Meralco Financial Statements

Manila Electric Company or MERALCO, holds a congressional franchise under Republic Act or RA No. 9209 effective June 28, 2003. RA No. 9209 grants MERALCO a 25-year franchise valid through June 28, 2028 to construct, operate, and maintain the electric distribution system in the cities and municipalities, and barangays in the provinces of Batangas, Laguna, Pampanga, and Quezon. On October 20, 2008, the Energy Regulatory Commission or ERC, granted MERALCO a consolidated Certificate of Public Convenience and Necessity for the operation of electric service within its franchise coverage, effective until the end of MERALCO’s congressional franchise, MERALCO is the largest power distribution utility or DU, in the Philippines.

The power segment, primarily power distribution, consists of operations of MERALCO and its subsidiary, Clark Electric Distribution Corporation or CEDC. CEDC is registered with Clark Development Corporation or CDC, under RA No. 9400, Bases Conversion Development Act of 1992, as a Clark Special Economic Zone or CSEZ, enterprise, primarily engaged in owning, operating, and maintaining a power distribution system within CSEZ. Separately, MERALCO organized a subsidiary for its re-entry into power generation through its wholly-owned subsidiary, MERALCO PowerGen Corporation or MGEN, and another unit for its entry into retail electricity supply or RES.

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The MERALCO local RES, otherwise known as MPower, is a business unit within MERALCO.

Through several other subsidiaries, its other business segments provide engineering, construction and consulting services, bill collection services, energy management services and information systems and technology services. MERALCO’s investment in common equity shares of Rockwell Land Corporation or Rockwell Land, was declared as property dividends on February 27, 2012 to stockholders of record as at March 23, 2012.

On April 25, 2012, the Securities and Exchange Commission or SEC, approved the property dividends on May 11, 2012. The details of declaration are Note 6 – Discontinued Operations. MERALCO and its subsidiaries are collectively referred to as MERALCO Group. MERALCO is owned by three major shareholder groups and the public. As at December 31, 2012, Beacon Electric asset Holdings, Inc. or Beacon Electric, owns 48.30% of the common shares. Beacon Electric jointly owned by Metro Pacific Investments Corporation or Metro Pacific and PLDT Communications and Energy Ventures, Inc., or PCEV, both of which are domestic corporations and are affiliates of First Pacific Company Limited, a Hong Kong-based investment and management company. San Miguel Corporation or SMC, together with its subsidiaries, San Miguel Purefoods Company Inc. and San Miguel Global Power Holdings, owns 32.83% of the outstanding shares of MERALCO. First Philippine Holdings Corporation or First Holdings, and First Philippine Utilities Corporation, collectively own 3.94%. The balance of MERALCO’s common shares is held by the public. The common share of MERALCO are listed on and traded in the Philippine Stock Exchange or PSE, with security symbol MER. The registered office address of MERALCO is Lopez Building, Ortigas Avenue, Pasig City, Philippines. The accompanying consolidated financial statements as at December 31, 2012 and 2011 and for each of the three years in the period ended December 31, 2012, were reviewed and recommended for approval to the Board of Directors or BOD by the Audit and Risk Management Committee on February 20, 2013. On February 25, 2013, these consolidated financial statements were approved and authorized for issue by the BOD. 2. Rate Regulations

As DUs, MERALCO and CEDC are subject to the rate-making regulations and regulatory policies of the ERC. Billings of MERALCO and CEDC to customers are itemized or “unbundled” into a number of bill components that reflect the various activities and costs incurred in providing electric service. The adjustment to each bill component Is governed by mechanisms promulgated and enforced by the ERC, mainly: [i] the “Rules Governing the Automatic Cost Adjustment and True-up Mechanisms and Corresponding Confirmation Process for Distribution Utilities,” which govern the recovery of pass-through costs, including over-or under-recoveries of the bill components, namely, (a) generation charge, (b) transmission charge, (c) system loss or SL, charge, (d) lifeline subsidy, and (e) local franchise tax or LFT, and business tax; and [ii] the “Rules for the Setting of Distribution Wheeling Rates or RDWR,” as modified by ERC Resolution NO. 20, Series of 2008,which govern the determination of MERALCO’s distribution, supply, and metering charges.

The rate-setting mechanism of CEDC is likewise in accordance with the ERC regulations. The following is a discussion of matters related to rate-setting of MERALCO and CEDC.

Rate Application
CEDC Rate Unbundling

On August 19, 2011, CEDC received an ERC Order to implement certain revisions of its schedule of rates effective on its August 2010 billing cycle, after the ERC approved CEDC’s unbundling application pursuant to Section 36 of RA No. 9136, Electric Power Industry Reform Act of 2001 or EPIRA.

Thereafter, on June 12, 2012, CEDC received an Order from the ERC (docketed on May 28, 2012) directing CEDC to refund to its customers the amount of P804, 587 (difference between its then existing rates and the rates approved by the ERC) at a rate equivalent to P0.0067 per kilowatt hour or kWh, for a period of five (5) months or until the said amount shall have been fully refunded. The refund process was completed by CEDC in October 2012.

Performance-Based Regulations or PBR
MERALCO
MERALCO was among the Group A entrants to the PBR, together with Dagupan Electric Corporation and Cagayan Electric Power and Light Company, Inc.

Rate-setting under PBR is governed by the RDWR. The PBR scheme sets tariffs based on the regulated asset base of the DUs, and the required operating and capital expenditures once every regulatory period or RP, to meet operational performance and service level requirements responsive to the needs adequate, reliable and quality power, efficient service, and growth of all customer classes in the franchise area as approved by the ERC. The PBR also employs a mechanism that penalizes or rewards a DU depending on its network and service performance.

As part of the PBR, MERALCO implements payouts to customers for instances when its performance is beyond the guaranteed service levels or GSL. See
Note 23 – Trade Payables and Other Current Liabilities.

Rate fillings and settings are done on a RP basis. One (1) RP consists of four (4) Regulatory Years or RYs. An RY for MERALCO begins on July 1 and ends on June 30 of the following year. As at December 31, 2012, MERALCO is operating in the first half of the second RY of the third RP. The third RP is from July 1, 2011 to June 30, 2015.

Maximum Average Price or MAP for RY 2008 and RY 2009

On January 11 and April 1, 2008, MERALCO filed separate applications for the approval of its proposed translation of the MAP for RY 2008 and RY 2009, respectively, into the different rate schedules for its various customer segments. A portion of the distribution charge under-recoveries as a result of the delayed implementation of the PBR was incorporated in the proposed MAP for RY 2009.

In April 2009, the ERC approved the implementation of MERALCO’s average distribution rate of P1.2227 per kWh effective billing period of May 2009. This rate is inclusive of the under-recoveries for calendar year 2007 of {o.1285 per kWh.

On May 28, 2009, certain electricity consumer groups filed a Petition with the Court of Appeals, or CA, questioning the decision and Order of the ERC on MERALCO’s rate translation application for RY 2008 and RY 2009. In the decision dated January 27. 2010, the CA denied the Petition. Consequently, the consumer groups brought the case to the Supreme Court of the Philippines or SC. Comments and responses were filed by both parties with a Manifestation filed by MERALCO on January 26, 2011. As at February 25, 2013, the SC has yet to render its decision on this case.

MAP for RY 2010
In accordance with the ERC’s Guidelines for RY 2010 Rate Reset for First Entrant Distribution Utilities, the MAP for RY 2010 was computed at P1.4917 per kWh. In a Decision dated December 14, 2009, the ERC approved the said
calculated MAP for RY 2010. Subsequently, however, on January 26, 2010, MERALCO filed a manifestation with the ERC voluntarily suspending the implementation of the ERC’s December 14, 2009 decision on the petition, to allow the regulator time to resolve issues raised by an intervenor. On March 10, 2010, the ERC resolved the Motion for Reconsideration and approved a new rate schedule affirming that there is no rate distortion and no cross-subsidies, other than the lifeline subsidy, in MERALCO’s rates. Consequently, MERALCO implemented the new rate schedule beginning with its April 2010 billing cycle.

Certain electricity consumer groups filed a Petition for Certiorari with the SC questioning the decision rendered by the ERC. On July 6, 2011, the SC dismissed the petition. Thereafter, on December 14, 2011, a motion for reconsideration filed by the same intervenors was denied with finality by the SC.

MAP for RY 2011
On December 6, 2010, the ERC approved MERALCO’s application for MAP for RY 2011 of P1.6464 per kWh and ordered MERALCO to implement, starting with its January 2011 billing cycle, the approved distribution, supply and meeting charges. The 2011 MAP rates were implemented until September 2011.

Third RP Reset Application

On June 18, 2010, MERALCO filed an application for the approval of its proposed Annual Revenue Requirement or ARR and Performance Incentive Scheme or PIS for the third RP, the Final Determination of which was approved on June 6, 2011. The PIS, which sets the performance measures and targets that apply throughout the third RP, was also approved. A Petition for Certiorari of the ERC;s decision was filed by an intervenor with the CA.

On February 3, 2012, the CA denied such petition. This prompted the same intervenor to file a motion for reconsideration on such Resolution, which motion was likewise denied by the CA on June 28, 2012. Hence, said intervenor filed a Petition for Rview on Certorari of the CA’s resolutions
with the SC.

On August 29, 2012, the SC denied such petition. The motion for reconsideration of such Resolution filed by the same intervenor was denied with finality by the SC on November 26, 212.

MAP for RY 2012
On June 21, 2011, MERALCO filed its application for the approval of its MAP for RY 2012 and its translation into rate tariffs by customer category. On October 6, 2011, the ERC provisionally approved the MAP for RY 2012 or P1.6012 per kWh and the rate translation per customer class was reflected commencing with the October 2011 customer bills. As at February 25, 2013, hearings for the final approval of the application have been completed and all parties have submitted their respective memoranda. The application is pending approval by the ERC.

MAP for RY 2013
On June 11, 2012, the ERC provisionally approved the MAP for RY 2013 of P1.6303 per kWh which was reflected starting with the July 2012 customer bills. Hearings on this case have been completed and MERALCO is awaiting the final decision of the ERC.

CEDC
CEDC was among the four Group D entrants to the PBR. Similar to MERALCO, it is subject to operational performance and service level requirements approved by the ERC. The RP of CEDC began on October 1, 2011 and ends on September 30, 2015.

Reset Application and MAP for RY 2012
In compliance with the ERC;s PBR rate setting mechanism, CEDC filed a reset application for the approval of its ARR and PIS with the ERC, CEDC filed its revised application November 3, 2010, which underwent a series of hearings and public consultations in 2011. The ERC issued CEDC’s Final Determination on August 5, 2011. Subsequently, CEDC filed with the ERC its application for RY 2012 Rate Translation into the different customer classes.

On April 10, 2012, the ERC approved with modification, CEDC’s application for the approval of the translation into distribution rates of different customer classes for the first RY of the approved ARR under the PBR for the RP October 1, 2011 to September 30, 2015. CEDC implemented the approved distribution, supply and metering charges of P0.8527 per kWh and the new customer segments in its June 20 billing.

MAP for RY 2013
On August 30, 2012, CEDC filed its application for the approval of its MAP for RY 2013. The ERC, on December 17, 2012, approved a MAP of P0.8953 per kWh. The revised rates based on the approved MAP 2013 were implemented by CEDC starting January 2013.

SC Decision on Unbundling Rate Case
On May 30, 2003, the ERC issued an Order approving MERALCO’s unbundled tariffs that resulted in a total increase of P0.17 per kWh over the May 2003 tariff levels. However, on August 4, 2003, certain customer and civil society groups filed a Petition for Review of the ERC;s ruling with the CA. On July 22, 2004, the CA set aside the ERC’s ruling on MERALCO’s rate unbundling and remanded the case to the ERC. Further, the CA opined that the ERC should have asked the Commission on Audit or COA, to audit the books of MERALCO. The ERC and MERALCO subsequently filed separate motions asking the CA to reconsider its decision. On January 24, 2005, as a result of the denial by the CA of the motions, the ERC and MERALCO elevated the case to the SC.

In an En Banc decision promulgated on December 6, 2006, the SC set aside and reversed the CA ruling saying that a COA audit was not a prerequisite in the determination of a utility’s rates. However, while the SC affirmed ERC’s authority in rate-fixing, the SC directed the ERC to request COA to undertake a complete audit of the books, records and accounts of MERALCO. On January 15, 2007, in compliance with the directive of the SC, the ERC requested COA to conduct an audit of the books, records and accounts of MERALCO using calendar years 2004 and 2007 as test years.

The COA audit, which began in September 2008, was completed in August 2009.

On February 17, 2010, the ERC issued its Order directing MERALCO and all intervenors in the caste to submit, within 15 days from receipt of the order, their respective comments on the COA’s “Report NO. 2009-01 Rate Audit Unbundled Charges.”

On July 1, 2011, the ERC maintained and affirmed its findings and conclusions in its Order dated March 20, 2003. The ERC stated that the COA recommendation to apply disallowances under PBR to rate unbundling violates the principle against retroactive rate-making. An intervenor group filed a motion for reconsideration of the said Order. On September 5, 2011, MERALCO filed its comment to the intervenor’s motion for reconsideration. On February 4, 2013, the ERC denied the intervenor’s motion for reconsideration. A petition for Review of the ERC’s order was filed by an intervenor group with the CA.

Applications for the Recovery of Generation Costs and SL Charges MERALCO filed separate applications for the full recovery of generation costs, including value-added tax or Vat, incurred for the supply months of August 2006 to May 2007 or total under-recoveries of P12,679 million generation charges and P1,295 million for Sl charges.

The separate applications for the full recovery of generation charges have been approved by the ERC in its decisions released on January 18, 2008, September 3, 2008 and August 16, 2010.

As at December 31, 2012, the remaining balance of P1,162 million of such unrecovered generation costs will be billed in 2013 at the rate of p0.0314 per kWh until fully recovered. The amount recoverable within 12 months is included in the “Trade and other receivables” account while the long-term portion is included in the “Other noncurrent assets” account.

With respect to the P1,295 million SL charge under-recoveries, the ERC
ordered MERALCO to file a separate application for the recovery of SL adjustments after the ERC confirms the transmission rate to be used in the calculation of the SL rate in accordance with the SL rate formula of the Automatic Generation Rate Adjustments Guidelines. MERALCO has filed the application recovery of the P1,295 million SL charge under-recoveries with the ERC. This was included in the Consolidated Application of under/over recoveries in generation, transmission, SL and lifeline charges filed on March 31, 2011, MERALCO with the ERC. Hearings were completed on October 25, 2011. On December 12, 2011, MERALCO filed for the admission of its Supplemental Application. An expository hearing was conducted on February 1, 2012. As at February 25, 2013, MERALCO has already filed its Formal Offer of Evidence or FOE and is awaiting the final resolution by the ERC.

Inter-Class Cross Subsidies and Lifeline Subsidies
MERALCO filed separate applications to recover inter-class cross subsidies (on November 14, 2007) and lifeline subsidies (on February 19, 2008).

In a decision dated November 16, 2009, the ERC authorized MERALCO to recover th inter-class cross subsidy under-recoveries covering the period June 2013 to October 2006 amounting to P1,049 million and total lifeline subsidy under-recoveries covering the period June 2003 to December 2007 amounting to P856 million.

In December 2009, MERALCO implemented the decisions of the ERC on the inter- class cross and lifeline subsidies. As at December 31, 2012, the total amount of billed inter-class cross subsidies and lifeline subsidies amounted to P963 million and P638 million,respectively. The unbilled balance of inter-class cross subsidies is P86 million and is expected to be recovered within 12 months is included in the “Trade and other receivables” account while the long-term portion is included in the “Other noncurrent assets” account.

Consolidated Applications for the Confirmation of Ever/Under-recoveries of Pass-through charges

On August 12, 2009, the ERC issued Resolution No. 16, Series of 2009, adopting the “Rules Governing the Automatic Cost Adjustment and True-up Mechanisms and Corresponding Confirmation Process for Distribution Utilities.” These rules govern the recovery of pass-through costs, including over- or under-recoveries with respect to the following bill components: generation charge, transmission charge, SL charge, lifeline and interclass rate subsidies, LFT and business tax. On October 18, 2010, the ERC promulgated ERC Resolution No. 21, Series of 2010, amending certain formula contained in ERC Resolution No. 16, Series of 2009, and setting March 31, 2011 (covering adjustments from January 2011 to December 2013) as the new deadlines for DUs in Luzon to file their respective applications. Subsequent filings shall be made every three years thereafter.

On March 31, 2011, MERALCO flied a consolidated application with the ERC to confirm its under-or ever-recoveries accumulated from June 2003 to December 2010 in compliance with Resolution No. 16, Series 2009, as subsequently amended by Resolution No. 21, Series of 2010. Hearings were completed on October 25, 2011. On December 8, 2011, MERALCO filed an Omnibus Motion praying, among other things, for the admission of the Supplemental Application. In an Order dated December 12, 2011, the ERC granted MERALCO’s Omnibus Motion and admitted its Supplemental Application. Accordingly, hearings on the Supplemental Application were conducted where MERALCO presented additional evidence. MERALCO filed its FOE on September 13, 2012. The consolidated filing includes net generation charge under-recoveries of P1,000 million, net transmission and charge over-recoveries P111 million, net lifeline subsidy under-recoveries of P9 million and net SL over-recoveries of P425 million, excluding any applicable carrying charges.

On July 6, 2012, MERALCO filed a consolidated application with the ERC to confirm its under- or over-recoveries for the calendar year 2011. The consolidated filing includes ner generation charge under-recoveries of P1,826 million, transmission charge under-recoveries of P253 million, net lifeline subsidy under-recoveries of P39 million and SL over-recoveries of P445 million, excluding any applicable carrying charges. As at February 25, 2013, hearings on the application have been terminated and MERALCO has
submitted its FOE on January 25, 2013. The application is pending approval by the ERC.

Petition to Implement a Lower Generation Charge for the February 2010 Supply Month
MERALCO’s generation cost abruptly increased to P15,934 million for the supply month of February 2010. This translated to a generation charge of P6.76 per kWh to tits customers for the March 2010 billing. The sharp increase in generation cost was mainly due to abnormally high prices in the Wholesale Electricity Spot Market or WESM. A Petition was filed by MERALCO to mitigate the effects of the abrupt increase in generation cost through a voluntary deferral of a portion of generation costs, with the differential to be recovered over a period, which shall be approved by the ERC. In an Order dated March 10, 2010, the ERC provisionally approved a lower generation charge of P5.8417 per kWh representing P13,773 million generation cost for the subject month. MERALCO was also provisionally allowed to charge over a six month period starting April 2010 the generation charge at the rate of P0.07 per kWh, corresponding to the incremental costs of the condensate fuel used by First Gas Corporation or FGC’s Sta. Rita and FGP Corp. or FGP’s San Lorenzo power plants during the said month. In its decision dated July 25, 2011, the ERC authorized MERALCO to collect the additional generation cost for the period January 26, 2010 to February 25, 2010 including carrying charges. The approved recovery was implemented starting with its September 2011 billin cycle. The amount was fully recovered in October 2012.

Deferred PPA
On October 14, 2009, the ERC released its findings on MERALCO’s implementation of the collection of the approved pass-through cost under-recoveries in 2004. ERC directed MERALCO to refund P268 million of deferred PPA transmission line costs related to Quezon Power (Philippines) Limited Company or QPPL and deferred accounting adjustments or DAA incurred to customers, along with P184 million in carrying charges, or an equivalent of P0.0169 per kWh. MERALCO implemented the refund beginning November 2009 until September 2010. However, the ERC has yet to rule on MERALCO;s deferred
PPA under-recoveries of P106 million, which does not represent the transmission line fee. As at February 25, 2013, MERALCO has filed a Motion for Reconsideration, which is pending decision by the ERC.

Application for Recovery of Local Franchise Taxes or LFT
On March 25, 2011, MERALCO filed with the ERC an application for recovery of LFT paid but not yet billed to customers for the period beginning first quarter of 1993 up to the second quarter of 2004 for five provinces, namely; Bulacan, Batangas, Cavite, Laguna and Rizal; and 14 cities, namely: San Jose Del Monte, Batangas, San Pablo, Tagaytay, Lucena, Mandaluyong, Marikina, Quezon, Caloocan, Pasay, Las piñas, Manila, Pasig and Calamba. The LFT is recognized as a legitimate and reasonable DU expense in the ERC’s unbundling decision.

In a Decision dated February 27, 2012, the ERC released its Order approving with modifications MERALCO’s application. The ERC approved recovery of LFT amounting to P1.571 million plus carrying charges of P730 million. The recovery of LFT and carrying charges were recognized as part of “Other income” account and “Interest and other financial income” account, respectively, in the 2012 consolidated statement of income. As directed by the ERC, the recovery was reflected as a separate item in the MERALCO billing statement to its customers beginning April 2012. As at December 31, 2012, a total of P393 million LFT and carrying charges have been billed to affected customers.

SC Decision on the P0.167 per kWh Refund
Following the SC;s final ruling that directed MERALCO to refund affected customers P0.167 per kWh for billings made from February 1994 to April 2003, the ERC approved the release of the refund in the four phases. The refund is still ongoing. See Note 21 – Customers’ Refund.

3. Basis of Preparation and stamen of Compliance

The accompanying consolidated financial statements have been prepared on a historical cost basis, except for MERALCO’s utility plant and others and
investment properties acquired before January 1, 2004, which are carried at deemed cost and for derivative financial instruments and available-for-sale, or AFS, financial assets, which are measured at fair value. Derivatives financial instruments are shown as part of “Other current assets” or “Trade payables and other current liabilities” accounts, as applicable, in the consolidated statement of financial position. AFS financial assets are included as part of “Other noncurrent assets” account in the consolidated statement of financial position.

The accompanying consolidated financial statements are presented in Philippine peso, the MERALCO Group’s function and presentation currency. All values are rounded to the nearest million peso, except when otherwise indicated.

Statement of Compliance
The consolidated financial statements of MERALCO and its subsidiaries have been prepared in compliance with Philippine Financial Reporting Standards or PFRS. PFRS includes statements named PFRS and Philippine Accounting Standards or PAS, including Interpretations issued by the Philippine Financial Reporting Standards Council or PFRSC.

Basic of Consolidation
The consolidated financial statements comprise the financial statements of MERALCO and its subsidiaries as at December 31 of each year, except for Meralco Industrial Engineering Services Corporation or MIESCOR, whose financial reporting date ends on September 30. Adjustments and disclosures are made for the effects of significant transactions or events that occurred between the date of MIESCOR’s financial statements and the date of MERALCO Group’s consolidated financial statements.

The SEC and the Bureau of Internal Revenue or BIR approved the change in reporting period for MIESCOR (January 2013), Meiscor Logistics, Inc. or MLI (October 2012 and December 2012, respectively), from fiscal year ending September 30 to calendar year ending December 31.

The consolidated financial statements include the financial statements of MERALCO and the following directly and indirectly-owned subsidiaries:

Subsidiaries are fully consolidated from the date of acquisition, being the date at which MERALCO obtains control, and continue to be consolidated until the date that such control ceases. Control is the power to govern the financial and operating policies of the entity.

The consolidated financial statements are prepared using uniform accounting policies for like transactions and other events with similar circumstances. All intra-group balances, income and expenses, unrealized gains and losses and dividends resulting from intra-group transactions are eliminated in full.

Non-controlling interests represent the portion of profit or loss and net assets in CEDC and MIESCOR and its subsidiaries not held by MERALCO and are presented separately in the consolidated statement of income, consolidated statement of comprehensive income and within equity in the consolidated statement of financial position, separately from equity attributable to equity holders of the parent.

Total comprehensive income within a subsidiary is attributed to the non-controlling interest even if that results in a deficit.

A change in the ownership interest of a subsidiary, without a change of control, is accounted for as an equity transaction.

If the MERALCO Group loses control over a subsidiary, it: (a) derecognizes the assets (including goodwill) and liabilities of the subsidiary; (b) derecognizes the carrying amount of any non-controlling interest; (c) derecognizes the cumulative translation adjustments deferred in equity; (d)_ recognizes the fair value of consideration received; (e) recognizes the fair value of any investment retained; (f) recognizes any surplus or deficit in profit or loss ; and (g) reclassifies MERALCO’s share of components previously recognized in the consolidated statement of comprehensive income to the consolidated statement of income.

4. Significant Accounting Policies, Changes and Improvements Changes in Accounting Policies and Disclosures
The accounting policies adopted in the preparation of consolidated financial statements are consistent with those of the previous financial year except for the adoption of the following amendments and improvements to existing standards, which were effective beginning January 1, 2012. The adoption of these changes and improvements did not have any significant effect on the consolidated financial statements.

* PFRS 7, Financial Instruments: Disclosures – Enhanced Derecognition and Transfer of Financial Assets Disclosure Requirements – The amended standard requires additional disclosure on financial assets that have been transferred but not derecognized and an entity’s continuing involvement in the derecognized assets. This disclosure is required to enable the user of the financial statements to evaluate the related risks. * PAS 12, Income Taxes – Deferred Taxes : Recovery of Underlying Assets (Amended) – The amendment clarifies that the deferred tax on investment property measured using the fair value model in PAS 40m Investment Property should be determined considering that its carrying value will be recovered through sale. Deferred tax on non-depreciable assets that are measured using the revaluation model in PAS 16, Property, Plant and Equipment should also be measured on a sale basis.

New Accounting Standards and Interpretations to Existing Standards Effective Subsequent to December 31, 2012

The MERALCO Group will adopt the following revised standards and interpretations enumerated below, which are relevant when these become effective. Except as otherwise indicated, the MERALCO Group does not expect the adoption of these revised standards and amendments to PFRS to have a significant impact on the MERALCO Group’s consolidated financial statements.

Effective 2013
PFRS 7, Financial Instruments: Disclosures – Offsetting Financial Assets and
Financial Liabilities

These amendments require an entity to disclose information about rights of set-off and related arrangements (such as collateral agreements). The new disclosures are required for all recognized financial instruments that are set off in accordance with PAS 32, Financial Instruments: Presentation. These disclosures also apply to recognized financial instruments that are subject to an enforceable master netting arrangement or ‘similar agreement’, irrespective of whether they are set-off in accordance with PAS 32. The amendments require entities disclose, in a tabular format unless another format is more appropriate, the following minimum quantitative information. These are presented separately for financial assets and financial liabilities recognized at the end of the reporting period:

(a) The gross amounts of those recognized financial assets and recognized financial liabilities; (b) The amounts that are set off in accordance with the criteria in PAS 32 when determining the net amounts presented in the statement of financial position; (c) The net amounts presented in the statement of financial position; (d) The amounts subject to an enforceable master netting arrangement or similar agreement that are not otherwise included in (b) above including: i. Amounts related to recognized financial instruments that do not meet some or all of the offsetting criteria in PAS 32 ; and ii. Amounts related to financial collateral (including cash collateral) ; and (e) The net amount after deducting the amounts in (d) from the amounts in © above.

