Accounting procedures and entries - Transfers between client...

Learning Outcomes

This article explains the procedures and accounting entries required when transferring money between a firm's client bank account and its business bank account, including:

• SRA Accounts Rules governing transfers, particularly the requirement to deliver a bill before transferring client money for costs
• Permissible circumstances for client-to-business and business-to-client transfers
• Double-entry bookkeeping and ledger entries for cash transfers
• Handling mixed receipts involving both client and business money
• Controls, authorisations, supervision, and sufficient client funds before withdrawals
• Billing for anticipated disbursements and future work, and treatment of billed anticipated disbursements remaining in the client account
• Common pitfalls and breach correction, including the prohibition on using the client account as a banking facility and remedies for mispostings or shortfalls
• Practical journal entries for scenarios such as partial transfers, interest payments to clients, and transfers to rectify errors (e.g., dishonoured cheques)
• Regulatory compliance considerations relevant to the SQE1 assessment

SQE1 Syllabus

For SQE1, you are required to understand how money is transferred between client and business bank accounts in compliance with the SRA Accounts Rules 2019, including when transfers are permitted, particularly in relation to paying the firm's costs, and the accounting entries required, with a focus on the following syllabus points:

• The requirement to keep client money separate from the firm’s own money (Rule 4.1).
• The rules governing the transfer of client money to pay the firm’s costs, including the necessity of delivering a bill (Rule 4.3).
• The accounting entries required for cash transfers between the client bank account and the business bank account.
• Procedures for handling mixed receipts containing both client and business money (Rule 4.2).
• The need to correct breaches promptly, particularly those involving improper transfers (Rule 6.1).
• The requirement to supervise and authorise withdrawals from the client account appropriately, and only withdraw if sufficient funds are held for the specific client (Rules 5.2 and 5.3).
• The prohibition on using a client account to provide banking facilities and the link to money laundering risk (Rule 3.3).

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Under which SRA Accounts Rule can a firm transfer money from the client bank account to the business bank account to pay its billed costs?
   1. Rule 2.3
   2. Rule 4.3
   3. Rule 5.1
   4. Rule 7.1
2. A firm receives a single payment of £1,500 from a client. £500 is in payment of a delivered bill, and £1,000 is money on account of future costs. What is the best initial action under the SRA Accounts Rules?
   1. Pay the entire £1,500 into the business account.
   2. Pay the entire £1,500 into the client account.
   3. Split the payment, paying £500 into the business account and £1,000 into the client account.
   4. Return the payment and ask for two separate cheques.
3. A firm holds £500 for Client X in the client bank account. The firm issues a bill for £700. Which statement is correct regarding transferring money to pay the bill?
   1. The firm can transfer £700 from the client account to the business account.
   2. The firm can transfer £500 from the client account to the business account immediately.
   3. The firm must wait for the client to pay the £700 into the business account.
   4. The firm can transfer £500 from the client account only after receiving the additional £200 from the client.

Introduction

Law firms handle both their own money (business money) and money belonging to clients or third parties (client money). The SRA Accounts Rules 2019 (the Rules) mandate the strict separation of these funds (Rule 4.1). However, situations arise where money needs to be transferred between the firm’s client bank account and its business bank account. Understanding the rules and procedures for these transfers is essential for compliance and maintaining the safety of client money. This article focuses on these transfers, often called cash transfers, outlining the permissible circumstances and the required accounting entries.

Transfers must be considered within the wider framework of the Rules:

• Client money should be paid promptly into the client account unless a specific exception applies (Rule 2.3).
• Client money must be available on demand unless an alternative arrangement is clearly agreed in writing (Rule 2.4).
• The client account must not be used as a banking facility purely for convenience or cashflow management—payments in and out must relate to regulated legal services (Rule 3.3).
• Withdrawals from the client account must be properly authorised, supervised, and only made if sufficient funds are held for the specific client (Rules 5.2 and 5.3).
• Any breach, including mispostings or shortfalls, must be corrected promptly (Rule 6.1).

Key Term: Business Money
Money belonging to the firm itself, such as money received for billed costs, or funds to cover the firm's operational expenses.

Key Term: Client Money
Money held or received by a firm relating to regulated services, belonging to a client or third party, including money held as trustee, agent, stakeholder, or money received for unbilled fees and disbursements (Rule 2.1).

Key Term: Cash Transfer
The movement of funds between a firm’s client bank account and its business bank account. Each transfer requires corresponding entries in the firm's ledgers and cash account.

