I was asked yesterday to explain my blog about reviews the other day and how the CPA overlooked the fact that the manager recorded the full special assessment instead of unearned interest income. It was a great question.
What actually tipped us was the foot note for the receivable. It said, in part, that monthly payments were required by owners (including interest).
When we looked at the manager’s profit and loss statement for the special assessment fund, it showed
Interest income $0
Interest expense $20,000
The second clue was looking back at the special assessment fund balance.
2014 $80,000
2015 $65,000
2016 $50,000
Each year the equity is being reduced because the interest expense was being recorded but there was no offsetting interest income. Since there was a special assessment receivable, an effective review test would be multiplying the average receivable balance by the stated interest rate.
In this case, the average receivable balance was $300,000. This multiplied by the 6.0% interest rate meant $18,000 of interest income would be expected. The association recorded no interest income. This is a very large deviation from expectations.
Under SSARS, Statement on Standards for Accounting and Review Services, the accountant performs certain analytical tests and compares those to industry standards, historical evidence and certain expectations driven by experience with both the client and the particular industry. In this case, our experience with special assessment receivables led us to believe that there should have been interest income. Although if the accountant simply compared it to the prior year, then the zero matched the zero in the prior year and even the year before that.
This would be incorrect though. Another requirement of SSARS and GAAS is to maintain professional skepticism, or the willingness to look beyond the assumption that an explanation may be correct.
So, we said, “Wait a second, how can it be zero if we calculate $18,000? How could the prior year be zero when the average receivable was $400,000? We then asked the question of management and they said it was always zero.
And our response was, so what? It didn’t feel right. In short, we were skeptical that their explanation was sufficient. Remember, the foot note said each payment included interest. This meant that somewhere along the way the preparer of the financials read a document that stated this.
Sure enough we found that document. Sure enough we found the next document which showed the original entry and that it included the full amount of the special assessment – including interest. That is, by the way, why the fund balance had a positive balance all the way back when it was created. The special assessment “revenue” was higher than the costs of the renovation project. It should have, at best, been a break even.
We could then model it and show the board how the financial statements were incorrectly reporting the special assessment. We then showed them how it was supposed to be.
No, it hasn’t been cheap for the association. It was all driven, unfortunately, by not having the financial statement reviewed in the year of the special assessment. Having the statements reviewed years later almost guaranteed that it would be overlooked. It is possible that it could have been overlooked in a review of that year too, I am not saying that it would have been caught necessarily, but the odds would have definitely been improved.
So yes, board members, especially treasurers, you can run your own analysis. If you would like, I can send you a spreadsheet with some of the more common ratios and analysis to help you get a good overview of your financial statements before your accountant sets in on the review. It can’t hurt and could potentially head off a disaster.
Have a great day. If you would like to learn more about how to analyze your non-profit, business, or property association, feel free to contact me and request the spreadsheet. C.O.R.E. Services is here to be of service to you.
Accounting Clarity 