Supplementing Your Accounting System

At a meeting last week, I was asked what software we recommend for accounting.  The owners runs a small business, fewer than 10 employees and sales in about a dozen states.  They are currently using QuickBooks but it doesn’t track everything they want easily, especially their inventory which is often stored in multiple locations.

I suggested keeping QB but supplementing it.  “With Excel?” one of the owners asked.  No, I replied, with Access.

I am a big fan of doing work, especially accounting work, in database systems.  This isn’t to say that spreadsheet’s don’t have a place, they do, but in a lot of cases, a well structured database enables a company to run complementary systems with minimal investment or complexity.

For example, we use Access to manage the complex owner payments for a condominium project we are managing.  The system automatically generated the assessments to each owner and we can receive payment and split the payment up much easier than in Excel.  Plus, we created a series of sub-tables which allow us to set up and create daily ACH files to upload to the processing system.  In the 3 months we have been using the Access system, we have cut our time to record and reconcile deposits about 90%.  And we know so much more about who, when and how owners pay their assessments than you could ever get out of Excel or even QB.

We set up the deposit form with a series of check boxes which allow us to manage payments to the special assessments – and allocate interest to the payments – as well as flagging us to record the deposit in QB.  Every week, I can run a specific query which searches the deposits table for unrecorded deposits and create a matrix table showing me how much to record as a deposit in QB to each owner receivable GL account as well as the amounts which were deposited to the various bank accounts.

We can track significant detail for each owner, including multiple emails and phone numbers as well as setting which method the owner prefers their information.  And, because we know how important it is to know when one owner’s responsibility ends and another’s begins, we created a specific process to track unit sales and split the transaction up to help both the buyer and seller know when and how much they owe at time of closing.

And the best part is, when we need something kicked out to Excel, we can create a routine which gathers the information in a query and automatically creates an Excel workbook.  Doug used this feature to help with the budgeting process to ensure that the allocation percentages were accurate without having to rekey data for each of the various scenarios.  And, once the budget was approved, we could reimport the Excel file to create the new year’s assessment charges for the Owners statements.

Excel is great.  We use it extensively, especially for financial statements and analysis.  But when you need to control data entry and you want to ensure only approved data are used, I strongly suggest you consider Access, or any other database application you like, as it is superior than Excel for multi-user and data management.

 

The Contract, Control and Your Condo Accounting

Theoretical question: Does an HOA or condominium association ever try to enhance its accumulated assets?  Or, is the association’s sole purpose to breakeven, that is cover its expenses over the long-term so that unit owners do not have to continually reach deep to pay bills?

I follow the later theory.  When you think about the association and its reason to exist, you will be hit by the fact that it budgets for breakeven and it attempts to accumulate assets only in sufficient amounts to satisfy potential future claims.  Specifically, the operating assessment is designed to cover all of an association’s expenses and the reserve assessment to accumulate assets to deal with the inevitable problems of owning things.  Over the life of the co-owned assets, the reserve should have only enough in the fund to pay for the expected future repair and replacement value of the shared assets.

What does this mean to an association and the upcoming changes under ASC 606?  You will likely not have a statement of revenue, expenses and changes in fund balances that means a great deal.  I say this because as we move towards the control principle of revenue recognition, it is highly likely that assessments (revenue) will only be recognized as a specific expense is recognized.

Under ASC 606, your budget should not only be a bunch of numbers, it should also be a bunch of performance expectations.  Thus, for every expense items, such as landscaping or management, you will want to identify when you believe you have “gotten what you paid for”, so you can recognize the revenue.  And some of you will even say, “This isn’t a problem, we have a contract.”

Thus, today’s exercise.  Do your contracts actually spell out performance obligations so that you can easily determine when the provider delivers and your association has met a performance obligation to those with whom you contract (the Owners)?  I think you are going to be both surprised and horrified as to how little thought goes into most contracts and how your management and board can identify if and when revenue should be recognized in your Association financial statement.

We obviously read a ton of contracts.  We produce them as well – an audit engagement letter for instance is a contract.  So, taking the audit ELA as our first example, lets walk through this to determine when and how an association will likely have to address revenue recognition.

In 2020, you prepare a budget and your budget calls for $5,000 for your annual audit of the 2019 year end.  Your auditor sends you the retainer agreement in January 2020 for $2,500.  The entry, done properly, would be

  • Prepaid expense – audit              $2,500
    • Accounts Payable                                $2,500

You also bill your owners for the audit.  Sometimes this is done through an annual budget process but in this particular case, the owners all agreed that bills would be split up and charged to the owners as they come in.  The 50 owners each receive their bill for $50.  How do you recognize it?

