Avoiding an Audit (Best Of)

Welcome to Accountants Law Pod, where accounting professionals and law firms converge, hosted by Linda Artesani, Sarah Prevost, and Steven Libhart.

Welcome back to the podcast, everyone, and we've got a topic that is a bit scary this week, and it's actually avoiding an audit. How do you avoid an audit, Steve? How do you avoid an audit?

Run.

Run, because there's multiple kinds of audits, right? So we have— but there's compliance ones, and there's— a client can call one in on you, and then you can have one that can be random. I mean, right now, California, right, Sarah?

Oh, bar audits for bar— yeah.

Oh, you're talking about the other— oh, you know, I don't want to talk about the other.

I'm not qualified for that one.

Yeah. Oh, I thought we were talking about bar audits. You mean, like, well, Like tax audit?

Well, bar audit. I mean, like you were just saying, Linda, California is— they've wanted to do this. I didn't know that, that they've wanted to do it. The random audit.

Well, we Googled that case that caused this, the Girardi case, and, or whatever, in California, what started this whole— because the bar got in trouble. The bar got in trouble because some people on the bar were, like, helping this person that Was using funds inappropriately. And, um, yeah, it's crazy.

Bad case. And it's really scary to think that you could— that this individual, um, had means of and ways to do things with current, uh, bar individuals at the state level and basically stole people's rightful money from cases. And now it's, it's a disgusting idea.

Well, you know what? This makes me think— and sorry, guys, everybody on the podcast, Steve is tiny today. He's having camera issues. So you have tiny Steve in the podcast.

If you see the podcast.

But anyway, this makes me think about, though, we started talking about what type of audit. If you know what, if, if, if, if they're being audited, by the bar, what are their books like? What kind of other things could open them up to tax audits? So I mean, this does kind of cross over. We can talk both things here.

Well, yeah, I mean, it's tax audit. It can come from—

turn into, um, literally it's just the next—

Well, I think when you think about it too, a lot of times what we see, it's not so much, um, I, I think, uh, overall we've seen more of people leaving money in trust and not moving it into operating, which then becomes a problem not showing your income.

Right.

Because they just are afraid. There's a fear around the trust account. So they just, I'll leave that in for a cushion.

I'll do it next Thursday, which becomes a month and 2 later. And yeah.

And then it grows, and then they don't— then it gets to a point where they didn't move it. So now they don't know what's in there to move. So they just leave even more over there because they're too afraid to move it. And then if you get an audit, they're going to be after you for, first of all, you never moved the money you earned it. You didn't move it over. I think there's many levels of audit that we could, we could discuss here.

Yeah, I think on the topic that you're talking about right now, Linda, what we've seen in, in some of our cleanups is the methodology of, well, I'm just going to balance it this way, so I'm going to batch move money.

Bingo, bingo, big trouble.

Big trouble, right? Because you are not identifying per ledger Who's inside of that pooled set of money? That's a problem. You can't be operating in that. I'm just going to bulk transfer out, bulk transfer out. All right. Well, and then you got busy. To Steve's point, it's a month and 2 later. Are you honest? I cannot— I kind of know what I did in January because of a tax deadline, but I do not know what I did.

Well, you know what else, Sarah? I've seen where they'll take a batch of money and move it and go, you know, we think that's what we're going to do with our billing at the end of the month.

Or—

oh yeah, I've seen that. Have you guys seen that?

I've seen that one time.

And yeah, boy, that scares me when we come across that. It's like, how in the heck do you ever unravel that, you know? Um, because they can't tell you which batch of bills it belonged to.

