Accounting for Estates and Trusts
Estate accounting is concerned with accounting for the administration and distribution of the decedent’s property. In effect, this unit explores the legal and accounting aspects of estate administration and trust.
3.2 legal aspects of estate administration
According to Oxford current English dictionary, estate refers to person’s assets and liabilities at death. The estates of deceased persons (decedents), or missing person should be administered distributed, and accounted by certain laws. The deceased person may or may not leave his will about the estates.
If a person died with a valid will, he/she is considered to have died testate. This person is called testator.
The disposition of such person’s real and personal property is governed by the will of the testator.
On the other hand, a person may not leave his will in part/wholly about the real and personal proprieties. He/she is considered to have died (in testate). In this case, the distribution of such person is governed by the provisions of certain laws (laws of intestacy).
The administration of estate involves marshaling the estate’s assets, paying the debts of the decedent, and the distribution of the remaining in accordance with the testator’s wishes or the laws of intestacy. If the deceased left the will, the validity of the will should be validated. The process by which the validity of a will is established is called probating the will. Once a will has been admitted to probate, the court will proceed to appoint a personal representative of the deceased whose function is to administer the estate. This person is called an executor (executrix). An executor is a male fiduciary named in the will be the decedent to administer the estate. An executrix is a female fiduciary named in the will of the decedent to administer the estate.
If the decreased dies intestate, the court will appoint a personal representative who can administer the estate. This person is called an administrator (adiminstiratrix). An administrator is a male fiduciary appointed by a court to administer the estate of an in testate decedent. An administratrix is a female fiduciary appointed by a court to administer the estate of an intestate decedent. The appointed person is issued letters of administration as evidence of that individual’s authority to act as a fiduciary to administer the estate of the intestate decedent.
Once appointed, the personal representative will take the possession and control of the decedent’s property. If it is a business enterprise, the representative may continue to operate a business for some time (no longer than four months in USA) with the specified period (three months in USA), the personal representative must submit to the court an inventory of property owned by the decedent on the date of death. He/she also submits a list of any leins that exist against the property. If additional assets of the decedent are discovered after the filing of the inventory with the court, supplementary inventory reports must be filed with the court.
Claims against the estate
Once appointed, the representative must give public notice in a newspaper of general circulation at sometime interval. The purpose of the notice is to request that those who have claims against the estate present them within the specified time, or be forever barred from asserting such claims.
Some allowances and exemptions precede all claims against estate. These are described as follows:
1. Homestead allowance
It refers to an allowance of certain amount ($500 in USA) to a surviving spouse or surviving minor children of the decedent. This allowance is additional to any other share of the estate that passes to the spouse or children by the will.
2. Family allowance
It refers to a reasonable cash allowance (not to exceed $6000 for the 1st 12 months after death in USA) to the decedent’s surviving spouse and dependent children. Except homestead allowance, family allowance has priority over all claims against the estate.
3. Exempt property
It is a decedent’s household furnishings, automobile and other personal effects up to a value of certain amount ($3500 in USA) and not available to creditors of the estate to the surviving spouse and children.
After the above allowances are excluded, the representative pays in the claims in the following order:
- The expense of administering the estate
- The funeral expense as well as the hospital and medical expense of the decedent’s last illness.
- Debts and taxes that have preference under federal or state laws.
- All remaining claims
The Settlement of an Estate
Once the claims against the estate have been established and paid, the personal representative has the duty to distribute the remaining assets of the estate to persons entitled to it.
Distribution of Intestate
When a person has died intestate, his/her estate will be distributed in accordance with the applicable law. This is generally distributed to a spouse or blood relative. Real property is distributed to heirs under the laws of the state where the property is located (in USA). Personal property is distributed to next of kin under the laws of the state in which the decedent was domiciled.
Distribution of Testate
If a person dies testate, the distribution of the decedent’s property is mostly governed by the terms of the will. In such a situation, the gift of real property is called a devise. The recipient (beneficiary) is called a devisee. Testamentary gifts of personal property are called bequests or legacies. The recipient (beneficiary) is called legatee.
