Accountancy and the Legal Profession – Why is accountancy important even to Lawyers

For the layman, accountancy means a method of keeping a track of the money received and the money spent.  Accountancy is all pervasive, starting right from a simple housewife, who has to manage her household expenses in a limited budget to a large corporate entity where accounting implies, apart from complying with statutory requirements, a means to measure the value of the business.

For an ordinary individual, for example, a housewife, accountancy is a loosely termed as ‘hisab’ and merely involves keeping a track of money in hand, received or earned and money spent on day to day expenses. For daily earners, accountancy or even hisab holds no meaning and importance, but for obvious reasons.

In the strict term, accountancy can be defined as the principles of recording the incomes earned and expenses incurred to earn the income, wealth, or assets created out of the income earned and the liability taken upon towards running of an enterprise and generating income and wealth.

The importance of core accounting is necessarily understood by persons, individuals or entities, who are involved in an activity that generates income out of the efforts of such individuals or entities.  This is because, for every effort put in, the result is measured in terms of value earned for the effort.  For every value earned, the efforts put in involve certain amount of  expenses, which may be incurred out of the existing available resources or from borrowed funds.  Unless there is a proper system of accounting for any entrepreneurial activity, the satisfaction of viewing the final results of the activity will not be easily identifiable.

Accountancy is a compulsory part of almost all medium and large scale business and service oriented enterprises, mainly due to the fact of compliance with statutory provisions and tax
laws.  For example, in case of a corporate entity, maintenance of books of accounts is mandatory along with Statutory Audits and Tax Audits in certain cases.   In case of small and medium enterprises, which are not corporate structures, accountancy is compulsory to comply with tax laws and the laws governing the small and medium enterprises. Individuals operating as proprietors are not governed by any law other than the Income Tax laws and hence maintenance of books of accounts is compulsory for certain proprietorship concerns.

As mentioned earlier, accountancy is important to any entrepreneurial activity, which involves not only the business of trading but also activities of professionals like doctors, chartered
accountants, lawyers and management consultants.  I shall now discuss accountancy in relation to the activities of a legal professional.

For an advocate, the most important investment in his profession is the qualification earned.  This can be called as the initial investment required for setting up a legal practice.  Unlike a business activity, where initial capital investment can be brought into account, a professional qualification cannot be quantified and accounted as initial capital investment.  However, one of the important ingredients for a practicing professional should be a bank account meant only for the purpose of the practice, as distinct from a normal savings or current account which may be in existent at the time of beginning of the practice.  The amount put in at the time of opening the bank account can for the purpose of accounting be termed as the initial capital investment.

The purpose of accounting, as explained earlier, is to keep a track of the incomes earned and expenses incurred towards earning the income.  Applying this concept to the legal profession, an advocate needs to necessarily account for fees due and receivable against every client and also to record expenditure incurred purely towards his efforts on individual matters.  Accounting does not help in costing or valuation of fees to be billed to a client, which may depend on the standing of the advocate in the profession, the type of matters that he handles and to some extent, the worth of the clients who come to him.  Accounting helps the advocate to keep a track of the value earned towards any particular legal matter handled by him.

The receipts of an advocate may not always be towards fees.  Advocates recover expenses from the clients towards filing fees, cost of stationery and other ancillary expenses, which are not to be met from the fees chargeable to the client.  In this situation, it is all the more important that the advocate keeps a proper track of the money that has been given to him for expenses and identify all the expenses against the particular receipts.  In the absence of such a method, and in the event the expenses exceed the amount given to the advocate by the client, the advocate may end up paying costs for the client from the fees that he receives for that particular matter.  It is also ideal that an advocate or a legal firm maintains a separate bank account that may be termed as CLIENT ACCOUNT.  This bank account should be used purely for expenses on behalf of clients and each receipt and expenditure against the receipt should be properly credited and debited to the respective client account in the books.

An advocate may sometimes receive a lump sum amount from a client towards fees.  However, with particular emphasis on the legal profession, the fees billed by an advocate to a client may be dependent on the stage the matter has reached before a Court or any other judicial authority.  If suppose an advocate has quoted Rs. 1 lakh towards fees for appearing in a Court matter, the process involves various stages viz. filing of plaint, admission of suit matter, initial arguments and final hearing before disposal of the matter.  An advocate may chose to ‘book’ or account for his fees stage wise simply because of the fact that legal disputes tend to spill over a period exceeding one financial year.  If the total fees due is accounted in one financial year, while the matter spreads over two or more financial years, the advocate ends up paying tax on an income which has actually not accrued to him in that year.  In such a case, accounting principles provide that the advocate can treat only that portion of the amount received from the client as fees as is directly proportional to the stage the matter has reached.  The balance amount can be shown as Advance against Fees and should ideally be retained in the Client Account rather than the normal practice bank account.  At this point, however, it is necessary for the advocate to also apportion the TDS element relevant for the assessment year in which the fees is declared as income and claim the balance portion of TDS in the subsequent years.  In the absence of an accounting system in place, the advocate may never be able to keep track of such situations.

For an advocate, the major expenses include cost of running an office, if any, subscriptions to law journals, purchase of books, salaries of staff, if any, telephone, mobile bills and in some cases, conveyance expenses.  Other than that, for an advocate, there are not many avenues to account for expenses.  In case of a legal firm, there may be more options to account for expenses.

At the end of a financial year, an advocate would also draw up his Profit and Loss Account and Balance Sheet to understand the amount that he has earned out of his professional practice and the assets and liabilities created during the year as a result of undertaking professional practice.  All this is not possible for an advocate who either does not keep a proper record of his income and outgoes or does it in a primitive fashion. Accountancy also has a direct connection with taxation and taxation laws apply even to advocates.  However, the connection of accountancy and tax as a combination applicable to lawyers is another subject matter.  As a specialized subject, taxation involves many intricacies which cannot be fully discussed in
connection with any subject in brief.

Accountancy is not meant only for those who have a huge or sizeable turnover.  This thought itself is a regressive approach.  To grow big one has to think big.  For every penny earned today, the multiplication factor would be seen only in the long run.  But for that, it is very necessary that accounting as a disciplined approach is adopted even by the lawyers.  Let it not be seen that the legal profession can avoid accountancy by finding out any provision in law that allows them this exemption, for there is none.  And a smart advocate would necessarily want to know his brand value, which grows with time and effort, but can be measured only with figures in black and white.

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