An Open Letter to Certain Community Management Companies

Dear Community Management Company,

In response to the emails we have been receiving, please allow me to once again point out to you certain truths regarding the relationship between the auditor, the board, you as management and the owners.  This is a very important point to understand and can save you from performing an inordinate amount of rework, recriminations, general ill-feelings and time wasted writing pointless emails to me about how your feelings are hurt.

First, please understand that we are performing an audit of the financial statements prepared by management on behalf of the readers of that financial statement – i.e. current and prospective owners.  We are engaged to perform the audit by the board of directors who are elected by the owners’ within the association.  Our audit is on the financial statements prepared by you, as management.

It has likely not slipped by you that you, as management, are not included in the chain of authority.  We are engaged to audit your work.  The people who hire us, as part of their fiduciary responsibility, verify that we are independent of management.  That means we do not work for you, are not paid by you, and are not responsible to you.  We are, in fact, completely independent of you.

Auditor independence is an ethics requirement.  Auditor independence means that we are not involved in any manner with the people or companies we are auditing.  One step that we at C.O.R.E. take is to verify, prior to the start of any engagement: be it audit, review, consulting or other, that the work we are being asked to do does not put us in a position where a reasonable person might conclude that our work could be compromised because of some other relationship.

This doesn’t mean, by the way, that we cannot perform consulting or even management services.  We can even elect to perform certain services on behalf of management.  As a matter of fact, given the, shall we say, ethically challenged behaviors we have witnessed of late, we are seriously contemplating offering association management services.  The owners have the right to have someone looking out for their best interest and we think we are a superior choice for the right board and association.

What we could not do, is perform an independent audit of that association for which we are also performing management services.  THAT, is a conflict of interest.  The board and owners deserve to have someone independently examine our work to ensure we comply, not only with GAAP, but with basic common-sense internal control.  The obvious things like getting board approval for writing yourself a check in excess of your contract.  And the not so obvious things like performing and paying yourself for work that the board authorized another contractor to do.

Being able to offer a superior service to what you are offering is not a conflict of interest.  It is competition.  Modern capitalism encourages those who can offer a superior service at a reasonable price to put inferior businesses in that marketplace – OUT OF BUSINESS.  Walmart put tens of thousands of small time corner drug stores out of business and there was never a conflict of interest – there was just good old fashioned competition.

But you are correct, we could, in theory, leverage our position as the independent auditor to point out your significant internal control weaknesses over your clients’ money to suggest they hire us instead.  But if you were to think about it you would realize that would create a conflict of interest.  I cannot audit someone with the intention of going to work for them in another capacity because, you guessed it, there are ethics rules against it.  And we take our ethical responsibility seriously.  You do not want to even hint otherwise.

No, I do not owe you an explanation for a report to the board on your material weaknesses over internal control.  No, I am not obligated to help you fix your accounting errors.  No, I don’t have to ignore your failure to follow ethical business practices.  And, finally, no, I don’t have to communicate with you directly.  Unless you are ready to pay my rather hefty consulting fees.  Which, by the way, I couldn’t take, because it would cause a conflict.  Elegant, isn’t it?

Competing with you for management services is not a conflict of interest my dear management company friends.  Making journal entries to paper over your accounting errors 12 months after the fact possibly is.  Perhaps other auditor’s don’t see the irony, but make no mistake, we do.

Because if a board ever questioned your logic, they would wonder why they have to pay three times:

  • Once for you to get it wrong in the first place
  • Once for the auditor to make adjustments to fix your error
  • and you the second time to post the journal entries to the accounting system you control and shouldn’t have gotten wrong to begin with

Please, management, remember that the auditor does not work for you.  We are ok if you don’t want to refer us to your boards – they will find us anyhow.  We are even OK if you want to form a CPA firm to perform audits in competition with us.  We actually encourage it – after all –

you might learn something.

And for those management companies who take their responsibilities seriously, we would like to work with your boards in auditing you.  We appreciate that are open to the fact that sometimes things go wrong and you want to get it right.  We are thankful that you are open to constructive criticism and are willing to evaluate how our thoughts on effective internal controls might work better for you.  And we are happy to refer our audit clients to you.  Not because we are friends or you give us a kick-back but because you have your clients’ interest in mind and that makes our job just a little bit easier.  So thank you and we look forward to auditing you.

Have a great day.

The Right Way

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.

Impairment and the Balance Sheet

Typically it goes like this, “I googled this accounting term and it says that I am not required to do what you are saying.”  Ugh

Do not put your google search up against my accounting degree and constant hours of study of accounting principles.  Kubae actually saw that on a coffee cup and I thought it was pretty awesome.  Clichéd but awesome.

As I wrote on my other blog today GAAP is an accounting model that is selected by the organization.  If you elected to follow GAAP then, when a situation arises that GAAP covers, you are required to comply.

Or not.  Remember it is a choice.

We have worked with a few businesses recently who needed their financial statements reviewed.  They each have bank loans with covenants that require their financial statements to be prepared in accordance with GAAP.  And have those financial statements reviewed.

In each instance revenues are down year over year.  In each instance the companies have substantial non-cash assets: inventory, property, facilities and equipment, goodwill.  And we have asked each of them if they determined that their assets are impaired in value.

Sorry but this is a necessary question in a review.  GAAP requires that assets be tested for impairment, that is, loss of value.   And since you have a loan covenant requiring GAAP financial statements you have to follow the steps called for by GAAP.

