Solicitors Accounts Rules 2011: Change on the way

As part of the Solicitors Regulation Authority’s (SRA) ongoing programme of regulatory reform, it has issued guidance on the completion of the annual accountant’s report form given the changes to the Accounts Rules and reporting requirements which has now received approval by the Legal Services Board.  These changes will take effect for accounting periods ending on or after 1 November 2015.

The SRA requires firms of solicitors to obtain an independent accountant’s report in order to confirm that the overall objective in Rule 1.1 has been achieved – which is to ensure that client money is kept safe.  Before the latest wave of changes were approved, the Rules themselves were very prescriptive and required the accountant to undertake specific testing through the application of Rule 39 Test procedures which outlined specific tests that the accountant was required to carry out in order to complete the annual accountant’s report.

The SRA have relaxed the reporting requirements and will now rely on the reporting accountant’s professional judgement when they are preparing and finalising the report.  In addition, the SRA will only require qualified reports to be submitted to them.  Firms of solicitors may also be exempt from the requirement to obtain an independent accountant’s report if, during an accounting an accounting period they:

• hold only a small balance of client money which is an average of less than or equal to £10,000 as well as a maximum of less than or equal to £250,000 at each reconciliation date; or
• only hold monies from the Legal Aid Agency.

Test procedures

Rule 39 has been removed and instead Rule 38 Provisions of details of bank accounts, etc says that the reporting accountant must use their professional judgement in determining the work required for the firm they are instructed to obtain the report on in order to assess risks to client money arising from compliance with the Rules.  In addition, the reporting accountant must also use their professional judgement in deciding whether their subsequent report needs to be qualified.

Qualified reports

Many reporting accountant’s reports are qualified due to breaches of the Rules.  The most common types of breaches in such an engagement include:

• bank interest being credited to the general client account;
• failure to transfer costs from client account to office account within the 14-day window;
• overdrawn client accounts; and
• failing to prepare the client account bank reconciliations within the five-week timescale.

The SRA have stated that, in their view, the report should only be qualified where the breaches identified by the reporting accountant are material and are likely to put client money at risk.  The guidance issued by the SRA contains two classes of factors, ‘serious’ and ‘moderate’, which, in the SRA’s view, are likely to result to a definite and potential qualification respectively.  The factors (which are not exhaustive) are as follows:

Serious factors – one or more is likely to be material and/or represent a significant weakness in the firm’s systems and controls and lead towards a definite qualification:

1. A significant and/or unreplaced shortfall (including client debit balances or office credit balances) on client account, including client monies held elsewhere. The exception to this would be where the bank has caused the error and the error has been rectified in a timely manner.
2. Where there is evidence of wilful disregard for the safety of client money, an example of which would be deliberate overriding of the Accounts Rules or Accounting Guidelines.
3. Actual or suspected fraud or dishonesty by managers/employees of the law firm, which may have an impact on the safety of client money.
4. Where material breaches have occurred which have not been reported by the firm to the SRA in accordance with the Authorisation Rules or the SRA’s Handbook or serious misconduct by any person in accordance with Outcome 10.3 and 10.4 of the Code of Conduct. This applies to discovery of such breaches by the reporting accountant as part of their work programme in respect of client money.
5. Inadequate (or no) accounting records are being maintained by the firm.
6. Significant failures to provide documentation to the reporting accountant on their request.
7. Three-way client account bank reconciliations not being carried out.
8. Banking facilities being provided to the firm’s clients.

Moderate factors – one or more may be material and/or represent a significant weakness in the firm’s systems and controls and lead towards a potential qualification

1. Where a significant shortfall has occurred but this has been fully replaced (including client debit balances or office account credit balances) on a client account, unless caused by bank error and rectified in a timely manner.
2. Actual or suspected fraud or dishonesty by a third party which may have an impact on the safety of client money.
3. Material breaches which have arisen that have not been reported to the SRA within one month of identification in accordance with the Authorisation Rules.
4. The accounting records maintained are insufficient or unreliable or have not been retained for six years.
5. Three-way client account bank reconciliations have not been carried out at least every five weeks.
6. A poor control environment.
7. Performance or review of the three-way bank reconciliations are not adequate.
8. Longstanding residual balances are owed to clients.
9. Suspense accounts are used improperly.

