Modified Accrual Accounting is one of the most popular forms of accounting methods for HOAs. At first, it can be difficult to master for those that do not have prior experience in the accounting sector. To learn more about how to apply Modified Accrual Accounting to your HOA’s books, read and understand the information below.
In this article:
- HOA Modified Accrual Accounting Explained
- How Revenues & Expenses Are Calculated With Accrual Accounting
- How Revenues & Expenses Are Calculated With Cash Accounting
- Benefits of Using Accrual Accounting
- What Is the Difference Between Accrual Accounting & Modified Accrual Accounting?
- Is Modified Accrual Accounting the Best?
- Should I Outsource Accounting for My HOA?
- Choose the Right Accounting Method for Financial Success
HOA Modified Accrual Accounting Explained
For the benefit of accounting novices, there are three accounting methods most homeowners associations use. There is the Accrual Basis of Accounting, Cash Basis of Accounting, and Modified Accrual Basis of Accounting. In this article, we will be discussing Modified Accrual Accounting. So, what is Modified Accrual Accounting anyway? Before you can grasp the idea behind Modified Accrual Accounting for HOAs, you must first understand the first two methods.
How Revenues & Expenses Are Calculated With Accrual Accounting
Using Accrual Accounting, you report revenues when you earn them, not when you receive them. As a result, an asset account titled “Assessments Receivable” appears on the Balance Sheet. As you start to get payments, your cash balance will increase. Furthermore, the account title “Assessments Receivable” decreases or “Prepaid Assessments” increases.
For example, you will report assessments as “Assessments Receivable” when it is time to collect dues. This is because members still have unpaid assessments.
Similarly, you report expenses when you incur them, as opposed to when you disburse money. Therefore, you should find a liability account titled “Accounts Payable” on the financial statement. When you pay for these expenses, your cash balance will decrease, hence, a reduction in your “Accounts Payable” account, too.
How to Calculate Revenues and Expenses Under Cash Accounting
The differences between Accrual and Cash Accounting are night and day. As opposed to the Accrual method, the Cash Basis method records revenues when your HOA receives the money. Similarly, it only records expenses when you disburse actual cash. It pays no mind when you earn revenue or incur expenses.
Using this method, there are no “Assessments Receivable” or “Accounts Payable” account titles. There’s no need for these because recording income and expenses only happen when there is an exchange of cash.
Benefits of Using Accrual Accounting
Under the Accrual framework, all financial activities of your HOA are reported to the HOA’s financial statements. It is the most efficient accounting method because it paints the clearest picture of your HOA’s overall financial health than other accounting methods. The Accrual basis, which conforms with the GAAP, means that revenue is recorded the moment it is earned, and expenses are recorded when they are acquired, regardless of when the actual cash is exchanged.
What Is the Difference Between Accrual Accounting & Modified Accrual Accounting?
Modified Accrual Accounting is a bit different than the Accrual one because it is not formally adopted by the GAAP. However, California does allow it, according to the California Civil Code Section 5200. Modified Accrual Accounting is a combination of the Accrual and Cash Basis. It’s also known as Modified Cash Accounting.
For revenues, your HOA records them when you earn them, not when you receive money. The process is similar to traditional Accrual Accounting. For expenses, your HOA records them when you incur them, not when you pay them. The process is similar to the least favored Cash Basis.
With Modified Accrual Accounting, you will find account titles like “Assessments Receivable” and “Prepaid Assessments” on financial statements. This is because the timing for reporting revenues is the same as the Accrual Basis. For expenses, though, you will notice a difference between the Balance Sheet and Accounts Payable Report. Because the process corresponds to the Cash Basis, the unpaid invoices will not agree.
Is Modified Accrual Accounting the Best?
When it comes to the best accounting method to use, most experts agree that the Accrual Basis of Accounting takes the title. Modified Accrual Accounting has its pros. It gives you a chance to focus on short-term assets and liabilities. But, arguably, its biggest advantage is its ease of use.
If your HOA is more concerned about its long-term financials, though, Accrual Accounting is the best method to adopt. Accrual Accounting gives you a more accurate picture of your HOA’s financial condition. Therefore, it allows you to make important decisions based on reliable information.
Should I Outsource Accounting for My HOA?
HOAs have to be extra careful about their accounting practices to avoid unnecessary audits or substantial taxation fees. Previously, there has been a great deal of corruption with HOA funds, which is why there’s a need for stricter regulations to crack down on dishonest HOAs.
It is a burden for HOAs when they have to manage these practices. It is usually best to consider outsourcing accounting needs because it will free up time for HOA management to focus on other important aspects of their community.
Be sure to carefully research which company you would like to handle your HOA’s accounting needs. Typically, it is best to find a company that can help your HOA with many of its management needs to provide better service to your community members. If you take the time to make this transition, the approval of your HOA will increase dramatically with your residents.
Choose the Right Accounting Method for Financial Success
Both Modified Accrual Accounting and Cash Accounting work great for interim reports. However, if you want accurate financials, it is best to go with Accrual Accounting. Ultimately, the decision lies with you and your HOA. Keep in mind, though, that the method you choose can make or break your financial stability. Plus, switching accounting methods on the regular can come with a fair amount of trouble and headache. So, make sure to choose wisely.
If you are unsure whether to choose Modified Accrual Accounting or something else, it pays to consult with a professional. Should you find yourself in that situation, don’t hesitate to give us a call.
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