Reconciliation in Accounting: What Lawyers Need to Know

Reconciliation in accounting—the process of comparing sets of records to check that they’re correct and in agreement—is essential for ensuring the accuracy of financial records for all kinds of businesses. For the legal profession, however, regular, effective reconciliation in accounting is key to maintaining both financial accuracy and legal compliance—especially when managing trust accounts.

But just what do lawyers need to know about reconciliation in accounting?

In the following post, we’ll cover the crucial types of reconciliation for legal professionals and delve into the fundamentals of three-way reconciliation accounting. Plus, we’ll offer useful best practices for reconciliation in accounting for lawyers to help make the process easier, more effective, and more efficient.

What is reconciliation accounting?

Reconciliation in accounting is the process of comparing multiple sets of financial records (such as the balances and transactions recorded in bank statements and internal records) to ensure their correctness and agreement. 

This reconciliation process allows you to confirm that the records being compared are complete, accurate, and consistent. Conducting frequent account reconciliation, for example, allows businesses or individuals to spot differences between financial records and accounts—whether due to factors like the timing of deposits in transit or nefarious reasons like fraud—that may otherwise go unnoticed. 

By catching these differences through reconciliation in accounting, you can resolve discrepancies, help prevent fraud, better ensure the accuracy of financial records, and avoid regulatory compliance issues. It not only allows you to protect your clients’ funds, but your firm too as a result.

Similarly, reconciliation in accounting serves a few key purposes for lawyers navigating law firm financials. Specifically, regular account reconciliation helps lawyers to:

• Ensure the accuracy and integrity of financial records
• Detect potential fraud or irregularities
• Comply with regulatory requirements
• Protect client funds

For lawyers, account reconciliation is particularly important when it comes to trust accounts. In fact, most jurisdictions have requirements for trust account reconciliation. For example, you may need to reconcile your trust account bank statement with client balances at a specific frequency, such as monthly or quarterly. 

Failure to adhere to compliance requirements that apply to account reconciliation can potentially lead to negative legal and professional consequences, including regulatory penalties, civil liability, and even disbarment. For this reason, it’s very important to check with your state bar association for the jurisdictions in which you operate and are licensed to practice for any account reconciliation requirements that apply to you and your law firm.

What are the types of reconciliation?

There are many types of reconciliation in accounting, with the best method for a situation generally depending on the type of account that you’re looking to reconcile. 

The following types of reconciliation in accounting are key for lawyers to know:

Bank reconciliation

Bank reconciliation is an accounting process where you compare your bank statement with your own internal records to ensure that all transactions are accounted for, accurate, and in agreement. 

The goal of bank reconciliation is to check that ending balances match on both your bank statement and your records. Should there be any discrepancies that come up through the reconciliation process, you can then take action to resolve them.

Typically, this process of reconciling bank statements with internal records follows the following steps:

• Collect necessary data. In order to conduct the comparison, you need the bank statement and the internal records for that account, for the same time period. You will also need to look at undeposited funds, i.e., funds accounted for in Clio and internal records but that haven’t hit the bank account yet, as this sometimes means month end totals won’t match.
• Compare. Next, you review each transaction on the bank statement, and compare it to the corresponding transaction in your records. If they match, check them off.
• Investigate any discrepancies. If you identify any discrepancies, find the reason for them (whether they are due to errors, deposit timing differences, undeposited funds, or other reasons).
• Adjust internal records. If there are transactions that were not accurately recorded or have not yet hit the bank account, make any required adjustments.
• Reconcile. Reconcile the ending balances for the bank statement and internal records.
• Record. Document the reconciliation process, including any adjustments that were made.
• Double-check for accuracy. Confirm that the ending balances for the bank statement and internal records.
• Resolve any outstanding discrepancies. If there were any discrepancies that couldn’t be resolved, take action to investigate further.

