Financial Management of Community Associations | Budgets and Replacement Reserves
Part 2 : Budget Preparation
A budget usually applies to a 12-month period (Jan 1 to Dec 31, Jul 1 to June 30, etc.). Your community’s budget should be approved a minimum of 45 days in advance of the start of the fiscal or budget year. This will enable distribution of the approved budget to owners before it goes into effect, and allow for printing of billing documents (coupons or statements).
Before beginning work on the budget, pull together all related documents and reports (i.e., this years budget, a comparison of actual expenses to budget expenses, other financial reports or statements, and bills paid over the past year). To meet approval and distribution deadlines, you should begin work on the next year’s budget several months in advance.
Budgeting Methods: There are two basic methods of budget preparation:
- Zero Based Budgeting: With this method, all line items are set to zero and the amount of funds allotted to each must be justified.
- Historical Trend Budgeting: This method begins with the assumption that existing line items are needed. The amount of funds allotted to each during the current year is adjusted for expected changes in the coming year. Sources of historical information include financial reports, existing contracts, and bills from the past year.
A highly effective approach to developing the operating budget activities section of a budget (devoted to operating activities incurred during normal course of operations, not planned expenses from the reserves) is to combine elements of both zero-base budgeting and historical trend budgeting. The zero-base approach keeps you from accepting this year’s figures at face value. It requires you to analyze the reasons for the actual amounts spent. The actual dollar figure may be less or more than the budgeted figure because of circumstances you cannot assume will exist during the coming year. For example, lawn maintenance costs during a dry season will be low, but a community cannot assume that the coming year will be just as dry. Or water expenses may have been higher due to an unidentified leak which once corrected, will not repeat in the coming year. The historical trend approach provides you with a starting point of existing data when you develop your estimates for the coming year.
Development of Budget Line Items: Each line item in a budget represents a different account or category of revenue or expense. There are two types of expenditures in a community budget - mandatory line items and discretionary ones:
- Mandatory line items - community and owner needs and obligations (taxes, repairs, utilities, maintenance, etc.)
- Discretionary line items - owner, board and committee desires or expectations (social and recreational expenses, picnic areas, patrols, pool towels, etc.)
There are standard ways to describe common line items for community associations. A Chart of Accounts is an organized list of the titles, descriptions and assigned numbers of all accounts in an organization’s general ledger. The assigned number helps you locate the account, while the title describes the purpose of the account. There are three rules of thumb to keep in mind when selecting line items for your community’s budget:
- Select line items that reflect your community’s activities
- Select line items that will give your board the information it needs to plan and control your community’s operations
- Keep line items as simple as possible
Even though there are customary ways of listing common line items in a budget, your community association can decide how detailed a set of line items it wants to use. It is very important that the same account numbers and names be used in the budget, the general ledger, and all financial reports. Without this consistency, it is impossible to get a clear picture of the community’s financial operations over a period of time.
When preparing your draft budget, list your line items in as much detail as possible to help you assign costs. For example, utility line items may include: water-irrigation, water-sewer, electricity, streetlights, natural gas, garbage, telephone, cable TV, etc. In order to prepare line items for specific types of goods and services, you may need to solicit bids and proposals, such as insurance, lawn maintenance, snow removal, and pool management. However, when you prepare published copies of the adopted budget and any monthly or annual financial reports, it is appropriate to combine detailed line items under a more general one. For example, you might combine Landscape - grounds maintenance, Landscape - seasonal planting, and Landscape - Mulch into one line item titled “Landscape Maintenance.”
Budgeting by Month: One of the best financial management tools for both the manager and the board members is the Statement of Revenue and Expenses, that, among other data, compares actual expenditures and revenue sources to budgeted amounts in each category. Thoughtful and deliberate calculation of each budget line item is important. Logically the report would be more informational if the budgeted amounts are shown in the months the revenue or expense is expected to occur, rather than simply dividing the total expense by 12 months and showing 1/12 each month in the Statement of Revenue and Expense. For example, snow removal would show in winter months, pool lifeguard in summer months, etc. When you compare actual figures with budgeted figures, you can:
- identify all significant differences or variances between actual and planned figures
- determine the reasons for the differences
- executive any corrective action that may be needed as soon as possible
- on accrual basis reports, the budgeted assessment income should equal the actual assessment income
Establishing Annual Assessments: Annual assessments are based on the community’s budget for the fiscal year. The amount of the total annual assessment is the amount of income that the board decides to obtain from owner assessments - given the community association’s other revenue sources. Each owner is assigned a share of the community’s annual obligation. Frequently an owner’s share is based on the number of owners in the community or on the square footage the owner’s unit occupies.
In condominiums, an owner’s share is most often based on his or her percentage interest in the common elements (though thee can be other methods, such as additional fees high rise condominiums place on units on higher floors). Here is the standard formula for calculating assessment fees for condominium owners:
Total Assessments Required in Annual Budget X Percentage Interest as Found in DCCR’s
Number of Installment Payments in a Year
- Assume a total required assessment of $410,000
- Assume a percentage interest in the common elements of 4.682% for a two bedroom unit
- Assume monthly payments
- $410,000 x .004682 / 12 = $160 monthly assessment fee
In our last article we looked at the basics of the budget, future articles will include more in depth looks at budgetary roles and responsibilities, and reserve funding and allocation.