The Davis-Stirling act does not define, limit or place requirements on “goods and services” or “capital improvements.” However, most CC&Rs have a one-year limitation on contracts entered into by associations which requires membership approval to override. Also, typical bylaws require membership approval for capital improvements greater than 5% of the budgeted gross expenses of the association for that year, whether or not a special assessment is required. There are also CC&R restrictions and rules for “annexation” of common area property.
Services. Since the Davis-Stirling Act does not define these terms and California case law on the subject for common interest developments does not exist, we must look to common language and accounting standards for guidance. On the surface the term “goods and services” seems obvious. A long-term management contract, for example, is clearly a service subject to the rule.
Long-Term Leases. Long-term leases such as a neighboring parking lot or a golf course are not so easily categorized. Such a lease could be both a “good” and a “capital improvement.” Here is why:
- One Webster definition of a “good” (n.) is “something useful or beneficial” and “something that has economic utility or satisfies an economic want.” Therefore, a “good” can be tangible or intangible. A long term lease is an intangible asset that has economic utility. It is a “good.”
- The Financial Accounting Standards Board (FASB) establishes accounting standards and rules for the United States. It establishes its standards and rules with an intent to reflect economic reality and to avoid misleading financial statements and reports. FASB (Accounting Standards Code Topic 842) with rare exceptions considers long term (over 12 months) leases as, in substance, purchases and some flavor of a capital asset. Therefore, any such future lease payment obligations must be combined with a market based interest rate to compute the lease’s “present value” or the effective purchase price. This present value cost would be the amount used for the capital improvement 5% test. (For more information, see Lease Accounting Guide.)
Recommendation: When faced with this situation, boards should seek legal and accounting advice as individual facts and circumstances will vary.
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