Estate Accounting and Financial Reporting.
The purpose of this article is to identify the presentation, disclosure, and reporting issues that the CPA is likely to encounter when preparing/reporting on financial statements of an estate. Questions that will be addressed in this article include:
* Do generally accepted accounting principles [GAAP] exist for financial statements of an estate?
* What are the unique aspects of an estate accounting?
* Are the Statements on Standards for Accounting and Review Services [SSARSs] applicable to estate accounting engagements?
* If the SSARSs reporting requirements are applicable to an estate accounting, what type compilation/review report should be issued as a result of these engagements?
Do GAAP Exist for Financial Statements of an Estate?
Since no authoritative rule-making body designated by the Council of the American Institute of Certified Public Accountants [AICPA] has issued any technical literature applicable to an estate accounting, and since the determination of how to account for an estate depends upon [or is subject to] a proper interpretation of a governing instrument [i.e., the will] and the laws of the state having jurisdiction over the estate, some CPAs argue that there are no GAAP related to an estate accounting. However, the fact that no AICPA Council-designated pronouncement addresses estate accounting and reporting issues does not necessarily mean that there are no GAAP for these engagements.
The basic accounting conventions included in The Uniform Principal and Income Act [the Act] of 1931 and/or the 1962 Revised Act have been adopted by forty-two states. Also, the Uniform Laws Commission has developed two new model statutes that, if/when adopted, will change the statutory responsibilities of trustees/fiduciaries. The Uniform Prudent Investor Act "raises the bar" of care for trustees/fiduciaries by requiring them to utilize modem portfolio theory in the development of investment management strategies. To date, thirty-six states have enacted this law. The new Uniform Principal and Income Act  also was approved by the Commission in July 1997. However, to date, only one state [Oklahoma] has adopted the provisions of the 1997 Act. As such, this article utilizes the provisions of the more widely-used 1931 Act [as amended in 1962].
Section 2(a) of the 1962 Revised Act provides a hierarchy of accounting authority for the treatment of a fiduciary transaction [including transactions associated with an estate]. This GAAP hierarchy is as follows:
* First level -- the governing instrument [i.e., the will].
* Second level -- if the governing instrument is silent related to a particular transaction, the CPA should look next to state law.
* Third level -- if state law is silent about a particular transaction, the Act stipulates that the accounting for the transaction should be based on whatever is considered to be both reasonable and equitable.
The Act creates an interesting dilemma for CPAs. On the positive side of the issue, it establishes a body of accounting guidance that can be applied consistently in most states. On the negative side [by making the governing instrument the overriding authority for each estate accounting engagement], it creates an inconsistent set of circumstances where potentially no two estates are accounted for in the same manner. The potential inconsistency in accounting, and the ability of the governing instrument to establish unique estate accounting principles, are the main reasons that some CPAs believe that GAAP do not exist for fiduciary engagements. CPAs who agree with this reasoning conclude that the basis of accounting used by an estate is not GAAP; rather, they argue that it is the basis defined in the governing instrument [i.e., the will].
[Practitioner Note: After outlining a GAAP hierarchy for an estate accounting, the Act also discusses in detail how to account for various receipts and expenditures as well as delineating what transactions normally affect principal and income. CPAs should become very familiar with this Act and/or other governing state laws when they are engaged to prepare an accounting of an estate.]
In addition to the Act, the Committee on National Fiduciary Accounting Standards [formed in 1972 with its report issued in May 1980], comprised of representatives from the American Bankers Association Trust Division, the American Bar Association Section on Real Property, Probate and Trust Law, the American College on Probate Counsel, the National Center for State Courts, the National College of Probate Judges, and the AICPA jointly formed a National Fiduciary Accounting Standards Project Committee. The final report of the Committee, Uniform Fiduciary Accounting Principles and Model Account Formats, establishes a basic objective for an estate accounting and six accounting principles that may be utilized in the accounting for an estate.
According to the Committee report, the fundamental objective of an estate accounting should be to provide essential and useful information in a meaningful form to the parties interested in the accounting process. It also is important that the accounting be sufficiently simple to enable its preparation without unreasonable expense to the estate or undue distraction from the ongoing administration of the estate. Finally, although the parties should understand the nature of the accounting process and the need to protect their interests, the relationship of trust and confidence existing between the executor of the estate and the beneficiaries of the estate is [within itself] very important and the accounting should not be presented in an adversarial format that will impair this relationship.
