Change of Accounting Method Allowed Under the Tax Code Provided It Truly Reflects Income for the Period

April 10, 2002 BIR RULING NO. 014-02 Sec. 43 RR 000-00 Joaquin Cunanan & Co. PricewaterhouseCoopers 29th Floor Philamlife Towers Paseo de Roxas 1226 Makati City Attention: Mrs. Tomasa H. Lipana Managing Partner Tax Services Gentlemen : This refers to your letter dated March 28, 2001 stating that your client, First Malayan Leasing and Financing Corporation (FMLFC), is a corporation organized and existing under the laws of the Philippines and is engaged primarily in the general financing and investments business including, but not limited to, extending credit facilities for construction of housing projects and commercial and industrial development projects and discounting of notes, drafts and similar evidence of indebtedness. It has adopted the Rule of 78 Method in determining the interest income which you described as follows: "Under the Rule of 78 Method, the proceeds of a loan granted to a borrower on an agreed term (12 to 60 months) shall be net of interest since the interest due thereon shall be deducted in advance. Hence, the granting of a loan will be recorded in the books of our client as follows: Finance Receivable xxx Cash xxx Unearned Interest & Discounts (UID) xxx UID represents the unearned portion of interest collected in advance on discount notes or loans. The earned UID is recognized as income on a monthly basis using the Rule of 78 Method (otherwise known as the sum of the months method) based on the computed factor for each month. For example, to compute for the factor of a loan with a term of 24 months: Factor = Term (Term + 1) 2 = 24 (24 + 1) 2 = 300 Interest Income = 24/300 X Balance of UID (First Amortization) Interest Income = 23/300 X Balance of UID Under this method, the interest earned is higher during the first few years and would eventually decline as the loan nears its maturity. This method was adopted by FMLFC since it is commonly used in the industry. However, the Rule of 78 Method is not in accordance with the Statement of Financial Accounting Standards (SFAS) No. 19, Summary of Generally Accepted Accounting Principles for Banks and Financial Intermediaries issued by the Accounting Standards Council. Under the said SFAS No. 19, unearned interests and discounts and interest on discounted loans should be amortized using the interest method or annuity method. Interest income is to be recognized based on the outstanding principal balance of a loan." Your client is now requesting permission to change from Rule of 78 Method to Annuity Method because the Rule of 78 Method is not in accordance with the Statement of Financial Accounting Standards (SFAS) No. 19, Summary of Generally Accepted Accounting Principles for Banks and Financial Intermediaries issued by the Accounting Standards Council. In reply, please be informed that on the basis of the above representations, FMLFC is hereby granted permission to change its accounting method of determining interest income from Rule of 78 Method to Annuity Method provided that it truly reflects your income for the period. The change of accounting method from one system to another is allowed under the provision of Section 43 of the Tax Code of 1997, in relation to Section 167 of Revenue Regulations No. 2 the pertinent portion of which provides as follows: "Sec. 43. General Rule. The taxable income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping with the books of such taxpayer; but if no such method of accounting has been employed or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner clearly reflects the income. . . Section 167 of Revenue Regulations No. 2 ". . . It is recognized that no uniform method of accounting can be prescribed for all taxpayers and the law contemplates that each taxpayer shall adopt such forms and systems of accounting as are in his judgment best suited for his purpose. . . Any approved standard method of accounting which reflects taxpayer's income may be adopted. . . " With regard to your request that the authority granted retroact to January 1, 2001, since the request for change of accounting method was filed with this Office on March 29, 2001, or within the 90-day period required by Section 168 of Revenue Regulations No. 2, please be advised that the same is granted. Section 168 of Revenue Regulations No. 2 states: "Section 168. Change in Accounting Methods. xxx xxx xxx Application for permission to change the method of accounting employed and the basis upon which the return is made shall be filed within 90 days after the beginning of the taxable year to be covered by the return. . . ." This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) REN G. BAEZ Commissioner of Internal Revenue