The Statement of Recommended Practice Accounting by Limited Liability Partnerships (the LLP SORP), issued in July 2014, is the fourth version published since LLPs were introduced into UK legislation in 2001.
Within UK Generally Accepted Accounting Practice (UK GAAP), SORPs are not strictly mandatory, although compliance with the recommendations of a SORP is required in order for financial statements to give a true and fair view.
The new LLP SORP is an update to the previously published versions, essentially to ensure that its requirements are consistent with the provisions of Financial Reporting rel="noopener noreferrer" Standard 102 (FRS 102), The Financial Reporting Standard applicable in the UK and Republic of Ireland, which is applicable for accounting periods that commence on or after 1 January 2015.
SORPs provide guidance that is specific to a particular industry, sector or business vehicle. There are elements of FRS 102 that will require professional firms to change their accounting policies which may impact profit. The LLP SORP does not deal with all these issues as there is nothing in the application of that requirement that is particular to LLPs. The SORP concentrates on those areas where specific guidance is necessary or helpful.
Many of the requirements of the new SORP are consistent with the past and existing practice need not change. There are, however, a small number of substantive changes and clarification given to existing requirements. These clarifications are not intended to change existing treatment but, clearly, if clarification has been required, firms may conclude that a different treatment is required in the future.
Form and content of financial statements
The form and content of LLP financial statements has remained broadly the same since the first LLP SORP was published in 2002. The latest version, however, introduces changes partly as a result of FRS 102 but, in the case of the members’ report, drawing on the feedback received during the consultation phase. The changes in the new SORP are summarised in the table below:
|New LLP SORP||Old LLP SORP|
|Income statement (Profit and loss account)||Profit and loss account|
|Statement of comprehensive income||Statement of total recognised gains and losses|
|OPTION Single statement of comprehensive income combining both elements above||-|
|Statement of financial position (Balance sheet)||Balance sheet|
|Statement of changes in equity|
|Statement of cash flows||Cash flow statement|
|Notes to the financial statements||Notes to the financial statements|
LLPs are not required under company law to produce an equivalent to the directors’ report and strategic report that are required by companies. The explicit requirement for a members’ report has been removed from the new LLP SORP although many of the disclosures previously required have been retained.
If a members’ report is not produced then those disclosures will need to be included in the financial statements themselves.
The new SORP uses the terminology employed in FRS 102 for the components of the financial statements, which is consistent with that used in International Financial Reporting Standards. Using the familiar titles of profit and loss account and balance sheet will continue to be acceptable.
A new requirement is for the presentation of a statement of changes in equity as a primary statement. If applied in its basic form, this would be a statement reconciling the movement in ‘members’ other interests’. For many LLPs, this may result in a statement which does not contain any meaningful information.
In companies, equity comprises share capital, retained profits and other reserves. In LLPs, members’ capital and profits not yet drawn from the LLP are commonly included in ‘loans and other debts due to members’ which is not ‘equity’, although this is dependent on the terms of the members’ agreement. For this reason, the SORP permits the statement of movement in members interests (which includes both the debt and equity interests of members), currently provided as a note to the accounts, to be presented as a primary statement. Where this approach is taken, a full statement of comparatives for the prior period will also be required.
The treatment of members’ interests has always been a complex area, in particular:
(a) deciding whether members’ balances with the LLP represent debt or equity and:
(b) understanding the mechanism by which profits of the LLP become due as a debt to the members.
Participation rights – equity or debt
The distinction of whether members’ interests in a LLP are equity or debt is an important one. An interest that represents a debt due to the members means that the member has a legal entitlement to the interest and, in the absence of any agreement otherwise, in the case of an insolvent winding up the members will rank ‘pari passu’ with other unsecured creditors of the LLP. Equity interests are, essentially, still under the legal ownership of the LLP itself and so are available for distribution to the creditors in such a situation.
The exception to this rule concerns ‘members’ capital’. The fact that GAAP may require members’ capital to be classified in financial statements as equity or debt does not alter the underlying nature of the transaction and it is widely held that members’ capital in an LLP is akin to share capital in a company and is likely to be ‘lost’ in the event of an insolvent winding up.
The SORP acknowledges this issue in the requirement to disclose where amounts included in ‘loans and other debts due to members’ (i.e. members’ interests classified as debt) would rank on a winding up. This disclosure has been required since the first SORP published in 2002 on the grounds that LLPs do not have any ‘capital maintenance’ provisions in law. The new SORP has clarified, however, the disclosure of protection afforded to other creditors on a winding up and the ability of members to reduce the equity of the LLP.
