Keeping Your Finances in Shape

There are basically three kinds of audits that can be performed by an auditor at a cooperative or condominium: the annual audits, completed within four months of the end of each fiscal year; a compilation report, which is not an audit but only an attempt by the auditor to take the information that he receives and put it in a report without checking the veracity of the information; and a forensic audit, which is used when the board believes that a more complex audit is required to determine whether fraud has been committed. It is essential that the co-op or condo receive an actual audit and not a compilation report. If there is indication of fraud, the board must also have a forensic audit.

This month, we will discuss the procedures for the annual audit. The purpose of an audit is to enable the auditor to obtain sufficient knowledge of the environment to understand the attitudes, awareness, and actions of the board concerning the internal controls of the co-op or condo. This requires the auditor to personally visit the management office.

To assess the strengths and weaknesses of the co-op or condo, the auditor might consider the the role and qualifications of the board and the managing agent; the role of staff; the frequency of board meetings; the extent of the board’s involvement in building operations; the organizational structure of the co-op or condo (as defined by its governing documents); management’s attention to security risks; external influences (including regulatory and other reporting requirements); and the existence, limits, and conditions of fidelity insurance and catastrophic insurance.

The auditor must identify and understand who is responsible for the accounting system, the maintenance of proper records, and the internal controls over the financial reporting.

In reviewing the books, the auditor also considers the policies that ensure proper authorization of transactions and activities; the independent controls over the bidding process for significant contracts; the policy for comparing actual results with budgeted amounts and investigating significant variances; documentation of significant transactions; minutes from board meetings; the use of a managing agent and staff; billing and collection procedures; purchasing procedures, such as the use of competitive bidding; payment procedures, such as a requirement for board approval before invoices are paid; existence of a conflict-of-interest or ethics policies for staff and board members; and the professional designations of the staff, including training and continuing education.

The auditor should also consider the extent to which the board monitors and controls the managing agent’s activities; the use of cash funds; the manner in which the managing agent is compensated, such as the use of a fixed fee or other method; the extent, if any, to which the managing agent commingles operating funds and/or reserve funds with other properties’ funds; whether the board maintains separate records for transactions initiated by the managing agent; whether the board controls funds separately from funds controlled by the managing agent; the frequency of managing agent reports and the board’s policy for reviewing them; the control program used by the agent; existence of a conflict-of-interest or ethics policies for the managing agent; professional designations of the agent; and training and the continuing education of the manager and his staff.

The Rep Letter

Before the accountant completes the review of financial records, the board and the managing agent will be asked to sign a letter acknowledging that they, not the accountant, have primary responsibility for the financial statements and that, to the best of the board’s and management company’s knowledge, the statements are correct.

This “representation letter,” called the “rep letter,” does not change or add to the fundamental responsibilities of the board or the management company, nor does it relieve the accountant of any of his responsibilities. It simply clarifies the traditional roles that the accountant performs. The American Institute of Certified Public Accountants (AICPA) requires that accountants obtain a rep letter from their review clients, which makes this letter a mandatory part of the audit process.

The accountant must comply with rigorous standards that govern the process and procedures of a review. The AICPA has deemed that the “management” of co-op or condo associations includes offsite management companies, on-site management personnel, and the board, so the accountant needs the rep letter to support management’s statements. The manager and the board have access to the most detailed information about the entity and have daily, first-hand exposure to transactions and other events reported in the financial statements.

A rep letter documents the information relating to the manager’s and board’s knowledge of the entity and its intentions. The letter complements other procedures the accountant performs to review the financial statements. Since the manager has primary responsibility for receipts and expenditures, the management company’s completion is of particular relevance to the auditor, the board, the owners, and anyone else reviewing the financial statements.

The rep letter also has several benefits for the board and management. It prevents misunderstandings and provides a checklist for important matters that affect the financial statements. During the review, the agent responds to many of the accountant’s questions. The rep letter contains these answers, but the representations made in a rep letter do not displace other essential review procedures. As part of a review of financial statements, the accountant is required to obtain a written representation from management to confirm the oral representations that are made to the accountant. Without the rep letter, the CPA is left to wonder if management has withheld information, which might raise doubts about the reliability of management’s oral responses to the accountant’s inquiries.

The opening paragraph of the rep letter usually states that “we confirm, to the best of our knowledge and belief, the following representations made to you during your audit.” So the letter seeks to ascertain only what the manager knows. In reviewing the property’s financial records, the accountant is seeking information relating to: the extent to which the board monitors and controls the managing agent’s activities; the use of the co-op’s or condo’s funds; the manner in which the managing agent is compensated; whether the co-op or condo maintains separate records for transactions initiated by the managing agent; whether the co-op or condo controls funds separately from funds controlled by the agent; the policy for board review of managing agent reports; the frequency of managing agent reports; the existence of conflict-of-interest or ethics policies for the managing agent; professional designations of the managing agent; and the training and continuing education of the agent and his or her staff.

Generally, the purpose of the rep letter is to reassure the accountant that the audit is complete and accurate. The members of boards are usually too busy with their private lives and jobs to monitor every action taken on their behalf by the manager. Since the members of the board have a fiduciary duty to shareholders and unit-owners, the board has to rely on its professional advisors – particularly the management company – to act on its behalf.