Income recognition: firms are kidding themselves

To impress a former girlfriend, I told her early in the relationship that I too was a huge Ronan Keating fan.

Oh, I’d liked him right back to his Boyzone days, I bluffed. I admired his solo material. Even had him down as a future Sinatra, or something to that effect.

I even perfected a rather decent impression of the fella (which can still be revived if you buy me a drink or two).

Alas, what started out as a slight extension of the truth came back to haunt me when we met Ronan and I failed to show the requisite excitement. The actual truth spilled out that I was, at best, apathetic. It would have been best in hindsight if I’d said nothing at all.

Law firms, particularly those with shareholders, have a similar compulsion and they too can be creative with the truth when it comes to how much money they’re actually making. The problem is when you start to dig, the hole gets bigger and you end up kidding yourself about the success you’re enjoying.

Creating financial statements on income yet to be cashed is building a house out of sand.

Now we’re seeing the fallout, and it just might be the wake-up call much of the sector needs to face reality.

Minster Law this week declared eye-watering losses of £35m – a figure partly attributed to how it recognised income.

Managing director Michael Warren was refreshingly frank about the changes that had been made accounting policy, saying the work in progress estimates had previously been ‘optimistic’ and that income would in future only be expected once a case has progressed further.

In effect, this means not taking income for granted until the cheque is cashed.

Minster is the second major firm to go public on changes to accounting policy.

Slater and Gordon, a firm which has had a year best described as mixed, announced last month it has adopted a new standard which requires revenue is recognised only when it is ‘highly probable’ benefits of a case will come. The previous marker was just ‘probable’ – a small amendment but a major leap in facing up to realities.

Slater and Gordon admitted the change would knock off up to 20% off WIP balances, but would offer ‘greater consistency and a more systematic approach to generating reported values of revenue and WIP’.

It should be noted both firms were acting within the rules and have done nothing wrong - this was their interpretation of what was required of them. Neither Minster nor S+G would have enjoyed the headlines that followed their declarations, but at least now they enjoy certainty. Coming out, as such, represents a fresh start.

Who knows how many other firms have similar accounting policies? My guess is these two aren’t the only ones. I’ve heard of some firms deliberately inflating costs to satisfy the accountant, knowing there’s not a hope of ever seeing the money. It only takes a George Osborne kick to the unmentionables and you’re suddenly exposed.

To paraphrase my biblical namesake, once law firms know the truth, the truth may set them free. Until then, they’re stuck listening to Ronan Keating on a loop and suffering for it.

John Hyde is Gazette deputy news editor