Audit in Specialized Industries 2020-2021 PDF

INSTRUCTIONAL MATERIAL FOR ACCO 30073 – Audit in Specialized Industries (Simplified Module for the New Normal, Second Semester of AY – 2020-2021) COMPILED BY: PROF. MARK ANECITO R. PERLAS...

INSTRUCTIONAL MATERIAL FOR ACCO 30073 – Audit in Specialized Industries (Simplified Module for the New Normal, Second Semester of AY – 2020-2021) COMPILED BY: PROF. MARK ANECITO R. PERLAS PROF. LADY DIANA P. NOLEAL All rights reserved. March 15, 2021 Prepared by: Prof. Mark Anecito R. Perlas Prof. Lady Diana P. Noleal Instructors Reviewed by: Prof. Lilian DM. Litonjua Chairperson – Accountancy Noted by: Dr. Julieta G. Fonte Dean Approved by: Dr. Emanuel C. De Guzman Vice-President for Academic Affairs 2  MODULE 1 Auditing Banking and other Financial Institutions Overview: The banking and finance sector performs a critical function in the Philippine economy as it is primarily responsible for the mobilization of domestic savings and the conversion of these funds into directly productive investments. Financing the needs of firms which desire to raise productive capacity by purchasing additional capital equipment, acquiring, or leasing idle property, building, and expanding factories, and increasing inventory are responsible for sustaining economic growth in the long term, alongside the creation of new jobs. It is very important for the banking and finance sector to continue finding ways to encourage households to save their unspent income in various financial assets so that these resources could be used and transformed into loans that will finance the expansion of directly productive business ventures. The Philippines' banks are classified into three types: universal and commercial banking, rural and cooperative banking, and thrift banking. Of these segments, universal and commercial banks that accepted domestic deposits and offered checking account services had dominated the Philippines' banking industry, with its total deposits valued at approximately 12 trillion Philippine pesos. Module Objectives: Know the nature and background of the particular specialized industry; Learn the overview, statistics, and updates of the specialized industry in the Philippine setting; Identify the different audit considerations and trends for the industry. Nature and Background of Specialized Industry The banking and finance sector is primarily responsible for mobilizing domestic savings and converting these funds into directly productive investments. Financing the needs of firms 3 which desire to raise productive capacity by purchasing additional capital equipment, acquiring or leasing idle property, building and expanding factories, and increasing inventory are responsible for sustaining economic growth in the long term, alongside the creation of new jobs. Banks perform the function of safekeeping money and valuables and extending loans, credit and payment services in the form of checking accounts, money orders, cashier’s checks as well as the issuance of debit and credit cards. Large banks (particularly the universal and commercial banks) are also allowed to engage in other intermediation activities such as investment banking (underwriting debt instruments and or stocks for other firms) and may offer other forms of portfolio investment instruments and insurance products. The financial system is composed of two general groups namely: banks and non-bank financial institutions. Banking institutions include: universal banks, commercial banks, thrift or savings banks and the rural and cooperative banks. These institutions are allowed to collect savings and time deposits to fund loans and also perform the function of providing credit and payment services. Large banks, particularly the universal and commercial banks, can engage in other intermediation activities such as investment banking and may offer other forms of portfolio investment instruments and insurance products. Non-bank financial institutions on the other hand, are composed of insurance companies, pension fund institutions, investment banks, financing companies, pawnshops and mutual fund institutions. These institutions are not allowed to collect deposits but may encourage the general public to invest household savings in various financial instruments. Premium payments for term insurance policies, regular contributions to pension funds, investment into mutual funds or purchases of shares of stock in financing companies and pawnshops are some of the ways by which non-bank financial institutions can source funds to finance lending and or investment operations. Universal and commercial banks have the largest resources and offer the widest variety of banking services outside of collecting deposits and providing loans. These other services include underwriting and other functions of investment houses, investing in equities and non-allied undertakings. Thrift banks include savings and mortgage banks, private development banks, stock savings and loan associations and microfinance thrift banks. They accumulate the savings of depositors and provide housing loans and financing for short-term working capital as well as medium- and long-term financing to small and medium scale enterprises engaged in agriculture, services, and industry. Rural and cooperative banks promote and expand the rural community by 4 mobilizing savings and extending loans and other financial services to farmers to help with the purchase of seeds, livestock, fertilizers, and other farm inputs and the marketing of their produce. Non-bank financial institutions, on the other hand, are composed of insurance companies, pension fund institutions, investment banks, financing companies, pawnshops, and mutual fund institutions. There are several types of non-bank financial institutions offering a wide variety of services such as investment houses, financing companies, investment companies, securities dealers/brokers, lending investors, government non-bank financial institutions, venture capital corporations, non-stock savings and loans associations, pawnshops and credit card companies. Overview, Updates, Statistics of the Specialized Industry in the Philippines The Bangko Sentral ng Pilipinas (BSP) is the independent central monetary authority of the Philippines that has regulatory and supervisory power over banks and non-bank financial institutions. The BSP supervises the nation’s banking system. Non-bank financial institutions such as insurance companies and investment houses are overseen by the Insurance Commission and Securities and Exchange Commission, respectively. The role of financial intermediation in the Philippine economy continues to expand and is expected to create greater prospects for employment over the next several years. The share of financial intermediation output to total service sector output as well as to gross domestic product has continually increased over the recent past. 5  The main services of commercial banks in the Philippines are accepting deposits and offer checking account services, universal banking on the other hand provides all kinds of services of commercial banking and exercise the powers of an investment house and invest in non-allied enterprises. In the Philippines, these kinds of banks are the largest group of financial institutions and the most popular among customers with different financial needs because of its wide array of financial services. As of October 2020, the value of loans granted by universal and commercial banks in the Philippines amounted to nearly 9.7 trillion Philippine pesos. Of these loans, approximately 364 billion Philippine pesos have been granted for motor vehicle loans for household consumption and approximately 1.6 trillion Philippine pesos worth of loans granted for production of real estate businesses in the country. While granting loans for customers seeking financial help for a business venture or providing loans for household consumption have been increasing, a sound and healthy banking sector is essential to sustain this growing pattern. Bank loans that have nonperforming loans are generally considered bad debts and can affect a bank’s cash flows. A low ratio of nonperforming loans to total gross loans meant a healthy banking sector. As of 2019, the ratio of bank nonperforming loans to total gross loans in the Philippines was almost two percent and has significantly decreased over the past years. The Philippine banking industry is not spared from the adverse impact of this pandemic. The Bangko Sentral ng Pilipinas (BSP) issued the implementing rules and regulation for the Bayanihan Act RA No. 11469. The law requires all lenders under BSP supervision to grant a 30-day grace period or extension for the payment of loans due within the enhanced community quarantine (ECQ) period, without imposing additional interest, penalties or charges on their borrowers. Further, the BSP also relaxed the know-your-customer (KYC) requirements for both over the counter and electronic or online transactions. This is to make sure that Filipinos continue to have access to basic government and financial services amid the COVID-19 situation. 6 Recent Issuances 7 Audit Considerations 8 Key Risks Considerations (PFRS 9) Reporting on the Financial Statements (see Philippine Auditing Practice Statement 1006 AUDITS OF THE FINANCIAL STATEMENTS OF BANKS for more details) In expressing an opinion on the bank’s financial statements, the auditor: adheres to any specific formats and terminology specified by the law, the regulatory authorities, professional bodies and industry practice; and determines whether adjustments have been made to the accounts of foreign branches and subsidiaries that are included in the consolidated financial statements of the bank to bring them into conformity with generally accepted accounting principles in the Philippines. This is particularly relevant in the case of banks with foreign branches and subsidiaries because most countries local regulations prescribe specialized accounting principles applicable primarily to banks. This may lead to a greater divergence in the accounting principles followed by branches and subsidiaries, than is the case in respect of other commercial entities. 9  The financial statements of banks are prepared in the context of the legal and regulatory requirements and accounting policies are influenced by such regulations. The BSP regulatory accounting principles for banks (RAP) may differ materially from generally accepted accounting principles (GAAP). When the bank is required to prepare a single set of financial statements that comply with both frameworks (i.e., RAP and GAAP), the auditor may express a totally unqualified opinion only if the financial statements have been prepared in accordance with both frameworks. If the financial statements are in accordance with only one of the frameworks, the auditor expresses an unqualified opinion in respect of compliance with that framework and a qualified or adverse opinion in respect of compliance with the other framework. When the bank is required to comply with RAP instead of GAAP, the auditor considers the need to refer to this fact in an emphasis of matter paragraph. By assessing key risks, it is evident that there are challenges on all sides. Banks are under attack, being subject to enforcement actions, fines, penalties, and expensive remediation action. Regulators and politicians are under pressure from the public, and sometimes each other, to deal more firmly with the banking sector, the banks, and bankers involved in breaches of regulations, criminal law, public trust, and confidence. Auditors have perhaps been too accommodating in allowing bank management and directors to somehow “manage” the audit relationship to their advantage, and in order to mitigate their reputation and regulatory risk. Throughout history, in moments of crisis and challenge, there are great opportunities. As stated in the new Basel Committee “Corporate Governance Principles for Banks”, internal audit provides independent assurance ….in promoting an effective governance process and the long-term soundness of the bank. The audit profession must rise to the challenge, embrace the key audit trends for 2015, and raise the standard of auditing to meet the higher level of Banking Governance now required. Assessments: 1. State the nature and background of the specialized industry. 