3.3 The Classification of Legacies
As defined above, legacy refers to the testamentary gifts of personal property. There are various types of legacies. They are described below:
a. A specific legacy
It is a gift of personal property specifically identified in the will such as a specific piece of Jewelry.
b. A demonstrative legacy
It is a testamentary gift payable out of a source specified in the will such as a specific amount of money to be paid out of a specific bank account or the proceeds from a specific insurance policy.
c. A general legacy
It is a gift of an indicated amount of money or quantity of something without designation as to source.
d. Residual legacy
It is a testamentary gift of property remaining in an estate after all debts have been satisfied and all other legacies have been distributed, or otherwise provided for.
3.4 Accounting Aspects of Estate Administration
Facilitating the reporting by the personal representative, called fiduciary to the court is the major purpose of estate accounting. The reporting involves two aspects. There are:
Accountability emphasizes that the personal representative is responsible for the assets of the deceased and for their administration and disposition. In this case, estate accounting reflects the assets for which the fiduciary is charged with responsibility and the distributions and payments to creditors and beneficiaries. The fiduciary is credited with the distributions and payments to creditors and beneficiaries.
2. The Distinction Between Principal and Income
The distinction between principal and income is the basic to estate accounting. Principal, also called corpus, is defined as the property set aside by the owner (or the person legally entitled to do so) so that it is held in trust for eventual delivery to remainderman. Remainderman is a person named to receive the principal of an estate at the conclusion of the income beneficiary’s interest. Principal consists of the net assets of the estate on the date of death.
Net Assets = Gross Assets – Liabilities
- Proceeds of insurance on property forming part of the principal
- Stock dividends and liquidating corporate distributions
- Rents or other types of revenues which already accrued at the date of death of the testator
- All proceeds from the sale or redemption of bonds
- Cash dividends declared prior to a decedent’s death.
Charges against estate principal include:
- All expenses incurred in connection with the settlement of an estate. These include funeral expenses, debts, estate taxes, interest on taxes, penalties on taxes, and family allowances.
- Part of court costs and accountant’s fees, attorneys’ fees, personal representatives fees, and trustees’ fees. The remaining part of these costs should be charged against income.
- Costs incurred in preparing principal property for sale or rent.
- Cost of investing and reinvesting principal assets
- Major repairs to principal assets
- Income taxes on receipts or gains allocable to principal
- Rental expenses payable at the date of death of the decedent.
Income is defined as the return in money, or property derived from the use of principal. Income represents the earnings on the net assets of the estate. Income includes
- Cash dividend
- Receipts from business and farming operations
- Any revenue earned during the administration of a decedent’s estate.
Income may be charged with the following items:
- Ordinary expenses incurred in the management and preservation of estate or trust property. This includes regularly recurring taxes assessed on the principal
- Water charges
- Insurance premiums
- Ordinary repairs
- Depletion and depreciation depending on the expressed intention of the testator with respect to the preservation of the principal of the estate
- Expenditures required to preserve the normal operating efficiency of depreciable assets.
Depending on the testator’s will, the income of the estate (or a portion of it) accrues for the benefit of one party for a stipulated period of time. The party who is entitled for the income of the estate is called income beneficiary for a limited period of time after which the principal is to be distributed to another party, called remainderman. Remainderman was defined earlier. To illustrate the difference between income beneficiary and remainderman, assume that Ato Bulcha has a business enterprise called Bulcha Company. W/ro Biftu is the spouse of Ato Bulcha. Ato Bulcha has also three children. Assume further that Ato Bulcha has died on May 10,2004, at which time the net asset of his business is Br. 200,000. Before his death, he expressed that income from his business is to be used by his spouse, and after her death the Br. 200,000 would be used by his children.
From the above description, the Br. 200,000 represents the principal. W/ro Biftu is called income beneficiary, Ato Bulcha’s children are called remaindermen.
3.5 Accounting and Reporting for Estates
As indicated earlier, the major focus of estate accounting is on the accountability for estate assets and for their proper administration and distribution. Therefore, regarding fiduciaries, the fundamental accounting equation is shown below:
Assets = Accountability
The accounts are primarily designed to maintain the distinction between principal (capital, or corpus), and income.
3.5.1 Accounts relating to principal
The following accounts are used in relation to principal
1. Individual asset accounts
The accounting for an estate begins when the fiduciary files an inventory of the decedent’s property with the court. At that time each asset account is debited at the asset’s fair market value. For example, if the decedent has cash of Br. 10,000 and inventory with a market value of Br. 15000 on the date of death, cash account is debited for Br. 10,000, and inventory account is debited for Br. 15,000.
