Metro District Creative Accounting Practices

The old adage that "nothing in life is free" continues to hold true today and, as consumers and homeowners, we would do well to remember this advice as we manage our personal finances. Regardless of whether we have taken an accounting class in school, most of us have gained an understanding of and apply certain basic accounting principles when we manage our personal finances. Whether we are buying a car or buying a house, we understand the cost and impact on our personal finances from making such purchases is greater than the monthly debt payments. Companies also recognize and apply these cost principals when accounting for the cost of products and services sold to their customers.

Despite these widespread practices of identifying and accounting for costs, most Colorado metro districts fail to follow common accounting practices widely adopted and used by the rest of society. Why? Most metro districts are controlled non-independent directors who use the taxation and borrowing powers of such districts for the financial benefit of land development companies that employ or are owned by the directors. Such cost accounting practices reduce the financal gains that can be realized by land development companies that create and control metro districts.

Financing a car purchase
	For most people, one of the rights of passage into adulthood is purchasing their first car. Most people quickly learn that the cost of owning a car is much more than paying monthly principal and interest payments on a car loan. Other reoccurring costs related to owning and operating a car include insurance premiums, registration fees, gas, oil changes, tire changes and other maintenance costs.  So, if the personal budget to own and operate a car is $500/month, most people recognize it would be foolish to purchase a car that must be financed with monthly loan payments of $500.
Financing a home purchase
	The Consumer Financial Protection Bureau (CFPB) is a U.S. government regulatory agency that ensures banks, lenders, and other financial companies treat borrowers fairly. The CFPB has rules stating that the debt-to-income ratio of homebuyers cannot exceed 43% in order to qualify for a “Qualified Mortgage” – a category of loans where the CFPB offers certain protections to both the lenders and the borrowers. The CFPB doesn't want homebuyers’ total debt, including a new mortgage payment, plus car payments, credit card payments, and other monthly obligations, to exceed 43% of the homebuyers’ income.
The cost of owning a home is far more than just principal and interest payments on the mortgage. The cost of owning and maintaining a house may include one or more of the following costs: property taxes, HOA dues, water and sewer service fees, weekly trash pick-up service fees, homeowners insurance, landscape maintenance costs and security service fees. If home buyers can convince a bank that their personal consumption costs are low (e.g. weekly trash pick-up service provided by the city, electric bills are minimal due to solar panels and water bills will be low due to covering the landscapeable areas in the front and back yards with rocks), the bank may be willing to offer a larger loan to the home buyers that exceeds a 43% debt-to-income ratio. However, the bank should verify homeowners' claims to see if the city provides trash pick-up services, solar panels are operational and the HOA would allow rocking in the landscapeable areas.
Cost Allocation Practices - Corporate America
	Nestle and Procter & Gamble - the two largest consumer product manufacturers in the world - apply the principles of cost allocation to determine the true cost of manufacturing each product line. (If you don't know how much it costs to manufacture each product, how can you set a price and know how much profit you are making on the sale of each product?) These companies track the cost of materials and labor related to manufacturing each product line.
These companies also recognize that there are other costs related to manufacturing each product line - "indirect" costs that are shared across multiple product lines. Accountants, attorneys, executive salaries, liability insurance, payroll services, leases on administrative offices - these are all costs that support the manufactuing activities of multiple product lines and such products cannot be manufactured without incurring the indirect costs of these support services. Whether there is one product line or ten product lines, indirect costs remain relatively flat and companies allocate such costs across all product lines.
Cost Allocation Practices - Colorado Metro Districts Controlled by Land Developers
	Developer-controlled metro districts are aware there are costs beyond principal and interest payments related to managing and repaying debt. Common costs incurred by metro districts related to managing the repayment of debt include: (a) legal, underwriting, accounting and other consulting costs related to the issuance of debt;  (b) collection fees paid to the county treasurer to collect property tax assessments from homeowners; (c) service fees paid to bond trustees who manage the cash inflows and outflows from trust accounts used to receive cash from metro districts and disburse cash to bondholders;
(d) operating and reporting compliance costs (e.g. financial statement audit fees, fees paid to professionals to prepare mandatory periodic financial and operational reports to the City and State, etc) that protect metro districts' rights to collect property taxes needed to pay the periodic principal and interest payments due on debt; (e) professional fees related to applying and monitoring accounting controls over the collection of district revenues, repayment of debt and payment of debt management costs; (f) costs related to managing metro districts' annual property tax assessment processes; and (g) premiums on insurance policies that protect metro districts from liability exposure that potentially could arise from performing these activities. Most developer-controlled metro districts recognize (a), (b) and (c) as debt management costs but ignore the remaining costs [(d) through (g)]. Why? To accomplish the goal of maximizing the amount that a district can borrow, the developer-controlled districts underreport debt management costs. Developer-controlled metro districts claim the repayment of districts' debts does not require accountants, attorneys, a functional board of directors or insurance. Regardless of whether such metro districts provide any public services to district residents, developer-controlled districts recognize 0% of such costs as debt management costs allocable to the districts' debt funds.  In theory, home buyers who successfully under report costs could also increase the amount of the mortgage they could receive from the bank. The important difference here between home buyers and developer-controlled metro districts is that home buyers who under report costs and receive a larger loan must personally repay the inflated loan. On the other hand, the repayment of inflated debt issued by developer-controlled metro districts is funded by the current and future taxpayers of such districts (rather than the developers who controlled the metro district boards and received the inflated debt proceeds). So, land developer-controlled metro districts have less incentive to curtail the amount of debt issued by the metro districts.
Debt-Only Metro Districts
Many metro districts that provide no public services to residents and only exist for the sole purpose of assessing and collecting taxes to repay the districts' debt are improperly reporting debt management costs in the general fund and impropertly funding the payment of such costs with property tax revenue generated from a general mill levy assessment. When a district provides no public services to its residents, all costs related to operating the district are debt management costs that should be charged to the district's debt fund and funded from property taxes generated from the debt mill levy. In some cases where districts are highly leveraged with debt and such districts already assesses the maximum debt mill levy, such districts are likely violating statutory and service plan debt mill levy limits by assessing a general mill levy (on top of the maximum debt mill levy) to fund the districts' debt management costs. The purpose of a debt mill levy cap is to protect homeowners from paying property taxes on excessive amounts of debt issued by the metro districts. While some law firms, accounting firms, land developers and bondholders will argue that such debt management costs cannot be funded from the debt mill levy (and would be a violation of the terms of the bond agreement), none of these firms will acknowledge that taxpayers have a constitutional right to vote to reduce a metro district's general mill levy down to zero. By not acknowledging this constitutional right provided to taxpayers, such firms can avoid the obvious question of how does a metro district pay for all of its debt management costs if such costs cannot be funded from the debt mill levy and taxpayers vote the general mill levy down to zero? Failure to properly record all debt management costs in the debt fund is a violation of generally accepted accounting principles. Assessing and collecting property taxes under a general mill levy to fund debt management costs is also incorrect and increases the risk a district is in violation of debt mill levy limits established by statute and/or by the district's service plan. Lastly, such accounting practices raises the risk that taxpayers are being taxed above and beyond the tax limitations placed upon such metro districts.

