Unpacking the Law Firm Chart of Accounts

Welcome to Accountants LawPod, where accounting professionals and law firms converge, hosted by Lynda Artesani, Sarah Prevost, and Stephen Libhart.

Welcome back, everyone. We have a fun topic today.

I mean, it's not so fun.

We'll be right back after this message.

It's important though. Yeah, yeah.

It's about, you know, Law firms chart of accounts, which what are those?

Call it the COA because nobody that's not a tax person or an accountant knows what that is. And you start talking to your client and you're like, well, your COA blah blah blah. And they look at you like, what the heck is a COA? Do I owe money on that now? Do I owe money?

Do I have to budget for that?

Yeah. But it is important because we've seen some doozies, haven't we? Steve, you too, right?

Oh, yeah. Oh, yeah.

Well, I was joking around earlier off camera. If you don't have a proper chart of accounts, it can get really jacked up and pretty bad. And it's, uh, one thing for sure is please do us all a favor and don't have every vendor you pay as a ledger line.

How am I going to track it, Sarah, if I don't put the names on there? That's—

Yeah, and all the employees.

That's what they're thinking.

Well, how am I going to track it? A bank wants to know that you've paid for Merchant services with, say, well, 8 AM now. I can't get this name.

That is the weirdest thing.

Moving past that one. Trademark.

You mean I shouldn't have a chart of accounts that says Adobe, Google?

Staples, Office Mac. No.

Oh, man.

Can you have Google and Microsoft? No, I'm kidding. Yeah.

But you need to have a good chart of accounts because the one that comes— let me tell you a secret. The one that comes with QuickBooks, is not the one for a lawyer. Let me tell you, it's not. You don't have job supplies. You don't have— I mean, there's some strange accounts on there. Inventory.

Inventory. Yeah, yeah.

It's like a ghost. It comes back if you delete it. It comes back with a -1. Um, there's a few accounts that are specific to QuickBooks that you cannot delete, but there are— you really want to have a good one. And I— one of the things I think we always do is we try to bucket the operating and the IOLTA accounts separately because it makes it easier to track the trust If it's got its own place, even if you have just one, you know, have an operating and have your savings, your checking, your payroll, or whatever in the top, and then make an IOLTA one and just have that. Maybe you have 1 or 2 or 3 IOLTAs. I mean, we've got some that have 10 or 13 or 14, but you want to separate them.

And you want—

yeah, you want to have that separated so you can roll it all up to double-check on your balance sheet that they— the 2 numbers match.

Yeah.

Probably. And that's something we tend to do. The other thing that's really important with the chart of accounts— see, now you got me going— is your equity section.

Oh.

Make sure your equity section, if you are in a partnership, whatever, you're not owners paying expenses, or even worse, putting owners paying expenses in the profit and loss side. You want to make sure that the equity section is built out for the type of entity you have. And we've seen where they're not. And a lot of times that's another tell that, you know, that somebody set it up that didn't know what they were doing. Or didn't understand accounting, and you really want it to be stated properly, especially if you're going to go for a loan or something like that with a bank. You want to make sure it looks professional.

Yeah. Um, the other big part too is, Steve, you brought it up, is you don't want all these vendor names. That's not a professional-looking profit and loss.

That's not a chart of an account— chart of accounts item. No.

Yeah, we could call it that. Chart of an account.

Chart of an account.

But the thing that troubles me, and it depends on your payroll systems and so forth, if you're using certain ones, is you've got this long list in your liabilities, and then they double up because of this, that, and the other. And honestly, I worked on a firm that went from desktop to online payroll, and it was really messy. And it was— it got to the point where the auditors were asking questions of like, What does this mean? Was this really owed at this time, or was this actually owed back to the firm? And it was truly hard to decipher because of the enumerating years and the rollovers and all the issues that were going on to understand it. So I had to regroup it. So liabilities, we talk a lot about trust liabilities because we always talk about client funds and so forth, but The other liabilities, ones that are super important to the firm, are your employee liabilities, your credit card setups too. And so those all need to be super clean. They can't just be hodgepodged everywhere. We've seen— we have seen— I hate to say this, and I'll have to say it— we have seen credit cards only listed in the assets and not in a liability. And I was like, wow, that's terrible.

That's really—

I mean, these are—

or as an expense line.

These are taxes that are being paid on bad numbers. That's another thing, not just for budgeting.

That's huge.

That's a big reason here.

Glad you brought that up.

