Transcript Presentation Title Optional Subtitle

Washington State Chapter
COMMUNITY
ASSOCIATIONS
INSTITUTE
The professional organization providing
education, resources, and advocacy
for community association living.
Budgets & Reserve Contributions
Catherine Kuhn, CPA
Ken Harer, Attorney
[email protected] 206-633-1520
[email protected] 425-641-4808
Topics Today:
 Accounting Basics- Balance Sheet & Income
Statement
 Cash vs. Accrual Accounting
 Reserve Study Basics
 Statute Requirements
 Budgets
 Reserves
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Audit Requirements Related to Reserves
Reserve Funding Plans
Assumptions about inflation & earnings
Interest and borrowing of reserves
Who Are You?
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Old Act Condominiums (created <1990)
New Act Condominiums (created >1990)
Mixed Use Condominiums
Homeowner’s Associations (Planned Unit
Developments)
• Association Managers
You?:
By Total Budget Size:
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$100K or less
$100K to $250K
$250K to $500K
Over $500K
Accounting Basics
 Balance Sheet
Financial Position at a Point in Time
(e.g. Dec 31, 2012)
– Assets (What you OWN)
– Liabilities (What you OWE)
– Members’ Equity (Net Worth, Fund
Balance, Retained Earnings)
“Accounting Equation”
Assets MINUS Liabilities EQUALS Members’ Equity
Assets EQUAL Liabilities PLUS Members’ Equity (Balance!)
Balance Sheet ~ Assets
• Cash (Operating & Reserve)
• Accounts Receivable (Cash Yet to be Received)
Typically Past Due Assessments (billing 1st of the month)
Allowance for Bad Debt “contra” (offset) account
• Other Owner Receivables (Water billings, bill-backs)
• Prepaid Insurance (Ins Premium Paid in Advance of Use)
Balance Sheet ~ Liabilities
• Accounts Payable – Expenses to be paid
• Prepaid Assessments – Assessments that are paid in before
they are owed to the Association
• “Due between Funds” - Can be an asset or a liability
depending on the Fund (discuss later)
Members’ Equity (Fund Balance)
 What you OWN (Assets) less What you OWE
(Liabilities)
• Two Types of Equity:
• Operating
• Reserves
Sample Fund Balance Sheet
Income Statement
 “Statement of Revenues & Expenses”
 Results over a period of time
• Assessments Revenue - Should be total budgeted assessments
for the year (accrual basis) Some allocated to operations, some
to reserves
• Interest income (operating and reserve)
• Expenses – We all know what that is!
• “Net Income” Revenue Minus Expenses (Hopefully positive or
$0!)
• Reserve Net Income can be positive or negative --- OKAY
Sample Income Statement
Cash vs. Accrual
• Cash– Checkbook Accounting – Recorded when
PAID
• Accrual – Matches Income with Expense as incurredRecorded when Incurred
Cash vs Accrual
• Revenue (Assessments)
Accrual records assessments at the beginning of the month based on budget
Cash records assessments as collected
• Expenses
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Accrual- Landscaper performs work in January- expense recorded in
January Income Statement
Cash- Landscaper performs work in January and billed/ paid in FebruaryExpense recorded in Feb
Is Accrual Required??
• GAAP is “Accrual”
“Generally Accepted Accounting Principles”
Old Act Condos:
No mention of GAAP, we recommend GAAP
New Act Condos:
GAAP required- Resale Certificate Implications
HOA Act:
GAAP not required – Our preference is GAAP
Accounting Basics
• QUESTIONS
????
Reserve Study Basics
• Long term financial planning tool
• Provides information to include in annual
budget for major maintenance expenses
• 30 year projection of expenses
• Calculates steady contributions over 30 years
Core Information from Studies
• Fully Funded Balance Calculation
• Cash Flow Contribution calculation
• Funding Plans
• Baseline Funding – never run out of money
• Full Funding – Build over 30 years to be
100% funded
• Consultant’s Recommended Funding
Reserve Study Basics
• QUESTIONS
????
Progression of Laws
• 1990 reserves
mentioned
• 2008 required for condos
• 2012 required for HOAs
• 2012 budget disclosure
required
Requirement to Fund Reserves
• CAI National Policy on Funding
• Statutory Requirement to Fund
• Neither requires funding
• Belief that Boards know best how to fund
for future expenses
New(er) Statutory Requirements
• Applies to New Act Condos and HOAs
• Budgets proposed to owners now must include
information on status of reserves.
• Key concept: 1) Current savings, 2)
Recommended by consultant, 3)
Proposed Budget
• Goal is to keep membership informed.
• Complex Statute requires specific information be
submitted to owners at budget time.
What if You Don’t Comply?
