Condo association board members have more responsibility than you might think. Many boards rely on audits to assess internal controls and provide an overall financial assessment of the association.
But questions will always persist. What is an association audit? When is it required? But most importantly: what is the difference between an audit, a review, or a compilation?
This article takes a close look at the condo association audit process. It will address the procedures performed, costs, and other critical compliance issues. Let’s dive right in.Easy Navigation
- What is a condo association audit?
- How does a condo association audit work?
- Who completes an audit?
- What types of procedures are performed?
- How is an audit different from a review or compilation?
- What is a review report?
- What is a compilation report?
- What type of report should a condo association choose?
- When is an audit considered?
- How much does a condo association audit cost?
- How often should a condo association be audited?
- What about fraud or embezzlement?
- Final thoughts
What is a condo association audit?
Most condo association board members don’t grasp all the association’s financial details. Each association should consider an audit to take a close look at the condo financials. An audit may not need to be completed annually but should at least be considered every few years.
A condo association audit is when a Certified Public Accountant (“CPA”) performs procedures to the financial accounts to determine whether the financial statements are fairly presented.
It involves examining and reviewing the financial statements and discussing internal controls with the management company. An audit will, at its face, provide reasonable assurance over the financial statements.
How does a condo association audit work?
The audit process is complicated. It involves thorough analysis, reviews, and procedures performed on the financial data.
The analytic portion of the audit process will heavily rely on the HOA’s historical financial statements. Audits offer the highest level of assurance, and it means that the risk of material misstatement is low.
Financial statement audits adhere to a financial reporting framework often referred to as Generally Accepted Accounting Practices (or “GAAP”). The CPA will utilize this framework and examine the association’s profit and loss statement, balance sheet, and the statement of cash flows.
The CPA must perform audit procedures to obtain reasonable assurance that the financial statements as a whole are free from material misstatement. After the engagement, the CPA issues a report that will provide an opinion on whether the statements are materially and reasonably presented according to the standards. The CPA is required to report material weaknesses in internal control and disclose accounting policies in the report footnotes.
Who completes an audit?
Licensed and experienced CPA firms perform audits. But not any CPA firm. The company should be knowledgeable in the complexities of condo association audits.
Audits are a lot riskier for CPAs compared to tax returns. As a result, most CPA firms don’t do audits. The legal exposure is too high.
During the audit process, a CPA is required to:
- perform analytical procedures and inquiries of management;
- perform examination and verification procedures on the account balances;
- assess the risk of fraud and understand the internal control structure
- be independent
But on the lighter side, a condo association audit is a little easier than most small business audits. It still mandates knowledge of how condo associations work and the risk areas.
Some critical areas involve management fraud, minimal internal controls, and inadequate reserve studies. Inexperienced and untrained board members also contribute to control weaknesses.
What types of procedures are performed?
Audit testing can be extensive. But it will depend on the size of the association and the environment it operates in.
Audit procedures include the following actions:
- management inquiry;
- analytical procedures;
- physical inspection (if necessary);
- third-party account confirmations, and
- other procedures deemed necessary
We have briefly touched on some of the audit procedures. But let’s look at some specifics:
- Bank account reconciliations: The CPA will test bank reconciliations for completeness and accuracy. The CPA must confirm the bank account balances directly with the bank.
- Fluctuation analysis: This process involves comparing financial statement line items to the prior year. The difference and percent change is identified, and variances are examined.
- Cash receipts and disbursements analysis: This examination will look at cash receipts and the processing of disbursements.
- Reserve funds: The CPA will examine the association reserves and footnote any reserve studies.
Remember that an audit only provides reasonable assurance that the financial statements presented are free from material misstatement. But what does “material” mean? Materiality is a concept that looks at how a change would impact a user’s decision on the financial results. Materiality is assessed during the planning stage to design adequate procedures to detect any material changes.
How is an audit different from a review or compilation?
Many condo associations don’t realize that there are different types of financial reports available to them. The three main options are audits, reviews, and compilations. There is also an agreed-upon procedures report.
Many condo boards will refer to all of them as “audits.” But this is not accurate. The level of comfort (or assurance) will vary between the three different types of reports.
We have already discussed audit procedures. Here is an overview of the procedures performed for the other engagements:
- Compilation: This type is the lowest level of financial assurance. The CPA must inquire and resolve any identified issues or report problems. But the report itself comes with no verification by the CPA.
- Review: This report involves inquiries of management and analytical procedures that are applied to the financials.
- Agreed-upon procedures: This report provides specific procedures applied to mutually agreed guidelines.
What is a review report?
A review is very different from an audit, and it provides a lower level of assurance. In a review, the CPA performs analytical procedures and management inquiries. These procedures alone will provide a basis for the report’s opinion.
The CPA only performs limited testing in a review and is not required to confirm amounts independently with outside parties. If the CPA notes a discrepancy, he or she will perform additional procedures to resolve the issue. Since a review has a lower scope than an audit, it only provides a limited form of assurance that the financial statements are free of any material misstatement.
What is a compilation report?
A compilation report is the lowest level of assurance. This type of report will show management’s presentation of the financials. No procedures or testing is performed. But the CPA is required to dive deeper if discrepancies exist.
If the bylaws don’t state when an audit is required, state law may provide a definitive answer. Many states will specify which type of report is required.
What type of report should a condo association choose?
The financial report depends on the association and the level of comfort it desires. Why does the association need it in the first place? Do the bylaws require it? Is it required by state law? Is fraud suspected?
Association size will often drive audit frequency. Small condo complexes will typically have few financial transactions. The risk of fraud or material misstatement is usually low. As such, an audit might not be necessary.
When is an audit considered?
There are many reasons why an association would consider an audit. As a general rule, an association might consider an audit in the following situations:
- the condo bylaws require it;
- it is required based on state law;
- there is a new management company, and internal controls are in question;
- embezzlement or fraud is suspected;
- there is unusual reserve fund activity;
- improper segregation of duties exist, and one person is responsible for most financial activity;
- the association has transitioned from the developer;
State law often requires associations to conduct financial statement engagements on an annual basis. The bylaws often indicate when an audit is required. Some condo associations require an annual audit, while others may only need one every few years.
How much does a condo association audit cost?
Audit fees can vary based on the association’s size and location. Associations located in large cities will often have higher audit fees. As a general rule, most audits will cost $2,000 to $6,000.
Audits will certainly cost more than basic tax returns. The planning, fieldwork procedures and reporting requirements are extensive.
How often should a condo association be audited?
It depends on the association and the goals of the Board. If it is not required by the state or the bylaws, it is up to the discretion of the Board. Some boards want annual audits even if there is limited risk. An audit may limit the Board liability.
What about fraud or embezzlement?
By now you are aware that an audit provides the highest level of financial statement assurance. But contrary to public opinion, an audit does not guarantee that the financials are free of fraud or embezzlement.
Identifying embezzlement and fraud is a byproduct of an audit and is not the stated goal. There is no guarantee that fraud will be detected.
If a condo association board believes that a high likelihood of fraud exists, it might make more sense to have a fraud audit or agreed-upon procedures report.
Condo association boards have significant financial oversight. One of the most important is monitoring the financial health of the association.
While some associations may frown on audit fees, it might make sense for the association. An audit can uncover financial irregularities and may put the board at ease.
Not only may an audit be required by state law or the bylaws, but it may also limit board liability. The comfort it provides can help board members sleep at night.