Question of the Week: Why do I need to run three-way reconciliations and how do I do it?
Three-way reconciliations are one of the most critical components of trust accounting. This particular report verifies the accuracy of three balances in order to make sure there is no apparent fraudulent behavior or bookkeeping mistakes. While these reports are necessary for compliant trust accounting, they’re also extremely helpful for any firm who wants to ensure accuracy and mitigate the risk of embezzlement.
In a three-way reconciliation, you compare the balances of your bank statement, the general ledger and the sum of your client ledgers. This is very similar to the traditional two-way reconciliation most businesses run, with an additional layer included to address trust accounts.
Why run a three-way reconciliation?
If you deal with IOLTA accounts, running a three-way reconciliation isn’t always optional. Each state has its own specific rules for trust account reporting, but many states require these reports to be generated on a monthly or quarterly basis. Designed to protect clients from negligence, this report checks for any misappropriation of funds or fraud.
To see which states require three-way reconciliations, take a look at the article, Why do I need to do a three-way reconciliation of each trust account?
How to run a three-way reconciliation
Now that you know why these reports are so important, the next thing most lawyers want to know is how to create them.
Three-way reconciliations can be completed by paper or spreadsheet, by first reconciling your bank statement with your general ledger. Once you have the final number, that should be compared with the sum of your client ledgers up until the date on the bank statement. All three numbers should be equal to one another.
While these reports can be created manually, the process is time-consuming and prone to errors.
Because individual client ledgers are unique to law firms, three-way reconciliations aren’t common in other industries. Therefore, generic software isn’t designed to create these reports without modifications needed. While there are customizations that can be made and having software handle the calculations reduces the possibility of errors, this isn’t the ideal method. The workarounds can be difficult to put into place, and many times there is no protection against accidental edits to past reconciliations.
Created specifically to handle all the tasks law firms have to handle, legal-specific accounting programs typically have a built-in option to run three-way reconciliations. On the back end, this type of software will do the heavy lifting and automatically calculate reconciliations, as well as address any necessary issues. With the click of a few buttons, you’ll be able to generate your report and save it as a .PDF. Once completed, this reconciliation and its related transactions can be locked to avoid any unintended changes.
Staying on top of generating these reports can be cumbersome, so it’s important to choose a method for completing them that works for you. If you dislike manual accounting and as a result put off doing it, that shouldn’t be the approach you take with three-way reconciliations. These reports are often mandatory and not doing them has significant repercussions, so take care to set up a routine and complete them regularly.
Want to see what a typical three-way reconciliation looks like? You can find one here: What is a three-way reconciliation?