Recent changes in GAAP will have a radical effect on financial reporting by Limited Liability Partnerships (LLPs). In September, in response to these changes, the Consultative Committee of Accountancy Bodies (CCAB) published an exposure draft proposing amendments to the existing Statement of Recommended Practice (SORP) on Accounting by LLPs.
Much of the original SORP published in 2002 remains unchanged. But the provisions of( ), Financial Instruments: Disclosure and Presentation, and UITF Abstract 39, Members' Shares in Co-operative Entities and Similar Instruments, mean that the CCAB has been forced to reconsider the presentation of members' interests. The result is that members' shares in an entity are equity only 'if the entity has an unconditional right to refuse redemption of the members' shares' (UITF 39, paragraph 7).
This has led many people to the conclusion that the financial statements of all LLPs will show no capital and no profits. This will not necessarily be the case, as the classification of capital and other members' interests in an LLP is not straightforward and will differ from one LLP to another.
However, it is likely that in many LLPs that are managed as traditional partnerships, members' capital will be shown as loan capital rather than equity capital.
Nor will reported profits necessarily be zero. However, if all the profits are divided amongst the members, either automatically or by agreement, then the profit and loss account will show no profit for the year.
This movement in the dividing line between debt and equity has hit other types of entity with member involvement - for example, investment trusts.
Clearly, LLPs' financial statements prepared in line with the proposals in the exposure draft will in many cases look very different from financial statements prepared under the current SORP. However, the changes do to some extent reflect the fact that an LLP is a separate legal entity rather than a partnership, and that members are generally remunerated for their participation in the activity of the business. The exposure draft suggests formats and additional explanations to help offset the impact of this change, and to make the financial statements clearer.
The income tax consequences of these proposals are likely to be neutral.
The principle of tax transparency, under which members of an LLP are taxed as if they were partners in a general partnership, even though the LLP is a separate legal entity, should mean that merely charging members' remuneration as an expense rather than treating it as an appropriation, will have no tax effects.
Another major change proposed in the exposure draft is that any liability for post-retirement payments to members (annuities) is to be accrued as the rights to the payments accrue. Such rights in many cases arise during the period of a member's service to the LLP, but under current practice would not be recognised until the member's retirement. Although the date for recognising such liabilities will be changed, the draft SORP retains the current treatment of applying the recognition and measurement criteria of, Provisions, Contingent Liabilities and Contingent Assets, to the liability arising in respect of annuities, where appropriate.
Given the importance of the new proposals, members are encouraged to comment on the exposure draft by the deadline of 31 December 2005.Under the new proposals, therefore:
• amounts contributed by members to the LLP will be shown as debt rather than equity, unless the LLP has the right to withhold repayment;
• members' remuneration will be charged as an expense in the profit and loss account, rather than treated as an appropriation of profit, unless the LLP has the right to withhold payment.
Copies of the exposure draft and further information are available at: www.icaew.co.uk/llps or from.