Understanding Cash, Accrual, and Modified Methods of HOA Bookkeeping and Accounting
In life, timing is everything! Never truer than when determining how to set up your condominium association or HOA accounting program. Knowing how and why to set up your association’s accounting methodology is critical to your association’s overall financial planning and reporting. This article will explore the differences between Cash Basis accounting, Accrual accounting, and Modified accounting.
The Cash Basis method of accounting is a recognition of revenue and expenses, while the Accrual method focuses on anticipated revenue and expenses. The Modified method of accounting is a hybrid of sorts that draws from both Cash Basis accounting and Accrual accounting. All three have their place in HOA Bookkeeping and Accounting. Which one is right for you?
The key advantage of the Cash Basis method is its simplicity. It accounts for expenses when payments are issued and revenue when cash is received for assessments or other income. It does not reflect any monies that are due to the HOA, or any outstanding invoices for expenses that have been incurred. It also does not take into account any prepaid expenses (such as annual insurance premium payments) which are reflected as an expense in the month the payment was made. It does not comply with Generally Accepted Accounting Principles (GAAP), which outline what procedures companies, including condominiums and HOAs, must follow when preparing their officially reported financial statements.
The key advantage of the Accrual method is that it includes accounts receivables (monies owed to the HOA) and payables (monies the HOA owes) which produces a more accurate picture of the finances of the association. This is because the accrual method records income when it is charged/billed (not when it is received) and expenses when they are incurred. Some like the way this method flatten out the highs and lows that the cash method can create. The accrual method also makes it easier to create a future year budget. The disadvantage of the Accrual method is that it is more difficult to track cash flow and, as a result, might not account for a short-term cash shortage even though the association is fine in the long term. Accrual is the only method that is GAAP approved and it is a requirement for California communities. It also helps accounting staff be certain that owner balances are accurate as they are tied to the accounts receivables and prepaid assessments on the monthly financials. It is generally the method we recommend.
The Modified method of accounting is a hybrid of Cash Basis and Accrual accounting. Borrowing elements from both techniques, the Modified method can better balance short-term and long-term accounting items. Short-term items, like a regular monthly utility expense, are recorded according to the cash basis, which results in a monthly income statement populated mostly with items based on the cash basis. Long-term items that do not change within a given financial year are recorded using the accrual basis. However, it is important to note that the Modified method is only used for internal purposes. It does not comply with Generally Accepted Accounting Principles (GAAP), which outline what procedures companies, including condominiums and HOAs, must follow when preparing their officially reported financial statements. Since it is not GAAP compliant it can create additional work when it comes to audits and taxes which can cause higher costs for these activities.
Community Financials guides self-managed condominium associations and HOAs through these sometimes tricky and often confusing methods of accounting. Call us today to learn how we can help you navigate these choices to arrive at the perfect accounting and bookkeeping solution for your association.
