Accounting for Homeowners' Associations (#353)
/In a homeowners’ association, the residents all own their own homes, while the HOA owns all the common property. Anyone who buys property within the area controlled by the HOA has to pay dues – which is about all that most people know about HOAs. But there’s quite a bit more.
The Reserve Study
Everything starts with something called a reserve study. This is a study by a third party that inventories all the common property, assesses its condition, estimates its remaining useful life, and then estimates its replacement cost. This report is used to derive the amount that should be in an asset replacement fund, which is used to pay for all of those asset replacements over time. And the recommended size of this fund is what drives part of the assessment that the HOA sends to all of its members. So, if you’re ever wondering why your HOA fees are so high, request a copy of the reserve study.
Operating Expenses
But the reserve study is not the only reason for your HOA fees. The rest of the fee comes from ongoing operating expenses, and that varies by HOA. If your HOA doesn’t provide much in the way of services, then the fee is pretty low. But if that’s not the case, then ongoing operations could add up to a lot of expenses.
Accounting for Assessments
So, the reserve study and ongoing operations are the inputs to your HOA assessment. What’s the accounting like for that? Well. A lot of HOAs bill their members early, so they can get paid as quickly as possible. The trouble is that these bills might be issued a month before the period to which they apply, so any early payments by members have to be recorded as a deferred revenue liability. And then, when the HOA actually enters the correct billing period, the liability is eliminated and the payments are recorded as revenue instead. Sort of.
Actually, the portion of the assessment that relates to current operations is recognized as revenue right away, while the portion that relates to the reserve fund is parked in that fund until it’s actually spent. When the cash is spent, then it’s recognized as revenue.
Another interesting HOA assessment item is that the developer might initially be assessed some of these fees. This is because when a development is still being built out, the amount of assessments collected won’t be enough to pay for all of the HOA expenses, so the developer commits to pay an assessment on the unfinished lots until enough of them have been sold to cover the HOA’s expenses.
Accounting for Late Fee Income
Some of an HOA’s revenues also come from late fees. Sometimes, members might pay assessments really late, which can pile up the fees. This is a particular problem for HOAs, because they have no control over their credit risk. Think about it – an HOA has to collect assessments from anyone who owns property inside of the area that it controls; the HOA has no control at all over who buys this property. So if someone in financial trouble is also a member, then the HOA is going to be spending a lot of time collecting its assessments. And piling up late fees. If it can collect any money at all.
Accounting for Insurance Settlements
Another revenue item is insurance settlements. If an HOA’s assets are damaged in a natural disaster – like the HOA office being flooded – then there’s going to be an insurance settlement. This is classic contingency accounting, where you can’t recognize a recovery claim until the claim receipt is probable and the amount can be reasonably estimated. If the claim is still being litigated, then you can’t recognize anything. And here’s an extra twist; if the payment can be recognized, and the HOA has not capitalized the related assets, then the settlement is recognized as revenue. But, if the HOA had capitalized the related assets, then it has to recognize a gain or a loss on the transaction – probably a loss. If that’s the case, the loss is calculated as the difference between the carrying amount of asset and the settlement received.
Accounting for Utility Pass-Throughs
Here's another sort of revenue-ish item – utility pass-throughs. A utility might install a single master meter to track usage, rather than installing individual metering for each unit. In that case, the HOA pays the bill, and then turns around and bills the members for their usage. This usage might be a simple allocation, such as for Internet usage, or it might require individual metering for each unit by the HOA, such as for electricity.
An HOA might record these pass-through amounts as revenue, and then record offsetting member payments in an expense account. Or, it can net the revenues and expenses together, which should result in a pretty small net amount that’s made up of unpaid billings to members.
Accounting for Cable Television Marketing Fees
Here’s another revenue item. A cable television provider might pay an HOA an up-front fee to get exclusive access to its residents. This fee is paid in advance, usually for a multi-year period. When that’s the case, the HOA has to spread out the revenue recognition over the term of the agreement, which could easily be for five years.
Accounting for Developer Contributions
There’s one unique fixed asset area that you’ll only find in an HOA. When a development is completed, the developer will probably transfer some common area assets over to the HOA. This might be things like roads, swimming pools, fences, and drainage systems. When the HOA receives these assets, it records them at their fair value as of the acquisition date. It can be difficult to derive fair value, so an HOA could at least take the developer’s costs into consideration when it’s compiling fair values.
Accounting for Asset Retirement Obligations
Here's another HOA item. It might actually have to record an asset retirement obligation. This is pretty rare for most businesses, but it’s a possibility for an HOA, especially if it has fuel tanks somewhere on the premises that will have to be removed someday. And if that seems unlikely, consider that an HOA might run a golf course for its members, and that golf course might have a buried fuel tank for its maintenance vehicles.
Interfund Accounting
Another accounting area is interfund accounting. An HOA might record its operating activities in one fund, and its capital replacement activities in another fund. There might be a lot more funds than just those two, since you might want a separate fund if the HOA is also running a golf course, or another one for settlement proceeds, if the HOA is involved in insurance payouts and lawsuit settlements. Sometimes, it might pay from one fund for an expenditure that related to a different fund. When this happens, you create a receivable for the paying fund and a payable for the other one. So, the interfund accounting can get pretty tangled.