Good synopsis, but the calculations should use the expected future replacement cost rather than the current replacement cost. For things that far out, the replacement cost is often a scientific wild ass guess, but as you get closer to replacement you can get estimates from vendors and refine the estimated replacement cost. Each year, the required reserve contribution would be the estimated replacement cost less the current reserve divided by the remaining estimated life. To be clear, we didn't always assess for 100% of the required contribution but were working towards doing so.
However, 100% funding isn't really required because the funding formula doesn't consider interest earned on reserves. Let's say that you just had your roofs replaced and it cost $12,000. The estimated cost of the next roof, 20 years from now assuming 3% inflation would be ~$22,000. If you assess $1,100 a year for roofs at the end of 20 years and get 3% interest, you would have $29,557, much more than the $22,000 needed. In reality if you consider the 3% interest on reserves in the calculation, you only really need to assess $825 annually.
If you use the current $12,000 replacement cost and assess $600 annually for 20 years your reserve balance with interest is $16,122 and not near enough to cover the ~$22,000 replacement cost in 20 years.
All of that said, I think component reserving is a bit crude and is inferior to pooled reserves where you just run a 20-30 year forecast of reserves and calibrate assessments so you never have a negative balance during the projection time horizon.
As I wrote:
"For simplification purposes, I have not future-valued the $12,000, but reserve funds do, so each year an inflation figure (typically matching the federal governments calculation of annual CPI."
My example was to clarify what the all important
'reserve fund ratio' represents.
You're correct on annual funding & forecasting; you have to fund based on future value replacement costs. Inflation should be adjusted annually as appropriate. But inflation is not the only factor involved in reserve funds.
Line items can also get added, removed, and adjusted. Roofs may turn out to last 18 years on average vs. 20 originally projected. That means earlier owners did not pay their fair share and somebody, like a new buyer, inherits that shortfall. If I see a reserve fund with 25 years on roofs, I suspect it's not realistic (but doing so keeps homeowner fees lower) and if i see 18, I'm impressed. And what if inflation actually ran 4% rather than 3%? If that 1% difference was due to cost of food, then it's not relevant, otherwise, we need to adjust the upcoming year accordingly but rarely does it apply equally to all components.
And perhaps more lumber fencing was added in the community or removed. And some lumber decks were replaced with simulated Trex-like material to last longer (we converted wood to Trex over the course of 13 years), so we kept two line items, one for each group requiring replacements at vastly different costs and useful life. And perhaps cement for sidewalks increased 20% for several years owing to marketplace supply shortages (which happened to us). And our irrigation pumps replacement costs went way up as copper prices skyrocketed for a couple years. How to keep track of all these changes and their financial impacts.
When all reserve fund items are treated as one unit, nobody can spot these issues, especially at any moment in time, like a buyer's viewpoint. These are examples of an evolving component inventory in addition to inflationary factors.
As an informed buyer, I would not accept the former, I want to be able to evaluate the reasonableness of forecasted costs, useful lives, inflation estimates, and the degree to which the HOA demonstrates their standard of care over keeping updated reserve fund component inventory. I can't see that when everything is lumped together with focus on inflation only.
My point is that keeping reserve components by line item has many advantages, to include providing an audit trail that holds up over time so everybody involved can understand where we've been and where we're going and reasons for it.
Annual funding is one issue, but keeping line items separate allows us to accurately calculate the impact of not only time, but all evolving financial impacts unrelated to inflation as well.
Your reply was educational for readers, and I'm probably wading in too deep on details. But ignoring these kinds of details caused significant shortfalls in our reserve fund and trying to figure out why without prior line item details was a nightmare. So we learned the hard way to keep line items and detailed explanatory footnotes so we can keep track of where we've been and where we're going.