The amendments to PFRS 7 are to be applied restropectively and are effective for annual periods beginning on or after January 1, 2013. The amendments affect disclosures only and have no impact on MERALCO Group’s financial position or performance.

PFRS 10, Consolidated Financial Statements
PFRS 10 replaces the portion of PAS 27, Consolidated and Separate Financial Statements, that addresses the accounting for consolidated financial statements. It also includes the issues raised in Standing Interpretations
Committee or SIC 12, Consolidation – Special Purpose Entities. PFRS 10 establishes a single control model that applies to all entities including special purpose entities. The changes introduced by PFRS 10 will require management to exercise significant judgment to determine which entities are controlled, and therefore, are required to be consolidated by a parent, compared with the requirements that were in PAS 27. The standard becomes effective for annual periods beginning on or after January 1, 2013.

A reassessment of control was performed by MERALCO on all its subsidiaries and associates in accordance with the provisions of PFRS 10. Based on the reassessment made, MERALCO has not determined any change in the control in any of its subsidiaries and associates.

PFRS 11, Joint Arrangements
PFRS 11 replaces PAS 31, Interests in Joint Ventures, and SIC 13, Jointly Controlled Entities- Non- Monetary Contributions by Venturers. PFRS 11 removes the option to account for jointly controlled entities that meet the definition of a joint venture must be accounted for using the equity method. The standard becomes effective for annual periods beginning on or after January 1, 2013. The application of this new standard will have no impact in the consolidated financial statements of the MERALCO Group.

PFRS 12, Disclosure of Interests in other Entities
PFRS 12, includes all the disclosures related to consolidated financial statements that were previously in PAS 27, as well as all the disclosures that were previously included in PAS 31 and PAS 28, Investments in Associates. These disclosures relate to an entity’s interests in subsidiaries, joint arrangements, associates and structured entities. A number of new disclosures are also required. The standard becomes effective for annual periods beginning on or after January 1, 2013.

The adoption of PFRS 12 will affect disclosures only and will have no impact on the MERALCO Group’s financial position or performance.

PFRS 13, Fair Value Measurement
PFRS 13 establishes a single source of guidance under PFRS for all fair value measurements. PFRS 13 does not change when an entity is required to use fair value, but rather provides guidance on how to measure fair value under PFRS when fair value is required or permitted. This standard should be applied prospectively as of the beginning of the annual period in which it is initially applied. Its disclosure requirements need not be applied in comparative information provided for periods before initial application of PFRS 13. The standard becomes effective for annual periods beginning on or after January 1, 2013.

The MERALCO Group does not anticipate that the adoption of this standard will have any significant impact on its financial position and performance.

PAS 27, Separate Financial Statements (as revised 2011)
As a consequence of the issuance of the new PFRS 10 and PFRS 12, what remains of PAS 27 is limited to accounting for subsidiaries, jointly controlled entities, and associates in the separate financial statements. The adoption of the amended PAS 27 will not have any significant impact on the separate financial statements of the entities in the MERALCO Group. The amendment becomes effective for annual periods beginning on or after January 1, 2013.

PAS 28, Investments in Associates and Joint Ventures (As Revised in 2011) As a consequence of the issuance of the new PFRS 11 and PFRS 12, PAS 28 has been renamed PAS 28, Investments in Associated and Joint Ventures, and described the application of the equity method to investments in joint ventures in addition to associates. The adoption of the amended PAS 28 will not have a significant impact on the consolidated financial statements of the MERALCO Group. The amendment becomes effective for annual periods beginning on or after January 1, 2013.

PAS 1, Presentation of Financial Statements – Presentation of Items of Other Comprehensive Income or OCI

The amendments of PAS 1 change the grouping of items presented in OCI. Items that can be reclassified (or “recycled”) to profit or loss at a future point
in time (for example. Upon derecognition or settlement) will be presented separately from items that will never be recycled. The amendments affect presentation only and have no impact on the MERALCO Group’s financial position or performance. The amendment becomes effective for annual periods beginning on or after July 1, 2012. The amendments will be applied retrospectively and will result in the modification of the presentation of items of OCI.

PAS 19, Employee Benefits (Amendments)
Amendments to PAS 19 range from fundamental changes such as removing the corridor mechanism and the concept of expected returns on plan assets to simple clarifications and rewording. The revised standard also requires new disclosures such as, among others, a sensitivity analysis for each significant actuarial assumption, information on asset-liability matching strategies, duration of the defined benefit obligation, and disaggregation of plan assets by nature and risk. The amendments become effective for annual periods beginning on or after January 1, 2013. Once effective, the MERALCO Group shall apply the amendments retrospectively to the earliest period presented. The MERALCO Group reviewed its existing employee benefits and determined that the amended standard will have a significant impact on its accounting for retirement benefits. The MERALCO Group obtained the services of an external actuary to compute the impact on the concoslidated financial statements upon adoption of the standard. The effects are detailed below :

| As at| As at| As at|
| December 31,| December 31,| January 1,|
| 2012| 2011| 2011|
Consolidated statements of financial| (In Millions)| |
position| | | |
Increase (decrease) in:| | | |
Net defined benefit liability| (P565)| P2,356| P3,072| Deferred tax assets| (170)| 707 | 922 |
Other comprehensive income| 262 | (1,682)| (2,151)| Retained earnings| 135 | 33 | -|

| For the years ended December 31|
| 2012| 2011|
| (In Millions)|
Consolidated statements of financial| |
Increase (decrease) in:| | |
Net benefit cost| (P145)| (P47)|
Provision for income tax| 43 | 14 |
Profit for the year attributable to:| | |
Equity holders of the Parent| 102 | 33 |
Non-controlling interests| -| -|

Philippine Interpretation IFRIC 29, Stripping Costs in the Production Phase of a Surface Mine

This interpretation applies to waste removal (stripping) costs incurred in surface mining activity, during the production phase of the mine. The interpretation addresses the accounting for the benefit from the stripping activity. The interpretation is effective for annual periods beginning on or after January 1, 2013. This new interpretation in not relevant to the MERALCO Group.

Effective 2014
PAS 32, Financial Instruments: Presentation – Offsetting Financial Assets and Financial Liabilities

The amendments clarify the meaning of “currently has a legally enforceable right to set-off “ and also clarify the application of the PAS 32 offsetting criteria to settlement systems (such as central clearing house systems) which apply gross settlement mechanisms that are not simultaneous. The amendments affect presentation only and have no impact on the MERALCO Group’s financial position or performance. The amendments to PAS 32 are to be applied retrospectively for annual periods beginning on or after January 1, 2014.

Effective 2015
PFRS 9, Financial Instruments: Classification and Measurement

PFRS 9, as issued, reflects the first phase on the replacement of PAS 39 and applies to the classification and measurement of financial assets and liabilities as defined in PAS 39, Financial Instruments: Recognition and Measurement. Work on impairment of financial instruments and hedge accounting is still ongoing, with a view to replacing PAS 39 in its entirely. PFRS 9 requires all financial assets to be measured at fair value at initial recognition. A debt financial asset may, if the fair value option or FVO is not invoked, be subsequently measured at amortized cost if it is held within a business model that has the objective to hold the assets to collect the contractual cash flows and its contractual terms give rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal outstanding. All other debt instruments are subsequently measured at fair value through profit or loss. Equity financial assets are measured at fair value either through other OCI or profit or loss. All equity financial assets held for trading must be measured at fair value through profit or loss. For FVO liabilities the amount of change in the fair value of liability that is attributable to changes in credit risk must be presented in OCI. The remainder of the change in fair value is presented in profit or loss, unless presentation of the fair value change is presented in profit or loss, unless presentation of the fair value change in respect of the liability’s credit risk in OCI would create or enlarge an accounting mismatch in profit or loss. All other PAS 39 classification and measurement requirements for financial liabilities have been carried forward into PFRS 9, including the embedded derivative separation rules and the criteria for using the FVO. MERALCVO Group conducted an evaluation of the early adoption of PFRS 9 and has assessed that the first phase of PFRS 9 will have an effect on the classification and measurement of financial assets. The MERALCO Group will quantify the effect on the consolidated financial statements in conjunction with the other phases, when issued, to present a comprehensive picture. PFRS 9 is effective for annual periods beginning on or after January 1, 2015.

Deferred Effectivity

Philippine Interpretation IFRIC 15, Agreements for the Construction of Real Estate

This interpretation covers accounting for revenue and associated expenses by entities that undertake the construction of real estate directly or through subcontractors. The interpretation requires that revenue on construction of real estate be recognized only upon completion, except when such contract qualifies as construction contract to be accounted for under PAS 11 or involves rendering of services in which case revenue is recognized based on stage of completion. Contracts ownership are transferred to the buyer on a continuous basis will also be accounted for based on stage of completion. The Philippine SEC and the FRSC have deferred the effectivity of this interpretation until the final revenue standard is issued by the International Accounting Standards Board an evaluation of the requirements of the final Revenue standard against the practices of the Philippine real estate industry is completed.

Annual Improvements to PFRS (2009-2011 cycle)

The Annual Improvements to PFRS (2009-2011 cycle) contain non-urgent but necessary amendments to PFRS. The amendments are effective for annual periods beginning on or after January 1, 2013 and to be applied retrospectively. Earlier application is permitted.

PFRS I, First-time Adoption of PFRS – Borrowing Costs

The amendment clarifies that, upon adoption of PFRS, an entity that capitalized borrowing costs in accordance with its previous generally accepted accounting principles, may carry forward, without any adjustment, the amount previously capitalized in its opening statement of financial position at the date transition. Subsequent to the adoption of PFRS, borrowing costs are recognized in accordance with PAS 23, Borrowing Costs. The amendment does not apply to the MERALCO Group as it is not a first-time
adopter of PFRS.

PAS 1, Presentation of Financial Statements – Clarification of the requirements for comparative information

The amendment clarifies the requirements for comparative information that are disclosed voluntarily and those that are mandatory due to retrospective application of an accounting policy, or retrospective restatement or reclassification or items in the financial statements. An entity must include comparative information in the related noted to the financial statements when it voluntarily provides comparative information beyond the minimum required comparative period. The additional comparative period does not need contain a complete set of financial statements. On the other hand, supporting notes for the third balance sheet (mandatory when there is a retrospective application of an accounting policy, or retrospective restatement or reclassification of items in the financial statements) are not required. The amendments affect disclosures only and have no impact on the MERALCO Group’s financial position or performance.

PAS 16, Property, Plant and Equipment – Classification of servicing equipment

The amendment clarifies that spare parts, stand-by equipment and servicing equipment should be recognized as property, plant and equipment when the meet the definition of property, plant and equipment and should be recognized as inventory if otherwise. The amendment will not have any significant impact on the MERALCO Group’s financial position or performance.

PAS 16, Property, Plant and Equipment – Classification of serving equipment

The amendment clarifies that spare parts, stand-by equipment and serving equipment should be recognized as property, plant and equipment when the meet the definition of property, plant and equipment and should be recognized as inventory if otherwise. The amendment will not have any significant impact on the MERALCO Group’s financial position or performance.

PAS 32, Financial Instruments: Presentation – Tax effect of distribution to Holders of Equity instruments

The amendment clarifies that income taxes relating to distributions to equity holders and to transaction costs an equity transaction are accounted for in accordance with PAS 12, Income Taxes. The MERALCO Group expects that this amendment will not have any impact on its financial position or performance.

PAS 34, Interim Financial Reporting – Interim Financial reporting and segment information for total assets and liabilities

The amendment clarifies that income taxes relating to distributions to equity holders and to transaction costs of an equity transaction are accounted for in accordance with PAS 12, Income Taxes. The MERALCO Group expects that this amendment will not have any impact on its financial position or performance.

Significant Accounting Policies

The principal accounting policies adopted in the preparation of the consolidated financial statements are as follows:

Business Combinations and Goodwill

Business combinations are accounted for using the acquisition method. The cost of an acquisition is measured as the aggregate of the consideration transferred measured at acquisition-date fair value and the amount of any non-controlling interest in the acquiree. For each business combination, the MERALCO Group elects whether to measure the non-controlling interest in the acquire at fair value or at the proportionate share of the acquiree’s identifiable net assets. Acquisition-related costs in a business combination are expensed.

When a business is acquired, an assessment is made of the identifiable assets acquired and liabilities assumed for appropriate classification and designation in accordance with the contractual terms, economic and other
pertinent conditions as at acquisition date. This includes the separation of embedded derivatives in host contracts by the acquiree.

If the business combination is achieved in stages, the acquirer’s previously held equity interest in the acquiree is remeasured at fair value as at acquisition date and any resulting gain or loss is recognized in profit or loss.

Any contigent consideration to be transferred by the acquirer will be recognized at fair value at the acquisition date. Subsequent changes to the fair value of contingent consideration, which is deemed to be an asset or liability will be recognized in accordance with PAS 39, either in profit or loss or other comprehensive income. If the contingent consideration is classified as equity, it shall not be remeasured until it is finally settled within equity.

Goodwill is initially measured at cost being the excess of the aggregate of the consideration is classified as equity, it shall not be remeasured until it is finally settled within equity.

Goodwill is initially measured at cost being the excess of the aggregate of the consideration transferred, any non-controlling interest in the acquire and, in a business combination achieved in stages, the acquisition-date fair value of the previously held equity interest in the acquire, over the fair value of net identifiable assets acquired. If the difference is negative, such difference is recognized as gain in the consolidated statement of income.

After initial recognition, goodwill is measured at cost less any accumulated impairment losses. For the purpose of impairment testing, goodwill acquired in a business combination is, from acquisition date, allocated to each of the cash generating units that are expected to benefit from the combination, irrespective of whether other assets or liabilities of the acquire are assigned to those units, beginning on the acquisition date.

Where goodwill forms part of a cash-generating unit and part if the operation within that unit is disposed of, the goodwill associated with the operation disposed of is included in the carrying amount of the operation when determining the gain or loss on disposal of the operation. Goodwill disposed of in such circumstances is measured based on relative values of the operation disposed and the portion of the cash-generating unit retained.

Business combinations involving entities under common control are accounted for similar to the pooling-of-interest method. The assets and liabilities of the combining entities are reflected at their carrying amounts reported in the consolidated paid and the share capital of the “acquired” entity is reflected within equity additional paid-in capital. The consolidated statement of income reflects the results combining entities for the full year, irrespective of when the combination takes place. Comparatives are presented as if the entities had always been combined since the date the entities were under common control.

Utility Plant and Others

Utility plant and others, except land, are stated at cost, net of accumulated depreciation and amortization and accumulated impairment loss, if any. Costs included the cost of replacing part of such utility plant and other properties when such cost is incurred, if the recognition criteria are met. All other repair and maintenance costs are recognized as incurred in the consolidated statement of income. The present value of the expected cost for the decommissioning of the asset after use is included in the cost of the repective asset if the recognition criteria for a provision are met.

Land is stated at cost less any impairment in value.

MERALCO’s utility plant and others are stated at deemed cost. The revalued amount recorded as at January 1, 2004 was adopted as deemed cost as allowed by the transitional provisions of PFRS 1. The balance of revaluation increment was closed to retained earnings. See Note 16- Equity for the related discussion.

Depreciation and amortization of utility plant and others are computed using the straight-line method (Except for certain subtransmission and distribution assets, which use straight-line functional group method) over the following estimated useful lives: (TABLE 167)

An item of utility plant and others is derecognized upon disposal or when no future economic benefits are expected from its use or disposal. Any gain or loss arising as a result of the derecognition of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the asset) is included in the consolidated statement of income in the year the asset is derecognized.

The asst’s residual values, useful lives and methods of depreciation and amortization are reviewed, and adjusted prospectively if appropriate, at each financial year-end to ensure that the residual values, periods and methods of depreciation and amortization are consistent with the expected pattern of economic benefits from items of utility plant and others.

Construction in Progress

Construction in progress is stated at cost, which includes cost of construction, plant and equipment, capitalized borrowing costs and other direct costs. Construction in progress is not depreciated until such time that the relevant assets are substantially completed and available for their intended use.

Borrowing Costs

Borrowing costs are capitalized if they are directly attributable to the acquisition, construction or production of a qualifying asset. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Capitalization of borrowing costs commences when the activities necessary prepare the asset for its intended use or sale have been undertaken and expenditures and borrowing costs have
been incurred. Borrowing costs are capitalized until the asset is substantially available for its intended use.

Borrowing costs include interest charges and other costs incurred in connection with the borrowing of funds, as well as any exchange differences arising from any foreign currency-denominated borrowings used finance the projects, to the extent that they regarded as an adjustment to interest costs.

All other borrowing costs are expensed as incurred.

Investment Properties

Investment properties, except land, are stated at cost, net of accumulated depreciation and accumulated impairment loss, if any. The carrying amount includes transaction costs and costs of replacing part of an existing investment property at the time such costs are incurred if the recognition criteria are met and excludes the costs of day-to-day servicing of an investment property.

Investment properties include properties that are being constructed or developed for future use as investment property.

Land classified as investment property is carried at cost less any impairment in value.

MERALCO;s investment properties acquired before January 1, 2004 are stated at deemed cost. See Note 16 – Equity for the related discussions.

Investment properties, except land, are being depreciated on a straight-line basis over the useful life of five to 35 years.

Investment properties are derecognized either when they have been disposed of or when these are permanently withdrawn from use and no future economic benefit is expected from its disposal. Any gain or loss from the
derecognition of the investment properties are recognized in the consolidated statement of income in the year these are disposed or retired.

Transfers are made to investment property when and only when there is a change in use, evidenced by ending of owner-occupation or commencement of an operating lease to another party. If owner-occupied property becomes an investment property, the MERALCO Group accounts for such property in accordance with the policy stated under utility plant and others up to the date of the change in use. Transfer are made from investment property when, and only when, there is a change in use, evidenced by commencement of owner-occupation or commencement of development with a view to sale. Transfers from investment property are recorded using the carrying amount of the investment property at the date of change in use.

Asset Retirement Obligations

Under the terms of certain lease contracts, the MERALCO Group is required to dismantle the installations made in leased sites and restore such sited to their original condition at the end of the term of the lease contracts. The MERALCO Group recognizes a liability measured at the present values of the estimated costs of these obligations and capitalizes such costs as part of the balance of the related item of utility plant and others and investment properties. The amount of asset retirement obligations is accreted and such accretion is recognized as interest expense.

Intangible Assets

Intangible assets acquired separately are initially measured at cost. Following initial recognition, intangible assets are carried at cost less accumulated amortization and any accumulated impairment loss. The useful lives of intangible assets are assessed at the individual asset level as having either finite or indefinite useful lives.

Intangible assets with finite lives are amortized over the useful economic lives of five years using the straight-line method and assessed for
impairment whenever there is an indication that the intangible assets may be impaired. At a minimum, the amortization period and the amortization method for an intangible asset with a finite useful life are reviewed at each reporting date. Changes in the expected useful life or the expected consumption pattern of future economic benefit embodied in the asset are accounted for by changing the amortization period or method, as appropriate, and treated as change in accounting estimates. The amortization expense of intangible assets with finite lives is recognized in the consolidated statement of income.

Intangible assets with indefinable useful lives are not amortized, but are assessed for impairment annually either individually or at the cash-generating unit level. The assessment of indefinite useful life is done annually at every reporting date to determine whether such indefinite useful life continues to exist. Otherwise, the change in the useful life assessment from indefinite to finite is made on prospective basis.

Gains or losses arising from derecognition of an intangible asset are measured as the difference between the net disposal proceeds and the carrying amount of the asset, and are recognized in the consolidated statement of income.

Intangible assets generated within the business are not capitalized and expenditures are charged to profit or loss in the year these are incurred.

Investments in Associates
An associated is an entity over which MERALCO has significant influence and which is neither a subsidiary not a joint venture. Investments in associates are accounted for using the equity method of accounting and are initially recognized at cost.

Under the equity method, investment in an associate is carried in the consolidated statement of financial position at cost plus post-acquisition changes in the MERALCO Group’s share of net assets of the associate, less any impairment in value. Any goodwill relating to an associate is included
in the carrying amount of the investment and is not amortized nor individually tested for impairment. The consolidated amount of the income reflects the MERALCO Group’s share of the results operations of the associates. Where there has been a change recognized directly in the equity of the associate, the MERALCO Group recognizes its share in any change and discloses this, when applicable, in the consolidated statement of comprehensive income and changes in equity. Unrealized gains and losses resulting from transactions between and among the MERALCO Group and the associates are eliminated to the extent of the interest in those associates.

The share in profits and losses of associates is shown on the face of the consolidated statement of income. This is the profit or loss attributable to equity holders of the associate and is therefore profit or loss after tax and net of non0controlling interest in the subsidiaries of the associates.

The reporting date of the associates and that of the MERALCO Group are identical and the associates’ accounting policies conform with those used by the MERALCO Group for like transactions and events in similar circumstances.

After application of the equity method, the MERALCO Group determines whether it is necessary to recognize an impairment loss on the investments in associates. At the end of each reporting date, the MERALCO Group determines whether there is any objective evidence that each of the investments in associates is impaired. If this is the case, the MERALCO Group calculates the amount of impairment as the difference between the recoverable amount of the investment in associate and its carrying value and recognizes the amount in the consolidated statement of income.

Upon loss of significant influence over the associate, the MERALCO Group measures and recognizes any remaining investment at its fair value. Any difference between the carrying amount of the investment in associate upon loss of significant influence, and the aggregate of the fair value of the remaining investment and proceeds from disposal, is recognized in the consolidated statement of income.

Investment in Joint Ventures
The MERALCO Group’s ownership interests in Indra Philippines, Inc. or Indra Philippines, and Rockwell Business Center, both jointly controlled entities, are accounted for using the equity method of accounting in the consolidated financial statements. The interests in joint ventures are carried at cost plus post-acquisition changes in the MERALCO Group’s share in net assets of the joint ventures, less any impairment in value. The MERALCO Group’s share in the results of operation of the joint ventures is recognized in the consolidated statement of income.

A joint venture is a contractual arrangement whereby two or more parties undertaken an economic activity that is subject to joint control. A jointly controlled entity is a joint venture that involves the establishment of a separate entity in which each venturer has an interest. The financial statements of the joint ventures are prepared for the same reporting year as that of the MERALCO Group, using consistent accounting policies.

Adjustments are made in the consolidated financial statements to eliminate the MERALCO Group’s share of unrealized gains and losses on transactions between the MERALCO Group and the jointly controlled entities. The joint venture is carried at equity method until the date on which the MERALCO Group ceases to have joint control over the jointly controlled entity.

The MERALCO Group measures and recognizes the remaining investment at fair value upon loss of control and provided the jointly controlled entity does not become a subsidiary or associate. Any difference between the carrying amount of the jointly controlled entity upon loss of joint control, and the aggregate of the fair value of the remaining investment and proceeds from disposal, is recognized in the consolidated statement of income. When the remaining investment constitutes significant influence, it is accounted for as investment in an associate.

Impairment of Nonfinancial Assets

The MERALCO Group assesses at each reporting date whether there is an
indication that a nonfinancial asset (utility plant and others, investment properties, investments in associates and joint ventures, pass-through VAT, deferred input Vat, receivable from the BIR and intangible assets), other than goodwill and intangible assets with indefinite useful life, may be impaired. If any such indication exists, the MERALCO Group makes an estimate of the asset’s recoverable amount. An asset’s recoverable amount is the higher of an individual asset’s or a cash-generating unit’s fair value less costs to sell and its value in use. Where the carrying amount of an asset exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount. The fair value is the amount obtainable from the sale of the asset in an arm’s-length transaction. In determining fair value less cots to sell, an appropriate valuation model is used. These calculations are corroborated by valuation factors/parameters, quoted share prices for publicly traded securities or other available fair value indicators. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of time value money and the risks specific to the asset. Impairment losses are recognized in the consolidated statement of income.

An assessment is also made at each reporting date as to whether there is any indication that previously recognized impairment losses may no longer exist or may have decreased. If such indication exists, the MERALCO Group estimates the individual asset’s or cash-generating unit’s recoverable amount. A previously recognized impairment loss is reversed only if there has been a change in the estimates used to determine the asset;s recoverable amount since the last impairment loss was recognized. If a reversal of impairment loss is to be recognized, the carrying amount of the asset is increased to its recoverable amount. The increased amount cannot exceed the carrying amount that would have been determined had no impairment loss been recognized for the asset in prior years. Such reversal is recognized in the consolidated statement of income. After such reversal, the depreciation and amortization expense are adjusted in future periods to allocate the asset’s revised carrying amount, less any residual value, on a systematic basis over its remaining useful life. Intangible assets with indefinite useful lives
are tested for impairment annually at ever reporting date or more frequently if events or changes in circumstances indicate that the carrying value may be impaired, either individually or at the cash-generating unit level, as appropriate. The amount of impairment is calculated as the difference between the recoverable amount of the intangible asset and its carrying amount. The impairment loss is recognized in the consolidated statement of income. Impairment losses relating to intangible assets may be reversed in future periods. Goodwill is reviewed for impairment annually at every reporting date or more frequently if events or changes in circumstances indicate that the carrying value may be impaired. Impairment is determined for goodwill by assessing the recoverable amount of the cash-generating unit or group of cash-generating units, to which the goodwill relates. Where the recoverable amount of the cash-generating unit or group of cash-generating units is less than the carrying amount of the cash generating unit or group of cash-generating units to which goodwill has been allocated, an impairment loss is recognized. Impairment losses relating to goodwill cannot be reversed in future periods. If there is incomplete allocation of goodwill acquired in a business combination to cash0generating units or group of cash-generating units, an impairment testing of goodwill is only carried out when impairment indicators exist. When impairment indicators exist, impairment testing of goodwill is performed at a level at which the acquirer can reliably test for impairment. Inventories

Materials and supplies are stated at the lower of cost or net realizable value. Costs of acquiring materials and supplies including costs incurred in bringing each item to their present location and condition are accounted using the moving average cost method. Net realizable value is the estimated selling price in the ordinary course of business less the estimated cost to sell or the current replacement cost of the asset.

Financial Assets
Initial Recognition
Financial assets are classifies as at FVPL, loans and receivables, held-to-maturity or HTM investments, AFS financial assets, or as derivatives designated as hedging instruments in an effective hedge, as appropriate. The
classification of financial assets is determined at initial recognition and, where allowed and appropriate re-evaluated at each reporting date.

Financial assets are recognized initially at fair value. Transaction sots are included in the initial measurement of all financial assets, except for financial instruments measured at FVPL.
Purchases or sales of financial assets that require delivery of assets within a timeframe established by regulation or convention in the market place (regular way purchase) are recognized on the trade date, which is the date the MERALCO Group commits to purchase or sell the asset.

The MERALCO Group’s financial assets include cash and cash equivalents, trade and non-trade receivables, advance payments to a supplier, quoted and unquoted equity securities and embedded derivatives that are not accounted for as effective accounting hedges.