Some developer-controlled metro districts work with accounting and law firms to adopt financial practices intended to increase the amount of taxpayer dollars that are transferred to the land developers - despite any voter-imposed, city-imposed or statutory-imposed tax limits to which the metro district must comply.

Accounting practices adopted by some developer-controlled metro districts to attempt to circumvent borrowing limits and debt mill levy limits placed on metro districts include the following:

1) Transferring to the debt fund all specific ownership tax revenue intended to fund the general operations and public services provided by a metro district

2) Funding a portion of a district's debt management costs with property tax revenue intended to fund the general operations and public services provided by a metro district

3) Funding inflated service contracts between the land developer and the metro district with property tax revenue intended to fund the general operations and public services provided by a metro district (A common practice when land developers are unsuccessful transferring property taxes from a metro district's debt mill levy to the land developer to repay claims under a BCF Agreement.)

4) Simply ignoring the voter-imposed tax limits and adopting budgets with mill levies that exceed such limits 

Lack of regulatory oversight over metro districts is the primary reason why such practices continue to occur among developer-controlled metro districts. The only practical way to stop such practices is for homeowners to assume control of their metro district boards and hire accounting and law firms that do not promote or support such practices.  

Many developer-controlled metropolitan districts recognize as liabilities claims accrued under various contingent agreements with the primary developers of land within such districts. These contingent agreements are identified by various names including but not limited to (a) funding and reimbursement agreements, (b) infrastructure acquisition agreements and (c) acquisition and reimbursement agreements (collectively “Blank Check Funding" Agreements or BCF Agreements).

