As you may well know, being a member of the Board of Directors for your homeowners association means having an immense financial obligation to your community. Your job will become convoluted by illegible or inaccurate financial reports and records, which—if you are not prepared—can be overwhelming. Because of this, it is essential that you’re able to decipher and analyze these reports in order to prepare your HOA for homeowner bankruptcy, common area maintenance and repair, or financial dishonesty amongst board members and other HOA employees.
Now, we know we’ve gone over HOA financials before, and yes we understand you might be getting bored of all this accounting mumbo-jumbo; but, in our experience, HOA accounting is one of the least understood aspects of the board member’s job, which can be extremely problematic when you are in a pinch. With that in mind, here is our in-depth look at other accounting aspects we may not have covered before, and why you need to be well-versed in them.
Understanding Your HOA’s Monthly Financial Reports
Any accountant or statistician will let you know that proper reporting—and understanding of said reporting—is absolutely necessary to run a successful business; this remains true when running a homeowners association as a board member. As such, you need to pay close attention to your monthly financial reports, usually presented to you by your HOA management company. If you are a self-managed association, the treasurer of your HOA should be providing these reports, as well as recording them on a financial software program such as QuickBooks. Generally accepted accounting principles require certain financial reports for your HOA on a monthly basis, such as:
- The Balance Sheet: The balance sheet is the report that gives the association’s financial condition. A comparison of the assets of the association minus the liabilities gives the association the net worth. This is the report that shows how much money is actually in the association’s bank account. Unfortunately, board members often find balance sheets to be one of the most confusing statements in your homeowners association’s financial statements. The idea behind your HOA’s balance sheet is that it should always balance, with no exceptions. Listed assets are things such as cash, amounts owed, liabilities, remaining values on unused insurance, etc. Insurance is listed here because it’s typically paid-for in advance, and is then capitalized to the balance sheet. As you use your insurance, the balance of this asset decreases until it is gone. So, if your homeowners association purchases a one-year policy in January for $1200, this $1200 will be recorded to the balance sheet in January as the value of the policy. As each month passes, $100 of that value will be expensed, and the value of the asset will then decrease by $100 as it’s used up. The board should compare the amount in the association’s operating fund with the actual bank statement. As for liabilities, these refer to money that your HOA owes, such as an unpaid water bill, a loan taken out for a project, or your HOA management company fee. Liabilities can also refer to money that you have received, but that you have not yet earned (e.g. prepaid assessments). For your homeowners association, equity is typically going to consist of the balance of your HOA’s reserve account. Your Board of Directors will also see retained earnings on this portion of the balance sheet. Retained earnings are calculated using your beginning retained earnings from last year, plus the net income so far this year. They can be looked at as your HOA’s cumulative retention of earnings since its inception.
- Statement of Income and Expense: The statement of income and expense is probably the most important management tool available to an association and its community manager. This report contains the actual amount spent for the month, compared to the budgeted amount for that month. It also displays the difference between these two amounts. Additionally, the year-to-date numbers are also accounted for on this report. Overall, this report gives a snapshot of where your HOA is money-wise, for the month and for the year. Your HOA’s board members can use this report to determine if there are any categories that need to be worked on or fixed, as well as to plan for future expenses.
- General Ledger: The general ledger contains the accounting record for each transaction in numerical order (chart of accounts) and occurrence (date order). This accounting tool gives your HOA and community manager detailed information tracking the financial transactions for the association.
- Cash Disbursements Ledger: The cash disbursements ledger (or check register) informs your board members of checks written. The register should contain information relating to who the check was written to, the check number and date written, the invoice number, a chart of the account number (budget code number) and description of expense, an accounts payable report, and an account delinquency report.
- Accounts Payable Report: Finally, the accounts payable report refers to unpaid expenses, and informs the association of expenditure obligations incurred in the current month, while the account delinquency report refers to the accounts receivable and provides the association with a list of members not current on their assessment obligations, late fees, deed restriction fees, and legal fees, etc.
All of these reports are needed to understand the money that is coming in and out of your HOA’s accounts, so make sure you are getting these reports or that your HOA management company provides them; without them, your community may falter.
HOA Annual Audit
Adding to the reports that you should be keeping, many homeowners associations review their previous year’s financials—including amounts owed to the association, as in the case of homeowner bankruptcy—to better prepare for the next year. Whether your HOA’s governing documents require it or not, it is often recommend that associations with a large cash flow get an annual audit. Some board members choose to get a yearly audit, while others choose to simply get their financials reviewed. Your HOA management company may have someone on staff that can do this for you, or may even be able to recommend a reputable Certified Public Accountant (CPA) for the job.
Any CPA you choose to look over your records is required by professional standards to issue you one of three different reports. Before any work is performed, your association will decide on what report they would like to be conducted. Depending on the size, scope, and complexity of your association, there will be a type of report best suited for your HOA. You may want to review the scope of each of the three different reports, as well as contact your HOA management company.
Compilation is the most basic of financial services. A CPA will compile your financial records and apply basic accounting principles to make sure your financials have been kept properly. Here, a CPA will only check for obvious errors. If necessary, they may take extra steps to adjust any entries before compiling and preparing your financial reports. You will then receive the report, but it will come with “no assurance.” In this kind of report, the CPA cannot expressly make any guarantee as to the accuracy of your financials.
