information and connections. However, SNS comments also include negative evaluations and comments about companies, and there are concerns about an increase in reputation risk through their dissemination that could inflict financial or non-financial loss from a decline in brand value and corporate credibility. The Kao Group expects to continue increasing communication of various information and brand marketing activities using SNS. However, the spread through SNS of inappropriate expressions in the advertisements or other publications of the Group, or the spread of negative evaluations or erroneous information about the Group’s business activities or brand image could lower the Kao Group’s brand value or credibility. Risks related to Raw Material Procurement Market prices for natural fats and oils and petroleum products used as raw materials for the Kao Group’s products are affected by factors including global business conditions, geopolitical risks, the balance between supply and demand, abnormal weather, and currency exchange rate fluctuations. A sudden change in market prices could render the Kao Group unable to attain its target for profits. In addition, some of the raw materials used in the Kao Group’s products are rare, thus entail risks relating to stable procurement. If the supply of products to the market is disrupted due to a sudden change in demand or difficulties at suppliers, the Kao Group may not only be unable to attain its targets for net sales and profits, but its credibility could also decline. At the same time, the Kao Group is largely dependent on natural capital such as palm oil, paper, and pulp for its raw materials, and it must fulfill its corporate social responsibility by realizing sustainable procurement with extensive environmental considerations including resource conservation, global warming prevention and biodiversity preservation, as well as social considerations including safety, sanitation, labor conditions, and human rights. However, if the Kao Group’s efforts for sustainable and responsible procurement are deemed to be inadequate due to reasons in the supply chain, the Group’s brand image and credibility could decline. Management Discussion and Analysis Main Initiatives As personal and organizational measures for information security, the Kao Group has established rules and systems globally and implemented activities to protect trade secrets, personal information and information security using the PDCA cycle (awareness-raising activities, self-checks, and the setting of improvement targets). The Kao Group is also strengthening its system for responding when an incident occurs. As technical measures, the Information Security Committee has determined a policy on security measures to be implemented, and has implemented measures including the elimination of vulnerabilities by introducing anti-virus software and updating software, the prevention of unauthorized access, and the prevention of e-mail phishing. • Main Corporate Risk Themes and Countermeasures Risks related to cyberattacks and personal information protection: The Kao Group has created response procedures in the event that an incident occurs, and has conducted relevant training. The Group is also reinforcing its global information security and personal information protection systems. From the perspective of ESG, the Kao Group is establishing a pre-check system and conducting internal education as measures to prevent inappropriate expressions in advertising and SNS messages. The Kao Group also globally monitors external information, including information on SNS, and strives to discover risks at an early stage. If a reputation risk incident occurs that adversely affects business and brand activities, the Kao Group responds promptly and strives to maintain its reputation by publicly announcing information, its corporate stance and other matters, as necessary, at the appropriate time. • Main Corporate Risk Themes and Countermeasures Reputation risk: The Kao Group has established a system for monitoring SNS and other external information and is further strengthening its emergency response system in the event a reputation risk incident occurs. Risks associated with the use of digital media: The Kao Group established a pre-check system, enhanced internal education and conducted a review of guidelines and other matters for risks that could become reputation risks, such as inappropriate expressions and stealth marketing in advertisements, and promoted the establishment of advertisement distribution tools for improving and maintaining brand value. The Kao Group is working to reduce the impact of increases in raw material prices by reducing costs and conducting measures to pass increases on to selling prices. In addition, for risks relating to stable procurement, the Kao Group is augmenting facilities at its main suppliers and cultivating secondary suppliers to diversify risks. The Kao Group also reviews contracts and proactively cooperates with suppliers to reduce risks. On the other hand, to address risks relating to sustainable and responsible procurement, the Kao Group conducts human rights due diligence based on the Kao Human Rights Policy and risk assessment of suppliers based on the Guidelines for Supplier’s Assessment for social issues. For environmental issues, the Kao Group promotes sustainable procurement of palm oil, paper and pulp based on the Guidelines for Sustainable Procurement of Raw Materials. Over the medium to long term, the Kao Group is also working to thoroughly reduce the amount of raw materials it uses and to switch to raw materials from non-food biomass sources. The Kao Group is also strengthening coordination with suppliers through initiatives such as the use of Sedex for supplier monitoring, establishment of an auditing system to eliminate compliance violations by suppliers, and the CDP Supply Chain Program. In addition, with the aim of building a sustainable supply chain for palm oil, in 2020 the Kao Group began a program in cooperation with local partners to help oil palm smallholders in Indonesia improve yields and acquire sustainable palm oil certification. The Kao Group strives to disclose these initiatives to its stakeholders proactively and transparently. Kao Corporation Financial Report 2020 14 Details of Main Risks Risks related to Compliance Main Initiatives In conducting its business activities, the Kao Group is subject to various laws and regulations on matters including product quality and safety, process safety, environmental protection, chemicals management, accounting standards, taxation, labor, and transaction management. As competition intensifies globally, there is concern of growing temptation to commit improprieties due to factors including difficulties in achieving product differentiation, meeting product launch schedules and delivery timelines, and pressure to achieve performance targets. The risk of harassment may increase due to the generational gap in values and growing employee diversity. A serious violation of compliance by the Kao Group, its subcontractors or other related parties could have an impact on the Group’s credibility, financial condition and business results. The Kao Group regards “Integrity” (behaving lawfully and ethically, and conducting sound and honest business activities) as the starting point of compliance, and promotes it as a foundation for earning the respect and trust of all stakeholders. As such, the Kao Group promotes activities such as ongoing education about the Kao Business Conduct Guidelines, which are its code of conduct, and responding appropriately to communications received via the compliance hotlines. In addition, as activities focused on reducing serious compliance risks, the Kao Group systematically promotes compliance with laws and regulations that apply to its business, and the Compliance Committee monitors the implementation status of particularly important laws and regulations. Furthermore, the Kao Group is conducting activities designed to create an open workplace that allows immediate reporting to management and an appropriate response in the event that a serious violation of compliance occurs. Risks related to Securing Human Capital The Kao Group strives to secure diverse and talented human capital in order to achieve its business targets globally. Meanwhile, with the advent of the digital revolution and low birthrates and aging populations in some countries, employment conditions, expertise requirements, and values with respect to working styles are changing significantly amid the trend to promote ESG management. In addition, COVID-19 is having a significant impact in areas such as people’s values and working styles. An inability to systematically implement hiring, development and assignment of human capital with the advanced expertise required in each area, as well as leaders who anticipate major environmental changes, could create a bottleneck in business activities or other factors that have a negative impact on business results. Risks related to Currency Exchange Rate Fluctuations The Kao Group also conducts business activities outside Japan, and currency exchange rate fluctuations affect foreign currency- denominated sales and the cost of procuring raw materials. They also affect the conversion into yen of the amounts on the financial statements of consolidated subsidiaries outside Japan for the consolidated settlement of accounts. Larger-than-expected fluctuations in foreign currency exchange rates against the yen, which is the Kao Group’s functional currency, could have an impact on financial condition and business results. Risks related to Litigation During the fiscal year ended December 31, 2020, no lawsuit or other legal action was filed that had a material effect on the Kao Group. However, the Kao Group conducts diverse businesses globally, and various types of litigation or other action may be brought against it. The result of such litigation or other legal action could have an impact on the Kao Group’s financial condition and business results. Based on the recognition that human capital is the Kao Group’s most important asset, the Human Capital Development Committee, with top management as members, discusses and promotes the assignment and development of the human capital and effective organizational management that support sustainable growth. In addition, in order to generate great vitality by drawing out the unlimited potential of individual employees and to maximize that vitality as an organization, the Kao Group employs measures such as using its global human capital information system, improving organizational capabilities through an employee opinion survey, conducting human capital management through job rank, evaluation and training systems and compensation policies that are shared globally, and implementing a health promotion program. To maximize the power and potential of employees, the Kao Group will further develop its cultivation of a corporate culture in which employees are willing to take on challenges, and further promote diverse work styles. The Kao Group mitigates the impact of foreign-currency denominated transactions on business results by hedging risk of currency exchange rate fluctuations through measures including using foreign currency accounts for transaction settlement and derivative transactions such as forward exchange contracts and currency swaps. The Kao Group does not engage in derivative transactions for the purpose of speculation. In addition, the Kao Group monitors fluctuations in major currencies and the impact of these fluctuations on its business, and reports its findings to the Management Committee in a timely fashion. Under the direction of management, relevant departments consider measures to mitigate the impact on business as required. The Kao Group complies with various laws and regulations relating to its business, and strives to prevent disputes by providing safe and reliable products, properly acquiring and using intellectual property rights, clarifying contract conditions, negotiating with other parties, and other methods. In addition, the Kao Group has created a global mechanism for prompt and reliable reporting on the filing of important lawsuits and their current status, and has established a system for responding to litigation or other legal actions in cooperation with the individuals in charge at related companies in each country, law firms and other parties. 15 Kao Corporation Financial Report 2020 Consolidated Statement of Financial Position Kao Corporation and Consolidated Subsidiaries As of December 31, 2020 Assets Current assets Notes 2020 2019 (Millions of yen) Cash and cash equivalents ............................................................................................ Trade and other receivables .......................................................................................... Inventories ..................................................................................................................... Other financial assets .................................................................................................... Income tax receivables .................................................................................................. Other current assets ..................................................................................................... Total current assets ................................................................................................ Non-current assets Property, plant and equipment ...................................................................................... Right-of-use assets ........................................................................................................ Goodwill ........................................................................................................................ Intangible assets ........................................................................................................... Investments accounted for using the equity method ................................................... Other financial assets .................................................................................................... Deferred tax assets ....................................................................................................... Other non-current assets .............................................................................................. Total non-current assets ......................................................................................... 7, 33 8, 33 9 33 10 11 16 12 12 13 33 14 10, 18 353,176 200,087 197,641 7,257 2,085 18,150 778,396 430,914 149,543 177,031 48,256 8,657 23,608 42,274 6,937 887,220 289,681 208,839 199,672 13,788 2,440 22,606 737,026 436,831 164,822 179,707 47,770 8,287 26,104 47,876 5,496 916,893 Total assets ........................................................................................................ 1,665,616 1,653,919 Liabilities and equity Liabilities Current liabilities Notes 2020 2019 Trade and other payables .............................................................................................. Bonds and borrowings .................................................................................................. Lease liabilities .............................................................................................................. 15, 16, 31, 33 Other financial liabilities ................................................................................................. Income tax payables ...................................................................................................... Provisions ...................................................................................................................... Contract liabilities .......................................................................................................... Other current liabilities .................................................................................................. Total current liabilities ............................................................................................ 15, 33 16, 33 17, 33 24 20 19 Non-current liabilities Bonds and borrowings .................................................................................................. Lease liabilities .............................................................................................................. 15, 16, 31, 33 Other financial liabilities ................................................................................................. Retirement benefit liabilities .......................................................................................... Provisions ...................................................................................................................... Deferred tax liabilities .................................................................................................... Other non-current liabilities ........................................................................................... Total non-current liabilities ..................................................................................... 16, 33 15, 33 18 19 14 215,842 30,465 19,787 6,571 28,109 1,811 23,098 99,721 425,404 97,229 126,725 7,862 51,858 9,175 4,584 4,585 302,018 222,314 25,505 19,653 6,766 36,208 2,054 20,616 99,411 432,527 101,636 141,438 7,527 80,579 10,122 3,747 4,922 349,971 Total liabilities ..................................................................................................... 727,422 782,498 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 ......................................................................................................... 