March 9, 2018

The Board of Directors

Madrigal Ave., Alabang, Muntinlupa City

ATTENTION:

RE: ANSWER TO INQUIRY CONCERNING THE DERECOGNITION/

IMPAIRMENT OF SPECIFIC BALANCE SHEET ACCOUNTS

Gentlemen:

This has reference to your e-mail dated February 28, 2018 requesting for our opinion regarding the write-
off of the Company’s accounts payable, accounts receivable, creditable withholding tax and specific items
of investment account. The accounting bases as well as the tax consequences for the proposed write-off are
discussed under the appropriate captions hereunder.

Derecognition of Accounts Payable

The basis for derecognition of accounts payable (financial liability) is found under the Philippine
Accounting Standards (PAS) 39, Financial Instruments: Recognition and Measurement. It provides that a
financial liability is derecognized (removed from the statement of financial position) when, and only when,
it is extinguished, that is, when the obligation specified in the contract is either discharged or cancelled or
expired.1 It further provides that: where there has been an exchange between an existing borrower and
lender of debt instruments with substantially different terms, or there has been a substantial modification of
the terms of an existing financial liability, this transaction is accounted for as an extinguishment of the
original financial liability and the recognition of a new financial liability. A gain or loss from
extinguishment of the original financial liability is recognized in profit or loss.2

The Company’s records show accounts payable amounting to ₱4,020,070.77 have been long outstanding
and that there is no indication that the creditors will pursue collection of these accounts. However, as
required by PAS 39 cited above, the Company must first establish that it has been legally released from its
responsibility under the contract before it can write-off the accounts payable from its books. The same is
also true with respect to the accrued expense amounting to ₱2,312,660.61 Thus, it is submitted that the
total accounts payable and accrued expense shall not be derecognized in full but on a per “line item” basis
which requires individual assessment for each account/creditor to determine whether the Company has
been legally released from its obligation therefrom.

As to the tax effect, we submit that since the “expenses” corresponding to the accounts payable has been
utilized as a deduction for income tax purposes in the year they were incurred, the subsequent
derecognition results to a tax benefit and thus, should be subjected to income tax. Moreover, the Output
VAT corresponding thereto shall be recognized and paid considering that such reversal is a taxable benefit.
Please refer to sample computation of income tax enclosed herewith as annex “A”.

1
PAS 39.39
2
PAS 39.40-41
1
Impairment of Financial Assets

The same standard requires that an entity shall assess at the end of each reporting period whether there is
any objective evidence that a financial asset or group of financial assets is impaired. 3

A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only
if, there is objective evidence of impairment as a result of one or more events that occurred after the initial
recognition of the asset (a ‘loss event’) and that loss event (or events) has an impact on the estimated future
cash flows of the financial asset or group of financial assets that can be reliably estimated. 4

Objective evidence is defined as any observable data that comes to the attention of the holder of the asset
about the following loss events:

(a) significant financial difficulty of the issuer or obligor;

(b) a breach of contract, such as a default or delinquency in interest or principal payments;
(c) the lender, for economic or legal reasons relating to the borrower’s financial difficulty, granting to
the borrower a concession that the lender would not otherwise consider;
(d) it becoming probable that the borrower will enter bankruptcy or other financial reorganization;
(e) the disappearance of an active market for that financial asset because of financial difficulties; or
observable data indicating that there is a measurable decrease in the estimated future cash flows
from a group of financial assets since the initial recognition of those assets, although the decrease
cannot yet be identified with the individual financial assets in the group.5 (Emphasis supplied)

The Company’s data shows that investment amounting to ₱598,163 which forms part of the total ₱3.5
million investments are not supported by any evidence of ownership (e.g. stock certificates). As such, there
exists not only a measurable decrease in the estimated future cash flows but total lack of basis for
expecting future cash flows. Thus, it is submitted that the Company shall further check if there are other
evidence to support the investment of ₱598,163 otherwise, impairment loss shall be recognized from such
investment either by direct method or through allowance. The deductibility of this amount for income tax
purposes, however, is subject to the requirements for deductibility pursuant to the tax code.

As to other financial assets, the Company proposes to write-off the entire amount of ₱2,440,191.29 and the
creditable withholding tax amounting to ₱833,974. It is our opinion that the aforementioned PAS 39
provision has been complied with when the Company recognized allowance for impairment for these
accounts. The total write-off will have an impact, however, on the income tax computation for this year
since the impairment loss, which was considered a non-deductible expense in the year it was recognized,
may now be deducted from gross income as a deductible loss provided the requirements for deductibility
of expense under the tax code have been complied with.

Final Note
Considering that the Company’s corporate purpose has been amended from being engaged in hardware
merchandise to being a mere investing/holding company, it is just proper that the accounts relating to the
former purpose be written-off to conform to the accounting requirements relevant to the nature of its
current business or purpose.

We hope that we have satisfactorily explained our opinion on this matter.

Very truly yours,

3
PAS 39.58
4
PAS 39.59
5
Ibid.
2