Years ended March 31, 1998 and 1997 1. Basis of Presentation of Financial Statements Kobe Steel, Ltd. (the "Company"), a Japanese corporation, maintains its records and prepares its financial statements in Japanese yen in accordance with generally accepted accounting principles in Japan. The accompanying consolidated financial statements have been translated from the consolidated financial statements which are prepared for Japanese domestic purposes, in accordance with the provisions of the Securities and Exchange Law of Japan and filed with the Ministry of Finance of Japan and stock exchanges in Japan. Certain modifications, including presentation of the statements of stockholders' equity and cash flows, have been made in the accompanying consolidated financial statements to facilitate understanding by foreign readers. Certain reclassifications have been made in the accompanying consolidated financial statements for the year ended March 31, 1997 to conform to the presentation for 1998. For convenience only, U.S. dollar amounts presented in the accompanying consolidated financial statements have been translated from Japanese yen at the rate of 132.10 yen to US$1, the rate prevailing on March 31, 1998. 2. Summary of Accounting Policies (1) Consolidation The consolidated financial statements include the accounts of the Company and its significant majority-owned subsidiaries (the "Group"). For the year ended March 31, 1998, the accounts of 110 (109 in 1997) subsidiaries have been included in the consolidated financial statements. Intercompany transactions and accounts have been eliminated. Foreign subsidiaries' financial statements, prepared under accounting principles generally accepted in the respective countries, are used in the preparation of the consolidated financial statements. Investments in unconsolidated subsidiaries and 20 percent to 50 percent owned affiliates, except for insignificant companies, are accounted for by the equity method. For the year ended March 31, 1998, 49 (51 in 1997) affiliates were accounted for by the equity method. The difference, if considered significant, between the cost of investments and the equity in their net assets at their dates of acquisition is amortized over five years (forty years for acquisitions made by certain foreign consolidated subsidiaries). When the Company's share of the net losses of an affiliate exceeds the adjusted cost of the investment, the Company discontinues applying the equity method and the investment is reduced to zero. At March 31, 1998 and 1997, the Company's share of such accumulated losses which were not reflected in the carrying amount of investments were 609 million yen ($4,610 thousand) and 306 million yen, respectively. (2) Cash Equivalents The Group considers time deposits (due within one year) to be cash equivalents. (3) Allowance for Doubtful Accounts The allowance for doubtful accounts is provided in amounts considered to be sufficient to cover possible losses on collection. With respect to the Company and consolidated domestic subsidiaries it is determined by adding the uncollectable amounts individually estimated for doubtful accounts to a maximum amount permitted for tax purposes, which is calculated collectively. The allowance for doubtful accounts of foreign consolidated subsidiaries is determined by estimates of management. (4) Marketable Securities and Investments in Securities Listed equity securities included in both marketable securities and investments in securities, except for certain equity securities of unconsolidated subsidiaries and affiliates, in which the Company's ownership equals or exceeds 25 percent, are principally stated at the lower of moving average cost or market value. Other securities, excluding investments accounted for by the equity method, are stated at moving average cost. If significant impairment of value is deemed permanent, cost is appropriately reduced. (5) Inventories Inventories are valued at cost, as determined principally by the following methods: Two main works in the Iron and Steel Sector and the three main plants in the Aluminum and Copper Sector.............Last-in, first-out method Finished goods and work in process in one plant in the Iron and Steel Sector and the Machinery and Electronics and Information Sector............................Specific identification method Others...........................Average method (6) Depreciation of Plant and Equipment Depreciation of plant and equipment is principally provided using the straight-line method over estimated useful lives. (7) Long-term Construction Contracts Sales and the related costs of certain long-term (over one year) construction contracts of the Company are recognized by the percentage of completion method. (8) Research and Development Expenses Expenses of the Company in respect of the development of new products and research into and the application of new technologies (being in each case expenses which are expected to contribute to future sales), are deferred and amortized over five years. (9) Income and Enterprise Taxes Income and enterprise taxes are payable by the Company and its domestic consolidated subsidiaries on the basis of taxable income. Income and enterprise taxes