Once the requirements of the law firm are understood, it is very clear why a generalized accounting solution, like QuickBooks, may not be the best option for all of your accounting needs.
Law firms have unique accounting requirements. Selecting the proper accounting system for a law firm requires an understanding of those unique requirements. For example, law firms are required by the code of ethics to account for any funds held in trust on behalf of clients. This is one of many obligations legal professionals must adhere to when it comes to properly managing their chart of accounts. Once the requirements of the law firm are understood, it is very clear why a generalized accounting solution, like QuickBooks, may not be the best option for all of your accounting needs.
The requirements of a law firm accounting solution are different from most other businesses. The accounting of trust funds must satisfy all the requirements of the Safekeeping Rules. There are no other industries that have these same professional requirements. The Safekeeping Rules specify that all money received in a trust bank account and all money disbursed out of the trust account must be accounted for by client/file. The reports required to properly account for trust funds are typically not found in generalized accounting packages. Applications developed for law firms have all the required reports and the controls required to ensure all trust transactions are accounted for by client/file. Legal software will have controls to ensure money cannot be disbursed if the funds are not available for that client/file regardless of the trust bank balance. These controls ensure that the law firm will comply with the Safekeeping Rules. Using a generalized accounting package can easily create trust imbalances and non-compliance issues which can result in disbarment.
Billing and Accounting
The next account requirement for law firms relates to funds that the law practice expends on behalf of their client in support of legal services. The costs incurred are paid for out of the law firms’ operating bank account(s). Client costs need to be recorded by client/file and included in scheduled billings. If these costs are not accounted for properly and recovered, this will reduce earnings. There are many legal solutions that do not integrate accounting and billing. The lack of integration will often result in client costs being paid out of the accounting system, but not recorded in the billing system to be recovered. It’s best to work with a legal practice management platform that has embedded billing and accounting software to ensure that client costs are accounted for properly.
How client costs are reported on accounting statements represent another unique accounting requirement of law firms. One method of accounting for client costs is recording the client costs as an expense in the year incurred. This method is used if the client cost is expected to be recovered within a year. Recovered client costs will reduce the client costs incurred. For example, personal injury and contingent firms typically will recover client costs more than a year after they are incurred. Therefore the client costs are not expensed, but rather recorded as a receivable. With this method, the unbilled client costs should be able to be reconciled against the detailed client/file records of unbilled costs. Very few accounting systems give you the functionality of recording costs to clients/customers, let alone allow you to determine how those costs are classified.
Service industries are required under generally accepted accounting principles to report income at the time it is paid, not when it is billed. This method of accounting is called cash accounting. Most other businesses will recognize income once the client/customer is billed. This is considered the accrual method of accounting. Cash basis accounting is based on the movement of money. Income is recognized when received and expenses are recognized when paid. Most generalized accounting systems will report based on the accrual method of accounting, which is not conducive to properly managing your law firm’s books.
Many accountants are familiar with QuickBooks, and therefore are very quick to recommend their clients use the accounting software to manage all of their businesses’ billing and accounting needs. That does not mean it is the best solution for legal billing.
Performance and Profitability
Reports that reflect timekeeper productivity and profitability on a client/file level are unique to law firms, and some other service industries. Most legal accounting solutions will include performance reporting that the law firm can use to make better management decisions. For example, it is important for a managing partner(s) of a firm to know how timekeepers are performing. Reports that present timekeeper working, billable and collected fees can be used to evaluate staff and professionals. These numbers determine whether the timekeeper is earning enough based on the cost to the firm for that timekeeper. These reports are often used in the calculations for timekeeper and/or partner compensation. Law firms frequently will compensate timekeepers based on fees collected by the originating, working and responsible attorney. Evaluating fees collected by type of law is another important part of managing and evaluating a firm’s income. If a law firm is charging a flat or fixed fee for services rendered, it is important to know if the time spent performing the work is greater or less than the fees collected. Clients/files that are not profitable should be carefully considered in the future or fees should be adjusted to reflect the real time required to work on the case. Generalized accounting packages do not have the reporting capacity to provide any of these time tracking metrics, which makes it even more important to make sure your firm has the proper tools to track and collect this data.
Many accountants are familiar with QuickBooks, and therefore are very quick to recommend their clients use the accounting software to manage all of their businesses’ billing and accounting needs. That does not mean it is the best solution for legal billing. All legal accounting systems have the exact same accounting reports that are in QuickBooks. Accountants need to be able to confirm that all entries are recorded to the proper classification. A detailed general ledger will provide the accountant with all the necessary information to confirm whether or not the proper accounting has been done. This is a standard report in all legal accounting packages along with all financial reports. An accountant should adapt to the law firm, not the law firm adapting to the accountant.
Legal Accounting: In Conclusion
The accounting requirements for law firms are very specific and should be considered as billing and accounting solutions are selected and reviewed. Trust accounting can be accomplished, but the controls to keep everything balanced are not included in the generalized accounting software. The performance reporting for timekeepers and case profitability are rarely found in the generalized accounting packages. If there isn’t a control to ensure all costs are recorded and recovered the firm’s profits will be negatively impacted. For all these reasons, generalized accounting packages like QuickBooks Online Advanced and QuickBooks Desktop do not satisfy the accounting requirements of a law firm.
This is why a law firm should invest in legal practice management software that has all of the capabilities necessary for your firm to run smoothly and efficiently. Whether you need to keep track of billable hours, manage trust accounting, track time, or monitor cash flow into the firm, you need an accounting software that will cater to all of your needs.
Written by CARET Legal partner, Deborah J. Schaefer. Deborah is a Certified Public Accountant in Connecticut and New York, who specializes in the selection, implementation, training, and support of computer-based accounting systems for law firms. Practicing for over 35 years, she has worked with hundreds of firms across the US and internationally.