Understanding Cooperative Financial Statements: Not for Professionals Only

Financial statements – the mere term often causes eyes to glaze over and minds wander. Let’s just leave that job to the professionals, right? Wrong! If you’re a board member of a cooperative, a basic understanding of financial statements is one of your important responsibilities. To govern your cooperative responsibly, you don’t need to have a certified public accountant (CPA)’s level of financial expertise. You don’t need to master the science of accounting. But you do need to have a rudimentary comprehension of the cooperative’s financial information – enough to feel comfortable with its basic financial statements, interpret them in a meaningful way and ask appropriate questions.

Here’s the dirty little secret: tacking this financial work doesn’t have to be an exercise in misery. In fact, it can be somewhat fun. My personal history reflects that. During my first experience living in a housing cooperative, in my much younger days, I was elected to the board of directors. I considered myself to be rather clueless (and looking back on that phase of my life years later, that was a pretty astute observation). I assumed that analyzing the financial information was best left to the masters of the craft, the professionals who could essentially speak a different language. The more I learned, however, the more I realized how false this assumption was.

It does take a lot of work to master the science of accounting. Years of study and experience are required to become an expert. However, the basic rules that govern accounting are not particularly complicated – in fact, the topic is founded on a few rather simple concepts.

One of the best starting points to the whole accounting world is to consider two of the most important financial statements: the balance sheet and the income statement.

The balance sheet represents a cooperative’s financial position at a particular point in time while an income statement reveals the cooperative’s financial performance over a given period over time. Much of the academic study of accounting – in fact, much of the study involved to become a CPA – delves into nuanced definitions of these items. The balance sheet manifests one of the simplest – and the most fundamental – rules of accounting: assets are equal to liabilities plus equity. That is, what you have (assets), can, by definition, be divided up into two components: what you owe (liabilities) and what you own (equity). So, what assets might a cooperative have? Assets are things of economic value that a cooperative possesses. All its cash accounts are one example. And its buildings unless it leases them and the underlying land are two more. And all the furniture it owns, its equipment. . .assets are good things. What about its liabilities? A liability is pretty much synonymous with an obligation. What obligations does a cooperative have? Its loans payable is usually the biggest, along with amounts it owes its vendors, which are commonly known as accounts payable. And the difference between these two – the assets (what it has) minus the liabilities (what is owes) – is the equity, what it owns, its net worth.

Obviously, any organization would prefer to have its equity be large and its liabilities be small. Relatively low amounts of debt give the cooperative more freedom and flexibility. Relatively high amounts of debt put the cooperative in a more precarious situation, and higher carrying charges need to be assessed to cover the required loan payments.

The other basic financial statement, the income statement (also known as the statement of profit and losses), is even more simple. Revenue, which is also known as income, represents transactions that increase in the financial wealth of the cooperative while expenses consist of transactions that decrease its financial wealth. The “bottom line” shows the revenue minus the expenses – the net income. When expenses exceed revenue, which a cooperative never likes to see, the result is a net loss.

The income statement is very much related to the cooperative’s annual operating budget. In fact, to a large extent, the budget is the cooperative’s financial target for the year, and the income statement shows how the cooperative has been performing against that benchmark. Directors should compare the income statement (actual) to the budget (target) each month or quarter.

These two basic financial statements are interrelated. Remember the equity section of the balance sheet? This increases in tandem with the cooperative’s net income (Of course, if the cooperative has a net loss, equity decreases by a similar amount). During the year, the equity section will show a component called “Net income (loss),” reflecting the cooperative’s financial performance to date. At the end of the year, the total net income (loss) is absorbed into a specific equity account called retained earnings, which is the sum total of the prior years’ net incomes and losses of the cooperative that have been “retained” in the organization. And simultaneously, revenue and expenses revert to zero at the start of the new year.

As previously noted, the format of the budget closely mirrors that of the income statement. And the income statement is crucial to creating next year’s budget: the upcoming budgetary expenses are derived, at least in part, from the cooperative’s actual current expenses, and the budgetary income needs to be high enough to cover those expenses, plus proper allocations to reserve accounts. The balance sheet is an important tool in developing the annual budget as well. What is the loans payable on which the cooperative is obligated to make payments? The liability section of the balance sheet provides such insights. How quickly does the cooperative need to build up its reserves to replace its current assets? The assets section of the balance sheet gives information about the exiting property and equipment as well as the current level of cash reserves.

While you’re digesting this information, let me throw out a final twist: there’s more than one way to record revenue and expenses. During the course of the year, most cooperative finance staff records revenue as cash is received and records expenses as cash is paid. This is known as the cash basis of accounting, and it aligns nicely with the cooperative’s annual budget. After the year is closed, management often works to transform the financials into the accrual basis of accounting, which recognizes revenue as it’s earned and expenses when they’re incurred. The accrual basis of accounting is required for financial statements to be presented in accordance with generally accepted accounting principles (GAAP), which is usually the case in a formal document such as an audit report.

What are the major differences between these two bases? Well, member carrying charge income on the cash basis would be shown as the amounts of cash payments that were received. On the accrual basis, however, carrying charge income would be shown as the amounts charged to the members. Amounts billed but not paid would show up as accounts receivable (an asset), and amounts paid prior to being billed would be noted as deferred revenue (a liability). In the expenses section, operational costs on the cash basis show up as expenses as the cooperative pays its vendors, whereas expenses are recorded when incurred to vendors on the accrual basis.

Expenses incurred before they’re paid would be recorded as accounts payable (a liability), and payments made before expenses are incurred are known as prepaid expenses (an asset). Overall, the important point to remember is that the year-end audit report will usually present the financial statements a bit differently than the internal financial reports that the board reviewed during the year.

These guidelines won’t make you an accounting expert. But you don’t need to be a financial authority to function effectively as a board member; you just need to be informed and have a little bit of knowledge. And a little knowledge can go a long way!

This article was featured in CHQ fall 2020 issue. Click here to read the PDF newsletter.

Brian Dahlk, CPA, a senior manager at Wegner CPAs in Madison, Wisc., has been a member of three different housing cooperatives and has provided audits, financial reviews, tax returns and consulting services for cooperative organizations across the country.

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