FRS 102 Changes: What professional practice accountants and advisors should be doing now

For accountants working in and advising law firms, the focus should now be shifting from understanding the technical requirements to preparing for implementation. The two areas with the greatest potential impact are revenue recognition (Section 23) and lease accounting (Section 20).

The revised Section 23 introduces a five-step revenue recognition model broadly aligned with IFRS 15. Firms will need to identify the contract with the client, identify the performance obligations, determine the transaction price, allocate the transaction price and recognise revenue as those obligations are satisfied.

For many traditional time-cost engagements, the accounting outcome may not change significantly. However, the underlying analysis will become more important. A key consideration is whether the firm has an enforceable right to payment for work performed to date, including where an engagement is terminated early. Engagement letters and terms of business should be reviewed now to ensure they adequately support the chosen accounting treatment.

Particular attention should be paid to:

• fixed-fee and milestone-based assignments;
• corporate finance and transaction work with success fees;
• contingent fee arrangements (CFAs);
• damages-based agreements (DBAs); and
• significant work in progress balances.

Many firms currently recognise work in progress using portfolio-based approaches or broad estimates of recoverability. The new requirements may require a more granular assessment of individual engagements, particularly where consideration is variable or dependent on successful outcomes. Success fees, for example, are generally not recognised until the success condition has been satisfied and the firm has an enforceable right to payment.

Accountants should therefore begin undertaking impact assessments across key service lines and reviewing whether existing systems can capture the information required to support the new model.

The other major change is the introduction of an "on-balance-sheet" accounting model for lessees. Under the revised Section 20, most leases will result in recognition of a right-of-use asset and a corresponding lease liability. The distinction between operating and finance leases will largely disappear.

For many law firms, office premises represents the most significant area of impact. Firms occupying substantial and city-centre premises may see material increases in both assets and liabilities following transition.

The implications extend beyond financial statement presentation:

• balance sheet totals may increase significantly;
• financial ratios and banking covenant calculations could change;
• EBITDA is likely to improve as rental costs are replaced by depreciation and interest;
• profits may become more volatile due to the front-loaded nature of lease finance costs; and
• additional disclosures will be required.

For LLPs, there is an additional commercial consideration. The new accounting model is likely to affect reported profits throughout the life of a lease, potentially creating perceived inequities as members join and leave the LLP. Some firms may wish to consider whether statutory profits remain the most appropriate basis for member distributions.

A number of areas within the new lease standard require careful consideration. Accountants and advisors should now be encouraging firms to start gathering lease data.

Key areas include:

• determining the enforceable lease term;
• assessing whether renewal options are reasonably certain to be exercised;
• establishing appropriate discount rates;
• identifying lease incentives and rent-free periods;
• evaluating dilapidation obligations; and
• assessing whether any short-term or low-value lease exemptions apply.

Serviced office arrangements may prove particularly challenging. Some arrangements that appear short term at first glance may still require recognition if there is evidence that the firm is economically compelled to remain in occupation.

With transition now underway, accountants should be helping those in the professional practice sector prepare rather than waiting for the first affected year-end.

Practical actions firms should be taking and discussing with advisers include:

1. Performing an impact assessment covering both revenue and lease changes.
2. Reviewing engagement letters and terms of business to ensure they support revenue recognition conclusions.
3. Identifying high-risk fee arrangements, including success fees, CFAs and DBAs.
4. Creating a complete lease register and gathering relevant documentation.
5. Modelling the impact on financial statements, covenants and LLP profit-sharing arrangements.
6. Considering systems and ledger changes needed to accommodate right-of-use assets, lease liabilities and enhanced disclosures.
7. Assessing whether increased balance sheet totals could affect size classifications, audit thresholds or LLP reporting requirements.

The firms that start preparing now will be best placed to avoid surprises. Whilst the accounting changes are significant, early planning will allow practices to understand the commercial consequences, update their processes and ensure a smoother transition to the revised FRS 102 regime.

At Crowe UK we can help law firms understand the impact of the changes to FRS 102 and what it means for them. Our multi-disciplinary team deliver a tailored solution to professional firms including partnerships, LLPs, LPs, and limited companies of all sizes and always tailoring our advice to best suit your needs. Please do not hesitate to get in touch if there is anything in the above article which you would like to discuss further.

• Professional Practices | Crowe UK

^{*the views expressed are the author’s and not ICAEW’s}