A small law firm has the same bookkeeping as any professional practice, rent, payroll, software, and marketing, plus one thing almost no other business has: money in its bank account that belongs to someone else and that it is professionally obligated to account for to the cent.
That is the client trust account. How it must be handled is governed by the rules of professional conduct in your state, and those rules vary, so the details below are general and your state bar's trust accounting guidance is the final word. The bookkeeping principles underneath them are consistent everywhere.
Two kinds of money: trust and operating
Client funds, such as advance fee deposits, settlement proceeds, and money held for a transaction, go into a trust account, often an IOLTA account for nominal or short-term balances. Firm money goes into the operating account. The two are never mixed. Firm expenses are not paid from trust, firm money is not kept in trust beyond any small amount your rules allow to cover bank charges, and client money is not deposited into operating.
In the books, the trust bank account is an asset, matched by a liability of the same amount: funds held for clients. Money in trust is not revenue and does not belong on the P&L. A firm that records retainer deposits as income is overstating its revenue and blurring exactly the line the rules require it to keep.
Beneath that single liability sits a ledger for each client showing every deposit, disbursement, and transfer on their matter. No client ledger should ever go negative, because a negative balance means one client's money was used on another client's matter.
When a retainer becomes income
An advance fee deposit stays in trust until it is earned. When you bill time against it, and after giving the client whatever notice your rules require, the earned amount is transferred from trust to operating. That transfer is when it becomes firm revenue: the client's ledger goes down, the trust liability goes down, and income is recorded on the operating side.
Transfer earned fees promptly rather than letting them accumulate, since leaving the firm's earned money in trust is its own form of commingling. And make each transfer traceable to a specific invoice, so any withdrawal from trust can be tied to work the client was billed for.
Card payments deserve attention. If clients pay retainers by credit card into trust, processing fees generally should not come out of the trust account, because that takes the fee out of client money. Many firms set up processing so fees are charged to the operating account instead.
Advanced client costs and the three-way reconciliation
Filing fees, court reporters, expert fees, and records requests paid on a client's behalf should be tracked by client and matter, whether or not the client will reimburse them. In contingency matters especially, those costs can be large and outstanding for years. How they are treated for tax purposes depends on the fee arrangement and is a question for your CPA, but the bookkeeping requirement is simple: know, at any moment, what has been advanced on every open matter.
The trust account itself is reconciled three ways, and many states require it on a set schedule. The bank statement balance, the trust account balance in your books, and the total of all individual client ledgers must agree. When the bank and the books match but the client ledgers do not add up, money has been posted to the wrong client, which is exactly the error a three-way reconciliation exists to catch.
Keeping the firm's own books current
Trust accounting compliance remains the attorney's responsibility, and practice management software usually holds the client ledgers. What a firm also needs is operating books that are closed every month, so the partners know what the practice actually earned, what it spent, and what it has advanced on clients' behalf.
Evolv Bookkeeping is $199 per month flat. Every account reconciled to its statement, transactions categorized against a chart of accounts set up for how a firm actually runs, and your P&L and Balance Sheet closed and delivered by day 2 of the following month, with 1099 prep at year end for the contract attorneys, investigators, and other vendors you paid.
If the operating books have fallen behind, catching up a backlog is $199 for each month behind, done within 2 days and guaranteed in writing. No contracts, cancel anytime, and you can get an instant quote on our homepage.