HOA Financial Audits
There are three levels of examination for financial statements.
Audit. If an association's governing documents require an audit, a licensee of the California State Board of Accountancy (a Certified Public Accountant) performs an extensive examination of the association's financial records and issues a statement as to their compliance with generally accepted accounting principles (GAAP). An audit is performed in accordance with GAAS (generally accepted auditing standards) established by the American Institute of CPAs (AICPA). The auditing standards are described in Statements on Auditing Standards (SAS). An audit provides a "reasonable level of assurance" that the financial statements are materially correct. As a result, audits are more expensive than reviews and compilations.
Forensic Audit. A forensic audit is more intrusive (and more expensive) than a regular audit and uses an investigative approach to financial records. It is often conducted to ferret out fraud, embezzlement, or other financial improprieties.
Review is Required. Unless an association's governing documents require an audit, the Davis-Stirling Act requires a "review" of the association's finances for any fiscal year in which the association's gross income exceeds $75,000. (Civ. Code § 5305) In a review, a CPA performs limited inquiries in accordance with GAAS (generally accepted auditing standards) established by the AICPA and gives "limited assurance" that the financial statement is materially correct. Reviewing standards are described in Statements on Standards for Accounting and Review Services (SSARS). A copy of the review of the financial statement must be distributed to the members within 120 days after the close of each fiscal year, by individual delivery pursuant to Section 4040. (Civ. Code § 5305)
Compilation. A compilation is the lowest level of review in which a CPA assembles information provided by an association. The CPA need not be independent and is required to perform only a few procedures. Further, the CPA takes little responsibility for the financial statement and gives no assurance of compliance with GAAP. A compilation can be done if an association's gross income is $75,000 or less.
NOTE: Neither audits nor reviews guarantee that embezzlement will be detected.
Auditor's Opinion
The purpose of an audit is to determine the accuracy of an association's financial statement. Once the auditor has examined the financial records, the auditor will issue a written opinion. Four types of opinions may be offered:
- Unqualified Opinion. An "unqualified opinion" means the auditor's opinion of the financial statement is given without any reservations. It means the auditor believes the association followed all accounting rules appropriately and that the financial reports accurately represent its financial condition.
- Qualified Opinion. A "qualified opinion" by the auditor means some limitations exist, such as an inability to gather certain information or a significant upcoming event that may or may not occur.
- Disclaimer. A "disclaimer" means the auditor could not express an opinion on the association's financial condition because it was unable to obtain certain relevant facts.
- Adverse Opinion. An "adverse opinion" means the auditor does not believe the association's financial statements are accurate.
Sarbanes-Oxley Audit Standards
Sarbanes-Oxley is the name of federal legislation passed by Congress in 2002 following accounting scandals at Enron, Tyco, WorldCom, Global Crossing, and others. The legislation set new auditing standards to ensure that public companies issued accurate financial statements and required the adoption of conflict-of-interest policies. Board Responsibilities under Sarbanes-Oxley:
- The board is responsible for adopting auditing, internal control, and ethical standards for the company.
- The board must adopt standards for evaluating public accounting firms and must require the firm to keep accurate records supporting audit findings for at least seven years.
- The board must ensure a second partner approves each audit.
- The board must develop internal controls in accordance with the revised audit standards for the public accounting firm to evaluate the company's compliance with those controls.
Impact on Associations. The new laws apply only to public companies, not to nonprofit community associations. Even so, the fallout has affected all audits. Audit requirements regarding documentation have increased, as auditors must evaluate internal controls, document that evaluation, test internal controls, and then communicate the deemed weaknesses to their clients.
Recommendation: Association boards should work with the association's auditor to adopt and implement internal financial controls and a conflict-of-interest policy.
ASSISTANCE: Associations needing legal assistance can contact us. To stay current with community association issues, subscribe to the Davis-Stirling Newsletter.