Yeah. So, and when you think about things as owners, like Lynda, what you brought up, and Steve, you might have a few words on this, is when an owner is infusing capital into it, is it an advance? Is it a liability? What is Is it handled correctly? Or if you had a line of credit, did you actually put that money that you got from the line of credit as income on the profit and loss? Because we've seen—

And then be careful too when you start to connect that at the bank level. We've seen it where it completely puts everything in backwards and it's not correct and we've had to disconnect it. But also I think of when you're doing the trust accounts in a good set of books, you have bank account A, trust bank account A, you should have trust liability account A, trust bank account B. Trust liability. They should be separated, but still you can collapse it all up to the main one. But you really need to have that separated to make life easier for reconciliation purposes. That's important.

And clean for audit purposes.

Yep. Very, very much so.

Steve, can you talk about the client costs versus operating? Sorry, Lynda. I was just thinking, like, Steve has done advanced client costs and operating. Like, could you talk about how that should be done correctly?

Well, I like advanced client costs as an asset on the balance sheet. That's where I like to see those. And I like to break them down. I don't like to have just one line, especially with the type of law firms that I work with. You know, they're very—

But if you have software, Steve, it only can connect to one. So, because it's not really necessary to break down in advanced client costs, you're loaning the money, you're getting paid back. It's not really relative. To the, uh, the law firm's books unless they don't get replenished for that amount.

Exactly. Unless they don't get reimbursed for that amount.

It's a clearing account basically in the law office.

Right. And that's, that's considering that they have the, um, the billing software linked to QuickBooks.

Oh yeah, yeah, yeah.

You know, I always start them out with not doing that until they learn the ropes of how to handle cost receivables. Once they learn the ropes, then you can collapse it all and, and have a really nice clean clearing account.

Mm-hmm.

But when they don't do that, when they forget to enter a cost receivable into their billing software, and then you've got it on the book side and the two don't match, if you've got just one clearing account line, that can get away really easy. But that's a chart of account item, um, is your cost receivable. And whether you collapse it as one clearing account or you break it down by client like you do with your liability accounts for trust, you know, is a decision to make at that point in time. But costs receivable are not a client cost on the P&L.

No, unless we see it though. We see them put billable expenses on income. And then there's— I've had multiple conversations with attorneys or their staff about why that is. And sometimes it's an older set of books. That's always the way it's been. But then you have to have the conversation about how is this handled at year end? Because if you've had a lot of expenses out, And not the income back yet. You got to find that sweet spot, and your tax person is going to make an adjustment. So you want to make sure that your books are tied to tax. But another thing, kind of going back to a conversation we had earlier today, talking about payroll companies— Sarah, get your green glasses on. So this one, the payroll system inside of QuickBooks just makes its own accounts. And then it— you didn't put it there. It just appeared. And it could be a bank account. And you're like, I have nothing to match my, my paychecks to.

Yeah.

Why aren't they matching? And then lo and behold, a whole other bank account with almost the same name on it. And it made a brand new bank account with all those checks sitting there. And you can't match them until you merge the bank account and make sure you merge it the right way. Because if you merge it old into the new, you're going to lose all your bank reconciliations. So Oh, it makes accounts called payroll correction. I mean, I've seen some craziness on the, on the chart of accounts that was made by the system. What is it called?

System, system admin or system, system generated or something. It's like generate. Yeah.

What's that? You know? Yeah. It's a bad surprise.

The one that people don't— Lynda, I know you zero in on this. One that people don't think about very often is You have this money in transit or undeposited funds, as we call it. So Lynda has a great analogy. It's like putting— when you used to go to the bank once a week, you always put the checks in the check drawer, and then you make out, fill out the deposit slip, and you go. Well, oftentimes we see if things have not been handled right, that that just accumulates, and then it's like this large number. Well, guess what, friends? That goes on a tax return. I can remember doing—

I can remember doing a cleanup and pricing it out. And this is going back a long time ago. This is back to desktop days. And I forgot to look there.

Oh.

And when I got in that account, Sarah, it had 50 pages of undeposited funds sitting on the books that I did not factor in my price. And I had to clean up because I wasn't going to go back to the client and say, I missed this. I had to clean up 50 pages of hanging undeposited funds because nobody— they didn't know what that was. Nobody looked at it. I missed it completely. And it— I mean, I was like, oh, how bad can it be? Oh, the whole page, because there's 50 on each page.

And I had 50 pages. Yeah.

50 pages. So make sure you look at that if you're a bookkeeper listening, because a lot of the software, if there's a tweak over here, I'll use Clio for the example because it's a perfect one. If somebody changes something, it'll shoot a transaction because it's a one-way sync. And then they'll sit there like a ghost. They'll never have a place because it's already been, you know, the transaction may have already been put in and you gotta make sure you stay on top of that monthly to clear any of those out and that you don't have these duplicate entries because they'll just sit kind of in perpetuity up there and never, you know, they get whiskers. They've been there so long. Whiskers.

