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Quantity Surveyors

Asset Management Consultants

Taxation Depreciation Consultants

Leary & Partners

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1. To demonstrate compliance with the legislation

2. To provide a reliable basis for budgets

3. To produce predictable outgoings in line with owners’ incomes

4. To avoid special levies as a result of poor planning

5. To provide funds to meet maintenance requirements

6. To act as a maintenance calendar

7. To minimise maintenance related owners corporation disputes

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A body corporate must establish and maintain a sinking fund to pay for:

• anticipated expenditure of a capital or non-recurrent nature

(including particularly common property painting),

• the periodic replacement of items of a major capital nature, and

• any other expenditure that should reasonably be met from capital

[sec. 139(3) Standard Module]

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The body corporate’s sinking fund budget must take into account both

expenditure to be incurred in that financial year and “an appropriate proportional

share of amounts necessary to be accumulated to meet anticipated major

expenditure over at least the next nine years after that financial year”.

[ sec. 139(3)(a)]

The annual sinking fund levies must be set at an amount that covers the

expenses calculated in under section 139(3).

[sec. 139(3)(b)]

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Accrual accounting in action

• deterioration of the building and its components occurs slowly

• a professionally prepared sinking fund forecast matches levies with the rate

of deterioration of the building

• owners pay for their proportion of maintenance costs

• equity in owner contributions is ensured over the life of the building

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The user pays

• an owner cannot avoid paying for his or her share of the maintenance

costs by selling out before the maintenance costs are due

• owners who purchase a unit in an older building can be certain they will not

inherit other people’s accrued expenses

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Predictable replacement items

Before you can justify asking unit owners to contribute towards the future

maintenance of an item, you must be able to show that you can reasonably

forecast

• that an expense will occur,

• approximately when the expense will occur,

• the estimated cost.

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Typical replacement items include

• replacing carpet

• replacing gutters & down pipes

• replacing pumps and motors

• replacing major lift components

Predictable repair items include

• Painting

• timber fences

• pool surfaces

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• minor one-off costs

(i.e. cutting a new door key)

• items with overall lives of 12 months or less

(i.e. filtration cartridges or light bulb replacements)

These costs should be paid for from the body corporate’s administrative budget

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A structural defect, in the context we are talking about here, is a major failure

in one of the building’s core elements, things like concrete spalling to walls or

foundation subsidence. These items tend to be the result of inadequate design,

defective materials or bad construction practices. In many cases, the problem is

revealed by the failure of the element. There is no fore-warning.

• they are a one-off event

• they are not predictable

• they cannot be included in a forecast prepared prior to their occurrence

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You can’t budget for the rectification until you have identified the problem and

gone through the process of working out what remedial action is going to be

required.

• they may be included in a forecast prepared in the year of their occurrence

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If the fault requires immediate rectification you have two funding options.

1. either you meet the cost from a special administrative levy, or

2. mitigate the impact on the owners by paying the cost out of the existing

sinking fund balance (assuming there are funds to cover it), then rebuild your

fund to the necessary balance by using larger ‘catch up’ levies in the

following years.

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A refurbishment is an upgrade to existing finishes as opposed to the normal

repair and replacement of items. It often involves the replacement of items prior

to the end of their physical life.

• relevant to high profile buildings

• relevant when buildings need to compete with newer developments - hotels

are typical

• where there is a fair degree of certainty that a refurbishment will be required,

it may be considered a predictable expense

• may be included in the sinking fund forecast

• often require architectural design

• design is then costed and included in forecast

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• we carry out a thorough site inspection

• we determine what items should be included in the sinking fund

• we establish the variables used in the forecast calculations

• our software calculates the optimum contribution scheme

• the report is quality assurance checked for quality assurance purposes

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The quantity surveyor identifies those items in the building which will require

either major repairs or total replacement over the sinking fund period.

• The choice of sinking fund period has a major impact on the forecast results.

• A forecast based on a 10 year period may give a substantially different result

to one based on a twenty year period.

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• The 10 year forecast will result in a fluctuating contribution stream. This is

because a 10 year time frame does not capture the life cycle of large

expensive items such as lifts. As a result, each year when you recalculate the

forecast, large expense items may be being added or omitted from the

calculations, causing significant variation to the levies.

