Approved Q&As on Philippine Financial Reporting Standards

Philippine Interpretations Committee

Approved Q&As onPhilippine FinancialReportingStandardsJune 30, 2021


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Table of Contents

Preface .......................................................................................................................................xApproved PIC Q&As as of June 30, 2021 ................................................................................1

General Q&As .........................................................................................................................2

Q&A No. 2013-02: Conforming Changes to PIC Q&As – Cycle 2013 ...................................2




Q&A No. 2018-13: Conforming Changes to PIC Q&As – Cycle 2018 .................................12



PFRS 1, First-time Adoption of Philippine Financial Reporting Standards .............................21

Q&A No. 2011 – 05 (amended July 2019): PFRS 1 – Fair Value or Revaluation as DeemedCost ...................................................................................................................................21

PFRS 3, Business Combinations ...........................................................................................29

Q&A No. 2011 - 02: PFRS 3.2 – Common Control Business Combinations .......................29

Q&A No. 2012 - 01 (amended June 2018): PFRS 3.2 – Application of the Pooling ofInterests Method for Business Combinations of Entities under Common Control inConsolidated Financial Statements ....................................................................................33

Q&A No. 2012 – 02 (amended July 2019): Cost of a new building constructed on the site ofa previous building .............................................................................................................43

Q&A No. 2018 - 08: PFRS 10 and PFRS 3 - Accounting for the acquisition of a non-whollyowned subsidiary that is not a business .............................................................................51

PFRS 7, Financial Statements: Disclosures...........................................................................55

Q&A No. 2017 – 05 (amended June 2018): PFRS 7 – Frequently asked questions on thedisclosure requirements of financial instruments under PFRS 7, Financial Instruments:Disclosures ........................................................................................................................55

PFRS 9, Financial Instruments ..............................................................................................62


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Q&A No. 2011 - 03 (amended June 2020): Accounting for Inter-company Loans...............62

PFRS 10, Consolidated Financial Statements .......................................................................71

Q&A No. 2006 – 02 (amended May 2017): PFRS 10.4(a) – Clarification of criteria forexemption from presenting consolidated financial statements ............................................71

Q&A No. 2017 – 07: PFRS 10 – Accounting for reciprocal holdings in associates and jointventures .............................................................................................................................73

Q&A No. 2017 – 08 (amended June 2020): PFRS 10 – Requirement to prepareconsolidated financial statements where an entity disposes of its single investment in asubsidiary, associate or joint venture .................................................................................77

Q&A No. 2017 – 11: PFRS 10 and PAS 32 - Transaction costs incurred to acquireoutstanding non-controlling interest or to sell non-controlling interest without a loss ofcontrol ................................................................................................................................81

Q&A No. 2018 - 08: PFRS 10 and PFRS 3 - Accounting for the acquisition of a non-whollyowned subsidiary that is not a business .............................................................................86

PFRS 13, Fair Value Measurement .......................................................................................90

Q&A No. 2011 - 03 (amended June 2020): Accounting for Inter-company Loans...............90

Q&A No. 2018 - 03: PFRS 13, PAS 16 and PAS 36 - Fair value of property, plant andequipment and depreciated replacement cost ....................................................................99

Q&A No. 2018 - 16: PFRS 13 - Level of fair value hierarchy of government securities usingBloomberg’s standard rule on fair value hierarchy............................................................ 103

PFRS 15, Revenue from Contracts with Customers ............................................................ 127

Q&A No. 2016 – 04: Application of PFRS 15 “Revenue from Contracts with Customers” onSale of Residential Properties under Pre-completion Contracts ....................................... 127

Q&A No. 2018 – 12: PFRS 15 implementation issues affecting the real estate industry ... 151

SUMMARY OF THE IMPLEMENTATION ISSUES IDENTIFIED BY THE SPECIAL TASKFORCE......................................................................................................................... 151STEP 1 – Requires an Entity to Identify the Contract with the Customer. ..................... 155STEP 2 – Requires an Entity to Identify the Distinct Goods or Services Promised withinthe Contract (Horizontal Development) ......................................................................... 158STEP 2 – Requires an Entity to Identify the Distinct Goods or Services Promised withinthe Contract (Vertical Development) ............................................................................. 164STEP 3 – Requires an Entity to Determine the Transaction Price for the Contract ....... 167


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STEP 5 – Specifies How an Entity Should Determine When to Recognize Revenue inRelation to a Performance Obligation (Measurement of Progress) ............................... 180STEP 5 – Specifies How an Entity Should Determine When to Recognize Revenue inRelation to a Performance Obligation (Measurement of Progress) ............................... 199STEP 5 – Specifies How an Entity Should Determine When to Recognize Revenue inRelation to a Performance Obligation (Costs to Obtain a Contract) .............................. 202Accounting for Common Usage Service Area (CUSA) Charges ................................... 206

Q&A No. 2019 – 01: Accounting for service charges under PFRS 15, Revenue fromContracts with Customers ................................................................................................ 213

Q&A No. 2019 – 03: Revenue recognition guidance for sugar millers .............................. 218

Q&A No. 2020 – 02: Conclusion on PIC QA 2018-12E: On certain materials delivered onsite but not yet installed.................................................................................................... 224

Q&A No. 2020 – 03: Q&A No. 2018-12-D: STEP 3 – On the accounting of the differencewhen the percentage of completion is ahead of the buyer’s payment ............................... 229

Q&A No. 2020 – 04 (Addendum to PIC Q&A 2018-12-D): PFRS 15 - Step 3 - Requires andEntity to Determine the Transaction Price for the Contract ............................................... 234

Q&A No. 2020 – 05: PFRS 15 - Accounting for Cancellation of Real Estate Sales........... 238

PFRS 16, Leases ................................................................................................................ 252

Q&A No. 2019 – 08: Accounting for Asset Retirement or Restoration Obligation with theAdoption of PFRS 16, Leases .......................................................................................... 252

Q&A No. 2019 – 09: Accounting for Prepaid Rent or Rent Liability Arising from Straight-lining under PAS 17 on Transition to PFRS 16 and the Related Deferred Tax Effects ..... 256

Q&A No. 2019 – 10: Accounting for variable payments with rent review .......................... 262

Q&A No. 2019 – 11: Determining the current portion of an amortizing loan/lease liability. 267

Q&A No. 2019 – 12: Determining the lease term under PFRS 16, Leases ....................... 270

Q&A No. 2019 – 13: Determining the lease term of leases that are renewable subject tomutual agreement of the lessor and the lessee ................................................................ 274

Q&A No. 2020 – 06: Accounting for payments between and among lessors and lessees 277

PAS 1, Presentation of Financial Statements ...................................................................... 295

Q&A No. 2009 – 01 (amended June 2020): Framework 3.9 and PAS 1.25 – Financialstatements prepared on a basis other than going concern ............................................... 295


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Q&A No. 2010 – 02 (amended June 2018): PAS 1R.16 – Basis of preparation of financialstatements ....................................................................................................................... 299

Q&A No. 2010 – 03: PAS 1R.16 – PAS 1 Presentation of Financial Statements – Current/non-current classification of a callable term loan .............................................................. 303

Q&A No. 2011 – 03 (amended June 2020): Accounting for Inter-company Loans ............ 306

Q&A No. 2016 – 03 (amended June 2020): Accounting for Common Areas and the RelatedSubsequent Costs by Condominium Corporations ........................................................... 315

Q&A No. 2018 – 15 (amended July 2019): PAS 1- Classification of Advances toContractors in the Nature of Prepayments: Current vs. Non-current ................................ 320

PAS 2, Inventories ............................................................................................................... 325

Q&A No. 2012 - 02: Cost of a new building constructed on the site of a previous building ........................................................................................................................................ 325

Q&A No. 2017 – 02 (amended July 2019): Capitalization of depreciation of right-of-useasset cost as part of construction costs of a building ........................................................ 333

Q&A No. 2017 - 06: PAS 2, 16 and 40 – Accounting for Collector’s Items ....................... 338

Q&A No. 2018 - 10: PAS 2 - Scope of disclosure of inventory write-downs ...................... 342

Q&A No. 2018 - 11: Classification of land by real estate developer .................................. 344

Q&A No. 2019 - 02: Accounting For Cryptographic Assets .............................................. 351

PAS 8, Accounting Policies, Changes in Accounting Estimates and Errors ......................... 364

Q&A No. 2017 - 12: Subsequent Treatment of Equity Component Arising fromIntercompany Loans ........................................................................................................ 364

Q&A No. 2018 - 01: PAS 8 - Voluntary changes in accounting policy ............................... 367

PAS 12, Income taxes ......................................................................................................... 370

Q&A No. 2020 - 07: Accounting for the Proposed Changes in Income Tax Rates under theCorporate Recovery and Tax Incentives for Enterprises Act (CREATE) Bill ..................... 370

PAS 16, Property, Plant and Equipment .............................................................................. 379


Q&A No. 2017 – 02 (amended July 2019): Capitalization of depreciation of right-of-useasset cost as part of construction costs of a building ........................................................ 387



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Q&A No. 2018 - 03: PFRS 13, PAS 16 and PAS 36 - Fair value of property, plant andequipment and depreciated replacement cost .................................................................. 396

PAS 19, Employee Benefits (Revised)................................................................................. 400

Q&A No. 2008 – 01 (Amended April 2016): PAS 19.83 – Rate used in discounting post-employment benefit obligations ........................................................................................ 400

Q&A No. 2013 – 03 (Revised): PAS 19 – Accounting for Employee Benefits under aDefined Contribution Plan subject to Requirements of Republic Act (RA) 7641, ThePhilippine Retirement Law ............................................................................................... 402

PAS 21, The Effects of Changes in Foreign Exchange Rates .............................................. 409

Q&A No. 2018 – 09: PAS 21 - Classification of deposits and progress payments asmonetary or non-monetary items ..................................................................................... 409

PAS 24, Related Party Disclosures ..................................................................................... 412


Q&A No. 2017 - 04 Related party relationships between parents, subsidiary, associate andnon-controlling shareholder .............................................................................................. 421

PAS 27, Separate Financial Statements .............................................................................. 426

Q&A No. 2011 - 03 (amended June 2020): Accounting for Inter-company Loans............. 426

Q&A No. 2018 - 06: PAS 27 - Cost of investment in subsidiaries in separate financialstatements when pooling is applied in consolidated financial statements ......................... 435

Q&A No. 2019 - 06: Accounting for step acquisition of a subsidiary in a parent’s separatefinancial statements ......................................................................................................... 439

PAS 28, Investments in Associates and Joint Ventures ....................................................... 444


Q&A No. 2017 – 03: PAS 28 - Elimination of profits and losses resulting from transactionsbetween associates and/or joint ventures......................................................................... 453

PAS 32, Financial Instruments: Presentation ....................................................................... 457


Q&A No. 2011 – 04 (amended June 2018): PAS 32.37-38 – Costs of Public Offering ofShares ............................................................................................................................. 466

Q&A No. 2016-02: PAS 32 and PAS 38 (amended June 2018) – Accounting Treatment ofClub Shares Held by an Entity ......................................................................................... 472


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Q&A No. 2017 – 11: PFRS 10 and PAS 32 - Transaction costs incurred to acquireoutstanding non-controlling interest or to sell non-controlling interest without a loss ofcontrol .............................................................................................................................. 476

Q&A No. 2019 – 07: Classification of Members’ Capital Contributions of Non-Stock Savingsand Loan Associations (NSSLA) ...................................................................................... 481

PAS 36, Impairment of Assets ............................................................................................. 486

Q&A No. 2018-02: PAS 36 - Non-controlling interests and goodwill impairment test ........ 486

Q&A No. 2018 - 03: PFRS 13, PAS 16 and PAS 36 - Fair value of property, plant andequipment and depreciated replacement cost .................................................................. 491

PAS 37, Provisions, Contingent Liabilities and Contingent Assets ....................................... 495

Q&A No. 2018 – 05 (amended July 2019): PAS 37 - Liability arising from maintenancerequirement of an asset held under a lease ..................................................................... 495

PAS 38, Intangible Assets ................................................................................................... 498

Q&A No. 2016-02: PAS 32 and PAS 38 (amended June 2018) – Accounting Treatment ofClub Shares Held by an Entity ......................................................................................... 498

Q&A No. 2019 - 02: Accounting For Cryptographic Assets .............................................. 502

PAS 40, Investment Property .............................................................................................. 514

Q&A No. 2007 – 03: PAS 40.27 – Valuation of bank real and other properties acquired(ROPA) ............................................................................................................................ 514



Q&A No. 2017 – 10 (amended July 2019): PAS 40 - Separation of property andclassification as investment property ................................................................................ 528

Q&A No. 2018 - 11: Classification of land by real estate developer .................................. 533

PAS 41, Agriculture ............................................................................................................. 539

Q&A No. 2018 – 04: PAS 41 - Inability to measure fair value reliably for biological assetswithin the scope of PAS 41, Agriculture ........................................................................... 539

Amended PIC Q&As as of June 30, 2021 ............................................................................. 543Q&A No. 2006 – 02 (amended May 2017): PFRS 10.4(a) - Clarification of criteria forexemption from presenting consolidated financial statements .......................................... 544


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Q&A No. 2008–01 (amended April 2016): PAS 19.83 – Rate used in discounting post-employment benefit obligations ........................................................................................ 546

Q&A No. 2009 – 01 (amended June 2018): Framework.4.1 and PAS 1.25 - Financialstatements prepared on a basis other than going concern ............................................... 548

Q&A No. 2010 – 02 (amended June 2018): PAS 1R.16 – Basis of preparation of financialstatements ....................................................................................................................... 552


Q&A No. 2011 – 04 (amended June 2018): PAS 32.37-38 – Costs of Public Offering ofShares ............................................................................................................................. 564

Q&A No. 2011 – 05 (amended June 2018): PFRS 1.D1-D8 – Fair Value or Revaluation asDeemed Cost ................................................................................................................... 570

Q&A No. 2012 – 01 (amended June 2018): PFRS 3.2 – Application of the Pooling ofInterests Method for Business Combinations of Entities under Common Control inConsolidated Financial Statements .................................................................................. 578

Q&A No. 2016 – 02 (amended June 2018): PAS 32 and PAS 38 – Accounting Treatment ofClub Shares Held by an Entity ......................................................................................... 589

Q&A No. 2016 – 03 (amended June 2020): Accounting for Common Areas and the RelatedSubsequent Costs by Condominium Corporations ........................................................... 593

Q&A No. 2017 – 05 (amended June 2018): PFRS 7 – Frequently asked questions on thedisclosure requirements of financial instruments under PFRS 7, Financial Instruments:Disclosures ...................................................................................................................... 598

Q&A No. 2018 – 07 (amended June 2018): PAS 27 and PAS 28 - Cost of an associate,joint venture, or subsidiary in separate financial statements ............................................. 605

Q&A No. 2011 – 05 (amended July 2019): PFRS 1.D1-D8 – Fair Value or Revaluation asDeemed Cost ................................................................................................................... 610

Q&A No. 2011 - 06 (amended July 2019): PFRS 3, Business Combinations (2008), andPAS 40, Investment Property – Acquisition of investment properties – asset acquisition orbusiness combination?..................................................................................................... 619

Q&A No. 2012 – 02 (amended July 2019): Cost of a new building constructed on the site ofa previous building ........................................................................................................... 629

Q&A No. 2017 – 02 (amended July 2019): Capitalization of operating lease costdepreciation of right-of-use asset as part of construction costs of a building .................... 637


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Q&A No. 2017 – 10 (amended July 2019): PAS 40 - Separation of property andclassification as investment property ................................................................................ 642

Q&A No. 2018 - 05 (amended July 2019): PAS 37 - Liability arising from maintenancerequirement of an asset held under a lease ..................................................................... 647

Q&A No. 2018 – 15 (amended July 2019): PAS 1- Classification of Advances toContractors in the Nature of Prepayments: Current vs. Non-current ................................ 650

Q&A No. 2009 – 01 (amended June 2020): Framework 3.94.1 and PAS 1.25 - Financialstatements prepared on a basis other than going concern ............................................... 655

Q&A No. 2011 – 03 (amended June 2020): Accounting for Inter-company Loans1........... 659

Q&A No. 2016-03 (amended June 2020): Accounting for Common Areas and the RelatedSubsequent Costs by Condominium Corporations ........................................................... 668

Q&A No. 2017 – 08 (amended June 2020): PFRS 10 – Requirement to prepareconsolidated financial statements where an entity disposes of its single investment in asubsidiary, associate or joint venture ............................................................................... 673

Q&A No. 2018 – 14 (amended June 2020): PFRS 15 - Accounting for Cancellation of RealEstate Sales ..................................................................................................................... 677

Withdrawn and superseded PIC Q&As as of June 30, 2021 ............................................... 688Q&A No. 2006 – 01: PAS 18, Appendix, paragraph 9 – Revenue recognition for sales ofproperty units under pre-completion contracts ................................................................. 689

Q&A No. 2007 – 01: PAS 1.103(a) – Basis of preparation of financial statements if an entityhas not applied PFRSs in full ........................................................................................... 693

Q&A No. 2007 – 02: PAS 20.24, 20.37 and PAS 39.43 – Accounting for government loanswith low interest rates ...................................................................................................... 697

Q&A No. 2007 – 04: PAS 101.7 – Application of criteria for a qualifying NPAE ................ 700

Q&A No. 2008 – 01: PAS 19.78 – Rate used in discounting post-employment benefitobligations........................................................................................................................ 702

Q&A No. 2008 – 02: PAS 20.43 – Accounting for government loans with low interest ratesunder the amendments to PAS 20 ................................................................................... 704

Q&A No. 2009 – 02: PAS 39.AG71-72 – Rate used in determining the fair value ofgovernment securities in the Philippines .......................................................................... 707

Q&A No. 2010 – 01: PAS 39.AG71-72 – Rate used in determining the fair value ofgovernment securities in the Philippines .......................................................................... 715


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Q&A No. 2011 - 01: PAS 1.10(f) – Requirements for a Third Statement of Financial Position ........................................................................................................................................ 726

Q&A No. 2011 – 06 (amended July 2019): PFRS 3, Business Combinations (2008), andPAS 40, Investment Property – Acquisition of investment properties – asset acquisition orbusiness combination?..................................................................................................... 732

Q&A No. 2017 – 09: PAS 17 and Philippine Interpretation SIC-15 - Accounting forpayments between and among lessors and lessees ........................................................ 741

Q&A No. 2018 – 07 (amended June 2018): PAS 27 and PAS 28 - Cost of an associate,joint venture, or subsidiary in separate financial statements ............................................. 750

Q&A No. 2018 – 14 (amended June 2020): PFRS 15 - Accounting for Cancellation of RealEstate Sales ..................................................................................................................... 754

PFRS for Small and Medium-sized Entities (SMEs) ............................................................. 764

Q&A No. 2013 - 01: Applicability of SMEIG Final Q&As on the application of IFRS for SMEsto Philippine SMEs ........................................................................................................... 764

Appendix ............................................................................................................................... 767List of Approved Q&As as of June 30, 2021 by date of issuance ......................................... 767


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Preface

The International Financial Reporting Standards (IFRSs), locally referred to as PhilippineFinancial Reporting Standards (PFRSs), has become a buzzword, not only in the accountingworld, but also in the business sector. The initial adoption of PFRSs in 2005 was one of themost daunting tasks as far as application of the accounting standards is concerned. This difficulttask continues to date. The continuing review and revisions or amendments of the PFRSs andthe actual implementation of these standards continue to pose challenges for both the usersand the preparers of financial statements.

Being principles-based standards, there are instances when provisions of PFRSs require theexercise of significant judgment in its interpretation. Hence, guidance is needed in theimplementation of these standards. The need for such guidance was what prompted thecreation of the Philippine Interpretations Committee or PIC.

The main objective of the PIC is to provide implementation guidance on Philippine AccountingStandards (PASs) and Philippine Financial Reporting Standards (PFRSs) issued by theFinancial Reporting Standards Council (FRSC). These PASs and PFRSs are primarily basedon accounting pronouncements issued by the International Accounting Standards Board, theglobal standard-setting body that issues IFRSs.

Composed of 15 members from various accounting firms, business organizations, the academeand regulators, the PIC deals with accounting issues that are considered to have significantimpact to companies operating in the Philippines.

The main product of the work of the PIC is the PIC Questions and Answers (Q&As). These PICQ&As make reference to the related paragraphs in the PFRSs. The issues and the backgroundof such are discussed thoroughly, ending with a consensus that lead to their resolution and,hence, a clearer guidance in the implementation of the standards.

In the past, these Q&As were released individually. However, the current PIC members thinkthat it is high time that these Q&As be consolidated and issued in one comprehensivepublication that would be a valuable reference and a useful resource for users of financialaccounting information, whether they be from public practice, commerce, the academe or thegovernment.


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This publication is the compilation of the PIC Q&As approved by the PIC as of June 30, 2021,grouped according to their related standards. It also contains the PIC Q&As superseded as ofthe same date.


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Date approved by PIC: June 30, 2021

PIC Members

Wilson P. Tan, Chairman

Emmanuel Y. Artiza Ma. Gracia F. Casals-Diaz

Christian Francis S. Felismino Zaldy D. Aguirre

Joeffrey Mark P. Ferrer Ferdinand George A. Florendo

Gerry I. Piator Eduardo M. Olbes

Rosario S. Bernaldo Lyn I. Javier

Ma. Isabel E. Comedia Arnel Onesimo O. Uy

Jerome Antonio B. Constantino Lovely M. Del Amen-Aquino

Date approved by FRSC: August 11, 2021


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Approved PIC Q&As as ofJune 30, 2021


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General Q&As

Q&A No. 2013-02: Conforming Changes to PIC Q&As – Cycle 2013

Introduction

This Q&A No. 2013-02 sets out the changes (i.e., amendments or withdrawal) to certain PICQ&As. These changes are made as a consequence of the issuance of new Philippine FinancialReporting Standards (PFRS) and amendments to certain existing PFRS that are effective as ofAugust 31, 2013. The consequential amendments are set out in the same section as theamended PIC Q&As attached to this Q&A No. 2013-02. In addition, a marked-up copy of theamended PIC Q&A showing the changes made (i.e., new text is underlined and deleted text isstruck through) is attached as an appendix to the amended PIC Q&A.

The effective date of the amendments is included in the Q&As affected.

PIC Q&As Amended

The following table summarizes the changes made to the amended PIC Q&As:

PIC Q&As Amended Amendments

PIC Q&A No. 2006-02: PAS 27.10(d) –Clarification of criteria for exemption frompresenting consolidated financial statements

Change in the reference to the PFRS uponwhich PIC Q&A No. 2006-02 was based as aresult of the issuance of the amended PAS27, Separate Financial Statements, and thenew PFRS 10, Consolidated FinancialStatements

PIC Q&A No. 2009-01: Framework.23 andPAS 1.23 – Financial statements preparedon a basis other than going concern

1. Change in the reference to PFRS uponwhich PIC Q&A No. 2009-01 was basedas a result of the issuance of TheConceptual Framework on FinancialReporting and the amendments to PAS 1,Presentation of Financial Statements

2. Clarification on the composition of acomplete set of financial statements of anentity prepared on a basis other thangoing concern


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PIC Q&As Withdrawn

The following table summarizes the basis and effective date of withdrawal of the Q&Aswithdrawn:

PIC Q&As Withdrawn Basis for Withdrawal

PIC Q&A No. 2007-04: PAS 101.7 –Application of criteria for a qualifying NPAE

PIC Q&A No. 2007-04 contained theconsensus on certain issues relating toparagraph 7 of Philippine AccountingStandard (PAS) 101, Financial ReportingStandards for Non-publicly AccountableEntities (NPAEs). PAS 101 was withdrawn inOctober 2009 upon the adoption by thePhilippine Financial Reporting StandardsCouncil (FRSC) of the PFRS for Small andMedium-sized Entities (PFRS for SMEs),which became effective for annual periodsbeginning on or afterJanuary 1, 2010.

Consequently, PIC Q&A No. 2007-04 isconsidered withdrawn effective as ofJanuary 1, 2010, the effective date of PFRSfor SMEs.

PIC Q&A No. 2010-01: PAS 39.AG71-72 –Rate used in determining the fair value ofgovernment securities

PIC Q&A No. 2010-01 contained theconsensus on certain issues relating toparagraph AG 71-72 of PAS 39, FinancialInstruments: Recognition and Measurement.The said issues have been addressed inPFRS 13, Fair Value Measurement, whichbecame effective for annual periodsbeginning on or after January 1, 2013.

Consequently, PIC Q&A No. 2010-01 iswithdrawn and should no longer be appliedfor annual periods beginning on or afterJanuary 1, 2013, the effective date ofPFRS 13.

PIC Q&A No. 2011-01: Requirements of athird statement of financial position

PIC Q&A No. 2011-01 contained theconsensus on certain issues relating to


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paragraph 10 (f) of PAS 1, Presentation ofFinancial Statements. The said issues havebeen clarified upon the issuance of theAnnual Improvements to PFRS 2009-2011Cycle, which became effective for annualperiods beginning on or after January 1,2013.

Consequently, PIC Q&A No. 2011-01 iswithdrawn and should no longer be appliedfor annual periods beginning on or afterJanuary 1, 2013, the effective date of theAnnual Improvements to PFRS 2009-2011Cycle.

Date approved by PIC: September 25, 2013

PIC Members

Dalisay B. Duque, Chairman

Wilfredo A. Baltazar Edmund A. Go


Sharon S. Dayoan Ma. Concepcion Y. Lupisan

Gina S. Detera Wilson P. Tan

Ma. Gracia F. Casals-Diaz Normita L. Villaruz

Date approved by FRSC: October 8, 2014


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Introduction

This Q&A No. 2015-01 sets out the amendments to certain PIC Q&As. These changes are madeas a consequence of the issuance of new Philippine Financial Reporting Standards (PFRS) andamendments to certain existing PFRS that are effective as of January 1, 2013. The consequentialamendments are set out in the same section as the amended PIC Q&As attached to this Q&ANo. 2015-01. In addition, a marked-up copy of the amended PIC Q&A showing the changesmade (i.e., new text is underlined and deleted text is struck through) is attached as an appendixto the amended PIC Q&A.


PIC Q&As Amended



PIC Q&A No. 2012-01: PFRS 3.2 –Application of the Pooling of Interests Methodfor Business Combinations of Entities underCommon Control in Consolidated FinancialStatements

Change in the reference to the PFRS uponwhich PIC Q&A No. 2012-01 was based as aresult of the issuance of the amendedPAS 27, Separate Financial Statements, andthe new PFRS 10, Consolidated FinancialStatements

PIC Q&A No. 2011-03: Accounting for Inter-company Loans

1. Change in the reference to PFRS uponwhich PIC Q&A No. 2011-03 was basedas a result of the following:

a. Issuance of The ConceptualFramework on Financial Reporting

b. Issuance of the amended PAS 27,Separate Financial Statements, andPAS 28, Consolidated FinancialStatements

2. Minor changes in the wordings

Date approved by PIC: July 29, 2015


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PIC Members


Emmanuel Y. Artiza Sharon G. Dayoan

Clark Joseph C. Babor Gina S. Detera

Wilfredo A. Baltazar Ferdinand George A. Florendo

Gloria T. Baysa Jose Emmanuel U. Hilado


Ma. Isabel E. Comedia Ma. Concepcion Y. Lupisan

Jerome Antonio B. Constantino Normita L. Villaruz



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Introduction

This Q&A No. 2016-01 sets out the changes (i.e., amendments or withdrawal) to certain PICQ&As. These changes are made as a consequence of the issuance of new Philippine FinancialReporting Standards (PFRS) and amendments to certain existing PFRS that are effective as ofDecember 31, 2015. The consequential amendments are set out in the same section as theamended PIC Q&As attached to this Q&A No. 2016-01. In addition, a marked-up copy of theamended PIC Q&A showing the changes made (i.e., new text is underlined and deleted text isstruck through) is attached as an appendix to the amended PIC Q&A.


PIC Q&As Amended



PIC Q&A No. 2008-01: Rate used indiscounting post-employment benefitobligations

Changed in the reference to the PFRS uponwhich PIC Q&A No. 2008-01 was based as aresult of the issuance of the revised PAS 19,Employee Benefits.

PIC Q&A No. 2011-05: Fair Value orRevaluation as Deemed Cost

Deleted reference to PIC Q&A No. 2011-01,which was withdrawn in 2013.

PIC Q&As Withdrawn

The following table summarizes the basis and effective date of withdrawal of the Q&Aswithdrawn:


PIC Q&A No. 2008-02: PAS 20.43 –Accounting for Government Loans with LowInterest Rates

PIC Q&A No. 2008-02 contained theconsensus on certain issue relating toparagraph 43 of Philippine AccountingStandard (PAS) 20, Accounting forGovernment Grants and Disclosure of


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Government Assistance. PAS 20 wasamended so that accounting treatment of thedifference is to be consistent with that ofPAS 39 Financial Instruments: Recognitionand Measurement.

Consequently, PIC Q&A No. 2008-02 isconsidered withdrawn effective as ofJanuary 1, 2009, the effective date of theamendment.

Date approved by PIC: April 27, 2016

PIC Members











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Introduction

This Q&A No. 2017-01 sets out the changes (i.e., amendments or withdrawal) to certain PIC Q&As.These changes are made as a consequence of the issuance of new Philippine Financial ReportingStandards (PFRS) and amendments to certain existing PFRS that are effective as of December 31,2016. The consequential amendments are set out in the same section as the amended PIC Q&Asattached to this Q&A No. 2017-01. In addition, a marked-up copy of the amended PIC Q&A showingthe changes made (i.e., new text is underlined and deleted text is struck through) is attached as anappendix to the amended PIC Q&A.


PIC Q&As Amended



PIC Q&A No. 2010-02: PAS 1R-16 - Basis ofPreparation of Financial Statements

Change in the reference indicated in footnote1 from “SRC Rule 68.1” to “SRC Rule 68, PartII” was based as a result of the issuance of theSecurities Regulation Code (SRC) Rule 68,Part II.

PIC Q&A No. 2006-02 (amended August2013): PFRS 10.4(a) – Clarification of criteriafor exemption from preparing consolidatedfinancial statements

Change reference indicated in footnote 1,page 1 from paragraph 3 to paragraph 7 to ofPAS 1.


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PIC Q&A Withdrawn

The following table summarizes the basis and effective date of withdrawal of the Q&A withdrawn:

PIC Q&A Withdrawn Basis for Withdrawal

PIC Q&A No. 2013-01: Applicability ofSMEIG Final Q&As on the Application ofIFRS for SMEs to Philippine SMEs

PIC Q&A No. 2013-01 contained theconsensus on the applicability of the FinalQ&As issued by the SME ImplementationGroup (SMEIG) on the applicability ofInternational Financial Reporting Standard forSmall and Medium-Sized Entities (IFRS forSMEs) to the Philippine SMEs.IFRS for SMEs (and consequently, PFRS forSMEs) was amended to, among others,incorporate the contents of the Final Q&As inthe main body of this standard.Consequently, PIC Q&A No. 2013-01 isconsidered withdrawn effective as ofJanuary 1, 2017, the effective date of theamendments to PFRS for SMEs.


11

Date approved by PIC: May 24, 2017

PIC Members



Clark Joseph C. Babor Zaldy D. Aguirre






Date approved by FRSC: May 24, 2017


12


Introduction

This Q&A No. 2018-13 sets out the changes (i.e., amendments or withdrawal) to certain PICQ&As. These changes are made as a consequence of the issuance of new Philippine FinancialReporting Standards (PFRSs) that become effective starting January 1, 2018 and other relevantdevelopments. The consequential amendments are set out in the same section as the amendedPIC Q&As attached to this Q&A No. 2018-13. In addition, a marked-up copy of the amended PICQ&A showing the changes made (i.e., new text is underlined and deleted text is struck through) isattached as an appendix to the amended PIC Q&A.

The effective date of the amendments is included in the affected Q&As.

PIC Q&As Amended


PIC Q&As Amended AmendmentsPIC Q&A No. 2009-01: Framework 4.1 andPAS 1.25 - Financial statements prepared ona basis other than going concern

References to PAS 39 have been updated toPFRS 9, Financial InstrumentsUpdated to include PFRS for Small Entitiesas one of the financial reporting frameworksin the Philippines

PIC Q&A No. 2010-02: PAS 1R.16 – Basis ofpreparation of financial statements

Updated to include PFRS for Small Entitiesas one of the financial reporting frameworksin the Philippines

PIC Q&A No. 2011-03: Accounting for Inter-company Loans

Updated to comply with the provisions ofPFRS 9

PIC Q&A No. 2011-04: PAS 32.37-38 –Costs of Public Offering of Shares

Reference to PAS 39 has been updated toPFRS 9

PIC Q&A No. 2011-05: PFRS 1.D1-D8 –Fair Value or Revaluation as Deemed Cost

Updated to include PFRS for Small Entitiesas one of the financial reporting frameworksin the PhilippinesReference to PAS 39 has been updated toPFRS 9

PIC Q&A No. 2012-01: PFRS 3.2 –Application of the Pooling of Interests Methodfor Business Combinations of Entities underCommon Control in Consolidated FinancialStatements


PIC Q&A No. 2016-02: PAS 32 and PAS 38– Accounting Treatment of Club Shares Heldby an Entity

Reference to PAS 39 has been updated toPFRS 9


13

PIC Q&As Amended AmendmentsPIC Q&A No. 2016-03: Accounting forCommon Areas and the Related SubsequentCosts by Condominium Corporations

Updated definition of revenue based on theprovisions of PFRS 15, Revenue fromContracts with Customers

PIC Q&A No. 2017-05: PFRS 7 – Frequentlyasked questions on the disclosurerequirements of financial instruments underPFRS 7, Financial Instruments: Disclosures


PIC Q&A No. 2018-07: PAS 27 and PAS 28- Cost of an associate, joint venture, orsubsidiary in separate financial statements


PIC Q&A Withdrawn

The following table summarizes the basis and effective date of withdrawal of Q&As affected bynew PFRSs:

PIC Q&A Withdrawn Basis for WithdrawalPIC Q&A No. 2006-01: PAS 18, Appendix,paragraph 9 – Revenue recognition for salesof property units under pre-completioncontracts

This PIC Q&A is considered withdrawnstarting January 1, 2018, which is theeffective date of PFRS 15.



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PIC Members



Chase M. Sarmiento Zaldy D. Aguirre





Jerome Antonio B. Constantino Lovely M. Del Amen



15


Introduction



PIC Q&As Amended


PIC Q&A Amended AmendmentPIC Q&A No. 2011-05: PFRS 1 – Fair Valueor Revaluation as Deemed Cost

Updated because of applying PFRS 16,Leases, for the first time starting January 1,2019

PIC Q&A No. 2011-06: Acquisition ofinvestment properties – asset acquisition orbusiness combination?

Reference to PAS 40, Investment Property,has been updated because of applyingPFRS 16 for the first time starting January 1,2019.

PIC Q&A No. 2012-02: Cost of a new buildingconstructed on the site of a previous building

Reference to PAS 40 has been updatedbecause of applying PFRS 16 for the firsttime starting January 1, 2019.

PIC Q&A No. 2017-02: PAS 2 and PAS 16 -Capitalization of operating lease cost as partof construction costs of a building

Updated to comply with the provisions ofPFRS 16 and renamed as PIC Q&A No.2017-02: PAS 2 and PAS 16 - Capitalizationof depreciation of right-of-use asset as part ofconstruction costs of a building

PIC Q&A No. 2017-10: PAS 40 - Separationof property and classification as investmentproperty

Reference to PAS 40 has been updatedbecause of applying PFRS 16 for the firsttime starting January 1, 2019.

PIC Q&A No. 2018-05: PAS 37 - Liabilityarising from maintenance requirement of anasset held under a lease


PIC Q&A No. 2018-15: PAS 1- Classificationof Advances to Contractors in the Nature ofPrepayments: Current vs. Non-current

Reference to PAS 40 (included as anattachment to the Q&A) has been updatedbecause of applying PFRS 16 for the firsttime starting January 1, 2019.


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PIC Q&A Withdrawn

The following table summarizes the basis and effective date of withdrawal of Q&As affected bynew PFRSs and IFRIC agenda decision:

PIC Q&A Withdrawn Basis for WithdrawalPIC Q&A No. 2017-09: PAS 17 andPhilippine Interpretation SIC-15 - Accountingfor payments between and among lessorsand lessees

This PIC Q&A is considered withdrawnstarting January 1, 2019, which is theeffective date of PFRS 16. PFRS 16superseded PAS 17, Leases, and PhilippineInterpretation SIC-15, Operating Leases—Incentives.

PIC Q&A No. 2018-07: PAS 27 and PAS 28 -Cost of an associate, joint venture, orsubsidiary in separate financial statements

This PIC Q&A is considered withdrawn uponpublication of IFRIC agenda decision -Investment in a subsidiary accounted for atcost: Step acquisition (IAS 27 SeparateFinancial Statements) in January 2019.

Date approved by PIC: August 1, 2019

https://www.ifrs.org/news-and-events/updates/ifric-updates/january-2019/#4




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PIC Members



David Ernesto V. Cruz Zaldy D. Aguirre


Marko Romeo L. Fuentes Jose Emmanuel U. Hilado






18


Introduction



PIC Q&As Amended


PIC Q&A Amended AmendmentFramework 4.1 and PAS 1.25 - Financialstatements prepared on a basis other thangoing concern

References to The Conceptual Framework forFinancial Reporting have been updated due tothe revised framework effective January 1,2020.

Q&A No. 2016 - 03: Accounting for CommonAreas and the Related Subsequent Costs byCondominium Corporations


Q&A No. 2011 - 03: Accounting for Inter-company Loans


Q&A No. 2017 – 08: PFRS 10 – Requirementto prepare consolidated financial statementswhere an entity disposes of its singleinvestment in a subsidiary, associate or jointventure


Q&A 2018 – 14: PFRS 15 - Accounting forCancellation of Real Estate Sales


PIC Q&A Withdrawn

The following table summarizes the basis and effective date of withdrawal of Q&As affected bynew PFRSs and IFRIC agenda decision:


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PIC Q&A Withdrawn Basis for WithdrawalPIC Q&A No. 2011-06: Acquisition ofinvestment properties – asset acquisition orbusiness combination?

With the amendment to PFRS 3 on thedefinition of a business effective January 1,2020, there is additional guidance inparagraphs B7A-B12D of PFRS 3 inassessing whether acquisition of investmentproperties is an asset acquisition or businesscombination (i.e. optional concentration testand assessment of whether an acquiredprocess is substantive).



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PIC Members











21

PFRS 1, First-time Adoption of Philippine Financial ReportingStandards

Q&A No. 2011 – 05 (amended July 2019): PFRS 1 – Fair Value orRevaluation as Deemed Cost

Issue 1

What is the proper accounting treatment for the revaluation increment of property, plant andequipment when revalued amounts are accounted for as “deemed cost” at the date of transition toPFRS (or PFRS for SMEs1 / PFRS for Small Entities2)?

Background

Under paragraphs 6-7 of PFRS 1, First-time Adoption of Philippine Financial Reporting Standards,an entity shall:

prepare and present an opening PFRS statement of financial position at the date oftransition to PFRSs. This is the starting point for the entity’s accounting in accordancewith PFRSs.

use the same accounting policies in its opening PFRS statement of financial position andthroughout all periods presented in its first PFRS financial statements. Thoseaccounting policies shall comply with each PFRS effective at the end of the entity’s firstPFRS reporting period, except as specified in paragraphs 13-19 and appendices B-E ofPFRS 1.

PFRS 1 provides guidance on when a first-time adopter may adopt the “deemed cost” approach. Itdefines “deemed cost” as an amount used as a surrogate for cost or depreciated cost at a givendate. Guidance on when a first-time adopter may adopt the “deemed cost” approach is presentedin paragraphs D5-D8B of PFRS 1 as follows:

“D5 An entity may elect to measure an item of property, plant and equipment at the date oftransition to PFRSs at its fair value and use that fair value as its deemed cost at that date.

D6 A first-time adopter may elect to use a previous GAAP revaluation of an item ofproperty, plant and equipment at, or before, the date of transition to PFRSs as deemed cost atthe date of the revaluation, if the revaluation was, at the date of the revaluation, broadlycomparable to:

1 For relevant provisions for medium-sized entities, refer to PFRS for SMEs, Sections 16-18 and 35.2 For relevant provision for small entities, refer to par. 480 of PFRS for Small Entities.


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(a) fair value; or

(b) cost or depreciated cost in accordance with PFRSs, adjusted to reflect, forexample, changes in a general or specific price index.

D7 The elections in paragraphs D5 and D6 are also available for:

(a) investment property, if an entity elects to use the cost model in PAS 40,Investment Property;

(aa) right-of-use assets (PFRS 16, Leases); and

(b) intangible assets that meet:

(i) the recognition criteria in PAS 38 (including reliable measurement of originalcost); and

(ii) the criteria in PAS 38 for revaluation (including the existence of an activemarket).

An entity shall not use these elections for other assets or for liabilities.

D8 A first-time adopter may have established a deemed cost in accordance with previous GAAPfor some or all of its assets and liabilities by measuring them at their fair value at one particulardate because of an event such as a privatization or initial public offering.

(a) If the measurement date is at or before the date of transition to PFRSs, the entitymay use such event-driven fair value measurements as deemed cost for PFRSsat the date of that measurement.

(b) If the measurement date is after the date of transition to PFRSs, but during theperiod covered by the first PFRS financial statements, the event-driven fair valuemeasurements may be used as deemed cost when the event occurs. An entityshall recognize the resulting adjustments directly in retained earnings (or ifappropriate, another category of equity) at the measurement date. At the date oftransition to PFRSs, the entity shall either establish the deemed cost by applyingthe criteria in paragraphs D5–D7 or measure assets and liabilities in accordancewith the other requirements in this PFRS.”

D8A Under some national accounting requirements exploration and development costs for oiland gas properties in the development or production phases are accounted for in costcenters that include all properties in a large geographical area. A first-time adopter usingsuch accounting under previous GAAP may elect to measure oil and gas assets at thedate of transition to PFRSs on the following basis:

(a) exploration and evaluation assets at the amount determined under the entity’sprevious GAAP; and


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(b) assets in the development or production phases at the amount determined for thecost center under the entity’s previous GAAP. The entity shall allocate this amountto the cost center’s underlying assets pro rata using reserve volumes or reservevalues as of that date.

The entity shall test exploration and evaluation assets and assets in the developmentand production phases for impairment at the date of transition to PFRSs in accordancewith PFRS 6, Exploration for and Evaluation of Mineral Resources, or PAS 36respectively and, if necessary, reduce the amount determined in accordance with (a) or(b) above. For the purposes of this paragraph, oil and gas assets comprise only thoseassets used in the exploration, evaluation, development or production of oil and gas.

D8B Some entities hold items of property, plant and equipment, right-of-use assets orintangible assets that are used, or were previously used, in operations subject to rateregulation. The carrying amount of such items might include amounts that weredetermined under previous GAAP but do not qualify for capitalization in accordance withPFRSs. If this is the case, a first-time adopter may elect to use the previous GAAPcarrying amount of such an item at the date of transition to PFRSs as deemed cost. Ifan entity applies this exemption to an item, it need not apply it to all items. At the date oftransition to PFRSs, an entity shall test for impairment in accordance with PAS 36 eachitem for which this exemption is used. For the purposes of this paragraph, operationsare subject to rate regulation if they are governed by a framework for establishing theprices that can be charged to customers for goods or services and that framework issubject to oversight and/or approval by a rate regulator (as defined in PFRS 14,Regulatory Deferral Accounts).

When the Philippines transitioned to PFRS, certain entities adjusted or classified the values ofproperty, plant and equipment, intangible assets, and investment property under previous GAAP intheir statement of financial position using the deemed cost as one of the voluntary exemptions,taking the resulting adjustment as an adjustment to retained earnings or to another category ofequity, referred to herein as “Revaluation Reserve.”

An entity that used a Revaluation Reserve account either:

(a) recycled the balance of the Revaluation Reserve to retained earnings using the sameestimated useful life and method of depreciation/amortization used for depreciating therelated asset adjusted to deemed cost. The amount recycled to retained earningseffectively offsets the increase in depreciation/amortization expense charged to profitor loss; or

(b) maintained the Revaluation Reserve at its original amount and recycled such amountone time to retained earnings when the related asset is fully depreciated or disposedof. This is usually accompanied by a note disclosure as to the portion of revaluationreserve already absorbed through depreciation.

In either approach, the related asset is no longer subsequently revalued since its measurement basis


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has been treated as deemed cost.

Paragraphs 30 to 31C of PFRS 1 and paragraphs D5 to D8B of Appendix D to PFRS 1 enumeratethe bases of deemed cost that a first-time adopter of PFRSs may use. However, those paragraphsdo not specify directly where the increase in carrying values of the assets should be adjusted –whether as an adjustment to retained earnings or to another equity category.

Further, Paragraph 11 of PFRS 1 states that: “The accounting policies that an entity uses in itsopening PFRS statement of financial position may differ from those that it used for the same dateusing its previous GAAP. The resulting adjustments arise from events and transactions before thedate of transition to PFRSs. Therefore, an entity shall recognize those adjustments directly inretained earnings (or, if appropriate, another category of equity) at the date of transition to PFRSs.”This provision would normally be interpreted to mean that the effect of most adjustments toassets and liabilities in the first-time adopter’s opening PFRS balance sheet would be reflectedin retained earnings.

Making the adjustment to retained earnings under PFRS 1 is also consistent with the requirement ofPAS 8, Accounting Policies, Changes in Accounting Estimates and Errors. PAS 8.26 states that:“…When an entity applies a new accounting policy retrospectively, it applies the new accountingpolicy to comparative information for prior periods as far back as is practicable. Retrospectiveapplication to a prior period is not practicable unless it is practicable to determine the cumulativeeffect on the amounts in both the opening and closing statements of financial position for thatperiod. The amount of the resulting adjustment relating to periods before those presented in thefinancial statements is made to the opening balance of each affected component of equity ofthe earliest prior period presented. Usually the adjustment is made to retained earnings…”

Consensus

Based on the discussions above, the entity which, upon transition to PFRS (and even to PFRSfor SMEs or PFRS for Small Entities), opted to adopt the “deemed cost method” for its property, plantand equipment account should, in accordance with PFRS 1.11 and PAS 8.26, close out therevaluation increment account to the opening retained earnings in the financial statements at theearliest prior period presented and not to another equity category. However, the amount closed toretained earnings should not form part of retained earnings available for dividend distribution(see Issue 4). This information should be properly disclosed in the notes to financial statements(see Issue 2).

Issue 2

What are the additional disclosures required in order to comply with the relevant provisions ofPAS 8 and the requirements of the Securities and Exchange Commission?

Background

PAS 8.29 states that: “When a voluntary change in accounting policy has an effect on thecurrent period or any prior period, would have an effect on that period except that it is impracticable


25

to determine the amount of the adjustment, or might have an effect on future periods, an entityshall disclose:

(a) the nature of the change in accounting policy;

(b) the reasons why applying the new accounting policy provides reliable and more relevantinformation;

(c) for the current period and each prior period presented, to the extent practicable, theamount of adjustment:

(i) for each financial statement line item affected; and

(ii) if PAS 33applies to the entity, for basic and diluted earnings per share;

(d) the amount of the adjustment relating to periods before those presented, to the extentpracticable; and

(e) if retrospective application is impracticable for a particular prior period, or for periodsbefore those presented, the circumstances that led to the existence of that conditionand a description of how and from when the change in accounting policy has beenapplied.

Financial statements of subsequent periods need not repeat these disclosures.”

The following shall also be disclosed:

(a) the remaining balance of the deemed cost adjustment included in retained earnings,and

(b) the amount of the deemed cost adjustment absorbed through depreciation in profit andloss, in case of depreciable assets, that is available for dividend declaration.

Consensus

Closing out the Revaluation Reserve to retained earnings is a voluntary change in accountingpolicy and, as such, the required disclosures under PAS 8.29 should be complied with.

Annually, the entity shall include the following note disclosure related to retained earnings:

As of December 31, 201X and 201X, the balance of retained earnings includes the remainingbalance of the deemed cost adjustment amounting to Phpxxx and Phpxxx, respectively, relatedto certain property, plant and equipment which arose when the Company transitioned to PFRS in2005. This amount has yet to be absorbed through additional depreciation in profit and loss in thecase of depreciable assets [and through sale in the case of land].

PAS 33, Earnings Per Share.


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Issue 3

Is a third statement of financial position required in compliance with PAS 1.10(f)?

Background

Paragraph 10(f) of PAS 1 requires a statement of financial position as at the beginning of theearliest comparative period when an entity:

applies an accounting policy retrospectively,

makes a retrospective restatement of items in its financial statements, or

reclassifies items in its financial statements.”

This means that in all cases above, any material adjustments to previously reported amountsand presentation give rise to the requirement for an additional statement of financial position.

The third statement of financial position is a requirement under PFRS when retrospective changeshave been performed but is not required under PFRS for SMEs and PFRS for Small Entities.

Consensus

Closing out the Revaluation Reserve to retained earnings does not affect any other item within acomparative statement of financial position and thus does not change any information previouslyprovided to financial statement users. In such a case, the inclusion of an additional statement offinancial position would not significantly influence the economic decisions of users in evaluatinghistorical financial information and thus is not considered material to financial statements preparedin accordance with PFRS. A disclosure about the closing out of the Revaluation Reserve tothe opening retained earnings account will be sufficient for this purpose.

In determining whether it is necessary to present a third statement of financial position, theentities should consider the materiality of the information that would be contained in a thirdstatement of financial position and whether this would affect economic decisions made by auser of the financial statements. In doing so, it would be useful to take into consideration factors,such as:

the nature of the change and the alternative disclosures provided,

whether the change in accounting policy actually affected the financial position at thebeginning of the comparative period (if the accounting policy allows a prospective orlimited retrospective application) , and

additionally, specific views from regulators that should be considered in this assessment.


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Issue 4

How would the adjustment of the Revaluation Reserve against retained earnings affect anentity’s compliance with SEC Memorandum Circular 11 Series of 2008 (SEC MC 11-2008)?

Background

SEC MC 11-2008 provides guidelines on the determination of retained earnings available fordividend declaration. It requires the submission of a reconciliation schedule for this purpose.Section 5 of SEC MC 11-2008 enumerates the unrealized items that shall be considered as notavailable for dividend declaration.

Consensus

The deemed cost adjustment can be categorized under SEC MC 11-2008 as an unrealized itemunder the group “Other unrealized gains or adjustments to retained earnings brought about bycertain transactions accounted for under the PFRS.” Examples of which are as follows: accretionincome under PFRS 9, Financial Instruments, day 1 gains on initial recognition of financialinstruments, reversal of revaluation increment to retained earnings, and the negative goodwill oninvestments in associate. Consequently, retained earnings shall be reduced by the amount of theremaining balance of the deemed cost adjustment to arrive at retained earnings available fordividend declaration.

Effective Date

The consensus in and amendments to this Q&A are effective from the date of approval by theFRSC.

Date originally approved by PIC: October 20, 2011Date amendments approved by PIC: August 1, 2019


28

PIC Members









Date originally approved by FRSC: January 25, 2012Date amendments approved by FRSC: August 14, 2019


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PFRS 3, Business Combinations

Q&A No. 2011 - 02: PFRS 3.2 – Common Control BusinessCombinations

Issue

How should business combinations involving entities under common control be accounted for,given that these are outside the scope of PFRS 3, Business Combinations?

Background

Business combinations involving entities under common control are excluded from the scope ofPFRS 3, Business Combinations (PFRS 3.2(c)). There are, however, no specific rules underexisting PFRS which prescribe how common control combinations shall be accounted for. ThisQ&A seeks to provide guidance in accounting for common control combinations in order tominimize diversity in current accounting practices until further guidance is provided by theInternational Accounting Standards Board (IASB).

A business combination is a “common control combination” if the combining entities orbusinesses are ultimately controlled by the same party or parties both before and after thebusiness combination, and that control is not transitory1. This means that the same party orparties have the ultimate control over the combining entities or businesses both before and afterthe business combination.

Some examples of common control combinations include:

combinations between subsidiaries of the same parent; the acquisition of a business between entities in the same group; and, the insertion of a new parent company at the top of a group.

Common control combinations are typically accounted for using the “pooling of interestsmethod” and, in some cases where there is commercial substance to the transaction, using the“acquisition method” under PFRS 3.

1 Judgment is required to assess whether the common210 control is transitory or not. The conclusion thatcommon control is transitory may lead to the inclusion of the business combination within the scope ofPFRS 3 so that it shall be accounted for using the acquisition method.


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Consensus

1. PAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, requires that inthe absence of specific guidance in PFRS, management shall use its judgment indeveloping and applying an accounting policy that is relevant and reliable (PAS 8.10). Themost relevant and reliable accounting policies for common control business combinationwould either be:

a. the pooling of interests method2; orb. the acquisition method in accordance with PFRS 3.

2. The pooling of interests method is widely accepted in accounting for common controlcombinations. This method is prescribed under the US generally accepted accountingprinciples (GAAP) and permitted under the UK GAAP. The relevant guidance on pooling ofinterests method is provided under Financial Accounting Standards Board AccountingStandards Codification (FASB ASC) 805-50.

3. Common control business combinations shall be accounted for using either the pooling ofinterests method or the acquisition method. However, where the acquisition method ofaccounting is selected, the transaction must have commercial substance from theperspective of the reporting entity.

4. When evaluating whether the transaction has commercial substance, the following factorsmay be considered:

a. the purpose of the transaction;b. the involvement of outside parties in the transaction, such as non-controlling

interests or other third parties;c. whether or not the transaction is conducted at fair value;d. the existing activities of the entities involved in the transactions;e. whether or not the transaction is bringing entities together into a “reporting entity”

that did not exist before;f. where a new company is established, whether it is undertaken as an integral part of

an Initial Public Offering (IPO) or spin-off or other change in control and significantownership; and,

g. the extent to which an acquiring entity’s future cash flows are expected to change asa result of the business combination in which:

i. the configuration (risk, timing, and amount) of the cash flows of the assetreceived differs from the configuration of the cash flows of the assettransferred; or

2 A related guidance on the application of pooling of interests method shall be covered by a separate PICQ&A.


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ii. the entity-specific value of the portion of the entity’s operations affected bythe transaction changes as a result of the combination; and

iii. the difference in item i and item ii above is significant relative to the fair valueof the assets exchanged.

5. Since the acquisition method results in a reassessment of the value of the net assets of oneor more of the entities involved and/or the generation of goodwill, there must be commercialsubstance to the combination before it can be applied. PFRS contains limited circumstanceswhen net assets may be restated to fair value and restricts the recognition of internallygenerated goodwill, and common control business combination cannot be used tocircumvent this limitation by applying the acquisition method.

6. The accounting policy for common control business combination shall be appliedconsistently for similar transactions.

7. The following shall be disclosed in addition to required disclosures under applicablePAS/PFRS:

a. accounting policy applied for common control business combination and the rationalefor applying that policy;

b. any significant/relevant details on the common control business combination;c. if the pooling of interests method is applied, an entity shall likewise disclose how the

methodology was applied; and,d. if the acquisition method is used, an entity shall disclose the factors considered to

support its conclusion that the transaction has commercial substance.

Effective DateThe consensus in this Q&A is effective for annual financial statements beginning on or afterJanuary 1, 2012. Earlier application is encouraged.


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Q&A approved by PIC: August 24, 2011

PIC Members


Wilfredo A. Baltazar Judith V. Lopez

Rosario S. Bernaldo Ma. Concepcion Y. Lupisan

Ma. Elenita B. Cabrera/Rufo R. Mendoza Edmund A. Go

Ma. Gracia F. Casals-Diaz Ruby R. Seballe

Sharon G. Dayoan Wilson P. Tan

Lyn I. Javier/Reynold E. Afable Normita L. Villaruz

Q&A approved by FRSC: November 23, 2011


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Q&A No. 2012 - 01 (amended June 2018): PFRS 3.2 – Application of thePooling of Interests Method for Business Combinations of Entitiesunder Common Control in Consolidated Financial Statements

Issues

1. What carrying values shall an entity use when applying the pooling of interests method forcommon control business combinations in its consolidated financial statements?

2. Is an entity required to restate the financial information in its consolidated financialstatements for business combinations under common control for periods prior to thecombination, if it elects to apply the pooling of interests method?

3. If the entity elects not to restate financial information in the consolidated financial statementsfor periods prior to the business combination, how shall the equity reserves, if any, beaccounted for?

This Q&A does not address legal mergers between a parent and a subsidiary.1

Background

Common control business combinations are excluded from the scope of PFRS 3, BusinessCombinations; however, there are no specific rules under existing PFRS which prescribe howsuch transactions shall be accounted for. In August 2011, the Philippine InterpretationsCommittee (PIC) issued Q&A No. 2011 – 02, PFRS 3.2 – Common Control BusinessCombinations, to provide guidance in accounting for common control business combinations inorder to minimize diversity in the current practices until further guidance is provided by theInternational Accounting Standards Board (IASB).

The Consensus in Q&A No. 2011-02 provides that common control business combinations shallbe accounted for using either (a) the pooling of interests method, or (b) the acquisition method inaccordance with PFRS 3. Q&A No. 2011 – 02 then further provides guidance in selecting theappropriate method to use in accounting for common control business combinations; however, itdoes not provide guidance on how to apply the pooling of interests method.

To address that gap, this Q&A 2012 – 01 is issued to provide guidance in applying the pooling ofinterests method once this method is selected by an entity to account for the common controlbusiness combination (after considering the guidance in Q&A 2011-02). It shall be applied untilsuch time that further IASB guidance becomes available. Reference may also be made to FASBAccounting Standards Codification (FASB ASC) 805-50 which provides relevant guidance on thepooling of interests method.

1 Legal merger is where a parent and (one of) its subsidiaries become a single entity without any consideration(other than shares issued by the surviving entity).


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The pooling of interests method is generally considered to involve the following:

The assets and liabilities of the combining entities are reflected in the consolidatedfinancial statements at their carrying amounts. No adjustments are made to reflect fairvalues, or recognize any new assets or liabilities, at the date of the combination thatotherwise would have been done under the acquisition method. The only adjustmentsthat are made are those adjustments to harmonize accounting policies.

No 'new' goodwill is recognized as a result of the combination. The only goodwill that isrecognized is any existing goodwill relating to either of the combining entities. Anydifference between the consideration paid or transferred and the equity 'acquired' isreflected within equity.

The consolidated income statement reflects the results of the combining entities for thefull year, irrespective of when the combination took place.

Comparatives are presented as if the entities had always been combined.

However, apart from the second bullet point, the application of the above general guidance forthe pooling of interests method in the context of accounting for business combinations involvingentities under common control under PFRS raise certain issues, guidance on which arediscussed below using the following example.

Example

Entity A currently has two businesses operated through two wholly-owned subsidiaries, Entity Band Entity C. The present group structure (ignoring other entities within the group) follows:

Both subsidiaries have been owned by Entity A for a number of years.


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On October 1, 20X2, Entity A restructures the group by transferring its investment in Entity C toEntity B, such that Entity C becomes a subsidiary of Entity B. The group structure after thetransfer follows:

The policy adopted by the group to account for business combinations involving entities undercommon control is to apply the pooling of interests method.

Consensus

Issue 1: Carrying values to use for assets and liabilitiesIn Entity B's consolidated financial statements for the year ended December 31, 20X2, whatvalues should be reflected in respect of Entity C?

There are two available approaches for determining what carrying values to use when applyingthe pooling of interests method, namely:

Approach 1: To use the carrying values reported in the consolidated financial statementsof the parent.

Approach 2: To use the carrying values reported at the level of the separate financialstatements of the combining entities. This Approach 2, however, may be appropriatewhen the specific factors noted below are present.

Issue 1 / Approach 1: To use the carrying values reported in the consolidated financialstatements of the parent

Under Approach 1, in its consolidated financial statements for the year ended December 31,20X2, Entity B should generally use the carrying values of Entity C’s assets and liabilities asreported in Entity A's consolidated financial statements, rather than the carrying values reportedin Entity C's separate financial statements.

Accordingly, the carrying values of Entity C’s assets and liabilities will be based on theirrespective fair values as at the date Entity C became part of the Entity A group and adjusted forsubsequent transactions. Any goodwill relating to Entity C that was previously recognized inEntity A's consolidated financial statements will also be recognized. The carrying values of theassets and liabilities of Entity B will remain as before.

The rationale for applying this approach is that the transaction is essentially a transfer of assets


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and liabilities of Entity C from the consolidated financial statements of Entity A to the financialstatements of Entity B. From a group perspective, nothing has changed, except for the locationof those assets and liabilities. Entity B has effectively taken on the group’s ownership.Therefore, the values used in the consolidated financial statements are the appropriate andmost relevant values to apply to the assets and liabilities of Entity C, as they represent thecarrying values of those assets and liabilities to the Entity A group.

Issue 1 / Approach 2: To use the carrying values reported at the level of the financial statementsof the combining entities

Under Approach 2, the assets and liabilities of Entity C in the financial statements of Entity Bafter the business combination are recognized at the carrying amounts as previously reflected inthe financial statements of Entity C prior to the business combination.

From the perspective of the new consolidated entity (Entity B + Entity C), the group’sperspective is ignored when accounting for the transaction. The concept of pooling is applied asa sharing of control by the shareholders. Therefore, the carrying values in the financialstatements of Entity C prior to the merger will be relevant.

However, the use of carrying values in the financial statements of Entity C may not always beappropriate. Accordingly, this approach may be applied after consideration, at the minimum, ofall of the following factors:

Consistent accounting policies – Paragraph 13 of PAS 8, Accounting Policies, Changesin Estimates and Errors, requires an entity to select and apply its accounting policiesconsistently for similar transactions, unless a PFRS specifically requires or permitsdifferent accounting policies. Accounting for legal mergers of a parent and a subsidiaryrequires similar accounting policy selections, therefore, there must be consistencybetween the policies selected to account for such mergers and common controlbusiness combinations.

Timing of the transactions – The further in history the carrying values of the assets andliabilities were determined, the less relevant such carrying values may be for users of thefinancial statements.

Grooming transactions – If there is a plan or intention for Entity B to be sold, spun-off, oris otherwise being groomed or prepared for another transaction, the carrying valuesdetermined using Approach 1 would provide more relevant financial information thanthose determined using Approach 2.

Users of the financial statements – If the majority of the users of Entity B’s financialstatements after the business combination are parties that previously relied upon thefinancial statements of Entity C (for example, if there are significant non-controllingshareholders), using Approach 2 might provide more relevant financial information thanusing Approach 1.


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Issue 2: Restatement or non-restatement of financial information in consolidated financialstatements for periods prior to the date of the business combination

In preparing its consolidated financial statements for the year ended December 31, 20X2,should Entity B include financial information for Entity C for the period prior to the date ofobtaining control on October 1, 20X2 (thereby restating the 20X1 comparatives) in itsconsolidated financial statements as if the business combination (and the investment in EntityC) took place from January 1, 20X1?

The main issue is whether financial information in consolidated financial statements for periodsprior to the date of the business combination, including comparatives, should be restated or notwhen applying the pooling of interests method and, if restated, the extent of such restatement.As indicated earlier, the pooling of interests method is generally considered to involvecomparatives being presented as if the entities had always been combined.

In some jurisdictions, however, regulators take the view that comparatives cannot be restatedas such treatment is inconsistent with PFRS 10, Consolidated Financial Statements. Thisappears to be on the basis that, even though PFRS 3 is not being applied to the businesscombination, PFRS 10 requires that a parent's consolidated financial statements can onlyinclude the income and expenses of a subsidiary from the acquisition date as defined inPFRS 3, i.e., the date it obtains control of the subsidiary. Such a view would also mean that,when applying the pooling of interests method, the pre-acquisition income and expenses of asubsidiary in the current year should also not be included.

Therefore, in applying the pooling of interests method, an entity has two approaches to choosefrom:

Approach1: To restate the financial information in the consolidated statements forperiods prior to the transaction.

Approach 2: Not to restate the financial information in the consolidated financialstatements for periods prior to the transaction.

An entity must consistently apply the chosen accounting policy.

Issue 2 / Approach 1: To restate the financial information in the consolidated financialstatements for periods prior to the transaction

Under Approach 1, the financial information in the consolidated financial statements arerestated for periods prior to the combination of the entities under common control to reflect thecombination as if it had occurred from the beginning of the earliest period presented in thefinancial statements, regardless of the actual date of the combination.

However, financial information in the consolidated financial statements for periods prior to thecombination is restated only for the period that the entities were under common control.The rationale for Approach 1 is that, in business combinations of entities under common control,there is no change in control, because the ultimate controlling party always has control over the


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combined resources – the ultimate controlling party merely changed the location of its resources.Accordingly, if the ultimate controlling party had control of these resources in the comparativeperiod, then the comparatives are restated.

Paragraph 20 of PFRS 10 indicates that an entity cannot be included in the consolidatedfinancial statements until the date that it is under the control of the acquirer. Under Approach 1,this paragraph is not considered to be in conflict with the concept of pooling, which is only amethod of presenting the information. This paragraph restricts the application of pooling until theentities have actually come under direct control, not how pooling is applied.Therefore, under Approach 1, the financial information in the consolidated financial statementsis presented as though the combination of entities under common control occurred at thebeginning of the earliest comparative period.

In the above example, since Entity C has been part of the Entity A group for a number of years,then Entity B shall include financial information for Entity C from January 1, 20X1, restating the20X1 comparatives presented in its consolidated financial statements for 20X2.

The above example assumes that Entity C had been part of the Entity A group for a number ofyears. If this had not been the case, Entity B still has a choice of whether to restate or not torestate. Should it choose restatement, the financial information in the consolidated financialstatements for periods prior to the combination is restated only for the period that the entitieswere under common control. If the ultimate controlling party has not always controlled thesecombined resources, then application of the pooling of interests method shall reflect that fact.That is, an entity cannot restate the comparative financial information in the consolidatedfinancial statements in respect of the period that common control did not exist.

Issue 2 / Approach 2: Not to restate the financial information in the consolidated financialstatements for periods prior to the transaction

Under Approach 2, the requirements of Paragraph 20 of PFRS 10 are viewed as being inconflict with the concept of pooling, hence, financial information in the consolidated financialstatements for the combined entity is not restated for periods prior to the combination of theentities under common control. Specifically, the scope of PFRS 10 applies to all consolidatedfinancial statements, without any scope exclusions for combinations of entities under commoncontrol. The fact that this combination is outside of the scope of PFRS 3 is irrelevant whenconsidering the requirements of PFRS 10. Therefore, the pooling of interests method will affectonly the values assigned to the assets and liabilities, and no restatement of financial informationfor periods prior to the transaction is made.

In the above example, Entity B shall not restate the financial information in its consolidatedfinancial statements for the year ended December 31, 20X2 (including the 20X1 comparatives)for any financial information for Entity C prior to October 1, 20X2 (the date of the combination).


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Issue 3: Accounting for equity reserves when the entity elects not to restate financialinformation in the consolidated financial statements for periods prior to the transaction

When the ‘acquired’ entity has equity reserves, what values should be assigned to such equityreserves?

When an entity has opted not to restate the financial information in the financial statements forperiods prior to the transaction, and the ‘acquired’ entity has equity reserves, it has the followingtwo approaches to choose from to determine what value to assign to such equity reserves:

Approach 1: To carry over the equity reserves at ‘pooling of interests values’ that reflectthe application of pooling of interests method.

Approach 2: To carry over the equity reserves at book values considering the transactionas an initial recognition of net assets.


Overall, both approaches give the same net asset position at the date of the combination.However, the two approaches will have a different effect on the components within equity andsubsequent results in the future.

Issue 3 / Approach 1 – No restatement of prior periods – to carry the equity reserves at ‘poolingof interests values’ that reflect the application of pooling of interests method

Under Approach 1, while the financial information for periods prior to the transaction are notrestated, the values assigned to the ‘acquired’ entity, including equity reserves, are determinedas if the pooling of interests method had been applied since the entities were under commoncontrol.

This means that any equity values associated with the ‘acquired’ entities that would have beenrecognized in equity are created as at the date of the transaction. This includes:

Fair value reserve on financial assets at fair value through other comprehensive income(FVOCI);

hedging reserves; foreign currency translation reserves; and other asset revaluation reserves.

The history of transactions is retained for such things as recycling of fair value gain or loss ondebt financial assets at FVOCI to profit or loss, transfer of fair value reserve on equity financialassets at FVOCI to retained earnings, or reversing impairment charges on non-current assetstaken in previous periods.

If there are changes to the carrying values of assets or liabilities arising from the combination(e.g., due to revised impairment tests and/or reversals or changes in deferred taxes due tochanges in the tax base), adjustments are recognized in profit and loss as part of the activity ofthe business for the year.


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Under this view, the fact that no restatement occurs is considered a presentation issue only, andfor all intents and purposes, the guidance as discussed under Issue 2 / Approach 1 above isapplied in full.

In the above example, assume that on October 1, 20X2 Entity C had a fair value reserve on debtfinancial assets at FVOCI of Php100. Before December 31, 20X2, the debt financial asset atFVOCI is sold. In Entity B’s consolidated financial statements, Entity B will recognize a fair valuereserve of Php100 at the date of the business combination. When the debt financial asset issubsequently sold, the Php100 will be recycled to profit or loss during the year.

Issue 3 / Approach 2 – No restatement of prior periods – to carry over the equity reserves atbook values considering the transaction as an initial recognition of net assets

Under Approach 2, while the financial information for periods prior to the transaction are notrestated, the combination gives rise to an initial recognition of net assets at the previouscarrying values of the assets and liabilities of the acquired entity.

This means that the assets essentially have a new deemed cost, and there is no historyretained of previous transactions affecting the assets. Therefore, to the extent that there areequity balances arising from past transactions that would have been recognized directly inequity, those equity balances are not restated, nor recycled to the profit or loss in subsequentperiods. Similarly, if an asset had been impaired in the past, the impairment loss previouslyrecognized shall not be subsequently reversed.

If there are changes to the carrying values of assets or liabilities arising from the combination(e.g., due to revised impairment tests and/or reversals or changes in deferred taxes due tochanges in the tax base), these are reflected in the net adjustment to equity at the time ofrecognizing the business combination.

Under this view, the fact that no restatement occurs is considered to be more than a presentationissue. It is viewed as an initial recognition event at the date of the transaction, and the valuesassigned to the assets or liabilities are determined using the concepts of the pooling of interests –that is at their book values. However, this results in the assets and liabilities effectively having anew ‘cost base’ and the history associated with them is not relevant from the perspective of thenew group. That is, for assets or liabilities where changes are recognized directly in equity, thehistory associated with the past changes in value is lost and will not be rolled forward.

This also means that if at the date of the transaction, the combination is believed to generateadditional value such that previous impairments would reverse at that date, the effect shall berecognized at that date as part of the adjustment to equity, i.e., as part of the pooling reserve inequity. Similarly, if the combination results in a change in the tax base of assets, the effect ofthe change in deferred taxes is recognized as part of the adjustment to equity

Therefore, in the above example, Entity B will not recognize a fair value reserve on debt financialassets at FVOCI at the date of the business combination. When the investment is subsequentlysold, the Php100 fair value reserve that formed part of the carrying value of the debt financialasset and not separately recognized will not be recycled to profit or loss during the year.


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Disclosures and Other Restatements

PAS 33, Earnings per Share, contains the requirements to restate prior periods' earnings pershare (EPS) for events that resulted in a change in the number of outstanding shares of stockwithout a corresponding change in resources. To ensure comparability of EPS figures, forentities required to disclose EPS and those entities, although not required have opted todisclose EPS, the basic and diluted EPS for all periods presented should be adjusted for theeffects of business combinations that are accounted for using the pooling of interests method.

The following should be disclosed in addition to the required disclosures under applicablePAS/PFRS, including disclosures required under PAS 8:

a. The rationale for applying the pooling of interests method;b. Any significant/relevant details on the common control business combination; andc. How the pooling of interests methodology was applied.

Effective Date

The consensus in this Q&A is effective for annual financial statements beginning on or afterJanuary 1, 2013. The amendments to this Q&A are effective from the date of approval by theFRSC. Earlier application is encouraged.

Date originally approved by PIC: September 26, 2012Date amendments approved by PIC: June 27, 2018


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PIC Members









Date originally approved by FRSC: January 29, 2013Date amendments approved by FRSC: October 10, 2018


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Q&A No. 2012 – 02 (amended July 2019): Cost of a new buildingconstructed on the site of a previous building

Relevant PFRS

PAS 2, InventoriesPAS 16, Property, Plant and EquipmentPAS 40, Investment PropertyPFRS 3, Business Combinations

Issue

When an entity which owns a property (consisting of land and an old building) constructs a newbuilding on the site of the old building, how shall the entity account for the carrying value of theold building under the following scenarios?

Scenario 1: The entity acquired the property in the current reporting period, with the intention ofdemolishing the old building and replacing it with a new building. The entity will notuse the old building prior to its demolition.

Scenario 2: The entity acquired the property in a prior reporting period and used it as owner-occupied property. In the current reporting period, the entity decides to demolishthe old building and replace it with a new building.

Under each scenario, assume that the new building will be classified as:

(a) Owner-occupied property (or part of property, plant and equipment);

(b) Sold in the ordinary course of the entity’s business (or as part of inventories); or

(c) Held to earn rentals or for capital appreciation (or as part of investment property).

Background and Discussion

An entity may acquire a piece of land with one or more existing buildings, with the intention toeither demolish the old building right away in order to construct a new building on its site as partof its planned redevelopment, or to initially use the old building as an owner-occupied propertyand then demolish it in a future period and replace it with a new building. The new building caneither be:

(a) used as an owner-occupied property, which is within the scope of Philippine AccountingStandard (PAS) 16, Property, Plant and Equipment;


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(b) sold in the ordinary course of the entity’s business, which is within the scope ofPAS 2, Inventories; or

(c) held to earn rentals or for capital appreciation, which is within the scope ofPAS 40, Investment Property.

When the old building is demolished to give way for the construction of the new building, therearises a question as to whether or not the cost allocated to the old building, or, in the case of apreviously owner-occupied property, the carrying value of the old building as at the date theentity decides to demolish it, should form part of the cost of the new building. A related issue ishow to account for the demolition costs incurred to physically tear down the old building.

Allocation of cost of property to the land and building at date of acquisition

Philippine Financial Reporting Standard (PFRS) 3.2(b) states that the acquisition cost of anasset or a group of assets that does not constitute a business “shall be allocated to theindividual identifiable assets and liabilities on the basis of their relative fair values at the date ofpurchase.”

Applying this principle, the cost of the property acquired should be allocated to the land and thebuilding at date of acquisition based on their relative fair values. The specific intention of theacquiring entity to demolish rather than use a building does not affect its fair value that will beused in the cost allocation. However, in circumstances where the existing building is unusableor is likely to be demolished right away by the entity acquiring it, the fair value of the existingbuilding might be low and much less than the fair value of the land. This is because a rationalbuyer intending to demolish the existing building and construct a new building is unlikely toacquire a piece of land with a highly valuable building. In such cases, it may be appropriate toallocate the entire purchase price to the land. On the other hand, if the existing building is stillusable and the acquiring entity intends to use it for a while before it is demolished in a futureperiod, it will be inappropriate not to allocate any cost to the existing building. Hence, part of thepurchase price shall be allocated as cost of the existing building which cost shall be depreciatedover the building’s remaining estimated useful life.

Classification of the property on initial recognition

The classification of the property or the land and building will be as follows:

Scenario 1(a) The land and building will be classified as two separate items under Plant,Property and Equipment measured at their allocated cost determined using therelative fair value method.

Scenario 1(b) The land and building will be classified as one item under Inventories.


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Scenario 1(c) If the land and building will be subsequently measured using the fair value model,the land and building will be classified as one item under Investment Property. Ifthe subsequent measurement of the property will be made using the cost model,the land and building will be classified as two separate items under InvestmentProperty at their allocated cost determined using the relative fair value.

Scenario 2(a), 2(b) and 2(c) As the entity, at date of acquisition, has decided to initially use theproperty as owner-occupied property, the land and building will be classified astwo separate items under Plant, Property and Equipment measured at theirallocated cost determined using the relative fair value method.

Elements of cost

The provisions in related PFRS that deal with the elements of costs are cited below:

For property, plant and equipment under PAS 16

“16 The cost of an item of property, plant and equipment comprises:

(a) its purchase price, including import duties and non-refundable purchase taxes, afterdeducting trade discounts and rebates.

(b) any costs directly attributable to bringing the asset to the location and conditionnecessary for it to be capable of operating in the manner intended by management.

(c) the initial estimate of the costs of dismantling and removing the item and restoring thesite on which it is located, the obligation for which an entity incurs either when the item isacquired or as a consequence of having used the item during a particular period forpurposes other than to produce inventories during that period.

“17 Examples of directly attributable costs are:

(a) costs of employee benefits (as defined in PAS 19, Employee Benefits) arising directlyfrom the construction or acquisition of the item of property, plant and equipment;

(b) costs of site preparation;

(c) initial delivery and handling costs;

(d) installation and assembly costs;


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(e) costs of testing whether the asset is functioning properly, after deducting the netproceeds from selling any items produced while bringing the asset to that location andcondition (such as samples produced when testing equipment); and

(f) professional fees.”

For inventories under PAS 2

“10 The cost of inventories shall comprise all costs of purchase, costs of conversion andother costs incurred in bringing the inventories to their present location andcondition.

“11 The costs of purchase of inventories comprise the purchase price, import duties and othertaxes (other than those subsequently recoverable by the entity from the taxing authorities),and transport, handling and other costs directly attributable to the acquisition of finishedgoods, materials and services. Trade discounts, rebates and other similar items arededucted in determining the cost of purchase.

“12 The costs of conversion of inventories include costs directly related to the units ofproduction, such as direct labor. They also include a system allocation of fixed and variableproduction overheads that are incurred in converting materials into finished goods.

“15 Other costs are included in the cost of inventories only to the extent that they are incurred inbringing the inventories to their present location and condition. For example, it may beappropriate to include non-production overheads or the costs of designing products forspecific customers in the cost of inventories.”

For investment property under PAS 40

“20 An owned investment property shall be measured initially at its cost. Transactioncosts shall be included in the initial measurement.

“21 The cost of a purchased investment property comprises its purchase price and any directlyattributable expenditure. Directly attributable expenditure includes, for example,professional fees for legal services, property transfer taxes and other transaction costs.”


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Consensus

Accounting for the Allocated Cost or Carrying Value of the Old BuildingApplying the relevant PFRS provisions cited above, the allocated cost or carrying value of theold building shall be accounted for as presented below.

Under Scenario 1Under Scenario 1, the entity intends to demolish the old building and will not use the old buildingprior to its demolition.

Scenario 1(a): New building will be used as an owner-occupied property

PAS 16 does not include any explicit guidance on whether the allocated cost or carrying valueof an old building that will be demolished is part of the cost of the replacement building.Nevertheless, it is viewed that the allocated cost, if any, of the old building to be demolished isnot a cost directly attributable to the new building as provided in PAS 16.16 (b) and PAS 16.17cited earlier. Therefore, the allocated cost of the old building shall not form part of the cost ofthe new building. Also, since the old building will not be used, hence, no further economicbenefits are expected from its use, the allocated cost of the old building should be derecognizedas required under PAS 16.67 and the loss arising from derecognition is included in profit or lossas required under PAS 16.68.

Scenario 1(b): New building will be sold as an inventory

Development property (i.e., property intended for sale in the ordinary course of business, or inthe process of construction or development for such sale) is within the scope of PAS 2 ratherthan PAS 16.

The cost of inventories under PAS 2.10 cited earlier is a somewhat lower threshold than thecost of an item of property, plant and equipment under PAS 16. For example, the cost ofinventories under PAS 2.10 need not be directly attributable. Accordingly, it is appropriate forthe acquiring entity or property developer to include any cost allocated to the old building as partof the cost of the new building or development property that will be sold as an inventory.

Scenario 1(c): New building will be held as an investment propertyProperty (land or a building—or part of a building—or both) held (by the owner or by the lesseeunder a finance lease) to earn rentals or for capital appreciation or both is within the scope ofPAS 40.

PAS 40.21 on what shall constitute the cost of investment property refers to “directly attributableexpenditure” which is somewhat similar to the related provision under PAS 16. Accordingly, theconsensus under Scenario 1(a) above can also be applied to Scenario 1(c), hence, the costallocated, if any, to the old building shall not form part of the cost of the new building that will be


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held as an investment property. Also, since the old building will not be used, hence, no furthereconomic benefits are expected from its use or disposal, any cost allocated to the old buildingshould be de-recognized (eliminated from the statement of financial position) as required underPAS 40.66 and the loss arising from de-recognition is included in profit or loss as required underPAS 40.69.

Under Scenario 2

Under Scenario 2, the entity acquired the property in a prior reporting period and initially usedthe property as an owner-occupied property. In the current reporting period, it decided todemolish the old building and replace it with a new building.

As the building is a depreciable asset, the entity depreciates the cost allocated to the oldbuilding from the date of purchase on a systematic basis over the asset’s useful life, afterconsidering any residual value. As required under PAS 16.51, the residual value and the usefullife of the building shall be reviewed at least at each financial year-end and, if expectations differfrom previous estimates, the change shall be accounted for as a change in an accountingestimate in accordance with PAS 8, Accounting Policies, Changes in Accounting Estimates andErrors.

As provided under PAS 16.57, the useful life of an asset is defined in terms of the asset’sexpected utility to the entity. The asset management policy of the entity may involve thedisposal of assets after a specified time or after consumption of a specified proportion of thefuture economic benefits embodied in the asset. Therefore, the useful life of an asset may beshorter than its economic life. The estimation of the useful life of the asset is a matter ofjudgment based on the experience of the entity with similar assets.

Applying the above principles, the entity, at the time it makes the decision to demolish the oldbuilding at a specific date in the future, has to recompute the related depreciation charges onthe building to depreciate the remaining carrying value of the building over the remainder of itslife (or the remaining period before it is demolished). Hence, the old building will have a nilvalue at the date of the planned demolition.

If for some reason there is a remaining carrying value of the old building at the time ofdemolition, such amount shall not be capitalized as part of the cost of the new building; instead,such amount shall be charged to profit or loss. This is because:

(a) the carrying value of the old building represents the un-depreciated cost of the oldbuilding rather than a cost incurred in the construction of the new building; and

(b) the demolition of the old building is regarded as similar to a disposal for zero proceeds.


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The above consensus applies to all situations under Scenario 2, i.e., Scenario 2(a) where thenew building will be used an owner-occupied property, Scenario 2(b) where the new building willbe sold as an inventory, and Scenario 2(c) where the new building will be held as an investmentproperty.1

General Guidance on Accounting for Demolition Costs

The demolition (or the physical tearing down) of the old building to give way for the constructionof the replacement building will have related costs, referred to as demolition costs. There arisesthe issue on whether or not the demolition costs may be capitalized.

PAS 16.16(b) provides that any costs directly attributable to bringing the asset to the locationand condition necessary for it to be capable of operating in the manner intended bymanagement shall form part of the cost of the asset. The examples of directly attributable costspresented in PAS 16.17 cited earlier include ‘costs of site preparation.’

Demolition costs of the old building can be considered as part of costs of site preparationmentioned under PAS 16.17(b) and, therefore, may be capitalized. Although there is no clearguidance as to what account (i.e., land or new building) such demolition costs should becapitalized, it is preferable to capitalize the demolition costs as part of the cost of the newbuilding since the demolition of the old building is a direct result of the decision to construct thenew building.

Effective Date

The consensus in and amendment to this Q&A are effective from the date of approval by theFRSC.

Date originally approved by PIC: December 19, 2012

Date amendment approved by PIC: August 1, 2019

1 This Q&A does not cover transfers to, or from, the investment property account; accounting for any suchtransfers shall be made in accordance with the relevant provisions of PAS 40.


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PIC Members




Ma. Gracia F. Casals-Diaz Rufo R. Mendoza

Sharon G. Dayoan Hankerson Jane L. Talatala

Edmund A. Go Wilson P. Tan

Lyn I. Javier Normita L. Villaruz

Date originally approved by FRSC: June 11, 2013

Date amendment approved by FRSC: August 14, 2019


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Q&A No. 2018 - 08: PFRS 10 and PFRS 3 - Accounting for theacquisition of a non-wholly owned subsidiary that is not a business

Issue

How does an acquirer account for the acquisition of a controlling interest in anotherentity that is not a business when there is a non-controlling interest (NCI) with no rightsto the underlying assets - specifically, at what amounts are the assets acquired and thenon-controlling interest recognized?

This Q&A focuses solely on the accounting for the acquisition where the acquiree(subsidiary) does not constitute a business, and once it is determined that an acquirer(the parent) controls that subsidiary. It does not address how to assess whether anacquiree is a business or whether the acquirer has control over the acquiree.

Fact pattern

Entity A acquires 80% of the share capital of Entity B, which holds a single asset, or agroup of assets not constituting a business. The remaining 20% of the share capital isheld by Entity M, an unrelated third party. The fair value of the asset is CU200. Entity Acontrols Entity B, as defined in PFRS 10, Consolidated Financial Statements.

Variations of this base fact pattern are reflected in the scenarios below:

Scenario Rights of NCI (Entity M) Cash paid by A Fair value of NCI1 Present ownership interest,

entitled to a proportionateshare of Entity B’s net assetsin the event of liquidation

CU160 CU40

2 Present ownership interest,entitled to a proportionateshare of Entity B’s net assetsin the event of liquidation

CU170 CU40

3 Present ownership interest,not entitled to aproportionate share of netassets in the event ofliquidation (e.g., preferenceshares).

CU170 CU40


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Scenario Rights of NCI (Entity M) Cash paid by A Fair value of NCI4 Not a present ownership

interest, but classified as NCI(e.g., options, warrants). Inthis case, however, Entity Awill have acquired 100% ofthe outstanding equity.

CU170 CU40

Relevant guidance and analysis

Under PFRS 10, an entity must consolidate all investees that it controls, not just thosethat are businesses, and the parent will recognize any non-controlling interest in non-wholly owned subsidiaries.

When the acquisition of an entity is not a business combination, the remainingrequirements of PFRS 3 relating to the allocation of the consideration transferred to theidentifiable assets and liabilities and the recognition of goodwill are not applicable.Paragraph 2(b) of PFRS 3 states that upon the acquisition of an asset or a group ofassets that does not constitute a business:

“…the acquirer shall identify and recognize the individual identifiable assets acquired(including those assets that meet the definition of, and recognition criteria for, intangibleassets in PAS 38, Intangible Assets) and liabilities assumed. The cost of the groupshall be allocated to the individual identifiable assets and liabilities on the basis of theirrelative fair values at the date of purchase. Such a transaction or event does not giverise to goodwill.” (Emphasis added)

Therefore, paragraph 2 of PFRS 3 acknowledges that the cost paid for the assets maydiffer from the sum of their fair values and hence may need to be allocated to the assetsand liabilities acquired.

PAS 16, Plant, Property and Equipment and PAS 38, Intangible Assets, state:

“Cost is the amount of cash or cash equivalents paid or the fair value of the otherconsideration given to acquire an asset at the time of its acquisition or construction or,where applicable, the amount attributed to that asset when initially recognized inaccordance with the specific requirements of other PFRSs, e.g., PFRS 2, Share-basedPayment.”


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Therefore, when an asset is acquired subject to a non-controlling interest, its cost is theamount of consideration paid, plus the amount of NCI recorded related to that asset –as this represents a ‘claim’ relating to that asset.

Paragraph 19 of PFRS 3 states:

“For each business combination, the acquirer shall measure at the acquisition datecomponents of non-controlling interests in the acquiree that are present ownershipinterests and entitle their holders to a proportionate share of the entity's net assets inthe event of liquidation at either:

(a) fair value; or

(b) the present ownership instruments' proportionate share in the recognizedamounts of the acquiree's identifiable net assets.

All other components of non-controlling interests shall be measured at their acquisition-date fair values, unless another measurement basis is required by PFRSs.”

If there is more than one asset, the amount referenced above for the assets would beallocated between the assets based on their relative fair value.

Consensus

Assets are recognized at cost, which is the sum of all consideration given and any NCIrecognized. If the NCI has a present ownership interest and is entitled to a proportionateshare of net assets upon liquidation, the acquirer has a choice to recognize the NCI atits proportionate share of net assets or its fair value (measured in accordance withPFRS 13, Fair Value Measurement); in all other cases, NCI is recognized at fair value(measured in accordance with PFRS 13), unless another measurement basis isrequired in accordance with PFRSs.

With respect to the scenarios above, the following entries would be recorded:

Scenario Asset acquired (Debit) NCI (Credit) Cash (Credit)1 200 40 1602 210 40 1703 210 40 1704 210 40 170


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Transition and effective date

The consensus in this Q&A is effective from the date of the approval by the FRSC.

Date approved by PIC: January 31, 2018

PIC Members









Date approved by FRSC: March 14, 2018


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PFRS 7, Financial Statements: Disclosures

Q&A No. 2017 – 05 (amended June 2018): PFRS 7 – Frequently askedquestions on the disclosure requirements of financial instrumentsunder PFRS 7, Financial Instruments: Disclosures

Background

PFRS 7 applies to all entities that hold financial instruments. However, the extent ofdisclosure required depends on the extent of the entity's use of financial instruments andits exposure to risk.

The disclosure requirements of the PFRS are intended to: (1) provide information that willenhance the understanding of the significance of financial instruments to a company’sfinancial position, performance, and cash flows; and (2) assist in evaluating the risksassociated with these instruments, including how the entity manages those risks. PFRS 7must be applied for accounting periods beginning on or after January 1, 2007.

Issues

Applying PFRS 7 gives rise to a number of application issues. Below are the frequentlyasked questions on the disclosure requirements of financial instruments under PFRS 7.

Liquidity Risk

1. In the maturity analysis of gross undiscounted cash flows of financial liabilities, how arecoupon payments from interest-bearing borrowings presented?

2. Are companies required to show a reconciliation of amounts presented in the maturityanalysis and in the statement of financial position?

3. In practice, most companies manage liquidity risk based not on the remaining


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contractual maturities but on expected maturities. How should companies disclosethis?

4. What should the company include in the maturity analysis of financial assets in itsliquidity risk disclosure, if such analysis is necessary to evaluate the nature and extent ofliquidity risk?

5. For floating-rate financial liabilities, what rates should be used in calculating itsinterest cash flows in the maturity analysis?

Market Risk

1. What should be the basis of the company in preparing the basic sensitivity analysis?

2. In disclosing the sensitivity analysis, what is the time frame over which the companyshould make its analysis?

3. Should the disclosure about sensitivity analysis be based on a pre-tax or post-tax basis?

4. What foreign currency risk impacts should be captured in the market risk disclosure?

5. Should commodity contracts that are not within the scope of PFRS 9, FinancialInstruments be included in the market risk sensitivity analyses?

Credit Risk

1. Where should the disclosure on concentration of credit risk be based?

Fair Value

1. Are over-the-counter (OTC) derivative contracts classified as Level 1 measurementin the fair value hierarchy?

2. In the fair value hierarchy disclosure, how should an instrument measured at fair


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value be categorized?

3. An instrument for which there is currently no active market and the entity used avaluation model. A significant input to the model is a credit spread based onhistorical default statistics and credit rating assigned by an agency to theinstrument. Under what level should we classify the instrument under the fair valuehierarchy table and why?

4. The entity uses a model to calculate the fair value of the loan/debt instrument. Themodel uses discounted cash flows based on the risk-free rate plus a credit spread.Under what level will the loan/debt instrument fall under the fair value hierarchy?

Other Disclosures

1. Is it possible to include interest expense on short positions (financial liability held fortrading) in net gains or net losses on financial liabilities at fair value through profit orloss (FVPL)?

2. If financial liabilities that are not at fair value through profit and loss are used tofinance a portfolio of trading financial assets (for example, trading debt securities),can the interest expense (funding costs) on such liabilities be included in net gainsor net losses on financial assets or financial liabilities at fair value through profit orloss (FVPL)?

Consensus

Liquidity Risk

1. Companies are not required to show interest cash flows separately from principalcash flows in the analysis, although some do.

2. No, but companies may opt to present such reconciliation.

3. In PFRS 7.39, companies are required to disclose a maturity analysis of theirfinancial liabilities showing the undiscounted cash flows based on the remaining


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contractual maturities. Companies may wish to provide a separate maturityanalysis based on expected maturity dates. However, such an analysis will notremove the need to produce the required contractual maturity analysis.

4. Only those financial assets the company holds for managing liquidity risk (e.g.,financial assets that are readily saleable or expected to generate cash inflows tomeet cash outflows on financial liabilities). (PFRS 7.B11E)

5. The standard requires the amounts included in the analysis to be based onconditions at year-end. For floating-rate borrowings, one should look to the spotrates at year-end, although a degree of sophistication may be introduced by usingyear-end forward rates.

Market Risk

1. The basic sensitivity analysis should be prepared on the basis of financialinstruments held at the reporting date. Therefore, an entity does not need toforecast the financial instruments that will be held over the next year, nor does ithave to work out what financial instruments it held during the previous year. Areasonably possible change in relevant market risk variables should be applied todetermine the theoretical impact on profit or loss and equity, and it is this impact thatshould be disclosed. A reasonably possible change should not include remote orworst case scenarios or stress tests. (PFRS 7.B19)

2. The Application Guidance of the Standard makes it clear that the sensitivity analysisshould show the effects of changes that are reasonably possible over the perioduntil the company will next present its risk disclosures. (PFRS 7.B19)

3. The disclosure may be on either a pre-tax or a post-tax basis. This is a policy choiceto be made and applied consistently, and disclosed in the financial statements.

4. PFRS 7 is clear that the foreign currency risk impacts that should be captured arethose arising from monetary items denominated in a currency that is different fromthe functional currency of the entity holding them. Therefore, it should not capturesensitivity from translating the results and assets of foreign operations, althoughthere is nothing wrong with showing these as additional information. (PFRS 7.B23)


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5. They should not be included, although there is nothing wrong with showingadditional information about them on a voluntary basis or to comply with thedisclosure requirements of other standards. For VaR-type disclosures it will dependon whether the analysis used by management to manage risk includes thosecontracts. (PFRS 7.5)

Credit Risk

1. PFRS 7 requires disclosure of all risk concentrations to which an entity is exposedin relation to financial instruments, based on financial instruments that have similarcharacteristics such as geographical area, currency, industry, market, and type ofcounterparty. (PFRS 7.B8)

Fair Value

1. An OTC derivative contract is a unique bilateral contract between twocounterparties for which quoted prices are not continuously available. Given theirnature, OTC derivative contracts are not normally classified as Level 1measurements in the fair value hierarchy disclosures. Depending on theobservability of the inputs used, the instrument would either be classified as Level 2or Level 3 measurements.

2. The disclosure on fair value hierarchy focuses on the inputs used in valuationtechniques rather than the valuation techniques themselves. The level in the fairvalue hierarchy shall be based on the lowest level input that is significant to the fairvalue measurement in its entirety. For this purpose, the word “significant” refers towhat is significant to the valuation of the instrument in its entirety.

3. Credit spreads are not normally evidence of market transactions thus the instrumentwill be classified under Level 3.

4. If the credit spread is considered significant, the conclusion is Level 3. However, ifthe credit spread is insignificant, then the conclusion could be Level 2.


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Other Disclosures

1. Yes. Interest expense on short positions should be presented in a mannerconsistent with the treatment of interest expense on long positions, included ineither interest expense or in gains and losses on financial instruments at fair valuethrough profit or loss as appropriate. There should be consistent application fromperiod to period and the company should disclose its accounting policy.

2. No. The interest expense incurred on such liabilities, although such liabilities maybe used to fund the company’s trading portfolio, is not considered to arise directlyfrom the company’s trading activities and should be included in interest expense. If,however, the financial liability funding the trading assets is designated as held fortrading, it would be appropriate to include the interest expense in net gains or netlosses on financial assets or financial liabilities at fair value through profit or loss.

Date originally approved by PIC: June 28, 2017

Date amendments approved by PIC: June 27, 2018


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PIC Members









Date originally approved by FRSC: October 11, 2017

Date amendments approved by FRSC: October 10, 2018


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PFRS 9, Financial Instruments

Q&A No. 2011 - 03 (amended June 2020): Accounting for Inter-company Loans1

Relevant PFRSPAS 1, Presentation of Financial StatementsPAS 24, Related Party DisclosuresPAS 27, Separate Financial StatementsPAS 28, Investments in Associates and Joint VenturesPAS 32, Financial Instruments: Disclosure and PresentationPFRS 9, Financial InstrumentsPFRS 13, Fair Value Measurement

Issue

How should an interest free or below market rate loan between group companies be accountedfor in the separate/stand-alone financial statements of the borrower and of the lender if the loanhas contractual cash flows that are solely payments of principal and interest (SPPI) and is held bythe lender within a hold-to-collect business model?

a. On initial recognition of the loan; andb. During the periods to repayment.

Background

Loans between related entities within a group (i.e., inter-company loans) may take various forms.In some cases, it can be subject to interest free or below-market rate of interest. It may also bemade with no stated date for repayment or repayable on demand.

Inter-company loans may have formal contractual lending agreements that are enforceable underthe law or they may, in substance, be part of the investment in another entity. Therefore, the firststep is to ascertain if the inter-company loan is (i) within the scope of PFRS 9, (ii) an investmentin subsidiary within the scope of PAS 27 or (iii) an investment in associate or a joint venturewithin the scope of PAS 28. In this PIC Q&A, only inter-company loans within the scope ofPFRS 9 will be addressed. This PIC Q&A does not address the question on whether theinstrument is within the scope of PAS 27, PAS 28 or PFRS 9, nor does this address theapplication of PFRS 9’s impairment requirements.

1 This PIC Q&A is issued without prejudice to the rules/regulations governing transactions with relatedparties that are issued by relevant supervisory authorities (such as the Bangko Sentral ng Pilipinas).


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For inter-company loans within the scope of PFRS 9, both the lender and the borrower arerequired to initially record the loan at fair value (plus directly attributable transaction costs foritems that will not be measured at fair value through profit or loss subsequently) in accordancewith PFRS 9.5.1.1.

Inter-company loans do not have an active market, hence, their fair values must be estimated.PFRS 13.47 provides that the fair value of a financial liability with a demand feature is not lessthan the amount repayable on demand, discounted from the first date that the amount could berequired to be paid. PFRS 9.B5.1.1 clarifies that the appropriate way to estimate the fair value ofa long-term loan or receivable that carries no interest is to determine the present value of futurecash flows using the prevailing market rate of interest for a similar instrument.

The fair value of inter-company loans at initial recognition may not necessarily be the same as theloan amount, thus, a “difference” will arise. For loans between a parent and a subsidiary, thisdifference, however, cannot be classified as outright income or loss as contributions from anddistributions to “equity participants” do not meet the basic definition of income or expenses(paragraph 4.70, The Conceptual Framework for Financial Reporting).

Paragraph 11 of PAS 32, Financial Instruments: Disclosure and Presentation, includes thefollowing definitions:

“A financial liability is any liability that is:a) a contractual obligation:

(i) to deliver cash or another financial asset to another entity; or(ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the entity; or …”

“An equity instrument is any contract that evidences a residual interest in the assets of anentity after deducting all of its liabilities.”

PAS 32.15 further clarifies that the substance of a financial instrument, rather than its legal form,governs its classification on the entity’s balance sheet. In this regard, PAS 32.17 provides that“…Although the holder of an equity instrument may be entitled to receive a pro rata share of anydividends or other distributions of equity, the issuer does not have a contractual obligation tomake such distributions because it cannot be required to deliver cash or another financial assetto another party.”

A related guidance under paragraph 38 of PAS 28, Investments in Associates and JointVentures, provides that “…an item for which settlement is neither planned nor likely to occur inthe in the foreseeable future is, in substance, an extension of the entity’s investment in thatassociate. Such items may include…long-term receivables or loans but do not include tradereceivables, trade payables or any long-term receivables for which adequate collateral exists,such as secured loans….”


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Consensus

1. The treatment of the different types of inter-company loans in the books of the parentcompany and subsidiaries are summarized as follows:

a. Loans by a parent to a subsidiary which is payable on demand

Accounting treatment by parent/lender:Initial Recognition The parent shall record the loan on initial recognition at the amount to

be repaid by the subsidiary.

Current/Non-CurrentClassification

Generally, the loan shall be classified as current asset. If, however,the parent has no intention of demanding repayment in the near term(e.g., by expressing an intent not to collect within the next 12 months),it would classify the receivable as non-current in accordance withPAS 1, Presentation of Financial Statements (paragraph 66(c)).

SubsequentMeasurement

The parent shall record the loan at the amount repayable by thesubsidiary.

Accounting treatment by subsidiary/borrower;Initial Recognition The subsidiary shall record the loan liability on initial recognition at the

amount repayable


The loan liability shall be classified as current.


The subsidiary shall record the loan liability at the amount repayable

b. Fixed term loan made by a parent to a subsidiary

Accounting treatment by parent/lender:Initial Recognition Fixed term loans (e.g., 3-year loan) shall be recognized initially at fair

value. The “difference” between the loan amount and its fair valueshall be recorded as an investment, i.e., as a component of the overallinvestment in the subsidiary. The fair value of the loan is estimated bydiscounting the future loan repayments using a rate that the subsidiarywould pay to an unrelated lender for a loan with similar conditions(amount, term, security, etc.).

Current/Non-Current Loans which meet the current classification under PAS 1.66, e.g.,


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Classification those that are expected to be collected within 12 months after thebalance sheet date shall be classified as current, otherwise, as non-current.


Subsequently, the loan shall be measured at amortized cost, using theeffective interest method. This involves the unwinding of the“difference” (i.e., discount) such that, at repayment date, the carryingvalue of the loan equals the amount to be repaid by the subsidiary.The unwinding of the “difference” shall be reported as interest income.

Estimates of repayments (excluding modifications in accordance withparagraph 5.4.3 of PFRS 9 and changes in estimates of expectedcredit losses) should be evaluated in future periods and revised ifnecessary. The effect of change in estimate is accounted for inaccordance with PFRS 9.B5.4.6., i.e., the adjustment is recognized inprofit and loss as income or expense.

Accounting treatment by subsidiary/borrower;Initial Recognition On initial recognition, the loans payable shall be recognized at fair

value. The “difference” between the loan amount and the fair valueshall be recorded as a component of equity of the subsidiary (i.e.,equity contribution by the parent) if it meets the definition of equityunder PAS 32.


Loans which meet the criteria for current classification under PAS1.69,e.g., those repayable within 12 months after the balance sheet dateshall be classified as current, otherwise, as non-current.


Subsequently, the loan shall be measured at amortized cost, using theeffective interest method. This involves the unwinding of the“difference” (i.e., discount) such that, at repayment date, the carryingvalue of the loan equals the amount to be repaid. The unwinding of the“difference” shall be reported as interest expense.

Estimates of repayments should be evaluated in future periods andrevised if necessary. The effect of change in estimate is treated as anadjustment to the carrying amount of the loan with a correspondingcredit/charge to profit or loss in accordance with PFRS 9.B5.4.6.


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c. Loans from parent to subsidiary with no stated date for repayment

Accounting treatment by parent/lender:Initial Recognition If the loan is expected to be payable on demand by the parent,

Item 1.a shall apply.

If the loan is expected to be repaid within a certain period of time(e.g., 3 years), the accounting shall be based on management’sbest estimate of future cash flows and initial recognition shall

follow the same approach for fixed term loans as provided inItem 1.b.


If the loan is expected to be payable on demand by the parent,Item 1.a shall apply.

If the loan is expected to be repaid within a certain period of time,the classification of the loan would be the same as provided inItem 1.b.


If the loan is expected to be payable on demand by the parent, theparent shall subsequently measure the loan at the amountrepayable by the subsidiary.

If the loan is expected to be repaid within a certain period of time,the subsequent measurement of the loan would be the same asprovided in Item 1.b.

Accounting treatment by subsidiary/borrower;Initial Recognition If the loan is expected to be payable on demand by the parent, the

guidance in Item 1.a shall apply.

If the loan is expected to be repaid within a certain period of time(e.g., 3 years), the accounting shall be based on management’sbest estimate of future cash flows and initial recognition shall followthe same approach for fixed term loans as provided in Item 1.b.