One thing I was thinking about too is, you know, a lot of— I don't know why this is— changes need to happen in prior period. We've of late have had a few changes in prior period that really were pretty locked in. Like this, these sets of books, certain sets of books are really locked in and they shouldn't change because the bank activity occurred. So how do you handle that if you don't have the proper chart of accounts set up, or if you don't have what we call these glaringly obvious moments where we have an account that's literally do not use or uncategorized and what's that? You're, you're not looking at it in the same way. It's easy to collapse things and not see it. So when you go to write a budget or produce financials to a bank, or you're doing something for an audit, And they start zeroing in. That's when you get really embarrassed because you're like, wait, what is that? How come?

What's in there? Yeah. Yeah.

Steve, what's your opinion about taking the— all right, so you've got software.

Yep.

I'll just use Clio again because it's the most popular. And then you've got all the income dropped into legal income, legal fee income. What is your— what do you think about subbing down the practice areas? Do you do that?

It depends on the type of firm.

Because you want to track it by practice area.

They want to track it by practice area, but then you're falling into the thought process of what are you doing further on down the P&L and the chart of accounts for payroll? You know, are you—

are you—

do you know where I'm going with this, Sarah? You know, is it legal fee income? And now, so is it suddenly, um, corporate income, commercial income? And then down in the payroll, they want to sub it down that way— associate attorney, paralegal, you know, all those sorts of things. So you have to have that discussion with the client. Again, depending on the type of firm that they are. Smaller solo ones, I try to encourage them, it's just legal fee income for now.

Yeah, I think sometimes they're the ones that will dial in and want to have all the—

Oh, they do.

Detail. And I think—

You know why they want to do that? I think it's because they want to figure out where their source of income is coming from.

But they get a lot of reports out of Clio.

You do.

You get that data out of Clio, right? Push it into QuickBooks. But do you need to? Or your payroll, your Gusto, right? You've got your stuff in Gusto. That's where you're going to pull that data from.

Right.

The big thing too, to your point, Stephen, we brought this up earlier and both Lynda, you said this, you got to set it up right at the beginning. So if you're— oftentimes we see in the practice management software, whatever it is that you're using, You're half using it and then you're expecting magic on the other side.

You're expecting magic on the other side. And then you want a banker— when you, to your point, Sarah, when you go to get a loan, you want them to look at that and go, what the heck?

Yeah.

You know, especially if they turn classes on and they don't fill out every single one.

Yeah.

You have to put that warning up that you can't save a transaction without the class because it's so easy to beep bop in and you don't save the class. Another one I might— one of my favorites, and this is a Sarah pet peeve, not a Lynda one. Reimbursable expense. Oh, she loves that one.

Tell us why, Sarah.

Where on a tax return does just reimbursable—

It's like, what's in there? What did you reimburse for? Because they call it reimbursable. I think, does QuickBooks payroll send it?

Call it what it is. Put it in the right bucket. I don't remember. There's multiple.

Travel.

There's multiples, actually. There's a— I mean, paychecks.

Oh, the other one too. The miscellaneous expense. That's your other favorite one.

Oh, yeah.

Yeah. I zero in on these. And only reason, very similar to Linda and probably yourself, Steve, once you've, like, I don't want to say burned, but once it's happened to you, been like a zing of something, like it's a memory and your eyes just immediately go to it. I have been a little frustrated at times with my own self. And like everyone else, like every business owner, you sort of are going through the range, you're going through everything, and then one day you're like, what the heck is that? You just didn't see it before.

Yeah.

And then you see it. So it's hard to see everything. And to be fair to all of us business owners and all of us people in accounting and law firm owners, please understand, like, this is a suggestion. These are not perfect. Everyone's human in all of this. But we're just highlighting areas that are truly focused areas that we find are deficits or when we immediately can open up a set of books All 3 of us and go, oh, God, this is not set up correctly at all. And it's not easy to move stuff, by the way, friends. When you're asking us to just clean up the books, just cleaning up, that's not like cleaning a house. That's like decluttering, emptying it all out, putting it all—

Oh, I'm glad you're explaining it that way. Yeah, definitely.

It is not, oh, just move it here. Just move it. No, we don't. That's not smart. Because at some point somebody's gonna go back through those records and they don't make sense. So when you are— if you're existing and you need a cleanup or a look back, have another set of eyes. Okay, we can evaluate, no problem. Any one of us could evaluate that and say, okay, you're looking pretty good. For those of you that just humming along and you're, you know, you're just thinking it's all good and you're starting out and it's And you've got— you're probably taking note that we've put— we've named some things in here that make you nervous, or you're looking at it, you're going, cut it off at the pass now.

