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As an HOA Board member, it is essential that you understand the 3 methods used in HOA accounting services and how they effect financial statements. There is a significant difference in how revenue and expenses are recorded in each method— and this affects the financial position of the HOA at the year end.
The three methods are:
- Accounting services Cash Basis
- Accrual Basis
- Modified Accrual Basis
To have a clearer understanding of these 3 methods, let’s look at them in detail:
Accounting Services Cash Basis
This method records revenues and expenses only when the actual payment is made. This is against GAAP (Generally Accepted Accounting Principles), however, simplifies the accounting for the HOA in many ways.
Things like accounts receivables, accounts payable, unearned income and prepaid expensesare eliminated from the books by using this method. This also allows the HOA to display a healthy cash flow at the end of the year in their cash flow statement.
The downside of using this method is that it shows an inaccurate picture of the financial position of the HOA, which could create lots of problems in planning. Lack of cash at appropriate times is one common issue that is faced by HOA that follow this method.
Accrual Basis
Accrual basis can be considered to be the superior accounting services method among all three, as it follows the rules laid down by GAAP. In this method, expenses are recorded in the period in which they are incurred, regardless of when the payment is made. Similarly, revenue is recorded only when it is earned, regardless of when the money is received.
However, this method makes the preparation of the statement of financial position a bit more complicated.
This means that accounts receivables, accounts payable and possibly unearned income and prepaid expenses have to be created.
The thing that makes this method superior though, is that it allows the HOA to track the payments of the homeowners. Accounts receivable is created and clearly shows the HOA the list of homeowners who owe to the association.
How much they owe and for how long has the amount been outstanding. Therefore, they can send reminders to the homeowners when they are overdue.
The total of the account receivables goes into the statement of financial position as a current asset.
Similarly, the accounts payable will show the HOA the amount that they owe in utilities, and track their expenses in a single year accordingly.
An important consideration in this method is that if any homeowners pay their dues in advance, it should be recorded as unearned income. And will go in unearned income in the statement of financial positon. On the other hand, when the HOA makes a payment for a bill in advance. They would record it as a prepaid expense and show it as a current asset in the books.
Modified Cash/Accrual Basis
Books are simplified and not face with cash problems at the end of the year. Most HOAs uses modified version of cash and accrual basis. But not according to GAAP.
Business revenue is recorded when earned. Regardless of the time when the homeowners make a payment. Expenses on the other hand are recorded when paid.
This means that the there is an account receivable account as unearned income in the statement of financial position. However, there is no such thing as accounts payable anywhere in the books.
By delaying payments, the HOA can make their financial position look healthy.
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