After initially saying it was thinking of removing the requirement for law firms to submit an accountant’s report, the SRA has issued its new requirements, which make a number of changes for firms with periods ending on or after 1 November 2015.
While not removing the requirement for all firms to file a report, there are new exemptions available for those firms that hold relatively small amounts of client money - where the average client account balance is £10,000 or less and the maximum client account balance is no more than £250,000. Those figures are based on the total of all client accounts, including designated deposit accounts.
The main changes impacting most firms relate to the removal of Rule 39 and its list of prescriptive tests which the reporting accountant must carry out in order to complete the accountants report. In its place is an extension to Rule 38 requiring the accountant to use his/her professional judgement in adopting a suitable work programme. This has the potential to increase costs as more risk is passed to the reporting accountant.
While there is still a requirement to submit a qualified report to the SRA, the issues resulting in a qualification should only be those breaches which are material and likely to put client money at risk. The guidance notes which the SRA have issued define material breaches as those “likely to arise as a result of an intention to break the rules and/or as a result of a significant weakness in the firm's systems and controls such that there has been a systematic breakdown of controls designed to prevent breaches”.
This means that going forward there are likely to be far fewer qualified reports, and as a result those that are qualified and therefore submitted to the SRA are likely to receive much more scrutiny. We may be moving from a regime where it was better to have breaches reported to a new regime where it is better not to have them reported.
In the SRA’s opinion one or more of the following is likely to be material and/or represent a significant weakness in the firm’s systems and controls and thus lead to a definite qualification:
A significant and/or un-replaced shortfall on a client account, unless caused by bank error and rectified in a timely manner
Evidence of the wilful disregard for the safety of client funds by such action as the deliberate overriding of the SRA Accounts Rules 2011 and/or Accounting Guidelines
Actual or suspected fraud or dishonesty by the managers or employees of the firm that may impact upon the safety of client funds
Material breaches that have not been reported by the COFA to the SRA
No or inadequate accounting records
Significant failure to provide documentation requested by the reporting accountant
Bank reconciliations not carried out in accordance with Rule 29.12
Client account used as a banking facility
Helpfully, the SRA have provided a table detailing the type of areas the reporting accountant could concentrate on and even more helpfully detailing the behaviours indicative of best practice as well as those behaviours indicative of below adequate processes and controls. That section of the guidance notes is well worth a read by all COFAs that want to maximise their firm’s chances of having a clean accountant’s report.
It should be noted that while the emphasis of the accountant’s report has changed from qualifying reports for every breach other than the most trivial to qualifying only when breaches put client money at risk or represent a systemic failure in controls, the SRA Accounts Rules (SRAAR) still have to be complied with in their entirety.
So what does this mean for those firms that will still require an annual SRAAR report? You’ll still get a visit from your accountant but the focus of the work they carry out is likely to shift from the rigid transactional testing to documenting the firm’s accounting procedures and controls, and testing compliance therewith. This could involve following a client matter from start to finish to ensure that the firm’s procedures as documented in its handbook are effectively adhered to, and that there is adequate documentation at each stage that approval has been given by the appropriate person. Hand in hand with this will be a review of the COFA’s work in respect of ensuring that file reviews are carried out and documented and the breach register is adequate and up to date.
It is possible that the need to obtain copies of paid cheques will reduce, provided the firm’s authorisation procedures are adequate, and that bank audit letter will not be required.
Where procedures are deemed to be inadequate the firm runs the risk of having their report qualified on that basis, but this will also likely result in the accountant being required to carry out further detailed testing to satisfy themselves of the extent of any failing, which may result in increased costs.
In summary, the best thing to do to prepare for the new regime is to ensure that your office procedures manual is up to date and that you adhere to it; and that there is adequate documentation that the COFA has fulfilled their role. Also talk to your accountant to see how they expect to tackle the new rules so that you can prepare accordingly and minimise the risk of a qualified report and the resultant additional scrutiny of the SRA.
Further changes are planned to remove the detailed rules and replace them with systems and controls more akin to outcomes focused regulation. We’ll keep you up to date with the changes, so watch this space.
If you’d like to talk through the changes in more detail and how they could affect your firm, please contact me at mark.baines@armstrongwatson.co.uk.
