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
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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
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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
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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.
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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.
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Recent Issuances
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Audit Considerations
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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.
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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.
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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
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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.
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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 frontoffice 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.
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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
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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 -
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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:
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•
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 workfrom-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-fromhome setup.
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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
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•
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.
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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.
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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.
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Figure 2
Life cycle of
mining
Exploration
Project
development
Mining and milling
Abandoned mine /
rehabilitation
Mine closure
Smelting and refining (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
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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.
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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.
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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 workfrom-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 worldwide 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)).
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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,
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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
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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.
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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
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•
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
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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?
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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.
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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 laborsaving 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.
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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.
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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 generation of both electricity and heat from the same fuel, (2) electric
generating plants intending to sell their production to the grids, (3) electric generating plants intended
primarily for the internal use of the owner, and (4) electric generating plants outside the NPC grids.
The latest EPIRA status report released by the Department of Energy (DOE), which covers
November 2014 to April 2015 period, highlights the privatization of the remaining generation assets,
particularly the Power Barges (PBs) 101-104 as well as the transfer of contract to an Independent
Power Producer Administrator (IPPA) of Unified Leyte Geothermal Power Plant (ULGPP) for the
Bulk Energy. As of June 2015 4, the privatization level of NPC generating facilities has reached
89.7%, following the successful bid of Naga Power Plant Complex in March 2014. Meanwhile, the
proposed closing and turn-over schedule of Angat Hydro-electric Power Plant to Korean Water
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Resources, Inc. was officially done in October of the same year. Another entity established by the
EPIRA is the Energy Regulatory Commission (ERC). Its main task is to promote competition,
encourage market development, and enforce regulations in the newly restructured market. This is
because, contrary to PD 40, power generation under the EPIRA was not considered a public utility
operation, as stated in Section 6 of RA 9136 otherwise known as EPIRA Act of 2001. This made the
generation sector of the industry competitive and opens to other players in the market. Under the
EPIRA, any person or entity engaged in generation and supply shall not be required to apply for a
national franchise; provided that it secures a certificate of compliance from the ERC. Thus, the
industry changed in tranches and was restructured as illustrated by the diagram below.
To briefly discuss the phases the power industry’s supply chain:
1. Power Generation - Power generation in the Philippines is not considered as a public
utility operation, which means interested parties do not need to secure a congressional
franchise to operate a power generation company. However, power generation is
regulated by the Energy Regulatory Commission (ERC) who must issue a certificate
of compliance to interested parties to ensure that the standards set forth in the Electric
Power Industry Reform Act of 2001 (EPIRA) are followed. The ERC is also responsible
for determining any power abuse or anti-competitive behavior. Electricity in the
Philippines is produced from various sources such as coal, oil, natural gas, biomass,
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hydroelectric, solar, wind, and geothermal sources. The allocation of electricity
production can be seen in the table below.
Types of source of energy are enumerated below:
a. Conventional sources – coal, gas, oil, hydropower, and nuclear power; and
b. Non-conventional sources – solar, wind, biogas (from organic wastes), and bagasse
(byproduct of sugarcane).
2. Power Transmission – this is a common carrier business (i.e. regulated by the
government, serves its franchise area without discrimination, responsible for any losses
incurred during delivery). It is regulated by the ERC who has rate-making powers and the
final say in the valuation of transmission assets. Pursuant to the Electric Power Industry
Reform Act (EPIRA) and the Transmission Development Plan or TDP, maintenance and
operations of the nationwide transmission system was subjected to competitive public
bidding conducted by the Power Sector Assets and Liabilities Management (PSALM).
The National Grid Corporation of the Philippines (NGCP) was the highest bidder. It
assumed control of the national transmission system from the National Transmission
Corporation (TransCo), whom assumed the same function from the now defunct National
Power Corporation (by way of RA 9511 enacting congressional franchise for a total of 50
years).
a. The National Grid Corporation of the Philippines (NGCP) is the transmission
system operator for three grids constituting the Philippine grid and as a franchise
holder, it is in charge of operating, maintaining, and developing the country's
state-owned power grid. The Philippine transmission system is composed of
three grids, the Luzon Grid, Visayas Grid, and Mindanao Grid. One
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characteristic of the grids is that most bulk generation sites are found far from
the load centers, necessitating use of long-distance transmission lines.
b. Functions:
i. Operations and Maintenance - NGCP's task is to ensure that the country's
transmission assets are in optimal condition to convey safe, quality, and
reliable electricity.
ii. System Operations - NGCP acts as System Operator that balances the
supply and demand of power to maintain the quality of electricity that flows
through the grid.
iii. Planning and Engineering - NGCP ensures that the grid is prepared
whenever new plants come online and when the demand for power in a
certain area increases by anticipating these scenarios and constructing
new facilities.
3. Power distribution - The circulation of electricity to end-users is a controlled common
carrier business requiring a national franchise. The power to grant national franchises is
exclusively vested to the Congress of the Philippines. Distribution of electric power to all
end-users or consumers of electricity may be handled by private distribution utilities,
cooperatives, local government units presently undertaking this function and other duly
authorized entities, under the regulation of the ERC.
A distribution utility has the task to provide distribution services and connections to its
system for any end-user within its franchise area, as there are different distribution utilities
available for different areas, consistent with the distribution code. They are required to
provide open and non-discriminatory access to its distribution system to all users.
Retail rates charged by distribution utilities are subject to regulation of the ERC under the
principle of full recovery, that is, distribution utilities subdivide their retail rate into two
distinct categories, namely pass through charges and wheeling charges. Pass through
charge follows the principle of full economic recovery where a distribution utility may pass
on all the charges it incurred in the distribution of power such as the price of the power,
transmission charge, systems loss charge, etc. to its customers. The wheeling charge is
an additional premium charged to the customer akin to a mark-up on the cost of power
acquired by the distribution utility. The wheeling charge follows the principle of
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reasonable return on base (RORB) which allows the distribution utility to operate viably
as determined by the ERC.
a. Electric Cooperatives (“ECs”) are entities owned by the member-consumers
within the vicinity covered by the said entity. These are controlled by a Board of
Directors elected by member-consumers and their management and operations
supervised by the National Electrification Administration.
b. Private Distribution Utilities (“PDUs”) are electric distribution companies that are
owned by private entities. As of 2018, if ranked based on output, the main
distribution utilities across the country include the following Private Distribution
Utilities (“PDUs”):
The Manila Electric Company (“MERALCO”), the largest electric distribution
utility in the Philippines, has the 24th highest weighted average retail tariffs
among 46 countries. As compared to its neighboring countries, Philippines has
higher electricity costs due to:
1. Lack of Subsidies; and
2. High Intrinsic Cost of Supply and Transmission due to:
a. Dependence on expensive imported fossil fuel for generating electricity and
no tax or tariff relief given for fuel imports used for power generation;
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b. Relatively low generating capacity of the Philippines. The current supply of
electricity is forecasted to be overtaken by the demand of the country;
c. Relatively small and fragmented grid size result into transmission losses, no
economies of scale, and inefficient operations; and
d. As an archipelago, there are geographic challenges of transmission. The
Philippines relies on submarine cables to interconnect the islands.
c. Municipality Unit (“MUs") are entities that are owned by the local government.
The local government officials, who are elected by the end-users within the
municipality, regulates, controls, and manages the utilities.
Water Utility Industry
The Philippines’ water supply system dates back to 1946, after the country declared
independence. The main components of water resources management in the Philippines are vested
in the mandates of the various government agencies that undertake most of the water resources
programs and projects in the country. There are more than thirty such agencies and offices, each
dealing with a particular aspect of water resources development. Thus, there are separate agencies
dealing mainly with each of the sectors of water supply, irrigation, hydropower, flood control,
pollution, watershed management, etc.
Under this setting, the National Water Resources Board (NWRB) was created in 1974 as the
authoritative national organization to coordinate and integrate all activities in water resources
development and management. Its main objective is to achieve scientific and orderly development
and management of all the water resources of the Philippines consistent with the principles of
optimum usage, conservation and protection to meet present and future needs.
Fragmentation among water-related agencies is evident in three areas of concern: water
supply and distribution, economic and resource regulation, and planning and policy formulation.
The following agencies are involved in water supply and distribution:
•
the Metropolitan Waterworks and Sewerage Services (MWSS) and its two
concessionaires (after it was privatized in 1997) for Metro Manila, servicing 62.68
percent of its total population;
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•
the Local Water Utilities Administration (LWUA) and its water district offices for other
cities and municipalities, servicing 58 percent of the total urban population within its
area of responsibility; and
•
the departments of Interior and Local Government (DILG) and Public Works and
Highway (DPWH) and local governments which manage community water systems.
The water infrastructure provided is classified into three levels:
1. Level I – Stand-alone water points (e.g. handpumps, shallow wells, rainwater
collectors) serving an average of 15 households within a 250-meter distance;
2. Level II - Piped water with a communal water point (e.g. borewell, spring system)
serving an average of 4–6 households within a 25-meter distance;
3. Level III - Piped water supply with a private water point (e.g. house connection)
based on daily water demand of more than 100 liters per person
Service providers for this sector are also listed down below, by which different tariff
structures and levels according to the respective management model are imposed.
