As with any organization, strong accounting can make all the difference in maintaining a well-run, functional HOA. While good accounting practices can lead to happier homeowners and communities (not to mention HOA boards), poor financial management can have a lasting, negative impact.
In this article, we’ll cover everything you need to know about HOA accounting, including why it is so important, what it entails, and what HOA boards can do to ensure that their associations are following best financial practices.
Why HOA accounting matters
An HOA has various responsibilities to its community, many of which come at a cost. Common area maintenance, equipment repairs, general landscaping, and amenity care (parks, pools, gyms, and clubhouses) all require some financial investment. Proper accounting surrounding all aspects of an HOA’s finances matters for several key reasons.
- Financial transparency. Since HOAs are funded by homeowners, homeowners should always have a clear understanding of how their money is being spent. Solid accounting will paint a clear picture of where the money is going. This allows transparency between the HOA and homeowners, which in turn builds trust and reduces conflicts within the community.
- Budgeting and planning. Accurate accounting allows the HOA board to create and stick to a realistic budget. Without good accounting, HOAs may not be able to plan properly, potentially leading to unexpected financial shortfalls.
- Legal and regulatory compliance. HOAs are subject to certain rules and laws that govern their financial operations. Strong accounting practices help HOAs operate within these laws so that they can avoid legal issues.
- Building a reserve. Sometimes, HOAs need to plan and financially prepare for projects that are still several years out. Additionally, unexpected expenses could potentially arise that can put an HOA in financial trouble if they don’t have money set aside for such circumstances. Building adequate reserve funds for these situations is essential to covering long-term and surprise costs.
- Decision making. When a board has accurate financial data, they are able to make smarter decisions for the community at large. The financial state of the HOA at any given moment could influence the board’s decisions, so clear and correct data is crucial.
Key principles of HOA accounting
HOA board members should all understand the key principles of HOA accounting. Let’s start with a quick overview of important terms.
- Assessments: The payments homeowners make to the HOA. Assessments are usually charged on a regular basis (e.g., monthly or quarterly), and the amount charged to each homeowner is determined by the board.
- Accounts payable: Payments the HOA owes
- Accounts receivable: Payments owed to the HOA
- Audit: Regularly conducted, comprehensive review of HOA financials. Some associations require an annual audit, but even if not required, a yearly financial review is usually a good idea. (Tip: Consider hiring a CPA to perform your annual audit; they’ll know what to look for and will spot things an untrained eye might miss.)
- Assets: Anything the HOA owns that may have monetary value, including buildings, furniture, and equipment. This also includes funds in the HOA’s bank accounts, and its investments.
- Liabilities: Anything the HOA owes, including loans, prepaid assessments, unearned revenue, or other outstanding expenses
- Equity: The monetary value of the HOA, often represented on the balance sheet as retained earnings or losses
HOAs should use a variety of reports to help them see and understand their financial situation in any given moment, month, or year. Here are some of the accounting reports commonly used.
- Balance sheet: Statement listing the liabilities, assets, and equity of the HOA. This delivers a quick look at the association’s overall financial health, and can help you understand daily, monthly, and yearly income and spending.
- Income and expense statement: Document that compares the HOA’s planned spending to its actual spending. This allows the board to see, at a glance, whether or not the HOA is sticking to its budget.
- General ledger report: Detailed record of each individual transaction for every budget item, including information about who made and received a payment. Different accounting softwares will allow you to organize and sort this information in various ways, allowing you to view transactions by date, category, or other variables.
- Cash distribution statement: Tracks all checks written by the association. It should include who the check was written to, check number, date, budget code, and a description of the payment
- Accounts delinquency statement: Specifically for accounts receivable, including homeowners who are not current with their assessment payments
- Accounts payable statement: Specifically for tracking unpaid expenses, including bills
Cash vs. accrual accounting
Another important thing to understand in the world of HOA accounting are the basic accounting methods an organization may use to track their finances. There are two main methods of accounting: cash-based and accrual-based.
In cash accounting, revenue is recognized when a payment is received, and expenses are recognized when cash is paid. While this is a fairly simple and straightforward way of accounting, it doesn’t account for future financial obligations or income that has been earned but not received. Because of this, organizations that follow this accounting method may have a strong sense of how much cash they actually have on hand, but not a clear picture of overall financial position or performance.
