Certain information that has been previously filed with the SEC in other reports, including English summaries of non-consolidated (parent company alone) financial information, is not included in this English translation.

Net sales

Income before income taxes and minority interests

Net income

Stockholders’ equity

Total assets

Stockholders’ equity per share (Yen)

Net income per share: basic (Yen)

Net income per share: diluted (Yen)

Stockholders’ equity to total assets (%)

Cash flows from operating activities

Cash flows from investing activities

Cash flows from financing activities

Cash and cash equivalents at end of period

Number of employees

[Average number of temporary employees]

 

Canon’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles.

Consumption tax is excluded from the stated amount of net sales.

Canon made a three-for-two stock split on July 1, 2006, for shareholders recorded in the shareholders’ register as of June 30, 2006. The Stockholders’ equity per share, basic net income per share and diluted net income per share has been calculated based on the number of outstanding shares following the implementation of the stock split. As a result, the per share information has been restated for all prior-periods. The per share information that does not reflect the stock split are as follows:

Stockholders’ equity per share

Net income per share: basic

Net income per share: diluted

Canon’s number of employees by product group is summarized as follows:

Business Machines

Cameras

Optical and other products

Corporate

 

Total

 

 

The number of employees represents the total number of employees excluding those who do not work full time.

Canon has 39,848 temporary employees on average during fiscal 2007 1st half.

This number includes seasonal workers as well as temp-staff employees such as security staff, meal service staff and janitorial staff.

Looking back at the global economy in the first half of 2007, economic expansion was fairly steady during the term. The U.S. economy continued to display growth, supported by healthy consumer spending, despite a decrease in housing investment and a moderate slowdown in corporate capital investment. In Europe, while exports appeared somewhat sluggish due to the appreciation of the euro, the region indicated a trend toward moderate recovery as domestic demand expanded in major European countries, boosted by such factors as increased consumer spending owing to improvements in the employment environment. Within Asia, the Chinese economy maintained a high rate of growth while other economies in the region also enjoyed generally favorable conditions. In Japan, the economy maintained a trend toward recovery thanks to such factors as increased capital spending fueled by strong corporate performances and gradual improvements in consumer spending.

As for the markets in which the Canon Group operates, within the camera segment, demand for digital single-lens reflex (SLR) cameras and compact digital cameras continued to realize healthy growth during the term. Within the office imaging product market, demand for network digital multifunction devices (MFDs) remained solid amid the shift in all regions toward color models and advanced functionality. In the computer peripherals segment, which includes printers, while demand for laser beam printers grew for both color and monochrome models, and demand for inkjet printers shifted from single-function to all-in-one models, multifunctional models in particular suffered amid severe price competition. In the optical equipment segment, while demand for steppers, used in the production of semiconductors, indicated a moderate recovery, the market for projection aligners, which are used to produce liquid crystal display (LCD) panels, declined due to restrained investment by LCD manufacturers. The average value of the yen in the first half was ¥120.07 to the U.S. dollar and ¥159.77 to the euro, representing year-on-year decreases of about 4% against the U.S. dollar, and about 12% against the euro.

Amid these conditions, Canon’s consolidated net sales for the first half increased by 11.0% from the year-ago period to ¥2,166.7 billion, boosted by a solid rise in sales of digital cameras, color network MFDs and laser beam printers, along with the positive effect of favorable currency exchange rates. The gross profit ratio improved 1.0 point year-on-year to reach 51.1%. The improved gross profit ratio was mainly the result of such factors as suppressing price decline through the launch of new products and cost-reduction efforts realized through ongoing production-reform and procurement-reform activities,

