You are on page 1of 16

05/12/2006

PICPA
Tax Implications of New Accounting Agenda

Standards*
Introduction
December 1, 2006 Summary of key changes from old GAAP
PFRS and IFRS moving forward – updates in 2006 and beyond
Application of PFRS – common issues and examples
Questions and answer

*connectedthinking

Part
Introduction

• PFRS which is aligned with IFRS has been adopted in the


Philippines effective January 1, 2005
• In the region, some countries will fully adopt IFRS effective
2006 and 2007. HK, China, Singapore, Malaysia, Australia,
Introduction New Zealand now substantially under IFRS.

1
• US GAAP and IAS/IFRS expected to be substantially
harmonized by end of 2007.

For Management

PICPA: Tax Implications of New Accounting Standards Page 4


Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

1
05/12/2006

Part
Key changes

PFRS 1 – First time adoption of PFRS

Changes Accounting Implications Tax Implications

Requires an entity to Certain assets/liabilities Adjustments resulting from


prepare a PFRS opening from previous GAAP need adoption of PFRS have no
balance sheet at January to be re-measured, tax implications.
1, 2004, the date of recognized and/or
Key changes transition to PFRS derecognized. Adjustments

2
arising need to be adjusted
against the opening
balance of retained
earnings at January 1,
2004 and 2005.

PICPA: Tax Implications of New Accounting Standards Page 6


Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Key changes Key changes

PFRS 2 – Stock-based compensation


PFRS 3 – Business Combination
Changes Accounting Implications Tax Implications Changes Accounting Implications Tax Implications
Allows only the application Acquired assets and liabilities Goodwill not deductible until related
Requires recognition Employee expense with a Grant date:
of purchase method for all assets are sold.
corresponding credit to equity Not deductible (employer), need to be measured at fair
of the fair value of the business combinations
or liability is required to be not taxable (employee) value at date of acquisition
stock options granted (pooling of interest allowed Negative goodwill credited to P&L:
recorded in the financial under old GAAP) Not taxable
to employees at grant Excess of investment cost over
statements Exercise Date: Employer
date Goodwill no longer subject fair value of net assets Assets acquired will have the same bases
- Excess of FMV over exercise to amortization but now acquired =goodwill as those in the hands of transferor
required to be tested for (acquired) in a tax-free merger or
price is deductible
impairment annually Excess of fair value of net consolidation
- Withhold income tax on
excess (DA 135-97) assets acquired over
Negative goodwill no The term “merger” or “consolidation”,
- Pay FBT for managerial/ longer allowed. Negative investment cost=negative means:
supervisory (DA 255-05) goodwill will have to be goodwill - the ordinary merger or consolidation, or
- Conflict to be resolved by credited to profit and loss. - the acquisition by one corporation of all
BIR? or substantially (80%) all the properties of
Business combination another corporation solely for stock;
between entities under
Exercise Date: Employee common control need to be provided, that transaction must be
accounted at cost. undertaken for a bona fide business
- Excess of FMV over exercise purpose and not solely for the purpose of
price is taxable escaping the burden of taxation.
PICPA: Tax Implications of New Accounting Standards Page 7 PICPA: Tax Implications of New Accounting Standards Page 8
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

2
05/12/2006

Key changes Key Changes

PFRS 3 – Business Combination


PFRS 5 – Non current assets held for sale and discontinued operations
Changes Tax Implications
If transaction is not tax free, tax base of assets
acquired shall be net of negative goodwill.
Changes Accounting Implications Tax Implications

Impairment of goodwill -
•Not deductible
Requires non-current • Impairment loss adjustment • Impairment loss and gain not
•Deduction may be claimed upon disposal assets to be classified as to bring down the carrying deductible/taxable at the time
of related assets acquired non-current assets held amount to fair value will be of recognition
charged to profit and loss.
for sale if its carrying
Transfer of assets and liabilities in a merger or • Impairment loss/gain is
consolidation amount will be recovered • Subsequent recovery of temporary difference
•Not subject to VAT through sale rather than impairment losses needs to
•Input VAT of acquiree transferable to through continuing use be credited to profit and • Gain/loss to be realized at the
acquiror (RR No. 16-05)
loss only to the extent of time of actual sale
Deferred tax asset These assets need to be cumulative losses
•Allowed to be transferred by implication stated at the lower of previously recognized (See also Tax Implication of
(Rulings DA 661-11-29-99 / DA 621-04)? carrying amount and fair PAS 36, slide no.22)

NOLCO value less cost to sell


•If transferor of NOLCO owns 75% or
more of outstanding shares of assignee,
NOLCO will still be allowed as deductions
in the hands of assignee
PICPA: Tax Implications of New Accounting Standards Page 9 PICPA: Tax Implications of New Accounting Standards Page 10
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Key Changes Key changes

