Legal Bookkeeping Explained
Bookkeeping for attorneys is not the same as bookkeeping for other small business types. Attorneys have distinct financial and legal regulatory requirements that they must adhere to. To plan for these needs, attorneys’ need someone with knowledge of their specific requirements.
As a new legal practice owner, you need to understand legal bookkeeping so you can set up the systems to properly manage, track, organize and maintain your financial records. It is also important to have a legal accounting software system to automate these tasks as much as possible. Lawyers have certain ethical and legal obligations when it comes to handling client funds. The IOLTA trust accounts are designed to just hold client funds in an account for a client’s future use , not for use by the attorney operating the law practice. Poor management of your trust accounts can lead to disciplinary action against you by your State Bar Association.
Bookkeeping for legal professionals involves important tasks beyond tracking revenues and expenses including: tracking client trust deposits and disbursements, tracking and managing client retainers, and complying with IOLTA reporting requirements. These unique requirements affect how finances get tracked, recorded, reconciled and reported. This includes matters such as tracking operating funds separately from trust funds, billing and invoicing client retainer deposits, producing monthly financial reports, annual tax reporting and providing the State Bar Association with IOLTA trust fund account information.
Essential Elements of Legal Bookkeeping
The primary components of legal bookkeeping include client trust accounting, billing, and compliance with ethical and legal rules. While you can certainly complete the basics on your own, a legal bookkeeping system that is less than stellar can leave you and your staff open to significant risks. First, let’s take a look at client trust accounting and what it entails.
Client trust accounting is the section of your law firm bookkeeping system that manages client funds received prior to completing legal work for that client. Because other individuals will have access to these funds, how you manage them is extremely important.
As an LSBA practice management advisor stated in a Louisiana Bar Journal article, "OSB [Oregon State Bar] found that an attorney’s failure to keep client trust account funds separate, or having sole access to the account, [was] the most common condition associated with theft from an estate after the death of a lawyer."
In other words, managing the client trust portion of your bookkeeping system is crucial in terms of reducing risk to prevent employee fraud. Client trust funds are often held in IOLTA accounts, which means that your bank is more attune to looking for issues related to incorrect handling of these funds. In many cases a bank will actually call you if there is a flag on any trust account transactions.
But, of course, a bank isn’t the only place that might catch a problem. Caught running away with client funds using a Ponzi scheme, the now former senior partner of Dewy & Leboeuf, Steven Bauman, pleaded guilty to theft of $92 million from the firm and its clients.*
* For starters Bauman stole $55 million from Dewey’s accounts, reportedly for his own personal use. The theft was uncovered when a subsequent Dewey senior partner took the place of Bauman and discovered the missing money. To cover the theft and avoid having the firm file bankruptcy, Bauman then set up a Ponzi scheme using $9 million in client funds, which he needed to repay immediately. To date he has repaid over $15 million, but there is still a lot more repayment to be done. The theft is not the only issue you could run into if you aren’t using a qualified legal accounting system. There are various other issues that can occur as well, including: In short, and if you aren’t already doing this, put your money where your mouth is and hire someone who knows how to properly handle client trust funds, including IOLTA accounting requirements. If your firm cannot afford in-house bookkeeping expertise, get an outsourced professional.
As you can see, there are various areas of your firm’s bookkeeping system that must be handled with due diligence. Of course, with a legal bookkeeping system, there are also various legal regulations that you must comply with.
Legal Bookkeeping Pitfalls
Despite the necessity for precise bookkeeping, this does not come without its challenges. Law firms are especially susceptible to these bookkeeping miscues because many firm owners do not believe that their bookkeeping requires a significant amount of time and do attempt to complete this work on their own. Some of the most common challenges that can be encountered in legal bookkeeping include the following:
Inaccurate bookkeeping records
Legal transactions are not matched up to the scope of work conducted by the firm. The result for a firm is most often an inaccurate assessment of the firm’s financial standing at any given point in time. While you may believe you have more money coming in than is truly the case, you could be on thin ice with respect to cash flow and accounts payable. This can leave a firm vulnerable to falling behind in their bill payments.