Subsequent Measurement
The subsequent measurement of financial assets depends on the classification as follows:
Financial Assets at FVPL
Financial assets at FVPL include financial assets held-for-trading and financial assets designated upon initial recognition as at FVPL. Financial assets are classified as held-for-trading if they are acquired for the purpose of selling in the near term. Derivative assets, including separated embedded derivatives are also classified as held-for-trading unless they are designated as effective hedging instruments. Financial assets designated as at FVPL are carried in the consolidated statement of financial position at fair value with gains or losses on fair value changes recognized in the consolidated statement of income under “Interest and other financial income” or “Interest and other financial charges” account, respectively. Interest earned and dividends received from investment designated as at FVPL are also recognized in the consolidated statement of income under “ Interest and other financial income” account.

Financial assets may be designated at initial recognition as at FVPL if any
of the following criteria are met: (i) the designation eliminated or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets or recognizing gains or losses on them on a different basis; (ii) the financial assets are part of a group, which are managed and their performance are evaluated on a fair value basis, in accordance with a documented risk management strategy; or (iii) the financial assets contain one or more embedded derivatives that would need to be recorded separately.

Derivatives embedded in host contracts are accounted for as separate derivatives and characteristics are not closely related to those of the host contacts and the host contracts are not carried at fair value. These embedded derivatives are measured at fair value with gains and losses arising from changes in fair value recognized in the consolidated statement of income. Reassessment only occurs if there is a change in the terms of the contract that significantly modifies the cash flows that would otherwise be required under the contract.

Loans and Receivables
Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. Such financial assets are carried at amortized cost using the effective interest method. This method uses an effective interest rate that discounts estimated future cash receipts through the expected life of the financial asset to the net carrying amount of the financial asset. Gains or losses are recognized in the consolidated statement of income when the loans and receivables are derecognized or impaired, as well as when these are amortized. Interest carried or incurred is recorded in “Interest and other financial income” or “Interest and other financial charges” account, respectively, in the consolidated statement of income. Assets in this category are included under current assets except for assets with maturities beyond 12 months from the reporting date, which are classified as noncurrent assets.

HTM Investments
Non-derivative financial assets with fixed or determinable payments and
fixed maturities are classified as HTM when the MERALCO Group has the positive intention and ability to hold these assets maturity. After initial measurement, HTM investments are measured at amortized cost using the effective interest method. Gains or losses are recognized in the consolidated statement of income. Assets in this category are included in the current assets except for maturities beyond 12 months from the reporting date, which are classifies as noncurrent assets.

AFS Financial Assets
AFS financial assets are non-derivative financial assets that are designated as AFS or are not classified in any of the three foregoing categories. They are purchased and held indefinitely and may be sold in response to liquidity requirements or changes in market conditions. After initial measurement, AFS financial assets are measured at fair value with unrealized gains or losses recognized in other comprehensive income until the investment is derecognized in the consolidated statement of income, or determined to be impaired, at which time the cumulative loss recorded in other comprehensive income is recognized consolidated statement of income. Interest earned on holding AFS debt securities are included under “Interest and other financial income” account in the consolidated statement of income. Dividends earned on holding AFS equity are recognized in the consolidated statement of income under “Interest and other financial income” account when the right of payment has been established. These are included under noncurrent assets unless there is an intention to dispose of the investment within 12 months from the reporting date.

Financial Liabilities
Initial Recognition
Financial liabilities are classified as financial liabilities at FVPL, other financial liabilities, or as derivatives designated as hedging instruments in an effective hedge, as appropriate. The classification of the financial liability is determined at initial recognition.

Financial liabilities are recognized initially at fair value inclusive of directly attributable transaction costs, except for financial liabilities at
FVPL.
The MERALCO Group’s financial liabilities include notes payable, interest-bearing long-term financial liabilities, trade payables and other current liabilities (excluding output VAT, accrued taxes, reinsurance liability and deferred lease income), customers’ deposits, refundable service extension costs, customers’ refund, other noncurrent liabilities and derivatives that are not accounted for as effective accounting hedges.

Subsequent Measurement
The subsequent measurement of financial liabilities depends on their classification as follows:
Financial Liabilities at FVPL include financial liabilities held-for-trading and financial liabilities designated initial recognition as at FVPL. Financial liabilities are classified as held-for-trading if they are incurred for the purpose of repurchasing in the near term. Derivative liabilities, including separated embedded liabilities are also classified as held-for-trading unless they are designated as effective hedging instruments. Financial liabilities at FVPLS are carried in the consolidated statement of financial position at fair value with gains or losses recognized in the consolidated statement of income under “ Interest and other financial income” or “Interest and other financial charges” account, respectively. Interest incurred on financial liabilities designated as at FVPL is recognized in the consolidated statement of income under “Interest and other financial charges” account. Financial liabilities may be designated at initial recognition as at FVPL, if any of the following criteria are met: (i) the designation eliminates or significantly reduce the inconsistent treatment that would otherwise arise from measuring the liabilities or recognizing gains or losses on them on a different bases; (ii) the financial liabilities are part of a group which are managed and their performance are evaluated on a fair value basis, in accordance with a documented risk management strategy; or (iii) the financial liabilities contain one or more embedded derivatives that would need to be recorded separately. The MERALCO Group does not have financial liabilities designated as at FVPL as at December 31, 2011.

Other Financial Liabilities
After initial recognition, other financial liabilities are subsequently measured at amortized cost using the effective interest method. Gains and losses are recognized in the consolidated statement of income when the liabilities are derecognized as when these are amortized. Amortized cost is calculated by taking into account any discount or premium on acquisition and fees or costs that are integral part of the effective interest rate. The effective interest amortization is included either under “Interest and other financial Charges” or “Interest and other financial income” account in the consolidated statement of income.

Derivative Financial Instruments
Initial Recognition and Subsequent Measurement
MERALCO has separated embedded foreign currency forwards which are derivative financial instruments used to hedge risks associated with foreign currency fluctuations. Derivative instruments, including separated embedded derivatives, are initially recognized at fair value on the date at which a derivative transaction is entered into or separated, and are subsequently re-measured at fair value. Changes in fair value of derivative instruments, other than those accounted for as effective hedges, are recognized immediately in the consolidated statement of income. Changes in fair value of derivative instruments accounted as effective hedges are recognized in other comprehensive income. Derivatives are carried as assets when the fair value is derivatives accounted for under hedge accounting. An embedded derivative is separated from the hybrid or combined contract if all the following conditions are met: (a) the economic characteristics and risks of the embedded derivative are not clearly and closely related to the economic characteristics and risks of the host contract; (b) a separated instrument with the same terms as the embedded derivative would meet the definition of a derivative; and (c) the hybrid instrument is not recognized as at FVPL. Subsequent reassessment is prohibited unless there is a change in the terms of the contract that significantly modifies the cash flows that otherwise would be required under the contract. An entity determines whether a modification to cash flows is significant by considering the extent to which the expected future cash flows associated with the embedded derivative, the
host contract or both have changed. See Note 28 – Financial Assets and Liabilities

Offsetting of Financial Instruments
Financial assets and liabilities are offset and the net amount is reported in the consolidated statement of financial position if, and only if, there is currently enforceable legal right to offset the recognized amounts and there is an intention to settle on a net basis, or to realize the assets and settle the liabilities simultaneously.

Fair Value of Financial Instruments
The fair value of financial instruments that are actively traded in organized financial markets is determined by reference to quoted market prices at the close of business at the transaction or reporting date. When current bid and asking prices are not available, the price of the most recent transaction provides evidence of the current fair value as long as there has not been a significant change in economic circumstances since the time of the transaction. For financial instruments where there is no active market, fair value is determined using valuation techniques. Such techniques include use of recent arm’s-length market transactions, reference to the current market value of another instrument, which are substantially the same, discounted cash flow analysis and other pricing models.

Amortized Cost of Financial Instruments
Amortized cost is computed using the effective interest method less any allowance for impairment and principal repayment, plus or minus, the cumulative amortization of premium or discount. The calculation takes into account any premium or discount on acquisition and includes transaction costs and fees that are an integral part of effective interest.

‘Day 1’ Profit or Loss
Where the transaction price in a non-active market is different from the fair value of other observable current market transactions in the same instrument or based on a valuation technique whose variables include only data from observable market, the MERALCO Group recognizes the difference between the
transaction price and fair value (a ‘Day 1’ profit or loss) in the consolidated statement of income, unless it qualifies for recognition as some other type of asset or liability. In cases where date is used are not observable, the difference between the transaction price and model value is only recognized in the consolidated statement of income when the inputs become observable or when the instrument is derecognized. For each transaction, the MERALCO Group determines the appropriate method of recognizing the ‘Day 1’ profit or loss amount.

Impairment of Financial Assets
The MERALCO Group assess at each reporting date whether a financial asset or group of financial assets is impaired. A financial asset or a group of financial assets is deemed to be impaired if, and only if, there is objective evidence of impairment as a result of one or more events that has occurred after the initial recognition of the asset (an incurred ‘loss event’) and that loss event has an impact on the estimated future cash flows of the financial asset or group of financial assets can be reliably estimated. Evidence of impairment may include indications that the debtor or a group of debtors is experiencing significant financial difficulty, default or delinquency in interest or principal payments, the probably that they will enter bankruptcy or other financial reorganization and where observable date indicate that there is a measurable decrease in the estimated future cash flows, such as changes in arrears or economic conditions that correlate with defaults.

Financial Assets Carried at Amortization Cost
For financial assets carried at amortized cost, the MERALCO Group first assess whether objective evidence of impairment exists individually. If it is determined that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, the asset is included in a group of financial assets with similar credit risk characteristics and that group of financial assets is collectively assessed for impairment based on historical loss experience. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognized are not included in a collective assessment of
impairment. MERALCO and CDC consider termination or disconnection of service and significant financial difficulties of debtors as objective evidence that a financial asset or group of financial assets is impaired. For both specific and collective assessments, any deposits, collateral and credit enhancement are considered in determining the amount of impairment loss. If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate (i.e., the effective interest rate computed at initial recognition). If a loan is subject to variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate. The carrying amount of the asset is reduced either directly or through the use of an allowance account and the amount of the loss is recognized in the consolidated statement of income. Interest income continues to be accrued on the reduced carrying amount based on the original effective interest rate of the asset. The financial asset together with associated allowance is written off when there is no realistic prospect of future recovery and all collateral or deposits has been realized or has been transferred to the MERALCO Group. If, in a subsequent period, the amount of the estimated impairment loss increases or decreases because of an event occurring after the impairment was recognized, the previously recognized impairment loss is increased or reduced by adjusting the allowance account. If an asset written off is recovered, the recovery is recognized in the consolidated statement of income. Any reversal of an impairment loss is recognized in the consolidated statement of income, to the extent that the carrying value of the asset does not exceed its amortized cost at the reversal date.

AFS Financial Assets
In the case of equity instruments classified as AFS, objective evidence would include a significant or prolonged decline in the fair value of the investment below its cost. When a decline in the fair value of an AFS financial asset has been recognized in other comprehensive income and there is objective evidence that the asset is impaired, the cumulative loss that
had been recognized in other comprehensive income is reclassified from equity or profit or loss even though the financial asset has not been derecognized. The amount of the cumulative loss that is reclassified from equity to profit or loss is the difference between the acquisition cost (net of any principal repayment and amortization) and current fair value, less any impairment loss on the financial asset previously recognized in profit or loss. Impairment losses recognized in profit or loss for investment in equity instruments are not reversed in the consolidated statement of income. Subsequent increases in fair value after impairment are recognized directly in other comprehensive income. In the case of debt instrument classified as AFS, impairment is assessed based on the same criteria as financial assets carried at amortized cost. Future interest income is based on the reduced carrying amount and is accrued based on the rate of interest used to discount future cash flows for the purpose of measuring impairment loss. Such accrual is recorded as part of “Interest and other financial income” in the consolidated statement of income. If, in a subsequent period, the fair value of a debt instrument increases and the increase can be objectively related to an event occurring after the impairment loss was recognized in the consolidated statement of income, the impairment loss is reversed in the consolidated statement of income.

Assets Carried at Cost
If there is objective evidence that an impairment loss has been incurred on an unquoted equity instrument that is not carried at fair value because its fair value cannot be reliably measured, or on a derivative asset that is linked to and must be settled by delivery of such an unquoted equity instrument, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the current market rate of return for a similar financial asset.

Derecognition of Financial Instruments
Financial Assets
A financial asset (or where applicable, a part of financial asset or part of a group of similar financial assets) is derecognized when: * The right to
receive cash flows from the asset has expired; * The MERALCO Group has transferred its right to receive cash flows from the asset or has assumed an obligation to receive cash flows in full without material delay to a third party under a “pass-through” arrangement; and * Either the MERALCO Group (a) has transferred substantially all the risks and rewards of the asset, or (b) has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset. Where the MERALCO Group has transferred its right to receive cash flows from an asset or has entered into a “pass-through” arrangement, and has neither transferred nor retained substantially all the risks and rewards of the asset nor transferred control of the asset, a new asset is recognized to the extent of the MERALCO Group’s continuing involvement in the asset. Continuing involvement that takes the form of guarantee over the transferred asset is measured at lower or of original carrying amount of the asset and the maximum amount of consideration that the MERALCO Group could be required to repay.

Financial Liabilities
A financial liability is derecognized when the obligation under the liability is discharged or cancelled or has expired. Where an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability, and the difference in the carrying amount of a financial liability extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed is recognized in the consolidated statement of income.

Redeemable Preferred Stock
MERALCO’s peso-denominated redeemable preferred stock has characteristics of a liability and is thus recognized as a liability in the consolidated statement of financial position. The corresponding dividends on those shares are recognized as part of “Interest and other financial charges” account in the consolidated statement of income. Dividends are no longer accrued when
such shares have been called for redemption.

Provisions
Provisions are recognized when the MERALCO Group has a present obligation, legal or constructive, as a result of a past event, and when it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. Where the MERALCO Group expects a provision, or a portion, to be reimbursed, for example under an insurance contract, the reimbursement is recognized as a separate asset but only when the reimbursement is virtually certain. The expense relating to any provision is presented in the consolidated statement of income, net of any reimbursement. If the effect of the time value of money is material, provisions are discounted using a current pre-tax rate that reflects, where appropriate, the risks specific to the liabilities. Where discounting is used, the increase in the provision due to the passage of time is recognized as part of “Interest and other financial charges” account.

Retirement Benefits
MERALCO and substantially all of its subsidiaries have distinct, funded, noncontributory defined benefit retirement plans covering all permanent employees. MERALCO’s retirement plan provides for post-retirement benefits in addition to a lump sum payment to employees hired up to December 31, 2003. Retirement benefits for employees hired commencing January 1, 2004 were amended to provide for a defined lump sum payment only. MERALCO also has contributory Provident Plan introduced in January 2009 in which employees hired commencing January 1, 2004 may elect to participate. The costs of providing benefits under the distinct defined benefits plans are determined using the projected unit credit actuarial valuation method. This method reflects services rendered by employees to the date of valuation and incorporates assumptions concerning employees’ projected salaries. Retirement costs include current service cost, interest costs, return on plan assets plus amortizations of past service cost, experience adjustments and changes in actuarial assumptions. Past service cost is recognized as an expense on a straight-line basis over the average period until the benefits
become vested. If the benefits vest immediately following the introduction of, or changes to a pension plan, past service cost is recognized immediately. Actuarial gains and losses are recognized as income or expense when the net cumulative unrecognized actuarial gains and losses at the end of the previous reporting year exceeded 1-% of the higher of the defined benefit obligation and the fair value of plan assets at that date. These gains or losses are recognized over the expected average remaining working lives of the employees participating in the plan. The defined benefit liability (or asset) is the aggregate of the present value of the defined benefit obligation and any actuarial gains not yet recognized reduced by past service cost and actuarial losses not yet recognized and the fair value of plan assets out of which the obligations are to be settled directly. Plan assets are assets that are held by a long-term employee benefit fund. Fair value is based on market price information, and the published bid price in the case of quoted securities. The amount of any defined benefit asset recognized is restricted to the sum of any past service cost and actuarial gains or losses not yet recognized and the present value of any economic benefits available in the form of refunds from the plan or reductions in the future contributions to the plan. The retirement costs under the defined contribution plan are recorded based on MERALCO’s contribution to the defined contribution plan as services are rendered by the employee.

Employee Stock Purchase Plan or ESPP
Up to 2009, MERALCO had an employee stock purchase plan, which covered active and retired employees. Under the plan, the qualified participant may purchase fixed number of shares of stock at a pre-agreed price. The plan features include vesting requirements and payment terms. The cost of equity-settled transactions with employees is measured by reference to the difference between the fair value of the shares on the grant date and the price at which the share may be purchased under the award or offer. In valuing equity-settled transactions, no account is taken of any performance conditions other than market conditions. The cost of equity-settled transactions is recognized, together with a corresponding increase in equity, over the period in which the performance and/or service conditions are fulfilled, ending on the date at which the relevant employees become
fully entitled to the award (‘the vesting date’). The cumulative expense recognized for equity-settled transactions at each reporting date until the vesting date reflects the extent to whichthe vesting period has expired and MERALCO’s best estimate of the number of equity instruments that will ultimately vest. The profit or loss charge or credit for a year represents the movement in cumulative expense recognized as at the beginning and end of the reporting year. No expense is recognized for awards that do not ultimately vest. When the terms of the equity-settled awards are modified and the modification increases the fair value of the equity instruments granted, as measured immediately before and after the modification, the entity shall include the incremental fair value granted in the measurement of the amount recognized for services received as consideration for the equity instrument granted. The incremental fair value granted is the difference between the fair value of the modified equity instrument and that of the original equity instrument, both estimated as at the date of the modification. If the medication occurs during the vesting period, the incremental fair value granted is included in the measurement of the amount recognized for services received over the period from the amount based on the grant date fair value of the original equity instruments, which is recognized over the remainder of the original vesting period. If the modification occurs after vesting date, the incremental fair value granted is recognized immediately or over the vesting period if the employee is required to complete an additional period of service before becoming unconditionally entitled to those modified equity instruments. Long-term Incentive Plan

Liability arising from the long-term incentive plan is determined using the projected unit credit actuarial valuation method. The liability relating to the long-term incentive plan comprises the present value of the defined benefit obligation at the end of the reporting date. Revenue Recognition

Revenues are stated at amounts invoiced to customers, inclusive of pass-through components, net of discounts, rebates, VAT and other taxes, where applicable. Revenue is recognized to the extent that it is probable that the economic benefits will flow to the MERALCO Group and the revenue
can be reliably measured. In addition, collectibity is reasonably assured and the delivery of the arrangements against specific criteria in order to determine if it is acting as principal or agent. The MERALCO Group concluded that it is acting as principal in all of its revenue arrangements. The following specific recognition criteria must also be met before revenue is recognized: Sale of Electricity

Revenues are recognized upon supply of power to the customers. The Uniform Filinf requirements or UFR, on the rate unbundling released by the ERC on October 30, 2001 specified the following bill components: (a) generation charge, (b) transmission charge, (c) SL charge, (d) distribution charge, (e) supply charge, (f) metering charge, (g) Currency Exchange Rate Adjustment or CERA I and II, where applicable and (h) interclass and lifeline universal charges are also separately presented in the customer's billing statement. VAT, LFT and universal charges are billed and collected on behalf of the national and local governments and do not form part of MERALCO and CEDC's revenues. Sale of Services

Revenues from construction contracts are recognized and measured using the percentage-of-completion method of accounting for the physical portion of the contract work, determined based on the actual costs incurred in relation to the total estimated costs of the contract. Revenue from contracts to manage, supervise or coordinate construction activity for others and contracts where materials and services are supplied by project owners are recognized only to the extent of the contracted fees. Contract costs principally included subcontracted costs related to contract performace. Expected losses on contracts are recognized immediately when it is probable that the total contract costs will exceed total contract revenues. The amount of such loss is determined irrespective of whether or not wotk has commenced on the contract; the stage of completion of contract activity; or the amount of profits expected to arise on the other contracts, which are not treated as a single construction contract. Changes in contract performance, contract settlements and after gross margins are recognized in the year in which the changes are determined. Service and consulting fees are recognized when the services are rendered. Interest Income

Revenue is recognized as interest accrues, using the effective interest method. The effective interest rate is the rate that discounts estimated future cash receipts through the expected life of the financial instrument. Dividends

Revenue is recognized when the MERALCO Group's right to receive the payment is established. Lease Income arising from lease of investment properties and poles is accounted for on a straight-line basis over the lease term. Lease income is included under “Revenues – Sale of services and others” account in the consolidated statement of income. Leases

The determination of whether an arrangement is, or contains a lease is based on the substance of the arrangement at the inception date of whether the fulfillment of the arrangement is dependent on the use of a specific asset or the arrangement conveys a right to use the asset. Company as Lessee

Operating lease payments are recognized as expense in the consolidated statement of income on a straight-line basis over the lease term. Company as Lessor
Leases where the MERALCO Group does not transfer substantially all the risk and benefits of ownership of the asset are classified as operating lease. Initial direct costs incurred in negotiating an operating lease are added to the carrying amount of the leased asset and recognized over the lease term on the same basis as rental income. Contingent rents are recognized as revenue in the period in which they are earned. Foreign Currency-Denominated Transaction and Translations

The consolidated financial statements are presented in Philippine peso, which is also MERALCO's functional and presentation currency. The Philippine peso is the currency of the primary economic environment in which MERALCO Group operates, except for LOIL. This is also the currency that mainly influences the revenue from and cost of rendering services. Each entity in MERALCO Group determines its own functional currency and items included in the financial statements of each entity are measured using that functional
currency. The functional currency of LOIL is the United States or US dollar. Transactions in foreign currency are initially recorded in the functional currency rate prevailing at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are re-translated using functional currency closing rate of exchange prevailing at the end of reporting date. All differences are recognized in the consolidated statement of income except for difference that relate to capitalizable borrowing costs on qualifying assets. Nonmonetary items that are measured in terms of historical cost in foreign currency are translated using the exchange rate as at the date of the initial transactions. As at the reporting date, the monetary assets and liabilities of an associate, and lOIL whose functional currency is other than Philippine peso, are translated into Philippine peso at the rate of exchange prevailing at the end of the reporting period, and income and expenses of an associate are translated monthly using the weighted average exchange rate for the month. The exchange differences arising on translation are recognized as a separate component of other comprehensive income as cumulative translation adjustments. On disposal of the associate, the amount of cumulative translation adjustments recognized in other comprehensive income is recognized in the consolidated statement of income. Income Taxes

Current Income Tax
Current income tax assets and liabilities for the current and prior years are measured at the amount expected to be recovered from or paid to the taxation authority. The tax rate and tax laws used to compute the amount are those that are enacted or substantively enacted as at the reporting date. Deferred Income Tax

Deferred income tax is provided using the balance sheet liability method on all temporary differences at the reporting date between the income tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred income tax liabilities are recognized for all taxable temporary differences, except: * where the deferred income tax liability arises from the initial recognition of goodwill or of an asset or liability in a transaction that is not a business combination and, at the time of the
transaction, affects neither the accounting profit nor taxable profit or loss; and * in respect of taxable temporary differences associated with investments in associates and joint ventures, where the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future. Deferred income tax assets are recognized for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary differences can be utilized except: * when the deferred income tax asset relating to the deductible temporary difference arises from the initial recognition of an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting profit nor taxable profit or loss; and * in respect of deductible temporary differences associated with investments in subsidiaries, associates and joint ventures, deferred income tax assets are recognized only to the extent that it is probable that the temporary differences will reverse in the foreseeable future and taxable profit will be available against which the temporary differences can be utilized. The carrying amount of deferred income tax assets is reviewed at each reporting date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred income tax assets to be utilized. Unrecognized deferred income tax assets are reassessed at each reporting date and are recognized to the extent these have become probable that future taxable profit will allow the deferred income tax assets to be recovered. Deferred income tax assets and liabilities are measured at the tax rate that are expected to apply in the year when the asset is realized or the liability is settled, based on tax rate and tax laws that are enacted or substantively enacted as at the reporting date. Deferred income tax items are recognized in correlation to the underlying transaction either in profit or loss or directly in equity.

Earnings per Share
Basic earnings per share is calculated by dividing the net income for the year attributable to equity holders of the parent by the weighted average number of common shares outstanding, adjusted for the effects of any
dilutive potential common shares.

Contingencies
Contingent liabilities are not recognized in the consolidated financial statements. These are disclosed in the notes to consolidated financial statements unless the possibility of an outflow of resources embodying economic benefits is remote. Contingent assets are not recognized unless the realization of the assets is virtually certain. These are disclosed in the notes to consolidated financial statements when an inflow of economic benefits is probable. Events After the Reporting Date

Post reporting date events that provide additional information about the MERALCO Group’s financial position at the reporting date (adjusting events) are reflected in the consolidated financial statements. Post reporting date events that are not adjusting events are disclosed in the notes to consolidated financial statements, when material. Equity

Common stock is measured at par value for all shares issued. Incremental costs incurred directly attributable to the issuance of new shares are shown as a deduction from equity, net of any related tax. The amount of proceeds and/or fair value of consideration, net of incremental costs incurred directly attributable to the issuance of new shares, received in excess of par value is recognized as additional paid-in capital. Employee stock purchase plan cost represents the cumulative compensation expense recognized based on the amount determined using an option pricing model. The 14th and last ESPP, which was awarded in 2009 fully vested in October 2012. Since 2009kk there have been no ESPP’s awarded. Change in the ownership interest of a subsidiary, without loss of control, is accounted for as an equity transaction and presented as “Excess of acquisition cost over carrying value of non-controlling interest acquired”. Other comprehensive income comprises items of income and expenses, including reclassifications, which are not recognized in profit or loss as require or permitted by PFRS. Retained earnings include net income attributable to the equity holders of the Parent and reduced by dividends on common stock. Dividends are recognized as a liability and deducted from retained earnings when they are declared.
Dividends approved after the financial reporting date are disclosed as events after the financial reporting date. Non-controlling interests represent the equity interests in CEDC and MIESCOR and its subsidiaries, which are not held by MERALCO.

5. Management’s Use of Judgments, Estimates and Assumptions
The preparation of the MERALCO Group’s consolidated financial statements requires management to make judgments, estimates and assumptions that affect the reported amounts of revenues, expenses, assets and liabilities, and the disclosure of contingent assets and liabilities, at the end of the reporting period. However, uncertainty about these assumptions and estimates could result in outcomes that require a material adjustment to the carrying amount of the asset or liability affected in future periods.

Judgments
In the process of applying the MERALCO Group’s accounting policies, management has made the following judgments, which have the most significant effect on the amounts recognized in the consolidated financial statements.

Determination of functional Currency
The functional currencies of the entities under the MERALCO Group are the currencies of the primary economic environment in which each entity operates. It is currency that mainly influences the revenue and cost of rendering services.

