By Victoria Lovell, Legal Sector Assistant Manager
During the annual accountants processes to prepare financial statements, tax computations and returns for law firms, there a several accounting adjustments that tend to be most common. These adjustments are necessary to ensure the annual accounts produced are accurate and show the true financial performance of firms. They include:
Fixed assets
Many firms choose to capitalise all equipment purchased. This can range from a brand-new server costing thousands of pounds, down to replacement computer keyboards and mice for less than £50. Consideration should be given to setting a monetary limit for capitalisation, with anything below this value being treated as a renewal and charged to the profit and loss account.
A detailed fixed asset register should be maintained for additions and regularly updated to remove any assets either sold or disposed of. This can be as simple as setting up a spreadsheet, and by ensuring only equipment over a certain level is included should help keep track of the assets held. This then also becomes a useful tool when looking to renew building and contents insurance as key information is readily available.
Appropriate depreciation rates also need to be set for all categories of assets. For example, if your firm’s policy is to renew laptops every four years, then computer equipment should be depreciated over four years to reflect the expected useful life of the asset.
Bad debt provision
Many firms do not calculate a provision for bad debts. All trade debtor balances should be reviewed as part of the year end procedures (and kept on top of monthly too) and relevant provision made for any balances not deemed recoverable. These balances could be specific debts for clients known to be ‘bad debts’ or any balances from clients due over payment days terms. This specific provision is then also a tax deductible cost for the firm.
Any unbilled disbursements should also be reviewed for recoverability and, again, provision made against any thought to be non-billable.
Prepayments
Law firms incur several large annual costs with professional indemnity insurance and practising certificates being the main examples. These expenses can cover multiple accounting periods, but financial information doesn’t always reflect this with some firms treating the costs as an expense in the year they are incurred. This can have a significant negative impact on your firm’s recorded profitability. Any large expenses covering future accounting periods should be treated as prepayments so that relevant costs fall over the period the costs cover, including partially into future years.
Work in progress
Recoverable non-contingent work in progress (WIP) at the balance sheet date should be included within the firm’s accounts. If your firm time records, this will not simply be the value of WIP recorded as at the year end. Any year end WIP reports need to be thoroughly reviewed to remove any non-recoverable or contingent WIP to leave a more accurate WIP figure. This can be done by applying a recovery rate based on historical analysis or reviewing actual billable WIP by client.
If your policy is not to time record, consideration needs to be given on how to value WIP accurately such as based on a percentage of completion for any fixed fee agreements. This policy should be applied consistently from year to year.
Loans and financing
Law firms frequently find it necessary to take out finance to cover costs such as professional indemnity insurance or to fund new computer software. It is important that any finance agreements are correctly set up within the accounts with relevant liabilities being included for the loans and interest accounted for correctly. There is sometimes a tendency to include all finance repayments as a profit and loss expense, when in fact these are repayments of a liability and should be a balance sheet entry.
Ledgers not agreeing to nominal codes
As part of a firm’s three way bank reconciliation, matter balances will be reviewed and checked against the client bank account on a regular basis. However, from our experience, checking the matter balances to the nominal ledger doesn’t happen as often and differences can creep in. Differences between the ledgers and nominal codes tend to only occur when journal entries are posted in an attempt to correct an error. It is worth checking the matter balance to the nominal at the year end to ensure no differences have arisen.
This review should also be extended to cover trade debtors and trade creditors. The balances on their respective year end reports should be checked to ensure they agree to the values in the nominal and any differences swiftly investigated.
Accruals
It is important to ensure all late invoices are captured and recorded, and that any anticipated costs relating to the financial year in question are also included. As an example this will include the accountancy and SRA accountant’s report fees, and also various overhead costs such utility bills relating to the year. Again, these will be tax deductible costs so are important not to be missed.
Impact of improved record-keeping
The above common accounting issues can have a substantial impact on your profitability and results, and it may be that you can identify with some of these issues. If you are relying on your firm’s financial records to make business decisions, then it is imperative they are as up to date and accurate as possible. The list above may seem overwhelming if they are adjustments that have never been factored in before, however, once set up they should quickly become embedded into a monthly or year-end routine.
If you would like further guidance on any of the above issues or would like some bespoke guidance around your accounting record keeping, please get in touch. Call 0808 144 5575 or email help@armstrongwatson.co.uk.