21 21 21 21 21 85,424 106,618 (3,865) (43,376) 778,886 923,687 14,507 938,194 85,424 108,715 (4,309) (32,974) 700,839 857,695 13,726 871,421 Total liabilities and equity .................................................................................... 1,665,616 1,653,919 Kao Corporation Financial Report 2020 16 Consolidated Statement of Income Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2020 Net sales .................................................................................................................... Notes 6, 24 2020 1,381,997 Cost of sales .............................................................................................................. 9, 11, 12, 16, 18 (791,304) Gross profit ................................................................................................................ 590,693 (Millions of yen) 2019 1,502,241 (848,723) 653,518 Selling, general and administrative expenses ............................................................ 11, 12, 16, 18, 25 (415,826) (442,912) Other operating income ............................................................................................. 24, 26 Other operating expenses ......................................................................................... 11, 12, 16, 18, 27 Operating income ...................................................................................................... 6 Financial income ........................................................................................................ 6, 18, 28 Financial expenses ..................................................................................................... 6, 16, 18, 28 Share of profit in investments accounted for using the equity method ..................... 6, 13 Income before income taxes ..................................................................................... Income taxes ............................................................................................................. Net income ................................................................................................................ Attributable to: Owners of the parent ................................................................................................. Non-controlling interests ............................................................................................ Net income ................................................................................................................ Earnings per share Basic (Yen) ................................................................................................................. Diluted (Yen) .............................................................................................................. 6 14 29 29 15,801 (15,105) 175,563 1,711 (5,839) 2,536 15,192 (14,075) 211,723 2,027 (5,231) 2,126 173,971 210,645 (45,904) 128,067 (60,296) 150,349 126,142 1,925 128,067 148,213 2,136 150,349 262.29 262.25 306.70 306.63 17 Kao Corporation Financial Report 2020 Consolidated Statement of Comprehensive Income Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2020 Net income .......................................................................................................................... Other comprehensive income Items that will not be reclassified to profit or loss: Notes 2020 128,067 (Millions of yen) 2019 150,349 Net gain (loss) on revaluation of financial assets measured at fair value through other comprehensive income ..................................................... 30, 33 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 .......................... 30 30 30 30 168 16,365 25 16,558 (6) (1,180) (17) (1,203) (9,942) (2,489) (167) (10,109) (36) (2,525) Other comprehensive income, net of taxes ..................................................................... Comprehensive income ..................................................................................................... 6,449 134,516 (3,728) 146,621 Attributable to: Owners of the parent ........................................................................................................ Non-controlling interests ................................................................................................... Comprehensive income .................................................................................................... 132,941 1,575 134,516 144,508 2,113 146,621 Kao Corporation Financial Report 2020 18 Consolidated Statement of Changes in Equity Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2020 Equity attributable to owners of the parent Other components of equity (Millions of yen) Exchange differences on translation of foreign operations Net gain (loss) on derivatives designated as cash flow hedges Subscription rights to shares Net gain (loss) on revaluation of financial assets measured at fair value through other compre hensive income Share capital Capital surplus Treasury shares Notes Remeasurements of defined benefit plans Total Retained earnings Total Non- controlling interests Total equity — — (32,974) 700,839 857,695 13,726 871,421 — 126,142 126,142 1,925 128,067 16,353 16,353 6,799 6,799 — 6,799 (350) 6,449 126,142 132,941 1,575 134,516 — — — — — (177) (194) 2 (27) (394) — — — 2 (27) (394) — — (64,925) (64,925) (1,269) (66,194) — (1,605) 475 (1,130) — — — — (668) (16,353) (17,024) 17,024 — — — (16,353) (17,201) (48,095) (66,949) (794) (67,743) — (43,376) 778,886 923,687 14,507 938,194 — — — — (30,029) 670,002 822,360 13,149 835,509 — 740 740 — 740 (30,029) 670,742 823,100 13,149 836,249 — 148,213 148,213 2,136 150,349 (1,085) (1,085) (3,705) (3,705) — (3,705) (23) (3,728) 148,213 144,508 2,113 146,621 — — — — — 1,085 1,085 — — — 1 (50,033) 337 — — (50,033) 337 (60,459) (60,459) (1,290) (61,749) — 241 (246) — — — — (5) — 858 (858) — — 760 (118,116) (109,913) (1,536) (111,449) — (32,974) 700,839 857,695 13,726 871,421 6,208 — 184 184 — — — — — (668) 5,724 6,458 — 6,458 — (23) (23) — — — — — (227) (227) 6,208 — — (0) (0) — — — — — — — (0) (1) — (1) — 1 1 — — — — — — — — January 1, 2020 85,424 108,715 (4,309) 448 (39,630) Net income .................... Other comprehensive income ......................... Comprehensive income .... Disposal of treasury shares .......................... Purchase of treasury shares .......................... Share-based payment transactions ................. Dividends ...................... Changes in the ownership interest in subsidiaries ..... Transfer from other components of equity to retained earnings ..... Total transactions with the owners .................. — — — — — — — 21 21 32 23 — — — — — — — — — — (9,738) (9,738) (98) 471 (177) — (27) — — — — — — — (49,368) — — — — (3) (180) 268 (394) — — (1,605) — — — — — — — (2,097) 444 December 31, 2020 ......... 85,424 106,618 (3,865) January 1, 2019 (as previously reported).. Changes in accounting policy1 .. January 1, 2019 (after adjustment) ......... Net income .................... Other comprehensive income ......................... Comprehensive income .... Disposal of treasury shares .......................... Purchase of treasury shares .......................... Share-based payment transactions ................. Dividends ...................... Changes in the ownership interest in subsidiaries ..... Transfer from other components of equity to retained earnings ..... Total transactions with the owners .................. 21 21 32 23 — — — — — — — — — — 85,424 108,245 (11,282) — — — 546 — (37,032) — 85,424 108,245 (11,282) 546 (37,032) — — — — — — — — — — (2,598) (2,598) — (50,033) 337 — 241 — — — — — 470 6,973 — — — — — (98) 448 — — — — — — — (39,630) December 31, 2019 ......... 85,424 108,715 (4,309) Note: 1. It represents the financial effect from the adoption of IFRS 16 “Leases.” 19 Kao Corporation Financial Report 2020 (108) 57,006 (98) (98) (56,799) 1 Consolidated Statement of Cash Flows Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2020 Notes 2020 2019 (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 ........................................................................................... Other ................................................................................................................................. Net cash flows from investing activities .................................................................... Cash flows from financing activities Increase (decrease) in short-term borrowings .................................................................. Proceeds from long-term borrowings ............................................................................... Repayments of long-term borrowings .............................................................................. Proceeds from issuance of bonds .................................................................................... Redemption of bonds ....................................................................................................... Repayments of lease liabilities .......................................................................................... 31 Purchase of treasury shares ............................................................................................. Dividends paid to owners of the parent ............................................................................ Dividends paid to non-controlling interests ....................................................................... Other ................................................................................................................................. 173,971 86,080 (1,571) 2,533 (2,536) 3,301 6,443 646 (4,227) (28,818) 31,852 267,674 1,516 2,060 (2,650) (53,882) 214,718 (14,053) 19,661 (59,396) (10,454) 2,301 (61,941) (41) 1,080 (48) 24,939 (24,942) (20,912) (28) (64,987) (1,235) (891) 210,645 83,369 (1,885) 2,840 (2,126) 3,323 12,862 (2,848) 696 (3,788) (2,936) 300,152 1,711 2,146 (2,806) (56,680) 244,523 (35,188) 36,660 (83,959) (9,819) (1,960) (94,266) 19 46,220 (40,054) — (12) (20,565) (50,033) (60,512) (1,287) 58 Net cash flows from financing activities .................................................................... (87,065) (126,166) 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 ........................................................... 7 7 65,712 289,681 (2,217) 353,176 24,091 265,978 (388) 289,681 Kao Corporation Financial Report 2020 20 Notes to Consolidated Financial Statements Kao Corporation and Consolidated Subsidiaries Year ended December 31, 2020 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 located 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 (4) Early Adoption of New or Revised Standards and Standards (hereinafter “IFRS”) Interpretations 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) 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. The Group has early adopted amendment to IFRS 16 “Leases,” “Covid-19-Related Rent Concessions” (issued in May 2020 in preparing its consolidated financial statements). (5) Changes in Presentation (Consolidated Statement of Cash Flows) “Payments for business combinations,” which was separately presented as an item within “Investing activities” for the fiscal year ended December 31, 2019, is included in “Other” for the fiscal year ended December 31, 2020 due to its immateriality. The consolidated financial statements for the fiscal year ended December 31, 2019 have been reclassified to reflect these changes in presentation. Consequently, “Payments for business combinations,” which was presented as a cash outflow of 195 million yen within “Investing activities” of the consolidated statement of cash flows for the fiscal year ended December 31, 2019, is reclassified to “Other.” 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 21 Kao Corporation Financial Report 2020 non-controlling interests are adjusted and the fair value of the consideration paid or received is recognized directly in equity attributable to the Group. Non-controlling interests in subsidiaries are identified separately from the Group’s equity therein. Comprehensive income of subsidiaries is attributed to owners of the parent 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. (3) Foreign Currency Translation 1) Functional currency and presentation currency The presentation currency used in the Group’s consolidated financial statements is Japanese yen, which is the Company’s functional currency. Subsidiaries and associates in the Group determine their own functional currencies and each entity’s transactions are measured in its functional currency. 2) Foreign currency transactions Foreign currency transactions are translated into the functional currency at the spot exchange rate at the date of the transaction, or an exchange rate that approximates the spot rate. At the end of each reporting period, foreign currency monetary items are translated into the functional currency using the rates at the end of each reporting period. Non-monetary items that are measured in terms of historical cost in foreign currencies are translated using the exchange rates at the date of acquisition. Non-monetary items that are measured at fair value in foreign currencies are translated into the functional currency using the exchange rates at the date when the fair value was measured. Exchange differences arising from such translations and settlements are recognized in profit or loss. However, exchange differences arising from equity instruments measured at fair value through other comprehensive income and cash flow hedges are recognized in other comprehensive income. 3) Financial statements of foreign operations Assets and liabilities of foreign operations are translated at the rates at the end of each reporting period. Income and expenses are translated at the average exchange rates for the period, provided that there were no significant fluctuations in the exchange rates during the period. Exchange differences arising from translation of the financial statements of foreign operations are recognized in other comprehensive income. On the disposal of a foreign operation, the cumulative amount of exchange differences relating to that foreign operation is reclassified from equity to profit or loss when the gain or loss on disposal is recognized. (4) Financial Instruments 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. Kao Corporation Financial Report 2020 22 (ii) Classification and subsequent measurement The Group classifies the financial assets it holds as (a) financial assets measured at amortized cost; (b) debt instruments measured at fair value through other comprehensive income; (c) equity instruments measured at fair value through other comprehensive income; or (d) financial assets measured at fair value through profit or loss. This classification is determined at initial recognition, and measurement of financial assets after initial recognition is performed 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 23 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements after the impairment loss has been recognized, the impairment loss will be reversed to the extent of the decrease and credited to profit or loss. (iv) Derecognition of financial assets The Group derecognizes financial assets only when the contractual rights to the cash flows from the financial assets expire, or when the Group transfers financial assets and substantially all the risks and rewards of ownership of the financial assets. 2) Financial liabilities (i) Initial recognition and measurement The Group initially recognizes bonds and borrowings at the date they are issued, and other financial liabilities at the transaction date. Upon initial recognition, all financial liabilities are measured at fair value. However, financial liabilities measured at amortized cost are measured in the full amount after deducting directly attributable transaction costs from the fair value. Transaction costs of financial liabilities measured at fair value through profit or loss are recognized in profit or loss. (ii) Classification and subsequent measurement The Group classifies financial liabilities as either financial liabilities measured at fair value through profit or loss, or financial liabilities measured at amortized cost. This classification is determined at initial recognition. Measurement of financial liabilities after initial recognition is performed as follows, according to the classification of the financial liability. The Group’s financial liabilities measured at fair value through profit or loss are derivative liabilities. The Group has not irrevocably designated any financial liabilities as measured at fair value through profit or loss at initial recognition. Financial liabilities measured at fair value through profit or loss are measured at fair value after initial recognition, and any changes in their fair value are recognized in profit or loss for the period. Financial liabilities measured at amortized cost are subsequently measured at amortized cost using the effective interest method. Amortization using the effective interest method and gains and losses on derecognition are recognized in profit or loss for the period. (iii) Derecognition of financial liabilities The Group derecognizes financial liabilities when they are extinguished (i.e., when the obligation specified in the contract is discharged or cancelled or expires). 3) Offsetting of financial assets and financial liabilities Financial assets and financial liabilities are offset and the net amount is presented in the consolidated statement of financial position only when the Group currently has a legally enforceable right to set off the recognized amount and intends either to settle on a net basis or realize the assets and settle the liabilities simultaneously. 