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Accounting for common interest realty associations.

Accounting For Common Interest Realty Associations

In 1961, the U.S. Congress enacted the National Housing Act which extended the government issuance of mortgages to condominiums. This was viewed as a declaration of confidence by the U. S. Congress and the Federal Housing Authority which provided the impetus for condominium legislation on the state level such that by 1969 all 50 states had passed some form of condominium legislation.(1) Legislation for other similar forms of real estate ownership began to appear in the years that followed.

Today, condominiums, cooperatives, planned unit developments and time shares are household terms. Unique to these forms of real estate ownership is the existence of common property and the establishment of an association to manage such property. These associations are generally referred to as common interest realty associations (CIRAs). Indeed, so popular is this form of real estate ownership that the Community Associations Institute recently reported that one of every eight Americans lives in housing that is managed by CIRAs.(2)

CIRAs are required to provide financial information to their members on a regular basis. Financial statements of CIRAs are of utmost importance to members of the CIRA in order to determine whether assessments are used for budgetary purposes and whether common property is maintained and replaced according to a specified plan. Potential buyers are also keenly interested in these statements in order to properly assess the value of their purchases. Only through an understanding of these statements can new buyers and existing owners avoid costly surprises. Many other users, such as real estate agents, lenders, insurers and taxing authorities, are also interested in the information provided in a CIRA's financial statements.

Today, all user groups demand better accountability from the managers of CIRAs. This demand, in turn, encourages CIRA management teams to utilize the services of accountants. The increasing number of CIRAs and the emphasis placed upon improving the quality of information provided in financial statements have expanded the need for accounting services. Given the growing importance of this market, practitioners should be aware of those regulatory and accounting developments that affect CIRAs, especially in such bellwether states as Florida and California.

For example, Florida now requires condominium association boards to deliver to each unit-owner a complete report of actual cash receipts and disbursements for the last 12 months. The Florida administrative code requires condominium associations to provide:

1. Compiled statements when

annual cash receipts total from

$100,000 to $200,000, 2. Reviewed financial statements

when annual receipts are

within $200,000 to $400,000, 3. Audited financial statements

when annual receipts are

$400,000 or more.

The requirement to provide compiled/reviewed/audited statements may be waived annually by the majority vote of the unit owners.(3)

Under the Florida administrative code, reviews and audits must be performed by certified public accountants. At the same time, the code of ethics of certified public accountants allows an accountant to both compile and audit the financial statements of the same CIRA. In Florida, unit owners and/or CIRA managers are well-advised to retain public accountants instead of CPAs for their compilation work. This will assure the independence of the CPAs because they will not be auditing their own work.

Accounting for CIRAs is an ever-expanding market, and practitioners must keep pace with recent developments in order to provide the best possible service to clients. One such development is the expected issuance by the AICPA in 1990 of the first official guide for CIRA accounting.

Exposure Draft

The exposure draft of the proposed guide is composed of nine chapters and an appendix with illustrative financial statements. Of the nine chapters, three are devoted to accounting for common property, future major repairs and replacements and financial statement presentations. The remaining six chapters are on industry background, budgets, income taxes, audit considerations, review and compilation engagements and cooperative housing corporations. The most controversial issues are accounting recognition, measurement and reporting issues.

In the income tax chapter, the exposure draft addresses the issues of "what is" rather than "what will be". Income tax considerations are covered very briefly and somewhat supperficially in the exposure draft, and the reader is advised to find other sources for more detailed information. The exposure draft states that all CIRAs are required to file federal income tax returns, and elections are made annually as to which should be used.

Those CIRAs that wish to be taxed like regular corporations must file federal Form 1120 and must pay income taxes for the excess of member assessments over expenditures, unless such excess is either distributed to homeowners or designated for capital replacements. Tax rates are the usual graduated corporate tax rates.

CIRAs may also wish to file under Internal Revenue Code Section 528 (homeowners associations). In this case, Form 1120H is filed where income from member assessments are tax exempt. Therefore, capital expenditures need not be designated and segregated. The applicable tax rate for all taxable income over $100 is 30%.

Very few CIRAs will be tax exempt under Section 501(c) of the Code (civic leagues or social welfare organizations) since they only provide benefits to the members in the immediate neighborhood. Those that qualify under the foregoing section will file Form 990. The previously mentioned elections can be made annually.

