In the realm of legal practice, managing client funds ethically and in compliance with regulatory requirements is paramount. The Interest on Lawyers' Trust Accounts (IOLTA) system plays a crucial role in ensuring that client funds held in trust generate interest, with the proceeds contributing to legal aid programs. This guide provides lawyers with a comprehensive overview of IOLTA Trust accounting. Covering essential steps from setting up the IOLTA Trust Bank account to navigating deferred revenue and earned revenue transitions, this guide aims to assist legal professionals in maintaining accurate and compliant financial records. By following the principles of GAAP accrual accounting and adhering to state-specific regulations, lawyers can confidently navigate the intricacies of IOLTA Trust accounting while reinforcing their commitment to transparency and client financial protection. See IOLTA Litigation Summary for details.
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Establish the Accounting System:
1.) Establish the IOLTA Trust Bank account Interest bearing account for Client funds held in Trust. (Interest on Lawyers' Trust Accounts)
2.) Establish the Main Checking account for Business Operations
3.) Setup the IOLTA Service Item for Deferred Revenue (setup products and service item with income account=deferred revenue for Invoices, expense/purchases account=deferred revenue for Bills) This item represents the Deferred Deposit-Retainer collected.
4.) Setup Service Items for Billable Expenses as needed with sales price and purchase cost. LEDES/UTBMS codes: (setup item with income account= billable expenses income for Invoices, expense account=billable expenses for Bills/Expenses)
Correct setup means the actual Bills and Expenses for these items, are marked and categorized as direct billable expenses (Cost of Service), when incurred, rather than overhead expenses on the Income Statement.
5.) Add IOLTA Vendor (Firm Name) for deferred revenue to earned revenue transactions.
6.) Add IOLTA Customer (Firm Name) for Interest received.
Interest earned in the IOLTA Trust Bank Account increases the deferred revenue liability account and the IOLTA Trust Bank Account. Note, that it is not recorded as P&L Interest Income (use a money in bank rule set to deposit the earned interest on the IOLTA account to a deferred revenue liability account automatically)
7.) Add Client Accounts with details and customizations (Customer or Project) Projects preferred-add Project (requires QuickBooks Online Advanced) attach contract to new Project or Client/Customer account
8.) Multi-Lawyer Firms: Add Legal Payroll Employees and/or Legal Contractor/Vendors. Timesheets for both are always fielded for the client as COS labor billable expenses item and paid from the Main Checking.
9.) Set up any class, locations or custom fields for more in depth reporting. Such as;
Area of Law Practice: Litigation, Counseling, Project, Bankruptcy, Trademark.
Office Locations or any other meaningful data; Case numbers, attorney names, et...
Follow Consistent Accounting Procedures:
Accounting in QuickBooks follows a specific and structured process. As an accrual-based system that complies with GAAP standards, following consistent accounting procedures is imperative. Proper setup of products and services, including standard sales and purchase prices, is essential for calculating COGS when no bill is linked to an invoice. The primary goal of GAAP accounting is to align expenses and bills with the revenue generated from invoices, creating a clear audit trail to connect all transactions seamlessly and produce accurate financial statements.
The accounting process is:
Estimate (optional) to PO (optional) to Bill Item or Expense Item (marked billable, attach receipt) to bank feed (transaction) matched to bill or expense, will populate the Unbilled Charges Report, adding Inventory (quantity) and COGS (amount) to your financial statements. When invoiced (add billable items to the invoice from the suggested transaction pop out drawer). This process Bill + Invoice is critical for correct accounting of Sales, COGS and Inventory, is GAAP Compliant and produces accurate financial statements.
My accounting preference is to GAAP accounting (matching purchase with revenue to calculate accurate Gross Profit) following correct workflows.
If you are pre-entering vendor or store receipts that will be billable to a client, use a bill, then match in the bank feed (bank transactions) These bills will remain on A/P until paid, from a bank feed transaction or otherwise.
Pre-entered bills will dictate whether the expense/purchase is for:
Item dropdown lines for products and services purchased for resale, typically billable items sold and matched to an invoice. OR
Category dropdown lines for indirect overhead expenses, asset purchases, liability payments, and are typically non-billable. You can enter a bill or expense for COGS directly to the Income Statement, using the category field, for cash accounting transactions only <not recommended/especially where inventory is concerned, and valuations are necessary.