4) Fair value of financial instruments The Group recognizes the fair value of financial instruments using various valuation methodologies and inputs. The fair values recognized based on the observability of inputs into the valuation methodologies are grouped into the following three levels: Level 1: Fair value measured with quoted prices in active markets for identical assets or liabilities Level 2: Fair value measured with inputs other than quoted prices categorized within Level 1 that are observable for the asset or liability, either directly or indirectly Level 3: Fair value measured with unobservable inputs for the asset or liability 5) Hedge accounting The Group uses interest rate swaps and other derivatives to hedge interest rate risk. At the inception of a hedging relationship, the Group formally designates and documents the hedging relationship and the interest rate risk management objective and strategy for undertaking the hedge. The documentation includes identification of the hedging instrument, the hedged item, the nature of the risk being hedged, and the methods of assessing whether the hedging relationship meets the hedge effectiveness requirements. In addition, the Group assesses whether the hedging relationship meets the hedge effectiveness requirements, both at the inception and on an ongoing basis. Ongoing assessments are conducted either at each reporting date or upon a significant change in the circumstances affecting the hedge effectiveness requirements, whichever comes first. 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 2020 24 (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 For leases in which the Group acts as the lessee, the lease liability is initially measured at the present value of the accrued lease payments. Right-of-use assets are measured at the initial amount of the lease liability adjusted for any initial direct costs and any prepaid lease payments, plus any costs including restoration obligations and other factors under the lease contracts. Right-of-use 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 interest expenses and the reduction of the outstanding liability using the interest method. Interest expenses are presented on the consolidated statement of income separately from depreciation expenses of right-of-use assets. The Group does not recognize right-of-use assets and lease liabilities for short-term leases with a lease term of 12 months or less and leases for which the underlying asset is of low-value assets. The Group recognizes the lease payments associated with these leases as expenses on either a straight-line basis or another systematic basis over the lease term. With the application of a practical expedient, rent concessions that are a direct consequence of the COVID-19 pandemic and meet specified conditions are accounted for as variable lease payments rather than being treated as lease modifications. The Group has no significant leases in which it acts as the lessor. (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 25 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements value of money and the risks specific to the asset, for which the future cash flow estimates have not been adjusted. If it is not possible to estimate the recoverable amount of an individual asset, the recoverable amount of the cash-generating unit to which the asset belongs is measured. Goodwill acquired in business combinations is allocated to each of the cash-generating units or groups of cash-generating units of the Group that is expected to benefit from synergies of the business combinations after the acquisition date, and is tested for impairment. Because corporate assets do not generate separate cash inflows, the recoverable amount of individual corporate assets cannot be measured unless management has decided to dispose of the asset. If there is an indication that a corporate asset may be impaired, the recoverable amount of the cash-generating unit or group of cash-generating units to which the asset belongs is measured and compared with the carrying amount. Impairment losses are recognized in profit or loss whenever the recoverable amount is less than the carrying amount. Such impairment losses of the cash-generating unit or group of cash- generating units are recognized by first reducing the carrying amount of any goodwill allocated to the cash-generating unit or group of cash-generating units, and then allocating the rest of the losses to other assets of the unit pro rata on the basis of the carrying amount of each asset in the unit. The Group reviews assets other than goodwill at each fiscal year end to determine whether there is any indication that previously recognized impairment losses may no longer exist or may have decreased. If there are any such indications, the Group estimates the recoverable amount of the asset. Impairment losses on assets other than goodwill that were recognized in prior fiscal years are reversed only when there have been changes in the estimates used to determine the recoverable amount of the asset since the last impairment loss was recognized. In this case, the carrying amount of the asset is increased as a reversal of impairment loss to the recoverable amount. Impairment losses are reversed up to the carrying amount, net of amortization or depreciation, that would have been determined had no impairment loss for the asset been recognized in prior fiscal years. (11) Employee Benefits 1) Post-employment benefits The Group sponsors a defined benefit plan and a defined contribution plan as post-employment benefit plans for employees. (i) Defined benefit plan For the defined benefit plan, the projected unit credit method is used to individually determine the present value of defined benefit obligations, related current service costs and past service costs of each plan. The discount rate is determined by referring to market yields at the end of the fiscal year on high quality corporate bonds corresponding to the period until the expected date of future benefit payment. The net amount of the present value of defined benefit obligations and the fair value of plan assets is accounted for as a liability or asset. However, if the defined benefit plan has surplus, the net defined benefit asset is limited to the present value of any economic benefits available in the form of refunds from the plan or reductions in the future contributions to the plan. Net interest on the net defined benefit liability (asset) is recognized in profit or loss as financial expenses (income). Remeasurements of the net defined benefit liability (asset) are recognized in other comprehensive income and immediately reclassified to retained earnings in the period in which they occur. Past service costs are recognized in profit or loss for the period in which they are incurred. (ii) Defined contribution plan Payments to 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. Kao Corporation Financial Report 2020 26  The amounts recognized as provisions are the best estimates of necessary expenditures to settle the present obligation at the end of the reporting period, taking into account the risks and uncertainties associated with the obligation. When the effect of the time value of money is material, the amount of provision is measured at the present value of the expenditures expected to be required to settle the obligation. (14) Revenue The Group recognizes revenue based on the following five-step model: Step 1: Identify the contract with a customer Step 2: Identify the performance obligations in the contract Step 3: Determine the transaction price Step 4: Allocate the transaction price to the performance obligations in the contract The carrying amount of deferred tax assets is reviewed each period and reduced to the extent that it is no longer probable that sufficient future taxable income will be available to realize benefits from all or part of the assets. Unrecognized deferred tax assets are reassessed each period and are recognized to the extent that it has become probable that future taxable income will allow the deferred tax assets to be recovered. Deferred tax assets and liabilities are not recognized for the following temporary differences: • Taxable temporary differences arising from initial recognition of goodwill • Temporary differences arising from initial recognition of assets and liabilities from transactions that are not business combinations and affect neither accounting income nor taxable income Step 5: Recognize revenue when the entity satisfies a • Taxable temporary differences on investments in 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 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. 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. (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 27 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements for sale are measured at the lower of the carrying amount and fair value less costs to sell. are resolved upon by the General Meeting of Shareholders and interim dividends are resolved upon by the Board of Directors. (18) Equity and Other Capital 1) Ordinary shares Ordinary shares are recognized in share capital and capital surplus at their issue price. Share issuance costs are deducted from the issue price. 2) Treasury shares Treasury shares are recognized at cost and deducted from equity. No gain or loss is recognized on the purchase, sale or retirement of the Company’s treasury shares. Any difference between the carrying amount and consideration received on the sale of treasury shares is recognized directly in equity. (19) Dividends Dividend distributions to shareholders of the Company are recognized as liabilities in the period in which year-end dividends (20) Changes in Significant Accounting Policies (Leases) From the fiscal year ended December 31, 2020, the Group early adopted Amendment to IFRS 16 “Leases,” “Covid-19-Related Rent Concessions” (issued in May 2020). With the application of a practical expedient, rent concessions for leases of lessees that are a direct consequence of the COVID- 19 pandemic and meet specified conditions are accounted for as variable lease payments rather than being treated as lease modifications. Variable lease payments are included in selling, general and administrative expenses in the consolidated statement of income for the year ended December 31, 2020, but their impact is immaterial. 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. Significant accounting estimates and judgments have been made in consideration of the impact of the COVID-19 pandemic. A consensus opinion on when the COVID-19 pandemic will subside has not been made public, and its impact may continue beyond the current fiscal year, but a gradual recovery in the future is assumed. 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, Right-of-use Assets, Goodwill and Intangible Assets The Group conducts impairment tests for property, plant and equipment, right-of-use assets, 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 12 “Goodwill and Intangible Assets” presents the method for measuring the recoverable amount and sensitivity associated with goodwill. (2) Lease Term of Right-of-use Assets The Group determines the lease term as the non-cancellable period of the lease, together with any periods when it is reasonably certain such lease will be extended or will not be terminated. Specifically, the lease term is estimated in consideration of factors including variation in rent due to Kao Corporation Financial Report 2020 28 extension or termination of the lease, whether there is a penalty for termination, and the period for recovery of investment in improvements of important leaseholds. Note 3 “Significant Accounting Policies (9) Leases” presents details related to lease terms. Note 33 “Financial Instruments” presents amounts. (3) 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 18 “Employee Benefits” presents actuarial assumptions and related sensitivity. (4) 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 19 “Provisions” presents the nature and amounts of these provisions. (5) Income Taxes The Group recognizes and measures income tax payables and income taxes based on reasonable estimates of the amounts to be paid to the taxation authorities in each country. Such estimates are made using the tax rates and tax laws enacted or substantively enacted by the end of the reporting period. Calculating income tax payables and income taxes requires estimates and judgments of various factors, including interpretations of tax regulations by the Group and the taxation authorities and the experience of past tax audits. Therefore, if the final tax outcome is different from the amount initially recognized, the difference is recognized in the period when the tax outcome is finalized. Deferred tax assets are recognized for deductible temporary differences, the carryforwards of unused tax losses and the carryforwards of unused tax credits to the extent that it is probable that future taxable income will be available. The realizability of deferred tax assets is assessed using the tax rates that are expected to apply to the period when the asset is realized, based on tax rates and tax laws enacted or substantively enacted by the end of the reporting period. Recognition and measurement of deferred tax assets are based on management’s best estimates and judgments, but may be affected by future changes in business plans or other conditions, or by the amendment or promulgation of related laws. Any revisions that become necessary could have a material effect on the amounts recognized in the consolidated financial statements in future periods. Note 14 “Income Taxes” presents income taxes and amounts. (6) Fair Value The Group uses various inputs, including unobservable inputs, and valuation methodologies to estimate the fair value of specific assets and liabilities. When measuring fair value, the Group maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs, and management’s best estimates and judgments are required in that process. The fair value of these assets and liabilities is based on management’s best estimates and judgments, but could be affected by factors including changes in inputs due to changes in economic conditions. Any revisions that become necessary could have a material effect on the amounts recognized in the consolidated financial statements in future periods. Note 33 “Financial Instruments” presents fair value measurement methods and amounts for major financial assets and liabilities measured at fair value. (7) Contingencies Contingencies are disclosed when there are items that could have a material effect on future business after considering the probability of occurrence and the amount of financial impact, taking into account all available evidence at the end of the reporting period. 5 New Standards and Interpretations Not Yet Adopted The impacts of new or revised major Standards and Interpretations that were issued by the date of approval presented in Note 38 “Approval of the Consolidated Financial Statements,” but were not yet early adopted by the Group as of December 31, 2020 are immaterial. 29 Kao Corporation Financial Report 2020 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. 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 Cosmetics Counseling cosmetics, self-selection cosmetics Skin care products Soaps, facial cleansers, body cleansers Hair care products Shampoos, conditioners, hair styling agents, hair coloring agents, men’s products Sanitary products Sanitary napkins, baby diapers Personal health products Bath additives, oral care products, thermo products Beverage products Beverages Fabric care products Laundry detergents, fabric treatments Home care products Kitchen cleaning products, house cleaning products, paper cleaning products, commercial-use products Oleo chemicals Fatty alcohols, fatty amines, fatty acids, glycerin, commercial-use edible fats and oils Chemical Business Performance chemicals Specialty chemicals Surfactants, plastics additives, superplasticizers for concrete admixtures, asphalt additives Toner and toner binder for copiers and printers, ink and water- based pigment inkjet ink, fragrances and aroma chemicals Kao Corporation Financial Report 2020 30 (2) Sales and Results of Reportable Segments Fiscal year ended December 31, 2020 (Millions of yen) Reportable segments Consumer Products Business Cosmetics Business Skin Care and Hair Care Business5 Human Health Care Business Fabric and Home Care Business Subtotal Chemical Business Total Reconciliation1 Consolidated Net sales Sales to customers ............... 234,068 308,897 233,971 374,367 1,151,303 230,694 1,381,997 — 1,381,997 Intersegment sales and transfers2 ............................. — — — — — 38,517 38,517 (38,517) — 308,897 50,823 233,971 12,850 374,367 80,908 1,151,303 269,211 27,692 147,165 1,420,514 174,857 (38,517) 706 Total net sales .......................... 234,068 Operating income ..................... 2,584 Financial income ................... Financial expenses ................ Share of profit in investments accounted for using the equity method ...................... Income before income taxes ..... 1,381,997 175,563 1,711 (5,839) 2,536 173,971 Other items Depreciation and amortization3 ...................... Capital expenditures4 ............ 14,644 13,366 14,795 16,284 22,214 16,487 18,638 23,831 70,291 14,733 69,968 14,619 85,024 84,587 1,056 1,562 86,080 86,149 Notes: 1. The operating income reconciliation of 706 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 11 “Property, Plant and Equipment,” Note 12 “Goodwill and Intangible Assets” and Note 16 “Leases” present the details of depreciation and amortization. 4. Capital expenditures include investments in property, plant and equipment, right-of-use assets and intangible assets. 5. The Group changed its method of recognizing sales for certain transactions from the gross amount to the net amount. Fiscal year ended December 31, 2019 (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 ............... 