1. Local Government Units
2. Water Districts
3. Large-scale private operators
4. Small-scale independent providers
Common water sources and water treatment plants for this industry includes but not limited
to the following:
1. Water Sources
a. Angat Dam
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b. Ipo Dam
c. La Mesa Dam
2. Water Treatment Plants - Raw water undergoes several treatment processes before
it passes the standards for potable water. Conventional water treatment consists of
the following processes: coagulation/flocculation, sedimentation, filtration and
disinfection/chlorination.
a. Balara treatment plant
b. East La Mesa treatment plant
c. Cardona treatment plant
To ensure that the water delivered to the customers satisfies regulatory standards on quality,
the Company’s Laboratory Services Department processes an average of around 900 water
samples from the distribution network per month. The samples are collected on a regular basis from
strategically located sampling points all over the East Zone. This number of sampling points
surpasses the regulatory requirement and all results of the sampling have been consistently 100%
compliant with the Philippine National Standards for Drinking Water (PNSDW), five percent above
the requirement.
After distribution and of water, the waste water (used water basically) will undergo sewerage.
Sewerage services include the operation and maintenance of networks of sewer pipelines that
collect and convey sewage to a Sewage Treatment Plant (STP) which then clean the wastewater
before safely returning it to our water bodies. Through a variety of mechanisms and processes, these
treatment plants produce treated wastewater safe enough for re-use or discharge to receiving bodies
of water.
Telecommunications Industry
The industry was deregulated in 1995 when President Fidel Ramos signed Republic Act
7925 (The Public Telecommunications Policy Act of the Philippines). This law opened the sector to
more private players and improved the provision of telecom services are better and fairer rates. The
industry was deregulated in 1995, leading to the creation of many telecommunication service
providers for mobile, fixed-line, Internet and other services.
Some of the regulatory frameworks relative to this industry are listed below:
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•
Republic Act No. 3846, An act providing for the regulation of radio stations and radio
communications in the Philippine Islands, and for other purposes.
•
Republic Act No. 6849, An act providing for the installation, operation and maintenance of
public telephones in each and every municipality in the Philippines, appropriating funds
therefor and for other purposes.
•
Republic Act No. 7925, An act to promote and govern the development of Philippine
telecommunications and the delivery of public telecommunications services.
•
Republic Act No. 10844, An act creating the Department of Information and Communications
Technology (DICT), defining its powers and functions appropriating funds thereof, and for
other purposes.
The surge of digital users in the Philippines has been on the rise in recent years. Time spent
on the internet by Filipinos, which was the highest among other Asian countries, led to more
demands for improving fixed broadband services from the country's internet service providers
despite its growth in numbers. The lack of dependable broadband connections in the Philippines
able to provide higher internet speed, halts better user experience, resulting to one of the lowest
fixed subscription growths among the Asia-Pacific region in 2018.
Despite several telecommunication service providers, the Philippines telecommunications
industry has long been dominated by legacy players Philippine Long-Distance Telephone Company
(PLDT) and Globe Telecom.
All players are expected to upgrade their network capabilities, install fiber-optic and sub-sea
systems and cables, purchase modern networking equipment/storage/servers, and utilize cloud and
cybersecurity services. As disruptive as this industry can get, its key players are striving to catch up
with each of the industries market segments’ new technologies.
1. Mobile Market with 126 million subscribers as of 2016;
2. Broadband Market
a. Wi-Max
b. Wi-Fi
3. Fixed Line Market
a. Fixed Line Voice
b. Fixed Line Data Market
4. International Long Distance Market
5. Hybrids
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Updates & Statistics of the Specialized Industry in the Philippines
Power Industry
As of 2021, the cost of
electricity produced for coal
amount to PHP 4.18/KWh. The
cost is primarily comprised of
fuel and capital recovery costs.
The effect of variable and O&M
costs are low. Based on ERC
rate cases that were found,
geothermal energy was found
to have the lowest cost of
electricity per KWh at PHP4.07/KWh, this pertains to the BACMAN geothermal plant in Pampanga
with the rate case application filed as of 2018. For the top ranking Private Distribution Utilities per
grid, see Private Distribution Utilities section.
Water Utility Industry
The leading companies on this industry are ranked below in terms of revenue and size:
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Telecommunications Industry
According to Statista, the following are the fastest internet providers as of June 2020.
Despite this, PLDT and Globe Telecom, remained at the top spot with a 2020 CAPEX that is
above $ 1 billion. Meanwhile, a new ISP, Dito plans aims to spend $5 billion on the rollout of its
services in the next 5 years. All players are price sensitive and do have a bias of purchasing
equipment from China.
Key Market Trends
1. The Impact of COVID-19 on the Power, Water, and Telecommunications Industry
With the prevalent economic impact of the pandemic, the power industry is expected to have
a decline in energy demand, coal utilization in the spot market, collection efficiencies of Electric
Cooperatives, and delays in renewable energy projects. Nonetheless, the global telecom market
has shown substantial growth over 2015-2021 not only due to the adoption of advanced
infrastructures, but also as the global need for stable internet connection arose along with the
remote work setup during the pandemic.
2. Alternative Sources of Energy
a. The conventional thermal power segment held a significant market share in 2018, and it is
likely to dominate the market in the forecast period.
b. The Philippines government has planned to phase out its coal usage by 2040 and focus
more on energy production from natural gas and renewable. This, in turn, is expected to
create several opportunities for the power generation EPC companies in the near future.
c. The upcoming and ongoing projects of power plants are likely to drive the power EPC
generation market in the Philippines, during the forecast period.
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3. Internet of Things (IoT) - The utility industry has been witnessing a revolution of sorts thanks to
the Internet of Things (IoT). IoT, which connects previously ‘mute’ objects to the internet,
empowers consumers to be in control of the utilities they use. Yes, they can heat their homes,
switch on their lights and fill their bath tubs remotely with a few clicks from a device. More
importantly, it also allows consumers to monitor and manage the amount of the earth’s resources
they use.
a. Forging Partnerships - To offer subscribers convenience – and to secure new revenue
streams – mobile operators have forged innovative partnerships. Smart metering based on
M2M (Machine to Machine) technology is effectively distributing and managing the
electricity supply, i.e. Kuryente Load, a prepaid electricity service by MERALCO. Forming
strategic partnerships with telecoms operators is a win-win. It strengthens the proposition
for both companies and allows both organizations to maximize the IoT potential.
b. Mediation: Mobile operators use robust mediation solutions to manage and monitor multiple
devices that are online 24/7/365. With the advent of IoT, utility companies will similarly have
intelligent – smart – meters and multiple “always connected” devices. Telecoms mediation
solutions can effectively integrate and manage these devices for utility companies for
smarter billing.
4. New business models - Some companies in the mobile industry have launched Mobile Virtual
Network Operators (MVNOs). That is when a company sells mobile phone services by making
use of another telco’s existing network infrastructure. As telcos look to collaborate, utility-based
MVNOs may not be a far-fetched idea. The technology being utilized within the
telecommunications industry to manage subscriber databases, the HLR (Home Location
Register), can also be used by utility companies.
5. Seamless online billing - Mobile operators have deployed real-time Online Charging Systems
(OCS) to make it easy for subscribers to pay their bills. Prepaid vouchers can be purchased over
the counter and credit can be added almost instantaneously. Utility companies should look to
introduce such schemes that can add energy or water credit. The technology available in
telecoms can be adapted to match specific serial numbers to smart meters for seamless ‘topping
up’. This could be an effective solution for utility companies who have to extend their grids to
areas where post-paid billing is not an option.
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6. Integrated water systems - In October 2011, a bill (commonly referred to as “the Angara bill”
after its proponent) was filed with Congress, that sought to adopt the integrated water resources
management (IWRM) approach to water supply management by dividing the country into
provincial water resource zones, within which all water utilities would be synergized and
integrated.
7. Mobile banking - Internet banking allowed customers to accomplish transactions through
computers and the Internet. It was at this point that banks started to veer away from their
traditional bricks and mortar operations, integrating both online and offline operations into their
physical presence.
Audit Considerations
Industry Challenges:
•
COVID 19 pandemic such as decline in energy demand, coal utilization in the spot market,
collection efficiencies of Electric Cooperatives, and delays in renewable energy projects.
•
Increasing public concerns on increasing rates and billings
•
New power generation technologies, aging infrastructure
•
Impact of climate change and shifting dynamics
•
Managing regulatory risks
•
Managing fraud
•
Uncontrollable risks such as shortage of natural gas
•
Land acquisitions
•
Tariffs – as of June 2020, power tariffs in the Philippines are among the highest in Asia.
•
Disclosures on industry and regulatory framework changes, rate regulations, statement of
compliance, significant judgments, accounting estimates & assumptions, segment
information, utility plant and its movements, acquisitions, and other matters.
o
On September 11, 2020, President Duterte signed into law Republic Act No. 11494,
the Bayanihan to Recover as One Act (“Bayanihan 2”) which serves as the
government’s second coronavirus pandemic relief measure. In an Advisory dated
September 23, 2020, the DOE directed power sector entities to observe the grace
period and staggered payment for unpaid bills provided under the Bayanihan 2.
o
In an Advisory dated February 5, 2021, the DOE directed all distribution utilities to
implement a non-disconnection policy due to non-payment of bills for all electricity
65
consumer whose consumption levels are within the lifeline rate set by the ERC. The
policy shall apply to all unpaid regular bills and installment payments relative to
various advisories of DOE and ERC.
