Accounting Basics for Lawyers

Aside from accounting lawyers, most legal professionals are more focused on the practice of law than they are on law firm accounting. Still, accounting for lawyers matters more than you may think. 

For lawyers and legal professionals, knowing the basics of accounting is crucial for ensuring they stay compliant with ethics rules, maintain accurate records, and set their firm up for financial success and growth—especially if their law firm doesn’t have a dedicated accounting team or bookkeeper on staff. 

But where should you start if you want to learn the basics of accounting for lawyers?

In this post, we’ll introduce the essentials of law firm accounting to help get you started. From common accounting issues to watch out for to tips many law firms find effective for financial management, read on to explore the fundamentals you should know.

Accounting for lawyers shouldn’t be such a headache—which is why we created Clio Accounting, legal accounting software designed with legal professionals in mind. Book your Clio Accounting demo today.

What is accounting for lawyers?

Accounting for lawyers refers to the range of accounting practices that lawyers and law firms take on to meet the financial, regulatory, and tax requirements that come with the practice of law and running a legal practice.

Examples of common accounting tasks for lawyers include:

• Law firm budgeting and financial forecasting
• Tracking billable hours and expenses
• Maintaining law firm financial records
• Managing client trust accounts
• Ensuring compliance with accounting standards and regulations

Why is accounting important for lawyers?

While some law firms may have dedicated accounting staff or legal accounting software to lessen the burden of accounting, that doesn’t mean that lawyers can ignore all things accounting.

No matter where you are in your legal career, it’s important to know the essentials of accounting for lawyers for several reasons, including:

• Compliance. In addition to staying compliant with tax laws, you need to know and understand your jurisdiction’s regulatory and ethical rules and guidelines related to finances and accounting. Failing to stay compliant can lead to steep professional and legal consequences.
• Effective financial management. If you want to ensure that your law firm is operating as efficiently and profitably as possible, you need to understand your law firm’s finances.
• Business growth. Similarly, having a grasp of accounting makes it easier for you to make better-informed financial decisions for your firm.

Basic accounting principles for law firms

While there’s definitely a big difference between a CPA and lawyer, taking some time to familiarize yourself with basic accounting principles will make it easier for you to understand your law firm’s accounting throughout the year. 

Here are some basic accounting principles and terms to know:

Accounting methods: accrual basis vs. cash basis accounting

Do you know whether your firm follows a cash or accrual accounting method? While this is chosen when a new law firm opens (specifically, before the firm’s first tax return is filed), it’s important to know which method your firm follows. 

Here’s a quick definition of both methods, which are the most common in the US:

• Accrual basis accounting: records revenue when it’s earned and expenses when they’re incurred.
• Cash basis accounting: records revenue and expenses when the cash is received/paid by your firm.

Bookkeeping vs. accounting

While these two terms are often used interchangeably, accounting and bookkeeping for lawyers are technically different things. Essentially, legal bookkeeping involves recording and balancing financial transactions at your firm, while accounting involves analyzing, interpreting, and summarizing that financial data.

Chart of accounts

A law firm’s chart of accounts lists all of your firm’s financial accounts to provide a framework for where to record transactions. It’s essentially your firm’s financial backbone. While your firm’s chart of accounts may differ based on factors like your firm’s size, jurisdiction, and practice area, it will typically have five core categories under which each account exists: assets, liabilities, owner’s equity, revenue, and expenses.

A law firm’s chart of accounts should also include:

• The Interest on Lawyer Trust Accounts (IOLTA) account or trust account
• A trust liabilities account

Double-entry bookkeeping

Also known as double-entry accounting, this is a method of bookkeeping that uses a two-sided accounting entry where every transaction impacts at least two accounts. 

Generally accepted accounting principles (GAAP)

The generally accepted accounting principles (GAAP) are the set of accounting rules that companies in the US must follow when compiling financial statements. Put simply, the goal of GAAP is to see to it that the financial statements of a business are:

• Complete
• Consistent
• Comparable

Note: While GAAP provides the standard financial reporting framework for US companies, it’s important to learn any specific accounting rules and regulations that apply to law firms in your jurisdiction.

General ledger

In accounting, a general ledger is the main record-keeping system for a law firm’s financial data.  A general ledger is broken down into account types, or subledgers, such as assets, liabilities, equity, expenses, and income.

Interest on Lawyers Trust Accounts (IOLTA)

An IOLTA account is a type of trust account used by lawyers to compliantly hold client funds (for example for retainers or settlement proceeds) while ensuring any interest earned goes towards funding legal aid for those who couldn’t otherwise afford a lawyer. This type of account for US law firms is designed to keep client funds separate from a law firm’s business or operating accounts. 

