Most Common Mistakes in Legal Accounting

Welcome to Accountants Law Pod, where accounting professionals and law firms converge, hosted by Lynda Artesani, Sara Prevost, and Stephen Libhart.

Hello everyone, and welcome back to the podcast. Before we get started today, we have a new word. I was told, told by Sara and Lynda that I was voluntold. Oh, and Tiara too. I was voluntold to open up the podcast today, so I want everyone to practice their voluntold sentences this week. And welcome back. How are you guys doing?

Welcome back. Oh man, we're good.

Everybody good today? It's, it's a Monday morning where I think we're all feeling it today.

Yeah, kinda.

Kinda, yeah. Well, today's an, today's an easy subject. We just want to talk about most common mistakes in legal accounting. Whether you're an attorney watching this or whether you're a bookkeeper accountant that supports law firms, this will really have some, uh, some impact for you today. So, um, who wants to kick it off? Who wants to tell us some of the mistakes they've come across?

Should we voluntold them again, Sara?

Yes, let's— no, let's voluntold Lynda.

Our theme. Common mistakes is their trust account doesn't balance and they don't have workflows in place to ensure that it's going to be balanced and reconciled and everything else. So, and the simplest little thing like your bank, you know, you ordered new checks for the trust account and they took it out of there and they took the funds and those are not, there's no cushion funds to cover that from your firm. Something simple like that throws it out of balance and you have to balance your, your trust records.

How often do you think they should do it?

Depends on the size. We have firms that we kind of soft reconcile if it's big because it makes the job easier. But then most of the time, just monthly. I wouldn't do quarterly because It's the more you go digging, the more mess you gotta clean up.

Harder.

Yeah, definitely harder.

I agree. And you know, some law firms require a couple times a week. I mean, depends on the type of law you're practicing and how many accounts, you know, trust accounts you have. So let's break that down a little bit more. What about lumping them all together in one line on the books or breaking them out by client?

Well, that's the great debate. We've had fistfights on the Law Lab about which way is the right way. And the answer is both. It all depends. For my brain, The way we do it at the Proper Trust is the way that I think is the right way because for me it's easier to just kind of look at a high level. I see them and actually because of the way QuickBooks is, I can flip a switch and make the— if there's any negative balances, make them red. Like if we're doing a big cleanup, that stands out on the report. Like you've got negative trust accounts, there's a problem. I don't know, to me it just looks better. I can pull a ledger really quick and I think I can manage it better because you can take off The ones that are not, that are completed and get them off the list. And I don't know, the customer method to me was very hard to follow when I tried to do it.

Yeah, you have to really be diligent about tagging and the way that you enter that information. And if, you know, there's any sort of split details that go on in any of that, it can create a problem. I do feel like one of the biggest areas, to be honest, and we're kind of talking about this a little bit very lightly, Is when you're first starting out, you use— you don't use an accounting software to, to track things correctly. You use just a spreadsheet. And I feel like this is the same thing, because a lot of times when you build those style reports that Lynda was referencing, you a lot of times need to take them out into a spreadsheet to get them into the place that you need them to work for you. So To me, it's a red flag when you're a business. I mean, that's what you are. You're a business and you put your money into the practice management software, but you did not do that with the accounting ledger. You're a business. And like, to my brain is like, you've got to be in some sort of ledger system that works. So.

Absolutely. What about software, billing software? Should we use our Xero or our QuickBooks or whatever to Bill the clients, or should we use legal software, accounting, legal billing, excuse me, software?

I think that depends too, because if you're a personal injury firm, you probably don't need it because you're not really technically billing. You're actually just, you know, you, you are billing, but you just collect the retainer and kind of divvy the funds out and then cut your invoice for yourself for that piece. But for the most part, I would recommend it. And, you know, with This day and age, with all of the things that can go wrong with billing, I would recommend using the software. Like, just for example, Clio alone, you're going to get in that product ways to communicate with your clients securely. I mean, this is the big thing with the security, right?

Absolutely.

