4370.2 REV-1

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CHAPTER 3. FINANCIAL REPORTS AND SUPPORTING DATA

3-1. INTRODUCTION

This chapter discusses the submission of reviewed financial

statements and the IPA\'s report on those statements, the report

on the internal control structure, the report on the compliance

with applicable laws and regulations and the supplemental data

reports required by HUD.

The mortgagor is responsible for submitting the annual financial

statements as required by HUD and the IPA audits the reports

and furnishes an opinion on the financial statements. The

owners are expected to maintain books and records in

accordance with Generally Accepted Accounting Principles

(GAAP) and the auditor must thoroughly review these records

using Generally Accepted Auditing Standards (GAAS) and

Government Auditing Standards (GAS). The IPA must also use

the audit guide: IG 2000.4, Consolidated Audit Guide for

Audits of HUD Programs.

GAAP are broad rules adopted by the accounting profession as

guides in measuring, recording, and reporting the financial

activities of a business. GAAS refer to the ten auditing

standards that have been approved and adopted by the

members of the AICPA. GAAS are divided into three groups

\(1\) general standards (2) standards of field work (3) standards

of reporting. GAS (which are issued by the U.S. General

Accounting Office (GAO) are standards for audits of

government organizations, programs, activities and functions of

government funds received by contractors, nonprofit

organizations, and other nongovernmental organizations.

The purpose of an audit is to have the IPA render a

professional opinion on the reliability of the financial

statements as an accurate reflection of the project\'s condition

and performance.

Project owners should use competitive bidding processes when

procuring the services of an IPA. These processes could vary

depending upon the size and the needs of the project from a

simple telephone bidding (of at least three auditors) to a

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3-1 5/92

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4370.2 REV-1

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comprehensive invitation for bids (IFB)/request for proposal

(RFP) process.

Once an auditor\'s proposal is accepted, the proposal in effect

becomes a contract between the auditor and the mortgagor.

The auditor\'s proposal/engagement letter should include the

following:

o objective of the audit

o a description of the work to be done and the

approach, including that the performance of the

audit will be in accordance with GAS and IG

Handbook 2000.4

o auditor\'s proposed staffing plan for the audit

o discussion of professional time and fees (in

IFBs/RFPs, cost issues are separately bound

and reviewed)

o the auditor, or audit firm\'s qualifications

o Finally, the engagement letter must allow for

duly authorized agents of the Secretary to

examine the IPA\'s working papers supporting

the audit report.

Projects which have audits performed using OMB Circular A-133,

Audits of Institutions of Higher Education and Other Non-Profit

Institutions should ensure that those audits comply with

the guidelines defined in this handbook.

In addition, the project owners should consider the following

IPA issues relating to the preparation of the audited statements:

A. Independent Public Accountants (IPAs) that perform

bookkeeping services for a project, are prohibited from

performing audits of the project.

B. To the extent permitted by GAS or GAAS, IPAs may

rely on physical inspections of projects made by HUD

or mortgagees.

C. The mortgagor\'s records include prior year IPA audits,

HUD Management Reviews, HUD/Mortgagee physical

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5/92 3-2

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4370.2 REV-1

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inspection reports and HUD-OIG audits. This

information should be provided to IPAs and should be

stated in the IPA engagement letter.

D. When conducting compliance tests for Affirmative Fair

Housing Market Action Plans, in addition to verifying

that such a plan exists, if required by the Regulatory

Agreement, IPAs should sample some items, (e.g.,

advertising expenses) to verify compliance.

E. Tests that the IPA might make regarding the adequacy

of Reserve Fund balances should normally be limited to

testing that involves the nature of a \"going concern\"

basis of the mortgagor.

3-2. AUTHORITY

HUD Regulations, regulatory agreements, and other documents

through which the Secretary exercises control over the

mortgagor, require the submission of various financial reports

and supporting data. Such reports shall be prepared at an

interim date or as of the end of the annual accounting period to

supply HUD and project management with a full disclosure of

the results of operation, as well as the financial condition of

the project.

A. From the Regulatory Agreement, the requirement for

an annual report states: \"Within 60 days following the

end of each fiscal year, the Secretary shall be

furnished with a complete annual financial report based

upon an audit of the books and records of the

mortgagor, prepared in accordance with the

requirements of the Secretary , certified to by an officer

or responsible \'Owner\' and, when required by the

Secretary , prepared and certified by a Certified Public

Accountant, or other person acceptable to the

Secretary \".