If the loan is expected to be payable on demand by the parent, theclassification under Item 1.a shall apply.

If the loan is expected to be repaid within a certain a certain periodof time, the classification of the loan would be the same as


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provided in Item 1.b.


If the loan is expected to be payable on demand by the parent, thesubsidiary shall subsequently measure the loan at the amount tobe repaid.


Note: In some cases, loans that bear no interest and has no fixed term for repayment include acondition that there will be repayment only when agreed in the future by both the parent and thesubsidiary. Based on the contractual terms, the subsidiary has no contractual obligation since itessentially has an unconditional right to defer payment of the loan indefinitely as it still needs toagree to its settlement in the future. Consequently, these loans meet the definition of equity fromthe perspective of the subsidiary as they bear no interest and the subsidiary has theunconditional right to avoid settlement of the loans in cash or another financial asset. The loanswill thus be classified by the subsidiary as equity in their entirety, with no subsequent re-measurement required. From the perspective of the parent, since the loans are not usually of acommercial nature and has no set term, they are, in substance, an addition to the parent’sinvestment in the subsidiary.

d. Loans between fellow subsidiaries

Accounting treatment by the lending subsidiary:Initial Recognition The loan shall be recorded at fair value on initial recognition. The

initial “difference” between the loan amount and its fair value shouldusually be recorded in profit or loss (i.e., loss). In some circumstances,however, when it is clear that the transfer of value from the lendingsubsidiary to the borrowing subsidiary has been made under theinstruction from the parent, the acceptable alternative treatment is forthe initial “difference” to be treated as a distribution, hence, isrecorded as a debit to equity (e.g., Retained Earnings).


Loans which meet the current classification under PAS 1.66, e.g.,those that are expected to be collected within 12 months after thebalance sheet date shall be classified as current, otherwise, asnon-current.


Subsequently, the loan shall be measured at amortized cost using theeffective interest method. This involves the unwinding of the“difference” (i.e., discount) such that, at repayment date, the carryingvalue of the loan equals the amount to be repaid by the borrower. The


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unwinding of the “difference” shall be reported as interest income.

Accounting treatment by the borrowing subsidiary;Initial Recognition The loan shall be recorded at fair value on initial recognition. Any

initial difference between loan amount and its fair value should usuallybe recorded in profit or loss (i.e., gain). In some circumstances,however, when it is clear that the transfer of value from the lendingsubsidiary to the borrowing subsidiary has been made under theinstruction from the parent, the acceptable alternative treatment is forany gain to be recorded as a credit to equity (i.e., treated as a capitalcontribution).




Subsequently, the loan shall be measured at amortized cost, using theeffective interest method. This involves the unwinding of the“difference” (i.e., discount) such that, at repayment date, the carryingvalue of the loan equals the amount to be repaid by the borrower. Theunwinding of the “difference” shall be reported as interest expense.

e. Loans from subsidiary to parent

Accounting treatment by the subsidiary lender:Initial Recognition The loan shall be recorded at fair value on initial recognition. Any

initial difference between the loan amount and its fair value shall betreated as a distribution by the subsidiary to the parent, hence, shallbe recorded as a debit to equity (e.g., Retained Earnings).


Loans which meet the criteria for current classification under PAS1.66,e.g., those repayable within 12 months after the balance sheet date,shall be classified as current, otherwise, as non-current.


Subsequently, the loan shall be measured at amortized cost, using theeffective interest method. This involves the unwinding of the“difference” (i.e., discount) such that, at repayment date, the carryingvalue of the loan equals the amount to be repaid by the parent. Theunwinding of the “difference” shall be reported as interest income.


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Accounting treatment by the parent borrower;Initial Recognition The loan shall be recorded at fair value on initial recognition. Any

initial “difference” between loan amount and its fair value shall berecorded as income (i.e., in substance dividend income).




Subsequently, the loan shall be measured at amortized cost, using theeffective interest method. This involves the unwinding of the“difference” (i.e., discount) such that, at repayment date, the carryingvalue of the loan equals the amount to be repaid by the parent. Theunwinding of the “difference” shall be reported as interest expense.

2. Impairment. Inter-company loans measured at amortized cost are subject to the impairmentrequirements of PFRS 9 paragraph 5.2.2.

3. Disclosure. Inter-company loans meet the definition of related party transactions underparagraph 9 of PAS 24, Related Party Disclosures. The disclosure requirements in PAS 24.12-22 must be complied with to enable users of the financial statements to determine the effect ofinter-company loans on the company.

It should be emphasized that the above guidance in this Q&A is applicable only in the preparationof separate/stand-alone financial statements. On consolidation, inter-company loans will beeliminated, including any discount or premium (and the effect of unwinding thereof) arising fromthe initial difference between the fair value of the loan and the loan amount.

Effective Date

The consensus in this Q&A is effective for annual financial statements beginning on or afterJanuary 1, 2012, the original effective date of this Q&A. The amendments to this Q&A areeffective for annual periods beginning on or after January 1, 2020. Earlier application isencouraged.

Date originally approved by PIC: September 21, 2011Date amendments approved by PIC: July 29, 2015


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PIC Members









Date originally approved by FRSC: November 23, 2011Date approved by FRSC: October 14, 2015


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PFRS 10, Consolidated Financial Statements

Q&A No. 2006 – 02 (amended May 2017): PFRS 10.4(a) – Clarificationof criteria for exemption from presenting consolidated financialstatements

Background

Paragraph 4 of PFRS 10, Consolidated Financial Statements, which is effective for annualperiods beginning on or after January 1, 2013, provides four conditions when a parent need notpresent consolidated financial statements. PFRS 10.4(a)(iv) states:

"its ultimate or any intermediate parent of the parent produces consolidated financialstatements available for public use that comply with International FinancialReporting Standards (IFRS) or Philippine Financial Reporting Standards (PFRS)."(emphasis added)

Issue 1

When are consolidated financial statements considered “available for public use"?

Consensus

The term “consolidated financial statements available for public use” refers to general purposefinancial statements1 which the public may avail of. This includes consolidated financialstatements of the ultimate or immediate parent that are:

posted in the website of the parent company or of its ultimate or any intermediate parent, or filed with the Philippine SEC (which become available to the public once filed) or other

bodies that make filed financial statements available to the public (e.g., the Philippine StockExchange makes available financial statements of brokers and dealers in securities).

Issue 2: Are consolidated financial statements of the ultimate or any intermediate parentprepared in conformity with a financial reporting framework, other than IFRS or PFRSacceptable for purposes of the exemption from the preparation of consolidated financialstatements?

1 PAS 1, Presentation of Financial Statements, paragraph 7 defines general purpose financial statementsas those intended to meet the needs of users who are not in a position to demand reports tailored to meettheir particular needs. They include those that are presented separately or within another publicdocument such as an annual report or a prospectus.


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Consensus

For Philippine financial reporting purposes, other financial reporting standards that areconverged or virtually converged with IFRS such as those of Australia, Singapore, Hong Kong,or countries in the European Union2, or are conceptually similar to IFRS, such as those of theUnited States, United Kingdom, or Canada, are deemed acceptable in applying the provisions ofPFRS 10.4(a) on the exemption from the preparation of consolidated financial statements.

Effective Date

The consensus in this Q&A is effective from December 18, 2006, the original date of approvalby the FRSC. The amendments to this Q&A are effective for annual periods beginning on orafter January 1, 2013, the effective date of PFRS 10, Consolidated Financial Statements.Earlier application is permitted.

Date originally approved by PIC: November 7, 2006Date amendments approved by PIC: September 25, 2013 and May 24, 2017

PIC Members




Sharon G. Dayoan Ma. Concepcion Y. Lupisan



Date originally approved by FRSC: December 18, 2006Date amendments approved by FRSC: October 8, 2014 and August 9, 2017

2 Other countries’ financial reporting standards may become acceptable for purposes of the exemptionfrom consolidation as these other countries converge with IFRS.


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Q&A No. 2017 – 07: PFRS 10 – Accounting for reciprocal holdings inassociates and joint ventures

Issues

1. How does an entity account for reciprocal holdings in associates in accordancewith paragraph 27 of PAS 28, Investments in Associates and Joint Ventures?

2. Does an entity adjust earnings per share calculation for the cross holdings?

Background

Entity A has a 20%-owned associate, Entity B.

Entity B, in turn, has a 20% ownership in Entity A, where Entity B exercises significantinfluence. Entity B accounts for Entity A as an associate.

Both Entity A’s and Entity B’s share capital is 100,000 shares at Php1 unit each.

Entity A’s profit, excluding its share in Entity B, is Php100; Entity B’s profit, excluding itsshare in Entity A, is also Php100.

Taxation is ignored and there are no dividends.

Thus, the economic reality that Entity A’s profit (a) is dependent on Entity B’s profit (b)and vice versa is solved by simultaneous equations as follows:

a = Php100 + 0.2b

b = Php100 + 0.2a

Therefore, solving the simultaneous equation results in:

a = Php125 and b = Php125


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Consensus

1. In applying Paragraph 27 of PAS 28, Entity A should recognize its share of EntityB’s profits, including Entity B’s share in the profits of Entity A. However, in thecase of reciprocal holdings, this approach results in a portion of Entity A’s profitsbeing double-counted. Therefore, the net approach, which simply accounts for20% of the associate’s profit (before the reciprocal profit is added), is moreappropriate in this case. In this fact pattern, the net approach results in Entity Aand Entity B both recognizing profit in the amount of Php120. The difference ofPhp5 represents the equity effect of the reciprocal holdings and therefore, is notrecognized in profit.

This view is supported by the fact that the equity method of accounting employsconsolidation-type procedures such as the elimination of unrealized profits.Under paragraph B86(c) of PFRS 10, income arising on an investment held by asubsidiary in its parent company is eliminated. Therefore, in applyingconsolidation procedures in equity accounting, income arising from theassociate’s investment in its investor is also eliminated.

2. The number of ordinary shares on issue is adjusted for the same reasons thatprofit is determined using the net approach – namely, that the equity method isrequired to be applied using consolidation procedures and this includes theelimination of intragroup balances such as the associate’s investment in theinvestor.

Therefore, in calculating earnings per share, the weighted-average number ofordinary shares is reduced by the amount of the effective cross-holding. In thefact pattern, Entity A’s and Entity B’s ordinary shares are reduced by 4,000(100,000 times 20% of the 20%) to 96,000 for the purpose of the earnings pershare calculation. This adjustment reduces the entity’s equity balance and itsinvestment in the associate by its effective 4% interest in its own shares.

It should be noted, however, that the associate is not part of the group andtherefore, the shares held in the investor are not ‘treasury shares’ as defined.This consensus, however, does not rely on viewing the associate’s holding astreasury shares. Rather, it relies on the fact that paragraph 26 of PAS 28 statesthat many of the procedures that are appropriate for the application of the equitymethod are similar to the consolidation procedures described in PFRS 10. If asubsidiary holds shares in its parent company, these are eliminated under B86(c)of PFRS 10. The same procedure should, therefore, apply to equity accounting.


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This will result in a similar treatment of treasury shares that are eliminated fromequity and, accordingly, excluded in determining earnings per share.

Relevant guidance

Paragraph 27 of PAS 28 states:

“A group’s share in an associate or a joint venture is the aggregate of the holdings inthat associate or joint venture by the parent and its subsidiaries. The holdings of thegroup’s other associates or joint ventures are ignored for this purpose. When anassociate or a joint venture has subsidiaries, associates or joint ventures, the profit orloss, other comprehensive income and net assets taken into account in applying theequity method are recognized in the associate’s or joint venture’s financial statements(including the associate’s or joint venture’s share of the profit or loss, othercomprehensive income and net assets of its associates and joint ventures), after anyadjustments necessary to give effect to uniform accounting policies…”

Paragraph 26 of PAS 28 applies consolidation procedures to equity balances as follows:

“Many of the procedures that are appropriate for the application of the equity methodare similar to the consolidation procedures described in PFRS 10. Furthermore, theconcepts underlying the procedures used in accounting for the acquisition of asubsidiary are also adopted in accounting for the acquisition of an investment in anassociate or a joint venture.”

Paragraph B86 of PFRS 10 states:

“Consolidated financial statements:…(c) eliminate in full intragroup assets and liabilities,equity, income, expenses and cash flows relating to transactions between entities of thegroup (profits or losses resulting from intragroup transactions that are recognized inassets, such as inventory and fixed assets, are eliminated in full).”

Effective Date

The consensus in this Q&A is effective from the date of approval by the FRSC.


PIC Members


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Clark Joseph L. Babor Zaldy D. Aguirre




Maria Isabel E. Comedia Ma. Concepcion Y. Lupisan




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Q&A No. 2017 – 08 (amended June 2020): PFRS 10 – Requirement toprepare consolidated financial statements where an entity disposes ofits single investment in a subsidiary, associate or joint venture

Issue

Is an entity required to prepare consolidated financial statements if during the year itdisposes of its only subsidiary?

Background

Parent Company A (the reporting entity) has an investment in one subsidiary that itconsolidated in prior reporting periods. In the current reporting period, the entitydisposed of the investment. As a result, at the end of the reporting period, there is nogroup. Parent Company A does not meet the exemption in PFRS 10, ConsolidatedFinancial Statements, from preparing consolidated financial statements.

Parent Company A also issues separate financial statements prepared in accordancewith PFRSs, where it accounts for its investment in the subsidiary at cost.

Consensus

Parent Company A is required to present consolidated financial statements for thereporting period in which it has a subsidiary, regardless of whether or not it has anyinvestments in subsidiaries at the end of the reporting period.

Although Parent Company A is not a parent at the end of the reporting period, it was aparent during the reporting period. Paragraph B88 of PFRS 10 requires theconsolidated financial statements to include the income and expenses of a subsidiaryup to the date on which the parent ceases to control the same subsidiary.

Paragraph B98 of PFRS 10 also requires the gain or loss from loss of control of asubsidiary to be calculated based on the difference between the proceeds and thecarrying amounts of the assets and liabilities of the subsidiary at the date when controlis lost. The carrying amount as of the date of disposal reflects the income and expenseof the subsidiary during the reporting period. The gain or loss recognized on disposal inthe consolidated financial statements is therefore generally different from the gain orloss in the separate financial statements of Parent Company A.


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Paragraph 1.12 of The Conceptual Framework for Financial Reporting states that thegeneral purpose financial reports provide information about the effects of transactionsand other events that changed a reporting entity’s resources and claims.

A ‘reporting entity’ includes a group. The disposal of a subsidiary in any reporting periodis usually a significant transaction by the group in that period and therefore the effects ofthat transaction on the financial position and performance of the group are relevant.

This same principle applies to investments in associates or joint ventures when theseconstitute the only investments in group entities, and these investments are sold duringthe period.

Relevant guidance


“An entity includes the income and expenses of a subsidiary in the consolidatedfinancial statements from the date it gains control until the date when the entity ceasesto control the subsidiary. Income and expenses of the subsidiary are based on theamounts of the assets and liabilities recognized in the consolidated financial statementsat the acquisition date…”


“If a parent loses control of a subsidiary, it shall:

(a) derecognize:(i) the assets (including any goodwill) and liabilities of the subsidiary at their

carrying amounts at the date when control is lost; and(ii) the carrying amount of any non-controlling interests in the former subsidiary

at the date when control is lost (including any components of othercomprehensive income attributable to them).

(b) recognize:(i) the fair value of the consideration received, if any, from the transaction, event

or circumstances that resulted in the loss of control;(ii) …(iii) …

(c) …


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(d) recognize any resulting difference as a gain or loss in profit or loss attributable tothe parent.

Paragraph 1.12 of The Conceptual Framework for Financial Reporting states that“General purpose financial reports provide information about the financial position of areporting entity, which is information about the entity’s economic resources and theclaims against the reporting entity. Financial reports also provide information about theeffects of transactions and other events that change a reporting entity’s economicresources and claims. Both types of information provide useful input for decisions aboutproviding resources to an entity.”

Effective Date


Date approved by PIC: June 28, 2017Date amendments approved by the PIC: June 30, 2020

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Date amendments approved by the FRSC: August 19. 2020


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Q&A No. 2017 – 11: PFRS 10 and PAS 32 - Transaction costs incurredto acquire outstanding non-controlling interest or to sell non-controlling interest without a loss of control

Issue

How does a parent account for transaction costs incurred to acquire outstanding non-controlling interest (NCI) in a subsidiary, or transaction costs incurred to sell non-controlling interest in a subsidiary without loss of control, in the consolidated financialstatements of the parent?

Background

Scenario 1

Entity A (reporting entity) acquired a 70% controlling interest in Subsidiary B in 20X1.

In 20X8, Entity A acquires the remaining 30% interest in Subsidiary B. In thistransaction, Entity A incurred directly attributable incremental transaction costs of P500.(Consideration for the remaining 30% interest acquired by Entity A may be settled by acash payment or by the issue of shares of Entity A)

Scenario 2


In 20X8, Entity A sells a 30% interest in Subsidiary B without losing control. In thistransaction, Entity A incurred directly attributable incremental transaction costs of P300.

In both scenarios, the entity has a December year-end.

The effect of taxation is not considered as this is covered by PAS 12, Income Taxes.


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Consensus

Any directly attributable incremental transaction costs incurred to acquire outstandingnon-controlling interest in a subsidiary or to sell non-controlling interest in a subsidiarywithout loss of control are deducted from equity. This is regardless of whether theconsideration is in cash or shares. The transaction costs in Scenario 1 of P500 and inScenario 2 of P300 are deducted directly from equity.

PFRSs do not specify where to allocate the costs in equity – in particular, whether to theparent (who incurred the costs) or to the non-controlling interest (whose equity wasissued/repurchased). Therefore, Entity A may choose where to allocate the costs withinequity, based on the facts and circumstances surrounding the change in ownership, andany legal requirements.

Regardless to which account in equity the charge is allocated, the amount is notreclassified to profit or loss in future periods. Consequently, if the costs are allocated toNCI, this amount must be separately tracked. Therefore, if Subsidiary B is later sold in aseparate transaction (i.e., loss of control), the transaction costs previously recognizeddirectly in equity to acquire or sell the non-controlling interest are not reclassified fromequity to profit and loss, because they do not represent components of othercomprehensive income.

Although PFRS 10, Consolidated Financial Statements, is clear that changes in aparent's ownership interest in a subsidiary that do not result in the parent losing controlof the subsidiary are equity transactions (i.e., transactions with owners in their capacityas owners) it does not specifically address how to account for related transaction costs.

Nevertheless, the entity accounts for transaction costs as a deduction from equitybecause there is clear guidance elsewhere in PFRSs regarding the treatment of suchcosts.

Relevant guidance

Paragraph 35 of PAS 32, Financial Instruments: Presentation, states that “transactioncosts of an equity transaction shall be accounted for as a deduction from equity.”

Paragraphs 106 and 109 of PAS 1, Presentation of Financial Statements, are clear thatfor transactions with owners in their capacity as owners the related transactions costsare presented within equity separately from profit and loss or other comprehensiveincome.


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This conclusion also applies if the parent issues equity to acquire non-controllinginterest. Although there is no change in total consolidated equity, there are twotransactions – an issue of new equity and a repurchase of existing equity. The entityaccounts for transaction costs on the two elements in the same manner as if they hadoccurred separately.

In the absence of specific guidance, the entity may allocate costs within equity asappropriate and considering any legal requirements.

The guidance in paragraph 37 of PAS 32 is also applied in determining which costsqualify as transaction costs, i.e., only those “incremental costs directly attributable to theequity transaction that otherwise would have been avoided”.

Since the transaction costs do not qualify as a component of other comprehensiveincome as defined in paragraph 7 of PAS 1, they are not reclassified from equity toprofit or loss when the parent loses control over the subsidiary.


“An entity shall present a statement of changes in equity as required by paragraph 10.The statement of changes in equity includes the following information:

...

(d) for each component of equity …

(i) profit or loss;

(ii) other comprehensive income; and

(iii) transactions with owners in their capacity as owners, showing separatelycontributions by and distributions to owners and changes in ownership interests insubsidiaries that do not result in a loss of control.”


“ … Except for changes resulting from transactions with owners in their capacity asowners (such as equity contributions, reacquisitions of the entity’s own equityinstruments and dividends) and transaction costs directly related to such transactions,


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the overall change in equity during a period represents the total amount of income andexpense, including gains and losses, generated by the entity’s activities during thatperiod.”


“Changes in a parent's ownership interest in a subsidiary that do not result in the parentlosing control of the subsidiary are equity transactions (i.e., transactions with owners intheir capacity as owners).”


“When the proportion of the equity held by non-controlling interests changes, an entityshall adjust the carrying amounts of the controlling and non-controlling interests toreflect the changes in their relative interests in the subsidiary. The entity shall recognizedirectly in equity any difference between the amount by which the non-controllinginterests are adjusted and the fair value of the consideration paid or received, andattribute it to the owners of the parent.”


“… Transaction costs of an equity transaction shall be accounted for as a deductionfrom equity.”


“ … The transaction costs of an equity transaction are accounted for as a deductionfrom equity to the extent they are incremental costs directly attributable to the equitytransaction that otherwise would have been avoided.”

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Q&A No. 2018 - 08: PFRS 10 and PFRS 3 - Accounting for theacquisition of a non-wholly owned subsidiary that is not a business

Issue

How does an acquirer account for the acquisition of a controlling interest in anotherentity that is not a business when there is a non-controlling interest (NCI) with no rightsto the underlying assets - specifically, at what amounts are the assets acquired and thenon-controlling interest recognized?

This Q&A focuses solely on the accounting for the acquisition where the acquiree(subsidiary) does not constitute a business, and once it is determined that an acquirer(the parent) controls that subsidiary. It does not address how to assess whether anacquiree is a business or whether the acquirer has control over the acquiree.

Fact pattern

Entity A acquires 80% of the share capital of Entity B, which holds a single asset, or agroup of assets not constituting a business. The remaining 20% of the share capital isheld by Entity M, an unrelated third party. The fair value of the asset is CU200. Entity Acontrols Entity B, as defined in PFRS 10, Consolidated Financial Statements.

Variations of this base fact pattern are reflected in the scenarios below:

Scenario Rights of NCI (Entity M) Cash paid by A Fair value of NCI1 Present ownership interest,

entitled to a proportionateshare of Entity B’s net assetsin the event of liquidation

CU160 CU40

2 Present ownership interest,entitled to a proportionateshare of Entity B’s net assetsin the event of liquidation

CU170 CU40

3 Present ownership interest,not entitled to aproportionate share of netassets in the event ofliquidation (e.g., preferenceshares).

CU170 CU40


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Scenario Rights of NCI (Entity M) Cash paid by A Fair value of NCI4 Not a present ownership

interest, but classified as NCI(e.g., options, warrants). Inthis case, however, Entity Awill have acquired 100% ofthe outstanding equity.

CU170 CU40


Under PFRS 10, an entity must consolidate all investees that it controls, not just thosethat are businesses, and the parent will recognize any non-controlling interest in non-wholly owned subsidiaries.

When the acquisition of an entity is not a business combination, the remainingrequirements of PFRS 3 relating to the allocation of the consideration transferred to theidentifiable assets and liabilities and the recognition of goodwill are not applicable.Paragraph 2(b) of PFRS 3 states that upon the acquisition of an asset or a group ofassets that does not constitute a business:

“…the acquirer shall identify and recognize the individual identifiable assets acquired(including those assets that meet the definition of, and recognition criteria for, intangibleassets in PAS 38, Intangible Assets) and liabilities assumed. The cost of the groupshall be allocated to the individual identifiable assets and liabilities on the basis of theirrelative fair values at the date of purchase. Such a transaction or event does not giverise to goodwill.” (Emphasis added)

Therefore, paragraph 2 of PFRS 3 acknowledges that the cost paid for the assets maydiffer from the sum of their fair values and hence may need to be allocated to the assetsand liabilities acquired.

PAS 16, Plant, Property and Equipment and PAS 38, Intangible Assets, state:

“Cost is the amount of cash or cash equivalents paid or the fair value of the otherconsideration given to acquire an asset at the time of its acquisition or construction or,where applicable, the amount attributed to that asset when initially recognized inaccordance with the specific requirements of other PFRSs, e.g., PFRS 2, Share-basedPayment.”


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Therefore, when an asset is acquired subject to a non-controlling interest, its cost is theamount of consideration paid, plus the amount of NCI recorded related to that asset –as this represents a ‘claim’ relating to that asset.


“For each business combination, the acquirer shall measure at the acquisition datecomponents of non-controlling interests in the acquiree that are present ownershipinterests and entitle their holders to a proportionate share of the entity's net assets inthe event of liquidation at either:

(c) fair value; or

(d) the present ownership instruments' proportionate share in the recognizedamounts of the acquiree's identifiable net assets.

All other components of non-controlling interests shall be measured at their acquisition-date fair values, unless another measurement basis is required by PFRSs.”

If there is more than one asset, the amount referenced above for the assets would beallocated between the assets based on their relative fair value.

Consensus

Assets are recognized at cost, which is the sum of all consideration given and any NCIrecognized. If the NCI has a present ownership interest and is entitled to a proportionateshare of net assets upon liquidation, the acquirer has a choice to recognize the NCI atits proportionate share of net assets or its fair value (measured in accordance withPFRS 13, Fair Value Measurement); in all other cases, NCI is recognized at fair value(measured in accordance with PFRS 13), unless another measurement basis isrequired in accordance with PFRSs.

With respect to the scenarios above, the following entries would be recorded:

Scenario Asset acquired (Debit) NCI (Credit) Cash (Credit)1 200 40 1602 210 40 1703 210 40 1704 210 40 170


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Q&A No. 2018 - 03: PFRS 13, PAS 16 and PAS 36 - Fair value of property,plant and equipment and depreciated replacement cost

Issue

Can depreciated replacement cost be used to measure the fair value of an item of property,plant or equipment in accordance with PFRS 13, Fair Value Measurement?

Fact pattern

An entity provides port freight and logistics services. Its plant or equipment compriseshighly-specialized assets from which the entity earns berthing and tonnage fees. The entityaccounts for these assets in accordance with PAS 16, Property, Plant and Equipment,using the revaluation model.

At the end of the reporting period, the assets are tested for impairment under PAS 36,Impairment of Assets. As part of determining the assets’ recoverable amount, the entitymay need to determine their fair value less costs of disposal. However, there are fewobservable inputs available to use in measuring fair value because of the highly specializednature of the assets and because there is no history of such assets ever being sold, otherthan as part of a business combination.

Relevant guidance

Paragraphs 2-3 of PFRS 13 clarify that fair value is not an entity-specific measurement.Rather it is a market-based measurement, regardless of whether observable information isavailable or not. The objective of all fair value measurements is:

“...to estimate the price at which an orderly transaction to sell the asset or to transfer theliability would take place between market participants at the measurement date under currentmarket conditions (i.e., an exit price at the measurement date from the perspective of amarket participant that holds the asset or owes the liability).

...Because fair value is a market-based measurement, it is measured using the assumptionsthat market participants would use when pricing the asset or liability, including assumptionsabout risk...”

In addition, paragraph 27 of PFRS 13 clarifies that:


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“A fair value measurement of a non-financial asset takes into account a market participant'sability to generate economic benefits by using the asset in its highest and best use or byselling it to another market participant that would use the asset in its highest and best use.”

An entity must select techniques and inputs that will ensure the resulting fair valuemeasurement reflects this objective. Paragraph 61-62 of PFRS 13 states:

“An entity shall use valuation techniques that are appropriate in the circumstances and forwhich sufficient data are available to measure fair value, maximizing the use of relevantobservable inputs and minimizing the use of unobservable inputs.

The objective of using a valuation technique is to estimate the price at which an orderlytransaction to sell the asset or to transfer the liability would take place between marketparticipants at the measurement date under current market conditions. Three widely usedvaluation techniques are the market approach, the cost approach and the income approach...An entity shall use valuation techniques consistent with one or more of those approaches tomeasure fair value.”

Using techniques that are consistent with the cost approach do not change the objective of afair value measurement. Paragraph B8-B9 of PFRS 13 clarifies that:

“The cost approach reflects the amount that would be required currently to replace the servicecapacity of an asset (often referred to as current replacement cost).

From the perspective of a market participant seller, the price that would be received for theasset is based on the cost to a market participant buyer to acquire or construct a substituteasset of comparable utility, adjusted for obsolescence. That is because a market participantbuyer would not pay more for an asset than the amount for which it could replace the servicecapacity of that asset. Obsolescence encompasses physical deterioration, functional(technological) obsolescence and economic (external) obsolescence and is broader thandepreciation for financial reporting purposes (an allocation of historical cost) or tax purposes(using specified service lives). In many cases the current replacement cost method is used tomeasure the fair value of tangible assets that are used in combination with other assets orwith other assets and liabilities.”


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Consensus

Depreciated replacement cost can be used to measure the fair value of an item of property,plant or equipment only in limited circumstances. PFRS 13 defines fair value as current exitprice, whereas depreciated replacement cost measures the entry price for an asset.Therefore, only when this entry price equals a current exit price can depreciatedreplacement cost be used to measure fair value.

PFRS 13 permits the use of a cost approach for measuring fair value. However, care isneeded in using depreciated replacement cost to ensure the resulting measurement isconsistent with the requirements of PFRS 13 for measuring fair value.

Before using depreciated replacement cost as a method to measure fair value, an entityneeds to ensure that both:

The highest and best use of the asset is its current use, and

The exit market for the asset (i.e., the principal market or in its absence, the mostadvantageous market) is the same as the entry market (i.e., the market in which theasset was/will be purchased).

In addition, the resulting depreciated replacement cost must be assessed to ensure marketparticipants are willing to transact for the asset in its current condition and location at thisprice. In particular, an entity must ensure that both:

The inputs used to determine replacement cost are consistent with what marketparticipant buyers will pay to acquire or construct a substitute asset of comparableutility, and

The replacement cost has been adjusted for obsolescence that market participantbuyers will consider – i.e., that the depreciation adjustment reflects all forms ofobsolescence (i.e., physical deterioration, technological (functional) and economicobsolescence), which is broader than depreciation calculated in accordance withPAS 16.




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Q&A No. 2018 - 16: PFRS 13 - Level of fair value hierarchy ofgovernment securities using Bloomberg’s standard rule on fair valuehierarchy

Issue

Is the standard rule of fair value hierarchy leveling of Bloomberg for Philippine governmentsecurities using Bloomberg Valuation (BVAL) in accordance with the requirements of PFRS 13, FairValue Measurement?

Background

The Philippines has a Philippine Securities and Exchange Commission (SEC)-registered market forFixed Income Securities operated by the Philippine Dealing & Exchange Corp. (PDEx), a part of thePhilippine Dealing System Holdings Corp., a member-owned and member-governed provider offinancial market trading to settlement infrastructure.

The registered PDEx Fixed Income Securities market encompasses the Over-the-Counter (OTC)Market and an Exchange Market, and includes the Inter-Dealer, Inter-Professional, and RetailInvestor (as represented by Broker Participants) segments of the Philippine fixed income market.As of September 30, 20188, PDEx has 39 Dealing Participants that buy and sell debt securities fortheir own account, 33 Brokering Participants or "public representatives" that execute buy and sellorders on behalf of client investors, and 3 Qualified Investor Participants or institutional investorsallowed to directly act on prices posted by Dealing or Brokering Participants.

The traded debt issues are comprised of Philippine Government Securities (GS) and PhilippineCorporate Securities, with the former having most of the volume.

In support of its activities, PDEx sought and was granted licenses by the SEC to operate an OTCmarket, an exchange, as well as the Self-Regulatory Organization (SRO) license to oversee itsTrading Participants' activities in both the OTC and Exchange sectors of its trading platform.

PDEx is also the Calculation Agent of Philippine Dealing System Treasury (PDST) ReferenceRates, appointed by the Bankers Association of the Philippines to use the SRO powers granted tomonitor the daily setting of these key benchmark interest rates.

8 Information based on published information from the website http://www.pds.com.ph/index.html%3Fpage_id=25.html

http://www.pds.com.ph/index.html%3Fpage_id=25.html


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Effective October 22, 2018, publication of the reference rates will be transferred by PDEx toBloomberg through its valuation technology, Bloomberg Valuation (BVAL). BVAL providesEvaluated Prices that are based on market observations from contributed sources.

Pricing using BVAL

For Government, Supranational, Agency, and Corporate bonds, the Final BVAL Price is a weightedprice derived using an approach based on a combined sequence of proprietary BVAL algorithms ofthe following (see Appendix 1):• Direct Observations – these inputs use trades, executable bid/asks and indicative quotes on the

identical security.• Observed Comparables – these inputs use direct observations on comparable bonds to derive

a relative value price for the security when observable market data on the security isinsufficient.

To corroborate the results of each algorithm, prices are analyzed using both steps, regardless ofthe quality achieved in the first step. The results are then appropriately weighted and aggregatedbased on each algorithm’s relative strength to derive a Final BVAL Price.

Below is the sample screen in BVAL <GO>, showing sections of Snap and Methodology screen of‘Evaluated Pricing’ tab. In this example, the Final BVAL price, 109-22 ¼, was derived from DirectObservations with 100% weight. No weight was attributed to observed comparables.

Direct observationsThe “Direct Observations” analyzes market data received from BVAL’s array of pricing contributorsfor the identical security. This includes institutional size trades and indicative market quotes frombanks, broker-dealers, and exchanges as well as executable bids/asks from electronic Bloomberg’sFixed Income Electronic Trading (FIET) platform. The weighted price is algorithmically calculated,


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considering the volume of trades and time-decay. Key highlights of the data that appears includethe following (See Appendix 2):• Trade Prices – weighted price calculated based on done deal transactions• Executable Bids/Asks – weighted price calculated based on executable prices posted by

selected market-making banks/broker-dealers.• Indicative Bids/Asks - indicative quotes and calculated YTM from selected market-making

banks/broker-dealers. The last Indicative Bid and Ask per contributor appears for over a two-week period for the security.

Below is the screen in BVAL <GO>, a screen under ‘Direct Observations’ tab, showing the price fortrades, executable bids/asks and indicative bids/ask and their related yield-to-maturities, zero-volatility spread, weight and scores for each direct observations data.

It must be noted that BVAL Score is not a statement of accuracy, relative quality or an indicator ofconfidence in the BVAL price. BVAL Score is a proprietary metric designed to give insight into theamount and consistency of data used to produce the BVAL Price. The BVAL Score is not a liquidityindicator. However, it is possible that securities with a higher BVAL Scores have more marketmakers providing prices. Scores of 6-10 do imply that there are recent direct observations on thetarget security which may be either trades, executable or indicative data.

Observed ComparablesThe Observed Comparables algorithm is the second stem in calculating the Final BVAL Price.BVAL uses Observed Comparables in conjunction with the Direct Observations algorithm to price atarget security based on its relative value to comparable bonds, used especially in pricing a securitywith little to no market data. Refer to Appendix 3 for illustrative screen for Observed Comparables.

The following are the different Observed Comparables algorithmic approaches BVAL uses basedon the target security's asset class and structure for government bonds :


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• Bullet par issuer curve model – Used for investment-grade bullet bonds (fixed and floating)across government, supranational, agency and investment-grade corporate sectors. Thismethodology first normalizes the Target Bond for technical characteristics, namely high couponpremiums, size of issue, age in the market and not-rated status. This information is then used toderive a bullet par issuer curve based on direct market observations across an issuer’s termstructure. A Target Bond with no market observation is algorithmically priced using theappropriate maturity point on its par issuer curve. If a par issuer curve cannot be derived fromdirect market observations on bonds within the same issuer, then an appropriate referencecurve is created using a combination of comparable liquid par peer curves within the sameindustry, credit quality and seniority rank in the capital structure.

• Normalized Yield-to-Maturity Model – Supports high yield bonds across Corporate andEmerging Market sectors. This methodology uses liquid bonds throughout an issuer’s capitalstructure to create normalized yield-to-maturity curves at each rank in the capital structure. If anappropriate capital structure curve cannot be derived for the borrower, this methodology usesmarket observations of comparable bonds of the same credit quality and within the sameindustry to derive a relative value price

Below is the screen in BVAL <GO> showing the price for Observed Comparables and related yield-to-maturity, zero-volatility spread, weight and score. For Observed Comparables, the maximumscore is 5.


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BVAL <GO> also shows the adjustments made to the model in determining the ObservedComparables prices to take into account the security’s unique characteristics.

The Market Residual is the difference between direct observation yield and the sum of Base YTCand all adjustments. The Base YTC is the base yield of the BVAL or the expected call generatedfrom the price surface. On the other hand, Used Residual is the residual used in the algorithm,either the Observed Market (if available) or Predicted Residual (the aggregated par curve, coupon,age and size adjustments (in basis points)).

For purposes of determining the inputs used in the valuation, BVAL also provides furtherinformation of the composition of the final BVAL price through the Price Transparency Tab. ThePrice Transparency tab provides a breakdown of the portion of the price that is derived from directobservations, observed comparables, and other sources.


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Bloomberg Fair Value Hierarchy Leveling (FVHL) Rules and analysis

Bloomberg has created a set of standard FVHL rules that were developed based on a thoroughreview and understanding of the accounting standards and years of feedback from Bloomberg’sclients (Refer to Appendix 4).

A"Level" shows the fair value level of the Target Security based on the FVHL rules ofBloomberg

B "Asset Class" shows category in which the Target Security is classified and the specific FVHLrules that will apply for the price leveling.

Bloomberg uses field inputs, called BRAM fields, to design the rules in determining the hierarchy level of the Final BVAL price, depending on the inputs used in calculating the final BVAL price.

Level 1 inputs:• Must be accessible: Prices that are derived from executable prices shows that there are in

fact accessible, executable quotes for the identical security. In order to capture this,Bloomberg uses the following rule to ensure that that the prices come from accessiblemarkets.

BRAM Direct Observation Executable Percent > 0

AB


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Direct Observations consists of trades, executable bids/asks and indicative bids/asksappropriately weighted to derive the Direct Observations price

• Must be directly observable (without adjustment): Prices that are sourced from observabletrade and executable prices shows that inputs to price are directly observable quotes. Inorder to capture this, Bloomberg uses the following rule to ensure that that the prices comefrom accessible markets.

BRAM Price Percent Observable = 100OR BRAM Yield Percent Observable = 100

These BRAM field is related to the inputs from Direct Observation and ObservedComparables.

• Identical assets or liabilities: PFRS 13 require Level 1 inputs be quoted prices for “identicalassets and liabilities”. In order to capture this, Bloomberg uses the following rule to ensurethat that the prices come from accessible markets.

BRAM Direct Observation Percent = 100

Bloomberg’s pricing data breaks quotes into two categories: direct observations andobserved comparables (“comps”). Simply put, Direct Observations are prices from identicalassets, while Observed Comparables are based on similar or comparable assets. In orderto ensure that the price is entirely derived from identical assets and liabilities, the priceneeds to be entirely derived from direct observations. The weight algorithmically assigned toDirect Observations should be 100%

• Active Markets: Level 1 inputs used in determining fair value of instruments must come froman ‘active market’. In the Price Transparency tab screen, Bloomberg BVAL provides


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information of the average age of the quotes, which provides indication of the marketactivity/inactivity.

In determining whether a market is active, Bloomberg uses the average age of the quotes.Bloomberg uses the Direct Observation average age specifically, because the FVHL rule isonly interested in how actively traded identical instruments are (not comparableinstruments). Lower average ages obviously mean a more inactive market. As a result,Bloomberg have tried to use ages that are reflective of the different market norms in thefixed income, mortgage and muni markets.

In order to capture this, Bloomberg uses the following rule to ensure that that the pricescome from active markets.

BRAM Executable Direct Observation Weighted Average Age <= X(where X = 5 for fixed income, X = 6 for pools and securitized products and X =10 for munis)

Different asset classes are expected to trade at different frequencies. Therefore, the rulesdiverge for different asset classes.

As a result, Bloomberg have tried to use ages that are reflective of the different marketnorms in the fixed income, mortgage and muni markets.

Level 2 inputsMust be observable, either directly or indirectly: PFRS 13 explicitly require that all Level 2 inputsmust be observable, either directly or indirectly. This means that either the price must becomposed of quoted prices or any pricing information not observable in the market must rely onobservable inputs.


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Bloomberg’s Level 2 rules differ between assets classes as the sources of prices differ from assetclass to asset class. For Sovereigns, Investment Grade Corporates & Agencies (Yield CouponModel), there are no unobservable inputs. Therefore, those securities under this asset that will notfall under Level 1 inputs will be considered Level 2.

The following examples may include prices that qualify as Level 2 inputs:• Prices that include inputs from Observed Comparables• Prices from Direct Observations but did not meet the active market criteria

Level 3 inputsLevel 3 input effectively represents those instruments that do not meet the criteria to be classifiedas Level 1 or 2. This would include model-based pricing where the model features subjective,unobservable inputs.

For Sovereign securities, as all inputs are observable, there will be no security that will fall underLevel 3.


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Consensus

The FVHL rules are consistent with requirements under PFRS 13. Refer to the summary analysis below for each Standard FVPLrule and the corresponding assessment with PFRS 13 requirements.

Any changes in the FVHL rules should be monitored and assessed if it still meets the requirements of PFRS 13.

FVHL Rules PFRS 13 Guidance Assessment

Level 1 inputsIdentical assets or liabilities

BRAM Direct Observation Percent = 100

Direct Observations are prices from identical assets.

Paragraph 76“Level 1 inputs are quoted prices(unadjusted) in active markets foridentical assets or liabilities that theentity can access at the measurementdate (underscoring added)“

Paragraph 79(c)“… If no adjustment to the quotedprice of the asset is required, theresult is a fair value measurementcategorized within Level 1 of the fairvalue hierarchy. However, anyadjustment to the quoted price of theasset results in a fair valuemeasurement categorized within alower level of the fair value hierarchy.”

This rule ensures that prices underLevel 1 are derived from identicalassets or liabilities only, consistentwith the requirements of paragraph 76of PFRS 13.

Must be accessible

BRAM Direct Observation Executable Percent > 0

Direct Observations are prices from identical assets.Executable price are matching bid/ask prices posted byselected market-making banks/broker-dealers.

This rule ensures that the inputs toprices under Level 1 are derived fromprices that are executable, consistentwith the requirements of paragraph 76of PFRS 13.

Directly observable (without adjustment)


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BRAM Price Percent Observable = 100OR BRAM Yield Percent Observable = 100

Observable prices are prices that are sourced from eitherDirect Observations or Observed Comparables. DirectObservations are prices from identical assets and ObservedComparables are based on comparable assets

Paragraph 77“A quoted price in an active marketprovides the most reliable evidence offair value and shall be used withoutadjustments to fair value wheneveravailable...”

Appendix A“An active market is a market in whichtransactions for the asset or liabilitytake place with sufficient frequencyand volume to provide pricinginformation on an ongoing basis.”

This rule ensures that prices arederived from inputs that areobservable and without anyadjustments, consistent withparagraph 79(c) of PFRS 13.

Active market

BRAM Executable Direct Observation Weighted AverageAge <= X

where:X = 5 for fixed income,X = 6 for pools and securitized products andX = 10 for municipal securities

In determining whether a market is active, Bloomberg usesthe Direct Observation average age to identify how activelytraded identical instruments are (not comparableinstruments). Lower average ages mean a more inactivemarket.

Judgment is to be taken into accountin determining what is considered anactive market. Having an averageage of price of less than 5 days mayindicate that there is sufficientfrequency and volume to providepricing information on ongoing basis.

Level 2 inputs

Must be observable, either directly or indirectly Paragraph 81


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Bloomberg’s Level 2 rules differ between asset classes asthe sources of prices differ from asset class to asset class.For Sovereigns, Investment Grade Corporates & Agencies(Yield Coupon Model), there are no unobservable inputs.Therefore, those securities under this asset that will not fallunder Level 1 inputs will be considered Level 2.

“Level 2 inputs are inputs other thanquoted prices included within Level 1that are observable for the asset orliability, either directly or indirectly.”

Paragraph 82“If the asset or liability has a specified(contractual) term, a Level 2 inputmust be observable for substantiallythe full term of the asset or liability.Level 2 inputs include the following:

a) quoted prices for similarassets or liabilities in activemarkets.

b) quoted prices for identical orsimilar assets or liabilities inmarkets that are not active.

c) inputs other than quoted pricesthat are observable for theasset or liability, for example:

i. interest rates and yieldcurves observable atcommonly quotedintervals;

ii. implied volatilities; andiii. credit spreads.

d) market-corroborated inputs.(underscoring added)”

As price inputs are mainly derivedfrom direct observable and observedcomparables, those prices that will notfall under Level 1 are still consistentwith paragraphs 81 and 82 ofPFRS 13.


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Level 3 inputs

Instruments which do not meet the criteria above are level 3.For example, instruments where the fair value includessignificant unobservable inputs, which includes model-basedpricing where the model features subjective, unobservableinputs.

For Sovereign securities, as all inputs are observable, therewill be no security that will fall under Level 3.

Paragraph 86“Level 3 inputs are unobservableinputs for the asset or liability.”

Paragraph 87“Unobservable inputs shall be used tomeasure fair value to the extent thatrelevant observable inputs are notavailable, thereby allowing forsituations in which there is little, if any,market activity for the asset or liabilityat the measurement date…”

It is expected that no governmentsecurity will fall under Level 3 as thereare always observable inputs that canbe used in valuing the securities.

For additional or detailed guidance on fair value hierarchy considerations, reference should be made to paragraphs 72 through 90 ofPFRS 13. For disclosures with respect to the fair value hierarchy, reference should be made to paragraphs 93(b) through 73(h) andparagraph 94 through 95.


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Date approved by PIC: December 14, 2018

* * * * *

PIC Members









Date approved by FRSC: January 9, 2019


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Appendix 1

BVAL Evaluated Pricing Screen

• Snap: Displays key information from the BVAL valuation, including the date and timestamp for the valuation. This section also displays the Final BVAL Price, which is theresult of the comprehensive BVAL evaluated pricing analysis. The accompanying FinalBVAL Score provides insight into the amount and consistency of data underlying theBVAL price.

• Issue Information: Displays key descriptive information on the selected security forquick reference.

Snap

IssueInformation

Methodology

BVAL History


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• Methodology: Provides transparency into the values used calculate the Final BVALPrice. The values in the Direct Obs row are based on recent observations on a per assetclass basis and corroborated to compute an independent Direct Observations Price.

• BVAL History: Charts the bond's historical BVAL valuation (line chart) andcorresponding BVAL score (lower bar chart). The valuation chart's vertical y-axisdisplays the price (or yield) value. The score chart's vertical y-axis displays the BVALscore values.


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A User shall select in Snap the following: (i) Bid, Ask or Mid prices (ii) pricing date and (iii) cut-offtime

B "Final BVAL Price" shows the price of the security as of the pricing date based on selection inA. The Final BVAL Price is the algorithmically weighted based on the Direct ObservationsPrices and Observed Comparisons Prices.

C "Final BVAL Score" is a proprietary metric designed to give insight into the amount andconsistency of data used to produce the BVAL Price.

D "Issue Information" shows the key features and terms of the security being priced.

E "BVAL History" shows the historical BVAL prices in a graph.

ABC

D

E


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Appendix 2

BVAL Direct Observation Screen

Direct Observations uses Bloomberg’s proprietary screening algorithm to analyze market datareceived from BVAL’s pricing contributors. This algorithm works to include trades as well asexecutable and indicative quotes from banks and broker-dealers on the target security. TheDirect Observations algorithm uses either price or spread over benchmark inputs according toasset-class convention to generate a bid, mid and ask price for every target security.


Snap

IssueInformation

Methodology

DirectObservations

Direct Observations Data


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• Issue Information: Displays key descriptive information on the selected security forquick reference. You can click the section's Issue Information (DES) heading to displaythe full Description (DES) function for the security.

• Direct Observations Data: Displays the number and standard deviation of filteredmarket observations used in the Direct Observations algorithm.

• Methodology: Displays the values used calculate the Final BVAL Price. The DirectObservations algorithm uses either price or spread over benchmark inputs based on theasset class to generate a bid, mid, and ask price for every target security. Each rowrepresents the results from different pricing methodologies, allowing you to makecomparisons.

• Direct Observations: Charts the individual observations contributing to the directobservation pricing algorithm results. The horizontal x-axis displays the age of the quote.The vertical y-axis displays the spread to the specified benchmark curve (in basispoints). The color-coded icons that appear in the chart correspond to the datadescriptions in the Methodology section.


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A "Trades" shows prices and calculated YTM of done dealsB "Exec Bids/Asks" shows executable quotes and calculated YTM from banks and broker

dealers on the target security.C "Indic Bids/Asks" shows indicative quotes and calculated YTM from selected banks and

broker dealers. According to BBG, the list is still being finalized for Philippines. The listdepends on the list approved by the Bangko Sentral ng Pilipinas

D "Weight" shows the weight algorithmically assigned to Trades, Executable and Indicative.E "Score" An index that combines the number of weighted observations with the standard

deviation of those observations to determine a proprietary metric on the data used to producethe BVAL Price.

D

ABCBC

E


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Appendix 3

BVAL Observed Comparable Screen

Observed Comparables uses Bloomberg’s proprietary relative value algorithm to price securitieswith limited or no market observations. A security with insufficient market data is priced relativeto comparable liquid securities.


• Residual: Displays residual adjustments for technical issues specific to the bond’sunique characteristics. These adjustments take into account high premiums (like those

Snap

Residual

Methodology

ObservedComparables


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associated with high-coupon bullet bonds), size of issue, and age in the market. In theabove example, the Observed Comparables algorithm calculates results, but the row ofdata appears in grey to indicate the data has a 0% weighting in calculating the FinalBVAL Price.

• Methodology: Displays the values used calculate the Final BVAL Price. The ObservedComparables methodology derives a price using market data from comparable bondsand, therefore, only can receive a maximum BVAL Score of 5.

• Observed Comparables: Charts the individual observations contributing to theObserved Comparables pricing algorithm results. The horizontal x-axis displays maturityterms for investment grade bonds or duration for high yield target securities. The verticaly-axis displays yield information.


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Appendix 4

Price Transparency Tab Screen

This screen provides a breakdown of the portion of the price which is derived from directobservations and observed comparables relative value model, breaking each of thesecategories down further by whether those inputs are indicative or executable. Additionally, thescreen provides information on the count, age and standard deviation of prices used. The topleft hand portion shows the fair value leveling information based on market consensus levelingrules based on the set parameters, where securities are categorized as Level 1, 2 or 3 based onthe significance of unobservable inputs.

PriceComposition

BRAM FieldList

Algorithm

Fair Value Leveling


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• Fair Value Leveling: Displays prices as Level 1, 2, or 3, based on the significance ofunobservable inputs. The values are calculated using standard rules created andmaintained by Bloomberg and the pricing transparency data that goes into the BVAL price.

• Algorithm: Displays summary data on the age, count, and weight of direct observations(both indicative and executable) and observable comparables (both indicative andexecutable) used in the determination of the BVAL price for the specified instrument.

• Price Composition: Displays algorithm information as a chart that shows the portion ofthe BVAL price that is based on direct observations (both indicative and executable),observable comparables (both indicative and executable), and model-basedmethodologies.

BRAM Field List: Displays the most relevant and requested pricing transparency or "BRAM"fields, which provide granular information on the composition of the Bloomberg ValuationService (BVAL) prices. BRAM fields are the inputs to the Fair Value Leveling rules.


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PFRS 15, Revenue from Contracts with Customers

Q&A No. 2016 – 04: Application of PFRS 15 “Revenue from Contractswith Customers” on Sale of Residential Properties under Pre-completion Contracts

This Q&A No. 2016-04 is a guidance issued by FRSC and should be read in conjunction withthe respective applicable accounting standards specifically, PFRS 15 “Revenue from Contractswith Customers”.

This Q&A supersedes previously issued PIC Q&A No. 2006-01: PAS 18, Appendix paragraph 9– Revenue recognition for sales of property units under pre-completion contracts.

This Q&A is based on the Fact Pattern presented as Appendix A. The conclusion may differshould there be changes to or differences from the fact pattern presented in Appendix A.

Scope

This Q&A applies to the accounting for revenue from the sale of a residential property unit underpre-completion stage (i.e., construction is on-going or has not yet commenced) by a real estatedeveloper that enters into a Contract to Sell (CTS) with a buyer, and the developer hasdetermined that the contract is within the scope of PFRS 15 by satisfying all the criteria inparagraph 9 of PFRS 15.

This Q&A does not deal with the accounting for other aspects of real estate sales such asvariable considerations, financing components, commissions and other contract costs, timing ofsales of completed properties, etc.

Issue

Would the sale of a residential property under pre-completion stage covered by a CTS meet thecriteria for revenue recognition over time?


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Consensus and Basis of Consensus

Under PFRS 15, an entity shall recognize revenue when (or as) the entity satisfies aperformance obligation by transferring a promised good or service (i.e., an asset) to a customer.An asset is transferred when (or as) the customer obtains control of that asset. Paragraph 35 ofPFRS 15 states that an entity transfers control of a good or service over time and, therefore,satisfies a performance obligation and recognizes revenue over time if one of the followingcriteria is met:

(a) the customer simultaneously receives and consumes the benefits provided by theentity’s performance as the entity performs;

(b) the entity’s performance creates or enhances an asset (for example, work inprogress) that the customer controls as the asset is created or enhanced; or

(c) the entity’s performance does not create an asset with an alternative use to the entityand the entity has an enforceable right to payment for performance completed to date.

The criterion in paragraph 35 (a) of PFRS 15 is not relevant in determining whether revenuefrom sale of residential property under pre-completion stage is recognized over time. This isbecause the buyers generally do not consume all of the benefits of the property as thedeveloper constructs the property. Rather, those benefits will be consumed in the future whenthe property is completed. This criterion generally is relevant for service contracts wherein thecustomer consumes the services as they are provided.

The criterion in paragraph 35(b) of PFRS 15 considers whether the customer controls the assetas it is created(Note 1). Based on the terms of the CTS, it is assessed that the buyer is not able tocontrol the property under development as the buyer cannot make changes to it or direct its use.

Using paragraph 35(c) as basis, a developer shall consider whether:

(i) the developer’s performance does not create an asset with an alternative use to theentity; and

(ii) the entity has an enforceable right to payment for performance completed to date.

Developer’s performance does not create an asset with an alternative use

Paragraph 36 of PFRS 15 states: “An asset created by an entity’s performance does not havean alternative use to an entity if the entity is either restricted contractually from readily directingthe asset for another use during the creation or enhancement of that asset or limited practically

(Note 1) Paragraph B5 of PFRS 15 states, “In determining whether a customer controls an asset as it iscreated or enhanced in accordance with paragraph 35(b), an entity shall apply the requirements forcontrol in paragraphs 31–34 and 38. The asset that is being created or enhanced (for example, a work-in-progress asset) could be either tangible or intangible.”


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from readily directing the asset in its completed state for another use. The assessment ofwhether an asset has an alternative use to the entity is made at contract inception.”

Paragraph B6 of PFRS 15 further clarifies that “In assessing whether an asset has analternative use to an entity in accordance with paragraph 36, an entity shall consider the effectsof contractual restrictions and practical limitations on the entity’s ability to readily direct thatasset for another use, such as selling it to a different customer. The possibility of the contractwith the customer being terminated is not a relevant consideration in assessing whether theentity would be able to readily direct the asset for another use.”

The promised property is specifically identified in the CTS by its plot, lot and parcel number andits attributes (such as its size and location). The buyer could enforce its rights to the promisedproperty if the developer seeks to sell the unit to another buyer. This contractual restriction onthe developer’s ability to direct the promised property for another use is considered substantiveas the property is not interchangeable with other properties that the entity could transfer to thebuyer without breaching the contract and without incurring significant costs that otherwisewould not have been incurred in relation to that contract.

Based on the above, the Committee is of the view that the promised property under the CTSdoes not have an alternative use to the developer.

Developer has an enforceable right to payment for performance completed to date

Paragraph 37 of PFRS 15 states: “An entity shall consider the terms of the contract, as well asany laws that apply to the contract, when evaluating whether it has an enforceable right topayment for performance completed to date in accordance with paragraph 35 (c). The right topayment for performance completed to date does not need to be for a fixed amount. However,at all times throughout the duration of the contract, the entity must be entitled to an amount thatat least compensates the entity for performance completed to date if the contract is terminatedby the customer or another party for reasons other than the entity’s failure to perform aspromised.”

Paragraph B11 of PFRS 15 further states: “In some contracts, a customer may have a right toterminate the contract only at specified time during the life of the contract or the customer mightnot have any right to terminate the contract. If a customer acts to terminate a contract withouthaving the right to terminate the contract at that time (including when a customer fails toperform its obligations as promised), the contract (or other laws) might entitle the entity tocontinue to transfer to the customer the goods or services promised in the contract and requirethe customer to pay the consideration promised in exchange for those goods or services. Inthose circumstances, an entity has a right to payment for performance completed to datebecause the entity has a right to continue to perform its obligation in accordance with thecontract and to require the customer to perform its obligations (which include paying thepromised consideration).”


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The buyer has certain rights and obligations under the CTS and under Philippine laws. Inaccordance with the provisions of the CTS, the buyer is contractually obliged to makepayments to the developer according to the payment schedule. The buyer’s protective rightsare set out under Republic Act No. (RA) 6552, “The Maceda Law,” (see discussion below) andPresidential Decree (PD) 957, “Condominium and Subdivision Buyers’ Protective Decree.” PD957 provides the buyer with the right to terminate the CTS only if the developer fails to developthe property in accordance with the approved plans and within the approved time limit.However, the buyer does not have the unilateral right to terminate the CTS.

Similarly, the developer does not have the unilateral right under the CTS to terminate the CTSexcept in the event of default by the buyer.

The Maceda Law provides protective rights to the buyer in the case of default in payments,among them are settlement of unpaid installments due without additional interest within acertain grace period and the right to refund installment payments made. However, before thebuyer could invoke its right to refund under the Maceda Law, the following conditions must bemet: (1) the buyer has paid at least 2 years of installments; and (2) there should be a notarizednotice of cancellation issued by the developer.

The Maceda Law further provides that in case where less than two years of installments werepaid, the seller shall give the buyer a grace period to settle the installment due. If the buyerfails to pay the installments due at the expiration of the grace period, the seller may cancel thecontract after thirty days from receipt by the buyer of the notice of cancellation or demand forrescission of the contract by a notarial act.

Whether default happens before or after the buyer has paid two years of installments, the sellerhas to issue a notice of cancellation for the CTS to be cancelled. Without the cancellation bythe seller, the CTS is considered valid and binding, and the developer may continue to fulfill itsperformance (that is, complete construction) and require exact performance from the buyer(that is, pay the consideration agreed in the CTS).

The Real Estate Industry Group(Note 2) has obtained legal opinion confirming the position that theMaceda Law cannot be enforced unless the developer agrees to a cancellation, and thatwithout such consent, the developer can continue to fulfil its obligation and take legal actionagainst the buyer for specific performance. Similarly, the Committee noted that the developer’spast business practices of terminating the CTS in the event of default by the buyer do not affectthe developer’s contractual right to continue to perform the contract and be entitled to all of thepromised consideration.

(Note 2) Subdivision and Housing Developers Association (SHDA)Asia-Pacific Real Estate Association (APREA)Chamber of Real Estate and Builders' Association (CREBA)Organization of Socialized Housing Developers of the Philippines Inc. (OSHDP)National Real Estate Association (NREA)


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On the basis of said legal opinion, notwithstanding that the developer could terminate the CTS,the developer has a right to payment for performance completed to date because the developercould choose to complete the construction of the property and enforce its rights to full paymentunder the CTS. The fact that the developer may choose to terminate the CTS in the event thebuyer defaults on its obligations would not affect the assessment as the developer’s rights torequire the buyer to continue to perform as required under the CTS are enforceable and thedeveloper is entitled to all of the promised consideration when construction is completed.

Based on the discussions with the Real Estate Industry Group and the legal opinion mentionedabove, the Committee is of the view that the developer has an enforceable right to payment forperformance completed to date.

In view of the foregoing, the Committee concludes that sales of residential properties underpre-completion stage (and based on the Fact Pattern presented in Appendix A) meet thecriteria under paragraph 35(c) of PFRS 15; and therefore, revenue therefrom shall berecognized over time.

Transition and Effective Date

The consensus in this Q&A is effective on the same date as the effective date of PFRS 15Revenue from Contracts with Customers.

Date approved by PIC: November 16, 2016

PIC Members



Clark Joseph L. Babor Gina S. Detera

Wilfredo A. Baltazar Ferdinand George G. Florendo





Date approved by FRSC: December 7, 2016


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Appendix A

Application of PFRS 15 “Revenue from Contracts with Customers” on Sale of Real EstateProperties under Pre-completion Contracts

Fact Pattern

1. For agreements for the construction of residential real estate in the Philippines, sellingactivities are usually performed while construction is in progress (“pre-selling”). Pre-selling activities will commence after appropriate requirements are complied with andLicense to sell (LTS) is issued to the developer per discussion below.

2. Project should generally be about 20% completed prior to the issuance of LTS forvertical real estate projects (high rise condominiums) (other requirements includeapproval of development plans, clearing of the site, construction of the projectfoundation). In some cases, temporary LTS may be issued to the developer.Temporary LTS will allow the developer to engage in pre-selling activities until the LTS isissued. However, all funds obtained from selling will be held in escrow. All amountscollected from buyers (e.g. reservation fees and down payments) prior to issuance ofLTS are required to be deposited in an Escrow Fund.

3. A developer is required to post a performance bond as a requirement for the issuance ofLTS. The performance bond is based on the total project cost. On a yearly basis,HLURB inspects the project and the performance bond is adjusted based on the totalcost to complete. In case the developer fails to complete the project, the performancebond is forfeited in favor of HLURB and HLURB takes over the project.

4. A Contract to Sell (CTS) is executed when the buyer starts making equity payments.The buyer pays a deposit and makes payments throughout the construction period oreven after project completion depending on the payment scheme agreed with thedeveloper. The schedule of payments may not be related to the progress of theconstruction.

5. When the developer has obtained the LTS, there is no restriction on how the developeruses the payments received from the buyer. The developer is not required to set aside afund for the specific use of the project.

6. The relevant building approvals by the authorities set out the construction plan and lay-out of the property that cannot be changed unilaterally by the developer. Any change inplan (alterations/modifications) should be approved by the relevant government body ormajority of the existing buyers.


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7. The buyer does not have the right to revise or dictate the features of the unit underconstruction (e.g., main structure, fittings and furnishing).

8. The rights of the buyer under a CTS are governed by the concept of “equitable interest”or “beneficial interest.” Equitable interest is defined as an interest held by virtue of anequitable title or claimed on equitable grounds, such as the interest held by a trustbeneficiary. The concept of equitable interest is recognized by Philippine laws under theCivil Code of the Philippines (R.A. 386), and has been defined by jurisprudence as theprofit, benefit, or advantage resulting from a contract, or ownership of an estate asdistinct from the legal ownership or control.

9. The buyer can sell or transfer his/her right or interest on the asset to another personeven before full payment for the property and before completion of construction subjectto certain tax rules and legal requirements.

10. The buyer cannot transfer or assign its rights and obligations under the CTS withoutgiving prior notice to and obtaining the consent of the developer. Further, some CTSgive the developer the right of first refusal to purchase the CTS before it can be offeredto a third party.

11. A provision in the CTS precludes the developer from transferring the specified unit toanother customer. This is considered a substantive contractual restriction, as thecustomer could enforce its right to the promised asset if the developer seeks to direct theasset for another use.

12. A provision in the CTS specifies that the developer may annul the CTS if the buyerdefaults in payments.

13. The buyer’s rights are protected by Philippine laws, to wit:

(a) Republic Act (RA) 6552 – “Maceda Law” (The Realty Installment Buyer Act)

The Maceda Law gives the buyer, in the event of default, the right to pay within agrace period and the right to refund under certain conditions.

Please see Appendix A.1 or the full text of the Maceda Law.


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(b) Presidential Decree (PD) 957 - Condominium and Subdivision Buyers’ ProtectiveDecree

PD 957 provides remedies to the buyer should the developer fail to develop thesubdivision or condominium project according to the approved plans and within thetime limit for complying with the same.

Please see Appendix A.2 for the full text of PD 957.


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Appendix A.1

REPUBLIC ACT No. 6552AN ACT TO PROVIDE PROTECTION TO BUYERS OF REAL ESTATE ON INSTALLMENT

PAYMENTS. (Rep. Act No. 6552)

Section 1. This Act shall be known as the "Realty Installment Buyer Act."

Section 2. It is hereby declared a public policy to protect buyers of real estate on installmentpayments against onerous and oppressive conditions.

Section 3. In all transactions or contracts involving the sale or financing of real estate oninstallment payments, including residential condominium apartments but excluding industriallots, commercial buildings and sales to tenants under Republic Act Numbered Thirty-eighthundred forty-four, as amended by Republic Act Numbered Sixty-three hundred eighty-nine,where the buyer has paid at least two years of installments, the buyer is entitled to the followingrights in case he defaults in the payment of succeeding installments:

(a) To pay, without additional interest, the unpaid installments due within the total graceperiod earned by him which is hereby fixed at the rate of one month grace period forevery one year of installment payments made: Provided, That this right shall beexercised by the buyer only once in every five years of the life of the contract and itsextensions, if any.

(b) If the contract is canceled, the seller shall refund to the buyer the cash surrender valueof the payments on the property equivalent to fifty per cent of the total payments made,and, after five years of installments, an additional five per cent every year but not toexceed ninety per cent of the total payments made: Provided, That the actualcancellation of the contract shall take place after thirty days from receipt by the buyer ofthe notice of cancellation or the demand for rescission of the contract by a notarial actand upon full payment of the cash surrender value to the buyer.

Down payments, deposits or options on the contract shall be included in the computation of thetotal number of installment payments made.

Section 4. In case where less than two years of installments were paid, the seller shall give thebuyer a grace period of not less than sixty days from the date the installment became due. If thebuyer fails to pay the installments due at the expiration of the grace period, the seller maycancel the contract after thirty days from receipt by the buyer of the notice of cancellation or thedemand for rescission of the contract by a notarial act.

Section 5. Under Section 3 and 4, the buyer shall have the right to sell his rights or assign the


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same to another person or to reinstate the contract by updating the account during the graceperiod and before actual cancellation of the contract. The deed of sale or assignment shall bedone by notarial act.

Section 6. The buyer shall have the right to pay in advance any installment or the full unpaidbalance of the purchase price any time without interest and to have such full payment of thepurchase price annotated in the certificate of title covering the property.

Section 7. Any stipulation in any contract hereafter entered into contrary to the provisions ofSections 3, 4, 5 and 6, shall be null and void.

Section 8. If any provision of this Act is held invalid or unconstitutional, no other provision shallbe affected thereby.

Section 9. This Act shall take effect upon its approval.

Approved: August 26, 1972.


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Appendix A.2

PRESIDENTIAL DECREE No. 957 July 12, 1976REGULATING THE SALE OF SUBDIVISION LOTS AND CONDOMINIUMS, PROVIDING

PENALTIES FORVIOLATIONS THEREOF

WHEREAS, it is the policy of the State to afford its inhabitants the requirements of decenthuman settlement and to provide them with ample opportunities for improving their quality of life;

WHEREAS, numerous reports reveal that many real estate subdivision owners, developers,operators, and/or sellers have reneged on their representations and obligations to provide andmaintain properly subdivision roads, drainage, sewerage, water systems, lighting systems, andother similar basic requirements, thus endangering the health and safety of home and lotbuyers;

WHEREAS, reports of alarming magnitude also show cases of swindling and fraudulentmanipulations perpetrated by unscrupulous subdivision and condominium sellers and operators,such as failure to deliver titles to the buyers or titles free from liens and encumbrances, and topay real estate taxes, and fraudulent sales of the same subdivision lots to different innocentpurchasers for value;

WHEREAS, these acts not only undermine the land and housing program of the government butalso defeat the objectives of the New Society, particularly the promotion of peace and order andthe enhancement of the economic, social and moral condition of the Filipino people;

WHEREAS, this state of affairs has rendered it imperative that the real estate subdivision andcondominium businesses be closely supervised and regulated, and that penalties be imposedon fraudulent practices and manipulations committed in connection therewith.

NOW, THEREFORE, I, FERDINAND E. MARCOS, President of the Philippines, by virtue of thepowers vested in me by the Constitution, do hereby decree and order:

Title ITITLE AND DEFINITIONS

Section 1. Title. This Decree shall be known as THE SUBDIVISION AND CONDOMINIUMBUYERS' PROTECTIVE DECREE.


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Section 2. Definition of Terms When used in this Decree, the following terms shall, unless thecontext otherwise indicates, have the following respective meanings:

(a) Person. "Person" shall mean a natural or a juridical person. A juridical person refers to abusiness firm whether a corporation, partnership, cooperative or associations or a singleproprietorship.

(b) Sale or sell. "Sale" or "sell" shall include every disposition, or attempt to dispose, for avaluable consideration, of a subdivision lot, including the building and other improvementsthereof, if any, in a subdivision project or a condominium unit in a condominium project. "Sale"and "sell" shall also include a contract to sell, a contract of purchase and sale, an exchange, anattempt to sell, an option of sale or purchase, a solicitation of a sale, or an offer to sell, directlyor by an agent, or by a circular, letter, advertisement or otherwise. A privilege given to amember of a cooperative, corporation, partnership, or any association and/or the issuance of acertificate or receipt evidencing or giving the right of participation in, or right to, any land inconsideration of payment of the membership fee or dues, shall be deemed a sale within themeaning of this definition.

(c) Buy and purchase. The "buy" and "purchase" shall include any contract to buy, purchase, orotherwise acquire for a valuable consideration a subdivision lot, including the building and otherimprovements, if any, in a subdivision project or a condominium unit in a condominium project.

(d) Subdivision project. "Subdivision project" shall mean a tract or a parcel of land registeredunder Act No. 496 which is partitioned primarily for residential purposes into individual lots withor without improvements thereon, and offered to the public for sale, in cash or in installmentterms. It shall include all residential, commercial, industrial and recreational areas as well asopen spaces and other community and public areas in the project.

(e) Subdivision lot. "Subdivision lot" shall mean any of the lots, whether residential, commercial,industrial, or recreational, in a subdivision project.

(f) Complex subdivision plan. "Complex subdivision plan" shall mean a subdivision plan of aregistered land wherein a street, passageway or open space is delineated on the plan.

(g) Condominium project. "Condominium project" shall mean the entire parcel of real propertydivided or to be divided primarily for residential purposes into condominium units, including allstructures thereon.

(h) Condominium unit. "Condominium unit" shall mean a part of the condominium projectintended for any type of independent use or ownership, including one or more rooms or spaceslocated in one or more floors (or part of parts of floors) in a building or buildings and suchaccessories as may be appended thereto.


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(i) Owner. "Owner" shall refer to the registered owner of the land subject of a subdivision or acondominium project.

(j) Developer. "Developer" shall mean the person who develops or improves the subdivisionproject or condominium project for and in behalf of the owner thereof.

(k) Dealer. "Dealer" shall mean any person directly engaged as principal in the business ofbuying, selling or exchanging real estate whether on a full-time or part-time basis.

(l) Broker. "Broker" shall mean any person who, for commission or other compensation,undertakes to sell or negotiate the sale of a real estate belonging to another.

(m) Salesman. "Salesman" shall refer to the person regularly employed by a broker to perform,for and in his behalf, any or all functions of a real estate broker.

(n) Authority. "Authority" shall mean the National Housing Authority.

Title IIREGISTRATION AND LICENSE TO SELL

Section 3. National Housing Authority The National Housing Authority shall have exclusivejurisdiction to regulate the real estate trade and business in accordance with the provisions ofthis Decree.

Section 4. Registration of Projects The registered owner of a parcel of land who wishes toconvert the same into a subdivision project shall submit his subdivision plan to the Authoritywhich shall act upon and approve the same, upon a finding that the plan complies with theSubdivision Standards' and Regulations enforceable at the time the plan is submitted. Thesame procedure shall be followed in the case of a plan for a condominium project except that, inaddition, said Authority shall act upon and approve the plan with respect to the building orbuildings included in the condominium project in accordance with the National Building Code(R.A. No. 6541). The subdivision plan, as so approved, shall then be submitted to the Directorof Lands for approval in accordance with the procedure prescribed in Section 44 of the LandRegistration Act (Act No. 496, as amended by R.A. No. 440): Provided, that it case of complexsubdivision plans, court approval shall no longer be required. The condominium plan as likewiseso approved, shall be submitted to the Register of Deeds of the province or city in which theproperty lies and the same shall be acted upon subject to the conditions and in accordance withthe procedure prescribed in Section 4 of the Condominium Act (R.A. No. 4726). The owner orthe real estate dealer interested in the sale of lots or units, respectively, in such subdivisionproject or condominium project shall register the project with the Authority by filing therewith asworn registration statement containing the following information:


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(a) Name of the owner;

(b) The location of the owner's principal business office, and if the owner is a non-residentFilipino, the name and address of his agent or representative in the Philippines is authorized toreceive notice;

(c) The names and addresses of all the directors and officers of the business firm, if the ownerbe a corporation, association, trust, or other entity, and of all the partners, if it be a partnership;

(d) The general character of the business actually transacted or to be transacted by the owner;and

(e) A statement of the capitalization of the owner, including the authorized and outstandingamounts of its capital stock and the proportion thereof which is paid-up.

The following documents shall be attached to the registration statement:

(a) A copy of the subdivision plan or condominium plan as approved in accordance with the firstand second paragraphs of this section.

(b) A copy of any circular, prospectus, brochure, advertisement, letter, or communication to beused for the public offering of the subdivision lots or condominium units;

(c) In case of a business firm, a balance sheet showing the amount and general character of itsassets and liabilities and a copy of its articles of incorporation or articles of partnership orassociation, as the case may be, with all the amendments thereof and existing by-laws orinstruments corresponding thereto.

(d) A title to the property which is free from all liens and encumbrances: Provided, however, thatin case any subdivision lot or condominium unit is mortgaged, it is sufficient if the instrument ofmortgage contains a stipulation that the mortgagee shall release the mortgage on anysubdivision lot or condominium unit as soon as the full purchase price for the same is paid bythe buyer.

The person filing the registration statement shall pay the registration fees prescribed therefor bythe Authority.

Thereupon, the Authority shall immediately cause to be published a notice of the filing of theregistration statement at the expense of the applicant-owner or dealer, in two newspapersgeneral circulation, one published in English and another in Pilipino, once a week for twoconsecutive weeks, reciting that a registration statement for the sale of subdivision lots orcondominium units has been filed in the National Housing Authority; that the aforesaidregistration statement, as well as the papers attached thereto, are open to inspection during


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business hours by interested parties, under such regulations as the Authority may impose; andthat copies thereof shall be furnished to any party upon payment of the proper fees.

The subdivision project of the condominium project shall be deemed registered upon completionof the above publication requirement. The fact of such registration shall be evidenced by aregistration certificate to be issued to the applicant-owner or dealer.

Section 5. License to sell. Such owner or dealer to whom has been issued a registrationcertificate shall not, however, be authorized to sell any subdivision lot or condominium unit inthe registered project unless he shall have first obtained a license to sell the project within twoweeks from the registration of such project.

The Authority, upon proper application therefor, shall issue to such owner or dealer of aregistered project a license to sell the project if, after an examination of the registrationstatement filed by said owner or dealer and all the pertinent documents attached thereto, he isconvinced that the owner or dealer is of good repute, that his business is financially stable, andthat the proposed sale of the subdivision lots or condominium units to the public would not befraudulent.

Section 6. Performance Bond. No license to sell subdivision lots or condominium units shall beissued by the Authority under Section 5 of this Decree unless the owner or dealer shall havefiled an adequate performance bond approved by said Authority to guarantee the constructionand maintenance of the roads, gutters, drainage, sewerage, water system, lighting systems, andfull development of the subdivision project or the condominium project and the compliance bythe owner or dealer with the applicable laws and rules and regulations.

The performance bond shall be executed in favor of the Republic of the Philippines and shallauthorize the Authority to use the proceeds thereof for the purposes of its undertaking in case offorfeiture as provided in this Decree.

Section 7. Exempt transactions. A license to sell and performance bond shall not be required inany of the following transactions:

(a) Sale of a subdivision lot resulting from the partition of land among co-owners and co-heirs.

(b) Sale or transfer of a subdivision lot by the original purchaser thereof and any subsequentsale of the same lot.

(c) Sale of a subdivision lot or a condominium unit by or for the account of a mortgagee in theordinary course of business when necessary to liquidate a bona fide debt.

Section 8. Suspension of license to sell. Upon verified complaint by a buyer of a subdivision lotor a condominium unit in any interested party, the Authority may, in its discretion, immediately


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suspend the owner's or dealer's license to sell pending investigation and hearing of the case asprovided in Section 13 hereof. The Authority may motu proprio suspend the license to sell if, inits opinion, any information in the registration statement filed by the owner or dealer is or hasbecome misleading, incorrect, inadequate or incomplete or the sale or offering for a sale of thesubdivision or condominium project may work or tend to work a fraud upon prospective buyers.

The suspension order may be lifted if, after notice and hearing, the Authority is convinced thatthe registration statement is accurate or that any deficiency therein has been corrected orsupplemented or that the sale to the public of the subdivision or condominium project will neitherbe fraudulent not result in fraud. It shall also be lifted upon dismissal of the complaint for lack oflegal basis.

Until the final entry of an order of suspension, the suspension of the right to sell the project,though binding upon all persons notified thereof, shall be deemed confidential unless it shallappear that the order of suspension has in the meantime been violated.

Section 9. Revocation of registration certificate and license to sell. The Authority may, motuproprio or upon verified complaint filed by a buyer of a subdivision lot or condominium unit,revoke the registration of any subdivision project or condominium project and the license to sellany subdivision lot or condominium unit in said project by issuing an order to this effect, with hisfindings in respect thereto, if upon examination into the affairs of the owner or dealer during ahearing as provided for in Section 14 hereof, if shall appear there is satisfactory evidence thatthe said owner or dealer:

(a) Is insolvent; or

(b) has violated any of the provisions of this Decree or any applicable rule or regulation of theAuthority, or any undertaking of his/its performance bond; or

(c) Has been or is engaged or is about to engage in fraudulent transactions; or

(d) Has made any misrepresentation in any prospectus, brochure, circular or other literatureabout the subdivision project or condominium project that has been distributed to prospectivebuyers; or

(e) Is of bad business repute; or

(f) Does not conduct his business in accordance with law or sound business principles.

Where the owner or dealer is a partnership or corporation or an unincorporated association, itshall be sufficient cause for cancellation of its registration certificate and its license to sell, if anymember of such partnership or any officer or director of such corporation or association hasbeen guilty of any act or omission which would be cause for refusing or revoking the registration


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of an individual dealer, broker or salesman as provided in Section 11 hereof.

Section 10. Registers of subdivision lots and condominium units. A record of subdivision lotsand condominium units shall be kept in the Authority wherein shall be entered all orders of theAuthority affecting the condition or status thereof. The registers of subdivision lots andcondominium units shall be open to public inspection subject to such reasonable rules as theAuthority may prescribe.

Title IIIDEALERS, BROKERS AND SALESMEN

Section 11. Registration of dealers, brokers and salesmen. No real estate dealer, broker orsalesman shall engage in the business of selling subdivision lots or condominium units unlesshe has registered himself with the Authority in accordance with the provisions of this section.

If the Authority shall find that the applicant is of good repute and has complied with theapplicable rules of the Authority, including the payment of the prescribed fee, he shall registersuch applicant as a dealer, broker or salesman upon filing a bond, or other security in lieuthereof, in such sum as may be fixed by the Authority conditioned upon his faithful compliancewith the provisions of this Decree: Provided, that the registration of a salesman shall ceaseupon the termination of his employment with a dealer or broker.

Every registration under this section shall expire on the thirty-first day of December of eachyear. Renewal of registration for the succeeding year shall be granted upon written applicationtherefor made not less than thirty nor more than sixty days before the first day of the ensuingyear and upon payment of the prescribed fee, without the necessity of filing further statementsor information, unless specifically required by the Authority. All applications filed beyond saidperiod shall be treated as original applications.The names and addresses of all persons registered as dealers, brokers, or salesmen shall berecorded in a Register of Brokers, Dealers and Salesmen kept in the Authority which shall beopen to public inspection.

Section 12. Revocation of registration as dealers, brokers or salesmen. Registration under thepreceding section may be refused or any registration granted thereunder, revoked by theAuthority if, after reasonable notice and hearing, it shall determine that such applicant orregistrant:

1. Has violated any provision of this Decree or any rule or regulation made hereunder; or

2. Has made a material false statement in his application for registration; or

3. Has been guilty of a fraudulent act in connection with any sale of a subdivision lot orcondominium unit; or


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4. Has demonstrated his unworthiness to transact the business of dealer, broker, or salesman,as the case may be.

In case of charges against a salesman, notice thereof shall also be given the broker or dealeremploying such salesman.

Pending hearing of the case, the Authority shall have the power to order the suspension of thedealer's, broker's, of salesman's registration; provided, that such order shall state the cause forthe suspension.

The suspension or revocation of the registration of a dealer or broker shall carry with it all thesuspension or revocation of the registrations of all his salesmen.

Title IVPROCEDURE FOR REVOCATION OF REGISTRATION CERTIFICATE

Section 13. Hearing. In the hearing for determining the existence of any ground or grounds forthe suspension and/or revocation of registration certificate and license to sell as provided inSection 8 and 9 hereof, the following shall be complied with:

(a) Notice. No such hearing shall proceed unless the respondent is furnished with a copy of thecomplaint against him or is notified in writing of the purpose of such hearing.

(b) Venue. The hearing may be held before the officer or officers designated by the Authority onthe date and place specified in the notice.

(c) Nature of proceeding. The proceedings shall be non-litigious and summary in nature withoutregard to legal technicalities obtaining in courts of law. The Rules of court shall not apply in saidhearing except by analogy or in a suppletory character and whenever practicable andconvenient.

(d) Power incidental to the hearing. For the purpose of the hearing or other proceeding underthis Decree, the officer or officers designated to hear the complaint shall have the power toadminister oaths, subpoena witnesses, conduct ocular inspections, take depositions, andrequire the production of any book, paper, correspondence, memorandum, or other recordwhich are deemed relevant or material to the inquiry.

Section 14. Contempt.

(a) Direct contempt. The officer or officers designated by the Authority to hear the complaintmay summarily adjudge in direct contempt any person guilty of misbehavior in the presence ofor so near the said hearing officials as to obstruct or interrupt the proceedings before the sameor of refusal to be sworn or to answer as a witness or to subscribe an affidavit or deposition


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when lawfully required to do so. The person found guilty of direct contempt under this sectionshall be punished by a fine not exceeding Fifty (P50.00) Pesos or imprisonment not exceedingfive (5) days, or both.

(b) Indirect contempt. The officer or officers designated to hear the complaint may also adjudgeany person in indirect contempt on grounds and in the manner prescribed in Rule 71 of theRevised Rules of Court.

Section 15. Decision. The case shall be decided within thirty (30) days from the time the same issubmitted for decision. The Decision may order the revocation of the registration of thesubdivision or condominium project, the suspension, cancellation, or revocation of the license tosell and/or forfeiture, in whole or in part, of the performance bond mentioned in Section 6hereof. In case forfeiture of the bond is ordered, the Decision may direct the provincial or cityengineer to undertake or cause the construction of roads and of other requirements for thesubdivision or condominium as stipulated in the bond, chargeable to the amount forfeited. Suchdecision shall be immediately executory and shall become final after the lapse of 15 days fromthe date of receipt of the Decision.

Section 16. Cease and Desist Order. Whenever it shall appear to the Authority that any personis engaged or about to engage in any act or practice which constitutes or will constitute aviolation of the provisions of this Decree, or of any rule or regulation thereunder, it may, upondue notice and hearing as provided in Section 13 hereof, issue a cease and desist order toenjoin such act or practices.

Section 17. Registration. All contracts to sell, deeds of sale and other similar instrumentsrelative to the sale or conveyance of the subdivision lots and condominium units, whether or notthe purchase price is paid in full, shall be registered by the seller in the Office of the Register ofDeeds of the province or city where the property is situated.

Whenever a subdivision plan duly approved in accordance with Section 4 hereof, together withthe corresponding owner's duplicate certificate of title, is presented to the Register of Deeds forregistration, the Register of Deeds shall register the same in accordance with the provisions ofthe Land Registration Act, as amended: Provided, however, that it there is a street, passagewayor required open space delineated on a complex subdivision plan hereafter approved and asdefined in this Decree, the Register of Deeds shall annotate on the new certificate of titlecovering the street, passageway or open space, a memorandum to the effect that except byway of donation in favor of a city or municipality, no portion of any street, passageway, or openspace so delineated on the plan shall be closed or otherwise disposed of by the registeredowner without the requisite approval as provided under Section 22 of this Decree.

Section 18. Mortgages. No mortgage on any unit or lot shall be made by the owner or developerwithout prior written approval of the Authority. Such approval shall not be granted unless it isshown that the proceeds of the mortgage loan shall be used for the development of the


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condominium or subdivision project and effective measures have been provided to ensure suchutilization. The loan value of each lot or unit covered by the mortgage shall be determined andthe buyer thereof, if any, shall be notified before the release of the loan. The buyer may, at hisoption, pay his installment for the lot or unit directly to the mortgagee who shall apply thepayments to the corresponding mortgage indebtedness secured by the particular lot or unitbeing paid for, with a view to enabling said buyer to obtain title over the lot or unit promptly afterfull payment thereto;

Section 19. Advertisements. Advertisements that may be made by the owner or developerthrough newspaper, radio, television, leaflets, circulars or any other form about the subdivisionor the condominium or its operations or activities must reflect the real facts and must bepresented in such manner that will not tend to mislead or deceive the public.

The owner or developer shall answerable and liable for the facilities, improvements,infrastructures or other forms of development represented or promised in brochures,advertisements and other sales propaganda disseminated by the owner or developer or hisagents and the same shall form part of the sales warranties enforceable against said owner ordeveloper, jointly and severally. Failure to comply with these warranties shall also be punishablein accordance with the penalties provided for in this Decree.

Section 20. Time of Completion. Every owner or developer shall construct and provide thefacilities, improvements, infrastructures and other forms of development, including water supplyand lighting facilities, which are offered and indicated in the approved subdivision orcondominium plans, brochures, prospectus, printed matters, letters or in any form ofadvertisement, within one year from the date of the issuance of the license for the subdivision orcondominium project or such other period of time as may be fixed by the Authority.

Section 21. Sales Prior to Decree. In cases of subdivision lots or condominium units sold ordisposed of prior to the effectivity of this Decree, it shall be incumbent upon the owner ordeveloper of the subdivision or condominium project to complete compliance with his or itsobligations as provided in the preceding section within two years from the date of this Decreeunless otherwise extended by the Authority or unless an adequate performance bond is filed inaccordance with Section 6 hereof.

Failure of the owner or developer to comply with the obligations under this and the precedingprovisions shall constitute a violation punishable under Sections 38 and 39 of this Decree.

Section 22. Alteration of Plans. No owner or developer shall change or alter the roads, openspaces, infrastructures, facilities for public use and/or other form of subdivision development ascontained in the approved subdivision plan and/or represented in its advertisements, without thepermission of the Authority and the written conformity or consent of the duly organizedhomeowners association, or in the absence of the latter, by the majority of the lot buyers in thesubdivision.


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Section 23. Non-Forfeiture of Payments. No installment payment made by a buyer in asubdivision or condominium project for the lot or unit he contracted to buy shall be forfeited infavor of the owner or developer when the buyer, after due notice to the owner or developer,desists from further payment due to the failure of the owner or developer to develop thesubdivision or condominium project according to the approved plans and within the time limit forcomplying with the same. Such buyer may, at his option, be reimbursed the total amount paidincluding amortization interests but excluding delinquency interests, with interest thereon at thelegal rate.

Section 24. Failure to pay installments. The rights of the buyer in the event of this failure to paythe installments due for reasons other than the failure of the owner or developer to develop theproject shall be governed by Republic Act No. 6552.

Where the transaction or contract was entered into prior to the effectivity of Republic Act No.6552 on August 26, 1972, the defaulting buyer shall be entitled to the corresponding refundbased on the installments paid after the effectivity of the law in the absence of any provision inthe contract to the contrary.

Section 25. Issuance of Title. The owner or developer shall deliver the title of the lot or unit tothe buyer upon full payment of the lot or unit. No fee, except those required for the registrationof the deed of sale in the Registry of Deeds, shall be collected for the issuance of such title. Inthe event a mortgage over the lot or unit is outstanding at the time of the issuance of the title tothe buyer, the owner or developer shall redeem the mortgage or the corresponding portionthereof within six months from such issuance in order that the title over any fully paid lot or unitmay be secured and delivered to the buyer in accordance herewith.

Section 26. Realty Tax. Real estate tax and assessment on a lot or unit shall be paid by theowner or developer without recourse to the buyer for as long as the title has not passed thebuyer; Provided, however, that if the buyer has actually taken possession of and occupied thelot or unit, he shall be liable to the owner or developer for such tax and assessment effective theyear following such taking of possession and occupancy.

Section 27. Other Charges. No owner or developer shall levy upon any lot or buyer a fee for analleged community benefit. Fees to finance services for common comfort, security andsanitation may be collected only by a properly organized homeowners association and only withthe consent of a majority of the lot or unit buyers actually residing in the subdivision orcondominium project.

Section 28. Access to Public Offices in the Subdivisions. No owner or developer shall deny anyperson free access to any government office or public establishment located within thesubdivision or which may be reached only by passing through the subdivision.


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Section 29. Right of Way to Public Road. The owner or developer of a subdivision withoutaccess to any existing public road or street must secure a right of way to a public road or streetand such right of way must be developed and maintained according to the requirement of thegovernment and authorities concerned.

Section 30. Organization of Homeowners Association. The owner or developer of a subdivisionproject or condominium project shall initiate the organization of a homeowners associationamong the buyers and residents of the projects for the purpose of promoting and protecting theirmutual interest and assist in their community development.

Section 31. Donations of roads and open spaces to local government. The registered owner ordeveloper of the subdivision or condominium project, upon completion of the development ofsaid project may, at his option, convey by way of donation the roads and open spaces foundwithin the project to the city or municipality wherein the project is located. Upon acceptance ofthe donation by the city or municipality concerned, no portion of the area donated shallthereafter be converted to any other purpose or purposes unless after hearing, the proposedconversion is approved by the Authority.

Section 32. Phases of Subdivision. For purposes of complying with the provisions of thisDecree, the owner or developer may divide the development and sale of the subdivision intophases, each phase to cover not less than ten hectares. The requirement imposed by thisDecree on the subdivision as a whole shall be deemed imposed on each phase.

Section 33. Nullity of waivers. Any condition, stipulation, or provision in contract of sale wherebyany person waives compliance with any provision of this Decree or of any rule or regulationissued thereunder shall be void.

Section 34. Visitorial powers. This Authority, through its duly authorized representative may, atany time, make an examination into the business affairs, administration, and condition of anyperson, corporation, partnership, cooperative, or association engaged in the business of sellingsubdivision lots and condominium units. For this purpose, the official authorized so to do shallhave the authority to examine under oath the directors, officers, stockholders or members of anycorporation, partnership, association, cooperative or other persons associated or connectedwith the business and to issue subpoena or subpoena duces tecum in relation to anyinvestigation that may arise therefrom.

The Authority may also authorize the Provincial, City or Municipal Engineer, as the case maybe, to conduct an ocular inspection of the project to determine whether the development of saidproject conforms to the standards and specifications prescribed by the government.

The books, papers, letters, and other documents belonging to the person or entities hereinmentioned shall be open to inspection by the Authority or its duly authorized representative.


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Section 35. Take-over Development. The Authority, may take over or cause the developmentand completion of the subdivision or condominium project at the expenses of the owner ordeveloper, jointly and severally, in cases where the owner or developer has refused or failed todevelop or complete the development of the project as provided for in this Decree.

The Authority may, after such take-over, demand, collect and receive from the buyers theinstallment payments due on the lots, which shall be utilized for the development of thesubdivision.

Section 36. Rules and Regulations. The Authority shall issue the necessary standards, rulesand regulations for the effective implementation of the provisions of this Decree. Suchstandards, rules and regulations shall take effect immediately after their publication three timesa week for two consecutive weeks in any newspaper of general circulation.

Section 37. Deputization of law enforcement agencies. The Authority may deputize thePhilippine Constabulary or any law enforcement agency in the execution of its final orders,rulings or decisions.

Section 38. Administrative Fines. The Authority may prescribe and impose fines not exceedingten thousand pesos for violations of the provisions of this Decree or of any rule or regulationthereunder. Fines shall be payable to the Authority and enforceable through writs of execution inaccordance with the provisions of the Rules of Court.

Section 39. Penalties. Any person who shall violate any of the provisions of this Decree and/orany rule or regulation that may be issued pursuant to this Decree shall, upon conviction, bepunished by a fine of not more than twenty thousand (P20,000.00) pesos and/or imprisonmentof not more than ten years: Provided, That in the case of corporations, partnership,cooperatives, or associations, the President, Manager or Administrator or the person who hascharge of the administration of the business shall be criminally responsible for any violation ofthis Decree and/or the rules and regulations promulgated pursuant thereto.

Section 40. Liability of controlling persons. Every person who directly or indirectly controls anyperson liable under any provision of this Decree or of any rule or regulation issued thereundershall be liable jointly and severally with and to the same extent as such controlled person unlessthe controlling person acted in good faith and did not directly or indirectly induce the act or actsconstituting the violation or cause of action.

Section 41. Other remedies. The rights and remedies provided in this Decree shall be inaddition to any and all other rights and remedies that may be available under existing laws.

Section 42. Repealing clause. All laws, executive orders, rules and regulations or part thereofinconsistent with the provisions of this Decree are hereby repealed or modified accordingly.


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Section 43. Effectivity. This Decree shall take effect upon its approval.

Done in the City of Manila, this 12th day of July, in the year of Our Lord, nineteen hundred andseventy-six.


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Q&A No. 2018 – 12: PFRS 15 implementation issues affecting the realestate industry

SUMMARY OF THE IMPLEMENTATION ISSUES IDENTIFIED BY THE SPECIAL TASKFORCE

PFRS 15, Revenue from Contracts with Customers, is a complex Standard, introducing far moreprescriptive requirements than were previously included in PFRSs, and it may result insubstantial changes to revenue recognition policies for some entities. One of those industriesthat will be affected by PFRS 15 is the real estate industry. PFRS 15 requires the application ofsignificant judgment in some areas, but in other areas it is relatively prescriptive, allowing littleroom for judgment.

PFRS 15 is required to be applied for annual periods beginning on or after January 1, 2018, andit outlines a single comprehensive model for entities to use in accounting for revenue arisingfrom contracts with customers. The core principle is that an entity recognizes revenue to depictthe transfer of goods or services to customers in an amount that reflects the consideration towhich the entity expects to be entitled in exchange for those goods or services.

The new Standard focuses on the identification of performance obligations and distinguishesbetween performance obligations that are satisfied at a point in time and those that are satisfiedover time, which is determined by the manner in which control of goods or services passes tothe customer. This was the focus of the study conducted by the first special task force createdby the PIC. The first task force studied on the accounting issue on “Would the sale of aresidential property under pre-completion stage covered by a Contract to Sell (CTS) meet thecriteria for revenue recognition over time?” The study resulted to the issuance of PIC Q&A2016-04, which states that the sale of residential properties under pre-completion stage meetthe criteria under paragraph 35 (c) of PFRS 15, and therefore, revenue shall be recognized overtime.

Other specific topics on which more prescriptive requirements have been introduced by PFRS15 include:

1. The identification of a contract with a customer;2. The identification of distinct performance obligations and the allocation of the

transaction price between those obligations;


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3. Accounting for variable consideration and significant financing components;4. Recognition of revenue arising from licenses; and5. Presentation and disclosure of revenue from contracts with customers, and other

balances related to revenue.

Other changes also introduced include –1. The scope of PFRS 15 has been expanded to cover costs relating to contracts;

distinguishing between costs of obtaining a contract and costs of fulfilling a contract,and providing detailed guidance on when it is appropriate to capitalize such costs; and

2. Whereas PAS 11 provides specific requirements for accounting for constructioncontracts, such contracts are accounted for in accordance with the general principles ofPFRS 15.

Considering these other changes introduced by PFRS 15, a Special Task Force was againcreated by the Philippine Interpretations Committee (PIC) to study the implementation issuesaffecting the real estate industry. The below enumerated implementation issues are the focusof the study of the Special Task Force.

Requirement of the Standard Implementation Issues IdentifiedStep 1 – requires an entity to identify thecontract with the customer. A contract doesnot have to be written in order for it to meetthe criteria for revenue recognition; however,it does need to create enforceable rights andobligations.PFRS 15 provides detailed guidance on howto identify a contract.

What elements of a contract for a sale of realestate development would meet therequirements of PFRS 15?

Step 2 – requires an entity to identify thedistinct goods or services promised withinthe contract. Distinct goods or servicesshould be accounted for as separatedeliverables. These distinct goods or servicesare referred to as “performance obligations.”Specific guidance should be considered todetermine whether a good or service isdistinct.

What are the performance obligations in acontract to sell under both horizontal andvertical developments?


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Step 3 – requires an entity to determine thetransaction price for the contract. This will beaffected by a number of factors including: variable consideration; the extent to which the recognition of

variable consideration should beconstrained;

significant financing components within acontract, which will require an adjustmentfor the time value of money;

if non-cash consideration is received inexchange for transferring promisedgoods or service; and

if any consideration is payable to thecustomer as part of the transaction.

Would a mismatch between the Percentage-of-Completion (POC) and schedule ofpayments constitute a significant financingcomponent in determining the transactionprice given the following scenarios:

i. Higher payment (buyer pays ahead of thepercentage of completion); and

ii. Lower payment (percentage of completionis ahead of the buyer’s payment).

Step 4 – requires an entity to allocate thetransaction price determined in Step 3 to theperformance obligations identified in Step 2.PFRS 15 requires this allocation to be basedon the stand-alone selling price of eachperformance obligation.

In relation to Step 2 –How should the transaction price beallocated among performance obligations, ifapplicable?

Step 5 – specifies how an entity shoulddetermine when to recognize revenue inrelation to a performance obligation, andwhether that revenue should be recognizedat a point in time or over a period of time.PFRS 15 focuses on when control of the goodor service passes to the customer, which maybe over time or at a point in time.

1. What is the appropriate measure ofprogress to be used in the revenuerecognition of the real estate developer?

2. How should the following elements beconsidered in measuring the progress ofsatisfying the performance obligation?

i. Land element

ii. Connection fees

iii. Borrowing costs

iv. Materials delivered on site but notyet installed

v. Developer-supplied materials

vi. Common amenities/area


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3. How should the real estate developeraccount for the benefits given to salesagents?

4. How should the real estate developeramortize the capitalized incrementalcosts of obtaining a contract?

Another issue identified by the Task Force is as follows – Is the real estate developer acting as a principal or agent in goods and services that it

delivers based on contract of lease with the tenants?

The consensus presented in this paper does not cover any tax implications.


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Q&A No. 2018-12- A

STEP 1 – Requires an Entity to Identify the Contract with the Customer.

Issue

What elements of a contract for a sale of a real estate development would meet therequirements of PFRS 15?

Background

In a real estate business, there are three (3) main contracts that the developer and the buyerhave to execute; these are the reservation agreement, the contract to sell and the deed ofabsolute sale.

Reservation agreement refers to an agreement whereby the buyer manifests his intention andoffers to purchase from the seller a specific property and requests that property to be reservedfor his purchase. This agreement gives the buyer a certain period, normally thirty (30) calendardays from payment of reservation fee, to proceed with the purchase. The amount of reservationfee is only minimal and normally non-refundable.

The obligation of the seller is to reserve a specific property for the buyer’s purchase within acertain period in exchange for a reservation fee. The buyer is not obliged to pay the totalcontract price of the property reserved for him and may cancel his reservation without theconsent of the seller. Should the buyer decide to cancel his reservation, the reservation fee willbe forfeited by the seller.

However, should the buyer decide to proceed with his purchase, a contract to sell with the sellerwill be executed upon payment of the down payment and a deed of absolute sale upon fullpayment of the purchase price.

PFRS 15 paragraph 6 states that, “an entity shall apply this standard to a contract (other than acontract listed in paragraph 5) only if the counterparty is a customer. A customer is party thathas contracted with an entity to obtain goods or services that are an output of the entity’sordinary activities in exchange for consideration.”


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Based on the above paragraph, it is a revenue contract if the customer obtains goods or servicesthat are an output of an entity’s ordinary activities. In the case of a developer, its normal outputis the real estate property.

In addition, PFRS 15 appendix A defines a contract as an agreement between two or moreparties that creates enforceable rights and obligations. The standard-setter decided tocomplement this

definition by specifying criteria that must be met before an entity can apply the revenuerecognition model. These criteria would be assessed at contract inception and would not bereassessed unless there is an indication that there has been a significant change in facts andcircumstances.

PFRS 15 paragraph 9 enumerates the following criteria:

a) The parties to the contract have approved the contract (in writing, orally or in accordancewith other customary business practices) and are committed to perform theirobligations;

This criterion is relevant to make the contract enforceable.

b) The entity can identify each party’s rights regarding the goods or services to betransferred;

This is relevant to assess the transfer of goods.

c) The entity can identify the payment terms for the goods or services to be transferred;

This is relevant to determine the transaction price.

d) The contract has commercial substance (i.e., the risk, timing or amount of the entity’sfuture cash flows is expected to change as a result of the contract); and

This is relevant to avoid the artificial inflation of revenue.

e) It is probable that the entity will collect the consideration to which it will be entitled inexchange for the goods or services that will be transferred to the customer. Inevaluating whether collectability of an amount of consideration is probable, an entityshall consider only the customer’s ability and intention to pay that amount ofconsideration when it is due. The amount of consideration to which the entity will be


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entitled may be less than the price stated in the contract if the consideration is variablebecause the entity may offer the customer a price concession.

This is relevant because customer’s credit risk is an important part to determine whethera contract is valid. This is a consequence of the standard-setter’s decision thatcustomer’s credit risk should not affect the measurement or presentation of revenue.

PFRS 15 paragraph 14 requires that if a contract with a customer does not meet the criteria inparagraph 9, an entity shall continue to assess the contract to determine whether the criteria inparagraph 9 are subsequently met.

PFRS 15 paragraph 15 requires that when a contract with a customer does not meet the criteriain paragraph 9 and an entity receives consideration from the customer, the entity shallrecognize the consideration received as revenue only when either of the following events hasoccurred:

a) The entity has no remaining obligations to transfer goods or services to the customerand all, or substantially all, of the consideration promised by the customer has beenreceived by the entity and is non-refundable; or

b) The contract has been terminated and the consideration received from the customer isnon-refundable.

PFRS 15 paragraph 16 requires that an entity shall recognize the consideration received from acustomer as a liability until one of the events in paragraph 15 occur or until the criteria inparagraph 9 are subsequently met.

Article 1403(2)(e) of the Civil Code of the Philippines requires that sale of real property or of aninterest therein to be in writing and subscribed by the party charged, or by his agent.

Consensus

PFRS 15 paragraph 9 and Article 1403(2) (e) of the Civil Code enumerates the criteria for a validrevenue contract.

The reservation agreement will not meet the foregoing criteria, particularly letters (b) to (e),because the object of this agreement is the reservation right given by the developer to the buyerand not the property itself. Hence, the buyer is not obliged to pay the contract price of the


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property. In this case, the reservation fee will be initially recorded as a deposit from a customeror a liability and subsequently will be recognized as revenue either when the futureperformance obligation is transferred or when the reservation fee is forfeited. That is, if thecustomer proceeds with the purchase, the reservation fee will become part of the considerationfor the purchase of the real estate property.

The contract to sell will meet the foregoing criteria because the object is the property itself,which is the normal output of a real estate business. In addition, this contract containsinformation such as the contracting parties’ rights and payment terms, which are essentialelements for a valid revenue contract. However, this contract must be signed by the contractingparties to make it enforceable prior to revenue recognition. Also, the developer must assessthe commercial substance of the contract and the probability that it will collect theconsideration.

