As creator of an online publication with worldwide readership, I suppose you might think it ill behooves me to launch a critical salvo at the media (“mainstream” and otherwise, a distinction increasingly without a difference), but I have often found consensus choices about what’s newsworthy and what’s not to be driven more by fashion and the herd instinct than by common sense and, dare I say, a longer-term perspective.
Which brings us to today’s topic.
I fear that most of you may be unaware that Congress is considering a proposal that would have, I believe, have tremendously negative consequences for Law Land, without any scintilla of a principled justification or countervailing benefit other than a cheap shot one-time hit of revenue heroin.
Those of you who are aware of this proposal may have dismissed its prospects as extremely unlikely on the assumption that it would only be enacted as part of a truly comprehensive tax reform initiative. Don’t be so sure. I understand from one governmental affairs person I’ve spoken with that the Congressional reflex to grab revenue when they can may trump any longer-term perspective.
Yes, Adam Smith, Esq. has been and always will be uncompromisingly apolitical, and that remains resolutely the case. This isn’t an issue of Democratic or Republican, left or right, progressive or conservative: It’s an issue of accounting, finance, and dollars and cents—and the international competitiveness of the US legal industry.
The Congressional proposal sounds innocent enough: It would require law firms, among other qualifying professional service firms, with annual revenues over $10-million to switch from cash-basis to accrual-basis accounting. Permit me today to describe the straightforward factual implications of this propsed change; future columns will elaborate upon (a) the financial impact; and (b) the implications for US law firms’ competitiveness on today’s global landscape.
A brief Accounting 101 recap: Cash basis accounting recognizes income when cash is actually received and expenses when actually paid. Simple, straightforward, inarguable, full stop. Accrual basis accounting requires recognition of income and expenses more or less when the associated economic performance is complete: Income when the right to receive it has accrued and expenses when they are fixed and determinable. You can already begin to see that responsible accrual accounting entails a high degree of judgment and line-drawing—sometimes rising almost to a metaphysical level. A friend who’s a financial professional once described it to me, long before today’s proposal, as having to decide “at what point during dawn or dusk does it actually change between night and day.”
The potential consequences of engaging in such judgment calls over an indefinite period of accounting cycles, with the cumulative opportunities for optimism, a desire to present one’s best face to the world, the understandable wish to accommodate the preferences of one’s partners, and so forth, all piling up (dare I say “accruing”?) over time, are self-evident. It requires no assumptions about chicanery or questionable intentions to see the difficulty. May I invoke the Biblical, “lead us not into temptation?”
Let me briefly foreshadow the two columns to follow.
The next will outline in dollars and cents the one-time transitional costs of moving the industry from cash to accrual. Without going into detail, the gist is that partners would be required to recognize—and pay cash taxes on—an extra three months or so of phantom income unsupported by cash payments covering the liability. Firms now in debt would have to go deeper, and firms not in debt would have to become indebted for the first time.
The third and last will address some of the systemic, strategic, and anti-competitive consequences stretching forward into the future. including:
- Making AFA’s suddenly unattractive;
- Introducing possible structural contortions and suboptimal decisions about future combinations designed to avoid the $10-million/year revenue threshold; and
- The impact on the US legal sector’s global competitiveness.
Not to be oblique, folks: This I view as a deeply serious issue for our industry calling for a concerted and widespread response to Congress. I hope to hear your thoughts.