1 KOLON INDUSTRIES, INC. NON-CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED DECEMBER 31, 2010, AND INDEPENDENT AUDITORS REPORT
2 Independent Auditors Report English Translation of a Report Originally Issued in Korean To the Stockholders and Board of Directors of Kolon Industries, Inc.: We have audited the accompanying non-consolidated statement of financial position of Kolon Industries, Inc. (the Company ) as of December 31, 2010, and the related non-consolidated statements of income, appropriations of retained earnings, changes in stockholders equity and cash flows for the year then ended, all expressed in Korean won. These non-consolidated financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these non-consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the Republic of Korea. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the non-consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2010, and the results of its operations, changes in its retained earnings and its stockholders equity, and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the Republic of Korea.
3 Accounting principles and auditing standards and their application in practice vary among countries. The accompanying financial statements are not intended to present the financial position, results of operations, changes in stockholders equity or cash flows in accordance with accounting principles and practices generally accepted in countries other than the Republic of Korea. In addition, the procedures and practices utilized in the Republic of Korea to audit such financial statements may differ from those generally accepted and applied in other countries. Accordingly, this report and the accompanying financial statements are intended for use by those who are knowledgeable about Korean accounting procedures and auditing standards and their application in practice. March 2, 2011 Notice to Readers This report is effective as of March 2, 2011, the auditors report date. Certain subsequent events or circumstances may have occurred between the auditors report date and the time the auditors report is read. Such events or circumstances could significantly affect the accompanying financial statements and may result in modifications to the auditors report.
4 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS OF DECEMBER 31, 2010 A S S E T S 2010 (In Korean won) CURRENT ASSETS: Cash and cash equivalents (Notes 2,14 and 26) 54,732,240,559 Less: government subsidy (Note 2) (4,399,989,903) Short-term financial instruments 130,000,000,000 Accounts receivable - trade (Notes 4, 14 and 16) 422,164,819,986 Less: Allowance for doubtful accounts (Note 2) (5,182,842,394) Accounts receivable - other (Notes 14 and 21) 15,117,918,212 Less: Allowance for doubtful accounts (Note 2) (94,007,478) Accrued income 749,894,568 Short-term loans 488,232,671 Advance payments 3,102,763,638 Prepaid expenses 4,339,650,706 Deposits 5,634,205 Current deferred income tax assets (Notes 2 and 22) 31,601,431,399 Current derivative assets (Notes 2 and 30) 3,342,289,330 Inventories (Notes 2, 5 and 27) 382,554,101,090 Other current assets 198,007,336 Total current assets 1,038,720,143,925 NON-CURRENT ASSETS: INVESTMENT ASSETS: Long-term financial instruments (Note 3) 41,500,000 Available-for-sale securities (Notes 2 and 6) 188,363,583,703 Equity method investment securities (Notes 2, 7 and 28) 640,784,209,598 Long-term loans 915,569,959 Other investments (Note 2) 907,955,419 Total investment assets 831,012,818,679 (Continued)
5 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF FINANCIAL POSITION (CONTINUED) AS OF DECEMBER 31, 2010 A S S E T S 2010 (In Korean won) PROPERTY, PLANT AND EQUIPMENT (Notes 2, 8, 15, 16, 26, 27, 28 and 34): Land 283,506,887,793 Buildings 296,434,335,581 Structures 72,087,229,039 Machinery 1,194,063,152,450 Vehicles 8,423,140,512 Tools and equipment 40,662,774,890 Office equipment 102,239,510,346 Capital lease assets 674,959,902 Construction in progress 69,297,614,625 Total 2,067,389,605,138 Less: Government subsidy (365,070,043) Accumulated depreciation (959,395,920,377) Accumulated impairment loss (129,014,944) Property, plant and equipment, net 1,107,499,599,774 INTANGIBLE ASSETS, NET (Notes 2 and 9): Patents - industrial 18,633,281,764 Goodwill 9,535,104,062 Negative goodwill (5,671,978,177) Other intangible assets 596,266,034 Intangible assets, net 23,092,673,683 OTHER NON-CURRENT ASSETS: Long-term prepaid expense 1,422,867,236 Guarantee deposits (Note 14) 53,734,688,812 Less: Accumulated impairment loss (306,600,000) Long-term accounts receivable - other 997,526,308 Total other non-current assets 55,848,482,356 TOTAL ASSETS 3,056,173,718,417 (Continued)
