Let’s play a game. I’m going to list a few things about practicing law and you tell me which one is most likely to take your firm down.
- You have been working on a case for several months, but unfortunately, the decision was not in your client’s favor.
- The trust funds your firm manages may not be compliant with new state regulations.
- One of the partners at your firm has a pet tiger that he brings to the office on Tuesdays.
Which option did you pick? Certainly, option C could cause some problems when bringing clients in to discuss their legal matters, but a simple leash or cage could take care of that.
Option A is unfortunate, but over time it’s nearly impossible for an attorney to land on the right side of every decision.
Option B has the potential to be the most dangerous. Your firm’s ability to remain compliant when it comes to the client trust funds it manages is supremely important. Failure to remain compliant can result in ethics issues that could mean disbarment for you and your firm.
Trust accounting is an area of legal accounting that, when mismanaged, can be potentially dangerous — damaging to your clients and your firm. Here are some of the specific activities and errors associated with trust fund accounting that could take your firm down.
Trust Fund Accounting Pitfalls
It’s commonplace for firms to use retainers to secure cash flow from clients. This means that your firm is likely in possession of funds that don’t belong to your firm, at least, until those funds have been earned.
Commingling of Client Funds
What makes trust fund accounting so difficult is that firms need to track client ledgers individually while funds from different clients are most often pooled in a single trust banking account. Your firm needs to ensure that one client’s funds are not commingled with another client’s and that none of these funds are used to pay for any of your firm’s expenses.
Overdrafting The Client Ledger at the Transaction Level
A ledger shows the amount of client funds available for a specific matter. It is imperative that disbursements and invoice payments are only made from the ledger that is associated with that legal matter. Overdrafting on a client’s ledger is, unfortunately, not guarded against in many generic business accounting programs — watch out!
Posting Transactions to an Inappropriate Account
Trust retainers should only be posted to the correct client funds liability accounts. Too often firms will post retainers as fee income. This will result in inaccurate numbers and can lead to severe penalties to your firm.
Neglecting 3-Way Reconciliation or Not Doing It Frequently Enough
Many jurisdictions require firms to perform a 3-way reconciliation every 30 to 60 days. It is incredibly important that your firm meets these requirements, otherwise, you may fall out of compliance. Compliance aside, your firm should really be reconciling accounts daily. Waiting until the end of the month to reconcile your trust accounts could mean that costly and potentially dangerous errors go unnoticed until the end of the month, and it may be too late.
Know Your Trust Accounting Options
Trust accounting is a difficult and dangerous area for many attorneys. The truth is, an attorney isn’t an accountant, and many accountants don’t understand the specific needs associated with trust accounting. It’s important to have the proper tools in place to help your firm practice proper trust accounting. CosmoLex is a legal-specific accounting program that has safeguards in place to ensure that you don’t make the costly trust accounting errors that could take your firm down with ethics violations and compliance issues. Features such as matter-based record keeping, overdraft safeguards, bank data feeds, and automatic 3-way reconciliation are some basic features that your trust accounting program should offer and are just a few of the tools you get when using CosmoLex. If you’re interested in learning more about the Top 5 Pitfalls of Trust Accounting and how CosmoLex can help, click here.