Regulatory and Compliance Training & Consultancy

Accountants Reports Rule Changes Phase Two

August 2015

A new version of the SRA Accounts Rules 2011 is due to be introduced on 1st November 2015 which will bring significant changes to the Accountants Report regime.

Introduction

At a meeting of the Solicitors Regulation Authority (SRA) Board on 15 July 2015, significant amendments to the SRA Accounts Rules 2011 were approved which will see more firms exempted from the need to instruct a Reporting Accountant to prepare an Accountants Report. However, the biggest impact of the proposed changes to the SRA Accounts Rules 2011 relates to the role of the Reporting Accountant. In summary, the proposed changes will see Reporting Accountants given much greater freedom in the way they undertake their solicitors accounts rules audits and, most importantly, on what SRA Accounts Rules breaches they choose to include within their Accountants Reports.

These changes represent Phase Two, of the SRA's three phase process aimed at reducing the regulatory burden on both traditional firms of solicitors and Alternative Business Structures (ABS). Read about the changes introduced on 31 October 2014 under Phase One. Phase Two was originally due to be implemented in April 2015 but the SRA Board felt that the original timescale would have consequences for larger firms where interim SRA audits may have already been undertaken under the old regime. Therefore, the proposed changes to the SRA Accounts Rules 2011 will be introduced on 1st November 2015 when Version 15 of the SRA Handbook will be published subject to the approval of the Legal Services Board (LSB).

Exemptions from the Requirement to obtain an Accountants Report

Phase One introduced an exemption for Legal Aid firms (more information here) and that exemption remains in place subject to a minor tweak to the wording of the provision.

When the changes introduced by Phase Two take effect on 1st November 2015, smaller firms will be exempt from the requirement to obtain an Accountants Report provided that the transactions through their client account meet certain criteria. For the accounting period in question, the average balance on all client bank accounts must not exceed £10,000 AND the maximum balance on all client bank accounts must not exceed £250,000.

The average balance is calculated by taking the total balance of all client bank accounts when carrying out reconciliations, at least once in every five week period, under Rule 29.12 of the SRA Accounts Rules 2011 and by dividing the total of all such balances by the number of balances obtained. For most firms, this will probably mean that the balance is taken from a monthly reconciliation but it could be that reconciliations are prepared weekly, daily or at some other frequency, provided that one is prepared at least once in every five week period. The frequency at which bank reconciliations are undertaken will be important where the balance on the client bank accounts fluctuates from week to week or from day to day as demonstrated by the example below:

Example

Week 1 - Balance £1,000
Week 2 - Balance £50,000
Week 3 - Balance £2,500
Week 4 - Balance £3,000
Week 5 - Balance £7,500

If the firm were to undertake bank reconciliations on a 5 weekly basis, the maximum allowed under Rule 29.12 of the SRA Accounts Rules, the effective average balance for the above accounting period would be £7,500 as only one balance was ‘obtained’. However, if bank reconciliations are being prepared on a weekly basis, the effective average balance for the above accounting period becomes £12,800 thereby exceeding the £10,000 limit for the exemption from the need to obtain an Accountants Report to apply.

The SRA's New Approach to Audits under Rule 32 of SRA Accounts Rules 2011

The current version of the SRA Accounts Rules 2011, Version 14, provides Reporting Accountants with detailed information about the nature of the test procedures they are required to carry out before completing their Accountant‘s Report. The SRA Accounts Rules 2011 also restrict a Reporting Accountant’s ability to exercise discretion when deciding whether or not to include breaches of the SRA Accounts Rules 2011 in their Accountant‘s Report, as there is currently no concept of materiality and all but a limited category of breaches will give rise to a qualified Accountant’s Report having to be issued.

The amendments contained within the new Rule 38 of the SRA Accounts Rules 2011, means that for accounting periods ending on or after 1st November 2015, a Reporting Accountant will be required, “…to exercise his or her 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 these rules (SRA Accounts Rules 2011). This should cover the work that the accountant considers is appropriate to enable completion of the report required by the SRA at the date the report is commissioned.”

The Reporting Accountant will be expected to qualify his or her report where, having considered the SRA‘s guidance, material breaches of the Accounts Rules are found and/or significant weaknesses in the firm’s systems and controls for compliance with the Accounts Rules are identified.

