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ACCOUNTING

Basic Accounting Concepts for
Townhome, Condominium and other
Common Interest Developments

The fair and accurate reporting of the financial status and activities of the Homeowners association is the basis for accounting theory and practice. With the increasing size and complexity of Community Associations in California and the increasing economic role of government, the responsibility placed on the Association’s Treasurer and accountants for presenting fairly the results of the association’s business operations is greater today than ever before. Therefore, financial statements and other reports prepared by the treasurer or accountants are vital to the successful working of the Community Association.

The basic assumptions which underlie current accounting practice have evolved over the years in response to the needs of various users of the financial reports. Certain organizations, governmental agencies, and legislative acts have been extremely influential in shaping the development of the existing body of accounting theory.

The AICPA. The American Institute of Certified Public Accountants is the professional organization of the practicing Certified Public Accountant (CPA). As a professional organization, the Institute has been vitally concerned with developing standards of practice, both ethical and professional, of its members. The “Journal of Accountancy” has been published monthly since 1905 as a forum for practicing CPA’s. Beginning in the early 1930s the Institute, in concert with the newly created Securities and Exchange Commission, began to develop standards of sound financial reporting. During the 20 years from 1939 to 1959 the Institute published 51 Accounting Research Bulletins dealing with a wide variety of timely accounting problems.

In 1959 the Institute took the formal step of committing itself to a more comprehensive program of research into the problems of financial reporting. The Accounting Principles Board was formed with the responsibility of formulating and promulgating accounting principles related to financial reporting based on underlying research. The result has been the adoption of accounting procedures which purportedly conform to the basic principles of accounting and which minimize taxable income.

RECORDING FINANCIAL TRANSACTIONS

Accounting has frequently been called the “language of business.” This designation is applied to accounting because it is the method of communicating business information. Like other languages, it is undergoing continuous change in an attempt to discover better means of communicating.

The AICPA has defined accounting as follows: “the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof..”(AICPA Committee on Terminology, Accounting Terminology BuUetin No. 1, Review and Resume, p. 9).

The three steps of recording, classifying, and summarizing form the basic process by which accounting data are created. These procedures are carried out in accordance with a set of rules and conventions which have been developed over time. A thorough knowledge of the rules and standards is necessary for a complete understanding of the data and the manner in which they are accumulated.

The ultimate objective of accounting is the use of these data, through analysis and interpretation, as a basis for business decisions. Data derived from accounting records serve management in controlling current operations and planning future operations. Published financial statements afford homeowners and outsiders a means of analyzing and interpreting past operations of the association in which they have an interest. Accounting statements are for the most part reports of past events. The past however, is often the key to the future and for this reason accounting information is highly valued by decision makers both inside and outside the association.
The Accounting Cycle

The accounting cycle is a complete sequence of accounting procedures which are repeated in the same order during each accounting period. The cycle includes:

  1. Recording transactions in the books of the association as journal entries
  2. Classifying data by posting he Journals to the ledger
  3. Summarizing data from the ledger on a trial balance
  4. Adjusting and correcting recorded data after due consideration of all pertinent facts
  5. Summarizing adjusted data in the form of financial statements
  6. Closing the books to summarize the activities of the period
  7. Reversing certain adjustments to facilitate the recording process subsequent periods

When these steps are completed, the cycle begins again for the next period.

The Accounting Period

The normal accounting period for Homeowner Associations is one year, beginning on any given day and ending 12 months later. A calendar year accounting period ends on December 31; all other 12-month accounting periods are known as fiscal years. Associations frequently adopt accounting periods as set by the developer.

Double-entry System

The most common system of accumulating data for an enterprise is the double-entry system. As the name implies, the entry made for each transaction is composed of two parts, a debit and a credit. The system is based on the theory that the resources used to acquire the assets must be provided by other entities or persons. This situation is usually expressed in terms of the equation, assets equal liabilities plus owners’ equity All accounting entries are made within the framework of this equation, and each transaction must, therefore, be analyzed in terms of the elements of this equation.

Double-entry bookkeeping is a universal concept; it takes its name from the fact that equal debit and credit entries are made for every transaction. The terms debit and credit can be related to the equation A=L + OE.

Cash Basis of Accounting.

Under the cash basis of accounting, revenue is recognized when cash is received; expenses are recorded when they are paid in cash. The determination of income thus rests upon the collection of revenues and the payment of expenses, rather than upon the earning revenues and the incurring of expenses.

A strict cash basis of accounting is seldom found in practice, but a modified cash basis (really a mixed cash-accrual basis) is allowed for income tax purposes. Nearly all individual taxpayers prepare their returns on this modified cash basis. Also many physicians, law firms, other professional firms, and small service-type businesses rely on a modified cash basis of accounting.