A review includes everything described above in compilation, but also includes a more analytical look at your association’s financial records. This report comes with “limited assurance.” The CPA guarantees that there is no material modification needed upon your receipt of the report.
Finally, an audit is all-inclusive; it includes verification and substantiation procedures, where the CPA will personally verify with all debtors and creditors on any amounts owed, as well as physically inspect all of the association’s inventories. The CPA will also conduct an inspection of your HOA’s minutes and contracts for errors. This report comes with a “positive assurance.” The CPA expressly guarantees that all financial statements correctly identify the financial position and health of your homeowners association and all of its operations.
The main question that most HOA Board members find themselves asking is whether to get a financial review report or a financial audit report. Of course, there are several major differences between the objectives of a financial audit and the objectives of a financial review. The goal of an audit is to reasonably express the financial statements in their entirety, in order to determine where the association stands financially. This expression is not found in a review, as this form of report does not take into account any internal controls, or the risk associated with the inspection of financial records and the gaining of evidence through personal observation on the CPA’s part. A review may or may not bring any significant errors in your association’s financial statements to the CPA’s attention. Also, a review does not include the assurance that an audit does, due to the lack of internal information discovered in the services of a review.
As a board member, you may opt for either one of these reports annually or not; it really is up to you, as they are not necessarily required. But, having some understanding of these various reports and what they entail will help you make that decision when all is said and done.
Managing your HOA’s Bank Account and Assets
Though reports are a major facet that helps you track and begin the path to a financially respectable HOA, all this reporting will be for naught if you do not properly manage your bank accounts and assets. With that in mind, your HOA, community manager, and management company should all have internal controls for handling association funds to protect the community’s assets.
One of the community manager’s primary goals should be to protect the association’s assets with financial procedures of checks and balances, to minimize risk of errors and losses. The optimal level of internal control is when no one person has responsibility or access to more than one function of the financial operation. An example would be to ensure that neither the accounts payable department (the person who writes the checks) nor the accounts receivable department (the person who enters the money received) reconcile the bank statement.
Association funds should be directly deposited into the association’s bank account on a daily basis, and recorded by the receivable department. The community manager must review all invoices for accuracy and approve invoiced work prior to payment. Invoices should then be entered into the accounting system, and checks would need to be issued by the accounts payable department. The treasurer of the association or the community manager would then review invoices or an open item payable report prior to authorizing signature. The community manager’s finance department should receive the bank statements and review the deposits and checks issued, to reconcile the cash position on a monthly basis. The primary function of the finance department is to achieve an accurate and consistent record of information on financial transactions of the organization. The financial statements and all supporting documentation should be given to the association’s directors for their review on a monthly basis.
In a checks and balances system, the association should make all decisions concerning homeowner accounts, while the community manager should recommend an annual audit or review to be performed by an independent certified public accountant (CPA). The association should have all final authorization over replacement and reserve transactions.
The Homeowner Bankruptcy Process
Even as you take measures to protect the investments made in your HOA by residents, it’s inevitable that at some point, a homeowner in your HOA will declare bankruptcy. Bankruptcy is happening more and more frequently across the United States, as homeowners are falling on hard times and having to take extreme measures. The big question for your homeowners association is how you’ll obtain dues owed to the HOA after a homeowner has undergone the process of bankruptcy. Here are just a few things to keep in mind on that front, and when dealing with the bankruptcy process:
- It’s recommended that your board discuss the issue with your HOA management company and/or HOA attorney first. You’ll want to proceed carefully, as bankruptcy changes the relationship between your HOA and the homeowner. A homeowner that declares bankruptcy is under the protection of the bankruptcy laws and bankruptcy court. If you have any pending legal action for past due assessments, you will need to review those cases with your management company and your attorney. You’ll most likely need to alter the course of action from that point forward.
- Take measures to instruct your HOA management company not to continue pre-petition collection action. This means that any amounts owed prior to the bankruptcy being filed (pre-petition amounts) cannot be collected using normal methods. You may need to contact the bankruptcy court and/or bankruptcy trustee to collect any pre-petition amounts.
- Homeowners associations sometimes ask if they can turn off access to amenities for members that are going through bankruptcy and have past-due assessments. Generally speaking, your HOA should not turn off their access to amenities. This is something you should discuss further with your HOA management company and attorney.
- During this whole process, remember to respect the bankrupt homeowner. Make an effort to be kind, and assist the bankrupt homeowner if possible. In every situation, your HOA Board of Directors should consider knowledge of the bankruptcy a private matter and not discuss it with other homeowners in your neighborhood.
Remember; dealing with a bankruptcy is a very delicate process, and one that should not be taken lightly. If you’re unsure how to proceed or simply don’t want to invite possible legal action against your association, speak to an HOA lawyer or contact your HOA management company today. This is the only surefire way to avoid future difficulties.
As a member of your association’s Board of Directors, it’s your job to know and understand these key financial concepts and safeguards, in order to better protect your community’s funds and properly serve your fiduciary duty. Ethics and compassion should guide your judgment, particularly when it comes to homeowners and the honest maintenance of financial records. In the end, you want to make your community a beautiful and financially sound place to live for all residents.