Chapter 3 Funding the Reserves MVF Style Oh, What a tangled web we weave!
Bill Hurley, in his book “Montgomery Village, A New Town,” writes in the chapter on “Funding the Corporations, “Recognizing basic to the long terms success of the entire Montgomery Village project Kettler Brothers had to make certain commitments to ensure the continuing enhancement and growth of the value of the residents and the success of the Homes Corporations and the Foundation”.
The first Kettler commitment was to “complete the common property according to plan, design specification and turnover or deep the property to the Homes Corporations and the Foundation free of debt. “For the first 12 years of development Kettler paid a gratuity to the Foundation for each home or apartment built, as a start-up fund”, 1968 to 1980. True to its word over time common property, buildings and recreation facilities were deeded to the Foundation and each Homes Corporation, as it was completed and ready for use.
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When the first homes became occupied in1968 accounting standards and practices for reporting of common property assets on the book and records of Common Interest Realty Associations (CIRA) had not been established.
When the Foundation began operation and set up financial reporting system the values of each property grouping of common property assets was valued on the MVF’s balance sheet based Kettler Brothers initial construction cost as property assets with a corresponding property fund equity balance.
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There were two (2) rationales to capitalize common property assets.
1. The annual depreciated amount of each asset could be a method of estimated the contribution to reserves to be included in the annual assessment for future major repair and replacement.
2. The annual deprecation cost may from time to time be allowed as expenses to offset revenue for federal or state income tax reporting.
However, long before the publishing of the initial CIRA accounting and auditing guidelines by the American Institute of Public Accountants in 1991 common property and equipment held by individual members in common or by the Association was not recognized as having value and the legal and accounting requirements for determining the annual funding of contribution to reserves for major repair and replacement were well established.
Reporting on Common Property - Common property of a CIRA includes all real property to which individual members hold ownership in common or by the CIRA directly. It also includes personal property, such as furnishings and recreational and maintenance equipment that is owned by the CIRA and used on common real property. Each member of a CIRA has a beneficial or undivided interest in the property. A CIRA can acquire common property as a transfer or deed from the developer or it may buy property on the open market.
The Role of the Association Treasurer published by Community Associations Press by Howard A. Goldklang CPA, MBA
Capitalization Policy for Association-Purchased Assets Capitalization is the recognition on the balance sheet of the association’s property and equipment. The capitalization policy set guidelines regarding what assets are appropriate for capitalization and at what dollar amount the assets should be capitalized. The elements of a good capitalization policy are as follows:
A clear understanding of what is appropriate for capitalization. Real property and common areas acquired from the developer and related improvements to such property are not capitalized because those properties are owned by the individual unit owners in common and not by the association.
Property that would capitalized are those assets having the following criteria:
1. The association has clear title or other evidence of ownership.
2. The association can dispose of the property for cash.
3. The property is to be used by the association to generate cash from non-member sources.
Property & Equipment Except for those purchased assets as outlined by Goldklang above fixed assets are not significant in CIRA record keeping, budgeting and reporting.
Applying the above guidelines and rules MVF was only allowed to capitalize and depreciate approximately $400,000 equipment and vehicles used by the Landscaping and Public Works department to generate Maintenance Activity F und (MAF) income. That ended with the sale of this equipment to The Brickman Group in December 2011.
Undesignated Operating Surplus (UDOS) is the accumulation of prior surplus and contributed capital since the CIRA was first established. The term “Undesignated Surplus” can be misleading and viewed as a discretionary fund to lower assessments. Undesignated Operating Surplus is needed working capital to operate a multi million operation. Consequently, the Association’s Budget Policy should mandate UDOS should be sufficient to pay operating funds timely, fund monthly reserve contributions and absorb unanticipated budget deficits. Howard Goldklang recommends UDOS should equal ten percent of the annual operating budget or as in case of MVF approximately $700,000.
Normal Practice When a developer of Condominium or Large Scale Common Interest Realty Association turns over control of an Association to an elected homeowner Board of Directors, early on, through the existing management organization, hires an engineering firm to complete a reserve study to determine the annual Contribution to Reserve Assessment and allocate initial reserve funds between the property components and working capital.
Funding the Replacement Reserves MVF Style MVF Independent Auditor’s Report for fiscal year 2001 prepared by Regardie, Brooks & Lewis, Notes to Financial Statements note 9 Future major repairs and replacements.