2. What are the relevant statistics, and updates of the specialized industry in the Philippine setting? 3. Identify the different audit and accounting considerations and trends for the industry. 4. Look for at least 2-3 audited financial statements of companies under the specialized industry in the Philippines and list down your observations from audit report to the financial statements. 10  MODULE 2 Auditing Business Process Outsourcing Industry Overview: Today, many multinational organizations are going through finance, tax, or IT transformation project to drive efficiency and reduce costs. Often, these transformations include the use of technology to automate processes or centralizing common functions using shared centers. No matter what delivery model that your organization finds best to support statutory reporting or other compliance tasks, there are four elements that must work together in harmony to enable success: people, process, data, and technology. Business process outsourcing (BPO) remains a strong trend among organizations regardless of size. As early as 2010, 60 percent of CEOs at global enterprises believed that BPO played a very important role in supporting business models (Forbes Insights survey). Today, nearly all companies outsource some part of their operations. Oxford Business Group predicts that the global business process outsourcing industry will be worth $250 billion by the year 2020. Business process outsourcing in the Philippines accounts for 10 to 15 percent of the global BPO market, where the local BPO sector has grown at a compound annual rate of 10 percent over the past decade. The Philippines has also consistently ranked among the top five outsourcing destinations in the world. Module Objectives: Know the nature and background of the particular specialized industry; Learn the overview, statistics, and updates of the specialized industry in the Philippine setting; Identify the different audit considerations and trends for the industry. Nature and Background of Specialized Industry Business process outsourcing (BPO) is the practice of contracting a specific work process or processes to an external service provider. The services can include payroll, accounting, telemarketing, data recording, social media marketing, customer support, and more. BPO usually 11 fills supplementary — as opposed to core — business functions, with services that could be either technical or nontechnical. From fledgling startups to massive Fortune 500 companies, businesses of all sizes outsource processes, and the demand continues to grow, as new and innovative services are introduced and businesses seek advantages to get ahead of the competition. BPO can be an alternative to labor migration, allowing the labor force to remain in their home country while contributing their skills abroad. BPO is often divided into two main types of services: back office and front office. Back-office services include internal business processes, such as billing or purchasing. Front-office services pertain to the contracting company’s customers, such as marketing and tech support. BPOs can combine these services so that they work together, not independently. The BPO industry is divided into three categories, based on the location of the vendor. A business can achieve total process optimization by combining the three categories: 1. Offshore vendors are located outside of the company’s own country. For example, a U.S. company may use an offshore BPO vendor in the Philippines. 2. Nearshore vendors are located in countries that neighbor the contracting company’s country. For example, in the United States, a BPO in Mexico is considered a nearshore vendor. 3. Onshore vendors operate within the same country as the contractor, although they may be located in a different city or state. For example, a company in Seattle, Washington, could use an onshore outsourcing vendor located in Seattle, Washington, or in Huntsville, Alabama. Each BPO company will specialize in specific services. They may be grouped as follows: Customer interaction services: The BPO company would cover a business’s voicemail services, appointment schedules, email services, marketing program, telemarketing, surveys, payment processing, order processing, quality assurance, customer support, warranty administration, and other customer feedback. 12 Back-office transactions: This includes check, credit, and debit card processing; collection; receivables; direct and indirect procurement; transportation administration; logistics and dispatch; and warehouse management. IT and software operations: These technical support functions include application development and testing, implementation services, and IT helpdesk. For example, manual data entry can be replaced with automated data capture, increasing data intake and reducing cycle time. Finance and accounting services: These functions include billing services, accounts payable, receivables, general accounting, auditing, and regulatory compliance. Human resource services: BPOs can help address workforce challenges. They can also cover payroll services, healthcare administration, hiring and recruitment, workforce training, insurance processing, and retirement benefits. Knowledge services: These higher-level processes may include data analytics, data mining, data and knowledge management, and internet and web research, as well as developing an information governance program and providing the voice of customer feedback. How does BPO work? Organizational executives arrive at the decision to outsource a business process through a variety of avenues. Startup companies, for example, often need to outsource back-office and front- office functions because they do not have the resources to build the staff and supporting functions to preform them in-house. On the other hand, an established company may opt to outsource a task that it had been performing all along after an analysis determined that an outsourced provider could do the job better and at a lower cost. Management experts advise enterprise executives to identify functions that can be outsourced and then evaluate that function against the pros and cons of outsourcing to determine if shifting that task to an outsourced provider makes strategic sense for the organization. If so, the organization then must go through the process of not only identifying the best vendor for the work, but also shifting the work itself from in-house to the external provider. This requires a significant amount of change management, as the move to an outsourced provider generally impacts staff, established processes and existing workflows. 13  The shift also impacts the organization's finances -- not only in terms of shifting costs from the internal function to the outsourced providers, but often also in terms of taxes and reporting requirements. The organization may also have to invest in a technology solution to enable the smooth flow of work from the organization itself to the outsource provider, with the extent and cost of that technology solution dependent on the scope of the function being outsourced and the maturity of the technology infrastructure in place at both enterprises. Scope of work As an organization moves a function to a new outsourced provider, it must identify the scope of the work shifting from in-house staff to the external partner. Executives should identify the workflows and processes impacted by this shift and adjust, if necessary, those workflows and processes to accommodate the outsourcing of the work. Executives should also identify the key objectives for outsourcing a function -- whether it's cost savings, increased quality, quicker turnaround or some other objective -- and then use that criteria to determine which provider would be best suited to handle the work. Those objectives should also serve as the basis for contractual obligations that can be used to help assess the performance of the outsourced provider and success of the function once it is outsourced. Overview, Updates, Statistics of the Specialized Industry in the Philippines Globally, the BPO sector is worth over $300 billion. BPO vendors employ more than 3 million people in India, and more than 1 million people in the Philippines. Millions more are employed by BPO companies in Europe and the United States. BPO vendors are located all over the world, especially in developing nations with low income tax. South Africa has shown recent dominance in the BPO market, notably in call centers. Over the years, one of the key reasons behind the growth of BPO in Philippines has been the extended support of the Government led Philippines Development Plan, which ensured 14 incentivized local and international investments and other tax benefits. Also, there have been other contributing factors as well which have played a huge role in how the BPO industry has changed the face of the island nation's economy. Let's have a look at them - 15 5 Key Factors that Contributed to the Growth of BPO Industry in Philippines 1. In the initial years, when the BPO industry was still in its nascent stages, Bill Gates, the then CEO of Microsoft, donated free Microsoft Apps Licenses to the PCPS program, ensuring the government could hit the ground running with its initiative for fast and effective BPO industry growth in the country, while avoiding huge capital expenditures 2. Investors in the Philippine BPO industry are offered a sizeable number of incentives, including tax holidays, tax exemptions on imported equipment, simplified import procedures, and freedom to employ foreign nationals. 3. Filipino employees are not only fluent in Western-accented English as compared to their Indian counterparts but are also more patient; a trait which comes in handy when facing irate customers. Their close affinity to Western culture, and high problem-solving capabilities also set them apart from other similarly skilled workforce. 4. The government is always quick to pass key legislative changes which favor global organizations looking to outsource to Philippines. A recent example for the same would be the Data Privacy Act, which puts into place stringent international quality data privacy standards, thereby ensuring that sensitive information being handled daily remain secure. 