Essentially, an IOLTA account is used for client funds that, if they had their own account, wouldn’t generate enough interest to cover the costs of opening and maintaining that account. By pooling the money with other client funds, enough interest is generated to fund public service programs. While the specifics can vary by jurisdiction, when using an IOLTA account, any interest earned on the account is collected and forwarded to the state bar (usually to funds for social justice). 

Trust accounting

Law firm trust accounting is the practice of tracking and monitoring client funds that are given and held in trust. Funds kept in trust must be held in a separate account from a law firm’s operating funds and must be held until they are earned from a specific client’s case.

Reconciliation

In accounting, reconciliation refers to the process of comparing sets of financial records to ensure that they are correct and in agreement.

Law firms also use a process of three-way reconciliation to check that their internal trust ledgers align with client trust ledgers and trust bank account statements. This reconciliation process may be completed manually, or with legal trust accounting software. Following completion, these reports are submitted to a law firm’s jurisdiction on their specified cadence. This cadence varies by geography.

Key financial statements for lawyers

In addition to the above accounting principles, it’s also important for lawyers to familiarize themselves with key financial statements (i.e., reports summarizing detailed financial accounting information about your firm). 

The three essential law firm financial statements lawyers should know include:

1. The balance sheet, which provides an overview of where your firm stands financially at a certain point in time. The balance sheet should include a snapshot of the firm’s assets, liabilities, and owner/shareholder equity. An easy equation to remember this financial report is:

Assets = Liabilities + Equity

In simple terms, we can also look at this equation as:

What You Own (Assets) = What You Owe (Liabilities) + The Value of Your Company (Equity)

2. The income statement, which indicates how profitable your firm was during a specific period (such as a month, quarter, or year). Sometimes known as a “profit and loss statement,” the income statement should summarize the firm’s performance in terms of revenues, expenses, gains, and losses for the period. An easy equation to remember this financial report is:

Income = Revenue – Expenses

3. The cash flow statement tracks how much cash entered—and how much cash left—your firm over a specific period.

By understanding these financial statements, which are a necessary component of preparing your firm’s year-end financials, you will gain a better understanding of your firm’s overall financial situation—which can help you make decisions to maximize your firm’s future financial performance.

Common accounting issues for law firms

Proper accounting is crucial for law firms that want to stay compliant and grow as a business, but it can also be complex. The following are just a few of the more common accounting challenges that law firms can watch out for:

Managing trust accounts and client funds

As previously noted, trust accounting is the process of law firms tracking and monitoring client funds that have been held in trust. 

It’s absolutely crucial that trust accounts be managed correctly, as trust accounting errors (such as commingling funds, even accidentally, or forgetting to keep accurate records) can lead to severe consequences ranging from penalties to losing your law license.

To help avoid trust accounting errors, there are several best practices you can follow, including:

• Learning and abiding by the specific rules for your jurisdiction
• Having a separate trust account, and using that account only for unearned funds
• Maintaining detailed records at both an account and client level
• Use trust accounting-specific software (like Clio Manage’s trust account management features alongside a tool like QuickBooks Online’s trust accounting features through the integration with Clio Manage), which helps to streamline trust accounting workflows and reduce the risk of error

Tracking billable hours and expenses accurately 

Properly tracking billable hours and expenses is necessary for law firms to accurately record law firm revenue, issue correct invoices, and maintain financial records. Errors in tracking can lead to client disputes, lengthy collections processes, and lost revenue. Plus, falling behind on tracking expenses can impact the earning potential of a law firm when you consider how some jurisdictions calculate the payout after expenses or liens have been deducted. 

Here too, technology can help. Clio’s legal timekeeping and expense tracking software, for example, lets lawyers record hours in real-time.

Tax considerations for law firms 

Law firms must comply with all applicable tax regulations for their jurisdiction—such as income tax and payroll tax. 

While it’s up to law firms and their tax accountants to ensure that they comply with tax laws, failing to keep accurate accounting records can make this more difficult, and can lead to accidental tax filing errors. These errors can have serious consequences for law firms, ranging from penalties to legal ramifications.

For lawyers and law firms, it’s a good idea to keep meticulous records and work with tax accountants to ensure that they meet all tax regulations (as well as that they make any allowed tax deductions).

Effective financial management for law firms 

Law firm accounting can unlock opportunities for business growth and financial success when you put your law firm’s financial data to good use. How? Effective law firm accounting allows you to collect and analyze accurate information about your law firm’s financials—which can, in turn, provide a full financial picture and empower your firm to make data-driven business decisions.

