FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Report of Foreign Issuer
Pursuant to Rule 13a-16 or 15d-16 of
the Securities Exchange Act of 1934

For the month of    September    , 2006  

CANON INC.

(Translation of registrant’s name into English)

30-2, Shimomaruko 3-Chome, Ohta-ku, Tokyo 146-8501, Japan

(Address of principal executive offices)

     [Indicate by check mark whether the registrant files or will file annual reports under cover Form 20-F or Form 40-F.

Form 20-F    X    Form 40-F       

     [Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes        No   X   

     [If “Yes” is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b):82-             

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

*Print the name and title of the signing officer under his signature.

The following materials are included.

1.

Semiannual Report filed with the Japanese government pursuant to the Securities and Exchange Law of Japan For the six months ended June 30, 2006

[English summary with full translation of consolidated financial information]

 

 

 

 

 

Semiannual Report filed with the Japanese government
pursuant to the Securities and Exchange Law of Japan

 

 

For the six months ended
June 30, 2006

 

 

 

 

 

 

CANON INC.
Tokyo, Japan

CONTENTS

				Page.
I		Corporate Information
		(1) Consolidated Financial Summary		3
		(2) Number of Employees		4
II		The Business
		(1)   Operating Results		4
		(2)   Production and Sales		7
		(3)   Managerial Issues to be Addressed		8
		(4)   Research and Development Expenditure		8
III		Property, Plant and Equipment
		(1)   Major Capital Investment		8
		(2)   Prospect of Capital Investment in fiscal 2006		8
IV		Shares
		(1)   Shares		9
		(2)   Major Shareholders		9
		(3)   Stock Price Transition		9
V		Financial Statements		10

Disclaimer Regarding Forward-Looking Statements

     This semiannual report includes forward-looking statements (within the meaning of Section 27A of the U.S. Securities Act of 1933 and Section 21E of the U.S. Securities Exchange Act of 1934) concerning Canon Inc. and its subsidiaries. To the extent that statements in this semiannual report do not relate to historical or current facts, they constitute forward-looking statements. These forward-looking statements are based on the current assumptions and beliefs of Canon in light of the information currently available to them, and involve known and unknown risks, uncertainties and other factors. Such risks, uncertainties and other factors may cause Canon’s actual results, performance, achievements or financial position to be materially different from any future results, performance, achievements or financial position expressed or implied by these forward-looking statements. Canon undertakes no obligation to publicly update any forward-looking statements after the date of this semiannual report. Investors are advised to consult any further disclosures by Canon in its subsequent filings with the U.S. Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 and its other filings.

     The risks, uncertainties and other factors referred to above include, but are not limited to, exchange rate fluctuations; the uncertainty of Canon’s ability to implement its plans to localize production and other measures to reduce the impact of exchange rate fluctuations; uncertainty as to economic condition, in Canon’s major markets; uncertainty of continued demand for Canon’s high-value-added products; uncertainty as to the recovery of computer and related markets; uncertainty of recovery in demand for Canon’s semiconductor production equipment; Canon’s ability to continue to develop products and to market products that incorporate new technology on a timely basis, are competitively priced and achieve market acceptance; the possibility of losses resulting from foreign currency transactions designed to reduce financial risks from changes in foreign exchange rates; and inventory risk due to shifts in market demand.

Note:

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.

I. Corporate Information

(1) Consolidated Financial Summary

		Millions of Yen (except per share amounts)
		Six months ended June 30												Year ended December 31
		2004				2005				2006				2004				2005
Net sales			1,648,420				1,755,840				1,952,255				3,467,853				3,754,191
Income before income taxes and minority interests			259,974				283,733				341,045				552,116				612,004
Net income			160,776				175,268				214,174				343,344				384,096
Stockholders’ equity			2,006,734				2,363,970				2,762,380				2,209,896				2,604,682
Total assets			3,353,465				3,657,425				4,107,366				3,587,021				4,043,553
Net assets per share (Yen)			1,509.27				1,776.29				2,074.49				1,661.22				1,956.35
Net income per share: basic (Yen)			121.23				131.74				160.85				258.53				288.63
Net income per share: diluted (Yen)			120.78				131.59				160.79				257.85				288.36
Stockholders’ equity to total assets (%)			59.8				64.6				67.3				61.6				64.4
Cash flows from operating activities			297,827				257,961				323,878				561,529				605,678
Cash flows from investing activities			(109,920	)			(181,056	)			(210,297	)			(252,967	)			(401,141	)
Cash flows from financing activities			(64,326	)			(38,409	)			(57,832	)			(102,268	)			(93,939	)
Cash and cash equivalents at end of period			811,221				935,921				1,055,163				887,774				1,004,953
Number of employees			104,947				109,434				121,588				108,257				115,583