The following fiduciary accounting principles were established by the Committee:
* Accounts should be stated in a manner that is understandable by persons who are not familiar with practices and terminology peculiar to the administration of estates.
* An estate accounting should include a concise summary of its purpose and content.
* An estate accounting should contain sufficient information to put the interested parties on notice as to all significant transactions affecting the administration of the estate during the reporting period.
* An estate accounting should include both carrying values [representing the value of assets at acquisition by the executor] and current values at the beginning and end of the reporting period.
* Gains and losses incurred during the reporting period should be shown separately in the same schedule.
* The estate accounting should reflect significant transactions that do not affect the amount for which the executor is accountable.
What are the Unique Aspects of an Estate Accounting?
CPAs quickly will become aware of the fact that an estate accounting engagement is unique when compared to other "typical" accounting engagements. Some of the unique aspects of these engagements are:
* The normal valuation basis for the assets of an estate is the current value of those assets as of the date that the financial statement(s) is prepared. This valuation basis contrasts sharply with the historical cost basis of accounting utilized in financial statements of the typical corporate reporting entity.
* The determination of how to account for principal and/or income of the estate normally depends on the terms of each will or on the requirements of state law. As such, there can be a lack of consistency between/among individual estates in the accounting for transactions that affect principal or income. This inconsistency significantly is different from the relative consistency of accounting for most transactions of the typical corporate reporting entity.
* The executor of an estate is not responsible for recording liabilities; he/she only is responsible for the assets of the estate. Creditors are responsible for filing claims against the estate, but these claims are not reflected as liabilities in the financial statements. Further, notes payable secured by a deed of trust on assets of an estate are not reflected in the estate accounting as liabilities; only cash payments on these claims/debts are reflected in the estate accounting under the disbursement caption. Accounting requirements for the typical corporate reporting entity include measurements associated with both assets and liabilities.
* Although some estate accountings are a matter of public record, rarely are they requested by [or submitted to] third parties. Rather, these accountings merely are a part of the legal papers in an accounting proceeding, served on the specific parties interested in the estate being settled. Financial statements of the typical corporate reporting entity are considered to be "general purpose" financial statements available for use by a wide variety of investors, creditors, and other interested parties.
The primary accounting practices that have emerged in recent years that could be categorized as GAAP for an estate accounting are as follows:
* The assets under the executor's control should be accounted for in accordance with the will and/or state law. Normally, such accounting pertains to the determination of transactions that affect the interests of various classes of beneficiaries.
* Assets over which the executor has no control are excluded from any financial statements reported on and/or prepared.
[Practitioner Note: Most importantly, CPAs should be aware that the term "estate" might have different meanings in different contexts. The "administrative estate" and the "taxable estate" of a decedent in many cases will include different property. For example, a taxable estate may include gifts made before death that still are considered to be taxable property of the estate. These gifts would not be part of the administrative estate since the executor has no control over these assets. Financial statements that are prepared on an income tax basis, rather than on a GAAP basis, would be considered prepared on a comprehensive basis of accounting other than GAAP. In these circumstances, certain assets over which the executor has no control might be included in the estate accounting.]
* Assets are not recognized in the estate accounting until there is passage of legal title, other indications of ownership, or the asset has been converted to cash. Therefore, receivables are not recognized unless there is written evidence of their existence. Further, accrued interest and dividends may be assets for estate tax purposes but not for GAAP estate accounting purposes.
* Liabilities and disbursements are not recognized until there is payment by transferring cash or another asset of the estate. This is a departure from the usual practice [even for a tax or modified cash basis reporting entity] of recognizing liabilities when assets are acquired. For example, the assets of an estate might include a farm with a related mortgage payable. The estate accounting would disclose the current value of the farm but not the related mortgage debt. Many CPAs are uncomfortable with this departure from "typical" accounting practices for reporting entities other than estates and encourage the executor to disclose in a note the related debt in note [or parenthetically on the face of the financial statement].
[Practitioner Note: The use of cash basis recognition principles creates another potentially confusing issue for CPAs. Some CPAs believe that the term GAAP is synonymous with accrual accounting. Therefore, they believe it would be incorrect to imply that the accounting for an estate is in accordance with GAAP. As such, these CPAs would characterize the estate accounting as being in accordance with cash basis accounting and reporting principles.]
