Early Detection of Erroneous Bookkeeping Entries In Trust Account Records: Part 1

Posted on Posted in Bookkeeping, For Law Firms

The key to appropriately managing a client trust account is having a system in place that will alert the attorney as soon as possible that a transaction may have been entered erroneously.  Several simple, monthly checks will help you discover errors quickly.  In the first of this series, we look at the importance of ensuring that the total balance in the trust bank account always matches the total balance in the client trust liability account.

Using the example above, we can confirm there are no obvious errors in the firm’s client trust accounting by adding up the total debits and credits for the Trust Bank Account and the Client Trust Liability account.  If the accounting has been done correctly, Column 1 (Debits) for the Trust Bank Account will equal Column 2 (Credits) for the Client Trust Liability account.  We calculate this as follows:  Looking at the Trust Bank Account, we have $15,000.00 in Column 1 (Debits), and $5,000.00 in Column 2 (Credits), which nets out to $10,000.00 in Column 1 (Debit).

Trust Bank Account Ledger Column 1 (Debit) Column 2 (Credit)
Client 1 Deposit $10,000.00
Client 2 Deposit    $5000.00
Client 2 Withdrawal to pay fees    $5000.00
Balance $10,000.00

Looking at the Client Trust Liability account, we have a total of $5,000.00 in Column 1 (Debits), and $15,000.00 in Column 2 (Credits), which nets out to $10,000.00 in Column 2 (Credit):

Client Trust Liability Column 1 (Debit) Column 2 (Credit)
Client 1 Deposit $10,000.00
Client 2 Deposit   $5,000.00
Client 2 Withdrawal to pay fees $5,000.00
Balance $10,000.00
Account Balance Column 1 (Debit) Column 2 (Credit)
Trust Bank Account $10,000.00
Client Trust Liability $10,000.00

When these two columns match, it’s less likely that there are trust accounting mistakes.

This is not math that the attorney has to perform manually each month; simply having your bookkeeper run an end-of-month report that shows the balances for each of these accounts, and confirming those balances match, will suffice.

Now let’s look at a very common trust accounting mistake that many attorneys, and even bookkeepers, often make, and see what that does to the balance in each account.  Let’s assume, as we did above, that Client 1 previously deposited $10,000.00 into trust, and Client 2 deposited $5,000.00 into trust.  Let’s also assume, as we did above, that Client 2’s funds were used to pay an invoice.  Except this time, our bookkeeper fails to enter one balancing transaction to withdraw the money from trust, and another balancing transaction to pay the invoice and deposit the money to the operating account; instead, our bookkeeper simply transfers the funds from the Trust Bank Account to the Firm Operating Bank Account,[1] and enters the transaction as a simple transfer.  The debits and credits for those transactions will look like this:

Account Column 1 (Debit) Column 2 (Credit) Explanation
Trust Bank Account $10,000.00 Client 1’s Initial Trust Deposit
Client Trust Liability $10,000.00
Trust Bank Account $5,000.00 Client 2’s Initial Trust Deposit
Client Trust Liability $5,000.00
Trust Bank Account $5,000.00 Transfer of Client 2 Funds to Operating
Firm Operating Bank Acct $5,000.00

In this case, the debits and credits still balance out because we have a total of $20,000.00 in Column 1 (Debit), and $20,000.00 in Column 2 (Credit).  What doesn’t match are the Trust Bank Account and the Client Trust Liability account balances.  In the Trust Bank Account, there is a total of $15,000.00 in Column 1 (Debits), and $5,000.00 in Column 2 (Credits), for a net total of $10,000 in Column 1 (Debit).  In the Client Trust Liability account, there is a total of $0 in Column 1 (Debits), and $15,000.00 in Column 2 (Credits), for a net total of $15,000.00 in Column 2 (Credit):

Account Column 1 (Debit) Column 2 (Credit)
Trust Bank Account $10,000.00
Client Trust Liability $15,000.00

When the bookkeeper runs the balance reports for the Trust Bank Account and the Client Trust Liability account, the balances will not match, and the attorney responsible for that trust accounting will know that there is a problem that must be resolved.

A final accounting check that should be run each month (or not less than quarterly under the ABA Model Rules for Client Trust Account Records, Rule 1(i)) is to compare the balances above with the total balance of individual client trust account ledgers.  Do the total trust funds allocated to each individual client match the account balances above?  If so, the client trust accounting is likely in good shape.

[1] Such a transfer is permitted under the ABA Model Rules, under Model Rule 2(c), which allows withdrawals from client trust accounts to be made “only by check payable to a named payee…or by authorized electronic transfer.

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