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Eight Trust Accounting Challenges for Canadian Lawyers using QuickBooksTM Online

In any industry proper bookkeeping is essential, but accounting for Canadian lawyers goes beyond best practices – it’s necessary to ensure compliance. Lawyers can run into challenges when using accounting solutions like QuickBooksTM Online, but there is a solution to ensure all requirements, rules, and regulations are being met.

Law Societies oversee the more than 100,000 lawyers in Canada and have set forth regulations for law firms designed to protect the public with a strong focus on trust account records. Each province or territory’s Law Society has their own set of Trust Compliance requirements, which makes it essential to check with your governing Law Society to make sure you’re following all locally mandated best practices.

These compliance requirements are extensive, as shown by the Law Society of Ontario’s publication of By-Law 9 – Financial Transactions and Records and The Bookkeeping Guide for Lawyers. The basic principles of trust accounting in Ontario are similar to other provinces and their respective regulations, making the guide a good starting point to view the general trust accounting compliance requirements of Law Societies. The Trust Accounting Handbook produced by the Law Society British Columbia shows similar lengthy regulations along with sample trust accounting checklists and required internal controls developed by Law Societies.

The strict requirements surrounding trust accounts can be time-consuming and prone to human error when handled manually, so for years, most law firms relied on desktop programs designed specifically for the legal industry such as PCLaw® or ESILaw®. With the introduction of cloud computing and countless added benefits like mobility, reduced IT costs, business continuity, and automatic updates, law firms have been transitioning to more modern practice management programs in recent years.

Modern practice management programs provide a wealth of benefits for law firms, offering a way for lawyers to be more efficient and organized. Pulling many practice-related tasks into one system, it becomes easier to track case matters, provide updates to clients, and is instrumental in making sure no part of the case falls through the cracks. A quality program helps firms become more productive in areas such as:

  • Conflict checking
  • Case management
  • Time & billing
  • Calendaring and docketing management
  • Tracking documents, notes, and tasks
  • 24/7 anytime, anywhere access

Early cloud practice management systems like Clio®, however, have one missing piece: the lack of a built-in accounting program designed for law firms. Instead, law firms become dependant on separate general business accounting programs like QuickBooksTM, QuickBooksTM Online or XeroTM. These business accounting programs are robust, stable products known for their vast support network of bookkeepers and accountants. They are also attractive to many businesses because they are compatible with nearly every market at a reasonable price point and scale easily.

However, meeting the specific needs of law firms can present a challenge when using programs like QuickBooks Online. Because such accounting programs are created for general purposes, law firms can run into difficulties when trying to meet trust accounting compliance requirements, handling legal-specific accounting, and integrating with separate practice management systems. As an example, trust accounting tends to be one of the harder areas to manage in QuickBooks Online; often organized  by developing workarounds in the system to meet compliance requirements, which can present a problem when it comes to reporting given the ramifications of improper bookkeeping of trust accounts as governed by law societies.

Trust Accounting Basics

Trust accounts serve as a way to protect clients’ money while ensuring the funds are kept separate from any other account of the law firm. Keeping the amounts separate helps eliminates any appearance of impropriety, reduces the risk of embezzlement or theft and makes it easier to track the exact amount in each client account. The funds in these accounts remain the clients’ and are never considered as truly belonging to the lawyer or law firm.

The following are the types of funds to be included in trust accounts:

  • Settlement/judgment funds
  • Unearned income (such as cost advances and retainers)
  • Third-party funds (such as probate matters)

Money that should never go into a trust account includes:

  • Reimbursement for expenses made on a client’s behalf
  • Payment for legal services after a bill is sent to a client
  • Law firm or lawyer funds

In addition to making sure there is no commingling of the law firm or lawyer’s funds with the client funds, accurate record keeping is also mandatory. Within trust accounting, the math required to maintain clean books is no more complicated than simply adding and subtracting. The problems arise in leaving a clear audit trail, such as remembering to log each transaction in the correct matter location with proper documentation like a deposit slip or copy.

