‌Broker COURSE 2: BUSINESS MANAGEMENT – ELEARNING

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COURSE 2: BUSINESS MANAGEMENT – ELEARNING

Exam Study Guide

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Module 1: Building and Maintaining General Records for a Brokerage Disclaimer: This is a reference document which contains pages from the Accessible eLearning module. You should complete the eLearning module to proceed to the next step. Please note that the accessible module on the LMS only contains the interactive pages and you need to go through the content of this document thoroughly to attempt the interactive activities in the module. Please use Adobe Acrobat Reader (Recommended version 9 or above) to navigate through this PDF. Real Estate Broker Program © 2021 Real Estate Council of Ontario. All Rights Reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or in any means – by electronic, mechanical, photocopying, recording or otherwise without prior written permission, except for the personal use of the Real Estate Broker Program learner.

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Module 1: Building and Maintaining General Records for a Brokerage As a broker of record, you will ultimately be responsible for establishing the general record management system for your brokerage and ensuring that it complies with REBBA, as well as other federal and provincial legislation. You will also need to ensure that these responsibilities are met if you are acquiring an existing brokerage. The efficiency of your brokerage operations depends on how records are organized, managed, and retained. In this module, you will learn about the various types of records that a brokerage is required to retain for specified time periods. In addition, you will be introduced to the responsibilities that you, as a broker of record, will have towards managing records in your brokerage to comply with REBBA. This module also explains further responsibilities that you will have as they relate to various provincial and federal legislation regarding record management. To check your understanding of this module, you must complete all the activities in the online module. While navigating through the online module, click the Legislation button to view laws and regulations related to this module. The contents of the thumbnails Accessible PDF.

and References from the module are added to support your learning throughout this

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Menu: Building and Maintaining General Records for a Brokerage

Number of Lessons

Lesson Number

5 Lessons

Lesson Name

Lesson 1

Record Management

Lesson 2

Record Retention Requirements

Lesson 3

Record Storage System

Lesson 4

Summary Practice Activities Module Summary

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Lesson 1 | Page 1 of 15

Lesson 1: Record Management

This lesson provides an overview of the different types of records used in a brokerage. It also explains the brokerage's responsibilities for storing and maintaining various types of records in compliance with REBBA and other provincial and federal legislation.

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Lesson 1 | Page 2 of 15

As a broker of record, you will need to define a system to ensure all general records and documents created during various brokerage transactions are prepared, filed, and stored in accordance with REBBA and other legislation. These responsibilities must also be met in cases where you take over as broker of record at an existing brokerage. You must be aware of the types of records that a brokerage must retain and the responsibilities that you must fulfill with respect to record management to ensure compliance. Upon completion of this lesson, you will be able to: • Differentiate between trade-related records and business records • Describe the brokerage responsibilities for record management under REBBA • Identify the employee records that a brokerage needs to maintain

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Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

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Lesson 1 | Page 3 of 15

A brokerage is required to retain and maintain records, regardless if they are paper-based or electronic, in order to comply with REBBA and other provincial and federal legislation. As a broker of record, you must adequately supervise your brokers, salespersons, and administrative staff as they perform their duties. This will help you ensure that your brokerage operates in accordance with REBBA. You should also recognize that record management requires a detailed understanding of responsibilities, together with an appreciation of differences when dealing with trade-related records, as distinct from general business records. Trade-related records are documents created during direct and indirect trade-related activities. General business records refer to any document involving the operation of the brokerage.

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Lesson 1 | Page 4 of 15

What is a Record? REBBA does not define the word “record” but refers to original records made in the course of trading in real estate. Trading, or more specifically the word “trade,” encompasses a wide range of activities and associated documents. As per REBBA, the word “trade” refers to the disposition or acquisition of or transaction in real estate by sale, purchase, agreement for purchase and sale, exchange, option, lease, rental, or otherwise; and any offer or attempt to list real estate for the purpose of such a disposition, acquisition or transaction, and any act, advertisement, conduct or negotiation, directly or indirectly, in furtherance of any disposition, acquisition, transaction, offer or attempt, and the verb “trade” has a corresponding meaning. All documents that are created as a result of trading activities at a brokerage are referred to as records.

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As mentioned earlier, records can be categorized into trade-related records and general business records.

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Lesson 1 | Page 5 of 15

Trade-related Records All documents (electronic or paper-based) created during direct and indirect trade-related activities are called traderelated records. Trade-related records must be maintained by the brokerage to comply with REBBA. The following list specifies the various types of trade-related records and the related forms and documents: 1. Agreements of purchase and sale: The related forms and documents are receipts for deposits, amendments, schedules, counter offers, waivers, fulfillments of conditions, terminations, and mutual releases 2. Agreements to lease: The related forms and documents are amendments and rental applications, first rights of refusal, exchanges, and options 3. Seller and buyer representation agreements: The related forms and documents are amendments, suspensions, assignments, cancellations, schedules, comparative market analyses, and mortgage verifications 4. Customer service agreements: Amendments are the related document for this trade-related record 5. Disclosure documents: The related forms and documents are information before agreement, confirmation of co-operation and representation, multiple representation, personal acquisition of real estate – broker or salesperson’s statement as buyer (or seller) and disclosure of benefits or payment to the broker or salesperson 6. Seller property information statements: Supporting documents and schedules are the related document for this trade-related record 7. Trade record sheets: All supporting records related to trade record sheets are the related documents in this case 8. FINTRAC documents: The related forms and documents are risk assessment records, personal and corporate identification information records, consent agreements, and receipt of funds records 9. Real estate trust account: All supporting records including the real estate trust ledger and monthly trust account reconciliations are the related documents in this case 10. Commission trust account (if applicable): All supporting records are the related documents in this case

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11. Supporting documents and miscellaneous communication relating to the trading of real estate: The related forms and documents are all correspondence, memos, emails, notes, client presentations, faxes, registry and land title searches and documents, surveys, powers of attorney, and receipts for deposits

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Lesson 1 | Page 6 of 15

General Business Records A general business record refers to any paper-based or electronic document involving the operation of the brokerage. As per REBBA, a brokerage is obligated to maintain general business records that are required for the operation of the brokerage’s business of trading in real estate. The following list specifies the types of general business records that must be maintained in a brokerage and the related forms and documents: 1. Employment agreements: The related forms and documents are broker or salesperson employment agreements, independent contractor agreements, and administrative employee agreements 2. Other employee records: The related forms and documents are employee information, taxation and source deduction information, for example, Canada Pension Plan (CPP) and Employment Insurance (EI), information required pursuant to the Employment Standards Act, and Canada Revenue Agency (CRA) forms and support documents 3. Employee-specific records: The related forms and documents are certificates of registration and related forms 4. Financial records: The related forms and documents are deposit books, cheques and/or stubs, bank statements and monthly reconciliations, invoices, receipts, cash receipt and disbursement journals, payroll journal, the general ledger, and financial statements 5. Brokerage/corporate records: The related forms and documents are brokerage registration documents, business name registration, articles of incorporation, bylaws, share registers, shareholder agreements, and minute books 6. Other general business records: The related forms and documents are insurance policies, equipment and related inventories, correspondence and contracts and leases, lease of office space, any employee benefit program, and lists of office supplies, signs, and open house signs

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Lesson 1 | Page 7 of 15

Many different types of files and records are stored in a brokerage. The broker of record has selected some records that they will use to train the newly hired administrative staff members on how to categorize them appropriately. Determine which of the following items must be categorized under trade-related records. There are five options. There are multiple correct answers. 1

Certificates of registration

2

Representation agreements

3

Individual identification form

4

Disclosure documents

5

Employment contracts

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Lesson 1 | Page 8 of 15

REBBA specifies various requirements for record management, record storage, and record retention for brokerages. As a broker of record, you will be responsible for ensuring that your brokerage operates in accordance with these requirements.

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Lesson 1 | Page 9 of 15

Broker of Record’s Responsibilities Regarding Record Management As mentioned earlier, REBBA, as well as other provincial and federal legislation, specifies requirements for record management. A broker of record, with the assistance of third-party service providers, should create brokerage policies that support these requirements. Brokerage procedures should then be designed to support the brokerage policies that in turn support the legislative requirements.

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A broker of record is responsible for monitoring the activities of the broker and salesperson as well as the administrative staff functions. They are also responsible for taking corrective action as needed for non-compliance as it relates to record management and retention requirements for a brokerage. In addition, they are responsible for addressing consumer complaints and providing the necessary documentation during a RECO inspection. To be able to fulfill these responsibilities, a broker of record is directly involved in: • Creation of an initial plan and implementation of brokerage record organization • Creation and approval of policies and procedures related to record management • Development of an effective record storage system • Coordination of internal record access (that is, authority and security levels) • Compliance with REBBA and other statutory provisions concerning record management and storage, and notification to RECO of registrant changes within prescribed time periods

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Lesson 1 | Page 10 of 15

Record Management Requirements: Trade-related Records and General Business Records REBBA sets out various record management requirements for trade-related records and general business records. It is important for a broker of record to understand these requirements so that they can ensure their brokerage operates in compliance. The following three sections contain information on the requirements.

Agreements with sellers and buyers (trade-related records) If a broker or a salesperson enters into a written agreement with a seller or buyer for the purpose of trading in real estate (for example, a seller representation agreement or customer service agreement), the broker or salesperson must give the seller or buyer a copy of the agreement and deliver a copy to the brokerage at the earliest practicable opportunity.

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Trade documents (trade-related records) Where a broker or a salesperson has secured the acceptance of an offer to sell, exchange, lease, or rent real estate: • They must ensure that all parties to the agreement receive a copy of the agreement at the earliest practicable opportunity. • They must also confirm that a copy of the agreement and all related correspondence and documentation is delivered, at the earliest practicable opportunity, to their employing brokerage. • A brokerage that represents a client or provides services to a customer who has entered into an agreement to convey an interest in real estate must keep a copy of the agreement, and all related correspondence and documentation, in the brokerage’s records. • Where a brokerage has not secured acceptance of an offer and has placed a deposit in trust, it must also keep on file one signed (buyer) copy of the offer. A co-operating brokerage must follow the same procedure.

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Certificates of registration (general business records) A brokerage receives a certificate of registration for the main office as well as for each branch office, if any. The original certificate must be prominently displayed within the business premises to which the certificate relates. A copy of the certificate(s) is kept at the main office of the brokerage and, upon request of any person, must be shown. Proper management of certificates of registration (originals and duplicates) is essential for any brokerage. REBBA requires that brokers and salespersons carry their certificates of registration and show them to any person upon request. They may carry the MyRECO Certificate electronic version on their smartphones. Brokerages are required to keep the duplicate original certificates of registration issued to brokers and salespersons and to show the certificate to any person upon request. If RECO suspends, revokes, cancels, or refuses to renew the registration of a brokerage, broker, or salesperson, the brokerage must immediately return the duplicate original certificate of registration to RECO. The brokerage must also return the duplicate original certificate of registration when a broker or a salesperson ceases to be employed by the brokerage.

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Lesson 1 | Page 11 of 15

Record Retention Requirements as per REBBA A brokerage’s record retention policies must focus and adhere to REBBA requirements, along with other selected statutes that impact brokerage activities. Beyond those minimum statutory requirements, prudence is the best policy. You will learn about the brokerage record retention requirements as per other provincial and federal legislation in the next lesson. The following three sections contain information on record retention requirements as set out in REBBA.

Retention time for brokerage records REBBA requires that a brokerage must retain all documents and records for a minimum of six years after the documents or records came into existence. Documents and records must be retained beyond that time limit if directed by RECO and in the case of outstanding matters, such as disciplinary proceedings and litigation.

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Storage location of brokerage records A brokerage that does not conduct business from a branch office must keep all original records made in the course of trading in real estate at the location that RECO specifies. If RECO has not specified a location, all original records must be kept at the brokerage’s main office. A brokerage that conducts business from a branch office must, at the earliest practicable opportunity, transfer all original records made in the course of trading in real estate from the branch office to the location that RECO specifies. If RECO has not specified a location, all original records must be transferred to the brokerage’s main office.

Retention requirements for offers that are not accepted Brokerages are required to have procedures in place to ensure that a copy of all offers that the brokerage receives on behalf of a seller are retained. This requirement extends the obligation to retain accepted offers in their entirety to include all unsuccessful offers. Unsuccessful offers must be kept for at least one year after the date the brokerage received the written offer and may be stored electronically or as a hard copy. For a buyer’s offer that is unsuccessful, the seller’s brokerage may retain an equivalent summary document for each offer rather than retaining a copy of that offer in its entirety. However, a summary document may only be used if the unsuccessful offer is made through a brokerage on behalf of that buyer (that

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is, the buyer is either a client or a customer of a brokerage). For more information on summary documents, you can access RECO’s ‘Bill 55: Changes for handling of offers’ fact sheet.

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Lesson 1 | Page 12 of 15

Brokerages must also retain general business records to meet other legislative requirements, in addition to REBBA requirements. Employment agreements and employee records are examples of general business records that brokerages are required to maintain for a specified period of time. As a broker of record, you must ensure that brokerage files are maintained for brokers, salespersons, and administrative staff in order to comply with various provincial and federal legislation, such as the Income Tax Act and the Employment Standards Act.

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Lesson 1 | Page 13 of 15

Other General Business Records that a Brokerage Must Maintain Every brokerage is required to maintain and retain all general business records, such as employee records, to comply with various federal and provincial legislation. A broker of record can use these records to resolve employment issues and disputes that may sometimes occur between a brokerage and an individual working for the brokerage. For example, a potential dispute could involve the commission paid out to the salesperson. In such cases, employee records could be used to validate the agreed upon arrangement as a means of resolving the dispute. The following three sections contain information on the various general business records that a brokerage must maintain.

Employee file documents The brokerage must maintain employee files for every salaried person, broker, and salesperson. Employee file documents vary but typically include the application form, personal profile information, start date, any written reviews, employment agreement (employee or independent contractor), record of remuneration levels and dates (salaried personnel), a TD1 form (salaried individuals) or a TD1X (employed brokers and salespersons), and any relevant letters or other communication relating to the individual.

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Payroll journals and commission distribution records Accurate and efficient payroll calculations rely on detailed employee payroll information for administrative staff and employee brokers or salespersons, and commission distribution records for independent contractor brokers or salespersons. The brokerage must maintain up-to-date records with separate sheets in the payroll journal for every employee (staff), employee broker or salesperson, and independent contractor. Entries for wages (that is, salaried personnel) must be in compliance with the Employment Standards Act and must itemize the period covered, amount of gross pay, statutory deductions (CPP, EI, and income tax), other deductions, total deductions, net pay, date of payment, and cheque number. Employed broker and salesperson accounts would typically include commissions payable, source deductions (for example, CPP, EI, and income tax), miscellaneous deductions (for example, special arrangements with particular individuals, such as donations for a cause), and various expenses (if paid by specific individuals). Independent contractors are not technically grouped under payroll, but rather have a commission distribution account. Payroll and commission distribution records must be maintained for a minimum of six years from the end of the last taxation year to which the records and books of account relate to comply with the Income Tax Act. Permission to destroy documents prior to the six-year period must be obtained from the CRA.

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Record of employment The record of employment (ROE) is a form every employer must complete for every employee who stops working in insurable employment. Generally, an ROE must be issued within five calendar days, subject to selected exceptions, after the later of the interruption of earnings itself or the date the employer becomes aware of the interruption. Employment information contained on the ROE is used to decide if a person qualifies for employment insurance benefits, the benefit rate, and the length of eligibility.

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Lesson 1 | Page 14 of 15

A broker of record is conducting a training session for the administrative staff on the maintenance of general business records according to various legislation. Which statements regarding general business records are correct? There are four options. There are multiple correct answers.

1

Brokerages are required to maintain payroll journals to comply with the Income Tax Act and the Employment Standards Act.

2

Brokerages are required to maintain commission distribution records to comply with the Income Tax Act and the Employment Standards Act.

3

Brokerages are required to maintain ROEs, following the interruption of earnings, to comply with REBBA.

4

Brokerages are required to maintain payroll journals for independent contractors to comply with the Income Tax Act and the Employment Standards Act.

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Lesson 1 | Page 15 of 15

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Differentiate between trade-related records and business records • Describe the brokerage responsibilities for record management under REBBA • Identify the employee records that a brokerage needs to maintain There are three sections on this page with a summary of the key topics that were discussed in this lesson.

Types of records

All documents that are created as a result of trading activities at a brokerage are referred to as records. Records are categorized into: • Trade-related records: Trade-related documents are all documents (electronic or paper based) that are created during direct and indirect traderelated activities. • General business records: General business records refer to any document (electronic or paper based) involving the operation of the brokerage.

Record retention requirements as per REBBA

REBBA sets out various record management and retention requirements for brokerages. A brokerage must retain all documents and records as defined under the Act for a period of not less than six years. Brokerages are required to have procedures in place to ensure that a copy of all offers that the brokerage receives on behalf of a seller are retained. Unsuccessful offers must be kept for at least one year after the date the brokerage received the written offer and may be stored electronically or as a hard copy. For a buyer’s offer that is unsuccessful, the seller’s brokerage may retain an equivalent summary document for each offer rather than retaining a copy of that offer in its entirety.

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It is important to store all records at the brokerage’s main office, unless otherwise specified by RECO.

Other general business records that a brokerage needs to maintain

A brokerage must retain all employee records to comply with various legislation. A broker of record must verify that certificates of registration are managed in accordance with REBBA. The broker of record must also make sure that the record of employment is completed for every employee who stops working in insurable employment. Employee records are maintained on the basis of various legislation, such as the Employment Standards Act and the Income Tax Act.

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Lesson 2 | Page 1 of 16

Lesson 2: Record Retention Requirements

This lesson identifies the record retention requirements for brokerages as per provincial and federal legislation.

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Lesson 2 | Page 2 of 16

A brokerage should have processes in place to organize, keep, and maintain records in order to comply with various legislation. As a broker of record, it is important for you to develop and ensure that processes are in place to address legislative requirements. This will help provide better consumer protection and consumer experience as well as help avoid any litigation and/or fines. You will learn more about processes for effective file management to improve the overall function of your brokerage workflow and align with legislative requirements in the next lesson. As a broker of record, you would also need to establish training for the brokers and salespersons regarding the brokerage’s strategies to comply with various legislation. You will learn more about this in a later course. Upon completion of this lesson, you will be able to: • Identify the brokerage record retention requirements as per provincial and federal legislation Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

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Lesson 2 | Page 3 of 16

As a broker of record, it is important for you to understand your brokerage’s obligations to comply with the record retention requirements set out by various provincial and federal legislation other than REBBA. These requirements are applicable for both paper-based and electronic records. However, these are only minimum statutory record retention requirements. The best strategy is to retain records for as long as possible beyond these minimum requirements. While REBBA and the Income Tax Act require a retention of a minimum of six years, the needs of the brokerage may well extend beyond that time period. For example, while the Limitations Act provides that, for most causes of legal

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action, a two-year limitation applies from the day that the claim was discovered, the ultimate limitation period is 15 years. This fact should be carefully considered when establishing a brokerage record retention policy.

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Lesson 2 | Page 4 of 16

Business Corporations Act (Ontario) If a brokerage ownership type is a corporation, the brokerage falls under special requirements as set out in the Business Corporations Act. Corporate documents are viewed as permanent records and include: • Articles of incorporation

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• Minutes of meeting • Share registers • General ledger • Corporate bylaws • Shareholder agreements In Ontario, the Business Corporations Act requires that such records must be retained for five years after dissolution.

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Lesson 2 | Page 5 of 16

Income Tax Act Record retention provisions set out in the Income Tax Act generally provide that taxpayers must retain sufficient records and books of account until the expiration of six years from the end of the last taxation year to which the

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records and books of account relate. If the brokerage has filed a tax objection or appealed a CRA decision, the applicable records should be retained until the matter is settled or the time limit involving any further appeal has expired. As a general guideline, sufficient records and books of account for a real estate brokerage include but are not limited to: • Ledgers • Journals • Real estate trust account(s) • Real estate trust ledger • Commission trust account • General account • Trade record sheets • Tax remittance and reporting forms • Bank statements and reconciliations • Cancelled cheques • Deposit slips • Invoices and receipts • Salary, wage, and commission distribution records • Operating expenses • Tax-related correspondence (including emails) • Credit card purchases and statements • Spreadsheets • Appointment books • Computer software files • Any other documentation relating to business operations and income and expenses

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Brokers of record are advised to seek assistance from third-party service providers for specific guidance regarding records and books of accounts. Brokers of record can visit the Government of Canada web site for additional information regarding record retention requirements as per the Income Tax Act.

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Lesson 2 | Page 6 of 16

FINTRAC Brokerages have obligations to comply with the Financial Transactions and Reports Analysis Centre (FINTRAC) when addressing record retention matters. FINTRAC has prepared guidelines to assist brokerages in ongoing administration of their compliance regime, as well as interpretation notices that focus on technical interpretations regarding certain provisions contained in the Proceeds of Crime (Money Laundering) and Terrorist Financing Act and its

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associated regulations. Real estate brokerages are responsible for continuously developing, applying, and updating written compliance policies, as well as record retention requirements, in accordance with FINTRAC. Brokerages are required to retain records and make them available for any FINTRAC request for a period of five years from the last date of business activity with the party. These records include: • Individual Identification Information Record • Corporation/Entity Identification Information Record • Identification Mandatory/Agent Agreement • Receipt of Funds Record • Risk Assessment Form • Large Cash Transaction Report • Large Virtual Currency Transaction Report • Suspicious Transaction Report • Terrorist Property Report Brokerages are not required to keep a power of attorney or a will for FINTRAC purposes. However, brokerages should keep in mind that if a brokerage retains these documents, FINTRAC may ask for them to facilitate an examination of the brokerage. You will learn more about FINTRAC in a later course. Brokers of record can visit the Financial Transactions and Reports Analysis Centre of Canada web site for additional information regarding the record retention requirements as per FINTRAC.

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Lesson 2 | Page 7 of 16

Employment Standards Act: Employee Records In order to comply with the Employment Standards Act, brokerages have obligations for record retention. Employers are required to keep written records for each person hired and to ensure that these records are readily available for inspection. The following list specifies the various employee records and their retention requirements: 1. The retention requirements for the employee’s name, address, and starting date of employment is for three years after the employee stopped working for the brokerage. 2. The retention requirements for the employee’s date of birth if the employee is a student under 18 is for three years after their eighteenth birthday or for three years after the employee stopped working for the brokerage, whichever happens first. 3. The retention requirements for the hours worked by the employee each day and each week is for three years after the last day or week of work, and in case of salaried employees, only excess hours over and above regular workday and work week need to be recorded. 4. The retention requirements for the information contained in an employee’s wage statement is for three years after the information was given to the employee. 5. The retention requirements for the documents involving an employee’s pregnancy, parental, family medical, organ donation, personal emergency, declared emergency, or reservist leave is for three years after the day the leave expired. Remember that these are minimum periods for record retention for employment standards enforcement only. REBBA and the Income Tax Act provisions extend the retention requirement to six years and reasonable caution suggests even longer. Brokers of record can visit the Ministry of Labour, Training and Skills Development web site for additional information regarding the record retention requirements as per the Employment Standards Act.

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Lesson 2 | Page 8 of 16

Electronic Commerce Act Brokerages have obligations when working electronically to comply with the Electronic Commerce Act. Employees who choose a technology for electronic signatures must ensure that the technology meets specific criteria, including: • Authentication: The ability to confirm the signature is from the person from whom it is supposed to be • Unauthorized use: The signature must be permanent and tamper-proof to prevent fraudulent use of the signature

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All parties to an agreement must consent to the use of electronic signatures. While consent can be implied, it is recommended that the consent be in writing to avoid future disputes. If any party to an agreement insists on using written signatures, brokers and salespersons must oblige. Mortgage providers and financial institutions may also insist on paper documents with written signatures. Due to the critical nature of an agreement of purchase and sale, brokers of record should ensure that extra caution is taken when using electronic signatures because of specific procedures and audit trails that must take place. An audit trail is a security-relevant chronological record that provides documentary evidence of the sequence of activities that have affected a specific transaction at any time. It supports the evidence of authentication and unauthorized use. Working electronically does not change any obligation brokers and salespersons have under REBBA. Brokerages must ensure that records are stored in an unalterable scanned format (such as a non-editable PDF format) for the required minimum six-year period, so long as these records can be easily reproduced for inspection by RECO. If both parties agree to sign agreements electronically, a clause should be added to the agreements that states that both parties consent and agree to the use of electronic signatures pursuant to the Electronic Commerce Act, as amended, with respect to this agreement and with any other documents related to the transaction.

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Lesson 2 | Page 9 of 16

Personal Information Protection and Electronic Documents Act (PIPEDA) In order to comply with the Personal Information Protection and Electronic Documents Act (PIPEDA), brokerages have obligations for record retention. Personal information collected pursuant to PIPEDA should be kept only as long as necessary to satisfy the purposes for which it was collected. Regular reviews of personal information on file should be conducted to determine whether such information is still required. A broker of record must ensure that disposal methods do not cause improper access. Personal information, which forms part of trade-related documents, would fall under REBBA time requirements. A broker of record must ensure that the brokers, salespersons, and administrative staff understand the brokerage policy and procedures that must be followed with a consumer’s personal information. The brokerage is responsible for collection, use, safeguarding, and proper disposal of the information when no longer needed. Any compromise to a person’s confidential information must be brought to the consumer’s attention at the earliest practical opportunity so that mitigation steps can be taken to prevent any further harm. When developing policies to protect consumers’ personal information and to comply with the federal law, brokers of record can visit the Government of Canada web site for more information. You will learn more about PIPEDA in a later course.

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Lesson 2 | Page 10 of 16

Consent PIPEDA requires that consent be obtained from individuals to collect, store, use, and disclose their personal information in the course of a brokerage’s commercial activity. Examples of personal information include credit reports that would be required: • For a tenant when a landlord is reviewing a tenant’s application • For a buyer when a seller is reviewing the buyer’s offer and the buyer is requesting a seller take-back mortgage It is important to note that personal information does not include the name, title, business address, or business telephone number of an employee of an organization. • The safest and most reliable way to obtain consent is directly in writing, signed by the individual whose personal information is to be collected, used, or disclosed. The signed consent form can be provided as evidence, if required. • It is also possible to obtain implied consent by providing a notice with an "opt out" opportunity. Consent will only be valid if a reasonable person would consider the purposes for which the information is being collected, used, or disclosed as appropriate regarding the circumstances. Invalid consent is inappropriate information collection, use, or disclosure in circumstances that include: • Purposes that would be otherwise unlawful • Profiling or categorization that leads to unfair, unethical, or discriminatory treatment contrary to human rights laws • Purposes that are known or likely to cause significant harm to the individual • Publication of personal information with the intended purpose of charging individuals for its removal In other words, no one can consent to their personal information being used for these purposes.

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Brokers of record can visit the Office of the Privacy Commissioner of Canada web site for additional information regarding record retention requirements as per PIPEDA.

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Lesson 2 | Page 11 of 16

Digital Privacy Act The Digital Privacy Act has made a number of changes to PIPEDA. A broker of record should be aware of these changes, as they may impact how they collect, store, use, and disclose personal information. Of particular note are changes that: • Require a brokerage to maintain a record of all privacy breaches involving personal information under their control • Require privacy breach notifications where a breach creates a real risk of significant harm to an individual (In such cases, brokerages must report the breach to the affected individual, the Privacy Commissioner of Canada, and other government institutions where the government institution could mitigate the harm) • Provide the Privacy Commissioner of Canada with a new power to enter into compliance agreements to ensure compliance with PIPEDA, where the Commissioner believes, on reasonable grounds, that the brokerage has committed, is about to commit, or is likely to commit a breach of PIPEDA It is important to note that offences to the Digital Privacy Act are punishable by fines of up to $100,000. Brokers of record can visit the Office of the Privacy Commissioner of Canada web site for additional information regarding the record retention requirements as per the Digital Privacy Act.

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Lesson 2 | Page 12 of 16

Privacy Breach Reporting Privacy breaches under PIPEDA must be reported by the brokerage to the Privacy Commissioner and to individuals affected by a breach where it is reasonable to believe that the breach creates a real risk of significant harm to an individual. Real risk of significant harm includes factors such as: • The sensitivity of the personal information involved in the breach • The probability that the personal information has been, is being, or will be misused In the event of a privacy breach, your brokerage is also obligated to notify other brokerage(s) or government institutions of the breach if you believe that the other brokerage(s) or government institutions may be able to reduce the risk of harm or mitigate the harm resulting from the breach. Brokers of record can visit the Office of the Privacy Commissioner of Canada web site for additional information regarding privacy breach reporting.

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Lesson 2 | Page 13 of 16

Consequences of Breaching PIPEDA Failure to comply with PIPEDA could have serious consequences. It could result in your brokerage, along with the brokers and the salespersons, being subject to an investigation by the Office of the Privacy Commissioner of Canada, who has broad powers to investigate and audit a brokerage’s privacy practices. The Privacy Commissioner may publish the results of its audit, which could be damaging to your brokerage’s reputation. They may also require compliance agreements with your brokerage to ensure compliance with PIPEDA. In addition, certain violations of PIPEDA are criminal offences, including:

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• Where an individual has requested access to their personal information held by a brokerage and the brokerage fails to retain the requested information for as long as necessary to allow the individual to exhaust their recourse • Where a brokerage contravenes the "whistleblower" provisions (for example, by terminating an employee who reports a contravention of PIPEDA) • Where a brokerage obstructs the investigation of a complaint or the conduct of an audit under PIPEDA • Where a brokerage fails to notify the Privacy Commissioner or the affected individuals when there is a privacy breach that creates a real risk of significant harm to an individual

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Lesson 2 | Page 14 of 16

The broker of record at ABC Real Estate Ltd. is developing an office policy, which will include the retention period for each type of document based on applicable legislation. One of the sections of the policy is titled, “Records that can be destroyed at the end of five years.” Which sets of records can be included in the section “Records that can be destroyed at the end of five years”? There are four options. There are multiple correct answers. 1

Risk assessment forms

2

Trade record sheets

3

Minutes of meeting

4

Individual Identification Information Records

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Lesson 2 | Page 15 of 16

A broker of record is developing an office policy that will include the retention period for each type of document based on applicable legislation. Which of the following records does not have a specified retention period? There are three options. There is only one correct answer.

