International Capital Budgeting Institute
Interpretations of Generally Accepted Reserve Study Principles
General Principles – Section 1
1-1.1 – Physical facilities deteriorate over time and organizations have the responsibility to maintain certain common area physical facilities. It is possible to identify, quantify, and evaluate the condition of those facilities that require long term major repair or replacement.
1-2.1 Maintenance plans - Maintenance plans are normally integrated to include both operating maintenance activities and long term major repair and replacement activities, as the operating maintenance activities can have a significant impact on the long term major repair and replacement activities. It is the responsibility of the governing body to establish maintenance plans and long term capital repair and replacement budgets. The governing body may engage outside professionals to assist them in the establishment of both the maintenance plan and the long term capital repair and replacement budget.
1-3.1 Reserve studies – Reserve studies are a specialized type of long term capital budget used generally within the community association and timeshare association industries to establish funding plans based on regular member assessments.
1-4.1 – Funding Plan - In the case of a reserve management plan, the organization should adopt the final funding plan. In the case of an independent reserve study, the reserve professional assumes responsibility for recommending a funding plan, which may or may not be adopted by the organization. Organizations should establish separate reserve bank accounts and segregate reserve funds from operating funds. It is generally considered prudent to provide for regular periodic interim funding and to avoid special assessments.
1-5.1 – Reserve study policies should generally address the following items
a. Criteria for determining what components are included in the study
b. Criteria for determining what components are excluded from the study
c. Policy on timing of updates of reserve study
d. Funding goals or general guidelines for funding plan
e. Reserve cash handling policies and procedures
1-6.1 - Reserve study updates - Reserve studies should be updated on a regular, periodic basis.
Reserve studies that include a site analysis should be performed based on age or condition of the facilities, or an unrelated triggering event. Examples are:
· Age – If physical facilities are limited to real estate, updates should occur no less frequently than every five years during the first fifteen years since completion of construction, and no less frequently than every three years thereafter. Inclusion of significant personal property with shorter useful lives may require more frequent updates that include a site analysis.
· Condition – Significant change in condition, observed deterioration, or accelerated deterioration may indicate that an update is necessary.
· Triggering event – Events unrelated to age or condition, such as developer turnover, unexpected expenditures, significant changes in replacement cost, significantly shorter useful lives than anticipated, discovery of previously omitted components, or significant changes in available funding, may require that an update be prepared.
Reserve study updates that do not include a site analysis should be performed annually except for any year in which a site analysis is performed.
Component Principles – Section 2
2-1.1 – Real property components included in reserve study - Townhouse or other attached single family homes associations often have governing documents specifying that the members have responsibility for exterior building maintenance, yet policies, whether formal or informal, wherein the association has assumed that maintenance responsibility. This is often done to ensure adequate and uniform maintenance of building exteriors. In such a case, the reserve study should reflect the actual maintenance plan, even if it contradicts the governing documents.
2-1.2 Personal property components – Some organizations do not include personal property components in the reserve study under the theory that (1) replacement of personal property components is optional, as their use could be eliminated by changing to use of an outside service, or (2) funding for replacement can be achieved through funding depreciation expense in the operating fund.
Both theories are rejected. Unless an actual plan exists to change to an outside service that would eliminate the requirement to replace personal property, such components should be included in the reserve study, as it is the assumption that they will need to be replaced. Funding through the operating fund by funding depreciation expense has two significant weaknesses (a) most organizations have such volatility in their operating budgets that funding cannot be guaranteed, and (b) funding in the amount of depreciation, a backward looking system that does not consider inflation, usually results in significant underfunding.
2-2.1 – Component general characteristics - The general component characteristics should identify all components that exist. It is up to the organization to determine if certain of those components should be excluded from the reserve study.
