Law firms have a legal and financial responsibility to ensure they remain in compliance with the law by properly maintaining their client funds and financial records. Part of this responsibility is conducting a mid-year legal audit to verify their compliance with the law and to ensure the financial health of their law firms.
Doing a “mid-year” audit is essential for the success of your law firm. It will allow your law firm to improve its financial planning and conduct early tax planning to maximize its tax-saving opportunities.
Audit Client Trust Accounts
Law firms use client trust accounts to hold client funds for each of their cases securely. Client trust accounts help a law firm keep client funds separate from the firm’s funds. That way, the law firm can avoid any confusion, miscalculations, or accidental spending of a client’s funds.
When conducting a mid-year legal audit for your law firm, you must confirm that you have properly managed your client’s funds and that you have all the necessary financial documentation associated with those funds. The proper handling of client funds is essential for upholding the integrity of your law firm and earning the trust of your client.
Here are some helpful tips on how to audit client trust accounts accurately and thoroughly:
1) Audit and Reconcile Your Client Trust Accounts
Law firms must reconcile their trust accounts mid-year to ensure the financial details remain accurate and consistent. Account reconciliation, of course, means comparing the law firms’ client ledgers (collection of financial records) to the bank statements of the trust accounts to see if the details match. That way, you can have peace of mind knowing that the information in the ledger is accurate and consistent in case of a tax audit.
Law firms should always reconcile their client trust accounts before the end of the year, but it is better to make reconciliations more frequent throughout the year. After all, the more frequently you reconcile accounts, the earlier you will catch potential inconsistencies in the financial data before they cause a severe problem for your law firm or clients.
Some states require law firms to reconcile trust accounts every year or month. In California, for example, the law requires attorneys to reconcile trust accounts every month by balancing the client ledgers against the client trust account balances. The reconciliation process can be a lot of work for law firms with limited staff to perform manually, which is why an increasing number of firms are using trust accounting software to make it easier to maintain accurate trust account balances.
2) Assess Billing Practices
A big part of the auditing process is to assess your law firm’s billing practices by evaluating the accuracy and timeliness of billing and collections.
As you know, law firms bill their clients for the money they owe them, usually with an invoice sent to their mailing address or email address. While some clients pay their bills on time without any issues, other clients may not pay their bills on time or at all.
If you send an invoice to a client but it has not been paid for several months, the chances are that it probably will not get paid fully or at all unless you take additional steps to collect on that debt. The goal is to recover all the owed funds from clients before the end of the year because it will look much better on your law firm’s financial statements when going into the new year.
Here are some tips on how to assess and improve your law firm’s billing practices:
Review your law firm’s billing policies and ensure your clients understand them. Focus on:
Acceptable payment methods
How the bills are sent
When the bills are sent
When the bills are due
What happens if the bills are unpaid
Generate an accounts receivable report to see all paid and unpaid invoices.
Streamline your invoicing with automated billing software to automatically bill clients without having to remember to do it manually.
Conduct monthly reconciliations of the trust accounts and client ledgers.
Hire an independent law firm accounting practice to maintain and review all financial records for accounts receivable and payable.
Prepare billing reports that show outstanding debts that need to be collected.
The law firm accounting practice can also assist with the collections process to sustain the financial health of your law firm.
3) Verify Regulatory Compliance
The overall purpose of mid-year legal audits for law firms is to verify regulatory compliance to ensure adherence to all legal and ethical standards. Law firms should comply with all federal and state laws to maintain their licenses as legitimate law practices.
Law firms must comply with the following regulations:
The American Bar Association guidelines pertain to professional conduct, client communication, and conflict of interest. Law firms are obligated to protect clients' information, serve their best legal interests, and resolve breaches of client data quickly and professionally.
All federal anti-money laundering laws forbid concealing the source of money transferred from one account to another. That is the reason why your client ledgers and trust account statements must be accurate and consistent.
All the rules of your state bar, such as the California Rules of Professional Conduct, if your law firm is based in California.
Failure to comply with ethical and legal regulatory requirements could lead to severe penalties, including monetary fines and the possible suspension of your law license. Therefore, it is critically important to verify your law firm’s regulatory compliance every mid-year so that you can resolve any regulatory issues before they cause legal problems for your law firm.
4) Hire Specialized Law Firm Accountants
Smaller law firms do not have the staffing power to focus on their accounting accuracy and consistency every day. Even with powerful accounting software, you will still need an accounting professional who knows how to use it effectively. That’s why it is more beneficial for your law firm to hire specialized law firm accountants whose expertise is managing the accounting activities of law firms.
Regularly updating your financial records and providing accurate information to your accountant is crucial for compliance and effective planning. As long as you can do that, your accountants can do the rest to ensure your law firm remains compliant with all regulatory requirements and sustains its financial health and stability.
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