Accounting procedures and entries - Disbursements using the agency and principal methods

Learning Outcomes

After reading this article, you will be able to distinguish between the agency and principal methods for accounting for disbursements under the SRA Accounts Rules. You will know when each method applies, how to identify the correct ledger entries, and how VAT is treated in each scenario. You will also be able to apply these rules to practical SQE1-style questions and avoid common compliance errors.

SQE1 Syllabus

For SQE1, you are required to understand the correct accounting treatment of disbursements paid by a firm on behalf of a client. This includes knowing when to use the agency or principal method, how to record the transactions, and the VAT implications. In your revision, focus on:

• the distinction between the agency and principal methods for disbursements
• how to determine which method applies based on the addressee of the supplier's invoice
• the correct double-entry bookkeeping for each method, including VAT treatment
• the compliance requirements under the SRA Accounts Rules for disbursements
• the practical impact of each method on VAT recovery for the firm and the client

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. A solicitor pays a surveyor's invoice addressed to the client. Which method should be used to account for this disbursement and VAT?
   1. Agency method
   2. Principal method
   3. Either method
   4. Neither method
2. Under the principal method, from which account must the firm pay the third-party supplier's invoice?
   1. Client account
   2. Business account
   3. Either account
   4. Petty cash
3. When using the agency method, who is responsible for reclaiming VAT on the disbursement?
   1. The solicitor's firm
   2. The client
   3. HMRC
   4. The supplier

Introduction

Solicitors frequently pay expenses to third parties on behalf of clients. These payments, known as disbursements, must be accounted for correctly under the SRA Accounts Rules. The method used—agency or principal—affects both the ledger entries and the VAT treatment. Understanding the distinction is essential for SQE1 and for compliance in practice.

Disbursements: Agency and Principal Methods

Disbursements are payments made by a firm to a third party in connection with a client matter. Examples include court fees, search fees, expert reports, and counsel's fees. The correct accounting treatment depends on whether the firm is acting as agent or principal in the transaction.

Key Term: disbursement
A payment made by a solicitor to a third party on behalf of a client in the course of providing legal services.

The Agency Method

The agency method applies when the firm simply arranges payment to a third party on the client's behalf, and the third party's invoice is addressed to the client.

Key Term: agency method
The accounting method for disbursements where the firm acts as agent, paying a third party on behalf of the client. The supply is deemed to be made directly to the client.

Under the agency method:

• The invoice is addressed to the client.
• The firm pays the third party using client money (if available) or business money.
• The VAT-inclusive amount is recorded as a single figure.
• The firm does not record input or output VAT for the disbursement.
• The client, if VAT registered, can reclaim VAT using the supplier's invoice.

Accounting Entries – Agency Method

If paid from the client account (sufficient client funds):

• DR Client ledger (client account columns) – VAT-inclusive amount
• CR Cash sheet (client account columns) – VAT-inclusive amount

If paid from the business account (insufficient client funds):

• DR Client ledger (business account columns) – VAT-inclusive amount
• CR Cash sheet (business account columns) – VAT-inclusive amount

Worked Example 1.1

A solicitor pays a search fee of £120 (including £20 VAT) for a client. The invoice is addressed to the client. The solicitor holds enough client money.

Question: What are the correct ledger entries?

Answer:
DR client ledger (client account) £120
CR cash sheet (client account) £120
No VAT entry is made by the firm. The client can reclaim VAT if eligible.

The Principal Method

The principal method applies when the firm is treated as receiving the supply from the third party, and then resupplying it to the client. This is the case when the invoice is addressed to the firm.

Key Term: principal method
The accounting method for disbursements where the firm is treated as principal, receiving the supply from the third party and resupplying it to the client. The invoice is addressed to the firm.

Under the principal method:

• The invoice is addressed to the firm.
• The firm must pay the third party from the business account.
• The firm records input VAT on the payment.
• When billing the client, the firm recharges the net amount plus output VAT.
• The client can reclaim VAT only if the firm’s invoice is addressed to the client and the client is VAT registered.

Accounting Entries – Principal Method

Stage 1: Pay the third-party supplier (from business account):

• DR Client ledger (business account columns) – net amount
• CR Cash sheet (business account columns) – net amount
• DR HMRC VAT ledger – VAT amount
• CR Cash sheet (business account columns) – VAT amount

Stage 2: Bill the client (recharge disbursement + VAT):

• DR Client ledger (business account columns) – net amount (if not already entered)
• DR Client ledger (business account columns) – VAT amount (output VAT)
• CR Profit costs ledger – profit costs (if included)
• CR HMRC VAT ledger – output VAT

Worked Example 1.2

A solicitor pays an expert's invoice of £600 + £120 VAT, addressed to the firm. Later, the solicitor bills the client £1,000 profit costs plus the expert's fee, plus VAT.

Question: What are the correct entries?

Answer:
Stage 1:
DR client ledger (business account) £600
CR cash sheet (business account) £600
DR HMRC VAT ledger £120
CR cash sheet (business account) £120

Stage 2:
DR client ledger (business account) £1,000 (profit costs)
DR client ledger (business account) £720 (VAT on £1,000 + £600 = £1,600 × 20%)
CR profit costs ledger £1,000
CR HMRC VAT ledger £320 (output VAT on profit costs)
CR HMRC VAT ledger £120 (output VAT on expert fee)
(The firm reclaims £120 input VAT and accounts for £320 output VAT.)

Exam Warning

If the invoice is addressed to the firm, you must use the principal method and pay from the business account, even if client funds are available. Do not pay from the client account in this scenario.

VAT and Disbursements: Key Points

• Under the agency method, the firm does not account for VAT on the disbursement; the client reclaims VAT if eligible.
• Under the principal method, the firm reclaims input VAT and charges output VAT to the client.
• The addressee of the invoice determines which method applies.

Key Term: VAT
Value Added Tax, a tax charged on most goods and services supplied in the UK, currently at 20%.

Counsel's Fees: Special Concession

Historically, HMRC allowed firms to treat counsel's fees as agency disbursements if the fee note was amended to show the client's name. This allowed the client to reclaim VAT directly. However, unless the facts specify this concession, assume the principal method applies if the invoice is addressed to the firm.

Revision Tip

Always check the addressee of the invoice. Client's name = agency method; firm's name = principal method.

Summary

Key Point Checklist

This article has covered the following key knowledge points:

• The agency method applies when the invoice is addressed to the client; the firm acts as agent and does not account for VAT.
• The principal method applies when the invoice is addressed to the firm; the firm must pay from the business account and account for input and output VAT.
• The correct ledger entries differ for each method and must be applied precisely.
• The addressee of the invoice is the critical factor in determining the correct method.
• Counsel's fees may be treated exceptionally if the fee note is amended to the client's name, but this is not the default.

Key Terms and Concepts

• disbursement
• agency method
• principal method
• VAT