Time to check the money trail

I just posted this to my blog and thought I'd re-post it here:

In the last two weeks we've seen three management companies being investigated for their mishandling of association funds. In at least two of the cases, the firms have closed, with embezzlement charges looming over the principals. In two other situations, long-time board members, with apparently unchecked access to association funds, are also now accused of mishandling them. The hundreds of associations involved are now going to go through a miserable time, with accusations flying back and forth, and litigation that will probably go on for years, not to mention the costs that will be involved. The ultimate responsibility will lie with the board members,current and past, who failed to make sure the association's funds were being handled properly.

There are a few simple things a board can do to reduce the risk in the handling of association funds. Start with where the money is kept and how the transactions are reported. With electronic banking becoming more readily available to associations, it gives associations the ability to have more than one person review the transactions. Some banks, that cater to community associations, can allow the entire board to view (not create or change) all banking transactions, including the viewing of both sides of any check written, so you can also see who cashed it. You can also set up electronic approvals, so that when a check is authorized, another party has to log in to the account and approve the transaction before the money is sent. In most of the cases, the perpetrators would not have been able to get away with their actions for so long a time if the board had required the electronic approval, or had just looked at who was cashing the checks.

In the past, requiring second signatures, or separate approval (by a board member), was time consuming and costly. That is disappearing. If your management company, or bank, can't provide these simple measures now, you might want to start giving them a jab in the ribs, to help move them into the 21st centrury. Transparency in financial transactions should be the standard, not the exception.

Second, especially if you're self-managed, always require two signatures on any check over a certain amount, say $500. No one person should be able to write checks, or transfer association operating or reserve funds.

Third, I am still amazed at the number of associations who fail to have an annual, independent review of their financial records. Even when required in the CC&R's or Bylaws, associations resist spending the money to have a qualified accountant look at the books. First, IT'S NOT YOUR MONEY!!! It's care was entrusted to you to either handle directly, or to retain someone to do it for you. In any event, you should want ot be able to show the owners that you handled that job carefully, and you do that by having someone examine the books and records and provide a report. That person(s) should be an independent, qualified Certified Public Accountant, preferrably with knowledge of community association finances, not the bookkeeper down the street, nor the Treasurer's brother-in-law, who promise to do it a little cost. The board should obtain at least 3 proposals from qualified CPA's, and include the requirement that the CPA or firm has no ties to the association board, officers, or management firm.

There are three different formats the examination of the books can take: Audit, Review or Compilation

A financial audit, (sometimes called a certified audit) or more accurately, an audit of financial statements, is the examination by an independent third party of the financial statements of an association, resulting in the publication of an independent opinion on whether or not those financial statements are relevant, accurate, complete, and fairly presented. The books and records are tested according to Generally Accepted Accounting Principles (GAAP).

A "Review" is performing inquiry and analytical procedures that provide the accountant with a reasonable basis for expressing limited assurance that there are no material modifications that should be made to the financial statements for them to be in conformity with GAAP.

A "Compilation" is presented in the form of financial statements that is the representation of management without the accountant undertaking to express any assurance on the statements.

Obviously, only the full audit can give a board any reasonable assurances as to the accuracy of the financial reports. But since its also the most time-consuming and therefore most expensive, its often not done. Here's some "rules of thumb" to help you in making your decision:

You should have the full audit if:

Your documents or state law require it
You change management companies
You just assumed control of the association through transition from developer control
Your Treasurer can sign checks and you change Treasurers

You may have a review if:

If your documents or state law allow it
Your association has had a full audit within the last two years
You have very little in the way of association income and expenses

You may have a compilation if:
I really don't see any reason why you would have a compilation. There are no tests or checks of any substance to see if the reports are accurate.

You may have noticed that I didn't make any differentiation between large and small associations or between condo's and HOA/POA's. That's because there is no hard and fast rule as to the dollar amount that would require an audit as opposed to a review. Baiscally, if you're a small association, there's probably no harm in having an audit every three years and reviews during the intervening years, as long as one of the other audit criteria doesn't come into play. However, if you're a large association, handling large sums of money, then the annual audit is the only way to go.

Last, but not least, is the issue of Fidelity Bonds. Often an association will rely on a management company's bond, but what they may not be aware of is that this often only protects the owner of the management company from theft by an employee. It might not protect the association if it is the owner who is, in fact, stealing the funds, as it appears to be in some of the above cases. An association should always have its own Fidelity Bond on everyone who has access to the funds.

Remember:

Its not your money
It's only been entrusted to you, not given
Better safe than sorry
It's not your job to keep assessments low, but to spend the money wisely!

Joe

Joe, thanks for your excellent post. Our ad illustrates our feelings about the importance of protecting the associations funds.