PAS 17 - Leases
PAS 2 – Inventories Changes Accounting Tax Implications
Implications
Changes Accounting Implications Tax Implications
Capital leases Lessee • For income tax purposes, such capital
LIFO no longer allowed Inventories valued at LIFO LIFO also no longer allowed lease shall be treated as sale
need to be revalued The leased asset will be (conditional)
A lease is capital lease if recorded as asset • Amounts to be received by
Inventory needs to be using acceptable BIR approval for change following indicators exist: measured at present lessor/vendor will be considered to be
carried at lower of cost valuation method under must be secured within value of minimum payments of sales price to the extent
a) Transfer of ownership of
of net realizable value IFRS. 90 days from start of assets to the lessee at the
lease payments such amounts do not represent
interest and other charges (RR 19-86)
(selling price less cost to taxable year end of the lease term Lessor • The gain on sale of asset = total lease
sell/completion). b) Lessee has the option to
payments receivable net of interest
purchase the asset at a
Reversal of write-down price that is lower than fair
Will treat the lease as component less carrying value
now allowed by PFRS outright sale at the • Lessee/Vendee shall be allowed to
value of the asset inception of the lease. claim depreciation plus interest (if not
(not allowed by previous c) The lease term is for the
capitalized)
GAAP) major part of the economic
• For GRT, gross receipts of banks and
life of the asset non-bank financial intermediaries
d) Present value of minimum
shall consist of interest income (RR 9-
Forex loss can no longer lease payments amounts 04)
be capitalized as part of to or substantially equal to • For VAT, taxable base shall be the
the fair value of the asset
inventory cost under e) Leased assets are of such
total amount to be paid by the
PAS 21. lessee/vendee under the contract (RR
a specialized nature that
16-05)
only lessee can use the
PICPA: Tax Implications of New Accounting Standards Page 11 PICPA: asset without of
Tax Implications modification.
New Accounting Standards Page 12
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

3
05/12/2006

Key changes Key Changes

PAS 17 - Leases IAS 12 – Income tax


Changes Accounting Implications Tax Implications Changes Accounting Implications Tax Implications
Operating leases Impact of lease escalation and For income tax purposes, gross
free rent will have to be income of lessor shall consist of: Requires recognition of The requirement to recognize Appraisal increase not taxable
Lease income/cost, amortized under the straight- • Rental actually earned but deferred income tax deferred income tax liability is
including lease line method over the term of uncollected and mandatory whether or not the
• Advance rentals received
liability on appraisal
incentives such as free the lease entity intends to dispose the
No rent income to be recognized increase arising from
rent, to be recognized Straight-lining of lease asset
during rent-free period revaluation of property,
under the straight-line income/cost will create
method over the term of temporary difference between plant and equipment.
Allowable deductions to lessee
the lease the actual amount of cash
received/paid and actual • Rent paid or accrued including all
amount of income/expense expenses lessee is required to
recorded in the accounts pay to or for the account of the
lessor (such as insurance
expenses)
• Advance payment to be
amortized
• Amount arising from straight-
lining of lease cost/expense not
taxable income/deductible
expense

PICPA: Tax Implications of New Accounting Standards Page 13 PICPA: Tax Implications of New Accounting Standards Page 14
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Key changes Key changes

PAS 16 – Property, plant and equipment


PAS 16 – Property, plant and equipment
Changes Accounting Implications Tax Implications
Asset retirement obligation ARO asset to be recognized at Depreciation on ARO is not
(ARO) is required to be present value In the balance sheet deductible for tax Changes Accounting Implications Tax Implications
capitalized at the date of
ARO asset will be depreciated over purposes.
acquisition and/or
installation
the estimated useful life of the Interest on qualifying Tax impact
related assets Accretion cost (classified as asset may be
Component accounting A corresponding liability (also at finance cost) not capitalized as part of Depreciation for each of the
present value) is required to be deductible for tax components of a large asset
Cost of
the asset account
recorded. purposes. should be aligned with
commissioning/testing an The accretion cost (the during the depreciation for tax purposes.
asset, net of proceeds from
amortization of the difference Upon ultimate disposal of an construction period
selling any items produced
between the PV and the nominal asset, unamortized (IAS 23 – Borrowing Interest for tax purposes is
while the asset is being
tested such as sample amount of ARO) is charged to balance of ARO will not be costs allowed deductible when paid/incurred
products expense over the discount period included in the alternative treatment) or maybe capitalized as part of
(should be the same with the life of determination of taxable the asset. Depending on the
the asset) income from disposal. company policy, this may
create temporary difference
Actual restoration costs between accounting and tax
deductible when incurred. base.
ARO - Actual restoration costs
deductible when incurred.
PICPA: Tax Implications of New Accounting Standards Page 15 PICPA: Tax Implications of New Accounting Standards Page 16
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

