1. Washington State Chapter COMMUNITY ASSOCIATIONS INSTITUTE The professional organization providing education, resources, and advocacy for community association living.

2. Budgets & Reserve Contributions Catherine Kuhn, CPA Ken Harer, Attorney ken@condolaw.net 206-633-1520 cathy@hoacpa.com 425-641-4808

3. Topics Today: Accounting Basics- Balance Sheet & Income Statement Cash vs. Accrual Accounting Reserve Study Basics Statute Requirements Budgets Reserves Audit Requirements Related to Reserves Reserve Funding Plans Assumptions about inflation & earnings Interest and borrowing of reserves

4. Who Are You? Old Act Condominiums (created <1990) New Act Condominiums (created >1990) Mixed Use Condominiums Homeowner’s Associations (Planned Unit Developments) Association Managers

5. You?: By Total Budget Size: $100K or less $100K to $250K $250K to $500K Over $500K

6. Accounting Basics Balance Sheet Financial Position at a Point in Time (e.g. Dec 31, 2012) –Assets (What you OWN) –Liabilities (What you OWE) –Members’ Equity (Net Worth, Fund Balance, Retained Earnings) “Accounting Equation” Assets MINUS Liabilities EQUALS Members’ Equity Assets EQUAL Liabilities PLUS Members’ Equity (Balance!)

7. Balance Sheet ~ Assets Cash (Operating & Reserve) Accounts Receivable (Cash Yet to be Received)  Typically Past Due Assessments (billing 1 st of the month)  Allowance for Bad Debt “contra” (offset) account Other Owner Receivables (Water billings, bill-backs) Prepaid Insurance (Ins Premium Paid in Advance of Use)

8. Balance Sheet ~ Liabilities Accounts Payable – Expenses to be paid Prepaid Assessments – Assessments that are paid in before they are owed to the Association “Due between Funds” - Can be an asset or a liability depending on the Fund (discuss later)

9. Members’ Equity (Fund Balance) What you OWN (Assets) less What you OWE (Liabilities) Two Types of Equity: Operating Reserves

10. Sample Fund Balance Sheet

11. Income Statement “Statement of Revenues & Expenses” Results over a period of time Assessments Revenue - Should be total budgeted assessments for the year (accrual basis) Some allocated to operations, some to reserves Interest income (operating and reserve) Expenses – We all know what that is! “Net Income” Revenue Minus Expenses (Hopefully positive or $0!) Reserve Net Income can be positive or negative --- OKAY

12. Sample Income Statement

13. Cash vs. Accrual Cash– Checkbook Accounting – Recorded when PAID Accrual – Matches Income with Expense as incurred- Recorded when Incurred

14. Cash vs Accrual Revenue (Assessments) Accrual records assessments at the beginning of the month based on budget Cash records assessments as collected Expenses Accrual- Landscaper performs work in January- expense recorded in January Income Statement Cash- Landscaper performs work in January and billed/ paid in February- Expense recorded in Feb

15. Is Accrual Required?? GAAP is “Accrual” “Generally Accepted Accounting Principles” Old Act Condos: No mention of GAAP, we recommend GAAP New Act Condos: GAAP required- Resale Certificate Implications HOA Act: GAAP not required – Our preference is GAAP

16. Accounting Basics QUESTIONS ????

17. Reserve Study Basics Long term financial planning tool Provides information to include in annual budget for major maintenance expenses 30 year projection of expenses Calculates steady contributions over 30 years

18. Core Information from Studies Fully Funded Balance Calculation Cash Flow Contribution calculation Funding Plans Baseline Funding – never run out of money Full Funding – Build over 30 years to be 100% funded Consultant’s Recommended Funding

19. Reserve Study Basics QUESTIONS ????

20. Progression of Laws 1990 reserves mentioned 2008 required for condos 2012 required for HOAs 2012 budget disclosure required

21. Requirement to Fund Reserves CAI National Policy on Funding Statutory Requirement to Fund Neither requires funding Belief that Boards know best how to fund for future expenses

22. New(er) Statutory Requirements Applies to New Act Condos and HOAs Budgets proposed to owners now must include information on status of reserves. Key concept: 1) Current savings, 2) Recommended by consultant, 3) Proposed Budget Goal is to keep membership informed. Complex Statute requires specific information be submitted to owners at budget time.

23. What if You Don’t Comply? There is no penalty for failure to have a reserve study Owners can petition to have included in next year’s budget Some Associations need not have Studies Statute is silent on penalty for failure to disclose reserve information during budget Risk is that the budget would be found invalid, so any increase from prior budget would not be collectible from delinquent owners.

