Some HOA board members might consider accounting boring or difficult, but its role in financial stability is undeniable. Before anything else, your HOA must decide on a basis of accounting to use for financial reporting. While the cash basis for HOA financial statements is the easiest, it’s not exactly the best.
Using Cash Basis for HOA Financial Statements
There are three main bases for accounting: cash basis, accrual basis, and modified accrual basis. The basis of your accounting determines how and when you record transactions. While it may seem like these are simply three different ways to report the same information, they can have a dramatic impact on how your community or homeowners association runs, how you prepare financial reports, and how you reconcile your accounts at the end of the year.
Association members want to know their money is being used properly. That means it’s essential to choose the right basis for your community association’s accounting. You might find the cash basis the easiest to navigate, but this method is not as simple as it may initially seem.
What Is Cash Basis of Accounting?
Under the cash basis of accounting, you record both income and expenses only when cash is exchanged. It pays no attention to when income was earned or when expenses were incurred. In other words, transactions are recorded as soon as the money changes hands.
The result is a running tally of income and expenses, much like you’d see on your checking account. This method is extremely straightforward and easy to understand. The balance sheet always clearly shows how much cash the association has on hand at that moment. It also has the benefit of being a single-entry system. This means it does not require software any more complicated than a typical spreadsheet to manage.
The Effects of Cash Basis Accounting on Your Financials
The basis of accounting informs the way you record financial transactions. As a result, financial reports vary depending on the method used. But, regardless of the basis you choose, your financial statements should include two main reports:
- The balance sheet shows the association’s financial situation at a specific point in time. It compares assets against liabilities to give a net worth. It ultimately shows how much money is in the HOA’s bank account and gives you a quick snapshot of the association’s financial health.
- The statement of income and expense or income statement shows the association’s income and expenses over a period of time (month, year to date). Using the information in this report, you can compare your income and expenses against the budget for the same period. This report shows you how much money you earned or lost for the given time period.
Because transactions are only recorded when they actually happen on a cash basis, these reports will be missing a few things compared to reports under other bases. Specifically, you will not see amounts for Accounts Payable, Assessments Receivable, and Prepaid Assessments. Even if the board prepares these statements separately, they will not be able to be easily verified against the balance sheet.
The Benefits of Cash Basis Accounting
Like all things, the cash basis of accounting has its pros and cons. When deciding whether to use it for your HOA, consider both sides of the equation first. Here are the advantages of cash basis financial statements:
- Ease of Use. Because cash basis accounting uses a single-entry system, it’s very easy to master. Even accounting novices can get a good grasp of its principles. You don’t have to keep track of a lengthy chart of accounts. Plus, it doesn’t go into the specifics as much as the accrual basis or modified accrual basis.
- No Software Required. Due to its uncomplicated nature, homeowners associations don’t have to look toward accounting programs to implement the cash basis of accounting.
- Know Your Cash on Hand. This basis of accounting tracks all cash transactions, allowing you to immediately know how much cash on hand your HOA currently has.
On the other hand, here are the disadvantages of cash basis financial statements:
- Limited Look at Your Financial Health. The cash basis only records transactions when money is exchanged. Therefore, you have no way of knowing how much your HOA owes or expects to receive. This gives you a very limited and inaccurate picture of your HOA’s finances
- Misjudged Long-Term Profitability. When you don’t have an accurate view of your financial health, you can’t make sound long-term financial decisions. Tracking only cash transactions can be misleading. You might end up spending more money than you really have.
- More Room for Error. The single-entry system used in cash basis accounting doesn’t rely on accounting equations. Because you have less control over transaction posting, you’re likelier to commit mistakes.
- Harder to Switch Bases. Changing your HOA’s accounting method from a cash basis to accrual or modified accrual will take a lot of work.
Is It Recommended to Use Cash Basis for Financial Reports?
So, can you use the cash basis for HOA financial statements? Sure, you can. But, should you use it? Probably not. While the simplicity of a cash basis can be very attractive to HOAs trying to handle their own finances, it leaves them open to a lot of problems down the road.
Because it does not pay attention to unpaid bills or uncollected fees, nothing can be verified, and long-term planning becomes very difficult. For these reasons, it is recommended that all but the smallest of community associations look toward the best accounting basis.
Accounting Can Make or Break Your Finances
Proper financial management is more than just counting your money and keeping it safe. It involves accurate bookkeeping of all your financial transactions. While using the cash basis for HOA finances is the easiest option, a good HOA board shouldn’t settle for less. After all, money matters are tricky.
Of course, you don’t need to make this kind of decision alone. In fact, unless you have experience in accounting or finance, you probably shouldn’t. If you want to outsource HOA financial management, contact a remote HOA management company like us today!
- Basic HOA Accounting: A Guide For HOA Board Members
- In Depth Look At Homeowners Association Accounting
- 6 Practical Reasons Why You Should Outsource HOA Accounting