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Personal Financial Statements: Why They Matter – Part I

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Many are familiar with the traditional balance sheet and income statement used for reporting and record-keeping purposes by business entities. Personal financial statements, which are often underestimated in importance, serve a similar purpose by reporting the assets, liabilities and net worth of an individual, married couple or family at a point in time.

Typical personal financial statements under general accepted accounting principles (“GAAP”) include:

Statement of Financial Condition – Listing of assets and liabilities to arrive at net worth at a specified date

Statement of Changes in Net Worth – An optional statement that reports the major sources of increases and decreases in net worth

Disclosure Footnotes – Sufficient disclosures to make the statements informative

Why would you need a personal financial statement? These statements help an individual to formally organize and plan his or her financial affairs. CPAs are frequently asked to prepare, compile or review personal financial statements for use related to:

  • Obtaining a loan
  • Income tax planning
  • Estate planning
  • Retirement planning
  • Public disclosure of personal affairs for public officials and candidates running for public office

SPECIAL PURPOSE FRAMEWORKS
Personal financial statements generally should be prepared under GAAP; however, they can also be prepared using “special purpose frameworks.” Special purpose frameworks include cash, modified cash, tax and historical cost bases.

The benefit of preparing personal financial statements prepared in accordance with a special purpose framework is the ability to present financial statements on the basis of accounting normally used by an individual without listing each departure from GAAP. However, the Financial Accounting Standards Board (FASB) recommends the presentation of personal financial statements under GAAP regardless of the basis the individual uses to keep their records.

Therefore, our primary focus for the purposes of this blog will be financial statements as presented under GAAP, which require assets and liabilities under the accrual basis to be reported at their estimated current values and amounts.

TERMS DEFINED
FASB defines the estimated current value of assets as “the amount at which the item could be exchanged between a buyer and seller, each of whom is well informed and willing, and neither of whom is compelled to buy or sell” and states that liabilities should be reported at their estimated current amount, or “the discounted amount of cash to be paid.” Net worth is defined as the difference between assets and liabilities after deducting the provision for income taxes.

As previously discussed, personal financial statements consist of the “Statement of Financial Condition” and “Changes in Net Worth.”

Statement of Financial Condition
The Statement of Financial Condition includes the following:

  • Assets stated at their estimated current values, in order of liquidity and maturity
  • Liabilities stated at their estimated current amounts, in order of liquidity and maturity
  • A provision for income taxes on the difference between the estimated current values of assets and the estimated current amounts of liabilities and their tax bases
  • Net worth at a specific date

Statement of Changes in Net Worth
The Statement of Changes in Net Worth include the following increases and decreases to net worth:

  • Income
  • Expenses
  • Increase or decrease in the estimated current value of each asset
  • Increase or decrease in the estimated current amount of each liability
  • Increase or decrease in the provision for income taxes

DISCLOSURES
Disclosures may be in the body of the financial statements or in the footnotes. Disclosures can vary greatly depending on the complexity of the individual assets and liabilities. Examples of common disclosures include:

  • Specific identification of the individuals covered
  • Disclosure of the reporting framework (i.e. “GAAP”) and confirmation that the assets are presented at their estimated current value and liabilities at their estimated current amounts
  • The method used to determine the estimated current value of assets or the estimated current amount of liabilities, or the method used in determining the major grouping of asset and liabilities
  • Description of changes in the methods used, if different from one period to another
  • If property is held in a joint venture or jointly, description of the nature of the individual’s ownership and ownership of the other parties
  • If the individual has a significant investment in a closely held business disclosure of:
    • The name of the company and percentage of ownership
    • The nature of the business
    • Summary of the assets, liabilities, and results of operations for the most recent year which should include the reporting framework used by the entity
  • The face amount of life insurance owned
  • A description of intangibles and their estimated useful lives
  • The following tax information should also be disclosed:
    • Methods and assumptions used to estimate the provision for income taxes
    • A statement that the income tax provision will differ from the amounts eventually paid, since the provision is calculated using information such as tax laws and regulations in effect which may change when the disposal, realization and liquidation actually occur and the taxes are paid
    • Unused operating losses
    • Capital loss carryforwards
  • Details relating to receivables and debts such as maturities, interest rates, collateral, and other information deemed pertinent

The purpose of this blog was to present an overview of the reasons for which you would need a personal financial statement, the components included and the basis under which a personal financial statement can be prepared. In Part II of this series, we will discuss how the estimated current value of assets and liabilities is determined.

FOR MORE INFORMATION
Putting together a personal financial statement can be a daunting task, depending on the complexity of your individual assets and liabilities. The components you will need to consider when undertaking the preparation of personal financial statements will differ based on your specific scenario, and for that reason it is always recommended that you consult with your financial and/or accounting advisor(s) to ensure you are taking all necessary steps into account. Here at FF&F our experienced staff will act as your advisors before and throughout each of these steps to help you confidently compile your personal financial statements. For more information on this topic, or to hear more about our services, please contact us at info@fffcpas.com or (212) 245-5900.


MP HeadshotMarisa Pershad, CPA, CVA, is an Accounting & Audit Partner at Farkouh, Furman & Faccio with over 35 years of experience. Marisa’s industry expertise includes clients predominantly in the commercial, financial services (including investment partnerships and broker-dealers), and not-for-profit industries. She specializes in the audit of GAAP and OCBOA basis financial statements.