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“STRATEGIC AND FINANCIAL PLANNING FOR PROPERTY MANAGERS” MANUAL REVISION

REQUEST FOR PROPOSAL

BACKGROUND The Institute of Housing Management (IHM) offers courses in-class and through distance learning for those involved in the property management sector. Students who successfully complete four courses (Maintenance, Strategic and Financial Planning, Administration, and Human Relations) and two electives, and who have five years qualifying experience may apply for the Accredited Member of the Institute of Housing Management (AIHM) designation. Further details on the Institute, our courses and accreditation can be found on our website, www.ihm-canada.com. STRATEGIC AND FINANCIAL PLANNING FOR PROPERTY MANAGERS – CURRENT COURSE DESCRIPTION This course is designed to provide a complete review of the accounting process and principles, the managerial use of accounting and financial statements and their analysis, and budget preparation procedures for property managers. In addition, the techniques and approaches for establishing and organizing objectives and implementing strategies will be discussed. SAMPLE OF THE MANUAL A brief sample of the current manual and the table of contents are attached, to give you an idea of style, content and layout. AIM OF WORK The current manual is very heavily focused on financial accounting. Although a property manager should have a good understanding of generally accepted accounting principles, in the judgment of the Institute's Education Committee, a property manager is unlikely to be involved in the creation and maintenance of financial records and the preparation of financial statements. Accordingly, an in-depth discussion of these areas is inappropriate. A property manager should be able to interpret the information provided by financial statements to permit him/her to control expenses and enhance returns from the property, create and monitor budgets, ensure compliance with loan covenants (if any) and monitor and improve cash flow. In addition, a property manager needs to understand the issues related to taxation, acquisition and financing of assets, and business planning. Accordingly, in revising the manual, the work should be done with this in mind. SCOPE OF WORK IHM will provide a Microsoft Word version of the existing manual. Changes, additions and deletions are to be made using Word’s “Track Changes” feature. You should also make any format changes you feel are necessary, again using “Track Changes”. If you are the successful bidder, you will need to:

• Read through the manual and, with the above-discussed aim of work in mind, o Conduct preliminary information gathering and develop a draft outline,

including topics and a brief summary for each chapter o Meet with the Education Committee to develop an approved outline of

deliverable work (two meetings may be required) o Mark for deletion those sections that should be removed entirely o Change and update those sections requiring it

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o Identify new sections which may not currently be part of the manual and write the new content for those sections or re-write existing material

o If the structure of the manual should be changed, reorganize the material and change the table of contents

o For all new and revised material, suggest possible chapter review questions and exam questions for consideration by the Education Committee

Please note that all changes must be made to the Word version of the manual, as this will be the only document you produce that will be considered by the Education Committee QUALIFICATIONS The successful bidder will have demonstrated experience and knowledge of business and financial planning, especially in property management and in the social housing sector, and will have a working knowledge of relevant legislation within Ontario. In addition, the successful bidder will be able to demonstrate his/her ability to interpret technical information and communicate it in readily understandable terms. TIMELINES The following timelines must be adhered to:

• May 31, 2012 – proposals due • June 15, 2012 – winning bidder selected • July 15, 2012 – submission of draft outline for deliverable work • September 15, 2012 – submission of a complete draft of the manual in Microsoft Word

format, incorporating all recommended changes • October 31, 2012 – comments returned to you by the Education Committee • December 15, 2012 – submission of the complete final version of the manual

YOUR PROPOSAL Your proposal will be evaluated on a rating scale and should include:

• Background, illustrating your understanding of the project (15%) • Project Methodology and Schedule, explaining how you plan to undertake the work

and your proposed schedule for doing so (25%) • Experience, showing your ability to produce quality work within budget and on time (a

sample manual and a list of references with contact information should be included for evaluation) (30%)

• Finance, giving the total cost of the contract (30%) •

Your total proposal should not be longer than ten (10) pages, including all samples. NOTICE The lowest, or any, bid will not necessarily be accepted. All proposals become property of IHM. All materials included with this RFP and, if you are the successful bidder, sent to you for review and revision, are the property of IHM, and you do not gain any rights to them. You also do not gain any rights to the revised material; those rights remain with IHM. CONTRACT TERMS The successful bidder will be required to sign a contract with the Institute, as the contract will include penalties for late, unsatisfactory or non-performance of the bidder’s obligations, we are disclosing them at this time. Payments

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• An initial payment of thirty percent (30%) of the total contract value will be payable on submission of the complete draft manual

• A second payment of sixty percent (60%) of the total contract value will be payable on submission of the complete final manual

• A final payment of ten percent (10%) of the total contract value will be paid upon acceptance/approval of the complete final manual by the Institute

Penalties Late submission of the draft manual will result in a penalty of five percent (5%) of the total value of the contract for each week the draft manual is late, for up to three (3) weeks, unless an extension has been granted. In the event an extension has been granted, penalties will apply as of the extended draft manual submission date. Late submission of the final version of the manual will result in a penalty of six percent (6%) of the total value of the contract for each week the final manual is late, for up to three (3) weeks, unless an extension has been granted. In the event an extension has been granted, penalties will apply as of the extended final manual submission date. If submission of either the draft or final manual is more than three (3) weeks late, IHM reserves the right to terminate the contract without notice and negotiate an equitable financial settlement with the contractor for work done up to the date of termination. Upon termination, all work done by the contractor becomes the property of IHM and must be submitted to IHM, along with all material sent to the contractor for review and revision. Penalties will be deducted from the next scheduled payment. Extensions A request for an extension of a deadline must be submitted in writing at least one (1) week prior to that deadline, along with the reasons for the request. IHM has the sole right to determine whether an extension will be granted, and is under no obligation to allow an extension. A given deadline will only be extended once, and the maximum extension for each original deadline will be two (2) weeks. If the successful bidder does not request an extension of the draft submission deadline, the maximum allowable extension for the final version submission deadline remains two (2) weeks. Review of Contractor’s Work IHM has the right to review work done to date at any point during the contract, in addition to its review of the draft outline of work and the draft manual. If, upon such review and in the sole judgment of IHM, the contractor is not meeting his/her contractual obligations in a satisfactory manner, IHM reserves the right to terminate the contract without notice and negotiate an equitable financial settlement with the contractor for work done up to the date of termination. Upon termination, all work done by the contractor becomes the property of IHM and must be submitted to IHM, along with all material sent to the contractor for review and revision. Conflict of Interest The successful bidder will be required to sign a statement disclosing any interests s/he/they has/have which conflict, or may be perceived to conflict, with the interests of the Institute. CONTACT INFORMATION If you have any questions, please contact: Josée Lefebvre Institute of Housing Management 2175 Sheppard Ave. E., Suite 310 Toronto, ON M2J 1W8 Tel: 416.493.7382 ext 255

Tollfree: 1.866.212.4377 Fax: 416.491.1670 Email: [email protected]

