The accountant’s ’magic’ asset

Alexander B. Cabrera Chairman and Senior Partner, PwC Philippines 31 Mar 2019

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(First of two parts)

To be honest, I never liked accounting in the beginning. I wanted to be a lawyer, and for pre-law, I wanted to have a career in theater arts. My father said I would just go hungry doing “vaudeville”, and accounting is the best match to a legal career. I didn’t know better so I instead enrolled in an accounting school with a good reputation – and in a new campus, only one ride away from Antipolo City where we lived.

Having foregone the arts, imagine how my teenaged eyes opened wide on the first day of class when my professor said, “Accounting is an art.” It was amusing to think of accounting that way, but I learned that that is simply not true. Art is unbound, while accounting is subject to very specific rules. If accounting is considered an art, it most likely means that it’s being used (or misused) to hide something. What I considered rather as the principle that gave me refuge was that accounting must be reflective of the transaction. Otherwise, it’s an “art”.

So imagine today how my tired but seasoned eyes became wide open when new accounting rules challenged what had been my refuge when in doubt – that the accounting treatment should be that which is most reflective of the transaction. It is no longer necessarily the case in my view, in light of some new accounting rules.

This Sunday, I am writing this for accountants, finance people, persons responsible for tax, and my curious readers.

1. New lease rules – the magic asset.

The popular knowledge is that when you lease, it’s because you do not own the asset. However, the new accounting rules effective January 2019 would require you to recognize an intangible called the ‘right-of-use’ asset. This is equivalent to roughly the present value of your expected lease payments during the term of the lease or beyond if you expect to renew the lease contract anyway. This means that you will recognize the right to use asset for, in the case of real property, the present value of lease payments even for a 25-year lease, or a 99-year lease, for that matter. IFRS 16 compensates by requiring you to recognize an equivalent liability for the right to use asset that you set up. There is no change in net equity but there is a new asset that cannot be attached, and a new liability that can confuse the debt-to-equity ratio.

For accounting purposes, you claim an expense from the amortization of the right-of-use asset and the related interest expense coming from the discount, and not based on the actual rent. This expense may be higher than the actual rent because the lease rates generally escalate based on contract. So when you add up all your future leases and amortize them straight line, you would get a higher expense amount, accounting-wise, as early as today.

Tax rules generally follow the accounting rules in computing for income, unless there is a specific tax rule that’s applicable or when the legal character of the transaction dictates a different treatment. In this case, the contractual amount of the lease will be the deductible expense for tax purposes, which should likewise be the basis of the withholding tax. The BIR is not expected to argue otherwise because they will not allow the windfall from the higher accounting expense to be claimed as deduction.

So while laws are being passed trying to ease doing business, accounting rules seem to be going the other way. Now we have a situation where both the lessor and lessee could reflect theoretically the same asset in their respective financial statements. And liabilities – referring to future liabilities – are now reflected simply to offset the effect of the “magic” asset. (Note that you do not record future utilities expense, for instance, that you expect to incur in the next 10 years or so as liabilities.)

Why did the accounting authorities do this to us? The new rules on leases are best suited to help investors in businesses such as airlines where the company’s revenue is dependent on expensive assets they do not own. A memorandum in the Notes to Financial Statements could have done the trick, but the accounting authorities want the asset and the contra liability reflected in the financials for impactful transparency.

2. Distinct contract treatment – the freebie is not free.

Mobile postpaid plans with free phone, brand new car plus free LTO registration for three years, air conditioning units plus free installation – these are examples of marketing packages, or if you like, contractual terms in a sale.

But for accounting, by virtue of IFRS 15 effective 2018, the entire bundle is but a “product combo” where nothing is free. You have to allocate proportionately to the products sold and the service given free (or vice versa) the proportionate revenue based on the relative market price.

Beware that a financial statement prepared this way will certainly mislead tax examiners who need to make the assessment based on tax rules. There is a different timing for VAT on goods (on invoice) versus services (on official receipt). Local governments tax sale of goods and sale of service differently as well. So stick to the contract for tax purposes. That being said, an invoice reflects contractual terms. So if that invoice shows separate amounts for telco services and the phone unit that comes with the plan respectively, one is estopped from denying the phone is free.

3. Volume discount – discount before the volume.

Granting discounts when a customer purchase reaches a certain volume is obviously made to encourage sales volume. So the volume still isn’t there in the beginning. But the new accounting rules effective 2018 would require you to already record your sales, net of the volume discount. Conservative for accounting purposes, true, but dangerous for tax, particularly for VAT purposes. The VAT is based on gross sales and volume discounts are ignored as deductions. Only trade discounts – those granted at the time of sale – can reduce sales for VAT purposes.

In my view, a true-up or alignment at the end of the year for actual discounts given, is fair financial statement reporting. As such, we would rather have the discretion to ignore this accounting rule during the year than create the unnecessary mistake of underpaying VAT by unwittingly underreporting sales in our quarterly VAT returns.

I will continue my discussion, but I think if these new rules don’t make you hate accounting, then you are in love with it – and that is a good thing.


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 aseasyasABC@ph.pwc.com. 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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