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Tips For Protecting Your Association Finances

Volunteer boards of directors of condominiums, cooperatives, and homeowners’ associations often perform a number of functions vital to the successful self-governing of the association: fostering community harmony, maintaining common areas, and establishing and enforcing rules.

The ability of the association to perform these functions depends upon its success as a business.  One of the most important business functions of the board is to oversee the association’s financial well-being.  Here are 15 tips to help protect association finances.  Before implementing the suggestions in this pamphlet, however, check your governing documents for specific requirements applicable to your association.

    1. CONDUCT AN ANNUAL AUDIT, REVIEW, OR COMPILATION.  A certified public accountant (CPA), selected by the association board, should conduct an annual analysis of the association’s finances.  The accountant should have access to original books and records.  All personnel, contractors, and volunteers should cooperate fully during the course of the analysis.

The association board may request one of three levels of service from the accountant:  compilation, review, or audit.In a compilation, the accountant presents the association’s financial statements in a manner consistent with generally accepted accounting principles.  A compilation involves little analysis and no confirmation of balances.  Often, the accountant will prepare the year-end adjustments, such as accounts payable or income tax accruals.In a review, the accountant investigates record-keeping practices and accounting policies and analyzes the statements.  The accountant prepares the disclosures on unusual items or trends that may require explanation.In an audit, the accountant performs a more thorough analysis, which may include confirming bank balances, making physical inspections, and tracing transactions to invoices and evidence of payments.  Although an audit is a more comprehensive examination of an association’s financial statements, it is not an analysis of the board’s policy decisions or its use of resources.   After the analysis is completed, the accountant expresses an opinion based on the results of the audit tests and examination.  The opinion is independent of the association and management.Before deciding which method to use, check association documents and state statutes.  A full audit may be required.  The Colorado Common Interest Ownership Act (“CCIOA”), C.R.S. §38-33.3-308(4)(b)(I) requires an audit, using generally accepted auditing standards, or a review at least once every two years under certain circumstances.  And always consider conducting a review or audit when a major change is made in the way the association handles its finances (e.g., transition from developer to owner control or a change in management).

  • ASK YOUR ACCOUNTANT FOR A MANAGEMENT LETTER.  Ask your accountant for a management letter.  In this letter, the accountant reports any weaknesses in the association’s financial systems, as well as issues concerning internal control, income tax, reserves, and document compliance.  The cost of the report is minor compared to the consequences of an inadequately scrutinized financial system.  After the accountant has written the management letter, he or she should review it with the board.
  • RECONCILE BANK STATEMENTS AT LEAST FOUR TIMES PER YEAR (QUARTERLY).  The board should review bank statements or passbooks for all cash accounts at least once every three months.  The board must see that bank statements are reconciled in a timely fashion.  If the treasurer reconciles the bank statements, then the board should designate another person to review the reconciliation.  If the reconciliations are done by a manager, management agent, or bookkeeping service, the treasurer of the board should carefully evaluate the system, its internal controls, and the reconciliations and calculations.
  • REQUEST MONTHLY OR QUARTERLY FINANCIAL STATEMENTS.  The accountant should submit a financial report to the board at least every three months.  The report should include a balance sheet, profit and loss statement, and a comparison of the budget to actual expenditures.  The financial statements should show activity for both the operating and reserve funds.  The financial statements may be prepared on either a cash, accrual, or modified cash basis. The accrual method is effective for most associations because it matches revenues to expenses incurred more accurately.  Regardless of the accounting method used by the association, the board should monitor an aged list of accounts receivable (delinquencies) and accounts payable (unpaid bills).

 

The financial report should be accompanied by an explanation of any significant variances, such as significant cash surpluses, shortages, excessive accounts payables or receivables, or major budget overruns.  The board should investigate any excessive variances and ask questions if the financial statements are not produced 15 to 30 days after the close of the period.  The board should closely review the income statement, compare it with the budget, and question any major differences.

  • ENSURE THE BOARD HAS CONTROL OF RESERVE TRANSACTIONS.  The board must have full and separate control over the association’s reserve account(s), including the signatory control of bank accounts.  All transactions made by board designees should be reported and verified in writing.  These transactions should be approved by the board, and approval should be documented in the board’s meeting minutes.  The reserve cash funds should be separate from the operating cash accounts.

 

A reserve study should be prepared every three to five years, and it should be reviewed annually.  This study should be used in reviewing the adequacy of reserves as well as the funding and spending of reserve funds.

