Accountants' reports and regulatory compliance - Role of acc...

Learning Outcomes

This article outlines the important role accountants play in ensuring law firms comply with regulatory requirements, particularly the SRA Accounts Rules. It details the purpose, requirements, and implications of accountants' reports. For the SQE1 assessment, you will need to understand the functions of accountants in legal practice, the process for obtaining and delivering accountants' reports, the exceptions to these requirements, and the consequences of non-compliance. You should also be confident in applying the core accounting controls that underpin a report, including proper record keeping, five-week reconciliations, separation of client and business money, and the prohibition on using a client account as a banking facility. This knowledge will enable you to apply the relevant rules and principles to SQE1-style single best answer MCQs.

SQE1 Syllabus

For SQE1, you are required to understand the practical aspects of regulatory compliance and the role of accountants within that framework, including the requirements for obtaining and delivering accountants' reports, recognising situations where reports may be qualified, and understanding the implications of breaches, with a focus on the following syllabus points:

• The requirement to obtain and deliver accountants' reports (Rule 12).
• The circumstances under which an accountant's report may be qualified.
• Exceptions to the requirement for obtaining an accountant's report (Rule 12.2).
• The duty to keep and maintain accurate accounting records (Rule 8).
• The requirement for reconciliations (Rule 8.3).
• The storage and retention periods for accounting records (Rule 13).
• The role and responsibilities of the Compliance Officer for Finance and Administration (COFA).
• The separation of client money and business money (Rule 4.1), including mixed receipts and transfers.
• The prohibition on using client accounts to provide banking facilities (Rule 3.3).
• The conditions for withdrawals from client account (Rule 5.1) and prompt return of client money when no longer needed (Rule 2.5).
• Interest on client money and written interest policies (Rule 7.1–7.2), as part of the wider control environment reviewed by reporting accountants.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which Rule in the SRA Accounts Rules 2019 details the requirements for obtaining and delivering accountants' reports?
   1. Rule 7
   2. Rule 8
   3. Rule 12
   4. Rule 13
2. Under what circumstances must a firm deliver its accountant's report to the SRA?
   1. Only if the report is qualified.
   2. In all circumstances within six months of the accounting period end.
   3. Only if the firm holds more than £1 million in client money.
   4. Only if requested by the SRA.
3. For how long must accounting records generally be retained by a firm?
   1. Three years
   2. Five years
   3. Six years
   4. Ten years
4. Which of the following firms is MOST likely to be exempt from the requirement to obtain an accountant's report under Rule 12.2?
   1. A firm whose average client account balance was £15,000 but never exceeded £200,000.
   2. A firm whose maximum client account balance was £300,000 but averaged £8,000.
   3. A firm whose only client money received was from the Legal Aid Agency.
   4. A large commercial firm handling multi-million-pound transactions.

Introduction

Solicitors and the firms they work in are subject to strict regulatory requirements concerning the handling of money, particularly client money. The Solicitors Regulation Authority (SRA) Accounts Rules 2019 ('the Rules') provide the framework for this. A key aspect of ensuring compliance with these rules involves independent scrutiny by accountants. Accountants play a key role in verifying that firms comply with the Rules, thereby safeguarding client money and maintaining public trust in the legal profession. This article focuses on the accountant's role, specifically concerning accountants' reports and associated regulatory duties.

Key Term: accountant's report
A formal report prepared by a qualified independent accountant following an examination of a law firm's accounting records, assessing compliance with the SRA Accounts Rules.

The Role of the Accountant

While solicitors and their staff are responsible for the day-to-day handling of client money and maintaining accounting records, accountants provide an essential layer of independent oversight. Their involvement is primarily mandated through the requirement for firms holding client money to obtain an accountant's report.

Accountants assess whether the firm’s systems and records meet the Rules and whether any non-compliance presents a risk to client money. This is not a statutory audit of financial statements; it is a risk-based assurance exercise focused on the safeguarding of client funds. Typical procedures include:

• Reviewing the firm’s internal accounting records (cash book, client ledgers, business ledgers) and bank statements for all client accounts.
• Testing five-week client account reconciliations for accuracy, timeliness, and proper investigation of differences.
• Assessing whether client money is kept separate from business money (Rule 4.1), including correct treatment of mixed receipts and transfers.
• Checking that withdrawals from client account comply with Rule 5.1 and that client funds are not overdrawn on any individual matter.
• Inspecting the central record of bills and other written notifications of costs (Rule 8.4) and verifying entitlement before client-to-business transfers.
• Evaluating compliance with Rule 2.5 (prompt return of client money) and Rule 3.3 (prohibition on using client account as a banking facility).
• Reviewing the firm’s interest policy (Rule 7.1–7.2) and evidence of interest calculations and payments where appropriate.
• Considering the COFA’s breach register and remediation actions, and whether any pattern of breaches raises a material risk to client money.