Always add, customer or job, class and location to each document
The rule of COGS calculations:
An invoice (income) + bill attachment (Item: COGS) with markup = gross profit.
An invoice (income) + bill attachment (Item: COGS) and no markup is a reimbursement = zero gross profit.
An invoice with no bill or expense attachment will not calculate COGS (if not stated in your products and services), increasing your stated gross profit-income, and your tax liability.
An Invoice with only a receipt attachment may not calculate the true COGS, or COGS at all, to your income statement (from the receipt) if the price and cost are pulling from the products and services and no billable expense item is attached. Increasing gross profit income and your tax liability.
Sales, Inventory and COGS should be reconciled EOM.
Create a (BOM) monthly and save to My Accountant > Shared Documents, maintaining a historical record of Inventory, COGS and Sales.
How do you keep your products and services price and cost updated?
Average Costing of Completed Cases by Case Type (class structure)
A. Project Cost Estimate (Non-Posting)
Upon signing the engagement letter/contract, the project cost estimate is marked as accepted. This document outlines the terms and conditions of legal representation, including the scope of work, fees, and other crucial details related to IOLTA Service items that will later become billable expenses. If you have markup turned on, markup for expenses that will occur will be visible when matching in the bank feed and when invoiced from the estimate (always invoice from an approved estimate). Always make a copy of the original Project Cost Estimate before beginning the invoice process. Once an estimate is approved do not change line items or amounts.
B. Deferred Revenue-Retainer-Deposit Invoice:
(1) Create the IOLTA Client Invoice for the retainer as a whole or % (rounded to a whole number of the item being deferred) from the approved estimate and removed line items not included on the deferral invoice. The Invoice to (IOLTA service item on an Invoice increases the deferred revenue liability and the IOLTA Account). Current date, send to client for payment.
(2) Receive payment to undeposited funds and wait for IOLTA Account bank deposit matching for the entirety of the deferred retainer deposit amount invoiced.
Note: IOLTA Trust Bank Account and Deferred Revenue Liability Accounts should always be equal amounts on the balance sheet.
Notes about: Expense Items: *Paid from Main Checking
Managing Billable Expenses:
Billable Expenses (Any billable product or service): If you are using markup and have turned on markup in Accounts and Settings there are
Two ways to proceed:
(1 Items can be marked up directly from the Estimate, with markup calculated and included on the subsequent PO + Bill + Invoice. If Invoicing directly from the estimate, with predetermined marked up items, when the actual expense arrives, in the banking center, the bill, fielded for the client should NOT be marked up again, only check marked billable (to populate the Unbilled Charges Report). When earned revenue is realized directly from the estimate and invoiced, the markup is already calculated and the difference on the Income Statement is the estimated Income less the billed item (COGS) = Gross Profit with no visible markup calculations.
(2 The items are check marked billable and marked up directly on the bill (Cost Plus billing) and matched to a PO and an expense in the bank feed, then invoiced. The markup amount will appear as a separate Income line item on the Income Statement. Billable Income and Billable Expense line items should match EOM. Typical of Cost-Plus Billing, your Income will be clearly visible as the difference between Markup Income + Item Income - billed Item COGS = Gross Profit
(example: Bill $100 + 20% MU = $120 Invoiced = $20 Markup Income)
*If no markup was added to the estimate or bill, attached to an invoice, the income and COGS expense will be equal amounts known as reimbursements and should have a separate category on the Chart of Accounts to manage EOM balance.
How will you know what bank feed expense belongs to which customer? You should have already marked a PO as received, and entered a bill fielded to the customer, check marked billable, for that specific customer and amount. The bank feed expense will be matched to the unpaid bill on the Unbilled Charge Report.
Do not duplicate billable items from the original estimate, that have already been marked up and converted to an invoice. Bills and subsequent Invoicing with markup are reserved for Un-Invoiced Charges or Change Orders and are common practice for Cost Plus Billings.
(****Caution should be taken! Failure to mark an expense transaction billable or duplication of transactions can be challenging to reconcile EOM****) In either case, determine whether these bills should be marked as prepaid to a particular Job Phase and that they are attached to the Purchase Order.
Receipts for goods purchased can be uploaded to the general company forwarding email (or new AI feature) and should be attached to at least one of the PO-Bill-Invoice transactions since they are all connected.
