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Do Lawyers Need Accounting Expertise to Keep Out of Jail?

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By Jonathan R. Tung, Esq. on December 14, 2015 2:57 PM

Few other times in history has the subject of accounting been so captivating as it was in the criminal fraud scandal of executives at the collapsed law firm of Dewey & LeBooeuf. The trial revolved around the arguably gray-area practices of three executives in the law firm who were charged of just falling short of cooking the books in order to "inflate" income of the once venerated law firm.

Who would have believed that such a precise professional service could be so murky?

Accrual Method: What Most Firms Do

The case against a handful of individuals of the firm Dewey & LeBoeuf involves the acceptable accounting practices that law firms are privileged to engage in here in the United States. Generally, under a regime known as Generally Accepted Accounting Principles (GAAP), Firms of all sizes record a sale once a good is sold or service is performed -- right at the time of tender. This is true regardless if payment came or not. This is known as the Accrual Method of accounting.

Cash Method: What LAW Firms Do

Most law firms, on the other hand, take advantage of an accounting scheme that is allowed in the United States that lets firms report revenue when the money comes in, regardless of when the service was provided. Even more cute, law firms can use modified cash accounting to defer income to later years; or deduct expenses over time. Therefore, firms can deduct huge expenses over time to make the balance sheet in the purchasing year appear higher -- and distribute the difference to partners as a bonus. In the cash of Dewey, there were allegations that law firm partners were asking clients to backdate checks because the income was "constructively received" the year before.

This allows for the squishy application of rules, that surprisingly, has no centralized or standard practice scheme.

Old Habits Die Hard

There is a strong undercurrent by law firms that favors the status quo cash accounting method. Attempts to force accrual have died on take-off. The cry from the law firms is that accrual accounting is unfair to attorneys and other professionals because it requires the recording of revenue even if payment is never received. Another charge is that it would interfere with the client-attorney relationship because it would force attorneys to ask for payment sooner.

Across the Pond

But there is evidence that doom and gloom is not an inevitable end result of law firms moving to accrual. George Bull, a principle at RSM U.K. Tax and Accounting Ltd., recalls how there were similar protests in the U.K. when the accrual switch was made in his country. Today, he says, the legal profession is bigger and strong than ever before.

In his opinion, monthly or periodic statements on the client are much preferred to simply asking a giant sum at the end of the year. "It's bad for the client's cash flow and bad for the firm's cash flow," he said. He opined too that U.S. firms would be more diligent about their collections if they were forced to go to accrual accounting.

What to Do?

With the offering of plea bargains to the main players in the Dewey scandal, it's unclear whether or not the trial will end up doing anything more than causing law firms to intake air sharply. But at least we lawyers know that there are alternatives to sometimes archaic accounting principles -- one's that won't land us in prison. No one needs to be an accountant in order to stay out of prison ... just keep it simple.

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