1

A tenant’s credit report

2

An employee’s employment contract

3

An electronically signed seller representation agreement

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Lesson 2 | Page 16 of 16

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Identify the brokerage record retention requirements as per provincial and federal legislation There are six sections on this page with a summary of the key topics that were discussed in this lesson.

Business Corporations Act (Ontario)

Corporate records are viewed as permanent and must be retained for five years following dissolution of the corporation under the Business Corporations Act. Corporate records include articles of incorporation, minutes of meeting, share registers, the general ledger, corporate bylaws, shareholder agreements, and so on.

Income Tax Act

Record retention provisions set out in the Income Tax Act generally provide that taxpayers must retain sufficient records and books of account until the expiration of six years from the end of the last taxation year to which the records and books of account relate.

FINTRAC

Brokerages are required to retain records and make them available for any FINTRAC requests for a period of five years from the last date of business activity with the party. These records include: • Individual Identification Information Record • Corporation/Entity Identification Information Record • Identification Mandatory/Agent Agreement • Receipt of Funds Record • Risk Assessment Form • Large Cash Transaction Report

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• Large Virtual Currency Transaction Report • Suspicious Transaction Report • Terrorist Property Report

Employment Standards Act: Employee Records

The Employment Standards Act sets out the requirements for retention of employee records for a minimum of three years after the date of an event, such as after the day the leave expired, after the last day of employment, and so on.

Electronic Commerce Act

Brokerages who choose a technology for electronic signatures must ensure that the technology meets specific criteria, including authentication and unauthorized use. All parties to an agreement must consent to the use of electronic signatures. While consent can be implied, it is recommended that the consent be in writing to avoid future disputes. Brokerages must ensure that these records are stored in an unalterable scanned format (such as a non-editable PDF format) for the required minimum six-year period, as long as these records can be easily reproduced for inspection by RECO.

Personal Information Protection and Electronic Documents Act (PIPEDA)

PIPEDA is federal privacy legislation that requires consent be obtained from individuals to collect, store, use, and disclose their personal information in the course of a brokerage’s commercial activity. Personal information collected pursuant to PIPEDA should only be kept as long as necessary to fulfill the purpose for which it was collected.

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Lesson 3 | Page 1 of 13

Lesson 3: Record Storage System

This lesson explains key factors to consider when setting up a file management system, storing records on electronic systems and devices, as well as important tips for managing brokerage document security.

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Lesson 3 | Page 2 of 13

An effective file management system improves the overall function of a brokerage’s workflow. It also organizes important data and provides a searchable database for quick retrieval. This is applicable for both paper-based and electronic record storage. Regardless of how a brokerage keeps track of its files, the system must allow the brokerage to readily locate and make available all documents and records that are required, as per REBBA. Upon completion of this lesson, you will be able to: • Describe the brokerage responsibilities for record management under REBBA Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

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Lesson 3 | Page 3 of 13

As a broker of record, you will need to ensure that all documents and records in your brokerage are maintained in a proper and easily retrievable format. This will help you avoid any delays in accessing records when they are required, such as in the event of amending agreements, addressing consumer and salesperson queries, or a RECO inspection.

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Lesson 3 | Page 4 of 13

File Management System for Trade-related Records When setting up a brokerage, the broker of record must ensure that the administrative staff have quick access to files. When taking over as broker of record at an existing brokerage, the broker of record should complete an audit of all records and files to ensure that all record-keeping is in compliance with REBBA. Misplaced files and information may indicate poor office controls and procedures, and may lead to errors. File management systems for trade-related records vary somewhat by brokerage but should generally align with a structure organized around six categories. The following six sections contain information on the six categories of a basic file management system for trade-related records when setting up a new brokerage or when taking over an existing brokerage.

Seller representation agreements (listings) and seller customer service agreements Brokerages should implement the following file management system for seller representation agreements (listings) and seller customer service agreements: • They are usually filed by address; condominiums include the applicable unit number. • Local built-up areas or incorporated towns or villages are grouped alphabetically. • New developments are arranged by project name and sequential lot or unit number.

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• Township, lot, and concession are used for rural or recreational areas where the local area is not readily identifiable. • Recreational brokerages may sort alphabetically by lake and township, lot, or concession. Smaller rural brokerages may file by seller name only. • Some brokerages merge this file with the conditional or firm trade file at point of sale.

Buyer representation agreements and buyer customer service agreements Brokerages should implement the following file management system for buyer representation agreements and buyer customer service agreements: • They should be filed by buyer client name (or customer name for customer service agreements). • Some brokerages merge this file with the conditional or firm trade file at point of sale.

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Conditional and firm trades Brokerages should implement the following file management system for conditional and firm trades: • They should be organized by ascending trade number, assigned manually or automatically (software program) on the date received or alphabetically by street address. • A separate file folder should contain the trade record sheet and related documentation. • "Open" (pending) trade file folders should be kept separate from "closed" (completed) trade file folders. • Trade files are typically grouped as conditional or firm (in alphabetical order). • Some brokerages merge the applicable representation or customer service file when the trade is firm or at closing.

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Closed or cancelled trades Brokerages should implement the following file management system for closed or cancelled trades: • They should be organized by ascending trade number or alphabetically by street address. • When archiving, the left side of the file typically contains a trade processing checklist and associated administrative notes or forms. The right side has transaction records beginning with the trade record sheet, any correspondence (organized in date order), agency disclosure and acknowledgement forms, and all trade documentation including the agreement of purchase and sale, amendments, waivers, and mutual releases. Archiving (storage) procedures vary by brokerage. You will learn more about trade processing checklists in a later course.

(Expired) seller representation agreements and seller customer service agreements Brokerages should implement the following file management system for expired seller representation agreements and expired seller customer service agreements: • They are typically organized by property address, listing number, seller name, or property description, but this varies based on brokerage size and specialty area. • This does not apply to property sold situations where a brokerage merges the original seller representation (listing) or customer service © 2021 Real Estate Council of Ontario

agreement file with the conditional or firm trade file at point of sale. • When archiving, the left side of the file typically contains a representation or service agreement checklist and administrative notes or forms. The right side has the original representation or service agreement, correspondence relating to the property, agency disclosure and acknowledgement forms, and copies of any seller provided materials, for example, survey and tax notice, additional photos, and originals of any advertising or promotional pieces (if applicable).

(Expired) buyer representation agreements and buyer customer service agreements Brokerages should implement the following file management system for expired buyer representation agreements and expired buyer customer service agreements: • They should be filed by buyer client or buyer customer name. • When archiving, the left side of the file often contains a representation or service agreement checklist and administrative notes or forms. The right side has the original representation or service agreement, correspondence relating to the buyer, agency disclosure and acknowledgement forms, notes, or other materials concerning showings and copies of any materials provided by the buyer.

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Lesson 3 | Page 5 of 13

Brokerage Management Software Computerized record-keeping systems have revolutionized internal brokerage administrative procedures. Initially, software packages were largely trade-generated, and accounting packages remained generally separate and functionally distinct. Current software offerings, while still front-end trade driven, provide more extensive links and financial reporting capabilities with data connections to either internal or retail accounting packages.

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Through a single interface, brokerages can track revenues and expenses, generate broker or salesperson accounts, track closing dates, produce trial balances, manage real estate trust accounts and commission trust accounts, generate trust reconciliations, and generally administer the brokerage operation. Modular add-ons can lead to fully integrated brokerage functions including listing inventory tracking, communication with employees, access to local listing services, budgeting and cash flow spreadsheets, form preparation (for example, representation and customer service agreements, agreements of purchase and sale, and notices or amendments), and data connections for multi-branch operations.

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Lesson 3 | Page 6 of 13

Modular-based Enhancements Integrated or suite packages include modules that typically address administrative, front office, internal, and external links. The following information provides general guidance to brokers of record on options that may be further investigated to address individual and/or specific brokerage requirements. Please note that the following information is intended for general descriptive purposes only. The following four sections contain information on the modular-based enhancements.

Administration Administration software packages should include the following: • Trade record preparation and related reporting structures • Commission calculation versatility (variety of commission plans) with full reporting flexibility • Harmonized Sales Tax and other pre-set calculations (for example, franchise fees and referral commission) • Automatic posting to receivables and payables (for example, to employed registrants and cooperating brokerages) • Detailed trade record reports including historical tracking facilities

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• Trust account administration including supplementary deposits, interest-bearing calculations, a detailed trust ledger, and full bank reconciliation capabilities • Payroll preparation including hourly, salaried, and management payments, and automatic source deduction calculations including summary reporting for income tax, EI, CPP, T4, and T4A preparation • Commission payments for brokers and salespersons with employment agreements and independent contractor status • Broker and salesperson accounts including billing and tracking, invoice generation, and summary billing reports • Customization features based on brokerage size, range of financial reporting, and scope of management control

Front office Front office software packages should include the following: • Listing inventory management with data links to administrative functions, most notably trade processing • Integration of property photos during listing input process • Full property database including extensive tracking, reporting, and maintenance systems

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• Appointment and property tracking system (for example, expiry dates, keys, showings, and open houses) • Call coordination facilities if applicable (for example, routing of incoming enquiries) • Printing facility for listing inventory, for example, open house schedules, feature sheets, and pro forma statements (commercial) • Custom report generators for listing and sales statistics (internal and external tracking systems) • Daily management controls (for example, transaction closings, listing expiries, brokers and salespersons registration renewals, and trust deposits due) • Mail merge and word processing facilities with full integration into the brokerage property database or other lists established for employed brokers and salespersons or the brokerage

Broker and salesperson links Broker and salesperson links software packages should include the following: • Email links to brokers and salespersons, including integration with front office module • Wireless capabilities for offsite access, including personal digital assistants • Message board systems for brokerage announcements, policies, events, and market activity updates

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• Intranet listing and sale information databases for broker and salesperson on-site and off-site access and monitoring • Broker and salesperson selective viewing of personal account statements and trade information (password protected) • Personalized customer and client databases and contact management facilities, including email • Integration with mapping facilities and other graphic interfaces (for example, promotional designs and desktop publishing)

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External resources and links External resources and links software packages should include the following: • Listing upload and download to local listing service board server (if available within the applicable board’s jurisdiction) • Links to central server (for example, multibranch operation or franchisor) and integration with brokerage web site • Extranet capabilities for password protected communication and access involving customers and clients • Links to social media programs (for example, blogs) for enhanced customer contact • Creative marketing strategies (for example, virtual tours, transaction progress reporting, and property search details)

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Lesson 3 | Page 7 of 13

Document Storage Software A brokerage relying solely on paper-based storage systems may have to resort to off-site storage of archived data. This may cause a delay in retrieving off-site information, and it may also be more difficult to properly secure these files. Paper-based storage systems may also add to a brokerage’s expenses. A brokerage may incur additional costs such as rent of storage facilities, physical security, and additional labour. Therefore, brokerages should consider investing in document storage software if they are considering cost reduction. Document storage software can provide quick back-ups on a daily (or more frequent) basis, allowing for fast retrieval of information when needed through text search facilities, accommodation of hyperlinking for cross© 2021 Real Estate Council of Ontario

reference purposes, provision of detailed historical tracking (for example, date entered, individual involved, and file commentary), and secure access through individual permissions. Brokerages are permitted to keep records in an unalterable scanned format (such as a non-editable PDF format) for the required minimum six-year period, so long as these records can be easily reproduced for inspection by RECO. As stated earlier, these requirements are also applicable for paper-based records.

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Lesson 3 | Page 8 of 13

Leading Practices for Electronic Record Storage A broker of record, when converting or storing records to an electronic format, should ensure that the system and the procedures meet certain minimum leading practices guidelines. Leading practices include the following: • Electronic records associated with a particular trade in real estate are appropriately linked to ensure that an individual can readily access trade and all related documents • Electronic records include appropriate file identifiers for logical organization and ease of retrieval

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• The identity of the person converting the records to electronic format is readily discernible within the electronic file (for example, initials), along with the date of conversion • Electronic records are properly secured, kept confidential, and are only accessible by the broker of record and authorized individuals within the brokerage • Electronic records and associated software are secured with passwords and/or other security codes and mechanisms so that records cannot be altered • The broker of record has the ability to alter security codes, modify security levels for brokerage employees, and generally control access to the records • Appropriate policies and procedures are in place describing all processes and procedures including the storage and retrieval of records • The operating system is reliable for initial conversion, as well as ongoing tracking, accessibility, and retrieval • Sufficient paper-based instructional information about the software and access procedures are available to allow ready access by authorized persons • A copy of the software and associated documentation used for electronic document storage is securely stored, should problems arise with the storage or retrieval of such documentation • The system will not allow for the deletion of electronic records before the required six-year minimum period, as set out in REBBA • The system will provide for an audit trail of any deleted electronic records (after the six-year period) • Brokerages are required to store the data in Ontario ─ w h en u sin g an on lin e p rovid er to store d ata in th e cloud, brokerages must ensure that the servers are located in Ontario It is important for brokers of record to establish policies and procedures to back up data, as electronic storage devices can fail. System failure is not an excuse for failing to meet record-keeping obligations under REBBA.

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Lesson 3 | Page 9 of 13

Digital Record Storage Challenges Electronic communication, if not addressed properly, can create confusion for brokerage staff when dealing with record storage. Brokerages may face challenges given the ease of creating, distributing, and storing electronic communication, documents, pictures, and videos. Problems can arise when a brokerage fails to address digital realities. Brokers and salespersons may be sending emails and attachments without any regard for brokerage record-keeping. Further, when receiving emails about trade-related activities, brokers or salespersons may routinely store them in off-site personal computer files not accessible by the brokerage. To compound matters, many © 2021 Real Estate Council of Ontario

employees believe that idle office chit-chat, comments, and opinions wander into cyberspace oblivion with no discernible trace. Nothing is further from the truth when technology is involved. A single email can, in theory, be archived somewhere forever. A broker of record can take positive steps to minimize risk. For example, if the brokerage’s email is set up using Internet Mail Application Profile (IMAP), then all received and sent emails can be viewed and stored on a central server accessible from multiple locations or computers. Alternatively, if Post-Office Protocol (POP) is used, the tracking of emails is more difficult since messages are retrieved, sent, and stored using folders on individual users’ computers. Detailed office policies and controls should be established, along with appropriate training for all administrative and sales staff, to help avoid issues with digital record management.

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Lesson 3 | Page 10 of 13

Brokerage Record Security It is a primary concern for the broker of record to securely maintain all documents and records in compliance with REBBA and other provincial and federal legislation. A broker of record should create an appropriate record security policy that describes the restricted access and security measures for all records. A broker of record should implement the policies and develop procedures to ensure compliance either when starting a new brokerage or when acquiring an existing brokerage. This will help the broker of record effectively operate their brokerage. The following three sections contain information on important tips for managing brokerage document security.

Brokerage records access All paper-based documents and records should be strictly secured. Only the broker of record and designated staff will have access to the brokerage files. No file is accessed unless approved by the broker of record or designated staff, and brokers and salespersons must review and sign applicable trade records only at the administration counter or arrange pick-up and review at a designated time. For brokerages that use paper-less systems, trade record sheets should be sent electronically to be reviewed and signed by brokers and salespersons. Brokerages should use software that tracks all actions, such as when the file was opened and signed electronically. The software also ensures that the records do not get deleted.

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Computer security Brokerages should invest in computer security to ensure that records are safely stored. Inefficient computer security can compromise the stored documents and records, which can cause liability for a brokerage. A brokerage should have a firewall installed between the local area network (LAN) and all external internet access points. Antivirus software that automatically repairs files by detecting and removing unidentified macro viruses should be installed on all systems. If repair is impossible, the file should not be opened to avoid any possible corruption of internal data. Only the broker of record should have the ability to alter security codes; modify security levels for brokers, salespersons, and administrative staff; and generally control access to the records. However, a broker of record may assign these tasks to an administrative staff member or IT personnel. A broker of record should also ensure that all brokerage staff are trained on how to maintain computer security.

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Physical premises Brokerages should consider an extra layer of securing all documents and records by installing a full perimeter and internal motion security system, complete with individual access codes or key fobs for all staff, including brokers and salespersons. Personal codes should be changed on a quarterly basis. The exterior of the building should be well-lit, and all entrances and exits should be clearly visible. The broker of record should have a policy and developed processes to safely secure sellers’ keys and records of electronic lockbox information.

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Lesson 3 | Page 11 of 13

A broker of record is reviewing the document filing system with the office administrator regarding effective strategies to maintain the record management system. Which strategies should be applied to ensure an effective record management system? There are four options. There are multiple correct answers.

1

Organize trade files by ascending trade number

2

Organize trade files by the date of receipt of the trade documents from the brokers or the salespersons

3

Organize open trade files separately from closed trade files

4

File expired seller representation agreements by property address

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Lesson 3 | Page 12 of 13

A broker of record has chosen to use an electronic record storage management system and wants to put a system in place to control and avoid risks related to storing files electronically. What actions should the broker of record take to minimize the risks? There are four options. There are multiple correct answers.

1

Password protect electronic records and associated software

2

Delete the records at the end of five years to prevent misuse

3

Keep electronic records in an alterable format for future revision

4

Retain the rights to alter any security codes and level of access

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Lesson 3 | Page 13 of 13

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Describe the brokerage responsibilities for record management under REBBA There are three sections on this page with a summary of the key topics that were discussed in this lesson.

Record storage

An effective file management system helps a brokerage organize important data and provides a searchable database for quick retrieval. This is applicable for both paper-based and electronic record storage. Regardless of how a brokerage keeps track of its files, the system must allow the brokerage to readily find all documents and records that are required as per REBBA.

Document storage software

Document storage software can provide quick back-ups on a daily (or more frequent) basis, allowing for fast retrieval of information when needed through text search facilities, accommodation of hyperlinking for cross-reference purposes, provision of detailed historical tracking (for example, date entered, individual involved, and file commentary), and secure access through individual permissions. Brokerages are permitted to keep records in an unalterable scanned format (such as a non-editable PDF format) for the required minimum six-year period, so long as these records can be easily reproduced for inspection by RECO. These requirements also apply for paper-based records.

Leading practices for electronic record storage

The broker of record, when converting or storing records to an electronic format, should ensure that the system and the procedures meet certain minimum leading practices guidelines. These leading practices include the following:

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• Electronic records associated with a particular trade in real estate are appropriately linked to ensure that an individual can readily access trade and all related documents. • Electronic records include appropriate file identifiers for logical organization and ease of retrieval. • The identity of the person converting the records to electronic format is readily discernible within the electronic file (for example, initials), along with the date of conversion. • Electronic records are properly secured, kept confidential, and are only accessible by the broker of record and authorized individuals within the brokerage. • Electronic records and associated software are secured with passwords and/or other security codes and mechanisms so that records cannot be altered. A broker of record should establish policies and procedures to back up data, as electronic storage devices can fail. System failure is not an excuse for failing to meet record-keeping obligations under REBBA.

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Lesson 4 | Page 1 of 6

Lesson 4: Summary Practice Activities

This lesson provides a series of activities that will test your knowledge on the entire module.

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Lesson 4 | Page 2 of 6

This lesson provides summary practice activities. Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

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Lesson 4 | Page 3 of 6

A brokerage, acting as a co-operating brokerage and representing the buyer as a client, has just received an accepted agreement of purchase and sale, along with other documents, from one of their salespersons. The brokerage received the records in PDF formats. What procedures must the brokerage follow to satisfy the legislative requirements for management of trade-related records? There are four options. There are multiple correct answers.

1

Store the buyer representation agreement alphabetically by buyer’s name

2

Retain the agreement of purchase and sale and other related documents in an unalterable scanned format for a period of three years

3

Create a trade file and store alphabetically by street address

4

Retain the trade file for a minimum of one year

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Lesson 4 | Page 4 of 6

A broker of record is conducting a training session for the branch managers and the administrative staff to ensure that the brokerage is in compliance with FINTRAC requirements. The broker of record presents some situations to the group. Which of the following situations addresses FINTRAC requirements? There are three options. There is only one correct answer.

1

The brokerage is required to retain FINTRAC records and make them available for any FINTRAC requests for five years.

2

The brokerage is required to retain a power of attorney or a will document when used in a real estate transaction.

3

The brokerage is required to update their compliance policies (compliance regime) every five years.

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Lesson 4 | Page 5 of 6

A broker of record for a new brokerage is creating a brokerage policy and wants to include a section to address PIPEDA requirements. Which brokerage policy items align with the legislative requirements found in PIPEDA? There are four options. There are multiple correct answers.

1

The brokerage requires that personal information collected must include the name, title, and business address of an employee of an organization.

2

In a case of a privacy breach of an individual’s personal information, the brokerage should notify the individual and the Privacy Commissioner.

3

The brokerage must obtain consent from individuals in order to collect their personal information.

4

The brokerage must retain personal information for a minimum period of five years.

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Lesson 4 | Page 6 of 6

Congratulations, you have completed the lesson!

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Module Summary | Page 1 of 3

Module Summary

This lesson contains a summary of the entire module.

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Module Summary | Page 2 of 3

Congratulations, you have completed this module! The next page will present a summary of the lessons in this module.

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Module Summary | Page 3 of 3

There are three sections on this page with a summary of the key topics that were discussed in this module.

Record Management

REBBA sets out various record management and retention requirements for brokerages. A brokerage must retain all documents and records as defined under the Act for a period of not less than six years. Every brokerage is also required to maintain and retain all employee records to comply with various legislation. A broker of record must verify that certificates of registration are managed in accordance with REBBA. The broker of record must also make sure that the record of employment is completed for every employee who stops working in insurable employment. Employee records are maintained on the basis of various legislation, such as the Employment Standards Act and the Income Tax Act. Completion of this lesson has enabled you to: • Differentiate between trade-related records and business records • Describe the brokerage responsibilities for record management under REBBA • Identify the employee records that a brokerage must maintain

© 2021 Real Estate Council of Ontario

Record Retention Requirements

A brokerage must have policies in place for building and maintaining records, as stated in various legislation, to avoid litigation and/or fines. These legislative requirements include: • Business Corporations Act (Ontario): Corporate records are viewed as permanent and must be retained for five years following dissolution of the corporation. • Income Tax Act: Record retention provisions set out in the Income Tax Act generally provide that taxpayers must retain sufficient records and books of account until the expiration of six years from the end of the last taxation year to which the records and books of account relate. • FINTRAC: Brokerages are required to retain records and make them available for any FINTRAC requests for a period of five years from the last date of business activity with the party. These records include: • Individual Identification Information Record • Corporation/Entity Identification Information Record • Identification Mandatory/Agent Agreement • Receipt of Funds Record • Risk Assessment Form • Large Cash Transaction Report • Large Virtual Currency Transaction Report • Suspicious Transaction Report • Terrorist Property Report • Employment Standards Act: The Employment Standards Act sets out the requirements for retention of employee records for a minimum of three years after the date of an event, such as after the day the leave expired, after the last day of employment, and so on. • Electronic Commerce Act: Brokerages who choose a technology for electronic signatures must ensure that the technology meets specific criteria, including authentication and unauthorized use. All parties to an agreement must © 2021 Real Estate Council of Ontario

consent to the use of electronic signatures. Brokerages must ensure that these records are stored in an unalterable scanned format (such as a noneditable PDF format) for the required minimum six-year period, so long as these records can be easily reproduced for inspection by RECO. • PIPEDA: PIPEDA requires that consent be obtained from individuals to collect, use, and disclose their personal information. Personal information should only be kept for as long as is necessary to fulfill the purpose for which it was collected. Completion of this lesson has enabled you to: • Identify the brokerage record retention requirements as per provincial and federal legislation

Record Storage System

An effective file management system helps a brokerage organize important data and provides a searchable database for quick retrieval. Brokerages are permitted to keep records in an unalterable scanned format (such as a non-editable PDF format) for the required minimum six-year period, as long as these records can be easily reproduced for inspection by RECO. These requirements are also applicable for paper-based records. Completion of this lesson has enabled you to: • Describe the brokerage responsibilities for record management under REBBA

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V6

Module 2: Setting Up and Managing the Accounting System for a Brokerage Disclaimer: This is a reference document which contains pages from the Accessible eLearning module. You should complete the eLearning module to proceed to the next step. Please note that the accessible module on the LMS only contains the interactive pages and you need to go through the content of this document thoroughly to attempt the interactive activities in the module. Please use Adobe Acrobat Reader (Recommended version 9 or above) to navigate through this PDF. Real Estate Broker Program © 2021 Real Estate Council of Ontario. All Rights Reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or in any means – by electronic, mechanical, photocopying, recording or otherwise without prior written permission, except for the personal use of the Real Estate Broker Program learner.

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Module 2: Setting Up and Managing the Accounting System for a Brokerage A brokerage’s success, as with most business ventures, is heavily dependent on sound financial management techniques. Ultimate responsibility rests with the broker of record for the prudent, diligent administration of all financial records, notwithstanding the fact that others (for instance, an administrative staff member) perform various bookkeeping and/or accounting functions. Therefore, as a broker of record, you should understand the importance of financial management and familiarize yourself with basic accounting procedures and fundamentals. It is recommended that you continue to learn about concepts related to financial management outside of this course and program. When overseeing the financial management of your brokerage, you will rely on a third-party service provider to help you set up and update the accounting system, analyze the financial data, and make key financial decisions. In this module, you will learn about aspects related to financial management and components of typical accounting systems in a brokerage. You will review information related to unique expense tracking mechanisms involving recoverable and non-recoverable expenses. Further, you will study about leading practices for implementing administration controls in a brokerage and fraud prevention. © 2021 Real Estate Council of Ontario

To check your understanding of this module, you must complete all the activities in the online module. While navigating through the online module, click the Legislation button to view laws and regulations related to this module. The contents of the thumbnail

and References from the module are added to support your learning throughout this

Accessible PDF.

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Menu: Setting Up and Managing the Accounting System for a Brokerage

Number of Lessons

Lesson Number

6 Lessons

Lesson Name

Lesson 1

Financial Management in a Brokerage

Lesson 2

Accounting System in a Brokerage

Lesson 3

Tracking System for Expenses

Lesson 4

Internal Administration Controls

Lesson 5

Summary Practice Activities Module Summary

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Lesson 1 | Page 1 of 14

Lesson 1: Financial Management in a Brokerage This lesson describes the responsibilities of a broker of record with regards to the financial management of a brokerage, as well as the requirement to maintain separate accounts for consumer deposits and monies belonging to the brokerage. This lesson also describes the leading practices to maintain the accompanying minimum books and records for these accounts.

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Lesson 1 | Page 2 of 14

Financial management refers to the strategic planning, organizing, and controlling of financial activities of the brokerage so that the brokerage may have the resources for sustainability and growth. As a broker of record, you will be a key player in the financial management of your brokerage. While you will rely heavily on the expertise of a Certified Professional Accountant (CPA), you should routinely inspect the financial statements for your brokerage. This will help you make informed decisions related to expenditures, planning investments, and controlling your brokerage’s cash flow. Please note that, in the past, there were other designations used to refer to accounting professionals. However, the governing body streamlined naming conventions to refer to accounting professionals as Certified Professional Accountant (CPA). Upon completion of this lesson, you will be able to: • Describe the importance of financial management as a broker of record © 2021 Real Estate Council of Ontario

• Describe the general accounting requirements of a brokerage, as per REBBA Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

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Lesson 1 | Page 3 of 14

As a broker of record, it is important for you to have a working knowledge of accounting principles and systems applicable to a brokerage, whether they are completed manually or through automated means. This will help you monitor the financial pulse of your brokerage and ensure that your brokerage operates in compliance with REBBA.

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Lesson 1 | Page 4 of 14

Importance of Financial Management A broker of record should actively oversee and review the financial management of the brokerage. This involves overseeing financial records, monitoring financial controls, tracking cash flow, interpreting financial statements and other reports, creating a budget and making other refinements to it, and prudently allocating resources in the pursuit of brokerage goals. © 2021 Real Estate Council of Ontario

Financial management is neither static nor predictable. It is an ongoing process that requires regular and ongoing attention and cannot be hurriedly addressed at month end, only to be forgotten for another 30 days. Financial management starts long before the official opening (or acquisition) of a brokerage. Initially, a business plan should set out capital requirements and forecasted financial statements (often called “pro forma” statements) based on budgeted forecasts. As the brokerage develops and matures, the accuracy of financial statements and accounting records is essential along with continuous, diligent administrative control. Financial management also involves risk assessments and careful allocation of resources. The desire to maximize wealth brings with it inherent risks. A financial decision today that augments current profits may, in the long-term, jeopardize future financial security. To make informed financial decisions, a broker of record should be: • Disciplined: An insistence that proper accounting and control procedures be instituted and maintained • Involved: A willingness to actively participate in the financial process • Aware: An ability to speak the language of bookkeeping and accounting, understand the processes, and effectively administer the modern, monetary dynamics of an active brokerage • Knowledgeable: A sound understanding of accounting basics and the financial framework underlying prudent brokerage decisions

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Lesson 1 | Page 5 of 14

Bookkeeping and Accounting Bookkeeping and accounting assist in documenting the details of financial transactions within a brokerage and help the broker of record make informed decisions. Bookkeeping focuses on recording entries into the journals, maintaining those journals, issuing cheques, and the basic reporting of the day-to-day functioning of the brokerage. Accounting generally involves transferring information from various journals into the general ledger, with the subsequent production of financial statements for the brokerage. The following two sections contain information on bookkeeping and accounting.

Bookkeeping Bookkeeping involves the systematic recording of business transactions in journals and ledgers and is governed by rules and procedures involving financial processing. This financial data ultimately leads to the preparation of financial statements. A bookkeeper is involved in day-to-day financial entries and activities, as set out by the brokerage’s accountant or other financial advisor. Brokerages can elect to have the bookkeeping function performed by staff, an accounting firm, a thirdparty service provider, or a combination thereof.

