Experience has shown a majority of residents in homeowner associations do not take the time to understand their financial statements and assume the Board of Directors know what’s going on, and are doing the right things regarding HOA financials, but that’s not always the case.
Depending on the size of homeowner associations an accrual system is the most preferred rather than a modified cash basis accounting system. The accrual system provides a more accurate picture of what the balance sheet shows as the current financial condition of the association. Assets would show accounts receivable a (unpaid assessments), and liabilities would include accounts payable (unpaid bills). The income statement also would show accrued assessments and other revenue as current income, and bills received and other accrued obligations as current expenses. Cash and modified cash systems are easier to book keep, which smaller associations tend to lean toward a simplified accounting system.
Accounting Methods for Financial Reporting
The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method is a more immediate recognition of revenue and expenses, while the accrual method focuses on anticipated revenue and expenses.
- Accrual accounting means revenue and expenses are recognized and recorded when they occur, while cash basis accounting means these line items aren’t documented until cash exchanges hands.
- Cash basis accounting is easier, but accrual accounting portrays a more accurate portrait of an association’s health by including accounts receivable and accounts payable.
- The accrual method is the most commonly used method as it smoothes out revenues and expenses over time.
Accrual Accounting Method
Revenue is accounted for when it is earned. Typically, revenue is recorded before any money changes hands. Unlike the cash method, the accrual method records revenue when a product or service is delivered to a customer with the expectation that money will be paid in the future. Expenses of goods and services are recorded despite no cash being paid out yet for those expenses.
The advantage of the accrual method is that it includes accounts receivables and payables and, as a result, is a more accurate picture of the association’s financial status, particularly in the long term. The reason for this is that the accrual method records all revenues when they are received and all expenses when they are incurred.
The accrual method is most commonly used by associations. One reason for the accrual method’s popularity is that it smoothes out financials over time since it accounts for all revenues and expenses as they’re generated instead of being recorded intermittently under the cash-basis method.
Cash Basis Accounting Method
Revenue is reported on the income statement only when cash is received. Expenses are only recorded when cash is paid out. The cash method is mostly used by small associations and for personal finances.
The key advantage of the cash method is its simplicity—it only accounts for cash paid or received. Tracking the cash flow of an association is also easier with the cash method.
Accrual Accounting vs. Cash Basis Accounting Example
Let’s say the HOA bills quarterly assessments on the first of each quarter, under the cash method, that amount is not recorded in the books as revenue until the HOA receives the check or payment. Under the accrual method, the assessment is recorded as revenue and an Accounts Receivable immediately when the bill is made, even if you receive the money a few days or weeks later.
The same principle applies to expenses. If you receive a landscaping bill for $1,700, under the cash method, the amount is not added to the books until you pay the bill. However, under the accrual method, the $1,700 is recorded as an expense and an Accounts Payable the day you receive the bill.
Accrual basis methods produce a clearer picture of business performance while using cash basis records for other items helps to keep costs down where possible; maintaining a set of full accrual accounting records is more time-consuming. However, the HOA is already maintaining an Accounts Receivable record for assessments.