DIRECTORS FINANCIAL RESPONSIBILITIES
By: Gary A. Porter, CPA
Most individuals elected to serve as a director of a community association are not experienced in financial matters, well-versed in Robert's Rules of Orders, or has great experience in the up-keep and maintenance of a community association complex, and has probably never heard of the concept of reserves. The director is thrust into this job with little idea of what his duties and responsibilities are, and unless he has been an active member of CAI (which is not likely if he is a first time director), is not even aware of the educational resources that are available for guidance in learning what a director's responsibilities are. Further, many directors serve only a one-year term and, therefore, have little incentive to go to the effort of getting the education necessary for performing their job, when their job will be completed before they can begin to learn everything they should know. This is the typical case; however, there are certain individuals who bring management or business skills to the job with them that give them an edge in performing their duties.
The purpose of this article is to attempt to provide, in a checklist format, guidance to the director on his or her financial responsibilities for the association. The first and foremost rule with respect to the financial transactions of an association is that they should be well-documented. While the association may produce monthly financial statements and an annual budget, it is also important to document, preferably in the minutes of the Board of Directors, the following types of financial decisions:
- Authorization for new bank accounts.
- Authorization of changes in signers of bank accounts.
- Approval of transfers of cash between accounts.
- Authorization for purchases of major equipment, or major expenditures.
- Approval of the annual budget.
- Acceptance of, or the approval of, monthly treasurer's report.
- Acceptance of, or approval of, the monthly interim financial statements from the management company.
- Approval of the annual audit or review report.
- Authorization for an officer of the association to sign the annual income tax returns of the association.
- Documentation of board actions and responses with respect to the accountant's management letter that accompanies the annual audit or review report.
- Collection actions. Authorization to lien member property, authorization to foreclose on member property.
- Documentation of board decisions regarding insurance coverage (I recommend that the Board of Directors meet annually with the Association's agent to review the adequacy of coverage).
- Adoption of a conflict of interest policy. California and presumably other states require disclosure of financial transactions with related parties (this means any directors of the association).
- Authorization of contract for preparation of a reserve study.
- Authorization for reserve expenditures.
- Adoption of reserve policies.
- Adoption by the Association of its Revenue Ruling 70-604 Election. This election should be made annually and preferably should be made at the annual membership meeting rather than at a Board of Directors meeting.
The above list represents a good starting point for the director, but the next question is how does a non-accounting person know how to read financial statements, or how to understand the annual audited or reviewed financial statements from a Certified Public Accountant. Accounting is a complex, technical subject that very few people actually take an active interest in. However, the impact of financial transactions is something that permeates every aspect of our lives, and certainly that of a community association. While no individual can be given a complete accounting education in a short enough period of time for them to have a complete understanding during the term of their directorship, there are certain things that the director can and should do on a procedural basis that would allow him or her to adequately exercise the oversight responsibilities of a member of the Board of Directors of an association.
I suggest that the monthly financial reporting package for a community association should consist of the following documents:
- Monthly financial statements.
a. Balance Sheet on an accrual basis.
b. Income Statement on an accrual basis with budget to actual comparisons.
- General Ledger
- Cash Disbursements Journal
- Aged Accounts Receivable Listing.
- Copies of all bank reconciliations.
- Copies of all bank statements.
While the above list may seem like overkill, ideally these documents should be distributed to the board members prior to the Board meeting so that they have had an adequate opportunity to review them and be ready at the time of the meeting to either approve the reports or ask the necessary questions. It is unreasonable to expect even a CPA to sit in a board meeting, be given a set of financial statements, and during that board meeting, review, understand and approve the financial statements, and, by inference, the underlying transactions.
Now that the director has received this financial package, what does he do with it? First, the director must understand what each of these items are.
The balance sheet is a statement that reflects the financial status of the Association, at a specific point in time, generally month end or year end.
Common components of a balance sheet are:
Cash - Petty cash on hand, checking accounts, savings accounts or other types of accounts with a financial institution.
Assessments Receivable - Dues/assessments owed to the Association as of the date of the financial report.
Fixed Assets - Property acquired by the Association with a useful life greater than one year and of significant cost.
Prepaid Expenses - Payments of expenses in the current period that will pay for more than one period (such as insurance).
Accounts Payable - Expenses incurred, but not yet paid.
Prepaid Assessments - Dues/assessments paid in advance.
Income Taxes Payable - Income taxes due for the current year and any prior years.
Replacement Fund - Amount set aside for future repairs and replacements (this balance should have an equal amount of cash set aside to accumulate for major expenses).
Operating Fund - Accumulated earnings or losses of the Association from the current year and prior years.
The income statement reflects, for a period of time, the income and expense activities of the Association. A preferred format would reflect the current months budgeted and actual activities, and the year-to-date budgeted and actual activities. Revenues should consist of member assessments, fines, vending machine or parking or other income and interest income. Expenses would include operating maintenance costs, utilities, management company fees, other administrative and operating fees, and amounts transferred to reserves.
The general ledger is a document which underlies the financial statements and summarizes all of the activity by account. For instance, if three different checks during the month were written for repairs, even though the checks were not in sequential order, they would be grouped into the repairs expense account and the total of those three checks would represent the current months total repair expense, which should agree to the income statement. This document can be used by the director to research questions such as "what is in utility or repair expense this month", and "why is it so high compared to prior months or prior years"? The general ledger should provide sufficient detail for you to find the answer to that question.
The cash disbursements journal is simply a listing of checks in numerical order for the current month, noting the date, payee and amount. The other reports are self-explanatory.
The procedures that the director might employ in analyzing these documents should consist of:
- Examine the balance sheet and compare it against prior periods to see that cash balances and assessments receivable balances appear reasonable. Note if there are any significant fluctuations between restricted reserves in the current period versus prior periods.
- Examine the bank reconciliations and see that they agree to the amounts reflected as cash on the balance sheet. Investigate any differences.
- Examine the aged accounts receivable listing and compare it to the balance sheet. The total of assessments receivable should agree to the balance sheet.
- Review the income statement comparison of budgeted to actual activity both for the current month and the year-to-date, and question any significant variations.
- For any questioned income or expense items, trace the account to the general ledger and review the detail for that account.
- Compare the bank statements to the bank reconciliations. The bank reconciliation should begin with cash per bank and reconcile down to cash per financial statements and general ledger. The reconciling items will generally consist of deposits in transit and outstanding checks. Investigate and question any large or old outstanding checks.
- Review the bank statements to ascertain that all interest income has been recorded in the financial statements.
- Make sure that all bank accounts are recorded in the general ledger of the Association.
- Review the cash disbursements journal for the month and challenge the propriety of all expenses. For instance, if any checks are written to any director of the Association, find out why. If the management company is being paid more than their contractual fee, find out why.
- Review the aged accounts receivable listing and question any assessments receivable that are more than thirty days old. The association should adopt a strict collection policy that would consist of assessment of late charges, warning letters, filing of a lien and ultimately foreclosing on member property for non-payment of assessments. There can be no exceptions to these rules, especially for directors of the Association.
It will take some time for the director to perform all of the above procedures, but it will provide you with insight as to the financial transactions of the Association, and a greater understanding of how your Association operates. While this may seem like too much work to be done on a monthly basis, you, as a director, have a fiduciary responsibility to the members of the Association to safeguard the assets of the Association. Only through diligence and a step by step procedural review of transactions can this be done.