Yeah, no, you don't want to be doing that. You know, it's funny, we have a client that I adore, I adore, and he's so good about like, if we find anything that didn't In the month, we see something that maybe he moved the money over, but he didn't. We moved it over in Clio, but we didn't move it over physically. And if we have corrections that need to be made, he makes every— and it can be a pain in the neck, but he makes every one individually so we can put the notes to tell the story behind, like, oh, this check, you know, the girl in the office deposited to operating. It really belonged in trust, so I had to move it over. And those are the things that happen in the day-to-day life of an attorney and a law firm and trust accounting. And there's always a way. Like, he's really good about notes. The notes come through on the a bank feed. And they're also with the transfers. And then we're also able to go back and forth and in a cleanup, fix the cleanup and go through it all. And each— and it can be in a cleanup, you can come out at the end of the day with maybe 20, 30 transactions. And the client might say to you, if you're a bookkeeper listening, they might say, can I just move the net? And we're like, please do the transaction so we can— Put the transactions in because you're in that audit. You want to be able to tell that story and it's super clear. But if, like you said before, if it's all bulked in, it's hard to tell that story. And it almost gives it a visualization of you're hiding something when you kind of— and it's just, it's not like, how hard is it to make a transfer? Yeah, you have 20 of them. It's a pain. It shouldn't happen every month. And, but it, it's just to tell the story in a clear way. And like Sarah says, follow the money.

Ding, ding, ding.

You're putting it back. You know, it's what you're doing.

A question, okay, around when you're doing a cleanup or when you're in the middle of beginning to work with the client and you realize that there's, uh, things just hanging from prior period that no one— prior years that no one knows. What do you do there?

Hanging what? Deposits?

Hanging trust money that they don't know. It's not identified.

You can't identify those prior years transactions.

What do you do there?

Like, oh, the unidentified ones, those are hard. They have to— you have to have them do their homework, try to figure out where it was.

Exactly.

Not that long ago. They need to go back into the banking and ask the bank, pay the bank to get the copies if they can, because you really need to know. It's not a place you can guess.

Yeah.

And just leave it be. You have to know where it came from. Yeah.

And then you have the scenario. You have the scenario where we've talked about this before, where they suddenly open up another bank account to fix it.

Never works.

It affects those prior years. And, you know, here's the other thing too.

How about other software? Oh, I'm just going to move to a different software.

Right, right, right. And here's the other thing too. They have these prior years, some states. And if you're, if you're a bookkeeper or accountant out there listening or watching this podcast, bone up on what the requirements are in the state where the attorney is practicing or multi-states sometimes. Because some states give you the opportunity to self-report, the attorney the opportunity to self-report. And when you get into some of those big messes, sometimes it's appropriate to say to them, maybe you do want to self-report. And when you do that, tell them these— this is what you're doing to fix it. I've brought in this firm to help me fix it.

Yeah, I mean, like an outside firm fixing it. Some states have success when you've asked an attorney to do that, that actually will Self-report? Because I can't imagine. Yeah, I did.

I had one, and this— they were very lenient with them, um, because they were—

So they were— it did have a positive effect. It didn't—

Yeah.

And then one of the classes that I went to with the state was— and I attended the class, and they knew we were there. Joy and I went, and they knew we were there, and they were like, we're going to ask you if you agree or disagree with this as we present in the class. And, and so that was really cool. But they, you know, they said if you self-report That shows us that you really have an interest in fixing this. So it's not as scary as you're making it out to be. The other thing, some states require that you keep copies of the checks that you write, front and back. Other states don't require— other states don't require that. So know all the nuts and bolts and use that in a way to avoid the audit. These are some tools you can use to avoid the audit.

Just flat out 3-way bank reconciliation. That's your best guide. Do that monthly. That's how you can avoid— it won't avoid the audit, audit, but you'll be be ready if you get audited, because one of the ways you're going to be triggering an audit is if your trust account goes in the negative. That's an automatic audit. If you end up bouncing a check in the trust account—

What if a client overpays you and you put it in the operating account? What happens to the audit then?

Well, and you never transfer the funds or acknowledge the overpayment. That's a problem. There's a— there's also another thing that happened Linda and I's experience through our tenure together is one, a multi-state, to your point, Steve, multi-state. One of the states, the bank went negative. It triggered an audit, which then the other states jumped on board.

Really? How did they find out?

Well, it got reported, and I don't know the exact how these, all these 3 locations or 4 locations figured it out, but it triggered the other ones. So then we had to Not only do we have to make sure we're diligently doing the things that we normally do, but we have to make sure, like, every, every siloed state and all the pooled funds in those on the liability are also very clean.