In other words, the mortgagor is responsible for

preparing the required financial statements and

certifying that the statements are accurate. However,

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3-3 5/92

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4370.2 REV-1

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an Independent Public Accountant examines the

financial statements to express an opinion.

B. The Regulatory Agreement also contains an option to

require monthly occupancy reports: \"At the request of

the Secretary , his agents, employees, or attorneys, the

Owners shall furnish monthly occupancy reports and

shall give specific answers to questions upon which

information is desired from time to time relative to the

revenue, assets, liabilities, contracts, operation, and

condition of the property and the status of the insured

mortgage.\"

C. Under certain circumstances, special operating

(revenue) statements must be submitted.

1\. When occupancy occurs during the construction

period, an operating (revenue) statement is

required covering the period from the date of

first occupancy to the cutoff date for inclusion

of interest. At the option of the mortgagor, the

statement may cover the period from the date

of first occupancy to the last day of the month

in which the final Inspection Report was signed.

If this election is made, interest, taxes,

insurance, and mortgage insurance premiums

will also be cut off (i.e. treated as capital

costs) as of the month-end date used for the

statement.

2\. In the rare instance when more than three

months intervene between the cost certification

cutoff date and the first principal payment as

originally scheduled, an income statement is

required, covering all operating revenue and

expenses during the period, for an advanced

amortization determination. This requirement

does not apply to investor-sponsor or nonprofit

mortgagors, or to any project wherein the

mortgage does not exceed \$200,000.

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5/92 3-4

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4370.2 REV-1

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3-3. REQUIREMENTS OF FINANCIAL REPORTS. The

following requirements pertain to all controlled projects except

cooperative housing:

A. Financial reports shall be based on data obtained from

separate books and records established for and relating

solely to the project. Particular care must be taken in

cases where an individual person owns and operates

additional projects. In other words, each project\'s

books must be separate and distinct. There are

instances where other projects have similar officers or

identity of interest management firms managing the

property.

B. Reports must cover the project\'s entire fiscal period

under review. A financial report is required even if any

fiscal period is less than a full year.

C. The Annual Financial Statements must be prepared on

an accrual basis, after making all year-end adjustments.

Since the report is based on an examination of books

and records of and related to the mortgagor, or entity,

the mortgagor shall advise the mortgagee, at least 30

days prior to the end of the mortgagor\'s fiscal year, that

a statement reporting the escrow, and various reserve

fund balances is required as of the date on which the

fiscal year ends. As part of the annual audit, the IPA

will ask the mortgagee to confirm the amounts of all

funds under its control and that they are Federally

insured as to principal.

D. The Report shall be audited by an Independent Public

Accountant (IPA) who is a Certified Public Accountant

(CPA) or a licensed or registered public accountant

having no business relationship with the mortgagor

except for the performance of audit, systems work and

tax preparation. IPAs who are not Certified Public

Accountants must have been licensed or registered by a

regulatory authority of a State or other political

subdivision of the United States on or before 12/31/70.

In states that do not regulate the use of the title \"public

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3-5 5/92

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4370.2 REV-1

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accountant,\" only Certified Public Accountants may be

used to make these audits.

3-4. PREPARATION OF FINANCIAL REPORTS

TYPES OF REPORTS AND REPORT CONTENT: The

financial statements, except for cooperative housing projects,

must contain the following reports, as applicable:

A. A Statement of Financial Position (Balance Sheet

including a Statement of Changes in Owners/Partners

Equity. (Appendix 4). The Balance Sheet shows the

financial position of an entity at a specified point in

time.

The Balance Sheet must reflect all prepaid and deferred

items. For nonprofit elderly housing projects only, if

founders\' fees, life membership contracts or similar

funds are received, the Balance Sheet must show:

1\. In appropriately titled Fund (Asset) accounts,

the aggregate of such cash on hand at the end

of the fiscal year, and

2\. In appropriately titled Deferred Income

(Liability) accounts, any portions of such cash

received but not earned at the end of the fiscal

year. If there are differences in the conditions

under which the funds were received, a

separate account shall be established for each

class. For example, separate accounts are

required if certain classes of funds are

refundable, either in whole or in part, while

others are not.

