Chapter 22 Estates and Trusts by Jeanne M

Chapter 22: Estates and Trusts by Jeanne M. David, Ph. D. , Univ. of Detroit Mercy to accompany Advanced Accounting, 10 th edition by Floyd A. Beams, Robin P. Clement, Joseph H. Anthony, and Suzanne Lowensohn © Pearson Education, Inc. publishing as Prentice Hall 22 -1

Estates and Trusts: Objectives 1. Understand basic accounting for the estate of a decedent. 2. Understand the principal versus income issues in estate and trust accounting. 3. Understand basic accounting for a trust. 4. Understand how estates are taxed. © Pearson Education, Inc. publishing as Prentice Hall 22 -2

Estates and Trusts 1: Estates © Pearson Education, Inc. publishing as Prentice Hall 22 -3

Understanding Estates • Estates come into existence at the death of an individual (decedent) – Testate (with a valid will) – Intestate (no will or will not validated by probate court) • Governed by state laws – Uniform Probate Code followed in text – Not all states have adopted it • Court-appointed administrator or executor – Personal representative of deceased – Administers the estate © Pearson Education, Inc. publishing as Prentice Hall 22 -4

Administering the Estate Executor or Administrator – 30 days to inform heirs and devisees of appointment • Those entitled to property according to will (devisees) and law (heirs) – 3 months to file inventory of property • Fair value • Disclose liens and claims • May exclude personal items of limited value – Notices in county newspaper for three consecutive weeks © Pearson Education, Inc. publishing as Prentice Hall 22 -5

Intestate Succession • All passes to spouse if – Decedent has no living descendants, or – All surviving descendants are also descendants of spouse • Otherwise – Spouse receives first $100, 000 – Plus one-half of remaining estate – Remainder to other descendants – Varies by state © Pearson Education, Inc. publishing as Prentice Hall 22 -6

Exempt Property • Uniform Probate Code allows – Homestead allowance $15, 000 – Entitlement to personal property (furniture, vehicles) $10, 000 – Family allowance • Reasonable amount during administration of estate • To surviving spouse (equally to minor children if none) © Pearson Education, Inc. publishing as Prentice Hall 22 -7

Classification of Claims • If estate is insufficient to pay all claims, payments are made – Administration costs and expenses – Reasonable funeral and medical expenses of last illness – Debts and taxes with legal preference – All other claims © Pearson Education, Inc. publishing as Prentice Hall 22 -8

Accounting for the Estate • Purpose – Property for which responsibility has been assumed – Manner in which that responsibility is discharged • Liabilities of decedent are not assumed by executor/administrator – Record the payment of the debt, not the unpaid debt © Pearson Education, Inc. publishing as Prentice Hall 22 -9

Charge-Discharge Statement • Assets of estate – Included in inventory – Discovered after inventory • Payments and distributions of estate principal – Cash payments for expenses, debts, to heirs and devisees – Distributions in kind in settlement of expenses, debts, or made to heirs and devisees • Estate income: receipts and disposition © Pearson Education, Inc. publishing as Prentice Hall 22 -10

© Pearson Education, Inc. publishing as Prentice Hall 22 -11

Record Inventory Cash – principal Notes receivable Interest receivable FFF common stock 30 93 2 40 Municipal bonds Summer home 2005 Nissan Estate principal 15 55 8 243 • Assets are recorded at fair value at decedent's death © Pearson Education, Inc. publishing as Prentice Hall 22 -12

Collect on Receivables Cash - principal Notes receivable Interest receivable 95 93 2 • Collect the note and interest due. • If additional interest had accrued, the additional amount is recorded • Debit: Cash – income • Credit: Estate income © Pearson Education, Inc. publishing as Prentice Hall 22 -13

