New year, new rules

While changes were happening in our day-to-day lives in the past year, finance people had to deal with an extra number of changes in accounting and regulatory rules. In 2018, banks and financial institutions addressed significant changes brought about by ‘Philippine Financial Reporting Standards (PFRS) 9 – Financial Instruments’, and a lot of companies in specialized industries got considerably affected by the changes introduced by the new revenue recognition standard ‘PFRS 15 – Revenue from Contracts with Customers’.

As we welcome 2019, let’s familiarize ourselves with a new accounting standard and a new accounting framework:

New standard: PFRS 16 – Leases

The new lease standard involves recognizing an asset (‘right of use asset’) in the company’s financial records even if the company does not have legal ownership over the property. Direct recognition of lease expense to profit or loss would only be applicable to short-term lease contracts with no intention to renew. With these, almost all lease arrangements are accounted for like a finance lease.

Apart from the accounting impact, companies should also be mindful of the effect of this standard on operating results and financial ratios. The new lease standard requires recognizing an asset and the corresponding lease liability that would be subject to amortization and interest, respectively. These changes would affect calculation of debt-to-equity ratio, earnings before income tax, depreciation and amortization (EBITDA), among others, therefore leading to a possible effect on companies’ key performance indicators (KPIs) and compliance to loan covenants.

New framework: PFRS for small entities (SEs)

This simplified accounting framework was locally developed to encourage startup companies and small businesses to comply with the regulators’ reportorial requirements. Among the other requisites for adoption, PFRS for SEs is available for companies with total assets or total liabilities of over P3 million but not more than P100 million.

PFRS for SEs provides simplified accounting, disclosures, and accounting treatment options; and lessens the need to account for estimation and judgments. I have written about some of the interesting changes introduced by the new framework in my August 2017 article, when PFRS for SEs was still at its proposal stage, but here is a short summary of what we should primarily be aware of upon adoption of PFRS for SEs this year:

Lease contracts are all accounted as operating lease, and straight lining of income/expense is no longer required. Expense/income is recognized when it is actually earned/incurred based on contract.

• Pension liability is recognized using straightforward calculation based on accrual method using the current salaries of entitled employees.
• There is an option not to recognize deferred taxes and follow taxes payable method approach.
• There is no requirement to provide disclosures about management estimates and judgment, including information on sensitivity analysis.
• Investors have the option not to consolidate and adjust equity account investment in subsidiaries.
• Restatements and reclassifications of the comparative year of the financial statements in cases of restatements and reclassifications are no longer required. Impact of restatements or reclassifications will be charged to beginning retained earnings of the current year financials.

While PFRS for SEs gives simplified accounting treatment and options, companies should also be mindful of the potential financial and operational impact of its new provisions. For example, straightforward calculation of pension liability would normally result in a higher amount of expense and liability, and non-recognition of deferred income taxes may compel companies to maintain a separate monitoring of income and expenses treated as temporary differences for annual income tax calculation.

International and local regulators view all of these changes as a means to improve financial reporting and compliance. To be able to prepare and fully comply for 2019 reporting, it is never too early to involve your consultants and auditors, as well as the companies’ IT team for necessary accounting system updates.

Once the euphoria of the new year wears off, most people would also forget to follow through on their resolutions. Change is the only constant thing in this world, so let us just remember that every change is for the good of most people. As we face the rest of 2019, let us hold on to our resolutions but never forget the real objective of all the changes – planned or not – that are coming our way.