And which is probably why the state— most bar associations require if you have a trust account in Oregon and then you have one in Washington, you have the bank account in each and you keep that money separate because the business is happening in One state or the other.

I bet that's what happened.

I bet that the bank was in the money in one and took the money out of the other.

And the client was in another state. I'll bet you.

Client might have moved.

Yeah.

And it can happen. And then it's just messy. And then you're kind of on high alert and you don't get like— we've been through audits, as you have, Stephen. It's the bar doesn't give you a lot of time to come up with the paperwork, which is why you have to have really good record keeping.

That's the hard part. Yeah.

Because if it's messy and you get get audited, you can't go to them and say, oh, I haven't really paid attention to my books. I haven't done a bank reconciliation for a whole year. Can you give me a few months to fix it? They don't give you a few months. They're not—

I can remember the first audit I went through was in a firm back in 2007. I was working in the firm and we had an audit and they didn't give enough time. And I literally spent an entire weekend copying and copying and copying. And I took a ruler and measured And it was 11 inches tall, the stack of paper.

Yeah.

Yeah.

Because you have to put it on their form. You can't just pop it out of QuickBooks and say, here you go. You have to put it on their forms in the format they want to see.

Yeah.

Which can be— we had one that was like that. It was a lot of trust accounts, and we had to take that data out of QuickBooks and put it in their form, type in their PDF. And it was a lot. And they wanted to see not just the balance at a specific snippet of window of time, They wanted to see if this account had a balance. They wanted the individual amounts behind that balance. They wanted that register view, which is why we do that in QuickBooks.

So like, if you're looking at a set of books and for the month that they, like, they want to pull that, say that month, year end, if there was a balance in the prior year, what, Lynda, you're saying is they want to know what's behind that opening balance that prior year, which is to kind of to our method of We've seen, and it's fine if you want to do it this way, if you have strong reporting this way, if you want to do a client-level report out of a trust liability account, that's fine. We choose not to do that because we find, we find the errors like the bank might have charged a fee that otherwise would have never been identified properly because it's not to a client name. We found little ridiculous things that have happened. Checking transposed numbers.

They needed a check. Checks to write to the client, and they take the checking, you know, the fee for the checks out of the trust. And if there's no amount, like the state doesn't let you get— put amount in or enough in there to cover it, you've got to replenish that. Wire fees happen and out of Violta, and they— you have to replenish that.

Set up their entire law pay with the incorrect debits out of the bank account.

Oh, yeah. Yeah.

So that was also— and if you're not Like, to your point, Linda and Steve, you, you do this too. But if you're not doing it on a cadence that's supportive, that at any point calls to action— and think about it this way. So we're talking about trust side. So you want to have that cadence in there. Well, now you want to make sure your income's right, because to your point, Steve, if you're putting— if you're not moving the money at the time that it's earned, which is required, you're supposed to do that, and moving it over at year end. And you've left quite a bit of money in there and that settlement came through, that's a mess that you can look at, right? So then you're not showing the earnings correctly on the other side, or you've over-shown your earnings because you've put people that have given you money for retainers in the wrong bank account. You've inflated that. Now you got to move it over. I mean, to both of your points earlier, there's multiple ways to look at this through this audit's perspective. Be compliant on the trust side and also be compliant in your set of books and make sure—

Well, and in your, in your, your workflow accounting, don't just post the transactions and move on and, oh yay, I did it, and rush off to the next thing. Post it, look at it. And when I say look at it, that means go and look what the effect is in the bank account, what the effect is on the trust ledger. Look at the effect of the work that you just posted. Stop and do that. That's what we are being paid to do. Yeah, you rush through it and you don't double-check it, and oh my gosh, I mean, it's so—

They can make a mistake. The bank, they do, which is why we connect it to Clio. Because if we're— I'll stop it. Because if we're validating Clio's side, right? Yeah, the, the attorney can put whatever they want in there. There's no validation if I'm not validating the Push over to the into QuickBooks, and then seeing that the amounts align because that's the thing that can happen that they don't align. And then and it can be forty-five cents is fifty-four cents, and that little stupid ninety-cent delta which we all know how to look for, but that can happen really easily. And it's it can be at the bank or it could be the person didn't put the right amount on the deposit slip when they wrote it out or whatever if they're still doing that because some people do some of the firms still do things taking the money to the bank with checks. And yeah, it can be they. Give me lots of ways that can lay itself out.

