Law Firm Bookkeeping 101

Fortunately, with a combination of technology, best practices, and the right help, it’s possible to stay on top of your bookkeeping with little effort.

This guide will provide an overview of law firm bookkeeping, some best practices to follow, mistakes to watch out for, and tools to make the whole process easier.

The difference between law firm bookkeeping and accounting

People tend to use the terms bookkeeping and accounting interchangeably, but bookkeeping is actually just the first step in the accounting process. It involves recording and classifying financial transactions, preparing bank reconciliation, and tracking all income and expenses.

Accounting takes financial reporting a step further. Accountants typically take the books and records prepared by a bookkeeper and use them to provide business advice, prepare financial statements, and file tax returns.

Of course, the line between bookkeeping and accounting can get blurred. Some accountants record financial transactions, and some bookkeepers assist with business decisions and prepare financial statements. However, for our purposes, when we refer to “bookkeeping services,” we’re referring to tasks like recording income and expenses, reconciling bank accounts and credit card statements, and tracking payables and receivables.

Best practices in law firm bookkeeping

Lawyers spend years honing their legal skills, but they often have little knowledge of accounting practices. The following tips can help you get a better handle on your finances.

Select cash or accrual accounting

You generally have two options when it comes to keeping your books: the cash method or the accrual method.

In cash basis accounting, you record income and expenses when money changes hands. In accrual accounting, you record revenue when earned and expenses when incurred, regardless of when cash changes hands.

Most small businesses, including small law firms, choose the cash basis of accounting, as this method allows the firm to delay paying taxes on income until the payment comes in the door.

Streamline your chart of accounts

A chart of accounts is a list of your firm’s financial statement accounts. The primary types of accounts include:

• Assets
• Liabilities
• Equity
• Revenue
• Expenses

Within each of those categories, you may have dozens of general ledger accounts. For example, you might have an operating account, lawyers trust accounts, accounts receivables, and fixed assets within the assets category.

You can add as many accounts to your chart of accounts as you need to prepare accurate and informative financial statements, but don’t let your chart of accounts get too unwieldy.

For example, if you purchase office supplies for your business, you should have an “Office Supplies Expense” account. But you don’t want to set up separate accounts for legal pads, pens, printer ink, etc.

Having too many accounts creates headaches later on, as it takes more time to review the books and increases your chances of making mistakes.

Stay on top of bookkeeping tasks

When pressed for time, it’s tempting to let recordkeeping fall by the wayside. But if your law firm bookkeeping isn’t up to date, it’s tough to stay on top of cash flow and ensure client funds are handled properly.

Recording all revenues and expenses when they happen is much easier with accounting software as it connects to your firm’s bank account and automatically records and classifies all transactions.

Collect outstanding receivables

Accounts receivables, also known as A/R, are amounts owed to you by clients. Staying on top of receivables is essential to the financial health of your business.

When clients are slow to pay or don‘t pay their bills, you may find yourself unable to pay your staff or cover other overhead expenses. At least once a month, review your receivables and follow up on outstanding client invoices to keep your cash flow strong.

How to handle IOLTAs in your bookkeeping

One unique aspect of law firm bookkeeping is trust accounting. Interest on Lawyer Trust Accounts, also known as IOLTA accounts, are bank accounts used to hold client retainers, settlement funds, and other money that belongs to clients.

Keeping client funds separate ensures the money isn’t inadvertently used for your business or personal expenses.

There are two ways to handle IOLTA accounts:

1. Maintain a single trust account and hold all client funds in one account.
2. Set up individual trust accounts for each client, so client funds aren’t commingled.

Most state bar associations require you to document client trust accounting with three-way reconciliations. A three-way reconciliation means ensuring that the following three numbers match:

1. The bank account balance
2. Your book balance
3. Each client’s trust ledger

If there are any differences between the three, your trust reconciliation report should show the reason for the discrepancy. For example, say you deposited a check for $10,000 to the trust account on December 30 but the deposit didn’t clear the bank until January 2. The December 31 bank statement shows a balance that is $10,000 less than your books or the client’s trust ledger due to a timing difference. You would note this in your reconciliation report and ensure your January 31 bank statement includes the deposit.

It’s also a good idea to reconcile trust accounts at least once a month and prepare monthly reports for each client, listing all of the activity in and out of the account and the ending balance.

Common mistakes in law firm bookkeeping

If you’re trying to handle bookkeeping on your own in addition to putting in all those billable hours, it’s easy to overlook workflow steps or make mistakes. Here are several common legal accounting mistakes to avoid.

Data entry errors

Small data entry errors like posting a transaction to the wrong account, transposing numbers, or misplacing a decimal point can lead to client funds not being properly accounted for and other financial reporting issues.

Using accounting software or a professional bookkeeping service can help you avoid those mistakes, as these solutions have error-reducing features and layers of checks and balances to ensure your numbers are correct.

Recording deposits to IOLTA accounts as income

It’s easy to record all deposits to bank accounts as income, but deposits made to IOLTA accounts aren’t income for your law firm—they belong to your client.

Instead of debiting cash and crediting income, you should debit the IOLTA account with a corresponding credit to Trust Account Liabilities. When you later earn your fee, you would debit Trust Account Liabilities and credit your revenue account.

Procrastinating

As a busy lawyer, it’s easy to put off bookkeeping tasks until year-end when you need year-end numbers to file a tax return. But putting off handling your legal bookkeeping and reconciling financial accounts makes it tough to get paid, pay your own bills on time, and make informed financial decisions.

Bookkeeping solutions

You don’t necessarily need accounting software or a professional bookkeeper to handle your law firm bookkeeping. When you’re just starting out, you can keep costs low by recording all income and expenses in a spreadsheet, like our Excel Income Statement Template.

But as your firm grows and you have more transactions, you’ll eventually need to move on from Excel. When that time comes, here are a few options to consider:

• DIY accounting software. Cloud accounting software like Xero and QuickBooks offers a full suite of tools to help you with accounts payable and receivable, bank reconciliations, and financial reporting. Keep in mind that you’ll still be performing all your own bookkeeping tasks—you’ll just be using software to help streamline the process.
• Virtual bookkeeping service. If tracking your finances isn’t something you have time for (or interest in), consider outsourcing your bookkeeping to a service like Bench. Our trained bookkeepers can help keep your law firm on track and ensure your trust accounting is compliant. We can also help with tax filing.
• Bookkeeping firm. Working with a freelance bookkeeper or bookkeeping firm is often one of the most expensive options, but you can find one that works in the way that’s most convenient for you. For example, you may be able to find someone willing to come by your office to pick up paperwork each month.