Notes:
1		Canon’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles.
2		Consumption tax is excluded from the stated amount of net sales.
3		Canon has made a three-for-two stock split on July 1, 2006, for shareholders recorded in the shareholders’ register as of June 30, 2006. The net assets 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:

		Yen
		Six months ended June 30								Year ended December 31
		2004				2005				2004				2005
Net assets per share			2,263.90				2,664.44				2,491.83				2,934.53
Net income per share: basic			181.84				197.61				387.80				432.94
Net income per share: diluted			181.17				197.38				386.78				432.55

(2)

Number of Employees

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

		As of June 30, 2006
Business Machines			82,650
Cameras			17,911
Optical and other products			15,076
Corporate			5,951
Total			121,588

II.

The Business

(1)

Operating Results

		Looking back at the global economy in the first half of 2006, the U.S. economy continued to display growth despite concerns over the effects of high crude oil prices and an increase in interest rates accompanying inflation fear, with private sector spending and corporate capital expenditure supporting expanded domestic demand. In Europe, the economy continued moving toward moderate recovery amid strong exports. Within Asia, China and India maintained high rates of growth while other economies in the region also enjoyed generally favorable performances. In Japan, the economy continued to indicate a trend toward recovery, boosted by an improvement of employment conditions and increased capital spending fueled by an upturn in corporate profits.
		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 toward color. As for computer peripherals, including printers, while demand within the laser beam printer market grew for color models, and shifted within the inkjet printer market from single-function to multifunction models, the segment suffered amid severe price competition. In the optical equipment segment, although the market for steppers, used in the production of semiconductors, indicated a trend toward 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 ¥115.63 to the U.S. dollar and ¥142.36 to the euro, representing year-on-year decrease of about 9% against the U.S. dollar, and 5% against the euro.
		Amid these conditions, Canon’s consolidated net sales for the first half increased by 11.2% from the year-ago period to ¥1,952.3 billion, boosted by a solid rise in sales of digital cameras, color network MFDs and laser beam printers, along with the positive effects of favorable currency exchange rates. The gross profit ratio marked a high level, improving 1.7 points year on year to reach 50.1%. The increase in the gross profit ratio was mainly the result of such factors as the launch of new products and cost reduction efforts realized through ongoing production-reform and procurement-reform activities, along with favorable sales of high value-added products. These absorbed the effects of escalating raw material costs, as well as severe price competition in the consumer product market. Owing to the increase in sales and an improvement in the gross profit ratio, first-half gross profit increased by 15.1% to ¥978.7 billion. As for operating expenses, while first-half R&D expenditures grew by ¥10.1 billion for the year-ago period to ¥146.5 billion, the operating expense to net sales ratio improved 0.2 points year on year as a result of limiting growth in selling, general and administrative expenses, with the exception of a temporary increase in expenses related to the relocation of operating