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Accounting Accounting, often called the language of business, is the cornerstone of sound financial planning. A broker of record should understand the interplay of source documents, journals, ledgers, trial balances, and financial statements to properly oversee a brokerage and to enhance the financial well-being of that enterprise. Financial versus Managerial Accounting Accounting can be viewed from two perspectives: • Financial accounting involves the preparation of financial reports. These reports are provided to external parties, such as shareholders, other investors, banks, taxation authorities, and RECO (when required to do so). These financial reports are prepared by an accountant. • Managerial accounting focuses on the preparation of reports for internal decision-making and is more informal in nature. Managerial accounting is designed to assist the broker of record in making informed decisions and typically involves custom reports tailored to specific brokerage needs.

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Lesson 1 | Page 6 of 14

Responsibilities of a Broker of Record in Financial Management To ensure diligent financial management in a brokerage, a broker of record should: • Set up and oversee the accounting system framework by consulting a third-party service provider, such as an accountant. • Review entries in journals and ledgers that lead to the creation of the financial statements. • Identify any errors and unusual entries in journals and ledgers. • Review transfer of journal entries to the general ledger. • Identify the tracking system for recoverable and non-recoverable expenses. © 2021 Real Estate Council of Ontario

• Ensure the general accounting requirements, as described in REBBA, are met. • Oversee general and trust accounts to ensure cross-reference details are noted in the deposits and withdrawals of monies. • Complete fully detailed audit trails, from the initial trade record preparation to the final disbursement of funds. A broker of record will review the contents of the files, such as agreements of purchase and sale, real estate trust ledgers, deposit books for all accounts, cheques or electronic transfers, and trade record sheets. You will learn more about the details related to these responsibilities later in this module. Ultimate responsibility for the prudent, diligent administration of all financial records rests with the broker of record, notwithstanding the fact that they may engage with administrative staff and a third-party service provider to perform various bookkeeping and/or accounting functions. Knowledge of brokerage accounting, whether manual or automated, is essential. When a brokerage purchases accounting software, often training is part of the purchase. The broker of record should participate in the training along with the administrative staff. This will allow them to understand the software and the extent of permissible actions for administrative staff based on the level of access provided to them. The broker of record’s role is to establish policies and procedures such that financially responsible business practices are adhered to in a brokerage. These practices include maintaining accurate and up-to-date accounting records, undertaking adequate financial planning, and leveraging trustworthy professionals to assist with administering such practices.

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Lesson 1 | Page 7 of 14

In a previous module, you learned that REBBA includes guidelines related to how trust monies must be handled and maintained. Brokerages typically set up three different bank accounts: a real estate trust account, a general account, and a commission trust account. The real estate trust account is used to maintain consumer deposits. The general account contains monies belonging to the brokerage. The commission trust account is used to process remuneration owing to other brokerages and payments to the brokerage’s brokers and salespersons. Only the real estate trust account is a legislative requirement under REBBA. Failure to keep the consumer deposits separate from the brokerage funds is a violation of REBBA. It can put both the consumer and the brokerage at risk and can lead to prosecution and civil litigation if consumer deposits are exposed to risk. © 2021 Real Estate Council of Ontario

Lesson 1 | Page 8 of 14

Accounting Requirements and Leading Practices REBBA requires that every brokerage maintain trust money separate (both physically, in separate accounts and in terms of recordkeeping) from money belonging to the brokerage at all times. The real estate trust account records the receipt and the disbursement of trust funds. The general account records all other business transactions of the brokerage. REBBA does not focus excessively on general accounting requirements. Most emphasis in the Act and its regulations is on trade-related documents, trade processing, and administration of the real estate trust account. However, RECO © 2021 Real Estate Council of Ontario

reserves the right to request financial statements signed by the broker of record and certified by an accountant licensed under the Public Accounting Act. A broker of record should ensure that the brokerage maintains the minimum books for recordkeeping, such as deposit book with duplicate pages and monthly statements, to monitor brokerage transactions. Note: Although not a requirement of REBBA, most brokerages also maintain a commission trust account for disbursement of commissions. These may be required due to the nature of the brokerage business or to comply with real estate board or association requirements. You were introduced to the commission trust account in a previous module. You will learn more about this account in detail in a later course.

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Lesson 1 | Page 9 of 14

Minimum Books Required for Recordkeeping A brokerage should implement leading practices for recordkeeping to ensure safeguards are in place to monitor activities in the general account and the real estate trust account. The minimum books and records are subject to routine inspections by RECO. In addition to the minimum books, a brokerage may also choose to take advantage of electronic banking. If a brokerage uses a bank scanner to deposit directly from their office, the scanner provides easy access to deposit reports, which can include copies of the cheques that were deposited. ATM receipts are generally kept in the file to which they pertain or stored as a PDF in the appropriate electronic storage trade folder, if the brokerage does not keep paper copies. You will learn more about this in detail in a later course. © 2021 Real Estate Council of Ontario

Lesson 1 | Page 10 of 14

Real Estate Trust Account The real estate trust account is a legislative requirement under REBBA. The minimum books and records to be maintained for the real estate trust account are: • Duplicate page bank deposit book (or bank acknowledged deposit receipts): This will identify what was deposited into the account and the appropriate cross-referencing information (the consumer deposit and trade number) and the required reference for performing monthly reconciliation of the real estate trust account. • Cheque books with stubs attached or duplicate cheques: The brokerage must make written record of consumer deposit monies. When preparing cheques, the brokerage will identify who the payment was made to with appropriate cross-referencing information noted on the cheque and the required reference for performing monthly reconciliation of the real estate trust account. • Monthly bank statements with copies of cheques that have cleared or been cashed: This is required for confirming which deposits and cheques have been applied to the real estate trust account and is needed for completion of monthly bank reconciliation of the real estate trust account. • Real estate trust ledger: This is the brokerage’s internal recordkeeping of all trade records issued, consumer deposits, and disbursements. This is needed for monthly reconciliation of real estate trust account and is used to produce total real estate trust liability. • Monthly written bank reconciliations (signed and dated by the broker of record), including a written list of trust liability: Each month, the brokerage must complete a reconciliation of the real estate trust account. This will

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confirm the accuracy of what consumer deposit money is held in trust by the brokerage and deposited with the bank in comparison to internal records using the real estate trust ledger. • A proper audit trail concerning any electronic funds transfers: This is the brokerage’s recordkeeping of all electronic deposits and transfers from the real estate trust account with proper cross-referencing information relating to trade records. For more information on working electronically, review the Document Storage and Funds Transfer presentation on the RECO website.

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Lesson 1 | Page 11 of 14

General Account Money in the general account is used for paying for expenses of the brokerage, such as personnel, occupancy, and operating expenses. Leading practices related to maintaining minimum books and records should be followed to adequately control business transactions (other than trust). The minimum books and records to be maintained for the general account account are: • Duplicate page bank deposit book (or bank acknowledged deposit receipts): This will identify what was deposited into the account and the appropriate cross-referencing information and needed reference for performing monthly reconciliation of the general account. • Cheque books with stubs attached or duplicate cheques: This will identify who the payment was made to with appropriate cross-referencing information noted on the cheque and needed reference for performing monthly reconciliation of the general account. • Monthly bank statements with copies of cheques that have cleared or have been cashed: This is required for confirming which deposits and cheques have been applied to the general account and is needed for completion of monthly bank reconciliation of the general account. • Cash receipts and disbursement journals: This is the brokerage’s internal recordkeeping of cash and cheques received and deposited into the bank accounts. • Monthly written bank reconciliations: In addition to the requirement for the real estate trust account, as a leading practice, the brokerage will complete a monthly reconciliation for other accounts and confirm the accuracy of what money is in the account against internal records and bank records. © 2021 Real Estate Council of Ontario

RECO also requires that the general account be operated in accordance with established accounting principles and practices. Although REBBA does not set out specific requirements concerning the general account, records related to this account are routinely inspected by RECO staff to ensure that trust money transactions are made in accordance with statutory requirements.

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Lesson 1 | Page 12 of 14

A broker of record wants to verify that all financial components of the trade record files have been correctly entered into the accounting system by way of appropriate journal and ledger entries. They want to conduct a detailed review, starting with the initial trade record preparation to the final disbursement of funds. What will the broker of record review as part of their inspection of the bookkeeping and accounting entries? There are four options. There are multiple correct answers.

1

Entries in the general and trust account ledgers

2

Entries made to the financial reports provided to shareholders

3

Daily financial entries posted to the journals and cheque issuance

4

Transfer of journal entries to the general ledger

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Lesson 1 | Page 13 of 14

A broker of record is training a newly recruited administrative staff member on the minimum books and records for the general account and the real estate trust account, which are maintained as a leading practice. Identify which of the following records are required to be maintained for the real estate trust account. There are three options. There are multiple correct answers.

1

Signed and dated monthly bank reconciliation

2

Audit trail concerning any electronic funds transfers

3

Cash receipts and disbursement journals

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Lesson 1 | Page 14 of 14

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Describe the importance of financial management as a broker of record • Describe the general accounting requirements of a brokerage, as per REBBA There are three sections on this page with a summary of the key topics that were discussed in this lesson.

Financial management in As a broker of record, you will be a key player in the financial management of your a brokerage brokerage. Financial management is an ongoing process that involves overseeing financial records, monitoring financial controls, tracking cash flow, interpreting financial statements and other reports, creating a budget and making other refinements to it, and prudently allocating resources in the pursuit of brokerage goals. Ultimate responsibility for the prudent, diligent administration of all financial records rests with the broker of record, notwithstanding the fact that they may engage with administrative staff and a third-party service provider to perform various bookkeeping and/or accounting functions.

Bookkeeping and accounting

Bookkeeping focuses on recording entries into the journals, maintaining those journals, issuing cheques, and the basic reporting usual to the day-to-day functioning of the brokerage. Accounting generally involves transferring information from various journals into the general ledger, with the subsequent production of financial statements for the brokerage. © 2021 Real Estate Council of Ontario

General accounting requirements

Brokerages typically set up three different bank accounts: a real estate trust account, a general account, and a commission trust account. Only the real estate trust account is a legislative requirement under REBBA. REBBA requires that every brokerage maintain trust money separate (both physically, in separate accounts and in terms of recordkeeping) from money belonging to the brokerage at all times. Leading practices related to maintaining minimum books and records should be followed to adequately control business transactions (other than trust). A brokerage may also choose to take advantage of electronic banking. Minimum books and records to be maintained for real estate trust account are: • Duplicate page bank deposit books (or bank acknowledged deposit receipts) • Cheque book with stubs attached or duplicate cheques • Monthly bank statements with copies of cheques that have cleared or been cashed • Real estate trust ledger • Monthly written bank reconciliations (signed and dated by the broker of record), including a written list of trust liability • A proper audit trail concerning any electronic funds transfers Minimum books and records to be maintained for general account are: • Duplicate page bank deposit book (or bank acknowledged deposit receipts) • Cheque books with stubs attached or duplicate cheques • Monthly bank statements with copies of cheques that have cleared or been cashed • Cash receipts and disbursement journals • Monthly written bank reconciliations © 2021 Real Estate Council of Ontario

• General ledger

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Lesson 2 | Page 1 of 28

Lesson 2: Accounting System in a Brokerage

This lesson describes various accounting system components, including journals, ledgers, trial balance, and financial statements. It further explains cash versus accrual accounting, double entry bookkeeping, and chart of accounts with emphasis on account groupings.

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Lesson 2 | Page 2 of 28

An accounting system can help a brokerage collect, record, manage, process, retrieve, and report its financial data. This data can be used by the broker of record, shareholders, other investors, banks, and taxation authorities. Accounting systems are an integral tool for financial management in a brokerage. They are designed to help you, as a broker of record, make better spending decisions, create accurate financial reports, and manage assets. Therefore, it is important for you to be aware of the key components of typical brokerage accounting systems. Closely monitoring the accounting system will enable you to ensure that all entries have been correctly posted. It will also help you determine the financial position of your brokerage at any given point. Upon completion of this lesson, you will be able to: • Describe the key components of an accounting system framework for a brokerage • Describe accounting basics that apply to a brokerage © 2021 Real Estate Council of Ontario

• Determine the typical setup of account structure in a brokerage Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

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Lesson 2 | Page 3 of 28

Series of Events Leading to Production of the Income Statement, Balance Sheet, and Cash Flow Statement © 2021 Real Estate Council of Ontario

Accounting entails more than just recording the financial transactions in everyday brokerage operations. An accounting system provides a framework for recording transactions, summarizing, and transferring financial details from various journals to the general ledger and, ultimately, to the financial statements. The accounting system refers to the numeric values captured in various documents and not the storage of these documents. A basic accounting system consists of source documents, journals, and a general ledger. The trial balance and the financial statements are derived from details found in the general ledger. The accounting system handles both input (entries) from traderelated documents and general business records. You will learn more about these components of the accounting system later in this module. As a broker of record, an understanding of the accounting system will help you make sense of the financial data and meet your obligation to oversee the operations of your brokerage.

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Lesson 2 | Page 4 of 28

Source Documents and Typical Entries Source documents are the initial documents that capture the numeric values of the income and expenses for a brokerage. Income and expenses identified in these source documents will be the basis for entries in the accounting system. The following table lists the source documents and typical entries made to various journals: Source Documents

Typical Entries

Trade record sheets

Commission payment received for completed transaction Entries made to cash receipts journal include: • Debit entry to cash • Credit entry to commission receivable

Invoices from suppliers

Payment sent to supplier (e.g. for local newspaper advertising space) Entries made to cash disbursement journal include: • Credit entry to cash • Debit entry to advertising

Contracts and letters of employment (These documents are stored for maintaining employee records. The terms defined in

Payroll data (e.g. for an individual salesperson who is an independent contractor) Entries made to payroll journal • Gross commission payable entry • Expenses deducted, if applicable © 2021 Real Estate Council of Ontario

the contract are used as reference for payroll.)

Miscellaneous

• Net commission payable

Journal entries Entries made to general journal include: • Debit entry for insurance expenses • Credit entry for prepaid expenses

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Lesson 2 | Page 5 of 28

Accounting System Principles An accounting system is generally founded on the following principles: • Recording assets initially at cost. • Spreading this cost through amortization over the estimated economic life of the asset. • Assessing the fair value of each intangible asset annually by management to test for impairment. If the fair value has declined below its carrying amount (book value), then it is written down to such fair value. • Providing fair and reasonable disclosure to avoid misleading readers. © 2021 Real Estate Council of Ontario

• Applying the principle of consistency. This principle requires that once a brokerage adopts an accounting principle or method, they should continue to follow it consistently in future accounting periods so that the results reported from period to period are consistent. For example, brokerages operate on an accrual accounting system, which means they cannot arbitrarily switch to a cash system. You will learn more about accrual accounting and cash systems later in this module. • Using the matching principle with all expenses and revenues. The matching principle requires that a brokerage report an expense on its income statement in the same period in which a related revenue is earned, even if the expense is not paid in that same period. For example, a brokerage earns a commission from a sale in September and recognizes the income but does not pay the salesperson their portion of commission until the transaction closes the following month. The commission expense to the salesperson will be recognized in September not October. • Using Canadian accounting standards for private enterprises, if a privately owned brokerage, effective for fiscal periods beginning on or after January 1, 2011. Public companies that carry on a brokerage business will have already converted to using International Financial Reporting Standards.

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Lesson 2 | Page 6 of 28

Journals A journal provides a format where transactions are recorded in chronological order as they occur, resulting in a sequenced financial record of all similar transactions of the business. The various journals are often referred to as the books of original entry, as all transactions enter the accounting system at this point. Each transaction is initially recorded by an entry in the appropriate journal, using source documents such as trade record sheets, cheques received and issued, and payroll data. Every time an accounting transaction is made, two journal entries are recorded. The entries are recorded as debits (DR) and credits (CR). This entry system will be explained later in this module. © 2021 Real Estate Council of Ontario

Brokerages may use different types of journals to record their transactions like the cash receipts journal, cash disbursements journal, payroll journal, and general journal. The only journal that is used by all brokerages is the general journal. All other types of journals are optional and can be used based on the unique requirements of the brokerage. The following four sections contain information on the various types of journals.

Cash receipts journal The cash receipts journal records all cash and cheques received and deposited to the bank.

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Cash disbursements journal The cash disbursements journal records all payments issued by the brokerage. As most brokers and salespersons are independent contractors, the commissions they receive will technically be recorded as payment issued by the brokerage in the cash disbursements journal.

Payroll journal The payroll journal records all monies paid through salaries or commissions and source deductions made, where applicable. While the cash disbursements journals provide a central record of all monies coming in and out of a brokerage, the payroll journal records specific disbursements relating to payroll for each individual working at the brokerage. These disbursements would also appear in the central record, namely the cash disbursements journal. They can appear as individual entries in the cash disbursements journal or one consolidated entry © 2021 Real Estate Council of Ontario

for a specific period, such as one month. No source deductions are made to commissions when brokers and salespersons are independent contractors. You will learn more about this in a later course. General journal

The general journal records non-routine transactions that do not align with the parameters of the other journals. General journal entries are also used to record amortization, to adjust allowances (such as an allowance for bad debts) and other similar entries.

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Lesson 2 | Page 7 of 28

General Ledger The general ledger is comprised of a listing of accounts representing the various assets, liabilities, revenues, and expenses of the brokerage. For example, cash in bank is an account found in the general ledger, which records an ongoing total of the bank account balance, such as: • Totals of receipts, disbursements, and net payroll are posted to this account from the cash receipts journal, disbursements journal, and payroll journal respectively, thus providing an updated bank account balance • Entries are cross-referenced back to the originating journal so that, if necessary, an entry can be traced to the source documentation Each account in the general ledger has a cumulative debit, credit, or nil balance. Adding all the debit balances while subtracting all the credit balances must result in a total of zero, thus, ensuring that the books are in balance. This is the principle for double-entry bookkeeping, which reflects the fact that in each transaction the debits equal the © 2021 Real Estate Council of Ontario

credits. If the sum total is not zero, it indicates an error in the entries made. You will learn more about this later in this module.

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Lesson 2 | Page 8 of 28

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Trial Balance A listing of all account balances, known as a trial balance, is typically prepared monthly as a record that the books are balanced. The trial balance is a list of all accounts and their balances after the closing entries have been recorded in the journal and posted to the general ledger. The information is displayed in three columns: account names, debits, and credits. Both the debit and the credit columns are calculated at the bottom of the trial balance. The trial balance demonstrates the mathematical correctness of the general ledger, but does not guarantee the accuracy of recorded items, nor does it ensure that such items have been properly entered. A broker of record should review the trial balance and look for discrepancies compared to the general ledger. Discrepancies may exist if a transaction was never entered, is posted twice, or is posted in reverse (something that was supposed to be posted as a debit (DR) was posted in error as a credit (CR) and vice versa). Errors detected on the trial balance can be corrected using general journal entries, which are then posted to the general ledger.

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Lesson 2 | Page 9 of 28

Financial Statements Based on a brokerage’s ongoing financial performance, financial statements help in providing the backdrop for sound decision making. For example, if a brokerage has additional money available in a savings account at one per cent interest rate, the broker of record may decide to use the money to reduce long-term debt at a higher interest. They may decide to take advantage of a pre-payment privilege with no penalty for paying down the loan. Financial statements have real value from both internal and external perspectives. Internally, the owner and/or the broker of record rely on these statements when determining the current status and the stability of the business, making decisions about future directions, strategies, and the associated allocation of funds. A broker of record needs to understand that these statements often fall under close scrutiny by external parties. These could be investors seeking to invest in the brokerage, taxation authorities levying taxes based on financial performance, and lenders determining the credit worthiness and the value of a brokerage when granting loans. Financial statements involve three core documents: income statement, balance sheet, and cash flow statement. You will learn more about financial statements in detail in a later module. The following three sections contain information on the core types of financial statements.

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Income statement The income statement (sometimes called the statement of profit and loss) represents the financial performance of the brokerage over a specific period of time. Revenue and expense categories in the income statement are used to arrive at net income for the period. Brokers of record now have the advantage of computerized accounting systems that can generate income statements on demand. As a leading practice, a broker of record should review income statements on a monthly basis to confirm accuracy and question any unusual entries, such as a one-off entry of a new capital purchase or an unusually high value in a specific account like office supplies.

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Balance sheet The balance sheet represents a financial snapshot of the brokerage at a specific point in time. The balance sheet lists the brokerage’s assets and liabilities with the difference being the owner’s equity (or shareholder’s equity in the case of a corporation).

Cash flow statement The cash flow statement provides financial data relating to the source and the use of cash over a specific period of time. It classifies these transactions as operational activities (cash derived from normal business operations), financing activities (cash derived from borrowings or used for debt repayment), and investing activities (cash used to purchase capital assets or used for or derived from the purchase or sale of securities).a

competitive

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Lesson 2 | Page 10 of 28

The broker of record of a brokerage is meeting with their accountant who is describing the distinct features of the financial statements necessary for the operation of the brokerage. Identify which of the following statements is correct with respect to the distinct feature of the corresponding financial statement. There are three options. There is only one correct answer.

1

Income statement provides financial data relating to the source and the use of funds over a specific period of time.

2

Cash flow statement represents the financial performance of the brokerage over a specific period of time.

3

Balance sheet represents a financial snapshot of the brokerage at a specific point in time.

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Lesson 2 | Page 11 of 28

As a broker of record, you will be exposed to different terms when reviewing and analyzing financial statements. You will need to familiarize yourself with accounting basics and terminologies to have meaningful discussions with the administrative staff, accountant, owner (if applicable), and other external parties, such as investors, lenders, and taxation authorities.

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Lesson 2 | Page 12 of 28

Cash Accounting versus Accrual Accounting Cash accounting requires that the accounting system revenue recorded as cash is received during a specific period of time, without respect to when the goods or services were provided. Similarly, cash accounting records expenses as amounts that are disbursed during the same period, without regard to when the goods or services were received or used. The Income Tax Act restricts the use of the cash method of accounting to commissioned salespersons, farmers, and fishermen. © 2021 Real Estate Council of Ontario

Brokerages must apply the accrual method of accounting. Accrual accounting modifies cash accounting by including accounts receivable in revenue period-end; that is, money owed to the business as the date of the period-end because the goods have been delivered or the services provided (but the money has not yet been received). Similarly, liabilities incurred but not paid at the period-end are recorded and the inventory of goods on hand and projects in progress must be valued and recorded into the accounts. In other words, the accrual basis of accounting is a system of recognizing revenues and expenses when they are incurred, instead of focusing on when they are paid or collected. A broker of record should clearly understand the difference between cash and accrual accounting. The difference lies in the timing of when sales and purchases are recorded in the accounts. Cash accounting recognizes revenue and expenses only when money changes hands, but accrual accounting recognizes revenue when it is earned (but not necessarily received), and expenses when they are billed (but not paid). This means that both revenues and expenses are recognized and recorded in the accounting period when they occur instead of when payments are actually made. Brokers and salespersons use cash accounting. However, brokerages use the accrual basis of accounting that recognizes revenues and expenses when they are earned or occur because it more accurately reflects their financial position.

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Lesson 2 | Page 13 of 28

The accountant of the brokerage is discussing the principles of applying accrual accounting, among other things, with the new broker of record for a brokerage. Which of the following situations require the use of accrual accounting? There are four options. There are multiple correct answers.

1

The brokerage purchased some office supplies

2

The brokerage placed an order for “For Sale” signs and is waiting for a proof

3

The brokerage sends an invoice to a listing brokerage for a commission payment

4

The brokerage sends an invoice to the seller for arranging a residential lease

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Lesson 2 | Page 14 of 28

Double-Entry Bookkeeping Double-entry bookkeeping reflects the fact that there are two sides to every economic transaction — debit and credit. For example, if you purchase a car, you also give up some cash or incur a loan. In double-entry bookkeeping, the car is recorded as a debit and the reduction in your bank account or the loan incurred are recorded as credits. In each transaction, the debits equal the credits. People often have erroneous notions about the meaning of the terms debit and credit. Your bank statement may show a credit balance (i.e., money the bank owes you), but the reason it shows this way is that it is the bank’s credit — they have a liability to you in that they owe you the money. It is your debit, an asset. © 2021 Real Estate Council of Ontario

The balance is the dollar difference between total debits and total credits in an account. If the debits exceed the credits, the account has a debit balance; if the credits exceed the debits, the account has a credit balance.

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Lesson 2 | Page 15 of 28

Debit and Credit Entries The double-entry system is based on the principle of exchange; i.e., every business transaction involves two considerations, value received and value given. In the case of a sale, you acquire cash or an account receivable, which is recorded as a debit and you provide goods or a service, which is recorded as a credit of the same amount in a revenue account. If Harmonized Sales Tax (HST) applies on the sale, the debits will be greater than the sale amount, with the difference being credited to the HST liability account. Similarly, when you incur an expense, the amount is debited to an expense account, while the credit is recorded as an account payable or as a decrease in your brokerage’s bank account. If HST applies on the purchase, then the credit will be more, and the additional debit is recorded as HST recoverable. © 2021 Real Estate Council of Ontario

Lesson 2 | Page 16 of 28

Asset, Liability, and Equity Accounts Asset accounts represent the various types of economic resources owned or controlled by the brokerage. Some common examples of asset accounts are cash, real estate, inventory, prepaid expenses, and accounts receivable. In an asset account, such as cash, increases are recorded as debits to the account and decreases are recorded as credits. All asset accounts normally have debit balances; that is, increases are greater than decreases. Increases in liability and owners’ equity accounts are recorded by credit entries, with decreases recorded by debits. Assets and liabilities are the key ingredients of a brokerage’s financial position. When these are used to create a balance sheet, important information emerges about a brokerage’s economic situation. The relationship between entries and their position on the balance sheet may be summed up as follows: © 2021 Real Estate Council of Ontario

• Liability and owners’ equity accounts normally have credit balances • An increase in a liability or shareholder’s (owner’s) equity account is recorded as a credit You will learn more about this later in this module.

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Lesson 2 | Page 17 of 28

Revenue and Expense Accounts Revenue or income accounts represent the earnings of the brokerage, such as commissions, desk fees, revenue from salesperson’s expenses, and property management fees. Expense accounts represent the brokerage’s expenditures. Some common expense items are utilities, bank charges, payroll, advertising, taxes, and insurance. When expenses are subtracted from revenues, the result is net operating income, meaning revenue exceeds expenses. The opposite can also occur resulting in periodic losses that is when expenses exceed revenue. Net operating income represents the amount of funds available to the brokerage after all income has been realized and expenses paid. It can be used

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by a broker of record to invest money back into the brokerage for long-term growth, pay dividends and staff bonuses, provide investment capital, and secure long-term financing like mortgages. Since revenues increase and expenses decrease the owner’s equity, the rules of debit and credit for recording revenue and expenses logically follow this relationship. Applying this rule to revenue and expenses, the following applies: • Revenue increases owner’s equity; therefore, revenue is recorded by a credit • Expenses decrease owner’s equity; therefore, expenses are recorded by debits

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Lesson 2 | Page 18 of 28

The chart of accounts is a list of all accounts that comprise the accounting system for a brokerage and is used to organize financial transactions. An understanding of the chart of accounts will help you, as a broker of record, review and interpret the relevant information from the financial statements.

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Lesson 2 | Page 19 of 28

Chart of Accounts The chart of accounts is a listing of all the financial accounts in the general ledger. It is an organizational tool that provides a breakdown of all financial transactions that a brokerage would conduct during a specific accounting period. This chart includes all accounts making up the income statement and balance sheet. © 2021 Real Estate Council of Ontario

Brokerages vary in terms of the number and the variety of accounts required for an accounting system. The chart of accounts falls into five categories: assets, liabilities, equity, revenues, and expenses. From these basic categories, an income statement and a balance sheet are developed.

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Lesson 2 | Page 20 of 28

Account Groupings: Examples Individual accounts are grouped under various categories and the words parent, child, and grandchild are often used to describe these groupings. Nested grouping allows further breakdown for description to arrive at a designated account. For example, in the illustration, the initial grouping is Expense (parent), then subsequently differentiated from other expenses under the category Communication Expense (child), and lastly by its designated account name Telephone Expense (grandchild). This helps a broker of record specifically identify the Telephone Expense instead of a grand total of expenses. The chart of accounts may be grouped depending on the type of entry being listed. The following three sections contain a few typical examples of account groupings.

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Billboard Billboard advertising is an expense account on the income statement. In the case of billboard advertising, the initial grouping is Expense (parent), then subsequently differentiated from other expenses under the category Advertising (child), and lastly by its designated account name Billboard (grandchild).

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Bank – general account Bank – general account is an asset account on the balance sheet. All assets are divided into either current or fixed categories. Therefore, it is initially defined as an asset account (parent), more specifically as a current asset (child), and lastly by its designated account name Bank — general account (grandchild).

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Financial statements The chart of accounts is also grouped in terms of whether the account is normally a debit or a credit account. Debits and credits become very important in the posting procedure.

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Lesson 2 | Page 21 of 28

Numbering and Expansion Although account numbers may not be required by an accountant, they are usually assigned as a means of streamlining the accounting system. This aids the broker of record in categorizing income and expense accounts and in searching for entries in an automated system. No fixed rules exist for assigning account numbers, but assets usually appear first, followed by liabilities, equity, revenues, and expenses. The accounts can be expanded at any time. If a certain area of expense is to be tracked, then appropriate account numbers are assigned, along with account names. This information is added to the chart of accounts and the general ledger.

