Address: 8F, No.3-1, YuanQu St., Taipei 115, Taiwan, R.O.C. (NanKang Software Park) Telephone:

Transcription

1 CONSOLIDATED FINANCIAL STATEMENTS WITH REPORT OF INDEPENDENT AUDITORS FOR THE YEARS ENDED DECEMBER 31, 2012 AND 2011 Address: 8F, No.3-1, YuanQu St., Taipei 115, Taiwan, R.O.C. (NanKang Software Park) Telephone: The reader is advised that these financial statements have been prepared originally in Chinese. In the event of a conflict between these financial statements and the original Chinese version or difference in interpretation between the two versions, the Chinese language financial statements shall prevail. 1

2 INDEX Items Pages Cover 1 Index 2 Report of Independent Auditors 3 Consolidated Balance Sheets 4 Consolidated Statements of Income 5 Consolidated Statements of Changes in Stockholders Equity 6 Consolidated Statements of Cash Flows 7 Notes to Consolidated Financial Statements

3 To Sercomm Corporation REPORT OF INDEPENDENT AUDITORS English Translation of a Report Originally Issued in Chinese We have audited the accompanying consolidated balance sheets of Sercomm Corporation and subsidiaries (the Company ) as of December 31, 2012 and 2011, and the related consolidated statements of income, changes in stockholders equity and cash flows for the years ended December 31, 2012 and These consolidated financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Guidelines for Certified Public Accountants Examination and Reporting on Financial Statements and generally accepted auditing standards in the Republic of China. 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sercomm Corporation and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for the years then ended, in conformity with Business Entity Accounting Act, Regulation on Business Entity Accounting Handling with respect to financial accounting standards, Guidelines Governing the Preparation of Financial Reports by Securities Issuers, and generally accecpted accounting principles in the Republic of China. As described in Note 3 to the consolidated financial statements, effective from January 1, 2011, the Company has adopted the third revision of the Statement of Financial Accounting Standards No. 34, Financial Instruments: Recognition and Measurement of the Republic of China. March 19, 2013 Taipei, Taiwan Republic of China Notice to Readers The accompanying consolidated financial statements are intended only to present the consolidated financial position, results of operations and cash flows in accordance with accounting principles and practices generally accepted in the Republic of China and not those of any other jurisdictions. The standards, procedures and practices to audit such consolidated financial statements are those generally accepted and applied in the Republic of China. 3

4 English Translation of Consolidated Financial Statements Originally Issued in Chinese CONSOLIDATED BALANCE SHEETS December 31, 2012 and 2011 (Expressed in Thousands of New Taiwan Dollars) As of December 31, As of December 31, Assets Notes Amount % Amount % Liabilities and Stockholders' Equity Notes Amount % Amount % Current assets Current liabilities Cash and cash equivalent 4 $4,660, $3,868, Short-term loans 3 and 28 $1,904, $2,819, Financial assets at fair value through profit or loss-current 2 and 5 1, , Notes payable 107, , Derivative financial assets for hedging 2 and 6 21, Accounts payable 3,959, ,277, Notes receivable-net 2 and 7 301, , Income tax payable 2 and , , Accounts receivable-net 2 and 7 1,513, ,890, Accrued expenses , , Other receivables 7 339, , Financial liabilities at fair value through profit of loss-current 2 and Inventories-net 2 and 8 2,275, ,907, Derivative financial liability for hedging 2 and 6 30, Other current assets 157, , Bond payable- current 2 and , Deferred income tax assets-current 2 and 24 32, , Lease payables-current 2 and 15 19, , Restricted assets 28 26, , Other current liabilities , , Total current assets 9,330, ,976, Total current liabilities 7,436, ,771, Funds and investments Financial assets as fair value through profit or loss-noncurrent 2 and Long-term liabilities Other financial assets-noncurrent , , Bonds Payable 2 and 14 1,287, , Financial assets measured at cost-noncurrent 2 and 9 47, , Lease payables-noncurrent 2 and , , Total funds and investments 183, , Total long-term liabilities 1,600, , Property, plant and equipment 2, 12 and 28 Land 213, , Other liabilities Buildings 1,095, , Accrued pension liabilities 2 and 16 7, , Machinery and equipment 1,476, ,268, Deferred income tax liabilities-noncurrent 2 and 24 8, , Research and development equipment 373, , Total other liabilities 15, , Office and other equipment 147, , Total liabilities 9,052, ,751, Leased assets 457, , Total cost 3,763, ,998, Less: Accumulated depreciation (900,456) (6.98) (714,930) (5.94) Stockholders' equity Construction in progress 16, , Capital 17 Prepayments for equipment 146, , Common stock 1,956, ,826, Property, plant and equipment-net 3,026, ,496, Advance receipts for common stock 16, , Capital reserve 19 Intangible assets 2 and 11 Bonds conversion premiums 2 and , , Computer software cost-net 64, , Employee stock option 2 42, , Other intangible assets 77, , Stock option 2 and , , Land use right , , Retained earnings 20 and 21 Total intangible assets 251, , Legal reserve 362, , Unappropriated earnings 896, , Other assets Adjusting items in stockholders' equity Property not used in operations 2 and 12 14, , Cumulative translation adjustments 2 128, , Refundable deposits 28 29, , Unrealized gain / loss on financial instrument 2 and 5 (8,772) (0.07) - - Deferred charges 2 51, , Total stockholders' equity 3,850, ,272, Deferred income tax asset-noncurrent 2 and 24 15, Total other assets 111, , Total assets $12,903, $12,024, Total liabilities and stockholders' equity $12,903, $12,024, The accompanying notes are an integral part of the consolidated financial statements. 4

