Does Your HOA’s Budget Include a Line Item for “Bad Debt?” ….. It Should

Assessment income is the lifeline for homeowners associations. Without owners paying assessments to the association, the association has insufficient income to pay its expenses. Despite the importance of the association collecting assessments from every owner, in the real world there are things that happen in the lives of homeowners that interfere with their ability to pay their homeowners association’s assessments. Since association’s budgets are based on expected revenue and expenses, the impact of not receiving anticipated assessments frequently depends on whether or not the association had included “bad debts” as a line item in the association’s budget.

When assessment income is included in an association’s annual budget, it assumes that all of the units within the association will pay their assessments in full. If some of the owners do not pay their assessments as anticipated, the association does not collect all of the income that was needed to pay the expenses that were budgeted. The amount of this shortfall is dependent on the number of units that do not pay their assessments and the number of months that they go without paying. As the uncollected amounts grow, the amount of the funds that is available for payment of association expenses decreases. This shortfall is then compounded by additional unforeseen ( and thus, unbudgeted) expenses for costs that are incurred for actions that are taken to try to collect the assessments that are not being paid by the owners such as attorney fees, court costs, and costs associated with lien enforcement procedures.

Associations that experience a shortfall in the income that was budgeted are forced to make decisions about how to absorb that shortfall. Considerations include: (i) fall behind in the payment of other expenses; (ii) withhold deposits into the reserve account; (iii) borrow money from the reserve account, thereby decreasing the available reserves; (iv) hold off on scheduled maintenance of common area; (v) increase the amount of the monthly assessments; and (vi) impose a special assessment. Each of these options present different ramifications that create issues for the association’s directors and owners concerning the operations of the association. Frequently, these issues become compounded by shortsighted and misguided decisions that are made about how to deal with the shortfall in funds that are required for the proper operations of the association.

Associations that do not budget for bad debts are not being realistic as there are always going to be some owners that are not paying their assessments for one reason or another. Every dollar that is not collected from owners is one less dollar that is available to pay known expenses. It is inevitable that over time, this shortfall is going to create financial burdens on the association. To minimize the problems that are associated with uncollectable assessments, an association’s budgeted assessment income needs to be reduced by the amount that is potentially uncollectable. This is accomplished by including a line item on the association’s budget for “Bad Debt” expense. While including bad debt as a budgeted line item has the effect of increasing the assessments paid by owners, it enables the association to pay its operating expenses in the most efficient manner without having to consider the various alternatives described above that tend to have more negative ramifications.

The amount that an association should include in its budget for bad debt varies from association to association and fluctuates with changing economic conditions. Past history of annual totals for assessments that were not collected and the additional associated expenses for collection efforts should be considered and will provide a basis for determining the appropriate amount to budget for bad debt. After the budgeted amount has been established, associations should book their actual bad debt expense on a monthly basis to confirm that the budgeted amount is an accurate amount for the projected annual bad debt expense. As delinquent amounts are collected from homeowners, adjustments can be made to develop a more accurate projection of future projected bad debt.

An association’s board is vested with the responsibility for properly managing the association’s finances. By budgeting for and recording actual bad debt expense throughout the year, associations will develop more realistic budgets and financial statements. This will increase the likelihood of the association collecting the amounts that are required to pay the association’s expenses on an annual basis and avoid being forced into a position that will necessitate making more unpleasant decisions about how to deal with a shortfall in the income that is necessary in order to properly operate the association.