The reserve study is a multi-purpose tool. Following its recommendations should ensure an association smooth budgetary transitions from one fiscal year to the next, and either decrease or eliminate the need for "surprise" assessments. It serves as a "consumer guide" to prospective purchasers, and provides current homeowners with a yearly disclosure as to the financial condition of their association. The study is necessary to the accountant during the preparation of the annual audit, and it is requested by financial institutions during the processing of loan applications.
The provisions of Civil Code 1365(a) set forth the essential elements of a reserve study. The report is to be distributed to the members "not less than 45 days nor more than 60 days" before the beginning of each fiscal year, and must:
The community's governing documents (usually
the declaration formerly referred to as "CC&R's"),
through which the members have delegated maintenance responsibility
to the association, should provide the initial guidelines as to
what assets are to be included in the reserve study. This information
is frequently of a general nature, however, and components must
be examined individually to determine whether they should be budgeted
as operational or reserve expenses.
It is an unfortunate fact that the determination of whether an
expense should be included in the operational or reserve category
of an association's budget, or excluded altogether, has historically
been made subjectively. Since guesswork can have disastrous effects
on a financial plan which concerns so many, it should be minimized.
The need for "judgment calls" can be decreased by subjecting
each of an association's assets to the following test:
Generally, operational expenses:
Reserve Expenses:
Budgeting is normally excluded for:
Reserve Assets:
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 or valuation
guides. These can also be obtained from contractor quotations.
Remaining lives are calculated from the useful lives and ages
of assets, and adjusted accordingly 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 practical meaning. Several methods
have been developed, ranging from simple to complex. The least
complicated method is the straight-line approach, in which the
replacement cost in today's dollars is divided by the estimated
useful life of the asset. Given more time and effort, the reserve
study calculations could be completed by hand, using this or a
similar formula. However, as the effects of inflation, taxes and
interest yields compound over the years, a more detailed approach
is recommended. The most precise calculations involve determining
the replacement cost in future dollars, and include provisions
for interest on invested funds net of taxes, and membership contribution
increases each year in line with cost of living changes. During
this phase of the reserve study, it is particularly relieving
to have engaged an outside firm with a specialized computer program.
An association which increases its reserve fund according to the recommendations of an effective reserve study should avoid any major shortfalls. However, to remain accurate (and as mandated by law), the report must be updated each year to reflect changes such as shifts in economic parameters, phases or reserve assets added to the community, or expenditures of reserve funds. A community can assist in simplifying the annual update process by keeping accurate records of these changes throughout the year.
Association board members should become aware of the various factors which comprise the reserve study process, and pay close attention to be sure the report on which they will be depending is detailed and reliable. In this manner, it will remain a helpful and versatile implement which will guide the association past potential budgetary disasters, and assist the board in fulfilling its legal and fiduciary duties.