Accountant's Report Requirement

Rule 12.1 of the Rules states that a firm which has held or received client money during an accounting period must obtain an accountant's report within six months of the end of that period. The reporting accountant must be independent, appropriately qualified, and able to exercise professional judgment about risks to client money. In practice, reporting accountants follow SRA guidance on planning and completing reports and tailor their work to the size, complexity, and risk profile of the firm.

The purpose of the report is to provide the SRA with assurance that the firm is complying with the Rules and that client money is being handled appropriately. The accountant exercises professional judgment to assess risks to client money arising from the firm's compliance (or non-compliance) with the Rules.

Qualified Reports

The accountant is required to 'qualify' the report if they form the judgment that the firm has failed to comply with the Rules such that money belonging to clients or third parties is, or has been, or is likely to be placed, at risk. The report will then set out the areas of non-compliance and the reasons those failures create or have created risk to client funds.

Key Term: qualified report
An accountant's report that indicates non-compliance with the SRA Accounts Rules, highlighting issues that pose a risk to client money.

Issues that often lead to qualification include:

• Failure to complete accurate five-week reconciliations or to investigate unreconciled differences promptly (Rule 8.3).
• Transfers from client to business account without entitlement (for example, no bill, or wrong matter ledger).
• Using a client account in a way that amounts to providing banking facilities (Rule 3.3), such as processing payments unrelated to the delivery of regulated services.
• Repeated or unremedied breaches that indicate weak controls (for instance, frequent overdrawn client ledgers or late remediation of errors).
• Poor record keeping that means the firm cannot demonstrate exact client money liabilities (Rule 8.1).

A qualified report signifies serious concerns about the firm's handling of client money or its accounting systems.

Delivery to the SRA

Under Rule 12.1(b), a firm is only required to deliver the accountant's report to the SRA if it is qualified. This must be done within six months of the end of the relevant accounting period. Unqualified reports (where the accountant finds no material breaches putting client money at risk) do not need to be submitted to the SRA, although the SRA retains the power under Rule 12.4 to request a report in certain circumstances, such as if the firm ceases to hold client money or if the SRA considers it in the public interest.

Worked Example 1.1

A firm's accounting period ends on 31st March. Their accountant completes the report on 1st September, finding several minor administrative errors but no significant risk to client money. The report is therefore unqualified. When must the firm deliver the report to the SRA?

Answer:
The firm is not required to deliver the unqualified report to the SRA. They must simply obtain the report from the accountant within six months of the accounting period end (i.e., by 30th September).

Worked Example 1.2

A firm consistently performs reconciliations every five weeks but leaves differences unexplained for two consecutive reconciliation cycles, and client-to-business transfers are occasionally made before a bill is delivered. The accountant judges these failings present a risk that the firm could take more than it is entitled to, or fail to detect shortages promptly. Should the report be qualified and delivered?

Answer:
Yes. Unexplained reconciliation differences and transfers without entitlement are Rule breaches that risk client funds. The report should be qualified and delivered within six months of the accounting period end.

Exceptions to Requiring a Report

Rule 12.2 provides two exceptions where a firm does not need to obtain an accountant's report:

1. Legal Aid Agency Money Only: If all the client money held or received during the accounting period was from the Legal Aid Agency.
2. Low Client Money Balances: If the aggregate balance of client money held during the period did not exceed:
   • an average of £10,000; and
   • a maximum of £250,000 at any one time.

Both thresholds must be met. The “average” is assessed by reference to client account balances over the period (using the firm’s reconciliations at least every five weeks); the “maximum” is the highest point the client account balance reaches at any time in the period. Firms must include all client accounts and designated deposit accounts when calculating the aggregate balance.

Key Term: client money
Money held or received by a firm relating to regulated services, including money held for clients, third parties, as trustee, or for fees and unpaid disbursements prior to billing (Rule 2.1).

Exam Warning

Be careful with the low balances exception (Rule 12.2(b)). Both conditions (average ≤ £10,000 AND maximum ≤ £250,000) must be met for the exemption to apply. If either threshold is exceeded, the firm must obtain a report. Ensure you consider all reconciliations across the period (at least every five weeks), and include separate designated deposit client accounts within the aggregate balance.

