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  • Recognizing Revenue(8/21/2020)

    by: John Watkins, CMCA, AMS, PCAM

    THE CHANGES in accounting requirements made in 2019 by the Financial Accounting Standards Board (FASB) do not entirely serve the purpose of financial reports and audits for community associations. The FASB interpretation of revenue recognition for reserves considerably understates the financial health of a community association like mine.

    I manage a 30-year-old, mixed-use gated community that is 80% single-family homes and with more than 2,600 owners. Our concern is that reporting should give the most accurate information to respond to questions such as: What is the likelihood of a special assessment? Will the assessment rate go up rapidly? How much is a home actually worth? Is a nonprofit association supposed to pay taxes on accumulated funds?

    The association owns about a third of the 2,850 acres in the community but does not own or operate the golf course, swimming pools, tennis courts, gym, or boat yard. It does own and maintain roadways, open spaces, walking trails, parts of rivers and creeks, 96 retention ponds plus a large drainage system, two small gatehouses, and a 2,000-square-foot office building. About 20% of annual revenue is allocated to reserves for replacements, emergency repairs, and capital expenditures. The reserve study has a 40-year projection and is updated annually.

    The primary basis of the new FASB ruling appears to be that assessments and other revenue collected in advance for services to be provided cannot be recognized as revenue until the services are given (and, in many cases, further supported by a contract or other binding commitment). If an association collects assessments in advance and is obligated to give services over time, it might not be recorded as revenue until the service is provided. Revenue for most communities is often collected on a monthly or quarterly basis, and services and maintenance must be provided.

    The association's objections to its auditor's interpretation of the new FASB ruling is the use of the “deferred revenue" category and whether certain funds should be reported in the liability or equity sections of the balance sheet. Our gross annual revenues are slightly over $4 million—88% from assessments and the other 12% either from tolls for use of our private roads by commercial vehicles or from telecommunications company agreements.

    The three largest uses of these funds are security operations, landscaping of association-owned property, and reserves to maintain roads, storm drains, retention ponds, and for capital improvement projects and emergency repairs. We essentially have no directly paid expenditure for services or insurance on properties owned by private owners.

    Deferred revenue is used for funds paid with the expectation they will be repaid or are used as payments in advance for future assessments. Deposits for construction activities are repaid if the project is completed and passes a final inspection, if they are properly classed as deferred revenue until the project is closed.

    Owners who pay more than the current assessment and are prepaying a future assessment have their payments treated as deferred revenue, because if the owner leaves before the property is next assessed, the association will refund that money. If assessments are paid for the entire year and the home sells from one owner to another, the closing transaction settles a credit for the paid assessment, but the association does not refund any assessment money.​​

    The interpretation on reserve funds completely fails to recognize normal practices in reserves. Our general concept is that current owners should pay as they go. If a road needs repair 15 years from now, the owner who lived here and contributed annually for those 15 years has properly paid into the reserve. The owner who bought just last year has only made one contribution but also has only put one year's worth of wear and tear on the roads.

    Most importantly with reserve funds is the fluidity and the suggested criteria FASB states regarding when reserve funds can be recognized as revenue. We collect and hold money for roads and drainage repairs which may well occur 15–25 years out. We own about 32 miles of road and 33 miles of drainpipe. We cannot saddle homeowners 20 years from now with special assessments. The actual value of a home in our community depends, in part, on recognizing that reserve funds are assets and should have a status similar to retained earnings in the equity section.

    What is done at the start of each year is approval of an annual budget by homeowners that authorizes reserve expenses planned for the next year. We might plan for a primary road to be resurfaced in six years, but it might happen in four or eight years. If another hurricane comes along, we would most likely move some funds planned either for replacement or capital projects to emergency repair so that we do not have spikes in assessments to pay for large storms. FASB wants commitment to a contract, but such a contract will not be codified or authorized for some years.

    In summary, more than 90% of our total revenue would be deemed deferred for some period of time, and some of it deferred for years. It is not an accurate representation of our financial position.

    » How is your community navigating the FASB's new accounting requirements?

    John Watkins is the general manager of Dunes West Property Owners Association in Mount Pleasant, S.C. jwatkins@sw-community.com

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