Accounting is Hard, Legal Accounting is Harder
More so than in any other industry, the legal industry faces the most extreme levels of scrutiny and penalization associated with accounting. Legal accounting errors and inaccuracies go far beyond a misrepresentation of a firm’s bottom line. These errors can be so devastating to a firm that they could even result in disbarment.
Hearing all of this, it will come as no surprise to you that law firms encounter many accounting challenges that are unique to legal accounting. Before any firm can navigate these challenges it’s important that they are aware of them and can identify them. Here are some of the accounting challenges that only law firms and professionals in the legal industry may face.
Customizations Associated With Legal Specific Chart Of Accounts
One of the major challenges that many law firms and legal professionals face is access to a legal-specific chart of accounts. It’s often the case that smaller firms or firms just starting out, do not have accounting expertise on staff and they depend on general business accounting software to manage their finances. Unfortunately, without multiple software customizations, that cost a firm both time and money, general business accounting software lacks many of the legal-specific charts needed to remain compliant.
The best way to avoid these complications is to employ legal-specific accounting software that features legal chart of accounts like:
- Client Trust Funds (Liability)
- Client General Retainer – Trust (Liability)
- Client General Retainer – Operating (Liability)
- Advanced Client Costs (Asset)
- Reimbursed Client Expenses (Direct) (Income)
- Inhouse Reimbursed Expenses (Indirect) (Income)
- Fee Income (Income)
- Discount (Income)
- Reimbursable Client Costs (Expense)
- Non-Reimbursable Client Costs (Expense)
- Unrecovered Client Expenses (Expense)
Client Funds Accounting
It’s not at all unusual for firms to rely on client trust funds to secure cash flow from their clients. While it certainly isn’t an unusual practice, it does, however, create multiple challenges for law firms.
When firms utilize trust funds to secure cash flow from clients it means that they are technically in possession of funds that they have yet to earn. Even though the firm is in possession of those funds via the trust account, those funds still don’t belong to the firm until they are earned. Mismanaging how these funds are handled can create compliance issues that could ultimately result in disbarment of the firm.
It is extremely likely that firms have multiple clients, with multiple matters. Each of these matters will need their own trust ledgers, and none of them can be commingled or used to pay for the firm’s expenses.
The best way to ensure that a practice has a firm grip on their trust accounting is to utilize legal accounting solutions that have safeguards in place that ensure that operating and retainers trusts are clearly differentiated to avoid any and all commingling, otherwise a strong firm can be easily taken down by compliance issues associated with client trust fund accounting errors.
Proper Revenue Allocation
When money comes into a law firm it doesn’t necessarily mean it’s income. In fact, when money first comes in, it most likely cannot be classified as income. Any and all revenue that comes into a firm must be prioritized appropriately for a firm to remain compliant. There are actually three steps that must be met before any firm can realize any actual income.
First, any liabilities that the firm has must be paid. After liabilities have been paid, the firm is required to reimburse any assets like advanced client costs. After this, the firm must address any hard or soft costs that are related to the legal matter that has been invoiced. It is only after these three requirements have been met that a firm can actually realize any income.
While the prioritization of revenue allocation can be challenging for firms on its own, it has the potential to become even more challenging when you consider the fact that many legal invoices are paid in installments and not all at once.
Credit Card Payments
While legal accounting has its own specific challenges, legal clients do not have their own specific habits. Just like in any other business clients of law firms enjoy the ease in which they can pay their bills with a credit card. Unfortunately, without the right legal-specific solutions in place, accepting credit card payments can create its own set of challenges for law firms.
When accepting credit card payments from legal clients it isn’t always clear which invoices are being paid. Invoices are created and distributed in the billing system while payments are processed in an accounting system. Unless these two systems are integrated, the accounting system has no way of telling which invoices payments should be attached to.
Another challenge associated with law firms accepting payment via credit cards stems from the practice of credit card batching. This means that multiple clients’ payments come into the firm’s accounting system as one deposit. Unless these credit card payments are reconciled on a daily basis this can create a major compliance issue pertaining to the commingling of funds.
Tracking Income By Practice Area
A firm may have the best lawyers in the world, but if they aren’t effective business people the firm could be in for a short lifespan. So many firms experience difficulty in tracking their income by practice area.
Not tracking a firm’s income by practice area is like throwing darts with a blindfold on. The firm has no idea which areas of their business are bringing in the most revenue, and ultimately bringing success to the firm.
Conquering The Specific Challenges of Legal Accounting
An article focused on all of the challenges of legal accounting could make the best attorneys want to crawl into a shell and hope for the best, but all of these challenges can be met head-on if legal-specific accounting solutions are put to use. The greatest challenges can turn into some of the greatest areas of growth and opportunity for the firms who address them appropriately.