5. Philippines focuses on growing industries in both voice and non-voice sectors such as global in-house centers (GICs), healthcare information management, animation, and gaming also ensured future BPO growth in the country. BPO Philippines Statistics 2020 and the Effects of the Pandemic The ill-effects of COVID-19 have left most SMEs cash-strapped. Some struggled to survive, while some have taken the challenge to ride the tide of change brought by this pandemic. Larger businesses with bigger cash buffers, on the other hand, also experienced a sharp drop in revenues. This is especially true for businesses under the travel, hospitality, and tourism industries. The decline in demand directly affects the BPO industry in the Philippines. Some clients pulled out their accounts, leaving employees on floating status. While these challenges delay the growth of the outsourcing market, many Philippine BPO companies still stand strong. Key points: 16  Investment pledges for January to July 2020 are 37-percent higher compared to the same period in 2019. IBPAP CEO Rey Untal said the pandemic will significantly affect the 2020 headcount and revenue projections. He added that it will also cause changes in the existing work and service models within the industry. The IT-BPM industry continued its business operations and increased its capacity amidst the community quarantines with the support of different government agencies — Department of Trade and Industry, the Philippine Economic Zone Authority, and the Inter-Agency Task Force on Emerging Infectious Diseases. According to UNESCO, the Philippines has an average of 98.2-percent literacy rate — 98.2% for females and 98.1% for males. There are 788 BPO companies composed of large and SMEs, according to PEZA. Effects of COVID-19 3 out of 5 BPO employees are still employed as outsourcing companies utilized the work- from-home strategy. 22% of employees continue to work from the office. The government ordered BPO companies to provide accommodation, shuttle, and meals to employees who work on-site. Before the lockdown, 40% of workers are already working from home. 18% of IBPAP member companies are looking at the option to retrench some of their employees. 36% of IBPAP member companies do not expect any growth while 3% to 7% are still expecting some growth. Globally, the travel, hospitality, and tourism industries got the heaviest hit of the pandemic due to travel restrictions and community quarantines. Enforced community quarantines, which restrict people from going outside their homes, boost the growth of e-commerce-industries, financial services, and logistics To adapt to the new normal, companies invest millions of dollars to facilitate the work-from- home setup. 17 Audit Considerations The Risks of Business Process Outsourcing Security: In outsourcing, especially when information systems (IS) are involved, companies face communication and privacy risks. Security is more difficult to maintain when the business taking care of your IS is not in the same country, especially one with different security requirements. Potential data privacy breaches and vulnerability disclosures are a real threat, particularly with the current prevalence of hacking. The internet, which makes BPO for IT feasible, also may offer a portal through which hackers enter. Underestimating the costs of services: Companies that employ BPO vendors often underestimate the running costs, especially in upgrades and contract renegotiation. Other hidden costs include vendor selection, currency fluctuations, hardware and software upgrades, internal transitions, layoffs, and the potential decrease in individual worker productivity. Overdependence on service providers: Once a company designates a vendor for specific processes, the vendor becomes a part of the workflow. The company can incur extraneous costs and decreased productivity when the vendor encounters problems or lapses in its work — for example, when the cost of hiring workers increases. Vendors often replace veteran employees with less experienced workers to keep costs down, and quality suffers as a result. Communication issues: Language barriers can limit activities when your company hires individual service providers spread across the globe. This can result in delays in new processes and curbs on feedback from different departments, and it can potentially magnify current problems in your business operations. Further, customer-facing services may present language barriers to third-party vendors. When outsourcing your processes and parts of your business, you face significant risks, depending on the type and structure of your company. For example, in very large segmented companies, outsourcing only the back data entry can carry a low risk. But for a small business that is reliant on BPO as part of its manufacturing, the risk increases. Other possible risks associated with outsourcing include: Data breaches Quality control 18  Operation restoration Nonlocal employees Maintenance of strategic alignment Political instability Changes in technology and exposure to hacking Specialization to the point that the niche demand is no longer necessary Tax Considerations A form of government support for the Philippine BPO industry is the Special Economic Zone Act that provides tax incentives, exemptions, and other privileges to foreign investors. Income tax holiday or corporate income tax exemption for four to eight years Option to pay a 5% gross income tax in place of all national and local taxes after the tax holiday. Tax-free and duty-free import of capital equipment, spare parts, supplies, and raw materials Permanent resident status for foreign investors (and their immediate family members) with an initial investment of US$150,000 Assessments: 1. State the nature and background of the specialized industry. 2. What are the relevant statistics, and updates of the specialized industry in the Philippine setting? 3. Identify the different audit and accounting considerations and trends for the industry. 4. Look for at least 2-3 audited financial statements of companies under the specialized industry in the Philippines and list down your observations from audit report to the financial statements. 19  MODULE 3 Auditing Mining Industry Overview: The mining industry sector is a major backbone of the Philippine economy. The long history of the industry has been much affected by the vicissitudes of the international market, as well as other domestic factors. With the adoption of the 1986 Constitution, the concept of awarding mineral rights has been drastically changed from leasehold to a system of contracts for various modes of production. Such changes have, as expected, temporarily unsettled the industry. The preponderance of small-scale mining, the growing public awareness on the environment, increasing labor and energy costs are concerns which should be addressed. Amidst all these, and in the framework of very stiff competition in the region for investments, new thrusts and directions, without compromising general stability, are urgently required for the overall development not only of the industry but for the whole country. The Philippines is the fifth most mineral-rich country in the world for gold, nickel, copper, and chromite. It is home to the largest copper-gold deposit in the world. The Mines and Geosciences Bureau (MGB) has estimated that the country has an estimated $840 billion worth of untapped mineral wealth, as of 2012. About 30 million hectares of land areas in the Philippines is deemed as possible areas for metallic minerals. According to the Mines and Geosciences Bureau (MGB), about nine million hectares of land areas is identified as having high mineral potential. The Philippines metal deposit is estimated at 21.5 billion metric tons and non-metallic minerals are at 19.3 billion metric tons, as of 2012. Module Objectives: Know the nature and background of the particular specialized industry; Learn the overview, statistics, and updates of the specialized industry in the Philippine setting; Identify the different audit considerations and trends for the industry. 20 Nature and Background of Specialized Industry A country’s socio-economic development largely depends on the extent and composition of its natural resources. Examples of natural resources include forestry, minerals, and commercial sources of energy (like coal, oil, natural gas, and hydro power). Mining and mineral processing are activities for extraction and processing minerals for commercial use. The mining sector is likely to contribute to the development of the economy of any country through taxes from large-scale mining companies and contribute to social–economic infrastructural development within the area where the mine is located. The mining sector can: create employment opportunities both directly in the mines and indirectly on services to the mines, provide education and health services, increase foreign exchange reserves, (reducing a country’s foreign exchange deficit), improve infrastructure like roads and water supply, and create other economic activities to support the mines instead of importing all supplies from abroad. A working definition of mining according to the United Nations Environmental Program (UNEP) could simply be “the extraction of minerals from the earth”. The word “minerals” in this case would cover a wide variety of naturally occurring substances extracted for human use. Although this definition is adequate for our purposes, mining can also be seen as a process that begins with the exploration and discovery of mineral deposits and continues through ore extraction and processing to the closure and remediation of worked-out sites. Minerals are a non-renewable resource, so mining represents a temporary use of the land. The mining life cycle during this temporary use of the land can be divided into the following stages: exploration, development, extraction, processing, and mine closure. In this section, we explain the various phases of mining, the associated impact in each phase, and the suggested mitigation or amelioration measures. The figure below sets out the five physical stages of the life cycle of a mine. 21  Figure 2 Life cycle of mining Project Exploration Mining and milling development Abandoned mine / Smelting and refi- Mine closure rehabilitation ning (benefication) The exploration phase of mining Exploration activities encompass all actions in the field that precede feasibility studies. Exploration activities include initial reconnaissance flights and geophysical surveys, stream sediment studies and other geochemical surveys, construction of access roads, clearing of test drilling sites, installation of drill pads and drilling rigs, benching, trenching/pitting, erection of temporary accommodation, and power generation for exploratory drilling. Exploration activities also include determining the location, size, shape, position, and value of a body of ore using prospecting methods. The development phase of mining The development of a mine consists of several principal activities: conducting a feasibility study, including a financial analysis to decide whether to abandon or develop the property; designing the mine; acquiring mining rights; filing an Environmental Impact Assessment (EIA); and preparing the site for production. The development phase may include such activities as overburden stripping and placing, road/trail, building and/or helicopter transport, drilling and trenching, erecting treatment plants, preparing disposal areas, and constructing services, infrastructure such as power line or generating plants, railways, water, supplies and sewerage, laboratories and amenities. Overview, Updates, Statistics of the Specialized Industry in the Philippines The extractive sector in the Philippines makes a relatively small contribution to the national economy. The latest disclosure (2018 EITI Report) shows the mining sector contributes the most in 22 the sector with 0.89% to GDP and 5.99% to total exports. However, there is considerable anti-mining sentiment in the country especially at subnational levels where environmental impact and displacement of indigenous peoples caused by mining operations have been the focus of much debate. Small-scale mining is also contentious, due to poor regulations and overlapping policies between central and local government. The Philippines is a leading producer of mineral commodities such as nickel, gold and copper. While mineral production volume increased slightly in 2018, production has gradually decreased since 2015 -2017. Nevertheless, the country is only behind Indonesia as the world's leading producer of nickel. Other commodities being produced in the Philippines include chromite, zinc, iron, silver, crude oil and natural gas. While the mineral sector slightly picked up in 2018, coal saw a slight dip in production compared to its 2017 value. Domestic oil production follows a similar trend as coal - declined from 3 million barrels of oil in 2014 to only 1.1 million barrels in 2018. Exploration activities in mining are spread nationwide, while coal production is focused in the province of Antique. Oil and gas exploration is focused offshore. The Philippines is one of the most highly mineralized countries in the world with vast reserves of gold, silver, copper, nickel, and chromite. In 2018, the Philippines accounted for 6.4% of the world’s total estimated reserves of nickel. 