You're going to be able to have calendars, templates, even like with LeanLaw, you're going to have— you can create language in the invoicing that you're able to reuse firm-wide. So you have a very copacetic kind of grouping of all your invoices, the same messaging going out. And I think that alone, plus you're going to get metrics, right? So the metrics will be there where you lose some of that with QuickBooks. I know the metrics are there. Like I was just telling everybody, I took part of the testing this weekend on the advisory, and there are some reports you can get inside of QuickBooks. But obviously with a PI firm, you really wouldn't need it. But I think you kind of need it because it's Like putting the lawyer suit on top of QuickBooks. Now it's law-specific product, and I think that's important if you're working and doing this kind of work. For the price that it costs to have it, it's worth it in the time saved with the work that you don't have to do when you do the manual processes through QuickBooks or, or Xero.

I would say no matter what contingency-style company you are, there's so much more value to what you're saying, Lynda, of like You might have a practice area that may just be kind of creeping in and that offers a billable rate. You don't know what you start off in business or you are in a segment of a business and partnerships change. You need a platform that can adapt to that change. And so to your point, you know, just a ledger system alone sometimes, unless that's what you're— that's all that you're going to do.

But that's typically not what everybody does because your cash flow gets kind of sticky if that's all you have is contingency. They usually layer in a different practice area to kind of get you through the hard times when you're feast or famine, which is usually what we see.

Yeah. Yeah. So I would say, like, I mean, sure, it's one way to start out if you're shopping too, I think.

Yeah.

But then finding what works for your personality, your style, What is the value that you need out of the software? That might be another thing to look at.

Let's talk about client costs then, advanced client costs. We talked about the ledger for trust accounting. So now let's talk about client costs and where do those belong? Do they belong on the balance sheet or the P&L, the income statement? Where do they live?

It's funny when you're talking about your PI firms again, right? You want to put it as an asset because they're going to sit there as you're outpouring money to loan it to the client. until you win that case or matter, which they usually win most of them, you need to track it. And sometimes you might need to have that view of the— you might have to have that subaccount view like you do with the trust accounting.

Yeah.

Because you might want that visibility to watch, because those cases go on for years and you want to know every penny because you want to recoup it if you win that case. Otherwise it becomes a firm expense. So, um, in that case you might want to do that method. But I think you— we see it all.

Like, we see it all. Yeah.

And it depends too on the client. Is the client going to tell you on every expense that you— what client it goes to? Or are you just going to get a pile of expenses thrown at you? And Sarah, you know, Dext is great. We love it. We use it. And it's the best.

Yeah, it is. That digital accounts payable file box is what I call it. But yeah, no, I I think we've seen it both ways. We've seen it the hybrid, what we call the hybrid way. So we track it one way, we do an entry at the end of year to accommodate the hybrid method. But really in the end, when you look at those advanced client costs, they are an advancement prior to billing. So those have a— they get treated a certain way.

And sometimes if the people are not diligent about doing that, it can cost the firm money. And also we've seen it where we get a set of books come at us that's brand new client, and we look and we're like, whoa, the billable expenses are like in the thousands, like big money. Not a PI firm, but a regular firm. And then the billable income is not there, and it's such a huge delta between the two. Tax professional is going to say, what happened here? What's going on? Because they need to address it.

So, um, I think it's also to your point, Linda, is we have to tailor it. We have to look at if we're going to make any change in that area, it has to be very tailored, systematic, a Proper workflow because you can't just switch the thing and say, okay, one firm does everything into client expenses on the P&L, and then one year they switch it all to the other. It's not a method you go back and forth on.

So, oh gosh, no.

It's—

no, right? We've seen people try, and then if they come to us, sometimes we get a— they come to us and they'll say, you know, I've been— the firm's been doing it this way for 25 years. And you have to have an accounting professional help you with this because they'll say, we want to switch now. We want to do it the way the IRS says you should be doing it. Advanced client costs, that's really how we're doing it. And now you got to figure out what you have, what's existing, what's it going to change to, how much have you expensed already. It's a little bit of a math problem and you really want to make sure that you address it the right way.

Yeah.

And like I said, get your tax person, get your bookkeeping firm, which that's another thing that's a common mistake, trying to do it yourself at night.

Yeah.