Key Term: Bill of Costs
A formal invoice issued by a law firm to a client detailing the professional fees (profit costs) and disbursements incurred for legal services provided.

Key Term: Mixed Receipt
A payment received by the firm comprising both client money and money belonging to the firm (business money).

Key Term: Sum in Lieu of Interest
A fair amount paid by the firm to a client to reflect interest attributable to client money held in a general client account (Rule 7.1), typically transferred from business to client account.

Key Term: Anticipated Disbursements
Disbursements billed in advance that have not yet been incurred or paid. Under SRA guidance, even if billed these may suitably remain in the client account until actually paid to protect the client.

Cash Transfers: Moving Money Between Accounts

A cash transfer involves the movement of money from the client bank account to the business bank account, or vice versa. These transfers must be accurately recorded in the firm's accounting records using double-entry bookkeeping principles.

A robust approach includes:

• Ensuring that the transfer relates to an allowable purpose (e.g. payment of a delivered bill; correcting a breach; paying a sum in lieu of interest).
• Checking the client ledger shows a sufficient credit balance for the particular client before withdrawing client money (Rule 5.3).
• Ensuring authorisation/sign-off and supervision in accordance with internal policy (Rule 5.2), normally by senior personnel or the COFA.
• Recording the two related pairs of entries—out of one bank account and into the other—so ledgers and cash account are consistent and complete.

Client to Business Transfers

The most common reason for a client-to-business transfer is to pay the firm's billed costs. Rule 4.3 governs this process strictly.

Rule 4.3 Requirements:

A firm can only transfer client money from a client account to pay its costs if:

• A bill of costs or other written notification of costs incurred has been given to the client or paying party.
• The transfer is made after the bill has been delivered.
• The transfer is for the specific sum identified in the bill and is covered by the amount held for that particular client.

Delivery of a bill allows the firm to transfer client money for the profit costs and any disbursements included on the bill. However, in line with SRA guidance, if the bill includes anticipated disbursements (not yet incurred or paid), the sums billed for those anticipated items should remain in the client account until the disbursements are actually incurred and paid. This protects clients from the risks that may arise if those sums are held in the firm’s business account but the matter does not proceed or the firm suffers an insolvency event.

Accounting Entries (Client to Business Transfer for Costs):

This transfer involves two pairs of double entries, reflecting money moving out of the client account and into the business account.

• Payment from client account:
  • DR Client Ledger (Client Account column)
  • CR Cash Account (Client Account column)
• Receipt into business account:
  • DR Cash Account (Business Account column)
  • CR Client Ledger (Business Account column)

Many firms record these two stages on a single line in the ledgers for efficiency, clearly marking it as a transfer.

Worked Example 1.1

A firm holds £1,000 for Client A in the client bank account on account of costs. On 15th May, the firm issues a bill to Client A for £600 profit costs plus £120 VAT (£720 total). On 16th May, the firm transfers the amount due from the client account to the business account.

What are the journal entries for the transfer on 16th May?

Answer:

• Transfer out of Client Account: DR Client Ledger (Client A) Client Account £720; CR Cash Account Client Account £720
• Transfer into Business Account: DR Cash Account Business Account £720; CR Client Ledger (Client A) Business Account £720

Note: The bill on 15th May would have been recorded as DR Client Ledger Business Account £720 (split between profit costs and VAT); CR Profit Costs Ledger £600; CR HMRC VAT Ledger £120.

Partial Transfers when Insufficient Funds Are Held

Where the client ledger shows a smaller credit balance than the billed amount, the firm may only transfer up to the amount held for that specific client. The remainder must be collected from the client or paid direct into the business account as business money.

Worked Example 1.2

A firm holds £500 for Client C in the client bank account. It delivers a bill for £700 (£583.33 fees + £116.67 VAT). The client has not yet paid anything further.

What can be transferred now and what entries are required?

Answer:

• The firm may transfer only £500 now, as that is the amount held for Client C.
• Transfer out of Client Account: DR Client Ledger (Client C) Client Account £500; CR Cash Account Client Account £500
• Transfer into Business Account: DR Cash Account Business Account £500; CR Client Ledger (Client C) Business Account £500

The unpaid balance of £200 remains due and should be settled by the client into the business account (recorded as DR Cash Account Business Account £200; CR Client Ledger (Client C) Business Account £200 when paid).

Billing Future Work and Anticipated Disbursements

Rule 4.3 permits transfer of client money for costs once a bill or other written notification has been delivered. Firms may issue bills for work done to date and, in some instances, for future work. If a bill contains anticipated disbursements not yet incurred or paid, the SRA’s guidance expects the sums relating to those anticipated disbursements to remain in the client account until the firm actually pays those disbursements. This approach safeguards clients and avoids placing them at risk.

