Personal financial statements. (includes related article) (2024)

Off the beaten path of financial presentations is the personalfinancial statement. Unlike businesses, individuals rarely maintainformal accounting systems or other historic records of what they own andwhat they owe. Also, rarely do individuals prepare personal financialstatements as a matter of routine. High-net-worth individuals mayrequest a personal financial statement for reasons such as thefollowing:

* Obtaining a loan;

* Making a guarantee;

* Various investment transactions;

* Meeting a co-op board's financial requirements;0

* Developing an estate, retirement, or other financial plan;

* Developing strategies for minimizing income taxes;

* Identifying property under a divorce proceeding; or

* Running for public office.

Users of personal financial statements may seek CPA involvement toprovide an independent voice about the reliability of the information.In this capacity, a CPA could audit, review, or merely issue acompilation report on personal financial statements depending on thelevel of assurance desired.

When a CPA is associated with personal financial statements, he or sheis guided by professional standards, either GAAS or SSARS, depending onthe level of service. GAAP for personal financial statements is setforth in AICPA Statement of Position (SOP) 82-1, Accounting andFinancial Reporting for Personal Financial Statements. Guidance on thescope of work performed and the form of report issued for personalfinancial statements in accordance with SOP 82-1 is cited in the AICPAPersonal Financial Statements Guide.

CPAs may also be asked to report on specified elements, accounts, oritems of personal financial statements. In the latter circ*mstances,guidance is provided by SAS 62, Special Reports, SAS 35, SpecialReports-Applying Agreed-Upon Procedures to Specified Elements, Accounts,or Items of a Financial Statement, or Accounting and Review Services(ARS) Interpretation 8 of SSARS 1, Reports on Specified Elements,Accounts, or Items of a Financial Statement.

Some CPAs have been reluctant to become associated with personalfinancial statements. When asked to perform an audit, CPAs have viewedthe general lack of an internal control structure for individuals as amajor stumbling block. Even the thought of the limited assurance calledfor in a review engagement might be viewed by some with trepidation. Asa result, the most common level of service that a CPA performs onpersonal financial statements is a compilation.

ACCEPTING THE ENGAGEMENT

As with any potential client relationship, before accepting anengagement involving personal financial statements, the CPA shouldevaluate the potential client relationship.

Facts That Might Bear on the Integrity of the Prospective Client. Thecharacter and reputation of the individual should be considered. Thegoal is to minimize the possibility of involvement with a client wholacks integrity.

Circ*mstances That Present Unusual Business Risk. Circ*mstances thatpresent an unusual business risk should be considered. Unusual businessrisks might include an individual in serious financial difficulty.

The Ability to Serve the Prospective Client. Professional standardsrequire a certain level of knowledge of the client's financialactivities. Before accepting an engagement, the CPA should considerwhether an appropriate understanding can be obtained of the nature ofthe client's financial activities and the specialized accountingprinciples and practices related to the prospective client's financialactivities.

The Effect of the Lack of Independence on the Type of Report That MayBe Issued. Lack of independence precludes a CPA from issuing a reviewreport or audit opinion, but permits a CPA to issue a compilationreport.

Whether Available Accounting Records or Other Data Provide SufficientBasis for Providing the Services Requested. Incomplete or inadequateaccounting records of a client's financial activities are sometimeslikely to lead to problems in compiling, reviewing, or auditing personalfinancial statements.

Once an engagement is accepted, an understanding with the clientshould be established regarding the services to be performed and theterms and objectives of the engagement. Professional standards do notrequire a written engagement letter. However, obtaining an engagementletter is always advisable so no misunderstanding occurs as to theindividual's responsibility for the personal financial statements andthe estimates that are included therein.

Other accounting services may be rendered before providing audit,review, or compilation services. Those services usually involvegathering information by making inquiries of the client and reviewingavailable financial records. In gathering data for inclusion inpersonal financial statements, a CPA may consider the followingdocuments. This list is not necessarily all inclusive, but it providesexamples of key sources of information concerning the individual'sassets and liabilities:

* Checkbooks. The individual's checkbook may serve as the primaryrecord of cash receipts and disbursem*nts and can provide informationconcerning the addition or disposition of assets and the creation orpayment of liabilities.

