The accounting treatment for the special assessment called Serial Assessment
Addressing the recognition and reporting of a complex transaction under accounting principles generally accepted in the United States (GAAP).
Over the last four or five years, there has been an attempt to create a hybrid mechanism to protect condominium assessments and the associated lien rights which attach to those liens. This research does not address the individual claims against property and owners and instead focuses on the specific accounting treatment to ensure that the transaction is recorded correctly under US GAAP. Our concern in this analysis is the appropriate accounting treatment of assessments under existing GAAP. We do not attempt to clarify the impact of the new pronouncement of ASC 606 as it pertains to assessments.
The Basics of a Serial Assessment
- It derives its power to assess from the bylaws of the condominium organization which typically grants the board of directors broad powers to levy assessments for “special” situations.
- The special situations are those which lie outside the standard budget and assessment cycle – the operating assessments
- The special situation generally addresses funding shortfalls in the reserve fund when specific reserve projects are required to be done
- Serial assessments attempt to levy a sum of money on a periodic basis over a period in excess of one year.
- Serial assessments might incorporate an interest charge for those periods in excess of one year
- Serial assessments may grant the right to a unit owner to pay off the serial assessment, either in the beginning or at certain times during the assessment period
- If a serial assessment is not paid at time of transfer of a unit, the buyer takes the unit with that serial assessment still outstanding
- The serial assessment is “levied” periodically instead of at the time of the original assessment, which attempts to ensure that there is a continuing lien against the property regardless of transfer of title or default and discharge
GAAP on Serial Assessments
The Financial Accounting Standards Board (FASB) has issued the Accounting Standards Codification (ASC) which details accounting principles generally accepted in the United States of America (GAAP). GAAP are based on the economic qualities of a transaction, not necessarily its legal structure. The objective of financial reporting is to provide information that is useful in making decisions about providing resources to an entity. The purpose of financial reporting is to provide decision makers with useful information.
Some of the qualitative aspects of financial reporting include
- Usefulness for decisions
- Faithful representation
ASC 972 provides GAAP for Common Interest Realty Associations (CIRA), of which condominiums are a specific type of CIRA.
ASC 972-605-20 provides that CIRA’s are typically funded by periodic assessments of its members so that the CIRA can provide ongoing management, maintenance, administration, repair and replacement services on behalf of the organization’s members. These are the annual operating and reserve assessments which are approved by the board of directors and which may need to be ratified by the ownership at an annual meeting.
Any other assessment is a special assessment. Boards of directors are given the power, typically stated in the bylaws, to assess the ownership and members for non-budgetary transactions, i.e. special transactions. This special transaction could be to address a deficit in the operating fund due to unforeseen common operating expenses or to address a deficit in the reserve fund for either specified reserve projects or to build up the general reserve fund for unspecified future projects.
ASC 927-605-25-1 states that “Special assessments shall be reported as revenue, unless they are deferred in accordance with the guidance in paragraph ASC 972-403-25-1.”
ASC 972-403-25 states, “Deferred revenue may include items such as a special assessment designed for specific costs that have not yet been incurred. Such amounts shall be reported as revenues when the corresponding liabilities and expenses are reported.”
Both ASC 972-603-25-1 and ASC 972-403-25 are built upon the conceptual framework. For the purpose of this analysis, we provide the following definitions from CON 6:
Assets – Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
Revenues – Inflows or other enhancements of assets of an entity or settlement of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major and central operations
An event is a happening of consequence to an entity. It can be an internal event or an external event with another entity or with the environment in which the entity operates.
A transaction is a particular kind of event. It is an external event that involves transferring something of value to another entity.
Accrual is the accounting process of recognizing the effects of future cash receipts and payments in the current period. Accrual accounting attempts to record the financial effects on an entity of transactions and of other events and circumstances that have consequences for the entity in the period in which those transactions, events, and circumstances occur rather than in the periods in which cash is received or paid by the entity.
Matching is the simultaneous recognition of the revenues and expenses that result directly and jointly from the same transaction or event.
Analysis of the Facts and Conclusions
A serial assessment is a special assessment. It is a special assessment as it is prepared outside the normal budgeting and assessment process for determining the operating assessment and the reserve contribution to be levied against the owners in the upcoming fiscal year.
There is no legislative support for the concept of a serial assessment. As a matter of fact, most state laws are silent even as to the power of a special assessment. The right to assess the owners and memberships outside the standard budget cycle is generally a power given to a board of directors by its bylaws. It is generally understood that where state law does not directly contradict a governing document, the governing document will prevail.
There is also no specific codification to be found in the accounting literature addressing serial assessments. That is because the serial assessment can be analyzed as either an operating, or common, assessment, or a special assessment. If the assessments has the characteristics of an operating assessment, it should be treated as an operating assessment; if it has the characteristics of a special assessment it should be treated as such.