indicate an aggregate statutory tax rate of approximately 52 percent. Enterprise tax is included in selling, general and administrative expenses. Deferred taxes relating to temporary differences between financial accounting and tax reporting are recognized by certain foreign consolidated subsidiaries and in respect of the elimination of intercompany profits and other tax effects resulting from consolidation. (10) Employees' Retirement Benefits Substantially all employees of the Company and its domestic consolidated subsidiaries are entitled to a lump-sum payment at the time of retirement. The amount is, in general, determined on the basis of length of service, base salary at the date of retirement and cause of retirement. In the case of involuntary retirement, the employee is entitled to a greater payment than in the case of voluntary retirement. Employees of the Company whose employment is terminated after the age of 50 may elect to take part of their retirement benefits in the form of pension payments. The funds required to make pension payments are entrusted to an outside trustee. The liability in respect of lump-sum retirement benefits is stated at the present value of the unfunded portion of the expected future retirement benefits attributable to eligible employees' years of service as at the balance sheet date. Prior service costs in respect of the pension plan, less that portion of the provision in respect of lump-sum retirement benefits no longer required by reason of the introduction of the pension scheme, are amortized on the declining balance method at the rate of 15 percent per annum. The Company's domestic consolidated subsidiaries provide for retirement benefits principally at the rate of 40 percent of the expected future retirement benefits attributable to eligible employees' years of service as at the balance sheet date. Certain foreign consolidated subsidiaries also have retirement benefit plans covering eligible employees. (11) Allowance for Special Repairs Blast furnaces and hot blast stoves, including related machinery and equipment, periodically require substantial component replacement and repair. The estimated future costs of such work are provided for and charged to income on a straight-line basis over the period to the date of the anticipated replacement and repair. The difference between such estimated costs and actual costs is charged or credited to income at the time the repairs take place. (12) Translation of Foreign Currencies Current receivables and payables denominated in foreign currencies are translated at historical rates in accordance with Statement No. 55 of the Audit Committee of the Japanese Institute of Certified Public Accountants. All other assets and liabilities denominated in foreign currencies are translated at historical rates except those, including bonds denominated in foreign currencies, hedged by forward exchange contracts. Such bonds are translated into Japanese yen at the contracted forward exchange rates and the difference between the amount at the contracted forward exchange rate and the amount at the spot rate at the date of issue of the bonds is deferred and shown as deferred income in the consolidated balance sheets. The deferred income is amortized over the life of the forward exchange contracts. Financial statements of consolidated foreign subsidiaries are translated into Japanese yen at the year end rate except for share capital accounts which are translated at historical rates and retained earnings which are translated initially at the rate in effect at March 31, 1996 and subsequently at the historical rate. (13) Leases Finance leases which do not transfer ownership and do not have bargain purchase provisions are accounted for in the same manner as operating leases by the Company and consolidated domestic subsidiaries. (14) Net Income per 1,000 Shares Computations of net income per 1,000 shares are based on the weighted average number of shares outstanding during the year. 3. Differences between Japanese Accounting Principles and International Accounting Standards The accompanying consolidated financial statements of the Group are prepared in conformity with accounting principles generally accepted in Japan, which differ from International Accounting Standards ("IAS") with respect to the Group as described below. IAS extant at January 1, 1998 and effective with respect to the years ended March 31, 1998 and 1997 are used for the purpose of this comparison. (1) Consolidation and the Equity Method of Accounting Generally accepted accounting principles in Japan require that (i) all subsidiaries be consolidated and (ii) all affiliated companies be accounted for by the equity method with the exception that investments that are immaterial may be excluded from this treatment. These Japanese accounting principles are in substantial agreement with IAS 27 and IAS 28 which require, except on certain specific grounds, the consolidation of all subsidiaries and the application of the equity method to all affiliated companies. (2) Tax Effect Accounting Income taxes are provided, in principle, based on taxable income and on the basis of amounts currently payable for each period. The Company and consolidated domestic