Associations with financial statement years beginning after December 15, 2018 and who have been reporting their financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP), are now required to follow the new standard for reporting revenues from contracts with customers – ASC 606. Potentially, your association accounting could be more challenging, but also more informative.
This new standard is a major departure from GAAP as you used to implement it. Up to now, GAAP covered associations under a special section – ASC 972 “Common Interest Realty Associations”. As of this year, this special section no longer determines the timing and extent of how revenues are recognized. Which means that you are facing some potentially difficult decisions.
To be brief, ASC 606 requires all revenues generated by a contract to follow a five (5) step process for recognition:
1. Identify the Contract
2. Identify the Performance Obligations
3. Determine the Transaction Price
4. Allocate the Transaction Price to the Performance Obligations
5. Recognize Revenues when (or as) each Performance Obligation is satisfied
In the past, your association assessed the owners the amounts necessary to cover the operating expenses identified in the budget. You might have also identified additional reserve contributions that were needed based upon a reserve study. Typically, each month, owners were “assessed” and those assessments were considered “revenue”. It was simple and relatively straightforward. The new five step method is (or may be) considerably different as it is based upon your determination of
The contract itself; what is stated or implied; who are the parties
What performance obligations are included in the contract; that is, what does the association do for assessments
The actual transaction price; how do you handle situations where assessments might change
How you allocate the transaction price to each performance obligation
How you identify the completion or delivery of the performance obligations
The reason we are bringing this to your attention is that you may have options to avoid implementing the new standard. For instance, for HOA’s in Washington, under RCW 64.38.045 (3), “At least annually, the association shall prepare, or cause to be prepared, a financial statement of the association.” What this appears to say is that, under the RCW’s, while HOA’s are required to prepare a financial statement – the financial statement is not required to be prepared in accordance with GAAP. Based on this, your board may be able to change from GAAP basis accounting to some other comprehensive basis of accounting. Your condominium management might not be ready or prepared to implement this new standard for you.
Sadly, some associations, such as condominiums in Washington, are stuck as state law (RCW 64.34.372(1) requires financial statements to be prepared in accordance with GAAP. Associations may also run into an issue when articles of incorporation, the declaration, or bylaws state that you are obligated to prepare your financial statements in accordance with GAAP. If your association formation documents have this type of language, it may be best to speak with your association legal counsel as soon as possible to see what steps you can take to remove this language from your documents and have that section follow more closely in line with state law if the law does not specifically require GAAP.
Provided that there is no language referencing GAAP, or you amended your formation documents, you can look at other options for preparing your financial statements. The most important element is that your financial statements be comprehensive – that is it should strive to provide all the information that is relevant to your Association. Below is a list of the various methods of accounting which you could elect, other than generally accepted:
Cash Basis of Accounting
Modified Accrual Basis of Accounting
Financial Reporting Framework for Small to Medium-sized Entities © (FRF for SME)
A little bit about the Financial Reporting Framework for Small to Medium-sized Entities. FRF for SME is a recent accounting policy published by the American Institute of Certified Public Accountants (AICPA) to deal with the complexity of some of the more recent GAAP standards. The most prominent one that FRF for SME attempts to address is ASC 606. The AICPA recognizes that most small entities do not have the accounting and management depth necessary to successfully implement ASC 606 and, more importantly, realizes that for most, the way their accounting was being handled was perfectly acceptable to the readers of the financial statements.
Under the FRF for SME, your association’s accounting is accrual based; you would continue the accounting as you did (provided you were following GAAP and not one of the other bases of accounting) by recognizing
the receivable for unpaid assessments;
the liability for prepaid assessments and accounts payable;
accrued and prepaid expenses.
Your association would continue to recognize assessment revenues over the course of the year – just as you have been doing. The upside is that, other than stating you are adopting a new accounting basis, there is no new accounting treatment to implement. The downside is that this standard is not generally accepted, and you could run into trouble should you ever need to borrow money from the bank; and the bank demands financial statements prepared in accordance with GAAP.
Following GAAP may be the correct course of action for your association. The reality is though, implementing ASC 606 will demand accounting and management expertise. The new standard will require documentation on the selection of your performance obligations and how you allocate assessments over those obligations. As a board, you will want to ensure your involvement in these important decisions. Let’s face it; managers change; but your accounting policies need to remain the same.
Adopting ASC 606 is also not something you can put off until the end of your fiscal year as there are far too many decisions to make and much of your interim accounting could be incorrect. This could result in major accounting adjustments and confusion on behalf of your management, your board and your owners. Ultimately, it could also lead to higher audit and review costs and possibly even to adverse opinions (or no opinion) because of the lack of preparation.
You also cannot (or rather should not) rely upon your auditor to help you implement this new standard. Your auditor must walk a very careful line: If the auditor starts selecting performance obligations and allocating the transaction price, it is highly likely this level of involvement could impair independence. The easiest way to impair independence? The auditor reviewing their own work. Clients will need to choose between the auditor’s help implementing ASC 606 or providing the audit, the auditor really should not do both.
This said, your auditor can help you understand the five steps of ASC 606 and what your requirements are under the new standard. We strongly encourage you to reach out to your audit firm as soon as possible to help you identify the right steps for your association and how you can ensure successful implementation of your decision well before the end of the year.
ASC 606 is the single most comprehensive change to the accounting standards – ever. While it could provide better and more effective information to owners, it will come at a cost. Determining if a benefit is greater than the cost is one of the more important decisions you make as a board. Work with your manager, your CPA and potentially reach out to others who might be able to help you make the best decision for your association. Starting early will help ensure you make the best decision for today and for your association’s future.