However, a valid revenue contract is not limited to a contract to sell. The developer mayconsider other documents, provided these will meet the foregoing criteria.

Q&A No. 2018-12-B

STEP 2 – Requires an Entity to Identify the Distinct Goods or Services Promised within theContract (Horizontal Development)

Issues

What are the performance obligations in the following contracts to sell?

i. Contract to sell serviced lot only

ii. Contract to sell serviced lot and house

Background

a) In the Philippines, real estate developers usually purchase bare land which previouslyhas not been developed and is consequently not connected to any infrastructure (roads,utilities, etc.). In order to sell these blocks of land, developers typically divide a block ofland into separate plots and sell together with the promise to develop the infrastructure


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necessary to service all the plots. Such transactions are referred to as sale of “servicedland or lot” of a subdivision project.

b) Under Presidential Decree (PD) 9571, the developer shall submit its subdivision plans forapproval to the National Housing Authority (Authority) in accordance with SubdivisionStandards and Regulation, which the latter will then submit to the Director of Lands forfurther approval in accordance with the procedure prescribed in Section 44 of the LandRegistration Act (Act No. 496, as amended by R.A. No. 440).

c) PD 12162 requires that a subdivision should provide road, alleys, sidewalks and reservedopen space for parks and recreational use, as may be deemed suitable to enhance thequality of life of the residents therein.

d) The approved subdivision plan shall not be altered or changed without the permissionof the Authority and the written conformity or consent of the duly organizedhomeowner’s association, or in the absence of the latter, by the majority of the lotbuyers in the subdivision.

e) The infrastructure constructed in the serviced land, as detailed in the approvedsubdivision plans, includes earthworks, concrete (includes road works), drainage andsewer systems, water distribution system, electricity system, perimeter fencing, gateand guardhouse among others (collectively referred to as land development).

f) The serviced land of a subdivision project may also include the construction of clubhouse, playground, swimming pool and commercial facilities depending on the projectplan.

g) Depending on the construction plan, size of the bare land and the sales take-up, the landdevelopment of a serviced lot usually takes two (2) to five (5) years to complete.

h) While the subdivision project is still in the pre-completion stage (i.e., construction ofland development is on-going or has not yet commenced), developers would enter intoContracts to Sell (CTS) with buyers. The developer has the following types of CTS.

1. Contract to sell serviced lot only (CTS-L). The CTS-L specifies the lot and blocknumbers of the lot and the lot area with the selling price specified. At a later date,the buyer can have a house constructed on his own or the developer can

1 PRESIDENTIAL DECREE NO. 957, Subdivision and Condominium buyer's Protective Decree asamended by P.D. 1216), REGULATING THE SALE OF SUBDIVISION LOTS AND CONDOMINIUMS,PROVIDING PENALTIES FOR VIOLATIONS THEREOF2 PRESIDENTIAL DECREE No. 1216, DEFINING "OPEN SPACE" IN RESIDENTIAL SUBDIVISIONS ANDAMENDING Sec. 31 OF PRESIDENTIAL DECREE NO. 957 REQUIRING SUBDIVISION OWNERS TOPROVIDE ROADS, ALLEYS, SIDEWALKS AND RESERVE OPEN SPACE FOR PARKS ORRECREATIONAL USE


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construct the house. In case of the latter, the house construction is covered by aseparate contract.

2. Contract to sell serviced lot and house (CTS-HL). The CTS-HL specifies the lotand block numbers of the lot and the house model to be constructed. The CTS-HL also contains the lot and floor areas; and attached in it are the plans andspecifications of the house model selected by the customer from the variousmodels available for the specific lot size. The CTS-HL specifies one selling pricefor the house and lot.

Consensus

Based on the above fact pattern, the performance obligations of the developer are determinedas follows:

i. Contract to sell (CTS) serviced lot only – There is only one performance obligation underthe CTS. The developer’s obligation is to deliver the “serviced lot” as described above. Thedeveloper integrates the plots it sells with the associated infrastructure to be able to transferthe serviced land promised in the contract. The subsequent construction of the housewithin the serviced lot will give rise to a separate contract if the buyer commissions thedeveloper to perform such activity.

ii. Contract to sell (CTS) serviced lot and house – There is only one performance obligationunder the CTS. The developer has the obligation to deliver the house duly constructed in aspecific lot and fully integrated into the serviced land in accordance with the approved plan.

Accordingly, in response to issue under Step 4, no allocation of transaction price is necessaryas each of the CTS involves a single performance obligation.

Discussion

A performance obligation is a promise in a contract with a customer to transfer to thecustomer either:

a) a good or service (or a bundle of goods or services) that is distinct; or

b) a series of distinct goods or services that are substantially the same and that have thesame pattern of transfer to the customer.

A good or service is distinct if (i) the customer can benefit from the good or service on its owntogether with other resources that are readily available to the customer, and (ii) the entity’spromise to transfer the good or service to the customer is separately identifiable from otherpromises in the contract [PFRS 15, paragraph 27).


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Factors that indicate that an entity's promise to transfer a good or service to a customer isseparately identifiable (in accordance with paragraph 27(b)) include, but are not limited to, thefollowing factors. Analysis of how the factors apply to the above contracts is shown below:

Factors Considered Analysis

(a) the entity does not provide a significantservice of integrating the good orservice with other goods or servicespromised in the contract into a bundleof goods or services that represent thecombined output for which thecustomer has contracted. In otherwords, the entity is not using the goodor service as an input to produce ordeliver the combined output specifiedby the customer.

In both CTS above, the developer performssignificant activities of land development inaccordance with the approved subdivisionplan. This includes, but is not limited to,provision of drainage, sewerage, water andelectricity system which integrates thecommon areas and saleable lots. Thesedevelopment activities however, are notdistinct promises but rather necessary andrequired inputs relative to the developer’spromise to deliver the serviced lot for CTS-Land house and lot for CTS-HL.

For CTS-L, the developer integrates the landplot it sells with the infrastructure/landdevelopment to be able to transfer the“serviced lot” promised in the CTS.

For CTS-HL, the developer integrates the lot,land development and the house as promisedin the CTS. This includes further activities suchas excavation for the foundation of the houseand the integration of the sewerage, drainage,water and electric system embedded in the lotinto the structure of the house.

(b) the good or service does not significantlymodify or customize another good orservice promised in the contract.

For CTS-L, the developer’s promise is todeliver the serviced lot only which isintegrated into a fully developed land, basedon the approved plan. Without integrating thespecific lot to the entire land development, thiswill not render the lot available for future useas specified in the contract. From theperspective of the buyer, the lot should beready either for house construction (which is


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not part of the promise under the contract) orfor sale to other parties in the future.

For CTS-HL, the main activity of the developeris to build a house based on agreedspecifications in a lot which is integrated intoa fully developed land. The construction of thehouse per se, without integrating it to the lotthrough excavation and connection of lotdevelopment will render the house untenableand not decent for human settlement becauserunning water, ready electricity and sanitaryconsiderations will not be available. Thus, theintegration of the house piping and systemsbuilt in the foundation and structure of thehouse into the developed lot modifies andcustomizes the house significantly into alivable space. The combined output of the lot,land development and house constructionenables the provision for a decent humansettlement, which is the intended output ofPD 957.

(c) the good or service is not highlydependent on, or highly interrelatedwith, other goods or services promisedin the contract. For example, the factthat a customer could decide to notpurchase the good or service withoutsignificantly affecting the otherpromised goods or services in thecontract might indicate that the good orservice is not highly dependent on, orhighly interrelated with, those otherpromised goods or services

Please see analysis in (b)

For CTS-L, the customer is actually buying aserviced lot which is integrated into a fullydeveloped land in accordance with theapproved plan. There is no option for thecustomer to buy a lot without the landdevelopment as this will be inconsistent withthe plan and CTS.

For CTS-HL, the customer is expecting thedeveloper to deliver the house dulyconstructed in a specified lot which isintegrated into a fully developed land. Clearly,the lot is a critical input in the houseconstruction while the land development willmake the house ready for use by the customer.Likewise, the CTS does not give the customeroption to exclude any components as this will


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render the main promise to deliver the houseinconsistent with terms of the CTS.

Revenue recognitionUnder Philippine Interpretation Committee (PIC) Q&A No. 2016-04, sale of residential propertiesunder pre-completion contracts, which includes sale of serviced lots and serviced lot and house,meet the criteria under paragraph 35(c) of PFRS 15; and therefore revenue is recognized overtime.


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Q&A No. 2018-12-C

STEP 2 – Requires an Entity to Identify the Distinct Goods or Services Promised within theContract (Vertical Development)

Issue

What are the performance obligations in the contract to sell a condominium unit?

Backgrounda) In the Philippines, real estate developers usually purchase bare land or land with

existing structures and develops or converts it into a residential condominium building(i.e., low rise, mid-rise or high rise vertical development).

b) Under Presidential Decree (PD) 9573, the developer shall submit its condominium plansfor approval to the National Housing Authority (Authority) in accordance withSubdivision Standards and Regulation and National Building Code (Republic Act (RA)No. 6541), which the latter will then submit to the Director of Lands for further approvalin accordance with the procedure prescribed in Section 4 of the Condominium Act (RANo. 4726).

c) The Implementing Rules and Regulations of PD 957 requires that a residentialcondominium building should provide access roads, parks and playground which couldintegrate other facilities such as swimming pool, tennis court, etc., basic facilities andservices such as service area, water supply, power, sewerage and drainage utilities andgarbage disposal. Such improvements in the condominium building are referred to as“common service area and facilities”.

d) The approved condominium plan shall not be altered or changed without the permissionof the Authority and the written conformity or consent of the duly organizedcondominium corporation, or in the absence of the latter, by the majority of the lotbuyers in the condominium.

3 PRESIDENTIAL DECREE NO. 957, Subdivision and Condominium buyer's Protective Decree asamended byP.D. 1216), REGULATING THE SALE OF SUBDIVISION LOTS AND CONDOMINIUMS, PROVIDINGPENALTIES FOR VIOLATIONS THEREOF


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e) Depending on the construction plan, size of the bare land and the sales take-up, theconstruction of the condominium usually takes two (2) to five (5) years to complete.

f) While the condominium project is still in the pre-completion stage (i.e., construction ofland development is on-going or has not yet commenced), developers would enter intoContracts to Sell (CTS) with buyers. The CTS specifically identifies the promisedproperty by its floor and unit number.

Consensus

There is only one performance obligation in the contract to sell a condominium unit. Thedeveloper has the obligation to deliver the specific unit with common service area and facilitiesavailable to the customer.

Accordingly, in response to issue under Step 4, no allocation of transaction price is necessaryas the CTS involves a single performance obligation.

Discussion

A performance obligation is a promise in a contract with a customer to transfer to thecustomer either:

a) a good or service (or a bundle of goods or services) that is distinct; or

b) a series of distinct goods or services that are substantially the same and that have thesame pattern of transfer to the customer.

A good or service is distinct if (i) the customer can benefit from the good or service on its owntogether with other resources that are readily available to the customer and (ii) the entity’spromise to transfer the good or service to the customer is separately identifiable from otherpromises in the contract [PFRS 15, paragraph 27).

Factors that indicate that an entity's promise to transfer a good or service to a customer isseparately identifiable (in accordance with paragraph 27(b)) include, but are not limited to, thefollowing factors. Analysis of how the factors apply to the CTS is shown below:

Factors Considered Analysis

(a) the entity does not provide a significantservice of integrating the good orservice with other goods or services

In the CTS above, the developer performssignificant activities of land development inaccordance with the approved condominium


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promised in the contract into a bundleof goods or services that represent thecombined output for which thecustomer has contracted. In otherwords, the entity is not using the goodor service as an input to produce ordeliver the combined output specifiedby the customer.

plan. The developer integrates the buildinginto the bare land, together with otheramenities such as water and power supplies,access to common areas, sewerage anddrainage utilities and garbage disposal tomake the condominium unit tenable. Thecommon service areas and facilities and otheractivities while capable of being distinct, arenot accounted for separately as it would notresult in a faithful depiction of the developer’spromise under the contract. The landdevelopment, building construction and allamenities form part of the input to the ultimatepromise to deliver the condominium unit tothe customer.

(b) the good or service does not significantlymodify or customize another good orservice promised in the contract.

The developer provides a service ofintegrating the lot, the specific unit in thecondominium building and common servicearea and facilities as promised in the CTS. Theconstruction of the condominium building perse, without integrating it to the lot throughexcavation and connection of lot developmentwill render the condominium building andcommon service area and facilities unusableand not decent for human settlement becauserunning water, ready electricity and sanitaryconsiderations will not be available.

(c) the good or service is not highlydependent on, or highly interrelatedwith, other goods or services promisedin the contract. For example, the factthat a customer could decide to notpurchase the good or service withoutsignificantly affecting the otherpromised goods or services in thecontract might indicate that the good orservice is not highly dependent on, orhighly interrelated with, those otherpromised goods or services

Please see analysis in (b)

The buyer is bound by the CTS to buycondominium unit specified in the CTStogether with its share in the plot of land andcommon service area and facilities and will nothave the option to take out any of the promisesin the CTS.

Q&A No. 2018-12-D


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STEP 3 – Requires an Entity to Determine the Transaction Price for the Contract

Issue

Would a mismatch between the Percentage-of-Completion (POC) and schedule of paymentsconstitute a significant financing component in determining the transaction price given thefollowing scenarios:

i. Higher payment (buyer pays ahead of the percentage of completion); andii. Lower payment (percentage of completion is ahead of the buyer’s payment).

Background

A real estate developer recognizes revenue over time using the percentage of completion(POC) method. Under this method, the Developer satisfies its performance obligation to delivera “portion” of the property to the Customer over time, thus the recognition of revenue. ThePOC is expressed in percentage (%) based on the progress of the construction which iscomputed on a consistent basis in accordance with the accounting policy of the Developer.

Now, given that the Developer offers different payment schemes to its Customers, the patternof collection of these periodic payments may significantly be different from the POCpercentage computed at any given time (i.e., end of the reporting period). These circumstanceswhere the Customer’s payment of the transaction price does not coincide with the POCpercentage of the Project gives rise to possibility of significant financing either by the Customerto the Developer or vice versa. Should contracts from Customers encompass a significantfinancing component, a portion of the transaction price is regarded as interest income orinterest expense.

Paragraph 60 of PFRS 15 states that, “In determining the transaction price, an entity shall adjustthe promised amount of consideration for the effects of the time value of money if the timingof payments agreed to by the parties to the contract (either explicitly or implicitly) provides thecustomer or the entity with a significant benefit of financing the transfer of goods or servicesto the customer. In those circumstances, the contract contains a significant financingcomponent. A significant financing component may exist regardless of whether the promiseof financing is explicitly stated in the contract or implied by the payment terms agreed to bythe parties to the contract.”


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Under paragraph 61 of PFRS 15, “The objective when adjusting the promised amount ofconsideration for a significant financing component is for an entity to recognize revenue at anamount that reflects the price that a customer would have paid for the promised goods orservices if the customer had paid cash for those goods or services when (or as) they transfer tothe customer (i.e., the cash selling price). An entity shall consider all relevant facts andcircumstances in assessing whether a contract contains a financing component and whetherthat financing component is significant to the contract, including both of the following:

(a) the difference, if any, between the amount of promised consideration and the cashselling price of the promised goods or services; and,

(b) the combined effect of both of the following:

(i) the expected length of time between when the entity transfers the promisedgoods or services to the customer and when the customer pays for those goodsor services; and

(ii) the prevailing interest rates in the relevant market.”

In addition, paragraph 63 provides that, “As a practical expedient, an entity need not adjust thepromised amount of consideration for the effects of a significant financing component if theentity expects, at contract inception, that the period between when the entity transfers apromised good or service to a customer and when the customer pays for that good or servicewill be one year or less.”

However, paragraph 62 of PFRS 15 states that, “Notwithstanding the assessment in paragraph61, a contract with a customer would not have a significant financing component if any of thefollowing factors exist:

(a) the customer paid for the goods or services in advance and the timing of the transfer ofthose goods or services is at the discretion of the customer.

(b) a substantial amount of the consideration promised by the customer is variable and theamount or timing of that consideration varies on the basis of the occurrence or non-occurrence of a future event that is not substantially within the control of the customeror the entity (for example, if the consideration is a sales-based royalty).

(c) the difference between the promised consideration and the cash selling price of thegood or service (as described in paragraph 61) arises for reasons other than theprovision of finance to either the customer or the entity, and the difference betweenthose amounts is proportional to the reason for the difference. For example, the


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payment terms might provide the entity or the customer with protection from the otherparty failing to adequately complete some or all of its obligations under the contract.”

Consensus

I. Higher payment (buyer pays ahead of the percentage of completion) – when series ofregular payments are made by the buyer which are ahead of the percentage ofcompletion and the difference between the timing of payment and the satisfaction ofthe performance obligation is more than one year, there is significant financingcomponent without predisposition of the circumstances under PFRS 15 paragraph 62.Under these cases, it is proper for the seller to recognize an interest expense becausethe buyer is ‘as if’ financing the seller by paying more than the amount of satisfiedperformance obligation.

See Annex ‘A’ attached hereto, showing the illustration under “Higher payment (buyerpays ahead of the percentage of completion)”.

II. Lower payment (percentage of completion is ahead of the buyer’s payment) – when thepercentage of completion is ahead of the regular payments made by the buyer (e.g.,POC is 45% but customer pays 20%) and the difference between the timing of paymentand the satisfaction of the performance obligation is more than one year, there issignificant financing component without predisposition of the circumstances underPFRS 15 paragraph 62. For this case, it is proper for the seller to recognize an interestincome because the seller is ‘as if’ financing the buyer by paying less than the amountof satisfied performance obligation.

See Annex ‘B’ attached hereto, showing the illustration under “Lower payment(percentage of completion is ahead of the buyer’s payment)”


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Annex A

Higher payment (buyer pays ahead of the percentage of completion)

Illustration

For purposes of this illustration, assume the following:

Contractinception

1 January 1, 2017 4,000,000December 31, 2021 -Php5,000,000 in installment -Php4,000,000 at the inception of the contract

-

Completion Date

Payment Options

Milestones Year 3Expected Milestones Actual Milestones

For the Year CumulativeFor theYear

Cumulative

2017 20.00% 20.00% 22.00% 22.00%2018 15.00% 35.00% 20.00% 42.00%2019 25.00% 60.00% 25.00% 67.00%2020 30.00% 90.00% 23.00% 90.00%2021 10.00% 100.00% 10.00% 100.00% Total 100.00% 100.00%

Assumptions:1. Unless otherwise stated, the entity concludes that the contract contains a significant

financing component because of the effect of both the length of time between when thecustomer pays for the asset and when the entity transfers the asset to the customer, andthe prevailing interest rates in the market.

2. The borrowing rate is 4.15 % which is judged to be consistent with a rate that would bereflected in a separate financing transaction between the entity and its customer. The entityuses the rate that would reflect the credit characteristics of the party receiving financing inthe contract as well as any collateral or security provided by the customer or the entity,including assets transferred in the contract as prescribed in PFRS 15.64.


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3. The expected milestone of the entity is used as basis of determining the transaction priceat the inception of the contract.

Transaction Price if Spot Cash

Borrowing Rate 2 4.15%

Year Principal,Beg

Interestexpense

Assumedpayments based

on expectedmilestones

Principal, End

2017 Php4,000,000Php166,00

0 Php800,000 Php3,200,0002018 3,200,000 132,800 600,000 2,600,0002019 2,600,000 107,900 1,000,000 1,600,0002020 1,600,000 66,400 1,200,000 400,0002021 400,000 16,600 400,000 -Total 489,700 4,000,000

Transaction Price Php4,489,700

Note: Effectively, the advance payment is paid by the developer as it satisfies theperformance obligation, including the interest expense.

Calculation of POC Revenue based on Actual Milestones

Year POC Revenue2017 Php987,7342018 897,9402019 1,122,4252020 1,032,6312021 448,970 Total Php4,489,700


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Sample Pro-forma Journal EntriesNature Cash

Dr(Cr)

Contract

Liability

Dr(Cr)

Interest

Expense

Dr(Cr)

Revenue

Dr(Cr)

2017

To record cash advancereceived Php4,000,000 (Php4,000,000) Php- Php-

To record interest expense - (166,000) 166,000 -

To record revenue - 987,734 - (987,734)

Total at December 31, 2017 4,000,000 (3,178,266) 166,000 (987,734)

2018



Total at December 31, 2018 (2,413,126) 132,800 (897,940)

2019


To record revenue - 1,122,425 - (1,122,425)

Total at December 31, 2019 - (1,398,601) 107,900 (1,122,425)

2020


To record revenue - 1,032,631 - (1,032,631)

Total at December 31, 2020 - (432,370) 66,400 (1,032,631)

2021



Total at December 31, 2021 - - 16,600 (448,970)


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Total Php4,000,000 Php- Php489,700 (Php4,489,700)

Annex B

Lower payment (percentage of completion is ahead of the buyer’s payment)

Illustration

For purposes of this illustration, assume the following:Contract inception 1 January 1, 2017

4,000,000Completion Date December 31, 2021

-Payment Options Php5,000,000 in installment

-Php4,000,000 at the inception of the contract

-

MilestonesYear 3 Expected Milestones Actual Milestones

For the Year Cumulative For the Year Cumulative2017 20.00% 20.00% 22.00% 22.00%2018 15.00% 35.00% 14.00% 36.00%2019 25.00% 60.00% 25.00% 61.00%2020 30.00% 90.00% 25.00% 86.00%2021 10.00% 100.00% 14.00% 100.00% Total 100.00% 100.00%

Assumptions:1. Unless otherwise stated, the entity concludes that the contract contains a significant

financing component because of the effect of both the length of time between when thecustomer pays for the asset and when the entity transfers the asset to the customer, andthe prevailing interest rates in the market.

2. The lending rate is 5.33 % which is judged to be consistent with a rate that would bereflected in a separate financing transaction between the entity and its customer. The entityuses the rate that would reflect the credit characteristics of the party receiving financing inthe contract as well as any collateral or security provided by the customer or the entity,


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including assets transferred in the contract as prescribed in PFRS 15.64.

3. The expected milestone of the entity is used as basis of determining the transaction priceat the inception of the contract.

Transaction price Php4,651,699

Lending Rate 2 5.33%

Year Expected revenuebased on expected

milestones

Collection InterestIncome

OutstandingBalance

2017 Php930,340 Php625,000 Php- Php305,3402018 697,755 125,000 16,272 894,3672019 1,162,925 125,000 47,663 1,979,9552020 1,395,509 125,000 105,517 3,355,9812021 465,170 4,000,000 178,849 -Total Php4,651,699 Php5,000,000 Php348,301

Note: Transaction price is the present value of the installment payments discounted to the datethe entity expects to satisfy its performance obligation (i.e., based on the expected milestones).Assumes that there is no interest on the first year as payment is made at the end of the year,and that revenue is only earned at the end of the year.

Calculation of POC Revenue based on Actual Milestones

Year POC Revenue2017 Php1,023,3742018 651,2382019 1,162,9252020 1,162,9242021 651,238Total Php4,651,699

Revised amortization table in Year 2


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Transaction price Php4,651,699Lending Rate 5.33%

Year Expected revenue basedon revised expected

milestones below

Collection Interestincome

OutstandingBalance

2017 Php1,023,374 Php625,000 Php- Php398,3742018 651,238 125,000 2,972 927,5842019 1,255,959 125,000 49,433 2,107,9762020 1,348,992 125,000 112,340 3,444,3082021 372,136 4,000,000 183,556 -Total Php4,651,699 Php5,000,000 Php348,301

Assume expected milestones are revised as follows:2017 (actual)2018 (actual)

201920202021Total

22.00%14.00%27.00%29.00%8.00%

100.00%

Note: Amortization table has to be revised since the expected milestone at the start of thecontract was not realized. As the previous amortization table was based on those expectedmilestones, the ending outstanding balance will no longer zero out if the table is not updated.Note that underPFRS 15, the initial interest rate should not be changed. This means that there has to be a catch-up adjustment in Year 2 in order to preserve the initial interest rate and initial interest incomeas required by PFRS 15.


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Transaction price 4,651,699Lending Rate 5.33%

Year Expected revenuebased on revised

expected milestonesbelow


OutstandingBalance


Assume expected milestones are revised as follows:2017 (actual) 22.00%2018 (actual) 14.00%2019 (actual) 25.00%

2020 24.00%2021 15.00%Total 100.00%



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OutstandingBalance


Assume expected milestones are revised as follows:2017 (actual) 22.00%2018 (actual) 14.00%2019 (actual) 25.00%2020 (actual) 23.00%

2021 16.00%Total 100.00%



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OutstandingBalance


Assume expected milestones are revised as follows:

2017 (actual) 22.00%2018 (actual) 14.00%2019 (actual) 25.00%2020 (actual) 25.00%2021 (actual) 14.00%

Total 100.00%



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Sample Pro-Forma Journal EntriesNature Cash

Dr(Cr)

ContractAssetDr(Cr)

ContractRevenue

Dr(Cr)

InterestIncomeDr(Cr)

2017

To record revenue Php- Php1,023,374 (Php1,023,374) Php-

To record collection 625,000 (625,000) -

Total at December 31, 2017 625,000 398,374 (1,023,374) -

2018

To record revenue 651,238 (651,238) -

To record interest - 2,972 - (2,972)


Total at December 31, 2018 750,000 927,584 (651,238) (2,972)

2019

To record revenue - 1,162,925 (1,162,925) -



Total at December 31, 2019 875,000 2,035,291 (1,162,925) (69,782)

2020

To record revenue - 1,162,924 (1,162,924) -



Total at December 31, 2020 1,000,000 3,184,035 (1,162,924) (110,820)

2021

To record revenue - 651,238 (651,238) -


To record collection 4,000,000 (4,000,000) - -

Total at December 31, 2021 5,000,000 - (651,238) (164,727)

Total Php5,000,000 Php- (Php4,651,699) (Php348,301)


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Q&A No. 2018-12-E

STEP 5 – Specifies How an Entity Should Determine When to Recognize Revenue in Relationto a Performance Obligation (Measurement of Progress)

Issues

a. What is the appropriate measure of progress to be used in the revenue recognition of thereal estate developer?

b. How should the following elements be considered in measuring the progress of theperformance obligation?

i. Land element

ii. Connection fees

iii. Borrowing costs

iv. Materials delivered on site but not yet installed

v. Common amenities/area

Background

A real estate developer enters into contracts with customers for the construction and saleof any of the following real estate units:

a) units in a high-rise building which can be for office or residential use

b) serviced lot

c) serviced lot and house

The real estate developer has concluded that each contract above is a single performanceobligation and that revenue is to be recognized over time in accordance with PFRS 15.35(c).

A real estate developer would usually engage a project manager (can be an internal orexternal party) who works closely with the contractors, subcontractors, suppliers, architectsand engineers, among others, to ensure that the progress of the development is based onplan. The project manager will collate progress reports from various contractors andsubcontractors based on the bill of quantity for the labor, overhead and materials provided.For vertical developments, the progress of work is monitored based on major activities such


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as general construction, architecture, plumbing, electrical and sewerage. For horizontaldevelopments, the progress of work is broken into progress of work of the landdevelopment and house construction. The land development is monitored based on majoractivities such as land clearing, drainage, plumbing, guard house and fencing whilemonitoring of house construction is similar to that of vertical developments. These majoractivities are assigned with weight percentages based on the estimated cost of an activityover the total estimated cost of the project. These are summarized by the project managerto determine the overall progress of work.

The accounting department of the real estate developer has its monitoring of cost incurredto date. This process would require strict coordination between the construction site andthe accounting department in determining the actual costs incurred.

Other elements of the real estate development also include:

a) Land - this is the cost of land on which the real estate development will beconstructed

b) Connection Fees - these are fees paid to utility providers for the connection of thestructure/building to the source of electricity and water.

c) Borrowing costs - these are finance costs incurred for loans obtained to developthe property.

d) Materials delivered on-site but uninstalled - materials are delivered on site, suchas steels and rebars, elevators and escalators, which are yet to beinstalled/attached to the main structure.

The real estate developer, as part of its promised performance obligation to the customer,also constructs common service areas, facilities, and amenities (common areas/facilities)such as club house, swimming pool, playground, and sports facilities which are shared byunit owners of the real estate development.

The real estate developer retains legal title to the real estate unit (and any land attributed toit) until construction is complete. The contract gives the customer a right to the real estateunit under construction. The customer can resell or pledge the right as the real estate unitis being constructed, subject to the real estate developer performing a credit risk analysisof the new buyer of the right (if the customer has not paid the entire purchase price of theunit).

Consensus

a. The real estate developer may use either output method or input method in measuring theprogress of the performance obligation provided that the method selected faithfully depicts


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the entity’s performance in transferring control of the real estate development. The methodselected should be consistent for each performance obligation identified.

b. The assessment on how the following elements are treated in the measurement of progressfollow:i. Land element – excluded

ii. Connection fees – excluded

iii. Borrowing cost – excluded

iv. Materials delivered on-site but not yet installed – excluded

v. Common amenities/area – included

Discussion

a. When an entity has determined that a performance obligation is satisfied over time, thestandard requires the entity to select a single revenue recognition method for the relevantperformance obligation that faithfully depicts the entity’s performance in transferringcontrol of the goods or services.

Paragraphs 41 - 43 of PFRS 15 state that, “Appropriate methods of measuring progressinclude output methods and input methods. Paragraphs B14–B19 provide guidance forusing output methods and input methods to measure an entity's progress towardscomplete satisfaction of a performance obligation. In determining the appropriatemethod for measuring progress, an entity shall consider the nature of the good or servicethat the entity promised to transfer to the customer.

When applying a method for measuring progress, an entity shall exclude from themeasure of progress any goods or services for which the entity does not transfer controlto a customer. Conversely, an entity shall include in the measure of progress any goodsor services for which the entity does transfer control to a customer when satisfying thatperformance obligation.

As circumstances change over time, an entity shall update its measure of progress toreflect any changes in the outcome of the performance obligation. Such changes to anentity's measure of progress shall be accounted for as a change in accounting estimatein accordance with PAS 8 Accounting Policies, Changes in Accounting Estimates andErrors.”

While the standard requires an entity to update its estimate related to the measure ofprogress selected, it does not permit a change in method. According to BC161 of PFRS15, “The boards decided that an entity should apply the selected method for measuring


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progress consistently for a particular performance obligation and also across contractsthat have performance obligations with similar characteristics. An entity should not usedifferent methods to measure its performance in satisfying the same or similarperformance obligations, otherwise that entity's revenue would not be comparable indifferent reporting periods. The boards also noted that if an entity were permitted toapply more than one method to measure its performance in fulfilling a performanceobligation, it would effectively bypass the requirements for identifying performanceobligations.”

Based on the above provisions of PFRS 15, a performance obligation is accounted forusing the method the entity selects (i.e., either the specific input or output method it haschosen) from inception until the performance obligation is fully satisfied.

Output methods

Output methods recognize revenue on the basis of direct measurements of the value tothe customer of the goods or services transferred to date relative to the remaining goodsor services promised under the contract. Output methods include methods such assurveys of performance completed to date, appraisals of results achieved, milestonesreached, time elapsed and units produced or units delivered. When an entity evaluateswhether to apply an output method to measure its progress, the entity shall considerwhether the output selected would faithfully depict the entity's performance towardscomplete satisfaction of the performance obligation. An output method would notprovide a faithful depiction of the entity's performance if the output selected would failto measure some of the goods or services for which control has transferred to thecustomer. For example, output methods based on units produced or units deliveredwould not faithfully depict an entity's performance in satisfying a performance obligationif, at the end of the reporting period, the entity's performance has produced work inprogress or finished goods controlled by the customer that are not included in themeasurement of the output.

An objective evidence of the progress of work based on output method is the monthlyproject accomplishment report prepared by the construction manager which integratesthe surveys of performance to date of the construction activities that are sub-contractedand that are fulfilled by the developer itself.

Input methods

Input methods recognize revenue on the basis of the entity’s efforts or inputs to thesatisfaction of a performance obligation (for example, resources consumed, labor hours


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expended, costs incurred, time elapsed or machine hours elapsed) relative to the totalexpected inputs to the satisfaction of that performance obligation. Most common sourceof information for input method is the cost accumulated by the accounting department.

Paragraph B19 of PFRS 15 states, “A shortcoming of input methods is that there may notbe a direct relationship between an entity's inputs and the transfer of control of goods orservices to a customer. Therefore, an entity shall exclude from an input method theeffects of any inputs that, in accordance with the objective of measuring progress inparagraph 39, do not depict the entity's performance in transferring control of goods orservices to the customer. For instance, when using a cost-based input method, anadjustment to the measure of progress may be required in the following circumstances:

(a) When a cost incurred does not contribute to an entity's progress in satisfying theperformance obligation. For example, an entity would not recognise revenue on thebasis of costs incurred that are attributable to significant inefficiencies in the entity'sperformance that were not reflected in the price of the contract (for example, the costsof unexpected amounts of wasted materials, labour or other resources that wereincurred to satisfy the performance obligation).

(b) When a cost incurred is not proportionate to the entity's progress in satisfying theperformance obligation. In those circumstances, the best depiction of the entity'sperformance may be to adjust the input method to recognise revenue only to theextent of that cost incurred. For example, a faithful depiction of an entity'sperformance might be to recognise revenue at an amount equal to the cost of agood used to satisfy a performance obligation if the entity expects at contractinception that all of the following conditions would be met:

(i) the good is not distinct;(ii) the customer is expected to obtain control of the good significantly before

receiving services related to the good;(iii) the cost of the transferred good is significant relative to the total expected

costs to completely satisfy the performance obligation; and(iv) the entity procures the good from a third party and is not significantly

involved in designing and manufacturing the good.”

b. Below is the analysis on how certain cost items incurred by the real estate developer aretreated in the measurement of progress:

i. Land As the cost to procure the land is notproportionate to the entity’s progress insatisfying the performance obligation, under

https://live.atlas.ey.com/#document/1259670/pid109293462-1259670?pref=20052/9/1007&crumb=6/SL33184180-396647/C_25906428/C_25906578/1259679


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paragraph B19(b) of PFRS 15, it should beexcluded in the measure of progress when theinput method is used. The entity, however,needs to assess if it can recognize revenue to theextent of the cost of the land.

Under paragraph B19 (b), revenue can berecognized to the extent of the cost incurred ifall conditions laid out in the paragraph are met.One such condition is for the customer to obtaincontrol of the good significantly beforereceiving services related to the good.

Paragraph 33 of PFRS 15 defines control as theability to direct the use of, and obtainsubstantially all of the remaining benefits fromthe asset. For the fact pattern presented, thecustomer does not obtain control of the landupfront or prior to completion of constructionfor the following reasons: The customer has no ability to direct the use

of any land attributed to the real estate unitbeing purchased other than for its currentuse.

Although the customer is exposed tochanges in market value (appreciation ordepreciation) of the real estate unit(including the attributed land), which mayindicate that the customer has the ability toobtain substantially all of the remainingbenefits from the unit, it still does not givethe customer control of the unit since thecustomer does not have the ability to directthe use of the unit (including any landattributed to it).

Although the customer has the right to resellor pledge its right to the real estate unit(including any land attributed to it), the right


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to sell or pledge this right is not evidence ofcontrol of the real estate unit itself (includingany land attributed to it). This position isconsistent with the position taken by theIFRS Interpretations Committee (IFRIC) in itsmeeting held in September 2017. In thatmeeting, IFRIC indicated that, “in a contractfor the sale of a real estate unit that an entityconstructs, the asset created is the realestate unit itself. It is not, for example, theright to obtain the real estate unit in thefuture. The right to sell or pledge this right isnot evidence of control of the real estate unititself.”

In view of the above, control of the land is nottransferred to the buyer upfront, but rather,when the construction has been completed.Thus, paragraph B19 (b)(ii) is not met and theentity cannot recognize revenue relating to thecost of the land element.

As the land is necessary for the entity to fulfill itsperformance obligation to the customer, thecost of the land will be accounted for asfulfillment cost in accordance with paragraph 95of PFRS 15. The fulfillment cost would beamortized over the period of performance. Arational basis of allocation would be themeasure of progress used for the performanceobligation, which is percentage of completion.

(Refer to Annex A - Example 1 - Accounting forland and other components of real estatedevelopment in revenue and cost recognition)


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ii. Connection fees Similar to land, the customer is not expected toobtain control of the good (i.e., connection)significantly before receiving the servicesrelated to the goods (i.e., real estate unit) andthus paragraph B19(b)(ii) is not met and the costof the connection fees cannot be included in themeasure of progress. The connection fees willalso be treated as fulfillment cost and amortizedover the period of performance.

iii. Borrowing costs Borrowing costs (whether or not they arecapitalized in accordance with PAS 23) areexcluded in the measure of progress since thesedo not contribute to an entity’s progress insatisfying the performance obligation (PFRS15.B19(a)).

iv. Materials delivered on sitebut not yet installed

Paragraph B19(b)(ii) is not met as control overthe uninstalled materials is not transferred tothe customer upon delivery to the site but onlywhen these are installed or when they becomepart of the constructed building.

v. Common amenities/area Common amenities/area are part of thepromised performance obligation to thecustomer. The entity’s accomplishment in theconstruction of these common amenities andarea contribute to the entity’s performance oftransferring the control of goods and services tothe customer.

Annex A Example 1 - Accounting for land and other components of real estate development in revenue

and cost recognition Example 2 - Determination of Percentage of Completion for Vertical Development Example 3 - Determination of Percentage of Completion for Horizontal Development with

House and LotAnnex A


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Example 1 – Accounting for the land and other components of development in revenue andcost recognition.

Real estate developer develops a mid-rise condominium building divided into 10 saleable units.Total estimated development costs and other costs expected to be incurred by the real estatedeveloper follows:

Land Php 1,000,000Connection fees 200,000Construction costs – Building 3,000,000Construction costs – Common area 800,000Total Php 5,000,000

Costs of land and connection fees (Inventory – fulfillment costs) were incurred by the real estatedeveloper prior to the start of development. Construction costs – building, and constructioncosts – common area (Inventory – development costs) pertain to the estimated costs the realestate developer expects to incur until project completion.

Area of each of the saleable unit is approximately 100 square meter (sqm), resulting to a totalarea of 1,000 sqm for the entire development. Cost per square meter of inventory – fulfillmentcosts is Php1,200 (Php1,200,000 cost of land and connection fees divided by 1,000 sqm) whilecost per square meter of inventory – development costs is Php3,800 (Php3,800,000 total cost ofborrowing costs and construction costs of building and common area divided by 1,000 sqm).

Total contract price of each unit is Php1,000,000. Milestone completion of the mid-risecondominium building follows:

Incremental CumulativeYear 1 50% 50%Year 2 30% 80%Year 3 20% 100%


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Assuming that four (4) units were sold in year 1 and two (2) units were sold in year 2, beloware the illustrative entries to record the related revenue and costs.

Year 1

Real estate receivable 2,000,000Real estate sales a 2,000,000

a (4 units sold at Y1 x Php1,000,000 x 50% POC at Y1)

Cost of real estate sales 1,000,000Inventory – fulfillment costs b 240,000Inventory – development

costs c760,000

b (4 units sold at Y1 x 100 sqm x 50% POC at Y1 x Php1,200/sqm)c (4 units sold at Y1 x 100 sqm x 50% POC at Y1 x Php3,800/sqm)

Year 2

Real estate receivable 2,800,000Real estate sales e 2,800,000

e (4 units sold at Y1 x Php1,000,000 x 30% incremental POC at Y2) + (2 units sold at Y2 xPhp1,000,000 x 80% cumulative POC at Y2)

Cost of real estate sales 1,400,000Inventory – fulfillment costs f 336,000Inventory – development

costs g1,064,000

f (4 units sold at Y1 x 100 sqm x 30% incremental POC at Y2 x Php1,200/sqm) + (2 units sold at Y2 x100 sqm x 80% cumulative POC at Y2 x Php1,200/sqm)

g (4 units sold at Y1 x 100 sqm x 30% incremental POC at Y2 x Php3,800/sqm) + (2 units sold at Y2x 100 sqm x 80% cumulative POC at Y2 x Php3,800/sqm)

Year 3

Real estate receivable 1,200,000Real estate sales h 1,200,000

h (4 units sold at Y1 x Php1,000,000 x 20% incremental POC at Y3) + (2 units sold at Y2 xPhp1,000,000 x 20% incremental POC at Y3)


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Cost of real estate sales 600,000Inventory – fulfillment costs i 144,000Inventory – development costs j 456,000

i (4 units sold at Y1 x 100 sqm x 20% incremental POC at Y3 x Php1,200/sqm) + (2 units sold at Y2 x100 sqm x 20% incremental POC at Y3 x Php1,200/sqm)

j (4 units sold at Y1 x 100 sqm x 20% incremental POC at Y3 x Php3,800/sqm) + (2 units sold at Y2 x100 sqm x 20% incremental POC at Y3 x Php3,800/sqm)


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Example 2 – Determination of Percentage of Completion for Vertical Development

Real estate developer builds a two-tower residential condominium development. The twotowers stand on a common podium which serves as foundation for both buildings and willallow tenants to share access to the swimming pool, sports facilities and playground (podiumand the latter amenities will be collectively referred to as common areas).

Real estate developer has determined that the sale of residential units to customers is aperformance obligation that will be satisfied over time and that input method (e.g., costsincurred to date divided by total estimated costs) is the appropriate method that faithfullydepicts the real estate developer’s transfer of control of the development to the customer. Eachof the building will occupy the same area of land and podium. Building 2 however will havemore floors, thus will have more saleable area.

Real estate developer has determined that the most suitable allocation method1 for the cost ofland is based on area occupied of each building and for the common area will be based on thesaleable area of the buildings. Real estate developer estimates that the following costs will beincurred. Costs allocation to each building is also shown below.

1This is just for illustration purposes and other reliable basis of allocating the cost of land to eachbuilding maybe applied.

Table 2.1 Summary of CostsTotal Costs Building 1 Building 2

Specific costs:Development costs a Php 5,000,000 Php 2,000,000 Php 3,000,000

Common costs:Landb 1,500,000 750,000 750,000Common area c 500,000 200,000d 300,000e

TOTAL Php 7,000,000 Php 2,950,000 Php 4,050,000Total costs excluding land Php 5,500,000 Php 2,200,000 Php 3,300,000

a Total saleable area of the development is 20,000 sqm for Building 1 and 30,000 sqm for Building 2. b Each building occupies the same area of land, thus, cost of land is equally divided into Building 1 and

Building 2. c Allocation of cost of common area in proportion to saleable area of each building in relation to total

saleable area. d 500,000* [20,000/(20,000+30,000)] e 500,000* [30,000/(20,000+30,000)]


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Real estate developer incurred the following costs per year from the start of the project untilproject completion:

Table 2.2 Summary of Costs IncurredDevelopment Costs

Land Common area Building 1 Building 2 TotalYear 1 Php 1,500,000 Php 100,000 Php 500,000 Php – Php 2,100,000Year 2 – 350,000 900,000 400,000 1,650,000Year 3 – 50,000 600,000 900,000 1,550,000Year 4 – – – 1,100,000 1,100,000Year 5 – – – 600,000 600,000Total Php 1,500,000 Php 500,000 Php 2,000,000 Php 3,000,000 Php 7,000,000

Based on the above information, real estate developer calculates percentage of completion foreach of the five (5) years as follows:

Table 2.3 Calculation of percentage of completion for Building 1Building 1

Share inCommon area

DevelopmentCosts

Total Costfor the Year

TotalCumulative Cost

Percentage ofCompletion b

Year 1 Php 40,000 Php 500,000 Php 540,000 Php 540,000 25%Year 2 140,000 900,000 1,040,000 1,580,000 72%Year 3 20,000 600,000 620,000 2,200,000 100%Year 4 – – – 2,200,000 100%Year 5 – – – 2,200,000 100%Total Php 200,000a Php 2,000,000 Php 2,200,000

a Cost of common area is divided between the two buildings in proportion to their saleable area (500,000)*[20,000/(20,000+30,000)].b Percentage of completion is determined by dividing the total actual cumulative cost by the totalestimated cost excluding land cost.

Table 2.4 Calculation of percentage of completion for Building 2Building 2

Share inCommon area

DevelopmentCosts

Total Costfor the Year

TotalCumulative Cost

Percentage ofCompletion b

Year 1 Php 60,000 Php – Php 60,000 Php 60,000 2%Year 2 210,000 400,000 610,000 670,000 20%Year 3 30,000 900,000 930,000 1,600,000 48%Year 4 – 1,100,000 1,100,000 2,700,000 82%Year 5 – 600,000 600,000 3,300,000 100%Total Php 300,000a Php 3,000,000 Php 3,300,000


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a Cost of common area is divided between the two buildings in proportion to their saleable area (500,000)*[30,000/(20,000+30,000)]

b Percentage of completion is determined by dividing the total actual cumulative cost by the totalestimated cost excluding land cost

Example 3 – Determination of Percentage of Completion for Horizontal Development withHouse and Lot

Real estate developer sells residential house and lot in a horizontal project with two phases.The buyers of the properties in both phases will share access to the amenities which includesclub house, swimming pool, other sports facilities and playground (collectively referred to ascommon areas). Real estate developer has determined that the sale of the house and lotpackages to customers is a performance obligation that will be satisfied over time and that inputmethod (e.g., costs incurred to date divided by total estimated costs) is the appropriate methodthat faithfully depicts the real estate developer’s transfer of control of the development to thecustomer.

Phases 1 and 2 have the same saleable area of land and each phase offers 10 house and lotpackages. Each of the 20 units has the same lot area but housing units in Phase 2 have biggerfloor areas.

Real estate developer has determined that the most suitable allocation method for the cost ofland, land development and common area will be based on the saleable area of land.


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Real estate developer estimates that the following costs for the development will be incurred.Also shown below is the allocation per phase.

Table 3.1 Summary of CostsCost Allocation

Land andCommon

AreaPhase 1 Phase 2

Specific costs:Construction cost a Php 100,000 Php 200,000Land development costs b 1,000,000 1,000,000

Common costs:Land b Php 1,500,000 750,000 750,000Common area b 1,000,000 500,000 500,000

TOTAL Php 2,500,000Costs excluding land Php 1,000,000

a Specific costs for each of the housing unitb Cost is allocated equally to each phase because Phases 1 and 2 have the same saleable land area

Construction of the house starts only when a contract is entered into with a buyer. Real estatedeveloper incurred the following costs per year from the start of the project until projectcompletion:

Table 3.2 Summary of Cost Incurred

Land Common Area

LandDevelopment

Costs – Phase 1

LandDevelopment

Costs – Phase 2 TotalYear 1 Php 1,500,000 Php 200,000 Php 300,000 Php – Php 2,000,000Year 2 – 500,000 600,000 300,000 1,400,000Year 3 – 300,000 100,000 350,000 750,000Year 4 – – – 250,000 250,000Year 5 – – – 100,000 100,000Total Php 1,500,000 Php 1,000,000 Php 1,000,000 Php 1,000,000 Php 4,500,000

There were no sales made in Year 1. In Year 2, real estate developer sold one (1) house and lotpackage in Phase 1. In Year 3, real estate developer sold one (1) house and lot package in Phase1 and two (2) house and lot packages in Phase 2. Construction costs for each housing unit wereincurred by the real estate developer in the following manner:


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Table 3.3 Costs of Construction of Housing UnitsH&L 1 – Phase 1 H&L 2 – Phase 1 H&L 1 – Phase 2 H&L 2 – Phase 2

Year 1 Php – Php – Php – Php –Year 2 50,000 – – –Year 3 50,000 100,000 50,000 100,000Year 4 – – 150,000 75,000Year 5 – – – 25,000Total Php 100,000 Php 100,000 Php 200,000 Php 200,000

Percentage of completion is determined by the real estate developer for each of the five (5)years as follows:

Table 3.4 Calculation of percentage of completion for House and Lot#1- Phase 1House and Lot #1 - Phase 1

Share inCommon

Area a

LandDevelopment

Costs bHousing

CostsTotal Cost

for the Year

TotalCumulative

CostPercentage

of Completionc

Year 1 Php 10,000 Php 30,000 Php – Php 40,000 Php40,000

16%

Year 2 d 25,000 60,000 50,000 135,000 175,000 70%Year 3 15,000 10,000 50,000 75,000 250,000 100%Year 4 – – – – 250,000 100%Year 5 – – – – 250,000 100%Total Php 50,000 Php 100,000 Php 100,000 Php 250,000

a Common area costs are divided equally among the number of house and lot packages for both phasesgiven the same land saleable area for all packages (20 packages for both phases)b Land development costs are divided equally among number of house and lot packages for Phase 1 giventhe same saleable area for all packages in Phase 1c POC determined by dividing the total actual cumulative cost by the total estimated cost per housing unit excluding land costd Revenue will be recognized starting Year 2 being the time the house and lot package was sold to a buyer


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Share inCommon

Area a

LandDevelopment

Costs aHousing

CostsTotal Cost

for the Year

TotalCumulative

CostPercentage

ofCompletion b

Year 1 Php 10,000 Php 30,000 Php – Php 40,000 Php 40,000 16%Year 2 25,000 60,000 – 85,000 125,000 50%Year 3 d 15,000 10,000 100,000 125,000 250,000 100%

Year 4 – – – – 250,000 100%Year 5 – – – – 250,000 100%Total Php 50,000 Php 100,000 Php 100,000 Php 250,000

a Common area costs are divided equally among the number of house and lot packages for bothphases given the same land saleable area for all packages (20 packages for both phases)b Land development costs are divided equally among number of house and lot packages for Phase 1given the same land saleable area for all packages in Phase 1c POC determined by dividing the total actual cumulative cost by the total estimated cost per housingunit excluding land costd Revenue will be recognized starting Year 3 being the time the house and lot package was sold to abuyer


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Share inCommon

Area a

LandDevelopment

Costs bHousing

CostsTotal Cost

for the Year

TotalCumulative

CostPercentage ofCompletion c

Year 1 Php 10,000 Php – Php – Php 10,000 Php 10,000 3%Year 2 25,000 30,000 – 55,000 65,000 19%Year 3 d 15,000 35,000 50,000 100,000 165,000 47%

Year 4 – 25,000 150,000 175,000 340,000 97%Year 5 – 10,000 – 10,000 350,000 100%Total Php 50,000 Php 100,000 Php 200,000 Php 350,000

a Common area costs are divided equally among the number of house and lot packages for bothphases given the same saleable area for all packages (20 packages for both phases)b Land development costs are divided equally among number of house and lot packages for Phase 2

given the same land saleable area for all packages in Phase 2c POC determined by dividing the total actual cumulative cost by the total estimated cost per housingunit excluding land costd Revenue will be recognized starting Year 3 being the time the house and lot package was sold to a

buyer


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Share inCommon

Area a

LandDevelopment

Costs bHousing

CostsTotal Cost

for the Year

TotalCumulative

CostPercentage ofCompletion c

Year 1 Php 10,000 Php – Php – Php 10,000 Php 10,000 3%Year 2 25,000 30,000 – 55,000 65,000 19%Year 3 d 15,000 35,000 100,000 150,000 215,000 61%Year 4 – 25,000 75,000 100,000 315,000 90%Year 5 – 10,000 25,000 35,000 350,000 100%Total Php 50,000 Php 100,000 Php 200,000 Php 350,000

a Common area costs are divided equally among the number of house and lot packages for bothphases given the same land saleable area for all packages (20 packages for both phases)b Land development costs are divided equally among number of house and lot packages for Phase 2given the land same saleable area for all packages in Phase 2c POC determined by dividing the total actual cumulative cost by the total estimated cost per housingunit excluding land costd Revenue will be recognized starting Year 3 being the time the house and lot package was sold to abuyer


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Q&A No. 2018-12-F

STEP 5 – Specifies How an Entity Should Determine When to Recognize Revenue in Relationto a Performance Obligation (Measurement of Progress)

Issue

When applying the OUTPUT METHOD, how should costs incurred in fulfilling the performanceobligation (i.e., land and building development costs) be measured?

Background

A real estate developer enters into contract with customers for the construction and saleof residential units. The real estate developer has concluded that each contract containsa single performance obligation (i.e., the delivery of the residential unit) and thatrevenue is to be recognized over time in accordance with PFRS 15.35(c).

The real estate developer applies output method to measure the progress of thedevelopment, generally based on the survey of work performed by internal engineers.

The real estate developer typically incurs upfront costs such as land costs andconnection fees, which are accounted for as fulfillment costs, and land and buildingdevelopment costs, which contribute to the construction progress of the developmentproject.

Consensus

Assuming the following additional case facts:

Total units available for sale: 10Selling price per unit: Php800,000Number of units sold at Year 1 4

Total Per Unit 1

Fulfilment costs (land costs and connection fees) Php1,000,000 Php100,000Land and building development costs 3,000,000 300,000

1 Calculated based on the total costs divided by the total units for sale (10)


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Percentage of completion (POC) based on output method (i.e., physical survey) and actualcosts incurred per year are as follow:

PhysicalPOC

(Cumulative)

PhysicalPOC

(Increment)

Actual Costs(Cumulative)

Actual Costs(Increment)

Actual CostPer Unit

(Increment) 2

Year 1 25.00% 25.00% Php900,000 Php900,000 Php90,000Year 2 47.50% 22.50% 1,500,000 600,000 60,000Year 3 70.00% 22.50% 2,250,000 750,000 75,000Year 4 100.00% 30.00% 3,000,000 750,000 75,000

2 Calculated based on the actual costs per year divided by the number of total units for sale (10)

Given the case facts above, how much revenue and costs for the four (4) units sold at Year1 should be recognized by the real estate developer from Year 1 to Year 4?

1. Costs relating to (partially) satisfied performance obligation should be expensed asincurred.

PFRS 15.98 states that an entity shall recognise the following costs as expenses whenincurred:(a) general and administrative costs (unless those costs are explicitly chargeable to the

customer under the contract, in which case an entity shall evaluate those costs inaccordance with paragraph 97);

(b) costs of wasted materials, labour or other resources to fulfil the contract that were notreflected in the price of the contract;

(c) costs that relate to satisfied performance obligations (or partially satisfied performanceobligations) in the contract (i.e., costs that relate to past performance); and

(d) costs for which an entity cannot distinguish whether the costs relate to unsatisfiedperformance obligations or to satisfied performance obligations (or partially satisfiedperformance obligations).

PFRS 15.98(c) requires that costs relating to (partially) satisfied performance obligationsshould be expensed as incurred. This means that the real estate developer should recognizecontract costs (i.e., land and building development costs) as expense as the work to whichthey relate is performed.

In addition, PFRS 15.BC308 clarifies that only costs that give rise to resources that will beused in satisfying performance obligations in the future and that are expected to berecovered are eligible for recognition as assets. Those requirements ensure that only coststhat meet the definition of an asset are recognized as such and that an entity is precludedfrom deferring costs merely to normalize profit margins throughout a contract by allocating


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revenue and costs evenly over the life of the contract. To provide a clear objective forrecognizing and measuring an asset arising from the costs to fulfil a contract, the boardsdecided that only costs that relate directly to a contract should be included in the cost of theasset.

Based on PFRS 15.95, if the costs incurred in fulfilling a contract with a customer are notwithin the scope of another Standard (for example, PAS 2 Inventories, PAS 16 Property,Plant and Equipment or PAS 38 Intangible Assets), an entity shall recognize an asset fromthe costs incurred to fulfil a contract only if those costs meet all of the following criteria:(a) the costs relate directly to a contract or to an anticipated contract that the entity can

specifically identify (for example, costs relating to services to be provided under renewalof an existing contract or costs of designing an asset to be transferred under a specificcontract that has not yet been approved);

(b) the costs generate or enhance resources of the entity that will be used in satisfying (orin continuing to satisfy) performance obligations in the future; and

(c) the costs are expected to be recovered.

2. Revenue and cost that will be recognized by the real estate developer follow:

Year 1 Year 2 Year 3 Year 4 CumulativeRevenue a Php800,000 Php720,000 Php720,000 Php960,000 Php3,200,000Cost b, c 460,000 330,000 390,000 420,000 1,600,000Margin 340,000 390,000 330,000 540,000 1,600,000% Margin 42.50% 54.17% 45.83% 56.25% 50.00%

a [Selling price per unit (800,000) x 4 units sold x incremental POC for the year]b [Fulfilment costs per unit (100,000) x 4 units sold x incremental POC for the year] + [Actual cost per unit during

the year x 4 units sold]c Costs assumes that there are no uninstalled materials at year-end. Uninstalled materials meet all the criteria

under PFRS 15.95 and may be capitalized as an asset and will form part of expense when consumed to satisfythe performance obligation


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Q&A No. 2018-12-G

STEP 5 – Specifies How an Entity Should Determine When to Recognize Revenue in Relationto a Performance Obligation (Costs to Obtain a Contract)

Issues

a. How should the real estate developer account for the benefits given to sales agents?

b. How should the real estate developer amortize the capitalized incremental costs ofobtaining a contract?

Background

A real estate developer enters into contracts with customers for the construction and saleof residential units. The developer has concluded that:

a. Each contract (i.e., each residential unit) is a single performance obligation

b. Revenue is to be recognized over time in accordance with PFRS 15.35(c) – cost-to-costis the appropriate method to measure progress

The developer has sales agents who are responsible for the marketing and sale of itsresidential units. These real estate sales agents typically receive the following benefits fromthe developer:

a. Fixed monthly living allowance which is granted to sales agents regardless ofwhether they booked sales or not.

b. Transportation allowance which is granted to sales agents regardless of whether theybooked sales or not.

c. Sales commission equivalent to a certain percentage of the total contract price of theresidential unit being sold, paid as follows: 20% paid upon reservation, 30% uponsigning of contract, and 50% upon full payment.

Consensus

a. The assessment on the costs incurred by the real estate developer are as follows:


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i. Fixed monthly living allowance and transportation allowance – expensed asincurred.

ii. Sales commission – expensed for the portion paid prior to signing the contract(20% of sales commission), capitalized as an asset for the portion that would beincurred after signing the contract (80% of sales commission).

b. The real estate developer will amortize the capitalized incremental costs using thepercentage of completion method (same as measure of progress in satisfying theperformance obligation under the related revenue contract).

Discussion

a.Paragraphs 91-94 of PFRS 15 state that, “An entity shall recognize as an asset theincremental costs of obtaining a contract with a customer if the entity expects to recoverthose costs.

The incremental costs of obtaining a contract are those costs that an entity incurs toobtain a contract with a customer that it would not have incurred if the contract had notbeen obtained (for example, a sales commission).

Costs to obtain a contract that would have been incurred regardless of whether thecontract was obtained shall be recognized as an expense when incurred, unless thosecosts are explicitly chargeable to the customer regardless of whether the contract isobtained.

As a practical expedient, an entity may recognize the incremental costs of obtaining acontract as an expense when incurred if the amortization period of the asset that theentity otherwise would have recognized is one year or less.”

The analysis of the fixed monthly living and transportation allowances, and salescommissions provided by the real estate developer to its real estate agent based onPFRS 15 par. 91-94 are as follows:

Fixed monthly living allowanceand transportation allowance

Expensed as incurred.

The fixed monthly living allowance andtransportation allowance provided to the realestate agents do not meet the capitalizationcriteria since the real estate developer wouldstill incur these costs regardless of whether thecontract to sell residential condominium unit isobtained from the customer


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Sales commission (paid ininstallment)

Expensed for the portion paid prior to signingthe contract (20% of sales commission),capitalized as an asset for the portion that wouldbe incurred after signing the contract (80% ofsales commission).

The 20% of the sales commission paid uponreservation will still be paid to the real estatebroker even if the customer does not proceedwith the purchase of residential unit. As such,this portion of the sales commission representscost that the entity would incur regardless ofwhether a contract is obtained and should berecognized as an expense.

The remaining 80% of the sales commissionwhich would be paid after signing of thecontract represents cost that the real estatedeveloper would not have incurred if thecontract to sell residential unit has not beenobtained. Further, the real estate developer canexpect to recover this contract acquisition costthrough indirect recovery (i.e., through theconsideration / payments inherent in thecontract).

Upon signing of the contract, the real estatedeveloper will recognize the remaining 80% asan asset and record a corresponding liability (toconsider effect of discounting), since uponrevenue recognition the real estate developermust have already concluded that the partiesare ‘committed to perform their respectiveobligations’. The fact that the payment of thesales commission will occur over time does not


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affect whether the full 80% sales commission iscapitalized upon obtaining the contract. Theaccrual of commission the entity expects to payis appropriate since the entity has a presentobligation resulting from a past event and theamount of commission is reliably estimable.

As required by paragraph 101 of PFRS 15, theasset is subject to impairment assessment.

b. Based on PFRS 15 paragraph 99, an asset recognized in accordance withparagraph 91 or 95 shall be amortized on a systematic basis that is consistent with thetransfer to the customer of the goods or services to which the asset relates.

The real estate developer recognizes revenue over time (percentage of completion)which represents a continuous transfer of control to the customer. Consequently, thecapitalized incremental costs of obtaining the contract will be amortized using thepercentage of completion method since this represents the transfer to the customer ofthe goods or services to which the capitalized asset relates.


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Q&A No. 2018-12-H

Issue

Is the real estate developer acting as a principal or customer in goods and services that itdelivers based on contract of lease with the tenants?

Accounting for Common Usage Service Area (CUSA) Charges

Background

Real estate developer has existing commercial building that is being leased out totenants. Based on the contract of lease, the real estate developer bills and charges thetenant for the following every month. The details are incorporated in the monthlyprinted bill.

a. Electricity usage – Actual consumption of electricity in kilowatt hour (kwh) based onthe readings of sub-meters installed in the commercial building multiplied by therate per kwh as determined by the real estate developer based on the actual ratecharged by the electricity distribution company plus a certain percentage mark-up(e.g. 10%) as distribution charges.

b. Water usage – Actual consumption of water in cubic meter based on the readings ofsub-meters installed in the commercial building multiplied by the rate per cubicmeter as determined by the entity based on the actual rate charged by the waterutility company plus a certain percentage mark-up (e.g. 10%) as distribution charges.

c. Air conditioning charges – Charges to the tenant for the air conditioning servicesprovided by the real estate developer for the common areas and the occupied areaof the tenant. Air conditioning charges rate per square meter (sqm) is determinedby the developer and this is multiplied by the total area occupied by the tenant.

d. Common use service area (CUSA) expenses – Electricity consumption, security,maintenance and all other common area expenses incurred by the real estatedeveloper in its administration of the commercial building. A CUSA rate per sqm ispre-determined by the developer and this is multiplied by the total area occupied bythe tenant. The contract of lease provides that the rates stipulated may be adjustedwhenever the cost of the electricity, labor and other charges changes.


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Real estate developer is primarily responsible for ensuring that the leased space is availablefor the tenant/customer’s use based on the lease agreement. The responsibility of the realestate developer is to provide for the free and uninterrupted passage and running of water,drainage, electricity, telecommunications or other public utilities or services. They maintainan administrative office which are fully staffed to resolve any issues or concerns of thetenants in relation to these facilities.

Based on the general terms and conditions of the contract of lease, the real estate developermay shut off all utilities to the premises occupied by the tenant/customer at any time if theyhave failed to pay the outstanding billings due to the real estate developer.

Consensus

The principal vs. agent analysis of the goods and services provided by the real estate developerfollows:

a. Electricity usage – Agent

b. Water usage – Agent

c. Air-conditioning charges – Principal

d. Common use service area (CUSA) charges and administrative and handling fees – Principal

Discussion

Based on PFRS 15.B34, when another party is involved in providing goods or services to acustomer, the entity shall determine whether the nature of its promise is a performanceobligation to provide the specified goods or services itself (i.e., the entity is a principal), or toarrange for those goods or services to be provided by the other party (i.e., the entity is an agent).An entity determines whether it is a principal or an agent for each specified good or servicepromised to the customer. A specified good or service is a distinct good or service (or a distinctbundle of goods or services) to be provided to the customer. If a contract with a customerincludes more than one specified good or service, an entity could be a principal for somespecified goods or services and an agent for others.

In accordance with PFRS15.B34A, to determine the nature of its promise, the entity shall:

(a) identify the specified good or service to be provided to the customer in the contract (i.e.,whether it is to provide the specified goods or services, or to arrange for those goodsand services to be provided by another party); and,


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(b) assess whether it controls each specified good or service before that good or service istransferred to the customer.

Appropriately identifying the good or service to be provided is a critical step in determiningwhether an entity is a principal or an agent in a transaction. In many situations, especially thoseinvolving tangible goods (e.g., sale of residential unit), identifying the specified good or servicemay be straightforward. However, the assessment may require significant judgment in othersituations, such as those involving intangible goods or services (e.g., right to access utilities).

In addition, PFRS 15.BC385O provides that the fact that the entity will not provide the goods orservices itself is not determinative. Instead, the entity evaluates whether it controls the right togoods or services before that right is transferred to the customer. In doing so, it is often relevantto assess whether the right is created only when it is obtained by the customer, or whether theright to goods or services exists before the customer obtains the right. If the right does not existbefore the customer obtains it, an entity would be unable to control that right before it istransferred to the customer.

In addition, the second step in determining the nature of the entity’s promise (i.e., whether it isto provide the specified goods or services or to arrange for those goods or services to beprovided by another party) based on PFRS 15. B34A is for the entity to determine whether theentity controls the goods and services before it is transferred to the customer. An entity cannotprovide the specified goods or service to a customer (and, therefore, be a principal) unless itcontrols the good or service prior to its transfer. That is, the Board noted in the Basis forConclusions, control is the determining factor when assessing whether an entity is a principalor an agent.

Control of an asset refers to the ability to direct the use of and obtain substantially all theremaining benefits from the asset.

In addition, the standard provides three indicators of when an entity controls the specified goodor service (and is, therefore, a principal) as follows:

a. The entity is primarily responsible for fulfilling the promise to provide the specified goodsor service;

b. The entity has inventory risk before the specified goods or service has been transferred tothe customer or after the transfer of control to the customer; and,

c. The entity has discretion in establishing the price for the specified good or service.


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Principal vs. agent analysis of the real estate developers’ performance obligation based on thedefinition of control as well as the indicators of control follows:

Electricity and Water usage Conclusion: Agent

The specified goods or service that the entity promisedto the tenant is for the entity to arrange for theelectricity and water supply to be provided by a utilitycompany (i.e., right to obtain electricity and watersupply).

Indicators of controla. Not met. The utility company, and not the real

estate developer, is primary responsible for theprovisioning of the utilities. The real estatedeveloper, being the assigned administrator of thebuilding is the party who coordinates with theutility companies to ensure that tenants haveaccess to utilities

b. Not applicable. Utilities are not inventoriable.c. Not met. Real estate developer does not have the

discretion on the pricing of the services providedsince the price is based on the actual rate chargedby the utility providers.

Common use service area(CUSA) expenses and airconditioning charges

Conclusion: Principal

The specified goods or service that the entity promisedto the tenant is for the entity to arrange for themaintenance of the common service area (e.g.,cleaning, maintenance, security, lighting, etc.) andprovision of air conditioning services to be provided byanother party. The right to the subcontractor servicesproviding the maintenance services mentioned nevertransfers to the tenant. Instead, the entity retains theright to direct the service provider as it chooses.


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ControlThe entity has the ability to direct the use of and obtainsubstantially all the remaining benefits from theservices being delivered to the tenants. The entity candirect the maintenance, security and cleaning andadministrative services.

Indicators of controlvi. Met. Real estate developer is the party responsible

to provide the necessary services to the commonuse service area and to provide proper ventilationand air conditioning to the leased premises.

vii. Not applicable. Services are not inventoriable.viii.Met. Real estate developer has the discretion on

how to price the CUSA and air conditioning charges.


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References

PFRS 15, Revenue from Contracts with Customers

PAS 1, Presentation of Financial Statements

PAS 2, Inventories

PAS 40, Investment Properties

PIC Q&A No. 2016-04, Application of PFRS 15 “Revenue from Contracts with Customers” onsale of residential properties under pre-completion contracts

PRESIDENTIAL DECREE NO. 957, Subdivision and Condominium buyer's Protective Decree 9(as amended by P.D. 1216), REGULATING THE SALE OF SUBDIVISION LOTS ANDCONDOMINIUMS, PROVIDING PENALTIES FOR VIOLATIONS THEREOF

PRESIDENTIAL DECREE No. 1216, DEFINING "OPEN SPACE" IN RESIDENTIAL SUBDIVISIONSAND AMENDING Sec. 31 OF PRESIDENTIAL DECREE NO. 957 REQUIRING SUBDIVISIONOWNERS TO PROVIDE ROADS, ALLEYS, SIDEWALKS AND RESERVE OPEN SPACE FORPARKS OR RECREATIONAL USE


The consensus in these Q&As are effective on the same date as the effective date of PFRS 15.



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PIC Members









Date approved by FRSC: February 14, 2018


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Q&A No. 2019 – 01: Accounting for service charges under PFRS 15,Revenue from Contracts with Customers

Issue

Should service charge be excluded from the transaction price in a contract to sell services to arestaurant customer or hotel guest?

Background

In the Philippines, it is a common practice for the hotel and restaurant industry to collect a fixedpercentage service charge of the qualified revenues4, on behalf of its employees. The servicecharge ranges from 8%-10%, which is also presented as a separate item in the bill of thecustomer.

In the past, the practice in the Philippines was to give the tips to the front office staff, like waitersand reception personnel. It was considered as gratuity, and are therefore not income of therestaurant/hotel but income of the employees. Practice then evolved where tips are shared notonly among the front office staff, but also include the backroom operation (e.g. kitchen) andbackroom support (e.g. finance), arguing that the service experience extended to the ultimateguest or hotel customer would not be completed without the backroom support and operation.

Over time, the hotels and restaurants have put a formal structure by which to receive the tips,which now became “service charge”, and is separately presented in the official receipt. Thecollected service charge is treated as a fund or cash held by the hotel and restaurantestablishments in trust from the guests or customers for the employees.

On May 1, 1974, then President Ferdinand Marcos signed Presidential Decree (PD) No. 442 (asamended by PD No. 850 on December 16, 1975) or the Labor Code of the Philippines toregulate and direct the distribution of any collected service charge, effectively institutionalizingthe service charge into a law. Under Article 96 of the Labor Code “All service charges collectedby hotels, restaurants and similar establishments shall be distributed at the rate of eighty-fivepercent (85%) for all covered employees and fifteen percent (15%) for management. The shareof the employees shall be equally distributed among them...”

4 Revenue subjected to service charge which vary depending on the hotel and restaurant establishmentpolicies and practices.


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Currently, a minimum of 85% of the collected service charge is distributed to coveredemployees every month (bi-monthly for some hotels). Commonly, employees entitled for servicecharge distribution are the local regular employees of the hotels and restaurants. The servicecharge distributed to employees is subjected to withholding taxes on compensation. Theremaining service charge is retained by the hotels and restaurants and is ultimately recognizedas income. The portion retained by the hotels and restaurants is normally used to cover forbreakages incurred by the hotel and restaurant employees (i.e., damaged operating equipment).There are also certain hotels who are distributing more than the 85% requirement (e.g. about90% to 95%) of the collected service charge to the covered employees. Hotel and restaurantestablishments that distribute more than the 85% minimum requirement cannot just reduce therate of distributed service charge as it would violate the “non-diminution of benefits” principle ofthe Labor Code.

Consensus

Under PFRS 15, revenue is measured at the amount of consideration to which an entity expectsto be entitled in exchange for transferring promised goods or services to a customer and shouldexclude amounts collected on behalf of third parties. Treatment of the service charge should beas follows:

Portion due to the employees (85%5 of the collected service charge) – should beexcluded from the transaction price

Paragraph 47 of PFRS 15 defines transaction price as “the amount of consideration towhich an entity expects to be entitled in exchange for transferring promised goods orservices to a customer, excluding amounts collected on behalf of third parties”. The 85%of the collected service charge represents benefits that are directly distributable /attributable to the employees as required by the Labor Code of the Philippines. Giventhe mandate of the law, the 85% of the collected service charge does not form part ofthe transaction price. It should be recognized as a liability to the employees.

Remaining portion (15% or lower2 if the customary business practice of the company isto remit more than 85% to the employees) - should be included in the transaction pricebecause this is an additional consideration in exchange for the goods and servicesprovided and benefits directly inure to the hotel/restaurant.

5 If the hotel or restaurant has made it a practice to remit a higher percentage of the service charge to theemployees (e.g., 90%), then this becomes the percentage that the hotel/restaurant is legally bound tocontinually remit to the employees. The hotel/restaurant cannot just decide to reduce it as it would be aviolation of the principle of “non-diminution of benefits” that is provided for in the Labor Code.


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Illustrative examples are provided below6:

1. Restaurant establishment

A bill was presented to a customer for food and beverage consumption in a restaurantwith the following information:

Food and beverage Php500Service charge 50

The transaction price will be Php507.50 (Food and beverage of Php500 +management’s share on the service charge = 15% × Php50).

The restaurant prepares the following journal entry to record revenue upon rendering ofservices:

Particulars Dr Cr

Cash / Receivable Php550.00

Revenue Php507.50

Liability for employees’ share in service charge 42.50

2. Hotel room accommodation

A guest folio was presented to the hotel guest upon check-out for a one (1) night roomstay in the hotel. Breakdown of the guest folio amount is presented below:

Room night Php7,500Service charge 750

The transaction price will be Php7,612.50 (Room night of Php7,500 + management’sshare of the service charge = 15% × Php750).

6 Accounting for related taxes not considered


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The hotel prepares the following journal entry to record revenue upon renderingof services:

Particulars Dr Cr

Cash / Receivable Php8,250.00

Revenue Php7,612.50

Liability for employees’ share in service charge 637.50


The effective date and transition provision of this Q&A follow that of PFRS 15, upon approval ofthe FRSC.



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* * * * *PIC Members











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Q&A No. 2019 – 03: Revenue recognition guidance for sugar millers

Background:

There are two key players in the Philippine sugar milling industry: (1) the Planters; and(2) the sugar milling companies (the “Miller”). The Planters are engaged in the businessof cultivating and farming sugar canes that are delivered to the Miller upon harvest. Inmost cases, the sugar cane farming is a sole activity of the Planter and therefore, itmakes all necessary decisions on the land, equipment and farm materials required ingrowing the canes, including hauling the harvested canes to the Miller’s yard.

On the other hand, the Millers own and operate exclusively the milling facilities andtechnology that are needed to convert the canes supplied by the Planter into raw sugar.Acceptance of canes for milling is subject to certain quality specifications and the Millerreserves the right to refuse canes that are of below-standard quality. The normalmilling process (conversion of canes to raw sugar) does not take more than a day tocomplete.

At present, the milling arrangement between the Miller and the Planter takes in the formof either: (a) output sharing arrangement; or (b) cane purchase agreement. Thearrangement is mutually agreed between the Miller and the Planter each time canes aredelivered for milling.

Output sharing arrangement

Traditionally, the Millers have carried out their milling operations under an outputsharing arrangement with the Planters. Under this arrangement, the resultant sugar isshared between the Planter and the Miller based on a sharing scheme agreed either inwriting via a milling contract or verbally.

At present, the Planter-Miller output sharing ratio ranges between 60:40 to 70:30, infavor of the Planter. The Planter’s share is determined at the time of delivery of canesbased on a standard formula that takes into account the quality of canes (e.g. polarity,sucrose content, thrash %, etc.)

Molasses, which is a by-product, is likewise shared following the sugar output sharingarrangement.


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In the absence of a milling contract, customary business practice generally dictates therights and obligations of the Miller and Planter and the consideration to be received bythe contracting parties. Consideration include the sharing percentage of the sugaroutput between the Miller and Planter. The Planter either receives quedansrepresenting the raw sugar inventory or cash equivalent to its share of the output fromthe sugar milling.

Cane purchase agreement

Instead of the typical output sharing arrangement such as described above, it hasbecome a practice recently for some Millers to enter into a Cane Purchase Agreement(CPA) with the Planters. Under the cane purchase structure, the Miller will buy outrightthe canes of the Planters for its (Miller) milling operation. The CPA is executed eitherverbally or in writing. The monetary consideration for the purchase of canes from thePlanters is based on the market value of a pre-determined volume of sugar at the end ofmilling (e.g. based on the expected sugar that the Planter would have received underthe typical sugar output sharing scheme as discussed above). Consequently, ALLsugar produced from the purchased canes will be owned by and quedanned under thename of the Miller.

Sugar trading in the Philippines

Following the regulatory requirements in the Philippines, all raw sugar owned by bothPlanters and Millers are covered by quedans (the Quedan). A Quedan is a negotiablewarehouse receipt evidencing ownership of certain volume of sugar signed bydesignated officers of the Miller. Likewise, the Quedan contains information amongother, the charges that the Planter has to pay upon withdrawal of sugar, the related cropyear the sugar was produced, and the classification of sugar based on the allocationorder of the Sugar Regulatory Administration (SRA).

By way of endorsement of Quedans, the Planters and Millers can sell their respectiveraw sugar without the need to physically deliver the actual volume of sugar to the buyer(e.g. sugar traders, industrial users, etc.). The Quedan can change hands until it iseventually surrendered to and cancelled by the Miller when sugar is finally withdrawn byits (the Quedan) holder. In other words, the raw sugar is stored at the Miller’swarehouse and remains as an accountability of the Miller until it is withdrawn. Inaccordance with the milling contract, the Miller safekeeps the sugar owned by thePlanters free of storage charge up to a certain period. Otherwise, a storage fee is


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charged if Planters are unable to withdraw their sugar after the lapse of the “freestorage period”.

Issues:

1. How should the Miller recognize revenue arising from its sugar milling operation foreach of the following scenarios?

a. Ouput sharing arrangement

b. Cane purchase agreement

2. Is the free storage period a separate performance obligation capable of beingdistinct and distinct in the contract of the contract?

Consensus:

Issue 1a: Revenue recognition under the output sharing arrangement

Standard Output Sharing AgreementUnder a standard output sharing arrangement, the Miller is engaged in the business ofrendering sugar milling services (e.g. sale of service). In accordance with PFRS 15, theMiller shall recognize revenue as it satisfies its obligation (performance obligation) in thecontract –that is, upon conversion of the Planter’s canes into raw sugar. The Miller’sshare in the raw sugar output represents the consideration for the milling services. Asthe raw sugar is a non-cash consideration, the amount of revenue shall be determinedbased on the fair value of the raw sugar at the time of production (PFRS 15, para. 66).The unsold raw sugar owned by the Miller shall be accounted for as inventory inaccordance with PAS 2 until it is disposed or sold.

The subsequent sale of raw sugar via endorsement of Quedans (as described above)by the Miller creates another sale transaction (e.g. sale of goods) which shall beaccounted for separately in accordance with PFRS 15. In this case, revenue isrecognized upon transfer of control over the raw sugar to the customer-buyer. Thiswould generally coincide at the time of endorsement of Quedans to the buyer (point intime).


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Without Formal AgreementsPromises to provide goods or services might be implied by the entity’s customarybusiness practices or industry norms (i.e., outside of the written contract). For millingtransactions entered into without formal contracts, a careful analysis of the facts andcircumstances needs to be made to determine the substance of transaction. Forinstance, Planters which generally receives cash as payment of its sugarcane produceand not Quedans, and has no practical ability to direct the use of the resultant rawsugar, the Mill shall account for this transaction under a cane purchase model (in-substance purchase).

See accounting discussion under the Revenue Recognition under the Cane Purchase Model.

Issue 1b: Revenue recognition under the cane purchase model.

The Miller shall treat the purchase of canes in a similar fashion as an entity buying rawmaterials for its own manufacturing requirements. Accordingly, the canes shall becomethe Miller’s raw materials and serve as input to its sugar milling operation. By virtue ofthe CPA, the Miller gains control (i.e., ability to direct the use of, and obtain substantiallyall of the remaining benefits from the asset) over the use of purchased canes andacquires rights over all resultant sugar output. Effectively, the cost of purchased caneswill be accounted for as production or milling cost of the Miller.

The Miller, having the entire sugar output quedanned under its name, can sell the rawsugar and enjoy the full value as its revenue. Revenue from the sale of raw sugar shallbe accounted for in accordance with PFRS 15—that is, upon transfer of control over thesugar to the buyer or customer. This would generally coincide at the time ofendorsement of Quedans to the buyer (point in time).

Issue 2: Free Storage Period under a standard OSA as a separate performance obligation

The free storage period is a distinct performance obligation since: a) the Planter canbenefit from the free storage period on its own (i.e., the free storage is capable of beingdistinct; and b) the Miller’s promise to provide free storage is separately identifiable fromthe promise to deliver milling services (i.e., the promise to provide free storage isdistinct in the context of the contract (PFRS 15, par. 27). This will impact therecognition of sugar milling services as the Miller has two separate performanceobligations: mill the sugar cane into raw sugar and provide free storage for certainperiod of time.


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The Miller should allocate the fair value of the noncash consideration received based onthe stand-alone selling prices of the milling and storage services. This will result in therecognition of a contract liability pertaining to the allocated revenue for the free storageand will be subsequently recognized as revenue as storage service is being rendered.


The effective date and transition provision of this Q&A is upon approval by the FRSC.

Date approved by PIC: March 26, 2019


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PIC Members



David V. Cruz Zaldy D. Aguirre




Maria Isabel E. Comedia Arnel Onesimo O. Uy




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Q&A No. 2020 – 02: Conclusion on PIC QA 2018-12E: On certainmaterials delivered on site but not yet installed

IssueHow should the uninstalled materials be considered in measuring the progress of theperformance obligation?

BackgroundThe real estate contract to sell qualify for percentage of completion for its revenuerecognition. In order to fulfill its obligation, real estate developers enter into supplycontracts with suppliers for the provision and installation of materials as follows:

1. Customized materials. These are materials specific to the design, measurementsand structure of the projects. The terms of the contract include, but are not limited tothe following:

a) To supply materials that are manufactured and assembled at supplier’s site asthese require use of precision equipment and machinery for customization.Examples are (a) architectural materials (kitchen cabinets, doors and windows),(b) electrical components (panelboards, bus duct), (c) plumbing/sanitary; and (d)conveying equipment; among others.

b) Materials are assembled and retained in supplier’s site until completed and willbe installed based on agreed schedule as these are impractical to store in projectsite to avoid damages. The installation instructions are also agreed between thereal estate developer and the supplier.

c) The customized materials cannot be used for any other projects aside from theproject to which it was measured and fitted to be installed.

Cancellation of orders are not allowed. In the event that the real estate developerfails to pay for the balance of the customized materials, the supplier forfeits anyprevious payments the developer has made and supplier is entitled to repossess themerchandise. The supplier forfeits the developer’s down payment for cancellation oforder for reasons other than guaranteed circumstances.


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2. Materials that are not customized. These are materials that are not customizedbut are already delivered on site but not yet installed or used in construction.Examples are gravel, sand, hollow blocks, steel and elevators.

Conclusion and Discussion

The PIC has concluded that in recognizing revenue using a cost-based input method,customized materials are to be included in the measurement of the progress of workwhile materials that are not customized should be excluded.

Paragraph 39 of PFRS 15 requires that for each performance obligation satisfied overtime, an entity shall recognize revenue by measuring the progress towards completesatisfaction of that performance obligation. The objective when measuring progress is todepict an entity’s performance in transferring control of goods or services promised to acustomer (i.e. the satisfaction of an entity’s performance obligation).

As indicated in paragraph B18 of PFRS 15, under the input method, revenue isrecognized on the basis of the entity’s effort or inputs to the satisfaction of aperformance obligation.

In the case of the customized materials, the real estate developer is not just providing asimple procurement service to the customer as it is significantly involved in the designand details of the manufacture of the materials. The customization and manufacture ofthe materials, which is done at the supplier site, is the more significant portion of thework compared to the installation portion at the project site. Moreover, the customizedmaterials have no alternative use to the real estate developer as these cannot be usedin any other project. As such, the costs incurred on the customized materials, even ifstill uninstalled, are to be included in the measurement of progress to properly capturethe efforts expended by the real estate developer in completing its performanceobligation.

The Company should maintain adequate records and adopt robust systems andprocesses that will help ensure proper monitoring of the progress of work and relatedcosts incurred on customized materials that are manufactured or assembled atsuppliers’ sites.


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In the case of uninstalled materials that are not customized., since the real estatedeveloper is not involved in their design and manufacture, revenue should only berecognized upon installation or use in construction. Revenue cannot be recognizedeven up to the extent of cost because all criteria under paragraph B19(b)(ii) are not met.

Effective date

The effective date of the consensus in this Q&A follow that of PIC QA 2018-12, uponapproval by the FRSC.

Date approved by PIC: October 29, 2020

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Date approved by FRSC: November 6, 2020


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References:

PFRS 15.39 For each performance obligation satisfied over time in accordance withparagraphs 35–37, an entity shall recognize revenue over time by measuring theprogress towards complete satisfaction of that performance obligation. The objectivewhen measuring progress is to depict an entity’s performance in transferring control ofgoods or services promised to a customer (i.e. the satisfaction of an entity’sperformance obligation).

PFRS 15.B18 Input methods recognize revenue on the basis of the entity’s efforts orinputs to the satisfaction of a performance obligation (for example, resourcesconsumed, labor hours expended, costs incurred, time elapsed or machine hours used)relative to the total expected inputs to the satisfaction of that performance obligation. Ifthe entity’s efforts or inputs are expended evenly throughout the performance period, itmay be appropriate for the entity to recognize revenue on a straight-line basis.

PFRS 15.B19 A shortcoming of input methods is that there may not be a directrelationship between an entity’s inputs and the transfer of control of goods or services toa customer. [Refer: Basis for Conclusions paragraph BC176] Therefore, an entity shallexclude from an input method the effects of any inputs that, in accordance with theobjective of measuring progress in paragraph 39, do not depict the entity’s performancein transferring control of goods or services to the customer. For instance, when using acost-based input method, an adjustment to the measure of progress may be required inthe following circumstances:

(a) When a cost incurred does not contribute to an entity’s progress in satisfyingthe performance obligation. For example, an entity would not recognize revenue on thebasis of costs incurred that are attributable to significant inefficiencies in the entity’sperformance that were not reflected in the price of the contract (for example, the costsof unexpected amounts of wasted materials, labor or other resources that were incurredto satisfy the performance obligation). [Refer: Basis for Conclusionsparagraphs BC177 and BC178]


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(b) When a cost incurred is not proportionate to the entity’s progress in satisfying theperformance obligation. In those circumstances, the best depiction of the entity’sperformance may be to adjust the input method to recognize revenue only to the extentof that cost incurred. For example, a faithful depiction of an entity’s performance mightbe to recognize revenue at an amount equal to the cost of a good used to satisfy aperformance obligation if the entity expects at contract inception that all of the followingconditions would be met:

(i) the good is not distinct;

(ii) the customer is expected to obtain control of the good significantly before receivingservices related to the good; [Refer: Basis for Conclusions paragraphs BC170–BC175]

(iii) the cost of the transferred good is significant relative to the total expected costs tocompletely satisfy the performance obligation; and

(iv) the entity procures the good from a third party and is not significantly involved indesigning and manufacturing the good (but the entity is acting as a principal inaccordance with paragraphs B34–B38).


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Q&A No. 2020 – 03: Q&A No. 2018-12-D: STEP 3 – On the accountingof the difference when the percentage of completion is ahead of thebuyer’s payment

Issue

What is the accounting for the difference between the percentage of completion (POC)and the buyer’s payment with the POC being ahead?

Background

Company A enters into a contract with a customer in June 2020 for the construction ofcondominium units. The scheduled completion and delivery date is June 1, 2022.Revenue is recognized over time. The transaction price (TP) is CU1,000 and, as at 31December 2020, the contract is 30% complete. The financial reporting date of CompanyA is every December 31.

As of December 31, 2020, Company A recognizes revenue of 30% at CU300. Beloware the payment terms, which indicate that the first instalment is due on January 1,2021.

30% (10% of TP every month) from January 1,2021 to March 1,2021 70% of TP in June 1, 2022

If Company A fails to complete and deliver the asset, the customer will be entitled to arefund of any consideration paid.

Conclusion and Discussion

View 1

Company A recognizes a contract asset. PFRS 15.107 states that a contract asset isrecognized if an entity has the right to consideration in exchange for goods or servicesthat the entity has transferred to a customer. Company A recognizes a contract assetbecause as of December 31, 2020, there is no unconditional right to a consideration(receivable) yet since the first instalment of 10% is not due until January 1, 2021. This isconsistent with Example 39 of PFRS 15.IE201-203.


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View 2

Company A recognizes a receivable. PFRS 15.108 states that a receivable is anentity’s right to consideration that is unconditional. A right to consideration isunconditional if only the passage of time is required before payment of thatconsideration is due. The required payment on 1 January 2021 arises from acontractually agreed payment term, and only the passage of time is required beforeCompany A has a right to consideration.

The PIC has concluded that both Views above are acceptable as long as this isconsistently applied in transactions of the same nature. If presented as a contract asset,the disclosures required under PFRS 15 should be complied with. If presented as areceivable, the disclosures required under PFRS 9 should be followed.

Effective date

The effective date of the consensus in this Q&A follow that of PIC QA 2018-12, uponapproval by the FRSC.

Date approved by PIC: September 30, 2020


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References

PFRS 15.107 If an entity performs by transferring goods or services to a customerbefore the customer pays consideration or before payment is due, the entity shallpresent the contract as a contract asset, excluding any amounts presented as areceivable. A contract asset is an entity’s right to consideration in exchange for goods orservices that the entity has transferred to a customer. An entity shall assess a contractasset for impairment in accordance with PFRS 9. An impairment of a contract assetshall be measured, presented and disclosed on the same basis as a financial asset thatis within the scope of PFRS 9 (see also paragraph 113(b)).

PFRS 15.108 A receivable is an entity’s right to consideration that is unconditional. Aright to consideration is unconditional if only the passage of time is required beforepayment of that consideration is due. [Refer: Basis for Conclusions paragraphs BC323–BC326] For example, an entity would recognize a receivable if it has a present right topayment even though that amount may be subject to refund in the future. An entity shallaccount for a receivable in accordance with PFRS 9. Upon initial recognition of areceivable from a contract with a customer, any difference between the measurement ofthe receivable in accordance with PFRS 9 and the corresponding amountof revenue recognized shall be presented as an expense (for example, as animpairment loss).

Example 39—Contract asset recognized for the entity’s performance

PFRS 15.IE201 On 1 January 20X8, an entity enters into a contract to transferProducts A and B to a customer in exchange for CU1,000. The contract requiresProduct A to be delivered first and states that payment for the delivery of Product A isconditional on the delivery of Product B. In other words, the consideration of CU1,000 isdue only after the entity has transferred both Products A and B to the customer.Consequently, the entity does not have a right to consideration that is unconditional (areceivable) until both Products A and B are transferred to the customer.


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PFRS 15.IE202 The entity identifies the promises to transfer Products A and B asperformance obligations and allocates CU400 to the performance obligation to transferProduct A and CU600 to the performance obligation to transfer Product B on the basisof their relative stand-alone selling prices. The entity recognizes revenue for eachrespective performance obligation when control of the product transfers to the customer.

PFRS 15.IE203 The entity satisfies the performance obligation to transfer Product A:

Contract asset CU400

Revenue CU400

Example 40—Receivable recognized for the entity’s performance

PFRS 15.IE205 An entity enters into a contract with a customer on 1 January 20X9 totransfer products to the customer for CU150 per product. If the customer purchasesmore than 1 million products in a calendar year, the contract indicates that the price perunit is retrospectively reduced to CU125 per product.

PFRS 15.IE206 Consideration is due when control of the products transfer to thecustomer. Therefore, the entity has an unconditional right to consideration (i.e. areceivable) for CU150 per product until the retrospective price reduction applies (i.e.after 1 million products are shipped).

PFRS 15.IE207 In determining the transaction price, the entity concludes at contractinception that the customer will meet the 1 million products threshold and thereforeestimates that the transaction price is CU125 per product. Consequently, upon the firstshipment to the customer of 100 products the entity recognizes the following:

Receivable CU15,000(a)

Revenue CU12,500(b)

Refund liability (contract liability) CU2,500


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Q&A No. 2020 – 04 (Addendum to PIC Q&A 2018-12-D): PFRS 15 - Step3 - Requires and Entity to Determine the Transaction Price for theContract

Issue

Would a mismatch between the Percentage-of -Completion (POC) and schedule ofpayments constitute a significant financing component in determining the transactionprice given the following scenarios:

i. Higher payment (buyer pays ahead of the POC); andii. Lower payment (percentage of completion is ahead of the buyer’s payment).

Background

Please refer to the case facts in PIC Q&A No. 2018-12-D issued last February 14, 2018.

Consensus

In reference to PFRS 15.62(c), there is no significant financing component, if thedifference between the promised consideration and the cash selling price of the good orservice (as described in paragraph 61) arises for reasons other than the provision offinance to either the customer or the entity, and the difference between those amountsis proportional to the reason for the difference.

The support should be documented in writing, by the real estate entity, considering bothqualitative and quantitative factors.

Examples of scenarios or payment schemes where there maybe no significant financingcomponents are as follows:

a) Upfront payment of full cash price with discount - the contract to sell has no SFC,if the amount of discount generally corresponds to the amount of the savings oninventory holding costs and selling costs which the real estate developer shareswith the customer.


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b) Other real estate sale payment schemes that might provide the entity or thecustomer with protection from the other party failing to adequately completesome or all of its obligations under the contract.

Also, as provided under paragraph 63 of PFRS 15, an entity need not adjust thepromised amount of consideration for the effects of a significant financing component ifthe entity expects, at contract inception that the timing difference of the receipt of fullpayment of the contract price and that of the completion of the project, are expectedwithin one year and SFC is not expected to be significant.

Transition and Effective DateThe consensus in this Q&A is effective from the date of approval of the FRSC and willfollow the transition provision of the previously issued PIC Q&A.


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REFERENCES

PFRS 15.61The objective when adjusting the promised amount of consideration for a significantfinancing component is for an entity to recognize revenue at an amount that reflects theprice that a customer would have paid for the promised goods or services if thecustomer had paid cash for those goods or services when (or as) they transfer to thecustomer (i.e. the cash selling price). An entity shall consider all relevant facts andcircumstances in assessing whether a contract contains a financing component andwhether that financing component is significant to the contract, including both of thefollowing:(a) the difference, if any, between the amount of promised consideration and the cash

selling price of the promised goods or services; and(b) the combined effect of both of the following:

(i) the expected length of time between when the entity transfers the promisedgoods or services to the customer and when the customer pays for those goods orservices; and(ii) the prevailing interest rates in the relevant market.

PFRS 15.62Notwithstanding the assessment in paragraph 61, a contract with a customer would nothave significant financing component if any of the following factors exist:(a) the customer paid for the goods or services in advance and the timing of the

transfer of those goods or services is at the discretion of the customer.(b) a substantial amount of the consideration promised by the customer is variable and

the amount or timing of that consideration varies on the basis of the occurrence ornon-occurrence of a future event that is not substantially within the control of thecustomer or the entity (for example, if the consideration is a sales-based royalty).

(c) the difference between the promised consideration and the cash selling price of thegood or service (as described in paragraph 61) arises for reasons other than theprovision of finance to either the customer or the entity, and the difference betweenthose amounts is proportional to the reason for the difference. For example, thepayment terms might provide the entity or the customer with protection from theother party failing to adequately complete some or all of its obligations under thecontract.”


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PFRS 15.63

As a practical expedient, an entity need not adjust the promised amount ofconsideration for the effects of a significant financing component if the entity expects, atcontract inception, that the period between when the entity transfers a promised good orservice to a customer and when the customer pays for that good or service will be oneyear or less.


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Q&A No. 2020 – 05: PFRS 15 - Accounting for Cancellation of RealEstate Sales

Background

Company X is a real estate developer and is in the business of pre-sellingcondominium units while construction is not yet completed.

As allowed under Philippine Financial Reporting Standards, Company X uses thepercentage-of-completion (POC) method in accounting for its real estate sales.

In January 20x1, Company X pre-sold a condominium unit at Php1,000,000,payable for 3 years on an installment basis7. Under the sale contract, legal title tothe unit remains with Company X until full payment is made by the buyer.

Estimated cost to construct the unit is Php800,000. As at December 31, 20x1, POC of the unit is at 30% and collection from the buyer

is 15% of the selling price (Php150,000). Amounts recognized in the calendar year20x1 financial statements follow:

In June 20x2, the buyer defaulted on its payment and Company X agrees to thecancellation of the contract and subsequently repossessed the property8. Under thecontract, the title of the property is retained by Company X until the entire selling price iscollected.

At the time of repossession, the property was 50% completed (i.e. , at that point,Company X has already recognized revenue of Php500,000 and cost of sales ofPhp400,000). As agreed under the contract, Company X forfeits all paymentspreviously made by the buyer.

7 For simplicity, accounting for significant financing component is ignored in the discussion.8 Upon default of the buyer, the developer has the option to pursue collection or to repossess theproperty.

Amount in PhpReal Estate Revenue (1,000,000*30%) 300,000

Cost of Real Estate Sales (800,000*30%) 240,000


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Assume the following for purposes of discussion:Amount in Php

Receivable balance9 350,000Fair value4 of repossessed property 550,000Repossession cost5 5,000

It is assumed that fair value can be measured reliably.

Issue 1. How should Company X account for the sales cancellation andrepossession of the property?

Consensus:

Any of the three approaches below are acceptable but each approach should beapplied consistently.

Approach 1: The repossessed property is recognized at its fair value less cost torepossess

As the repossessed property will be accounted for as inventory, it will be initiallymeasured at cost under PAS 2.9. Cost as defined under the ConceptualFramework is the fair value of the consideration given at the time of acquisition. Inthis case, the consideration given in exchange for the property is the Receivablefrom the buyer. Just before the repossession happens, the Receivable has becomea right to receive the property, so the fair value of the Receivable is the fair value ofwhat Company X has claim to (i.e., the 50%-completed property) less any cost torepossess the property.

Just prior to repossession, Company X has to update its impairment assessment onthe Receivable. For example, if the fair value of the property to be repossessedless any repossession cost is higher than the carrying amount of the Receivable,then any previously recognized impairment on the Receivable has to be reversed(with reversal limited to the unimpaired amount).

9 Under PFRS 15, this includes Contract Asset (unbilled revenue) balance4 Fair value should be measured in accordance with PFRS 13 and in this illustration, should consider thatit is uncompleted.5 Refer to paragraph 10 of PAS 2, Inventories


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Upon repossession, the difference between the carrying amount of the Receivableto be derecognized and the fair value of the repossessed property lessrepossession cost will be recognized in profit or loss.

In the case at hand, the Receivable is unimpaired just prior to repossessionbecause the fair value less repossession cost of the property is Php545,000 and isgreater than the outstanding amount of the Receivable of Php350,000. Uponrepossession, a gain on repossession of Php195,000 will be recognized (Fair valueless repossession cost of Php545,000 less carrying amount of the Receivable ofPhp350,000). The repossession cost of Php5,000 will be capitalized as part of thecost of the repossessed property but subject to impairment.

See illustrative entries below (excludes the effect of taxation, Maceda law and anyunamortized cost of obtaining a contract):

Inventory 545,000

Receivable 350,000

Gain from repossession* 195,000

Inventory 5,000

Cash/Payable 5,000


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Approach 2: The repossessed property is recognized at its fair value plusrepossession cost

As there is no specific guidance in PAS 2 on accounting for repossessed property,reference can be made to the guidance in PAS 16.24 and PAS 40.27 for propertyacquired in exchange for a non-monetary asset/s or a combination of monetary andnon-monetary assets. Under these paragraphs, the asset received (in this case,the uncompleted property) is recognized at fair value.

Just prior to repossession, Company X has to update its impairment assessment onthe Receivable. For example, if the fair value of the property to be repossessedless any repossession cost is higher than the carrying amount of the Receivable,then any previously recognized impairment on the Receivable3 has to be reversed(with reversal limited to the unimpaired amount).

Upon repossession, the difference between the carrying amount of the Receivableto be derecognized and the fair value of the repossessed property2 will berecognized in profit or loss. Any cost incurred to repossess the property will becapitalized in accordance with PAS 2.15.

In the case at hand, the Receivable is unimpaired just prior to repossessionbecause the fair value less repossession cost of the property is Php545,000 and isgreater than the outstanding amount of the Receivable of Php350,000. Uponrepossession, a gain on repossession of Php200,000 will be recognized (Fair valueof Php550,000 less carrying amount of the Receivable of Php350,000). Therepossession cost of Php5,000 will be capitalized as part of the cost of therepossessed property but subject to impairment.

See illustrative entries below (excludes the effect of taxation, Maceda Law and anyunamortized cost of obtaining a contract:

Inventory 550,000Receivable 350,000Gain from repossession* 200,000

Inventory 5,000Cash/Payable 5,000

2 Upon default of the buyer, the developer has the option to pursue collection or torepossess the property.3 Under PFRS 15, this includes Contract Asset (unbilled revenue) balance


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Approach 3:

The cancellation is accounted for as a modification of the contract (i.e., from non-cancellable to being cancellable). The scope has also changed because Company Xwill no longer construct the property for the customer. Applying the provisions ofmodification of a contract, Company X will have to reverse the previously recognizedrevenues (PFRS 15.21B) and related costs recognized. Paragraphs 20 and Par 21A ofPFRS 15 do not apply since there is only one obligation in the contract and there are noremaining performance obligations at the time of the cancellation/modification.

See illustrative entries below (excludes the effect of taxation, Maceda Law and anyunamortized cost of obtaining a contract):

Inventory 400,000Receivable 350,000Gain from repossession* 45,000Cash/Payable 5,000

Sales 500,000 Cost of Sales 400,000 Gain from Repossession 100,000

*All approaches above should consider payments to buyers required under the MacedaLaw and the write off of any unamortized portion of cost of obtaining a contract in itsdetermination of gain/loss from repossession.

Given the history of cancellations, real estate developers should continuously revisitwhether the established level of down payment over the total contract price (equitydown payment) is still the level which indicates that it is probable that it will collect theentire consideration under the contract, which is one of the criteria to be met before therevenue recognition model applies.


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QUESTION 2

Would the accounting for the repossession change if the repossessed property isalready 100% completed?

Consensus:

No, the state of completion of the repossessed property will not impact the accountingtreatment. It is only relevant in determining the fair value of the property.

Transition and Effective DateThe consensus in this Q&A is effective from the date of approval of the FRSC and willbe applied prospectively from the date of approval of FRSC.


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REFERENCES

PAS 2.9

Inventories shall be measured at the lower of cost and net realizable value.

PAS 2.6

Net realizable value is the estimated selling price in the ordinary course of business lessthe estimated costs of completion and the estimated costs necessary to make the sale.

Fair value is the price that would be received to sell an asset or paid to transfer a liabilityin an orderly transaction between market participants at the measurement date.

PAS 2.7

Net realisable value refers to the net amount that an entity expects to realise from thesale of inventory in the ordinary course of business. Fair value reflects the price atwhich an orderly transaction to sell the same inventory in the principal (or mostadvantageous) market for that inventory would take place between market participantsat the measurement date. The former is an entity-specific value; the latter is not. Netrealisable value for inventories may not equal fair value less costs to sell.

PAS 2.10

The cost of inventories shall comprise all costs of purchase, costs of conversion andother costs incurred in bringing the inventories to their present location and condition.

PAS 2.11

The costs of purchase of inventories comprise the purchase price, import duties andother taxes (other than those subsequently recoverable by the entity from the taxingauthorities), and transport, handling and other costs directly attributable to theacquisition of finished goods, materials and services. Trade discounts, rebates andother similar items are deducted in determining the costs of purchase.


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PAS 2.15

Other costs are included in the cost of inventories only to the extent that they areincurred in bringing the inventories to their present location and condition. For example,it may be appropriate to include non-production overheads or the costs of designingproducts for specific customers in the cost of inventories.

Conceptual Framework 4.55

A number of different measurement bases are employed to different degrees and invarying combinations in financial statements. They include the following:

1. (a) Historical cost. Assets are recorded at the amount of cash or cashequivalents paid or the fair value of the consideration given to acquire them atthe time of their acquisition. Liabilities are recorded at the amount of proceedsreceived in exchange for the obligation, or in some circumstances (for example,income taxes), at the amounts of cash or cash equivalents expected to be paid tosatisfy the liability in the normal course of business.