6 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF FINANCIAL POSITION (CONTINUED) AS OF DECEMBER 31, 2010 LIABILITIES AND STOCKHOLDERS EQUITY 2010 (In Korean won) CURRENT LIABILITIES: Accounts payable - trade (Notes 14 and 16) 352,706,812,870 Short-term borrowings (Notes 12, 28 and 29) 140,000,000,000 Accounts payable - other (Note14) 91,273,593,666 Advance receipts (Note 21) 4,020,659,098 Withholdings (Note 11) 17,117,403,274 Accrued expenses (Note 14) 70,755,226,567 Dividends payable 18,507,356 Income tax payable (Notes 2 and 22) 7,891,348,572 Current portion of bonds payable (Notes 13 and 26) 296,500,000,000 Less: Discount on bonds payable (84,051,651) Current portion of long-term borrowings (Notes 13, 26 and 28) 22,000,000,000 Current derivative liabilities (Notes 2 and 30) 704,027,995 Current portion of capital lease liabilities (Notes 2 and 15) 202,621,886 Total current liabilities 1,003,106,149,633 NON-CURRENT LIABILITIES: Bonds payable (Notes 13 and 26) 400,000,000,000 Less: Discount on bonds payable (160,658,895) Bonds with stock warrants (Notes 2, 13 and 17) 56,205,040,000 Discount on bonds with stock warrants (509,087,910) Redemption premium with stock warrants 5,497,358,758 Adjustment account for stock warrants detachable stock (3,907,703,088) Long-term borrowings (Notes 13, 26 and 28) 141,000,000,000 Long-term accounts payable - other 16,790,141,454 Less: Present value discount (Note 2) (737,587) Long-term accrued expenses (Note 20) 33,720,518 Leasehold deposits received 5,917,079,894 Deposits received 13,028,439,999 Accrued severance indemnities (Note 2) - Net of transfers to the National Pension Fund and deposits for severance indemnities 23,674,850,961 Non-current deferred income tax liabilities (Notes 2 and 22) 70,393,698,203 Non-current derivative liabilities (Notes 2 and 30) 836,711,837 Capital lease liabilities (Notes 2 and 15) 305,631,585 Total non-current liabilities 729,104,485,729 Total liabilities 1,732,210,635,362 (Continued)
7 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF FINANCIAL POSITION (CONTINUED) AS OF DECEMBER 31, 2010 LIABILITIES AND STOCKHOLDERS EQUITY 2010 (In Korean won) STOCKHOLDERS EQUITY: Capital stock (Notes 1 and 17): Common stock 117,233,615,000 Preferred stock 13,839,300,000 Total capital stock 131,072,915,000 Capital surplus: Additional paid-in capital (Notes 17 and 31) 717,796,982,378 Other additional capital (Notes 2, 7 and 17) 1,636,719,597 Total capital surplus 719,433,701,975 Capital adjustments: Treasury stock (Note 18) (236,412,382) Total capital adjustments (236,412,382) Accumulated other comprehensive income: Gain on valuation of available-for-sale securities 113,571,798,056 (Notes 2, 6, 19 and 22) Increase in equity of associates 59,821,501,672 (Notes 2, 7, 19 and 22) Decrease in equity of associates (1,177,995,703) (Notes 2, 7, 19 and 22) Gain on valuation of derivatives (Notes 2, 19, 22 and 30) 1,932,950,939 Loss on valuation of derivatives (Notes 2, 19, 22 and 30) (552,071,276) Revaluation surplus reserve (Notes 2, 8 and 22) 89,030,745,979 Total accumulated other comprehensive income 262,626,929,667 Retained earnings: Unappropriated retained earnings 211,065,948,795 Total retained earnings 211,065,948,795 Total stockholders equity 1,323,963,083,055 TOTAL LIABILITIES AND STOCKHOLDERS EQUITY 3,056,173,718,417 (Concluded) See accompanying notes to non-consolidated financial statements.
8 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, (In Korean won) NET SALES (Notes 2, 16, 21, 25 and 34) 3,241,178,403,512 COST OF SALES (Notes 2, 9, 10, 16, 21 and 32) (2,410,661,996,663) GROSS PROFIT 830,516,406,849 SELLING AND ADMINISTRATIVE EXPENSES (Notes 2, 9, 10, 20, 32 and 33) (579,170,142,363) OPERATING INCOME (Notes 25 and 34) 251,346,264,486 NON-OPERATING INCOME (EXPENSES): Interest income (Note 2) 2,710,979,500 Interest expenses (Note 2) (83,858,695,719) Dividends income 1,270,105 Loss on foreign currency transactions, net (Note 2) (131,486,785) Loss on foreign currency translation, net (Note 2) (519,393,807) Gain on transactions of derivatives, net (Notes 2 and 30) 348,518,455 Gain on valuation of derivatives, net (Notes 2 and 30) 88,194,135 Loss on disposal of accounts receivable - trade (Note 4) (6,403,053,200) Gain on disposal of investment securities, net 1,736,512,013 Loss on impairment of investment securities (780,366,085) Equity in income of associates, net (Notes 2 and 7) 72,804,534,952 Loss on disposal of property, plant and equipment, net (1,468,045,204) Loss on impairment of property, plant and equipment (Notes 2 and 8) (129,014,944) Donations (1,924,949,740) Other, net (4,997,470,632) Total (22,522,466,956) (Continued)
9 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF INCOME (CONTINUED) FOR THE YEAR ENDED DECEMBER 31, (In Korean won) INCOME BEFORE INCOME TAX 228,823,797,530 INCOME TAX EXPENSE (Notes 2 and 22) (17,757,848,735) NET INCOME (Notes 19 and 25) 211,065,948,795 INCOME PER SHARE (Notes 23 and 25): Basic net income per common share 12,012 Diluted net income per common share 11,730 (Concluded) See accompanying notes to non-consolidated financial statements.
10 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF APPROPRIATIONS OF RETAINED EARNINGS FOR THE YEAR ENDED DECEMBER 31, (In Korean won) UNAPPROPRIATED RETAINED EARNINGS: Net income 211,065,948,795 End of year 211,065,948,795 APPROPRIATIONS: Legal reserve 3,158,952,355 Dividends (Note 24) 31,589,523,550 Subtotal 34,748,475,905 UNAPPROPRIATED RETAINED EARNINGS TO BE CARRIED FORWARD TO SUBSEQUENT YEAR 176,317,472,890 See accompanying notes to non-consolidated financial statements.
