Limited Liability Partnerships: SORP points

The CCAB's new SORP provides the answers to LLP accounting conundrums.

Hannah King

There is a price to pay for limited liability protection in the form of greater regulation and accountability. Under the Limited Liability Partnerships Regulations 2001, LLPs are required to prepare and file financial statements in accordance with UK GAAP under the accounts and audit requirements of the Companies Act 1985 (modified as appropriate). For many high profile partnerships this will enable public scrutiny of their financial performance and position for the first time.

Unique accounting conundrums

The partnership structure raises some unique accounting conundrums. These have been addressed, within the confines of the Regulations and existing GAAP, by the CCAB in its recently published SORP, Accounting by Limited Liability Partnerships. The development of the SORP has not been without some controversy and debate, but the final product is to be welcomed for providing clear guidance on some difficult issues.

So what are these 'unique accounting conundrums' and how do they impact the financial statements? They primarily stem from the fact that the members (ie, the partners) of the LLP, as well as owning the business, actively work for and manage the business. Members may be rewarded through a mixture of contractual salary, bonus, interest, risk premium, profit share and a promise of a share of future profits post-retirement. In a corporate scenario there is a clear distinction between an employee, director and member (ie, shareholder) and the benefits accruing to each role, even though an employee or director may also be a shareholder. However, that distinction is blurred under the partnership structure and hence the difficulties arise.

On reading a set of LLP accounts, the first noticeable difference, when compared to those of a company, is the variation in the formats of the primary statements. This is to cater for the differences discussed above. The panel gives an example of an LLP's primary statements.

Profit and loss account

The Regulations require the profit and loss account to be drawn up to a total 'Profit or loss for the financial year before members' remuneration and profit shares'. Members' remuneration is defined by the SORP as 'any outflow of benefits to a member' and includes salaried remuneration of members as well as profit share. Hence salaried remuneration of members cannot be included in operating profit.

The SORP defines salaried remuneration of members as 'remuneration that is payable to a member such that it falls to be treated as a charge against profits and not an allocation of profits because it is an obligation which a member can claim from the LLP without any decision or agreement to divide profits having been taken'. Or, put more simply, salaried remuneration of members is payable by the LLP to members without regard to profit appropriation and is essentially akin to employment costs.

The SORP requires salaried remuneration of members to be treated as a cost of the LLP and deducted from profit before members' remuneration and profit shares to arrive at 'Profit for the financial year available for division among members'. All other members' remuneration is treated as an appropriation of profits to the members, rather than a cost of the LLP.

One difficulty with this approach is that in some scenarios the level of 'fixed' remuneration is pretty arbitrary, and yet can have significantly different accounting consequences. This is particularly so when all members are given a fixed salary remuneration element, which is then taken into account when determining final profit shares. If it is reasonable to expect that total profits generated before all members' remuneration will more than cover the fixed remuneration element, then arguably there is little difference in substance between salaried and other remuneration.

Cash flow statement

In the cash flow statement, there is no distinction between cash flows to and from members that are costs of the LLP and those that are appropriations of profit or capital injections or repayments. The SORP states that all payments to members, whether relating to salaried remuneration or otherwise, are grouped together under one heading 'transactions with members and former members'. This caption replaces the redundant

FRS 1, Cash Flow Statements, heading 'Equity dividends paid'. Stock and work in progress

The same issue also affects the calculation of stock and work in progress. Under the SORP, when determining the amount of the cost of members' time in stock or work in progress, all overheads related to that time, including salaried remuneration, are included, but all other members' remuneration, which is treated as an appropriation of profits, is excluded. It could be argued that this significantly undervalues the year-end stock figure, particularly when members have been promised an allocation of profits by the year-end. However, it has the advantage of consistency with the p&l account treatment of members' remuneration.

Loans and other debts due to members

The balance sheet looks much as we would expect it to for all items down to provisions for liabilities and charges. After that, but before net assets, is a new line item, inserted by the Regulations, labelled 'Loans and other debts due to members'.

An alternative approach would have been to include this statutory line item in the bottom half of the balance sheet, rather than as a deduction from net assets, because it represents balances with members and forms part of members' total interests in the LLP. This would have been permitted under the Regulations, but the SORP prohibits it on the basis that the balances are obligations of the LLP to members and therefore should be treated as liabilities of the LLP.

Recognising that these balances do form part of total members' interests, however, the SORP requires a memorandum item to be shown at the foot of the balance sheet, reconciling members' other interests to members' total interests.

Allocation of profits

Another tricky issue tackled in the SORP is: at which point should profit shares yet to be paid to members be treated as allocated to members and therefore included in 'loans and other debts due to members' rather than as part of reserves? At present, in companies' financial statements, final dividends declared after the year-end but relating to pre year-end profits are accrued for, ie, treated as a liability. Should the same approach be adopted in respect of an LLP's appropriation of current year profits that is not determined until after the year-end?

