A new board gets one clean moment to establish what it was handed. That moment is the turnover, and the instrument is a transition audit: an independent look at the association's finances covering the developer's years of control.
Boards skip it because it costs money the budget didn't plan for, and because nobody on a volunteer board wants their first act to be hiring an accountant. Then a shortfall turns up in year three and there's no way to tell whether it started before or after the handover.
If the handover itself is still ahead of you, what changes hands at developer turnover sets out the delivery obligations first.
What the audit is looking at
Most associations are nonprofit corporations, and their books follow nonprofit conventions. AccountingTools' guide to nonprofit accounting describes the framework: fund accounting, which tracks resources by purpose and restriction, with accounts kept on the accrual basis under GAAP.
The same page names the four statements a nonprofit presents. The statement of financial position stands in for a balance sheet and reports assets, liabilities and net assets at a point in time. The statement of activities replaces the income statement and reports revenues, expenses and the change in net assets over a period. The statement of cash flows covers operating, investing and financing movements. The statement of functional expenses breaks spending down by both natural categories such as salaries and rent and by function.
For a community association that translates into a short list of questions. What did the association receive, what did it spend, what does it hold now, and are the amounts set aside for future repairs really set aside?
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What an audit adds that a review does not
AccountingTools puts the case for an annual financial statement audit in terms that map onto a turnover. An audit provides independent assurance that the statements are fairly presented under the applicable framework, which for a US association is GAAP. It gives the board objective insight into financial condition, internal controls and compliance. And the process itself surfaces control deficiencies, accounting errors and operational risks that management hasn't detected.
A new board is looking for the things nobody noticed, in a set of books kept by people who have now left.
The same guide lists the controls a nonprofit is expected to run, and they double as a checklist for what the association should have in place going forward: segregation of duties between authorization, custody and recordkeeping; board approval of budgets and periodic review of the statements; dual signatures or approval thresholds for disbursements; and independent bank reconciliations performed monthly.
Several state acts require a developer to deliver an audit of the association's funds at turnover, prepared by an independent CPA and paid for by the developer rather than the association. Check yours before you commission your own, because you may already be owed one.
The red flags
Reserves that were never really funded. Association Reserves' reserve study guide explains percent funded as the ratio of the reserve fund balance to the fully funded balance, and gives the bands: 70 percent to 130 percent funded is a strong reserve fund, below 70 percent qualifies as underfunded, and 0 percent to 30 percent is weak. The guide is direct about the consequence, which is that underfunded reserves are what drive boards to special assessments.
A developer-era budget often carries a reserve line that was set when the community had a fraction of its eventual roofs, fences and pavement. A current reserve study is the way to find out where the association sits, and how much an HOA reserve fund should hold covers how boards read the answer.
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Unpaid declarant assessments. Developers owe assessments on the lots they still own, unless the declaration says otherwise in terms your attorney has read. Some declarations substitute a subsidy arrangement, where the developer covers the operating deficit rather than paying per-lot assessments. Know which one applied, whether it was honored, and what the budget looks like the month it stops.
A budget built for a smaller community. Landscaping acreage, insurance limits, utility costs and management fees all scale with build-out. A budget that hasn't been rebuilt since half the homes existed will leave the association short.
Receivables with no story. Old balances nobody can explain, credits applied without documentation, owner accounts that don't tie to the ledger.
Capitalized items with no paperwork. Common-area assets the association now owns and maintains, with no invoice, no warranty and no as-built drawing behind them.
Doing it in the right order
Commission the audit before the board makes structural decisions. Fix the opening position in writing, because every month that passes mixes the developer's numbers with the new board's.
Then keep the result somewhere other than one director's email. If your board is weighing whether the exercise is worth it at all, when an HOA needs an audit walks through the thresholds.
Related Reading
- HOA Developer Turnover: How Your Community Changes Hands
- What Is a Declarant in an HOA? Meaning, Rights, and Control
- HOA Audits: When Your Board Needs One and What to Expect
- HOA Reserve Fund: How Much Is Enough for Your Board?
Ask your board one question at the next meeting: what was the reserve balance on the day we took over?
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