The course covers the whole spectrum of personal financial statements: accounting standards, engagement and representation letters, compilation performance standards, disclosures, reporting, documentation, and engagement administration. If you prepare personal financial statements for individuals, you will find this course a reliable guide through the maze of professional standards and practice issues.
Highlights include the difference between personal financial statements and personal financial plans; internal use vs. third-party use statements; accounting and disclosure issues; accountants’ reports and more.
Objectives:
Identify the steps to prepare and report on personal financial statements in conformity with all applicable current professional standards
Prerequisite: Experience with compilations
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Chapter 1 - Introduction to Personal Financial Statements
Learning Objectives
• Understand the general nature of personal financial statements.
• Be aware of the key issues in preparing personal financial statements.
Introduction
Personal financial statements are prepared for individuals either to formally organize and plan their financial affairs in general or for specific purposes, such as obtaining credit, income tax planning, retirement planning, gift and estate planning, or public disclosure of their financial affairs. Users of personal financial statements rely on them in determining whether to grant credit, in assessing the financial activities of individuals, in assessing the financial affairs of public officials and candidates for public office, and for similar purposes. Personal financial statements include the financial statements of an individual or a group of related individuals, such as a husband and wife or a family.
Prior to 1982, the 1968 AICPA Industry Audit Guide, Audits of Personal Financial Statements, supported historical cost as the primary basis of measurement for personal financial statements and recommended the presentation of estimated current values as additional information. The preface to that guide stated that "generally accepted accounting principles and auditing standards developed for commercial enterprises are applicable in general to personal financial statements." However, the increasing use of personal financial statements and experience with the use of the guide suggested the need to reassess those conclusions in light of the purposes for which personal financial statements are prepared, the users to whom they are directed, and the ways in which they are used. Statement of Position (SOP) 82-1, Accounting and Financial Reporting for Personal Financial Statements, is the result of that reassessment; it supersedes the accounting provisions of the 1968 AICPA Industry Audit Guide, Audits of Personal Financial Statements.
Key Issues in Preparing Personal Financial Statements
A basis of accounting is a framework for determining what and how information is presented in the financial statements and related notes. However, many issues have arisen in practice when preparing personal financial statements. These issues are summarized as follows.
Ownership of Assets
Personal financial statements generally present the combined assets and liabilities of a husband and wife. In these cases, it may be useful to disclose each individual's interest in the net assets in an additional statement or in a note to the financial statements.
When personal financial statements are prepared for only one of a group of joint owners, only the individual's share should be included as part of his or her assets. If an individual is a joint owner of property, state law should be used to determine the individual's interest in the property. The individual's interest in the property will determine what proportion of the value of the property should be included in the individual's personal financial statements. If ownership is based on joint tenancy, however, it may be necessary to consult legal counsel to determine the individual's interest in the property. In addition, if the client has an interest in a separate business (for example, is the owner of a closely held corporation), the property should be shown as a separate asset and not presented with other investments.
Choosing the Basis of Accounting
SOP 82-1 states that personal financial statements should present assets at their estimated current values and liabilities at their estimated current amounts and describes in detail the principles for such presentations. SOP 82-1 also states that assets, liabilities, and changes in them should be accounted for on the accrual basis.
The AICPA's Personal Financial Statements Guide (Guide) states that the accountant may compile, review, or audit personal financial statements that are prepared in conformity with a comprehensive basis of accounting that presents assets and liabilities at values and amounts other than estimated current values and amounts. The Guide states that other comprehensive bases of accounting include, for example, historical cost, tax, and cash.
• Historical cost basis - This basis generally measures the individual's assets and liabilities in accordance with GAAP used for business entities.
• Income tax basis - This basis measures the individual's assets and liabilities in accordance with the principles the individual uses for federal or other income tax reporting.
• Cash basis - Under the pure cash basis, the only asset reported is cash and there are no liabilities; only cash receipts and disbursements are reported as increases and decreases in net assets.
• Modified cash basis - Under the modified cash basis, the pure cash basis is modified to report certain assets and liabilities, generally as they would be reported under either the historical cost or income tax basis.
Basic Financial Statements
Under GAAP, a complete set of financial statements consists of a statement of financial condition, a statement of changes in net worth, and the related notes. Each financial statement should include references to the notes and should state that the notes are an integral part of the financial statements.
The GAAP statement of financial condition, or balance sheet, is divided into four main sections:
• Assets
• Liabilities
• Income tax effects
• Net worth
In the asset section, the economic resources of the client (individual or group of individuals) are presented. Generally, assets should be presented in order of liquidity. The liability section of the statement of financial condition displays the client's debt. Liabilities should be presented in order of maturity.
Significant assets and liabilities may represent limited business activities. That is, the activity does not constitute a separate trade or business. An investment in commercial real estate financed with a mortgage is an example of a limited business activity. Assets and liabilities related to a limited business activity should be reported as separate amounts and not netted against one another.
The third section of a statement of financial condition prepared in conformity with GAAP presents the estimated income tax effect on the difference between the reported assets and liabilities and their tax bases.
The final section of the statement of condition measures the net worth of the individual. In the net worth section, a single amount is presented, and no attempt is made to differentiate among the types of net worth (such as donated capital, earned capital, and appreciated capital). A statement of changes in net worth is the activity statement in a set of personal financial statements. The statement summarizes the transactions and events that have increased and decreased the client's net worth for the year.
Observation: SOP 82-1 states that the presentation of a statement of changes in net worth is optional. In practice, the statement is rarely presented because creditors do not normally consider it necessary.
Disclosures
Some information is better provided, or can only be provided, by notes to the financial statements, by supplementary information, or by other means. A common misconception about personal financial statements is that there are no requirements for disclosures in personal financial statements. Although there is no comprehensive list of what notes should be included in personal financial statements, according to SOP 82-1 the CPA should include sufficient disclosures to make the financial statements adequately informative. Specifically, informative disclosures can be classified in the following categories:
• Summary of significant accounting policies
• Financial statement items
• Presentation requirements
• Other information
Reporting
Certain modifications must be made when reporting on personal financial statements. The statement titles in the reports must reflect the personal financial statement titles. When compiled financial statements omit substantially all disclosures, the compilation report must disclose the fact that the assets are presented at their estimated current values and that the liabilities are presented at their estimated current amounts.
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