In June of 2020, the financial accounting standards board (FASB), issued accounting standards update (ASU) 2020-05, halting the implementation of ASU 2014-09, Revenue from Contracts with Customers (ASC 606) and delaying the required implementation to January 1, 2020. Entities that had not yet issued their financial statements for the fiscal year ending December 31, 2019 were eligible to push back implementation.
For clarification, a Common Interest Realty Association (CIRA) is an association of owners which is responsible for providing certain services and maintaining certain property that all the owners share or own in common. The most common types of CIRAs are Homeowners' associations (HOAs), condominium associations and timeshare associations.
This broad reaching ASC requires changes in almost every industry and supersedes existing guidance on revenue recognition for CIRAs. The intention of ASC 606 is to provide a consistent principles-based revenue recognition standard that can be consistently applied across all industries and transactions.
ASC 606 provides a 5-step process for recognizing revenue as follows:
Identify the contract with the customer.
Identify the separate performance obligations in the contract.
Determine the transaction price.
Allocate the transaction price to the separate performance obligations.
Recognize revenue when (or as) each performance obligation is satisfied.
Impact on Common Interest Realty Associations
Unlike many other industries the FASB did not establish a working group to help with the implementation of ASC 606. As such, there remains some disagreement amongst practitioners as to the application of the standard to CIRAs.
Short of additional guidance from the FASB, the current consensus is that a CIRAs declaration, legal/organizational documents and annual budget create a contract between the CIRA and the owners/members and thus ASC 606 applies to all CIRAs. A summary of the accounting and reporting impact by fund is as follows:
Operating fund
We anticipate that most CIRAs will have minimal changes as a result of implementing ASC 606. Most CIRAs currently recognize revenue over the fiscal year consistent with its annual budget, this process should continue. One potential impact will be the adjustment of revenue based on the probability of collection from an owner/member. If it is not probable that dues will be collected, then the CIRA would reduce revenue recognized to equal the probable amount to be collected.
Replacement reserve fund
The most significant and controversial change resulting from the implementation of ASC 606 is the timing of recognizing revenue for replacement and reserve funds.
Under ASC 606, a CIRA will recognize revenue as individual performance obligations are met or in this case as replacement reserve funds are spent. To implement ASC 606, CIRAs will start by moving the beginning fiscal year fund balance for the replacement reserve fund to a new liability account named “Contract Liabilities – Assessments Received in Advance – Replacement Reserve Fund”. Next all replacement reserve fund assessments will be posted to this same contract liability account. As reserve expenses are incurred and thus performance obligations met, the CIRA will recognize the revenue by moving the funds spent from the liability to revenue. This is similar to the historical treatment of special assessment funds. The end result of these adjustments on the replacement reserve fund, in the absence of interest income, being that the Balance Sheet will show a zero fund balance and the Statement of Revenue and Expenses, will net to zero each year. Although guidance is not clear, we do believe interest income generated on the replacement reserve funds would generate fund balance in the replacement reserve fund after implementation and not create an additional contract liability.
Special Assessment fund
The accounting for special assessments continues as it has historically with funds now deferred in a contract liability account until the special assessment is spent thus matching the revenue with the expense for reporting purposes.
In addition to the accounting changes above the CIRA financial statements will include a further footnote disclosures related to the impact of the implementation of ASC 606.
Summary
As noted above, ASC 606 will require significant changes to a CIRAs’ financial statements. Additional education will be required for users of these statements, owners/members, lenders, sales teams etc.
The implementation will require special attention as CIRAs move forward with closing their books for the 2020 fiscal year. Please don’t hesitate to reach out to your trusted Reese Henry advisor for more information.