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Accounting for Lawyers: A Beginner’s Guide to Law Firm Accounting

Accounting for lawyers is way more complex than general business accounting.

Here is a beginner’s guide to law firm accounting. It will help you have an understanding of accounting and bookkeeping for lawyers.

Bookkeeping for lawyers:

The bookkeeper is involved in recording all the financial transactions and maintaining the final accounts for your firm.

They collect, organize, and summarize the company’s financial transactions in systematic and chronological order.

Legal bookkeeping is done first in the law firm. It is related to tracking cash related to administration.

Accounting for lawyers:

Accounting is more subjective, while bookkeeping is transactional and administrative. It provides meaningful insights into the financial health of the law firm based on legal bookkeeping.

The legal accountant uses the financial data provided by the bookkeeper to prepare financial statements, perform financial forecasting, and capture expenses.

Basic bookkeeping and accounting terms.

  • Charts of accounts:

Charts of accounts are a list of all the firm’s accounts. It provides you with the framework for recording every transaction.

It is customized and structured according to the law firm’s size, judications, and practice areas. Generally, there are five categories: assets, liabilities, owner’s equity, revenue, and expenses.

Setting up and recording the charts of accounts for a law firm should comply with the requirement of State Bar association rules. The chart of accounts must include a trust account (IOLTA) and a trust liability account.

  • Double-entry accounting system:

It is a bookkeeping system where every entry to an account has a corresponding and opposite entry into a different account with an equal amount.

Every financial transaction has two sides: debit and credit.

The total of the debit side must be equal to the total credit side. Further, these transactions get sorted into specific categories- assets, liabilities, and equity. The total asset must equal total liabilities plus equity.

  • Trust Accounting:

Trust accounting is common practice for law firms. It refers to keeping a client’s funds safe in a special bank account called a trust account.

It includes unearned fees such as a retainer, court fees, settlement funds or advance costs, etc. The trust account is a separate account from the law firm account.

  • Interest in Lawyer Trust Accounts (IOLTA):

An IOLTA is the type of bank account from which any interest earned on the account is collected and transferred to the state bar for aiding social causes.

The lawyers are required to deposit all the clients’ funds into IOLTA accounts. They are not allowed to collect interest on money held in this trust account.

The main idea behind the IOLTA account is to keep the client’s funds separate from the firm’s operating account, which can accrue interest.

Following is the basic rule that you must comply with:

  1. The balance in the IOLTA account must match the amount in the IOLTA trust liability account.
  2. There must be a detailed ledger showing transactions for every inflow and outflow for each client.
  3. The total amount reflected in each client’s IOLTA trust account balance on the firm’s books adds up to the balance of IOLTA bank accounts.
  • Three  ways reconciliation

Reconciliation and verification of the financial transaction quarterly or periodically is an important aspect of accounting for law firms. It can be done either manually or with the help of legal trust accounting software.

Reconciliation of the bank statement and trust accounts.

Client trust ledger for checking the statement of activity for trust accounts.

FAQs

  1. Why do law firms need a different accounting system than other businesses?
    Law firms deal with client funds, trust rules, and strict state bar laws. This makes law books more strict than firm books.
  2. What role do books play in a law firm?
    Bookkeeping records daily money in and out. It helps track fees, costs, and trust funds so the firm has a clear and accurate view of cash flow.
  3. How do law firm books and accounts not match?
    Books track raw facts. Accounts use those facts to make reports, plan trends, and guide firm growth. The two work as one.
  1. What is a chart of accounts, and why is it vital for lawyers?
    A chart of accounts is a list of all accounts a firm uses. It sets the base for tracking assets, costs, income, and trust funds in line with bar rules.
  2. Why is trust accounting key in law firms?
    Trust books keep client cash safe in its own bank. This way, client funds do not mix with firm funds. It keeps the firm in rule.
  1. What does IOLTA mean, and how does it work?
    IOLTA stands for Interest on Lawyer Trust Accounts. It holds client funds, and any interest earned is sent to the state bar to support legal aid causes.
  2. How does reconciliation help a law firm stay compliant?
    Reconciliation checks bank records against the firm’s books. It makes sure trust accounts, ledgers, and client funds match, which lowers the risk of error or penalty.
  3. Can law software make trust tasks smoother?
    Yes, Software can track ledgers, create reports, and automate reconciliation. This saves time, reduces mistakes, and keeps the firm compliant with trust rules.

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