She just snowballs it. That's kind of me. Steve, what is your, what is your take on, on some of this stuff that we're talking about as far as the spreadsheets, ledgers, tracking overall, the, the common—

Well, workflows. I mean, you, you mentioned workflows a couple minutes ago. Workflows are hugely important. I know they can be a pain in the butt to have to Create, however, um, you know, workflows create timely billing, you know, timely entering of time. If your workflow simply says you don't go home at night until your time's entered, that's part of the workflow. I mean, so much money is lost with poor timekeeping. Um, you know, how, what's the workflow for the client cost? How do you, you know, are you entering that in-house? Do you have software like, uh, LeanLaw? That has a 2-way sync, let's say with QuickBooks. And, you know, so when it gets entered by the accountant, then is it going over to LeanLaw properly? Is it getting the right descriptions in there? I mean, we can enter it for you, certainly can enter it for you because we're going to, we're going to do the accounting on it anyway. However, we may not— we don't know what your workflow is inside the law firm.

Mm-hmm.

So we're going to enter, let's say, a filing fee. What kind of description do you want in that filing fee to show up on the client bill? So there's, you know, there's a lot of things involved. You need to start with the building blocks of the workflow for all of the things that we're talking about and get involved with your, your accountant and your CPA, your tax preparer, and have these discussions so that everything is laid out black and white for everybody to understand.

Yeah, yeah, yeah. I, I do feel like it's the core of how the business— like Lynda and I more and more The longer we've done this together, it's the functionality of the business, it's the structure of the business that supports the workflows. And I don't want to say it's a mistake of a firm. I think it's just you go from working by yourself to you got somebody come working with you, or you come out of working with a large firm and you're not used to having all this.

You don't know what you don't know.

You're just not. And so you go into it innocently and naturally. That's the way you do it. You're just like, oh, I'm sure I can handle this. And then till what, you know, we've brought up before multiple times, before you know it, it's end of the year. What, how do you make your decisions? You don't have the reports. You're having to Google or search or ask. It's not a great feeling. And when you're staring at a barrel of like a tax bill, let's say a potential large tax bill, that's also really daunting to think about how to navigate that. And it just hangs over you. It's unfortunate. And the mistakes that you make because you're hurrying. So then you make these what I call kind of stupid mistakes, not because you're not smart. It's just you overlooked things. You forgot about expenses. You incurred expenses in your personal account quite accidentally because the same color blue card you have in your wallet. Like, things like that happen. It's just, it happens. And before you know it, you're really— you've overpaid in taxes for your poor accounting.

And ultimately, that's where all the common legal mistakes will land you, that you're paying more taxes. Who wants to do that? Yeah, nobody. Nobody. We already pay enough in taxes. So having the— you know, you can have somebody not— you could have a bookkeeper that knows nothing about legal accounting working on your books.

Mm-hmm.

And you're billing over here, but you didn't connect Clio because you heard that's not a good idea. And then this person's working remotely and just booking all the bank deposits in as income, but then shoving over the payments, which is sitting up in the—

Yeah.

In undeposited funds, but they don't know anything about undeposited funds. They don't look there. So you've got years worth of that up there. That's a huge mess to fix because now you're doubling up your income. Do you really want to do that? You want to pay double? What you shouldn't— if you have the right people in place that know what they're doing and know your industry, I think that that's the key to avoiding all the common mistakes in legal accounting.

Or what have we seen, Lynda? So you don't actually— you do great at billing. You have no workflow on the back end, so your cash is tight. Or the other thing, and I understand this, you're required because of compliance sake to offer a benefit. But you really didn't do your due diligence. And someone on the team who's worked at other firms kind of is smarter and got their way on how they want those benefit packages written. And then before you know it, at the end of the day, you're like, I'm paying too much. It's not right for my size firm.

We see that all the time. You know, that's a good point.

Yeah.

So that gets away from so many firm owners as they grow.

Yeah.

It does. Oh my gosh. I'm glad you brought that up.

It's like 100% or 90%. Is that digestible just because it was offered at X, Y, and Z?

Yeah.

You're 1 or you're 5 and they're 50. How do you— how do you do that? Sizing it right. Like, yeah.

