Accounting, specifically understanding the balance sheets, is difficult and
unfamiliar territory to most people. To make matters more confusing, an HOA
doesn’t function the same way a typical corporation would when dealing with
balance sheets. So, we hope this article will help remedy some of the fear
involved with going over the balance sheet. Remember, by employing a management
company, you can always ask your manager to teach you what to look at on your
balance sheets.
Simply put, the balance sheet shows your community’s financial situation at
any given moment via assets, cash, and debts owed.
What can make balance sheets for HOAs hard to understand is whether or not
the relationship between the HOA and its members is understood. Members of an
HOA do have control over specific communal property assets within the
community. After all, one of the core reasons the HOA even exists is to help
manage these items.
In a typical corporation, when an item or asset is in need of building,
replacement or repair, the value of the corporation doesn’t change. It has
simply turned the cash spent into an asset with assumed value of what was
spent. The corporation’s balance sheet then shows that the value is still the
same, it’s just adjusted the value of cash and assets to display where the
value of the corporation is in its entirety.
Unfortunately, this isn’t the case with an HOA.
HOAs only manage assets for a community, they don’t own or have direct
control of them. So when an asset is in need of building, replacement, or
repair for a community, the cash that went towards that asset isn’t represented
by that asset on the balance sheet like it would be with a typical corporation.
However, this isn’t to say that an HOA doesn’t own some community items,
like furniture and electronics in communal areas. These are the items that
should be represented on a balance sheet as assets.
For an asset to be owned by the HOA and not its members, the HOA must hold
the title and be able to make changes to or get rid of the asset entirely
without a community vote.
As you can see, there are some differences when it comes to managing a
balance sheet for an HOA compared to a typical company. However, with these
differences kept in mind, maintaining finances isn’t nearly as daunting of a
task as it might seem.
Cash or Accrual
Accounting?
Even though Nevada HOA's are required to use accrual-based accounting, we
thought it'd be worth exploring what it means to use accrual-based accounting
and how it compares to cash-based accounting. First, let’s take a quick look at
what the two different types of accounting are:
Expenses are added when incurred and not when
paid, and money is added when earned and not received.
Money is added and removed as it is literally
received and expensed.
Accrual accounting is the way to go. In fact, just about all HOAs operate on
accrual accounting and are even required to do so by state law, depending on
the size of the HOA.
You’re probably wondering why cash-based accounting is a no-go for HOAs,
which is understandable. On the surface, it seems to be the most
straightforward approach to working with money. In general, it provides a
pretty good idea of where the community finances are on a day-to-day basis.
However, accrual accounting provides a much more complete idea of the overall
financial health of the community. Here’s why:
Cash-based accounting only allows for the
acknowledgment of the face value of the item at the time of its purchase. With
accrual accounting, an item that the HOA has purchased can continually be
written off each subsequent year at its deprecated value as long as the item is
still in use.
Cash-based accounting offers no way of taking
into account bills that have not yet been paid. Accrual accounting allows an
HOA to factor in the bills that have not yet been paid, so that the HOA will never
make the mistake of assuming it has more readily available funds than it truly
does. This knowledge can help the community plan for expenses, projects, and
maintenance.
Unpaid debts do not show up on the ledger in a
cash-based accounting system. With accrual accounting, the debt is accounted
for in the books with or without receiving payment. This allows the community
to keep track of unpaid debts much more successfully and also allows the HOA to
gauge whether or not they are adequate at collecting on those debts in a timely
fashion.
So whether or not your state requires accrual accounting, the choice is
clear. While it may not be the easiest or most straightforward system at first
glance, accrual accounting will help your community succeed at a much higher
rate when it comes to managing finances.