|Paragraph 63 in SORP 2014||Paragraph 63 in SORP 2010|
|This SORP requires the notes to the accounts to explain where amounts in ‘Loans and other debts due to members’ (other than members’ capital classified as debt) would rank in relation to other creditors who are unsecured in the event of a winding up. The notes should disclose details of any protection afforded to other creditors in such an event which is legally enforceable and cannot be revoked solely by a decision of the members. The notes should also disclose what restrictions or limitations exist on the ability of the members to reduce the amount of ‘Members’ other interests’ or state that there are no such restrictions.||The notes to the accounts should explain where amounts in ‘Loans and other debts due to members’ … would rank in relation to other creditors who are unsecured in the event of a winding up. Details of any protection afforded to creditors in such an event which is legally enforceable and cannot be revoked at will by the members should be included in a note to the accounts. Where no such protection is afforded in respect of items shown under balance sheet [Members’ other interests], that fact should be disclosed.|
Profit divisions – remuneration charged as an expense or equity divisions
How profit is divided to the members is a matter for the members’ agreement but in many agreements there is a lack of detail not only surrounding the process for division but and in making the distinction with the arrangements for profit-sharing . This lack of clarity in agreements can make it difficult when preparing financial statements to determine what, if any, profits have been divided during the year and, as a result, whether undrawn profits at the year end represent debt or equity.
Ordinarily the mechanisms by which members assume a legal right to their share of the profits of an LLP are:
(a) there is a right to remuneration or profits through the contractual arrangement with the LLP;
(b) profits (or part thereof) are divided to the members through an automatic mechanism;
(c) a decision to divide the profits by the LLP under whatever mechanism for that is specified in the members’ agreement; or
(d) a combination of some or all of the above.
The issue that is fundamental to determining how divisions of profit are treated in the financial statements is whether the LLP has “an unconditional right to refuse payment based on the LLP agreement in force at the time” (paragraph 48). The guidance in the revised SORP has been updated and makes it clear that if the LLP agreement provides that the profit for a financial period will be divided to the members at a particular point (which may be, for example, after the accounts for the year have been approved) and there is no decision necessary for that division to be effected, then the profit for the year represents a debt due to the members at the year end and the whole of the profit for the year should be presented in the profit and loss account as ‘remuneration charged as an expense’.
Where divisions of profit require a decision of the LLP to divide, then those amounts are discretionary and result from an ‘equity participation’ and such divisions of profit are reflected only through the statement of movements in members’ interests. A discretionary decision to divide profits after the year end date is a non-adjusting post balance sheet event and so should not be reflected in the financial statements for that year.
Salaried members of LLPs
Although not dealing specifically with the situation that may arise should a member of an LLP fall to be taxed as though an employee under the new salaried members’ legislation, the LLP SORP has included additional guidance that is applicable in those circumstances.
The LLP SORP has always made it clear that members’ remuneration charged as expense should include any related employment costs (e.g. employers’ National Insurance contributions). It is conceivable that a ‘salaried member’ might receive a bonus or profit share that does fall to be treated as contractual under the terms of the members’ agreement and requires a discretionary division of profit. The SORP now includes guidance in paragraph 36A that “if an LLP incurs incremental tax expense in respect of amounts presented in equity as distributions to members, that incremental tax expense should also be presented in equity”. Accordingly, employers’ NI contributions on that member’s bonus, although reducing the total profits available for sharing amongst the members, will not be charged in the profit and loss account.
The examples and illustrations of different treatments and presentation of members’ interests in both Appendix 1 and Appendix 2 of the SORP have been further updated and expanded.
Post-retirement payments to former members
The guidance on how to deal with post-retirement payments to former members has been expanded significantly as the various different arrangements that might exist require different treatments under the new UK GAAP.
Although the exact nature of arrangements varies from firm to firm, the table below sets out the most common forms of arrangements together with an analysis of how they should be dealt with in the future as well as an indication of whether there may be a significant change in treatment:
|Nature of arrangement
||Treatment under the new UK GAAP
||Basis and impact
|Payments are either fixed or uncertain (e.g. profit-related) for an uncertain term (e.g. for life)||Insurance contract under FRS 103 as there is a mortality risk||Unlikely to be significant change from current practice|
|Payments are of a fixed amount for a fixed term||Liabilities that are basic financial instruments (section 11 of FRS 102)||Measure at amortised cost using the effective interest method. Unlikely to be a significant impact|
|Payments are of an uncertain amount for a fixed period||Liabilities that are complex financial instruments (section 12 of FRS 102)||Measure at fair value. There may be some difference from previous accounting for such liabilities|
|Constructive obligation of uncertain timing or amount or conditional on further service||Provision for liability (section 21 of FRS 102)||Measure at best estimate of amount required to settle the obligation. Unlikely to be significant impact.|
A useful flowchart has been included to help preparers of the financial statements understand which approach is appropriate for their particular situation.
As with many situations with LLPs, the devil is not only in the detail of the LLP SORP but also in the members’ agreements of individual firms. These will require careful reading and analysis in determining the appropriate treatments of members’ participation rights and annuities under the new LLP SORP.
This article first appeared in managingpartner.com on October 2014.