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Audit, Review and Compilation Comparison and Taxes

November 27, 2018 2:28 PM | Talia Lionetti (Administrator)

By: Brad Schneider of Condo CPA

INTRODUCTION

Most homeowners and managers understand that Certified Public Accountants (CPAs) can perform audit services and issue an audit report on a community association’s financial statements. However, some may not be familiar with the alternatives to an audit. CPAs can provide other levels of services such as a Review, Compilation or an Agreed upon procedures engagement. The purpose of these engagements is to add credibility to and enhance the reliability of the Association’s financial statements. All audit and review engagements must be performed by an independent CPA. A compilation can be performed by a CPA that is not independent from the association but must state that fact in the accountant’s report included with the financial statements.

COMPILATION ENGAGEMENT

The compilation, which is the lowest level of service that a CPA can provide for a client’s financial statements, requires substantially less time than a review or audit engagement because fewer procedures are required. Various states allow a CPA to perform a compilation without having a Peer Review for their firm. Unfortunately there is a wide variance in the quality of the financial statements and accountant’s work papers for compilation engagements since firms that have not followed the Peer Review quality standards generally have not developed a system of quality similar to those firms that follow the standards included in the Peer Review membership program of the American Institute of Certified Public Accountants (AICPA).

Compilation standards do not require the accountant to perform any procedures to verify or corroborate the financial statement information provided by the Association’s management. However, the accountant must address significant questions that arise in the course of the compilation engagement. If the accountant has reason to believe the information supplied by the Association’s management is inaccurate, incomplete or otherwise unsatisfactory, the accountant is required to obtain revised or corrected information before reporting on the financial statements. The AICPA compilation standards require the accountant to possess an adequate level of knowledge about the accounting principles and practices of the Community Association industry and have a general knowledge about the nature of the Association’s business. The accountant is required to read the compiled financial statements and consider whether they are in appropriate form and free from obvious material errors. Because of the limited scope of compilation procedures, the standard Compilation report disclaims any degree of assurance on the financial statements. The report also states that the accountant has “not audited or reviewed the financial statements and accordingly, does not express an opinion or provide any assurance about whether the financial statements are in accordance with the applicable reporting framework.”

At a minimum, a compilation engagement with the accompanying accountant’s report is required anytime an external CPA is associated with the financial statements of the Association.

REVIEW ENGAGEMENT

A review engagement requires the limited procedures included in a compilation engagement as well as other procedures that enable the accountant to provide limited assurance on the financial statements. These additional requirements are inquiries of the association’s management and analytical procedures. Inquiries are typically directed to knowledgeable persons having responsibility for financial and accounting matters. Please note the questions are being asked of the client’s management and accountants without outside verification. Accountants exercise their professional judgment to determine the extent of inquiries that are needed. Although specific inquiries are tailored for each Association, the inquiries should, at a minimum, relate to: the accounting practices and principles used by the organization; the procedures for recording and accumulating financial information; and the actions taken at meetings of the Board.

Analytical procedures include:

  • Comparison of current year financial statements with the budget and prior year’s statements
  • Study of the financial statements to identify items or relationships between items that do not conform to expectations based on earlier reports or budget or other information
  • Review and consideration of adjustments made to the financial statements of prior years.

The purpose of analytical procedures is to identify account balances or relationships that appear unusual so that additional inquiries or review of financial data can be made to determine the cause of the unexpected results. Based on these inquiries adjustments to the financial statements may be necessary.

Because of the inquiry and analytical procedures included in a review engagement accountants are able to express limited assurance on the Association’s financial statements. Remember in the compilation report the accountant disclaims any assurance on the association’s financial statements. The standard Accountant’s Review Report states that a review is substantially less in scope than an audit, the objective of which is the expression of an opinion regarding the financial statements as a whole and that, accordingly, the accountant does not express such an opinion. However, a review report does state that “we are not aware of any materials modifications that should be made to the financial statements.”

AUDIT ENGAGEMENT

An audit engagement provides the highest level of assurance on the Association’s financial statements, because many important audit procedures are performed. Some of the more important auditing procedures are:

  • Consideration and evaluation of the internal control system of the Association, which may include testing the effectiveness of the system
  • Tests of the underlying documentation to support the account balances
  • Outside confirmation of bank and investment accounts, loans, insurance coverage and legal status.

In addition, the auditor is specifically  required to obtain reasonable assurance that the financial statements are not materially misstated due to fraud. In a compilation or review engagement the accountant is not required to document any assessment of fraud risk, nor are they required to consider fraud or search for fraud in the course of the engagement. However, in a compilation or review the accountant is required to report any significant deficiencies in internal control or fraud that comes to their attention. The possibility of this happening is less likely in a review and even less in a compilation since the procedures are less comprehensive in these levels of service. The audit report reflects a higher level of assurance based on the more extensive procedures performed. The standard audit report states, “In our opinion, the financial statements referred to above prevent fairly, in all materials respects, the financial position of your association as of December 31, 20xx and the results of its operations and cash flows for the year then ended in conformity with accounting principles generally accepted in the U.S.

AGREED UPON PROCEDURES

ENGAGEMENTS

When special circumstances are present it is often more beneficial to have an Agreed Upon Procedures engagement performed. This type of engagement is often performed when there is either a suspected fraud or a specific issues(s) that the association is trying to address. It is a way to efficiently assist in obtaining evidence and minimize cost by focusing only on those areas of concern to the board. For example, perhaps the association wants to address a garage employee that was suspected of theft, or reconcile special assessment billing. In these cases the procedures to be performed would be designed to test the areas of concern in order to gather any relevant evidence.

TAXES

For calendar year-end Associations, (December 31st), the corporate tax returns will be due on March 15th. The Illinois tax returns are due on the same day. The IRS allows you to extend the filing of the tax return to September 15th and Illinois allows the extension to October 15th of 2019. The extension does NOT grant you any additional time to pay the taxes. Fortunately with the low interest rates offered on investments it is more the rarity that an Association owes taxes. Most condominiums, townhomes and homeowner associations can decide which federal form to file each year, the regular corporate tax return, (1120) or the homeowners association tax return, (1120-H). If they are a cooperative they should be filing the 1120-C. The decision to file the 1120 versus the 1120-H is based on a number of factors. If they owe tax the 1120 begins at the 15% rate versus the 1120-H which has a flat rate of 30%. Since most Associations do not pay income taxes, we usually recommend the filing of the 1120- H. It is much safer to file this form with the IRS. Filing the 1120 has numerous issues to deal with that upon IRS audit can trigger the assessment of a large amount of tax. One Association in the Southwest was told that they had painting and other non-capital items going through the reserve fund and that the entire reserve was to be considered taxable. The IRS has attacked the Reserve accumulation in a variety of ways for various Associations across the US. The bottom line is that generally speaking the 1120-H is a better form to file if there is no tax due.

CONCLUSION

There are various levels of service that may fit the needs of the various associations. Each association is unique and may have substantially different expectations of what they are trying to accomplish with the CPA firm they select. There are even different levels of CPAs and CPA firms: those that are Peer Reviewed and those that choose not to be Peer Reviewed. Some CPA firms specialize in Community Associations because they love them while others see Community Associations only as a means to supplement their revenue. Whatever your Association’s circumstances, we hope you choose a CPA that is best suited for you based on your specific needs and level of service that you deem appropriate.

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