Accounting procedures and entries - Transfers between client and office accounts

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. You will learn the specific SRA Accounts Rules that govern these transfers, particularly the requirement to deliver a bill before transferring client money for costs. After reading this article, you should understand the permissible circumstances for such transfers, the necessary accounting entries using the double-entry bookkeeping system, and how to handle mixed receipts involving both client and business money, ensuring compliance with regulatory standards relevant to the SQE1 assessment.

SQE1 Syllabus

For SQE1, you need a practical understanding of how money is transferred between client and business bank accounts in compliance with the SRA Accounts Rules 2019. This involves knowing when transfers are permitted, particularly in relation to paying the firm's costs, and the accounting entries required.

As you revise this topic, focus on:

• 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).

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.

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).

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.

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.

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.

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.

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.

1. Payment from Client Account:
   • DR Client Ledger (Client Account column)
   • CR Cash Account (Client Account column)
2. 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:

1. Transfer out of Client Account: DR Client Ledger (Client A) Client Account £720
   CR Cash Account Client Account £720
2. Transfer into Business Account: DR Cash Account Business Account £720
   CR Client Ledger (Client A) Business Account £720

Note: The initial 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.

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 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.
3. Advancing Funds: A firm might advance its own money into the client account to cover a necessary payment for a client if insufficient client funds are available at that moment (Rule 14.2(b)). This advance then becomes client money.

Accounting Entries (Business to Client Transfer):

This also involves two pairs of double entries:

1. Payment from Business Account:
   • DR Client Ledger (Business Account column)
   • CR Cash Account (Business Account column)
2. Receipt into Client Account:
   • DR Cash Account (Client Account column)
   • CR Client Ledger (Client Account column)

Worked Example 1.2

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: The firm must immediately transfer £500 from the business account to the client account. The entries are:

1. Transfer out of Business Account: DR Client Ledger (relevant client) Business Account £500
   CR Cash Account Business Account £500
2. Transfer into Client Account: DR Cash Account Client Account £500
   CR Client Ledger (relevant client) Client Account £500

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.

Handling Mixed Receipts

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

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

Rule 4.2 requires that firms allocate funds from mixed payments promptly to the correct account (client or business).

Options for Handling Mixed Receipts:

1. Split the Payment (if possible): If feasible (e.g., receiving two separate cheques or the bank allows splitting a single cheque), the firm can pay the client money element directly into the client account and the business money element into the business account. This requires two separate pairs of double entries upon receipt. This is rare in practice.
2. Pay All into One Account, then Transfer: The more common method is to pay the entire mixed receipt into either the client account or the business account initially. The portion belonging to the other account must then be transferred out promptly.
   • Initial Payment into Client Account: If the whole sum goes into the client account first, the business money element must be transferred to the business account promptly (using a client-to-business cash transfer).
   • Initial Payment into Business Account: If the whole sum goes into the business account first, the client money element must be transferred to the client account promptly (using a business-to-client cash transfer).

The SRA has not defined 'promptly' but previous rules suggested 14 days for client-to-business transfers, and immediate/next working day for business-to-client transfers. Firms should have a clear policy. Paying into the client account first is often preferred as it minimises the risk of inadvertently using client money from the business account.

Worked Example 1.3

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. The accounting entries for this transfer are:

1. Transfer out of Client Account: DR Client Ledger (Client B) Client Account £500; CR Cash Account Client Account £500
2. Transfer into Business Account: DR Cash Account Business Account £500; CR Client Ledger (Client B) Business Account £500

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.
• 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 earned on the general client account.
• 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.

Key Terms and Concepts

• Business Money
• Client Money
• Cash Transfer
• Bill of Costs
• Mixed Receipt