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ACCT10003 Accounting Processes and Analysis Assignment 2 - Semester 1, 2017 Group Assignment THE CASE OF GREEN MEADOWS BODY CORPORATE Inception The real estate subdivision known as Green Meadows opening in the early 1990s. Located in a fairly upmarket suburb of a major metropolitan area, the subdivision started with plans for 133 custom homes. The common properties of the subdivision included a park with a playground, a full-sized pool, a baby/wading pool, and a building that housed restrooms and showers. After approximately 50 homes were sold, the developer created a body corporate called Green Meadows Homeowners' Association. (The definition and operation of a body corporate are discussed in Appendix A). Seven homeowners volunteered to serve - four as officers and members of the board, one as a member of the board, and two as the architectural control committee. The association needed a president, vice-president, secretary, treasurer and one additional board member to prevent any tied votes on decisions. Two of these volunteers were a married couple. These officers worked hand-in-hand with the developer to file an application and the association's articles of incorporation with the state. Being the first board members of a new body corporate required a great deal of time to create the by-laws and policies for the association and to locate and engage service providers to maintain the common properties. The board members were a congenial group and enjoyed working together. To some extent their meetings were like a productive social event. Some of the policies and procedures established by the board included the following: Treasurer: A cheque account would be opened in the name of Green Meadows Homeowners' Association (GMHA). The treasurer would be on the signature card and be responsible for record-keeping for the account. All receipts and payments (disbursements) of cash would be made by the treasurer from this account. The treasurer would provide a list of all cash receipts and disbursements and present it along with the monthly bank statement reconciliations to the board members at their quarterly meetings. Page 1 Annual dues owed by each homeowner would be $650 a year. A notice would be mailed by the treasurer in January of each year stating the amount due and the due date. A stamped, return envelope addressed to the treasurer would be included with the notice. Cheques would be payable to the Green Meadows Homeowners' Association. The treasurer would purchase a stamp used to endorse cheques for deposit to GMHA's cheque account. President: The president would approve cash disbursements. The president would initial invoices as evidence of authorisation and give them to the treasurer to pay. The president would be responsible for making sure all maintenance work was completed on time and to specifications. The president would be responsible for calling board/officer meetings as needed. These meetings were usually to discuss maintenance issues. Vice-president: The vice-president would act in the place of the president in the event of the president's absence or inability to act and perform any other duties as requested by the board members. Secretary: The secretary would prepare minutes of the board meetings. This person would send the minutes to the members of the board and provide copies to any association members who requested them. The secretary would provide nuts and chips to the board meetings. The vicepresident would bring the beer. Board members: The board members would determine any special assessments or changes in dues. The board members would decide what maintenance work to do and what service provider to use. Subsequent events By 2005, the five original volunteer board members were ready to pass on their responsibilities. Surprisingly, there had been no turnover in these positions in the approximately 15 years they had served. The group was dedicated to making their subdivision a pleasant place to live and enjoyed working together. Also, they were smart enough to realise the better their subdivision was maintained, the greater the chance their property values would remain stable or increase. Page 2 Luigi, an affable resident of the neighbourhood who owned a struggling pool business, stepped up to become the new president of the GMHA. Most of the residents were happy and grateful that someone was willing to volunteer for this position. To streamline operations and save on the cost of maintaining a post office box for GMHA, Luigi had all bank statements and bills sent to his home address. He was able to quickly hand-pick four volunteers to replace the others, i.e., three officer/board members and one board member. Luigi felt it was important for the volunteer board members to feel comfortable serving on the board so he made sure that the insurance to limit the liability of the board members was kept up-to-date. Luigi has remained president of the GMHA to the present day. During the summer of 2016, it came to some of the residents' attention that not all was well with the GMHA. Below is a recount of recent events. December 2015 Luigi held a special meeting for all the members to vote on a 10 percent increase in the annual fees, which had not increased since 1996. Luigi pointed out the costs of maintaining the common areas had increased while fees had not. Also, repairs were needed to the pools and the playground equipment, all of which had been in use for nearly 25 years. Because swimming pools were Luigi's area of expertise, he