Or you can say you are not going to follow GAAP.

By the way, you should be worried about value impairment in the situation where revenues are dropping and profits are slipping.  It is a sign that perhaps you have surplus inventory, desks that are not being used, expensive plant equipment that is sitting idle, shop space unused.  Why wait until the CPA says something?

That was a rhetorical question.  At this stage businesses have bigger problems than if their assets no longer have value.  Your bank moving you to special assets is chief among them.  You are focused on profitability because you think that is what the bank is concerned with.  And slamming more expenses into your fragile profit and loss statement is the last thing you want to happen.

Testing for impairment doesn’t necessarily lead to a write-off of value.  But if it does, so what?  If you are carrying inventory that you haven’t moved in a year then maybe adjusting its value to what you can get for it is a good move.  Think about it, you are trying to correct for past decisions and return to profitability.  Your inventory, and other assets, were a reflection of those past decisions and not dealing with them will actually hamper your turnaround.

Capitalized leasehold improvements has been a big issue for us on review.  What we find is that the accountant (even us) records the depreciation/amortization over 39 years.  Why?  because it fits with MACRS.  But it isn’t disclosed properly.  And then the problem is compounded by the fact that the company has a 5 year lease with one 5-year extension.

There are three years left on the extension.  Revenues and profits are down and management is looking for smaller, more affordable space.  And the company is sitting on $350,000 net book value of leasehold improvements.  It is painfully obvious isn’t it?

The value is impaired like it or not.  You don’t have a $350,000 asset, you have a huge rock tied to your ankles while you plummet the depth of the ocean.   Ignoring the problem isn’t going to help.  When it is time to move to the new facility the business will have to take a $300,000 write off for the inaccurate reporting of the economic life.  And that is the year your line of credit renews.

We know this isn’t an easy subject but you elected to follow GAAP.  Look at your assets and ask if it is still worth it.  You should do this even if you are vastly profitable since it is highly likely that there are assets or asset classes that you are no longer utilizing.

Or don’t follow GAAP.  The choice is yours.  Just don’t get mad at the CPA because she questions your balance sheet.

Have a great weekend.  If you would like more information about impairment or any other GAAP issue, feel free to contact us through our website.  We look forward to being of service to you.

 

The Importance of Independence

Yesterday, Doug and I discussed taking on a new client.  It is not an HOA or condo but a for-profit business.  Yes, even though we focus primarily on HOA audits and condominiums, we do the for-profit financial statement attest as well.  It is with for-profit businesses that our focus on remaining independent really helps.

With HOA’s and condo audits, the boards typically change every few years so we are pretty confident that we can remain independent.  The one class of client we will never do any work for is community management companies – as we firmly believe that this would impair our independence.  We are, after all, passing judgement on their work as it relates to their associations and we believe nothing impairs independence better than taking money from the watchdog.

The biggest independence issue with for-profit companies is that we typically do work for both the owner/shareholders and then perform the attest service on the business.  In most cases, this isn’t a big problem but occasionally, like the engagement we are evaluating now, the two may end up at odds.

Obviously this client does not want a review of its financial statements for its own benefit – although I think it is smart for every business to prepare financial statements and have them reviewed by an independent CPA.  In this case, they have bank covenants that require a reviewed financial statement.  And our independence issue is that we both have social contact with several of the shareholders and actually enjoy their friendship – which, by the way, is what provided us the opportunity to propose our review service.

The ethics rules don’t prohibit a CPA from being friendly with shareholders and management – I mean, lets face it, accountant’s are not the most likeable people on the planet so to deny us the few close friends we MAY be able to conjure would be cruel.  But we look at the independence issue a little deeper.  Is a friendship more important than our objectivity?

It is easy to say that “No, I would never let my friendship get in the way of doing my job!”  But when push comes to shove, are you willing to speak objectively about your friend’s job performance?  Do you have such a strong enough moral compass that you can deal with the glares and whispers from people you both know who have heard one side of the story, because yours has to remain silent?

Perhaps an example will help.

Last year we were performing a review engagement and during the engagement found that the controller had taken an incorrect stance on a certain transaction.  Her stance led to the understatement of liabilities by about $5.0 Million.  with that additional debt recorded, the company would have blown through their loan covenants and probably been put in special assets.

We called the controller on it.  She fought back and said that we could issue our report with an “Except for” paragraph if we wanted but she was not willing to book the liability.  Our friendship, a very strong personal relationship was on the line and all we had to do was go along with the non-recording of the transaction and issue a modified review report.

Doug and I discussed it and agreed that the most appropriate response was to inform the board of the controllers decision, our understanding of the transaction and that we were not willing to allow the financial statements to be issued without the liability being booked.

This is one of the reasons, by the way, that I took the chance to start C.O.R.E. Services with Doug.  He agreed that, if push came to shove, it was far better to be fired by a client for keeping our integrity than cave in – because once we cave we can never regain our original position.

So yes, when you select your CPA for attest services, those pesky audits and reviews, pick one who is willing to stand up for what is right – and not just because the rules say so – but because in the end you want someone of the highest moral principal you can find standing behind your financial statements.

Have a great weekend.  And as always, if you are looking for a CPA to perform an audit or review, check our website and schedule a conversation with us.  I think you will be glad you did.