How to Adopt Accrual Basis Financial Statements for Your HOA
Accrual basis accounting gives a more complete picture of a homeowners association’s health and financial status than cash basis, making board members increasingly interested in converting their HOA’s financial statements to accrual basis. Accrual basis accounting provides a better matching of revenues and expenses for the period they are earned, not just as received.
Steps to Converting to Accrual Basis Accounting
Accrual basis accounting gives a more complete picture of a homeowners association’s health and financial status than cash basis, making board members increasingly interested in converting their HOA’s financial statements to accrual basis. Follow these two steps to successfully switch your association’s accounting method from cash basis to accrual.
Gather Lists of Receivables and Payables
To setup the initial conversion, your HOA needs to gather lists of receivables and payables. Uncollected revenues need to be recorded for the prior periods due, and the expenses need to be setup for the payables due or accrued. This is most easily done at year-end or the beginning of a new fiscal year because the equity accounts will need to be adjusted anyway for the receivables and payables at the beginning of the year.
This is a one-time adjustment, usually coordinated by your HOA’s bookkeeper or CPA.
Apply to the IRS for Permission to Change
Apply to the IRS for permission to change to accrual basis accounting for your tax reporting. If you have been filing your taxes with the IRS on the cash basis, you may still do so, though it may be easier to simply change. Homeowners associations generally have no tax difference and it is an automatic approval by the IRS. A one-time form just has to be prepared and filed, which your homeowners association’s CPA or tax preparer usually does.
That’s it! By following those two steps, you have successfully converted to accrual basis accounting.
Maintaining Accrual Basis Financial Statements
The ongoing maintenance of the records should not be significantly more time consuming than your cash basis statements with separate lists. The integration of the information will actually give more confidence in the integrity of the financial records.
Changes in HOA Financial Statement Responsibility
Cash, receivables, and payables will be reconciled between the bank and the general ledger. The cash should already be reconciled with your HOA’s bank and general ledger, so this provides no change. The aging of receivables and payables are seldom reconciled in a stand-alone system (i.e. off of the general ledger system) so that unapproved adjustments and write-offs can be made without board notice and approval.
Monthly assessments and other revenues billed needs to be posted to the general ledger, but theoretically this was already being maintained off-line in order to give you the list of receivables due.
Recording cash received is done the same as before.
Posting the payables and accruals takes a little more time than just listing them (as is done in the cash basis statements). Since the payment clears the accrual, however, only the new payables have to be listed each month. This actually makes it easier to track and budget for items that are not paid monthly.
For example, let’s look at water, which is often billed every other month. Let’s say water for February and March costs $600. In February an accrual of $300 is made since water was used (though not yet billed). In March the actual bill is for $598, meaning March is only charged $298 of expense. The payment will then bring the payable/accrual back to $0.
Recognizing Different Types of Revenues and Expenses
Sometimes the revenue recognition gets tricky when it is more than assessments, late fees, and interest earnings.
Here is a list of potentially confusing revenues and expenses with tips on how to properly handle them:
|Type of Revenue/Expense||How to manage with accrual basis financial statements|
|Laundry Receipts||Anticpate and accrue monthly, even if the monies are only received periodically.|
|Advertising Revenue||Let fall in the same period as the newsletter is issued.|
|Newsletter Expenses||Let fall in the same period as the newsletter is issued.|
|Certifcates of Deposit||Hold until maturity, record at cost, and do not adjust for market conditions.|
|Treasury Bills||Hold until maturity, record at cost, and do not adjust for market conditions.|
|Bonds||Hold until maturity, record at cost, and do not adjust for market conditions.|
|Investment Revenue||Track at cost basis, not market value unless “Available for Sale” trading securities.|
For certificates of deposit, treasury bills and bonds, the interest is recognized and recorded as it is earned, regardless of when it is received. For investment revenues, as the investment matures the HOA will be able to receive its principal and interest.
Benefits of Converting to Accrual Basis Accounting
Accrual basis accounting gives a more complete picture of a homeowners association’s health and financial status than cash basis, making board members increasingly interested in converting their HOA’s financial statements to accrual basis.
Accrual basis accounting provides a better matching of revenues and expenses for the period they are earned, not just as received, while its cash counterpart only tells the actual cash status. Cash based accounting fails to cover both what an HOA owes and what is owed to an HOA, financially speaking. These can make a major difference in how the homeowners association is viewed.
Calculating Your Homeowners Association’s Assessment Collection
Calculating your homeowners association’s accrual basis revenue for assessments is a straightforward formula:
Monthly assessment x Number of Units = Monthly Revenue
By using accrual basis accounting, your HOA will be able to see costs due and when members pay their assessments in advance. Cash basis revenue is more limiting by showing only the actual amount received, neglecting the due/owed information. For example, say an HOA member pays her March assessments in January. With accrual basis accounting, the revenues will be accounted for in March’s financial statements, not January when they were received.
Control of Your HOA’s Finances
Homeowners associations should seek control of their finances by following up on monies owed to them and paying off expenses in a reasonable amount of time (i.e. not waiting unduly long to pay an outstanding painting bill). This means that the homeowners association needs to watch its cash flow. An integrated accrual basis statement can greatly assist in understanding a homeowners association’s cash flow. Accrual basis financial statements show how receivables and payables relate to income and expense accounts, providing a more accurate detailing of an HOA’s cash flow.
Cash basis statements, on the other hand, make it much more difficult to project cash needs. Cash basis advocates will tell you they can accomplish the same goal by having cash basis statements with listings of receivables, which they have tracked elsewhere, and a listing of bills due to be paid. Even if such a list is provided, the relationship of the accrual items to the income/expenses would not be presented.
Example: Imagine a 25 lot homeowners association with $100 per month assessments. The HOA has $100,000 in the bank, $7,500 owed in receivables, and a painting bill for $50,000. It seems the HOA is missing three months of assessments or maybe some owner(s) simply haven’t paid for a long time. Or perhaps a special assessment is due. On top of this, the HOA has a painting bill greater than a year’s worth of regular assessments. Maybe there was special assessment for it or perhaps it was planned to be paid from the accumulated earnings. With cash basis financial statements, none of this information is clear, but with an accrual statement, we could know for sure.
Civil Code – Budgeting with Accrual Basis
Civil Code §5300(b)(1) requires:
A pro forma operating budget, showing the estimated revenue and expenses on an accrual basis
The law is designed this way to ensure that the year’s income and expenses are reflected in the year budgeted. This benefits homeowners in that they will:
- Know exactly what to expect in full assessments
- Become aware of the effects of owners not paying assessments (since paying members will have to cover the debts of non-paying members)
With the HOA’s budget on the accrual basis, true budget to financial statement comparison can only occur with accrual basis statements. Cash basis would neglect critical information on periods owed for and accounts to be charged for the accumulation of receivables and payables, making a budget comparison near impossible.
Adapted from information provided by Joelyn Carr-Fingerle, an accountant in Fremont, CA with a large CID practice. Carr-Fingerle is a member of the Accountants Resource Panel and the ECHO Legislative Committee.
Image adapted from a photo by Ken Teegardin, CC BY-SA 2.0.