IHM - Strategic and Financial Planning for Property Managers

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CHAPTER 1

INTRODUCTION

OBJECTIVES At the conclusion of Chapter 1 the student should be able to: 1. Understand the principles used to create financial information 2. Understand the difference between stakeholders of an organization, and the

financial information which is of interest to them 3. Understand how financial managers use financial information to meet the

objectives of the stakeholders 4. Differentiate between assets, liabilities, capital, revenues and expenses 5. Understand the different financial standards of International Financial

Reporting Standards (IFRS) and Private Enterprises TERMINOLOGY Accounting Accounting is a systematic process developed over several centuries

to record the economic events of an organization. Asset An asset is a tangible or intangible item that will create future

economic wealth for the organization. Capital Is the portion of the organization retained by the owners of the

organization. Credit Is an accounting term describing the effect a transaction has on an

account. A credit has the following effects on the following types of accounts:

Assets Decrease Liabilities Increase Capital Increase Revenue Increase Expense Decrease


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Reserve Fund A separate cash fund established to finance major repairs and

common elements of the condominium corporation. Debit Is an accounting term describing the effect a transaction has on an

account. A debit has the following effects on the following types of accounts:

Assets Increase Liabilities Decrease Capital Decrease Revenue Decrease Expense Increase

Expense An expense is the outflow of economic resources or service

that is usually cash of the organization to generate revenues for the organization during a specific period of time.

Liability A liability is an obligation or future outflow of assets of the

organization for a good or service that is consumed in advance of the payment.

Revenues Are the economic resources earned by the organization during

a specific period of time. Stakeholder A stakeholder in a particular organization is an individual or

group that has a vested interest in the performance of this particular organization.

KEY CONCEPTS Some of the most significant functions performed by a property manager are the financial responsibilities. These responsibilities are comprised of: determining the current level of resources for the organization, understanding the organization's financial objectives, the ability to assist the stakeholders in developing a financial plan, executing the plan with the appropriate adjustments for unforeseen

circumstances, understanding the key components of IFRS and when to use this reporting

standard, understanding the key components of reporting standard for Private

Enterprises and when to use this reporting standard


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reporting to the stakeholders on the plan's success in reaching their objectives and,

does the condominium corporation’s resources sufficient to fund future obligations of the corporation.

ACCOUNTING CONCEPTS Accounting is a highly technical field; however, it is essential for all business professionals to have a basic understanding of accounting to be successful. The profession of accounting has been referred to as the language of business. As with every language, accounting is a means of communication, which is evolving and changing in response to the demands of business and society. It conveys business and financial information which is essential for stakeholders to make decisions concerning the organization ranging from investing more resources to liquidating their investment. Stakeholders The most important information provided by accounting, is the summarization of the day to day transactions of the organization in a timely, efficient, reliable and consistent manner to assist with investment decisions. Information should provide the user with answers to questions about a business or economic entity such as:

What are the resources or items owned by the entity?

What are the obligations or debts of the entity?

What are the earnings/income/surplus of the entity?

What are the expenses of the entity? Stakeholders are defined as being individuals or groups that have an interest in the organization such as: owners, creditors, government taxation agencies, employees and tenants. As a result, the property manager has to ensure the financial information is user oriented. This information must be presented and assist the stakeholder in making prudent business decisions and/or actions.


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The types of decisions these stakeholder will be making are:

1. Owners

Does the entity generate a sufficient rate of return for the risk the owners are taking on in comparison to other investment opportunities and does the entity have sufficient cash flow i.e. cash coming in over cash going out to meet all its financial obligations.

2. Creditors

Does the organization generate sufficient incoming cash flows to pay expenses and service the debt of the lender.

3. Government Taxation Agencies

Government agencies will use financial information to assess the tax liability of the organization. For individuals, the income from a business is added to the individual’s income from working, investment and other businesses. Income tax is assessed based on the level of income and is payable by April 30 after the end of the year. Residents of Ontario must file a federal tax return with appropriate supporting provincial schedules. For corporations, tax is based on the type of corporation and the income of the corporation and is payable three months after the end of the fiscal year. The fiscal year of a corporation can be any 365 period in the year and thus does not coincide with the calendar year. The tax return must be submitted within 6 months of the fiscal year. For non-profit organizations, they must file a return called Information Return. In all instances, it may be beneficial to seek professional assistance to complete the appropriate return.

4. Employees

Does the organization have the ability to generate sufficient cash flow to allow for the payment of salaries competitive with similar organizations and the entity can pay the wages at the designated times.


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5. Tenants

Is the organization able to provide rental accommodation that is competitive with the residential or commercial marketplace.

6. Unit Holder Condo/Shareholder

Does the condominium corporation have sufficient resources to meet its obligations and is the replacement reserve sufficient to fund future repairs.

TYPES OF INFORMATION The stakeholders of the organization require several types of information to determine the organization's success in achieving the two primary business objectives of:

1. Profitability or Surplus for condominium owners 2. Solvency

Profitability has been defined as the residual revenues generated by an organization after all expenses have been accounted for. Profitability is a primary objective of the following stakeholders: owners/unit holders, provincial/federal taxation agencies, employees and tenants. The first few chapters of the manual are dedicated to determining profitability. Solvency has been defined as an organization's ability to have sufficient cash inflowing resources to meet its obligations or cash outflows as they come due. Several later chapters in the manual are dedicated to determining and analyzing solvency. Solvency is the primary objective of owners, unit holders, creditors and employees. The long-term success of an organization requires profitability and solvency. However, for limited periods of time, the organization may not be profitable and/or suffer periods of poor solvency. It is necessary for the property manager to be able to determine when these situations are about to arise and to undertake a course of action to remedy the situation. TYPES OF ORGANIZATIONS Property management or real estate ownership can be organized in the following three types of business organizations:


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Sole Proprietorship A sole proprietorship is the simplest form of a business organization. It is owned by one individual, and is not organized under any federal or provincial legislation. There are no legal requirements in starting a sole proprietorship; however, the owner should register the name of the proprietorship with the Ontario Ministry of Government Services to protect their right to use the name as a registered entity for a specific geographical area. Due to the simplicity of this business organization, most business entities begin as sole proprietorships and as the organization becomes more complex, management may decide to change the organization into a partnership or corporation. From an accounting perspective, the owner and the business are seen as two separate organizations and have to be accounted for separately. The business must maintain a set of records for all the transactions involving the business entity separate from the transactions of the individual. From a legal context, the owner(s) of unincorporated organizations (i.e. sole proprietorships and partnerships) are held accountable for the debts and obligations of the business should the organization fail or become insolvent. This is the major disadvantage of these types of organizations. Partnership A partnership is a business organization owned by two or more individuals or business entities i.e. other partnerships or corporations. Partnerships are widely used in business and have the same risks and benefits of a sole proprietorship. Partnerships are usually created to pool the resources such as financial, technical or contacts of the partners to create an organization that is greater than the sum of the individual’s business entities. Partnerships should have an agreement that outlines the rights and obligations of each partner. Typical Clauses in partnership agreements are:


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Clause Purpose

Roles and Responsibilities Outlines what each partner is to contribute to the partnership in financing, skills or other attributes

Profit/Loss Splits Outlines how profits and losses will be split by the partnership

Termination Clause This clause outlines to each partner their ability to terminate other partners for their actions or failure to live up to their roles and responsibilities. Also the clause should outline if and when funds may be due to a terminated partner as well as the payment terms.