301,547 340,757 255,224 359,507 1,257,035 245,206 1,502,241 — 1,502,241 Intersegment sales and transfers2 ............................. — — — — — 40,729 40,729 (40,729) — 340,757 49,524 255,224 17,166 359,507 71,774 1,257,035 285,935 30,839 179,862 1,542,970 210,701 (40,729) 1,022 Total net sales .......................... 301,547 Operating income ..................... 41,398 Financial income ................... Financial expenses ................ Share of profit in investments accounted for using the equity method ...................... Income before income taxes ..... 1,502,241 211,723 2,027 (5,231) 2,126 210,645 Other items Depreciation and amortization3 ...................... Capital expenditures4 ............ 14,865 17,962 13,814 18,389 21,627 27,314 17,899 22,139 68,205 14,205 82,410 85,804 24,189 109,993 959 3,394 83,369 113,387 Notes: 1. The operating income reconciliation of 1,022 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 11 “Property, Plant and Equipment,” Note 12 “Goodwill and Intangible Assets”and Note 16 “Leases” present the details of depreciation and amortization. 4. Capital expenditures include investments in property, plant and equipment, right-of-use assets and intangible assets. 31 Kao Corporation Financial Report 2020 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 ........................................................................................................................................................... Americas .................................................................................................................................................... Europe ....................................................................................................................................................... Total ................................................................................................................................................... Note: Sales are classified by country or region based on the location of customers. 2020 853,628 284,114 128,721 115,534 1,381,997 (Millions of yen) 2019 947,096 293,388 137,819 123,938 1,502,241 Non-current Assets (excluding Financial Assets, Deferred Tax Assets and Retirement Benefit Assets) (Millions of yen) Japan ......................................................................................................................................................... Asia ............................................................................................................................................................ Americas .................................................................................................................................................... Europe ....................................................................................................................................................... Total ................................................................................................................................................... 2020 588,781 100,138 92,282 37,119 818,320 2019 597,950 104,643 98,730 39,444 840,767 7 Cash and Cash Equivalents Cash and cash equivalents consist of the following: Cash and deposits ..................................................................................................................................... Short-term investments ............................................................................................................................. Total ................................................................................................................................................... 2020 328,376 24,800 353,176 (Millions of yen) 2019 239,781 49,900 289,681 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. 8 Trade and Other Receivables Trade and other receivables consist of the following: Trade receivables ....................................................................................................................................... Other receivables ...................................................................................................................................... Allowance for doubtful receivables ........................................................................................................... Total ................................................................................................................................................... 2020 195,483 6,647 (2,043) 200,087 (Millions of yen) 2019 204,322 6,179 (1,662) 208,839 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 2020 32 9 Inventories Inventories consist of the following: Merchandise and finished goods ............................................................................................................... Work in progress ....................................................................................................................................... Materials and supplies ............................................................................................................................... Total ................................................................................................................................................... 2020 149,471 12,847 35,323 197,641 (Millions of yen) 2019 155,611 12,893 31,168 199,672 The amount of inventories recognized as expenses and included in cost of sales for the fiscal years ended December 31, 2020 and 2019 were 668,508 million yen and 729,425 million yen, respectively. Write-downs of inventories recognized as expenses for the fiscal years ended December 31, 2020 and 2019 were 7,457 million yen and 6,065 million yen, respectively. 10 Other Assets Other assets consist of the following: Other current assets (Millions of yen) 2020 2019 Insurance receivable .............................................................................................................................. Prepaid expenses .................................................................................................................................. Other ...................................................................................................................................................... Total ................................................................................................................................................... Other non-current assets Insurance receivable .............................................................................................................................. Long-term prepaid expenses ................................................................................................................. Retirement benefit assets ..................................................................................................................... Other ...................................................................................................................................................... Total ................................................................................................................................................... 376 7,892 9,882 18,150 1,721 1,522 3,018 676 6,937 521 8,587 13,498 22,606 2,263 472 2,146 615 5,496 33 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements 11 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, 2019 ........................................................... 435,771 738,417 121,551 Changes in accounting policy1 ................................. (11,853) (47) (10) Buildings and structures Machinery and vehicles Tools, furniture and fixtures (Millions of yen) Construction in progress Total 34,543 1,405,965 — (11,934) Land 75,683 (24) 34,543 78,671 — — (71,293) (159) (7) 41,755 58,059 (5) January 1, 2019 (after adjustment) .............................. 423,918 738,370 121,541 75,659 Additions .................................................................. Acquisitions through business combinations .......... Sales and disposals .................................................. Reclassification ........................................................ Exchange differences on translation of foreign operations .................................................. Other ........................................................................ 162 15 (3,878) 14,151 (751) 169 493 — (18,094) 40,741 (509) 310 1,084 1 (8,952) 12,285 (37) (513) — — (373) 4,116 109 — December 31, 2019 ..................................................... 433,786 761,311 125,409 79,511 Additions .................................................................. Sales and disposals .................................................. Reclassification ........................................................ Exchange differences on translation of foreign operations .................................................. Other ........................................................................ December 31, 2020 ..................................................... 356 (2,034) 19,967 (1,170) (159) 450,746 240 (14,680) 31,120 (5,054) 388 773,325 Note: 1. It represents the financial effect from the adoption of IFRS 16 “Leases.” 508 (8,968) 10,902 20 — 3,210 (65,199) (343) (473) (456) 127,052 — 82,268 (543) 247 34,314 Accumulated Depreciation and Accumulated Impairment Losses Buildings and structures Machinery and vehicles Tools, furniture and fixtures January 1, 2019............................................................ 300,433 582,438 93,839 Changes in accounting policy1 ................................. (9,434) (27) January 1, 2019 (after adjustment) .............................. 290,999 582,411 Depreciation2 ............................................................ Sales and disposals .................................................. 13,453 (3,324) 32,031 (17,265) Exchange differences on translation of foreign operations .................................................. Other ........................................................................ (510) 135 December 31, 2019 ..................................................... 300,753 Depreciation2 ............................................................ Sales and disposals .................................................. 13,760 (1,818) (444) 316 597,049 33,583 (13,891) Exchange differences on translation of foreign operations .................................................. (395) (3,181) Other ........................................................................ December 31, 2020 ..................................................... 159 312,459 498 614,058 (9) 93,830 12,012 (8,684) 0 (339) 96,819 12,344 (8,650) (287) (272) 99,954 Land 10,320 — 10,320 — — — — 10,320 — — — — 10,320 Construction in progress — — — — — — — — — — — — — 1,394,031 80,410 16 (31,297) — (1,347) (41) 1,441,772 59,183 (25,687) — (7,583) 20 1,467,705 (Millions of yen) Total 987,030 (9,470) 977,560 57,496 (29,273) (954) 112 1,004,941 59,687 (24,359) (3,863) 385 1,036,791 Notes: 1. It represents the financial effect from the adoption of IFRS 16 “Leases.” 2. 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. Kao Corporation Financial Report 2020 34 Carrying Amount Buildings and structures Machinery and vehicles Tools, furniture and fixtures January 1, 2019 ........................................................... 135,338 December 31, 2019 ..................................................... 133,033 December 31, 2020 ..................................................... 138,287 155,979 164,262 159,267 27,712 28,590 27,098 (Millions of yen) Construction in progress 34,543 41,755 34,314 Total 418,935 436,831 430,914 Land 65,363 69,191 71,948 (2) 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. (3) Commitments Note 36 “Commitments” presents information on commitments to acquire property, plant and equipment. 12 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) Goodwill Software Trademarks Intangible assets Customer relationships January 1, 2019 ........................................................... 180,286 29,320 14,710 13,739 Additions .................................................................. Acquisitions through business combinations .......... Sales and disposals .................................................. Reclassification ........................................................ Exchange differences on translation of foreign operations .................................................. Other ........................................................................ — — — — (579) — 76 1 (5,048) 6,990 (50) (3) — — — — (210) — — — (294) — (211) — December 31, 2019 ..................................................... 179,707 31,286 14,500 13,234 Additions .................................................................. Sales and disposals .................................................. Reclassification ........................................................ Exchange differences on translation of foreign operations .................................................. Other ........................................................................ December 31, 2020 ..................................................... — — — (2,676) — 177,031 102 (5,786) 7,788 43 26 33,459 — — — — — — (751) — 13,749 (621) — 12,613 Note: 1. Software in progress is included in other in intangible assets. Other1 6,735 9,702 — (1,789) (6,990) (34) (75) 7,549 10,368 (16) (7,788) (84) (71) 9,958 Total 64,504 9,778 1 (7,131) — (505) (78) 66,569 10,470 (5,802) — (1,413) (45) 69,779 35 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements Accumulated Amortization and Accumulated Impairment Losses (Millions of yen) Goodwill Software Trademarks Intangible assets Customer relationships January 1, 2019 ........................................................... Amortization1 ............................................................ Sales and disposals .................................................. Exchange differences on translation of foreign operations .................................................. Other ........................................................................ December 31, 2019 ..................................................... Amortization1 ............................................................ Sales and disposals .................................................. Exchange differences on translation of foreign operations .................................................. Other ........................................................................ December 31, 2020 ..................................................... — — — — — — — — — — — 14,395 5,938 (5,027) (46) 6 15,266 6,896 (5,783) 43 10 16,432 736 765 — (12) — 666 898 (294) (14) — 1,489 1,256 750 — (103) — 2,136 737 — (67) — 1,926 Other 2,158 430 (1,787) (13) — 788 307 (16) (46) (4) 1,029 Total 17,955 8,031 (7,108) (85) 6 18,799 8,690 (5,799) (173) 6 21,523 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 Goodwill Software Trademarks Intangible assets Customer relationships January 1, 2019 ........................................................... 180,286 December 31, 2019 ..................................................... 179,707 December 31, 2020 ..................................................... 177,031 14,925 16,020 17,027 13,974 13,011 11,613 13,073 11,978 10,687 (Millions of yen) Other 4,577 6,761 8,929 Total 46,549 47,770 48,256 (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 ................................................................................................................................................... 2020 130,398 119,400 10,998 26,968 23,303 3,665 17,219 2,446 177,031 (Millions of yen) 2019 130,605 119,400 11,205 28,412 24,545 3,867 18,160 2,530 179,707 (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 medium-term plans for the Cosmetics Business that reflect past performance and forecasts. These medium-term plans include information on sales by region and brand. 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 medium-term plans approved by management were calculated using an annual growth rate of 0% and were discounted to present value using a weighted average cost of capital (WACC) Kao Corporation Financial Report 2020 36 of 7.3% for the fiscal year ended December 31, 2020 and 6.8% for the fiscal year ended December 31, 2019. For the fiscal year ended December 31, 2020 and 2019, management determined that there was a low probability that the recoverable amounts of relevant cash-generating units would be less than their carrying amounts even in cases where key assumptions used in the impairment test changed within a reasonably possible range. (4) Intangible Assets with Indefinite Useful Lives The intangible assets above include no material intangible assets with indefinite useful lives. (5) Commitments Note 36 “Commitments” presents information on commitments associated with the acquisition of intangible assets. 13 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 ................................................................................ 2020 8,657 (Millions of yen) 2019 8,287 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 ........................................................................................... 2020 2,536 (142) 2,394 (Millions of yen) 2019 2,126 (53) 2,073 14 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, 2020 (Millions of yen) January 1, 2020 Recognized in profit or loss Recognized in other comprehensive income Other December 31, 2020 Deferred tax assets Property, plant and equipment and intangible assets ................................................ Lease liabilities ..................................................... Retirement benefit liabilities ................................ Accrued expenses ............................................... Unused tax losses ............................................... Other .................................................................... Total deferred tax liabilities ...................................... Deferred tax liabilities Property, plant and equipment and intangible assets ................................................ Right-of-use assets .............................................. Financial assets .................................................... Undistributed foreign earnings ............................ Other .................................................................... Total deferred tax liabilities ...................................... Deferred tax assets, net .......................................... 20,715 46,026 21,419 10,240 387 16,005 114,792 9,948 45,926 2,516 11,533 740 70,663 44,129 37 Kao Corporation Financial Report 2020 1,220 (2,917) (1,395) 800 804 (983) — — (6,888) — — — (76) (730) 52 (4) (1) 80 21,859 42,379 13,188 11,036 1,190 15,102 (2,471) (6,888) (679) 104,754 462 (3,324) — (474) 609 (2,727) 256 — — 97 — 133 230 (7,118) (262) (638) (294) — 92 (1,102) 423 10,148 41,964 2,319 11,059 1,574 67,064 37,690 Notes to Consolidated Financial Statements Fiscal year ended December 31, 2019 (Millions of yen) January 1, 2019 (as previously reported) Changes in accounting policy1 January 1, 2019 (after adjustment) Recognized in profit or loss Recognized in other comprehensive income Other December 31, 2019 Deferred tax assets Property, plant and equipment and intangible assets .............................. 19,217 — Lease liabilities ................................... — 46,887  Retirement benefit liabilities .............. Accrued expenses ............................. Unused tax losses ............................. Other .................................................. Total deferred tax assets ....................... 24,093 10,446 1,400 15,866 71,022 19,217  46,887  24,093  10,446  1,400  — — — — 46,887  15,866  117,909  Deferred tax liabilities Property, plant and equipment and intangible assets .............................. 10,188 — Right-of-use assets ............................ — 46,887 Financial assets .................................. Undistributed foreign earnings .......... Other .................................................. Total deferred tax liabilities .................... Deferred tax assets, net ........................ 2,635 11,161 744 24,728 46,294 — — — 46,887 — 10,188  46,887  2,635  11,161  744  71,615  46,294  Note: 1. It represents the financial effect from the adoption of IFRS 16 “Leases.” 1,519 (1,137) (2,177) (184) (551) 521 (2,009) 424 (1,202) — 372 153 (253) (1,756) — — (480) — — — (480) — — (18) — — (18) (462) (21) 276 (17) (22) (462) (382) (628) (664) 241 (101) — (157) (681) 53 20,715 46,026 21,419 10,240 387 16,005 114,792 9,948 45,926 2,516 11,533 740 70,663 44,129 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 ............................................................................................................................ 2020 42,274 4,584 37,690 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 ......................................................................................................................................................... 2020 2,434 12,037 14,471 (Millions of yen) 2019 47,876 3,747 44,129 (Millions of yen) 2019 2,687 11,879 14,566 Unused tax losses for which no deferred tax asset is recognized will expire as follows: (Millions of yen) 2020 2019 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 ......................................................................................................................................................... 465 291 520 388 770 2,434 343 458 288 493 1,105 2,687 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, 2020 and 2019 were 15,353 million yen and 13,648 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 2020 38 (2) Income Taxes Income taxes consist of the following: Current taxes ............................................................................................................................................. Deferred taxes1 .......................................................................................................................................... Total ....................................................................................................................................................... 2020 46,160 (256) 45,904 (Millions of yen) 2019 58,540 1,756 60,296 Note: 1. Deferred taxes include 145 million yen and 79 million yen for the fiscal years ended December 31, 2020 and 2019, 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: 2020 30.62 (2.24) (1.81) 0.15 0.08 (0.41) 26.39 (%) 2019 30.62 (1.90) (1.42) 0.69 0.04 0.59 28.62 (Millions of yen) Average interest rate1 (%) Maturity 1.19 0.11 0.75 — — 0.54 0.93 — — 2022-2029 — — — 2022-2066 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 .............................................................................................................................. 15 Bonds and Borrowings and Other Bonds and borrowings and lease liabilities consist of the following: Short-term borrowings ....................................................................... Current portion of long-term borrowings ............................................ Long-term borrowings ........................................................................ Current portion of bonds2 ................................................................... Bonds2 ................................................................................................ Lease liabilities (Current) .................................................................... Lease liabilities (Non-current) ............................................................. Total ........................................................................................ Current liabilities Bonds and borrowings .................................................................... Lease liabilities ................................................................................ Subtotal ....................................................................................... Non-current liabilities Bonds and borrowings .................................................................... Lease liabilities ................................................................................ Subtotal ....................................................................................... Total ........................................................................................ 2020 408 30,045 47,232 12 49,997 19,787 126,725 274,206 30,465 19,787 50,252 97,229 126,725 223,954 274,206 2019 450 48 76,582 25,007 25,054 19,653 141,438 288,232 25,505 19,653 45,158 101,636 141,438 243,074 288,232 Notes: 1. The average interest rate is the weighted average interest rate on the balance as of December 31, 2020. 2. Details of bonds issued are as follows: Issuer Bond name Issue date 2020 2019 Interest rate (%) Collateral Maturity date (Millions of yen) The Company 4th unsecured bonds June 14, 2013 — The Company 5th unsecured bonds June 19, 2018 24,971 The Company 6th unsecured bonds September 18, 2020 24,942 Subsidiaries Total ................................................................................ Other bonds — 96 50,009 24,995 24,958 — 108 50,061 0.62 0.08 0.13 — None None None — June 19, 2020 June 20, 2023 September 19, 2025 — 39 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements 16 Leases As a lessee, the Group leases assets including buildings etc. Some lease contracts include extension options and termination options. The Group has no restrictions or covenants imposed by leases. Income and expenses relating to leases consist of the following: Depreciation charge for right-of-use assets1 Buildings and structures ........................................................................................................................ Other ...................................................................................................................................................... Total ................................................................................................................................................... Interest expense on lease liabilities2 .......................................................................................................... Expenses relating to short-term leases3 .................................................................................................... Other Total .................................................................................................................................................... (Millions of yen) 2020 2019 16,249 1,454 17,703 1,490 1,686 669 3,845 16,171 1,671 17,842 1,676 1,562 907 4,145 Notes: 1. Depreciation of right-of-use assets is included in cost of sales, selling, general and administrative expenses and other operating expenses in the consolidated statement of income. 2. Interest expense on lease liabilities is included in financial expenses in the consolidated statement of income. 3. Expenses relating to short-term leases are included in cost of sales, selling, general and administrative expenses and other operating expenses in the consolidated statement of income. The total cash outflow for leases for the fiscal years ended December 31, 2020 and 2019 were 24,777 million yen and 24,722 million yen, respectively. Carrying amount of right-of-use assets consists of the following: (Millions of yen) 2020 2019 Right-of-use assets Buildings and structures ........................................................................................................................ Other ...................................................................................................................................................... Total ................................................................................................................................................... 141,728 7,815 149,543 156,965 7,857 164,822 Note 31 “Cash Flow Information” presents additions to right-of-use assets. Note 33 “Financial Instruments” presents lease liabilities by maturity date. Kao Corporation Financial Report 2020 40 17 Trade and Other Payables Trade and other payables consist of the following: Trade payables ........................................................................................................................................... Non-trade payables .................................................................................................................................... Total ...................................................................................................................................................... 2020 137,680 78,162 215,842 (Millions of yen) 2019 144,864 77,450 222,314 18 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 performance of 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 ............................................................................................................. 2020 351,077 (302,237) 48,840 51,858 (3,018) 48,840 (Millions of yen) 2019 362,080 (283,647) 78,433 80,579 (2,146) 78,433 41 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements 2) Defined benefit obligations Changes in the present value of defined benefit obligations are as follows: The present value of the defined benefit obligations at beginning of year ................................................ Current service cost1 .............................................................................................................................. Interest expense2 .................................................................................................................................. Remeasurements Actuarial (gains) losses arising from changes in demographic assumptions ...................................... Actuarial (gains) losses arising from changes in financial assumptions ............................................. Actuarial (gains) losses arising from experience adjustments ........................................................... Benefits paid3 ......................................................................................................................................... Exchange differences on translation of foreign operations and other ................................................... The present value of the defi ned benefi t obligations at end of year ......................................................... 2020 362,080 10,639 2,209 (337) (8,622) 399 (14,120) (1,171) 351,077 (Millions of yen) 2019 342,130 9,804 2,710 2,389 17,402 365 (12,381) (339) 362,080 Notes: 1. Current service cost is recognized in profit or loss and included in cost of sales, selling, general and administrative expenses and other operating expenses in the consolidated statement of income. 2. Interest expense or interest income associated with the net of the present value of the defined benefit obligations and the fair value of plan assets is recognized in profit or loss and included in financial expenses or financial income in the consolidated statement of income. 3. The weighted average duration of the defined benefit obligations in Japan was mainly 17.2 years at December 31, 2020 and 18.0 years at December 31, 2019. 3) Plan assets Changes in the fair value of plan assets are as follows: The fair value of plan assets at beginning of year ..................................................................................... Interest income ...................................................................................................................................... Remeasurements Return on plan assets (excluding amounts included in interest income) ........................................... Contributions to the plan by the employer1 ........................................................................................... Payments from the plan ........................................................................................................................ Exchange differences on translation of foreign operations and other ................................................... The fair value of plan assets at end of year ............................................................................................... 2020 283,647 1,675 14,826 15,714 (12,880) (745) 302,237 (Millions of yen) 2019 258,744 1,911 19,456 14,870 (11,242) (92) 283,647 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 17,236 million yen to the defined benefit plan for the fiscal year ending December 31, 2021. Plan assets consist of the following: 2020 2019 Market price in an active market Market price in an active market (Millions of yen) Equity securities ......................... Japan ...................................... Overseas ................................. Debt securities ........................... Japan ...................................... Overseas ................................. Other .......................................... Total .................................... Quoted 11,651 — 11,651 7,248 — 7,248 462 19,361 Unquoted 62,649 30,996 31,653 208,061 138,520 69,541 12,166 282,876 Total 74,300 30,996 43,304 215,309 138,520 76,789 12,628 302,237 Quoted 11,623 — 11,623 7,863 — 7,863 334 19,820 Unquoted 57,118 28,412 28,706 195,263 130,418 64,845 11,446 263,827 Total 68,741 28,412 40,329 203,126 130,418 72,708 11,780 283,647 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. Kao Corporation Financial Report 2020 42 4) Significant actuarial assumptions and related sensitivity analysis Significant actuarial assumptions are as follows: Discount rate ............................................................................................................................................ Mainly 0.8% Mainly 0.6% 2020 2019 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: (Millions of yen) 2020 2019 The impact on defined benefit obligations 0.5% increase in discount rate ........................................................................................................... 0.5% decrease in discount rate .......................................................................................................... (25,482) 26,815 (27,430) 28,821 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. 5) Defined contribution plans Expenses related to the defined contribution plan recognized in profit or loss were 3,488 million yen and 3,820 million yen for the fiscal years ended December 31, 2020 and 2019, 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, 2020 and 2019 were 277,244 million yen and 274,937 million yen, respectively. 19 Provisions Components of and changes in provisions consist of the following: Provision for loss related to cosmetics Provision for asset retirement obligations Other provisions January 1, 2020 .................................................................................... 5,959 Increase ............................................................................................ Interest expense on discounted provision ........................................ — 11 Decrease (provision used) ................................................................ (844) Decrease (provision reversed) .......................................................... Exchange differences on translation of foreign operations ........................................................................... — — December 31, 2020 .............................................................................. 