View Issue PDF View Issue Flipbook Back to Latest Issue
A Push for Consistency, Transparency & Clarity
By Edmund Leong | Other articles by Edmund Leong
It is no wonder with record inflation, labour disruptions, supply chain shortages that condo lending has been more popular than ever. Condo lending is really the industry's easy button when it comes to financing rapidly rising costs for major repairs and replacements without having owners go though large special assessments and brings needed repairs to the corporation faster than internally financed options. I have found that the downside of much of the lending is various parties' understanding of complex accounting disclosures and presentation.
Let's walk through the life of the condo loan and where it would impact the audited statements. When the borrowing by-law has been passed, the board can then engage a condo lender to lend the necessary funds to conduct the major repair. Typically, condo lenders will be paying the contractor directly for the repairs up to the agreed upon amount as set by the loan agreement. As this may cross the financial year end of the corporation, the final amount of the loan may not have been fully advanced due to the progression of the repair. Property management accountants should be tracking the amount of the advances made by the lending company and in turn at the fiscal year end the corporation should disclose the amount of expenditures made in the reserve fund (more on this later) and at the same time, a liability should be booked to the condo lender for the amount advanced as a short term loan. The condo lender should be able to provide the progress payment details both for property management accountants and the auditor to review. Note: disclosures should be made to the audited statements to indicate the terms of the loan and that the final loan amounts will be set up once the final repair work has been completed. The total loan should be disclosed as part short term loan and part long term loans. The short term portion of the loan represents the principal portion of the loan due a year after the financial statement date.
The reserve fund should now reflect the total expenditures made to repair the common elements and the loan balance should reflect the full balance owing to the condo lender. As you can appreciate, the reserve fund has been hit with a massive charge sometimes in the millions with the repair work and can put a low running reserve fund into a deficit. The owners, managers, board will raise the issue as to why and how the reserve fund is running a negative balance. It has been our practice in this case to segregate the condo loan into a separate reserve fund called condo loan fund. The balance in this condo loan fund will be a negative figure (ie negative equity) and will correspond to the loan figure in the balance sheet.
The next confusing matter is how the monthly payments to the condo loan are dealt with amongst the statement of operations, statement of reserve and statement of condo loan fund. We have seen property management classify the loan payments out of operations which is not factually correct as the loan is a reserve fund matter. So let's take a few steps back to figure out how the loan is paid. During the proposal process of the loan, owners are presented some "what if " scenarios of how much their condo fees would increase as a result of this loan. Let's be realistic as you cannot expect that loan payments cannot come out of thin air. The debt service will likely come out of additional common element assessments unless management and the board can carve it out of other expenses. Where funding comes from the owners additional assessments, it is in my opinion that a new reserve fund study should be conducted by the engineers which factors in for the term of the loan's increased funding for the debt service. The engineer's study would have only accounted for the cost of the major repair or replacement and a new study would be needed to cover the cost of the interest. So if we have increased condo loan funds outflow where does that money come from? That would of course be higher condo fees and in turn higher appropriations to the condo loan fund.
So let's take it from the top with the statement of operations. The condo fees would have been increased and the appropriations to the condo loan fund increased as a flow though effect of the cash required for the debt service. End of story and no confusion that operations are paying for the condo loan.
Then let's move onto the statement of reserve fund. The running balance in this loan, in theory, would also run alongside the engineer's report for major repairs and replacements. The statement should also be positive equity and as well be comparable to the engineer's 30 year cash flow plan.
We now move to the statement of condo loan fund which, as stated above, shows a large negative figure (negative equity) equivalent to the loan balance in the balance sheet or statement of financial position. Here is where we get to allocate principal and interest. We will see that the expense of this fund will be the interest portion of this loan and then the balance that gets dropped out is the principal portion of the loan. This principal portion then reduces the negative loan fund to the ending balance in the loan amortization table. Owners, the board and management can see then with clarity that the ending loan fund agrees to the liability in the statement of financial position.
The convergence of Condominium Act, fund accounting, appropriations, disclosure, revised engineer studies, loan mechanics has made this article seem more complex than it is. However, where if the transactions are not properly tracked or disclosed consistently in the monthly financials or in the annual audit, it will cause boards, owners and management to lose transparency of the cash flows and as well create a high level of confusion. The confusion is enhanced with new and existing owners who have not had the opportunity to have the financials explained to them in detail. The auditor should enhance clarity by using good financial statement note disclosures and by explaining how the flow of cash moves from condo fee to debt service through all the statements at the annual AGM.