Material breaches are likely to occur when there is a deliberate intention to break the rules and/or as a result of significant weaknesses in the firm’s systems and internal controls to the extent that there has been a systematic breakdown of the controls which are designed to prevent breaches occurring.  Where a breach arises due to clerical error, these are less likely to be material; but may become material if they are persistent due to a lack of controls in place or a breakdown of internal controls and have put client money at risk.  The SRA have acknowledged that trivial, non-material breaches of the Rules take place in many firms but they are not expecting such breaches to be notified to the SRA in the form of a qualified reporting accountant’s report.

Guidance for accountants

The SRA have acknowledged that the previous version of the Rules were prescriptive, particularly Rule 39 which outlined the procedures the reporting accountant should have applied in preparing the annual accountant’s report and hence the SRA have recognised that law firms and reporting accountants will need some assistance and guidance.

The guidance issued by the SRA is not mandatory, but is aimed to give an idea as to the type of work that a reporting accountant may wish to consider so they can complete the accountant’s report and report any concerns to the SRA.  The guidance itself has three sections:

• the provisions of the SRA Accounts Rules which have to be considered by the reporting accountant and which need to be covered by the accountant’s report;
• the factors which may give rise to a qualified report (see above); and
• a table which sets out some examples of test procedures/checks which may be undertaken by the accountant together with the types of results/situations which accountants and the firm’s compliance officer for finance and administration (COFA) and managers might expect to see in an above adequate, adequate and below adequate firm.

Rules that reporting accountant’s assess for compliance

Not all of the Rules have to be checked for compliance by the reporting accountant and the guidance confirms the following rules are required to be assessed for compliance by the law firm:

• Rule 1 The overarching objective and underlying principles
• Rule 7 Duty to remedy breaches
• Rule 13 Client accounts
• Rule 14 Use of a client account
• Rule 17 Receipt and transfer of costs
• Rule 18 Receipt of mixed payments
• Rule 20 Withdrawals from a client account
• Rule 21 Method of and authority for withdrawal from a client account
• Rule 27 Restrictions on transfers between client accounts
• Rule 29 Accounting records for client accounts

The guidance also confirms that where the circumstances outlined in Rule(s) 8, 9, 10, 15, 16 and 19 apply then the accountant must assess compliance accordingly.

Test procedures under the new Rules

Section 3 of the guidance outlines examples of some of the test procedures which might apply in all circumstances when a reporting accountant is carrying out their work.  The section is not designed to provide a mandatory or definitive list of all test procedures and hence reporting accountants might wish to discuss with their solicitor client the areas which they intend to cover during the course of their work.  It is worth emphasising that the reporting accountant has a responsibility to ensure that they work which they undertake is sufficient so as to enable the completion of the accountant’s report and the work therefore must be proportionate and targeted to the size of the firm and nature of the firm’s work.

Reporting deadline

Firms which have to have a report completed must continue to do so within six months of the accounting year-end; hence a firm with a 30 September year-end will have to have a report completed by 31 March.  Where the report is qualified it must be submitted to the SRA within six months of the year-end either my email or by post.

If, for whatever reason, a law firm is unable to meet the reporting deadline then they can apply for an extension of time.  The SRA allow extensions for a period of up to three months but such requests can only be considered if they are received before the deadline has passed.

If the firm obtains a report late and/or delivers a qualified accountant’s report late, then the SRA will treat it as a late submission and the provisions of Regulation 3.1(c) of the SRA Practising Regulations 2011 will apply.  This will mean that the principal and any individuals who have responsibility for obtaining and delivering the report will be required to pay a penalty of £200 when applying for their next practising certificate.

Conclusion

The reporting requirements for reporting accountants have been relaxed due to the SRA’s regulatory reform programme, and the prescriptive requirements of the Rules have been replaced with a regime which will require more professional judgement on the part of the reporting accountant, particularly in terms of what will and what will not give rise to a qualified report.  Copies of the guidance to which this article relates can be obtained from this news release link which also contains a link to the revised accountant’s report form.

Category: Accounting and standards, Audit