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Accounting for Lawyers
Wayne State University Law School
Schenk, Alan

Accounting for Lawyers OUTLINE

Schenk; Fall 2011

Professional Income – all expenses = net income

– Increase in an expense is a debit

– Decrease to an expense is a credit

– Increase to income is a credit

– Decrease to income is a debit

– Income statements need to be closed out before the income is added to the balance sheet

– Process:

o Do journal entries for all expenses and sales/service income

o Make individual T-charts for each account

o Take totals from the T chart, which are recorded on the Income Sheet and close out to Profit and Loss T chart

§ Do new journal entries for each account:

Debit to Profit and Loss

Credit to Rent expense

Debit to Income

Credit to Profit and Loss

o Then close out Profit and Loss total to Proprietorship/Partner Equity/etc.

Profit and Loss

– Close out Profit and Loss to Equity Portion of Balance Sheet with journal entries

Debit to Profit and Loss

Credit to Propreitorship/Partner Equity, etc.

– Record final income to appropriate account under Equity on the Balance Sheet

o NEVER carry over income from one balance sheet to another

o Always close out with an income and profit/loss statement

Accrual and Deferral

– Accrual: need to accrue to a different period; income has already been received/cash not yet paid

o Income: did the services or sales but did not yet get paid

Debit to accrued revenue/sales $2000 (ASSET)

Credit to Revenue/sales of $2000

o Expense: have an expense that has been accrued but did not pay yet

Debit to expense acct

Credit to accrued expense acct (LIABILITY)

– Defferal: need to defer to a future period (cash has moved)

o Income: if you received the cash but have not yet done the service/sale

§ Ex: a client prepays you for work that will be done in the next period

§ Create a deferred sales for amount (LIABILITY) and credit it for the amount

o Expense: pre pay an expense that will not all be used in the current period

§ Ex: co. pays for a 3 year insurance policy upfront

Debit to Insurance expense $3000

Credit to cash $3000

· At end of period would have to adjust to show that 2000 of the insurance expense was for future periods so.

· Create a deferred interest account/pre paid expense (ASSET) and…

Debit pre-paid expense $2000

Credit Insurance expense $2000

– Can’t put these all in the current period because there would be a disparity

– Interest on loans (have to accrue in following periods)


– Historic Cost: record assets at historic/original cost

– Objective: accounting principles have to be objective; everyone does the same

– Revenue Recognition: only recognize revenue when 1) an exchange has occurred and 2) the acctg entity has completed the earnings process

– Matching: Must match expenses and revenue in same acctg period

– Consistency: stay consistent each year

– Full Disclosure: have to disclose anything relevant

– Emerging Fair Value/Relevance Principle: things are changing

Modifying Conventions:

– Materiality:

o Quantitative: depends on size of the company and what the error is to determine if actually material

§ Rule of thumb, if more than 5% of total assets, is material

§ Also look to ratios for liquidity

o Qualitative; if money is paid for illegal reasons always material

– Conservatism: be conservative

– Industry Practices: what are the practices of that industry


– Bought a machine to produce goods and paid a specific amount

o Bought machine in cash, so need to debit the cash account for amount

o And is an asset to machinery for that amount

o BUT the machine will actually be used for 5 years, so can’t put all the amount in the machine asset account

o Have to create a deferred asset account “depreciation of machinery” and credit it with how much will be used in later years

o So debit machinery for amount and credit an accumulated depreciation account for that year.

he problems (ex: internal controls)

§ Companies do not like this; does not look good

– U.S. has GAAP, but internationally there are different accounting standards

o Problematic for companies that work internationally

o SEC is supposed to write opinion about convergence by end of year

– Bily v Arthur Young & Company

o Company goes out of business; investors lost all money; bring lawsuit against auditing firm Arthur Young and claim liabilities were misstated on the balance sheet and audit gave clean opinion (see notes pg. 15-16)

o Court said different standards of imposing liability

o General Negligence

§ Court relied on the decision from the Ultramares case out of NY

§ Have to look at privity, came from Ultramares case in New York:

· In order for an auditor to be liable under general negligence there has to be privity

o Privity: direct relationship

· Has to be direct contractual relationship- auditor and client; so client could sue, but not these investors

· This was also confirmed in Credit Alliance case

· Ultramares said that general negligence only is ok for the client

§ So first the court looked to this case, but went on

§ There is another way to base a lawsuit under general liability

§ Foreseeability Standard under RESTATEMENT 2d of TORTS, section 552

· This is an easier standard to prove, need less of a connection

· Only liable if there is a causal link; the auditor should have foreseen that the third party would have relied on this report

· Have to have justifiable reliance on the information

· But here this auditor did not prepare for any particular third party