A Time for Financial Reckoning

A Time for Financial Reckoning

Checking Those Checks and Balances

By Kathy Danforth / Published September 2018

Photo by iStockphoto.com/utah778

For condominiums and homeowners associations, financial review is required (as well as advised) depending on the size and type of association. Florida Statute 718.111 (13)(a) requires that condominiums with revenue under $150,000 have a statement of cash receipts and disbursements; revenue of $150,000–$300,000 requires a financial compilation; $300,000–$500,000 necessitates a financial review; and revenue of more than $500,000 triggers an audit. In the case of HOAs, an audit is required if total revenue is $400,000 or more. Debbie Penton with FirstService Residential shares, “The Florida Statute does not provide an option for associations to waive the reporting requirement (or the other lesser reporting requirements, whichever is applicable). An association’s members can vote to prepare reports of cash receipts, compilations, or reviewed financial statements in lieu of audited financials.

     “Although the report of cash receipts and disbursements could be completed by a bookkeeper, it does include specific requirements on the content and form. Compilation reports provide a consistent formatting of the presentation and include footnotes and disclosures, which provide a greater depth of understanding to the reader,” explains Penton. “A reviewed financial statement is inspected by a CPA to see if it appears reasonable and complete.  A review will provide limited assurance, including screening for any red flags or points requiring attention, without confirming balances.”

     Going a step further is the financial audit. “The purpose of an audit is to provide reasonable assurance that the financial statements are free from material error. In order to accomplish this, the auditors can request just about any documents they feel are necessary,” comments David Rofe with AKAM On-Site.

     Lydia Dominique with Leland Management comments, “Typically, an auditor will request the following records for the year being audited (full financial report for the year):  year-end balance sheet, year-end income statement, year-end aged receivable report, year-end prepaid assessment report, year-end open accounts payable report, year-end check disbursement report, year-to-date general ledger, check register for first month of the new year, bank statement and reconciliation reports for last month of the fiscal year, and the budget for the new year.”

     Penton relates, “For a financial audit, the auditor is given all back-up he or she needs to confirm the balances and trace all the steps—that what is in the financial statement ties to the invoices, contracts, payments that were made, and so on.” Penton also notes, “Though the audit can be made by any CPA, because the statutes in Florida have very specific requirements for fund accounting in some cases, it can be useful to have auditors who have specialized in this type of fund accounting.

     “It is important to note that a ‘material’ error for one association might not be material for another,” adds Penton. “Also, the intent of the audit is to sample random transactions, not to examine every record. Some people might misinterpret that an audit will examine everything that could possibly be wrong and give assurance that absolutely everything is correct if the auditor comes back with a clean opinion.”

     A number of documents may be required for an auditor to determine if an association is handling its finances in accordance with all requirements. “The most recent reserve study and schedule will be examined to determine if reserves are properly funded per the study and funds are being used for the listed items,” says Penton. “Chapter 718 is specific on what is included, so the auditor will ensure funds are spent according to the intent.”

     Association minutes will be reviewed to ensure procedures are followed, special assessments are properly approved, and a collection policy is in place. “The auditor needs to be familiar with what is going on in the association, especially special projects,” explains Penton. “The auditor will examine what and how much has been written off, which will be included as a disclosure, as well as other delinquent amounts and what allowance the association has for late fees. Based on the association’s policy, the auditor will review if there is an allowance in place for potential future write-offs, and whether that makes sense considering the delinquent account.

     “A CPA might need association documents to determine if the association’s requirement for providing notice for budget meetings is more stringent than the Florida Statute,” remarks Penton. “Also, in some associations owners may pay differing fees, possibly based on access to amenities. That would be spelled out, and the CPA would need to understand those differences.

     “If the board has proposed a special assessment, the documents will state how that has to be approved. The special assessment documents will include what the amount is comprised of, and contracts and bids will back up the approved items. The industry uses fund accounting, so certain funds are ‘siloed’ and can only be spent for the specifically approved items.

     “An auditor will be interested in any litigation,” adds Penton, “to understand the legal expenses and any risks the association is facing. Part of the audit is disclosure of significant contracts and litigation.”

     Rofe notes, “Many people are surprised when the auditor requests documents related to events that occurred subsequent to year end. However, the audited financial statements are required to include any significant subsequent events that occurred through the date that the audit was completed. This may include disclosure of a lawsuit, the passing of a special assessment, or any other information that would be useful to the potential users of the audited financial statements. Potential users of the audited financial statements may include current unit owners, potential unit owners, or banks that are considering lending money to the association.”

