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.

 

Why GAAP matters

Sadly I am not allowed to say too much about today’s meeting as the board was in executive session but the gist of the other accountant’s opinion is that economic reality doesn’t matter only the legal form of a transaction.

Really?

When pressed about how that could possibly be the case since contractors obviously have earned a certain amount of revenue based upon an economic theory, the reply was, “Well you can’t confuse for profit with non-profit.”

Really?

When asked how, when a contract shows the total amount due or, if you elect you can pay a sum each month over XXX number of months and it includes interest at Y%, this someone does not create a sum certain for accounting purposes,  there is not somehow some understanding that the sum certain is a receivable, the replay was, “The contract says it is revenue only upon the payment of the monthly amount.”

Really?

The board naturally is confused.  Rightly so.  Two professionals, two different opinions, one type of transaction.

Except that one professional has a position backed up by research on the application of GAAP and how the Accounting Standards Codifications call for the transactions to be recorded.  The other is an opinion based upon his 30+ years of experience so he doesn’t need to know GAAP.

Honestly, if I were the board I would fire us both.  Me for yelling at a dumbass accountant who thinks that if he appeases his fired client he will continue to reap referrals and the other accountant for being a dumbass and trying to provide accounting 101 lessons.

I was wrong to lose my temper.  At the end of the day the treatment we selected is appropriate and consistent with GAAP.  But there was almost $2,500 of billing listening to a lecture of how debits are on the left and credits are on the right.  I was infuriated not for myself but the fact that these board members have owned and run businesses, sat on boards and really do understand the basics of accounting theory.  They paid $2,500 to listen to a self-proclaimed expert prattle on how form matters over substance.

Each person in the room understands that Enron happened.  That WorldCom cost them and their friends dearly.  When no matter how you cut it, you can’t incur an expense without the expectation that there exists a pool of resources to pay the attendant liability. And one expects their financial statements to reflect the reality of that situation.

GAAP exists for a reason.  GAAP doesn’t reflect – or rather should not reflect – the mere form of a transaction.  GAAP reflects economic reality.  And it does matter.  Because the next time you go to buy a home and you look at the books and it shows zero receivable from the owners and a bank liability of any amount, please understand, you are likely facing a special assessment only no one wants you to know.  And, had those books been properly kept on GAAP, you would have known the problem exists.  You probably still would have bought but at least you won’t be able to say (with a straight face) that you weren’t warned.  Which is the whole point of a financial statement anyways – to help you make better investing decisions.

So, GAAP is GAAP.  If you are bothered by the fact that your accounting is complex, look to the reality of your transaction as it is likely complex.  The further you get from doing work and billing for it, the more complex you make accounting in addressing your transactions.  Don’t blame the accountants… We are simply the messengers.

What did I say?

I guess I stepped in it today.

On my other blog for CORE, I wrote today about independence, you know that little section of rules which constrain the CPA from essentially reporting on their own work.

  • Yes, I know that it is done;
  • Yes, I know it is done all the time;
  • Yes, it is a literal interpretation;
  • No, I don’t think you should try and paper it over.

Two reports require the CPA to be independent of the client and management: Audit and Review.  No one is forcing the CPA firm to perform an audit or a review.  If you want to be part of management, I say GO FOR IT!  Help management get their act together.  Help them adjust their books and, more importantly, know when they need to debit this and credit that.  Help them, but don’t come back and then claim your independence isn’t impaired.

Impairment of independence isn’t just a factual matter.  Yes, you can create lots of paper which says that Ms. Whatshername, the a/p clerk, understands what you are doing on her behalf and she is ok with you making that journal entry for her.  But when you are brought in to re-enter the entire accounts payable because Ms. Whatshername didn’t enter anything and the controller was fired so there is no one to check your work… don’t push your luck.

The appearance of impairment is even more important for those reviews and audits.  You are dealing with the integrity of the profession when you ignore what some other person might think about your independence, or lack of it.  If it looks to an innocent person that you are doing the work of management, well, guess what?  You are.

