Category: Auditors

When Assessments become loans

~ C.O.R.E. Beliefs ~ Leave a comment

We had an interesting one come up last week.  A 100 unit condo Association passed the following in a resolution:

  • Monthly payments of $200 per month
  • Term of the assessment is for 10 years
  • The assessment is transferred to the buyer at time of sale unless the buyer demands it to be paid in full at time of sale

This passed in February of 2016.  The association waived the 2016 audit (not wise) and then contacted us for a 2017 audit.  The dilemma?  How should this transaction be recorded?

The board and management argued that it is a monthly, on-going assessment.  But we are not so certain that is the correct way to handle it.  As we dug deeper we discovered:

  • Bank loan with a principal balance of about $1.8 Million dollars at 4.0% interest
  • Monthly payments on the loan of $20,000
  • Can pay any amount of principal after year 3 of the loan

We believed their assertion was incorrect and requested they capitalize the full receivable as a loan.  Our reasoning?

  • The present value of the payment stream could be calculated using the interest rate provided by the bank as the minimum interest charged
  • The assessment was directly tied to the repayment of the bank loan
  • The assessment was assumable but only if the buyer accepted it, otherwise it had to be paid in full at time of settlement

It is important because most state laws require disclosure of outstanding balances due from owners.  There is a huge difference between stating that the amount in arrears on an assessment is $0 and there is a $20,000 special assessment balance outstanding.  In some instances, the amount disclosed on the resale certificate is the maximum amount of liability that the buyer can assume at closing.  Management disclosed the seller’s maximum amount due on the disclosure.

Finally, since the buyer could assume, but didn’t have to, all the available evidence indicated that it should be treated as a loan to the owners.

Now there is a 10 year receivable to record.  There is interest to charge to the owner which splits their payment into two parts – principal and interest.  And because they didn’t adjust it correctly for 2016, the Association’s cost for the financial statement is going to almost double to correct for the prior year.

All of this could be avoided by consulting with a CPA firm which specializes in association (CIRA) accounting and auditing.  If you are a board that is looking at doing something that hadn’t been done before, it will be well worth the few hundred dollars you will be charged to get an idea of the complexity involved in accounting for the activity.  Can your management handle this type of transaction?  Will their software perform the calculations correctly?  How will our reports change?  All of this is as important as making sure you legally dot your “I’s” and cross your “T’s”.  Otherwise, don’t be surprised when your auditor says, “No, sorry it can’t work that way.”

Ask your accountant or feel free to reach out to us.  We are happy to assist you in any way we can as a little work up front can stop a landslide later.

At C.O.R.E. Services, we focus on being a strong independent check on management and their assertions. Which is why we enjoy working with Property Owner Associations. The boards are dedicated but typically outsource the management who record the transactions and prepare financial statements for the board to review. Our audits are designed to help the board and owners rely upon those statements. You can find more information about us on our website.

The Right Way

~ C.O.R.E. Beliefs ~ Leave a comment

People’s reaction to conflict is often amusing.  Last week’s battle with a management company is a great example.

When we first brought the issue to the attention of the management company, they told us that they had authorization to do the work and invoice for it.  Never mind the fact that the minutes to the directors meeting didn’t say that the management company’s proposal was accepted and approved.  The minutes were silent.

As I have pointed out in other blog posts, the minutes in this case were kept by the management company.  This is so even though the bylaws state the board secretary is responsible for recording the meetings and securing the minutes.  But even though the management company kept the minutes, the minutes did not provide approval.

They did the work anyways.  And then billed extra.  We questioned the transaction as we think any good auditor would.

The manager’s response?  They updated the minutes.

Really?  I know, it is wrong on so many levels.  But even though they updated the minutes they still didn’t say that the board approved the transaction.  Even they knew there is a line they can’t cross.

After that, we were met with silence.  Three times we inquired as to additional proof that the transaction was valid and we were met with silence each time.  They figured we would go away or worse, feel no choice but to accept their statement.