Accounting for Common Property

The Issue of Recognition

Of those issues under consideration, one of the most controversial is the accounting recognition of the common property. When title or other evidence is in the name of the CIRA, questions arise as to whether or not common property should be recognized as an asset on the CIRA's balance sheet. In large part, the discussion has centered around the various interpretations of the FASB's definition of "assets of an entity". This definition states that in order for an item to qualify as an asset, it must "embody a future benefit, be under control of the entity and be the result of a past event or transaction." It is, therefore, proposed that if title or other evidence of ownership is in the name of a CIRA, then, in general, the property should be recognized as an asset on a CIRA's balance sheet. If, on the other hand, a CIRA does not hold title to common property, as would be the case for most condominium associations, no asset would be recognized.

Consider, for example, common property such as a seawall. The guide does not permit a condominium association to recognize this type of asset because the condominium association does not hold title to the seawall. However, the guide requires other types of associations to recognize the identical type of asset (seawalls) since these associations usually hold title to seawalls. It is argued that recognition of such an asset either does or does not have information content for the users of financial statements. If it is decided that this is useful information then the legal form should not take precedence over the substance of the issue.

The chairman of the Task Force on Accounting for CIRAs stated that the initial position of the exposure draft outlined above was revised early in 1989. The revision recognized the current practice of not reporting such assets if the CIRA cannot dispose of the asset and retain the proceeds.(4) This, of course, will be the case for most common real property but not for common personal property such as furniture. Therefore, most common real property will not be reported on a CIRA balance sheet. Fortunately, this revision requires disclosure under such circumstances.

The primary logic supporting the guide's position regarding the recognition of assets is that the lack of ability to dispose of and use the proceeds derived from these assets indicates a lack of control, which is one of the requirements of the definition of an asset. Such logic can be refuted when one considers the case of capital leases. A lessee cannot sell leased property and use the proceeds of the sale yet the property is recorded as an asset.

The Issue of Measurement

CIRAs that hold title to property as well as control the disposition and proceeds of the property face the problem of determining the value at which the asset should be recorded. The proposed guide relies on the historical cost concept: an asset is recognized at cost to the acquirer, and if no cost exists (as in the case of a non-reciprocal transfer of an asset by the developer to the CIRA), then the fair value of the asset received is used for the cost basis. Naturally, if fair value does not exist, which will be the case in most instances, then the cost to the developer is used. Failing that (for example, the developer's cost is not available), then no asset is recognized.

The guide relies solely on the definition of an asset and the historical cost concept. We believe, however, that the debate over the definition of an asset is misdirected since the perspective of individual owners and the uniqueness of the reporting entity (CIRA) is not properly evaluated. Although this topic has received token recognition, proper attention has never been directed toward the objectives of CIRA financial statements from the users' perspective.

Almost 10 years ago, the accounting profession decided that the objectives of business financial statements are different from the objectives of personal financial statements. While the historical cost concept is appropriate for the former, it is not suitable for the latter. Although CIRAs may hold title to common property, the CIRA acts as conduit for its members. Therefore, control remains with the members. This, therefore, is the reason why the definition of an asset is not satisfied even when CIRAs hold title to the property in question. At the same time, there is now an entity that reports to owners in the same way that a business entity does. It appears that the proposed guide has made no attempt to draw from the underlying principles of personal financial statements.

Objectives of Financial Reporting

The argument exists that the accounting profession should address the subject of the objectives of a hybrid entity's financial statements. CIRAs are unique entities because their reporting requirements do not fall entirely under the principles of reporting by business entities nor do they fall entirely under the principles developed for personal financial statements. Objectives of CIRA financial statements have differences as well as similarities with objectives of both business and personal financial statements. The similarities and differences cited below are meant to be illustrative rather than exhaustive.

Business financial statements emphasize earnings whereas personal financial statements emphasize net worth. For most CIRAs, earnings are not even a concern. In fact, if it is ever a concern, then this is directed toward holding sales revenue down so as to break even only and thus maintain the tax-exempt status. In this regard, CIRA statements are comparable to personal financial statements and reporting assets; liabilities and fund balances are far more important than reporting earnings for current and potential owners. When substantial CIRA assets are not reported for one reason or another, then unit owners have no way of knowing what property may be held in common, the amounts invested in common property and whether proper attention is given to such property. Even though it may be argued that assets are disclosed in notes, the accounting profession has never accepted the position that good disclosure compensates for bad accounting.

Business financial statements report on managerial performance whereas personal financial statements have no such objective. In this respect the perspective of CIRA reporting is similar to business reporting. It is important for unit owners to know if management has properly discharged its stewardship function.

Individuals frequently are unable to provide the necessary documents to determine the cost of many assets they own. The same seems to be true for CIRAs. For various reasons, the cost of common real property is unavailable. Therefore, it becomes costly to apply the historical cost concept. Indeed, this was one of the major practical reasons for rejecting recognition of certain CIRA assets. Not surprisingly, it also was the reason for the adoption of market values for personal financial statements.

