In December 2021, CCAB published a new edition of the Statement of Recommended Practice – Accounting by Limited Liability Partnerships (LLPs SORP). There has been some inconsistency in LLPs’ treatment of transactions and balances with members, and the revised SORP seeks to provide clarification and additional guidance in this area. As a result, there is a risk that some LLPs will find their current accounting policies are not acceptable under the revised SORP. The new edition of the SORP is effective for periods commencing on or after 1 January 2022, with early adoption permitted. For many LLPs the first year end where the new SORP will apply will be 31 December 2022 or 30 April 2023. However, as it seeks to clarify rather than change the recommended treatments for members’ transactions and balances, we recommend that all LLPs review their accounting policies in these areas - should any change be required there is a strong argument that it should be implemented immediately.
The key issue surrounds when balances with members, including those relating to undrawn profit for a financial year, should be treated as debt or equity, and when distributions to partners should be treated as an expense in the income statement or a distribution from equity.
This debate has a long history: when LLPs were first introduced in England and Wales in 2002, there was concern that treatment of balances with members as debt would cause LLPs to appear insolvent, giving rise to issues with bankers and creditors. As a result, many LLPs went to lengths to ensure their LLP agreements were structured such that members’ balances would appear as equity. As the situation evolved, it became clear that such concerns were generally overstated: under the LLP SORP, the balance sheet is “cut” at net assets due to members, so that both equity and debt balances with members are included within net assets; and users of the financial statements have become used to the presentation of items in the LLP financial statements. Nevertheless, many LLP agreements make reference to allocation of profit occurring at the point of a post balance sheet approval, which has previously been considered a key indicator that the profit remains as equity, available for distribution, at the year-end.
The revised SORP challenges LLPs to revisit this assumption. There may be a post year-end approval process, but if the LLP is required to make full or partial distribution of profit – or, put another way, does not have the unconditional and indefinite right to withhold distribution of all profit – this amount is debt. As a result, some firms that have previously treated profit for the year as equity, available for discretionary distribution post year-end, may be required to reclassify it as debt, and charge it through the income statement as members’ remuneration charged as an expense. The SORP sets the expectation that members’ participation rights will “generally… result in a liability unless” there is an unconditional right to avoid make payment, but does recognise there will be situations in which that unconditional right exists. For example, the SORP clarifies that the “default” position may be for the LLP to divide profits in full, but the amounts will still be classified as equity if the LLP has an unconditional and indefinite right not to do so. The key is to analyse the LLP agreement to establish the extent to which division of profit it discretionary or automatic, and, where this is not explicitly addressed, to consider all facts and circumstances relating to the enforceable rights of the LLP and its members.
It may be that your LLP agreement both reflects the intended rights and obligations between the LLP and its members, and is appropriately treated in your financial statements. However, if the revised SORP highlights an inconsistency in your accounting treatment, this raised the question: does the accounting need to be changed properly to reflect the rights and obligations between the LLP and its members; or does the members’ agreement not properly reflect the intended rights and obligations, in which case, does this need revisiting?
It should be emphasised that these amendments are explanatory in nature and are not intended to change the underlying principles of LLP accounting set out in the previous SORP.
There have also been inconsistencies in practice in the cash flow statement classification of profit distributions (whether discretionary or automatic) and drawings on account. The new SORP explains the arguments for presenting these within either operating or financing cash flows. It allows LLPs an accounting policy choice between these two options but introduces a requirement to disclose the chosen policy and to apply it consistently between accounting periods.
This article is for general information only and is not a substitute for reading the full SORP and for seeking professional advice on this subject. We have focused our article on specific areas only, and these are not the only areas of the SORP that have been revised. Please refer to the CCAB press release which gives a full list of updates under the revised SORP.