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Most computerized accounting packages use a suggested chart of accounts that can be modified on the recommendations of an accountant to reflect the unique financial circumstances of a brokerage. All charts of account, however, will contain the five basic categories of accounts that can be expanded, as required. As you learned earlier in this module, these categories are assets, liabilities, equity, revenue, and expenses. For example, an advertising expense account can be expanded using sub-categories for items such as classified ads, online advertising, billboards, community events, etc. In this case, expenses would be a “parent” category. A further breakdown of expenses would be advertising (child). Even further, it can be broken down to billboards (grandchild) to allow for a better understanding. Additional Examples of Numbering and Expansion for Illustrative Purposes: Example 1: A broker of record concentrates their advertising strategy on social media. Originally, one account was provided in the chart of accounts, #6050 – Social Media. However, an increase in accounts appears wise to provide a more accurate delineation of expenditures: • Acct. #6050.001 – Social Media, Facebook • Acct. #6050.002 – Social Media, Twitter Example 2: A chart of accounts should provide flexibility for future expansion of the business. This can be accomplished by providing sufficient numerical space between initial accounts to allow for new accounts (e.g., 6050, 6100, 6150, 6200, etc.). Further, a suffix can be added to the base number to identify departments or branches. A broker of record is opening a new branch in West Side and wants various expenses allocated between the main and branch offices. They establish as follows: • Acct. #6200.001 – Rent Expense, Lease Head Office © 2021 Real Estate Council of Ontario

• Acct. #6200.002 – Rent Expense, West Side Branch • Acct. #6200.003 – Rent Expense, East Side Branch • Acct. #6200.004 – Rent Expense, North Side Branch

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Lesson 2 | Page 22 of 28

Revenue Account Groupings No standardized set of revenue accounts exists. A broker of record can exercise discretion in establishing these accounts; suggested groupings are included for illustrative purposes only. The suggested groupings provide certain advantages for month-to-month and year-to-year comparisons. © 2021 Real Estate Council of Ontario

The recommended order can be customized to suit a particular brokerage’s business model and specific needs. The following two sections contain information on guidelines and rationales for the two categories of revenue accounts.

Gross revenue (incoming revenue) • Commission: Commission revenues can be divided into residential, commercial, or other categories, as required. Note: A similar change should then be made in the commission expense category to mirror this alteration; i.e., Commission to Brokers and Salespersons (Res.) and Commission to Brokers and Salespersons (Com.). • Referral commission: This revenue account represents all revenue received from outgoing referrals. Minimal expense is incurred to generate this revenue, so it is an interesting category to track in terms of bottom line results. • Desk fees: All revenues generated from desk fee arrangements are entered on this line. Desk fee is typically a monthly fee paid to the brokerage by brokers and salespersons for use of desk or office within brokerage premises. This account category applies to desk fee brokerages, as well as to those brokerages offering different compensation models (including desk fees). © 2021 Real Estate Council of Ontario

• Commissions and fees generated by owner: Isolating owner-generated revenue provides a more accurate picture of brokerage performance (with or without owner revenues). A corresponding expense account, which isolates the owner’s commission payout, appears under the commission expense grouping. • Other revenue: Other revenue can involve property management, appraisal, and incidental revenue. This miscellaneous revenue source account is needed so that pure commission revenues are accurately isolated for analysis and tracking purposes. A more detailed set of accounts is required with brokerages having specific departments and/or branches. Other revenue can also include penalties and interest charges; for example, revenue generated from overdue broker and salesperson accounts.

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Commissions to other brokerages (to arrive at adjusted gross revenue) • Commission (other brokerages): This account is grouped under revenues but would have a debit balance (rather than a credit balance usual to revenue accounts), given revenue is being paid out to other brokerages. Commission (other brokerages) is placed in the revenue account grouping, so that these payouts are deducted from total revenue, thereby resulting in an accurate adjusted gross revenue for the brokerage. • Referral commission (other brokerages): This referral payout refers to monies received to which referral cheques should be issued to other brokerages. The total revenue received is not specifically isolated, as it is included in Commission. As with commission (other brokerages), this account is grouped under the revenue accounts, but would have a debit balance.

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Lesson 2 | Page 23 of 28

Expense Account Groupings As with revenue accounts, as a broker of record, you can establish expense account groupings based on personal preferences. A template for ongoing expense analysis is displayed for illustrative purposes. Accounting advice from a third-party service provider, such as an accountant, should be sought when setting up individual accounts under these and associated groupings. Expense Accounts: Guidelines/Rationale • Commission: This account grouping provides ongoing expense data concerning commission plans and payouts. Commission payouts are useful for internal month-to-month or year-to-year comparisons. Brokerage-tobrokerage comparisons are not normally possible, given unique variables affecting payout within different brokerages; for example, broker and salesperson participation in expenses and payment of desk fees. © 2021 Real Estate Council of Ontario

• Advertising: This account grouping would include most advertising media usual to a real estate brokerage. • Personnel: Ensure that all source deductions (Employment Insurance and Canada Pension Plan) expenses are included, as well as Employer Health Tax (if applicable). Owner’s salary should be isolated and full- and part-time staff should be separated to meaningfully analyze costs. • Communication: Brokerages typically incur various communication expenses. For example, telephone expense is usually grouped under equipment costs and long distance. This allows for recovery of toll charges from brokers and salespersons (see subsequent discussion on recoverable or shadow expenses). • Occupancy: If owner-occupied, the rent should be the economic rent for the premises. The range of accounts will vary based on specific occupancy arrangements.

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Lesson 2 | Page 24 of 28

Operating and General Expenses The division of expense accounts beyond the main account groupings (of commission, advertising, personnel, communication, and occupancy expense) is a decision normally made by a third-party service provider, such as an accountant. The subcategories are used to provide greater clarity to the reader of the statements regarding the expense transactions of the brokerage. Brokerage accounts often include categories such as selling expense, sales and promotion, administration expense, and sales and marketing expense. These may be adequate but can prove difficult to properly analyze. As an option, a brokerage should consider the simplicity of two groupings, operating expenses and general expenses. The following two sections contain information on operating and general expenses.

Operating expenses Operating expenses are the costs involved in running the day-to-day operations of a brokerage and include costs for brokerage’s membership fees to local listing board, office supplies, photocopying, printing, postage, etc. As a general guideline, operating expenses vary with brokerage sales production. These variable expenses may or may not be recovered from brokers and salespersons, depending on the specific compensation plans being used.

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General Expenses General expenses include expenses incurred while running the core line of the brokerage. General expenses vary only slightly with production levels. They tend to be fixed and somewhat predictable on a year-to-year basis. Normally, most somewhat stable overhead expenses would appear in this category, as would professional fees, legal costs, registration (brokerage only) and any other required licences, automobile expenses involving brokerage vehicles and associated costs, bank charges (penalties, charges and related costs owed to lending institutions), and depreciation concerning owned equipment.

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Lesson 2 | Page 25 of 28

General and Operating Expenses: Examples EXAMPLE 1: Photocopier The photocopier lease is $233 per month and the current supplies used are $197. The lease is a general expense for the brokerage; the supplies are an operating expense as they vary from month to month. Supplies, along with the lease cost, may be recovered through copy charges to broker and salesperson. Alternately, the lease can be absorbed either as part of office expenses and built into the overall commission split or covered through a desk fee. EXAMPLE 2: Automobile Owner’s automobile lease is $583 and gasoline for the automobile is $139. Both are charged to general expenses as these costs are part of the brokerage overhead. © 2021 Real Estate Council of Ontario

EXAMPLE 3: Real estate boards Real estate board invoice is $955 ($300 for brokerage membership, $100 each for five salespersons, and $155 for board supplies). The $300 is a general expense, the dues of $500 for the salespersons is a general expense that may be ultimately recovered, and supplies of $155 is an operating expense.

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Lesson 2 | Page 26 of 28

A broker of record is reviewing the allocation of expenses into operating or general expenses with the new bookkeeper. Identify which of the following are operating expenses. There are four options. There are multiple correct answers.

1

An owner’s car lease is $453 and gas for the car is $120

2

The cost of photocopier supplies used this month is $170

3

A real estate board invoice of $887 for broker of record membership

4

An invoice of $600 from the photographer

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Lesson 2 | Page 27 of 28

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Describe the key components of an accounting system framework for a brokerage • Describe accounting basics that apply to a brokerage • Determine the typical setup of account structure in a brokerage There are five sections on this page with a summary of the key topics that were discussed in this lesson.

Accounting systems

Accounting systems are an integral tool for financial management in a brokerage. They are designed to help you, as a broker of record, make better spending decisions, create accurate financial reports, and manage assets. The accounting system refers to the numeric values captured in various documents and not the storage of these documents. A basic accounting system consists of source documents, journals, and a general ledger. The trial balance and the financial statements are derived from details found in the general ledger.

Journal

A journal provides a format where transactions are recorded in chronological order as they occur, resulting in a sequenced financial record of all similar transactions of the business. There are four basic journals: • • • •

Cash receipts journal Cash disbursements journal Payroll journal General journal © 2021 Real Estate Council of Ontario

General ledgers

The general ledger is comprised of a listing of accounts representing the various assets, liabilities, revenues, and expenses of the brokerage. Each account in the general ledger has a cumulative debit, credit, or nil balance.

Trial balance

The trial balance is a list of all accounts and their balances after the closing entries have been recorded in the journal and posted to the general ledger. The information is displayed in three columns: account names, debits, and credits.

Financial statements

Financial statements provide the backdrop for sound decision making based on a brokerage’s ongoing financial performance. Financial statements involve three core documents: • Income statement: Represents the financial performance of the brokerage over a specific period of time • Balance sheet: Provides a financial snapshot of the brokerage at a specific point in time • Cash flow statement: Provides financial data relating to the source and use of cash over a specific period of time

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Lesson 2 | Page 28 of 28

There are three sections on this page with a summary of the addittional key topics that were discussed in this lesson.

Cash versus accrual accounting

Cash accounting requires that the accounting system revenue recorded as cash is received during a specific period of time, without respect to when the goods or services were provided. Accrual accounting modifies cash accounting by including accounts receivable in revenue period-end; i.e., money owed to the business as the date of the period-end because the goods have been delivered or the services provided.

Double-entry bookkeeping

Double-entry bookkeeping reflects the fact that there are two sides to every economic transaction – debit and credit. The double-entry system is based on the principle of exchange; i.e., every business transaction involves two considerations, value received and value given. In the case of a sale, you acquire cash or an account receivable, which is recorded as a debit and you provide goods or a service, which is recorded as a credit of the same amount in a revenue account.

Chart of accounts

The chart of accounts is a listing of all accounts that comprise the accounting system for a brokerage and is used to organize financial transactions. This chart includes all accounts making up the income statement and the balance sheet. Individual accounts are grouped under various categories and the words parent, child, and grandchild are often used to describe these groupings. As an option, a brokerage should consider the simplicity of two groupings, operating expenses and general expenses. © 2021 Real Estate Council of Ontario

Lesson 3 | Page 1 of 11

Lesson 3: Tracking System for Expenses This lesson describes the difference between a recoverable and a non-recoverable or shadow expense. This lesson also provides a detailed sample of a broker or a salesperson account that is, a summary of the monies owed to the brokerage. The broker or the salesperson account further portrays the individual’s performance in relation to nonrecoverable expenses and the net contribution of the broker and the salesperson from the brokerage’s perspective.

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Lesson 3 | Page 2 of 11

When recruiting and retaining brokers and salespersons, brokerages may sometimes consider offering high commission splits in addition to other value propositions owing to a highly competitive marketplace. In such cases, brokerages need to be attentive to the expenses, as they can impact profits and long-term sustainability. It is important to carefully consider the sustainability of the commissions and value propositions offered to brokers and salespersons without having to retract in the future. As a broker of record, you need to realize that any increase in expense needs to be recovered from somewhere else. When tracking expenses, you will need to examine whether the brokerage expenses are in line with productivity or if the costs are higher than expected. If the costs are higher than expected, you need to decide if they can be charged back to the broker or the salesperson and recovered. If the costs cannot be recovered, you need to see if the tasks © 2021 Real Estate Council of Ontario

can be outsourced to keep the expenses in line. This may not be a simple solution, as it may impact the employment of the administrative staff. Upon completion of this lesson, you will be able to: • Identify tracking systems for recoverable and non-recoverable expenses for a brokerage • Determine recoverable and non-recoverable expenses for broker and salesperson accounts Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

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Lesson 3 | Page 3 of 11

Tracking expenses and balancing them against the revenue will help you, as a broker of record, identify ways to ensure brokerage sustainability and growth. For example, expenses can sometimes be offset to a degree by an increase in the productivity of brokers and salespersons due to the increase in sales volumes. When examining expenses, you may realize that they can be recovered by an increase in productivity. If not, you may consider recovering the cost of expenses that can be attributed to each broker and salesperson. Recoverable expenses are billed directly to the individual while non-recoverable expenses are covered through commission splits and other revenue sources. Advertising, photocopying, signs, supplies, etc. are count as recoverable expenses. Other expenses, such as lease costs for brokerage premises, or administrative staff salaries that cannot be directly attributed to a broker or salesperson, are considered non-recoverable expenses. © 2021 Real Estate Council of Ontario

Two expense tracking methods are typically used by brokerages: • Recoverable expenses tracked and invoiced to an individual broker or salesperson • Expense items tracked for management control and budgeting purposes that are not billed and are not directly recovered from brokers and salespersons

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Lesson 3 | Page 4 of 11

Recoverable Expenses As part of the recruitment process, brokerages define, discuss, and document the compensation package offered to brokers and salespersons in the employment contract. You will learn more about this in a later course. As part of the compensation package, brokerages may detail expenses that brokers and salespersons would be responsible for. The brokerage may initially pay these expenses and then recover the amount through monthly billings. When recovering expenses, the brokerage will track total expenses by category, recovered amounts from brokers and salespersons, and any net amount within the specific expense account, such as advertising or communication. When the brokerage uses recovery accounts, expense categories are divided into two major columns. The first column contains total expenses and recovered expenses, while the second column provides cumulative figures for each account, showing the net expense to the brokerage. Example of Expense Categories for Illustrative Purposes: Total expenses and recovered expenses Newspaper – classified = $7,239.49 Newspaper – classified (recovered) = –$5,329.92 Cumulative figure: Net newspaper – classified = $1,909.57 The recovery account system has proven attractive to brokers of record, given its accuracy in tracking gross expenses, recoverable amounts, and net brokerage expenditures. This arrangement also provides a meaningful grouping by expense category within the income statement. Otherwise, monies collected from individual brokers and salespersons would be lumped together and recorded as other © 2021 Real Estate Council of Ontario

revenue, with no adjustment made to appropriate expense categories. This approach can produce a much-distorted revenue and expense picture. Having an accurate net amount to an expense can help a broker of record identify the brokerage expenses at a granular level. For example, in the illustration above, the actual expense to the brokerage for newspaper – classified is $1,909.57 and not $7,239.49.

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Lesson 3 | Page 5 of 11

Expense Categories Most expense categories can be viewed as recoverable. Some are tracked by exact usage (for example, long distance, photocopies, and classified advertisements), while others are prorated (for example, meeting costs, charitable events, and special promotions). Recovery amounts and allocations will vary by brokerage, based on contractual arrangements with individual brokers and salespersons.

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In theory, brokerage recoverable accounts would be at zero if all funds expended are retrieved from the brokers and the salespersons. Recovery accounts are usually set up to show: • Total paid by brokerage • Total recovered from brokers and/or salespersons • Net paid by brokerage (if any) A residual amount in the net paid by brokerage could be recovered by a desk fee, retrieved through a general levy, or treated as a brokerage expense offset by brokerage revenues. Following is an example of expense categories: • Newspaper–Classified = $7,239.49 • Newspaper–Classified (Recovered) = –$5,329.92 • Net Newspaper–Classified = $1,909.57 • Sign Installations = $659.50 • Sign Installations (Recovered) = –$175.50 • Net Sign Installations = $484.00 • Telephone–Long Distance = $739.45 • Telephone–Long Distance (Recovered) = –$321.00 • Net Telephone–Long Distance = $418.45

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Lesson 3 | Page 6 of 11

Shadow Expense Accounts The shadow expense account system focuses on non-recoverable expenses incurred by the brokerage. The approach is used by brokerages to track and to allocate expenses to individual brokers and salespersons, even though no © 2021 Real Estate Council of Ontario

attempt is made to collect these amounts. The shadow expense system more accurately portrays revenue performance of a broker or a salesperson in relation to the costs of having that individual work for the brokerage. The term “shadow” refers to the fact that the tracking of these items is separate from the formal bookkeeping system within the brokerage. Variations are often found in the marketplace, based on specific commission plans and unique requirements within brokerage offices. For example, in a desk fee operation, the desk fee payable would also be included to fairly reflect broker or salesperson contribution to the overall brokerage operation. Following is an example of shadow expense accounts: Broker of Record Gallo sets up a detailed chart of accounts including recovery accounts for a branch office. Following is an example using three operating expense categories (totals for all brokers and salespersons): • • • • • • •

Advertising/Classified = $4,421.00 Advertising/Classified (Recovered) = –3,627.45 Net Advertising/Classified = $793.55 Photocopier = $148.00 Board Fees = $1,728.00 Board Fees (Recovered) = –1,470.00 Net Board Fees = $258.00

The broker of record, in developing these accounts can precisely track both Advertising/Classified and Board Fees, but not individual usage associated with the photocopier. While it is possible to introduce a card access system for the copier and precisely charge for copies, the broker of record wants to track this type of expense outside of the bookkeeping system, but not charge the brokers and salespersons. In other words, she wants a shadow system that is not part of the formal bookkeeping system. In theory, any number of office expenses can be allocated as either recoverable or shadow items. The individual registrant’s account can be simple or complex at the discretion of the brokerage.

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Salesperson Lee, according to photocopy records, used 346 copies during the month of May. His statement of account will not reflect the shadow expense of (346 x .10) $34.60. However, the broker of record’s version will show the full statement reflecting both recoverable items and the photocopy allocation. Once shadow expense accounts are developed, an additional subsection would be required in a detailed statement of account provided to a broker or salesperson.

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Lesson 3 | Page 7 of 11

As a broker of record, it is important for you to be able to review billed recoverable expenses, shadow expenses, and the net contribution of the individual broker or salesperson to the brokerage. This will provide you with information on individual production levels but more importantly on how much revenue a salesperson is contributing to the nonrecoverable expenses, as well as their net contribution to the brokerage. This information will assist you in making strategic decisions around compensation, performance management, training, and coaching brokers and salespersons. © 2021 Real Estate Council of Ontario

Lesson 3 | Page 8 of 11

Detailed Broker or Salesperson Account

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A detailed broker or salesperson account summarizes the monies owed to the brokerage and the net contribution (brokerage portion of commission revenue less shadow expenses) of the broker or the salesperson from the brokerage’s perspective. The detailed broker or salesperson account would only be made available to the broker of record. The broker or the salesperson would only receive the “Billed Expenses” part. The illustration shows a detailed salesperson account, which includes billed (recoverable) expenses and shadow expenses, along with net contribution from the brokerage’s perspective. As of May 31, a salesperson has an outstanding balance of $75 on their account. In other words, the salesperson owes $75 to the brokerage. Total commission revenue (brokerage portion) for the month of May ($3,727.50) – Total shadow expenses for the month of May ($2,089.80) = Net contribution of the salesperson for the month of May ($1,637.70). This is an opportunity for the brokerage to focus on the salesperson’s performance in relation to non-recoverable expenses against the revenue earned from the salesperson.

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Lesson 3 | Page 9 of 11

Net Contribution Net contribution – sometimes referred to as net worth – is a powerful tool for owners and brokers of record, as it provides a true picture of the broker’s or the salesperson’s contribution to the bottom line that is the revenue of the © 2021 Real Estate Council of Ontario

brokerage. Owners and brokers of record are often swayed by the gross earnings of brokers and salespersons, only to discover that while a significant cash flow was created, it resulted in low profitability. Conversely, brokers and salespersons with average commission earnings may demonstrate high profitability, given prudent advertising methods and limited use of brokerage facilities. A broker of record can use month-to-month or year-to-year net contribution calculations for coaching and performance reviews, expense analysis, production goals, and overall brokerage contribution. Net contribution can be applied to almost any commission arrangement offered through a real estate brokerage. As with most performance indicators, this technique is best viewed in combination with other management and financial inputs. Net Contribution = Commission Revenue (Brokerage Receivable) – Shadow Expense Commission revenue may also include additional revenue earned by the brokerage (such as desk fee or fees from office space, administration fee, or transaction fee) from the broker or the salesperson, as per employment agreement. Following is an example of net contribution: Broker of Record Gallo sets up a detailed chart of accounts including recovery accounts for a branch office. Following are two examples based on a monthly desk fee plan and an 80/20 commission plan for Salesperson A and Salesperson B: Desk Fee Plan—Salesperson A, May 2020 • • • • • •

Brokerage Revenue Monthly Desk Fee = $ 842 5% of Gross Commission Revenue = 1,000 Transaction Fees = 200 Recoverable Expenses (All variable expenses recovered) = 0 Shadow Expenses (Occupancy, Staff and Communication) = –490 © 2021 Real Estate Council of Ontario

• Net Contribution = 1,552 80/20 Commission Plan—Salesperson B, May 2020 • • • •

Brokerage Revenue (20% of Gross Commission Revenue) = $ 4,000 Selected Recoverable Expenses (Advertising, Telephone and Board Dues) = 0 Shadow Expenses (All Remaining Expenses Paid By Brokerage) = –2,448 Net Contribution = 1,552

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Lesson 3 | Page 10 of 11

While reviewing the brokerage’s financial position, a broker of record is establishing new commission plans and addressing recoverable and non-recoverable expenses. Identify which of the following items fall under recoverable expenses for the brokerage. There are four options. There are multiple correct answers.

1

Property listing board fees and advertising costs – classified

2

Leased premises for the brokerage

3

Leased photocopier

4

“For Sale” sign installations

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Lesson 3 | Page 11 of 11

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Identify tracking system for recoverable and non-recoverable expenses for a brokerage • Determine recoverable and non-recoverable expenses for broker or salesperson accounts There are three sections on this page with a summary of the key topics that were discussed in this lesson.

Recoverable and nonrecoverable expenses

Recoverable expenses are billed directly to the individual while non-recoverable expenses are covered through commission splits and other revenue sources. Advertising, photocopying, signs, supplies, etc. are count as recoverable expenses. Other expenses, such as lease costs for brokerage premises, or administrative staff salaries that cannot be directly attributed to a broker or salesperson, are considered non-recoverable expenses. Two expense tracking methods are typically used by brokerages: • Recoverable expenses tracked and invoiced to an individual broker or salesperson • Expense items tracked for management control and budgeting purposes that are not billed and are not directly recovered from brokers and salespersons

Shadow expense accounts

The shadow expense account system focuses on non-recoverable expenses incurred by the brokerage. This approach is used to track and to allocate expenses to individual brokers or salespersons, even though no attempt is made to collect © 2021 Real Estate Council of Ontario

these amounts. A shadow expense system more accurately portrays broker and salesperson revenue performance in relation to the costs of having that individual work for the brokerage. The term “shadow” refers to the fact that the tracking of these items shadows and is separate from the formal bookkeeping system within the brokerage.

Net contribution

Net contribution can be an effective management tool to assess the financial contribution of an individual broker or salesperson towards brokerage profitability. Net contribution can be applied to almost any commission arrangement offered through a real estate brokerage. Net Contribution = Commission Revenue (Brokerage Receivable) – Shadow Expense

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Lesson 4 | Page 1 of 12

Lesson 4: Internal Administration Controls

This lesson describes the leading practices for internal administration controls to ensure the accuracy and validity of accounting records. This lesson also describes key guidelines for identifying and preventing fraudulent activities in a brokerage.

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Lesson 4 | Page 2 of 12

As a broker of record, you will need to extend your focus beyond tracking expenses to all aspects of the accounting systems and practices followed in your brokerage. When setting up a brokerage, you will consult an accountant to understand what policies, procedures, and controls should be established in your brokerage to document and review accounting records. For example, the accountant may suggest restricting data entry and access to authorized individuals in the brokerage, which will help protect data integrity and security. They may also recommend setting up procedures to record and review data, such as using source documents (invoices, trade-related files, etc.) for crossreferencing. Further, when acquiring a brokerage, you will also need to be familiar with its existing policies, procedures, and controls. © 2021 Real Estate Council of Ontario

Internal administration controls help ensure validity and accuracy in a brokerage’s accounting records. You can use administration controls to prevent errors in accounting records and avoid the occurrence of fraud. You learned about risk response strategies in a previous course. These administration controls can help you avoid and mitigate risks related to accounting practices followed in your brokerage. Upon completion of this lesson, you will be able to: • Explain key internal administration controls that apply to a brokerage • Explain guidelines for fraud prevention that apply to a brokerage Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 3 of 12

As a broker of record, you will need to consult with an accountant to develop, implement, and maintain policies, procedures, and administration controls. The accountant will also assist you with the ongoing application of these controls. However, it is still your responsibility to enforce the implementation of the defined policies, procedures, and controls. You will need to audit the administration controls to ensure they are achieving the desired results.

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 4 of 12

Internal Administration Controls The internal administration controls rely on hiring the right administrative staff who will then be responsible for data entry and maintenance of the accounting system. Implementing strict controls of access to the existing system is one of the leading practices that can help you maintain data integrity. Accurate, timely information relies completely on data integrity and how that data is interpreted and input into the accounting system. These controls also create an avenue to systematically audit data to determine unusual activity or potential fraud. The following four sections contain information on leading practices designed to assist brokers of record when implementing internal administration controls for single-office brokerages, as well as for multiple-branch operations.

Deposit books Deposit books provide details regarding deposits made on a specific date and acknowledged by the bank through a teller’s stamp and initials. As per leading practices, deposits should clearly indicate crossreferencing information, such as name of individual or company, trade number, and property address to avoid confusion when backtracking for errors.

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Cheques and stubs (or duplicates) For cheques and stubs, leading practices suggest: • Identifying all pertinent details clearly to avoid any confusion • Creating an accurate paper trail and minimize timeconsuming error searches • Storing pre-numbered blank cheques in a secure location. Keep all voided cheques (or copies, if applicable) • Not signing blank cheques, cheques without supporting documentation, or have cheques made out to cash • Not delegating cheque-signing authority, unless absolutely necessary. Use a two-signature approach if administrative staff are involved in cheque signing

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Invoices Some leading practices that a broker of record should ensure that the administrative staff fulfills are: • Checking the calculations on each invoice and matching details to the original purchase order (or other internal purchase record, as applicable) • Verifying that the purchased item has been received and is as requested • Checking the invoice for proper delivery, penalty, or other charges, as originally agreed • Using the “paid” stamp with date paid, initials, amount, and payment method (including cheque number, if applicable) if the invoice is paper based

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Cash receipts and disbursement journals Some leading practices related to cash receipts and disbursement journals are: • If using manual paper-based system, it is recommended to use separate journals. • Accounting programs are sorted by the date entered by the user, regardless of the order in which items are entered. If using manual paperbased system, all disbursements should be recorded in a chronological order. • Structuring of these journals will vary based on the chart of accounts, size of brokerage operation, and accounting procedures used. • Fully identifying entries in journals and supporting records for cross-referencing purposes.

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Lesson 4 | Page 5 of 12

Internal Administration Controls The following four sections contain information about additional leading practices designed to assist brokers of record when implementing internal administration controls for single-office brokerages, as well as for multiple-branch operations.

Payroll journals Some leading practices related to payroll journals that brokerages can follow are: • Preparing a ledger sheet for each employed broker, salesperson, and salaried staff member • Including all details related to payroll and commission payment entries, trade and address identification (as required) and deductions (as applicable) • Considering that salaried staff are subject to source deductions • Remitting Income Tax, CPP, EI, and Employer Health Tax (if applicable) for brokers and salespersons (employee status only) and salaried staff. EI is available for self-employed people (i.e., independent contractors) © 2021 Real Estate Council of Ontario

General journal A leading practice related to journals is to ensure that the journal is limited to non-routine transactions; for example, writing off bad debts and adjustments to close books at year end.

General ledger Some leading practices related to general ledgers are: • Entries are cross-referenced to the originating journal • Every account has a debit, credit, or nil balance • Total debit balances equal total credit balances for the books to be in balance

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Trial balance A broker of record should check trial balance carefully. Achieving balance is not necessarily a guarantee of accuracy. Discrepancies may exist; for example, transaction was not posted, is posted twice, or is posted in reverse. Such circumstances would result in over or under statements of selected accounts, but books would remain in balance.

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Lesson 4 | Page 6 of 12

Leading Practices for General Administration Control A broker of record should ensure that internal administration policies, procedures, and controls have been developed and implemented when setting up a brokerage or are in place when acquiring one. A broker of record can implement the following leading practices for general administration controls in their brokerage: • Limit the use of petty cash, wherever possible: Use of cash can be difficult to track, predict, and plan as an expense. If misused, it could reduce profitability. • Review all pending trades and cash flow projections on a regular basis. Have accounting staff provide frequent financial updates, particularly detailed cash flow reports: This will help with up-to-date record of upcoming receivables. • Invest in brokerage accounting software: Accounting software provides all the necessary tools to track financial performance, along with appropriate reports. • Schedule routine inspections of accounting records, with particular emphasis on pending, closed, and cancelled trade-related files: Routine inspections help ensure that proper recordkeeping is applied. • Ensure monthly reconciliations for the real estate trust account, commission trust account, and general account are properly reviewed and accurate before signing and dating: A review of monthly reconciliations will help verify that the source of all monies being deposited to and disbursed from these accounts are properly maintained. • Insist on a monthly reconciliation of pending trades to commission pending: This will help with up-to-date record of upcoming commissions receivable. © 2021 Real Estate Council of Ontario

• Ensure that all government remittances are processed in a timely manner: This will help to avoid any penalties or other problems. • Monitor all broker and salesperson accounts (for example, desk fees, other fees, and recoverable amounts): This will help manage receivables effectively; for example, charge interest on overdue amounts and, in cases of no pending trades, arrange for post-dated cheques over a period of time to satisfy the outstanding amount. • Ensure that all outstanding obligations of a brokerage employee are settled before a final cheque is issued at point of termination: This will help avoid difficulty in recovering money owed to the brokerage at a later stage. • Delegate functions, but not necessarily the associated authority. Delegate authority only when warranted and then only within defined limits: Effective delegation ensures proper accountability and responsibility. For example, a broker of record can authorize the administrative staff to make some emergency purchases within a budget. • Develop office procedures that clearly delegate responsibilities and provide for separation of duties. For example, delegate, where feasible, to an individual who signs cheques for the general account. However, this could be different from the individual providing bookkeeping services involving that account. The reconciliation should be further reviewed and approved by the broker of record: This establishes a review mechanism, which reduces the probability of errors and fraud occurrence. • Ensure that an employee is only placed on payroll when all required documentation is in the employee’s file: Employee records must be maintained by the brokerage to comply with legislative requirements. • Require secrecy and confidentiality agreements when individuals are in key administrative positions: This will help protect unauthorized access and misuse of the brokerage’s intellectual property. It will also help the brokerage fulfill fiduciary duties to their clients and customers. • Instruct the bookkeeper to immediately report any irregularity in the accounting system to the broker of record (or other delegated individual): Encouraging the staff to report unusual entries and errors can help a broker of record mitigate any risks to the brokerage. © 2021 Real Estate Council of Ontario

Lesson 4 | Page 7 of 12

A broker of record is establishing a checklist of leading practices regarding general administrative procedures to be followed by the brokerage. What should the broker of record include in the checklist? There are four options. There is are multiple correct answers.

