LESSON 2
Financial Statements and Budgeting
Assigned Reading
1.
Real Estate Division. 2009. Residential Property Management. Vancouver: UBC Real Estate
Division.
Chapter 3: Financial Statements and Budgeting.
Recommended Reading
Selected recommended readings can be found under "Online Readings" on your Course Resources webpage.
1.
Real Estate Division. 2010. Rental Property Management. Vancouver: UBC Real Estate Division.
Chapter 20: Introduction to Mortgage Finance.
2.
Real Estate Division. 2009. Taxes on Real Property. Vancouver: UBC Real Estate Division.
Learning Objectives
Upon completion of this lesson, the student should be able to:
1.
List the different forms of business organizations and discuss their legal rights and responsibilities.
2.
Describe the generally accepted accounting principles on which financial statements are based.
3.
Explain the purpose of and differences between a balance sheet, income statement, and income tax
return.
4.
Discuss how financial statements differ for the proprietorship, partnership, and corporate forms of
business organizations.
5.
Discuss the purpose of a budget and explain the components of an operating budget.
6.
Develop an operating budget and prepare a revenue forecast.
7.
Develop a capital budget and prepare an operating statement.
Instructor's Comments
Chapter 3 discusses financial statements and budgeting. Financial statements and budgeting are very important
to real estate management as they help decision makers plan and control an organization's daily and long-term
operations and plans. While financial statements are a record of the past, budgets reflect how property managers
take the information from the financial statements and use it to plan for the future.
It is important to know the differences between various organizational structures. The structure of an
organization can affect its level of liability and the way it is taxed. Some organizations, such as corporations,
are separate legal entities and have limited liability. Accordingly, separate entities must be taxed separately from
2.1
Lesson 2
the owners. However, in the case of a sole proprietorship, the organization is inseparable from the owner, and
the income derived from the organization is paid directly through the owner's income tax.
When preparing financial statements, a certain standard must be adhered to. The Generally Accepted
Accounting Principles (GAAP) set guidelines regarding when revenues and expenses can be recorded, how to
account for expenses that are gradually consumed, and other financial statement practices. It is important to
ensure consistency and objectivity in creating financial statements.
Different types of financial statements are used to convey different information. The balance sheet lists the
assets, liabilities, and owner's equity of an organization at a certain point in time. The income statement lists an
organization's revenues, expenses and net income, but unlike the balance sheet, the income statement covers a
period of time. The income statement summarizes the organization’s net income, although on a pre-tax basis –
taxes must still be deducted.
There are two types of budgets that are regularly used by property managers. The first is the operating budget,
which tracks the month-to-month activities. This makes it easy to compare expected and actual revenues and
expenses, and helps identify variances and possible causes. The capital budget has more of a long-term scope.
It is used to plan for expenses such as renovations, modernization, and redevelopment. It is important to keep
these expenses in mind because they eventually become necessary in order to avoid a property’s obsolescence
and vacancy.
2.2
Financial Statements and Budgeting
Review and Discussion Questions
1.
Explain the differences between sole proprietorship, general partnerships, limited partnerships, and
corporations. For each organization, describe a property management scenario where that type of
organization would be the best choice.
2.
Refer to the list of Generally Accepted Accounting Principles in the course manual. Provide reasons for
why each of these guidelines is necessary. Do you think any of these guidelines are unnecessary? If so,
explain why.
3.
Kyla, the owner of a rental property, thinks that the calculation of the capital cost allowance is
unnecessarily complicated and she doesn't understand why she must calculate it. Explain to her the
purpose CCA serves and how it can benefit her.
4.
Find an older rental building that is in need of significant changes in order to avoid obsolescence.
Describe the renovations, modernizations, and/or redevelopments that you recommend the building
should undergo. Provide an explanation of why you believe these immediate expenses are justifiable
over the long-term.
5.
Explain why property managers use both operating budgets and capital budgets. Why is it inappropriate
or less than ideal to include all the information on the same budget?
2.3
Lesson 2
ASSIGNMENT 2
CHAPTER 3: Financial Statements and Budgeting
Marks: 1 mark per question.
1.
Which of the following statements is/are TRUE?
A.
B.
C.
D.
