What are the different methods used for accounting?

What are the different methods used for accounting?

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There are three main methods of accounting that HOA management companies use. These are GAAP accounting (accrual accounting), cash-based accounting and modified accounting. As an HOA board member, it is important to have an understanding of the three methods that are used, their effects on financial reporting and the advantages/disadvantages of each method to your HOA.

GAAP Accounting

GAAP is short for Generally Accepted Accounting Principles. This method of accounting is also referred to as the accrual basis of accounting. In this method, revenues are recorded when earned, and expenses are recorded when incurred (regardless of the time when the payments are actually made). The advantage of this accounting method is that it gives an accurate picture of the state of the HOA and all its transactions at any given time. This is because transactions are recorded at the time they occur and therefore the books are always up to date.

How Transactions are recorded under the Accrual Basis

As previously mentioned, the accrual basis operates by the principle of recording revenues when earned and expenses when incurred (not when the cash is actually received). If the HOA, for example, sells one of its assets today, the transaction is immediately recorded in two accounts; one called the assets account (the assets account is credited because that particular asset has been sold) and the accounts receivables is debited (this is the account that records transactions for which payment is expected at a later date). In most cases, payment is not made immediately as in a regular cash transaction, therefore, the need for recording payments that are owed to the HOA. Once payment is made for the asset, the accounts receivable is credited (to reduce its balance because the debt has now been cleared) and the cash account is debited (to increase the balance because the cash has been received).

In the case of monthly dues owed by members, the accounts receivable is debited (balance increased) for members that are yet to pay their monthly dues, and it is credited (balance reduced) for members that have paid their dues in advance. The cash account is then debited/credited appropriately as payments are received.

This method is allowed by the Davis-Stirling Act.

Cash-based HOA Accounting

The cash basis of accounting records income and expenses when the cash is received, as opposed to when the transaction is made. The cash basis does not involve the use of accounts receivables. The cash account is simply debited when the cash is received (for example from member dues), and it is credited when cash is reduced (for example when paying expenses).

The disadvantage of this method is that it can be difficult to keep track of all the transactions for which payment is pending to the HOA or to which the HOA owes money. It is also not possible to compare the values of these transactions to the final balance sheet prepared at the end of the period in order to verify accuracy.

This method is NOT allowed by the Davis-Stirling Act.

Modified Accounting

The modified accounting basis (also referred to as modified accrual basis) is a combination of the cash and accrual basis of accounting. In this method, revenues are recorded when earned (just like accrual) but expenses are recorded when paid, rather than when incurred (just like cash basis).

This reporting method has the effect of having your accounts receivables accurate and up to date at all times while having your unpaid expenses pending to be recorded (therefore not present on the balance sheet) until the payments are made.

A modified accounting method is deemed appropriate for preparing interim financial reports for the HOA as you wait to make all payments for expenses that the HOA has incurred. Many HOA finds it easier to record revenues when earned but to wait to record their expenses until they have made the payment.

In conclusion, the accrual basis of accounting is the only method accepted under the Generally Accepted Accounting Principles (GAAP). This is because transactions are always recorded as soon as they occur, and all stakeholders of the HOA can look at the financial documents to get a clear picture of the status of the HOA at any given time.

This method is allowed by the Davis-Stirling Act.

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