To paraphrase a letter which went from an association to the owners of a condominium:

  • Management way back when got it wrong
  • New management starting in 20XX got it even more wrong
  • New management denied their work was wrong consistently from then until now
  • New management denied it was wrong even after being beat over the head with it
  • Board hired independent CPA to redo management’s work
  • Independent CPA recalculated the numbers, resulting in a major change
  • The CPA says their work is correct
  • And, you can rely upon the CPA for this because they are trustworthy

Sorry, but that wonderful letter praising the CPA now means the CPA probably is no longer independent as to the financial statement audit.

Their work was awesome.  Totally correct.  Nailed it to within $0.02 for every owner.  Told the attorney and the board they were right and said so in a letter to the owners.  they were worth every dime they were paid to fix the mess.

But their independence is now impaired.  There is no one, not management, not the board, definitely not the attorney, who is going to take responsibility for the CPA’s work.  The CPA owns it.  They said so.  Under the rules, both of the AICPA and common sense, they are no longer independent of the client.

No independence no audit.

I get it, it is my interpretation.  Well… Not really.  It is 20 odd years of practicing in this area and reading hundreds of ethics interpretations.  It is having to struggle with deciding when we cross a line and are no longer looked at by Tommy Banker or Amanda Bonding Agent as separate from management.  When the question is, “Are you getting paid to help management or to report on them?”; it does become a little more clear.

Attest firms MUST err on the side of caution.  The big 4 don’t, the next 8 don’t.  Their failures don’t give the rest of us license to slide down that wonderful chute into impairment hell.  Take the road less traveled but best for your client.  Have integrity to admit your lack of independence when it exists.

Make the right call.  Help management or report on them.  If you can’t tell the difference, well, you probably shouldn’t be playing this game.

 

A Focus on Cash Flow

At a recent board and owner meeting, I was asked about cash basis of accounting being a better reflection of activity than GAAP.  This owner was an observer at a prior board meeting where I discussed this issue with the board so I think she wanted me to go on record in front of others.

GAAP, for all its flaws, is superior to the cash basis of accounting when it comes to reporting outside of management.  While I agree that GAAP can include requirements that are complex and perhaps outside the competency of management, that doesn’t mean that GAAP is inappropriate: It means that management is likely over its head.

Since this was a condominium association, I asked the board if management told them how much money owners had not paid for the reporting period.  The answer – Yes.  But it wasn’t included in the financial statements.  Management prepared a report showing how much money was collected and spent during the month, and then provided a separate statement with

  • How much owners hadn’t paid
  • How much in vendor invoices came in but were not paid yet

Also known as accounts payable and accounts receivable. The concern I have is not that they were doing this on a monthly basis but rather that management decided that this was an appropriate year-end reporting model as well.  This was the mistake.

Management could have made essentially three journal entries to ensure that the books and records accrued non-cash activity:

  • Record the due but unpaid assessments
  • Record the due but unpaid vendor invoices
  • Adjust the insurance for the amount that is considered prepaid

There is absolutely nothing wrong with keeping a set of management books and a set of financial reporting books.  It is, in fact, encouraged since decision-makers have different information needs.  Keeping separate books should not entail a great deal of work either.  Most software today is sophisticated enough to easily track cash in and cash out while at the same time tracking the amounts which have not been converted to cash.  The excuse that it is too much work is just that; an excuse.

But I would go further.  The board should receive a GAAP based balance sheet and statement of operations for each meeting.  But, management should also create special reports, or dashboards, for the various members of the board.  The treasurer is mostly worried about current cash receipts and disbursements.  The president, on the other hand, may be worried about reserve project expenditures in relationship to the reserve study.  It is most appropriate, indeed it should be considered essential, to give the information to decision-makers which is most appropriate for their particular needs.

GAAP fills a need for external reporting.  It is as complicated as the entity makes itself out to be.  Internal management reporting can be as simple and targeted as the user wants it to be and indeed should be.  The point of keeping the books on GAAP basis is to ensure that transactions are not overlooked at year-end; Otherwise both management and the auditor have to put more effort into the accounting than is likely warranted.  But if no one minds paying extra to address the conversion from one accounting basis to another, it is likely fine with the auditor.  I know it is fine with us.