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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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