Keeping it Balanced: Lawyer’s Guide to Accounting Dec 20, 2023
As a lawyer, your focus naturally gravitates towards legal matters. Although having an understanding of accounting holds some importance, whether you work for a big firm or are a sole practitioner – You may need to handle the finances or client accounts and track the expenses incurred during your day-to-day work.
In this blog, we will break down different aspects of accounting that might be relevant to your practice.
How is Legal Accounting different from other Accounting?
Billing processes in law firms are distinct and heavily compliance-driven compared to general business accounting practices. Law firms must navigate a unique landscape where managing finances is intricately tied to legal principles and stringent regulatory requirements.
One fundamental requirement is the establishment and management of a trust account. Legal professionals need to be well-versed in the necessity of maintaining this account, ensuring prompt issuance of trust receipts to clients, strict adherence to regulations governing money movement in and out of the trust account, monthly reconciliations conducted within specific timelines, and annual audits at designated periods. This creates a highly compliance-driven regime within accounting practices specific to law firms.
Additionally, managing an office or transaction account alongside the trust account adds another layer of complexity. On one side, you must raise your accounts receivable invoices for your client on your Practice management systems like LEAP or SmokeBall, as per the costs agreement and the requirements of the Law Society in your state. On the other hand, you also have to maintain your own book in the Accounting Software like XERO, MYOB or something else. In some cases, the integration between the practice management systems and accounting systems is often on a cash basis, and you cannot see the debtor’s invoices if you integrate the two. So there is a level of double entry, in a lot of the accounting practices.
Moreover, the month-end billing process also has its own complexities. Draft bills undergo partner review, potentially involving write-offs or additions before final bills are issued. This bespoke billing complexity is intrinsic to law firms, intertwining compliance and process-driven methodologies. Managing these intricacies requires specialised expertise to navigate the compliance-driven, process-oriented accounting landscape unique to the legal profession.
What are the Important Factors of Accounting for Law Firms and Lawyers?
1. Understanding the Basics of Generally Accepted Accounting Principles (GAAP)
Understanding the fundamentals of Generally Accepted Accounting Principles (GAAP) can significantly benefit law firms in ensuring proper financial accounting and preparation of financial statements. GAAP, established by the Financial Accounting Standards Board (FASB), serves as a set of common rules, standards, and procedures that guide the creation of comprehensive and comparable financial statements across various companies, including law firms.
While delving into the intricate details of GAAP might not be necessary for lawyers, having a basic understanding can foster more effective collaboration with accountants. This collaboration can improve the overall efficiency and accuracy of financial documentation. For instance, understanding how to track and provide specific information to accountants could streamline the preparation and completion of financial documents.
In the context of law firms, accountants play a crucial role in ensuring that all accounting details are meticulously handled and comply with GAAP standards when preparing documents for the firm, the IRS, and other mandated entities. While this responsibility primarily falls on the accountant, collaborating with them to facilitate smoother processes can strengthen the business relationship and enhance overall efficiency. By working together to navigate the complexities of GAAP, lawyers and accountants can ensure compliance and accuracy in financial reporting, ultimately benefiting the law firm and its stakeholders.
2. Familiarising with the Accounting Method of your Practice
Understanding your law firm’s accounting method can help you comprehensive financial management. There isn’t a one-size-fits-all approach in accounting, and different methods hold varying implications for your firm’s financial picture.
Firstly, there’s cash-based accounting, a straightforward method where revenue is recorded upon receipt rather than when services are provided. This method offers a clear view of cash flow and delays tax payment until income is in your account.
Alternatively, accrual basis accounting records income when billed, regardless of payment receipt timing. While it provides a clearer month-to-month performance snapshot and aids in budgeting and forecasting, it prompts tax obligations upon billing, not cash receipt.
For those seeking a middle ground, the modified cash basis, also known as a hybrid model, combines cash and accrual methods. It utilises cash basis accounting for day-to-day records while incorporating accrual for long-term expenses, maintaining a balance between real-time cash tracking and a clearer financial overview.
Determining the right accounting method for your law firm hinges on various factors and specific accounting needs rather than a one-size-fits-all solution. While some officials might mandate the adoption of the accrual method for larger firms exceeding $10 million in annual revenue, the decision for others depends on several considerations.
3. Understand the Financial Statements
Whether the goal is to grasp financial performance and valuation intricacies or to reduce dependence on external professionals like CPAs and bookkeepers for financial insights – understanding the financial statements is one of the first steps that can help you understand the financial landscape of the firm.
They give you vital insights into the firm’s financial performance, liquidity, and overall health. Based on those insights, you can make informed decisions, take proactive measures to address financial challenges and capitalise on opportunities for growth. Here’s a breakdown of these statements:
- Income Statement: This report tracks a law firm’s performance over a specific period, showcasing total revenue, expenses, and net income. Total revenue sits at the top, followed by expenses deducted from revenue, culminating in net income at the bottom. It’s a snapshot of the firm’s profitability within the defined period.
- Balance Sheet: Displaying a snapshot of the firm’s financial position at a specific moment, the balance sheet delineates assets (both tangible and intangible), liabilities (such as accounts payable, rent, or mortgages), and owner/shareholder equity (assets minus liabilities). It provides a holistic view of the firm’s resources and obligations.
- Cash Flow Statement: This statement outlines how money flows into and out of the firm within a set period, typically a month. It tracks cash inflows and outflows, categorising activities into operating, investing, and financing activities. It’s instrumental in monitoring liquidity and assessing the firm’s ability to meet short-term obligations.
What kind of records should be documented?
Managing your law firm’s records isn’t just about bookkeeping—it’s your ticket to financial clarity and IRS compliance! Keep your receipts, statements, invoices, and past tax returns neatly organised. Think of it as your legal arsenal—essential for your bookkeeper, CPA, and tax returns. Each document plays a crucial role, from financial statements to time records and client cases. Know the retention periods, some as long as 10 years, to ensure you’re on the right side of the IRS. And here’s a tip: while the IRS might not mandate it for smaller expenses, keeping digital copies is smart!
Deductions can be a game-changer for law firms! Track everything from meals and travel to home office costs and professional fees. These deductions lighten your tax load and showcase your firm’s operational expenses. Stay on top of your expenses—every dollar saved counts. Curate a comprehensive list of deductions to leverage every opportunity for tax savings.
Bookkeeping System for Lawyers
Bookkeeping is the backbone of a solid financial foundation, ensuring long-term success for any business. Procrastinating on bookkeeping only leads to a more stressful catch-up game at year-end, consuming valuable time and causing unnecessary pressure.
The typical tasks involved in bookkeeping encompass a range of critical activities:
- Recording daily financial transactions systematically
- Managing debits and credits
- Reconciling bank statements
- Generating essential financial reports
- Handling customer invoices and sales records
- Managing vendor invoices and expenses
- Maintaining and balancing ledgers and historical accounts
- Managing payroll
For lawyers delving into accounting, grasping the basics can significantly alleviate concerns.
Once armed with this foundational knowledge, reviewing essential financial statements such as income statements, cash flow statements, and balance sheets becomes easier.
Moreover, being aware of common complexities in legal accounting allows you to navigate financial management more effectively, steering clear of potential challenges that others might encounter.
Law Firm Accounting with Team SBA
You’ve got too much on your plate? SBA’s dedicated Accounting team stands ready to alleviate the burden of bookkeeping tasks so that you can focus on your primary legal responsibilities without the stress of managing financial intricacies. Our seasoned professionals handle the meticulous aspects of daily financial recording, bank reconciliations, generating comprehensive reports, managing invoices, and maintaining ledger accuracy.