Gary Porter

A New Light on Reserve Studies ICBI establishes new standards, procedures and software to create primarily a financial report

GARY PORTER

The reserve study industry was effectively born about 40 years ago and has undergone few changes since then. Most associations give little thought to the reserve study, often treating it as a statutory obligation or just trusting that the reserve preparer knows the job and will get it right.

But there have always been a number of reserve preparers who said, “We can do better than this.” Failing to gain traction inside the change-resistant mainstream, this group formed the International Capital Budgeting Institute (ICBI) in 2014 to critically examine the reserve study process and to develop standards that would provide better results.

They characterized the reserve study report as a financial report, challenging the concepts of most mainstream reserve

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preparers that it is an engineering study, a maintenance plan, a project condition assessment or an appraisal. The reserve study is a financial projection, a budget.

They also identified the three characteristics of financial documents that cause the public to have confidence in those documents: clarity, consistency and comparability, then developed standards to produce those characteristics in reserve studies. ICBI gathered 16 people from six countries, representing every stakeholder group in the community association industry to form the ICBI Standards Committee. The committee challenged the status quo by examining the reserve study process itself and the resulting reserve study report. The committee identified three skill sets representing three separate disciplines that comprise the reserve study process: component skills, valuation skills and financial skills. These skills do not overlap and it is rare that any individual will

have high-level knowledge in all three of these disciplines. The component-centric reserve preparers that make up the majority of reserve preparers generally have high components skills but lower skills in the other two disciplines. The ICBI standards were carefully developed to build the calcu

lation and financial reporting requirements into the standards themselves, substantially reducing the requirement for reserve preparers to independently possess those skills. They just have to follow the standards.

The ICBI standards differ from traditional standards used by many reserve preparers by giving comprehensive, professional guidance to reserve preparers. ICBI identified and adopted the principles that underlie the reserve study process and developed performance standards that preparers must follow to result in reports that provide clarity, consistency and comparability. The primary differences are: • ICBI standards have an expanded definition of activities (not just components) that should be included in the reserve study. ICBI rejected the arbitrary limitations of “predictable life” and “predictable remaining life” used by others and replaced those with “maintenance related activity” and “non-annual expenditures.” This results in removing the confusion many reserve preparers have over such items as landscape replacement, which does not have a predictable life—always allowed under ICBI standards, questionable under other standards. • ICBI standards require that all replaceable components either be included in the funding plan or disclosed as to why they are not being included in the funding plan. The biggest issue is infrastructure components such as inwall, under-slab and underground utilities (plumbing, gas, electric). Other standards specifically tell you not to include such components unless they show signs of failure—in other words, about 50 years too late. Most associations choose to

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Imaging Inspection • Flood, Sewage, and Mold Cleaning disclose rather than fund such items, but at least members are informed of the existence of components not being funded. • ICBI standards require specific calculations including the most contentious of those, the percent-funded calculation. Given that we can document 64 variations of this calculation, there must be consistency in how reserve preparers apply the only defensible version of that calculation. • ICBI standards for reporting differs with the requirement for specific financial exhibits, specific reporting elements in those exhibits, a narrative preparer’s report, narrative disclosures that explain the assumptions used in the financial exhibits, and a supplemental exhibit meeting the FASB (Financial Accounting Standards Board) disclosure requirements for community associations. These are all standard protocols in the accounting world that never previously made it to the reserve study world. • ICBI standards require the use of software that has been certified under objective testing protocols to meet the ICBI software calculation and reporting requirements. This is the most controversial of the ICBI requirements, but is a requirement that is inflexible. If software has not been tested for consistency and integrity, it cannot be relied upon for accurate reporting.

All ICBI members must follow the same basic reporting format but are allowed to add any additional financial exhibits they deem helpful to understand the reserve study. The basic reporting format is limited to six financial exhibits produced on a summary level, generally category or location, such that most of these exhibits are limited to one or two pages only. The goal of the reserve study report is to communicate actionable information, not bury the reader of the report in hundreds of pages of detail. Supplemental schedules issued separately from the primary report are encouraged to provide component-level detail information. The result for the community association industry is that reserve study reports issued by ICBI members will all be very similar while meeting the reporting goals of clarity, consistency and comparability. You can only get that from ICBI members. Will their reports differ? Certainly, as different professional judgments are applied to component maintenance activities, pricing of components and modeling the financial plan.

The future of reserve studies started with the formation of ICBI in 2014 and the issuance of ICBI’s Generally Accepted Reserve Study Principles and Generally Accepted Reserve Study Standards in 2015. A growing number of reserve study companies are continuing to join ICBI. ❖

Gary Porter is the president of ICBI. He is also CEO of Facilities Advisors International, which has offices nationwide, including in Hawaii. He has been published or quoted in the Wall Street Journal, Money, Kiplinger’s Personal Finance, CAI’s Common Ground and Ledger Quarterly. He is the coauthor of Reserve Studies: The Complete Guide, CPA’s Guide to Homeowners Associations, Homeowners Association Tax Library and more than 400 articles. Porter is a past national president of CAI and is a member of 12 CAI chapters, including Hawaii. Reach him at gary@faireserves.com.