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Accounting guidelines for community associations.

Accounting Guidelines for Community Associations

Common interest realty associations (CIRAs) are a rapidly growing segment of the U.S. housing market. They include condominiums, timeshare developments, planned unit developments (PUDs), and cooperative housing corporations.

It is estimated that there are currently more than 130,000 associations nationwide, representing at least 50 percent of the market share of new home sales in the 50 largest metropolitan areas. These associations spend over $12.5 billion and maintain another $5 billion in reserves - a buying power greater than the total annual budget for the State of Illinois. Given current population trends and considering the economics of home buying, it is estimated that by the year 2000, there will be over 225,000 associations and in excess of 18.5 million units (CAI, 1988).

CIRAs and financial information

The responsibilities of owning a collective property are much different from those of owning a house. Each unit owner has a shared responsibility for maintaining the property held in common with his or her neighbors. A key feature of this common ownership arrangement is the existence of an association of owners which is responsible for providing services and maintaining property that all the owners share or own in common.

Associations have governing documents (Covenants, Conditions, and Restrictions, or CC&Rs) that typically state the owners' rights and restrictions on the use of common property, as well as their obligations to participate in the governing and funding of the association.

Complying with the CC&Rs and maintaining the common property requires a substantial investment of time and money. Generally, the association members elect a board of directors to act as a responsible party on behalf of the association. In many associations, the board of directors delegates the day-to-day management function to a property management company.

The management company's responsibility is to maintain the association's common property in accordance with the wishes of the board of directors. In most instances, the management company is entrusted with collecting homeowner assessments and paying bills. In smaller associations, the management company may only perform the bookkeeping function. However, in larger associations the management company also may be actively involved in engaging repair and maintenance persons, answering members' complaints, and enforcing association rules through the imposition of fines.

Because of the large number of people and the significant amounts of money involved, CIRAs have special accounting and auditing needs. The primary users of association financial information are individual owners. They are interested in information that indicates that assessments are being expended for the common good of the association. They want to know whether the assessments are adequate to cover current operating expenses and if there is a need to raise the assessments or impose a special assessment for future repairs and replacements.

Financial information that indicates that the association is fiscally sound may help owners sell their units and enhance the value of individual units. Financial information also helps members judge whether the management company is adequately performing its contractual obligations and whether the association's board of directors is complying with CC&Rs and acting for the common good of the membership.

However, interest in the financial statements is not limited to association members. Financial information is often requested by third parties, such as:

* the lender to the developer who holds the financing on the property during the development period;

* lenders to buyers of units;

* prospective buyers of units;

* federal, state, and local tax authorities; and

* insurance companies used by the CIRA or individual members.

Because of the many entities that use association financial information, the need for uniform financial reporting among CIRAs is becoming increasingly important. To ensure accurate, consistent reporting of financial data, many associations turn to third-party accounting firms.

The role of the CPA

To ensure that association financial statements are reliable, many CC&Rs and state statutes generally require a certified public accountant (CPA) to annually examine the financial records and report to the membership about the association's financial position, results of operation, and cash receipts and payments for the year.

In any case, an association, especially one employing a management company, should engage a CPA to perform an annual "review" or "audit" as a normal business practice and to comply with federal, state, and local taxing authority requirements.

A "review" by a CPA consists of inquiries of association and property management personnel and analytical procedures applied to financial data, using standards established by the American Institute of Certified Public Accountants. The outcome of this work is a report indicating that the CPA is not aware of any material modifications that should be made to the financial statements in order for them to be in conformity with generally accepted accounting principles (GAAP).

An "audit" is a more detailed examination of the financial statements, including tests of the association's or management company's accounting procedures and financial data. An audit includes evaluating such things as internal accounting controls, confirming bank account balances and accounts receivable, making physical observations of assets, and tracing transactions to invoices and evidence of payments.

The outcome is the CPA's opinion that the financial statements present fairly the financial position and results of operations in conformity with generally accepted accounting principles. Significant weaknesses in internal accounting control noted during the audit must be communicated to the association's board of directors, but an audit is not designed to locate such weaknesses unless they would have a significant effect on the financial statements.