What about cash, Linda? They get cash.

Oh, cash. Yeah.

Where is that recorded? So the thing that I think we're leaning into too is the practice management software where we follow the money. I don't care what you put in that thing. You don't have it properly tagged for us to identify and mark back to and put it into the right register for that individual.

Linda, you've shared a story before about a place where you worked where they took cash and they didn't write a receipt.

That would— yeah. And they— that was when I was doing petty cash. I was handling petty cash, and the bookkeeper I was taking over for, she said, oh, we just give them the money that they requested, and then if they— then they bring the receipt back. And I'm like, I got this bucket of cash. To me, it was like, it was like $200. We're not talking a lot of money. But if there was money missing, who were they gonna go to? The person with the key. And there was no formal, like, paper trail. So I made a form. They had to request it. I made it very formalized because I didn't want Anybody coming back to me and saying, well, where'd this money go? And to me, I felt like it was a lot of— back then, it felt like a lot of money that I was handling, and I didn't want any, any thought of impropriety on my part. And I just was not comfortable with just handing it off to the workers and saying, here, you need, you know, for a box of nails, here's the money, and then bring me back the change, and then you forget. So, yeah, no, had a, had a workflow. You have to have workflow whenever you're dealing with cash. There has to be a workflow. And, you know, we work with immigration firms. There's always cash involved in immigration firms. And We have specific subset of workflows is overseeing so that the money is being counted, the money's being accounted for, it's written down because we need to track it. And then it eventually ends up in the bank, but we need to make sure because that's the place, that's a weak point in a workflow if you've got cash available to people.

And this is a way, this subject right here is a way to avoid an audit. Have your documented workflow, have your SOP. You know what? This weekend I was playing with my ChatGPT and writing SOPs. Oh my God. It was beautiful. It was beautiful. You know, I've double-checked them, make sure everything was right.

But yeah, it's a great tool because it's so fast compared to if we had to mentally manually do that.

It's like those are ways to avoid an audit. Have your workflow, hold people accountable. Who does what, when, where, how? You know, especially with trust money.

Well, the other thing too is one thing we've seen is when you're, you're earning all this money and you've got a terrible workflow for payroll. You don't have payroll set up correctly. You're not doing it correctly. That other side of the audit would be, you know, if you're going through a state or workers' comp or a federal audit, all of that, that's not one you ever want to mess with. Nope. So you—

they will hound you for $0.48 per month.

Yeah, they will.

But the workflows and making sure— we talked about this earlier about multistate bank accounts in multiple states. You've got workers in multiple states. And we literally, for a firm, that's based in California looked up the rules on how you reimburse people for their home office. There's a whole thing with California for that, right?

Always California, Sarah.

To all of this. Yeah, but I'm just saying, like, in general, our knowledge of information and what we've got our minds set in is we've got this layer of the stuff that needs to happen just purely on the fact that you're handling other people's money. And then we have this layer of what is your business doing? How is it operating? And how to make sure that you're being diligent about your own set of books and making sure that what you've earned is being transferred over timely to Linda's point.

Yeah.

And what you've brought up, Steve, you don't go months on end. And so it's just having all those workflows, and we see it all the time, I think, is we see like, oh, Like you said, I'll open up another account, or, oh, I'll just go to this practice management software and it will be better. Our services are tailored services, right? Like, and every— I think every kind of person that serves in this niche as an accountant, you have to be tailored services.

You do. Yeah.

Mindset. And so you have to know what you're working with and how integration works and why Linda and I will duke you over this on integration of Clio to QuickBooks.

We're picking on him because you weren't here in the beginning conversation, but Steve—

Okay, let's move on.