1

Outstanding obligations on an employee account should be cleared within four months following the date of termination from the brokerage.

2

Frequent financial updates, particularly detailed cash flow reports, should be provided by the accounting staff.

3

Reconciliations should be reviewed and approved by the brokerage administrator.

4

Routine inspections of accounting records should be scheduled, with emphasis on pending, closed, and cancelled trade-related files.

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Lesson 4 | Page 8 of 12

A brokerage can become a victim to fraud. An understanding of types of fraud that can impact a business (and by extension, brokerages) and important warning signs can help you, as a broker of record, to protect your brokerage. You should also include this subject when defining the training topics for your brokerage staff. An accountant will help you develop policies and procedures to prevent cases of fraud. However, as the broker of record, it will be your responsibility to be attentive to financial matters and enforce these policies.

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Lesson 4 | Page 9 of 12

Types of Fraud Two types of fraud are predominantly observed in businesses across the country and are referred to as off book and on book. Off book fraud is most commonly associated with illegal payments and criminal activities, typically involving drug trafficking, protection rackets, skimming, and the like. Off book fraud, from a brokerage perspective, can involve agreements of purchase and sale, property flips, mortgage financing, and associated fraudulent misrepresentations. On book fraud concerns fraud involving the books of account of the business. On book fraud can arise either through some form of false financial reporting or financial records (or other source documents) that are either manipulated, falsified, or altered. Misrepresentations can involve more than one individual and typically revolve around the omission of salient information, the direct theft of monies or other assets, embezzling, and misuse of assets accompanied by misleading documents to obscure the fraud. © 2021 Real Estate Council of Ontario

The majority of on book fraud is committed by employees and most is discovered simply by chance. In these cases, management actions to prevent fraud are typically reactive in nature; that is, a sincere effort is made to stop the problem only after it is discovered. Usually, on book fraud in brokerages involves an administrative staff member with access to the accounting system. For example, incorrect expense items can be created whereby the payment of the account payable will be made to a fictitious third party or a family member. When creating receivables, the invoice can be inflated, and the staff member can skim the inflated amount when the payment is received. Petty cash can be pilfered, and bogus receipts can be used to account for the stolen funds. Although, on a positive note, proactive prevention controls can dramatically reduce fraud risk. You learned about the leading practices for general administration controls earlier in this module. When these practices are followed, they can help you prevent the occurrence of fraud in your brokerage.

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Lesson 4 | Page 10 of 12

Warning Signs of Fraud Potential warning signs of a fraud taking place in a brokerage include: • Administrative staff are overly evasive in response to direct questions concerning brokerage operations. • Brokerage displays weak financial controls in the form of lack of supervision, no controls over who has access to information, and infrequent reviews. For example, due to excessive workload, lack of accounting knowledge, and inefficient delegation, the broker of record may not pay the required amount of attention to financial reports. Lack of supervision over the administrative staff may lead them to engage in fraudulent activities. © 2021 Real Estate Council of Ontario

• Management and administrative personnel demonstrate a lack of respect for regulatory bodies. This could result in a pervasive attitude of not following rules, which could degenerate into illegal activity. • Management is effectively controlled by one individual other than the owner or the broker of record, or by a few persons routinely acting in concert beyond the immediate perusal of senior management. • Risks are routinely taken (such as ordering supplies without authenticating the supplier, inflating invoices from suppliers and skimming the excess, unauthorized payroll adjustments, holding bills for unusual periods of time due to unrecorded for cash flow shortages, etc.), and the brokerage does not define and/or frequently update policies and procedures. • Brokerage is only loosely structured in terms of management reporting mechanisms and lacks an ongoing plan for monitoring financial and other performance indicators. This results in the administrative staff member making decisions without discussing with the broker of record. • Profitability is not in step with other similar brokerages in the marketplace. However, profitability may not be in step with other brokerages due to poor management and a proper investigation of the causes is important. A broker of record should establish policies and procedures to avoid these potential cases of fraud. If they identify any warning signs in their brokerage, it is in their best interest to investigate the causes and even consult with third-party professionals, if required.

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 11 of 12

A broker of record is establishing policies and procedures for their new brokerage to prevent any occurrence of fraud. What leading practices should the broker of record implement to prevent fraudulent activities? There are four options. There are multiple correct answers.

1

Cheques should not be signed unless accompanied by supporting documentation.

2

Mail (paper and electronic) should be not be handled and opened by anyone other than the individual delegated to bookkeeping and other financial recordkeeping.

3

Access level to brokerage accounting software should be limited.

4

Controls for managing purchases and payment of office supplies should be assigned to one administrative staff person.

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 12 of 12

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Explain key internal administration controls that apply to a brokerage • Explain guidelines for fraud prevention that apply to a brokerage There are two sections on this page with a summary of the key topics that were discussed in this lesson.

Leading practices for general administration control

As a broker of record, you will need to extend your focus beyond tracking expenses to all aspects of the accounting systems and practices followed in your brokerage. You will need to consult with an accountant to develop, implement, and maintain policies, procedures, and administration controls. The accountant will also assist you with the ongoing application of these controls. Some of the leading practices for general administration control are: • Limiting the use of petty cash, wherever possible • Reviewing all pending trades and cash flow projections on a regular basis and have accounting staff provide frequent financial updates, particularly detailed cash flow reports • Investing in brokerage accounting software • Scheduling routine inspections of accounting records, with particular emphasis on pending, closed, and cancelled trade-related files

© 2021 Real Estate Council of Ontario

• Ensuring monthly reconciliations for the real estate trust account, commission trust account, and general account are properly reviewed and accurate before signing and dating • Insisting on a monthly reconciliation of pending trades to commission pending • Ensuring that all government remittances are processed in a timely manner • Monitoring all broker and salesperson accounts (for example, desk fees, other fees, and recoverable amounts) • Ensuring that all outstanding obligations of a brokerage employee are settled before a final cheque is issued at point of termination • Delegating functions, but not necessarily the associated authority. Delegate authority only when warranted and then only within defined limits • Developing office procedures that clearly delegate responsibilities and provide for separation of duties • Ensuring that an employee is only placed on payroll when all required documentation is in the employee’s file • Requiring secrecy and confidentiality agreements when individuals are in key administrative positions • Instructing the bookkeeper to immediately report any irregularity in the accounting system to the broker of record (or other delegated individual)

Fraud prevention

Two types of fraud are predominant in the marketplace and are referred to as off book and on book. © 2021 Real Estate Council of Ontario

Off book fraud is most commonly associated with illegal payments and criminal activities, typically involving drug trafficking, protection rackets, skimming, and the like. Off book fraud, from a brokerage perspective, can involve agreements of purchase and sale, property flips, mortgage financing, and associated fraudulent misrepresentations. On book fraud concerns fraud involving the books of account of the business. On book fraud can arise either through some form of false financial reporting or financial records (or other source documents) that are either manipulated, falsified, or altered. The majority of on book fraud is committed by employees and most is discovered simply by chance. In these cases, management actions to prevent fraud are typically reactive in nature; that is, a sincere effort is made to stop the problem only after it is discovered. As a broker of record, you should look for the potential warning signs in your brokerage and establish policies and procedures to avoid potential cases of fraud. If you identify any warning signs, you should investigate the causes and even consult with third-party professionals, if required.

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Lesson 5 | Page 1 of 7

Lesson 5: Summary Practice Activities

This lesson provides a series of activities that will test your knowledge on the entire module.

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Lesson 5 | Page 2 of 7

This lesson provides summary practice activities. Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

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Lesson 5 | Page 3 of 7

A broker of record, as part of their analysis of general accounting procedures, has requested to see the general ledger account list (that is, the chart of accounts) for the brokerage. The broker of record wants to ensure that the expense categories are properly grouped. Identify which of the following expense categories should be placed under grandchild grouping. There are three options. There are multiple correct answers.

1

Telephone

2

General

3

Salaries

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Lesson 5 | Page 4 of 7

A broker of record, as part of their analysis of general accounting procedures, has requested to see the general ledger account list (that is, the chart of accounts) for the brokerage. The broker of record wants to ensure that the expense categories are properly grouped. Identify which of the following expense categories should be placed under child grouping. There are three options. There are multiple correct answers.

1

Operating

2

Janitorial services

3

Advertising

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 5 of 7

A broker of record is analyzing the net contributions of a salesperson, who is the highest net contributor employed by the brokerage. In the month of May, the brokerage has processed the following closed trades for the salesperson: • 2381 Western Blvd., $18,750 • 39 Laguna Drive, $16,820 • 493 Highgate Avenue, $10,355 • 2223 Lakeshore Drive (Unit 1701), $17,620 The salesperson is on a commission revenue structure with their brokerage of 95 per cent and 5 per cent (commonly known as a 95/5 split) and pays a monthly desk fee of $927. Total shadow expenses are $842. Recoverable expenses for May amount to $887, which have been paid in full. The broker of record needs to assess the salesperson’s performance for May. What will be the salesperson’s net worth to the brokerage (rounded to the previous whole number)? There are three options. There is only one correct answer.

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1

$2,362

2

$3,262

3

$3,622

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 6 of 7

A broker recently acquired an existing brokerage and wants to have a hands-on management approach to oversee office performance. What leading practices should the broker of record implement for accounting record and general administrative procedures? There are four options. There are multiple correct answers.

1

Review monthly reconciliation of all bank accounts

2

Check to ensure that the general journal is limited to routine transactions

3

Check the calculation on every invoice and match to original purchase order

4

Check general journal for duplicate or reverse entries

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Lesson 5 | Page 7 of 7

Congratulations, you have completed the lesson!

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Module Summary | Page 1 of 3

Module Summary

This lesson contains a summary of the entire module.

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Module Summary | Page 2 of 3

Congratulations, you have completed this module! The next screen will present a summary of the lessons in this module.

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Module Summary | Page 3 of 3

There are four sections on this page with a summary of the key topics that were discussed in this module.

Financial Management in As a broker of record, you should routinely inspect trade processing, entries in accounts, journals and ledgers, oversee general, commission trust, and real estate a Brokerage

trust accounts, and generally review all accounting input leading to financial statements. Knowledge of brokerage accounting, whether manual or automated, is essential. The onus and responsibility sit squarely with you, as the broker of record, notwithstanding the fact that you will engage with administrative staff and a thirdparty service provider to perform various bookkeeping and/or accounting functions. REBBA requires that every brokerage maintains trust money separate (both physically, in separate accounts and in terms of recordkeeping) from money belonging to the brokerage at all times. Leading practices related to maintaining minimum books and records should be followed to adequately control business transactions (other than trust). Completion of this lesson has enabled you to: • Describe the importance of financial management as a broker of record • Describe the general accounting requirements of a brokerage, as per REBBA

Accounting System in a Brokerage

Accounting systems are an integral tool for financial management in a brokerage. They are designed to help you, as a broker of record, make better spending decisions, create accurate financial reports, and manage assets. The accounting system refers to the numeric values captured in various documents and not the storage of these documents. A basic accounting system consists of source © 2021 Real Estate Council of Ontario

documents, journals, and a general ledger. The trial balance and the financial statements are derived from details found in the general ledger. A broker of record should clearly understand the difference between cash and accrual accounting. The difference lies in the timing of when sales and purchases are recorded in the accounts. Cash accounting recognizes revenue and expenses only when money changes hands, but accrual accounting recognizes revenue when it is earned (but not necessarily received), and expenses when they are billed (but not paid). Double-entry bookkeeping reflects the fact that there are two sides to every economic transaction – debit and credit. Revenue or income accounts represent the earnings of the brokerage, such as commissions, desk fees, revenue from salesperson’s expenses, and property management fees. Expense accounts represent the brokerage’s expenditures. The chart of accounts falls into five categories; that is assets, liabilities, equity, revenues, and expenses. From these basic categories, an income statement and a balance sheet are developed. Completion of this lesson has enabled you to: • Describe the key components of an accounting system framework for a brokerage • Describe accounting basics that apply to a brokerage • Determine the typical setup of account structure in a brokerage

Tracking System for Expenses

Tracking expenses and balancing them against the revenue will help you, as a broker of record, identify ways to ensure brokerage sustainability and growth. Expenses can be recoverable or non-recoverable based on whether or not they can be directly attributed to a broker or salesperson. © 2021 Real Estate Council of Ontario

The shadow expense account system focuses on non-recoverable expenses incurred by the brokerage. This approach is used to track and to allocate expenses to individual brokers or salespersons, even though no attempt is made to collect these amounts. A shadow expense system more accurately portrays broker and salesperson revenue performance in relation to the costs of having that individual working for the brokerage (this indicates the net worth of the broker or the salesperson to the brokerage). A detailed broker or salesperson account summarizes the monies owed to the brokerage and the net contribution (brokerage portion of commission revenue less shadow expenses) of the broker or the salesperson from the perspective of the brokerage. Net Contribution = Commission Revenue (Brokerage Receivable) – Shadow Expense Completion of this lesson has enabled you to: • Identify tracking system for recoverable and non-recoverable expenses for a brokerage • Determine recoverable and non-recoverable expenses for broker and salesperson accounts

Internal Administration Controls

As a broker of record, you will need to extend your focus beyond tracking expenses to all aspects of the accounting systems and practices followed in your brokerage. Internal administration controls help ensure validity and accuracy in a brokerage’s accounting records. You can implement various leading practices for internal administration controls in their brokerage. A brokerage can become a victim to fraud, and an understanding of the types of fraud and important warning signs can help you protect your brokerage. Two types of fraud impact businesses: off book and on book. Off book fraud for a brokerage can involve agreements of purchase and sale, property flips, mortgage financing, © 2021 Real Estate Council of Ontario

and associated fraudulent misrepresentations. On book fraud concerns fraud involving the books of the business. On book fraud will arise either through false financial reporting or financial records (or other source documents) being either manipulated, falsified, or altered. You can prevent fraud by identifying potential warning signs of a fraud taking place in your brokerage and establishing policies and procedures to avoid fraud. Completion of this lesson has enabled you to: • Explain key administration controls that apply to a brokerage • Explain guidelines for fraud prevention that apply to a brokerage

© 2021 Real Estate Council of Ontario

V6

Module 3: Analyzing Financial Statements Disclaimer: This is a reference document which contains pages from the Accessible eLearning module. You should complete the eLearning module to proceed to the next step. Please note that the accessible module on the LMS only contains the interactive pages and you need to go through the content of this document thoroughly to attempt the interactive activities in the module. Please use Adobe Acrobat Reader (Recommended version 9 or above) to navigate through this PDF. Real Estate Broker Program ©2021 Real Estate Council of Ontario. All Rights Reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or in any means – by electronic, mechanical, photocopying, recording or otherwise without prior written permission, except for the personal use of the Real Estate Broker Program learner.

© 2021 Real Estate Council of Ontario

Module 3: Analyzing Financial Statements A broker of record reviews the financial statements to analyze the financial performance of their brokerage. It is important for a broker of record to understand their business and how to correctly read and analyze these financial statements. A broker of record relies on other individuals such as administrative staff and third-party professionals (for example, bookkeepers and accountants) to create a brokerage’s financial statements. This module discusses the effectiveness of financial reports (such as balance sheets, cash flow statements, and income statements) in assessing the financial health and performance of a brokerage. This module also discusses the six key financial ratios and horizontal and vertical analysis techniques, which provide a quick insight into the financial performance of a brokerage. To check your understanding of this module, you must complete all the activities in the online module. While navigating through the online module, click the Legislation button to view laws and regulations related to this module. The contents of the thumbnails this Accessible PDF.

and References from the module are added to support your learning throughout © 2021 Real Estate Council of Ontario

Menu: Analyzing Financial Statements

Number of Lessons

Lesson Number

7 Lessons

Lesson Name

Lesson 1

Financial Statements

Lesson 2

Financial Ratios, Vertical and Horizontal Analysis

Lesson 3

Capital Cost Allowance

Lesson 4

Tracking Financial Performance

Lesson 5

Taxation

Lesson 6

Summary Practice Activities Module Summary

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Lesson 1 | Page 1 of 22

Lesson 1: Financial Statements This lesson describes the need for financial statements as well as the key components of balance sheets, income statements, and cash flow statements.

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Lesson 1 | Page 2 of 22

As a broker of record, you will need to make decisions about your brokerage’s operations daily. A key aspect of the decision-making process involves understanding how these decisions affect the financial position of the brokerage. To clearly understand this position, you must correctly read and analyze financial statements, including associated notes. Notes accompanying the financial statements provide additional information about a brokerage’s financial operation, clarify line items in the statements, identify noteworthy changes (for example, loss incurred on a particular asset), disclose important judgments and assumptions made, outline significant accounting policies, and detail reporting practices. Upon completion of this lesson, you will be able to: • Identify key terms commonly found in the financial statement of a brokerage • Identify the key components commonly found in a balance sheet of a typical brokerage © 2021 Real Estate Council of Ontario

• Identify the key components commonly found in an income statement of a typical brokerage • Identify the key components commonly found in the cash flow statement of a typical brokerage Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

© 2021 Real Estate Council of Ontario

Lesson 1 | Page 3 of 22

Financial statements convey a full and accurate picture of the past performance, financial position, and comparative progress of the brokerage. They help an owner and/or a broker of record make informed decisions, since they highlight which areas of the brokerage provide the best return on investment and which areas drain money from the brokerage. In cases where the owner and broker of record are different individuals, the broker of record’s analysis of the financial statements helps the owner make informed decisions. As a broker of record, you will rely on internally generated monthly financial statements to monitor your brokerage’s progress throughout the year. It is important that the monthly financial statements are prepared © 2021 Real Estate Council of Ontario

and reviewed by you on a timely basis in order to be able to react to any negative trends. At the fiscal year end, annual financial statements are prepared for presentation to external users such as the Canada Revenue Agency (CRA) and external lenders. While the monthly financial statements can be prepared by the administrative staff, external certified professional accountants (CPAs) are usually used to prepare the annual financial statements. The monthly financial statements typically provide a more detailed breakdown of financial statement items than the annual statements. There are different types of financial statements and key terms commonly found in the financial statements that you should understand.

© 2021 Real Estate Council of Ontario

Lesson 1 | Page 4 of 22

Types of Financial Statements As mentioned earlier, financial statements provide the backdrop for informed decision-making based on a brokerage’s ongoing financial performance. Internally, a broker of record relies on these statements when determining the current status of the business and when making decisions about future directions and strategies and the associated allocation of funds. Externally, these statements often fall under close scrutiny by investors seeking to invest in the brokerage, taxation authorities levying taxes based on financial performance, and lenders determining the creditworthiness and value of a brokerage when granting loans. Financial statements, including associated notes, are not pure statements of fact because they contain assumptions, estimates, and judgments that affect reporting. A broker of record should use all three types of © 2021 Real Estate Council of Ontario

financial statements in combination to assess the true financial state of the brokerage. The three types of financial statements include:

•

Balance sheet: Summarizes the brokerage’s assets and liabilities at a specific point in time and provides an indication of business stability and ability to satisfy debts when they become due

•

Income statement: Reviews financial performance (income and expenses) over a defined period

•

Cash flow statement: Summarizes how cash was generated and used over a defined period

© 2021 Real Estate Council of Ontario

Lesson 1 | Page 5 of 22

Key Terms in Financial Statements Key financial terms often found in financial statements that a broker of record should be familiar with include: • Assets: A resource with economic value that a brokerage owns or controls with the expectation that it will provide a future benefit o Current assets: Cash and other assets (such as interest-bearing certificates) that are expected to be converted to cash within a year  Commissions receivable: The balance of money due to a brokerage for goods or services delivered or used but not yet paid for by consumers © 2021 Real Estate Council of Ontario

o Non-current assets:  Fixed assets: Assets used in the business not intended for resale, such as furniture and fixtures, leasehold improvements, computers, vehicles, and owned land and buildings used as office premises  Other assets: Assets that have no physical presence (also known as intangible assets, such as goodwill, patent, copyright, and so on) • Liabilities: Debt owed by a company that requires the entity to give up an economic benefit (cash, assets, and so on) to settle past transactions or events o Current liabilities: Liabilities that are expected to be paid within one year o Non-current liabilities:  Long-term liabilities: Liabilities with a payment period of over a year • Shareholders’ equity: Includes the investment in the company, plus the amount of undistributed earnings • Retained earnings: Accumulated net income of a corporation since the inception, less any distribution of dividends

© 2021 Real Estate Council of Ontario

Lesson 1 | Page 6 of 22

As a broker of record, you will use the balance sheet to review what your brokerage owns that has value and what is owed at a specific point in time. It portrays the complete financial status of your brokerage and provides a snapshot, as of a specific date, of the financial position by listing all assets, liabilities, and equity. You will need to review the balance sheet on a regular basis to capture any trends that are developing in your brokerage.

© 2021 Real Estate Council of Ontario

Lesson 1 | Page 7 of 22

Balance Sheet The balance sheet provides important information when bankers, lenders, and investors delve into a brokerage’s business affairs. While the income statement is important, savvy financial managers know the depth of information that lies within the balance sheet. It summarizes the brokerage’s assets and liabilities, provides an indication of business stability, and helps assess financial risk for investors. The balance sheet sets out what the brokerage owns and what is owed at a specific point in time. It portrays the financial status of the brokerage and provides a snapshot of the financial position by listing all assets, liabilities, and equity. It can reveal many things, for example, what liquid assets are available to fund growth (or perhaps pay shareholders a dividend), if the brokerage may need a loan to move forward, and whether it can comfortably pay bills. © 2021 Real Estate Council of Ontario

The balance sheet shows the brokerage’s resources (assets) and funding for those resources (liabilities and shareholders’ equity). Assets must always equal the sum of liabilities and equity. As a leading practice, brokers of record should review the balance sheet on a monthly basis so that trends are readily visible. This will help them identify and investigate any significant fluctuations and potential liquidity issues on the horizon.

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Lesson 1 | Page 8 of 22

Structure of a Balance Sheet Balance sheets appear in two formats. Most commonly, assets are listed at the top of the page, followed by liabilities, and then equity. Brokerage software packages typically use this vertical arrangement. Alternatively, a balance sheet can be arranged with assets on the left side of the page and liabilities and/or owners (or shareholders) equity on the right. A balance sheet addresses the entire financial picture of business operations. However, a large brokerage might create subsidiary balance sheets for operating divisions. In that © 2021 Real Estate Council of Ontario

instance, a consolidated balance sheet is produced, which consists of the parent company and its controlled subsidiaries. When examining a balance sheet, the following equation applies: Total Assets = Total Liabilities + Shareholder’s (Owner’s) Equity This relationship exists because all debits must equal all credits in the accounting system. A sample balance sheet for a real estate brokerage is illustrated for reference. You will learn more about assets and liabilities in the following screens.

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Lesson 1 | Page 9 of 22

Assets Assets are economic resources of the business, including items used in the business. This includes anything of future use to the brokerage that will benefit the business. Assets may be monetary or non-monetary, tangible or intangible, and current or non-current. The following two sections contain information about the types of assets.

Current assets Current assets refer to cash and other assets that will most likely be converted to cash or provide benefit within the operating cycle of the business (usually within one year from the date of the balance sheet). Current assets include: • Cash: This is money in the real estate general account. • Commissions receivable: These are amounts due to the brokerage for transactions that have closed but the funds have not yet been received. • Advances: These are monies advanced to individual brokers and salespersons that should be repaid from future commissions.

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• Prepaid expenses: These are amounts paid in advance, such as the prorated future portion of insurance premiums, prepaid advertising, and utility and rent deposits. Inventory would also be listed under current assets (for example, raw materials, work in progress, and finished goods). In a brokerage, inventory may consist of houses or land owned by the brokerage that are available for sale or large stocks of supplies or promotional items.

Non-current assets Non-current assets include: • Fixed assets (property, plant, and equipment): Property, plant, and equipment is a standard accounting term used to describe assets that are not intended for resale, such as furniture and fixtures, leasehold improvements, computers, and vehicles. Owned land and a building used as an office premises would also be classified as fixed assets. • Accumulated amortization: Amortization represents the reduction in the value of the assets over their lifetime. The property, plant, and equipment (except land) are depreciated. © 2021 Real Estate Council of Ontario

Assets are generally recorded at cost and reduced by accumulated amortization, where applicable. • Other assets (intangible assets): Other noncurrent assets are long-term investments, goodwill (if purchased), up front (initial) franchise fees, patents, and trademarks. Assets are generally recorded at cost. Accordingly, a balance sheet may show a value for land and a building purchased several years ago when, in fact, the real value of the property (land value portion, in particular) is significantly different than declared. An intangible asset is an asset that is not physical in nature, such as goodwill, patents, and trademarks. For example, when a brokerage corporation acquires another brokerage, goodwill associated with that purchase is an intangible asset. Goodwill provides some type of competitive advantage (such as benefiting a brokerage’s reputation). Goodwill cannot be separated from the business itself. However, the value of this goodwill can be calculated based on the purchase price of the acquired brokerage less © 2021 Real Estate Council of Ontario

the fair value of the assets minus liabilities acquired. The value of these intangibles is recorded at cost on the balance sheet and are subject to future adjustments if the value decreases. The CRA rules concerning intangible capital property should be consulted on all such matters. • Real estate trust asset: This is a total of consumer deposits as on the date of the balance sheet. This balance should equal the amount shown under the real estate trust liabilities.

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Lesson 1 | Page 10 of 22

Liabilities Liabilities are economic obligations of the business, payable on a fixed or determinable future date. Liabilities, like assets, are generally current or non-current. The following two sections contain information about the types of liabilities.

Current liabilities Current liabilities are claims that will be paid from items listed as current assets. Such claims are due usually within one year from the date of the balance sheet. Current liabilities include: • Accounts payable: These are amounts due to suppliers for goods and services received. • Commissions payable: These are amounts due to brokers, salespersons, and other brokerages for transactions that have closed. • Deductions payable: These are statutory deductions from payroll, such as Canada Pension Plan (CPP), Employment Insurance (EI), income taxes, and any other deductions, including the employer’s portion where applicable.

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• Bank loan payable: When bank indebtedness appears in the current liabilities section, it usually indicates an operating line of credit, a demand loan, or the current obligation (for example, annual prepayment requirement) under a longer-term loan. Another example of bank loan payable is when a brokerage uses their operating line of credit for a sign order, recovers the cost of the sign order from their brokers and salespersons over the next 90 days, and the operating line of credit is repaid. It is important to note that any bank loan that exceeds the repayment period of one year is considered a long-term liability. • Corporate income tax: Corporate income tax is viewed as a current liability, as taxes are due within three months of the corporate year end. • HST payable: The net amount payable to the CRA is HST charged on revenue (commission income) less “input credits” (HST paid or payable on purchases). • Accrued liabilities: Accrued liabilities are an estimate of liabilities pertaining to the period ended, the exact amount of which is unknown (for example, audit and legal fees). © 2021 Real Estate Council of Ontario

Non-current liabilities or long-term liabilities Non-current or long-term liabilities are debts that are due later than one year from the date of the balance sheet. Examples of long-term liabilities include: • A mortgage for the purpose of the business premises • A loan to add an addition onto the building to be used for the business premises These are examples of long-term loans that can range from 2 to 25 years. The terms of long-term indebtedness are usually disclosed as a footnote to the balance sheet. Real estate trust liabilities fall under the category of non-current liabilities. This is a total of consumer deposits as on the date of the balance sheet. This balance should equal the amount shown under the real estate trust assets.

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Lesson 1 | Page 11 of 22

Shareholder’s (Owner’s) Equity The shareholder’s or owner’s equity includes the investment in the company and the amount of undistributed earnings. The following two sections contain information about the types of shareholder’s or owner’s equity.

Shareholders: Capital stock As you learned in a previous course, the different classes of shares in the corporation that can be issued include: • Common shares: These are the voting shares of the company. Common shareholders are at the greatest risk but also stand to gain the most if stock value increases. Common shareholders are entitled to dividends only after preferred shareholders, if any, are paid in full. However, no limit is put on dividends that can be paid to them. • Preferred shares: These are senior to common shares. Preferred shares could be voting or non-voting. Preferred shareholders have a claim on the assets of the company subordinate to that of debt holders but have preference over common shareholders in © 2021 Real Estate Council of Ontario

dividend rights (usually up to a limited amount) and liquidation.

Retained earnings Retained earnings are the accumulated net income of a corporation since its inception, less any distribution of dividends. If the company has an accumulation of losses or has distributed dividends in excess of accumulated earnings, it is termed a deficit.

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Lesson 1 | Page 12 of 22

The income statement (sometimes also referred to as the statement of profit and loss) details a brokerage’s revenue and expenses over a specific accounting period. When analyzing the income statement, a broker of record is able to see whether the period of time was profitable for the brokerage.

