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Introduction & Basics ofInternal Audit
November 30, 2012CMII, ICAI
Real Estate
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IntroductionReal estate is an imperishable asset, ever increasing in value. It is the most solid
security that
human ingenuity has devised. It is the basis of all security and about the only
indestructible security. - Russell Sage
Real Estate sector is a large, huge diversified sector, with many verticals such as land,
design/construction, development, investment, lending etc.
India, emerging as one of the most important business locations in the world with its
favourable demographics and strong economic growth, makes it an attractive place for
property investors as the demand for property is determined mainly by businessdevelopment and demographic trends.
Of late, the nature of demand is also changing, with heightened consumer expectations
that are influenced by higher disposable incomes, increased globalization and the
introduction of innovative real-estate products and services.
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Advantage India
GrowingDemand
Demand forresidential propertyhas gone up due to
increasedurbanisation
Growing economydriving demand for
commercial and retailspace
Investment
FDI of more thanUSD9 billion in real
estate in the lastdecade
Real estate alsoemerged as the
popular sector forprivate equity (PE)
funds, whichwitnessed
investments worthUS$ 1,700 million in
the sector during2011.
Policies
Allocation of USD625million for rural
housing
FDI up to 100 percent allowed with
governmentpermission for
developing townshipsand settlements
AttractiveOpportunities
Growingrequirements of
space from sectorssuch as education
and healthcare
Growth in tourismproviding
opportunities in thehospitality sector
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Real Estate Being Driven byPolicies and growing economy
GrowthDrivers
Urbanization
GrowingEconomy
Policy Support
EasierFinancing
EpidemiologicalChanges
Growth inTourism
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Professional Opportunities InReal Estate
Advisory
Risk Based Advisory
CostConsultancy
ProcessImprovement
Feasibilitystudy
Taxation
Managementof Indirect Tax
Provisions
Managementof Direct Tax
provisions
Return filling
Registrationwith taxationauthorities
Statutory
Accounting
Statutory Audit
IFRS Accounting
Otherservices
Valuation
Draftingdocuments
Registration &Stamp duty
InvestmentFunding
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Basics Risks for RealEstate Companies
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Business process framework for real estate developer
Shareholders Government Lenders Vendors/Contractors
Lessees/ Customers Employees
Op
ao
Product Conceptualization Business Development
Capital Mobilization Financing
Strategic Alliances
Sae
S
HR Secretarial IT
Financeegalaxation
Stakeholder Management
Design Architecture Projectsand Acquisition
Sales Marketing -Residential
Revenue Billing andcollection
Contract management
Purchase
Inventory management
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Risk Category
Departments/functions addressing the risk
Risk definition
Core functions Support Functions
BusinessDevelopme
nt
Architecture
Sales &Marketi
ng
Finance IT HR
Legal
Admin
CustomerCare
Land acquisition
Title and ownership of land isnot clear/secured
x x
Title of the site being acquired/already acquired is notclear/is defective This may occur on account of
reasons such as insufficient diligence at the time ofacquisition or ATS being entered into with multipleparties by the seller or not safeguarding ownershiprecords post the acquisition of land..
Commercial & technicalfeasibility of site
x x x
The cost of acquisition of the site and construction isnot commensurate to the potential realisation fromthe developable area on the site. This may be due toacquisition of land where construction is notpermissible/feasible on account of factors such asenvironment, site, archaeological, FSI restrictionsetc. or paying a premium for the site that is not
justifiable by the market conditions. Also, where theacquisition of land is by way of shares of a landholding company, hidden liabilities andencumberances may be acquired by the Company
Delays in closure of proposalfor site acquisition
x x x xPotential loss in time for development/loss ofopportunity to acquire a site on account of delays inclosure of the purchase transaction
Risk of contracting andcontract commitments relatingto land acquisition
x x
The risk manifests itself in 3 forms:a. inability to enforce the Agreement to Sell/ jointlydevelop the land; b. the terms of the contract areprejudicial to the interests of the Company; and c.non-performance of the contractual obligations
Risks associated withcreating, managing andacquiring Special PurposeEntities for acquiring land
Compliance, taxation and diligence risks associatedwith creating, merging and maintaining landacquisition companies
Ln
Aqs
o
Risk to be primarily managed by this functionx These functions also play an active role in supporting risk management
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Risk Category
Departments/functions addressing the risk
Risk definition
Core functions Support Functions
BusinessDevelopme
nt
Architecture
Sales &Marketin
g
Finance IT HR
Legal
Admin
CustomerCare
Architecture
Product failure x xThe product being sold does not address theneed of the market resulting in unsold inventory/lower realisation from the developed area
Delays/changes in finalisingdesign
x
Delays in finalising the design/ frequent changesto design post finalisation. This may occur asthe customer needs have either changed orwere not appropriately understood etc.
High cost of
construction/ownership
High cost of construction/ownership on accountof over-design of HVAC, structural engineeringetc.