along with the in-house production of key components, which absorbed the effects of escalating raw material costs and severe price competition in the consumer product market. Owing to the increase in sales and the improved gross profit ratio, first-half gross profit rose by 13.2% to ¥1,107.6 billion. As for operating expenses, while first-half R&D spending grew by 16.2% from the year-ago period to ¥170.3 billion, the selling, general and administrative (SG&A) expenses to net sales ratio was approximately the same level as for the corresponding period of last year, with SG&A expense increasing 11.1% year on year, almost the same rate of growth as for net sales. In addition, from the second quarter of this year, the company implemented a change in the accounting method used to estimate depreciation of fixed assets, which resulted in a combined increase of ¥19.3 billion in cost of sales and operating expenses compared with the previously used method. Consequently, operating profit in the first half totaled ¥388.9 billion, a year-on-year increase of 14.9%. Other income (deductions) improved by ¥14.7 billion, due to such factors as an increase in surplus funds and interest income accompanying the rise in the interest rate, as well as a decrease in currency exchange losses on foreign-currency-denominated trade receivables. Income before income taxes and minority interests in the first half totaled ¥406.1 billion, a year-on-year increase of 19.1%, and first-half income totaled ¥255.2 billion, both recording all-time highs on a first-half basis.

Basic net income per share for the first half was ¥194.38, a year-on-year increase of ¥33.53.

Canon’s semiannual results by business segment are summarized as follows:

In the business machine segment, demand for network digital MFDs, which are grouped in the office imaging products sub-segment, has continued to expand for color models in both domestic and overseas markets. Additionally, among color network digital MFDs, the competitively priced iR C2880 series and the new high-end iR C5185 series continued to enjoy strong demand. Among monochrome network digital MFDs, the iR5055 series and the new energy-saving iR3025 series contributed to expanded sales. Overall, sales of office imaging products for the first half realized a year-on-year increase of 8.0%. In the field of computer peripherals, laser beam printers achieved a year-on-year unit sales growth of almost 40%, with both color and monochrome low-end models selling particularly well. In addition, consumables also recorded healthy sales growth, contributing to an increase of 19.2% in value terms for the segment. As for inkjet printers, despite a continuing decline in unit sales for single-function models and severe price competition in the market, sales in value terms increased by 14.0%, boosted by such factors as increased unit sales of multifunction models, such as the PIXMA MP600, and favorable sales growth for consumables. As a result, sales of computer peripherals for the first half realized a year-on-year increase of 17.6%. Sales of business information products, however, decreased by 1.9% due to a decline in sales of personal computers in the Japanese market. Collectively, sales of business machines for the first half totaled ¥1,446.6 billion, a year-on-year increase of 12.4%. Operating profit for the business machine segment totaled ¥335.5 billion, a year-on-year increase of 13.9%, made possible by such factors as an increase in gross profit and an improvement in the expense to net sales ratio.

Within the camera segment, demand for digital SLR cameras fueled growth, with the EOS DIGITAL REBEL XTi model, launched in September 2006, selling particularly well. This, in turn, led to expanded sales of interchangeable lenses for SLR cameras. As for compact digital cameras, the company strengthened its lineup with the launch of ten new models, including three stylish ELPH-series models and seven PowerShot-series models that cater to a diverse range of shooting styles. Accordingly, unit sales of digital cameras for the first half expanded nearly 20% compared with the year-ago period. As a result, camera sales overall for the first half increased by 12.9% from the year-ago period to ¥519.6 billion. The gross profit ratio for the camera segment also rose substantially, boosted by such factors as strong sales of newly introduced products, which served to suppress declines in prices, along with cost-reduction efforts realized through production-reform and procurement-reform activities. As a result, operating profit for the camera segment increased by 26.3% year on year to ¥137.3 billion.

In the optical and other products segment, while steppers, used in the production of semiconductors, enjoyed steady demand, sales of optical products decreased in the first half amid declining demand for aligners, used to produce LCD panels, as investment by LCD manufacturers remains at a low level. As a result, sales for the segment totaled ¥200.5 billion, a year-on-year decrease of 2.3%. Operating profit for the segment decreased by 7.8% year on year to ¥21.4 billion.

Semiannual results by domestic and overseas company location are summarized as follows:

Sales in Japan increased by 0.8% from the previous same period to ¥509.9 billion, mainly due to expanded sales in digital cameras and color network digital MFDs. Geographical operating profit rose by 12.0% from the previous same period to ¥417.3 billion.

