If you could secretly speak to most attorneys, not as an accountant, but as a friend, they would probably tell you that legal accounting is one of the things that keep them up at night. Sure, they know how to do the law practice work. But when it comes to doing accounting, it's so foreign to them. Now, they understand income and expenses, but it's not what they do when it comes to aligning the trust retainers in the software. It's not their expertise-it's ours.
Why is Legal Accounting Complex?
Legal accounting is complex because of the nature of it. Attorneys receive the money upfront as a retainer and hold that money in a special bank account. They have to account for that money as part of their compliance work. Remember, retainers are not their money — not until they've earned it.
The next barrier is the fees. Sometimes attorneys will pay fees as part of processing the case or the matter. They will pay for them out of the operating account, which means they've now fronted the client for these fees. It can get confusing because you have been prepaid, and yet you're using attorney funds to cover expenses on the case or matter. These will be recouped when it's time to bill the client and then apply that retainer to the bill. Sometimes the attorney will pay for the fees right out of the client ledger. It depends on where they are practice law and if this is allowed by their state bar.
The Accounts Receivable Moment
Accounts receivable is when the magic happens. We now have to show that the attorney has spent some time on the case, whether they are doing research or depositions, it maybe they are spending money on the client expenses, and now it's time to invoice the client for all of this. When the invoice happens, you now have that accounts receivable moment.
The attorney has now received legal income when we apply that retainer to the open invoice. It's a simple as that, but it's also complex because now you have to show this in the accounting properly. This is where are you see the difference between income and revenue. Any client expenses that are reimbursed or not income. Client fees are where most bookkeepers that are generalists fail. Not understanding legal accounting and its setup can cause those entries to show as overstated income, and even worse, badly managed trust accounting ledgers.
Another way attorneys will choose their bookkeeper is by having the tax professional handle your monthly bookkeeping. It makes sense, right? It's like a one-stop-shop. They know your tax return, so they should be able to manage your bookkeeping.
If you're picking a generalist tax professional, you're probably going to get a generalist bookkeeper--one that is not an expert in your industry. I have seen multiple people come to us that have been using this exact scenario. Then I noticed that they don't have real-time books presented to them. They get cash-basis bookkeeping where the tax professional staff takes the bank feeds and dumps in anything that comes into the operating as legal income. They don't take the time to even look at the accounts receivable or even managing the trust side. They let the client handle the trust side ledgers.
My clients have told me that the tax professional says,
"I don't want to handle that trust ledger side; you handle that."
To me, that's like giving somebody half a cookie. Nobody wants half a cookie. And in this case, it's not even a good cookie. It just can't be a more ugly situation for the client. After-the-fact, cash-basis bookkeeping does not work in the legal profession--even if you file your books on a cash basis at tax time. Attorneys live in an accrual world — attorneys invoice.
As soon as the law firm starts to grow and starts to think about how will I manage my work? Attorneys don't get the answers from the tax professional's bookkeeper. Why is that? There is no ongoing dialogue. To do the books right, you have to have touch points with your client throughout the year. I don't see that happening with my attorney clients that have hired that tax professionals firm. What I am seeing is that these tax professionals do a data dump right before tax time. There's no transparency and no interaction with the client whatsoever. It is basically the giant data dump done with bank rules and just before the tax return is due.
Software to the Rescue!
To put these transactions in, if you're doing it manually without software, it can be many entries to show this properly. If you have legal time in billing software or legal practice management software, connecting your software to QuickBooks is imperative. It will give you a place and a source to validate all of your data. I like when a client uses legal software because it keeps them out of the accounting side of the books--they live in the attorney software. As their accountant, our domain is QuickBooks Online Advanced.
It's imperative to make sure that you have that three-way bank reconciliation. Whatever the figures are in the accounting software, from your balance sheet, they should align with your legal software. It should also align with the bank's adjusted balance which includes, plus or minus, a few uncleared checks and maybe a deposit or two that did not clear in that month.
When the Books go Awry
I typically see an attorney who will come to me and has been doing their own bookkeeping. They may be at a point where they have an extensive caseload, and they are doing the bookkeeping at 10:30 PM. That kind of work at night? Never! They are usually exhausted, and as I mentioned earlier, they are not accountants. So, they're trying to save some money and do the work that needs to be done to keep themselves compliant and satisfy the tax professional at the end of the year.
Because they are rushed, or they're tired, they don't pick up the details. Maybe they don't track their practice area. Perhaps they're not tracking every single expense because they're trying to do this all manually on a spreadsheet, and this is where the software can pay for itself. Or at least by having the right legal software in place for accurate bookkeeping.
They know they need help because they are falling behind. Remember what I mentioned about compliance? If they lose track of those client ledgers, it just takes one phone call from one unhappy client to call the bar and trigger an audit. Or even worse, they are managing the trust account ledgers improperly, and the bank account goes negative—instant audit.
Once an audit is triggered, the clock starts ticking. That adds even more pressure to getting the books up-to-date. In addition, this will cause even more sleepless nights for the attorney. Fortunately, this can be rectified with the correct accounting professional. We have had attorneys come to us in this exact situation, and we've been able to help them detangle a mess.
We also can provide that important letter to the bar association every month, validating that the books are correct. Hiring that third party to handle this type of situation can you alleviate any worries and concerns over an audit.
If you are an attorney or work in a law firm and are struggling to keep up, call us today. We can help you.
If you're an accountant or bookkeeper and just landed your first attorney-client and want to learn more, join our Facebook group, the Accountants Law Lab. We also have a private page group with more one-on-one training.