Death Clause Outlines how the partnership will be valued, role of a deceased partner’s family in the partnership and how funds will be paid to the estate of a partner

Valuation Clause Provides specific details on how the partnership will be valued if the termination or death clauses are executed

Shot gun clause This specific clause is included when the partners are in good standing within the terms of the agreement but have irreconcilable differences. In this case one partner executes the agreement that says the partner will sell their interest in the partnership for an amount they specify. The other partner(s) must decide within a specified number of days if they will purchase the shares. If the partner(s) decide not to buy the shares for this price they automatically are required by this agreement to offer the shares for sale to the partner executing the clause for the same proportionate price.

Liability Clauses Specifies the requirements of partners to enter into significant financial obligations to prevent the partners from being over extended.


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The partnership must maintain a set of records independent of the individual partners. There are three types of partnerships: general, limited and limited liability. In a general partnership, all the partners are held equally responsible for the obligations of the partnership. This means each partner can be held responsible for all the debts of the partnership no matter if they own only a small portion of the partnership. This is a major limitation of a general partnership and was the reason limited partnership was created. In a limited partnership, there is at least one general partner, and several partners referred to as limited partners. The general partner(s) assume the responsibilities for the obligations of the partnership. The limited partners’ liability is restricted to the amount of their investment or based upon a legal agreement. To limit their liability, a limited partner cannot participate in the day-to-day management of the partnership. If the courts determine a limited partner has been active in the day to day operations of the partnership, the courts will deem this partner to be a general partner. Limited partnerships are generally used as a financing tool because of their limited liability and beneficial tax treatment. A Limited Liability Partnership is a class of partnership brought about in response to the liability of the legal and accounting professions in response to the failure of Enron Corp. in the United States. Prior to the implementation of the legislation each partner in a law or accounting practice was responsible for the action of all the partners in the firm as described in the general partnership section above. The collapse of Enron and other accounting irregularities at other clients of Arthur Anderson resulted in the business community losing faith in Arthur Anderson’s professional capabilities. Furthermore several large class action lawsuits that caused liabilities greater than the assets of the firm. Ultimately these two issues lead to several large clients departing the firm and the ultimate sale of the practice to other accounting firms. In response to this situation, the government in Canada and the US introduced legislation that limits the liability of the firm to the partners involved in the engagement. Corporation A corporation is a business entity that is created in agreement with Federal or Provincial legislation. As a result a corporation is a separate legal entity with the rights of any individual. The main benefit is that the corporation is responsible for all of the obligations or debt it incurs, not the owners of the corporation. This concept is referred to as limited liability. As a result, the maximum loss the owners of the corporation can incur is the amount of their original investment and earnings retained by the corporation.


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Since a corporation is a separate legal entity, the corporation maintains an accounting for all of the financial transactions of the corporation. All condominium organizations are corporations. If the owners of the corporation sign a personal guarantee with a lender, they will loose the limited liability of the corporation for this debt. What this means, is that the stakeholder has agreed to repay the lender if the corporation doesn’t have the ability to pay the loan. Thus the guarantee removes the limited liability. In addition the guarantee will impact the future borrowing capacity of the individual. ACCOUNTING AND MANAGEMENT Property managers must have a thorough understanding of accounting to effectively perform their duties. They must be well versed in record keeping, preparation of all types of financial reports and budgeting. Moreover, they must have the ability to understand, analyze and interpret financial information and apply their knowledge and analytical expertise to making informed and prudent decisions affecting the properties under their administration. Accounting is a systematic process developed over several centuries to record the economic events of an organization. In Canada, the Canadian Institute of Chartered Accountants (CICA) is responsible for defining “broad rules adopted by the accounting profession as guides in measuring, recording and reporting the financial affairs and activities of an organization.” In the past these conventions were referred to as Generally Accepted Accounting Principles (GAAP) and consist of a number of concepts, principles and procedures. GAAP evolved over time to address changes in practices and industry environments. As a result, the property manager should remain knowledgeable of any changes in GAAP related to their industry. Recently accounting bodies around the world were moving to one standard called the International Financial Reporting Standards. In addition, the information provided to stakeholders is to assist the stakeholder in assessing the performance of the entity. As a result, it is necessary that accounting information be:

Relevant, Reliable and Comparable.

Relevant accounting information assists the user in making decisions on the past performance of the entity and assists the user in estimating future performance. Most relevant information provides the user with details of an entity’s profitability and solvency.


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The concept of reliable accounting information suggests that the data is reasonable and accurate. Accounting information incorporates estimates, therefore, an entity’s performance cannot be seen as absolute, but must be representative of an entity’s economic performance. Comparable information allows a user to compare the information of one business entity to another. Therefore it is necessary for all organizations to use similar processes in aggregating financial information. Some of these processes are noted in this chapter. FINANCIAL REPORTING STANDARDS: Prior to the globalization of the world’s economies, each country had their own financial accounting standards. For the more developed nations the standards were fairly consistent with a focus on reliability over relevance and comparability. After the significant financial and accounting crisis over the last 10 years, the world regulators began a movement to one accounting standard for international firms. In 2011 most of the world will be moving to one financial reporting standard called the International Financial Reporting Standards or IFRS. The intent of the new standard is to make financial information more relevant which will change some of the concepts in this text to rely on more current information but this will require more judgment by management and disclosure in the financial statements. The change for Canada is less dramatic than other developed nations since our standards have a lot of similarities to IFRS. Both standards require income statements, balance sheets, Statement of changes in cash flow and notes to the financial statements (all discussed in Chapter 4) the differences usually relate to how specific items are measured, presented in the financial statements and disclosed in the notes to the financial statements. One of the greatest concerns the industry and the regulators had were the reliance on judgment requires the accountant to complete more work to provide assurance the information is complete. So regulators recognized the need to comply with international standards for companies engaged in the world markets and a different standard for smaller and public sector enterprises. In this text we will highlight the importance differences in the three types of accounting standards and when they should bee used. In practice in the field you will need work with your accounting advisor to assess which type of organization you are working for/with and how that may impact the financial practices/policies you may use.


