Two File Method with Trust Accounting

You may have seen this title and wondered what the heck is Lynda talking about? What is a two-method file setup?

Many people believe that having the trust accounting in a separate QuickBooks file or different files is the way to go when working with attorneys and trust accounting.

One File System 

The benefits

Keeping the file separate ensures that you're keeping the trust ledgers and the trust money out of your accounting. Remember, clients give the attorney a retainer; these funds are not your money until the revenue is earned. Then it is transferred out of the trust account to operating.  

Many accountants like to keep this separate and not even show the trust bank account or the trust ledger's for the attorney's clients on the attorney's books at all. Different files make sense because it's not the attorney's money yet.

Using this method keeps the two files clean and separate. The separation is in the books and the mindset or the thought on this for your attorney-client.

When this method fails

When we inherit a file that is set up in the two file system we find the attorneys are working inside the legal software for the trust ledgers, they invoice their clients and enter the transactions around, but there's not always a way to prove that the actual funds have been transferred.  

Yes, you can reconcile the trust account to the bank, but if you don't see the other side, how do you prove that the monies have transferred? For example, if a client account is completed and you have earned all the money in trust, you create an invoice and a payment to show revenue recognition. All this happens on the trust side. Now, let's imagine that you forget to move the money to the operating bank account.  You reconciled the bank on the bank's side in the operating account—that's fine— it balances. You didn't move the money and reconciled the trust bank account, and that side stays with an open transaction. There's no way to see in a clear picture because the files are separate from noticing that the money has not been transferred.

Practice Panther is one software that is very popular with attorneys. And all the files that I've reviewed with Panther, almost every attorney says, "my files are perfect —I keep on top of practice Panther. But they never reconcile it. The reconciliation part is a little clunky, and very easy to uncheck a cleared transaction without any way of knowing that you did that. I have yet to see a practice panther file validated in a three-way bank rec when a client uses that software.

Two File System

The benefits

Although attorneys can be resistant to having it all in one file, the beauty is in having that one big picture. 

There's plenty of report tools out there that can extract trust account if a client doesn't want to see them on their books. You know my favorite is Reach Reporting. It's straightforward to pull out the client-side liability and pull out the bank account, which should match.

With one file, you can easily see the ins and outs. You validate all the transactions, and you can instantly see if funds have not been transferred. It's very transparent. And this is our preferred method. You can keep a file clean, which is most of the time the argument of why you shouldn't do this method by doing a three-way bank reconciliation. You should be doing this anyway if you're doing the accounting for attorneys. 

As you can see in the picture below, it's a very clean system. Adding an application like LeanLaw in Panther's place makes life easy for the accountants and the attorneys. As pretty as practice Practice Panther is, it's just not a great system. The integration with QuickBooks is not great. Clio is another option, but working with this software does require some additional work on our side. But it is a great alternate option if a client needs that practice management software.

I hope this clears up some of the beat around a one or a two file system. I'd love to hear your comments or arguments about why one is better than the other.