Learning Outcomes
After studying this article, you will be able to explain the accounting procedures for submitting, reducing, and paying bills in legal practice, including the correct double-entry bookkeeping for each stage. You will understand how VAT applies to profit costs and disbursements, the distinction between agency and principal methods for VAT, and how to record all related transactions in compliance with the SRA Accounts Rules. You will also be able to identify common errors and apply the correct entries in SQE1-style scenarios.
SQE1 Syllabus
For SQE1, you are required to understand the accounting procedures and entries for billing in legal practice, including VAT treatment. In your revision, focus on:
- the process and accounting entries for submitting a bill to a client (profit costs and VAT)
- how to record reductions (abatements) of bills and the correct double entries
- the accounting entries for payment of bills, including from client funds and direct payments
- the distinction between money on account and billed sums
- VAT treatment of profit costs and disbursements, including agency and principal methods
- compliance with SRA Accounts Rules for all billing and VAT transactions
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.
- What are the correct double-entry accounting entries when a law firm submits a bill for profit costs and VAT to a client?
- How should a reduction (abatement) of a bill be recorded in the ledgers?
- What is the difference between the agency and principal methods for VAT on disbursements?
- When can money held on account in the client account be transferred to the business account?
Introduction
Legal billing procedures require strict compliance with the SRA Accounts Rules and accurate accounting entries at each stage: submitting a bill, reducing (abating) a bill, and recording payment. VAT must be correctly applied to profit costs and, in some cases, to disbursements. Understanding the correct double-entry bookkeeping for each transaction is essential for SQE1 and for legal practice.
SUBMITTING A BILL: PROFIT COSTS AND VAT
When a law firm completes work for a client, it submits a bill for its profit costs (fees for legal services) and any applicable VAT. The bill may also include disbursements (payments to third parties on the client’s behalf).
Key Term: profit costs
The firm’s charges for legal work performed for the client, excluding disbursements.Key Term: VAT
Value Added Tax, currently 20% on most legal services in England and Wales.
When a bill is submitted, the firm must record the transaction in its ledgers. The correct double-entry bookkeeping is:
- Debit (DR) the client ledger (business account) for the profit costs and VAT.
- Credit (CR) the profit costs ledger for the profit costs amount.
- Credit (CR) the VAT ledger for the VAT amount.
No entry is made in the cash account at this stage, as no money has yet been received.
Worked Example 1.1
A firm submits a bill to a client for £1,000 profit costs plus £200 VAT.
Answer:
DR client ledger (business account) £1,000 (profit costs)
DR client ledger (business account) £200 (VAT)
CR profit costs ledger £1,000
CR VAT ledger £200
Revision Tip
When revising, memorise that submitting a bill involves only the client ledger (business account), profit costs ledger, and VAT ledger. No cash entries are made until payment is received.
REDUCING A BILL (ABATEMENT)
Sometimes a bill is reduced after submission, for example, due to a client complaint or negotiation. This reduction is called an abatement.
Key Term: abatement
An agreed reduction in a client’s bill, including the VAT element.
To record an abatement, reverse part of the original entries:
- Credit (CR) the client ledger (business account) for the abated profit costs and VAT.
- Debit (DR) the profit costs ledger for the abated profit costs.
- Debit (DR) the VAT ledger for the abated VAT.
Worked Example 1.2
A firm reduces a previously submitted bill by £200 profit costs and £40 VAT.
Answer:
CR client ledger (business account) £200 (profit costs)
CR client ledger (business account) £40 (VAT)
DR profit costs ledger £200
DR VAT ledger £40
Exam Warning
When recording an abatement, always enter the reduction amount, not the new total. For example, if a bill is reduced from £1,200 to £1,000, the abatement is £200 (plus VAT), not £1,000.
PAYMENT OF A BILL
Once a bill has been submitted, the client may pay by bank transfer, cheque, or from funds already held in the client account. The accounting entries depend on the source of payment.
Payment by Client (Direct to Business Account)
If the client pays the bill directly (e.g., by bank transfer), the entries are:
- Debit (DR) the cash account (business side) for the amount received.
- Credit (CR) the client ledger (business account) for the same amount.
Payment from Client Account (Money on Account)
If the firm is holding client money on account (received before the bill was submitted), the firm may transfer the relevant amount to the business account after submitting the bill. The entries are:
- Debit (DR) the client ledger (client account) for the amount transferred.
- Credit (CR) the cash account (client side) for the same amount.
Then:
- Debit (DR) the cash account (business side) for the amount received from the client account.
- Credit (CR) the client ledger (business account) for the same amount.
Key Term: money on account
Client money received in advance of a bill, to be held in the client account until a bill is submitted.
Worked Example 1.3
A client pays £1,200 directly to the business account in settlement of a bill.
Answer:
DR cash account (business) £1,200
CR client ledger (business account) £1,200
If the firm holds £1,200 in the client account and transfers it after submitting the bill:
DR client ledger (client account) £1,200
CR cash account (client) £1,200
DR cash account (business) £1,200
CR client ledger (business account) £1,200
VAT ON DISBURSEMENTS: AGENCY AND PRINCIPAL METHODS
Disbursements may or may not attract VAT, depending on the nature of the expense and the name on the supplier’s invoice.
Key Term: disbursement
A payment made by the firm to a third party on behalf of the client, such as court fees or expert reports.Key Term: agency method
The firm pays a third party on behalf of the client (invoice in client’s name); VAT is not charged by the firm to the client.Key Term: principal method
The firm pays a third party for services supplied to the firm (invoice in firm’s name); VAT is charged by the firm to the client when the bill is submitted.
Agency Method
If the invoice is in the client’s name, the firm pays the supplier and reclaims the exact amount from the client. No additional VAT is charged by the firm. The payment can be made from the client account (if funds are available) or the business account.
Principal Method
If the invoice is in the firm’s name, the firm pays the supplier (including VAT), claims input VAT, and charges the client VAT on the disbursement when submitting the bill. The payment must be made from the business account.
Worked Example 1.4
A firm pays a surveyor’s invoice for £500 + £100 VAT. The invoice is in the client’s name (agency method).
Answer:
DR client ledger (client account) £600
CR cash account (client) £600
If the invoice is in the firm’s name (principal method):
DR client ledger (business account) £500
DR VAT ledger £100
CR cash account (business) £600
When the bill is submitted to the client, VAT is charged on the disbursement.
COMMON ERRORS AND SRA ACCOUNTS RULES
Exam Warning (Common Errors)
Never transfer money from the client account to the business account in payment of a bill unless a bill has been submitted. Money on account must remain in the client account until a bill is delivered.
Revision Tip (Common Errors)
For SQE1, memorise the correct ledgers for each entry:
- Submitting a bill: client ledger (business), profit costs ledger, VAT ledger
- Abatement: reverse the above
- Payment: cash account and client ledger
- Disbursements: agency or principal method determines VAT treatment
Key Point Checklist
This article has covered the following key knowledge points:
- Submitting a bill requires double entries in the client ledger (business), profit costs ledger, and VAT ledger.
- Reducing a bill (abatement) reverses part of the original entries for the reduction amount.
- Payment of a bill is recorded in the cash account and client ledger; source of payment determines the ledgers used.
- Money on account must remain in the client account until a bill is submitted.
- VAT on disbursements depends on whether the agency or principal method applies.
- All billing and VAT transactions must comply with the SRA Accounts Rules.
Key Terms and Concepts
- profit costs
- VAT
- abatement
- money on account
- disbursement
- agency method
- principal method