•
For water utility industries, Non-revenue water (NRW) is defined as the difference between
the amount of water put into the distribution system and the amount of water billed to
consumers. It is usually used as an indicator for water utility performance. High levels of nonrevenue water usually indicate low-quality water utility. It has three components:
o
Physical losses, which consist of leakage from the system caused by poor operations
and maintenance, the lack of active leakage control, and poor quality of underground
assets.
o
Commercial losses, caused by under-registration of water meters, errors in data
handling, and theft.
o
Unbilled authorized consumption, which includes water used by a specific utility for
operational purposes (e.g. firefighting and specific consumer groups).
•
Environmental concerns and institutional fragmentation - More than 30 different agencies in
the Philippines have some role in water resources and water supply and sanitation, but there
is currently no single department or body with overall responsibility for sector policy and
coordination, or for overseeing implementation of sector reforms, especially outside Metro
Manila.
•
For telco companies, inability to contain and reduce costs poses a risk with revenues from
legacy services remaining either static or falling and the revenue potential of new services
uncertain, many operators need to cut costs.
•
Both a challenge and an opportunity, risk on disruption of blockchain technology can be
counted as one of the industry challenges as well. Interest in the technology continues to
grow, resulting from its potential to overhaul business models while improving processes
such as roaming and identity management. As more telco companies experiment with
blockchain applications, it’s apparent that many value-added opportunities exist.
Key Audit Procedures:
1. Revenue Recognition Principles and Test of Reasonableness
a. For power industry, distribution retail rate components, as proper billing is the key
aspect in distribution.
66
b. For water industry, the water billing components:
i. Basic charge - this covers the cost of operating, maintaining, improving and
expanding the distribution network, as well as the facilities responsible for
bringing potable water to the end-user. The Basic Charge is based on the
latest approved tariff schedule.
ii. Foreign Currency Different Adjustment (FCDA) - this is a percentage of the
basic charge which accounts for fluctuations of the Philippine Peso against
other countries' currencies subject to periodic review and adjustment. The
FCDA for the second quarter of 2015 is 0.18% of the Basic Charge.
iii. Environmental Charge - this is for the mitigation of environmental impacts in
the course of water and wastewater operation. It is 20% of the Basic Charge
applicable to all customers.
iv. Sewer Charge - 0% of the Basic Charge is added for Residential and SemiBusiness customers with a sewer line connection. 30% of Basic Charge, on
the other hand, is charged for Commercial and Industrial customers.
v. Maintenance Service Charge - this covers the maintenance of the water
meter. The charge changes depending on the size of the water meter. The
minimum charge is 1.50 Philippine pesos for a 13mm-sized meter.
vi. Other charges such as VAT, prior billings, etc.
67
c. Tax Incentives;
d. Carbon credit-related income - Carbon credit, also known as emission permit, allows
the holder to emit a specified amount of greenhouse gases. One carbon credit is
equivalent to one ton of carbon dioxide. The features of carbon credits do vary such
that the terms and conditions attached to them often result in a broad range of
accounting issues. The revenue from carbon credits is calculated by the amount of
carbon emission that would have been emitted had fossil fuel or other polluting power
generator been used to produce the same MW of power. One of the methods to
calculate the carbon reduction emission may be based on the generation-weighted
average emission factor of all facilities generating RE, multiplied by the amount of
electricity generated by the company’s wind power plant during the year. Revenue
from the sale of carbon credits can be recognized on an accrual basis when
verification and certification processes have been completed. More importantly, the
important criteria of PAS 18, Revenue, should have been met, namely: that the
economic benefits associated with the transaction will flow to the company and such
economic benefits can be estimated reliably. Since diverse accounting practices are
applied, management’s judgment plays a crucial role in determining the appropriate
treatment of assets, revenue and expenses of wind power companies. (Loyola, n.d.)
2. Property, Plant, and Equipment – PPE usually comprise the biggest asset account on the
balance sheet of most plant owners and project developers, since most aspects of the wind
power industry are capital intensive. Depreciation of wind turbines and sale of electricity
during the commissioning period are also important areas to consider. If any of the wind
turbines is individually capable of generating power, depreciation should start even if other
wind turbines are still under construction.
3. Cost-recovery - the operation ratio (O) of a certain water service provider reflects its costrecovery situation, where O is the operation cost, C is the total annual cost, and R is the
annual revenue. An operation ratio under 1 means that revenues cover the costs of operation
and maintenance. In a study last 2004, only 5 out of 45 had an operating ratio of more than
1, reflecting a poor operation ratio among the majority of the participating utilities. All the lossmaking providers were operated directly by LGUs and were mostly characterized by a high
share of non-revenue water, poor service continuity, low tariffs, and low coverage within their
respective service areas.
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4. Safety Auditing through workplace inspections, employee safety perception surveys, and
work/behavioral observations
a. Safety Management Audits - The Safety Management Audit goes beyond regulatory
compliance and assesses the safety programs the organization has in place to
sustain or improve the current level of performance. The Safety Management Audit
assesses more than the mere existence of safety policies and programs. The audit
examines the quality and effectiveness of the activities to provide a thorough
evaluation of the state of safety management in the company.
5. Operational Audits
a. Generation Phase
i. Installed capacity and capacity utilization
ii. Plant load factor
iii. Planned outage
iv. Forced outage
v. Reserve outage
vi. Loss due to backing down – due grid failure, shortage of raw materials or
reduced demand from consumers
vii. Plant availability
viii. Calorific value of fuel – amount of heat released with the burning of coal
ix. Station heat rate
x. Power quantity reconciliation
xi. Fuel supply agreement
xii. Man-power deployment
xiii. Stacking loss
b. Transmission
i. Operational performance
ii. Voltage management
iii. Transmission losses
iv. Tariff determination
v. Grid management
vi. Material management
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c. Distribution
i. Aggregate technical and commercial losses
ii. Transformer and its installed capacity
iii. Repairs and maintenance of distribution transformer
iv. Power factor (ratio between real power to do the actual work and the apparent
power supplied by circuit) and capacitor bank (develops the power factor by
regulating the current flow.
v. Tariff fixation
6. Regulatory Compliance Audits
a. Assess the applicable safety regulations, as well as the more significant national
safety standards and codes that apply to the operations.
b. Assess the level of compliance of the operations to the safety regulations, standards
and codes.
c. Include field verification samplings of operating centers.
d. Acknowledge the organization’s activities that meet the regulatory requirements.
e. Identify non-compliance issues that need to be addressed.
f.
Assist in a due diligence defense in case of a serious accident.
7. Other considerations:
a. Fuel accounting;
b. Cost Centers
i. Boiler
ii. Turbine & Generator
iii. Cost Handling Plant
iv. Demineralization Plant
v. Hydrogen-generating Plant
vi. Fuel Oil Handling Plant
vii. Ash Handling Plant
viii. Maintenance Costs
ix. Instrumentation Control
c. Inventory costing method and wastage
d. Insurance;
e. High debt-to-equity ratio as a risk factor.
70
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 one audited financial statements of companies under each specialized industry
(Power, Water, and Telecommunications) in the Philippines and list down your observations from
audit report to the financial statements.
71
MODULE 7
Auditing Not-for-Profit Entities and Hospitals
Overview:
Not-for-profit organizations are types of entities that do not earn profits for its owners. All of
the money earned by or donated to a not-for-profit organization is used in pursuing the organization's
objectives and keeping it running. These organizations play a vital role in building healthy
communities by providing critical services that contribute to economic stability and mobility. They
also strengthen communities in a variety of important ways.
On the other hand, according to the World Health Organization (“WHO”), a healthcare system
consists of all organizations, people and actions whose primary interest is to promote, restore, or
maintain health. It includes efforts to influence determinants of health as well as more direct healthimproving activities which encompasses the pyramid of publicly owned facilities that deliver personal
services. The goal of a healthcare system, such as a hospital, is to improve health and health equity
through ways that are responsive, financially fair, and best or most efficient use of available
resources, while achieving intermediate goals such as greater access to and coverage for effective
health interventions and making sure that provider quality and safety are not compromised.
As many countries experienced economic downturns and threats to public safety due to
pandemic outbreaks and emerging infection diseases, many realized the growing importance of
NPOs and healthcare – now more than ever, improving the health of a nation’s citizens can directly
result in economic growth, as there will be more people able to conduct effective activities in the
workforce.
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.
72
Nature, Background, and Overview of Specialized Industry
The Philippine healthcare delivery system is a complex set of organizations interacting to provide an
array of health services. It is composed of the following tranches:
•
Public - a largely financed through tax–based system with a decentralized management system
at national and local level, providing for social health insurance of the general public.
a. National: Department of Health (“DOH”) - Specialty, retained and regional hospitals,
medical centers, DOH representatives.
b. Local: Local Government Units (“LGUs”) - Provincial and district hospitals, regional health
units, barangay health stations.