		bases. Consequently, operating profit in the first half totaled ¥338.5 billion, a year-on-year increase of 25.3%. Although other income (deductions) declined mainly due to an increase in currency exchange losses on foreign-currency-denominated transactions, income before income taxes and minority interests in the first half totaled ¥341.0 billion, a year-on-year increase of 20.2% as interest income grew in line with the rise in the interest rate, and first-half net income totaled ¥214.2 billion, both recording all-time highs on a first-half basis.
		Basic net income per share for the first half was ¥160.85, a year-on-year increase of ¥29.11. (Note: The basic net income per share calculation is based on the number of outstanding shares following the implementation of the stock split previously mentioned in this report.)
		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 increased significantly for color models in the U.S. and European markets, as well as in the domestic Japanese market. Within this sector, the iR C3170 series, equipped with a new high-speed image-processing chip, and the iR C3220 series continued to sell well, as did the new high-speed iR C6870-series models. Among monochrome network digital MFDs, mid-level models such as the iR4570 series contributed to expanded sales, along with the iR6570, featuring energy-saving performance, while low-end models, such as the iR2020 series with enhanced networking features, also contributed to sales growth. Overall, sales of office imaging products for the first half realized a year-on-year increase of 3.1%. In the field of computer peripherals, sales of laser beam printers increased for both low-end monochrome and color models while sales of supplies also recorded healthy growth, resulting in a year-on-year increase in sales of 15.4%. As for inkjet printers, despite a decline in the unit sales of single-function models and severe price competition in the market, sales in terms of value increased by 4.3% thanks to such factors as a significant increase in unit sales of multifunction models, such as the mid-level PIXMA MP500 and entry-level PIXMA MP150 for overseas markets, as well as favorable sales growth for consumables. As a result, sales of computer peripherals for the first half increased 11.9% year on year. Within the field of business information products, sales increased by 5.8%, amid healthy demand for an expanded lineup of document scanners. Collectively, sales of business machines for the first half totaled ¥1,286.6 billion, a year-on-year increase of 7.5%. Operating profit for the business machines segment totaled ¥294.6 billion, a year-on-year increase of 13.5%, supported by such factors as an improvement in the expense ratio and an increase in gross profit accompanying the growth in sales.
		Within the camera segment, digital SLR cameras continued to enjoy robust growth, bolstered by particularly strong sales of the EOS DIGITAL REBEL XT and the newly introduced EOS 30D, which has also led to expanded sales of interchangeable lenses. Sales of compact-model digital cameras also continued to expand steadily, with healthy demand for the PowerShot SD550 and PowerShot SD450, as well as the PowerShot SD700 IS, PowerShot SD630, and PowerShot SD600, launched in the first half. Accordingly, unit sales of digital cameras for the first half expanded more than 20% compared with the year-ago period. In the field of digital video camcorders, newly introduced DVD models delivered strong performances, as did Mini DV models. As a result, overall camera sales for the first half increased by 21.4% from the year-ago period to ¥460.3 billion. The gross profit ratio for the camera segment also rose substantially, boosted by such factors as favorable sales in high value-added products, along with cost-reduction efforts realized through production-reform and procurement-reform activities. As a result, operating profit for the camera segment increased by 75.8% year on year to ¥108.7 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, due to restrained investment by LCD manufacturers. As for the other products included in the segment, the subsidiary that was acquired last year contributed to significant sales growth. As a result, first-half sales for the optical and other products segment totaled ¥205.4 billion, a year-on-year increase of 14.3%. Operating profit for the segment grew by 10.2% year on year to ¥23.2 billion, boosted by the increase in gross profit accompanying the increase in sales.
		Semiannual results by domestic and overseas company location are summarized as follows:
		Japan
		Sales in Japan increased 5.1% from the previous same period to ¥505.9 billion, mainly due to expanded sales in digital cameras and color network digital MFDs, as well as increased sales from the subsidiaries newly acquired last year. Geographical operating profit rose 19.9% from the previous same period to ¥372.7 billion.
		Americas
		Sales increased 14.3% from the previous same period to ¥590.9 billion, mainly due to expanded sales in digital cameras as well as laser beam printers. Geographical operating profit increased by 27.6% from the previous same period to ¥22.8 billion.
		Europe
		Sales increased 10.9% from the previous same period to ¥610.3 billion, mainly due to expanded sales in digital cameras and laser beam printers. Geographical operating profit also increased 28.9% from the previous same period to ¥18.1 billion.
		Asia and others
		Sales increased 18.4% from the previous same period to ¥245.2 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 61.3% from the previous same period to ¥22.4 billion.