Just as it is with any business or professional, bank reconciliation is an important process for lawyers. Specifically, conducting regular bank reconciliation allows lawyers to:

• Ensure accurate financial records
• Help avoid fraud
• Stay compliant with regulations and ethical responsibilities
• Protect client trust
• Resolve any financial errors or discrepancies promptly
• Make informed financial decisions

Account reconciliation

Beyond bank reconciliation, lawyers should conduct account reconciliation with other accounts to help ensure that they maintain accurate financial records, uphold ethical standards, stay compliant, and maintain client trust. 

This proactive approach involves regularly comparing account statements with internal records for other key law firm accounts, including:

• Accounts receivable (AR), to compare and reconcile internal law firm records (like outstanding client invoices) with client payments, billing statements, and financial records. This type of account reconciliation can help lawyers accurately understand their cash flow and how much clients owe.
• Accounts payable (AP), to compare the law firm’s internal records for outstanding bills and payable to statements and documentation (like invoices) from vendors and creditors to the firm. The type of account reconciliation is essential to help lawyers maintain accurate financial records in relation to its liabilities and financial obligations.
• Trust accounts, to reconcile the bank statements of trust accounts with a law firm’s in-house ledgers or record-keeping systems. Account reconciliation is crucial for trust accounts, which lawyers have legal and ethical obligations to handle properly.

Business reconciliation

Businesses and companies need to conduct reconciliation to ensure the consistency and accuracy of financial accounts and records within the business. 

For law firms, for example, one key type of business reconciliation is three-way reconciliation for trust accounts.

What is a three-way reconciliation?

A three-way reconciliation is a specific accounting process used by law firms to check that the firm’s internal trust ledgers line up with individual client trust ledgers and trust bank statements. For lawyers, this process helps to ensure accuracy, consistency, transparency, and compliance.

Three-way reconciliation accounting compares three sets of records to verify they are all accurate and consistent. Specifically, three-way reconciliation accounting reconciles:

• Internal records, specifically the trust account ledgers maintained by the law firm. These records should contain all of the transactions in and out of the trust account.

• Client records, which are represented by client ledgers. Maintained by the law firm, client ledgers for trust accounts assign each transaction in the trust accounts to a specific client. The balances for the internal trust account ledgers and client ledgers should match.
• Bank statements for the trust account. The trust account bank statement is generated by the bank. It offers third-party verification of the trust account’s transactions.

Reconciling law firm trust bank accounts regularly via three-way reconciliation allows you to uphold your duty to keep proper, accurate accounting records for client funds held in trust, while also ensuring you stay compliant.

How often should you conduct the three-way reconciliation accounting process? As noted earlier, your state may have specific requirements for how often you must conduct three-way reconciliation—such as monthly or quarterly. Be sure to check the exact rules for your jurisdiction.

How to perform a three-way trust reconciliation

To perform a three-way reconciliation, you must compare three sets of financial records—internal trust account ledgers, client records or client ledgers, and trust account bank statements—to ensure that they’re accurate, consistent, and properly recorded.

While your state bar may have specific requirements you must follow, the general steps for how to perform a three-way trust reconciliation, are as follows:

Step 1: Collect the necessary documents

Before you can conduct three-way reconciliation, you must have your three sets of records on hand for the specified time period, whether these are paper records or records accessed electronically or in your practice management software. 

These records include:

• The firm’s internal trust account ledger
• The client records/client ledgers
• The bank statement for the trust account

Take note that you may need to keep an eye out for transactions that may not match immediately between the sets of records for which you may need to make adjustments due to timing differences. For example, a transaction that may not yet have cleared the trust bank account could be recorded in the client ledger, but may not yet be visible on the trust account bank statement. Again, this is what’s called an undeposited fund.

Step 2: Reconcile internal trust accounts and client ledgers

Once you have access to all the necessary records, you need to reconcile, or compare, the internal trust account’s ledger to individual client ledgers. 

All trust transactions in the internal ledger should be accurately recorded and should align with transactions in the individual client ledgers.

Step 3: Reconcile trust bank account

Once the individual client ledgers and the firm’s trust account ledger are aligned, you can then reconcile the client ledgers and trust account ledgers with your trust bank account statement. 