Worked Example 1.3

Premier Solicitors held client money throughout their accounting period ending 30 April 2023. Reconciliations showed the following total client money balances: May 2022: £8,000 June 2022: £9,000 July 2022: £15,000 Aug 2022 - Apr 2023: Balances fluctuated between £5,000 and £9,500.

Is Premier Solicitors required to obtain an accountant's report?

Answer:
Yes, likely. The maximum balance did not exceed £250,000, but the July peak of £15,000 suggests the average across all five-week reconciliations may exceed £10,000. The average must be calculated across the entire period using all reconciliation points. If the average is above £10,000 at any time during the year, the firm must obtain a report. On the figures given, the average is likely above £10,000, so a report is required.

Worked Example 1.4

A small firm’s five-week reconciliations over a 12‑month accounting period show aggregate client account balances of: £4k, £6k, £8k, £5k, £7k, £6k, £9k, £10k, £7k, £6k. The highest balance was £10k. Does Rule 12.2(b) apply?

Answer:
Yes. The maximum balance (highest point) is £10k, well below £250k, and the average of the reconciliation points is £6.8k (below £10k). Both conditions are met, so the firm is exempt from obtaining a report under Rule 12.2(b).

Accounting Records and Reconciliations

The accountant's report relies on the firm maintaining accurate and up-to-date accounting records, as mandated by Rule 8. The reporting accountant will evaluate the adequacy of those records and the firm’s control environment when deciding whether the report should be qualified.

Record Keeping

Rule 8.1 requires firms to keep accounting records properly written up, showing dealings with client money and any office money relating to client matters. This includes maintaining individual client ledgers and a cash account (cash book). Records must be accurate, contemporaneous, and chronological. Practical expectations include:

• Maintaining clear narratives for entries (date, details, debit/credit, running balance).
• Keeping separate client and business columns on ledgers where relevant (for example, on the cash sheet and matter-ledgers that can include both).
• Ensuring balances are monitored so that client ledgers do not become overdrawn.
• Operating a central record of bills and written notifications of costs (Rule 8.4) that is readily accessible.
• Obtaining bank statements for all client accounts and retaining them securely.

Reconciliations

Rule 8.3 mandates that firms must perform reconciliations between their bank statements and their internal cash account and client ledger records at least every five weeks. Reconciliations must:

• Compare the client account bank statement closing balance with the total of client ledger balances and the cash book, explaining any timing differences.
• Identify and promptly investigate discrepancies (for example, uncleared items, posting errors, or stale cheques).
• Be reviewed and signed off by the COFA or a manager, evidencing oversight and timely remediation.

Key Term: reconciliation
The process of comparing internal accounting records (like the cash book and client ledger balances) with external bank statements to ensure they match and to identify and correct any discrepancies.

Key Term: COFA (Compliance Officer for Finance and Administration)
The individual within a firm designated as responsible for ensuring compliance with the SRA Accounts Rules.

As part of the report, the accountant will inspect whether reconciliations are on time, complete, accurate, and properly investigated. Failure to reconcile or leaving differences unexplained can lead to qualification of the report because it increases the risk that client funds are not properly safeguarded.

Retention of Records

Rule 13.1 requires firms to store accounting records securely and retain them for at least six years from the date of the last entry. This includes client ledgers, cash accounts, bank statements, reconciliations, and the central record of bills. Electronic records must be retained in a form that cannot be altered, and should be reproducible promptly if required.

Revision Tip

Remember the key timeframes: reconciliations at least every 5 weeks; accountant's report obtained within 6 months of the accounting period end; delivery of qualified reports to SRA within 6 months; retention of records for at least 6 years.

Accountant's Duties and Firm's Obligations

The reporting accountant’s role is to exercise professional judgment about risks to client money arising from compliance with the Rules, completing the report in the form required by the SRA at the date the report is commissioned. In practice, they will request details of all accounts kept or operated in connection with the firm’s practice (client accounts, business accounts, any designated deposit client accounts, and relevant joint or client-operated accounts used in practice contexts) and review the firm’s systems.

Firms must provide the accountant with all necessary information and access to records to enable them to complete their report (Rule 12.8). Significant failure to provide documentation may result in the accountant qualifying the report on the grounds that they cannot properly prepare it, or the SRA requiring a report under Rule 12.4.