11 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY FOR THE YEAR ENDED DECEMBER 31, 2010 Capital stock Capital surplus Capital adjustment (In Korean won) Accumulated other comprehensive income Retained earnings Total Balance at January 5, 2010 (Date of foundation establishment) 97,465,250, ,643,902, ,417,938, ,527,090,924 Net income ,065,948, ,065,948,795 Exercise of bonds with warrants (Payment in cash) 3,601,690,000 15,921,199, ,522,889,613 Exercise of bonds with warrants (Exchange bonds) 5,975,000 23,321, ,296,485 Acquisition of treasury stock - - ( 236,412,382) - - (236,412,382) Increase of capital 30,000,000, ,543,124, ,543,124,150 Valuation of available-for-sale securities ,024,911,323-69,024,911,323 Change due to equity method - 302,153,807 - (3,006,740,959) - (2,704,587,152) Valuation of derivatives (809,178,701) - (809,178,701) Balance at December 31, ,072,915, ,433,701,975 ( 236,412,382) 262,626,929, ,065,948,795 1,323,963,083,055 See accompanying notes to non-consolidated financial statements.
12 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, (In Korean won) CASH FLOWS FROM OPERATING ACTIVITIES Net income 211,065,948,795 Expenses not involving cash payments: Loss on valuation of inventories (cost of sales) 3,657,237,599 Provision for severance indemnities 19,258,439,577 Depreciation 124,024,819,830 Amortization of intangible assets 7,907,325,783 Stock option compensation expense 122,600,552 Sales promotional expenses 14,434,382,959 Amortization of discount on bonds payable 870,475,179 Amortization of stock warrants adjustment 3,065,484,669 Amortization of present value discount 48,871,124 Loss on foreign currency translation 1,753,434,404 Loss on valuation of derivatives 704,027,995 Loss on disposal of accounts receivable - trade 6,403,053,200 Loss on disposal of investment securities 24,033,787 Loss on impairment of investment securities 780,366,085 Equity in loss of associates 496,890,475 Loss on disposal of property, plant and equipment 1,999,778,348 Loss on impairment of property, plant and equipment 129,014,944 Subtotal 185,680,236,510 Income not involving cash receipts: Reversal of valuation allowance for inventories (cost of sales) (3,062,122,214) Gain on foreign currency translation (1,225,637,994) Gain on valuation of derivatives (792,222,130) Gain on disposal of investment securities (1,760,545,800) Equity in income of associates (73,301,425,427) Gain on disposal of property, plant and equipment (531,733,144) Other (2,052,012) Subtotal (80,675,738,721) (Continued)
13 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 2010 CASH FLOWS FROM OPERATING ACTIVITIES 2010 (In Korean won) Changes in assets and liabilities related to operating activities: Accounts receivable - trade ( 125,751,782,008) Accounts receivable - other 5,872,792,198 Accrued income 435,827,971 Advance payments 6,874,586,753 Prepaid expenses (645,155,079) Deposit (480,000) Current deferred income tax assets (471,628,883) Other current assets (37,653,437) Current derivative assets (895,255,950) Inventories (53,547,541,594) Long-term prepaid expense (1,733,442,311) Guarantee deposits (6,037,571,208) Long-term accounts receivable - other (997,526,308) Accounts payable - trade 44,731,440,313 Accounts payable - other (13,433,458,173) Advance receipts 1,992,703,139 Withholdings (15,022,698,649) Accrued expenses 18,125,424,022 Dividends payable (1,397,990) Income tax payable (712,454,120) Long-term prepaid expense (112,686,662) Deposits received 193,604,320 Succession of accrued severance indemnities from affiliate 660,272,368 Payments of severance indemnities (15,813,711,214) Transfers to National Pension Fund 94,934,300 Pension plan assets (50,126,094,555) Deposits for accrued severance indemnities 35,658,934,498 Non-current deferred income tax liabilities 2,320,277,481 Derivative liabilities 836,711,837 Subtotal (167,543,028,941) Net cash provided by operating activities 148,527,417,643 (Continued)
14 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 2010 CASH FLOWS FROM INVESTING ACTIVITIES 2010 (In Korean won) Cash inflows from investing activities: Withdrawal of short-term financial instruments 20,010,000,000 Collection of short-term loans 670,943,908 Disposal of available-for-sale securities 255,207,782 Disposal of equity method investment securities 9,354,166,817 Proceeds from reduction in capital stock of affiliate by payments of cash 25,000,001,000 Disposal of property, plant and equipment 4,235,057,315 Disposal of intangible assets 75,569,485 Increase of government subsidy 406,901,032 Subtotal 60,007,847,339 Cash outflows for investing activities: Acquisition of short-term financial instruments (150,000,000,000 ) Increase of long-term loans (610,000,000) Acquisition of available-for-sale securities (8,699,874,073 ) Acquisition of equity method investment securities (46,132,135,000 ) Acquisition of other investment securities (171,324,200) Acquisition of property, plant and equipment (159,262,468,112 ) Acquisition of intangible assets (16,753,619,835) Subtotal (381,629,421,220) Net cash used in investing activities ( 321,621,573,881) (Continued)
15 KOLON INDUSTRIES, INC. NON-CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 2010 CASH FLOWS FROM FINANCING ACTIVITIES 2010 (In Korean won) Cash inflows from financing activities: Proceeds from capital increase 295,543,124,150 Proceeds from short-term borrowings 275,700,000,000 Proceeds from issuance of bonds payable 290,000,000,000 Proceeds from exercise of bonds with warrants 19,245,586,154 Proceeds from long-term borrowings 71,000,000,000 Increase in long-term accounts payable - other 8,167,951,262 Increase in deposits received 3,585,657,904 Subtotal 963,242,319,470 Cash outflows for financing activities: Repayment of short-term borrowings (459,925,256,932 ) Repayment of current portion of bonds payable (247,000,000,000) Repayment of current portion of long-term debt (50,875,878,000 ) Repayment of long-term borrowings (4,596,462,250) Decrease in long-term accounts payable - other (5,850,066,306 ) Repayment of capital lease liabilities (188,767,339) Acquisition of treasury stock (236,412,382 ) Decrease in deposits received (4,246,918,649) Subtotal (772,919,761,858) Net cash provided by financing activities 190,322,557,612 NET INCREASE IN CASH AND CASH EQUIVALENTS 17,228,401,374 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 37,503,839,185 CASH AND CASH EQUIVALENTS AT END OF YEAR 54,732,240,559 (Concluded) See accompanying notes to non-consolidated financial statements.