24. Risk During Collections if New Budget Process Not Followed Risk during collections if the new Budget Process is not followed Same risk as before that Board does not comply with law requiring Reserve study New difference is that the Budget section of New Act Condo and HOA laws were revised without same exceptions in law.

25. Questions? Law & Risk

26. SPECIFIC REQUIREMENTS OF 2012 LAW FOR ASSOCIATION BUDGETS HOAs and Condos formed after July 1, 1990 Committee’s intent was all condos, but code reviser at legislature did not know that

27. Requirements of 64.34.308(4) and 64.38.025 Well intended legislation, with a goal of fully informing owners about: 1 – How they are currently doing on saving for future needs, and what happens over the next 5 years. 2 – What the professional is recommending and how that looks. 3 - What the proposed budget includes and what that will do over 5 years.

28. Requirements of 64.34.308(4) and 64.38.025 (a) State current, recommended, and proposed reserve contribution rates, and Funding Plan used by the professional to make the recommendation. (b) State if additional funding will be required, when it is due, and what it would be for. (Example: special assessment of $100,000 to replace the roof in 2015). Show amount per unit per year and month for those expenses

29. Requirements of 64.34.308(4) and 64.38.025 (c) State if the association will run out of money in the next 30 years at its CURRENT contribution rate. This is a YES or NO question (d) If the answer to (c) is “YES”, then attach a spreadsheet showing for all 30 years when it is short, and by how much. These are not easy calculations to do.

30. Requirements of 64.34.308(4) and 64.38.025 (e) State the projected year end: Reserve Account Balance per the Study Reserve Account Balance per Budget, & The Percent Fully Funded as of the Reserve Study date (f) Estimated Year End Balance for the next 5 years at RECOMMENDED contribution rate, and CURRENT rate, & PERCENT FULLY FUNDED each of those years

31. Requirements of 64.34.308(4) and 64.38.025 (g) Estimated Year End Balance the next 5 years at the BUDGETED contribution rate, the FULLY FUNDED BALANCE for each of the next 5 years, and the PERCENT FUNDED each of the next 5 years at the BUDGETED contribution rate Intent is to show how the Current, Recommended, and BUDGETED contribution rates compare over time

32. We provided three samples of forms that three providers have created to try and respond to the new law Questions on statutory requirement for budget?

33. Unplanned Reserve Expenses Building related expenses are OK, even if not planned, or not included in the reserve study Borrowing from reserves for unrelated expenses triggers notice requirement to owners and a repayment plan to restore balances within two years.

34. Failing to Fund Planned Reserves Is failing to fund for lack of money the same as borrowing from Reserves?

35. CPA Audits and your Reserves Budget – relation to Reserve Study Missing Budgeted Reserve Deposits “Due Between Funds” “Transfer Between Funds” Operating vs. Reserve Expenses Controls- Reserves Audit Reports – Required Disclosures

36. What if Budget NOT = Reserve Study? Does your association budget’s reserve contribution MATCH the RS annual contribution recommendation? What happens if your annual budget contributions don’t match the study? Is there an accounting “issue” if it doesn’t?

37. What if Budget NOT = Res Study? There is NO accounting (books) issue if your annual budget does not match the RS There IS a possible audit report disclosure issue if the annual budget contribution doesn’t match the study

38. What if we MISS budgeted reserve deposits? GAAP: Requires that the budgeted reserve allocation (contribution) be shown as the “revenue” on the reserves Income Statement, regardless if “paid” into the fund or not. (ie “accrual method”) GAAP: If not paid to reserves, it will show as a “payable” to reserves or a “Due Between Funds”.

39. Due Between Funds When one fund owes another fund money Can be a result of ~ Reserve deposits not made Expenses not paid out of right fund Wrong amounts – either deposited or paid Wrong coding of expense Monies borrowed Interest not properly posted Accounting errors (e.g. journal entries)

40. What if we don’t pay back the missed Reserve Deposit? GAAP- Considered a “transfer between funds” and a “permanent transfer” is made from the reserve fund to the operating fund.

41. Transfer Between Funds When one fund moves assets from one fund to another Can be a result of: Moving cash permanently between funds “Forgiving” loans “Forgiving” amounts Due Between Funds

42. Due Between Funds vs. Transfer - GAAP How to determine for GAAP? True Receivable and Payable? Intention to repay? Documented plans to repay? New Reserve Study? Ability to repay? Enough operating cash/fund?