Accountants are also expected, under their engagement terms and SRA guidance, to report directly to the SRA if they discover evidence of fraud or theft relating to client money, or have reasonable cause to believe information is likely to be of material significance to the determination of whether a solicitor or firm is fit and proper to hold client money. While references to this duty appeared in earlier versions of the Accounts Rules, the current approach reflects the reporting accountant’s professional obligations and SRA guidance issued from time to time. In practice, direct reports are made where the safety of client funds is at risk, and firms should expect the accountant to engage promptly with the SRA in such cases.

COFA responsibilities in the reporting process

The COFA has a central role in ensuring the firm’s systems comply with the Accounts Rules and in supporting the reporting accountant’s work. In practice, the COFA should:

• Take all reasonable steps to ensure compliance with the Rules, including regular checks on the accounting system and controls.
• Maintain a breach log that records all failures to comply, monitor patterns, and ensure prompt remediation.
• Report material breaches to the SRA as soon as reasonably practicable, considering client detriment, scale, risk to public confidence, and overall impact.
• Ensure appropriate authorisations exist for withdrawals from client account and that entitlement is established before client-to-business transfers.
• Facilitate prompt access by the reporting accountant to the firm’s records and provide explanations for reconciliations and any differences.

A robust COFA function makes qualification less likely and provides evidence to the reporting accountant that risks to client money are being managed effectively.

Banking facilities prohibition: relevance to reports

Rule 3.3 prohibits using client accounts to provide banking facilities. The reporting accountant will consider whether funds handled through client account relate to the provision of regulated services. Examples of problematic use include:

• Receiving and paying money for a client unrelated to a matter in which the firm is delivering regulated services (e.g., paying personal bills at a client’s request from sale proceeds held long after completion).
• Processing large volumes of funds through client account following a client’s business failure with no legal work connected to the payments.

These patterns raise money laundering risks and fall outside proper solicitor conduct. Accountants will generally qualify the report where such use is identified.

Worked Example 1.5

A firm completes a sale and continues to hold the net proceeds at the client’s request for several months, making payments for the client’s personal expenses unconnected with any legal matter. The reporting accountant finds multiple payments to non-legal recipients during this period. How should this be reflected in the report?

Answer:
The use breaches Rule 3.3 and risks client funds. The report should be qualified, and the accountant should consider direct notification to the SRA due to the nature and persistence of the issue.

Worked Example 1.6

During testing, the accountant notes several transfers from client to business account to settle bills, but on two matters the bill had not yet been delivered. Reconciliations were timely, and errors were corrected within a week after discovery. Does this still justify qualification?

Answer:
Likely yes. Transfers without entitlement (no bill) breach the Rules and create risk to client money. While timely remediation helps, repeated instances can indicate control weakness. The accountant should judge whether the pattern and risk warrant qualification; often, a qualification is appropriate with details of remedial measures.

Key Point Checklist

This article has covered the following key knowledge points:

• Firms holding client money must generally obtain an accountant's report within 6 months of their accounting period end (Rule 12.1).
• Only qualified reports must be delivered to the SRA (Rule 12.1(b)); however, the SRA can require delivery in the public interest or if the firm ceases to hold client money (Rule 12.4).
• The report is risk-focused: it assesses compliance with the Accounts Rules and risks to client money.
• A report must be qualified if the accountant identifies failures that put, or are likely to put, client money at risk (for example, reconciliation failures, transfers without entitlement, or banking facilities breaches).
• Exceptions apply if only LAA money is held, or if client money balances meet both low-balance thresholds (average ≤ £10k and maximum ≤ £250k) (Rule 12.2).
• Accurate and contemporaneous accounting records must be kept (Rule 8.1), including a central record of bills (Rule 8.4).
• Reconciliations between client account bank statements and internal records must occur at least every 5 weeks and be promptly investigated and signed off by a manager or the COFA (Rule 8.3).
• Client money must be kept separate from business money (Rule 4.1). Mixed receipts must be allocated promptly to the correct account, and withdrawals must satisfy Rule 5.1.
• Using client accounts as banking facilities is prohibited (Rule 3.3).
• Client money must be returned promptly when there is no longer any proper reason to hold it (Rule 2.5).
• Records must be retained for at least 6 years from the last entry (Rule 13.1).
• Accountants may be required, under SRA guidance and engagement terms, to report directly to the SRA in cases of theft, fraud, or serious concerns about fitness to hold client money.
• Firms must cooperate with reporting accountants and provide necessary access and information; serious failures may lead to qualification (Rule 12.8).
• The COFA must maintain breach logs, remediate promptly, and report material breaches to the SRA, supporting the reporting process.

Key Terms and Concepts

• accountant's report
• qualified report
• client money
• reconciliation
• COFA (Compliance Officer for Finance and Administration)