Most bookkeeping errors cost money. Trust accounting errors can cost your licence. That asymmetry is why client trust accounts deserve their own treatment rather than being folded into general bookkeeping and hoped for.
The reassuring part: trust accounting is not intellectually difficult. It follows a small set of rules very strictly. The problem is that most bookkeepers have never been taught those rules, so they apply ordinary bookkeeping logic to an account where ordinary logic does not apply.
What California requires
Under Rule of Professional Conduct 1.15, client funds must be deposited in clearly identifiable trust accounts. That covers settlement proceeds, advance fees and money held for court costs.
Small amounts held briefly go into IOLTA accounts, where the interest funds legal services organisations across California. Where a client’s funds are large enough or held long enough to earn more than the cost of servicing the account, they belong in a separate non-IOLTA account with interest running to the client.
Since the Client Trust Account Protection Program came in, California attorneys must annually register every trust account, IOLTA and non-IOLTA, complete a self-assessment of their trust accounting practices, and certify compliance with the safekeeping rules.
That certification is the point at which vague record-keeping becomes a problem you have signed your name to.
The three-way reconciliation
This is the control that matters, and the one most commonly missing.
Three numbers must agree, every month:
- The trust bank statement balance, adjusted for outstanding items
- The trust account balance in your general ledger
- The sum of every individual client ledger
An ordinary bank reconciliation ties the first two. That is where most bookkeepers stop, and stopping there is the problem, because the first two can agree perfectly while the third is wrong.
Suppose $5,000 is disbursed on Client A’s matter but posted against Client B’s ledger. The bank agrees with the general ledger. Everything looks reconciled. But Client B’s ledger is now $5,000 short and Client A’s is $5,000 over, which means you are holding one client’s money against another client’s obligation.
Only the third leg catches that.
The errors we actually find
A client ledger goes negative
A negative client balance means you have disbursed more for that client than you held. By definition you spent another client’s money. This is the single most serious trust accounting error and it is invisible without per-client ledgers.
Earned fees left sitting in trust
Fees that have been earned belong in the operating account. Leaving them in trust commingles firm money with client money, which is its own violation even though it looks conservative.
Bank fees taken from trust
Service charges hitting the trust account consume client funds. The account needs to be structured so fees are drawn from operating.
Disbursing against uncleared deposits
A settlement cheque that has been deposited but not cleared is not money you can disburse. If it bounces you have paid out other clients’ funds.
Reconciliation performed but not documented
An undocumented reconciliation is indistinguishable from no reconciliation when someone asks to see it.
What good practice looks like
- Three-way reconciliation performed monthly, on a schedule, and signed
- A ledger for every client and matter, current at all times
- Trust and operating accounts fully separated, with no transfers that are not documented and earned
- Bank charges configured to hit operating, never trust
- Records retained for the period the rules require, in a form you can produce quickly
None of it is complicated. All of it has to be done consistently, which is precisely the thing that slips when the person doing it is also running the firm.
Practice management software is not a reconciliation
Clio and similar systems maintain client ledgers well. They do not, on their own, reconcile those ledgers to your bank statement and general ledger. The three-way still has to be performed, and someone has to look at it.
Talk it through with a Fresno CPA
We perform monthly three-way reconciliations for Fresno law firms and keep the documentation that supports your annual CTAPP certification. See our professional services accounting page.
Schedule a meeting or call 559-372-9213.
This post is general information, not advice for your specific situation. Tax figures are current for the year stated and many are indexed annually. Talk to a CPA before acting on any of it.