4
05/12/2006

Key changes Key changes


PAS 19 – Employee benefits (focus on pension plans)
IAS 18 – Revenue recognition
Changes Accounting Implication Tax Implication
Changes Accounting Implications Tax Implications Annual pension cost charge now Past service cost amortization Deductible pension costs:
composed of: is effectively higher - Actual contribution for pension
Revenue recognition should be Individual elements of a sales contract If sale is billed thru a single invoice, compared to previous liability for current year
1) Current service cost - One-tenth of reasonable amount
applied to individual separately may have different revenue recognition entire invoice amount (net of VAT) 2) Interest cost on liabilities
GAAP.
identifiable components of a pattern (ex – sale of equipment with free paid to the trust to cover pension
single transaction. maintenance for 3 years; in this case, a
shall be recognized as revenue for 3) Return on plan asset Transition liability need to be liability for prior years or to place
separate revenue should be recorded for income tax & VAT purposes at time 4) Recognized actuarial gains recognized at IFRS the trust on sound financial basis
For sale of services (i.e. maintenance which should be earned of sale. and losses transition date and can be
consultancy), revenue recognition over a period of 3 years) All other components of pension cost
5) Past service costs amortized over a
should be based on percentage of Sale of services – to be recognized as charge not deductible
6) Amortization of transition maximum period of five
completion method (revenue For sale of services, fixed fee revenue for income tax purposes liability, if any Transition liability – not deductible for
recognized by reference to the arrangements need to be accounted
when earned (upon billing or years
stage of completion) at balance either under completed contract method income tax purposes
sheet date. or percentage of completion method) accrual) Past service costs need to be Transition asset can be
- subject to VAT upon amortized over the vesting recognized at transition Transition asset – not taxable for income
Certain deflators (ie display rental Designing accounting policies on collection of bills. period (used to be amortized date if the asset exceeded tax purposes. Future refunds from
given to retailers) need to be deflators can be challenging the fund are taxable when refunds
presented as “sales deduction”
over the average remaining the present value of are received. Deferred tax liability
Sale of real properties – for installment lives of employees
rather than advertising and or deferred payment plan schemes,
defined benefit obligation. however needs to be recognized
promotions. on recognized pension asset
Sale of real property in the Philippines under RR 16-2005, if collections for Allows only projected credit arising from future refund.
IAS 18 does not deal with sale of has been generally based on the initial year exceed 25% of the method as acceptable
real property in details conventions and FAS 66. Installment selling price, the entire gross profit valuation model.
method a common practice. Some are is taxable. Otherwise, installment
adopting full accrual method for sale of method applies.
raw lands. Profit sharing and bonus can be
recognized if present legal or
PICPA: Tax Implications of New Accounting Standards Page 17 PICPA: constructive
Tax Implicationsobligation
of New Accounting
exists Standards Page 18
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Key changes Key changes


PAS 21 - Effects on changes in foreign exchange rates
PAS 24 – Related party disclosure
Changes Accounting Implication Tax Implication
Requires that functional General ledger supporting Taxable income – To be determined by
the financial statements translating functional currency Changes Accounting Implications Tax Implications
currency be determined income and expenses on a monthly
by an entity. The need to be maintained using
basis using average exchange PDS Requires disclosure of details More detailed disclosure of Disclosure of
the functional currency.
functional currency is rates then adding all the 12 monthly of transactions with related related party transactions management
the basis of recording peso equivalents parties during the reporting
Foreign exchange losses personnel benefits
transactions. period Disclosure of key management
previously capitalized need All other taxes – shall be based on will provide wider
personnel benefits has
to be written-off or adjusted historical peso amounts or actual
Requires disclosure of key been a sensitive issue window for the tax
Capitalized foreign against the opening balance conversion/prevailing PDS rates on
transaction days, whichever is management personnel since the adoption of PFRS authorities to
exchange losses no of retained earnings.
applicable; subsidiary records have compensation in total and assess accuracy of
longer allowed. to be maintained the following: taxed earnings
Capitalized forex loss written off – If • Short term benefits (ie
capitalized loss represents actual
loss, choose from two options:
SSS)
- continue claiming depreciation • Post employment benefits
- secure approval from BIR for the • Other long term benefits
change in the accounting/tax • Termination benefits
treatment? • Share-based payments
(stock options)
If loss is not realized, write-off upon
realization.
PICPA: Tax Implications of New Accounting Standards Page 19 PICPA: Tax Implications of New Accounting Standards Page 20
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