5 English Translation of Consolidated Financial Statements Originally Issued in Chinese CONSOLIDATED STATEMENTS OF INCOME For the years ended December 31, 2012 and 2011 (Expressed in Thousands of New Taiwan Dollars, Except for Per Share Data) Notes Amount % Amount % Sales $19,441, $13,515, Less : Sales returns and allowances 173, , Net sales 2 19,267, ,241, Cost of goods sold 8 and 23 16,282, ,261, Gross profit 2,985, ,979, Operating expenses 23 and 27 Selling expenses 573, , General and administrative expenses 571, , Research and development expenses 808, , Subtotal 1,953, ,417, Operating income 1,032, , Non-operating income Interest income 32 34, , Dividend income Gain on disposal of investments , Foreign exchange gain-net , Gain on valuation of financial assets-net 2, 5, 14 and 32 8, , Other income 30, , Total non-operating income 74, , Non-operating expenses Interest expense 12, 14 and 32 84, , Loss on disposal of property, plant and equipment 2 3, , Foreign exchange loss-net 2 21, Impairment loss of financial asset 2 and 9 58, Other losses 4, , Total non-operating expenses 171, , Income from continuing operations before income tax 934, , Income tax expense 2 and 24 (179,880) (0.93) (118,415) (0.89) Net income $754, $583, Before tax After tax Before tax After tax Basic earnings per share (New Taiwan Dollars) 2 and 26 Net income $4.83 $3.90 $3.95 $3.29 Minority interests Stockholders of the parent $4.83 $3.90 $3.95 $3.29 Diluted earnings per share (New Taiwan Dollars) 2 and 26 Net income $4.25 $3.45 $3.38 $2.81 Minority interests Stockholders of the parent $4.25 $3.45 $3.38 $2.81 The accompanying notes are an integral part of the consolidated financial statements. 5

6 English Translation of Consolidated Financial Statements Originally Issued in Chinese CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the years ended December 31, 2012 and 2011 (Expressed in Thousands of New Taiwan Dollars) Capital Retained Earnings Cumulative Unrealized gain Capital collected Capital Unappropriated Translation /loss on financial Treasury Description Notes Common Stock in advance Reserve Legal Reserve Earnings Adjustments instrument Stock Total Balance as of January 1, 2011 $1,747,405 $13,468 $196,598 $273,125 $385,131 $34,841 $- $(53,388) $2,597,180 Appropriation of 2010 retained earning 20 and 21 Legal reserve ,444 (31,444) Cash dividends (267,816) (267,816) Change in cumulative translation adjustments of investees , ,338 Exercise of employee stock options 2 and 18 13,060-1, ,366 Compensation costs for Treasury stock transfer to employees Treasury stock transfer to employees 2 and ,388 53,388 Convertible bonds converted into common stock 2 and 14 65,872 (11,845) 59, ,219 Equity instrument from Convertible bonds 2 and , ,786 Net income in , ,041 Balance as of December 31, ,826,337 1, , , , , ,272,609 Appropriation of 2011 retained earning 20 and 21 Legal reserve ,304 (58,304) Cash dividends (468,684) (468,684) Change in cumulative translation adjustments of investees (33,642) - - (33,642) Exercise of employee stock options 2 and 18 6,350 16,760 14, ,747 Convertible bonds converted into common stock 2 and ,408 (1,623) 124, ,197 Equity instrument from Convertible bonds 2 and , ,371 Net change in unrealized gain/loss on hedging derivative financial instruments 2 and (8,772) - (8,772) Net income in , ,836 Balance as of December 31, 2012 $1,956,095 $16,760 $498,409 $362,873 $896,760 $128,537 $(8,772) $- $3,850,662 The accompanying notes are an integral part of the consolidated financial statements. 6