5,126 4,506 231 55 (108) — 11 4,695 1,711 555 — (1,042) (38) (21) 1,165 (Millions of yen) Total 12,176 786 66 (1,994) (38) (10) 10,986 (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 1,128 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 right-of-use 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. 43 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements 20 Other Current Liabilities Other current liabilities consist of the following: Accrued expenses ..................................................................................................................................... Consumption tax payables ........................................................................................................................ Obligation for unused paid absences ........................................................................................................ Other ......................................................................................................................................................... 2020 72,701 10,508 8,201 8,311 Total ....................................................................................................................................................... 99,721 (Millions of yen) 2019 72,551 10,663 7,948 8,249 99,411 21 Equity and Other Equity Items (1) Share Capital The numbers of shares authorized and issued are as follows: 2020 2019 (Shares) Authorized ................................................................................................................................................. 1,000,000,000 1,000,000,000 Issued1 Beginning balance .................................................................................................................................. 482,000,000 488,700,000 Change during the year2 ......................................................................................................................... — (6,700,000) Ending balance ....................................................................................................................................... 482,000,000 482,000,000 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, 2019 decreased by 6,700,000 shares due to the retirement of treasury shares pursuant to the resolution of the Board of Directors. (2) Capital Surplus Capital surplus consists of capital reserve and other capital surplus. The Companies Act stipulates that over half of the capital contributed from the issue of shares must be included in share capital and that the remainder must be included in capital reserve. Moreover, capital reserve may be included in share capital by resolution of the General Meeting of Shareholders. (3) Treasury Shares The changes in treasury shares are as follows: 2020 2019 (Shares) Beginning balance1 .................................................................................................................................... 1,083,466 Increase2 ................................................................................................................................................ Decrease3 ............................................................................................................................................... 28,823 (58,270) Ending balance4 ......................................................................................................................................... 1,054,019 2,043,272 5,786,409 (6,746,215) 1,083,466 Notes: 1. 556,492 shares of treasury shares held by associates were included at December 31, 2020 and 2019. In addition, 226,550 shares and 242,675 shares held by the Board Incentive Plan Trust (hereinafter “BIP Trust”) were included at December 31, 2020 and 2019, respectively. 2. The increase of 28,823 shares of treasury shares during the fiscal year ended December 31, 2020 resulted from an increase of 25,605 shares due to changes in treasury shares held by associates accounted for by the equity method and the purchase of 3,218 fractional shares. The increase of 5,786,409 shares of treasury shares during the fiscal year ended December 31, 2019 resulted from the acquisition of 5,782,400 shares by resolution of the Board of Directors and the purchase of 4,009 fractional shares. 3. The decrease of 58,270 shares of treasury shares during the fiscal year ended December 31, 2020 resulted from a decrease of 43,000 shares due to the exercise of stock options, a decrease of 15,000 shares due to the grant to the Board of Directors by the BIP trust and the sale of 270 fractional shares. The decrease of 6,746,215 shares of treasury shares during the fiscal year ended December 31, 2019 resulted from the retirement of 6,700,000 shares by resolution of the Board of Directors, a decrease of 30,000 shares due to the exercise of stock options, a decrease of 16,125 shares due to the grant to the Board of Directors by the BIP trust and the sale of 90 fractional shares. 4. 582,097 shares and 556,492 shares of treasury shares held by associates were included at December 31, 2020 and 2019, respectively. In addition, 211,550 shares and 226,550 shares held by the BIP Trust were included at December 31, 2020 and 2019, respectively. Kao Corporation Financial Report 2020 44 (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 32 “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. 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. (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. 22 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 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 uses surplus funds to flexibly conduct share repurchases, aiming to continuously increase dividends to reflect improvements in business results. While making returns to shareholders and improving EVA, the Group retains the capital necessary to make timely investments for growth and to ensure the appropriate resources to deal with unexpected situations. For the fiscal year ended December 31, 2020, EVA decreased 25.1 billion yen compared with the previous fiscal year to 62.3 billion yen due to a decrease 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. 45 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements 23 Dividends Dividends paid are as follows: Fiscal year ended December 31, 2020 Date of resolution 114th Annual General Meeting of Shareholders held on March 25, 2020 Board of Directors meeting held on July 29, 2020 Total dividends¹ (Millions of yen) Dividends per share (Yen) Record date Effective date 31,260 33,666 65 70 December 31, 2019 March 26, 2020 June 30, 2020 September 1, 2020 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 114th Annual General Meeting of Shareholders held on March 25, 2020 was 31,310 million yen before the deduction. The dividend resolved at the meeting of the Board of Directors held on July 29, 2020 was 33,721 million yen before the deduction. Fiscal year ended December 31, 2019 Date of resolution 113th Annual General Meeting of Shareholders held on March 26, 2019 Board of Directors meeting held on July 31, 2019 Total dividends¹ (Millions of yen) Dividends per share (Yen) Record date Effective date 29,199 31,259 60 65 December 31, 2018 March 27, 2019 June 30, 2019 September 2, 2019 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 113th Annual General Meeting of Shareholders held on March 26, 2019 was 29,247 million yen before the deduction. The dividend resolved at the meeting of the Board of Directors held on July 31, 2019 was 31,310 million yen before the deduction. Dividends with an effective date after the fiscal year end are as follows: Fiscal year ended December 31, 2020 Date of Resolution 115th Annual General Meeting of Shareholders held on March 26, 2021 Fiscal year ended December 31, 2019 Date of Resolution 114th Annual General Meeting of Shareholders held on March 25, 2020 Total dividends (Millions of yen) Dividends per share (Yen) Record date Effective date 33,722 70 December 31, 2020 March 29, 2021 Total dividends (Millions of yen) Dividends per share (Yen) Record date Effective date 31,310 65 December 31, 2019 March 26, 2020 24 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: Kao Corporation Financial Report 2020 46 Fiscal year ended December 31, 2020 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 164,165 177,720 144,867 324,250 811,002 111,084 (34,029) 888,057 Asia 45,354 25,332 88,942 40,643 200,271 56,472 (2,626) 254,117 Americas 5,539 68,619 119 9,338 83,615 42,773 (72) Europe 19,010 37,226 43 136 56,415 58,882 (1,790) (Millions of yen) Total 234,068 308,897 233,971 374,367 1,151,303 269,211 (38,517) 126,316 113,507 1,381,997 10,203 — — — 10,203 Total revenue from contracts with customers 898,260 254,117 126,316 113,507 1,392,200 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. The Group has changed its method of recognizing sales for certain transactions for the Skin Care and Hair Care Business in Japan from the gross amount to the net amount. Fiscal year ended December 31, 2019 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 232,132 199,541 160,312 307,658 899,643 123,422 (35,911) 987,154 Asia 42,725 28,485 94,793 40,347 206,350 57,349 (2,851) 260,848 Americas 6,047 71,430 113 11,245 88,835 46,076 (60) Europe 20,643 41,301 6 257 62,207 59,088 (1,907) (Millions of yen) Total 301,547 340,757 255,224 359,507 1,257,035 285,935 (40,729) 134,851 119,388 1,502,241 8,973 — — — 8,973 Total revenue from contracts with customers 996,127 260,848 134,851 119,388 1,511,214 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 47 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements termination of products is expected to occur. Because the Group has an obligation to refund the consideration for a product if a customer returns it, the Group recognizes a liability for sales returns as a deduction from revenue for projected refunds to customers. To estimate liabilities related to such sales returns, the Group uses the most likely outcome method based on historical experience and other factors, and revenue is recognized only to the extent that it is highly probable that a significant reversal will not occur. When customers return products, the Group has the right to collect the products from the customers, but because returned goods are primarily the result of a product termination, the products returned have no asset value and therefore such assets are not recognized. 2) Chemical Business The Chemical Business sells chemical products such as fatty alcohols and surfactants. Its customers are mainly the users and distributors of the products. Revenue from such sales is recognized when control of a product is transferred to a customer, i.e., at the point in time a product is delivered and handed over at the place designated by a customer because legal title to the product, physical possession and the significant risks and rewards of ownership of the product are transferred to the customer and the customer has the right to decide the method of sale and selling price of the product. Revenue from sales of products in the Chemical Business is measured at transaction prices for contracts with customers. (2) Liabilities from Contracts with Customers Liabilities from contracts with customers are as follows: Fiscal year ended December 31, 2020 Contract liabilities January 1, 2020 December 31, 2020 (Millions of yen) Advances ........................................................................................................................... Refund liabilities ................................................................................................................. Total ............................................................................................................................... 384 20,232 20,616 298 22,800 23,098 Fiscal year ended December 31, 2019 Contract liabilities January 1, 2019 December 31, 2019 (Millions of yen) Advances ........................................................................................................................... Refund liabilities ................................................................................................................. Total ............................................................................................................................... 181 18,206 18,387 384 20,232 20,616 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, 2020 and 2019 were recognized as revenue during the fiscal years ended December 31, 2020 and 2019, respectively. The amount of revenue recognized during the fiscal year ended December 31, 2020 from performance obligations satisfied in previous periods was not material. (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, 2020 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. (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. Kao Corporation Financial Report 2020 48 25 Selling, General and Administrative Expenses Selling, general and administrative expenses consist of the following: Advertising ................................................................................................................................................. Sales promotion ......................................................................................................................................... 2020 71,984 45,543 (Millions of yen) 2019 77,545 56,943 Employee benefi ts ..................................................................................................................................... 148,281 148,431 Depreciation .............................................................................................................................................. Amortization .............................................................................................................................................. Research and development ....................................................................................................................... Other ......................................................................................................................................................... 18,586 8,632 58,509 64,291 18,775 7,950 59,143 74,125 Total ....................................................................................................................................................... 415,826 442,912 26 Other Operating Income Other operating income consists of the following: Revenue of logistics services to third parties ............................................................................................ Royalty income .......................................................................................................................................... Other ......................................................................................................................................................... 2020 10,203 1,002 4,596 (Millions of yen) 2019 8,973 1,244 4,975 Total ....................................................................................................................................................... 15,801 15,192 27 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 ................................................................. Other ......................................................................................................................................................... 2020 9,311 3,347 2,447 (Millions of yen) 2019 8,293 3,600 2,182 Total ....................................................................................................................................................... 15,105 14,075 49 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements 28 Financial Income and Financial Expenses Financial income consists of the following: (Millions of yen) 2020 2019 Interest income Financial assets measured at amortized cost ........................................................................................ Retirement benefi t assets ..................................................................................................................... 1,415 23 1,707 28 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 ......................................................................................................................................................... 16 135 4 118 8 162 7 115 Total ............................................................................................................................................... 1,711 2,027 Financial expenses consist of the following: Foreign exchange loss1 .............................................................................................................................. Interest expenses2 Financial liabilities measured at amortized cost ..................................................................................... Lease liabilities ....................................................................................................................................... Retirement benefi t liabilities .................................................................................................................. Other ......................................................................................................................................................... Total ............................................................................................................................................... 2020 2,624 1,043 1,490 557 125 5,839 (Millions of yen) 2019 1,521 1,164 1,676 827 43 5,231 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. 29 Earnings per Share (1) The Basis for Calculating Basic Earnings per Share Net income attributable to owners of the parent ...................................................................................... 