Worked Example 1.3

A firm holds £2,500 for Client D on account. It delivers a bill for £1,200 profit costs + £240 VAT and includes an anticipated disbursement of £1,000 Land Registry fees.

What transfers may be made from the client account?

Answer:

• The firm may transfer only the costs already billed and incurred (£1,200 + £240 = £1,440).
• Sums for the anticipated disbursement (£1,000) remain in the client account until paid.
• Entries:
  • Transfer out of Client Account: DR Client Ledger (Client D) Client Account £1,440; CR Cash Account Client Account £1,440
  • Transfer into Business Account: DR Cash Account Business Account £1,440; CR Client Ledger (Client D) Business Account £1,440

Business to Client Transfers

Transfers from the business account to the client account are less common but necessary in specific situations:

1. Correcting breaches: If client money was wrongly paid into the business account, or if money was improperly withdrawn from the client account (creating a shortfall), the firm must immediately transfer its own business money into the client account to rectify the breach (Rule 6.1).
2. Paying interest: If the firm calculates that interest (or a fair sum in lieu of interest) is due to a client on money held in the general client account, it must transfer a sum in lieu of interest from the business account to the client account (Rule 7.1).
3. Advancing funds: If a payment for a client must be made urgently but there is an insufficient client balance, the firm may advance its own money to the client account to make the payment. Once paid in, the advance becomes client money and is subject to the Rules.

Key Term: COFA
The Compliance Officer for Finance and Administration is the person responsible for ensuring compliance with the SRA Accounts Rules and overseeing systems and controls for client account operation.

Accounting Entries (Business to Client Transfer):

As above, two pairs of entries are required:

• Payment from business account:
  • DR Client Ledger (Business Account column)
  • CR Cash Account (Business Account column)
• Receipt into client account:
  • DR Cash Account (Client Account column)
  • CR Client Ledger (Client Account column)

Worked Example 1.4

A firm incorrectly paid a client receipt of £500 (money on account of costs) into its business bank account instead of the client bank account. The error is discovered the next day.

What accounting entries are required to correct this breach?

Answer:

• Transfer out of Business Account: DR Client Ledger (relevant client) Business Account £500; CR Cash Account Business Account £500
• Transfer into Client Account: DR Cash Account Client Account £500; CR Client Ledger (relevant client) Client Account £500

This correction must be done immediately upon discovery to remedy the breach (Rule 6.1).

Worked Example 1.5

A firm calculates a sum in lieu of interest of £80 for Client E on completion of a matter. It needs to pay the £80 from business to client account.

What are the entries?

Answer:

• Transfer out of Business Account: DR Client Ledger (Client E) Business Account £80; CR Cash Account Business Account £80
• Transfer into Client Account: DR Cash Account Client Account £80; CR Client Ledger (Client E) Client Account £80

Exam Warning

Remember that under Rule 4.3, a transfer from the client account to the business account for costs can only occur after a bill or written notification of costs has been delivered to the client. Transferring funds before billing is a breach of the Rules.

In addition:

• Never withdraw client money unless the firm holds sufficient funds for that specific client (Rule 5.3). Using other clients’ money will breach the Rules.
• Do not use the client account to provide banking facilities for clients or third parties (Rule 3.3). Payments must relate to regulated legal services.
• Ensure appropriate authorisation and supervision of withdrawals and transfers (Rule 5.2), and correct any breach promptly (Rule 6.1).

Handling Mixed Receipts

A mixed receipt is a single payment received by the firm that contains both client money and business money.

Rule 4.2 requires that firms allocate funds from mixed payments promptly to the correct account (client or business). The Rules do not define “promptly”; good practice, derived from prior arrangements and current guidance, is immediate or next working day for business-to-client reallocations and within a short, clear policy window (often up to 14 days) for client-to-business reallocations.

Options for Handling Mixed Receipts:

• Split the payment (if feasible): Rare in practice, as banks usually do not split cheques. If the bank allows a split, pay client money to the client account and business money to the business account at the outset.
• Pay all into one account, then transfer:
  • Initial payment into client account: Transfer the business money element to the business account promptly (client-to-business transfer).
  • Initial payment into business account: Transfer the client money element promptly into the client account (business-to-client transfer).

Paying mixed receipts into the client account first is commonly preferred to minimise the risk of business money being temporarily mixed with client funds in the business account, and to avoid any risk of client money being retained incorrectly outside the client account.