2-2.2 – Component general characteristics - The definition of components as defined by other organizations (CAI and APRA) also include having a predictable life as a characteristic of a component to be included in a reserve study. It is not logical to require “predictable life” as a basic characteristic of a component, as there are some components that require funding that do not fit this definition. Some components can often be characterized as lifetime components, but still have unpredictable, periodic, partial failures that require funding. It is irresponsible to not fund at least some estimate for future expenditures to avoid the risk of leaving the organization in an underfunded position. Providing an estimated “allowance” for repairs of such items, or provide for funding for a percentage of replacement, allows organizations to set aside funds for such components. Examples of components where these types of estimates occur are; concrete block walls, steel fencing, vinyl fencing, wood siding, street substrate, and fairways, greens and tee boxes of golf courses.
2-2.3 - Component general characteristics - The cost of preparing the reserve study and the cost of amending governing documents are two items that are often routinely included in reserve studies. Such costs should not be included, as they do not represent physical components that are the maintenance responsibility of the organization. Reserve components should represent only significant non annual maintenance expenses.
Components that were overlooked in prior reserve studies should be added to the reserve funding plan when discovered. Expenditures for such omitted components may be made from the reserve fund in spite of the omission, but would generally require an immediate recalculation of the reserve funding plan.
2-2.4 - Component characteristics - It is the organization’s maintenance plan that drives reserve study funding, but it is possible that items traditionally considered reserve components can be funded through the annual operating budget, if component expenditures represent approximately equal annual expenditures. Example – organization establishes a ten year cycle annual painting program wherein one portion of the organization is painted each year, and in year eleven they start over. Assuming the funding is approximately equal each year, it is not unreasonable to pay this cost out of the operating budget.
2-3.1 – Additional component considerations – One component normally excluded from reserve studies is the replacement of in wall, under slab, and underground utilities, such as water lines, wastewater lines, gas, electrical, and cable wiring. Replacement of these utility items is generally the most expensive component in a condominium type association because replacement requires the partial destruction of building structures. Utility lines such as these generally have a life of 40 to 60 years, so they do meet the definition of components that should be included in a reserve study. Most organizations will probably opt to exclude funding for these components, but their exclusion from the reserve study should be disclosed.
Calculation Principles – Section 3
3-1.1 – Replacement Cost – Replacement cost shall include the purchase cost of the repair or replacement component, including all costs to place the component into service, including shipping or delivery costs, sales tax, installation cost, cost to remove the component being replaced, and any design or other costs associated with the acquisition and installation of the new component.
Some organizations may use their own maintenance staff for both operating and reserve projects. In such cases, the organization should attempt to allocate costs to the reserve fund of staff time for reserve projects. This should include direct labor amounts plus reasonable overhead allocations.
3-2.1 – Inflation – Projected future component expenditures should include a factor for inflation / deflation for the 30-year projection period, or the report shall include a disclosure that inflation / deflation has been omitted. Inflation / deflation rates applied shall be disclosed in the reserve study report. If inflation / deflation is reported differently or omitted for certain time periods, that fact shall be disclosed.
Studies show that inflation has occurred for the last 70 years. Inflation affects future replacement costs and should be included for the entire 30-year projection period, with disclosure of inflation rates assumed. Failure to include inflation may result in establishing an unrealistically low assessment structure resulting in underfunding and the possibility of special assessments.
3-3.1 – One time expenditures – One time expenditures should be included in the reserve study if applicable. Non recurring expenditures may be projected to correct construction or repair of components that otherwise may not require replacement. Such expenditures should be included in inflation and percent funded calculations if percent funded calculations are made.
3-4.1 – Percent funded calculations – Percent funded calculations are not required, but, if made, should always be made using the inflation adjusted method. Current or future cost percent funded calculations create biased results and over or underfunding as compared to the inflation adjusted method. Current or future cost methods should be used only where required by regulatory reports, and should never be used to replace a funding plan used for budgetary purposes.