7 English Translation of Consolidated Financial Statements Originally Issued in Chinese CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 2012 and 2011 (Expressed in Thousands of New Taiwan Dollars) Cash flows from operating activities: Net income $754,836 $583,041 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 315, ,121 Amortization of discount on bonds payable 21,117 14,866 Gain on valuation of financial assets (8,767) (19,079) Loss on disposal of property, plant and equipment 3,405 4,728 Compensation costs for treasury stock transfer to employees Impairment loss of financial asset 58,272 - Changes in assets and liabilities: Financial assets at fair value through profit or loss-current 36,853 (7,609) Notes receivable-net 431,057 (732,669) Accounts receivable-net 377,086 (100,622) Inventories-net (367,893) (591,000) Other receivables (48,554) (157,029) Other current assets 69,735 (40,892) Deferred income tax assets (16,923) (28,651) Notes payable 30,254 34,596 Accounts payable 682,123 1,175,334 Income tax payable 119,412 (39,563) Accrued expenses 172, ,548 Financial liabilities at fair value through profit or loss-current - 5,058 Other current liabilities (84,751) 130,846 Accrued pension liabilities 1, Deferred income tax liabilities (95,547) 91,249 Net cash provided by operating activities 2,451, ,394 Cash flows from investing activities: Increase in restricted assets-current (15,042) (2,903) Increase in other financial assets-noncurrent (664) - Acquisition of property, plant and equipment (825,451) (516,043) Proceeds from disposal of property, plant and equipment 6,487 6,075 Increase in computer software cost (25,911) (25,327) Increase in other intangible assets (28,369) (26,042) Increase in land use right - (7,004) Decrease (increase) in refundable deposits 15,616 (19,447) Increase in deferred charges (31,851) (37,812) Net cash used in investing activities (905,185) (628,503) Cash flows from financing activities: Increase (Decrease) in short-term loans (915,613) 1,336,904 Issuance of bonds payable 595, ,000 Decrease in lease payables (17,125) (15,628) Cash dividends (468,684) (267,816) Exercise of employee stock options 37,747 14,366 Treasury stock transfer to employees - 53,388 Net cash (Used in) provided by financing activities (768,675) 1,716,214 Effects from exchange rate changes 14,231 15,921 Net increase in cash 791,597 1,824,026 Cash at beginning of the year 3,868,609 2,044,583 Cash at end of the year $4,660,206 $3,868,609 Supplemental disclosures of cash flows information: Cash paid for income tax $124,401 $99,722 Cash paid for interest $80,435 $63,432 Financing activities not affecting cash flows: Idle asset transfer in fixed assets $- $78,566 Lease payables-current $19,272 $18,864 Bond payable-current $- $425,426 The accompanying notes are an integral part of the consolidated financial statements. 7

8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2012 and 2011 (Expressed in Thousands of New Taiwan Dollars unless Otherwise Stated) 1. Organization and Operations Sercomm Corporation ( the Company ) was incorporated on July 29, 1992 under the laws of the Republic of China (R.O.C.). The Company primarily engages in the research, development, manufacturing and sale of access server (router), print server and network server. The Company s common shares were traded on the GreTai (Over-the-counter) Securities Market of the R.O.C. in May 1999, and its shares were publicly listed and traded on the Taiwan Stock Exchange (TSE) in December The numbers of employees of the Company and its subsidiaries as of December 31, 2012 and 2011 were 4,172 and 3,977, respectively. 2. Summary of Significant Accounting Policies The consolidated financial statements were prepared in conformity with requirements of the Guidelines Governing the Preparation of Financial Reports by Securities Issuers and accounting principles generally accepted in the Republic of China (R.O.C.). Summary of significant accounting policies is as follows: (1) Summary of consolidation The Company s consolidated financial statements include the following subsidiaries: Percentage of ownership Name of the Name of As of December 31, investors subsidiaries Nature of Business The Company Senslinq Inc. Sales of IT products % % The Company Sercomm Investment holding, % % Investments Ltd. international trading The Company Sercomm Trading Co. Ltd. Investment holding, international trading % % 8

9 Percentage of ownership Name of the Name of As of December 31, investors subsidiaries Nature of Business The Company Shukuan Investment activity % % Investment Ltd. The Company Sercomm France Sales of IT products % % SARL The Company Sercomm Sales of IT products % - Deutschland GmbH (Note A) The Company Sercomm Japan Corp. (Note B) Sales of IT products % % Sercomm Trading Co. Ltd. Zealous Investments Ltd. Sercomm Trading Smart Trade Inc. Co. Ltd. Zealous Sernet Technology Investments Ltd. (Suzhou) Smart Trade Inc. Dwnet Technology (Suzhou) Limited Sercomm France Sercomm Italinan SARL SRL (Note C) Investment holding, international trading % % Investment holding, % % international trading Manufacture of routers, communication products, Wlan products; sales and after-sales service % % Manufacture of routers, % % communication products, Wlan products; sales and after-sales service Sales of IT products % - Note A: Sercomm. Deutschland GmbH incorporated on June, Note B: On July, 2012, the Company acquired 100% shareholding in Sercomm Japan Corp. from Shukuan Investment Ltd. The Company recorded net assets acquired from Shukuan Investment Ltd. on the basis of their carrying value. The acquisition was accounted for as an organization restructuring in accordance with ARDF Interpretation No Note C: Sercomm Italian SRL was incorporated on February,