Sales increased by 8.0% from the previous same period to ¥638.4 billion, mainly due to expanded sales in digital cameras and laser beam printers. Geographical operating profit increased by 4.7% from the previous same period to ¥23.9 billion.

Sales increased by 18.3% from the previous same period to ¥721.7 billion, mainly due to expanded sales in digital cameras and laser beam printers. Geographical operating profit also increased by 63.8% from the previous same period to ¥29.7 billion.

Sales increased by 21.0% from the previous same period to ¥296.7 billion, mainly due to an increase in digital camera, despite a decrease in sales of aligners for the production of LCDs. As a result, geographical operating profit increased by 7.6% from the previous same period to ¥24.1 billion.

Cash and cash equivalents decreased by ¥46.9 billion from the end of the previous year, to ¥1,108.7 billion at the end of the first half of 2007.

In the first half of 2007, Canon maintained cash flow from operating activities of ¥440.3 billion, a year-on-year increase of ¥116.4 billion, reflecting the substantial growth in net sales and net income.

Cash flow from investing activities totaled ¥209.3 billion, a year-on-year decrease of ¥1.0 billion, due to such factors as active capital investment, used mainly to expand the company’s production capabilities.

Cash flow from financing activities recorded an outlay of ¥279.8 billion, a year-on-year increase of ¥221.9 billion, mainly resulting from the dividend payout of ¥66.6 billion in accordance with the company’s basic policy regarding profit distribution and the ¥200.0 billion purchase of treasury stock with the aim of improving capital efficiency and ensuring a flexible capital strategy.

As a result, free cash flow totalled ¥231.0 billion, an improvement of ¥117.4 billion from ¥113.6 billion for the year-ago period.

Canon’s production by product group are summarized as follows:

Business Machines

Cameras

Optical and other products

 

Total

 

 

Amount of production is calculated by sales price.

Consumption tax is excluded from the stated amount of production.

Canon’s sales by product group are summarized as follows:

Business Machines

Camera

Optical and other products

 

Total

 

 

Consumption tax is excluded from the stated amount of net sales.

Canon’s sales to significant customer are summarized as follows:

Hewlett-Packard Company

 

There were no significant changes or new developments in Canon’s managerial and financial issues to be addressed during the first half of 2007.

From 2006, Canon will make use of the solid management foundation achieved through the two five-year plans as the company initiates Phase III, a new five-year management initiative, targeting further growth and improved corporate value, pursuing sound growth by maintaining a high level of profitability while further expanding the company’s corporate scale. Canon’s research and development expenditures for the six months ended June 30, 2007 totalled ¥170,267 million.

Research and development expenditures by product group are summarized as follows:

Business Machines

Cameras

Optical and other products

Corporate

 

Total

 

There were no significant changes to the status of existing major capital investment during the first half of 2007.

There were no significant changes for the plans for new construction and retirement of capital investment, originally made at the end of the previous year, during the first half of 2007. Also, there were no significant additional plans for new construction or retirement of capital investment, during the first half of 2007.

Total number of authorized shares is 3,000,000,000 shares. The common stock of the Company is listed on the Tokyo, Osaka, Nagoya, Fukuoka, Sapporo and New York stock exchanges. Total issued shares are as follows:

Total issued shares (share)

Note:

The increase of the total issued shares during this term reflects the conversion of convertible shares.

The Dai-Ichi Mutual Life Insurance Co.

The Master Trust Bank of Japan, Ltd. (Trust

Account)

Japan Trustee Services Bank, Ltd. (Trust Account)

Moxley and Co.

Nomura Securities Co., Ltd.

State Street Bank and Trust Company

State Street Bank and Trust Company 505103

Mizuho Corporate Bank, Ltd. (Note 1)

BNP PARIBAS Securities ( Japan ) Limited

Sompo Japan Insurance Inc.

Apart from the above shares, Mizuho Corporate Bank, Ltd holds 7,704,000 shares contributed to a trust fund for its retirement and severance plans.

