Preparing the annual budget and overseeing the association’s finances are perhaps the most important responsibilities of board members. The annual operating and reserve budgets reflect the planning and goals of the association and set the level and quality of service for all of the association’s activities.
- PREPARING THE BUDGET
The association’s budget consists of two basic parts, income and expenses. When preparing the association’s budget it is wise to begin with expenses. This allows for an objective statement of needs before determining the sources of income. After the expenses are identified and quantified, ideal expectations may then be weighed against practical considerations and a balanced budget may be prepared.
- DETERMINING EXPENSES
The budget process begins with an accurate inventory of all the major components for which the association is responsible. Determining what constitutes an operational versus a reserve expense may have a major impact on the financial plans of the association and subjective determinations should be minimized. The following should be considered when labeling an expense:
- Operational Expenses. Operational expenses occur at least annually and can be effectively budgeted for each year. They are characterized as being reasonably predictable both in terms of frequency and cost.
- Reserve Expenses. Reserve expenses are major expenses that occur other than annually and which must be budgeted for in advance in order to provide the necessary funds in time for their occurrence. Reserve expenses are reasonably predictable both in terms of frequency and cost. However, they may include significant assets which have an indeterminable but potential liability if they were not reserved for in advance. Examples of reserve expenses include paint, asphalt overlays and roof repair.
- Budgeting. Budgeting is normally excluded for repairs or replacements of assets which are deemed to have an estimated useful life equal to or exceeding the estimated useful life of the facility or community itself, or exceeding the legal life of the community as defined in an association’s governing documents. Examples include the complete replacement of elevators, tile roofs, wiring and plumbing.
- PREPARING THE RESERVE STUDY
Once the reserve assets have been identified and quantified, their respective replacement costs, useful lives and remaining lives must be assigned so that a funding schedule can be constructed. Replacement costs and useful lives can be found in published manuals such as construction estimators, appraisal handbooks, and valuation guides. Remaining lives are calculated from the useful lives and ages of assets and adjusted according to conditions such as design, manufacture quality, usage, exposure to the elements and maintenance history.
Certain calculations must be performed on the compiled data in order for the study to take on a practical meaning, ranging from simple to complex methods. The least complicated method is the straight-line approach in which the replacement cost in today’s dollars, less accumulated reserves, is divided by the estimated remaining life of the components.
The association should update the report on an annual basis to reflect such changes as shift in economic parameters, additions of phases or assets, or expenditures of reserve funds. The reserve analysis update process can be simplified by keeping accurate records of these changes throughout the year.
- DISTRIBUTION OF ACCUMULATED RESERVES
To determine the ideal level of reserves and actual distributions for each asset an evaluation of the second step is to identify the ideal level of reserves for each asset. A calculation of the component’s age proportionate to its estimated useful life and current replacement cost must be made as follows.
IDEAL LEVEL OF RESERVES =
USEFUL LIFE X CURRENT REPLACEMENT COST
This method of calculating the ideal level of reserves does not consider future replacement cost, nor interest earned on the accumulated reserves. However, it is a general indicator of the adequacy of the Association’s current reserves, based on current conditions and replacement cost. If the reserves are underfunded, the monthly contribution requirements can be expected to be higher than normal.
- LEGAL REQUIREMENTS
Most Association governing documents require the funding of a reserve. Further, several states now have laws requiring reserve studies.
Reserves are often underfunded in the development stage of the project. Developers have competing objectives: first, to maintain low Association dues to entice buyers, but second, to collect sufficient dues to maintain an adequate reserve. Developers may have a fiduciary duty to provide for an adequate reserve.