While you’ve spent years honing your skills to become a great lawyer, you didn’t understand deeply about accounting or bookkeeping, especially when it comes to legal accounting. Even though you hire a seasoned accountant, who may be great at handling small business accounting, you need to be sure your accountant understands what is involved in accounting for law firms. It’s important to highlight that law firm accounting and other general business accounting is far more different.
How Does Accounting for Law Firms differ from other types of accounting?
Attorneys routinely receive their client’s funds more than in most industries. Accountants in law firms spend much of their time tracking what money is coming and leaving law firms and what needs to go to clients, the courts, or third parties. They also need to handle many things to keep your firm stay compliant with ethics rules.
What special considerations in law firm accounting do you need to pay attention to?
Chart of Accounts
A chart of accounts is a list of all your firm’s financial accounts, usually used by an accountant and available for bookkeepers. Account numbers of char of account are structured to suit the needs of your law firm, the jurisdiction, and the practice area. Typically, there are 5 core categories consisting of assets, liabilities, owner’s equity, revenue, and expenses.
Setting up and recording the chart of accounts for law firms isn’t just suggestions, they are requirements. State Bar association rules require law practices to record transactions meticulously so there is no impropriety when dealing with Interset on Lawyers Trust Accounts (IOLTA), or other trust accounts.
Client trust account (CTA)
Client trust accounts are used by attorneys or law firms to hold their client’s funds in trust.
More specifically, an attorney usually receives and handles their client funds for future use such as security settlement payments, fees advanced for services. Because the money has not yet been distributed, the attorney can deposit it into a client trust account with interest earned belonging to their clients.
In this way, a client trust account is acted as an insurance guarantee that clients’ money will not be withdrawn before the conclusion of the client’s legal issue.
Interest on Lawyers Trust Accounts (IOLTA)
IOLTA accounts are a type of CTA. An IOLTA account is a pool, internet-bearing checking account. While the interest rate earned from CTAs belongs to clients, the interest earned from IOLTAs generates funds for IOLTA programs and is used mainly for charitable purposes and helping improve the justice system.
A retainer fee is an advance payment that is made by a client to secure the service of a lawyer. Retainer fees are paid upfront and usually recur monthly. How you charge retainers depends on the agreement with your client.
The retainer fees aim to protect the attorney from unforeseen circumstances in the future that can prevent clients from meeting their obligation. Once the case has started, the attorney can charge any cost against the retainer fee instead of asking the client to provide extra funds.
An attorney is required to reconcile their trust bank statement to their client’s individual balance on a quarterly, or even monthly basis. While the reconciliation process is one of the most important rules in trust account management, attorneys most often fail to properly perform this step on a regular basis, which causes unfortunate consequences.
3 components involved in the reconciliation process consist of the trust ledger, the client ledger, and the trust reconciliation.
The Trust ledger provides a summary of all the transactions involved in a trust account.
The Client ledger assigns each transaction to a specific client and groups together all the trust account activity associated with each individual client.
The Trust Reconciliation - the trust bank statement provides a third-party verification to the transactions posted to the trust account.
Proper accounting and bookkeeping are essential components of a successful practice, your law firm’s survival, and profitability. Whether you are a general-purpose CPA or an attorney you should have a full grasp of what is involved in law firm accounting.