Apart from the above shares, the Company holds 32,993,191 shares (2.47% of total issued shares) of Treasury stock.

Mizuho Corporate Bank, Ltd and its three affiliated companies listed below submitted a report on large share holdings to the Kanto Local Finance Bureau on January 22, 2007 in their joint names and reported that they owned 71,820,736 shares (5.39%) of the Company as of January 15, 2007 in total as detailed below. However, the Company has not confirmed the status of these holdings as of June 30, 2007.

Mizuho Corporate Bank, Ltd.

Mizuho Bank, Ltd.

Mizuho Trust & Banking Co., Ltd.

Dai-Ichi Kangyo Asset Management Co., Ltd.

(Current Mizuho Asset Management Co., Ltd.)

total

The following table sets forth the monthly reported high and low sales prices of the Company’s common stock on the Tokyo Stock Exchange for the first half of fiscal 2007:

High

Low

Index of Consolidated Financial Statements of Canon Inc. and Subsidiaries:

 

 

 

 

Current assets:

Cash and cash equivalents

Time deposits

Marketable securities (notes 2 and 7)

Trade receivables, net (note 3)

Inventories (note 4)

Prepaid expenses and other current assets
(note 6)

 

Total current assets

 

Noncurrent receivables (note 13)

Investments (notes 2 and 7)

Property, plant and equipment, net
(notes 5 and 7)

Other assets (note 6)

 

Total assets

 

Current liabilities:

Short-term loans and current portion of long-term debt
(note 7)

Trade payables (note 8)

Income taxes

Accrued expenses (note 13)

Other current liabilities

 

Total current liabilities

 

Long-term debt, excluding current installments (note 7)

Accrued pension and severance cost (note 9)

Other noncurrent liabilities

 

Total liabilities

 

Minority interests

 

Commitments and contingent liabilities (note 13)

Stockholders’ equity:

Common stock

(Number of authorized shares)

(Number of issued shares)

Additional paid-in capital

Legal reserve

Retained earnings

Accumulated other comprehensive income (loss)

(note 10)

Treasury stock

(Number of shares)

 

Total stockholders’ equity

 

Total liabilities and stockholders’ equity

 

Net sales

Cost of sales

Gross profit

Operating expenses:

Selling, general and administrative expenses (notes 1 and 13)

Research and development expenses

 

Operating profit

Other income (deductions):

Interest and dividend income

Interest expense

Other, net (note 1)

 

Income before income taxes and minority interests

Income taxes

Income before minority interests

Minority interests

Net income

Net income per share (note 11):

Basic

Diluted

Balance at December 31, 2006

Cumulative effect of a change in accounting
principle-adoption of EITF 06-2, net of tax

Conversion of convertible debt and other

Cash dividends

Transfers to legal reserve

 

Comprehensive income:

Net income

Other comprehensive income (loss), net of tax
(note 10)

Foreign currency translation adjustments

Net unrealized gains and losses on securities

Net gains and losses on derivative instruments

Pension liability adjustments

 

Total comprehensive income

 

 

Repurchase of treasury stock, net

 

Balance at June 30, 2007

Balance at December 31, 2005

 

Conversion of convertible debt and other

Cash dividends

Transfers to legal reserve

 

Comprehensive income:

Net income

Other comprehensive income (loss), net of tax
(note 10)

Foreign currency translation adjustments

Net unrealized gains and losses on securities

Net gains and losses on derivative instruments

Minimum pension liability adjustments

 

Total comprehensive income

 

 

Repurchase of treasury stock, net

 

Balance at June 30, 2006

Balance at December 31, 2005

 

Conversion of convertible debt and other

Cash dividends

Transfers to legal reserve

 

Comprehensive income:

Net income

Other comprehensive income (loss), net of tax
(note 10)

Foreign currency translation adjustments

Net unrealized gains and losses on securities

Net gains and losses on derivative instruments

Minimum pension liability adjustments

 

Total comprehensive income

 

 