Cash Flows

		Cash and cash equivalents increased by ¥50.2 billion from the end of the previous year, to ¥1,055.2 billion at the end of the first half of 2006.
		Cash flows from operating activities
		In the first half of 2006, Canon maintained cash flow from operating activities of ¥323.9 billion, a year-on-year increase of ¥65.9 billion, reflecting the substantial growth in sales and increased cash proceeds from sales, combined with an increase in net income and depreciation expenses.
		Cash flows from investing activities
		Capital expenditure totaled ¥208.7 billion, which was used mainly to expand production capabilities in both domestic and overseas regions, as well as to bolster the company’s R&D-related infrastructure. As a result, cash flow from investing activities totaled ¥210.3 billion, representing a year-on-year increase of ¥29.2 billion.
		Cash flows from financing activities
		Cash flow from financing activities recorded an outlay of ¥57.8 billion, a year-on-year increase of ¥19.4 billion, mainly resulting from the dividend payout of ¥59.9 billion, an increase of ¥24.4 billion compared with the previous year.

As a result, free cash flow totaled ¥113.6 billion, an improvement of ¥36.7 billion from ¥76.9 billion for the year-ago period.

(2)

Production and Sales

		Production
		The company’s production by product group are summarized as follows:

		Millions of yen
		Six months ended June 30, 2006
		Production				Change (%)
Business Machines			1,099,725				108.0
Cameras			505,183				126.8
Optical and other products			178,754				121.1
Total			1,783,662				114.1

Notes:
1.		Amount of production is calculated by sales price.
2.		Consumption tax is excluded from the stated amount of production.
		Sales
		The company’s sales by product group are summarized as follows:

		Millions of yen
		Six months ended June 30, 2006
		Sales				Change (%)
Business Machines			1,286,596				107.5
Camera			460,285				121.4
Optical and other products			205,374				114.3
Total			1,952,255				111.2

Notes:
1.		Consumption tax is excluded from the stated amount of net sales.
2.		The company’s sales by main customer are summarized as follows:

Millions of yen

Six months ended June 30, 2005

Six months ended June 30, 2006

Sales

Proportion (%)

Sales

Proportion (%)

Hewlett-Packard Company

363,424

20.7

425,088

21.8

(3)

Managerial Issues to be Addressed

There were no significant changes or new developments in Canon’s managerial and financial issues to be addressed during the first half of 2006.

(4)

Research and Development Expenditure

     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, 2006 totaled ¥146,527 million.

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

		Millions of yen
		Six months ended June 30
		2005				2006
Business Machines			57,724				54,877
Cameras			18,959				19,896
Optical and other products			13,417				13,316
Corporate			46,286				58,438
Total			136,386				146,527

III.

Property, Plant and Equipment

(1)

Major Capital Investment

There were no significant changes to the status of existing major capital investment during the first half of 2006.

(2)

Prospect of Capital Investment in fiscal 2006

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 2006. Also, there were no significant additional plans for new construction or retirement of capital investment, during the first half of 2006.

IV.

Shares

(1)

Shares

Total number of authorized shares is 2,000,000,000 shares. The common stock of the Company is listed on the Tokyo, Osaka, Nagoya, Fukuoka, Sapporo, Frankfurt am Main and New York stock exchanges. Total issued shares are as follows:

		As of December				As of June 30,				As of September 28,
		31, 2005				2006				2006
Total issued shares (share)			888,742,779				888,883,727				1,333,353,646

	Notes:
	1.		The increase of the total issued shares during this term reflects the conversion of convertible shares.
	2.		The number of authorized shares and issued shares as of December 31, 2005 and June 30, 2006 does not reflect the three-for-two stock split that has become effective on July 1, 2006.
	3.		The total issued shares as of September 28, 2006 does not include the shares issued during the month of September 2006 due to the conversion of convertible shares.

(2)

Major Shareholders

		As of June 30, 2006
		Number of shares held				Number of shares held /
		(Number of shares)				Number of shares issued
The Dai-Ichi Mutual Life Insurance Co.			62,208,400				7.00	%
Japan Trustee Services Bank, Ltd. (Trust Account)			51,985,500				5.85	%
Moxley and Co.			48,991,900				5.51	%
The Master Trust Bank of Japan, Ltd. (Trust Account)			46,482,300				5.23	%
State Street Bank and Trust Company 505103			23,311,872				2.62	%
State Street Bank and Trust Company			22,959,172				2.58	%
Nomura Securities Co., Ltd.			21,958,420				2.47	%
The Chase Manhattan Bank, N.A., London			19,114,639				2.15	%
Mizuho Corporate Bank, Ltd.			18,946,491				2.13	%
Sompo Japan Insurance Inc.			15,273,565				1.72	%

		Note:
		The number of shares held does not reflect the three-for-two stock split that has become effective on July 1, 2006.