• There is no penalty for failure to have a reserve
study
Owners can petition to have included in next year’s
budget
Some Associations need not have Studies
• Statute is silent on penalty for failure to disclose
reserve information during budget
• Risk is that the budget would be found invalid, so
any increase from prior budget would not be
collectible from delinquent owners.
Risk During Collections if New Budget
Process Not Followed
• Risk during collections if the new Budget
Process is not followed
• Same risk as before that Board does not comply
with law requiring Reserve study
• New difference is that the Budget section of
New Act Condo and HOA laws were revised
without same exceptions in law.
Questions?
• Law & Risk
SPECIFIC REQUIREMENTS OF 2012
LAW FOR ASSOCIATION BUDGETS
• HOAs and Condos formed after July 1, 1990
• Committee’s intent was all condos, but code
reviser at legislature did not know that
Requirements of 64.34.308(4) and
64.38.025
• Well intended legislation, with a goal of
fully informing owners about:
• 1 – How they are currently doing on
saving for future needs, and what
happens over the next 5 years.
• 2 – What the professional is
recommending and how that looks.
• 3 - What the proposed budget includes
and what that will do over 5 years.
Requirements of 64.34.308(4) and
64.38.025
• (a) State current, recommended, and
proposed reserve contribution rates, and
Funding Plan used by the professional to make
the recommendation.
• (b) State if additional funding will be required,
when it is due, and what it would be for.
(Example: special assessment of $100,000 to
replace the roof in 2015). Show amount per unit
per year and month for those expenses
Requirements of 64.34.308(4) and
64.38.025
• (c) State if the association will run out of money
in the next 30 years at its CURRENT
contribution rate.
This is a YES or NO question
• (d) If the answer to (c) is “YES”, then attach a
spreadsheet showing for all 30 years when it
is short, and by how much.
• These are not easy calculations to do.
Requirements of 64.34.308(4) and
64.38.025
• (e) State the projected year end:
Reserve Account Balance per the Study
Reserve Account Balance per Budget, &
The Percent Fully Funded as of the Reserve Study
date
• (f) Estimated Year End Balance for the next 5 years
at RECOMMENDED contribution rate, and
CURRENT rate, &
• PERCENT FULLY FUNDED each of those years
Requirements of 64.34.308(4) and
64.38.025
• (g) Estimated Year End Balance the next 5
years at the BUDGETED contribution rate, the
FULLY FUNDED BALANCE for each of the
next 5 years, and the
PERCENT FUNDED each of the next 5 years at
the BUDGETED contribution rate
• Intent is to show how the Current,
Recommended, and BUDGETED contribution
rates compare over time
We provided three samples of
forms that three providers have
created to try and respond to the
new law
Questions on statutory requirement
for budget?
Unplanned Reserve Expenses
• Building related expenses are OK,
even if not planned, or not
included in the reserve study
• Borrowing from reserves for
unrelated expenses triggers notice
requirement to owners and a
repayment plan to restore
balances within two years.
Failing to Fund Planned Reserves
• Is failing to fund for lack of money the same
as borrowing from Reserves?
CPA Audits and your Reserves
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Budget – relation to Reserve Study
Missing Budgeted Reserve Deposits
“Due Between Funds”
“Transfer Between Funds”
Operating vs. Reserve Expenses
Controls- Reserves
Audit Reports – Required Disclosures
What if Budget NOT = Reserve Study?
• Does your association budget’s
reserve contribution MATCH the RS annual
contribution recommendation?
What happens if your annual budget
contributions don’t match the study?
Is there an accounting “issue” if it doesn’t?
What if Budget NOT = Res Study?
• There is NO accounting (books)
issue if your annual budget does not
match the RS
• There IS a possible audit report
disclosure issue if the annual budget
contribution doesn’t match the study
What if we MISS budgeted
reserve deposits?
• GAAP: Requires that the budgeted reserve
allocation (contribution) be shown as the
“revenue” on the reserves Income Statement,
regardless if “paid” into the fund or not. (ie
“accrual method”)
GAAP: If not paid to reserves, it will show as a
“payable” to reserves or a “Due Between
Funds”.
Due Between Funds
• When one fund owes another fund money
• Can be a result of ~
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Reserve deposits not made
Expenses not paid out of right fund
Wrong amounts – either deposited or paid
Wrong coding of expense
Monies borrowed
Interest not properly posted
Accounting errors (e.g. journal entries)
What if we don’t pay back the missed
Reserve Deposit?
• GAAP- Considered a “transfer between
funds” and a “permanent transfer” is made
from the reserve fund to the operating fund.
Transfer Between Funds
• When one fund moves assets from one fund
to another
• Can be a result of:
• Moving cash permanently between funds
• “Forgiving” loans
• “Forgiving” amounts Due Between Funds
Due Between Funds vs. Transfer GAAP
• How to determine for GAAP? True
Receivable and Payable?
• Intention to repay?