5
05/12/2006

Key changes Key changes

PAS 32/39 – Derivative financial instruments and hedging


PAS 27/28 – Consolidated financial statements /Investments in associates
Changes Accounting Implications Tax Implications
Changes Accounting Tax Requires measurement and Mark to market/derivative losses Temporary differences and fair value
recognition of the fair value and gains (unrealized in adjustments are not taxable
Implications Implications of derivatives, including nature) need to be measured income/deductible losses
Exemption from the Restatement of prior embedded derivatives at each reporting date
preparation of year financial None Gain or loss to be recognized upon
Financial assets/liabilities need Fair value adjustments of financial realization
consolidated financial statements to to be measured initially at assets and liabilities will be
statements under certain apply cost method FV less cost of transaction. charged/credited to operations Necessary to determine whether
circumstances to all investments. Subsequently, assets must (except available for sale realized gain or loss is capital or
be measured at FV as financial assets which is part ordinary
Cost method for Special purpose Consolidation and follows: of the equity accounts)
Interpretation SIC 12 investment be applied to entities (SPEs) will group Capital loss deductible only from
reporting not 1) Assets/liabilities at FV Application of effective interest capital gains
all investment in have to be
through profit and loss – at method will create temporary
subsidiaries and consolidated with allowed.
FV (market) difference between actual Loans to employees without interest
associates the entity that Taxation 2) Held to maturity amount of interest or (rate below 12%) will give rise
controls economic applicable at investments – at amortized received/paid and amount to taxable fringe benefit
Special purpose entities benefits arising entity level cost using the effective reported under effective
need to be consolidated from the activities interest method interest method.
(ie landholding of the SPEs. 3) Loans and receivables –
same as 2 above Tax impact
companies)
4) Available for sale financial Timing differences and fair value
assets – at FV (market) adjustments taxable
income/deductible losses?
PICPA: Tax Implications of New Accounting Standards Page 21 PICPA: Tax Implications of New Accounting Standards Page 22
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Key changes Key changes

PAS 32/39 – Derivative financial instruments and hedging PAS 36– Impairment of assets
Changes Accounting Implications Tax Implications
Changes Accounting Implications Tax Implications
Some preferred shares now See separate examples See examples
classified as liability rather Requires long term Impairment loss requires to be Impairment loss – Not deductible as the
than equity assets and recognized on the following: general rule is losses must be
evidenced by close and completed
investments to be
Equity and liability elements of See examples See examples • Underutilized and unused transaction fixed by identifiable event
tested for assets (e.g,. sale)
compound instruments
need to be valued and
impairment. • Obsolete assets
treated separately in the Impairment exist • Investments in subsidiaries that Possible Exceptions (Income Tax
balance sheet when the carrying are loss making Regulations):
value of the asset is • Licenses/patents
Long term financial assets and Portion of the non-interest bearing Accretion income/expense arising less than its 1) Loss sustained when the usefulness
liabilities which are non- assets/liabilities will be treated from discounting of long term Tax impact of the asset is suddenly terminated
recoverable value.
interest bearing need to be either as an interest expense assets and liabilities are not Impairment loss deductible for tax due to change in business conditions
stated at present value by or income using the effective taxable. Note however interest purposes? such that the taxpayer discontinues
discounting the balance interest method maybe imputed by BIR on non- Previously recognized the business or discards the assets
Reversal of impairment losses
using a rate that is implicit interest bearing inter-company impairment losses taxable gain? permanently from use in such
to the agreement/balance. advances/loans. can be reversed if business (Sec. 98).
market conditions
improved.

PICPA: Tax Implications of New Accounting Standards Page 23 PICPA: Tax Implications of New Accounting Standards Page 24
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

6
05/12/2006

Key changes Key changes

PAS 36– Impairment of assets IAS 37 – Provisions, contingent assets and contingent liabilities
Changes Accounting Implications Tax Implications Changes Accounting Implications Tax Implications
2) If the whole or any portion of a physical
property is clearly shown as being affected
by economic conditions that will result in the
asset being abandoned at a prior date prior Material accruals that The difference between the Mere provisions are not
to end of its normal useful life, so that are expected to be present value and the deductible. Accretion
depreciation deductions are insufficient to
return the cost, a reasonable allowance for
settled beyond 1 amount of accrual is expense not deductible for
obsolescence may be allowed, in addition to year may need to be treated as accretion tax purposes.
depreciation (Sec 110). discounted at expense (part of financing
present value costs) in the profit and
3) If a patent becomes obsolete prior to its
expiration, the remaining proportionate loss
depreciable amount may be deducted subject
to CIR approval (Sec. 111).

Impairment gain – Recovery of impairment loss


not taxable (not realized)
Note: Impairment gain/loss shall be treated as
temporary difference

PICPA: Tax Implications of New Accounting Standards Page 25 PICPA: Tax Implications of New Accounting Standards Page 26
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Key changes Key changes

