Manhattan Condo Board Finds Six-Figure Sponsor Debt Due to Accounting Discrepancies

A Manhattan condominium board recently discovered they were owed a six-figure sum from their building's sponsor — two years after the sponsor control period had ended. The discovery came as a complete surprise to the board, which had already taken over control of the building and was operating under the assumption that all financial obligations had been properly settled.

"We were engaged for a 2023 audit," explains Amy Jennings, a manager at the accounting firm WilkinGuttenplan. "When we did our initial review of the 2022 financial statements (the condo had begun operating in 2021), we anticipated seeing a proper accounting,” she said. “What we ended up seeing was that there were some discrepancies in how that activity was reported."

Accounting Snafus

When a sponsor is trying to sell condo units, he or she often implements what’s called a waiver period. This is where the sponsor takes responsibility for paying all the operating expenses of the building. This common arrangement seems straightforward — the sponsor pays the bills while selling units — but the accounting can be tricky, and mistakes can be costly for the eventual residential board, says Jennings. "We noticed that the building operated at a significant deficiency for the initial period," Jennings says. "The revenues were not sufficient to cover the expenses of the building." In other words, whatever the sponsor had contributed didn't look like it was covering all the necessary expenses. Adding to the confusion, contributions from the sponsor were recorded as a component of equity, which Jennings describes as "inappropriate revenue recognition."

The problem originated in two key areas. First, the property manager had been tracking expenses on a cash basis — looking only at bills that had been paid in a given month — while proper accounting procedures call for an accrual basis that accounts for when expenses were actually incurred, regardless of when they were paid. Second, and probably the bigger issue, was the question of who had been minding the books during the sponsor control period.

"The original auditor was someone who worked with the sponsor frequently," Jennings explains. This relationship potentially compromised the auditor's independence and objectivity. Moreover, the sponsor's accountant may not have had specialized expertise in condominium accounting, missing critical details in the governing documents. One such detail proved significant: according to the offering plan, the sponsor was also responsible for funding reserves during the waiver period — an obligation that had been completely overlooked.

After recalculating the true-up for expenses (the period between the sponsor activity and the end of the waiver period) and the required reserve funding, Jennings' team identified a six-figure sum that the sponsor still owed the condominium.

Board Transition Tips

The situation highlights a critical challenge for new residential boards. When transitioning from sponsor control, boards should carefully review all professional service relationships, especially with auditors who might have pre-existing relationships with the sponsor. "It's a really good idea to look at those professional service relationships with a fresh eye," Jennings advises. "It's really important to engage an auditor or a CPA who is both independent in appearance and fact."

For boards facing similar situations, Jennings recommends getting legal counsel involved as early as possible. "The sponsor can certainly be caught off guard. Even the board could be caught off guard if we identify these amounts," she says. Discrepancies like this, if identified, can be leveraged in addressing other issues with the sponsor. "This exercise can be used as a bargaining chip in other settlement procedures or proceedings with the sponsor," Jennings notes, such as negotiations regarding construction defects. 

For new residential boards, the takeaway is clear: when taking control of your building, a fresh set of eyes on the financial statements — preferably from an accountant with specialized condo expertise — could save your building significant sums and provide important leverage in dealing with ongoing sponsor issues.