Accrual Basis of Accounting

Revenue is recognized when it is realized and expenses are recognized when incurred, without regard to time of receipt or payment. The focus of accrual accounting is on the realization of revenue, the incurrence of costs, and the matching of revenue realized and the cost expired. Adopting the assumption that revenue is recognized when realization occurs and the corollary assumption that costs contributing to the earning of this revenue can be traced through the earning process requires the use of an accrual-deferral system of accounting.

The need for frequent and current appraisals of the past performance of the enterprise as the basis for decisions about the future by management and investors alike has forced the accountant to progress from cash basis to accrual accounting. The financial statements resulting from accrual accounting are less precise than cash flow statements but are at the same time more complex and more useful. The accrual basis of accounting is essentially a process of recording cash inflows and outflows of all four types.

Under the accrual system, the accounts are adjusted periodically to make the data which have been recorded consistent with the basic assumptions of the system. The accountant reviews the accounts periodically, usually monthly, to ascertain whether all revenue realized has been recognized in the accounts, whether the costs incurred in current and prior periods have been allocated properly, whether any revenue has been recognized that has not met the test of realization, and whether any costs have been incurred but not recorded. In reality, the accountant is adjusting the cash flows for leads and lags which have occurred during the month or year.

THE INCOME STATEMENT: A REPORT ON OPERATING PERFORMANCE

A good income statement is something more than an itemized list of revenues and expenses. The treasurer should give some thought to such issues as the system of classification, the amount of detail that is useful, the order of presentation, the relation between the elements of net income, and the titles used to describe the items appearing on an income statement.

To management, a report of net income for the association may not be as significant as statements showing income by products, departments, or divisions of responsibility. Managers are obviously interested in detailed accounting and statistical data that throw light on the contribution of the various elements of an association to its overall efficiency and success. Such information might also be of great interest to outsiders, but because management is unwilling to reveal operating details to competitors, the information appearing in published income statements is usually highly condensed.

Classification of Revenues

For most Homeowners Associations the major source revenue is association dues. Examples of secondary sources of revenue are laundry equipment, use of clubhouse, golf course etc. One objective in reporting revenues on an income statement is to disclose the major sources of revenue and to separate primary from ancillary sources.

Revenue offsets should be clearly distinguished from expenses and deducted from gross revenues in the revenue section of the income statement . Such items as late fee or fine reductions do not represent expenses but rather revenues that are never in fact realized.

Classification of Expenses

Expenses are classified in income statements to help the reader grasp important operating cost relationships. Classification may be according to the nature of the expense elements, business functions, areas of responsibility, or any other useful basis.

The Balance Sheet: A report on financial position

The Balance Sheet reports the financial position of the association by disclosing the amount of cash the association has in the bank, cash in savings or other investments, the amount of dues uncollected and other receivables. The Balance Sheet reports the association’s liabilities or other financial obligations and sets forth the association’s allocation of reserves.

Disclosure

The accounting assumption of disclosure has been described as follows, “Accounting reports” should disclose that which is necessary to make them not misleading. (Maurice Moonitz, “The Basic Postulates of Accounting,” Accounting Research Study No. 1, AICPA (New York: 1961) This statement is deliberately broad, but it points squarely to the objective of adequate disclosure of all material known facts which will aid an informed reader of financial statements in interpreting accounting results. Published accounting reports include not only the financial statements (Balance sheet and Income statement) but should include all the necessary supporting information to convince the reader of it’s accuracy. Accounting reports should include a schedule of all checks issued during the month, a schedule of all monies received and the source from which received. A list of all homeowners and the amount each paid during the month including check number date of check and amount. The financial report should include a schedule or list of all homeowners that are not current in the payment of their dues and the total amount of each delinquent homeowner. The report should include supporting reconciled bank statements and balances of accounts in each bank. And finally the report should include a list of all journal entries made during the month. Indeed, at the end of a fiscal period, a homeowner should be able to take all twelve reports and set them side by side and track the finances of the association for the entire year.

PLANNING CASH ACTIVITIES

The administration of cash is of major importance in any business or association because cash is the means of commanding goods and services. In addition, careful scrutiny of cash transactions is required because this asset may be readily misappropriated.

The administration of cash generally is centered around two areas: cash budgeting and accounting control. The responsibility of the Treasurer and management with respect to cash is (1) to ensure that there is sufficient cash to carry on the daily operations, (2) to invest any idle cash which is not needed for current operations, and (3) to prevent loss of cash due to theft or misappropriation. Cash budgeting is necessary for the proper planning of future operations and to assure that cash is available at the right times but that cash balances are not excessive. Accounting safeguards are necessary to provide a basis for the planning function, and in addition to assure that the cash is used for proper business purposes and not wasted, misused, or stolen. The Treasurer is responsible for controlling and protecting all assets of the association. He/She faces special problems in controlling cash, however, because money is universally attractive and can be easily misappropriated.