2. Estate principal account
Estate principal account is credited when asset accounts are debited. In the above example, estate capital account is credited for Br. 25,000 (i.e 10,000 Br. 15,000 – 25,000) if the decedent had no liability. Estate principal account is the basic equity of the estate.
3. Assets Subsequently Discovered account
Assets Subsequently Discovered account is used to record assets that were not inventoried of the date of death of the estate. This account is credited when the market value of the asset discovered is debited to an appropriate asset account.
4. Gain (loss) on realization
This account is used to record any gain or loss upon the disposal of the deceased person’s assets. Loss on realization account is debited if loss arises on disposal of assets. On the other hand, if the disposal of assets results in gain, gain on realization account is credited.
5. Debts of Decedent Paid account
This account is used by the personal representative to indicate reduction of accountability for estate assets in the form of payment of debts and legacies. Legacy refers to a testamentary gift of personal property.
3.5.2 Accounts relating to income
The following accounts may be used in relation to income:
1. Estate Income account
Estate Income account is used to record income collections.
2. Expense accounts
They are used to record expenses allocable against the interests of income beneficiaries.
3. Distributions to Income Beneficiaries accounts
It is used to record the distribution of income to income beneficiary.
3.5.3 Reporting for estates
The personal representative is required to prepare reports for estates and submits to the court. He/she is required to prepare two types of reports. There are:
- Charge and discharge statement - principal
- Charge and discharge statement – income
3.6 Legal and Accounting Aspects of Trusts
Estate administration Vs Trust administration
Estate administration is generally a short-term process that aims at the expeditious distribution of estate assets. On the other hand, trust administration consists of the prudent management of funds over longer period of time.
A trust may be created by a living grantor who transfer property for the benefit of another person (beneficiary) to a trustee. The trustee is responsible to hold assets for the beneficiary. The income from a trust is ordinarily distributed periodically to an income beneficiary. The principal of the trust ultimately goes to a remainderman. The income beneficiary and the remainderman may be the same person.
The trust may be testate or instate. When a trust is created by a will, it is called a testamentary trust.
The accounting procedures for a trust are very similar to those of an estate. With respect to reporting, the trustee is required to fill an accounting with the court concerning events of the previous period, specifying the accounting period, and giving the names and addresses of the living beneficiaries. The trustee must give a statement of unpaid claims and reasons for non-payment within the reporting period. Besides, the trustee must render final accounting covering the period since the last intermediate accounting at the termination of the trust. He/she must also prepare the plan for the distribution of trust assets still on hand. To conclude, the function of the trustee is the administration of the trust, preservation of the assets, the discharging of liabilities, and the equitable distribution of principal and income to those entitled to them in accordance with applicable laws and the intent of legal requirements.
The planning for and the administration of estates and trusts involves accounting skills, and knowledge of tax and other specialized areas of law. The focus of estate and trust accounting is not on compliance with generally accepted accounting principles, rather on specialized bookkeeping practices and accounting statements that aim at carrying out the intent of the law and the intent of those who leave estates or create trusts.
A decedent died with testate leaves a will directing the distribution and administration of his/her property. Whether the decedent had died testate or intestate, the administration of the estate is normally under the jurisdiction of a court handling probate matters. The court issues lesser of testamentary if the decedent died testate, and letters of administration if the decedent died intestate.
Claims against estate are in the order of allowances and exemptions (homestead allowance, family allowance, and exempt property) and followed by creditors.
If the estate is sufficient to liquidate all of the debts of the decedents with some estate property remaining, the fiduciary may proceed with the distribution of the estate’s real property and its personal property. The gift of real property is called a devise and the recipient is a devisee. A gift of personal property is called a bequest or legacy and the recipient is a legatee. A legacy may be any of the following:
- Specific legacy – legacy specifically identified
- Demonstrative legacy – a sum of money payable out of a particular bank account
- General legacy – sum of money without naming the source of the funds
- Residual legacy – balance in the estate after paying all debts and other legacies.
The fiduciary has to classify the estate assets in to principal and income because income beneficiary is different from principal beneficiary. Accounts used in principal accounting and income accounting are different. Ultimately two separate statements are prepared by the fiduciary – charge and discharge statement – principal, and charge and discharge statement – income.
Finally, the administration of trusts is similar to that of estates – the administrator of a trust is called a trustee and the recipient of a trust’s benefits is a beneficiary.