(3)

Stock Price Transition

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 2006:

(Yen)

		January				February				March				April				May				June
High			7,320				7,370				7,930				8,870				9,020				8,250
																							5,640	*
Low			6,850				6,970				7,160				7,830				7,760				7,270
																							5,280	*

	Notes:
	1.		The stock price does not reflect the three-for-two stock split that has become effective on July 1, 2006.
	2.		Stock price after ex-right date of stock split is shown with an asterisk(*).

V.

Financial Statements

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

		Page.
Consolidated Balance Sheets As of June 30, 2005 and 2006, and December 31, 2005			11
Consolidated Statements of Income for the six months ended June 30, 2005 and 2006, and the year ended December 31, 2005			13
Consolidated Statements of Stockholders’ Equity for the six months ended June 30, 2005 and 2006, and the year ended December 31, 2005			14
Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2006, and the year ended December 31, 2005			16
Notes to Consolidated Financial Statements			17

CANON INC. AND SUBSIDIARIES
Consolidated Balance Sheets

as of June 30, 2005 and 2006, and December 31, 2005

		Millions of yen
		June 30								December 31
		2005				2006				2005
Assets
Current assets:
Cash and cash equivalents			935,921				1,055,163				1,004,953
Marketable securities (notes 2 and 7)			1,236				10,373				172
Trade receivables, net (note 3)			542,192				637,624				689,427
Inventories (note 4)			485,887				533,468				510,195
Prepaid expenses and other current assets (notes 6 and 7)			249,867				247,908				253,822
Total current assets			2,215,103				2,484,536				2,458,569
Noncurrent receivables (note 12)			14,162				14,708				14,122
Investments (notes 2 and 7)			99,808				104,068				104,486
Property, plant and equipment, net (notes 5 and 7)			1,042,448				1,185,913				1,148,821
Other assets (note 6)			285,904				318,141				317,555
Total assets			3,657,425				4,107,366				4,043,553

CANON INC. AND SUBSIDIARIES
Consolidated Balance Sheets

as of June 30, 2005 and 2006, and December 31, 2005

		Millions of yen
		June 30								December 31
		2005				2006				2005
Liabilities and stockholders’ equity
Current liabilities:
Short-term loans and current portion of long-term debt (note 7)			11,645				14,564				5,059
Trade payables (note 8)			437,210				481,476				505,126
Income taxes			78,324				101,485				110,844
Accrued expenses (note 12)			197,405				229,739				248,205
Other current liabilities			181,525				174,327				209,394
Total current liabilities			906,109				1,001,591				1,078,628
Long-term debt, excluding current installments (note 7)			25,056				16,199				27,082
Accrued pension and severance cost			124,816				66,724				80,430
Other noncurrent liabilities			45,425				47,042				52,395
Total liabilities			1,101,406				1,131,556				1,238,535
Minority interests			192,049				213,430				200,336
Commitments and contingent liabilities (note 12) Stockholders’ equity:
Common stock			174,153				174,543				174,438
(Authorized shares) (note 14)			(3,000,000,000	)			(3,000,000,000	)			(3,000,000,000	)
(Issued shares) (note 14)			(1,332,544,030	)			(1,333,325,590	)			(1,333,114,169	)
Additional paid-in capital			402,013				403,355				403,246
Legal reserve			42,186				43,201				42,331
Retained earnings			1,838,441				2,171,681				2,018,289
Accumulated other comprehensive income (loss) (note 9)			(87,487	)			(24,911	)			(28,212	)
Treasury stock at cost			(5,336	)			(5,489	)			(5,410	)
(Number of shares) (note 14)			(1,700,692	)			(1,733,020	)			(1,718,523	)
Total stockholders’ equity			2,363,970				2,762,380				2,604,682
Total liabilities and stockholders’ equity			3,657,425				4,107,366				4,043,553

