HOA Auditing Guidelines: Facts You Need to Know

What is an HOA Audit?

Understanding HOA Audit Requirements: A Comprehensive Guide
The introduction to HOA audits should do two main things: (1) explain what is meant by the term "audit" in this context and (2) say a few words about why audits are required. Audits are commonly referred to as "annual audits" even when they are not technically audits at all but merely agreed-upon procedures (AUP). "Agreed-upon procedures" refers to the process by which the association’s financial statements are prepared. The type of "audit" performed will depend on what the governing documents and the statutes require.
Audits have long been mandatory for Utah non-profits like homeowner associations. This is true regardless of whether the association is registered with the Department of Commerce or the Department of Corporations (the name used before 2011 when this department changed its name to the Division of Corporations & Commercial Code). Which statutes apply , to which entity and when depends on how the HOA is organized and when it was formed and the facts and circumstances surrounding that formation (please see separate section devoted to this). This article contains a comprehensive discussion of not only association audits but financials. Long story short, statutory requirements will vary based on the association’s status and its bylaws. As written, the statute specifies in which circumstances an audit may be:
Yes, some audits are simply optional. The decision to have a mandatory audit instead of an optional audit turns on certain facts and circumstances. Since there is so much work to be done in evaluating whether to have a mandatory or optional audit, it makes sense to hire a lawyer with expertise in HOA financial matters. Please see separate section devoted to the various types of audits and what they examine.

Legal Mandates for an HOA Audit

In addition to the normal business records requirements mandated by the HOA’s governing documents, homeowner associations are held to specific auditing requirements. While each state may differ slightly, there are general, nationally applicable laws and requirements for both condominium and planned community HOAs.
State-specific requirements are set forth by the respective Real Estate Commissions and generally require an examination of the books of account of an association on at least a triennial basis. However, such audit is not mandatory where the number of lots is less than 77 for an eleven unit or more planned community or 121 units for a condominium association. F.S. 720.303(7) and F.S. 718.111 While some states such as North Carolina do not mandate audits, instead requiring an accounting of the books of account, it is prudent to have such examination completed. In North Carolina, the NC Planned Community Act does require that associations make its financial statements available to members and the NC Condominium Act requires an annual accounting of receipts and expenditures with the latter requiring that such "books and vouchers .. be made available for examination by [the members]." N.C.G.S. 55A-7-32 and N.C.G.S. 47C-3-123. Other state laws, like F.S. Section 718.113(2)(a) and F.S. 720.303(7) specifically require the auditor to prepare a management letter. The auditor must submit the management letter attesting to the accountants opinion regarding the HOA’s financial statements. The management letter addresses the HOA’s financial flexibility and sources of funds, as well as advise the HOA’s Board of Directors of any findings that might suggest failure to comply with GAAP. The management letter also advises the Board of any disclosure deficiencies in the financial statements and other matters relevant to the HOA’s financial operations. The management letter is meant to aid the Board of Directors in their fiduciary duty to safeguard and protect the financial resources of the HOA. By advising the Board of any findings that indicate noncompliance with applicable laws or GAAP, the auditor assists the Board in taking appropriate action. If a member has published an annual accountant’s compilation, or audited, review or agreed upon procedures financial statement of the association, such statement shall be made available to the members of the association. Most states do not require any type of audit, but rather the requirements are established in the HOA’s governing documents. However, where the governing documents require the appointment of an audit committee and/or pertaining to the manner in which an audit is conducted, the auditor shall observe such requirements. Failure to comply with audit requirements can result in criminal sanctions. F.S. 468.385. To ensure compliance, boards are encouraged to develop and maintain an audit committee.

Different Types of HOA Audits

There are different types of audits that an HOA may have performed depending on the purpose of the audit. Most commonly, we see financial statement audits performed at owner-occupied communities (meaning that the homeowners own their unit in fee simple ownership and not as a leasehold estate). The financial statement audit is a limited scope audit the purpose of which is to determine if the HOA’s financial statements are presented fairly, in all material respects, in accordance with generally accepted accounting principles applied on a consistent basis. These audits do not focus on testing operational and other internal procedures and controls.
If it is determined that an HOA has not been collecting or assessing its owners correctly or on a timely basis, the HOA may elect to have a compliance audit performed. In the audit engagement letter, the auditor will list all of the obligations that the association is required by statute or by its governing documents to meet, all of which will be verified. For example, if the bylaws require 5 days’ notice for an annual meeting, the auditor will look to see if that meeting was properly noticed and will also review past owner meeting notices to determine whether the association is in compliance with the requirements in the bylaws for noticing those meetings. Other items the auditor will verify include "Notice of Special Assessment" and "Liens". The attorney for the HOA may be involved in this process to ensure that all items are properly addressed.
The internal audit typically performed for a management company and involves a much broader scope than the financial statements. The focus is on the internal procedures, controls and processes utilized to manage and operate the properties under management. Testing may focus on items such as: KPM has employed auditors to conduct internal audits of management companies, the purpose of which is to determine the effectiveness of management procedures, controls and processes. The internal audit is typically a three month project over which the auditor will perform a substantial amount of testing to determine the effectiveness of internal procedures.

