How is the financial health of your community?
I don’t want to scare you, but as a community association or HOA board member, it’s your fiduciary responsibility to know the answer to this question. Reviewing your monthly financial statements is a good start, but you also need to be comfortable with the information behind the numbers, including incoming and outgoing payments, bank account balances, reserves, contracts, and insurance. That level of knowledge requires a deeper dive into your books and records.
The detailed financial examination of an association’s financial (and other) records is most commonly known as an audit, but there are similar procedures that accomplish the same or better results for less money. Here are some tips to help you get the most out of this process.
Choose the right “audit”
The word “audit” may mean something different to a board member or community resident than it does to a CPA. I answer to a higher authority (the American Institute of CPAs) which has very specific requirements for an audit, including activities that may not be necessary unless your association has strict covenants or is applying for a loan. An audit, as defined by Generally Accepted Accounting Procedures (GAAP), is the most time-consuming and expensive option.
Here are several alternatives to an official GAAP audit. The first option may offer your neighborhood the same or better results for a lot less money and hassle.
- Agreed-upon procedures engagement. You might call this a targeted examination, since it is a very detailed look at financial areas more prone to errors or issues. Examples are outlined below.
- Review. This procedure is more of a cursory look at financial statements to confirm they conform with GAAP. Normally, associations want more than just this assurance.
- Compilation. This is basically a restatement of the Association’s financial statements. I don’t see much value in this.
Even if your covenants require an audit, the lack of a specific audit definition may give you some flexibility to choose a more effective procedure. Please clarify with your association’s attorney.
Uncovering the right stones
Just paying for a financial engagement isn’t enough. Your board and CPA will want to focus the most energy on the areas where there is the greatest chance of error or issue. Especially if you decide on an agreed-upon procedures engagement, here are some areas to target:
- Cash receipts and cash disbursements. Incoming funds (like resident assessments) are accounted for, and outgoing funds (like bills and petty cash) have appropriate backup.
- Budget. Review actual revenue and expenses vs. your budget to ensure that all variances can be explained. Correct miscoded entries.
- Bank reconciliations. The checkbook (and other bank account) balances match the amounts on the financial reports.
- Reserves. The reserve account is adequately funded per the reserve study. This is important to check during developer turnover.
- Vendor contracts. Contracts, especially larger and long-term contracts, match payments. Be sure to review handling of special projects like construction.
- Insurance. This includes property & casualty, general liability, board member (directors & officers), and fidelity bond coverage.
Remember that audit or other financial procedure can help your community in two ways. It may uncover potential issues, but a well-written report also recommends financial process enhancements that will benefit both the current and future boards.
We’re just an HOA. How bad can it really get?
Working with associations for more than 15 years, you’d be shocked at what we have seen. Simple mistakes build over time, or real issues can quickly escalate without appropriate oversight. Here are a few examples:
- Petty cash was being used to reimburse a board member’s gas expenses – from gas stations in other states.
- A board was paying $2,000 monthly for a contract that was set at $600. There was actually no impropriety, but the contract was years out of date and required renegotiation.
- A construction project was $200,000 over budget before a review uncovered the issue.
- An association’s insurance policy covered 100 homes – although the neighborhood had grown to 500 homes and a clubhouse.
- A property manager siphoned about $250,000 from the HOA’s checking account. A simple bank account reconciliation would have kept this from occurring.
Setting up your board to succeed
Given the information presented above, I hope you agree that it’s best to have at least one board member who has some financial experience. It doesn’t have to be a CPA, although that certainly helps. Whether or not your community association covenants require it, you should also consider conducting an audit or other financial procedure every couple of years, as well as during major events such as developer, management, or board turnover. That’s the best way to catch potential issues today, and implement better processes for the future.