AUDITING CONSTRUCTION AND REAL ESTATE INDUSTRY
2. Commercial - Included in this type of real estate
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.
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.
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,
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.
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.
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 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.
 Status of ongoing negotiations with tenants or lenders
(e.g., loss of tenants, lease modifications, COVID-19-related
relief received or provided, debt modifications or
refinances).
 Audit timing. Consider and anticipate any delays or
inefficiencies due to the current work- from-home
environment.
 Status of any legal or regulatory issues, including
communications with an attorney regarding potential or
pending legal matters.
 Subsequent events, such as tenant vacancies, which may
require adjustments to financial statements or related
disclosures.
 Delays in adopting applicable accounting standard updates
(e.g., Topic 606 Revenue Recognition and Topic 842
Leases).
 Changes to deadlines, including SEC filings, and the impact
of the amended definition of accelerated filers.
2. Review major transactions and changes to internal
controls and processes:
 Update internal control narratives for any changes during
the current year, such as any changes as a result of working
from home or key staff turnover.
 Provide detailed explanations, along with all supporting
executed legal documents, for transactions that have
occurred during the year, such as executed lease
amendments or a loan-closing binder.
3. Prepare for changes in audit requests:
 Anticipate new requests, such as virtual meetings with
property managers, or cash flow projections.
 Use the auditor’s secure site, to view and upload
documents. Management should verify that all necessary
personnel can access the site during planning discussions
with the auditors.
 Discuss and walkthrough processes and procedures
remotely.
 Determine if remote access to general ledger systems
exists within the system.
Going Concern Considerations
While going concern is always an audit consideration,
consider the pandemic and, at a minimum, discuss with the audit
team. An entity’s ability to continue as a going concern may be
impacted by a variety of adverse conditions, such as loss of a major
tenant, negative operating cash flows, or non-compliance with loan
terms and covenants.
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.

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.
 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.

5. Asset Impairment: For entities reporting under GAAP, PFRS 15 Revenue from Contracts with Customers Considerations
perform an impairment analysis of assets if management determines
 How are different goods and services within a contract
a “triggering event” has occurred. A triggering event may include, for
identified?
example, the loss of a major tenant or the occurrence of negative
 Should contract costs be capitalized?
operating cash flows. Management should determine if any such
 Should Revenue be Recognized Over Time or at a Point in
triggering events have occurred and, if one has, determine if the
Time?
carrying amounts of any assets are not recoverable over their
 Should revenue be adjusted for the effects of the time
remaining useful lives. This is not a consideration under the ITB.
value of money?
 What is the impact if a contract is modified?
 When should variable or uncertain revenues be
BEST PRACTICES recognized?
 Differences of PAS 11 Construction Contracts and PFRS 15.
There are several things to keep an eye on in any year that will
 See PIC Q&A 2018-12 for more details.
facilitate a successful audit season.

1. Management’s responsibilities:
Republic Act (RA) 6552 - The Realty Installment Buyer Act, more
 Review financial statements, whether prepared by
commonly known as the Maceda Law, provides remedies should the
management or an external party.
buyer default from payment based on the payment schedule initially
 Design, implement and maintain internal controls relevant
agreed with the developer. Under this law, in the event of buyer’s
to the preparation and fair presentation of financial
default, the buyer should be given grace period and refund of 50
statements.
percent to 90 percent of what has been paid (provided that the
 Prepare and review a complete financial reporting package
buyer has paid installments for at least 2 years). Also, under the Act,
of schedules and relevant documents that will be provided
notice of cancellation and then the refund (twin requirements)
to the auditors.
should be completed before cancellation of the contract to sell can
be carried out. Some legal opinions will say that without such
cancellation, the contract between buyer and developer remains
2. Designate an audit point person from your team. valid.
3. Verify the listing of accounts to be confirmed, including With these provisions on cancellation (cancellation right of the
cash, debt and investment accounts. Sign all paper confirmations or developer), there is a chance that the real estate companies can
give electronic authorization prior to year-end, if possible. sustain its legal right to payment. The discussion in the new revenue
standard explains that, notwithstanding that an entity may choose to
4. If the business has hard-to-value investments, prepare
waive its right to payment in similar contracts, an entity would
detailed supporting schedules and documentation. This should
continue to have a right to payment to date, if in the contract with
include a comprehensive write-up of the valuation methodology.
the customer, its right to payment for performance to date remains
5. Discuss with your auditors if there are schedules or enforceable. This legal position on enforceability of right to payment
documentation you can provide in advance for possible interim to support the recognition of revenue on sale of real estate is
testing. In a year where nothing has been ordinary in the real estate currently being reviewed by the real estate industry.
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.