Translation, Please!
Understanding Your Building's Financial Statements

Carl Cesarano

JULY 2000

Whether you’re a co-op or condo owner or on your building’s board, you are considered a primary user of the property’s financial statements. As such, you should definitely make it a point to understand what you’re looking at–to not only be aware of the financial health of your building but to discern certain trends and relationships and anticipate the future. Other users include potential buyers, lenders, vendors, taxing authorities and insurers. As a result, financial statements are meant to present condensed organized summaries of extensive detailed financial information.

The objective of these documents is to communicate the economic effects of completed transactions and certain other events on the financial position and operations of the co-op or condo.

The financial statements of a co-op or condo contain the same basic information as that of a commercial business. The statements include the balance sheet, statement of revenues, expenses and accumulated surplus or deficit (also known as retained earnings), statement of cash flows and notes to the financial statements.

Building boards should use the financial statements in conjunction with a well-organized management report. The management report should be specifically designed to provide internal decision-makers with detailed, sometimes confidential, information needed to control and monitor the day-to-day operations of the co-op or condo.

Know What You’re Looking At

A balance sheet reports assets, liabilities and the difference between the two, which is referred to as stockholders’ equity (condos use the term "fund balance" or "members’ equity"). Assets are presented in order of liquidity and liabilities are presented in order of maturity.

The statement of revenues, expenses and accumulated surplus or deficit reports present information about revenues (maintenance or common charges, special assessments, interest income, administrative fees, etc.) and expenses (wages, real estate professional fees, taxes, etc.) The statement of revenues and expenses should also report the excess or deficiency of revenues over expenses for the period as well as a reconciliation of beginning and ending accumulated surplus or deficit with results of operations for the period.

The statement of cash flows is a reconciliation of the balance of cash at the beginning of the year to the balance at the end of the year. It provides an analysis of the excess or deficiency of revenues over expenses to cash flows operating, investing and financing activities. In short, it measures changes in the balance sheet, as well as the bottom line from operations to account for the change in the entity’s cash balance from one year to the next.

The notes to the financial statements provide additional explanations to certain line items on the financial statements as required by Generally Accepted Accounting Principles (GAAP). Some that are required by disclosures include the organization or legal form (corporation or association) of the entity, the location and number of units, summary of significant accounting policies, restrictions on cash or other assets, the components of property and equipment, mortgage information (including pledged assets), commitments and contingencies, and income tax filing status (including income tax liabilities and credits.)

In addition to the basic financial statements and notes, the American Institute of Certified Public Accountants (AICPA) requires co-ops and condos to disclose supplemental information about the estimated remaining lives and replacement costs of the property and the funding of future major repairs and replacements. This analysis is an essential tool for boards in meeting their fiduciary duty to maintain and preserve the property. It is also their responsibility to decide how to fund the cost of future major repairs and replacements. Inadequate funding can adversely affect the ability of owners to sell or refinance their units, because of the concerns of prospective buyers, or because of the difficulty of obtaining mortgages. Additionally, because all owners share the costs, proper budgeting for such costs can be made over an extended period of time, eliminating the need for unreasonably large, one-time assessments.

Say What?
Interpreting Financials

Accountants and financial analysts have developed many approaches to analyzing and interpreting financial statements. The following three steps are an integral part of this process: read the accountants’ report; examine the overall financial statements and look for trends and relationships; and examine the notes and supplemental schedule of future major repairs and replacements.

The first step in evaluating financial statements is reading the accountants’ report. This report tells the reader the level of service provided by the accountant and the extent to which the information in the report has been verified by the accountant. The highest level of responsibility in reporting on financial statements is referred to as an audit. An audit is the process by which an independent certified public accountant (CPA) accumulates and evaluates evidence supporting the financial statements and determines if they are fairly presented, in all material respects, in accordance with GAAP. The auditors’ report will be on the auditor’s letterhead and typically includes four paragraphs.

The introductory paragraph includes statements that the financials were audited and are the responsibility of management, and that the auditor’s responsibility is to express an opinion on the audited financial statements.

The scope paragraph includes statements that the audit was conducted in accordance with Generally Accepted Auditing Standards (GAAS), what GAAS requires, what an audit includes, and that the auditor believes that his or her audit provides a reasonable basis for an opinion.

The opinion paragraph gives the auditors opinion as to whether the financial statements are presented fairly, in all material respects, in conformity with GAAP. When the auditor has formed an opinion that the financial statements are fairly presented, it is referred to as an unqualified opinion. Of particular importance is the possibility that instead of an unqualified opinion, the auditor may give a qualified opinion, an adverse opinion, or a disclaimer of opinion. Each of these three unfavorable opinions must include an explanation by the auditor of the factors underlying the decision to render such opinion. These unfavorable opinions serve to alert the statement user to a major problem area that should be investigated.

The "Explanatory Paragraph Regarding Required Supplementary Information" reports the status of the disclosure, required by the AICPA regarding future major repairs and replacements.

Other standard types of reports are a review report and a compilation report. A review involves performing inquiry and analytical procedures intended to provide a reasonable basis for expressing limited assurance that the financial statements conform to GAAP. A compilation is the preparation of financial statements from information supplied by management without expressing any assurance on them.

If the financial statements are not audited, one should ascertain their credibility before relying on them.

Examine Trends and Relationships

One of the primary objectives is to look for major changes in trends, amounts and relationships in each line item on the financial statements. For example, if repairs and maintenance expenses are increasing, or there is a dramatic decrease in cash, this may provide a warning of a significant problem, which requires an explanation as to the reasons underlying the change. An increase in maintenance or common charge arrears or accounts payable and accrued expenses can signal a cash flow problem. Additionally, look at the bottom line in the statement of revenues and expenses. Operating revenues should equal or exceed operating expenses before depreciation. If there is a deficit, this could be a sign of future maintenance/common charge increases and or special assessments.

The overall examination should include careful reading of the notes and supplemental schedule of future major repairs and replacements. Each note provides additional detail to certain line items on the financial statements. The official position of the accounting profession is that the notes are an integral part of the financial statements.

The supplemental schedule of future major repairs and replacements provides an analysis of the major components of the property, their remaining useful life, and estimated current replacement costs. This schedule is a barometer of future capital expenditures as well as the adequacy of the reserve fund.