PAS 38 – Intangible assets


PAS 38 – Intangible assets
Changes Accounting Implications Tax Implications
Changes Accounting Implications Tax Implications
Recognize only All recorded intangible assets Research and Development -deductible
intangible assets if that do not meet the as ordinary and business expenses
provided not chargeable to capital Intangibles the use of which in
following are all met: criteria of IAS 38 need to
account.
be written-off in the business is not limited will not
• Identifiable financial statements Deferred R & D not chargeable to usually be a proper subject of
• Probable that property subject to depreciation or depreciation allowance
economic benefits depletion shall be amortized over 60
months or more beginning from the
Loss from de-recognition or write-off
will flow to the entity
• The cost of the month taxpayer first realizes benefits of the intangible asset shall not
asset can be (Sec. 34 I, Tax Code). be allowed as a deduction
measured reliably unless it qualifies under the
Intangibles, the use or value of which is
Pre-operating only for a limited period which can be exception explained under
expenses/start up estimated from experience with Impairment
costs no longer reasonable certainty may be the
allowed to be subject of a depreciation allowance
provided the facts are fully shown in
Any change in accounting/tax
deferred in the treatment should have prior CIR
the return to the satisfaction of the
balance sheet. Need
CIR. e.g., patents, copyrights and approval
to be charged to franchises
expense as (Sec. 107 – Income Tax Regulations)
incurred.
PICPA: Tax Implications of New Accounting Standards Page 27 PICPA: Tax Implications of New Accounting Standards Page 28
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

7
05/12/2006

Part
Key changes

PAS 40 – Investment properties


Changes Accounting Implications Tax Implications

Requires assets that At the date of adoption, Gain or loss arising from
are held for any appraisal surplus changes in fair value not
appreciation or for of assets previously taxable/deductible
rental be classified as classified as fixed
Investment properties. assets that now qualify Depreciation charge on
PFRS and IFRS – Moving forward (updates in 2006 and beyond)

3
as investment property appraisal surplus not
Investment properties shall be credited to deductible; basis should
can either be carried retained earnings. be historical cost.
at cost (with annual Any changes in fair value
depreciation charges) subsequent to adoption
or fair value (subject date shall be charged
to annual impairment or credited to
testing) operations

PICPA: Tax Implications of New Accounting Standards Page 29


Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Key changes Key changes

Relevant updates in 2006/2007 and beyond Relevant updates in 2006/2007 and beyond
Changes Accounting Implications Tax Implications Changes Accounting Tax Implications
Implications
Fair values are here to stay Amendments to IAS 19 – extensive
• Fair value option under IAS 39 The standard permits an entity to Gain or loss arising from changes in fair disclosures
(effective 2006) designate, on initial recognition value not taxable/deductible • To include trends in plan assets and
financial assets and liabilities to be liabilities as well as assumptions No impact except for extensive No tax impact on additional
FV through PL underlying components of defined benefit disclosures. These are ordinarily requirements. Refer to related
costs provided by actuaries discussion in PAS 19.
IFRS 2 – amendments to include an To impact only in determining the vesting Tax still due upon exercise for the excess of
expanded definition of vesting period/condition and the resulting FMV over option price (the cost)
conditions (ie payment of expense recognition ED 8 – Operating segments (IAS 14) Complexity of identifying and No tax implication
counterpart contributions) – 2007 effective 2007 quantifying operating segments
• Likely to result in increase in the reported
ED on borrowing costs – to require Capitalization is required where interest Refer to same discussion under PAS 16. segments
capitalization of interest on cost is incurred in constructing • See through eyes of management
qualifying asset (similar to that of qualifying assets
FAS 34) – 2008 ED on presentation of financial statements Presentation of balance sheet only. None
• To converge with FASB Balance sheet maybe presented
ED 7 – Financial instruments: Expanded disclosure in the financial No tax implications. • Introduction of Other recognized gains and in 3 columns
Disclosures – this provides statements. To impact heavily losses in the equity section Will benefit those that are listed in the
expanded disclosure on classes those entities with heavy trading of • Balance sheet may include opening US stock market as this will
of performance and position of financial instruments/derivatives statement of financial position eliminate differences in the face
various financial instruments • To take effect 2008 of the balance sheet and PL

PICPA: Tax Implications of New Accounting Standards Page 31 PICPA: Tax Implications of New Accounting Standards Page 32
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

8
05/12/2006

Part
Application of PFRS – common issues and examples
Example:
Measurement - Inventories

Company A manufactured Product A at cost of P100,000.

4
Product A is sold at P110,000 at a 5%
discount. Delivery costs is estimated to be P10,000.

How much should be the carrying amount of Product A ?

PICPA: Tax Implications of New Accounting Standards Page 34


Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Fixed assets

Example of tax treatment of ARO


Measurement - Inventories

IFRS Tax
Example: Acquisition cost:
Purchase price P5,000,000 P5,000,000
Carrying amount of Product A: Installation costs 100,000 100,000
- Cost = P100,000 PV of ARO 200,000 -
- NRV = P94,500 (P110,000 – P5,500 discount – P10,000) Total Initial Cost P5,300,000 P5,100,000
- Lower of Cost and NRV = P94,500

Annual Depreciation P530,000 P510,000


Under the above, there is a charge to cost of sales for inventory write-down (assuming a 10 year life)
amounting to P5,500. This is not deductible for tax purposes because cost of sales
under the tax rules represents the actual cost of producing/purchasing the inventory
The related accretion cost of ARO liability (treated as
Similarly, any recovery in the value of the inventory will not be a taxable income financing cost in the profit and loss) is also not deductible for
tax purposes.