CANON INC. AND SUBSIDIARIES
Consolidated Statements of Income

for the six months ended June 30, 2005 and 2006, and fiscal year ended December 31, 2005

		Millions of yen
		Six months ended								Year ended
		June 30								December 31
		2005				2006				2005
Net sales			1,755,840				1,952,255				3,754,191
Cost of sales			905,800				973,542				1,935,148
Gross profit			850,040				978,713				1,819,043
Selling, general and administrative expenses (note 1)			443,465				493,709				949,524
Research and development expenses			136,386				146,527				286,476
Operating profit			270,189				338,477				583,043
Other income (deductions):
Interest and dividend income			5,970				11,143				14,252
Interest expense			(771	)			(625	)			(1,741	)
Other, net (note 1)			8,345				(7,950	)			16,450
			13,544				2,568				28,961
Income before income taxes and minority interests			283,733				341,045				612,004
Income taxes			101,268				118,814				212,785
Income before minority interests			182,465				222,231				399,219
Minority interests			7,197				8,057				15,123
Net income			175,268				214,174				384,096

		Yen
Net income per share (note 10):
Basic			131.74				160.85				288.63
Diluted			131.59				160.79				288.36

CANON INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity

for the six months ended June 30, 2005 and 2006, and fiscal year ended December 31, 2005

Millions of yen

																		Accumulated
						Additional												other								Total
		Common				paid-in				Legal				Retained				comprehensive				Treasury				stockholders’
		Stock				capital				reserve				earnings				income (loss)				stock				equity
Balance at December 31, 2004			173,864				401,773				41,200				1,699,634				(101,312	)			(5,263	)			2,209,896
Conversion of convertible debt and other			289				289																				578
Capital transaction by consolidated subsidiaries and affiliated companies							(49	)																			(49	)
Cash dividends															(35,475	)											(35,475	)
Transfers to legal reserve											986				(986	)											—
Comprehensive income
Net income															175,268												175,268
Other comprehensive income (loss), net of tax (note 9)
Foreign currency translation adjustments																			13,049								13,049
Net unrealized gains and losses on securities																			(634	)							(634	)
Net gains and losses on derivative instruments																			760								760
Minimum pension liability adjustments																			650								650
Total comprehensive income																											189,093
Repurchase of treasury stock, net																							(73	)			(73	)
Balance at June 30, 2005			174,153				402,013				42,186				1,838,441				(87,487	)			(5,336	)			2,363,970

Millions of yen

																		Accumulated
						Additional												other								Total
		Common				paid-in				Legal				Retained				comprehensive				Treasury				stockholders’
		Stock				capital				reserve				earnings				income (loss)				stock				equity
Balance at December 31, 2005			174,438				403,246				42,331				2,018,289				(28,212	)			(5,410	)			2,604,682
Conversion of convertible debt and other			105				109																				214
Cash dividends															(59,912	)											(59,912	)
Transfers to legal reserve											870				(870	)											—
Comprehensive income
Net income															214,174												214,174
Other comprehensive income (loss), net of tax (note 9)
Foreign currency translation adjustments																			2,193								2,193
Net unrealized gains and losses on securities																			252								252
Net gains and losses on derivative instruments																			619								619
Minimum pension liability adjustments																			237								237
Total comprehensive income																											217,475
Repurchase of treasury stock, net																							(79	)			(79	)
Balance at June 30, 2006			174,543				403,355				43,201				2,171,681				(24,911	)			(5,489	)			2,762,380

CANON INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity

for the six months ended June 30, 2005 and 2006, and fiscal year ended December 31, 2005

