February 02, 2011

Reconstructed Church Financial Statements for Bank Financing

Question:

A church owns real estate and has no mortgage. There are no records indicating the original cost of land or improvements (circa 1955). The church now plans to buy land and to build elsewhere. The bank wants financial statements as the church seeks a loan. How does the the treasurer value assets for which s/he has no costs? This includes not only the building and land, but most of the furnishings.

Answer:

The answer depends, in part, on the requirements placed on the church by the bank. If it insists on financial statements in accordance with Generally Accepted Accounting Principles (GAAP), then the treasurer has a lot of work ahead for him or her, and the bank is going to wait a while to receive its statements. Further, professional assistance may be required.

It might be that switching to GAAP reporting is long overdue for many large churches, but most small churches use non-GAAP cash or modified cash methods which work well for their congregations.

GAAP will require the church to inventory its assets (land, building, building additions, furnishings, and equipment), determine as best it can the original purchase dates and costs (not market value), and depreciate the assets using standard depreciation rules.

Of course, a 55 year-old building would likely be fully depreciated by 2011 and perhaps reflect a zero net book value on the Balance Sheet. Also, the original land, recorded at cost, will not reflect its current value. In the end, if the bank plans to use the old property as collateral or if the church plans to sell it to partially fund the new facilities, then appraised value may be the only relevant amount, not what the GAAP financial statements disclose.

Collateral is not the only determinant of the bank's willingness to grant credit to the church. Annual financial statements from the church that can demonstrate consistent cash flows sufficient to support the new debt will be very important. A strong General Fund Balance on the Balance Sheet generated by substantial cash balances (or other liquid assets) in excess of accounts payable and other non-mortgage debt is necessary. Further, evidence from the annual Profit and Loss statements of the church that its revenues consistently exceed its expenses, enough to absorb the additional new demands on the budget due to the mortgage payments, must be demonstrated.

It may very well be that the production of GAAP financial statements is less important to the bank than everything else I've discussed above. In this case, the typical church's current non-GAAP financial statements may be satisfactory. Church leaders should inquire of bank personnel whether the inventorying of assets and many other issues related to GAAP financial reporting is required.

Further, church leaders should carefully read any subsequent loan agreements with the bank to be fully informed of the bank's financial reporting requirements after the loan is secured.

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