Trust accounting compliance can be one of the most difficult tasks of running a law firm due to the many requirements and pitfalls, but it’s also one of the most critical. The responsibility of properly handling trust accounts, no matter who in a firm is overseeing the accounting or trusts, falls directly on the lawyer. Non-compliance can result in severe consequences including sanctions, but you can ensure the accuracy and proper management of your trust accounts with the regular production of several essential trust accounting reports.
Trust Accounts and Funds
Trust account funds are those which belong to clients and a lawyer is acting as the fiduciary for. These funds can come from a number of different sources. Settlement funds from personal injury cases or real estate settlements, unearned income (retainers or cost advances) and third-party funds all belong in trust accounts. Law Firm funds, earned income, payroll, and any other funds where you’re not the fiduciary of those monies do not need to be placed into a trust account and aren’t bound by the same rules.
What to Watch Out For
At first glance, dealing with trust accounts should be easy. There’s no profit or loss as the money belongs to your clients and there’s no interest, depreciation or amortization. This means no tax accounting and you even are able to avoid bank account management fees.
If only it were that simple. Given the number of funds lawyers are often tasked with managing for clients, there are a large number of rules and regulations surrounding trust accounts and how they must be handled. All of these requirements are in place to protect consumers but it can place a burden on lawyers who have to add these tasks into their daily practice of law.
Administering these processes manually is where many firms run into trouble, as it can be difficult to try to remember the numerous requirements and avoid inaccuracies. There’s plenty of room for pitfalls and one mix-up can result in commingled funds, trust account overdrafts or uncleared funds going unnoticed – all compliance violations. When using separate accounting and billing systems and no safeguards in place to prevent these errors, lawyers can find themselves doing extra work with double data entry and increasing their risk unnecessarily.
You can learn more about potential areas for trust accounting mistakes in 5 Accounting Pitfalls Law Firms Must Avoid in 2019.
In order to make sure all trust accounts are properly reconciled and being maintained accordingly, law firms should be producing several reports regularly. Certain practice management programs like CosmoLex have both billing and accounting in the same system, allowing you to easily create these reports with the click of a button. Simplifying the process will make it more likely that you’ll regularly run these reports and will also reduce the chance of an incorrectly entered piece of data.
These reports should be maintained and produced by your firm on a regularly scheduled basis:
- Bank Ledger. Summary of all trust account activity, including receipts, disbursements and voids identified by client matter, date, amounts, and purpose.
- Receipts Journal. Record of all cash and funds received from your clients.
- Disbursements Book. Record of all funds withdrawn from a trust account.
- Client Ledger Balances. The balances for each of your client’s individual trust accounts.
- Individual Client Trust Ledger. Records of all individual client trust account activity, including deposits and withdrawals.
- Bank Reconciliations. Comparison of your book balance and the adjusted bank balance/bank statement.
- 3-Way Reconciliation. Similar to the bank reconciliations, three-way reconciliations add in the trust account ledgers. These three balances should all be equal.
There are some steps you can take to make sure you’re taking every precaution possible to avoid a trust accounting error (and the resulting sanctions).
Every month conduct all of the required reports, especially the reconciliations. Running these monthly will help you to catch any mistakes and fix them. If you wait too long the process of correcting the error will be even more time-consuming and costly. Always be sure to print these monthly reports as well, just in case any files are deleted or corrupted.
Consider using a practice management program that has integrated accounting and billing as well as safeguards in place to prevent many of the most common trust accounting mistakes. For example, CosmoLex has a feature which prevents the overdrafting of individual trust accounts. Even if you happen to forget a rule or overestimate the number of funds in an account, these types of mechanisms will prevent you from breaking trust accounting rules.
Accurate and compliant trust accounting is an absolute must for every law firm. To maintain proper records, be sure your firm is running the above-mentioned reports and adhering to best practices. Using the right technology will make it easier to avoid any errors and reduce the amount of time spent inputting trust account entries into two different systems.
To learn more about how to generate and validate these essential trust accounting reports, be sure to watch our complete on-demand webinar 7 Essential Trust Accounting Reports for Lawyers.