Condominium townhouse investment (cti): a case for accounting courses

Condominium Townhouse Investment (CTI): A Case for Accounting Courses Where Cases are not the Emphasis

Condominium Townhouse Investment (CTI): A Case with Instruction Guide for Accounting Courses Where Cases are not the Emphasis

ABSTRACT

This accounting case/instructional aid describes methods and strategies for students new to the case method and an actual case to work on. The objectives of this aid are: 1) to present a detailed approach that a student new to the case method can use for working on cases, independent of the need for instructor aid during class time; 2) to instill into the student that accounting is not always about arriving at a final number, but includes many interesting situations that require a variety of skills from an accountant; and 3) to provide a small real-life actual case for students to work on.

The Condominium Townhouse Investment case (CTI) uses introductory management accounting concepts and analysis to introduce students to the case method of learning. The main concepts reinforced are relevant costs and benefits; and opportunity and sunk costs. The student is not only asked to identify these concepts, but to apply them in a decision on whether to rent out or sell a residential property. This decision is something students would be interested in and can relate to personally, because they themselves will eventually be involved in home ownership decisions. Nevertheless, the case focuses on real estate as an investment. The consequences of the alternative decisions are both monetary and qualitative, that require managerial and financial analysis to evaluate.

Keywords Case method; Sunk and Opportunity costs; Decision making; Actual case

CASE SYNOPSYS

Mr. George Adams is a theoretical economist by education and training, but has always been interested in getting into the real estate market. Currently, he works full time in a management position as a senior financial analyst for a public insurance company which is listed on the NYSE. In December of 2001 he finally decided to take a chance and bought a brand new Condominium Townhouse (CTI) in Mississauga, Ontario, Canada. At that time, only a deposit of

$15,000 was required to be paid to the builder. Since this was the last unit the builder had for sale in this subdivision that backed on to a protected wildlife reserve, George made the non- refundable deposit and signed the “Agreement to Purchase” without consulting his wife.2

The possession date was May 31, 2002, with a probable ownership date of September 2002. The CTI rules state that the unit cannot be rented out or sold until ownership. An occupancy fee of $1,400 per month will be charged between the possession date and ownership date. Only Mr. Adams’ family can occupy the unit during the occupancy period. Mr. Adams already has a residence and his primary occupation is that of an economist. Mr. Adams’ intention for this property was for it to be an investment and not his personal residence.

It is now November 1, 2002. Mr. Adams has taken title of the unit and is now free to rent it out to anyone. Of course, taking title of the unit required taking out a mortgage of

$145,000 and $40,000 as a down payment. Mr. Adams made such a large down payment because a 20% down payment did not require the mortgage to be insured from the Canadian Mortgage and Housing Corporation (CMHC) by his bank. The standard insurance premium can cost up to

2 George and his wife (who works as a nutritionist for a major Toronto hospital) have subsequently argued many times about making such a large purchase without discussing it with her. This is an actual case with only minor changes to real events and numbers.

3.1 % of the mortgage amount, which Mr. Adams has avoided.3 However, the higher down payment would reduce the amount of interest that can be expensed for tax purposes if the CTI is rented out.

After months of frustration waiting for the builder and the municipality to approve the taking of title, he is now pondering what to do next. George realizes that there are property management companies that can rent out and manage the CTI, but he desires to take on the responsibility of a landlord himself.

George has asked you, Jacqueline Books, to advise. Since you are a friend of George, you agreed not to charge him and only take 20 minutes of his time with your ANALYSIS.

Jacqueline is not only a good accountant but she has some experience with residential real estate, which is why George asked for her analysis. She was able to forecast the cash flows from renting the property (Exhibit 1) and from selling it (Exhibit 2).

Amounts omitted from the exhibits are the occupancy costs paid during the months between the possession period and taking of title; the initial deposit; the down payment; and taxes. In Canada, net rental income is fully taxed and only half of the capital gain is taxable. –

3 http://www.cmhc-schl.gc.ca/en/co/moloin/moloin_005.cfm.

Rental Income

20,400

Cash outlays:

Mortgage (interest of 500 and principal of 200 per   month)

8,400

Property Taxes

3,000

Condo fees (include insurance of Unit)

1,200

Maintenance & unexpected expenses

1,000

Property Manager Fees

2,040

Total Expenses

15,640

Expected   Net Cash inflow before income tax

4,760

Sale Proceeds

240,400

Costs to dispose of property:

Mortgage paid back to Bank of Nova Scotia

145,000

Real Estate Commissions

12,000

Total Outflows

157,000

Expected   Net Cash inflow before income tax

83,400

REQUIREMENTS:

Determine the purchase price of the townhouse unit.

1. Identify any combination of four sunk costs and opportunity costs, and give amounts if applicable. Identify if the cost is a sunk cost or an opportunity cost.

2. Take the role of Jacqueline Books and advise your friend George Adams.

a. Identify the issue(s).

b. Provide 2-4 alternatives and an analysis for each of the alternatives. Be sure to use the projections in Exhibits 1 and 2 in your alternatives.

Quantitative analysis can be within the report or as appendices.

c. Qualitative issues need to be addressed.

d. A recommendation is not required but you may include one.

3. What additional information would have been useful in the analysis?

Are taxes important in the decision choices?

Sample Case Marking Key

(marks are unique for each case)

Sample Grading Key

ISSUE(S) OR PROBLEM(S) IDENTIFICATION

· Usually one issue

· Problem identification – usually more than one Max 5

ALTERNATIVES

3 are usually enough Max 4

ANALYSIS OF ALTERNATIVES

Can use S. W. O. T., Advantages (Pros.), Disadvantages (Cons.), etc. to evaluate and analyze each of the above alternatives. Max 8

for each alternative Try not to mentally come up with a recommendation at this phase. Finalizing now could lead you to overlook something. Max 20

for section

RECOMMENDATION(S)

More than one recommendation is expected if there are many complimentary tasks the

company/firm/person(s) need to do.

Max

3

Format and Grammar

Logical Format

Max

3

Appropriateness of Recommendation(s)

Max

1

Clarity

Max

3

Conciseness and Spelling

Max

1

Maximum   marks awarded

35

Notes:

· The marks available are greater than the number of marks for the case in order to allow flexibility of answers for each section.

· When doing the analysis of alternatives, appendices may be appropriate for calculations. Always refer to these appendices within the case solution.

To consider:

Prepare forecasted Income Statements for the next 5 years that includes 1 year where the unit is
not rented. Make sure to list assumptions below statement. [To save space, only use 1 column for
each yr. and not a separate stmt. for each year

Provide the Net Present Value [NPV] and accounting rate of return for each year of the CTI
investment if it is rented for 4 years and sold at the end of 5 years. Show calculations and list all
assumptions you make. Be consistent with your Income Statements above