This means the serial assessment must be judged based upon its economic consequence. In order to determine how the transaction should be recorded, we must look to the underlying reason why the assessment is being levied to the owners and members.
Example 1: Large construction project coming due
In this example, the hypothetical condominium association AB Condo Association has identified that in three years, it will be required to expend approximately $5,000,000 for a series of reserve projects. The board has determined it will have a reserve funding deficit of $2,000,000 when that project is done. The board passes a special assessment and calls it a serial assessment where the $2,000,000 is going to be levied monthly to the ownership over 36 months.
The board identified that there is a reserve fund deficit and calls for an assessment of $2,000,000. Because the board called for a special assessment for the full amount but is allowing owners to pay in monthly installments over 36 months, the Association should record the receivable and a deferred revenue item for the $2,000,000 which will become revenue as the reserve project is completed.
From an economic standpoint, the board and owners have acknowledged a funding deficit exists. The board and owners have agreed to a process to address the funding deficit. This meets the requirements of an asset as laid out in the Concept Statement 6 and should therefore be recorded at is present value.
While our analysis is focused exclusively on the appropriate accounting treatment of the assessment, the interest factor should not be ignored. Because this assessment is being collected over 36 months, ASC 835 Interest should be taken into consideration. Since the board has not stated that there is an interest component on the payments from owners who elect to pay over the 36 months, the interest should be imputed at a market rate. This is necessary as financial statements prepared in accordance with GAAP should have assets and liabilities stated at their present value. (ASC 835-30-10)
Example 2: Desire to build up the reserve account
AB Condo Association board of directors has a concern that the Association could be underfunding its replacement reserve. It decides to assess a 12 month serial assessment against the units for a total of $1,000,000 and levy it monthly until all units have paid.
From an economic standpoint, the board and owners also acknowledge a funding deficit exists. The board and owners have agreed to a process to address the funding deficit. This is a special assessment for the full amount with installment payments due in under twelve months. Because the special assessment is for less than twelve months, ASC 835-30-10 will not apply.
Example 3: Large construction project coming due and board borrows funds for the construction
Similar to Example 1 ,only the AB condo board has identified that it cannot collect the full assessment due for the deficit which exists for this reserve project. The board borrows $2,000,000 from a bank. It states that owners have two options: pay their portion of the special assessment up front or pay it over 120 months with interest due on those payments equal to the bank’s rate of interest it will charge on the loan. The board calls this a serial assessment and owners have the option, but not the obligation, to pay their outstanding balance on their assessment at the time of sale of their unit.
As in example 1, the board recognizes a deficit in the reserve fund to pay for the construction. To facilitate the immediate construction, the board addresses the funding deficit by borrowing funds. The Association will record revenues to match the construction costs paid for by the bank financing and will have a receivable from the owners for the total amount of the construction costs above what has been financed from the established reserves.
Example 4: Large construction project coming due, board borrows funds for the construction and there is no special assessment
Similar to examples 1 and 3, only the board does not pass a special resolution to assess the deficiency to the owners. Instead, the board agrees to increase the annual operating assessment in an amount sufficient to pay the bank a monthly principal and interest payment.
The board recognizes that there is a deficiency in the reserve fund. The borrowed funds are used to pay for the construction. To match the construction costs, revenues should be recorded and properly charged to the owners as a receivable. The amount of the receivable is the present value of the discounted cash flows of the excess operating assessments charged to the owners. If, for instance, the actual operating expenses of the association are $200,000 and the board increases the operating assessment to collect funds to pay the bank its principal and interest by $200,000 per year and this will run for 15 years, the present value, at an appropriate market interest rate (assume 5% for this example) would be the present value of that additional assessment charge. In this case, $200,000 over 15 years at 5% interest rate is a present value of $2,075,000.
The authoritative guidance for assessments all support the premise that the Association has an economic claim against the unit owners for the present value of the payments which are incurred to pay for addressing a funding deficit. GAAP calls for matching the revenues to the expenses in a given reporting period and, to the extent that funding deficits are identified and a plan put in place to address it, the funding plan has economic substance and should be recognized as an asset.
The determination of its recording as income earned by the Association or deferred is a matter of the facts and circumstance which led to the special assessment. If the special assessment is for a designated purpose, the assessment should be deferred until the related costs are incurred and then recognized as revenue. If the special assessment is put in place to address an overall funding deficit, the amounts are likely revenue upon the assessment.
The economic reality is that the owners, especially in a condominium, own the common elements. Charges to repair or rehabilitate the common elements are, in fact, the responsibility of the owners. Thus, either the Association has pre-collected those funds and have established a reserve for those future amounts, or the Association has an obligation to assess the owners upon the identification of the actual funding deficit. Either way, the Association clearly has an asset under the accounting standards.