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Settling what expenses belong to a sponsor and what belong to the new co-op can be daunting.
AUTHORChristopher Saray, WilkinGuttenplan
At newly built condos, it’s common for construction and other building issues to crop up, and for boards to focus their attention on them. But accounting and record-keeping is equally important, as one of your clients recently discovered. What’s the story?
We were engaged to audit a 120-unit condo that had been operating for a couple of years. It was a mixed-use building with residential and commercial units, and there were a lot of operational intricacies. Reviewing the prior financials, we found that there was a pretty significant balance — $200,000 — due from the sponsor.
Was that unusual?
It’s common in newer construction buildings. For the first few years, boards often determine that certain expenditures related to construction issues or mechanical system issues are the responsibility of the sponsor. For example, let’s say the HVAC system goes during the first year people are living in the building. The board might say, “Hey, this is supposed to be a new system,” and they might request that the sponsor reimburse them for any costs to repair it.
What happened after you discovered the outstanding balance at the condo?
We reached out to the sponsor representative with a detailed letter that said: “Per our audit, you owe $200,000 to the condo for these expenses. Can you please approve this amount?” In this case, the sponsor basically said: “Hold on, I don’t think we owe this sum of money.” So we did some digging, starting from the current year and then going backwards. When we gave them the current year’s audit per management records and per the board, the rep agreed with it, so we were OK there.
Which meant you had to dig back further.
Yes. We obtained ledgers and records from management and from the sponsor dating back to the commencement of operations and tried to reconcile the two. We looked at each and every invoice that the board charged the sponsor and asked the sponsor, “Do you agree with this?” And so on and so forth. We looked at payment records, payment ledgers, bank statements and copies of checks and tried to match dollar for dollar every amount that the condo charged to the sponsor. For the most part, everything kind of jibed. We looked a little further into individual account details and found that the root of the problem was the complexity of this building.
Meaning the fact that there were both residential and commercial units?
Yes. The sponsor still owned many unsold residential units and still owned a few of the commercial units. There was a kind of pass-through set-up when it came to utilities. The condo incurred the utility expenses, paid Con Ed, and then billed back the unit-owners for the usage. Because the sponsor owned a lot of units, a lot of those charges went to the sponsor. In turn, the condo received a lot of money from the sponsor, and some of it was in lump sum.
Why was that a problem?
The sponsor would cut a check to the condo for, say, $50,000, some of it for utility charges, but some of it would also be for expenses that the board had requested reimbursement for. It got a little complicated there. There were so many different accounts and so much activity between the two parties that it got to a point where it just wasn’t always clear where the money coming in should be applied. And in some instances, it just got put in the wrong place.
Can there be wider repercussions from these kinds of mix-ups? What happens, for example, if somebody who wants to buy a unit in the building asks to see the financials and sees that the condo’s balance sheet shows a line item of being owed $200,000? Does that affect anything from a bank’s perspective?
Not necessarily. If this building had been operating for years and years and there were lingering amounts due from the sponsor even though the sponsor wasn’t involved much anymore, that’s something that might raise a red flag to a bank. But in this case, it was a new building. Banks understand that there’s sponsor involvement in those initial few years, and I don’t think it would be such a red flag to a bank or to any potential buyer.
So what is the takeaway for boards?
First, it’s important for boards and management and everyone involved to discuss the amounts on their balance sheet with their auditors. A board should know how the amounts were calculated, where they came from and the activity year over year if it’s a recurring amount. The board should have an understanding of how the auditor confirmed the amount. If the auditor is not doing that, the board should make sure that they have the amounts approved by the sponsor.
Management must have a role to play here as well.
I think a board can discuss the possibilities of having management be very detailed with sponsor-related transactions in their general-ledger account. For example, if there’s a description for a specific expense in the repairs account in the general ledger, writing “To be billed back from sponsor” in big bold type would be helpful to an auditor or to a managing agent reading the monthly financials.
The board ultimately has to approve amounts being paid to vendors, and when you’re reviewing those bills it’s a good idea to pinpoint those expenses that are to be billed back to the sponsor, have a conversation with the sponsor rep, and maybe just hand the bill over to them so they can pay it directly to the vendors. That way you avoid the board paying for it out of the condo’s account, sending a bill to the sponsor for reimbursement and waiting for that money to come in.
That makes a lot of sense, so the building doesn’t act as a pass-through.
Exactly. These expenditures essentially aren’t the condo’s expenses, right? It’s common practice — like 95% of the time — that the condo is paying the bill and requesting reimbursement from the sponsor. In a perfect world, you wouldn’t even have that expense running through the records of the condominium when it’s not a repair that the condo should have paid for.
Christopher Saray is a manager with the accounting company WilkinGuttenplan.