Get it done now.

It's not easy to clean up.

Another good conversation to have on chart of accounts is, should a chart of accounts for a law firm have cost of goods sold?

Yeah.

Because there's a couple of ways of thinking about that, and I've seen it both ways. I've seen it mostly without it, but I think it's not a bad thing to have on the chart of accounts because it does cost you the money for your sales and to know that figure and it's not messed in with the rest of the records. I mean, that's—

What kind of things are you dropping in that bucket?

Payroll, client-related expenses. If I see business meals up there, I'm going to say, no, down the line, get it back down. That does not generate— in your mind, that's part of overhead to run the business.

She's talking pure cost of sale.

Pure cost of sale.

Legal services.

You have, you know, contractors that you co-counsel or pure, like, literally for every dollar that's up top that purely has an association, it's had no rhyme or reason to be in the business that can go in there. But yeah.

Interesting. Another way to look at it. Yeah.

Well, you want to know your true gross profit prior to your overhead, which Again, goes back to our budgeting conversation, and then for better reporting, and then goes back to that whole conversation we have with Danielle, which is, what is your true gross profit to run this business? You would not have incurred that expense if you didn't have the revenue for it. Now, if you've incurred the expense regardless of up top, that's at the bottom. That sits in the next area, what, what we call the 6,000s. Yeah. Numbering your chart of accounts is also a big thing, I should say.

What about reconciliation discrepancy account?

Oh my God.

No.

No.

Steve, it was off by $0.02 and I couldn't deal with it anymore.

Find it. Find it.

Or deal with— if it's immaterial enough, depending on the type of account. Now, trust is totally different. Not trust. Everything else. Immaterial enough and it's on the operating, let's say, and it's $0.02. Okay, let's be honest about the, the dollars spent to find that. We may have to rack it up to a certain moment.

I couldn't sleep if I didn't.

But I don't want the message to be to, especially to new attorneys out there, to plug those 2 and 3 cents, because then suddenly you're plugging dollars and suddenly you're becoming lax on your trust account and, you know, you're creating bad habits. It's so easy.

I took my glasses off because in QuickBooks, a lot of people love to use transfers.

Oh my God.

I thought they were gonna eliminate them and they never did. I don't know why.

It's terrible. I've seen— I hate to say this. I have seen people use credit card transfer or payments. They pay the credit card from the credit card.

Oh, yeah.

Oh, yeah.

It's the same. It goes in and out of the same account.

In and out of the same. And then you wonder why it's a big negative or a big positive and why they don't— okay, well, friends, You do law. We do accounts— accounting.

This is why we have people doing what they do in all kinds of trades, folks.

All kinds of trades.

I am not going to go and put 2 wires together in the wall of my house. I won't do it. I'm not going to get under the kitchen sink and fix a pipe.

Oh, but didn't you see that on the DIY house thing?

And I will not, I will not at the grocery store go to the self-service line.

Me either. Me either.

Thank you.

We will not do it.

Nope.

Nope. I will wait in line. I'm not taking a drive away. And I don't, I, I did not go to school to stand and be a cashier.

Exactly.

That's how I feel about it.

You know what I hate?

While an employee stands there overlording you and staring at you.

Yeah.

While you're bringing up your tomatoes, you know?

We've done it a few times depending on the line, right?

But we have 2 things, but yeah, but not when we have 2.

But what I hate is when you get up there and you realize, oh crap, I got the thing that has no barcode. I have to go look it up.

Uh-uh.

That's somebody else's job.

I'm done.

Don't make me do it.

Yeah.

And to your point, if I'm at a Walmart, which I don't go to a lot, but if I am, I'll put dark glasses on and go through the self-checkout with 2 items.

We digress.

Okay.

Chart of accounts. Okay, so let's do some basic things over here on chart of accounts. We kind of went through. So when you set up, especially law firms, there's specialized moments in here, but breaking down the sections correctly. You have assets, liabilities, equity, income, expenses, which those are just basics. Yes.

I'm a new attorney. Where can I go besides— before I call the bookkeeper, I want them to think I know what I'm talking about. Where can I find some law firm chart of account examples?

Oh, Steve.

Oh, we have it on our blog. There's a blog up there and we have a link.

On the blog. There's a link on the blog. The American Bar Association.

There too.

There's lots of different places.

Some practice areas, they have like specialized—

Well, then right, how specialized from there? Because yeah, makes you think. Makes you think. So then you've got your trust accounts and your liabilities, your IOLTA, the whole thing Lynda brought up, your advanced client cost versus operating. That's a very meaty topic.

