Fund Accounting and Reserve Study Implications for Community Associations

1. Association Finances-Reserves and Other Fund ThingsWSCAI-Spokane11/02/13Catherine Kuhn, CPACagianut & Company, CPA

2. Catherine Kuhn, CPA, manages the Bellevue office of Cagianut & Company, CPA, which is devoted exclusively to serving the financial needs of close to 600 Community Associations in Washington. C&C has over 20 years of experience in serving Community Associations.

3. Fun things- Priest Lake My favorite place on Earth!

4. Outline Today: • What is Fund Accounting and should we be using it? Is it required or recommended? • What are the accounting implications if our budget doesn’t match our reserve study? • What happens if we miss reserve deposits that are budgeted for? • What are the accounting issues if we don’t pay back the missed reserve deposits?

5. Questions to Answer • Why do operating and reserve expenses need to be segregated? • What impact do the “new” Washington reserve study disclosure laws have on the audit report? • What is disclosed in the audit report about our reserve study? • How do I read our financial statements to recognize if these issues exist in our association?

6. Which Hat to Wear? • GAAP (Generally Accepted Accounting Principles) as defined by FASB • RCW – Washington law for condominiums and HOAs • IRS – Internal Revenue Service rulings and guidance • Industry Standards – Prevalent industry practices that are commonly held to be accepted

7. What is Fund Accounting?? • Records financial activity by fund (operating fund, construction fund, reserve fund, insurance fund, special assessment fund) • Specific dollars earmarked for specific projects

8. Sample Fund Balance Sheet

9. Sample Income Statement Sample Fund Income Statement

10. GAAP Standards: • Assessments for major repairs and replacements (reserves) must be reported separately from operations. • Fund reporting not required – but is “more informative to users” • If no fund reporting - shown as “appropriation of retained earnings”

11. Types of Funds • Operating • Replacement • Insurance – NOT Reserve • Property • Other – Special Project, Settlement

12. Why Fund Accounting? • Know when reserve deposits are not made • Know when expenses are paid out of the wrong fund • Know when monies are borrowed or transferred between funds • Have a usable operating fund net income statement that can be used as a comparative with the budget • Better information for decisions

13. Fund Accounting in the Industry • Fund accounting is definitely the industry standard • Trending to fund accounting in Washington

14. Questions on Fund Accounting??

15. Fun Thing…. HOOPFEST!!

16. What if Budget Does NOT Equal the Reserve Study? • Does your association budget’s reserve contribution MATCH the Reserve Study annual contribution recommendation? • What happens if your annual budget contributions don’t match the study? • Is there an accounting “issue” if it doesn’t?

17. What if Budget Does NOT Equal the Reserve 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

18. 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”.

19. “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)

20. Due Between Funds Example Example: • Not all reserve allocations were transferred during the year. • Interest was earned on reserve cash and posted to reserve fund • Expenses were coded to reserve expenses, but were paid out of operating cash.

21. Operating Cash owes Reserve Cash $1,200

22. 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.

23. 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

24. 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?

25. Due Between Funds vs. Transfer - RCW • Is not funding the same as borrowing? • True borrowing – must be repaid within 24 months (out of cycle res exp or a reserve component not yet in the study is not a borrowing)

26. 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 • filed form 1120 if large Due Between Funds or Transfers

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

28. Ready to JUMP in to the next section? Priest Lake

29. 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

30. 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

31. Ops versus Reserve 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

32. Controls on Reserve Activity • 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?

33. Controls on Reserve Activity • 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.

34. 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 Reserve Study • Why reserve deposits are missed/plans --

35. Questions? Operating/Reserve Expense:

36. Fun Things… The View from Elkins Resort @ Priest- Chimney Rock!

37. Fun Things… Making it to the TOP of Chimney Rock!

38. Audit Reports and Reserve Disclosures • Footnotes to the Audited Statements: • Requirements to accumulate funds (statutes), including FHA (RCW: no funding requirement) • Funding Policy • Reserve allocation for the year (Income Stmt) • Reserve Study status • Reserve Study annual allocation – compared to budget

39. Required (Unaudited) Supplementary Information (RSI) • Estimates of current or future costs of major repairs and replacements for all existing components (i.e., Reserve Study) • Components, useful lives • Funds accumulated (i.e. Reserve Fund Equity) • C&C adds: “Percent Funded” R S I

40. Required (Unaudited) Supplementary Information (RSI) • Auditor’s Report: • A statement that the RSI (Reserve Study) is included, or, a statement that it has been omitted • The Auditor’s Report is the only thing the CPA “owns” in the financial statements- so this is on the first page R S I

41. Required (Unaudited) Supplementary Information (RSI) • If a Reserve Study was presented in a prior audit report: • The CPA is now required to COMPARE RSI to RSI: (Disclosed in Reserves footnote) • Material changes in components • Material changes in estimated current/future costs • Material changes in component lives • Anything else the reader should know R S I

42. New Reserve Study Requirements:RCW 1/1/12 • Certain required disclosures now in the annual BUDGET document (Talaga presentation) • Most of our 12/31/12 audit clients did NOT have this disclosure in their 2013 budgets • Internal Control Report “comment” if not included in Budget document

43. Questions? Audit/Internal Control Disclosures?

44. Fun Things…. BloomsDay! 2013 Corporate Cup table with my sister, daughters, nieces

45. Fun Things…. AFTER BloomsDay 2013! Cousins taking a break….

46. Reading Your Financials: Spot the “Issues” • The BOARD is responsible for the financial statements, disclosures, reserve study

47. Reading Your Financials: Spot the “Issues” • Read Budget to Actual Income Statement each month • Helps identify misclassifications in operating and reserve expense • Look for “Due Between Funds” (i.e. amounts owed to reserves) • Easier to spot if you have Fund Accounting • ASK your Manager or Accountant if you don’t understand!

48. Reading Your Financials: Spot the “Issues” • Transfers between Funds: • There shouldn’t be ANY changes in the equity/fund accounts each month unless authorized/documented by the Board • DOCUMENT the reasons for any permanent funds transfers (ie forgiveness of amounts owed to reserves) • Communicate with reserve preparer

49. DOCUMENT • Document • Document! • Document!!

50. Questions? Spotting Issues….