Based on the economic substance of the underlying circumstances, the functional and presentation currency of MERALCO and its subsidiaries, except LOIL, is the Philippine peso. The functional and presentation currency of LOIL is the US dollar.

Operating Lease Commitments
As Lessor
As a lessor, the MERALCO Group has several lease arrangements. Based on the terms and conditions of the arrangements, it has evaluated that the significant risks and rewards of ownership of such properties are retained
by the MERALCO Group. The lease agreements do not transfer ownership of the assets to the lessees at the end of the lease term and do not give the lessees a bargain purchase option over the assets. Consequently, the lease agreements are accounted for as operating leases.

As Lessee
As a lessee, MERALCO Group has commercial lease arrangements covering certain office spaces, payment offices and substation sites and towers. The MERALCO Group has determined, based on the evaluation of the terms and conditions of the arrangements, that it has not acquired any significant risks and rewards of ownership of such properties because the lease arrangements do not transfer to the MERALCO Group the ownership over the assets at the end of the lease term and do not provide the MERALCO Group a bargain purchase option over the leased assets. Consequently, the lease agreements are accounted for as operating leases.

Arrangement that Contains a Lease
MERALCO’s Purchased Power Agreements or PPA’s with Independent Power Producers, or IPPs, qualify as leases on the basis that MERALCO and the IPPs have ‘take or pay’ or TOP arrangements where payments for purchased power are made on the basis of the availability of the power plant and not on actual consumption. In determining the lease classification, it is judged that substantially all the risks and rewards incident to the ownership of the IPPs’ power plants are with the IPPs. Thus, the PPAs are classified as operating leases. Accordingly, capacity fees, fixed operating and transmission line fees that form apart of purchased power expense are accounted for similar to a lease.

Components of purchased power expense, which have been accounted for similar to a lease, amounted to P18,946 million, P20, 135 million and P19,960 million in 2012, 2011 and 2010, respectively. These are recognized as “Purchased power” in the consolidated statements of income.

See Note 25 – Revenues and Purchased Power.
Contingencies
The MERALCO Group has possible claims from or obligation to other parties from past events and whose existence may only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within its control. Management has determined that the present obligations with respect to contingent liabilities and claims with respect to contingent assets do not meet the recognition criteria, and therefore has not recorded any such amounts.

See Note 30 – Contingencies and Legal Proceedings.
Estimates and Assumptions
The key assumptions concerning the future and other key sources of estimation uncertainty as at the reporting date that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed in the following:

Estimating Useful Lives of Utility Plant and Others, Intangible Assets with Finite Lives and Investment Properties
The MERALCO Group estimates the useful lives of utility plant and others, intangible assets with finite lives and, investment properties based on the periods over which such assets are expected to be available for use. The estimate of the useful lives of the utility plant and others, intangible assets with finite lives and investment properties based on management’s collective assessment estimated useful lives are reviewed at least at each financial year-end and are updated if expectations useful lives are reviewed at least each financial year-end and are updated expectations differ from previous estimates due to physical wear and tear, technical or commercial obsolescence and legal or other limitations on the use of such assets. It is possible, however, that future results of operations could be materially affected by changes in estimates brought about by changes in the factors mentioned in the foregoing. The amounts and timing of recorded expenses for any period would be affected by changes in these factors and circumstances. A reduction in the estimated useful lives of utility plant and others, intangible assets with finite lives and investment properties would increase recorded operating expenses and decrease noncurrent assets.

The total depreciation and amortization of utility plant and others amounted to P5,474 million, P5,466 million and P5,958 million for the years ended December 31, 2012, 2011 and 2010, respectively. Total carrying values of utility plant and others, net of accumulated depreciation and amortization, amounted to P109,312 million and P105,510 million as at December 31,2012 and 2011, respectively.

Total deprecation of investment properties amounted to P8 million, P138 million and P219 million for the years ended December 31, 2012, 2011 and 2010, respectively. Total carrying value of intangible assets with finite lives, net of accumulated amortization amounted to P1,021 million and P689 million as at December 31, 2012 and 2011, respectively.

See Note 8 – Utility Plant and Others, Note 10 – Investment Properties and Note 11 – Other Noncurrent Assets
Impairment of Nonfinancial Assets
PFRS requires that an impairment review ne performed when certain impairment indicators are present. These conditions include obsolescence, physical damage, significant changes in the manner by which an asset is used, worse than expected economic performance, drop in revenues or other external indicators, among others. In the case of goodwill, at a minimum, such asset is subject to an annual impairment test and more frequently whenever there is an indicator that such asset may be impaired. This requires an estimation of the value in use of cash generating unit to which the goodwill is allocated. Estimating the value in use requires preparation of an estimate of the expected future cash flows from the cash generating unit and choosing an appropriate discount rate in order to calculate the present value of those cash flows.

Determining the recoverable amount of utility plant and others, investment properties, investments in associates and joint ventures, good will and other noncurrent assets, requires (i) the determination of future cash flows expected to be generated from the continued use as well as ultimate disposition of such assets and (ii) making estimates and assumptions that can materially affect the consolidated financial statements. Future events
may cause management to conclude the utility plant and others, construction in progress, investment properties, investments in associates and joint ventures, and other noncurrent assets are impaired. Any resulting impairment loss could have a material adverse impact on the MERALCO Group’s consolidated financial position and results of operations.

The preparation of estimated future cash flows involves significant estimations and assumptions. While management believes that the assumptions are appropriate and reasonable, significant changes in the assumptions may materially affect the assessment of recoverable values and may lead to future impairment changes under PFRS.

The carrying values of nonfinancial assets as at December 31, 2012 and 2011 subject to impairment review are as follows: Account| 2012| 2011|
| | | | | (Amounts in Millions)|
Utility plan and others-net| | | P109,312| P105,510| Investment properties- net| | | 1,634| 1,642| Investments in associates and joint ventures| 1,815| 844| Receivable from the BIR| | | 577| 577|

Intangible assets| | | | 1,021| 689|
Goodwill| | | | | 36| 36|
See Note 8 – Utility Plant and Others, Note 9 – Investments in Associates and Joint Ventures, Note 10 – Investment Properties and Note 11 – Other Noncurrent Assets
Goodwill
The MERALCO Group’s consolidated financial statements and results of operations reflect acquired businesses after the completion of the respective acquisition. MERALCO Group accounts for the acquisition of businesses using the acquisition method of accounting, which requires extensive use of accounting judgments and estimates to allocate the purchase price to the fair market values of the acquiree’s identifiable assets and liabilities and contingent liabilities, if any, at the acquisition date. Any excess in the purchase price over the estimated fair market values of the net assets acquired is recorded as goodwill in the consolidated statement of
financial position. Thus, the number of items, which involve judgments made in estimating the fair market value to be assigned to the acquiree’s assets and liabilities can materially affect the MERALCO Group’s results of operations.

Realizability of Deferred Tax Assets
The MERALCO Group reviews the carrying amounts of deferred tax assets at the end of each reporting period and reduces these to the extent that it is no longer probable that sufficient taxable income will be available to allow all or part of th deferred income tax assets to be utilized. Assessment on the recognition of deferred tax assets on deductible temporary differences is based on the level and timing of forecasted taxable income for the subsequent reporting periods. This forecast is based on past results and future expectations on revenues and expenses as well as future tax planning strategies. Management believes that sufficient taxable profit will be generated to allow all or part of the deferred tax assets to be utilized. The amounts of the deferred tax assets considered realizable could be adjusted in the future if estimates of taxable income are revised.

Based on the foregoing assessment, following are the relevant consolidated information with respect to deferred tax assets: | | | | | 2012| 2011|
| | | | | (Amounts in Millions)|
Recognized deferred tax assets| | P13,360| P10,073| Unrecognized deferred tax assets| | 513| 115|

See Note 29 – Income Taxes and Local Franchise Taxes.
Determination of Fair Values of Financial Assets and Liabilities
Where fair value of financial assets and financial liabilities recorded in the consolidated statement of financial position cannot be derived from active markets, they are determined using valuation techniques including the discounted cash flows model. The inputs to these models are taken from observable markets where possible, but when this is not feasible, a degree of judgment is required in establishing fair values. The judgments include considerations of inputs such as liquidity risk, credit risk and volatility.
Changes in assumptions about these factors could affect the reported fair value of financial instruments.

Total fair values of financial assets and liabilities as at December 31, 2012 amounted to P84, 815 million and P95, 337 million, respectively, while the total fair values of financial assets and liabilities as at December 31, 2011 amounted to P68,388 million and P89, 866 million respectively.

See Note 28 – Financial Assets and Liabilities.
Estimating Allowance for Doubtful Accounts
If there is objective evidence that an impairment loss has been incurred in the trade and other receivables balance of the MERALCO Group, an estimate of the allowance for doubtful accounts related to trade and other receivables that are specifically identified as doubtful of collection is made. The amount of allowance is evaluated by management on the basis on the best available facts and circumstances, including but limited to, the length of the MERALCO Group’s relationship with the customer and the customer’s credit status based on third party credit reports and known market factors, to record specific reserves for customers against amounts due in order to reduce the MERALCO Group’s receivables to amounts that management expects to collect is applied. These specific reserves are reevaluated and adjusted as additional information received affect the amounts estimated.

In addition to specific allowance against individually significant receivables, an assessment for collective impairment allowance against credit exposures of the customers, which were grouped bases on common credit characteristics, although not specifically identified as requiring a specific allowance, have a greater risk of default then when the receivables were originally granted to customers is done. This collective allowance is based on historical loss experience using various factors, such as historical performance of the customers within the collective group, deterioration in the markets in which the customers operate, and identified structural weaknesses or deterioration in the cash flows of customers.

Total asset impairment provision for trade and other receivables and other
current assets recognized in the consolidated statements of income amounted to P832 million, P2,243 million and P961 million for the years ended December 31, 2012, 2011 and 2010, respectively. Trade and other receivables, net of asset impairment, amounted to P28, 077 million and P29, 108 million as at December 31, 2012 and 2011, respectively.

See Note 13 – Trade and Other Receivables and Note 15 – Other Current Assets.
Estimating Net Realizable Value of Inventories
Inventories consist of materials and supplies used in the power distribution and services segments. The excess of cost over net realizable value relating to inventories consists of collective and specific provisions. The cost of inventories is written down whenever the net realizable value of inventories becomes lower than the cost due to damage, physical deterioration, obsolescence, change in price levels or other causes. The lower of cost or net realizable value of inventories is reviewed on the periodic basis. Inventory items identified to be obsolete and unusable are written-off and charged as expense in the consolidated statement of income.

The carrying values of inventories amounted to P1,371 million and P1,675 million as at December 31, 2012 and 2011, respectively.
See Note 14 – Inventories.
Estimation of Retirement Benefit Costs
The cost of defined benefit plans and present value of the pension obligation are actuarially determined. Actuarial valuation requires formulating various assumptions, which include discount rates, expected rates of return on plan assets, rate of compensation increases and mortality rates. Actual results that differ from the MERALCO Group’s assumptions are recognized as income or expense when the net cumulative unrecognized actuarial gains and losses at the end of the previous reporting period exceed 10% of the higher of the defined benefit obligation and the fair value of plan assets at that date. Due to complexity valuation, the underlying assumptions and its long-term nature, a defined benefit obligation is highly sensitive to changes in assumptions. While management
believes that the assumptions are reasonable and appropriate, significant differences in the actual experience or significant changes in the assumptions may materially affect cost for pension and other retirement obligations. All assumptions are reviewed at each reporting date.

Total consolidated defined pension benefit costs and other long – term post – employment benefits costs amounted to P1,364 million, P1,461 million and P1,750 million for the years ended December 31, 2012, 2011 and 2010, respectively. Unrecognized net actuarial gains amounted to P836 million as at December 31, 2012, and unrecognized net actuarial losses as at December 31, 2011 amounted to P1,900 million. Consolidated net pension liability as at December 31, 2012 and 2011 amounted to P6,838 million and P6,585 million, respectively.

See Note 26 – Expenses and Income and Note 27 – Long-term Employee Benefits.
Insurance Liabilities Arising from Insurance Contracts
RSIC estimates the expected ultimate costs of claims reported and claims incurred but not yet reported at reporting date. It takes a significant period of time to establish with certainty the ultimate cost of claims.

The primary technique adopted by RSIC’s management in estimating the cost of claims incurred but not yet reported is using the past claims settlement trend to predict the future claims settlement trend. At each reporting date, prior year claim estimates are reassessed for adequacy and any changes are charged to provisions. Insurance contract liabilities are not discounted for the time value of money.

As at December 31, 2012 and 2011, gross carrying values of insurance liabilities arising from insurance contracts (included in “Other noncurrent liabilities” account) amounted to P625 million and P622 million, respectively.

Provision for Asset Retirement Obligations
Provision for asset retirement obligations is recognized in the period in which they are incurred if a reasonable estimate of fair value can be made.
This requires an estimation of the cost to restore or dismantle, on a per area basis, depending on the location, and is based on the best estimate of the expenditure required to settle the obligation at the future restoration/dismantlement date, discounted using a pre-tax rate that reflects the current market assessment of the time value of money and, where appropriate, the risk specific to the liability.

No asset retirement obligation was recognized since the amount is immaterial.
Provisions
MERALCO is involved in various legal proceedings as discussed in Note 30 – Contingencies and Legal Proceedings. MERALCO’s estimate for probable costs for the resolution of these claims, assessments and cases has been developed in consultation with external counsels handling of potential outcome.

MERALCO, in consultation with its external legal counsels, does not believe that these proceedings will have a material adverse effect on the consolidated financial statements. It is possible, however, that future financial performance could be materially affected by changes in the estimates or the effectiveness of management’s strategies relating to these proceedings.

MERALCO recognized provisions amounting to P19,411 million and P16,919 million as at December 31, 2012 and 2011, respectively.

Revenue Recognition
The MERALCO Group’s revenue recognition policies require the use of estimates and assumptions that may affect the reported amounts of its revenues and receivables.
Revenues from sale of electricity by MERALCO and CEDC are billed based on customer-specific billing cycle cut-off date for each customer, while recording of related power purchase cost in the accounts is based on calendar month is provided in the terms of the Power Supply Agreement or PSAs. The recognition of unbilled revenues for billing cycles with earlier than month-end cut-off dates requires the use of estimates.

The difference between the amount initially recognized based on provisional invoices and the settlement of the actual billings by the generators is taken up in the subsequent periods.
Revenues and costs from construction contracts of MIESCOR are recognized based on the percentage of completion method. This is measured principally on the basis of the estimated completion of a physical proportion of the contract work as determined from the reports of the contractors and project consultants. There is no assurance that such use of estimates may not result in material adjustments in future periods. 6. Discontinued Operations

In 2011, upon approval by the BOD of MERALCO of the divestment plan of MERALCO’s investment in common shares of Rockwell Land through the declaration of property dividends, MERALCO reclassified the related assets, liabilities and cumulative other comprehensive income of Rockwell Land as “Assets of discontinued operations”, “Liabilities of discontinued operations” and “Unrealized fair value gains on AFS investments of discontinued operations”, respectively, in the 2011 consolidated statement of financial position.

On February 27, 2012, the BOD of MERALCO approved the declaration of its investment in common shares of Rockwell Land as property dividends in favor of common stockholders as of March 23, 2012, except for foreign common stockholders who were paid the cash equivalent of the property dividends. Such property dividends were paid on May 14, 2012, within five (%) trading days after approval of the property dividends by the SEC and registration of the Rockwell Land shares under approval of the property dividend by the SEC and registration of the Rockwell Land shares under the Securities Regulation Code and the listing thereof with the PSE on May 11, 2012. As of the date of declaration, MERALCO owned 3,176,474,995 common shares at P1.46 per share with a total cost of P4,638 million. On April 25, 2012, the SEC approved the property dividend declaration. MERALCO recognized gain from the divestment of Rockwell Land amounting to P780 million, included in “Income from discontinued operations, net of income tax” in the 2012 consolidated statement of income.

The assets and liabilities of Rockwell Land classified as “Assets of discontinued operations” and “Liabilities of discontinued operations”, respectively, in the consolidated statement of financial position as at December 31, 2011 are as follows:

| | Amount|
| | (In Millions)|
Noncurrent Assets:| | |
Property and equipment| | P465|
Investment properties| | 6,297 |
Other noncurrent assets| | 362 |
Current assets:| | |
Cash and cash equivalents| | 769 |
Trade and other receivables| | 2,782 |
Land and development costs| | 5,950 |
Other current assets| | 1,724 |
| | P18,349|
Noncurrent Liabilties:| | |
Interest-bearing long-term financial liabilities| P2,867| Deposits from pre-selling condominium units| 284 | Deferred tax liabilities - net| | 146 |
Other noncurrent liabilities| | 470 |
Current Liabilities:| | |
Trade and other payables| | 5,258 |
Income tax payable| | 88 |
| | P9,113|

Investment Properties

Investment properties of Rockwell Land in 2011 are stated at cost. These consist of real properties held for (i) capital appreciation, and (ii) lease mainly the Rockwell Power Plant Mall in Makati City.

The aggregate fair value of the Rockwell Power Plant Mall in 2011 amounted
to P6,267 million.

Rockwell Land’s interest-bearing long-term financial liabilities are partly collateralized by the Rockwell Power Plant Mall.

Receivables
Installment Contracts Receivable
Installment contracts receivable represent receivables from sale of condominium units with credit terms ranging from one to five years. As at December 31, 2011, the gross undiscounted trade receivables (both recognized and future receivables) from the sale of condominium units at the “Number One Rockwell” or One Rockwell, “The Grove by Rockwell” or The Grove, and “Edades tower and Garden Villas” or Edades projects amounting to P0.3 billion, P1.6 billion and P1.1 billion, respectively, have been assigned as security for interest-bearing long-term financial liabilities. Under the terms of the assignment, Rockwell Land will deliver all Contracts to Sell and customers’ copies of the condominium Certificates of Title covered by these receivables to be held in custody by the counterparty until the receivables are paid and/or repurchased by Rockwell Land. Installment contracts receivable amounting to “2,368 million as of December 31, 2011 is included in “Assets of discontinued operations” account in the 2011 consolidated statement of financial position.

Inventories
Condominium units for sale amounting to P63 million is included in “Assets of discontinued operations” account in the 2011 consolidated statement of financial position. As at December 31, 2011, the condominium units for sale are stated at cost.

Land and Development Costs
Land and development costs of Rockwell Land are stated at net realizable value of P5,950 million which is lower than its cost as at December 31, 2011. These are presented as part of “Assets of discontinued operations” account in the 2011 consolidated statement of financial position. The development costs pertain to the Greater Rockwell, Edades, and the Grove
located in Pasig City.

Specific borrowings capitalized as part of development costs amounted to P175 million in 2011. Capitalization rate used was 7.9% in 2011.

Interest-bearing long-term financial liabilities
P4.0 Billion Note Facility Agreement
Rockwell Land signed a P4.0 billion Fixed Rate Note Facility Agreement with a consortium of local banks to finance the acquisition of properties for development and to refinance certain obligations. The fixed rate notes consist of Tranche 1 was drawn in April 2011 and is payable in 22 quarterly payments starting January 2013 until April 2018. The balance of the Tranche 1 notes of P2,500 million is included under “liabilities of discontinued operations” in the 2011 consolidated statement of financial position.

Loans from Various Local Banks and Financial Institutions

Peso denominated loans from various local banks and financial institutions of Rockwell Land consist of bridge facilities, mostly payable by the end of 2011, and a term loan payable in December 2014.

All interest-bearing loans and borrowings outstanding as of December 31, 2011 are secured by assignment of One Rockwell and The Grove receivables, a parcel of land and Mortgage Participation Certificates in a Mortgage trust Indenture and its amendments and supplements over the Rockwell Power Plant Mall. The balance of the various denominated loans from various local banks amounting to P1,060 million is included under “Liabilities of discontinued operations” account in the 2011 consolidated statement of financial position.

Installment Payable
In November 2011, Rockwell Land entered into a Deed of sale with a third party for the purchase of land for development adjacent to the Rockwell Center. This is the site of its latest residential condominium projects of Rockwell Land called the “Proscensium”.

Under the Deed of Sale, Rockwell Land will pay for the cost of the property in installment until 2015 and a one-time payment in 2020. The installment payable and the corresponding land held for development were recorded at present value using the discount rate of 8%.

Installment payable is partially secured by standby letters of credit from various financial institutions.

As at December 31, 2011, the carrying value of installment payable amounted to P3 billion and is included under “Liabilities of discontinued operations” account in the 2011 consolidated statement of financial position.

The interest-bearing financial obligations of Rockwell Land are secured by the assignment of receivables from the sale of One Rockwell and The Grove units and Mortgage Participation Certificates in a Mortgage Trust Indenture and its amendments and supplements over the Rockwell Power Plant Mall.

Included in accumulated other comprehensive income as at December 31, 2011 are unrealized fair value gains on AFS investments amounting to P14 million.

The results of operations of Rockwell Land for the four months ended April 30,2012 and for the years ended December 31, 2011 and 2010 are presented as “Income from discontinued operations, net of income tax” in the consolidated statements of income. The details are presented as follows:

| | | | 2012| 2011| 2010|
| | | (Amounts in Millions Except Per Share Data)|
Revenues| | | | P1,501| P5,834| P4,378|
Cost and expenses| | | 1,288| 4,887| 3,687|
Gross profit| | | 213| 947| 691|
Interest and other financial income| 114| 520| 571|
Interest and other financial expenses| (71)| (183)| (153)| Others| | | | 805| 4| 10|
Income before income tax| | 1,061| 1,288| 1,119|
Provision for income tax| | (83)| (322)| (297)|
Net income from discontinued operations| P978| P966| P822| | | | | | | |
Earnings Per Share of Discontinued| | | |
Operations| | | | | |
Basic| | | | P0.87| 0.86| 0.73|
Diluted| | | | 0.87| 0.86| 0.73|

The net cash flows for the four months ended April 30,2012 and the years ended December 31, 2011 and 2010 are as follows:

| | | | 2012| 2011| 2010|
| | | (Amounts in Millions)|
Operating activities| | | P104| P398| (P39)|
Investing activities| | | (5)| (214)| 157|
Financing activities| | | 1,085| (58)| (187)|
Net cash flows| | | P1,184| P126| (P69)|

Significant Contracts and Commitments
Operating Lease Commitments

Rockwell Land is a lessor of commercial spaces included in its investment properties portfolio. These non-cancellable leases have remaining terms up to six years from 2011. All leases include an annual escalation to enable upward revision of the rental charge on an annual basis according to prevailing market conditions.

Construction Contracts of Rockwell Land
One Rockwell

In April 2008, Rockwell Land entered into a contract with DATEM Incorporated for the construction of the superstructure of One Rockwell, amounting to P2,500 million, inclusive of all taxes and related costs. As at December 31, 2011, the accumulated amount incurred was P2,120 million.

The Grove
The superstructure works related to The Grove project was contracted by Hilmarc’s Construction Corporation or Hillmarc. The contract sum for the work amounted to P1,600 million, inclusive of all pertinent local and national taxes, overhead and cost of labor and materials and all cost necessary for the proper execution of the work. Superstructure works commenced in February 2010. As at December 31, 2011, total amount incurred and paid related to this contract amounted to P669 million.

Edades

In October 2010, Rockwell Land contracted Hilmarc to do substructure works related to the Edades project. The contract amounted to a fixed fee of P2,500 million, inclusive of all pertinent local national taxes, overhead and cost of labor and materials and all cost necessary for the proper execution of the work. Superstructure works commenced in Nvember 2010 and are currently ongoing. As at December 31, 2011, P168 million has been incurred and was already paid.

7. Segment Information

Each operating segment of the MERALCO Group engages in business activities from which revenues are earned and expenses are incurred (including revenue and expenses relating to transactions with other business segments within the MERALCO Group). The operating results of each of the operating segments are regularly reviewed by MERALCO’s chief operating decision-maker (Management Committee) to determine how resources are to be allocated to the operating segments and to assets their performances for which discrete financial information is available.

For management purposes, the MERALCO Group’s operating businesses are recognized and managed separately according to the nature of services provided, with each segment representing a strategic business unit that offers different products and/or services, as follows:

* Power

The Power segment consists of (a) electricity distribution, (b) power generation and (c) RES. In 2010, the MERALCO Group declared its strategic decision to re-enter into the power generation business. In 2011, MERALCO obtained a local RES license to participate in the forthcoming Retail Competition and Open Access or RCOA.

Electricity distribution – This is principally electricity distribution and supply of electricity covering the MERALCO franchise area and CEDC franchise area in the Luzon Grid. Electricity distribution within the MERALCO franchise area accounts for approximately 55% of the power requirements of the country. CEDC’s service area covers the CSEZ.

Power generation – The MERALCO Group’s strategic decision to re-enter into power generation through MGen is through its investment in Redondo Peninsula Energy, Inc. or RP Energy. RP Energy is undertaking the ongoing development of a 2 x 300 MW Circulating Fluidized Bed or CFB, coal-fired power generation plant in the Subic Freeport Zone. Simultaneously, Mgen is in various stages of pre-development of other power generation projects.

RES – This covers the sourcing and supply of electricity to qualified contestable customers upon the start of RCOA. The MERALCO Group will serve as a local RES only within its franchise area under the brand MPower. Mpower has been assisting customers in preparing for the commencement of RCOA.

* Services and Others
The services segment is involved principally in electricity-related services such as electro-mechanical engineering, construction, consulting and related manpower as well as light rail-related maintenance services, e-transaction and bills collection, insurance and e-business development and energy systems management. These services are provided by MIESCOR, MBI, MLI and Miescorrail (collectively known as “MIESCOR Group”), CIS, Bayad Center and CFSI (collectively referred to as “CIS Group”), RSIC, LOIL, Finserve, e-MVI and MEI.

MERALCO’s Real Estate segment, which was provided by Rockwell Land, is involved in luxury residential and commercial real estate development and leasing. In 2012, the accounts of Rockwell Land were deconsolidated form those of MERALCO as discussed in Note 6 – Discontinued Operations.

The Management Committee monitors the operating results of each business unit separately for the purpose of determining resource allocation and assessing performance. Performance is evaluated based on net income for the year, earnings before interest, taxes, and depreciation and amortization or EBITDA: and consolidated core net income. Net income for the year is measured consistent with reported consolidated net income in the consolidated financial statements.

EBITDA is measured as net income excluding depreciation and amortization, impairment of noncurrent assets, interest and other financial charges, interest and other financial income, equity in net earnings of associates and joint ventures, foreign exchange gain or loss, mark-to-market gain or loss, provision for income tax and other non-recurring gain or loss, if any.

Consolidated core net income for the year is measured as net income attributable to equity holders of MERALCO adjusted for foreign exchange gain or loss, mark-to-market gain or loss, impairment of noncurrent assets and other non-recurring gain or loss, net of tax effect of the foregoing adjustments.