PAS 16.24

One or more items of property, plant and equipment may be acquired in exchange for anon-monetary asset or assets, or a combination of monetary and non-monetary assets.The following discussion refers simply to an exchange of one non-monetary asset foranother, but it also applies to all exchanges described in the preceding sentence. Thecost of such an item of property, plant and equipment is measured at fair value unless(a) the exchange transaction lacks commercial substance or (b) the fair value of neitherthe asset received nor the asset given up is reliably measurable. The acquired item ismeasured in this way even if an entity cannot immediately derecognise the asset givenup. If the acquired item is not measured at fair value, its cost is measured at thecarrying amount of the asset given up.


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PAS 40.27

One or more investment properties may be acquired in exchange for a non-monetaryasset or assets, or a combination of monetary and non-monetary assets. The followingdiscussion refers to an exchange of one non-monetary asset for another, but it alsoapplies to all exchanges described in the preceding sentence. The cost of such aninvestment property is measured at fair value unless (a) the exchange transaction lackscommercial substance or (b) the fair value of neither the asset received nor the assetgiven up is reliably measurable. The acquired asset is measured in this way even if anentity cannot immediately derecognise the asset given up. If the acquired asset is notmeasured at fair value, its cost is measured at the carrying amount of the asset givenup.

PAS 18.16

If the entity retains significant risks of ownership, the transaction is not a sale andrevenue is not recognised. An entity may retain a significant risk of ownership in anumber of ways. Examples of situations in which the entity may retain the significantrisks and rewards of ownership are:

(a) when the entity retains an obligation for unsatisfactory performance not covered bynormal warranty provisions;

(b) when the receipt of the revenue from a particular sale is contingent on the derivationof revenue by the buyer from its sale of the goods;

(c) when the goods are shipped subject to installation and the installation is a significantpart of the contract which has not yet been completed by the entity; and

(d) when the buyer has the right to rescind the purchase for a reason specified in thesales contract and the entity is uncertain about the probability of return.


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PFRS 13.24

Fair value is the price that would be received to sell an asset or paid to transfer a liabilityin an orderly transaction in the principal (or most advantageous) market at themeasurement date under current market conditions (ie an exit price) regardless ofwhether that price is directly observable or estimated using another valuation technique.

PFRS 15.18

A contract modification is a change in the scope or price (or both) of a contract that isapproved by the parties to the contract. In some industries and jurisdictions, a contractmodification may be described as a change order, a variation or an amendment. Acontract modification exists when the parties to a contract approve a modification thateither creates new or changes existing enforceable rights and obligations of the partiesto the contract. A contract modification could be approved in writing, by oral agreementor implied by customary business practices. If the parties to the contract have notapproved a contract modification, an entity shall continue to apply this Standard to theexisting contract until the contract modification is approved.

PFRS 15.21B

An entity shall account for the contract modification as if it were a part of the existingcontract if the remaining goods or services are not distinct and, therefore, form part of asingle performance obligation that is partially satisfied at the date of the contractmodification. The effect that the contract modification has on the transaction price, andon the entity’s measure of progress towards complete satisfaction of the performanceobligation, is recognised as an adjustment to revenue (either as an increase in or areduction of revenue) at the date of the contract modification (ie the adjustment torevenue is made on a cumulative catch-up basis).


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PFRS 15.20An entity shall account for a contract modification as a separate contract if both of thefollowing conditions are present:

(a) the scope of the contract increases because of the addition of promised goods orservices that are distinct (in accordance with paragraphs 26–30); and

(b) the price of the contract increases by an amount of consideration that reflects theentity’s stand-alone selling prices of the additional promised goods or services and anyappropriate adjustments to that price to reflect the circumstances of the particularcontract. For example, an entity may adjust the stand-alone selling price of an additionalgood or service for a discount that the customer receives, because it is not necessaryfor the entity to incur the selling-related costs that it would incur when selling a similargood or service to a new customer.

PFRS 15.21If a contract modification is not accounted for as a separate contract in accordancewith paragraph 20, an entity shall account for the promised goods or services not yettransferred at the date of the contract modification (ie the remaining promised goods orservices) in whichever of the following ways is applicable:

(a) An entity shall account for the contract modification as if it were a termination of theexisting contract and the creation of a new contract, if the remaining goods or servicesare distinct from the goods or services transferred on or before the date of the contractmodification. The amount of consideration to be allocated to the remaining performanceobligations (or to the remaining distinct goods or services in a single performanceobligation identified in accordance with paragraph 22(b)) is the sum of:

(i) the consideration promised by the customer (including amounts alreadyreceived from the customer) that was included in the estimate of the transactionprice and that had not been recognised as revenue; and(ii) the consideration promised as part of the contract modification.

[Refer: Basis for Conclusions paragraphs BC78, BC79 and BC81(c)Illustrative Examples, example 5 Case B and examples 6 and 7]


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(b) An entity shall account for the contract modification as if it were a part of the existingcontract if the remaining goods or services are not distinct and, therefore, form part of asingle performance obligation that is partially satisfied at the date of the contractmodification. The effect that the contract modification has on the transaction price, andon the entity’s measure of progress towards complete satisfaction of the performanceobligation, is recognised as an adjustment to revenue (either as an increase in or areduction of revenue) at the date of the contract modification (ie the adjustment torevenue is made on a cumulative catch-up basis). [Refer: Basis for Conclusionsparagraphs BC80 and BC81(c) and Illustrative Examples, examples 8 and 9]

(c) If the remaining goods or services are a combination of items (a) and (b), then theentity shall account for the effects of the modification on the unsatisfied (includingpartially unsatisfied) performance obligations in the modified contract in a manner that isconsistent with the objectives of this paragraph.

PFRS 15.B20

In some contracts, an entity transfers control of a product to a customer and also grantsthe customer the right to return the product for various reasons (such as dissatisfactionwith the product) and receive any combination of the following:

(a) a full or partial refund of any consideration paid;

(b) a credit that can be applied against amounts owed, or that will be owed, to the entity;and

(c) another product in exchange.


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PFRS 15.B21

To account for the transfer of products with a right of return (and for some services thatare provided subject to a refund), an entity shall recognise all of the following:

(a) revenue for the transferred products in the amount of consideration to which theentity expects to be entitled (therefore, revenue would not be recognised for theproducts expected to be returned);

(b) a refund liability; and

(c) an asset (and corresponding adjustment to cost of sales) for its right to recoverproducts from customers on settling the refund liability.

PFRS 15.B22

An entity's promise to stand ready to accept a returned product during the return periodshall not be accounted for as a performance obligation in addition to the obligation toprovide a refund.

PFRS 15.B23

An entity shall apply the requirements in paragraphs 47–72 (including the requirementsfor constraining estimates of variable consideration in paragraphs 56–58) to determinethe amount of consideration to which the entity expects to be entitled (ie excluding theproducts expected to be returned). For any amounts received (or receivable2) for whichan entity does not expect to be entitled, the entity shall not recognise revenue when ittransfers products to customers but shall recognise those amounts received (orreceivable2) as a refund liability. Subsequently, at the end of each reporting period, theentity shall update its assessment of amounts for which it expects to be entitled inexchange for the transferred products and make a corresponding change to thetransaction price and, therefore, in the amount of revenue recognised.

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PFRS 15.B24

An entity shall update the measurement of the refund liability at the end of eachreporting period for changes in expectations about the amount of refunds. An entityshall recognise corresponding adjustments as revenue (or reductions of revenue).

PFRS 15.B25

An asset recognised for an entity's right to recover products from a customer on settlinga refund liability shall initially be measured by reference to the former carrying amountof the product (for example, inventory) less any expected costs to recover thoseproducts (including potential decreases in the value to the entity of returned products).At the end of each reporting period, an entity shall update the measurement of the assetarising from changes in expectations about products to be returned. An entity shallpresent the asset separately from the refund liability.


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PFRS 16, Leases

Q&A No. 2019 – 08: Accounting for Asset Retirement or RestorationObligation with the Adoption of PFRS 16, Leases

Background

In many cases, a lessee would enter into a lease agreement that requires the lessee to restorethe leased asset back to its original condition (e.g., remove any leasehold improvements) at theend of the lease term. These are more commonly known as asset retirement or restorationobligations or asset decommissioning liabilities.

Under PAS 17, Leases, operating leases are not recognized on the balance sheet andaccordingly, entities recognize the costs associated with asset retirement obligations (ARO) asa provision (i.e., a liability) in accordance with PAS 37, Provisions, Contingent Liabilities andContingent Assets and the corresponding asset as an item of property, plant and equipment inaccordance with paragraph 16(c) of PAS 16, Property, Plant and Equipment. However, uponadoption of PFRS 16, Leases, the accounting for such asset will change as PFRS 16.24(d)specifically indicate that the right-of-use asset (ROU) shall include, “an estimate of costs to beincurred by the lessee in dismantling and removing the underlying asset, restoring the site onwhich it is located or restoring the underlying asset to the condition required by the terms andconditions of the lease, unless those costs are incurred to produce inventories”.

This accounting alert aims to provide guidance on how a lessee should account for an AROupon adoption of PFRS 16, including how a lessee should, on transition, account for anyexisting ARO that was previously recognized as a provision and capitalized as part of propertyand equipment when the lessee was applying PAS 17.

Fact pattern 1:

On March 1, 2019, a lessee entered into a 10-year contract for the lease of a building. Underthe terms of the contract, the lessee is required to remove any equipment installed and restorethe building to its original condition at the end of lease term. Assume that applying PAS 37requirements, the estimated cost of dismantling and restoration would be CU200,000.


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Issue 1: Accounting for ARO at lease commencement date

How should the lessee account for the cost of dismantling the equipment and restoring thebuilding to its original condition?

Consensus:

The cost of dismantling and restoration (i.e., the ARO) should be calculated and recognized asa provision in accordance with PAS 37, with a corresponding adjustment to the related ROUasset as required by PFRS 16.24(d). In this fact pattern, the lessee will add CU200,000 to thecost of the ROU asset on lease commencement date, which will then form part of the amountthat will be amortized over the lease term.

Issue 2: Change in ARO after initial recognition

How should the lessee account for changes in the measurement of the ARO provision afterinitial recognition?

Consensus:

PAS 37.59 requires that provisions related to ARO be reviewed at the end of each reportingperiod or whenever there is a change in assumptions used (e.g., estimated cash outflowsrequired to settle the ARO or timing of those cash flows) to reflect the current best estimate ofthe provision. Reference is then made to IFRIC 1, Changes in Existing Decommissioning,Restoration and Similar Liabilities for guidance in accounting for changes in the ARO provision.

IFRIC 1 applies to any decommissioning, restoration or similar liability that has been bothrecognized as part of the cost of an asset measured in accordance with PAS 16 or as part of thecost of a ROU asset in accordance with PFRS 16, and recognized as a liability in accordancewith PAS 37. It addresses how the effect of the following events that change the measurementof an existing decommissioning, restoration or similar liability should be accounted for:

a. a change in the estimated outflow of resources embodying economic benefits (e.g., cashflows) required to settle the obligation;

b. a change in the current market-based discount rate (this includes changes in the timevalue of money and the risks specific to the liability); and

c. an increase that reflects the passage of time (also referred to as the unwinding of thediscount).

IFRIC 1 requires that for a change related to (c) above, the periodic unwinding of the discount isrecognized in profit or loss as a finance cost as it occurs. For a change caused by (a) or (b)


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above, the change in the liability should be added to or deducted from the cost of the asset (inthis fact pattern, the ROU asset) to which it relates (assuming the asset is measured atcost*). The adjusted depreciable amount of the asset is then depreciated prospectively over itsremaining term.

*IFRIC 1 also provides guidance if the asset is measured using the revaluation model.

Fact pattern 2:

A lessee has a 10-year contract for the lease of a building, which has been accounted for as anoperating lease under PAS 17. Under the terms of the contract, the lessee is required toremove any equipment installed and restore the building to its original condition at the end oflease term. On lease commencement date, the lessee recognized a provision relating to theequipment dismantling and restoration cost with a corresponding debit to property andequipment in accordance with PAS 16.16(c). On transition (to PFRS 16) date, the remaininglease term is 5 years.

Issue:

At transition date, how should the lessee account for any existing ARO recognized prior toadoption of PFRS 16?

Consensus:

Because ARO is not included as a component of lease liability, the measurement of such AROis outside the scope of PFRS 16. Hence, its measurement is generally not affected by thetransition to PFRS 16. Except in cases where the reassessment of lease-related assumptions(e.g., lease term) would affect the measurement of ARO-related provision, the amount of AROexisting at transition date would not be remeasured; rather, the balance of the ARO provisionand any related asset will remain as previously measured. The asset will simply be reclassifiedfrom property and equipment to the related ROU asset as required under PFRS 16.24(d).

Assuming there is a change in lease-related assumptions that would impact the AROmeasurement (e.g., change in lease term due to the new PFRS 16 requirements), the followingwill be the accounting treatment depending on the method used by the lessee in adopting PFRS16:

a. Modified retrospective approach - Under this approach, the lessee uses the remaininglease term to discount back the amount of provision to transition date. Any adjustment isrecognized as an adjustment to the ROU asset and ARO provision. This adjustment


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applies irrespective of which of the two methods in measuring the ROU asset will bechosen under the modified retrospective approach.

b. Full retrospective approach - The ARO provision and related asset, which gets adjustedto the ROU asset, should be remeasured from commencement of the lease, and thenamortized over the revised or reassessed lease term. Because full retrospectiveapproach is chosen, it is possible that the amount of cumulative adjustment to the AROprovision and the ROU asset at the beginning of the earliest period presented will not bethe same; hence, it is possible that it might impact retained earnings.

Effective date

The effective date of the consensus in this Q&A follow that of Appendix C of PFRS 16, uponapproval by the FRSC.


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Q&A No. 2019 – 09: Accounting for Prepaid Rent or Rent LiabilityArising from Straight-lining under PAS 17 on Transition to PFRS 16and the Related Deferred Tax Effects

This Q&A aims to provide guidance on the following:

1. How a lessee should account for its transition from PAS 17 to PFRS 16 using the modifiedretrospective approach. Specifically, this aims to address how a lessee should, ontransition, account for any existing prepaid rent or rent liability arising from straight-liningof an operating lease under PAS 17, and

2. How to account for the related deferred tax effects on transition from PAS 17 toPFRS 16.

Fact pattern

Assume that prior to adoption of PFRS 16, a lessee has a 5-year lease contract whichcommenced on January 1, 2018. The lease was accounted for as operating lease underPAS 17. Accordingly, the lessee recognized rent expense on a straight-line basis over the leaseterm, even though the lease payments escalate annually by 5%. At date of transition to PFRS 16(January 1, 2019), the lessee has rent liability amounting to CU1,000 because of the applicationof the straight-lining concept.

In the entity’s tax jurisdiction, lease payments become deductible for tax on a cash basis,accordingly, there is a deductible temporary difference on which deferred tax asset amounting toCU300 (assume tax rate of 30%) is recognized.

Issue 1

On transition to PFRS 16, how should the entity account for the rent liability that arose out of thestraight-lining under PAS 17?

Consensus

PFRS 16 allows an entity to apply either the a) full retrospective approach or b) modifiedretrospective approach in transitioning to PFRS 16. The approach selected should be appliedconsistently to all leases where the entity doing the transition is a lessee.

a. Under the full retrospective approach, a lessee will measure the right-of-use asset and leaseliability in accordance with PAS 8 and will restate all comparative information. Under thismethod, a lessee will assume that PFRS 16 had always been applied and accordingly, will


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adjust any effect of transition (including any effect of reversing any outstanding prepaid rentor rent liability arising from straight-lining under PAS 17) to retained earnings as of thebeginning of the earliest period presented.

b. Under the modified retrospective approach, a lessee will apply PFRS 16 with cumulativeeffect of initial application recognized in retained earnings or other component of equity, asappropriate, at date of initial application, and will not restate any comparativeinformation. Under this approach, a lessee in a previously classified operating leaserecognizes a lease liability at date of initial application at the present value of the remaininglease payments, discounted using the lessee’s incremental borrowing rate at date of initialapplication. At the same time, such lessee recognizes a right-of-use (ROU) asset at date ofinitial application, measured using either of two methods chosen on a lease-by-lease basis:

Method 1 - at an amount as if PFRS 16 had been applied since commencement date,but discounted using the lessee’s incremental borrowing rate at date of initial application;or

Method 2 - at an amount equal to the lease liability, adjusted by the amount of anyprepaid or accrued lease payments relating to that lease recognized in the statement offinancial position immediately before the date of initial application.

As indicated above, under Method 2, any prepaid rent or rent liability arising from straight-lining under PAS 17 is capitalized as part of the ROU asset on transition. If straight-liningresulted in prepaid rent, that would have increased the ROU asset on transition; had itresulted in rent liability, it would have otherwise decreased the ROU asset. There istherefore no expected adjustment to retained earnings in so far as straight-lining effectunder PAS 17 is concerned. On the other hand, under Method 1, there may be anadjustment to retained earnings at transition date.

Please refer to Appendix 1 for the illustrative entries.

Issue 2

How should the deferred tax be accounted for at the transition date?

Consensus

Accounting for the deferred tax at transition date depends on which of the acceptableapproaches below is selected by the entity.

Approach 1A: - Recognize deferred tax on initial recognition - consider asset and liabilityseparately. The entity recognizes: (1) a deferred tax asset for the temporary difference on the


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lease liability and (2) a deferred tax liability for the temporary difference on the right-of-useasset.

Approach 1B: Recognize deferred tax - consider asset and liability as in-substance linked toeach other. The entity regards the right-of-use asset and the lease liability as a single item. Onthis basis, the net asset or liability is compared to its tax base and deferred tax is recognized onthat net amount. On this basis, the net carrying amount of the right-of-use asset and the leaseliability is zero on initial recognition, as is the tax base. Consequently, there is no temporarydifference and the initial recognition exemption (IRE) does not apply. Deferred tax is recognizedon subsequent temporary differences that arise when the net asset changes from zero.

Approach 2: Apply the IRE. The entity recognizes neither the deferred tax asset for thetemporary difference on the lease liability nor the corresponding deferred tax liability for thetemporary difference on the right-of-use asset.

IFRS Development

The International Accounting Standards Board has issued an Exposure Draft proposing anarrow-scope amendment to IAS 12. That narrow-scope amendment proposes that the IRE inparagraphs 15 and 24 of IAS 12 should not apply to transactions that give rise to bothdeductible and taxable temporary differences to the extent that an entity would otherwiserecognize a deferred tax asset and deferred tax liability of the same amount in respect of thosetemporary differences. The Exposure Draft is currently under comment period (comment periodends November 14, 2019). Pending finalization of this Exposure Draft, Approach 2 describedabove will remain acceptable.

Effective date




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Appendix:

Accounting for related deferred tax effect on transition:

Full Retrospective ApproachROU asset and lease liability are calculated as of January 1, 2018 (the lease commencementdate), using information available at that date. Assuming ROU asset and lease liability ofCU45,000, the following transition entry is made at January 1, 2018:

Dr. ROU Asset CU45,000Cr. Lease Liability CU45,000

In addition, the straight-lining effect under PAS 17 is also reversed as of January 1, 2018.

For years 2018 and 2019, the lessee will also recognize amortization of ROU asset andaccretion of lease liability. These might trigger restatement of previously issued financialstatements of 2018.


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Modified Retrospective ApproachMethod 1The ROU asset is calculated as of January 1, 2018 (the lease commencement date) using theincremental borrowing rate as of January 1, 2019 (the initial application date) and amortized upto January 1, 2019. If the amortized cost of the ROU asset as of January 1, 2019 is CU37,500while the lease liability is CU40,000, the following transition entries are made:

Dr. ROU Asset CU37,500Dr. Retained Earnings* CU2,500Cr. Lease Liability CU40,000

* difference between the ROU asset and the lease liability

Dr. Rent Liability CU1,000Cr. Retained Earnings** CU1,000

** for the reversal of the rent liability arising from straight-lining under PAS 17

Method 2The ROU asset, which is initially equal to the lease liability of CU40,000, is adjusted for anyprepaid or accrued lease payments recognized under PAS 17. In accordance with the transitionprovision of PFRS 16, the rent liability amounting to CU1,000 under PAS 17 is closed againstthe ROU asset. The following transition entry is made:

Dr. ROU Asset CU39,000Dr. Accrued Rent Liability CU1,000Cr. Lease Liability CU40,000

Accounting for related deferred tax effect on transition:

Full Retrospective ApproachDepending on the applied approach, the following transition entry is made with respect to thedeferred tax effect of the lease at its initial recognition as of January 1, 2018 (the leasecommencement date):

Approach 1A Approach 1B Approach 12Dr. Deferred Tax Asset CU13,500 Nil NilCr. Deferred Tax Liability CU13,500 Nil Nil

In addition, any deferred tax previously recognized on the straight-lining effect under PAS 17 isalso reversed as of January 1, 2018 (consistent with the reversal of such straight-lining effect).


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Modified Retrospective ApproachApproach 1ARecognize deferred tax on initial recognition - consider asset and liability separately (grossbasis). Under this approach, the entity will derecognize the existing deferred tax assetamounting to CU300 and recognize deferred tax based on the new temporary differencesarising from the initial recognition of the ROU asset and lease liability:

Method 1 Method 2Dr. Retained Earnings* CU300 CU300Cr. Deferred Tax Asset CU300 CU300* to derecognize deferred tax asset on the effect of the straight-lining concept

Dr. Deferred Tax Asset CU12,000 CU12,000Cr. Retained Earnings CU750 CU300Cr. Deferred Tax Liability CU11,250 CU11,700

Approach 1BRecognize deferred tax - consider asset and liability as in-substance linked to each other (netbasis).Same as approach 1A, but the deferred tax asset and liability are recognized on a net basis:

Method 1 Method 2Dr. Retained Earnings* CU300 CU300Cr. Deferred Tax Asset CU300 CU300* to derecognize deferred tax asset on the effect of the straight-lining concept

Dr. Deferred Tax Asset - net CU750 CU300Cr. Retained Earnings CU750 CU300

Approach 2Apply the IRE (deferred tax is not recognized). The IRE applies to the balance of the ROUasset, net of the accrued rent liability. The initial recognition of the ROU asset, net of theaccrued rent liability, happens at the transition date - accordingly, the entity can invoke the IREon the balance of the ROU asset. The related deferred tax asset on the rent liability amountingto CU300 should be derecognized and charged against retained earnings.

Method 1 Method 2Dr. Retained Earnings CU300 CU300Cr. Deferred Tax Asset CU300 CU300


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Q&A No. 2019 – 10: Accounting for variable payments with rent review

Some lease contracts provide for market rent review in the middle of the lease term to adjust thelease payments to reflect a fair market rent for the remainder of the lease term. This Q&A providesguidance on how to measure the lease liability when the contract provides for a market rentreview.

Fact pattern

A lessee entered into a lease contract for the lease of land for 10 years. The contract providesfor annual lease payments of Php10,000 payable at the end of each year with fixed annualescalation of 2% up to Year 5. At the beginning of Year 6, a rent review will be done and leasepayments will be reset to reflect market including the subsequent escalation rates, if any.Assume there is no floor or ceiling on the rent review at the beginning of Year 6.

Issue 1

What payments should be included in the initial calculation of the lease liability?

Consensus

For initial measurement, the lessee uses the current rate of Php10,000 with escalation of 2% upto Year 5 and considers the remaining lease payments from Years 6 -10 as variable leasepayments that depend on an index or rate because these vary to reflect changes in marketrental rates as contemplated in PFRS 16 paragraph 28. In this case, the variability comes fromthe rent review which will only be resolved at the beginning of Year 6 and not from theapplication of the fixed annual escalation.

Applying the requirement of PFRS 16 paragraph 27(b), which provides that variable leasepayments that depend on an index or rate that will be included in the measurement of the leaseliability should be measured using the index or rate as at commencement date, the lesseeshould use the inception rate of Php10,000 as the assumed market rental rate from Years 6 - 10until such time that the variability is resolved when the rent review is completed at the beginningof Year 6. This is consistent with PFRS 16 paragraph 42(b) where the finalization of rent reviewtriggers reassessment of lease liability as it is considered as an event that resolves variability.

Refer to Appendix for the illustration of the calculation of the lease liability.


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Issue 2

Assume that after the rent review, the agreed rate for Year 6 is Php12,000 with annual increaseof 1% thereafter; how should the lessee update the lease payments for Years 6-10?

Consensus

Upon the agreement on the new rates at the beginning of Year 6, the lease liability should beupdated to reflect the revised lease payments. The agreement on the new rates following therent review at the beginning of Year 6 means that the variability has been resolved for Years 6 -10; hence the cash flows should be updated in the liability calculation [PFRS 16.42(b)].

PFRS 16 paragraph 42(b) provides that, “A lessee shall determine the revised lease paymentsfor the remainder of the lease term based on the revised contractual payments.” Therefore, incalculating the revised lease liability at the beginning of Year 6, the cash flows for Years 6 - 10should be updated to reflect the result of the market rent review. Accordingly, lease paymentswill now be at Php12,000 starting from Year 6 plus 1% annual escalation for Years 7 - 10.

Refer to Appendix for the illustration of the calculation of the lease liability and relatedadjustment.

Effective date



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Appendix

Issue 1 – Illustration of the calculation of the lease liability

Year Lease PaymentDiscount Factor

@ 8%Present Value ofLease Liability

1 Php10,000 0.9259 Php9,2592 10,200 0.8573 8,7443 10,404 0.7938 8,2594 10,612 0.7350 7,8005 10,824 0.6806 7,3676 10,000 0.6302 6,3027 10,000 0.5835 5,8358 10,000 0.5403 5,4039 10,000 0.5002 5,002

10 10,000 0.4632 4,632Php68,603

Notes:1. For the purpose of this illustration, assume that the incremental borrowing rate of the

lessee is 8%.2. Escalation of 2% per annum was effected for Years 2 to 5. For Years 6-10, Php10,000

rent rate was used.


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Amortization table of lease liability

Year Lease PaymentInterestExpense Amortization

Carrying amountof lease liability

0 Php68,6031 10,000 5,488 4,512 64,0912 10,200 5,127 5,073 59,0183 10,404 4,721 5,683 53,3354 10,612 4,267 6,345 46,9905 10,824 3,759 7,065 39,9256 10,000 3,194 6,806 33,1197 10,000 2,650 7,350 25,7698 10,000 2,062 7,938 17,8319 10,000 1,426 8,574 9,257

10 10,000 741 9,257 –

Illustrative journal entries:

Year 0

ROU asset 68,603Lease liability 68,603

To recognize the ROU asset and lease liability at commencement date

Years 1 -5

Amortization expense 34,302Accumulated amortization 34,302

To recognize the amortization of the ROU asset for Years 1-5(Php68,603 x 5/10 years)

Lease liability 28,678Lease interest expense 23,362

Cash 52,040To record lease payments and interest expense on lease liability for Years 1-5


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Issue 2 – Illustration of the calculation of the lease liability after rent review

Year Lease PaymentDiscount Factor

@ 8% Present Value6 12,000 0.9259 Php11,1117 12,120 0.8573 10,3908 12,241 0.7938 9,7179 12,363 0.7350 9,087

10 12,487 0.6806 8,499Php48,804

Note:1. In this scenario, the original incremental borrowing rate of 8% shall be used to discount the

remaining lease payments.

Adjustment to the lease liability and ROU asset is computed as follows:

PV of lease liability after rent review Php48,804Carrying of original lease liability at end of Year 5 39,925Adjustment to lease liability and ROU asset Php8,879

Carrying of the ROU asset at end of Year 5 Php34,301Adjustment to ROU asset 8,879Adjusted carrying amount of ROU asset* Php43,180*To be depreciated over the remaining lease term.

Illustrative journal entries:

Year 6ROU asset 8,879

Lease liability 8,879To adjust lease liability and ROU asset due to the rent review

Amortization expense 8,636Accumulated amortization 8,636

To recognize the amortization of the ROU asset for Year 6(Php43,180 / 5 years)

Lease liability 8,096Lease interest expense 3,904

Cash 12,000To record lease payment and interest expense on lease liability for Year 6


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Q&A No. 2019 – 11: Determining the current portion of an amortizingloan/lease liability

This Q&A aims to provide guidance on how to determine the current portion of an amortizingloan/lease liability for proper classification/presentation between current and non-current in thestatement of financial position.

Issue

How is the split between the current and non-current portion of an amortizing loan/lease liabilitycalculated at each respective year end?

Fact Pattern

On January 1, 20x1, an entity enters into a five (5)-year loan agreement for a principal amountof CU4,212. The loan has an effective interest rate of 6%, and will be paid off in 5 equalinstallments of CU1,000, payable annually in arrears (ie, every December 31).

Based on the above information, the amortization table for the loan follows:

Yearend Payment Opening liability Interest Principal Closing liability(A) (B) (B) x 6% = (C) (A) - ( C ) = (D) (B) - (D ) = (E)

12/31/20x1 1,000 4,212 253 747 3,46512/31/20x2 1,000 3,465 208 792 2,67312/31/20x3 1,000 2,673 160 840 1,83312/31/20x4 1,000 1,833 110 890 94312/31/20x5 1,000 943 57 943 -

(Note: The table above would also apply to a 5-year lease agreement with CU1,000 per annumrental rate, payable annually in arrears with an IRIL/IBR of 6%).

Guidance

PAS 1.60 provides that an entity shall present current and non-current assets, and current andnon-current liabilities, as separate classifications in its statement of financial position, exceptwhen a presentation based on liquidity provides information that is reliable and more relevant.When that exception applies, an entity shall present all assets and liabilities in order of liquidity.


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Under PAS 1.61, whichever method of presentation is adopted, an entity shall disclose theamount expected to be recovered or settled after more than twelve (12) months for each assetand liability line item that combines amounts expected to be recovered or settled:(a) no more than 12 months after the reporting period, and(b) more than 12 months after the reporting period.

Further, PAS 1.69 states that an entity shall classify a liability as current when:

(a) it expects to settle the liability in its normal operating cycle;(b) it holds the liability primarily for the purpose of trading;(c) the liability is due to be settled within 12 months after the reporting period; or(d) it does not have an unconditional right to defer settlement of the liability for at least twelve

months after the reporting period. Terms of a liability that could, at the option of thecounterparty, result in its settlement by the issue of equity instruments do not affect itsclassification.

An entity shall classify all other liabilities as non-current.

Consensus

View A - The current portion of the financial liability is the principal portion that is due to besettled in the next 12 months.

The financial liability is viewed as a single amortizing loan that will accrue interest on the totalprincipal amount and will be repaid through a future stream of cash flows. Applying PAS 1.69(that a liability shall be classified as current when ‘the liability is due to be settled within 12months’), the current portion is based only on the actual principal to be repaid within the next12 months. In the fact pattern, this is equivalent to the difference between the closing liability atreporting period date and the closing liability at the following reporting period date.

Yearend Current Noncurrent Total12/31/20x1 792 2,673 3,46512/31/20x2 840 1,833 2,67312/31/20x3 890 943 1,83312/31/20x4 943 - 94312/31/20x5 - - -

View B: The current portion of the financial liability is the present value of the cash repaymentthat is due to be settled within the next 12 months.


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The liability represents the aggregate of five (5) discrete cash flows, each discounted at the 6%EIR for the respective number of periods, which at commencement aggregate to a liability ofCU4,212.

The current portion (CU943) is calculated as the present value of the payment due within thenext 12 months (CU1,000), discounted at the effective interest rate of 6% for 12 months[CU1,000/(1.06)].

Yearend Current Noncurrent Total12/31/20x1 943 2,522 3,46512/31/20x2 943 1,730 2,67312/31/20x3 943 890 1,83312/31/20x4 943 - 94312/31/20x5 - -

View A is the technically correct and preferred view, but the entity is not precluded from applyingView B, until there is further guidance as the IASB completes the amendments to PAS 1. Anyview opted by the entity should be applied consistently to all its financial/lease liabilities.

Effective date

The consensus in this Q&A becomes effective upon approval by the FRSC.


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Q&A No. 2019 – 12: Determining the lease term under PFRS 16,Leases

This Q&A aims to provide guidance in determining the lease term under the new leasesstandard. Such exercise may require significant judgment especially when the lease agreementcontains an option to either extend or terminate the lease.

Issue

How should an entity determine the lease term under PFRS 16, Leases?

Discussion

PFRS 16, Leases, defines “lease term” as the non-cancellable period of a lease, together withboth:

a) periods covered by an option to extend the lease if the lessee is reasonably certain toexercise that option; and

b) periods covered by an option to terminate the lease if the lessee is reasonably certainnot to exercise that option.

The Basis for Conclusions of PFRS 16 indicates that a contract would be considered to existonly when it creates rights and obligations that are enforceable. Therefore, any non-cancellableperiod or notice period in a lease would meet the definition of a contract and, thus, would beincluded as part of the lease term. To be part of a contract, any option to extend or terminatethe lease that are included in the lease term must also be enforceable. For example, thelessee must be able to enforce its right to extend the lease beyond the non-cancellable period.

If optional periods are not enforceable (e.g., if the lessee cannot enforce the extension of thelease without the agreement of the lessor), the lessee does not have the right to use the asset


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beyond the non-cancellable period. Consequently, by definition, there is no contract beyond thenon-cancellable period (plus any notice period) if there are no enforceable rights and obligationsexisting between the lessee and lessor beyond that term. In assessing the enforceability of acontract, an entity should consider whether the lessor can refuse to agree to a requestfrom the lessee to extend the lease. Accordingly, if the lessee has the right to extend orterminate the lease, there are enforceable rights and obligations beyond the initial non-cancellable period and thus, the parties to the lease would be required to consider thoseoptional periods in their assessment of the lease term. In contrast, a lessor’s right toterminate a lease is ignored when determining the lease term because, in that case, thelessee has an unconditional obligation to pay for the right to use the asset for the periodof the lease, unless and until the lessor decides to terminate the lease.

In assessing whether a lessee is reasonably certain to exercise an option to extend a lease, ornot to exercise an option to terminate a lease, an entity shall consider all relevant facts andcircumstances (i.e., including those that are not indicated in the lease contract) that create aneconomic incentive for the lessee to exercise the option to extend the lease, or not to exercisethe option to terminate the lease.

Practical examples in determining lease term

1. Lease for twelve months without renewal option but lessee has historically renewedthe lease. Even though it is usually expected of the lessee to renew the lease based oncustomary business practices and/or past experience of the lessee, the lease term is still12 months and will qualify as a short-term lease since absent any option, the lessee has noenforceable right to renew the lease beyond 12 months. Under PFRS 16.7, every time thereis a modification to the lease term of a short-term lease, it shall be treated as a new lease.

2. Zero penalty leases - lessee. Assume a 14-year lease that can be terminated by thelessee every two years without incurring any penalty. Because it is only the lessee that canterminate the lease, only the lessee has the absolute right to enforce the entire duration ofthe lease. It is not impacted by the preference of the lessor. In assessing the period overwhich the lessee will enforce the lease, it should be assessed as to what the lessee can doand what the lessee is reasonably certain to do. Among those that can be considered arethe leasehold improvements that the lessee has built on the leased properties, theinteraction of this lease contract with the other arrangements that the lessee has enteredinto, and the experience of the lessee in leases of similar assets in the past.

3. Zero penalty leases - both parties. A similar example in No. 2, but this time, either partycan terminate the lease for zero penalty. This is an example where PFRS 16 B34 will comein. B34 states that “a lease is no longer enforceable when the lessee and the lessor each


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has the right to terminate the lease without permission from the other party with no more thanan insignificant penalty”. However, while the contract states that either party on terminationwill not pay any penalty to the other, PFRS 16 requires an entity to consider all relevantfacts and circumstances that create an economic incentive for either party to exercise or notto exercise the option. For example, if either party will suffer more than an insignificantamount of resource outflows or losses on termination (e.g., significant cost of leaseholdimprovements built and cost of relocating for the lessee, or significant cost of finding a newtenant for the lessor), then this becomes an economic penalty for the concerned party not toexercise the termination clause. In this example, the lessee has already built significantleasehold improvements on the leased property, hence there is significant economicdisincentive or penalty for the lessee to exercise its termination option. In effect, only thelessor has the option to terminate the lease at zero penalty. Under PFRS 16 B35, “if onlythe lessor has the right to terminate a lease, the non-cancellable period of the lease includesthe period covered by the option to terminate the lease”. In this example, the lessee actuallyhas the right to terminate the lease but because of the significant economic penaltyinvolved, similar to No. 2 above, the lessee has to assess the period over which the lesseeis reasonably certain to continue leasing the asset. Depending on the lessee’sassessment, the lease term could be 14 years. In conclusion, this example illustrates thathaving a zero penalty on either party to terminate the lease will not automatically make thecontract unenforceable as discussed in B34 because of the presence of other economicpenalties that render such zero penalties without substance.

4. Lease continues to be renewed until either party terminates. In this example, a leasehas an initial term of 12 months and gets automatically renewed for an indefinite periodunless cancelled by either the lessee or lessor. The issue in this example is whether thelease is enforceable beyond the 12-month period, and if yes, what is the lease term absentany specific date up to when the lease can be renewed. Similar to the discussions inExamples 2 and 3 above, if the economic penalty for either party to terminate is no morethan insignificant, then the renewal period beyond the initial 12 months is consideredunenforceable; hence the term cannot be more than 12 months. On the other hand, if eitherparty can cancel but will sustain an economic penalty that is more than insignificant (i.e.,renewal period is considered enforceable), then it will be assessed as to whether the lesseeis reasonably certain to continue with the lease and for how long, keeping in mind theentity’s reasonable expectation of the period over which the asset will be used. Judgementwill need to be exercised in this assessment considering the available facts andcircumstances including the significant economic incentives and penalties to the lessee andthe length of time the lessee typically uses this kind of asset.

5. Rolling 12-month extension options. In this example, a lease has an initial period of 10years and the lessee can extend the contract on a rolling basis for 12 months


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thereafter. Also, there are no termination payments if the extensions are nottaken. Assuming that after 10 years, the lessee concludes that the remaining lease term atthat time is only 12 months, can the PFRS 16 recognition exemption for short-term leasesbe applied? The answer is No because the basis of the IASB in coming up with the off-balance sheet reprieve available to short-term leases is a purely cost saving measure andhence applicable only to clearly simple and straight-forward short term leases. Thisexample is a case of a revised lease term (following the exercise by the lessee of anextension option) that requires remeasurement of a lease asset and liability that are alreadyon the balance sheet.

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Q&A No. 2019 – 13: Determining the lease term of leases that arerenewable subject to mutual agreement of the lessor and the lessee

This Q&A is a supplement to PIC Q&A 2019-12, providing guidance on determining the leaseterm under PFRS 16. This focuses on lease contracts that are renewable subject to mutualagreement of the parties.

Issue 1:

What is the non-cancellable lease term?

Fact Pattern 1:

A lessee enters into a lease contract with a lessor for the lease of land over a one-year period,renewable for another year subject to agreement of both parties. The lessee constructedleasehold improvement on the leased land.

Consensus:

The non-cancellable period is just one year because there is no enforceable contract after theone-year period. Under PFRS 16, a renewal option is only considered in determining the leaseterm if it is enforceable. The renewal option in this case is not enforceable as both parties stillneed to agree to renew, including the terms of the renewal. A renewal that is still subject tomutual agreement of the parties is legally unenforceable under Philippine laws until both partiescome to an agreement on the terms.

Fact Pattern 2:

Same as in Fact Pattern 1, except that historically, the parties have always come to a mutualagreement to renew the contract.

Consensus:

The non-cancellable period is still just the one-year contractual period. Despite the history ofrenewal, the lessee’s right to use the underlying asset does not go beyond the one-year periodcovered by the current contract as any renewal still has to be agreed on by both parties. Arenewal is treated as a new contract.

Other reminders:


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Note that the above fact patterns are different from Example 4 (Lease continues to berenewed until either party terminates or an “evergreen lease”) of PIC Q&A No. 2019-12. Inthat fact pattern, while the initial term is only for 12 months, the contract specificallyindicated that the lease will automatically renew for an indefinite period until either partycancels the contract. Thus, in that fact pattern, the lessee has an enforceable right tocontinue using the underlying asset beyond the initial 12 month-period until either the lessorcancels the contract or the lessee decides to stop leasing the asset.

Note also that an evergreen lease is still enforceable even if the future lease rates are still tobe mutually agreed by the parties because it provides the lessee with a right to use theasset beyond the initial one-year period.

Issue 2:Under both Fact Patterns 1 and 2 above, what is the depreciable life of the related leaseholdimprovement?

Consensus:The assessment on whether a renewal option is enforceable or not would impact thedetermination of the amortization period of any related leasehold improvements as PAS 16requires consideration of any legal limits imposed on the use of the asset. In the fact patternsabove, the amortization period cannot go beyond the one-year contractual period.

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Q&A No. 2020 – 06: Accounting for payments between and amonglessors and lessees

Issue

What is the accounting treatment, from both the lessor’s and the lessee’s perspectives, inrespect of payments made between and among lessors and lessees (both old lesseesand new lessees)?

Fact Pattern

1. Lessor pays:

A. Old lessee to get out of a lease agreement as it intends to redevelop or renovatethe property. The lease is classified by the lessor as an operating lease.

B. Old lessee to get out of the lease agreement as the lessor intends to or hasalready re-let the same premises to a new lessee that will pay a significantlyhigher rent than the old lessee, or is of higher quality, or both. No amount orportion paid to old lessee is for redevelopment or renovation of the property.The lease is classified by the lessor as an operating lease.

C. A new lessee in the form of an incentive to occupy the property immediately.

D. For alterations to the building specific to the new lessee, which the new lesseemakes on its own behalf, that have no further value to the lessor after thecompletion of the lease period. The alterations are owned by the new lessee. Thelease contract does not contain any renewal options.

2. Old lessee pays:

A. The lessor to enable the old lessee to immediately vacate the leased premises.The lease is classified by the lessor as an operating lease.

B. A new lessee to immediately take over the lease.


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3. A new lessee pays:A. The lessor (at or before lease commencement) in order to secure the right to

obtain a lease agreement. The amount paid is non-refundable.[In this fact pattern, the leased asset meets the definition of property, plant andequipment in Philippine Accounting Standard (PAS) 16.]

B. An old lessee to buy out the lease agreement effective immediately (commonlyknown as payment of “key money”).

Consensus

1. Lessor pays:

A. Old lessee to get out of a lease agreement as it intends to redevelop orrenovate the property. The lease is classified by the lessor as an operatinglease.

Lessor accounting: This is a lease modification and so the lessor will have torecalculate the revised lease payments (net of the one-time/off amount to be paid tothe old lessee) at modification date. Any prepaid or accrued lease existing atmodification date that arose from the contract prior to modification shall be includedas part of the lease payments under the modified contract. The revised leasepayments will be amortized as income on a straight-line basis or another systematicbasis over the revised/shortened lease term.

A net payable (i.e., if the one-time payment by the lessor exceeds the amounts to bereceived by the lessor over the remaining lease term) by the lessor to the lessee willbe recognized by the lessor as an expense at the time of lease modification, unlessthe payment to the old lessee meets the definition of construction costs under PAS16 or PAS 40. If a payment meets the definition of construction costs, it is capitalizedas part of the associated property. For example, an entity that acquired a shoppingmall and made payments to evict existing retail lessees in order to redevelop theproperty into an office building would capitalize the payments.


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Old lessee accounting: The accounting involves the following:1) The old lessee determines the proportionate decrease in the carrying amount of

the right-of-use asset based on the remaining right-of-use asset (i.e., for theremaining period at the effective date of the modification rather than the originallease term) and calculates the remaining lease liability as the present value of theremaining lease payments (net of any amount to be received from the lessor)discounted using the original discount rate of the lease. Based on the amountscalculated, the old lessee reduces the carrying amount of the right-of-use assetand the carrying amount of the lease liability and recognize the difference as again or loss in profit or loss at the effective date of the modification.

2) The old lessee remeasures the remaining lease liability calculated above usingthe revised discount rate (i.e., the interest rate implicit in the lease for theremainder of the lease term or the incremental borrowing rate as of the effectivedate of the lease modification). Any adjustment to the remaining lease liability isalso recognized as an adjustment to the right-of-use asset.

3) The old lessee revisits the amortization period of the right-of-use asset and relatedleasehold improvement, if any, following the shortening of the term.

B. Old lessee to get out of the lease agreement as the lessor intends to or hasalready re-let the same premises to a new lessee that will pay a significantlyhigher rent than the old lessee, or is of higher quality, or both. No amount orportion paid to old lessee is for redevelopment or renovation of the property.The lease is classified by the lessor as an operating lease.

Lessor accounting: Conclusion is same as A. above.

Old lessee accounting: Conclusion is same as A. above.


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C. A new lessee in the form of an incentive to occupy the property immediately.

Lessor accounting: If the lease is a finance lease, PFRS 16 requires the lessor todeduct, at commencement date, any lease incentives payable, from the leasepayments included in the measurement of the net investment in the lease.Accordingly, when the incentive is payable after lease commencement (i.e., it waspayable but not paid on or before the lease commencement), the incentive payable iscredited with an offsetting debit entry to the net investment in the lease.

If the lease incentive has been paid to the lessee at or prior to the commencementdate, the incentive is included in the calculation of gain or loss on disposal on afinance lease. Accordingly, after the payment is made, the amount of the netinvestment in the lease is the same, whether the incentive is payable or paid at leasecommencement.

If the lease is an operating lease, PFRS 16 requires the lessor to add initial directcosts incurred in obtaining an operating lease to the carrying amount of the underlyingasset and recognize those costs as an expense over the lease term on the samebasis as the lease income.

New lessee accounting: The receipt is recorded as a deduction from the cost of theright-of-use asset. Any lease incentive receivable is also included (as reduction) in themeasurement of lease liability. Therefore, a separate financial asset is not recognizeddue to the existence of a lease incentive receivable. After lease commencement,when the lessee receives the lease incentive payment, the amount received is debitedwith an offsetting credit entry to the lease liability.


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D. For alterations to the building specific to the new lessee, which the newlessee makes on its own behalf, that have no further value to the lessor afterthe completion of the lease period. The alterations are owned by the newlessee. The lease contract does not contain any renewal options.

Lessor accounting: The payment is accounted for in the same manner as C. above.

New lessee accounting: The receipt is accounted for in the same manner as C.above.

The costs incurred by the new lessee for the alterations to the building are capitalizedas leasehold improvement (i.e., PPE) if they qualify for capitalization under PAS 16,or as investment property if they qualify for capitalization under PAS 40. The newlessee should depreciate its PPE or investment property over the shorter of the leaseterm or the asset’s useful life, assuming it applies the cost model for PPE andinvestment property.

2. Old lessee pays:


Old lessee accounting: The payment is recognized as an expense immediatelyunless the payment was already stipulated in the contract (e.g., as a lease pre-termination option) and the probability criterion under paragraph 19 of PFRS 16 waspreviously met, in which case the amount would have already been recognized aspart of the lease liability. Because the giving up of the leased premises is immediate,the old lessee will also derecognize any remaining lease liability and right-of-use assetwith the difference recognized in profit or loss.


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Lessor accounting: The receipt is recognized as income immediately unless thepayment was already stipulated in the contract (e.g., in relation to a lease pre-termination option exercisable by the lessee) and the probability criterion waspreviously met under paragraph 19 of PFRS 16, in which case the financial impactwould have been recognized already as income using either a straight-line basis oranother systematic basis. Because the pre-termination is immediate, the lessor wouldalso derecognize any remaining lease receivable (net of any amount that would still becollected prior to pre-termination) and any prepaid/deferred rent on account of straightlining, with a charge to profit and loss.


Old lessee accounting: The payment is recognized as an expense immediately.Because the giving up of the leased premises in favor of the new lessee is immediate,the old lessee will also derecognize any remaining lease liability and right-of-use assetwith the difference recognized in P&L.

New lessee accounting: The receipt is recognized as income immediately.

3. A new lessee pays:

A. The lessor (at or before lease commencement) in order to secure the right toobtain a lease agreement. The amount paid is non-refundable.

New lessee accounting: The payment is recognized as cost of the right-of-use asset.

Lessor accounting: If finance lease, PAS 16 requires the gain or loss arising from thederecognition of an item of PPE to be determined as the difference between the netdisposal proceeds and the carrying amount of the item. PAS 16 requires that thegain or loss is included in profit or loss when the item is derecognized.

If operating lease, the receipt (including a lease payment received prior to leasecommencement date) is recognized as deferred revenue and amortized over thelease term on a straight-line basis or another systematic basis.


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Old lessee accounting: The receipt is recognized as a gain immediately. Anyremaining lease liability that will no longer be settled and right-of-use asset will bederecognized with the difference recognized in P&L.

New lessee accounting: The payment to the previous lessee should be accounted foras an initial direct cost included in the measurement of the right-of-use asset of thenew lease in accordance with PFRS 16. The payment is not in the scope of PAS 38,Intangible Assets.

Note: For ease of reference, the consensus for each of the scenarios issummarized in tabular format in Appendix 1.


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Basis for Consensus

PFRS 16 deals with costs incurred by a lessor in relation to a lease and paymentsbetween lessees and lessors on recognition of a lease. PFRS 16 deals with howincentives and lease modifications should be accounted for both by lessors andlessees.

1. Lessor pays:

B. Old lessee to get out of a lease agreement as it intends to redevelop orrenovate the property. The lease is classified by the lessor as an operatinglease.

Lessor accounting: The transaction qualifies as a lease modification in accordancewith paragraph 87 of PFRS 16 in which the lessor will have to recalculate the revisedlease payments and amortize over the revised lease term after deducting thepayments to be made to the old lessee.

In situations where the amount to be paid by the lessor exceeds the remaining leasereceipts over the revised lease term, the net liability is deemed as an incentive givenby the lessor to the old lessee to vacate, but such cost may be not be recoupedthrough the existing lease contract. Instead, it may be recovered through thedevelopment of the underlying asset. It does not make sense for a lessor to be in anet expense/liability position in consideration of the right to use its property.Therefore, the cost, which is not directly attributable to the lease, is to be recognizedimmediately rather than amortized over the remaining lease term.

If the payment meets the definition of construction costs of an item of property, plantand equipment contained in paragraph 6 of PAS 16, or investment property inaccordance with paragraph 21 of PAS 40, it must be capitalized.

Old lessee accounting: This is a lease modification that is not accounted for as aseparate lease which involves shortening of the lease term representing a partialtermination of the lease, assuming this was not included in the original agreement(e.g., as an option that can be exercised by the lessee). Under paragraph 45 of


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PFRS 16, if a transaction qualifies as a lease modification, the lessee is required toremeasure the lease liability by discounting the revised lease payments (net of anyamount to be received from the lessor) using a revised discount rate.

Example 18 of Illustrative Examples of IFRS 16 issued by the IASB illustrates how toaccount for the effects of shortening the lease term from the lessee’s point of view.Based on that illustrative example, the old lessee is required to recognize thedifference between the decrease in the lease liability and the decrease in the right-of-use asset as a gain or loss in profit or loss at the effective date of the modification.

The lessee should also revisit the amortization period of the right-of-use asset andany related leasehold improvement following the shortening of the term inaccordance with paragraphs 56-57 of PAS 16.

C. Old lessee to get out of the lease agreement as the lessor intends to or hasalready re-let the same premises to a new lessee that will pay a significantlyhigher rent than the old lessee, or is of higher quality, or both. No amount orportion paid to old lessee is for redevelopment or renovation of the property.The lease is classified by the lessor as an operating lease.

The conclusions and bases for conclusion are same as in A. above.

A payment by a lessor to a lessee to terminate the lease in order to re-let it toanother lessee does not meet the definition of initial direct cost for arranging a newlease (paragraph 83 of PFRS 16). This is because this cost is incurred in relation tothe lease with the old lessee and is not directly related to the new lease, even if thenew lease has been entered into.

D. A new lessee in the form of an incentive to occupy the property immediately.

Lessor accounting: A payment by a lessor to a new lessee to occupy the property isan integral part of the net consideration agreed for the use of the leased asset. Thismeets the definition of lease payments that were paid at or before the leasecommencement date.


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In case the lease is classified as a finance lease, paragraph 68 of PAS 16 statesthat “The gain or loss arising from the derecognition of an item of property, plantand equipment shall be included in profit or loss when the item is derecognized(unless PFRS 16 requires otherwise on a sale and leaseback).” Paragraph 71 ofPAS 16, on the other hand, states that “The gain or loss arising from thederecognition of an item of property, plant and equipment shall be determined asthe difference between the net disposal proceeds, if any, and the carrying amountof the item.” The lessor will therefore account for the prepaid lease payment as partof the net disposal proceeds and recognize any gain or loss in profit or loss whenthe item is derecognized.

In case the lease is classified as an operating lease, paragraph 83 of PFRS 16states that “A lessor shall add initial direct costs incurred in obtaining an operatinglease to the carrying amount of the underlying asset and recognize those costsasan expense over the lease term on the same basis as the lease income.”

New lessee accounting: The new lessee recognizes the receipt as a reduction ofthe lease liability and right-of-use asset. Paragraph 24 of PFRS 16 states that “Thecost of the right-of-use asset shall comprise:a. the amount of the initial measurement of the lease liability, as described in

paragraph 26;b. any lease payments made at or before the commencement date, less any lease

incentives received;c. any initial direct costs incurred by the lessee; andd. an estimate of costs to be incurred by the lessee in dismantling and removing the

underlying asset, restoring the site on which it is located or restoring theunderlying asset to the condition required by the terms and conditions of thelease, unless those costs are incurred to produce inventories. The lessee incursthe obligation for those costs either at the commencement date or as aconsequence of having used the underlying asset during a particular period.”


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E. For alterations to the building specific to the new lessee, which the new lesseemakes on its own behalf, that have no further value to the lessor after thecompletion of the lease period. The alterations are owned by the new lessee.The lease contract does not contain any renewal options.

Lessor accounting: A payment by the lessor to a lessee to reimburse the lessee forthe costs of leasehold improvements to the building at the direction of the lessee is alease incentive and hence, accounted for by the lessor in the same manner and forthe same reasons as C. above.

Lessee accounting: The amount received from the lessor is a lease incentive and istherefore accounted for by the lessee in the same manner and for the same reasonsas C. above. If the costs incurred by the new lessee for the alterations to the buildingmeet the capital expenditure criteria in PAS 16 or PAS 40, they are capitalized aseither PPE or Investment Property as applicable.

2. Old lessee pays:


A payment made by the lessee to the lessor to immediately get out of a leaseagreement does not meet the relevant definitions in PAS 16 or PAS 38 and is notaccounted for under PFRS 16 since there is no longer a lease in existence. It istherefore generally expensed.

Similarly, from the lessor’s perspective, income is recorded.

However, if the payment to the lessor for the lessee to vacate the premises wasalready stipulated in the original lease contract (e.g., an option to pre-terminate thelease at the sole option of the lessee) and the exercise of that option (andaccordingly the related payment) was assessed as reasonably certain during theterm of the lease, both the lessee and lessor would have revised the lease term inaccordance with par. 18 of PFRS 16. For the lessee, all relevant amounts including


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exit costs would have been accrued and amortized over the revised lease term. Forthe lessor, the receipt of such payment from the lessee would have been amortizedover the revised lease term from the time that the option became reasonably certainto be exercised.


A payment made by an existing lessee to a new lessee to take over the lease doesnot meet the definition of an asset under PAS 16 or PAS 38 and is not accounted forunder PFRS 16 since there is no longer a lease in existence. It should therefore beexpensed.

The new lessee recognizes the receipt as income at the commencement of thelease. The receipt does not qualify as a lease incentive in respect of the leasecontract of the new lessee because the amount received did not come from thecounterparty (i.e., the lessor) to the lease agreement. Appendix A of PFRS 16states that payments or receipts qualify as lease incentives only if coming from thecounterparty to the lease. Hence, the amount cannot be deferred and amortizedover the lease term.

3. A new lessee pays:

A. The lessor (at or before lease commencement) in order to secure the right toobtain a lease agreement. The amount paid is non-refundable.

A payment made by a new lessee to the lessor in connection with a leasearrangement is accounted for by the new lessee as part of the cost of the right-of-useasset in accordance with paragraph 24 of PFRS 16 and amortized over the leaseterm.

If the lessor classifies the lease as a finance lease, paragraph 71 of PAS 16 requiresthat the gain or loss arising from the derecognition of an item of property, plant andequipment be determined as the difference between the net disposal proceeds(including the prepayment made by the new lessee prior to lease commencement)and the carrying amount of the item. Such difference (i.e., the gain or loss) is included


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in profit or loss when the item is derecognized.

If the lessor classifies the lease as an operating lease, the lessor treats the receiptfrom the new lessee (including payment from the lessee prior to the commencementdate) as income amortized over the lease term, using either a straight-line basis oranother systematic basis. Paragraph 81 of PFRS 16 states that “A lessor shallrecognize lease payments from operating leases as income on either a straight-linebasis or another systematic basis.”


A payment made by a new lessee to an old lessee to buy out the old lessee’s lease(with a third-party lessor) is directly related to the new lessee’s lease (i.e., theagreement between the new lessee and the third-party lessor). The payment wouldnot have been paid if the lease had not been obtained and therefore meets thedefinition of an initial direct cost under Appendix A and Example 13 in paragraph IE5of PFRS 16. Therefore, it should be accounted for as part of the cost of the initiallyrecognized right-of-use asset in accordance with paragraph 24 of PFRS 16.

From the perspective of the old lessee, the receipt is treated as a gainimmediately and any remaining balances of the lease (i.e., right-of-use asset andlease liability) are removed from the accounts and netted off against the amountreceived to calculate any resulting gain.


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Appendix 1

Accounting treatment of payments made between lessors and lessees (both old lesseesand new lessees)

Treatment in the financial statements ofTransaction Lessor Old Lessee New Lessee BasisLessor paysold lessee -lessor intendsto renovate thebuilding

(fact pattern1A)

Recalculate therevised leasedpayments (net of theone-off amount tobe paid) andamortize over therevised lease term.If net payable,recognize asexpense unless theamount to be paidqualifies ascapitalizable costunder PAS 16 orPAS 40; in whichcase it is capitalizedas part of thecarrying amount ofthe associatedproperty if it meetsthe definition ofconstruction costsunder PAS 16 orPAS 40.

Recognize inprofit and loss atthe date ofmodification thedifferencebetween theproportionatedecrease in theright-of-use assetbased on theremaining right-of-use asset for theremaining periodand remaininglease liabilitycalculated as thepresent value ofthe remaininglease paymentsdiscounted usingthe originaldiscount rate ofthe lease.Recognize theeffect ofremeasurement ofthe remaininglease liability asan adjustment tothe right-of use-asset by referring

PFRS 16; par.87

PAS 16; pars. 6,16-17

PAS 40; par. 21 PFRS 16; par.

45 Illustrative

example 18issued by IASB

PAS 16; pars.56-57


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Treatment in the financial statements ofTransaction Lessor Old Lessee New Lessee Basis

to the revisedlease payments(net of anyamount to bereceived from thelessor) and usinga revised discountrate.Revisit theamortizationperiod of right-of-use asset and anyrelated leaseholdimprovementfollowing theshortening of theterm.

Lessor paysold lessee -new lease withhigherquality lessee

(fact pattern1B)

Same as in factpattern 1A.



PFRS 16; par.83

Lessor paysnew lessee -an incentive tooccupy

(fact pattern1C)

i. Finance lease: If made after

commencementdate, incentivepayable is creditedwith offsetting debitentry to the netinvestment lease.

If paid at or prior tocommencement

i. Record as adeduction to thecost of the right-of-use asset.

ii. Lease incentivereceivable isalso included asreduction inmeasurement oflease liability.

PAS 16; par. 68 PAS 16; par. 71 PFRS 16; par.

83 PFRS 16; par.

24


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date, included in thecalculation of gain orloss on disposal onfinance lease.

ii.Operating lease -add the initial directcosts to the carryingamount of underlyingasset and recognizeas expense over thelease term either ona straight-line basisof anothersystematic basis.

iii. When lesseereceives thepayment oflease incentive,the amountreceived isdebited with acredit entry togross up thelease liability.

Lessor paysnew lessee -buildingalterationsspecific to thelessee with nofurther value tolessor

(fact pattern1D)

Same as in factpattern 1C.

i. Same as in factpattern 1C.

ii. Capitalize costsincurred by thelessee foralterations to thebuilding asleaseholdimprovement inaccordance withPAS 16 or PAS40.

Same as in factpattern 1C.

PAS 40; par. 21 PAS 16; pars.

16-17

Old lesseepays lessor tovacate theleasedpremises early

(fact pattern2A)

Recognize asincome immediately,unless it was withinthe originalcontract and theprobability criterionwas previously met,in which case, theamount would have

Recognize asexpenseimmediatelyunless it waswithin the originalcontract and theprobabilitycriterion waspreviously met, in

PAS 16 PAS 38 PFRS 16; par.

18


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already beenrecognized asincome using eithera straight-line basisor anothersystematic basis.

which case, thefinancial impactwould have beenrecognizedalready as part ofthe lease liability.

Old lesseepays newlessee to takeover the lease

(fact pattern2B)

Recognize as anexpenseimmediately.

Recognize asincomeimmediately.

PAS 16 PAS 38 PFRS 16;

Appendix A

New lesseepays lessor tosecure the rightto obtain aleaseagreement

(fact pattern3A)

i. If finance lease,recognize gain orloss in the profit orloss arising from thederecognition ofunderlying asset onfinance lease.

ii. If operating lease,recognize asdeferred revenueand amortize overthe lease term on astraight-line basis oranother systematicbasis.

Recognize aspart of the costof the right-of-use asset.

PFRS 16; par.24

PAS 16; par. 71 PFRS 16; par.

81

New lesseepaysold lessee tobuyout the leaseagreement

Recognize as again immediately.Any remaininglease liability andright-of-use assetwill be

Account for asinitial direct costincluded in themeasurement ofthe right-of-useasset.

PFRS 16;Appendix A

PFRS 16;Example 13 inpar. IE5

PFRS 16; par.


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(fact pattern3B)

derecognized withnet amountthrough P&L.

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PAS 1, Presentation of Financial Statements

Q&A No. 2009 – 01 (amended June 2020): Framework 3.9 andPAS 1.25 – Financial statements prepared on a basis other than goingconcern

Issue 1

Are financial statements that are prepared on a basis of accounting other than a going concernbasis, which may sometimes be referred to as a liquidation basis, in compliance with PhilippineFinancial Reporting Standards (PFRS)?

Background

Paragraph 3.9 of The Conceptual Framework for Financial Reporting states that financialstatements are normally prepared on the assumption that an entity is a going concern andwill continue in operation for the foreseeable future. Paragraph 25 of PAS 1, Presentationof Financial Statements, states that financial statements shall be prepared on a going concernbasis unless management either intends to liquidate the entity or to cease trading, or has norealistic alternative but to do so.

Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtailmaterially the scale of its operations. If such an intention or need exists, the financial statementsmay have to be prepared on a different basis and, if so, the basis used is disclosed.

Paragraphs 14 to 15 of PAS 10 (revised 2010), Events after the Reporting Period, providesthat if the going concern assumption is no longer appropriate, the effect is so pervasive thatthe Standard requires a fundamental change in the basis of accounting, rather than anadjustment to the amounts recognized within the original basis of accounting.

If management of an entity has the intention, needs to liquidate or curtails materially the scaleof its operations, then the financial statements will have to be prepared on a basis which is otherthan a going concern basis, sometimes referred to as a liquidation basis.

Given appropriate disclosure as to the basis of accounting in a set of financial statementsprepared on a basis other than going concern, is it appropriate for management to make anexplicit and unreserved statement of compliance with PFRS in the notes to financial statements?


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Consensus

Yes, financial statements prepared on a basis other than going concern can be in compliancewith PFRS if the financial statements comply with all the requirements of PFRS, including therelevant PFRS guidance for the measurement of assets, liabilities and equity and recognition ofincome, expenses, gains and losses. For example:

Non-current assets that are not carried at fair value and are intended for sale should bemeasured using the principles in PFRS 5, Non-current Assets Held for Sale andDiscontinued Operations.

Assets that are carried at fair value should be accounted for under the relevant PFRS; forexample, PFRS 9, Financial Instruments, for financial assets and financial liabilities; PAS40, Investment Property, for investment properties.

Provisions for liabilities should be recognized and measured in accordance with PAS37, Provisions, Contingent Liabilities and Contingent Assets, (i.e., only when there is a presentobligation).

In addition, a complete set of financial statements as required under PAS 1.10 should bepresented and the minimum line items required to be included in each of the financialstatements, if applicable to the entity, should also be considered. An entity need not presenta statement of comprehensive income (or a statement of income and a statement of totalcomprehensive income) if it does not have any operations (both within and outside the normalcourse of business) during the period covered by the financial statements prepared on thebasis other than going concern. The non-presentation of such statement (assuming that otherincome items, if any, are not material), is consistent with the provision of paragraph 31 of PAS 1which allows that disclosures need not be provided if the information is not material. A disclosure,however, should be made in the notes to financial statements to clearly indicate the omissionof said statement as this information is useful for regulatory purposes (for instance, the SECallows an entity that has no operations for the last two years not to present an income statementas part of its financial statements).

Appropriate disclosures in accordance with paragraph 25 of PAS 1 should also be made todescribe the basis of accounting used in the preparation of the financial statements and its impacton the accounting policies selected. PAS 1 requires the following disclosures:

The fact that the financial statements are not prepared on a going concern basis,

The basis on which the financial statements are prepared, and

The reason why the entity is not regarded as a going concern.

The financial statements would state that the financial statements are in compliance with PFRS.The change in the underlying basis to reflect that the entity is no longer a going concern wouldbe disclosed in the financial statements together with the impact on management’s selectionof accounting policies. This selection of accounting policies would depend on how managementexpects to recover the assets of the entity and settle its liabilities. These accounting policychanges would need to be permitted by and be in compliance with the relevant PFRS.


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Illustrative Disclosure (assuming that the entity will be liquidated)

Basis of preparation of financial statements

The stockholders of XYZ Company approved a plan of liquidation on (date) . Accordingly, theCompany has changed its basis of accounting for periods subsequent to (date) , from thegoing-concern basis to the liquidation basis, whereby assets as of (reporting date) are presentedat estimated realizable values and liabilities, at estimated settlement amounts.

Statement of compliance with Philippine Financial Reporting Standards

The financial statements of X Company have been prepared in accordance with PhilippineFinancial Reporting Standards, on the basis described above. If the entity qualifies as either asmall entity or a medium-sized entity, the financial statements prepared on a basis other thangoing concern can be in compliance with PFRS for Small Entities or PFRS for Small andMedium-sized Entities provided that the standards are applied in the measurement of the assets,liabilities and equity and in the recognition of income, expenses, gains and losses of the entity.Appropriate disclosures should be made to describe the basis of accounting and its impact onthe accounting policies selected.

Effective Date

The consensus in this Q&A is effective from March 16, 2009, the original date of approval by theFRSC. The amendments to this Q&A are effective from the date of approval by the FRSC. Earlierapplication is permitted.

Date originally approved by PIC: February 18, 2009Date amendments approved by PIC: September 25, 2013


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PIC Members









Date originally approved by FRSC: March 16, 2009Date amendments approved by FRSC: October 8, 2014


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Q&A No. 2010 – 02 (amended June 2018): PAS 1R.16 – Basis ofpreparation of financial statements

Background

Under the Philippine Financial Reporting Standards issued by the Financial ReportingStandards Council, there are three frameworks for financial reporting:

(a) Philippine Financial Reporting Standards (PFRSs) (or full PFRSs);

(b) Philippine Financial Reporting Standard for Small and Medium-sized entities (PFRS forSMEs) which is applied by entities that qualify as medium-sized entities1; and

(c) Philippine Financial Reporting Standard for Small Entities which is applied by entitiesthat qualify as small entities (effective beginning January 1, 2019 with earlier applicationpermitted)2.

The primary regulators of certain entities gave transition relief or exemptions in the applicationof full PFRSs. These include banks, pre-need companies, and mining companies which areexempted by the Securities and Exchange Commission (SEC) from applying certain provisionsof specified PFRSs3. These also include insurance companies which were allowed by theInsurance Commission (IC) to defer application of certain PFRSs.

1Refer to Securities Regulation Code (SRC) Rule 68 for the definition of a medium-sized entity.2Refer to SRC Rule 68 for the definition of a small entity.3 The SEC allowed the following transitional relief or exemptions in the application of PFRSs:

Certain exchange offers of the Bureau of Treasury of eligible government securities to newgovernment bonds were exempted from the tainting provision of PAS 39 (SEC Notice datedJanuary 19, 2006).

Pre-need companies were allowed to submit their 2006 financial statements based on theexisting Pre-need Uniform Chart of Accounts (PNUCA) whereby revenues and financial liabilitiesarising from education and pension plans were accounted for in accordance with the existingacceptable practices of the industry (SEC Notice dated March 5, 2007). (On December 3, 2009,the Pre-need Code of the Philippines was signed into law transferring the jurisdiction over thepre-need companies from the SEC to the Insurance Commission (IC). The IC has released theImplementing Rules and Regulations (IRR) of the Pre-need Code on March 8, 2010. Amongother things, the IC has the authority to prescribe accounting rules and regulations applicable forpre-need companies, as well as the format of and details to be shown in financial statements ofthose companies.)

Pre-2005 hedging contracts of mining companies were exempted from the fair valuerequirements of PAS 39 (SEC Notice dated November 30, 2006).


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Micro entities (entities with total assets and total liabilities of less than P3 million) may applyeither the income tax basis or PFRS for Small Entities. If a micro entity uses a basis ofaccounting other than PFRS for Small Entities, management of the said entity shall assess theacceptability of such basis of accounting in the light of the nature of entity and the objective ofthe financial statements, or the requirements of the law or regulators.

Issue:

How does an entity describe the basis of presentation of its financial statements?

Consensus

PAS 1 (Revised), Presentation of Financial Statements, paragraph 16, states that “An entityshall not describe the financial statements as complying with PFRSs unless they comply with allthe requirements of PFRSs.” The Standard further requires in paragraph 112(a) that an entitypresent in the notes to financial statements information about the basis of preparation of thefinancial statements.

Paragraph 3.3 of PFRS for SMEs provides that “Financial statements shall not be described ascomplying with the PFRS for SMEs unless they comply with all the requirements of this PFRS.”

Paragraph 3.17 of PFRS for Small Entities provides that “An entity that meets the requirementsof this Framework and whose financial statements comply with this Framework, shall make anexplicit and unreserved statement of compliance with this Framework in the notes to thefinancial statements.”

Following are illustrative disclosures of the basis of presentation of financial statements underthe various accounting frameworks:

Entity complied in full with PFRS

…. “The financial statements have been prepared in accordance with Philippine FinancialReporting Standards (PFRSs).”

Entity complied in full with the PFRS for SMEs

….“The financial statements have been prepared in accordance with Philippine FinancialReporting Standard for Small and Medium-sized Entities (PFRS for SMEs).”

Entity complied in full with the PFRS for Small Entities

….“The financial statements have been prepared in accordance with Philippine FinancialReporting Standard for Small Entities.”


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Entity given transition relief or exemption by a regulator

“…The financial statements have been prepared in accordance with the applicable financialreporting framework for entities that are given relief from certain requirements of PhilippineFinancial Reporting Standards as described in Note X.”

Micro entities that apply income tax basis of accounting

“…The financial statements have been prepared in accordance with income tax basis ofaccounting whereby revenue is recognized when received rather than when earned, andcertain expenses are recognized when paid rather than when incurred. Property andequipment are depreciated over their estimated useful lives and recognized in currentoperations.”

Effective Date


Withdrawal of Q&A No. 2007–01 (Revised)

This Q&A supersedes Q&A No. 2007–01 (Revised): PAS 1.103(a) – Basis of preparation offinancial statements if an entity has not applied PFRSs in full, approved by the PIC and FRSCon August 8, 2007 and August 23, 2007, respectively.

Date originally approved by PIC: March 2, 2010Date amendments approved by PIC: June 27, 2018

PIC Members






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Date originally approved by FRSC: June 4, 2010Date amendments approved by FRSC: October 10, 2018


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Q&A No. 2010 – 03: PAS 1R.16 – PAS 1 Presentation of FinancialStatements – Current/ non-current classification of a callable termloan

Issue

Is a term loan that is not repayable within twelve months after the reporting period but callableby the lender at anytime classified as a current or non-current liability by the borrower?

Background

In general, banks normally grant loans that are either demand loans (e.g., loans that arerepayable at any time at the discretion of the lender), and term loans (e.g., loans that arerepayable at specified terms or repayable on demand upon the occurrence of a specified breachor default). The terms and conditions of the loans are normally stated in the loan agreement, inthe loan facility agreement, in the general terms and conditions of the loan agreement, or in theloan facility agreement.

PAS 1, paragraph 69 states that:

“An entity shall classify a liability as current when:

(a) it expects to settle the liability in its normal operating cycle;(b) it holds the liability primarily for the purpose of trading;(c) the liability is due to be settled within twelve months after the reporting period; or(d) the entity does not have an unconditional right to defer settlement of the liability

for at least twelve months after the reporting period (see paragraph 73). Terms ofa liability that could, at the option of the counterparty, result in its settlement bythe issue of equity instruments do not affect its classification.

An entity shall classify all other liabilities as non-current.”

Demand loans are classified as current liabilities because the borrower does not have anunconditional right to defer settlement of the liability for at least twelve months from the reportingperiod since the lender may demand for repayment at any time. Conversely, term loans not dueto be settled within twelve months from the reporting date and do not meet the other criteriadescribed in PAS 1, paragraph 69, are classified as non-current liabilities.

Banks have provided loans to borrowers with the characteristics of both demand loans and termloans (hereinafter referred to as “Hybrid Loans”). Typically, the loan agreements or loan facilityagreements of these Hybrid Loans include payment terms, maturity date, and other provisions


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that are normally found in term loan facilities. The loan facility agreements also may or may notinclude contingent demand repayment provisions triggered upon events of default or debtcovenant violations. In addition to these provisions typically found in term loan agreements, theloan agreements or loan facility agreements would also include an encompassing repayment ondemand provision which allows the lender to demand repayment at anytime.

Below are some examples of typical repayment on demand provisions found in these loanagreements or loan facility agreements for Hybrid Loans:

1. “The facilities are subject to review at any time and also subject to the Bank's overridingright of withdrawal and repayment on demand, including the right to call for cash coveron demand for prospective and contingent liabilities.”

2. “By signing this letter, you expressly acknowledge that we may suspend, withdraw ormake demand for repayment of the whole or any part of the facilities at any timenotwithstanding the fact that the following covenants/undertakings are included in thisletter and whether or not the Guarantor is in breach of any suchcovenants/undertakings.”

3. “As a general banking practice and notwithstanding any terms and conditions specifiedabove, the Lender reserves its overriding right to cancel or to modify the Facility, or todemand immediate repayment of all outstanding balances whether due or owing, actualor contingent under the Facility without prior notice.”

4. “Notwithstanding any provisions stated in this letter, the Facilities are repayable ondemand by the Bank. The Bank has the overriding right at any time to requireimmediate payment (of all principal, interest, fees and other amounts outstanding underthis letter or any part thereof) and/or to require cash collateralization of all or any sumsactually or contingently owing to it under the Facilities.”

5. “Notwithstanding anything contained in this letter, the Facilities are subject to the Bank'soverriding right of repayment on demand, to review, amend, and/or cancel any or all ofthe Facilities at its sole discretion.”

Consensus

PAS 1, paragraph 69(d) states that, "an entity shall classify a liability as current when it does nothave an unconditional right to defer settlement of the liability for at least twelve months after thereporting period".

Based on the repayment on demand terms typically found in these Hybrid Loan agreements, thelender has a clear and unambiguous right to demand repayment at any time at its solediscretion notwithstanding any provisions stated in the agreement.


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Consequently, the borrower does not have an unconditional right to defer settlement of theliability for at least twelve months after the reporting period since the lender may demandrepayment at anytime if the lender chooses to do so. Therefore, all loans with repayment ondemand provisions should be classified as current liabilities instead of non-current liabilitiesdespite any other terms within the agreement which may indicate that the loan should beclassified as a non-current liability. In relation to the required disclosures on the contractualmaturity analysis under PFRS 7, paragraph 39(a), such amount classified as current liabilityshall be presented in the earliest time band, in accordance with the guidance in PFRS 7,paragraph B11(a).

Effective Date


Q&A approved by PIC: September 29, 2010

PIC Members


Wilfredo A. Baltazar Lyn I. Javier/Reynold E. Afable

Rosario S. Bernaldo Judith V. Lopez

Ma. Elenita B. Cabrera/Rufo R. Mendoza Ma. Concepcion Y. Lupisan

Ma. Gracia F. Casals-Diaz Ramon G. Opulencia


Edmund Go Normita L. Villaruz

Q&A approved by FRSC: April 25, 2012


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Q&A No. 2011 – 03 (amended June 2020): Accounting for Inter-company Loans1


Issue



Background



For inter-company loans within the scope of PFRS 9, both the lender and the borrower arerequired to initially record the loan at fair value (plus directly attributable transaction costs for



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items that will not be measured at fair value through profit or loss subsequently) in accordancewith PFRS 9.5.1.1.










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Consensus










amount repayable










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Effective Date




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PIC Members









Date originally approved by FRSC: November 23, 2011



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Q&A No. 2016 – 03 (amended June 2020): Accounting for CommonAreas and the Related Subsequent Costs by CondominiumCorporations

This PIC Q&A deals with the accounting for common areas (including land) that were constructedbefore the creation of the Condominium Corporation and the accounting treatment for subsequentcosts related to common areas incurred by the Condominium Corporation.

Background

Section 2 of R.A. 4726 The Condominium Act defines a “condominium” as an interest in realproperty consisting of separate interest in a unit in a residential, industrial or commercial buildingand an undivided interest in common, directly or indirectly, in the land on which it is located and inother common areas of the building. A condominium may include, in addition, a separate interestin other portions of such real property.

Title to the common areas, including the land, or the appurtenant interests in such areas, may beheld by a Condominium Corporation in which the holders of separate interest shall automatically bemembers or shareholders, to the exclusion of others, in proportion to the appurtenant interest oftheir respective units in the common areas. Whenever the common areas in a condominiumprojects are held by a condominium corporation, such corporation shall constitute the managementbody of the project. The corporate purposes of such a corporation shall be limited to the holding ofthe common areas.

In current practice, the ownership of the land is not transferred to the Condominium Corporation. TheTransfer Certificate of Title (TCT) is cancelled by the Registry of Deeds and they annotate the masterdeeds of restrictions and separate Condominium Certificate of Titles (CCTs) are issued inreplacement of the TCT. The individual CCT shall be issued in the name of the original developerand then subsequently transferred to their buyers. The land description is no longer indicated in theDeed of Sale or CCT of the buyer but the project name and the master deed with declaration ofrestrictions and the unit number is always stated.

For purposes of paying real property tax, a separate tax declaration is issued and the CondominiumCorporation pays based on the assessed value or special assessment. Depending on the policy ofthe Board of the Condominium Corporation, this may form part of the association dues which is beingpaid by the unit owners on a monthly basis. Further, as part of the Condominium Corporation’smanagement of the common areas (including the land), it incurs major expenditures, the costs ofwhich are collected from the unit owners through special assessment. This special assessment isbeing collected in advance from the unit owners and subsequently disbursed and paid to the suppliersas the major expenditures progress.

In practice, the accounting for land and other common areas is not consistent among Condominium


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Corporations. Some do not record the land and other common areas, while others record thesebased on cost or appraised value.Another issue related to accounting for land and other common areas is the accounting for specialassessments. Special assessments are made by Condominium Corporations in order to financespecific projects.

The accounting for special assessments and the related expenditures differs among CondominiumCorporations. Some Condominium Corporations recognize these as revenues while others treatthese assessments as liability or equity.

Issue 1

How should the Condominium Corporations account for the land and other common areas?

Consensus

Paragraph 5.1 of the Conceptual Framework discusses when an element (assets, liabilities, income,expenses) can be recognized in the financial statements. It indicated that “Recognition is the processof incorporating in the balance sheet or income statement an item that meets the definition of anelement and satisfies the criteria for recognition set out in paragraph 4.38. It involves the depiction ofthe item in words and by a monetary amount and the inclusion of that amount in the balance sheet orincome statement totals. Items that satisfy the recognition criteria should be recognized in the balancesheet or income statement. The failure to recognize such items is not rectified by disclosure of theaccounting policies used nor by notes or explanatory material.”

Paragraph 4.3 of the Conceptual Framework defines an asset as “a present economic resourcecontrolled by the entity as a result of past events.” While PAS 16 Property, Plant and Equipmentparagraph 6 defines Property, plant and equipment as: “…tangible items that: (a) are held for use inthe production or supply of goods or services, for rental to others, or for administrative purposes; and(b) are expected to be used during more than one period.”

Paragraph 4.14 of the Conceptual Framework provides that: “An economic resource is a right thathas the potential to produce economic benefits. For that potential to exist, it does not need to becertain, or even likely, that the right will produce economic benefits. It is only necessary that the rightalready exists and that, in at least one circumstance, it would produce for the entity economic benefitsbeyond those available to all other parties.”

Paragraph 4.12 of the Conceptual Framework also states that “In many cases, the set of rightsarising from legal ownership of a physical object is accounted for as a single asset. Conceptually,the economic resource is the set of rights, not the physical object. Nevertheless, describing the setof rights as the physical object will often provide a faithful representation of those rights in the mostconcise and understandable way.”.


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The definition of asset in the conceptual framework recognizes the fact that for an entity to recognizean asset, it must have control over the economic benefits expected to be derived from such asset.Control over an asset is the ability of the entity to direct the use of the asset so as to obtain economicbenefits. An entity has the right to direct the use of an asset if the entity can direct how and for whatpurpose the asset is used.

The Condominium Corporation cannot direct how and for what purpose the land and other commonareas will be used. The decision as to how and for what purpose these common areas will be usedare made by the unit owners rather than the Condominium Corporation.

Furthermore, the ownership or the title over the common areas is not a requirement for an entity torecognize an asset; rather, as provided by paragraph 4.9 of the conceptual framework, “not all of anentity’s rights are assets of that entity—to be assets of the entity, the rights must both have thepotential to produce for the entity economic benefits beyond the economic benefits available to allother parties… and be controlled by the entity.” Thus, regardless of whether the title of the land istransferred to the Condominium Corporation or not, this is not essential in the determination ofwhether the common areas (including the land) is to be recognized in the financial statements of theCondominium Corporation.

Accordingly, Condominium Corporations should not recognize the land and other common areas asassets in its financial statements.

Issue 2

How should the Condominium Corporations recognize the special assessments and the subsequentexpenditures?

Consensus

Considering that the Condominium Corporation is a non-stock and non-profit entity, it shall need fundsto sustain its operations. Thus, as time and in such manner as the Condominium Corporation Boardmay reasonably and necessarily determine, there shall be an assessment against each Unit ownerproportionate to his or its appurtenant interest.

The Condominium Corporation Board, may from time to time, designate such amount or amounts tobe collected from Unit owners as and by way of special assessment to cover such expendituresdeemed necessary but is not considered in the regular assessment such as major buildingimprovement projects approved by the Unit owners.

Revenue, as defined in Appendix A of PFRS 15, Revenue from Contracts with Customers, is theincome arising in the course of an entity’s ordinary activities, whereas income is defined by theConceptual Framework as increases in economic benefits during the accounting period in the form ofinflows or enhancements of assets or decreases of liabilities that result in increases in equity, otherthan those relating to contributions from equity participants.


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Considering that the special assessment is collected for specific purpose and will only be spent onsaid purpose, there will be no gross inflow of economic benefits to the Condominium Corporation.Thus, such could not be recognized as revenue. However, since the Condominium Corporationreceived cash from the unit owners, it has the liability to ensure that said cash is intact and will bespent on the purpose it is collected. In this regard, a liability should be recognized in the books of theCorporation and once spent, said liability will be reversed. Any excess from the cash received fromthe unit owners against the amount spent for special assessments will be reversed to equity as itrepresents an increase in equity relating to contributions from the unit owners as equity participants.

To illustrate, journal entries are as follows:

Dr. Cash……………………………………P xxxxCr. Liabilities for Special Assessments.………….P xxxxTo record receipts of cash from unit owners.

Dr. Liabilites for Special Assessments…..P xxxxCr. Cash……………………………………………..P xxxxTo record actual expenditures for special assessments.

In case of any excess assessment, the amount be recognized directly in equity. However, in caseswhere the excess assessment will be applied against future association dues, then said amount willbe amortized accordingly to revenue.


The consensus in and amendments to this Q&A are effective for annual periods beginning onor after January 1, 2018 and should be applied retrospectively. Earlier application is permitted.

Date originally approved by PIC: August 31, 2016Date amendments approved by PIC: June 30, 2020


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PIC Members









Date approved by FRSC: October 11, 2017Date amendments approved by FRSC: August 19, 2020


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Q&A No. 2018 – 15 (amended July 2019): PAS 1- Classification ofAdvances to Contractors in the Nature of Prepayments: Current vs.Non-current

Background:Companies usually make advance payments to suppliers or sellers of goods and/orservices. These advances are non- financial assets in nature as these will be fulfilled bydelivery of goods and/or services. These advances, in effect, are in the nature ofprepayments. Examples of advances in the nature of prepayments are advances tocontractors for the construction of (a) real estate properties intended for sale (i.e., held asinventory); (b) property and equipment; and (c) investment properties.

Issue: How should these advances to contractors in the nature of prepayments beclassified in the statement of financial position?

DiscussionView 1. Treatment will follow the classification of the asset to which the advancespertain to.Under PAS 1.66, an entity shall classify an asset as current when it expects to realize theasset, or intends to sell or consume it, in its normal operating cycle. PAS 1.68 definesoperating cycle as the time between the acquisition of assets for processing and theirrealization in cash or cash equivalents. When the entity’s normal operating cycle is notclearly identifiable, it is assumed to be twelve months. PAS 1.68 further states that currentassets include assets (such as inventories and trade receivables) that are sold, consumedor realized as part of the normal operating cycle even when they are not expected to berealized within twelve months after the reporting period.

Applying, the above PAS 1 guidance, advances in the nature of prepayments shall beclassified as follows:

Current - If the advances to contractors will be applied as payments for construction ofassets to be classified as inventories;


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Noncurrent – If the advances to contractors will be applied as payments for constructionof assets to be classified as property, plant and equipment and investment properties.

View 2. Current for advances expected to be applied against progress billings forthe next 12 months, otherwise, these are presented as noncurrent.

Still in reference to PAS 1.66, the realization date is construed to be the timing whenthese advances are applied against billings or timing of delivery of goods and/services.Using the examples above, advances to contractors expected to be applied againstprogress billings for the next 12 months are classified as current, otherwise, these arepresented as noncurrent.

Consensus:View 1. The advances to contractor account is a temporary account. The eventualrealization of such advances is determined by the usage/realization of the asset to whichit was advanced for.

Effective Date

The consensus in this Q&A is effective from the date of approval of the FRSC and shouldfollow the provisions under PAS 8, Accounting Policies, Changes in Accounting Estimatesand Errors.

Date approved by PIC: June 27, 2018Date amendment approved by PIC: August 1, 2019


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PIC Members








Jerome Antonio B. Constantino Lovely M. Del AmenDate approved by FRSC: October 10, 2018Date amendment approved by FRSC: August 14, 2019


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REFERENCES (Amended July 2019)PAS 1.60An entity shall present current and non-current assets, and current and non-currentliabilities, as separate classifications in its statement of financial position in accordancewith paragraphs 66–76 except when a presentation based on liquidity providesinformation that is reliable and more relevant. When that exception applies, an entity shallpresent all assets and liabilities in order of liquidity.

PAS 1.61Whichever method of presentation is adopted, an entity shall disclose the amountexpected to be recovered or settled after more than twelve months for each asset andliability line item that combines amounts expected to be recovered or settled:

(a) no more than twelve months after the reporting period, and(b) more than twelve months after the reporting period.

PAS 1.66An entity shall classify an asset as current when:(a) it expects to realise the asset, or intends to sell or consume it, in its normal operatingcycle;(b) it holds the asset primarily for the purpose of trading;(c) it expects to realise the asset within twelve months after the reporting period; or(d) the asset is cash or a cash equivalent (as defined in PAS 7) unless the asset isrestricted from being exchanged or used to settle a liability for at least twelve months afterthe reporting period.

An entity shall classify all other assets as non-current.

PAS 1.68The operating cycle of an entity is the time between the acquisition of assets forprocessing and their realisation in cash or cash equivalents. When the entity’s normal

https://live.atlas.ey.com/#document/522058/pid85743532-522058?pref=20052/9/1007&crumb=2/549663


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operating cycle is not clearly identifiable, it is assumed to be twelve months. Currentassets include assets (such as inventories and trade receivables) that are sold, consumedor realised as part of the normal operating cycle even when they are not expected to berealised within twelve months after the reporting period. Current assets also includeassets held primarily for the purpose of trading (examples include some financial assetsthat meet the definition of held for trading in PFRS 9) and the current portion of non-current financial assets.

PAS 2.6Inventories are assets:(a) held for sale in the ordinary course of business;(b) in the process of production for such sale; or(c) in the form of materials or supplies to be consumed in the production process or in therendering of services.

PAS 16.6Property, plant and equipment are tangible items that:(a) are held for use in the production or supply of goods or services, for rental to others, or

for administrative purposes; and(b) are expected to be used during more than one period.

PAS 40.5Investment property is property (land or a building—or part of a building—or both) held(by the owner or by the lessee as a right-of-use asset) to earn rentals or for capitalappreciation or both, rather than for:(a) use in the production or supply of goods or services or for administrative purposes; orsale in the ordinary course of business.


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PAS 2, Inventories

Q&A No. 2012 - 02: Cost of a new building constructed on the site of aprevious building

Relevant PFRS


Issue

When an entity which owns a property (consisting of land and an old building) constructs a newbuilding on the site of the old building, how shall the entity account for the carrying value of the oldbuilding under the following scenarios?


Scenario 2: The entity acquired the property in a prior reporting period and used it as owner-occupied property. In the current reporting period, the entity decides to demolish theold building and replace it with a new building.






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An entity may acquire a piece of land with one or more existing buildings, with the intention toeither demolish the old building right away in order to construct a new building on its site as part ofits planned redevelopment, or to initially use the old building as an owner-occupied property andthen demolish it in a future period and replace it with a new building. The new building can eitherbe:


(b) sold in the ordinary course of the entity’s business, which is within the scope of PAS 2,Inventories; or

(c) held to earn rentals or for capital appreciation, which is within the scope of PAS 40,Investment Property.

When the old building is demolished to give way for the construction of the new building, therearises a question as to whether or not the cost allocated to the old building, or, in the case of apreviously owner-occupied property, the carrying value of the old building as at the date the entitydecides to demolish it, should form part of the cost of the new building. A related issue is how toaccount for the demolition costs incurred to physically tear down the old building.


Philippine Financial Reporting Standard (PFRS) 3.2(b) states that the acquisition cost of an assetor a group of assets that does not constitute a business “shall be allocated to the individualidentifiable assets and liabilities on the basis of their relative fair values at the date of purchase.”

Applying this principle, the cost of the property acquired should be allocated to the land and thebuilding at date of acquisition based on their relative fair values. The specific intention of theacquiring entity to demolish rather than use a building does not affect its fair value that will beused in the cost allocation. However, in circumstances where the existing building is unusable oris likely to be demolished right away by the entity acquiring it, the fair value of the existing buildingmight be low and much less than the fair value of the land. This is because a rational buyerintending to demolish the existing building and construct a new building is unlikely to acquire apiece of land with a highly valuable building. In such cases, it may be appropriate to allocate theentire purchase price to the land. On the other hand, if the existing building is still usable and theacquiring entity intends to use it for a while before it is demolished in a future period, it will beinappropriate not to allocate any cost to the existing building. Hence, part of the purchase priceshall be allocated as cost of the existing building which cost shall be depreciated over thebuilding’s remaining estimated useful life.


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Scenario 1(a) The land and building will be classified as two separate items under Plant, Propertyand Equipment measured at their allocated cost determined using the relative fairvalue method.


Scenario 1(c) If the land and building will be subsequently measured using the fair value model,the land and building will be classified as one item under Investment Property.If the subsequent measurement of the property will be made using the cost model,the land and building will be classified as two separate items under InvestmentProperty at their allocated cost determined using the relative fair value.

Scenario 2(a), 2(b) and 2(c) As the entity, at date of acquisition, has decided to initially use theproperty as owner-occupied property, the land and building will be classified as twoseparate items under Property, Plant and Equipment measured at their allocatedcost determined using the relative fair value method.

Elements of cost





(b) any costs directly attributable to bringing the asset to the location and condition necessaryfor it to be capable of operating in the manner intended by management.

(c) the initial estimate of the costs of dismantling and removing the item and restoring the siteon which it is located, the obligation for which an entity incurs either when the item isacquired or as a consequence of having used the item during a particular period forpurposes other than to produce inventories during that period.


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(a) costs of employee benefits (as defined in PAS 19, Employee Benefits) arising directly fromthe construction or acquisition of the item of property, plant and equipment;




(e) costs of testing whether the asset is functioning properly, after deducting the net proceedsfrom selling any items produced while bringing the asset to that location and condition(such as samples produced when testing equipment); and



“10 The cost of inventories shall comprise all costs of purchase, costs of conversion andother costs incurred in bringing the inventories to their present location and condition.

“11 The costs of purchase of inventories comprise the purchase price, import duties and othertaxes (other than those subsequently recoverable by the entity from the taxing authorities),and transport, handling and other costs directly attributable to the acquisition of finishedgoods, materials and services. Trade discounts, rebates and other similar items are deductedin determining the cost of purchase.

“12 The costs of conversion of inventories include costs directly related to the units of production,such as direct labour. They also include a system allocation of fixed and variable productionoverheads that are incurred in converting materials into finished goods.

“15 Other costs are included in the cost of inventories only to the extent that they are incurred inbringing the inventories to their present location and condition. For example, it may beappropriate to include non-production overheads or the costs of designing products for specificcustomers in the cost of inventories.”


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“20 An investment property shall be measured initially at its cost. Transaction costs shallbe included in the initial measurement.

“21 The cost of a purchased investment property comprises its purchase price and any directlyattributable expenditure. Directly attributable expenditure includes, for example, professionalfees for legal services, property transfer taxes and other transaction costs.”

Consensus

Accounting for the Allocated Cost or Carrying Value of the Old BuildingApplying the relevant PFRS provisions cited above, the allocated cost or carrying value of the oldbuilding shall be accounted for as presented below.



PAS 16 does not include any explicit guidance on whether the allocated cost or carrying value ofan old building that will be demolished is part of the cost of the replacement building.Nevertheless, it is viewed that the allocated cost, if any, of the old building to be demolished is nota cost directly attributable to the new building as provided in PAS 16.16 (b) and PAS 16.17 citedearlier. Therefore, the allocated cost of the old building shall not form part of the cost of the newbuilding. Also, since the old building will not be used, hence, no further economic benefits areexpected from its use, the allocated cost of the old building should be de-recognized as requiredunder PAS 16.67 and the loss arising from de-recognition is included in profit or loss as requiredunder PAS 16.68.


Development property (i.e., property intended for sale in the ordinary course of business, or in theprocess of construction or development for such sale) is within the scope of PAS 2 rather thanPAS 16.

The cost of inventories under PAS 2.10 cited earlier is a somewhat lower threshold than the costof an item of property, plant and equipment under PAS 16. For example, the cost of inventoriesunder PAS 2.10 need not be directly attributable.


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Accordingly, it is appropriate for the acquiring entity or property developer to include any costallocated to the old building as part of the cost of the new building or development property thatwill be sold as an inventory.

Scenario 1(c): New building will be held as an investment property

Property (land or a building—or part of a building—or both) held (by the owner or by the lesseeunder a finance lease) to earn rentals or for capital appreciation or both is within the scope of PAS40.

PAS 40.21 on what shall constitute the cost of investment property refers to “directly attributableexpenditure” which is somewhat similar to the related provision under PAS 16. Accordingly, theconsensus under Scenario 1(a) above can also be applied to Scenario 1(c), hence, the costallocated, if any, to the old building shall not form part of the cost of the new building that will beheld as an investment property. Also, since the old building will not be used, hence, no furthereconomic benefits are expected from its use or disposal, any cost allocated to the old buildingshould be de-recognized (eliminated from the statement of financial position) as required underPAS 40.66 and the loss arising from de-recognition is included in profit or loss as required underPAS 40.69.

Under Scenario 2

Under Scenario 2, the entity acquired the property in a prior reporting period and initially used theproperty as an owner-occupied property. In the current reporting period, it decided to demolish theold building and replace it with a new building.

As the building is a depreciable asset, the entity depreciates the cost allocated to the old buildingfrom the date of purchase on a systematic basis over the asset’s useful life, after considering anyresidual value. As required under PAS 16.51, the residual value and the useful life of the buildingshall be reviewed at least at each financial year-end and, if expectations differ from previousestimates, the change shall be accounted for as a change in an accounting estimate inaccordance with PAS 8, Accounting Policies, Changes in Accounting Estimates and Errors.

As provided under PAS 16.57, the useful life of an asset is defined in terms of the asset’sexpected utility to the entity. The asset management policy of the entity may involve the disposalof assets after a specified time or after consumption of a specified proportion of the futureeconomic benefits embodied in the asset. Therefore, the useful life of an asset may be shorterthan its economic life. The estimation of the useful life of the asset is a matter of judgment basedon the experience of the entity with similar assets.


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Applying the above principles, the entity, at the time it makes the decision to demolish the oldbuilding at a specific date in the future, has to re-compute the related depreciation charges on thebuilding to depreciate the remaining carrying value of the building over the remainder of its life (orthe remaining period before it is demolished). Hence, the old building will have a nil value at thedate of the planned demolition.

If for some reason there is a remaining carrying value of the old building at the time of demolition,such amount shall not be capitalized as part of the cost of the new building; instead, such amountshall be charged to profit or loss. This is because:

(a) the carrying value of the old building represents the un-depreciated cost of the old buildingrather than a cost incurred in the construction of the new building; and


The above consensus applies to all situations under Scenario 2, i.e., Scenario 2(a) where the newbuilding will be used an owner-occupied property, Scenario 2(b) where the new building will besold as an inventory, and Scenario 2(c) where the new building will be held as an investmentproperty.24


The demolition (or the physical tearing down) of the old building to give way for the construction ofthe replacement building will have related costs, referred to as demolition costs. There arises theissue on whether or not the demolition costs may be capitalized.

PAS 16.16(b) provides that any costs directly attributable to bringing the asset to the location andcondition necessary for it to be capable of operating in the manner intended by management shallform part of the cost of the asset. The examples of directly attributable costs presented in PAS16.17 cited earlier include ‘costs of site preparation.’

Demolition costs of the old building can be considered as part of costs of site preparationmentioned under PAS 16.17(b) and, therefore, may be capitalized. Although there is no clearguidance as to what account (i.e., land or new building) such demolition costs should becapitalized, it is preferable to capitalize the demolition costs as part of the cost of the new buildingsince the demolition of the old building is a direct result of the decision to construct the newbuilding.



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Effective Date


Q&A approved by PIC: December 19, 2012

PIC Members








Q&A approved by FRSC: June 11, 2013


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Q&A No. 2017 – 02 (amended July 2019): Capitalization of depreciationof right-of-use asset cost as part of construction costs of a building

Issue

Does depreciation of right-of-use asset constitute part of the cost of:

1. Constructing a building that is accounted for under PAS 2, Inventories, and will be sold?

2. Constructing a building that is accounted for under PAS 16, Property, Plant andEquipment, and will be for own use?

3. Leasehold improvements to a building that is held for own use?

Fact Pattern

Scenario 1 – land is leased and building is constructed to be held for sale

On January 1, 20X0, an entity enters into a 20-year lease of land. Under the lease agreement,the entity makes an initial upfront payment of P1,000 and pays rent of P200 quarterly in advance.The entity intends to construct a building on the land and, as part of its ordinary businessactivities, plans to sell the building once construction is completed.

However, the entity must obtain planning permission for the building, and this process takes threeyears. Construction of the building begins on January 1, 20X3 and is completed in two years.

The building is sold but the lease of land is retained by the entity. The entity intends to sub-leasethe land to the buyer of the building for the rest of its lease term with the landowner1.

1 In the absence of such intent, there may arise an issue of whether there is an onerous contract for the remaining lease term whichwill have to be assessed under PAS 37, Provisions, Contingent Liabilities and Contingent Assets; and such right-of-use asset willhave to be assessed under PAS 36, Impairment of Assets, for possible impairment. Moreover, in the absence of such an intent (i.e.,no subsequent sub-lease arrangement to the buyer of the building), there may be a need to assess if the selling price of the buildingcontains an element intended to cover for the cost of future rentals which may have to be accounted for separately under PFRS 15,Revenue from Contracts with Customers..


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Scenario 2 – land is leased and a building is constructed that will be owner- occupied

Fact pattern is the same as Scenario 1, except that the entity plans to occupy the building itselfonce construction is completed.

The entity applies the cost model for its property, plant, and equipment.

Scenario 3 – building is leased and leasehold improvements are made

On January 1, 20X0, the entity enters into a 10-year lease of a building at a rent of P200payable quarterly in advance.

To make the building suitable for its requirements, the entity makes substantial leaseholdimprovements at the beginning of the lease (i.e., first quarter of 20X0). During this time, thebuilding must be vacant and the entity can only move in after the work is completed. On April 1,20X0, the entity moves into the property.

Consensus and Basis for Consensus

Scenario 1

The entity intends to hold the building for sale in the ordinary course of business; therefore, thebuilding meets the definition of inventories under paragraph 6 of PAS 2.


“The cost of inventories shall comprise all costs of purchase, costs of conversion and othercosts incurred in bringing the inventories to their present location and condition”.


“The costs of conversion of inventories include costs directly related to the units of production,such as direct labor. They also include a systematic allocation of fixed and variable productionoverheads that are incurred in converting materials into finished goods. Fixed productionoverheads are those indirect costs of production that remain relatively constant regardless ofthe volume of production, such as depreciation and maintenance of factory buildings, equipmentand right-of-use assets used in the production process, and the cost of factory management andadministration […]”

As the entity enters into the lease with the intention of constructing the building, depreciation ofright-of-use asset incurred during the construction period should be capitalized as part of the


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construction costs of the building because it was incurred in bringing the inventories to theirpresent location and condition.

Scenario 2


“[...] If an entity makes similar assets for sale in the normal course of business, the cost of theasset is usually the same as the cost of constructing an asset for sale (see PAS 2) […]”.

Accordingly, the same principles that apply to the construction of an asset held for sale alsoapply to the construction of an asset that will be owner-occupied.

Depreciation of right-of-use asset is a directly attributable cost in the terms of paragraph 16(b) ofPAS 16, which states that the cost of property, plant and equipment comprises (among otherthings):

“costs directly attributable to bringing an asset to the location and condition necessary for it tobe capable of operating in the manner intended by management.”

In particular, in the scenario indicated, depreciation of right-of-use asset is an unavoidable costof developing the property. Without this lease no construction can occur.

Consequently, depreciation of right-of-use asset incurred during the construction period shouldbe capitalized as part of the construction costs of the building.

Since paragraph 22 of PAS 16 refers to PAS 2, the accounting treatment for cost capitalizationmust be applied consistently to transactions of the type described in both Scenario 1 andScenario 2.

Scenario 3

Refer to the reasons for conclusion provided for the Scenarios 1 and 2 above. Take note that inthis scenario, the building must be vacant while the leasehold improvements are made. Thisprovides additional argument to support the capitalization of the depreciation of right-of-useasset during the period in which the building is not being used. Capitalization of depreciation ofright-to-use asset in the carrying amount of the leasehold improvements commences once theentity starts making the improvements and ceases once the improvements are in the location andcondition necessary for them to be capable of operating in the manner intended by management.



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“Recognition of costs in the carrying amount of an item of property, plant and equipment ceaseswhen the item is in the location and condition necessary for it to be capable of operating in themanner intended by management […]”

Effective Date and Transition

The effective date and transition provision of this Q&A follow those of PFRS 16, Leases,Appendix C, upon approval by the FRSC.




