During our weekly meetings, we identified the upcoming changes to revenue recognition codified in ASC 606 could likely be a significant disruption for community associations and how they report activity. Currently, condominiums and HOA’s follow the guidance provided in ASC 972-605 for reporting revenues. Beginning in 2020, this industry specific guidance goes away and associations will need to follow ASC 606 Revenues from Contracts with Customers.
The first thing to understand is that ASC 606 will apply to associations. Associations enter into contract agreements with their unit owners which state that unit owners will agree to provide resources to pay for the expenses incurred for the common good. Since it is an agreement between the parties it is considered a contract. Since you have identified the existence of a “Contract”, the next big question is, “Now what?”
First, it depends on whether you identify a single contract or n number of contracts where n represents the number of units in your association. Our take on it right now is that there is a single contract between the association and its unit owners. We believe this is conceptually correct as the unit owners, as a group, vote to ratify the budget. Plus we believe it fits since the association has a single contractual purpose which is to maintain the common elements. But you can see that, right off the bat, there is a basis for a disagreement.
We believe the next step would be to record the following transaction once the budget is approved and ratified:
Owner Contract Asset $XXX,XXX
Unearned Contract Revenue $XXX,XXX
This identifies that the association expects to receive, as payments from the unit owners as the party to the contract, a certain amount to address the expenditures to maintain the common elements.
I can see the confused looks. It’s ok, we understand. Think about it this way:
Your association has a fiscal year which begins January 1 and ends December 31. In November the board passes a budget for $250,000 in assessments. The owners meet and ratify the budget on December 1. Because the association passes the budget for the annual cycle, it is creating the claim for the contract which begins January 1. Since it won’t begin to perform work until January 1 the association would not recognize the revenues until that date. Never-the-less, because the final step of the contract, its ratification, happened in December, we believe it is appropriate to record the transaction as stated above on the date of ratification, even though it is clearly not effective until January 1.
On a practical basis, what this means is that your management company should be changing its account structure and its memorized transactions – ASSUMING you want your manager to report the association’s accounting information in accordance with GAAP. If you want to follow some other accounting principle, well this blog is not for you.
What does this mean to you as a board? That the issuance of a paper statement, a coupon book, a web portal, no longer dictates when something is revenue. All these items do is determine the timing of when payments are received. What you will be most focused on, as a board, is this series of transactions
Owner Receivable $XXX
Owner Contract Asset $XXX
Followed by this when payment is received:
Operating Bank Account $XXX
Owner Receivable $XXX
We will delve more into this over the next 10 days, but the key takeaway today is that your association will still invoice unit owners when you want payment and the money will still be deposited to your bank. How and when it is recognized as revenues will be independent of the billing.
Obviously, even at this point you can see where there could be lots of opportunity for confusion. We have always been taught that it is revenue when invoiced. While I can prove that this is hardly ever the case, it is what has been treated as truth for as long as I can remember. And moving away from this will require boards and management to think long and hard about the process.
Next up: Performance Obligations for associations – No more “Net Income” on your Management Reports.
Have a great weekend. If you have questions or would like to participate in a discussion about how ASC 606 will impact community associations, feel free to email me for an invitation to our next webinar on the subject.