126,142 Amounts not attributable to ordinary shareholders of the parent .............................................................. — 2020 2019 148,213 — Net income used to calculate basic earnings per share ............................................................................ 126,142 148,213 (Millions of yen, unless otherwise noted) Weighted average number of ordinary shares (Thousands of shares) ...................................................... 480,929 483,252 Basic earnings per share (Yen) .................................................................................................................. 262.29 306.70 Kao Corporation Financial Report 2020 50 (2) The Basis for Calculating Diluted Earnings per Share Net income used to calculate basic earnings per share ............................................................................ 126,142 Adjustments to net income ....................................................................................................................... — 2020 2019 148,213 — Net income used to calculate diluted earnings per share .......................................................................... 126,142 148,213 (Millions of yen, unless otherwise noted) Weighted average number of ordinary shares (Thousands of shares) ...................................................... 480,929 483,252 Increase in ordinary shares Subscription rights to shares (Thousands of shares) ............................................................................. 68 Weighted average number of ordinary shares after dilution (Thousands of shares) ................................. 480,998 104 483,356 Diluted earnings per share (Yen) ............................................................................................................... 262.25 306.63 Summary of potential ordinary shares not included in the calculation of diluted earnings per share because they have no dilutive effect ..................................................................................................... — — 30 Other Comprehensive Income Amount arising during the fiscal year, reclassification adjustments to profit or loss and tax effects for each component of other comprehensive income are as follows: Fiscal year ended December 31, 2020 Gains (losses) arising for the year Reclassification adjustments Before tax effect Tax effect (Millions of yen) After tax effect 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 ......... 265 Remeasurements of defi ned benefi t plans ....................... 23,386 Share of other comprehensive income of investments accounted for using the equity method ........................... 36 Total of items that will not be reclassifi ed to profi t or loss .. 23,687 Items that may be reclassified subsequently to profit or loss Exchange differences on translation of foreign operations ... (9,936) 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 ............................................................. (167) (10,103) Total ........................................................................... 13,584 — — — — (6) — (6) (6) 265 23,386 36 23,687 (9,942) (167) (10,109) (97) (7,021) (11) (7,129) — 0 0 168 16,365 25 16,558 (9,942) (167) (10,109) 13,578 (7,129) 6,449 51 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements Fiscal year ended December 31, 2019 Gains (losses) arising for the year Reclassification adjustments Before tax effect Tax effect (Millions of yen) After tax effect 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 .. (24) (700) (24) (748) Items that may be reclassified subsequently to profit or loss Exchange differences on translation of foreign operations ... (2,723) 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 ............................................................. (36) (2,759) — — — — 234 — 234 (24) (700) (24) (748) (2,489) (36) (2,525) 18 (480) 7 (455) — (0) (0) (6) (1,180) (17) (1,203) (2,489) (36) (2,525) Total ........................................................................... (3,507) 234 (3,273) (455) (3,728) 31 Cash Flow Information (1) Changes in Liabilities Arising from Financing Activities Fiscal year ended December 31, 2020 The following table presents the changes in liabilities arising from financing activities for lease liabilities. January 1, 2020 Changes from financing cash flows New leases Other December 31, 2020 Non-cash changes (Millions of yen) Lease liabilities ...................................... 161,091 (20,912) 16,358 (10,025) 146,512 Except for lease liabilities, the major changes in liabilities arising from financing activities were changes from financing cash flows and there were no significant non-cash changes for the fiscal year ended December 31, 2020. Fiscal year ended December 31, 2019 The following table presents the changes in liabilities arising from financing activities for lease liabilities. January 1, 2019 (as previously reported) Changes in accounting policy1 January 1, 2019 (after adjustment) Changes from financing cash flows New leases Other December 31, 2019 Non-cash changes (Millions of yen) Lease liabilities ...................................... — 167,435 167,435 (20,565) 22,804 (8,583) 161,091 Note: 1. It represents the financial effect from the adoption of IFRS 16 “Leases.” Except for lease liabilities, the major changes in liabilities arising from financing activities were changes from financing cash flows and there were no significant non-cash changes for the fiscal year ended December 31, 2019. (2) Non-cash Transactions For the fiscal year ended December 31, 2020 and 2019, the non-cash transactions comprised the acquisition of right-of-use assets resulted from leases of 16,496 million yen and 23,199 million yen, respectively. Kao Corporation Financial Report 2020 52 32 Share-based Payments (1) Stock Options 1) Outline of stock options The Company issued the following type of stock option to directors and executive officers of the Company. Due to the introduction of a performance share plan, the stock option plan has been abolished except for the options already granted. 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 2) Number of stock options and weighted average exercise price were intended to motivate and inspire recipients to enhance the Company’s results and value of shares and to further enhance corporate value by aligning the interests of recipients with those of shareholders by further increasing the linkage among the compensation of recipients, the Company’s results and value of shares. • Vesting conditions: Set on date of grant • Settlement: Shares settled • Exercise period: Five years from July 1 of two years after the date the stock options were granted Beginning balance of outstanding ................................. Granted ...................................................................... Exercised ................................................................... Expired at maturity ..................................................... Ending balance of outstanding ...................................... Ending balance of exercisable ....................................... 2020 2019 Number of shares Weighted average exercise price (Shares) 95,000 — (43,000) (1,000) 51,000 51,000 (Yen) 1 — 1 1 1 1 Number of shares (Shares) 125,000 — (30,000) — 95,000 95,000 Weighted average exercise price (Yen) 1 — 1 — 1 1 Notes: 1. The weighted average share price on the date of exercise for the fiscal years ended December 31, 2020 and 2019 was 8,400 yen and 8,118 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 2020 Number of shares (Shares) 51,000 Weighted average remaining contractual life Exercise price (Years) 1.7 (Yen) 1 2019 Number of shares (Shares) 95,000 Weighted average remaining contractual life (Years) 2.2 (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. 53 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements 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 .............. Weighted average fair value (Yen) .............................. 34,125 6,821 2020 Achievement-linked points Fixed points 14,625 6,443 2019 Achievement-linked points 35,000 6,821 Fixed points 15,000 6,551 (3) Share-based Payment Expenses The amount of share-based payment expenses recognized in the consolidated statement of income for the fiscal year ended December 31, 2020 and 2019 were 394 million yen of reversal of expenses and 337 million yen of expenses, respectively. 33 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) 2020 2019 Cash and cash equivalents (Note 7) ....................................................................................................... Trade and other receivables (Note 8) ..................................................................................................... Other ...................................................................................................................................................... Financial assets measured at fair value through profit or loss Cash and cash equivalents (Note 7) ....................................................................................................... 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 ............................................................................................................................................... 338,276 200,087 17,907 14,900 81 3,034 9,843 584,128 353,176 200,087 7,257 560,520 23,608 584,128 269,781 208,839 25,893 19,900 214 3,063 10,722 538,412 289,681 208,839 13,788 512,308 26,104 538,412 Kao Corporation Financial Report 2020 54  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, 2020 Company name (Millions of yen) Fair value Aeon Co., Ltd. ........................................................................................................................................... Seven & i Holdings Co., Ltd. ..................................................................................................................... Saiwai Trading Co., Ltd. ............................................................................................................................ Livedo Corporation ................................................................................................................................... Japan Alcohol Trading Co., Ltd. .................................................................................................................. Tokio Marine Holdings, Inc. ...................................................................................................................... Keytrading Co., Ltd. ................................................................................................................................... Izumi Co., Ltd. .......................................................................................................................................... Kawaken Fine Chemicals Co., Ltd. ........................................................................................................... Kyoto Seisakusho Co., Ltd. ....................................................................................................................... 1,433 1,375 1,308 1,286 739 677 431 374 272 194 As of December 31, 2019 Company name (Millions of yen) Fair value Seven & i Holdings Co., Ltd. ..................................................................................................................... Saiwai Trading Co., Ltd. ............................................................................................................................ Livedo Corporation ................................................................................................................................... Aeon Co., Ltd. ........................................................................................................................................... Tokio Marine Holdings, Inc. ...................................................................................................................... Japan Alcohol Trading Co., Ltd. ................................................................................................................ Keytrading Co., Ltd. .................................................................................................................................. Izumi Co., Ltd. .......................................................................................................................................... Kawaken Fine Chemicals Co., Ltd. ........................................................................................................... Kyoto Seisakusho Co., Ltd. ....................................................................................................................... 2,360 1,308 1,201 952 910 700 414 394 245 205 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) .......................................................................................................................... 2020 1,224 968 (Millions of yen) 2019 400 328 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, 2020 and 2019, were 668 million yen and 227 million yen, respectively. 55 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements The amounts of each classification of financial liabilities are as follows: Financial liabilities measured at amortized cost Financial liabilities (Millions of yen) 2020 2019 Trade and other payables (Note 17) ....................................................................................................... Bonds and borrowings (Note 15) ........................................................................................................... Lease liabilities (Note 16) ....................................................................................................................... Other ...................................................................................................................................................... 215,842 127,694 146,512 14,065 Financial liabilities measured at fair value through profi t or loss Derivatives ............................................................................................................................................. 368 Total ............................................................................................................................................... 504,481 222,314 127,141 161,091 13,898 395 524,839 Current liabilities Trade and other payables ....................................................................................................................... 215,842 222,314 Bonds and borrowings ........................................................................................................................... Lease liabilities ....................................................................................................................................... Other fi nancial liabilities ......................................................................................................................... 30,465 19,787 6,571 25,505 19,653 6,766 Subtotal .............................................................................................................................................. 272,665 274,238 Non-current liabilities Bonds and borrowings ........................................................................................................................... Lease liabilities ....................................................................................................................................... Other fi nancial liabilities ......................................................................................................................... Subtotal .............................................................................................................................................. Total ............................................................................................................................................... 97,229 126,725 7,862 231,816 504,481 101,636 141,438 7,527 250,601 524,839 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, 2020 and 2019 totaling 12,789 million yen and 12,790 million yen, respectively. The average interest rate on deposits received as of December 31, 2020 was 0.13%. (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 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. Kao Corporation Financial Report 2020 56 Derivatives transactions Foreign exchange forward contracts: Selling 2020 Contract amount over 1 year Carrying amount (fair value)¹ Contract amount U.S. dollar ......................................................... Euro .................................................................. 10,776 80 Buying Euro .................................................................. Chinese yuan ................................................... 31 111 — — — — (0) 2 (0) (0) (Millions of yen) 2019 Contract amount over 1 year Carrying amount (fair value)1 — — — — 4 0 (1) (9) Contract amount 21,052 19 105 458 Note: 1. Note 33 “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, 2020 Net exposure .................................................................................................................. 23,198 U.S. dollar As of December 31, 2019 Net exposure .................................................................................................................. U.S. dollar 23,641 Euro 2,201 Euro 1,725 (Millions of yen) Chinese yuan 11,074 (Millions of yen) Chinese yuan 11,630 The following table illustrates the impact on income before income taxes in the consolidated statement of income from foreign currency-denominated financial instruments held by the Group at the end of each fiscal year if the Japanese yen appreciated by 10% against the U.S. dollar, the euro and the Chinese yuan. The effects of translating financial instruments denominated in the Group’s functional currency, and the assets, liabilities, income and expenses of foreign operations are not included in the analysis. The analysis also assumes that currencies other than those used in the calculation remain constant. U.S. dollar .................................................................................................................................................. Euro ........................................................................................................................................................... Chinese yuan ............................................................................................................................................. 