Nowhere to hide
24 January 2005
The publication of league tables in the legal press has in the past occasionally brought a wry smile to the faces of accountants in the know – ie those who act for firms of solicitors. Reported information regarding many firms has been totally accurate, but for a handful it has been less so.
As firms convert to the limited-liability partnership (LLP) status, there will be no hiding place. Accounts will become a matter of public record and league tables will be all the more reliable. As a result of the accounting requirements for an LLP, there will be greater consistency in the way firms prepare their accounts. More attention will be able to be given to the analysis of the underlying profitability of firms, their structures and how widely their equity is held.
Partners in firms that have converted to LLP will normally have noticed little if any difference in the way in which their firm is managed – an LLP is very flexible in this regard. However, as part of the conversion process, firms should pay close attention to how their accounts will look in future.
Partnership accounts and accounting policies do not follow any set standard. The overriding principle is normally to ensure that there is equity among the different generations of partners. The format of a firm’s accounts may have been long established and one which partners will be comfortable with.
In contrast, the annual accounts for LLPs are, in many ways, standardised. LLPs have to comply with the accounting requirements of the Companies Act 1985, with appropriate amendments to reflect the particular issues faced by LLPs. The profit and loss account and balance sheet have to be prepared using standard formats and the notes that are required by legislation; accounting standards and the Statement of Recommended Practice for LLPs are likely to be much more extensive than firms have produced previously in their accounts.
The accounting rules that apply to LLPs are such that statutory balance sheets might present a very different picture from the partnership balance sheet. As an LLP is a separate, corporate entity, the accounting policies that LLPs are required to apply will not be concerned with ensuring equity among the members (owners) of the business. They will be concerned with ensuring that the balance sheet and profit and loss account, together with the related notes, present a true and fair view.
Particular areas that may give cause for concern are annuities, leases, staff pension schemes and, perhaps surprisingly, amounts due to members.
Where partnerships have annuity obligations to former partners that are being passed on to the LLP, the balance sheet will have to reflect the total of the expected annuity payments to those partners who have retired at the balance sheet date. Where the annuity obligation is for a fixed sum for a fixed number of years, the calculation at least is straightforward, although the number might be large. Where the obligation is for life and is perhaps calculated with reference to a percentage of profits, then this will present greater problems. LLPs will be expected to project earnings into the future in order to estimate what the obligation will be in future years and will possibly require the assistance of an actuary for projections of life expectancy. These obligations can be discounted to their present value, but potentially the quantum could be highly significant in terms of reducing the apparent net assets of the LLP.
Leases are likely to cause a problem when an LLP is no longer receiving a benefit from a lease that it is still paying for – for example when it is still paying rent for a building that it is not occupying and it has not managed to sublet at a rate that recoups the rental payments. In that scenario, the LLP should provide for the total remaining lease payments on the property, less any subletting income that it will receive. Again, depending on the length of the lease remaining and the annual rent, this amount could be significant.
LLPs that have defined benefit schemes for staff will have to comply with the requirements of the Statement of Standard Accounting Practice 24 or, for accounting periods starting on or after 1 January 2005, Financial Reporting Standard 17 (FRS 17). FRS 17 requires the surplus or deficit of a defined benefit pension scheme to be reflected in the balance sheet of the sponsoring employer.
In LLP accounts, some amounts owed to members will need to be shown as a liability and deducted from net assets. Generally, these will be loans from members to the LLP and profits that have been divided and not paid. Where an LLP has a policy of automatically dividing the profit to members at the balance sheet date, it is likely that the net assets of the LLP will be reduced to the level of the capital held by the members. Where there is some profit undivided at the year-end, this is not treated as owing to the members, and is accordingly shown as a reserve of the LLP. This is the one area where LLPs do retain complete flexibility on their accounting policy.
Partnership accounts will sometimes show partners’ retentions for future income tax payments as a creditor. Income tax, however, is a personal liability of a member, and not a liability of the LLP. Payments of tax are, effectively, distributions of profit, and whether or not retentions for future tax payments are shown as amounts owing to the members will again depend on the profit division policy of the LLP.
LLPs and those considering converting to LLP status should ensure that they give appropriate thought to these issues and also consider what the impact on the different readers of the accounts will be. The fact is, of course, that an LLP’s accounts will be available for public inspection through Companies House, so it is not just the partners who will be interested.
David Furst (left) and Steve Gale are accountants at Horwath Clark Whitehill