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Understanding Your HOA Finances

Recommendation B: Investments reflect the reserve fund balance

Industry standard (and in some cases state law) encourages (or requires) communities to set aside part of the maintenance fees in reserve funds, and further recommends (requires) that a community segregate operating funds and reserve funds. Reserve funds should be invested in safe monetary vehicles like CDs and insured money market accounts. The total amount in those accounts should be the same amount that’s listed on the balance sheet for the reserve fund.

Recommendation C: Reserves funded in accordance with the reserve study.

Not only is it important to support the reserve fund balance with actual cash in the reserve investment account(s), it is also important to review the reserve balance as it compares to the amount recommended by the association’s reserve study. Special attention should be paid to this during budget preparation time. Rather than simply plugging in the recommended annual contribution number, an analysis should be done to determine the current projected year-end reserve balance and whether an adjustment to next year’s reserve contribution is warranted. For example, if the reserve study recommends a balance of $400,000 in the reserve funds at the end of fiscal year 2010 and it is determined that the actual balance at the end of FY 2010 is projected to be $300,000, a multi-year plan needs to be established to increase the reserve contribution to make up the $100,000 deficit. In some states, an annual or regular reserve study update is required; a comparison between actual and forecasted balances would be completed during that review. Similarly, if there are more funds in the reserve account than the reserve study recommends and all the recommended capital replacement projects have been performed, the reserve contribution could be decreased.

Recommendation D: 10-20% of the total annual assessment amount in is reflected in Prior Year Equity (this is a recommendation that auditors make so that the association has a “cushion” in the event of a major unanticipated event).

Prior Year Equity, which auditors frequently refer to as Unappropriated Members Equity or just Members Equity, is the accumulated operating deficit or surplus from the association’s inception. While the developer is funding the operating deficit, the Prior Year Equity balance is usually $0. Once the developer is no longer funding the deficit and the association is self-sustaining, the association should work to achieve the 10-20% Prior Year Equity level. For example, if your community has budgeted $300,000 for the total annual assessment income, auditors recommend that the amount accumulated in Prior Year Equity be between $30,000 and $60,000. Any amount lower than $30,000 would be noted by auditors as insufficient and any amount over $60,000 would be noted as excessive. The auditors feel that this gives the association excess funds to cover a major unanticipated event not covered by insurance, such as plumbing lines that develop pinhole leaks, that would lead to a substantial operating deficit. The result could be not having adequate funds to replace or coat the plumbing lines. So, what happens if you aren’t adequately funded in Prior Year Equity? In future years’ budgets, the association should consider budgeting for an Operating Contingency (funds not earmarked for any specific expense) or should consider creating a line item specifically to fund Prior Year Equity in order to bring the balance into the 10-20% range.

Recommendation E: Delinquency rate does not exceed 3-5% of the total annual assessment income.

Using the example above with a community that has budgeted $300,000 for the total annual assessment income, the total delinquent assessment amount should be less than $15,000 to be financially healthy. It is important that associations do everything possible to aggressively pursue collection of delinquent accounts, in accordance with applicable federal and state law, the association’s governing documents, and established collection policy. It is also important that the association, in accordance with the collections attorney, periodically review delinquent accounts and decide to write off accounts that are not collectible or where further collection effort is not cost-effective for the association, after the mortgage company foreclosed on the home. Many boards hesitate to write off uncollectible accounts, but often it is the wisest decision for the board to make.

Recommendation F: Establishment of an Allowance for Doubtful Accounts line item in the financial statements and budget

The Allowance for Doubtful Accounts line item is what is referred to as a “contra-asset” and appears in the asset section of the balance sheet as a negative number (to counter the accounts receivable asset). The purpose of the Allowance for Doubtful Accounts is to more accurately reflect the association’s financial position. Without the Allowance, the association’s balance sheet would show the entire delinquent amount as a collectible asset. The Allowance for Doubtful Accounts posts as a negative number to “decrease” the accounts receivable number to more accurately reflect the association’s assets. Prior to each fiscal year end, associations should review their delinquencies and determine the amount to enter in the Allowance category. There are many different ways to calculate the amount, so talk with your managing agent and association auditor to determine the right number for your association.

When drafting the annual budget in years when assessment delinquencies are high, creating a line item for Allowance for Doubtful Accounts (also known as Bad Debt Write-off) will provide a better understanding of what the maintenance fees should be. For example, if the budget indicates that the association must collect $100,000 to pay all expenses and transfer the appropriate amount to a reserve account but it’s estimated that 20% of the owners will not pay, create a separate Allowance for Doubtful Accounts expense line item reflecting a $20,000 uncollectable amount. By creating this line item, calculating total income and expenses will show that the association must collect $120,000 in order to ensure that they have the $100,000 necessary to pay the budgeted expenses. Maintenance fees calculation would be based on $120,000.

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