Introduction to Legal Accountancy:

Introduction:

This note will explain the meaning of accounting, the distinction between bookkeeping and accounting, highlight the various forms/types of financial statements prepared by businesses, and explain why lawyers should study accounting or the importance of accounting to lawyers.

Meaning of Accounting:

In the Course Manual for Legal Accountancy, accounting is defined as:

The art of recording, classifying, and summarising in a significant manner and in terms of money, financial transactions, and interpreting the results thereof.

It was also defined in the manual as:

The process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by the users of the information.

Horngren et al. in Introduction to Financial Accounting, 11 ^th ed.,

The process of identifying, recording, and summarizing economic information and reporting it to decision makers.

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Accounting organizes and summarizes economic information so decision makers can use it. Accountants present this information in reports called financial statements. To prepare these statements, accountants analyze, record, quantify, accumulate, summarize, classify, report, and interpret economic events and their financial effects on an organization.[1]

From these definitions, it is clear that accounting comprises various distinct activities, such as identifying and recording financial transactions, classifying them, summarising the classified data, and interpreting the results.

We now discuss each activity.

1. Identifying and Recording Financial Transactions:

Businesses engage in numerous financial transactions throughout their operations. For instance, a retail business might acquire a store, purchase goods from suppliers, or make sales to customers. All these transactions are financial in nature as long as they can be quantified in monetary terms.

Identifying and recording financial transactions involves recognising events that have financial implications and documenting them systematically in accounting records. This step ensures that every transaction is accurately captured with relevant details such as date, amount, parties involved, and a brief description.

2. Classifying Recorded Financial Transactions:

In recording the financial transactions, there is often a classification of similar items together. For example, in recording several transactions consisting of sales and purchases of fixed assets, all sales transactions are classified separately from all purchases of fixed assets.

3. Summarising the Classified Data into Financial Statements:

Periodically, the classified financial information is further summarised into what are known as financial statements. These statements provide stakeholders with a comprehensive overview of the financial performance and position of the business. These statements highlight key aspects such as the profit or loss generated, assets and liabilities, cash flows, among others.

Financial statements serve as essential tools for decision-making, enabling stakeholders to assess the company’s performance, growth potential, and sustainability.

These financial statements include:

1. Balance sheet or statement of financial position: This presents an entity’s assets, liabilities, and equity at a given point in time. Assets are the resources an entity owns, and liabilities are the debts or obligations that an entity owes to other parties.
2. Income statement or profit and loss statement or P&L Statement or statement of earnings: This is a report of all revenues and expenses of a business. It shows whether the business is making profits or incurring losses at the end of the accounting period.
3. Statement of changes in equity: This reflects the increases and decreases in the net assets of an entity during the period (Course Manual).
4. Statement of cash flows: Horngren et al. [1] succinctly describes this as “one of the basic financial statements that reports the cash receipts and cash payments of an entity during a particular period and classifies them as financing, investing, and operating cash flows.”

These statements are discussed extensively in subsequent notes.

4. Interpreting the Statements:

The statements may be further interpreted to provide a better understanding to all stakeholders.

Bookkeeping versus Accounting:

Per the Course Manual, bookkeeping is “the aspect of recording financial data in the cash book and ledgers.” Among others, bookkeeping focuses on recording day-to-day financial transactions with the aim of maintaining accurate and complete records of all financial transactions.

On the other hand, accounting is much broader. It encompasses bookkeeping, as well as the processes of classifying, summarising, analysing, and preparing financial statements to support informed decision-making.

Why Lawyers Study Accounting:

1. Lawyers are legally required to keep accounts:

In Section 48 (1) of the Legal Profession Act 1960 (Act 32) , it is provided that:

(1) The General Legal Council may by legislative instrument make rules requiring lawyers—

(a) to open and keep separate bank accounts of clients' moneys, and

(b) to keep accounts containing particulars and information as to moneys received, held or paid by them, for or on account of their clients.

Pursuant to this power, the General Legal Council made several provisions in Rule 6 of the Legal Profession (Professional Conduct And Etiquette) Rules, 1969 (LI 613) by which laws are to keep accounts and record various financial transactions.

In Rule 27 of the Legal Profession (Professional Conduct and Etiquette) Rules 2020 (L.I. 2423) , for instance, it is provided that:

27. (1) A lawyer shall

(2) A lawyer shall keep books of account and proper records in relation to the accounts that may be necessary

(a) to show the dealings of the lawyer with

(i) moneys of a client held, received or paid by the lawyer, and

(ii) any other moneys dealt with by the lawyer through an account of a client; and

(b) to distinguish

(i) moneys held, received or paid by the lawyer on account of each client, and

(ii) moneys of clients from other moneys held, received or paid by the lawyer on any other account.

(3) A lawyer shall record the matters specified in paragraph (a) of subrule (2) in a form including in

(a) a cash book of clients, or a client's column of a cash book; and

(b) a ledger of clients, or a client's column of a ledger.

(4) A lawyer shall record other dealings of the lawyer in relation to the practice of that lawyer in a form including in a cash book, ledger or a column of a cash book or ledger that the lawyer may choose to maintain.

(5) A lawyer shall preserve the books, accounts and records kept by the lawyer under this rule for a period of not less than six years from the date of the last entry.

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Understandably, the ability of lawyers to comply with this rule is dependent on their ability to record and classify financial data. Studying accounting provides one with the knowledge to comply with Rule 6 (supra) .

2. Ability to cross-examine accountants or witnesses on financial issues:

During trials, lawyers may need to cross-examine accountants or witnesses on financial issues. To be able to do so effectively, lawyers must understand basic accounting terms and concepts.

3. Management of their firm’s finances:

Running a law firm involves budgeting, managing expenses, monitoring cash flow, and ensuring profitability—all of which require a solid understanding of accounting principles.

4. Properly advising clients on financial issues:

Lawyers may be required by their clients to handle cases involving mergers, acquisitions, valuations, and financial contracts. To be able to do so effectively, lawyers need to have some accounting knowledge. With such knowledge, lawyers can also identify financial irregularities and advise clients on financial risks and compliance issues.

Conclusion:

This note discussed the meaning of accounting as the art of recording, classifying, and summarising in a significant manner and in terms of money, financial transactions, and interpreting the results thereof. The note also distinguished accounting from bookkeeping on the basis that while bookkeeping is focused on recording all financial transactions on a day-to-day basis, accounting is broader and includes bookkeeping, interpreting, analysing, and preparing financial statements to guide decisions. Finally, the note discussed why lawyers should study accounting.

References

[1] Charles T. Horngren: Introduction To Financial Accounting 11Th Edition