3-5.1 – Cash flow funding method – The cash flow method shall be used for all budgetary reserve study calculations where more than one component exists. The cash flow method calculates funding based on the aggregation of all components projected future expenditures. The cash flow method does not contemplate any specific funding goal.
3-5.2 – Component funding method – The component method should never be used for calculating reserve study funding for budgetary purposes, as it requires assumptions that can be used to manipulate the funding plan, whether purposely or inadvertently. It also requires re-assessing those assumptions annually. The component method should be used only where required for regulatory reporting purposes, and should not replace the cash flow method used for budgetary reporting.
Service Level Principles – Section 4
4-1.1 – Independent Reserve Study – The independent reserve study is what the industry has traditionally perceived as the only form of reserve study through early 2015. The independent reserve study is one prepared by the reserve professional based solely on his or her professional judgment. The reserve professional may receive information from a variety of sources, but ultimately must exercise his or her judgment on all factors affecting the reserve study. The reserve professional may not accept another’s judgment in place of his own. The independent reserve professional assumes all responsibility, and liability for, the accuracy of the reserve study.
4-2.1 – Reserve Management Plan – The reserve professional works with the organization to assist them in determining a reserve management plan, and the reserve study report is the tangible work product of that plan. The reserve management plan engagement includes providing assistance to management by helping them identify key factors, develop assumptions, gather information, assemble the information, and develop a financial model so they may consider the results based upon their stated assumptions. The organization assumes responsibility for all significant factors and assumptions contained in the reserve study. The reserve management plan differs significantly from the independent reserve study in that the organizations assumes responsibility for the factors supporting and the ultimate accuracy of the reserve study.
4-3.1 – Reserve Study Consulting Services – The reserve professional may engage in services that do not result in the issuance of a report.
Reporting Principles – Section 5
5-1.1 – Reserve Study Reports – Reserve studies differ from other long term capital budgets in that they have a designated source of funding, and an obligation by the organization to provide for that funding. The primary focus of reserve study reports is the funding plan.
5-2.1 – Types of Reports – There are three types of reports that may be issued:
A. Full reserve study with a site analysis – Generally an initial report that includes identification, evaluation, and quantification and measurement of components based upon a site analysis. The full reserve study report may be based on an independent reserve study or a reserve management plan level of service.
B. Update reserve study with a site analysis – An update of a previously issued report that includes a site analysis evaluation of components. This study generally does not require the identification or measurement of components, as the prior study may be relied upon. The update with site analysis reserve study report may be based on an independent reserve study or a reserve management plan level of service.
C. Update of reserve study without a site analysis – An update of a previously issued report that does not include a site analysis, but is rather an “accounting” update of remaining life, replacement cost, and a revision of the funding plan. The update without site analysis report may be based on an independent reserve study or a reserve management plan level of service.
5-3.1 – Preparer Report – Reserve professionals shall issue a “preparer’s report” that describes the reserve study engagement, summarizes procedures and conclusions, and refers to professional standards applicable to the engagement. The preparer’s report shall be issued by the reserve study company as opposed to the individual preparer. The preparer’s report shall include the following:
a) a title that identifies the type of report and level of service
b) identification of the subject matter and the responsible party
c) a statement that the subject matter is the responsibility of the responsible party (governing board)
d) a description of the nature and scope of the work performed
e) a reference to generally accepted reserve study standards governing the engagement
f) a statement that the engagement is less in scope than an independent engineering report and no such opinion is expressed
g) the report shall disclose if site analysis or any other significant portion of the financial projection is prepared by another individual or company
h) a statement about whether the practitioner is aware of any material modifications that should be made to the subject matter in order for it to be based on the criteria indicated in the report
i) a statement about whether or not the software used in preparation of the financial exhibits meets ICBI software standards
j) a statement restricting the use of the report to specified parties
k) a statement identifying required supplemental information included in the reserve study report
l) a statement identifying regulatory information included in the reserve study report
m) statement identifying any supplemental information that is not required included in the reserve study report
n) the report shall state that the reserve professional is not responsible for any events subsequent to the date of the report
5-3.2 – Independent Reserve Study Preparer’s Report – A significant departure from past practice is that the independent reserve professional is required to include a “preparer’s report” as part of the independent reserve study. The preparer’s report summarizes the preparer’s procedures and findings, and is in addition to the narrative disclosures and financial exhibits that comprise the reserve study report.
