Fall is the time HOAs do many of their budgets. For many people, budgets look like a mess of meaningless numbers. But, like it or not, the Board is responsible for understanding what those numbers mean so you can guide the financial course of the HOA.
Financial statements may be prepared according to three methods: Cash, Accrual, or modified. You must know and understand the method used to understand the financial statements. What method is used has a major impact on the numbers in the financial report. The methods differ as follows:
Cash. Cash accounting method is like a personal check that tracks when cash is received or paid out. Income is recorded when a deposit is made. Expenses are recorded when a check is written. States financial flows method is easy to understand and prepare. However, do not give the full picture because they omit information on unpaid bills or uncollected assessments.
Accrual. Accrual accounting tracks all transactions, even if money is received or paid. Revenues are recorded when the assessments are due instead of when charged. The same is true for expenditures. Expenses are recorded when incurred. For example, if the HOA purchase of new equipment, the purchase is registered, even if the project has not been paid. Because the tracks all income and expenses, accrual method accounting more accurately records the financial activity of a period of time.
Modified cash. Most HOAs use the modified cash method for record keeping. Methods is a mixture of cash and accrual. With this method, most transactions are recorded on the cash method, but some are recorded in an accrual basis. For example, accounts receivable (amounts owners owe the HOA) are recorded as they are billed (accrual method). Expenditure is recorded in the accounts are paid (cash method). Other regularization settings, such as prepaid expenses and tax provisions, not made. The modified cash method is less complex than the accrual method, but during an audit, a CPA often must convert the financial statements to accrual basis, as it more accurately groups income and expenses in the fiscal year applied.
There are two basic types of financial statements: the Balance Sheet and Statement of Income and Expenses. A balance sheet is sometimes called the Assets and Liabilities Declaration. The Board must receive both states – usually monthly, or at least every three months – soon after the end of the reporting period. Reviewing the financial report to the Board of the necessary corrections early.
Income and expenses. The purpose of this report is to keep abreast of state revenue and expenditure for a period of time. “Eight months ended August 31, 2003″ for example, the income statement generally shows the current period – either the month or quarter – as well as the total year to date. At the end of each year (accounting) years, this statement “closes” and starts again with the start of new fiscal year.
An important feature of the statement of income and expenditure is the budget for the actual comparison that shows whether a special budget is over or under budget. If there is significant variation, it is easier to detect. The accounting method used, cash or accrual, impacts on the report. If you use the cash method, revenue is recorded when the assessments are paid and deposited. With the accrual method, revenues are recorded when it is “earned.” For this reason, a report of accumulation typically show a much larger income figure that a cash report unless all assessments have been paid on time. Same scenario for the payment of bills. With accrual accounting, the energy bill that applies to December but not received until January, is still reflected in the December report. Not so with a report cash method. These differences can greatly distort the financial position of the HOA, if the Board is not aware of them.
Balance Sheet. The balance sheet takes a “snapshot” of the financial status of the HOA at a certain date. It compiles assets, liabilities and equity.
Assets. These are the elements of the HOA owns. Financial flow statements generally list only effective method as an asset. A financial statement accrual method may show cash, to collect fees, prepayments and deposits (money held by the HOA, which will be returned).
Capital goods like furniture, vehicles, tools, equipment and depreciation may appear in an effective or financial statement accrual method. Capital goods can also be items that the HOA has the title and generate significant cash flow as a golf course or in the garage. However, the ownership of common areas is not included in the balance of the Homeowners Association.
Liabilities. These are the amounts owed by the HOA, whether products, services or taxes. Financial flow statements usually contain no obligations method. Liabilities may arise in a state of flow modified method, but only updated at the end of the year, and that expenditures are accrued monthly or quarterly.
Equity. This is also known as retained earnings, and generally states the current balance of reserve funds and operations. However, some accountants prefer to list reserves as a liability. The total assets must equal the sum of liabilities and equity. Thus, the term “balance” sheet.
Reserve is money budgeted for future repairs and replacements of common areas. Often it is the amount of cash from the Homeowners Association has reserved but can also be the amount the Homeowners Association projects that will have on your replacement by a certain date. The presentation of the amounts allocated to reserves is very variable. The HOA should consult an expert on HOA operations and financial statements must comply with CPA at year end to show the amounts budgeted for reserves, the reserves were spent, and any transfers between operating and reserve.
When it comes to interpreting financial statements, the Board is responsible for the financial stability of the Homeowners Association. It is a fiduciary duty to understand them.