The accountant’s ‘magic’ asset

Alexander B. Cabrera Chairman and Senior Partner, PwC Philippines 07 Apr 2019


(Second of two parts)

How do you own top-of-the-line BMW models when you can’t afford them? You don’t. You lease them.

I am neither advertising nor saying that the lease program is still available. But leasing makes sense in that if you buy a high-end car and get back only a fraction of the price when you resell it after three years, then there is an actual unrecovered cost. Compare this unrecovered cost with the sunk cost of lease payments in a lease arrangement and you can evaluate which works better. In lease arrangements, you can replace the car if the engine doesn’t start for no reason, while you are stuck with that asset if you own it.

The new accounting rules bring, if you like, a fresh perspective because even if the asset is leased, it will require the lessee to record an asset – the right-of-use asset over the period of the lease term. I would not say though that operating leases are now like finance leases or like a purchase of asset just because an asset is recognized. Take note that the (unamortized) right-of-use asset can be written off if the lease is preterminated – which, in a way, shows that this asset is make-believe.

Turning to the side of the lessor – he is not required to mirror what the lessee is required to do. There is no change in how the lessor should recognize income for accounting purposes. For tax purposes, the reporting of income of the lessor is maverick compared to that of a seller of goods or a service provider. While advance payments for purchase of goods or services are considered liabilities of the seller, advance lease payment is considered income of the lessor.

It is tough to find a specific local tax law to support this income treatment, but it seems the support is more practical than legal.

Advances for future purchase of goods is not taxable because the goods must be delivered for the seller to deserve the payment. There is even more reason to say that advances for services is not income to the service provider because he can choose not to render the service. The constitutional prohibition against involuntary servitude guarantees that no one can be compelled to render service against his moods or will – but he can be made liable for damages if he is in breach.

Advances for lease is different and should be recognized as income because: (1) the object leased has been delivered and is in the possession of lessee, (2) the income can be disposed of freely by the lessor, and (3) the rights of the lessee to enjoy the property leased is protected by the contract.

There is another asset that is like a magic trick because it rests as a deferred account until called to duty to reduce tax liabilities: the deferred tax asset. Let me discuss some interesting ones:

Loss of useful value. Some assets may have been subjected to provisions for obsolescence, or impairment. These are not deductible at the point of provision. Note, however, that an asset that loses its useful value (like an old equipment that has become very costly to operate) can be written off and deducted, based on its book value less any scrap value.

Inventory destroyed. Provision for inventory obsolescence is a common accounting entry, but in order to claim a tax deduction, you need an actual act of destruction. You will find in BIR issuances that you need to invite a BIR representative to witness the destruction. This is reasonable, but if they do not come, you can continue to destroy the inventory anyway, invite your external auditor to witness it, take pictures, and retain records about such inventory. The point is to prove that the inventory disappeared not because you sold it.

Bad debts based on discretion. If there were any deduction that could be taken out of the exercise of discretion, it would be the write-off of bad debts. The key is to show that you determined it to be worthless in the year you wrote it off. You do not need to file then lose a case in court to prove that the debt is worthless. So long as you can show that it will be “throwing good money after bad” to go after the debt, you would be able to justify the write-off of a debt that you are trying hard to collect. Evidence of worthlessness (e.g., debtor cannot be found, or is bankrupt) coupled with exercise of sound judgment by the board are the key ingredients of this deduction.

Allow me, at this point, to give a shoutout to my colleagues who are still in the thick of the fight of the busy season going into April 15. The Holy Week would often linger close, almost as if to say that accountants go through their own Sorrowful Mysteries. The Carrying of the Cross on an annual basis, during the peak season, shows that this profession is not for the weak of heart, nor the weak of mind. Here we work both smart, and hard, because there is no shortcut to building trust.

Like an embattled ship on a stormy sea, we keep the vessel on course, and not merely seaworthy, drawing strength from as little as a bit of empathy, and a bit of affirmation, from those for whom we hold the sail.

Alexander B. Cabrera is the chairman of the Integrity Initiative Inc. (II, Inc.), a non-profit organization that promotes common ethical and acceptable integrity standards. He is also the chairman and senior partner of Isla Lipana & Co./PwC Philippines. Email your comments and questions to This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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Alexander B. Cabrera

Chairman and Senior Partner, PwC Philippines

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