Trust Accounting in the Legal Industry
Trust accounting, as any lawyer will tell you, is one of the two most critical pieces of accounting in his practice. The other, tracking billable hours and costs, may cost him money if performed incorrectly, but the repercussions of inadequate trust accounting can mean the end of the responsible lawyer’s career! Clearly, it is important to get this correct.
So, what is so special about trust accounting in the legal industry?
ALL MONEY IN THE TRUST ACCOUNT BELONGS TO THE CLIENT AND MUST ONLY BE USED FOR THE BENEFIT OF THE CLIENT
Trust accounts are set up differently from operating accounts and maintained differently from operating accounts. While all banks have bank fees for all business bank accounts, the fees for a trust account must be withdrawn from the operating account. If the bank does happen to make a mistake, this must be rectified immediately! Any shortages, including those fees taken by the bank, will need to be reimbursed out of the operating account when necessary to ensure all client monies are intact at all times.
About trust accounts, the types of accounts, and disbursements of any interest earned
A law firm will usually have a pooled trust account with mixed funds from various clients. This account may earn interest – but any interest received on this account does not belong to the clients or to the law firm. Interest earned on this account is to be remitted to the Alberta Law Foundation. They may also have a separate interest-bearing account that is maintained on behalf of a specific client. This account would be used in particular circumstances such as real estate transactions. Any interest earned on this account must be recorded and is to be disbursed to the client with the regular trust monies.
Special Reconciliation Considerations
When you reconcile the operating acount or, indeed, any other bank account, you merely reconcile the bank account and the general ledger to ensure they both match. However, trust accounts actually require a 3-way reconciliation. While you still need to ensure the GL and bank accounts reconcile, you also need to maintain a trust ledger detailing the source of all monies received, all monies paid out (payee, cheque number, client name/file number, and balance) and this ledger must also always remain in balance with the GL and bank account balance. A trust account reconciliation must be completed and signed off by the responsible lawyer within one month of the statement date. If this is not done in time the responsible lawyer must file for an extension with the law society. Failure to comply with this can cost the responsible lawyer his license to practice law, so clearly law firms are extremely particular about ensuring the accuracy and timeliness of all trust account reporting.
Additional trust records to be maintained
Not only must a trust reconciliation and trust ledger be maintained as above, but all law firms most maintan a ledger of all transfers between the trust ledger accounts, a general journal detailing all transactions, a billing journal/ledger, bank account statemnts containing duplicate deposits and negotiated cheques, a receipt book, in duplicate, recording any cash payments received by the client, record of cash payments made to the client (including client signature of receipt), and a detailed accounts receivable ledger showing all bills, receipts, and running balance for each client. These items, with the exception of the trust ledger account (which must be maintained in a format capable of being printed on demand) must be printed every month. In the age of digital technology, printing to pdf format is considered acceptable. This must be maintained for 11 years at the place of business.
The adequacy of record keeping for a trust account – and the necessity of ensuring that all funds held on behalf of clients are in the trust account at all times, including, if necessary, replacing funds out of the firm operating account for bank errors, NSF deposits from clients if funds have been disbursed on behalf of the client, and any other shortages however they happen – is paramount to all law firms and should be taken with extreme seriousness.
Bookkeepers working with law firms need to ensure they understand and comply with these rules at all times – and they need to be certain to immediately contact the responsible party should anything unexpected occur in this account!