ACCOUNTANTS’ HANDBOOK VOLUM phần 8 pptx

The date of the compilation report The standard form of compilation report for a financial forecast is as follows: We have compiled the accompanying forecasted balance sheet, statements o

rather than prospective financial statements In that case, the accountant is not required to provide astandard service on the prospective data Chapter 23 of the AICPA Guide contains guidelines forcompilations, examinations, and application of agreed-upon procedures to partial presentations It

does not require those services on partial presentations, but provides guidance for the accountant

who is engaged to provide them

(ii) Third-Party Use. Third parties generally are any persons outside the entity presentingthe prospective financial statements Sometimes, however, such persons may not need to beconsidered third parties for the purpose of determining whether the guidance on accountants’services applies

The AICPA Guide (Section 10.02) provides the following guidelines for determining whether siders are considered third parties:

out-In deciding whether a party that is or reasonably might be expected to use an accountant’s report

is considered to be a third party, the accountant should consider the degree of consistency of terest between [management] and the user regarding the forecast If their interests are substan-tially consistent (for example both the [preparer] and the user are employees of the entity aboutwhich the forecast is made), the user would not be deemed to be a third party On the other hand,where the interests of the [preparer] and user are potentially inconsistent (for example, the [pre-parer] is a nonowner manager and the user is an absentee owner), the user would be deemed athird party In some cases, this determination will require the exercise of considerable profes-sional judgment

in-In considering whether the statements will be restricted to internal use, the accountant maygenerally rely on management’s oral or written representations, unless something leads the ac-countant to believe that, despite management’s representations, the statements are likely to bedistributed to a third party

(iii) Assemble and Submit “Assembly” means the “manual or computer processing of

mathe-matical or other clerical functions related to the presentation of the prospective financial statements”(AICPA Guide, Section 3.16) This refers to converting the assumptions into prospective amounts orputting the amounts into the form of statements Assembly does not mean merely copying or collat-ing statements prepared by someone else

(c) INTERNAL USE The accountant may provide compilation, examination, or agreed-upon

pro-cedures engagements for internal use if engaged to do so However, for internal use, the accountanthas more flexibility to accommodate the varying circumstances of the engagement Normally, theseengagements involve consulting or planning (such as in management-consulting or tax-planning ser-

vices) rather than third-party reliance Common reporting options for internal use include assembly reports and plain paper prospective financial statements Internal-use services are discussed in more

detail in Subsection 38.9(a)

(d) PROHIBITED ENGAGEMENTS The AICPA Guide prohibits the accountant from submitting

or reporting on prospective financial statements intended for third-party use if those statements omitthe disclosure of significant assumptions Similarly, the accountant is prohibited from submitting orreporting on a projection for third-party use if it does not identify the hypothetical assumption or de-scribe the limitations on the usefulness of the presentation

The accountant also may not submit or report on a financial projection that is intended for eral use (unless it supplements a forecast for the same period) because such use is considered in-appropriate [see Subsection 38.2(b)] This prohibition means that the accountant could notassemble and submit such a presentation even if management agreed not to present the accoun-tant’s report or refer to the accountant in the document containing the projection that would be pre-sented to general users

gen-(e) MATERIALITY. Accountants consider materiality in conducting engagements on

pro-spective financial statements much as they do for historical financial statements The AICPAGuide (Section 10.31) states, however, “Materiality is a concept that is judged in light of the ex-pected range of reasonableness of the information; therefore, users should not expect prospec-tive information (information about events that have not yet occurred) to be as precise ashistorical information.”

It follows, then, that materiality criteria would be higher for prospective statements thanfor the same company’s historical statements That is, an amount that would be material to thehistorical statements might not be material to the prospectives There is no consensus in practice, however, as to just how much higher materiality should be for prospective financialstatements

(f) SEC PERSPECTIVE Relevant SEC rules regarding accountants’ services on prospective

finan-cial statements in filings subject to the SEC’s authority include the Safe Harbor Rule for Projectionsand as policies stated in equation S-K § 229.10 These rules, however, add relatively little to the re-quirements for accountants’ procedures and reports established by the AICPA Guide The more sig-nificant SEC policies in this area are less formal ones Two particularly significant positions taken by

the SEC involve compilation services and independence rules.

(i) Compilations in SEC Filings Although not stated in formal SEC rules, the Commission’s staff

has been reluctant to accept compilations of prospective financial statements Thus, although thatservice is allowed under the AICPA literature for both public and nonpublic entities (unlike compila-tions of historical statements, which are only appropriate for nonpublic companies), they generallyare not an option for filings subject to SEC authority

(ii) Independence. The SEC independence rules differ from those established by the AICPA

As a general rule, AICPA literature considers independence impaired when the accountant eitherhas a direct financial interest in the client or when the accountant is acting in the capacity ofmanagement or an employee Thus, providing a service on prospective financial statementswould not, in and of itself, affect the auditor’s independence for the audit of its historical finan-cial statements or any other service

The SEC rules, however, are based on a different concept, which the SEC refers to as “mutuality

of interest.” The SEC considers that the accountant’s assistance in preparing prospective financialstatements creates a mutuality of interest in the prospective results Thus, it has stated that, generally,

an accountant who actively participates in the preparation of the prospective data loses the dence necessary to examine and report on that prospective data

indepen-In a letter to an accountant, the SEC staff pursued this reasoning even further, stating that activeassistance in the preparation of a company’s prospective financial statements would also affect the

accountant’s independence in regard to its historical financial statements for the length of the

prospective period This independence impairment would occur regardless of whether the tive statements were forecasts or projections or whether they were issued to the public or restricted

prospec-to internal use.1

(g) IRS PERSPECTIVE The IRS Circular 230 applies to prospective financial statements included

in tax shelter offerings It states that an accountant who reports on prospective financial statements in

such offerings must either provide a tax shelter opinion or rely on one issued by another

profes-sional, such as another accountant or a lawyer

A tax shelter opinion under Circular 230 states whether, in the professional’s opinion, it is morelikely than not that an investor will prevail on the merits of each material tax issue that involves a

1Letter from Chief Accountant to Amper, Politzner, and Mattia, April 14, 1987; CCH, 1990, paragraph7986

reasonable possibility of challenge by the IRS and an overall evaluation of the extent to which thematerial tax benefits are likely to be realized in the aggregate.

38.6 COMPILATION SERVICES

(a) SCOPE OF THE COMPILATION SERVICE A compilation of prospective financial

state-ments is similar to a compilation of historical financial statestate-ments performed subject to SSARS No

1, “Compilation and Review of Financial Statements” (1978) It relies primarily on an informedreading of the statements with an eye for obvious problems, but it does not provide any assurance onthe statements

The AICPA Guide states that a compilation of prospective financial statements involves thesethree:

1 Assembling, to the extent necessary, the prospective financial statements based on

manage-ment’s assumptions

2 Performing the required compilation procedures, including reading the prospective financial

statements with their summaries of significant assumptions and accounting policies and sidering whether they appear to be presented in conformity with AICPA presentation guide-lines and not obviously inappropriate

con-3 Issuing a compilation report

(b) ASSEMBLY Assembly, which is defined in Subsection 34.5(b)(iii), refers to performing the

necessary mathematics to turn assumptions into prospective financial data and drafting prospectivefinancial statements in the appropriate form In some cases, such as when the client has a sophisti-cated financial reporting function and prepares its own statements, assembly may not be required in

a compilation Often, however, assembly assistance is one of the primary benefits the client receivesfrom the accountant

Assembly does not include identifying key factors or developing assumptions, although tants often help clients in these areas in a compilation

accoun-(c) COMPILATION PROCEDURES The compilation procedures required by AICPA standards

are listed in Exhibit 38.4

There are two principal differences between the procedures done in a compilation of prospective

statements and a compilation of historical statements: the requirement to consider the actual results for any expired portion of the prospective period and the requirement to obtain signed representa- tions from the client.

Another difference between prospective and historical compilations is that working papers are

re-quired in a compilation of prospective financial statements The working papers serve mainly to:

• Provide the principal support for the accountant’s report, including the representation regardingobservance of the standards of fieldwork, which is implicit in the reference in the report to theattestation standards

• Aid the accountant in the conduct and supervision of the engagement In this regard, the ing papers should be sufficient to (1) enable members of the engagement team with supervisionand review responsibilities to understand the nature, timing, extent, and results of proceduresperformed, and the information obtained and (2) indicate the engagement team member(s) whoperformed and reviewed the work

work-(d) REPORTING ON A COMPILATION. The standard report on a compilation of

prospec-tive financial statements includes:

1 An identification of the prospective financial statements presented by the responsible party

2 A statement that the accountant has compiled the prospective financial statements in

accor-dance with attestation standards established by the AICPA

In performing a compilation of prospective financial statements the practitioner should, whereapplicable—

a Establish an understanding with the client regarding the services to be performed The understanding

should include the objectives of the engagement, the client’s responsibilities, the practitioner’s sponsibilities, and limitations of the engagement The practitioner should document the understanding

re-in the workre-ing papers, preferably through a written communication with the client If the practitionerbelieves an understanding with the client has not been established, he should decline to accept or per-form the engagement

b Inquire about the accounting principles used in the preparation of the prospective financial statements.

•For existing entities, compare the accounting principles used to those used in the preparation of vious historical financial statements and inquire whether such principles are the same as those ex-pected to be used in the historical financial statements covering the prospective period

pre-•For entities to be formed or entities formed that have not commenced operations, compare ized industry accounting principles used, if any, to those typically used in the industry Inquireabout whether the accounting principles used for the prospective financial statements are those thatare expected to be used when or if the entity commences operations

special-c Ask how the responsible party identifies the key factors and develops its assumptions.

d List, or obtain a list of, the responsible party’s significant assumptions providing the basis for the

prospective financial statements and consider whether there are any obvious omissions in light of thekey factors upon which the prospective results of the entity appear to depend

e Consider whether there appear to be any obvious internal inconsistencies in the assumptions.

f Perform, or test the mathematical accuracy of, the computations that translate the assumptions into

prospective financial statements

g Read the prospective financial statements, including the summary of significant assumptions, and

con-sider whether—

•The statements, including the disclosures of assumptions and accounting policies, appear to be notpresented in conformity with the AICPA presentation guidelines for prospective financial state-ments.1

•The statements, including the summary of significant assumptions, appear to be not obviouslyinappropriate in relation to the practitioner’s knowledge of the entity and its industry and, for

a— Financial forecast, the expected conditions and course of action in the prospective period.

Financial projection, the purpose of the presentation.

h If a significant part of the prospective period has expired, inquire about the results of operations or

sig-nificant portions of the operations (such as sales volume), and sigsig-nificant changes in financial position,and consider their effect in relation to the prospective financial statements If historical financial state-ments have been prepared for the expired portion of the period, the practitioner should read such state-ments and consider those results in relation to the prospective financial statements

i Confirm his understanding of the statements (including assumptions) by obtaining written

representa-tions from the responsible party Because the amounts reflected in the statements are not supported byhistorical books and records but rather by assumptions, the practitioner should obtain representations

in which the responsible party indicates its responsibility for the assumptions The representationsshould be signed by the responsible party at the highest level of authority who the practitioner be-lieves is responsible for and knowledgeable, directly or through others, about matters covered by therepresentations

•For a financial forecast, the representations should include the responsible party’s assertion that the

fi-nancial forecast presents, to the best of his knowledge and belief, the expected fifi-nancial position, sults of operations, and cash flows for the forecast period and that the forecast reflects the responsibleparty’s judgment, based on present circumstances, of the expected conditions and its expected course

re-of action The representations should also include a statement that the forecast is presented in mity with guidelines for presentation of a forecast established by the AICPA The representationsshould also include a statement that the assumptions on which the forecast is based are reasonable Ifthe forecast contains a range, the representation should also include a statement that, to the best of theresponsible party’s knowledge and belief, the item or items subject to the assumption are expected toactually fall within the range and that the range was not selected in a biased or misleading manner

confor-Exhibit 38.4 Standard compilation procedures (Source: AICPA, Statement on Standards for

Attesta-tion Engagements, AT 301.)