16 KOLON INDUSTRIES, INC. NOTES TO NON-CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED DECEMBER 31, GENERAL: Kolon Industries, Inc. (the Company ) was newly established on January 5, 2010, from split-off of Kolon Corporation, which spun off all business divisions on December 31, 2009, in order to engage primarily in manufacturing and selling fibers and industrial materials such as films, electronic materials, plastics, tire cord and specialty chemicals, clothes, sport and leisure products. As of December 31, 2010, the capital stock of the Company is 131,072,915 thousand (including 13,839,300 thousand of preferred stock). As of December 31, 2010, the shares of common stock are held by the following: Number of shares Ownership ratio Kolon Corporation 7,495, % Doray (Japanese Company) 1,021, % Others 14,924, % Treasury stock 5, % Total 23,446, % The largest stockholder does not own preferred stock as of December 31, The shares of preferred stock are held by other companies and individual stockholders. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: a. Basis of Financial Statement Presentation The Company maintains its official accounting records in Korean won and prepares nonconsolidated financial statements in the Korean language (Hangul) in conformity with the accounting principles generally accepted in the Republic of Korea. Certain accounting principles applied by the Company that conform with financial accounting standards and accounting principles in the Republic of Korea may not conform with generally accepted accounting principles in other countries. Accordingly, these non-consolidated financial statements are intended for use by those who are informed about Korean accounting principles and practices. The accompanying nonconsolidated financial statements have been condensed, restructured and translated into English (with certain expanded descriptions) from the Korean language financial statements. Certain information included in the Korean language financial statements, but not required for a fair presentation of the Company s financial position, results of operations, changes in stockholders equity or cash flows, is not presented in the accompanying non-consolidated financial statements.
17 The accompanying non-consolidated financial statements to be submitted to the Company s general stockholders meeting were approved by the Board of Directors on February 14, b. Cash and Cash Equivalents Cash and cash equivalents include cash, substitute securities including checks issued by others, and checking accounts, ordinary deposits and financial instruments, which can be easily converted into cash and whose value changes due to changes in interest rates are not material, with maturities (or date of redemption) of three months or less from acquisition. c. Allowance for Doubtful Accounts The Company provides an allowance for doubtful accounts to cover estimated losses on receivables (accounts receivable - trade, accounts receivable - other, loans and other), based on collection experience and analysis of the collectibility of individual outstanding receivables. d. Inventories Inventories with cost determined using the moving average method, except for goods in transit, for which cost is determined using the specific identification method. The Company maintains perpetual inventory system, which is adjusted to physical inventory counts performed at year-end. When the market value of inventories (net realizable value for merchandise and current replacement cost for supplies) is less than the carrying value, carrying value is stated at the lower of cost or market. The Company applies the lower of cost or market method by group of inventories, and loss on inventory valuation is presented as a deduction from inventories and charged to cost of sales. However, when the circumstances that previously caused inventories to be written down below cost no longer exist and the new market value of inventories subsequently recovers, the valuation loss is reversed to the extent of the original valuation loss and the reversal is deducted from cost of sales. e. Securities (Excluding the Equity Method Investment Securities) Debt and equity securities are initially stated at the market value of consideration given for acquisition (market value of securities acquired if market value of consideration given is not available) plus incidental costs attributable to the acquisition of the securities and are classified into trading, available-for-sale and held-to-maturity securities depending on the purpose and nature of acquisition. The Company presents trading securities as short-term investment securities, and available-for-sale securities and held-to-maturity securities as short-term or long-term investment securities depending on their nature in the non-consolidated statement of financial position. In addition, the moving average method for equity securities and the specific identification method for debt securities are used to determine the cost of securities for the calculation of gain (loss) on disposal of those securities.
