For those of us who have community associations in states where financial statements prepared with Generally Accepted Accounting Principles (GAAP) are required, 2019 may be especially difficult. Financial reporting has undergone significant changes in 2019 for those associations that report on the GAAP basis. The main change to GAAP is the revenue recognition principles. The new standards completely change how and when an association recognizes revenue.
Real Estate entities such as homeowners and condominium associations used to have their own carve out for recognizing members assessments in GAAP, contained in ASC 972. Under ASC 972 associations would typically recognize revenue from members in the period they were assessed. For example if an association assessed dues to all the members in a given month, it would all be reported as revenue in that month. This was a pretty straight forward entry. The entry was to debit accounts receivable and credit revenue for the same amount. While this was a simple entry it really missed one of the main principles of GAAP, which is the matching principle. Under the matching principle revenue should be matched to the corresponding expenses when possible. If you consider that the revenues are assessed to pay for the operating and reserve expenses of an association, it doesn't make sense to recognize the revenues if the corresponding maintenance or other related expense haven't taken place. This is where the new revenue recognition principles of ASC 606 come into play.
ASC 606 eliminates the revenue recognition standards of 972. ASC 606 tries to recognize revenues with the corresponding expenses and it lays out a method to do this, however this won't necessarily be an easy task for associations. There are five steps to this process:
- Identify the contract with the customer: While identifying the customer may seem pretty straightforward, in the case of an HOA it may be the unit. While some people might argue the owner is the customer, I would ask them who has membership in the Association the unit or the owner? The important question becomes what is the contract? The definition of the contract is "Agreement between two or more parties that creates enforceable rights and obligations" What in an association creates enforceable rights an obligations? This could be the governing documents, such as the declaration and bylaws, or it may be the budget that is created each year.
- Identify the performance obligations, or the (promises) in the contract: This is where associations and the industry will have a hard time. What are the performance obligations within an association? What does the association promise to provide to the customers (units)? This will really vary between associations. There could be two performance obligations or there could be 15. For example the promises or performance obligations may be to maintain the building, it may be to provide professional services, or it may be to collect an administer funds for the repair an replacements of the individual units and common areas. This is the step that most associations will struggle with and need help with, but it is necessary because all the other steps require that the performance obligations be identified before revenue is recognized.
- Determine the transaction price: This is the amount of consideration to which the association expects to be entitled in exchange for transferring the promised services to the customer (unit). While this may seem straightforward, it can get difficult when you think of special assessments, because interest and financing have to be taken into consideration among other things.
- Allocate the transaction price: The association will then allocate the transaction price to each of the performance obligations.
- Recognize revenue when the association satisfies a performance obligation: This is where the matching principle comes into play. For example how much of the dues will be recognized when the association performs the landscaping for the month, and how much revenue will be recognized when the reserve study is completed. If the association identifies future replacements as a performance obligation, It would not recognize the revenue collected from the units, until the replacements are completed.
This would be a great time to have that conversation with your management company, because waiting until year end will be to late. We are having this conversation with our clients now, so if you have any questions, or would like to discuss how this will affect your association or management, please give us a call. You can read more about ASC 606 at our company blog: CORE beliefs blog
Doug McLain, CPA
CORE Services, LLC
Providing attest and financial services to associations