3 A statement that a compilation is limited in scope and does not enable the accountant to

ex-press an opinion or any other form of assurance on the prospective financial statements or theassumptions

4 A caveat that the prospective results may not be achieved

5 A statement that the accountant assumes no responsibility to update the report for events and

circumstances occurring after the date of the report

6 The manual or printed signature of the accountant’s firm

7 The date of the compilation report

The standard form of compilation report for a financial forecast is as follows:

We have compiled the accompanying forecasted balance sheet, statements of income, retained ings, and cash flows of XYZ Company as of December 31, 20XX,* and for the year then ending, inaccordance with attestation standards established by the American Institute of Certified Public Ac-countants

earn-A compilation is limited to presenting in the form of a forecast information that is the representation

of management and does not include evaluation of the support for the assumptions underlying theforecast We have not examined the forecast and, accordingly, do not express an opinion or anyother form of assurance on the accompanying statements or assumptions Furthermore, there willusually be differences between the forecasted and actual results, because events and circumstancesfrequently do not occur as expected, and those differences may be material We have no responsi-bility to update this report for events and circumstances occurring after the date of this report.[Signature]

[Date]

* If the presentation is summarized, the opening sentence of the report would begin, “We have piled the accompanying summarized forecast of XYZ Company as of December 31, 20X1 .”

com-•For a financial projection, the representations should include the responsible party’s assertion that

the financial projection presents, to the best of his knowledge and belief, the expected financial sition, results of operations, and cash flows for the projection period given the hypothetical as-sumptions, and that the projection reflects his judgment, based on present circumstances, ofexpected conditions and its expected course of action given the occurrence of the hypotheticalevents The representations should also (1) identify the hypothetical assumptions and describe thelimitations on the usefulness of the presentation, (2) state that the assumptions are appropriate, (3)indicate if the hypothetical assumptions are improbable, and (4) if the projection contains a range,include a statement that, to the best of the responsible party’s knowledge and belief, given the hy-pothetical assumptions, the item or items subject to the assumption are expected to actually fallwithin the range and that the range was not selected in a biased or misleading manner The repre-sentations should also include a statement that the projection is presented in conformity with guide-lines for presentation of a projection established by the AICPA

po-j Consider, after applying the above procedures, whether he has received representations or other

in-formation that appears to be obviously inappropriate, incomplete, or otherwise misleading and, if so,attempt to obtain additional or revised information If he does not receive such information, the prac-titioner should ordinarily withdraw from the compilation engagement.2(The omission of disclosures,other than those relating to significant assumptions, would not require the practitioner to withdraw.)

1Presentation guidelines for entities that issue prospective financial statements are set forth and illustrated

in the AICPA Guide for Prospective Financial Information.

2The practitioner need not withdraw from the engagement if the effect of such information on theprospective financial statements does not appear to be material

Exhibit 38.4 Continued.

The standard form of report for the compilation of a financial projection is as follows:

We have compiled the accompanying projected balance sheet, statements of income, retained ings, and cash flows of XYZ Company as of December 31, 20XX,* and for the year then ending, inaccordance with attestation standards established by the American Institute of Certified Public Ac-countants The accompanying projection was prepared for [state special purpose, for example, “thepurpose of negotiating a loan to expand XYZ Company’s plant”]

earn-A compilation is limited to presenting information in the form of a projection that is the tion of management and does not include evaluation of the support for the assumptions underlyingthe projection We have not examined the projection and, accordingly do not express an opinion orany other form of assurance on the accompanying statements or assumptions Furthermore, even if[describe hypothetical assumption, for example, “the loan is granted and the plant is expanded”],there will usually be differences between the projected and the actual results, because events andcircumstances frequently do not occur as expected, and those differences may be material We have

representa-no responsibility to update this report for events and circumstances occurring after the date of thisreport

The accompanying projection and this report are intended solely for the information and use of[identify specified parties, for example, “XYZ Company and DEF Bank”] and are not intended to

be and should not be used by anyone other than these specified parties

[Signature]

[Date]

* If the presentation is summarized, the opening sentence of the report would begin, “We havecompiled the accompanying summarized projection of XYZ Company as of December 31,20X1 .”

If the presentation is shown as a range, the accountant’s report also includes a paragraph thatstates that management has shown the results of one or more assumptions as a range The following

is an example of such a paragraph:

As described in the summary of significant assumptions, management of XYZ Company haselected to portray forecasted [description of the financial statement element or elements for whichthe expected results of one or more assumptions fall within a range, and identification of the as-sumptions expected to fall within a range, e.g., “revenue at the amounts of $XX and $YY, which

is predicated upon occupancy rates of XX% and YY% of available apartments”] rather than as asingle-point estimate Accordingly, the accompanying forecast presents forecasted financial posi-tion, results of operations, and cash flows [description of the assumptions expected to fall within

a range, e.g., “at such occupancy rates”] However, there can be no assurance that the actual sults will fall within the range [description of the assumptions expected to fall within a range, e.g.,

re-“occupancy rates”] presented

(e) PROBLEM SITUATIONS Potential problems in a compilation engagement include scope

lim-itations, deficiencies in the prospective financial statements, and lack of independence.

(i) Scope Limitations. Scope limitations might include a client’s inadequate responses tothe limited inquiries required in a compilation or its refusal to supply signed representations.The AICPA Guide does not allow a scope-limitation compilation report An accountant whocannot apply all the necessary procedures cannot complete the engagement and ordinarilyshould withdraw

(ii) Presentation Deficiencies Possible deficiencies in the prospective financial statements

might affect either the assumptions or the other required disclosures If the deficiency affects

disclo-sures other than assumptions, the accountant may mention it in the compilation report For example,

if management chose to omit the disclosure of significant accounting policies, the accountant mightadd the following paragraph to the compilation report:

Management has elected to omit the summary of significant accounting policies required by the lines for presentation of a financial forecast established by the American Institute of Certified PublicAccountants If the omitted disclosures were included in the forecast, they might influence the user’sconclusions about the Company’s financial position, results of operations, and cash flows for the fore-cast period Accordingly, this report is not intended for those who are not informed about such matters.

guide-If the deficiency affects the disclosure of assumptions and the accountant is unable to have it

cor-rected, the accountant is not permitted merely to mention it in the report In that case, the accountantordinarily would withdraw from the engagement

(iii) Independence Since a compilation provides no assurance, an accountant may compile

prospective financial statements when not independent In that case, the report would indicate thelack of independence, but not the reason for it The following sentence would be added to the com-pilation report to indicate the lack of independence:

We are not independent with respect to XYZ Company

38.7 EXAMINATION SERVICES

(a) SCOPE OF AN EXAMINATION. An examination of prospective financial statements issimilar to an audit of historical financial statements It is based on evidence-gathering proceduresand results in positive assurance about the statements The main difference between the two ser-vices involves the evidence-gathering procedures Because completed transactions do not gener-ally constitute the bulk of the data underlying prospective financial statements, the accountant’sprocedures generally consist primarily of inquiry and analysis rather than of document inspectionand confirmation

An examination of prospective financial statements involves the following four evaluations:

1 Evaluating the preparation of the statements

2 Evaluating the support underlying the statements

3 Evaluating the presentation of the statements for conformity with AICPA presentation

guidelines

4 Issuing a report as to whether, in the accountant’s opinion,

a The prospective financial statements are presented in conformity with AICPA presentation

guidelines and

b The assumptions provide a reasonable basis for the forecast or, for a projection, whether

the assumptions provide a reasonable basis given the hypothetical assumptions

(i) Evaluating Preparation The accountant considers the process that management uses to

de-velop its prospective financial statements to determine how much support will need to be lated This consideration is similar to the consideration an auditor gives to a company’s internalcontrol in planning and performing an audit of historical financial statements The better controlledthe process of developing the financial statements, the less work the accountant generally needs to do

accumu-in obtaaccumu-inaccumu-ing support for them

In judging the process the entity uses in developing its prospective financial statements, the countant generally compares the process to the guidelines discussed in Subsection 38.3(a)

ac-(ii) Evaluating Assumptions The accountant performs procedures to determine whether the

as-sumptions provide a reasonable basis for the prospective financial statements The accountant candecide that they do if the accountant can conclude that:

• Management has identified all key factors expected to affect the entity during the prospectiveperiod.

• Management has developed assumptions for each key factor

• The assumptions are suitably supported

To determine whether management has identified all key factors and developed assumptions for

each one, the accountant needs to possess, or obtain during the engagement, an appropriate edge of the industry in which the entity will operate and the accounting principles and practices ofthat industry

knowl-The accountant can conclude that the assumptions are suitably supported if the preponderance of

information supports each significant assumption Preponderance here does not imply a statisticalmajority of information A preponderance exists if the weight of available information tends to sup-port the assumption The AICPA Guide states, however, “Because of the judgments involved in de-veloping assumptions, different people may arrive at somewhat different but equally reasonableassumptions based on the same information.”

The accountant need not obtain support for the hypothetical assumptions in a projection, since

they are not necessarily expected to occur For a projection, the accountant considers whether thehypothetical assumptions are consistent with the purpose of the projection and whether the otherassumptions are suitably supported given the hypothetical assumption

In evaluating the support for the assumptions, the accountant considers six factors:

1 Whether sufficient pertinent sources of information, both internal and external to the entity,

have been considered

2 Whether the assumptions are consistent with the sources from which they are derived

3 Whether the assumptions are consistent with each other

4 Whether the historical financial information and other data used in developing the

assump-tions are sufficiently reliable for that purpose

5 Whether the historical information and other data used in developing the assumptions are

comparable over the periods specified or whether the effects of any lack of comparability wereconsidered in developing the assumptions

6 Whether the logical arguments or theory, considered with the data supporting the

assump-tions, are reasonable

Support for assumptions may include market surveys, engineering studies, general economic dicators, industry statistics, trends and patterns developed from an entity’s operating history, and in-ternal data and analysis, accompanied by their supporting logical argument or theory

in-The accountant determines whether the assumptions provide a reasonable basis for the statementsbut cannot conclude that any outcome is expected because (1) realization of prospective results maydepend on management’s intentions, which cannot be examined; (2) there is substantial uncertainty inthe assumptions; (3) some of the information accumulated about an assumption may appear contra-dictory; and (4) different but similarly reasonable assumptions concerning a particular matter might

be derived from common information

(iii) Evaluating Presentation The accountant compares the presentation of the prospective

finan-cial statements to the AICPA presentation guidelines [see Subsections 38.4(b) and (c)]

(b) STANDARD EXAMINATION REPORT The accountant’s standard report on an examination

of prospective financial statements includes six statements:

1 A title that includes the word “independent”

2 An identification of the prospective financial statements presented

3 An identification of the responsible party and a statement that the prospective financial

state-ments are the responsibility of the responsible party

4 A statement that the accountant’s responsibility is to express an opinion on the prospective

fi-nancial statements based on the examination

5 A statement that the examination of the prospective financial statements was conducted in

ac-cordance with attestation standards established by the AICPA and, accordingly, included suchprocedures as the accountant considered necessary in the circumstances

6 A statement that the accountant believes that the examination provides a reasonable basis for

the opinion

7 The accountant’s opinion that the prospective financial statements are presented in

confor-mity with AICPA presentation guidelines and that the underlying assumptions provide a sonable basis for the forecast or a reasonable basis for the projection given the hypotheticalassumptions

rea-8 A caveat that the prospective results may not be achieved

9 A statement that the accountant assumes no responsibility to update the report for events and

circumstances occurring after the date of the report

10 The manual or printed signature of the accountant’s firm

11 The date of the examination report

The standard report on the examination of a financial forecast is as follows:

Independent Accountant’s Report

We have examined the accompanying forecasted balance sheet, statements of income, retainedearnings, and cash flows of XYZ Company as of December 31, 20XX,* and for the year then end-ing XYZ Company’s management is responsible for the forecast Our responsibility is to express

an opinion on the forecast based on our examination

Our examination was conducted in accordance with attestation standards established by the can Institute of Certified Public Accountants and, accordingly, included such procedures as we con-sidered necessary to evaluate both the assumptions used by management and the preparation andpresentation of the forecast We believe that our examination provides a reasonable basis for ouropinion

Ameri-In our opinion, the accompanying forecast is presented in conformity with guidelines for tion of a forecast established by the American Institute of Certified Public Accountants, and the un-derlying assumptions provide a reasonable basis for management’s forecast However, there willusually be differences between the forecasted and actual results, because events and circumstancesfrequently do not occur as expected, and those differences may be material We have no responsi-bility to update this report for events and circumstances occurring after the date of this report.[Signature]

presenta-[Date]

* If the presentation is summarized, the opening sentence of the report would begin, “We have amined the accompanying summarized forecast of XYZ Company as of December 31, 20X1 .”The standard report on the examination of a financial projection is as follows:

ex-Independent Accountant’s Report

We have examined the accompanying projected balance sheet, statements of income, retained ings, and cash flows of XYZ Company as of December 31, 20XX, and for the year then ending.*XYZ Company’s management is responsible for the projection, which was prepared for [state spe-cial purpose, for example, “the purpose of negotiating a loan to expand XYZ Company’s plant”].Our responsibility is to express an opinion on the projection based on our examination

earn-Our examination was conducted in accordance with attestation standards established by the ican Institute of Certified Public Accountants and, accordingly, included such procedures as we

Amer-considered necessary to evaluate both the assumptions used by management and the preparationand presentation of the projection We believe our examination provides a reasonable basis for ouropinion.