Pre-paid Expenses (from Main Checking): (are normally expense carrying over for 12 months) However, if the firm is prepaying expenses on behalf of the client, from the Main Checking, in advance set up the Prepaid other current asset account. This process will follow GAAP matching principles.
Step (1) Create a Bill to the vendor being paid, categorized to the Prepaid Expense Current Asset (increase Prepaid) and pay the Bill from the Main Checking Account. (enter Client/Customer name and note the Expense Item in the description line, but do NOT mark billable)
Step (2) Immediately following create an opposing Bill dated to the revenue deferral date (earned revenue date) with the expense Item, previously prepaid, and mark as billable LESS (-) Prepaid Expense Current Asset category (decrease Prepaid NOT marked billable.) This net zero transaction does not affect A/P since the Bill was already paid from the Main Checking. It reduces the Prepaid Expense Current Asset on the revenue deferral date (earned revenue date) and marks the expense to be billed. The bill will populate the Unbilled Charges Report.
*Receipts can be forwarded to the company email in QBO and attached to the bills.
Step (3) Create an Invoice from the approved estimate on the same date of the revenue deferral (earned revenue date), add the Prepaid billable expense Items, from the (suggested transactions pop out drawer) to the invoice (replace estimated costs, assuming the expense line items are identical, if not leave the additional cost on the linked bill line) This will clear the unbilled charges report. Any additional cost over the original estimate is a Change Order, present on the Estimate vs Actuals Report, waiting to be invoiced. Continue to Step C....adding any other open billable expenses (change orders not part of the approved original estimate) to the invoice, followed by the movement of funds from the IOLTA Trust Bank Account to the Main Checking Account.
C. Deferred Revenue to Earned Revenue with Incurred Expenses Transition:
(1) Step 3 was: Create a separate net zero Invoice to the IOLTA Client for the total amount of the earned revenue billable service Items LESS the IOLTA Service Item for Deferred Revenue (to reduce the liability). Dated to the deferral (earned revenue), the date revenue should show up on the Income Statement. Typically, monthly billing.
*Do not send the earned revenue net zero invoice to the client/customer. For internal accounting only.
(2) Next, create a deposit from the IOLTA Account to the Main Checking Account for the same amount as the earned revenue net zero transaction, followed by an actual Bank Transfer or ACH from the IOLTA Account to Main Checking and wait for bank feed matching. This will move funds from the IOLTA Account to the Main Checking Account. Check to be sure the Deferred Revenue Liability and IOLTA bank account balances are equal.
(Note: All transactions going in and out of the IOLTA Liability Account should have the IOLTA Trust Bank Account Associated, and all Billable Expenses should be paid from the Main Checking Account. Don't forget to check your A/P and unbilled charges reports and if the case isn't closed and the IOLTA Account is depleted, go back to Step B
Below is an example of the above process(s):
D. Reconcile both the Trust Account and Main Checking accounts monthly.
If the customer deposit in the IOLTA Bank Account is depleted and the case is not closed Invoice the client, with an additional (Deferred Revenue-Retainer Deposit Invoice from the Project Cost Estimate, if still open), continuing this process until the case is closed.
Footnote: By following these steps, the business adheres to the principles of GAAP accounting, recognizing expenses as they are incurred, matching revenues with associated expenses, while accurately presenting the financial position and performance of the business over time. These steps also adhere to the rules of IOLTA Trust Accounting established by the state's legal or judicial regulatory body, such as the State Bar Association or the Supreme Court. QuickBooks Online provides a complete solution. Accounting, Payroll, Time Tracking and Integrated Applications.
**With the integration of Lean Law software or other apps your firm can create smooth, professional invoicing workflows. Pre-bill review, batch invoicing, fixed and hybrid fees such as; Rate with Contingency Fee, Fixed Fee with Performance Bonus, Subscription-Based with Project Add-ons, Retainer Fee with Success Fee, Hourly Rate with Equity Stake, Commission with Base Salary, and create LEDES invoices (Legal Electronic Data Exchange Standard) with UBTMS, or (Uniform Task-Based Management System) for Coding, custom invoices, electronic payments, batch invoice payments (including those from trust accounts). QuickBooks Online is the source of truth for accounting data. Lean Law adds legal customization. Use of this app may require additional customizations within QuickBooks Online depending on your firm's requirements.
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