23  The main taxes levied on the mining sector are corporate income tax, excise tax on minerals and royalties on mineral reservations, while the major oil and gas levies are the government’s share in oil and gas revenues, corporate income tax and withholding tax on profit remittance to principal. The Bureau of Internal Revenue (BIR) is the main body responsible for collecting taxes paid to central government, while the Mines and Geosciences Bureau of the Department of Environment and Natural Resources and the Department of Energy collect sector levies for mining and coal, oil, and gas respectively. Local government units (LGUs) are responsible for collecting subnational payments. Oil and gas service contracts (PSCs) are awarded through competitive public bidding, while mining permits are awarded through direct negotiation. Several moratoriums on the issuance of mining licenses implemented in previous years from 2012 to 2017 have affected the number of mining projects in the country. As of February 2021, there were 309 Mineral Production Sharing Agreements, 5 Financial or Technical Assistance Agreements and 13 existing Exploration Permits for the mining sector. Beneficial Ownership (BO) disclosure and Politically Exposed Persons (PEP) reporting in the Philippines has been a significant aspect of transparency in the Philippines. The multi-stakeholder group identifies tax evasion, money laundering, and compliance with the Constitutional provisions on the nationality of mining companies as the national issues that their work on beneficial ownership aims to address. It faces constraints, however, in terms of data privacy restrictions. The Philippines EITI previously published a Beneficial Ownership (BO) roadmap on 15 December 2016. Several milestones of the Roadmap have been accomplished by the beginning of 2021, including the integration of BO in the mainstreaming efforts of PH-EITI, the increased coordination with the SEC and the pilot disclosure of BO information. According to the 2018 EITI Report published in December 2020, 41 out of 65 covered companies/projects fully or partially disclosed beneficial ownership information. A total of 128 name entries were declared as beneficial owners. Securities Exchange Commission (SEC) Memorandum Circular (MC) No. 15 (issued in July 2019) enhanced the BO Declaration form. The revised General Information Sheet (GIS) under MC 24 No. 15 mandates corporations to fill out a beneficial information declaration form that asks for nine categories of beneficial owners and their information, including complete name, residential address, nationality, tax identification number, and percentage of ownership or voting rights. While there is currently no public register of beneficial owners, work has begun to ensure that BO information, contracts and extractives information is integrated into one publicly-available portal. Audit Considerations Key Financial Concepts in the Mining Industry (see PFRS 6 Exploration and Evaluation of Mineral Resources for more information) Revenue: Ore (tons) x Grade (g/t) x Recovery x Payability x Metal Price Royalties: Properties often have royalties on them (e.g., 2% Net Smelter Return) Operating costs: Per ton basis (e.g., $2.50/ton for mining) Capital costs: Includes initial capital (construction of mine) and sustaining capital (ongoing equipment, etc.) Reclamation costs: Takes place at the end of a mine’s life; accrued for accounting purposes but not accrued in a cash flow model. Depreciation: A percentage of production bases over the entire life of the mine Taxes: Can often be complicated with mining companies operating in several countries; mining specific taxes and royalty agreements need to be considered Changes in working capital: Changes in accounts receivable, inventory, and accounts payable should be factored into a cash flow model. Challenges in Mining Industry in the Philippines Responsible Mining under Philippine Mining Act Circumvention of Permits Interfacing with LGUs Delays in the declaration of Indigenous Peoples (institutional issues with National Center for IPs) Impact of COVID-19 pandemic 25 High-Level Questions About Revenues from the Extraction of Minerals Are the revenues from the extraction of minerals significant? (Each source of revenue should be assessed individually, and their importance should also be assessed in the aggregate. While large revenues can be significant on their own, some smaller sources of revenues may also be significant because of their function. For example, leases, licenses, and permits may be important because they enable departments to know who should be paying royalties and fees.) 26  Is there a significant difference between predicted and actual revenues? If so, what is the explanation for this difference? Are there any new revenue sources? (For example, is there a new resource with its own royalty system, such as a recently developed diamond mining industry?) Has new relevant legislation or regulation been introduced or have significant changes been made to existing legislation and regulation recently? When was the last review of the revenue framework conducted? When is the next one planned? Where significant changes in revenues are observed, are they in line with current market conditions and production levels? Has the revenue framework (and supporting regulations) been criticized for being overly complex or unclear? Is there significant public interest in the topic? Have there been any public complaints or reporting of any inappropriate practices in the sector (transfer mispricing, for example)? Have annual financial audits identified significant or chronic issues with regard to the collection of revenues from the extraction of minerals? Is there a regulated royalty audit regime in place? If so, is there 100-percent audit coverage or risk-based coverage? Are audits completed on a timely basis? In addition, have internal audits of revenue collection processes been conducted? Is there significant reliance on self-reporting of production level? Does the government have sufficient expertise to verify information reported by the private sector? Have previous performance audits of mining revenues been conducted by the audit office? Has progress been made by the government to address prior recommendations? Is there segregation of duties between the collection of revenues and the assessment of the completeness of revenues received? Has the government clearly established the objective it is pursuing through its revenue framework for the mining sector? Is there legislation or regulation in place to ensure the public has access to reliable information on the payments the government receives from mining companies? 27 High-Level Questions About Financial Assurances for Site Remediation Is there a regulated system of financial assurances for site remediation in place? Is the system recent or well-established? Has a remediation fund been established? What is the current cost estimate (potential liability) for rehabilitating all mining sites in the jurisdiction? What is the state or risk of unfunded liability in the jurisdiction? Is the risk increasing over time? If there is a remediation fund, what is the current balance of this fund? Have there been any recent or looming changes in environmental standards or legislation that are expected to affect required securities? Does the duration of the securities match the expected duration of the expected liability? Is there documented guidance on how to estimate remediation costs? Are remediation cost estimates periodically reviewed by the government or an independent expert? If regulations allow for self-insurance, what is the relative frequency of self-insurance by mining companies in the jurisdiction? Are there mechanisms for regular monitoring of sites and monitoring of associated securities? Are these mechanisms implemented? What is the frequency of site visits? Are the licensing and inspection functions segregated? Is there a process to ensure that financial assurances are released only when compliance with site remediation requirements is achieved and documented? Are site inspections providing sufficiently complete assessments? (For example, can inspections identify underground contamination?) Are there sufficient penalties in place to encourage compliance with financial assurance requirements? Assessments: 1. State the nature and background of the specialized industry. 2. What are the relevant statistics, and updates of the specialized industry in the Philippine setting? 3. Identify the different audit and accounting considerations and trends for the industry. 4. Look for at least 2-3 audited financial statements of companies under the specialized industry in the Philippines and list down your observations from audit report to the financial statements. 28  MODULE 4 Auditing Construction and Real Estate Industry Overview: One successful business in the construction world is the real estate industry. This industry covers many aspects of the property such as development, leasing, appraisal, marketing, and management of commercial, residential, agricultural, and industrial properties. The industry fluctuates depending on the economies but at the same time remains consistent since people always need homes and businesses need commercial space. While Covid-19 has thrown the Philippines’ economy into flux, early indications suggest that construction and real estate is one of the most resilient sectors and could provide a platform for national recovery. However, with construction projects delayed by lockdowns during the second quarter of 2020, and demand for office space and high-end residential developments weakened by mobility restrictions, the sector still faces headwinds. At the same time, the disruption of the pandemic is giving rise to new opportunities. For instance, with the pandemic inducing a significant shift towards working from home as companies adhere to social-distancing measures, co-working spaces are emerging as a solution for firms seeking to decentralize while ensuring a sound operating environment for employees. Agile real estate developers have the chance to establish a first-mover advantage and capitalize on emerging opportunities as tenants and buyers seek projects that meet the demands of the new normal. Module Objectives: Know the nature and background of the particular specialized industry; Learn the overview, statistics, and updates of the specialized industry in the Philippine setting; Identify the different audit considerations and trends for the industry. 