Allowance for Doubtful Accounts (ADA)

The new auditor we are working with is looking for a detailed policy for the allowance for doubtful accounts. In the past, the HOA has “gauged” by feel what that value should be and our auditor would like a method or formula in place to remove any question at how the value is calculated. I am looking forward to the feedback on this issue.
Thanks,
M

Mark,

I did not serve as treasurer but I was never satisfied with how income and ADA was handled in my association. Instead of projecting the total income if all owners paid up, our treasurer used some sort of voodoo to arrive at a projected income with the ADA amounts already deducted. We had no idea how much he was allowing for ADA and no idea as to how he arrived at that figure. Even though the net result is the same, I would have been much more comfortable seeing a gross income with an allowance for doubtful accounts.

Our History: Until 6 years ago, we never needed an ADA. Eventually, we always collected assessments. We didn't always collect late fees and fines, which the Board often waived.

Then 6 years ago, a HO abandoned a house. The mortgage on the house kept getting sold. Foreclosure was initiated 3 different times, but until earlier this year, the foreclosure sale never took place.

Also, within the last few years, we have 2 new situations. One HO defaulted on a reverse mortgage. Another filed for Ch 7 bankruptcy and is offering deed in lieu to the mortgage holders.

Our ADA Policies:

1. We do not budget any $ for late fees and fines. Whatever gets collected is a buffer that we use to minimize the effect of non-payment of assessments. The amount that gets collected each year in late fees and fines doesn't change that much from year to year, so it's relatively easy to estimate a $ amount. Except for our 3 problem accounts, we always collect more than enough in late fees and fines to cover non-payment of assessments.

2. We convinced our CPA that we would not carry the empty house on the books anymore. That took some doing, because that's not the way that CPAs like to handle it. In our financials, that house is described in a footnote, but the numbers for that house are not mixed in with everything else. If we included that house, we would show a huge delinquency and need a huge ADA - which in our opinion would distort the true picture (When fully loaded with late fees, interest, fines, and legal costs, the one house would show more than a $90k delinquency.) So we run things as if that house doesn't exist.

3. To handle the reverse mortgage and the bankruptcy houses, we figure that all we are ever going to recover until these houses change hands is the 6 months super-lien that is guaranteed by PA statute. So we estimated how long we think it will take for these 2 houses to change hands, and came up with an ADA number.

Summary:

Under ordinary circumstances, we don't need an ADA if we don't budget for late fees and fines. In the extreme case of an abandoned house for 6 years, we stopped carrying the house on the books. For troubled units, we estimate how long past the statutory super-lien we'll have to wait before start collecting assessments again.

I've read a few articles that suggest this amount should be 4% of your community's annual budget. Given the real estate crash of 2008, a lot of HOAs were well over that percentage.

Why not take a look at the last two or three years of what your association allowed vs. what was actually written off? Also consider the reasons why the accounts were written off. Did everyone declare bankruptcy and the amount was discharged? Did people abandon the house and the bank started the foreclosure, but didn't complete it until after they got a seller? They do this to avoid paying assessments they'd be responsible for after the foreclosure was complete - a whole 'nother conversation. What was the average loss per house?

Compare the actual write off vs. the budgeted item - if the actual exceeded the budget by a huge amount, you may want to increase it by a certain percentage.

And while you're working on a policy, consider coming up with a checklist of specific actions that should have been taken to collect the money before the Board makes a decision. For example, did the Association do its own foreclosure? If not, why not? (e.g. the mortgage company started its action and so it wouldn't make sense)

These are my comment form my experience:

First, as long as the homeowner is residing on the property the account should never be written off. Make sure a lien has been PROPERLY recorded per your state laws. If a bankruptcy has been filed, the association will have two accounts numbers for the owner, one prior to the filing date, the other after the filing date. The lien is against the property, not the individual.

Once the property has sold and the owner has moved out, any remaining balance, THEN should be written off and sent to a collection agency. Anything they collect would be a bonus.

Can't speak for self-managed HOA's, but ones that employ an MC, their financials generally are set up as a modified cash accrual. Any late fees, interest and violation fines that Board may waive should then written off as uncollectable as the income had already be accrued when posted to the owners account.

Smaller associations may not have a budget line item. If they do, as other budget items review past history and increase for the following year accordingly.