* Broker's Statements. A broker's statement can be used as a sourceof information regarding marketable securities and loans that might beoutstanding.

* Property Insurance Policies and Schedules. Insurance policies andschedules can be used to identify assets for possible inclusion.

* Wills. Assets in bequests in an individual's will should beconsidered for inclusion.

* Leases. Leases may be a source of information about assets andliabilities.

* Listing of Vault or Safe Deposit Contents. A list of contents canbe used to consider whether all assets stored and owned are included inthe financial statements.

* Real Estate and Personal Property Tax Returns. Tax returns can be asource for identifying assets and liabilities due the taxingauthorities.

* Income Tax Returns. Income tax returns and revenue agents' reportscan be used to identify assets providing income and potential income taxliabilities.

* Financial Records of Other Entities. Financial statements or taxreturns of separate entities, such as a closely held business, a trust,or a profit-sharing or deferred compensation plan can be used as sourcesof information regarding the individual's interest in the entities.

* Inquiries. Inquiries can be made of the individual and, with theindividual's authorization, of others who might have knowledge of theindividual's financial activities concerning possible unrecorded assetsand liabilities.

HOW ARE PERSONAL FINANCIAL STATEMENTS PRESENTED?

Basis of Presentation

Users of personal financial statements rely on them for makingfinancial and economic decisions with the focus primarily on anindividual's assets and liabilities. They believe it is more relevant toportray current values of assets and estimated current amounts ofliabilities rather than historical cost information. Lenders require theuse of estimated current value information to assess collateral.Personal loan applications generally require current value information.Estimated current values are required for estate, gift and income taxplanning, and estimated current value information about assets is oftenrequired in federal and state filings of candidates for public office.Recognizing this, the AICPA Accounting Standards Division, issued SOP82-1, which states that personal financial statements should present allassets at their estimated current value and liabilities at theirestimated current amounts.

Presentation of Personal Financial Statements

Presentation of assets and liabilities in personal financialstatements should be made in the most useful and readily understoodmanner. Thus, assets and liabilities should be presented in order ofliquidity and maturity, without classification as to current andnoncurrent status because the working capital concept applied tobusiness entities is inappropriate.

Statement of Financial Condition. The statement of financial conditionis the basic personal financial statement that presents estimatedcurrent values of assets, amounts of liabilities, income taxes on thedifferences between the estimated current values of assets and amountsof liabilities and their tax bases, and net worth at a specified date.The term net worth is used in the statement of financial condition todesignate the difference between the total assets and total liabilities.

Statement of Changes in Net Worth.

This statement is not considered a basic financial statement; itspresentation is optional pursuant to SOP 82-1. The statement of changesin net worth presents the major sources of changes in net worth asfollows:

* Income and expenses;

* Increases and decreases in estimated current values of assets;

* Increases and decreases in the estimated current amount ofliabilities; and

* Changes in estimated income taxes on the differences betweenestimated current values and amounts and tax bases.

The presentation of comparative financial statements for the currentperiod and one or more prior periods may be desirable. SOP 82-1 statesthat comparative financial statements can be more informative than thepresentation of financial statements for only one period. However, thepresentation of comparative financial statements is optional.

When personal financial statements are prepared for one individualfrom a group of joint owners of assets, only that person's interest as abeneficial owner--determined under the property laws of the state havingjurisdiction--should be included in personal financial statements. Legaladvice may be required to determined whether an interest in propertyshould be included as a person's asset, especially when property is heldin joint tenancy, as community property, or through a similar jointownership arrangement.

If an individual's business interest constitutes a large part of totalassets, that interest should be shown separately from other investments.The estimated current value of an investment in a separate entity, suchas a closely held corporation, a partnership, or a sole proprietorship,should be shown in one amount as an investment if the entity ismarketable as a going concern. Assets and liabilities of the separateentity should not be combined with similar personal items.

The estimated current values of assets and the estimated currentamounts of liabilities of limited business activities, such as aninvestment in real estate and a related mortgage, should be presented asseparate amounts, especially if a large portion of the liabilities maybe satisfied from soures unrelated to the investment.

