Years ago I was managing a 500+ unit condo association in California that was approximately 25 years old and had almost nothing in reserves. When I took over the Association management, it was clear to me that assessments had been too low for too long. These were relatively low-end units and therefore attractive to what are commonly known as the entry and exit housing market: young families making their first home purchase and elderly individuals on fixed income. Therein lay the strong motivation to keep assessments as low as possible for as long as possible.
Understanding CPA Service Levels - Compilation, Review and Audit
Written by Gary PorterThe By-laws, CC&R's or other controlling documents of most community associations delineate the requirement for preparation of financial statements of the Association. In addition, several states have minimum financial statement requirements.
The first level of financial reporting is performed by the association or its management company as monthly “interim” (meaning not year-end) financial statements for the association. The purpose of these financial statements is to provide the board of directors and management with the necessary financial tools to evaluate financial performance, primarily budgetary performance. This is known as managerial accounting, and is completely separate from external financial reporting. Financial statements prepared for this purpose are generally considered to be for internal use only.
If a secondary level of financial reporting exists, it generally applies to the association’s year-end financial statements only, and is performed in addition to the financial statements prepared for internal use. This generally means that that an independent CPA will be associated with the year-end financial statements of the association. The purpose of these financial statements is not just for management use, but is for external financial reporting, to the members of the association and others. While some association governing documents contain wording vague in this area, and simply refer to distribution of “year-end financial statements,” others are quite specific in requiring financial statements “prepared by an independent CPA,” or even more specific in defining the level of financial statement services as either compilation, review, or audit. In some states there are regulatory requirements that may take precedence over the governing documents to require a compilation, review, or audit.
Certified Public Accountants (CPAs) are licensed by their respective State Board of Accountancy, and must abide by the rules and regulatory requirements of their respective state. In addition, the CPA must comply with the requirements of any other state’s Board of Accountancy in which they practice. As a general rule, a CPA may preform service for an association in any state, so long as services are not performed within that state. So, if a management company in Texas manages an association in California, and the financial services are performed by the CPA in Texas, that CPA needs to comply only with the Texas Board of Accountancy. If that same engagement required the Texas CPA to travel to California to complete the engagement, then the CPA must either be licensed in California or register to practice in California and agree to be bound by California Board of accountancy rules. Almost all states have “signed on” to the CPA Portablity Act, which allows CPAs to cross state lines to perform services, mostly by simply registering with the state in which they wish to perform services. Each state’s requirements are different in this regard, but relatively uniform.
In addition, the CPA must comply with AICPA (American Institute of Certified Public Accountants) professional standards on performance of services. It is AICPA that established the service levels of compilation, review, and audit, and has created the standards of performance for each of these levels of service.
The CPA must also comply with generally accepted accounting principles (GAAP), which are established by the Financial Accounting Standards Board (FASB). The FASB codification of accounting standards is a codification created in 2009 to assemble in a single location all standards for GAAP, and it combined what were previously a number of different sets of standards into a single set of standards. These standards have generally evolved through official pronouncements of various national bodies or through common industry usage.
Lastly, the CPA must comply with any state specific requirements related to the industry. As an example, the state of Nevada requires that year-end financial statements produced by the independent CPA must contain a budget to actual comparison of the operating and reserve funds. There is rarely any continuing conflict between the regulatory requirements of a state and generally accepted accounting principles.
Under generally accepted accounting principles today, CPA's may render three levels of service with respect to an association's financial statements. These levels are known as compilation, review or audit, and these services may only be performed by a licensed Certified Public Accountant.
A brief summary of each of these levels of service is described below.
COMPILATION - The CPA compiles information in the form of financial statements. Such information is specifically the representation of management of the association. The CPA takes little responsibility for these statements, is required to perform very few procedures, and gives no assurance as to compliance with generally accepted accounting principles (GAAP). The CPA is not required to be independent of the associations, but must disclose if he or she is not independent.
REVIEW - The CPA performs limited procedures, consisting primarily of inquiries and analytical procedures; and provides negative assurance to the Association that financial statements are properly prepared in accordance with (GAAP). This level of service requires familiarity with the industry by the CPA and that the CPA be independent with respect to the association.
AUDIT - The CPA performs an examination of the financial statements, and issues a positive statement as to their compliance with GAAP. Extensive procedures are performed. This level of service requires more extensive industry knowledge by the CPA, and that the CPA be independent with respect to the association.
The table below compares various aspects of these three levels of service for association financial statements.
|
Criteria |
Compilation |
Review |
Audit |
|
Level of Assurance as to GAAP |
No assurance |
Limited assurance |
Positive statement as fairly presented in presented in accordance with GAAP |
|
Knowledge of industry |
Knowledge of accounting principles applicable to the industry and under- standing of the client’s business |
Knowledge of accounting principles applicable to the industry and under- standing of the client’s business |
Knowledge of accounting principles applicable to the industry and under- standing of the client’s business |
|
Procedures required |
Assemble in the form of financial statements – no inquiry or other procedures required unless information provided by client is questionable |
Inquiry and analytical procedures required |
Inquiry and analytical procedures required, plus substantive tests of balances |
|
Independence requirement |
CPA not required to be Independent, but must disclose any lack of independence |
CPA required to be independent |
CPA required to be independent |
|
Cost of engagement |
Least |
More |
Most |
|
Service required? |
If required by association governing documents or state statutes |
If required by association governing documents or state statutes |
If required by association governing documents or state statutes |
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