• Documented plans to repay?
• New Reserve Study?
• Ability to repay?
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Enough operating cash/fund?
Due Between Funds vs. Transfer ~ IRS
• Form 1120-H
• No impact
• Form 1120
• May fail the tests ~
• Strict segregation of cash
• Use of monies as intended
• May not be qualified to
file form 1120 if large
Due Between Funds or Transfers
Questions??
Due to Reserves, transfers, missed
deposits~
Operating vs Reserve Expenses
Is it a Reserve Expense?
GAAP: Major repair or replacement
Industry Standard:
• Major repair/replacement not an annual event
• Extends the life of common area component
• Included in the reserve study
• Board determination
Is it a Reserve Expense?
• RCW: “Infrequent and significant nature
make them impractical to be included in the
annual budget”
• IRS: Must be “capital” in nature
Ops versus Res Expense?
Why important?
• Reserve Study will not be accurate if
operating and reserve expenses are not
segregated and improper expenses are taken
out of reserve cash
• Operating Income Statement analysis of
Budget to Actual will be inaccurate
• For IRS purposes, very important to
segregate operating and reserve expenses
Controls – Reserves
• Funding in accordance with the budget
• Does your Board know when reserve deposits are
missed?
• Reserve expenses
• Operating or Reserve expense?
• Paid from correct fund?
• Approvals?
Controls- Reserves
• Funding in agreement with Reserve Study
• Spending in agreement with Reserve Study
Changes in either not funding or not spending
according to the Reserve Study can significantly
impact future cash flow projections.
Controls on Reserve Activity
• BOARD MINUTES – Very Important!
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Nature and amount of reserve expenses
Decisions to repay reserves, payment plans
Decisions to transfer funds (instead of repay)
Why the budget does not match the RS
Why reserve deposits are missed/plans --
Questions? Operating/Res Exp and
Controls:
Audit Reports and Reserve
Disclosures
• Footnotes to the Audited Statements:
 Requirements to accumulate funds (statutes), including FHA
(RCW: no funding requirement)
 FHA requirement that 10% of op budget go to reserves
 Funding Policy
 Reserve allocation for the year (Income Statement)
 Reserve Study status
 Reserve Study annual allocation – compared to budget
Required (Unaudited) Supplementary
Information (RSI)
• Estimates of current or future costs of major
repairs and replacements for all existing
components (ie, Reserve Study)
• Components, useful lives
• Funds accumulated (ie Reserve Fund Equity)
C&C adds: “Percent Funded”
New RS Requirements:
RCW 1/1/12
• Certain required disclosures now in the
annual BUDGET document
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Most of our 12/31/12 audit clients did NOT have
this disclosure in their 2013 budgets
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Internal Control Report “comment” if not included
in Budget document
Questions?
Audit/Internal Control Disclosures?
Investment Options for Reserves
• CAI best practices from 2001
• Statutes silent on investments
• Federally insured investments
no loss of principal possible.
• Laddered investments
• Investment Portfolio Management
Budgeting for Inflation and Income
on Reserve Balances
• Over 30 years these two components cause
substantial shifts in estimated contributions
• Can you earn more than inflation?
• Who makes estimate of these for your
reserve study and your budgets?
How this affects budgets and needs
Contributions increase at 5%
Funding Plans - options
• 1 - Baseline Funding – Saving at steady rate so that
you don’t run out of money for 30 years
• 2 - Full Funding – Saving at steady rate so that you
are 100% fully funded at end of 30 years
Difference may be increased contribution of 13%
• 3 – Threshold Funding – More than Baseline
• 4 – Planned Special Assessments as needed
• 5 – Defer repairs and maintenance
Fully Funded at end of 30 years
Becoming Fully Funded – 30 years
What Funding Plan should you use?
• Depends on specifics of each community
Age of building and timing of future repairs
Circumstances of owners now and in future
Risk tolerance
Ability of owner to pay on short notice
Ability of owners to invest funds and earn more
• One thing all providers agree on: More money in
reserves means fewer special assessments.
Risks of no Study, or of not funding,
per Study recommendation
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Boards must act with reasonable and ordinary care
Statutes could be used to define that standard of care
Primary risk is no money for necessary repair
Secondary risk is owners can’t or won’t pay if you
special assess for repairs
• Disclosure to owners/buyers can reduce risk.
Resource: hoacpa.com
Resource: condolaw.net
Question & Answer Session
Thank you!
Ken Harer, Attorney
Catherine Kuhn, CPA
Condominium Law Group, PLLC
Cagianut & Company, CPA
[email protected] 206-633-1520
[email protected] 425-641-4808
CAI and the
Washington State Chapter of CAI
Working Together to Serve You
National CAI
caionline.org
(888) 224-4321
Washington State CAI
wscai.org
(425) 778-6378