* There is one principal financial statement [referred to as a Charge and Discharge Statement or a Summary of Account] that may be supported by supplementary schedules and/or notes explaining items reflected in the financial statement. The statement most closely resembles the Statement of Cash Flows that is included in the financial statements of the typical corporate reporting entity. It begins with assets available at the beginning of the period, shows receipts and disbursements during the period, and ends with assets available at the end of the period. Exhibit I represents an example of a typical Charge and Discharge Statement.
* Assets are reported in the financial statement(s) of the estate at fiduciary acquisition value, which represents the market value of the assets on the date they are transferred to the executor [or cost for assets purchased] and at current value as of the financial statement date.
Are the SSARSs Applicable to an Estate Accounting Engagement?
Pursuant to the provisions of SSARS No. 1, entitled Compilation and Review of Financial Statements, a financial statement is a presentation of financial data, including the accompanying notes, derived from accounting records that is intended to communicate a reporting entity's economic resources and/or obligations at a particular point in time, or changes in these resources/obligations for a given period of time, in accordance with GAAP or other comprehensive basis of accounting [OCBOA]. Paragraph 4 of SSARS No. 1 stipulates that an estate financial statement qualifies as a presentation of financial data on which the SSARSs reporting requirements generally are applicable. However, the applicability of these reporting requirements easily can vary depending on the unique nature of the engagement.
For example, situations likely will occur where the CPA is named to be the executor of an estate of a deceased relative, friend, or client. In these circumstances [assuming there are no contrary requirements of a court or law], some CPAs have questioned whether they are subject to the SSARSs reporting requirements. The answer to this question is not clear and practice varies. Some CPAs believe that when they are acting as the executor of an estate, this work falls outside the purview of public accounting [i.e., the SSARSs would not apply] while others believe that this work is public accounting-related [i.e., the SSARSs would apply].
CPAs who argue that fulfillment of an obligation of executor would not fall within the realm of public accounting would argue that this work is analogous to the executor preparing his/her own personal income tax return or financial statements. In these circumstances, the executor is the "primary signer" of the estate tax return; he/she does not sign the return as if he/she were a third-party preparer. Since there is no SSARSs reporting requirement that exists for a CPA preparing his/her own financial statements, some CPAs argue that the SSARSs should not be applicable to an estate accounting where the CPA is the executor of the estate.
Another argument that CPAs utilize related to the inapplicability of the SSARSs to an estate accounting when the CPA is the executor of the estate is that the SSARSs are not applicable to a CPA in industry who is a representative of the company who employed him/her. Since CPAs in industry who prepare financial statements of their employers are not subject to the SSARSs reporting requirements, some CPAs argue that an executor who is issuing financial statements of an estate also should not be subject to the reporting requirements of the SSARSs.
CPAs who believe that the SSARSs reporting requirements are applicable when the CPA is designated to be the executor of the estate argue that the will typically stipulates that the executor is to be paid a reasonable fee for his/her services. If the CPA is receiving a fee for services, the "general public" probably would view the CPA as practicing public accounting, even though the CPA also has been designated to be executor of the estate.
While both of these arguments [applicability versus inapplicability of the SSARSs] appear to have merit, a logical approach to resolving this issue would be to consider the perception by the parties interested in the estate accounting [e.g., creditors of the estate, beneficiaries of the estate, and/or a court of law]. When an individual CPA is related to the deceased, and he/she personally [not the CPA firm that employs him/her] is named to be the executor of an estate, it is unlikely that he/she would be viewed by interested parties as practicing public accounting while he/she is administering the estate. Conversely, if the CPA is not a relative but, instead, the former CPA of the deceased, the CPA probably would be perceived as practicing public accounting by parties interested in the estate accounting. If the CPA is not practicing public accounting, the SSARSs would not be applicable; if the CPA is practicing public accounting, the SSARSs would be applicable.
When a CPA is hired by an executor to perform an estate accounting that results in a financial statement(s), then the provisions of the SSARSs would be applicable unless there is a court of law requirement to the contrary. In these circumstances, most CPAs probably would agree that they would be practicing public accounting since they have been engaged by a third-party [i.e., the executor] to prepare and/or report on the financial statements.