Worked Example 1.6

A firm receives a bank transfer of £1,500 from Client B. £1,000 is money on account of costs (client money) and £500 is payment for a bill already delivered (business money). The firm pays the full £1,500 into the client bank account.

What further action is required?

Answer:

• The firm must promptly transfer the £500 business money element from the client account to the business account.
• Transfer out of Client Account: DR Client Ledger (Client B) Client Account £500; CR Cash Account Client Account £500
• Transfer into Business Account: DR Cash Account Business Account £500; CR Client Ledger (Client B) Business Account £500

Worked Example 1.7

A firm receives £2,000 by bank transfer, paid in error to the business account. £1,600 relates to net conveyancing proceeds (client money), and £400 pays a delivered bill (business money).

How should the firm regularise the posting?

Answer:

• Transfer the £1,600 client money element promptly to the client account:
  • Out of Business Account: DR Client Ledger (relevant client) Business Account £1,600; CR Cash Account Business Account £1,600
  • Into Client Account: DR Cash Account Client Account £1,600; CR Client Ledger (relevant client) Client Account £1,600
• The £400 business money element remains in the business account (recorded on the client ledger business account and cash account when the receipt is recognised).

Worked Example 1.8

A client’s cheque for £1,000 paid into the client account bounces after the firm has already paid out £800 for a disbursement. This creates a shortfall attributable to the client.

What corrective steps and entries are required?

Answer:

• The firm must immediately replace the shortfall from its business account:
  • Transfer out of Business Account: DR Client Ledger (relevant client) Business Account £800; CR Cash Account Business Account £800
  • Transfer into Client Account: DR Cash Account Client Account £800; CR Client Ledger (relevant client) Client Account £800
• The client remains liable to reimburse the firm. Any subsequent repayment by the client will be posted into the business account.

Operational Controls and Common Pitfalls

Transfers are high-risk steps if controls are weak. Maintain:

• Written procedures for authorising withdrawals and transfers, with a clear list of authorised signatories and approval workflow (linked to Rule 5.2).
• A requirement to check the client ledger balance before every withdrawal from the client account (Rule 5.3).
• A central record of bills and written notifications of costs (Rule 8.4) to justify client-to-business transfers.
• Reconciliations at least every five weeks for client accounts (Rule 8.2–8.3) so mispostings and shortfalls are identified rapidly.
• A clear policy on “promptly” and consistent application for mixed receipts; record reasons where timing deviates.

Avoid:

• Using client account as a banking facility or convenience for unrelated payments (Rule 3.3).
• Transferring round sums on account of costs not supported by a delivered bill (Rule 4.3).
• Paying for a client’s disbursement from the client account when insufficient client funds are held—either request funds first or pay from business account and later recharge.
• Retaining residual client balances indefinitely—return promptly when no longer needed; where the owner cannot be traced, follow the SRA’s residual balance guidance and prescribed circumstances for charitable payments.

Key Point Checklist

This article has covered the following key knowledge points:

• Firms must keep client money and business money separate (Rule 4.1).
• Cash transfers move money between the client bank account and the business bank account.
• A client-to-business transfer for costs is only permitted after a bill or written notification of costs has been delivered (Rule 4.3) and only for the specific sum billed.
• If a bill includes anticipated disbursements not yet incurred or paid, those amounts should remain in the client account until payment to the third party, safeguarding the client.
• The accounting entries for a client-to-business transfer involve debiting the client ledger (client account) and crediting the cash account (client account), then debiting the cash account (business account) and crediting the client ledger (business account).
• A business-to-client transfer is necessary to correct breaches (e.g., client money paid into business account) or to pay interest owed to clients on the general client account (Rule 7.1).
• The accounting entries for a business-to-client transfer involve debiting the client ledger (business account) and crediting the cash account (business account), then debiting the cash account (client account) and crediting the client ledger (client account).
• Mixed receipts contain both client and business money and must be allocated promptly to the correct accounts (Rule 4.2), usually by paying into one account and transferring the relevant portion to the other.
• Withdrawals must be authorised and supervised appropriately and only made if sufficient funds are held for that particular client (Rules 5.2 and 5.3).
• Any breach must be corrected promptly on discovery, often by immediate business-to-client transfer to restore the client account (Rule 6.1).
• The client account must not be used to provide banking facilities (Rule 3.3).

Key Terms and Concepts

• Business Money
• Client Money
• Cash Transfer
• Bill of Costs
• Mixed Receipt
• Sum in Lieu of Interest
• Anticipated Disbursements
• COFA