New accounting standard is left hanging as firms cite confusion

Law firms are ignoring the changes introduced last year to how they account for revenue because of the unprecedented level of confusion about the new rules.

A string of firms that have reported figures have made no adjustment as a result of the introduction of a controversial new rule last November, which provides for earlier recognition of revenues.

The rule, known as Application Note G to FRS5, and introduced by the Accounting Standards Board, allows firms to recognise revenue to the extent to which they are entitled to be paid. In other words, as PricewaterhouseCoopers (PwC) partner Alistair Rose puts it, “if you’ve done the work and you have a right to be paid, then you should recognise it in the books”.

So far this year, several firms, including Addleshaw Goddard, Eversheds, Freshfields Bruckhaus Deringer, Finers Stephens Innocent and Lovells, say they have made no changes to the way they account for revenue. Foot Anstey Sargent managing partner Jane Lister says the firm’s accountant advised her there was as yet no clear guidance on the rule change. “As such, we have decided not to bring in any adjustment,” said Lister.

George Bull, head of the professional practices group at accountants Baker Tilly, backs Lister by saying that, with so much uncertainty, it was doubtful there was a generally accepted accounting practice (GAAP) in this area. “Until there’s definitive official guidance,” added Bull, “many firms feel it’s right to stick with their established accounting policies.”

The confusion is fast turning out to be the most significant aspect of the Application Note G furore. According to Lovells finance director Russ Houlden, it is extremely unusual for there still to be such a difference of opinion so long after the introduction of an accounting standard. Houlden says it was “ironic” that an accounting standard change designed to stop WorldCom-style fiascos, where revenue had been recognised too early, should cause law firms to potentially accelerate the way they recognise revenue. “I say ‘potentially’,” adds Houlden, “because we still don’t yet know the full effect.”

The lack of consensus among accountants over the new rules is making it difficult for law firms to know what is the UK GAAP. This is leading many firms to ignore the rules for accounting purposes.

Non-limited-liability partnership (LLP) firms such as Lovells are not bound by UK GAAP rules in respect of income recognition. Instead, the firm uses its own accounting policies for the partnership accounts and for the purposes of determining dividend distributions.

“We don’t have to use UK GAAP,” says Houlden, “and in the light of the differing interpretations of FRS5 Application Note G, we therefore don’t plan to use it in our partnership accounts for the year ended 30 April 2004.”

Under the Finance Act 1998, LLPs are required to use UK GAAP for their tax computations, and it is here that the most significant financial effect of the change is likely to be felt. Thanks
to the current confusion, most firms were unable to estimate the extra cost of the tax on profits, but it is likely to be significant.

As Freshfields finance director Laurence Milsted points out: “The change will definitely have an impact and it will be in the millions, although we’re still determining quite how many millions. That’s still for final discussion with the auditors.”