Transfer prices between operating segments are set on an arm’s-length basis in a manner similar to transactions with third parties. Segment revenues, segment expenses and segment results include transfers among business segments. Those transfers are eliminated in the consolidation.

The MERALCO Group mainly operates and generates substantially all its revenues in the Philippines (i.e., one geographical location). Thus, geographical segment information is not presented. The MERALCO Group has no revenues from transactions with a single external customer accounting for 10% or more of its revenues from external customers.

The following table shoes the reconciliation of the consolidated EBITDA to reported consolidated net income:

| | | | 2012| 2011| 2010|
| | | | (Amounts in Millions)|
Consolidated EBITDA| | P17,545| P24,602| P18,841|
EBITDA from discontinued operations| (1,154)| (1,262)| (900)| EBITDA from continuing operations| 26391| 23340| 17941| Depreciation and amortization| | (5,576)| (5,504)| (5,911)| Interest and other financial income| 2,569 | 2,264 | 1,605 | Interest and their financial charges| (1,528)| (1,445)| (561)| Equity in net earnings (losses) of | | | |

associates and joint ventures| (15)| 67 | 283 |
Derivative mark-to-market gain (loss)| 40 | (16)| (7)|
Foreign exchange loss| | (4)| (7)| (32)|
Consolidated income before income tax| 21,877 | 18,699 | 12,318 | Provision for income tax| | (5,697)| (5,939)| (4,023)| Income from continuing operations| 16,180 | 12,760 | 9,295 | Income from discontinued operations,| | | |

net of income tax| | 978 | 966 | 822 |
Reported consolidated net income | P17,158| P13,726| P10,117|

The following table shows the reconciliation of the consolidated core net income to the consolidated net income:

| | | | 2012| 2011| 2010|
| | | | (Amounts in Millions)|
Consolidated core net income| | | | |
for the year| | | P16,265| P14,887| P12,155|
Add (deduct) non-core items, net of tax:| | | |
Gain on divestment from Rockwell| | | |
Land| | | 780 | -| -|
Non-core expense| | (56)| (1,556)| (3,903)|
Mark-to-market gain (loss)| | 28 | (12)| 2 |
Foreign exchange loss| | (1)| (2)| (36)|
Day "1" loss of advance payments| | | |
to a supplier| | | -| (95)| -|
Gain on return of an investment| -| 17 | 248 |
Reversal of interest on bill deposits| -| -| 1,219 | Net income for the year attributable| | | |
to equity holders of the Parent| 17,016 | 13,227 | 9,685 | Net income for the year attributable| | | |
to non-controlling interest| | 142 | 499 | 432 | Reported consolidated net income| P17,158| P13,726| P10,117|

8. Utility Plant and Equipment

A significant portion of MERALCO’s and CEDC’s utility plant and others are purchased from foreign suppliers. Such transactions are concluded in currencies other that the Philippine peso, principally the U.S dollar. MERALCO and CEDC record the assets and liabilities in Philippine peso using the exchange rate at the date of the transaction. The outstanding amount of foreign currency-denominated liabilities is restated at each reporting date.

See Note 23 – Trade Payable and Other Current Liabilities and Note 28 – Financial Assets and Liabilities

Construction in progress pertains to on-going electric capital projects or ECPss and non-electric capital projects or NEPs, ECPs are capital projects involving construction of new electric distribution-related facilities and the upgrade and major rehabilitation of existing electrical facilities. In 2012, major ECPs under construction in progress include the development of a 230kV-115kV delivery point and construction of a 115kV line, among others. NEPs relate to construction of non-network structures and/or major renovation of existing non-network facilities.

Total interest capitalized amounted to P127 million, P82 million and P119
million for the years ended December 31, 2012, 2011 and 2010, respectively.

The average annual interest rates used for capitalization in 2012, 2011 and 2010 ranged from 5.5% to 6.2%, 5.3% to 6.2% and 7.6% to 8.6%, respectively.

9. Investments in Associates and Joint Ventures

This account consists of the following as at December 31, 2012 and 2011:

| | | | | | | | | 2012| 2011|
| | | | Country of Incorporation| Principal Activities| | Percentage of Ownership| Associates| | | | | | | | | |
RP Energy| | | Philippines| | Power generation| | 47| 47| Bauang Private Power Corporation or| Philippines| | Power generation| | 38| 38| BPPC| | | | | | | | | | |

General Electric Philippines Meter and| Philippines| | Sale of metering products| 35| 35| Instrument Company, Inc. or| | | | and services| | | | GEPMICI| | | | | | | | | |

Joint Ventures| | | | | | | | | |
Indra Philippines| | | Philippines| | Management and information| 50| 50| | | | | | | technology, or IT, consultancy| | Rockwell Business Center| | Philippines| | Real estate| | 30| -|

The movements in investments in associates and joint ventures account are as follows:

| | | | 2012| 2011|
| | | | (Amounts in Millions)|
Acquisition costs:| | | | |
Balance at beginning of year| | P538| P62|
Additions| | | | 1,025 | 517 |
Return of capital| | | -| (41)|
Balance at end of year (Carried Forward)| 1,563 | 538 |

| | | | 2012| 2011|
| | | | (Amounts in Millions)|
Balances at end of year (Brought Forward)| P1,563| P538| Accumulated equity in net earnings:| | |
Balance at beginning of year| | 294 | 247 |
Equity in net earnings (losses)| (15)| 67 |
Dividends received| | | (33)| (20)|
Adjustment| | | 3 | -|
Share in cumulative translation adjustments| 249 | 294 | of an associate| | | 3 | 12 |
| | | | P1,815| P844|

The additions of P1,025 million in 2012 include the P827 million investment in Rockwell Business Center.

Investment in RP Energy
On July 22, 2011, MGen signed a Shareholder’s Agreement with Therma Power Inc. or TPI, and Taiwan Cogeneration International Corporation – Philippine Branch or TCIC for the construction and operation of a 2 x 300 MW CFB coal-fired power plant to be located in the Subic Bay Freeport Zone. RP Energy is a partnership among TPI, MGen and TCIC for the development of the coal-fired power plant project.

As at February 25, 2013, site preparation work is almost complete and RP Energy has commenced negotiations with the lowest bidder for the engineering, procurement and construction of the power plant. The department of Environment and Natural Resources or DENR has issued the Environmental Compliance Certificate or ECC for 2 x 300 MW coal-fired power plant following a rigorous review and public consultation process. The Board of Investments or BOI has approved the registration of RP Energy, qualifying it for various BOI incentives. The Subic Bay Metropolitan Authority or SBMA has approved the lease agreement for the 2 x 300 MW coal-fired power plant, which approval remains to be ratified. Development activities are continuing with the aim of bringing the first 300MW plant into commercial operations by
first half of 2016 and the next 300MW six months after.

A Writ of Kalikasan was filed with the SC by certain parties in opposition to the RP Energy project. The case was remanded by the SC to the CA for hearing on the merits thereof. A decision has been issued by the CA denying the Writ of Kalikasan, but noting certain deficiencies in the process of the DENR in its issuance of the original ECC for a 300 MW coal-fired power plant and in the process of the SBMA and RP Energy have filed their respective Motions for Reconsideration with the CA, strongly asserting the legality and validity of the original ECC and the original LDA.

Total capital commitment of MGen in RP Energy is P1.4 billion in 2013.

Investment in BPPC
BPPC was organized in October 1992 to engage in the power generation business.

In accordance with the Build-Operate-Transfer or BOT Agreement signed in 1993, First Private Power Corporation or FPPC, then parent company, constructed the 215 MW Bauang Power Plant or Bauang Plant, and operated the same under a 15-year Cooperation Period up to July 25, 2010.

On July 26, 2010, FPPC turned-over the Bauang Plant to the National Power Corporation or NPC, without any compensation and fee ofany liens. Thereafter, FPPC and BPPC were legally merged, with BPPC as the surviving entity. Subsequent thereto, BPPC began winding down operations.

Investment in GEPMICI

GEPMICI was established in 1979 together with General Electric Company of U.S.A. to serve the Philippine market for ANSI-type Watt-hour meters.

Investment in Indra Philippines

Indra Philippines is an IT service provider in the country and in the Asia Pacific region, with a wide range of services across various industries.
Indra Philippines supports MERALCO’s information technology requirements in the area of system development, outsourcing of IS and IT operations and management consulting.

Investment in Rockwell Business Center

Investment in Rockwell Business Center represents the 30% interest of MERALCO, accounted for using equity method upon MERALCO’s divestment of its investment in common shares of Rockwell Land in April 2012. Rockwell Land owns the remaining 70% interest in Rockwell Business Center. Prior to MERALCO’s divestment from Rockwell Land, the assets, liabilities, revenues and expenses of Rockwell Business Center were consolidated line by line in MERALCO’s consolidated financial statements.

The carrying values of investments in associates and joint ventures follow:

| | | | | |
| | | | 2012| 2011|
| | | | (Amounts in Millions)|
Rockwell Business Center| | P847| P-|
RP Energy| | | 648| 516|
Indra Philippines| | | 253| 216|
GEPMICI| | | | 58| 64|
BPPC| | | | 9| 48|
| | | | P1,815| P844|

The condensed financial information of RPEnergy, BPPC, GEPMICI, INdra Philippines and Rockwell Business Center follow:

2012|
| | Rp Energy| BPPC| GEPMICI| Indra Philippines| Rockwell Business Center| | | (Amounts in Millions)|
Current assets| P611| P24| P230| P984| P465|
Noncurrent assets| 723 | -| 14 | 161 | 2,586 |
Current liabilities| (63)| -| (47)| (635)| (139)|
Noncurrent liabilities| -| -| (32)| (4)| (8)|
Net assets| P1,271| P24| P165| P506| P2,904|

2011|
| | Rp Energy| BPPC| GEPMICI| Indra Philippines|
| | (Amounts in Millions)|
Current assets| P628| P56| P235| P507|
Noncurrent assets| 419 | 1 | 14 | 142 |
Current liabilities| (4)| (1)| (66)| (206)|
Noncurrent liabilities| -| -| -| (10)|
Net assets| P1,043| P56| P183| P433|

2012|
| | Rp Energy| BPPC| GEPMICI| Indra Philippines| Rockwell Business Center| | | (Amounts in Millions)|
Revenues| | P8| P2| P514| P1526| P302|
Costs and expenses| (149)| (43)| (476)| (1,453)| (198)| Net Income (loss)| (P141)| (P41)| P38| P73| P104|

2011|
| | Rp Energy| BPPC| GEPMICI| Indra Philippines|
| | (Amounts in Millions)|
Revenues| | P-| P-| P172| P964|
Costs and expenses| (39)| -| (116)| (880)|
Net Income (loss)| (P39)| P-| P56| P84|

2010|
| | BPPC| GEPMICI| Indra Philippines|
| | (Amounts in Millions)|
Revenues| | P442| P115| P948|
Costs and expenses| (451)| (100)| (888)|
Net Income (loss)| (P9)| P15| P60|
| | | | |

10. Investment Properties

The movements in investment properties are as follows:

| | | | | 2012| | |
| | | | | Buildings and| |
| | | | Land| Improvements| Total|
| | | | (Amounts in Millions)|
Cost| | | | P1,535| P206| | P1,741|
Less accumulated depreciation:| | | | | |
Balance at beginning of year| | -| 99| | 99|
Depreciation| | | -| 8| | 8|
Balance at end of year| | -| 107| | 107|
| | | | P1,535| P99| | P1,634|

There were no additions or disposal of investment properties in 2012.

| | | 2012|
| | | | | Buildings and| |
| | | Note| Land| Improvements| Total|
| | | | (Amounts in Millions)| |
Cost:| | | | | | |
Balance at beginning of year| | P3,280| P6,128| P9,408| Additions during the year| | -| 42 | 42 |
Disposals| | | | (2)| -| (2)|
Discontinued operations| | (1,743)| (5,964)| (7,707)|
Balance at end of year| | 1,535 | 206 | 1,741 |
Less accumulated depreciation:| | | |
Balance at beginning of year| | -| 1,371 | 1,371 |
Depreciation| | | -| 138 | 138 |
Discontinued operations| | -| (1,410)| (1,410)|
Balance at end of year| | -| 99 | 99 |
| | | | P1,535| P107| P1,642|

Investment properties are stated at cost. These consist of real properties held for capital appreciation, previous substation sites and other
non-regulatory asset base real properties, some of which are being leased out.

The aggregate fair values of the investment properties are as follows:

| | | | | 2012| 2011|
| | | | | (Amounts in Millions)|
Land| | | | | P1,853| P1,853|
Other investment properties held for lease/capital| | |
appreciation| | | | 173| 173|
| | | | | | |

Land pertains to non-regulatory asset base properties currently unutilized and the properties where the BPO building and “Strip” mall are located.

The fair values of investment properties were determined by independent, professionally qualified appraisers. The fair value represents the amount at which the asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable willing seller in an arm’s-length transaction at the date of valuation.

11. Other Noncurrent Assets
This account consists of:

| | | Note| 2012| 2011|
| | | | (Amounts in Millions)|
Unbilled receivables - net| 2 and 13| P4,954| P3,321|
Deferred input Vat| | | 11,148 | 1,054 |
Intangible assets - net| | 1,021 | 689 |
Receivable from the BIR| 30 | 577 | 577 |
Advance payments to a supplier| 31 | 325 | 239 |
Deferred reinsurance premium| | 209 | 193 |
AFS investments| | | 331 | 140 |
HTM investments| | | 123 | 106 |
Goodwill| | | | 36 | 36 |
Others| | | | 113 | 239 |
| | | | P8,837| P6,594|

Unbilled Receivables

This account represents generation and other pass-through costs incurred by MERALCO and CEDC and still to be billed, which are covered by the approved recovery mechanism of the ERC. This also includes certain other unbilled generation and pass-through charges of current and prior years, which are the subject of various applications for recovery with and approval by the ERC.

Deferred Input VAT

The amount includes the proportion of input VAT incurred and paid in connection with purchase of capital assets in excess of P1 million per month. As provided for in RA No. 9337 or “EVAT Law”, said portion of input VAT shall be deferred and credited evenly over the estimated useful life of the related capital assets or 60 months. Whichever is shorter, against the output VAT due.

Intangible Assets
The movements of intangible assets are as follows:

| | | | | 2012| |
| | | Note| Software| Franchise| Total|
| | | (Amounts in Millions)|
Cost:| | | | | | |
Balance at beginning of year| P734| P49| P783|
Additions| | | 315 | -| 315 |
Reclassification| | 8 | 476 | -| 476 |
Balance at end of year| | 1,525 | 49 | 1,574 |
Less accumulated amortization:| | | | |
Balance at beginning of year| 94 | -| 94 |
Amortization| | | 94 | -| 94 |
Reclassification| | 8 | 365 | -| 365 |
Balance at end year| | 553 | -| 553 |
| | | | P972| P49| P1,021|

| | | | 2012| |
| | | Software| Franchise| Total|
| | | | | |
Cost:| | | | | |
Balance at beginning of year| P525| P49| P574|
Additions| | 209 | -| 209 |
Balance at end of year| 734 | 49 | 783 |
Less accumulated amortization:| | | |
Balance at beginning of year| 61 | -| 61 |
Amortization| | 33 | -| 33 |
Balance at end year| 94 | -| 94 |
| | | P640| P49| P689|

12. Cash and cash Equivalents

This account consists of:

| | | | 2012| 2011|
| | | | (Amounts in Millions)|
Cash on hand and in banks| | P3,256| P2,704|
Cash equivalents| | | 57,244 | 41,437 |
| | | | P60,500| P44,141|

Cash in banks earns interest at prevailing bank deposit rates. Cash equivalents are temporary cash investments, which are made for varying periods up to three months depending on the MERALCO Group’s immediate cash equivalents, and earn interest at the prevailing short-term investment rates.

13. Trade and Other Receivables
This account consists of:

| | | | Note | 2012| 2011|
| | | | | (Amounts in Millions)|
Trade:| | | | | | |
Electricity:| | | | | |
Billed| | | | P23,338| P23,299|
Unbilled| | | 2 and 11| 4,630 | 5,440 |
Service contracts| | | 816 | 821 |
Insurance receivable| | | 383 | 319 |
Cost and estimated earnings in excess of| | |
billings on | | | | 258 | 168 |
Nontrade| | | | | 1,358 | 1,193 |
| | | | | 30,783 | 31,240 |
Less allowance for doubtful accounts| | 2,706 | 2,132 | | | | | | P28,077| P29,108|

Billed receivables from sale of electricity of MERALCO and CEDC consist of the following:

| | | | 2012| 2011|
| | | | (Amounts in Millions)|
Residential| | | P6,181| P7,009|
Commercial| | | 4,916 | 6,043 |
Industrial| | | | 11,870 | 9,415 |
Flat streetlights| | | 371 | 832 |
| | | | 23,338 | 23,299 |
Less allowance for doubtful accounts| 2,559 | 1,952 |
| | | | P20,779| P21,347|

Movements in allowance for doubtful accounts for trade and other receivables are as follows:

| | | | 2012| | |
| | | Balance| | | Balance|
| | | at beginning| Provisions| Write-offs/| at end| | | | of year| (Reversals)| Others| of year|
Billed trade receivables:| | | | |
Residential| | P528| P272| (P244)| P556|
Commercial| | 911 | 159 | (42)| 1,028 |
Industrial| | 74 | 702 | (4)| 772 |
Flat streetlights| | 439 | (139)| (97)| 203 |
| | | 1,952 | 994 | (387)| 2,559 |
Other receivables| | 180 | 12 | (45)| 147 |
| | | P2,132| P1,006| (P432)| P2,706|

| | 2012|
| | | | | Flat| | |
| | Residential| Commercial| Industrial| Streetlights| Others| Total| | | (Amounts in Millions)|
Individually impaired| P345| P142| P207| P64| P147| P905| Collectively impaired| 211 | 886 | 565 | 139 | -| 1,801 | | | P556| P1,028| P772| P203| P147| P2,706|

| | | | 2011| | |
| | | Balance| | | Balance|
| | | at beginning| Provisions| Write-offs/| at end| | | | of year| (Reversals)| Others| of year|
Billed trade receivables:| | | | |
Residential| | P361| P142| P25| P528|
Commercial| | 858 | 91 | (38)| 911 |
Industrial| | 57 | 31 | (14)| 74 |
Flat streetlights| | 242 | 199 | (2)| 439 |
| | | 1,518 | 463 | (29)| 1,952 |
Other receivables| | 183 | -| (3)| 180 |
| | | P1,701| P463| (P32)| P2,132|

Trade Receivables – Electricity

Trade receivables of MERALCO and CEDC include charges for pass-through costs. Pass-through costs consist largely of generation and transmission charges, which represent 65% and 11%, respectively, of total billed amount in 2012
and 62% and 13% respectively, of the total billed amount in 2011. Billed receivables are due 10 days after bill date.

Unbilled receivables represent electricity consumed after the meter reading cut-off dates, which will billed to customers in the immediately following billing period. This is also includes the current portion of pass-through cost under-recoveries, net of over-recoveries, which are billed to the customers over the period approved by the ERC. MERALCO’s and CEDC’s trade receivables are noninterest-bearing and are substantially secured by bill deposits. See Note 19 – Customers’ Deposits and Note 28 – Financial Assets and Liabilities.

Services Contracts

Services contracts receivable arise from contracts entered into by MIESCOR and subsidiaries, e-MVI, CIS, Bayad Center and MEI for construction, engineering, related manpower, consulting, light rail maintenance, data transport, bills collection, tellering and e-business development and energy management services to third parties. Receivables from service contracts and others are noninterest-bearing and are generally on 30 to 60-day terms. 14. Inventories

| | | | 2012| 2011|
| | | | (Amounts in Millions)|
Materials and supplies:| | | |
At net realizable value| | P1,371| P1,675|
At cost| | | 1,578 | 1,927 |
Total inventories at the lower of cost or| | |
net realizable value| | P1,371| P1,675|

15. Other Current Assets

| | | | Note | 2012| 2011|
| | | | | (Amounts in Millions)|
Pass-through VAT - net| | | P1,389| P1,644|
Prepaid tax| | | | 475 | 211 |
Creditable withholding tax| | | 127 | 101 |
Prepayments to suppliers| | | 93 | 123 |
Prepaid expenses| | | | 60 | 249 |
Input VAT| | | | 47 | 24 |
Derivative assets| | | 28 | 24 | 4 |
Others| | | | | 80 | 144 |
| | | | | P2,295| P2,500|

Pass-through VAT pertains to VAT on generation and transmission costs. Remittance of such deferred VAT is based on collection of billed receivables from the customers.

16. Equity
Common Stock
The movement in the number of shares of MERALCO’s common stock is as follows:

| | | | 2012| 2011|
| | | | (Amounts in Millions)|
Authorized - P10 par value a share| 1,250 | 1,250 |
Issued and outstanding| | | |
Balance at beginning of year| | 1,127 | 1,127 |
Treasury shares acquired during the year| -| -|
Balance at end of year| | 1,127 | 1,127 |

On January 8, 1992, MERALCO listed its common shares in the PSE. There are 47,892 and 49,150 shareholders of MERALCO’s common share as at December 31, 2012 and 2011, respectively. Unappropriated Retained Earnings

The unappropriated retained earnings include undeclared accumulated earnings of subsidiaries, associates and joint ventures, and the balance of MERALCO’s revaluation increment in utility plant and others and investment properties carried at deemed cost, deferred tax assets and derivative assets amounting to P33,076 million and P33,242 million as at December 31, 2012 and 2011, respectively. Such amounts are restricted for dividend declaration purposes.

The following are cash dividends declared on common shares in 2012, 2011 and 2010:

| | | | | Dividend| |
Declaration| | Record Date| | Payment Date| Per Share| Amount| | | | | | | (In Millions)|
July 30, 2012| | August 29, 2012| | September 24, 2012| P4.00| P4,508| February 27, 2012| | March 23, 2012| | April 23, 2012| 4.10| 4,621 | November 2, 2011| | December 2, 2011| | December 27, 2011| 1.70| 1,916 | July 25, 2011| | August 17, 2011| | September 13, 2011| 3.45| 3,888 | February 28, 2011| | March 28, 2011| | April 20, 2011| 2.65| 2,987 | December 13, 2010| | December 29, 2010| | January 17, 2011| 1.30| 1,465 | July 26, 2010| | August 23, 2010| | September 16,2010| 2.50| 2,818 | March 22, 2010| | April 21, 2010| | May 11, 2010| 3.15| 3,550 |

MERALCO pays regular cash dividends equivalent to 50% consolidated core net income for the year, which may be supplemented by a special dividend determined on a “look-back” basis. Any declaration and payment of special dividend is dependent on the availability unrestricted retained earnings and availability of free cash. The declaration, record and payment dates shall be consistent with the guidelines and regulations of the SEC.

Appropriated Retained Earnings

Retained earnings of P6,000 million have been appropriated for planned business expansion of MERALCO, mainly power generation projects, the development of one of the planned projects (RP Energy) is ongoing. The expected commercial operations date of such development is mid-2016. Such business expansion plan was approved by the BOD on February 22, 2010.

See Note 9 – Investment in Associates and Joint Ventures.

Treasury Shares

Treasury shares represent subscribed shares and the related rights of employees who have opted to withdraw from the ESPP in accordance with the provisions of the ESPP and which MERALCO purchased. For the years ended December 31, 2012 and 2011, a total of 25,830 shares and 146,023 shares, respectively, were acquired from the cancellation of employee participation in the ESPP.

17. Employee Stock Purchase Plan

MERALCO has an ESPP, which entitles participants to purchase its common shares subject to certain terms and conditions, during a nominated offer period. There were no other ESPP awards since October 2009. Movements in the number of common shares subscribed by employees under the ESPP are as follows: | | | | 2012| | |

| | | 13th| 13th A| 14th| Total|
Balances at beginning of year| 1,189,306 | 389,355 | 12,284,290 | 13,862,951 | Fully paid| | | (1,185,997)| (251,747)| (4,507,093)| (5,944,837)| Cancelled| | | -| (1,905)| (23,925)| (25,830)|

Balances at end of year| 3,309 | 135,703 | 7,753,272 | 7,892,284 |

| | | | 2011| | |
| | | 13th| 13th A| 14th| Total|
Balances at beginning of year| 1,548,404 | 407,137 | 12,410,516 | 14,366,057 | Fully paid| | | (357,083)| -| -| (357,083)|
Cancelled| | | (2,015)| (17,782)| (126,226)| (146,923)| Balances at end of year| (1,189,306)| 389,355 | 12,284,290 | 13,862,951 |

MERALCO allotted a total of 55 million common shares for ESPP awards. As at December 31, 2012, 13 million common shares are available for any future offerings.

The fair value of the offerings was estimated at the dates of the grant using
the Black-Scholes Option Pricing Model.

Total expense arising from the employee stock purchase plan amounted to P134 million in 2012, P172 million in 2011 and P174 million in 2010.

18. Interest-bearing Long-term Financial Liabilities
This account consists of the following:

| | | | 2012| 2011|
| | | | (Amounts in Millions)|
Long-term portion of interest-bearing| | | |
financial liabilities:| | | | | |
Long-term debt| | | | P20,466| P19,816|
Current portion of interest-bearing financial liabilities:| | | Long-term debt| | | | 766 | 2,909 |
Redeemable preferred stock| | 1,594 | 1,651 |
| | | | 2,360 | 4,560 |
| | | | P22,826| P24,376|
All of the redeemable preferred shares have been called for redemption as at June 30, 2011, consistent with the terms of the Preferred Shares Subscription Agreement. The unpaid dividends amounted to P256 million and P261 million as at December31, 2012 and December 31, 2011, respectively. Interest is no longer accrued on the preferred shares, which have been called for redemption.

See Note 23 – Trade Payables and Other Current Liabilities. The details of interest-bearing long-term financial liabilities are as follows:

Description| | | | 2012| 2011|
| | | | (Amounts in Millions)|
Floating Rate Loan| | | | |
MERALCO| | | | | |
P2.5 Billion Term Loan Facility| | P2,488| P2,500| P3.0 Billion Term Loan Facility| | 1,200 | 1,800 | Fixed Rate Loan| | | | | |
MERALCO| | | | | |
P5.0 Billion Note Facility Agreement| | 4,950 | 5,000 | P5.0 Billion Note Facility Agreement| | 4,900 | 4,950 | P4.8 Billion Note Facility Agreement| | 4,776 | 4,800 | P3.0 Billion Note Facility Agreement| | 3,000 | -| P5.0 Billion Note Facility Agreement| | -| 2,172 | P5.5 Billion Note Facility Agreement| | -| 1,600 | Total long-term debt| | | | 21,314 | 22,822 |

Less unamortized debt issuance costs| | 82 | 97 |
| | | | 21,232 | 22,725 |
Redeemable Preferred Stock| | 1,594 | 1,651 |
| | | | 22,826 | 24,376 |
Less portion maturing within one year| | 2,360 | 4,560 | Long-term portion of interest-bearing financial liabilities| P20,466| P19,816|

All of MERALCO’s interest-bearing long-term financial liabilities as at December 31, 2012 and 2011 are denominated in Philippine pesos. The scheduled maturities of MERALCO’s outstanding long-term debt at nominal values as at December 31, 2012 are as follows: Year| Amount|

| (In Millions)|
2013| P766|
2014| 766|
2015| 189|
2016| 4,845|
2017| 2,054|
After 2017| 12,694|
| P21,314|

Floating Rate Loan
P2.5 Billion Term Loan Facility

The P2,500 million, 7-year Floating Rate Term Loan Facility was drawn in January 2011 from a local bank. Interest rate is repriced every six months
based on 6-month PDST-F plus a spread. The principal is payable in nominal annual amortizations with a balloon payment on maturity date.