But in light of that, like, we want, we want to, to your point, Steve, we want to make sure that we're keeping our eyes on things as you earn it, as you receive it, as it— if it's come in the wrong bank account. So I think in total, to avoid audits is really going back to the foundation of how do you work How does the business operate? What are the proper procedures we need to have in place? What are the items that we need to look out for? And when you make a mistake, it— and it's just a mistake, we'll help you.

Right.

If you do get an audit and it's a random audit, nothing triggered it. It just happens to be that they just decided to pick you, like getting jury duty summons that I got on the wall over here. It's, it's just make sure that you follow, read through everything and follow the paperwork. And then if you are in that audit and they do find something wrong and they start to bring it to another level with you, that's when, as an attorney, you have to hire somebody to protect you.

Yes.

You have to hire— don't try to represent yourself. Try to get somebody who can help you represent you and just take you out of it. I think is the best way to do it. Um, because there's a lot of processes. I mean, obviously that's the, like, worst case scenario. It gets to that point you need to hire an attorney, but If you look at the— I think I've got it on one of our blogs in the Accountant's Law Lab where it shows you— it's an image and it shows you the way an audit works and how the process of an audit through the bar and where it comes from. If somebody calls in and says, I didn't get my retainer back, and how it can go through the steps and how it can get to you and how there's lots of ways that the bar can come look at it and say, oh, this is— there's nothing wrong here. This person was notified. But some states and some of the bar rules, even If you're, if you're holding money and you're not doing any work for multiple months, sometimes in some states you have to send a statement saying that we're holding this money for you. Nothing came in, nothing went out, but this is here. And you need to know your state bar rules.

I'm glad you brought that one up.

Yeah, it's so true. And you also brought up before, Linda, we've talked about this where we've had folks come to us and they really didn't respond to the first— Yeah, they ignore it.

Don't ignore it.

That's the hardest part. And then pretend you don't get it.

Same with my jury duty thing. I can't ignore that. I'm gonna get in trouble. You know, I did write and said, hey, I'll meet you in May. I don't want to do March 15th for my jury duty. This is not a great time for an accountant. And they gave me a pass. But it's the same thing. You need to make sure when you're dealing with something like that, you, you have to take care of that and make sure that you do the— what it says to do to comply with them. That's your best best bet if you can avoid it. And avoiding it really is make sure your books are reconciled and then you've got all the proper paperwork and protocols and steps and workflows. And really, that's the key to the whole thing.

Now let's take it just another step deeper, because I mentioned at the beginning of the podcast that this can, this can flow into your books in other areas.

Yeah.

During an audit, the bar might want to look at where's your receipt For this item that you billed this client for that makes up this trust dollar amount that we're looking at. And if the attorney goes back and says, well, I don't keep copies of my FedEx bills, I just post them from online. Or, you know, you get the gist here.

Yeah.

And it can flow deeper into your books as far as, you know, don't, don't provide a hand-typed receipt that I took a taxicab and I need to be reimbursed for it. You know, those sorts of things. Really have your documentation. Attorneys are looked at much harder than a lot of other businesses. That's why on 1099s, what do we have on 1099s, you guys? Attorneys and landlords. There's a reason that they single them out.

And fishermen. Don't trust the fishermen. Don't trust the fishermen.

You're right. I forgot about that one.

You do a lot of— and you still do this, but I don't know how often you're doing it, but you've done a lot of how to set your books up right for your bar. Like you've done a lot of classes.

I teach the class every August.

Every August. Okay. So inside of that, you're a new firm, you're just getting set up, and I'm sure you field a lot of questions, but ultimately, like you said just now, it comes down to what are the fundamental pieces you need? I think of it like this. I'm your client. I'm giving you my $5,000 retainer. I want to see on my bill, what are your fees separate from my expenses that I incurred? And if I can't pay for that receipt, I want it.

And I may ask you, and I, I'm the type that would ask for the receipt. Did you, did you really spend this much money on that transcription service?

Yeah.

Yeah.

You know, for them to do the word processing, I'm being charged $300. I want to see what they did.