But there was a right way to handle this.  First would have not been to do any work not explicitly authorized by the board.  The management company, after all, works for the board the same as the auditor does.  They have a contract which specifies the work they are to do and the compensation they are to receive.  When there is work to be performed beyond the management agreement, that work needs to follow the basic rules the board has laid out.

The right way would have been to solicit three bids from reputable contractors.  The manager would have presented these to the board so they could make an informed decision.  The manager then would have contacted the awarded contractor and scheduled the work.

The right way would include not submitting a proposal from a contractor who didn’t agree to the terms that were apparently presented to the board.  The right way would also not have the manager offer to step in to fulfill the service when the contractor said no.

From our perspective as the auditor, there is a right way and a wrong way.  The right way means acting with integrity and intention.  It means accepting responsibility when things go wrong and reconsidering your processes so that they can’t happen again.

The wrong way is to blame the CPA for questioning the transaction.  The wrong way is to say that the board is wrong and to argue that everyone knew how hard you worked.  The wrong way is to tell us that you can find five different CPA firms who will see it your way and that you will make sure we never audit another of your clients.

As auditors, C.O.R.E. Services follows a simple rule: Do it the Right Way.  If at the end of the day, our clients, the boards of property owner associations and other entities, prefer to have us focus on their rules and compliance so they can feel good about the financial statements, then we will continue to offer our service.  And if the market shifts and these same boards no longer want to know that things are done correctly, well then the market will win and we will have to find some other line of work where our integrity and intention will matter.

As we explained to this community manager, the cost for their referral was too high.  I would rather starve then become beholden to a community management company who skates on ethical thin ice.  And if the day comes when boards would prefer to have a community management company lackey as their auditor so they can avoid the conflict of challenging the manager’s decisions, then we will stand by waiting for the inevitable lawsuits to begin so we can offer our services in support of the litigation.

Do things the right way.  Act with intention.

If you are a board who would like to ensure that your community manager is preparing financial statements you can rely upon, feel free to reach out to us.  And, if you are a community manager who lives with intention and works with integrity, we would love to get to know you and help you by auditing your work on behalf of your boards.  Our mutual client will be most grateful for the opportunity for us to work together on their behalf.

Have a great Monday.

Understanding risk

~ C.O.R.E. Beliefs ~ Leave a comment

We were asked to propose on a review engagement about 10 days ago.  This is for a commercial business doing about $20 million in revenue.  Their prior accountant got out of doing attest work – it seems the peer review burden and trying to stay in compliance with the standards was more than he wanted to undertake.

We asked for and received copies of their past two year financial statements as well as their interim statements.

  • Significant losses in 2015
  • Significant losses in 2016
  • Significant profits in 2017

We started asking some high level questions of the controller and her response bothered us.  She started by asking if we were accusing her of “cooking the books”.

If you own a business, or are the responsible accounting person, you need to understand how this goes.  It is all about risk and from the independent accountant’s perspective, the risk is based on who reads your financial statement – so our job (in a review) is to make sure that nothing comes to our attention to make us think the financial statements are not correct.

When we see a pattern like this, we are skeptical.  Believe it or not, skepticism is a job requirement.  The code of professional conduct requires us to be skeptical.  But skepticism is not cynicism and automatically assuming the worse, it is thinking that maybe something is overlooked.

Imagine your teen brings home 2 progress reports in a row which say that homework is not being turned in.  You walk into his room while he is playing video games and ask if he completed his homework.  He says “Yeah of course.”

It isn’t that you don’t believe him.  But lets face it, history isn’t kind and he does have a track record of not doing it.  So what do you do?

Ask if you can see it of course.  You are skeptical.  You are not accusing him of not doing it, you are simply verifying that it is complete and ready to be turned in.

If it is done, great!  Pat on the head and maybe even a hint on how to beat the level.  If it isn’t, well I wouldn’t say he lied, I would say that no doubt the game is interfering with his memory and say that perhaps it is better off in your closet.  Until his memory improves and the homework is done.