PICPA: Tax Implications of New Accounting Standards Page 35 PICPA: Tax Implications of New Accounting Standards Page 36
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

9
05/12/2006

De-recognition of assets
Example – straight-lining of operating lease under PAS 17

PFRS Tax Impact Case – Lease with rent-free period

Lease term (inclusive of rent-free period) 5 yrs


An asset is de-recognized when: Deduction for loss of useful value of an
asset is allowed if due to sudden
Annual rent P1,000,000
(a) it is being disposed; or business changes, an asset has been
(b) no future economic prematurely discarded, or where new
Rent-free period 6 months
benefits are expected legislation directly or indirectly makes
from its use or disposal. the continued profitable use of the
Total lease payments P4,500,000
property impossible.
Any impairment loss arising from the de-
Annual rent (P4,500,000/5 yrs) P900,000
recognition of a fixed asset is included
in profit or loss when the item is de-
recognized.

PICPA: Tax Implications of New Accounting Standards Page 37 PICPA: Tax Implications of New Accounting Standards Page 38
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Example - Finance Lease under PAS 17

Example continued…. Case - Finance lease of an equipment

Accounting entries under PFRS below: Assumptions:

Lease term 5 years

Total lease payment P660,000


Lessor Lessee
Dr. Cash P500,000 Dr. Rent Expense P900,000 Annual lease P132,000
Dr. Receivable 400,000 Cr. Cash P500,000
Cr. Rent Income P900,000 Cr. Payable 400,000 Applicable interest rate 10%
Taxable rent income will still be P500,000, the Deductible rent expense will be
actual amount of rent income due under the lease P500,000. The P400,000 will be treated PV of annuity 3.791
agreement. The P400,000 will be treated as a as temporary difference in the accounts
temporary difference PV of MLP P500,000

If the lease agreement is non-interest bearing, the discount rate will either be the
rate implicit to the lease agreement or the lessee’s incremental borrowing rate had
the asset been financed elsewhere
PICPA: Tax Implications of New Accounting Standards Page 39 PICPA: Tax Implications of New Accounting Standards Page 40
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

10
05/12/2006

Example continued Example continued…

Amortized lease liability/receivable: Payments/receipts applied to interest below:

Lease liability/balance: Interest on Outstanding Liability/Receivable:

Inception date P500,000 Year 1 P50,000


Year 2 41,800
End of year 1 418,000 Year 3 32,800
Year 4 22,900
End of year 2 327,800 Year 5 12,500
______
End of year 3 228,600
Total P160,000
End of year 4 119,500 ______

End of year 5 0

PICPA: Tax Implications of New Accounting Standards Page 41 PICPA: Tax Implications of New Accounting Standards Page 42
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Example continued….
Example continued… PFRS entries subsequently would be (in ‘000):

Lessor’s book Lessee’s Books


PFRS accounting entries at the inception of the lease would be: Year 1

Dr. Cash P132 Dr. Lease liability P82


Cr. Lease receivable 132 Dr. Interest expense 50
Dr. Unearned Int. Income 90 Cr. Cash P132
Cr. Interest Income 90
Lessor’s book Lessee’s Books
Year 2
Dr. Cash P132 Dr. Lease liability P90.2
Dr. Lease receivable P660,000 Dr. Equipment P500,000
Cr. Lease receivable 132 Dr. Interest expense 41.8
Cr. Equipment P500,000 Cr. Lease liability P500,000 Dr. Unearned Int. Income P41.8 Cr. Cash P132
Cr. Unearned interest Income 160,000 Cr. Interest Income 41.8

Year 3
Dr. Cash P132 Dr. Lease liability P90.2
Cr. Lease receivable 132 Dr. Interest expense 32.8
Dr. Unearned Int. Income P32.8 Cr. Cash P132
Cr. Interest Income 32.8

PICPA: Tax Implications of New Accounting Standards Page 43 PICPA: Tax Implications of New Accounting Standards Page 44
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

11
05/12/2006

Finance leases – tax considerations Finance leases – tax considerations

PFRS Tax impact PFRS Tax Impact

Lessee – Initial recognition Lessee – Lease payments Deduction for tax purposes shall be the
depreciation expense on leased asset and
Lessee shall recognize finance leases Each payment will be allocated between interest payments. (Taxpayer has option to
lease and interest. The lease payment will expense or capitalize interest).
as assets and liabilities in its balance The cost of the asset will be the
be applied against the liability under capital
sheets at amounts equal to the fair difference between the total payments lease. Open tax issue: Implicit interest expense on non-
value of the leased property, or if lower, and the interest. (Consistent with interest bearing agreements – deductible for
the present value of the minimum lease PFRS PV) The lessee will also record a regular tax purposes?
payments each determined at the (RR 19-86) depreciation expense for the leased asset.
inception of the lease.