The Cash Budget

The cash budget is a forecast of cash transactions for a stated time period It is a statement of estimated cash receipts and disbursements. The cash budget is neither a pro forma operating statement nor a forecast of financial results. Rather it is a prediction of the cash flow through the association based on analysis of past operations and study of future requirements of the association. This prediction is necessary to enable the Board of directors and management to plan the financial affairs of the association, an area of decision making equally as important as the planning of maintenance and repairs.

The time covered by a cash budget is largely determined by the pattern of operations. An association which demonstrates an erratic management pattern presents special problems for the forecaster, and a very short range forecast may be all that is feasible and useful. On the other hand, a useful cash forecast can be made for several months in the future for an association which demonstrates a regular pattern of activity. Normally cash budgets are prepared for each month of the budget period; however, if large inflows or outflows of cash occur at particular times during a month, the interval may be changed to reflect these special situations. The manager needs information about the extremes of the cash position; these extreme points do not always occur at the end of the month.

There are two types of cash budgets: (1) the short-term or operating budget, which usually encompasses a year or a shorter time period, an (2) the long-term or policy budget, which usually covers several years. The short-term budget is used in planning daily operations and serves as the guide for daily operations.

CONTROLLING CASH TRANSACTIONS - Internal Control

The purpose of a system of internal control is to assure that assets which belong to the association are received when tendered, are protected while in the custody of the business, and are used only for business purposes. The system of internal control consists of all measures employed by a business for purposes of (1) safeguarding its resources against waste, fraud, and inefficiency; (2) promoting accuracy and reliability in records kept; (3) encouraging and measuring compliance with association policy; and (4) judging the efficiency of operations. Internal controls are not designed primarily to detect errors but rather to reduce the opportunity for errors or dishonesty to occur. (This definition of internal control was adapted from Walter B. Meigs, Principles of Auditing, 3rd ed., Richard D. Irwin, Inc. (Homewood, Ill.: 1964), p. 77.)

Implicit in all control systems of internal control is the concept that no one person should handle all phases of a given transaction from beginning to end. For example, if one person were permitted to order supplies or enter into contracts, receive the supplies or monitor the performance of the contract, write a check in payment of the goods and services and record the transaction in the official records of the association, there would be no protection against either fraud or accidental errors. In all Homeowner Associations separate and independent persons or agencies should be established for such functions as purchasing, receiving, finance, and accounting, which assures that no one person handles all phases of a transaction.

In many associations the system of internal control is improved by physical safeguards. Computers and other business machines help to improve the efficiency and accuracy of the record keeping function. Purchase orders approved by the Board and signed by the Treasure pre-numbered checks and other business forms are also very helpful in safeguarding the asset and establishing responsibility for it. The system, regardless of the plan, must be supervised with care if it is to function effectively.

Controlling Cash Receipts and Disbursements

The objective sought in the control of cash receipts is to ensure that all cash due to the association is collected and recorded without loss or diminution. The system of controlling cash disbursements should be designed to ensure that no unauthorized payments are made. Control is accomplished by division of responsibility so as to achieve independent verification of the cash transactions without duplication of effort. Cash is safeguarded by depositing it in banks and through the use of petty cash funds, which locate responsibility for relatively small sums of cash in a single person.

Imprest Cash Funds (petty cash)

The term imprest cash refers to a fund of fixed amount used for making small expenditures that are most conveniently paid in cash. The imprest fund is restored to its original amount at frequent intervals by writing a check on the general bank account payable to Petty Cash. The replenishment check is equal in amount to the expenditures made from the fund. Imprest cash funds placed in the custody of the treasurer or other responsible homeowners thus serve to maintain control over cash without burdening the Board with involved procedures for small disbursements.

The size of the fund should be sufficient to meet the normal need for small cash payments for a period of two or three weeks. As each cash payment is made, a voucher or receipt is placed in the fund in lieu of the cash removed. These vouchers are reviewed and canceled when the fund is replenished.

Reconciliation of Bank Balances

The cash balance as indicated on the associations balance sheet and the balance shown on the bank statement will seldom agree. Because of financial transactions that have not been received by the bank such as checks issued or deposits not yet recorded by the bank (in Transit) the bank will show a different balance than the association. For this reason it is essential for the association to reconcile their bank statements each month.

Reconciliation of Receipts and Disbursements

Cash balances per bank statements and the company’s ledger are reconciled in order to establish the accuracy of the records. In some cases accountants find reconciliations of cash receipts and disbursements (the bases of the balances) to be useful in establishing the accuracy of the balances.