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APPLICATION OF STANDARDS In Canada you have the choice of three standards. In this section we will discuss the standard that you should apply in a generic sense. We recommend that you discuss which standard is appropriate for your organization with your financial advisor who will be aware of specific issues, concerns or elections impacting your choice of financial standards you will use. The three standards are:

IFRS Private Enterprise Standards Public Sector Accounting Board standards

We will now examine how to determine which standard is appropriate for which organization. IFRS IFRS are a requirement for financial accounting periods for organizations defined as publicly accountable enterprises starting after January 1, 2011. The CICA has defined publicly accountable enterprise as:

A company that has issued shares or debt that is traded on a stock exchange or over the counter and/or

An organization that holds assets for a broad group of outsiders as one of its main reasons for business. These typically are trusts, so many of the real estate income trusts in the property management industry would be captured under this clause and required to use IFRS.

Only large sophisticated organizations have been mandated to use IFRS because they have the resources and expertise to allow them to meet the requirements. Organizations that do not meet the threshold requiring them to use IFRS can elect to use the standards. The main reasons an organization would elect to use the IFRS standard is that they are owned by a company or organization that is required to use IFRS so it would make the financial reporting for the overall entity simpler if the entity used the same rules. The second reason an organization would elect to use IFRS would be in anticipation of a private company starting to sell either stocks or debt on a public stock exchange. Private Enterprise Standards (PES) Private Enterprise Standards are more commonly referred to made in Canada GAAP to reflect that the standards are for smaller enterprises that operate solely in Canada with limited number of users that will be familiar with the operations of the entity. Utilizing this definition you can see for most of the property management world this will be the most appropriate standard and the most used set of standards. For the text


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we will be using this standard and identifying the significant variations between Private Sector Standards and IFRS. Public Sector Accounting Board (PSAB) Public Sector Accounting Board standards apply to not for profit sector. As at September 2010 the CICA stated that public sector and not for profit organizations should follow the same principals as for profit companies except around capital assets. Key Changes in IFRS to Old Canadian GAAP The areas most impacted by the change from GAAP to IFRS are:

Classification changes for financial instruments Hedge accounting Transition accounting for contracts Trust units Foreign currency Accounting for organizations you partially own Loyalty programs such as Air Miles Revenue recognition pricing (note they are specific new requirements when

an entity uses the percentage completion revenue recognition criteria for real estate development)

Asset capitalization criteria Provisional threshold (note this criteria may require the recognition of

liabilities and expenses sooner than under GAAP) Pension plan accounting Amortization now commences when the asset is available for use not when it

is put into use Income taxes Presentation of interest as income and expenses and debt in breach of

covenants Investment properties can elect to disclose assets at fair value or depreciated

cost; and Stock compensation.

In reviewing the significant changes in the move from old GAAP to IFRS there is little impact on the day to day operations of the company and the work typically completed by the property manager. The property manager should be aware of the potential changes in capitalization of assets allowing more items to be capitalized during construction and when the period of construction ends and operations begins. The other major are impacting the property manager is the use of fair value to value assets. If an organization uses this model all increases and decreases in values of properties will be reflected in the financial statements. This will increase the volatility of income and require the property manage to be able to explain these transactions to stakeholders throughout the year.


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Key Changes Old Canadian GAAP to Private Enterprises GAAP The areas most impacted by the change are:

Fewer options for accounting for financial instruments, Publicly traded equities and derivatives are accounted for an fair market

value basis, Goodwill and other intangible assets are eliminated

ACCOUNTING METHODOLOGY Business Entity Each business entity, no matter the type of organization, is treated as a separate business entity. The affairs of the organization and the owners are separate from the owners. It is important to understand your role in any transaction to assist you in understanding the transaction will have on the entity Going Concern Going Concern is a term that states the entity or organization is expected to be able to continue into the foreseeable future i.e. several future years. The recording of accounting transactions of an entity and management estimates are based on the assumption that the organization will continue to be in existence for the foreseeable future. As a result, if assets are liquidated, they can obtain current fair market value, which is equal to or greater than the book value of the asset. If there is a strong possibility that the organization may not exist, the property manager should ensure that this information is disclosed to the stakeholders of the business entity because it has negative implications on the asset values listed on the balance sheet. Stable Dollar Under PES accounting information assumes that every dollar the organization earns and disburses is equal no matter if it occurs today, 20 years ago or will occur 20 years from now. As a result, accounting information does not reflect the effects of inflation. Therefore it is important for the user of financial information of an entity to understand the affect this methodology might have on decisions involving divesture and acquisition of assets. This concept is being reconsidered under IFRS and how to apply the standard. ACCOUNTING PRINCIPLES Historical Cost Principle Under PES Financial transactions of the entity are recorded at their cash-equivalent basis at the date of the transaction and do not change because of economic events. So


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the purchase of a property will remain on the books of the company for what the company originally paid for it till it is sold. In almost all instances the property appreciates in values but this principle prevents the increase from being recognized as a profit until the year the property is sold. This principle could negatively impact how you look at a company if you were not aware of its impacts. Under IFRS the gains and losses in appreciation each year are recorded and reflected on the income statement as non-cash revenue if the asset increases in value and as an expense if it decreases in value. The value on the balance sheet will change each year for properties. For a property ownership corporation the use of IFRS increases the vitality of net income over the use of PES Related Party Transactions Financial transactions usually occur between businesses working independently of each other this ensures the transactions are recorded at a fair value and without influence. In some instances transactions occur between related companies. For example the entities are related to each other by having similar owners. For Private Sector Enterprises standards transactions between related parties or corporations, the organization should inform users of the dollar amount of any significant number of transactions or any large dollar transactions between related companies and/or individuals. In addition, the financial manager should attempt to ensure these transactions are recorded at their fair market value. An example of a related party transaction is ABC Properties rents an office from one of the owners of ABC Properties. Under IFRS we have to disclose the related party transaction and the compensation of key management personnel. IFRS does not require any disclosure whether the transactions were at fair Market value or not. Matching Principle The matching principle strives to record expenses in the same period that the revenues they generate are recorded in. For example, when a building is purchased, management’s expectation is that the building will generate revenue streams for several years. The matching principle states that a portion of the building’s cost should be allocated annually as an expense against the income the building generates. Realization Principle Realization principle states revenues should be recognized at the amount that the organization expects to receive. If the organization determines this full amount will not be realized, the organization should recognize the difference as a loss.


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Conservatism Principle Expense This principle suggest financial managers should realize permanent losses when The losses are known and quantifiable, instead of when the loss is realized. For example, commercial property in many southern US states that was purchased in the mid 2000’s, is probably worth less today than when the property was purchased. As a result, the organization should have reduced the value of the asset in the accounting records when the decline was known and quantifiable which would have been in the 2010 or 2011. Under Private Enterprise Standards once the asset value is reduced, the rules prevent the entity from increasing the value of the asset on the books and records of the company if market conditions result in an appreciation of the property values over time. Under IFRS the company is allowed to increase the value of the property if the property recovers its value. This improves the performance of the company. Since the impact is material the auditors and accountants will want to examine the assertion being made by management. This will require more work by the auditors and may require a property valuation to be completed to ensure the financial statements meet the reliability standard. All of these extra steps will take time and resources and therefore will be more expensive for the company than using Private Enterprise Standards. Revenue For gains in asset values for Private Enterprise Standards, the conservatism principle states that we do not realize gains, until the gain has been realized. For example, if we had acquired a property that has increased in value over the last two years, we would not recognize the gain until the asset is sold. Under IFRS the company is allowed to report the gain. Full Disclosure Principle This principle suggests that financial information should include all relevant information to accounting users to allow the user to make rational and informed decisions. The full disclosure principle is discussed in more detail in Chapter 4, Notes to the Financial Statements Section. This information is both financial and operational in nature. For example to meet the full disclosure requirements an organization is required to report on events that will impact future performance such as the termination dates of material anchor tenants in commercial properties or fire that destroyed a significant property of the company.