And probably the other thing that we do see when we're— I'm just thinking about what we see when we see records come our way. AR, massive amounts sitting up in AR and nobody collects. You know, it's up to the attorney to collect on their own work, but they don't. And it's sitting there because they're still just collecting a paycheck. And then nobody wants to be the one calling up. So maybe a large amount of unpaid AR, so uncollected AR, big problem because that's money you've worked for. You've maybe paid your employees for and they're not collecting it. So I mean, there's companies out there. We love Coalbox and there's companies out there that help with that kind of work. And I think that sometimes you see, when you see this happening, I think sometimes people just don't want to address it. So they just ignore it and it's not, it's something you want to ignore at all because it can grow. We've seen millions of dollars on the open AR. We've made a point when we start looking, we look at the trust first to see if it's balanced and then blow it up to see where it went out of balance. And then we go to the AR and then we go down to deposit and funds. Those are the places we see all the time. And I know sometimes we were like, like it took our breath away when we've seen some of the records, like, wow, we can really help these people because they can— we can help collect. And the older it gets, the harder it is to collect. So then you have to implement workflows again. To you and Steve's point, we have to have good workflows in place at the firm that this is addressed and it's constantly addressed and it's kept up on. And maybe there's ways of making that so that you can make it where the team is invested in collecting for the work that they've done.

Well, you know, speaking of the workflow with that, one of my, my largest clients, and you know who you are because you watch this podcast. So, I'm gonna call you out here, but I'm so proud of them. In their workflow, every Friday afternoon, late afternoon, their operations manager goes into Clio and prints out all the graphs, the reports, everything, and sends it to the managing partners and says, this is where we are by timekeeper. This is where we are on collections. This is where we are on outstanding. And they get that information every week and they can act on it. And guess what? They run a really tight ship. I'm so proud of them.

Yeah. What a difference it makes, right?

Oh, huge, huge difference. Makes— and on our side of the fence, it makes reconciling so much easier.

That's a really good point because we have a firm that once in a while we'll see something come past our desk, Lynda, and I will— it'll say like, could you separate this revenue? And I'm thinking, oh, okay. And in my mind, I'm thinking it's in the tools, it's in the practice management tools. But I understand what they're looking to do is they're looking to see what it does What on their profit and loss, right, that they are as a firm. So you have the firm, like to your point, the firm view, but you also want the individuals to understand what they're working to.

Correct.

Yeah, correct. Yeah.

And we talked about the, the next thing I wanted to bring up. We talked about in the Law Lab last Friday, and that was, um, ignoring state bar trust and accounting compliance rules. Um, especially if you're, you know, if you're, you're licensed in more than one state.

I don't find— I agree that they tend to stay on top of that, whether they're in the bar and I do all those things. But, um, I don't see attorneys really having trouble with, um, staying on top.

They seem to be more sensitive to that than—

For the bookkeeping side, the bookkeeper side, yes, you should be looking up where your clients are. But when it comes to The other, I think it's important to make sure that— I mean, I don't see that as one of the bigger issues because attorneys tend to stay on top of the rule changes. You know, part of their license, so they get those notifications. But for us, it's important to know if anything changes. Every state is different. Sometimes you're not at the state level. Sometimes, like where Sarah is, it goes all the way down to the county, and you want to know all of those rules. And we haven't really had too many times where we've had to tell an attorney about a rule, but I know, like, in California, it changed That was a big deal. California changed a couple years ago, and they, they kind of laid it off in the soft way, and they're going to start, you know, really ramping that up, which is important to know that you've got to keep your records good because anytime they can come knocking at the door, any bar, any state, and want to see your records just randomly. There's no— it doesn't have to be a client complaining. It can be caused by lots of reasons, but sometimes it's just a random check. And if you don't have your records in place— And easily accessed within a timely fashion. So, you know, a lot of times the attorneys don't do their— they do their own, they're doing it at home at night, and then it kind of gets pushed aside, and then they're months and months behind, and they decide to call us and get it fixed. And it's like, you know, you really want to stay on top of it all the time because it can become unmanageable really quick.

Really quick.

The, the other thing too, and I think about this Like you're saying, Lynda, in our experience of seeing some employees, so associates of a law firm, they're not— you have to take the requirements, right, to keep your bar status up to date, but you don't have control over those. But you should know about the rule, the general rules. I get that sense from a lot of the different bar jurisdictions. The thing that's interesting is, though, sometimes if you're not in the day-to-day, you're not the managing partner, but you're one of the partners, it is a lot of work to follow sometimes because the rules are shifting on you. So there are times where we have brought up, and it's very innocent, you know, we'll be told, hey, we're going to enter into this new state for work. So we'll want to track revenue accordingly. We go in and try and grab the bar rules that are available for us to review to ensure, are you seeing this the way we're seeing this? It appears that you need to actually have a trust account within that state that's at their, you know, with an address or a bank that's in their jurisdiction or a called-out one. Not everybody knows that.