18 - Trading securities Securities that are bought and held principally for sale in the near term to generate profits from short-term price differences are classified as trading securities. Trading securities are recorded at their fair value, and valuation gains or losses from trading securities are recorded in current earnings. - Held-to-maturity securities Debt securities whose payment terms for principal and interest are fixed or determinable by a contract and for which the management has an intent and ability to hold until maturity are classified as held-to-maturity securities in the non-current assets section. However, if the maturity of a held-to-maturity security is within one year from the end of the reporting period, it is presented as a current asset. Held-to-maturity securities are recorded at their amortized cost with the difference between the acquisition cost and the par value being amortized over the payment periods of the securities using the effective interest method. Such amortization is reflected in interest income. When the amortized cost exceeds the recoverable value, the excess amount is recognized in the current operations as impairment loss. If the value of impaired securities subsequently recovers and the recovery objectively relates to an event arising after the period when the impairment loss was recorded, such recovery is credited in the current operations up to the amortized cost, which would have been recorded if the impairment loss had not been recorded. - Available-for-sale-securities Debt and equity securities that do not fall under the classification of trading or held-to-maturity securities are categorized and presented as available-for-sale securities included in investment assets. However, if an available-for-sale security matures or it is certain that such security will be disposed of within one year from the end of the reporting period, it is classified as a current asset. Available-for-sale securities are recorded at fair value. Unrealized gain or loss from available-forsale securities is presented as gain or loss on valuation of available-for-sale securities included in accumulated other comprehensive income (loss) in stockholders equity. In addition, accumulated gain or loss on valuation of available-for-sale securities is reflected in either gain or loss on disposal of available-for-sale securities or loss on impairment of available-for-sale securities upon disposal or recognition of impairment of the securities. However, available-for-sale equity securities that are not marketable and whose fair value cannot be reliably measured are recorded at acquisition cost.
19 When there is objective evidence that the available-for-sale securities are impaired and the recoverable amount is lower than the cost (amortized cost for debt securities) of the available-forsale securities, an impairment loss is recognized as loss on impairment of available-for-sale securities in non-operating expense and the related unrealized gain or loss remaining in stockholders equity is adjusted to impairment loss. If the value of impaired securities subsequently recovers and the recovery can be objectively related to an event occurring after the impairment loss was recognized, the reversal of impairment loss can be recognized up to the previously recorded impairment loss as a reversal of loss on impairment of available-for-sale securities in non-operating income. However, if the fair value increases after the impairment loss is recognized but does not relate to the recovery of impairment loss as described above, the increase in fair value is recorded in stockholders equity. f. Equity Method Investment Securities Investments in equity securities of companies, over which the Company exercises significant influence, are reported using the equity method of accounting. - Accounting for changes in the equity of the investee Under the equity method of accounting, the Company records changes in its proportionate equity of the net assets of the investee depending on the nature of the underlying changes in the investee as follows: (i) equity in income (loss) of associates in the non-operating income (expense) for net income (loss) of the investee; (ii) increase (decrease) in retained earnings of associates in the retained earnings for changes in beginning retained earnings of the investee; (iii) increase (decrease) in equity of associates in accumulated other comprehensive income (loss) for other changes in stockholders equity of the investee. When the equity method investee s unappropriated retained earnings carried over from prior period change due to significant error corrections, the Company records the changes in equity as equity in income (loss) of associates included in the non-operating income (expense) if the impact of the changes on the Company s non-consolidated financial statements is not significant. If the changes result from the changes in accounting policies of the equity method investee, they are reflected in unappropriated retained earnings carried over from prior period in accordance with Statements of Korea Accounting Standards (SKAS) on changes in accounting policy and error corrections. When the investee declares cash dividends, the dividends to be received are deducted directly from equity method investment securities. - Treatment of investment difference Difference between the acquisition cost and the Company s proportionate equity in the fair value of net assets of the investee upon acquisition ( investment difference ) is considered as (negative) goodwill and accounted for in accordance with accounting standards for business combination. The goodwill portion is amortized over useful lives (within 10 years) on a straight-line method, while the negative goodwill portion is amortized over the weighted-average useful lives of depreciable non-monetary assets of the investee. The amortization is included in equity in income (loss) of associates.
20 When the Company s equity interest in the investee increases due to an increase (or decrease) in contributed capital with (or without) consideration, the change in the Company s proportionate equity in the investee is accounted for as investment difference. If the Company s equity interest decreases, the changes are accounted for as gain (loss) on disposal of the equity method investment securities. However, if the investee is the Company s subsidiary, those changes are recorded as capital surplus (capital adjustments). - Difference between the fair value and book value of net assets of the investee Upon acquisition of the equity method investment securities, the Company s proportionate shares in the differences between the fair values and book values of the identifiable assets and liabilities of the investee are amortized/reversed and included in equity in income (loss) of associates in accordance with the investee s methods of accounting for the assets and liabilities. - Elimination of unrealized gain or loss from intercompany transactions The Company s proportionate share in the gain (loss) arising from transactions between the Company and the investee, which remains in the book value of assets held as of the end of the reporting period, is considered as unrealized gain (loss) and adjusted to equity method investment securities. If the investee is a subsidiary of the Company, unrealized gain (loss) from sale of an asset by the Company to the investee (downstream transaction) is fully eliminated and adjusted to equity method investment securities. - Impairment loss on equity method investment securities When there is objective evidence that the equity method investment securities are impaired and the recoverable amount is lower than the carrying amount of the equity method investment securities, an impairment loss is recognized as loss on impairment of equity method investment securities included in non-operating expense, and the unamortized investment difference is reduced first. When the recoverable amount is recovered after the recognition of impairment loss, the reversal of impairment loss can be recognized as income up to the previously recorded impairment loss. The book value of the equity method investment securities after the reversal of the impairment loss cannot exceed the book value calculated as if the impairment loss had not been originally recognized. The reversal of the impairment loss recognized against the unamortized investment difference is not allowed. - Translation of financial statements of overseas investees For overseas investees whose financial statements are prepared in foreign currencies, the equity method of accounting is applied after assets and liabilities are translated in accordance with the accounting treatments for the translation of the financial statements of overseas subsidiaries for consolidated financial statements. The Company s proportionate share of the difference between assets net of liabilities and stockholders equity after translation into Korean won is accounted for as increase (decrease) in equity of associates included in accumulated other comprehensive income (loss).