In our opinion, the accompanying projection is presented in conformity with guidelines for tation of a projection established by the American Institute of Certified Public Accountants, and theunderlying assumptions provide a reasonable basis for management’s projection [describe the hy-pothetical assumption, for example, “assuming the granting of the requested loan for the purpose ofexpanding XYZ Company’s plant as described in the summary of significant assumptions”] How-ever, even if [describe hypothetical assumption, for example, “the loan is granted and the plant isexpanded”], there will usually be differences between the projected and actual results, becauseevents and circumstances frequently do not occur as expected, and those differences may be mater-ial We have no responsibility to update this report for events and circumstances occurring after thedate of this report

presen-The accompanying projection and this report are intended solely for the information and use of[identify specified parties, for example, “XYZ Company and DEF National Bank”] and are not in-tended to be and should not be used by anyone other than these specified parties

[Signature]

[Date]

* If the presentation is summarized, the opening sentence of the report would begin, “We have amined the accompanying summarized projection of XYZ Company as of December 31,20X1 .”

ex-When the prospective financial statements are presented as a range, the report also includes a arate paragraph describing the range [see Subsection 38.6(d) for an example]

sep-(c) MODIFIED EXAMINATION REPORTS. There are four types of modified examinationreports:

1 A qualified report, used when the statements depart from the AICPA presentation guidelines

but the deficiency does not affect the assumptions (although if the matter is highly material,the accountant may issue an adverse report)

2 An adverse report, used when the statements fail to disclose significant assumptions or when

the assumptions do not provide a reasonable basis for the presentation

3 A disclaimer used when the accountant is precluded from applying procedures considered

necessary in the circumstances

4 A reference to another accountant, used when another accountant examines the prospective

fi-nancial statements of a significant portion of the entity, such as a major subsidiary

(i) Qualified Opinion The accountant issues a qualified opinion if there is a material

presenta-tion deficiency that does not affect the assumppresenta-tions The following is an examinapresenta-tion report qualifiedbecause of a presentation deficiency:

Independent Accountant’s Report

We have examined the accompanying forecasted balance sheet, statements of income, retainedearnings, and cash flows of XYZ Company as of December 31, 20XX, and for the year then ending.XYZ Company’s management is responsible for the forecast Our responsibility is to express anopinion on the forecast based on our examination

Our examination was conducted in accordance with attestation standards established by theAmerican Institute of Certified Public Accountants and, accordingly, included such procedures as

we considered necessary to evaluate both the assumptions used by management and the tion and presentation of the forecast We believe our examination provides a reasonable basis forour opinion

prepara-The forecast does not disclose significant accounting policies Disclosure of such policies is quired by guidelines for presentation of a forecast established by the American Institute of CertifiedPublic Accountants.

re-In our opinion, except for the omission of the disclosure of the significant accounting policies asdiscussed in the preceding paragraph, the accompanying forecast is presented in conformity withguidelines for presentation of a forecast established by the American Institute of Certified PublicAccountants, and the underlying assumptions provide a reasonable basis for management’s fore-cast However, there will usually be differences between the forecasted and actual results, becauseevents and circumstances frequently do not occur as expected, and those differences may be mater-ial We have no responsibility to update this report for events and circumstances occurring after thedate of this report

[Signature]

[Date]

(ii) Adverse Report The accountant who believes a significant assumption is unsupported or not

disclosed issues an adverse opinion An adverse opinion is also issued when the accountant believesthat a departure from the presentation guidelines not involving the assumptions is serious enough towarrant it The following is an example of an adverse report issued by the accountant because an as-sumption was unreasonable:

Independent Accountant’s Report

We have examined the accompanying forecasted balance sheet, statements of income, retainedearnings, and cash flows of XYZ Company as of December 31, 20XX, and for the year then ending.XYZ Company’s management is responsible for the forecast Our responsibility is to express anopinion on the forecast based on our examination

Our examination was conducted in accordance with attestation standards established by the can Institute of Certified Public Accountants and, accordingly, included such procedures as we con-sidered necessary to evaluate both the assumptions used by management and the preparation andpresentation of the forecast We believe our examination provides a reasonable basis for our opinion

Ameri-As discussed under the caption “Sales” in the summary of significant forecast assumptions, theforecasted sales include, among other things, revenue from the Company’s federal defense con-tracts continuing at the current level The Company’s present federal defense contracts will expire

in March 20XX No new contracts have been signed and no negotiations are under way for newfederal defense contracts Furthermore, the federal government has entered into contracts with an-other company to supply the items being manufactured under the Company’s present contracts

In our opinion, the accompanying forecast is not presented in conformity with guidelines for sentation of a financial forecast established by the American Institute of Certified Public Accoun-tants because management’s assumptions, as discussed in the preceding paragraph, do not provide

pre-a repre-asonpre-able bpre-asis for mpre-anpre-agement’s forecpre-ast We hpre-ave no responsibility to updpre-ate this report forevents and circumstances occurring after the date of this report

[Signature]

[Date]

There is no caveat about actual results differing from those forecasted since the accountant lieves the forecast assumptions to be unreasonable

be-(iii) Disclaimer The accountant who cannot apply all the procedures deemed necessary to support

an opinion on the statements issues a disclaimer An example of a disclaimer follows:

Independent Accountant’s Report

We were engaged to examine the accompanying forecasted balance sheet, statements of income, tained earnings, and cash flows of XYZ Company as of December 31, 20XX, and for the year thenending XYZ Company’s management is responsible for the forecast

re-As discussed under the caption “Income from Investee” in the summary of significant forecastassumptions, the forecast includes income from an equity investee constituting 23% of fore-casted net income, which is management’s estimate of the Company’s share of the investee’s income to be accrued for 20XX The investee has not prepared a forecast for the year ending December 31, 20XX, and we were therefore unable to obtain suitable support forthis assumption.

Because, as described in the preceding paragraph, we are unable to evaluate management’s sumption regarding income from an equity investee and other assumptions that depend thereon,the scope of our work was not sufficient to express, and we do not express, an opinion with re-spect to the presentation of, or the assumptions underlying, the accompanying forecast We have

as-no responsibility to update this report for events and circumstances occurring after the date ofthis report

(iv) Divided Responsibility When another accountant is involved in the examination, the

princi-pal accountant may refer to the work of the other accountant as a basis, in part, for the principrinci-pal countant’s own report The reference is done in essentially the same way divided-responsibilityreports are done for audits of historical financial statements

ac-(d) INDEPENDENCE The accountant who examines prospective financial statements is required

to be independent If not, the accountant generally issues a compilation report rather than disclaim anopinion after the examination

38.8 AGREED-UPON PROCEDURES

(a) SCOPE OF SERVICE. An engagement to apply agreed-upon procedures to prospectivefinancial statements involves applying the procedures specified by the users of the statementsand reporting the results of their application The level of service is flexible; the accountant’sreport may only be distributed to the users who specified the procedures Thus, it is a limited-distribution service

(b) PROCEDURES The procedures applied in an engagement may be limited or extensive,

de-pending on the users’ needs For example, the service may consist of procedures below the leveldone in a compilation (such as mere assembly) or may be similar to those done in an examination.Alternatively, the service may consist of different levels of procedures applied to different amounts

in the statements, such as a high level of work done on forecasted sales and very limited procedures

on forecasted expenses

An accountant may perform an agreed-upon procedures attest engagement on prospective nancial statements provided that the following conditions are met:

fi-1 The accountant is independent.

2 The accountant and the specified parties agree upon the procedures performed or to be

per-formed by the accountant Generally, the accountant’s procedures may be as limited or asextensive as the specified parties desire, as long as the specified parties take responsibilityfor their sufficiency However, mere reading of a financial forecast does not constitute a

procedure sufficient to permit an accountant to report on the results of applying upon procedures.

agreed-3 The specified parties take responsibility for the sufficiency of the agreed-upon procedures for

their purposes

4 The prospective financial statements include a summary of significant assumptions.

5 The prospective financial statements to which the procedures are to be applied are subject to

reasonably consistent evaluation against criteria that are suitable and available to the fied parties

speci-6 Criteria to be used in the determination of findings are agreed upon between the accountant

and the specified parties

7 The procedures to be applied to the prospective financial statements are expected to result in

reasonably consistent findings using the criteria

8 Evidential matter related to the prospective financial statements to which the procedures are

applied is expected to exist to provide a reasonable basis for expressing the findings in the countant’s report

ac-9 Where applicable, the accountant and the specified users agree on any agreed-upon

material-ity limits for reporting purposes

10 Use of the report is to be restricted to the specified parties.

(c) REPORTS. The accountant’s report on the results of applying agreed-upon proceduresshould contain the following elements:

1 A title that includes the word “independent”

2 Identification of the specified parties

3 Reference to the prospective financial statements covered by the accountant’s report and the

character of the engagement

4 A statement that the procedures performed were those agreed to by the specified parties

iden-tified in the report

5 Identification of the responsible party and a statement that the prospective financial

state-ments are the responsibility of the responsible party

6 A statement that the agreed-upon procedures engagement was conducted in accordance with

attestation standards established by the AICPA

7 A statement that the sufficiency of the procedures is solely the responsibility of the specified

parties and a disclaimer of responsibility for the sufficiency of those procedures

8 A list of the procedures performed (or reference to them) and related findings

9 Where applicable, a description of any agreed-upon materiality limits

10 A statement that the accountant was not engaged to and did not conduct an examination of

prospective financial statements; a disclaimer of opinion on whether the presentation of theprospective financial statements is in conformity with AICPA presentation guidelines and onwhether the underlying assumptions provide a reasonable basis for the forecast, or a reason-able basis for the projection given the hypothetical assumptions; and a statement that if theaccountant had performed additional procedures, other matters might have come to the ac-countant’s attention that would have been reported

11 A statement of restrictions on the use of the report because it is intended to be used solely by

the specified parties

12 Where applicable, reservations or restrictions concerning procedures or findings

13 A caveat that the prospective results may not be achieved

14 A statement that the accountant assumes no responsibility to update the report for events and

circumstances occurring after the date of the report

15 Where applicable, a description of the nature of the assistance provided by a specialist

16 The manual or printed signature of the accountant’s firm

17 The date of the report

The following is an example of a report on the application of agreed-upon procedures:

Independent Accountant’s Report

on Applying Agreed-Upon Procedures

Board of Directors—XYZ Corporation

Board of Directors—ABC Company

At your request, we have performed certain agreed-upon procedures, as enumerated below, with spect to the forecasted balance sheet, statements of income, retained earnings, and cash flows ofDEF Company, a subsidiary of ABC Company, as of December 31, 20XX, and for the year thenending These procedures, which were agreed to by the Boards of Directors of XYZ Corporationand ABC Company, were performed solely to assist you in evaluating the forecast in connectionwith the proposed sale of DEF Company to XYZ Corporation DEF Company’s management is re-sponsible for the forecast

re-This agreed-upon procedures engagement was conducted in accordance with attestation standardsestablished by the American Institute of Certified Public Accountants The sufficiency of these pro-cedures is solely the responsibility of the specified parties Consequently, we make no representa-tion regarding the sufficiency of the procedures described below either for the purpose forwhich this report has been requested or for any other purpose

a With respect to forecasted rental income, we compared the occupancy statistics about pected demand for rental of housing units used in the forecast to occupancy statistics for thefollowing comparable properties Comparable properties for this purpose are defined as [de-scribe characteristics of comparability, e.g., those located in Sample City with between xxxand yyy rental units, rental prices within z% of those used in the forecast.]

ex-[List comparable properties]

As a result of performing this procedure, we found occupancy statistics used in the forecast were[describe findings]

b We traced each amount in the forecast to underlying schedules prepared by management andtested the arithmetical accuracy of management’s calculations of rental income, operating in-come, and income tax expense contained thereon

We found no differences as a result of these procedures

We were not engaged to, and did not, conduct an examination, the objective of which would bethe expression of an opinion on the accompanying prospective financial statements Accord-ingly, we do not express an opinion on whether the prospective financial statements are pre-sented in conformity with AICPA presentation guidelines or on whether the underlyingassumptions provide a reasonable basis for the presentation Had we performed additional pro-cedures, other matters might have come to our attention that would have been reported to you.Furthermore, there will usually be differences between the forecasted and actual results, be-cause events and circumstances frequently do not occur as expected, and those differences may

be material We have no responsibility to update this report for events and circumstances ring after the date of this report

occur-This report is intended solely for the information and use of the Boards of Directors of ABC pany and XYZ Corporation and is not intended to be and should not be used by anyone other thanthese specified parties

Com-[Signature]

[Date]

38.9 INTERNAL USE SERVICES

(a) SCOPE OF SERVICES The accountant who assembles and submits or reports on prospective

financial statements for third-party use, must compile, examine, or apply agreed-upon procedures to them However, for internal use the accountant’s services and reports can be more flexible.

Internal use services generally are provided in the form of consulting, tax planning, or so-calledcontrollership services In these types of service, the objective of the service is not to lend credibility

to the statements and there is no third-party reliance on them, so AICPA guidelines allow the tant to structure the engagement and report to fit the circumstances

accoun-The accountant may provide compilation, examination, or agreed-upon procedures for internaluse prospective financial statements but is not required to do so

(b) DETERMINING WHETHER USE IS INTERNAL The accountant may provide internal use

services if the accountant believes that third-party use is not reasonably expected In arriving at thisbelief, the accountant may rely on the oral or written representation of management, unless some-thing comes to the accountant’s attention to contradict management’s representation

The AICPA Guide (Section 10.02) provides the following guidelines for determining whether siders are considered third parties:

out-In deciding whether a party that is or reasonably might be expected to use an accountant’s report

is considered to be a third party, the accountant should consider the degree of consistency of terest between [management] and the user regarding the forecast If their interests are substan-tially consistent (for example both the [preparer] and the user are employees of the entity aboutwhich the forecast is made), the user would not be deemed to be a third party On the other hand,where the interests of the [preparer] and user are potentially inconsistent (for example, the [pre-parer] is a nonowner manager and the user is an absentee owner), the user would be deemed athird party In some cases, this determination will require the exercise of considerable profes-sional judgment

in-(c) PROCEDURES The procedures applied in an internal use engagement are usually based on

the nature of the engagement They may focus on developing prospective data, or they may focus onimproving operations or financial planning with prospective data being only a by-product of the en-gagement

(d) REPORTS The accountant’s report for internal use services is flexible Such reports

some-times speak solely to the prospective financial statements, but often they focus on alternative or ommended courses of action

rec-The standard compilation, examination, or agreed-upon procedures reports may be issued for ternal use, but often they are not used

in-Reports on prospective financial statements for internal use generally take three broad forms:

plain paper, legend, and formal Where there is a report on the statements, it may stand alone or may

be incorporated into another report, such as a consultant’s report

(i) Plain Paper “Plain paper” means that the accountant provides neither a report on the

state-ments nor any other written communication that accompanies them In a plain-paper situation, therewould be nothing apparent to the reader to associate the accountant with the statements

(ii) Legend When an accountant’s written communication (such as a transmittal letter)

accompa-nies the prospective financial statements, the AICPA Guide (Section 22.09) requires that the tant include (1) a caveat that prospective results may not be achieved and (2) a statement that theprospective financial statements are for internal use only Many accountants choose to present this as

accoun-a legend on the staccoun-atement itself.

(iii) Formal Report The accountant may decide to issue a report on a service However, the

ac-countant is not permitted to report on a forecast or projection, even for internal use, if it does not close the significant assumptions

dis-According to the AICPA Guide (Section 22.06), a report for internal use preferably:

• Is addressed to management

• Identifies the statements being reported on

• Describes the character of work performed and the degree of responsibility taken with respect

to the statements

• Includes a caveat that the prospective results may not be achieved

• Indicates the restrictions as to the distribution of the statements and report

• Is dated as of the date of the completion of the accountant’s procedures

• For a projection, describes the limitations on the usefulness of the presentation

The following is an example of a report on an internal use service consisting of assembly of

* If the presentation is summarized as discussed in Subsection 38.4(b), the first sentence would read, in part, “We have assembled the accompanying summarized forecast of XYZ Company ”

An example of a report on the assembly of a projection is as follows:

To Mr John Doe, President

XYZ Company

We have assembled, from information provided by management, the accompanying projected balancesheet, statements of income, retained earnings, and cash flows, and summaries of significant assump-tions and accounting policies of XYZ Company as of December 31, 20XX,* and for the year then end-ing The accompanying projection and this report were prepared for [description of the special purpose,e.g., “presentation to the Board of Directors of XYZ Company for its consideration as to whether to add

a third operating shift”] We have not compiled or examined the financial projection and express no surance of any kind on it Further, even if [description of the hypothetical assumption, e.g., “the thirdoperating shift is added”], there will usually be differences between the projected and actual results, be-cause events and circumstances frequently do not occur as expected, and those differences may be ma-terial In accordance with the terms of our engagement, this report and the accompanying projection arerestricted to internal use and may not be shown to any third party for any purpose

as-* If the presentation is summarized as discussed in Subsection 38.4(b), the first sentence would read, in part, “We have assembled the accompanying summarized forecast of XYZ Company ”

In addition to the above, the accountant’s report on prospective financial statements for ternal use would:

in-1 Indicate if the accountant is not independent with respect to the client (the report would not

express any assurance on the statements if there is a lack of independence) and

2 Note any disclosures required under the presentation guidelines (see Subsection 34.4(a))

whose omission comes to the accountant’s attention (other than omitted assumptions).The report might either describe the omitted disclosures or merely note the omission of dis-closures in a manner such as:

This financial forecast was prepared to help you develop your personal financial plan.Accordingly, it does not include all disclosures required by the guidelines established

by the American Institute of Certified Public Accountants for presentation of a financialforecast

38.10 SOURCES AND SUGGESTED REFERENCES

American Institute of Certified Public Accountants, Accounting and Review Services Committee, “Compilationand Review of Financial Statements,” Statement on Standards for Accounting and Review Services No 1.AICPA, New York, 1978

, Auditing Standards Board, “Attestation Standards: Revision and Recodification,” Statement on dards for Attestation Engagements No 10, AICPA, New York, 2001

Stan-, Guide for Prospective Financial Information AICPAStan-, New YorkStan-, 1999.

Commerce Clearing House, SEC Accounting Rules CCH, Chicago, 1990.

Financial Accounting Standards Board, “Statement of Cash Flows,” Statement of Financial Accounting dards No 95 FASB, Stamford, CT, 1987

Stan-Pallais, Don, and Holton, Stephen D., Guide to Forecasts and Projections, 3rd ed Practitioners Publishing, Fort

Worth, TX, 1998

CHAPTER 39

PERSONAL FINANCIAL STATEMENTS

Dennis S Neier, CPA

Goldstein Golub Kessler LLP

Joel O Steinberg, CPA

Goldstein Golub Kessler LLP

(a) Applicable Professional Standards 2

(b) Acceptance of Clients 2

(c) Establishing an Understanding

(d) Client Representation Letters 3

39.2 GENERAL DESCRIPTION AND

(d) Limited Partnership Interests 9

(f) Options on Assets Other than

Marketable Securities 10

(h) Closely Held Businesses 10

(d) Income Taxes Payable 12

39.5 PROVISION FOR INCOME

39.1 GUIDANCE

(a) APPLICABLE PROFESSIONAL STANDARDS. The authoritative guide on the tion of personal finance statements is Statement of Position (SOP) 82-1, “Accounting and Fi-nancial Reporting for Personal Financial Statements,” issued by the American Institute ofCertified Public Accountants (AICPA)

prepara-Accountants are often engaged to compile, review, or audit personal financial statements.Standards for compilation of financial statements prescribed by Statement on Standards for Ac-counting and Review Services (SSARS) No 1, “Compilation and Review of Financial State-ments,” as amended by SSARS 8, “Amendment to Statement on Standards for Accounting andReview Services No 1,” are applicable to the compilation of personal financial statements in thesame manner as to the compilation of other financial statements

However, a subsequent AICPA release, SSARS No 6, “Reporting on Personal FinancialStatements Included in Written Personal Financial Plans,” allows accountants to prepare per-sonal financial statements that omit disclosures required by generally accepted accounting prin-ciples (GAAP) so long as the statement will be used solely in the development of the client’spersonal financial plan and not to obtain credit or to meet other disclosure requirements If anaccountant prepares a personal financial statement under this exemption, he should issue a writ-ten report stating the restricted purpose of the statement and noting that it has not been audited,reviewed, or compiled Nonetheless, SSARS No 6 does not preclude an accountant from com-plying with SSARS No 1, as amended, in such engagements (Also see Section 39.8, “Compi-lation and Review”)

Standards for review of financial statements prescribed by SSARS No 1, as amended, apply

to the review of personal financial statements in the same manner as to the review of other nancial statements (also see Section 39.8) and generally accepted auditing standards (GAAS)apply to the audit of personal financial statements in the same manner as to the audit of other fi-nancial statements

fi-Accountants may also be asked to report on specified elements, accounts, or items of a sonal financial statement In those circumstances, the guidance provided by Statement on Audit-ing Standards (SAS) No 62, “Special Reports,” or Accounting and Review ServicesInterpretation No 8 of SSARS No 1, “Reports on Specified Elements, Accounts, or Items of aFinancial Statement,” should be followed as applicable

per-(b) ACCEPTANCE OF CLIENTS. Before accepting an engagement involving personal cial statements, the accountant ordinarily would evaluate certain aspects of the potential clientrelationship

finan-The accountant may wish to consider facts that might bear on the integrity of the prospectiveclient Consideration of the character and reputation of the individual helps to minimize the pos-sibility of association with a client who lacks integrity The extent of the accountant’s inquiriesbefore acceptance might depend on his or her previous knowledge of the client and the nature ofthe client’s financial activities The accountant may want to consult predecessor accountants orauditors, attorneys, bankers, and others having business relationships with the individual re-garding facts that might bear on the integrity of the prospective client This does not suggestthat, in accepting an engagement, the accountant vouches for the integrity or reliability of aclient However, prudence suggests that an accountant be selective in determining his or herprofessional relationships

The accountant may also wish to consider circumstances that present unusual business risk,such as considering whether an individual is in serious financial difficulty

In addition, the accountant may want to consider the effect of the lack of independence onthe type of report he may issue in compliance with professional standards SSARS No 1 permitsthe accountant to issue a compilation report on personal financial statements of an individualwith respect to whom he is not independent However, the accountant should be independent toissue a review report or an audit opinion

Before accepting an engagement involving personal financial statements, the accountant maywant to ask the potential client about the availability of records and consider whether availablerecords provide a basis sufficient for providing the services requested Incomplete or inadequateaccounting records are likely to give rise to problems in compiling, reviewing, or auditing per-sonal financial statements Because of the informal nature of most personal financial records,the accountant should evaluate the need to perform other accounting services in conjunctionwith personal financial records.