Yeah.

It's fascinating to me. And so you have to look at, like you said, Lynda, the types of cases too, because sometimes federal cases are different than jurisdictional cases. But again, if you're not in any sort of software tracking these types of things or understanding it, I don't know how the heck you sift through that data. No, you can't sift through that really very easily sometimes in the ledger. It's not as apparent sometimes. You need to be in a practice management software. That's—

you really do. You do, and it protects you, right? So if the client gives you $10,000 and you end up paying back $10,200, you can't do that in that software. If they gave you $10,000 and you end up clearing out the account billing, and then at the end of the day you return whatever's not used, you're not going to over-return because it's set up to protect you.

Yeah.

Um, I think that gets lost on some of the things just between, like Steve said, with the hourly billing and you get a time tracker, it's all built in together. Those are the little things that add up to, you know, whatever. I don't even know what Clio costs nowadays, but it's not a lot. And not a lot when you look at the investment.

Oh, it pays for itself.

Yeah, it really does. And then you keep your— you're keeping your attorneys working in this where you're over here with QuickBooks or Xero and there are no employees in that. So you're completely separating that part and that's good.

One area too that I think is really important is Everyone had some sort of business accounting course, but you don't know how to set up your chart of accounts appropriately to drive these things. And you brought this up, Steve, where they look at reports out of a, say, a practice management. But as the owner, partners, whoever, you need to also look at that whole piece, right? You want to know genuinely. And so what does that look like? And does it align correctly? Are people labeled correctly? Are the— maybe the non-equity partners in the firm carrying their weight of what it costs to run the firm? How do you find that out?

And not everything goes in miscellaneous expense.

No.

You don't know where it goes.

But those are really important pieces that go beyond, obviously, your practice management. They kind of I call them— they come together in their marriage, right, between the firm running and the individuals.

So I got one more for you before we close. How about at the end of the year when they give out their bonuses and they handwrite checks and don't tell us and they don't put it through payroll? That's another common mistake. Or commission checks too. When you think about commissions too, that can be done wrong as well. So, I mean, those are the spreadsheets not calculating, then they're not really calculating it back. You know, they're based on the records, but they're not because nobody's really tying the numbers back. No one's keeping track of the formulas. It doesn't make sense. So there's like a couple other places that are outside of the ledger that can, you know, especially payroll. When we see mistakes happen in payroll, there can be some significant mistakes in payroll.

You don't want to— The IRS does not like having those checks written that way.

You know, the tax— Neither do we see when we find out next year. We don't like it either when we see them maybe mid-January and like, what is this for? Oh, I gave out bonus checks. And now you can't go back into the old payroll to put back, you know, tax them because it's all closed down. It's like, what are you doing?

This does not— You're gonna pay the tax as the employer. You're paying both sides now.

Or if they buy gifts too, they, they don't realize that you have to— some of that stuff's taxable.

And yeah.

Well, one other, one other quick thing I wanted to throw out there that you made me think of it, uh, Sarah, a couple minutes ago. Having worked in law firms myself, if you're an attorney listening to this and you're newer to the industry, um, and you get involved in cases outside of your state or federal cases, your docketing is going to be different.

Right.

Okay, so as an example, you might have a 20-day response time on something that needs to be docketed within your state, but federal says it has to be done in 7 days, or they might— it might be 30 days or whatever. So being aware of that. Number 2, that ties into your fee agreements, and we didn't get to touch on those, but, you know, knowing your fee agreements and when you can take trust money. And if you make a mistake on docketing, let's say, and you get, you know, reprimanded by the court for whatever, that can affect you financially. So, you know, those are all very important things on the accounting side, really.

Yeah.

That, you know, because it can throw off your fee agreement, it can throw off everything. So just wanted to kind of toss that little tidbit out there.

That's a good one. That's a good closing tip.

Yeah, it is.

I think these guys want to close.

Oh, that was a great subject today. I, I really love that.

Easy one for us. Thank you.

Easy one for us. Yeah.

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Thanks, Lynda.

And as always, don't forget to join the conversation inside the Accountants Law Lab Mastermind group at accountantslawlab.com, where collaboration meets inspiration every week.

Awesome. Well, thank you. That was a good one.

Thank you. That was a good conversation. Look forward to seeing you all next week.

Bye.