Fielding questions about a co-op or condominium’s official audited financial statement can be one of the more daunting tasks board members will face at their annual meeting. Sure, the board can rely on the property manager, along with the accountant who performed the audit, to be there to walk residents through the balance sheet, the breakdown of cash flows, and other documents that make up the statement. But the board will still quite likely have to help with explanations.
It only makes sense to spend time reviewing the statement ahead of the meeting. Admittedly, for any board member without a background in business or finance, reading through financial documents that can run to dozens of pages can be an exercise in frustration at best. But accountants highly recommend that boards do so.
Even if they don’t understand all of the math, boards can assess the statement by focusing on the following areas that auditing experts identify as primary concerns.
1. The Auditor’s Opinion
The first page of the statement is a memo from the auditor with a lot of boilerplate language about the auditor’s role and responsibilities. Look for the section marked “Opinion,” which is the auditor’s overall judgment as to the fairness and accuracy of the financial statements as prepared by management.
Carl Cesarano, a principal at the accounting firm Cesarano & Kahn, says board members should read that opinion carefully. Ideally, it should be an unqualified endorsement. If it is qualified in any way – for example, noting that the financial statements aren’t in accordance with generally accepted accounting principles – the board will want to read the details in the notes and possibly follow up with management. In rare cases, the opinion will be adverse, signaling that the auditor suspects some sort of deliberate wrongdoing such as fraud, Cesarano says.
God is in the details, and the details are in those notes. “The thing I always tell boards is, read the notes,” says Michael A. Esposito, a certified public accountant at the Kleiman & Weinshank division of WilkinGuttenplan, who teaches seminars on how to read co-op and condo financial statements. “The notes tell a story.”
2. Operating Results
The aim is always to ensure that your assets are covering your liabilities. That can be more complicated than is immediately clear to the inexpert eye. But one thing you should look at is your operating cash and reserve fund accounts on the balance sheet. Financial statements typically display results for the past two years. “You must compare year over year what’s going on with these accounts,” Cesarano says. “If you see the operating cash being depleted, the question should be: are we taking in less money than we spend for day-to-day operations?” he says. “And if so, why?”
You should also look at the Statement of Operations, which breaks out revenues and expenses and shows the totals for the past two years. “It’s maybe not as simple as this,” says Esposito, “but basically you’re looking to see if your income is more than your expenses.” If you are generating losses, a question should arise. “Does that mean you’re not charging enough maintenance?” he says. “By the same token, if you’re generating large surpluses, maybe you’re charging too much, or can keep maintenance flat.”
Board members should always check to make sure that any assessments they collected for the reserve fund actually ended up there, says the accountant Stephen Beer, a partner at Czarnowski & Beer. “I see this all the time,” he says. “The managing agents are busy, they have a lot going on, so the money doesn’t get moved over from the operating account. If it’s something that the board intended, they need to make sure it’s correct on the financial statement.”
This is also a good time to consider the adequacy of the reserve fund. If it’s deemed too low, what is the plan to replenish it? Beer’s firm recommends minimum reserve funds of $2,000 per unit, or a minimum of $100,000 in total.
But analyzing the adequacy of the reserve fund is an inexact science unless the board has sought a professional assessment of the condition of the building and its systems. “You really should have some sort of study to determine costs for at least the next five years,” says Esposito. “And you should update it annually.”
In condominiums that rely on their unit-owners having access to Fannie Mae mortgage financing, boards should make sure that 10 percent of yearly common charges are being set aside for reserves, Beer advises. That’s a Fannie Mae underwriting requirement for condominiums, unless they have undertaken an official reserve study of estimated capital costs over the next 30 years.
4. Security Deposits
Alteration or security deposits paid by shareholders or unit-owners doing renovations to their apartments may also be noted in a liability line item on the balance sheet. Sometimes, instead of being returned to owners after renovation work is completed (assuming no damage was done by the contractors), that deposit money is allowed to sit there and never gets cleaned up, Beer says.
“I don’t understand why people don’t ask for their money back, but these things just accumulate,” he says. This is not a good practice, however, because at some point, the funds could be subject to seizure by the state as abandoned property.
“Ask the property manager: ‘How much are they holding, and why?’” Beer says. “It’s a helpful exercise.”
5. Accounts Payable
The balance sheet has a line item for accounts payable, which means outstanding bills. Compare this year’s figure with last year’s. If it’s substantially higher, it’s prudent to explain the increase in a note, Cesarano says.
“Things can have variances,” he BOARD BUSINESS adds. Maybe this was the year the building started to undergo major facade repairs or an elevator replacement. “But the explanation needs to makes sense. If we don’t have enough cash to pay our bills, that’s a major problem.”
6. Commercial Rent
In buildings that rely on commercial tenants for revenue, board members should check the notes for details on existing lease agreements, paying particular attention to when those leases expire, Esposito says. The notes should give the approximate minimum rents for the next five years. If an agreement is close to expiration, the board will want to discuss whether it wants to renew the tenant’s lease, and if so, whether the rent should remain the same, rise, or come down. The prevalence of vacant retail space in the city might come into play in this conversation.
“I’ve had some co-ops that have gone a significant amount of time without rental income, either because they couldn’t find a new tenant or were being very picky about who they wanted for a tenant,” Esposito says. “Shareholders have to pick that up.” This is one area, among many, where boards need to be realistic.