The term "Blank Check Funding" Agreements is applied to these types of agreements because such agreements are designed to allow the land developer significant latitude in determining how much the land developer can claim is owed by the metro district to the land developer. In many cases, such agreements are disguised as public infrastructure purchase agreements where metro districts agrees to purchase newly constructed public infrastructure from the land developer (even though land developer are typically under contract with the city to transfer ownership of such public infrastructure to the city). [See "Assets that are not Assets" section on this website for further information on this accounting issue.] There is no construction contract between developer-controlled metro districts and the land developers allowing the metro districts control over the construction project (because the risk exists that homeowners could take control of the metro district and, thus, take control of the construction project).

Land developers argue that such agreements are not "blank check" agreements. The two primary points land developers use to support their position are:

1) BCF Agreements limit a land developer's claims to amounts certified by a consulting firm. For example, if a land developer claims $10 million is owed by the metro district to the land developer under a BCF Agreement but an engineering firm "certifies" that only $7 million of such claims should be paid by the metro district, the metro district must only pay the land developer the "certified" amount of $7 million. What land developers do not disclose is the fact that (a) the consulting firms that certify the land developer claims are usually not independent from the land developers and (b) consulting firms are not required to follow any specific, uniform process to gather or test data supporting the land developers' claims (unlike CPA firms that must comply with numerous audit rules to support their financial statement audit opinions). Regarding point (b), since no specific process exists to "certify" a land developers' claims, the "certifications" issued by these consulting firms are actually professional opinions rather than "certifications" issued in accordance with specific, uniform standards. Further, these professional opinions are issued by consulting firms that are not independent from the land developers hiring these firms to issue such opinions. 

2) BCF Agreements (sometimes) contain ceilings on how much a land developer can claim is owed by the metro district. For example, a BCF Agreement could contain a limit that allows a land developer to claim up to $20 million is owed to the land developer by the metro district. However, if the true cost of the related construction project was, say, $3 million, can land developers really argue that a $20 million capped "reimbursement" agreement should not be characterized as a "blank check" agreement? Homeowners are at a significant disadvantage when evaluating land developers' claims under these BCF Agreements because (a) the metro districts do not control the public infrastructure construction projects (no construction records maintained by the districts), (b) the construction projects are not subject to the public bid process, (c) the "certification" of claims are usually issued by non-independent consulting firms with strong ties to the land developers and (d) the firms providing accounting and legal services to the metro districts are inherently biased because they were involved with assisting in the creation of such BCF Agreements. 

BCF Agreements contain a key provision that any amounts claimed by the land developer as owed by the metro district is “…subject to annual appropriation…” by the metro district’s board. Most developer-controlled metro districts have concluded that including such provisions in BCF Agreements prevents such Agreements from being classified as “multiple-fiscal year direct or indirect debt” as identified in Article 10 Section 20 (“Taxpayer’s Bill of Rights” aka TABOR) of the Colorado Constitution. TABOR prohibits metro districts from issuing multiple-fiscal year direct and indirect debt unless approval is first obtained from the voters. 

The Issues with Recognizing Liabilities Arising From BCF Agreements

Many developer-controlled metro districts attempt to structure BCF Agreements so they do not qualify as multiple-fiscal year direct debt that counts against the metro districts' borrowing limits established by the voters and by the (usually) more restrictive borrowing limits established in the metro districts’ service plans.

The following two issues exist regarding metro districts’ improper recognition of land developer claims accrued under BCF Agreements as liabilities:

Issue 1 – Metro districts that recognize as liabilities contractor claims accrued under BCF Agreements fail to consider whether such liabilities exceed voter and/or city-imposed borrowing limits

In nearly all cases, by recognizing amounts claimed by land developers under BCF Agreements as liabilities, metro districts must also recognize that such liabilites must be repaid over multiple years (i.e. a multiple fiscal year obligation). Why? default have invalidated their claim that such amounts should not be counted against the metro districts' borrowing limits established by the voters and the metro districts' service plans. Land developers' claims accrued under BCF Agreements are usually larger than the metro districts' current available cash flows and larger than available cash flows projected to be generated by the districts in any single future year. Thus, metro districts would need to generate funds (through property tax assessments and/or issuance of long-term debt) across multiple years to pay down land developers' claims accrued under BCF Agreements.  If a liability requires districts to pay off such debt through assessing property taxes for multiple years, such liabilities are multiple fiscal year obligations that (1) cannot exceed the borrowing limits established in the metro districts' service plans and (2) require voter approval per Colorado's constitutional protections of taxpayers provided under the Taxpayer Bill of Rights (TABOR).