10 (2) Principles for consolidation Consolidated financial statements were prepared in accordance with the R.O.C. SFAS No.7. Transactions between consolidated entities are eliminated in the consolidated financial statements. Investees in which the Company and subsidiaries hold more than 50% of voting rights, including those that are exercisable or convertible, are consolidated, since the Company and subsidiaries are considered to possess control. Consolidation shall also be implemented if any of the following circumstances exists: i. the total amount of voting rights held in the investee exceeds 50% due to agreement with other investors ii. as permitted by law, or by contract agreements, the Company controls an entity s finances, operations and personnel affairs iii. the Company has authority to appoint or discharge more than half members of board of directors (or equivalents), by whom the investee is controlled iv. the Company leads and controls more than half of the members of the board of directors (or equivalents), by whom the investee is controlled v. other indications of control possession (3) Classification of current and noncurrent assets and liabilities Current assets are assets held for trading purposes and assets expected to be converted to cash, sold or consumed within one year from the balance sheet date. Current liabilities are obligations incurred for trading purposes and obligations expected to be settled within one year from the balance sheet date. Assets and liabilities that are not classified as current are noncurrent assets and liabilities, respectively. (4) Foreign currency transactions and translation of foreign currency financial statements The Company s and subsidiaries accounts are maintained in NTD, USD and RMB. Transactions denominated in foreign currencies are converted into NTD, USD and RMB at exchange rates prevailing at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies are translated into NTD using the exchange rates prevailing at the balance sheet date, with the related exchange gains or losses included in the consolidated statement of income. 10

11 The long-term foreign investments of the Company and the subsidiaries are converted into NTD and USD at exchange rates prevailing at the dates of the transactions. While recording under equity method, the long-term foreign investments of the Company and the subsidiaries are converted into NTD and USD at the weighted-average exchange rate during the reporting period. The long-term foreign investments will be adjusted at the exchange rate prevailing at the balance sheet date. Adjusting differences are recorded as cumulative translation adjustments under stockholders equity. The Company prepares consolidated financial statement. Financial statements of foreign subsidiaries are translated into New Taiwan Dollars ( NTD ) at the exchange rates prevailing at the balance sheet date for assets and liabilities accounts, historical exchange rates for equity accounts, and weighted-average exchange rates during the reporting period for profit and loss accounts. Translation differences resulting from the translation of such financial statement into NTD are recorded as cumulative translation adjustments, a separate component of stockholders equity. (5) Financial assets and financial liabilities In accordance with the R.O.C. SFAS No. 34, Accounting for Financial Instruments and Guidelines Governing the Preparation of Financial Reports by Securities Issuers, financial assets are classified as either financial assets at fair value through profit or loss, derivative financial assets for hedging, financial assets measured at cost or available-for-sale financial assets. When financial assets are recognized initially, they are measured at fair value, plus transaction costs for all financial assets not measured at fair value through profit or loss. Financial liabilities are to be classified as either financial liabilities at fair value through profit or loss, derivative financial liabilities for hedging or financial liabilities measured at cost. The Company and its subsidiaries account for regular purchase or regular sale of financial assets as of the trade date, which is the date the Company and its subsidiaries commit to purchasing or selling the asset. Regular purchase or regular sale is that the delivery period of a transaction for a financial asset is in a regular period or required period by law. 11

12 a. Financial assets and financial liabilities at fair value through profit or loss Financial assets or financial liabilities at fair value through profit or loss are subsequently measured at fair value and changes in fair value are recognized in profit and loss. This category has two sub-categories: financial assets or liabilities held for trading and those designated at fair value through profit or loss at inception. b. Available-for-sale financial assets Available-for-sale financial assets are non-derivative financial instruments not classified as financial assets at fair value through profit or loss, held-to-maturity financial assets, bond investments for which no active market exists. Investments designated as available-for-sale are reported at fair value, with unrealized gains and losses, net of tax, recorded in other items in stockholders equity until the investment is derecognized or until the investment is determined to be impaired at with time the cumulative gain or loss previously reported in equity is included in the statement of operations. c. Derivative financial assets and liabilities for hedging Derivative financial assets and liabilities for hedging that have been designated in hedge accounting relationships and are effective hedging instruments and reported at fair value. d. Financial assets measured at cost Equity investments without reliable market prices, or derivatives linked to and settled in are measured at cost. The fair value of stock of listed companies or beneficiary certification is measured by closing price at balance sheet date. The fair value of open-end funds is measured at the unit price of the net assets at the balance sheet date. (6) Assessment of impairment for account receivables The Company first assesses as of balance sheet date whether objective evidence of impairment exists for notes, accounts and other receivables that are individually significant. If there is objective evidence that an impairment loss has occurred, the amount of impairment loss is assessed individually. For notes, accounts and other receivables other than those mentioned above, the Company groups those assets with similar credit risk characteristics and collectively assess them for impairment. 12

