The Best HOA Accounting Method: Cash, Accrual, Or Modified Accrual?
HOA accounting is a vital part of operating a homeowners association, but it can be very tedious and difficult. Because it is so important, you want to avoid inaccurate or incomplete financial reports at all costs. The first step to financial success is to use the best HOA accounting method.
The Three Types of HOA Accounting Methods
As a board member, you should know how to analyze financial reports to prepare the association for maintenance, repairs, and homeowner bankruptcy. But, you can’t just start running before you learn how to walk. Lay a good foundation for successful financial management by using the best HOA accounting method.
Before we decide which one is the best, let’s take a look at each one first. Your HOA can make use of several methods to prepare your HOA’s financial statements. In most states though, associations can choose one of three accounting methods to prepare interim statements: Cash, Accrual, and Modified Accrual.
1. Cash Basis of Accounting
Using this method, you record payment receipts during the period you receive them, as opposed to when you earn them. Additionally, the cash basis method does not include Assessments Receivable or Prepaid Assessments accounts on the balance sheet.
Also, the cash accounting method only records expenses when you pay them, not when you incur them. When using this method, the cash balance is the only balance that decreases. Therefore, there is no Accounts Payable account on the balance sheet.
You may be wondering what effect this has on your financial statements. With the cash basis method, amounts for Accounts Payable, Assessments Receivable, and Prepaid Assessments are not reported on your association’s balance sheet. Your board may choose to prepare these reports anyway if you would like. But, the downside is that you can’t easily verify or determine the accuracy of the reports.
2. Accrual Basis of Accounting
Using this method, you record revenue as you earn them, regardless of when you received the money. In the same way, you report expenses as you incur them, paying no mind to when you disburse cash. Using this accounting method, you report all HOA financial activities on the financial statements. Furthermore, there is an asset section of the Balance Sheet called “Assessments Receivable.”
This is usually considered the best method because it produces a better overview of the HOA’s financial status than other methods. By recording transactions as they occur, you get an accurate and up-to-date view of your HOA’s financial health.
The accrual basis method will have a significant effect on your HOA’s financial statements. With this method, you record transactions on a daily, weekly, and monthly basis as you incur them. This results in very detailed reports that are automatically generated. For every report, the amounts reported as a liability or asset should equal the total balance on your association’s balance sheet.
The accrual basis of accounting produces three financial reports for your HOA:
- Accounts Payable. This report lists money owed by your HOA to all vendors.
- Aged Assessments Receivable. This report lists owners in your community who have not fully paid assessments and other fees by the end of the accounting period. It also includes details on the amount of their outstanding debt.
- Prepaid Assessments. This report records all prepaid assessments. It lists down all owners who have paid assessments in advance, along with the amount each owner prepaid, and the total prepaid balance.
3. Modified Accrual Basis of Accounting
In terms of revenues, the modified accrual basis of accounting follows the same pattern as the accrual method. This method reports revenues when they are earned, as opposed to when they are received. On the other hand, you only report expenses when they are paid as opposed to incurred. This process borrows from the cash method of accounting.
When using modified accrual accounting, it is important to understand how your financial statements will turn out. With the modified accrual basis method, the amounts on the balance sheet will equal the amounts for Prepaid Assessments and Assessments Receivable. This is similar to the accrual basis method.
Modified accrual is a bit different than accrual, though. For example, if you report unpaid invoices under Accounts Payable, the amounts will be different than those recorded on the balance sheet. Why? Because you used the cash method to record these expenses.
Which Accounting Method Is Recommended for HOAs?
In most states, you can choose between cash, accrual, and modified accrual accounting. To confirm what your state allows, check your state’s law governing HOA accounting. Both the cash and modified accrual methods are good for interim reports. Generally, though, it is best to go with the accrual method for official reports.
The accrual method is the only basis of accounting that conforms with the Generally Accepted Accounting Principles (GAAP). Because you record transactions as you incur or earn them, you instantly know how well your HOA is doing financially. It produces the most comprehensive overview of your HOA’s financial status.
Compared to the other two HOA accounting methods, the accrual basis can offer you fairer and more useful information. If you have a good picture of your current financial standing, you can plan for your future better.
Use the Best Accounting Method for Financial Success
Every HOA fears financial ruin. Not only will it have a negative effect on property values, but it also opens your board up to litigation. If you don’t maintain financials properly, homeowners will feel as though you failed to fulfill your duties.
Knowing the three methods of accounting is a key factor in financial success. But, an even bigger factor is knowing which one to use. Arm yourself with the right HOA accounting method from the start. This way, you won’t have trouble keeping track of your financials over time.
Dealing with your HOA’s financials can be tough. Even if you have a solid understanding of accounting principles, it still helps to get professional assistance. If you ever decide to outsource the service, don’t hesitate to give us a call.