Professional standards require the accountant to attain a certain level of knowledge of hisclient’s financial activities Before accepting an engagement, the accountant should considerwhether he can obtain an appropriate understanding of the nature of the prospective client’s fi-nancial activities and the specialized accounting principles and practices related to any of theclient’s financial activities

(c) ESTABLISHING AN UNDERSTANDING WITH THE CLIENT. Once the accountant hasdecided to accept an engagement involving personal financial statements, he should establish anunderstanding with the client, preferably in writing, regarding the services to be performed andthe terms and objectives of the engagement

(d) CLIENT REPRESENTATION LETTERS. During an engagement, the client makes manyrepresentations to the accountant Generally accepted auditing standards require that an inde-pendent auditor performing an audit in accordance with GAAS obtain written representationsfrom management for all financial statements and periods covered by the auditor’s reports Therepresentation should be addressed to the auditor and should be made as of a date no earlier thanthe date of the auditor’s report

SAARS No 1 requires that the accountant obtain a representation letter from the client aspart of every review engagement as well Compilation engagements do not contemplate tests ofaccounting records and of responses to inquiries by obtaining corroborating evidential matter.However, because of the informal nature of most personal financial records, it is advisable toobtain written representation from the client to confirm the oral representation made in all per-sonal financial statement engagements

39.2 GENERAL DESCRIPTION AND REQUIREMENTS

(a) DEFINITION. A personal financial statement presents the personal assets and liabilities of

an individual, a husband and wife, or a family It is not a financial statement on a business owned

by the person; in fact, it differs from a business financial statement in several important ways (seeExhibit 39.1)

The essential purpose of a personal financial statement is to measure wealth at a specified date—

to take a snapshot of the person’s financial condition It does this by presenting:

• Estimated current values of assets

• Estimated current amounts of liabilities

• A provision for income taxes based on the taxes that would be owed if all the assets were dated and all the liabilities paid on the date of the statement

liqui-• Net worth

The basic personal financial statement containing this information is called a statement of cial condition, not a balance sheet Values and amounts for one or more prior periods may be in-cluded for comparison with the current values and amounts, but this is optional The statement ofchanges in net worth is also optional (also, see Section 39.8) It presents the major sources of in-crease or decrease in net worth (see Exhibit 39.2)

finan-(b) OWNERSHIP. A personal financial statement covering a whole family usually presents theassets and liabilities of the family members in combination, as a single economic unit However,the members may have different ownership interests in these assets or liabilities For example, thewife may have a remainder interest in a testamentary trust, whereas the husband may own life in-surance with a net cash surrender value It may be useful, especially when the statement is to beused in a divorce case, to disclose each individual’s interests separately This may be done in sep-arate columns within the statement, in the notes to the statement, or in additional statements foreach individual.

Often an individual covered by the statement is one of a group of joint owners of assets, as withcommunity property or property held in joint tenancy In this case, the statement should includeonly the individual’s interest as a beneficial owner under the laws of the state If the parties’ shares

in the assets are not clear, the advice of an attorney may be needed to determine whether the son should regard any interest in the assets as his or her own, and if so, how much The statementshould make full disclosure of the joint ownership of the assets and the grounds for the allocation

per-of shares

(c) USES Many individuals or families use personal financial statements for investment, tax,

re-tirement, gift and estate planning, and obtaining credit A personal financial statement may also berequired for disclosure to the court in a divorce case or to the public when the individual is a candi-date or an incumbent of public office

(d) ACCOUNTING BASIS SOP 82-1 establishes the use of estimated current values and

amounts and the accrual basis of accounting as GAAP for personal financial statements The AICPA

Personal Financial Statements Guide (the “Guide”) allows accountants to prepare, compile, review,

or audit personal financial statements on other comprehensive bases of accounting, such as cal cost, tax, or cash

histori-(e) ORDER OF PRESENTATION Assets are presented in order of liquidity and liabilities in

order of maturity No distinction is made between current and long-term assets and liabilities becausethere is no operating cycle in a person’s financial affairs

Objective Measurement of wealth Reporting of earnings, evaluation of

performanceUses Facilitation of financial planning;

procural of credit; provision ofdisclosures to the public or thecourt

Procural of credit, information forshareholders, regulatoryrequirements

Method of

accounting

Classification None: assets presented in order of

liquidity, liabilities in order ofmaturity

Assets and liabilities classified current

or long term

Excess of assets

over liabilities

Exhibit 39.1 Personal and business financial statements compared.

Assets and liabilities of a closely held business that is conducted as a separate entity are notcombined with similar personal items in a personal financial statement Instead, the estimatedcurrent net value of the person’s investment in the entity is shown as one amount But if theperson owns a business activity that is not conducted as a separate entity, such as a real estateinvestment with a related mortgage, the assets and liabilities of the activity are shown as sepa-rate amounts.

JAMES AND JANE PERSON Statements of Financial Condition December 31, 20X3 and 20X2

Vested interest in deferred profit-sharing plan 111,400 98,900Remainder interest in testamentary trust (Note 6) 171,900 128,800Cash value of life insurance ($43,600 and $42,900), less loans

payable to insurance companies ($38,100 and $37,700)

Income taxes—current year balance $00,08,800 $0,000,400

Contingent liabilities (Note 11) $0,000,000 $0,000,000

132,000 125,400Estimated income taxes on the differences between the estimated

current values of assets and the estimated current amounts of

liabilities and their tax bases (Note 12) 239,000 160,000

$1,384,000 $1,206,700

The notes are an integral part of these statements

(Continued)

Exhibit 39.2 Illustrative financial statements (Source: Reproduced with permission from AICPA,

Per-sonal Financial Statements Guide, Appendix E: Statement of Position No 82-1, ing and Financial Reporting for Personal Financial Statements,” 1992, pp 53–58.)

“Account-JAMES AND JANE PERSON Statements of Changes in Net Worth For the Years Ended December 31, 20X3 and 20X2

Year ended December 31

Realized increases in net worth

Gains on sales of marketable securities $0,001,000 $000,500

$0,103,300 $091,300Realized decreases in net worth

Marketable securities (net of realized gains on securities sold) 3,000 500

$0,147,100 $060,500Unrealized decrease in net worth

Estimated income taxes on the differences between the

estimated current values of assets and the estimated current

amounts of liabilities and their tax bases $0,079,000 $022,000Net unrealized increase in net worth $0,068,100 $038,500

Net worth at the beginning of year $0,921,300 $863,000

The notes are an integral part of these statements

Exhibit 39.2 Continued.

JAMES AND JANE PERSON Notes to Financial Statements Note 1 The accompanying financial statements include the assets and liabilities of James and Jane

Person Assets are stated at their estimated current values and liabilities at their estimated currentamounts

Note 2 The estimated current values of marketable securities are either (a) their quoted closing prices

or (b) for securities not traded on the financial statement date, amounts that fall within the range of quoted

bid and asked prices

Marketable securities consist of the following:

December 31, 20X3 December 31, 20X2 Number of Estimated Number of Estimated Shares or Current Shares or Current

Stocks

Note 3 Jane Person owns options to acquire 4,000 shares of stock of Winner Corp at an option price

of $5 per share The option expires on June 30, 20X5 The estimated current value is its published sellingprice

Note 4 The investment in Kenbruce Associates is an 8% interest in a real estate limited partnership.

The estimated current value is determined by the projected annual cash receipts and payments ized at a 12% rate

capital-Note 5 James Person owns 50% of the common stock of Davekar Company, Inc., a retail mail order

business The estimated current value of the investment is determined by the provisions of a shareholders’agreement, which restricts the sale of the stock and, under certain conditions, requires the company to re-purchase the stock based on a price equal to the book value of the net assets plus an agreed amount forgoodwill At December 31, 20X3, the agreed amount for goodwill was $112,500, and at December 31,20X2, it was $100,000

A condensed balance sheet of Davekar Company, Inc., prepared in conformity with generally cepted accounting principles, is summarized below:

ac-(Continued)

Exhibit 39.2 Continued.

Note 6 Jane Person is the beneficiary of a remainder interest in a testamentary trust under the will of

the late Joseph Jones The amount included in the accompanying statements is her remainder interest inthe estimated current value of the trust assets, discounted at 10%

Note 7 At December 31, 20X3 and 20X2, James Person owned a $300,000 whole life insurance

pol-icy

Note 8 The estimated current value of the residence is its purchase price plus the cost of

improve-ments The residence was purchased in December 20X1, and improvements were made in 20X2 and20X3

Note 9 The estimated current values of personal effects and jewelry are the appraised values of those

assets, determined by an independent appraiser for insurance purposes

Note 10 The mortgage (collateralized by the residence) is payable in monthly installments of $815 a

month, including interest at 10% a year through 20Y8

Note 11 James Person has guaranteed the payment of loans of Davekar Company, Inc., under a

$500,000 line of credit The loan balance was $300,000 at December 31, 20X3, and $400,000 at cember 31, 20X2

De-Note 12 The estimated current amounts of liabilities at December 31, 20X3, and December 31,

20X2, equaled their tax bases Estimated income taxes have been provided on the excess of the estimatedcurrent values of assets over their tax bases as if the estimated current values of the assets had been real-ized on the statement date, using applicable tax laws and regulations The provision will probably differfrom the amounts of income taxes that eventually might be paid because those amounts are determined

by the timing and the method of disposal or realization and the tax laws and regulations in effect at thetime of disposal or realization

The estimated current values of assets exceeded their tax bases by $850,000 at December 31, 20X3,and by $770,300 at December 31, 20X2 The excess of estimated current values of major assets over theirtax bases are—

December 31

Vested interest in deferred profit-sharing plan 111,400 98,900

Exhibit 39.2 Continued.

39.3 ASSETS

(a) ESTIMATED CURRENT VALUE Assets are presented at their estimated current value This

is defined by SOP 82-1 as “the amount at which the item could be exchanged between a buyer and

a seller, each of whom is well informed and willing, and neither of whom is compelled to buy orsell.” Sales commissions and other costs of disposal should be considered if they are expected to bematerial

SOP 82-1 recognizes that determining the estimated current value of some assets may be difficult,and if the costs of doing so would appear to exceed the benefits, it recommends that the person usehis judgment

In general, the best way to determine estimated current value is by reference to recent marketprices of similar assets in similar circumstances If recent market prices are not available, other meth-ods may be used, including the use of appraisals, the adjustment of historical cost by reference to aspecific price index, the capitalization of past or prospective earnings, the use of liquidation values,

or the use of discounted amounts of projected cash receipts

Whatever method is used, it should be consistently applied from period to period for the sameasset

(b) RECEIVABLES Receivables are presented at the discounted amounts of cash expected to be

collected, using the prevailing interest rate at the date of the statement

(c) MARKETABLE SECURITIES. Marketable securities are stocks, bonds, unfulfilled futurescontracts, options on traded securities, certificates of deposit, and money market accounts forwhich market quotations are publicly available The estimated current value of a marketable secu-rity is its closing price on the date of the statement, less the expected sales commission IndividualRetirement Accounts and Keogh accounts should be presented net of the penalty charge for earlywithdrawal

If the security was not traded on that date, but published bid and asked prices are available, SOP82-1 states that the estimated current value should be within the range of those prices Some accoun-tants, however, believe that only the bid price should be used, because “people can ask all they wantfor an asset, but what matters is what others will pay for it.”1

If bid and asked prices are not available for the date of the statement, the estimated current value

is the closing price on the last day that the security was traded, unless the trade occurred so far back

in the past as to be meaningless by the date of the statement

On over-the-counter securities, unfortunately, the market does not speak with a single voice ferent quotations may be given by the financial press, quotation publications, financial reporting ser-vices, and various brokers In such a case, the mean of the bid prices, of the bid and asked prices, or ofthe prices quoted by a representative sample of brokers may be used as the estimated current value.Large blocks of stock may also pose a problem If a large block of stock were dumped on the mar-ket, the price might not hold up On the other hand, a controlling interest might be worth more, sharefor share, than a minority interest Market prices may need to be adjusted for these factors to deter-mine estimated current value Preparers should consult a qualified stockbroker for an opinion on thisproblem