21 g. Property, Plant and Equipment Property, plant and equipment are stated at cost (acquisition cost or manufacturing cost plus expenditures directly related to preparing the asset ready for use) and assets acquired from investment in kind, by donation or free of charge in other ways are stated at fair value. However, certain assets that are revalued in accordance with the Korean Assets Revaluation Act and adopted revaluation model for land in accordance with the amendment to SKAS No. 5 are recorded at revalued amounts. Expenditures after acquisition or completion that increase future economic benefit in excess of the most recently assessed capability level of the asset are capitalized. Other expenditures are charged to expense as incurred. Borrowing costs in relation to the manufacture, purchase, construction or development of assets are charged to current operations. When the expected future cash flow from use or disposal of the property, plant and equipment is lower than the carrying amount due to obsolescence, physical damage or other causes, the carrying amount is adjusted to the recoverable amount (the higher of net sales price or value in use), and the difference is recognized as an impairment loss. When the recoverable amount subsequently exceeds the carrying amount of the impaired asset, the excess is recorded as a reversal of impairment loss to the extent that the reversed asset does not exceed the carrying amount before previous impairment as adjusted by depreciation. In addition, the Company applies revaluation model to recognize the Company land s book value after acquisition. For this reason, the Company s land was recorded at revalued amount in 2009 before split-off. Depreciation is computed using the straight-line method (except for machinery, vehicles, tools and equipment, office equipment, which are depreciated using the declining-balance method) based on the following useful lives: Useful lives (years) Buildings Structures 5 40 Machinery 5 20 Vehicles 4 5 Tools and equipment 4 5 Office equipment 4 5 An asset whose use is discontinued and which is held for disposal or retirement is no longer depreciated. The carrying amount of the asset upon discontinuance of its use is reclassified into an investment asset and tested for impairment at each fiscal year-end.
22 h. Intangible Assets To assess whether an internally generated intangible asset meets the recognition criteria, the Company classifies the generation process into a research phase and a development phase. All costs incurred during the research phase are expensed as incurred and included in selling and administrative expense. Costs incurred during the development phase are recognized as assets only if they satisfy all criteria for recognition. An intangible asset is recognized only if (1) it is probable that future economic benefits that are attributable to the asset will flow into the entity and (2) the cost of the asset can be measured reliably. If the costs incurred fail to satisfy all of these criteria, they are recorded as manufacturing cost as incurred. Intangible assets are initially recognized at acquisition cost (purchase cost plus expenditures directly related to preparing the asset ready for use) and subsequently presented at amortized cost using the straight-line method, with amortization from the time the asset is available for use. Intangible assets are amortized based on the following useful lives: Useful lives (years) Patents - industrial 5 Goodwill 5 10 Other intangible assets 5 20 Negative goodwill is amortized using subsidiary s weighted-average useful life (12.02 years) of non-depreciable non-monetary assets by straight-line method. i. Government Subsidy and Others Government subsidy and contribution for construction granted for the purpose of acquisition of certain assets are recorded as a deduction from the assets granted or other assets acquired for temporary use of the assets granted. When the related assets are acquired, they are recorded as a deduction from the acquired assets and are offset against the depreciation of the acquired assets over their useful lives. In addition, government subsidy and contribution for construction without any repayment obligation are offset against the related expenses for which they are intended to be compensated; however, if there is no matching expense, they are recorded as operating revenue or non-operating revenue depending on whether they are directly related to the Company s principal operating activities. Government subsidy and contribution for construction with a repayment obligation are recorded as a liability.