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PIC Members









Date originally approved by FRSC: December 13, 2017



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Q&A No. 2017 - 06: PAS 2, 16 and 40 – Accounting for Collector’sItems

Issue

How does an entity account for collector’s items (e.g., paintings, rare items, vintageitems, classic cars) under the following scenarios?

Scenario 1: The entity holds collector’s items for administrative or aesthetic purposes(e.g., paintings placed on the walls in the entrance hall or conference rooms).

Scenario 2: An entity invests in collector’s items for long-term investment purposes. Theentity does not trade these collector’s items in the ordinary course of business.

Scenario 3: An entity invests in collector’s items for short-term investment purposes.The entity also trades these collector’s items in the ordinary course of business.

Consensus

Collector’s items do not meet the definition of intangible assets under PAS 38,Intangible Assets, because they have physical substance. As defined under Paragraph8 of PAS 38, intangible assets are identifiable non-monetary assets that do not havephysical substance. Therefore, in determining the appropriate accounting for collector’sitems, entities must consider the purpose for which the collector’s items is held.

Scenario 1

Items that are collected for administrative / aesthetic purposes and are not traded in theordinary course of business meet the definition of an item of property, plant andequipment under paragraph 6 of PAS 16, Property, Plant and Equipment. Accordingly,the entity measures a collectible at cost at initial recognition. Subsequently, the entitymeasures the collector’s items under the guidance provided for by PAS 16; that is ateither cost less accumulated depreciation or at revaluation model, provided that theentity can measure the fair value of the collector’s items reliably.

In accounting for the collector’s items in accordance with PAS 16, the entity should alsoassess the residual value of a collectible. Generally, at initial recognition, such residualvalue is close to its purchase price, thus, the depreciable amount for a collectible isgenerally negligible. In addition, since these collector’s items are held for administrative


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/ aesthetic purposes, they do not independently generate cash inflows. Therefore, whentesting for impairment, the entity should test these collector’s items for impairment onthe level of the cash-generating unit to which they relate, or as corporate assets.Scenario 2

PFRS does not have specific guidance on the accounting for collector’s items held forlong-term investment purposes. Entities will therefore need to refer to the hierarchy ofguidance in the selection of accounting policies laid out in PAS 8, Accounting Policies,Changes in Estimates and Errors, and consider the guidance under other PFRS / PASthat deal with similar and related issues.

Therefore, an entity refers to PAS 40, Investment Property, because PAS 40 deals withassets (land and other tangible assets) that an entity holds for long-term investmentpurposes when the entity is a passive investor, which are similar to collector’s itemsheld for long-term investment purposes:

They both have a physical, tangible nature (i.e., a non-financial asset); They both are often, rare, unique and individually valuable; They both do not have a fixed life that limits the ability of the entity to hold the

item long-term; They both are not used in the production or supply of goods or services; They both are held primarily for the benefit of investors.

With the above, an entity can apply PAS 40 by analogy and recognize the collector’sitems at cost upon initial recognition. Subsequently, the entity accounts for thecollector’s items either at cost less accumulated depreciation or at fair value, providedthat such fair value can be measured reliably, with the gains and losses from thechange in fair value recognized in profit or loss.

Unlike Scenario 1, under this scenario, these collector’s items can generate cash flowsupon sale independently from other assets. Therefore, the entity tests collector’s itemsheld for long-term investment purposes for impairment at the asset level.

Scenario 3

Similar to Scenario 2, PFRS has no specific guidance on the accounting of collector’sitems held for short-term investment purposes or trading in the ordinary course ofbusiness. Applying the hierarchy guidance stated in PAS 8, an entity refers to PAS 2,Inventories, as this standard deals with assets that an entity holds for trading in the


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ordinary course of business. Therefore, an entity will initially recognize such collector’sitems at cost and subsequently measure them at the lower of cost and net realizablevalue in accordance with the requirements of PAS 2.

If the characteristics of the collector’s items are similar to those of a commodity, and theentity qualifies as a broker or trader in accordance with paragraph 3(b) of PAS 2, theentity will initially recognize such collector’s items at cost and subsequently measurethem at fair value less costs to sell.

Since determining the appropriate accounting for collector’s items also requirejudgment, an entity should consider the requirements of paragraph 122 of PAS 1,Presentation of Financial Statements, on disclosing judgment management has made inthe process of applying the entity’s accounting policies on collector’s items.

Effective Date




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PIC Members











342

Q&A No. 2018 - 10: PAS 2 - Scope of disclosure of inventory write-downs

Issue

Is an entity required to disclose a write-down of any inventory at the end of an annualreporting period or any write-down during the annual reporting period?


Paragraph 36(e) of PAS 2, Inventories, requires the disclosure of the amount of any write-down of inventories recognized as an expense in the period in accordance with paragraph34 of PAS 2.

Paragraph 34 of PAS 2 requires

“…the amount of any write-down of inventories to net realizable value and all losses ofinventories shall be recognized as an expense in the period the write-down or lossoccurs…”

Taken literally this guidance means that any write-down, including any sales below costduring the reporting period, would be scoped into this disclosure paragraph. However, thenotion of ‘write-down’ is used in the context of the lower of cost and net realizable valuetest. An entity only performs this test at a reporting date.

Consensus

An entity is required to disclose only write-downs of inventory held at the end of thereporting period.





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PIC Members


Zaldy D. Aguirre Ma. Gracia F. Casals-Diaz

Chase M. Sarmiento Emmanuel Y. Artiza








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Q&A No. 2018 - 11: Classification of land by real estate developer

Issue

What is the correct classification of the land owned by real estate developer?

Classification of land by real estate developer

Background

A real estate developer develops residential and commercial units which are sold orleased out to customers. These projects can be horizontal or vertical projects which areeither: (a) units in a high-rise building which can be for office or residential use; (b)serviced lot; or (c) serviced lot and house. Projects can be in a single phase or in multiplephases and usually take more than one year to complete (e.g. 3-5 years).

In the normal course of its business, the real estate developer purchases the followingraw land:

Land A - The entity has plans to construct and develop the parcel of land as aresidential subdivision for sale as approved by the entity’s Board of Directors. Thepreparation of the master plan, detailing the plans as residential property, hascommenced but the entity intends to start the physical construction activities (e.g.excavation) two years from the government approval of the master plan.

Land B –The entity has plans to construct and develop the parcel of land as aresidential subdivision for sale as approved by the entity’s Board of Directors. Thepreparation of the master plan, detailing the plans, has not commenced.

Land C - The entity intends to develop the land into a commercial center for leasebut preparation of master plan has not commenced and the entity does not intendto commence the physical construction activities within the year.

Land D -The entity purchased the parcel of land to establish presence in thelocation but does not have any concrete plans on how to develop the property.


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Conclusion

a. Land A – Classified as inventory presented as current assets

b. Land B – Classified as inventory presented as current assets

c. Land C – Classified as investment property presented as non-current asset

d. Land D – Classified as investment property presented as non-current asset

Discussion

In accordance with paragraph 6 of PAS 2:

Inventories are assets:

a. held for sale in the ordinary course of business;b. in the process of production for such sale; orc. in the form of materials or supplies to be consumed in the production process or in

the rendering of services.


Investment property is property (land or a building—or part of a building—or both) held (bythe owner or by the lessee as a right-of-use asset) to earn rentals or for capital appreciationor both, rather than for:

(a) use in the production or supply of goods or services or for administrative purposes;or

(b) sale in the ordinary course of business.

Paragraph 8 of PAS 40 further provides the following examples of investment property:

(a) land held for long-term capital appreciation rather than for short-term sale in theordinary course of business.

(b) land held for a currently undetermined future use. (If an entity has not determined thatit will use the land as owner-occupied property or for short-term sale in the ordinarycourse of business, the land is regarded as held for capital appreciation.)


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(c) a building owned by the entity (or held by the entity under a finance lease) and leasedout under one or more operating leases.

(d) a building that is vacant but is held to be leased out under one or more operatingleases.

(e) property that is being constructed or developed for future use as investment property.

In accordance with paragraph 66 of PAS 1, an entity shall classify an asset as current when:

a. it expects to realize the asset, or intends to sell or consume it, in its normal operatingcycle;

b. it holds the asset primarily for the purpose of trading;

c. it expects to realize the asset within twelve months after the reporting period; or

d. the asset is cash or a cash equivalent (as defined in PAS 7) unless the asset is restrictedfrom being exchanged or used to settle a liability for at least twelve months after thereporting period.


In addition, paragraph 68 of PAS 1 defines the operating cycle of an entity as the timebetween the acquisition of assets for processing and their realization in cash or cashequivalents. When the entity's normal operating cycle is not clearly identifiable, it isassumed to be twelve months. Current assets include assets (such as inventories and tradereceivables) that are sold, consumed or realized as part of the normal operating cycle evenwhen they are not expected to be realized within twelve months after the reporting period.Current assets also include assets held primarily for the purpose of trading (examplesinclude some financial assets that meet the definition of held for trading in PFRS 9) andthe current portion of non-current financial assets.

Analysis of the classification of the parcel of lots purchased by the entity are as follows:

a. Land A meets the requirements for an asset to be classified as inventory and currentasset. See analysis below:

Current or Non-current Inventory or InvestmentProperty

(a) it expects to realizethe asset, orintends to sell or

Met. Land A waspurchased by the entityfor the purpose of

Inventory, since it meets thecriteria of PAS 2, paragraph 6 (a),which is land held for sale in the


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consume it, in itsnormal operatingcycle;

converting it into aresidential subdivisionfor sale. As definedabove, operating cycle ofan entity is the timebetween the acquisitionof assets for processingand their realization tocash or cash equivalents.Given the nature ofbusiness of real estatedevelopment, whereinprojects usually takemore than one year toconstruct/develop andrequires certain periodfor selling andconversion to cash, thenormal operating cycle ismore than one year formthe time of purchase.Given this, the raw landwill be classified ascurrent asset.

ordinary course of business asevidenced by the BOD approvaland preparation of master plan.

(b) it holds the assetprimarily for thepurpose of trading;

Met. Real estateinventories are held bythe entity for sale tocustomers.

(c) it expects to realizethe asset withintwelve monthsafter the reportingperiod; or

Not applicable. Seediscussion in (a)

(d) the asset is cash ora cash equivalent(as defined in PAS7) unless the assetis restricted from

Not applicable. Theasset is not cash or cashequivalent.


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being exchanged orused to settle aliability for at leasttwelve monthsafter the reportingperiod.

b. Land B meets the requirements for an asset to be classified as inventory and currentasset. Even though the preparation of the masterplan has not commenced, the intentionof the entity to hold the land for development for sale in the ordinary course of businessis evident, given that the plan was approved by its Board of Directors. It is classified ascurrent because it meets the criteria of PAS 1, Paragraph 66 (a) and (b) given the samerationale for Lot A.


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c. Land C meets the requirements for an asset to be classified as investment property andnon-current asset. See analysis below:

Current or Non-current Inventory or Investment Propertyi. it expects to realize

the asset, orintends to sell orconsume it, in itsnormal operatingcycle;

Not Met. The parcel of lotis not expected to berealized, sold orconsumed within theentity’s normaloperating cycle.

Investment property, since itmeets the criteria of PAS 40where the lot is held to earnrentals and is not used in theproduction or supply of goods orservices or for administrativepurposes; or for sale in theordinary course of business.ii. it holds the asset

primarily for thepurpose of trading;

Not Met. Investmentproperties are not heldfor sale to third party.

iii. it expects to realizethe asset withintwelve monthsafter the reportingperiod; or

Not Met. See discussionin (i)

iv. the asset is cash ora cash equivalent(as defined in PAS7) unless the assetis restricted frombeing exchanged orused to settle aliability for at leasttwelve monthsafter the reportingperiod.


d. Land D meets the requirements for an asset to be classified as investment property andclassified as non-current asset. The same analysis as Land C above for the classificationas current or non-current. Land D is an investment property, since it meets the criteriaof PAS 40 where it is held for capital appreciation and is not used in the production orsupply of goods or services or for administrative purposes; or for sale in the ordinarycourse of business. In addition, PAS 40.8(b) cites that land held for a currentlyundetermined future use is an example of an investment property.


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The consensus in this Q&A is effective from the date of approval of the FRSC.


PIC Members











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Q&A No. 2019 - 02: Accounting For Cryptographic Assets

Background:

Cryptographic assets are transferrable digital representations that are designed in a waythat prohibits their copying or duplication. The technology that facilitates the transfer ofcryptographic assets is referred to as “blockchain” or distributed ledger technology.Blockchain is a digital, decentralized ledger that keeps a record of all transactions thattake place across a peer-to-peer network and that enables the encryption of information.

Currently, there is no legal definition of cryptographic assets, as there is for securities invarious jurisdictions; however, some cryptographic assets can be legally consideredsecurities by local regulators. Cryptographic assets are used for a variety of purposes,including as means of exchange, as a medium to provide access to blockchain-basedgoods or services, and as a way to raise funding for an entity developing activities in thisarea.

The characteristics that are being most relevant for classifying cryptographic assets foraccounting purposes are:

the primary purpose of the cryptographic asset; and how the cryptographic asset derives its inherent value.


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Based on the characteristics detailed above, there are four possible specific subsets ofcryptographic assets, as set out in the following table:

Subset Purpose Inherent Value

Cryptocurrency Cryptocurrencies are digital tokens or coinsbased on blockchain technology, such asBitcoin. They currently operateindependently of a central bank and areintended to function as a medium ofexchange. Examples of cryptocurrenciesare Bitcoin, XRP, Ethereum, Bitcoin Cash,EOS, Stellar, Tether, Litecoin, Tron, andBitcoin SV

None – derives itsvalue based onsupply and demand.

Asset-backed token An asset-backed token is a digital tokenbased on blockchain technology thatsignifies and derives its value fromsomething that does not exist on theblockchain but instead is a representationof ownership of a physical asset (forexample, natural resources such as gold oroil).

Derives its valuebased on theunderlying asset.

Utility token Utility tokens are digital tokens based onblockchain technology that provide userswith access to a product or service andderive their value from that right. Utilitytokens give holders no ownership in acompany’s platform or assets and, althoughthey might be traded between holders, theyare not primarily used as a medium ofexchange.

Value is derivedfrom the demand forthe issuer’s serviceor product.

Security token Security tokens are digital tokens based onblockchain technology that are similar innature to traditional securities. They canprovide an economic stake in a legal entity:

Value is derivedfrom the success ofthe entity, since theholder of the token


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sometimes a right to receive cash oranother financial asset, which might bediscretionary or mandatory; sometimes theability to vote in company decisions and/ora residual interest in the entity.

shares in futureprofits or receivescash or anotherfinancial asset.

It should be noted that some cryptographic assets might exhibit elements of two or moreof the identified subclasses. These result in hybrid cryptographic assets that will have tobe assessed further. This document focuses on cryptographic assets that carry simplefeatures, instead of hybrid tokens.

The most common method of issuing tokens is via initial coin offerings (ICO). An ICO is aform of fundraising that harnesses the power of cryptographic assets and blockchain-based trading. Similar to a crowdfunding campaign, an ICO allocates crypto tokensinstead of shares to investors/subscribers. These ICO tokens typically do not represent anownership interest in the entity, but they often provide access to a platform (if and whendeveloped) and can often be traded on a crypto exchange. The population of ICO tokensin an ICO is generally set at a fixed amount.

Each ICO is bespoke and will have unique terms and conditions. It is critical for issuers toreview the whitepaper or underlying documents accompanying the ICO token issuance,and to understand what exactly is being offered to investors/subscribers. In situationswhere rights and obligation arising from a whitepaper or their legal enforceability areunclear, legal advice might be needed, to determine the relevant terms.

ICOs might be considered to be securities by a securities regulator, but it is important tonote that there is no uniform global view. As a result, issuers should monitor regulatorydevelopments closely and consider the impact that any changes might have on financialreporting.

In the Philippines, the use of cryptocurrencies particularly Bitcoin is becoming popular. Atpresent, certain local companies that deal in Bitcoin and other cryptocurrencies haveacquired registrations from the Bangko Sentral ng Pilipinas (BSP) as money changingand remittance entities. Accordingly, these companies are required to comply with the


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applicable BSP regulations such as the traditional “Know Your Customer” (KYC) and anti-money launder (AML) compliance, among others.

Issues:

1) In the absence of a definitive accounting and reporting guidance from the InternationalAccounting Standards Board (IASB), how should a company as a “holder” report thefollowing cryptographic assets in their financial statements?

a) Cryptocurrencies held by an entity

b) Cryptographic assets other than cryptocurrencies

2) How should a company as an “issuer” report crypto tokens in their financialstatements?


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Consensus:

PFRS does not include specific guidance on the accounting for cryptographic assets andthere is no clear industry practice, so the accounting for cryptographic assets could fallinto a variety of different standards. Consideration should also be given to the entity'spurpose for holding the cryptographic assets to determine the accounting model. Theaccounting standards and other considerations that might be relevant to the subsets ofcryptographic assets are presented below:

Issue 1.a - Accounting for cryptocurrencies held by an entity

1. Cryptocurrencies can be treated as Inventory under PAS 2, “Inventories”

PAS 2 does not require inventories to be in a physical form, but inventory should consistof assets that are held for sale in the ordinary course of business. Inventory accountingmight be appropriate if an entity holds cryptocurrencies for sale in the ordinary course ofbusiness. An entity that actively trades the cryptocurrencies, purchasing them with a viewto their resale in the near future, and generating a profit from fluctuations in the price ortraders’ margin, might consider whether the guidance in PAS 2 for commodity broker-traders should be applied.

However, if the entity holds cryptocurrencies for investment purposes (that is capitalappreciation) over extended periods of time, it would likely not meet the definition ofinventory.

Measurement

PAS 2 requires inventories to be measured at lower of cost or net realizable value,unless the holder is a commodity broker-trader, in which case it may be measuredat fair value less costs to sell. [PAS 2 par. 3] The term ‘commodity’ is not defined inPAS 2, but a broker-trader that concluded a cryptocurrency was a commodity wouldmeasure the inventory at fair value less cost to sell with changes in fair value recognizedin profit or loss.


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2. Cryptocurrencies can be treated as Intangible asset under PAS 38

Cryptocurrencies appear to meet the definition of an intangible asset: identifiable as canbe sold, exchanged or transferred individually; not cash and non-monetary asset; have nophysical form.

PAS 38.12 describes an asset as identifiable if it is separable (i.e., it is capable of beingseparated or divided from the entity and sold, transferred, licensed, rented or exchanged)or if it arises from a contractual or legal right.

PAS 38.8 and 38.13 define an asset as a resource controlled by an entity as a result ofpast events and from which future economic benefits are expected to flow to the entity.Control in this context means that the entity has the power to obtain the future economicbenefits that the asset will generate and to restrict the access of others to those benefits.

It appears therefore, that cryptocurrencies would meet the definition of an Intangibleasset.

Measurement

An intangible asset shall be measured initially at cost.

After initial recognition, the entity can choose either the cost model or the revaluationmodel as its accounting policy.

Under the cost model, an intangible asset shall be carried at its cost less anyaccumulated amortization and any accumulated impairment losses.

If an intangible asset is accounted for using the revaluation model, all the other assets inits class shall also be accounted for using the same model, unless there is no activemarket for those assets

Under the revaluation model, an intangible asset shall be carried at a revalued amount,being its fair value at the date of the revaluation less any subsequent accumulatedamortization and any subsequent accumulated impairment losses. For the purpose ofrevaluations, fair value shall be measured by reference to an active market. Revaluationsshall be made with such regularity that at the end of the reporting period the carryingamount of the asset does not differ materially from its fair value.


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If an intangible asset's carrying amount is increased as a result of a revaluation, theincrease shall be recognized in other comprehensive income and accumulated in equityunder the heading of revaluation surplus. However, the increase shall be recognized inprofit or loss to the extent that it reverses a revaluation decrease of the same assetpreviously recognized in profit or loss.

One must look at the activity in a market for each individual cryptocurrencies to concludeif it meets the definition of “active market”. Therefore, for the largest cryptocurrencies suchas Bitcoin and Ethereum, it is likely this definition would be met.

Issue 1.b - Accounting for cryptographic assets other than cryptocurrencies heldby an entity

A similar thought process shall apply when considering the accounting for cryptographicassets other than cryptocurrencies. These cryptographic assets include security tokens,asset-backed tokens and utility tokens (together referred to as “crypto tokens”) held by anentity for own account.

1. Crypto tokens with the characteristics of asset-backed tokens.

Asset-backed tokens may give the holder a right to an underlying asset. These tokensmay be used to transfer the ownership of underlying assets without physically movingthem. It is a means to transact the underlying asset at minimal cost. As a result, theaccounting will likely be driven by the nature of the underlying asset and the relevantaccounting standard.

2. Crypto tokens with the characteristics of utility tokens

Utility tokens usually give the holder a right to future goods or services. These tokens area prepayment for goods or services. A prepayment for goods or services might meet thedefinition of an intangible asset and PAS 38 could be applied. Where it does not meet thedefinition of an intangible asset, it is accounted for similar to other prepaid assets.

3. Crypto tokens with the characteristics of security tokens

Security tokens might give the holder a right to cash, based on the platform’s future profitsor a residual interest in the net assets. Such rights might be discretionary or mandatoryand might be accompanied by the ability to vote to impact decisions relating to the


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underlying platform. A contractual right to cash or another financial asset may exist inthese circumstances, in which case, these security tokens meet the definition of afinancial asset subject to PFRS 9.

4. Crypto tokens with hybrid characteristics

Crypto tokens exhibiting elements of two or more subclasses require further analysis andjudgement is required to determine the applicable accounting treatment. Factors toconsider will include the interaction of contractual clauses, their substance and relevancein the context of the overall characteristics of the token.


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Issue 2 - Accounting for crypto tokens by the issuer

When an ICO is undertaken, the issuing entity receives consideration. The form of theconsideration varies (for example, cash or another cryptographic asset) and, foraccounting purposes, it is key to understand the economics and characteristics of thetransaction.It is possible that an ICO could create a joint arrangement requiring further analysis basedon PFRS 11, ‘Joint Arrangements’. The fact that the subscribers provide the majority ofthe funding might suggest that the arrangement is a collaboration between the ICO entityand the subscriber. However, the subscribers are typically passive, which suggests thatthe arrangement might not provide the parties with joint control. Some issuers might grantveto rights over the future direction of the project to subscribers, typically, these areprotective in nature and in most cases will not create joint control.

Where consideration for the ICO is not in the form of cash but another cryptographicasset, the transaction might be an exchange of similar goods or services. An exchange ofsimilar goods might mean that no accounting is needed. However, we believe that it isunlikely that an ICO will be an exchange of ‘similar goods or services’, because no twocryptographic assets are generally alike.

Assuming that there is an exchange transaction and the arrangement does not createjoint control, the consideration received by the ICO entity is recorded as the debit side ofthe journal entry.

However, the key challenge for issuing entities is determining the accounting for the ICOtoken issued (that is, the credit side of the journal entry). This will depend on the nature ofthe ICO token issued, as well as the guidance of the applicable accounting standard.

The following table provides a possible analysis framework of accounting models toconsider when determining the nature of, and accounting for, the issued ICO token.Consideration of the contract terms is needed, to understand the obligations of the issuer.

Does the ICO token meet the definition ofa financial liability?

Apply guidance in PFRS 9

Does the ICO token meet the definition ofan equity instrument?

Apply guidance in PAS 32


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Is the ICO token a prepayment for goodsand services from a contract with acustomer?


Does the ICO token not meet any of theabove?

Consider other relevant guidance

Financial liability

An issuer of an ICO token should assess whether a token meets the definition of afinancial liability. Specifically, an entity would consider the definition in PAS 32, whichstates that a financial liability is:

- a contractual obligation to deliver cash or another financial asset to another entity or to exchange financial assets or financial liabilities with another entity under

conditions that are potentially unfavorable to the entity or- a certain contract that will or might be settled in the entity's own equity instruments,

such as those that violate the principle stated in paragraph 11 of PAS 32 (commonlyknown as the ‘fixed-for-fixed’ principle)

If the ICO token is a financial liability, the accounting would follow the applicable guidancein PFRS 9.

Many ICO tokens will not meet the definition of a financial liability, but there are situationswhere the terms and conditions might provide for a refund of proceeds up to the point ofachieving a particular milestone. There might be situations in which the contract creates afinancial liability at least up to the point at which the refund clause falls away.

Equity instrument

An equity instrument is any contract that evidences a residual interest in the assets of anentity after deducting all of its liabilities (PAS 32 para 11). Typically, ICO tokens do notprovide the holders with such a residual interest; for example, they do not give the holdersrights to residual profits, dividends, or entitlement to proceeds on winding up or


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liquidation. These ICO tokens might therefore lack the characteristics of an equityinstrument. Careful consideration is needed to assess whether the rights to the cash flowsonly relate to a specific project or whether, in substance, they provide rights to residualcash flows of the ICO entity.

Revenue transaction/prepayment for future goods and services

The issuing entity should consider whether the ICO token issued is in substance acontract with a customer that should be accounted for under PFRS 15.

PFRS 15 would apply if (1) the receiver of the ICO token is a customer, (2) there is a‘contract’ for accounting purposes, and (3) the performance obligations associated withthe ICO token are not within the scope of other standards.

Appendix A to PFRS 15 defines a customer as “a party that has contracted with an entityto obtain goods or services that are an output of the entity’s ordinary activities inexchange for consideration”.

To determine whether a contract with a customer exists, an entity should considerwhether the whitepaper, purchase agreement and/or other accompanying documentscreate ‘enforceable rights or obligations’ (PFRS 15 App A). To be a contract with acustomer for the purposes of PFRS 15, such rights should be legally enforceable. Thisassessment might be challenging where the documentation provided by the issuer is notwell defined. Entities should further evaluate all of the criteria in paragraph 9 of PFRS 15,to determine if a contract with a customer exists.

In many circumstances, issuers might use the consideration received in the ICO todevelop a software platform. Hosting and maintaining the specific platform is often anintegral part of the ICO’s future business model. The token could provide the holder withaccess to the platform, which might be operated as part of the entity’s ordinary activities.

This might result in the holders meeting the definition of ‘customers’, from the perspectiveof the ICO entity; accordingly, the proceeds from the ICO could be revenue of the issuingentity, which will likely be initially deferred.


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Determining the performance obligations, how they are satisfied and the period overwhich to recognize revenue will be judgmental and will depend on the specific facts andcircumstances of the ICO offering.


Where none of the above considerations appears to be relevant, the hierarchy in PAS 8should be considered in determining the appropriate accounting treatment. We believethat it is unlikely that issuers will receive consideration without taking on an obligation tothe subscribers. Even if the arrangement does not give rise to a financial instrument or apromise to deliver goods or services to a customer, there is likely to be a legal orconstructive obligation to the subscriber. This might result in the issuer recognizing aprovision in accordance with PAS 37, ‘Provisions, Contingent Liabilities and ContingentAssets’.

Effective Date




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PIC Members











364

PAS 8, Accounting Policies, Changes in Accounting Estimatesand Errors

Q&A No. 2017 - 12: Subsequent Treatment of Equity ComponentArising from Intercompany Loans

Issue

How should a Subsidiary account for the Equity component arising from its borrowings from theParent Company subsequent to initial recognition?

Background

PIC Q&A No. 2011-03, Accounting for Inter-company Loans, provides guidance on how theParent Company and the Subsidiary will account for intercompany borrowings. Under such PICQ&A, the Subsidiary recognizes the loan from the Parent Company at fair value. The differencebetween the fair value and the face amount of the loan (the ‘Day 1’ difference) shall be recordedas a component of equity (i.e., equity contribution by the parent). However, the PIC Q&A providesno guidance on how to account for such component of equity subsequent to initial recognition.

Relevant guidance

Paragraph 10(a) of PAS 8, Accounting Policies, Changes in Accounting Estimates and Errorsindicates that in the absence of a PFRS that specifically applies to a transaction, other event orcondition, management shall use its judgment in developing and applying an accounting policythat results in information that is relevant to the economic decision-making needs of users.

Paragraph 11 of PAS 8 provides that in making the judgment, management shall refer to, andconsider the applicability of, the following sources in descending order:

(a) the requirements in PFRSs dealing with similar and related issues; and(b) the definitions, recognition criteria and measurement concepts for assets, liabilities,

income and expenses in the Framework.

Paragraph 41 of PAS 16, Property, Plant and Equipment states that:


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“The revaluation surplus included in equity in respect of an item of property, plant and equipmentmay be transferred directly to retained earnings when the asset is derecognized. This may involvetransferring the whole of the surplus when the asset is retired or disposed of. However, some ofthe surplus may be transferred as the asset is used by an entity. In such a case, the amount of thesurplus transferred would be the difference between depreciation based on the revalued carryingamount of the asset and depreciation based on the asset's original cost. Transfers fromrevaluation surplus to retained earnings are not made through profit or loss.”

Consensus

Taking into consideration the nature of the transaction, it is presumed that the “equity contribution”recognized in the books of the subsidiary is equivalent to additional paid-in capital (APIC).

On the other hand, since there is no specific accounting standard that deals with the subsequenttreatment of “equity contribution” recognized in the books of the subsidiary, paragraph 11 of PAS8 states that, in making the judgment required by paragraph 10 of PAS 8, management can referto, and consider the applicability of the requirements in PFRSs dealing with similar and relatedissues. The Subsidiary can analogize the provisions of paragraph 41 of PAS 16 which states thatrevaluation surplus included in equity in respect of an item of property, plant and equipment maybe transferred directly to retained earnings when the asset is derecognized or as used by theentity (i.e., through depreciation and amortization). Applying the guidance of PAS 16, as theSubsidiary amortizes the “Day 1” difference using the effective interest method, an equivalentamount may be adjusted from the “Equity reserve” account to retained earnings.

Accordingly, the Subsidiary has an accounting policy choice to apply the following:

Option 1 (Preferred view) – The equity component arising from the difference between thefair value and face value of the loan is initially recognized as “Equity reserve”. Subsequently,the said adjustment will be closed to APIC upon settlement of the loan. This option entails aone-time charge to APIC without any future reclassification to retained earnings.

Option 2 – the equity component arising from the difference between the fair value and facevalue of the loan is also initially recognized as “Equity reserve”, similar to Option 1.Subsequently, as the “Day 1” difference is amortized using the effective interest methodthrough profit or loss, an amount equivalent to the amortization for the period is transferredfrom “Equity reserve” to retained earnings.


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If Option 2 is applied, the entity needs to disclose this accounting policy in its financial statements.Otherwise, it will be assumed that Option 1 is applied.

The policy adopted by a subsidiary shall be applied consistently for similar transactions.

It should be emphasized that the above guidance is applicable only in the preparation ofseparate/standalone financial statements of the subsidiary. On consolidation, intercompany loanswill be eliminated, including any discount or premium (and the effect of unwinding thereof) arisingfrom any ‘Day 1’ difference.


The consensus in this Q&A is effective from the date of the approval by the FRSC. It shall beapplied retrospectively.

Date approved by PIC: July 26, 2017

PIC Members











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Q&A No. 2018 - 01: PAS 8 - Voluntary changes in accounting policy

Issue

What criteria are considered in assessing whether or not a proposed accounting policyprovides information that is reliable and more relevant than the existing policy, when anentity wants to voluntarily change its accounting policy?

Fact pattern

An entity wishes to change its accounting policy in an area where Philippine FinancialReporting Standard (PFRS) permits an entity to choose from multiple accounting policies(either under the standard itself, or where PFRS is not clear).

Consensus

The criteria to consider when assessing whether a proposed new accounting policy ismore relevant than the existing policy are:

Whether support for the proposed accounting policy exists in PFRSs, PhilippineInterpretations and rejection notices issued by the IFRS Interpretations Committee;

Whether the proposed accounting policy is a widely recognized and prevalentpractice;

Whether, in the particular circumstances of the entity, the proposed accountingpolicy results in information that is more useful in enabling users to evaluate past,present or future events. In this regard, it is necessary to consider the substance,including the business purpose, of transactions or events that are subject to thechange in accounting policy to assess whether the proposed policy results infinancial information that fairly represents the substance and economic reality ofthose transactions and events. This includes a consideration of management’splans.

When all the above criteria are satisfied, it is possible to conclude that the proposedaccounting policy provides ‘reliable and more relevant information’.


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However, it is not always necessary for a proposed accounting policy to meet all theabove criteria for it to provide ‘reliable and more relevant information.’ In rare cases, it ispossible to demonstrate that the proposed accounting policy results in information that ismore useful in helping readers to evaluate past, present or future events, even in theabsence of authoritative support for the proposed policy in accounting literature and/or ifthe policy is not a widely recognized and prevalent practice.

For example, the fact that a majority of entities in the same industry adopted the proposedpolicy provides support for the change in policy, since it would result in greatercomparability. Consequently, the proposed change is likely to result in ‘reliable and morerelevant information’ as it would help users of the financial statements to evaluate past,present and future events. At the same time, the entity must determine whether theproposed accounting policy conflicts with the accounting policies applied by entitiesoutside the industry for similar or analogous transactions. It is also necessary todetermine that there is authoritative support for the proposed policy and that its adoptionresults in financial information that represents faithfully the substance and economicreality of the transactions entered into by the entity.

Further, an entity needs to disclose the reasons why applying the new accounting policyprovides reliable and more relevant information.





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PIC Members











370

PAS 12, Income taxes

Q&A No. 2020 - 07: Accounting for the Proposed Changes in IncomeTax Rates under the Corporate Recovery and Tax Incentives forEnterprises Act (CREATE) Bill

Issues

1. Is the CREATE Bill considered substantively enacted as of December 31, 2020?

2. Is the subsequent enactment of the CREATE Bill considered an adjusting event?

3. What is the impact on the calendar year (CY) 2020 and CY2021 financialstatements (FS) of companies covered by the reduced income tax rates, in casethe CREATE bill (with retroactive effect in 2020 as described below) will be passedinto law after the reporting period of a company:

a. But before its audited FS issue date and before the actual filing of theCY2020 annual income tax return (ITR)?; Or

b. After its audited FS issue date but before the actual filing of the CY2020annual ITR?

Fact Pattern

On November 26, 2020, the Senate approved on 3rd and final reading Senate Bill No.1357, otherwise known as the “Corporate Recovery and Tax Incentives for EnterprisesAct” or “CREATE”, which seeks to reduce the corporate income tax rates and torationalize the current fiscal incentives by making it time-bound, targeted, andperformance-based.

Initially, the House of the Representatives, which already passed their counterpartmeasure in September 2019, informed the Senate that the latter’s version would beadopted by the Lower House. However, on December 15, 2020, the Senate received anofficial letter from the Lower House indicating that in fact, they have designated membersfor the bicameral conference, with the intention of holding a bicameral conference toreconcile disagreeing provisions on the Lower House and the Senate versions of the bill.


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The proposed law will be transmitted to the President of the Philippines for his approvalinto law only after the reconciled version of the measure is ratified by both houses ofCongress in plenary.

As of December 31, 2020, the CREATE bill is pending ratification by both Houses.

The proposed changes to Corporate Income Tax (CIT) rate under the Senate version (i.e.,the CREATE Bill) are, as follows:

1. Reduction in CIT rate effective July 1, 2020 as follows:

Domestic corporations shall be subject to the following reduced CIT ratesdepending on their assets and taxable income:

a. Those with assets amounting to P100,000,000 and below, and with taxableincome equivalent to P5,000,000 and below will be subjected to a 20% taxrate;

b. Those with assets above P100,000,000 or those with taxable incomeamounting to more than P5,000,000 will be subjected to a 25% tax rate.

(Note: Computation of total assets is exclusive of the value of the land wherethe property, plant, and equipment are situated.)

Foreign Corporations (resident and nonresident foreign corporations) will have afixed reduced tax rate of 25%.

2. Proprietary educational institutions and hospitals which are nonprofit previouslysubject to a tax of 10% on their taxable income, shall be imposed a tax rate of 1%beginning July 1, 2020 until June 30, 2023.

3. Regional Operating Headquarters (ROHQs) of multinational companies previouslysubject to a tax of 10% on their taxable income shall be subject to the regularcorporate income tax effective December 31, 2020.

4. Effective July 1, 2020 until June 30, 2023, the MCIT rate shall be one percent(1%).


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Since the CREATE Bill will still have to go through the Bicameral Committee Hearing andhas to be submitted to the President for approval, the same may not be passed into lawuntil the first quarter of 2021, at the earliest.

Unless the Bicameral Committee changes the rates or the retroactive effectivity to July 1,2020 as provided in the current version or the President reject such provisions using hisveto power, the reduced CIT rate of 20% or 25% (as the case may be) and the 1% CIT onproprietary hospitals / educational institutions may retroact to July 1, 2020 as intended.Accordingly, the annual income tax return for CY2020 to be filed on or before April 15,2021 may already have to use the prorated CIT rate for CY2020.

Consensus

1. The CREATE Bill is not considered substantively enacted as of reporting date, 31December 2020, given the following circumstances as of said date:

a. Congress as the legislative body and the President representing the executivebody of the Government are separate and independent from each other;

b. The bill is still pending with the bicameral committee of Congress, andconsequently not yet submitted to the President of the Philippines;

c. Upon submission the President of the Philippines, he may either approve it orexercise his veto power to stop the enactment of the subject bill;

d. In case the bill is vetoed by the President, Congress may not be able to garnerthe required two-thirds vote to overturn the presidential veto.

2. Under PAS 10.22h, if the bill is passed into law after the balance sheet date butbefore the issuance of the audited financial statements, it is treated as a non-adjustingevent. Disclosure of the nature of changes and impact to the financial statements isrequired if the impact is expected to be significant.

3. On the other hand, if the bill is passed into law after the issue date of the CY2020audited FS but prior to the actual filing of the CY2020 annual ITR, there is nosubsequent event that requires related FS disclosure. However, companies mayconsider disclosing the general key features of the proposed bill and expected


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financial impact.

4. Based on the foregoing consensus, below are the impact to the CY 2020 financialstatements and CY 2021 financial statements:

CY 2020 FS Current and deferred taxes for FS reporting purposes will still be measured using

the applicable income tax rates as of December 31, 2020 since the CREATE billwas not yet enacted / substantively enacted as of such date (there will bedifference between the provision for current income tax per CY2020 FS and theamount of income tax due per CY2020 ITR).

If the CREATE bill is enacted prior to CY2020 audited FS issue date and beforethe actual filing of the CY2020 ITR, this is a non-adjusting event but significanteffects of changes in tax rates on current and deferred tax assets and liabilitiesshould be disclosed (Companies in this case will have to compute for current anddeferred taxes based on adjusted tax rates to determine the impact of the changein the tax rate).

If the CREATE bill is enacted after CY2020 audited FS issue date and before theactual filing of the CY2020 ITR, this is no longer a subsequent event, butcompanies may consider disclosing the general key features of the proposed billand the expected impact in its audited FS.

CY2021 FS PAS 12 provides that components of tax expense (income) may include “any

adjustments recognized in the period for current tax of prior periods” and “theamount of deferred tax expense (income) relating to changes in tax rates or theimposition of new taxes”, among others (PAS 12.80.b and PAS 12.80.d)

An explanation of changes in the applicable tax rate(s) compared to the previousaccounting period is also required to be disclosed. (PAS 12.81.d)

Hence, the provision for current income tax for CY2021 will include the differencebetween income tax per CY2020 FS and CY2020 ITR (since the latter will not betaken up in CY2020 FS and thus be taken up in CY2021 FS)

Deferred tax assets and liabilities as of December 31, 2021 will be remeasuredusing the new tax rates. The impact of remeasurement is recognized in profit orloss (i.e., provision for/benefit from deferred income tax), unless it can be


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recognized in other comprehensive income or another equity account as providedfor in PAS 12.61A

Any movement in deferred taxes arising from the change in tax rates that will formpart of the provision for/benefit from deferred taxes will be included as well in theeffective tax rate reconciliation.

Basis for Consensus

Issue 1 PAS 12, Income Taxes, requires current and deferred taxes to be measured with

reference to the tax rates and laws, as enacted or substantively enacted by the end ofthe reporting period. (PAS 12.46 and PAS 12.47)

In some jurisdictions, announcements of tax rates (and tax laws) by the governmenthave the substantive effect of actual enactment, which may follow the announcementby a period of several months. In these circumstances, tax assets and liabilities aremeasured using the announced tax rate (and tax laws). (PAS 12.48)

PAS 12 gives no guidance as to how this requirement is to be interpreted in differentjurisdictions. In most jurisdictions, however, a consensus has emerged as to themeaning of ‘substantive enactment’ for that jurisdiction. Nevertheless, in practiceapparently similar legislative processes in different jurisdictions may give rise todifferent treatments under PAS 12. For example, in most jurisdictions, a tax legislationcan only be deliberated and promulgated by a separate legislative body after which,requires the formal approval of the executive head of state in order to become a law.However, in some jurisdictions the head of state has the sole power to announce,promulgate and issue tax laws through presidential decrees, whereas in others, thehead of state has a more ceremonial role (and cannot practically fail to approve thelegislation).

The general principle tends to be that, in those jurisdictions where the head of statehas executive power that is independent and separate from the legislative body, alegislation is not substantively enacted until actually approved by the head of state.Where, however, the head of state’s powers are more ceremonial, substantiveenactment is generally regarded as occurring at the stage of the legislative process


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where no further amendment is possible.

The Philippines is a republic with a presidential form of government wherein the poweris equally divided among its three branches: executive, legislative, and judicial. Onebasic corollary in a presidential form of government is the principle of separation ofpowers wherein legislation belongs to Congress, execution to the Executive, andsettlement of legal controversies to the Judiciary. Under the Philippine legislationprocess, bills are laws in the making. They pass into law when they are approved byboth Houses (i.e., the House of Representatives and the Senate) and the President ofthe Philippines. Under Article VI, Section 21 of the Constitution, the President has thepower to veto a legislative bill and stop its enactment. The House of Representativesmay overturn a presidential veto by garnering a two-thirds vote. If the President doesnot act on a proposed law submitted by Congress, it will lapse into law after 30 days ofreceipt. (https://www.officialgazette.gov.ph/about/gov/the-legislative-branch/)

Issue 2PAS 10, Events after the Reporting Period, identifies the enactment or announcement ofa change in tax rates and laws after the end of the reporting period as an example of anon-adjusting event [PAS 10.22(h)]. For example, an entity with a reporting period endingon 31 December issuing its financial statements on 20 April the following year wouldmeasure its tax assets and liabilities by reference to tax rates and laws enacted orsubstantively enacted as at 31 December even if these had changed significantly before20 April and even if those changes had retrospective effect. However, in thesecircumstances the entity would have to disclose the nature of those changes and providean estimate of the financial effect of those changes if the impact is expected to besignificant. [PAS 10.21]

Issue 3Refer to Basis for Conclusion of Issues 1 and 2

Transition and Effective DateThe consensus in this Q&A is effective from the date of approval of the FRSC.


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PIC Members



Christian Francis S. Felismino Zaldy D. Aguirre








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REFERENCES

PAS 12.46Current tax assets or liabilities are measured at the amount expected to be paid to(recovered from) the taxation authorities, using the tax rates (and tax laws) that havebeen enacted or substantively enacted by the end of the reporting period.

PAS 12.47Deferred tax assets and liabilities are measured at the tax rates that are expected to applyin the period when the asset is realized or the liability is settled, based on tax rates (andtax laws) that have been enacted or substantively enacted by the end of the reportingperiod.

PAS 10.3Events after the reporting period are those events, favorable and unfavorable, that occurbetween the end of the reporting period and the date when the financial statements areauthorized for issue. Two types of events can be identified:(a) those that provide evidence of conditions that existed at the end of the reporting period(adjusting events after the reporting period); and(b) those that are indicative of conditions that arose after the reporting period (non-adjusting events after the reporting period).

PAS 10.21If non-adjusting events after the reporting period are material, non-disclosure couldinfluence the economic decisions that users make on the basis of the financialstatements. Accordingly, an entity shall disclose the following for each material categoryof non-adjusting event after the reporting period:(a)the nature of the event; and(b)an estimate of its financial effect, or a statement that such an estimate cannot bemade.

PAS 10.22(h)Changes in in law enacted or announced after the reporting period is an example of non-adjusting events, that if material, warrant disclosure in financial statements. PAS 10mentions tax law only, but this rule is applicable to changes in law in general.


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PAS 12.80Components of tax expense (income) may include:(a) current tax expense (income);(b) any adjustments recognized in the period for current tax of prior periods;(c) the amount of deferred tax expense (income) relating to the origination and reversal of

temporary differences;(d) the amount of deferred tax expense (income) relating to changes in tax rates or

the imposition of new taxes;(e) the amount of the benefit arising from a previously unrecognized tax loss, tax credit or

temporary difference of a prior period that is used to reduce current tax expense;(f) the amount of the benefit from a previously unrecognized tax loss, tax credit or

temporary difference of a prior period that is used to reduce deferred tax expense;(g) deferred tax expense arising from the write-down, or reversal of a previous

write-down, of a deferred tax asset in accordance with paragraph 56; and(h) the amount of tax expense (income) relating to those changes in accounting policies

and errors that are included in profit or loss in accordance with IAS 8, because theycannot be accounted for retrospectively.

PAS 12.61ACurrent tax and deferred tax shall be recognized outside profit or loss if the tax relates toitems that are recognized, in the same or a different period, outside profit or loss.Therefore, current tax and deferred tax that relates to items that are recognized, in thesame or a different period:(a) in other comprehensive income, shall be recognized in other comprehensive income

(see paragraph 62).(b) directly in equity, shall be recognized directly in equity (see paragraph 62A).


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PAS 16, Property, Plant and Equipment


Relevant PFRS


Issue









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381






Scenario 2(a), 2(b) and 2(c) As the entity, at date of acquisition, has decided to initially use theproperty as owner-occupied property, the land and building will be classified as twoseparate items under Property, Plant and Equipment measured at their allocatedcost determined using the relative fair value method.

Elements of cost





(b) any costs directly attributable to bringing the asset to the location and condition necessaryfor it to be capable of operating in the manner intended by management.

(c) the initial estimate of the costs of dismantling and removing the item and restoring the siteon which it is located, the obligation for which an entity incurs either when the item isacquired or as a consequence of having used the item during a particular period forpurposes other than to produce inventories during that period.



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(a) costs of employee benefits (as defined in PAS 19, Employee Benefits) arising directly fromthe construction or acquisition of the item of property, plant and equipment;




(e) costs of testing whether the asset is functioning properly, after deducting the net proceedsfrom selling any items produced while bringing the asset to that location and condition(such as samples produced when testing equipment); and





“12 The costs of conversion of inventories include costs directly related to the units of production,such as direct labour. They also include a system allocation of fixed and variable productionoverheads that are incurred in converting materials into finished goods.



“20 An investment property shall be measured initially at its cost. Transaction costs shallbe included in the initial measurement.


383


Consensus


Under Scenario 1

Under Scenario 1, the entity intends to demolish the old building and will not use the old buildingprior to its demolition.


PAS 16 does not include any explicit guidance on whether the allocated cost or carrying value ofan old building that will be demolished is part of the cost of the replacement building.Nevertheless, it is viewed that the allocated cost, if any, of the old building to be demolished is nota cost directly attributable to the new building as provided in PAS 16.16 (b) and PAS 16.17 citedearlier. Therefore, the allocated cost of the old building shall not form part of the cost of the newbuilding. Also, since the old building will not be used, hence, no further economic benefits areexpected from its use, the allocated cost of the old building should be de-recognized as requiredunder PAS 16.67 and the loss arising from de-recognition is included in profit or loss as requiredunder PAS 16.68.



The cost of inventories under PAS 2.10 cited earlier is a somewhat lower threshold than the costof an item of property, plant and equipment under PAS 16. For example, the cost of inventoriesunder PAS 2.10 need not be directly attributable.



384

Scenario 1(c): New building will be held as an investment propertyProperty (land or a building—or part of a building—or both) held (by the owner or by the lesseeunder a finance lease) to earn rentals or for capital appreciation or both is within the scope of PAS40.


Under Scenario 2

Under Scenario 2, the entity acquired the property in a prior reporting period and initially used theproperty as an owner-occupied property. In the current reporting period, it decided to demolishthe old building and replace it with a new building.



Applying the above principles, the entity, at the time it makes the decision to demolish the oldbuilding at a specific date in the future, has to re-compute the related depreciation charges on thebuilding to depreciate the remaining carrying value of the building over the remainder of its life (orthe remaining period before it is demolished). Hence, the old building will have a nil value at thedate of the planned demolition.


385


(a) the carrying value of the old building represents the un-depreciated cost of the old buildingrather than a cost incurred in the construction of the new building; and







Effective Date





386

PIC Members










387

Q&A No. 2017 – 02 (amended July 2019): Capitalization of depreciationof right-of-use asset cost as part of construction costs of a building

Issue

Does depreciation of right-of-use asset constitute part of the cost of:




Fact Pattern


On January 1, 20X0, an entity enters into a 20-year lease of land. Under the lease agreement,the entity makes an initial upfront payment of P1,000 and pays rent of P200 quarterly in advance.The entity intends to construct a building on the land and, as part of its ordinary businessactivities, plans to sell the building once construction is completed.



1 In the absence of such intent, there may arise an issue of whether there is an onerous contract for the remaining lease term whichwill have to be assessed under PAS 37, Provisions, Contingent Liabilities and Contingent Assets; and such right-of-use asset willhave to be assessed under PAS 36, Impairment of Assets, for possible impairment. Moreover, in the absence of such an intent (i.e.,no subsequent sub-lease arrangement to the buyer of the building), there may be a need to assess if the selling price of the buildingcontains an element intended to cover for the cost of future rentals which may have to be accounted for separately under PFRS 15,Revenue from Contracts with Customers..


388








Scenario 1





“The costs of conversion of inventories include costs directly related to the units of production,such as direct labor. They also include a systematic allocation of fixed and variable productionoverheads that are incurred in converting materials into finished goods. Fixed productionoverheads are those indirect costs of production that remain relatively constant regardless ofthe volume of production, such as depreciation and maintenance of factory buildings, equipmentand right-of-use assets used in the production process, and the cost of factory management andadministration […]”

As the entity enters into the lease with the intention of constructing the building, depreciation ofright-of-use asset incurred during the construction period should be capitalized as part of the


389

construction costs of the building because it was incurred in bringing the inventories to theirpresent location and condition.

Scenario 2




Depreciation of right-of-use asset is a directly attributable cost in the terms of paragraph 16(b) ofPAS 16, which states that the cost of property, plant and equipment comprises (among otherthings):


In particular, in the scenario indicated, depreciation of right-of-use asset is an unavoidable costof developing the property. Without this lease no construction can occur.

Consequently, depreciation of right-of-use asset incurred during the construction period shouldbe capitalized as part of the construction costs of the building.

Since paragraph 22 of PAS 16 refers to PAS 2, the accounting treatment for cost capitalizationmust be applied consistently to transactions of the type described in both Scenario 1 andScenario 2.

Scenario 3

Refer to the reasons for conclusion provided for the Scenarios 1 and 2 above. Take note that inthis scenario, the building must be vacant while the leasehold improvements are made. Thisprovides additional argument to support the capitalization of the depreciation of right-of-useasset during the period in which the building is not being used. Capitalization of depreciation ofright-to-use asset in the carrying amount of the leasehold improvements commences once theentity starts making the improvements and ceases once the improvements are in the location andcondition necessary for them to be capable of operating in the manner intended by management.



390

“Recognition of costs in the carrying amount of an item of property, plant and equipment ceaseswhen the item is in the location and condition necessary for it to be capable of operating in themanner intended by management […]”


The effective date and transition provision of this Q&A follow those of PFRS 16, Leases,Appendix C, upon approval by the FRSC.




391

PIC Members












392


Issue





Consensus


Scenario 1




393








Scenario 3



394




Effective Date




395

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396

Q&A No. 2018 - 03: PFRS 13, PAS 16 and PAS 36 - Fair value ofproperty, plant and equipment and depreciated replacement cost

Issue

Can depreciated replacement cost be used to measure the fair value of an item ofproperty, plant or equipment in accordance with PFRS 13, Fair Value Measurement?

Fact pattern

An entity provides port freight and logistics services. Its plant or equipment compriseshighly-specialized assets from which the entity earns berthing and tonnage fees. Theentity accounts for these assets in accordance with PAS 16, Property, Plant andEquipment, using the revaluation model.

At the end of the reporting period, the assets are tested for impairment under PAS 36,Impairment of Assets. As part of determining the assets’ recoverable amount, the entitymay need to determine their fair value less costs of disposal. However, there are fewobservable inputs available to use in measuring fair value because of the highlyspecialized nature of the assets and because there is no history of such assets everbeing sold, other than as part of a business combination.

Relevant guidance


“...to estimate the price at which an orderly transaction to sell the asset or to transfer theliability would take place between market participants at the measurement date undercurrent market conditions (i.e., an exit price at the measurement date from the perspectiveof a market participant that holds the asset or owes the liability).

...Because fair value is a market-based measurement, it is measured using theassumptions that market participants would use when pricing the asset or liability,including assumptions about risk...”


397


“A fair value measurement of a non-financial asset takes into account a marketparticipant's ability to generate economic benefits by using the asset in its highest and bestuse or by selling it to another market participant that would use the asset in its highest andbest use.”



The objective of using a valuation technique is to estimate the price at which an orderlytransaction to sell the asset or to transfer the liability would take place between marketparticipants at the measurement date under current market conditions. Three widely usedvaluation techniques are the market approach, the cost approach and the incomeapproach... An entity shall use valuation techniques consistent with one or more of thoseapproaches to measure fair value.”

Using techniques that are consistent with the cost approach do not change the objective ofa fair value measurement. Paragraph B8-B9 of PFRS 13 clarifies that:

“The cost approach reflects the amount that would be required currently to replace theservice capacity of an asset (often referred to as current replacement cost).

From the perspective of a market participant seller, the price that would be received for theasset is based on the cost to a market participant buyer to acquire or construct a substituteasset of comparable utility, adjusted for obsolescence. That is because a marketparticipant buyer would not pay more for an asset than the amount for which it couldreplace the service capacity of that asset. Obsolescence encompasses physicaldeterioration, functional (technological) obsolescence and economic (external)obsolescence and is broader than depreciation for financial reporting purposes (anallocation of historical cost) or tax purposes (using specified service lives). In many casesthe current replacement cost method is used to measure the fair value of tangible assetsthat are used in combination with other assets or with other assets and liabilities.”


398

Consensus

Depreciated replacement cost can be used to measure the fair value of an item ofproperty, plant or equipment only in limited circumstances. PFRS 13 defines fair valueas current exit price, whereas depreciated replacement cost measures the entry pricefor an asset. Therefore, only when this entry price equals a current exit price candepreciated replacement cost be used to measure fair value.




The exit market for the asset (i.e., the principal market or in its absence, the mostadvantageous market) is the same as the entry market (i.e., the market in whichthe asset was/will be purchased).

In addition, the resulting depreciated replacement cost must be assessed to ensuremarket participants are willing to transact for the asset in its current condition andlocation at this price. In particular, an entity must ensure that both:

The inputs used to determine replacement cost are consistent with what marketparticipant buyers will pay to acquire or construct a substitute asset ofcomparable utility, and

The replacement cost has been adjusted for obsolescence that marketparticipant buyers will consider – i.e., that the depreciation adjustment reflects allforms of obsolescence (i.e., physical deterioration, technological (functional) andeconomic obsolescence), which is broader than depreciation calculated inaccordance with PAS 16.


399




PIC Members











400

PAS 19, Employee Benefits (Revised)

Q&A No. 2008 – 01 (Amended April 2016): PAS 19.83 – Rate used indiscounting post-employment benefit obligations

Issue

What rate shall be used in discounting post-employment benefit obligations?

Background

Paragraph 83 of PAS 19, Employee Benefits, provides that the rate used to discountpost-employment benefit obligations shall be determined by reference to market yields at thebalance sheet date on government bonds in countries where there is no deep market in highquality corporate bonds. The currency and term of the government bonds shall be consistentwith the currency and estimated term of the post-employment benefit obligations. Paragraph85 of PAS 19 also provides that the discount rate reflect the timing of benefit payments.

The more common source of discount rates by actuaries is the Philippine Dealing andExchange Corporation (PDEX). The PDS rates published by PDEX, usually used by actuaries,are based on the yield for peso government issued coupon bearing instruments which pay outinterest payments on a periodic basis over the term of the bond and the principal upon maturity.

Another source of discount rates is Bloomberg which provide rates for peso government bondsthat are the effective yield for debt instruments which repays the investor one time and onlyupon maturity, the principal and any effective interest (zero coupon).

Since employees of an entity retire at different points in time, the entity has to determine thevarious duration of retirement liabilities. In practice, actuaries will either (1) get the averageduration of retirement liabilities and use this as the basis of the term of the peso governmentbond in determining the appropriate discount rate, or (2) derive the discount rate by applying asingle weighted average discount rate that reflects the estimated timing and amount of benefitpayments in which the benefits are to be paid.

Consensus

The rate used to discount post-employment benefit obligations shall reflect the pattern of cashflow for the payment of retirement benefits. Employees become entitled to retirement benefitsat the end of their service lives. A rate that would be reflective of a one-time payment uponmaturity is that of a zero coupon instrument which has a single cash flow. Although paymentschemes may vary (e.g., lump sum or periodic payments over the life of the retiredemployees), it may be assumed for actuarial purposes that payments would be made in one


401

lump sum.

If the rate reflects the yield for peso government bonds that pay out interest payments on aperiodic basis over the term of the bond and the principal upon maturity, such rate may beconverted to a zero coupon rate1 to reflect a reasonable estimate of the benefit payments.

Since zero coupon rates are theoretically derived, the notes to financial statements shalldisclose the basis used for discounting post-employment benefit obligations.

Effective Date


Date originally approved by PIC: November 26, 2008Date amendments approved by PIC: April 27, 2016

PIC Members










1Reference may be made to the PDEx website or to Bloomberg website for zero coupon rates for government securities.


402

Q&A No. 2013 – 03 (Revised): PAS 19 – Accounting for EmployeeBenefits under a Defined Contribution Plan subject to Requirementsof Republic Act (RA) 7641, The Philippine Retirement Law1

Issue

If an entity has a defined contribution plan as its only post-employment benefit plan for itsemployees and is likewise subject to RA 7641, The Philippine Retirement Law, which requires alevel of minimum benefits,

1. How should the retirement plan be accounted for under PAS 19, Employee Benefits?2. What are the required disclosures relating to the retirement plan?3. How should the obligation under the retirement plan be measured under PAS 19?

Background

RA 7641 provides for the minimum retirement pay to qualified private sector employees in thePhilippines. Benefits due under RA 7641 are accounted for as defined benefit plan underPAS 19. However, there are instances when an employer establishes a defined contributionplan and does not have an equivalent defined benefit plan covering the benefits required underRA 7641.

This Q&A seeks to provide guidance in accounting for post-employment benefits for an entitywhich has opted to provide a defined contribution plan as its only post-employment benefit plandespite the minimum retirement benefits required to be provided to employees under RA 7641.

RA 7641 and its Implementing RulesAmong other things, RA 7641 and its Implementing Rules provide that:

- Any employee may be retired upon reaching the retirement age established in thecollective bargaining agreement or other applicable employment contract.

- In case of retirement, the employee shall be entitled to receive such retirement benefitsas he may have earned under existing laws and any collective bargaining agreementand other agreements. This is provided, however, that an employee's retirement benefitsunder any collective bargaining and other agreements shall not be less than thoseprovided under RA 7641.

1The official title of RA 7641 is “An Act Amending Article 287 of Presidential Decree No. 442, As Amended, Otherwise Known asThe Labor Code of the Philippines, by Providing for Retirement Pay to Qualified Private Sector Employees in the Absence of anyRetirement Plan in the Establishment.”


403

- the absence of a retirement plan or agreement providing for retirement benefits ofemployees in the establishment, an employee upon reaching the age of sixty (60) yearsor more, but not beyond sixty-five (65) years which is declared the compulsoryretirement age, who has served at least five (5) years in the said establishment, mayretire and shall be entitled to retirement pay equivalent to at least one-half (1/2) monthsalary for every year of service, a fraction of at least six (6) months being considered asone whole year.

- For the purpose of determining the minimum retirement pay due an employee under theImplementing Rules of RA 7641, the term “one-half month salary” shall include fifteen(15) days salary of the employee based on his latest salary rate.

- Unless the parties provide for broader inclusions, the term one-half (1/2) month salaryshall mean fifteen (15) days plus one-twelfth (1/12) of the 13th month pay and the cashequivalent of not more than five (5) days of service incentive leaves.

Classification of a defined benefit plan or a defined contribution plan under PAS 19

Under PAS 19, post-employment plans are classified as either a defined contribution or adefined benefit plan. The classification of the plan determines the accounting treatment for theemployee benefits provided under the plan.

PAS 19.8 provides the following definitions of a defined contribution plan and a defined benefitplan:

“Defined contribution plans are post-employment benefit plans under which an entity paysfixed contributions into a separate entity (a fund) and will have no legal or constructiveobligation to pay further contributions if the fund does not hold sufficient assets to pay allemployee benefits relating to employee service in the current and prior periods.

Defined benefit plans are post-employment benefit plans other than defined contributionplans.”

Further discussions are provided in paragraphs 29 and 30 of PAS 19 relating to the abovedefinitions:

“29 Examples of cases where an entity’s obligation is not limited to the amount that it agreesto contribute to the fund are when the entity has a legal or constructive obligation through:

(a) a plan benefit formula that is not linked solely to the amount of contributions and requiresthe entity to provide further contributions if assets are insufficient to meet the benefits inthe plan benefit formula;


404

(b) a guarantee, either indirectly through a plan or directly, of a specified return oncontributions; or

(c) those informal practices that give rise to a constructive obligation.

30 Under defined benefit plans:

(a) the entity’s obligation is to provide the agreed benefits to current and formeremployees; and

(b) actuarial risk (that benefits will cost more than expected) and investment risk fall, insubstance, on the entity. If actuarial or investment experience are worse thanexpected, the entity’s obligation may be increased.”

Consensus

1. How should the retirement plan covered under this Q&A 2013-03 be accounted forunder PAS 19?

The benefits mandated under RA 7641 are considered as a minimum benefit guarantee forqualified private sector employees in the Philippines. Hence, for an entity that provides adefined contribution plan as its only post-employment benefit plan, its obligation for post-employment benefits is not limited to the amount it agrees to contribute to the fund, if any. Inthis case, therefore, the entity’s retirement plan shall be accounted for as a defined benefitplan.

2. What are the required disclosures relating to the above retirement plan?

The relevant disclosure requirements of PAS 19 for a defined benefit plan should becomplied with. In addition, the accounting policy describing the accounting treatment forsuch a plan should also be disclosed in the notes to financial statements. Partial illustrativedisclosures are presented in Appendix A.

3. How should the obligation under the above retirement plan be measured underPAS 19?

The obligation should be measured as at reporting date as follows:

a. Step 1:

1. Calculate the DC liability measured at the fair value of the DC assets upon which thebenefits depend, with an adjustment for any margin on asset returns where this isreflected in the benefits, less any forfeitures during the period.


405

2. If there is an excess of the projected DB obligation over the projected DC obligation,apply the projected unit credit method on such excess to determine the additional DCliability.

b. Step 2:

Recognize the PAS 19 liability measured at the higher of the amount determined underStep 1 and DB liability*.

*DB liability is the present value of the obligation mandated under RA 7641 using theprojected unit credit method.

(Note: While this Q&A does not cover the mechanics of measuring the DB obligation,companies are encouraged to refer the measurement of the DB obligation to a qualified actuary,consistent with paragraph 57 of PAS 19. General guidance is provided in Appendix B.)

Effective Date

The consensus in this Q&A is effective for annual financial statements with period beginningJanuary 1, 2014 and should be applied retrospectively following the provisions of PAS 8,Accounting Policies, Changes in Accounting Estimates and Errors.

Q&A approved by PIC: July 30, 2014

PIC Members



Wilfredo A. Baltazar Ma. Gracia F. Casals-Diaz

Rosario S. Bernaldo Jose Emmanuel U. Hilado


Sharon G. Dayoan Normita L. Villaruz

Lyn Javier

Q&A approved by FRSC: October 8, 2014


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Appendix A

Partial Illustrative Disclosures(These partial illustrative disclosures are provided as guidance only and shall be tailored asapplicable to consider the specific circumstances of the entity.)

Note x. Significant Accounting Policies (in part)

(x) - Retirement plan (in part)

The Company maintains a defined contribution (DC) plan that covers all regular full-timeemployees. Under its DC plan, the Company pays fixed contributions based on the employees’monthly salaries. The Company, however, is covered under Republic Act (RA) No. 7641, ThePhilippine Retirement Law, which provides for its qualified employees a defined benefit (DB)minimum guarantee. The DB minimum guarantee is equivalent to a certain percentage of themonthly salary payable to an employee at normal retirement age with the required creditedyears of service based on the provisions of RA 7641.

Accordingly, the Company accounts for its retirement obligation at each reporting date under thehigher of the DB obligation relating to the minimum guarantee and the sum of DC liability andthe present value of the excess of the projected DB obligation over projected DC obligation.The DB obligation and the present value of the excess of the projected DB obligation over theDC obligation are calculated annually by a qualified independent actuary using the projectedunit credit method. The Company determines the net interest expense (income) on the net DBliability (asset) for the period by applying the discount rate used to measure the DB obligation atthe beginning of the annual period to the then net DB liability (asset), taking into account anychanges in the net DB liability (asset) during the period as a result of contributions and benefitpayments. Net interest expense and other expenses related to the DB plan are recognized inprofit or loss.

The DC liability, on the other hand, is measured at the fair value of the DC assets upon whichthe DC benefits depend, with an adjustment for margin on asset returns, if any, where this isreflected in the DC benefits.

Remeasurements of the net DB liability, which comprise actuarial gains and losses, the returnon plan assets (excluding interest) and the effect of the asset ceiling (if any, excluding interest),are recognized immediately in other comprehensive income.

When the benefits of a plan are changed or when a plan is curtailed, the resulting change inbenefit that relates to past service or the gain or loss on curtailment is recognized immediatelyin profit or loss. The Company recognizes gains or losses on the settlement of a DB plan whenthe settlement occurs.


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Note xx. Retirement Plan (in part)As discussed in Note x, the Company maintains a defined contribution (DC) plan which isaccounted for as a defined benefit (DB) plan with minimum guarantee.

Following are the details of the Company’s DB obligation for the DB minimum guarantee: (TheCompany should provide here the applicable disclosure requirements for DB plans under theamended PAS 19.)


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Appendix B

Guidance on How to Measure the Additional DB Liability (Ref: Consensus 3b)

The determination of the entity’s retirement obligation involves the following steps:

1. Project the liability on retirement date under the terms of the defined contribution plan(DC liability). This considers the following:

o The required contributions plus the related returns on plan assets, if any, lessforfeitures. Forfeitures pertain to the benefits accruing to employees who left thecompany prior to vesting (employee turnover).

o The rate to be used in projecting the return on plan assets shall be the discountrate used to measure the defined benefit obligation.

2. Project the liability on retirement date based on RA 7641 (DB liability). The projected DBliability is the ultimate cost that the entity is required to provide to its employees underRA 7641 on retirement date. Probability of employees’ entitlement to the pension benefitshall be considered in the calculation.

3. Determine the excess of projected DB liability (Step 2) over projected DC liability (Step1), if any.

4. Attribute the excess of projected DB liability over projected DC liability over periods ofservice on a straight-line basis and account for it using the projected unit credit method(PUC) method.


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PAS 21, The Effects of Changes in Foreign Exchange Rates

Q&A No. 2018 – 09: PAS 21 - Classification of deposits and progresspayments as monetary or non-monetary items

Issue

Are deposits or progress payments made when acquiring fixed assets or inventoriesfrom foreign suppliers retranslated as monetary items or as non-monetary items?

Fact pattern

Entities may be required to pay deposits or progress payments when acquiring fixedassets or inventories from foreign suppliers. A local entity contracts to purchase an itemof plant and machinery for Thailand Baht (THB)10,000 on the following terms:

Payable on signing contract (August 1, 20X1) – 10% Payable on delivery (December 19, 20X1) – 40% Payable on installation (January 7, 20X2) – 50%

The entity paid the first two amounts on the due dates, when the respective exchangerates were THB1 = Philippine Peso (PHP)1.25 and THB1 = PHP1.20. The closing rateat the end of the reporting period, December 31, 20X1, is THB1 = PHP1.15.

Relevant guidance

PAS 21, The Effects of Changes in Foreign Exchange Rates, generally requires thatmonetary items denominated in foreign currencies be retranslated using closing rates atthe end of each reporting period and non-monetary items are not retranslated.

According to paragraph 8 of PAS 21, monetary items are defined as:

“units of currency held and assets and liabilities to be received or paid in a fixed ordeterminable number of units of currency”.

The standard elaborates further on this guidance by stating in paragraph 16 of PAS 21:

“the essential feature of a monetary item is a right to receive (or an obligation to deliver)a fixed or determinable number of units of currency”.


410

Examples given by PAS 21 are pensions and other employee benefits to be paid incash; provisions that are to be settled in cash; and cash dividends that are recognizedas a liability. Examples that are more obvious are cash and bank balances; tradereceivables and payables; and loan receivables and payables. Conversely, the essentialfeature of a non-monetary item is the absence of a right to receive (or an obligation todeliver) a fixed or determinable number of units of currency. Examples given by thestandard are amounts prepaid for goods and services (e.g. prepaid rent); goodwill;intangible assets; inventories; property, plant and equipment; and provisions that are tobe settled by the delivery of a non-monetary asset.

Consensus

The conclusion depends on the nature of the payments.

If the payments made are prepayments or progress payments, then the amounts aretreated as non-monetary items and included in the statement of financial position atPHP4,133 (= (1,000 * 1/1.25) + (4,000 * 1/1.20)).

However, if the payments made are deposits, and are refundable, then the amountscould possibly be treated as monetary items and included in the statement of financialposition at PHP4,348 (= (1,000 * 1/1.15) + (4,000 * 1/1.15)) and an exchange gain ofPHP215 is recognized. A variant of this would be to only treat the first payment as adeposit until the second payment is made, since once delivery is made it is less likelythat the asset will be returned and a refund sought from the supplier.

In practice, it is often necessary to consider the terms of the contract to ascertain thenature of the payments made to determine the appropriate accounting treatment.





411

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412

PAS 24, Related Party Disclosures



Issue



Background





413











414

Consensus










amount repayable










415













416



















417














418
















419










Effective Date




420

PIC Members












421

Q&A No. 2017 - 04 Related party relationships between parents,subsidiary, associate and non-controlling shareholder 1

Issues

The ownership structure of a reporting group as per below fact pattern may give rise tovarious related party relationships.

1. Is entity B a related party of entity A in A’s consolidated financial statements?2. Is entity B a related party of entity C in C’s separate financial statements?3. Is entity D a related party of entity A in A’s separate financial statements?4. Is entity D a related party of entity A in A’s consolidated financial statements?

Fact Pattern

Consensus

1. Yes, entity B is a related party of A in the consolidated financial statements of A.

2. Yes, entity B is a related party of C in the separate financial statements of C.

3. No, entity D is not a related party of A in the separate financial statements of A.

4. Entity D would not normally be a related party of A in the consolidated financialstatements of A. However, since D and C are related parties, depending on the


Parent

A

Associate

B

Subsidiary

C

Non-controllingshareholder


422

relative size of C within A’s group, D might have significant influence over A’sgroup.

Basis for Consensus

Paragraph 9 of PAS 24, Related Party Disclosures, defines those related partyrelationships that are required to be disclosed in financial statements. Paragraph 10 ofPAS 24 also requires that the substance of relationships between entities is also to beconsidered in identifying possible related party relationships.

Scenario 1

B is related to A in A’s consolidated financial statements because B is an associate of A(as stated in paragraph 9(b)(ii) of PAS 24).

Scenario 2

Because B is a related party of A, B is also a related party to all members in the samegroup as A. Therefore, B is a related party of subsidiary C in the separate financialstatements of C (as stated in paragraph 9(b)(ii) of PAS 24).

Scenario 3

No, entity D is not a related party to A in the separate financial statements of A as itdoes not have significant influence over A.

Scenario 4

Entity D has significant influence over C in the group and hence any transactionsbetween D and C are disclosed in C’s separate financial statements as related partytransactions. This does not mean D is automatically a related party of A. However,consideration should be given to the level of influence held by the NCI shareholder onthe total group (i.e. amount of influence of NCI shareholders on C and weighting of C intotal group). If the level of influence on A is considered material, it may be decision-useful information to users of the group financial statements if transactions between Cand D (as related party transactions) were disclosed in entity A’s consolidated financialstatements.


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Relevant Guidance

Paragraph 9 of PAS 24 defines a related party as:

“A related party is a person or entity that is related to the entity that is preparing itsfinancial statements (in this Standard referred to as the ‘reporting entity’).

(a) A person or a close member of that person’s family is related to reporting entity ifthat person:

(i) has control or joint control over the reporting entity;

(ii) has significant influence over the reporting entity; or

(iii) is a member of the key management personnel of the reporting entity or ofa parent of the reporting entity.

(b) An entity is related to a reporting entity if any of the following conditions applies:

(i) The entity and the reporting entity are members of the same group (whichmeans that each parent, subsidiary and fellow subsidiary is related to theothers).

(ii) One entity is an associate or joint venture of the other entity (or anassociate or joint venture of a member of a group of which the other entityis a member).

(iii) Both entities are joint ventures of the same third party.

(iv) One entity is a joint venture of a third entity and the other entity is anassociate of the third entity.

(v) The entity is a post-employment benefit plan for the benefit of employeesof either the reporting entity or an entity related to the reporting entity. Ifthe reporting entity is itself such a plan, the sponsoring employers are alsorelated to the reporting entity.

(vi) The entity is controlled or jointly controlled by a person identified in (a).


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(vii) A person identified in (a)(i) has significant influence over the entity or is amember of the key management

(viii) The entity, or any member of a group of which it is a part, provides keymanagement personnel services to the reporting entity or to the parent ofthe reporting entity.

Paragraph 3 of PAS 28¸ Investments in Associates and Joint Ventures definessignificant influence as:

"the power to participate in the financial and operating policy decisions of the investee,but is not control or joint control over those policies."

Paragraph 10 of PAS 24 indicates:

"In considering each possible related party relationship, attention is directed to thesubstance of the relationship and not merely the legal form." [Emphasis added]

Paragraph 9 of PAS 1 defines the purpose of financial statements as:

“Financial statements are a structured representation of the financial position andfinancial performance of an entity. The objective of financial statements is toprovide information about the financial position, financial performance and cash flowsof an entity that is useful to a wide range of users in making economic decisions.Financial statements also show the results of the management’s stewardship of theresources entrusted to it. …” [Emphasis added]

Effective Date



425


PIC Members











426

PAS 27, Separate Financial Statements



Issue



Background





427











428

Consensus










amount repayable










429













430



















431














432
















433










Effective Date




434

PIC Members












435

Q&A No. 2018 - 06: PAS 27 - Cost of investment in subsidiaries inseparate financial statements when pooling is applied in consolidatedfinancial statements

Issue

In the separate financial statements of the acquiring entity, where the acquirer accountsfor its investments in subsidiaries at cost, how does the acquirer measure the cost of aninvestment in a subsidiary acquired as part of a common control business combination,when the pooling of interest method is applied in the consolidated financial statements?

This issue does not address when a new holding company is inserted above the parent.Such fact patterns are addressed by the guidance in paragraphs 12, 13 and 14 ofPAS 27, Separate Financial Statements.

Fact pattern

Scenario 1 - Fair value of consideration equals the fair value of the subsidiary

Parent owns a 100% direct interest in Sub 1 and Sub 2. As part of a groupreorganization, the parent transfers its direct interest in Sub 2 to Sub 1 in exchange forconsideration of CU200 (equal to the fair value of Sub 2).

The following diagram illustrates this fact pattern:

Before the transaction: After the transaction:

Parent

Subsidiary 1 Subsidiary 2

Parent

Subsidiary 1

Subsidiary 2


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The following table summarizes details of the transaction:

Carrying amount of investment in Sub 2 in separate financialstatements of parent (i.e., cost)

CU50

Carrying amount of Sub 2’s net assets in the separate financialstatements of Sub 2

CU110

Fair value of Sub 2 CU200Fair value of consideration paid by Sub 1 CU200

Sub 1 also prepares separate financial statements and has an accounting policy ofusing cost for investments in subsidiaries.

Scenario 2 - Fair Value of consideration is more or less than the fair value of thesubsidiary

Same as Scenario 1, except that the fair value of the consideration is CU150, which isless than the fair value of Sub 2.


When separate financial statements are prepared, paragraph 10 of PAS 27 permitsinvestments in subsidiaries to be accounted for either (a) at cost, (b) in accordance withPAS 39, Financial Instruments: Recognition and Measurement (or PFRS 9, FinancialInstruments when it becomes effective), or (c) using the equity method as described inPAS 28, Investments in Associates and Joint Ventures.

PAS 27 does not define ‘cost’. However, where PFRS/IFRS uses the term elsewhere,cost generally means the fair value of the consideration plus incidental costs. InJuly 2009, the IFRS Interpretations Committee (IFRIC) also expressed this view, whenthey noted, that generally under IFRSs, cost comprises the purchase price and to othercosts directly attributable to the acquisition. Whilst the IFRIC made this comment in thecontext of associates, this comment appears equally applicable to subsidiaries.Therefore, in the separate financial statements, it is appropriate to base the cost of theinvestment in a subsidiary on the fair value of the consideration given for the acquisitionof the business (or the relevant part of it) in the consolidated financial statements underIFRS 3 Business Combinations (or PFRS 3, Business Combinations, the equivalentlocal accounting standard). This is the fair value of the consideration given plus anycosts directly attributable to the acquisition of the investment.


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Paragraph B86(b) of PFRS 10, Consolidated Financial Statements, also appears torequire this measurement when it states:

“Consolidated financial statements ... offset (eliminate) the carrying amount of theparent’s investment in each subsidiary and the parent’s portion of equity of eachsubsidiary (PFRS 3, Business Combinations, explains how to account for any relatedgoodwill).”

Although the acquirer might choose to use book value accounting for the acquisition inits consolidated financial statements, that treatment is not available in its separatefinancial statements. Although PFRS 3 provides relief from the purchase method forcommon control business combinations, there is no corresponding relief from PAS 27 indetermining the cost of the investment in the separate financial statements. In addition,since a parent does not account for an investment in a subsidiary as businesscombination, but rather as an investment, there is no basis for analogizing to theexemption for common control combinations.

Consensus

Scenario 1 - Fair value of consideration equals the fair value of the subsidiary

The cost of an investment in a subsidiary that is acquired as part of a groupreorganizations is the fair value of the consideration given (be it cash, other assets oradditional shares), plus, where applicable, any costs directly attributable to the acquisition.It is not appropriate to measure cost based upon either the cost of the transferring entity’sinvestment or the acquired entity’s net book value, because neither of these amountsrepresent the cost to the acquirer.

Therefore, the cost to Sub 1 in Scenario 1 is CU200. The cost is not the carrying amountof the investment in Sub 2 in separate financial statements of Parent (i.e., CU50) or thecarrying amount of Sub 2’s net assets in the separate financial statements of Sub 2 (i.e.,CU110), because neither of these amounts represent the cost to Sub 1 of acquiring Sub 2.

Scenario 2 - Fair Value of consideration is more or less than the fair value of the subsidiary

The conclusion in Scenario 1 applies even if the fair value of the consideration given ismore or less than the fair value of the acquiree. Therefore, the cost to Sub 1 in Scenario 2is CU150.


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Because this fact pattern is different from the fact pattern described in paragraphs 13 and14 of PAS 27, it is clear that no analogy is permitted.




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Q&A No. 2019 - 06: Accounting for step acquisition of a subsidiary ina parent’s separate financial statements

Issue

How should a parent account for the step acquisition of a subsidiary in its separate financialstatements?

Fact pattern

An entity elects to account for its investments in subsidiaries at cost in the separatefinancial statements by applying par. 10 of PAS 27, Separate Financial Statements.

The entity holds an initial investment in another entity (investee).

The investment is an investment in an equity instrument as defined in par. 11 of PAS 32,Financial Instruments: Presentation.

The investee is not an associate, joint venture or subsidiary of the entity and,accordingly, the entity applies PFRS 9, Financial Instruments, in accounting for its initialinvestment (initial interest).

The entity subsequently acquires an additional interest in the investee, which results inthe entity obtaining control of the investee––i.e., the investee becomes a subsidiary ofthe entity.

Consensus

PAS 27 does not define ‘cost’, nor does it specify how an entity determines the cost ofan investment acquired in stages. Cost is defined in other standards (for example, par. 6 ofPAS 16, Property Plant and Equipment, par. 8 of PAS 38, Intangible Assets, and par. 5 ofPAS 40, Investment Property).


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Based on the agenda decision - Investment in a subsidiary accounted for at cost: Stepacquisition published in January 2019, the IFRIC concluded that a reasonable reading of therequirements in IFRSs could result in the application of either one of the two approaches:

1. Fair value as deemed cost approach

Under this approach, the entity is exchanging its initial interest (plus consideration paidfor the additional interest) for a controlling interest in the investee (exchange view).Hence, the entity’s investment in subsidiary is measured at the fair value at the time thecontrol is acquired.

2. Accumulated cost approach

Under this approach, the entity is purchasing additional interest while retaining the initialinterest (non-exchange view). Hence, the entity’s investment in subsidiary is measuredat the accumulated cost (original consideration).

Any difference between the fair value of the initial interest at the date of obtainingcontrol of the subsidiary and its original consideration is taken to profit or loss,regardless of whether, before the step acquisition transaction, the entity had presentedsubsequent changes in fair value of its initial interest in profit or loss or othercomprehensive income (OCI).

In IFRIC’s view, this difference meets the definition of income or expenses in theConceptual Framework because the change of status of the investee results from anevent (i.e., obtaining control) (Par. 61, September 2018 IFRIC agenda paper oninvestment in a subsidiary accounted for at cost: Step acquisition).

Furthermore, no IFRS requires or permits the presentation of any difference between thecost of an investment retained and its fair value other than in profit or loss (Pars. 66-67,September 2018 IFRIC agenda paper on investment in a subsidiary accounted for atcost: Step acquisition). There is also no basis to recognize the difference in equitybecause the difference does not result from a transaction with owners in their capacityas owners.

The election in paragraph 4.1.4 of IFRS 9 to present changes in OCI applies only to‘subsequent changes in fair value’. This difference does not arise from a change in thefair value of the instrument––the entity ceases to apply IFRS 9 and immediately appliesIAS 27 so no fair value change has occurred. Accordingly, the entity presents thedifference in profit or loss. (Par. 68, September 2018 IFRIC agenda paper on investmentin a subsidiary accounted for at cost: Step acquisition)


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Illustrative example (lifted from September 2018 IFRIC agenda paper on investment in asubsidiary accounted for at cost: Step acquisition)

Entity X holds a 10% equity interest in Entity Y, which it originally acquired for CU100. Entity X subsequently acquires an additional 45% interest in Entity Y and obtains control

of Entity Y. Entity X pays CU540 for this additional interest. On the date Entity X obtains control of Entity Y, the fair value of the initial 10% interest in

Entity Y is CU120.

Applying the two approaches set out in the IFRIC agenda decision, Entity X would determinethe cost of its investment in Entity Y on the date it obtains control of Entity Y as follows:

Fair value as deemed cost Accumulated costConsideration paid for the 10%initial interest CU100Fair value of the 10% initialinterest CU120Consideration paid for the 45%additional interest 540 540Cost of the investment inEntity Y (55% interest) CU660 CU640

The entity using the fair value as deemed cost approach prepares the following journal entries:

Particulars Dr Cr

Investment in Entity Y CU100

Cash or payable CU100

To record initial acquisition of investment in Entity Y

Investment in Entity Y 20

Fair value increase* 20

To recognize changes in the fair value of the initial interest in Entity Y

Investment in Entity Y (subsidiary) 660


Cash or payable 540


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To recognize the step acquisition transaction

*Entity X would present this increase in profit or loss unless, applying PFRS 9.4.1.4, it elects to present inOCI subsequent changes in fair value of its initial interest. If Entity X avails of the presentation election, itdoes not subsequently transfer to profit or loss the amounts presented in OCI. However, the cumulativefair value gain or loss may be transferred by Entity X within equity.

The entity using the accumulated cost approach prepares the following journal entries:

Particulars Dr Cr

Investment in Entity Y CU100

Cash or payable CU100

To record initial acquisition of investment in Entity Y


Fair value increase** 20

To recognize changes in the fair value of the initial interest in Entity Y

Investment in Entity Y (subsidiary) 540

Cash or payable 540

To recognize the purchase of additional interest in Entity Y

Adjustment to the cost of equity instrument***(taken to profit or loss)

20


To reset the value of the initial interest from fair value to original cost

**Entity X would present this increase in profit or loss unless, applying PFRS 9.4.1.4, it elects to presentin OCI subsequent changes in fair value of its initial interest. If Entity X avails of the presentation election,it does not subsequently transfer to profit or loss the amounts presented in OCI. However, the cumulativefair value gain or loss may be transferred by Entity X within equity.

***If the measurement of Entity X’s initial interest increases because the fair value of the initial interest onthe date of obtaining control is lower than its original cost, the IFRIC thinks that the entity also would needto consider whether its investment in the subsidiary is impaired under IAS 36 Impairment of Assets.


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Transition

If an entity decides to change its accounting policy as a result of the issuance of this PIC Q&A,the change in accounting policy shall be applied retrospectively in accordance with PAS 8,Accounting Policies, Changes in Accounting Estimates and Errors.

Effective date



* * * * *

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PAS 28, Investments in Associates and Joint Ventures



Issue



Background





445











446

Consensus










amount repayable










447













448



















449














450
















451










Effective Date




452

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Q&A No. 2017 – 03: PAS 28 - Elimination of profits and lossesresulting from transactions between associates and/or joint ventures

Issue

Does the investor eliminate transactions between associates and/or joint ventures whenthe investor accounts for these associates and/or joint ventures using the equitymethod?

Fact Pattern

Entity H has the following interests in associates A and B:

Interest in A – 25%

Interest in B – 30%

During the reporting period, Entity A sold inventory to Entity B, all of which remains onEntity B’s statement of financial position at the end of the reporting period.

Cost of inventory for A – P1,000,000

Proceeds from sale by A – P1,200,000

Consensus

The unrealized profit arising from the transaction between associates and/ or jointventures is eliminated to the extent of the investor’s interests in the associates and/orjoint venture.

In the fact pattern above, Entity H eliminates P15,000 (i.e., 25% × 30% × P200,000) asits share of the profits that is unrealized.


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Basis for Consensus

Paragraph 28 of PAS 28, Investment in Associates and Joint Ventures, states:

“Gains and losses resulting from ‘upstream’ and ‘downstream’ transactions between anentity (including its consolidated subsidiaries) and its associate or joint venture arerecognized in the entity’s financial statements only to the extent of the unrelatedinvestor’s interests in the associate or joint venture.”


“Many of the procedures appropriate for the application of the equity method are similarto the consolidation procedures described in PFRS 10.”

Paragraph B86(c) of PFRS 10, Consolidated Financial Statements, states:

“eliminate in full intragroup assets and liabilities, equity, income, expenses and cashflows relating to transactions between entities of the group (profits or losses resultingfrom intragroup transactions that are recognized in assets, such as inventory and fixedassets, are eliminated in full).”

The fact that paragraph 28 of PAS 28 only refers to the upstream and downstreamtransactions is considered to be an illustration of the requirements of paragraph 26 ofPAS 28 of the typical transactions to be eliminated and are not the only situations to beeliminated by this principle. Therefore, applying the same principles in paragraph 28 ofPAS 28 and paragraph B86(c) of PFRS 10, the unrealized profit in the investor’sfinancial statements arising from any transaction between the associates and/or jointventures is eliminated to the extent of the related investor’s interests in the associatesand/or joint ventures, as appropriate.


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An illustration of the elimination of profit follows:

Effective Date



Profitrecognized

by A

H Group’sinterest inA’s profit

(25%)P50,000

Third parties’interest inA’s profit

(75%)P150,000

Attributableto H’s

holding in B(30%)

P15,000

Attributableto third partyinterests in B

(70%)P35,000


456

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457

PAS 32, Financial Instruments: Presentation



Issue



Background





458











459

Consensus










amount repayable










460













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Effective Date




465

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466

Q&A No. 2011 – 04 (amended June 2018): PAS 32.37-38 – Costs ofPublic Offering of Shares

Issue

How should the costs of a Public Offering (PO) that involves issuing new shares and alisting with the stock exchange be accounted for?1

Background

An entity often lists its existing shares and simultaneously issues new shares. As part of thelisting and offering process, the entity incurs various costs (e.g., certain legal fees, listingsponsor fees, or accounting fees) that are incremental costs and jointly relate to the listingof existing shares and issue of new shares.

Paragraph 37 of PAS 32, Financial Instruments: Presentation, requires that transactioncosts2 that are directly attributable to issuing new shares be deducted from equity, net of anyrelated income tax benefit. Costs that relate to the stock market listing, or otherwise are notincremental costs directly attributable to issuing new shares, should be recorded as anexpense in the income statement.

PAS 32.38 further requires transaction costs that relate jointly to more than one transaction(for example, costs of a concurrent offering of some shares and a stock exchange listingof other shares) to be allocated to those transactions using a basis of allocation that isrational and consistent with similar transactions. However, PAS 32 provides no furtherguidance as to what basis of allocation is rational and consistent with the joint transactions.

Consensus:

The requirement in PAS 32.37 clearly relates to equity transactions, such as issuing orbuying back of own shares. The costs of listing shares are not considered as costs of an“equity transaction” since no equity instrument has been issued and, hence, such costs arerecognized as an expense in profit or loss when incurred.

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1This Q&A does not deal with the listing of existing shares, which include treasury shares and secondary shares.Refer to PAS 32.33 for the accounting provisions on treasury shares.2Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of afinancial asset or financial liability. (Ref.: PFRS 9, Financial Instruments)


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The offering and listing of shares are usually done simultaneously. Incremental costs thatrelate jointly to more than one transaction are allocated to those transactions according tothe facts and circumstances using a basis that is rational and consistent with similartransactions.

PAS 32.38 clearly states that transaction costs that relate jointly to more than onetransaction (for example, costs of a concurrent offering of some shares and a stockexchange listing of other shares) are allocated to those transactions using a basis ofallocation that is rational and consistent with similar transactions. No one method isprescribed in PAS 32; hence, determining whether what basis of allocation is morerational and consistent to the joint transactions requires the exercise of judgment.

The most appropriate basis of allocation is one based on the proportion of the number of newshares sold compared to the total number of outstanding shares immediately after the newshare issuance.

An assessment of the application of any method other than on the proportion of newly soldshares to total number of shares outstanding immediately after the new share issuancemust be made, given the subjectivity that can surround such facts and circumstances.Examples of such different allocations are:

1. An allocation based on the proportion of the number of newly issued sharescompared to the total number of shares sold through the offering (i.e., including theshares of existing shareholders who are selling shares as part of the offering). Thisapproach may be appropriate if there is/are a shareholder(s) using the listing as anexit strategy and the remaining existing shareholders have not encouraged the entity tolist for their benefit and there is evidence to support that the remaining shareholdersdo not intend to sell shares in the foreseeable future.

2. An allocation entirely to the new shares sold. This approach may be appropriate ifno existing shareholders are selling shares as part of the offering. Further, existinginvestors have not encouraged the entity to list for their own benefit (i.e., the purpose ofthe listing is only to raise new capital) and there is evidence to support that theexisting shareholders do not intend to sell shares in the foreseeable future.

The following table provides a general indication as to some of the costs incurred in a POthat involves issuance of new shares and concurrent listing of existing shares, and thebasis on which the costs might be allocated. The list is not exhaustive as the stockexchange and the Securities and Exchange Commission (SEC) may prescribe additionalfees necessary to the joint transactions.

Type of Cost Share Issuance/ Listing General TreatmentTaxes:

Documentary stamp tax Share issuance Deduction to equity


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Other percentage tax Share issuance – as the POtax on primary offering3 isimposed and shall be paid bythe issuing corporation

Deduction to equity

Professional fees on:Underwriting Share issuance Deduction to equityAudit and otherprofessional advicerelating to prospectus

Joint – as it is typicallyrequired both for the offer ofshares to the public and forlisting procedures to complywith requirements establishedby SEC and the stockexchange

For allocation to equityand expense

Opinion of Counsel Joint – as it is typicallyrequired both for the offer ofshares to the public and forlisting procedures to complywith requirements establishedby SEC and the stockexchange


Tax Opinion Joint – as it is typicallyrequired both for the offer ofshares to the public and forlisting procedures to complywith requirements establishedby SEC and the stockexchange


Fairness Opinion andValuation Report



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3Primary offering refers to the original sale made to the investing public by the issuer corporation ofits unissued shares of stock. (Ref.: RR 6-2008)


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Type of Cost Share Issuance/ Listing General TreatmentOther costs:Prospectus design andprinting

Joint – although in caseswhere most prospectuscopies are sent to potentialnew shareholders, themajority of such costs mightrelate to share issuance


Road show presentation Listing – although it may helpto sell the offer to potentialinvestors and hencecontributes to raising equity, itis usually a generalpromotional activity

Profit or loss item

Public relationsconsultant’s fees

Listing – these costsgenerally relate to overallcompany promotion and arenot, therefore, incremental tothe share issuance

Profit or loss item

Newspaper publicationfees

Share issuance – if theadvertising relates directly tothe share issue and is notgeneral advertising aimed atenhancing the entity’s brand

Deduction to equity

SEC registration fees fornew shares

Share issuance Deduction to equity

Stock exchange listingfees

Listing Profit or loss item

Example

Go-public Company undertakes an IPO for the listing and issuance of 700,000 newshares and 300,000 existing shares. In relation to this, the company incurred thefollowing costs:

a. Documentary stamp tax P 25,000b. Fairness opinion and valuation report 125,000c. Tax opinion 75,000d. Newspaper publication 200,000e. Listing fee 300,000f. Other joint costs 275,000

P 1,000,000

Go-public will recognize the listing fee of P300,000 immediately to profit or loss.


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The documentary stamp tax and newspaper publication fee amounting to P25,000 andP200,000, respectively, will be recognized as a deduction to equity.

a. Issue price of shares at above par value

Share premium 225,000Cash/ Creditor 225,000

b. Issue price of shares at par value

Share Issuance Costs 225,000Cash/ Creditor 225,000

The share issuance costs will be treated as a contra shareholders’ equity account as adeduction to the following in the order of priority:

1. Share Premium from previous share issuance; or2. Retained Earnings with appropriate disclosure.

Joint costs, which include fee for fairness opinion and valuation report, tax opinion cost andother joint costs, amounting to P475,000 will be allocated using the proportion of newly soldshares to the total number of shares outstanding immediately after the new share issuance.

Costs to be recognized as deduction to equity:

P475,000 x 700,000/1,000,000 = P332,500

Observe that 700,000 is used for the allocation as this relates to the new shares issuedconsidered as equity transaction. 1,000,000 shares were listed and issued but only700,000 shares have been added to the number of shares outstanding after thelisting and issuance of shares. This means that the 300,000 shares listed and issuedpertain to those that were issued by existing shareholders, thus, not resulting to theissuance of new shares on the part of ABC Company.

Costs to be recognized immediately in profit or loss:

P475,000 x 300,000/1,000,000 = P142,500

Effective Date

The consensus in this Q&A is effective for annual financial statements beginning on or afterJanuary 1, 2012. The amendments to this Q&A are effective for annual periods beginning on orafter January 1, 2018. Earlier application is encouraged.


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Q&A No. 2016-02: PAS 32 and PAS 38 (amended June 2018) –Accounting Treatment of Club Shares Held by an Entity

Issue

How should club shares held by an entity be accounted for assuming the entity’s holding doesnot give it control, joint control or significant influence over the club?

Background

A club is an association established by a group of people united by a common interest or goal.There are several types of clubs: business, resort, country and various sports clubs. Clubshareholder’s rights and privileges depend on the issuing club and type of share acquired –proprietary versus non-proprietary.

Proprietary club shares

Proprietary club shares entitle the holder to name a nominee to become the member to: use and enjoy the facilities and services; to vote and be voted in meetings of the shareholders; and to be entitled to a share in the net assets upon liquidation and dissolution.

The 2015 Implementing Rules and Regulations of the Securities Regulation Code (SRC IRR)defines ‘proprietary share or certificate’ as “an evidence of interest, participation or privilege in acorporation which gives the holder of the share or certificate the right to use the facilitiescovered by such certificate and to receive dividends or earnings from the corporation. Uponliquidation of the corporation, the holder shall have proportionate ownership rights over itsassets.”

Non-proprietary club shares

Non-proprietary club shares do not entitle the holder to the right to the net assets of the clubupon its liquidation.

SRC IRR defines ‘non-proprietary share or certificate’ as “an evidence of interest, participation,or privilege over a specific property of a corporation that allows the holder of the share orcertificate to use such property under certain terms and conditions. The holder, however, shallnot be entitled to dividends from the corporation or to its assets upon its liquidation.”


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Relevant guidance

Paragraph 11 of Philippine Accounting Standard (PAS) 32, Financial Instruments: Presentationstates that:

“A financial asset is any asset that is:(a) cash;(b) an equity instrument of another entity;(c) a contractual right:

(i) to receive cash or another financial asset from another entity; or(ii) to exchange financial assets or financial liabilities with another entity under

conditions that are potentially favorable to the entity; or(d) a contract that will or may be settled in the entity's own equity instruments and is:

(i) a non-derivative for which the entity is or may be obliged to receive a variablenumber of the entity's own equity instruments; or

(ii) a derivative that will or may be settled other than by the exchange of a fixedamount of cash or another financial asset for a fixed number of the entity's ownequity instruments. For this purpose the entity's own equity instruments do notinclude puttable financial instruments classified as equity instruments inaccordance with paragraphs 16A and 16B, instruments that impose on the entityan obligation to deliver to another party a pro rata share of the net assets of theentity only on liquidation and are classified as equity instruments in accordancewith paragraphs 16C and 16D, or instruments that are contracts for the futurereceipt or delivery of the entity's own equity instruments.” (emphasis added)

“An equity instrument is any contract that evidences a residual interest in the assets of an entityafter deducting all of its liabilities.”

Paragraph 8 of PAS 38, Intangibles Assets states that:“An intangible asset is an identifiable non-monetary asset without physical substance.”

Paragraph 11 of PAS 38 states that:“The definition of an intangible asset requires an intangible asset to be identifiable to distinguishit from goodwill. Goodwill recognized in a business combination is an asset representing thefuture economic benefits arising from other assets acquired in a business combination that arenot individually identified and separately recognized. The future economic benefits may resultfrom synergy between the identifiable assets acquired or from assets that, individually, do notqualify for recognition in the financial statements.”

Paragraph 17 of PAS 38 states that:“The future economic benefits flowing from an intangible asset may include revenue from thesale of products or services, cost savings, or other benefits resulting from the use of the assetby the entity. For example, the use of intellectual property in a production process may reducefuture production costs rather than increase future revenues.”


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Consensus

Club shares as financial assetsEquity instruments of another entity are considered as financial assets of the investor/holder inaccordance with PAS 32.11. Furthermore, PAS 32.11 defines an equity instrument as anycontract that evidences a residual interest in the assets after deducting its liabilities.

A proprietary club share entitles the shareholder to a residual interest in the net assets uponliquidation which justifies that such instrument is an equity instrument and thereby qualifies as afinancial asset to be accounted for under PFRS 9, Financial Instruments.

Club shares as intangible assetsPAS 38 defines an intangible asset as an identifiable non-monetary asset without physicalsubstance. The key characteristics of intangible assets are that they are resources controlledby the entity from which the entity expects to derive future economic benefits, lack physicalsubstance and are identifiable to be distinguished from goodwill.

A non-proprietary club share, though an equity instrument in its legal form, is not an equityinstrument in the context of PAS 32. Furthermore, it does not entitle the holder to a contractualright to receive cash or another financial asset from the issuing corporation. The holder of theshare, in substance, only paid for the privilege to enjoy the club facilities and services but not forownership of the club. In such case, the holder must account for the share as an intangibleasset under PAS 38.

Date originally approved by PIC: April 27, 2016Date amendments approved by PIC: June 27, 2018


475

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Date approved by FRSC: June 8, 2016Date amendments approved by FRSC: October 10, 2018


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Q&A No. 2017 – 11: PFRS 10 and PAS 32 - Transaction costs incurredto acquire outstanding non-controlling interest or to sell non-controlling interest without a loss of control

Issue

How does a parent account for transaction costs incurred to acquire outstanding non-controlling interest (NCI) in a subsidiary, or transaction costs incurred to sell non-controlling interest in a subsidiary without loss of control, in the consolidated financialstatements of the parent?

Background

Scenario 1


In 20X8, Entity A acquires the remaining 30% interest in Subsidiary B. In this transaction,Entity A incurred directly attributable incremental transaction costs of P500.(Consideration for the remaining 30% interest acquired by Entity A may be settled by acash payment or by the issue of shares of Entity A)

Scenario 2


In 20X8, Entity A sells a 30% interest in Subsidiary B without losing control. In thistransaction, Entity A incurred directly attributable incremental transaction costs of P300.

In both scenarios, the entity has a December year-end.

The effect of taxation is not considered as this is covered by PAS 12, Income Taxes.


477

Consensus

Any directly attributable incremental transaction costs incurred to acquire outstanding non-controlling interest in a subsidiary or to sell non-controlling interest in a subsidiary withoutloss of control are deducted from equity. This is regardless of whether the considerationis in cash or shares. The transaction costs in Scenario 1 of P500 and in Scenario 2 ofP300 are deducted directly from equity.

PFRSs do not specify where to allocate the costs in equity – in particular, whether to theparent (who incurred the costs) or to the non-controlling interest (whose equity wasissued/repurchased). Therefore, Entity A may choose where to allocate the costs withinequity, based on the facts and circumstances surrounding the change in ownership, andany legal requirements.

Regardless to which account in equity the charge is allocated, the amount is notreclassified to profit or loss in future periods. Consequently, if the costs are allocated toNCI, this amount must be separately tracked. Therefore, if Subsidiary B is later sold in aseparate transaction (i.e., loss of control), the transaction costs previously recognizeddirectly in equity to acquire or sell the non-controlling interest are not reclassified fromequity to profit and loss, because they do not represent components of othercomprehensive income.

Although PFRS 10, Consolidated Financial Statements, is clear that changes in a parent'sownership interest in a subsidiary that do not result in the parent losing control of thesubsidiary are equity transactions (i.e., transactions with owners in their capacity asowners) it does not specifically address how to account for related transaction costs.

Nevertheless, the entity accounts for transaction costs as a deduction from equitybecause there is clear guidance elsewhere in PFRSs regarding the treatment of suchcosts.

Relevant guidance

Paragraph 35 of PAS 32, Financial Instruments: Presentation, states that “transactioncosts of an equity transaction shall be accounted for as a deduction from equity.”

Paragraphs 106 and 109 of PAS 1, Presentation of Financial Statements, are clear thatfor transactions with owners in their capacity as owners the related transactions costs arepresented within equity separately from profit and loss or other comprehensive income.


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This conclusion also applies if the parent issues equity to acquire non-controlling interest.Although there is no change in total consolidated equity, there are two transactions – anissue of new equity and a repurchase of existing equity. The entity accounts fortransaction costs on the two elements in the same manner as if they had occurredseparately.

In the absence of specific guidance, the entity may allocate costs within equity asappropriate and considering any legal requirements.

The guidance in paragraph 37 of PAS 32 is also applied in determining which costs qualifyas transaction costs, i.e., only those “incremental costs directly attributable to the equitytransaction that otherwise would have been avoided”.

Since the transaction costs do not qualify as a component of other comprehensive incomeas defined in paragraph 7 of PAS 1, they are not reclassified from equity to profit or losswhen the parent loses control over the subsidiary.


“An entity shall present a statement of changes in equity as required by paragraph 10.The statement of changes in equity includes the following information:

...

