UK: The Changing Face Of LLP Accounting

Following the revised SORP for LLPs, Clare Copeman surveys how larger firms are interpreting the rule changes in their members’ agreements and annual accounts.

The introduction of new accounting rules for Limited Liability Partnerships (LLPs) has changed the way many professional firms present their annual accounts, notably in the treatment of members’ balances and remuneration. These changes are due to the revised Statement of Recommended Practice (SORP) for LLPs, which applies for periods ending after 31 March 2006. The revised SORP not only impacts the way firms must deal with their accounts but, for some practices, has also led firms to review their members’ agreements. Given that the filing deadline for April 2006 year-ends has now passed, a number of annual accounts have been published that allow us to examine how different firms have been affected.

Although we don’t have access to all members’ agreements, a review of a number of larger firms’ accounts suggests some significant differences, both in the rights of the members relative to the firm and in the way that the recent accounting developments have been interpreted.

Early commentators were concerned that the new SORP required members’ capital balances to be treated as a liability of the LLP to the member, unless the LLP has the unconditional right to refuse repayment.

Attention was centred on those firms where members’ capital is repayable on retirement. This is because those practices would be required to treat members’ capital as a liability, even when capital withdrawn by a retiring member would normally be replaced by new or existing members.

Firms that want their capital balances to be classified as equity might include a clause in the members’ agreement that the LLP would not be required to repay the capital of a retiring member where this would cause total capital to fall below a base level. This approach allows the base level of capital to be treated as equity rather than a liability.

In practice, the provisions of the SORP relating to members’ capital appear to have been something of a non-event. This is probably because, in the recommended presentation, the balance sheet divides at ‘net assets attributable to members’. All members’ balances, whether equity or liability, are shown in the bottom half of the balance sheet.

Of the accounts reviewed, the majority show all capital balances as a liability. Firms seem to conclude that neither their bankers nor readers of their accounts will mind whether their capital is categorised as equity or liability. Furthermore, the possibility of classifying members’ capital accounts as a liability rather than equity – perhaps providing the member with additional protection over these balances in the case of insolvency – has been a factor in some firms’ decisions.

Where LLPs have paid members from current-year profits which cannot be reclaimed, the revised SORP requires that these payments should be treated as an expense in the current year’s profit and loss account. Furthermore, current-year profit that has not been paid at the year-end, which the LLP does not have the unconditional right to withhold from members, should also be treated as an expense, creating a liability in the balance sheet.

Profit available for discretionary distribution among members (treated as equity in the balance sheet) should only arise where the LLP has the unconditional right to withhold undrawn profit from the members (or the unconditional right to reclaim drawn profit).

Treatment of payments to members as an expense was initially worrying, in that firms that make full distribution might find themselves with a zero balance on their profit and loss account – as well as potentially having zero equity in the balance sheet. However, these early concerns appear to have been unfounded, although, compared to members’ capital, there is a much wider variance between the firms in our sample.

The split was fairly even between the number of firms for which materially all amounts paid or payable to members were treated as an expense, those for which materially all amounts were treated as available for discretionary distribution, and those for which there was a mixture of the two.

While there is no choice regarding amounts paid under an employment contract or non-discretionary fixed shares, there has been some pragmatism in determining the rights attached to residual profit shares. In determining these rights, firms have looked at the accounting impact on reported profit and equity. They have also considered what other firms might be doing and the rights of members over undrawn balances in an insolvent situation.

Prior to the revised SORP, there was a greater presentational incentive for undrawn profit to meet the criteria of equity. In such cases, amounts treated as liabilities were deducted in the top half of the balance sheet, reducing the apparent strength of the firm’s balance sheet. It seems that firms whose existing members’ agreement required post year-end approval for the division of profit have, in many cases, not amended their members’ agreement. In contrast, newer LLPs have been more inclined to draft a members’ agreement that allows for the automatic division of profit.

There have been some differences in accounting treatment between firms. Under the revised SORP, all members’ balances – whether equity or debt – can be shown in the bottom half of the balance sheet as part of net assets attributable to members. Yet there have been cases where members’ liability balances were deducted from net assets. Also, while most firms matched the treatment in the profit and loss account with that in the balance sheet (for instance, expense giving rise to a liability and amounts available for discretionary distribution giving rise to equity), not all practices have followed this approach.

It has been a time of significant change for LLP financial reporting and we suggest that there is not yet a consistent view on all of the judgemental areas of the revised SORP. Whether the differences remain or interpretations converge in the coming periods remains to be seen.

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