23 j. Present Value Discount for Receivables and Payables Receivables or payables from long-term installment transactions, long-term loans/borrowings or the other similar transactions are stated at present value, which is determined by discounting total receivable or payable amounts in the future using the effective interest rate, if the nominal value is significantly different from the present value. The discount or premium resulting from the determination of present value is reported in the non-consolidated statement of financial position as a direct deduction from or addition to the nominal value of the related receivables or payables, and the amortization by the effective interest rate method is included in the income (loss) during the period. k. Translation of Assets and Liabilities Denominated in Foreign Currency Transactions denominated in foreign currencies are recorded in Korean won translated at the exchange rate prevailing on the transaction date, and the resulting gain (loss) from foreign currency transactions is included in non-operating income (expense). Monetary assets and liabilities denominated in foreign currency are translated into Korean won at the base rates announced by Seoul Money Brokerage Services, Ltd. at the end of the reporting period, which were 1, to USD 1.00 at December 31, l. Accrued Severance Indemnities In accordance with the Company s policy, all employees with more than one year of service are entitled to receive lump-sum severance payments upon termination of their employment, based on their current rates of salary and years of service. The accrual for severance indemnities is computed as if all employees were to terminate as of the end of the reporting period and amounted to 74,201,528 thousand for the year ended December 31, In accordance with the National Pension Law of Korea, a portion of its severance indemnities that had been transferred in cash to the National Pension Fund through March 1999 for the transferred employees is presented as a deduction against accrued severance indemnities. The Company has insured a portion of its obligations for severance indemnities by making deposits that will be directly paid to employees by Samsung Life Insurance and Dongyang Life Insurance, and records them as deposits for severance insurance deposits, which are directly deducted from accrued severance indemnities. Since current year, the Company provides defined benefit plan to its employees, and benefit plan asset or pension asset is deducted from accrued severance indemnities. If an employee s service period met the requirement to receive the benefit payment and elected to be the recipient of such severance payment upon termination, present value of total severance liability to be paid to the terminated employee subsequent to the end of reporting period is estimated, recorded as severance payable and added to accrued severance indemnities.
24 Actual payments for severance indemnities totaled 15,813,711 thousand for the year ended December 31, m. Derivative Instruments The Company records rights and obligations arising from derivative instruments in assets and liabilities, which are stated at fair value. Gains and losses that result from the changes in the fair value of derivative instruments are recognized in current earnings. However, for derivative instruments for which the cash flow hedge accounting applies to, the effective portion of the gain or loss on the derivatives instruments is recorded as gain (loss) on valuation of derivatives included in accumulated other comprehensive income (loss). n. Accounting for Leases A lease is classified as a finance lease or an operating lease depending on the extent of transfers to the Company of the risks and rewards incidental to ownership. If a lease meets any one of the following criteria, it is accounted for as finance lease, and all other leases are treated as operating leases: The lease transfers ownership of the asset to the lessee by the end of the lease term; The lessee has the option to purchase the asset at a bargain price and it is certain that the option will be exercised; The lease term is for the major part (75% or more) of the economic life of the asset even if title is not transferred; At the date of lease commencement, the present value of the minimum lease payments amounts to at least substantially all (90% or more) of the fair value of the leased asset; or The leased assets are of such a specialized nature that only the Company can use them without major modifications. For operating leases, lease payments excluding guaranteed residual value are recognized as an expense on a straight-line basis over the lease term and contingent rent is expensed as incurred. Finance leases are recognized as assets and liabilities at the lower of fair value of the leased property or the present value of the minimum lease payments discounted using the implicit interest rate of the lessor (or the Company s incremental borrowing rate if the implicit interest rate is not practicable to determine). Any initial direct costs incurred by the Company are added to the amount recognized as an asset. The depreciation policy for depreciable leased assets is consistent with that for the similar depreciable assets that are owned by the Company. Annual minimum lease payments excluding guaranteed residual value are allocated to interest expense, which is calculated using the effective interest rate, and finance lease repayment amount. Contingent rents relating to finance are charged as expenses in the periods in which they are incurred; however, if the amount is material, they are allocated to principal and interest over the remaining lease term.
25 o. Convertible Bonds or Bonds with Stock Warrants When issuing convertible bonds or bonds with stock warrants, the proceeds from issuance are allocated between the liability feature, representing the straight bonds; and the equity feature, representing the conversion right or the stock acquisition right. The amount allocated to the equity feature is recognized as consideration for the conversion right or stock warrants and is classified as other paid-in capital. When additional stocks are issued as a result of the exercise of the conversion right or the stock warrants, it is reclassified as paid-in capital in excess of par value. Interest expense on a convertible bond or a bond with stock warrant is measured by applying the effective interest rate of the straight bond to the book value of the bond. The book value of the bond refers to the amount measured by adjusting 1) Bond discount or premium, 2) Conversion right adjustment or stock warrant adjustment and 3) Premium on bond redemption (when there are specific payment terms) to the face value of the bond. p. Revenue Recognition Revenue generated from sale of goods is recognized upon delivery; however, revenue is recognized when the terms of the sales have been fully met if there are sales terms related to postdelivery. Revenue recognition on service or construction contract is recognized based on percentage-ofcompletion method. When loss from service or construction contract is probable, the loss is immediately recognized as provision for construction losses and charged to cost of sales or cost of construction in the same period. In addition, when the Company has an obligation for construction warranty after the construction or service is complete, total estimated construction warranty expense is included in cost of construction or service in the fiscal year during which the construction is completed or service is rendered, and records the provision for construction warranty liability in the statement of financial position. q. Income Tax When the Company recognizes deferred income tax asset or liability for the temporary differences between the carrying amount of an asset and liability and tax base, a deferred income tax liability for taxable temporary difference is fully recognized except to the extent in accordance with related SKAS, while a deferred tax asset for deductible temporary difference is recognized to the extent it is almost certain that taxable profit will be available against which the deductible temporary difference can be utilized. Deferred income tax asset (liability) is classified as current or non-current asset (liability) depending on the classification of related asset (liability) in the statement of financial position. Deferred income tax asset (liability), which does not relate to specific asset (liability) account in the statement of financial position such as deferred income tax asset recognized for tax loss carryforwards, is classified as current or non-current asset (liability) depending on the expected reversal period. Deferred income tax assets and liabilities in the same tax jurisdiction and in the same current or noncurrent classification are presented on a net basis. Current and deferred income tax expense are included in income tax expense in the statement of income, and additional income tax or tax refunds for the prior periods are included in income tax expense for the current period when recognized.