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Lesson 1 | Page 13 of 22

Income Statement Unlike the balance sheet, which gives a portrayal of the brokerage at one point in time, the income statement details the brokerage’s revenue and expenses over a specific accounting period. Brokers of record are advised to review monthly income statements on a timely basis to detect and correct any negative trends in revenue or expenses. The income statement begins with gross revenues earned from which expenses are deducted until the bottom line is reached (that is, profit or loss).

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Lesson 1 | Page 14 of 22

Structure of an Income Statement For brokerages, revenue is typically generated through commission sales but can also involve other revenue sources, such as appraisal fees. Revenues are recorded when the commission is earned (that is, usually when the sale is a completed transaction) or when the other revenue service has been performed and recorded in the accounting system. This is an example of accrual accounting. You learned about accrual accounting in a previous module. An income statement for a brokerage is typically divided into two sections: revenue earned at the top, followed by a listing of expenses.

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The decision of how to organize an income statement is based on several factors, including the type of business, personal preferences, ease of reading and/or understanding the statement (that is, whether internal or external persons are analyzing the statement), and software package used.

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Lesson 1 | Page 15 of 22

Customizing the Income Statement A broker of record can customize an income statement based on recommendations provided by their accounting software or guidance provided by their accountant. A broker of record should carefully review the monthly income statement, comparing the figures to the prior year and to prior months, to ensure that it accurately portrays trends, reflects amounts recovered from brokers and/or salespersons, and clearly distinguishes commission payouts from other expenses. A broker of record should consider the following leading practices when customizing an income statement for their brokerage: • Avoid catch-all categories that blur important dimensions of the brokerage operation. For example, a general category of Selling Expenses might include a summary amount of $53,282, but the breakdown reveals important expense details. The breakdown should be in line with the following example: 1. The main category is Advertising.  The expense of the subcategory flyers, postcards, and door hangers is $4,570.  The expense of the subcategory newspaper advertising is $13,983.  The expense of the subcategory institutional advertising is $3,947.  The expense of the subcategory sign installations is $2,785.  The expense of the subcategory promotion is $5,123. Total expenses for advertising is $30,408. 2. The main category is Operating.  The expense of the subcategory local listing service is $6,344. Total expenses for operating is $6,344. © 2021 Real Estate Council of Ontario

3. The main category is General.  The expense of the subcategory professional development is $4,938.  The expense for the subcategory Auto expenses is $11,592. Total expenses for operating is $16,530. 4. The total expenses of the brokerage is $53,282. o The amounts are grouped as subcategories under the main expense categories (that is, commission, advertising, personnel, occupancy, operating, and general expenses). o The range of statement categories varies by brokerage size and how accounts are organized. The advertising expense category may include several general ledger accounts as subcategories (for example, newspaper classifieds, newspaper institutional, sign installations, radio and/or television, and miscellaneous media). You learned about the subcategories of account groupings in an earlier module. o The number of categories and subcategories listed is discretionary. The primary objective is to ensure accurate, meaningful information that has relevance to the broker of record’s financial management strategy. o The auto expenses undoubtedly relate to the broker of record’s automobile and is more appropriate under general expense. o Promotion may only involve public relations and should appear under advertising. o Local listing service expenses may involve membership fees, not listing fees. o Institutional advertising may be offset by special broker or salesperson levies buried in the revenue portion of the income statement. • Avoid grouping commissions, salaries, and benefits. Combining these categories distorts important distinctions between salaried personnel (administrative staff) and brokers and salespersons, thereby

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undermining commission payout analysis to brokers and salespersons, contribution of the owner (which can be a substantial factor), and the true cost of salaried personnel. • Make the income statement align with brokerage business realities. For example, many income statements include a separate category for bad debt and cost of sale. These references are more retail oriented and generally do not apply in a brokerage business. Make certain revenue categories clearly mirror commission plan structure. Multiple plans (for example, revenues associated with conventional splits and desk fee plans) should be differentiated in the income statement for meaningful tracking.

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Lesson 1 | Page 16 of 22

An owner is preparing to hire a broker of record for their brokerage. One of the many responsibilities of the broker of record will be to oversee selected financial matters of the brokerage. The owner is interested in assessing the broker of record’s accounting knowledge, specifically regarding the various items that appear in the financial statements. The owner asks the prospective broker of record to categorize a few accounts into their appropriate statements. Which of the following accounts appear in the balance sheet? There are three options. There are multiple correct answers.

1

Accounts payable

2

Mortgage payable

3

Advertising expense

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Lesson 1 | Page 17 of 22

An owner is preparing to hire a broker of record for their brokerage. One of the many responsibilities of the broker of record will be to oversee selected financial matters of the brokerage. The owner is interested in assessing the broker of record’s accounting knowledge, specifically regarding the various items that appear in the financial statements. The owner asks the prospective broker of record to categorize a few accounts into their appropriate statements. Which of the following accounts appear in the income statement? There are three options. There are multiple correct answers.

1

Short-term deposit

2

Communication expense

3

Bank charges and interest

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Lesson 1 | Page 18 of 22

A cash flow statement provides details of how cash was generated and used over a defined period of time. As a broker of record, you will use a cash flow statement to identify financing needs, potential areas for future cash requirements, sources of significant cash drains, and the ability of your brokerage to pay debts when they are due.

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Lesson 1 | Page 19 of 22

Cash Flow Statement A cash flow statement focuses on net increase or decrease in cash. Most notably, this statement indicates how the brokerage generated cash and how that cash was used to effect changes to the balance sheet accounts, such as purchasing new assets and retiring long-term commitments.

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Lesson 1 | Page 20 of 22

Structure of a Cash Flow Statement The cash flow statement is made up of three components: operating, investing, and financing activities. 1. The component operating activities indicates whether a brokerage is generating cash or requires a cash infusion, with consistent negative cash flows forewarning of potentially serious financial problems. Examples of this component are net income, adjusted to add back amortization (book entry, not a cash expense) and further adjusted to account for increases or decreases in receivables, payables, and other current items. 2. The component investing activities indicates how surplus funds are being used in the pursuit of growth (for example, new equipment). Examples of this component are purchase and/or sale of assets (for example, equipment) and sale of property. 3. The component financing activities itemizes debt repayments and borrowed funds obtained to sustain or expand operations. Examples of this component are long-term or short-term loans and dividends.

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Lesson 1 | Page 21 of 22

Free Cash Flow A broker of record can use the cash flow statement to identify the free cash flow performance metric. They can use this metric to identify the free cash available for reinvestment in the brokerage, repayment to creditors, or payment of dividends and interest to investors. Free cash flow measures cash generated by the brokerage less the investment required (that is, capital assets) to keep it operating and functioning smoothly. There are several ways to calculate free cash flow, but the

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simplest is subtracting “cash flow from investing activities” from “cash flow from operating activities”. These numbers can be found in the cash flow statement. Example: If a brokerage generated $108,148 in cash flow from operating activities and $29,534 in negative cash flow from investing activities, the free cash flow is: Free Cash Flow = Cash Flow from Operating Activities – Cash Flow from Investing Activities Free Cash Flow = $108,148 – $29,534 = $78,614 The brokerage has $78,614 in free cash flow to maintain the business enterprise through appropriate investment in capital assets. These funds are available to conduct market research, buy new equipment, reduce short- and long-term debt, and pay dividends.

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Lesson 1 | Page 22 of 22

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Identify key terms commonly found in the financial statement of a brokerage • Identify the key components commonly found in a balance sheet of a typical brokerage • Identify the key components commonly found in an income statement of a typical brokerage • Identify the key components commonly found in the cash flow statement of a typical brokerage There are three sections on this page with a summary of the key topics that were discussed in this lesson.

Balance sheet

The key highlights of a balance sheet are as follows: • It provides a financial snapshot of a brokerage at a specific point in time by listing all assets, liabilities, and equity. • Total Assets = Total Liabilities + Shareholder’s (Owner’s) Equity. This equation signifies that all debits must equal all credits in the accounting system. • It summarizes what the brokerage owns and all amounts owed to creditors; the difference represents the shareholder’s (owner’s) equity. • It can reveal what liquid assets are available to fund growth (or perhaps pay shareholders a dividend) as well as if the brokerage may need a loan to continue operations. • Assets are generally recorded at cost, reduced by accumulated amortization (where applicable). Current market value of the property, © 2021 Real Estate Council of Ontario

plant, and equipment may differ significantly from book value (that is, amortized cost). • As a leading practice, brokers of record should review the balance sheet on a monthly basis so that trends are readily discernible.

Income statement

The key highlights of an income statement are as follows: • It identifies the financial performance of a brokerage over a specified period. • It includes revenue and expense components to arrive at income before income taxes and net income. Businesses generally include three key elements: sales, cost of goods sold (cost of merchandise), and operating expenses to arrive at income before income taxes. (Cost of goods sold is not applicable to a real estate brokerage.) • The range of statement categories varies by brokerage size and how accounts are organized. The category advertising expense may include several general ledger accounts as subcategories (for example, newspaper classifieds, newspaper institutional, sign installations, radio and/or television, and miscellaneous media). • The number of categories and subcategories listed is discretionary. The primary objective is to ensure accurate, meaningful information that has relevance to the broker of record’s financial management strategy.

Cash flow statement

The key highlights of a cash flow statement are as follows: • It provides data not specifically outlined in the income statement or balance sheet.

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• It assists in analyzing how the brokerage acquired funds and how those funds were spent. • It offers a summary of cash flow from operating, investing, and financing perspectives. • It helps identify financing needs, potential areas for future cash requirements, sources of significant cash drains, and ability of a company to pay debts when due. • It provides an important free cash flow performance metric.

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Lesson 2 | Page 1 of 11

Lesson 2: Financial Ratios, Vertical and Horizontal Analysis

This lesson describes financial ratios and how to use them. It also describes vertical and horizontal analysis methods that are used to analyze the financial data of a brokerage.

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Lesson 2 | Page 2 of 11

Financial ratios are an effective, expedient means to analyze or assess the financial strengths and weaknesses of a brokerage. Financial ratios, along with published or generally accepted industry standards, serve as the basis for the analysis. Horizontal and vertical analysis can provide a further interpretation of the brokerage’s financial performance. Upon completion of this lesson, you will be able to: • Use financial ratios to analyze the financial performance of a brokerage • Use vertical and horizontal analysis to analyze the financial data of a brokerage Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

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Lesson 2 | Page 3 of 11

Financial ratios are valuable for trend analysis and represent an early warning system to identify worsening financial conditions and/or performance levels. Ratios are broadly grouped under three categories: liquidity, debt, and profitability. As a broker of record, you will need to understand these ratios to make informed decisions. Knowledge of these ratios can also help you create an efficient financial plan.

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Lesson 2 | Page 4 of 11

Types of Ratios A broker of record may use different methods to gain insight into the financial well-being of the brokerage. Different types of ratios help to determine distinct information about the brokerage. As mentioned earlier, financial ratios are broadly grouped under liquidity, debt, and profitability. The following six sections contain information about the types of ratios.

Current ratio (liquidity) The current ratio is a ratio of current assets to current liabilities, which helps determine whether a business can meet short-term obligations. This ratio is derived from information contained in the balance sheet. Current ratio is most commonly associated with financial strength. A ratio of close to two is considered prudent (for example, $200,000 in current assets to $100,000 in current liabilities); less than one is considered unsound. The issue is not whether debt is good or bad but rather that it is appropriately counterbalanced by assets. Current ratio = Current assets ÷ Current liabilities © 2021 Real Estate Council of Ontario

Example: ABC Real Estate Inc. has current assets amounting to $450,000 and current liabilities of $350,000. The current ratio is: Current ratio = Current assets ÷ Current liabilities $450,000 ÷ $350,000 = 1.29 For each dollar of current liabilities, there is $1.29 available in current assets. If all current assets were converted to cash, the sum of current debt could be retired with funds still available to the brokerage. As a leading practice, a brokerage should maintain an average current ratio between 1.0 and 2.0, with 2.0 being prudent. A very high current ratio is indicative of idle assets. This means that current assets could have been put to better use, such as through investing in an advertising campaign to generate income, pay off debts, and so on. A low current ratio can be an indicator that the brokerage is in a financially precarious position. Unfortunately, the determination of what is an excessively high or low ratio is somewhat subjective in nature and can vary based on the specific enterprise and overall market circumstances.

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Acid-test ratio: Quick ratio (liquidity) The acid-test ratio is a variation of the current ratio that addresses only the most liquid assets of a brokerage. This ratio is derived from information contained in the balance sheet. Acid-test ratio is often referred to as quick ratio, as it demonstrates ability to pay off short-term obligations by way of liquid assets. As a leading practice, a brokerage should maintain a quick ratio of 1:1 or higher. In other words, for every dollar of current liabilities, the brokerage should have one dollar or more in the most liquid current assets. Quick ratio = Cash + Marketable securities + Receivables ÷ Current liabilities

Debt ratio (debt) The debt ratio is the ratio of total liabilities (minus real estate trust liabilities) to total assets (minus real estate trust assets), which measures the proportion of assets financed by borrowings and can provide an indication of excessive debt. This ratio is derived from information contained in the balance sheet. The debt ratio reveals the proportion of debt in relation to total assets. As a leading practice, a © 2021 Real Estate Council of Ontario

brokerage should maintain a debt ratio figure of under 0.50 (50 per cent). When the debt ratio is higher than 0.50 (50 per cent), creditors have a larger investment in the brokerage than the owners. The debt ratio can range from 0 for a brokerage with no debt to 1.0 for a brokerage financed entirely by debt, or higher (above 1.0) if liabilities exceed assets. Creditors typically prefer a lower debt ratio, given the cushion of safety provided by the owner’s investment. A debt ratio of 0.50 or less is usually acceptable, but this can be subject to other factors, including the type of business, market conditions, and lender policies. Debt ratio = (Total liabilities – Real estate trust liabilities) ÷ (Total assets – Real estate trust assets) Example: If total liabilities for ABC Realty Inc. are $238,540 and total assets are $717,440, the debt ratio is: Debt ratio = Total liabilities ÷ Total assets $238,540 ÷ $717,440 = 0.33 This means that 33 per cent of the brokerage is financed by creditors.

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Debt service coverage ratio (debt) The debt service coverage ratio (DSCR) compares net operating income to total debt service, also commonly referred to as the debt coverage ratio. The DSCR is frequently used by loan underwriters to establish whether a business is capable of handling debt payments (current or future). This ratio is derived from information contained in the income statement. The DSCR is arrived at by dividing the earnings before interest, taxes, depreciation, and amortization (EBITDA) by total debt service (principal and interest payments). The ratio should be in a positive range (that is, above 1) for income to properly address total debt service. For example, a lender may require a debt coverage ratio of 1.2 or higher when considering a business loan application. In other words, for each dollar of debt, EBITDA of $1.20 is available to service that debt. DSCR = EBITDA ÷ Total debt service Example: A buyer is seeking financing for an existing brokerage. The lender requires a DSCR of 1.2. The EBITDA is $28,373. The borrower is seeking a loan © 2021 Real Estate Council of Ontario

with monthly payments of $1,670 per month. The DSCR is: DSCR = EBITDA ÷ Total debt service $28,373 ÷ (12 x $1,670) = 1.42 This means that for each dollar of debt, the brokerage would have $1.42 available to service the debt. Therefore, the buyer’s financing needs would meet the lender’s criteria.

Gross profit ratio (profitability) The gross profit ratio (also referred to as a margin when quoted in percentage terms) is a financial indicator based on gross profit divided by gross revenue. The gross profit ratio is not designed for brokerage operations but can be creatively adapted when comparing a particular period with a prior corresponding period to identify significant changes in gross profit. As a leading practice, gross profit is expressed as a ratio of gross revenue. This ratio is derived from information contained in the income statement. Gross profit ratio = (Gross revenue – Payment to other brokerages – Commission expense) ÷ Gross revenue Gross profit ratios have limited applicability in real estate given the range of commission splits and © 2021 Real Estate Council of Ontario

methods of allocating and recovering the expenses of brokers and salespersons. Example: To calculate revenue: Gross revenue is $982,850 Payment to other brokerages is $227,900 Adjusted gross revenue = Gross revenue – Payment to other brokerages i.e., $982,450 $227,900 = $754,950 To calculate expenses: The expenses for commission are $421,683 The expenses for advertising are $23,443 The expenses for personnel are $98,750 The expenses for occupancy are $48,275 The expenses for operating are $24,877 The general expenses are $26,021 Total expenses are $643,049 To calculate net income: Income before income taxes is $111,901 Provision for income taxes is $27,975 Net income is $83,926

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Based on this income statement, the gross profit ratio would be: Gross revenue – (Payment to other brokerages + Commission expense) ÷ Gross revenue = Gross profit ratio $982,850 – ($227,900 + $421,683) ÷ $982,850 = 0.34 This means that for every dollar of gross revenue, the brokerage has 34 cents in gross profit available to pay overhead and profit. Expressed as a percentage, the brokerage’s profit is 34 per cent of the gross revenue.

Net profit ratio (profitability) The net profit ratio is based on the net profit (that is, income before income taxes) after payment of all expenses. It is often referred to as the bottomline margin or return on sales (when expressed in percentage terms). This ratio is derived from information contained in the income statement. Limitations detailed under gross profit ratio apply. Adjusted gross revenue could also be used, based on personal preference. The net profit ratio is designed to measure relative efficiency. No universal reporting method © 2021 Real Estate Council of Ontario

presently exists to promote effective brokerage-tobrokerage analysis. Net profit ratio = Net profit (Income before income taxes) ÷ Gross revenue Example: To calculate revenue: Gross revenue is $982,850 Payment to other brokerages is $227,900 Adjusted gross revenue = Gross revenue – Payment to other brokerages i.e., $982,450 $227,900 = $754,950 To calculate expenses: The expenses for commission are $421,683 The expenses for advertising are $23,443 The expenses for personnel are $98,750 The expenses for occupancy are $48,275 The expenses for operating are $24,877 The general expenses are $26,021 Total expenses are $643,049 To calculate net income: Income before income taxes is $111,901 Provision for income taxes is $27,975 © 2021 Real Estate Council of Ontario

Net income is $83,926 Based on the income statement, the net profit ratio would be: Net profit (Income before income taxes) ÷ Gross revenue = Net profit ratio $111,901 ÷ $982,850 = 0.1138 This means that for every dollar of gross revenue, the brokerage has 11.38 cents in net profit. Expressed as a percentage, the brokerage’s profit is 11.38 per cent of the gross revenue.

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Lesson 2 | Page 5 of 11

Vertical analysis is a method of analyzing financial statements where each line item is listed as a percentage of another item. Horizontal analysis is a method of analyzing financial statements where each line item is analyzed to determine significant year-to-year changes and trends. As a broker of record, understanding vertical and horizontal analysis will help you budget for expenditures and better analyze the balance sheet and income statement. The analysis will help you identify any trends and spot concerns early, allowing you to take advantage of an opportunity or timely corrective action.

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Lesson 2 | Page 6 of 11

Vertical Analysis Vertical analysis involves comparing different amounts within the same financial statement, typically expressed as a percentage. Vertical analysis is most commonly used with income statements in which expenses are stated as a percentage of gross revenue (or adjusted gross revenue) depending on how the statement is structured. Vertical analysis helps a broker of record budget for expenditures. For expenses, knowing what percentage of total expenditures is apportioned to each expense category is important. For example, what percentage of adjusted gross revenue is salaries and what percentage is advertising. © 2021 Real Estate Council of Ontario

Example: The broker of record at ABC Real Estate Inc. is analyzing the income statement in terms of expenses as a percentage of adjusted gross revenue. They have recently increased the payout on their commission split plan but have also adjusted the amount recovered from brokers and salespersons concerning variable expenses, and they want to assess the impact. Here is their calculation (based on the adjusted gross revenue and rounded to the nearest percentage): To calculate revenue: Gross revenue is $1,782,850 Payment to other brokerages is $583,900 Gross revenue – payment to other brokerages = Adjusted gross revenue i.e., $1,198,950; this is 100% of the revenue. To calculate expenses: The expenses for commission are $758,620. This is 63% of total expenses. The expenses for advertising are $53,443. This is 4% of total expenses. The expenses for personnel are $132,750. This is 11% of total expenses. The expenses for occupancy are $68,700. This is 6% of total expenses. The expenses for operating are $44,877. This is 4% of total expenses. The general expenses are $26,021. This is 2% of total expenses. Total expenses are $1,084,411 To calculate income before income taxes: Income before income taxes is $114.539. This is 10% of the revenue.

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Lesson 2 | Page 7 of 11

Horizontal Analysis Horizontal analysis is used to identify significant trends based on period-to-period comparisons. Horizontal analysis can be an effective line-to-line analysis of the balance sheet or income statement. Each account is scrutinized to determine increases and/or decreases, which provides a basis for critical analysis; for example, did the money spent increase revenues? Horizontal analysis provides a further analysis of the balance sheet and income statement by demonstrating what percentage change has occurred in the year-to-year comparison. The broker of record does a year-to-

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year review of each line item to analyze the changes in the amounts and evaluate the impact of these changes on the brokerage. Example: The broker of record at ABC Real Estate Inc. is completing a horizontal analysis of the financial statements looking for significant year-to-year changes and trends. Following are examples including questions that ABC Real Estate Inc. might pose. • Income Statement: In 2020, entertainment was $29,000, while in the prior year it was $18,000. The broker of record should critically analyze the income statement to identify: o If the $11,000 increase in spending positively impacted the brokerage o If the money was spent on events planned by the brokerage, aimed at retaining and engaging staff o If the money was spent to entertain potential recruits (brokers and salespersons who join the brokerage) o If the money was wisely spent under the circumstances (present or future gain) o If more detailed analysis is required • Balance Sheet: Cash in 2020 was down substantially to $15,000 from the previous year’s level of $32,000. The broker of record should critically analyze the balance sheet to identify: o If cash was used for purchase of other assets o If cash was used for repayment of debts o If this requires further analysis

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Lesson 2 | Page 8 of 11

The owner of ABC Real Estate Inc. wants to discuss the financial statements with the new broker of record. The first item they want to analyze is the balance sheet to determine whether their business can meet all their short-term obligations. • Current assets o Cash in hand = $82,000

o Commission receivable = $54,000 o Prepaid expenses = $6,452

o Short-term deposit = $28,000

•

Current liabilities = $70,000

Calculate the acid-test ratio (quick ratio) from the information provided (rounded off to two decimals places). Quick ratio = (Cash + Marketable securities + Receivables) ÷ Current liabilities There are three options. There is only one correct answer. 1

2.34

2

2.60

3

2.92 © 2021 Real Estate Council of Ontario

Lesson 2 | Page 9 of 11

The owner of ABC Real Estate Inc. is preparing a report for a meeting with the stakeholders. The owner wants to discuss the debt for which the brokerage is liable with the new broker of record. The balance sheet of ABC Real Estate Inc. for December 2020 shows that: Total Assets = $408,013 Total Liabilities = $55,108 Total Long Term Liabilities = $116,500 Calculate the debt ratio from the information available (rounded off to two decimals places). Note: Debt ratio = Total liabilities ÷ Total assets There are three options. There is only one correct answer. 1

0.42

2

0.60

3

0.82

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Lesson 2 | Page 10 of 11

The owner of ABC Real Estate Inc. wants to compare the brokerage’s gross profit ratio to that of the previous year with the new broker of record. ABC Real Estate Inc. had a gross revenue of $982,850 this year. They made a payment to other brokerages of $227,900 and a commission expense to their own salespersons of $421,638. Which of the following is the gross profit ratio (rounded off to two decimals places)? Note: Gross profit = Gross revenue – (Payment to other brokerages + Commission expense) ÷ Gross revenue There are three options. There is only one correct answer.

1

0.34

2

0.50

3

0.80

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Lesson 2 | Page 11 of 11

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Use financial ratios to analyze the financial performance of a brokerage • Use vertical and horizontal analysis to analyze the financial data of a brokerage There are two sections on this page with a summary of the key topics that were discussed in this lesson.

Financial ratios

Current ratio (liquidity) • The current ratio is a ratio of current assets to current liabilities, which helps determine whether a business can meet short-term obligations. As a leading practice, brokerages should maintain a current ratio of close to two (for example, $200,000 in current assets to $100,000 in current liabilities). A current ratio of less than one is considered unsound. • The issue is not whether debt is good or bad but rather that it is appropriately counterbalanced by assets. Acid-test ratio: Quick ratio (liquidity) • The acid-test ratio is a variation of the current ratio that addresses only the most liquid assets of a brokerage. • The acid-test ratio is often referred to as quick ratio, as it demonstrates ability to pay off short-term obligations by way of liquid assets. As a leading practice, brokerages should maintain a quick ratio of 1:1 or better.

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Debt ratio (debt) • The debt ratio reveals the proportion of debt in relation to total assets, excluding the real estate trust assets and real estate trust liabilities. As a leading practice, brokerages should maintain a debt ratio figure of under 0.50 (50 per cent). • When the debt ratio is higher than 0.50 (50 per cent), creditors have a larger investment in the brokerage than the owners. Debt service coverage ratio (debt) • This ratio compares net operating income to total debt service and is often used by lenders. Gross profit ratio (profitability) • The gross profit ratio (also referred to as a margin when quoted in percentage terms) is a financial indicator based on gross profit divided by gross revenue. • This ratio may be useful in period-to-period comparisons within a brokerage. • No universal reporting method exists to promote effective brokerage-tobrokerage analysis. Net profit ratio (profitability) • The net profit ratio is designed to measure relative efficiency. • No universal reporting method presently exists to promote effective brokerage-to-brokerage analysis.

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Vertical and horizontal analysis

Vertical analysis is commonly associated with income statements and is used to determine what portion of adjusted gross income is used for each expense, typically expressed as a percentage. Horizontal analysis can be applied to both balance sheets and income statements to identify significant trends based on period-to-period comparisons and is typically expressed as a percentage change.

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Lesson 3 | Page 1 of 17

Lesson 3: Capital Cost Allowance

This lesson introduces capital cost allowance and half-year rule. It also discusses capital gain and capital loss.

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Lesson 3 | Page 2 of 17

Capital cost allowance (CCA) acknowledges the existence of depreciation that is the result of wear and tear over the life of an asset and the ability to offset income in relation to the cost of that asset. Upon completion of this lesson, you will be able to: • Calculate the capital cost allowance (CCA) that would apply to assets of a brokerage Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

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Lesson 3 | Page 3 of 17

CCA is an allowable deduction under the Income Tax Act that can be claimed on depreciable assets when calculating taxable income. The accountant for the brokerage is best suited to explain the benefits and calculations of CCA deductions to the owner or broker of record. As a broker of record, an understanding of CCA calculations will enable you to know what allowable deductions are potentially available and allow you to spot any errors if an asset is not depreciated properly. An accountant will help you spot these errors during preparation of tax returns.

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Lesson 3 | Page 4 of 17

Capital Cost Allowance (CCA) When an asset is purchased that will be used over a period of years (for example, office equipment), brokerages are not permitted to deduct the full purchase price in the year of acquisition. Rather, they are allowed to write off a portion of the purchase price as CCA using the maximum rates outlined in the Income Tax Act. CCA is the maximum rate set under the Income Tax Act that a taxpayer can claim for depreciation. CCA is not a cash flow item but rather a matter of taxation and tax-deductible expenses. The amount of CCA is calculated using two different methods: the declining balance method and the straight-line method. The Income Tax Act and Regulations detail various classes for purposes of CCA calculation. Brokerages are normally concerned with categories such as classes 8, 10, 10.1 (expensive automobiles), 12, 13, and 14. The following table illustrates selected classes that might be used, particularly by a brokerage involved with commercial properties. • A rate of 4% DB is applied to buildings built after 1987 and excess renovations to Class 3 Buildings. They are Class 1 assets and half-year rule is applied to these assets. • A rate of 5% DB is applied to buildings built before 1988 and renovated after 1988. They are Class 3 assets and half-year rule is applied to these assets. • A rate of 10% DB is applied to farm buildings, fences, and oil and water storage tanks. They are Class 6 assets and half-year rule is applied to these assets. • A rate of 20% DB is applied to miscellaneous capital property not included in other classes (for example, office equipment and furniture). They are Class 8 assets and half-year rule is applied to these assets. • A rate of 30% DB is applied to automobiles or trucks used for business purposes; computers and system software They are Class 10 assets and half-year rule is applied to these assets. © 2021 Real Estate Council of Ontario

• 100% DB is applied to computer application software, tools, utensils, and uniforms. They are Class 12 assets and there are some exceptions to half-year rule for these assets. • SL rate of method is applied to leasehold interest and leasehold improvements paid for by tenant. They are Class 13 assets and there are special rules applicable regarding the half-year rule for these assets. • A variable rate of method is applied to patent, franchise of limited life, and licence. They are Class 14 assets and half-year rule is not applicable to these assets. • A rate of 8% DB is applied to roads, sidewalks, parking areas, or storage areas. They are Class 17 assets and half-year rule is applied to these assets. • A rate of 45% DB is applied to computer hardware and system software acquired after March 22, 2004. They are Class 45 assets and half-year rule is applied to these assets. *Half-year rule: The half-year rule states that 50 per cent of purchases during the year, minus the lesser of capital cost and proceeds of disposition of assets in the class during the year, is deducted before the CCA for the year is calculated. For example, the half-year rule would apply if a brokerage purchases an asset totaling $10,000 (assuming no dispositions have occurred). This means that depreciation can only be calculated on $5,000 (half of $10,000) for the first year. ** Methods: • DB (declining balance): Declining balance method allows for depreciation to be calculated on the declining balance of the capital cost. • SL (straight-line): In the straight-line method, the value of an asset is reduced uniformly over each period until it reaches the end of its useful life. Typically, the only assets of a brokerage that would claim CCA on a straight-line method would be leasehold improvements in class 13. The rate of CCA applied to each class is specified as a maximum rate. Therefore, a taxpayer may claim any CCA amount up to the maximum by multiplying the CCA rate by the balance in the class at the end of the taxation © 2021 Real Estate Council of Ontario

year. Only the amount of CCA actually claimed is deducted from the balance of the class, and the remaining balance, which is the undepreciated capital cost (UCC), is carried forward and available for future CCA claims.