Which is why, like, we use Dext. You're using a system that's in place that we're getting those bills, we're putting them in, or Hubdoc, or QuickBooks has it, and pull those receipts in and code them properly so they're attached to the transaction. So if there ever is a question, It takes 2 seconds to be able to pull that up for the auditor and show them this is the person, this has got their name on it, this is the date that the deposition happened or whatever.

Exactly.

Put that back up for it.

A deposition is a great example because there's a, there's a whole hornet's nest there of things that can happen.

It's in there. And we put in our engagement letter, but it is true. I mean, if you had not just a state audit, if you had a different style audit, And they want to see the receipt. Your credit card statement doesn't work, friends. No. Bank statement doesn't work. What is behind it? I went shopping at Sam's Club or Costco, one of those 2. You could buy everything in there. What supports your $50 purchase? Not that $50 is a lot of money, but I'm just, I'm tongue-in-cheeking this right now.

But, well, everything on Amazon is office expense.

Oh, God. Yeah. Is it really everything? I mean, like, really?

According to the clients, it is.

According to the client, it is. But yeah, to your point, Steve, you're right. It—

you—

It goes deeper. It goes deeper.

That's why I brought up the payroll thing. That's why I brought up the other pieces, because you really— you are a business. You have an extra layer to the business, and we have extra compliance pieces that we want to help you with. And it's just— it's just common sense stuff. And yeah, it's not fun. I mean, I don't like—

But the audit's not fun either, Sarah.

They're not. They're the worst. I mean, I don't wanna have to do all these little— it is hard to manage right now too, Linda, don't you think, with the electronic receipts? I'm so quick to put in my phone number or put in my email.

Yep.

And then I'm like, what did I do with it?

Where did it go? Yeah. It's also, I think too, when you're working with clients, it, it's really, if you're sitting back and you know that your books aren't in a good order, it really take care of it before they come knocking at your door. Yeah, that's a good piece of advice to avoid the audit, and it'll help you sleep at night too. Hire a professional.

It does cost it, just like it costs somebody to come to you as an attorney. It does cost for you to find people like us to clean up the trust accounts. And, you know, sometimes we don't have—

A lot of attorneys come to us, they want us to clean it up, and then when we're all done, they're like— and it's the 3-way too. So if you're, you're an attorney that has books and it's being done by a bookkeeper and all they're doing is reconciling in the bank account and QuickBooks, That is not a 3-way bank reconciliation. You have to have a proper one. So I think a lot of times to know that it's a separate document and it has to tie in all the pieces like a Clio and bank balance and QuickBooks balances, you need to have that separate document, separate Excel spreadsheet or wherever it lies. It's separate and you have a way to tie all those pieces together unless you're in an all-in-one like Cosmolex. You can't really do that without having that third piece.

Oh, and don't get us started on an all-in-one sometimes where it's—

No, I don't recommend an all-in-one software, but Some people are on Cosmolex, so I mean, something like that, or, or any of them, you know, the Clio Accounting and whatever. My case has one, so you could be in that and then you can produce it out of the software. But if you're not in one of those and you have that separate piece, you need to have the reconciliation separate, separate paperwork. So if you're not getting that from your bookkeeper, ask for it. You might not realize that you need that piece, but that's what you're going to need because that's what the auditor is going to ask for. Mm-hmm.

Yeah, I was thinking of something earlier, but it's— we've given so many good tips inside of this. I think we've covered so—

I mean, that's just talking about a bar audit. I mean, there's plenty of other audits, but, you know, I've been through sales tax ones. Those are nightmares.

Those are nightmares.

I mean, some of them are really terrible to go through, but usually law firms, we're looking at the bar audit, you know.

Yeah, we got a big focus on that.

Well, good topic. Good topic. Steve, I hope your head gets bigger by next week.

I'll work on it. Next week I'll fill up the entire screen. You should hear how they talk about me behind the scenes, you guys. Cast is over.

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I feel like I need like the little dance when she does that.

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I know.

She's so good at it and she changes it so it's not the same all the time.

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We love Tierra. We love her.

Yeah, our behind-the-scenes girl that keeps us straight. All right, well, thanks, everybody.

Thank you, everybody. Bye-bye.