Canon 2014 Annual Report Download - page 39

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establishing such allowances in any accounting period. In
estimating the market value of its inventories, Canon consid-
ers the age of the inventories and the likelihood of spoilage
or changes in market demand for its inventories.
Impairment of long-lived assets
Long-lived assets, such as property, plant and equipment, and
acquired intangibles subject to amortization, are reviewed
for impairment whenever events or changes in circumstanc-
es indicate that the carrying amount of an asset may not
be recoverable. If the carrying amount of the asset exceeds
its estimated undiscounted future cash flows, an impair-
ment charge is recognized in the amount by which the car-
rying amount of the asset exceeds the fair value of the asset.
Determining the fair value of the asset involves the use of
estimates and assumptions.
Property, plant and equipment
Property, plant and equipment are stated at cost. Depreciation
is calculated principally by the declining-balance method,
except for certain assets which are depreciated by the straight-
line method over the estimated useful lives of the assets.
Goodwill and other intangible assets
Goodwill and other intangible assets with indefinite use-
ful lives are not amortized, but are instead tested for impair-
ment annually in the fourth quarter of each year, or more
frequently if indicators of potential impairment exist. Canon
performs its impairment test of goodwill using the two-step
approach at the reporting unit level, which is one level below
the operating segment level. All goodwill is assigned to the
reporting unit or units that benefit from the synergies aris-
ing from each business combination. If the carrying amount
assigned to the reporting unit exceeds the fair value of the
reporting unit, Canon performs the second step to measure
an impairment charge in the amount by which the carrying
amount of a reporting unit’s goodwill exceeds its implied fair
value. Fair value of a reporting unit is determined primari-
ly based on the discounted cash flow analysis which involves
estimates of projected future cash flows and discount rates.
Estimates of projected future cash flows are primarily based
on Canon’s forecast of future growth rates. Estimates of dis-
count rates are determined based on the weighted average
cost of capital, which considers primarily market and indus-
try data as well as specific risk factors. Intangible assets with
finite useful lives consist primarily of software, license fees,
patented technologies and customer relationships. Software
and license fees are amortized using the straight-line method
over the estimated useful lives, which range primarily from 3
years to 5 years for software and 5 years to 10 years for license
fees. Patented technologies are amortized using the straight-
line method principally over the estimated useful lives,
which range from 8 years to 16 years. Customer relationships
are amortized principally using the declining-balance meth-
od over the estimated useful life of 5 years.
Income tax uncertainties
Canon considers many factors when evaluating and estimat-
ing income tax uncertainties. These factors include an evalua-
tion of the technical merits of the tax positions as well as the
amounts and probabilities of the outcomes that could be real-
ized upon settlement. The actual resolutions of those uncer-
tainties will inevitably differ from those estimates, and such
differences may be material to the financial statements.
Valuation of deferred tax assets
Canon currently has significant deferred tax assets,
which are subject to periodic recoverability assessments.
Realization of Canon’s deferred tax assets is principally
dependent upon its achievement of projected future tax-
able income. Canon’s judgments regarding future profitabil-
ity may change due to future market conditions, its ability
to continue to successfully execute its operating restructur-
ing activities and other factors. Any changes in these factors
may require possible recognition of significant valuation
allowances to reduce the net carrying value of these deferred
tax asset balances. When Canon determines that certain
deferred tax assets may not be recoverable, the amounts,
which may not be realized, are charged to income tax
expense and will adversely affect net income.
Employee retirement and severance benefit plans
Canon has significant employee retirement and severance
benefit obligations that are recognized based on actuari-
al valuations. Inherent in these valuations are key assump-
tions, including discount rates and expected return on plan
assets. Management must consider current market condi-
tions, including changes in interest rates, in selecting these
assumptions. Other assumptions include assumed rate of
increase in compensation levels, mortality rate, and withdraw-
al rate. Changes in assumptions inherent in the valuation
are reasonably likely to occur from period to period. Actual
results that differ from the assumptions are accumulated and
amortized over future periods and, therefore, generally affect
future pension expenses. While management believes that the
assumptions used are appropriate, the differences may affect
employee retirement and severance benefit costs in the future.
In preparing its financial statements for 2014, Canon esti-
mated a weighted-average discount rate used to determine
benefit obligations of 1.1% for Japanese plans and 2.9% for
foreign plans and a weighted-average expected long-term
rate of return on plan assets of 3.1% for Japanese plans and
4.9% for foreign plans. In estimating the discount rate,
Canon uses available information about rates of return on
high-quality fixed-income government and corporate bonds
currently available and expected to be available during
the period to the maturity of the pension benefits. Canon
establishes the expected long-term rate of return on plan
assets based on management’s expectations of the long-
term return of the various plan asset categories in which it
invests. Management develops expectations with respect to
each plan asset category based on actual historical returns