100% Funded: What Does it Mean?
The percent funded metric is arguably the most misunderstood concept in the lexicon of HOA financial planning. More correctly stated, we are referring to the “percentage of the fully funded reserve fund balance,” which may also be referred to as 100% funded.
The Community Associations Institute (CAI) 2023-Reserve Study Standards (RSS-2023) defines the term Fully Funded Balance, and hence 100% percent funded as follows:
“An indicator against which the actual (or projected) reserve balance can be
compared. The reserve balance that is in direct proportion to the fraction of life “used up” of the current
repair or replacement cost. This number is calculated for each component, and then summed for an
association total.”
The RSS-2023 then provides this formula for calculating the Fully Funded Balance (FFB) for a single funded reserve component:
FFB = Current Cost X Effective Age/Useful Life
Example: For a component with a $10,000 current replacement cost, a 10-year useful life, and effective
age of 4 years, the fully funded balance would be $4,000.
When CIDA consulted two prominent West Coast reserve study software developers to confirm whether the use of the term summed (add together) in the last sentence of the CAI definition was correct, we were told by the first that YES, the use of the term “summed,” was correct.
The second developer told us the calculation for determining the FFB for the reserve fund itself (not a single component) was a multi-step process that involved calculating the FFB for each funded component in a reserve study and then averaging the percent funded level for each funded component in the study.
While this may seem like much to do about nothing the difference between the two methodologies is significant. The fact that two prominent reserve study software developers don’t seem to agree about how the percent funded level of the reserve fund is calculated raises any number of questions worthy of a separate blog post.
From a practical perspective, the percent funded level found in most reserve studies expresses the ratio between the accumulated reserves and the value of the common elements lost to depreciation, and for which reserves are being accumulated to pay for the eventual replacement of those common elements.
The percent funded calculation performed by most reserve study software compares the accumulated reserves at the close of the budget year (Closing Fund Balance) to the accumulated depreciation (through the closing date) of the common elements for which the reserves are being accumulated.
The formula uses the straight-line depreciation method, which assumes all common elements are assigned a useful life that is measured in years, with the asset value losing the same amount each year throughout the service life of the asset.
Hence an asset with a service life of 10 years is assumed to lose 1/10th of its economic value each year.
Note that salvage value is not included in the percent-funded formula development by the CAI, whereas a depreciation schedule prepared for most financial accounting purposes would take into account some amount of remaining economic value at the end of the service life of a depreciable asset.
Most important to your understanding the percent funded principle is that the term 100% funded does NOT mean that the accumulated reserves represent 100% of the money that is required to renew or replace all of the common elements for which the reserves are established by the study.
Instead, the terms 100% funded and fully funded or Fully Funded Balance means the accumulated reserves are equal to the accumulated depreciation of the common elements for which reserves are established by the study, at a specific point in time. Typically this point in time is the end of the Association’s budget year.
The percent funded formula is not a perfect measure of the strength of the Association’s reserve funding status but is a useful and important metric that all buyers and HOA members should understand. CIDAnalytics 2024-©.