Annual Financial Statement Review: Working with your CPA

Licensed

Don’t forget to check the status of the CPA’s license with the state. Simply go to the website for the California Board of Accountancy (www.dca.ca.gov/cba/lookup.shtml).

Peer Review

Ask to see the CPA’s most recent peer review report, which is titled “System Review Report”. All California licensed CPAs are required to have a Peer Review every 3 years. According to the Board of Accountancy, a “peer review is a systematic review of a [CPA] firm’s accounting and auditing [review] services performed by a peer reviewer who is unaffiliated with the firm…to ensure work performed conforms to professional standards.”

What Should You Expect From Your CPA?

Once you have selected a CPA, you should know what to expect your CPA to do in order to accomplish their goal, which is to examine the information in your financial statements, recommend any appropriate adjustments, and issue a report to the Board of Directors for distribution to the membership. 

The rules and procedures that your CPA is required to follow have been well established by the American Institute of Certified Public Accountants (AICPA). These rules and procedures are set forth in the AICPA’s Statement on Standards for Accounting & Review Services, No. 19 (SSARS 19).

Under SSARS 19, the CPA must perform selected procedures sufficient to provide a reasonable basis that there are no material modifications to your financial statements. This process is based on making inquiries as well as performing analytical procedures related to your financial statements. This is designed to provide the CPA with limited assurance that the financial statements are prepared in accordance with Generally Accepted Accounting Procedures (GAAP).

This work can occur: before the year is over, and after your financial statements have been presented for review.

Before the Year is Over

Establish an Understanding (Review Engagement Letter)

Your CPA must first establish an understanding with management in writing as to the nature and extent of the work to be performed – a Review Engagement Letter. This engagement letter must be signed and dated before any work can begin.

Initial Inquiries and Selected Financial Analysis

Your CPA may make initial inquiries of the Board of Directors, management and the bookkeeper regarding the accounting practices for your association, and perform selected financial analysis before the end of the year. The objective is to develop a clear understanding of these practices and, in the event problems are identified, to discuss those problems with management before the end of the year.

After Your Financial Statements Have Been Presented for Review

Inquiries and Analytical Procedures

Although inquiries may initially be performed before the year is over, they are to continue throughout the entire review process. Analytical procedures are based on information obtained through inquiry, and on the relationships between the current year’s financial activities and the current year’s budget, as well as other financial information.

These analytical procedures may require your CPA to examine various individual account balances and, if necessary, to examine supporting documents to make sure there are no material discrepancies, or if there are, to insure these discrepancies are properly reflected in their recommended adjustments.

It is management’s (including the bookkeeper’s) responsibility to provide your CPA with whatever information they may need to accomplish their goal. Failure to work directly with your CPA can result in the review not being completed or, if completed, not available for distribution to the membership on a timely basis.

Recommended Adjustments

During the course of their review, your CPA may find that adjustments are necessary to insure your financial statements are presented in accordance with GAAP. These adjustments are to be presented in the form of recommendations, and must be communicated to management and the bookkeeper before the review can be finalized. This requirement enables everyone to make sure there aren’t any misunderstandings as to the nature and reason for any recommended adjustments.

This open dialogue between all parties will prevent potential mistakes by the CPA and will assist the bookkeeper in establishing new, or improving upon existing, accounting procedures for future financial reporting.

Keep in mind that it is management’s responsibility to read, understand, agree to, and accept responsibility for, these recommended adjustments before the review can be completed.

It is also important to note that all recommended adjustments must have a material effect on the financial statements taken as a whole. A material adjustment is one which, if not made, would cause the reader of the financial statements to be misled as to the financial health of your association.

Because the objective of a review is to obtain limited assurance that there are no material modifications to be made to your financial statements, immaterial adjustments generally should not be made. However, they may be brought to the attention of management for future bookkeeping purpose.

There may be some exceptions to this materiality rule, as follows:

1. Income Taxes – It is common practice for your CPA to prepare your annual tax returns simultaneously with their review. Therefore, they may recommend adjustments that are designed simply to agree your financial statements to your tax returns.
2. Assessments – Members’ assessments should agree to the amount actually charged to the members. Therefore, if there are immaterial discrepancies between the amount reported on the financial statements and the amount actually charged, then an immaterial adjustment may be warranted.
3. Management Requests – Management may request that all adjustments discovered by the CPA be recorded regardless of their materiality. Whenever this request is made by management, immaterial adjustments are to be recorded.

If there is disagreement as to the nature or extent of the recommended adjustments and that disagreement cannot be resolved, the only recourse the CPA has is to:

1. Withdraw from the engagement and not issue a report, or
2. Issue a report, but with a middle paragraph quantifying the financial effect of the disagreement on your financial statements.

Accountant’s Review Report

An annual review is meant to provide limited assurance that no material modifications are necessary (beyond those material adjustments already identified in their review) in order to bring your financial statements to be in conformity with GAAP reporting. Therefore, your accountant’s (CPA’s) review report is intended to disclose this fact. Please note that the accountant’s review report is owned by the CPA; whereas, the financial activity reflected in the report is owned by the association.

1. Review Report – The report issued by the CPA identifies the period covered by the review and reflects the CPA’s position that no material modifications should be made to the financial information.
2. Financial Statements – The reviewed financial statements will include a Balance Sheet, Income Statements (for each fund or activity), and a Statement of Cash Flows. These financial statements can only be changed by the CPA with management’s permission, see Recommended Adjustments above.
3. Notes to Financial Statements – The notes to financial statements are an integral part of the review. However, most knowledgeable CPAs will work with management in developing these notes to make sure they comply with all disclosure requirements and clearly identify various accounting policies and procedures reflected in the financial statements.
4. Supplementary Information – Unique for homeowners’ associations is the addition of required supplementary information. This supplementary information, in summary format, reflects the information contained in the association’s most recent reserve study.

Management Representations

The final document to be provided by management to the CPA is a Management Representation Letter. This letter states that management takes full responsibility for the preparation and fair presentation of the financial statements in accordance with GAAP, and is responsible for designing, implementing and maintaining internal control.

This Management Representation Letter must be signed by management before the review report can be issued by the CPA.

Timeliness

Finally, your CPA must complete their review on a timely basis, which depends to a large degree on the full cooperation of management. The review is to be completed and a report issued in time for management to have a chance to examine the results of the review (including accepting the recommended adjustments and signing the representation letter). The “final” report must be available for distribution to the membership no later than 120 days after the end of the association’s fiscal year.

Assuming that management has reviewed and approved the financial statements as presented by the CPA without disagreement, and the Management Representation Letter has been signed, the “final” report may be issued.

A Review is Not an Audit

Your governing documents may call for an audit of your financial statements to be performed by a CPA, which is a higher level of examination, but this is not a requirement of the Davis-Stirling Common Interest Development Act. The civil code only calls for a review; therefore, please don’t confuse the two – a review is not an audit.

Conclusion

As you can see, once you have selected your independent CPA, there are procedures that must be followed during the course of their review (SSARS 19). More importantly, a successful review engagement requires open and regular communication as well as full cooperation between your CPA, management and the bookkeeper. Without regular communication and full cooperation between all participants, the review may not be completed accurately or timely. Therefore, it is essential that everyone works together to be able to accomplish this very important required annual review of your association’s financial statements.

James H. Ernst, CPA, MS-Tax, CCAM is a Certified Public Accountant and a member of ECHO. His CPA firm, James Ernst Accounting, has been providing accounting and tax services since 1993, and he specializes in providing professional services for the homeowners’ association industry. He can be reached at 866.289.6000 or jim@ernst-cpa.com.