Collection of Accounts Previously Written Off

When the decision is made to charge off an uncollectible account, the charge against the Allowance account and credit to Accounts Receivable has no effect on either the book value of accounts receivable or on the net income of the period in which the write-off occurs. If an account that has been written off is late collected, a common procedure is to debit Accounts Receivable and credit Allowance for Uncollectible Accounts. This reverses the entry, erroneously made, and the collection is then recorded in the usual manner.

There is no objection to this procedure if the only error was in writing off an account prematurely or if the amounts are small. The collection of a large amount previously considered uncollectible, however, may indicate a need to review receivable more closely before they are written off.

CONDOMINIUMS, TOWNHOMESPLANNED UNIT DEVELOPMENTS (PUDs)COMMON INTEREST DEVELOPMENTS (CIDs)
Selected excerpts from the Common Interest Realty Associations’ Audit and Accounting guide
prepared by the American Institute of Certified Public Accounts (AICPA) Condominiums

1.03 The term condominium indicates a legal form of ownership in which each owner has title to a defined interior space within a building or combination of buildings and an undivided ownership interest in common property within a development, such as the grounds, recreational facilities, and exteriors of buildings shared in common with all other owners. A condominium association generally owns no real property, but it is responsible for maintaining the common property and providing necessary services. In certain jurisdictions, condominiums may be established as condominium trusts; such entities may own the real estate and all the improvements. If they do, the accounting and reporting for condominium trusts are the same as for cooperatives.

Planned Unit Developments (PUDs)

1.04 A PUD is a form of land development in which various residential and nonresidential structures are clustered to allow optimal use of the property and to provide certain open

spaces and amenities not otherwise available in traditional forms of subdivision developments. In many PUDs, tracts of land are set aside for all owners to use for active or passive recreational purposes, parking areas, and streets.

1.17 Bylaws are organizational documents used to establish the specific operating procedures of CIRAs for such matters as meetings, voting procedures, leadership positions, duties and responsibilities of specific officers, and committees. The declaration and the articles of incorporation always take precedence over the bylaws.

Board of Directors’ Actions

1.18 The policies, procedures, and resolutions of a CIRA’s board of directors are established to carry out the association’s responsibilities as prescribed in the declaration or articles of incorporation and the bylaws, and they set forth internal operating practices for handling financial and other matters.

1.19 The board of directors adopts rules and regulations that deal mostly with restrictions on the use of property and on the behavior of unit owners. Financial matters occasionally are prescribed in the rules and regulations, particularly those concerning delinquent assessments.

Management of CIRAs

1.27 CIRAs are managed in various ways. For example, while some CIRAs contract with property management companies, others hire employees to work directly for the board of directors and carry out its management responsibilities. Still other CIRAs rely almost exclusively on volunteer management and occasional contractors and consultants, as needed.

1.28 Management personnel, on staff or by contract, are primarily responsible for the CIRA’s financial administration as well as the physical maintenance of the property or the supervision of contractors that physically maintain the property.

1.29 In most CIRAs, management personnel, or designated volunteers, prepare periodic financial reports for the board of directors. Such reports may or may not be available to unit owners. Most CIRAs, however, have annual meetings at which financial statements for the preceding year and budgets for the following year are presented to unit owners. Financial statements may also be provided to others, such as the CIRA’s insurance agents, lenders on individual unit mortgages, lenders on the CIRA’s mortgages in cooperatives, prospective buyers of new or resale units, and local and state regulatory agencies.

1.30 CIRAs often retain legal counsel to assist in enforcing their rules and for other purposes. CIRAs engage accountants to provide accounting, auditing, tax, and consulting services to CIRAs.

Unique Characteristics of CIRAs

1.31 The following characteristics are common to all CIRAs:

  • A CIRA’s functions are to operate, preserve, maintain, repair, and replace common property and provide other services. Its activities relate primarily to these functions. CIRAs generally provide services such as security guards, swimming pool lifeguards, snow removal, and rubbish removal.
  • A CIRA’s members, who provide its resources, expect to receive benefits in the form of maintenance and replacement of the common property.
  • Membership in a CIRA is generally mandatory for owners and is a condition in the agreement to purchase either shares in a cooperative or a unit in a condominium or HOA.
  • A CIRA’s members have defined ownership interests that they can transfer to buyers of their shares or units and are entitled to share in the distribution of resources in the event of liquidation.
  • A CIRA’s excess of assessments over expenses at year-end may be distributed to members, credited toward members’ assessments in the following year, or allocated to a major repairs and replacements fund, depending on actions taken by the board of directors, requirements of the governing documents, or state statutes.

Users of Financial Statements of CIRAs

1.32 The rapid growth of CIRAs has created a corresponding growth in the demand for financial information to satisfy the needs of users of the financial statements of such entities.

