For a crystal-clear picture of how an association is doing, there are few better lenses than the community's budgets and financial reports. From an investment perspective, they show the shareholders, managers, tenants, owners, and board whether the property is solvent or not. If the numbers add up and the monies coming in and out balance, you can safely assume everyone is doing their job, and upholding their financial duty to the community. If the property is in the red, it’s important to determine why that is, and what needs to be done differently to turn the situation around and restore solvency.
Maintaining and updating the accounting of their property is one of the primary responsibilities of a board—one that is all-too-frequently neglected, according to the pros.
Brad L. Schneider, CPA, president of CondoCPA in Elmhurst, says that there are three main purposes of financial documents. “First, they assist the property manager and the board members in managing the association in the short term and the long term. Second, financial documents will show unit owners that the management and board are doing a good job and to alleviate suspicions that there is anything going on that is not in the best interest of the association. Lastly, they can be a good sales tool to help give a good impression to prospective buyers that the association is on sound financial footing and that it is run in a professional manner,” he explains.
It’s important to understand each financial document and its purpose so you can have a better understanding of exactly what’s going on in your association. So here’s a little Financial Paperwork 101.
Financial Statements
Financial statements show the income and expenses for an association. Steve Silberman CPA, shareholder at Frost, Ruttenberg & Rothblatt, PC in Deerfield, suggests that these files be updated on a monthly basis and smaller associations can get away with doing so once every quarter. Reviewing and recording changes and discrepancies is important, otherwise the process becomes almost worthless. What is the point of creating and maintaining a budget if you are not sure of your incoming and outgoing expenses?
“What we recommend is that on a monthly basis an association's board should get certain documents. Those documents include a balance sheet, an income statement, a bank reconciliation, check register and a cash receipts journal, a general ledger, there should be a replacement fund report and an accounts receivable report. Those are things that they should get every single month,” says Silberman.
An important component of managing finances is completing an annual audit. According to the Institute for Internal Auditors, “internal auditing bridges the gap between management and the board, assesses the ethical climate and the effectiveness and efficiency of operations, and serves as an organization’s safety net for compliance with rules, regulations, and overall best business practices.”
“We always recommend that associations do have audits,” says Silberman. “What happens is often, especially with smaller associations, they don't see the need to have a third party financial statement. They feel that their in-house treasurer's or management company's financial statement is fine but it is always good and we think it is part of their fiduciary responsibility to have a third party financial statement. We recommend an audit, but if they can't afford to do an audit every year, we believe there should be a review or compilation done by an outside accounting firm.”
For Your Eyes Only
It is also important to consider who can see which documents. Certain paperwork should only be accessible to board members, while other files can and should be viewable by owners and even prospective buyers, in order to disclose the status of the association and expenses. It is important to note that being too generous with who can see what can lead to problems and unnecessary unease, but on the other end, being too secretive can lead to distrust in residents who might suspect that the board or management has something to hide. In other words, it is a very fine line to tread.
According to the Illinois Condominium Property Act (ICPA), the board must provide a clear summary of income and expenses required by Section 18(a)(7) of the ICPA. The board is required to supply each year an itemized accounting of common expenses for the preceding year actually incurred or paid, along with a list of specific items allocated to reserves, capital expenditures, repairs and real-estate taxes. The tabulation must compare the income and expenditures to the budget.
As a rule of thumb, Schneider suggests that only board members have access to scavenger rebates, the annual report with the Secretary of State, common area maintenance agreements and annual calculation documentation, parking tax returns (if in Cook County and have outside parkers), and loan documents as well as the monthly statements from the bank.
Owners and prospective buyers should be entitled to view the reserve study, monthly financial statements, including the balance sheet and budget to actual comparison, annual audit, (or compilation or review), year-to-date general ledger, check register, monthly bank and investment statements, accounts receivable listings, paid invoices, and copies of contracts.
For documents that are not readily available for owners, “unit owners can request additional documents and they can go back a few years, but they need to have a purpose as to why they are requesting them. So if they want more detailed records, they can request it and the board has to make a decision within 30 days. And if there is a cost, the unit owner has to pay for that,” says Silberman.