29 Nature and Background of Specialized Industry Construction. The construction industry comprises of building, alteration, and/or repair. Examples include residential construction, commercial construction, bridge erection, roadway paving, excavations, demolitions, and large scale painting jobs. Residential construction refers to the building or renovation dwellings. The vast majority of residential construction jobs are small renovations, such as addition of a room or renovation of a bathroom or kitchen. Commercial construction includes apartments, office and retail buildings, hotels, schools, public buildings, industrial and manufacturing buildings, highways and bridges, sewers, pipelines, power lines, power plants, and other civil engineering projects. Real estate is any real property consisting of land and improvements such as fixtures (i.e., access door, lighting, awnings, etc.), buildings, roads, structures, and even utility systems. Here are the four types of real estate: 1. Residential - This includes both new construction and resale. A common category of residential real estate is single-family homes. Other residential real estate’s include condominiums, co-ops, townhouses, triple-deckers, high-value homes, duplexes, quadplexes, vacation, and multi-generational homes. 2. Commercial - Included in this type of real estate are strip malls, shopping centers, educational and medical buildings, hotels, and offices. Apartments, although used for residences, are often considered commercial since they are owned to produce income. 3. Industrial - This kind of real estate includes manufacturing buildings and property, including warehouses. There can be various uses for industrial buildings such as research, 30  production, distribution, and storage of goods. However, buildings where goods are distributed, are considered as commercial real estate 4. Land - Land can either mean vacant land, ranches, or working farms. Subcategories of this kind of real estate include undeveloped, early development or reuse, subdivisions, and site assembly. How the Real Industry Works 1. Development Real estate development is the process of purchasing raw land, rezoning, renovation and construction of buildings, as well as sale or lease of finished products to end-users. Real estate developers end profit by adding value to the land such as creating buildings or improvements or rezoning and taking a risk in financing a project. 2. Sales and Marketing Firms that focus primarily on sales and marketing work with developers to sell buildings and units that they create. Commissions are earned by these firms for creating all marketing material and using sales agents to sell completed units. Sales and marketing firms focus more on new units. 3. Brokerage A brokerage is a firm with a team of real estate agents or realtors as employees. The real estate agents help in facilitating a transaction between buyers and sellers of property. One of their jobs is to represent either party and help them achieve the purchase or sale with the best possible team. 4. Real Estate Lending Lenders include banks, private lenders, credit unions, and government institutions. They play a huge role in the real estate industry since all properties and developments use debts to finance their business. 5. Property Management Property management firms play a role in helping real estate owners rent out the units in their buildings. Some of their jobs include collecting rent, fixing deficiencies, performing repairs, showing units, and managing the tenants. They charge a fee which is a percentage of the rent to property owners. 31  6. Professional services There are a variety of real estate professionals who work in the industry and help make it function. The most common examples (other than the ones listed above) are accountants, lawyers, interior designers, stagers, general contractors, construction workers, and tradespeople. Overview, Updates, Statistics of the Specialized Industry in the Philippines The construction sector is one of the important industries that the government has been focusing on since 2016. With the aim to build more infrastructure construction to help ease traffic and trade across all regions, 100 infrastructure flagship projects have been prepared by the public sector as of February 17, 2020. The majority of these developments would be enforced by the Department of Public Works and Highways and the Department of Transportation. The DPWH would manage 38 projects and 42 projects from DOTr. One of the big tickets in the government's infrastructure development plan is the Metro Manila Subway Project, which would be managed by the DOTr, which would cost around 357 billion Philippine pesos. Its targeted completion year is on 2025, and the construction would commence in six to eight months from February 2020. Other high-valued tickets in the pipeline that would begin construction in six to eight months are the North-South Commuter railway extensions (PNR North 2, PNR South commuter), PNR South long haul, Bataan-Cavite interlink bridge, Panay-Guimaras Negros bridge, Taguig integrated terminal exchange and the New Manila International Airport. The" Build Build Build" program which significantly introduces the administration's intent to propel the country in achieving more developed and connected life among Filipinos, have so far increased the number of licenses for building contractors in the Philippines. In 2018, approximately 4.8 thousand permits were issued for general engineering contractors, around three thousand for general building, nearly two thousand for trade contractors, and around one thousand for specialty contractors, respectively. In addition, the number of building permits has been on the rise since 2016. For non-residential building permits alone, there were approximately 24.4 thousand permit issuances in 2018 compared to only 17.9 thousand licenses in 2016. 32  Within the private sector, the motivation to construct buildings is driven not only by the "Build build build" program but also by the income potential in the real estate business. Private construction caters both to residential and non-residential unit consumers. Different business sectors occupy a large amount of office space in the country, especially in the National Capital Region for their operations. Across the region, the Philippine Offshore Gaming Operators (POGO) occupied about 738 thousand square meters of office space while businesses engaged in information technology occupied around 573 thousand square meters. Other companies not belonging to these categories occupied only 379 thousand square meters. In terms of residential units' supply, the number of condominium units within the major districts of Metro Manila has shown a different kind of appetite on property investments. At the end of 2018, the supply of condominium units among the highly urbanized cities of Fort Bonifacio, Makati, Bay area, and the Ortigas Center were higher compared to Alabang, Araneta Center and Rockwell Center. The Philippines real estate market has been penetrated with high investments arising from the presence of both, domestic and international players, in the market. The Philippines real estate market is expected to post revenues of USD XX billion by 2020 due to the increasing urbanization and expansion in the real estate construction projects. The demand is expected to rise due to growth in the number of multinational companies and a number of BPO’s. The real estate market in Philippines is poised for growth at an estimated CAGR of XX.X% over the forecast period, from 2016 to 2021. Drivers A growth in the number of multinational companies and BPO’s, increasing urbanization and expansion in the real estate construction projects are the major drivers for the real estate sector in the Philippines. More number of Filipinos are moving to urban areas and are adopting better ways of living and the difference between the rich and the poor is on the decline leading to growth in the middle-class population that can afford to buy properties. Moreover, a large chunk of the 33 population works in the large number of BPO’s and MNCs, which are expected to rise, leading to an increase in the demand for commercial spaces. Restraints and Challenges Currently, it is important for the real estate developers to meet the growing demand for properties in the Philippines. It is necessary to solve the problem of housing backlog in the market. Moreover, the major challenge the government faces is to boost the infrastructure spending and provide more incentives to the real estate developers so that they shift their focus towards socialized housing. The fear of property bubble has been around for some time now and has limited the growth of the market. Opportunities Investing in real estate is considered as one of the best investments, globally. The size and scale of the real estate market make it an attractive and lucrative market for many investors, who can invest directly in physical real estate or choose to invest indirectly through managed funds. Investing directly in real estate involves purchasing residential or commercial properties to generate income or for resale at a future time. The Philippines, being a developing economy, will never be short of opportunities and in addition, more people are adopting urban lifestyles. Audit Considerations The construction and real estate industry differs in many ways from other types of business. Both can be quite cyclical and require a strong understanding of project accounting, revenue recognition and valuation issues. They also require investors/financial institutions, builders, developers and brokers to focus heavily on the future, constantly examining new trends in development, monitoring population shifts, and adapting to fluctuations in the market. There are some steps management and owners can take now to help make those audit kick-off discussions as productive as possible. 1. Plan ahead for discussions with auditors regarding: The current status and forecast of operations. 34  Status of ongoing negotiations with tenants or lenders (e.g., loss of tenants, lease modifications, COVID-19-related relief received or provided, debt modifications or refinances). Audit timing. Consider and anticipate any delays or inefficiencies due to the current work- from-home environment. Status of any legal or regulatory issues, including communications with an attorney regarding potential or pending legal matters. Subsequent events, such as tenant vacancies, which may require adjustments to financial statements or related disclosures. Delays in adopting applicable accounting standard updates (e.g., Topic 606 Revenue Recognition and Topic 842 Leases). Changes to deadlines, including SEC filings, and the impact of the amended definition of accelerated filers. 2. Review major transactions and changes to internal controls and processes: Update internal control narratives for any changes during the current year, such as any changes as a result of working from home or key staff turnover. Provide detailed explanations, along with all supporting executed legal documents, for transactions that have occurred during the year, such as executed lease amendments or a loan-closing binder. 