Financial Statements for Non-Accountants

Two funds, four reports

Every association keeps its money in at least two separate buckets, and mixing them up is one of the most common mistakes a new board makes.

"Fund accounting is a system of accounting used by non-profit entities to track the amount of cash assigned to different purposes and the usage of that cash."

Source: Fund accounting definition, AccountingTools

The operating fund "pays for the things the community uses today: landscaping, utilities, insurance premiums, management fees, payroll, pool chemicals," while the reserve fund "pays for the things the community will need tomorrow: roof replacement, asphalt resurfacing, pool resurfacing, elevator modernization."

Source: Operating Fund vs. Reserve Fund: The Critical Distinction Every HOA Board Must Understand, Common Interest Community Standards Council

On top of that split sit four documents worth knowing by name: a balance sheet, an income statement, a budget-vs-actual report, and a bank reconciliation. Together they answer four different questions: what the association owns and owes right now, how revenue compared to expense over the period, how actual spending compared to the plan, and whether the books agree with what the bank says. The Reading financial statements lesson walks through all four side by side.

Which rule wins when they disagree

An association's numbers answer to several authorities at once, and they rank in a specific order. Governing documents, meaning the CC&Rs, bylaws, and any board-adopted financial policy, usually come first for day-to-day questions. State statute sets the floor beneath them.

California requires the board to review a specific list of documents every month under Civil Code Section 5500, including account reconciliations, budget-to-actual comparisons, and the delinquent assessment receivable report. Other states set their own standard, or none at all, so check your own state's statute and your governing documents before assuming this list applies to you.

GAAP, as codified in FASB ASC 972 for community associations, governs how a CPA actually calculates the numbers once an engagement starts. It answers how, not whether. Federal tax rules govern only the tax return, and the return's accounting basis is legitimately allowed to differ from what the board sees monthly.

One more layer binds only associations that want their units to stay eligible for standard mortgage financing.

Lenders "divide the annual budgeted replacement reserve allocation by the association's annual budgeted assessment income," and that result must currently be "at least 10% of the budget."

Source: Selling Guide, B4-2.2-02, Full Review Process, Fannie Mae

When two of these layers seem to conflict, the right move is to name which layer is actually speaking, not to guess which one wins.

What most boards get wrong

A large reserve balance is not the same as a fully funded reserve. Percent funded compares cash on hand to the total future obligation identified in a reserve study, and a big number can still fall short if the roof, the pool, and the elevator are all due in the same five years.

An audit does not mean fraud was ruled out, because only an audit even assesses the risk.

In a compilation, "a CPA does not provide any assurance." In an audit, the CPA must "perform inquiry and analytical procedures, as well as to obtain an understanding of the business's internal controls and assess the risk of material misstatement, including fraud risk."

Source: What is the difference among a compilation, review, and audit?, AICPA & CIMA

A board that has only ever received compiled statements has had zero independent assurance of any kind, not a lesser amount, none. And a healthy income statement does not guarantee cash in the bank: current industry practice, as one CPA firm describes it, recognizes assessment revenue in the period it is assessed, not the period it is collected, so a chunk of that "income" can still be sitting unpaid in accounts receivable. The Spotting unusual transactions and Questions directors should ask every month lessons turn this from a one-time read into a habit.