BALANCED BUDGETS. Boards have a duty to assess the membership sufficient to carry out their duties as directors. In addition, budgets need to be balanced: "An association shall not impose or collect an assessment or fee that exceeds the amount necessary to defray the costs for which it is levied. (Civ. Code 5600(b).) Any increase in annual assessments (dues) requires the preparation, approval, and distribution of a budget within certain statutory guidelines and deadlines as described below.
1. Pro Forma Budget. A pro forma operating budget is typically prepared by management or a budget committee or the board (or a combination of the three). An operating budget encompasses all expenses for the fiscal year including contributions to reserves. The budget must estimate revenue and expenses on an accrual basis. (Civ. Code §5300(b)(1).)
2. Basis for Budget. As nonprofit organizations, associations must budget so that revenues do not exceed expenses, i.e., total income minus expenses should equal zero. There are two techniques for preparing budgets:
A. Zero-Base Budgeting. This approach starts each year's budget from a zero base, i.e., at the beginning of the budgeting process all budget line items have a value of $0 and must be justified.
i. Advantages. Since each line item starts at zero, the budget committee must justify each item in the budget. This should bring to light any wastage and obsolete operations.
ii. Disadvantages. This approach can be very time consuming.
B. Incremental Budgeting. In incremental budgeting the current year's budget serves as a basis for next year's budget and is simply adjusted. The most common methods of adjustment are:
i. CPI Adjustment. The easiest and least effective method is to simply take the Consumer Price Index (the measure of inflation published by the government) and apply it to all line items. The disadvantage is that not all items in a budget are affected by the CPI. This results in some line items being over-budgeted and others being under-budgeted.
ii. Variance Projections. This is the method used by most associations. Since most line items in an association's budget are necessary rather than discretionary (utilities, insurance, maintenance, etc.), the budget committee starts with the current year's budget and looks at variances projected through the end of the fiscal year. This gives the committee an estimate of actual expenses for the year for each line item so it can adjust expenses up or down, as needed.
3. Approve the Budget. The draft budget is put on the agenda of an open board meeting for review and approval by the board. Approval of the budget is sufficient for any increase in assessments (up to 20%) that might be contained in the budget. Approval requirements are found in Civil Code §5605.
4. Annual Budget Report. Once the budget has been approved by the board, an "Annual Budget Report" must be prepared. The Report must contain the following (Civ. Code §5300(b)):
- A pro forma operating budget.
- A summary of the association’s reserves.
- A statement regarding any deferral of reserve item repairs.
- A statement whether special assessments are anticipated related to reserves or reserve components.
- A statement of how reserves will be funded.
- A statement of how the reserves were calculated.
- A statement regarding any outstanding association loans.
5. Distribute the Report. The Annual Budget Report must be distributed to the membership not less than 30 nor more than 90 days before the end of the association's fiscal year. (Civ. Code §5300(a).)
a. Summary. In lieu of a full report, the board may distribute a summary and reserve summary with a written notice (in at least 10-point bold type on the front page of the summary of the budget) that the complete budget is available at the business office of the association or other location and copies can be made, if requested, at the association's expense. (Civ. Code §5320.)
b. Request for Full Report. If a member requests a copy of the full budget report rather than a summary, the association must provide it (Civ. Code §5320) by individual delivery (Civ. Code §4040.)
c. Email Distribution. Unless members authorize delivery by email, budgets must be distributed in non-electronic form, i.e., paper.
d. Disclosure Checklist. See disclosure checklist.
e. Remailing Budget Report. Sometimes absentee members forget to update their contact information and the budget package is returned to the association. See remailing the budget report.
Failure to Meet Deadline. Failure to distribute the annual budget report at not less than 30 nor more than 90 days prior to the end of the fiscal year voids any increase in regular assessments approved by the board of directors. Any such increase must then be approved by a majority of a quorum of members. (Civ. Code §5605(a).)
Excess Income. Since budgets are only projects, associations sometimes end a fiscal year with excess income. Since associations are nonprofit, the excess funds are taxable. See Filing Tax Returns.
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