B. A Statement of Income for the year under review.

(Appendix 5). The Statement measures the results of

operations for the year under review. This must

conform to the following requirements:

1\. It must be submitted on Form HUD-92410.

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5/92 3-6

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4370.2 REV-1

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2\. It must show Gross Potential Income less

vacancies to arrive at a Net Rental Income.

3\. Any apartments or commercial space occupied

but not producing revenue must be shown as an

expense under the applicable expense

classification, and a supporting schedule must

be submitted listing the names of such

occupants and their connection with the project.

If no such revenue applies, it shall be so

indicated on the statement.

For Section 221 and Section 236 nonprofit projects only:

4\. If gross potential unit rental revenue reported

differs from that shown on the Form HUD-92458,

Rental Schedule and Information on

Rental Project (see Appendix 6), then in effect,

a detailed statement accounting for the

difference must be attached.

5\. Any expenses reported for salaries or other

compensation to supervisory or administrative

employees, officers, directors, or stockholders

must be supported by a schedule showing

duties, salary paid, and date of prior written

HUD approval.

6\. A full explanation is required concerning any

receipts from charges for facilities or services,

other than reimbursement for breakage or

damage by tenants.

For nonprofit elderly housing projects only:

7\. Receipts from donations, subsidy payments,

portions of founders\' fees, life membership

contracts, and similar funds earned during the

current year, etc., shall be reported and fully

identified.

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3-7 5/92

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4370.2 REV-1

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C. A Statement of Retained Earning (Appendix 8). This

shall include an explanation of changes in the account

other than net income or loss for the operating period.

D. A Statement of Shareholders\' Equity or Partners\'

Capital (Appendix 9). This shall include a full

explanation of origins, additions, and deductions during

the operating period. This statement could also be

shown as part of the Statement of Financial Position

(Balance Sheet).

E. Statement of Cash Flows, (Appendix 10) shall include

funds provided and applied for all cash and certain

non-cash expenses (e.g. depreciation) to reflect net

increase/decrease in cash during the operating period.

The statement shall include no less detail than that

shown in Appendix 10 and may include footnotes, if

applicable. It shall be prepared using the Direct

Method and shall include all receipts, i.e., rental

revenue, concessions, commercial property, advances by

owner, releases from the Reserve for Replacements, etc.

It shall also include all disbursements, whether by check

or in cash. In addition, a schedule of funds in the bank

must be attached showing each depository by name,

account title, and balance, including funds held in the

Reserve Fund for Replacements and the Residual

Receipts Accounts whether these accounts are

maintained by a mortgagee or by the mortgagor.

F. Notes to Financial Statement includes notes relative to

the mortgagor organization and policy changes affecting

the preparation of financial statements and account

balances, as well as significant accounting policies that

have been followed in the preparation of the financial

statement by the mortgagor\'s accountant. In addition,

the notes should indicate the type of project and basis

for computation of distributions shown.

G. Supporting Data, in the form of explanatory comments

or appropriate schedules. See Appendix 11 Supporting

Data for samples of the reports required by HUD. This

must include the following:

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5/92 3-8

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4370.2 REV-1

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1\. Accounts and Notes Receivable. A complete,

detailed analysis shall be included of any

accounts or notes receivable other than regular

tenant accounts, including date acquired,

original amount, terms, name of borrower and

balance due.

2\. Delinquent Tenant Accounts Receivable. A

summary analysis shall be made of delinquent

tenant accounts, including the number of

tenants and amounts delinquent for 30 days,

30-60 days, 60-90 days, and over 90 days.

3\. Mortgagor Escrow Deposits. A breakdown

shall be made of the items making up the total

amount on deposit with the mortgagee in

anticipation of future disbursements for

mortgage insurance premiums, taxes, property

insurance, etc. This amount shall be confirmed

in writing by the mortgagee.

4\. Tenant Deposits. A complete, detailed analysis

shall be included of funds maintained in any

regular tenant accounts such as security/pet

deposits.

5\. Reserve Funds. An analysis shall be made of

all required reserve funds, including:

a\. A statement as to the amount required.

If more than one fund is required to be

established, a separate statement must

be submitted for each fund.

b\. A statement as to the form in which

these funds are provided. If funds are

in cash, the names of the depository of

each fund are required, if invested in

securities, full details are required.