Within law firms, the most common type of trust fund account is a mixed or pooled account, where the funds from multiple clients are placed into one account. In this type of trust fund account, maintaining compliance can become even more complex. Using a program to track each account’s balance, money in and out and overall transactions makes the likelihood of an error leading to non-compliance considerably lower. To learn more about specific trust accounting requirements, you can check out these video resources:

Oversight by Law Societies

The fiduciary responsibilities of lawyers managing trust accounts are overseen by Law Societies, each with their own particular set of requirements when it comes to proper recordkeeping. Each of the fourteen law societies of Canada requires the keeping of specific records, and the submission of a trust report completed annually to ensure law firms are properly maintaining their trust accounts.

Each Law Society also requires monthly reconciliations of trust accounts. Mistakes can happen, and reconciliations are a way to ensure they are caught and corrected if need be. Monthly reconciliations are critical for making sure client trust account ledgers are error-free and bookkeeping is completed in accordance with Law Society requirements.

The Law Societies also perform audits of law firms with regular frequency. A Law Society regulatory team and its inspectors conduct these audits by looking for a clear trail of what has happened to client funds from the moment they were received. In the event of an audit, lawyers are expected to be able to produce all documents necessary to track client funds over a given period.

Many disciplinary cases resulting from these audits are not for misappropriations such as taking client funds for personal use but rather are related to poor recordkeeping and improper compliance practices. The Law Society has stated not knowing a particular rule doesn’t excuse not being compliant and will sanction lawyers whether or not the violation was intentional. It’s important to be knowledgeable and choose the proper tools to avoid being in such a situation.

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8 Challenges of Trust Accounting with QuickBooks Online

QuickBooks Online is well-known for helping businesses with their general office accounting needs. However, QuickBooks Online (QBO) for law firms is another story — the unique bookkeeping and report requirements making it a challenge to stay compliant.

Because QBO was not created with law firms in mind, there are many challenges lawyers run into when using QBO for their law firm bookkeeping. It is important for law firms to be aware of these potential challenges prior to deploying QuickBooks Online so appropriate controls can be established.

#1 Tracking trust funds to client matters
One of the most important and fundamental pieces of trust fund accounting is tracking of every cent by client matter. Every client’s trust account should have its own ledger with the ability to know what funds have been received and disbursed. While funds can be tracked by client matter using the trust bank account, a matching liability trust account and including the client matter on the transaction, QuickBooks Online allows trust transaction entries without enforcing these required pieces. Below image depicts the basic fundamental characteristics of a pooled Trust Account bookkeeping which must be maintained at all times:

If transactions are entered without identification of a matter, it makes it nearly impossible to track funds and have an accurate client ledger. This lack of automatic controls can also lead to issues with the Law Society, as funds technically belong to the client and not the lawyer and should able to be dispensed back to a client at any given point in time.

#2 Overdrafts

Another basic tenet of trust accounting is to never overdraft a client account. QuickBooks Online has no mechanism in place to prevent overdraft of the individual client ledgers, leaving lawyers at risk. Using one client’s fund to pay for another client matter without proper cause and documentation, even if done unintentionally, is considered to be stealing from a client by the Law Society. Having a built-in safeguard ensures not just lawyers but the entire law firm staff are protected from a common trust mistake.

Because all the funds are pooled into one account, it could be possible to overdraft one client account and pull funds from another to cover the difference. The overall balance of the primary account isn’t the main concern, but rather the balance of each client matter.

#3 Trust funds as a liability

While normal fund transactions are routinely assigned to a chart of accounts as an income or office expenses by QuickBooks Online, trust fund transactions must only impact trust liability accounts. The money doesn’t actually belong to the firm itself but rather to the clients. QuickBooks Online does not have a built-in mechanism to enforce this requirement. Assigning trust funds to the wrong category leads to inaccurate books.