Accounts payable, accrued operating costs, current portion of long-term debt – all are examples of liabilities where the entity has the obligation and financial ability to settle such liabilities within a single year. Such liabilities are not multiple fiscal year obligations that fall under the restrictions imposed by TABOR. When land developers' claims accrued under BCF Agreements exceed metro districts' current available financial resources, repayment of such claims requires funding generated from multiple years of tax assessments and/or funding from the proceeds of another multiple-fiscal year obligation.

For most metro districts, the operating and debt mill levies are fixed by statute and/or fixed per the districts’ service plans. In addition, per the bond offering documents of those metro districts that have issued long-term debt, such districts usually project all property tax revenue generated for the next 20+ years will be used to repay the metro districts’ existing debt loads.  Thus, most metro districts with outstanding debt are limited in how much “excess” revenue they can generate to pay off "liabilities" accrued under BCF Agreements. The payoff of such amounts would require multiple years of annual appropriations and/or proceeds generated from issuing multiple-fiscal year debt.

It is also worth noting that borrowing limits established by metro district voters becomes stale 20 years after the election. Thus, metro districts with outstanding debt supported by a mill levy set at the maximum allowed rate will unlikely be able to issue additional debt in the future to repay contractor claims accrued under BCF Agreements unless such districts hold elections requesting its voters to authorize the districts to issue additional debt. 

Although many metro districts are recognizing claims accrued under BCF Agreements as liabilities, such districts fail to include such amounts in the calculation of total multiple-fiscal year debt issued by the district (which is typically disclosed in the debt obligation notes to the districts’ financial statements). If liabilities recognized under BCF Agreements were included in the calculation of total multiple-fiscal year debt, some metro districts would be in violation of the borrowing limits established by either the voters or the metro districts' service plans.

Violations of voter-authorized and/or city-imposed borrowing limits pose significant legal and financial implications, and GAAP requires significant legal contingencies to be disclosed in metro districts’ annual financial statements.

Issue 2 – Metro districts cannot reasonably predict the future discretionary actions of political officials serving on district boards

Per GASB codification section C50.110 (“Liability and Expenditure/Expense Recognition and Measurement”), a liability should be recognized when the following two conditions are met:

1.    Information available before the financial statements are issued indicates that it is probable …a liability had been incurred at the date of the financial statements; and

2.    The amount of the loss can be reasonably estimated.

Per C50.112, “Probable” is defined as “the future event or events are likely to occur.”

How can a metro district conclude future annual appropriations by a its board authorizing payments of claims accrued under a BCF Agreement is probable even though the composition of the metro district board can change (1) at any time due to potential recall elections that could be initiated by residents or (2) at least every two years after the regular biannual board elections? The future discretionary actions of any political official serving at any level of government in any given year is not a predictable event.

BCF Agreements provide metro district boards with sole discretion to decide whether to appropriate funds each year to pay claims accrued under such Agreements. However, if such BCF Agreements did not grant sole discretion to metro district boards to decide whether to appropriate funds to pay claims accrued under these Agreements, then the future payments of amounts accrued under such Agreements would be probable and properly recognized as liabilities (and likely a multiple-fiscal year debt).

Best Efforts Clause: Some BCF Agreements contain clauses that metro districts must exercise “best efforts” in repaying any unpaid, outstanding amounts claimed by the land developer under such Agreements. However, “best efforts” does not negate the rights of metro district boards to exercise their discretion on whether to appropriate any funds each year towards the payment of any amounts claimed by land developers under such Agreements.

Incorrect Comparisons of BCF Agreements to Collateralized Loans

Some firms that have created numerous BCF Agreements for land developers argue that claims accrued under BCF Agreements are comparable to contingent lease agreements entered into by other governmental agencies. Some governments at the state and local levels enter into contingent multi-year agreements with private companies to lease office equipment, vehicles and office space. Although these lease agreements lock in the lease payment for multiple years, the governments add language to the lease agreement to include an "out" clause by stating that such lease agreements are subject to the governments appropriating funds each year in the government's annual budget to pay for such leases. (Hence, such lease agreements are considered "contingent" lease agreements.) Such language in these contingent lease agreements allows such agreements to NOT be classified as multiple-fiscal year debt requiring approval from the taxpayers. However, the total payments due under the life of these contingent lease agreement are recorded as a liability and the related equipment is recorded as an asset on the government's financial statements.