     Insurance policies are reviewed for coverage and proper accounting. Penton explains, “By generally accepted accounting principles (GAAP), expenses are recorded when incurred rather than when paid, so we use accruals and deferrals. If a policy runs from July 1–June 30 but the entire premium was paid on day one, the auditor will be looking at why only half of the check amount is shown.

     “The auditor will be examining transactions to see if all policies are followed,” says Penton. “The auditor will need to know what protection is in place to prevent hacking and fraud and what the policies are for purchase order approval, invoice approval, check writing, and levels of review. The audit will test to see if the procedures the association says are happening are being followed.”

     According to Penton, “The cost and length of an audit may vary greatly for different associations due to factors such as complexity of the association’s financial statements and operations, existing special assessments, local/regional cost factors, availability of prior audits and requested data, timely responses from third parties, etc. In very general terms, an audit may take four to eight weeks, and costs are typically in the $5,000–$20,000 range.”

     When complete, Penton advises, “The financial audit will assure the community (or not, depending on the auditor’s opinion) that the financial statements are free of material misstatement. Boards, management, and residents alike should look for the auditor’s opinion on whether the financial statements show, in all material (significant) respects, the financial position of the association. The auditor’s report to the board (separate from the audit documents) will detail areas of concern regarding processes and internal control deficiencies. While it is possible for a financial audit to identify questionable or fraudulent transactions during the process of confirming amounts, specifically looking for theft is not within the scope of a financial audit.”

     Rofe advises that even though an audit is not designed to discover every error or theft, theft or fraud can be one of the major problems uncovered. “However,” he states, “more common audit findings are usually related to reclassifications, accruals, and recommendations. It is important to note that the auditor is not ‘recording’ journal entries. Instead, they are ‘proposing’ journal entries that are necessary in order for the financial statements to comply with GAAP. The Board’s signing of the audit representation letter is, in part, their acceptance of the proposed audit entries. Some management companies make the mistake of not preparing their financial statements in accordance with GAAP, with the expectation that the auditor will make the necessary corrections during the audit process. This is not proper and can result in the audited financial statement being practically unrecognizable when compared to the unaudited financial statements.”

     Penton advises that some of the problems most frequently discovered are insufficient funding of reserves relative to the reserve study, bank account balances in excess of the FDIC coverage limits, management’s method of calculation of bad debt allowance, and weaknesses in disbursement review and approval.

     According to Dominique, “Some common identifiable audit problems include the comingling of operating and reserve funds, sufficiency or insufficiency of reserve funding, assets that should be depreciated, and allowing for accounts receivable that may not be collectible.”

     Even though an auditor may address association financial procedures that are lacking, that is not the purpose of a financial audit. According to Penton, “A financial audit is not intended to express an opinion on internal controls, investment strategies, contract terms, etc.”

     Rofe points out also, “Unfortunately, an audit would usually not reveal fraud related to unrecorded receipts or liabilities or illegal kickbacks. Since the payments are occurring behind the scenes and are not paid directly by the association, they are very difficult to uncover. This is one of the reasons that a board should select a trusted management company.”

     Dominique advises, “As a board member, there are a few things you should look for in an audit. Boards should review monthly financial statements for consistency as good practice. For the audit, review the net income to determine if income is sufficient to meet operating expenses and if an increase in assessments is needed for the following year. The reserve balances should be checked to determine if funds are sufficient for major replacements based on replacement costs and to ensure funding is per an engineer’s report or based on replacement costs and remaining useful life of reserve components. Practice due diligence by confirming that all bank accounts for the association are federally insured; and finally, don’t be afraid to question any substantial, unexpected transactions such as special assessments or insurance claims.”

     “The board should review all aspects of the audit before signing the representation letter,” recommends Rofe. “This includes the management letter, the audit opinion, the financial statement, and the notes that accompany the financial statements, as well as the proposed journal entries. The goal is to obtain an unqualified opinion, which is basically a clean opinion.”

     Penton notes a risk-based audit can be conducted to ensure proper processes and controls are in place. “Also, associations should understand that they can have an audit even if it’s not required,” Penton advises. She says, “That higher level of scrutiny is always a good idea.”



Debbie Penton is with FirstService Residential. For more information, visit www.fsresidential.com.

David Rofe is with AKAM On-Site. For more information, visit www.akam.com.

Lydia Dominique is with Leland Management. For more information, visit www.lelandmanagement.com.