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Ready to file your ITR and financial statement?

Ready to file your income tax return and financial statement? by: Leonardo D. Cuaresma, Jr.

What is common between an annual income tax return (ITR) and a set of financial statements (FS)? 

Although the ITR is accomplished based on existing tax rules, while the FS are prepared in accordance with the Philippine Financial Reporting Standards, both documents show the results of operations of an entity for the covered period.

Furthermore, both documents are prepared by a reporting entity to which the information contained therein pertains and are, therefore, the responsibility of such reporting entity.

Unfortunately, when an external auditor’s report is attached to the audited FS of a reporting entity, it is often misconstrued by users of financial information that the FS – and the preparation of FS – are the external auditor’s responsibility.

The same incorrect impression is also created with regard to the ITR because the audited FS, which include the external auditor’s opinion, are one of the attachments to an entity’s ITR. Clearly, this is a wrong perception of the role of an external auditor.

An external auditor’s role is distinct from that of FS preparers’.  An external auditor independently verifies, on a test basis, the accounts, amounts, disclosures and other information (including income tax amounts) presented in a set of FS that is prepared by someone else – the reporting entity’s management. 

The objective is to obtain reasonable assurance (not absolute assurance) that the FS are free from material misstatements, whether due to fraud or error. 

The audit evidence obtained is then used by the external auditor as basis in expressing an opinion on whether the FS are prepared, in all material respects, in accordance with the financial reporting framework used by management in preparing the FS.

On the other hand, the management of the reporting entity is the preparer of the reporting entity’s FS, consisting of the statement of financial position; either a single statement of comprehensive income or a separate statement of income and a separate statement of comprehensive income; statement of changes in equity; statement of cash flows; and notes to financial statements. 

The FS, together with certain information as maybe requested by the external auditor to complete the audit, such as records and documentation, and other matters that are relevant to the preparation and presentation of the FS, are provided by the reporting entity’s management to the external auditor who will perform the independent verification.

To make clear the distinction between the roles of the external auditor and the reporting entity over financial statements, in December 2009, the Philippine Securities and Exchange Commission (SEC) issued SEC Memorandum Circular No. 16, Series of 2009, Reminders on the Preparation and Audit of Annual Financial Statements (SEC Circular No. 16). 

Specifically, SEC Circular No. 16 emphasized that “The company should neither allow nor require its external auditor to prepare its financial statements and/or any of its supporting documents.  The external auditor’s duty is to conduct an independent examination of the company’s financial statements and supporting documents pursuant to the prescribed auditing standard practices.” 

The rule issued by the SEC is very clear – the external auditor shall not prepare the financial statements of the entity that is subject of its audit.  And this is in line with the Code of Ethics for Professional Accountants in the Philippines which requires an external auditor to maintain independence with their clients.  If the external auditor prepares the FS himself, it creates a situation that gives rise to a “self-review threat.” 

For the same reason, the external auditor shall not compute the income tax liability and prepare the tax return of the entity subject of its audit.  This will also give rise to a self-review threat because the tax liabilities of the entity will be one of the accounts that the external auditor will verify.

This potential conflict in the role of the external auditor has been recognized, too, by tax authorities.

The bookkeeping regulations of the Bureau of Internal Revenue (BIR) explicitly provide that an external auditor is prohibited from being employed by the taxpayer that he audits to keep the records of accounts or to supervise the keeping of such books of accounts. He must be engaged exclusively to audit the books of accounts of the taxpayer and shall not have any business or professional relationship which may in any way affect the independence of his professional actuations.

Therefore, a firm of certified public accountants cannot audit or examine the books of accounts of a taxpayer when such firm, or one of the firm’s members, is actually keeping or supervising the keeping of the taxpayer’s books of accounts.

There are certain safeguards that may be instituted by the external auditor to eliminate the threats to independence, or reduce them to an acceptable level. When this cannot be done, however, the external auditor may not be considered independent of the reporting entity, and he may have no other course of action but to decline the audit.

The restrictions mentioned above are not really new; they have been there for quite some time.

However, the prevailing practice at present, for most cases anyway, is that the external auditors “draft” the FS and the ITR for expediency.  The FS are then approved and the ITR is signed by the reporting entity’s management, and this act of approval signifies the management’s “owning” up of the FS and ITR.  But this practice will have to end.

The 2009 business year has just ended and the deadlines for the filing of ITR with the BIR and audited FS with the SEC are fast approaching.  Inevitably, ITR and FS will have to be prepared.

Considering the bookkeeping regulations of the BIR and the move by the SEC to strictly implement its requirements, management of an entity should now recognize that it can no longer delegate the preparation of the FS and ITR to its external auditor.

The earlier that management accepts this, the sooner it can make an assessment whether  internal resources are available for it to undertake properly these processes, or whether expert assistance from external service providers is needed to assist the entity in complying with these requirements.

These decisions need to be made soon as the process of preparing the FS and ITR requires a good understanding of the business of the entity.  Clearly, the goal is for management and an external auditor to properly play their respective distinct roles with respect to FS and ITR.

This article is not intended to be a substitute for professional advice.  For comments and inquiries, you may e-mail the author at  For other tax concerns, please check out our other tax services.