Trust accounting keeps track of client funds given in trust, away from law firm operating funds. While each of the separate jurisdictions has its requirements, there are two main ideas to keep in mind. When accounting for law firms, the first thing to know is that trust funds cannot cannot mingle within the firm's funds, such as a commission fee before a closing. The next is that firms must maintain accurate and detailed records of money coming in and out of the trust account, and they must use the client's own money for the related client matters. Basically, this means that a lawyer cannot take money from one person's trust to pay for another person's trust as they spend their money if it is a shared trust.
Trust accounting can be one of the more intimidating concepts for running a law firm and certainly a task for an accounting law firm . Without going into any horror stories, it is a very important point to understand from the very start that this is not an area of accounting for law firms you want to make a mistake with. That being said, trust accounting is simple in theory. Unfortunately, it is a bit more complicated in the reality of things, but it can be done as long as you take your time and follow the steps.
There are quite a few rules and practices that go into running a trust account, but if you follow the steps and always double-check your work, it is a very achievable process. The first step touches upon a point previously made regarding noticing funds from accounts. Money should stay in one area until it is time to be moved for good. The next step may sound like a no-brainer, but keep a separate record of the funds received from the account holders. This goal is primarily to ensure no mistakes are made and to create a sense of checks and balances on how the money is being allocated. One side rule to keep in mind as we move along to some of the bigger concepts is that you cannot collect interest in this type of dealing, and if you do it must be allocated to the clients.
The final rule is the most simple yet can be the one that messes things up the most. Following your state regulations is a deceptively simple idea because while most of the rules already follow some form of national consensus, they each have their little nuances. As it is the right of states to create laws passed by their government, the playing field can change from state to state and change over time as different governments are in office. It goes without saying that an office's law and operating system change depending on who sits in the chair.
Now that we have gone over the basics of what trust accounting is and how to go about it, we figured this is a good time to tell you some of the benefits of this difficult process when accounting for law firms trust accounts. Proper trust accounting avoids client issues. It also allows you to maintain your license to practice law. There are numerous counts of lawyers fraudulently spending client trust funds unfortunately, and some have even lost their license to practice law as a result of this. Even in some more blatant cases of trust fund malpractice, some attorneys have gone to jail. As a licensed CPA firm, we understand that it is very important to maintain our license and when accounting for law firms trust accounts, Interactive Accountants takes that same responsibility when reconciling your trust accounts
To start, choosing the right accounting law firm is key. Working with a CPA firm is also a strong recommendation as they too understand the importance of a law firms license. Next is to ensure you have an accounting system that can handle multiple client deposits and track those by legal matter. Here at Interactive Accountants we use QBO and each client matter is assigned its own liability account on the balance sheet. Here’s an example of how it works: First, the client or third party, such as an insurance company, will hand your office a check for the money that is not yours, such as settlement proceeds. This money is deposited into the trust account; depending on your jurisdiction rules, you may be obligated to open a new interest-bearing account solely for that client. But in general, it goes into the normal pool to the attorney trust account and in your accounting records you will create a new liability account for that matter, or post to an existing liability account, should the proceeds be from a past matter. When a case ends, and all matters are settled, you would move funds from the trust account to your operating account for your fee and then remit the remaining proceeds to your client. Accounting would then post those payments against the liability account and record any revenue earned by your law firm. That’s just a quick example and there are certainly more which is why it’s so important to have an accounting law firm that knows what they are doing!
Having the information you now possess from reading this article, we would like to extend an invitation for you to have a consultation with us individually where we can properly assess your needs. Our firm specializes in four types of business, including accounting for law firms.
At Interactive Accountants, helping businesses grow and succeed financially is our number one goal. We are here to help! If you're still not convinced yet to give us a call, feel free to look at our other blogs regarding the help we offer various businesses and offices.
If you are a professional in any field that these tips apply to, schedule a free consultation here with our owner Matthew Shiebler, CPA. He's been practicing accounting for over 25 years now and is a business owner, just like you!