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Lesson 3 | Page 5 of 17

Undepreciated Capital Cost (UCC) UCC is the capital cost associated with a specific improvement under a particular class, less any CCA already taken and less the proceeds of previous disposals in the same class. Example: Assume that the CCA for an item for which the half-year rule does not apply is $20,000 with a pro-rated straight-line calculation of depreciation based on a 10-year period. Following are the entries for the first twoyear period: • The capital cost is $20,000 • The year 20xx depreciation (1⁄10 x 20,000) is –$2,000 The remaining capital cost (UCC) is $18,000 • The year 20x1 depreciation (1⁄10 x 20,000) is –$2,000 The remaining capital cost (UCC) is $16,000 © 2021 Real Estate Council of Ontario

Lesson 3 | Page 6 of 17

CCA Calculations: Declining Balance Method Most CCA classes in the Income Tax Act use the declining balance method of calculating CCA. Declining balance involves the reduction of the capital cost by a percentage, as set out for a particular class of property, with subsequent reductions always applied to the declining balance (UCC) within that class. Example: ABC Real Estate Inc. begins the year with a UCC in a specific class of $50,000 with purchases and dispositions made during that year. The CCA for the applicable year and the UCC for the beginning of the following year are calculated below. Assume that the CCA rate for the class is 10 per cent. UCC of class at beginning of year = $50,000 Add: Purchases during year = +$5,000 Less: Lesser of dispositions during year: Original cost, or $3,000 Proceeds at disposition $3,500 = –$3,000 UCC before adjustment = $52,000 Less: 1/2 net increase (5,000 – 3,000 ÷ 2) = –$1,000 (Recall the half-year rule detailed earlier in this lesson) UCC before CCA = $51,000 Less: CCA for class for the year = –$5,100 © 2021 Real Estate Council of Ontario

Add: 1/2 net amount (see above) = $1,000 UCC of the class at beginning of the next year = $46,900

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Lesson 3 | Page 7 of 17

CCA Calculations: Straight-Line Method Typically, the only assets of a brokerage that would claim CCA using a straight-line method would be leasehold improvements in class 13 and limited-life intangible assets (for example, franchise agreements) in class 14. The rules are complex, but in essence, a $10,000 leasehold improvement at the beginning of a 10-year lease would result in a claim of $500 (5 per cent) CCA in the first year (half-year rule), $1,000 (10 per cent) in each of the second to tenth years, and $500 in the eleventh year. Brokers of record are advised to seek assistance from third-party service providers, such as an accountant, when calculating CCA using the straight-line method.

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Lesson 3 | Page 8 of 17

Half-year Rule The half-year rule, detailed earlier in the lesson, was implemented to correct the fact that assets purchased at the end of a taxation year would otherwise provide an amount in a class eligible for the maximum CCA in that year. This rule states that 50 per cent of purchases during the year, minus the lesser of capital cost and proceeds of disposition of assets in the class during the year, is deducted before the CCA for the year is calculated. By effectively reducing the CCA on purchases (in excess of dispositions) made during the year, the tax advantage of a late purchase is reduced. In the first year of operation, CCA calculation is pro-rated based on the start-up date of the brokerage. Example: On October 1, 2019, ABC Real Estate Inc. began operations and purchased office furniture at a cost of $8,700. In the following year, additional office furniture costing $15,000 was purchased. The maximum CCA that can be claimed for both years, along with the UCC, is calculated below. Office furniture is categorized under Class 8, with a 20 per cent CCA rate and depreciation is calculated by the declining balance method. Because it is the brokerage’s first year of operation, the 2019 CCA calculation is prorated based on the start-up date of the brokerage. In addition, the equipment purchased in 2019 and 2020 is subject to the half-year rule based on the applicable year of acquisition. Since no dispositions occurred in either year, only the net amount of additions is used for calculations. As ABC Real Estate Inc. started operations on October 1, 2019, the ratio for pro-rating during that year is 92/365. For year 2019 Purchases = $8,700 • CCA © 2021 Real Estate Council of Ontario

(Half-year rule on purchases) 50% x $8,700 = $4,350 (Pro-rate CCA calculation for first year of operation) (October 1, 2019 to December 31, 2019 = 92 days) $4,350 x 20% x 92 ÷ 365

= ─$219

• UCC at January 1, 2020 = $8,481 For year 2020 Purchases = +$15,000 (New purchases are added to the book balance) = $23,481 • CCA (Half-year rule on purchases) $15,000 x 50% = $7,500 (Depreciation calculation on $7,500 + declining balance of $8,481) $7,500 + $8,481 = $15,981 (Apply tax rate for depreciation) $15,981 x 20% = ─$3,196 • UCC at January 2021 = $20,285

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Lesson 3 | Page 9 of 17

Recaptured CCA At the time of capital property disposition, the Income Tax Act requires the recapture of CCAs if the net proceeds received exceed the UCC of that class of asset. The recapture cannot exceed the capital cost deductions allowed in previous years. As a rule, if the UCC has a positive balance and no assets remain, terminal loss can be claimed. If a negative UCC balance occurs due to asset disposition, recapture (that is, income inclusion) occurs, even if assets remain in that particular class. Recapture must be declared as income. Recapture is not normally an issue with capital acquisitions concerning brokerage operations (for example, business equipment) but can be in the sale of buildings owned by the brokerage. In that situation, deferral of

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recapture is possible in some instances (for example, if a replacement property is acquired within a specified time limit). An accountant would complete these calculations as well as tax filing on behalf of the brokerage. The broker of record should have a basic understanding of these calculations so that they can follow the information presented by the accountant and make informed decisions.

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Lesson 3 | Page 10 of 17

A broker of record incorporated their brokerage on November 1, 2019 and acquired office equipment and furniture worth $27,600 prior to the end of that taxation year (not a leap year). In 2020, the broker of record purchased an additional $7,000 worth of office equipment and furniture near the end of that year. The CCA rate for office equipment and furniture is 20 per cent. Assuming the corporation chooses a fiscal period end of December 31, calculate the UCC using the declining balance method as of January 1, 2020 and January 1, 2021 (rounding off calculations to the nearest dollar). There are three options. There is only one correct answer.

1

2

3

January 1, 2020 – $27,139 January 1, 2021 – $28,011 January 1, 2020 – $26,00 January 1, 2021 – $27,311 January 1, 2020 – $25,000 January 1, 2021 – $29,00

© 2021 Real Estate Council of Ontario

Lesson 3 | Page 11 of 17

A brokerage, who had been in business for several years, already owned furniture. On January 1, 2019, the furniture had a UCC of $24,300. On February 14, 2019, the brokerage purchased additional furniture worth $8,000. Based on the declining balance method, calculate the UCC for the furniture as of January 1, 2020. Assume the CCA rate for furniture was 20 per cent. There are three options. There is only one correct answer.

1

$26,640

2

$28,000

3

$26,000

© 2021 Real Estate Council of Ontario

Lesson 3 | Page 12 of 17

Capital Gain Capital gain is the financial gain from the disposition of capital property that is sold for a value in excess of its adjusted cost base (generally the original purchase price). A percentage of this gain must be added to taxable income on disposition of the asset. Capital property includes any item from which a capital gain or loss would be realized and includes depreciable property. Under current legislation, 50 per cent of the capital gain is exempt from tax. The remaining 50 per cent, termed taxable capital gain, is included in income. The accountant would report this capital gain when completing tax filing on behalf of the brokerage. The broker of record should realize that this capital gain will impact the income tax to be paid by the brokerage. A capital gain is a gain on the sale or exchange of capital assets that meets the applicable criteria, as set out in the Income Tax Act. An example is displayed involving a gain by a corporation and the applicable gain calculation based on an assumed taxation level. An adjusted cost base is included, as it factors into the calculation. The adjusted cost base represents the acquisition price of the property with adjustments as prescribed by the Income Tax Act (for example, selling costs such as commission, legal fees, advertising, and so on). Example: Anycity Investments Inc. acquired a commercial building several years ago and has recently sold the property for $1,329,684. The adjusted cost base was determined to be $1,000,000. The president of the company is estimating both the capital gain and taxable capital gain as follows: • Sale price is $1,329,684 Adjusted cost base = $1,000,000 Selling costs = $59,832 © 2021 Real Estate Council of Ontario

• Sale price – (Adjusted cost base + Selling costs) = $269,852 i.e., the Capital gain • Taxable capital gain (50%) is $134,926 The example assumes that the gain realized meets the criteria for a capital gain. Furthermore, the tax on $134,926 taxable capital gain may not constitute the total tax liability on the sale. Consideration must also be given to any recaptured CCA. The applicable tax rate for Anycity Investments Inc. is then applied to taxable income to arrive at the tax liability. In other words, the capital gain of $134,926 will be reported in tax filing and will affect the tax liability owed to the CRA. However, consideration must also be given to any recaptured CCA that may cause a larger tax liability.

© 2021 Real Estate Council of Ontario

Lesson 3 | Page 13 of 17

Capital Gain versus Taxable Income The Income Tax Act does not specifically set out whether a gain or loss is capital in nature. The taxpayer is responsible for reporting the gain as income or capital gain. This report may then be challenged by the CRA with the onus of proof on the taxpayer. If the gain is considered income rather than a capital gain, the entire amount of the gain is subject to tax. For real estate transactions, profits would likely be taxed as regular business income if a taxpayer sells and buys real estate on a regular basis. However, if the taxpayer can prove that these dispositions were a planned and necessary part of a total investment program, then there may be a case for capital gains treatment of the © 2021 Real Estate Council of Ontario

profit. In the case of a brokerage, if the brokerage purchases a property, uses it as a business premises, and later disposes of the property for a profit, this will likely be regarded as a capital gain. Furthermore, if a sale of real estate is not planned (that is, brokerages are not employed, the property is not advertised, and no sign or other visible evidence of active marketing is present), then the profit may be treated (but not always) as a capital gain. In some cases, the profit from an eventual sale of the property may be deemed as a capital gain where the taxpayer purchased real estate for a third party to whom they expected to transfer it without profit and was then left with the property when the third party backed out of the transaction. It is strongly recommended that owners and brokers of record obtain advice from their accountants on all taxation matters.

© 2021 Real Estate Council of Ontario

Lesson 3 | Page 14 of 17

Guidelines: Capital Gain versus Taxable Income Over the years, the determination of whether a gain is considered income rather than a capital gain has been made based on several factors. Should a debate proceed to the Tax Court of Canada, the court will consider relevant factors concerning taxpayer conduct before, during, and after the period under appeal. Certain factors carry more weight in the process. A broker of record should be aware of this information when deciding if their brokerage will acquire and dispose of real estate for investment purposes, as this will impact the brokerage’s tax payable. It is recommended that brokers of record obtain advice from an accountant regarding such matters. The following five sections contain information about these factors.

Intention What was the taxpayer’s intention at the time the property was purchased? When a property is bought for investment, any resale profit could still be considered taxable as ordinary income if the apparent intent were to resell for a profit at a future date. The Tax Court will consider such factors as reasons for the sale, compelling necessity, change in circumstances, and external influences.

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Frequency of transactions The CRA will assess how often a taxpayer engages in the sale of capital property. Frequency of such occurrences may suggest the taxpayer is operating a business for profit. Assessment as ordinary business income may be the result. However, even an isolated transaction can be so judged, given the right set of circumstances.

Relationship to the taxpayer’s business The Tax Court will classify profits as taxable under ordinary business income when a taxpayer uses expertise acquired in regular business activity to generate a profit on the purchase and/or sale of similar or related commodities. The court also looks at the time and attention the taxpayer spent on the transaction. Real estate transactions by contractors, renovators, brokerages, brokers, salespersons, and appraisers have typically fallen under close scrutiny.

© 2021 Real Estate Council of Ontario

Nature of transaction and assets Taxable income may be indicated if the asset cannot normally be used either personally or for investment purposes. Mortgages are often judged under this test. If a mortgage is purchased at a substantial discount or has a short maturity date, the mortgagee may be viewed as being in a business that realizes profit from the transaction, thereby invoking business income as opposed to capital gain.

Objects of the corporation The Tax Court will review the articles of incorporation to determine if a transaction falls under the objects of the corporation and if it is part of usual business. However, the absence of this provision may not be deemed conclusive by the court. Proving that a specific sale fell beyond the normal course of affairs of the company is difficult, and the burden of proof rests with the taxpayer.

© 2021 Real Estate Council of Ontario

Lesson 3 | Page 15 of 17

Capital Loss A capital loss is the loss incurred from the disposition of capital property. Provisions in the Income Tax Act provide for the deduction of capital losses for both individuals and corporations but only against taxable capital gains. Example: In 2015, a broker of record purchased vacant land for their sole proprietorship brokerage at a cost of $488,000 with the intention of building a new office on it. A few years later, they sold the property for $500,000. During the time of ownership, they made no significant improvements to the property. Real estate commission to a co-operating brokerage and other allowable expenses amounted to $30,000 with legal fees totaling $2,800. The capital loss calculation is as follows: • Sale price = $500,000 • Adjusted cost base = $488,000 • Cost of sale = $32,800 • Sale price – (Adjusted cost base + Cost of sale) = –$20,800 i.e., the Capital gain (loss) The broker of record can deduct one half of the capital loss (that is, $10,400) on their income tax return but only from taxable capital gains. If they have no taxable capital gains in the year of loss, they can go back to any of the last three years and deduct it from taxable capital gains in those years, or they can carry it forward indefinitely until they have taxable capital gains in the future. This will help the brokerage reduce the amount of tax payable whenever the capital loss is claimed.

© 2021 Real Estate Council of Ontario

Lesson 3 | Page 16 of 17

Anycity Investments Inc. acquired a commercial building several years ago and has recently sold the property for $4,890,000. The adjusted cost base was determined to be $2,700,000. The selling costs were determined to be $268,832. Calculate the capital gain on the investment. There are three options. There is only one correct answer.

1

$1,921,168

2

$1,910,150

3

$1,911,000

© 2021 Real Estate Council of Ontario

Lesson 3 | Page 17 of 17

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Calculate the capital cost allowance (CCA) that would apply to assets of a brokerage There are five sections on this page with a summary of the key topics that were discussed in this lesson.

Capital cost allowance

CCA is the maximum rate set under the Income Tax Act that a taxpayer can claim for depreciation. CCA is not a cash flow item but a matter of taxation and tax-deductible expenses. The Income Tax Act and regulations detail various classes for purposes of CCA calculation. Brokerages are normally concerned with categories such as classes 8, 10, 10.1 (expensive automobiles), 12, 13, and 14.

Declining balance method

Most CCA classes in the Income Tax Act use the declining balance method of calculation. Declining balance involves the reduction of the capital cost by a percentage, as set out for a particular class of property, with subsequent reductions always applied to the declining balance (UCC) within that class.

Half-year rule

The half-year rule impacts how much the CCA can be claimed in the first year of asset acquisition.

Capital gain versus taxable income

Capital gain is the financial gain from the disposition of capital property, a percentage of which must be added to taxable income on disposition of the asset. Capital property includes any item from which a capital gain or loss would be realized and includes depreciable property. Under current © 2021 Real Estate Council of Ontario

legislation, 50 per cent of the capital gain is exempt from tax. The remaining 50 per cent, termed taxable capital gain, is included in income. The determination of whether income is a capital gain or a taxation income is complex. Guidelines are provided to assist in that determination.

Capital loss

A capital loss is the loss incurred from the disposition of capital property. Provisions in the Income Tax Act provide for the deduction of capital losses for both individuals and corporations but only against taxable capital gains.

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 1 of 21

Lesson 4: Tracking Financial Performance

This lesson describes budgeting, variable and fixed expenses, payback period, and break-even analysis. This lesson also discusses certain tips that will help a broker of record when budgeting and reviewing the financial performance of a brokerage.

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Lesson 4 | Page 2 of 21

It is paramount for brokerages to be financially viable. To help achieve this, a broker of record and owner (if applicable) should prepare an annual budget (with assistance from a third-party professional, such as an accountant) to project the anticipated income and expenditures for the purpose of attaining target income and keeping expense allocations under control. Upon completion of this lesson, you will be able to: • Forecast and track financial performance of a brokerage against plan Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 3 of 21

Budgeting and forecasting are important to a brokerage’s success because they help an owner and/or a broker of record set targets for income and expenditures. As a broker of record, you will need to ensure that a detailed budget is prepared that aligns with the brokerage’s vision and business plan in order to run a successful brokerage, as well as to forecast and track the performance of the brokerage.

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Lesson 4 | Page 4 of 21

Budgeting and Forecasting A budget is an estimate of future financial performance based on a brokerage’s projected revenue and/or expenses and a critical assessment of relevant business circumstances. The most accurate budgets are developed using several years of historical data, but effective budgets can be developed with less information. Budgeting is an ongoing process and not just a one-time event. A broker of record may use the budget as a guide and a measuring tool for performance. However, a budget is only an estimate, and many unexpected factors come into play. The broker of record should review the budget regularly but not focus solely on numbers. They should consider other factors, such as upcoming transactions, delayed closings, listing inventories that will turn into trades, long-term trends, and other economic influences. A budget is only an estimate providing a guide for the figures and not the real numbers. Brokers of record should not lose sight of the overall picture by narrowly focusing on specific details.

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 5 of 21

© 2021 Real Estate Council of Ontario

Budget Worksheet A budget worksheet, sometimes referred to as a financial worksheet, can accommodate various brokerage business models, brokerage sizes (for example, multiple branches), commission plans, and expense recovery systems. A budget worksheet helps a broker of record capture details of revenue from all sources and address various expenses that are not as obvious and that they may not have initially considered. This helps the broker of record plan for spending over the course of a period (usually a month or a year). A sample budget worksheet is shown in the thumbnail. Please note that this sample is for reference purposes only. The sample layout allows for further breakdown of revenue and expenses (parent, child, and grandchild, which you learned in the previous module). The worksheet requires consideration as to which expenses are fixed and which will vary depending on real estate activities for the given period of time.

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Lesson 4 | Page 6 of 21

Fixed and Variable Expenses As illustrated on the previous screen, a budget worksheet provides a section for fixed and variable expense analysis, which is helpful for some owners and/or brokers of record when tracking fixed overhead versus fluctuating expenses. This analysis can assist when establishing recovery accounts and calculating break-even and minimum performance levels for brokers and salespersons. Fixed costs, such as occupancy, remain relatively constant despite increases and decreases in production. Variable expenses change with the amount of business transacted (for example, classified and/or internet advertising and sign installations).

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Lesson 4 | Page 7 of 21

Leading Practices for Budgeting Budgeting for a brokerage can present significant challenges. The high mobility of sales staff, aggressive commission plans, fluctuating economic conditions, marketplace swings, competition within the market area, and other unique internal and external influences will affect the process of estimating expenses and forecasting cash flows. The following leading practices for an owner and/or broker of record may prove helpful to put various matters in perspective: • Anticipate revenue delays: Include a delay factor between sales production and the ultimate receipt of commission.

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• Set realistic hiring goals: Avoid being too optimistic about the number of brokers and salespersons that can be hired. Make certain that associated sales production estimates and cash flow projections are realistic. • Avoid high debt load: Carefully assess the debt load that will be carried given typical losses during the first few months (or longer) of brokerage operations. • Prepare for cash flow demands: Cash flows are critical. Retain sufficient funds to carry on the operation for a realistic period of time if revenue is delayed or drastically cut. Have contingency plans. • Accurately estimate start-up expenses: Include a sufficient buffer for unusual startup expenses. Also include legal, accounting, and other professional fees, initial dues for memberships, business taxes, special levies, and permits. Carefully assess all incidental costs in opening an office, for example, supplies, forms, and special printing requirements (cheques, business cards, and letterhead). • Avoid initial high overheads: Avoid starting out with too many full-time employees and too high fixed expenses. • Plan for market swings: Avoid setting the budget solely on strong market conditions without regard for weaker markets. • Contemplate leasing versus buying: Assess the merits of leasing to retain sufficient capital in case a downturn should occur. • Work with rounded numbers: Round the numbers to the nearest hundred dollars.

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 8 of 21

Budgeting and Capital Expenditures As with any business, a brokerage must plan ahead for capital expenditures to replace outdated equipment and/or acquire additional capital assets to further the brokerage’s goals. Capital budgeting techniques, typically employed by large corporations, are used to rank projected purchases based on which will generate the greatest yield over a predetermined time period. However, capital expenditure budgeting in brokerages can range from these formal, multi-step procedures to more informal decision making. Typically, informal decision making is commonly practiced in most brokerages.

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Lesson 4 | Page 9 of 21

Formal versus Informal Procedures The formal procedure for developing a capital budget begins with proposals from operating departments. Individual departments submit proposals to senior management based on the need for new equipment (or other capital assets) to further departmental goals and objectives. Senior management conducts a review and establishes priorities for the upcoming capital budget period (which typically spans three to five years). When the approval is given, the capital expenditures are made, and the costs are tracked in line with subsequent departmental performance. Senior management then reviews performance to ensure that the capital outlays were justified and produced positive results. If otherwise, corrective action is taken as appropriate. Formal decision-making procedures are rarely practiced in brokerages. © 2021 Real Estate Council of Ontario

For most brokerages, the formal decision-making procedure has some applicability, but with less formal structures. For example, an administrative staff person may have identified a piece of equipment that may be suitable for the brokerage’s needs. They may get the broker of record’s approval to investigate further details, such as pricing and features. The administrative staff person would return with their findings and make a final recommendation to the broker of record. The broker of record then makes the final decision. This is referred to as informal decision-making procedure. Appraisal methods can help brokers of record assess whether a purchase of an asset is in line with the budgeted capital. Appraisal methods to help prioritize capital investment decisions can involve either nondiscounted analysis (for example, payback period) or discounted methods (for example, net present value and internal rate of return). Payback period is most commonly used for evaluating small investments, typical of most brokerage capital purchases.

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Lesson 4 | Page 10 of 21

Payback Period Many people calculate the payback period as part of their initial budgeting procedures given its relative simplicity. The payback period represents the number of years necessary to recover the original cash outlay. The cash outlay includes initial asset price plus all installation costs. The net profit or loss attributable to the cost of the asset is known as the cumulative cash flow. Cumulative cash flow = Revenue forecast ─ Estimated expense (if applicable) While payback period is easily calculated, its simplicity warrants caution. The payback calculation does not take into account the cost of borrowed money to make the acquisition (that is, the time value of money), taxation considerations, maintenance (or service contracts), inflation, and the equipment’s residual value at the end of © 2021 Real Estate Council of Ontario

the payback period. A broker of record uses the payback period calculation to decide which investments or projects to pursue and budget for. Example: Assume a brokerage is acquiring a new computer, software, scanner, and colour printer for $18,000 to produce custom newsletters, promotional materials, and listing presentations. Forecasted revenue involving services to brokers and salespersons within the office is $4,500 per year. Using the formula provided, the payback period would be four years. Payback period = Cost of capital asset ÷ Annual cumulative cash flows = $18,000 ÷ $4,500 = 4 years

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Lesson 4 | Page 11 of 21

Given a forecasted positive income before income taxes, a broker of record is contemplating capital expenditures, including a new computer system with extensive graphics capabilities. The broker of record is confident that the equipment will generate internal revenue and be marketable to other businesses in the immediate area. The initial cost is $20,370. The revenue forecast and estimated expenses for the next five years are as follows: • For year 1, revenue forecast is 8,200 and estimated expenses are 9,200. • For year 2, revenue forecast is 12,700 and estimated expenses are 8,400. • For year 3, revenue forecast is 14,800 and estimated expenses are 9,700. • For year 4, revenue forecast is 15,700 and estimated expenses are 9,300. • For year 5, revenue forecast is 17,300 and estimated expenses are 10,200. Calculate the payback period (in number of years) based on the revenue and expense forecasts provided in the worksheet above. There are three options. There is only one correct answer.

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1

5 years

2

7 years

3

9 years

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 12 of 21

Asset Acquisition versus Lease Part of planning capital expenditures is determining whether assets should be acquired or leased. Assets can be purchased outright, financed through a loan, or leased by a financial (capital) lease or operating lease. A financial lease is basically a method of financing the acquisition of an asset. For financial statement purposes, a fixed asset and related liability will appear on the balance sheet of the brokerage. A financial lease must be of such a length that the lessee will derive all the benefits of ownership from its useful lifespan. As such, the lessor will recover cost from lease payments made by the lessee. Financial leases are uncommon in brokerage operations. © 2021 Real Estate Council of Ontario

Alternatively, an operating lease may sometimes be terminated early (usually with penalties), provided that proper notice is given. Typically, the lessor still has substantial value in the capital asset at point of termination. Often, an operating lease is referred to as a rental lease (for example, telephone equipment within a brokerage office or an automobile leased by the brokerage for its owner). Most leases involving brokerages are operating leases and are treated as operating expenses. As such, the operating expense appears on the income statement and not as a capital asset on the balance sheet, as would be the case with a financial lease.

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Lesson 4 | Page 13 of 21

Asset Acquisition versus Lease The decision to lease or purchase assets depends on various factors. Before making any decisions, brokers of record should weigh the advantages and disadvantages of making an outright purchase, financing the purchase, or leasing the asset. As financial leases are uncommon in brokerage operations, they have not been included in this comparison. The following are the advantages of purchasing the asset outright with cash: • Purchase price is known. • Buyer may negotiate a better deal by paying cash. • No monthly payments are made. • Item is owned and reflected as an asset on the financial statements. • Asset may be pledged as security. • If equipment is no longer required, it can be sold to generate cash flow. • CCA can be claimed. The following are the disadvantages of purchasing the asset outright with cash: • Outright purchase may seriously affect cash flow. • Technology may change before the value of the asset has been fully recovered. The following are the advantages of financing the asset purchase: • Purchase price may be negotiable if asset is financed through the vendor. • Set interest rate may be negotiable. © 2021 Real Estate Council of Ontario

• No large capital outlay is required. • Asset is owned subject of the lien. • If equipment is no longer required, it can be sold to generate cash flow. • Interest is deductible. • CCA can be claimed. The following are the disadvantages of financing the asset purchase: • Monthly payments are required. • Chattel mortgage is usually registered. • Owner may be required to make a substantial down payment from personal funds. • Registered loan may affect ability to arrange other financing. • Asset cannot be pledged as security until the loan is fully paid. The following are the advantages of leasing the asset: • Risks of obsolescence are avoided. If the original cost of the asset is completely amortized during the lease, then the risk is passed on to the business. • Asset can be acquired without a down payment. • Lease payments are 100 per cent tax deductible. • Lease obligation for an operating lease does not appear on the balance sheet as debt and can have a favourable effect when calculating financial ratios. • Assets can be easily added or upgraded. The following are the disadvantages of leasing the asset: • Unless written into the lease agreement, the residual value of the asset (if any) passes back to the lessor at the end of the term. © 2021 Real Estate Council of Ontario

• Interest cost of leasing is typically higher than the interest cost of debt. • Lessee is responsible for all lease payments under the terms of the contract and, if problems arise, may be forced to buy out the lease.

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Lesson 4 | Page 14 of 21

Budgeting and Break-even Analysis Revenue unit analysis and break-even calculations are useful performance metrics when tracking activity and sales production. However, their effectiveness will depend on brokerage structure and how revenues are generated. Both measures are useful barometer benchmarks but can lose value for some business models (for example, desk fee operations that rely primarily on rental revenue from individual brokers and salespersons). A revenue unit represents one end of a real estate transaction. Revenue units are often referred to simply as ends (that is, each transaction has two ends, one listing and one selling). For example, a multiple representation transaction where a brokerage lists as well as sells the property would be counted as two revenue units and is referred to as getting both ends or double ending. Revenue units are used by some brokerages to accompany budget figures and gain a more meaningful sales performance overview. They can also be useful when evaluating overall sales activity. Revenue units are normally tallied as follows: • In the event of single listing sold, the revenue unit is 1. • In the event of single sale to buyer, the revenue unit is 1. • In the event of double end, the revenue unit is 2. Revenue units have proven effective in measuring performance, compared with traditional methods that rely on sales volume. Sales volume comparisons are somewhat awkward, as there is no universally accepted method of calculation, and rapidly increasing prices can distort the true picture. For example, increased volumes may not be due to increased market share but merely the sale of increasingly expensive properties. In fact, brokerage market share can actually be shrinking, while sales volume is expanding in a buoyant market.

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By tallying units, brokerages can gather valuable year-on-year information concerning activity generated and not just dollar volume. Also, the revenue unit is preferred to calculations based on total number of transactions, as this approach ignores the contribution of in-house (double end) sales.