Adjustment to initially apply SFAS 158, net of
tax

 

Repurchase of treasury stock, net

 

Balance at December 31, 2006

Cash flows from operating activities:

Net income

Adjustments to reconcile net income to net
cash provided by operating activities:

Depreciation and amortization

Loss on disposal of property, plant and equipment

Deferred income taxes

(Increase) decrease in trade receivables

Increase in inventories

Increase (decrease) in trade payables

Increase (decrease) in income taxes

Increase (decrease) in accrued expenses

Decrease in accrued pension and severance cost

Other, net

Net cash provided by operating activities

 

Cash flows from investing activities:

Purchases of fixed assets

Proceeds from sale of fixed assets

Purchases of available-for-sale securities

Proceeds from sale and maturity of available-for-sale
securities

Proceeds from maturity of held-to-maturity securities

(Increase) decrease in time deposits

Acquisitions of subsidiaries, net of cash acquired

Purchases of other investments

Other, net

Net cash used in investing activities

 

Cash flows from financing activities:

Proceeds from issuance of long-term debt

Repayments of long-term debt

Decrease in short-term loans

Dividends paid

Purchases of treasury stock, net

Other, net

Net cash used in financing activities

 

Effect of exchange rate changes on cash and cash
equivalents

Net change in cash and cash equivalents

Cash and cash equivalents at beginning of period

Cash and cash equivalents at end of period

Cash paid during the period for:

Interest

Income taxes

The Company issued convertible debentures in the United States in May 1969 and established a program in which its American Depositary Receipts (ADRs) were traded in the U.S. over-the-counter market. Since then, under the U.S. Securities Act of 1933 and the U.S. Securities Exchange Act of 1934, the Company has prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles and filed them with the U.S. Securities and Exchange Commission on Form 20-F. The Company’s ADRs were listed on the NYSE in September 2000 after being quoted on NASDAQ from February 1972 to September 2000.

Canon’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles. In the accompanying consolidated financial statements, the segment information is disclosed in conformity with financial accounting standards of Japan, but not with U.S. generally accepted accounting principles.

The number of the consolidated subsidiaries and the affiliated companies that were accounted for on the equity basis as of June 30, 2007 and 2006, and December 31, 2006 are summarized as follows:

Consolidated subsidiaries

Affiliated companies

 

Total

Canon Inc. (the “Company”) and subsidiaries (collectively “Canon”) is one of the world’s leading manufacturers in such fields as office imaging products, computer peripherals, business information products, cameras, and optical and other products. Office imaging products consist mainly of network multifunction devices and copying machines. Computer peripherals consist mainly of laser beam and inkjet printers. Business information products consist mainly of computer information systems, document scanners and calculators. Cameras consist mainly of digital single lens reflex (“SLR”) cameras, digital compact cameras, interchangeable lenses and digital video camcorders. Optical and other products include semiconductor production equipment, mirror projection mask aligners for liquid crystal displays (“LCDs”) panels, broadcasting equipment, medical equipment and large format printers. Canon’s consolidated net sales for the six months ended June 30, 2007 were distributed as follows: office imaging products 29%, computer peripherals 35%, business information products 3%, cameras 24%, and optical and other products 9%.

Sales are made principally under the Canon brand name, almost entirely through sales subsidiaries. These subsidiaries are responsible for marketing and distribution, and primarily sell to retail dealers in their geographical area. Approximately 76% of consolidated net sales for the six months ended June 30, 2007 were generated outside Japan, with 29% in the Americas, 33% in Europe, and 14% in other areas.

Canon sells laser beam printers on an OEM basis to Hewlett-Packard Company; such sales constituted approximately 24% of consolidated net sales for the six ended months ended June 30, 2007.

Canon’s manufacturing operations are conducted primarily at 23 plants in Japan and 17 overseas plants which are located in countries and regions such as the United States, Germany, France, Taiwan, China, Malaysia, Thailand and Vietnam.