HOA Audit Process

Preparing for an audit requires some advanced planning and organization. The Board and/or management must review what kind of audit the association is required to have performed and what kind of audit is affordable to the association. It is helpful for the Board to know in advance what is going to be needed to complete an audit. Many questions need to be asked in advance such as: "What insurance are we carrying?" and "Are there any conflicts in our insurance policies?" Once an audit has been started, it is critical that the management of the association be as organized and on top of the information as possible. An audit is a big deal and an audit is an expensive procedure once the auditors start looking at records that are disorganized. When the auditors ask for something, make sure you have complied with their requests right away. If you can anticipate what the auditors want, you will save time, money and headaches. That makes life easier for both the Board and for management.
There are three main sections involved in an audit: The audit steps generally go as follows. The accountant will send a letter agreeing to perform an audit. Your association’s information will be initially reviewed by the auditor. From that review, the auditor will outline the areas where more clarification is needed. The audit usually begins with management and/or the Board answering questions about prior year events, when certain items were purchased, and whether or not certain invoices were in the documents for the period being audited. During the audit, the auditor will request confirmations from third-party vendors. Then the auditor provides an account to the Board for review. Ultimately, the Board of Directors must approve the audit and the audit is presented to the unit owners. Many times an audit is presented to the members along with the annual meeting for the association.
Unfortunately, this process usually does not go smoothly or even on schedule. From delays obtaining information from the manager to missing documents to the accountant missing his/her own deadlines, audits tend to be a mess. Many times, an association may have significant amounts of money missing, or the auditor may be held off for weeks or months. As an attorney, I only hope that we never miss a statute of limitation or have a fraud that we should have caught or at least noticed sooner. When this happens, our only course of action is to file a lawsuit. This can be very expensive and leave your association with a large legal bill for something that really isn’t your fault. For instance, say an association’s management compiles a list of missing documents that were requested by the auditor, and then the accounting manager at that accounting firm is let go. The auditor writes down a note to indicate which documents were and were not provided. The new accountant then either forgets about that note or thinks that the prior accountant was nuts and just discards the note. So, without any proof of who was provided documents, the auditor issues a clean audit. Then the association might find out that there was a lot of money missing and the association is sued for negligence and breaching the contract to maintain adequate internal control. This is not the fault of the Board or the association, but the association can still get stuck paying large legal bills because they do not have a proper paper trail for a properly executed audit.

How to Select an Auditor for Your HOA

Once your board has determined that your HOA will need an audit or review, you’ll want to search for an appropriately qualified firm. You may already have some CPA firms in mind as a result of performing the annual tax return preparation and/or compilation work. However, a CPA firm that doesn’t have plenty of experience with audits and ​reviews of associations is not the best choice for those type of services. Save the compilation work for an audit service level, and then seek a different CPA for the compilation work going forward.
Another question you would want to ask is whether or not the CPA firm has experience with community associations and how long they’ve been providing audit and review services to associations. If the firm hasn’t worked with HOAs before, they don’t have a clue about what is involved in those processes, the rules your association needs to be following, or how to be efficient in helping you.
Ways you can vet potential auditors:
Interviewing and hiring a firm that you like and feel comfortable with during interviews is important. You will want to know how much of the auditors’ time will be spent on your property. Will the audit work be done by a junior auditor along with the manager or partnership? If so, who is going to sign off on the work? Will the auditors be providing a report to your board based on the audit, or will the report be prepared by the accountant and just signed by the partner? You can ask all of these questions and if a firm isn’t willing to spend lots of time explaining these types of questions, you can be pretty certain that they don’t have the time to spend on these questions . No doubt you are paying several thousand dollars for an audit of your property, so you will want to choose a firm that is not only qualified but also willing to spend time with you.
Cost questions
It’s likely that the costs for audit and review may be over $10,000, and can even exceed that range based on the association’s size and circumstances. It’s important to ensure that the fees for the audit match what the association is being charged by their current CPA for the compilation fees. In some HOA managers’ experience, it’s common for accountants to "up sell" their services by suggesting an audit at a cost that’s several thousand dollars more per year than the drafting of a compilation was the past year. While those extra dollars can seem small in the scope of a full year’s budget, keep in mind that your monthly assessments will go up to cover those extra dollars multiplied by the association’s membership.
CPA qualifications
Call around to find out some CPA firms that have the experience you need. Beyond that, check references or ask your CPA for another recommendation. You may already have a list of CPAs you’re considering for the audit/review. Be sure to check their licenses and credentials by going to CALCPA. You can search by name and/or license number. For additional information about the CPA firm you may contact CALCPA directly.

