State laws and/or an association’s governing documents typically contain provisions that require a homeowners association to have periodic financial audits, reviews, or compilations, and association boards and management personnel should be familiar with such provisions to insure compliance. These investigations into the financial affairs of a homeowners association are important to identify the association’s financial strength and potential issues concerning the financial management of the association and to protect against mismanagement, fraud and misappropriations of the association’s funds.
A financial audit is an examination of the financial records, accounts, business transactions, accounting practices, and internal controls of a homeowners association by an “independent” auditor (typically, a CPA). “Independent” refers to the fact that the auditor/CPA is not an employee of the nonprofits but instead is retained through a contract for services, and hence is “independent.” During the independent audit, the auditor will review the organization’s financial statements to determine whether they adhere to generally accepted accounting principles.
Following an investigation, the auditor issues a report to the association’s board of directors expressing a professional opinion about the association’s financial practices indicating whether the financial statements fairly present the financial position of the association without any inaccuracies or material misrepresentations. The following are four types of opinions that an auditor could issue upon completion of the audit:
- Unqualified opinion – which states that the association’s financial statements follow generally accepted accounting principles and fairly represent the financial position of the association without any inaccuracies or material misrepresentations. (This would be the most desired opinion);
- Qualified opinion – which states that the auditors found one or more situations where the association is not following generally accepted accounting principles, but overall there no material misstatements of any financial position(s);
- Adverse opinion – which states that the auditor found one or more material misstatements or that the association is not conforming to generally accepted accounting principles; or a
- Disclaimer of opinion – which states that items were discovered that prevented the auditor from expressing an opinion. (This would be the least desired opinion).
An association audit that contains an adverse opinion or disclaimer of opinion is a “red flag” that should not be ignored by the association’s board of directors. Any such opinion should be immediately investigated and corrective action should be taken.
The key difference between an audit and a review is that conducting an audit requires the auditor to obtain independent confirmation or verification of the financial information examined. If a formal audit is not required, associations may have a “financial review” performed. A “financial review” is a less intensive procedure that is designed to verify that an association’s financial statements comply with generally accepted accounting principles. As such, a review is not conducted with the same level of investigation or analysis as an independent audit. During a review, the auditor examines the financial statements but does not conduct an examination of the nonprofit’s internal controls (which is normally included in the scope of an independent audit). Instead the review provides a limited level of assurance that the financial statements are free of misrepresentations.
State laws and association governing documents commonly require associations to provide their members with a periodic review of the association’s financial statement (generally on an annual basis). A “review of the financial statement” typically includes complete financial statements, accompanied by a letter from an accountant confirming that the financial statements have been prepared in accordance with generally accepted accounting standards and that all disclosures required by the standards have been made. If the applicable state laws and/or the association’s governing documents do not require an independent accountant’s report, the review should contain a statement by an authorized officer of the association indicating that the report was prepared without audit from the association’s books and records.
The report provided by an auditor after a review is not considered to provide a professional opinion about the association’s financial statements as a whole. Instead, the auditor’s report after a review will note whether the auditor is aware of any “material modifications” that should be made to the financial statements.
A compilation is an organization of financial records into a format required by accounting standards. During a compilation the auditor does not collect and examine source documents such as canceled checks or bank statements or the internal controls that are utilized by the association to test the accuracy of the association’s accounting records (which is done in an audit). In a compilation the auditor reformats the financial statements but does not make any determination of whether the account balances are reasonable by comparing them to his or her expectations (which is part of a review). The period covered by a compilation can be a month, a quarter, or an entire year’s financial records. In the report after conducting a compilation, the auditor will not provide any opinion or assurance that the financial statements accurately reflect the financial position of the organization as is done following an independent audit.
Compilations are beneficial to organize an association’s financial information into the format that is necessary for the preparation of formal financial statements. Thus, if an association does not have the internal capacity to put its financial records into a professional format, a compilation can accomplish that.
Association’s should have policies in place that insure that they are complying with mandates contained in their state’s laws and/or their governing documents relative to the periodic performance of financial audits, reviews, and compilations. These important financial checks offer multiple benefits to the association and are key components of proper HOA management. Even if not mandated, the performance of periodic audits, reviews and compilations and the delivery of that information to all of the association’s members will protect against internal fraud and mismanagement, will demonstrate an association board of directors’ commitment to financial transparency, and will greatly reduce the risks of future conflicts and operating problems within the association.