It’s a silly analogy but true.  As the independent accountant, we are concerned with risk.  Risk to ourselves naturally, but also the risk that might be taken by the reader of the financial statement if it turns out it isn’t accurate.  We are proud of our independence and objectivity.  And this requires us to ask questions which make people uncomfortable.

Keep in mind, most of us who still perform attest services have seen a thing or two, so we know a thing or two. (Sorry Farmers, I owe you two cents) We realize that the bank is probably paying very close attention to your numbers.  We are pretty certain that another year of losses could end up with you in special assets.  We know that some peoples jobs are potentially on the hook if profits don’t improve.

We have seen it before.  But it isn’t cynicism, it is skepticism.  The patterns are there so we have to reduce the risk that the pattern is real.  And we do this by asking questions.  Sometimes painful questions.

We have to learn your business, your processes.  We have to understand the industry you compete in and sometimes the multiple industries you try to make a profit in.  We have to know what others in your industry do when it comes to capitalizing assets and recording liabilities.  We have to understand your motivation and tolerance for risky behavior.

Keep this in mind when your independent accountant starts asking questions.  And, if your accountant isn’t asking questions, maybe it is time for you to get another accountant.

Have a great day.  If you have a need for an audit or review in Washington or Oregon, feel free to learn more about us on our website and contact us for more information.  We are here to be of service to you.

Auditing investments

~ C.O.R.E. Beliefs ~ Leave a comment

It is always refreshing to see associations which take responsibility for their future replacements by trying to find investments which can actually grow beyond the rate of inflation.  A solid investment plan can help them ease the burden of reserve assessments by using collected funds to grow at an accelerated, but reasonably safe, rate of return.

Auditing these investments is challenging though.

Conceptually, auditing investments is not any harder than auditing cash.  Except that investments carry certain additional disclosure requirements and the treasurer typically has little to no exposure on how to record the transactions let alone report them to be audited.  Which means that our work as the auditor grows significantly.

You see, Generally Accepted Accounting Principles (GAAP) requires that the investments be reported as either trading, available for sale or held to maturity.  How many investment advisors even understand what can be assigned to these categories?  And our role, as auditor, is to make sure that the investments are properly categorized and that the related gains, losses, and earnings is properly reported in the statement of activity; i.e. the profit and loss statement.  To ensure that they are properly recorded in the period, the accounting department has to know the difference between realized and recognized gains and losses, temporary impairment, other than temporary impairment and put those in the right reporting areas.

Which of course leads to another big accounting issue, accumulated other comprehensive income.  This is the series of holding accounts for the unrealized gains.  You have to know how to close out the transaction to recognize the ultimate sale of the investment.

Did I mention that you have to also track bond premiums and discounts and do some accounting work to get the amortization right?  Again, all this has to be tracked correctly to report in accordance with GAAP.

The rub is that treasurers and boards don’t really understand the complexity of this and often don’t really care.  Their issue is the investment and the return, not its reporting.  Which brings us to our dilemma.

Trying to account for, and then audit, investments can add a substantial cost to the engagement.  It is a cost that probably won’t be valuable to the board and owners in the association.  So, do we allow for a GAAP departure on the investments and simply say they are recorded at cost and have associations report gains and losses at the time of sale?

It is a difficult position.  On the one hand we want the statements to fairly represent the financial activity of the association but on the other hand we don’t want to drive up the cost of the engagement to the point where they find another auditor.  One who perhaps will take huge shortcuts on the reporting and auditing side.  Yes, we see that far too often as well.

So, putting your reserve fund to work by investing it strategically and at reasonable risk is a fair approach to managing the money.  But there are other things to consider besides the actual investing and you, as a board, need to be aware of these issues and take a position on how to report this to the owners in your association financial statement.

Have a great day and an awesome weekend.  And, if you are looking for an experienced audit team to help you maintain effective controls over your association’s finances, feel free to contact us anytime.  We look forward to the opportunity to be of service to you.