(d) for each component of equity …

(i) profit or loss;

(ii) other comprehensive income; and

(iii) transactions with owners in their capacity as owners, showing separatelycontributions by and distributions to owners and changes in ownership interests insubsidiaries that do not result in a loss of control.”


“ … Except for changes resulting from transactions with owners in their capacity asowners (such as equity contributions, reacquisitions of the entity’s own equity instrumentsand dividends) and transaction costs directly related to such transactions, the overallchange in equity during a period represents the total amount of income and expense,including gains and losses, generated by the entity’s activities during that period.”


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“Changes in a parent's ownership interest in a subsidiary that do not result in the parentlosing control of the subsidiary are equity transactions (i.e., transactions with owners intheir capacity as owners).”


“When the proportion of the equity held by non-controlling interests changes, an entityshall adjust the carrying amounts of the controlling and non-controlling interests to reflectthe changes in their relative interests in the subsidiary. The entity shall recognize directlyin equity any difference between the amount by which the non-controlling interests areadjusted and the fair value of the consideration paid or received, and attribute it to theowners of the parent.”


“… Transaction costs of an equity transaction shall be accounted for as a deduction fromequity.”


“ … The transaction costs of an equity transaction are accounted for as a deduction fromequity to the extent they are incremental costs directly attributable to the equitytransaction that otherwise would have been avoided.”

Effective Date




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Q&A No. 2019 – 07: Classification of Members’ Capital Contributions ofNon-Stock Savings and Loan Associations (NSSLA)Background:

The Bangko Sentral ng Pilipinas (BSP) issued Circular No. 1045 on August 29, 2019 to amend theManual of Regulations for Non-Bank Financial Institutions Applicable to Non-Stock Savings andLoan Associations (MORNBFI-S) – Regulatory Capital of Non-Stock Savings and LoanAssociations (NSSLAs) and Capital Contributions of Members.

Under the Circular, each qualified member of an NSSLA shall maintain only one capitalcontribution account representing his/her capital contribution. While only one capital account ismaintained, the Circular breaks down a member’s capital contributions as follows:

a. Fixed capital which cannot be reduced for the duration of membership except upontermination of membership. The minimum amount of fixed capital is Php1,000, but ahigher minimum can be prescribed under the NSSLA’s by-laws.

b. Capital contribution buffer, which pertains to capital contributions in excess of fixedcapital. The capital contribution buffer can be withdrawn or reduced by the memberwithout affecting his membership. However, the NSSLA shall establish and prescribe theconditions and/or circumstances when the NSSLA may limit the reduction of the members’capital contribution buffer, such as, when the NSSLA is under liquidity stress or is unableto meet the capital-to-risk assets ratio requirement under Sec. 4116S of the MORNBFI-SRegulations. Such conditions and/or circumstances have to be disclosed to the membersupon their placement of capital contribution buffer and in manners as may be determinedby the Board.

For purposes of identifying and monitoring the fixed capital and capital contribution buffer of amember’s capital contribution, NSSLAs shall maintain subsidiary ledgers showing separately thefixed and capital contribution buffer of each member. Further, upon receipt of capital contributionsfrom their members, NSSLAs shall simultaneously record the amount contributed as fixed andcapital contribution buffer in the aforementioned subsidiary ledgers. However, NSSLAs may useother systems in lieu of subsidiary ledgers provided that that the system will separately show thefixed and capital contribution buffer of each member.

Issue

Would both the Fixed capital and the Capital contribution buffer qualify as “equity” in the NSSLA’sfinancial statements?


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Consensus

As both Fixed capital and Capital contribution buffer give its members the right to requireredemption for cash, they meet the definition of puttable instruments. In assessing whether theseinstruments qualify as equity, reference has to be made to paragraphs 16A and 16B ofPAS 32, Financial Instruments: Presentation.

PAS 32 16A and 16B Requirements Assessment

16A A puttable financial instrument includes acontractual obligation for the issuer torepurchase or redeem that instrument forcash or another financial asset on exerciseof the put. As an exception to the definitionof a financial liability, an instrument thatincludes such an obligation is classified asan equity instrument if it has all thefollowing features:

(a) It entitles the holder to a pro rata shareof the entity's net assets in the event ofthe entity's liquidation. The entity's netassets are those assets that remainafter deducting all other claims on itsassets. A pro rata share is determinedby:

(i) dividing the entity's net assets onliquidation into units of equalamount; and

(ii) multiplying that amount by thenumber of the units held by thefinancial instrument holder.

Met for both Fixed capital and Capitalcontribution buffer.Upon liquidation, the assets of the NSSLAare distributed to members after settlingits liabilities. A member’s share in the netassets of the NSSLA is based on his totalcapital contributions (both Fixed capitaland Capital contribution buffer are treatedthe same)


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(b) The instrument is in the class ofinstruments that is subordinate to allother classes of instruments. To be insuch a class the instrument:

(i) has no priority over other claims tothe assets of the entity onliquidation, and

(ii) does not need to be converted intoanother instrument before it is in theclass of instruments that issubordinate to all other classes ofinstruments.

Met for both Fixed capital and Capitalcontribution buffer.Both Fixed capital and Capital contributionbuffer meet the two (2) characteristics tobe considered included in the mostsubordinate class of instruments. Uponliquidation, both capital are treated thesame. That is, payment is based on thesame formula and there is no prioritygiven to either capital in terms of priority ofpayment.

(c) All financial instruments in the class ofinstruments that is subordinate to allother classes of instruments haveidentical features. For example, theymust all be puttable, and the formulaor other method used to calculate therepurchase or redemption price is thesame for all instruments in that class.

Met for both Fixed capital and Capitalcontribution buffer.Both Fixed capital and Capital contributionbuffer have the same redemption rightsand features. Both can be withdrawnanytime using the same redemptionformula. The only difference is loss ofmembership upon withdrawal of the Fixedcapital, but this is not a consideration as itdoes not impact ability to withdraw

(d) Apart from the contractual obligation forthe issuer to repurchase or redeem theinstrument for cash or another financialasset, the instrument does not includeany contractual obligation to delivercash or another financial asset toanother entity, or to exchange financialassets or financial liabilities withanother entity under conditions that arepotentially unfavorable to the entity, andit is not a contract that will or may besettled in the entity's own equityinstruments as set out in subparagraph(b) of the definition of a financialliability.

Met for both Fixed capital and Capitalcontribution buffer.There are no other features that wouldcause liability classification for both typesof capital.


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(e) The total expected cash flowsattributable to the instrument over thelife of the instrument are basedsubstantially on the profit or loss, thechange in the recognized net assets orthe change in the fair value of therecognized and unrecognized netassets of the entity over the life of theinstrument (excluding any effects of theinstrument).

Met for both Fixed capital and Capitalcontribution buffer.Members share in the profit of the NSSLAonce a year on the basis of their capitalcontributions.

16B In addition to the instrument having all thefeatures in (a) to (e) above, the issuer musthave no other financial instrument or contractthat has:

a. total cash flows based substantially onthe profit or loss, the change in therecognized net assets or the change inthe fair value of the recognized andunrecognized net assets of the entity(excluding any effects of such instrumentor contract); and

b. the effect of substantially restricting orfixing the residual return to the instrumentholders.

Met for both Fixed capital and Capitalcontribution buffer.There are no other types of capitalcontributions or financial instruments withcash flows based on the profit or loss ofthe NSSLA and with the effect ofrestricting the net income distributions tothe Fixed capital and Capital contributionbuffer.

Given that both types of capital contributions meet all the requirements of paragraphs 16A and16B of PAS 32, they both qualify to be classified as equity by the NSSLA.


The consensus in this Q&A is effective from the approval date and should be applied retrospectively.



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PAS 36, Impairment of Assets

Q&A No. 2018-02: PAS 36 - Non-controlling interests and goodwillimpairment test

Issues

Paragraph 19 of PFRS 3, Business Combinations, provides the acquirer a choice on theaccounting for components of non-controlling interests in the acquiree that are presentownership interests and entitle their holders to a proportionate share of the entity’s netassets in the event of liquidation (hereafter: non-controlling interest) at either fair value orthe proportionate share in the recognized amount of the acquiree’s identifiable net assets.

Paragraph C4 of Appendix C to PAS 36, Impairment of Assets, requires an entity to grossup the carrying amount of goodwill for the impairment test in certain situations.

1. In which scenario/s does an entity need to gross up goodwill for any amount ofgoodwill not recognized due to a current or previously outstanding non-controllinginterest when performing a goodwill impairment test related to a subsidiary?

2. How does a subsequent acquisition of non-controlling interests affect this analysis?

Fact pattern

As of January 1, 20X0, Entity A owns 80% of the shares of Entity B. Entity A performs therequired annual goodwill impairment test at December 31, 20X0. Entity B is a (single)cash-generating unit.

Scenario 1

On June 30, 20X0, Entity A acquires the remaining 20% ownership interest in Entity B.Entity A previously measured the non-controlling interest at initial recognition at itsproportionate interest in the net identifiable assets.Scenario 2

On June 30, 20X0, Entity A acquires the remaining 20% ownership interest in Entity B.Entity A previously measured the non-controlling interest at initial recognition at its fairvalue.

Scenario 3


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On June 30, 20X0, Entity A acquires 10% of the remaining ownership interest in Entity B,leaving a non-controlling interest of 10% as of December 31, 20X0. Entity A previouslymeasured the non-controlling interest at initial recognition at its proportionate interest inthe net identifiable assets.

Scenario 4

On June 30, 20X0, Entity A acquires 10% of the remaining ownership interest in Entity B,leaving a non-controlling interest of 10% as of December 31, 20X0. Entity A previouslymeasured the non-controlling interest at initial recognition at its fair value.

Scenario 5

On June 30, 20X0, Entity A sells 20% of the ownership interest in Entity B, resulting in anon-controlling interest of 40% as of December 31, 20X0. Entity A previously measuredthe non-controlling interest at initial recognition at its proportionate interest in the netidentifiable assets.

Scenario 6

On June 30, 20X0, Entity A sells 20% of the ownership interest in Entity B, resulting in anon-controlling interest of 40% as of December 31, 20X0. Entity A previously measuredthe non-controlling interest at initial recognition at its fair value.

Consensus

Entity A does not adjust goodwill for the goodwill impairment test once it is wholly owned.Entity A compares the carrying amount of the unit (Entity B), including the recognizedgoodwill against the recoverable amount of the unit (Entity B).

Entity A grosses up the goodwill for the impairment test if a non-controlling interest existsat the date of the impairment test, and if Entity A measured the non-controlling interest atinitial recognition at its proportionate interest in the net identifiable assets. In all othercases, Entity A does not gross up the goodwill.

The table below summarizes the scenarios and accounting:

Measurement of non-controlling interest (NCI) at initial recognitionProportionate share of net assets Fair value


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No NCI at dateof impairmenttest (100%owned)

No gross up of goodwill(Scenario 1)


NCI outstandingat date ofimpairment test(<100% owned,stake increasedafter initialrecognition)

Yes, gross up goodwill(Scenario 3)


NCI outstandingat date ofimpairment test(<100% owned,stake decreasedafter initialrecognition)

Yes, gross up goodwill(Scenario 5)


Grossing up of goodwill may be complex in situations with subsequent transactions(scenarios 3 and 5). Suppose goodwill was calculated at 80 initially, where the NCI wasmeasured at the proportionate interest in the net identifiable assets. Using a mechanicalgross up, this would lead to a grossed up goodwill amount of 100 (80 x 100% / 80%).Using a similar approach in scenario 3 would lead to grossed up goodwill of 88.9 (80 x100% / 90%). This would make an impairment less likely. This approach would beacceptable due to the analogy with scenario 1, where no gross up is required anymore.An alternative way would be where a company would still gross up goodwill to 100, similarto the calculation done before.

Using the approach where goodwill is grossed up with the effective interest held, scenario5 would lead to grossed up goodwill of 133.3 (80 x 100% / 60%). It would not beappropriate to use this grossed up amount, as no additional goodwill was created due tothe transaction. Additionally, only the original NCI of 20% was measured based on theidentifiable net assets excluding goodwill. Because a NCI exists at reporting date and theNCI was accounted for at the proportionate share of the net assets, a gross-up is stillrequired. In this situation, 100 should be used as the amount of grossed up goodwill.

Basis for consensus


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Paragraph 90 of PAS 36 indicates that in testing a cash-generating unit for impairment, theentity compares the carrying amount of the unit, including goodwill, with the recoverableamount of the unit.

Once Entity B is wholly owned, following the acquisition of the non-controlling interest, nonotional adjustment is required anymore. A gross up is only required under C4 of AppendixC to PAS 36, which states:

“If an entity measures non-controlling interests as its proportionate interest in the netidentifiable assets of a subsidiary at the acquisition date, rather than at fair value,goodwill attributable to non-controlling interests is included in the recoverable amount of therelated cash-generating unit but is not recognized in the parent's consolidated financialstatements. As a consequence, an entity shall gross up the carrying amount of goodwillallocated to the unit to include the goodwill attributable to the non-controlling interest. Thisadjusted carrying amount is then compared with the recoverable amount of the unit todetermine whether the cash-generating unit is impaired.” (emphasis added)

When Entity A is entitled to 100% of the recoverable amount of Entity B, no allocationbetween Entity A and the non-controlling shareholder is relevant.





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Q&A No. 2018 - 03: PFRS 13, PAS 16 and PAS 36 - Fair value ofproperty, plant and equipment and depreciated replacement cost

Issue

Can depreciated replacement cost be used to measure the fair value of an item ofproperty, plant or equipment in accordance with PFRS 13, Fair Value Measurement?

Fact pattern

An entity provides port freight and logistics services. Its plant or equipment compriseshighly-specialized assets from which the entity earns berthing and tonnage fees. Theentity accounts for these assets in accordance with PAS 16, Property, Plant andEquipment, using the revaluation model.

At the end of the reporting period, the assets are tested for impairment under PAS 36,Impairment of Assets. As part of determining the assets’ recoverable amount, the entitymay need to determine their fair value less costs of disposal. However, there are fewobservable inputs available to use in measuring fair value because of the highlyspecialized nature of the assets and because there is no history of such assets ever beingsold, other than as part of a business combination.

Relevant guidance


“...to estimate the price at which an orderly transaction to sell the asset or to transfer theliability would take place between market participants at the measurement date undercurrent market conditions (i.e., an exit price at the measurement date from the perspective ofa market participant that holds the asset or owes the liability).

...Because fair value is a market-based measurement, it is measured using the assumptionsthat market participants would use when pricing the asset or liability, including assumptionsabout risk...”


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“A fair value measurement of a non-financial asset takes into account a market participant'sability to generate economic benefits by using the asset in its highest and best use or byselling it to another market participant that would use the asset in its highest and best use.”



The objective of using a valuation technique is to estimate the price at which an orderlytransaction to sell the asset or to transfer the liability would take place between marketparticipants at the measurement date under current market conditions. Three widely usedvaluation techniques are the market approach, the cost approach and the incomeapproach... An entity shall use valuation techniques consistent with one or more of thoseapproaches to measure fair value.”

Using techniques that are consistent with the cost approach do not change the objective of afair value measurement. Paragraph B8-B9 of PFRS 13 clarifies that:

“The cost approach reflects the amount that would be required currently to replace theservice capacity of an asset (often referred to as current replacement cost).

From the perspective of a market participant seller, the price that would be received for theasset is based on the cost to a market participant buyer to acquire or construct a substituteasset of comparable utility, adjusted for obsolescence. That is because a market participantbuyer would not pay more for an asset than the amount for which it could replace the servicecapacity of that asset. Obsolescence encompasses physical deterioration, functional(technological) obsolescence and economic (external) obsolescence and is broader thandepreciation for financial reporting purposes (an allocation of historical cost) or tax purposes(using specified service lives). In many cases the current replacement cost method is usedto measure the fair value of tangible assets that are used in combination with other assets orwith other assets and liabilities.”


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Consensus

Depreciated replacement cost can be used to measure the fair value of an item ofproperty, plant or equipment only in limited circumstances. PFRS 13 defines fair value ascurrent exit price, whereas depreciated replacement cost measures the entry price for anasset. Therefore, only when this entry price equals a current exit price can depreciatedreplacement cost be used to measure fair value.




The exit market for the asset (i.e., the principal market or in its absence, the mostadvantageous market) is the same as the entry market (i.e., the market in whichthe asset was/will be purchased).

In addition, the resulting depreciated replacement cost must be assessed to ensuremarket participants are willing to transact for the asset in its current condition and locationat this price. In particular, an entity must ensure that both:

The inputs used to determine replacement cost are consistent with what marketparticipant buyers will pay to acquire or construct a substitute asset of comparableutility, and

The replacement cost has been adjusted for obsolescence that market participantbuyers will consider – i.e., that the depreciation adjustment reflects all forms ofobsolescence (i.e., physical deterioration, technological (functional) and economicobsolescence), which is broader than depreciation calculated in accordance withPAS 16.


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PAS 37, Provisions, Contingent Liabilities and ContingentAssets

Q&A No. 2018 – 05 (amended July 2019): PAS 37 - Liability arising frommaintenance requirement of an asset held under a lease

Issue

If an entity is required to return an asset under a lease in the same condition as at itsinception, does the entity recognize a liability for this obligation?

Fact pattern

An entity in the airline industry leases an aircraft. The requirements of the lease are suchthat the lessee is obliged to maintain the airworthiness of the aircraft. Airworthinessrequirements for the airline industry are the same whether the entity owns or leases theaircraft. The lease requires the entity to return the aircraft in the same condition as atinception of the lease.


Paragraph 10 of PAS 37, Provisions, Contingent Liabilities and Contingent Assets, definesas the following:

"[a provision is] a liability of uncertain timing or amount, [a liability is] a present obligationof the entity arising from past events, the settlement of which is expected to result in anoutflow from the entity of resources embodying economic benefits".

Paragraph 19 of PAS 37 states that an entity only recognizes those obligations arisingfrom past events that exist independently of an entity’s future actions (i.e., the futureconduct of its business).

Examples of such obligations are penalties or clean-up costs for unlawful environmentaldamage, both of which lead to an outflow of resources embodying economic benefits insettlement, regardless of the future actions of the entity. Similarly, an entity recognizes aprovision for the decommissioning costs of an oil installation or a nuclear power station tothe extent that the entity is obliged to rectify damage already caused.


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An example similar to the issue described above is the situation whereby property leasesoften contain clauses that specify that the tenant must pay for maintenance, dilapidations,or other damage occurring during the rental period. Therefore, an entity recognizes aprovision for specific damage or alteration to the property when the event creating theobligation under the lease occurs. Hence, if an entity erects partitioning, and under thelease the entity must remove the partitioning at the end of the lease, then the entityrecognizes a provision for these costs at the time of the partitioning.

The fact that an entity recognizes a provision for repairs when leasing an asset mightappear inconsistent with the fact that an entity may not recognize a provision for repairswhen the entity owns an asset. There is, however, a difference between the two cases. Ifthe entity owns the asset, it chooses whether to sell or repair the asset. Therefore, whenan entity owns an asset, the obligation is dependent of the entity’s future actions.However, for an entity leasing an asset, the entity is legally obliged to repair any damageunder the terms of the contract.

Consensus

Yes. The overhaul and maintenance of an asset is a contractual obligation under the lease.The specific event that gives rise to the obligation is each flown hour or cycle completed bythe aircraft as these determine the timing and nature of the overhaul that must be carriedout. Provision should therefore be made for the costs of overhaul as the obligation towardsthe lessor arises (typically based upon the specific requirements of each aircraft type suchas each flown hour or cycle), with a corresponding expense recognized in the statement ofcomprehensive income.

For certain aircraft types and aircraft leases, it is likely that the provision for the costs will bebuilt up and then released, as the expenditure is incurred, a number of times during the termof the lease.


The consensus in and amendment to this Q&A are effective from the date of the approvalby the FRSC.

Date originally approved by PIC: January 31, 2018Date amendment approved by PIC: August 1, 2019


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Date originally approved by FRSC: March 14, 2018Date amendment approved by FRSC: August 14, 2019


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PAS 38, Intangible Assets

Q&A No. 2016-02: PAS 32 and PAS 38 (amended June 2018) –Accounting Treatment of Club Shares Held by an Entity

Issue


Background









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Relevant guidance


“A financial asset is any asset that is:(e) cash;(f) an equity instrument of another entity;(g) a contractual right:


conditions that are potentially favorable to the entity; or(h) a contract that will or may be settled in the entity's own equity instruments and is:






Paragraph 17 of PAS 38 states that:“The future economic benefits flowing from an intangible asset may include revenue from thesale of products or services, cost savings, or other benefits resulting from the use of the assetby the entity. For example, the use of intellectual property in a production process may reducefuture production costs rather than increase future revenues.”


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Consensus







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Q&A No. 2019 - 02: Accounting For Cryptographic Assets

Background:

Cryptographic assets are transferrable digital representations that are designed in away that prohibits their copying or duplication. The technology that facilitates thetransfer of cryptographic assets is referred to as “blockchain” or distributed ledgertechnology. Blockchain is a digital, decentralized ledger that keeps a record of alltransactions that take place across a peer-to-peer network and that enables theencryption of information.

Currently, there is no legal definition of cryptographic assets, as there is for securities invarious jurisdictions; however, some cryptographic assets can be legally consideredsecurities by local regulators. Cryptographic assets are used for a variety of purposes,including as means of exchange, as a medium to provide access to blockchain-basedgoods or services, and as a way to raise funding for an entity developing activities inthis area.

The characteristics that are being most relevant for classifying cryptographic assets foraccounting purposes are:

the primary purpose of the cryptographic asset; and how the cryptographic asset derives its inherent value.


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Based on the characteristics detailed above, there are four possible specific subsets ofcryptographic assets, as set out in the following table:

Subset Purpose Inherent Value

Cryptocurrency Cryptocurrencies are digital tokens or coinsbased on blockchain technology, such asBitcoin. They currently operateindependently of a central bank and areintended to function as a medium ofexchange. Examples of cryptocurrenciesare Bitcoin, XRP, Ethereum, Bitcoin Cash,EOS, Stellar, Tether, Litecoin, Tron, andBitcoin SV

None – derives itsvalue based onsupply and demand.

Asset-backed token An asset-backed token is a digital tokenbased on blockchain technology thatsignifies and derives its value fromsomething that does not exist on theblockchain but instead is a representationof ownership of a physical asset (forexample, natural resources such as gold oroil).

Derives its valuebased on theunderlying asset.

Utility token Utility tokens are digital tokens based onblockchain technology that provide userswith access to a product or service andderive their value from that right. Utilitytokens give holders no ownership in acompany’s platform or assets and, althoughthey might be traded between holders, theyare not primarily used as a medium ofexchange.

Value is derivedfrom the demand forthe issuer’s serviceor product.

Security token Security tokens are digital tokens based onblockchain technology that are similar innature to traditional securities. They canprovide an economic stake in a legal entity:sometimes a right to receive cash or

Value is derivedfrom the success ofthe entity, since theholder of the tokenshares in future


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another financial asset, which might bediscretionary or mandatory; sometimes theability to vote in company decisions and/ora residual interest in the entity.

profits or receivescash or anotherfinancial asset.

It should be noted that some cryptographic assets might exhibit elements of two or moreof the identified subclasses. These result in hybrid cryptographic assets that will have tobe assessed further. This document focuses on cryptographic assets that carry simplefeatures, instead of hybrid tokens.

The most common method of issuing tokens is via initial coin offerings (ICO). An ICO isa form of fundraising that harnesses the power of cryptographic assets and blockchain-based trading. Similar to a crowdfunding campaign, an ICO allocates crypto tokensinstead of shares to investors/subscribers. These ICO tokens typically do not representan ownership interest in the entity, but they often provide access to a platform (if andwhen developed) and can often be traded on a crypto exchange. The population of ICOtokens in an ICO is generally set at a fixed amount.

Each ICO is bespoke and will have unique terms and conditions. It is critical for issuersto review the whitepaper or underlying documents accompanying the ICO tokenissuance, and to understand what exactly is being offered to investors/subscribers. Insituations where rights and obligation arising from a whitepaper or their legalenforceability are unclear, legal advice might be needed, to determine the relevantterms.

ICOs might be considered to be securities by a securities regulator, but it is important tonote that there is no uniform global view. As a result, issuers should monitor regulatorydevelopments closely and consider the impact that any changes might have on financialreporting.

In the Philippines, the use of cryptocurrencies particularly Bitcoin is becoming popular.At present, certain local companies that deal in Bitcoin and other cryptocurrencies haveacquired registrations from the Bangko Sentral ng Pilipinas (BSP) as money changingand remittance entities. Accordingly, these companies are required to comply with theapplicable BSP regulations such as the traditional “Know Your Customer” (KYC) andanti-money launder (AML) compliance, among others.


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Issues:

3) In the absence of a definitive accounting and reporting guidance from theInternational Accounting Standards Board (IASB), how should a company as a“holder” report the following cryptographic assets in their financial statements?

a) Cryptocurrencies held by an entity

b) Cryptographic assets other than cryptocurrencies

4) How should a company as an “issuer” report crypto tokens in their financialstatements?


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Consensus:

PFRS does not include specific guidance on the accounting for cryptographic assetsand there is no clear industry practice, so the accounting for cryptographic assets couldfall into a variety of different standards. Consideration should also be given to theentity's purpose for holding the cryptographic assets to determine the accounting model.The accounting standards and other considerations that might be relevant to thesubsets of cryptographic assets are presented below:

Issue 1.a - Accounting for cryptocurrencies held by an entity

1. Cryptocurrencies can be treated as Inventory under PAS 2, “Inventories”

PAS 2 does not require inventories to be in a physical form, but inventory should consistof assets that are held for sale in the ordinary course of business. Inventory accountingmight be appropriate if an entity holds cryptocurrencies for sale in the ordinary course ofbusiness. An entity that actively trades the cryptocurrencies, purchasing them with aview to their resale in the near future, and generating a profit from fluctuations in theprice or traders’ margin, might consider whether the guidance in PAS 2 for commoditybroker-traders should be applied.

However, if the entity holds cryptocurrencies for investment purposes (that is capitalappreciation) over extended periods of time, it would likely not meet the definition ofinventory.

Measurement

PAS 2 requires inventories to be measured at lower of cost or net realizable value,unless the holder is a commodity broker-trader, in which case it may bemeasured at fair value less costs to sell. [PAS 2 par. 3] The term ‘commodity’ is notdefined in PAS 2, but a broker-trader that concluded a cryptocurrency was a commoditywould measure the inventory at fair value less cost to sell with changes in fair valuerecognized in profit or loss.


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2. Cryptocurrencies can be treated as Intangible asset under PAS 38

Cryptocurrencies appear to meet the definition of an intangible asset: identifiable as canbe sold, exchanged or transferred individually; not cash and non-monetary asset; haveno physical form.

PAS 38.12 describes an asset as identifiable if it is separable (i.e., it is capable of beingseparated or divided from the entity and sold, transferred, licensed, rented orexchanged) or if it arises from a contractual or legal right.

PAS 38.8 and 38.13 define an asset as a resource controlled by an entity as a result ofpast events and from which future economic benefits are expected to flow to the entity.Control in this context means that the entity has the power to obtain the future economicbenefits that the asset will generate and to restrict the access of others to thosebenefits.

It appears therefore, that cryptocurrencies would meet the definition of an Intangibleasset.

Measurement

An intangible asset shall be measured initially at cost.

After initial recognition, the entity can choose either the cost model or the revaluationmodel as its accounting policy.

Under the cost model, an intangible asset shall be carried at its cost less anyaccumulated amortization and any accumulated impairment losses.

If an intangible asset is accounted for using the revaluation model, all the other assetsin its class shall also be accounted for using the same model, unless there is no activemarket for those assets

Under the revaluation model, an intangible asset shall be carried at a revalued amount,being its fair value at the date of the revaluation less any subsequent accumulatedamortization and any subsequent accumulated impairment losses. For the purpose ofrevaluations, fair value shall be measured by reference to an active market.Revaluations shall be made with such regularity that at the end of the reporting periodthe carrying amount of the asset does not differ materially from its fair value.


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If an intangible asset's carrying amount is increased as a result of a revaluation, theincrease shall be recognized in other comprehensive income and accumulated in equityunder the heading of revaluation surplus. However, the increase shall be recognized inprofit or loss to the extent that it reverses a revaluation decrease of the same assetpreviously recognized in profit or loss.

One must look at the activity in a market for each individual cryptocurrencies toconclude if it meets the definition of “active market”. Therefore, for the largestcryptocurrencies such as Bitcoin and Ethereum, it is likely this definition would be met.

Issue 1.b - Accounting for cryptographic assets other than cryptocurrencies heldby an entity

A similar thought process shall apply when considering the accounting for cryptographicassets other than cryptocurrencies. These cryptographic assets include securitytokens, asset-backed tokens and utility tokens (together referred to as “crypto tokens”)held by an entity for own account.

5. Crypto tokens with the characteristics of asset-backed tokens.

Asset-backed tokens may give the holder a right to an underlying asset. These tokensmay be used to transfer the ownership of underlying assets without physically movingthem. It is a means to transact the underlying asset at minimal cost. As a result, theaccounting will likely be driven by the nature of the underlying asset and the relevantaccounting standard.

6. Crypto tokens with the characteristics of utility tokens

Utility tokens usually give the holder a right to future goods or services. These tokensare a prepayment for goods or services. A prepayment for goods or services might meetthe definition of an intangible asset and PAS 38 could be applied. Where it does notmeet the definition of an intangible asset, it is accounted for similar to other prepaidassets.

7. Crypto tokens with the characteristics of security tokens

Security tokens might give the holder a right to cash, based on the platform’s futureprofits or a residual interest in the net assets. Such rights might be discretionary ormandatory and might be accompanied by the ability to vote to impact decisions relatingto the underlying platform. A contractual right to cash or another financial asset may


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exist in these circumstances, in which case, these security tokens meet the definition ofa financial asset subject to PFRS 9.

8. Crypto tokens with hybrid characteristics

Crypto tokens exhibiting elements of two or more subclasses require further analysisand judgement is required to determine the applicable accounting treatment. Factors toconsider will include the interaction of contractual clauses, their substance andrelevance in the context of the overall characteristics of the token.

Issue 2 - Accounting for crypto tokens by the issuer

When an ICO is undertaken, the issuing entity receives consideration. The form of theconsideration varies (for example, cash or another cryptographic asset) and, foraccounting purposes, it is key to understand the economics and characteristics of thetransaction.It is possible that an ICO could create a joint arrangement requiring further analysisbased on PFRS 11, ‘Joint Arrangements’. The fact that the subscribers provide themajority of the funding might suggest that the arrangement is a collaboration betweenthe ICO entity and the subscriber. However, the subscribers are typically passive, whichsuggests that the arrangement might not provide the parties with joint control. Someissuers might grant veto rights over the future direction of the project to subscribers,typically, these are protective in nature and in most cases will not create joint control.

Where consideration for the ICO is not in the form of cash but another cryptographicasset, the transaction might be an exchange of similar goods or services. An exchangeof similar goods might mean that no accounting is needed. However, we believe that itis unlikely that an ICO will be an exchange of ‘similar goods or services’, because notwo cryptographic assets are generally alike.

Assuming that there is an exchange transaction and the arrangement does not createjoint control, the consideration received by the ICO entity is recorded as the debit side ofthe journal entry.

However, the key challenge for issuing entities is determining the accounting for theICO token issued (that is, the credit side of the journal entry). This will depend on thenature of the ICO token issued, as well as the guidance of the applicable accountingstandard.


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The following table provides a possible analysis framework of accounting models toconsider when determining the nature of, and accounting for, the issued ICO token.Consideration of the contract terms is needed, to understand the obligations of theissuer.

Does the ICO token meet the definition ofa financial liability?


Does the ICO token meet the definition ofan equity instrument?

Apply guidance in PAS 32

Is the ICO token a prepayment for goodsand services from a contract with acustomer?


Does the ICO token not meet any of theabove?


Financial liability

An issuer of an ICO token should assess whether a token meets the definition of afinancial liability. Specifically, an entity would consider the definition in PAS 32, whichstates that a financial liability is:

- a contractual obligation to deliver cash or another financial asset to another entity or to exchange financial assets or financial liabilities with another entity under

conditions that are potentially unfavorable to the entity or- a certain contract that will or might be settled in the entity's own equity instruments,

such as those that violate the principle stated in paragraph 11 of PAS 32 (commonlyknown as the ‘fixed-for-fixed’ principle)

If the ICO token is a financial liability, the accounting would follow the applicableguidance in PFRS 9.

Many ICO tokens will not meet the definition of a financial liability, but there aresituations where the terms and conditions might provide for a refund of proceeds up tothe point of achieving a particular milestone. There might be situations in which the


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contract creates a financial liability at least up to the point at which the refund clausefalls away.

Equity instrument

An equity instrument is any contract that evidences a residual interest in the assets ofan entity after deducting all of its liabilities (PAS 32 para 11). Typically, ICO tokens donot provide the holders with such a residual interest; for example, they do not give theholders rights to residual profits, dividends, or entitlement to proceeds on winding up orliquidation. These ICO tokens might therefore lack the characteristics of an equityinstrument. Careful consideration is needed to assess whether the rights to the cashflows only relate to a specific project or whether, in substance, they provide rights toresidual cash flows of the ICO entity.

Revenue transaction/prepayment for future goods and services

The issuing entity should consider whether the ICO token issued is in substance acontract with a customer that should be accounted for under PFRS 15.

PFRS 15 would apply if (1) the receiver of the ICO token is a customer, (2) there is a‘contract’ for accounting purposes, and (3) the performance obligations associated withthe ICO token are not within the scope of other standards.

Appendix A to PFRS 15 defines a customer as “a party that has contracted with anentity to obtain goods or services that are an output of the entity’s ordinary activities inexchange for consideration”.

To determine whether a contract with a customer exists, an entity should considerwhether the whitepaper, purchase agreement and/or other accompanying documentscreate ‘enforceable rights or obligations’ (PFRS 15 App A). To be a contract with acustomer for the purposes of PFRS 15, such rights should be legally enforceable. Thisassessment might be challenging where the documentation provided by the issuer isnot well defined. Entities should further evaluate all of the criteria in paragraph 9 ofPFRS 15, to determine if a contract with a customer exists.

In many circumstances, issuers might use the consideration received in the ICO todevelop a software platform. Hosting and maintaining the specific platform is often anintegral part of the ICO’s future business model. The token could provide the holder with


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access to the platform, which might be operated as part of the entity’s ordinaryactivities.

This might result in the holders meeting the definition of ‘customers’, from theperspective of the ICO entity; accordingly, the proceeds from the ICO could be revenueof the issuing entity, which will likely be initially deferred.

Determining the performance obligations, how they are satisfied and the period overwhich to recognize revenue will be judgmental and will depend on the specific facts andcircumstances of the ICO offering.


Where none of the above considerations appears to be relevant, the hierarchy in PAS 8should be considered in determining the appropriate accounting treatment. We believethat it is unlikely that issuers will receive consideration without taking on an obligation tothe subscribers. Even if the arrangement does not give rise to a financial instrument or apromise to deliver goods or services to a customer, there is likely to be a legal orconstructive obligation to the subscriber. This might result in the issuer recognizing aprovision in accordance with PAS 37, ‘Provisions, Contingent Liabilities and ContingentAssets’.

Effective Date




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PAS 40, Investment Property

Q&A No. 2007 – 03: PAS 40.27 – Valuation of bank real and otherproperties acquired (ROPA)

Background

The Bangko Sentral ng Pilipinas (BSP) prescribes, in its Circular No. 494, dated September 20,2005, as amended, that properties acquired in settlement of loans be booked under the real andother properties acquired (ROPA) account, initially at the “carrying amount of the loan plusbooked accrued interest less allowance for credit losses plus transaction costs incurred uponacquisition.” Subsequently, said properties shall be accounted for using the cost model.

The BSP deems that this accounting provides a more prudent approach than using fair value inthe initial and subsequent measurement of the ROPA considering that the appraisal industryneeds further strengthening and the property market in the Philippines is not yet as developedcompared to more advanced economies.

Under paragraph 27 of PAS 40, Investment Property, the cost of an investment propertyacquired in exchange for a non-monetary asset or assets, or a combination of monetary andnon-monetary assets is measured at fair value unless (a) the exchange transaction lackscommercial substance or (b) the fair value of neither the asset received nor the asset given upis reliably measurable.

Under paragraph 30 of PAS 40, the investment property is measured subsequently either basedon the fair value model or the cost model.

Issue

Is the BSP prescribed accounting for ROPA consistent with the provisions of applicable PAS;and, if so, can it be required for banks?

Consensus

Under PAS 40, the asset received in exchange for a loan receivable is measured at fair valueunless (a) the exchange transaction lacks commercial substance or (b) the fair value of neitherthe asset received nor the asset given up is reliably measurable. Accordingly, under PAS 40, abank can measure ROPA upon initial recognition at fair value provided the specified conditionsare met. At subsequent measurement, the bank is allowed to choose either the fair value modelor the cost model.


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The reliability of fair values and, consequently, of the appraiser, is a matter that needs to beaddressed by the BSP, possibly by the accreditation of appraisers similar to what the Securitiesand Exchange Commission (SEC) requires for appraisers.

Alternatively, the BSP need not consider fair values used in a bank’s general purpose financialstatements for regulatory accounting purposes.

Effective Date

The consensus in this Q&A is effective from April 19, 2007, the date of approval by the FRSC.Earlier application is encouraged.

Date approved by PIC: February 21, 2007

PIC Members

David L. Balangue, Chairman

Wilfredo A. Baltazar Nenita S. Robles

Ma. Elenita B. Cabrera Ruby R. Seballe

Ernesto T. Diaz Editha O. Tuason

Dalisay B. Duque Jose T. Valencia

Ma. Concepcion Y. Lupisan Ma. Gracia Casals-Diaz

Ramon G. Opulencia Normita L. Villaruz

Date approved by FRSC: April 19, 2007


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Relevant PFRS


Issue

When an entity which owns a property (consisting of land and an old building) constructs a newbuilding on the site of the old building, how shall the entity account for the carrying value of theold building under the following scenarios?


Scenario 2: The entity acquired the property in a prior reporting period and used it as owner-occupied property. In the current reporting period, the entity decides to demolishthe old building and replace it with a new building.






An entity may acquire a piece of land with one or more existing buildings, with the intention toeither demolish the old building right away in order to construct a new building on its site as partof its planned redevelopment, or to initially use the old building as an owner-occupied propertyand then demolish it in a future period and replace it with a new building. The new building caneither be:



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When the old building is demolished to give way for the construction of the new building, therearises a question as to whether or not the cost allocated to the old building, or, in the case of apreviously owner-occupied property, the carrying value of the old building as at the date theentity decides to demolish it, should form part of the cost of the new building. A related issue ishow to account for the demolition costs incurred to physically tear down the old building.


Philippine Financial Reporting Standard (PFRS) 3.2(b) states that the acquisition cost of anasset or a group of assets that does not constitute a business “shall be allocated to theindividual identifiable assets and liabilities on the basis of their relative fair values at the date ofpurchase.”

Applying this principle, the cost of the property acquired should be allocated to the land and thebuilding at date of acquisition based on their relative fair values. The specific intention of theacquiring entity to demolish rather than use a building does not affect its fair value that will beused in the cost allocation. However, in circumstances where the existing building is unusableor is likely to be demolished right away by the entity acquiring it, the fair value of the existingbuilding might be low and much less than the fair value of the land. This is because a rationalbuyer intending to demolish the existing building and construct a new building is unlikely toacquire a piece of land with a highly valuable building. In such cases, it may be appropriate toallocate the entire purchase price to the land. On the other hand, if the existing building is stillusable and the acquiring entity intends to use it for a while before it is demolished in a futureperiod, it will be inappropriate not to allocate any cost to the existing building. Hence, part of thepurchase price shall be allocated as cost of the existing building which cost shall be depreciatedover the building’s remaining estimated useful life.



Scenario 1(a) The land and building will be classified as two separate items under Plant,Property and Equipment measured at their allocated cost determined using therelative fair value method.



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Scenario 2(a), 2(b) and 2(c) As the entity, at date of acquisition, has decided to initially use theproperty as owner-occupied property, the land and building will be classified astwo separate items under Plant, Property and Equipment measured at theirallocated cost determined using the relative fair value method.

Elements of cost





(b) any costs directly attributable to bringing the asset to the location and conditionnecessary for it to be capable of operating in the manner intended by management.

(c) the initial estimate of the costs of dismantling and removing the item and restoring thesite on which it is located, the obligation for which an entity incurs either when the item isacquired or as a consequence of having used the item during a particular period forpurposes other than to produce inventories during that period.


(a) costs of employee benefits (as defined in PAS 19, Employee Benefits) arising directlyfrom the construction or acquisition of the item of property, plant and equipment;





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(e) costs of testing whether the asset is functioning properly, after deducting the netproceeds from selling any items produced while bringing the asset to that location andcondition (such as samples produced when testing equipment); and



“10 The cost of inventories shall comprise all costs of purchase, costs of conversion andother costs incurred in bringing the inventories to their present location andcondition.

“11 The costs of purchase of inventories comprise the purchase price, import duties and othertaxes (other than those subsequently recoverable by the entity from the taxing authorities),and transport, handling and other costs directly attributable to the acquisition of finishedgoods, materials and services. Trade discounts, rebates and other similar items arededucted in determining the cost of purchase.

“12 The costs of conversion of inventories include costs directly related to the units ofproduction, such as direct labour. They also include a system allocation of fixed andvariable production overheads that are incurred in converting materials into finished goods.

“15 Other costs are included in the cost of inventories only to the extent that they are incurred inbringing the inventories to their present location and condition. For example, it may beappropriate to include non-production overheads or the costs of designing products forspecific customers in the cost of inventories.”


“20 An investment property shall be measured initially at its cost. Transaction costsshall be included in the initial measurement.

“21 The cost of a purchased investment property comprises its purchase price and any directlyattributable expenditure. Directly attributable expenditure includes, for example,professional fees for legal services, property transfer taxes and other transaction costs.”


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Consensus

Accounting for the Allocated Cost or Carrying Value of the Old BuildingApplying the relevant PFRS provisions cited above, the allocated cost or carrying value of theold building shall be accounted for as presented below.



PAS 16 does not include any explicit guidance on whether the allocated cost or carrying valueof an old building that will be demolished is part of the cost of the replacement building.Nevertheless, it is viewed that the allocated cost, if any, of the old building to be demolished isnot a cost directly attributable to the new building as provided in PAS 16.16 (b) and PAS 16.17cited earlier. Therefore, the allocated cost of the old building shall not form part of the cost ofthe new building. Also, since the old building will not be used, hence, no further economicbenefits are expected from its use, the allocated cost of the old building should be de-recognized as required under PAS 16.67 and the loss arising from de-recognition is included inprofit or loss as required under PAS 16.68.


Development property (i.e., property intended for sale in the ordinary course of business, or inthe process of construction or development for such sale) is within the scope of PAS 2 ratherthan PAS 16.

The cost of inventories under PAS 2.10 cited earlier is a somewhat lower threshold than thecost of an item of property, plant and equipment under PAS 16. For example, the cost ofinventories under PAS 2.10 need not be directly attributable.


Scenario 1(c): New building will be held as an investment propertyProperty (land or a building—or part of a building—or both) held (by the owner or by the lesseeunder a finance lease) to earn rentals or for capital appreciation or both is within the scope ofPAS 40.

PAS 40.21 on what shall constitute the cost of investment property refers to “directly attributableexpenditure” which is somewhat similar to the related provision under PAS 16. Accordingly, the


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consensus under Scenario 1(a) above can also be applied to Scenario 1(c), hence, the costallocated, if any, to the old building shall not form part of the cost of the new building that will beheld as an investment property. Also, since the old building will not be used, hence, no furthereconomic benefits are expected from its use or disposal, any cost allocated to the old buildingshould be de-recognized (eliminated from the statement of financial position) as required underPAS 40.66 and the loss arising from de-recognition is included in profit or loss as required underPAS 40.69.

Under Scenario 2

Under Scenario 2, the entity acquired the property in a prior reporting period and initially usedthe property as an owner-occupied property. In the current reporting period, it decided todemolish the old building and replace it with a new building.

As the building is a depreciable asset, the entity depreciates the cost allocated to the oldbuilding from the date of purchase on a systematic basis over the asset’s useful life, afterconsidering any residual value. As required under PAS 16.51, the residual value and the usefullife of the building shall be reviewed at least at each financial year-end and, if expectations differfrom previous estimates, the change shall be accounted for as a change in an accountingestimate in accordance with PAS 8, Accounting Policies, Changes in Accounting Estimates andErrors.

As provided under PAS 16.57, the useful life of an asset is defined in terms of the asset’sexpected utility to the entity. The asset management policy of the entity may involve thedisposal of assets after a specified time or after consumption of a specified proportion of thefuture economic benefits embodied in the asset. Therefore, the useful life of an asset may beshorter than its economic life. The estimation of the useful life of the asset is a matter ofjudgment based on the experience of the entity with similar assets.

Applying the above principles, the entity, at the time it makes the decision to demolish the oldbuilding at a specific date in the future, has to re-compute the related depreciation charges onthe building to depreciate the remaining carrying value of the building over the remainder of itslife (or the remaining period before it is demolished). Hence, the old building will have a nilvalue at the date of the planned demolition.

If for some reason there is a remaining carrying value of the old building at the time ofdemolition, such amount shall not be capitalized as part of the cost of the new building; instead,such amount shall be charged to profit or loss. This is because:

(a) the carrying value of the old building represents the un-depreciated cost of the oldbuilding rather than a cost incurred in the construction of the new building; and



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The above consensus applies to all situations under Scenario 2, i.e., Scenario 2(a) where thenew building will be used an owner-occupied property, Scenario 2(b) where the new building willbe sold as an inventory, and Scenario 2(c) where the new building will be held as an investmentproperty.1


The demolition (or the physical tearing down) of the old building to give way for the constructionof the replacement building will have related costs, referred to as demolition costs. There arisesthe issue on whether or not the demolition costs may be capitalized.

PAS 16.16(b) provides that any costs directly attributable to bringing the asset to the locationand condition necessary for it to be capable of operating in the manner intended bymanagement shall form part of the cost of the asset. The examples of directly attributable costspresented in PAS 16.17 cited earlier include ‘costs of site preparation.’

Demolition costs of the old building can be considered as part of costs of site preparationmentioned under PAS 16.17(b) and, therefore, may be capitalized. Although there is no clearguidance as to what account (i.e., land or new building) such demolition costs should becapitalized, it is preferable to capitalize the demolition costs as part of the cost of the newbuilding since the demolition of the old building is a direct result of the decision to construct thenew building.

Effective Date





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Issue





Consensus


Scenario 1




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Scenario 3



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Effective Date




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Q&A No. 2017 – 10 (amended July 2019): PAS 40 - Separation ofproperty and classification as investment property

Issues

1. How should paragraph 10 of PAS 40, Investment Property “… could be soldseparately…” interpreted?

2. If separation does not occur prior to the sale of property/assignment of a lease,does this prevent a portion of a property that otherwise meets the definition ofinvestment property in PAS 40 being so treated?

3. Does the intention to lease, or the action of leasing, out a portion of a propertyunder an operating rather than a finance lease prohibit the application ofPAS 40?

Fact Pattern

Scenario 1

A property is used partly to derive rental income and partly as owner-occupied property.For example, in an office tower, one could sub-divide the floors and sell individualportions. Similarly with industrial/commercial property, an owner could sub-divide andsubsequently sell some portions and retain others for own use.

Scenario 2

Properties that are physically sub-divided into different portions (for example differentfloors) are registered as one single property with the Land or Property registry, andneed to be legally sub-divided before a portion can be disposed of. Often, these legalproceedings are undertaken only at the point of sale of that portion of, or theassignment of a lease on that portion of, the property concerned. At the end of thereporting period, the legal sub-division has not occurred.

Scenario 3

Portions of a property are leased out under operating leases.


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Consensus

Scenario 1

To separately account for the portions of a property (part as an investment property andpart as property, plant and equipment), the property must be in a state and condition toenable it to be disposed of separately at the end of the reporting period.

Scenario 2

The fact that a property could be divided in future periods if the owner so chose isinsufficient to conclude that the portions can be accounted for separately. If the propertyrequires sub-division before the portions could be disposed of separately, then thoseparts are not accounted for separately until such sub-division occurs.

It seems clear that ‘separately’ needs to be assessed both in terms of the ‘physical’separation (e.g., mezzanine floors and partitioning walls) of the property and to ‘legal’separation (e.g., legally defined property boundaries and/or registered separately).

Judgement is required to determine whether the legal separation is a substantiverequirement that will restrict it being currently separable or whether it is a non-substantive requirement where it is currently separable.

Scenario 3

The intention to lease out a portion of a property, or the action of leasing out a portion ofa property, under an operating lease does not prohibit the application of PAS 40 to thatportion. However further assessment of the facts and circumstances are needed.

Basis for Consensus

Scenario 1

If a literal interpretation of paragraph 10 of PAS 40 were applied, almost any portions orelement of property would be capable of separate classification and, arguably, therestriction in paragraph 10 of PAS 40 would be mostly irrelevant.


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Paragraph 5 of PAS 40 defines investment property as:

“property (land or a building-or part of a building-or both) held (by the owner or by thelessee as a right-of-use asset) to earn rentals or for capital appreciation or both, ratherthan for:


(b) sale in the ordinary course of business.”

Further, paragraph 10 of PAS 40 states:

"Some properties comprise a portion that is held to earn rentals or for capitalappreciation and another portion that is held for use in the production or supply of goodsor services or for administrative purposes. If these portions could be sold separately (orleased out separately under a finance lease), an entity accounts for the portionsseparately. If the portions could not be sold separately, the property is investmentproperty only if an insignificant portion is held for use in the production or supply ofgoods or services or for administrative purposes."

Scenario 2

For the requirements in paragraph 10 of PAS 40 to be relevant to the decision toseparately classify portions of a property, it is believed that the interpretation of ‘couldbe sold separately’ must be assessed by reference to the asset’s present state andcondition. Consequently, if the property requires sub-division before the portions couldbe disposed of separately, then those parts are not accounted for as separate portionsuntil such sub-division occurs.

If the entity owning the property could not be prevented from legally sub-dividing theproperty then the property is already in a condition to be sold separately and this wouldnot prevent the portion of the property concerned being accounted for as investmentproperty.

This would be case where, for example: the process of sub-dividing the property wasentirely within the control of the entity and did not require permission from a third party(which would include the relevant authorities); or if permission from a third party wasrequired, this was no more than a formality.


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Conversely, if the entity was required to obtain the permission of third parties beforelegally sub-dividing the property, and such permission could be withheld, the portions ofthe property concerned are not accounted for separately until such sub-division occurs.

Therefore, if the portion of the property concerned otherwise meets the definition ofinvestment property at the end of the reporting period, judgment is required to assessthe legal position of the property in determining whether it is appropriate to account for aportion separately under PAS 40.

Scenario 3

Paragraph 10 of PAS 40 states that if portions could be

“…sold separately (or leased out separately under a finance lease)…”

they are accounted for separately. An intention to lease, or the action of leasing out aportion of a property under an operating lease is prima facie evidence that, if it sowished, the entity could also lease out the property under a finance lease – thedifference between the two commonly being just the length of the lease.

If, however, there is evidence that the property could not be leased out under a financelease, then PAS 40 could not be applied to that portion.

Effective Date

The consensus in and amendment to this Q&A are effective from the date of approval bythe FRSC.

Date originally approved by PIC: June 28, 2017Date amendment approved by PIC: August 1, 2019


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PIC Members









Date originally approved by FRSC: October 11, 2017Date amendment approved by FRSC: August 14, 2019


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Q&A No. 2018 - 11: Classification of land by real estate developer

Issue

What is the correct classification of the land owned by real estate developer?

Classification of land by real estate developer

Background

A real estate developer develops residential and commercial units which are sold orleased out to customers. These projects can be horizontal or vertical projects whichare either: (a) units in a high-rise building which can be for office or residential use; (b)serviced lot; or (c) serviced lot and house. Projects can be in a single phase or inmultiple phases and usually take more than one year to complete (e.g. 3-5 years).

In the normal course of its business, the real estate developer purchases the followingraw land:

Land A - The entity has plans to construct and develop the parcel of land as aresidential subdivision for sale as approved by the entity’s Board of Directors.The preparation of the master plan, detailing the plans as residential property,has commenced but the entity intends to start the physical constructionactivities (e.g. excavation) two years from the government approval of themaster plan.

Land B –The entity has plans to construct and develop the parcel of land as aresidential subdivision for sale as approved by the entity’s Board of Directors.The preparation of the master plan, detailing the plans, has not commenced.

Land C - The entity intends to develop the land into a commercial center forlease but preparation of master plan has not commenced and the entity doesnot intend to commence the physical construction activities within the year.

Land D -The entity purchased the parcel of land to establish presence in thelocation but does not have any concrete plans on how to develop the property.


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Conclusion

e. Land A – Classified as inventory presented as current assets

f. Land B – Classified as inventory presented as current assets

g. Land C – Classified as investment property presented as non-current asset

h. Land D – Classified as investment property presented as non-current asset

Discussion


Inventories are assets:

d. held for sale in the ordinary course of business;e. in the process of production for such sale; orf. in the form of materials or supplies to be consumed in the production process or in

the rendering of services.


Investment property is property (land or a building—or part of a building—or both) held(by the owner or by the lessee as a right-of-use asset) to earn rentals or for capitalappreciation or both, rather than for:

(e) use in the production or supply of goods or services or for administrative purposes;or

(f) sale in the ordinary course of business.

Paragraph 8 of PAS 40 further provides the following examples of investment property:

(f) land held for long-term capital appreciation rather than for short-term sale in theordinary course of business.

(g) land held for a currently undetermined future use. (If an entity has not determinedthat it will use the land as owner-occupied property or for short-term sale in theordinary course of business, the land is regarded as held for capital appreciation.)

(h) a building owned by the entity (or held by the entity under a finance lease) andleased out under one or more operating leases.


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(i) a building that is vacant but is held to be leased out under one or more operatingleases.

(j) property that is being constructed or developed for future use as investmentproperty.

In accordance with paragraph 66 of PAS 1, an entity shall classify an asset as current when:

e. it expects to realize the asset, or intends to sell or consume it, in its normal operatingcycle;

f. it holds the asset primarily for the purpose of trading;

g. it expects to realize the asset within twelve months after the reporting period; or

h. the asset is cash or a cash equivalent (as defined in PAS 7) unless the asset isrestricted from being exchanged or used to settle a liability for at least twelvemonths after the reporting period.


In addition, paragraph 68 of PAS 1 defines the operating cycle of an entity as the timebetween the acquisition of assets for processing and their realization in cash or cashequivalents. When the entity's normal operating cycle is not clearly identifiable, it isassumed to be twelve months. Current assets include assets (such as inventories andtrade receivables) that are sold, consumed or realized as part of the normal operatingcycle even when they are not expected to be realized within twelve months after thereporting period. Current assets also include assets held primarily for the purpose oftrading (examples include some financial assets that meet the definition of held fortrading in PFRS 9) and the current portion of non-current financial assets.

Analysis of the classification of the parcel of lots purchased by the entity are as follows:

e. Land A meets the requirements for an asset to be classified as inventory and currentasset. See analysis below:

Current or Non-current Inventory or InvestmentProperty

(a) it expects to realize theasset, or intends to sellor consume it, in itsnormal operating cycle;

Met. Land A waspurchased by the entityfor the purpose ofconverting it into aresidential subdivision

Inventory, since it meetsthe criteria of PAS 2,paragraph 6 (a), which island held for sale in theordinary course of business


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for sale. As definedabove, operating cycle ofan entity is the timebetween the acquisitionof assets for processingand their realization tocash or cash equivalents.Given the nature ofbusiness of real estatedevelopment, whereinprojects usually takemore than one year toconstruct/develop andrequires certain periodfor selling andconversion to cash, thenormal operating cycle ismore than one year formthe time of purchase.Given this, the raw landwill be classified ascurrent asset.

as evidenced by the BODapproval and preparationof master plan.

(b) it holds the assetprimarily for thepurpose of trading;

Met. Real estateinventories are held bythe entity for sale tocustomers.

(g) it expects to realize theasset within twelvemonths after thereporting period; or

Not applicable. Seediscussion in (a)

(h) the asset is cash or acash equivalent (asdefined in PAS 7)unless the asset isrestricted from beingexchanged or used tosettle a liability for atleast twelve monthsafter the reportingperiod.



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f. Land B meets the requirements for an asset to be classified as inventory and currentasset. Even though the preparation of the masterplan has not commenced, theintention of the entity to hold the land for development for sale in the ordinary courseof business is evident, given that the plan was approved by its Board of Directors. It isclassified as current because it meets the criteria of PAS 1, Paragraph 66 (a) and (b)given the same rationale for Lot A.

g. Land C meets the requirements for an asset to be classified as investment propertyand non-current asset. See analysis below:

Current or Non-current Inventory or Investment Propertyi. it expects to realize

the asset, orintends to sell orconsume it, in itsnormal operatingcycle;

Not Met. The parcel of lotis not expected to berealized, sold orconsumed within theentity’s normaloperating cycle.

Investment property, since itmeets the criteria of PAS 40where the lot is held to earnrentals and is not used in theproduction or supply of goods orservices or for administrativepurposes; or for sale in theordinary course of business.ii. it holds the asset

primarily for thepurpose of trading;

Not Met. Investmentproperties are not heldfor sale to third party.

iii. it expects to realizethe asset withintwelve monthsafter the reportingperiod; or

Not Met. See discussionin (i)

iv. the asset is cash ora cash equivalent(as defined in PAS7) unless the assetis restricted frombeing exchanged orused to settle aliability for at leasttwelve monthsafter the reportingperiod.


h. Land D meets the requirements for an asset to be classified as investment propertyand classified as non-current asset. The same analysis as Land C above for the


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classification as current or non-current. Land D is an investment property, since itmeets the criteria of PAS 40 where it is held for capital appreciation and is not used inthe production or supply of goods or services or for administrative purposes; or forsale in the ordinary course of business. In addition, PAS 40.8(b) cites that land heldfor a currently undetermined future use is an example of an investment property.


The consensus in this Q&A is effective from the date of approval of the FRSC.


PIC Members











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PAS 41, Agriculture

Q&A No. 2018 – 04: PAS 41 - Inability to measure fair value reliably forbiological assets within the scope of PAS 41, Agriculture

Issue

Under PAS 41, Agriculture, there is a presumption that the fair value of all biologicalassets within the scope of the standard (including produce growing on a bearer plant)can be measured reliably. This presumption can only be rebutted on initial recognitionfor a biological asset (not agricultural produce).

What does an entity need to consider in order to rebut this presumption and determinethat it is unable to reliably measure fair value for biological assets within the scope ofPAS 41?



“There is a presumption that fair value can be measured reliably for a biological asset.However, that presumption can be rebutted only on initial recognition for a biologicalasset for which quoted market prices are not available and for which alternative fairvalue measurements are determined to be clearly unreliable...”


“The presumption in paragraph 30 can be rebutted only on initial recognition. An entitythat has previously measured a biological asset at its fair value less costs to sellcontinues to measure the biological asset at its fair value less costs to sell untildisposal.”

The first criterion in paragraph 30 of PAS 41 requires that there be no quoted marketprices available. PAS 41 does not restrict the criteria to quoted prices in an activemarket. Therefore, in order to rebut the presumption, an entity would need to determinethat quoted prices in both active and inactive markets are unavailable for the asset.

The second criterion requires that an entity consider measures of fair value that do notrely on quoted market prices and demonstrate that these are clearly unreliable.


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Complexity in determining fair value, in and of itself, is not sufficient to suggest fair valueis unreliable.

If an entity is able to determine that quoted prices for the asset are unavailable, it wouldstill need to determine that all other methods for measuring fair value are clearlyunreliable before it can rebut the presumption. This is not the same as identifying that afair value measurement is complex and/or subjective. That is, measuring fair value ofteninvolves estimation and significant judgement, but this does not mean that it isautomatically unreliable. Furthermore, the requirement is for the measurements to be‘clearly unreliable’, which is arguably a higher hurdle than ‘unreliable’.

Consensus

PAS 41 assumes that reliable estimates of fair value will rarely, if ever, cease to beavailable. Therefore, in order to determine that fair value cannot be reliably measured, anentity must demonstrate both of the following:

a. quoted market prices for the biological asset are not available; andb. alternative fair value measurements for the biological asset are determined to be

clearly unreliable.

Both of these conditions must be met. Furthermore, determining that fair value cannot bereliably measured should be based on the weight of evidence available and inconsideration of the requirements in PFRS 13, Fair Value Measurement.

Demonstrating that quoted market prices are not available

In order to meet this condition, an entity would need to determine that quoted prices arenot available in active markets and inactive markets.

Demonstrating that alternative fair value measurements are clearly unreliable

To meet this condition, alternative fair value measurements must be ‘clearly unreliable’,which is arguably a higher hurdle than ‘unreliable’. An entity’s assessment should include,but not be limited to, considering the reliability of the following factors:

Estimates of quantities on hand and the stage of development – while estimatesare often required of quantities on hand (including current stage of biologicaltransformation and anticipated yields for future agricultural produce), the mere factthat estimates are used is not sufficient to demonstrate that fair value is unreliable.Rather, an entity would need to demonstrate that their estimates of the quantity and


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current state of their biological assets are often incorrect. This may be challengingfor entities to demonstrate if the underlying information is regularly used bymanagement to make decisions about future operations of the business.

Prices for the asset in a future state (e.g., for the mature biological asset or theagricultural produce that will ultimately be harvested).

Price for similar assets that can be used as an input into the fair valuemeasurement – this could include plants and animals that are similar to the assetheld by the entity or the ultimate agricultural produce that will result from managingthe biological transformation of the asset held by the entity.

Cash flow projections for the asset.

The replacement cost of the asset.

Entities may also need to consider whether other entities (within a country or globally) areable to demonstrate that fair value can be reliably measured for the same or similarassets.





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Amended PIC Q&As as ofJune 30, 2021


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Q&A No. 2006 – 02 (amended May 2017):PFRS 10.4(a) - Clarification of criteria for exemption from presentingconsolidated financial statements

Background

Paragraph 10 of PAS 27, Consolidated and Separate Financial Statements, 4 of PFRS 10,Consolidated Financial Statements, which is effective for annual periods beginning on or afterJanuary 1, 2013, provides four conditions when a parent need not present consolidated financialstatements. Paragraph 10(d) of the Standard PFRS 10.4(a)(iv) states:

"the its ultimate or any intermediate parent of the parent produces consolidated financialstatements available for public use that comply with International Financial ReportingStandards (IFRS) or Philippine Financial Reporting Standards (PFRS)." (emphasis added)

Issue 1

When are consolidated financial statements considered “available for public use"?

Consensus

The term “consolidated financial statements available for public use” refers to general purposefinancial statements1 which the public may avail of. This includes consolidated financial statementsof the ultimate or immediate parent that are:

posted in the website of the parent company or of its ultimate or any intermediate parent, or filed with the Philippine SEC (which become available to the public once filed) or other bodies

that make filed financial statements available to the public (e.g., the Philippine Stock Exchangemakes available financial statements of brokers and dealers in securities).

Issue 2

Are consolidated financial statements of the ultimate or any intermediate parent prepared inconformity with a financial reporting framework, other than IFRS or PFRS acceptable for purposesof the exemption from the preparation of consolidated financial statements?

Consensus

For Philippine financial reporting purposes, other financial reporting standards that are convergedor virtually converged with IFRS such as those of Australia, Singapore, Hong Kong, or countries

1 PAS 1, Presentation of Financial Statements, paragraph 73 defines general purpose financialstatements as those intended to meet the needs of users who are not in a position to demand reportstailored to meet their particular needs. They include those that are presented separately or within anotherpublic document such as an annual report or a prospectus.


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in the European Union2, or are conceptually similar to IFRS, such as those of the United States,United Kingdom, or Canada, are deemed acceptable in applying the provisions of PAS 27.10dPFRS 10.4(a) on the exemption from the preparation of consolidated financial statements.

Effective Date

The consensus in this Q&A is effective from December 18, 2006, the original date of approval bythe FRSC. The amendments to this Q&A are effective for annual periods beginning on or afterJanuary 1, 2013, the effective date of PFRS 10, Consolidated Financial Statements. Earlierapplication is permitted.

Date originally approved by PIC: November 7, 2006Date amendments approved by PIC: September 25, 2013 and May 24, 2017

PIC Members




Sharon G. Dayoan Ma. Concepcion Y. Lupisan



Date originally approved by FRSC: December 18, 2006Date amendments approved by FRSC: October 8, 2014 and _________________

2 Other countries’ financial reporting standards may become acceptable for purposes of the exemptionfrom consolidation as these other countries converge with IFRS.


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Q&A No. 2008–01 (amended April 2016): PAS 19.83 – Rate used indiscounting post-employment benefit obligations

Issue


Background

Paragraph 78 83 of PAS 19, Employee Benefits, provides that the rate used to discountpost- employment benefit obligations shall be determined by reference to market yields atthe balance sheet date on government bonds in countries where there is no deep marketin high quality corporate bonds. The currency and term of the government bonds shall beconsistent with the currency and estimated term of the post-employment benefitobligations. Paragraph 80 85 of PAS 19 also provides that the discount rate reflect thetiming of benefit payments.

The more common source of discount rates by actuaries is the Philippine Dealing andExchange Corporation (PDEX). The PDS rates published by PDEX, usually used byactuaries, are based on the yield for peso government issued coupon bearing instrumentswhich pay out interest payments on a periodic basis over the term of the bond and theprincipal upon maturity.

Another source of discount rates is Bloomberg which provide rates for peso governmentbonds that are the effective yield for debt instruments which repays the investor one timeand only upon maturity, the principal and any effective interest (zero coupon).

Since employees of an entity retire at different points in time, the entity has to determinethe various duration of retirement liabilities. In practice, actuaries will either (1) get theaverage duration of retirement liabilities and use this as the basis of the term of the pesogovernment bond in determining the appropriate discount rate, or (2) derive the discountrate by applying a single weighted average discount rate that reflects the estimated timingand amount of benefit payments in which the benefits are to be paid.

Consensus

The rate used to discount post-employment benefit obligations shall reflect the pattern ofcash flow for the payment of retirement benefits. Employees become entitled toretirement benefits at the end of their service lives. A rate that would be reflective of aone-time payment upon maturity is that of a zero coupon instrument which has a singlecash flow. Although payment schemes may vary (e.g., lump sum or periodic paymentsover the life of the retired employees), it may be assumed for actuarial purposes thatpayments would be made in one lump sum.


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If the rate reflects the yield for peso government bonds that pay out interest paymentson a periodic basis over the term of the bond and the principal upon maturity, such ratemay be converted to a zero coupon rate1 to reflect a reasonable estimate of the benefitpayments.


Effective Date


* * * * *

Date originally approved by PIC: November 26, 2008Date amendments approved by PIC: April 27, 2016

PIC Members










1 Reference may be made to the PDEx website or to Bloomberg website for zero coupon rates forgovernment securities


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Q&A No. 2009 – 01 (amended June 2018): Framework.4.1 and PAS1.25 - Financial statements prepared on a basis other than goingconcern

Issue 1

Are financial statements that are prepared on a basis of accounting other than a goingconcern basis, which may sometimes be referred to as a liquidation basis, in compliancewith Philippine Financial Reporting Standards (PFRS)?

Background

Paragraph 4.1 of The Conceptual Framework for Financial Reporting states that financialstatements are normally prepared on the assumption that an entity is a going concernand will continue in operation for the foreseeable future. Paragraph 25 of PAS 1,Presentation of Financial Statements, states that financial statements shall be prepared ona going concern basis unless management either intends to liquidate the entity or to ceasetrading, or has no realistic alternative but to do so.

Hence, it is assumed that the entity has neither the intention nor the need to liquidate orcurtail materially the scale of its operations. If such an intention or need exists, the financialstatements may have to be prepared on a different basis and, if so, the basis used isdisclosed.

Paragraphs 14 to 15 of PAS 10 (revised 2010), Events after the Reporting Period,provides that if the going concern assumption is no longer appropriate, the effect is sopervasive that the Standard requires a fundamental change in the basis of accounting,rather than an adjustment to the amounts recognized within the original basis ofaccounting.

If management of an entity has the intention, needs to liquidate or curtails materially thescale of its operations, then the financial statements will have to be prepared on a basiswhich is other than a going concern basis, sometimes referred to as a liquidation basis.

Given appropriate disclosure as to the basis of accounting in a set of financial statementsprepared on a basis other than going concern, is it appropriate for management to makean explicit and unreserved statement of compliance with PFRS in the notes to financialstatements?

Consensus

Yes, financial statements prepared on a basis other than going concern can be in compliancewith PFRS if the financial statements comply with all the requirements of PFRS, includingthe relevant PFRS guidance for the measurement of assets, liabilities and equity andrecognition of income, expenses, gains and losses. For example:

Non-current assets that are not carried at fair value and are intended for sale shouldbe measured using the principles in PFRS 5, Non-current Assets Held for Sale andDiscontinued Operations.


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Assets that are carried at fair value should be accounted for under the relevant PFRS;for example, PFRS 9, Financial Instruments, for financial assets and financialliabilities; PAS 40, Investment Property, for investment properties.

Provisions for liabilities should be recognized and measured in accordance withPAS 37, Provisions, Contingent Liabilities and Contingent Assets, (i.e., only when thereis a present obligation).

In addition, a complete set of financial statements as required under PAS 1.10 should bepresented and the minimum line items required to be included in each of the financialstatements, if applicable to the entity, should also be considered. An entity need notpresent a statement of comprehensive income (or a statement of income and a statement oftotal comprehensive income) if it does not have any operations (both within and outside thenormal course of business) during the period covered by the financial statementsprepared on the basis other than going concern. The non-presentation of such statement(assuming that other income items, if any, are not material), is consistent with the provisionof paragraph 31 of PAS 1 which allows that disclosures need not be provided if theinformation is not material. A disclosure, however, should be made in the notes tofinancial statements to clearly indicate the omission of said statement as this information isuseful for regulatory purposes (for instance, the SEC allows an entity that has no operationsfor the last two years not to present an income statement as part of its financial statements).

Appropriate disclosures in accordance with paragraph 25 of PAS 1 should also be made todescribe the basis of accounting used in the preparation of the financial statements and itsimpact on the accounting policies selected. PAS 1 requires the following disclosures:




The financial statements would state that the financial statements are in compliance withPFRS. The change in the underlying basis to reflect that the entity is no longer a goingconcern would be disclosed in the financial statements together with the impact onmanagement’s selection of accounting policies. This selection of accounting policieswould depend on how management expects to recover the assets of the entity and settle itsliabilities. These accounting policy changes would need to be permitted by and be incompliance with the relevant PFRS.


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The stockholders of XYZ Company approved a plan of liquidation on (date) . Accordingly,the Company has changed its basis of accounting for periods subsequent to (date) , from thegoing-concern basis to the liquidation basis, whereby assets as of (reporting date) are presentedat estimated realizable values and liabilities, at estimated settlement amounts.


The financial statements of X Company have been prepared in accordance with PhilippineFinancial Reporting Standards, on the basis described above.

If the entity qualifies as either a small entity or a medium-sized entity, the financial statementsprepared on a basis other than going concern can be in compliance with PFRS for Small Entitiesor PFRS for Small and Medium-sized Entities provided that the standards are applied in themeasurement of the assets, liabilities and equity and in the recognition of income, expenses,gains and losses of the entity. Appropriate disclosures should be made to describe the basisof accounting and its impact on the accounting policies selected.

Effective Date


* *

Date originally approved by PIC: February 18, 2009Date amendments approved by PIC: June 27, 2018


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PIC Members









Date originally approved by FRSC: March 16, 2009Date amendments approved by FRSC: October 10, 2018


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Q&A No. 2010 – 02 (amended June 2018): PAS 1R.16 – Basis ofpreparation of financial statements

Background

Under the Philippine Financial Reporting Standards issued by the Financial Reporting StandardsCouncil, there are three frameworks for financial reporting:

(d) Philippine Financial Reporting Standards (PFRSs) (or full PFRSs);

(e) Philippine Financial Reporting Standard for Small and Medium-sized entities (PFRS forSMEs) which is applied by entities that qualify as medium-sized entities1; and

(f) Philippine Financial Reporting Standard for Small Entities which is applied by entities thatqualify as small entities (effective beginning January 1, 2019 with earlier applicationpermitted)2.

The primary regulators of certain entities gave transition relief or exemptions in the application offull PFRSs3. These include banks, pre-need companies, and mining companies which areexempted by the Securities and Exchange Commission (SEC) from applying certain provisions ofspecified PFRSs4. These also include insurance companies which were allowed by the InsuranceCommission (IC) to defer application of certain PFRSs.

1Refer to Securities Regulation Code (SRC) Rule 68 for the definition of a medium-sized entity.Refer to Securities Regulation Code (SRC) Rule 68 for the definition of a medium-sized entity.2Refer to SRC Rule 68 for the definition of a small entity.3The SEC allowed the following transitional relief or exemptions in the application of PFRSs:

Certain exchange offers of the Bureau of Treasury of eligible government securities to newgovernment bonds were exempted from the tainting provision of PAS 39 (SEC Notice dated January19, 2006).

Pre-need companies were allowed to submit their 2006 financial statements based on the existingPre-need Uniform Chart of Accounts (PNUCA) whereby revenues and financial liabilities arisingfrom education and pension plans were accounted for in accordance with the existing acceptablepractices of the industry (SEC Notice dated March 5, 2007). (On December 3, 2009, the Pre-needCode of the Philippines was signed into law transferring the jurisdiction over the pre-needcompanies from the SEC to the Insurance Commission (IC). The IC has released the ImplementingRules and Regulations (IRR) of the Pre-need Code on March 8, 2010. Among other things, the IChas the authority to prescribe accounting rules and regulations applicable for pre-need companies,as well as the format of and details to be shown in financial statements of those companies.)

Pre-2005 hedging contracts of mining companies were exempted from the fair value requirementsof PAS 39 (SEC Notice dated November 30, 2006).


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Micro entities (entities with total assets and total liabilities of less than P3 million) may apply eitherthe income tax basis or PFRS for Small Entities. If a micro entity uses a basis of accounting otherthan PFRS for Small Entities, management of the said entity shall assess the acceptability of suchbasis of accounting in the light of the nature of entity and the objective of the financial statements,or the requirements of the law or regulators.

Issue:

How does an entity describe the basis of presentation of its financial statements?

Consensus

PAS 1 (Revised), Presentation of Financial Statements, paragraph 16, states that “An entity shallnot describe the financial statements as complying with PFRSs unless they comply with all therequirements of PFRSs.” The Standard further requires in paragraph 112(a) that an entity presentin the notes to financial statements information about the basis of preparation of the financialstatements.

Paragraph 3.3 of PFRS for SMEs provides that “Financial statements shall not be described ascomplying with the PFRS for SMEs unless they comply with all the requirements of this PFRS.”

Paragraph 3.17 of PFRS for Small Entities provides that “An entity that meets the requirements ofthis Framework and whose financial statements comply with this Framework, shall make anexplicit and unreserved statement of compliance with this Framework in the notes to the financialstatements.”


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Following are illustrative disclosures of the basis of presentation of financial statements under thevarious accounting frameworks:

Entity complied in full with PFRS

…. “The financial statements have been prepared in accordance with Philippine FinancialReporting Standards (PFRSs).”

Entity complied in full with the PFRS for SMEs

….“The financial statements have been prepared in accordance with Philippine FinancialReporting Standard for Small and Medium-sized Entities (PFRS for SMEs).”

Entity complied in full with the PFRS for Small Entities

….“The financial statements have been prepared in accordance with Philippine FinancialReporting Standard for Small Entities.”

Entity given transition relief or exemption by a regulator

“…The financial statements have been prepared in accordance with the applicable financialreporting framework for entities that are given relief from certain requirements of PhilippineFinancial Reporting Standards as described in Note X.”

Micro entities that apply income tax basis of accounting

“…The financial statements have been prepared in accordance with income tax basis ofaccounting whereby revenue is recognized when received rather than when earned, andcertain expenses are recognized when paid rather than when incurred. Property andequipment are depreciated over their estimated useful lives and recognized in currentoperations.”

Effective Date



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Withdrawal of Q&A No. 2007–01 (Revised)

This Q&A supersedes Q&A No. 2007–01 (Revised): PAS 1.103(a) – Basis of preparation offinancial statements if an entity has not applied PFRSs in full, approved by the PIC and FRSC onAugust 8, 2007 and August 23, 2007, respectively.

Date originally approved by PIC: March 2, 2010Date amendments approved by PIC: June 27, 2018

PIC Members









Date originally approved by FRSC: June 4, 2010Date amendments approved by FRSC: October 10, 2018


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Q&A No. 2011 – 03 (amended June 2020): Accounting for Inter-companyLoans1


Issue

How should an interest free or below market rate loan between group companies be accounted forin the separate/stand-alone financial statements of the borrower and of the lender if the loan hascontractual cash flows that are solely payments of principal and interest (SPPI) and is held by thelender within a hold-to-collect business model?


Background

Loans between related entities within a group (i.e., inter-company loans) may take various forms. Insome cases, it can be subject to interest free or below-market rate of interest. It may also be madewith no stated date for repayment or repayable on demand.

MInter-company loans may have formal contractual lending agreements that are enforceable underthe law or they may, in substance, be part of the investment in another entity. Therefore, the firststep is to ascertain if the inter-company loan is (i) within the scope of PFRS 9, (ii) an investment insubsidiary within the scope of PAS 27 or (iii) an investment in associate or a joint venture within thescope of PAS 28. In this PIC Q&A, only inter-company loans within the scope of PFRS 9 will beaddressed. This PIC Q&A does not address the question on whether the instrument is within thescope of PAS 27, PAS 28 or PFRS 9, nor does this address the application of PFRS 9’s impairmentrequirements.

For inter-company loans within the scope of PFRS 9, both the lender and the borrower are requiredto initially record the loan at fair value (plus directly attributable transaction costs for items that will



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not be measured at fair value through profit or loss subsequently) in accordance with PFRS 9.5.1.1.

Inter-company loans do not have an active market, hence, their fair values must be estimated.PFRS 13.47 provides that the fair value of a financial liability with a demand feature is not less thanthe amount repayable on demand, discounted from the first date that the amount could be requiredto be paid. PFRS 9.B5.1.1 clarifies that the appropriate way to estimate the fair value of a long-term loan or receivable that carries no interest is to determine the present value of future cash flowsusing the prevailing market rate of interest for a similar instrument.


Paragraph 11 of PAS 32, Financial Instruments: Disclosure and Presentation, includes the followingdefinitions:





A related guidance under paragraph 38 of PAS 28, Investments in Associates and JointVentures, provides that “…an item for which settlement is neither planned nor likely to occur in thein the foreseeable future is, in substance, an extension of the entity’s investment in that associate.Such items may include…long-term receivables or loans but do not include trade receivables, tradepayables or any long-term receivables for which adequate collateral exists, such as securedloans….”

Consensus1. The treatment of the different types of inter-company loans in the books of the parent company


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and subsidiaries are summarized as follows:









amount repayable









Loans which meet the current classification under PAS 1.66, e.g.,those that are expected to be collected within 12 months after thebalance sheet date shall be classified as current, otherwise, as non-current.


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If the loan is expected to be repaid within a certain period of time(e.g., 3 years), the accounting shall be based on management’s


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best estimate of future cash flows and initial recognition shall













If the loan is expected to be repaid within a certain a certain periodof time, the classification of the loan would be the same asprovided in Item 1.b.



If the loan is expected to be repaid within a certain period of time,


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the subsequent measurement of the loan would be the same asprovided in Item 1.b.

Note: In some cases, loans that bear no interest and has no fixed term for repayment include acondition that there will be repayment only when agreed in the future by both the parent and thesubsidiary. Based on the contractual terms, the subsidiary has no contractual obligation since itessentially has an unconditional right to defer payment of the loan indefinitely as it still needs toagree to its settlement in the future. Consequently, these loans meet the definition of equity fromthe perspective of the subsidiary as they bear no interest and the subsidiary has the unconditionalright to avoid settlement of the loans in cash or another financial asset. The loans will thus beclassified by the subsidiary as equity in their entirety, with no subsequent re-measurementrequired. From the perspective of the parent, since the loans are not usually of a commercialnature and has no set term, they are, in substance, an addition to the parent’s investment in thesubsidiary.







Subsequently, the loan shall be measured at amortized cost using theeffective interest method. This involves the unwinding of the“difference” (i.e., discount) such that, at repayment date, the carryingvalue of the loan equals the amount to be repaid by the borrower. Theunwinding of the “difference” shall be reported as interest income.


initial difference between loan amount and its fair value should usuallybe recorded in profit or loss (i.e., gain). In some circumstances,however, when it is clear that the transfer of value from the lending


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subsidiary to the borrowing subsidiary has been made under theinstruction from the parent, the acceptable alternative treatment is forany gain to be recorded as a credit to equity (i.e., treated as a capitalcontribution).


oans which meet the criteria for current classification under PAS1.69,e.g., those repayable within 12 months after the balance sheet dateshall be classified as current, otherwise, as non-current.
















2. Impairment. Inter-company loans measured at amortized cost are subject to the impairment


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requirements of PFRS 9 paragraph 5.2.2.

3. Disclosure. Inter-company loans meet the definition of related party transactions underparagraph 9 of PAS 24, Related Party Disclosures. The disclosure requirements in PAS 24.12-22must be complied with to enable users of the financial statements to determine the effect of inter-company loans on the company.

It should be emphasized that the above guidance in this Q&A is applicable only in the preparation ofseparate/stand-alone financial statements. On consolidation, inter-company loans will be eliminated,including any discount or premium (and the effect of unwinding thereof) arising from the initialdifference between the fair value of the loan and the loan amount.

Effective Date

The consensus in this Q&A is effective for annual financial statements beginning on or after January1, 2012, the original effective date of this Q&A. The amendments to this Q&A are effective forannual periods beginning on or after January 1, 2020. Earlier application is encouraged.


PIC Members











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Q&A No. 2011 – 04 (amended June 2018): PAS 32.37-38 – Costs ofPublic Offering of Shares

Issue

How should the costs of a Public Offering (PO) that involves issuing new shares and alisting with the stock exchange be accounted for? 1

Background

An entity often lists its existing shares and simultaneously issues new shares. As part ofthe listing and offering process, the entity incurs various costs (e.g., certain legal fees,listing sponsor fees, or accounting fees) that are incremental costs and jointly relate tothe listing of existing shares and issue of new shares.

Paragraph 37 of PAS 32, Financial Instruments: Presentation, requires that transactioncosts2 that are directly attributable to issuing new shares be deducted from equity, net ofany related income tax benefit. Costs that relate to the stock market listing, or otherwiseare not incremental costs directly attributable to issuing new shares, should be recordedas an expense in the income statement.

PAS 32.38 further requires transaction costs that relate jointly to more than onetransaction (for example, costs of a concurrent offering of some shares and a stockexchange listing of other shares) to be allocated to those transactions using a basis ofallocation that is rational and consistent with similar transactions. However, PAS 32provides no further guidance as to what basis of allocation is rational and consistent withthe joint transactions.

Consensus:

The requirement in PAS 32.37 clearly relates to equity transactions, such as issuing orbuying back of own shares. The costs of listing shares are not considered as costs of an“equity transaction” since no equity instrument has been issued and, hence, such costsare recognized as an expense in profit or loss when incurred.

1This Q&A does not deal with the listing of existing shares, which include treasury shares and secondaryshares. Refer to PAS 32.33 for the accounting provisions on treasury shares.2Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of afinancial asset or financial liability. (Ref.: PFRS 9, Financial Instruments)

The offering and listing of shares are usually done simultaneously. Incremental costs


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that relate jointly to more than one transaction are allocated to those transactionsaccording to the facts and circumstances using a basis that is rational and consistentwith similar transactions.

PAS 32.38 clearly states that transaction costs that relate jointly to more than onetransaction (for example, costs of a concurrent offering of some shares and a stockexchange listing of other shares) are allocated to those transactions using a basis ofallocation that is rational and consistent with similar transactions. No one method isprescribed in PAS 32; hence, determining whether what basis of allocation is morerational and consistent to the joint transactions requires the exercise of judgment.

The most appropriate basis of allocation is one based on the proportion of the number ofnew shares sold compared to the total number of outstanding shares immediately afterthe new share issuance.

An assessment of the application of any method other than on the proportion of newlysold shares to total number of shares outstanding immediately after the new shareissuance must be made, given the subjectivity that can surround such facts andcircumstances. Examples of such different allocations are:

1. An allocation based on the proportion of the number of newly issued sharescompared to the total number of shares sold through the offering (i.e., including theshares of existing shareholders who are selling shares as part of the offering). Thisapproach may be appropriate if there is/are a shareholder(s) using the listing as anexit strategy and the remaining existing shareholders have not encouraged the entityto list for their benefit and there is evidence to support that the remainingshareholders do not intend to sell shares in the foreseeable future.

2. An allocation entirely to the new shares sold. This approach may be appropriate ifno existing shareholders are selling shares as part of the offering. Further, existinginvestors have not encouraged the entity to list for their own benefit (i.e., the purposeof the listing is only to raise new capital) and there is evidence to support that theexisting shareholders do not intend to sell shares in the foreseeable future.


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The following table provides a general indication as to some of the costs incurred in a PO thatinvolves issuance of new shares and concurrent listing of existing shares, and the basis onwhich the costs might be allocated. The list is not exhaustive as the stock exchange and theSecurities and Exchange Commission (SEC) may prescribe additional fees necessary to the jointtransactions.

Type of Cost Share Issuance/ Listing General TreatmentTaxes:Documentary stamp tax Share issuance Deduction to equityOther percentage tax Share issuance – as the PO

tax on primary offering3 isimposed and shall be paid bythe issuing corporation

Deduction to equity

Professional fees on:Underwriting Share issuance Deduction to equityAudit and otherprofessional advicerelating to prospectus



Opinion of Counsel Joint – as it is typicallyrequired both for the offer ofshares to the public and forlisting procedures to complywith requirements establishedby SEC and the stockexchange


Tax Opinion Joint – as it is typicallyrequired both for the offer ofshares to the public and forlisting procedures to complywith requirements establishedby SEC and the stockexchange


3Primary offering refers to the original sale made to the investing public by the issuer corporation of itsunissued shares of stock. (Ref.: RR 6-2008)


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Type of Cost Share Issuance/ Listing General TreatmentFairness Opinion andValuation Report



Other costs:Prospectus design andprinting

Joint – although in caseswhere most prospectuscopies are sent to potentialnew shareholders, themajority of such costs mightrelate to share issuance


Road show presentation Listing – although it may helpto sell the offer to potentialinvestors and hencecontributes to raising equity, itis usually a generalpromotional activity

Profit or loss item

Public relationsconsultant’s fees

Listing – these costsgenerally relate to overallcompany promotion and arenot, therefore, incremental tothe share issuance

Profit or loss item

Newspaper publicationfees

Share issuance – if theadvertising relates directly tothe share issue and is notgeneral advertising aimed atenhancing the entity’s brand

Deduction to equity

SEC registration fees fornew shares

Share issuance Deduction to equity

Stock exchange listingfees

Listing Profit or loss item


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Example

Go-public Company undertakes an IPO for the listing and issuance of 700,000 new sharesand 300,000 existing shares. In relation to this, the company incurred the following costs:

a. Documentary stamp tax P 25,000b. Fairness opinion and valuation report 125,000c. Tax opinion 75,000d. Newspaper publication 200,000e. Listing fee 300,000f. Other joint costs 275,000

P 1,000,000

Go-public will recognize the listing fee of P300,000 immediately to profit or loss.The documentary stamp tax and newspaper publication fee amounting to P25,000 and P200,000,respectively, will be recognized as a deduction to equity.

a. Issue price of shares at above par value

Share premium 225,000 Cash/ Creditor 225,000

b. Issue price of shares at par value

Share Issuance Costs 225,000 Cash/ Creditor 225,000

The share issuance costs will be treated as a contra shareholders’ equity account as adeduction to the following in the order of priority:

1. Share Premium from previous share issuance; or2. Retained Earnings with appropriate disclosure.

Joint costs, which include fee for fairness opinion and valuation report, tax opinion cost and otherjoint costs, amounting to P475,000 will be allocated using the proportion of newly sold sharesto the total number of shares outstanding immediately after the new share issuance.

Costs to be recognized as deduction to equity:

P475,000 x 700,000/1,000,000 = P332,500

Observe that 700,000 is used for the allocation as this relates to the new shares issuedconsidered as equity transaction. 1,000,000 shares were listed and issued but only700,000 shares have been added to the number of shares outstanding after the listingand issuance of shares. This means that the 300,000 shares listed and issued pertain tothose that were issued by existing shareholders, thus, not resulting to the issuance of


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new shares on the part of ABC Company.

Costs to be recognized immediately in profit or loss:

P475,000 x 300,000/1,000,000 = P142,500

Effective Date

The consensus in this Q&A is effective for annual financial statements beginning on or afterJanuary 1, 2012. The amendments to this Q&A are effective for annual periods beginning on orafter January 1, 2018. Earlier application is encouraged.

* * * * *


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570

Q&A No. 2011 – 05 (amended June 2018): PFRS 1.D1-D8 – Fair Value orRevaluation as Deemed Cost

Issue 1


Background

Under paragraph 7 of PFRS 1, First-time Adoption of Philippine Financial Reporting Standards,an entity shall:


use the same accounting policies in its opening PFRS statement of financial position andthroughout all periods presented in its first PFRS financial statements. Thoseaccounting policies shall comply with each PFRS effective at the end of the entity’s firstPFRS reporting period, except as specified in paragraphs 13-19 and appendices B-E ofPFRS 1.

PFRS 1 provides guidance on when a first-time adopter may adopt the “deemed cost” approach. Itdefines “deemed cost” as an amount used as a surrogate for cost or depreciated cost at a givendate. Guidance on when a first-time adopter may adopt the “deemed cost” approach is presentedin paragraphs D5-D8 of PFRS 1 as follows:

“D5 An entity may elect to measure an item of property, plant and equipment at the date oftransition to PFRS at its fair value and use that fair value as its deemed cost at that date.

D6 A first-time adopter may elect to use a previous GAAP revaluation of an item ofproperty, plant and equipment at, or before, the date of transition to PFRS as deemed cost at thedate of the revaluation, if the revaluation was, at the date of the revaluation, broadly comparableto:

(a) fair value; or




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D7 The elections in the preceding paragraphs are also available for:

(a) investment property, if an entity elects to use the cost model in PAS 40,Investment Property; and


(i) the recognition criteria in PAS 38 (including reliable measurement of originalcost); and

(ii) the criteria in PAS 38 for revaluation (including the existence of an activemarket).


D8 A first-time adopter may have established a deemed cost in accordance with previous GAAPfor some or all of its assets and liabilities by measuring them at their fair value at one particulardate because of an event such as a privatization or initial public offering. It may use suchevent-driven fair value measurements as deemed cost for PFRSs at the date of that measurement.”



(a) recycled the balance of the Revaluation Reserve to retained earnings using the sameestimated useful life and method of depreciation/amortization used for depreciating therelated asset adjusted to deemed cost. The amount recycled to retained earningseffectively offsets the increase in depreciation/amortization expense charged to profitor loss; or

(b) maintained the Revaluation Reserve at its original amount and recycled such amountone time to retained earnings when the related asset is fully depreciated or disposedof. This is usually accompanied by a note disclosure as to the portion of revaluationreserve already absorbed through depreciation.

In either approaches, the related asset is no longer subsequently revalued since its measurementbasis has been treated as deemed cost.

2


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Paragraphs 16 to 17 of PFRS 1 (effective in 2005) and paragraphs D5 to D8 of Appendix D toPFRS 1 (effective on July 1, 2009) enumerate the bases of deemed cost that a first-time adopterof PFRSs may use. However, those paragraphs do not specify directly where the increase incarrying values of the assets should be adjusted – whether as an adjustment to retainedearnings or to another equity category.

Further, Paragraph 11 of PFRS 1 (effective July 1, 2009) states that: “The accounting policiesthat an entity uses in its opening PFRS statement of financial position may differ from those thatit used for the same date using its previous GAAP. The resulting adjustments arise from eventsand transactions before the date of transition to PFRSs. Therefore, an entity shall recognizethose adjustments directly in retained earnings (or, if appropriate, another category of equity) atthe date of transition to PFRSs.” This provision would normally be interpreted to mean that theeffect of most adjustments to assets and liabilities in the first-time adopter’s opening PFRSbalance sheet would be reflected in retained earnings.

Making the adjustment to retained earnings under PFRS 1 is also consistent with the requirementof PAS 8, Accounting Policies, Changes in Accounting Estimates and Errors. PAS 8.26 statesthat: “…When an entity applies a new accounting policy retrospectively, it applies the newaccounting policy to comparative information for prior periods as far back as is practicable.Retrospective application to a prior period is not practicable unless it is practicable to determinethe cumulative effect on the amounts in both the opening and closing statements of financialposition for that period. The amount of the resulting adjustment relating to periods before thosepresented in the financial statements is made to the opening balance of each affectedcomponent of equity of the earliest prior period presented. Usually the adjustment is made toretained earnings…”

Consensus

Based on the discussions above, the entity which, upon transition to PFRS (and even to PFRSfor SMEs or PFRS for Small Entities), opted to adopt the “deemed cost method” for its property,plant and equipment account should, in accordance with PFRS 1.11 and PAS 8.26, close out therevaluation increment account to the opening retained earnings in the financial statements at theearliest prior period presented and not to another equity category. However, the amount closedto retained earnings should not form part of retained earnings available for dividend distribution(see Issue 4). This information should be properly disclosed in the notes to financial statements(see Issue 2).

Issue 2



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Background

PAS 8.29 states that: “When a voluntary change in accounting policy has an effect on thecurrent period or any prior period, would have an effect on that period except that it isimpracticable to determine the amount of the adjustment, or might have an effect on futureperiods, an entity shall disclose:

(a) the nature of the change in accounting policy;

(b) the reasons why applying the new accounting policy provides reliable and more relevantinformation;

(c) for the current period and each prior period presented, to the extent practicable, theamount of adjustment:



(d) the amount of the adjustment relating to periods before those presented, to the extentpracticable; and

(e) if retrospective application is impracticable for a particular prior period, or for periodsbefore those presented, the circumstances that led to the existence of that conditionand a description of how and from when the change in accounting policy has beenapplied.



(a) the remaining balance of the deemed cost adjustment included in retained earnings,and

(b) the amount of the deemed cost adjustment absorbed through depreciation in profit andloss, in case of depreciable assets, that is available for dividend declaration.



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Consensus


An example of a disclosure is shown below (assuming that the adjustment is made in 2011 andfinancial statements for 2010 and 2009 are presented as comparatives):

In accordance with the general requirement under PFRS 1, the Company closed out to theRevaluation Reserve account with a balance of Phpxxx as of January 1, 2009 to retainedearnings. The Revaluation Reserve pertains to the remaining balance of the deemed costadjustment on certain property, plant and equipment account which arose when the Companytransitioned to PFRS in 2005. This adjustment to retained earnings has no effect on profit or lossand earnings per share for the years ended December 31, 2010 and 2009.


As of December 31, 201X and 201X, the balance of retained earnings includes the remainingbalance of the deemed cost adjustment amounting to Phpxxx and Phpxxx, respectively,related to certain property, plant and equipment which arose when the Company transitioned toPFRS in 2005. This amount has yet to be absorbed through additional depreciation in profit andloss in the case of depreciable assets [and through sale in the case of land].

Issue 3


Background






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Consensus

Closing out the Revaluation Reserve to retained earnings does not affect any other item within acomparative statement of financial position and thus does not change any information previouslyprovided to financial statement users. In such a case, the inclusion of an additional statement offinancial position would not significantly influence the economic decisions of users in evaluatinghistorical financial information and thus is not considered material to financial statementsprepared in accordance with PFRS. A disclosure about the closing out of the RevaluationReserve to the opening retained earnings account will be sufficient for this purpose.





Issue 4


Background

SEC MC 11-2008 provides guidelines on the determination of retained earnings available fordividend declaration. It requires the submission of a reconciliation schedule for this purpose.


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Section 5 of SEC MC 11-2008 enumerates the unrealized items that shall be considered as notavailable for dividend declaration.

Consensus

The deemed cost adjustment can be categorized under SEC MC 11-2008 as an unrealized itemunder the group “Other unrealized gains or adjustments to retained earnings brought about bycertain transactions accounted for under the PFRS.” Examples of which are as follows:accretion income under PFRS 9, Financial Instruments, day 1 gains on initial recognition offinancial instruments, reversal of revaluation increment to retained earnings, and the negativegoodwill on investments in associate. Consequently, retained earnings shall be reduced by theamount of the remaining balance of the deemed cost adjustment to arrive at retained earningsavailable for dividend declaration.

Effective Date


Date originally approved by PIC: October 20, 2011Date amendments approved by PIC: June 27, 2018


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578

Q&A No. 2012 – 01 (amended June 2018): PFRS 3.2 – Application of thePooling of Interests Method for Business Combinations of Entitiesunder Common Control in Consolidated Financial Statements

Issues

1. What carrying values shall an entity use when applying the pooling of interests method forcommon control business combinations in its consolidated financial statements?

2. Is an entity required to restate the financial information in its consolidated financialstatements for business combinations under common control for periods prior to thecombination, if it elects to apply the pooling of interests method?

3. If the entity elects not to restate financial information in the consolidated financial statementsfor periods prior to the business combination, how shall the equity reserves, if any, beaccounted for?

This Q&A does not address legal mergers between a parent and a subsidiary.1

Background

Common control business combinations are excluded from the scope of PFRS 3, BusinessCombinations; however, there are no specific rules under existing PFRS which prescribe howsuch transactions shall be accounted for. In August 2011, the Philippine InterpretationsCommittee (PIC) issued Q&A No. 2011 – 02, PFRS 3.2 – Common Control BusinessCombinations, to provide guidance in accounting for common control business combinations inorder to minimize diversity in the current practices until further guidance is provided by theInternational Accounting Standards Board (IASB).

The Consensus in Q&A No. 2011-02 provides that common control business combinations shallbe accounted for using either (a) the pooling of interests method, or (b) the acquisition methodin accordance with PFRS 3. Q&A No. 2011 – 02 then further provides guidance in selecting theappropriate method to use in accounting for common control business combinations; however, itdoes not provide guidance on how to apply the pooling of interests method.

To address that gap, this Q&A 2012 – 01 is issued to provide guidance in applying the poolingof interests method once this method is selected by an entity to account for the common controlbusiness combination (after considering the guidance in Q&A 2011-02). It shall be applied untilsuch time that further IASB guidance becomes available. Reference may also be made to FASBAccounting Standards Codification (FASB ASC) 805-50 which provides relevant guidance onthe pooling of interests method.

1 Legal merger is where a parent and (one of) its subsidiaries become a single entity without any consideration(other than shares issued by the surviving entity).


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The pooling of interests method is generally considered to involve the following:

The assets and liabilities of the combining entities are reflected in the consolidatedfinancial statements at their carrying amounts. No adjustments are made to reflect fairvalues, or recognize any new assets or liabilities, at the date of the combination thatotherwise would have been done under the acquisition method. The only adjustmentsthat are made are those adjustments to harmonize accounting policies.

No 'new' goodwill is recognized as a result of the combination. The only goodwill that isrecognized is any existing goodwill relating to either of the combining entities. Anydifference between the consideration paid or transferred and the equity 'acquired' isreflected within equity.

The consolidated income statement reflects the results of the combining entities for thefull year, irrespective of when the combination took place.

Comparatives are presented as if the entities had always been combined.

However, apart from the second bullet point, the application of the above general guidance forthe pooling of interests method in the context of accounting for business combinations involvingentities under common control under PFRS raise certain issues, guidance on which arediscussed below using the following example.

Example

Entity A currently has two businesses operated through two wholly-owned subsidiaries, Entity Band Entity C. The present group structure (ignoring other entities within the group) follows:

Both subsidiaries have been owned by Entity A for a number of years.


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On October 1, 20X2, Entity A restructures the group by transferring its investment in Entity C toEntity B, such that Entity C becomes a subsidiary of Entity B. The group structure after thetransfer follows:

The policy adopted by the group to account for business combinations involving entities undercommon control is to apply the pooling of interests method.

Consensus

Issue 1: Carrying values to use for assets and liabilitiesIn Entity B's consolidated financial statements for the year ended December 31, 20X2, whatvalues should be reflected in respect of Entity C?

There are two available approaches for determining what carrying values to use when applyingthe pooling of interests method, namely:

Approach 1: To use the carrying values reported in the consolidated financial statementsof the parent.

Approach 2: To use the carrying values reported at the level of the separate financialstatements of the combining entities. This Approach 2, however, may be appropriatewhen the specific factors noted below are present.

Issue 1 / Approach 1: To use the carrying values reported in the consolidated financialstatements of the parent

Under Approach 1, in its consolidated financial statements for the year ended December 31,20X2, Entity B should generally use the carrying values of Entity C’s assets and liabilities asreported in Entity A's consolidated financial statements, rather than the carrying values reportedin Entity C's separate financial statements.

Accordingly, the carrying values of Entity C’s assets and liabilities will be based on theirrespective fair values as at the date Entity C became part of the Entity A group and adjusted for


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subsequent transactions. Any goodwill relating to Entity C that was previously recognized inEntity A's consolidated financial statements will also be recognized. The carrying values of theassets and liabilities of Entity B will remain as before.

The rationale for applying this approach is that the transaction is essentially a transfer of assetsand liabilities of Entity C from the consolidated financial statements of Entity A to the financialstatements of Entity B. From a group perspective, nothing has changed, except for the locationof those assets and liabilities. Entity B has effectively taken on the group’s ownership.Therefore, the values used in the consolidated financial statements are the appropriate andmost relevant values to apply to the assets and liabilities of Entity C, as they represent thecarrying values of those assets and liabilities to the Entity A group.

Issue 1 / Approach 2: To use the carrying values reported at the level of the financial statementsof the combining entities

Under Approach 2, the assets and liabilities of Entity C in the financial statements of Entity Bafter the business combination are recognized at the carrying amounts as previously reflected inthe financial statements of Entity C prior to the business combination.

From the perspective of the new consolidated entity (Entity B + Entity C), the group’sperspective is ignored when accounting for the transaction. The concept of pooling is applied asa sharing of control by the shareholders. Therefore, the carrying values in the financialstatements of Entity C prior to the merger will be relevant.

However, the use of carrying values in the financial statements of Entity C may not always beappropriate. Accordingly, this approach may be applied after consideration, at the minimum, ofall of the following factors:

Consistent accounting policies – Paragraph 13 of PAS 8, Accounting Policies, Changesin Estimates and Errors, requires an entity to select and apply its accounting policiesconsistently for similar transactions, unless a PFRS specifically requires or permitsdifferent accounting policies. Accounting for legal mergers of a parent and a subsidiaryrequires similar accounting policy selections, therefore, there must be consistencybetween the policies selected to account for such mergers and common controlbusiness combinations.

Timing of the transactions – The further in history the carrying values of the assets andliabilities were determined, the less relevant such carrying values may be for users of thefinancial statements.

Grooming transactions – If there is a plan or intention for Entity B to be sold, spun-off, oris otherwise being groomed or prepared for another transaction, the carrying valuesdetermined using Approach 1 would provide more relevant financial information than


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those determined using Approach 2. Users of the financial statements – If the majority of the users of Entity B’s financial

statements after the business combination are parties that previously relied upon thefinancial statements of Entity C (for example, if there are significant non-controllingshareholders), using Approach 2 might provide more relevant financial information thanusing Approach 1.

Issue 2: Restatement or non-restatement of financial information in consolidated financialstatements for periods prior to the date of the business combination

In preparing its consolidated financial statements for the year ended December 31, 20X2,should Entity B include financial information for Entity C for the period prior to the date ofobtaining control on October 1, 20X2 (thereby restating the 20X1 comparatives) in itsconsolidated financial statements as if the business combination (and the investment in EntityC) took place from January 1, 20X1?

