Legal Bookkeeping Guide for Law Firms

The systemic activity of keeping books and records of a business. The simplified dictionary definition of bookkeeping. Legal bookkeeping is exactly that, except it is done for businesses providing legal services. Law firm bookkeeping and accounting can be a daunting task for general lawyers. It requires exceptional attention to detail. Confusion can be a cause for human errors in the law firm accounting procedures.

Why Bookkeeping and Accounting Matter for Law Firms?

Law firms handle more than legal work. They manage client trust accounts, track billable hours, pay staff, and stay compliant with strict financial rules. Without accurate bookkeeping and accounting, even a well-run firm can face serious problems.

Accurate records help keep client funds separate from the firm’s operating money, which is a legal requirement in most states. Proper accounting also makes it easier to track income, expenses, and profitability by case or practice area. This insight helps firm owners decide where to invest time and resources.

Timely bookkeeping supports smooth tax filing and reduces the risk of penalties. It also ensures partners and stakeholders have clear financial reports, which builds trust and transparency. In short, good bookkeeping and accounting protect a law firm’s reputation, keep it compliant, and support better business decisions.

Our guide on law firm bookkeeping helps our readers to be more vigilant by staying informed with a few basics.

A breakdown of three benefits among many of proper law office accounting and bookkeeping:

• Helps track the law firm’s cash flow.
• Keeps the law firm compliant with SRA guidelines. 
• Increases profitability and makes the law firm successful.

Legal Accounting vs. Legal Bookkeeping

Legal Accounting	Legal Bookkeeping
Invoicing expenses.	Recording and monitoring financial transactions.
Giving insights and building financial plans for the law firm.	Analysing the financial stability of the legal business.
Helping the business to stay in compliance with SRA rules.	Checking the accuracy of records.
Creating financial statements.	Managing payrolls.
Issuing payments and administration.	Managing the books.

Legal bookkeeping and legal accounting can be mutually exclusive. Both of them complement each other. Both are essential for a law firm to function. Most law firms seek to hire an experienced legal bookkeeper who would take care of both the bookkeeping and the accounting of the business. You cut down on the workload and your record-keeping stays consistent with your financial reports.

Types of Legal accounting

The main types of accounting you must have knowledge of when starting off as a legal bookkeeper are as follows.

1. Trust Accounting

Trust Accounting involves maintaining trust accounts for law firm clients. The clients’ funds are held within these accounts in trust. The clients are the trustees of the funds. When a client’s money is held in trust accounts, legal trust accounting basics suggest that the law firm must not:

1. Use the fund for law firm expenses.
2. Deposit law firm funds into the client’s trust account. 
3. Interest on the client’s trust account.
4. Withdraw funds for any reason other than legal service related.

2. IOLTA

IOLTA, or Interest on Lawyers Trust Account, are accounts that hold client funds from sources like settlements and retainers. Interest can be generated on IOLTA trust accounts. The earned interest does not belong to the law firm. Similar to basic trust accounting, they have certain rules. The law firm may only:

1. Use the interest in social services only, such as legal aid services.
2. Transfer the IOLTA trust funds from the trust account when earned.

3. Double-Entry Accounting

Double-Entry Accounting helps to analyse and identify any errors in the legal accounting. It involves two entries for every transaction, a debit and a credit. These entries add up to form a balance sheet containing assets, liabilities and equity. The amount on either side must be equal at all times.

4. Three-Way Trust Reconciliation

Three-Way Trust Reconciliation is done to ensure an error-free financial reporting at the end of a 30-days or 60-days period. It weeds out financial issues or impending ones within the law firm. It can be done by a bookkeeper with expert electronic bookkeeping, provided by excellent legal practice management softwares like Leap and QuickBooks Online.

Three-Way Trust Reconciliation involves three components:

1. Trust Bank Statement: Trust Bank Statement is issued by the law firm’s financial institution. It shows the amount in the client’s bank account. Since it is issued by a third-party, trust bank statements must be reconciled regularly. Any errors found in the statement should be acknowledged and reported with haste.
2. Trust Ledger: Trust Ledger shows the amount shown within the financial statements for the IOLTA account. A corresponding amount should show up in an accompanying liability account. The amount in the Trust Ledger must equal the Trust Bank Statement. If it does not, it should point out an uncleared transaction from old invoices or bank deposits. It can be resolved by clearing the old invoices or adjusting the bank balance with the uncleared transactions. 
3. Client Ledgers: Client Ledger shows the amount of funds remaining for each individual client. Similar to the Trust Ledger, this amount must always match with the amount in the Trust Bank Statement. Any errors should be identified and investigated promptly.