spent most of the meeting talking about the pools. Although the pools in general appeared to be in good repair, several problems needed to be addressed. The rebar (reinforcing steel rods in the concrete) were coming up through the big pool in two places and the baby pool in one place. Those needed to be fixed and the pool resurfaced. Several tiles were broken or loose; the pool needed an acid cleaning; the filter equipment was in danger of failing; pumps were wearing out; and the safety covers on all the drains needed to be replaced. Also, the baby pool had a leak. The bottom line, according to Luigi, was that without an increase in fees, the pools would no longer be operable and would have to be filled in. Luigi passed around a list of homeowners' names with two boxes to the side of each name for a 'yes' or 'no' vote for the fees increase. The increase was passed unanimously. September 2016 The GMHA held a meeting for members of the board and homeowners. Again, swimming pool issues were the major topic. Homeowners complained that during the offseason of April to September none of the pool repairs discussed at the December 2015 special meeting had been done despite an increase in fees to cover them. It was now September and time for the pool to open so the repairs could not be made for another six months. Luigi took this as an insult and a criticism that he was not doing a good job as president of the GMHA. Luigi countered that he had been taking care of the association for several years with no pay and no show of appreciation from the homeowners. He justified the need for the increase in annual fees by saying the pool maintenance company, which was not Luigi's company, was charging the GMHA $650 per month. He failed to mention the pool maintenance contract was only for six months per year because no pool maintenance was performed over the summer months. He also Page 3 pointed out that during the off-season he had the leak in the baby pool fixed and resurfaced at a cost of $4,000 to the GMHA. Luigi stated that the water bills the previous summer were unusually high because of the leak in the baby pool. A homeowner suggested that Luigi get other homeowners to help him with things like neighbourhood beautification and social activities, whereupon Luigi appointed two homeowners to be additional members of the board. One would be an advisor and the other (who ran a semi-successful website building company) would handle the website. Luigi appointed a long-time GMHA board member as the Architectural Control Committee chair. When a homeowner asked Luigi to produce the by-laws for GMHA, Luigi waved the homeowner's concerns away and said they were 'in his head'. The meeting was adjourned without a vote on the new board members and their assignments. October 2016 A resident who used the pool regularly for lap-swimming exchanged pleasantries with the owner of the maintenance company on a sunny Saturday morning. During their conversation, the resident found out that the pool maintenance company had not been paid the $650 per month agreed to orally by the pool company owner and Luigi. When the resident complained about the cost of resurfacing the baby pool by Luigi's pool company, the pool maintenance company owner exclaimed that if the cost of the job quoted by the resident was correct, then the repair cost approximately four times what it should have. He told the resident that, to his knowledge, no request for bids had been sent out, and currently his company was trying to repair the same leak 'fixed' by Luigi's company. A board member who was handling the landscaping contract became frustrated because Luigi did not respond to her request for records; he held special board meetings without her knowledge; and he made personal attacks against her in emails sent to other board members. Consequently, she resigned from the board and started airing her concerns to other homeowners. November 2016 The pool maintenance company stopped servicing the pools due to non-payment from GMHA. The owner of the company sent copies of his invoices and his notice that he would no longer provide services to GMHA to a concerned resident who had been trying to determine how and to whom bills were paid. Luigi did not respond to requests for records of cash disbursements, and the new treasurer had neither seen the books nor had been asked to pay any bills. Luigi explained he had not paid the pool company because the company billed some large maintenance repairs that were not cleared by Luigi prior to the repairs being completed. While all this was going on with the pool maintenance company, the landscape company complained to another resident that payment of its fees had not been made in a timely manner. Page 4 Late November 2016 Homeowners discovered Luigi had gone before City Council to request a local government grant to paint bicycle lanes and parking spaces along the main road that ran through the subdivision. Luigi told members of City Council he represented GMHA and that the homeowners agreed to this project. A homeowner who just happened to be at the meeting announced that this was the first he had heard of the project. Nevertheless, after working with a City Council member, Luigi was able to get the grant for this project. Early December 2016 Several concerned homeowners contacted the accounting firm that prepared financial statements for GMHA. The sole proprietor of the firm lived in the subdivision. She told the concerned homeowners they could come to her office in three days to review the books, but they