•
Private - a largely market–oriented fragmented system of profit and non-profit providers where
fees are paid at the point of service.
a. Profit: Commercial, market-oriented, and includes private practitioners, private clinics and
laboratories
b. Non-profit: Non-commercial, service-oriented, and composed of socio-civic groups,
religious organizations, or foundations
The WHO health systems framework proposes six building blocks that, when taken together, (a)
gives a picture of the state of health care system in a country, and (b) help achieve the intended
goals and outcomes. The discussion will use this framework as an outline in discussing the country’s
healthcare system overview.
73
DOH serves as the representation of leadership & governance in this industry. It is mandated
by the law to provide national policy direction and develop national plans, technical standards and
guidelines of health. It also provides technical assistance, capacity building, and advisory services
for disease prevention and control, as well as supplies medicines and vaccines to its scope. As the
lead agency for the Philippine health care (EO 119), its mission is to ensure accessibility and quality
of health care to improve quality of life of all Filipinos, especially the poor, aiming to produce better
health outcomes, more responsive health systems, and more equitable healthcare financing. The
below diagram shows the branches and scope of DOH.
In the Philippines, LGUs are responsible for providing basic services (including health
services) to its subjects as per Republic Act 7160 (Local Government Code of 1991). The delivery
and management of health services will come from DOH to locally elected provincial, city, and
municipal governments. This includes four essential health system functions:
1. Service provision;
2. Resource generation;
3. Financing; and
4. Stewardship.
These services are classified into (1) clinical services for in-patients and (2) ancillary services, which
are furthered classified into three levels, as shown on the next page.
74
As just important as leadership and governance, healthcare financing also plays a pivotal
role in the success of the healthcare industry. It encompasses effective allocation of finite financial
resources to different types of public and personal health services and pooling financial resources
across population groups and sharing financial risks. The goal of this area is to:
1. Raise adequate funds for health to ensure that people get to use needed services; and
2. Make people who use health services are shielded from financial catastrophe or impoverishment
associated with having to pay for them.
Based on 2012 statistics, the main fund sources for this industry are the government, social
health insurance, private sources (OOP, HMOs, life insurances, etc.), and grants. Notably, there is
a very high proportion of out-of-pocket (“OOP”) spending
and Filipino households continue to bear the heaviest
burden at 57.6% OOP. Upon provision of funding, the
healthcare workforce shall be sufficiently established with
the right mix of staff, system-wide deployment and
distribution (equitable), established job-related norms,
enabled
work
environments,
and
just
compensation/payment systems. There are known
geographic disparity in the availability of public health
workers: (1) Doctors to the Barrios (DTTB); (2) Nurses
Deployment Program (NDP); and (3) Rural Health Midwife
Placement Program (RHMPP).
Currently, the workforce is hospital-centric. Midwives
compose the majority of employees at 91% (public), then
nurses (61% on private sector), medical technologists (53% in public sector), and doctors (50% in
both sectors). Only 30% of the entire healthcare workforce are in the public sector causing a market-
75
oriented brain drain phenomenon, while newly licensed nurses are unable to find employment and
there is underproduction in other medical professions, i.e. doctors, dentists, med-technologists, etc.
Meanwhile, on the access to medicine and technology, the country has a supply-driven distribution
scheme through drugstores (80.1% of supply), hospitals (9.7%), and other distributors (10.2%) such
as government agencies (0.3%). There is a lax regulation on strong pharmaceutical/nutraceutical
companies’ lobbying influence and market-orientation is strong. Generics Act of 1988 is in force but
compliance to it still needs to push further. Health information and research is no exception to the
areas for development in the healthcare industry.
Service delivery is the most visible function of any health system of which the ultimate aim is to
maintain equity in health outcomes. In the public sector, as this is financed through taxes, budgeting
is performed at the local and national level. In that case, service should be free for the citizens at
the point of care. Meanwhile, in the private sector, there are both profit and non-profit providers. It is
market-driven and there are OOP schemes, insurance/HMO element, and may be funded externally
or through grants. The diagram to the left shows the standard hospital processes and service
delivery that is visible to the patient/public.
76
For a technologically-enhanced healthcare system, IBM provides the above operations map
for healthcare institutions, as applicable.
Updates & Statistics of the Specialized Industry in the Philippines
As of December 2019, there are around 843 private hospitals in the Philippines and 429 public
hospitals, totaling to 1,272 hospitals nationwide. Shown below are the distribution of service
providers per region.
77
Among these figures, there are 13 known specialty hospitals in NCR as listed below.
1. Government specialty hospitals
a. Dr Jose Fabella Memorial Hospital
b. Lung Center of the Philippines
c. National Center for Mental Health
d. National Children’s Hospital
e. National Kidney and Transplant Institute
f.
Philippine Children’s Medical Center
g. Philippine Heart Center
h. Research Institute for Tropical Medicince
i.
San Lazaro Hospital
2. Private specialty hospitals
a. Quezon Institute
b. St Christiana Hospital
c. Urology Center of the Philippines
d. VT Maternity Hospital
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As of 2012, these institutions are dominantly funded through private sources at P325.5 billion
– see table below. According to World Bank, 4.6% of the Philippine GDP is attributable to healthcare
industry, but global average is at 10.2%.
In 2020, the household final consumption expenditure for health in the Philippines was valued
at approximately 548 billion Philippine pesos. The household spending on health has increased
overall and was highest in 2020.
The majority of funding for universal healthcare comes from the DOH and PhilHealth
budgets, the former of which has fluctuated in the last half decade. The department’s total budget
jumped from P87bn ($1.73bn) in 2015 to P112.3bn ($2.23bn) in 2016, but then fell to P95.3bn
($1.90bn) in 2017. Funding recovered to P106.1bn ($2.11bn) in 2018, before dipping once again to
P97.7bn ($1.94bn) in 2019 and recovering slightly to reach P100.6bn ($2.00bn) in 2020. The 2020
figure accounted for 2.5% of the entire federal budget and some 0.5% of GDP. PhilHealth, for its
part, saw a budget of P71.4bn ($1.4bn) for the year, on par with 2019. In light of the Covid-19
pandemic, the federal budget for 2021 – approved in December 2020 – raised the DOH’s allocation
to a record P203.1bn ($4bn), while the budget for PhilHealth remained at P71.4bn ($1.4bn).
Key Market Trends
•
The impact of COVID-19 on demand and information dissemination
An important part of the pandemic response was the adoption of technology solutions, facilitating
access to care and knowledge sharing. Towards that end, the use of smartphone apps to monitor
and contain the virus increased during the crisis. In April 2020 the Department of Science and
Technology (DOST) developed an app that provides information on Covid-19-related research and
services, including efforts to secure and distribute test kits, personal protective equipment and
disinfectants. The private sector and universities also deployed apps for contact tracing, voluntary
symptom logging and community monitoring. For example, WeTrace was created by a DOSTfunded start-up and is used for patient mapping, case reporting and location tracking. The
government of Cebu has made it mandatory in the province.
79
•
Telemedicine/Remote consultations
With many Filipinos now concerned about their health but unable to go to hospitals because of the
lockdown or fears exposure to the coronavirus disease there, a number of medical companies and
individual doctors have offered their services online or through phone calls. (ABSCBN News, 2020)
•
Health Insurances and Government Subsidies
a. The Bayanihan to Heal as One Act, also known as Republic Act No. 11469, has
provided critical support to healthcare workers (HCWs) valiantly containing the
spread of the coronavirus pandemic, in the forms of urgently needed equipment
and hazard pay, as well as additional colleagues to bolster their ranks. Officially
enacted from March to June 2020, the Bayanihan to Heal as One Act is a crucial
core initiative of the Department of Health (DOH) to respond to the needs of HCWs.
b. The Department of Health (DOH) reported that it has delivered checks to the
families of healthcare workers who perished due to COVID-19, or those who
contracted a severe form of the disease, pursuant to the Bayanihan to Heal As One
Act. Said law grants public and private healthcare workers who contract severe
COVID-19 infection while in the line of duty to a P100,000 compensation, and one
million pesos (P1,000,000) to the family of any health worker who may die while
fighting the COVID-19 pandemic.
•
Internet of Things (IoT) and Blockchain on Healthcare Information Management
Systems
One of the major problems that a national health system face is the lack of a unified clinical data
management. There is not the appropriate technological and administrative infrastructure for a
unified patient medical history, prescriptions, laboratory tests or therapeutic plan. The integration
and implementation of a blockchain network as a complementary technology to the existing
information systems is proposed by several studies, so reliable and effective information
management could be provided by a healthcare organization or the national healthcare system.
Audit Considerations
Industry Challenges:
•
Impact of COVID 19 pandemic on healthcare workforce
o
High turnover healthcare workforce can have an adverse effect in the delivery of
services, where the ratio of nurses to patients are low such that nurses experience
“burned-out”;
80
•
o
High cost of training, mentoring and coaching new and experienced personnel in
terms of monetary and time spent;
o
Creating work environment where employees are encouraged to pursue goals is
more important than providing competitive pay is a challenge.