“Starting in 1984 the Foundation’s Board of Directors conducted a study which identifies all major maintenance and repairs and estimates the remaining useful lives and replacement cost of component of common property. The Board is funding for major repairs and replacement over the remaining useful lives on the components. Accordingly, the budgeted fund requirement for 2002 will be funded as follows $40,812 Contributed to Reserves, $487,065 estimated depreciation and actual interest earned on reserves funds interest”.
The start-up fund was used as the initial Undesignated Operating Surplus.
Advanced Reserve Solutions of Dover New Hampshire completed the first and only reserve study performed by Professional Engineer firm in July 2007, 39 year after Montgomery Village began operations. Unfortunately, whatever value ARS’ reserve study provided was ignored by the Foundation. Consequently, the establishment of “Schedule of Reserve Components” and “Distribution of Current Reserve Funds” noted in the Preface of ARS study pages I to v, were not established nor used “to allocate beginning reserve funds between the property components and working capital”.
At the May 23 2013 MVF board meeting, the board awarded Design Management Associates of Richmond, Virginia a contract for $13,800 to conduct an Interactive Reserve Analysis. This scenario sounds very similar to the 2009 Resident Survey that we’re not allow to see and the 2013 Resident Survey that lead to believe the Quality of Life in the Village is much improved since 2009 with Humpton and Snellings “running the show”, “sailing the ship”, “leading the charge”, or following the “bright star in the east” towards “Vision 2030”.
The Capitulation and Depreciation of the original common property is only a part of a larger scenario used to fictionalize property value to mask the transference of assessment income from Capital Replacement Reserve (RS) fund to cover ongoing deficits of MVF’s Fee for Service operations. Let’s review what the Foundation has does in behalf Montgomery Village property owners to ensure the continuing enhancement of their quality of life and equity value of their property”. It’s complicated, hopefully I can keep it simple for you.
1.Redefine and Reclassify the Fund Accounts. Montgomery Village has two types of operating funds; Member Assessment based funds and Fee for Services Funds. Member Assessment fund have two components, Operations and Future Major Repairs and Replacements (Reserves). There are three Assessment based funds, Montgomery Village Foundation, Inc. (MVF), Designated User Facility Fund (DU) and Poplar Spring Fund (PS). The income and expenses for the User Fee Program Fund (UFP) are incorporated into the MVF and DU funds. The Contribution to Reserves (CTR) comes from two sources, Assessments and Interest on Reserve investments.
The monthly CTR to Reserves from Assessments and Interest and any capital grant and Capital Contribution Fees (CCF) received during the month should be transferred into interest bearing accounts and investments in accordance with the Association’s investment policy. Any funds not transferred should be identified on the Balance Sheet as a current asset “Accounts Receivable Due to Reserves and as a current liability “Accounts Payable Due from Operations”.
From as early as 1994 MVF created a Fixed Asset/Capital Fund fund type and in 2006 Fixed Assets became an Operating fund type with Reserve Funds as a sub-component of Fixed Assets.
2.Change the Legal and Accounting Reporting Nature of the Foundation
The 2008 to 2012 Audits were preformed by Draper & McGinley of Frederick Maryland, not in accordance with the Accounting Guide for Common Interest Realty Associations (CIRA), but Not-for-Profit Entities, in violation of the provisions of the Maryland Homeowners Association Act (Real Property Article, Annotated Code of Maryland, Section 1IB-101,et.seq), Maryland Condominium Act (Real Property Article, Annotated Code of Maryland), and the Montgomery County Code, Commission on Common Ownership Communities (CCOC), (Chapters 10B, 11 A&B & 24B).
2012 Audit Note (1) Nature of Operations The financial structure of the Foundation consists of three funds. The first is used to account for the operations of the business activities (Operating Fund), the second hold the capitals assets (Fixed Asset Fund), and the third invests designated funds for the future repair and replacement of the Foundation assets (Reserve Fund).
Note (2) Financial statement presentation The financial state presentation follows Financial Accounting Standards Board Accounting Standards Codification (ASC) 958-210 which requires the Foundation to report information regarding financial position and activity according to three classes of net assets:
Unrestricted Net Assets – net assets that are not subject to donor imposed stipulations.
Temporarily Restricted Net Assets – net assets subject to donor imposed stipulations that may or will be met, either by actions of the Foundation and/or passage of time.
Permanently Restricted Net assets net assets subject to donor imposed stipulations that they be maintained permanently by the Foundation to use all or part of the income earned on any related investments for general or specific purposes. Montgomery Village Foundation currently does not have any permanently for general or specific purposes.
3. Make Future Major Repairs and Replacements Reserves funds (RES) disappear. The Replacement Reserve component is either totally missing from MVF Financial Statements, Audits and Budget presentations; not included, lumped with, or buried within the Operating Income or Fixed Assets/Capital categories.
