When does an HOA need a forensic audit?

Homeowner associations (HOA) and condominium associations (CA) are legal entities set up to manage the operations and finances on behalf of the owners. Typically, the management team (administrator) selected to run the HOA or CA is comprised of other homeowners or condo owners. If a lot of thought was put into the selection criteria, then the administrators will be knowledgeable individuals with experience in management and/or finance. If not, the administrator can end up being someone who can barely balance their own checkbook, let alone manage the books and records of a $5,000 annual budget or a $1,000,000 annual budget.

Depending on the bylaws of the HOA or CA, a forensic audit of the financial books and records may be required annually or never. However, a financial audit is not designed to detect fraud. At a minimum, homeowners should be presented with annual financial reporting, but monthly is preferred. The Educational Community for HOA Homeowners states that 18 months is the average time before a fraud scheme is detected.

Given today’s unlimited resources in accounting software, monthly reporting is not cumbersome and provides more relevant feedback on the management of HOA resources.

So, when does an HOA need a forensic audit?

1. When you suspect fraud

While a financial statement audit ensures that all the transactions are accounted for, it does not ensure that someone hasn’t stolen or misappropriated funds.  This is the number one reason for a forensic audit. If fraud is suspected, if becomes imperative to contact legal counsel and begin a fraud investigation right away. The longer the homeowners wait, the more funds that can be absconded and the more difficult it will become to recover them if fraud is found.

2. When there is no requirement for annual financial audits

The risk of fraud increases when no one is providing oversight to the administrators and their handling of the funds entrusted to them. Even simple forensic accounting such as verifying vendors could be beneficial.  Investigating whether payments are being provided to contractors and vendors that do actually exist and the payments are as agreed upon in written contracts or purchase orders, can mitigate vendor fraud. 

3. When requested reporting to the homeowners is untimely and confusing

Most small HOA’s provide annual reporting of last year’s results of operations, last year’s budget comparison, and a proposed budget for the upcoming year. If your homeowners are only seeing collections and spending once a year, a lot of fraud can be buried in those reports. At a minimum, homeowners should demand quarterly or monthly financial reporting on collections and budget versus actual spending. When the reports received by the homeowners bring up a lot of questions or just don’t make sense, it is the responsibility of the administrator to clarify.  If the reporting is not quarterly or monthly and the responses from the administrator don’t make sense, a forensic audit is a consideration.  Forensic audits for HOAs can be tailored to ensure bank reconciliations have been performed, reserve funds exist, and overbudget items are all valid and properly authorized transactions.

4. When the administrators are not maintaining the property as budgeted

Another sign of fraud is when the property appears to be deteriorating, despite low outstanding collections of homeowner dues. The funds contributed by the homeowners seem to be falling short of the funds need to maintain the property or constant increases in dues that increase at a greater rate than normal homeowner costs. This could be a sign of misappropriation of HOA funds or kickbacks from contractors, and a sign a financial audit is needed.

5. When the administrators appear to be living beyond their means

While no one wants to judge someone else’s lifestyle, homeowner associations and condo associations are often close-knit organizations.  There is often a lot of gossip and private information that gets passed about. Not all gossip is untrue. When the administrators appear to be buying a lot of big-ticket items, going on a lot of vacations, all without a change in job status or lottery winnings, it could be a sign of living beyond one’s means. This in itself does not mean they are committing fraud, but if the management of the HOA is seriously lacking, administrators are unresponsive to inquiries and dues are increasing, it does not hurt to have a financial audit.

Remember that a well-run HOA or CA also affects your property value positively and is an investment for the owners. A forensic audit of the HOA or CA finances can only serve to help preserve property values and demonstrate good stewardship of owner’s investments.