PICPA: Tax Implications of New Accounting Standards Page 45 PICPA: Tax Implications of New Accounting Standards Page 46
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Finance leases – tax considerations Leases – sale and leaseback tax considerations

PFRS Tax impact PFRS Tax

Lessor – Lessor Gain/Income from the sale shall already be


taxed in full at point of sale. Similar to
Lessor shall recognize assets held under a Lessor shall recognize a gain on the sale of the Sale/leaseback transactions - If finance ordinary sale.
finance lease in their balance sheets and asset and deferred interest income. lease, any excess of selling price over the
present them as a receivable at an amount carrying amount shall be deferred and
equal to the net investment in the lease. amortized over the lease term.
Taxable income from sale of asset consistent
Income from the sale of the asset is the with PFRS. If loss is compensated by future lease Loss shall be deductible, regardless of the
difference between the total lease payments payments at below market price, it shall be impact of future lease payments.
receivable, excluding interest charges, and deferred and amortized in proportion to the
the cost of the asset lease payments over lease term.

PICPA: Tax Implications of New Accounting Standards Page 47 PICPA: Tax Implications of New Accounting Standards Page 48
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

12
05/12/2006

PAS 32/39 examples - Liability vs. Equity instruments Example continued

Financial Liability -a contractual obligation to deliver cash or another Example:


financial asset to another entity or exchange financial asset or liability to
another entity that are potentially unfavorable to the entity. Company A issued on August 1, 2005 preferred shares with 10% dividend
per year and are redeemable on July 30, 2010.
Tax: a legal obligation. Normally covered by PN, Notes, etc
PFRS: The preferred shares will be treated and presented as liabilities
because they represent contractual obligations of the company to deliver
Equity Instrument under PFRS - when it represents a residual cash at a fixed maturity date. Dividend payments will be treated as interest
interest in the net asset of the issuer expense in the statement of income.

Tax: control or ownership. Tax : The preferred shares are treated as equity. Payout is dividend.

PICPA: Tax Implications of New Accounting Standards Page 49 PICPA: Tax Implications of New Accounting Standards Page 50
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Financial Liabilities vs. Equity Instruments - examples


Compound Instruments
Instrument PFRS Tax Dividend vs. Interest

Classification
Common shares Equity Equity Dividends

Redeemable preferred
The issuer of a financial instrument that contains both
shares with fixed dividend Accounting: Interest a liability and an equity should classify the instrument’s
each year subject to Liability Equity Tax: Dividends component parts separately.
availability of distributable
profits

Convertible bond which an Liability for bond Liability Accounting: Interest


option to convert into fixed and equity for and Dividend
number of shares option Tax: Interest

Convertible bond which Liability until Interest


converts into shares equal to Liability converted to
the value of the liability shares Upon conversion,
dividend

PICPA: Tax Implications of New Accounting Standards Page 51 PICPA: Tax Implications of New Accounting Standards Page 52
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

13
05/12/2006

Compound Instruments: Measurement Discounting of financial assets - example

PFRS:

(1) the liability component is to be valued first; Case: Non-interest bearing notes receivable of
and (2) the difference between the liability and the P45,000 due in the three yearly installments of
fair value of the entire instrument is assigned P15,000. Imputed interest rate is 10%.
to the residual value of equity component.
Face amount of Notes P45,000
Tax: Less: Present value of NR (P15000 x 2.4869) 37,304
-------------
Fl is either a liability or equity. Tax rules do not recognize Discount on Notes P 7,696
hybrid instruments. =======

Under PFRS, the discount will be amortized under the effective


interest method for 3 years. For tax purposes, imputed interest income is
not taxable (the transaction has been taxed at the date of the underlying
sales transaction
PICPA: Tax Implications of New Accounting Standards Page 53 PICPA: Tax Implications of New Accounting Standards Page 54
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Derivatives – tax aspects Short-Term Benefits under PAS 19

PFRS Tax
Profit-sharing and Bonus Plans are recognized when

Derivatives are measured at fair values Income/losses from derivatives and hedging • Company has present legal or constructive obligation (explicit on the
instruments shall be recognized only when employment contracts or bonus pay been given as a matter of policy)
Gains or losses on re-measurement to fair the underlying transaction/commodity
values are included in profit and loss unless covered by the instrument has been settled.
• Reliable estimate of the obligation can be made
the derivatives designated as cash flow
hedges or hedge of net investment in a
foreign operation which is recognized as part Fair value adjustments (ie mark to market
of equity. losses) at balance sheet date on
outstanding derivatives not a taxable
income/deductible expense (ie unrealized)