Leadership and governance - Prevalent inherent risks that we include in our objectives (or
assertions) are:
o
prevention of lost revenues,
o
to protect against fraudulent claims in the billing activities,
o
to guard against reimbursements deficiencies on documentations and,
o
to check frequencies or opportunities for reimbursables.
•
On health insurances: Corruption allegations on the Philippine Health Insurance Corporation,
which has been helping finance COVID-19 testing and treatment in the country, has been
rocked with allegations of fund mismanagement and overpricing.
•
Accounting for donations, grands, and subsidies
o
•
On May 22, the Philippines Charity Sweepstakes Office (PCSO) announced
US$9,000,000 in funding to 87 government hospitals to support procurement of
medical devices, equipment and supplies to combat COVID-19. These funds are part
of a larger US$60 million package, the bulk of which goes to PhilHealth (the national
healthcare system) and to cover hospital costs for COVID-19 patients.
Both a challenge and an opportunity, risk on disruption of blockchain technology can be
counted as one of the industry challenges as well. Existing DOH Information Gathering
Systems are allegedly computerized but are still highly reliant on outdated paper and pen
systems in the frontlines. Blockchain technology’s applications on healthcare systems has a
great potential in disrupting eFHSIS, PIDSR, SPEED, ClinicSys, and PhilHealth dashboard.
Key Audit Procedures:
1. Healthcare Financing
a. Secure/determine/inquire about the "rate structure of fees" and expenses, plus its
sharing scheme with Medical Professionals, resident or consultant (non-resident),
including specialists.
b. Ascertain/inquire about the "discount policy" for in-house/out-patients and how it
affects the billing and settlement.
c. Review concessionaire agreements and sharing schemes.
d. Procedures for SSS/Phil health claims/deductions, application of credit card
payments and utilization of medical insurance/HMOs.
2. Medical PPE, Products, and Technologies
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a. Establish or check internal controls on procurement / purchasing of assets,
medicines, importation of sophisticated (state-of-the-art) medical equipment, storage
of inventory items and its issuances, policy on clothing & provisions and
consumables.
b. Procedures on the [year-end] observance of inventory count.
3. Information and Research - Determine sources of funds for the purpose assessing the
efficacy of a particular medication
4. Leadership and Governance - secure Minutes or excerpts on financial transactions relating
to PPE, Investments, and financial powers (signing authority and limits).
5. Service Delivery
a. VAT & EWT impact on medical professionals concerning professional fees, room
rentals (for clinics) and segregation / set-up entries in billings and settlements, sale
of medicines both to in-patients administration and out-patient purchases.
b. For proper orientation, visit the hospital client and observe how each section
operates. Observe procedures.
c. There is always a document-trigger point before the procedure is performed.
6. Operational
audits,
safety
&
compliance
82
audits,
and
other
considerations.
83
Source: Maria Teresita Z. Dimaculangan, Specialized Industry Summit 2021
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 two to three audited financial statements of companies under the specialized industry
in the Philippines and list down your observations from audit report to the financial statements.
84
MODULE 8
Auditing Academic Institutions
Overview:
Educational Services is widely considered a counter-cyclical industry. Typically, when the
economy is doing poorly and unemployment is rising, more working adults, as their career
prospects start to dim, decide to upgrade their education. This, in turn, leads to higher enrollment
and increased profit at the schools. We note that traditional undergraduate education for young
students is generally non-cyclical. Culinary arts schools, however, can be labeled as moderately
cyclical. Also, certain types of educational institutions do perform largely in sync with the broader
economy. For example, providers of information technology instruction benefit in good times, when
companies are likely to boost related investment.
There is a growth element to this industry. Education companies are reporting a trend of
rising demand from working adults. More and more employers are requiring college degrees for a
greater range of jobs. Enrollment rates are tracking higher at most schools. To an 18-year-old,
thinking about the future, or a 30-year-old without a college degree, looking for a career boost,
diplomas are becoming the standard rather than the exception.
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 Educational Services sector comprises establishments that provide instruction and
training in a wide variety of subjects. This instruction and training is provided by specialized
establishments, such as schools, colleges, universities, and training centers. These
85
establishments may be privately owned and operated for profit or not for profit, or they may be
publicly owned and operated. They may also offer food and/or accommodation services to their
students.
Educational services are usually delivered by teachers or instructors that explain, tell,
demonstrate, supervise, and direct learning. Instruction is imparted in diverse settings, such as
educational institutions, the workplace, or the home, and through diverse means, such as
correspondence, television, the Internet, or other electronic and distance-learning methods. The
training provided by these establishments may include the use of simulators and simulation
methods. It can be adapted to the needs of the students, for example sign language can replace
verbal language for teaching students with hearing impairments. All industries in the sector share
this commonality of process, namely, labor inputs of instructors with the requisite subject matter
expertise and teaching ability.
The education industry can be described as the collection of organizations and businesses
that provide products and services aimed at enhancing the quality of education in society. The
education industry plays an increasingly important role in supporting public education by meeting
the demand for products and services that both complement basic education services and
supplement their underlying goals. The industry is defined by four main categories:
1. Schools/ Service Providers: – Providing Elementary and Secondary Education,
Alternative/Special Education Services, Education Management Organizations, Charter
Schools, Virtual Schools, and Proprietary Schools.
2. Supplemental Education Service Providers: Providing Higher Education, Vocational
Education, Learning Centers, Tutoring Services and Assessment Services.
3. Educational Products & Services Sector: Production and supply of educational material and
products including Educational Products, Publishing, and Supplemental Products.
4. Education Support Services Sector: – Providing support and ancillary services to the
education industry including Education Consultants, Education Information and Research,
Education Investment Services, Education Policy Specialists, and Technology Services.
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Overview, Updates, Statistics of the Specialized Industry in the Philippines
Philippines’ education industry has showcased a significant growth in the past decade owing
to the adoption of the enhanced basic education model. The financial support and aid from the
foreign countries such as Australia, Canada, US and others have been aiding the Philippines
government in restructuring the education system in the country. The several programs and
initiatives have been taken by the Philippines government to improve the quality of education in the
country. The increasing investments by the government and other local and foreign agencies for the
provision of universal access to quality education at all levels to the Filipinos are likely to boost the
total number of enrollments and establishments in the education industry in Philippines.
The K-12 education market has been the largest contributor to the overall revenues of the
Philippines education industry. The revenues of K-12 education market were estimated to be worth
USD ~ million in 2013, which grew from USD ~ million in 2008. The major growth driver in the K-12
education market was the implementation of the enhanced basic education program in Philippines.
This market has been highly fragmented with the presence of large number of public and private
players competing on the basis of tuition fees, infrastructure and other services. The major segments
in the K-12 education market are namely kindergarten, primary and high school. Secondary level of
education accounted for the majority share to the overall revenues of the K-12 education market.
The higher education market is the second largest contributor to the revenues of the
Philippines education industry. The market share of the higher education market in Philippines
declined to ~% in 2013. This declining market share was possibly due to the inclining tuition fees for
the private and public higher education institutions. Some of the major players operating in this
market are namely University of the Philippines, De La Salle University and others. This market is
likely to grow at a CAGR of ~% in the next 5 years.
The technical-vocational training segment accounted for a share of ~% in 2008 which
declined marginally to ~% in 2013. The major reason for this decline was the no or low fees charged
by the public technical-vocational training institutions in Philippines. This market is expected to
witness an increase in the revenues to USD ~ million over the period from 2013 to 2018. The
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Philippines private tutoring market has contributed a share of ~% in 2008 which decreased slightly
to ~% in 2013. The trend of homeschooling in Philippines can be attributed for the decline in the
market share. The major players operating in the tutoring market are namely AHEAD tutorial and
review center, MSA Academic Advancement Institute and others. It is expected that the private
tutoring market in Philippines will grow at a CAGR of ~% during the period from 2013 to 2018.
The test preparation market has been the fifth largest market in the Philippines education
industry. The market revenues for test preparation increased from USD Ì´ million in 2008 to USD ~
million in 2013. The Philippines test preparation market has been dominated by the private players
who compete with each other through review fees and other flexibility options in timings and
scheduling classes. The significant players in the Philippines test preparation market for civil
engineering review are namely Besaville Review Center, Padilla Review Center, Gillesania Review
Center and others. The inclining personal disposable incomes, escalating competition have been
some of the reasons for remarkable growth of this segment. This market is expected to grow at a
CAGR of ~% over the period 2013-2018.
The least share has been contributed by the Philippines teacher training market in 2008. It
is likely to grow gradually in the future years owing to the government initiatives and programs in
this segment. The teacher education market has also been growing rapidly and is expected to
maintain its growth momentum in the future years. The teacher education market has been
segmented into bachelors and masters degree programs offered in the field of teacher education in
Philippines.
The Philippines e-learning segment has been expanding rapidly and includes online-learning
and training, software development and e-content development. This market is likely to grow at a
remarkable rate in the future years. The Philippines education industry is estimated to register
escalating CAGR of ~% for the period from 2013 to 2018 with the private players established in the
industry driving the enrollments in the education industry in the coming years.
