LO 3.1.1: Construct a statement of financial position that is consistent with sound personal accounting standards

Question 1

2 financial statements planners generally use

Answer 1

the statement of financial position and the cash flow statement

Question 2

What is the most important function of personal financial statements

Answer 2

clear, accurate, and comprehensive communication of information during the financial planning process.

Question 3

Statement of Financial Position

Answer 3

• AKA. net worth statement
• AKA. personal balance sheet
• Profile of
  
  • what is owned (assets)
  • what is owed (liabilities), and
  • a snapshot of your client’s net worth on a specific date
• referred to as a “snapshot” of the client’s financial circumstances due to the frozen-in-time nature of this statement
• indicates what a client owns at a given point in time (a static snapshot)
• statement of financial position is what an individual uses
• compare to balance sheet – what a business uses

Question 4

Assets

Answer 4

Total assets: what client owns

Presented at Fair Market Value (FMV), clients may think otherwise (endowment bias)

Indicate titling on Statement of Financial Position

Question 5

Asset Categories

Answer 5

Assets may be separated in to 3 major categories:

• • 1) cash and cash equivalents
• • 2) invested assets
• • 3) personal use assets
• • There are also difficult-to-categorize assets
• • Assets are listed in liquidity order

Question 6

Cash and Cash Equivalents

Answer 6

• AKA. current assets
• Low risk assets that may be readily converted into cash
• Examples on p. 83:
  
  • checking accounts
  • savings accts
  • mmkt deposit accts
  • mmkt mutual funds
  • short-term certificates of deposit (CD) with a maturity of 90 days or less
• • sometimes listed as invested assets, especially when cash is earning interest, but they remain separate in this module.

Question 7

Invested Assets

Answer 7

Invested Assets

• Examples on p. 83
  
  • stocks
  • bonds
  • mutual funds
  • gems
  • gold and other precious metals
  • collectibles
  • investment real estate
  • fine art
  • ownership interests in closely held businesses
  • vested pension benefits
  • and similar assets
  • longer-term CDs

Question 8

Difficult-to-categorize assets

Answer 8

• Life insurance

* Personal residences

Question 9

Life Insurance (difficult-to-categorize asset)

Answer 9

• Cash surrender value / unique asset that doesn’t fit cleanly into any categories
• This is why life insurance is in its own category
• For some, life insurance is a cash or cash equivalent
• Others w/variable life insurance policy use it as an invested asset

Question 10

Residence (difficult-to-categorize asset)

Answer 10

• Some practitioners prefer to list as an invested asset
• Related to retirement planning
  
  • Upon retirement, some intend to sell home and avoid some or all of taxes from sale
  • Use the balance to buy smaller residence
• Reverse mortgages to supplement retirement income
• *Placement of residence on statement depends on point of view and intentions of each client

Question 11

Business Assets

Answer 11

• In this module no separate category for business assets
  
  • Sole proprietorship — Both business assets and liabilities should be shown separately from personal assets
    
    • Business assets should be itemized on the personal statement, or
    • another statement for the business could be prepared and the net (asset or liability) be carried over to personal statement
  • Partnership interests and ownerships of stock — should be shown under invested assets
  • If a business owner personally signs for a business liability, it is a contingent liability on the business owner’s personal financial statement

Question 12

How are assets on a statement valued

Answer 12

On a statement of financial position, assets are shown at fair market value (FMV)

Question 13

Fair Market Value (FMV)

Answer 13

• The price at which a willing and knowledgeable buyer would purchase an asset from a willing and knowledgeable seller
• An exception can be made if there is a good reason for doing otherwise
• Consider: endowment bias
• Examples on p. 84-85: DPPs/LPs

Question 14

Inheritance

Answer 14

• is not an asset, an inheritance of a known amount may be quite certain for some clients
  
  • May be that the death occurred, but distribution of estate assets hasn’t taken place
  • It may be there is no concern whether it will take place—only when it will occur
  • In this case, important to classify assets and liabilities for estate planning

Question 15

Common Abbreviations for Asset Titling

Answer 15

• p. 85
• Common abbreviations for property ownership and titling on the statement of financial position are as follows:
  
  • S1. Individual ownership of the named spouse (or in a CP state, the spouse’s separate property); the name of the S1 spouse appears in the statement of financial position footnotes).
  • S2. Individual ownership of the other named spouse (or in a CP state, the other spouse’s separate property); the name of the S2 spouse appears in the statement of financial position footnotes.
  • JT. Property that is held jointly with rights of survivorship (note that the respective joint tenants are usually, but not always, married spouses; if the joint tenants are non-spouses, it will be reflected in the footnotes on the stmt)
  • CP. Community property of the spouses
  • TIC. Tenants in common (less common)
  • TE. Tenants by the entirety (less common)

Question 16

Community Property

Answer 16

• Marital property — all money earned, debts incurred, and property acquired during the marriage
• Upon marriage — 1/2 of all property owned by 1 spouse before marriage is automatically owned by the other spouse

Question 17

Total liabilities

Answer 17

What client owes, debts / what is the amount owed without regard to interest rates

Question 18

How are liabilities presented

Answer 18

Presented at principal value without regard to interest obligations / what is the amount owed without regard to interest rates

Question 19

How can liabilities be listed

Answer 19

Can be listed in several different ways:

• descending by account balance,
• to reflect order payments are due,
• in order of shorter-term to longer-term obligations,
• depreciating assets separate from appreciating assets.

Question 20

Current (short-term) liabilities

Answer 20

• due within one year from the statement date

* such as a promissory note

Question 21

Long-term liabilities

Answer 21

• due more than one year from the statement date

Question 22

Net Worth

Answer 22

• Difference between assets and liabilities
• Client’s worth after all liabilities are paid in full
• Fluctuates form statement to statement, depending on the financial transactions that take place between the dates of statement preparation
• Should be increasing
• Comparison of net worth values over time can reveal how well client is doing in achieving financial goals that involve permanent increase in net worth
• Net Worth Equation:
• • Total Assets - Total Liabilities = Net Worth
• • Total Assets = Total Liabilities + Net Worth
• Example on p. 87 (Figure 3.1: Statement of Financial Position)

Question 23

Footnotes

Answer 23

Footnotes are integral part of all personal financial statements

• Should be taken into consideration when financial planner evaluates client’s situation
• Clarifies items on stmt or indicate values or circumstances not disclosed in body of stmt
• Can also indicate relevant contingencies

Question 24

Contingencies

Answer 24

Inheritance or pending lawsuit that may affect future assets or liabilities. See example test questions in notes 3.1.1.