3. Prepare for changes in audit requests: Anticipate new requests, such as virtual meetings with property managers, or cash flow projections. Use the auditor’s secure site, to view and upload documents. Management should verify that all necessary personnel can access the site during planning discussions with the auditors. Discuss and walkthrough processes and procedures remotely. Determine if remote access to general ledger systems exists within the system. Going Concern Considerations While going concern is always an audit consideration, consider the pandemic and, at a minimum, discuss with the audit team. An entity’s ability to continue as a going concern may be impacted by a variety of adverse conditions, such as loss of a major tenant, negative operating cash flows, or non-compliance with loan terms and covenants. 35  Technical Accounting Considerations There are considerations for entities reporting on either the income tax basis (“ITB”) of accounting or generally accepted accounting principles (“GAAP”). 1. Rent Concessions: ITB – If tenants received rent concessions, they would directly offset revenue and the corresponding account receivable. GAAP – The Financial Accounting Standards Board (“FASB”) has allowed for certain instances of rent relief to tenants due to COVID-19 as if such relief was already included in the original lease agreement. Thus, the entity may recognize the rent concession in the current period as opposed to accounting for it as a lease modification. 2. Rent Deferrals: ITB – If tenants received rent deferrals, this would merely impact the timing of cash collection from the tenant and not impact when revenue is recognized by the entity. GAAP – There are generally two options regarding COVID-19-related rent deferrals. Account for the deferral as if there are no changes to the lease contract, but merely a delay in cash receipts; account for such deferral as an offset to revenue during the deferral months. 3. Tenant-Related Assets: Accounts Receivable – Perform a thorough evaluation of the collectability of accounts receivable. Under ITB, once all collection efforts are exhausted, write off any uncollectible accounts receivable directly to operations. An allowance for doubtful accounts is not permitted. For GAAP, record an allowance for doubtful accounts against any receivable that may not be collectible. Tenant Improvements – For ITB and GAAP, identify tenant improvements relating to tenants who have vacated and terminated their lease agreement during the year. Can these assets provide any future economic benefit? Is the carrying amount of these assets recoverable over their remaining useful life? Are these assets tenant specific? Should the carrying amount of these assets be written off? Deferred Leasing Costs – For ITB and GAAP, identify deferred leasing costs related to tenants who have vacated and terminated their lease agreement during the year. Write off the remaining unamortized costs. 36 4. Deferred Financing Costs: If the entity entered into a transaction to extinguish or modify its debt, management should perform an analysis to determine the treatment of both any existing and/or new financing costs. The basis of accounting for which the entity is reporting on may contain nuances that dictate the treatment of financing costs. Extinguishment – Generally, write off the carrying amount of existing deferred financing costs as of the date of extinguishment. New costs incurred are capitalized and amortized over the term of the new loan. Modification – Generally, amortize over the term of the modified loan the carrying amount of existing deferred financing costs as of the date of modification. Expense any new cost in the period of the modification. However, under GAAP, capitalize new costs incurred and paid directly to the lender. 5. Asset Impairment: For entities reporting under GAAP, perform an impairment analysis of assets if management determines a “triggering event” has occurred. A triggering event may include, for example, the loss of a major tenant or the occurrence of negative operating cash flows. Management should determine if any such triggering events have occurred and, if one has, determine if the carrying amounts of any assets are not recoverable over their remaining useful lives. This is not a consideration under the ITB. Best Practices There are several things to keep an eye on in any year that will facilitate a successful audit season. 1. Management’s responsibilities: Review financial statements, whether prepared by management or an external party. Design, implement and maintain internal controls relevant to the preparation and fair presentation of financial statements. Prepare and review a complete financial reporting package of schedules and relevant documents that will be provided to the auditors. 2. Designate an audit point person from your team. 3. Verify the listing of accounts to be confirmed, including cash, debt and investment accounts. Sign all paper confirmations or give electronic authorization prior to year-end, if possible. 4. If the business has hard-to-value investments, prepare detailed supporting schedules and documentation. This should include a comprehensive write-up of the valuation methodology. 37 5. Discuss with your auditors if there are schedules or documentation you can provide in advance for possible interim testing. In a year where nothing has been ordinary in the real estate industry, spending time discussing business activities and planning with your auditors could help make the year-end audit process as efficient as possible. Main Industry Issues Distressed assets, in particular residential and commercial properties are in need of restructuring. PFRS, legal and other regulatory compliance Careful planning can optimize the tax position for real estate projects. Cost control and strong project management are essential to maximize potential returns on real estate projects. Measures to optimize cash flow can reduce the impact of the global economic downturn. A strong focus on quality and compliance maximizes financing and sale opportunities. PFRS 15 Revenue from Contracts with Customers Considerations How are different goods and services within a contract identified? Should contract costs be capitalized? Should Revenue be Recognized Over Time or at a Point in Time? Should revenue be adjusted for the effects of the time value of money? What is the impact if a contract is modified? When should variable or uncertain revenues be recognized? Differences of PAS 11 Construction Contracts and PFRS 15. See PIC Q&A 2018-12 for more details. Republic Act (RA) 6552 - The Realty Installment Buyer Act, more commonly known as the Maceda Law, provides remedies should the buyer default from payment based on the payment schedule initially agreed with the developer. Under this law, in the event of buyer’s default, the buyer should be given grace period and refund of 50 percent to 90 percent of what has been paid (provided that the buyer has paid installments for at least 2 years). Also, under the Act, notice of cancellation and then the refund (twin requirements) should be completed before cancellation of 38 the contract to sell can be carried out. Some legal opinions will say that without such cancellation, the contract between buyer and developer remains valid. With these provisions on cancellation (cancellation right of the developer), there is a chance that the real estate companies can sustain its legal right to payment. The discussion in the new revenue standard explains that, notwithstanding that an entity may choose to waive its right to payment in similar contracts, an entity would continue to have a right to payment to date, if in the contract with the customer, its right to payment for performance to date remains enforceable. This legal position on enforceability of right to payment to support the recognition of revenue on sale of real estate is currently being reviewed by the real estate industry. Assessments: 1. State the nature and background of the specialized industry. 2. What are the relevant statistics, and updates of the specialized industry in the Philippine setting? 3. Identify the different audit and accounting considerations and trends for the industry. 4. Look for at least 2-3 audited financial statements of companies under the specialized industry in the Philippines and list down your observations from audit report to the financial statements. 39  MODULE 5 Auditing Logistics and Transportation Industry Overview: Transportation is defined as the movement of people, animals, and goods from one location to another. These modes of transport may include air, rail, road, sea, cable, pipeline and space. This field is divided into infrastructure, vehicles, and operations. Transport is crucial as it enables trade and communication between one another, which ultimately establishes civilizations. The logistics industry can be defined as the science of obtaining, producing, and distributing material and products to the correct place and in the correct quantities. In a military sense, where it has a greater use, its meaning also includes the movement of personnel. Logistics includes the process of planning, implementing, and controlling procedures for the efficient and effective transportation and storage of goods. This includes services and related information from the point of source to the point of consumption for the purpose of fulfilling and conforming to customer requirements. The advancements of new technologies and improved business processes have had an enormous impact on transforming both the logistics industry and transport industry. Technologies have allowed real-time monitoring of flow and resources, transparency across multiple points and the seamless exchange of operational information with key performance indicators that have had a profound impact on the industry. In this highly competitive market both information and physical products must move with efficient speed and at lower cost, paired with improved service. Successful supply chain management and logistics are often the difference between surviving and flourishing in the current marketplace. Upon improving the supply chain will see immediate benefits in terms of lower costs and optimized delivery. 