Finding financial stability in economic uncertainty
In the accounting world everything works in balance, from income and expenses to debits and credits. And nowadays, bodies corporate are finding themselves under increasing financial pressure due to outstanding levies and debt.
This is where Stratafin has found an innovative solution to help bodies corporate ensure a steady cash flow to enable them to perform their duties. By purchasing the outstanding book debt at a reduced value, Stratafin gives the body corporate the funds it was struggling to recover and takes on the risk of recuperating those funds from homeowners who are in arrears.
Even though this model seems to follow a unique approach, it is supported by recognized financial reporting standards, which are the rules governing accounting. It is also in line with pronouncements made by the South African Institute of Chartered Accountants (SAICA).
What SAICA says
In their March 2017 FAQ, SAICA clarified that a body corporate may decide to prepare its financial statements in one of two ways.
The first option is by making use of a recognised financial reporting standard. In South Africa, the two financial reporting frameworks recognised as fair presentation frameworks are:
l) International Financial Reporting Standards (IFRS), and
2) International Financial Reporting Standards for Small and Medium-sized Entities (IFRS for SMEs).
The second option that a body corporate can use when preparing its financial statements, would be to make use of a basis of accounting as determined by the body corporate. This is also called an entity-specific basis of accounting. This by no means implies that the body corporate can do as it pleases in preparing its financial statements. The registered auditor of the sectional title scheme would still have to determine whether the financial reporting framework that was applied in preparing the financial statements of the body corporate is acceptable, in accordance with International Standards on Auditing (ISA).
In practice, most accounting practitioners and bodies corporate prepare the financial statements of sectional title schemes using IFRS for SMEs.
FRS for SMEs
Section 11 of IFRS for SMEs deals with basic financial instruments, specifically the recognising, derecognising, measuring and disclosing thereof, and it is relevant to all entities. The Standard explains that a financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability of another entity. It’s all about balance.
When it comes to sectional title schemes, the contractual agreement is between the owner of a unit and the body corporate. In this contract, the financial asset (namely debtors) must initially be measured at the undiscounted amount of cash receivable, normally referred to as the invoice price.
One should keep in mind that, at the Annual General Meeting (AGM), the body corporate must present annual financial statements that give a true reflection of the financial matters of the body corporate.
If debtors are in arrears and considered to be unrecoverable, the trustees (who exercise the powers and functions of the body corporate) have a fiduciary duty to act in good faith to give an honest and true valuation of the body corporate’s financial situation.
In Section 11.21 of IFRS for SMEs, the accounting standard recognises that an entity may not always be in a position to recover all if its outstanding debt. In fact, it states that at the end of each reporting period, an entity must assess if there is objective evidence of impairment (loss or diminishing value) of any financial assets. Considering South Africa’s history of economic uncertainty, rising unemployment rate and the devaluation of the currency, together with the current challenges we face in dealing with the Coronavirus pandemic, many bodies corporate are currently in serious financial trouble, since many homeowners who have lost their income are unable to pay their levies. The compound effect of historical arrears often results in the body corporate not being able to fulfil its functions. This puts the trustees at risk of not fulfilling their fiduciary duty.
When financial assets (debtors) are considered to be impaired, and there is objective evidence of this, IFRS for SMEs provides for that asset to be written off as an impairment loss. At the end of each financial year, bodies corporate must measure debtors at the initial amount of recognition, minus any reduction for impairment or uncollectability. This enables a body corporate to estimate the probable future cash flows it will receive from its debtors, and write off the difference between that amount and the book value of the debt.
Write off assets. Not your business.
In the unfortunate scenario where the debtors book makes it impossible for the body corporate to perform their statutory duties, Section 11.33 of IFRS for SMEs specifically allows for total derecognition of financial assets when an entity transfers all of the risks and rewards of ownership of the financial asset to another party. This is exactly where Stratafin assists the trustees of a body corporate to conclude an agreement for the sale of debtors comprised of arrear levies at a pre-determinable discounted rate.
In the end, it results in a win-win for both parties involved. Stratafin takes on the risk and rewards of collecting upon the impaired asset, while the body corporate restores its cash flow and regains its financial footing on South Africa’s economic tightrope – where everything is about balance.
To discover how Stratafin can help you solve your cash flow requirements, visit their website at www.stratafin.co.za or speak to to a friendly advisor on 011 051 8555/6.
Edited from an article written by
Dr Léandi Steenkamp
CA(SA), CISA, CIA, Professional Accountant (SA)
Head of Department: Accounting and Auditing, Faculty of Management Sciences at the Central University of Technology, Free State