The Use of OCBOA

As for other entities, personal financial statements may be preparedin conformity with a comprehensive basis of accounting other than GAAP.For purposes of personal financial statements OCBOA includes, forexample, the tax return, historical cost, and cash receipts anddisbursem*nts bases. Such statements should clearly state that thebasis of accounting used is not GAAP and the CPA's report would followthe guidance in SAS 62, Special Reports and The Personal FinancialStatements Guide.

Guidelines for Determination of Current Values and Amounts

SOP 82-1 states the estimated current value of an asset in personalfinancial statements is the amount at which the item could be exchangedbetween a buyer and seller, each of who is well informed and willing,and neither of whom is compelled to buy or sell. In determiningestimated current values, costs of disposal, such as commissions, ifmaterial, should be considered.

Estimated current value is sometimes difficult to determine and thecost of obtaining estimated current values of some assets directly mayexceed the benefits of doing so. SOP 82-1 recognizes those difficultiesand states judgment should be exercised in determining estimated currentvalue.

Recent transactions involving similar assets and liabilities insimilar circ*mstances generally provide a statisfactory basis for thedetermination of estimated current values of assets and estimatedcurrent amounts of liabilities. However, if recent sales information isunavailable, other methods may be used. Other methods might include thecapitalization of past or prospective earnings, the use of liquidationvalues, the adjustment of historical cost based on changes in a specificprice index, the use of appraisals, or the use of the discounted amountsof projected cash receipts and payments.

Specialists may need to be consulted for gathering informationnecessary for determining estimate current values of some assets.(Examples are works of art, jewelry, restricted securities, investmentsin closely held businesses, and real estate). In deciding whether theuse of a specialist is necessary, the nature of the item and itsmateriality with respect to the individual's financial condition shouldbe considered. Previous estimates may have been made by a specialist.If so, consideration should be given to the date of the previousestimate, the extent of changes in the circ*mstances since that date,and the method of up-dating the estimate.

Methods to determine estimated current values of assets and theestimated current amounts of liabilities should be consistently appliedfrom period to period, unless facts and circ*mstances dictate a change.Significant changes in estimation methods should be disclosed.

FINANCIAL STATEMENT DISCLOSURES

Personal financial statements should include sufficient disclosures tomake the statements adequately informative. The disclosures may be madewithin the body of the financial statements or in footnotes. Types ofinformation that ordinarily should be disclosed are:

* A clear indication of the individuals covered by the financialstatements;

* The methods used in determining the estimated current values ofmajor assets and the estimated current amounts of major liabilities ormajor categories of assets and liabilities, since several methods areavailable, and changes in methods from one period to the next;

* If assets held jointly by the individual and by others are includedin the statements, the nature of the joint ownership;

* If the individual's investment portfolio is material in relation tohis or her other assets and is concentrated in one or a few companies orindustries, the names of the companies or industries and the estimatedcurrent values of the securities.

* If an individual has a material investment in a closely heldbusiness, at least the following information:

a. The name of the company and the individual's percentage ofownership;

b. The nature of the business; and

c. Summarized financial information about assets, liabilities, andresults of operations for the most recent year based on the financialstatements of the business, including information about the basis ofpresentation (for example, GAAP, income tax basis, or cash basis) andany significant loss contingencies.

* Descriptions of intangible assets and their estimated useful lives;

* The face amount of life insurance the individual owns;

* Non-forfeitable rights that do not have certain characteristics, forexample, pensions based on life expectancy;

* The following tax information:

a. The methods and assumptions used to compute the estimated incometaxes on the differences between the estimated current values of assetsand the estimated current amounts of liabilities and their tax bases anda statement that the provision will probably differ from the amounts ofincome taxes that might eventually be paid because those amounts aredetermined by the timing and the method of disposal, realization, orliquidation and the tax laws and regulations in effect at the time;

b. Unused operating loss and capital loss carryforwards;

c. Other unused deductions and credits, with their expirationperiods, if applicable; and

d. The differences between the estimated current values of majorassets and the estimated current amounts of major liabilities orcategories of assets and liabilities and their tax bases.