#4 Trust balance on invoice

Clients want to know the balance of their trust fund as it belongs to them. Invoices generated from QuickBooks Online do not show these individual balances. To keep a client up to date on trust account activity constructing a separate report must be done manually rather than the software calculating out the proper balance.

Separate reports make it difficult to do quick monitoring of client accounts, should you need to make sure there are funds for a particular transaction. Running reports where client funds that have a zero balance have been removed is also problematic, which can lead to an exceptionally long report full of unnecessary information.

#5 Trust to general transfer

When firm issued bills are to paid from trust funds, trust funds becomes earned income. There is no easy way to do this very specific type of legal accounting in QuickBooks Online, which requires transferring from the trust account to the general account while simultaneously updating the accounts receivable balance and client trust ledger balance. Forgetting one piece of this multi-step process means incorrect books which can be difficult to correct later on.

#6 Final reconciliation reports

Trust accounts require three-way reconciliation reports to ensure bookkeeping of client trust account balances are correct as compared with bank statements. In a three-way reconciliation, the book balance, individual client ledger balances and the bank balances must all equal, while accounting for uncleared funds (e.g., funds recorded in the books but not cleared at the bank). If the sums are different, it’s a sign a mistake occurred, and the books must be checked to find the error. As QuickBooks Online is not a legal-specific program, performing a three-way reconciliation or getting requisite reports will not be straightforward and will likely require the generation of many reports.

Additionally, with QBO the final reconciliation reports do not include any changes to the transaction after the reconciliation. To include a change, the reconciliation must be undone and repeated. If this process is not handled correctly, it could be a significant issue at the time of audit given the importance Law Societies place on these reports.

#7 Locking of books

Best practices suggest the automatic locking of book and bank statements once they have been reconciled to prevent any accidental edits in reconciled months. Without being able to do so in QBO, there is the possibility of unintentional changes leading to inaccurate books.

#8 Standard trust reports

In Canada each law society requires particular trust reports in a predefined format at the time of an audit. There are quite a few reports required including:

  • Client Trust Listing: summary of funds available for each client and/or matter if there are multiple matters for a client that comprise the total bank balance
  • Client Trust Ledger: detail of what funds have gone in and come out for a specific matter
  • Trust Transfer Ledger: tracking of funds transferred from one trust fund to another
  • Trust Receipt Journals: deposits and documentation for what trust funds have come in
  • Trust Journal: all bank activity going in and out of the trust account
  • Trust Disbursements Journal: money that has come out of the trust and tracking documentation, such as check stubs
  • Trust-Client Reconciliation: matching of client trust listings with your bank balance and bank journal from the accounting system

QuickBooks Online is designed for general business accounting purposes and not for meeting law society guidelines, which makes creating these reports extremely cumbersome. A common workflow in QBO is to produce general reports and then do manual editing/reformatting to comply with these guidelines. This is a time-consuming and error-prone process.

The Trust Accounting Compliance Solution

The limitations of general accounting programs not meant for law firms has a simple solution: use a program built specifically for lawyers and trust accounting. With the extensive requirements of tracking client accounts, various ledgers, transactions, and balances, law firm-specific software is the best way to effectively keep precise records and protect your firm in the event of an audit. Having a program which integrates both practice management and bookkeeping means knowing the records in your system are accurate and compliant.

Cloud-based, legal-specific software allows lawyers to:

  • Easily generate reports required for compliance, such as three-way reconciliation reports
  • Track transactions and funds to specific client matters
  • Automatically prevent overdrafts and unintentional editing of reconciled books
  • Create reports by both client matter and client with balances

The consequences associated with inaccurate books are too high to risk the possibility of non-compliance. Failing an audit by the Law Society for issues in dealing with client financials can lead to ethics violations, sanctions, and other penalties. Accurate law firm bookkeeping and its complexities requires the right tool and legal-specific accounting to ensure compliance and peace of mind.

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“Canadian Lawyer’s Trust Accounting Challenges with QuickBooks Online”