2020 (2,320) (220) (1,107) (Millions of yen) 2019 (2,364) (173) (1,163) (ii) Interest rate fluctuation risk (iii) Share price fluctuation risk 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. The Group held marketable equity securities, primarily those of companies with which the Group has business relationships, totaling 4,699 million yen and 5,830 million yen at December 31, 2020 and 2019, 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. 57 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements The carrying amount after impairment of financial assets in the consolidated statement of financial position represents the Group’s maximum exposure to the credit risk of financial assets. The Group is not exposed to excessive credit risk associated with a particular customer that requires exceptional management. The Group recognizes an allowance for doubtful receivables for trade receivables and other financial assets measured at amortized cost by estimating future credit losses in consideration of recoverability and significant increases in credit risk. The Group determines if credit risk has increased significantly by evaluating changes in default risk with reference to factors including downgrading of internal credit ratings, the decline of counterparty results, and delinquency information. Trade receivables are particularly important financial assets for the Group. The Group collectively measures expected credit losses of the financial assets for the entire period to recognize the allowance for doubtful receivables. In the following situations that would adversely affect future cash 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 7,001 million yen and 6,829 million yen at December 31, 2020 and 2019, respectively. 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. (ii) Short-term investments Short-term investments are recognized in cash and cash equivalents and other financial assets. They are highly safe and liquid financial instruments that include commercial paper issued by entities with high bond ratings, bond investment trusts, and money held in trust. (iii) Loan receivables Loan receivables expose the Group to borrower credit risk. The Group manages this risk with an internal process for investigating and approving borrower credit on initial lending transactions, and by obtaining deposits, collateral or other guaranties as necessary. The Group also periodically reconfirms 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. Kao Corporation Financial Report 2020 58 The carrying amount of trade receivables and changes in the related allowance for doubtful receivables are as follows: Fiscal year ended December 31, 2020 (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, 2020 ..................................................................... 203,690 Change during the year (Recognition and derecognition) ...................................... Transfer to credit-impaired fi nancial assets ....................... Other changes ................................................................... (7,907) (59) (919) December 31, 2020 ............................................................... 194,805 632 (30) 59 17 678 Allowance for doubtful receivables January 1, 2020 ..................................................................... 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, 2020 ............................................................... 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 1,114 565 (157) (95) 57 6 1,490 520 82 (1) (16) (57) 15 543 Total 204,322 (7,937) — (902) 195,483 (Millions of yen) Total 1,634 647 (158) (111) — 21 2,033 Fiscal year ended December 31, 2019 (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, 2019 ..................................................................... 217,018 Change during the year (Recognition and derecognition) ...................................... Transfer to credit-impaired fi nancial assets ....................... Other changes ................................................................... (12,408) (100) (820) December 31, 2019 ............................................................... 203,690 576 (31) 100 (13) 632 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 Allowance for doubtful receivables January 1, 2019 ..................................................................... Increase during the year .................................................... Decrease during the year (charge-offs) .............................. Decrease during the year (other) ....................................... Transfer to credit-impaired fi nancial assets ....................... Other changes ................................................................... 957 323 (104) (73) 11 (0) December 31, 2019 ............................................................... 1,114 59 Kao Corporation Financial Report 2020 491 100 (12) (34) (11) (14) 520 Total 217,594 (12,439) — (833) 204,322 (Millions of yen) Total 1,448 423 (116) (107) — (14) 1,634 Notes to Consolidated Financial Statements The following tables present an analysis of the carrying amount of trade receivables and the allowance for doubtful receivables by days past due. As of December 31, 2020 Trade receivables ....................................................... Allowance for doubtful receivables ........................... Expected credit loss (%) ............................................ As of December 31, 2019 Trade receivables ....................................................... Allowance for doubtful receivables ........................... Expected credit loss (%) ............................................ (Millions of yen, unless otherwise noted) Days past due Not due 183,636 265 0.1 Less than 30 days Over 30 days Over 60 days Over 90 days 6,066 57 0.9 1,685 134 8.0 1,150 199 17.3 2,946 1,378 46.8 Total 195,483 2,033 1.0 (Millions of yen, unless otherwise noted) Days past due Not due 188,864 187 0.1 Less than 30 days Over 30 days 6,461 107 1.7 3,087 117 3.8 Over 60 days 1,728 69 4.0 Over 90 days 4,182 1,154 27.6 Total 204,322 1,634 0.8 3) Liquidity risk management Liquidity risk is the risk that the Group may not be able to fulfill its obligation to pay financial liabilities that come due. The Group uses methods such as scheduled medium- and long-term financing plans to understand its liquidity and consistently ensure the availability of sufficient funding. The Group has also implemented the Global Cash Management System to reduce liquidity risk through the focused and efficient management of the Group’s capital in Japan and overseas. Financial liabilities including derivative instruments by maturity date consist of the following: As of December 31, 2020 (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 ............. 215,842 215,842 215,842 Bonds and borrowings ................. 127,694 127,781 Lease liabilities1 ............................ 146,512 157,905 Long-term deposits payable ........ 7,001 7,001 30,465 21,088 — Derivative financial liabilities Currency related .......................... Interest rate related ..................... 222 146 222 146 164 — — 5,879 16,985 — 66,126 12,495 — 48 44 — 10 — — 22 10,403 — — 102 — 25,022 9,634 — — — — 267 87,300 7,001 — — Total ......................................... 497,417 508,897 267,559 22,956 78,631 10,527 34,656 94,568 Note: 1. Lease liabilities by maturity date consist of the following: As of December 31, 2020 (Millions of yen) Carrying amount Contract amount Not later than 1 year Later than 1 year but not later than 5 years Later than 5 years but not later than 10 years Later than 10 years but not later than 15 years Later than 15 years but not later than 20 years Later than 20 years Lease liabilities ........................ 146,512 157,905 21,088 49,517 33,987 22,787 18,588 11,938 Kao Corporation Financial Report 2020 60 As of December 31, 2019 (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 ............. 222,314 222,314 222,314 Bonds and borrowings ................. 127,141 127,187 Lease liabilities1 ............................ 161,091 174,820 Long-term deposits payable ........ 6,829 6,829 Derivative financial liabilities Currency related .......................... Interest rate related ..................... 320 75 320 75 25,510 21,245 — 248 — — 30,253 17,382 — 6,279 14,388 — 65,031 11,411 — 25 10,598 — — — — 72 19 — — — — — 56 — 89 99,796 6,829 — — Total ......................................... 517,770 531,545 269,317 47,635 20,758 76,442 10,679 106,714 Note: 1. Lease liabilities by maturity date consist of the following: As of December 31, 2019 (Millions of yen) Carrying amount Contract amount Not later than 1 year Later than 1 year but not later than 5 years Later than 5 years but not later than 10 years Later than 10 years but not later than 15 years Later than 15 years but not later than 20 years Later than 20 years Lease liabilities ........................ 161,091 174,820 21,245 53,779 40,588 24,192 19,691 15,325 (3) Fair Value of Financial Instruments 1) Fair value hierarchy levels For financial instruments measured at fair value, the fair values developed based on the observability of inputs into the valuation techniques used in measurement are categorized within the following three levels: Level 1: Fair value measured with quoted prices in active markets for identical assets or liabilities Level 2: Fair value measured with inputs other than quoted (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. prices categorized within Level 1 that are observable for the asset or liability, either directly or indirectly (iii) Equity securities Level 3: Fair value measured with inputs not based on observable market data for the asset or liability 2) Financial instruments measured at fair value The measurement methods for the main financial instruments measured at fair value are as follows: (i) Short-term investments (excluding short-term investments measured at amortized cost) Short-term investments are included in cash and cash equivalents, and are designated as financial assets measured at fair value through profit or loss. Short-term investments primarily consist of bond investment trusts and money held in trust, and are measured with a financial model using observable inputs such as interest rates. Equity securities are included in other financial assets, and are designated as financial assets measured at fair value through other comprehensive income. Equity securities that are categorized within Level 1 are publicly listed and traded in active markets, and are measured using market prices on exchanges. Equity securities that are categorized within Level 3 are unlisted, and are primarily measured using a net asset valuation model, which measures corporate value based on the net asset of the issuing company with adjustments based on fair value. 61 Kao Corporation Financial Report 2020 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, 2020 or 2019. As of December 31, 2020 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 ...................................................................................... — — — 4,699 4,699 — — 14,900 81 3,034 — 18,015 368 368 — — — 5,144 5,144 — — 14,900 81 3,034 9,843 27,858 368 368 As of December 31, 2019 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 ...................................................................................... — — — 5,830 5,830 — — 19,900 214 3,063 — 23,177 395 395 — — — 4,892 4,892 — — 19,900 214 3,063 10,722 33,899 395 395 Kao Corporation Financial Report 2020 62  Changes in financial instruments categorized within Level 3 are as follows: Beginning balance ..................................................................................................................................... Gains (losses)¹ ....................................................................................................................................... Purchases .............................................................................................................................................. Sales ...................................................................................................................................................... Other changes ....................................................................................................................................... 2020 4,892 203 50 (0) (1) (Millions of yen) 2019 4,500 391 — (0) 1 Ending balance .......................................................................................................................................... 5,144 4,892 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. 63 Kao Corporation Financial Report 2020 Notes to Consolidated Financial Statements 3) Financial instruments measured at amortized cost (i) Cash and cash equivalents (excluding short-term 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. investments measured at fair value), trade and other receivables, and trade and other payables Carrying amounts approximate fair value because these are settled in the short term. (ii) Bonds and borrowings The fair value of bonds is based on market prices. The fair value of borrowings is the present value of remaining principal and interest discounted using a deemed interest rate on equivalent new borrowings. The carrying amount and fair value hierarchy of financial instruments measured at amortized cost are as follows: As of December 31, 2020 Carrying amount Level 1 Level 2 Level 3 Total Fair value (Millions of yen) Financial liabilities Financial liabilities measured at amortized cost Bonds ............................................................ Borrowings .................................................... 50,009 77,685 — — 50,094 78,164 — — 50,094 78,164 As of December 31, 2019 Carrying amount Level 1 Level 2 Level 3 Total Fair value (Millions of yen) Financial liabilities Financial liabilities measured at amortized cost Bonds ............................................................ Borrowings .................................................... 50,061 77,080 — — 50,129 77,571 — — 50,129 77,571 Kao Corporation Financial Report 2020 64 34 Principal Subsidiaries Principal subsidiaries consist of the following. Voting rights at December 31, 2020 did not significantly change from a year earlier. Company name Principal businesses Kao Group Customer Marketing Co., Ltd. Control of sales companies and other subsidiaries in Japan Cosmetics Skin Care and Hair Care Human Health Care Fabric and Home Care Kanebo Cosmetics Inc. Cosmetics Kao Transport & Logistics Co., Ltd. Logistics and related services in Japan Kao (China) Holding Co., Ltd. Kao Corporation Shanghai Kao (Hefei) Co., Ltd. Kao Commercial (Shanghai) Co., Ltd. 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 Kanebo Cosmetics (China) Co., Ltd. Kao (Shanghai) Chemical Industries Co., Ltd. Cosmetics Chemical Kao (Taiwan) Corporation Pilipinas Kao, Inc. Kao Industrial (Thailand) Co., Ltd. Cosmetics Skin Care and Hair Care Human Health Care Fabric and Home Care Chemical Chemical Cosmetics Skin Care and Hair Care Human Health Care Fabric and Home Care Chemical Fatty Chemical (Malaysia) Sdn. Bhd. 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 PT Kao 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. 65 Kao Corporation Financial Report 2020 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 70.0 66.8 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Notes to Consolidated Financial Statements 35 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 ....................................................................................................................................................... 2020 1,213 32 (394) 851 (Millions of yen) 2019 1,069 33 337 1,439 36 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 ....................................................................................................................................................... 2020 22,611 1,883 24,494 (Millions of yen) 2019 25,041 3,735 28,776 37 Significant Subsequent Events At a meeting held on February 3, 2021, the Board of Directors resolved to purchase up to a maximum of 7 thousand shares or 50,000 million yen of the Company’s common stock from February 4 to April 30, 2021, in accordance with Article 156 of the Companies Act applicable pursuant to Article 165, paragraph 3 of the said Act. 38 Approval of the Consolidated Financial Statements The Consolidated Financial Statements were approved by Yoshihiro Hasebe, President and Chief Executive Officer, and by Kenichi Yamauchi, Executive Officer, Senior Vice President, Accounting and Finance, on March 18, 2021. Kao Corporation Financial Report 2020 66 Independent Auditor’s Report 67 Kao Corporation Financial Report 2020 Kao Corporation Financial Report 2020 68 69 Kao Corporation Financial Report 2020 Independent Auditor’s Report Kao Corporation Financial Report 2020 70 14-10, Nihonbashi Kayabacho 1-chome Chuo-ku, Tokyo 103-8210, Japan www.kao.com/global/en/ Investor Relations E-mail: ir@kao.co.jp Website: www.kao.com/global/en/investor-relations/ 

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