HOA Audits: How They Work and Why They're Important

When a small condominium unit is governed by a homeowners association, or an HOA, having a certain level of financial oversight is crucial. With an HOA audit, residents and board members get exactly that, although they don't always like what they find.

Not only can an HOA audit ensure residents that the financial health of the association is solid, but these audits can uncover common issues that become more difficult — and more costly — to fix the longer they're left unchecked.

Do you think your association is in need of an HOA audit? Maybe you're planning one already but not sure where to start. If you're wondering exactly how HOA audits work, if they're necessary and when to plan one, read on to learn more.

HOA Audits: What Are They?

An HOA audit is a thorough, detailed review of the financial statements of an HOA. The point of these audits is ensuring the financial stability of the organization, uncovering potential financial problems, and giving residents peace of mind when it comes to the use of their funds.

Generally speaking, board members within HOAs will decide to plan a HOA audit based on their own volition or the requirements in their HOA bylaws. However, there are instances where residents within a HOA community can demand one.

Either way, HOA audits are meant to be completed by uninterested third parties with professional credentials. Often, HOAs will hire an independent Certified Public Accountant (CPA) to conduct their HOA audit since they are trained to oversee the finances of an organization and comb through financial statements on the lookout for potential errors.

When an independent CPA firm is hired to conduct an audit, they will need to have a copy of an array of important documents related to the finances of the HOA. These documents can include (but are not limited to) the following:

• Board meeting minutes
• Internal financial statements from the HOA
• Annual tax returns
• HOA insurance policies
• Bank statements for all HOA accounts
• Invoices (both paid and unpaid)
• Contracts from vendors
• Payroll records
• Petty cash records
• Property tax records
• 1099s for contractors hired by the HOA
• Reserve schedules
• HOA dues schedules
• HOA bylaws

By thoroughly examining each of these documents and confirming that all the details and numbers add up, the CPA conducting an audit is performing an essential chore. When problems within an HOA are found, the organization can take steps to fix them right away. If the audit uncovers nothing but good news, that's a good sign for residents and board members alike.

While the cost of an HOA audit can vary, some sources say HOAs should expect to pay between $4,000 and $6,000 for a full audit of their financial statements. With that in mind, organizations should budget and plan for regular audits accordingly.

Are HOA Audits Necessary?

Because HOAs are run by humans who are unwittingly prone to errors, HOA audits are often seen as a necessary evil. These audits cost money, and those funds come directly from the residents who belong to an HOA. However, making the decision to avoid financial audits can also cost you. If your organization fails to find accounting mistakes or fraud for several years, for example, the losses could add up to much more than an HOA audit costs.

Audits are especially important for HOAs since there is often no backup source of money for them to rely on. If an HOA mismanages their funds or faces any other type of financial crisis, the HOA board can find themselves in a situation where they are unable to keep up with maintenance and repairs or pay their homeowners association insurance

And just like other organizations, HOAs have the potential to go bankrupt if their financial issues are left unchecked.

With that in mind, HOA audits are necessary because:

• HOA audits serve as a definitive report on the financial health of a homeowners association.
• These reports can help protect homeowners and their property values.
• Without HOA audits, financial issues within an organization only stand to get worse.
• If you rely on internal financial reports only, the individual creating the reports could be the same one causing your HOA's financial issues.
• Sometimes an audit from a third party is the only way to find out about major problems within an organization.

Common Problems HOA Audits Uncover

If your HOA audit reveals that all is well within your homeowners association, that's definitely a good sign. Unfortunately, many audits reveal an array of financial issues that can lead to long-term financial harm.

Common problems HOA audits can uncover include:

• Inappropriate use of petty cash
• Over-budgeting or under-budgeting for current and upcoming expenses
• Accounting errors
• Inadequate reserve funds
• Inadequate HOA insurance coverage
• Inadequate insurance coverage for HOA directors and officers
• Fraud or theft
• Embezzlement of funds

When to Plan a HOA Audit

Because not all HOA board members may have a real grasp on the financial situation of the organization, planning a periodic financial review makes a ton of sense. However, there are situations where HOA audits are compulsory,

For example, some HOAs have requirements for periodic audits within their bylaws. In this case, financial audits are planned according to a schedule laid out within the framework for the HOA, whether they take place every year or once every few years. It is also important to note that some states require an annual HOA audit. The state of California is one of them.

Outside of HOA audits planned for compliance purposes or meeting state guidelines, here are some other times planning an HOA audit makes sense:

• You're transitioning to new HOA management. Planning an HOA audit always makes sense when you're switching HOA management firms, and for more reasons than one. Not only can an audit find mistakes or problems caused by your old management company, but it can provide the new firm with a holistic view of your HOA's financial situation.
• Questions have been raised about the financial health of your organization. If HOA funds seem tighter than they should be or something seems "off" with the books, an HOA audit can help uncover any issues.
• You want to keep board members honest. Board members are only human, so it doesn't hurt to keep them on their toes. Planning a regular financial audit can help prevent issues like fraud and embezzlement before they start.

The Bottom Line

There's only one way to know if accounting errors, acts of ill will, or financial mismanagement are affecting an HOA's ability to operate, and an HOA audit is it. These third party assessments may not sound like a lot of fun, but they're a necessary standard when it comes to safeguarding the financial health of an organization.