The promise

Cherrylin M. Javier Assurance Partner, PwC Philippines 15 Apr 2016

Election Day is closing in fast and for many of us, the certainty of who possesses a good heart and can be trusted to pave the way for the Philippines to become a developed nation remains elusive. Much has been written about all the presidential candidates and two debates that were supposed to showcase their skills in defending their positions on certain issues had passed, but many are still likely to make up their minds down to the wire.

During the campaign period, promises are a politician’s best friend, but we know for a fact that promises can be left as that: mere promises. As history has shown, campaign promises are normally left half-fulfilled, if not broken. Campaign platforms are supposed to be based on the candidate’s good intentions to uplift the lives and well being of the people they seek to serve, but as the saying goes, it takes two to tango. Thus, if the general public does not bother to cooperate in bringing those promises to fruition, they should take part of the blame. If we like the sound of the promises we hear from a particular presidential wannabe, it would not hurt to first examine those promises to see if they are realistic.

Promises, likewise, exist in accounting. Several promises are made whenever a member of the management team signs contracts or financial statements—like a promise to deliver goods, to perform services, to pay, even to take care of one’s career.

The difference between politics and accounting is that in politics, promises do not require an accounting entry and the person pronouncing the promise can simply get away with breaking it. In accounting, promises are sealed with accounting entries or disclosures and the companies, whether by law, contractual or moral obligation, are duty-bound to fulfill their promises.

Audited financial statements help a reader identify promises embedded therein. There can also be promises that are not evident or not reckoned with on the financial statements but may exist nonetheless. Using easy to understand terms, I am briefly tackling two promises which are often overlooked: (1) the promise to an employee of a retirement pay; and (2) the promise to the general public, landlord or supplier of remediation, more commonly done by way of a clean-up, restoration, rehabilitation or preservation.

The promise of retirement pay

The Philippines has a Retirement Law (Republic Act No. 7641) that provides minimum retirement pay for qualified private sector employees. A qualified employee is one who, at the age of at least 60 (up to 65) years, is retiring after having completed service of at least five years with the same employer during the period. As applied in the Philippines, International Accounting Standard (IAS) 19, Accounting for Employee Benefits, mandates recognition of expense on a yearly basis over the estimated service life of an employee.

Hence, even if a company does not have a formal retirement plan, pension expense and pension obligation are supposed fixtures in the company’s financial statements.

While there are certain exemptions under the Retirement Law, a quick test to determine such exemptions is the test of 10—if your company has at least 10 employees and your financial statements do not contain any retirement-related account or disclosure, it is possible that there has been an oversight somewhere, or that someone may have been remiss. As what happens with many employers sometimes, they wait until vesting happens—someone in their employ reaches the retirement age—before they start accruing payments for retirement. Some other employers do that only on the sixth year of operations, mainly because any retirement-related item can only amount to something insignificant during the first five years. These two scenarios are clearly flawed: the first because technically under IAS 19, an employee starts earning his retirement pay on day one of his employment—the only question is how much? The second—ignoring employees’ demographics—could also create last-minute problems: what if a newly formed company hires a number of middle-aged employees on day one, or employs a couple of highly paid members of a management team? Such “excuses” mainly delay the company’s recognition of expense. If a company has less than 10 employees but expects to breach that magic number, it would also be good to start recognizing retirement expenses early on.

As you may have guessed, pension calculation is complex and hinges on a multitude of assumptions—employee demographics, compensation increases, mortality rates, service life, discount rate, etc. Accordingly, companies should ideally seek an actuarial valuation report from an independent actuary to determine amounts that need to be recognized in their financial statements. Lastly, it is important for employers to take note that funding a retirement plan is different from accounting for retirement benefits.

The promise of remediation

Remediation obligation, more commonly termed by accountants as asset retirement obligation (ARO), is a liability attached to retirement of an asset or vacating a property. It is important to understand that it is applicable across many industries and not only to extractive, energy, power and utility companies.

First and foremost, the obligation is triggered either legally or constructively—that is required by regulatory agencies such as the DENR, Bureau of Mines, lessors, the company’s very own health, security, environment, and safety policy, or its previously demonstrated but informal approach on cleaning up, or a similar obligatory responsibility.

As energy and utility companies are already well versed on this topic, my examples include others who may be affected, especially ordinary lessees whose contracts contain a specific clause that says “bring back to original condition” or “surrender the property at clean state” or other statements pointing out to “extra efforts” than simply vacating the leased property. Suffice it to say that extra efforts mean extra costs as well.

ARO is accounted for at the net present value of the liability or obligation under IAS 37, Provisions, Contingent Liabilities and Contingent Assets, with a corresponding debit to an asset account. The asset is then amortized over the life of the lease or the asset itself, while the obligation is accreted on a yearly basis to recognize the time value of money until such time that the obligation is settled.

Common examples where ARO must be recognized are: (1) an oil and gas depot, which should be returned without any trace of environmental hazards on and underneath it; (2) a leased office space where the lessee is required to dismantle all improvements and return the property to the lessor in its original state; and (3) a pipeline which should be locked or sealed at the end of its life. An even more specific example is reconstructing a single office into several individual units; in this particular case, the lessee has to rebuild the partitions including soundproofing, reroute electric lines, and close portions of the integrated vents as a result of the partitions.

Similar to the retirement expense, ARO estimation may require work from experts who are likely to be engineers, geologists, architects and similar professions.

Next steps

Today is a good day to revisit your promises if your business or company is in any of the industries mentioned above, or one that is engaged in environmentally “unfriendly” materials, or one that simply utilizes huge office space, or is labor-intensive. While it may seem simple from this article, there are complexities in accounting for retirement pay and ARO. Indeed, the promises do not come cheap and I won’t be surprised if some companies, after considering associated costs, end up adjusting product prices or service fees just to maintain the desired margin.

Promise means hope, love, and sometimes involves deception . . . but one thing is for sure, an accounting promise goes straight to the books, or at least gets disclosed through the notes to financial statements.

Vote wisely and good cheers for fulfilled promises.

Che is the Assurance Lead Partner for the Consumer and Industrial Products and Services Industry of PwC Philippines. 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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Cherrylin M.  Javier

Cherrylin M. Javier

Assurance Partner, PwC Philippines

Tel: +63 (2) 459 3010

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