26 However, income tax resulting from transactions or events, which was directly recognized in stockholders equity in current or prior periods, or business combinations is directly adjusted to equity account or goodwill (or negative goodwill). 3. RESTRICTED DEPOSITS: Details of restricted deposits as of December 31, 2010, are as follows (in thousands of Korean won): Account Business acquaintance This year Description Long-term Woori Bank 6,000 Guarantee deposits financial Daegu Bank 2,500 for checking accounts instruments Korea Exchange Bank 4,500 SC Korea First Bank 1,500 Kookmin Bank 5,000 Shinhan Bank 9,500 Hana Bank 7,500 Korea Development Bank 3,000 Industrial Bank of Korea 2,000 Total 41, TRANSFERS OF TRADE ACCOUNTS RECEIVABLE: Trade accounts receivable sold at discount with recourse by the Company amounted to 693,836,325 thousand for the year ended December 31, Loss on disposal of trade account receivable totaling 6,403,053 thousand for the year ended December 31, 2010, was recorded in non-operating expense. Trade accounts receivable sold at discount with recourse by the Company, which have not matured as of December 31, 2010, are as follows (in thousands of Korean won): Account 2010 Trade accounts receivable 145,290,666
27 5. INVENTORIES: The lower of cost or market method for inventories as of December 31, 2010, is summarized as follows (in thousands of Korean won): Account Acquisition cost Lower of cost or market value Valuation allowance Merchandise 119,712, ,818,878 (8,893,712) Finished goods 99,967,166 98,127,329 (1,839,837) Semifinished goods 80,108,346 79,225,661 (882,685) Work in process 2,833,833 2,833,833 - Raw materials 51,882,034 51,688,862 (193,172) Byproducts 3,088,486 3,088,486 - Supplies 25,909,013 25,909,013 - Goods in transit 10,862,039 10,862,039 - Total 394,363, ,554,101 (11,809,406) 6. AVAILABLE-FOR-SALE SECURITIES: Available-for-sale securities as of December 31, 2010, are summarized as follows: (1) Summary of available-for-sale securities (in thousands of Korean won): Acquisition cost Fair value or net asset value Book value Accumulated unrealized gain (loss) (Note) Accumulated impairment loss EQUITY SECURITIES Marketable equity securities 20,314, ,812, ,812, ,497,706 - Non-marketable equity securities 11,724,125 11,317,493 11,317,493 15,918 (422,550) Subtotal 32,038, ,129, ,129, ,513,624 (422,550) DEBT SECURITIES Subordinated bonds 9,642,821 9,734,066 9,734,066 91,245 - Convertible bonds 1,500,000 1,500,000 1,500, Subtotal 11,142,821 11,234,066 11,234,066 91,245 - Total 43,181, ,363, ,363, ,604,869 (422,550) (Note) Unrealized gain (loss) is the amount before adjustment of deferred income tax.
28 (2) Summary of marketable equity securities (in thousands of Korean won, except for shares): Shares Acquisition cost Fair value (Note) Book value Accumulated unrealized gain (loss) Accumulated impairment loss Capro Corporation 7,955,218 14,636, ,684, ,684, ,047,773 - The Korea Express Co., Ltd. 33,204 5,677,884 3,127,817 3,127,817 (2,550,067) - Total 20,314, ,812, ,812, ,497,706 - (Note) The fair value of a marketable security that is traded in an active public securities market refers to the quoted market price, which is the closing price quoted as of the end of the reporting period. However, if the closing price quoted as of the end of the reporting period is not available, the closing price quoted as of the immediately preceding trade date may be deemed as the fair value of a marketable security. (3) Summary of non-marketable equity securities (in thousands of Korean won, except for ownership ratio): Ownership ratio Acquisition cost Fair value or net asset value Book value Accumulated unrealized gain (loss) Accumulated impairment loss The Korea Economic Daily (Note 1) 0.05% 127, , , Korea Chemical Fibers Association 3.21% 22, (22,500) R-Stech Corporation (Note 1) 6.00% 700, , , Daegu Industrial Complex (Note 1) Daegu Complex Association (Note 1) Society Development Association (Note 1) - 5,000 5,000 5, Kolon Credit Union (Note 1) - 5,000 5,000 5, Korean International School-Hong Kong (Note 1) - 9,989 9,989 9, Korea Specialty Contractor Financial Cooperative - 107, , ,383 15,918 - HANJU Corp. (Note 1) 1.70% 96,000 96,000 96, Kihyup Technology Banking Corp. (Note 1) 0.34% 100, , , NPlatform 1.68% 190,370 90,320 90,320 - (100,050) Espopia 3.84% 300, (300,000) Golee Co., Ltd. (Note 1) CU Media (Note 1) 6.90% 3,119,262 3,119,262 3,119, Real Estate Fund (Note 1) - 6,939,874 6,939,874 6,939, Total 11,724,125 11,317,493 11,317,493 15,918 (422,550)