Bookkeeping for Law Firms: Trust Accounts & Compliance

Why Law Firm Bookkeeping Is Uniquely Complex

Law firms operate under a level of financial scrutiny that most businesses never face. The reason is trust money. When clients pay money to their lawyer for costs, settlements, or disbursements, that money is held in trust and is subject to strict regulations.

Getting trust account bookkeeping wrong does not just cause financial problems - it can result in professional disciplinary action, fines, or loss of your practising certificate. The stakes are high, and the bookkeeping must be impeccable.

Trust Accounts vs Office Accounts

Every law firm needs to understand the fundamental distinction between trust and office accounts.

Trust Account

The trust account holds money that belongs to clients, not the firm. Common trust money includes:

• Retainers or deposits paid by clients before work is done
• Settlement funds
• Money held for payment of disbursements (filing fees, barrister fees, expert reports)
• Funds from property settlements

Trust money is not the firm's money. It cannot be used to pay the firm's expenses, wages, or bills. Every jurisdiction has specific legislation governing trust accounts (e.g., the Legal Profession Uniform Law in NSW and Victoria, or the Legal Profession Act in Queensland).

Office Account

The office account holds the firm's own money - fees earned, payments for the firm's expenses, and the firm's profit. This is where normal business bookkeeping applies.

Trust Account Management

Record Every Transaction

Every deposit into and withdrawal from the trust account must be recorded with:

• The date
• The amount
• The client the money relates to
• The purpose of the transaction
• A unique receipt or cheque number

Maintain Individual Client Ledgers

Within the trust account, you must maintain a separate ledger for each client (or matter). This shows the balance held for each client at any time. The sum of all individual client ledgers must equal the total trust account bank balance.

Monthly Trust Reconciliation

Perform a trust account reconciliation at least monthly. This involves:

1. Reconciling the trust account bank statement to your trust account records
2. Verifying that the total of individual client ledger balances equals the reconciled bank balance
3. Investigating and resolving any discrepancies immediately

In most jurisdictions, these reconciliations must be retained for a specified period (usually seven years) and may be audited.

Trust Account Audit

Most jurisdictions require an external audit of trust accounts annually. The auditor (who must be approved by the relevant legal services commissioner or law society) verifies that:

• Trust money has been handled correctly
• Reconciliations have been performed
• No trust money has been misappropriated
• Record-keeping complies with legislative requirements

Time Billing and Revenue Recognition

Most law firms bill based on time spent on client matters. Accurate time recording is essential for both revenue and client trust.

Recording Time

Every lawyer and paralegal should record their time daily. Each time entry needs:

• The date
• The client and matter
• A description of the work done
• The time spent (in units - typically six-minute increments)
• The applicable rate

Work in Progress (WIP)

Time recorded but not yet billed is called work in progress. WIP is an asset on your balance sheet - it represents revenue you have earned but not yet invoiced.

Monitor WIP closely. Aged WIP (time that has been sitting unbilled for months) is a warning sign. The longer time sits unbilled, the harder it is to collect.

Revenue Recognition

Revenue is recognised when you issue a tax invoice (bill) to the client. At that point, WIP is converted to accounts receivable. When the client pays, accounts receivable is reduced.

If you receive payment from trust, the transaction involves:

1. Issuing a tax invoice to the client
2. Transferring funds from the trust account to the office account
3. Recording the receipt in the office account as payment against the invoice

Disbursements

Disbursements are costs incurred on behalf of clients. They can be:

Hard disbursements - Actual costs paid to third parties (court fees, search fees, barrister fees). These are typically GST-free when passed through to the client.

Soft disbursements - Internal charges for things like photocopying, postage, or travel. These may attract GST.

Track disbursements per matter and ensure they are billed to clients. Unbilled disbursements are money you are owed.

GST for Legal Services

Legal services are subject to GST. Key points:

• All legal fees are GST-inclusive (if the firm is registered for GST)
• Hard disbursements that are an exact reimbursement of a third-party cost may be GST-free
• Interest earned on the trust account is generally not subject to GST but has specific reporting requirements
• Trust distributions and settlements may or may not involve GST depending on the nature of the transaction

Common Law Firm Bookkeeping Mistakes

Mixing trust and office money - This is the cardinal sin of law firm bookkeeping. Never, under any circumstances, use trust money for office purposes.

Failing to reconcile trust monthly - Monthly reconciliation is a legal requirement in most jurisdictions. Falling behind puts your practising certificate at risk.

Poor WIP management - Letting time entries age without billing reduces your cash flow and makes collection harder.

Not tracking disbursements - Disbursements paid but not rebilled to clients are a direct cost to the firm.

Inadequate record retention - Trust records must be kept for a minimum period (typically seven years). Digital records should be backed up securely.

Technology for Law Firm Bookkeeping

Practice management software - LEAP, Smokeball, Actionstep, or similar. These platforms handle time recording, billing, matter management, and trust accounting in a single system.

Accounting software - Xero or QuickBooks for office account bookkeeping. Many practice management systems integrate directly with these platforms.

Automated categorisation - SortBooks can handle the categorisation of office account transactions, freeing up time that would otherwise be spent on manual data entry.

Document management - Ensure all financial records, invoices, and receipts are stored securely and accessibly.

Setting Up Your Law Firm's Books

1. Separate trust and office accounts completely - Different bank accounts, different ledgers, different reconciliation processes
2. Choose practice management software that handles trust accounting and integrates with your accounting platform
3. Set up individual client matter ledgers in your trust accounting system
4. Implement daily time recording discipline across the firm
5. Reconcile trust monthly without exception
6. Bill WIP regularly - monthly billing is ideal
7. Review financial performance monthly - revenue, WIP, debtors, and trust balances

Law firm bookkeeping demands precision and discipline. The trust account rules are non-negotiable, and the consequences of getting them wrong are severe. But with the right systems and habits, it is entirely manageable.