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The Philippines has 1,963 institutions of higher education. As of 2019, student enrollment
was 1.5 million for private and 1.6 million for public institutions. Through the Quality Tertiary
Education Act, public university tuition is free.
There is a strong presence of international schools in major cities such as Manila, Cebu, and
Davao. In Manila, there are more than ten popular schools: Brent International School, British
School of Manila, Chinese International School Manila, Domuschola International School,
International School of Manila, The King’s School Manila, Multiple Intelligence International School,
Reedley International School, Korean International School Philippines, The Beacon School, Faith
Academy, Australian International School, and Southville International School and Colleges. These
international schools offer both International Baccalaureate (IB) and Advanced Placement (AP)
programs, with annual tuition fees ranging from $13,000 to $15,000.
Most Filipino students studying abroad are from the local private education network. This
network is composed of 18,350 schools. The Coordinating Council of Private Educational
Associations (COCOPEA) is the umbrella organization of all private schools in the Philippines. The
Association consists of the Philippine Association of Colleges and Universities (PACU); the
Philippine Accrediting Association of Schools, Colleges, and Universities (PAASCU); Association of
Christian Schools, Colleges, and Universities (ACSCU); Catholic Education Association of the
Philippines (CEAP); and Technical Vocational Schools Association of the Philippines (TVSA).
The U.S. Embassy in the Philippines and CHED signed a Joint Statement on Higher
Education Cooperation in 2019 to increase collaboration in institutional linkages, capacity building,
and developing government/industry/academic ties. The joint statement recognizes the growing
market, the possible economic rebound after the pandemic, and the transition to a K-12 system to
allow more middle-class students to have the option of studying abroad.
SUB-SECTORS
•
Community college programs and boarding schools: Continues to be a niche market. Most
Filipino families prefer direct university entry.
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•
Higher education (undergraduate and graduate): According to the IIE Open Doors Report,
there were 3,295 Filipino students enrolled in the United States for the 2019-2020 academic
year, including 1,753 pursuing undergraduate degrees, 1,007 seeking graduate degrees,
444 pursuing Optional Practical Training (OPT), and 91 in other programs. The states with
the highest number of Filipino students are California, New York, Texas, Massachusetts,
Maryland, Illinois, Hawaii, Florida, Pennsylvania, and New Jersey. This mirrors locations
with the largest Filipino communities in the U.S., as community and family support networks
are determining factors in where Filipino students choose to study. With over 50% of the
population aged 24 and younger, there will be a surge of youth positioned to enter higher
education institutions.
•
Online programs and education technology: The pandemic has sparked demand for online
programs and education technology tools across all academic levels for distance
learning. However, this educational model shift has experienced challenges, primarily due
to the lagging Philippine Internet connectivity. Speedtest Global Index documents Philippine
mobile Internet speed at 14.24 Mbps (global average is 30 Mbps) and fixed broadband speed
at 23.80 Mbps (global average is 74.64 Mbps). For many years, the Philippines’ Internet
speed ranked lower than Syria and was the slowest in Asia. Cellular coverage is spotty at
best due to a long-lasting duopoly between two major players that has not encouraged
investment in the sector. The nation of 109 million people and 7,000 islands has only 20,000
cellular towers.
•
Research and development: Research and development opportunities lie in academic
programs relevant to the government priority disciplines of science, maritime, medicine,
health, engineering and technology, agriculture, teacher education, hospitality, and
architecture and town planning. Private and public institutions welcome partnership
opportunities for research and accommodate visiting fellows and professors for knowledge
exchange programs and capacity building.
•
Professional training services: The majority of the Philippine workforce is aged 25 – 54 years
old. There are more than 500,000 Philippine small- and medium-sized enterprises (SMEs)
seeking training to advance their business operations. Several training centers partner with
private and public sector employers to offer technical training and programs. There is an
increased interest in executive education programs and certificates among Philippine
business leaders. The Philippine Business for Education, a USAID-funded education
organization, and several others urge the government to create a national plan for workforce
competitiveness and skills development to support its growing economy.
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DIGITAL MARKETING STRATEGIES
Filipino students are fascinated by education events promoted via social media. As a social media
capital of the world, Filipinos actively use social media platforms for a whopping 10 hours per day,
seven days per week. The best platforms to reach the most students are Facebook (75 million active
users), Twitter (12 million active users), and Instagram (10 million active users). YouTube (11 million
active users) is the most popular platform for social video streaming. LinkedIn’s usage (8 million
active users) has also been growing among newly graduated students and young professionals.
Audit Considerations
A World Bank study assesses the quality of basic education services and the strength of
existing systems used to allocate and manage public education resources. It tracked public
education resources from national and local governments to a nationally representative sample of
elementary schools and high schools in the Philippines and assessed the availability and quality of
key education inputs. The key findings of the report are as follows:
Teachers
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·
The availability of teachers in schools has improved as a result of recent teacher hiring efforts.
However, there are signs of growing inefficiency in teacher deployment because of weaknesses in
teacher allocation systems.
·
Teacher absenteeism rates in elementary and high schools are generally low compared to
other countries. However, they tend to be high in highly urbanized cities.
·
There have been big improvements in the hiring process but significant delays still exist.
·
Teacher performance on content knowledge assessments is poor and professional
development systems are inadequate.
School infrastructure
·
The availability of key facilities has improved but classroom deficits still remain.
·
Public infrastructure improvement systems suffer from many problems which result in poor
quality and incomplete classrooms and water and sanitation facilities.
School funding and management
·
Schools have only limited discretionary funding to implement their own school improvement
plans.
·
While most discretionary funding is provided by the national government, a significant portion
fails to reach schools.
·
Schools face difficulties in using public funds because of burdensome management and
reporting requirements.
·
Transparency and accountability for fund use is relatively weak at the school level.
·
School level accountability through School Governing Councils is generally weak.
·
Parental awareness of the existence of School Governing Councils is limited. However,
parents are more aware and participate more actively in Parent Teacher Associations.
Local government funding
·
Local government funding to basic education is relatively low, declining and unequal.
·
Poor record-keeping and reporting makes it difficult to assess the distribution and effectiveness
of local government funding for education.
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Equity
·
Significant differences in levels of education spending and the quality of the learning
environment exist across regions and provinces.
·
Even though urban schools tend to serve wealthier populations, they tend to perform poorly
compared to rural schools.
·
Schools serving poorer communities tend to be more resource-constrained than wealthier
schools.
Detailed policy suggestions are provided in the main report for each of the topics covered. Common
policy suggestions include:
·
Increase public spending on education.
·
Improve allocation of education inputs through better planning.
·
Give schools greater authority in planning and resource management decisions and simplify
reporting requirements.
·
Improve transparency of fund allocation and resource use across the system.
·
Strengthen the role of School Governing Councils and Parent Teacher Associations.
·
Address funding and quality inequalities through improved financing mechanisms and focused
interventions for schools serving disadvantaged groups.
Accounting
The industry’s primary sources of income are – Fees, Subscriptions, Donations, Grants, etc.
A group of persons known as ‘Trustee’ or ‘Governing Body’ or ‘Executive Committee’ or ‘Board of
Management’ organise and manage it. Day-to-day routine activities are entrusted to a person who
is known as Secretary. Since there are many chances of fraud and embezzlement of the fund of the
Institutions, it becomes essential that the accounts of Institutions should be drawn properly.
Generally, accounts of an educational institution are maintained under cash-basis of accounting and
not under Mercantile-basis of accounting.
Collection of tuition fees, admission fees, fines, session charges and special fees—
laboratory fees, library fees, sports fees etc. — should be separately recorded in Collection Register.
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Students’ Ledger must be maintained where all these collections should be credited to the respective
students. Students’ Ledger should also include free studentship, concessions and writing-off
irrecoverable fees which are to be sanctioned by higher authority or Managing Committee etc.
Periodical reconciliation should also be made between the fees collected, fees outstanding
at the beginning and at the end of the period, fees written-off with fees that should have been
collected according to the number of students in different classes having regard to the number of
students enjoying free studentship, concessions etc.
Audit Trends
Integrated Strategic Planning and Monitoring • Turnaround Strategies (District, School, Support
Services) • Business Intelligence Systems • National Assessments and Examinations • Data Quality
Audits • Organizational Structure Design (Amalgamation/Rationalization) • Post Provisioning •
Business Process Re-engineering
Covid-19 Pandemic
The COVID-19 pandemic has forced the Philippine education sector not only to upgrade its
capabilities for remote learning, but more importantly, to realize that it could barely survive without
the social, economic, and political problems of the country being resolved. As it appears, charging
head on into a crisis with these problems as baggage would require Filipino students to take charge
of their education, since their respective families and teachers can only do so much to help them.
However, there is no need to leave these students alone to fend for themselves. Rather, an
opportunity presents itself: to gather students together into small communities – communities of
learning and inquiry – with the help of technology. With the new strategies being developed and
reintroduced, the direction now seems to point to the possibility of fostering communities of learning
and inquiry through distance education (Spencer, 2020), preferably, using social media. In the end,
it will be noteworthy for future researchers to look into how the community of inquiry and learning
framework can best help students from the Philippines as well as students from other developing
and poor countries to achieve quality education through technology-assisted interventions.
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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.