40 Module Objectives: Know the nature and background of the particular specialized industry; Learn the overview, statistics, and updates of the specialized industry in the Philippine setting; Identify the different audit considerations and trends for the industry. Nature and Background of Specialized Industry The logistics industry is much broader than the transportation industry. While transportation focuses on the movement of goods from one place to the other, the logistics industry implies a broader spectrum and refers to the whole ‘flow’ management. This includes not only the transportation and delivery of goods but also the storage, handling, inventory, packaging, and various other aspects. So, what are the main differences between the logistics industry and the transportation industry? Transportation is a function within the logistics industry operations. It is focused purely on the definition and deployment of transportation modes, such as sea, road and air. It is also important to differentiate between logistics and the supply chain. The supply chain refers to the entire value chain from the suppliers to the end customer, including after sales services and reverse logistics (recycling). Types of transportation are as follows: 1. Truck Freight — Road Transportation 2. Ship — Marine Transportation 3. Train — Rail Transportation 4. Plane — Air Transportation 5. Intermodal Transportation Logistics requires planning, whilst transportation is the mode to execute the planning when freighting goods from point A to B. They are not the same thing, but transportation is just simply a part of logistics. When it comes to the logistics industry, logistics executives must make further decisions beyond the mode of transportation to include: Packaging 41  Containerization Documentation Insurance Storage Importing and Exporting Regulations Freight Damage Claims Working and collaborating with other executives within the supply chain Managing vendors and partners Responsible for risk mitigation Three main directions correspond with the three logistical processes which we are going to focus on today. These are inbound logistics, outbound logistics, and reverse logistics. The information about these three supply chain directions is essential to know, especially to people inclined in the logistics industry. Inbound Logistics refers to the movement of goods between businesses and their suppliers to cut the definition short. In contrast, Outbound Logistics pertains to the flow of goods between companies and the end-user/consumer. And Reverse Logistics means that products’ movement from the end-user/consumer back to the manufacturer or reverse supply chain. 42  The expansion of the global marketplace puts the concept of global logistics into the limelight. Logistics experts must now manage all of the aforementioned logistics activities within a world- wide arena spanning a multitude of countries, languages, cultures, governments, and regulations. Along with this expansion of the marketplace comes the need for global channel intermediaries. Today's global logistics manager would be familiar with the role of each of the following: Foreign freight forwarders—handlers of a myriad of foreign freight services: rate quotes, vessel chartering, booking of vessel space, handling of documentation and cargo insurance, tracing and expediting, arranging inland transportation, and providing translation services. Export management companies—suppliers of expertise to those wishing to sell products overseas but lacking the necessary resources. Export trading companies—locaters of overseas buyers. They also handle export documentation, transportation, and the meeting of foreign government requirements. Customs house brokers—overseers of the movement of goods through customs. They also ensure that accompanying documents are complete and accurate. Ship brokers—sales representatives for ship owners and purchasing representatives for the shipper. Ship agents—local representative of the ship operator that handles the ship's arrival, berthing, clearance, loading and unloading. Export packers—suppliers of export packaging services. Port authorities—owner and operator of the port. They provide wharf, dock, and other terminal facilities at port locations. Overview, Updates, Statistics of the Specialized Industry in the Philippines The Freight and Logistics market in Philippines is segmented by Function (Freight Transport, Freight Forwarding, Warehousing, Value-added Services, Cold Chain Logistics) and by End-User (Manufacturing & Automotive, Oil & Gas and Quarrying, Agriculture, Construction, Distributive Trade (Wholesale and Retail Segments - FMCG included) and Other end-users (Pharmaceutical and telecommunications)). 43  The Philippines freight and logistics market is expected to grow at a CAGR of around 8.2% during the forecasted period. Currently, along with the introduction of new web technologies and surging E-commerce operations, last mile logistics has gained popularity in the Philippines, especially amongst domestic shipping companies in the country. Many distributions as well as warehousing centers in the Philippines are turning to technology and robotics to help them increase efficiency, accuracy and overall productivity in the near future. Also, the Department of Trade and Industry Philippines has introduced a National logistics master plan which aims at advancing Philippine competitiveness through the establishment of an efficient transport and logistics sector that will contribute towards a robust and resilient Philippine economy. Key Market Trends “Build, Build, Build Program” – Government Initiative The World Economic Forum ranks the Philippines 96th of 141 countries for the quality of its infrastructure. To improve the transport infrastructure. The government set up a long-term scheme to spend 9 trillion pesos ($177bn) on new infrastructure called “Build, Build, Build” program. The government is accelerating multiple infrastructure projects under “Build, Build, Build Program” and among those projects are three bus rapid transits, four seaports, six airports, nine railways and 32 roads and bridges. Moreover, as an initiative of the government to improve the transportation system in the country, there will be an implementation of the “Public Utility Vehicle Modernization Program (PUVMP).” 2.2 billion Philippine pesos has been allocated for the transport modernization plan, which will be used to provide subsidy to drivers and operators who will be buying electric jeepneys, as well as address the training for drivers. The training will serve as a refresher on the technicalities of driving, safe measures, and proper etiquette in dealing with passengers. Booming Express Delivery Market in Philippines With expanding reach of Internet, the e-commerce industry in Philippines has been on a growth spurt. About 71% (76 million) of the country’s population are internet users, and 70% of those internet users are Online shoppers. With the booming e-commerce sector, the need for efficient goods delivery is increasing. As a result, the Express Delivery market is also booming along with e-commerce in the region. Express delivery which comprises of services for documents, 44 mails, parcels and couriers at a premium price for faster delivery times has gained significant popularity amongst the Filipino population. The express delivery systems have created a door to door linkage across domestic and international markets and have developed advanced shipment tracking facilities to cater to the time sensitive needs of the logistics sector. The infrastructural growth and development in the country over the past few years has complemented the express delivery market in the country with an escalated preference of business and consumers to transport goods in shorter amount of time. The Philippines express sector majorly utilizes two modes of transportation, namely, air and road networks. In the year 2015, road express systems registered the major share of the express delivery market over air express. One of the major reasons of the lower share of air express has been the low traffic capacity and a smaller number of orders for same day delivery due to higher logistics cost relative to reasonable cost normal delivery/ courier/ parcel services. For Express Delivery Market DHL was observed as the major player in terms of revenues and was followed by FedEx. Also, a larger volume of trade has been observed to take place with the availability of international express delivery services. Competitive Landscape The competition in the Philippines freight and logistics market is highly fragmented with presence of many local and international logistics service providers. Some of the existing major players in the market include – FedEx, UPS, DHL, Yusen Logistics, XPO Logistics, Lorenzo Shipping Corporation, TNT, PHL Post, Nippon Express, 2GO Express, JRS Express and Maersk. Philippine’s logistics and warehousing market has evolved in recent years with increased trade activities in the country. Sectors such as automotive industry, electronic products, apparel and accessories, chemicals, and pharmaceuticals with their huge demand for logistics services are driving the logistics industry in the country. The latest Logistics Performance Index (LPI), an interactive benchmarking tool created by the World Bank to help countries identify the challenges and opportunities they face in their 45 performance on trade logistics and what they can do to improve their performance, ranks the Philippines 60 th out of 168 countries. The Philippines’ ranking has leaped 11 notches higher than in 2016 because of the government’s efforts to simplify government transactions with the enactment of the Ease of Doing Business Law and improve the quality of public infrastructures. LRG studies show that the Philippine Logistics Market is a thriving industry forecasted to have 8.2% to 8.8% growth rate for the period 2018 - 2024 and projected to be a Php 970 Billion to Php 1 Trillion market by 2023. LRG’s brief description of the current state of the different logistics service markets in the country allows for a better understanding of the Philippine Logistics Industry. Freight Forwarding 21.1% of the transporting storage and establishments are freight forwarding companies. Composed of the biggest chunk of transporting service in the country, this is largely dominated by road freight forwarding. Projected to continue to dominate the overall Logistics Market in the Philippines, freight forwarding is seen to grow further with the Government’s “Build Build Build” (BBB) Program. Warehouse Market Second biggest chunk for the Logistics Market is the Warehouse Market. With its strategic location, right on the edge of Pacific Ocean, the Philippines is one of the most convenient docking locations for supply routes as it essentially connects many export and import markets of different countries across the globe. Largest contributors for Warehouse Market are Industrial and Retail warehousing, as well as E-Commerce companies. Opportunities for the Logistics and Warehousing Industry The future looks promising for the country’s Logistics and Warehousing Industry given the country’s economic numbers - from its stable GDP growth; its active participation in international trade; and, the boom in specialized industries. There has also been a notable increase in consumer spending because of a rising middle class, growing outsourcing industry, and OFW remittances. 