Managing Investments
A solid and effective investment policy is another document that Illinois associations should be prudent about updating and most importantly, having. The investment policy is a written document that specifies how an association's funds are being invested.
“We see many associations that do not have an investment policy at all. To us, that is one of the key things, especially in the economy that we are in right now, that there needs to be an investment policy,” Silberman says.
“It is important to have a policy that states the goals of the association—is it to fund reserves?” he says. “Is it to avoid or minimize special assessments or borrowing and what are the investment products—are they more concerned with safety, liquidity or yield? Is there a criteria for selecting the type of investments?”
“The investment policy is where your procedures should be on who is controlling the account. Who is the signature on the account? You should put down who are the check signers. This is so the new board coming in knows exactly who is on those accounts and how many accounts you have. Too often new boards come in and if they have CDs in fifteen different banks, now they don't understand who is in the account. These are things that should be in the investment policy and it makes things easier for the association,” he explains.
Reserve Studies
Emergencies are going to happen and every association needs maintenance and repairs and should be prepared with enough financial reserves to cover the costs of these emergencies and repairs. To know what those costs are, associations will typically hire an architect and/or professional engineering company to complete a reserve study. A reserve study provides estimations on repairs and replacement costs for the property.
For example, the engineer determines the roof has seven years life span left before it needs to be replaced. The replacement cost is $100,000. To raise that much money, the association needs to save a minimum of $14,000 per year (x 7 years) just to cover this replacement, assuming no other money is already put aside.
The study is done every one to five years, and the cost depends on the depth of the study. “A professional should update it every 3-5 years, but the board needs to review it annually and they need to make changes to it because so many things happen each year, that the study, if they are not looking at it and updating it annually, the study is wrong,” says Silberman. “Maybe the study called for them to do a certain project but they were able to do certain maintenance to delay that project. Now they need to readjust their study and their funding. Let's say they are borrowing from reserves or didn't get the money into reserves they were supposed to, now they need to relook at this and readjust the funding for those items in the reserve study and that, we see is not being done as often as it should be.”
Where's the Money?
Many associations, especially smaller ones, only rely on one person to manage the documents. While this makes everyone else's role easier, it is not the preferable method of governance.
“It depends if you are managed or self-managed but the treasurer probably has more responsibility in being in charge of the documents but he or she also has the responsibility of making sure that all the board members are seeing these documents,” says Silberman.
“I can't say it enough, the board has to be involved, it can't just be that one person. Whenever we see just one person involved, that could lead to possible fraud or possibly other board members not doing their due diligence in understanding the financial documents. All of the board is responsible for the financial information of the association.”
Financial Security
Last year in Chicago, the co-owners of a defunct Chicago condominium management company were charged with fraud for allegedly stealing more than $2 million in assessment payments In Washington D.C., the FBI arrested the owners of a property management company accused of defrauding an estimated million dollars from homeowners. And this past spring, in Exeter, New Hampshire, a property manager was accused of stealing $67,000 from three Exeter condominium associations. He allegedly pocketed money meant to pay expenses. These examples are not meant to provoke panic and suspicion among residents and board members but serve to show that fraud can occur, especially during under-supervised and overly permissive circumstances.
So how does an association maintain financial security? There are a couple tasks to perform to ensure the confidentiality and safety of your documents and certify the integrity of employees and residents.
“Segregation of duties is very important. Most management companies except for extremely small ones will have a segregation of duties. The person approving the invoice for payment is different from the person preparing the check for payment. The person signing the check will not be involved with the management of the association directly,” says Schneider.
He also encourages associations to have the accounting performed by a management company or accounting firm, which “will be a good way to give the whole process some type of oversight.”
The key word is oversight. Be sure to require multiple signatures on checks, maintain records off-site, have more than one board member award a contract to a vendor and make sure you have competitive bidding.
Lisa Iannucci is a freelance writer and a frequent contributor to The Chicagoland Cooperator. Editorial Assistant Maggie Puniewska contributed to this article.
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