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ACCOUNTING CONCEPTS Accrual Basis of Accounting Accrual basis accounting recognizes incomes and expenses in the period that the major economic activity occurred. No relevance is placed on when the organization receives or pays the cash. For example, income is recognized when the major event has occurred to entitle the organization to the income. For a property manager or a landlord, the significant event is the passage of time. As a result, income is usually recognized at the beginning of the month when the management fee or maintenance charge is due. For expenses it is usually time or usage. For example, the cost amount of an insurance policy should be allocated equally to the months the insurance policy covers. For items such as utilities charges, the expense should be recorded in the period that the utility is used. As a result, the accrual basis of accounting provides financial information that is comparable, and reliable. However, since the accrual basis of accounting does not provide a significant detail on the cash flows of an organization, a user of accrual financial information requires additional information to make decisions regarding the cash position of the organization. Cash Basis of Accounting When an organization utilizes the cash basis of accounting, it does not recognize revenues or expenses until cash is paid out. For example, the total cost of a property is recognized as an expense when the organization pays for the property. As a result, the cash basis of accounting provides excellent information on the cash flows of the organization. The disadvantage of the cash basis of accounting is that the information provided does not have the comparability of financial information that is provided by the accrual basis of accounting. Also, the cash balance of accounting is more susceptible for management manipulation. Consequently, most stakeholders require accounting information to be created using the accrual basis of accounting. Now, the cash basis of accounting is almost solely used by Canada Revenue Agency for calculating taxable income. Fiscal Period Fiscal period is defined as a specific time period. A fiscal period is usually one year. However, a fiscal period can be identified by the organization.


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Debit Debit is an accounting term that means you are placing an item on the left side of the ledger in recording a transaction. The effect the debit has depends upon the type of account that is being affected. The standard abbreviation for debit is DR. Credit Credit is an accounting term that means you are placing an item on the right side of the ledger in recording a transaction. The effect the credit has depends upon the type of account that is being affected. The standard abbreviation for a credit is CR. Assets Assets are economic resources that are owned by a business that can be used to generate future income streams for the organization. Assets can be tangible or intangible. Examples of tangible assets are vehicles, equipment, buildings, inventory, cash, amounts owed to you by debtors, and prepaid expenses. Intangible assets are goodwill and trademarks of an organization. Assets are classified as current assets and fixed assets. Current assets are assets that are expected to be turned into cash in the next fiscal period. Fixed Assets are assets with a life expectancy greater than one year. Assets are usually listed in the order of liquidity (i.e.: ease the asset can be changed into cash). Assets normally have a debit balance. As a result, a debit to an asset increases the balance and a credit decreases an asset’s balance. Liabilities Liabilities represent future outflows of economic resources of the organization. Liabilities are often referred to as debt of the organization. Organizations holding the debt are referred to as creditors. Mortgages payable, trade payables taxes payables and shareholder loans are examples of liabilities. There are two basic types of creditors. The first type of creditor is a secured creditor. A secured creditor has the right to seize a particular asset if their debt is not paid. An example of a secured creditor is the organization holding the mortgage payable. The other type of a creditor is referred to as an unsecured creditor. Most creditors of a property management firm are unsecured creditors and an example of an unsecured creditor is a trade payable. An unsecured creditor does not have the right to seize an asset if not paid. Alternatives available to a creditor to collect a liability are collection agencies and bankruptcy proceedings. Liabilities normally have a credit balance. A credit to a liability account increases the liability and a debit decreases a liability. Liabilities are classified as current or long-term liabilities. Current liabilities are payable in the next fiscal period. Long term liabilities are payable beyond the next fiscal period.


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Capital Capital represents the owner’s interest in the business organization. For a sole proprietorship and partnership, the owner’s investment or equity is reflected in the capital account and is adjusted each accounting period for the income or loss earned by the organization. For a corporation, the capital section is based on two components. The first component is referred to as share capital. Share capital is the cash equivalent of the resources received by the organization for the shares issued. The second component is referred to as the retained earnings of the organization. Retained earnings are the sum of all net income and net losses of the organization from the date of incorporation to the last fiscal period. Payments to shareholders are referred to as dividends. Dividends are a debit balance and decrease retained earnings. The remaining capital accounts normally have a credit balance. The exception to this rule is if the organization has not generated net income. If this situation has occurred, the retained earnings will have a debit balance. A credit to a capital account will increase the account balance and a debit will decrease the account balance. Revenue Revenues are income streams accruing to the organization during the current fiscal period. An example of revenue is the rental charges for occupied units during a fiscal period. Revenues are normally a credit balance. As a result a credit to a revenue account increases the balance and a debit decreases the account balance. Expenses Expenses are the outflows committed to by the organization during the fiscal period to earn the revenues. Examples of expenses are utilities, administration expenses, mortgage interest, salaries and maintenance costs. Expenses normally have a debit balance, as a result, a debit to an expense account will increase the account balance and a credit will decrease the account balance. Net Income/Loss Net Income or loss is the residual of the revenues less the expenses. If revenues are greater than the expenses, the organization has generated a net income, which is a credit balance. If the expenses exceed the revenues, the organization has generated a net loss. A net loss is a debit balance.


Chapter 1 / Page 19

Double-Entry Accounting The double entry is the standard accounting process. This system of accounting states that each debit has a corresponding credit or the following equation:

Assets = Liabilities + Capital

As a result, the books of account of the organization must have an equal dollar amount of debits and credits to ensure the above equation remains in balance. Debits and Credits and the Banking System The first time most people encounter the terms debit and credit is in their bank statement or passbook. The depositor quickly determines the debit memo decreases their cash balance and a credit memo increases their cash balance. The information contained in this chapter appears to be inconsistent with the processes used by the banking industry. To understand how the banking system is consistent with the information contained in this chapter, the reader must use the business entity concept. In the case of the debit and credit memo system used by financial institutions, the business entity is the bank. When the bank receives cash from a depositor, the bank creates a liability with the depositor. At some future date, the depositor will withdraw the money they have deposited and applicable interest that accrues. As a depositor deposits more cash, the liability of the bank to the depositor increases. To record this transaction, the bank must credit the depositor’s account. If the depositor withdraws money, the amount of the liability decreases. To record this transaction, the bank will debit the account of the depositor. When the debit and credit memo system of the financial institution is examined from the point of view of the business entity being the bank, the debit and credit memo terminology is applied correctly. EXAMPLE The following case study is presented to allow the student the opportunity to test their understanding of assets, liabilities, capital, revenues and expenses. John Jones is a property manager with extensive experience in rental apartment management. He has decided to form a property management company specializing in managing and owning income producing properties. He incorporates a company, ABC Property Management Company (ABC) and rents a small office for his business. He announces his new property management business through a network of investment contacts. He also devises a detailed business plan for ABC Property Management Corporation.