When reconciling, look for:

• The bank statement’s starting balance should match the internal trust account ledger’s starting balance
• Each transaction on the bank statement should match the corresponding entry for the internal ledger.
• The client records should match both the internal ledger and the trust account bank statement.
• If there are any missing or duplicate transaction records, make any necessary adjustments to the internal ledger. 

• If you find any discrepancies between the client’s records and the internal ledger or trust account bank statement, investigate and resolve them.

Step 4: Ensure proper documentation

It’s also important to ensure you maintain detailed records of the three-way reconciliation accounting process.

To learn more about how Clio can help law firms to easily manage trust accounting and three-way reconciliation, while staying compliant, read our guide here.

Reconciliation Best Practices for Lawyers

In order to conduct effective and accurate reconciliation in accounting, we recommend following these best practices:

Establish clear processes and procedures

To implement effective reconciliation processes, you need to create and document the exact procedures that staff and lawyers should follow. 

• Document the step-by-step directions for your firm should handle reconciliation for financial records, trust accounts, and other accounts.
• Define who is responsible for each step in the reconciliation process.
• Establish policies for record creation and retention. Consistent, accurate documentation and record-keeping is essential in the reconciliation process.

A note on who’s responsible for reconciliation: Ultimately, the responsibility to maintain trust compliance, and the consequences of failing to do so, fall onto you as a  lawyer, even if staff complete reconciliations on your behalf. It’s therefore crucial that everyone handling aspects of this process does so with care.

Ensure regular and timely reconciliation

In order for reconciliation in account to be most effective in preventing errors and fraud, it’s important to conduct the process frequently. And, for some types of accounts, like trust accounts, there may be specific frequency requirements that you must follow to stay compliant with your state bar.

While the exact frequency varies depending on your firm’s policies, the type of account, and your jurisdiction’s requirements for certain accounts (like trust accounts), the following can provide a starting point for determining how often to reconcile accounts:

• Trust accounts: In most cases, you should reconcile trust accounts at minimum on a monthly basis (or as outlined by your state bar’s regulations).
• General operating accounts: Typically, these are reconciled on a weekly or even daily basis.
• Revenue accounts: Accounts tracking law firm income are typically reconciled on at least a monthly basis.

Utilize technology and automation

While reconciliation in accounting—and three-way reconciliation accounting in particular—may feel like a lot of work for lawyers, technology can streamline the process, help prevent accidental errors, and make it easier to stay compliant.

Legal software for trust accounting can help you track transactions and reconcile records and bank statements. Clio’s Trust Account Management features, for example, allow you to manage your firm’s trust accounting, reconcile directly in Clio, and run built-in legal trust account reports.

And, because Clio integrates with best-in-class accounting tools like QuickBooks and Xero, you can use them together to further simplify reconciliations. When using Clio together with these integrated accounting solutions, trust account updates made in Clio are then automatically updated in QuickBooks or Xero. 

By taking advantage of technology and automation in this way, you can save time and avoid duplicate data entry errors. 

Final thoughts on reconciliation accounting

For lawyers, reconciliation in accounting is essential for ensuring that financial records are accurate, consistent, and transparent. While proper reconciliation is the standard for how law firms should handle all financial accounts, it is particularly important—and often required—for the management of trust accounts.

By prioritizing reconciliation in accounting, lawyers and law firms can maintain financial accuracy and compliance, but that doesn’t mean that lawyers need to spend hours each day looking at accounts on paper or in Excel. By leveraging technology for more efficient reconciliation processes, lawyers can save time and greatly reduce the chance of error. 

And, by adopting best practices when it comes to process, timeliness, and documentation of reconciliation in accounting, law firms can help themselves meet their legal and ethical obligations, stay compliant, and ensure the integrity of their financial transactions.

Easy three-way trust reconciliation with Clio

Want to learn more about how to easily manage trust reconciliation with Clio? Check out our guide to managing trust accounting with Clio, or book a demo to see how it works firsthand.

Note: The information in this article applies only to U.S. practices. This post is provided for informational purposes only. It does not constitute legal, business, or tax advice.