An Original Essay by Matthew Faulkner
“I’m an Accountant and these financials don’t make sense” is one of the most difficult comments to respond to. Is a Strata Manager really supposed to know? Even the best Trust Accounts Officers know what they are doing, but not necessarily how that differs from corporate accounting.
This essay is the definitive comparison.
Company financials are classified as ‘General Purpose’ financial statements, meaning those reports are intended for a wide range of uses, such as credit analysis and share valuations. General Purpose financial statements must be prepared in accordance with a bunch of specific rules called the Australian Accounting Standards (AAS).
Strata plan financial statements are classified as ‘Special Purpose’ reports, meaning they are intended for the presentation to a limited group of users. Almost like a glorified memo. They must comply with the Strata Schemes Management Act rules, but as Special Purpose financial reports they do not have to follow Australian Accounting Standards.
There are many differences between what the AAS compels companies to do versus what strata industry standard accounting practices are.
Companies must prepare accounts on an ‘accruals basis.’ What is relevant for income is the period the income was for, as opposed to a ‘cash basis’ of when the income was received. What is relevant for expenses is when the work was performed, as opposed to a ‘cash basis’ of when the invoice for the work was paid.
With the AAS not applying to strata, the industry standard could have been all cash-based accounting, or all accruals based. Probably because accruals are unnecessarily difficult, the industry has evolved to be that Levies income is accrued, but in a different way to how companies do it, and expenses are recorded using the date they are paid, with certain expenses accrued, sometimes! Strata financial statements are a hybrid of cash and accrual accounting.
Levies ‘hit the accounts’ on the date they are raised. Corporate accounting would use the period the levy was for. For example, a plan with a year-end of 28th Feb that raised a quarterly levy due on 1st January would include the whole 3 months as revenue (regardless of whether it has been received). A company would also have accrued it but only included the 2/3rds for January and February, not March. Strata accrues levies, but not the same way a company would accrue it.
When an invoice has been received and is entered in as a creditor this is an accrual, since it is yet to be paid. However, this relies on creditors sending their invoices in on time. Agents can choose to accrue invoices they expected to receive, but it is not compulsory. In general, strata do not accrue invoices they have not received. If done properly, accruing can be particularly useful in minimising questions from owners and assisting the next year’s budget. For example, if only 3 quarterly water bills had been received, the water expense may read as $15,000. The following year might include 5 quarters and read $25,000. It looks like water expenses have exploded, but its only a timing difference. Accruing that 4th quarter of water would have evened out both years to be $20,000. When basing budgets off the prior year’s expenses, accruing is almost essential to have an accurate budget.
Insurance premiums that insure past the year end date would be apportioned to prepayments in a company. A $30,000 insurance premium for Jan-Dec with a year end of June would have $15,000 moved to prepayments in a company. In general, if no more than 12 months of expenses are in the accounts no allowance for prepayments occurs in strata. Even if those 12 months overlap other years.
Depreciation is something not seen in the financials of a strata plan. Companies have a ‘useful life’ concept that sends expenditure deemed to be an asset to the balance sheet instead of to an expense account. That asset is then expensed over a number of years until it is of zero value. For example, a $10,000 water tank would become an asset on a company balance sheet with say $1,000 a year being moved across to depreciation expenses until its value has reduced to zero after ten years.
There is an accounting term called a ‘Sunk’ cost which is the theoretical alternative to ‘capitalising’ an expense and depreciating it. A sunk cost is expensed in its entirety regardless of it having a long useful life. This is where the Capital Works Fund (formerly known as the Sinking Fund) gets its name.
There are a few important strata tax rules that companies would be unfamiliar with. Levies are classified as income on the financial statements, but owners are literally giving themselves money, making this classified as ‘Mutual income’ which is not taxable income.
Even with the principle of ‘Mutuality’ applying to levy income, plans do not get away with not incurring GST. Levies are included in the calculation of reaching the compulsory GST registration threshold. Plans are considered ‘Not For Profit’ entities for GST purposes with a $150,000 per annum threshold. Companies are classified as ‘For Profit’ entities with a $75,000 per annum threshold.
In stark contrast to GST, a plan is considered a ‘For Profit’ entity for tax purposes. Not only do they have to lodge tax returns, but they must also use a company tax return form!
Income from common property is not taxable income of the plan. Rent income from a common car space, lease income from a rooftop mobile phone tower and proceeds of the sale of a common room are all taxable…but in the tax returns of the owners!
Plans do not trade, so they pay tax at 30% on what little income is left to count, unlike companies who pay 25% tax (as a ‘base entity’).
Strata software has the unusual/unique option of reporting ‘gross’ figures (including GST) countered by a negative GST line item. Companies would never report with negative GST line items. Not all agencies choose to report in gross, but a lot do including several large agencies. A company accountant would find this practice very peculiar indeed.
Producing special purpose financial statements gives strata agents several choices on how to report financial data. These options create the only genuine problem in the industry, a lack of consistency in strata accounting methods.