New guide for common interest realty associations. Finally! There's guidance for these unique not-for-profit organizations.
Finally! There's guidance for these unique not-for-profit organizations.
What's a common interest realty association (CIRA)? A CIRA is an association of persons who own condominiums or another kind of housing with common property--property that all the owners hold in common. The CIRA is responsible for maintaining the common property and providing certain services, such as snow removal, guard service and lawn maintenance.
Why is a CIRA's financial reporting so important? CIRA financial statements directly affect and are more important to more people than the financial statements of any other kind of reporting entity. Community Associations Institute estimates that 29 million--or one in eight Americans--live in housing that has CIRAs. Those CIRAs spent over $12.5 billion last year and the numbers mount daily.
For most of these people, the CIRA is their single most important investment. The initial cash outlay for the unit (purchase price or downpayment) and subsequent payments (monthly maintenance, mortgage and special assessments) are the largest payments most people make. Investing in a CIRA means making such fundamental decisions as
* Where to live.
* Whom to live among.
* What rules to follow.
The decision to live in CIRA housing also should be based on the CIRA's financial statements.
CIRAs are generally not-for-profit organizations and their members are all the owners of the common property. Condominium associations, homeowner associations and cooperative housing corporations (co-ops) are all CIRAs. In non-co-op CIRAs, members own their individual real property dwellings (units). When a unit is bought, the owner becomes a member of the association. In co-ops, however, the members own shares of a corporation. Co-op shareholders are entitled to use certain property owned by the corporation--including the shareholders' individual housing units.
Until now, no financial reporting or auditing guidance existed specifically for CIRAs. However, such guidance soon will become available when the American Institute of CPAs issues its long-awaited audit and accounting guide, Common Interest Realty Associations.
The guide was prepared by a task force of seven members knowledgeable about CIRAs, including practitioners from small and medium-sized firms. It's intended to
* Make CIRA financial statements more useful to users.
* Increase the comparability of their financial statements.
* Provide guidance on auditing issues specific to CIRAs.
The guide has been approved by the AICPA accounting standards executive committee (AcSEC) and at press time is awaiting Financial Accounting Standards Board clearance. It's expected to be issued in January 1990 and will become immediately effective. (See exhibit 1 The birth of a CIRA guide)
WHAT THE CONCEPTS STATEMENTS SAY
According to FASB Concepts Statement no. 4, Objectives of Financial Reporting by Nonbusiness Organizations, the objectives of financial reporting by nonbusiness organizations are to provide
* Helpful information to current and potential resource providers and other users of financial statements in assessing the services the entity provides and its ability to continue to provide those services.
* Information that's helpful in assessing how the organization's managers discharged their stewardship responsibilities and other aspects of their performance.
* Information about the economic resources, obligations and net resources of the organization and the effects of transactions, events and circumstances that change the resources and interests in those resources.
* Information about the organization's performance during a specified period.
* Information about how the organization obtains and spends cash or other liquid resources, about its borrowings and repayments of borrowings and about other factors that may have an effect on its liquidity and solvency.
* Explanations and interpretations to help users understand the financial information provided.
WHAT USERS NEED IN CIRA STATEMENTS
The above general guidelines apply to all nonbusiness organizations, but what specific kinds of information do users of a CIRA's financial statements need?
Because CIRAs generally exist to operate, preserve, maintain, repair and replace property held in common by unit owners and provide other services, they're a unique kind of not-for-profit organization. They feature three special characteristics:
1. Their primary, and often only, sources of cash are assessment revenues received from their members. CIRAs act as conduits through which the unit owners pool their funds to operate their common property. Operating the property may be as simple as paying property taxes or as complex as the quasi-governmental task of running a community.
2. CIRAs often have rules and regulations that serve as local laws for their residents. Governing documents give CIRAs the power to enforce these rules and regulations and to punish members who break them with monetary fines and sometimes even with eviction.
3. CIRAs are separately identifiable reporting entities whose transactions, operations and financial positions represent the common interests of the property owners. The line separating the owners from the entity is gray. CIRAs don't take on a life of their own in the way other entities do--they're an extension of their members. If a CIRA has five members with equal ownership interests and $1,000 cash, each of the members has a beneficial interest in 200 of those dollars.
Because of these unique characteristics, the users of CIRA financial statements are primarily interested in evaluating
* How their money is being spent.
* How management is maintaining their common property.
* The estimated future costs of maintaining the property.
* The prospects of incurring future replacement costs.
FUTURE MAJOR REPAIRS AND REPLACEMENTS
The most significant innovation in the guide is the unprecedented requirement to report information that helps users estimate the future costs of major repairs and replacements. Such information, which is vital to users of a CIRA's financial statements, is required nowhere else by generally accepted accounting principles.
By analogy, the owner of a private home needs information to help estimate future costs of major home repairs and replacements--100% of which the owner will have to bear. For most homeowners, information about the likely cost of replacing their roofs or adding storm windows next year will directly affect other personal finances, such as how much they spend on this year's vacation or on a new car. The inability to estimate such expenditures wreaks havoc on a homeowner's personal finances. Moreover, such information can help prospective owners decide whether to buy a home.
Likewise, for the current or prospective members of a CIRA, information that helps estimate projected costs of major repairs and replacements of common property is vital, because the members must bear these costs. Information on funding policies, requirements and overall amounts helps users make such estimates. Thus, the CIRA guide requires this information be included in the audited notes to the financial statements. Such information includes
* Any requirements in state statutes or association documents to accumulate funds for future major repairs and replacements and the CIRA's compliance with them.