13 (7) Inventories Inventories are valued at the lower of cost and net realizable value. Costs incurred in bringing each product to its present location and condition is accounted for as follows: Raw materials Work in progress and finished goods - purchase cost on a weighted average cost formula basis. - cost of direct materials and labor and a proportion of manufacturing overheads based on normal operating capacity on a weighted average cost formula basis. Net realizable value is the estimated selling price in the ordinary course of business, less estimated costs of completion and the estimated costs necessary to make the sale. (8) Long-term investments accounted for under the equity method Investees wherein the Company exercises significant influence are accounted for by the equity method. According to the R.O.C. SFAS No. 23, Interim Financial Reporting and Disclosures, investment income or loss from investments in companies quarterly is accounted for under the equity method provided that the Company and subsidiaries owns at least 20% in its equity investee. The Company consolidates investee in which the Company owned, directly or indirectly, more than 50% of the voting shares of a company or less than 50% of voting shares but has a controlling financial interest in accordance with the R.O.C. SFAS No. 7, Consolidation of Financial Statements. Stock dividends are recognized only as an increase in the number of shares, and the cost per share has to be recalculated. Cost on disposal of stocks is determined by the weighted-average method. (9) Property, plant and equipment Property, plant and equipment are stated at cost less accumulated depreciation and impairment loss. Significant renewals and improvements are capitalized and depreciated over their estimated useful lives while ordinary repairs and maintenance are expensed as incurred. 13

14 Property being leased to others is classified as other assets and stated at the book value. Property not in use is classified to other assets and stated at the lower of book value or net realizable value. Upon disposal or sale of an item of property, plant and equipment, the related cost, accumulated depreciation and accumulated impairment loss are written off. Gains or losses on disposal of property, plant and equipment are recorded as non-operating income or expense. Depreciation is recognized on a straight-line basis using the estimated economic life of the assets less salvage value, if any. If the main property, plant and equipment are fully depreciated and sub property, plant and equipment are still in use, the depreciation is based on the newly estimated remaining useful life. The estimated economic life of the property, plant and equipment is as follows: Buildings Machinery and equipments Molding equipments Research and development equipments Office and other equipments Leased assets Years 3-10 Years 3-5 Years 3-5 Years 2-5 Years Years Equipments leased under capital lease are carried at the lower of the market value or the present value of the minimum lease payments at the inception date of the lease. Depreciation of leased assets is calculated based on the economic useful lives of years, and recognized as the lease payable. The Company recognizes the implicit interest of rental payments as interest expense in the period. Property leased to others under operating leases is classified as other assets and stated at book value. The value of the assets is depreciated using the straight-line method over the estimated useful lives. (10) Land use right Land use right is stated at cost and amortized over 50 years by using the straight-line method. 14

15 (11) Intangible assets All purchased and in-house developed computer software for manufacturing the Company s products (servers) shall be capitalized. Effective from January 1, 2007, the Company adopted R.O.C. SFAS No. 37 Accounting for Intangible Assets. In accordance with SFAS No. 37, an intangible asset should be measured initially at cost upon acquisition. After initial recognition, an intangible asset should be measured at its cost plus revaluation increment revalued in accordance with laws, less any accumulated amortization and any accumulated impairment losses. Intangible assets with finite useful lives should be amortized over its useful lives with impairment testing. The Company should assess, at each balance sheet date, whether there is any changes of the residual value, amortization period and amortization method of each intangible assets with finite useful lives. Such changes shall be accounted for as changes in accounting estimates. The Company s research and development project needs to consider the research phase and the development phase. If is unable to distinguish, all regards as research phase. Expenditure on research shall be recognized as an expense when it is incurred. The cost of development activities should be capitalized as intangible assets if, and only if, the Company can demonstrate all of the following. Otherwise, the cost of development activities should be expensed as incurred. a) the technical feasibility of completing the intangible asset so that it will be available for use or sale. b) its intention to complete the intangible asset and use or sell it. c) its ability to use or sell the intangible asset. d) how the intangible asset will generate probable future economic benefits. e) the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset. f) its ability to measure reliably the expenditure attributable to the intangible asset during its development. 15