So just don't use the QuickBooks default one.

Don't use that.

You got a lot of accounts that need to be shut off in that one.

Does Xero do that? Does Xero do that? Do they have a, like, a pretend beginner's—

They do, but starter set, whole thing that you can change, and it's not as— it's very— yeah, there's a lot.

It's an interesting thing with Xero because you have to know someone like Sarah that can make it fancied up because it's very flat. So she fancies it up and uses the subaccount, makes them to subaccounts in a different way. I've watched her. She just kind of pulls them over.

But it's really nice.

I don't think that piece is as intuitive as QuickBooks when it comes to chart of accounts.

It's not as, as, um, you don't have such a, like, I've got a new template in, so I do it a certain way, but it's, it's still doable.

We've seen it though, Sarah. We pulled up some chart of accounts on law firm books and we're like, whoa, is this a flat account? How the heck are they even, it's all over the place alphabetically and it's not grouped into sections so that you can see, like, your overhead, or you can see how much, you know, maybe your home office expenses, which maybe you didn't even think about, but that has to be on the chart of accounts. And there's so many, like, subsections of categories. You can really neaten it up. And that's usually the first thing we hop in and do, unless it's in a trust emergency that we got to fix a trust, to make that chart of accounts more manageable for, like we just talked about, budgeting. Right. So You want to be able to make it make sense and sometimes grab your tax return and look at how the tax return is laid out and mirror a lot, mirror a lot of that in your books.

A lot of it, sure.

That's going to help you connect the dots when it comes time to do the books. And then you get the tax return and now you marry that up to your books. It's going to help you think about it because there's accounts, for example, meals, that a lot of times we have that conversation like, Well, I lost— they spent $30,000 on meals. Well, they got $15,000 on the tax return because you get 50%. And those are the things that I like to call out on the chart of accounts. You don't have to, but I like to put that in the name so that reminds them that it's only getting 50%. Insurance is another one. Life insurance on the owner, partner, or whatever.

Yes.

If you're paying taxes— if you're not— if you're paying taxes on that money and you get that taken off of your tax return, You're paying for it with business expense. I like to drop that into an other expense to call it out at the bottom because I'm not going to get that expense. I'm going to pay taxes on it. So when in fact I die and the person, whoever's the beneficiary, gets it, they now have a non-taxable event with my insurance. So I've paid taxes on the insurance over the years.

Right.

There's that. What's the other ones that we like to call out as other? Other sometimes can be just a matter of Changes in the tax, say something happened in a prior year and we need to call that out.

When you sell something, you sell a piece of equipment, it goes into the other categories.

Recoup insurance.

Yeah. So you've got your revenue like we discussed, and then we— I'm going to add this layer, which is cost of goods for the direct. And then the other expenses, to what you're saying, Lynda, can be broken down into those expenses and other expenses. But in those expenses, Really is your marketing, your software, your rent, your utilities. Sometimes I'm building out for smaller firms, they don't really maybe have an office, so it's like a home office. You have to build out a little section for that. That's also, again, that may not be right depending on the tax person.

Yeah.

So it has to be really clear. Again, like you were saying, it goes back. And then once you get this general sense, Then you, you have leverage to your technology, to your reporting, to your budgets, to your conversations. Um, that's just an easy kind of like from top down.

Credit card reward income.

Yeah, other income.

It's not your typical—

it's other income.

It's below the line in the income bucket.

Your interest income should not be up there at the top. It needs to be at the top.

Well, we've seen it where it's been up there and we fix it. And, you know, it's just little things like that that are the end of the world. No. But do you want something that's more streamlined, professional, so you look professional and it aligns with your tax return? Yes, yes, yes.

Well, and how often do you work with attorneys who are corporate attorneys? They, they consult and work with businesses in business transaction Things, you know, buying and selling businesses and things like that. If we're teaching them how to have their own proper chart of accounts, that's going to filter over to their clients when they're talking to them about how to run their business.

So true. That's such a good point. Well, that was a lot about COAs. COAs.

Lots of—

a lot about COAs.

COAs.

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What's that song on You're on Your Way Up? Is that— that's when she says it, leveling up. I can't even talk. It's kind of that song somehow sticks in my head. I'm like, oh God, here we go.

Well, great subject today, you guys. Thank you.

Hopefully we helped a lot of people because I know this is a mystery. I mean, this is not what they go to law school for. So hopefully it helped everybody.

Yeah, absolutely. Thank you.

Bye-bye.

Thank you, everybody. Bye-bye.