Legal accounting is challenging for many solo practitioners and small law firms. There are five major challenges:
- Client Trust Fund Accounting
Like many other businesses, it is common for Legal firms to obtain deposits before beginning any work. In law firms, these are referred to as retainers. Retainer management is more significant and complex than deposits. Retainer funds remain the property of the client until earned. As an example -in a typical business, a customer can give the contractor a deposit to order garage doors, carpet, etc., that money no longer belongs to the customer, is usually non-refundable and is booked as income within the contractor business. In a law firm, the retainer remains an advance of the client and is a liability of the law firm until it has been earned for work performed by the attorney. These funds must be held in a Trust Account.
Complications can arise as Law firms need to track client ledgers separately from each other, while still keeping all trust funds collectively in a singular bank trust/IOLTA account. Law firms need to ensure that one client’s monies are not used on behalf of another client or used with the funds of the firm. This is where sound practice management and accounting systems are essential.
- Accurate Accounting of Matter Costs
Matter costs can be incurred from the beginning in legal cases. These expenses are either billed to the client or collected at settlement (if there is a settlement), depending upon the nature of the matter. It is required that all costs are accounted for accurately, which seems straightforward. However, in Legal accounting, not all expenditures can be treated the same.
- Differentiating Income & Revenue
The incurred costs of a matter must be allocated first when an invoice is paid. As this is not income, this portion must be logged separately. Inaccurate books will occur within the accounting records of firms who struggle with separating revenue that covers incurred costs from their actual revenue. This will result in compliance issues and a firm’s inability to recognize which cases are most valuable.
- Duplicated Data Entry & Resulting Errors
It is common for law firms to use two separate systems for their accounting and billing. As such it is crucial that a firm’s accounting and billing systems use identical sets of data. This is where compatible systems working together, such as Clio and Xero, is essential. This allows financial data across both systems to be linked. Failure to accurately keep accounting and billing systems in sync may create bookkeeping issues, which will result in billing complications, missed revenue, and possible ethics violations.
- Knowing Where the Money Comes From
Managing a caseload is just the beginning of the things a lawyer must contend with when also managing a firm. There must be a thorough understanding of how to segregate matter-related revenue and expenses. Knowing how to track and separate accounting transactions is essential. Engaging an accounting/bookkeeping firm experienced in legal accounting processes and systems is often the first step toward long-term success.