* Maturities, interest rates, collateral, and other pertinent detailsrelating to receivable and debt; and

* Non-cancelable commitments for example, operating leases.

GAAP other than those discussed in SOP 82-1 may apply to personalfinancial statements. SFAS 57, Related Party Disclosures, providesguidance on related party disclosures, and SFAS 5, Accounting forContingencies, and related amendments and interpretations, providesguidance on accounting for contingencies and are examples of such GAAPrequirements.

REPORTING ON PERSONAL FINANCIAL STATEMENTS

A CPA may be asked to audit, review or compile personal financialstatements. Standards for compilations, reviews, and audits areprescribed by SSARS 1 and GAAS, and are applicable for personalfinancial statements as for other financial statements.

Compilations

SSARS 1 states that the CPA should posses a general understanding ofthe nature of the individual's financial transactions, the form ofavailable accounting records, the stated qualifications of accountingpersonnel, the accounting basis on which the financial statements are tobe presented, and the form and content of the financial statements. TheCPA ordinarily obtains knowledge of these matters through experiencewith the individual or inquiry of the individual whose financialstatements are being compiled.

Ordinarily a CPA can compile personal financial statements based onthe individual's representation of the estimated current values ofassets and the estimated current amounts of liabilities. At a minimum,however, the CPA should obtain an understanding of the methods by whichthe individual determined the estimated current values of major assetsand current amounts of significant liabilities and consider whether themethods are appropriate in light of the nature of each asset orliability.

The CPA is not required to make inquiries or perform other proceduresto verify, corroborate, or review information supplied by theindividual. However, the CPA should obtain additional or revisedinformation if he or she becomes aware information supplied by theindividual is incorrect, incomplete, or otherwise unsatisfactory.

Reviews

The CPA should posses a level of knowledge of the accountingprinciples and practices applicable to personal financial statements andan understanding of the individual's financial activities and financialposition that will provide him, through the performance of inquiry andanalytical procedures, with a reasonable basis for expressing limitedassurance that there are no material modifications that should be madeto the financial statements for the statements to be in conformity withGAAP. The CPA's understanding of financial activities should include ageneral understanding of the nature of assets and liabilities, sourcesof income, and the nature of significant expenditures and materialtransactions with related parties.

Audits

The scope of the audit should enable the independent auditor toconclude that he or she has a reasonable basis for expressing an opinionon whether the statements are presented fairly, in all materialrespects, in conformity with GAAP. GAAS include gaining and documentingan understanding of the internal control structure, assessing controlrisk, testing accounting records, and obtaining responses to inquiriesand other procedures considered necessary. Because of the nature ofpersonal financial records, obtaining evidential matter may sometimes bedifficult. As a result, it may be impracticable to conduct an audit ofpersonal financial statements in accordance with GAAS and express anunqualified opinion.

Representation Letters

During an engagement, the client makes many representations to theCPA, oral and written, in response to specific inquiries or through thefinancial statements. Such representations from the client are animportant part of the information gathered. Written representationsfrom the client to confirm oral representations given to the CPAindicate and document the continuing appropriateness of thoserepresentations and reduce the possibility of misunderstanding.

GAAS require that the independent auditor obtain certain writtenrepresentations as part of every engagement. Review and compilationengagements do not contemplate tests of accounting records and responsesto inquiries by obtaining corroborating evidential matter. However,because of the informal nature of most personal financial records, it isadvisable to obtain written representations from the client to confirmthe oral representations made in all personal financial statementengagements.

Written representations should be addressed to the CPA. Because theCPA is concerned with events occurring through the date of the reportthat may require adjustment to or disclosure in the financialstatements, the representation letter should be dated as of that dateand signed by the individual whose financial condition is beingpresented.

AN INTELLECTUAL HURDLE

The preparation of personal financial statements for the high networth individual can be a major undertaking. Having a CPA provideassurances about the reliability of the information in the financialstatements is an additional significant task. In an article in theJournal of Commercial Bank Lending, May 1991, "Making Something of aPersonal Financial Statement," Dev Strischek stated, "For the smallbusiness borrower, the middle market guarantor, and the private bankcustomer, a CPA-prepared personal financial statement is still a luxuryas well as an intellectual hurdle."