16 The Company s policies for intangible assets are summarized at the table below: Description Estimated economic life Amortization method Computer software cost 2-5 years Straight-line method Development expenditures 5 years Straight-line method (12) Deferred charges Molding and product testing expenditures are amortized on a straight-line basis over their estimated economic lives, 2-5 years. (13) Convertible bonds The liability component of the convertible bonds is measured first, and the difference between the proceeds of the bond issued and the fair value of the liability is accounted for as the equity component. The embedded derivative is accounted for in accordance with the requirements under the R.O.C. SFAS No.34. The liability component is subsequently measured at amortized cost using effective interest rate method, and changes in fair value of the equity component are not recognized while changes in fair value of the embedded derivatives are reported to the income statement as valuation gains or losses on Financial Instruments. When the conversion option expires unexercised and at that time the market value of the common stock under conversion exceeds the put price, put premium should be credited to capital reserve, if the market value is otherwise lower than the put price, then it is recognized in profit or loss. When the bond holder exercises the conversion option before bond maturity, the adjusted carrying value of the liability components (including bonds and embedded derivatives) is credited to a capital stock account along with the carrying amount of the stocks converted. Bond issuance costs were allocated proportionately to the convertible bonds and embedded derivates based on their respective balances upon initial recognition. (14) Derecognition of financial assets and liabilities a. Financial assets The Company and its subsidiaries derecognize their financial assets or part of the financial assets when losing control of the contractual rights from the financial assets or part of the financial assets. When the Company and its subsidiaries transfer all or part of their financial assets and relinquish control of the financial assets, this transaction is considered as a sale within the range of exchange with reward. 16

17 When a transfer of a financial asset does not satisfy conditions required to be considered as lose of contro1, the Company and its subsidiaries treat the transfer as a guaranteed borrowing. The financial asset is not considered financial derivatives. b. Financial liabilities The Company and its subsidiaries derecognize their financial liabilities or part of the liabilities when extinguished by discharge, cancellation, or expiration of contractual obligation. When there has been an exchange of an existing financial liabilities between the Company and its subsidiaries and the creditor with substantially different terms, or there has been a substantial modification of the terms of the existing financial liabilities, and a simultaneous assumption of obligation from new financial liabilities, this transaction is accounted for as an extinguishment of the original financial liabilities and the recognition of new financial liabilities. A gain or loss from extinguishment of the original financial liability is recognized in the income statement. (15) Impairment of financial assets The Company assesses whether financial assets are impaired at each balance sheet date. Impairment of financial assets is measured by different methods as described below: a. Financial assets measured at cost If there is objective evidence that an impairment loss exists on an unquoted equity instrument that is not carried at fair value because its fair value cannot be reliably measured, or on a derivative asset that is linked to and must be settled by delivery of such an unquoted equity instrument has been incurred, the amount of the loss is measured as the difference between the asset s carrying amount and the present value of estimated future cash flows discounted at the current market rate of return for a similar financial asset. The impairment loss is not allowed to reverse. b. Available-for-sale financial assets If available-for-sale assets are impaired, an amount comprising the difference between its cost (net of any principal payment and amortization) and its current fair value, less any impairment loss previously recognized in profit or loss, is transferred from equity to the income statement. Reversals in respect of equity instruments classified as available-for-sale are not recognized in profit. Reversals of impairment losses on debt instruments are reversed through profit or loss; if the increase in fair value of the instrument can be objectively related to an event occurring after the impairment loss was recognized in profit or loss. 17

18 (16) Assets impairment Pursuant to the R.O.C. SFAS No. 35, Accounting for Asset Impairment the Company assesses indicators of impairment for all its assets within the scope of the standard at each balance sheet date. If impairment is indicated, the Company compares the carrying amount with the recoverable amount of the assets or the cash-generating unit ( CGU ) associated with the asset and writes down the carrying amount to the recoverable amount where applicable. Recoverable amount is defined as the higher of fair values less costs to sell and the values in use. For previously recognized losses, the Company shall assess, at each balance sheet date, whether there is any indication that the impairment loss may no longer exist or may have decreased. If there is any such indication, the Company has to recalculate the recoverable amount of the asset. If the recoverable amount increases as a result of the increase in the estimated service potential of the assets, the Company shall reverse the impairment loss to the extent that the carrying amount after the reversal would not exceed the carrying amount that would have been determined (net of amortization or depreciation) had no impairment loss been recognized for the assets in prior years. Impairment loss (reversal) is classified as non-operating losses (income). (17) Pension plan All regular employees are entitled to a defined benefit pension plan that is managed by an independently administered pension fund committee within the Company according to the Labor Standards Law of the R.O.C. Fund assets are deposited in the committee s name in the Bank of Taiwan and hence, not associated with the Company. Therefore the fund assets are not be included in the Company s financial statements. The Labor Pension Act of the R.O.C. (the Act), which adopts a defined contribution plan, became effective on July 1, In accordance with the Act, employees may choose to elect either the Act, by retaining their seniority before the enforcement of the Act, or the pension mechanism of the Labor Standards Law. For employees who elect the Act, the Company will make monthly contributions of no less than 6% of the employees monthly wages to the employees individual pension accounts. 18