(1)
(2)
(3)
(4)
2.
A and B
B, C, and D
Only B
None of the above
Carrie is the property manager of an apartment building and she wants to calculate the effective revenue
for the year. There are 12 units in the building, each with a rent of $1,400 per month. The coin
operated laundry facilities, parking fees, and storage fees bring in additional annual revenue of $15,000.
Carrie forecasts that vacancy losses will amount to 4% of the projected gross revenue and collection
losses will amount to 2% of the projected gross revenue. What is the effective revenue for Carrie's
building?
(1)
(2)
(3)
(4)
3.
Only the limited partners of a limited partnership are taxed as a separate legal entity.
Sole proprietors and general partners are personally liable for all debts.
The owners of a corporation are personally liable for all debts.
A trustee owns the assets of the trust company.
$189,504
$369,504
$216,600
$204,504
Match the following items to the correct balance sheet classification:
A.
B.
C.
D.
(1)
(2)
(3)
(4)
Accounts Receivable
Mortgage
Property Taxes Payable
Property
i.
ii.
iii.
iv.
Current Assets
Non-current Assets
Current Liabilities
Non-current Liabilities
A-i, B-ii, C-iv, D-iii
A-iii, B-iv, C-i, D-ii
A-i, B-iv, C-iii, D-ii
A-iv, B-i, C-ii, D-iii
***Assignment 2 continued on next page***
2.4
Financial Statements and Budgeting
4.
Which of the following documents would be given to a landlord to support the monthly operating
statement?
A.
B.
C.
D.
E.
(1)
(2)
(3)
(4)
5.
$108,000
$407,000
$17,250
$90,750
Which of the following items would be a part of a capital budget for an apartment building?
(1)
(2)
(3)
(4)
7.
Only documents B, C, and E.
Only documents C and D.
Only documents A, B, and E.
None of the above documents would be given to the landlord to support the monthly operating
statement.
A small corporation sold 2,875 real estate manuals for $200 per manual during the year. To produce
this revenue, it incurred interest payments of $60,000 and operating expenses of $45,000. Each manual
cost the firm $110, the beginning inventory was $17,250, and the ending inventory was $17,250.
Assuming that income taxes for the year amounted to $63,000, what is the corporation's after-tax net
income?
(1)
(2)
(3)
(4)
6.
Capital Budget
Bank Statements
Tenant Roll
Lease Contracts
Tenant arrears report
Minor patching of the roof surface.
Replacement of elevator cabs.
Maintaining the landscaping by mowing lawns and pruning trees.
Service contract for janitorial services on the common areas.
Which of the following statements regarding Generally Accepted Accounting Principles is FALSE?
(1)
(2)
(3)
(4)
Expenses are recognized at the time they are paid, not at the time they are incurred.
Revenue should be recognized when it is earned, not necessarily when the cash is received.
The accrual basis of accounting refers to the concept that revenue should be recognized when it
is earned, not necessarily when cash is received.
No taxation year can be longer than 53 weeks.
***Assignment 2 continued on next page***
2.5
Lesson 2
8.
Which of the following is the LEAST likely cause of an over-expenditure in a budgeted expense item?
(1)
(2)
(3)
(4)
9.
Which of the following statements is TRUE regarding the income statement?
(1)
(2)
(3)
(4)
10.
(4)
Losses occurring when recovery of rent from a tenant is impossible.
Losses due to vacancies between tenancies when the space is being cleaned and decorated.
Losses due to the premises remaining unoccupied for a period of time when there are no
immediate tenant prospects.
Losses due to not being able to increase the rent on a residential unit until one year after the
unit turns over to a new tenant.
Hilary's Pie House owns a truck used to make daily pie deliveries to her customers. Hilary purchased
the truck three years ago and at the time of purchase, the life of the truck was estimated to be 8 years.
After 8 years, the truck will have a salvage value of $7,500. If the annual depreciation expense is
$7,000, what is the book value of the truck today?
(1)
(2)
(3)
(4)
12.
Income statements are useful for corporations, but not proprietorships or partnerships.
Income statements can be for any period of time.
Assets and liabilities can be found on the income statement.
The Capital Cost Allowance account is almost always found on the income statement.
