Accrual vs Cash Accounting: HOA Accounting Best Practices

Every HOA board member comes into their position with a different set of goals and expectations. If you’re coming in without a lot of accounting or bookkeeping experience, you probably have a lot of questions.

One HOA bookkeeping basic that doesn’t get enough attention is accrual accounting. It’s different from cash basis accounting, which you probably use for your home finances.

We’re going to take a look at accrual accounting and cash basis accounting, their advantages and drawbacks, and what makes accrual the best method for most HOA bookkeeping.

What is Cash Basis Accounting?

What you’re likely to be most familiar with is cash basis accounting. In this type of bookkeeping you record income and expenses when funds are exchanged. The record becomes one of when bills and dues are paid, and for how much.

With cash basis accounting you keep an accurate record of the cash balances in your accounts at any given time. This is how most of us manage our household bookkeeping.

The advantage of cash basis accounting is its simplicity. You record what comes in and what goes out, from whom, and when. It streamlines ledgers and feels familiar to most board members.

But is it the best way to organize your HOA accounting? Even if your organization is very small, cash basis accounting does not give you the most accurate view of your HOA’s finances.

What is Accrual Accounting?

When you use accrual accounting for your HOA, income and expenses are recorded based on when they are due or incurred, rather than when they are paid. For example, you may have a maintenance contract under which the services completed one month are invoiced the following month.

Your homeowner assessments are recorded when they are due, not when they are paid. You have balance sheets showing accounts payable and accounts receivable, for which funds have not yet exchanged hands.

You also may have a balance sheet for prepaid expenses. These expenses have been paid, but the services have not yet been rendered. To reconcile the balance sheets, you’ll have an accrual statement.

Expenses

Using accrual accounting, services are recorded when they are received. They go on the accounts payable sheet, which is updated along with the cash balance when the service bill is paid.

We’ll use your monthly maintenance again as an example. Your January maintenance gets documented as an account payable on the date the service is performed. It is recorded as an accrual journal entry at the end of January.

You are now aware that the service was received and it is reflected in your total operating expenses on your income statement. On your balance sheet, it is reflected as an accrued expense liability, recognizing that the bill has yet to be paid.

When the January service invoice is paid in February, the accrual is reversed in the records.

If the HOA board approves a plan to replace the roof of a common building, the entire cost goes on the balance sheet when it is approved. It is then reconciled through accrual statements as the project proceeds and the funds leave the HOA’s account.

Insurance payments are some of the most common prepaid expenses. An HOA may pay for six months or a full year to get the best monthly rate. Those expenses are recorded on the balance sheet for the month for which they apply.

Income

For income, accrual accounting uses an accounts receivable balance sheet. Homeowner assessments are recorded as accounts receivable on the day they are due. Depending on the size and nature of your HOA that may be the first of every month or it may be once per year.

As your community members pay their assessments, those payments decrease the accounts receivable balance. The payment, considered an asset, is reclassified from an account receivable to cash when it enters the HOA’s bank account.

That’s Confusing! Why Would We Use Accrual Accounting?

You’re right. At first glance, accrual accounting seems confusing and unnecessarily complicated. Why not just use the same cash in/cash out system you use at home?

Cash basis accounting does not record the accurate timing of either expenses or income. Accrual accounting tells the board about every transaction, every month, and how and when each will affect the cash balance.

Expenses

It doesn’t matter when an expense is finally invoiced. The board needs to know when it was incurred. This is vital for both budget planning and general oversight. If an unexpected service was rendered, the board must adjust the budget to reflect changes as quickly as possible.

For large projects, the HOA has to behave as if the money has already been spent. That way the community doesn’t come up short as the project bills arrive.

Income

Accrual accounting allows you to track homeowner payments. Your HOA needs to know who has and has not paid their fees. Your board can work with members who are not in compliance. The budget planning committee can decide if it needs to make changes based on new estimates for income.

Benefits of Accrual Accounting

Your HOA will have a far more accurate picture of the organization’s financial health using accrual accounting. The board will have a complete record of all monthly expenses, paid or not, as well as income, received or not.

Short-term and long-term planning is easier when monthly income and expenses are accurately tracked. It’s too easy to be caught off guard by late invoices or missed homeowner assessments when you don’t have the full picture readily available.

Accrual Accounting Record Keeping

Think of accrual accounting as recording transactions in addition to cash flow. You’ll have a regular income statement that reports how much cash went into and out of the HOA’s account for each month.

On your balance sheet you’ll have accounts receivable (money you’re waiting for), accounts payable (money to be spent on services already received), and prepaid accounts (money already spent on services not yet rendered).

Using and keeping track of the moving parts of the balance sheet is where board members get stuck. Unless you’re fully versed in accrual accounting it isn’t always intuitive.

Accrual accounting is the best way to get a full picture of your association’s finances. It also conforms to General Accepted Accounting Principles (GAAP), which cash basis accounting does not. Your HOA bylaws may require your board to use GAAP methods, ruling out the cash basis method.

If you’re setting up or revising your HOA accounting, reach out to Homey Bookkeeping. We’ll help you assess the needs of your community and design an accounting method that works for you and your HOA.

Your HOA should never be afraid to ask for help. Professional accounting and bookkeeping services exist for this very reason. We understand that your time is valuable and that overextended board members become resentful and burned out.

Understanding the benefits of accrual accounting and investing in professional guidance are the best ways to keep your HOA financially healthy. It also helps your HOA maintain a consistent, informed board.

Contact Homey Bookkeeping today to learn more about accrual accounting for your homeowners’ association. Visit our Learn section to find more articles about HOA accounting and bookkeeping.