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3-9 5/92

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4370.2 REV-1

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c\. A statement of any withdrawals during

the year, including the purpose of and

authority for such withdrawals.

6\. Change in Fixed Asset Accounts. A schedule

shall be included, showing full details and

explanations of any Changes in Fixed Asset

Accounts.

7\. Accounts Payable. A list shall be included of

accounts payable, other than trade creditors,

segregated by those payable within 30 days,

30-60 days, and more than 60 days, with detailed

analysis of the latter group, to include date

incurred, original amount, purpose, terms,

creditor, and balance due. Accrued expenses

shall be shown separately from accounts

payable.

8\. Accrued Taxes Payable. A statement shall be

attached supporting any accrued taxes shown,

including each type of tax, basis for the accrual,

and date due.

9\. Notes Payable (Other than Mortgage). Details

shall be included of loans or notes payable,

other than the insured mortgage, including date

incurred, original amount, purpose, terms,

creditor, and balance due.

10\. Stock Actively Reports - Initial Submission. In

the initial report (the first report submitted on

the project), full details shall be included

concerning the issuance of all stock and/or

investments, including names of stockholders or

individuals interested, proportionate interest of

each and whatever consideration is received by

corporate or noncorporate projects

(considerations shall be itemized to show

amount of cash, land, services, etc.). Initially,

a list shall be furnished consisting of officers,

directors, and individuals having a financial

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5/92 3-10

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4370.2 REV-1

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interest in the project. Thereafter, details shall

be furnished of any changes in these positions

occurring during the year. If no changes have

occurred, it should be so noted.

11\. Distributions to Owners or Stockholders. If any

dividends were paid or if other distributions

were made to owners or stockholders (including

purchase or redemption of any stock of the

corporation), the amount declared on each class

of stock shall be shown along with the period

for which it was declared, the date of

declaration, and the date of payment. For

limited distribution mortgagors, a statement is

required as to both the cumulative and the

current (fiscal year) amount of return on equity

earned.

12\. Unauthorized Distribution of Project Revenue.

If any unauthorized distribution of project

revenue is revealed during the audit, a separate

schedule must be prepared detailing the

amounts involved, date of distribution and any

other relevant information.

13\. Comments on Statement of Position (Balance

Sheet) Items. Comments on and explanations

of all other Balance Sheet items not fully

explained by the title of the account shall be a

part of the report.

14\. Residual Receipts. For all projects required to

make deposits to a residual receipts fund, a

computation shall be included showing the

amount of any such receipts at the end of the

fiscal year and the date of their deposit to the

fund. An analysis of this fund and the

computation are required regardless of whether

or not residual receipts have actually been

generated.

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3-11 5/92

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4370.2 REV-1

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15\. Donations, Subsidy Payments, Founders Fees,

etc. for Non-Profit Elderly Housing Only. In

the initial report (the first report submitted on

the project) for nonprofit elderly housing only,

full details shall be reported concerning any and

all donations as well as subsidy payments,

founders\' fees, life membership contracts or

similar funds, etc., including original amounts

and purposes for which expended. In

subsequent reports, full details must be given

concerning such amounts received, due, and

expended during the year.

16\. Compensation of Partners or Officers. If a

project is owned by a corporation or

partnership, a statement detailing the

Compensation of Officers or Partners is

required. If no compensation was paid, a

statement to that effect will suffice.

17\. Listing of Identity of Interest Companies and

Activity. A listing of identity-of-interest (as

defined below) companies doing business with

the mortgagor and/or management agent of the

project, along with a breakdown of services

rendered and amounts received, shall be

required if the payments for services performed

for the project totalled \$1,000 during the

operating period.

HUD assumes an identity of interest to exist

between the project staff and the lender/vendor

when (1) the project staff member, or (2) any

officer, owner, or director of the project, or (3)

any person who directly or indirectly controls 10

percent or more of the project\'s voting rights is

also (1) an officer, owner, or director of the

lender/vendor, or (2) a person who directly or

indirectly controls 10 percent or more of the

lender/vendor\'s voting rights, or (3) directly or

indirectly owns 10 percent or more of the

lender/vendor. A vendor is any individual or

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5/92 3-12

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4370.2 REV-1

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establishment that provides goods or services of

any kind to the project for compensation or

remuneration.