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The following are the initial transactions of ABC during January: Mr. Jones invests $100,000 in ABC for common stock on January 1. This economic event is the investment by the owner. This results in the organization receiving an asset, $100,000 in cash, and a capital investment of $100,000. ABC purchases office equipment with a value of $10,000 with cash on January 3. This economic event is the purchase of an asset called equipment for $10,000 and a reduction in cash of $10,000. ABC purchases a vehicle for business purchases at a price of $14,500. The vehicle was paid for with $2,000 in cash and $12,500 of bank financing on January 2. This economic event is the purchase of an asset by using an asset and incurring a liability. An account reflecting equipment will increase by $14,500, our cash account will decrease by $2,000 and our liability will increase by $12,500. ABC rents an office paying first and last months rent. The monthly rental fee is $2,000 on January 4. This economic event results in the incursion of an expense of $2,000, a prepaid of $2,000 and a reduction in our cash of $4,000. ABC incurs $1,000 for office supplies on the corporate credit card. These economic events result in the incursion of an expense that has increased our liabilities by $1,000. ABC enters into a consulting contract with the terms of $15,000 at the time the agreement was executed and $5,000 when the work was completed. This economic event is the recognition of revenue of $20,000, $15,000 in cash and $5,000 in an account receivable to be collected at a later date.


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CHAPTER 4

FINANCIAL STATEMENT PREPARATION

OBJECTIVES At the conclusion of Chapter 4 the student should be able to: 1. Prepare a trial balance 2. Determine and complete the necessary adjusting journal entries necessary to

ensure an entity's financial records are in compliance with the accrual basis of accounting

3. Create an income statement, balance sheet and statement of changes in

financial position TERMINOLOGY Adjusting Journal Entries They are required to adjust the account balances of

the book of records of the entity to the accrual basis of accounting.

Balance Sheet Informs the users of the assets, liabilities and capital

of an entity as at a specific date in time to assist on decisions regarding solvency.

Income Statement Informs the users of the revenue sources and expenses

of an organization for a specific period of time to assist on decisions regarding profitability.

. Statement of Changes in Financial Position Informs the users of the sources and uses of cash

resources for the organization for a specific time period.

Trial Balance Ensures the ledger is in balance for a specific time

period.


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KEY CONCEPTS In the previous two chapters, we discussed the process an entity uses to accumulate financial information. In this Chapter, we will examine conventional methods to communicate the information to the stakeholders of the organization. Each statement provides the users with detailed financial information on the entity. The statements and entries are completed in the following order: Trial Balance; Adjusting Journal Entries; Income Statement; Balance Sheet; Statement of Changes in Financial Position; TRIAL BALANCE A trial balance is completed to determine if the ledger of an organization for a specific time period is in balance. To determine this, the accounts of the ledger and their balances are recorded and summarized. An “in balance” trial balance means the total of the debits and credits are equal. If the debits and credits do not equal, the ledger is out of balance and must be analyzed and corrected before the accounting information is summarized for the users. See Appendix A for an example of the trial balance. Note: This trial balance incorporates the adjusting journal entries discussed in this Chapter. In a manual system, the most common reasons for the ledger to be out of balance are incomplete posting of journal entities and mathematical errors. In a computer based system, the most common reason for the ledger to be out of balance is an error in the programming logic. Most “off the shelf” accounting packages will not allow the user to post an out of balance transaction. Once the ledger is in balance, the property manager should review the individual account balance to determine if they are reasonable based on comparisons to budget, expectations or historical trends. For any unusual balances, the property manager should review the entries posted to the account to ensure the entry is correct. For any errors noted, the property manager should prepare the appropriate journal entry or entries. ADJUSTING JOURNAL ENTRIES Adjusting journal entries ensure that the individual ledger account balances and the economic events are accounted for on an accrual basis. The basic types of accrual journal entries account for non cash transactions and record expenses and revenues that have been purchased or earned and cash has not been paid or received.


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As was stated in Chapter One, accrual accounting attempts to match expenses to the revenues that they generate. Adjusting journal entries ensure that the revenues and expenses are matched as they classify the expenses to a specific accounting period. Depreciation Fixed assets such as buildings and equipment provide resources to the organization that assist the entity in generating revenues for several years. As a result, the accrual basis of accounting requires the costs of these assets be matched to the revenues that they generate usually over the life of the assets. This is commonly referred to as depreciation. Depreciation of the assets is calculated by determining the portion of the asset cost used during the fiscal period. Based on the example in Chapter Two, depreciation must be calculated on the equipment and the buildings. The equipment cost $7,500 and had a useful life of three years. The annual depreciation is calculated as $2,500 (asset value/assets useful life or $7,500/3) and the monthly depreciation is $208. In the example we are informed that the buildings have a cost of $225,000 and $175,000. An analysis found Building A and B had a useful life of 10 and 20 years respectively. The annual depreciation charges for building A and B are $22,500 and $8,750 or $1,875 and $729 monthly. The journal entry to record this adjusting entry is: 6060 Equipment Depreciation $208 7080A Depreciation Building A $1,875 7080B Depreciation Building B $729 2310 Acc. Depreciation Building $2,604 2110 Acc. Depreciation Equipment $208 To record the monthly depreciation charges. Besides the passage of time, asset usage is commonly used to calculate depreciation expense. In the above example, if the equipment had a useful life of 4,000 operating hours and in the first month the organization used 100 hours the appropriate depreciation charge would be $188 or (100/4000)*$7500. The declining balance method of depreciation is the next most common method to depreciate assets. A modified version of this process is recognized by Revenue Canada for tax purposes. In this process, a certain rate is established to recognize the depreciation based on the type of asset. For example, equipment is usually depreciated at 20% per annum. Based on the above example the monthly depreciation charge would be $7,500*.20/12 or $125.