19 The accounting for pension is computed in accordance with the R.O.C. SFAS No.18, Accounting for Pensions. Net pension costs of the defined benefit plan are recorded based on an actuarial valuation. Pension cost components such as service cost, interest cost, expected return on plan assets, the amortization of net obligation at transition, pension gain or loss, and prior service cost, are all taken into consideration by the actuary. The Company recognizes expenses from the defined contribution pension plan in the period in which the contribution become due. The pension plan of foreign subsidiaries is estimated at local related regulation. (18) Employee stock option plan The Company uses intrinsic value method to recognize compensation cost for its employee stock options issued between January 1, 2004 and December 31, 2007, in accordance with Accounting Research and Development Foundation interpretation Nos ~072. For stock options granted on or after January 1, 2008, the Company recognizes compensation cost using the fair value method in accordance with R.O.C. SFAS No. 39 Accounting for Share-Based Payment. In accordance with R.O.C. SFAS No. 39, share-based payment transaction is measured by reference to the fair value of the equity instruments at the date on which they are granted; the fair value is determined by an external expert using an appropriate pricing model. The Company only enters into equity-settled share-based payment transaction with its and its subsidiaries employees. Pursuant to R.O.C. SFAS No. 39, the goods or services received under such transaction, and the corresponding increase in equity, shall be measured by reference to the fair value of the equity instruments granted. If there is no vesting condition attached, then the equity instrument is vested immediately, with the employee compensation costs recognized as at the grant date, with a corresponding increase in equity. If the equity instrument is vested over a certain period, then the employee compensation costs are recognized over the period, with a corresponding increase in equity. In valuing the fair value of the equity instrument granted, no account is taken of any vesting conditions other than market conditions. Instead, non-market vesting conditions shall be taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount, so that, ultimately, the amount recognized for goods or services received as consideration for the equity instruments granted shall be based on actual number of equity instruments that eventually vest. For grants of equity instruments with market conditions, the Company shall recognize the goods or services received from a counterparty that satisfies all other vesting conditions, irrespective of whether the market condition is satisfied. 19

20 (19) Employee bonuses and remunerations paid to directors and supervisors In accordance with Accounting Research and Development Foundation interpretation No effective January 1, 2008, employee bonuses and remunerations paid to directors and supervisors are charged to expense at fair value and are no longer accounted for as an appropriation of earnings. (20) Treasury stock The Company adopts the R.O.C. SFAS No. 30, Accounting for Treasury Stocks, which requires the treasury stock held by the Company to be accounted for under the cost method. The cost of treasury stock is shown as a deduction to stockholders equity, while any gain or loss from selling treasury stock is treated as an adjustment to capital reserve. If there is any deficiency, it is debited against retained earnings. (21) Revenue recognition The Company and its subsidiaries recognize revenue when the product or service has been delivered and significant risk has been transferred. The Company and its subsidiaries and their customers have agreed to use fair value in determining the sales prices, taking into account the related sales discounts. Since the receivables are collected within one year and such transactions are frequent, fair value of the receivables is equivalent to the nominal amount of the cash to be received. (22) Capital expenditure versus operating expenditure Expenditure exceeds a predetermined amount is capitalized when it is probable that the Company will receive future economic benefits associated with the expenditure. Otherwise, the expenditure is expensed as incurred. (23) Unrealized gain (loss) on inter-affiliate accounts Unrealized intercompany gains and losses arising from sales from the Company and its subsidiaries to equity method investees are eliminated in proportion to the Company s year-end ownership percentage until realized through transactions with third parties. Intercompany gains and losses arising from transactions between the Company and majority-owned (above 50%) subsidiaries are eliminated entirely until realized through transactions with third parties. 20