Insufficient tracking of billable hours
Marking down billable hours that correspond to the work you do can be difficult. If the scope of work that was done significantly surpasses the amount of billable hours that are marked down, there will be a major gap between the amount received and the value of the work done. In such cases, the invoices that are sent may not be reflective of the actual work that was done and, on occasion, this can result in the tossing out of the invoice entirely. Without sufficient tracking of billable hours, the work that you do for clients may not be accurately captured.
Inconsistencies in the classification of expenses
Independent contractors and regular employees are classified differently when it comes to taxes. Law firms need to be sure that expenses are classified properly and that the firm’s bookkeeping system matches with classifying employees and contractors with the proper labels. Additionally, certain types of expenses such as professional fees and office supplies are considered to be deductible as well. Practical expense guidelines are essential.
When developing a bookkeeping plan, law firms need to get organized immediately. For tracking expenses, all receipts need to be stored together, whether physically or electronically. With respect to billable hours, a system of organization is necessary and should seek to divide work into different tasks and groups. The use of timesheets and reporting can help keep a detailed record of the time that you spent on them. In some cases, it may be necessary to hire a bookkeeper to assist with your system.
Much of the time, the solution to these challenges is to call in a professional to help with your bookkeeping. While you may be able to manage some of this work on your own or with a member of your staff, working with a professional bookkeeper can assure that you receive the maximum benefits of the legal work you are doing.
Legal Bookkeeping Best Practices
Establishing a set of best practices for legal bookkeeping is crucial to gaining complete control of your law firm’s finances. In addition to a separate trust account, your firm should have a dedicated operating account. Using this account exclusively for firm-related transactions will help you maintain clear records of your law firm’s financial activity. As much as possible, avoid commingling your business and personal accounts, and avoid paying your personal expenses with firm funds, or vice versa.
Law firm bookkeeping software can simplify the task of keeping accurate and detailed accounting of your firm’s financial activities, especially if you work with clients in more than one state. Because each state has its own rules and regulations governing the usage of client trust account funds, your firm normally needs to have a dedicated bank account for each state where it pays income tax. Using software designed for law firms can help your firm follow the letter and spirit of each state’s rules. The best law firm accounting software will include convenient features designed to provide detailed reporting of not only your firm’s income and expenses, but also individual client trust funds.
Your law firm benefits from a robust accounts payable system that includes a means of tracking each of your firm’s bills and costs. Your law firm will benefit from making payments electronically whenever possible to keep strict control of its financial activities. Clearly label all of your charges, keeping them separate, and properly accounting for your administrative costs for each matter your firm handles. This practice will go a long way toward simplifying the process of billing for legal services.
The Impact of Tech on Legal Bookkeeping
As a law firm owner, you’re likely on the cutting edge of technology in some ways. Most notable here is the integration of Legal CRMs and Practice Management Software into the lawyer’s toolbox. These more innovative additions are meant to make life easier, with advanced calendaring, task management, remote access and, in the case of CRMs, portals to create a better client experience of project counseling. One area that tends to lag behind is Legal Bookkeeping.
There is a risk of getting stuck with the ways of the past when it comes to bookkeeping. To give you an idea of where you may have fallen behind, how reliant are you on spreadsheets? Are you still using Excel for time tracking, or, heaven forbid, free QBooks? There’s nothing wrong with using the free version of QBooks for personal tracking, but if you’re a business, you need better.
The first major curve to enter the legal market has been a Legal Billing Software solution. While we’re not outdated with spreadsheets, we’re still a bit behind, since Legal billing is still a bit of a one-way machine. The software is very robust, of course, and you sync your time entries into it. This is more than sufficient for most law firms as it; nonetheless, the legal tech market continues to expand.
Now that we’ve covered Legal Billing Software, we can talk about where technology is truly moving. It’s in the middle of a transformation to more advanced Legal Bookkeeping Software. Legal Bookkeeper offers powerful accounting solutions with dedicated features for law firms . This means some tools that are exclusively offered to lawyers, and tailored features to their business model. Lendio, offers essential fields that go above and beyond QBooks and even Legal Software. They offer the ability to create and maintain specific accounts for your business.
Lendio also comes with the benefit of being audit-friendly. When it comes to an IRS audit, they’ve got it covered. Detailed notes help guide you through any of the expenses or income you might have trouble recalling, and they also help you keep track of changes in tax codes and labor laws. With their Help Desk, you can get basic assistance with bookkeeping, such as finding old invoices, printing out a financial report, etc.