3-5. TYPES OF SUBMISSION

This paragraph highlights report submission requirements for

projects operating under the following situations.

A. The Partial-Year Financial Statement, covering the

period from cost certification cut-off through the end of

the fiscal year established by the mortgagor, shall

contain the same statements and supporting data

required in the annual financial report. Partial-year

financial statements also may be required as a result of

a Transfer of Physical Assets (TPA) which occurs before

the end of the current fiscal period as described in

HUD Handbook 4350.1, Insured Project Servicing

Handbook.

B. The Statement Covering the Period of Occupancy

During Construction must show gross rents received,

excluding security deposits and actual operating

expenses incurred during the period. In certain cases,

accrued expenses may be included.

1\. Additional allowable operating expenses for this

purpose may include:

a\. advertising expense,

b\. rental commissions customary for the

type of project, if any,

c\. a reasonable management fee

(excluding salaries paid to officers of

sponsor or mortgagor), and

d\. electricity, gas, water and operating

salaries (maintenance, cleaners,

gardeners, elevator operators, etc.) to

the extent they are not included in

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3-13 5/92

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4370.2 REV-1

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construction costs on Form HUD-92330

or Form HUD-92330A.

2\. Disallowable Expenses include the following

Occupancy costs:

a\. Depreciation

b\. Interest

c\. Taxes

d\. Property Insurance Premiums

e\. Mortgage Insurance Premiums (MIPs)

3\. If this statement shows an excess of revenue

over operating expenses, as defined, the excess

shall be treated as a recovery of construction

costs (line 15 of Form HUD-92330), except in

nonprofit-mortgagor cases.

a\. A copy of the statement, signed by the

mortgagor, must be attached to Form

HUD-92330.

b\. In nonprofit-mortgagor cases, net

income shall not be treated as a

recovery of cost, but transferred at final

closing to a residual receipts account

for future project needs. The operating

(revenue) statement, however, must be

reviewed to determine if any expense

items shown in the statement were paid

from Allowance to Make a Project

Operational (AMPO) funds or

otherwise included in cost certification

items. If so, the net income reflected

in the statement shall be adjusted

accordingly; and a requirement made

that such adjusted net income be

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5/92 3-14

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4370.2 REV-1

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transferred to the residual receipts

accounts.

4\. If operating expense exceeds revenue, no entry

is made on Form HUD-92330. In this case, the

recognized excess of expense over revenue may

be carried over as a reduction of net income.

a\. The statement shall also include

information on net income or loss, cash

flows, accounts receivable, and accounts

payable. It shall be accompanied by a

certification of the accountant.

C. The Statement Covering the Period Between Cost

Certification Cutoff Date and First Scheduled Principal

Payment. Although rarely needed, the income

statement covering the period between the cost

certification cutoff date and the first scheduled principal

payment requires special preparation.

1\. When final closing is scheduled after the close

of the accountability period, the statement shall

be submitted at or before final closing. When

final closing is scheduled prior to the expiration

of the accountability period, the mortgagor

must agree in writing:

a\. To furnish within 30 days after its

expiration an income and expense

statement for the required period.

b\. To apply immediately such portion of

the net operation revenue as the

Secretary may require as a mandatory

prepayment to the mortgage.

2\. All rents received, exclusive of security deposits,

shall be included as revenue. All expenses for

operation, including taxes, insurance, mortgage

insurance premium, interest and reasonable

management fees (but not officers\' salaries or

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3-15 5/92

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4370.2 REV-1

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depreciation), may be deducted in determining

net income for this purpose. If the income

statement submitted at cost certification reveals

an excess of expense over income, to the extent

recognized by the Secretary, such excess may be

carried forward as \"Unrecovered Expense\--Prior

Period\" to the operating (revenue) statement

required by this paragraph.

3\. The amount and the handling of the

prepayment of the mortgage required under

this paragraph are subject to the following:

a\. In no case shall the required payment

exceed the amount that would have

been due in cumulative principal

payments if the first payment had been

scheduled on the first of the month

following the month in which the

accounting period started.

b\. Prepayment is required only to the

extent that the amount of the net

income permits payment of one or

more full monthly principal payments

as scheduled.

c\. If the circumstances are such that the

operating (revenue) statement is

submitted before final endorsement, the

mortgagee and mortgagor may elect to

have the mortgage endorsed for less

than the face amount by a sum equal to

that which would have been required as

a mandatory prepayment.