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The object of the exercise is to capture the majority of expense items, and

provide a long enough lead time to accumulate the funds at an affordable,

predictable and constant rate.

Our experience has taught us that all forecasts should cover a minimum of at

least 10 years, and that a longer period of up to 15 years is probably required

for the majority of strata complexes. However, we don’t recommend a forecast

period longer than 20 years because after that length of time the variables

become too unpredictable.

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• the cost to repair or replace the item (at today’s value)

• their First Replacement [the number of years before they will require

replacement or repair] (FR) based on their age & condition

• their Replacement Cycle (RC) [frequency of replacement or repair] based on

industry standards and our experience with similar buildings

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• forecast inflation: allowance is made for the future cost of repairs and

replacements to increase in line with inflation.

• interest: the bank interest earned on the sinking fund balance is taken into

account when calculation contribution requirements

• tax levels: tax is deducted on the interest earned by the sinking fund at the

current company tax rate

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• contingency value: an allowance is included in the total estimated expenses

in order to cover minor unforeseen costs or variations in estimate cost due to

factors such as minor changes in item specification. (Our standard default is

10% of the total value of the forecast expenses. This is variable at the body

corporates’ request.)

• minimum balance: The minimum balance below which the sinking fund

should not fall is set. (Our standard default is the contingency value. This is

variable at the body corporates’ request.)

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• the date the forecast is to commence: the date on which the forecast will

commence is set. This is normally the first day of the body corporates’ next

financial year.

• the existing sinking fund balance at the start of the forecast period: in

determining the contributions required the software takes into account the

sinking fund balance as at the day the forecast commences

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Our in-house software utilises a complex series of goal seeking macros which

calculate the possible contribution schemes repeatedly until it finds the

contribution scheme which best meets 3 key goals.

• It ensures that all expenses can be met - the calculated sinking fund forecast

can never have a negative balance and in any year should never fall below

the set minimum balance.

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• It minimises unit owner levies - it enables all expenses to be met while

requiring the minimum possible contribution by owners over the period of

forecast.

• It achieves a steadily increasing contribution scheme that rises in line with the

increase in inflation - unit owners require a contribution scheme that behaves

predictably and which allows for logical budgeting. This goal may not be

completely obtainable where the sinking fund balance at the commencement

of the calculation is below the required level

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• the draft is checked in detail by the quantity surveyor who prepared the cost

estimate

• a secondary quality assurance check is done by another senior quantity

surveyor

• a draft report is sent to the body corporate for comment (if requested)

• any changes are made and the final report is issued.

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• Where the legislation requires a scheme to have a 10-year forecast, the

forecast must be reviewed when it no longer contains an estimate of

expenditure of the required 10 future years.

• We recommend a review of the sinking fund forecast (including a site

inspection) should be carried out at least every three years. This allows an

opportunity to ensure that items are wearing at the anticipated rate and that

new maintenance requirements have arisen.

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• L&P strongly recommends an annual ‘administrative’ update in other years.

The parameters of the sinking fund budget will change annually. For

example, the fund balance, when items of work are carried out, differences

between estimated and actual expenditure, the addition of new items to the

development and contingency items such as the inflation rate, will all vary to

some extent. This does not mean that the long range forecast is then made

redundant. It simply means that adjustments are necessary each year, as is

the case with all financial budgets to ensure accuracy over the larger term.

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A well prepared sinking fund forecast is an invaluable management asset tool. It

minimises the time and effort required to obtain Body Corporate approval for

necessary maintenance expenditure.

• There is less resistance to expenditure when the funds are already available

• It is easier to act swiftly if emergency work is required

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• It minimises ‘quick fix’ or ‘cut price’ maintenance solutions which frequently

result in discontented owners and the need for additional work

• It provides independent outside verification of the body corporate’s

maintenance responsibilities

• It allows you to focus that time and effort on the real objective

- carrying out the maintenance

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Quantity Surveyors

Asset Management Consultants

Taxation Depreciation Consultants

Tel: 1800 808 991 Fax: 1800 808 921

Email: enquiries@leary.com.au