The consolidated financial statements include the accounts of the Company, its majority owned subsidiaries and those variable interest entities where the Company or its consolidated subsidiaries are the primary beneficiaries under Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (revised December 2003) (“FIN 46R”), “Consolidation of Variable Interest Entities.” All significant intercompany balances and transactions have been eliminated.

The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Significant estimates and assumptions are reflected in valuation and disclosure of revenue recognition, allowance for doubtful receivables, valuation of inventories, environmental liabilities, valuation of deferred tax assets and employee retirement and severance benefit plans. Actual results could differ materially from those estimates.

All highly liquid investments acquired with an original maturity of three months or less are considered to be cash equivalents.

Assets and liabilities of the Company’s subsidiaries located outside Japan with functional currencies other than Japanese yen are translated into Japanese yen at the rates of exchange in effect at the balance sheet date. Income and expense items are translated at the average exchange rates prevailing during the year. Gains and losses resulting from translation of financial statements are excluded from earnings and are reported in other comprehensive income (loss).

Gains and losses resulting from foreign currency transactions, including foreign exchange contracts, and translation of assets and liabilities denominated in foreign currencies are included in other income (deductions). Foreign currency exchange losses, net were ¥10,520 million, ¥14,639 million and ¥25,804 million for the six months ended June 30, 2007 and 2006, and year ended December 31, 2006, respectively.

Canon classifies investments in debt and marketable equity securities as available-for-sale, or held-to-maturity securities. Canon does not hold any trading securities which are bought and held primarily for the purpose of sale in the near term.

Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are reported as a separate component of other comprehensive income (loss) until realized.

Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts.

Available-for-sale and held-to-maturity securities are regularly reviewed for other-than-temporary declines in carrying value based on criteria that include the length of time and the extent to which the market value has been less than cost, the financial condition and near-term prospects of the issuer and Canon’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. When such a decline exists, Canon recognizes an impairment loss to the extent by which the cost basis of the investment exceeds the fair value of the investment. Fair value is determined based on quoted market prices, projected discounted cash flows or other valuation techniques as appropriate.

Realized gains and losses are determined on the average cost method and reflected in earnings.

Other securities are stated at cost and reviewed periodically for impairment.

Allowance for doubtful trade and finance receivables is maintained for all customers based on a combination of factors, including aging analysis, macroeconomic conditions, significant one-time events, and historical experience. An additional reserve for individual accounts is recorded when Canon becomes aware of a customer’s inability to meet its financial obligations, such as in the case of bankruptcy filings. If circumstances related to customers change, estimates of the recoverability of receivables would be further adjusted. When all collection options are exhausted including legal recourse, the accounts or portions thereof are deemed to be uncollectible and charged against the allowance.

Inventories are stated at the lower of cost or market value. Cost is determined principally by the average method for domestic inventories and the first-in, first-out method for overseas inventories.

Investments in affiliated companies over which Canon has the ability to exercise significant influence, but does not hold a controlling financial interest, are accounted for by the equity method.

Long-lived assets, such as property, plant and equipment, and acquired intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of by sale are reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated.

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.

On April 1, 2007, the Company and its domestic subsidiaries elected to change the declining balance method of depreciating machinery and equipment from the fixed-percentage-on-declining base application to the 250% declining balance application.

Estimated salvage values were also reduced in conjunction with this change. The Company and its domestic subsidiaries believe that the 250% declining balance application is preferable because it provides a better matching of allocation of cost of machinery and equipment with associated revenues in light of increasingly short product life cycles. In according with Statement of Financial Accounting Standards No.154, “Accounting Changes and Error Corrections – a replacement of APB Opinion No.20 and FASB Statement No.3,” this change in depreciation methods represents a change in accounting estimate effected by a change in accounting principle. Accordingly, the affects of the change are accounted for prospectively beginning with the period of change. The change in depreciation methods caused a decrease in income before income taxes and minority interests and net income by ¥19,330 million and ¥11,178 million respectively for the six months ended June 30, 2007.

The depreciation period ranges from 3 years to 60 years for buildings and 2 years to 20 years for machinery and equipment.

