BUSINESS EXPENSES PERSONAL EXPENSES

- are costs of doing trade, business or practice of -include the living family expenses of individual
profession. taxpayers.
Employee salaries, office utilities, supplies and Family food, personal recreation and
rent, taxes, losses, bad debts, depreciation on transportation, medication, home rentals and
business properties, research and development. utilities, tuition fees of dependents, and other
similar expenses.

BUSINESS EXPENSE CAPITAL EXPENDITURE

-benefit only the current accounting period. -are expenses that benefit future accounting
-are costs of generating income or gains for the periods.
current period. -are initially recorded as assets upon acquisition
-these are deductible against gross income in the then later deducted against future gross income
current period. when used in the trade, business or profession of
-examples: the taxpayer.
*salaries and wages expense -the advances deduction of capital expenditures is
*utilities (electricity, telephone, internet, gas, not warranted as it contradicts the Lifeblood
water) Doctrine
*selling expenses (delivery and commission -examples:
expense) *Items of PPE
*rent *Inventory
*local taxes and permits *Investments
*Prepayments
*Acquisition of intangible assets (patent or
franchise, costs of defending the same in court)
*expenses to promote business goodwill
*rentals on capital lease or finance lease that
transfers ownership

NON-DEPRECIABLE ASSET DEPRECIABLE PROPERTIES

-the cost of assets that do not depreciate by usage -the “depreciable cost” or the acquisition cost, net
or by passage of time such as land is deducted of expected salvage value, is allocated as
against the selling price when sold. deduction over the useful life of the property. The
useful life of the property is the length of time it is
expected to be serviceable or its legal life, is
applicable, whichever is lower.

INVENTORY METHOD
For goods inventory and supplies, their costs are deducted when sold or used in the business using the
inventory method or the specific identification method with the aid of a Point-of-Sale (POS) machine

COMMON DEPRECIATION METHODS

1. Straight line method The depreciable cost is simply spread equally over the useful life.
The annual depreciation expense is computed as:
 (Acquisition cost – salvage value) / useful life in years
2. Sum-of-the-years-digit method The depreciation charge is computed as a fraction of the remaining
useful life over the total of the annual remaining useful life of the
asset.
3. Declining balance method A declining rate not exceeding double of the straight line rate is
applied to the book value of the property. For every period,
depreciation expense is computed by multiplying the depreciation
rate to the declining book value of the property. The salvage value
is initially ignored in computing depreciation expense, but is
considered in the terminal year of the property.
4. other methods which may be prescribed by the Secretary of Finance upon recommendation of the
Commissioner of Internal Revenue

INTANGIBLE ASSETS
Amortizable intangible assets or those that lose their value over time should be expensed over their
legal life or expected usage life whichever is lower.
Intangible assets that do not lose their value such as franchise of public utility vehicles shall not be
amortized.

COMPUTATION OF COST OF GOODS MANUFACTURED AND SOLD

Raw materials, beginning P xxx,xxx
Add: Net purchases xxx,xxx
Raw materials available for use xxx,xxx
Less: Raw materials, ending xxx,xxx
Raw materials used xxx,xxx
Direct Labor (direct worker’s salaries) xxx,xxx
Factory Overhead (all other plant costs) xxx,xxx
Total manufacturing costs xxx,xxx
Add: Cost of work in-process, beginning xxx,xxx
Total cost of goods placed into process xxx,xxx
Less: Cost of work in-process, ending xxx,xxx
Cost of goods manufactured (finished) xxx,xxx
Add: Cost of finished goods, beginning xxx,xxx
Total cost of goods available for sale xxx,xxx
Less: Cost of finished goods, ending xxx,xxx
Cost of goods sold xxx,xxx

PROPERTY REPAIRS AND IMPROVEMENTS

-that significantly increase the value or prolong the useful life of properties are capital expenditures.
-repairs that merely restore the value or functionality of the property without causes increase in fair
value or useful life of the property shall be deducted as outright expense.
-if fair value increases, the cost of RIA should be capitalized no to exceed the appreciation in fair value.
-if fair value is not determinable, the excess of the actual repair cost over the tax basis of the property is
presumed a capitalizable increase in fair value.
-improvements and additions to properties normally increase the value or useful life of properties;
hence, these are capitalized and depreciated.

REPLACEMENTS OF OLD OR DESTROYED PROPERTIES

The tax basis of the old property is deductible as a loss, but the cost of the replacement property is
capitalized subject to future provisions for depreciation.

