LLP SORP 2024 – significant changes ahead

The latest Limited Liability Partnership (LLP) Statement of Recommended Practice (SORP), which is effective for accounting periods commencing on or after 1 July 2024, could have a significant impact on the presentation of LLP financial statements if the LLP does not take action.

In this article, we aim to:

• Alert you to critical aspects of the changes to the LLP SORP.
• Explain points to consider as to when these should be applied.
• Suggest actions to take now.

What are the headline changes in the 2024 LLP SORP?

In addition to updating the SORP for climate-related financial disclosures and related legislation references, there are three key changes which may impact recognition and measurement for some LLPs:

1. Automatic division of profits to members who do NOT provide substantive services

• If applicable to your LLP, this potentially significant change requires:
  • annual remeasurement of members’ interests, to reflect the present value (or fair value) of expected future cashflows based on profit forecasts; and
  • the movement to be presented in members’ remuneration charged as an expense.
• We recommend considering:
  • are there members who only provide funding, with no substantive services? (substantive services is not defined); and
  • do these members receive an automatic return on investment? (eg a fixed percentage of profits with no decision by the LLP before profits are divided).

2. Consolidation issues – interests in subsidiary LLPs

• Clarification that non-controlling interests in the group’s net assets comprise only the equity interests not attributable directly or indirectly to the parent.

3. Amounts payable to former members

• Narrow scope scenarios, where Share Based Payments, or Insurance Contracts may apply, eg former members have the right to a share of proceeds on the future disposal of the business.
• Guidance on how these apply in different scenarios, such as vesting over a service period, is included in the SORP.

Automatic division of profits to members who do NOT provide substantive services

Point 1 above is likely to have the most significant impact as it introduces the concept of working members (those who provide services to the LLP) and non-working members (those who do not provide any substantive services to the LLP).

The LLP SORP now clarifies that an automatic division of profits is clearly identifiable as a return on amounts subscribed (capital) if receivable by a member who only provides funding and no substantive services (ie a non-working member).

All LLPs, including property investment businesses, Financial Conduct Authority (FCA) regulated businesses, or those within a private equity structure, should carefully consider the latest changes to the SORP. The decision as to whether members provide substantive services could be a significant judgement with far reaching consequences for the position and performance of the LLP shown in the financial statements.

The automatic division of profits gives rise to a financial liability, and as now clarified, the liability to non-working members is a non-basic financial instrument that must be measured on a basis that reflects the expected cash flows from the underlying profit share entitlement. Each of the methods (ie amortised cost or fair value) will produce a similar result. The relevant members’ interests liability will be remeasured at each reporting date based on expected future profits and the expected (or contractual) period of the members’ investment.

An example of automatic division of profits

Consider an LLP with four working members providing services, and two investor members who have each invested £1m capital in the LLP. The LLP is expected to make £600k profit per annum.

Investor member A receives, as a priority over other members, a 10% return on their investment each year, which is in line with the risk profile of the LLP.

Investor member B receives a 20% share of the remaining profits available for distribution in line with the working members.

All members are entitled to the balance on their current and capital accounts upon retirement.

The members interests of the four working members and member A, will be carried at historical cost, updated for payments to / from the members and their allocated profit shares.

The member’s interests of member B will be revalued each year with the revaluation booked to members remuneration charged as an expense. If the valuation increases, (eg because the expected future profits increase significantly), the amount of members remuneration charged as an expense would be in excess of the profits, resulting in a loss available for discretionary division amongst members. The LLP will need to consider how that loss is allocated amongst members, if at all.

If the valuation subsequently falls, the LLP will need to be mindful of not lowering the members interests of member B below the amount they could call on if they retired.

As shown in the example, the revaluation of members interests could have a significant impact on the measurement of critical figures on the balance sheet and income statement. Ensuring stakeholders understand the accounting changes and reasons why the LLP may have a profit / loss available for discretionary division is important.

What does substantive services mean?

The phrase “substantive services” has not been defined in the SORP, and so preparers may consider whether the dictionary definition should be used together with analogous uses in GAAP.

Other areas of GAAP include the distinction between substantive vs protective rights for shareholders.

By corollary, judgement will be required as to whether substantive services by a member to the LLP indicate that the members have some influence over the financial and operating policies, rather than just protecting their investment (eg by being able to influence the direction of the LLP rather than to block amendments to the LLP agreement). This determination could be complex and subjective, and where applicable will likely be a significant judgement to be disclosed in the accounting policies.

When should the revisions introduced by the SORP be applied?

These changes should be applied retrospectively from the first accounting period commencing after the effective date (periods commencing on or after 1 July 2024) of the revised SORP.

LLPs should consider discussing with their auditor (or accountant) the timing and impact of any changes they are considering making to their members agreement in the period prior to it becoming effective, eg in the period to 31 March 2025.

What should you do if you are in scope of the changes?

Particularly for those in scope of the changes for non-working members highlighted above, we recommend carefully considering this area, and then discussing the implications with your auditors as soon as possible. You may wish to revisit the members’ agreement and take legal, accounting and tax advice to address the possible accounting implications before the end of the current accounting period.

Possible changes you may wish to consider now, before the start of the period the change is effective in (eg by 31 March 2025 for a March year end) include:

• Removal of the automatic division of profits to members who do not provide substantive services, for example by requiring a vote from members to approve the division of profits.
• Introduction of a form of adjusted profit or loss for distribution purposes (ie to clarify working members will receive a share of profits before the re-measurement of non-working members interests).
• Clarifying the roles performed by classes of members.

The members may also wish to consider whether this change should be adopted at the same time as the changes resulting from the periodic review of FRS 102 (ie adopting the periodic review early), so that all changes are covered in one year, thus providing greater consistency going forward.

Once you have considered the impacts, we also recommend explaining the expected changes to the stakeholders of the LLP, thus avoiding any surprises when the financial statements are issued.

Please get in touch with your usual RSM contact, or Hywel Pegler, to discuss how the changes in the SORP may impact your LLP.