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MODULE 9
Auditing Electronic Commerce (E-commerce) Industry
Overview:
Although traditional commerce is still present in the Philippine market, e-commerce has
significantly penetrated the country by storm. In a country like the Philippines, going digital if you are
a business owner is beneficial, as most consumers are internet-savvy. In the last decade, the
number of internet users in the Philippines has surpassed other Asian countries. Across the
globe, Filipinos are one of the largest populations using the internet, spending at least an average
of 10 hours a day on the web. It tells a lot about the appetite of online consumers, and a large part
of them gravitate to play video games and search for fashion trends and make-up.
Sales through e-commerce have quickly accelerated in 2020 because of the long lockdown
periods in the Philippines. According to apparel and footwear e-commerce platform, Zalora, over
nine tenths of Filipino internet users searched for goods and services to purchase during the
lockdown period that began in March 2020. Even before the pandemic, e-commerce was rapidly
expanding in the Philippines, mostly drive by online marketplaces. However, in comparison to other
countries, the Philippines is still lagging in terms of e-commerce expansions. The reach of
Philippines’ e-commerce is not yet as established as other countries, providing much room for
growth in 2020. In fact, several key players have only started building their own e-commerce in 2020.
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.
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Nature and Background of Specialized Industry
Ecommerce (or electronic commerce) is the buying and selling of goods (or services) on the
internet. It encompasses a wide variety of data, systems, and tools for online buyers and sellers,
including mobile shopping and online payment encryption. Most businesses with an ecommerce
presence use an ecommerce store and/or an ecommerce platform to conduct online marketing and
sales activities and to oversee logistics and fulfillment.
Types of e-commerce
As commerce continues to evolve, so do the ways that it’s conducted. Following are the most
traditional types of e-commerce models:
1. Business to Consumer (B2C): B2C e-commerce is the most popular e-commerce
model. Business to consumer means that the sale is taking place between a business
and a consumer, like when you buy a rug from an online retailer.
2. Business to Business (B2B): B2B e-commerce refers to a business selling a good
or service to another business, like a manufacturer and wholesaler, or a wholesaler
and a retailer. Business to business e-commerce isn’t consumer-facing, and usually
involves products like raw materials, software, or products that are combined.
Manufacturers also sell directly to retailers via B2B ecommerce.
3. Direct to Consumer (D2C): Direct to consumer e-commerce is the newest model of
ecommerce. D2C means that a brand is selling directly to their end customer without
going through a retailer, distributor, or wholesaler. Subscriptions are a popular D2C
item, and social selling via platforms like InstaGram, Pinterest, Facebook, SnapChat,
etc. are popular platforms for direct-to-consumer sales.
4. Consumer to Consumer (C2C): C2C e-commerce refers to the sale of a good or
service to another consumer. Consumer to consumer sales take place on platforms
like eBay, Etsy, Fivver, etc.
5. Consumer to Business (C2B): Consumer to business is when an individual sells
their services or products to a business organization. C2B encompasses influencers
offering exposure, photographers, consultants, freelance writers, etc.
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Everyone from independent freelancers to small businesses to the largest of corporations
can benefit from the ability to sell their goods and services online at scale.
Here are some examples of types of e-commerce:
1. Retail: The sale of products directly to a consumer without an intermediary.
2. Drop shipping: The sale of products that are manufactured and shipped to consumers via
a third party.
3. Digital products: Downloadable items like templates, courses, e-books, software, or media
that must be purchased for use. Whether it is the purchase of software, tools, cloud-based
products, or digital assets, these represent a large percentage of ecommerce transactions.
4. Wholesale: Products sold in bulk. Wholesale products are usually sold to a retailer, who
then sells the products to consumers.
5. Services: These are skills like coaching, writing, influencer marketing, etc., that are
purchased and paid for online.
6. Subscription: A popular D2C model, subscription services are the recurring purchases of
products or services on a regular basis.
7. Crowdfunding: Crowdfunding allows sellers to raise startup capital to bring their product to
the market. Once enough consumers have purchased the item, it is then created and
shipped.
Benefits of e-commerce
Clearly online commerce offers a plethora of benefits. Let’s look at some of the biggest ones.
1. Convenience
Online commerce makes purchases simpler, faster, and less time-consuming,
allowing for 24-hour sales, quick delivery, and easy returns.
2. Personalization and customer experience
E-commerce marketplaces can create rich user profiles that allow them to
personalize the products offered and make suggestions for other products that they
might find interesting. This improves the customer experience by making shoppers
feel understood on a personal level, increasing the odds of brand loyalty.
3. Global marketplace
Customers from around the world can easily shop e-commerce sites – companies
are no longer restricted by geography or physical barriers.
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4. Minimized expenses
Since brick and mortar is no longer required, digital sellers can launch online stores
with minimal startup and operating costs.
E-commerce carries the following disadvantages:
•
Limited customer service. If you are shopping online for a computer, you cannot simply ask
an employee to demonstrate a particular model's features in person. And although some
websites let you chat online with a staff member, this is not a typical practice.
•
Lack of instant gratification. When you buy an item online, you must wait for it to be shipped
to your home or office. However, retailers like Amazon make the waiting game a little bit less
painful by offering same-day delivery as a premium option for select products.
•
Inability to touch products. Online images do not necessarily convey the whole story about
an item, and so e-commerce purchases can be unsatisfying when the products received do
not match consumer expectations. Case in point: an item of clothing may be made from
shoddier fabric than its online image indicates.
14 Ecommerce Trends Leading the Way
1. Augmented Reality enhances the reality of online shopping.
2. There will be a growing volume of voice search.
3. AI helps shops learn about shoppers.
4. On-site personalization uses those insights to create individualized experiences.
5. Big data plays a big part in creating personalized experiences.
6. Chatbots improve the shopping experience.
7. Mobile shopping is still on the move.
8. More ways to pay.
9. Headless and API-driven ecommerce allow continued innovation.
10. Customers respond to video.
11. Subscriptions keep customers coming back.
12. Sustainability is becoming more important.
13. Businesses should optimize digital strategy for conversion.
14. B2B is growing...and changing.
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Overview, Updates, Statistics of the Specialized Industry in the Philippines
COVID-19 has increased demand for eCommerce in the Philippines. While the younger
population was already open to online shopping, the need for social distancing has pushed the cash
centric and face to face shopping culture towards a more digital one, and this is expected to continue.
What is lacking is proper digital and logistics infrastructure to truly enable a digital economy. There
needs to be higher bandwidth capacity to service the retail market.
Current Market Trends
Filipinos are prolific users of social media. Estimates this year show that there are 76 million
active social media users from the Philippines. Of this number, 75 million are on Facebook; 12 million
on Twitter, and 4 million are LinkedIn users. There is good reason to be optimistic about eCommerce
growth in the Philippines. However, the country also faces the following challenges:
Infrastructure gap: Need for further improvement in internet speed. According to OOKLA’s
Speedtest Global Index, the Philippines’ fixed broadband internet speed is 22.74 Mbps in July 2020
and ranked 108th of 174th. Mobile broadband speed is 16.17 Mbps in June 2020 and ranked 121st
of 114th of 138th countries. The Philippines also ranked 63rd out of the 100 economies and 26th in
the 2020 Inclusive Internet Index conducted by the Economist intelligence unit. Logistics and
distribution also pose significant challenges in product delivery. A lack of cold chain storage limits
food products that can be transported for long distances. Traffic and an inefficient delivery network
also make delivery extremely unreliable in many areas.
Most internet users gain access through smartphones. Smartphone penetration is now at
48.4 percent of households.
•
Low Broadband Penetration: Many Filipinos access the web from mobile, home, internet cafés
and their workplace.
•
Low digital payment penetration: Bangko Sentral ng Pilipinas (BSP) in a 2018 report shows
that an estimated 66 percent of Filipinos do not use banks, and about eight percent use credit cards.
Hence, online stores in the Philippines provide cash on delivery payment options or payment centers
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(i.e., 7/11 branches). Different companies such as telcos, banks, and fintech start-ups have rolled
out e-wallets for unbanked populations. Significant players include PayMaya (PLDT), GCash
(Globe). The BSP also launched PESONet, a new electronic funds transfer service that enables
customers of participating banks, e-money issuers, or mobile money operators to transfer funds in
Philippine Peso currency to another customer of other participating banks, e-money issuers or
mobile money operators in the Philippines.
•
The Philippines is a fast-growing retail e-commerce market and the most popular retail e-
commerce platforms include Lazada, Shopee, Zalora, Ebay, and Kimstore.
•
Security concerns: Those who have credit cards are wary of transacting online, given the
numerous incidents of hacking and weak cybersecurity efforts that still plague the country.
Therefore, e-commerce platforms have established a cash payment mechanism using large
convenience store chains (i.e., 7/11 and Mini Stop) and local express delivery service (i.e., LBC).