1.33 The primary users of the financial information of a CIRA are unit owners, whose periodic payments of assessments or carrying charges enable the CIRA to perform its functions. They are primarily interested in information that indicates whether assessments are used for their designated budgetary purposes, and whether adequate funds have been accumulated for future major repairs and replacements. Adequate financial reporting may assist owners in assessing the extent to which the CIRA is meeting its responsibilities to maintain the common property.

1.34 Members of a CIRA’s board of directors need timely, comprehensive financial information to make financial decisions. Information on operating expenses and capital expenditures is a vital tool for identifying unusual trends and fluctuations in operating costs and, ultimately, in determining the assessments or carrying charges that a CIRA should collect from its members.

1.35 An understanding of a CIRA’s financial condition is helpful to potential buyers in assessing their possible investments. A CIRA’s financial statements revealing that the CIRA has a deficit in operating funds or that it has not obtained funds needed for property replacements or major repairs may alert a prospective buyer to seek other investment opportunities or to modify the offer. In contrast, financial information indicating that a CIRA is fiscally sound may help owners sell their units and enhance the value of individual units.

1.36 Other parties that may be interested in a CIRA’s financial statements include the following:

  • Lenders that hold the financing on the property during the development period
  • Second mortgage lenders
  • Direct lenders to buyers of units
  • Government lending-related organizations
  • Trade vendors
  • Federal, state, and local taxing authorities
  • Insurers

1.37 Financial information about amounts due from unit owners and about a CIRA’s policies for accumulating funds to meet future major repair and replacement costs on common property is a major concern of lenders, as well as of unit owners and prospective unit owners.

Future Major Repairs and Replacements

3.01 A CIRA’s primary duties are to maintain and preserve the common property. Because the costs of maintaining and preserving common property are shared by all owners, it is the CIRA’s duty to decide how to fund the cost of future major repairs and replacements. CIRAs generally fund those costs by assessing owners when funds are needed, or by budgeting for the anticipated costs over extended time periods and collecting assessments from owners regularly over those time periods. In certain limited circumstances, CIRAs may borrow for these purposes. If a CIRA chooses to fund the costs over extended time periods, it reports assessments in the fund for major repairs and replacements. ( The fund is commonly referred to as a reserve fund in the legal documents of CIRAs and in the industry. The term reserves is not used in this guide because different meanings are attached to it, and misinterpretations could result.)

3.02 A CIRA may be required to assess its members for future major repairs and replacements by statute, association documents, lenders’ requirements, or a decision of the board of directors supported by unit owners. Inadequate funding for future major repairs and replacements may adversely affect the ability of owners to sell or refinance their units, because of the concerns of prospective buyers, or because of the difficulty of obtaining mortgage financing under programs of various federal and quasi-federal lending-related organizations.

3.03 Before developing a funding policy for major repairs and replacements of common property, the board of directors is responsible for reviewing the governing documents and applicable state statutes. The board has the following options, subject to such documents and statutes, in developing a policy:

a. Funding through periodic assessments over the estimated life of the common property
b. Funding through special assessments at the time a major repair or replacement of common property is needed
c. Borrowing
d. A combination of these options

3.04 To implement a policy to accumulate funds for major repairs and replacements, a CIRA’s board of directors often needs to educate owners about the benefits of accumulating such funds in advance through periodic assessments and to understand that the systematic accumulation of funds is:

a. A means of assuring that funds for major repairs and replacements will be available when needed.
b. An equitable method of charging current rather than future owners with the cost of the current use of assets.
c. A means of preserving the market value of individual units or shares.

3.05 The documents of some CIRAs authorize their boards of directors to fund major repairs or replacements by levying special assessments when the money is needed. Often, the documents require that special assessments be approved by votes of unit owners. If a special assessment is not approved, the CIRA will not be able to fulfill its obligation to replace and repair the common property. In addition, because there may be uncertainties about the ability of some owners to pay large special assessments, the board may consider it preferable to fund in advance through periodic assessments. Above all, boards of directors need to be aware that the goal of whatever policies they set should be to enable them to meet their fiduciary duties to maintain and preserve the common property.

3.06 In developing a plan, the age and condition of the components of the common property are considered. The board estimates the required amounts and, in doing so, considers such factors as useful lives, inflation, and interest or other earnings rates. Estimates may be based on studies, such as engineering reports, developed to determine the timing and costs for future major repairs and replacements. A study generally includes the following:

  • Identification and analysis of each major component of common property
  • Estimates of the remaining useful lives of the components
  • Estimates of the costs of replacements or repairs

3.07 Replacement information may also be obtained from contractors and suppliers or by using tables in technical manuals on useful lives of various components. It is useful for a board to reevaluate its estimates each year. The specific components of common property that a CIRA may decide to include in its funding plan depend on the kind of project, its construction, and the CIRA’s applicable governing documents and state statutes. Such components may include electrical systems, plumbing, roofs, floor coverings, seawall, painting, air conditioning systems, heating and hot water equipment, roads, recreational facilities, and furniture and equipment owned or maintained by the CIRA. Components for which there are maintenance contracts may not be included if the contracts provide for maintenance and replacement of the components.

