More on Contracts in ASC 606

This morning I wrote on my other blog about the steps your Association will need to take when analyzing your annual owner assessments to determine when and how revenues will be recognized.   The approach there is going to be required for every entity which needs to produce financial statements in accordance with GAAP.  Specifically for HOA and condominium Associations though, there are a few things to keep in mind.

First you need to recognize who your customer is.  The vast majority of your Association’s revenues comes from assessments, also called dues, which are charged to your owners.  Thus, your contract is with the owner, both individually and collectively. So, how many contracts exist?  In theory, one for every owner in your association.

But in reality, there is really only one contract which every unit owner agrees to.  So, instead of looking at each owner agreement differently, you can combine those contracts into a single agreement for accounting purposes.  This is known as the Portfolio Approach and should be implemented for your Association as it applies ASC 606.

The reason this works is that each agreement with an owner is identical to every other agreement with every other owner.  The agreement calls for the same efforts to be expended by the Association on behalf of the owners.  The agreement is entered into on the same day and the payments are due over the same period of time.

Under the Portfolio Approach, you treat all the contracts as a single contract when it comes to revenue recognition.  This should simplify the accounting as you need only evaluate the performance obligations at the Association level, instead of looking to each owner agreement.

How do you handle this in reality?  It is dependent on both your software and accounting processes.  The easiest way is to separate the amounts due from the owners and revenues.  For our example, lets assume you are a 100 unit association with an annual budget of $120,000.  On December 31, the budget is passed by the board and ratified by the owners.  Ignoring performance obligations at the moment, you might want to consider the following entry at the time your budget is passed and ratified:

  • Owner Assessments Receivable                        $120,000
    • Association Unearned Revenue                                        $120,000

As owners pay, you receive their payment and reduce the owner assessments receivable.  This method is likely most appropriate since you passed and ratified an annual budget which obligates the units for the year’s assessments.  Owners can pay for their assessment in full or over the course of the year.  This can be somewhat challenging as we know most Associations and their management have gotten used to recording each monthly “invoice” as revenue; but keep in mind that what is billed is likely no longer tied to when revenues are earned.

For those Association’s which want to invoice monthly, this isn’t a particular problem.  The easiest way to handle this would be to record the following:

  • Annual Owner Obligation                                  $120,000
    • Association Unearned Revenue                                            $120,000

And then each month when you issue the invoice to the owners:

  • Owner Receivable                                                $10,000
    • Annual Owner Obligation                                                     $10,000

Notice though that we still haven’t recorded anything which recognizes revenues.  That is because the new rules under ASC 606 require you to look at the performance obligations inherent in your agreement with the owners.  Let’s say for our example, management determined that performance obligations equal to $10,000 were completed during the month:

  • Association Unearned Revenue                        $10,000
    • Assessments Income                                                                  $10,000

Management would analyze contract performance at least once a year to determine how much revenue from that contract is recognized.  This is important because it is quite possible that you will have areas of the contract which are still not performed.  Imagine if you will, the budget has $5,000 set for legal expenses.  It is your year-end and your Association has only spent $1,000.  What happens to the other $4,000?

The answer is, unfortunately, “It Depends”.  If you identified legal expenses as a performance obligation to your owners as part of the assessment, it should likely remain as Association Unearned Revenue.  This is especially true if you are carrying forward the budget item.  That is to say, when the board meets to pass the budget, if they say, “We didn’t use all the budget last year so lets still expect $5,000 but carry-forward the $4,000…” then it is highly likely that the board set a specific performance obligation which has not been completed yet and thus the $4,000 should remain in Association Unearned Revenue.

If your Association refunds excess assessments back to the owners in March of the following year, then you not only didn’t earn the revenue, you actually no longer have unearned revenue but rather a refund due to the owners.  This is likely even true if you don’t technically issue a check but rather use the unused budget money to reduce future assessment amounts.

Complicated?  Perhaps.  Impossible to implement?  Not at all.  What it requires is that board’s understand the expectations and rules and ensure they establish correct policies and then ensure those policies are carried out.  But hey, that is why you have audit, right?  If you have questions or concerns, feel free to write and we will try to help you understand how you may be impacted by the new rules.

At C.O.R.E. Services, we focus on being a strong independent check on management and their assertions. Which is why we enjoy working with Property Owner Associations. The boards are dedicated but typically outsource the management who record the transactions and prepare financial statements for the board to review. Our audits are designed to help the board and owners rely upon those statements. You can find more information about us on our website.

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