Accrual accounting, on the other hand, is more about matching income and expenses to the time periods in which they are earned or incurred. Revenue is recognized when it is earned and reliable, regardless of when the check comes in the mail or when the payment actually clears. Similarly, expenses are recognized when they are incurred, not when the money leaves the HOA’s account. For example, an expense that is still a few months away could be recorded immediately, even if the payment hasn’t been made yet.
While accrual accounting is usually seen as more complicated than cash accounting, it is also recognized as a more comprehensive way to determine financial standing.
Additionally, there is a third accounting method that is a mix of the two main types, known as the modified accrual or hybrid method. This is what the majority of HOAs use, because it allows them to recognize revenue/income once it is available for use, while also recording expenses once they leave the bank account. This mix of styles offers flexibility, accuracy, and informed planning.
- Cash accounting recognizes revenue and expenses as they are received or paid.
- Accrual accounting recognizes revenue when it is earned, and expenses when they are incurred.
- Most HOAs use hybrid/modified accrual accounting to track the state of the HOA’s finances according to their unique needs.
There are just a few other principles to understand in the world of HOA accounting, including:
- Fidelity bonds: Also known as fidelity insurance or crime insurance, these bonds provide protection against financial losses that result from fraudulent or dishonest acts committed against the HOA by people associated with the HOA (e.g., board members or other HOA employees). Such acts might include embezzlement, misappropriation of funds, or theft.
This type of coverage is required for associations in order for them to purchase properties with certain types of mortgages. These bonds should cover at least three months of HOA assessments. Beyond that, HOAs can choose a coverage limit that fits their specific needs.
Fidelity bonds can help offer peace of mind to homeowners and board members by demonstrating the HOA’s commitment to responsible financial management.
- Reserve studies: In financial terms, a “reserve” essentially acts as a “rainy day” fund.
An HOA reserve study assesses current and future needs for the funding of major repairs, replacements, and capital improvement projects within the community.
During a reserve study, the community’s physical assets—such as buildings, roofs, roads, sidewalks, pools, and other amenities—are evaluated for condition. The study then estimates the cost of repair or renovation based on the current market prices. Then the study attempts to determine when these expenses will occur and how much money will be required, before offering recommendations to the HOA as to how to build their reserve fund in a responsible manner to account for these upcoming projects.
Reserve studies can be extremely useful for helping the HOA create a financial plan for the future.
Best HOA accounting practices
Managing an HOA’s finances can be a big job, especially for anyone who isn’t an accounting or financial professional already. That said, a few best practices can help you do your part in keeping your organization on track.
- Become familiar with state laws. State laws may dictate what your association can and cannot do from a financial standpoint. Knowing the laws ahead of time will not only protect the association from potential legal problems, but will also save everyone involved a lot of time and energy.
- Utilize professional services. There are plenty of professional services available to HOAs that can help make financial management easier. One option is professional accounting software that is specifically designed for HOAs. You could also hire a CPA or accountant (preferably one who is already familiar with HOAs) to manage your association’s finances. Additionally, you can always communicate your financial questions or concerns to your HOA management company; they will be able to direct you to resources that can help.
- Establish clear financial policies. Homeowners want to know exactly what they are paying for. Set up clear policies that outline how assessments are calculated, how and when late fees are applied, how reserve funds are managed, and how funds are being spent. Make sure homeowners have access to these policies.
- Conduct regular audits. As mentioned above, regular audits help verify that all financial transactions are accurately recorded and accounted for. Audits will reveal any discrepancies that need to be addressed. The more often you audit your finances, the easier it will be to find the information you need to answer whatever questions come to light.
- Budget well. Set a practical budget every year. Do this by reviewing previous years’ spending, identifying upcoming costs (use the reserve study for this), determining where you might be able to cut costs, and how much money you need to put aside in reserve. Being smart about setting your budget will make it easier to stick to, and will prevent surprising your homeowners with special assessments to cover extra costs.
- Practice timely collection. Avoid cash flow issues by collecting assessments quickly.
- Educate board members. Even a small amount of training can go a long way toward helping board members understand HOA finances. When everyone is on the same page, everyone can work together to make financial decisions that benefit the entire community.
Solid accounting practices provide a strong foundation for an HOA to operate on. By tracking and managing funds appropriately, an HOA can ensure that they are financially prepared to create and maintain a safe, thriving community.