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Lesson 4 | Page 15 of 21

Break-even Calculations In addition to tracking performance trends, revenue units can also be used for break-even calculations using a four-step formula that involves the following: 1. Determine the value of the revenue unit. 2. Determine the variable cost factor. 3. Determine the break-even factor. 4. Determine number of units to break-even. A broker of record must first estimate adjusted gross revenue and anticipated number of revenue units to generate that revenue. This information would normally be derived from previous years’ performance or roughly forecasted in the case of a new brokerage. The break-even calculation relies on the division of fixed and variable expenses. The calculation below includes a fictitious fixed and/or variable summary using the budget worksheet and assumes that 536 revenue units will be generated in the budget year. Expense Analysis Summary: • Variable total commission expense is $4,189,754 • Fixed total advertising expense is $174,036 and variable total advertising expense is $239,783 • Fixed total personnel expense is $460,228 • Fixed total communication expense is $76,705 and variable total advertising expense is $54,145 • Fixed total occupancy expense is $177,903 • Variable total operating expense is $172,102 • Fixed total general expense is $193,373 © 2021 Real Estate Council of Ontario

• Total fixed expenses are $1,082,245 • Total variable expenses are $4,655,784 Total expenses = $5,738,029 Income Before Income Taxes: • Adjusted gross revenue (from revenue analysis)

is $6,445,775

• Total expenses (from expense analysis) are $5,738,029 • Adjusted gross revenue (from revenue analysis) – total expenses (from expense analysis) = $707,746 i.e., the Income before income taxes. Step 1: Determine the value of the revenue unit: Adjusted gross revenue ÷ # of units = $6,445,775 ÷ 536 = $12,026 Step 2: Determine the variable cost factor: Variable expenses ÷ Revenue units = $4,655,784 ÷ 536 = $8,686 Step 3: Determine the break-even factor: Value of revenue unit – Variable cost factor = $12,026 – $8,686 = $3,340 Step 4: Determine number of units to break-even: Fixed costs ÷ Break-even factor = $1,082,245 ÷ $3,340 = 324 units Based on this, the brokerage requires 324 ends (or revenue units) to meet fixed expenses, given a forecasted, adjusted revenue of $6,445,775. Assuming that 25 brokers and/or salespersons are expected to equally contribute in sales activity, the minimum performance level for each broker and/or salesperson is approximately 13 ends (324 ÷ 25) for the budget period. The broker of record can then establish goals with individual brokers and salespersons as to minimum performance levels required.

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Lesson 4 | Page 16 of 21

The broker of record of ABC Realty Inc. has forecasted adjusted gross revenue for the upcoming year at $1,237,981. Based on last year’s sales activities, they estimate that brokers and salespersons will generate 507 ends (including double ends). Total variable expenses are estimated at $764,582 with fixed costs at $349,601. Calculate the number of ends (also known as revenue units) required to achieve breakeven (rounding up the final answer to the next whole number). Steps to calculate the number of ends to achieve break-even: 1. Determine the value of a revenue unit: Adjusted gross revenue ÷ Number of ends 2. Determine the variable cost factor: Total variable expenses ÷ Number of ends 3. Determine the break-even factor: Value of revenue unit – Variable cost factor 4. Determine number of break-even units required: Fixed expenses ÷ Break-even factor There are three options. There is only one correct answer. 1

375

2

350

3

326 © 2021 Real Estate Council of Ontario

Lesson 4 | Page 17 of 21

© 2021 Real Estate Council of Ontario

Budget Analysis and Cash Flow Projections The budget provides an overall estimate of financial performance that can be converted to cash flow projections (that is, when cash is actually received by the brokerage). Cash flow analysis is normally based on historical trends by refining prior year estimates. If unavailable (for example, a new brokerage), previous statistics from a local listing service can provide a reasonable starting point. Cash flow analysis begins with estimating gross revenue for the upcoming year and then slotting this revenue by month in relation to typical activity of a local listing service. A 90-day delay is assumed from sale to closing and receipt of cash. Expense calculations are also based on current trends and historical data.

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Lesson 4 | Page 18 of 21

Revenue and Expense Projections Revenue projections are developed, where possible, based on historical brokerage information. Information from the local listing service may help a broker of record when allocating budgeted sales volume into workable monthly projections. The broker of record should categorize monthly cash flow projections to generally align with the financial statements. For example, a four-month cash flow projection is included based on gross revenue (projections using statistics from the local listing service) and other sources of revenue, such as referrals and owner contribution. From that total, payouts to other brokerages are deducted to arrive at adjusted gross revenue. The analysis assumes a traditional office in which brokers and salespersons are paid a split of total © 2021 Real Estate Council of Ontario

commission, and the brokerage is responsible for most expenses. The method by which brokers and salespersons are compensated can affect the budgeting process and organization of cash flow projections. Based on budget estimates, the broker of record is able to complete the expense portion of the cash flow analysis. A detailed four-month analysis is illustrated, including adjusted gross revenue, total expenses, and estimated income before income taxes.

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Lesson 4 | Page 19 of 21

The broker of record of ABC Realty Inc. has determined that 375 revenue units are required to achieve break-even. Assuming 18 brokers and/or salespersons are employed by the brokerage, how many revenue units must be generated by each individual every month to achieve break-even (assuming equal contribution by each broker and/or salesperson)? There are three options. There is only one correct answer.

1

2 revenue units

2

1 revenue unit

3

3 revenue units

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 20 of 21

The broker of record of ABC Real Estate Inc. has forecasted adjusted gross revenue for the upcoming year at $1,237,981. Based on last year’s sales activities, they estimate that brokers and salespersons will generate 507 ends (including double ends). Total variable expenses are estimated at $764,582 with fixed costs at $349,601. If 507 ends (also known as revenue units) are attained, and budgeted variable and fixed costs are correct for the period under analysis, what income before income taxes will the brokerage generate? There are three options. There is only one correct answer.

1

$123,798

2

$125,600

3

$120,000

© 2021 Real Estate Council of Ontario

Lesson 4 | Page 21 of 21

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Forecast and track financial performance of a brokerage against plan There are four sections on this page with a summary of the key topics that were discussed in this lesson.

Budgeting and forecasting

A budget is an estimate of future financial performance based on brokerage projected revenue and/or expenses and a critical assessment of relevant business circumstances. The most accurate budgets are developed using several years of historical data, but effective budgets can be developed with less information. Budgeting is an ongoing process and not just a one-time event. A broker of record may use the budget as a guide and a measuring tool for performance.

Budgeting and capital expenditures

A brokerage needs to budget for capital expenditures to remain profitable. Formal capital budgeting techniques help determine priorities for capital purchases. The two types of procedures for capital expenditure budgeting are formal and informal. Most brokerages commonly practice the informal decision-making procedure.

Break-even analysis

Break-even analysis is an extension of the budgeting process. Break-even analysis is based on revenue units, which establishes minimum performance levels for the brokerage and can be further refined for setting individual broker and/or salesperson production goals. © 2021 Real Estate Council of Ontario

Budget analysis and cash flow projections

A budget analysis provides the brokerage with an overview of its financial performance, which can be further analyzed to create cash flow projections. A broker of record preparing a sound budget will use historical sales information available from multiple sources.

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 1 of 12

Lesson 5: Taxation

This lesson describes the obligations that a brokerage must fulfil in order to comply with the legislative requirements for the Harmonized Sales Tax (HST) and income tax.

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Lesson 5 | Page 2 of 12

Taxation, from the perspective of a brokerage, is a key consideration both in terms of financial statements and overall financial management. Note that specific taxation questions should be directed to the CRA. As a broker of record, it is important for you to understand the terminologies and the obligations that must be fulfilled by your brokerage to comply with federal and provincial requirements related to taxation. This knowledge will also help you when having discussions with your brokerage’s accountant and or representatives from the taxation authorities. Brokers of record are encouraged to obtain advice from thirdparty professionals regarding matters related to taxation. © 2021 Real Estate Council of Ontario

Upon completion of this lesson, you will be able to: • Outline the key requirements related to harmonized sales tax and income tax for brokerage operations Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 3 of 12

HST applies to most transactions involving Canadian goods and services, including services provided by brokerages. The HST rate in Ontario is 13 per cent, which consists of a five per cent federal portion and an eight per cent provincial portion. The HST is collected by the CRA, which in turn coordinates payments to the participating provinces. Taxation is an important consideration both in terms of analyzing financial statements and overall financial management. For taxation purposes, the onus rests on the taxpayer to prove that expenses were incurred in pursuit of income. © 2021 Real Estate Council of Ontario

Brokerages provide services that trigger the HST, thereby imposing an obligation on the brokerage. Therefore, as a broker of record, you should have processes in place to support the collection and reporting procedures for the HST. It is also important for you to understand allowable and non-allowable expenses for the brokerage in order to make informed decisions from a financial management perspective.

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 4 of 12

Harmonized Sales Tax (HST) The HST applies to brokerage remuneration (that is, commissions and fees for the sale, lease, or exchange of property) and other trade-related activities, including: • Appraisal • Property management and consulting fees • Referral fees • Commission payments to independent contractors and co-operating brokerages • Franchise fees © 2021 Real Estate Council of Ontario

The amount of HST that is invoiced to clients and customers in the reporting period is remitted to the CRA. Note that the HST is invoiced, whether or not the fee and tax have been collected during the reporting period. However, prior to remitting, the brokerage is allowed to deduct any HST paid or payable on purchases during the reporting period. Such deductions are termed input tax credits. Therefore, when originally recording a purchase in the purchase journal or cash disbursements journal, it is extremely important to record any HST separately on the purchase. Failure to segregate the input tax credits means that the brokerage is not claiming money owed to it by the government. This failure to claim the HST paid on behalf of the brokerage will impact the bottom-line profitability of a brokerage. The difference between the HST invoiced and the input tax credits is payable to the government. In cases where the input tax credits exceed the HST invoiced, the government refunds the difference to the brokerage. You learned about registration requirements with the CRA for HST in the previous course.

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Lesson 5 | Page 5 of 12

Collecting HST and Reporting Procedures The CRA will assign the reporting period for filing HST returns at the point of registration. The assigned period can be changed by calling the CRA or by filling out and sending in the applicable form. Optional reporting periods are shown based on annual gross revenues (gross revenue before payments to co-operating brokerages). A broker of record may request an optional reporting period to utilize the HST received for brokerage operations. For each period, the brokerage must report the amount of HST charged and any input tax credits being claimed. HST returns must be filed on time even if no business has been conducted and no HST collected.

© 2021 Real Estate Council of Ontario

The following information related to collecting HST and reporting procedures is high-level and has been developed for illustrative purposes only. Brokers of record, in consultation with third-party professionals, must ensure brokerage policies and procedures are in place and align with all legislative requirements related to HST. The following three sections contain information about collecting the HST and reporting procedures.

Brokerage invoices Invoices must include certain information to ensure brokerage clients and customers are aware that HST is being charged. This can be done by indicating the total amount payable including HST, the total amount payable with HST shown separately, or the HST rate that applies to the invoice. For the final option, the HST rate shown is the total harmonized rate, not the federal and provincial components.

© 2021 Real Estate Council of Ontario

Input tax credits The brokerage can claim input tax credits to recover HST paid or payable on purchases and expenses used, consumed, or supplied to the brokerage as part of its business activities. Not all purchases and expenses can be claimed, and amount restrictions apply in certain situations. Brokerages must keep accurate records relating to input tax credits, including credit card receipts, invoices, cash receipts, and contracts. When filing a return, qualifying input tax credits are deducted from HST collected to arrive at a net HST amount. The net HST amount establishes whether a payment is due or a refund is requested for the applicable reporting period. The CRA requires that businesses must provide their HST number to others who are registered in order for those businesses to process their input tax credits and, accordingly, this number is normally printed on each invoice. As such, supporting documentation must include the brokerage name, invoice date, total amount payable or paid, total HST based on that amount, tax status (taxable status applies for brokerage commissions and fees), the brokerage HST registration number, description of services provided (including sale and/or lease terms), and the legal name of the buyer © 2021 Real Estate Council of Ontario

of those services. These requirements also apply to situations where a listing brokerage is paying a commission or fee to a co-operating brokerage or an independent contractor broker or salesperson within the brokerage.

Filing and/or payment options The CRA provides various electronic filing options for HST registrants. Amounts due can be paid using the electronic bill payment facility offered through most financial institutions or the CRA website payment option. Remittances can also be made in person at most financial institutions or sent by mail.

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 6 of 12

ABC Real Estate Inc. has an annual revenue of $3,000,000. The brokerage must report the HST charged, along with any input tax credit claimed to the CRA. What will be the assigned reporting period for ABC Real Estate Inc. based on their annual revenue? There are four options. There is only one correct answer.

1

Quarterly

2

Monthly

3

Annual

4

Bi-monthly

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 7 of 12

Income Tax Income tax is the annual obligation for taxes owed to the CRA based on the net income of a brokerage to comply with the Income Tax Act. A broker of record will need to have a solid understanding of how this legislation affects brokerages. For example, they will need to know about: • General allowable and non-allowable expense guidelines • Small business deductions impacting corporate tax paid, provided that the brokerage meets the definition of a Canadian-controlled private corporation • Taxation and corporate year end A broker of record will be responsible for having policies and procedures developed and in place that ensures their brokerage complies with the Income Tax Act. They should consult with third-party professionals when developing the processes and procedures to satisfy requirements for the Income Tax Act.

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 8 of 12

Allowable and Non-allowable Expenses An expense incurred for the purpose of earning income is generally deductible from business income, but the onus rests on the taxpayer to prove that such expense was incurred in the pursuit of that income. When an expense is incurred partially to earn income as well as another purpose, only the income-earning portion is deductible. Special rules apply outlining what portion of capital assets (property, plant, and equipment) can be deducted in any fiscal period.

© 2021 Real Estate Council of Ontario

To determine whether an outlay is capital in nature or expense related, the taxpayer must ask: Did this bring into being an asset of a permanent nature or was it a one-time expenditure? If the former, it is deemed to be a capital outlay; if the latter, it is deemed to be an expense. Qualifying capital expenditures are capitalized and depreciated yearly at rates set out under the Income Tax Act. Expenses are deductible for the year in which the expenditure occurred. While there is no statutory requirement in the Income Tax Act to have supporting vouchers and receipts to prove expenses, substantiating such payments is virtually impossible without proper documentation. During a CRA audit, the auditor will ask for all supporting invoices and receipts. At minimum, such documents should have the transaction date, amount, nature of the expense, supplier (that is, the company providing the goods or services), name of the taxpayer, HST number, HST amount, and, usually, an invoice number. The foregoing are the general rules regarding allowable expenses. However, the Income Tax Act also has rules that specifically limit or prohibit the deduction of certain expenses. For example, club dues for a dining, recreational, or sporting club are not deductible; interest and penalties paid to the CRA are not deductible, nor are golf green fees or other expenses incurred at the golf club before or after a golf game. The rules regarding automobile expenses are complex but limit the amount deductible, especially for those owning or leasing luxury vehicles. In case of any questions, brokers of record are encouraged to visit the CRA website for up-to-date information. Brokers of record are also encouraged to seek expert advice from third-party professionals regarding any questions on how to comply with the Income Tax Act.

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 9 of 12

Small Business Deduction A Canadian-controlled private corporation operating an active business can qualify for the small business deduction. A Canadian-controlled private corporation is defined as one not controlled by non-residents and whose shares are not publicly traded, nor is it controlled by a company whose shares are traded or any combination thereof. The term “active” is deemed to refer to any business carried on by a corporation, excluding a specified investment business and a personal service business (for example, an incorporated employee). A broker of record should understand that many brokerages would qualify for a small business deduction. The small business deduction is important when opening a brokerage as it reduces the overall rate of federal and provincial corporate taxes. Learners can visit the Government of Canada web site for more information on small business deduction.

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 10 of 12

Taxation and the Corporate Year End In establishing a corporate year end, the first fiscal period of a corporation cannot exceed 53 weeks but can be any fewer number of weeks at the option of the owner. An individual should consider this information and discuss it with third-party professionals when forming a corporation for a new brokerage. Example: If a brokerage is incorporated on July 25, 2019, then the corporate year end must fall between this date and July 31 of the following year (2020). The corporate year end can be subsequently amended, but such a request must be fully documented (including reasons) and is subject to approval by the CRA.

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 11 of 12

ABC Real Estate Inc. was incorporated on July 25, 2019. The broker of record needs to file taxes for the brokerage in compliance with CRA’s corporate filing criteria. Which of the following are permitted corporate year end dates for the new brokerage to file their income tax? There are four options. There are multiple correct answers.

1

December 31, 2019

2

March 31, 2020

3

July 25, 2020

4

August 15, 2020

© 2021 Real Estate Council of Ontario

Lesson 5 | Page 12 of 12

Congratulations, you have completed the lesson! Completion of this lesson has enabled you to: • Outline the key requirements related to harmonized sales tax and income tax for brokerage operations There are two sections on this page with a summary of the key topics that were discussed in this lesson.

Harmonized Sales Tax (HST)

HST applies to most transactions involving Canadian goods and services, including services provided by a brokerage. The HST rate in Ontario is 13 per cent, which consists of a five per cent federal portion and an eight per cent provincial portion. A brokerage must register with the CRA and collect and remit HST.

Income tax

Taxation is an important consideration both in terms of analyzing financial statements and overall financial management. For taxation purposes, the onus rests on the taxpayer to prove that expenses were incurred in pursuit of income. The small business deduction is available to qualifying Canadian-controlled private corporations. The small business deduction is important when opening a brokerage as it reduces the overall rate of federal and provincial corporate taxes. Brokers of record are recommended to seek expert advice from third-party professionals for matters related to taxation.

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 1 of 18

Lesson 6: Summary Practice Activities

This lesson provides a series of activities that will test your knowledge of the entire module.

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 2 of 18

This lesson provides summary practice activities. Throughout this lesson, you will participate in decision points to test your knowledge on the topics presented.

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 3 of 18

Scenario A broker of record purchased an existing brokerage seven months ago. The office administrator has provided the following information: • The brokerage recorded a gross revenue of $322,750 for the six-month period. • Payout to other brokerages has been approximately 23 per cent of the gross revenue. • Personnel expenses have amounted to $41,530 for the six-month period. The broker of record had forecasted that advertising would account for less than $15,000 (that is, five per cent of adjusted gross revenue) as most advertising is paid by employed brokers and salespersons. The broker of record forecasts the same results for the remaining six-month period. You can use this full scenario when answering the decision points in the next three screens.

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 4 of 18

Scenario: Question 1 of 3 Calculate the annual adjusted gross revenue. There are three options. There is only one correct answer.

1

$497,035

2

$499,535

3

$480,000

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 5 of 18

Scenario: Question 2 of 3 Using vertical analysis, calculate the percentage of annual adjusted gross revenue that will be used for personnel expenses. There are three options. There is only one correct answer.

1

16.7 per cent

2

15.3 per cent

3

14.2 per cent

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 6 of 18

Scenario: Question 3 of 3 Calculate the actual advertising expense amount (rounded to the nearest dollar) for the six-month period. There are three options. There is only one correct answer.

1

$12,426

2

$12,000

3

$11,315

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Lesson 6 | Page 7 of 18

The accountant for brokerage ABC Real Estate Inc. has completed the balance sheet for 2020. The broker of record is now analyzing the balance sheet for the years 2020 and 2019 to identify any significant changes comparing 2020 to the previous year. • Total Current Assets for 2019 = $106,378 • Total Current Assets for 2020 = $131,613 © 2021 Real Estate Council of Ontario

Complete a horizontal (line-by-line) analysis reflecting the percentage change for total current assets based on year 2019. There are three options. There is only one correct answer.

1

+23.72%

2

+24.00%

3

+22.00%

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Lesson 6 | Page 8 of 18

The accountant for brokerage ABC Real Estate Inc. has completed the balance sheet for 2020. The broker of record is now analyzing the balance sheet for the years 2020 and 2019 to identify any significant changes comparing 2020 to the previous year. • Total Property, Plant, and Equipment for 2019 = $186,700 • Total Property, Plant, and Equipment for 2020 = $176,400 © 2021 Real Estate Council of Ontario

Complete a horizontal (line-by-line) analysis reflecting the percentage change for total property, plant, and equipment based on year 2019. There are three options. There is only one correct answer.

1

-5.52%

2

-4.52%

3

-6.60%

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 9 of 18

The accountant for brokerage ABC Real Estate Inc. has completed the balance sheet for 2020. The broker of record is now analyzing the balance sheet for the years 2020 and 2019 to identify any significant changes comparing 2020 to the previous year. • Total Current liabilities for 2019 = $55,108 • Total Current liabilities for 2020 = $57,424

© 2021 Real Estate Council of Ontario

Complete a horizontal (line-by-line) analysis reflecting the percentage change for total current liabilities based on year 2019. There are three options. There is only one correct answer.

1

-4.03%

2

-5.07%

3

-5.03%

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 10 of 18

The accountant for brokerage ABC Real Estate Inc. has completed the balance sheet for 2020. The broker of record is now analyzing the balance sheet for the years 2020 and 2019 to identify any significant changes comparing 2020 to the previous year. • Total long-term liabilities for 2019 = $116,500 • Total long-term liabilities for 2020 = $124,800 © 2021 Real Estate Council of Ontario

Complete a horizontal (line-by-line) analysis reflecting the percentage change for longterm liabilities based on year 2019. There are three options. There is only one correct answer.

1

-6.65

2

-4.30%

3

-3.65%

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 11 of 18

The accountant for brokerage ABC Real Estate Inc. has completed the balance sheet for 2020. The broker of record is now analyzing the balance sheet for the years 2020 and 2019 to identify any significant changes comparing 2020 to the previous year. • Retained earnings (net worth) 2019 = $110,854 • Retained earnings (net worth) for 2020 = $136,405 © 2021 Real Estate Council of Ontario

Complete a horizontal (line-by-line) analysis reflecting the percentage change for retained earnings (net worth) based on year 2019. There are three options. There is only one correct answer.

1

+23.05%

2

+24.30%

3

+33.65%

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 12 of 18

As per the balance sheet for ABC Real Estate Inc. as of December 31, 2020: • Current assets for 2019 = $106,378 and current assets for 2020 = $131,613 • Current liabilities for 2019 = $57,424 and current liabilities for 2020 = $55,108 Calculate the current ratios based on years 2020 and 2019: • Current ratio (Current ratio = Current assets ÷ Current liabilities) There are four options. There are multiple correct answers.

1

Current ratio 2020 - 2.39

2

Current ratio 2020 - 2.90

3

Current ratio 2019 - 1.60

4

Current ratio 2019 - 1.85

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 13 of 18

As per the balance sheet for ABC Real Estate Inc. as of December 31, 2020: • Current liabilities for 2019 = $57,424 and current liabilities for 2020 = $55,108 • Cash for 2019 = $52,200 and cash for 2020 = $71,500 • Short term deposit for 2019 = $12,000 and short term deposit for 2020 = $15,000 • Commissions receivable for 2019 = $37,595 and commissions receivable for 2020 = $41,328 Calculate the quick ratios based on years 2020 and 2019: • Quick ratio (Quick ratio = (Cash + Marketable securities + Receivables) ÷ Current liabilities) There are four options. There are multiple correct answers.

1

Acid-test ratio: Quick ratio 2020 - 2.32

2

Acid-test ratio: Quick ratio 2019 - 1.78

3

Acid-test ratio: Quick ratio 2020 - 2.80

4

Acid-test ratio: Quick ratio 2019 - 1.31

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 14 of 18

As per the balance sheet for ABC Real Estate Inc. as of December 31, 2020: • Current liabilities for 2019 = $57,424 and current liabilities for 2020 = $55,108 • Long-term liabilities for 2019 = $124,800 and long-term liabilities for 2020 = $116,500 • Assets for 2019 = $293,078 and assets for 2020 = $308,013 Calculate the debt ratios based on years 2020 and 2019: • Debt ratio (Debt ratio = Total liabilities ÷ Total assets) There are four options. There are multiple correct answers.

1

Debt ratio 2020 - 0.56

2

Debt ratio 2019 - 0.62

3

Debt ratio 2020 - 0.35

4

Debt ratio 2019 - 0.10

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 15 of 18

The calculations from the horizontal analysis and financial ratios for ABC Real Estate Inc., based on years 2020 and 2019, are provided below. • • • •

Current ratio for 2019 = 1.85 and current ratio for 2020 = 2.39 Quick ratio for 2019 = 1.78 and quick ratio for 2020 = 2.32 Debt ratio for 2019 = 0.62 and debt ratio for 2020 = 0.56 Long-term liabilities for 2019 = $124,800 and long-term liabilities for 2020 = $116,500

Based on the calculations involving both horizontal analysis and financial ratios, which of the following statements are true in terms of financial performance of ABC Real Estate Inc. over the two-year period? There are four options. There are multiple correct answers.

1

Long-term liabilities have reduced.

2

Quick ratio has improved based on a year-on-year comparison.

3

Total assets have increased by 5.1 per cent due to new acquisitions.

4

62 per cent of the assets were financed in 2019.

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 16 of 18

A broker of record incorporated their brokerage on August 15, 2019 (not a leap year) and purchased office equipment for $18,000. Office furniture is categorized under class eight with a 20 per cent declining balance rate. Which if the following is the UCC as of January 1, 2020 (rounded off to the previous whole number)? There are three options. There is only one correct answer.

1

$17,315

2

$17,800

3

$16,000

© 2021 Real Estate Council of Ontario

Lesson 6 | Page 17 of 18

A broker of record’s forecast for adjusted gross income for next year is $1,178,200. Based on last year’s activities, the broker of record estimates that the salespersons will generate 482 ends (including double-ends), and total variable expenses are estimated at $682,918 with fixed costs of $302,971. Which of the following is the number of ends required to achieve break-even (rounded up to the next whole number)? Steps to calculate the number of ends to achieve break-even: 1.

Determine the value of a revenue unit: Adjusted gross revenue ÷ Number of ends

2.

Determine the variable cost factor: Total variable expenses ÷ Number of ends

3.

Determine the break-even factor: Value of revenue unit – Variable cost factor

4. Determine number of break-even units required: Fixed expenses ÷ Break-even factor There are three options. There is only one correct answer.

1

295

2

260

3

275 © 2021 Real Estate Council of Ontario

Lesson 6 | Page 18 of 18

Congratulations, you have completed the lesson!

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Module Summary | Page 1 of 4

Module Summary This lesson contains a summary of the entire module.

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Module Summary | Page 2 of 4

Congratulations, you have completed this module! The next screen will present a summary of the lessons in this module.

© 2021 Real Estate Council of Ontario

Module Summary | Page 3 of 4

There are five sections on this page with a summary of the key topics that were discussed in this module.

Financial Statements

Financial statements have real value both for internal management purposes and external users, including investors and lenders. Financial statements are not pure statements of fact because they contain assumptions, estimates, biases, and/or personal judgments that affect reporting. Key financial statements include: • Balance sheet • Income statement • Cash flow statement Completion of this lesson has enabled you to: • Identify key terms commonly found in the financial statement of a brokerage • Identify the key components commonly found in a balance sheet of a typical brokerage • Identify the key components commonly found in an income statement of a typical brokerage • Identify the key components commonly found in the cash flow statement of a typical brokerage

Financial Ratios, Vertical and Horizontal Analysis

Financial ratios enable owners and/or brokers of record to analyze and assess the financial strengths and weaknesses of the brokerage. Key financial ratios are: © 2021 Real Estate Council of Ontario

• Current ratio (liquidity) • Acid-test ratio: Quick ratio (liquidity) • Debt ratio (debt) • Debt service coverage ratio (debt) • Gross profit ratio (profitability) • Net profit ratio (profitability) Vertical analysis is commonly associated with the income statements and is used to determine what portion of adjusted gross income is used for each expense. Horizontal analysis can be applied to both balance sheets and income statements to identify significant trends based on period-to-period comparisons. Completion of this lesson has enabled you to: • Use financial ratios to analyze the financial performance of a brokerage • Use vertical and horizontal analysis to analyze the financial data of a brokerage

Capital Cost Allowance

Capital Cost Allowance (CCA) acknowledges the existence of depreciation that is the result of wear and tear over the life of an asset and the ability to offset income in relation to the cost of that asset. CCA rates are set as maximum rates under the Income Tax Act. The half-year rule impacts how much CCA can be claimed in the first year of asset acquisition. CCA calculations are made using the declining balance or straightline method. © 2021 Real Estate Council of Ontario

Completion of this lesson has enabled you to: • Calculate the capital cost allowance (CCA) that would apply to assets of a brokerage

Tracking Financial Performance

Brokers of record can use the budget worksheet to analyze fixed and variable expense analysis. Formal capital budgeting techniques help determine priorities for capital purchases. Payback period is a basic financial metric to assess the length of time required to recover initial cash invested in capital assets. Budget estimates can be converted into monthly cash flow projections. Tracking and proper control of variable expenses can improve budgeting accuracy and bottom-line benefits. Break-even analysis is an extension of the budgeting process. Break-even analysis is based on revenue units, which establishes minimum performance levels for the brokerage and can be further refined for setting individual broker and salesperson production goals. Completion of this lesson has enabled you to: • Forecast and track financial performance of a brokerage against plan

Taxation

Taxation is an important consideration both in terms of analyzing financial statements and overall financial management. For taxation purposes, the onus rests on the taxpayer to prove that expenses were incurred in pursuit of income. HST applies to brokerage remuneration (that is, commissions and fees for the sale, lease, or exchange of property) and other trade-related activities, including appraisal, property management and consulting fees, referral fees, © 2021 Real Estate Council of Ontario

commission payments to independent contractors and co-operating brokerages, and franchise fees. The Income Tax Act outlines which expenses are allowed and which expenses are not allowed to be deducted from business income. The small business deduction is available to qualifying Canadian-controlled private corporations. The small business deduction is important when opening a brokerage as it reduces the overall rate of federal and provincial corporate taxes. Brokers of record are recommended to seek expert advice from third-party professionals for matters related to taxation. Completion of this lesson has enabled you to: • Outline the key requirements related to harmonized sales tax and income tax for brokerage operations

© 2021 Real Estate Council of Ontario

Module Summary | Page 4 of 4

Course Closure You have now completed the second course in the Broker program: Business Management. A broker of record’s responsibilities extends to the creation and proper maintenance of records required for the conduct of the brokerage business in compliance with REBBA and other legislation. Brokerage success, as with most business ventures, is heavily dependent on sound financial management. Ultimate responsibility rests with the broker of record for the prudent, diligent administration of all financial records, notwithstanding the fact that others (for instance, administrative staff and third-party professionals such as an accountant) perform various bookkeeping and/or accounting functions. A broker of record reviews the financial statements to analyze the financial performance of a brokerage and to make informed decisions. In the next course, Human Resources, you will learn about establishing personnel requirements; hiring brokers, salespersons, and administrative personnel; and complying with employment standards and other statutory requirements. The course also discusses the registration requirements as per REBBA. It further discusses the best practices for training and standards enforcement that a broker of record should consider when leading a brokerage.

© 2021 Real Estate Council of Ontario