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Adjustments Other non-cash adjusting journal entries are adjustments to the allowance for bad debts and prepaid expenses. The allowance for bad debts should reflect the expectation of the amount in receivables that ultimately will not be collected. This is calculated by reviewing individual receivable accounts for “old” receivables and receivables from tenants that have vacated their unit. The journal entry is: 7096 Bad Debt Expense Dollar Amount 1075 Allowance for Bad Debts Dollar Amount

To record the bad debts expense The change will be reflected in income for the current year. For prepaid expenses, the property manager will allocate the portion of the prepaid expense that has expired to the appropriate expense account. An example of this type of entry is provided below: 7076A Insurance Bldg. A Dollar Amount 1080 Prepaid Expense Dollar Amount

To expense the insurance coverage that has expired. Accrual Entries Another type of adjusting journal entry is to record transactions that have taken place but have not yet been recorded on the books of the company. In the majority of cases, these types of transactions are related to recording unpaid expenses. The most common accruals are for unpaid interest on mortgages and loans, utilities, and property taxes. Based on the example in Chapter 2, the following accruals must be recorded for the first month of operation: Interest on the mortgage paid on the first of the following month was $2,000 for building A and $1,500 for building B. The water charges for building A and B are $340 and $420 respectively. The management fees are $450 for building A and $350 for building B. The adjusting journal entries to record these accruals are: 7060A Management Fees - Bldg. A $450 7060B Management Fees - Bldg. B $350 7040A Water & Sewer - Bldg. A $340 7040B Water & Sewer - Bldg. B $420 7000A Mortgage Interest - Bldg. A $2,000 7000B Mortgage Interest - Bldg. B $1,500 3100 Accounts Payable $5,060

To record the accrual of expenses for the first month of operation.


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INCOME STATEMENT OR STATEMENT OF SURPLUS For profit corporations refer to this statement as an Income Statement. For condominium corporations and not for profit organizations the statement is called Statement of Surplus. These are two typical names other corporations can use other descriptions. The purpose of the Income Statement/Statement of Surplus is to report the profitability of the entity to its stakeholders. As stated in Chapter 1 this is one of the most critical components that stakeholders are interested in determining and how to improve the profitability from current levels. The revenue and expense items contained in the general ledger are aggregated to a sufficient level of detail to allow the stakeholder to make rational decisions about the future of the organization. Sufficient level of detail means that the property manager has summarized the information but not so much that it is worthless to the stakeholders. Income Statements/Statement of Surplus are created for an organization at the end of each fiscal period or on an “ad hoc” basis when required. Usually these statements are reviewed by an external accountant on an annual basis on behalf of the stakeholders to ensure the statements truly reflect the performance of the organization. As a part of their control structure, most organizations require an internal Income Statement/Statement of Surplus on a monthly basis. The property manager will compare the information on the Income Statement/Statement of Surplus to budget to determine any changes in operation that are necessary to meet corporate objectives or exploit opportunities that have arisen. Most property management organization or development companies generate Income Statements on a project by project basis to determine the profitability of the individual projects. Once the individual Income Statements have been completed, a consolidated Income Statement is completed to report on the revenues and expenses of the organization as a whole. See Appendix B for an example of the monthly Income Statement for the first month of operations for the example introduced in Chapter 2. Title All Income Statements, whether for a single project or consolidated for the year, consist of several sections. The first section is the title and the title has three lines:

Name of the corporation or project, Income Statement/Statement of Surplus For the period ended December 31, 20__.

The three lines allow the user to identify the corporate entity or project, the statement they are reviewing and the specific period that the income and expenses were incurred.


Chapter 4 / Page 6

Revenues The second section of the Income Statement is the revenues section. In this section are listed the major income sources for the organization. For our example introduced in Chapter 2, the key revenue sources are service fees and rental fees. On the consolidated Income Statement the individual lines will represent the summation of each project’s revenues for this particular income source. Note the use of IFRS will record the increase or decrease in value of fixed assets as a non cash revenue or expense. In assessing performance it is important to understand how the accounting standard being used is impacting the income/loss of the organization. On an Income Statement\Statement of Surplus for a specific project, the organization would report on the revenues related to the specific project. The statement should not include revenues that are not directly associated with the project. Expenses The expense section provides the user with the detailed expenditures incurred to generate the revenues contained in the Income Statement/Statement of Surplus. As with the revenues, the expenses are aggregated by expense type. For example an organization may charge costs to the following accounts in the general ledger: snow removal, landscaping and general grounds maintenance. For reporting purposes on the Income Statement these expenses would be grouped under the heading of grounds maintenance. The Income Statement expenses are listed in descending order of the dollar amount. This allows the user to identify the most significant expenses of the organization very quickly. Net Income The net income/surplus or loss deficit is the difference between the income and the expenses. If the revenues exceed the expenses, the organization generated a net income. If the expenses exceed the income the organization generates a net loss. Conclusion The Income Statement/Statement of Surplus provides the property manager with information on the profitability of an organization and/or project. The property manager should review the performance to identify areas where profitability can be improved or opportunities in the market place exploited.


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BALANCE SHEET The Balance Sheet provides the user with a listing of the resources of the organization and lists the various stakeholders in the organization and the amounts of their investments. This statement is the stakeholder's primary statement to assess the short and long term solvency of the entity through ratio and other analysis to be discussed in Chapter 5. As with the Income Statement/Statement of Surplus, the Balance Sheet can be created for each project or on a consolidated basis. Most organizations provide their users with a consolidated balance sheet of the entities’ entire organization. The Balance Sheet must be prepared at least on an annual basis and is one of the core statements reviewed by an external accountant on behalf of the stakeholders. As with the income statement, a Balance Sheet is prepared at more frequent periods, usually on a monthly basis. Appendix C contains a Balance Sheet for the example introduced in Chapter 2. Titles All Balance Sheets, whether for a single project or consolidated for the year, consist of several sections. The first section is the title and it has three lines:

Name of the corporation or project, Balance Sheet As at December 31, 20__.

The three lines allow the user to identify the corporate entity or project, the statement they are reviewing and the specific period for the Balance Sheet. Assets As stated in earlier chapters, assets are economic resources of the entity and are the first item listed on the Balance Sheet. Assets are classified as current and long-term. Current assets are cash, cash equivalents or can be changed to cash within the next fiscal period, usually one year. Current assets are listed in their order of liquidity or how quickly they can be turned into cash, with the most liquid assets being listed first. Examples include such items as cash, accounts receivable and prepaid expenses. Long-term or fixed assets will not be converted to cash for more than one fiscal period and are listed based on their longevity. Examples of long-term assets are land, buildings and equipment.