The CCAB sought Counsel's opinion on this matter, which clarified that the profits of an LLP are only converted into a debt due to its members when the members have agreed to divide the profits among themselves.

This means that if the members do not agree to divide the profits until after the year-end, then there is no debt due to the members in respect of those profits at the balance sheet date. This is the case even though there might be a valid expectation that all the profits will be distributed to the members in accordance with a predetermined allocation basis. In such circumstances the profits should be included in 'Other reserves' as part of members' other interests, rather than treated as a liability of the LLP.

Members could, of course, agree to the automatic division of profits, in which case the profits available for division are credited directly to 'loans and other debts due to members' and can by-pass reserves.

Retirement annuities

The final peculiarity that tends to be prevalent in partnerships is in respect of retirement annuities or other benefits promised to former partners. Often these payments to former members are unfunded. In the past, many partnerships have not provided for the cost of those annuity payments on the basis that they are to be paid out of future profits.

The SORP puts an end to this, by requiring a liability to be recognised in the balance sheet of the LLP at the date of the member's retirement regardless of whether the annuity is dependent on sufficient future profits. However, rather than using the principles in

FRS 17, Retirement Benefits, the SORP requires the balance sheet provision to be recognised in accordance with FRS 12, Provisions, Contingent Liabilities and Contingent Assets, as the present value of the best estimate of the expected liability.

As noted in Appendix 2 to the SORP, the detailed requirements of

FRS 17 do not entirely match the particular circumstances in hand. Furthermore, FRS 17 does not yet apply to the primary statements and the extant standard, SSAP 24, Accounting for Pension Costs, because it is a p&l focused standard, is not appropriate. So using FRS 12 would seem to be a neat solution, even though retirement benefits are usually excluded from its scope.

Any investments in assets by the LLP for the purposes of funding the post-retirement benefits of members should be recognised in the relevant balance sheet asset classifications. However, the SORP requires separate disclosure of such assets either on the face of the balance sheet or in the notes.

Rather strangely, the SORP does not require the recognition of a liability in respect of retirement annuity promises accruing to members before they retire. Instead, on retirement, the total estimated liability is transferred from reserves to creditors or provisions, as appropriate, with the loss recognised in the statement of total recognised gains and losses (STRGL). The rationale for taking the loss through the STRGL is unclear. It would seem to be an allocation of profits that crystallises on a member's retirement, but no other profit allocations are recognised in the STRGL.

Any subsequent revisions to the retirement obligations to former partners, either from changes in terms or changes in estimates, must be charged or credited to the p&l account, within operating profit.

The SORP does acknowledge, however, that there may be cases, particularly on the transfer of the business of an existing partnership to an LLP, where the members enter into a private agreement among themselves and former members to forgo some of their profit share to pay annuities to former members. Such arrangements can be constructed so that no obligation falls on the LLP itself, in which case the LLP will not recognise a liability to former members for those retirement benefits.

In conclusion, much of an LLP's financial statements will look similar to those of any company. However, there are a few peculiarities brought about by the unique partnership structure, and the SORP deals with those specific accounting conundrums, as discussed above. Preparers and users of LLP financial statements had best be forewarned.

Hannah King is a senior manager in the Accounting Technical Department at PricewaterhouseCoopers

Panel: Example of an LLP's primary statements Profit and loss account
Turnover (continuing operations) X
Operating profit (continuing operations) X
Interest (X)
Profit before tax on ordinary activities X
Tax on profit on ordinary activities (X)
Profit for the financial year before members' remuneration and profit shares X
Salaried remuneration of members (X)
Profit for the financial year available for division among members X
Statement of total recognised gains and losses
Profit for the financial year available for division among members X
Exchange translation differences X Former members' pension liabilities (transfer from reserves) (X)
Total recognised gains and losses relating to the year X
Balance sheet
Fixed assets X
Current assets X
Creditors: amounts falling due within one year (X)
Net current assets X
Total assets less current liabilities X
Creditors: amounts falling due after more than one year (X)
Provisions for liabilities and charges (X)
Net assets before loans and other debts due to members X
Loans and other debts due to members (X)
Net assets X
Members' other interests  
Members' capital X
Other reserves X
Memorandum item:  
Loans and other debts due to members X
Less: Amounts due from members (X)
Members' other interests X
Total members' interests X
Cash flow statement
Operating activities X
Returns on investments and servicing of finance X
Taxation (X)
Capital expenditure and financial investments (X)
Acquisitions and disposals (X)
Transactions with members and former members  
  Payments to members (X)  
  Contributions by members X  
  Retirement benefits paid to former members (X)  
Management of liquid resources and financing X
Increase in cash X
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