Budgets & Reserve Contributions - Accounting Basics, Reserve Study Basics, Statute Requirements, Budgets, Reserves, Audi

1. Washington State ChapterCOMMUNITYASSOCIATIONSINSTITUTEThe professional organization providingeducation, resources, and advocacyfor community association living.

2. Budgets & Reserve Contributions Catherine Kuhn, CPA Ken Harer, Attorney ken@condolaw.net 206-633-1520 cathy@hoacpa.com 425-641-4808

3. Topics Today: • Accounting Basics- Balance Sheet & Income Statement • Cash vs. Accrual Accounting • Reserve Study Basics • Statute Requirements • Budgets • Reserves • Audit Requirements Related to Reserves • Reserve Funding Plans • Assumptions about inflation & earnings • Interest and borrowing of reserves

4. Who Are You? • Old Act Condominiums (created <1990) • New Act Condominiums (created >1990) • Mixed Use Condominiums • Homeowner’s Associations (Planned Unit Developments) • Association Managers

5. You?:By Total Budget Size: • $100K or less • $100K to $250K • $250K to $500K • Over $500K

6. 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!)

7. 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)

8. 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)

9. Members’ Equity (Fund Balance) • What you OWN (Assets) less What you OWE (Liabilities) • Two Types of Equity: • Operating • Reserves

10. Sample Fund Balance Sheet

11. Income Statement • “Statement of Revenues & Expenses” • Results over a period of time • Assessments Revenue - Should be total budgetedassessments 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!) • ReserveNet Income can be positive or negative --- OKAY

12. Sample Income Statement

13. Cash vs. Accrual • Cash– Checkbook Accounting – Recorded when PAID • Accrual – Matches Income with Expense as incurred- Recorded when Incurred

14. Cash vs Accrual • Revenue (Assessments) • Accrualrecords assessments at the beginning of the month based on budget • Cash records assessments as collected • Expenses • Accrual- Landscaper performs work in January- expense recorded in January Income Statement • Cash- Landscaper performs work in Januaryand billed/ paid in February- Expense recorded in Feb

15. 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

16. Accounting Basics • QUESTIONS ????

17. 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

18. 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

19. Reserve Study Basics • QUESTIONS ????

20. Progression of Laws • 1990 reserves mentioned • 2008 required for condos • 2012 required for HOAs • 2012 budget disclosure required

21. 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

22. 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.

23. 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.

24. 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.

25. Questions? • Law & Risk

26. 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

27. 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 currentlydoing on saving for future needs, and what happens over the next 5 years. • 2 – What the professional is recommendingand how that looks. • 3 - What the proposed budgetincludes and what that will do over 5 years.

28. 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 unitper yearand monthfor those expenses

29. 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 CURRENTcontribution 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.

30. 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 Fundedas of the Reserve Study date • (f) Estimated Year End Balance for the next 5 years at RECOMMENDED contribution rate, and CURRENTrate, & • PERCENT FULLY FUNDEDeach of those years

31. Requirements of 64.34.308(4) and 64.38.025 • (g) Estimated Year End Balance the next 5 years at theBUDGETED contribution rate, the FULLY FUNDED BALANCE for each of the next 5 years, and the PERCENT FUNDEDeach of the next 5 years at the BUDGETEDcontribution rate • Intent is to show how the Current, Recommended, and BUDGETEDcontribution rates compare over time

32. We provided three samples of forms that three providers have created to try and respond to the new lawQuestions on statutory requirement for budget?

33. 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.

34. Failing to Fund Planned Reserves • Is failing to fund for lack of money the same as borrowing from Reserves?

35. CPA Audits and your Reserves • 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

36. 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?

37. 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

38. 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”.

39. Due Between Funds • When one fund owes another fund money • Can be a result of ~ • 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)

40. 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.

41. 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

42. 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? • Enough operating cash/fund?

43. 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

44. Questions?? Due to Reserves, transfers, missed deposits~

45. 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

46. 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

47. 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

48. 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?

49. 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.

50. Controls on Reserve Activity • BOARD MINUTES – Very Important! • 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 --