would not \"find what they were looking for\". The homeowners visited the accounting firm only to find receipts and cheques from the manual ledger missing, payments made to board members without receipts, and purchases made without justification, e.g., $600 paid to Luigi each September for the pool opening activities, including the purchase of a new barbeque each year. Other questionable payments included a payment of $250 to the son of one of the board members for picking up rubbish in the neighbourhood and the purchase of some corrugated metal sheeting for the pool area that ended up in one of the board member's home. After the homeowners had reviewed the records for about an hour, the accountant became agitated and demanded that they leave immediately, thus shutting down the investigation. Mid-December 2016 Representatives from 11 families in the neighbourhood met to discuss the next steps. They hired a lawyer at their personal expense who specialised in homeowner association disputes. The lawyer suggested the following actions: Do research to determine the legal standing of GMHA and follow up on some of the irregularities found by various homeowners Prepare a report and official letters to board members, including Luigi, outlining concerns and requesting a response within 10 days. Request minutes of board meetings, audit reports, election results, bank statements, and bids and contracts related to major maintenance projects. In the event the records are inadequate and/or not produced, send a notice of intent by the homeowners to file a lawsuit against the board of GMHA If these actions did not resolve the problems with GMHA, then a potential lawsuit with forcible removal of the board members might be required. Included in this series of events would be a possible investigation by the public prosecutor into the alleged fraudulent activities by the board members. Page 5 In the meantime, a homeowner went to the City Council to tell them Luigi did not represent the homeowners with regard to the street painting project, as no survey of the homeowners had been made prior to the application for the grant. The City Council members requested a survey be made of the homeowners before the project moved forward. Early January 2017 Luigi sent a newsletter to all homeowners advising fees would be increased again pending a series of meetings later that year to gather votes for the increase. The newsletter announced that bicycle lanes and parking spaces would soon be painted on the main road into the subdivision. Luigi claimed the vote for this project was unanimous by the GMHA board. Meanwhile, the homeowner who had informed the City Council that GMHA members had not been given the opportunity to vote on the street painting project mailed a survey to the homeowners asking if they were for or against the project. More than half of the 133 property owners responded to the survey. Ninety percent of those were against the project. The Next Steps This scenario is ongoing. A large group of concerned homeowners is meeting regularly with the lawyer to determine what steps to take to revive the GMHA and the integrity of the board. APPENDIX A Definition of a Body Corporate Body Corporates, which are associations of homeowners, are common in house developments, apartment blocks and townhouse complexes and serve as the governing body for the purpose of protecting the value and desirability of the real estate. They are non-profit organizations. When a person buys a property governed by a Body Corporate, the owner automatically enters into a contract with the association, and agrees to obey all the rules adopted by the association. These rules address such issues as what materials and colours can be used for roofs, what kind of landscaping you can do, the size and height of structures that can be built in a yard, and whether election or contractor signs can be placed in yards. These rules are referred to as covenants, conditions and restrictions (CC&R). The Body Corporate assesses fees on homeowners. These fees are used to cover the costs to maintain the common areas used by all homeowners. These common areas may be, for example, swimming pools, playgrounds, walking paths and tennis courts. By adhering to the rules and paying the association fees, the implication is that amenities will be well-maintained. Page 6 When a developer completes a housing development and sells the first few properties, it is customary for the developer to create a body corporate. Some of the new homeowners volunteer to serve on the board. An election is held for the offices of president, vice-president, secretary and treasurer. Because these are unpaid positions that require time, volunteers can be hard to come by. As a result, often the board members and officers are the same people. In addition to the board members and officers, an architectural control committee is established to approve or disapprove changes to the property. Assignment Questions Question 1 Apply the fraud triangle to this case. Speculate on the motivation/pressures, opportunity and rationalisation of Luigi and board members. Question 2 Identify at least ten \"red flags\" for potential fraud in this case. Question 3 Identify the internal control weaknesses present in the case and tie them to the elements of the COSO (2013) Internal Control - Integrated Framework: the control environment, risk assessment, control activities, information and communication, and monitoring. For each weakness identified, suggest an appropriate control to address that weakness. Page 7