5-3.3 – Reserve Management Plan Preparer’s Report – The reserve professional issues a “preparer’s report” that summarizes the preparer’s procedures and findings of the reserve management plan, and is in addition to the narrative disclosures and financial exhibits that comprise the reserve study report. This report differs significantly from the independent preparer’s report in that the preparer is commenting on the organization’s reserve study report. The organization is considered to be the “owner” of the report.
Software Principles – Section 6
6 – Software is the technology tool used to interpret the calculation and reporting standards into information that understandable. Software is the most critical factor in allowing reserve professionals to comply with Generally Accepted Reserve Study Principles, and therefore software must be capable of making correct calculations in accordance with those standards
6-1.1 – General Calculations, Cash Flow Method – Generally Accepted Reserve Study Principles recognize only the cash flow method as an acceptable method for making funding calculations. The cash flow method aggregates the cost of projected future expenditures for all components, then calculates a revenue “cash flow” to provide sufficient funding to pay the projected expenditures. The cash flow method does not contemplate a funding goal, but is simply a method of calculating funding. Reserve study software must have the capability of making funding calculations on the cash flow method.
6-1.2 – General Calculations, Component Method – The component method, sometimes referred to as the straight line method, calculates future funding requirements at the individual component level. The component method requires an allocation of cash / investments on hand at the time the calculation is made. Depending on how the cash / investments amounts are allocated, it can result in significant variations in future funding requirements. Because this method is subject to manipulation, it is not considered a reliable method and should not be used for budgetary calculations.
Certain states require component method calculations for regulatory purposes. Reserve study software must therefore have the capability of making funding calculations on the component method.
6-2.1 – Component Calculations – Reserve study software must be capable of correctly making all required component calculations.
a. Inflation / deflation calculations
b. One time expenditures
c. Percent funded calculations at current cost, future cost, and inflation adjusted cost methods. Budgetary calculations should be made using only the inflation adjusted cost method. However, software must also be able to calculate both the current and future cost methods, which are required in certain regulatory settings.
d. Software must have capability of summarizing component data, either by category or another method to produce summary level reports.
6-3.1 - Funding Plan Calculations – Reserve study software must be capable of correctly making all required funding plan calculations.
a. Interest earnings calculations
b. Income tax calculations
c. Reserve assessments
d. Ability to modify reserve assessments
e. Special assessments
f. Loans and loan repayments
6-4.1 – Summary level financial reports - Reserve study software must be capable of producing summary level financial reports. Summary level reports should generally be one or two page reports only. If the organizations has a relatively small component list and detail reports can be presented in a one or two page format, then it is acceptable to insert detail reports in place of summary reports.
a. Statement of current position
b. 30-year cash flow funding schedule
c. 30-year expenditure summary
d. Summary component list
6-5.1 – Additional reports – Additional required reports that software must be capable of producing are:
a. Preparer’s report - narrative format
b. Disclosures – narrative format
c. Regulatory reports consisting of FASB (Financial Accounting Standards Board) disclosure and state required disclosures for all states in which software is used.
d. RSI – Required Supplementary Information – Component list at a detail level.
e. Supplemental reports may consist of any other financial exhibits that the reserve professional wishes to add to his or her report. Supplemental reports may contain any additional information desired by the preparer, but such reports may not contradict the summary level, basic, financial reports.
6-6.1 – Timeshare software requirements – Because of the unique requirements of timeshare associations, software for timeshare or other fractional associations must be capable of compiling unit component list by unit.