Reporting Considerations

3.08 CIRAs that assess owners annually for portions of future major repairs and replacements should report those assessed amounts separately from amounts assessed for normal operations. If a CIRA uses fund reporting, amounts assessed for future major repairs and replacements should be reported in the major repair and replacement fund separately from transactions in the operating fund. Transfers between funds that are not part of the current period operating revenues should be presented only in a statement of changes in fund balances or in a statement of changes in members’ equity, if a nonfund reporting approach is used. (See paragraphs 4.26 and 4.30 of this guide for recommended disclosures.)

Financial Statement Presentation, General Method of Presentation

4.01 As discussed in chapter I of this guide, CIRAs conduct and report on two primary kinds of activities: (a) the CIRA’s normal maintenance and service operations, such as gardening, management, snow removal, minor repairs, and janitorial services, and (b ) the CIRA’s long-term major repair and replacement requirements, such as roof replacements, street resurfacing, and painting. CIRAs usually assess their members for both purposes and generally should report such assessments separately. This guide recommends fund reporting, which is commonly used by not- for-profit organizations, because the AICPA Task Force on Accounting for Common Interest Realty Associations believes that it is the most informative method of presenting these separate activities. Some CIRAs may also conduct commercial operations or separate business activities, such as rental operations, in addition to their primary activities. Such activities may be reported on as one or more additional funds. Total amounts of all fund groups should be reported for each financial statement presented.

Method of Accounting

4.03 Generally accepted accounting principles (GAAP) requires the use of the accrual basis of accounting. Financial statements presented on an accrual basis are particularly useful for CIRAs, which assess members based on annual budgets, because they include information about amounts payable and assessments receivable from members and thus enable users to compare the results of operations to budgeted amounts.

4.04 If a CIRA prefers to present its financial statements on a cash basis, and the amounts differ materially from those in statements presented on an accrual basis, the financial statements are not in conformity with GAAP and are considered to be prepared on another comprehensive basis of accounting.

Financial Statements

4.05 Full presentations of financial statements for CIRAs presented in conformity with GAAP should include the following:

  • A balance sheet
  • A statement of revenues and expenses
  • A statement of changes in fund balances
  • A statement of cash flows
  • Notes to financial statements

Balance Sheet

4.06 Information about the operating fund should present assets, liabilities, and the fund balance specifically associated with the CIRA’s normal maintenance and service activities. For example, the operating fund should include information about cash, assessments receivable, prepaid expenses, and trade payables. Property and equipment, if reported as assets, are generally reported in the operating fund. If the amount of property and equipment held by a CIRA is significant, the CIRA may account for it in a separate fund.

Comparative Financial Statements

4.19 GAAP does not require comparative financial statements. Nonetheless, Accounting Research Bulletin (ARB) No. 43, chapter 2A, Comparative Financial Statements, states that “the presentation of comparative financial statements in annual and other reports enhances the usefulness of such reports and brings out more clearly the nature and trends of current changes affecting the enterprise.” Because of space limitations and to avoid cumbersome or confusing formats, some CIRAs present total-of-all-funds information for the prior period rather than information by individual funds. A continuing auditor need not report on the prior period financial statements if only summarized comparative information of the prior period is presented. Nonetheless, in some circumstances the client may request the auditor to express an opinion on the prior period as well as the current period. In those circumstances, the auditor should consider whether the information included for the prior period contains sufficient detail to constitute a fair presentation in conformity with GAAP. (Exhibits 1.1, 1.2, and 13A of appendix A illustrate comparative financial statements using a multi column format for the current period and a single total-of-all-funds column for the prior period.)

Accompanying Information

4.20 A CIRA’s records usually contain more details than are necessary to present financial statements in conformity with GAAP. Consequently, the financial statements may include accompanying information that is not required but may be meaningful to users. Accompanying schedules that compare details of the CIRA’s expenses with budgeted amounts provide users with additional information that is helpful in evaluating the performance of the CIRA’s board and management team. For example, although CIRAs budget and account separately for costs of insurance for property, liability, and directors’ errors and omissions, insurance expenses may be presented as a single line item in the financial statements. An accompanying schedule presenting insurance expenses by classification with comparative budget information provides more detailed formation. Further schedules comparing budgeted amounts with actual expenses for all accounts and reconciling them to the financial statements may be helpful to users.