P3.0 Billion Term Loan Facility

The P3,000 million, 5-year bilateral Floating Rate Term Loan Facility, was drawn in October 2009. The principal is payable over five years with final maturity in October 2014.

Fixed Rate Loans
P5.0 Billion Note Facility Agreement

In June 2011, MERALCO entered into a Fixed Rate Note Facility Agreement for its P500 million, 7-year notes and P4,500 million, 10-year notes due in 2018 and 2021, respectively. The principal is payable in nominal annual amortizations with a balloon payment on each of the two final maturity dates.

P5.0 Billion Note facility Agreement
In December 2010, MERALCO entered into a Fixed Rate Note Facility Agreement for the issuance of P23 million, 5-year fixed rate notes maturing in December 2015 and P4,977 million, 5.5-year fixed rate notes due in June 2016. The 5-year fixed rate notes are payable in full at maturity date while the 5.5- year fixed rate notes are payable in nominal annual amortizations with a balloon payment on maturity date.

P4.8 Billion Note Facility Agreement

In November 2010, MERALCO signed a Fixed Rate Note Facility Agreement for its P1,997 million, 70year fixed rate notes and P2,803 million, 10-year fixed rate notes. The notes were issued on December 2, 2010 and are payable in nominal annual amortizations with a balloon payments on each of the two maturity dates.

P3.0 Billion Notes Facility Agreement
On January 5, 2012, MERALCO signed a P3,000 million Fixed Rate Note Facility
Agreement for its P1,000 million, 7-year notes and P2000 million, 10-year notes due in 2019 and 2022, respectively. The notes were priced off the relevant 7-year and 10-year benchmarks plus a spread and issued on January 9, 2012. Principal repayments are through annual nominal amortizations and a balloon payment on maturity date.

P5.0 Billion Note Facility Agreement

In January 2009, MERALCO entered into a Note Facility Agreement for its P2,712 million fixed rate notes with final maturity in January 2014 and P2,285 million floating rate notes due in January 2010. The floating rate notes were prepaid in October 2009 without penalty while the fixed rate notes are payable in annual installments of 10% of the original principal amount form 2010 to 2013 with the remaining balance payable in 2014. The fixed rate notes were prepaid in January 2012 without penalty.

P 5.5 Billion Note Facility Agreement

On December 9, 2009, MERALCO signed a P5,500 million Note Facility Agreement covering its fixed and floating rate notes. The P1,600 million fixed rate notes are payable in full on maturity date in 2014. The P3,900 million floating rate notes were prepaid in December 2010 without penalty. The P1,600 million fixed rate notes were prepaid in December 2012 without penalty.

The average annual interest rates for the interest-bearing financial liabilities are as follows:

Fixed Rate Notes| | |
2012| | 5.23% to 7.47%|
2011| | 4.00% to 8.79%|
Floating Rate Notes| | |
2012| | 2.63% to 2.99%|
2011| | 4.60% to 5.88%|

Debt Covenants

MERALCO’s loan agreements require compliance with debt service coverage of 1.2 times calculated at specific measurement dates. The agreements also contain restrictions with respect to the creation of liens or encumbrances on assets, issuance of guarantees, mergers or consolidations, disposition of a significant portion of its assets and related party transactions.

As at December 31, 2012 and 2011, MERALCO is in compliance with all covenants of the loan agreements.

Unamortized Debt issuance Costs

Unamortized debt issuance costs amounted to P82 million and P97 million as at December 31, 2012 and 2011, respectively.

The following presents the changes to the unamortized debt issuance costs:

| | Note | 2012| 2011|
| | | (Amounts in Millions)|
| | | | |
Balance at beginning of year| | P97| P144|
Additions| | | 22 | 27 |
Accretions charged to interest| | | |
and other financial charges| 26 | (37)| (23)|
Unamortized debt issuance costs| | | |
of discontinued operations| | -| (21)|
Balance at end of year| | P82| P97|

Redeemable Preferred Stock

The movements in the number of shares of the redeemable preferred stock, which have all been called, are as follows:

| | 2012| 2011|
Balance at beginning of year| 165,129,647 | 191,964,025 | Redemptions| | (5,772,708)| (26,834,378)|
Balance at end of year| 159,356,939 | 165,129,647 |

The original “terms and Conditions: of MERALCO’s Special Stock Subscription Agreement, which required an applicant to subscribe to preferred stock with 10% dividend to cover the cost of extension of, or new distribution facilities, has been amended by the Magna Carta and the 2006, respectively. The amendment sets forth the guidelines for the issuance of preferred stock, only if such instrument is available.

19. Customers’ Deposits

This account consists of:

| | 2012| | | 2011| |
| Current| | | Current| | |
| Portion| Long-term| | Portion| Long-term| |
| (see Note 23)| Portion| Total| (see Note 23)| Portion| Total| | | | (Amounts in Millions)| | |
Meter deposits| P2,188| P-| P2,188| P2,226| P-| P2,266| Bill deposits| 4,064 | 23,313 | 27377| 27,377 | 24,080 | 26,429 | | P6,252| P23,313| P29,565| P29,565| P24,080| P28,695|

Meter Deposits

Meter deposit was intended to guarantee the cost of meters installed.

The Magna Carta for residential customers (effective June 17, 2004) and DSOAR (effective January 18, 2006) for non-residential customers exempt all customers and April 2006 for non-residential customers.

The ERC released Resolution NO. 8, Series of 2008, otherwise known as “Rules to Govern the Refund of Meter Deposits to Residential and Non-Residential Customers,” or Rules, which required the refund of meter deposits from the
effectivity of the said Rules on July 5, 2008. Under the Rules, a customer has the option of receiving his refund in cash, credit to future monthly billings, or as an offset to other due and demandable claims of the DU against him.

The total amount of refund shall be equivalent to the meter deposit paid by the customer plus the total accrued interest earned form the time the customer paid the meter deposit until the day prior to the start of refund.

On August 8, 2008, in compliance with the Rules, MERALCO submitted to the ERC an accounting of the total meter deposit principal amount for refund. The actual refund of meter deposits commenced on November 3, 2008.

As at December 31, 2012 and 2011, total meter deposits refunded by MERALCO amounted to P908 million (inclusive of P466 million interest) and P828 million (inclusive of P425 million interest), respectively.

Bill Deposits
Bill deposits serve to guarantee payment of bills by a customer in accordance with existing regulation.

As provided for under the Magna Carta and DSOAR, residential and non-residential customers, respectively, are required to deposit with the DU an amount equivalent to the estimated monthly bill calculated based on applied load, which shall be recognized as bill deposit of the customer.

On February 22, 2010, the amended DSOAR, which became effective on April 1, 2010, was promulgated by the ERC. Under the amended DSOAR, interest on bill deposits for both residential and non-residential customers shall be computed using the equivalent per savings account interest rate of the Land Bank of the Philippines or Land Bank, or other government banks, on the first working day of the year, subject to the confirmation of the ERC. Based on the foregoing, the interest rate effective April 1, 2010 through December 31, 2010 was 0.75% per annum. Effective January 1, 2011 until December 31, 2012, the interest rate for bill deposits is o.5% per annum.

The following are the movements of bill deposits account:

| | 2012| 2011|
| | (Amounts in Millions)|
| | | |
Balance at beginning of year| P26,429| P24,439|
Additions| | 3,211 | 2,506 |
Refunds| | (2,263)| (516)|
Balance at end of year| 27,377 | 26,429 |
Less portion maturing within one year| 4,064 | 2,349 |
Long-term portion of bill deposits and interest| P23,313| P24,080|

20. Provisions

Provisions consists amounts provided for probable charges and expenses from claims, among others. The movements follow:

| | 2012| 2011|
| | (Amounts in Millions)|
| | | |
Balance at beginning of year| P16,919| P12,875|
Provision| | 2,770 | 7,571 |
Settlements| | (278)| (126)|
Reclassification| | -| (3,401)|
Balance at end of year| P19,411| P16,919|

21. Customers’ Refund

This account represents the balance of the refund related to the SC decision promulgated on April 30, 2003, which has not yet been claimed by the customers.

In June 2003, the ERC, in the implementation of the SC decision, ordered MERALCO to refund to its customers an equivalent P0.167 per kWh for billings
made from February 1994 to April 2003.

On February 7, 20012, the ERC approved MERALCO’s proposal for the extension of the SC refund process for five years up to December 31, 2012, in view of difficulties encountered by (i) the customers in meeting the necessary documentation requirements to claim a refund and (ii) MERALCO in contacting or locating customers entitled to the refund.

22. Notes Payable

Notes payable represent unsecured, peso-denominated, interest-bearing working capital loans obtained from various local banks. Annual interest rates ranged from 3.9% to 6.5% in 2012 and 6.5% to 6.7% in 2011.

Interest expense on notes payable amounted to P5 million, P6 million and P26 million in 2012, 2011 and 2010, respectively. See Note 26 – Expenses and Income.

23. Trade Payables and Other Current Liabilities

This account consists the following:

| | Note | 2012| 2011|
| | | (Amounts in Millions)|
Trade accounts payable| 24 | P23,991| P22,475|
output VAT - net| | | 4,580 | 2,470 |
Accrued expenses:| | | | |
Employee benefits| | 2,629 | 1,940 |
Taxes| | | 2,590 | 1,440 |
Liability for GSL payout| | 741 | 580 |
Interest| | 18 | 308 | 192 |
Current portions of:| | | | |
Bill deposits and related interest| 19 | 4,064 | 2,349 | Meter deposits and related interest| 19 | 2,188 | 2,266 | Deferred lease income| | 761 | -|
Derivative liability| | 28 | -| -|
Refundable service extension costs| | 1,512 | 1,145 |
Dividends payable on| | | |
Common stock| | 16 | 1,023 | 598 |
Redeemable preferred stock| 18 | 256 | 261 |
Universal charges payable| | 320 | 573 |
Reinsurance charges liabilty| | 213 | 198 |
Regulatory fees payable| | 204 | 208 |
Refundable transmission charges| | 180 | 130 |
Other current liabilities| | 2,016 | 3,180 |
| | | P47,576| P40,011|
Trade Accounts Payable
Trade accounts payable mainly represent obligations to power supplies, namely, NPC/Power Sector Assets and Liabilities Management Corporation or PSALM, (including NPC successor generating companies or SGCs/Independent Power Plant Administrators or IPPAs), NGCP, Philippine Electricity AMrket Corporation or PEMC, FGPC and FGP, QPPL, Philippine Power Development Corporation, Montalban Methane Power Corporation or MMPC, Bacavalley Energy, Inc. or BEI, for costs of power purchased and for cost of transmission. IN addition, this account includes liabilities due to local and foreign suppliers for purchases of goods and services, which consist of transformers, poles, material and supplies and, contracted services.

Trade payables are noninterest-bearing and are generally settled within the 15 to 60-day trade term. Other payables are noninterest-bearing and are due in no more than six months from incurrence.

See Note 24 – Related Party Transactions and Note 31 – Significant Contracts and Commitments.

Refundable Service Extension Costs

Article 14 of the Magna Carta, specially, “Right to Extension of Lines and Facilities,” requires a customer requesting for an extension of lines and facilities beyond 30-meter service distance from the nearest voltage
facilities of the DU to advance the cost of the project. The amended DSOAR, which became effective April 1, 2010 requires such advances from customers to be refunded at the rate of 75% of the distribution revenue generated from the extension lines and facilities until such amounts are fully refunded. The related asset forms part of the rate base only at the rime a refund has been paid out. Customer advances are noninterest-bearing.

As at December 31, 2012 and 2011, the noncurrent portion of refundable service extension costs of P4,357 million and P3,794 million, respectively, is presented as “Refundable Service Extension Costs – net of current portion “account in the consolidated statement of financial position.

24. Related Party Transactions

The following provides the total amount of transactions, which have been provided and/or contracted by the MERALCO Group with related parties for the relevant financial year. The outstanding balances are unsecured, non-interest bearing and settled in cash.

PSAs with San Miguel Energy Corporation or SMEC and South Premier Power Corporation or SPPC.

MERALCO has PSAs with SMECand SPPC beginning December 26, 2012. See Note 31 – Significant Contracts and Commitments for the related discussions. There is no purchase transaction under these PSAs in 2012, hence there is no outstanding liability to SMEC and SPPC as at December 31, 2012.

SMEC and SPPC are subsidiaries of SMC.

Pole Attachment Contracts with the Philippine Long Distance Telephone Company or PLDT

MERALCO has a Pole attachment Contract with PLDT similar to third party pole attachment contracts of MERALCO with other telecommunication companies. Under the Pole attachment Contract, PLDT shall use the contracted cable
position exclusively for its telecommunication cable network facilities.

Sale of Electricity under Various Service Contracts
MERALCO sells electricity to related party shareholder groups such as PLDT, METRO Pacific and SMC and their respective subsidiaries, and affiliate for the latters’ facilities within MERALCO’s franchise area. The rates charged to related parties are the sane ERC-mandated rates applicable to customers within the franchise area.

Purchase of Telecommunication Services from PLDT and Subsidiaries The MERALC Group’s primary telecommunication carries are PLDT for its wireline and SMART for its wireless services. MERALCO Group also purchase its wireline services from Digitel Mobile Philippines, Inc., which became a subsidiary of PLDT in 2011. Such services are covered by standard service contracts between the telecommunications carries and each legal entity within the MERALCO Group.

Purchase of Goods and Services
In the ordinary course of business, the MERALCO group purchase good and services from its affiliates and sells power to such affiliates.

Transaction with MERALCO Pension Fund
MERACLO Pension Fund hold 6,000 common shares of RP Energy at P100 par value per share, with total carrying amount of P600,000 or an equivalent 3% equity interest in RP Energy. The fair value of RP Energy’s common shares cannot be reliably measured as these are not traded in the financial market. As at December 31, 2012, the fair value of the total assets being managed by MERALCO Pension Fund amounted to P30.5 billion.

See Note 27 – Long-Term Employee Benefits.
Compensation of Key Management Personnel
The compensation of key management personnel of the MERALCO Group by benefit type is as follows:

| | 2012| 2011| 2010|
| | | (Amounts in Millions)|
Short-term employee benefits| P432| P413| P376|
Long-term employee and retirement| | | |
benefits| | 69 | 112 | 133 |
Share-based payments| 31 | 16 | 14 |
Total compensation to key management| | | |
personnel| | P532| P541| P523|

Each of the directors is entitled to as per diem of P120,000 for every BOD meeting attended. Each member of the Audit and Risk Management, Remuneration and Leadership Development (formerly Compensation and Benefits), Finance, Governance and Nomination Committers is entitled to a fee of P20,000 for every committee meeting attended.

There are no agreements between the MERALCO Group and any of its key management personnel providing for the benefits upon termination of employment or retirement, except with respect to benefits provided under the retirement and pension plans. The Pension Plan covers employees hired up to December 31, 2003 only. The provident Plan, which is implemented on a voluntary basis, covers employees hired after January 1, 2004.

25. Revenues and Purchased Power

Electricity Revenue

Electricity revenues account for 99% of the total revenues in 2012, 2011 and 2010. Following is a breakdown of electricity revenues:

Distribution revenue accounted for 18%, 19% and 18% of total revenues in 2012, 2011 and 2010

See Note 7 – Segment Information
Purchased Power

Actual purchased power costs are pass-through costs and are revenue-neutral
to MERALCO and CEDC. The details are as follows.

Generation charge is inclusive of line rentals and must-run unit charges billed by PEMC.

Purchased power includes capacity fees, fixed operating fees and transmission line fees that are accounted for similar to a lease under Philippine Interpretation IFRIC 4, “Determining whether an arrangement contains a lease”. The total amounts billed by the suppliers presented as part of “Purchased power” account in the consolidated statements of income are P18,946 million, P20,135 million and P19,960 million in 2012, 2011 and 2010, respectively. This also includes the actual SL incurred but no more than 8.5%. MERALCO’s actual SL rates were 7.04%, 7.3% and 7.9, in 2011and 2010, respectively.

Purchased power cost in 2011 and 2010 is inclusive of the volume of banked gas consumed effectively reducing the cost of purchased power as these were sourced at lower prices then. In 2011, the balance of banked gas was fully utilized.

Generation and transmission cost over/under-recoveries occur as a result of the lag in the billing and recovery of generation and transmission costs from consumers. As at December 31, 2012 and 2011, the total generation and transmission cost over-recoveries included in “Other noncurrent liabilities” account in the consolidated statements of financial position amounted to P6,414 million and P4,004 million, respectively.

26. Expenses and Income

Salaries, Wages and Employee Benefits

| Note| 2012| 2011| 2010|
| | | (Amounts in Millions)|
Salaries and wages| | P8,219| P6,648| P6,412|
Pension expense| | 1,367 | 1465| 1752|
Health, medical and realted benefits| | 1,619 | 2,287 | 529 | Other long-term post-employment benefits| | 411 | 339 | 285 | Employee stock payment plan expense| | 134| 172 | 174 | | | P11,750| P10,911| P9,152|

Other Expenses

| Note| 2012| 2011| 2010|
| | | (Amounts in Millions)|
Materials and supplies| 14 | P527| P735| P846|
Rent and utilities| | 574 | 412 | 179 |
Transportation and travel| | 386 | 475 | 349 |
Corporate expenses| | 249 | 258 | 297 |
Insurance| | 208 | 259 | 222 |
Advertising expenses| | 179 | 197 | 188 |
Communication expenses| 24 | 68 | 62 | 61 |
Others| | 1,559 | 489 | 1,718 |
| | P3,750| P2,887| P3,860|

Interest and Other Financial Charges

| Note| 2012| 2011| 2010|
| | | (Amounts in Millions)|
Interest expense on interest-bearing| | | | |
long-term financial liabilities,| | | | |
net of interest capitalized| 8 and 18| P1,202| P1,163| P1,182| Interest expense on bill deposits| 19 | 91 | 83 | (1,326)| Amortizations of:| | | | |
Debt issuance costs| 18 | 37 | 23 | 73 |
Loan premium| | -| -| (24)|
Carrying charge on ERC-approved| | | | |
over-recoveries| 2 | 79 | 20 | 108 |
Interest expense on notes payable| 22 | 5 | 6 | 26 |
Interest expense on meter deposits| 19 | 1 | 3 | 76 |
Others| | 113 | 147 | 446 |
| | P1,528| P1,445| P561|
Interest and Other Financial Income

| Note| 2012| 2011| 2010|
| | | (Amounts in Millions)|
Interest on cash and cash| | | | |
equivalents| | P1,762| P1,379| P535|
Carrying costs on ERC-approved| | | | |
under-recoveries| 2 | 755 | 791 | 723 |
Gain on return of investment| | -| 24 | 355 |
Others| | 52| 70| (8)|
| | P2,569| P2,264| P1,605|

27. Long-term Employee Benefits

Liabilities for long-term employee benefits consist of the following:

| | 2012| 2011|
| | (Amounts in Millions)|
Pension liability| | P5,313| P5,398|
Long-term incentives| | 2,600 | 1,641 |
Other long-term post-employment benefits| | 1,525 | 1,187 | | | P9,438| P8,226|

Retirement Plan
The features of the MERALCO Group’s defined benefit plans are discussed in Note 4 – Significant Accounting Policies.

Actuarial Valuations are prepared annually by independent actuaries.

Net Pension Costs (included in “Salaries, wages and employee benefits” account)

| 2012| 2011| 2010|
| | (Amounts in Millions)|
Interest costs| P1,948| P1,956| P2,011|
Current service costs| 1,045 | 1,097 | 869 |
Expected return on plan assets| (1,633)| (1,595)| (1,133)| Past service costs| 1 | 1 | 1 |
Actuarial loss| 3 | 2 | 2 |
Net pension costs| P1,364| P1,461| P1,750|
Actual return on plan assets| P3,376| P1,863| P4,178|

Pension Liability

| 2012| 2011|
| (Amounts in Millions)|
Defined benefit obligation| P33,811| P33,234|
Fair value of plan assets| (30,532)| (27,283)|
Unrecognized net actuarial gains (losses)| 2,036 | (550)| Unrecognized past service costs| (2)| (3)|
Pension liability| P5,313| P5,398|

Changes in the present value of the defined benefit obligation are as follows:

| 2012| 2011|
| (Amounts in Millions)|
Defined benefit obligation at beginning of year| P33,234| P32,729| Interest costs| 1,948 | 1,956 |
Current service costs| 1,045 | 1,097 |
Benefits paid| (1,573)| (1,695)|
Actuarial losses (gains) due to:| | |
Changes in assumptions| (846)| 455 |
Experience adjustments| 3 | (1,140)|
Defined benefit obligation| | |
of discontinued operations| -| (168)|
Defined benefit obligation at end of year| P33,811| P33,234|

Changes in the fair value of plan assets are as follows:

| 2012| 2011|
| (Amounts in Millions)|
Fair value of plan assets at beginning of year| P27,283| P22,986| Contributions by employer| 1,446 | 4,323 |
Benefits paid| (1,573)| (1,695)|
Expected return on plan assets| 1,633 | 1,594 |
Actuarial gains| 1,743 | 269 |
Defined benefit obligation of discontinued| | |
operations| -| (194)|
Fair value of plan assets at end of year| P30,532| P27,283|

The Board of Trustees or BOT, which manages the retirement benefit fund, is chaired by the chairman of MERALCO, who is neither an executive nor a beneficiary. The other members of the BOT are (i) an executive member of the BOD; (ii) two (2) senior executives; (iii) an independent member of the BOD; (iv) a member of the BOD who represents the largest shareholder group and (v) a non-executive, non- BOD member of the BOD who represents the largest shareholder group and (v) a non-executive, non-BOD member who represents another shareholder group, all of whom are non-beneficiaries of the Plan.

The Fund follows a generally conservative investment approach where investments are diversified to minimize risks but ensures an increase in value of the Fund assets. Substantially all of the funds of the Plan are managed by four (4) trustee banks whose common objective is to maximize the long-term expected return of plan assets. As approved by the BOT, the funds are invested in a guided proportion of fixed income instruments, cash investments and equities.

MERALCO expects to contribute approximately P2,929 million to its defined benefit pension plan in 2013.

Net carrying amount and fair value of the assets of the fund as at December 31, 2012 and 2011 amounted to P30,532 million and P27,283 million, respectively.

The major categories of plan assets of MERALCO Pension Fund as a percentage of the fair value of total plan assets are as follows:

| 2012| 2011|
| (in Percentage)|
Government securities| 33 | 26 |
Marketable equity securities| 24| 38|
Bonds and commercial notes| 22| 14|
Cash and cash equivalents| 11| 16|
Receivables| 7| 3|
Real properties| 3| 3|
| 100| 100|

Marketable equity securities, government securities, bonds and commercial notes are investments held by the trustees banks. The Pension does not have any direct equity interests in MERALCO.

The overall expected rate of return on assets in determined based on the prevailing rates of return on equity and fixed income securities applicable for the period over which the obligation is to be settled.

Other Long-term Post-employment Benefits Liability

| 2012| 2011|
| (Amounts in Millions)|
Other long-term post-employment benefits| | |
obligation| P2,725| P2,537|
Unrecognized net actuarial losses| (1,200)| (1,350)|
| P1,525| P1,187|

Changes in the present value of other long-term post-employment benefits liability are as follows:

| 2012| 2011|
| (Amounts in Millions)|
Balance at beginning of year| P2,537| P2,471|
Interest costs| 176 | 156 |
Current service costs| 85 | 54 |
Benefits paid| (73)| (73)|
Actuarial gains| -| (71)|
Balance at end of year| P2,725| P2,537|

The principal assumptions used as at January 1, 2012, 2011 and 2010 in determining pension and other long-term post-employment benefits obligation are shown below:

| 2012| 2011| 2010|
Annual discount rate| 6%| 6%| 6 - 8%|
Expected annual rate of return on assets| 6%| 6%| 7-10%| Future range of annual salary increases| 6-8%| 6-8%| 5-9.6%|

MERALCO has a contributory Provident Plan effective January 1, 2009, intended to be a Supplemental Retirement Benefit for employees hired after 2004, on a voluntary basis. Each qualified employee-member who opts to participate in the plan shall have the option to contribute up to a maximum of 25% of his base salary. MERALCO shall match the member’s contribution up to the first 10% of the member’s base salary. Upon resignation, the member shall be entitled to the total amount credited to his personal retirement account immediately preceding his actual retirement date, subject to provisions of the Provident Plan. Total amount contributed by MERALCO are P3 million, P4 million and P2 million in 2012, 2011 and 2010, respectively.

Consolidated Pension Benefit Cost (included in “Salaries, wages and employee benefits” account)

| 2012| 2011| 2010|
| | (Amounts in Millions)|
Expense recognized for defined| | | |
benefit plans| P1,364| P1,461| P1,750|
Expense recognized for defined| | | |
contribution plan| 3 | 4 | 2 |
Consolidated pension benefit costs| P1,367| P1,465| P1,752|

Long-term Incentive Plan or LTIP

MERALCO’s LTIP covers qualified executive with at least the rank of superintendent. The LTIP hinges on MERALCO Group’s achievement of a certain level of consolidated core net income determined on an aggregate basis for the three year period ended December 31, 2012 and the executives’ attainment of a certain level of performance rating. Executives invited to the plan must serve a minimum uninterrupted period to be entitled to any pay-out under the plan.

28. Financial Assets and Liabilities

Financial assets consist of cash and cash equivalents and trade and non-trade receivables, which are generated directly from operations. The principal financial liabilities, other than derivatives, consist of bank loans, redeemable preferred shares, trade and non-trade payables, which are incurred to finance operations in the normal course of business. Accounting policies related to financial assets and liabilities are set out in Note 4 – Significant Accounting Policies.