* The CIRA's policy, if any, of funding major repairs and replacements and its compliance with that policy.
* Amounts assessed and collected that have been used for major repairs and replacements in the current period.
The guide requires projected costs of future major repairs and replacements be presented as unaudited supplementary information, similar to certain presentations required by FASB Statement no. 69, Disclosures about Oil and Gas Producing Activities. This additional information includes the following:
* A listing of components likely to need repair or replacement in the future--such as a roof--and category-by-category estimates of the remaining useful lives of the assets in each category.
* The amount of funds accumulated for each category to the extent designated by the CIRA's board.
* Estimates of current or future costs of major repairs and replacements including methods used to determine the amounts; the basis for calculations, including assumptions, if any, about interest and inflation rates; sources used; and the dates of studies made for these purposes, if any.
Such information must come from studies prepared by outside engineers or the board of directors. The guide requires auditors to highlight in an explanatory paragraph the omission of the supplementary information. It also requires independent auditors to apply certain limited procedures to the unaudited information.
The most debated issue in the guide concerns financial reporting of common real property to which a CIRA holds title. The guide says generally the CIRA should report such real property as its assets if it can (1) dispose of the property and (2) retain any proceeds.
CIRAs also should report as assets personal property held in common that's used by the CIRA in operating, preserving, maintaining, repairing and replacing common property and providing other services. Generally the CIRA can dispose of such common property and retain the proceeds. Examples include furniture, maintenance equipment and work vehicles.
Opinions differ on whether real property to which the CIRA holds title should be reported as assets if the CIRA cannot dispose of them and retain the proceeds, if any. AcSEC was unable to come to a conceptual consensus on this issue. In practice, virtually no CIRAs have reported such property as assets. Therefore, AcSEC agreed the guide should adopt this practice because it has as much conceptual support as other views, if not more. There are five major arguments supporting this opinion:
1. Such property doesn't meet the FASB's definition of assets. Such property provides no probable future economic benefit to the CIRA because it doesn't help a CIRA fulfill its responsibilities to preserve, maintain, repair and replace such property and to provide other services. Therefore, the property provides no service benefit to the CIRA, although it provides benefits to the members of the CIRA.
CIRAs are unique entities. Though a CIRA may hold title to or have other evidence of ownership of the property, such ownership is only a legal formality that has no effect on the financial position or operations of the CIRA. Title is held by CIRAs only for administrative efficiency: The economic benefits and obligations accrue to the members--not to the CIRAs. But the financial reporting is the CIRA's--not its members'. CIRAs function as conduits for their members by operating and maintaining the common property, but control of the property remains with the members.
2. The only substantive relationship between a CIRA and the common property to which it has title is its responsibility to maintain the property. Some observers argue the substance of such a relationship resembles a liability more than an asset.
3. The historical cost of such property is generally not measurable. Because it's usually acquired in a nonmonetary transaction with the developer, it would have to be initially recorded at its fair market value, in conformity with Accounting Principles Board Opinion no. 29, Accounting for Nonmonetary Transactions. The fair market value of such property is generally not measurable or is immaterial because
* Restrictive covenants usually severely limit and diminish the ability of CIRAs or the unit owners to dispose of or change the use of the property. Many people believe that makes the fair market value almost impossible to measure or reduces it to an amount that's likely immaterial because there's no market for such property.
* Any measurement of the fair market value would be speculative and, because there's no market for the property, the value is not verifiable.
4. Information about the cost of such property to which the CIRA has title isn't relevant and the cost of providing it isn't justified. Users of the CIRA's financial statements are primarily interested in the costs of the CIRA's current operations, its liabilities and the assets available to meet its future payments. They're interested in knowing how much the common real property will cost to maintain, operate, repair and, if necessary, replace. They're not interested in its cost. Moreover, to report such property as assets of the CIRA would be costly, because that would require many CIRAs to pay for appraisals.
5. Reporting such property as CIRA assets would reduce the comparability and usefulness of the financial statements. Many types of CIRAs are identical except for whether the CIRA or the unit owners have title to the property.
The guide requires, however, that if a CIRA holds title to common property but does not report it in its financial statements, it should disclose this fact in the notes.
A MARKED IMPROVEMENT
The new guide includes descriptions of other specialized financial reporting principles and auditing practices for the industry, including fund reporting versus nonfund reporting, statements of cash flows, presentation of budget information and independence issues. It also includes a discussion of income tax filing alternatives; illustrative financial statements; audit, review and compilation reports; and engagement letters. (See exhibit 2 Other guidance for CIRAs.)
The new CIRA guide should result in a significant improvement in financial reporting and auditing practices. Its use should provide relevant information about the rights and risks of ownership in an industry that has more financial statement users than any other.
Other guidance for CIRAs
Area Guidance Fund reporting versus Both are permitted, but fund nonfund reporting: reporting is preferred. Statement of cash flows: Should be presented in conformity with the guidance in FASB Statement no. 95, Statement of Cash Flows. Budget information: Presentation is not required. Method of reporting: Accrual basis.
[Exhibit 1 Omitted]
PHOTO : In many CIRA arrangements, members own their own individual real property dwellings. But common property, such as a swimming pool, is held in common for the benefit of all members.
MANDEL GOMBERG, CPA, is director of real estate services for the Practice Development Institute, Chicago. He is chairman of the American Institute of CPAs task force on accounting for common realty associations and a member of the Illinois CPA Society. JOEL TANENBAUM, CPA, is a technical manager in the AICPA accounting standards division. He is a member of the New York State Society of CPAs.