Future Major Repairs and Replacements

4.26 A CIRA should disclose information in its financial statements about its funding for future major repairs and replacements. Disclosures about such funding should include the following:

§ Requirements, if any, in statutes or the CIRA’s documents to accumulate funds for future major repairs and replacements and the CIRA’s compliance or lack of compliance with them A description of the CIRA’s funding policy, if any, and compliance with that policy

§ A statement that funds, if any, are being accumulated based on estimated future (or current) costs, that actual expenditures may vary from these estimates, and that the variations may be material

§ Amounts assessed for major repairs and replacements in the current period, if any

§ A statement indicating whether a study was conducted to estimate the remaining useful lives and the costs of future major repairs and replacements

CIRAs that fund future major repairs and replacements by special assessments or borrows when needs occur should disclose that information.

4.27 If the disclosure about a CIRA’s funding for major repairs and replacements required by paragraph 4.26 of this guide is absent or inadequate, the auditor should consider modifying his or her report as discussed in SAS No. 58, Reports on Audited Financial Statements.

Budgets

5.01 Budget information is not a required part of the basic financial statements. If presented, that information should be identified as supplementary and clearly marked as not covered by the independent auditor’s report.

5.02 The legal documents creating most CIRAs require that assessments be based on budgets. The budgets of CIRAs are the monetary expression of their goals and objectives and emphasize the stewardship responsibility of their boards of directors. According to FASB Statement of Financial Accounting Concepts No. 4, Objectives of Financial Reporting by Non-Business Organizations, budgets are used to allocate and control the use of resources. Budgets are also used to obtain resources. For example, budgets are pivotal in establishing levels of dues, taxes, and fees to be imposed.

5.03 The boards of directors of CIRAs use the budgeting process to determine the required assessments from owners to fund current services and to provide for future major repairs and replacements and deferred maintenance needs. Unit owners use budgets to evaluate the performance of boards of directors. Other users, such as creditors, Realtors, and potential buyers, may use budgets to compare CIRAs with other CIRAs and to monitor the ability of CIRAs to provide acceptable levels of service.

The Budget Process

5.04 A CIRA’s board of directors or governing body establishes the budget. The budget’s effectiveness depends on the board’s willingness to take prompt corrective action on unfavorable variations from the budget. In developing the budget, the board establishes standards and levels of service for the CIRA, which may involve using outside management firms, polling the CIRA’s owners through surveys or public hearings, and relying on the reports and plans of various board committees. The budget process includes the following:

  • A review of the CIRA’s documents, board minutes, and statutory requirements
  • A comparison of historical financial statements with related budgets
  • A review of existing contracts
  • The development of specifications to solicit bids from outside contractors
  • Consultation with public utilities to estimate future rates
  • Line-by-line analysis of current expenses and consideration of proposed changes and alternatives
  • Integration of special programs that may overlap the current budget cycle
  • Identification of seasonal and monthly variations
  • Forecasts of current period operating results and monthly cash flow forecasts

Other major factors that may be considered in the budget process are the level of deterioration of major common property components, the need for a provision for contingencies, and evaluation of outside contractors responding to bid requests. Ongoing budget reviews help refine estimates and spread the budget preparation workload throughout the year.

Format and Components of a Budget

5.05 It is useful to present budgets in a format that is consistent with the financial statements of CIRAs and comparable with prior periods. Budget presentations vary widely and many include descriptions of various line items and formulas to compute certain expenses, individual fees, or assessment calculations. Although such additional information is useful, its inclusion in the basic budget documents may confuse readers.

Operations

5.06 A budget’s provision for operations includes amounts for the CIRA’s routine operating expenses, such as management fees, utilities, staff payroll, insurance, rubbish removal, routine maintenance of common property, and certain minor additions to common property.

Future Major Repairs and Replacements

5.07 A budget’s provision for future major repairs and replacements includes amounts for repairs or replacements of major components of common property, such as roofs, parking areas, elevators, and swimming pools, and for painting. Budgeting for future major repairs and replacements involves establishing amounts of assessments needed to fund anticipated expenditures as well as amounts necessary to fund major repairs or replacements required during the current period. The noncurrent element of this portion of the budget would ideally be part of a plan spanning the present and future periods.

Other Expenditures

5.08 Provisions for other expenditures include amounts for significant nonrecurring expenditures or income-tax-related items that cannot be classified as operating or major repair and replacement activities, for example, capital additions, nonrecurring major expenditures such as legal fees or construction-related items, and replacements for which there are no other provisions. Such expenditures may be funded by CIRAs through special assessments or borrows.