Legal Bookkeeping Best Practices

Legal firm accountancy and bookkeeping can be mostly stressful for most lawyers. Therefore, with the following short list of best practices, it will be easier for your law firm’s lawyers to turn it around for themselves, professionally speaking. 

• Allocating budgets appropriately – Revenue vs profitability charts are important for your law firm. It is necessary to be aware of your incomes and expenses and maintain a healthy cash flow within the law firm. Once you do, make plans and allocate the budget for your law firm appropriately.

• Maintaining bank accounts – Create and maintain bank accounts with responsibility. Whether it is an IOLTA account, savings account or check account, the regulation of each account is essential for a trouble-free relationship with your clients and banking institutions.

• Managing separate accounts – Keep anything related to your law firm’s expenses separate. Any mingling with the trust account funds will certainly lead to discrepancies in the accounts. The less you use a trust account for transactions, the safer.
• Keeping track of expenses – Analyse your records daily. Keep track of all your expenses, even the miscellaneous ones that would tend to be looked over otherwise.
• Following the trend – Keep up with the marketplace. Study what new trends in the legal business, analayse your legal firm’s financial statement and plan your next move.
• Implementing automation – Automate your bookkeeping and accounting records. Use some of the best legal practice management softwares available.
• Hiring professional help – Asking your law firm’s lawyers to do all the accounting and bookkeeping can take away from their time practising actual law. Hand over the burden of responsibility to an experienced and competent legal bookkeeper instead. Your records should be in safe hands!

Accounting Terms You Need to Know

Understanding basic accounting terms helps you read financial reports and communicate clearly with your bookkeeper or accountant. Here are some key ones for law firms:

• Assets – Everything your firm owns that has value, such as cash, office equipment, and accounts receivable.
• Liabilities – Debts or obligations your firm owes, like loans, unpaid bills, or taxes.
• Equity – The value remaining after subtracting liabilities from assets. For partners, this often represents ownership share.
• Revenue – Money earned from client work before expenses are deducted.
• Expenses – Costs of running the firm, such as salaries, rent, utilities, and software fees.
• Accounts Receivable (A/R) – Money clients owe the firm for services provided but not yet paid for.
• Accounts Payable (A/P) – Bills or obligations the firm still needs to pay.
• Trust Account – A special account where client funds are held separately from firm funds, often required by law.
• Profit and Loss Statement (P&L) – A report showing revenue, expenses, and profit for a given period.
• Balance Sheet – A snapshot of assets, liabilities, and equity at a specific point in time.
• Cash Flow – The movement of money in and out of the firm, showing how easily you can cover expenses.
• Billable Hours – Hours worked on client matters that can be charged to clients.
• Retainer – An advance payment from a client for future legal services.

Avoiding Legal Bookkeeping Mistakes

Go big or go home. Just like the best practices, there are a few mistakes that you should avoid with your law firm accounting. 

• Stay away from the trust accounts – We have mentioned it before. It is against the law to use your client’s funds in your law firm’s interest. And we also cannot stress this enough. Use clients’ trust accounts as little as possible. Regularly check the accounts, create suspense ledgers, use automation softwares to monitor every transaction for any errors in the record-keeping. 

• Entering the wrong data – The mistake can be as harmless as a single zero. And yet, most errors made in law firm accounting are almost always unforgivable. Steer clear of data entry mistakes with the help of legal practice management softwares.
• Know the difference between revenue and income – One mistake that should be too obvious. You should be aware of what revenue and income counts as. Revenue is the capital that your law firm receives from your partners. Income is what is left of it at the end after deducting all the expenses.

Conclusion

Law firm bookkeeping can be a challenge for small law firms. With the right guidance and the proper help, it can be overcome with ease. All you need to do is be wary on your path to growth and success.