Years ended March 31, 1998 and 1997 1. Basis of Presenting Consolidated Financial Statements Kobe Steel, Ltd. (the "Company") and its consolidated domestic subsidiaries maintain their accounts and records in accordance with the provisions set forth in the Japanese Commercial Code and the Securities and Exchange Law and in conformity with accounting principles and practices generally accepted in Japan, which are different from the accounting and disclosure requirements of International Accounting Standards. The accounts of overseas consolidated subsidiaries are based on their accounting records maintained in conformity with generally accepted accounting principles and practices prevailing in the respective countries of domicile. The accompanying consolidated financial statements are a translation of the audited consolidated financial statements of the Company which were prepared in accordance with accounting principles and practices generally accepted in Japan from the accounts and records maintained by the Company and its consolidated subsidiaries and were filed with the Minister of Finance ("MOF") as required by the Securities and Exchange Law. In preparing the accompanying consolidated financial statements, certain reclassifications have been made in the consolidated financial statements issued domestically in order to present them in a form which is more familiar to readers outside Japan. The consolidated statements of cash flows have been prepared for the purpose of inclusion in the consolidated financial statements, although such statements are not customarily prepared in Japan and are not required to be filed with MOF. Certain prior year amounts have been reclassified to conform to 1999 presentation. These changes had no impact on previously reported results of operations or shareholders' equity. The translation of the Japanese yen amounts into U.S. dollars are included solely for the convenience of the reader, using the prevailing exchange rate at March 31, 1999, which was 120.55 yen to U.S.$1.00. The convenience translations should not be construed as representations that the Japanese yen amounts have been, could have been, or could in the future be, converted into U.S. dollars at this or any other rate of exchange. 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, 1999, the accounts of 115 (110 in 1998) subsidiaries have been included in the consolidated financial statements. Intercompany transactions and accounts have been eliminated. 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, 1999, 48 (49 in 1998) 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, 1999 and 1998, the Company's share of such accumulated losses which were not reflected in the carrying amount of investments were 193 million yen ($1,601 thousand) and 609 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. Commencing with the year ended March 31, 1999, the Company records recoveries of write-downs of securities in accordance with a revision in the Corporation Tax Law. There was no effect on net loss resulting from adopting this accounting policy. (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. Effective April 1, 1998, in accordance with a revision in the Corporation Tax Law, the Company and its domestic consolidated subsidiaries shortened the estimated useful lives of buildings, excluding building fixtures. The effect of this change was to increase loss before income taxes by 1,078 million yen ($8,942 thousand). The effect on segment information is stated in Note 11. Segment Information. (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 Effective April 1, 1998, the Company and certain domestic consolidated subsidiaries changed their methods of accounting for expenses in respect of the development of new products and research into and the application of new technologies (being in each case expenses which were expected to contribute to future sales) from deferring and amortizing over five years to charging directly to income. This change was made to improve the financial reporting of the Company and certain domestic consolidated subsidiaries in accordance with the "Opinion Concerning Establishment of Accounting Standards for Research and Development Costs, etc." by the Business Accounting Deliberation Council, etc. The effect of this change was to increase the loss before income taxes by 7,936 million yen ($65,832 thousand). The effect on segment information is stated in Note 11. Segment Information. (9) Amortization of Consolidation Difference In accordance with the new disclosure requirements effective from the year ended March 31, 1999, amortization of consolidation difference is included in selling, general and administrative expenses. Prior year amounts, which were presented between income taxes and net loss, have been reclassified to conform to the 1999 presentation. (10) Equity in Earnings of Affiliated Companies In accordance with the new disclosure requirements effective from the year ended March 31, 1999, equity in losses of affiliated companies is included in other income (expenses). Prior year amounts, which were presented between income taxes and net loss, have been reclassified to conform to the 1999 presentation. (11) Income taxes The Company and its domestic consolidated subsidiaries provided income taxes at the amounts currently payable for the year ended March 31, 1998. Deferred taxes relating to temporary differences between financial accounting and tax reporting were also recognized by certain foreign consolidated subsidiaries and in respect of the elimination of intercompany profits and other tax effects resulting from consolidation. Effective April 1, 1998, the Company and its domestic consolidated subsidiaries adopted the new accounting standard, which recognizes tax effects of temporary differences between the carrying amounts of assets and liabilities for tax and financial reporting. The asset and liability approach is used to recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The amount of deferred income taxes attributable to the net tax effects of the temporary differences at April 1, 1998 of 6,769 million yen ($56,151 thousand) is reflected as an adjustment to the retained earnings brought forward from the previous year. Prior years' financial statements have not been restated. The effect for the year ended March 31, 1999 was to decrease net loss by 26,304 million yen ($218,200 thousand). Also, the new disclosure requirements effective from the year ended March 31, 1999, require that enterprise tax, which is levied on taxable income at a normal tax rate of approximately 11%, be included in income taxes. Prior year amounts, which were included in selling, general and administrative expenses, have been reclassified to conform to the 1999 presentation. (12) 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. During the year ended March 31, 1999, to improve the financial soundness of the pension plan, the Company reduced the assumed rate of return on fund assets and reduced the rate of benefits to employees. The Company also changed its funding method from a full year contribution in March of each year to monthly funding. As a result, for the year ended March 31, 1999, only one month funding was contributed and charged to expenses. The effect of these changes was to decrease loss before income taxes by 6,997 million yen ($58,042 thousand). The effect on segment information is stated in Note 11. Segment Information. (13) 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. For the year ended March 31, 1999, the Company reversed the allowances for special repairs, which exceeded the future revised cost of repairs to hot blast stoves located in the Kakogawa Works and the Kobe Works, and which was related to two blast furnaces located in the Kobe Works which were shut down and disposed. Reversal of the allowance for special repairs is shown in the accompanying consolidated statements of operations. (14) 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 in other current and long-term liabilities 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 shareholders' equity accounts which are translated at historical rates. (15) 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. (16) Net Loss per 1,000 Shares Computations of net loss 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") mainly in the following respects: (1) 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. As described in Note 2 (15), in Japan, finance leases may be accounted for in the same manner as operating leases. For the years ended March 31, 1999 and 1998, 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. (2) Translation of Foreign Currencies As described in Note 2 (14), assets and liabilities denominated in foreign currencies are translated at historical exchange rates. 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. 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, 1999 by approximately 1,900 million yen ($15,761 thousand) and decrease income before income taxes for the year ended March 31, 1998 by approximately 900 million yen. Financial statements of foreign subsidiaries are translated into Japanese yen in the manner described in Note 2 (14). 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. (3) Inventories As noted in Note 2 (5), the Company and consolidated domestic subsidiaries value inventories at cost. 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. (4) Employees' Retirement Benefits The Company and its domestic consolidated subsidiaries provide for the liability in respect of lump-sum retirement benefits as described in Note 2 (12). Under IAS 19, pension costs are recognized and computed using a particular actuarial 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. (5) 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.