  • ESTABLISH AN INVESTMENT POLICY THAT ENSURES SAFETY OF PRINCIPAL.  The board must decide where and when to invest.  As of January 1, 2006, all associations must have a policy regarding the investment of reserve funds.  CAI’s Accountant’s Committee recommends (and many association documents require) all association funds be invested in government-insured accounts or instruments of similar security.  Make sure the balances do not exceed the bank’s or fiduciary’s insurance limits.  Safety of principal is the utmost investment objective for associations, not high yields.  The higher the yield, the riskier the investment.  Deal only with licensed, insured, and bonded brokers and agents.  For more on the topic of investing reserve funds, refer to CAI’s GAP Report #24: A Complete Guide to Replacement Reserve Funds and Long-Term Reserve Funding.
  • DO NOT COMMINGLE ASSOCIATION FUNDS.  The association’s funds should not be commingled with the funds of any other organization.  If the association does commingle funds, however, it should put the monies in a trust account with clearly defined safeguards.
  • PREPARE WRITTEN COLLECTION POLICIES.  The association should have a written collection policy for delinquent accounts receivable (the assessments).  As of January 1, 2006, all associations must have a policy in place addressing the collection of delinquent accounts.  This policy should be distributed to the membership and uniformly enforced.  To enhance collections, an association should obtain a bank lockbox so it can deposit assessments directly into its account.  Such a system speeds up deposits.  It also eliminates a number of “weak links” in the chain of financial management by ensuring the vast majority of association funds are sent into the association’s account without being handled by volunteers, employers, or agents.
  • DETERMINE POLICY FOR SIGNATORY CONTROL.  Associations should require two board signatures on all reserve checks, redemptions, or fund transfer requests.  One of these signatures should be from an appropriate board officer (e.g., treasurer).  For operating cash accounts, associations should consider requiring two signers for all checks above a certain amount.  Though obtaining a second signature for checks on operating cash can be an inconvenience, associations should weigh the extra control and protection this procedure provides against any delays it may cause.
  • INSIST ON FIDELITY BOND FOR MANAGER AND/OR EMPLOYEES.  Associations must insist that the manager and/or employees are sufficiently bonded to cover all association funds reasonably at risk.  The association should also have its own fidelity bond to cover volunteers and any employees who either have access to or who handle funds.  If possible, the association should add management employees and principals to the association’s bond.  Associations should require 60 days notice prior to cancellations or nonrenewals of the management agent’s or the association’s bonds.
  • SPECIFY THAT KICKBACKS ARE PROHIBITED.  Employment agreements and management contracts should specify that kickbacks from contractors, employees, or others are not allowed.  Also, associations should establish in writing that any benefits, credits, discounts, or free services provided by a financial institution or contractor must benefit the association, not the management agent, employee, or individual contractor.
  • REQUIRE DISCLOSURE OF CONFLICTS OF INTEREST.  The Colorado Revised Non-Profit Act and CCIOA require disclosure of board member conflicts of interest whenever a director has a financial interest in a transaction of the association.  The association should take this further and snsist that any significant relationship, regardless of whether the director will financially benefit from the transaction, among prospective consultants, contractors, attorneys, accountants, etc. be disclosed prior to retaining their services.  Again, as of January 1, 2006, Colorado law requires associations adopt a policy addressing board member conflicts of interest.  However, it’s wise for the policy to apply to the board, officers and committees, as well as to employees and the manager.
  • PURCHASE DIRECTORS & OFFICERS (“D&O”) LIABILITY INSURANCE.  The board of directors should have adequate D&O coverage to protect against lawsuits alleging errors or omissions by the board in the performance of its duties.
  • MAINTAIN CONTROL OF ASSOCIATION DOCUMENTS AT ALL TIMES.  Documents generated by the association and the manager in the course of the manager’s work, as well as association books and records, are the property of the association.  They must be turned over to the association at the conclusion of the management contract.
  • ESTABLISH GOOD FINANCIAL PROCEDURES.  The board must ensure the safety of its financial systems and implement effective internal controls.  Here are examples of good checks and balances:

 

    • Use multiple parties to handle cash, whether from assessments, vending machines, guest fees, etc.
    • Require two signatures on all checks over a certain amount and on all reserve or investment transactions
    • Do not allow the person who approves invoices to write checks
    • Do not allow the person recording receipts to make deposits
    • Minimize cash transactions
    • Write all checks to the payee, not “cash”
    • Pay all employees and vendors with a check
    • Insist all payments to the association be made out in the name of the association — not the manager, managing agent, or board member
    • Deposit checks directly to the association’s account on a daily basis or store overnight in a fireproof safe
    • Reconcile bank statements monthly
    • Arrange for annual audit, review, or compilation, including a management letter from the accountant
    • Obtain an engagement letter from the association’s accountant defining the work and fees
    • Conduct an annual review of all insurance policies, especially those relating to financial matters
    • Review the association’s tax status and tax planning for the upcoming year with an accountant
    • Have a reserve study prepared every three to five years, then review that study annually
    • If the association books are maintained on a cash basis, maintain the accounts receivable on an accrual basis.  A report of payables should accompany the financial statements
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