One of the objectives of business financial statements is comparability. This objective is of limited importance for personal financial statements. The same is true for CIRA financial statements.

Still other examples of similarities and dissimilarities can be cited, but suffice it to say that the objectives of CIRA financial statements are a combination of personal and business financial statements. Consequently, any standard that may be developed should draw from the objectives of both.

Members of a CIRA would like to know which assets are held in common and their approximate market values before attempting to seek a determination of management's stewardship function. With this in mind, it is recommended that all CIRA real common property be shown on the balance sheet regardless of how the title may be held and/or who has control over the proceeds of disposed assets. Tax appraisals and insurance appraisals adjusted for inflation can be used as surrogates for market values. That is to say, true market values are not necessary since practical approximations can be generated at a relatively low cost and still be useful.

The proposed guide requires the disclosure of replacement cost information for major repairs and replacements. However, it is ironic that a CIRA should be required to report the replacement cost of the roofs, floors, walls, plumbing and electrical systems of a club house but not the replacement cost of the club house itself. Unit owners trying to sell their units at certain prices would find it difficult to justify the higher asking prices by quoting the replacement cost of the common property's major components. The potential buyer will perceive the replacement cost of major components as future expenses rather than increased value of the common property over the years.

Personal property, such as exercise equipment or furniture, can be reported at historical cost. These are purchased assets for which the CIRA would have the necessary cost documentation. These are also assets where in many cases owners are not interested in replacement cost information.

Other Reporting Issues

The proposed guide does not require the disclosure of budgetary information. From the users' perspective, it is difficult to imagine any information in financial statements that is more useful. The quality of managerial planning and management's fiscal responsibility are reflected in budgets. Consequently, this is considered to be another weakness of the exposure draft.

The proposed guide allows the statement of cash flows to be prepared using either the direct or the indirect approach. Once again, it appears that the guide is attempting to comply with generally accepted accounting principles so as to parallel the cash flow statements of business enterprises. To some extent, the indirect method used in business enterprise cash flow reporting can be justified by stating that there are experts available who can interpret complex statements to lay users. However, it is difficult to imagine a lay owner either deciphering the cash flow from operations under the indirect approach or being in a position to seek the advice of a paid professional. More than likely such statements will not be used.

Finally, the proposed guide allows the use of fund or non-fund reporting. The guide expresses a preference for the fund approach used by not-for-profit organizations as a more informative presentation, since non-fund reporting does not enable users to determine whether or not the funds have been used for their designated purposes. The proposed guide justifies the non-fund reporting on the basis that certain CIRAs may not assess for future major repairs and, therefore, may not need fund reporting. If this is a concern, then the use of non-fund reporting should be restricted to those cases.


The proposed guide for CIRAs appears to have been developed with one point in mind: conform to generally accepted accounting principles as they now exist. The guide should have placed more emphasis on users' needs and therefore should have drawn from the underlying principles of both business reporting and personal financial statements.

Granted that the exposure draft of the proposed guide is a significant step forward considering the current state where no guidance for CIRA accounting exists. Nevertheless, the final result is disappointing considering that 10 years of time and effort have been invested in producing this guide. Perhaps this is the reason why the expected release early in 1990 of the new guide has not materialized. Regardless of the status of any guidance at this time, accountants should stay tuned to the needs of the common interest realty associations because this is a rapidly expanding opportunity for accountants to be of service to the community.


(1)Klink, James J., Real Estate Accounting and Reporting, (New York: John Wiley and Sons, Inc., 1980 page 88. (2)Gomberg, Mandel and Tanenbaum, Joel, "New Guide for Common Interest Realty Associations," Journal of Accountancy, November 1089, page 88. (3)Levine, Norman and Miller, Leonard, E., "New Rules for Mandatory Condominium Reporting," Florida Florida CPA Today, November, 1987, page 18. (4)Gomberg and Tanenbaum, op. cit., page 96.

Murat Neset Tanju is an associate professor of accounting at the University of Alabama at Birmingham. He earned his PhD and MAc degrees from the University of Georgia. He is a CPA and CMA. Dr. Tanju is a member of the American Accounting Association, American Institute of Certified Public Accountants and the National Association of Accountants. He is a national director of NAA and a past president of the South Birmingham chapter. He has been published in a number of accounting journals. A.J. Sylvestre is an assistant professor and chairman of the accounting department at the University of South Alabama. She earned her PhD degree from the University of Georgia. Dr. Sylvestre is a member of the American Accounting Association, the National Association of Accountants and the Institute of Internal Auditors. She has been published in a number of accounting journals.
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Author:Tanju, Murat Neset; Sylvestre, A.J.
Publication:The National Public Accountant
Date:Sep 1, 1990
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