How To Survive a Legal Audit Minefield: Top Legal Accounting Audit Flags

Maintaining compliance is about your survival as a licensed attorney at law and is central in your firm’s ability to be successful. For that reason we have pulled together a four post series on how to survive a legal audit minefield. Over the next several weeks we will focus on:

  • Legal Accounting Audit Flags
  • The Tools Needed To Successfully Survive an Audit
  • Accurate Legal Accounting Reports
  • The Appropriate Solution To Keep Your Firm Compliant

The first post of this 4 part series will highlight the red flags inside your legal accounting that could trigger a costly and stressful legal accounting audit on your firm.

Top Legal Accounting Audit Flags

  1. Commingling of Client Funds– There are three different examples of commingling that could land your firm in hot water.
    • The first is Client to Client Commingling. It is extremely important that you do not use funds from one client when dealing with another.
    • The second is Client to Firm Commingling. Many law firms receive funds in the form of a retainer. Your firm cannot look at these funds as income until it has been earned through the completion of legal services.
    • The third is Client’s Multiple Matters Commingling. This means that if you are dealing with multiple matters for a single client, each matter needs to be tracked as if it were a separate client.
  2. Trust Funds Overdrafts– This can occur when using general accounting software instead of legal accounting software. This flag is raised when you utilize more funds for a specific client than what is available in that specific client’s account. This means that the additional funds are coming from another client, and your bank cannot realize this.
  3. Failure to Perform 3 Way Trust Reconciliation– An auditor will look at three balances for your firm and they all need to be in synch. These three numbers are; your firm’s check book balance, adjusted bank balance accounting for funds in transit (i.e. uncleared transactions), and your individual client ledger balance. If these balances do not match up prepare to be audited.
  4. Incorrect Posting of Client Funds– Incorrectly posting these funds will bring compliance issues and inflated income numbers for your firm. There are three ways client funds can be posted.
  5. Uncleared Checks & Deposits & Uncollected Funds– If your legal accounting system and bank are not in line with each other, your firm could experience compliance issues. Until a client’s check has cleared the firm has a fiduciary responsibility to the trust account. Due diligence must be exercised when it comes to depositing client funds in a timely manner.
  6. Improper Accounting of Matter Costs– Law firms must handle matter costs in a prescribed manner. There are 4 different types of costs that need to be tracked separately depending on jurisdiction requirements. They are:
    • Advanced Client Costs
    • Reimbursable Client Costs
    • In-House Reimbursable Client Costs
    • Non-Reimbursable Client Costs
  7. Irregular Allocation of Invoice Payments– To be compliant revenue allocation must be prioritized appropriately. First, any liabilities must be paid. Second, any assets like advanced client costs must be reimbursed. Third, hard and soft expenses must be addressed. Finally your firm can now realize income. This process can be automated with Cosmolex’s law practice management software.
  8. Incomplete Data and Reports– One of the first things any auditor will ask for is a set of reports. Comprehensive and accurate reports will satisfy the auditor, and after testing a few transactions they will likely be on their way. If the reports prove to be incomplete or inaccurate the auditor will be looking for individual transaction data and access to your manual system or legal accounting software.

Avoiding these red flags will help your firm avoid a legal accounting audit. Now that you know what could trigger an audit, check back for our second installment of this series to understand what tools and systems are needed to remain compliant and avoid these red flags that could initiate an audit on your firm’s financial activity.

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