"DARCO has a record of 100% success on collections and Covenant compliance and we have never been to litigation. Our proprietary financial reports are clear and comprehensive. Our money handling procedures remove possibilities for theft."

We do consider an audit to be more stringent than your definition; but your's is what HOAs do which is called an audit.

Joseph,

Good post! You have a lot of good points, but I just wanted to bring up a few more with regards to an annual independent audit. I complete audits of companies and Not for Profit organizations for a living. I would encourage all board members to complete a cost-benefit analysis completed prior to enlisting the services of a CPA to perform an audit. I will be the first to admit that we are very expensive. In many cases, the audit costs more than it is actually worth. If you live in a large association with a large budget, then it is probably worth it to have an audit conducted. However, if you are a smaller association where the audit fee could be overwhelming, then a suggestion I have is to create a sub-committee to assist with the completion of an annual audit. You do not have to be a CPA to understand if all revenues have been accounted for appropriately or if expenses paid are the correct amounts. There are also quite a few high-level, simple procedures that can be completed on a monthly basis to ensure your books are in order. If you are currently paying to have an audit completed annually and you think you are paying too much, I encourage you to re-bid the job. The larger the accounting firm, the more you will pay because there is greater overhead absorbtion. Please feel free to reach out to me if you are interested in learning more about audits or have any questions. I would be happy to assist!

We recently moved into a condominium in Indianapolis. My partner was elected Board President and quickly learned that the previous boards have acted very dysfunctionally, if not loosly in management of the association. We are now professionally managed, however some disturbing things have been uncovered.

The previous Boards have compensated Board members for their services. This is prohibited in the by-laws of the association.
The incorporation documents state that there is to be "no pecuniary remuneration (except for reasonable compensation for services actually rendered)" The by-laws state that no Board member may recieve compensation.

The Board members were compensating themselves $100.00 per month which collectively amounted to $600.00 per month or $7200.00 per year, none of which is reflected on the annual budget.

Most disturbing is that the building, built in 1926, now requires approximately $225,000.00 in deferred maintenance.

To me, this constitutes a misuse of association funds and would require that the present non-compensated Board review past annual budgets and compensation practices to see how much has been paid out to Board members, money which should have been part of the general operating fund.

Our management company seems hesitant to address these issues and in fact prepared the last annual budget and did not include this compensation in the annual account.

Has anyone had a similar experience and how was it handled?

I really appreciate the comments you all have contributed. We have a relatively small (40 units) HOA with current assessments of $189/month. We have no pool, no golf course, no sizeable common areas to maintain. Our governing documents require an annual audit by a CPA, but none has been done in at least the last 3-5 years.

My concern is this. Our monthly assessment is allocated among specific itemized categories; some of the money funds reserves that I am fairly certain are underfunded. I have been on the baord for the past 2 years and have raised questions about the board spending because I beleive the board doesn't really know where the money came from and whether it is really "spendable." There is no allocation in our monthly assessment to fund an "operating account", but the person who has been president for the past 2 years currently and was on and off the board in the past, doesn't think it is at all unusual that there is/was $18,000 in "surplus" that he calls the operating account and which he uses to fund pet projects (surprise, surprise) like replacing a fountain at a cost of $3000+ out of those funds and covering required expenses like maintenance of exterior siding when the money budgeted for that purpose is underfunded.

I was appalled at our annual meeting in October 2006 at which the HOA is required to provide homeowners with a financial statement and instead of a Treasurer's Report, our Treasurer deferred to our outside "professional" manager who had already given his notice. The so-called professional actually shrugged his shoulders and said, "I got nuthin'." When pressed, our president read off the bank balances which, of course, tells the homeowners to borrow a phrase, "NUTHIN'".
I was the board member who pressed for an audit which was approved by the board and then the president tried first to bring the matter up at another board meeting where he thought he had the votes to overturn the prior vote without taking action. Then the president started telling anyone who would listen that I was accusing him of stealing money from the association funds. Then our new property manager said an audit would cost too much money and he was a CPA and he could a reserve study, although he never did and now after just 3 months, he has quit too.

I am not a CPA, but when your books don't "balance" by as much as $18,000 even if it is a surplus, isn't that indication of a potential problem????

Thank you for your comments!

Liz, to summarize - two MCs quit in 3 months; no audit in 3-5 years when an annual audit is required; Board members don't really know where the money came from and whether it is really "spendable"; poorly organized and run annual meeting; and the Board votes for audit and it is not done. Yes, I'd agree that your Board has problems. It all starts with the President, you need a better leader.

The $18,000 is not necessarily a problem nor does it indicate the books do not balance. It could be poor accouting practices. Why wasn't the $18,000 budgeted to increase the underfunded reserves? I'd guess it is probably for the same reason as the above problems - the HOA is being badly managed.