[Practitioner Note: Frequently, CPAs are asked to prepare an estate accounting for a court of law. In these circumstances, the requirements of the court have priority over the requirements of the SSARSs. If the court requests a report that would differ from the report required under the SSARSs, the CPA should comply with the court; conversely, if the court is silent related to reporting requirements, CPAs should follow the requirements of the SSARSs. Very importantly, the SSARSs reporting requirements are not applicable to tax return engagements; they would be applicable only to engagements where the CPA is engaged to prepare and/or report on a financial statement(s).]
What Type Compilation/Review Reports Would be Applicable for an Estate Accounting?
Outside circumstances where the CPA/executor is a relative of the decedent [the CPA is not practicing public accounting], and circumstances where a court requests a report that would be different from a report prepared under the SSARSs [the CPA should comply with the requirements of the court], the SSARSs should be considered applicable to engagements to prepare/report on financial statements of an estate. Even when the SSARSs are considered to be applicable, questions have been raised concerning whether the appropriate SSARSs report should be a standard GAAP-based report or a report related to a financial presentation that is in compliance with terms of an agreement.
CPAs who argue that the appropriate report for an estate accounting is the standard GAAP-based SSARSs report argue that adequate accounting principles exist so that GAAP do exist for these types of financial presentations. Utilizing the assumption that GAAP do exist for estate accountings, the SSARSs reporting requirements in these circumstances would parallel the requirements for any other "reporting entity" that follows GAAP presentation requirements. The substantive difference in a SSARSs report based on an estate accounting would be a modification of the terminology in the report to be consistent with the information being presented. Exhibit II represents an example of a standard compilation report that may be issued as a result of a GAAP-based estate accounting. Exhibit III represents an example of a standard review report that may be issued as a result of a GAAP-based estate accounting.
Paragraphs 19 through 21 of SSARS No. 1 allow CPAs to accept compilation engagements in circumstances where "management" elects to omit substantially all of the disclosures required by GAAP/OCBOA. In those circumstances, a third paragraph is added to the standard three paragraph compilation report that clearly indicates the election to omit the disclosures, the fact that if the disclosures were included in the financial statements, they might influence a user's conclusions about financial results, and the fact that the financial statements are not designed for uninformed users. As noted earlier, the Committee on National Fiduciary Accounting Standards concluded that estate accountings should be prepared in a manner that is understandable by persons who are not familiar with practices and terminology peculiar to estates. As such, while CPAs "technically" are allowed to accept a compilation engagement where the financial statements would omit substantially all disclosures, and the resulting report would indica te the omission of the disclosures, this approach probably should not be utilized by CPAs associated with an estate accounting.
Generally, CPAs should recommend [as a minimum] that the following disclosures accompany any estate accounting:
* A summary of significant accounting policies [explaining the accounting principles and practices utilized in the estate accounting].
* A disclosure of significant transactions that do not affect the amounts within the estate for which the executor is accountable [e.g., any debt that is secured by a deed of trust on the assets of the estate].
* A description of methods utilized to determine valuation measurements in the estate accounting.
* A disclosure of any significant subsequent events [e.g., a significant decline in the value of an investment] that occurred between the financial statement date and the date on the SSARSs report. Some CPAs believe that, because the governing instrument [the will] and state laws applicable to estates establish various accounting principles/practices applicable to estates, that GAAP do not exist for estate accountings. Using this argument, reports resulting from an estate accounting should be based on the terms of an agreement. Interpretation No. 18 of SSARS No. 1 allows CPAs to report on a financial presentation that is in accordance with terms of an agreement; however, this approach probably is an acceptable reporting alternative only when the governing instrument [the will] actually specifies a basis of accounting.
When reporting on compiled/reviewed financial statements prepared in accordance with the terms of an agreement, the CPA'S report should be expanded to include two explanatory paragraphs. The first additional paragraph should explain what the financial presentation is intended to present and include a reference to a note to the financial statements that describes the basis of the presentation and an explanation that the presentation is not intended to be in conformity with GAAP. The second additional paragraph should include a statement that restricts the distribution of the report [e.g., to the executor of the estate, the beneficiaries of the will, and/or a court of law].
[Practitioner Note: Some CPAs question whether a report prepared pursuant to the guidance in SSARS No.3, entitled Compilation Reports on Financial Statements Included in Certain Prescribed Forms, could be considered applicable to an estate accounting. This question generally arises when a probate court provides the executor with a specific set of instructions/illustrations to follow when preparing the estate accounting. Since the third paragraph of the SSARS No.3 report stipulates that the financial presentation differs from GAAP, and since guidance provided by the court would constitute GAAP in an estate accounting, the SSARS No.3 report probably should not be utilized in estate accountings.]