This is where the new ASC comes into play.  There are 5 steps you will need to go through to determine how you recognize revenue going forward:

  1. Identify the contract.  In this case, the owners agreed (contracted) to have a specific service performed and to pay the charge.  So, it appears we have a contract.  And, by the way, contracts are very liberally identified.  So if it looks like an agreement, it is likely a contract, even if it is not in writing.
  2. Identify the performance obligations.  You need to first understand that we are talking about the performance obligations that your customer, i.e. the owners, expect.  In this particular case, the owners expect the completed and issued audit report.
  3. Determine the transaction price.  In this specific instance, the price charged to the owners is identical to the price charged from the vendor so the completed audit report has a price of $5,000.
  4. Allocate the transaction price to the performance obligation. Since there is only one performance obligation (completed audit report) and the transaction price is for the completed audit report, the price per performance obligation is $5,000.
  5. Recognize revenue when (or as) the entity satisfies the performance obligation.

In our particular example, the invoice sent in by the vendor is for a retainer so the invoice to the owners is for the retainer – that is, the billing to the owners is not yet earned.  Thus, the entry is

  • Owner receivable                 $2,500
    • Unearned revenue                       $2,500

Notice that the charge to the owners sits in unearned revenue.  Since the performance obligation, that is the completed audit report, has not been presented, the revenue is not recognized.  When the audit report is completed and issued, the auditor sends in their final bill for $2,500;

  • Audit expense                           $5,000
    • Prepaid expense – Audit                $2,500
    • Accounts payable                            $2,500

And, since the audit is done, that is, the performance obligation has been met, you would record the revenue;

  • Unearned revenue                     $2,500
  • Owner receivable                       $2,500
    • Revenues                                            $5,000

This isn’t so bad right?  True, but I set you up with the easiest one first.  In this instance, the Association billed the owners directly for the costs.  But what happens when the audit is but one component of a $500,000 budget assessment?

You guessed it.  It is quite possible that your association is going to create, during its budgetary process, specific performance obligations for each of those contracts and, potentially pass those same performance obligations to the owners through your budgeting.

So, the more detailed your budget is, the greater the possibility that you are creating multiple performance obligations which require your assessments (the transaction price) to be allocated over those performance obligations.  And it is very unlikely that your auditor, those nice ladies and gentlemen looking out for your financial well-being, are going to accept the mere passage of time as a performance obligation.

ASC 606 is not something to ignore and hope your financial management team can figure out on the fly.  We talk with these managers and they either show incredible contempt for the change in how revenues are recognized or are thinking they can safely ignore it because their boards are not paying attention.  The one thing they are not doing is planning for this change.  You, as a board, need to start having this conversation, ESPECIALLY if you are obligated to issue financial statements prepared in accordance with accounting principles generally accepted in the United States of America.

Next up, looking at how ASC 606 performance obligations and assessments might work for you.

 

 

Impact of New Accounting Standards on Condo Associations Chapter 1.

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.

 

It’s worth it

This week, well actually almost this entire month, has been trying to overcome bad advice and management practice which was provided to a client.  I would love nothing more than to share names, opinions, and actions which got this entity into the mess they are in but that won’t solve the problem.  It would make me feel a whole lot better though.

Last night, after spending another 7 hours trying to figure out how to take incorrect balances and make them right, while at the same time trying to write the letter which explains to them why they now owe new balances, I asked myself, “Is it truly worth it?”

And when I almost convince myself to really question what I am doing, I think about the poor accounting clerk at the unnamed management company who, several years ago, no doubt discovered that what was being done, was wrong.  This accountant, filled with the righteous fury of making accounting meaningful, marched up to the unnamed boss at the management company, and laid out the facts.

“We are wrong.” The intrepid accounting person said.

“You are fired.” Said the boss.

Shooting the messenger is so much a part of the game isn’t it?  When things are not going well, it is easier to get rid of the those who question the steps, who report the unpleasantness, than to deal with the problem.  For the people who don’t want to hear it, they get silence and are grateful.  The ones who sounded the warning likely become gun shy and possibly vow to never raise a concern again.  There mantra might become, “It’s just how they do it here.”  Without realizing that by mouthing the phrase, they too become caught in the trap of decay.

Let’s be clear.  I think that when you start to simply accept poor behavior you become part of the problem.  When you see your manager using the company car on weekends, the same week you were involved in a termination of an employee who borrowed a work hammer, and you are silent, you are part of the problem.  Excusing the behavior of the manager simply because she is manager means that the rot won’t end.

Wrong is wrong.  Oh don’t misunderstand, no one will thank you for taking the stand.  Not your boss, not your bosses boss.  If you are lucky, you keep your job but get stuck with the title SNITCH.   But maybe, just maybe, people will start acting a little more ethical, at least in your presence.  And maybe, just maybe, they will act a little more ethically all the time because frankly it is too much work always looking over their shoulder to see if you are watching.

To that accounting clerk who, years ago, noticed that their employer was doing something completely wrong and called them on it, I thank you.  I know you tried and you succeeded.  Perhaps not as quickly as you might have hoped long ago but you are being vindicated.

One journal entry at a time.

Is it worth it?  Yes.  Doing right by people isn’t a zero sum game, it is the easiest way to live.  And like any questing knight, when you see people not wanting to correct a mistake, don’t be afraid to call them out.  Do it for the sake of the game, not because you expect an atta’ boy (or girl).  The greatest rewards in life are from within, when you can lie your head on the pillow and say, “Thank you, me, for a job well done.”