Lendio is also compatible with most cloud based services. I’m sure you’ve noticed the growing demand for cloud based software solutions over the past few years. Cloud-based services usually mean lower costs, and higher flexibility. What you may not have considered yet is how well they help security and performance.
All in all, modern Legal Bookkeeping tasks are:
Getting ahead of the curve isn’t complicated. In fact, it can be automated in many ways. For one, the more you automate, the more records you’ll have. If you ever did have to go to court, you have the evidence you need. You won’t need to panic about finding evidence or communication records. Everything is kept in order and ready to pull at a moment’s notice, should you need it.
Legal Bookkeeping Compliance
Compliance is important in every area of life. Areas such as investing, driving and even general health topics see massive amounts of guides and information online. The world of business and accounting is no exception to this general rule.
When it comes to legal bookkeeping for law firms, being compliant with the many different laws governing this process is essential for both keeping your firm healthy and staying out of legal trouble.
The main body of law that regulates bookkeeping for law firms is ABA Model Rule 1.15, which covers safekeeping of property, a standard that has been adopted with variations in law schools across the United States. A total of 39 states have adopted this model in some form or another.
While all states do have slightly different takes on the issue, the following categories are all covered under this basic rule.
All of these liabilities concern the handling of client money, be it direct payments, retainers or winning funds from settlements or awards. A competent legal bookkeeper will take advantage of a number of tools and best practices to ensure that you and your firm stay in 100% compliance without fail.
Generally speaking, standard business information systems, known colloquially as ‘systems of record’ help give law firms the means to comply with client trust accounting requirements. Accounting software such as Quickbooks is excellent for standard bookkeeping, but it is vital that law firms have separate software simply to fulfill client trust accounting requirements.
This is because the legal bookkeeping systems for the details of a firm’s trust accounts are incredibly complex and very hard to design and maintain. Because of this, there are now specialized client trust accounting systems such as DirectLaw and CaseGuard. These tools are made specifically to keep a law firm fully compliant for client trust accounting issues.
In addition to law firm bookkeeping software, it is hugely beneficial to keep virtual records of all financial records including billable hours and retainers. Programs such as TimeSolv and Workamajig allow law firms to have a digital record of all billable hours, cases and retainers to make sure that nothing is lost to time or the elements.
A law firm should only use a CPA that is experienced with handling the financial requirements of a law firm. Law firms generally have a very specific set of bookkeeping requirements and an inexperienced CPA can make some nasty mistakes that result in legal trouble for the law firm and a loss of profits.
If you’re a firm that uses email, social media or other modern means of communication for your business, add the handling of financial records to the list of tasks that should be handled by the firm’s trusted legal bookkeeping experts. Having a legal professional who is also a CPA on hand allows law firms to have better control over their bookkeeping than ever before.
Outsourcing Professional Legal Bookkeeping
One area where law firms often fall short is their bookkeeping. Unless you run a very small firm, there is just too much going on around the office to keep things in order. That is why hiring accounting and bookkeeping services for law firms is highly advantageous. The return on investment for making that choice is tremendous. By professionalizing your bookkeeping, you can ensure that deadlines are not missed and more money does not fall through the cracks. You’ll be able to provide comprehensive reports to your clients, make better decisions, and understand your profits and losses (P&L) much more easily.
When looking for a bookkeeping service, there are several things you should keep an eye out for. Industry Experience The first thing you will want to do is ensure that the bookkeeping service you intend to hire has relevant industry experience. There are accounting specialists that work with the legal industry in particular . They are familiar with the day-to-day financial record handling and can provide valuable strategies for making your firm more efficient in its handling of funds.
Services Offered Of course, you will want to determine what specific services are offered. Are they just bookkeeping services or do they provide other services as well? This is important because if you need them in the future, you may have to reorganize things to accommodate a new firm if they don’t offer expanded services.
Cost Finally, you’ll want to consider the costs. In general, fees are charged at an hourly rate. Figure out what you can afford and schedule meetings accordingly. You may find that your outsourced bookkeeping unit can help keep costs down by working more efficiently with your accounts than someone in-house could.
As you can see, hiring bookkeeping services for law firms can make a world of difference. Take the time to do your research and you could see a significant uptick in the way your finances are handled today.