Convert Some Assets to Cash – principal Cash – income 2005 Nissan Estate income 8 1 • Sell the Nissan for $9. – Fair value at time of death was $8 – Additional $1 is income to the estate • If $9 was deemed to be the true value at time of death • Cash – principal gets full $9 • Credit: Estate – principal $1 © Pearson Education, Inc. publishing as Prentice Hall 22 -14

Pay Expenses and Debts Administration expense Funeral expense Medical expense Debts of decedent 4 5 19 100 Cash - principal 128 • Expenses and debts are paid from principal • Payments and distributions must follow – State laws – Valid will © Pearson Education, Inc. publishing as Prentice Hall 22 -15

Distributions of Cash Devise - L. Hunt Devise - S. Tyson Devise - Church Cash – principal Devise - G. Olds Cash – income 19 6 10 35 1 1 • Cash distributions are from • Cash – principal • Cash – income • Records are specific as to recipients © Pearson Education, Inc. publishing as Prentice Hall 22 -16

Distributions in Kind Devise - summer home to L. Hunt 55 Devise - FFF common stock to M. Wallace 40 Summer home FFF common stock 55 40 • Distributions of assets other than cash • Clearly indicate both – Item distributed – Recipient © Pearson Education, Inc. publishing as Prentice Hall 22 -17

Settling the Estate • After payments and distributions of cash and assets – Expenses and costs – Debts – All devisees or heirs other than residual beneficiary Nominal accounts are closed, with remaining assets left in account balances • Make the final distribution to residual beneficiary (or trustee) • Prepare the Charge-Discharge Statement © Pearson Education, Inc. publishing as Prentice Hall 22 -18

Estates and Trusts 2: Principal versus Income © Pearson Education, Inc. publishing as Prentice Hall 22 -19

Principal and Income • Estates and trusts often have separate treatment for income and principal – One may remain in trust, the other distributed – Distributions may be to different individuals • Accounting must clearly differentiate principal and income amounts © Pearson Education, Inc. publishing as Prentice Hall 22 -20

Measurement • Initial fair values are recorded at the establishment of the • Estate or trust • Changes in value after that • Income (loss) • Adjustments for inaccurate fair values • Change to principal • Ex: Interest collected after establishing a trust • Principal, if receivable at start of trust • Income, if earned after start of trust © Pearson Education, Inc. publishing as Prentice Hall 22 -21

Estate Income • Accounting for estates has two control tools for income and principal • Use separate accounts for cash – Cash – principal • Cash in original inventory • Cash from conversion of other principal • Use separate Estate accounts • Estate – principal • Estate – income © Pearson Education, Inc. publishing as Prentice Hall 22 -22

Estates and Trusts 3: Trusts © Pearson Education, Inc. publishing as Prentice Hall 22 -23

Accounting for Trusts • Guidance – State laws – Uniform Trusts Act – Uniform Probate Code – Revised Uniform Principal and Income Act © Pearson Education, Inc. publishing as Prentice Hall 22 -24

Purpose of Trust • Accounting should provide sufficient evidence to show that the applicable laws and instructions of the particular trust • Control for income and principal – Use separate net asset accounts • Trust fund principal • Trust fund income • Often, trust funds do not segregate cash © Pearson Education, Inc. publishing as Prentice Hall 22 -25

Estates and Trusts 4: Estate Taxes © Pearson Education, Inc. publishing as Prentice Hall 22 -26

Estate Taxes • Estates may be subject to federal and/or state inheritance taxes • Economic Growth and Tax Relief Reconciliation Act of 2001 – Reduces inheritance taxes with total repeal in 2010 • Act expires in 2011 – Old inheritance tax rates will automatically reapply – Unless Congress takes action © Pearson Education, Inc. publishing as Prentice Hall 22 -27

Estate Tax Planning • Maximum tax rate in 2009 is 45% • Estates under $3, 500, 000 are exempt • For large estates, proper tax planning can lead to significant "savings" – Additional amounts available for heirs or devisees – Amounts available for charities and other organizations © Pearson Education, Inc. publishing as Prentice Hall 22 -28

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