Law Firm reporting: have we lost our way?

The apparently poor quality of the reporting and especially the brevity, of the published information has been frustrating. I could not uncover what I, as a Chartered Accountant, felt ought to be available. It led me to consider whether the firms’ accountants were doing enough to ensure compliance with the LLP SORP and for some firms, FRS 105, which applies to micro-entities.

Of course, there are significant exemptions available under the 2006 Companies Act and for firms qualifying under FRS105 and the SORP. It is perfectly acceptable for firms to take those exemptions. My concern is that the information available is less than even the legislation and standards would require and leaves unanswered questions. Not publishing your P&L is fine but not publishing your Accounting Policies, (for example), does not seem fine.

Out of frustration I undertook a review of 28 sets of filed law-firm accounts: 18 LLPs and 10 Limited Companies. I deliberately chose accounts of smaller, independent firms. I took it on trust that the larger firms which were audited, would be less likely to have manifest errors in their filed accounts. I, as a FCA, found the maze of legislation and standards far too difficult to be certain that an issue I encountered was incorrectly presented or not but in many cases the accounts raised as many questions as they answered.

There are many parts of legislation and Accounting Standards in play, the key ones being.

• The Companies Act 2006

• FRS 102

• FRS 105

• The Limited Liability Partnerships SORP.

The selection of the appropriate parts of each of these bits of legislation and Standards is a minefield, with a deal of cross-referral from standards back to legislation and application of exceptions here and there! In all of this, the need for financial statements to show a true and fair view, hangs around like Banquo’s ghost – troubling and difficult to ignore: although as the examples below show, perhaps true and fair has been ignored and, like Macbeth, I have been driven to distraction.

My constant thought was that the accountants, who would have helped prepare these accounts, have also found it too complicated to apply the options in a balanced and sensible way: so that the user is well served, as well as the client being given the best options within the available framework.

It is not easy, as one experienced professional told me, “I have to answer about fifty “Yes/No” questions before I get the right template for the law firm I am dealing with”: but should it be like this?

The most frequent issues encountered were:

• Whether or not an LLP has “equity” or not and therefore whether it should include a Movement in Equity. Most say they do not have equity and therefore do not have such a note: but two of the sample did include one. I could not see that their situation was any different from those who did not claim to have equity. Or others excluded that statement but did not explain why.

• A lack of - or highly truncated - Accounting Policies. One firm simply said their “Accounting Policies complied with Section 1A of FRS 102”. A single sentence. Many did not have sufficient information in their policy for me to understand how they calculated income, which may perhaps be the most important policy of all in a law firm.

• A firm that had converted to an LLP at the start of its accounting period did not have any comparative figures, which would be required by paragraph 115 – 119 of the SORP.

• Very few accounts were preceded by a Members’ Report. This is not compulsory, but it frequently led to there being no statement of Principal Activities. I had to take it on trust that I had found the law firm I was looking for and not some other business. One firm had a statement in its Accounting Policies that said its “Principal Activities were set out in its Members’ Report”: but that Members’ Report was – of course - not filed!

• Hardly any accounts had a Company Information page at the front. Including one is merely convention but not having one meant I could not identify the accountants in each case. While I could not refer to those accountancy firms to question their approach, I would at least know who to be wary of in future, when reviewing accounts that they have helped prepare. Of course, many may not use an external accountant at all, which gives rise to other concerns and may be the reason for some of the issues highlighted.

• A couple of firms have very large contingent liabilities and in one case, the crystallisation of the liability would have extinguished 85% of their Net Assets of £1.3M. But there was no indication of the nature of the contingency or an estimate of the likelihood of crystallisation. Were they uninsured claims or something else and what was I to make of it?

• And finally, one firm had Fixed Assets Investments of £100,000: but there was no list of what that investment balance related to. My research indicated that they were probably two dormant shell trustee companies, which in turn led me to question the carrying value of £100,000.

I have not mentioned the difficulty of working out what is going on when a corporate body owns part of an LLP or vice versa and worse – if they have different Accounting Policies. That was another issue.

In October 2020 15% of law firms were LLPs, 50% were Limited Companies and 35% were “Others”, mainly sole traders or partnerships, (Solicitors Regulation Authority). There seems to be a lack of consistency in the way we, in the profession, are dealing with their accounting and disclosure issues. There is an obligation to make the accounts useful to the reader - the user – of those accounts.

Law firms are an important part of corporate and civic society. Without the operation of law, managed by law firms, society creaks. The SRA, Professional Indemnity Insurers and others rely on the financial stability of those law firms: but they don’t have any direct evidence that they are financially sound – perhaps until it is too late - and my concern is that we cannot tell, from the outside, whether the guardians of our legal processes are financially secure.

There are legislative complexities. We can only lobby the politicians so they understand the impacts of the legislative changes that they may want to make, perhaps in the name of simplification: but we must work with the framework we have. We also must be careful about making further exemptions and options within the current Accounting Standards framework.

One solution could be that the full accounts for the shareholders and members of all law firms, regardless of size and structure, should be audited. Those audited accounts can be filed after taking advantage of all the statement and disclosure exemptions allowed under the current regime: so you preserve the shareholders’ and members’ financial confidentiality as at present. The audit report would need to be quoted in full but accompanied by an explanation that these are not full accounts.

Unincorporated bodies, as now, would not need to file accounts but the SRA and PII underwriters could ask for them, review them and hopefully be able to place more reliance upon them.

In the meantime, preparers of accounts need to look at the way we are interpreting the current framework and remember that our Ethical obligations. In particular, use technology such as checklists: but apply our professional scepticism and our “common sense” ruler and finally, remember our obligation to the reader.