Basis of Accounting for HOAs

1. Cash Basis: Cash basis accounting records transactions only when cash changes hands. Income is recognized when received, and expenses are recorded when paid. This method is straightforward and often used by small businesses or individuals.

Pros:

• Simple and easy to understand.
• Suitable for businesses with minimal transactions.

Cons:

• May not provide an accurate picture of long-term financial health.
• Doesn't capture future obligations or income received but not yet earned.

2. Accrual Basis: Accrual basis accounting records transactions when they occur, regardless of cash flow. Income is recognized when earned, and expenses are recorded when incurred. This method provides a more comprehensive view of financial activity.

Pros:

• Reflects a more accurate financial position over time.
• Better matches income and expenses, even if cash hasn't changed hands.

Cons:

• Requires careful tracking of receivables and payables.
• Can be complex, especially for businesses with numerous transactions.

EXAMPLES:

Assume 20 homeowners are billed monthly assessments of $100 each at the beginning of June.  During the month of June, 15 homeowners pay their dues. 

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Assume the Association receives a bill in June from a vendor who did maintenance in the amount of $300.  The Association writes a check in July to pay the vendor. 

Using the Cash Basis of Accounting, these transactions would be recorded as follows: 

Revenue for the month of June would reflect $1,500 (only the amount of cash collected).  There would be no receivable presented on the balance sheet.

The maintenance expense of $300 would not be reflected in June.  It would show on the income statement as an expense in the month of July when it is paid.

Using the Accrual Basis of Accounting, these transactions would be recorded as follows: 

Revenue for the month of June would reflect $2,000 (the entire amount invoiced to the homeowners).  There would be a receivable presented on the balance sheet in the amount of $500 (for dues that have not yet been paid).

The maintenance expense of $300 would be shown as an expense in June (when the vendor bill was received) and a payable would be presented on the balance sheet for the same amount.  When the check is written in July, it would offset the payable.

There are also alternative approaches known as modified cash and modified accrual methods in addition to the traditional cash and accrual basis.  

Modified Cash Basis: Modified cash basis accounting combines elements of both cash and accrual methods. It uses cash basis for certain transactions and accrual basis for others, based on predefined criteria.  This is mostly seen when revenues and expenses are recorded the same as cash basis with the exception of member dues that have been prepaid.  If a member pays their January dues in December, it is usually not recorded as revenue in December, but presented as deferred revenue on the balance sheet as it is unearned until January.

Modified Accrual Basis: Modified accrual basis accounting is commonly used by governments and nonprofits. It's a hybrid approach that combines accrual and cash methods. It recognizes revenues when they become available and measurable and expenses when they become due.

Choosing the Right Method: The choice of accounting method depends on factors like your business size, industry, reporting requirements, and long-term goals. Smaller businesses with straightforward operations might lean toward cash basis or modified cash basis, while larger enterprises and nonprofits often favor accrual or modified accrual basis for comprehensive insights.  

Property management companies vary in how they present financials.  Some will use the cash basis method, while others will do some form of the accrual basis.  If your board is interviewing management companies in anticipation of making a switch, it would be good to ask how they present the financials.

In conclusion, understanding the differences between these accounting methods empowers you to make informed decisions about your financial reporting. Each method has its strengths and weaknesses, and selecting the one that aligns with your organization's needs ensures accurate financial transparency and effective decision-making.