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