Whether an association needs an annual review or an audit by an independent accountant is dictated by its governing documents and state statutes. In either case, the CPA is not guaranteeing accuracy or precision because he or she is testing the financial statements through the use of various audit procedures and not looking at 100 percent of the information supporting the financial statements. A well-designed audit provides reasonable, but not absolute, assurance of detecting significant errors or fraud.

A review or audit should also be performed annually or whenever a major change is made in the handling of the association's finances, such as a change in management companies or during transition from developer to owner control.

Accounting and reporting issues

In an effort to bring a degree of consistency to the financial reporting by CIRAs, the AICPA has developed proposed accounting and auditing guidelines for this growing industry.

The guidelines are still in a draft stage, but are expected to be finalized by the end of 1989. While associations and property management companies will not be required to follow the guidelines, CPAs are likely to recommend that the guidelines be followed when association financial statements are reviewed or audited and an independent opinion is issued.

The proposed guide addresses several financial issues relating to CIRAs, including:

* the manner in which common property and facilities will be treated for accounting purposes;

* the inclusion of estimates for anticipated major repairs and replacement of common property in financial statements;

* the format used for presenting association financial statements;

* the use of accrual-basis vs. cash-basis accounting in financial statements;

* the inclusion of budget information in CIRA annual reports; and

* the tax treatment of various sources of association income.

While no final decisions have been made on the recommended guidelines, it is expected that the AICPA will make some recommendations concerning how its members should handle CIRA financial reporting.

Implications and conclusions

Users of CIRA financial statements will probably benefit from the implementation of the financial reporting and disclosure recommendations of the proposed guide. Increased uniformity will enable owners and interested parties to make better decisions. Consistent reporting of financial information will make it possible for owners and managers to compare data from one accounting period to the next and provide important information not currently disclosed, such as estimates for repairs and replacements and budget to actual comparisons.

While the benefits of uniform financial reporting and more disclosures by CIRAs are clear, such changes in financial reporting present both opportunities and pitfalls for property management companies.

If uniform financial reporting requirements are applied to all associations regardless of size, small associations may find the accounting and reporting requirements particularly burdensome and require professional assistance. Collecting, summarizing, and disclosing all the recommended information in the proposed guide will take extra time and increase operating costs for associations and management companies.

Self-managed associations and property management companies will need to develop and/or modify existing accounting procedures and computer software to collect additional data and produce the detailed financial reports outlined in the proposed guide.

The role of the CPA who provides service to CIRAs will change as well. A more thorough examination of legal documents, internal accounting controls, budgets, financial statements, and information on repair and replacement of common area components will be necessary before issuing an independent opinion.

If it is implemented, the new guide will create additional work for CIRAs, management companies, and CPAs. It may also generate increased legal liability in instances of noncompliance.

Will users of CIRA financial reports, particularly owners, perceive the benefits of uniform financial reporting to outweigh the costs of compliance? Presumably, they will. However, the boards of directors of associations and management company personnel will have to educate owners about these benefits in order to justify the higher fees associated with the information gathering and disclosure requirements of the proposed guide.


American Institute of Certified Public Accountants. Professional Standards. Commerce Clearing House, 1988. AICPA. Exposure Draft of Proposed Audit and Accounting Guide for Common Interest Realty Associations. AICPA, August 31, 1988. AICPA. The New Auditor's Report. AICPA, 1988. Bussman, J.F., and D.E. Wegman. "Accounting for Condominium Associations." Journal of Accountancy (January 1980), pp. 42-45. Requests for copies of the proposed accounting and auditing guide should be addressed to the American Institute of Certified Public Accountants, Accounting Standards Division, 1211 Avenue of the Americas, New York, NY 10036-8775. Ronald S. Stone, M.B.A., Ph.D., CPA, is a professor of accounting and management information systems at California State University, Northridge. He has been on the faculty at the University of Southern California and UCLA. Mr. Stone is a consultant to community associations and property management companies in Southern California. J. David Foxman, M.B.A., CPA, is a manager at Heller & Broida Accountancy Corporation in Los Angeles and has taught at California State University, Los Angeles. He provides accounting and tax services to the real estate industry.

PHOTO : Greater standardization in reporting assessments and expenditures will be a boon to the

PHOTO : investors

PHOTO : and residents who are beginning to return to the stagment condominium market.
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Author:Stone, Ronald S.; Foxman, J. David
Publication:Journal of Property Management
Date:May 1, 1989
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