HOA FINANCIAL STATEMENTS

Interim Financial Statements

Boards normally receive unaudited financial statements quarterly or monthly at their board meetings. The association's management company often generates them and may be prepared using accrual or modified accrual accounting. (Civ. Code § 5200(a)(3).) Interim statements normally contain the following records:

• General ledger
• Income statement
• Balance sheet
• Budget comparison

Board Duty to Review. Boards have a duty to review the association's finances. There is nothing in the Act about approving unaudited monthly financials. Although boards could approve monthly financial statements, doing so carries some risk since interim financials are a work in progress, and the board could approve inaccurate numbers.

Industry Practice. Industry practice is to have minutes reflect that "A monthly financial report was submitted to the Board." "The Treasurer's report was given." or "The Board received an interim financial statement along with the Treasurer's report." When the Treasurer's report is given, no action is required by the board, i.e., there is no need to make a motion. (RONR (12th ed.) 48:20.) The same is true for committee reports. The board does not approve a committee's report; it "receives" it. Moreover, committee reports (and interim financials) are not made part of the minutes unless there is an important reason to do so. (RONR (12th ed.) 48:24.)

Membership Review. Boards should routinely include a summary of the "Treasurer's Report" in their minutes and then post it for membership review.

General Ledger

A "general ledger" is a report that shows all transactions that occurred in an association's account over a specified period of time. (Civ. Code § 5200(a)(3)(D).) The general ledger is the core of the association's financial records since every transaction flows through the general ledger. Every account that is on the association's chart of accounts is included in the general ledger, which should be set up in the same order as the chart of accounts. While the general ledger does not include every single accounting entry in a given period, it does reflect a summary of all transactions made. The system used in recording entries on a general ledger is called a system of debits and credits. For every debit, there should be an equal and offsetting credit. Associations must use accrual or modified accrual accounting for the general ledger. (Civ. Code § 5200(a)(3).)

Income Statement

An income statement is also called a profit and loss statement, or a "P&L." It lists the association's income, expenses, and net income (or loss). The net income (or loss) is equal to the association's income minus its expenses. The income statement is prepared after all adjusting entries are made in the general journal, all journal entries have been posted to the general ledger, the general ledger accounts have been footed to arrive at the period end totals, and an adjusted trial balance has been prepared from the general ledger totals.

Balance Sheet

A balance sheet reflects the financial status of the an association at a specific point in time. It lists the association's assets and liabilities, and the difference between them, i.e., the association's equity.

ASSETS

• Cash. Petty cash, checking accounts, savings accounts, etc.
• Assessments Receivable. Dues and special assessments owed to the association as of the date of the report.
• Fixed Assets. Property acquired by the association with a useful life greater than one year and of significant cost.
• Prepaid Expenses. Payments of expenses for future periods, such as insurance premiums.

LIABILITIES

• Accounts Payable. Expenses incurred but not yet paid.
• Prepaid Assessments. Dues or assessments that have been paid in advance by an owner.
• Income Taxes Payable. Unpaid taxes.

FUND BALANCES (also known as members' equity or retained earnings)

• Replacement Fund. Amounts set aside for future repairs and replacements.
• Operating Fund. Accumulated earnings or losses from the current and prior years.

Annual Financial Statement

An annual "Financial Statement" is a report on the financial activities of an association. When reviewed by a Certified Public Accountant for publication to the members of an association, it contains the following:

• Accountant’s Report (Nature & scope of work, Management’s Responsibilities, Auditor’s or Accountant’s Opinion or Conclusion, and any other matters of emphasis)
• Balance Sheet (Assets, Liabilities, Net Assets or Fund Balances)
• Revenue & Expense Statement
• Cash Flow Statement (Explains the change in cash & investments (reserves) from the beginning of the year to the end of the year)
• Full Disclosure Notes (Specifically GAAP mandated plus client-specific issues)
• Mandatory Supplemental information regarding Major Repairs & Replacement obligations and funding plan (reserves).

Management Representations. The financial statement is partly based on management representations and includes disclosures regarding litigation that could have an unfavorable outcome for an association (under ASC 450-20-25, Accounting for Contingencies). As part of the review/audit process, CPAs require a signed representation letter describing the association's management practices. "Management" includes board members. The letter is one of the steps CPAs must follow to satisfy the review and auditing standards issued by the American Institute of CPAs. 

Signatures. Typically, the signatures of two board members (usually the president and treasurer) and the manager are required. The representations are to the best of the signers' knowledge and belief. Even though the financial statement is the association’s, the manager signs because they are the primary source of information in the statement. If directors refuse to sign, the CPA issues a draft report instead of a final signed statement.

Recommendation: Boards should be familiar with the representations in the letter. When associations are defrauded, it is usually because boards delegate too much financial responsibility to one director or the management company. It's always the "trusted" employee who has the opportunity to embezzle funds.

Accrual Basis. The financial statement is made on an accrual basis using GAAP methods as required by Civil Code § 5305. If the association's gross income exceeds $75,000, the report is either audited or reviewed, depending on which level is called for in the association's governing documents. If an association's documents are silent, a "review" must be performed at a minimum. (Civ. Code § 5305.)

1. Distribution of Statement. A copy of the reviewed financial statement must be distributed to members within 120 days after the close of each fiscal year. (Civ. Code § 5305.) Board members and owners should pay particular attention to any opinions expressed by the CPA in the financial statement.
2. Method of Delivery. Boards cannot merely notify members that the report is available; they must deliver the report by one of the following methods (Civ. Code § 5305; § 4040):

• first-class mail, registered or certified mail, express mail, or overnight delivery by an express service carrier;
• email, facsimile, or other electronic means if the recipient has consented, in writing, to that delivery method.

Associations with less than $75,000 in annual gross revenues have other annual financial reporting requirements as mandated by their governing documents and the California Corporations Code. Boards should consult their association’s attorney and CPA for these requirements.

ASC 606—Reserve Revenue Recognition. In December 2017, FASB issued Accounting Standards Code 606, “Revenue Recognition from Contracts with Customers,” which took effect for accounting years beginning after December 15, 2018. HOA CPAs have divided into two camps regarding how this ASC applies to HOA assessments, product purchases, and user fees.

OPINION #1. One group concludes that HOA owners are not “customers” in the usual and customary sense because they share in the risks and benefits of the HOA operation. Therefore, HOA assessments should be recognized (recorded) as income to the Association upon their levy or due date, as has been the practice. In the case where HOA owners are acting as customers, typically “buying” certain products (key fobs) or incurring user fees (Golf green fees), there would also be no change in when the revenue is recognized (recorded on the HOA’s financial reports).

OPINION #2. The second group concludes that the portion of the HOA assessments that the HOA has arbitrarily designated for Major Repairs & Replacements (MRR, Reserves) should not be recognized as revenue until the HOA expends the funds to satisfy this “Contract Liability.” This method treats reserve revenue differently from operating revenues and radically departs from how HOA assessments were recognized over the prior forty years. Many find that financial statements using this interpretation are difficult to understand and misleading.

Since neither FASB nor the AICPA has taken a position on how ASC 606 applies to homeowner association assessments, HOA boards can ask their CPA to prepare the association's annual financial statement using traditional methods for reporting assessment revenues. The Annual financial reports are the association's, not the CPA's. If the HOA’s preferred presentation complies with GAAP, is not misleading, and reflects the community’s economic reality, it may direct its CPA to accounting methods.

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