43. Due Between Funds vs. Transfer ~ IRS Form 1120-H No impact Form 1120 May fail the tests ~ Strict segregation of cash Use of monies as intended May not be qualified to file form 1120 if large Due Between Funds or Transfers

44. Questions?? Due to Reserves, transfers, missed deposits~

45. Operating vs Reserve Expenses Is it a Reserve Expense? GAAP: Major repair or replacement Industry Standard: Major repair/replacement not an annual event Extends the life of common area component Included in the reserve study Board determination

46. Is it a Reserve Expense? RCW: “Infrequent and significant nature make them impractical to be included in the annual budget” IRS: Must be “capital” in nature

47. Ops versus Res Expense? Why important? Reserve Study will not be accurate if operating and reserve expenses are not segregated and improper expenses are taken out of reserve cash Operating Income Statement analysis of Budget to Actual will be inaccurate For IRS purposes, very important to segregate operating and reserve expenses

48. Controls – Reserves Funding in accordance with the budget Does your Board know when reserve deposits are missed? Reserve expenses Operating or Reserve expense? Paid from correct fund? Approvals?

49. Controls- Reserves Funding in agreement with Reserve Study Spending in agreement with Reserve Study Changes in either not funding or not spending according to the Reserve Study can significantly impact future cash flow projections.

50. Controls on Reserve Activity BOARD MINUTES – Very Important! Nature and amount of reserve expenses Decisions to repay reserves, payment plans Decisions to transfer funds (instead of repay) Why the budget does not match the RS Why reserve deposits are missed/plans --

51. Questions? Operating/Res Exp and Controls:

52. Audit Reports and Reserve Disclosures Footnotes to the Audited Statements:  Requirements to accumulate funds (statutes), including FHA (RCW: no funding requirement)  FHA requirement that 10% of op budget go to reserves  Funding Policy  Reserve allocation for the year (Income Statement)  Reserve Study status  Reserve Study annual allocation – compared to budget

53. Required (Unaudited) Supplementary Information (RSI) Estimates of current or future costs of major repairs and replacements for all existing components (ie, Reserve Study) Components, useful lives Funds accumulated (ie Reserve Fund Equity) C&C adds: “Percent Funded”

54. New RS Requirements: RCW 1/1/12 Certain required disclosures now in the annual BUDGET document Most of our 12/31/12 audit clients did NOT have this disclosure in their 2013 budgets Internal Control Report “comment” if not included in Budget document

55. Questions? Audit/Internal Control Disclosures?

56. Investment Options for Reserves CAI best practices from 2001 Statutes silent on investments Federally insured investments no loss of principal possible. Laddered investments Investment Portfolio Management

57. Budgeting for Inflation and Income on Reserve Balances Over 30 years these two components cause substantial shifts in estimated contributions Can you earn more than inflation? Who makes estimate of these for your reserve study and your budgets?

58. How this affects budgets and needs

59. Contributions increase at 5%

60. Funding Plans - options 1 - Baseline Funding – Saving at steady rate so that you don’t run out of money for 30 years 2 - Full Funding – Saving at steady rate so that you are 100% fully funded at end of 30 years Difference may be increased contribution of 13% 3 – Threshold Funding – More than Baseline 4 – Planned Special Assessments as needed 5 – Defer repairs and maintenance

61. Fully Funded at end of 30 years

62. Becoming Fully Funded – 30 years

63. What Funding Plan should you use? Depends on specifics of each community Age of building and timing of future repairs Circumstances of owners now and in future Risk tolerance Ability of owner to pay on short notice Ability of owners to invest funds and earn more One thing all providers agree on: More money in reserves means fewer special assessments.

64. Risks of no Study, or of not funding, per Study recommendation Boards must act with reasonable and ordinary care Statutes could be used to define that standard of care Primary risk is no money for necessary repair Secondary risk is owners can’t or won’t pay if you special assess for repairs Disclosure to owners/buyers can reduce risk.

65. Resource: hoacpa.com

66. Resource: condolaw.net

67. Question & Answer Session Thank you! Ken Harer, Attorney Catherine Kuhn, CPA Condominium Law Group, PLLC Cagianut & Company, CPA ken@condolaw.net 206-633-1520 cathy@hoacpa.com 425-641-4808

68. CAI and the Washington State Chapter of CAI Working Together to Serve You National CAI caionline.org (888) 224-4321 Washington State CAI wscai.org (425) 778-6378