Dif-Restrictions on the transfer of a stock are yet another factor that might call for an adjustment ofmarket prices to determine estimated current value

(d) LIMITED PARTNERSHIP INTERESTS. If interests in a limited partnership are activelytraded, the estimated current value of such an interest should be based on the prices of recent

1M D Kinsman and B Samuelson, “Personal Financial Statements: Valuation Challenges and Solutions,”

Jour-nal of Accountancy, September 1987, p 139.

trades If interests in the partnership are not actively traded, the current value of the nership’s underlying assets may be used to measure the value of the interest [see Subsec-tions 39.3(a) and (h)] When this method is used, the person should consider discounting thevalue of the interest for lack of marketability and lack of control over the general partner.

part-If it is not feasible to estimate the current value of the partnership’s underlying assets (and the terests are not actively traded), the estimated current value of the interest may be shown as theamount of cash that the person has invested If the underlying assets of the partnership are considered

in-to be virtually worthless, however, the interest should be valued at zero

The person’s share of the partnership’s negative tax basis, if any, should be included in the putation of the provision for income taxes (see Section 39.5)

com-The statement should disclose the person’s share of any recourse debts of the partnershipand any commitments for future funding If the person’s interest in the partnership repre-sents a substantial proportion of ownership, it may be useful to disclose summarized finan-cial information about the partnership as an investment in a closely held business [see Subsection 39.3(h)]

(e) PRECIOUS METALS. The estimated current value of precious metals, like that of ketable securities, is their closing price on the date of the statement, less the expected salescommission

mar-(f) OPTIONS ON ASSETS OTHER THAN MARKETABLE SECURITIES Options to buy assets

other than marketable securities should first be valued at the difference between the exercise priceand the asset’s current value Then this difference should be discounted at the person’s borrowingrate over the option period, if this is material The borrowing rate should reflect the cost of a loan se-cured by the asset

(g) LIFE INSURANCE. The estimated current value of a life insurance policy is its cash render value, less any loans against it This information may be obtained from the insurancecompany

sur-Disclosure of the face value of the policy is required by SOP 82-1 It may also be useful to close the death benefits that would accrue to family members covered by the statement

dis-(h) CLOSELY HELD BUSINESSES If the person has a material investment in a closely held

busi-ness that is conducted as a separate entity, the statement should disclose the name of the company,the person’s percentage of ownership, and the nature of the business It should also disclose summa-rized financial information on the company’s assets, liabilities, and results of operations, based onthe company’s financial statements for the most recent year The basis of presentation of these state-ments, such as GAAP, tax, or cash, should also be disclosed, and so should any significant loss con-tingencies

Determining the estimated current value of an investment in a closely held business, whether aproprietorship, partnership, joint venture, or corporation, is notoriously difficult The objective is toapproximate the amount at which the investment could be exchanged, on the date of the statement,between a well-informed and willing buyer and seller, neither of whom is compelled to buy or sell.This value is presented as a single item in the statement of financial condition, and a condensed bal-ance sheet of the company should be presented in the notes

SOP 82-1 recognizes several methods, or combinations of methods, for determining the timated current value of a closely held business: appraisals, multiple of earnings, liquidationvalue, reproduction value, discounted amounts of projected cash receipts, adjustments of bookvalue, and cost of the person’s share of the equity of the business If a buyout agreement existsspecifying the amount that the person will receive when he withdraws, retires, or sells out,SOP 82-1 says that it should be considered but that it does not necessarily determine estimatedcurrent value

es-A question that SOP 82-1 does not address is whether an accountant preparing a personal cial statement should try to value a closely held business at all Competence in valuing businesses re-quires a considerable degree of concentration on the subject, and some accountants’ litigationliability coverage excludes valuations Qualified appraisers, such as members of the American Soci-ety of Appraisers or the Institute of Business Appraisers, are readily available to value the business.Thus, some accountants believe that “the accountant should refrain from valuing the business inter-est himself.”2

finan-(i) REAL ESTATE The estimated current value of an investment in real estate or a leasehold may

be based on sales of similar properties in similar circumstances; on assessed value for property taxes,considering the basis of the assessment and its relationship to market values in the area; on the dis-counted amounts of projected cash flows from the property; or on an appraisal from a qualified realestate appraiser

The estimated current value of a property should be presented net of expected sales commissionsand closing costs

(j) PERSONAL PROPERTY Personal property includes but is not limited to cars, jewelry,

an-tiques, and art These items should be valued at appraisal values derived from a specialist’s opinion

or at the values given in published guides such as the Blue Book for cars If the costs of an appraisal

seem to outweigh the benefits, historical cost should be used

(k) INTANGIBLE ASSETS Patents, copyrights, and other intangible assets should be presented at

the net proceeds of a current sale of the asset or the discounted amount of cash flow arising from itsfuture use If the amounts and timing of receipts from the asset cannot be reasonably estimated, theasset should be presented at its purchased cost, evaluated for impairment

(l) FUTURE INTERESTS. The following future interests should be shown in a personal financialstatement: guaranteed minimum portions of pensions, vested interests in pension or profit-sharingplans, deferred compensation contracts, beneficial interests in trusts, remainder interests in prop-erty subject to life estates, fixed amounts of alimony for a definite future period, and annuities.Any other future interests should also be shown, so long as they are nonforfeitable rights for fixed

or determinable amounts; are not contingent on the holder’s life expectancy or the occurrence of aparticular event, such as disability or death; and do not require future performance of service bythe holder

Such future interests should be presented at their discounted amounts Suppose, for example, thatSally Smith has an $80,000 interest in her employer’s profit-sharing plan, 75% of it vested Shewould receive her benefits in a lump sum one year after leaving the company Assume the current in-terest rates on similar investments are 10%, the present value of $1 to be received in one year is

$0.9091 Thus, Smith’s interest in the profit-sharing plan would be calculated as $80,000⫻ 0.75 ⫻0.9091, and would be shown at $54,546

39.4 LIABILITIES

(a) ESTIMATED CURRENT AMOUNT Payables and other liabilities are presented at their

esti-mated current amount This is the amount of cash to be paid, discounted by the rate implicit in thetransaction in which the debt was incurred Accounting Principles Board (APB) Opinion No 21, “In-terest on Receivables and Payables,” explains how to determine this rate

2J G Siegel and L Lederfich, “Accounting and Disclosures for Personal Financial Statements,” CPA Journal,

February 1988, p 67

Although certain kinds of liabilities are not discounted in business financial statements, all ities should be presented at their discounted amounts in personal financial statements No distinction

liabil-is made between current and long-term liabilities

With some home mortgages and other debts, the person may be able to pay off the debt currently

at an amount less than the present value of future payments If this alternative exists, the debt should

be presented at the lower amount

Personal liabilities such as home mortgages are shown separately from investment liabilities such

as margin accounts Obligations related to limited partnership investments should be shown if theperson is personally liable for them Debt that was included in the valuation of an investment in aclosely held business, however, should not be shown again here

(b) NONCANCELABLE COMMITMENTS Child support, alimony, pledges to charities, and

other noncancelable commitments to pay future sums should be presented as liabilities at their counted amounts if they have all of these characteristics:

dis-• The commitment is for a fixed or determinable amount

• The commitment is not contingent on someone else’s life expectancy or the occurrence of aparticular event, such as death or disability

• The commitment does not require future performance by others, as an operating lease does

(c) CONTINGENT LIABILITIES Among the contingent liabilities that should be considered for

disclosure are personal guarantees on others’ loans, liabilities for limited partnership obligations,lawsuits against the person, inadequate medical insurance coverage, and noncoverage for personalliability Statement of Financial Accounting Standards (SFAS) No 5, “Accounting for Contingen-cies,” as amended, provides guidance on whether a contingent liability should be recorded, dis-closed in a footnote, or omitted This pronouncement says, in short, that a liability should berecorded if its related contingent loss or range of loss can be estimated and its occurrence is proba-ble If the amount of loss cannot be estimated but its occurrence is either probable or possible, therelated liability should be disclosed in a footnote If its occurrence is remote, neither recording nordisclosure is required

(d) INCOME TAXES PAYABLE Income taxes currently payable include any unpaid income taxes

for past tax years, deferred income taxes arising from timing differences, and the estimated amount

of income taxes accrued for the elapsed portion of the current tax year to the date of the statement

If the statement date coincides with the tax year end, there is obviously no difficulty in estimatingthe amount for the current year If the dates do not coincide, the estimate should be based on tax-able income to date and the tax rate applicable to estimated taxable income for the whole year Thetaxes for the current year should be shown net of amounts withheld from pay or paid with esti-mated tax returns

39.5 PROVISION FOR INCOME TAXES

(a) DEFINITION The personal financial statement presents a provision for the income taxes that

would be owed if all of the person’s assets were sold, and all of his or her liabilities paid, on the date

of the statement This provision should be shown under its full title as given in SOP 82-1: “Estimatedincome taxes on the differences between the estimated current values of assets and the estimated cur-rent amounts of liabilities and their tax bases.” It is presented in the statement as one amount and isshown between liabilities and net worth A note discloses the methods and assumptions used to com-pute it (see Exhibit 39.2)

(b) COMPUTING THE PROVISION FOR INCOME TAXES. Currently applicable incometax laws and regulations, state and local as well as federal, should be used in computing the pro-vision for income taxes Recapture of depreciation, available carryovers, the exclusion for thegain on the sale of a residence, the deductibility of state income taxes against federal incometaxes, and alternative minimum taxes should all be considered.

Because most of these considerations apply to some assets or liabilities but not to others, the vision for income taxes should be computed separately for each asset and each liability It is not nec-essary, however, to disclose all these computations in the note For example, note 12 in Exhibit 39.2,which is reproduced from SOP 82-1, shows only the excess of estimated current values over the taxbases of major assets

pro-(c) TAX BASIS. It is often difficult to determine the tax basis of an asset or liability acquiredlong ago or by inheritance or trade In such a case, the preparer may use a conservative estimate ofthe tax basis in computing the provision for income taxes, with a note disclosing how the estimatewas determined

(d) DISCLAIMER SOP 82-1 requires a statement that “the provision will probably differ from the

amounts of income taxes that might eventually be paid because those amounts are determined by thetiming and the method of disposal, realization, or liquidation and the tax laws and regulations in ef-fect at the time of disposal, realization, or liquidation.” This statement should be made in the note(see Exhibit 39.2, note 12)

39.6 STATEMENT OF CHANGES IN NET WORTH

(a) DEFINITION. A statement of changes in net worth is an optional supplement to thestatement of financial condition It presents the major sources of change in the person’s networth

Whereas the statement of financial condition may or may not show amounts for prior ods and thus may not show change in net worth at all, the statement of changes in net worthshould present:

peri-• Increases in net worth produced by income, by increases in the estimated current values of sets, by decreases in the estimated current amounts of liabilities, and by decreases in the provi-sion for income taxes

as-• Decreases in net worth produced by expenses, by decreases in the estimated current values ofassets, by increases in the estimated current amounts of liabilities, and by increases in the pro-vision for income taxes

The statement of changes in net worth does not attempt to measure net income It combines come and other changes because the financial affairs of an individual or family are a mixture of busi-ness and personal activities

in-The accountant is not precluded from undertaking an engagement to issue a compilation port on a statement of financial condition when a statement of changes in net worth has notbeen prepared

re-(b) USES. Accountants have often found that lenders do not require a statement of changes innet worth from persons seeking credit; and that credit-seekers, for their part, are not eager to re-veal so much information about their standard of living But a statement of changes in net worthcan be very useful in financial planning As one accountant observes, knowing the amounts andsources of increase or decrease in wealth enables the person to estimate how much he or she will

have to increase earnings or decrease consumption to achieve a desired level of wealth—or, on theother hand, how much he or she may decrease earnings or increase consumption and still achievethe same goal.3

(c) FORMAT The sample statement of changes in net worth shown in Exhibit 39.2, which is

re-produced from SOP 82-1, distinguishes realized from unrealized sources of increase or decrease innet worth, thus dividing the sources into four categories: realized increases, realized decreases, unre-alized increases, and unrealized decreases

