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Canada (161,865)
Finance (362)
FIN 502 (69)
Joan Lobo (33)
Chapter 4

CFIN502- Chapter 4- Measuring and Controlling Personal Finances.docx

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FIN 502
Joan Lobo

CFIN502- Chapter 4- Measuring and Controlling Personal Finances ACCOUNTING AND PERSONAL FINANCE  Reason to prepare personal financial statements is for managing the family finances  No such thing as generally accepted accounting principles for personal financial statements o Prepare them in a way that works for you  Articulation that is necessary for business balance sheet and income statement isn’t critical in personal finance  Articulation- income statement items all link directly to the balance sheet o Net worth amount is exactly the sum of all the previous incomes minus dividends paid  Deal in cash rather than accrual income HOW MUCH IS THE FAMILY WORTH  Family balance sheet or statement of net worth—photograph of the family’s financial standing at a point in time o Summarizes the major asses and liabilities o Essential for; provides benchmark or measure of progress in meeting family’s goals and listing and valuation of assets shows what you have to mange  Defining family o Family- group of people who share their wealth, revenues, and expenses o Problem—when we look at the edges; grown child who is staying at home while searching for a job is sharing finances, but not for long  What assets do we include? o Financial assets- provide income or are part of what you will consume in retirement  Resources that determine progress toward financial goals o Personal use assets- are the ones you uses everyday life  Personal goal have appropriate accumulation of personal use assets  Don’t yield income, provide consumption o Luxury assets- also for personal use, but they are very marginal to the families needs  Depends on what the family considers necessary  Difference to personal use—luxury assets are of high value if liquidated  For most planning, you need only the financial assets, liabilities, major luxury assets you could sell, and perhaps the principal residence  Liabilities included o Any amounts that any member of the family owes to someone outside the family o Current liabilities- due within a month o Long-term liabilities- due later than a month, often payable monthly for many years o Risk—having to liquidate investments in order to pay them if the current income is insufficient  Valuation of assets and liabilities o Market value- what someone else would pay for the asset in a fair, arms length, unhurried transaction o Historic cost- original cost o Depreciated cost- historic cost minus an allowance for wear and obsolescence  Used in corporate accounting o Replacement cost- price to replace the asset in net condition  Close to market value for assets for which there is a ready market  Differences due to depreciation and transaction costs o Financial assets—value them at market  Purpose of their income or cash value—means to consumption  Historic cost irrelevant—we want to know how much we can consume by cashing in  Transactions cost will liquidate them—0.1%-0.5% of the market value  Rarely with the trouble to estimate—suggest deducting 2% if you want to be very precise; or ignore it  Cant ignore accumulated income taxes o Personal use assets  Irrelevant to financial planning except for insurance purposes  Future consumptions depends on your future earnings from labour and investment and not on selling the personal use assets 1 CFIN502- Chapter 4- Measuring and Controlling Personal Finances  If you value at replacement cost and hence increase your net worth on the balance sheet- misleading  Exceptions  Value house and cars at market value  Value all other personal use assets at replacement costs  Aggregate all the ordinary household assets into one estimate, with cars separate o Luxury assets  Value the same as personal use assets other than house and car  Difference between replacement and market is larger for luxury assets in general o Liabilities  Current value that you owe—not the same as market value  If interest rates have changed—loan may be worth more or less  What is net worth? o Short-run—net worth isn’t something you can spend  Simply exceeds your assets over your debt o Long-run—net worth converts to cash as the family starts selling its assets o Person use and luxury assets depreciate over time o When you add inflation to the equation, you must increase your net worth in nominal dollar terms in order to maintain the same level of well-being  Keeping track of assets o Help with insurance claims o Level of detail depends on the insurance company HUMAN CAPITAL  Human capital- earning power that a person possess  Why don’t we correct the balance sheet by adding an estimate for human capital? o Estimation is very difficult and may be seriously wrong  Provides a form of security  Important personal financial decisions o Acquire it—high material wealth is closely linked to higher levels of education o Protect human capital—higher level of human capital require more life and disability insurance more to lose o Maintain the human capital—depreciates over time  Education in the broadest sense must continue throughout the working life o Money and effort spent on it is not a luxury o Basic expenditure to maintain or improve the existing human capital and the income it commands THE FAMILY INCOME STATEMENT  Balance sheet—family’s position today  Income statement—hot it got to todays position from last years o See hoe we are moving towards our goals o Provides basis for the budget that is the plan for next year  Cash flow statement- record income and expenditure when they are received and paid; not when they are earned  Basic format o Income is net of income tax and other withholdings—take-home pay o Net of income tax paid or refunded on the income tax return o Expenditures- any outlay of cash o Expenses- recurring expenditures made for everyday living o Nondiscretionary expenditures- ones over whic
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