Assets leased to others under operating leases are stated at cost and depreciated to the estimated residual value of the assets by the straight-line method over the period ranging from 2 years to 5 years.

Goodwill and other intangible assets with indefinite useful lives are not amortized, but are instead tested for impairment annually in the fourth quarter of each year, or more frequently if indicators of potential impairment exist. Intangible assets with finite useful lives, consisting primarily of software and license fees, are amortized using the straight-line method over the estimated useful lives, which range from 3 years to 5 years for software and 5 years to 10 years for license fees. Certain costs incurred in connection with developing or obtaining internal use software are capitalized. These costs consist of payments made to third parties and the salaries of employees working on such software development. Costs incurred in connection with developing internal use software are capitalized at the application development stage. In addition, Canon develops or obtains certain software to be sold where related costs are capitalized after establishment of technological feasibility.

Liabilities for environmental remediation and other environmental costs are accrued when environmental assessments or remedial efforts are probable and the costs can be reasonably estimated. Such liabilities are adjusted as further information develops or circumstances change. Costs of future obligations are not discounted to their present values.

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Canon records a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not realizable.

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.

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.

Canon generates revenue principally through the sale of consumer products, equipment, supplies, and related services under separate contractual arrangements. Canon recognizes revenue when persuasive 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 (“EITF”) Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” Otherwise, revenue is deferred until the undelivered 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 functionality are successfully tested and demonstrated by Canon. Service revenue is derived primarily from maintenance contracts on equipment sold to customers and is recognized as services are provided.

Canon offers service maintenance contracts for most office imaging products, 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.

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 revenue is recognized and are included in selling, general and administrative expenses. Estimates for accrued product warranty costs are based on historical experience, and are affected by ongoing product failure rates, specific product class failures outside of the baseline experience, material usage and service delivery costs incurred in correcting a product failure.

Research and development costs are expensed as incurred.

Advertising costs are expensed as incurred. Advertising expenses were ¥60,096 million, ¥49,785 million and ¥116,809 million for the six months ended June 30, 2007 and 2006, and year ended December 31, 2006, respectively.

Shipping and handling costs totaled ¥31,060 million, ¥29,173 million and ¥62,626 million for the six months ended June 30, 2007 and 2006, and year ended December 31, 2006, respectively, and are included in selling, general and administrative expenses in the consolidated statements of income.

All derivatives are recognized at fair value and are included in prepaid expenses and other current assets, or other current liabilities in 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 discontinues 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 hedged item that is attributable to the hedged risk, are recorded in earnings. Changes in the fair value of a derivative that is designated and qualifies as a cash-flow hedge are recorded in other comprehensive income (loss), until earnings are affected by the variability in cash flows of the hedged item. Gains and losses from hedging ineffectiveness are included in other income (deductions). Gains and losses excluded from the assessment of hedge effectiveness (time value component) are included in other income (deductions).

Canon also uses certain derivative financial instruments which are not designated as hedges. Canon records these derivative financial instruments in the consolidated balance sheets at fair value. The changes in fair values are immediately recorded in earnings.

Canon recognizes, at the inception of a guarantee, a liability for the fair value of the obligation it has undertaken in issuing guarantees.

In June, 2006, the FASB ratified the EITF consensus on EITF Issue No.06-2, “Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No.43”

(“EITF06-2”). EITF06-2 provides guidance for an accrual of compensated absences which require a minimum service period but do not increase with additional years of service. EITF06-2 was adopted by Canon on January 1, 2007 through a cumulative-effect adjustment which increased accrued expenses by ¥4,402 million and decreased Retained earnings by ¥2,204 million.

Certain reclassifications have been made to the prior periods’ consolidated financial statements to conform with the presentation used for this period.

Marketable Securities and Investments
The cost, gross unrealized holding gains, gross unrealized holding losses and fair value for available-for-sale securities and held-to-maturity securities by major security type at June 30, 2007 and 2006, and December 31, 2006 were as follows:

June 30, 2007:

Current: