HOA board members have important responsibilities. Many boards and condo associations complete HOA audits to help with the overall financial assessment of the HOA.
But questions persist. What is an HOA audit? Under what situations would an HOA need an audit? What is the difference between an audit, a review or a compilation?
This post will take a close look at the HOA audit process. We will address the critical issues, including some changes for 2021. This includes procedures performed, costs and fee structures, as well as other compliance issues. Let’s jump in.Quick 2021 Navigation
- What is an HOA Audit?
- How does an association audit work?
- Who provides an HOA audit?
- What audit procedures are performed?
- What is the difference between an audit, review or compilation?
- When should an HOA consider an audit?
- How much does an HOA audit cost?
- How often should an HOA be audited?
- What about fraud?
- Top 5 HOA audit FAQs
- Final thoughts
What is an HOA Audit?
Most HOA board members don’t actually grasp all the association’s financial details. As a result, every association should consider an audit (at least periodically) to take a closer look at the HOA financial condition.
It also is a chance to make sure that the management company is properly recording transactions and reviewing accounts for variances.
An HOA audit is when accounting procedures are applied to financial records to determine whether the financials are properly stated. It involves examining and reviewing the financial statements and discussing internal controls with the management company.
An audit will also take a look at annual assessments and encompass vendor contracts and payments along with examining the sufficiency of reserves.
All things considered, an audit provides reasonable assurance that the numbers are good. An audit will assess internal controls and provide a high degree of comfort to the board and to the unit owners.
How does an association audit work?
The auditing process is complex. 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. An audit is the highest level of assurance offered by a CPA and it means that material misstatement risk is low.
Financial statement audits are based on a financial reporting framework oftenly known as Generally Accepted Accounting Practices (GAAP). The CPA will use this framework to review the association’s profit and loss, balance sheet, and cash flows statement.
According to GAAP, a CPA will perform an audit in order to obtain reasonable assurance that the financials taken as a whole are free from material misstatement. The CPA will gather supporting evidence and provide an opinion on whether the financial statements conform to the accounting standards.
At the end of the engagement, the CPA will issue a report that will express an opinion on whether the financial statements included are fairly presented, in all material aspects, in accordance with financial reporting requirements. The CPA must also report any significant or material weaknesses in the organization’s internal control structure.
Who provides an HOA audit?
An audit is performed by a licensed CPA firm. But this should not be just any CPA firm. The firm should have experience in the audits of HOAs and condo associations.
Audits are certainly more risky for CPAs. For this reason, many CPA firms will simply not perform them. The litigation risk is just too high and they are not able to offer competitive pricing. So most firms will simply pass on the engagement.
During an audit engagement, the CPA is required to:
- obtain an understanding of the association’s internal control systems and assess fraud risk
- perform inquiry of management and analytical procedures
- perform substantiation procedures along with verification
- be independent
An HOA audit is a little easier than the typical small business audit. But it still requires specialized knowledge of how HOAs and condo associations work and what areas of the audit require additional focus.
Some of the unique considerations involve reserve studies, management fraud and internal controls, along with board member knowledge and turnover.
What audit procedures are performed?
The audit procedures performed can be extensive. But is just depends on the size of the HOA or condo association as well as the internal control environment.
Audit evidence is obtained through the following activities:
- analytical procedures
- physical inspection
- third-party confirmations, and
- other procedures
We has discussed that audit procedures are more extensive than a review or compilation. So let’s examine some of the specific tests that are typically performed on the financial accounts:
- Bank reconciliations: The CPA will test the bank reconciliations to ensure that the HOA bank accounts have been properly reconciled. The CPA will also confirm the bank account balance will be completed through correspondence with the bank. This is typically called a “bank confirmation”.
- Fluxuation analysis: This process involves comparing each financial statement grouping and the corresponding amount in the prior. Since the prior year is a base year, the CPA will identify unusual variances in the accounts and perform inquiry or additional procedures to obtain comfort over the numbers.
- Cash receipts and cash disbursements review: This process will examine incoming receipts and outgoing disbursements. This will encompass the property assessments vendor payments.
- Insurance: The HOA must have insurance that will cover board members, plus ensure that the community has adequate general liability, property & casualty and also possibly bonding.
- Reserve fund: The HOA’s reserve fund should have proper accounting and adequate reserve studies.
At the completion of the audit, a report will be issued. The audit report will provide only a reasonable assurance that the financial statements taken as a whole are free from material misstatement.
What does the work “material” mean? The auditor is in a tough situation because materiality is actually defined from a user’s viewpoint. The CPA will assess materiality during the planning stage to make sure that sufficient audit procedures are in place to detect material misstatements.
What is the difference between an audit, review or compilation?
Many HOAs don’t realize that they can have different types of financial services available. There are actually audits, reviews and compilations.
Many people call them all “audits”. But this could not be farther from the truth. The procedures performed vary drastically between each attestation service offering.
To the average person, these types of reports might sound similar. But they are very different based on the testing procedures performed. Here is a quick overview:
- Agreed-upon procedures: This focuses on specific procedures to be performed based on mutually established guidelines.
- Compilation: This type of report is the lowest level of assurance. It merely presents the financial statements with no verification of any sort by the CPA. The CPA is only required to correct clearly identifiable issues.
- Review: This type of report involves management inquiries and analytical procedures applied to the financial information.
What is a review?
A review is substantially different than an audit. In a financial statement review, the CPA will perform mostly analytical procedures and inquiries to support the CPA opinion. Testing is performed to determine accuracy of the accounting records.
It’s important to note that in a review, the CPA will only perform limited procedures and generally not confirm amounts with outside parties. There is no “deep dive” into the numbers like you would see with an audit.
If discrepancies exist, the CPA must dig deeper, ask more direct questions and attempt to gain additional comfort on the numbers. Since a review is much lower in scope than an audit, it only provides limited assurance that the financials are free of material misstatement.
What is a compilation?
The bylaws should state how often the HOA should engage an audit and possibly when it can conduct a review.
If the governing bylaws don’t specify when or if an audit is required, state law may provide the answer. Many states require annual audits, reviews or compilations.
What type of service should an HOA select?
The answer is…it depends. Before an HOA decides which solution is best, it is essential to ask why the HOA is considering the report. Is it a requirement based on bylaws or is there the suspicion of fraud?
Also, think carefully about why you are considering an audit in the first place. Do the bylaws require it? Is it because there are concerns about potential fraud or embezzlement? Addressing these issues should help figure out whether an audit should be completed.
Another consideration to the audit frequency, is the association’s size. Smaller associations will generally have fewer assets and limited financial transaction. The risk of material misstatement and fraud is often low. So they may not require an audit.
Let’s take a look at the table below and examine the pros and cons and benefits of audits:
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When should an HOA consider an audit?
Financial statements reflect vital information regarding the financial health of the association. Because it is so essential to understand the financial aspects, an HOA should consider an audit. This ensures that the new board members do not inherit financial issues and it’ll rule out the possibility of mishandling funds.
An audit should be considered in the following situations:
- The bylaws require it of the HOA;
- The state requires it;
- There has been turnover in the management company and comfort is required to assess internal controls;
- New board member are coming in;
- Financial fraud is considered;
- An HOA has received huge amounts of money, such as in the case of insurance payouts or construction defect settlements;
- The board itself or the CPA notices significant or unusual reserve or replacement fund activity;
- The board has discovered that there is a poor internal control environment. This can be common with small associations and inexperienced management companies;
- Improper segregation of duties and one person is responsible for writing and signing checks and preparing bank reconciliations;
- If the association has an inadequate or inoperable accounting system;
- There is concern over fraud or embezzlement. Make sure the CPA is informed over the suspicions;
- There is infighting between board members and even with the management company;
- Where the previous board is forced to resign through special election or recall;
- When control of the association has been transitioned away from the developer;
- When the association is going through financial issues. A CPA would be a good option to audit the HOA’s finances to examine the proper accounts;
- Large associations with HOA assessments that exceed $1 million or have annual cash on hand in excess of $500,000 might have more reason to conduct an audit;
Many states require associations to conduct a compilation, review or an audit once a year. The bylaws will typically indicate when or if an audit is required. Some HOAs require an annual audit, while others may require it every so many years.
How much does an HOA audit cost?
HOA audit fees can vary widely based on the association’s location and size. Associations in larger cities will experience higher fee structures. But as a general rule, prices will start around $1,500 and get up well over $10,000. Most audits will cost $2,000 to $4,000.
There is no doubt that audits cost a lot more than a simple tax return. The fieldwork involved is much more extensive and so are the reporting requirements.
How often should an HOA be audited?
It really depends. First of all, the HOA may require annual audits based on state law or the bylaws. But if it is not legally required, it is really up to the discretion of the board.
Some boards demand annual audits even if there is no reason. It may be that the board just feels more comfortable with an audit and that it will limit their liability.
Some HOA boards are very risk adverse. An audit just becomes part of it’s annual process. There is nothing wrong with this approach. But it can greatly increase the accounting fees for the association.
What about fraud?
As discussed, an audit provides the highest level of assurance and is intended to provide the user a reasonable comfort level on the financial statement accuracy. A CPA will perform various procedures to obtain reasonable assurance (explicitly defined as a high level but not absolute) about whether the statements presented are free from material misstatement.
In a financial audit, the CPA must understand the fraud risk and the internal control processes. The CPA must also corroborate the account balances and financial statement disclosures.
Contrary to public opinion, an audit will not provide assurance that the financial statements are free of fraud. Identifying fraud or embezzlement is only a byproduct of an audit and is not a direct goal. If an HOA board believes that there is high likelihood that fraud exists, they could engage a fraud audit or agreed upon procedures.
By disclosing and discussing internal control weaknesses with the CPA, the HOA will hopefully improve its financial reporting process.
Top 5 HOA Audit FAQs
Because of the audit complexity, we will address below the top 5 audit questions that we get asked.
This of course will vary by HOA size and the complexity of the accounting and reporting environment. But a good audit fee range would be $2,000 to $4,000.
Simply stated, this is when a knowledgeable CPA performs financial tests to obtain reasonable assurance that the financials statement are free of error (often called material misstatement).
Typically it is required by the HOA bylaws, but it also can be required at the state level. The HOA board may also request n adult as a result of unusual situations like Board or management turnover.
The procedures performed are the most extensive compared to reviews and compilations. They consist of testing, examining financial accounts along with management inquiry and analytical procedures.
It depends. You may be required to have an annual HOA, so you don’t have much choice. But it usually makes sense to have an audit every several years just to make sure that the association has reasonable controls in place for accurate financial reporting.
HOA board member find that they have significant responsibilities. One of the most significant is to monitor the community’s financial health.
While some HOAs may frown on the cost of an audit, it may be well worth it. An audit will help uncover irregularities that would otherwise go unnoticed. It will often be accompanied by a management report with financial recommendations that will help the board improve financial controls and reporting.
Board members should at least consider an audit every several years. The Board will gain important insight and will maintain compliance with state regulations and association bylaws.
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