39.7 DISCLOSURES

A personal financial statement should include sufficient disclosures to make it adequately tive These disclosures may be made either in the body of the statement or in the notes The follow-ing list, although not exhaustive, indicates the nature and type of information that should ordinarily

informa-be disclosed:

• The names of the individuals covered by the statement

• The fact that assets are presented at their estimated current values and liabilities at their mated current amounts

esti-• The methods used to determine current values and amounts, and any change in these methodsfrom one period to the next

• If any assets shown in the statement are jointly held, the nature of the joint ownership

• If the person’s investments in securities are material in relation to his or her other assets, and ifthey are concentrated in one or a few companies or industries, the names of those companies orindustries and the estimated current value of each security

• Information on material investments in closely held businesses, including the name of the pany; the person’s percentage of ownership; the nature of the business; summarized financialinformation on the company’s assets, liabilities, and results of operations, based on the com-pany’s financial statements for the most recent year; the basis of presentation of these state-ments, such as GAAP, tax, or cash; and any significant loss contingencies

com-• Description of intangible assets and their estimated useful lives

• The face amount of life insurance

• Nonforfeitable rights, such as pensions based on life expectancy, that were omitted from thestatement because they do not have all the characteristics required for inclusion [see Sub-section 39.3(l)]

• The following tax information:

• The methods and assumptions used in computing the provision for estimated income taxes

on the differences between the estimated current values of assets and the estimated currentamounts of liabilities and their tax bases

• A statement that this provision will probably differ from the amounts of income taxes thatmight eventually be paid, because these amounts will be determined by the actual timing andmethod of disposal, realization, or liquidation, and by the tax laws and regulations in effect

at the time of disposal, realization, or liquidation

• Unused operating-loss and capital-loss carryforwards

• Other unused deductions and credits, with their expiration periods, if applicable

3I O Bull, “Personal Financial Statements—Suggestions for Improvement,” CPA Journal, December

1984, p 42

• The differences between the estimated current values of major assets and the estimatedcurrent amounts of major liabilities, or categories of assets and liabilities, and their taxbases

• Maturities, interest rates, collateral, and other pertinent details on receivables and debt

• Related-party transactions such as notes receivable or notes payable to other family members

• Contingencies such as pending lawsuits and loan guarantees

• Noncancelable commitments, such as operating leases, that do not have all the characteristicsrequired for inclusion [see Subsection 39.4(b)]

• Subsequent events, such as a decline in value of an asset after the statement date

39.8 COMPILATION

An accountant can compile or review personal financial statements based on an individual’s tation of the estimated current values of assets and the estimated current amounts of liabilities The ac-countant, however, should obtain an understanding of the methods the individual used to reach theconclusions regarding estimated values of assets and amounts of liabilities and determine that thosemethods were appropriate in the circumstances In many engagements, the accountant will be in-volved with the client in determining the estimated values

represen-The standards applicable to compilations of financial statements in SSARS No 1 are applicable

to personal financial statements

The SSARS No 1 performance standards require an accountant, in both a compilation and areview, to reach an understanding with the client as to the services to be performed—compila-tion, review, or audit The understanding may be oral or written However, the use of a well-written engagement letter spelling out all services to be performed and establishing the fee

structure is advised to avoid subsequent disputes and fee disagreements The AICPA Personal Financial Statement Guide includes sample engagement letters for compilations, reviews, and

audits in Appendix A

The accountant should also have a general understanding of the nature of the individual’s cial transactions, form of available records, qualifications of accounting personnel, if any, the ac-counting basis on which the statements are to be presented, and the form and content of thestatements For example, the statements may be on a GAAP, cash, or tax basis

finan-A compilation requires an understanding of the individual’s business and personal recordsnecessary to compile personal financial statements in appropriate format Similarly, an under-standing is necessary in a review engagement to determine the appropriate inquiry and analyt-ical procedures necessary to support the review assurance on the individual’s financialstatements

Knowledge required is generally gained through experience with the client’s records and ments and through inquiries The accountant must consider other services that may be necessary tocompile an individual’s financial statements, such as assembling records, determining values for as-sets, establishing current amounts of liabilities, income tax services, and so forth

state-Ordinarily an accountant can compile personal statements based on the individual’s sentation of the estimated current values of assets and the estimated current amounts of liabili-ties, although, as indicated, assistance in determining these amounts is often required of theaccountant At a minimum, the accountant should have a clear understanding of the methodsused to determine the estimated current values of significant assets and the estimated currentamounts of significant liabilities and be satisfied that those methods are appropriate consideringthe circumstances of the engagement

repre-Although it will be necessary, in most engagements, for the accountant to assist the client in ering the current values and amounts for the statements, it must be recognized that the accountant isnot an appraiser of assets or an expert in determining present values for items such as pension plans

gath-and other assets gath-and liabilities that may appear in personal financial statements Therefore, it is propriate for the accountant to rely on the services of an expert, such as a real estate appraiser or anactuary, in gathering and evaluating client information.

ap-In a compilation, the accountant is not required to make inquiries or perform other dures to verify, corroborate, or review information supplied by the individual However, if theaccountant has reason to believe that the information supplied by the client is not correct, is in-complete, or is otherwise unsatisfactory to support the compilation of personal financial state-ments, he should attempt to obtain additional or revised information If the client refuses toprovide additional or revised information, or the accountant cannot otherwise obtain theneeded information, he should withdraw from the engagement

proce-Before issuing the report, the accountant should read the compiled personal statementsand consider whether they appear to be appropriate in form and free from obvious materialerrors

The term “errors” refers to mistakes in compiling financial statements, including metical or clerical mistakes, and mistakes in applying accounting standards, which includesinadequate disclosure Examples of errors that might occur in personal financial statementsprepared in conformity with GAAP (SOP 82-1) include: failure to record estimated incometaxes on the differences between the estimated current values of assets and the estimated cur-rent amounts of liabilities and their tax bases; not disclosing the way estimated current val-ues and amounts were determined; and presenting asset or liability amounts at an obviouslyinappropriate value or amount

arith-Paragraphs 16 through 18 of SSARS No 1, as amended by SSARS No 8, permit an tant to compile financial statements that omit substantially all disclosures required by GAAP.However, if personal financial statements omit disclosure of the use of a comprehensive basis ofaccounting other than estimated current values and amounts, the accountant should follow theguidance in Interpretation 12 of SSARS No 1 Also, since GAAP for personal financial state-ments involve measurement principles different from those for other reporting entities, the ac-countant should disclose the use of estimated current values and amounts in his report if thedisclosure is not provided in the financial statements

accoun-If the accountant believes that the methods used to determine the estimated current values

of assets and the estimated current amounts of liabilities are not in accordance with SOP

82-1, or if he believes that the methods are not appropriate in light of the nature of each asset andliability, he should modify his report because of a departure from GAAP or withdraw from theengagement

If uncertainties are encountered in personal financial statements, the accountant would nothave to modify the standard report provided the financial statements appropriately disclose thematter However, the accountant may wish to draw attention to such uncertainty in an explana-tory paragraph of his compilation report If so, he should follow the guidance in Interpretation

No 11 of SSARS No 1

39.9 REVIEW

Performance standards for reviews of personal financial statements are identical to those lished in SSARS No 1 for compilation engagements In addition, however, in reviewengagements, the accountant must perform inquiry and analytical procedures sufficient to pro-vide a reasonable basis for expressing limited assurance that there are no material modifica-tions that should be made to the client’s personal financial statements for them to be inconformity with GAAP or other comprehensive basis of accounting

estab-A review is not an audit and does not include a study and evaluation of internal accounting trol, tests of accounting records, and other evidential procedures normally performed during an audit.Thus, a review does not provide assurance that the accountant will become aware of all significant

con-matters that would be disclosed in an audit However, if the accountant becomes aware of tion that appears incorrect, incomplete, or otherwise unsatisfactory, he or she should perform the ad-ditional procedures considered necessary to achieve limited assurance that there are no materialmodifications that should be made to the financial statements for them to be in conformity with thebasis of reporting.

informa-As amended, SSARS No 1 requires a written representation letter in all review engagements diting standards require such a representation letter in audit engagements Also, the Guide encour-ages use of the representation letter in personal financial statement compilation engagements Anexample representation letter appropriate for a compilation, review, or audit engagement is repro-duced in Appendix C of the Guide

Au-39.10 AUDITS

Generally accepted auditing standards apply to audits of personal financial statements, as they do toother audit engagements As with any financial statement, the audit objective in personal financialstatement engagements is to attest to the fairness of the assertions embodied in the statements Spe-cial attention must be given to the establishment of estimated current values and amounts in accor-dance with SOP 82-1

The GAAS requires a study and evaluation of internal accounting control, tests of accountingrecords and of responses to inquiries, and other evidence procedures considered necessary in the cir-cumstances of the engagement Because internal control is not usually a consideration, most of theindependent auditors’ effort in forming an opinion of personal financial statements consists of gath-ering evidential matter to support the assertions of existence and valuation of assets and the rightsand obligations associated with those assets

Often, as a result of the inadequacy of personal financial records, significant restrictions are posed on the auditor’s efforts to obtain needed evidential matter to support an opinion on personal fi-nancial statements Accordingly, expressing an unqualified opinion is not possible For this reason,most personal statement engagements are compilations, with some reviews

of changes in net worth Usually the accountant is asked to report on current period statements only, though sometimes comparative statements are required

al-Reporting standards in the SSARSs apply to compilations and reviews of personal financial ments In a compilation or review engagement, an accountant is required to issue a report wheneverthe compilation or review is complete; and this requirement is applicable to the personal financialstatements of an individual, as specified by SSARS No 1

state-Personal financial statements compiled by an accountant should be accompanied by a report ing that:

stat-A compilation has been performed in accordance with Statements on Standards for stat-Accounting andReview Services issued by the American Institute of Certified Public Accountants (modified bySSARS No 7)

A compilation is limited to presenting in the form of a personal financial statement(s) informationthat is the representation of the individual

The financial statement(s) have not been audited or reviewed and, accordingly, the accountant doesnot express an opinion or any other form of assurance on them.

(SSARS No 1, paragraph 14, modified for personal financial statements)

Any other procedures the accountant performs in connection with the engagement should not bementioned in the report

The compilation report is addressed to the individual whose financial statement(s) are compiledand the date of the report is the date of the completion of the compilation Also, each page of thestatement of financial condition (and the statement of changes in net worth, if presented) should in-clude a reference “See Accountant’s Compilation Report.”

The standard compilation report, covering both the statement of financial condition and the ment of changes in net worth, follows (from Chapter 5, paragraph 3 of the Guide, modified appro-priately by SSARS No 7):

state-I [we] have compiled the accompanying statement of financial condition of [James and Jane son] as of [date], and the related statement of changes in net worth for the [period] then ended, inaccordance with Statements on Standards for Accounting and Review Services issued by the Amer-ican Institute of Certified Public Accountants

Per-A compilation is limited to presenting in the form of financial statements information that is the resentation of the individuals whose financial statements are presented I [we] have not audited orreviewed the accompanying financial statements and, accordingly, do not express an opinion or anyother form of assurance on them

rep-An accountant may be asked to compile personal financial statements that omit substantially alldisclosures required by GAAP (SOP 82-1), including disclosures that might appear in the body of thestatements Such reporting is appropriate provided the omission of the disclosures is clearly indi-cated in the accountant’s compilation report and the accountant is not aware that the disclosures arebeing omitted for the purpose of misleading the intended users of the statements For example, itwould not be appropriate to omit from personal financial statements intended for use in obtaining ahome mortgage informative disclosures that would be important to the financial institution in makingthe loan decision If disclosures are omitted, and certain selected information is presented in the foot-notes, for example, information important in obtaining a mortgage loan, such information should belabeled “Selected Information—Substantially All Disclosures Required by Generally Accepted Ac-counting Principles Are Not Included.”