The main issue is whether financial information in consolidated financial statements for periodsprior to the date of the business combination, including comparatives, should be restated or notwhen applying the pooling of interests method and, if restated, the extent of such restatement.As indicated earlier, the pooling of interests method is generally considered to involvecomparatives being presented as if the entities had always been combined.

In some jurisdictions, however, regulators take the view that comparatives cannot be restatedas such treatment is inconsistent with PFRS 10, Consolidated Financial Statements. Thisappears to be on the basis that, even though PFRS 3 is not being applied to the businesscombination, PFRS 10 requires that a parent's consolidated financial statements can onlyinclude the income and expenses of a subsidiary from the acquisition date as defined inPFRS 3, i.e., the date it obtains control of the subsidiary. Such a view would also mean that,when applying the pooling of interests method, the pre-acquisition income and expenses of asubsidiary in the current year should also not be included.

Therefore, in applying the pooling of interests method, an entity has two approaches to choosefrom:

Approach1: To restate the financial information in the consolidated statements forperiods prior to the transaction.

Approach 2: Not to restate the financial information in the consolidated financialstatements for periods prior to the transaction.



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Issue 2 / Approach 1: To restate the financial information in the consolidated financialstatements for periods prior to the transaction

Under Approach 1, the financial information in the consolidated financial statements arerestated for periods prior to the combination of the entities under common control to reflect thecombination as if it had occurred from the beginning of the earliest period presented in thefinancial statements, regardless of the actual date of the combination.

However, financial information in the consolidated financial statements for periods prior to thecombination is restated only for the period that the entities were under common control.The rationale for Approach 1 is that, in business combinations of entities under common control,there is no change in control, because the ultimate controlling party always has control over thecombined resources – the ultimate controlling party merely changed the location of itsresources. Accordingly, if the ultimate controlling party had control of these resources in thecomparative period, then the comparatives are restated.

Paragraph 20 of PFRS 10 indicates that an entity cannot be included in the consolidatedfinancial statements until the date that it is under the control of the acquirer. Under Approach 1,this paragraph is not considered to be in conflict with the concept of pooling, which is only amethod of presenting the information. This paragraph restricts the application of pooling until theentities have actually come under direct control, not how pooling is applied.Therefore, under Approach 1, the financial information in the consolidated financial statementsis presented as though the combination of entities under common control occurred at thebeginning of the earliest comparative period.

In the above example, since Entity C has been part of the Entity A group for a number of years,then Entity B shall include financial information for Entity C from January 1, 20X1, restating the20X1 comparatives presented in its consolidated financial statements for 20X2.

The above example assumes that Entity C had been part of the Entity A group for a number ofyears. If this had not been the case, Entity B still has a choice of whether to restate or not torestate. Should it choose restatement, the financial information in the consolidated financialstatements for periods prior to the combination is restated only for the period that the entitieswere under common control. If the ultimate controlling party has not always controlled thesecombined resources, then application of the pooling of interests method shall reflect that fact.That is, an entity cannot restate the comparative financial information in the consolidatedfinancial statements in respect of the period that common control did not exist.


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Issue 2 / Approach 2: Not to restate the financial information in the consolidated financialstatements for periods prior to the transaction

Under Approach 2, the requirements of Paragraph 20 of PFRS 10 are viewed as being inconflict with the concept of pooling, hence, financial information in the consolidated financialstatements for the combined entity is not restated for periods prior to the combination of theentities under common control. Specifically, the scope of PFRS 10 applies to all consolidatedfinancial statements, without any scope exclusions for combinations of entities under commoncontrol. The fact that this combination is outside of the scope of PFRS 3 is irrelevant whenconsidering the requirements of PFRS 10. Therefore, the pooling of interests method willaffect only the values assigned to the assets and liabilities, and no restatement of financialinformation for periods prior to the transaction is made.

In the above example, Entity B shall not restate the financial information in its consolidatedfinancial statements for the year ended December 31, 20X2 (including the 20X1comparatives) for any financial information for Entity C prior to October 1, 20X2 (the date ofthe combination).

Issue 3: Accounting for equity reserves when the entity elects not to restate financialinformation in the consolidated financial statements for periods prior to the transaction

When the ‘acquired’ entity has equity reserves, what values should be assigned to such equityreserves?

When an entity has opted not to restate the financial information in the financial statements forperiods prior to the transaction, and the ‘acquired’ entity has equity reserves, it has thefollowing two approaches to choose from to determine what value to assign to such equityreserves:

Approach 1: To carry over the equity reserves at ‘pooling of interests values’ that reflectthe application of pooling of interests method.

Approach 2: To carry over the equity reserves at book values considering thetransaction as an initial recognition of net assets.


Overall, both approaches give the same net asset position at the date of the combination.However, the two approaches will have a different effect on the components within equity andsubsequent results in the future.


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Issue 3 / Approach 1 – No restatement of prior periods – to carry the equity reserves at‘pooling of interests values’ that reflect the application of pooling of interests method

Under Approach 1, while the financial information for periods prior to the transaction are notrestated, the values assigned to the ‘acquired’ entity, including equity reserves, aredetermined as if the pooling of interests method had been applied since the entities wereunder common control.

This means that any equity values associated with the ‘acquired’ entities that would have beenrecognized in equity are created as at the date of the transaction. This includes:

Fair value reserve on financial assets at fair value through other comprehensive income(FVOCI);

hedging reserves; foreign currency translation reserves; and other asset revaluation reserves.

The history of transactions is retained for such things as recycling of fair value gain or loss ondebt financial assets at FVOCI to profit or loss, transfer of fair value reserve on equity financialassets at FVOCI to retained earnings, or reversing impairment charges on non-current assetstaken in previous periods.

If there are changes to the carrying values of assets or liabilities arising from the combination(e.g., due to revised impairment tests and/or reversals or changes in deferred taxes due tochanges in the tax base), adjustments are recognized in profit and loss as part of the activityof the business for the year.

Under this view, the fact that no restatement occurs is considered a presentation issue only,and for all intents and purposes, the guidance as discussed under Issue 2 / Approach 1above is applied in full.

In the above example, assume that on October 1, 20X2 Entity C had a fair value reserve ondebt financial assets at FVOCI of Php100. Before December 31, 20X2, the debt financialasset at FVOCI is sold. In Entity B’s consolidated financial statements, Entity B will recognizea fair value reserve of Php100 at the date of the business combination. When the debtfinancial asset is subsequently sold, the Php100 will be recycled to profit or loss during theyear.


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Issue 3 / Approach 2 – No restatement of prior periods – to carry over the equity reserves atbook values considering the transaction as an initial recognition of net assetsUnder Approach 2, while the financial information for periods prior to the transaction are notrestated, the combination gives rise to an initial recognition of net assets at the previouscarrying values of the assets and liabilities of the acquired entity.

This means that the assets essentially have a new deemed cost, and there is no historyretained of previous transactions affecting the assets. Therefore, to the extent that there areequity balances arising from past transactions that would have been recognized directly inequity, those equity balances are not restated, nor recycled to the profit or loss insubsequent periods. Similarly, if an asset had been impaired in the past, the impairment losspreviously recognized shall not be subsequently reversed.

If there are changes to the carrying values of assets or liabilities arising from the combination(e.g., due to revised impairment tests and/or reversals or changes in deferred taxes due tochanges in the tax base), these are reflected in the net adjustment to equity at the time ofrecognizing the business combination.

Under this view, the fact that no restatement occurs is considered to be more than apresentation issue. It is viewed as an initial recognition event at the date of the transaction, andthe values assigned to the assets or liabilities are determined using the concepts of the poolingof interests – that is at their book values. However, this results in the assets and liabilitieseffectively having a new ‘cost base’ and the history associated with them is not relevant fromthe perspective of the new group. That is, for assets or liabilities where changes are recognizeddirectly in equity, the history associated with the past changes in value is lost and will not berolled forward.

This also means that if at the date of the transaction, the combination is believed to generateadditional value such that previous impairments would reverse at that date, the effect shall berecognized at that date as part of the adjustment to equity, i.e., as part of the pooling reservein equity. Similarly, if the combination results in a change in the tax base of assets, the effectof the change in deferred taxes is recognized as part of the adjustment to equity

Therefore, in the above example, Entity B will not recognize a fair value reserve on debtfinancial assets at FVOCI at the date of the business combination. When the investment issubsequently sold, the Php100 fair value reserve that formed part of the carrying value of thedebt financial asset and not separately recognized will not be recycled to profit or loss duringthe year.


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Disclosures and Other Restatements

PAS 33, Earnings per Share, contains the requirements to restate prior periods' earnings pershare (EPS) for events that resulted in a change in the number of outstanding shares of stockwithout a corresponding change in resources. To ensure comparability of EPS figures, forentities required to disclose EPS and those entities, although not required have opted todisclose EPS, the basic and diluted EPS for all periods presented should be adjusted for theeffects of business combinations that are accounted for using the pooling of interests method.The following should be disclosed in addition to the required disclosures under applicablePAS/PFRS, including disclosures required under PAS 8:

a. The rationale for applying the pooling of interests method;b. Any significant/relevant details on the common control business combination; andc. How the pooling of interests methodology was applied.

Effective Date




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589

Q&A No. 2016 – 02 (amended June 2018): PAS 32 and PAS 38 –Accounting Treatment of Club Shares Held by an Entity

Issue


Background









590

Relevant guidance


“A financial asset is any asset that is:(a) cash;(b) an equity instrument of another entity;(c) a contractual right:


conditions that are potentially favorable to the entity; or(d) a contract that will or may be settled in the entity's own equity instruments and is:






Paragraph 17 of PAS 38 states that:“The future economic benefits flowing from an intangible asset may include revenue from thesale of products or services, cost savings, or other benefits resulting from the use of the asset


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by the entity. For example, the use of intellectual property in a production process may reducefuture production costs rather than increase future revenues.”

Consensus







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593

Q&A No. 2016 – 03 (amended June 2020): Accounting for CommonAreas and the Related Subsequent Costs by CondominiumCorporations


Background

Section 2 of R.A. 4726 The Condominium Act defines a “condominium” as an interest in realproperty consisting of separate interest in a unit in a residential, industrial or commercial buildingand an undivided interest in common, directly or indirectly, in the land on which it is located andin other common areas of the building. A condominium may include, in addition, a separateinterest in other portions of such real property.

Title to the common areas, including the land, or the appurtenant interests in such areas, may beheld by a Condominium Corporation in which the holders of separate interest shall automaticallybe members or shareholders, to the exclusion of others, in proportion to the appurtenant interestof their respective units in the common areas. Whenever the common areas in a condominiumprojects are held by a condominium corporation, such corporation shall constitute themanagement body of the project. The corporate purposes of such a corporation shall be limitedto the holding of the common areas.

In current practice, the ownership of the land is not transferred to the Condominium Corporation.The Transfer Certificate of Title (TCT) is cancelled by the Registry of Deeds and they annotate themaster deeds of restrictions and separate Condominium Certificate of Titles (CCTs) are issued inreplacement of the TCT. The individual CCT shall be issued in the name of the original developerand then subsequently transferred to their buyers. The land description is no longer indicated in theDeed of Sale or CCT of the buyer but the project name and the master deed with declaration ofrestrictions and the unit number is always stated.

For purposes of paying real property tax, a separate tax declaration is issued and the CondominiumCorporation pays based on the assessed value or special assessment. Depending on the policy ofthe Board of the Condominium Corporation, this may form part of the association dues which isbeing paid by the unit owners on a monthly basis. Further, as part of the CondominiumCorporation’s management of the common areas (including the land), it incurs major expenditures,the costs of which are collected from the unit owners through special assessment. This specialassessment is being collected in advance from the unit owners and subsequently disbursed andpaid to the suppliers as the major expenditures progress.

In practice, the accounting for land and other common areas is not consistent amongCondominium Corporations. Some do not record the land and other common areas, while othersrecord these based on cost or appraised value.


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Another issue related to accounting for land and other common areas is the accounting for specialassessments. Special assessments are made by Condominium Corporations in order to financespecific projects.

The accounting for special assessments and the related expenditures differs amongCondominium Corporations. Some Condominium Corporations recognize these as revenueswhile others treat these assessments as liability or equity.

Issue 1

How should the Condominium Corporations account for the land and other common areas?

Consensus

Paragraph 5.1 of the Conceptual Framework discusses when an element (assets, liabilities, income,expenses) can be recognized in the financial statements. It indicated that “Recognition is theprocess of incorporating in the balance sheet or income statement an item that meets the definitionof an element and satisfies the criteria for recognition set out in paragraph 4.38. It involves thedepiction of the item in words and by a monetary amount and the inclusion of that amount in thebalance sheet or income statement totals. Items that satisfy the recognition criteria should berecognized in the balance sheet or income statement. The failure to recognize such items is notrectified by disclosure of the accounting policies used nor by notes or explanatory material.”

Paragraph 4.3 of the Conceptual Framework defines an asset as “a resource controlled by the entityas a result of past events and from which future economic benefits are expected to flow to theentity.” While PAS 16 Property, Plant and Equipment paragraph 6 defines Property, plant andequipment as: “…tangible items that: (a) are held for use in the production or supply of goods orservices, for rental to others, or for administrative purposes; and (b) are expected to be used duringmore than one period.”

Paragraph 4.8 of the Conceptual Framework provides that: “An economic resource is a right thathas the potential to produce economic benefits. For that potential to exist, it does not need to becertain, or even likely, that the right will produce economic benefits. It is only necessary that theright already exists and that, in at least one circumstance, it would produce for the entity economicbenefits beyond those available to all other parties.”

Paragraph 4.12 of the Conceptual Framework also states that “In many cases, the set of rightsarising from legal ownership of a physical object is accounted for as a single asset. Conceptually,the economic resource is the set of rights, not the physical object. Nevertheless, describing theset of rights as the physical object will often provide a faithful representation of those rights in themost concise and understandable way.”

The definition of asset in the conceptual framework recognizes the fact that for an entity to recognize


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an asset, it must have control over the economic benefits expected to be derived from such asset.Control over an asset is the ability of the entity to direct the use of the asset so as to obtain economicbenefits. An entity has the right to direct the use of an asset if the entity can direct how and for whatpurpose the asset is used.

The Condominium Corporation cannot direct how and for what purpose the land and other commonareas will be used. The decision as to how and for what purpose these common areas will be usedare made by the unit owners rather than the Condominium Corporation.

Furthermore, the ownership or the title over the common areas is not a requirement for an entity torecognize an asset; rather, as provided by paragraph 4.6 of the conceptual framework, “not all ofan entity’s rights are assets of that entity—to be assets of the entity, the rights must both have thepotential to produce for the entity economic benefits beyond the economic benefits available to allother parties… and be controlled by the entity.” Thus, regardless of whether the title of the land istransferred to the Condominium Corporation or not, this is not essential in the determination ofwhether the common areas (including the land) is to be recognized in the financial statements ofthe Condominium Corporation.

Accordingly, Condominium Corporations should not recognize the land and other common areasas assets in its financial statements.

Issue 2

How should the Condominium Corporations recognize the special assessments and thesubsequent expenditures?

Consensus

Considering that the Condominium Corporation is a non-stock and non-profit entity, it shall needfunds to sustain its operations. Thus, as time and in such manner as the Condominium CorporationBoard may reasonably and necessarily determine, there shall be an assessment against each Unitowner proportionate to his or its appurtenant interest.

The Condominium Corporation Board, may from time to time, designate such amount or amounts tobe collected from Unit owners as and by way of special assessment to cover such expendituresdeemed necessary but is not considered in the regular assessment such as major buildingimprovement projects approved by the Unit owners.

Revenue, as defined in Appendix A of PFRS 15, Revenue from Contracts with Customers, is theincome arising in the course of an entity’s ordinary activities, whereas income is defined by theConceptual Framework as increases in economic benefits during the accounting period in the formof inflows or enhancements of assets or decreases of liabilities that result in increases in equity,


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other than those relating to contributions from equity participants.

Considering that the special assessment is collected for specific purpose and will only be spent onsaid purpose, there will be no gross inflow of economic benefits to the Condominium Corporation.Thus, such could not be recognized as revenue. However, since the Condominium Corporationreceived cash from the unit owners, it has the liability to ensure that said cash is intact and will bespent on the purpose it is collected. In this regard, a liability should be recognized in the books ofthe Corporation and once spent, said liability will be reversed. Any excess from the cash receivedfrom the unit owners against the amount spent for special assessments will be reversed to equityas it represents an increase in equity relating to contributions from the unit owners as equityparticipants.

To illustrate, journal entries are as follows:

Dr. Cash……………………………………P xxxxCr. Liabilities for Special Assessments.………….P xxxxTo record receipts of cash from unit owners.

Dr. Liabilites for Special Assessments…..P xxxxCr. Cash……………………………………………..P xxxxTo record actual expenditures for special assessments.






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PIC Members











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Q&A No. 2017 – 05 (amended June 2018): PFRS 7 – Frequently askedquestions on the disclosure requirements of financial instrumentsunder PFRS 7, Financial Instruments: Disclosures

Background

PFRS 7 applies to all entities that hold financial instruments. However, the extent ofdisclosure required depends on the extent of the entity's use of financial instruments andits exposure to risk.

The disclosure requirements of the PFRS are intended to: (1) provide information that willenhance the understanding of the significance of financial instruments to a company’sfinancial position, performance, and cash flows; and (2) assist in evaluating the risksassociated with these instruments, including how the entity manages those risks. PFRS 7must be applied for accounting periods beginning on or after January 1, 2007.

Issues

Applying PFRS 7 gives rise to a number of application issues. Below are the frequentlyasked questions on the disclosure requirements of financial instruments under PFRS 7.

Liquidity Risk

1. In the maturity analysis of gross undiscounted cash flows of financial liabilities, how arecoupon payments from interest-bearing borrowings presented?

2. Are companies required to show a reconciliation of amounts presented in the maturityanalysis and in the statement of financial position?

3. In practice, most companies manage liquidity risk based not on the remainingcontractual maturities but on expected maturities. How should companies disclosethis?


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4. What should the company include in the maturity analysis of financial assets in itsliquidity risk disclosure, if such analysis is necessary to evaluate the nature and extent ofliquidity risk?

5. For floating-rate financial liabilities, what rates should be used in calculating itsinterest cash flows in the maturity analysis?

Market Risk

1. What should be the basis of the company in preparing the basic sensitivity analysis?

2. In disclosing the sensitivity analysis, what is the time frame over which the companyshould make its analysis?

3. Should the disclosure about sensitivity analysis be based on a pre-tax or post-tax basis?

4. What foreign currency risk impacts should be captured in the market risk disclosure?

5. Should commodity contracts that are not within the scope of PFRS 9, FinancialInstruments be included in the market risk sensitivity analyses?

Credit Risk

1. Where should the disclosure on concentration of credit risk be based?


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Fair Value

1. Are over-the-counter (OTC) derivative contracts classified as Level 1 measurementin the fair value hierarchy?

2. In the fair value hierarchy disclosure, how should an instrument measured at fairvalue be categorized?

3. An instrument for which there is currently no active market and the entity used avaluation model. A significant input to the model is a credit spread based onhistorical default statistics and credit rating assigned by an agency to theinstrument. Under what level should we classify the instrument under the fair valuehierarchy table and why?

4. The entity uses a model to calculate the fair value of the loan/debt instrument. Themodel uses discounted cash flows based on the risk-free rate plus a credit spread.Under what level will the loan/debt instrument fall under the fair value hierarchy?

Other Disclosures

1. Is it possible to include interest expense on short positions (financial liability held fortrading) in net gains or net losses on financial liabilities at fair value through profit orloss (FVPL)?

2. If financial liabilities that are not at fair value through profit and loss are used tofinance a portfolio of trading financial assets (for example, trading debt securities),can the interest expense (funding costs) on such liabilities be included in net gainsor net losses on financial assets or financial liabilities at fair value through profit orloss (FVPL)?


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Consensus

Liquidity Risk

1. Companies are not required to show interest cash flows separately from principalcash flows in the analysis, although some do.

2. No, but companies may opt to present such reconciliation.

3. In PFRS 7.39, companies are required to disclose a maturity analysis of theirfinancial liabilities showing the undiscounted cash flows based on the remainingcontractual maturities. Companies may wish to provide a separate maturityanalysis based on expected maturity dates. However, such an analysis will notremove the need to produce the required contractual maturity analysis.

4. Only those financial assets the company holds for managing liquidity risk (e.g.,financial assets that are readily saleable or expected to generate cash inflows tomeet cash outflows on financial liabilities). (PFRS 7.B11E)

5. The standard requires the amounts included in the analysis to be based onconditions at year-end. For floating-rate borrowings, one should look to the spotrates at year-end, although a degree of sophistication may be introduced by usingyear-end forward rates.

Market Risk

1. The basic sensitivity analysis should be prepared on the basis of financialinstruments held at the reporting date. Therefore, an entity does not need toforecast the financial instruments that will be held over the next year, nor does ithave to work out what financial instruments it held during the previous year. Areasonably possible change in relevant market risk variables should be applied todetermine the theoretical impact on profit or loss and equity, and it is this impact thatshould be disclosed. A reasonably possible change should not include remote orworst case scenarios or stress tests. (PFRS 7.B19)


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2. The Application Guidance of the Standard makes it clear that the sensitivity analysisshould show the effects of changes that are reasonably possible over the perioduntil the company will next present its risk disclosures. (PFRS 7.B19)

3. The disclosure may be on either a pre-tax or a post-tax basis. This is a policy choiceto be made and applied consistently, and disclosed in the financial statements.

4. PFRS 7 is clear that the foreign currency risk impacts that should be captured arethose arising from monetary items denominated in a currency that is different fromthe functional currency of the entity holding them. Therefore, it should not capturesensitivity from translating the results and assets of foreign operations, althoughthere is nothing wrong with showing these as additional information. (PFRS 7.B23)

5. They should not be included, although there is nothing wrong with showingadditional information about them on a voluntary basis or to comply with thedisclosure requirements of other standards. For VaR-type disclosures it will dependon whether the analysis used by management to manage risk includes thosecontracts. (PFRS 7.5)

Credit Risk

1. PFRS 7 requires disclosure of all risk concentrations to which an entity is exposedin relation to financial instruments, based on financial instruments that have similarcharacteristics such as geographical area, currency, industry, market, and type ofcounterparty. (PFRS 7.B8)

Fair Value

1. An OTC derivative contract is a unique bilateral contract between twocounterparties for which quoted prices are not continuously available. Given theirnature, OTC derivative contracts are not normally classified as Level 1measurements in the fair value hierarchy disclosures. Depending on the


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observability of the inputs used, the instrument would either be classified as Level 2or Level 3 measurements.

2. The disclosure on fair value hierarchy focuses on the inputs used in valuationtechniques rather than the valuation techniques themselves. The level in the fairvalue hierarchy shall be based on the lowest level input that is significant to the fairvalue measurement in its entirety. For this purpose, the word “significant” refers towhat is significant to the valuation of the instrument in its entirety.

3. Credit spreads are not normally evidence of market transactions thus the instrumentwill be classified under Level 3.

4. If the credit spread is considered significant, the conclusion is Level 3. However, ifthe credit spread is insignificant, then the conclusion could be Level 2.

Other Disclosures

1. Yes. Interest expense on short positions should be presented in a mannerconsistent with the treatment of interest expense on long positions, included ineither interest expense or in gains and losses on financial instruments at fair valuethrough profit or loss as appropriate. There should be consistent application fromperiod to period and the company should disclose its accounting policy.

2. No. The interest expense incurred on such liabilities, although such liabilities maybe used to fund the company’s trading portfolio, is not considered to arise directlyfrom the company’s trading activities and should be included in interest expense. If,however, the financial liability funding the trading assets is designated as held fortrading, it would be appropriate to include the interest expense in net gains or netlosses on financial assets or financial liabilities at fair value through profit or loss.


Date amendments approved by PIC: June 27, 2018


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PIC Members










Date amendments approved by FRSC: October 10, 2018


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Q&A No. 2018 – 07 (amended June 2018): PAS 27 and PAS 28 - Cost ofan associate, joint venture, or subsidiary in separate financialstatements

Issue

How is cost determined for an investment in an associate, joint venture, or subsidiary when valuingthe investment at cost in the separate financial statements? In particular, how are the followingfactored into the determination of cost:

Transaction costs

Contingent consideration

Step acquisitions

Fact pattern

Entity A accounts for its investments in associates, joint ventures and subsidiaries at cost in itsseparate financial statements. It entered into the following transactions:

Scenario 1

In June 20X0, Entity A acquires an 80% interest in Entity C. Entity A paid CU1,000 and will payadditional consideration in the future of CU2,000 if certain targets were met. The fair value of thecontingent consideration recognized in the consolidated financial statements was CU1,400.Transaction costs of CU300 were also incurred.

Scenario 2

Entity A has a 10% interest in Entity B, which it acquired in January 20X1 for CU300. Thisinvestment was a financial asset measured at fair value in accordance with PFRS 9, FinancialInstruments, in both the consolidated and separate financial statements of Entity A. In March20X1, Entity A acquires a further 15% interest in Entity B for CU720 (its then fair value), givingEntity A significant influence over Entity B. The original 10% interest had a fair value of CU480 atthat date. In addition, transaction costs were incurred for both tranches, in aggregate amounting toCU50.


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Cost for this purpose is not separately defined in PAS 27 or PAS 28.

However, where PFRS/IFRS uses the term elsewhere, cost generally means the fair value of theconsideration plus incidental costs. In July 2009, the IFRS Interpretations Committee (IFRIC) alsoexpressed this view, when they noted, that generally under IFRSs, cost comprises the purchaseprice and to other costs directly attributable to the acquisition.

‘Consideration given’ is likewise not defined and the key sources of guidance are:

‘consideration transferred’ in the context of a business combination, as referred to inparagraph 37 of PFRS 3. The 'consideration transferred' in a business combinationcomprises the sum of the acquisition-date fair values of assets transferred by the acquirer,liabilities incurred by the acquirer to the former owners of the acquiree, and equity interestsissued by the acquirer, and any goodwill given up. This includes any liability (or asset) forcontingent consideration, which is measured and recognized at its fair value at theacquisition date. The liability arising is a financial liability within the scope of PFRS 9,Financial Instruments; therefore, subsequent changes in measurement are recognized inprofit or loss.

‘cost’ as applied in relation to acquisitions of property, plant and equipment in accordancewith PAS 16, intangible assets in accordance with PAS 38 and investment property inaccordance with PAS 40.

The IFRS Interpretations Committee and the International Accounting Standards Board (IASB)have discussed the topic Variable payments for the separate acquisition of PPE and intangibleassets for a number of years, attempting to clarify how the initial recognition of the variablepayments, such as contingent consideration, and subsequent changes in the value of thosepayments should be recognized. The scope of the past deliberations did not specifically includethe cost of an investment in a subsidiary, associate or joint venture. However, the generalprinciples about the recognition of variable payments can be considered relevant in determiningthe cost of such investments. The Interpretations Committee decided that this issue is too broadfor it to address and concluded that the IASB should address accounting for variable paymentsmore comprehensively. Until the IASB issues further guidance, differing views remain about thecircumstances in which, and to what extent, variable payments such as contingent considerationshould be recognized when initially recognizing the underlying asset. There are also differingviews about the extent to which subsequent changes should be recognized through profit or lossor capitalized as part of the cost of the asset.Where entities have made an accounting policy choice regarding recognition of contingentconsideration and subsequent changes in accounting for the cost of investments in subsidiaries,associates or joint ventures in separate financial statements, the policy should be disclosed andconsistently applied.


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Consensus

The cost of an investment in an associate, joint venture, or subsidiary in the separate financialstatements of the parent is the sum of the consideration given for the transaction, includingtransaction costs, and, may also include, the fair value of any contingent considerationarrangement entered into at that date, depending on the entity’s accounting policy.

In a step acquisition, the cost of an investment in an associate, joint venture or subsidiary is thesum of the consideration given for each tranche. Therefore, if there were any changes in the fairvalue of the previous tranches (between the acquisition date and the date that a later tranche wasacquired), those changes in fair value must be analyzed to determine whether they should berecognized in profit or loss or in other comprehensive income, as appropriate.

Scenario 1

The cost is the sum of the consideration paid and the transaction costs. If the entity has anaccounting policy of recognizing contingent consideration, the fair value of the contingentconsideration arrangement at the date of gaining control is also part of the cost – CU2,700(CU1,000 + CU1,400 + CU300).

Scenario 2

The cost is the sum of the consideration given for each tranche plus transaction costs – CU1,250(CU300 + CU720 + CU50 + CU180). The increase in fair value of CU180 (CU480 – CU300)relating to the first 10% is: (1) recognized in profit or loss if the financial asset has previously beendesignated at fair value through profit or loss; or (2) recognized in equity if the financial asset haspreviously been designated at fair value through other comprehensive income on the date theincrease in ownership over the investee was made.

If Entity A purchased the 10% ownership in Entity B in 20X0 and has recognized the changes inthe fair value of this equity investment in other comprehensive income before, the amountrecognized in other comprehensive income should be transferred to retained earnings as if EntityA had disposed directly of the previously held equity interest.

The conclusions in this Q&A apply only to transactions within the scope of PAS 27, SeparateFinancial Statements, and PAS 28, Investments in Associates and Joint Ventures, and are not to beanalogized to for other assets and liabilities where cost is based on transaction price.


The consensus in and amendments to this Q&A is effective from the date of the approval by theFRSC.


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Date approved by PIC: January 31, 2018Date amendments approved by PIC: June 27, 2018


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PIC Members









Date approved by FRSC: March 14, 2018Date amendments approved by FRSC: October 10, 2018


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Q&A No. 2011 – 05 (amended July 2019): PFRS 1.D1-D8 – Fair Value orRevaluation as Deemed Cost

Issue 1


Background

Under paragraphs 6-7 of PFRS 1, First-time Adoption of Philippine Financial Reporting Standards,an entity shall:


use the same accounting policies in its opening PFRS statement of financial position andthroughout all periods presented in its first PFRS financial statements.Those accounting policies shall comply with each PFRS effective at the end of theentity’s first PFRS reporting period, except as specified in paragraphs 13-19 andappendices B-E of PFRS 1.

PFRS 1 provides guidance on when a first-time adopter may adopt the “deemed cost” approach. Itdefines “deemed cost” as an amount used as a surrogate for cost or depreciated cost at a givendate. Guidance on when a first-time adopter may adopt the “deemed cost” approach is presentedin paragraphs D5-D8B of PFRS 1 as follows:

“D5 An entity may elect to measure an item of property, plant and equipment at the date oftransition to PFRSs at its fair value and use that fair value as its deemed cost at that date.

D6 A first-time adopter may elect to use a previous GAAP revaluation of an item ofproperty, plant and equipment at, or before, the date of transition to PFRSs as deemed cost atthe date of the revaluation, if the revaluation was, at the date of the revaluation, broadlycomparable to:



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(a) fair value; or


D7 The elections in the preceding paragraphs D5 and D6 are also available for:

(a) investment property, if an entity elects to use the cost model in PAS 40,Investment Property; and

(aa) right-of-use assets (PFRS 16, Leases); and


a. the recognition criteria in PAS 38 (including reliable measurement of original cost);and

b. the criteria in PAS 38 for revaluation (including the existence of an activemarket).


D8 A first-time adopter may have established a deemed cost in accordance with previousGAAP for some or all of its assets and liabilities by measuring them at their fair value at oneparticular date because of an event such as a privatization or initial public offering. It mayuse such event-driven fair value measurements as deemed cost for PFRSs at the date ofthat measurement.”

(b) If the measurement date is at or before the date of transition to PFRSs, theentity may use such event-driven fair value measurements as deemed costfor PFRSs at the date of that measurement.

(b) If the measurement date is after the date of transition to PFRSs, but duringthe period covered by the first PFRS financial statements, the event-drivenfair value measurements may be used as deemed cost when the eventoccurs. An entity shall recognize the resulting adjustments directly inretained earnings (or if appropriate, another category of equity) at themeasurement date. At the date of transition to PFRSs, the entity shall eitherestablish the deemed cost by applying the criteria in paragraphs D5–D7 ormeasure assets and liabilities in accordance with the other requirements inthis PFRS.”


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D8A Under some national accounting requirements exploration and development costsfor oil and gas properties in the development or production phases are accountedfor in cost centers that include all properties in a large geographical area. Afirst-time adopter using such accounting under previous GAAP may elect tomeasure oil and gas assets at the date of transition to PFRSs on the followingbasis:

(c) exploration and evaluation assets at the amount determined under theentity’s previous GAAP; and

(d) assets in the development or production phases at the amount determinedfor the cost center under the entity’s previous GAAP. The entity shallallocate this amount to the cost center’s underlying assets pro rata usingreserve volumes or reserve values as of that date.

The entity shall test exploration and evaluation assets and assets in thedevelopment and production phases for impairment at the date of transition toPFRSs in accordance with PFRS 6, Exploration for and Evaluation of MineralResources, or PAS 36 respectively and, if necessary, reduce the amountdetermined in accordance with (a) or (b) above. For the purposes of thisparagraph, oil and gas assets comprise only those assets used in the exploration,evaluation, development or production of oil and gas.

D8B Some entities hold items of property, plant and equipment, right-of-use assets orintangible assets that are used, or were previously used, in operations subject torate regulation. The carrying amount of such items might include amounts thatwere determined under previous GAAP but do not qualify for capitalization inaccordance with PFRSs. If this is the case, a first-time adopter may elect to usethe previous GAAP carrying amount of such an item at the date of transition toPFRSs as deemed cost. If an entity applies this exemption to an item, it need notapply it to all items. At the date of transition to PFRSs, an entity shall test forimpairment in accordance with PAS 36 each item for which this exemption isused. For the purposes of this paragraph, operations are subject to rate regulationif they are governed by a framework for establishing the prices that can becharged to customers for goods or services and that framework is subject tooversight and/or approval by a rate regulator (as defined in PFRS 14, RegulatoryDeferral Accounts).



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(c) recycled the balance of the Revaluation Reserve to retained earnings using the sameestimated useful life and method of depreciation/amortization used for depreciating therelated asset adjusted to deemed cost. The amount recycled to retained earningseffectively offsets the increase in depreciation/amortization expense charged to profitor loss; or

(d) maintained the Revaluation Reserve at its original amount and recycled such amountone time to retained earnings when the related asset is fully depreciated or disposedof. This is usually accompanied by a note disclosure as to the portion of revaluationreserve already absorbed through depreciation.

In either approaches, the related asset is no longer subsequently revalued since its measurementbasis has been treated as deemed cost.

Paragraphs 1630 to 1731C of PFRS 1 (effective in 2005) and paragraphs D5 to D8B of AppendixD to PFRS 1 (effective on July 1, 2009) enumerate the bases of deemed cost that a first-timeadopter of PFRSs may use. However, those paragraphs do not specify directly where theincrease in carrying values of the assets should be adjusted – whether as an adjustment toretained earnings or to another equity category.

Further, Paragraph 11 of PFRS 1 (effective July 1, 2009) states that: “The accounting policiesthat an entity uses in its opening PFRS statement of financial position may differ from those that itused for the same date using its previous GAAP. The resulting adjustments arise from events andtransactions before the date of transition to PFRSs. Therefore, an entity shall recognize thoseadjustments directly in retained earnings (or, if appropriate, another category of equity) at the dateof transition to PFRSs.” This provision would normally be interpreted to mean that the effect ofmost adjustments to assets and liabilities in the first-time adopter’s opening PFRS balancesheet would be reflected in retained earnings.

Making the adjustment to retained earnings under PFRS 1 is also consistent with the requirement ofPAS 8, Accounting Policies, Changes in Accounting Estimates and Errors. PAS 8.26 states that:“…When an entity applies a new accounting policy retrospectively, it applies the new accountingpolicy to comparative information for prior periods as far back as is practicable. Retrospectiveapplication to a prior period is not practicable unless it is practicable to determine the cumulativeeffect on the amounts in both the opening and closing statements of financial position for thatperiod. The amount of the resulting adjustment relating to periods before those presented in thefinancial statements is made to the opening balance of each affected component of equity ofthe earliest prior period presented. Usually the adjustment is made to retained earnings…”


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Consensus

Based on the discussions above, the entity which, upon transition to PFRS (and even to PFRSfor SMEs or PFRS for Small Entities), opted to adopt the “deemed cost method” for its property, plantand equipment account should, in accordance with PFRS 1.11 and PAS 8.26, close out therevaluation increment account to the opening retained earnings in the financial statements at theearliest prior period presented and not to another equity category. However, the amount closed toretained earnings should not form part of retained earnings available for dividend distribution(see Issue 4). This information should be properly disclosed in the notes to financial statements(see Issue 2).

Issue 2


Background

PAS 8.29 states that: “When a voluntary change in accounting policy has an effect on thecurrent period or any prior period, would have an effect on that period except that it is impracticableto determine the amount of the adjustment, or might have an effect on future periods, an entityshall disclose:

(f) the nature of the change in accounting policy;

(g) the reasons why applying the new accounting policy provides reliable and more relevantinformation;

(h) for the current period and each prior period presented, to the extent practicable, theamount of adjustment:



(i) the amount of the adjustment relating to periods before those presented, to the extentpracticable; and

(j) if retrospective application is impracticable for a particular prior period, or for periodsbefore those presented, the circumstances that led to the existence of that conditionand a description of how and from when the change in accounting policy has beenapplied.


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(c) the remaining balance of the deemed cost adjustment included in retained earnings,and

(d) the amount of the deemed cost adjustment absorbed through depreciation in profit andloss, in case of depreciable assets, that is available for dividend declaration.

Consensus



As of December 31, 201X and 201X, the balance of retained earnings includes the remainingbalance of the deemed cost adjustment amounting to Phpxxx and Phpxxx, respectively, relatedto certain property, plant and equipment which arose when the Company transitioned to PFRS in2005. This amount has yet to be absorbed through additional depreciation in profit and loss in thecase of depreciable assets [and through sale in the case of land].



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Issue 3


Background







Consensus

Closing out the Revaluation Reserve to retained earnings does not affect any other item within acomparative statement of financial position and thus does not change any information previouslyprovided to financial statement users. In such a case, the inclusion of an additional statement offinancial position would not significantly influence the economic decisions of users in evaluatinghistorical financial information and thus is not considered material to financial statements preparedin accordance with PFRS. A disclosure about the closing out of the Revaluation Reserve tothe opening retained earnings account will be sufficient for this purpose.




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Issue 4


Background

SEC MC 11-2008 provides guidelines on the determination of retained earnings available fordividend declaration. It requires the submission of a reconciliation schedule for this purpose.Section 5 of SEC MC 11-2008 enumerates the unrealized items that shall be considered as notavailable for dividend declaration.

Consensus

The deemed cost adjustment can be categorized under SEC MC 11-2008 as an unrealized itemunder the group “Other unrealized gains or adjustments to retained earnings brought about bycertain transactions accounted for under the PFRS.” Examples of which are as follows: accretionincome under PFRS 9, Financial Instruments, day 1 gains on initial recognition of financialinstruments, reversal of revaluation increment to retained earnings, and the negative goodwill oninvestments in associate. Consequently, retained earnings shall be reduced by the amount of theremaining balance of the deemed cost adjustment to arrive at retained earnings available fordividend declaration.

Effective Date


Date originally approved by PIC: October 20, 2011Date amendments approved by PIC: August 1, 2019


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PIC Members









Date originally approved by FRSC: January 25, 2012Date amendments approved by FRSC: August 14, 2019


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Q&A No. 2011 - 06 (amended July 2019): PFRS 3, BusinessCombinations (2008), and PAS 40, Investment Property – Acquisition ofinvestment properties – asset acquisition or business combination?

Issue

If one entity acquires (a) directly an investment property or properties or (b) another entity thatholds one or more investment properties, should the transaction be accounted for as an assetacquisition or as a business combination? What are the relevant factors that should be consideredin determining whether a transaction is an asset acquisition or a business combination?

Background and Guidance

Introduction

If one entity acquires (a) directly an investment property or properties or (b) another entity thatholds one or more investment properties, a careful evaluation or analysis on a case-by-case basisis needed to determine whether such acquisition constitutes a business as defined by PFRS 3. Inpractice, it may be difficult to decide whether the acquisition meets the definition of a businessand, accordingly, the exercise of considerable judgment may be required.This Q&A focuses solely on the question of how to assess whether the said transaction is anasset acquisition or a business combination. It does not address the accounting for the acquisitionof a subsidiary that is not a business, or the acquisition of a controlling interest of less than 100%in another entity that is not a business.

Rationale of the issue

Applying the definition of a business based on PFRS 3 to an investment property is not, however,always straightforward because:

unlike most non-financial assets, investment properties usually generate revenues on astand-alone basis (earning rentals being one of their defining characteristics – [PAS 40.5]),while most other non-financial assets generate returns only in combination with otherassets and liabilities;

in simple asset acquisitions, no obligations or activities are acquired. However, investmentproperties are often acquired with tenants. Tenants’ leases usually include related serviceobligations. Servicing activities along with others, such as rent collection, can be regardedas integral to an investment property asset.


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It is common for a single investment property to be held in a separate legal entity and for apurchaser to acquire that entity rather than the property. By contrast, most asset acquisitions areeffected by acquiring the asset itself. Although acquiring a legal entity does not necessarilydetermine that a business combination has occurred, buying a legal entity brings with it all of theentity’s assets, liabilities, contractual agreements and obligations. In most cases, an asset orgroup of assets and liabilities that are capable of generating revenues, combined with all or manyof the activities necessary to earn those revenues, would constitute a business. However,investment property is a specific case in which generating earnings from the asset is one of thedefining characteristics. Such characteristic provides complexity in assessing an investmentproperty to constitute as a business following the definition of PFRS 3.

Implications: Business combination versus asset acquisition

The conclusion as to whether an acquired set of activities and assets is a business can lead tosignificantly different accounting results. If an acquired set of activities and assets does not meetthe definition of a business, the transaction is accounted for as an asset acquisition based on theprinciples described in other PFRS. There are many differences in the accounting for a businesscombination versus an asset acquisition, such as the following:

Goodwill or a gain on a bargain purchase arises only in a business combination. The initial measurement of assets acquired and liabilities assumed is generally at fair

value in a business combination versus allocated cost (on a relative fair value basis) in anasset acquisition.

Costs which are directly attributable to the acquisition are expensed in a businesscombination, but may be capitalized in an asset acquisition, to the extent that suchcapitalization does not result in an immediate impairment.

Deferred tax assets and liabilities arising on initial recognition are recognized in a businesscombination, but not in an asset acquisition.

Disclosures are much more onerous for business combinations than for asset acquisitions. Where the consideration is in the form of shares, PFRS 2 Share-based payment will apply

for an asset acquisition, but not for a business combination.

These differences not only will affect the accounting as of the acquisition date, but will also affectfuture amortization, depreciation and possible impairment. Accordingly, the conclusion as towhether a business has been acquired can have a significant effect on a company’s reportedfinancial position and financial performance.


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Review of related accounting literature: PAS 40 and PFRS 3

What is investment property?

The following definition of investment property is based on PAS 40.5.

“Investment property is property (land or a building – or part of a building – or both) held(by the owner or by the lessee under as a finance lease right-of-use asset) to earnrentals or for capital appreciation or both, rather than for:



Although the above definition of investment property seems relatively direct, in some practicalsituations, PAS 40.14 provides that judgment is needed to determine whether a property qualifiesas investment property.

What constitutes a business?

The terms “business combination” and “business” are defined in PFRS 3 Appendix A, Definedterms, as follows:

A business combination is “a transaction or other event in which an acquirer obtainscontrol of one or more businesses. Transactions sometimes referred to as “true mergers”or “mergers of equals” are also business combinations as that term is used under PFRS3.”

A business is “an integrated set of activities and assets that is capable of being conductedand managed for the purpose of providing a return in the form of dividends, lower costs orother economic benefits directly to investors or other owners, members or participants.”

On the other hand, paragraphs B5 to B12 of PFRS 3 Appendix B, Application guidance, provideguidance on identifying a business combination and the definition of a business as follows:

“B7 A business consists of inputs and processes applied to those inputs that have the ability tocreate outputs. Although businesses usually have outputs, outputs are not required for anintegrated set to qualify as a business. The three elements of a business are defined asfollows:


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(a) Input: Any economic resource that creates, or has the ability to create, outputs whenone or more processes are applied to it. Examples include non-current assets(including intangible assets or rights to use non-current assets), intellectual property,the ability to obtain access to necessary materials or rights and employees.

(b) Process: Any system, standard, protocol, convention or rule when applied to input orinputs, creates or has the ability to create outputs. Examples include strategicmanagement processes, operational processes and resource management processes.These processes typically are documented, but an organized workforce having thenecessary skills and experience following rules and conventions may provide thenecessary processes that are capable of being applied to inputs to create outputs.(Accounting, billing, payroll and other administrative systems typically are notprocesses used to create outputs.)

(c) Output: The result of inputs and processes applied to those inputs that provide orhave the ability to provide a return in the form of dividends, lower costs or othereconomic benefits directly to investors or other owners, members or participants.”

B8 (in part) However, a business need not include all of the inputs or processes that the seller usedin operating that business if market participants are capable of acquiring the businessand continuing to produce outputs, for example, by integrating the business with theirown inputs and processes.

B12 In the absence of evidence to the contrary, a particular set of assets and activities inwhich goodwill is present shall be presumed to be a business. However, a businessneed not have goodwill.”

Paragraph B10 of PFRS 3 Appendix B provides some factors, which are shown below, to beconsidered when determining whether an integrated set of activities and assets in thedevelopment stage is a business, although not all of these factors need to be present for aparticular set of activities and assets to be considered a business.

Planned principal activities have begun. There are employees, intellectual property and other inputs and there are processes that

could be applied to those inputs. A plan to produce outputs is being pursued. There will be an ability to obtain access to customers who will purchase the outputs.

What constitutes an asset acquisition?

PFRS 3.2(b) provides that if an entity acquires an asset or a group of assets, including anyliabilities assumed, that does not constitute a business, then the transaction is outside the scopeof PFRS 3 because it does not meet the definition of a business combination. Such transactions


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are accounted for as asset acquisitions, in which case, the cost of acquisition is allocated betweenthe individual identifiable assets and liabilities in the group based on their relative fair values at theacquisition date.

Consensus

If one entity acquires (a) directly an investment property or properties or (b) another entity thatholds one or more investment properties, then such transaction should be accounted for inaccordance with its substance. Depending on the facts and circumstances of each transaction,the acquisition will be accounted for as either a business combination or an asset acquisition. Theconsensus of this Q&A sets out the indicators that should be considered in making this decision.

Application of the definitions of a business combination and a business

In applying the PFRS 3 definitions of a business combination and a business to the acquisition ofan entity that holds one or more investment properties or to a direct acquisition of an investmentproperty, the acquirer should first identify the elements acquired; i.e., the inputs, processes andoutputs. In the context of investment property businesses (excluding developers and traders):

inputs are the property itself; processes are discussed in more detail below and could be ancillary type processes or

more strategic type processes; and outputs are the leases from which rental income is generated.

The existence of inputs and outputs alone (for example, the acquisition of a single tenantproperty) would not lead to a business combination. Furthermore, if the “processes” in aninvestment property business were insignificant to the arrangement as a whole, then this shouldnot in isolation cause the transaction to be a business combination. This is consistent with PAS40.11 which provides that if an entity provides ancillary services to the occupants of a propertythat it holds and such services are insignificant to the overall arrangement, then such propertyshould be treated as investment property.

Therefore, where only some processes are transferred to the acquirer, PAS 40 would lead to anassessment as to how significant the processes or services are relative to the acquiredinvestment property needed for the set of assets and activities to be a business. However, if theacquired set of assets and activities has no processes (e.g., only investment properties, and noactivities, were acquired), the acquired set of assets and activities, in most cases would notconstitute a business. Accordingly, such fact should be appropriately disclosed in the acquirer’sfinancial statements. In addition, the acquirer should disclose the reason for treating the


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transaction as an asset acquisition. All of the specific facts and circumstances must be consideredin applying this highly subjective judgment.

Indicators

In general, in making the determination of whether an entity’s acquisition of another entity thatholds one or more investment properties or a direct acquisition of an investment propertyconstitutes a business or not, there should be consideration as to whether or not propertymanagement services and/or ancillary services were acquired and the nature of these services.It is important to note that investment property transactions vary significantly in terms of the natureof the underlying assets and the service provision contracts that are acquired and it is not possibleto define a trigger point at which the transaction becomes a business combination as opposed toan asset acquisition.

However, there is a scale within which investment property transactions fall. At one end is asimple single-tenant property for which no services are included. At the other end of the scale isan investment property company.

The table below sets out the processes that can be viewed as purely administrative and would notindicate the acquisition of a business and those that are more strategic and may indicate that abusiness has been acquired. The table, however, is not an exhaustive list of the items or factorsthat should be considered. The facts and circumstances of each transaction must be considered.

Indicators of business combination Not necessarily indicators of businesscombination on their own

Substantive processes and/or servicesacquired/provided:

Lease management (rent reviews,negotiation of terms)

Selection of tenants Investment decisions Management of common areas to

promote increased footfall (forexample, themed evenings,marketing)

Marketing decisions

Administrative processes and/or ancillaryservices acquired/provided:

Security Cleaning Rent collection/invoicing Caretaker

In making the above analysis, the legal form of the acquisition should not change its substance.The acquisition of an investment property or properties for which no services are acquired orprovided does not become a business combination simply because it is effected using a


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“corporate shell.” Similarly, a business combination should not be accounted for as an assetacquisition simply because the acquiring entity purchases a series of assets rather than acompany.

See Appendix for the illustrative applications of the above indicators.

Effective Date

The consensus in and amendment to this Q&A is are effective from the date of approval by theFRSC.



PIC Members




Sharon G. Dayoan Rufo R. Mendoza




Date originally approved by FRSC: April 25, 2012



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Appendix

The application of the factors (indicators) discussed in the Q&A to certain transactions isillustrated in the following examples.

In the following examples, property investment company A acquires company B, an entity whoseonly activity is to hold and administer investment property assets. Is the acquisition a businesscombination or the acquisition of an asset (or assets)?

Example 1 - single property, no tenants or services.

B holds a single investment property. The property has no tenants. B has no staff and does notundertake any services.

Analysis

This is an asset acquisition. Company B is not revenue-generating, and no activities have beentransferred to company A.

Example 2 - single property with tenants

B holds only a single investment property. The property has tenants subject to rental agreementsbut no support services or contracts are transferred when B is acquired.

Analysis

This is also an asset acquisition. The acquired entity is revenue-generating, but no activities havebeen transferred to company A. Although the rental agreements are likely to contain servicingobligations, company A has not acquired any actual activities.

Example 3 - single property with tenants and services

B holds a single investment property. The investment property has tenants subject to rentalagreements. Certain outsourced service contracts associated with obligations contained in therental agreements are also transferred.


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Analysis

This is also an asset acquisition. In this case, support services have been transferred, eventhough they will be performed by external providers. However, these services are purely ancillaryto the property and its lease agreements. Activities ancillary to earning rentals are not consideredas processes that are used to create output and are given a lower weighting in deciding onclassification. However, business combination accounting is also acceptable in this scenario, ifsuch a policy is applied consistently by A in all similar transactions. This is because it would notbe inconsistent with PFRS 3 definitions to conclude that this scenario amounts to acquisition of abusiness.

Example 4 - multiple properties, tenants, services and staff

B holds 8 investment properties. The investment properties have tenants subject to rentalagreements. B also employs several staff dedicated to the property management, the provision ofservices included in the rental agreements and administration such as invoicing, cash collectionand management reporting.

Analysis

This is a business combination. B appears to have many of the capabilities associated with astandalone business (even if it was in fact a subsidiary). It is also questionable that certaintransferred activities, such as management reporting, are purely ancillary to the properties.Further, although B holding a portfolio of properties is not necessarily decisive in indicating abusiness combination this factor (i) makes it less likely that all of the services/activities transferredare specifically ancillary to individual properties; and (ii) meets the "group of assets" part of thePFRS 3 Appendix A definition. Also, the fact that staff have transferred to A suggests that A mighthave acquired employee-related obligations. However, asset acquisition accounting may also beacceptable if activities/services/staff transferred are ancillary to the portfolio as a whole, and sucha policy is applied consistently by A in all similar transactions.

Example 5 - multiple properties, tenants, services and management

Facts as in scenario 4 but the transferred staff also include managers responsible for portfoliomanagement, raising finance and marketing.


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Analysis

This is a business combination. Company A has acquired a group of revenue-generating assetsalong with various staff and activities that clearly go beyond activities ancillary to the propertiesand their tenancy agreements.


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Q&A No. 2012 – 02 (amended July 2019): Cost of a new buildingconstructed on the site of a previous building

Relevant PFRS


Issue





(d) Owner-occupied property (or part of property, plant and equipment);

(e) Sold in the ordinary course of the entity’s business (or as part of inventories); or

(f) Held to earn rentals or for capital appreciation (or as part of investment property).




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(d) used as an owner-occupied property, which is within the scope of Philippine AccountingStandard (PAS) 16, Property, Plant and Equipment;

(e) sold in the ordinary course of the entity’s business, which is within the scope of PAS2, Inventories; or

(f) held to earn rentals or for capital appreciation, which is within the scope of PAS40, Investment Property.








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Scenario 1(c) If the land and building will be subsequently measured using the fair value model,the land and building will be classified as one item under Investment Property. If thesubsequent measurement of the property will be made using the cost model, theland and building will be classified as two separate items under Investment Propertyat their allocated cost determined using the relative fair value.

Scenario 2(a), 2(b) and 2(c) As the entity, at date of acquisition, has decided to initially use theproperty as owner-occupied property, the land and building will be classified as twoseparate items under Plant, Property and Equipment measured at their allocatedcost determined using the relative fair value method.

Elements of cost




(d) its purchase price, including import duties and non-refundable purchase taxes, afterdeducting trade discounts and rebates.

(e) any costs directly attributable to bringing the asset to the location and condition necessaryfor it to be capable of operating in the manner intended by management.

(f) the initial estimate of the costs of dismantling and removing the item and restoring the siteon which it is located, the obligation for which an entity incurs either when the item isacquired or as a consequence of having used the item during a particular period forpurposes other than to produce inventories during that period.


(g) costs of employee benefits (as defined in PAS 19, Employee Benefits) arising directly fromthe construction or acquisition of the item of property, plant and equipment;


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(h) costs of site preparation;

(i) initial delivery and handling costs;

(j) installation and assembly costs;

(k) costs of testing whether the asset is functioning properly, after deducting the net proceedsfrom selling any items produced while bringing the asset to that location and condition(such as samples produced when testing equipment); and

(l) professional fees.”




“12 The costs of conversion of inventories include costs directly related to the units of production,such as direct labor. They also include a system allocation of fixed and variable productionoverheads that are incurred in converting materials into finished goods.



“20 An owned investment property shall be measured initially at its cost. Transaction costsshall be included in the initial measurement.


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Consensus




PAS 16 does not include any explicit guidance on whether the allocated cost or carrying value ofan old building that will be demolished is part of the cost of the replacement building.Nevertheless, it is viewed that the allocated cost, if any, of the old building to be demolished is nota cost directly attributable to the new building as provided in PAS 16.16 (b) and PAS 16.17 citedearlier. Therefore, the allocated cost of the old building shall not form part of the cost of the newbuilding. Also, since the old building will not be used, hence, no further economic benefits areexpected from its use, the allocated cost of the old building should be derecognized as requiredunder PAS 16.67 and the loss arising from derecognition is included in profit or loss as requiredunder PAS 16.68.



The cost of inventories under PAS 2.10 cited earlier is a somewhat lower threshold than the costof an item of property, plant and equipment under PAS 16. For example, the cost of inventoriesunder PAS 2.10 need not be directly attributable. Accordingly, it is appropriate for the acquiringentity or property developer to include any cost allocated to the old building as part of the cost ofthe new building or development property that will be sold as an inventory.


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Scenario 1(c): New building will be held as an investment propertyProperty (land or a building—or part of a building—or both) held (by the owner or by the lesseeunder a finance lease) to earn rentals or for capital appreciation or both is within the scope of PAS40.


Under Scenario 2

Under Scenario 2, the entity acquired the property in a prior reporting period and initially used theproperty as an owner-occupied property. In the current reporting period, it decided to demolish theold building and replace it with a new building.



Applying the above principles, the entity, at the time it makes the decision to demolish the oldbuilding at a specific date in the future, has to recompute the related depreciation charges on thebuilding to depreciate the remaining carrying value of the building over the remainder of its life (orthe remaining period before it is demolished). Hence, the old building will have a nil value at thedate of the planned demolition.


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(c) the carrying value of the old building represents the un-depreciated cost of the old buildingrather than a cost incurred in the construction of the new building; and

(d) the demolition of the old building is regarded as similar to a disposal for zero proceeds.






Effective Date

The consensus in and amendment to this Q&A is are effective from the date of approval by theFRSC.



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PIC Members








Date originally approved by FRSC: June 11, 2013



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Q&A No. 2017 – 02 (amended July 2019): Capitalization of operatinglease cost depreciation of right-of-use asset as part of construction costsof a building

Issue

Do operating lease costs (i.e., rentals or amortization of lease prepayments) Doesdepreciation of right-of-use asset constitute part of the cost of:




Fact Pattern


On January 1, 20X0, an entity enters into an operating a 20-year lease of land for a term of 20years. Under the lease agreement, the entity makes an initial upfront payment of P1,000 andpays rent of P200 quarterly in advance. The entity intends to construct a building on the land and,as part of its ordinary business activities, plans to sell the building once construction is completed.



1 In the absence of such intent, there may arise an issue of whether there is an onerous contract for the remaining lease term whichwill have to be assessed under PAS 37, Provisions, Contingent Liabilities and Contingent Assets, and; or once PFRS 16 takeseffect under which a right of use asset will have to be recognized by the lessee, such right-of-use asset will have to be assessedunder PAS 36, Impairment of Assets for possible impairment. Moreover, in the absence of such an intent (i.e., no subsequent sub-lease arrangement to the buyer of the building), there may be a need to assess if the selling price of the building contains an elementintended to cover for the cost of future rentals which may have to be accounted for separately under PFRS 15, Revenue fromContracts with Customers.


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Scenario 1

View 1: Capitalize as part of construction costs




Paragraph 15 12 of PAS 2 states:

“Other The costs are included in the cost of conversion of inventories only include costsdirectly related to the extent units of production, such as direct labor. They also include asystematic allocation of fixed and variable production overheads that they are incurred inbringing the inventories to their present location and condition. [...]” converting materialsinto finished goods. Fixed production overheads are those indirect costs of productionthat remain relatively constant regardless of the volume of production, such asdepreciation and maintenance of factory buildings, equipment and right-of-use assetsused in the production process, and the cost of factory management and administration[…]”


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As the entity enters into the lease with the intention of constructing the building, the lease costsdepreciation of right-of-use asset incurred during the construction period are "costs thatare should be capitalized as part of the construction costs of the building because it wasincurred in bringing the inventories to their present location and condition.

View 2: Expense as incurred

The operating lease expenses are for the right to control the use of the leased asset (i.e.,the land). As there is no distinction between the right to use a leased asset during theconstruction period and the right to use that asset after the construction period, an entityrecognizes the operating lease costs as an expense. That is, because the lease paymentsare not incremental, and must be paid regardless of whether the building is constructed,they cannot be a direct cost of the asset.

Scenario 2

View 1: Capitalize as part of construction costs




However, there are additional arguments that support the capitalization of rental expenseincurred during the construction period:

Rent Depreciation of right-of-use asset is a directly attributable cost in the terms ofparagraph 16(b) of PAS 16, which states that the cost of property, plant and equipmentcomprises (among other things):


In particular, in the scenario indicated, rent depreciation of right-of-use asset is anunavoidable cost of developing the property, because without. Without this lease noconstruction can occur. Consequently, depreciation of right-of-use asset incurred during


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the construction period should be capitalized as part of the construction costs of thebuilding.

View 2: Expense as incurred

Refer to View 2 set out for Scenario 1 - operating lease expenses are not a directlyattributable cost in terms of paragraph 16(b) of PAS 16, as the entity will have incurredthese expenses anyway, irrespective of whether construction of the building started.Therefore, these costs are not capitalized as part of the construction cost of the building.

Since paragraph 22 of PAS 16 refers to PAS 2, whichever policy is selected it theaccounting treatment for cost capitalization must be applied consistently to transactions ofthe type described in both Scenario 1 and Scenario 2.

Scenario 3

Refer to the reasons for conclusion provided for the Scenarios 1 and 2 above; therefore, inprinciple, there are arguments that support both accounting policies – capitalizing ORexpensing operating lease payments.

However, Take note that in this scenario there are additional arguments for expensingoperating lease payments. Under this scenario, lease payments are for the right to usethe existing building itself (whereas in Scenarios 1 and 2, the building does not yet exist).The way in which an entity uses a building, for example, by making leaseholdimprovements or by using the building in its current state, does not affect the expensesincurred for the right to use it. If one follows this argument, the entity recognizes thecosts for the operating lease as expenses as incurred. However, in this case, the buildingmust be vacant while the leasehold improvements are made, which. This provides additionalargument to support for the capitalization of the lease costs depreciation of right-to-use assetduring the period in which the building is not being used. Capitalization of depreciation ofright-to-use asset in the carrying amount of the leasehold improvements commencesonce the entity starts making the improvements and ceases once the improvements arein the location and condition necessary for them to be capable of operating in themanner intended by management.



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“Recognition of costs in the carrying amount of an item of property, plant and equipmentceases when the item is in the location and condition necessary for it to be capable ofoperating in the manner intended by management […]”

Accordingly, either accounting policy is permitted but must be applied consistently.


The consensus in this Q&A is effective from the date of and transition provision of thisQ&A follow those of PFRS 16, Leases, Appendix C, upon approval by the FRSC.



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Q&A No. 2017 – 10 (amended July 2019): PAS 40 - Separation ofproperty and classification as investment property

Issues

1. How should paragraph 10 of PAS 40, Investment Property “… could be soldseparately…” interpreted?

2. If separation does not occur prior to the sale of property/assignment of a lease,does this prevent a portion of a property that otherwise meets the definition ofinvestment property in PAS 40 being so treated?

3. Does the intention to lease, or the action of leasing, out a portion of a propertyunder an operating rather than a finance lease prohibit the application ofPAS 40?

Fact Pattern

Scenario 1

A property is used partly to derive rental income and partly as owner-occupied property.For example, in an office tower, one could sub-divide the floors and sell individualportions. Similarly with industrial/commercial property, an owner could sub-divide andsubsequently sell some portions and retain others for own use.

Scenario 2

Properties that are physically sub-divided into different portions (for example differentfloors) are registered as one single property with the Land or Property registry, andneed to be legally sub-divided before a portion can be disposed of. Often, these legalproceedings are undertaken only at the point of sale of that portion of, or theassignment of a lease on that portion of, the property concerned. At the end of thereporting period, the legal sub-division has not occurred.

Scenario 3

Portions of a property are leased out under operating leases.


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Consensus

Scenario 1

To separately account for the portions of a property (part as an investment property andpart as property, plant and equipment), the property must be in a state and condition toenable it to be disposed of separately at the end of the reporting period.

Scenario 2

The fact that a property could be divided in future periods if the owner so chose isinsufficient to conclude that the portions can be accounted for separately. If the propertyrequires sub-division before the portions could be disposed of separately, then thoseparts are not accounted for separately until such sub-division occurs.

It seems clear that ‘separately’ needs to be assessed both in terms of the ‘physical’separation (e.g., mezzanine floors and partitioning walls) of the property and to ‘legal’separation (e.g., legally defined property boundaries and/or registered separately).

Judgement is required to determine whether the legal separation is a substantiverequirement that will restrict it being currently separable or whether it is a non-substantive requirement where it is currently separable.

Scenario 3

The intention to lease out a portion of a property, or the action of leasing out a portion ofa property, under an operating lease does not prohibit the application of PAS 40 to thatportion. However further assessment of the facts and circumstances are needed.

Basis for Consensus

Scenario 1

If a literal interpretation of paragraph 10 of PAS 40 were applied, almost any portions orelement of property would be capable of separate classification and, arguably, therestriction in paragraph 10 of PAS 40 would be mostly irrelevant.


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Paragraph 5 of PAS 40 defines investment property as:

“property (land or a building-or part of a building-or both) held (by the owner or by thelessee under as a finance lease right-of-use asset) to earn rentals or for capitalappreciation or both, rather than for:



Further, paragraph 10 of PAS 40 states:

"Some properties comprise a portion that is held to earn rentals or for capitalappreciation and another portion that is held for use in the production or supply of goodsor services or for administrative purposes. If these portions could be sold separately (orleased out separately under a finance lease), an entity accounts for the portionsseparately. If the portions could not be sold separately, the property is investmentproperty only if an insignificant portion is held for use in the production or supply ofgoods or services or for administrative purposes."

Scenario 2

For the requirements in paragraph 10 of PAS 40 to be relevant to the decision toseparately classify portions of a property, it is believed that the interpretation of ‘couldbe sold separately’ must be assessed by reference to the asset’s present state andcondition. Consequently, if the property requires sub-division before the portions couldbe disposed of separately, then those parts are not accounted for as separate portionsuntil such sub-division occurs.

If the entity owning the property could not be prevented from legally sub-dividing theproperty then the property is already in a condition to be sold separately and this wouldnot prevent the portion of the property concerned being accounted for as investmentproperty.

This would be case where, for example: the process of sub-dividing the property wasentirely within the control of the entity and did not require permission from a third party(which would include the relevant authorities); or if permission from a third party wasrequired, this was no more than a formality.


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Conversely, if the entity was required to obtain the permission of third parties beforelegally sub-dividing the property, and such permission could be withheld, the portions ofthe property concerned are not accounted for separately until such sub-division occurs.

Therefore, if the portion of the property concerned otherwise meets the definition ofinvestment property at the end of the reporting period, judgment is required to assessthe legal position of the property in determining whether it is appropriate to account for aportion separately under PAS 40.

Scenario 3

Paragraph 10 of PAS 40 states that if portions could be

“…sold separately (or leased out separately under a finance lease)…”

they are accounted for separately. An intention to lease, or the action of leasing out aportion of a property under an operating lease is prima facie evidence that, if it sowished, the entity could also lease out the property under a finance lease – thedifference between the two commonly being just the length of the lease.

If, however, there is evidence that the property could not be leased out under a financelease, then PAS 40 could not be applied to that portion.

Effective Date

The consensus in and amendment to this Q&A is are effective from the date ofapproval by the FRSC.

Date originally approved by PIC: June 28, 2017Date amendment approved by PIC: August 1, 2019


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Q&A No. 2018 - 05 (amended July 2019): PAS 37 - Liability arisingfrom maintenance requirement of an asset held under a lease

Issue

If an entity is required to return an asset under a lease in the same condition as at itsinception, does the entity recognize a liability for this obligation?

Fact pattern

An entity in the airline industry leases an aircraft. The requirements of the lease aresuch that the lessee is obliged to maintain the airworthiness of the aircraft.Airworthiness requirements for the airline industry are the same whether the entity ownsor leases the aircraft. The lease requires the entity to return the aircraft in the samecondition as at inception of the lease.


Paragraph 10 of PAS 37, Provisions, Contingent Liabilities and Contingent Assets,defines as the following:

"[a provision is] a liability of uncertain timing or amount, [a liability is] a presentobligation of the entity arising from past events, the settlement of which is expected toresult in an outflow from the entity of resources embodying economic benefits".

Paragraph 19 of PAS 37 states that an entity only recognizes those obligations arisingfrom past events that exist independently of an entity’s future actions (i.e., the futureconduct of its business).

Examples of such obligations are penalties or clean-up costs for unlawful environmentaldamage, both of which lead to an outflow of resources embodying economic benefits insettlement, regardless of the future actions of the entity. Similarly, an entity recognizes aprovision for the decommissioning costs of an oil installation or a nuclear power stationto the extent that the entity is obliged to rectify damage already caused.

An example similar to the issue described above is the situation whereby propertyleases often contain clauses that specify that the tenant must pay for maintenance,dilapidations, or other damage occurring during the rental period. Therefore, an entity


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recognizes a provision for specific damage or alteration to the property when the eventcreating the obligation under the lease occurs. Hence, if an entity erects partitioning,and under the lease the entity must remove the partitioning at the end of the lease, thenthe entity recognizes a provision for these costs at the time of the partitioning.

The fact that an entity recognizes a provision for repairs when leasing an asset mightappear inconsistent with the fact that an entity may not recognize a provision for repairswhen the entity owns an asset. There is, however, a difference between the two cases.If the entity owns the asset, it chooses whether to sell or repair the asset. Therefore,when an entity owns an asset, the obligation is dependent of the entity’s future actions.However, for an entity leasing an asset, the entity is legally obliged to repair anydamage under the terms of the contract.

Consensus

Yes. The overhaul and maintenance of an asset is a contractual obligation under thelease. The specific event that gives rise to the obligation is each flown hour or cyclecompleted by the aircraft as these determine the timing and nature of the overhaul thatmust be carried out. Provision should therefore be made for the costs of overhaul as theobligation towards the lessor arises (typically based upon the specific requirements ofeach aircraft type such as each flown hour or cycle), with a corresponding expenserecognized in the statement of comprehensive income.

For certain aircraft types and aircraft leases, it is likely that the provision for the costs willbe built up and then released, as the expenditure is incurred, a number of times during theterm of the operating lease.


The consensus in and amendment to this Q&A is are effective from the date of theapproval by the FRSC.

Date approved by PIC: January 31, 2018Date amendment approved by PIC: August 1, 2019


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Q&A No. 2018 – 15 (amended July 2019): PAS 1- Classification ofAdvances to Contractors in the Nature of Prepayments: Current vs.Non-current

Background:Companies usually make advance payments to suppliers or sellers of goods and/orservices. These advances are non- financial assets in nature as these will be fulfilled bydelivery of goods and/or services. These advances, in effect, are in the nature ofprepayments. Examples of advances in the nature of prepayments are advances tocontractors for the construction of (a) real estate properties intended for sale (i.e., heldas inventory); (b) property and equipment; and (c) investment properties.

Issue: How should these advances to contractors in the nature of prepayments beclassified in the statement of financial position?

DiscussionView 1. Treatment will follow the classification of the asset to which the advancespertain to.Under PAS 1.66, an entity shall classify an asset as current when it expects to realizethe asset, or intends to sell or consume it, in its normal operating cycle. PAS 1.68defines operating cycle as the time between the acquisition of assets for processing andtheir realization in cash or cash equivalents. When the entity’s normal operating cycle isnot clearly identifiable, it is assumed to be twelve months. PAS 1.68 further states thatcurrent assets include assets (such as inventories and trade receivables) that are sold,consumed or realized as part of the normal operating cycle even when they are notexpected to be realized within twelve months after the reporting period.

Applying, the above PAS 1 guidance, advances in the nature of prepayments shall beclassified as follows:

Current - If the advances to contractors will be applied as payments for construction ofassets to be classified as inventories;


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Noncurrent – If the advances to contractors will be applied as payments for constructionof assets to be classified as property, plant and equipment and investment properties.

View 2. Current for advances expected to be applied against progress billings forthe next 12 months, otherwise, these are presented as noncurrent.

Still in reference to PAS 1.66, the realization date is construed to be the timing whenthese advances are applied against billings or timing of delivery of goods and/services.Using the examples above, advances to contractors expected to be applied againstprogress billings for the next 12 months are classified as current, otherwise, these arepresented as noncurrent.

Consensus:View 1. The advances to contractor account is a temporary account. The eventualrealization of such advances is determined by the usage/realization of the asset towhich it was advanced for.

Effective Date

The consensus in this Q&A is effective from the date of approval of the FRSC andshould follow the provisions under PAS 8, Accounting Policies, Changes in AccountingEstimates and Errors.

Date approved by PIC: June 27, 2018Date amendment approved by PIC: August 1, 2019


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Jerome Antonio B. Constantino Lovely M. Del AmenDate approved by FRSC: October 10, 2018Date amendment approved by FRSC: August 14, 2019


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REFERENCES (Amended July 2019)PAS 1.60An entity shall present current and non-current assets, and current and non-currentliabilities, as separate classifications in its statement of financial position in accordancewith paragraphs 66–76 except when a presentation based on liquidity providesinformation that is reliable and more relevant. When that exception applies, an entityshall present all assets and liabilities in order of liquidity.

PAS 1.61Whichever method of presentation is adopted, an entity shall disclose the amountexpected to be recovered or settled after more than twelve months for each asset andliability line item that combines amounts expected to be recovered or settled:

(c) no more than twelve months after the reporting period, and(d) more than twelve months after the reporting period.

PAS 1.66An entity shall classify an asset as current when:(a) it expects to realise the asset, or intends to sell or consume it, in its normal operatingcycle;(b) it holds the asset primarily for the purpose of trading;(c) it expects to realise the asset within twelve months after the reporting period; or(d) the asset is cash or a cash equivalent (as defined in PAS 7) unless the asset isrestricted from being exchanged or used to settle a liability for at least twelve monthsafter the reporting period.


PAS 1.68The operating cycle of an entity is the time between the acquisition of assets forprocessing and their realisation in cash or cash equivalents. When the entity’s normaloperating cycle is not clearly identifiable, it is assumed to be twelve months. Current

https://live.atlas.ey.com/#document/522058/pid85743532-522058?pref=20052/9/1007&crumb=2/549663


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assets include assets (such as inventories and trade receivables) that are sold,consumed or realised as part of the normal operating cycle even when they are notexpected to be realised within twelve months after the reporting period. Current assetsalso include assets held primarily for the purpose of trading (examples include somefinancial assets that meet the definition of held for trading in PFRS 9) and the currentportion of non-current financial assets.

PAS 2.6Inventories are assets:(a) held for sale in the ordinary course of business;(b) in the process of production for such sale; or(c) in the form of materials or supplies to be consumed in the production process or inthe rendering of services.

PAS 16.6Property, plant and equipment are tangible items that:(b) are held for use in the production or supply of goods or services, for rental to others,

or for administrative purposes; and(b) are expected to be used during more than one period.

PAS 40.5Investment property is property (land or a building—or part of a building—or both) held(by the owner or by the lessee under as a finance lease right-of-use asset) to earnrentals or for capital appreciation or both, rather than for:(b) use in the production or supply of goods or services or for administrative purposes;

orsale in the ordinary course of business.


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Q&A No. 2009 – 01 (amended June 2020): Framework 3.94.1 and PAS1.25 - Financial statements prepared on a basis other than goingconcern

Issue 1

Are financial statements that are prepared on a basis of accounting other than a going concernbasis, which may sometimes be referred to as a liquidation basis, in compliance with PhilippineFinancial Reporting Standards (PFRS)?

Background

Paragraph 3.94.1 of The Conceptual Framework for Financial Reporting states that financialstatements are normally prepared on the assumption that an entity is a going concern andwill continue in operation for the foreseeable future. Paragraph 25 of PAS 1, Presentationof Financial Statements, states that financial statements shall be prepared on a going concernbasis unless management either intends to liquidate the entity or to cease trading, or has norealistic alternative but to do so.

Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtailmaterially the scale of its operations. If such an intention or need exists, the financial statementsmay have to be prepared on a different basis and, if so, the basis used is disclosed.

Paragraphs 14 to 15 of PAS 10 (revised 2010), Events after the Reporting Period, providesthat if the going concern assumption is no longer appropriate, the effect is so pervasive thatthe Standard requires a fundamental change in the basis of accounting, rather than anadjustment to the amounts recognized within the original basis of accounting.

If management of an entity has the intention, needs to liquidate or curtails materially the scaleof its operations, then the financial statements will have to be prepared on a basis which is otherthan a going concern basis, sometimes referred to as a liquidation basis.

Given appropriate disclosure as to the basis of accounting in a set of financial statementsprepared on a basis other than going concern, is it appropriate for management to make anexplicit and unreserved statement of compliance with PFRS in the notes to financial statements?

Consensus

Yes, financial statements prepared on a basis other than going concern can be in compliancewith PFRS if the financial statements comply with all the requirements of PFRS, including therelevant PFRS guidance for the measurement of assets, liabilities and equity and recognition ofincome, expenses, gains and losses. For example:


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Non-current assets that are not carried at fair value and are intended for sale should bemeasured using the principles in PFRS 5, Non-current Assets Held for Sale andDiscontinued Operations.

Assets that are carried at fair value should be accounted for under the relevant PFRS; forexample, PFRS 9, Financial Instruments, for financial assets and financial liabilities; PAS40, Investment Property, for investment properties.

Provisions for liabilities should be recognized and measured in accordance with PAS37, Provisions, Contingent Liabilities and Contingent Assets, (i.e., only when there is a presentobligation).

In addition, a complete set of financial statements as required under PAS 1.10 should bepresented and the minimum line items required to be included in each of the financialstatements, if applicable to the entity, should also be considered. An entity need not presenta statement of comprehensive income (or a statement of income and a statement of totalcomprehensive income) if it does not have any operations (both within and outside the normalcourse of business) during the period covered by the financial statements prepared on thebasis other than going concern. The non-presentation of such statement (assuming that otherincome items, if any, are not material), is consistent with the provision of paragraph 31 of PAS 1which allows that disclosures need not be provided if the information is not material. A disclosure,however, should be made in the notes to financial statements to clearly indicate the omissionof said statement as this information is useful for regulatory purposes (for instance, the SECallows an entity that has no operations for the last two years not to present an income statementas part of its financial statements).

Appropriate disclosures in accordance with paragraph 25 of PAS 1 should also be made todescribe the basis of accounting used in the preparation of the financial statements and its impacton the accounting policies selected. PAS 1 requires the following disclosures:




The financial statements would state that the financial statements are in compliance with PFRS.The change in the underlying basis to reflect that the entity is no longer a going concern wouldbe disclosed in the financial statements together with the impact on management’s selectionof accounting policies. This selection of accounting policies would depend on how managementexpects to recover the assets of the entity and settle its liabilities. These accounting policychanges would need to be permitted by and be in compliance with the relevant PFRS.




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The stockholders of XYZ Company approved a plan of liquidation on (date) . Accordingly, theCompany has changed its basis of accounting for periods subsequent to (date) , from thegoing-concern basis to the liquidation basis, whereby assets as of (reporting date) are presentedat estimated realizable values and liabilities, at estimated settlement amounts.


The financial statements of X Company have been prepared in accordance with PhilippineFinancial Reporting Standards, on the basis described above.If the entity qualifies as either a small entity or a medium-sized entity, the financial statementsprepared on a basis other than going concern can be in compliance with PFRS for Small Entitiesor PFRS for Small and Medium-sized Entities provided that the standards are applied in themeasurement of the assets, liabilities and equity and in the recognition of income, expenses,gains and losses of the entity. Appropriate disclosures should be made to describe the basis ofaccounting and its impact on the accounting policies selected.

Effective Date


Date originally approved by PIC: February 18, 2009Date amendments approved by PIC: June 30, 2020


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Date originally approved by FRSC: March 16, 2009Date amendments approved by FRSC: August 19, 2020


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Issue



Background



For inter-company loans within the scope of PFRS 9, both the lender and the borrower arerequired to initially record the loan at fair value (plus directly attributable transaction costs foritems that will not be measured at fair value through profit or loss subsequently) in accordance


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with PFRS 9.5.1.1.










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Consensus2. The treatment of the different types of inter-company loans in the books of the parent

company and subsidiaries are summarized as follows:









amount repayable









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Loans which meet the current classification under PAS 1.66, e.g.,those that are expected to be collected within 12 months after thebalance sheet date shall be classified as current, otherwise, as non-current.













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If the loan is expected to be repaid within a certain a certain periodof time, the classification of the loan would be the same asprovided in Item 1.b.


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Effective Date

The consensus in this Q&A is effective for annual financial statements beginning on or afterJanuary 1, 2012, the original effective date of this Q&A. The amendments to this Q&A areeffective for annual periods beginning on or after January 1, 202018, the effective date of PFRS9, Financial Instruments. Earlier application is encouraged.



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Q&A No. 2016-03 (amended June 2020): Accounting for CommonAreas and the Related Subsequent Costs by CondominiumCorporations


Background

Section 2 of R.A. 4726 The Condominium Act defines a “condominium” as an interest in realproperty consisting of separate interest in a unit in a residential, industrial or commercial buildingand an undivided interest in common, directly or indirectly, in the land on which it is located and inother common areas of the building. A condominium may include, in addition, a separate interest inother portions of such real property.

Title to the common areas, including the land, or the appurtenant interests in such areas, may beheld by a Condominium Corporation in which the holders of separate interest shall automatically bemembers or shareholders, to the exclusion of others, in proportion to the appurtenant interest oftheir respective units in the common areas. Whenever the common areas in a condominiumprojects are held by a condominium corporation, such corporation shall constitute the managementbody of the project. The corporate purposes of such a corporation shall be limited to the holding ofthe common areas.In current practice, the ownership of the land is not transferred to the Condominium Corporation.The Transfer Certificate of Title (TCT) is cancelled by the Registry of Deeds and they annotate themaster deeds of restrictions and separate Condominium Certificate of Titles (CCTs) are issued inreplacement of the TCT. The individual CCT shall be issued in the name of the original developerand then subsequently transferred to their buyers. The land description is no longer indicated in theDeed of Sale or CCT of the buyer but the project name and the master deed with declaration ofrestrictions and the unit number is always stated.For purposes of paying real property tax, a separate tax declaration is issued and theCondominium Corporation pays based on the assessed value or special assessment. Dependingon the policy of the Board of the Condominium Corporation, this may form part of the associationdues which is being paid by the unit owners on a monthly basis. Further, as part of theCondominium Corporation’s management of the common areas (including the land), it incurs majorexpenditures, the costs of which are collected from the unit owners through special assessment.This special assessment is being collected in advance from the unit owners and subsequentlydisbursed and paid to the suppliers as the major expenditures progress.


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In practice, the accounting for land and other common areas is not consistent amongCondominium Corporations. Some do not record the land and other common areas, while othersrecord these based on cost or appraised value.Another issue related to accounting for land and other common areas is the accounting for specialassessments. Special assessments are made by Condominium Corporations in order to financespecific projects.

The accounting for special assessments and the related expenditures differs among CondominiumCorporations. Some Condominium Corporations recognize these as revenues while others treatthese assessments as liability or equity.

Issue 1How should the Condominium Corporations account for the land and other common areas?

Consensus

Paragraph 5.14.37 of the Conceptual Framework discusses when an element (assets, liabilities,income, expenses) can be recognized in the financial statements. It indicated that “Recognition isthe process of incorporating in the balance sheet or income statement an item that meets thedefinition of an element and satisfies the criteria for recognition set out in paragraph 4.38. Itinvolves the depiction of the item in words and by a monetary amount and the inclusion of thatamount in the balance sheet or income statement totals. Items that satisfy the recognition criteriashould be recognized in the balance sheet or income statement. The failure to recognize suchitems is not rectified by disclosure of the accounting policies used nor by notes or explanatorymaterial.”

Under paragraph 4.38, “An item that meets the definition of an element should berecognized if:(a) it is probable that any future economic benefit associated with the item will flow to orfrom the entity; and(b) the item has a cost or value that can be measured with reliability.”

Paragraph 4.34(a) of the Conceptual Framework defines an asset as “a present economicresource controlled by the entity as a result of past events and from which future economicbenefits are expected to flow to the entity.” While PAS 16 Property, Plant and Equipmentparagraph 6 defines Property, plant and equipment as: “…tangible items that: (a) are held for use inthe production or supply of goods or services, for rental to others, or for administrative purposes;and (b) are expected to be used during more than one period.”

Paragraph 4.148 of the Conceptual Framework provides that: “An economic resource is a rightthat has the potential to produce economic benefits. For that potential to exist, it does not


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need to be certain, or even likely, that the right will produce economic benefits. It is onlynecessary that the right already exists and that, in at least one circumstance, it wouldproduce for the entity economic benefits beyond those available to all otherparties. The future economic benefit embodied in an asset is the potential to contribute,directly or indirectly, to the flow of cash and cash equivalents to the entity. The potentialmay be a productive one that is part of the operating activities of the entity. It may alsotake the form of convertibility into cash or cash equivalents or a capability to reduce cashoutflows, such as when an alternative manufacturing process lowers the costs ofproduction”

Paragraph 4.12 of the Conceptual Framework also states that “In many cases, the set of rightsarising from legal ownership of a physical object is accounted for as a single asset.Conceptually, the economic resource is the set of rights, not the physical object.Nevertheless, describing the set of rights as the physical object will often provide a faithfulrepresentation of those rights in the most concise and understandable way. In determiningthe existence of an asset, the right of ownership is not essential; thus, for example,property held on a lease is an asset if the entity controls the benefits which are expectedto flow from the property. Although the capacity of an entity to control benefits isusually the result of legal rights, an item may nonetheless satisfy the definition of anasset even when there is no legal control”

The definition of asset in the conceptual framework recognizes the fact that for an entity torecognize an asset, it must have control over the economic benefits expected to be derived fromsuch asset. Control over an asset is the ability of the entity to direct the use of the asset so as toobtain economic benefits. An entity has the right to direct the use of an asset if the entity can directhow and for what purpose the asset is used.

The Condominium Corporation cannot direct how and for what purpose the land and othercommon areas will be used. The decision as to how and for what purpose these common areas willbe used are made by the unit owners rather than the Condominium Corporation.

Furthermore, the ownership or the title over the common areas is not a requirement for an entity torecognize an asset; rather, as provided by paragraph 4.9 of the conceptual framework, “not all ofan entity’s rights are assets of that entity—to be assets of the entity, the rights must bothhave the potential to produce for the entity economic benefits beyond the economicbenefits available to all other parties… and be controlled by the entity. in assessingwhether an item meets the definition of an asset, liability or equity, attention needs to begiven to its underlying substance and economic reality and not merely its legal form ”Thus, regardless of whether the title of the land is transferred to the Condominium Corporation ornot, this is not essential in the determination of whether the common areas (including the land) is tobe recognized in the financial statements of the Condominium Corporation.


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Accordingly, Condominium Corporations should not recognize the land and other common areasas assets in its financial statements.

Issue 2How should the Condominium Corporations recognize the special assessments and thesubsequent expenditures?

ConsensusConsidering that the Condominium Corporation is a non-stock and non-profit entity, it shall needfunds to sustain its operations. Thus, as time and in such manner as the Condominium CorporationBoard may reasonably and necessarily determine, there shall be an assessment against each Unitowner proportionate to his or its appurtenant interest.

The Condominium Corporation Board, may from time to time, designate such amount or amountsto be collected from Unit owners as and by way of special assessment to cover such expendituresdeemed necessary but is not considered in the regular assessment such as major buildingimprovement projects approved by the Unit owners.

Revenue, as defined in Appendix A of PFRS 15, Revenue from Contracts with Customers, is theincome arising in the course of an entity’s ordinary activities, whereas income is defined by theConceptual Framework as increases in economic benefits during the accounting period in the formof inflows or enhancements of assets or decreases of liabilities that result in increases in equity,other than those relating to contributions from equity participants.

Considering that the special assessment is collected for specific purpose and will only be spent onsaid purpose, there will be no gross inflow of economic benefits to the Condominium Corporation.Thus, such could not be recognized as revenue. However, since the Condominium Corporationreceived cash from the unit owners, it has the liability to ensure that said cash is intact and will bespent on the purpose it is collected. In this regard, a liability should be recognized in the books ofthe Corporation and once spent, said liability will be reversed. Any excess from the cash receivedfrom the unit owners against the amount spent for special assessments will be reversed to equityas it represents an increase in equity relating to contributions from the unit owners as equityparticipants.

To illustrate, journal entries are as follows:Dr. Cash……………………………………P xxxxCr. Liabilities for Special Assessments.………….P xxxxTo record receipts of cash from unit owners.Dr. Liabilites for Special Assessments…..P xxxxCr. Cash……………………………………………..P xxxxTo record actual expenditures for special assessments.


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Q&A No. 2017 – 08 (amended June 2020): PFRS 10 – Requirement toprepare consolidated financial statements where an entity disposes ofits single investment in a subsidiary, associate or joint venture

Issue

Is an entity required to prepare consolidated financial statements if during the year itdisposes of its only subsidiary?

Background

Parent Company A (the reporting entity) has an investment in one subsidiary that itconsolidated in prior reporting periods. In the current reporting period, the entitydisposed of the investment. As a result, at the end of the reporting period, there is nogroup. Parent Company A does not meet the exemption in PFRS 10, ConsolidatedFinancial Statements, from preparing consolidated financial statements.

Parent Company A also issues separate financial statements prepared in accordancewith PFRSs, where it accounts for its investment in the subsidiary at cost.

Consensus

Parent Company A is required to present consolidated financial statements for thereporting period in which it has a subsidiary, regardless of whether or not it has anyinvestments in subsidiaries at the end of the reporting period.

Although Parent Company A is not a parent at the end of the reporting period, it was aparent during the reporting period. Paragraph B88 of PFRS 10 requires theconsolidated financial statements to include the income and expenses of a subsidiaryup to the date on which the parent ceases to control the same subsidiary.

Paragraph B98 of PFRS 10 also requires the gain or loss from loss of control of asubsidiary to be calculated based on the difference between the proceeds and thecarrying amounts of the assets and liabilities of the subsidiary at the date when controlis lost. The carrying amount as of the date of disposal reflects the income and expenseof the subsidiary during the reporting period. The gain or loss recognized on disposal inthe consolidated financial statements is therefore generally different from the gain orloss in the separate financial statements of Parent Company A.


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Paragraph OB121.12 of The Conceptual Framework for Financial Reporting states thatthe general purpose financial reports provide information about the effects oftransactions and other events that changed a reporting entity’s resources and claims.

A ‘reporting entity’ includes a group. The disposal of a subsidiary in any reporting periodis usually a significant transaction by the group in that period and therefore the effects ofthat transaction on the financial position and performance of the group are relevant.

This same principle applies to investments in associates or joint ventures when theseconstitute the only investments in group entities, and these investments are sold duringthe period.

Relevant guidance


“An entity includes the income and expenses of a subsidiary in the consolidatedfinancial statements from the date it gains control until the date when the entity ceasesto control the subsidiary. Income and expenses of the subsidiary are based on theamounts of the assets and liabilities recognized in the consolidated financial statementsat the acquisition date…”


“If a parent loses control of a subsidiary, it shall:

(a) derecognize:(i) the assets (including any goodwill) and liabilities of the subsidiary at their

carrying amounts at the date when control is lost; and(ii) the carrying amount of any non-controlling interests in the former subsidiary

at the date when control is lost (including any components of othercomprehensive income attributable to them).

(b) recognize:(i) the fair value of the consideration received, if any, from the transaction,

event or circumstances that resulted in the loss of control;(ii) …(iii) …


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(c) …(d) recognize any resulting difference as a gain or loss in profit or loss attributable to

the parent.

Paragraph OB121.12 of The Conceptual Framework for Financial Reporting states that“General purpose financial reports provide information about the financial position of areporting entity, which is information about the entity’s economic resources and theclaims against the reporting entity. Financial reports also provide information about theeffects of transactions and other events that change a reporting entity’s economicresources and claims. Both types of information provide useful input for decisions aboutproviding resources to an entity.”

Effective Date


Date approved by PIC: June 28, 2017Date amendments approved by PIC: June 30, 2020

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Q&A No. 2018 – 14 (amended June 2020): PFRS 15 - Accounting forCancellation of Real Estate Sales

Background Company X is a real estate developer and is in the business of pre-selling

condominium units while construction is not yet completed.


In January 20x1, Company X pre-sold a condominium unit at Php1,000,000,payable for 3 years on an installment basis1. Under the sale contract, legal title tothe unit remains with Company X until full payment is made by the buyer.

Estimated cost to construct the unit is Php800,000.

As at December 31, 20x1, POC of the unit is at 30% and collection from the buyeris 15% of the selling price (Php150,000). Amounts recognized in the calendar year20x1 financial statements follow:

In June 20x2, the buyer defaulted on its payment and Company X repossessed theproperty2. At the time of repossession, the property was 50% completed (i.e., atthat point, Company X has already recognized revenue of Php500,000 and cost ofsales of Php400,000). As agreed under the contract, Company X forfeits allpayments previously made by the buyer.



Amount in PhpReal Estate Revenue (1,000,000*30%) 300,000Cost of Real Estate Sales (800,000*30%) 240,000


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Issue 1 - How should Company X account for the sales cancellation and repossessionof the property?

Consensus:

Both Approaches 1 and 2 below are acceptable but each approach should be appliedconsistently.

Approach 1: The repossessed property is recognized at its fair value less cost torepossess

As the repossessed property will be accounted for as inventory, it will be initiallymeasured at cost under PAS 2.9. Cost as defined under the ConceptualFramework is the fair value of the consideration given at the time of acquisition. Inthis case, the consideration given in exchange for the property is the Receivablefrom the buyer. Just before the repossession happens, the Receivable has becomea right to receive the property, so the fair value of the Receivable is the fair value ofwhat Company X has claim to (i.e., the 50%-completed property) less any cost torepossess the property (e.g., broker’s fees and lawyer’s fees, etc.).

Just prior to repossession, Company X has to update its impairment assessment onthe Receivable. For example, if the fair value of the property to be repossessedless any repossession cost is higher than the carrying amount of the Receivable,then any previously recognized impairment on the Receivable has to be reversed(with reversal limited to the unimpaired amount).



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Upon repossession, the difference between the carrying amount of the Receivableto be derecognized and the fair value of the repossessed property lessrepossession cost will be recognized in profit or loss.

In the case at hand, the Receivable is unimpaired just prior to repossessionbecause the fair value less repossession cost of the property is Php545,000 and isgreater than the outstanding amount of the Receivable of Php350,000. Uponrepossession, a gain on repossession of Php195,000 will be recognized (Fair valueless repossession cost of Php545,000 less carrying amount of the Receivable ofPhp350,000). The repossession cost of Php5,000 will be capitalized as part of thecost of the repossessed property but subject to impairment.


Inventory 545,000Receivable 350,000Gain from repossession 195,000


Approach 2: The repossessed property is recognized at its fair value plusrepossession cost

As there is no specific guidance in PAS 2 on accounting for repossessed property,reference can be made to the guidance in PAS 16.24 and PAS 40.27 for propertyacquired in exchange for a non-monetary asset/s or a combination of monetary andnon-monetary assets. Under these paragraphs, the asset received (in this case,the uncompleted property) is recognized at fair value.

Just prior to repossession, Company X has to update its impairment assessment onthe Receivable. For example, if the fair value of the property to be repossessedless any repossession cost is higher than the carrying amount of the Receivable,


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then any previously recognized impairment on the Receivable has to be reversed(with reversal limited to the unimpaired amount).

Upon repossession, the difference between the carrying amount of the Receivableto be derecognized and the fair value of the repossessed property will berecognized in profit or loss. Any cost incurred to repossess the property will becapitalized in accordance with PAS 2.15.

In the case at hand, the Receivable is unimpaired just prior to repossessionbecause the fair value less repossession cost of the property is Php545,000 and isgreater than the outstanding amount of the Receivable of Php350,000. Uponrepossession, a gain on repossession of Php200,000 will be recognized (Fair valueof Php550,000 less carrying amount of the Receivable of Php350,000). Therepossession cost of Php5,000 will be capitalized as part of the cost of therepossessed property but subject to impairment.




Both Approaches 1 and 2 above should consider payments to buyers required underthe Maceda Law and the write off of any unamortized portion of cost of obtaining acontract in its determination of gain/loss from repossession.

Discussion:

The Committee deliberated on two other views observed in practice, as follows:

1. To record the repossessed property at the carrying amount of the receivablegiven up; and,

2. To record the repossessed property at its original carrying amount (i.e., itscarrying amount at the time it was sold) and recognize any difference between


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the carrying amount of the derecognized receivable and the repossessedproperty in profit or loss.

The Committee agreed that the first view is not acceptable as the use of the carryingamount of the asset given up is only allowed if the fair value of the either the assetreceived or the asset given up is not available. The second view also lacks merit as it isin effect an application of the accounting treatment for sales returns. Repossession ofreal estate inventory is not of the nature of sales return. In view of the above, theCommittee concluded that these two views are not acceptable.

Issue 2 - Would the accounting for the repossession change if the repossessedproperty is already 100% completed?

Consensus:



The effective date and transition provision of this Q&A follow those of PFRS 15Appendix C, upon approval by the FRSC.



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REFERENCES

PAS 2.9Inventories shall be measured at the lower of cost and net realizable value.

PAS 2.6Net realizable value is the estimated selling price in the ordinary course of business lessthe estimated costs of completion and the estimated costs necessary to make the sale.

Fair value is the price that would be received to sell an asset or paid to transfer a liabilityin an orderly transaction between market participants at the measurement date.(See PFRS 13 Fair Value Measurement.)

PAS 2.7Net realisable value refers to the net amount that an entity expects to realise from thesale of inventory in the ordinary course of business. Fair value reflects the price atwhich an orderly transaction to sell the same inventory in the principal (or mostadvantageous) market for that inventory would take place between market participantsat the measurement date. The former is an entity-specific value; the latter is not. Netrealisable value for inventories may not equal fair value less costs to sell.

PAS 2.10The cost of inventories shall comprise all costs of purchase, costs of conversion andother costs incurred in bringing the inventories to their present location and condition.

PAS 2.11The costs of purchase of inventories comprise the purchase price, import duties andother taxes (other than those subsequently recoverable by the entity from the taxingauthorities), and transport, handling and other costs directly attributable to theacquisition of finished goods, materials and services. Trade discounts, rebates andother similar items are deducted in determining the costs of purchase.


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PAS 2.15Other costs are included in the cost of inventories only to the extent that they areincurred in bringing the inventories to their present location and condition. For example,it may be appropriate to include non-production overheads or the costs of designingproducts for specific customers in the cost of inventories.

Conceptual Framework 4.556.5A number of different measurement bases are employed to different degrees and invarying combinations in financial statements. They include the following:

2. (a) Historical cost. The historical cost of an asset when it is acquired orcreated is the value of the costs incurred in acquiring or creating the asset,comprising the consideration paid to acquire or create the asset plustransaction costs. The historical cost of a liability when it is incurred ortaken on is the value of the consideration received to incur or take on theliability minus transaction costs. Assets are recorded at the amount ofcash or cash equivalents paid or the fair value of the consideration given toacquire them at the time of their acquisition. Liabilities are recorded at theamount of proceeds received in exchange for the obligation, or in somecircumstances (for example, income taxes), at the amounts of cash or cashequivalents expected to be paid to satisfy the liability in the normal courseof business.

PAS 16.24One or more items of property, plant and equipment may be acquired in exchange for anon-monetary asset or assets, or a combination of monetary and non-monetary assets.The following discussion refers simply to an exchange of one non-monetary asset foranother, but it also applies to all exchanges described in the preceding sentence. Thecost of such an item of property, plant and equipment is measured at fair value unless(a) the exchange transaction lacks commercial substance or (b) the fair value of neitherthe asset received nor the asset given up is reliably measurable. The acquired item ismeasured in this way even if an entity cannot immediately derecognise the asset givenup. If the acquired item is not measured at fair value, its cost is measured at thecarrying amount of the asset given up.


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PAS 40.27One or more investment properties may be acquired in exchange for a non-monetaryasset or assets, or a combination of monetary and non-monetary assets. The followingdiscussion refers to an exchange of one non-monetary asset for another, but it alsoapplies to all exchanges described in the preceding sentence. The cost of such aninvestment property is measured at fair value unless (a) the exchange transaction lackscommercial substance or (b) the fair value of neither the asset received nor the assetgiven up is reliably measurable. The acquired asset is measured in this way even if anentity cannot immediately derecognise the asset given up. If the acquired asset is notmeasured at fair value, its cost is measured at the carrying amount of the asset givenup.

PAS 18.16If the entity retains significant risks of ownership, the transaction is not a sale andrevenue is not recognised. An entity may retain a significant risk of ownership in anumber of ways. Examples of situations in which the entity may retain the significantrisks and rewards of ownership are:

(a) when the entity retains an obligation for unsatisfactory performance not covered bynormal warranty provisions;

(b) when the receipt of the revenue from a particular sale is contingent on the derivationof revenue by the buyer from its sale of the goods;

(c) when the goods are shipped subject to installation and the installation is a significantpart of the contract which has not yet been completed by the entity; and

(d) when the buyer has the right to rescind the purchase for a reason specified in thesales contract and the entity is uncertain about the probability of return.

PFRS 13.24Fair value is the price that would be received to sell an asset or paid to transfer a liabilityin an orderly transaction in the principal (or most advantageous) market at the


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measurement date under current market conditions (i.e. an exit price) regardless ofwhether that price is directly observable or estimated using another valuation technique.

PFRS 15.B20In some contracts, an entity transfers control of a product to a customer and also grantsthe customer the right to return the product for various reasons (such as dissatisfactionwith the product) and receive any combination of the following:


(b) a credit that can be applied against amounts owed, or that will be owed, to the entity;and

(c) another product in exchange.PFRS 15.B21To account for the transfer of products with a right of return (and for some services thatare provided subject to a refund), an entity shall recognise all of the following:

(a) revenue for the transferred products in the amount of consideration to which theentity expects to be entitled (therefore, revenue would not be recognised for theproducts expected to be returned);


(c) an asset (and corresponding adjustment to cost of sales) for its right to recoverproducts from customers on settling the refund liability.

PFRS 15.B22An entity's promise to stand ready to accept a returned product during the return periodshall not be accounted for as a performance obligation in addition to the obligation toprovide a refund.


687

PFRS 15.B23An entity shall apply the requirements in paragraphs 47–72 (including the requirementsfor constraining estimates of variable consideration in paragraphs 56–58) to determinethe amount of consideration to which the entity expects to be entitled (i.e. excluding theproducts expected to be returned). For any amounts received (or receivable) for whichan entity does not expect to be entitled, the entity shall not recognise revenue when ittransfers products to customers but shall recognise those amounts received (orreceivable) as a refund liability. Subsequently, at the end of each reporting period, theentity shall update its assessment of amounts for which it expects to be entitled inexchange for the transferred products and make a corresponding change to thetransaction price and, therefore, in the amount of revenue recognised.

PFRS 15.B24An entity shall update the measurement of the refund liability at the end of eachreporting period for changes in expectations about the amount of refunds. An entityshall recognise corresponding adjustments as revenue (or reductions of revenue).

PFRS 15.B25An asset recognised for an entity's right to recover products from a customer on settlinga refund liability shall initially be measured by reference to the former carrying amountof the product (for example, inventory) less any expected costs to recover thoseproducts (including potential decreases in the value to the entity of returned products).At the end of each reporting period, an entity shall update the measurement of the assetarising from changes in expectations about products to be returned. An entity shallpresent the asset separately from the refund liability.




688

Withdrawn andsuperseded PIC Q&As

as of June 30, 2021


689

Q&A No. 2006 – 01: PAS 18, Appendix, paragraph 9 – Revenuerecognition for sales of property units under pre-completion contracts

Background

The Appendix to PAS 18, Revenue, provides examples of the application of the Standard in thesale of goods and rendering of services. The examples generally assume that the amount ofrevenue can be measured reliably, it is probable that the economic benefits will flow to the entityand the costs incurred or to be incurred can be measured reliably.

On the examples provided on the sale of goods, the Appendix states that the law in differentcountries may determine the point in time at which the entity transfers the significant risks andrewards of ownership and that the examples in the Appendix need to be read in the context ofthe laws relating to the sale of goods in the country in which the transaction takes place.

Paragraph 9 in the Appendix to PAS 18 which provides guidance on revenue recognition on realestate sales, states that:

“Revenue is normally recognized when legal title passes to the buyer. However, in somejurisdictions the equitable interest in a property may vest in the buyer before legal titlepasses and therefore the risks and rewards of ownership have been transferred at that stage.In such cases, provided that the seller has no further substantial acts to complete under thecontract, it may be appropriate to recognize revenue. In either case, if the seller is obliged toperform any significant acts after the transfer of the equitable and/or legal title, revenueis recognized as the acts are performed. An example is a building or other facility on whichconstruction has not been completed." (emphasis added)

In the Philippines, a real estate company or developer may begin selling units before thecompletion of a real estate project (for example, a condominium project) or even beforeconstruction commences provided it is licensed by the House and Land Use Regulatory Board(HLURB)1. The HLURB requires, among other things, the approval of the plan andspecifications of the project and completion of the project within a year or such other period asmay fixed by the Board.