Common Findings in an HOA Audit

There are several issues that are commonly found in an HOA audit. These include deficiencies in association recordkeeping, inadequate internal controls, and missing or misclassified transactions.
Poor Recordkeeping
Poor recordkeeping practices are one of the most common deficiencies seen in audits of HOAs. The most frequent recordkeeping deficiency is failing to maintain a record of owners. You may think this is not critical because you have a roster of owners from your annual meeting or ballot for electing board members. However, owners change every year. It is easy to miss one or two, and if these owners ever try to vote on something, you will have no record showing their ownership and they will not be allowed to cast a ballot. Other common recordkeeping deficiencies include:
Inadequate Internal Controls
While an independent audit can identify inadequate internal controls, it is up to the Board of Directors to make sure proper controls are adopted and followed. Associations should have comprehensive policies and procedures covering all aspects of financial management. In addition to having these policies and procedures, the policies must be followed. If your association’s bylaws or policies allow checks to be signed by anyone, the auditor will recommend that there be tighter controls put in place. Sometimes it is worth it to pay a little extra cost for proper controls to avoid bigger mistakes.
Missing or Misclassified Transactions
This happens more often than you think. Most accountants use a computer program to make the journal entries needed to properly classify money received, expenses paid, accounts payable, etc. Most of the programs being used error out if any information is missing or it does not provide for proper classification. It does not break it into the exact line item required by the IRS.
However, many CPAS and bookkeepers leave out the general journal, which really tells people what has been added and subtracted from each of the funds for accounting purposes. This means that owners cannot tell whether the accountants made mistakes or not because the general journal is not made available to owners.
Another common practice is to leave out the details of expenses paid. The CPAs may list utilities, water and sewer, security, landscaping, insurance, etc., but fail to give a breakdown of those expenses. Owners are entitled to see who was paid for insurance, and at a minimum, they should see the name of the insurance agent and the insurance carrier. Many times insurance is broken down into property, liability, and directors’ and officers’ (D&O). Owners should be given all the details for the above listed expenses. Without such information, owners cannot know whether the Association is getting a fair deal or not. It is just too easy to overcharge your HOA if the CPA or bookkeeper is not providing the details on expenses.

HOA Post Audit Compliance

Once an HOA has completed the audit process, there is more work to do. The audit may be designated as "clean" or "no exceptions"; however, that does not mean the audited period was error-free or that management will not need to take action on some items to get back into compliance with the HOA Audit Requirement. On the other hand, if unusual findings are uncovered during the audit, the HOA will have to determine how to address each finding. The audit will be of no value if the association ignores the findings and recommendations. Some strategies for maintaining compliance include:
To maintain compliance, the key is being proactive. Involving the audit firm in a board meeting to review the report and findings will ensure the board understands the areas in which the HOA must improve. The board then needs to develop an action plan to implement improvements in the recommended time frames; and, if needed, pursue further investigation of unusual findings by adding it as a specific item to the audit request to have the new auditor analyze the findings.

FAQ on HOA Audits

The following is a list and answers to some frequently asked questions we’ve received in relation to HOA audits:
How often do audits actually need to take place?
It depends on state law and/or your governing documents, the CC&Rs and bylaws, but a one-year cycle is common for most associations.
What can boards do to make audits move along and help the process?
A number of things. Consider providing your auditors with a written checklist of what they will need from the association during the audit. Make it as comprehensive as possible. Examples include prior year’s financial records, budgets, and assessing specific problems to ensure the auditors have all the resources necessary to get the best results.
Also, prepare your association for the audit as best as you can. For example , if you’ve made any dramatic changes (new accountant, new accounting procedures, etc.) that could impact the audit itself, be sure to inform your auditors in advance so they are prepared to deal with them.
What if I feel the audit process deserves more respect?
The audit process should be collaborative between the board, the auditor, and their team. If this is not the case, your auditor needs to know; there should be no negative effects on healthy collaboration. If your auditor is unapproachable, however, this is an audit firm whose services you should consider using again. As some boards have told me, "We’re paying them a lot and they are difficult to work with, so it’s uncomfortable for us," it also says something about the auditor’s degree of professionalism.