While there is no definitive guidance related to estate accounting in technical literature issued by the authoritative rule-making bodies within the accounting profession, many CPAs argue that there is a common body of knowledge available for use in preparing a financial statement(s) of an estate. These CPAs would argue that the standard GAAP-based SSARSs report should be issued as a result of the estate accounting engagement. Other CPAS argue that there is no common body of knowledge available for use in an estate accounting and that a financial statement(s) of an estate should be considered prepared based on the terms of an agreement. These CPAs would argue that the reporting option allowed in Interpretation No. 18 of SSARS No. 1 should be issued as a result of the estate accounting engagement.
As long as the financial statement(s) includes a comprehensive note that explains the particular accounting principles and practices associated with the estate accounting, either of these reporting options could be considered to be acceptable. The "agreement" reporting option simply would require an expansion of the standard two paragraph compilation report and three paragraph review report that would be issued under the assumption that these accountings are GAAP-based. However, since most governing instruments do not specify a basis of accounting to be utilized by the executor, probably the best reporting option available to CPAs is based on the assumption that the estate accounting is based on GAAP and that GAAP-based compilation/review reports should be issued.
Thomas A. Ratcliffe, Ph.D., CPA is a dean of the Sovell College of Business and Eminent Scholar in Accounting and Finance at Troy State University Dr. Ratcliffe who earned his Ph.D. at the University of Alabama, is the author of more than 100 articles and several books on accounting and auditing issues.
ESTATE OF E.H. SHERMAN THOMAS A. RATCLIFFE, EXECUTOR Charge and Discharge Statement September 30, 1997 to July 15, 1998 AS TO PRINCIPAL I charge myself with: Assets per inventory $150,000 Assets subsequently discovered 3,000 Gain on realization 4,000 Total $157,000 I credit myself with: Funeral and administration expenses $6,500 Debts of decedent paid 4,200 Legacies paid or distributed: Sue Beasley 5,000 Steve Grice 5,000 R.E. Stewart 5,000 Carol Smith 5,000 Loss on realization 1,000 31,700 Balance as to principal $125,300 Which includes: Cash $ 65,300 South Trust common stock 40,000 Regions Corporation bonds 20,000 Total $125,300 AS TO INCOME I charge myself with: Income collected or accrued$ 5,000 I credit myself with: Expenses chargeable to income $ 400 Distribution to income beneficiary 600 1,000 Balance as to income $4,000 Which includes: Cash $ 500 Dividend receivable 2,500 Interest receivable 1,000 Total $ 4,000
SAMPLE COMPILATION REPORT FINANCIAL STATEMENT IN ACCORDANCE WITH GAAP
To Thomas A. Ratcliffe, Executor Estate of E.H. Sherman
We have compiled the accompanying charge and discharge statement for the Estate of E.H. Sherman [Deceased], for the period September 30, 1997 to July 15, 1998, in accordance with Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants.
A compilation is limited to presenting, in the form of a financial statement, information that is the representation of the executor of the Estate of E.H. Sherman [Deceased]. We have not audited or reviewed the accompanying financial statement and, accordingly, do not express an opinion or any other form of assurance on the statement.
Frank Lamar & Associates
August 15, 1998
SAMPLE REVIEW REPORT FINANCIAL STATEMENT IN ACCORDANCE WITH GAAP
To Thomas A. Ratcliffe, Executor Estate of E.H. Sherman
We have reviewed the accompanying charge and discharge statement for the Estate of E.H. Sherman [Deceased], for the period September 30, 1997 to July 15, 1998, in accordance with Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants. All information included in this financial statement is the representation of the executor of the Estate of E.H. Sherman [Deceased].
A review consists principally of inquiries of the executor and analytical procedures applied to financial data. It is substantially less in scope than an audit in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the accompanying financial statement in order for it to be in conformity with generally accepted accounting principles.
Frank Lamar & Associates
August 15, 1998
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|Author:||Ratcliffe, Thomas A.|
|Publication:||The National Public Accountant|
|Article Type:||Brief Article|
|Date:||Nov 1, 1999|
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