subsidiaries do not recognize the tax effect of temporary differences, except as indicated in Note 2(9). Therefore, this policy is not in accordance with IAS 12 which requires that the tax expense for a period be determined on the basis of tax effect accounting. It has not been practicable to quantify the effect on net income of this difference in accounting policy. (3) Leases IAS 17 requires that finance leases be reflected in the lessee's accounts by recording an asset and liability equal to the lower of the net fair value of the leased property and the present value of the minimum lease payments. The asset should be depreciated and rentals apportioned between finance charges and reduction of the outstanding liability. Generally accepted accounting principles in Japan require that finance leases, as defined therein, be capitalized with the exception that finance leases that do not transfer ownership and do not have bargain purchase provisions may be accounted for in the same manner as operating leases. For the years ended March 31, 1998 and 1997, the Company had no finance leases that were required to be capitalized. It has not been practicable to quantify the effect on net income of this difference in accounting policy. (4) Translation of Foreign Currencies Short-term and long-term receivables and payables denominated in foreign currencies, except for long-term debt covered by forward exchange contracts, are translated at the exchange rate existing at the time of the transaction. This is not in accordance with IAS 21 which requires foreign currency monetary items to be translated at the rate of exchange in effect at each balance sheet date, except when covered by forward exchange contracts. The effect of applying IAS 21 to the financial statements would be to increase the loss before income taxes for the year ended March 31, 1998 by approximately 900 million yen ($6,813 thousand) and decrease income before income taxes for the year ended March 31, 1997 by approximately 500 million yen. Financial statements of foreign subsidiaries are translated into Japanese yen in the manner described in Note 2 (12). This translation policy is not in accordance with IAS 21 which requires income and expenses be translated at exchange rates at the dates of the transactions. (5) Inventories As noted in Note 2 (5), the Company and consolidated domestic subsidiaries value inventories at cost in accordance with generally accepted accounting principles in Japan. IAS 2 requires that inventories be measured at the lower of cost and net realizable value. Furthermore, for determining the cost of certain inventories the Company applies the last-in, first-out (LIFO) method which is an allowed alternative treatment under IAS 2 for which additional disclosure is required. It has not been practicable to quantify the effect on net income of this difference in accounting policy and determine the additional disclosure required under IAS 2 when the LIFO method is applied. (6) Research and Development Expenses Expenses in respect of the development of new products and in respect of research into and the application of new technologies (in each case expenses which are expected to contribute to future sales) are deferred and amortized over a five year period. This is not in accordance with IAS 9, which requires research and development costs to be charged as an expense of the period in which they are incurred except to the extent that development costs are deferred on certain specified grounds. (7) Employees' Retirement Benefits Substantially all employees of the Company and its domestic consolidated subsidiaries are entitled to a lump-sum payment at the time of retirement. The Company provides for the liability in respect of lump-sum retirement benefits at the present value of the unfunded portion of the expected future retirement benefits attributable to eligible employees' years of service as at the balance sheet date. The Company's domestic consolidated subsidiaries provide for retirement benefits principally at the rate of 40 percent of the expected future retirement benefits attributable to eligible employees' years of service as at the balance sheet date. Under IAS 19, pension costs are recognized and computed using a particular actual approach known as the accrued benefit valuation method or, alternatively, the projected benefit valuation method. It has not been practicable to quantify the effect on net income of this difference in accounting policy. (8) Financial Instruments Market value information relating to marketable securities and information relating to the nature, amounts, and unrealized gains and losses on outstanding derivative transactions are required to be disclosed in the non-consolidated financial statements in Japan. IAS 25 and 32 require disclosure, on a consolidated basis, for each class of financial asset, financial liability, and equity instrument, information relating to the extent and nature, accounting policies and methods adopted, exposure to interest rate and credit risk, and fair values. Since the required disclosure information is not available on a consolidated basis, the consolidated financial statement disclosure is not in accordance with IAS 25 and 32.