4. Capitalize donated property as Property and Equipment Assets and created a corresponding equity fund balance on the Balance Sheet.
Depreciate the capitalized value of the donated property each year the as a non-cash direct depreciation expense. The depreciation expense is charged to three general ledger expenses accounts, Contribution to Reserves Depression (a) Equipment (5800) (b) Office Equipment (c) Building (5850).
Transfer Reserve fund balances to Fixed Asset/Capital account - A non- cash Inter fund transfer equal to sum of the annual depreciation expense of Depreciation Equipment, Office and Building (5850) is made from Reserve Funds to Investment in Property and Equipment classified as Fixed Assets. Although these Inter fund transfer transactions are not Reserve expenditures they are shown as a withdrawal or reserve expense reducing reserve fund balances.
Capitalize the Reserve Interest Beginning in February 2006 A non-cash inter fund transfer of the annual Interest earned on Reserve Investments (4114) was made from CTR from Interest to Fixed Assets/Capital category.
I told you earlier It’s complicated and I would try to keep it simple, but I’m not sure I succeeded. However, at the February 22 2007 MVF Board of Director meeting all the above practices were confirmed and approved and best explained in the March 2 2007 Montgomery Village News.
Board takes action to reduce budget deficit by Mike Conroy March 2 2007 Montgomery Village News, “At its February 22 meeting, the Montgomery Village Foundation (MVF) Board of Directors voted in favor of recommendations from the Audit Committee in an effort to reduce on paper the amount of deficit in the 2006 budget. On recommendations from the Audit Committee, which had been called to a special meeting the previous evening, Interim Director of Finance and Administration Lois Campbell presented the details on the (Audit Cte) meeting’s sole action item. Three recommendations hinged on approval of those preceding it,
Starting in 2006 use Board-established budgeted contributions to reserves (CTR) for reporting purposes throughout the year. Establish final CTR at year-end by Board Action. The outcome means the Board will exercise full control over the contributions to reserves, which is a major operational expense.
Starting in 2006, indicate (hide) depreciation expense not as a Fixed Asset group of accounts. This action results in no accounting differences: it is merely a correction to the audited income statement, which more appropriately depicts depreciation. The result shows (hides) depreciation as an expense to the Fixed Asset group of accounts.
Contribute $0 to reserves in 2006. No CTR for 2006 results in a significant smaller deficit budget for the year and an equally lower balance in reserve account. The $404,000 CTR (which would be in the form of an IOU) is approximately $96,000.
Board member Jerry Donegan favored Campbell’s plan saying, “We need every nickel we’ve got in Operating to cover the deficit”. All three recommendations passed. Board member Bob Hydorn opposed all three with Sylvia Lake opposing the third recommendation.
Comments on Funding the Reserves MVF Style From the 2006 and 2007 Audits
Due to Reserves from Operating Funds $433,670 2006 & $904,321 2007
Loss CM Fund ($301,266) 2006 & ($609,922) 2007
Loss MA Fund ($609,922) 2006 & (638,691) 2007
Reserve Interest transferred to Fixed Assets $181,576 2006 & $185,884 2007
Contribution to Reserves Depreciation $538,986 2006 & $508,046 2007
Contribution to Reserve Real Money $000.00 2006 & $000.00 2007
As shown on the MVF Summary of Replacement Reserves 1994 to 2012 schedule included in the PDFS version of this post, the CTR from Members was $10,127,679 and reserve investment interest equaled $3,839,920 totaling $13,967,599 that should have been deposited into reserve investments accounts. Unfortunately, only $1,483,844 real money did. $8,643,835 from Depreciation and $4,035,256 recorded as reserve expense. The unfunded Contribution to Reserves for the 18 years from 1994 to 2012 owed to the Replacement Reserve Fund totals $13,179,129.
Funding the Reserves MVF Style Oh, What a tangled web we weave! Blog posting is the third in a series on MVF Financial History. Previously published was The Nature of Montgomery Village and MVF Financial Condition Fact or Fiction. In coming weeks The Montgomery Village Observer will post Chapter 4 Safety of Investment Funds, Chapter 5, Replacement Reserves, Chapter 6 Budgeting, and Chapter 7 The Annual Audit & Internal Controls. The timing of these chapter will correspond with this summers MVF 2014 Fiscal Year Operating and Reserve Budget preparation and approval cycle, Design Management Associates’ field inspection and condition analysis phase of the MVF 2013 Reserve Study and the bidding and selection process for MVF's next Auditing firm. I can’t wait.
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