PICPA: Tax Implications of New Accounting Standards Page 55 PICPA: Tax Implications of New Accounting Standards Page 56
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

14
05/12/2006

IAS 18 – Example
Percentage of completion
Short term benefits – tax considerations Issue Background Solution under PFRS
Progress payments and advances Entity A entered into a contract with entity B to The percentage of completion should be
PFRS Tax received from customers often do construct a power station. The cost of the determined from: the proportion of costs
not reflect the work performed station is estimated at 150,000 The total incurred to date; the percentage of
[IAS18R.24] [IAS11.30]. revenue from the contract is estimated at physical work complete; or services
200,000. Entity A will take 3 years to construct performed to date. Amounts invoiced to
On what basis should the power station. customers do not necessarily influence
Profit-sharing and Bonus Plans (due within Deduction to be claimed in the year when bonus management assess a project’s the stage of completion.
percentage of completion? At the end of year 1 entity A incurred costs of
12 months after the end of the period in is paid or the expense incurred/obligation 60,000. The customer was invoiced for 50,000 Based on the relationship between the
which the employee rendered the related determine (although BIR may raise issue on at the end of year 1. Payment of this progress costs incurred to date and total estimated
benefits) withholding tax) billing is due, early in year 2, in accordance costs, the contract is 40%
with the normal credit terms that A offers. (60,000/150,000) completed at the end
of year 1. Revenue of 80,000 (40% of
A liability shall be recognized if the entity has Management estimated the stage of completion 200,000) should be recognised at the
a present legal or constructive obligation to as 33%, based on the amount invoiced. end of year 1.
make such payments as a result of past Issue – tax basis?
events, and a reliable estimate of the
obligation can be made.

PICPA: Tax Implications of New Accounting Standards Page 57 PICPA: Tax Implications of New Accounting Standards Page 58
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

IAS 18 example - Bill and hold sales


IAS 18 – Example of multiple deliverables
Issue Background Solution
Revenue from bill and hold Entity W entered into a contract on 31 The conditions for revenue
sales is recognized when the December 20x2 to supply video game recognition have been met (as
Company A sells airconditioning unit with free 1 year maintenance service. buyer takes title provided consoles to customer A. The contract is below) and entity W can
Total selling price is P10,000. Company A can sell the maintenance certain conditions are met. for 100,000 game consoles at 50 each. recognise 100,000 game
service separately for P1,000. Revenue is not recognised The wholesaler has a stock of 120,000 consoles as sold.
when there is simply an consoles at 31 December 20X2. The The criteria for recognition of
intention to acquire or contract contains specific instructions revenue in a bill and hold sale
How does Company A book the revenue? manufacture the goods in with regard to the timing and location of are:
time for delivery [IAS18R the delivery. Entity W must deliver the
Selling price be allocated between the unit (P9,000) and the service Appendix 1] consoles to the customer in the following a) That delivery has been
reporting period at a date to be specified delayed at the buyer’s
(P1,000). The P9,000 is recognized at the date of delivery. The P1,000 How should management by the customer. request;
is recognized for a period of 1 year as maintenance is rendered. recognise revenue from a bill b) It is probable that delivery will
and hold sale? made;
c) The item is on hand, identified
For tax purposes, the basis of VAT and income is P10,000, the cash price
and ready for delivery and
reflected in the invoice. cannot be used to satisfy
other orders;
d) The buyer specifically
acknowledges the deferred
delivery instructions in writing;
and the seller’s usual payment
terms apply.
PICPA: Tax Implications of New Accounting Standards Page 59 PICPA: Tax Implications of New Accounting Standards Page 60
Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006 Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

15
05/12/2006

Part
Sale subject to installation and inspection

Issue Background Solution


Revenue is normally Entity C manufactures and Entity C should recognize revenue
recognised when the installs cable TV satellite when the installation is complete.
buyer accepts delivery, dishes at customers’ premises The installation is critical to
and installation and on behalf of cable TV operator customer acceptance and payment
inspection are complete B. Entity B placed an order from entity B.
[IAS 18 Appendix A with entity C to manufacture
Example 2 (a)]. and install 100 dishes at its The sale of goods is often made
customers’ premises on 1 subject to satisfactory installation,
Question and answer

4
At what point is it August 20X2. Entity C has the and the installation is rarely
appropriate for entity C to dishes on stock and expects to perfunctory or incidental, as it is
recognize revenue in the install them by the 14 usually essential to the functionality
following example? September 20X2. Payment is of the delivered goods.
due 14 days after installation
of the dishes. When to recognize the sale for tax
purposes? Basis of VAT?
Entity C expects to complete
most of the installations
successfully in one visit.

PICPA: Tax Implications of New Accounting Standards Page 61


Isla Lipana & Co./PricewaterhouseCoopers 17 July 2006

Thank you.

© 2004 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network


*connectedthinking
of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and
independent legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers.

16