The lessors of such vehicles and equipment are willing to allow such contingent language in the lease contracts because (1) governments are usually leasing a large volume of vehicles, equipment or office space which can be very profitable to the lessor and (2) if governments fail to appropriate funds to pay the lease payments in any given year, the lessor can re-possess the leased equipmment to minimize the financial impact to the lessor from the government terminating the lease contract.

BCF Agreements are not comparable to contingent lease agreements. In all types of lease and loan arrangements, the borrower recognizes both a liability and an asset (e.g. cash received in exchange for entering into a loan agreement; a house is received in exchange for entering into a mortgage). In a BCF Agreement, the metro districts receive no assets from the land developers since all constructed public infrastructure is transferred directly from the land developers to the cities. Also, in BCF Agreements, there is no collateral which the land developers can reclaim from the metro districts if the districts do not appropriate any funds to pay the land developers' claims. In a free market world where independent parties transact business, there are no examples where a lender enters into an uncollateralized loan with a borrower and allows the borrower sole discretion on determining if and when the borrower will repay the loan. This is a strong indicator that BCF Agreements are sham agreements.

Why are developer-controlled metro districts interested in reporting newly constructed public infrastructure as assets of the metro district?

First, developer-controlled metro districts want to demonstrate that the proceeds from government-issued bonds were used to purchase public infrastructure (as opposed to funding the general operations of the private land development companies). If the IRS determines the bonds were issued to fund private land development companies, the bonds issued by such metro districts could lose their classification as government bonds - meaning, the interest paid on these bonds would no longer be exempt from Federal and state taxation for the bondholders. If metro districts desire to report (even if only temporarily) the newly constructed public infrastructure as assets owned by the metro districts, the metro districts (rather than the land developers) must contract with the cities to construct and transfer ownership of the public infrastructure from the metro districts to the cities. However, developer-controlled metro districts rarely contract with cities to construct public infrastructure because, if the metro districts assume the responsibility to construct public infrastructure, the metro districts would be required to open the construction work to the public bid process and manage the construction project (which jepordizes land development companies desires to control the public construction projects and establish pricing in a non-competitive, no-bid environment).

Second, reporting the newly constructed public infrastructure as assets of the metro district (even if only temporarily) gives the appearance that the metro district controlled the construction of such public infrastructure even though quite the opposite is true. The agreements to construct public infrastructure within metro districts is usually between land developers and the cities. Thus, the land developers (rather than the metro districts) control the public construction projects - including the costs and pricing of such projects. BCF agreements typically require the metro districts to purchase completed public infrastructure from the land developers (even though the developers are under contract to transfer ownership of the public infrastructure to the cities) and are intended to be treated as purchase contracts - not construction contracts. Public construction contracts are subject to various statutory compliance requirements including the public bid process. BCF contracts that attempt to structure public construction projects as asset purchase agreements rather than construction contracts are a sham. Metro Districts can evaluate multiple contractors and manufacturers before purchasing vehicles, park equipment, office equipment, etc. However, metro districts do not have the option to shop around the purchase of roads, sewer lines, storm drains, landscaping, etc already constructed by the land developer within the boundaries of the District. Hence, this is the reason why metro districts - and all governmental entities generally - must control the construction of public infrastructure within the boundaries of such districts.

Why is correcting this improper accounting for public infrastructure important for homeowners? Proper accounting for newly constructed public infrastructure exposes the core problem to which homeowners are exposed - i.e. a heightened risk of over paying (through property tax assessments) for the construction of public infrastructure, which construction pricing was set by the land developers in non-competitive, no-bid environments.

Colorado Office of the State Auditor (OSA)

Colorado statutes require all metro districts to file their annual financial statements with OSA. OSA reviews these annual financial statement filings.However, OSA does not have the statutory authority to perform audits on the financial statements of metro districts.

Unfortunately, OSA allows metro districts wide latitude in accounting for assets and liabilities. For example, developer-controlled metro districts (which directors report significant conflicts of interest serving on such boards) record claims accrued under Blank Check Funding (BCF) Agreements as liabilities - but not muti-fiscal year obligations that count against the metro districts' borrowing limits. A growing number of metro districts where non-independent directors are removed and replaced with independent directors are NOT recognizing claims accrued under BCF Agreements as liabilities. OSA has allowed both acounting approaches for years (even though U.S. Generally Accepted Accounting Principles does not allow such lattitude) and refuses to take an official position on this significant accounting matter applicable to over 2,000 Colorado metro districts (which affects the property taxes assessed on hundreds of thousands of Colorado homeowners).

The State Auditor is appointed every 5 years by the Legislative Branch of the State of Colorado.