The following table sets forth the consolidated carrying values and estimated fair values of the financial assets and liabilities recognized as at December 31, 2012 and 2011:

| | Carrying Value| Fair Value|
| | 2012| 2011| 2012| 2011|
Noncurrent Financial Assets| | | | | |
AFS financial assets:| | | | | |
Quotes equity securities| | P128| P121| P128| P121| Unquoted equity securities| | 203 | 19 | 203 | 19 | Other noncurrent assets:| | | | | |
Advance payments to a supplier| | 325 | 239 | 390 | 302 |
HTM| | 123 | 106 | 123 | 106 |
Notes receivable| | -| 27 | -| 27 |
Total noncurrent financial assets| | 779 | 512 | 844 | 575 | Current Financial Assets| | | | | |
Cash and cash equivalents:| | | | | |
Cash on hand in banks| | 3,256 | 2,704 | 3,256 | 2,704 | Cash equivalents| | 57,244 | 41,437 | 57,244 | 41,437 | Trade and other receivables - net:| | | | | |
Billed electricity| | 20,779 | 21,347 | 20,779 | 21,347 | Service contracts| | 671 | 761 | 671 | 761 |
Insurance receivable| | 383 | 319 | 383 | 319 | Cost and estimated earnings in excess of billings on| | | | | uncompleted contracts| | 258 | 167 | 258 | 167 | Nontrade receivables| | 1,356 | 1,074 | 1,356 | 1,074 | Other current assets - derivative assets| | 24 | 4 | 24 | 4 | Total current financial assets| | 83,971 | 67,813 | 83,971 | 67,813 | Total Financial Assets| | P84,750| P68,325| P84,815| P68,388|

| | Carrying Value| Fair Value|
| | 2012| 2011| 2012| 2011|
Noncurrent Financial Liabilities| | | | | |
Interest-bearing long-term financial liabilities| | P20,466| P19,816| P22,427| P20,134| Customers; deposits - net of current portion| | 23,313 | 24,080 | 23,313 | 24,080 | Refundable service extension costs| | 4,357 | 3,794 | 4,357 | 3,794 | Total noncurrent financial liabilities| | 48,136 | 47,690 | 50,097 | 48,008 | Current Fianncial Liabilities| | | | | |

Trade payables and other current liabilities| | | | | | Trade accounts payable| | 23,991 | 22,475 | 23,991 | 22,475 | Accrued expenses| | 1,015 | 772 | 1,015 | 772 |

Current portion of:| | | | | |
Meter deposits and related interests| | 2188| 2,266 | 2,188 | 2,266 | Bill deposits and related interests| | 4,064 | 2,349
| 4,064 | 2,349 | Derivative liability| | -| 6| -| 6|

Dividend payable| | 1,279 | 859| 1,279 | 859|
Refundable service extension costs| | 1,512 | 1,145 | 1,512 | 1,145 | Regulatory fees| | 204 | 208 | 204 | 208 |
Reissuance liabilities| | 213 | 198 | 213 | 198 | Universal charges payable| | 320 | 573 | 320 | 573 | Refundable transmission charges| | 180 | 130 | 180 | 130 | Customers' refund| | 6,127 | 6,250 | 6,127 | 6,250 |

Interest-bearing financial liabilities| | | | | |
Notes payable| | 1,787 | 67 | 1,787 | 67 |
Current portion of interest-bearing long-term| | | | | | financial liabilities| | 2360| 4560| 2360| 4560| | | 45240| 41858| 45240| 41858|
Total Financial Liabilities| | P93,376| P89,548| P95,337| P89,866|

The fair values of the financial assets and liabilities are stated at the amounts at which the instruments could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The following methods and assumptions were used to estimated the fair value each class of financial instrument for which it is practicable to estimate such value:

Cash and Cash Equivalents, Trade and Other Receivables, Trade Payables and Other Current Liabilities and Notes Payable

Due to the short-term nature of transactions, the fair values of these instruments approximate their carrying amounts as at reporting date.

Bifurcated Foreign Currency Forward and Foreign Currency Forward The fair values of embedded currency forwards and freestanding currency forwards were calculated by reference to forward exchange market rates,

AFS Investments
The fair values were determined by reference to market bid quotes as at reporting date. The unquoted equity securities were carried at cost.

Meter Deposits and Customers’ Refund

Meter deposits and customers’ refund are due and demandable. Thus, the fair values of these instruments approximates their carrying amounts.

Bill Deposits
The carrying amount of bill deposits approximates their fair values as bill deposits are interest-bearing.

Interest-bearing Long-term Financial Liabilities

The fair values of interest-bearing long-term debt (except for redeemable preferred stock) were computed by discounting the instruments’ expected future cash flows using the rates ranging from 1.65% to 4.49% in 2012 and 2.73% to 5.68% in 2011.

Redeemable Service Extension Costs

The carrying amount of the preferred stock represents the fair value. Such preferred shares have been called and are payable anytime upon presentation by the shareholder of their certification. This is included under “Interest-bearing long-term financial liabilities” account.

Refundable Service Extension Costs

The fair values of refundable service extension costs cannot be reliably measured since the timing of related cash flows cannot be reasonably estimated and are accordingly measured cost.

Fair Value Hierarchy

MERALCO uses the following hierarchy in determining and disclosing the fair
value of financial instruments by valuation technique.

* Level 1 : quoted (unadjusted) prices in active markets for identical assets or liabilities * Level 2: other techniques where all inputs have a significant effect on the recorded fair value are observable, either directly or indirectly. * Level 3: techniques where inputs have a significant effect on the recorded fair value that are not based on observable market data

Below is the list of financial assets and liabilities carried at fair value that are classified using a fair value hierarchy:

| | December 31, 2012| December 31, 2011|
| Level 1| Level 2| Total| Level 1| Level 2| Total| | | (Amounts in Millions)|
Noncurrent financial assets -| | | | | | |
AFS investments| P128| P-| P128| P121| P-| P121| Current financial assets -| | | | | | |
Derivative assets| -| 24| 24| -| 4| 4|
| P128| P24| P152| P121| P4| P125|
Current financial liability -| | | | | | |
Derivative liability| P-| P-| P-| P-| P6| P6|

As at December 31, 2012 and 2011, the MERALCO Group does not have financial instruments with fair values determined using inputs that are not based on observable market data (Level 3).

For the years ended December 31, 2012 and 2011, there were no transfers between Level 1 and Level 2 fair value measurements, and no transfers into and out of Level 3, fair value.

Derivatives Financial Instruments
Embedded Currency Forward

MERALCO has bifurcated embedded currency forwards noted in various purchases
and service agreements denominated in currencies other than Philippine peso, which includes US dollar, Euro, among others. As at December 31, 2012 and 2011, these agreements represent 12% and 16% of MERALCO’s trade payables, respectively. As at December 31, 2011, the US dollar- and Euro-denominated agreements amounted to $15 million (equivalent to $620 million) and €1 million (equivalent to P44 million), respectively. As at December 31, 2011, the US dollar- and Euro-denominated agreements amounted to $14 million (equivalent to P630 million) and €1 million (equivalent to P48 million), respectively. These are part of “Trade payables and other current liabilities” account in the consolidated statements of financial position. The net fair value of embedded currency forward amounted to P24 million an P2 million a at December 31, 2012 and 2011, respectively.

The net movements in the fair value changes of the derivative financial instruments for the years ended December 31, 2012, 2011 and 2010 are as follows:

| 2012| 2011| 2010|
| | (Amounts in Millions)|
Balances at beginning of year| (p2)| P23| P155|
Net changes in fair value of derivatives not| | | |
designated as accounting hedges| 40 | (16)| 7 |
Fair value of settled instruments| (14)| (5)| (139)|
Balance at end of year| P24| (P2)| P23|

The fair value changes of the derivative instruments in 2012 and 2011 are presented as follows:

| Note| 2012| 2011|
| | (Amounts in Millions)| |
Derivative assets| 15 | P24| P4|
Derivative liabilities| 23 | -| (6)|
| | P24| (P2)|

Financial Risk Management Objectives and Policies

The main risks arising from the financial instruments are interest rate risk, foreign currency risk, commodity price risk, credit risk and liquidity risk. The importance of managing these risks has significantly increased in light of the considerable change and volatility in the Philippine and international financial markets. The BOD reviews and approves policies for managing each of these risks. Management monitors the market price risk arising from all financial instruments. The policies for managing these risks are as follows:

Interest Rate Risk

The MERALCO Group’s exposure to the changes in the market interest rates relates primarily to the debt obligations with floating interest rates since the MERALCO Group’s interest-bearing short-term investments mature within 90 days.

The MERALCO Group’s policy is to manage its interest rate risk exposure using a mix of fixed and variable rate debts. The strategy, which yields a reasonably lower effective cost based on market conditions, is adopted. Refinancing of fixed rate loans may also be undertaken to manage interest cost. As at December 31, 2012 and 2011, approximately 83% and 81% of the borrowings bear fixed rate of interest, respectively.

The following table sets out the maturity profile of the financial instruments that are exposed to interest rate risk (exclusive of debt issuance costs):

| | | | | | More| |
| Within| | | | | than 5| |
| 1 Year| 1-2 Years| 2-3 Years| 3-4 Years| 4-5 Years| Years| Total| | | (Amounts in Millions)| |
2012 Floating Rate| P612| P612| 13 | P13| P13| P2,425| P3,688| 2011 Floating Rate| 612 | 612 | 612 | 13 | 13| 2,438| 4,300|

Floating interest rate on bank loans is repriced at intervals of less than one year. The other financial liabilities of the MERALCO Group that are not included in the foregoing have fixed interest rate, or are noninterest-bearing, or have no fixed or determinable maturity and are therefore not subject to interest rate risk. The short-term investments are not exposed to significant changes in market rates because they mature within 90 days to coincide with MERALCO Group’s monthly payment obligations.

The following table demonstrates the sensitivity to a reasonably possible change in interest rates, with all other variables held constant, of MERALCO’s profit before tax as at December 31, 2012 and 2011 through the impact on floating rate borrowings. There is no other impact on MERALCO’s equity other than those already affecting the consolidated statement of income.

Interest expense on floating rate loans is computed for the year, taking into account actual principal movements during the year, based on management’s best estimate of a +/- 100 basis points change in interest rates. There has been no change in the methods and assumptions used by the management in the above analysis.

Foreign Currency Risk

The revaluation of any foreign currency-denominated financial assets and liabilities as a result of the appreciation or depreciation of the Philippine peso is recognized as foreign exchange gains or losses as at the end of each reporting period. The extent of foreign exchange gains or losses is largely dependent on the amount of foreign currency-denominated financial instruments. While an insignificant percentage of the MERALCO Group’s revenues and liabilities is denominated in US dollars, a substantial portion of MERALCO Group’s capital expenditures of electricity capital projects and a portion of the operating expenses are denominated in foreign currencies, mostly in US dollars. As such, a strengthening or weakening of the Philippine peso against the US dollar will decrease or increase in Philippine peso terms, the principal amount of the MERALCO Group’s foreign
currency-denominated liabilities and the related interest expense, foreign currency-denominated capital expenditures and operating expenses as well as US dollar-denominated revenues. The following table shows the consolidated foreign currency-denominated financial assets and liabilities as at December 31, 2012 and 2011, translated to Philippine peso at the following exchange rates:

All of MERALCO’s long-term financial liabilities are denominated in Philippine Peso. However, an insignificant portion of its trade payables are denominated in US dollars. Thus, the impact of P1 movement of the Philippine Peso against the US dollar will not have a significant impact on MERALCO’s principal and interest payments. Further, PBR assumes a forecast level of foreign currency movements in its calculation of the regulatory asset base and expenditures. PBR also allows for adjustment of the rates MERALCO charges should there be significant deviations in the foreign exchange forecast from what is actually realized.

The following table demonstrates the sensitivity to a reasonably possible change in the US dollar exchange rte vis-à-vis the peso, with all other variables held constant, of the MERALCo Group’s profit before tax as December 31, 2012 and 2011 (due to changes in the fair value of financial assets and liabilities). There is no other impact on MERALCO’s equity other than those already affecting the profit and loss.

Foreign exchange gain or loss is computed for the year based on management’s best estimate of a +/-5 percent change in the closing Philippine peso to US dollar conversion rate using the year-end balances of US dollar-denominated cash an d cash equivalents, accounts receivable, liabilities and forward contracts. There has been no change in the methods and assumptions used by management in the foregoing analysis.

Commodity Price Risk

Commodity price risk is the risk that the fair value or cash flows of a financial instrument will fluctuate because of changes in commodity prices.
The exposure of MERALCO and CEDC to price risk is minimal. The cost of fuel is part of MERALCo’s and CEDC’s generation costs that are recoverable through the generation charge in the billings to customers.

Credit Risk

Credit risk is the risk that the MERALCO Group will incur a loss arising from customers, clients of counterparties who fail to discharge their contracted obligations. The MERALCO Group manages and controls credit risk by setting limits on the amount of risk that it is willing to accept for individual counterparties and by monitoring exposures in relation to such limits.

The MERALCO Group trades only with recognized, creditworthy third parties. It is the MERALCO Group’s policy that all customers who wish to trade on credit terms are subject to credit verification procedures. In addition, receivables are monitored on an ongoing basis to reduce exposure to bad debt. Power distribution receivables are, to a certain extent, backed by bill deposits. Also, as a policy, disconnection notices are sent three days after the due date and disconnections are carried out beginning on the third day after receipt of disconnection notice.

With respect to placements of cash with financial institutions, these institutions are subject to the MERALCO Group’s accreditation evaluation based on liquidity and solvency ratios and on the bank’s credit rating. The MERALCO Group transacts derivatives only with similarly accredited financial institutions. In addition, the MERALCO Group’s deposit accounts in banks are insured by the Philippine Deposit Insurance Corporation up to P500,000 per bank account.

Credit risk on other financial assets, which include cash and cash equivalents, trade and other receivables and certain derivative instruments, arises from the potential default of counterparty.

Finally, credit quality review procedures are in place to provide regular identification of changes in the creditworthiness of counterparties.
Counterparty limits are established and reviewed periodically based on latest available financial information of counterparties, credit ratings and liquidity. The MERALCO Group’s credit quality review process allows it to assess any potential loss as a result of the risks to which it may be exposed and to take corrective actions.

There are no significant concentrations of credit risks within the MERALCO Group.

The table below shows the maximum exposure to credit risk for the components of the consolidated statement of financial position, including derivatives as at December 31, 2012 and 2011. The maximum exposure is equivalent to the nominal amount of the accounts.

| | Gross Maximum Exposure|
| | 2012| 2011|
| | (Amounts in Millions)|
Cash and cash equivalents:| | | |
Cash in banks| | P1,348| P792|
Cash equivalents| | 57,244 | 41,437 |
Trade and other receivables:| | | |
Billed electricity| | 20,779 | 21,347 |
Service contracts| | 671 | 761 |
Insurance receivable| | 383 | 319 |
Cost of estimated earnings in excess of billings| | | on uncompleted contracts| | 258 | 167 |
Nontrade receivables| | 1,356 | 1,074 |
Other current assets - derivative assets| | 24 | 4 |
Other noncurrent assets:| | | |
Advance payments to a supplier| | 325 | 239 |
HTM investments| | 123 | 106 |
Notes receivable| | -| 27 |
| | P82,511| P66,237|
Credit ratings are determined as follows:
* “High Grade”
‘High’ grade financial assets include “cash in banks and cash equivalents and derivative assets to counterparties with good credit rating or bank standing. Consequently, credit risk is minimal. These counterparties include large prime financial institutions, large industrial companies and commercial establishments, and government agencies. For trade receivables, these consist of current month’s billings (less than 30 days) that are expected to be collected within 10 days from the time bills are delivered.

* “Standard Grade”
‘Standard’ grade financial assets include trade receivables that consist of current month’s billings (less than 30 days) that are expected to be collected before due date (10 to 14 days after bill date).

* “Sub-standard Grade”
‘Sub-standard’ grade financial assets include trade receivables that consist of current month’s billings, which are not expected to be collected within 60 days.

The Following table shows the aging analysis of financial assets as at December 31, 2012 and 2011:

| | 2012 | | |
| Neither| | | | | |
| Past Due| Past Due But Not Impaired| Impaired| |
| nor| 31-60| | Over| Financial| |
| Impaired| Days| 61-90Days| 90 Days| Assets| Total| | | (Amounts in Millions)| | |
Cash and cash equivalents:| | | | | | |
Cash in banks| P1,348| P-| P-| P-| P-| P1,348|
Cash equivalents| 57,244 | -| -| -| -| 57,244 | Trade and other receivables:| | | | | | |
Billed electricity| 17,772 | 1,896 | 628 | 483 | 2,559 | 23,338 | Service contracts| 671 | -| -| -| | 836 |
Insurance receivable| 313 | 11 | 12 | 47 | 145 | 383 | Cost of estimated earnings in excess of billings| | | | | |
on uncompleted contracts| 258 | -| -| -| -| 258 | Nontrade receivables| 1,106 | 9 | 6 | 235 | 2 | 1,358 | Other current assets - derivative assets| 24 | -| -| -| -| 24 | Other noncurrent assets:| | | | | | |

Advance payments to a supplier| 328 | -| -| -| -| 325 | HTM investments| 123 | -| -| -| -| 123 |
| P79,184| P1,916| P646| P765| P2,706| P85,217|
Liquidity risk is the risk that the MERALCO Group will be unable to meet its payment obligations when these fall due. The MERALCO Group manages this risk through monitoring of cash flows in consideration of future payment of obligations and the collection of its trade receivables. The MERALCO Group also ensures that there are sufficient, available and approved working capital lines that it can draw from at any time.

The MERALCO Group maintains an adequate amount of cash and cash placements and government securities, which may be readily converted to cash in any unforeseen interruption of its cash collections. The MERALCO Group also maintains accounts with several relationship banks to avoid significant concentration of cash with one institution.

The maturity profile of bill deposits is not determinable since the timing of each refund is linked to the cessation of service, which is not reasonably predictable. However, MERALCO estimates that a portion of bill deposits (including related interest), amounting to P4,064 million, will be refunded in 2013. This is shown as part of “Trade payables and other current liabilities” account in the 2012 consolidated statement of financial position.

Capital Management

The primary objective of the MERALCO Group’s capital management is to enhance shareholder value. The capital structure is reviewed with the end view of achieving a competitive cost of capital and at the same time ensuring that returns on, and of, capital are consistent with the levels approved by its
regulators for its core distribution business.

The capital structure optimization plan is complemented by efforts to improve capital efficiency to increase yields on invested capital. This entails effort to improve the efficiency of capital assets, working capital and non-core assets.

The MERALCO Group monitors capital using debt to EBITDA ratio, which is gross debt divided by EBITDA. The MERALCO Group considers long-term debt, redeemable preferred stock and notes payable as debt.

| | 2012| 2011|
| (Amounts in Millions, except Debt to EBITDA)|
Long-term debt| | P21,232| P22,725|
Redeemable preferred stock| | 1,594 | 1,651 |
Notes payable| | 1,787 | 67 |
Debt (a)| | 24,613 | 24,443 |
EBITDA (b)| | 27,545 | 24,602 |
Debt to EBITDA ratio (a) (b)| | 0.89 | 0.99 |
29. Income Taxes and Local Franchise Taxes

Income Taxes
The components of net deferred tax assets (liabilities as at December 31, 2012 and 2011 are as follows:

| | Note | 2012| 2011|
| | | (Amounts in Millions)|
Deferred tax assets:| | | | |
Provisions for various claims| | 20 | P9,503| P17,126| Unfunded pension cost and| | | | |
unamortized past service cost| | | 1,759 | 1,873 | Allowance for doubtful accounts| | 13 | 777 | 593 | Allowance for excess of cost over| | | | |
net realizable value| | 14 | 62 | 148 |
Excess of effective interest rate| | | | |
amortization over straight-line| | | | |
amortization of debt| | | | |
issuance costs| | | -| 1 |
Others| | | 1,419 | 331 |
| | | 13,520 | 10,073 |
Deferred tax liabilities:| | | | |
Revaluation increment in utility| | | | |
plant and others| | 16 | 7,645 | 7,831 |
Depreciation method differential| | | 1,124 | 1,242 | Capitalized interest| | | 751 | 755 |
Capitalized duties and taxes| | | | |
deducted in advance| | | 655 | 676 |
Net book value of| | | | |
capitalized/realized| | | | |
foreign exchange losses| | | 37| 61|
Others| | | 76| 78|
| | | 10,288| 10,643|
| | | P3,232| (P570)|

The deferred tax assets and liabilities are presented in the consolidated statements of financial position as follows: | | 2012| 2011|
| | (Amounts in Millions)|
Deferred tax assets - net| | P3,232| P25|
Deferred tax liabilities - net| | -| (595)|
| | P3,232| (P570)|
Provision for income tax consists of:

| | 2012| 2011| 2010|
| | (Amounts in Millions)| |
Current| | P9,490| P8.454| P4,960|
Deferred| | (3,793)| (2,515)| (937)|
| | P5,697| P5,939| P4,023|

A reconciliation between the provision for (benefit from) income tax computed at statutory income tax rate of 30% in 2012, 2011 and 2010, and provision
for (benefit from) income tax as shown in the consolidated statements of income is as follows:

| 2012| 2011| 2010|
| | (Amounts in Millions)|
Income tax computed at statutory| | | |
tax rate of:| | | |
Continuing operations| P6,563| P5,600| P3,995|
Discontinued operations| 317 | 386 | 336 |
| 6,880 | 5,986 | 4,331 |
Income tax effects of:| | | |
Interest income subjected to lower| | | |
final tax rate| (521)| (590)| (183)|
Nondeductible expenses| 40 | 593 | 79 |
Nondeductible interest expense| 213 | 236 | 61 |
Equity in net losses (earnings) of| | | |
associates and joint ventures| 4 | (20)| (85)| Nontaxable income| (28)| (10)| (63)|
Others| (574)| 66 | 180 |
| 6,014 | 6,261 | 4,320 |
Less provision for income tax of| | | |
discontinued operations| 317 | 322 | 297 |
| P5,697| P5,939| P4,023|

On December 18, 2009, the BIR issued Revenue Regulation, or RR No. 16-2008, which implemented the provisions of RA No. 9504 on Optional Standard Deductions or OSD. Such regulation allows both individual and corporate taxpayers to use OSD in computing their taxable income. For corporations, they may elect to adopt standard deduction in an amount not exceeding 40% of gross income in lieu of the itemized deductions. For the years ended December 31, 2012, 2011 and 2010, non of the entities in the MERALCO Group availed of the OSD in computing taxable income, except for RSIC and CFS.

The temporary difference for which deferred tax assets have not been recognized pertains to the tax effect of net operating loss carryover
amounting P513 million and P115 million as at December 31, 2012 and 2011, respectively.

LFT

Consistent with the decisions of the ERC, LFT is a recoverable charge of the DU in the particular province city imposing and collecting the LFT. It is presented as a separate line item in the customer’s bill and computed as a percentage of the sum of generation, transmission, distribution services and related system loss charges.

Furthermore, the Implementing Rules and Regulations issued by the ERC provide that local franchise taxes shall be paid only on its distribution wheeling and captive market supply revenues. At present, pending the promulgation of guidelines from the relevant government agencies, MERALCO is paying LFT based on the sum of the foregoing charges in the customers’ bill.

30. Contingencies and Legal Proceedings

Overpayment of Income Tax related to SC Refund

With the decision of the SC for MERALCO to refund P0.167 per kWh to covered customers during the billing period February 1994 to May 2003, MERALCO overpaid income tax in the amount of P7,107 million for taxable years 1994 to 1998 and 200 to 2001. Accordingly, MERALCO filed a claim on November 27, 2003 for the recovery of such excess income taxes paid. After examination of the books of MERALCO for the covered periods, the BIR determined that MERALCO had in fact overpaid income taxes in the amount of P6,690 million. However, the BIR also maintained that MERALCO is entitled to a refund amount of only P894 million, which pertains to taxable year 2001, claiming that the period for filling a claim had prescribed in respect of the difference between MERALCO’s overpayment and the refund amount MERALCO is entitled to.

The BIR then approved the refund of P894 million for issuance of tax credit certificates or TCCs. Proportionate to the actual refund of claims to
utility customers. The BIR initially issued TCCs amounting to P317 million corresponding to actual refund to customers as at August 31, 2005.

As at December 31, 2012 and 2011, the amount of unissued TCCs of P577 million out of the P894 million refund entitlement is presented as part of “Other noncurrent assets” account in the consolidated statements of financial position.

See Note 11 – Other Noncurrent Assets.

MERALCO filed a Petition with the Court of Tax Appeals or CTA assailing the denial by the BIR of its income tax refund claim of P5,796 million for the years 1994 – 1998 and 2000, arising from the SC decision (net of P894 million approved by the BIR for taxable year 2001). In decision dated December 6, 2010, the CTA’s Second Division granted MERALCO’s claim and ordered the BIR to refund or to issue tax credit certificate in favor of MERALCO in the amount of P5,796 million in proportion to the tax withheld on the total amount that has been actually given or credited to its customers.

On appeal by the BIR to the CTA En Banc, MERALCO’s petition was dismissed on the ground of prescription in the Decision of the CTA En Banc dated May 8, 2012. On motion for Reconsideration by MERALCO of the said dismissal, the CTA En Banc partly granted MERALCO’s motion and issued an Amended Decision dated November 13, 2012, ruling that MERALCO’s claim was not yet barred by prescription and remanding the case back to the CTA Second Division for further reception of evidence.

The BIR filed a Motion for Reconsideration of the above Amended Decision, while MERALCO filed its Motion for Partial Reconsideration or Clarification of Amended Decision. Both parties already filed their respective Comments to the said motions. And these are now submitted for resolution at the CTA En Banc.

Overpayment of Income Tax Related to Change in Tax Basis

On February 4, 2008, the SC denied with finality a motion for reconsideration filed by the Commissioner of Internal Revenue or CIR, against MERALCO, with respect to the issue on excess income tax paid by the latter. The SC affirmed a CA decision and ordered the CIR to refund or issue a TCC in favor of MERALCO for P107 million representing overpaid income taxes for taxable years 1987 and 1988. The overpayment is in accordance with the effectivity of Executive Order No. 72, which subjected MERALCO to regular corporate income tax instead of 2% franchise tax based on gross receipts it was previously liable for. On February 5, 2013, MERALCO filed a Motion for Issuance of a Writ of Execution with the CTA to enforce the judgment of the SC. On February 14, 2013, the CTA promulgated a Resolution ordering the CIR and the OSG to comment on the Motion filed by MERALCO. As at February 25, 2013, the Motion is still pending with the CTA

LFT Assessments of Municipalities

Certain municipalities have served assessment notices on MERALCO for LFT. As provided in the Local Government Code or LGC, only cities and provincial governments may impose taxes on establishments doing business in their localities. On the basis of the foregoing, MERALCO and its legal counsel believe that MERALCO is not subject or liable for such assessments.

Real Property Tax or RPT Assessments

Six Local Government Units or LGUs, assessed MERALCO for deficiency RPTs on certain assets of MERALCO. The assets include electric poles, wires, insulators, and transformers, collectively referred to as TWIP. Of these LGUs, one has secured a favorable decision from the CA. Such decision was appealed by MERALCO to the SC for the other LGUs are pending with their respective administrative bodies or government offices.