Millions of yen

																		Accumulated
						Additional												other								Total
		Common				paid-in				Legal				Retained				comprehensive				Treasury				stockholders’
		Stock				capital				reserve				earnings				income (loss)				stock				equity
Balance at December 31, 2004			173,864				401,773				41,200				1,699,634				(101,312	)			(5,263	)			2,209,896
Conversion of convertible debt and other			574				574																				1,148
Capital transaction by consolidated subsidiaries and affiliated companies							899																				899
Cash dividends															(64,310	)											(64,310	)
Transfers to legal reserve											1,131				(1,131	)											—
Comprehensive income
Net income															384,096												384,096
Other comprehensive income (loss), net of tax (note 9)
Foreign currency translation adjustments																			53,979								53,979
Net unrealized gains and losses on securities																			(1,397	)							(1,397	)
Net gains and losses on derivative instruments																			(481	)							(481	)
Minimum pension liability adjustments																			20,999								20,999
Total comprehensive income																											457,196
Repurchase of treasury stock, net																							(147	)			(147	)
Balance at December 31, 2005			174,438				403,246				42,331				2,018,289				(28,212	)			(5,410	)			2,604,682

CANON INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows

for the six months ended June 30, 2005 and 2006, and fiscal year ended December 31, 2005

		Millions of yen
		Six months ended								Year ended
		June 30								December 31
		2005				2006				2005
Cash flows from operating activities:
Net income			175,268				214,174				384,096
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			98,556				108,155				225,941
Loss on disposal of property, plant and equipment			3,213				9,391				13,784
Deferred income taxes			8,608				8,014				(766	)
(Increase) decrease in trade receivables			59,839				57,191				`(48,391	)
(Increase) decrease in inventories			7,161				(18,953	)			27,558
Increase (decrease) in trade payables			(30,174	)			(20,089	)			16,018
Increase (decrease) in income taxes			(27,171	)			(8,877	)			1,998
Increase (decrease) in accrued expenses			(10,274	)			(21,293	)			31,241
Decrease in accrued pension and severance cost			(5,945	)			(14,790	)			(16,221	)
Other, net			(21,120	)			10,955				(29,580	)
Net cash provided by operating activities			257,961				323,878				605,678
Cash flows from investing activities:
Purchases of fixed assets			(185,601	)			(208,655	)			(395,055	)
Proceeds from sale of fixed assets			6,637				15,490				14,827
Purchases of available-for-sale securities			(381	)			(6,433	)			(5,680	)
Proceeds from sale of available-for-sale securities			2,371				1,034				12,337
Acquisitions of subsidiaries, net of cash acquired			(1,219	)			(605	)			(17,657	)
Purchases of other investments			(2,886	)			(7,228	)			(19,531	)
Other, net			23				(3,900	)			9,618
Net cash used in investing activities			(181,056	)			(210,297	)			(401,141	)
Cash flows from financing activities:
Proceeds from issuance of long-term debt			735				781				1,716
Repayments of long-term debt			(3,384	)			(3,063	)			(15,187	)
Increase (decrease) in short-term loans			1,544				(404	)			(12,011	)
Dividends paid			(35,475	)			(59,912	)			(64,310	)
Purchases of treasury stock, net			(73	)			(75	)			(147	)
Other, net			(1,756	)			4,841				(4,000	)
Net cash used in financing activities			(38,409	)			(57,832	)			(93,939	)
Effect of exchange rate changes on cash and cash equivalents			9,651				(5,539	)			6,581
Net increase in cash and cash equivalents			48,147				50,210				117,179
Cash and cash equivalents at beginning of period			887,774				1,004,953				887,774
Cash and cash equivalents at end of period			935,921				1,055,163				1,004,953
Supplemental disclosure for cash flow information
Cash paid during the period for:
Interest			814				638				1,919
Income taxes			120,264				120,110				211,540

CANON INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1)

Basis of Presentation and Significant Accounting Policies

	(a)		Basis of Presentation
			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 NYSE in September 2000 after being quoted on NASDAQ from February 1972 to September 2000.
			The Company’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 disclosed under 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, 2005 and 2006, and December 31, 2005 are summarized as follows:

		June 30								Dec. 31
		2005				2006				2005
Consolidated subsidiaries			187				216				200
Affiliated companies			16				13				13
Total			203				229				213

