Audit of Homeowners’ Associations: CPA’s Audit Process
Glenn Tyndall, CPA
- What should we expect during an audit of our homeowners’ association?
- What does a CPA do during the audit of HOA audit?
- How does our auditor verify that the homeowners’ association accounting records are accurate?
- What documents will our CPA need to conduct our HOA audit?
This audit process summary is intended to answer those questions by giving you an idea of what CPAs do when performing a homeowners’ association audit.
The audit process is presented as occurring in separate, sequential phases for the purposes of this discussion. In actuality, the phases are continuous and overlapping.
A homeowner’s association financial statement audit consists of 4 phases: planning, risk assessment, fieldwork, and reporting.
The planning process begins when a client calls a CPA to inquire about having an audit performed for their homeowners’ association. CPAs first need to establish an understanding with a potential client regarding the services to be performed for each audit engagement.
This understanding includes:
- The objective of the audit
- Timing of field work
- Report deadlines
- Audit fees
Homeowners’ associations are governed by Florida Statutes – Chapter 720, which dictate certain terms of the engagement. Florida law requires:
- The audit report to be delivered to owners within 120 days of the HOA’s fiscal year end
- HOA’s with annual revenues more than $400,000 must have an audit by a CPA
- HOA’s with annual revenues of $400,000 or less must have a review, compilation, or report of cash receipts and expenditures by a CPA.
Two special rules apply to audit requirements during transitional audits where the association is transferred from the developer to owners:
- The audit report must be delivered to the association within 90 days of the date of turnover.
- The homeowners' association must be audited from the date of inception to the turnover date.
After the CPA’s engaged to perform the audit of a homeowners’ association, the CPA will perform a risk assessment to determine what might go wrong during the audit so that attention can be focused on the most important and material areas.
CPAs conduct a risk assessment of a homeowners’ association simply to identifying the risks of what can go wrong in preparing the financial statements and the likelihood and significance that something went wrong. During the risk assessment phase, an auditor will ask questions, conduct walk-through of key processes, perform analytical procedures, and test internal controls to get a handle on the audit risks.
The CPA will also need to understand the homeowners’ association operations and review of the HOA’s financial performance.
To get this understanding, a CPA will need to review:
- The HOA’s most recent audited financial statements (if available)
- Copies of annual IRS tax return filings
- Adopted annual budget
- By-laws, board minutes, and other governing documents
The CPA conducting an audit will gather information about internal controls, such as processes relating to cash receipts, cash disbursements, payroll processing, property and equipment acquisition, and other items. The CPA will need a copy (or access to) the homeowners' association’s trial balance, general ledger, and journal entries to determine what accounts and transactions are material and significant to the audit. The auditor spends more time testing these items throughout the audit because they have the most impact on the financials.
The CPA will also need you to sign various confirmations to verify account balances or other items with 3rd parties.
- Bank account confirmations are sent to banks to confirm cash on hand with that institution.
- Loan confirmations are sent to financial institutions to confirm loan balance, interest rate, repayment terms and conditions.
- A legal representation letter to the homeowners’ association attorney(s) to confirm whether or not the organization is party to any lawsuits.
After the CPA has planned the audit and performed the risk assessment, the auditor conducts fieldwork to get detailed support for the client’s accounting records.
The auditor needs access to client records to conduct fieldwork. Although more fieldwork can be done offsite with improvements in technology, this work is usually done on-site so the auditor(s) will need a physical space to work. Fieldwork consists of substantive analytical testing and substantive tests of details. This testing is called “substantive” because it substantiates the client’s assertions and accounting records.
Analytical testing involves identifying relationships between an HOA’s balance sheet and income statement. The most basic form of analytical testing is a variance analysis, where current year’s results are compared to prior year’s results. Test of details involves selecting a sample of transactions to examine supporting documents. For example, a sample of expenses will be selected to examine supporting invoices to make sure the expense was properly authorized and recorded in the correct expense account for the right amount.
Other items that the auditor will examine during fieldwork include:
- Bank statements, bank reconciliations, and cancelled checks
- Original invoices expenses
- Payroll records
- Copies of signed contracts and leases
- Loan statements
- Proof of ownership of any land, buildings, and equipment
- Possibly look at major inventories, supplies, and capital assets
- Reasons for fluctuations between your budgeted and actual results
- Reserve study report
The audit report is issued after the CPA is satisfied that the homeonwers' association’s books and records are free of material misstatement and properly stated in accordance with GAAP.
A few items are addressed before a final audit report and financial statements are issued.
The “Management Representation Letter” needs to be signed before the final audit report is issued. The Management Letter is where homeowners’ association management and board declare that all disclosures were made and appropriate and without omission of material facts to the financial statements, to the best of their knowledge.
The board of directors will then get a draft financial report for review and approval and a final, signed copy of the audit report and financial statements will be issued to the homeowners’ association.