Financial Sense

Occasionally new clients or Board members express confusion about how community financials are reported.  For those of us working in the for-profit business world, using anything other than accrual-based accounting seems backward.

What is accrual accounting?   It is planning for the transfer of funds before they actually occur.  So, you report expected income a month or more in advance of when you actually receive money, and also post expenses for items that will come due at a future date.
However, for homeowner associations, there are downsides to this method:

• It may require that the financial books be kept open longer into the month so that bills can be received and properly accrued 
• It requires a higher level of accounting/bookkeeping knowledge to properly prepare financial statements 
• It can be more difficult for the layman user (most volunteer Board members) to understand
• Fraud/theft may take longer to detect

On the other hand, there is cash-based accounting, which is what most of us use for our personal banking.  Only at the time cash actually goes in or comes out of the bank are transactions recorded.  Delayed deposits or check payments result in an inaccurate picture of the financial status. A Board of Directors using this method may incorrectly assume that there is less or more cash, income and expenses than there actually is.

For small associations with very few transactions, the cash method of accounting may be appropriate. However, for most communities, most Georgia accountants feel that a modified cash method of accounting should be used.  The modified cash method is a hybrid between cash and accrual. There is no formal standard as to what items are modified, but common practice is to record income on the accrual method and expenses on the cash method. So you will only see accounts receivable on the balance sheet, not accounts payable.

This method of accounting is a valid option because most expenses are ‘standard’:  The majority of them occur on a monthly basis and are fairly static. Examples include utilities, management contract, pool and landscaping.   There really is no point in creating opportunities for error and confusion by accruing a future expense that rarely varies month-to-month!

When it comes to long-lasting (capital) assets like furniture, vehicles, tools & equipment, the depreciation question comes up.  Depreciation is a way of slowly reducing the value of these items, to spread an expense out over a period of years.  While it is possible to report this depreciation on the financials under any method of accounting, it is not typically done in not-for-profit associations.  The items in question are usually not integral to your core operations, and the main benefit of recognizing depreciation is during the tax season, which your CPA automatically handles for you. 

Another term you may hear mentioned when reviewing a Balance Sheet is the word ‘liability’.  This is just another way of saying ‘future expenses’.  Cash method financial statements generally do not list liabilities. While you may choose to list long-term liabilities (such as a bank loan) on a modified cash method statement, the balances often only update at year end, since the expenses are not accrued monthly or quarterly.

While the full accrual method is respected and has a valid place in for-profit corporations, for community associations CPAs recommend a K.I.S.S. (Keep it simple, stupid) approach by using modified cash to assist in understanding the financial health of your community. As always, please consult with your community's CPA about the benefits of all approaches prior to making any changes.