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Contra account assets appear in the assets section of the Balance Sheet but have credit balances. Their purpose is to recognize an impairment or utilization of specific assets, such as depreciation of a building or an allowance for bad debts. The allowance for bad debts account was established to recognize the fact that an entity may not collect all the credit it has advanced and to show management’s expectation of the dollar value of credit that may not be collected. The accumulated depreciation account recognizes the reduction in the equipment or building’s value over time. Liabilities Liabilities are future economic resources owed to third party organizations for benefits already received. Liabilities are classified as current or long-term. Current liabilities will be paid within the next fiscal year. Long-term liabilities will require economic resources of the entity for several years before the obligations are extinguished. Equity Equity represents the ownership of the organization. The equity section is divided between contributed capital and retained earnings. The capital section includes the capital stock and treasury shares. A corporation’s common stock consists of shares authorized and issued. Each corporation is authorized to issue from one to an unlimited number of shares. The number of shares issued refers to the amount of shares the corporation has sold or given to shareholders. The value of the shares is established by the market place. Treasury shares are shares of the corporation that the corporation has reacquired. The value of the shares are usually established by the marketplace and do not reflect the share value when they were issued. Treasury shares can be resold by the corporation at any future date. Retained earnings is the summation of earnings “retained by the corporation” from the date of incorporation to the date of the financial statements. Retained earnings do not equate to cash but represent the earnings of the corporation that have been retained. Retained earnings are increased/decreased by the corporation’s income/loss for the year. In addition, they will be reduced by the dollar amount of dividends paid by the corporation to its stakeholders. Conclusion The property manager should review the Balance Sheet to assess if the organization has a satisfactory solvency level and is appropriately financed. Based on this analysis, the property manager maybe required to develop an appropriate strategy to address the opportunities and risks identified.


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STATEMENT OF CHANGES IN FINANCIAL POSITION (SCFP) This statement is used by the stakeholder to assess the entity’s solvency. This statement is prepared on an annual basis after the balance sheet and income statement have been completed and focuses on the sources and uses of cash. The Statement of Changes in Financial Position consists of three sections: Operations; Investing; and Financing; The purpose of each section is to identify where the organization is generating and spending its cash resources. This statement focuses on the temporary change in the cash position of the organization.

Determining Sources and Uses of Cash A source of cash is defined as a change in an account balance that increases the cash position of the organization. If an asset decreases, it results in a cash “source” to the organization because cash resources were not used to replenish the asset. If a liability increases, it is a source of cash since the organization has been able to gain a benefit without utilizing their cash resources. Alternatively an increase in the value of an asset or a decrease in a liability are uses of cash resources for the organization. Titles All Statements of Changes in Financial Position consist of several sections. The first section is the title and has three lines:

Name of the corporation or project, Statement of Changes in Financial Position For the period ended December 31, 20__.

The three lines allow the user to identify the corporate entity or project, the statement they are reviewing and the specific period that the cash flows relate to. Operations This section describes the sources and uses of cash for the organization resulting from the day-to-day operations. Examples are changes in the net income and the incremental changes in the working capital items.


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The first major section under this title is net income. This represents the income or loss generated by the entity during the fiscal period. The net income is adjusted by the non-cash line items on the income statement. Non-cash expenses are income or expenses in the period that do not utilize cash resources of the organization. The most common types of non-cash revenues under IFRS are the appreciation or increase in market value of fixed assets in the year. The most common types of non-cash expenses under IFRS are decreases in market value of fixed assets, depreciation and bad debts expense. Under Private Enterprises Standards the most common types of non-cash expenses under IFRS are depreciation and bad debts expense. They are no impacts on income. The income or expenses are adjusted by the non cash expenses. The incremental changes in the current assets and current liabilities are the next items to be considered in this section. Each current asset and current liabilities is listed and the incremental change is recorded. Sources of cash are positive amounts and cash uses are negative amounts shown in brackets. As previously stated, decreases in assets and increases in liabilities are sources of cash. Decreases in liabilities and increase in assets are uses of cash. If the cash from operations is negative, the organization is depleting their cash resources. Management must take appropriate steps to rectify the situation such as reducing discretionary expenses or increasing revenues. If this does not occur, the organization may have a future solvency crisis. Investing This section reflects the organization’s uses and sources of cash from the purchase or sale of fixed assets. Increases in the fixed assets are a use of cash. A decrease in fixed assets is a source of cash. If a property manager determines an organization is relying on the sale of assets to remain solvent, he or she must determine the long-term viability of the organization and the necessary steps to correct the situation. Financing This section of the Statement of Changes in Financial Position details the changes in the corporation's long term financing. Listed here are the incremental changes for the long-term liabilities, common stock and treasury stocks. If any of these items increase, they represent a source of cash. A decrease in these items is a use of cash. The dollar value of dividends paid during the year should be reflected as a use of cash.


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Conclusion The property manager must review this statement in detail to determine how the organization is generating and utilizing cash flows and determine the appropriate course of action for the entity. This is a very important step. Many profitable corporations go bankrupt because of improper understanding and utilization of cash flows. Appendix D provides a Balance Sheet for ABC Rental Corporation. Appendix E contains a Statement of Changes in financial position for ABC Rental Corporation based on the information provided in Appendix D. The following chart provides a useful tool in determining the effect a change in an account will have on the statement of changes in financial position.


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Type of Information Used in SCFP Column 1

Type of Change

Increase

Decrease

By Definition

Asset Liabilities Common Stock

Incremental Incremental Incremental

Use Source Source

Source Use Use

Net Income Net Loss Dividends Non-Cash Expenses Depreciation Recapture Depreciation Allowance for Bad Debts

Under IFRS

Appreciation in s Property Values

Market Decreases in Property Values

Totality Totality Totality Totality Totality Totality

Totality

Totality

Source

Use

Source Use Use Source Use

Use

Source

CLOSING ENTRIES Closing entries prepare the financial records of the organization for the next fiscal period or year. This involves a journal entry to transfer the balances in the revenue and expense accounts to the retained earnings account. As a result, the revenue and expense accounts will have a zero balance. Most computerized accounting packages will perform this function automatically as a part of their year end procedures. .


Chapter 4 / Page 13

NOTES TO THE FINANCIAL STATEMENTS The notes to the financial statements provide the reader with additional information on specific line items and management estimates used to create this financial information. Some changes are:

FINANCIAL NOTE IMPACT Significant Accounting Policy

Allows user to understand how financial statements are created and allows user to make adjustments to make financial statements comparable between companies and industries. The accounting policies also define which accounting standard is being followed by the organization

Fixed Asset Provides details on types of fixed assets and their net book value. Net book value provides an indicator to the user on whether net book value and fair market value are equal.

Long-term Debt Provides user with information on organizations debt. Allows user to asses impact of debt renewal may have on the organization and the cash outflows of the organization.

Contingent Liability Depending upon some future event, the organization may have to pay out cash. Typically, this is an unresolved, significant lawsuit.

Going Concern Company may not be able to continue business for the foreseeable future. This will impact the ability to sell assets for full value.

Subsequent Event A material event has occurred after the fiscal year end that may impact the future economic performance of the organization. An example is a property burns down, therefore reducing rent revenue for the organization

Economic Dependence The future fiscal performance of the organization is dependent on the continued relationship with a stakeholder. For Rent Geared to Income housing it is dependent on continued support form government.

Related Party Transactions Identify transactions with organizations not dealing with entity at arms length. This allows the user, to adjust the performance based on the impact of the transaction.

As a result, it is essential that the property manager understand the information contained in the notes to the financial statements and the impacts the information may have on any potential action plans.

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