Which of the following correctly describes the term "turnover losses"?
(1)
(2)
(3)
11.
The budget was prepared for the first year of ownership of a property and no records for
previous years' expenses were available when this year's budget was prepared.
It was an extremely hot summer and the budget was prepared on the basis of an average year.
Assume that the landlord is responsible for air conditioning costs.
The building was half vacant all year, due to a downturn in the economy. The budget was
prepared with the assumption that the building would be 95% occupied all year. Assume that
the landlord is responsible for paying for janitorial services.
The controls on the heating and cooling systems were broken, causing the building to be heated
year-round.
$35,000
$42,500
$56,000
$63,500
Which of the following is NOT a typical budgeted expense item in the operating budget?
(1)
(2)
(3)
(4)
The cost of garbage disposal, including container rental and dumping charges.
The cost of janitorial services provided under contract.
The cost of chemicals to treat water in a hot water heating system.
The cost of repaving the parking lot every ten years when the asphalt wears out.
***Assignment 2 continued on next page***
2.6
Financial Statements and Budgeting
13.
Jessica's English Tea Company owns several machines that pick tea leaves. Which of the following
should Jessica use to allocate the cost of the machines when determining the taxes payable for the
company?
(1)
(2)
(3)
(4)
14.
Functional Depreciation
Straight Line Depreciation
Capital Cost Allowance
Curable Depreciation
Consider the following statements regarding joint ventures:
A.
B.
C.
D.
E.
The entities participating in a joint venture do not share in the profits and losses of
the joint venture, because profits are retained within the joint venture.
Investors in a joint venture enjoy the same limited liability as investors in a
corporation.
A joint venture pays income tax as a separate legal entity.
A joint venture consists of two or more legal entities which cooperate in a business
undertaking.
Although it is considered a separate legal entity, a joint venture is essentially a
form of co-ownership.
Which of the above statements is/are TRUE?
(1)
(2)
(3)
(4)
15.
One year ago, Pet Care Accessories Ltd. purchased a new factory at a total cost of $750,000 (for the
land and the building). At the time of purchase, the owner, Rocky, believes that the factory will last for
25 years, after which it will have no value. The CCA rate applied to the building is 4%. Now it is the
year end and Rocky must prepare the company's tax returns. If the income statement has a depreciation
expense of $15,000 (using the straight-line depreciation method), what is the building's capital cost
allowance for the first year?
(1)
(2)
(3)
(4)
16.
Only Statement D is true
Only Statements A and E are true
Only Statements A, B, and D are true
Only Statements B, C, D, and E are true
$7,500
$15,000
$30,000
$40,000
According to the Revenue Recognition Principle, which of the following would NOT be recognized as
revenue?
(1)
(2)
(3)
(4)
Rental income from tenants.
Funds received from the sale of a condominium by a developer.
Money earned for services rendered which has not yet been received.
All of the above would be considered revenue.
***Assignment 2 continued on next page***
2.7
Lesson 2
17.
Conor and Jeff went into business together on January 1, 2009. If they each have a taxable income from
the business in 2009 of $21,500 and together they claim a total of $3,000 in capital cost allowance and
$13,750 in depreciation expense in 2009, then what is the correct amount for net income (before-tax)
for the business in 2009?
(1)
(2)
(3)
(4)
18.
Which of the following statements best describes the relationship between the income statement and the
balance sheet?
(1)
(2)
(3)
(4)
19.
The revenue on the income statement is the same as the current assets on the balance sheet.
The net income or net loss on the income statement is transferred to the owner’s equity on the
balance sheet.
Subtracting the liabilities from the assets on the balance sheet finds the net income or net loss
on the income statement.
There is no relationship between the income statement and the balance sheet.
Tim has just sold his property which he owned for 10 years, and is getting his taxes ready. If the
current CCA rate is at 4%, what will he be able to claim on his property?
(1)
(2)
(3)
(4)
20.
$10,750
$26,250
$29,250
$32,250
Less than 4%.
Exactly 4%.
More than 4%.
He will not be able to claim any CCA.
The operating budget does not consider:
(1)
(2)
(3)
(4)
Renovations
Utilities
Administration
Janitorial
***End of Assignment 2 ***
2.8