Part 4 of a discussion on lawyers Three Step Trust Reconciliation.

• Part 1
• Part 2
• Part 3
• Part 4

Step 3: Trust Ledger Balance Analysis

In Part 2 we saw that Step One requires a high level overview of the trust position. Part 3 describes how to confirm the Trust Cash part of trust position by verifying that the Cash Book to Bank balances match.

Verification

While Step One requires a very high level test to confirm that the trust assets and liabilities correspond, the next steps require internal verification. We must verify the internal consistency of the reports we rely on.

Trust Ledger Balance Analysis

Now we investigate the client trust ledgers. By definition of the trust, all trust transactions must be allocated to specific ledger accounts, no ledger account may have a debit balance and all ledger accounts must have credit balances.

Client Trust Ledger Balances

 

Each client should have a separate account in the system. DynamicLTA maintains every single matter as a separate ledger. All trust transactions should be posted to its relevant ledger.

As discussed above, the integrated double entry system, allows for easy processing of transactions. The List of Client Balances and Trial Balance will indicate the ledger balance on the selected date.

On commercial accounting systems the Trial Balance will only reflect the business accounts. It is recommended that a List of Client Balances be drawn in addition to the Trial Balance to verify the trust ledger balances. Note that the DynamicLTA Trial Balance includes both the trust and business balances.

A ledger exists for each account. Each ledger contains the details of each transaction, allowing an accurate and complete drill down of each account as it is reflected on the high level reports, right down to the ledger and individual transactions.

Balancing the Trust

Transactions may occur on a client’s business account, which may allow the transfer of client funds from trust to business, such as paying for the professional fees incurred, or direct payment from trust, on behalf of or on instruction of a client.

DynamicLTA has a built in trust-and-business balancing transaction option. This will balance out the trust by generating ledger entries reflecting the amounts affected on each ledger. This is normally referred to as a trust to business transfer.

Regularly balancing the trust will force ledger entries which will balance each individual client trust ledger account, eliminating deficits on individual accounts and transferring surplus amounts to business.

The Trust Balance entry will ensure the integrity of the trust.

Note that this is only a ledger entry. This means that after using this function each individual client trust ledger should have a nil or credit balance. It remains for the lawyer to transfer the money between the trust and business bank accounts.

DynamicLTA allows multiple, repetitive transfers, meaning that such transfers can be done at any time during the month, week or day. Each such transfer will be accurate up to that point in time.

Deficits, or a surplus will appear by comparing the total trust ledger to the cash books. See Step 1: Trust Assets and Liabilities above. Also note that DynamicLTA does not link to any electronic banking facilities. A paper based cheque or electronic fund transfer must still be made between the firm’s banking accounts.

 

Step Three

Analyzing the client trust ledger will require at least two documents:

• List of Balances or Trial Balance
• Ledger

Client Trust Ledger Balances must not hide a deficit on certain accounts, by allowing a surplus on other accounts.

It is recommended that both the Trial Balance and the List of Client Trust Ledger Balances be used as confirmation of the accuracy of the balances. The risk exists that a deficit on one account may be hidden by a surplus on another account. By inspecting the reports for trust debit balances, such problematic accounts can be identified.

DynamicLTA supports a special six column ledger analysis report designed specifically to make understanding of the business-trust ledger easier.

Ledger History Analysis of a single ledger

A screenshot of a six column Ledger History Analysis. Trust and Business clearly distinct with running balances.

Step 1	Trust Ledger = Trust Cash
Step 2	Trust Cash = Trust Bank +/- Recon
Step 3	Client Trust Ledger Balances

Verification of the Client Trust Ledger Balances in Step Three, ensures that the remaining part of our trust position has been confirmed.

 

In Conclusion

In the discussion above, we have illustrated how the integrity of the lawyer’s trust account can be confirmed.

Think of the Three Step Trust Reconciliation process as a pyramid. At the top of the pyramid we take a very high level view of the trust, by simply confirming that the liabilities equal the assets. The next step is to verify that the assets (cash) are accurately reflected, and the last step is to verify that the liabilities (ledgers) are accurate.

DynamicLTA makes it easy to distinguish trust from business, maintain separate ledger accounts, and confirm the accuracy of both the high level trust and business ledger balances and cash books, and drill down to an individual cash book, ledger or to an individual transaction.

Sophisticated lawyers trust account software. Exactly what your trust needs.

[End]

–Dynamic

Part 3 of a discussion on lawyers Three Step Trust Reconciliation.

• Part 1
• Part 2
• Part 3
• Part 4

Step 2: Trust Cash Books and Banks

In Part 2 we saw that Step One requires a high level overview of the trust. Start the trust reconciliation with simply comparing the total trust assets to the total trust liabilities.

Verification

While Step One requires a very high level test to confirm that the trust assets and liabilities correspond, the next steps require internal verification.

Trust Ledger = Trust Cash

We must verify the internal consistency of the reports we rely on.

Now we investigate the trust cash books, the bank reconciliation and the bank statements.

Trust Cash Books & Bank accounts

Money is typically not kept on the premises. A common feature of trust accounting is that the trust assets must be secured. In the event of trust cash, this is done in a banking account.

Most jurisdictions have clear rules on which kind of bank account is allowed for use as a lawyers trust account. Generally these accounts will be at established banks or similar. Make sure that the bank you choose is approved.

Traditionally it was not uncommon for a law firm to manage multiple such trust bank accounts. Either a bank account for each client, or bank accounts per practice area, depending on need and regulation.

Each bank account should match a corresponding cash book in the law firms accounting records. Historically a cash book was a massive hard cover book, with analysis columns, used to capture and reflect cash received and paid out.

Bank Reconciliation

Process and Report

To reconcile, or reconciliation mean both

• a process, where by transactions on one report are matched individually to corresponding items on another report, which results in a report; and
• a document, printed out, confirming the result of the matching process, indicating the balances and transactions outstanding.

Reconciliation Process

Bank Reconciliation refers to a process of comparing the transactions on the cash book with the corresponding transactions on the bank statement.  This is a recurring event which closely follows reporting periods such as month ends, or quarters.  It can be done weekly, and should not be postponed beyond a quarter.

Regardless of local regulation it is recommended that bank reconciliations are conducted frequently. Not only does it verify that the trust cash book corresponds to the trust bank account, it also acts as an early fraud detection and warning mechanism.

Note that the bank statement reflects transactions “in the real world” as processed by the bank. We can not change the bank statement.

What we can change is the cash book. This means that as the bank statement is inspected, the cash book must be compared one transaction at a time, to make sure the transactions correspond. In the event of transactions which occur on the bank statement and not on the cash book, these must be placed on the cash book. An example would be a direct deposit, or fund transfer. Money has been received, but the client has not informed us of this fact yet. A new receipt must be posted to the client trust ledger account to benefit the client, and update the cash book balance. This is a practical application of the rule of thumb “put it where it isn’t”. Note that all transactions reflected on the bank statement must appear on the cash book.

Cash book transactions may not all reflect on the bank statement. These are shown as outstanding transactions. For example, in the event that a cheque (or check in the USA) is drawn on the trust banking account, this may appear on the cash book, but as it has not been presented to the bank for payment, it does not appear on the bank statement. It is shown as outstanding.

Reconciliation Document

It is an error to assume that the trust cash book and bank statement balances must match. Outstanding transactions will affect these balances.

Only after ALL transactions have been accounted for, either as matching both the cash book and bank statement, or as outstanding, will the balances match.

The result of a successful reconciliation process must be an accurate bank reconciliation report document which confirms the balances.

A bank reconciliation report document should at least contain the following:

• the bank balance (from the bank statement)
• the cash book balance (system generated)
• the difference between the bank balance and the cash book balance
• any outstanding transactions

Bank Reconciliation Document

A screenshot of a bank reconciliation showing the bank balance, the cash book balance, the total of outstanding transactions, and the 0.00 recon result. Outstanding transactions are listed below.

Note that on an accurate and complete bank reconciliation, the difference should be nil: 0.00 indicates that all transactions are accounted for.

Outstanding transactions represent those transactions which we have entered into the system, which does not yet reflect on the bank statement.  Inspect the outstanding items for stale transactions.

Step Two

Comparing cash book and bank balances is itself a process that requires three documents:

• Cash Book
• Reconciliation
• Bank Statement

Trust Cash = Trust Bank +/- Recon

The reconciliation report will indicate and confirm the correspondence of the trust cash book with bank statement balance.

In the event that a bank reconciliation is incomplete or inaccurate, the only conclusion to be drawn is that the cash book does not match up to the bank statement. This means that the first part of the verification process has failed. One of the primary reports used in the trust reconciliation is unreliable, and as a consequence the trust reconciliation has failed.

Step 1	Trust Ledger = Trust Cash
Step 2	Trust Cash = Trust Bank +/- Recon

Verification of the Trust Cash in Step Two, ensures that at least one part of our trust position has been confirmed.

[Part 4 Follows]

–Dynamic

Part 2 of a discussion on lawyers Three Step Trust Reconciliation.

• Part 1
• Part 2
• Part 3
• Part 4

Step 1: Trust Assets and Liabilities

When dealing with Lawyers Trust Accounts, several principles apply, and it is convenient to highlight some of these.

Principles of Trust

Generally trust refers to property not belonging to the law firm. Typically this means money, but may include other trust assets, including investments, loose goods and real estate. For the purpose of this discussion it will be assumed that all assets under discussion refer to money.

The Lawyers Trust Account is not a trading trust, or curated estate generating income. It does not trade, does not have a separate income, and is not a distinct legal entity. The Lawyers Trust Account exists because of and as an extension of the legal practice itself.

Defining the meaning of trust

Without reference to any specific jurisdiction, trust means that property which the lawyer holds on behalf of a client, and which does not form part of the estate of the lawyer. The lawyer does not own the trust.

• Trust assets are held apart from the business assets
• Trust assets do not belong to the lawyer or their firm
• Trust assets belong to an identifiable client

This also leads to the somewhat circular conclusion that the lawyer could hold trust assets on his own behalf.

Trust Assets

If a financial category must be assigned to these items, they are best described as extraordinary assets and liabilities, where the client trust ledger account balances represent the liability and the trust cash books represent an asset.

Why as extraordinary assets and liabilties?

In terms of GAAP and IAS all the assets and liabilities of a business must be reflected in the Financial Statements, and by classifying these as “extraordinary”, may be left off-balance sheet.  This creates a misrepresentation of the true affairs of the business.

However, consider that commercial accounting system cannot accurately reflect the distinction between business and trust items, and that the trust does not form part of the assets and liabilities of the business.  Using a commercial system, the trust would have to be reported separately.  In order to provide for consolidated, consistent reports in terms of these directives requires an explanation of the trust assets and liabilities.  We call them extraordinary.

Common Practices

Often lawyers will receive substantial amounts of money in advance of work done, based on the common understanding that a certain mandate will result in a quantifiable future charge.

Alternatively lawyers often receive substantial sums of money from third parties on behalf of their clients.

In either event, only once the lawyer has done the work required in terms of the mandate, may funds be transferred from the trust as payment to the law firm’s business account.

When a client deposits money with a lawyer the following scenario obtains:

• the lawyer is entitled to receive that money as payment for work done, reimbursement for expenses incurred; clearly the lawyer is entitled to this payment and it does not represent a trust transaction; or
• the lawyer still has to do work on behalf of the client and is not yet entitled to transfer or receive any of these funds to the firm’s business account, this is a typical trust transaction.

This basic distinction turns on the lawyers entitlement to receive the money.  If the lawyer is entitled to receive the money in own right, the money is business money, if the lawyer is not entitled to receive the money in own right, the money is trust money.  Please ascertain the local, formal, definition of trust money used in your jurisdiction.

Upon receiving money from the client or third party it is common practice to issue a receipt as documentary evidence of that transaction. This represents only the receipt of money as a distinct accounting entry and does not yet reflect any charge for work to be done or disbursement to be incurred.

By extension, as the ledger must reflect separate provision for trust, so the money must be kept in a bank account separate from that of the business. At least two banking accounts are required, one for business and one for trust.

Where trust money is received, a trust receipt must be issued.

The client’s trust ledger account must now reflect a trust credit entry. The corresponding trust cash book must contain a trust debit entry.

Each client’s trust ledger account balance must match to the balance on the trust cash book.

The images below proceed from the detail of single ledger account, to a high level overview of trust balances.  The first screenshot reflects an individual client’s trust ledger account, with a single trust receipt transaction.  The second screenshot shows a list of client trust ledger accounts with distinct trust credit balances. The third screeshot reflects the corresponding balances of the trust ledger accounts and the trust cash book.

Ledger History Report of a single ledger

A screenshot of a Ledger History Report. Client Trust Ledger Account reflecting transaction details. A Trust Receipt transaction, with a closing balance of the same amount. Note that the specific client to whom these funds belong is identified.

 

Client Account Balance Listing

A portion of a PDF print out of the Client Account Balance Listing. Client Accounts Listing distinct Business and Trust Ledger Account balances, reflecting the current business and trust balance on each such account. Note that the specific clients to whom these funds belong are identified.

 

Trial Balance

A portion of a PDF print out of the Trial Balance. Client Accounts are displayed with a leading T to indicate the trust balance. This is totaled in the line marked “*** CLIENT TRUST LEDGER BALANCES”. The individual Trust Cash Books are listed with their respective balances. The Trust Cash Book balances are totaled in the line marked “*** CLIENT TRUST CASH BOOK BALANCES”. The client trust credit balances match the trust cash book debit balances.

 

The Trial Balance is a standard report that simply lists all accounts with their balances. In this case a clear distinction is made between the clients’ business and trust accounts and provision is made for clearly and accurately reporting business and trust transactions, and account ledger balances separately.

Step One

Step One of the Three Step Trust Reconciliation process is to confirm that the totals of the trust ledger balances match the total balances of the trust cash books.

Compare the total client trust ledger account balances to the total of the trust cash book balances.

Accounting reports typically use balances as a summary of the result of transactions.

Trust Ledger = Trust Cash

In the example above it is clear that the total of the client trust ledger account balances match the total of the trust cash book balances. The trust is in balance.

Subsequent steps verify that the trust ledger and trust presented in Step One are a true reflection of the total trust position.

It is a common feature of trust accounting compliance assessment that the client balances must correspond with the trust cash. Any difference typically requires reporting and reflects inaccurate bookkeeping practices.

Where the liabilities exceed the assets, a deficit exists and may be indicative of theft of trust funds.

Where the assets exceed the liabilities, a surplus exists and typically represents a positive transfer of funds from trust to business.

Prudence and professional conduct rules require accurate, up-to-date bookkeeping entries and reports which are accurate and complete. Incomplete accounting records do not provide an accurate reflection of the state of the trust and can not be relied on for decision making.

[Part 3 Follows]

–Dynamic

 

Part 1 of a discussion on lawyers Three Step Trust Reconciliation.

• Part 1
• Part 2
• Part 3
• Part 4

Introduction

Ordinary commercial accounting software works for any business.

Lawyers need custom software to manage both their business accounts and client trust accounts.

Software tailored for lawyers trust accounts should provide for a clear distinction between business and trust transaction, as well as facilitate the easy reconciliation of the trust.

In the discussion which follows each of the Three Steps of Trust Reconciliation will be explained in detail.

General and Specific

Make sure that you understand the general concepts explained here. Bear in mind that local conditions may vary. It is important to understand that from General Concepts, we work towards Specific Application. Even if the general concept of trust accounting applies to you, your local jurisdiction may have rules which require specific conduct or reports which may be highly localized and unique.

The assumption is that the same basic concept of lawyers trust accounts, trust banking accounts and comparison of balances apply to all jurisdictions.

Make sure you understand what specific rules you need to comply with.

Regulation

Regulation refers to the rules that apply in your local jurisdiction. These may apply at national, state, provincial or local level, or even a combination of these. Regulation stipulates what conduct is acceptable and defines trust assets. Often administrative procedure and conduct and professional liability closely follow the requirements of the regulatory framework.

Compliance

Compliance entails conduct which conforms to the requirements stipulated by Regulation. Compliance entails certain administrative procedure and the production of reports which indicate that the results of conduct reflect compliance with regulation. Non-compliance indicates contravention of applicable regulation and may imply professional liability.

Enforcement

Non-compliance with Regulation typically results in Enforcement of the Regulatory requirements on the local firm to remedy non-compliance and guarantee regulatory compliance. Very often this is accompanied by serious sanctions directed at the responsible lawyer. Worse case scenario outcomes include prison terms for theft and disbarment from the legal profession.

 

Managing Client Trust Assets

Ethical exhortations not to steal clients funds are often more emotional than practical. The reality is that very few lawyers will actively engage in the theft of clients’ trust assets. Rather, lack of understanding of the regulatory framework and requirements and a failure to implement effective compliance measures, contribute over time to a situation of critical non-compliance resulting in deficits and trust reconciliation failures.

Three Step Trust Reconciliation

DynamicLTA uses easy to use and clear Three Step Trust Reconciliation reports which facilitate understanding of regulatory requirements and allows at sight confirmation of compliance with these requirements. Technology which supports your practice and provides peace of mind.

In the discussion which follows, each of the different Steps in the Trust Reconciliation process is discussed and illustrated with screen grabs from our software.

[Part 2 Follows]

–Dynamic