Gain a Better Understanding of Your Financial Statements

4/29/2016

Gain a Better Understanding of Your Financial Statements

Presented by: Chris Bailey, CPA Robert Kitchen, CPA

About Clark Schaefer Hackett

Top 60 CPA firm with more than 75 years of history

More than 400 employees in 7 locations 75 professionals focusing solely on

Affordable Housing 30 years of firm experience in Affordable

Housing Serving more than 1,300 clients across the

industry

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Learning Objectives

General overview of how to read affordable housing financial statements Background information to why this information is needed Overview of the components of the financial statements Ways to analyze and extract information from the financial statements

Background

How is a real estate project different than other businesses? It is often highly leveraged and generates losses due to depreciation, interest and other operating expenses

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Background ? Leveraging Your Investment

A very modest investment permits an owner to control a valuable rental property ? often a 20% down payment

As the property increases in value the owner's return on the investment increases at a multiple of the increase in the value of the property

Background ? Leveraging Your Investment

Example: Assume that an investor purchases a rental home for

$100,000 with a down payment of 20% or $20,000. Five years later the investor sells the property for $110,000, for a net increase of $10,000. Over the five- year period the value of the property has increased a modest 10%. However the investor's return on his initial investment of $20,000 is 50%: all because the investor was able to leverage the initial investment.

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Background ? Leveraging Your Investment

However; cash flow from a rental property is maximized when the property is not leveraged and minimized when the property is highly leveraged

Therefore, cash flow from operations is needed to service the debt on the project

Background ? Unique Real Estate Accounting

Net Income is not the overriding benchmark Net Operating Income and Cash Flow are the main

benchmarks Focus on asset appreciation Tax minimization (pass through entities)

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Background ? Unique Real Estate Accounting

Unclassified balance sheet presentation Assets and liabilities on the balance sheet are not broken down b/w current (less than one year) and long-term

Some internal statements will disclose the expected fair value of the rental property.

Cost segregation studies completed for tax purposes can accelerate depreciation out of 27.5 years for tax

Background ? The Legal Entity

Most real estate financial statements represents the activity of a single project Real estate projects often have different ownership structures within a controlled group Helps limit legal issues from affecting an entire real estate portfolio

Most real estate projects are set up as pass through legal entities ? (limited liability companies or limited partnerships)

The legal entity will impact how the financial statements are prepared and presented C-corporations (except for nonprofits) are not preferred due to the additional layer of tax

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Background ? The Legal Entity ? 1031 Exchange

Some real estate properties are owned in tenant in common ? often to facilitate a 1031 exchange

Selling a relinquished property and acquiring a replacement property in a tax ?deferred exchange under IRC Section 1031

Typically any income producing real estate asset will qualify as a like-kind exchange

Defers gain on the appreciation of real estate Allows for wealth amplification Reinvest the avoided tax bill to produce additional

income and equity growth Cons - Complex and expensive

Background ? Trusting the Numbers

The financial statements will often be accompanied by a report from an outside auditor

An audit is the process of verification that the financial statements can be relied upon as having been fairly presented

Be aware of qualifications in the report "except for" "subject to" that may indicate issues that the auditor found during the audit that was not corrected by management

Review (less assurance than an audit) Compilation (no assurance provided) Monthly statements are often prepared internally by

management and may not include all accruals which are often done at year-end

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Background ? Audit Opinions

Unmodified or clean opinion

Qualified opinion

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Background ? Basis of Accounting

Most financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP) or

Income tax basis of accounting

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Background ? Basis of Accounting - GAAP

Required by most lenders Promotes comparability among financial statements Most third party users are knowledgeable and

understand GAAP Limits of income tax basis of accounting

income tax basis of accounting does not record unfunded obligations or commitments until paid and interest due to a related party cannot be accrued and deducted

1031 exchange as we discussed previously The recognition of casualty gains and losses could

be in different periods

Background ? Basis of Accounting ? Income Tax Basis of Accounting

No third party users of the financial statements No third party debt The cost of complying with GAAP would exceed the

benefit Owners are involved in day to day operations Owners interested in the tax implications of

transactions Avoids duplication of accounting records for book and

tax (one depreciation schedule) Footnotes are often omitted saving time

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