Many HOAs introduce regular accounting audits to mitigate homeowners’ financial risks. In the framework of such an inspection, an independent third-party CPA (Certified Public Accountant)[56] conducts a comprehensive analysis of an association’s financial records and accounting procedures, to determine whether they are accurate, legitimate and compliant with Generally Accepted Accounting Principles (GAAP)[57] or other reporting frameworks.[58] Upon completion of the planned auditing procedures, a CPA issues an official report that states an opinion regarding the organization’s financial health.
Audit Obligations
In the US, auditing requirements vary from state to state, as well as from HOA to HOA. Some associations are obliged to audit their financial statements on an annual basis or once every few years. For others, it is enough to conduct a review, a compilation or an agreed-upon procedures engagement.
The HOA’s budget, size and terms prescribed in covenants and bylaws[59] often act as decisive factors when determining whether an audit is obligatory for a particular board.
Audit Frequency
An audit at the end of each fiscal year is deemed to be a good rule of thumb. However, the need for an unscheduled examination can arise in cases of major changes, like a transition to a new board or management company, implementation of a large-scale improvement project, receipt of a significant sum of money under unusual circumstances, suspicion of fraud or embezzlement, or other misconduct.[60]
Auditing Process
The auditing process for HOAs can be divided into four stages:[61]
Planning
An HOA board makes an initial inquiry to an accounting specialist about the need to conduct an audit. A consultation is held to negotiate the objectives, timeframe, report deadlines, and cost of the examination.
Risk Assessment
A CPA determines what obstacles can float up when testing the association’s accounting procedures and preparing financial statements, gauges the significance of potential problems, and finds ways to overcome them. To collect the necessary information and evaluate an HOA’s financial performance, the auditor interviews board members at their office, monitors the main day-to-day operations, tests their security, and performs analytical procedures.
The auditee must provide the CPA with the most recent audit report, copies of annual tax returns, current and ensuing year’s budget, board minutes, covenants, bylaws, and other internal documents.
The CPA tests internal controls for incoming and outgoing transactions, the maintenance of a reserve fund, the appropriateness of financing of major contracts and improvement projects, the proper disposal of funds acquired in legal cases and under other extraordinary circumstances, and the availability and accuracy of journal entries of receipts and disbursements. These issues are given the most attention, since they have the highest impact on an HOA’s financial health.
Also, an auditor reaches out to third-party organizations to verify the HOA’s transactions on both sides:
- Account confirmations are requested from banks to check whether the association’s operational and reserve accounts contain the claimed sums.
- The same is done for loans. A CPA verifies loan balances, interest rates, repayment terms and other important details.
- The HOA association’s attorney is contacted to check whether the association is involved in any legal cases.
Fieldwork
The auditor conducts a profound analysis to establish relationships between the association’s income statement and balance sheet. The previous year’s results are compared with the current results.
Since it is impossible to cover all of an HOA’s transactions in an audit, a CPA selects a sample of transactions and scrutinizes details. For example, they can use a sample of outgoing transactions to verify invoices and make sure all the funds were spent as intended and properly documented.
Also, an auditor can verify bank statements, reconciliations, payroll records, canceled checks, loan statements, approved contracts and leases, proof of real estate and equipment ownership, records on capital assets, supplies and inventories. If the HOA’s actual financial performance deviates from the planned indicators, the auditee must provide evidence that fluctuations are not due to the board’s negligence or misconduct.[62]
Reporting
An audit report states the CPA’s opinion on the HOA’s financial health and its compliance with accounting documents and with generally accepted standards. There are three types of audit reports:
- Unqualified opinion: in all respects, the HOA’s financial statements are accurate, legitimate, reflect the actual activity of the association and comply with GAAP.
- Qualified opinion: minor misrepresentations or deviations from GAAP were found in the HOA’s accounting papers. This does not significantly influence its overall financial performance, and mistakes are easy to correct.
- Adverse opinion: accounting violations that point to fraud or the board’s blatant negligence were detected.
One more option is a disclaimer of opinion, a document compiled when a CPA is unable to issue an audit report due to conflicting interests with an HOA, non-provision of the requested financial documents, or significant uncertainty in the association’s accounting operations.
Improvement recommendations in an audit report can be used to fix the board’s past mistakes, establish internal discipline, and adopt more effective accounting practices. Also, audited financial statements serve as evidence of the board’s good faith and sound strategies when reporting to unit owners, investors, potential real estate buyers, tenants and other interested parties.
Repeat Audits
The need for a repeat audit may arise if the board has received an adverse opinion and wants to restore its good name in the eyes of shareholders and investors. After issues revealed in the initial audit are fixed, a repeat examination is conducted according to the standard scenario.