Canon 2005 Annual Report Download - page 64

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CANON INC. AND SUBSIDIARIES
Canon records estimated reductions to sales at the time of sale
for sales incentive programs including product discounts, customer
promotions and volume-based rebates. Estimated reductions in
sales are based upon historical trends and other known factors at
the time of sale. In addition, Canon provides price protection to
certain resellers of its products, and records reductions to sales for
the estimated impact of price protection obligations when
announced.
Estimated product warranty costs are recorded at the time rev-
enue is recognized and are included in selling, general and admin-
istrative expenses. Estimates for accrued product warranty costs are
based on historical experience, and are affected by ongoing prod-
uct failure rates, specific product class failures outside of the base-
line experience, material usage and service delivery costs incurred
in correcting a product failure.
(s) Research and Development Costs
Research and development costs are expensed as incurred.
(t) Advertising Costs
Advertising costs are expensed as incurred. Advertising expenses
were ¥106,250 million ($900,424 thousand), ¥111,770 million and
¥100,278 million for the years ended December 31, 2005, 2004
and 2003, respectively.
(u) Shipping and Handling Costs
Shipping and handling costs totaled ¥50,052 million ($424,169
thousand), ¥46,953 million and ¥40,660 million for the years
ended December 31, 2005, 2004 and 2003, respectively, and are
included in selling, general and administrative expenses in the con-
solidated statements of income.
(v) Derivative Financial Instruments
All derivatives are recognized at fair value and are included in pre-
paid expenses and other current assets, or other current liabilities
on the consolidated balance sheets. On the date the derivative
contract is entered into, Canon designates the derivative as either a
hedge of the fair value of a recognized asset or liability or of an
unrecognized firm commitment (“fair value” hedge), or a hedge of
a forecasted transaction or the variability of cash flows to be
received or paid related to a recognized asset or liability (“cash
flow” hedge). Canon formally documents all relationships between
hedging instruments and hedged items, as well as its risk-
management objective and strategy for undertaking various hedge
transactions. Canon also formally assesses, both at the hedge’s
inception and on an ongoing basis, whether the derivatives that
are used in hedging transactions are highly effective in offsetting
changes in fair values or cash flows of hedged items. When it is
determined that a derivative is not highly effective as a hedge or
that it has ceased to be a highly effective hedge, Canon discontin-
ues hedge accounting prospectively.
Changes in the fair value of a derivative that is designated and
qualifies as a fair-value hedge, along with the loss or gain on the
hedged asset or liability or unrecognized firm commitment of the
(p) Issuance of Stock by Subsidiaries and
Equity Investees
The change in the Company’s proportionate share of a subsidiary’s
or equity investee’s equity resulting from the issuance of stock by
the subsidiary or equity investee is accounted for as an equity
transaction.
(q) Net Income per Share
Basic net income per share is computed by dividing net income by
the weighted-average number of common shares outstanding
during each year. Diluted net income per share includes the effect
from potential issuance of common stock based on the assumption
that all convertible debentures were converted into common stock.
(r) Revenue Recognition
Canon generates revenue principally through the sale of consumer
products, equipment, supplies, and related services under separate
contractual arrangements. Canon recognizes revenue when per-
suasive evidence of an arrangement exists, delivery has occurred
and title and risk of loss have been transferred to the customer, the
sales price is fixed or determinable, and collectibility is probable.
For arrangements with multiple elements, which may include
any combination of equipment, installation and maintenance,
Canon allocates revenue to each element based on its relative fair
value if such element meets the criteria for treatment as a separate
unit of accounting as prescribed in the Emerging Issues Task Force
Issue No. 00-21 (“EITF 00-21”), “Revenue Arrangements with Mul-
tiple Deliverables.” Otherwise, revenue is deferred until the unde-
livered elements are fulfilled as a single unit of accounting.
Revenue from sales of consumer products including office
imaging products, computer peripherals, business information
products and cameras is recognized upon shipment or delivery,
depending upon when title and risk of loss transfer to the
customer.
Revenue from sales of optical equipment such as steppers and
aligners sold with customer acceptance provisions related to their
functionality is recognized when the equipment is installed at the
customer site and the specific criteria of the equipment functional-
ity are successfully tested and demonstrated by Canon. Service
revenue is derived primarily from maintenance contracts on equip-
ment sold to customers and is recognized over the term of the
contract.
Most office imaging products are sold with service mainte-
nance contracts for which the customer typically pays a base
service fee plus a variable amount based on usage. Revenue from
these service maintenance contracts is recognized as services are
provided.
Revenue from the sale of equipment under sales-type leases is
recognized at the inception of the lease. Income on sales-type
leases and direct-financing leases is recognized over the life of each
respective lease using the interest method. Leases not qualifying as
sales-type leases or direct-financing leases are accounted for as
operating leases and related revenue is recognized over the lease
term.