Doctoring The HOA Budget
Written By: Richard Thompson
Thursday, November 14, 2013
To many people, homeowner association budgets look like a mess of meaningless numbers. But, like it or not, the board is responsible for understanding what those numbers mean so it can properly guide the financial course of the HOA. Be theres hope Dr. B.N. Counter to the rescue.
Financial statements can be prepared according to three methods: Cash, Accrual, or Modified Cash. You must know and understand which method is being used in order to understand the financial statement. Which method is used has a huge impact on the numbers that appear in the financial report. The methods differ as follows:
Cash. Cash method accounting is like a personal checkbook which tracks when cash is received or paid out. Income is recorded when a deposit is made. Expenses are recorded when a check is written. Cash method financial statements are easy to understand and to prepare. However, they dont give the full picture since they omit information on unpaid bills or uncollected assessments.
Accrual. Accrual accounting tracks all transactions, even if cash is not received or paid out. Income is recorded when the assessments are due instead of when collected. The same is true for expenses. Expenses are recorded when they are incurred. For example, if the HOA buys new equipment, the purchase is recorded even if the bill has not been paid. Because it tracks all income and expenses, accrual method accounting more accurately records the financial activity of a particular time period.
Modified Cash. Most HOAs use modified cash method for record keeping. It is a blend of cash and accrual methods. With this method, most transactions are recorded on the cash method, but some are logged on an accrual method. For example, accounts receivable amounts owners owe the HOA are recorded as they are billed accrual method. Expenses are recorded as the bills are paid cash method. Other accrual adjustments, such as prepaid expenses and income tax accruals, are not made. The modified cash method is less complex than accrual method but during an audit, a CPA often must convert the financial statements to accrual method since it more accurately groups income and expenses in the fiscal year to which they apply.
There are two basic types of financial statements: the Balance Sheet and Income amp; Expense Statement. A Balance Sheet is sometimes called an Assets amp; Liabilities Statement. The Board should receive both statements usually monthly, or at least quarterly, shortly after the end of the reporting period. Reviewing the financial status will inform the Board of needed corrections early.
Income amp; Expense Statement. The purpose of this report is to keep you abreast of income and expense status over a period of time; for example, "for eight months ended August 31, 2003." The income statement generally shows the current period - either the month or quarter - as well as a year to date totals. At the end of each fiscal accounting year, this statement "closes out" and starts again with the beginning of the new fiscal year.
An important feature of the Income amp; Expense statement is the Budget to Actual comparison which shows if a particular budget item is over or under budget. If there is a significant variance, it will easier to spot. The accounting method used, cash or accrual, impacts the report. If cash method is used, income is recorded as assessments are paid and deposited. With accrual method, the income is recorded as it is "earned." For this reason, an accrual report will typically show a much greater income figure than a cash report unless all assessments have been paid on time. Same scenario for paying bills. With accrual accounting, that electricity bill which applies to December but not received until January, is still reflected in the December report. Not so with a cash method report. These differences can greatly distort an HOAs financial position if the Board is not aware of them.
Balance Sheet. The balance sheet takes a "picture" of the HOAs financial status on a particular date. It is comprised of Assets, Liabilities, and Equity.
Assets. These are items the HOA owns. Cash method financial statements generally list only cash as an asset. An accrual method financial statement may list cash, assessments receivable, prepaid expenses, and deposits money held by the HOA, which will be returned.
Capital assets like furniture, vehicles, tools, equipment and depreciation may appear on either a cash method or accrual method financial statement. Capital assets can also be items that the HOA holds title to and generate considerable cash flow like a golf course or parking garage. However, most common area property is not included on an HOAs balance sheet.
Liabilities. These are amounts owed by the HOA, whether for products, services, or taxes. Cash method financial statements generally do not contain liabilities. Liabilities may appear on a modified cash method statement, but they are only updated at the end of the year, since the expenses are not accrued monthly or quarterly.
Equity. This is also known as Retained Earnings and generally states the current balance in the reserve and operating funds. However, some accountants prefer to list reserves as a liability item. The sum of the Assets must equal the sum of the Liabilities and Equity. Thus, the term "balance" sheet.
Reserves is money budgeted for future repairs and replacements of the common areas. It is often the amount of cash the HOA has set aside but may also be the amount the HOA projects it will have in its replacement fund by a particular date. The presentation of amounts allocated to reserves varies greatly. The HOA should discuss this with a CPA knowledgeable in HOA operations and the financial statements should be adjusted at year end to show the amounts budgeted for reserves, spent from reserves, and any transfers between operating and reserve funds.
Interpreting Financial Statements. The board is responsible for the HOAs financial stability. It is a fiduciary duty to understand them. Some questions the board should ask:
Is there enough cash to cover operating expenses?
- Is operating cash increasing or decreasing since the previous report?
- If it is increasing, should the excess is transferred to reserves?
- Are reserves being properly invested at the highest rate with the lowest risk?
- Are the HOAs reserves on target with projections?
- Are reserve expenditures being paid out of reserves?
- Has the HOA borrowed from reserves to meet monthly expenses? If so, is there a plan to repay the amount?
- Are the amounts members owe the HOA increasing or decreasing? If increasing, does the board needs to increase its collection actions? Does it need to "write off" bad debts or set up allowances for them?
- Are there miscellaneous income items? If so, do you know what they represent?
- Are collections keeping up with the budget?
- Are you over or under budget? If the HOA is seve>
There, that wasnt so bad was it? Didnt hurt a bit. Now review the article one more time. The>
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