If substantially all disclosures are omitted from the personal financial statements and thestatements do not disclose that the assets are presented at their estimated current values and thatthe liabilities are presented at their estimated current amounts, the accountant should include thisdisclosure in his or her compilation report If the statements have been presented on a compre-hensive basis of accounting other than GAAP, that basis of accounting, if not disclosed in thestatements, must be included in the accountant’s report

The standard compilation report for personal financial statements, omitting substantially alldisclosures, covering both the statement of financial condition and the statement of changes innet worth, is presented below from the Guide, Chapter 5, paragraph 4, modified appropriately bySSARS No 7:

I [we] have compiled the accompanying statement of financial condition of [James and Jane son] as of [date], and the related statement of changes in net worth for the [period] then ended, inaccordance with Statements on Standards for Accounting and Review Services issued by the Amer-ican Institute of Certified Public Accountants

Per-A compilation is limited to presenting in the form of financial statements information that is the resentation of the individuals whose financial statements are presented I [we] have not audited orreviewed the accompanying financial statements and, accordingly, do not express an opinion or anyother form of assurance on them

rep-[James and Jane Person] have elected to omit substantially all of the disclosures required by ally accepted accounting principles If the omitted disclosures were included in the financial state-ments, they might influence the user’s conclusions about the financial condition of [James and JanePerson] and changes in their net worth Accordingly, these financial statements are not designed forthose who are not informed about such matters.

gener-As previously stated, if the statements do not disclose the basis of valuing assets and the basis ofpresentation of liabilities, this information must be included in the above report The following sen-tence should be included at the end of the first paragraph of the above report:

The financial statements are intended to present the assets of [James and Jane Person] at estimatedcurrent values and their liabilities at estimated current amounts

Also, if the statements are presented on a comprehensive basis of accounting other than GAAPand that basis is not disclosed in the statements, the following sentence (which assumes the individ-ual is reporting on the tax basis) would be appropriate as the last sentence of the first paragraph of thecompilation report (SSARS No 1, Interpretation No 12, “Reporting on a Comprehensive Basis ofAccounting Other Than Generally Accepted Accounting Principles):

The financial statements have been prepared on the accounting basis used by the individual for eral income tax purposes, which is a comprehensive basis of accounting other than generally ac-cepted accounting principles

fed-An accountant may issue a compilation report on the personal financial statements of an dividual even though he or she is not independent with respect to that individual In such cases,the “not independent” accountant must modify the compilation report to clearly state the nonin-dependent status The specific reason or reasons for the lack of independence should not be dis-cussed The accountant should simply add a bland additional paragraph to the compilationreport stating:

in-I am [we are] not independent with respect to [name of individual]

Sometimes an accountant is requested by an individual to assist in assembling data for thecompletion of a standard preprinted loan form and sign the form, or to sign such a form theclient has compiled SSARS No 3, “Compilation Reports on Financial Statements Included inCertain Prescribed Forms,” provides an alternative form of standard compilation report when aprescribed form or related instructions call for departure from GAAP by specifying a measure-ment principle not in conformity with GAAP or by failing to request the disclosures required

de-If engaged to report on information included in a prescribed form meeting the definitions inSSARS No 3 regarding personal financial statements, an accountant should follow the standardform for such compilation reports prescribed by the Guide, Chapter 5, paragraph 8, as modified

by SSARS No 7 It is important to remember to use the following form of accountant’s reportfor personal financial statements included in prescribed forms that call for departures fromGAAP Such statements call for departures from GAAP by not requesting footnotes or by re-questing information in the body of the statements that is not in conformity with SOP 82-1, forexample, GAAP:

I [we] have compiled the [identification of financial statements, including period covered andname of individual(s)] included in the accompanying prescribed form, in accordance with State-ments on Standards for Accounting and Review Services issued by the American Institute of Cer-tified Public Accountants.

My [our] compilation was limited to presenting in the form prescribed by [name of body] tion that is the representation of the individuals whose financial statements are presented I [we]have not audited or reviewed the financial statements referred to above and, accordingly, do not ex-press an opinion or any other form of assurance on them

informa-These financial statements (including related disclosures) are presented in accordance with therequirements of [name of body], which differ from generally accepted accounting principles.Accordingly, these financial statements are not designed for those who are not informed aboutsuch differences

If the information presented in the prescribed form does not disclose that the personal ments present assets at their estimated current values and liabilities at their estimated currentamounts, the accountant’s compilation report should include the following as the final paragraph

state-of the above report:

Except as prescribed by the requirements of [name of body], the financial statements are intended topresent the assets of [James and Jane Person] at estimated current values and their liabilities at esti-mated current amounts

If there are departures from the requirements of the form, other than GAAP, and the tant is aware of these departures, he must modify the compilation report by adding an additionalparagraph or paragraphs, if necessary, to alert the reader to the deficiencies For example, thefinal paragraph of a compilation report with departures from the requirements of the form mightread:

accoun-However, I did become aware of a departure from generally accepted accounting principles that isnot called for by the prescribed form or related instructions [describe the departure and its effect onthe statements, if known, or state that the effect has not been determined]

An accountant should not sign a preprinted accountant’s report that does not conform with theguidance in SSARS No 1 regarding the standard compilation report If the preprinted report formcannot be appropriately revised, the accountant should attach his or her own report following theguidance provided in SSARS No 3 or SSARS No 1, as appropriate

An accountant compiling or reviewing personal financial statements may become aware of

a departure from GAAP—SOP 82-1 involving either measurement principles or disclosureprinciples, or both If the accountant decides that attempting to explain the GAAP deficien-cies in the personal financial statements in his report will not adequately communicate theproblems to potential statement users, the accountant should withdraw from the engagementand issue no report

If the accountant believes he can appropriately communicate the departure in the lation or review report, the problem should be described in a separate paragraph of the re-port The separate paragraph(s) should explain what GAAP requires, what the client hasdone, and the effects of the departure on the statements, if such effects have been deter-mined If the effects have not been determined, this fact should also be disclosed in the sep-arate paragraph(s)

compi-For example, if the client has reported an investment at cost, rather than at fair value as required

by GAAP for personal financial statements, and the accountant cannot persuade the individual tochange the amount, the following text might be added to a standard compilation on a “statement offinancial condition”—note that the last sentence of the second paragraph of the report has been mod-ified to reference the GAAP departure explained in the third paragraph:

I have compiled the accompanying statement of financial condition of [Tom Shipp] as of [date], inaccordance with Statements on Standards for Accounting and Review Services issued by the Amer-ican Institute of Certified Public Accountants.

A compilation is limited to presenting in the form of financial statements information that is therepresentation of the individual whose financial statements are presented I have not audited orreviewed the accompanying financial statement and, accordingly, do not express an opinion orany other form of assurance on it However, I did become aware of a departure from generallyaccepted accounting principles that is described in the following paragraph

As disclosed in Note x to the financial statements, generally accepted accounting principles quire that assets be presented at their estimated current values and that liabilities be presented

re-at their estimre-ated current amounts [Tom Shipp] has informed me thre-at his investment inBrooks, Inc., is stated in the accompanying financial statements at cost and that the effects of thisdeparture from generally accepted accounting principles on his financial condition have notbeen determined

If the above GAAP departure existed in a review engagement, an identical description paragraph would be added to the review report explaining the use of the cost basis in place ofestimated current amounts In the case of a review, the third paragraph of the review reportwould read:

Based on my review, with the exception of the matter described in the following paragraph, I amnot aware of any material modifications that should be made to the accompanying financial state-ment in order for it to be in conformity with generally accepted accounting principles

The final paragraph would be as presented above in the compilation report for Tom Shipp.(Modified from the Guide, Chapter 5, paragraph 12, to conform to current standards.)

The standard review report should express limited assurance that, based on the performance of quiry and analytical procedures, the accountant is not aware of any material modifications thatshould be made to the personal financial statements for them to be in conformity with GAAP or othercomprehensive basis of accounting

in-The standard review report, from the Guide, Chapter 5, paragraph 10, modified by SSARS

No 7, follows:

I [We] have reviewed the accompanying statement of financial condition of [James and Jane son] as of [date], and the related statement of changes in net worth for the [period] then ended, inaccordance with Statement on Standards for Accounting and Review Services issued by the Amer-ican Institute of Certified Public Accountants All information included in these financial statements

Per-is the representation of [James and Jane Person]

A review of personal financial statements consists principally of inquiries of the individuals whosefinancial statements are presented and analytical procedures applied to financial data It is substan-tially less in scope than an audit in accordance with generally accepted auditing standards, the ob-jective of which is the expression of an opinion regarding the financial statements taken as a whole.Accordingly, I [we] do not express such an opinion

Based on my [our] review, I am [we are] not aware of any material modifications that should bemade to the accompanying financial statements in order for them to be in conformity with generallyaccepted accounting principles

Reviews of personal financial statements are not nearly as frequent as compilations Reviews aremore involved, requiring inquiry and analytical procedures, and carry considerably more profes-sional responsibility on the part of the accountant than does a compilation engagement Also, theyare more expensive Generally, reviews are viewed by the public and the legal system as somethingjust below an audit in professional responsibility, when in fact a review does not include any of theevidence gathering procedures found in audit engagements Reviews are generally considered by the

profession to be just a step or two above a compilation and far below the responsibility associatedwith an audit engagement.

Audits of personal financial statements are the rarest of the three types of engagements primarilybecause of the general lack of adequate accounting records supporting personal assets, liabilities, andequities, and the transactions data affecting those balances Also, the standards requiring presentation

of a statement of financial condition with assets at estimated fair values and liabilities at estimatedcurrent amounts create audit problems The auditor frequently is unable to obtain sufficient compe-tent evidential matter to support an opinion on personal financial statements Many such engage-ments involve a “disclaimer of opinion” because of scope restrictions on the auditor’s ability toobtain necessary evidence

The auditor will attempt to obtain evidence as to the individual’s assertions regarding the tence of assets and the proper determination of their fair values and the amount of liabilities and theappropriateness of the underlying estimates

exis-Following is the auditor’s standard report appropriate for personal financial statements (Guide,Chapter 5, paragraph 13):

INDEPENDENTAUDITOR’SREPORT

I [We] have audited the accompanying statement of financial condition of [James and Jane Person]

as of [date], and the related statement of changes in net worth for the [period] then ended These nancial statements are the responsibility of [James and Jane Person] My [Our] responsibility is toexpress an opinion on these financial statements based on my [our] audit

fi-I [We] conducted my [our] audit in accordance with generally accepted auditing standards Thosestandards require that I [we] plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement An audit includes examining, on

a test basis, evidence supporting the amounts and disclosures in the financial statements An auditalso includes assessing the accounting principles used and significant estimates made by [James andJane Person], as well as evaluating the overall financial statement presentation I [We] believe that

my [our] audit provides a reasonable basis for my [our] opinion

In my [our] opinion, the financial statements referred to above present fairly, in all material spects, the financial condition of [James and Jane Person] as of [date], and the changes in their networth for the [period] then ended in conformity with generally accepted accounting principles

re-The Guide presents examples of auditor’s reports on personal financial statements modified cause of scope restrictions (qualified opinions and disclaimer of opinions) and reports modified be-cause of departures from GAAP (qualified opinions and adverse opinions) These reports are veryunusual because the individual will usually request a compilation or, at most, a review of personalstatements Only individuals in political office or those in positions where their financial status isbeing challenged will need an audit of their personal wealth

be-Statement on Auditing Standards No 62, “Special Reports,” paragraphs 9 and 10, probablyapply to disclosure in personal financial statements presented on the cash or tax basis of ac-counting (OCBOA) The disclosure standards in OCBOA statements are essentially the same

as for GAAP statements, especially for those items appearing in the tax basis or modified cashbasis statements that are the same as or similar to items that appear in GAAP basis statements(as AICPA AU 9623.88) For those items, such as depreciation, long-term debt, and owners’equity, the disclosures should be comparable to those in GAAP statements, but with much lessdetail in the disclosure information For example, a general description of the GAAP depreci-ation methods without the GAAP amounts and their differences from the OCOBA deprecia-tion may be sufficient to communicate the qualitative information needed to disclose thesubstance of the GAAP transaction.4

4“Emerging Issues Task Force Interpretation of SAS No 62,” AICPA, Journal of Accountancy, January 1988.