With this in mind, consider the following tips for effective financial management for law firms:

Stay on top of budgeting and forecasting for law firms 

A law firm budget is crucial for effective law firm financial management. After all, even with accurate accounting records, you need a budget to help you track and measure how much your firm spends on expenses. Similarly, forecasting future law firm revenues makes it easier to plan and track law firm cash flow and find cost-saving opportunities. 

Use financial reporting and analysis

Bookkeeping for lawyers allows law firms to collect key financial data, but much of the value of that data comes from how you analyze and use it. Creating and analyzing financial reports allows you to see where revenue is coming into your firm (and where it’s leaving), which can help you to identify opportunities for law firm growth or areas where you may want to reduce overhead.

Utilize accounting software for streamlined processes

Accurate law firm accounting is a key tenet of successful financial management, however, traditionally, law firm accounting has often been a headache for legal professionals who struggle to manage the time-consuming manual data entry and potential for input error. 

Fortunately, technology can assist. One of the easiest ways to make accounting for lawyers quicker, simpler, and more accurate is to use accounting software built for law firms. This can be legal accounting solutions, or it can be integrations between legal practice management solutions and best-in-class accounting tools.

As we outline in more detail in our guide to legal accounting software for lawyers, modern accounting software for law firms helps with legal-specific accounting and financial management by:

• Streamlining accounting and bookkeeping workflows
• Making it easier to stay compliant with ethics rules and regulations
• Helping to keep sensitive client information safe
• Making it simpler to monitor law firm cash flow

Compliance and ethics in legal accounting

When it comes to financial recordkeeping and legal accounting, it’s your firm’s responsibility to stay compliant with all ethics regulations and rules that apply to your practice. 

While ethical considerations and rules vary by jurisdiction (so be sure to do your own research and check with your state bar to ensure that you’re compliant with what applies to you), consider the following as a starting point:

Know your jurisdictions’s trust account compliance rules

Trust accounts must be treated carefully, and lawyers must ensure that they adhere to the regulations for their jurisdiction to stay compliant and avoid negative consequences.

Check your local rules of professional conduct

While we always advise referring to your specific state’s rules, the ABA’s Model Rules of Professional Conduct can offer direction for law firm accounting. Rule 1.15, for instance, provides details on a lawyer’s responsibilities when it comes to holding client funds in trust, keeping records of such account funds, and when lawyers should notify clients of the receipt of funds or property.

Avoid common accounting errors and fraud 

By taking steps to create and follow proper legal accounting procedures at your firm (like meticulous recordkeeping, proper reporting, and following the accounting standards and regulatory requirements that apply to your firm), working with accounting professionals, and using secure legal-specific accounting solutions, you can help mitigate the risk of common accounting errors. 

However, mistakes can still happen—especially if you aren’t aware of them. With this in mind, watch out for common legal accounting mistakes like:

• Commingling or mismanaging trust funds. While we’ve mentioned this before, it’s worth mentioning again: Be careful to never, ever commingle operating funds with client trust funds. Clio Manage’s trust account management features can make this easier to manage—allowing you to set up separate ledgers for trust and operating accounts, run built-in legal trust account reports, and reconcile directly in Clio. To see how it works, you can book a demo of Clio.
• Inaccurate tracking. From billable hours to expenses, it’s crucial that time and expense tracking be accurate.
• Data entry mistakes. Errors made when inputting data manually can create duplicate entries, mismatched financial records, and other accounting complications.

Maintaining confidentiality and client trust

In order to maintain client trust and meet your ethical obligations as a lawyer, you must maintain confidentiality and keep sensitive client data—including when working with client information as part of your law firm accounting. This means taking steps to ensure data security (using legal accounting software that maintains robust security standards can help with this).

Law firm accounting can help maximize profitability and growth

Lawyers may not be accountants, but law firms are businesses. This means that, in addition to using legal accounting to stay compliant, legal professionals can use proper law firm accounting to help maximize profitability and growth. 

When done correctly and consistently, legal accounting can help law firms better manage expenses and costs and identify opportunities for increasing revenue. Proper accounting records can also help lawyers make informed, data-driven decisions for their firms and can aid in financial planning for greater long-term success.

Clio Accounting allows law firms to manage their finances in one system of record, quickly generate financial reports, conduct three-way reconciliation, and effortlessly track their firm’s cash flow. Book a demo today and see how Clio Accounting can turn the headache of accounting into a powerful growth tool for your firm:

Book a Clio Accounting Demo

Disclaimer: This article applies to practices in the US. It is provided for informational purposes only, and does not constitute legal, business, or accounting advice.