The SRA is issuing separate guidance to accountants detailing the types of problems which may cause a qualified report to be issued. The guidance states that, “the presence of one or more of the following serious factors is likely to be material and/or represent a significant weakness in the firm's system and controls, and lead towards a definite qualification:-

• A significant and/or unreplaced shortfall (including client debit balances or office credit balances) on client account, including client monies held elsewhere 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 have not been reported by the firm to us in accordance with the Authorisation Rules or the separate duty to report serious failure to comply with the rules in 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 is in respect of material breaches that the Accountant becomes aware of as a result of work undertaken in respect of client money. A detailed assessment of the firm’s financial position is not required.

• No or wholly inadequate accounting records or records not retained. (Rule 29.17).

• Significant failure to provide documentation requested by the Reporting Accountant.

• Three way client account bank reconciliations not carried out (Rule 29.12).

• Client account used as a banking facility (Rule 14.5).

The presence of one or more of the following moderate factors may be material and/or represent a significant weakness in the firm's systems and controls, and lead towards a potential qualification:-

• A significant, fully replaced shortfall (including client debit balances or office credit balances) on client account, including client monies held elsewhere unless caused by bank error and rectified in a timely manner.

• Actual or suspected fraud or dishonesty by third parties that may impact on the safety of client funds.

• Material breaches that have not been reported to us within one month of identification in accordance with the Authorisation Rules.

• Accounting records insufficient or unreliable or not retained for 6 years (Rule 29.17).

• Three way client account bank reconciliations not regularly carried out at least every 5 weeks (Rule 29.12).

• Poor control environment.

• Performance or review of three way bank reconciliations not adequate.

• Longstanding residual balances due to clients.

• Improper use of suspense accounts.”

The SRA's guidance stresses that the list of both serious and moderate factors detailed above are illustrative only and not intended to be exhaustive.

Other SRA Accounts Rules 2011 Changes

The new version of the SRA Accounts Rules 2011 will include a number of other amendments when published on 1st November 2015 as well, of course, as various other consequential changes. Amongst the more interesting changes are the abolition of the requirement for a Reporting Accountant‘s Checklist to be completed and the removal of the stipulation that the Reporting Accountant should undertake their examination of the solicitor’s accounting records from the solicitor's offices rather than the office of the Reporting Accountant.

What to do Next if you are a Solicitor?

You need to think how these changes will impact on you. The SRA estimate that just over a thousand firms stand to benefit from these changes and will no longer be required to obtain an Accountants Report. For some on the margins, a little planning in advance could make all the difference. As demonstrated above, even the frequency at which reconciliations are undertaken could have an impact. If you require any further advice please contact Richard Lane on 0330 223 5346.

Although it is not a decision to be taken lightly, for some, a change of their accounting year end may be beneficial and will avoid the need to obtain an Accountants Report for the current year. However, it is imperative to take professional advice first as a change to the accounting year end will also have tax consequences.

If your current accounting year-end falls during August, September or October and you are likely to be exempt from the need to obtain an Accountants Report in the future you should, without delay, consider applying for a waiver now. To find out more information about who qualifies for an Accountants Report Waiver and how to apply for one request our Accountants Report Waiver information sheet.

What to do Next if you are a Reporting Accountant?

There is little doubt that the changes to the SRA Accounts Rules 2011 coming into effect on 1st November 2015 will have a greater impact on the Reporting Accountant than on solicitors and others subject to the SRA Accounts Rules 2011.

Hopefully, the more pro-active accountancy firms will use this as an opportunity to discard (or at least place less reliance) on their much loved existing audit work programs and seize the chance to think about the risks presented by client firms and plan their work accordingly. With less emphasis being placed on non-material breaches of the SRA Accounts Rules 2011 the new approach offers a chance to add value to the audit process.

From September 2015, our Acting for Solicitors: A Guide for Reporting Accountants course will focus on the practical application of the new rules and is an ideal way to introduce staff involved in the audit of solicitors firms to the new regime.

The Future

Phase Three, currently being developed, will begin in the autumn and will look at simplifying the SRA Accounts Rules themselves.

To find out more about the training and consultancy services we can provide to support your firm please contact Richard Lane on 0330 223 5346.

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