Property units may be purchased on cash or on installment, usually made over the constructionperiod. A contract to sell is executed when a buyer has paid the required minimum downpayment, e.g., about 20% of the purchase price. The buyer may issue postdated checks orobtain financing for the unpaid amount. Title to the unit is transferred to the buyer upon fullpayment. Default by a buyer on scheduled payments would result in penalties, cancellation and

1 As prescribed under Presidential Decree (PD) 957, known as the Condominium and SubdivisionBuyers' Protective Decree


690

rescission of the contract and forfeiture of amounts paid. A buyer may get a refund of a certainportion of the amounts paid depending on the number of payments made.

Issue 1: Does equitable interest vest in the buyer of a property unit before a condominiumbuilding is complete and before legal title passes?

Consensus

Equitable interest is defined as an interest held by virtue of an equitable title or claimed onequitable grounds, such as the interest held by a trust beneficiary.2

In the Philippines, equitable interest may vest in the buyer before a condominium building iscomplete and before legal title passes since the concept of equitable interest is recognized inPD 9573. PD 957 requires that, for the protection of the rights and interest of buyers under acontract to sell, such contract should be registered by the seller with the Register of Deeds ofthe province or city where the property is situated, whether or not the purchase price is paid infull.4 The developer may not mortgage the property without the prior written approval of theHLURB and, if approved, the mortgage loan shall be used for the development of the project.

The concept of equitable interest is also recognized by laws on registration of property5, the CivilCode (Republic Act No. 386), and various decisions of the Supreme Court on contracts to sellexecuted between a developer of a condominium project and a buyer of a unit in such projects.Under banking laws6, the buyer of a property unit in a condominium project, is allowed to avail ofa loan secured by such property.

2 Black’s Law Dictionary, 7th edition, page 816.3 See footnote 14 PD 957 requires that such contract, whether or not the purchase price is paid in full, be registered by theseller in the Register of Deeds. The real estate company may not mortgage the property without the priorwritten approval of the HLURB and, if approved, the mortgage loan shall be used for the development ofthe project.

5 PD 1529, the Property Registration Decree, codifies laws relating to the registration of property. ThePhilippines adheres to the Torrens system of land registration whereby the rights acquired by theregistrant are guaranteed by the government for which purpose there is an assurance which a registrantcan draw upon for damages.

6 Under the Manual of Regulations for Banks, a buyer is allowed to avail of a loan secured by suchproperty provided that the loan shall not exceed 70% of the appraised value of the real estate security,thereby implicitly recognizing the buyer's equity therein.


691

Issue 2: What conditions must be met in order that revenue is recognized as the acts areperformed?

Consensus

Since local laws recognize that equitable interest in a property may vest in a buyer before legaltitle passes, revenue is recognized as the acts are performed for sales of property units underpre-completion contracts (referred to in practice as the percentage of completion method).Revenue is recognized under this method when all the following conditions are met:

(a) equitable interest is transferred to the buyer,(b) the seller is obliged to perform significant acts,

The significant acts that must be performed by the seller are not specified in theAppendix to PAS 18. For purposes of accounting for sale of property units, construction,however, must be beyond the preliminary stage, i.e., engineering, design work,construction contract execution, site clearance and preparation, excavation and thebuilding foundation are finished.

(c) the amount of revenue can be measured reliably,

(d) the costs incurred or to be incurred can be measured reliably, and

With respect to items (c) and (d), consideration is given to sales volume, trends of unitprices, demand for the units, developer’s experience and ability to complete the project,geographical location and environmental factors.

(e) it is probable that the economic benefits will flow to the entityIt is probable that economic benefits will flow to the entity when the sales prices arecollectible. In accounting for sales of real estate, collectibility of the sales price isdemonstrated by the buyer's commitment to pay, which in turn is supported bysubstantial initial and continuing investments that give the buyer a stake in the propertysufficient that the risk of loss through default motivates the buyer to honor its obligationto the seller. It is presumed that initial and continuing investments by the buyer of about20% would demonstrate the buyer’s commitment to pay. Collectibility is also assessedby considering factors such as the credit standing of the buyer, age and location of theproperty.

Although the sale of property units under pre-completion contracts is not within the scope ofPAS 11, Construction Contracts, the method of determining the stage of completion andrevenue recognition as provided in that Standard may be referred to for guidance in determining


692

revenue as the acts are performed. For sales of property units under pre-completion contracts,however, the revenue recognized is based only on units sold.Effective Date

The consensus in these Q&As are effective from December 18, 2006, the date of approval bythe FRSC.

NOTE: The discussion in paragraph 9 in the Appendix to PAS 18, Revenue, is currently underdiscussion by IFRIC. The consensus in the above Q&As may change when IFRIC issues anInterpretation that may amend paragraph 9 in the Appendix to PAS 18.


PIC Members


Wilfredo A. Baltazar Ramon G. Opulencia

Ma. Elenita B. Cabrera Nenita S. Robles

Ernesto T. Diaz Ruby R. Seballe

Dalisay B. Duque Editha O. Tuason

Ma. Concepcion Y. Lupisan Jose T. Valencia

Roberto G. Manabat Normita L. Villaruz



693

Q&A No. 2007 – 01: PAS 1.103(a) – Basis of preparation of financialstatements if an entity has not applied PFRSs in full

Background

An entity is required by paragraph 1.103(a) of PAS 1, Presentation of Financial Statements, topresent in the notes to financial statements information about the basis of preparation of thefinancial statements.

Entities that have complied in full with Philippine Financial Reporting Standards (PFRSs) refer toPFRSs as the basis of preparation of their financial statements.

Certain entities, however, have been permitted to defer the application of PFRSs in part or infull, or to apply a specified set of accounting standards, such as the following:

(a) Qualifying non-publicly accountable entities (NPAEs) are permitted under PAS 101,Financial Reporting Standards for Non-publicly Accountable Entities, not to apply in theirgeneral purpose financial statements the PFRSs,that became effective after 2004.

(b) Entities which are required to comply with PFRSs but were allowed by a regulator not toapply specified PFRS(s) or certain provisions of a PFRS. For example, banks wereallowed by the Securities and Exchange Commission (SEC) not to apply certainprovisions of PAS 39, Financial Instruments: Recognition and Measurement.7

(c) Pre-need companies which are required by the SEC to apply the accounting standardsset forth in amended SEC Rule 31, Accounting Standards for Preneed Plans and Pre-need Uniform Chart of Accounts (PNUCA).

Issue:

What is the basis of presentation of financial statements of an entity which has been permittedto defer the application of PFRSs, in part or in full?

7 The SEC exempted certain exchange offers of the Bureau of Treasury of eligible government securitiesto new government bonds from the tainting provision of PAS 39 subject to conditions specified in SECNotice dated January 19, 2006. The SEC also approved transitional relief for hedging contracts of miningcompanies entered into and effective prior to January 1, 2005 and the exemption of these contracts fromthe fair value requirements of PAS 39 subject to conditions specified in SEC Notice dated November 30,2006. The Insurance Commission (IC) also allowed insurance companies to defer application of certainPFRSs in 2006.


694

Consensus

Paragraph 14 of PAS 1 states: “an entity whose financial statements comply with PFRSs shallmake an explicit and unreserved statement of compliance in the notes.”Accordingly, an entity that has not applied PFRSs in full may not refer to PFRSs as the basis ofpresentation of its financial statements.

The entity shall disclose the basis of preparation of its financial statements in the notes tofinancial statements, with disclosure of the accounting standards followed and any exemptionavailed of as follows:

(a) Non-publicly accountable entities – accounting principles generally accepted in thePhilippines for non-publicly accountable entities;

(b) Pre-need entities – accounting principles generally accepted in the Philippines for pre-need companies;

(c) Other entities with limited exemptions from a regulator – accounting principles generallyaccepted in the Philippines, with a description of any exemption availed of.

Following are illustrative disclosures:

(a) Non-publicly accountable entity (NPAE) (see footnote 1)

The financial statements of the Company have been prepared in accordance withaccounting principles generally accepted in the Philippines applicable to a non-publiclyaccountable entity (NPAE). The Company qualifies as an NPAE under PAS 101,Financial Reporting Standards for Non-publicly Accountable Entities and, as permittedunder that Standard, prepared its financial statements on the basis of Statements ofFinancial Accounting Standards (SFAS) and Statements of Financial AccountingStandards/International Accounting Standards (SFAS/IAS) effective as of December 31,2004.

(b) Pre-need company

The financial statements of the Company have been prepared in accordance with theaccounting standards set forth in the amended SEC Rule 31, Accounting standards forPreneed Plans and Pre-need Uniform Chart of Accounts (PNUCA), as required by theSecurities and Exchange Commission (SEC).

(c) Entity allowed by a regulator not to apply specified PFRS(s) or certain provisions of aPFRS


695

The financial statements of the Company have been prepared in accordance withaccounting principles generally accepted in the Philippines. The Company prepared itsfinancial statements in accordance with PFRSs, except for (describe exemption), whichwas permitted by the Securities and Exchange Commission (SEC).

When the basis of presentation of financial statements is referred to in other documents (e.g.Statement of Management’s Responsibility filed with the SEC), the entity shall describe thebasis of financial statements presentation. Reference may be made to the relevant note to thefinancial statements which provides a description of the basis of the financial statements. Forexample:

The management of (name of reporting company) is responsible for all information andrepresentations contained in the financial statements for the year (s) ended (date). Thefinancial statements have been prepared in conformity with accounting principlesgenerally accepted in the Philippines for non-publicly accountable entities, as describedmore fully in Note X to the financial statements, and reflect amounts that are based onthe best estimates and informed judgment of management with an appropriateconsideration on materiality.

Effective Date

The consensus in this Q&A is effective from, the date of approval by the FRSC. Earlierapplication is encouraged.



696

PIC Members



Rosario S. Bernaldo Ruby R. Seballe

Ma. Elenita B. Cabrera Editha O. Tuason






697

Q&A No. 2007 – 02: PAS 20.24, 20.37 and PAS 39.43 – Accounting forgovernment loans with low interest rates

Background

Government loans with low interest rate are sometimes provided to certain banks asgovernment financial assistance, the proceeds of which are to be invested by the recipient bankin government securities at prevailing interest rates.

Two standards apparently provide conflicting accounting guidance for loans with low interestrates. These are PAS 20, Accounting for Government Grants and Disclosure of GovernmentAssistance, and PAS 39, Financial Instruments: Recognition and Measurement.

Paragraph 37 of PAS 20 states that loans at nil or low interest rates are forms of governmentassistance, but the benefit is not quantified by the imputation of interest. Under PAS 20, theloan is recognized initially at the nominal amount of the loan and is not subsequently measuredat fair value. No fair value gain or loss is recognized. The nature, extent and duration of theassistance are, however, disclosed.

Under paragraph 43 of PAS 39, on the other hand, a government loan with low interest rate is afinancial liability which is required to be measured initially at the fair value of the loan (i.e., thepresent value of all future cash payments discounted using a market rate of interest). Underparagraph AG64 of PAS 39, the difference between the fair value at initial recognition and theloan proceeds received is recognized in income.

The Bangko Sentral ng Pilipinas supports the measurement of the government loan at initialrecognition at fair, consistent with PAS 39. It, however, considers the difference between thefair value at initial recognition and the loan proceeds received as a government grant to berecognized in income over the life of the loan, consistent with the accounting for governmentgrants under PAS 20.

The International Accounting Standards Board (IASB) has recognized the conflict between IAS20 and IAS 39, the basis for PAS 20 and PAS 39, respectively, at its July 2004 meeting. IAS 20explains that loans at nil or low interest rates are forms of government assistance, but thebenefit of the reduced loan is not treated as a government grant. The IASB noted that theserequirements conflict with the IAS 39 requirement to measure financial liabilities initially at fairvalue. The IASB, therefore, decided to delete the references to loans at nil or low interest ratesand guarantees from IAS 20. At its February 2006 meeting, the IASB acknowledged that IAS20 is inconsistent with the Framework for the Preparation and Presentation of FinancialStatements. However, IASB decided to defer the work on IAS 20 until further work on otherprojects are completed. To-date, issues relating to IAS 20 have not yet been resolved.


698

Issues

1. Should a government loan with low interest rate be initially recognized (a) at the nominalvalue of the loan, or (b) at fair value?

2. If the government loan is initially recognized at fair value, should the difference between thefair value at initial recognition and the loan proceeds be recognized (a) immediately inincome, or (b) on a systematic basis over the life of the loan?

Consensus

Because of the conflict in existing accounting guidance on loans with low interest provided inPAS 20 and PAS 39, the three following alternatives are considered acceptable. The alternativeadopted shall be consistently applied.

View 1

PAS 20 is followed because it is the more specific standard relating to government assistanceand is still in effect (i.e., it has not yet been amended or superseded). Under PAS 20, thegovernment loan is recognized initially at the nominal amount of the loan and is notsubsequently measured at fair value. No fair value gain or loss is recognized.

View 2

PAS 39 is followed because it is the more recent standard. In addition, PAS 39 does not scopeout government loans with low interest rates, and these are thus measured initially in the samemanner as low interest loans from any other creditor.

Under PAS 39, a government loan with low interest rate is a financial liability which is measuredinitially at fair value (i.e., the present value of all future cash payments discounted using amarket rate of interest). The difference between the fair value at initial recognition and the loanproceeds received is recognized in income.

View 3

A government loan, which is a financial liability, is measured initially at fair value (i.e., thepresent value of all future cash payments discounted using a market rate of interest) under PAS39. The difference between the fair value of the loan and the proceeds of the loan areconsidered a form of government grant under PAS 20, recognized as income on a systematicbasis over the period of the loan.


699

Effective Date


Transition

A change in accounting policy shall be accounted for in accordance with the requirements ofPAS 8, Accounting Policies, Changes in Accounting Estimates and Errors.

Date approved by PIC: February 21, 2007

PIC Members










700

Q&A No. 2007 – 04: PAS 101.7 – Application of criteria for a qualifyingNPAE

Background

Paragraph 7 of PAS 101, Financial Reporting Standards for Non-publicly Accountable Entities,states that the Standard shall be applied in the general purpose financial statements preparedand presented by an entity with no public accountability. PAS 101 lists qualifying NPAEs byreference to criteria for an entity that has public accountability, one of which is an economicallysignificant entity.

Paragraph 8 provides that an entity is considered economically significant if it exceeds either ofthe following: total assets of P250 million or total liabilities of P150 million. The total assets andtotal liabilities are based on the entity’s annual financial statements and on consolidated totals, ifthe entity presents consolidated financial statements.

Issue 1

If an entity that qualified as an NPAE in a previous year because it met the “not economicallysignificant” criterion, no longer qualifies as an NPAE in the following year, may it still apply PAS101?

Consensus

Yes, the entity may still apply PAS 101 in the above case. However, if the entity does not meetthe “not economically significant” criterion for three consecutive years, it shall no longer applyPAS 101. The three consecutive year period shall start from January 1, 2005, the effective dateof PAS 101.

Issue 2

For purposes of determining whether an entity is economically significant, should theassessment be based on beginning or ending total assets or total liabilities?

Consensus

The amounts of total assets or total liabilities should be based on the beginning balances of thecurrent reporting year starting in 2006 (e.g., based on total assets or total liabilities in December31, 2005 in audited financial statements of a calendar year entity).


701

Effective Date



PIC Members










702

Q&A No. 2008 – 01: PAS 19.78 – Rate used in discounting post-employment benefit obligations

Issue


Background

Paragraph 78 of PAS 19, Employee Benefits, provides that the rate used to discount post-employment benefit obligations shall be determined by reference to market yields at the balancesheet date on government bonds in countries where there is no deep market in high qualitycorporate bonds. The currency and term of the government bonds shall be consistent with thecurrency and estimated term of the post-employment benefit obligations. Paragraph 80 of PAS19 also provides that the discount rate reflect the timing of benefit payments.

The more common source of discount rates by actuaries is the Philippine Dealing andExchange Corporation (PDEX). The PDS rates published by PDEX, usually used by actuaries,are based on the yield for peso government issued coupon bearing instruments which pay outinterest payments on a periodic basis over the term of the bond and the principal upon maturity.

Another source of discount rates is Bloomberg which provide rates for peso government bondsthat are the effective yield for debt instruments which repays the investor one time and onlyupon maturity, the principal and any effective interest (zero coupon).

Since employees of an entity retire at different points in time, the entity has to determine thevarious duration of retirement liabilities. In practice, actuaries will either (1) get the averageduration of retirement liabilities and use this as the basis of the term of the peso governmentbond in determining the appropriate discount rate, or (2) derive the discount rate by applying asingle weighted average discount rate that reflects the estimated timing and amount of benefitpayments in which the benefits are to be paid.

Consensus

The rate used to discount post-employment benefit obligations shall reflect the pattern of cashflow for the payment of retirement benefits. Employees become entitled to retirement benefitsat the end of their service lives. A rate that would be reflective of a one-time payment uponmaturity is that of a zero coupon instrument which has a single cash flow. Although paymentschemes may vary (e.g., lump sum or periodic payments over the life of the retired employees),it may be assumed for actuarial purposes that payments would be made in one lump sum.


703

If the rate reflects the yield for peso government bonds that pay out interest payments on aperiodic basis over the term of the bond and the principal upon maturity, such rate may beconverted to a zero coupon rate1 to reflect a reasonable estimate of the benefit payments.


Effective Date



PIC Members







Normita L. Villaruz


1 Reference may be made to the PDEx website or to Bloomberg website for zero coupon rates forgovernment securities.


704

Q&A No. 2008 – 02: PAS 20.43 – Accounting for government loanswith low interest rates under the amendments to PAS 20

Issue

Does an entity that adopted one of the accounting treatments for government loans with lowinterest rates under Q&A 2007-02 change its policy as result of the amendments to PAS 20?

Background

In 2007, PIC Q&A 2007-02, Accounting for government loans with low interest rates, was issuedto provide guidance on the accounting for government loans with low interest rate that aresometimes provided to certain banks, the proceeds of which are to be invested by the recipientbank in government securities at prevailing interest rates.

Because of the conflict in accounting guidance at that time on loans with low interest provided inPAS 20, Accounting for Government Grants and Disclosure of Government Assistance andPAS 39, Financial Instruments: Recognition and Measurement, the three following accountingalternatives were considered acceptable:

1. The government loan is recognized initially at the nominal amount of the loan and is notsubsequently measured at fair value in accordance with PAS 20. No fair value gain orloss is recognized.

2. The government loan is measured initially at fair value (i.e., the present value of allfuture cash payments discounted using a market rate of interest) in accordance withPAS 39. The difference between the fair value at initial recognition and the loanproceeds received is recognized immediately in income.

3. The government loan is measured initially at fair value (i.e., the present value of allfuture cash payments discounted using a market rate of interest) under PAS 39. Thedifference between the fair value of the loan and the proceeds of the loan are considereda form of government grant under PAS 20, and is recognized as income on a systematicbasis over the period of the loan.

In August 2008, the Financial Reporting Standards Council (FRSC) approved the adoption ofthe Improvements to PFRSs. Among these improvements is an amendment to PAS 20 whichresolved the inconsistency of guidance in PAS 20 and PAS 39 with respect to loans at lowinterest rates.

Paragraph 10A of amended PAS 20 now provides that “the benefit of a government loan at abelow-market rate of interest is treated as a government grant. The loan shall be recognized


705

and measured in accordance with PAS 39. The benefit of the below-market rate of interest shallbe measured as the difference between the initial carrying value of the loan determined inaccordance with PAS 39 and the proceeds received. The benefit is accounted for inaccordance with amended PAS 20. The entity shall consider the conditions and obligations thathave been, or must be, met when identifying the costs for which the benefit of the loan isintended to compensate.”

The amendments to PAS 20 also deleted paragraph 37, which states that “loans at nil or lowinterest rates are a form of government assistance, but the benefit is not quantified by theimputation of interest.”

Consensus

An entity that adopted one of the accounting treatments adopted under Q&A 2007-02 does notchange the accounting for loans prior to the effective date of the amendments to PAS 20.

Paragraph 43 of amended PAS 20 provides that the amendments shall be applied prospectivelyto government loans received in periods beginning on or after January 1, 2009, with earlierapplication permitted. Accordingly:

Government loans received prior to January 1, 2009 will continue to be accounted under theaccounting treatment chosen under Q&A 2007-02.

Government loans received on or after January 1, 2009 will be accounted for under theamended provisions of PAS 20.

If an entity opts to early adopt the amendments to PAS 20, the amendments shall applyprospectively on government loans received on or after the date of early adoption. Forexample, if an entity chooses to adopt the amendments on January 1, 2008, theamendments shall be applied prospectively to government loans received in periodsbeginning on or after January 1, 2008.

Effective Date



706


PIC Members







Normita L. Villaruz



707

Q&A No. 2009 – 02: PAS 39.AG71-72 – Rate used in determining thefair value of government securities in the Philippines

Issue

What rate is used in determining the fair value of government securities in the Philippines?

Background

The Philippines has an Inter-Dealer Market, the Philippine Dealing & Exchange Corp. or PDEx,for government securities. Currently, PDEx has about 25 dealing participants (the market-making banks) that buy and sell securities for their own account and about 24 brokeringparticipants that buy and sell securities on behalf of its customers.

PDEx publishes the following market data for Philippine government securities:

Daily reports of trading data posted in the Government Securities (GS) Board Summary1

(see Appendix 1)

Last Yield - This is the last traded yield (short for "yield to maturity") of the specificsecurity.(Note: If the column for Trade Time has a time, this would mean that specific securitytraded on that day at that time. If it contains a date, then this would signify the last dateon which a trade was recorded for that specific security.)

Bid Yield - This is the BEST Bid Yield (lowest bid yield) still quoted on the Board as ofthe end of day on that date.

Offer Yield - This is the BEST Offer Yield (highest offer yield) still quoted on the Board asof the end of day on that date.

Close Yield - This is the last traded yield of the specific security as of the end of day ofthat date. (Note: The GS Board Summary is updated throughout the day. By the end ofday the last yield and close yield should have the same data.)

Benchmark rates* (see Appendix 2)

PDST-F is the calculated average of the best 60% of firm bid rates posted by designatedmarket-making banks for 12 tenors at 11:15am daily.

1 The GS Board Summary and the benchmark rates can be accessed at the PDEx website(http://www.pdex.com.ph/) through the Daily Reports under Downloads.


708

PDST–R1 benchmark is calculated from the weighted average yields of donetransactions totaling at least Php 50Mn from 9:00 am to 11:15 am or the best firm bid ofPDST market-making banks at 11:16 am in the absence of done deals. In the absenceof done transactions, firm bid yields of at least Php50 million posted by market-makingbanks is used.

PDST-R2 benchmark is calculated from the weighted average yields of donetransactions totaling at least Php 50Mn from 9:00 am to 4:15 pm or the best firm bid ofPDST market-making banks at 4:16 pm in the absence of done deals. In the absence ofdone transactions, firm bid yields of at least Php50 million posted by market-makingbanks is used.

Consensus

AG71 of PAS 39, Financial Instruments: Recognition and Measurement, provides that fair valueis defined in terms of a price agreed by a willing buyer and a willing seller in an arm’s lengthtransaction. The objective of determining fair value for a financial instrument that is traded in anactive market is to arrive at a price at which a transaction would occur at the end of thatreporting period in that instrument (i.e., without modifying or repackaging the instrument) in themost advantageous active market to which an entity has immediate access.PAS 39.AG72 contains a hierarchy for the determination of fair value:

a. The appropriate quoted market price for an asset held or liability to be issued is usually thecurrent bid price and, for an asset to be acquired or liability held, the asking price(sometimes referred to as ‘current offer price’).

A financial instrument is regarded as quoted in an active market if quoted prices arereadily and regularly available from an exchange, dealer, broker, industry group, pricingservice or regulatory agency, and those prices represent actual and regularly occurringmarket transactions on an arm’s length basis.

b. When current bid and asking prices are unavailable, the price of the most recenttransaction provides evidence of the current fair value as long as there has not been asignificant change in economic circumstances since the time of the transaction.

c. If the entity can demonstrate that the last transaction price is not fair value (e.g., because itreflected the amount that an entity would receive or pay in a forced transaction, involuntaryliquidation or distress sale), that price is adjusted.


709

Based on the guidance in PAS 39, the fair value of government securities in the Philippines,using market data published by PDEx, would be determined as follows:

a. Current bid yield, if available, on the balance sheet date.b. When a current bid yield is not available, the last or close yield on the balance sheet date.c. When there is no transaction for a security on the balance sheet date, the PDST-R2 rate

may be used. The PDST-R1 rate is not used because it only considers transactions in themorning, whereas PDST-R2 considers all transactions for the day.

The PDST-F rate would not be appropriate in determining the fair value of governmentsecurities in the Philippines because of the following:

The PDST-F rate is a benchmark rate derived from one-way quotes. A two-way quotebenchmark is more market oriented since it allows both buyers and sellers to haveaccessible prices.

It is computed to provide a basis for interest rate re-pricing of contracts that embed thePDST-F rate calculation methodology as a basis for re-pricing in its documentation.As it is a theoretical rate, an entity would usually not transact at that rate.

For additional or detailed guidance on fair value measurement considerations, reference shouldbe made to paragraphs AG71 and AG72 of PAS 39. For disclosures required with respect tothe determination of fair value, reference should be made to paragraph 27 of PFRS 7, FinancialInstruments: Disclosures.

Effective Date



710


PIC Members


Wilfredo A. Baltazar Judith Lopez


Ma. Elenita B. Cabrera Ramon G. Opulencia

Ma. Gracia Casals-Diaz Ruby R. Seballe


Normita L. Villaruz



711

Appendix 1

Trading Data

Shown below is a screen shot of the Government Securities (GS) Board Summary on the PDExwebsite which takes the trading data available at the end of day (at 4.15 PM).

Definitions

Last Yield - This is the last traded yield (short for "yield to maturity") of the specific security.Note: If the column for Trade Time has a time, this would mean that specific security traded onthat day at that time. If it contains a date, then this would signify the last date on which a tradewas recorded for that specific security.


712

Bid Yield - This is the BEST Bid Yield (lowest bid yield) still quoted on the Board as of the end ofday on that date.

Offer Yield - This is the BEST Offer Yield (highest offer yield) still quoted on the Board as of theend of day on that date.

Close Yield - This is the last traded yield of the specific security as of the end of day of that date.Note: While the GS Board Summary is updated throughout the day the Last Yield changes asnew trades are executed, by the end of day the last yield and close yield should have the samedata.

More Definitions

ISIN - stands for International Securities Identification Number. It is the unique identifier codefor a security. For example: PIBD0514A673 refers to FXTN 05-67

Inst Name - short for Instrument Name and refers to the short code given to securities and usedto identify them in the PDEx Trading System. The code is derived from the security's ISIN.

Instrument Names follow this convention:

Treasury Notes and Bonds: Security type (3 to 4 alphabetic code), tenor in years (2 digitnumeric code) and the series number for that issued tenor

Security Types for Government Securities (GS) are:Fixed Rate Treasury Notes (FXTN),Retail Treasury Bond (RTB),Special Purpose Treasury Bond (SPTB) andZero-Coupon Bond (ZCB)

Example: The Security with ISIN "PIBD0514A673" is a Fixed Rate Treasury Note andhas an Instrument Name of "FXTN 05-67" (denoting that is it the 67th issuance of a 5-Year Fixed Rate Treasury Note)

Treasury Bills: "TBILL" followed by its maturity date.

Example: The Security with ISIN "PIBL1209A010" is a Philippine Treasury Bill withInstrument Name of "TBILL 01.13.10" (denoting that it will mature on January 13, 2010)

Coupon - Denotes the rate of interest to be paid yearly by the bond issuer to bond holders.Bonds may have fixed rate coupon payments, or may have variable or floating rate coupon


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payments which are re-priced at set dates. Coupon payments on Philippine Treasury Notesand Bonds are paid semi-annually or quarterly.Tenor - This refers to the nearest whole monthly, semi-annual, or yearly period that a securityfalls into based on its remaining tenor to maturity

Maturity - Short for "Maturity Date" or the date when the debt security pays its final principal andcoupon payment.

Days - Short for "Days to Maturity" or the number of days from the trade settlement date untilthe maturity date of the security

Years - Short for "Years to Maturity" or the number of years from the trade settlement date untilthe maturity date of the security.This figure is equal to the "Days to Maturity" divided by 365.25

Daily Volume (M) - This is Daily Traded Volume of a specific security based on Face Amounttraded and expressed in PhP Millions.

Last Traded Time - This is the time at which the last transaction for a specific security wasexecuted

Weighted Ave., short for "Weighted Average Yield", refers to the weighted average yield tomaturity of all done trades for a specific security.

Open Yield - The yield to maturity of the first trade executed for a specific security for thattrading day

High Yield - The highest yield to maturity recorded among transactions for a specific security forthat trading day

Low Yield - The lowest yield to maturity recorded among transactions for a specific security forthat trading day


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Appendix 2

Benchmark Rates

Shown below is a screen shot of the Philippine Dealing & Exchange Corp. (PDEx) benchmarkrates.


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Q&A No. 2010 – 01: PAS 39.AG71-72 – Rate used in determining thefair value of government securities in the Philippines

Issue

What rate is used in determining the fair value of government securities in the Philippines?

Background

The Philippines has a Philippine Securities and Exchange Commission-registered market forFixed Income Securities operated by the Philippine Dealing & Exchange Corp. (PDEx), 1 a partof the Philippine Dealing System Holdings Corp., a member-owned and member-governedprovider of financial market trading to settlement infrastructure.

The registered PDEx Fixed Income Securities market encompasses the Over-the-Counter(OTC) Market and an Exchange Market, and includes the Inter-Dealer, Inter-Professional, andRetail Investor (as represented by Broker Participants) segments of the Philippine fixed incomemarket. As of February 2010, PDEx has 41 Dealing Participants that buy and sell debtsecurities for their own account, 28 Brokering Participants or "public representatives" thatexecute buy and sell orders on behalf of client investors, and 2 Qualified Investor Participants orinstitutional investors allowed to directly act on prices posted by Dealing or BrokeringParticipants.

The traded debt issues are comprised of Philippine Government Securities (GS) and PhilippineCorporate Securities, with the former having most of the volume.

In support of its activities, PDEx sought and was granted licenses by the SEC to operate anOTC market, an exchange, as well as the Self-Regulatory Organization (SRO) license tooversee its Trading Participants' activities in both the OTC and Exchange sectors of its tradingplatform.

PDEx is also the Calculation Agent of Phil. Dealing System Treasury (PDST) Reference Ratesappointed by the Bankers Association of the Philippines to use the SRO powers granted tomonitor the daily setting of these key interest rate benchmark rates.

PDEx publishes on its website (www.pdex.com.ph) the following market data for Philippinegovernment securities:

1 The PIC acknowledges the contribution of PDEx and the PDS Group in the development of this Q&Athrough the information they provided on the fixed income securities market in the Philippines, the role ofPDEx and the market data they provide.


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Daily reports of trading data posted in the Government Securities (GS) Board Summary(see Appendix 1)Last Yield - This is the last traded yield (short for "yield to maturity") of the specificsecurity. (Note: If the column for Traded Time has a time, this would mean that thespecific security was traded on that day at that time. If it contains a date, then this wouldsignify the last date on which a trade was recorded for that specific security.)

Bid Yield - This is the BEST Bid Yield (lowest bid yield) still quoted on the Board as ofthe end of day on that date. Offer Yield - This is the BEST Offer Yield (highest offeryield) still quoted on the Board as of the end of day on that date.

Close Yield - This is the last traded yield of the specific security as of the end of day ofthat date. (Note: While the GS Board Summary is updated throughout the day, the LastYield changes as new trades are executed; by the end of day, the last yield and closeyield should have the same data.)

Benchmark rates (see Appendix 2)

PDST-F is the calculated average of the best 60% of firm bid rates posted by designatedmarket-making banks for 12 tenors at 11:15am daily.

PDST–R1 benchmark is calculated from the weighted average yields of donetransactions totaling at least Php 50Mn from 9:00 am to 11:15 am or the best firm bid ofPDST market-making banks at 11:16 am in the absence of done deals. In the absenceof done transactions, firm bid yields of at least Php50 million posted by market-makingbanks are used.

PDST-R2 benchmark is calculated from the weighted average yields of donetransactions totaling at least Php 50Mn from 9:00 am to 4:15 pm or the best firm bid ofPDST market-making banks at 4:16 pm in the absence of done deals. In the absence ofdone transactions, firm bid yields of at least Php50 million posted by market-makingbanks are used.

Interpolated Rates (see Appendix 3)

Using each of the three sets of Benchmark Rates as the points with "known rates" forthe GS Yield Curve, PDEx calculates and publishes daily a page showing aninterpolated rate for each listed GS. The calculation uses a straight-line method ofinterpolation between the two "known rates" of the PDST Benchmark tenors.

PDSI-F is a set of interpolated rates for GS that uses the PDST-F rates as the set of"known rates" to base the interpolation, published after 11.20 am daily.


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PDSI-R1 is a set of interpolated rates for GS that uses the PDST-R1 rates as the set of"known rates" to base the interpolation, published after 11.20 am daily.PDSI-R2 is a set of interpolated rates for GS that uses the PDST-R2 rates as the set of"known rates" to base the interpolation, published after 4.20 pm daily.

PDEx considers the market for Philippine Government Securities as an active market, but theactivity is not evenly distributed among the listed issues. For example, for the year 2009, ninetypercent (90%) of the trading volume was concentrated in only 20 out of the 170 traded GSissues. Within that list of 20 issues, the top seven (7) issues accounted for 79.06% of thetraded volume. These most actively traded 7 GS issues are referred to as the Bureau of theTreasury (BTr) Benchmark Bonds, or BTr Benchmark GS.

The concentration of activity is also reflected in the turnover data, which is determined bydividing the Annual Traded Volume of a specific security (or set of securities) by the outstandingissue size of that specific security (or set of securities). For 2009, the top BTr Benchmark Bondachieved a turnover of 5.23 times its outstanding issue size; the group of 7 BTr BenchmarkBond issues cumulatively achieved a turnover of 2.75 times their cumulative outstanding size.

The uneven distribution of trading activity means that the daily availability of price data (i.e., bidyield and offer yield) and transaction data (i.e., last yield or close yield) is more consistent forthe highly traded BTr Benchmark Bonds, and much less likely to be available on a daily basisfor the less-traded non-BTr Benchmark GS.

Consensus

AG71 of PAS 39, Financial Instruments: Recognition and Measurement, provides that fair valueis defined in terms of a price agreed by a willing buyer and a willing seller in an arm’s lengthtransaction. The objective of determining fair value for a financial instrument that is traded in anactive market is to arrive at a price at which a transaction would occur at the end of thatreporting period in that instrument (i.e., without modifying or repackaging the instrument) in themost advantageous active market to which an entity has immediate access.

PAS 39.AG72 contains a hierarchy for the determination of fair value:

a. The appropriate quoted market price for an asset held or liability to be issued is usuallythe current bid price and, for an asset to be acquired or liability held, the asking price(sometimes referred to as ‘current offer price’).A financial instrument is regarded as quoted in an active market if quoted prices arereadily and regularly available from an exchange, dealer, broker, industry group, pricingservice or regulatory agency, and those prices represent actual and regularly occurringmarket transactions on an arm’s length basis. (underscoring added)


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b. When current bid and asking prices are unavailable, the price of the most recenttransaction provides evidence of the current fair value as long as there has not been asignificant change in economic circumstances since the time of the transaction.

c. If the entity can demonstrate that the last transaction price is not fair value (e.g.,because it reflected the amount that an entity would receive or pay in a forcedtransaction, involuntary liquidation or distress sale), that price is adjusted.

Based on the above assessment of the Philippine government securities market, the guidancein PAS 39 would be applied as follows:

a. For BTr Benchmark Bonds (or BTr Benchmark GS), the current bid yield, if available, aspublished on balance sheet date is used. When a current bid yield is not available, thelast or close yield as published on the balance sheet date is used.

b. For other Government Securities, the PDSI-R2 interpolated rate as published on thebalance sheet date may be used.

The PDST-R1 reference rates and resulting PDSI-R1 interpolated rates are not used becausethese only consider transactions done in the morning, whereas the PDST-R2 reference ratesand resulting PDSI-R2 interpolated rates consider all transactions for the day.

The PDST-F rate would not be appropriate for the following reasons:

The PDST-F rate is a benchmark rate derived from one-way quotes. A two-way quotebenchmark is more market oriented since it allows both buyers and sellers to haveaccessible prices.

It is computed to provide a basis for interest rate re-pricing of contracts that embed thePDST-F rate calculation methodology as a basis for re-pricing in its documentation. As itis a theoretical rate, an entity would usually not transact at that rate.

For additional or detailed guidance on fair value measurement considerations, reference shouldbe made to paragraphs AG71 and AG72 of PAS 39. For disclosures required with respect tothe determination of fair value, reference should be made to paragraph 27 of PFRS 7, FinancialInstruments: Disclosures.

Effective Date

The consensus in this Q&A is effective for annual financial statements beginning on or afterJanuary 1, 2010. Earlier application is encouraged.


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Withdrawal of Q&A 2009-2

Q&A 2010-1 supersedes Q&A 2009-2: PAS 39.AG71-72 – Rate used in determining the fairvalue of government securities in the Philippines, approved by the PIC and the FRSC onMarch 18, 2009 and April 20, 2009, respectively.

Q&A approved by PIC: March 2, 2010

PIC Members


Wilfredo A. Baltazar Lyn I. Javier/Reynold E. Afable

Rosario S. Bernaldo Judith V. Lopez

Ma. Elenita B. Cabrera/Rufo R. Mendoza Ma. Concepcion Y. Lupisan

Ma. Gracia F. Casals-Diaz Ramon G. Opulencia

Sharon Dayoan Ruby R. Seballe

Dalisay B. Duque Normita L. Villaruz



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Appendix 1

Trading Data

Shown below is a screen shot of the Government Securities (GS) Board Summary on the PDEx website(www.pdex.com.ph) as of March 2, 2010.

DefinitionsInst Name - short for Instrument Name and refers to the short code given to securities and used toidentify them in the PDEx Trading System (also referred to as "Series Name").

Philippine Government Securities instrument names are derived from the security's ISIN or maturity datefollowing these conventions.

Treasury Notes and Bonds: Security type (3 to 4 letter alphabetic code), original tenor uponissuance in years (2 digit numeric code) and the series number for that issued tenor

Security Types for Government Securities (GS) are:Fixed Rate Treasury Notes (FXTN),Retail Treasury Bond (RTB),Special Purpose Treasury Bond (SPTB) andZero-Coupon Bond (ZCB)

Example: The Security with ISIN "PIBD0514A673" is a Fixed Rate Treasury Note and has anInstrument Name of "FXTN 05-67" (denoting that is it the 67th issuance of a 5-Year Fixed RateTreasury Note)Treasury Bills: "TBILL" followed by its maturity date.


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Example: The Security with ISIN "PIBL1209A010" is a Philippine Treasury Bill with InstrumentName of "TBILL 01.13.10" (denoting that it will mature on January 13, 2010)

ISIN - stands for International Securities Identification Number. It is the unique identifier code for asecurity. Every ISIN has a corresponding Instrument Name (or Series Name), a shorter and easy toremember code that facilitates trading. For example: PIBD0514A673 refers to FXTN 05-67.

Tenor - This refers to the nearest whole monthly, semi-annual, or yearly period that a security falls intobased on its remaining tenor to maturity.

CPN (or Coupon) - Denotes the rate of interest to be paid yearly by the bond issuer to bond holders.Bonds may have fixed rate coupon payments, or may have variable or floating rate coupon paymentswhich are re-priced at set dates. Coupon payments on Philippine Treasury Notes and Bonds are paideither semi-annually or quarterly.

Days - Short for "Days to Maturity" or the number of days from the trade settlement date until the maturitydate of the security.

YRS (or Years) - Short for "Years to Maturity" or the number of years from the trade settlement date untilthe maturity date of the security. This figure is equal to the "Days to Maturity" divided by 365.25

Maturity - Short for "Maturity Date" or the date when the debt security is paid in full and ceases to be anobligation.

D. Vol. (or Daily Volume) (MM) - This is Daily Traded Volume of a specific security based on FaceAmount traded and expressed in PhP Millions.

Last Yield - This is the last traded yield (short for "yield to maturity") of the specific security.Note: If the column for Traded Time has a time, this would mean that the specific security was traded onthat day at that time. If it contains a date, then this would signify the last date on which a trade wasrecorded for that specific security.

Traded Time - This is the time at which the last transaction for a specific security was executed. If thisfield shows a date, this means that no trades were executed for the current trading date, and the datedisplayed is the date on which the last transaction for that security was done.

W. Ave. Yld. , short for "Weighted Average Yield", refers to the weighted average yield to maturity of alldone trades for a specific security.

Bid Yield - This is the BEST Bid Yield (lowest bid yield) still quoted on the Board as of the end of day onthat date.

Offer Yield - This is the BEST Offer Yield (highest offer yield) still quoted on the Board as of the end ofday on that date.

Open Yield - This is the yield to maturity of the first trade executed for a specific security for that tradingday.


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High Yield This the highest yield to maturity recorded among transactions for a specific security for thattrading day.

Low Yield This is the lowest yield to maturity recorded among transactions for a specific security for thattrading day.

Close Yield - This is the last traded yield of the specific security as of the end of day of that date.Note: While the GS Board Summary is updated throughout the day, the Last Yield changes as new tradesare executed; by the end of day, the last yield and close yield should have the same data.


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Appendix 2

Benchmark Rates

Shown below is a screen shot of the Benchmark Rates on the PDEx website (www.pdex.com.ph) as ofMarch 2, 2010.


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Appendix 3Interpolated Rates

Shown below is a screen shot of the Interpolated Rates on the PDEx website (www.pdex.com.ph) as ofMarch 1, 2010.


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Q&A No. 2011 - 01: PAS 1.10(f) – Requirements for a Third Statementof Financial Position

Issue 1When should an entity present a third statement of financial position in accordance withPhilippine Accounting Standard (PAS) 1, Presentation of Financial Statements, paragraph10(f)?

BackgroundPAS 1.10(f) requires a statement of financial position as at the beginning of the earliestcomparative period when an entity:

applies an accounting policy retrospectively, makes a retrospective restatement of items in its financial statements, or reclassifies items in its financial statements.

This means that in all cases above, any material adjustments to previously reported amountsand presentation give rise to the requirement for an additional statement of financial position.PAS 1 provides no further clarification as to when an entity is required to present an additionalstatement of financial position.

Consensus

It will often be necessary to exercise judgment in determining whether a third statement offinancial position is required to be presented. When applying judgment, it is necessary toconsider whether the information set out in an additional statement of financial position would bematerial to users of the financial statements. PAS 1.31 states that “an entity need not provide aspecific disclosure required by a PFRS if the information is not material.”

PAS 1.7 defines the term “material” as follows: “Omissions or misstatements of items arematerial if they could individually, or collectively, influence the economic decisions that usersmake on the basis of financial statements. Materiality depends on the size and nature of theomission or misstatement judged in the surrounding circumstances. The size or nature of theitem, or a combination of both, could be the determining factor.”

PAS 1 Basis for Conclusion paragraph 32 notes that “considering that financial statements fromprior years are readily available for financial analysis, the Board (the International AccountingStandards Board) decided to require only two statements of financial position, except when thefinancial statements have been affected by:


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retrospective application of accounting policy, retrospective restatement of items in its financial statements, or when a reclassification has been made on the items of the financial statements.

This Basis for Conclusion paragraph seems to suggest that a third statement of financialposition may be required when it provides additional information that was not included in prioryear financial statements. Conversely, if there would be no changes to the information that wasincluded in prior year financial statements, this may suggest that the information set out in thethird statement of financial position would not be material to users of the financial statements.

For example, if the adoption of a new or amended Philippine Financial Reporting Standards(PFRS) requires retrospective restatement of comparative amounts included in the financialstatements, and such change only affects the comparative amounts within the statement ofcomprehensive income or statement of cash flows, it is reasonable to conclude that suchchange is not material to the comparative statement of financial position. This is because thereare no changes in the amounts included in the comparative statement of financial position, orthe notes thereto. In this instance (i.e., where there is no effect on the comparative statement offinancial position), there is no need to present a third statement of financial position. However,in such cases, an entity discloses in the notes to the financial statements that the retrospectiverestatement has no impact on the comparative statement of financial position.

Accordingly, in determining whether it is necessary to present a third statement of financialposition, entities should consider the materiality of the information that would be contained in athird statement of financial position and whether this would affect economic decisions made bya user of the financial statements. In doing so, it would be useful to take into considerationfactors such as:

the nature of the change and the alternative disclosures provided, whether the change in accounting policy actually affected the financial position at the

beginning of the comparative period (if the accounting policy allows a prospective orlimited retrospective application) , and



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Examples

1. Circumstances requiring a third statement of financial position

In the following examples for an entity preparing financial statements for the year endedDecember 31, 2010, a third statement of financial position (as at January 1, 2009) is likely tobe required.

On adoption of PAS 23, Borrowing Costs (Revised 2007), an entity changes itsaccounting policy in respect of capitalizing borrowing costs. The entity opted tocapitalize borrowing costs as of January 1, 2008 and apply PAS 23 to all qualifyingassets for which the commencement date for capitalization is on or after January 1,2008. The restatement has a material impact on the statement of financial position as ofJanuary 1, 2009.

It has been determined that an entity has failed to recognize deferred tax assets in theprevious years. In 2010, the entity restates its financial statements to take up and reflectthe deferred tax assets in accordance with PAS 12, Income Taxes. The restatement hasa material impact on the statement of financial position as of January 1, 2009.

The entity has adopted the pooling of interests method for business combination undercommon control. Comparative period has been restated as if the entities have beencombined since the earliest period presented. The restatement has a material impact onthe statement of financial position as of January 1, 2009.

2. Circumstances not requiring a third statement of financial position

In the following examples for an entity preparing financial statements for the year endedDecember 31, 2010, and assuming there are no other factors to the contrary, a thirdstatement of financial position (as at January 1, 2009) is likely not to be required.

An entity adopted PFRS 3, Business Combinations, (Revised) prospectively effectiveJanuary 1, 2010.

An entity adopts the March 2009 amendment to PFRS 7, Improving Disclosures aboutFinancial Instruments: Disclosures. The amendments change the required disclosuresfor fair value measurement and liquidity risk and are effective for annual periodsbeginning on or after January 1, 2009 without the need for comparative information inthe first year of application. Entities should provide the disclosures required under PAS8, Accounting Policies, Changes in Accounting Estimates and Errors, regarding theimpact of changes in accounting policies and other restatements. Further, PAS 1.41sets out specific requirements when an entity has reclassified comparative amounts.


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Issue 2

What is meant by a ‘reclassification’ in the context of PAS 1?

Consensus

It appears that the phrase “reclassifies items in its financial statements” is intended to capturethe types of ‘reclassification’ described in PAS 1.41.PAS 1.41 addresses changes in the presentation or classification of items (i.e., an entitychanging its policy for the presentation or classification of a particular item), rather thanreclassifications that are driven by the requirements of a Standard, the passage of time or achange in the nature or status of the items themselves. Therefore, it appears that the followingprospective event-driven reclassifications, for example, were not intended to be captured byPAS 1.10(f), hence, will not trigger the presentation of a third statement of financial position:

reclassification of an asset or liability from non-current to current under PAS 1 becauseof the passage of time;

reclassification of a financial asset from the held-to-maturity to the available-for-salecategory and vice versa in accordance with PAS 39, Financial Instruments: Recognitionand Measurement;

reclassification of cumulative gains or losses on an available-for-sale financial asset fromequity to profit or loss as a reclassification adjustment on impairment or disposal of theasset;

classification of an operation as discontinued with reclassification of the comparativeperiod statement of comprehensive income;

reclassification of a property from inventories to investment property on commencementof an operating lease to another party;

a change in the analysis of expenses in profit or loss from ‘by nature’ to ‘by function’ andvice versa;

reclassification from cash flow hedging reserve to profit or loss on the sale of a cash flowhedging instrument as the hedge item affects profit or loss; or,

recognition in profit or loss of a foreign currency translation reserve on disposal offoreign operations.


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Examples

The following are some examples of reclassifications that affect the minimum line items(PAS1.54) in the statement of financial position as of the beginning of the earliest periodpresented which require the presentation of the third statement of financial position:

It has been determined that an entity has incorrectly presented investment property aspart of property, plant and equipment. The entity restates its statements of financialposition to show investment property as a separate line item in accordance with PAS 1.The restatement has a material impact on the statement of financial position as of thebeginning of the earliest period presented.

It has been determined that an entity has incorrectly presented its asset or liability ascurrent or non-current. The entity restates its statements of financial position to correctthe misclassification of the asset or liability in accordance with PAS 1. The restatementhas a material impact on the statement of financial position as of the beginning of theearliest period presented.

Based on the above situations, it is implied that a third statement of financial position shall beprepared when reclassification affects the minimum line items presented in the statements offinancial position as enumerated in PAS 1.54.

Issue 3

Which 'related notes' are required to be presented in respect of the third statement of financialposition?

Consensus

PAS 1.39 clarifies that, when the requirements of PAS 1.10(f) are triggered, the entity shouldpresent at a minimum, three statements of financial position, two of each of the otherstatements, and related notes.

Although PAS 1 is not explicit, it appears that only those notes that may be described assupporting the statement of financial position are required to be presented, i.e., thosedisclosures required by PAS 1.77 to 80A.

In this regard, notes to financial statement shall also provide narrative descriptions ordisaggregation of items presented in the three statements of financial position. Disclosure for allother statements shall be for two years only, except for public companies which are required topresent three statements of comprehensive income, statements of changes in equity andstatements of cash flows.


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This conclusion is also consistent with the PAS1.7 requirement which states that notes providenarrative descriptions or disaggregations of items presented in statements of financial position,statements of comprehensive income and the statements of cash flows, and information aboutitems that do not qualify for recognition in those statements.

In addition, preparers should have regard to the disclosure requirements of PAS 8 in respect ofchanges in accounting policies (see PAS 8.28 and 8.29) and corrections of errors (see PAS8.49) and of PAS 1.41 in respect of reclassifications.

Effective Date


Q&A approved by PIC: July 27, 2011

PIC Members




Ma. Elenita B. Cabrera/Rufo R. Mendoza Edmund A. Go




Q&A approved by FRSC: November 23, 2011


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Q&A No. 2011 – 06 (amended July 2019): PFRS 3, BusinessCombinations (2008), and PAS 40, Investment Property – Acquisitionof investment properties – asset acquisition or businesscombination?

Issue

If one entity acquires (a) directly an investment property or properties or (b) another entity thatholds one or more investment properties, should the transaction be accounted for as an assetacquisition or as a business combination? What are the relevant factors that should beconsidered in determining whether a transaction is an asset acquisition or a businesscombination?

Background and Guidance

Introduction

If one entity acquires (a) directly an investment property or properties or (b) another entity thatholds one or more investment properties, a careful evaluation or analysis on a case-by-casebasis is needed to determine whether such acquisition constitutes a business as defined byPFRS 3. In practice, it may be difficult to decide whether the acquisition meets the definition of abusiness and, accordingly, the exercise of considerable judgment may be required.This Q&A focuses solely on the question of how to assess whether the said transaction is anasset acquisition or a business combination. It does not address the accounting for theacquisition of a subsidiary that is not a business, or the acquisition of a controlling interest ofless than 100% in another entity that is not a business.

Rationale of the issue

Applying the definition of a business based on PFRS 3 to an investment property is not,however, always straightforward because:

unlike most non-financial assets, investment properties usually generate revenues on astand-alone basis (earning rentals being one of their defining characteristics – [PAS40.5]), while most other non-financial assets generate returns only in combination withother assets and liabilities;

in simple asset acquisitions, no obligations or activities are acquired. However,investment properties are often acquired with tenants. Tenants’ leases usually includerelated service obligations. Servicing activities along with others, such as rent collection,can be regarded as integral to an investment property asset.


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It is common for a single investment property to be held in a separate legal entity and for apurchaser to acquire that entity rather than the property. By contrast, most asset acquisitionsare effected by acquiring the asset itself. Although acquiring a legal entity does not necessarilydetermine that a business combination has occurred, buying a legal entity brings with it all of theentity’s assets, liabilities, contractual agreements and obligations. In most cases, an asset orgroup of assets and liabilities that are capable of generating revenues, combined with all ormany of the activities necessary to earn those revenues, would constitute a business. However,investment property is a specific case in which generating earnings from the asset is one of thedefining characteristics. Such characteristic provides complexity in assessing an investmentproperty to constitute as a business following the definition of PFRS 3.

Implications: Business combination versus asset acquisition

The conclusion as to whether an acquired set of activities and assets is a business can lead tosignificantly different accounting results. If an acquired set of activities and assets does notmeet the definition of a business, the transaction is accounted for as an asset acquisition basedon the principles described in other PFRS. There are many differences in the accounting for abusiness combination versus an asset acquisition, such as the following:

Goodwill or a gain on a bargain purchase arises only in a business combination. The initial measurement of assets acquired and liabilities assumed is generally at fair

value in a business combination versus allocated cost (on a relative fair value basis) inan asset acquisition.

Costs which are directly attributable to the acquisition are expensed in a businesscombination, but may be capitalized in an asset acquisition, to the extent that suchcapitalization does not result in an immediate impairment.

Deferred tax assets and liabilities arising on initial recognition are recognized in abusiness combination, but not in an asset acquisition.

Disclosures are much more onerous for business combinations than for assetacquisitions.

Where the consideration is in the form of shares, PFRS 2 Share-based payment willapply for an asset acquisition, but not for a business combination.

These differences not only will affect the accounting as of the acquisition date, but will alsoaffect future amortization, depreciation and possible impairment. Accordingly, the conclusion asto whether a business has been acquired can have a significant effect on a company’s reportedfinancial position and financial performance.


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Review of related accounting literature: PAS 40 and PFRS 3

What is investment property?

The following definition of investment property is based on PAS 40.5.

“Investment property is property (land or a building – or part of a building – or both) held(by the owner or by the lessee as a right-of-use asset) to earn rentals or for capitalappreciation or both, rather than for:

(a) use in the production or supply of goods or services or for administrativepurposes; or


Although the above definition of investment property seems relatively direct, in some practicalsituations, PAS 40.14 provides that judgment is needed to determine whether a propertyqualifies as investment property.

What constitutes a business?

The terms “business combination” and “business” are defined in PFRS 3 Appendix A, Definedterms, as follows:

A business combination is “a transaction or other event in which an acquirer obtainscontrol of one or more businesses. Transactions sometimes referred to as “truemergers” or “mergers of equals” are also business combinations as that term is usedunder PFRS 3.”

A business is “an integrated set of activities and assets that is capable of beingconducted and managed for the purpose of providing a return in the form of dividends,lower costs or other economic benefits directly to investors or other owners, members orparticipants.”

On the other hand, paragraphs B5 to B12 of PFRS 3 Appendix B, Application guidance, provideguidance on identifying a business combination and the definition of a business as follows:

“B7 A business consists of inputs and processes applied to those inputs that have the ability tocreate outputs. Although businesses usually have outputs, outputs are not required for anintegrated set to qualify as a business. The three elements of a business are defined asfollows:


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(d) Input: Any economic resource that creates, or has the ability to create, outputs whenone or more processes are applied to it. Examples include non-current assets(including intangible assets or rights to use non-current assets), intellectual property,the ability to obtain access to necessary materials or rights and employees.

(e) Process: Any system, standard, protocol, convention or rule when applied to input orinputs, creates or has the ability to create outputs. Examples include strategicmanagement processes, operational processes and resource managementprocesses. These processes typically are documented, but an organized workforcehaving the necessary skills and experience following rules and conventions mayprovide the necessary processes that are capable of being applied to inputs to createoutputs. (Accounting, billing, payroll and other administrative systems typically arenot processes used to create outputs.)

(f) Output: The result of inputs and processes applied to those inputs that provide orhave the ability to provide a return in the form of dividends, lower costs or othereconomic benefits directly to investors or other owners, members or participants.”

B8 (in part) However, a business need not include all of the inputs or processes that the sellerused in operating that business if market participants are capable of acquiring thebusiness and continuing to produce outputs, for example, by integrating the businesswith their own inputs and processes.

B12 In the absence of evidence to the contrary, a particular set of assets and activities inwhich goodwill is present shall be presumed to be a business. However, a businessneed not have goodwill.”

Paragraph B10 of PFRS 3 Appendix B provides some factors, which are shown below, to beconsidered when determining whether an integrated set of activities and assets in thedevelopment stage is a business, although not all of these factors need to be present for aparticular set of activities and assets to be considered a business.

Planned principal activities have begun. There are employees, intellectual property and other inputs and there are processes that

could be applied to those inputs. A plan to produce outputs is being pursued. There will be an ability to obtain access to customers who will purchase the outputs.

What constitutes an asset acquisition?

PFRS 3.2(b) provides that if an entity acquires an asset or a group of assets, including anyliabilities assumed, that does not constitute a business, then the transaction is outside the scopeof PFRS 3 because it does not meet the definition of a business combination. Such transactionsare accounted for as asset acquisitions, in which case, the cost of acquisition is allocated


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between the individual identifiable assets and liabilities in the group based on their relative fairvalues at the acquisition date.

Consensus

If one entity acquires (a) directly an investment property or properties or (b) another entity thatholds one or more investment properties, then such transaction should be accounted for inaccordance with its substance. Depending on the facts and circumstances of each transaction,the acquisition will be accounted for as either a business combination or an asset acquisition.The consensus of this Q&A sets out the indicators that should be considered in making thisdecision.

Application of the definitions of a business combination and a business

In applying the PFRS 3 definitions of a business combination and a business to the acquisitionof an entity that holds one or more investment properties or to a direct acquisition of aninvestment property, the acquirer should first identify the elements acquired; i.e., the inputs,processes and outputs. In the context of investment property businesses (excluding developersand traders):

inputs are the property itself; processes are discussed in more detail below and could be ancillary type processes or

more strategic type processes; and outputs are the leases from which rental income is generated.

The existence of inputs and outputs alone (for example, the acquisition of a single tenantproperty) would not lead to a business combination. Furthermore, if the “processes” in aninvestment property business were insignificant to the arrangement as a whole, then this shouldnot in isolation cause the transaction to be a business combination. This is consistent with PAS40.11 which provides that if an entity provides ancillary services to the occupants of a propertythat it holds and such services are insignificant to the overall arrangement, then such propertyshould be treated as investment property.

Therefore, where only some processes are transferred to the acquirer, PAS 40 would lead to anassessment as to how significant the processes or services are relative to the acquiredinvestment property needed for the set of assets and activities to be a business. However, if theacquired set of assets and activities has no processes (e.g., only investment properties, and noactivities, were acquired), the acquired set of assets and activities, in most cases would notconstitute a business. Accordingly, such fact should be appropriately disclosed in the acquirer’sfinancial statements. In addition, the acquirer should disclose the reason for treating thetransaction as an asset acquisition. All of the specific facts and circumstances must beconsidered in applying this highly subjective judgment.


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Indicators

In general, in making the determination of whether an entity’s acquisition of another entity thatholds one or more investment properties or a direct acquisition of an investment propertyconstitutes a business or not, there should be consideration as to whether or not propertymanagement services and/or ancillary services were acquired and the nature of these services.It is important to note that investment property transactions vary significantly in terms of thenature of the underlying assets and the service provision contracts that are acquired and it is notpossible to define a trigger point at which the transaction becomes a business combination asopposed to an asset acquisition.

However, there is a scale within which investment property transactions fall. At one end is asimple single-tenant property for which no services are included. At the other end of the scale isan investment property company.

The table below sets out the processes that can be viewed as purely administrative and wouldnot indicate the acquisition of a business and those that are more strategic and may indicatethat a business has been acquired. The table, however, is not an exhaustive list of the items orfactors that should be considered. The facts and circumstances of each transaction must beconsidered.

Indicators of business combination Not necessarily indicators of businesscombination on their own

Substantive processes and/or servicesacquired/provided:

Lease management (rent reviews,negotiation of terms)

Selection of tenants Investment decisions Management of common areas to

promote increased footfall (forexample, themed evenings,marketing)

Marketing decisions

Administrative processes and/or ancillaryservices acquired/provided:

Security Cleaning Rent collection/invoicing Caretaker

In making the above analysis, the legal form of the acquisition should not change its substance.The acquisition of an investment property or properties for which no services are acquired orprovided does not become a business combination simply because it is effected using a“corporate shell.” Similarly, a business combination should not be accounted for as an assetacquisition simply because the acquiring entity purchases a series of assets rather than acompany.


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See Appendix for the illustrative applications of the above indicators.

Effective Date

The consensus in and amendment to this Q&A are effective from the date of approval by theFRSC.



PIC Members




Sharon G. Dayoan Rufo R. Mendoza




Date originally approved by FRSC: April 25, 2012



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Appendix

The application of the factors (indicators) discussed in the Q&A to certain transactions isillustrated in the following examples.

In the following examples, property investment company A acquires company B, an entitywhose only activity is to hold and administer investment property assets. Is the acquisition abusiness combination or the acquisition of an asset (or assets)?

Example 1 - single property, no tenants or services.

B holds a single investment property. The property has no tenants. B has no staff and does notundertake any services.

Analysis

This is an asset acquisition. Company B is not revenue-generating, and no activities have beentransferred to company A.

Example 2 - single property with tenants

B holds only a single investment property. The property has tenants subject to rentalagreements but no support services or contracts are transferred when B is acquired.

Analysis

This is also an asset acquisition. The acquired entity is revenue-generating, but no activitieshave been transferred to company A. Although the rental agreements are likely to containservicing obligations, company A has not acquired any actual activities.

Example 3 - single property with tenants and services

B holds a single investment property. The investment property has tenants subject to rentalagreements. Certain outsourced service contracts associated with obligations contained in therental agreements are also transferred.

Analysis

This is also an asset acquisition. In this case, support services have been transferred, eventhough they will be performed by external providers. However, these services are purelyancillary to the property and its lease agreements. Activities ancillary to earning rentals are not


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considered as processes that are used to create output and are given a lower weighting indeciding on classification. However, business combination accounting is also acceptable in thisscenario, if such a policy is applied consistently by A in all similar transactions. This is becauseit would not be inconsistent with PFRS 3 definitions to conclude that this scenario amounts toacquisition of a business.

Example 4 - multiple properties, tenants, services and staff

B holds 8 investment properties. The investment properties have tenants subject to rentalagreements. B also employs several staff dedicated to the property management, the provisionof services included in the rental agreements and administration such as invoicing, cashcollection and management reporting.

Analysis

This is a business combination. B appears to have many of the capabilities associated with astandalone business (even if it was in fact a subsidiary). It is also questionable that certaintransferred activities, such as management reporting, are purely ancillary to the properties.Further, although B holding a portfolio of properties is not necessarily decisive in indicating abusiness combination this factor (i) makes it less likely that all of the services/activitiestransferred are specifically ancillary to individual properties; and (ii) meets the "group of assets"part of the PFRS 3 Appendix A definition. Also, the fact that staff have transferred to A suggeststhat A might have acquired employee-related obligations. However, asset acquisition accountingmay also be acceptable if activities/services/staff transferred are ancillary to the portfolio as awhole, and such a policy is applied consistently by A in all similar transactions.

Example 5 - multiple properties, tenants, services and management

Facts as in scenario 4 but the transferred staff also include managers responsible for portfoliomanagement, raising finance and marketing.

Analysis

This is a business combination. Company A has acquired a group of revenue-generating assetsalong with various staff and activities that clearly go beyond activities ancillary to the propertiesand their tenancy agreements.


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Q&A No. 2017 – 09: PAS 17 and Philippine Interpretation SIC-15 -Accounting for payments between and among lessors and lessees

Issue

What is the accounting treatment, from both the lessor’s and the lessee’s perspective, in respectof payments made between and among lessors and lessees (both old tenants and newtenants)?

Fact Pattern

1. Lessor pays:

A. Old tenant to get out of a lease agreement as it intends to redevelop or renovate theproperty.

B. Old tenant to get out of the lease agreement as the lessor intends to or has alreadyre-let the same premises to a new tenant that will pay a significantly higher rent thanthe old tenant, or is of higher quality, or both.

C. A new tenant in the form of an incentive to occupy the property.

D. For alterations to the building specific to the new tenant, which the new tenant makeson its own behalf, that have no further value to the lessor after the completion of thelease period.

2. Old tenant pays:

A. The lessor to enable the old tenant to vacate the leased premises early

B. A new tenant to take over the lease

3. A new tenant pays:

A. The lessor in order to secure the right to obtain a lease agreement

B. An old tenant to buy out the lease agreement


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Consensus

1. Lessor pays:

A. Lessor: A payment to the old tenant must be expensed as incurred unless they meetthe definition of construction costs under PAS 16, Property, Plant and Equipment. Ifa payment meets the definition of construction costs, it is capitalized as part of theassociated property. For example, an entity that acquired a shopping mall and madepayments to evict existing retail lessees in order to redevelop the property into anoffice building would capitalize the payments.

Old tenant: The receipt is recognized as income immediately.

B. Lessor: The payment is expensed.

Old tenant: The receipt is recognized as income immediately.

C. Lessor: The payment to the new tenant is a prepayment and amortized over thelease term on a straight-line basis under Philippine Interpretation SIC-15, OperatingLeases - Incentives.

New tenant: The receipt is recorded as a deferred lease incentive and amortizedover the lease term on a straight-line basis under Philippine Interpretation SIC-15.

D. Lessor: The payment is accounted for in the same manner as C above.

New tenant: The tenant records the amount that it receives from the lessor asdeferred lease incentive, which is amortized over the lease term under PhilippineInterpretation SIC-15.

The costs incurred by the tenant for the alterations to the building are capitalized asleasehold improvement. The tenant must adopt an approach to depreciate itsleasehold improvements over: (i) a period that is the shorter of the lease term or theasset’s useful life, or (ii) the expected useful life of the leasehold improvement.

2. Old tenant pays:

A. Old tenant: The payment is recognized as an expense immediately unless thepayment was already stipulated in the contract and the probability criteria was


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previously met, in which case the liability would have accrued over the expected lifeof the contract.

Lessor: The receipt is recognized as income immediately unless the payment wasalready stipulated in the contract and the probability criteria was previously met, inwhich case the financial asset would have accrued over the expected life of thecontract.

B. Old tenant: The payment is recognized as an expense immediately.

New tenant: The receipt is recognized as income immediately, unless the paymentwas made to compensate the new tenant for above market rentals, in which case thereceipt is recognized over the lease term.


A. New tenant: The payment is recognized as a prepayment (under PAS 17, Leases)and amortized over the lease term on a straight-line basis.

Lessor: The receipt is recognized as deferred revenue (under PAS 17) andamortized over the lease term on a straight-line basis.

B. Old tenant: The receipt is recognized as a gain immediately.

New tenant: The payment is recognized as an intangible asset (under PAS 38,Intangible Assets) with a finite economic life. Since the payment does not directlyrelate to the lease, it is not accounted for under PAS 17.

Accounting treatment of payments made between lessors and lessees (both old tenants andnew tenants)


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The following matrix shows possible business transactions between lessor and lessees onan arm’s length basis.

Treatment in the financial statements ofTransaction Lessor Old tenant New tenant

Lessor pays oldlessee – lessorintends to renovatethe building

(fact pattern 1A)

(i) Expenseimmediately ifthe paymentdoes not meetthe definition ofconstructioncosts inPAS 16.

(ii) Capitalize aspart of thecarrying amountof the leasedasset if thepayment meetsthe definition ofconstructioncosts inPAS 16.

Recognize asincomeimmediately

Lessor pays oldtenant – new leasewith higher qualitytenant

(fact pattern 1B)

Expenseimmediately

Recognize asincomeimmediately

Lessor pays newtenant – anincentive to occupy

(fact pattern 1C)

Recognize aprepayment andamortize this overthe lease term on astraight-line basisunder PhilippineInterpretationSIC-15

Recognize deferredlease incentive andamortize over the leaseterm on a straight-linebasis under PhilippineInterpretation SIC-15

Lessor pays newtenant – buildingalterations specificto the lessee withno further value to

Recognize aprepayment andamortize over thelease term on astraight-line basis

(i) Record amountreceived fromlessor as deferredlease incentive, andamortize it over the


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lessor

(fact pattern 1D)

under PhilippineInterpretationSIC-15

lease term on astraight line basis inaccordance withPhilippineInterpretationSIC-15

(ii) Capitalize costsincurred by thetenant foralterations to thebuilding asleaseholdimprovement

Old tenant payslessor to vacate theleased premisesearly

(fact pattern 2A)

Recognize asincomeimmediately, unlessit was within theoriginal contractand probabilitycriteria previouslymet (if so, it wouldhave been accruedover the lease term)

Recognize asexpenseimmediately unlessit was within theoriginal contractand probabilitycriteria previouslymet (if so, it wouldhave been accruedover the leaseterm)

Old tenant paysnew tenant to takeover the lease

(fact pattern 2B)

Recognize as anexpenseimmediately

Recognize as incomeimmediately (consistentwith the payment fromthe old tenant to thelessor) unless it is tocompensate for abovemarket rentals, in whichcase it is deferred andamortized over the leaseterm

New tenant payslessor to secure theright to obtain alease agreement

(fact pattern 3A)

Recognize asdeferred revenueunder PAS 17 andamortize over thelease term on astraight line basis

Recognize as aprepayment under PAS17 and amortize over thelease term on a straight-line basis


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New tenant paysold tenant to buyout the leaseagreement

(fact pattern 3B)

Recognize as again immediately

Recognize as anintangible asset (underPAS 38) with a finiteeconomic life

Basis for Consensus

PAS 17 deals with costs incurred by a lessor in relation to a lease and payments betweenlessees and lessors on recognition of a lease. Philippine InterpretationSIC-15 deals with how incentives in operating leases should be accounted for both by lessorsand lessees. However, PAS 17 and Philippine Interpretation SIC-15 do not deal with paymentsfor terminating leases or payments between a lessee and a third party.

1. Lessor pays:

A. Lessor: If the payment meets the definition of construction costs of an item ofproperty, plant and equipment contained in paragraph 6 of PAS 16, it must becapitalized. If not, the payment is expensed, as it does not meet the definition of anasset in PAS 16 or PAS 38.

Old tenant: As there is no further performance obligation, the receipt is income.

B. Lessor: A payment by a lessor to a lessee to terminate the lease in order to re-let itto another tenant does not meet the definition of initial direct cost for arranging a newlease (paragraph 52 of PAS 17). This is because this cost is incurred in relation tothe lease with the old tenant, and is not directly related to the new lease, even if thenew lease has been entered into. Therefore, the payment is expensed immediately.

Old tenant: Similar to the conclusion in 1A). Since the lessee has no futureperformance obligations, the receipt is recognized by the lessee as income.

C. Lessor: A payment by a lessor to a new tenant to occupy the property is an integralpart of the net consideration agreed for the use of the leased asset. Underparagraph 3 of Philippine Interpretation SIC-15 this is an incentive. Therefore, thelessor accounts for the payment as a prepayment that is amortized over the leaseterm on a straight line basis.


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New tenant: For the same reasons, the new tenant recognizes the payment asdeferred revenue and amortizes it over the lease term on a straight line basis, as areduction to the rental costs.

D. Lessor: A payment by the lessor to a lessee to reimburse the lessee for the costs ofleasehold improvements to the building at the direction of the lessee is accounted forby the lessor in the same manner and for the same reasons as C above.

Lessee: The amount received from the lessor will be deferred and amortized over thelease term in accordance with paragraph 5 of Philippine Interpretation SIC-15. Thecosts incurred by the tenant for the alterations to the building meet the capitalexpenditure criteria in PAS 16 and are capitalized.

2. Old tenant pays:

A. A payment made by the lessee to the lessor to get out of a lease agreement doesnot meet the relevant definitions in PAS 16 or PAS 38 and is not accounted for underPAS 17 since there is no longer a lease in existence. It is therefore expensed.

Similarly, from the lessor’s perspective, income is recorded in the same manner.

However, if the payment to the lessor to vacate the premises was already stipulatedin the original lease contract and the payment was assessed as probable during thelife of the contract, both the lessee and lessor would have accrued this over thelease term in accordance with the principles established in PAS 17.

B. A payment made by an existing tenant to a new tenant to take over the lease doesnot meet the definition of an asset under PAS 16 or PAS 38 and is not accounted forunder PAS 17 since there is no longer a lease in existence. It should therefore beexpensed.

The new tenant recognizes the receipt as income at the inception of the lease,unless the payment was made to compensate the new tenant for paying above-market rentals (similar in nature to an incentive to enter into the lease). In the caseof the latter, the receipt is deferred and amortized over the period of the lease.


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A. A payment made by a new tenant to the lessor in connection with a leasearrangement is accounted for under PAS 17 and therefore accounted for as aprepayment and amortized over the lease term by the new tenant.

Similarly this is treated by the lessor as revenue received in advance and amortizedover the lease term.

B. A payment made by a new tenant to an old tenant to buy out the old tenant’s lease(with a third party lessor), is not directly related to the new tenant’s lease (i.e., theagreement between the new tenant and the third party lessor). Therefore it cannot beaccounted for under PAS 17.

The payment will generally meet the definition of an intangible asset in paragraph 8of PAS 38, and therefore is amortized over the useful life – being the term of thelease. However, if this definition is not met due to other conditions andcircumstances in the arrangement, the payment is recognized as an expense in theperiod in which it is incurred.

From the perspective of the old tenant, the receipt is treated as a gain immediatelyand any remaining balances of the lease are removed and netted off with theamounts received to calculate any resulting gain.

Effective Date




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PIC Members











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Q&A No. 2018 – 07 (amended June 2018): PAS 27 and PAS 28 - Costof an associate, joint venture, or subsidiary in separate financialstatements

Issue

How is cost determined for an investment in an associate, joint venture, or subsidiary whenvaluing the investment at cost in the separate financial statements? In particular, how are thefollowing factored into the determination of cost:

Transaction costs

Contingent consideration

Step acquisitions

Fact pattern

Entity A accounts for its investments in associates, joint ventures and subsidiaries at cost in itsseparate financial statements. It entered into the following transactions:

Scenario 1

In June 20X0, Entity A acquires an 80% interest in Entity C. Entity A paid CU1,000 and will payadditional consideration in the future of CU2,000 if certain targets were met. The fair value ofthe contingent consideration recognized in the consolidated financial statements was CU1,400.Transaction costs of CU300 were also incurred.

Scenario 2

Entity A has a 10% interest in Entity B, which it acquired in January 20X1 for CU300. Thisinvestment was a financial asset measured at fair value in accordance with PFRS 9, FinancialInstruments, in both the consolidated and separate financial statements of Entity A. In March20X1, Entity A acquires a further 15% interest in Entity B for CU720 (its then fair value), givingEntity A significant influence over Entity B. The original 10% interest had a fair value of CU480at that date. In addition, transaction costs were incurred for both tranches, in aggregateamounting to CU50.


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Cost for this purpose is not separately defined in PAS 27 or PAS 28.

However, where PFRS/IFRS uses the term elsewhere, cost generally means the fair value ofthe consideration plus incidental costs. In July 2009, the IFRS Interpretations Committee(IFRIC) also expressed this view, when they noted, that generally under IFRSs, cost comprisesthe purchase price and to other costs directly attributable to the acquisition.

‘Consideration given’ is likewise not defined and the key sources of guidance are:

‘consideration transferred’ in the context of a business combination, as referred to inparagraph 37 of PFRS 3. The 'consideration transferred' in a business combinationcomprises the sum of the acquisition-date fair values of assets transferred by theacquirer, liabilities incurred by the acquirer to the former owners of the acquiree, andequity interests issued by the acquirer, and any goodwill given up. This includes anyliability (or asset) for contingent consideration, which is measured and recognized at itsfair value at the acquisition date. The liability arising is a financial liability within thescope of PFRS 9, Financial Instruments; therefore, subsequent changes inmeasurement are recognized in profit or loss.

‘cost’ as applied in relation to acquisitions of property, plant and equipment inaccordance with PAS 16, intangible assets in accordance with PAS 38 and investmentproperty in accordance with PAS 40.

The IFRS Interpretations Committee and the International Accounting Standards Board (IASB)have discussed the topic Variable payments for the separate acquisition of PPE and intangibleassets for a number of years, attempting to clarify how the initial recognition of the variablepayments, such as contingent consideration, and subsequent changes in the value of thosepayments should be recognized. The scope of the past deliberations did not specifically includethe cost of an investment in a subsidiary, associate or joint venture. However, the generalprinciples about the recognition of variable payments can be considered relevant in determiningthe cost of such investments. The Interpretations Committee decided that this issue is toobroad for it to address and concluded that the IASB should address accounting for variablepayments more comprehensively. Until the IASB issues further guidance, differing viewsremain about the circumstances in which, and to what extent, variable payments such ascontingent consideration should be recognized when initially recognizing the underlying asset.There are also differing views about the extent to which subsequent changes should berecognized through profit or loss or capitalized as part of the cost of the asset.

Where entities have made an accounting policy choice regarding recognition of contingentconsideration and subsequent changes in accounting for the cost of investments in subsidiaries,


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associates or joint ventures in separate financial statements, the policy should be disclosed andconsistently applied.

Consensus

The cost of an investment in an associate, joint venture, or subsidiary in the separate financialstatements of the parent is the sum of the consideration given for the transaction, includingtransaction costs, and, may also include, the fair value of any contingent considerationarrangement entered into at that date, depending on the entity’s accounting policy.

In a step acquisition, the cost of an investment in an associate, joint venture or subsidiary is thesum of the consideration given for each tranche. Therefore, if there were any changes in the fairvalue of the previous tranches (between the acquisition date and the date that a later tranchewas acquired), those changes in fair value must be analyzed to determine whether they shouldbe recognized in profit or loss or in other comprehensive income, as appropriate.

Scenario 1

The cost is the sum of the consideration paid and the transaction costs. If the entity has anaccounting policy of recognizing contingent consideration, the fair value of the contingentconsideration arrangement at the date of gaining control is also part of the cost – CU2,700(CU1,000 + CU1,400 + CU300).

Scenario 2

The cost is the sum of the consideration given for each tranche plus transaction costs –CU1,250 (CU300 + CU720 + CU50 + CU180). The increase in fair value of CU180 (CU480 –CU300) relating to the first 10% is: (1) recognized in profit or loss if the financial asset haspreviously been designated at fair value through profit or loss; or (2) recognized in equity if thefinancial asset has previously been designated at fair value through other comprehensiveincome on the date the increase in ownership over the investee was made.

If Entity A purchased the 10% ownership in Entity B in 20X0 and has recognized the changes inthe fair value of this equity investment in other comprehensive income before, the amountrecognized in other comprehensive income should be transferred to retained earnings as ifEntity A had disposed directly of the previously held equity interest.

The conclusions in this Q&A apply only to transactions within the scope of PAS 27, SeparateFinancial Statements, and PAS 28, Investments in Associates and Joint Ventures, and are not tobe analogized to for other assets and liabilities where cost is based on transaction price.


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The consensus in and amendments to this Q&A is effective from the date of the approval by theFRSC.

Date approved by PIC: January 31, 2018Date amendments approved by PIC: June 27, 2018

PIC Members









Date approved by FRSC: March 14, 2018Date amendments approved by FRSC: October 10, 2018


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Q&A No. 2018 – 14 (amended June 2020): PFRS 15 - Accounting forCancellation of Real Estate Sales

Background Company X is a real estate developer and is in the business of pre-selling condominium

units while construction is not yet completed.


In January 20x1, Company X pre-sold a condominium unit at Php1,000,000, payable for 3years on an installment basis1. Under the sale contract, legal title to the unit remains withCompany X until full payment is made by the buyer.

Estimated cost to construct the unit is Php800,000.

As at December 31, 20x1, POC of the unit is at 30% and collection from the buyer is 15%of the selling price (Php150,000). Amounts recognized in the calendar year 20x1 financialstatements follow:

In June 20x2, the buyer defaulted on its payment and Company X repossessed theproperty2. At the time of repossession, the property was 50% completed (i.e., at that point,Company X has already recognized revenue of Php500,000 and cost of sales ofPhp400,000). As agreed under the contract, Company X forfeits all payments previouslymade by the buyer.


Amount in PhpReal Estate Revenue (1,000,000*30%) 300,000Cost of Real Estate Sales (800,000*30%) 240,000


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Issue 1 - How should Company X account for the sales cancellation and repossession of theproperty?

Consensus:

Both Approaches 1 and 2 below are acceptable but each approach should be appliedconsistently.

Approach 1: The repossessed property is recognized at its fair value less cost to repossess

As the repossessed property will be accounted for as inventory, it will be initially measuredat cost under PAS 2.9. Cost as defined under the Conceptual Framework is the fair valueof the consideration given at the time of acquisition. In this case, the consideration given inexchange for the property is the Receivable from the buyer. Just before the repossessionhappens, the Receivable has become a right to receive the property, so the fair value of theReceivable is the fair value of what Company X has claim to (i.e., the 50%-completedproperty) less any cost to repossess the property (e.g., broker’s fees and lawyer’s fees,etc.).

Just prior to repossession, Company X has to update its impairment assessment on theReceivable. For example, if the fair value of the property to be repossessed less anyrepossession cost is higher than the carrying amount of the Receivable, then anypreviously recognized impairment on the Receivable has to be reversed (with reversallimited to the unimpaired amount).

Upon repossession, the difference between the carrying amount of the Receivable to bederecognized and the fair value of the repossessed property less repossession cost will berecognized in profit or loss.



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In the case at hand, the Receivable is unimpaired just prior to repossession because thefair value less repossession cost of the property is Php545,000 and is greater than theoutstanding amount of the Receivable of Php350,000. Upon repossession, a gain onrepossession of Php195,000 will be recognized (Fair value less repossession cost ofPhp545,000 less carrying amount of the Receivable of Php350,000). The repossessioncost of Php5,000 will be capitalized as part of the cost of the repossessed property butsubject to impairment.




Approach 2: The repossessed property is recognized at its fair value plus repossession cost

As there is no specific guidance in PAS 2 on accounting for repossessed property,reference can be made to the guidance in PAS 16.24 and PAS 40.27 for property acquiredin exchange for a non-monetary asset/s or a combination of monetary and non-monetaryassets. Under these paragraphs, the asset received (in this case, the uncompletedproperty) is recognized at fair value.

Just prior to repossession, Company X has to update its impairment assessment on theReceivable. For example, if the fair value of the property to be repossessed less anyrepossession cost is higher than the carrying amount of the Receivable, then anypreviously recognized impairment on the Receivable has to be reversed (with reversallimited to the unimpaired amount).

Upon repossession, the difference between the carrying amount of the Receivable to bederecognized and the fair value of the repossessed property will be recognized in profit orloss. Any cost incurred to repossess the property will be capitalized in accordance withPAS 2.15.

In the case at hand, the Receivable is unimpaired just prior to repossession because thefair value less repossession cost of the property is Php545,000 and is greater than theoutstanding amount of the Receivable of Php350,000. Upon repossession, a gain onrepossession of Php200,000 will be recognized (Fair value of Php550,000 less carrying


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amount of the Receivable of Php350,000). The repossession cost of Php5,000 will becapitalized as part of the cost of the repossessed property but subject to impairment.




Both Approaches 1 and 2 above should consider payments to buyers required under theMaceda Law and the write off of any unamortized portion of cost of obtaining a contract in itsdetermination of gain/loss from repossession.

Discussion:

The Committee deliberated on two other views observed in practice, as follows:

3. To record the repossessed property at the carrying amount of the receivable given up;and,

4. To record the repossessed property at its original carrying amount (i.e., its carryingamount at the time it was sold) and recognize any difference between the carryingamount of the derecognized receivable and the repossessed property in profit or loss.

The Committee agreed that the first view is not acceptable as the use of the carrying amount ofthe asset given up is only allowed if the fair value of the either the asset received or the assetgiven up is not available. The second view also lacks merit as it is in effect an application of theaccounting treatment for sales returns. Repossession of real estate inventory is not of thenature of sales return. In view of the above, the Committee concluded that these two views arenot acceptable.

Issue 2 - Would the accounting for the repossession change if the repossessed property isalready 100% completed?


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Consensus:



The effective date and transition provision of this Q&A follow those of PFRS 15 Appendix C,upon approval by the FRSC.



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PIC Members











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REFERENCES

PAS 2.9Inventories shall be measured at the lower of cost and net realizable value.

PAS 2.6Net realizable value is the estimated selling price in the ordinary course of business less theestimated costs of completion and the estimated costs necessary to make the sale.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants at the measurement date. (See PFRS 13 FairValue Measurement.)

PAS 2.7Net realisable value refers to the net amount that an entity expects to realise from the sale ofinventory in the ordinary course of business. Fair value reflects the price at which an orderlytransaction to sell the same inventory in the principal (or most advantageous) market for thatinventory would take place between market participants at the measurement date. The former isan entity-specific value; the latter is not. Net realisable value for inventories may not equal fairvalue less costs to sell.

PAS 2.10The cost of inventories shall comprise all costs of purchase, costs of conversion and other costsincurred in bringing the inventories to their present location and condition.

PAS 2.11The costs of purchase of inventories comprise the purchase price, import duties and other taxes(other than those subsequently recoverable by the entity from the taxing authorities), andtransport, handling and other costs directly attributable to the acquisition of finished goods,materials and services. Trade discounts, rebates and other similar items are deducted indetermining the costs of purchase.

PAS 2.15Other costs are included in the cost of inventories only to the extent that they are incurred inbringing the inventories to their present location and condition. For example, it may beappropriate to include non-production overheads or the costs of designing products for specificcustomers in the cost of inventories.


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Conceptual Framework 6.5A number of different measurement bases are employed to different degrees and in varyingcombinations in financial statements. They include the following:

3. (a) Historical cost. The historical cost of an asset when it is acquired or created is thevalue of the costs incurred in acquiring or creating the asset, comprising theconsideration paid to acquire or create the asset plus transaction costs. The historicalcost of a liability when it is incurred or taken on is the value of the consideration receivedto incur or take on the liability minus transaction costs.

PAS 16.24One or more items of property, plant and equipment may be acquired in exchange for a non-monetary asset or assets, or a combination of monetary and non-monetary assets. Thefollowing discussion refers simply to an exchange of one non-monetary asset for another, but italso applies to all exchanges described in the preceding sentence. The cost of such an item ofproperty, plant and equipment is measured at fair value unless (a) the exchange transactionlacks commercial substance or (b) the fair value of neither the asset received nor the assetgiven up is reliably measurable. The acquired item is measured in this way even if an entitycannot immediately derecognise the asset given up. If the acquired item is not measured at fairvalue, its cost is measured at the carrying amount of the asset given up.

PAS 40.27One or more investment properties may be acquired in exchange for a non-monetary asset orassets, or a combination of monetary and non-monetary assets. The following discussion refersto an exchange of one non-monetary asset for another, but it also applies to all exchangesdescribed in the preceding sentence. The cost of such an investment property is measured atfair value unless (a) the exchange transaction lacks commercial substance or (b) the fair valueof neither the asset received nor the asset given up is reliably measurable. The acquired assetis measured in this way even if an entity cannot immediately derecognise the asset given up. Ifthe acquired asset is not measured at fair value, its cost is measured at the carrying amount ofthe asset given up.

PAS 18.16If the entity retains significant risks of ownership, the transaction is not a sale and revenue is notrecognised. An entity may retain a significant risk of ownership in a number of ways. Examplesof situations in which the entity may retain the significant risks and rewards of ownership are:


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(a) when the entity retains an obligation for unsatisfactory performance not covered by normalwarranty provisions;

(b) when the receipt of the revenue from a particular sale is contingent on the derivation ofrevenue by the buyer from its sale of the goods;

(c) when the goods are shipped subject to installation and the installation is a significant part ofthe contract which has not yet been completed by the entity; and

(d) when the buyer has the right to rescind the purchase for a reason specified in the salescontract and the entity is uncertain about the probability of return.

PFRS 13.24Fair value is the price that would be received to sell an asset or paid to transfer a liability in anorderly transaction in the principal (or most advantageous) market at the measurement dateunder current market conditions (i.e. an exit price) regardless of whether that price is directlyobservable or estimated using another valuation technique.

PFRS 15.B20In some contracts, an entity transfers control of a product to a customer and also grants thecustomer the right to return the product for various reasons (such as dissatisfaction with theproduct) and receive any combination of the following:


(b) a credit that can be applied against amounts owed, or that will be owed, to the entity; and

(c) another product in exchange.PFRS 15.B21To account for the transfer of products with a right of return (and for some services that areprovided subject to a refund), an entity shall recognise all of the following:

(a) revenue for the transferred products in the amount of consideration to which the entityexpects to be entitled (therefore, revenue would not be recognised for the productsexpected to be returned);



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(c) an asset (and corresponding adjustment to cost of sales) for its right to recover productsfrom customers on settling the refund liability.

PFRS 15.B22An entity's promise to stand ready to accept a returned product during the return period shall notbe accounted for as a performance obligation in addition to the obligation to provide a refund.

PFRS 15.B23An entity shall apply the requirements in paragraphs 47–72 (including the requirements forconstraining estimates of variable consideration in paragraphs 56–58) to determine the amountof consideration to which the entity expects to be entitled (i.e. excluding the products expectedto be returned). For any amounts received (or receivable) for which an entity does not expect tobe entitled, the entity shall not recognise revenue when it transfers products to customers butshall recognise those amounts received (or receivable) as a refund liability. Subsequently, at theend of each reporting period, the entity shall update its assessment of amounts for which itexpects to be entitled in exchange for the transferred products and make a correspondingchange to the transaction price and, therefore, in the amount of revenue recognised.PFRS 15.B24An entity shall update the measurement of the refund liability at the end of each reporting periodfor changes in expectations about the amount of refunds. An entity shall recognisecorresponding adjustments as revenue (or reductions of revenue).

PFRS 15.B25An asset recognised for an entity's right to recover products from a customer on settling arefund liability shall initially be measured by reference to the former carrying amount of theproduct (for example, inventory) less any expected costs to recover those products (includingpotential decreases in the value to the entity of returned products). At the end of each reportingperiod, an entity shall update the measurement of the asset arising from changes inexpectations about products to be returned. An entity shall present the asset separately fromthe refund liability.




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PFRS for Small and Medium-sized Entities (SMEs)

Q&A No. 2013 - 01: Applicability of SMEIG Final Q&As on theapplication of IFRS for SMEs to Philippine SMEs

Issue

Are the Final Q&As issued by the SME Implementation Group (SMEIG) on the application ofInternational Financial Reporting Standard for Small and Medium-sized Entities (IFRS forSMEs) applicable to and can be applied by Philippine SMEs?

Background

IFRS for SMEs was issued to provide a common framework for financial reporting of SMEs inresponse to strong international demand for a rigorous and uniform set of accounting standardsfor SMEs. IFRS for SMEs simplified and reduced the detailed requirements that exist underIFRS.

In 2009, the Philippine Financial Reporting Standards Council (FRSC) and the Securities andExchange Commission (SEC) adopted IFRS for SMEs as Philippine Financial ReportingStandard (PFRS) for SMEs effective on January 1, 2010.

Following the issuance of IFRS for SMEs by the International Accounting Standards Board(IASB) in 2009, the SMEIG has issued seven final Q&As which aim to provide non-mandatoryand timely guidance to SMEs implementing IFRS for SMEs. SMEIG is an advisory body to theIASB in the implementation of IFRS for SMEs. Following are the seven Final Q&As issued bythe SMEIG, which are included as appendices to this Q&A and which are also available in theIASB website:

Q&A Number TitleQ&A 2011/01 Use of IFRS for SMEs in a parent’s separate financial statementsQ&A 2011/02 Entities that typically have public accountability

Q&A 2011/03Interpretation of ‘traded in a public market’ in applying the IFRSfor SMEs

Q&A 2012/01 Application of ‘undue cost or effort’Q&A 2012/02 Jurisdiction requires fallback to full IFRSsQ&A 2012/03 Fallback to IFRS 9, Financial Instruments

Q&A 2012/04Recycling of cumulative exchange differences on disposal of asubsidiary


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Consensus

The above SMEIG Final Q&As can be applied by Philippine SMEs adopting PFRS for SMEs,except for the following:

1. SMEIG Q&A 2011/01 – Use of IFRS for SMEs in a parent’s separate financialstatements

This Q&A allows a parent company to present its separate financial statements inaccordance with IFRS for SMEs even if it presents its consolidated financial statementsin accordance with full IFRSs as long as the parent company, based on its ownassessment and without considering other group entities, has no public accountability.As a result, there will be two different financial reporting frameworks used by thecompany, i.e., IFRS for SMEs in the separate financial statements and full IFRS in theconsolidated financial statements.

In the Philippines, however, it will not be possible to use PFRS for SMEs in the separatefinancial statements and full PFRSs in the consolidated financial statements because ofthe quantitative criterion provided by the SEC in determining whether an entity is anSME or not. Under the Securities Regulation Code (SRC) Rule 68 (As Amended 2011),SMEs are entities that meet all the criteria specified by the SEC, which include thisquantitative criterion: “Total assets of between P3 million to P350 million or total liabilitiesbetween P3 million to P250 million. If the entity is a parent company, the amount shall bebased on the consolidated figures" (underscoring supplied). This rule specificallyindicates that the assessment whether the entity qualifies as an SME is based on itsconsolidated figures. Hence, a separate assessment based on the parent’s own figuresis not appropriate. Therefore, once a parent company is determined to be not an SMEbased on its consolidated figures, it is likewise deemed not an SME even in its separatefinancial statements.

2. SMEIG Q&A 2011/02 – Entities that typically have public accountability

Entities with public accountability are not eligible to use IFRS for SMEs. An entity haspublic accountability if it holds assets in a fiduciary capacity for a broad group ofoutsiders as one of its primary businesses. Paragraph 1.3(b) of IFRS for SMEsidentifies banks, credit unions, insurance companies, securities brokers/ dealers, mutualfunds and investment banks as examples of the type of entity that ‘typically’ holds assetsin a fiduciary capacity for a broad group of outsiders as one of its primary businesses.This SMEIG Q&A 2011/02 clarifies that entities indicated in Paragraph 1.3(b) of IFRS forSMEs should not automatically be assumed to have public accountability. Judgment isrequired to assess whether these entities actually have public accountability as defined


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under the standard. Thus, it is possible that entities indicated in Paragraph 1.3(b) canbe eligible to apply IFRS for SMEs.In the Philippines, the entities indicated in Paragraph 1.3(b) of PFRS for SMEs areregulated entities that are considered as publicly accountable entities under SRC Rule68. Thus, those entities are not SMEs and are, therefore, not eligible to use PFRS forSMEs.

Effective Date


Q&A approved by PIC: January 30, 2013

PIC Members










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AppendixList of Approved Q&As as of June 30, 2021

by date of issuance

PIC Q&A Date approved byPIC

Date approvedby FRSC

Q&A No. 2006 – 02 (amended August 2013):PFRS 10.4(a) – Clarification of criteria forexemption from presenting consolidated financialstatements

November 7, 2006

AmendedSeptember 25, 2013

December 18,2006

AmendedOctober 8, 2014

Q&A No. 2007 – 03: PAS 40.27 – Valuation ofbank real and other properties acquired (ROPA)

February 21, 2007 April 19, 2007

Q&A No. 2008 – 01 (Revised): PAS 19.83 – Rateused in discounting post-employment benefitobligations

December 16, 2009

AmendedApril 27, 2016

June 4, 2010


Q&A No. 2009 – 01 (amended August 2013):Framework.23 and PAS 1.23 – Financialstatements prepared on a basis other than goingconcern

February 18, 2009

AmendedSeptember 25, 2013

March 16, 2009


Q&A No. 2010 – 02: PAS 1R.16 – Basis ofpreparation of financial statements

March 2, 2010 June 4, 2010

Q&A No. 2010 – 03: PAS 1R.16 – PAS 1Presentation of Financial Statements – Current/non-current classification of a callable term loan

September 29, 2010 April 25, 2012

Q&A No. 2011 - 02: PFRS 3.2 –PFRS 3.2 –Common Control Business Combinations

August 24, 2011 November 23,2011

Q&A No. 2011 – 03 (amended July 2015):Accounting for Inter-company Loans

September 21, 2011

Amended

November 23,2011

Amended


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July 29, 2015 October 14, 2015

Q&A No. 2011 - 04: PAS 32.37-38 – Costs ofPublic Offering of Shares

September 21, 2011 January 25, 2012

Q&A No. 2011 - 05: PFRS 1 – Fair Value orRevaluation as Deemed Cost

October 20, 2011

AmendedApril 27, 2016

AmendedAugust 1, 2019

January 25, 2012



Q&A No. 2012 - 01 (amended July 2015): PFRS3.2 – Application of the Pooling of Interests Methodfor Business Combinations of Entities underCommon Control in Consolidated FinancialStatements

September 26, 2012

AmendedJuly 29, 2015

January 29, 2013


Q&A No. 2012 - 02: Cost of a new buildingconstructed on the site of a previous building

December 19, 2012


June 11, 2013


Q&A No. 2013 - 03 (Revised): PAS 19 –Accounting for Employee Benefits under a DefinedContribution Plan subject to Requirements ofRepublic Act (RA) 7641, The Philippine RetirementLaw

July 30, 2014 October 8, 2014

Q&A No. 2016 - 02: PAS 32 and PAS 38 –Accounting Treatment of Club Shares Held by anEntity

April 27, 2016 June 8, 2016

Q&A No. 2016 - 04: Application of PFRS 15“Revenue from Contracts with Customers” on Saleof Residential Properties under Pre-completionContracts

November 16, 2016 December 7,2016

Q&A No. 2016-03 Accounting for Common Areasand the Related Subsequent Costs byCondominium Corporations

August 31, 2016 October 11, 2017


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Q&A No. 2017-04 PAS 24 - Related partyrelationships between parents, subsidiary,associate and non-controlling shareholder

June 28, 2017 October 11, 2017

Q&A No. 2017-05 PFRS 7 – Frequently askedquestions on the disclosure requirements offinancial instruments under PFRS 7, FinancialInstruments: Disclosures

June 28, 2017 October 11, 2017

Q&A No. 2017-07 PFRS 10 – Accounting forreciprocal holdings in associates and joint ventures

June 28, 2017 October 11, 2017

Q&A No. 2017-08 PFRS 10 – Requirement toprepare consolidated financial statements wherean entity disposes of its single investment in asubsidiary, associate or joint venture

June 28, 2017 October 11, 2017

Q&A No. 2017-10 PAS 40 - Separation of propertyand classification as investment property

June 28, 2017


October 11, 2017


Q&A No. 2017-11 PFRS 10 and PAS 32 -Transaction costs incurred to acquire outstandingnon-controlling interest or to sell non-controllinginterest without a loss of control

June 28, 2017 October 11, 2017

PIC Q&A No. 2017-02 PAS 2 and PAS 16 -Capitalization of operating lease cost as part ofconstruction costs of a building

June 28, 2017


December 13,2017


Q&A No. 2017-03 PAS 28 - Elimination of profitsand losses resulting from transactions betweenassociates and/or joint ventures

June 28, 2017 December 13,2017


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Q&A No. 2017-06 PAS 2, 16 and 40 - Accountingfor Collector’s Items

June 28, 2017 December 13,2017

Q&A No. 2017-12 Subsequent Treatment of EquityComponent Arising from Intercompany Loans

July 26, 2017 October 11, 2017

Q&A No. 2018-12 PFRS 15 implementation issuesaffecting the real estate industry

January 31, 2018 February 14,2018

Q&A No. 2018-01 PAS 8 – Voluntary changes inaccounting policy

January 31, 2018 March 14, 2018

Q&A No. 2018-02 PAS 36 – Non-controllinginterests and goodwill impairment test

January 31, 2018 March 14, 2018

Q&A No. 2018-03 PFRS 13, PAS 16 and PAS 36 –Fair value of property, plant and equipment anddepreciated replacement cost

January 31, 2018 March 14, 2018

Q&A No. 2018-04 PAS 41 – Inability to measurefair value reliably for biological assets within thescope of PAS 41, Agriculture

January 31, 2018 March 14, 2018

Q&A No. 2018-05 PAS 37 – Liability arising frommaintenance requirement of an asset held under alease

January 31, 2018


March 14, 2018


Q&A No. 2018-06 PAS 27 – Cost of investment insubsidiaries in separate financial statements whenpooling is applied in consolidated financialstatements

January 31, 2018 March 14, 2018

Q&A No. 2018-08 PFRS 10 and PFRS 3 -Accounting for the acquisition of a non-whollyowned subsidiary that is not a business

January 31, 2018 March 14, 2018

Q&A No. 2018-09 PAS 21 – Classification ofdeposits and progress payments as monetary ornonmonetary items

January 31, 2018 March 14, 2018


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Q&A No. 2018-10 PAS 2 – Scope of disclosure ofinventory write-downs

January 31, 2018 March 14, 2018

Q&A No. 2018-11 Classification of land by realestate developer

January 31, 2018 March 14, 2018

Q&A No. 2018-13 Conforming Changes to PICQ&As – Cycle 2018

June 27, 2018 October 10, 2018

PIC Q&A No. 2018-15 PAS 1- Classification ofAdvances to Contractors in the Nature ofPrepayments: Current vs. Non-current

June 27, 2018


October 10, 2018


PIC Q&A No. 2018-16 PFRS 13 - Level of fairvalue hierarchy of government securities usingBloomberg’s standard rule on fair value hierarchy(Subject to approval by the BOA)

December 14, 2018 January 9, 2019

Q&A No. 2019-01 Accounting for service chargesunder PFRS 15, Revenue from Contracts withCustomers

January 30, 2019 February 13,2019

Q&A 2019-02 Accounting for cryptographic assets January 30, 2019 February 13,2019

Q&A No. 2019-03 Revenue recognition guidancefor sugar millers

March 26, 2019 March 28, 2019


August 1, 2019 August 14, 2019

Q&A No. 2019-06 Accounting for step acquisitionof a subsidiary in a parent’s separate financialstatements

August 28, 2019 October 9, 2019

Q&A No. 2019-07 Classification of Members’Capital Contributions of Non-Stock Savings andLoan Associations (NSSLA)

November 28, 2019 December 11,2019


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Q&A No. 2019-08 Accounting for Asset Retirementor Restoration Obligation with the Adoption ofPFRS 16, Leases

December 17, 2019 December 23,2019

Q&A No. 2019-09 Accounting for Prepaid Rent orRent Liability Arising from Straight-lining underPAS 17 on Transition to PFRS 16 and the RelatedDeferred Tax Effects


Q&A No. 2019-10 Accounting for variablepayments with rent review


Q&A No. 2019-11 Determining the current portionof an amortizing loan/lease liability


Q&A No. 2019-12 Determining the lease termunder PFRS 16, Leases


Q&A No. 2019-13 Determining the lease term ofleases that are renewable subject to mutualagreement of the lessor and the lessee



June 30, 2020 August 19, 2020

Q&A No. 2020-02 Conclusion on PIC QA 2018-12E: On certain materials delivered on site but notyet installed

October 29, 2020 November 6,2020

Q&A No. 2020-03 Q&A No. 2018-12-D: STEP 3 –On the accounting of the difference when thepercentage of completion is ahead of the buyer’spayment

September 30, 2020 October 14, 2020

Q&A No. 2020-04 (Addendum to PIC Q&A 2018-12-D) PFRS 15 - Step 3 - Requires and Entity toDetermine the Transaction Price for the Contract

November 6, 2020 November 11,2020


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Q&A No. 2020-05 (Supersedes Q&A 2018-14)PFRS 15 - Accounting for Cancellation of RealEstate Sales

November 6, 2020 November 11,2020

Q&A No. 2020-06 (Supersedes Q&A No. 2017-09)PFRS 16 - Accounting for payments between andamong lessors and lessees


Q&A No. 2020-07 PAS 12 – Accounting for theProposed Changes in Income Tax Rates under theCorporate Recovery and Tax Incentives forEnterprises Act (CREATE) Bill

January 27, 2021 January 29, 2021

Approved Q&As on Philippine Financial Reporting Standards

Documents