Thoughts on Accounting and Reserve Funds

This weekend Doug and I were discussing the soon-to-be-required ASU 2014-09 and ASC 606 and how it applies to Common Interest Realty Association’s (CIRA).  As we look at this more closely, it is highly likely that something is going to have to change in order for Property Owner Association financial statements to comply with GAAP.

There may be a considerable problem with our current POA financial presentation that we, as a community of professionals, need to address. Specifically, how do we treat the receipt of resources paid to the Association for future activity in the Reserve Fund?

To review the 5 steps as they pertain to a reserve fund transaction as spelled out in ASU 2014-09 and ASC 606:

1. Identify the contract. The POA passes a motion (resolution) which states that all owners must contribute a certain sum of money. The owners agree (or fail to disagree in sufficient numbers). This likely creates the contract under 2014-09.
2. Identify the performance obligations. The purpose of the charge is to amass sufficient assets for future repairs and renovations. Thus, the reserve study, which is the underlying documentation calling for the expenditure of funds, creates the performance obligations. The POA could either call each discrete item its own performance obligation or bundle the annual expected disbursements into specific performance obligation groups. The grouping approach is allowed under 2014-09.
3. Determine the transaction price. The transaction price would be the sum total of the performance obligations as spelled out in the reserve study.
4. Allocate the transaction price to the performance obligations. Since each performance obligation already has an agreed-upon price, no further steps are warranted unless the POA receives information calling the transaction price into question.
5. Recognize the revenue when performance obligations are satisfied. And here is the problem.

Currently, GAAP treats the request for reserve funding as revenue when billed (received). It bases this on the premise that, while the income is, in theory, unearned, there is no right to request a refund and the funds are owned and controlled by the POA. Since the funds do not ever need to be refunded ASC 605 states that the most appropriate treatment is income.

But ASC 606 and ASU 2014-09 have the new performance obligation. If the performance obligation is in fact the future expenditure of resources in line with the reserve study, then this is no longer revenue but deferred revenues. It doesn’t matter if there is no right of refund anymore. These resources can only be taken into income when the reserve project is authorized and expenditures arise.

It would likely be incorrect to argue that the performance obligation is the mere demand for funds. An association is not allowed to amass assets without some rational basis – like the reserve study. Even if the reserve study is management’s, or the boards, best guest (meaning they don’t hire an independent expert to plan the amassing of reserve funds) the point of the accumulation is to pay it out at some future time: i.e. specific performance obligations.

This assumes, by the way, that the correct treatment of reserve transaction is, in fact, through the income statement. Since there is no profit motive, that is, the goal of the accumulation of reserve funds is to have sufficient assets on hand to address specific items without the expectation of additional accumulation of profits, it is possible that this is some sort of transaction other than revenue. This would imply that the transaction is a liability or an equity transaction, in that the accumulated assets are claims by other, currently unidentified contract members and participants receive the future benefit, but in the long-run since there is no real profit motive, the reserve breaks even.

The accumulation of assets is to ensure sufficient (hopefully) resources to address a future commitment to repair and renovate the property as called for in the reserve study. The problem, of course, is that the POA does not have title to the specific assets for which the funds are being accumulated. This amount is being taken in trust. Thus, the only “items of revenue” in the reserve fund would be the investment earnings and direct expenses, including any agreed-upon management fee, incurred directly by the fund. The payment of a reserve project would be recorded against the trust corpus and accumulated earnings – i.e. the liability account.

So, it is very possible that this new ASC will require a complete rethinking of how POA’s account for reserve funds. If the profession agrees that a POA is subject to ASC 606 for the contractual obligations then reserve funds will likely need to be treated as unearned until the performance obligation is satisfied. Or, if the profession believes that the transaction is not subject to ASC 606, then ASC 972 will need to be clarified to address how such funds are to be recorded. The contribution of those resources can be treated as temporarily restricted contributions in line with NPO accounting but this would necessitate the transition to NPO reporting and away from fund reporting. This will further necessitate an update to 972 to explicitly require this type of accounting. ASU 2014-09 calls into question how reserves will be treated moving forward and ASC 972 appears to be silent on the application of the ASU and the ultimate reporting of claims against assets accumulated for the future repairs and renovation of common property.

Welcome to Monday.  If you are looking for a firm which focuses on audits and reviews of Property Owner Associations and other types of organizations, feel free to get more information about us from our website.  We look forward to the opportunity to be of service to you.