4\. The statement shall also include information on

net income or loss, cash flows, accounts

receivable, and accounts payable. It shall be

accompanied by a certification of the

mortgagor, as well as an accountant.

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5/92 3-16

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4370.2 REV-1

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3-6. REPORTS TO BE ISSUED BY IPA\'S

A. Financial Statement Audit. An independent public

accountant shall examine the books and records of the

mortgagor and shall furnish an opinion on the annual

financial statements in accordance with GAAS and

GAS. The independent accountant shall justify any

material departure from the \"unqualified opinion\"

language as illustrated in Appendix 12.

B. Internal Control Structure. In accordance with GAAS

and GAS, an independent public accountant shall obtain

an understanding of the project\'s internal control

structure and shall furnish a written report on their

understanding of the entity\'s internal control structure

and the assessment of control risk made as part of a

financial statement audit. This report on the internal

control structure shall disclose all internal control

weaknesses considered to be reportable conditions,

including material weaknesses, as defined by

Government Auditing Standards, published by the

Comptroller General of the United States. This report

may be included in either the auditor\'s report on the

financial audit or a separate report. The independent

accountant shall justify any material departure from the

language as illustrated in Appendix 13.

C. Compliance with applicable laws and regulations. In

accordance with GAAS, independent public accountants

shall prepare a written report on their tests of

compliance with applicable laws and regulations in

accordance with IG Handbook 2000.4. This report,

which may be included in either the report of the

financial audit or a separate report shall include all

material instances of noncompliance. The independent

accountant shall justify any material departure from the

language as illustrated in Appendix 14.

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3-17 5/92

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4370.2 REV-1

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The following additional reports, which may be included in

either the report of the financial audit or issued as separate

reports, are recommended by GAAS, required by GAS, and are

also to be prepared and submitted. Samples of these reports

are included in Appendix 15.

D. Auditor\'s Schedule of Findings and Questioned Costs.

When the auditor identifies a finding, the following

information should be provided to HUD officials to

permit timely and proper corrective action to be taken.

The auditor should attempt to identify:

o condition (the nature of the problem)

o criteria (what the owner/management

agent should be doing)

o effect (what happened as a result of the

problem)

o cause (why the problem exists)

The findings reported by an auditor may serve as a

basis for HUD to perform additional reviews.

The auditor\'s \"Schedule of Findings and Questioned

Costs\" should be attached to the auditor\'s report on

compliance.

E. Auditor\'s Comments on Audit Resolution Matters. This

report identifies whether a project owner has taken

corrective actions on findings from the prior audit

report. The auditor should provide the project name,

prior audit report number, a brief description of the

findings and the status of the corrective action plan.

This report also includes findings contained in program

review reports, and state agency reports.

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5/92 3-18

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4370.2 REV-1

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3-7. MORTGAGOR\'S CERTIFICATION.

A. The annual financial report shall include: (1) a

certification by the mortgagor, when the project is

owned by an individual; (2) by two or more partners

(including at least two general partners if there are two

or more general partners), when it is owned by a limited

partnership; (3) by two officers one of which must be

the president of the corporation, when it is owned by a

corporation; (4) all joint venturers or partners, when the

project is a general partnership; or (5) trustee and

appropriate beneficiaries, when it is owned by a trust.

B. The following language shall be used:

\"I/we hereby certify that I/we have examined the

accompanying financial statements and supplemental

data of (mortgagor\'s name) and, to the best of my/our

knowledge and belief, the same is complete and

accurate.\"

C. The report also shall include the Employer

Identification Number (EIN) assigned to the project by

the Internal Revenue Service when the project is owned

by a partnership or a corporation or any entity having

an EIN. The EIN must be entered below the partner

or corporate signatures.

3-8. MANAGING AGENT\'S CERTIFICATION.

In instances where there is a management agent for the project,

a certification of the financial statements is required which shall

identify the individual, as well as the company responsible for

management. The Managing Agent\'s Certification should take

the form of the Mortgagor\'s Certification. Note: This

certification is not the Management Certification required for

management of the project as described in HUD Handbook

44381.5, Management Documents, Agents, and Fees.

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3-19 5/92