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In accordance with the Urgent Issues Task Force Abstract 40 (‘UITF 40’), legal professional earnings should be recognized on an accrual basis unless cash basis is expressly adopted.This issue arose following the application of financial reporting standard ( FRS5) revenue recognition. It is concerned with the recognition of revenue for accounting purposes in the case of service providers. Accordingly this has an impact on the professional firms such as barristers, solicitors and accountants.

There are Two principles that govern the application of UITF 40 in relation to FRS 5: 

Contract activity rather than contract completion or invoicing is the focus of revenue recognition; and When work is partly performed at the end of the period concerned, the fair value of the right to consideration should be brought in as revenue. 

In accordance with this provision, professional practitioners can not ignore all ‘work-in-progress’ regardless of the circumstances. Accordingly, If in any particular case or matter or other consultancy work has been performed by the year-end for which the practitioner has ‘obtained a right to consideration’, then for such accounting periods, that work should be taken into account in the same way and to the same extent as ‘completed work’ recognizing the balance money as receivable, which is treated as a current asset as at the balance sheet date. Even though this is the case, it might be rare that the professional earnings will be adjusted by the revenue authorities at the year end based on the materiality concept. However, it is always better to seek professional advice on how to calculate this materiality level which may be dependent upon the nature and size of the practice. Final comment
  • Work completed at the year-end must be brought into account as debtors or receivable, in the amount of the agreed or anticipated fee. 
  • In the case of incomplete work that straddles the year-end, it is necessary to bring in a reasonable estimate of the fee earned as a result of the work done at that date.
  • However, the above is subject to the “materiality concept”
The following frequently asked questions will clarify some of your doubts.  

Q1- A professional works on a "no win, no fee" basis. How should this be accounted for?  

Revenue should not be recognised until a case has been won. Because the professional has a right to consideration only at that stage  

Q2 - A professional undertakes to perform work on a "pay at end" basis. The fee is not agreed in advance, nor will the rate be fixed. The consideration is negotiated at the conclusion of the case.  

There is significant uncertainty about the amount of the fee at an accounting date prior to the end of the case. Nevertheless, it is clear that the relevant fee is not nil. There create two possible arguments: Where there is some uncertainty about the fee but a reasonable estimate can be made, at least of the minimum that will be earned, then an estimate should be made of the part of the total fee that has been earned as a result of work done to the balance sheet date. This estimated amount should be included as revenue. Where there is genuinely so much uncertainty that no reliable estimate can be made of the total fee and of the part of that total that has been earned to date, no revenue should be recognised until such time as the uncertainty has reduced and a reliable estimate can be made. This might be at a later stage of the case or it might not be until the fee is negotiated at the end of the case, depending on the facts and circumstances. There is a general assumption that amounts can be estimated with sufficient reliability to be included in financial statements. Non-recognition due to an amount not being reliably estimable should be very much the exception.  

Q3 - A professional works on certain types of cases that are done for a fixed fee. Currently, revenue is recognised on completion of the case. Is this correct? 
The appropriate accounting here is a matter of professional judgement depending on the facts of the situation. Where, for example, it is reasonably clear what a typical case involves (say two client meetings, one day's preparation and one day in court for an aggregate fee of £5,000), it will be possible to assess, for each case, how far through the case one is at the year end. If the barrister is halfway through the case, he would recognise half the fee, or perhaps somewhat less if there were genuine uncertainties about the time to complete. On the other hand, if the fee was agreed but the amount of remaining work and therefore time was open ended and therefore very difficult to predict, one would either (a) recognise some revenue but on the basis of a very conservative estimate or (b) argue that no reliable estimate can be made until the case is further progressed. As to the point about potentially losing the fee if the barrister cannot appear in court, the effect of this point on the accounting depends on the substance. If losing the fee due to being unable to present the case in court is rare, one would either disregard it or make an overall reduction of a few percentage points in the overall revenue figure to allow for the rare case in that category. On the other hand, if it is common that a barrister prepares a case and is not able to present it, thereby losing the fee, it may be that there is not sufficient certainty to justify recognition of revenue until the barrister does present the case in court and is thereby assured of earning the fee. Events after the balance sheet date (appearing or not being able to appear) may of course reduce the uncertainty in some cases.  

Q4 - Legal aid in some cases (Mostly in the UK) is not agreed until after the matter has been settled. In lengthy cases payments on accounts are made. This is a long and protracted procedure that can take many years. Often the payments on account will be for a greater amount than the eventually agreed fee and the legal practitioner has to return the excess. It has been agreed with the revenue authorities that the relevant tax point is payment, normally a payment on account, or the agreement of the fee, whichever comes first.  

Again, professional judgement has to be applied here and the accounting treatment will depend on the degree of uncertainty. In principle, revenue should be recognised according to the work done to date, rather than according to progress payments received. If a reasonable estimate can be made of the revenue that has been earned as a result of the work done to date, then that should be recognised. Prudence should be built in to that estimate in response to uncertainty. It may be that the level of uncertainty is so high that no reliable estimate can be made until either later in the process or until the case is completed and the fee agreed. Finally, a practitioner should not recognise all the progress payments received as revenue, even if they do bear a close relationship to the work done to date, if it is likely that some of the amounts received will have to be refunded. The above information is for guidance only. You should seek specific professional advice if this applies to you.
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