21 Unrealized intercompany gains and losses due to sales from equity method investees to the Company are eliminated in proportion to the Company s weighted-average ownership percentage of the investee until realized through transactions with third parties. (24) Income tax The Company and its subsidiaries have adopted inter-period and intra-period income tax allocation according to the R.O.C. SFAS No. 22, Accounting for Income Tax. Tax effects on taxable temporary differences are recognized as deferred tax liabilities. Tax effects on deductible temporary differences, operating loss carryforward, and investment tax credits are recognized as deferred tax assets. Valuation allowance is provided on deferred tax assets when they are not certain to be realized. A deferred tax asset or liability should, according to the classification of its related asset or liability, be classified as current or noncurrent. However, if a deferred asset or liability is not directly related to an asset or liability, then the classification is based on the expected length of time before it is settled or recovered. According to the R.O.C. SFAS No. 12, Accounting for Income Tax Credits, the Company recognized the tax benefit from research and development expenditure, employee training by the flow through method. Income tax (10%) on unappropriated earnings is recorded as expense in the year in which the shareholders have resolved earnings to be retained. The R.O.C. government has made the Alternative Minimum Tax Act ( AMT Act ) effective since January 1, Pursuant to AMT Act, the higher of the amount of income tax payable determined pursuant to the Income Tax Law or the minimum amount prescribed under the AMT Act is provided by the Company as income tax payable. In addition, the Company has considered the impact of AMT in future years when evaluating realized deferred tax asset. (25) Earnings per share Earnings per share are computed according to the R.O.C. SFAS No. 24, Earnings per share. Basic earnings per share are computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the current reporting period. Diluted earnings per share is computed by taking basic earnings per share into consideration plus additional common shares that would have been outstanding if the dilutive share equivalents had been issued. Net income (loss) is also adjusted for interest and other income or expenses derived from any underlying dilutive share equivalents. The weighted-average of outstanding shares is adjusted retroactively for stock dividends and bonus share issues. 21

22 (26) Derivatives financial instrument and hedge activities In order to hedge the resulting from the volatility in exchange rate, the Company and its subsidiaries entered into foreign exchange forward contracts. The derivative are initially recognized and re-measured at fair value. When the fair value is positive, the derivative is recognized as a financial asset; when the fair value is negative, the derivative is recognized as a financial liability. If the derivative financial products does not meet the criteria for hedge accounting, the changes in fair value is transferred to the income statement. In additional, the derivative financial products shall be reclassified as financial assets or liabilities for trade purpose. Hedges are classified as the following three categories: a. Fair value hedges Fair value hedges are hedges of the Company s exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment. b. Cash flow hedges Cash flow hedges are hedges of the exposure to variability in cash flows that is attributable to a particular risk associated with a recognized asset or liability or a highly probable forecast transaction and could affect profit or loss. The effective portion of the gain or loss on the hedging instrument is recognized directly in equity, while the ineffective portion is recognized in profit or loss immediately. c. A net investment in a foreign operation hedges At inception of the hedge, there is formal documentation of the hedging relationship and the Company s risk management objective and strategy for undertaking the hedge, including identification of the hedging instrument, the hedged item, the nature of the risk being hedged, and how the hedging instrument s effectiveness in offsetting the exposure to changes in the hedged item s fair value attributable to the hedged risk will be assessed. There must be a reasonable basis for how the Company plans to assess the hedging instrument s effectiveness. 22

23 Hedges which meet the strict criteria for hedge accounting are accounted for as follows: Fair value hedges Fair value hedges are hedges of the Company s exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, or an identified portion of such an asset, liability or firm commitment, that is attributable to a particular risk and could affect profit or loss. For fair value hedges, the carrying amount of the hedged item is adjusted for gains and losses attributable to the risk being hedged, the derivative is re-measured at fair value and gains and losses from both are taken to profit or loss. Cash flow hedges Under cash flow hedge accounting, the profit or loss on the hedging instrument is recognized as profit or loss in the same period when the profit or loss on the hedged item is affected. The profit or loss on the hedging instrument is recognized as an adjustment to stockholders equity and reclassified into current profit or loss when forecast transactions that are being hedged affect profit or loss. If a hedge of a forecast transaction subsequently results in the recognition of a financial asset or a financial liabilities, the associated gains or losses that were recognized directly in equity shall be reclassified into profit or loss in the same period or periods during which the asset acquired or liability assumed affects profit or loss. If a hedge of a forecast transaction subsequently results in the recognition of a non-financial asset or a non-financial liabilities, it removes the associated gains and losses that were recognized directly in equity and includes them in the initial cost or other carrying amount of the asset or liability. However, if the Company expects that all or a portion of a loss recognized directly in equity will not be recovered in one or more future periods, it shall reclassify the amount that is not expected to be recovered into profit or loss. The Company and its subsidiaries shall discontinue prospectively the hedge accounting for an existing hedge if any one of the following occurs: a. The derivative is expired or sold, or terminated, or exercised. b. Any criterion for hedge accounting is no longer met. c. The Company removes the designation of the fair value hedge. (27) Operating segment information An operating segment is a component of an entity that has the following characteristics: a. engaging in business activities from which it may earn revenues and incur expenses; b. whose operating results are regularly reviewed by the entity s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance; and c. for which discrete financial information is available. 23