Can you build a contingency into a body corporate budget?
29 May 2017
Click here to access a PDF version of this article.
Most of us have them. Not many are as big as the Federal government budget where every year they make some wonderful assumptions about where commodities, interest rates and employment are going and then plug those into a big matrix and voilà – we have a lesser deficit.
Even internally at Hynes Legal, it is a constant battle. As transactional / advice lawyers we know what we have on for the next two or so months at most. We wish we knew what May next year was going to be like, but all we can do is guess. If the phones don’t ring or emails stop coming in, we will be sitting here twiddling our thumbs.
Hence why we constantly communicate with our wonderful audience with what we hope is relevant and interesting content. It reminds people of what we do.
Anyway – can you have a line item as a contingency in a body corporate budget?
Budgeting for expenditure (particularly over the long term) is more an art than a science, but every body corporate must have budgets for their administration and sinking funds.
The administration fund should (in theory) zero out every year. You should raise money for the expenditure over the next 12 months, and spend it. You know you need to spend $15,000 on your strata manager, so you include that exact number in your budget. Insurance last year was $40,000, so you include that number plus a 3% increase.
After that, it gets murkier. You might need a lawyer throughout the year, so you allow $3,000. That is very much a guestimate based on what might happen. You might breeze through the year without a legal complaint, and if so, that is a bonus. Next year you are $3,000 ahead.
And don’t think just because money is included in a budget you can spend it. The decision to spend money, even if properly raised, still needs the appropriate level of authorisation.
The sinking fund has the same issues but obviously on a far larger scale. The sinking fund budget must provide for necessary and reasonable spending for the current financial year and reserve amounts necessary to meet costs for the next nine years in relation to expenditure of a capital or non-recurrent nature and for replacement of major items. Forecasting is mandatory, but the method of its calculation is very open to interpretation. If a committee was minded to it could tote up the numbers on the back of a beer coaster, but the much safer path is to engage a qualified professional to do the calculations for you by providing a sinking fund forecast. They can take into account everything that may need to be spent as well as the likely cost increases over time.
A sinking fund forecast is very much crystal ball gazing. Getting it right to the dollar is impossible. If you are budgeting for the replacement of the lift in 2026, the cost could be anything by the time you need the work actually done. What the cost is today, with some CPI indexation, might be close to accurate, or it might not.
What you absolutely cannot do is build a contingency (and call it that) into your budget. Having that as a line item is not lawful. The legislation focuses on anticipated expenditure and a contingency is not that. Some relevant comment from adjudicators includes:-
‘Contributions can only be raised to cover the estimated expenditure on specific budget items and should not be raised for unknown or uncertain contingencies.’
‘I consider it is contrary to the financial provisions of the legislation for a body corporate to deliberately seek to amass a surplus for unspecified or very loosely defined contingencies. Section 92 refers to budgets covering estimates of ‘necessary and reasonable spending’. Certainly, it can be difficult to estimate exact costs and may be reasonable to estimate at the higher end of the anticipated range to cover normal increases in the costs of budgeted items. However, contributions can only be raised to cover the estimated expenditure on specific budget items and should not be raised for unknown or uncertain contingencies.’
The answer to contingencies (if you read between those lines) is pretty simple.
Rather than building a contingency into your budget as an actual line item, you need to build it into each item of expenditure. If you think it may cost $100,000 for the lifts to be replaced, make the anticipated expenditure (and corresponding sinking fund levies to be raised) $110,000. In that way, you create a contingency without actually calling it that.
There is more than one way to peel a banana.