Running a community requires fundamental knowledge of HOA accounting. Board members must understand how accounting works, how it differs from bookkeeping, and what accounting encompasses as a whole. Even if an HOA seeks help from professionals, it pays for board members to have a basic grasp of how finances work.
What is HOA Accounting?
Accounting for HOAs is the systematic recording and management of a community’s financial transactions. It involves tracking incoming dues and fees, managing payments for services, and maintaining reserve funds for future repairs, among other things. While HOAs are non-profit, proper accounting is still necessary for financial health.
HOA Accounting vs HOA Bookkeeping
While they fall under the same umbrella, accounting and bookkeeping are not the same. Accounting focuses more on the analytical side, interpreting and reporting data to provide financial insights. Meanwhile, bookkeeping is more transactional. It records the association’s day-to-day financial activities and keeps them organized.
Accounting and bookkeeping work hand-in-hand. A bookkeeper records financial transactions in a ledger following the chart of accounts. An accountant can then interpret the data and present it in a formal report.
What are the Types of HOA Accounting?
The cash basis, accrual basis, and modified accrual basis are the three types of accounting methods for HOAs. Each one presents a different principle for recording transactions.
1. Cash Basis Accounting
Cash basis accounting tracks money when it changes hands instead of when it is incurred or earned. Transactions are recorded only when the association actually receives income or incurs expenses. It’s the simplest method of accounting and requires fewer entries than other forms.
That said, the downside of cash basis accounting is that it doesn’t show the full picture. Boards have no way of tracking accounts payable or future revenue.
2. Accrual Basis Accounting
Generally regarded as the best form of accounting for homeowners associations, accrual basis accounting records income and expenses when they are respectively earned and incurred. Recordation happens even if money has not actually moved.
Because of this, boards get a more complete picture of the association’s financial standing. It shows what the association owes and what it stands to earn. Furthermore, it’s the only method that complies with the Generally Accepted Accounting Principles (GAAP).
Of course, because of its nature, the accrual basis is more complex. Boards must consistently track transactions and reconcile accounts. Otherwise, it can result in inaccurate projections.
3. Modified Accrual Basis Accounting
Modified accrual basis accounting is a mix of cash-basis and accrual-basis methods. Here, income is recorded when it is earned, but expenses are recorded only when money changes hands. This makes it easier to manage than the accrual basis, but gives a clearer picture than the cash basis. That said, it is not compliant with GAAP standards.
Operating Fund vs Reserve Fund
Proper HOA accounting requires two separate accounts — one for the operating fund and another for the reserve fund. This is unlike standard for-profit businesses.
Dividing finances into two distinct accounts can help ensure the board uses funds for their intended purpose. Reserve funds should not be used to pay for operating expenses, and vice versa. The operating fund is designed for daily or recurring expenses, whereas the reserves are allocated for major capital repairs or replacements in the future.
What are HOA Financial Statements?
Financial statements are formal reports that depict the financial activities of an HOA or condo association. While exact statements can differ, most communities rely on a few common ones:
- Balance Sheet. This shows the association’s financial condition by comparing the assets against the liabilities and equity.
- Income Statement. Otherwise known as the Statement of Income and Expense, this report details the association’s actual income and expenses for a certain fiscal period. It shows whether the association has netted a profit, loss, or broken even.
- General Ledger. While not exactly a report, the General Ledger consists of all accounting transactions. It serves as a repository of financial activities and as the basis for all other reports.
- Accounts Payable Report. This report shows how much the association owes and the age of each debt. It allows the board to plan the budget to meet financial obligations.
- Account Delinquency Report. In contrast to the AP report, the Account Delinquency Report details the amounts homeowners owe to the association. It shows who is behind on their payments, how long they have been behind, and how much they owe.
How Often Should an HOA Prepare Financial Statements?
The required frequency for preparing financial statements will depend on the association’s governing documents. More often than not, HOAs and condos prepare these statements on a monthly, quarterly, and annual basis. Larger communities, in particular, benefit from more frequent reporting, as they tend to manage more money.
What is Bank Reconciliation?
Bank reconciliation compares actual bank statements against the association’s internal accounting records. The objective is to verify that all records and transactions have been accounted for. If there is a discrepancy, the board should re-check the association’s ledgers and reports to trace the cause.
It is a good idea to reconcile bank accounts every month. This will allow the board to identify problems or inaccuracies early on. Discrepancies usually stem from duplicate payments, uncashed checks, or automatic debits that were not recorded.
Is an HOA Audit Required in Maryland?
An audit is a comprehensive examination of an association’s financial records. It is typically performed by an independent Certified Public Accountant. Board members should never conduct an audit themselves, as there is a conflict of interest.
The purpose of an audit is to verify that the financial statements accurately reflect the financial condition of the association. It also confirms that the association is compliant with all legal standards.
In Maryland, neither HOAs nor condominiums are required to conduct an annual audit. That said, Section 11-116 of the Maryland Condominium Act gives unit owners the right to demand an audit if 5% of the units request one.
Moreover, board members should check their governing documents. Many CC&Rs or bylaws require an annual audit of the association’s finances.
The Importance of an HOA CPA
A Certified Public Accountant (CPA) is beneficial to a community because they can provide an essential HOA accounting service. A CPA can prepare the association’s financial statements, reconcile bank accounts, facilitate audits, and assist with tax returns.
While many CPAs provide HOA bookkeeping services, it is not their primary focus. Most of the time, they delegate this job to a dedicated bookkeeper. This allows the CPA to concentrate on high-level financial analysis and strategies.
How an HOA Management Company Helps
While HOA accounting is primarily the board’s job, help can come from an HOA management company. Most companies offer comprehensive accounting services, including bank reconciliation, financial reporting, and transaction recording.
Additionally, these companies also typically provide other financial services that HOA accounting firms do not. Beyond accounting and bookkeeping, management companies can also assist with dues collection, budget preparation and tracking, invoice processing, and reserve planning. Managers can also interpret financial data to provide valuable insights that support smarter decision-making.
Furthermore, management companies often have proven internal controls that prevent fraud, theft, and misuse of funds. Some practices include segregation of duties, strict disbursement requirements, and access restrictions. Most managers also need board approval for transactions over a certain threshold.
Part of the Job
Clearly, HOA accounting involves several moving parts and tasks that volunteer boards often can’t handle alone. That said, even with professional management, board members should have a basic understanding of how accounting works. This will allow them to identify suspicious activity or inaccurate transactions with ease.
Majerle Management, Inc. provides management services to HOAs and condo associations in Maryland. Call us today at (301) 220-1850 or contact us online to get started!
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