COST OF DEMOLISHING OLD BUILDINGS

The cost of demolishing the old building , net of any salvage scrap, are treated as additional cost of
acquisition of the land.
The cost of razing or removing an old building to give way for the erection of another in its place is not a
deductible expense, but capitalized as part of the cost of the replacement building.

ASSET ACQUISITION-RELATED COSTS

All costs directly related to the acquisition of an item of PPE are capitalized as part of the cost of the
property subject to depreciation.

Expenses incurred which are directly related to the acquisition of goods are expensed through COGS
when sold.

Cost of financing asset acquisition (interest expense) may, at the option of the taxpayer, be expensed
outright or capitalized and depreciated.

CASH BASIS ACCRUAL BASIS

Cash expenses (paid) P xxx,xxx Accrual expenses (paid or unpaid) P xxx,xxx
Amortization of prepayments xxx,xxx Amortization of prepayments xxx,xxx
Depreciation of properties xxx,xxx Depreciation of properties xxx,xxx
Cash basis deductions P xxx,xxx Accrual basis deductions P xxx,xxx

FOUR GENERAL PRINCIPLES OF DEDUCTIONS FROM GROSS INCOME

1. Expenses must be legitimate, ordinary, actual and necessary (LOAN)
2. The Matching Principle
only business expenses which contribute to, or are incurred in connection with the generation of
income, gain, or profits subject to regular income tax are deductible.
3. The Related Party Rule
In case of transactions between related parties, gains are taxable but losses are not deductible. Also,
pursuant to the transfer pricing rule, non-arm’s length expenses incurred between associated
enterprises may be restated to their arm’s length fair values to reflect the correct income of each of the
associated enterprises.
4. The Withholding Rule
No deduction is allowed unless the withholding tax required by the law or regulations to be withheld
on the income payment (i.e., expense) is withheld and remitted by the taxpayer.
 ORDINARY EXPENSE NECESSARY EXPENSE
-it is normal in relation to the business of the -if reasonable and essential to the development,
taxpayer and the surrounding circumstances. management, operation, or conduct of the trade,
- it is normally incurred by other taxpayers under business, or exercise of profession of the taxpayer.
the same line of business.

ACTUAL EXPENSE
-it is paid or resulted to an incurrence of an obligation to the taxpayer.
-in case of a loss, it must be sustained or realized by the taxpayer in a closed and completed transaction.

CLOSE AND COMPLETED TRANSACTION

-when no further transaction emanates from its occurrence.
-no right of recourse for indemnification or reimbursement from other parties exists.

THE MATCHING PRINCIPLE

-only business expenses that are incurred for the generation of items of gross income subject to regular
tax are deductible.

THE RELATED PARTY RULE

-Gains realized between related parties are taxable, but losses are non-deductible.
-examples:
1. members of a family (brothers and sisters, spouse, lineal ascendants and descendants)
2. Except in cases of distribution in liquidation, the direct or indirect controlling individual of a
corporation.
3. Except in cases of distribution in liquidation, corporations under direct or indirect common control
by or for the same individual.
4. Grantor or fiduciary of any trust.
5. Fiduciaries of trusts with the same grantor.
6. Fiduciary of a trust and the beneficiary of such trust.

TAX REPORTING CLASSIFICATION OF DEDUCTIONS

1. Cost of sales or cost of services
Is deducted outright against sales, revenues, receipts or fees of individual taxpayers in the
measurement of gross income from operations.
2. Regular allowable itemized deductions
Pertain to all necessary and ordinary expenses paid or incurred during the taxable year including
directly attributable costs in carrying on the development, management operation and/or conduct of
the trade, business or exercise of profession. E.g. administrative and selling expenses
3. Special allowable itemized deductions
Are additional deductions as provided under the NIRC or special laws.
a. Actual compliance expense (actual payments or transfers of funds)
b. Deduction incentives (are merely allowed to encourage taxpayers to support government programs)
4. Net Operating Loss Carry Over (NOLCO)
 Pertains to the excess of expenses deduction over gross income during a taxable year which is allowed
by the law to be deducted against the net income of the following three years.

MODE OF CLAIMING DEDUCTIONS FROM GROSS INCOME

1. Itemized Deductions
Taxpayers list every time of business expense they claim as deductions. Deductions are strictly
construed against the taxpayer.
2. Optional Standard Deductions
In lieu of the itemized deductions, regular or special, including NOLCO.
Merely presumes as a fixed percentage of gross income for corp and gross sales or gross receipts for
individuals.