Posts Tagged ‘Due Diligence’

Analyzing the financial health of an owners association may not be so clear cut, especially if the accounting is done on a cash basis.  The reason for this is that there may be some assets and liabilities not listed on the P&L and Balance Sheet.  These items include Accounts Payable and Accounts Receivables, and the amounts can be significant. 

Under cash basis accounting, an expense or receivable is not recorded until cash changes hands.  The only place you will see these items is on the AP and AR report which won’t hit the General Ledger and financials until paid or received. 

So how does the association operate when there is a significant cash shortfall? Through special assessments, budgeting a contingency line item, having a budget that’s already padded for this situation or even borrowing from Reserves.   The latter should be used as a last resort and I will address this issue on a different post.

Although cash basis accounting does not paint an accurate picture of the financial standing of an owners association, it should be supplemented with additional disclosures and reports.

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Reserve Account- This is money collected through assessments and set aside for large capital expenditures such as parking lot repairs/re-paving, or roof repairs or replacements.  The amount to be collected through assessments is determined by a reserve study which outlines the estimated amount of the capital expenses along with the timing of them.  For example, the study might conclude that the roof on all buildings will need to be replaced in 5 years at a cost of $40,000.  This amount is then to be collected through Reserve Assessments if there aren’t sufficient funds in the account already.

Now that we understand what this money is intended for I’ll continue with my story.  The BOD were excited at the idea of getting several thousand dollars refunded to them so they approved the refund.  A few months passed and the board member that persuaded everyone else to refund money from the reserve account sold his unit.  The buyer, did not properly perform his due diligence and bought into an Owners Association that needed extensive capital improvements!  Since there isn’t sufficient money to cover the expenses, there will most likely be a Special Assessment that every owner must pay in order to cover the cash shortfall.  The amount of this Special Assessment will most likely be…you guessed it, the amount that was refunded to everyone.

The moral of the story is to dig deep in the financials of an Owners Association that you are looking to buy into.  Look over the BOD meeting minutes, Reserve Study, and Reserve Account to assess if it has been properly funded.  Otherwise, you will get a bill for a Special Assessment for several thousand dollars.

Don’t forget to rate, comment and share my post and I’ll keep them coming!