Homeowners association accounting is a critical part of managing any HOA community. The key to successful accounting, though, starts at the beginning — choosing your accounting method. Among the three possible options, HOA accrual accounting remains unsurpassed.
What Is HOA Accrual Accounting?
The accrual basis of accounting dictates that you should record revenues and expenses as these transactions occur. It does not take into account when you actually receive payment or disburse cash.
When using accrual accounting for HOAs, you record all of the association’s financial activities on the HOA financial statements. Because of the timing of reporting revenues and expenses, account titles such as “Assessments Receivable” and “Accounts Payable” appear on the Balance Sheet. This gives you a better understanding of your association’s current financial standing.
HOA accrual accounting is inherently more complicated. Therefore, many find it more difficult to comprehend and execute. Regardless, it remains one of the HOA accounting best practices. It is widely used among homeowners and condo associations since it provides you with a more accurate view of your finances. Additionally, this HOA accounting method is the only one that conforms with the Generally Accepted Accounting Principles (GAAP).
HOA Accrual Accounting vs Cash and Modified Accrual Accounting
There are three accounting methods available to homeowners and condo associations: Accrual accounting, cash accounting, and modified accrual accounting. Typically, though, associations choose from one of the first two identified.
But, how does HOA accrual accounting differ from the other two methods anyway?
Cash accounting dictates that you should record all revenues and expenses as money moves. It primarily relies on the timing of the cash exchange. In this case, you would only record a revenue or expense account when you have either received (revenue) or paid (expense) money for it. Because of the timing of the cash method, account titles such as “Assessments Receivable” or “Accounts Payable” do not appear on homeowners association financial statements such as the Balance Sheet.
The final method, modified accrual accounting, is simply a combination of the other two methods. Using a modified basis, revenues are recorded when they are earned as opposed to when money is received. It follows the accrual principle. Expenses, on the other hand, are recorded when you disburse money regardless of when you incurred them. It follows the cash principle.
The Best Accounting Method for HOA
Given that there are three accounting methods that associations can choose from, you may wonder why most people favor the accrual basis of accounting. Simply put, accrual accounting remains the best HOA accounting method because it paints a more accurate picture of your association’s finances.
For example, if your association has unpaid invoices to a vendor that you have yet to pay for, under the accrual accounting principle, you would record it under “Accounts Payable.” The same goes for any debts owed to the association but has yet to be settled. Knowing that you have receivables or payable will give you a better idea of your financial condition. Using the cash accounting method, though, you might spend money without knowing that you have payables to take care of.
While modified accrual accounting does give you a clearer view of your revenues, it does not do the same for your expenses. HOA accrual accounting is simply superior because it helps you financially plan and budget for the future as well as allows you to make informed decisions.
Understanding the Pitfalls of Cash Accounting for HOAs
When your association uses cash accounting, it fails to report any receivables or payables. That means you have no way of knowing about any money coming in or any expenses you expect to pay — at least, not with a simple look at your financial records. This opens you up to the possibility of operating under a misapprehension regarding your finances.
Because receivables and payables do not appear on financial statements, you might think that your association has more cash than it actually does. Your cash account might reflect solvency, but you would not know for sure because you do not record payables. With the cash accounting method, you will find it hard to keep track of the money you owe and money owed to you. Thus, when unexpected expenses arise, you might end up spending money you actually do not have.
You can prepare reports to track your payables and receivables if you wish. But, you have no way of determining their accuracy because you cannot cross-reference them with your Balance Sheet or General Ledger.
Granted, the cash accounting method is the easiest to understand and execute, which is why some associations prefer it. But, it is best reserved for cash-based businesses and handling your personal finances. For an organization like an HOA, use accrual accounting.
The Role of the Law and Your Governing Documents
It is equally important to check state laws to see which accounting method you should ultimately use. Some states are more specific when it comes to HOA accounting, while others have no such laws. California, for instance, requires the use of the accrual basis of accounting when preparing a pro forma operating budget.
Your governing documents may also have a say in the decision. Some associations have it in their CC&Rs or bylaws that a certain method of accounting should be used when recording and preparing financial statements. Though, since HOA accrual accounting is the best, consider amending your governing documents if it asks you to use a different method. Check with your HOA attorney to see how you can amend your governing documents.
A Helping Hand
Accounting is a difficult subject that requires some background knowledge in order to execute properly. Understanding the idea behind HOA accrual accounting is just the tip of the iceberg. This is why many associations choose to seek the help of an accountant or invest in HOA accounting software.
Condo Manager USA provides software solutions for self-managed associations and HOA management companies. Our HOA and condo management software comes with a comprehensive accounting system that uses the accrual method of accounting. Schedule a free demo, call us at (800) 626-1267, or contact us online for more information.
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