	(b)		Description of Business
			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 related products. Office imaging products consist mainly of copying machines and digital multifunction devices. Computer peripherals consist mainly of laser beam and inkjet printers. Business information products consist mainly of computer information systems, micrographics and calculators. Cameras consist mainly of single lens reflex (“SLR”) cameras, compact cameras, digital cameras and video camcorders. Optical related products include steppers and aligners used in semiconductor chip production, projection aligners used in the production of liquid crystal displays (“LCDs”), broadcasting lenses and medical equipment. Canon’s consolidated net sales for the six months ended June 30, 2006 were distributed as follows: office imaging products 30%, computer peripherals 33%, business information products 3%, cameras 24%, and optical and other products 10%.
			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 74% of consolidated net sales for the six months ended June 30, 2006 were generated outside Japan, with 30% in the Americas, 31% in Europe, and 13% in other areas.
			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.

CANON INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

			Canon sells laser beam printers on an OEM basis to Hewlett-Packard Company; such sales constituted approximately 22% of consolidated net sales for the six ended months ended June 30, 2006.
	(c)		Principles of Consolidation
			The consolidated financial statements include the accounts of the Company, its majority owned subsidiaries and those variable interest entities where the Company is the primary beneficiary under FASB Interpretation No. 46 (revised December 2003) (“FIN 46R”), “Consolidation of Variable Interest Entities.” All significant intercompany balances and transactions have been eliminated.
	(d)		Use of Estimates
			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.
	(e)		Cash Equivalents
			All highly liquid investments acquired with an original maturity of three months or less are considered to be cash equivalents.
	(f)		Translation of Foreign Currencies
			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 ¥898 million, ¥14,639 million and ¥3,710 million for the six months ended June 30, 2005 and 2006, and year ended December 31, 2005, respectively.
	(g)		Marketable Securities and Investments
			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.

CANON INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

			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 gain and losses are determined on the average cost method and reflected in earnings.
			Other securities are stated at cost and reviewed periodically for impairment.
	(h)		Allowance for Doubtful Receivables 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.
	(i)		Inventories 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.
	(j)		Investments in Affiliated Companies 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.
	(k)		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 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 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.
	(l)		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. The depreciation period ranges from 3 years to 60 years for buildings and 2 years to 20 years for machinery and equipment.

CANON INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

			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.
	(m)		Goodwill and Other Intangible Assets Goodwill and 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.
	(n)		Environmental Liabilities 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.
	(o)		Income Taxes 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.
	(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 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.

CANON INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

			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 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 over the term of the contract.
			Most office imaging products are sold with service maintenance 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.
			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.
	(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 ¥44,782 million, ¥49,785 million and ¥106,250 million for the six months ended June 30, 2005 and 2006, and year ended December 31, 2005, respectively.

CANON INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

	(u)		Shipping and Handling Costs Shipping and handling costs totaled ¥24,319 million, ¥29,173 million and ¥50,052 million for the six months ended June 30, 2005 and 2006, and year ended December 31, 2005, respectively, and are included in selling, general and administrative expenses in the consolidated statements of income.
	(v)		Derivative Financial Instruments All derivatives are recognized at fair value and are included in prepaid 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 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 on the consolidated balance sheets at fair value. The changes in fair values are immediately recorded in earnings.
	(w)		Guarantees Canon recognizes, at the inception of a guarantee, a liability for the fair value of the obligation it has undertaken in issuing guarantees.
	(y)		Reclassification Certain reclassifications have been made to the prior periods’ consolidated financial statements to conform with the presentation used for this period.

CANON INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(2)

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, 2005 and 2006, and December 31, 2005 were as follows:

		Millions of yen
						Gross				Gross
						Unrealized				Unrealized
						Holding				Holding
		Cost				Gains				Losses				Fair Value
June 30, 2005:
Current:
Available-for-sale:
Bank debt securities			71				—				—				71
Equity securities			1,033				133				1				1,165
			1,104				133				1				1,236
Noncurrent:
Available-for-sale:
Government bonds			512				22				—				534
Corporate debt securities			72				6				—				78
Fund trusts			2,553				690				—				3,243
Equity securities			9,068				15,593				64				24,597
			12,205				16,311				64				28,452
Held-to-maturity:
Corporate debt securities			21,210				—				—				21,210
			33,415				16,311				64				49,662