MERALCO also filed a case against the CITY of MANILA before Regional Trial Court – Pasig branch or RTC-Pasig, to enjoin the collection of RPT on MERALCO’s TWIP and nullify RPT assessments made thereon based the argument that these are not within the ambit of the definition of real property under
the LGC. The case is set mediation after the City of Manila filed its comment on MERALCO’s petition.

IN the event that the assessments are sustained by the SC and payment is warranted or appropriate, MERALCo will file for the recovery of any resulting real estate tax payments from customers in the relevant LGU through separate application with the ERC.

Mediation with NPC

The NPC embarked on a Power Development Program or PDP, which consisted of contracting generating capacities and the construction of its own, as will as private sector, generating plants following a crippling power supply crisis. To address the concerns of the creditors of NPC, namely, Asian Development Bank and the World Bank, and Department of Energy or DOE required that MERALCO enter into a long-term supply contract with the NPC.

Accordingly, on November 21, 2994, MERALCO entered into a 10-year Contract for Sale of Electricity or CSE, with NPC to commence on January 1, 1995. The CSE and the rates and amounts charged to MERALCO therein were approved by the BOD of NPC and the then Energy Regulatory Board, respectively.

Separately, the DOE further asked MERALCO to provide a market for half of the output of the Camago-Malampaya gas field to enable its development and production of natural gas, which was to generate significant revenues for the Philippine Government and equally significant foreign exchange savings for the country to the extent of the fuel imports, which the domestic volume of natural gas will displace.

MERALCO’s actual purchases from NPC exceed the contract level in the first seven years of the CSE. However, the 1997 Asian crisis resulted in a significant curtailment of energy demand.

While the events were beyond the control of MERALCO, NPC did not honor MERALCO’s good faith notification of its off-take volumes. A dispute endued
and both parties agreed to enter into mediation.

The mediation resulted in the signing of a Settlement Agreement or SA, between the parties on July 15, 2003. The SA was approved by the respective BODs of NPC and MERALCO. The net settlement amount of P14,320 million was agreed upon by NPC and MERALCO and manifested before the ERC through a Joint Compliance dated January 19, 2006. The implementation of the SA is subject to the approval of ERC.

Subsequently, the Office of the Solicitor General or OSG filed a “Motion for Leave to Intervene with Motion to Admit Attached Opposition to the Joint Application and Settlement Agreement between NPC and MERALCO.” As a result, MERALCO sought judicial clarification with the RTC- Pasig. Pre-trials were set which MERALCO complied with and attended. However, the OSG refused to participate in the pre-trial and opted to seek a Temporary Restraining Order of TRO from the CA.

In a Resolution dated December 1, 2010, the CA issued TRO against RTC-Pasig, MERALCO and NPC restraining the respondents from further proceeding with the case. Subsequently, in a Resolution dated February 3, 2011, the CA issued a writ of preliminary injunction enjoining the RTC-Pasig from conducting further proceedings pending resolution of the Petition. IN a Decision dated October 14, 2011, the CA resolved to deny the Petition filed by the OSG and lifted the injunction previously issued. The said Decision likewise held that the RTC-Pasig committed no error in finding the OSG in default due to its failure to participate in the proceedings. The RTC-Pasig was thus ordered to proceed to hear the case ex-parte, as against the OSG, and with dispatch. The OSG has filed a motion for reconsideration which was denied by the CA in its Resolution dated April 25, 2012. The OSG filed a Petition for Review of the Certiorari with the SC. In a Resolution dated July 25, 2012, the SC required MERALCO to file a Comment. MERALCO’s Comment was filed on October 29, 2012. The SC then issued a Resolution dated November 26, 2012 requiring the OSG to file a Reply. On February 19, 2013, the OSG filed a motion for extension to file a consolidated reply. MERALCO has yet to receive the OSG’s consolidated reply.

With the dismissal of the petition filed by the OSG with the CA, MERALCO filed a motion for the reception of its evidence ex-parte with the RTC-Pasig pursuant to the ruling of the CA. In a Decision dated May 29, 2012, the RTC-Pasig declared the SA, independent to the pass-through for the Settlement amount which is reserved for the ERC, valid and binding. The OSG has filed a Notice of Appeal with the RTC-Pasig on June 19, 2012. MERALCO is awaiting receipt of OSG’s appeal brief.

Sucat-Araneta Balintawak Transmission Line

The Sucat-Araneta Balintawak transmission line is a two-party transmission line, which completed the 230kV-line loop within METRO Manila. The two main parts are the Araneta to Balintawak leg and Sucat to Araneta leg, which cuts through Dasmariñas Village, Makati City

On March 10, 2000, certain residents along Tamarind Road, Dasmarinas Village, Makati City or plantiffs, filed a cast against NPC with the Regional Trial Court – Makati Branch or RTC-Makati, enjoining NPC from further installing high voltage electric current through said cables because of the alleged health risks and danger posed by the same. Following its initial status quo Order issued on the plaintiffs. The decision was affirmed by the SC on March 23, 2006, which effectively reversing a decision of the CA to the contrary. The RTC-Makati subsequently issued a writ of execution based on the order of the SC. MERALCO, in its capacity as an intervenor, was constrained to file an Omnibus Motion to maintain status quo because of the significant effect of a de-energization of the Sucat-Araneta line to the public and economy. Shutdown of the 230-kV line will result in widespread and rotating brownouts within MERALCO’s franchise area with certain power plants unable to run at their full capacities.

On September 8, 2009, the RTC-Makati granted the motions for intervention filed by intervenors MERALCO and NGCP and dissolved the Writ of Preliminary Injunction issued, upon the posting of the respective counter bonds by defendant NPC, intervenors MERALCO and NGCP, subject to the condition that
NPC and intervenors pay all damages, which the plaintiffs may incur as a result of the Writ of Preliminary Injunction.

Thereafter, the plaintiffs questioned the RTC-Makati order before the CA. As at February 25, 2013, this case remains pending for resolution in the CA.

Petition for Dispute Resolution

On September 9, 2008, MERALCO filed a Petition for Dispute Resolution, against PEMC, TranCo, NPC and PSALM with the ERC as a result of the congestion in the transmission system of TransCo arising from the outages of the San Jose-Tayabas 500kV Line 2 on June 22, 2008, and the 500kV 600 Mega volt-ampere Transformer Bank No. 2 of TransCo’s San Jose, Bulacan substation on July 11, 2008. The Petition seeks to, among others, direct PEMC to adopt the NPC-TOU rate or the new price determined through the price substitution methodology of PEMC as approved by the ERC, as basis for its billing during the period of the congestion and direct NPC and PSALM to refund the transmission line loss components of the line rentals associated with NPC/PSALM bilateral transactions from the start of WESM operation on June 26, 2006.

In a Decision dated March 10, 2010, the ERC granted MERALCo’s petition and ruled that there is double charging of the Transmission Line Costs billed to MERALCO by NPC for the TSC quantities to the extent of 2.98% loss factor, since the start of the TSC in November 2006. Thus, NPC was directed to refund/collect line rental adjustment to/from MERALCO. In the meantime, the ERC issued an Order on May 4, 2011 directing PEMC to submit an alternative methodology for the segregation of line rental into congestion cost and line losses from the start of the WESM PEMC has filed its compliance submitting its alternative methodology.

On September 8, 2011, MERALCO received a copy of PEMC’s compliance to ERC’s directive and on November 11, 2011, MERALCO filed a counter-proposal which effectively simplifies PEMC’s proposal.

On November 11, 2011, MERALCO filed its Motion to Implement the Decision dated March 10, 2010 By Immediately Effecting the Refund/ (Collection) of Line Rental Adjustments to Consumers. On December 21, 2011, PSALM filed its comment on MERALCO’s said Motion. Then, in an Order dated January 24, 2012, the ERC directed PEMC, Transco and NPC to submit their respective comments on MERALCO’s motion within five days from receipt.

In an Order of the ERC dated June 27, 2012, MERALCO was directed to submit its computation of the amount of the double charging of line loss on per month basis from June 26, 2006 up to the present. On July 4, 2012, MERALCO filed its Compliance to the said Order. Thereafter, the ERC issued an Order directing the parties to comment on MERALCO’s submissions.

Hearings were then conducted on October 2 and 16, 2012, to discuss the parties’ proposals and comments. MERALCO has filed its Comment thereon and is awaiting the resolution of the ERC.

PSALM versus PEMC and MERALCO

Due to the unusually large increases in WESM prices during the 3rd and 4th months of the WESM operations, MERALCO raised concerns with the PEMC to investigate whether WESM rules were breached or if anti-competitive behavior had occurred.

While resolutions were initially issued by the PEMC directing adjustments of WESM settlement amounts, a series of exchanges and appeals with the ERC ensued. ERC’s decision directing the WESM settlement price for the 3rd and 4th billing months to be NPC-TOU rates prompted PSALM to file a Motion for Reconsideration with the CA, which was denied on November 6, 2009. In December 2009, PSALM filed a Petition for Review on Certiorari with the SC.

As at February 25, 2013, PSALM’s petition for review is pending resolution by the SC.

Petition for Dispute Resolution with NPC on Premium Charges

On June 2, 2009, MERALCo filed a Petition for Dispute Resolution against NPC and PSALM with respect to NPC’s imposition of premium charges for the alleged excess energy it supplied to MERALCO covering the billing periods May 2005 to June 2006. The premium charges amounting to P315 million during the May-June 2005 billing periods have been paid but are the subject of a protest by MERALCO, and premium charges of P318 million during the November 2005, February 2006 and April to June 2006 billing periods are being disputed and withheld by MERALCO. MERALCO believes that there is no basis for the imposition of the premium charges. The hearings on this case have been completed and MERALCO is now awaiting the resolution of the ERC on the petition.

Others

Management and its internal and external counsels believe that probable resolution of these issues will not materially affect the MERALCO Group’s financial position and results of operations.

31. Significant Contracts and Commitments

NPC

MERALCO and NPC entered into a Transition Supply Contract or TSC, effective the earlier of five years from November 16, 2006 up to December 25, 2011 or one year after the introduction of Open Access, should RCOA be in place within the five-year contract period. Two addenda for additional contracted volumes were signed, the most recent being in 2010. The adjusted contracted volume was for a total of more than 40,000 GWh up to 2011.

On December 26, 2011, the TSC with NPC was extended until December 25, 2012 or three months after the implementation of the RCOA, whichever comes first.

As a result of the extension of the TSC, the Customer Choice Program or CCP, which is a joint program of NPC and MERALCO aimed at providing NPC
time-of-use or TOU, benefits to qualified customers, has also been extended to be co-terminus with the TSC. The CCP program expired on December 25, 2012.

With respect to the TSC, MERALCO, NPC and PSALM then executed a Memorandum of Agreement or MOA which further extended the TSC until June 25, 2013 or turnover of the Angat Hydroelectric Power Plant to the winning bidder, whichever comes earlier, with a contracted monthly energy volume ranging from 112.846 GWh to 159.966 GWh.

Assignment of TSC Volume to Successor Generating Companies

Form 2008 to 2009, NPC privatized a number of its generating assets and IPP contracts in favor of the successful bidders. As a result, the contracted energy volume under the original TSC between MERALCO and NPC was assigned by NPC to the respective new owners and IPPAs. Following are the privatized plants and IPP contracts.

NPC/PSALM remains the contracting party of record of the supply of power to MERALCO. Payments of the contracted volume are made based on the billing instructions from NPC/PSALM received by MERALCO.

PSAs with Successor Generating Companies

MERALCO entered into separate PSAs with SPPC, Masinloc Power and Sem-Calaca on December 12, 20 and 21, 2011, respectively. Also, a PSA with Therma Luzon was executed on February 29, 2012. These PSAs are for a period of seven years, extendable for three years upon agreement of the parties.

In March 2012, the application for approval of the PSAs was filed with the ERC. On June 26, 2012, MERALCO BOD approved the grant of authority to MERALCO to enter into a PSA with SMEC for a period of seven years, extendable for three years upon agreement of the parties.

On March 16, 2012, MPower signed a new PSA with Masinloc Power for 30MW of contracted capacity from the Masinloc coal-fired power plant in Zambales fro
seven years, extendable for three years upon agreement of the parties.

On April 26, 2012, the BOD approved the PSA with Pangea Green Energy Philippines, Inc., or PGEP, a biogas power plant located in Payatas, Quezon City using methane gas extracted from the Payatas Landfill as its fuel. Its plant will have a total nominal generating capacity of 1,236 kW.

In separate Decisions dated December 17, 2012, the ERC approved with modifications the PSAs of MERALCO with Masinloc Power, SPPC, Sem-Calaca, Therma Luzon and SMEC.

Motions for Reconsideration were filed regarding the ERC decisions on the PSAs with SPPC, Sem-Calaca and SMEC. The motions are set for decision by the ERC upon the submission of the FOEs and other documents requested by the ERC.

With respect to the motion for reconsideration of the Decision on the PSA of Sem-Calaca, hearings have been scheduled.

On December 27, 2012, MERALCO executed the PSAs with Therma Luzon and Abolitiz Power to cover the volume needed by MERALCO during the six-month transition period before the start of the commercial operations of RCOA. Under the PSAs with Therma Luzon and Aboitiz Power, MERALCO will procure power from Therma Luzon and Aboitiz Power from the expiration of the TSC until June 25, 2013 conditioned upon ERC approval. The said PSAs had been submitted to the ERC for approval on January 2, 2013. The hearings on both PSAs have already been terminated and are already submitted for decision.

Under the PSAs, fixed capacity fees and fixed operating maintenance fees are recognized monthly based on their contracted capacities. The annual projection of these payments are shown in the table below:

Year| Contracted Capacity| Fixed Payment amount|
| (In Megawatt)| (In Million)|
2013| 2,850| P33,214|
2014| 2,850| 33,992 |
2015| 2,850| 35,570 |
2016| 2,880| 37,560 |
2017| 2,880| 38,101 |
2018| 2,880| 38,626 |
2019| 2,460| 33,140 |

FGPC and FGP.

IN compliance with the DOE’s program to create a market for Camago-Malampaya gas field and enable its development, MERALCO was committed to contract 1,500-MW of the 2,700 MW output of the Malampaya gas field.

Accordingly, MERALCO entered into separate 25-year PPAs with FGPC (March 14, 1995) and FGP (July 22, 1999) for a minimum number of kWh of the net electrical output of the Sta. Rita and San Lorenzo power plants, respectively, from the start of their commercial op0erations. The PPA with FGPC terminates on August 17, 2025, while that of FGP ends on October 1, 2027.

On January 7, 2004, MERALCO, FGP and FGPC signed an Amendment to their respective PPAs. The negotiations resulted in certain new conditions including the assumption of FGP and FGPC of community taxes at current tax rate. And subject to certain conditions increasing the discounts on excess generation, payment of higher penalties for non-performance up to a capped amount, recovery of accumulated deemed delivered energy until 2011 resulting in the non-charging of MERALCo of excess generation charge for such energy delivered beyond the contracted amount but within a 90 % capacity quota. The amended terms under the respective PPAs of FGP and FGPC were approved by the ERC on May 31. 2006.

Under the respective PPAs of FGP and FGPC, the fixed capacity fees and fixed operating and maintenance fees are recognized monthly based on the actual Net Dependable Capacity tested and proven, which is usually conducted on a semi-annual basi.

QPPL

MERALCO entered into a PPA with QPPL on August 12, 1994, which was subsequently amended on December 1, 1996. Under the terms of the amended PPA, MERALCO is committed to purchase a specified volume of electric power and energy from QPPL, subject to certain terms and conditions. The PPA is for a period of 25 years from the start of commercial operations up to July 12, 2025.

In a Letter Agreement signed on February 21, 2008, the amount billable by QPPL included a transmission line charge reduction in lieu of a previous rebate program. The Letter Agreement also provides that MERALCO make advances to QPPLS of $2.85 million per annum for 10 years beginning 2008 to assist QPPL in consideration of the difference between the transmission line charge specified in the TLA and the ERC-approved transmission line charge in March 2003. QPPL shall repay MERALCO the same amount at the end of the 10-year period in equal annual payments without adjustment. However, if MERALCO is able to dispatch QPPL at a plant capacity factor of no less than 96% in any particular year, MERALCO shall not be required to pay the $2.85 million in that year. This arrangement did not have any impact on the rates to be charged to consumers and hence, would not require any amendment in the PPA, as approved by ERC.

See Note 11 0 Other Noncurrent Assets
Committed Energy Volume to be Purchased

The following are forecasted purchases/payments to FGPC, FGP and QPPL corresponding to the Minimum Energy Quantity or MEQ, provisions of the contracts. The forecasted fixed payments include capacity charge and fixed operation and maintenance cost escalated using the US and Philippine Consumer Price Index or CPI.

| Minimum Energy| |
Year| Quantity (MEQ)| Equivalent Amount|
| (In Million Kilowatt-Hours)| (In Million)|
2013| 14,656| P20,167|
2014| 14,656| 20,346 |
2015| 14,656| 20,530 |
2016| 14,556| 20,524 |
2017| 14,556| 20,928 |
2018-2025| 116,450| 152788|

MPPC

MPPC operates an 8 MW (designed capacity of 11 MW) renewable energy generating facility, which utilizes landfill gas.

On May 13, 2009, MERALCO filed an application for the approval of the CSE with MMPC with the ERC. On June 9, 2009, ERC issued an order dated June 1, 2009 provisionally approving the CSE subject to the following conditions: (i) any amendments to the CSE shall be filed with the ERC for approval and the implementation shall be prospective; and (ii) in the event the rates approved are higher than the final rates, the amount corresponding to the excess shall be refunded by MERALCO to its customers by crediting the same in their electric bills.

On June 11, 2009, MPPC began delivering energy to MERALCO under a two year CSE. The CSE is a “take and pay” arrangement, without a minimum energy volume. Energy is billed to MERALCO on an hourly basis at the ERC-approved NPC TOU rate plus certain pre-agreed cost components. Being an embedded renewable energy generator, purchases from MMPC are VAT zero-rated. Energy deliveries from MMPC are exempted from power delivery service charge.

After a series of negotiations, on May 23, 2011, MERALCO and MMPC signed a Letter Agreement extending the CSE. Said Agreement likewise contained minor amendments to the CSE that were intended to benefit the consumers. On June 3, 2011, MERALCO filed a Manifestation with Motion with the ERC seeking the approval of the Letter Agreement, pursuant to the condition contained in the ERC Order dated June 1, 2009. On February 19, 2013, the ERC issued its Decision approving the application.

BEI

MERALCO signed a CSE with BEI on November 12, 2010. BEI owns and operates a 4MW renewable energy generation facility powered by landfill gas in San Pedro, Laguna.

The terms of the CSE with BEI are similar to that signed with MMPC. Purchases from BEI, an embedded renewable energy generator, are VAT zero-rated and exempt from power delivery service charge. MERALCO filed an application for the approval of the CSE with the ERC, for provisional implementation of the contract on December 15, 2010. In an order dated January 31, 2011, the ERC provisionally approved the said application which extended the implementation indefinitely. The said case is pending decision by the ERC.

Interconnection Agreement with Altenergy Philippine Holdings Corporation or Altenergy

On March 1, 2012, MERALCO signed an Interconnection Agreement with Altenergy for their 90MW Wind Farm Renewable Energy plant in Pililla, Rizal, which is an interconnection at MERALCO’s Malaya-Teresa 115kV line, Altenergy is thus an embedded generator. Altenergy shall construct at its own cost, operate and maintain the new 115kV line. Aside from supporting renewable energy, technical benefits of the interconnection agreement are slight lowering of the loading of Dolores Delivery Point Substation power transformers resulting in additional spare capacity, and slight improvement in the voltage at the 115kV and 34.5kV busses.

32. Earnings Per Share Attributable to Equity Holders of the Parent

Basic and diluted earnings per share are calculated as follows:

| 2012| 2011| 2010|
| (In Millions Except per Share Data)|
Net income attributable to equity holders| | | |
of the Parent (a)| P17,016| P13,227| P9,685|
Weighted average common shares (b)| 1,127 | 1,127 | 1,127 | Per Share Amounts| | | |
Basic and diluted earnings per share (a/b)| P15.10| P11.73| P8.59|

Basic and diluted earnings per share amounts are calculated by dividing net income for the year attributable to common shareholders of the parent by the weighted average number of common shares outstanding during the year. There are no potential dilutive common shares in 2012, 2011 and 2010.

There are no other transactions involving common shares or potential common shares between the reporting date and the date of completion of these financial statements.

To calculate earnings per share amounts for the discontinued operations, the weighted average number of common shares for both basic and diluted amounts is as per the table above.

33. Other Matters

Revised SL Caps

On December 8, 2008, the ERC promulgated a resolution providing for a lower maximum rate of SL (technical and non-technical) that a utility can pass on to its customers. The revised SL cap is 8.5% for private utilities, effective January 2010 billing. This is one percentage point lower than the SL cap of 9.5% provided under RA No. 9136 and RA No. 7832, by increasing the SL cap to not less than 9%. The hearing on the Petition was conducted on November 18, 2010. Thereafter, MERALCO was directed to submit its FOE.

The Petition is awaiting the resolution by the ERC as at February 25, 2013.

Retail Competition

On February 18, 2011, the ERC issued an Order setting public hearings for the
purpose of determining whether or not RCOA may already be declared.

Subsequently to the conduct of hearings, in a decision dated June 6, 2011, the ERC decided December 26, 2011 as the Open Access Date for the commencement of the operation of the competitive retail electricity market in Luzon and the Visayas. Effective such date, electricity end-users with an average monthly peak demand of one (1) MW for the 12 months preceeding December 26, 2011, as certified by the ERC, shall have the right to choose their own electricity suppliers.

MERALCO has formally advised the ERC of its firm intent to participate as a local RES under a RCOA regime.

However, on October 24, 2011, ERC resolved to defer RCOA commencement and to consider the study and recommendations of the DOE Steering Committee in setting up the new Open Access Date.

On February 24, 2012, the DOE issued a circular designating PEMC as the Central Registration Body and Settlement Agent to manage transactions in the competitive retail market.

In a joint statement with the DOE, the ERC set the updated implementation of RCOA on December 26, 2012 with the following timeline: a. December 26, 2012 to June 2013 – Transition period for all concerned parties to undertake all assigned tasks ensure a smooth transition to full RCOA implementation b. March 26, 2013 to May 25, 2013 – Trial operation program c. June 26, 2013 – Commercial transactions based on an interim development system d. Last quarter of 2013 – Establishment of information technology infrastructure

On December 17, 2012, the ERC promulgated ERC Resolution No. 16, Series of 2012, which embodied the RCOA Transitory Rules. Relative thereto, the DOE also released a DOE circular which embodied the Retail Rules for the Integration of RCOA in the WESM.

Philippine Export Zone Authority or PEZA – ERC Jurisdiction

On September 13, 2007, PEZA issued “Guidelines in the Registration of Electric Power Generation Facilities/Utilities/Entities Operating Inside the Ecozones” and “Guidelines for the Supply of Electric Power in Ecozones.” Under these Guidelines, PEZA effectively bestowed upon itself franchising and regulatory powers in Ecozones operating within the legislative franchise area of DUs which are under the legislatively-authorized regulatory jurisdiction of the ERC. The Guidelines are the subject of an injunction case filed by the DUs at the RTC-Pasig.

In support of the government’s objective of providing lower cost to Ecozone locators, MERALCO entered into a MOA with NPC on September 17, 2007 for the provision of special Ecozone rates to high load factor PEZA-accredited industries. The ERC authorized the immediate implementation of the Ecozone Rate Program or ERP.

The ERP was initially scheduled to expire by December 25, 2011 but has been extended twice and was terminated as at December 25, 2012.

In January 2013, MERALCO entered into a tripartite agreement with PEZA and Trans-Asia Oil and Energy Development Corporation for the sale of power to CEZ and its locators beginning February 27, 2013.

Purchase of Subtransmission Assets or STAs

On November 25, 2009, MERALCO signed a Contract to Sell with TransCo for the sale and purchase of certain subtransmission assets for {86 million. On February 25, 2010, the ERC approved this Contract to Sell. On June 1, 2012, the ERC rendered a decision dated March 6, 2012, approving the sale of the said STAs in favor of MERALCO for P85 million.

On April 17, 2012, MERALCO and Transco filed a joint application for the approval of the Batch 4 contract to sell with the ERC. The case is awaiting the resolution of the ERC.

On December 12, 2011, MERALCO signed various agreements for the acquisition of certain subtransmission assets of TransCo within the MERALCO franchise area for its sole account, as well as with a consortium with Batangas II Electric Cooperative, Inc., or BATELES II and First Bay Power Corporation. On September 18, 2012, an amended consortium agreement was executed between MERALCO and FBPC. On October 17, 2012, MERALCO signed two separate amended consortium agreements superseded the ones signed on December 12, 2011. On December 27 and 28, 2012, the Contract to Sell and Consortium Agreement, respectively, covering these subtransmission assets were filed with the ERC for approval.

Lifeline Subsidy

ON June 21, 2011, Republic Act No. 10150, “An Act Extending the Implementation of the Lifeline Rate, Amending for the Purpose Section 73 of the Republic Act 9136, Otherwise known as the EPIRA of 2001, “ was promulgated. The Act extended the implementation of the lifeline rate for another 10 years.

Expanded Senior Citizens Act of 2010 or ESCA

RA No. 9994, otherwise known as the Expanded Senior Citizens Act of 2010 or ESCA, was signed into law last February 16, 2010 mandating the grant of benefits to senior citizens.

The ESCA grants senior citizens whose monthly consumption does not exceed 100 kWh a minimum 5% discount on the monthly electric bill, for services that are registered in their name. The law also gives a discount of at least 50% on the consumption of electricity by senior citizens centers and residential care/group homes.

On January 5, 2011, the ERC issued a Resolution which took effect on January 22, 2011 adopting the “Rules Implementing the Discounts to Qualified Senior Citizen End-Users and Subsidy from the Subsidizing End-Users on Electricity Consumption under Sections 4 and 5 of RA No. 9994”. MERALCO implemented the
discount starting with its February 2011 billing.

MERALCO Peak/Off-Peak or POP Program

On November 15, 2012, MERALCO filed an application with the ERC for the approval of its revised Time of Use or TOU rates program, also known as the POP Program. The POP is a rate program being offered by the MERALCo to customers whose load characteristics can benefit from TOU rates as well as to those that can shift their loads from peak to off-peak hours. The proposed revised PPOP Rate aims to provide better savings to availees by providing them with a TOU program that has a wider pricing difference between peak and off-peak rates.

In an Order dated December 17, 2012, the ERC provisionally approved the POP Program.

34. Event after the Reporting Date

On February 25, 2013, the BOD declared final cash dividends of P6.10 a share to all shareholders of record as at March 26, 2013, payable on April 24, 2013.