Presentation of Budget Information in Financial Statements

5.09 CIRAs that present interim financial statements commonly include comparisons with the budget to determine areas that require management’s action. Budget compliance is particularly significant for CIRAs, because users of their financial statements compare budgeted to actual amounts to evaluate the board’s fiscal responsibility. Despite the helpfulness of such comparisons, budget information is not always presented in the annual reports of CIRAs, although such reports often may be the only financial information about the operations of CIRAs available to owners and other users.

Income Tax Considerations

6.01 All CIRAs are required to file federal, and possibly state and local, income tax returns, and they may be required to pay income taxes. The tax life of a CIRA begins on the earlier of the date of incorporation or the date it begins business operations as a corporation or as an unincorporated association taxable as a corporation. A review of a CIRA’s legal documents usually reveals that date.

Methods of Filing

6.02 CIRAs may elect to file income tax returns using Federal Form 1120 (corporate income tax returns) or Federal Forms 1120H (returns for HOAs) subject to Internal Revenue Code (IRC) section 528. The election is made annually. Some CIRAs may file Federal Form 990, a return for tax-exempt organizations. The filing method selected depends on the CIRA’s circumstances and its available income-tax-planning alternatives.

Audit Considerations

7.01 Generally accepted auditing standards apply to audits of the financial statements of CIRAs in the same manner as they do to audits procedures that specifically to audits of CIRAs. These procedures should be considered in addition to the audit procedures customarily performed in audits of financial statements.

Establishing an Understanding of the Engagement

7.02 The auditor should establish an understanding with the client, preferably in writing, regarding the services to be performed and the terms and objectives of the engagements. (A letter establishing such an understanding with respect to audit services is illustrated in exhibit 1 of appendix B)

Independence

7.03 A member of the AICPA who is engaged to audit a CIRA in accordance with generally accepted auditing standards (GAAS). must be independent. In making a judgment about whether he or she is independent, the member should be guided by Rule 101, Independence, of the AICPA Code of Professional Conduct, its interpretations, and the Ethic Rulings under it. A member may also seek advice from the. rulings to specific situations. AICPA’s professional Ethics Division on the application of interpretations and rulings to specific situations.

A CIRA’s Documents

7.04 The legal and other documents that CIRA generally describe the rights and responsibilities of the board of directors, including maintaining the property and responsibilities to unit owners, and its obligation to maintain the property and provide for future major repairs and replacements. In the planning phase of the audit, the auditor should review relevant documents, including bylaws, if any; the declaration for a condominium or HOA; or the corporate charter for a cooperative housing corporation.

Minutes

7.07 The board of directors of a CIRA generally meets periodically. Minutes of those meetings are generally prepared. The minutes usually document such matters as approvals and revisions of budgets and assessments, authorizations for expenditures for capital improvements, approvals of contracts for services to be performed, and authorizations for changes in the management company’s fees. Auditors should review minutes and consider matters that may affect the CIRA’s financial statements.

Budgets

7.21 The operations of most CIRAs are based on budgets, which are used as bases for assessments from unit owners. The auditor should consider the CIRA’s budgeting procedures in obtaining an understanding of the internal control structure and assessing control risk. SAS No. 56, Analytical Procedures, provides guidance on the use of analytical procedures and requires the use of analytical procedures in the planning and overall review stages of all audits. The auditor should consider comparing budgeted amounts with actual amounts as an analytical procedure in the audit of a CIRA.

Assessment Revenues

7.24 Audit procedures applied to assessment revenues should include comparing total reported assessments for the period under audit with budgeted amounts and testing whether amounts assessed to individual owners have been computed in accordance with the CIRA’s documents.

Assessments Receivable

7.25 In auditing assessments receivable, the auditor should design tests to provide reasonable assurance that:

  • All assessments receivable owed to the CIRA at the balance-sheet date are recorded.
  • Recorded assessments receivable represent amounts owed to the CIRA at the balance- sheet date.
  • Assessments receivable are properly described and classified in the financial statements.

The auditor may achieve these objectives by performing substantive tests or a combination of substantive tests and tests of control structure policies and procedures. One of the most widely used substantive tests for determining the existence and accuracy of receivables is confirmation of the amount receivable by direct communication with parties owing amounts to the entity being audited. SAS No. 67, The Confirmation Process, provides guidance about the confirmation process in audits performed in accordance with generally accepted auditing standards. If replies to confirmation requests are not received or if the replies are not satisfactory, the auditor should obtain satisfaction about the existence and accuracy of assessment receivable balances by alternative procedures such as examining subsequent cash receipts and the existence of liens filed against units, although such liens do not assure the collectibility of assessments receivable.

Future Major Repairs and Replacements

7.29 CIRAs may be required by state statutes or their governing documents to set aside funds on a systematic basis for future major repairs and replacements. The auditor should review the CIRA’s governing documents and relevant state statutes to determine whether such requirements exist. The auditor should also review the CIRA’s policy for accumulating the required funds.

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