Filipino consumers require further education on security measures that can protect their online
transactions. This will establish increased levels of confidence in online banking, purchasing, and
selling.
eCommerce Intellectual Property Rights
The Philippines has passed adequate legislation to promote eCommerce, the eCommerce Law,
Cybercrime, and Data Privacy Laws. However, enforcement agencies like the Department of Justice
and Philippine National Police and the local courts are not yet adept at handling cases involving
electronic transactions. The system is not, however, in place. The National Privacy Commission
(NPC) is tasked with implementing the Data Privacy Law, and they have had significant achievement
through Philippine-based companies designating “Data Privacy Officers” or DPOs. The NPC is also
leading the Philippines to be compliant with international privacy agreements such as the European
General Data Protection Regulation (GDPR) and APEC Cross Border Privacy Rules (CBPR).
Popular eCommerce Sites:
•
www.b2bpricenow.com– A trading portal with close to 8,000 members that are mostly from
cooperatives. The Philippine Congress officially endorses it as the Philippine e-Marketplace for
Agriculture and Fisheries. This site is a trading portal that provides up to the minute price update on
market information for agriculture, consumer goods, and industrial manufactures.
•
https://e-order.asiarx.com/– Caters primarily to the pharmaceutical and medical supply
industry have a regional scope, multilingual capabilities, tight real-time integration with supplier
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systems, and focus on the customer’s perspective and business processes. AsiaRx takes control of
the entire procurement process from finding the product to availability check, to order status
verification.
• http://philippines.tradekey.com – A B2B marketplace connecting Filipino exporters with
overseas buyers. It connects traders with global wholesalers, buyers, importers and exporters,
manufacturers, and distributors in over 240 countries.
• www.philippinecompanies.com – A Philippine business directory with 413,282 registered
companies. This website builds its database from publicly accessible directories such as Business
Registrations from various municipalities.
• http://philippines.tradeford.com – Provides global importers with information on products,
exporters, suppliers, manufacturers, and wholesalers. TradeFord’s buyers and suppliers’ database
covers major industries such as apparel, fashion, chemicals, construction, electronics, furniture, food
and beverage, health and beauty, machinery, transportation, and more.
•
https://www.kenresearch.com – Global industry research and information service company.
Provides industry intelligence, equity research reports and business consulting services covering
several sectors.
•
https://www.carousell.ph/ - Global online marketplace open in 45 countries in world used
for buying and selling of goods and services.
Online Payment
The increase in online shopping and access to online bank transactions is increasing payment in
the Philippines. Vendors are turning to online payment as a convenient buying method. However,
the security concerns over platforms and a cash-based society’s culture limits its effectiveness.
Mobile eCommerce
Data from Globe Telecom and the Philippine Long-Distance Telephone Company shows that there
are 163.7 million mobile subscribers in the Philippines. Most Filipinos access the internet through
their mobile phones, providing cost-effective and consistent access. Philippine and international
businesses sell products and services through mobile that has direct access to online consumers.
The Philippines is the fastest growing app market in Southeast Asia.
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Digital Marketing
The proliferation of social media and online platforms directly contributed to the growth of digital
marketing. An estimate of 76 million Filipino are online users and steady growth trends continue.
Traditional marketing companies emerged with new marketing techniques that include social media.
Businesses are continuing to transition to digital marketing to reach an even broader market for
potential customers, and this is becoming a reliable and growing trend.
Social Media
Filipinos are prolific users of social media. Estimates this year show that there are 76 million active
social media users in the Philippines. Of this number, 75 million use Facebook; 12 million use Twitter,
and 6.7 million are LinkedIn users. The Philippines is recognized as one of the top countries for
internet users worldwide in terms of time spent on social media; 4 hours on mobile and 5.2 hours on
desktop and tablet.
Challenges of eCommerce in the Philippines
Cash-based payment methods dominate, for now
One of the reasons behind the relatively slow uptake of eCommerce in the country in the
past few years is the continued dominance of cash-based transactions. According to the Philippines’
central bank, cash accounted for 99 per cent of all local transactions as of January 2018. In addition,
the country has been slow to adopt eWallets, with only 1.3 per cent of Filipinos owning electronic
money accounts based on Bangko Sentral ng Philippines’ 2017 Financial Inclusion Survey.
Meanwhile, merely 1.9 per cent of Filipinos over the age of 15 have a credit card. 68 per cent of
Filipinos with savings keep them at home instead of at a bank in 2019.
Logistics concerns due to unique geography.
With the Philippines being an archipelago of more than 7,600 islands, logistics naturally
presents a challenge you will have to prepare for when serving customers in this country. Consumers
living in the sprawling capital of Metro Manila enjoy access to huge shopping malls, flagship brickand-mortar stores, and even same-day online delivery from large marketplaces like Lazada and
Shopee.
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Growing pains with Internet connectivity
The Philippines has one of the slowest and most expensive Internet connections in Southeast
Asia. Coupled with high mobile phone and social media usage, this means online merchants must
pay attention to mobile optimization, particularly when it comes to the sizes of their product images,
this ensures that consumers can easily load on a smartphone on a 3G data connection.
Keep in mind that Facebook, the country’s most popular social media network has a free version for
mobile phone users in the Philippines. That means online merchants can leverage the network to
advertise and sell their products. In fact, PayPal’s research shows that 87 per cent of Filipino
merchants sell products on social media. Facebook also drives traffic and engagement on Lazada,
Shopee, and Zalora.
Changing eCommerce perceptions
A universal challenge for any online merchant is gaining buyers’ trust. For eCommerce, this
means using a combination of strategies, ranging from prompt delivery to accurate product
descriptions.
You also need to account for the low trust Filipino consumers have in credit cards. According
to a MoneyMax survey, many Filipinos are reluctant to get credit cards because they fear it will lead
to overspending and debt. Considering the challenges in Philippine eCommerce, online merchants
can also build trust by offering alternative payment options to credit cards. This may be in the form
of cash-on-delivery and local e-wallets.
Audit Considerations
E-commerce, or e-business, via the internet is now bringing fundamental changes to the way
business is conducted. The continued evolution of technology, the economics of the internet, and
the growth of e-commerce are significantly affecting the traditional business environment. Ecommerce is changing the competitive market and making international trading viable for a much
larger number of businesses.
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However, during these changes in the business environment, the auditor's responsibility to
provide an opinion on the financial report has remained unchanged. Although communication and
transactions over networks and through computers are not new features of the business
environment, the increasing use of the internet for e-commerce introduces new variables of risk and
control requiring audit consideration. E-commerce is not clearly defined or constrained but comes
with 'open boundaries' in terms of scope. The auditor requires appropriate skills to understand how
an entity's e-commerce strategy addresses the business risks that arise. Audit risk assessment for
e-commerce requires a paradigm shift in the way auditors consider client entities and the way
auditors plan audit procedures to reduce audit risk to an acceptable level.
When a business engages in e-commerce, it runs many new risks. The internet provides every entity
with the opportunity to trade in a global market. But when transactions are initiated by unknown
parties on the internet, there are risks relating to the authenticity and integrity of trading partners and
e-commerce transactions. Usually, management will identify e-commerce business risks, and
address those risks with appropriate security and control measures. In contrast, the auditor will
consider e-commerce business risks only in so far as they affect audit risk. Audit risk relates to the
risk that the entity's financial report (on which the auditor provides an audit report) is materially
misstated.
A business may be faced with a number of constraints when developing e-commerce,
including the availability of appropriate technical and marketing expertise, the need for continuing
investment, and the identification and resolution of security issues. Although these issues may
remain unresolved, many entities are continuing to develop e-commerce on a 'risk-reward' basis. As
a result, the e-commerce market is growing rapidly, particularly the use of e-commerce on a
business-to-business (B2B) basis to shorten supply lines and reduce costs. Such growth, without
due attention to the risks in an electronic trading environment, impacts on both business risk and
audit risk.
E-commerce business risks include those arising from:
•
the identity and nature of relationships with e-commerce trading partners;
•
the integrity of transactions;
•
electronic processing of transactions;
•
systems' reliability;
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•
privacy issues;
•
return of goods and product warranties;
•
taxation and regulatory issues.
Audit guidance relating to e-commerce is only one part of a much larger project, requiring
continuous research into the potential audit and assurance implications associated with
advancements in technology. For example:
•
The audit profession will face further challenges with the internet enablement of business
reporting using XBRL (Extensible Business Reporting Language) (visit www.xbrl.org for
further information), or another business reporting language. This 'next generation' of change
is already on the horizon, as the development and adoption of XBRL will also facilitate
process alignment between transactions from a website to back office reporting systems.
•
The migration of business from the document orientation of today's paper environment to the
electronic environment of the future (via existing internet technologies) will prompt further
change in the business reporting-information supply chain, and issues for audit
consideration.
•
As e-commerce continues to evolve, websites may become platforms to create new markets
and develop products. For example, facilities such as 'chat rooms' or e-commerce auctions
on their websites, may be used as platforms to reach new markets.
Each of these 'new' developments carries risks, which may not be identified in their early
stages. Therefore, as the auditor reconsiders the impact of e-commerce in each new reporting
period, the audit profession must remain aware of the potential impact of evolving internet
technology and emerging standards of industry practice on audit procedures.
Key Risks Areas in E- Commerce Industry
•
Supply Chain Management
•
Sales and Marketing Strategy
•
Vendor Management
•
Information Technology
•
Claim, Return, and Refund
•
Revenue Assurance
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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.
End of Module
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