46  Due to the growing popularity of the e-commerce market which allows for geographical ease; eliminates travel time and cost; is available 24/7; and allows for feedback from customers, the country is seeing an increase particularly in sales of food and beverage, clothing apparel, and electronics, which is fueling the demand for warehouses and storage facilities expansion. Another opportunity for the Logistic and Warehousing Industry is the expansion of both local and international manufacturing companies in Metro Manila’s outskirts like Cavite, Laguna, Batangas, Bulacan and Pampanga where vast sizes of land are still available and offered at reasonable prices. Lastly, the government’s P9.2 Trillion infrastructure and transport improvement system are on the upswing. The Impact of COVID-19 on the Logistics and Warehousing Industry The sudden onset of the pandemic has essentially interrupted and unsettled social and economic activities worldwide. COVID-19 has disrupted the global supply chain and its worldwide effects on logistics has been significant. Flights and cargos are mostly cancelled or delayed, countries on Lockdown (or in Quarantine) delay all shipments, unemployment has spiked rapidly, and some shipping companies have suffered Force Majeure. But through and beyond COVID-19, LRG remains optimistic that there is a lot of room for growth in the Philippines’ Logistics and Warehousing Market. While the pandemic has altered short term growth forecasts for the Philippines’ economy and industries, LRG assumes that mid-term forecasts will remain unchanged once the COVID-19 pandemic is contained. Audit Considerations Industry Challenges: COVID 19 pandemic such as flight declines and cancellations, travel bans, maritime fallout Maximizing revenues Meeting international financial reporting standards requirements 47  Managing tax risks Managing fraud Mergers and acquisitions as facilitator of industry restructuring Opportunities in the emerging markets such as automation and blockchain Financing transport infrastructure and public private partnerships build-operate-transfer or leasing agreements. Regulatory compliance and framework such as inefficient Custom Clearance Processes and manual processes. Traffic congestions particularly in Metro Manila. Key Audit Procedures: Businesses in the transportation industry provide specialized distribution services to clients, including inbound and outbound logistics. Audit procedures systematically analyze certain elements or records of a business to ensure that quality, safety, and legal standards are consistently upheld. In the transportation industry, companies often perform audits for revenue recognition, payroll records, safety policies, equipment maintenance and legal compliance. Understanding the different audit procedures employed in this industry can help you to keep your own transportation business running efficiently, while staying on the right side of legal regulations. 1. Revenue Recognition Principles 2. Payroll Audits Transportation companies can employ a range of non-salaried employees, such as truck drivers who are paid a set rate per mile driven or employees paid on an hourly basis with overtime. Payroll audits can be especially beneficial for companies that pay hourly or on a piece-rate scale, to ensure that all employees have been paid fairly and accurately for the work they performed. Payroll audits in the transportation industry involve systematically analyzing mileage records and hourly time sheets against payment records, looking for discrepancies between earnings and actual payments. If a payroll audit finds major discrepancies, it can reveal potential errors or fraud in the accounting system. 3. Safety Policy Audits Safety is of paramount importance in the transportation industry, for legal as well as practical reasons. It can be beneficial to audit a transportation company's safety policies and 48  procedures, including vehicle inspection procedures, disaster response plans and incident report policies, to ensure that safety plans and procedures remain relevant and effective over time. Safety audits analyze all documentation related to policies and procedures, as well as combing through previously filed incident reports to ensure that policies and procedures are actually being carried out. A safety audit can compare safety plans to actual accidents and identified hazards to determine how effective a safety policy truly is in practice. 4. Physical Equipment Audits As service providers, transportation companies rely on their equipment to generate income and drive profitability. Thus, it can be beneficial to conduct physical audits of productive equipment such as trucks, trailers, refrigerated storage facilities and loading machinery. Physical audits not only ensure that all equipment on the books is present and accounted for, but they can also audit the safety, repair and usage records of each piece of equipment to prevent damage to over-used equipment. Audits can identify vehicles and equipment that may need to be replaced or taken out of use for repair. Also consider PPE impairment 5. Legal Compliance Audits Transportation companies operate in a highly regulated industry. As such, compliance audits can be an important activity to perform at least once per year. Legal compliance audits can ensure that safety policies, equipment standards, accounting records and financial reporting remain in line with state and federal mandates. Compliance audits can ensure that all vehicles maintain current emissions tests, for example, and that accounting records comply with generally accepted accounting principles. The logistics audit can be framed by asking below given basic questions to any organization. 1. Are current logistics objectives consistent with current corporate, marketing and production strategies? 2. How is the company performing with respect to customer requirements and preferences? 3. What is the true total cost of the Logistics function? And how do those costs compare with others in the same industry or market segments? 4. Is the company using its Logistics resources and capacity effectively? 5. Is the company managing its material flow effectively through the supply chain? 6. Are the information systems and technologies meeting the needs of the users, the business, and the consumers? 49  7. How should the company plan proactive measures in reducing the cost by optimizing the supply chains and by reducing the inventories? 8. How the present order cycle time is addressing the customer satisfaction as far as lead time is concerned? 9. How to optimize the manufacturing operations? 10. How can we switch over to pull process from the present push process? 11. How to develop component vendors to avoid long distance buying? 12. How to react to the competition as far as innovative distribution strategies? 13. How can one optimize the resources and reduce the administrative costs? 14. What are the areas one can look into outsourcing to reduce the cost and increase the efficiency levels? Assessments: 1. State the nature and background of the specialized industry. 2. What are the relevant statistics, and updates of the specialized industry in the Philippine setting? 3. Identify the different audit and accounting considerations and trends for the industry. 4. Look for at least 2-3 audited financial statements of companies under the specialized industry in the Philippines and list down your observations from audit report to the financial statements. 50  MODULE 6 Auditing Power, Water, and Telecommunications Industry Overview: To define briefly, the power industry covers the generation, transmission, distribution and sale of power to the general public and industry. Meanwhile, the water industry provides drinking water and wastewater services (including sewage treatment) to residential, commercial, and industrial sectors of the economy. Typically, public utilities operate water supply networks. Lastly, the telecommunication sector is made up of companies that make communication possible on a global scale, whether it is through the phone or the Internet, through airwaves or cables, through wires or wirelessly. Utilities and telecommunications are essential services that play a vital role in economic and social development. Quality utilities are a prerequisite for effective poverty eradication. Governments are ultimately responsible for ensuring reliable universal access of service under accountable regulatory frameworks. Increased competition in the utilities sectors in recent years has entailed changes in regulatory frameworks and ownership structures of enterprises, in addition to business diversification. Further, remarkable progress in telecommunications technology has had, and will continue to have, an enormous impact on telecommunications manufacturing and service industries. In particular, digital technology that integrates transmission, switching, processing, and retrieval of information provides opportunities to merge various service modes into an integrated whole. This digitalization, merging the communications and computation functions, has been made possible by dramatic advances in device and material technology, including integrated circuits and optical fibers. As the role of digital processing increases, systems and services become more intelligent and labor- saving on the one hand, and more software-intensive on the other. These industries are highly interdependent, highly regulated, and any risk imposed on its continuance will not only mean a threat to its own and related industries, but a peril to the whole economy as well. 51 Module Objectives: Know the nature and background of the particular specialized industry; Learn the overview, statistics, and updates of the specialized industry in the Philippine setting; Identify the different audit considerations and trends for the industry. Nature, Background, and Overview of Specialized Industry Power Industry The electric power industry started in the Philippines as a private sector-led industry in 1890 and remained so until the late 1960s; the government pursued rural electrification through the cooperative business model starting in 1969; the monopoly of generation by the National Power Corporation (NPC) started in 1973; and then the re-entry of private sector in the generation sector through independent owner producers (IPPs) started in 1987. Prior to the 2001 restructuring under the Electric Power Industry Reform Act (“EPIRA”), the electric power industry had a vertically integrated generation and transmission sector through the NPC and wholesale power purchases from the IPPs were predominantly through the NPC (see diagram below). Distribution utilities were local monopolies in their respective service areas. 52  On August 14, 1969, Republic Act 6038 created the National Electrification Administration (NEA) and laid the groundwork for accelerated electrification in the countryside. The law provided a framework for rural electrification through not-for-profit cooperatives as a business model and loans and technical assistance from the NEA. In 1972, then President Ferdinand Marcos imposed Martial Law and shortly thereafter, the Marcos administration seized the assets of Meralco. After almost one and a half decades of government dominance in the electric power industry, in 1986, the administration of then president Corazon Aquino reverted Meralco to private ownership. The administration then decided not to operate the Bataan Nuclear Power Plant “for reasons of safety and economy” (EO 55 s. 1986). In 1987, Aquino issued Executive Order (EO) 215 reversing the policy of granting generation monopoly to NPC and entertained proposals from independent power producers (IPPs) for build-operate-transfer (BOT) and build-own-operate (BOO) arrangements for new generating capacity. EO 215 s. 1987 amended PD 40 to specifically allow the private sector to generate electricity and categorically state that "the generation of electricity, unlike the transmission and distribution of electricity, is not a natural monopoly and can be undertaken by more than one entity." The first BOT contract for a power plant was then signed in 1989 by the NPC and Hopewell Energy Management, Ltd. To facilitate the privatization process, the EPIRA provided for the creation of the Power Sector Assets and Liabilities Management Corporation (PSALM) to take over all existing generation assets and liabilities of the NPC. PSALM was also tasked to use the revenue generated to pay the outstanding debt of the NPC. Furthermore, Executive Order No. 215 series of 1987, which allows private sector to generate electricity, classifies four types of generating plants: (1) co-generation units or the simultaneous ge