Security and safety risk ofthe building structure
Due consideration has not been paid to safetyand security of the building in the design
Outsourcing risk
Design and architecture is outsourced to 3rdparties. While outsourcing, the design teamneeds to manage several risks such as quality of
design, timely delivery of intial design & GFCdrawiings, contracting at the right price, meetingcontract commitments, adherence of the designto regulatory requirements, avoiding singlesource dependence etc.
A
heu
e
Risk to be primarily managed by this functionx These functions also play an active role in supporting risk management
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Risk Category
Departments/functions addressing the risk
Risk definition
Core functions Support Functions
BusinessDevelopme
nt
Architecture
Sales &Marketin
g
Finance IT HR
Legal
Admin
CustomerCare
Legal & compliance
Regulatory Non-compliance x x x x x x
Non-compliance with applicable laws andregulations. This risk manifests itself differently
for different functions - for instance, architectureneeds to comply with building bye-laws, whereas finance with revenue laws.
Litigation
Risk of litigation is not effectively tackled - eitherthrough an effective strategy or itsimplementation. Litigation may arise inacquisition of land, suits with outsourcedcontractors, customers etc.
Hazards
Natural hazard andcalamity
Business interruptionInability to service customers on account ofdisruptions caused by catastrophic loss/ loss ofrecords/ loss of information
Risks associated with crisismanagement
Lack of sensitivity of the top level management /affected functions to initiate a timely response toa crisis. Inadequate handling of the situationvis--vis public, government agencies, newsmedia, shareholders, and other affectedexternal parties in case of a crisis situation.
Information
Breach of informationsecurity Loss of confidential information
Information availability andInfrastructure
Non-availability of information systems tosupport management decisions
L
Ha
d
nomao
Risk to be primarily managed by this functionx These functions also play an active role in supporting risk management
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Risk Category
Departments/functions addressing the risk
Risk definitionCore functions Support Functions
BusinessDevelopme
nt
Architecture
Sales &Marketin
g
Finance IT HR
Legal
Admin
CustomerCare
B. Financial
Liquidity riskInability to meet cash flow obligations in a timelyand cost-effective manner
Capital non-availabilityInsufficient access to capital threatens theverical's capacity to grow, execute its businessmodel and generate future financial returns.
Insurance risk
Assets of the Company are not adequatelyinsured and/ a high premium is being paid.
Also, the Company may not have takenadequate cover for different risks that it may be
exposed to
Mis-statement inaccounting, reporting anddisclosures
Mis-statement in financial reporting anddisclosures
Ineffective tax strategy andplanning
The taxation strategy is not effectivelyarticulated and executed to avail the lawfuladvantages provided by the fiscal regime
Tax non-compliance Non-compliance with the revenue laws of theState
Fnna
Risk to be primarily managed by this functionx These functions also play an active role in supporting risk management
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Risk Category
Departments/functions addressing the risk
Risk definition
Core functions Support Functions
BusinessDevelopme
nt
Architecture
Sales &Marketin
g
Finance IT HR
Legal
Admin
CustomerCare
D. Strategic
Budgeting & Forecasting x x xUnrealistic targets are set in the business plan/inability to meet the targets set forth for thedivision
JVs/Alliances Partnershipsand Alliance Management
x x
The Company has not exploited strategicpartnerships and alliances or the alliancesentered into are not in the best interests of theCompany
CompetitionRisk of effectively tackling local and nationalplayers as the XYZ brand expands beyond the area.
Changes in demand profile Changes in customer demands and trendsmake the product offering obsolete
Socio-Political risksChanges in the economic policies of theGovernment and risks arising out of politicalinstability in the country that may affect demand
Interest rate risk
Increase in interest rates may impact the
borrowing capacity/ repayment capacity ofcustomers resulting in dampening of demand orcredit defaults
Over-capacity Excess supply in commercial real estate maydampen the business potential for the division
Saec
Risk to be primarily managed by this functionx These functions also play an active role in supporting risk management
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Internal audit objective andworkflow
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Internal audit objective Processes and controls are designed to:
Address key businessrisks Create operationalefficiencies, reduce costsand plug leakages
Ensure regulatorycompliance
Technology is effectively deployed to support business processes & information flows
Timely and accurate information is available for management oversight and decision making
Assurance that people follow the ruleslaid down for the business
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ProtocolSetting
Risk Assessment Audit planpreparation
Agree on protocols,execution andreporting templates
Identify the key risks tobe addressed in theaudit
Identify the type of audits,locations to be auditedand the key focus areas
Auditinitiation
Auditfieldwork
Audit reporting
Initiate contactwith auditee,validate the scopeand introduceaudit procedures
Identify controlweaknesses, if anyand recommendimprovement plans
Report on auditobservations andagreedrecommendations
Managementpresentation
Results tracker
Log of observationsand recommendationsacross locations
Recommend-ation status
Track implementation ofrecommendations
1. Audit Planning
2. Audit execution and reporting
3. Recommendation follow up
Internal audit workflow
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Questions
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