Should Reserve Expenses be Approved in the Minutes?

Question- During our annual audit, our accountant requested that all reserve expenses be approved in the board meeting minutes. Why? Is this required? This seems like a lot of work and we have a reserve study which has our reserve components listed. Can you explain this recommendation?

Answer- An accountant is charged with the duty of ensuring that the financial statements are properly stated. The auditor also has a responsibility to plan and perform the audit to obtain reasonable assurance that the financial statements are free of material misstatement, whether caused by error or fraud. This requires the auditor to use judgment in determining the procedures they will use.

Each auditor will have different ideas as to what procedures are necessary to fulfill these requirements. There is little guidance in the CPA industry with regards to homeowner association audits. The American Institute of CPAs does publish periodic “Audit Risk Alerts” and this question was addressed in the 2000/01 edition as follows:

“What might you (the CPA) consider when reviewing the minutes of your CIRA client?”
Replacement fund transactions. Minutes highlight replacement fund transactions, including replacement expenditures and other additions or subtractions to or from the fund. In addition, minutes reveal the approval of any replacement fund expenditures, accompanied by specific details related to the expenditure.

On a related subject of internal control, the 1999/2000 edition stated the following:
“…more than one board member should review and indicate approvals of requests for all major work to be performed by contractors to help eliminate the opportunity for noncompetitive bidding.”

So is it REQUIRED to be in the minutes, from an auditor’s standpoint? No. It depends on what the individual accountant feels enhances their ability to determine the correctness of the financial statements and reduces the chance of fraud.

I have four additional reasons why I strongly advise that all reserve expenditures be approved in the board meeting minutes.

1. Washington law makes the point in various sections that reserve monies are “sacred”. Such items as requiring two board signers, requiring disclosure of reserve components, requiring payback of reserve monies in a timely manner, and defining reserve monies emphasize the point that reserve monies are to be used as intended and not for operating type of expenditures. Because Washington law specifically places the responsibility for reserve monies on the board of directors, I feel that the board needs to document their approval of use of monies out of the reserve (replacement) fund.
2. Reserve expenses are still not clearly defined. There is much judgment involved to determine when it is a reserve expense rather than an operating expense. What one board feels is a roof repair extending the life of the roof (thus, being a reserve expense) may be an operating expense in another Association. Of course, the board should go to the reserve study to determine the definition of the component to assist in their decision. Also, we have found that a board may choose to pay for a reserve expense out of operating when there are excess operating monies.
3. Reserve studies are still an art and a science (as noted by Robert Nordlund, R.S. of Association Reserves). As such, estimates are set up as to replacement cost and remaining useful lives. Thus, even if the board agrees that the expense should come from reserves and the component is in the reserve study, it is neither seldom at that exact amount nor on the exact date/year of projected replacement. If the expense is dramatically more than projected or significantly sooner than planned, this could impact the viability of the reserve fund in the future. Thus, the auditor cannot look to the reserve study to determine if the expense is correct as the amount and the replacement date will differ. Only the board can make that determination.
4. Approval in the minutes provides an audit trail as to the amount to be expended. There have been cases of error (and even fraud) where the board approved one amount and a larger amount was paid by the Association. Because this is a “non-standard” type of expense, it cannot be compared with past history or other analytical means. And, as noted in #3 above, the reserve study will not show the exact replacement amount either.

So to answer your questions~

Is it a requirement of an audit to record approval of reserve expenses in the minutes? No. Do I feel that it is a good thing to include board approval of reserve expenses in the meeting minutes? Yes. Does it take more time? Yes. Remember that the board of directors is responsible for running the Association in a fiscally prudent manner and their decisions may be questioned at a later date. Minutes are an important corporate record. Talk with the Association’s attorney if there are additional questions regarding minutes as a corporate record.