## **Learning Outcomes**

This article explains how debits and credits operate within client account records, focusing on liability and equity accounts and how these are examined in SQE1, including:

- Applying double-entry bookkeeping principles to client money, business money and mixed receipts
- Identifying asset, liability and equity accounts and predicting whether a debit or credit increases or decreases each balance
- Recording and interpreting entries on the cash sheet client columns and corresponding client ledgers, including reconciliations
- Mapping journals across client, business and equity ledgers so that every transaction is captured with equal and opposite entries
- Distinguishing clearly between client money and office (business) money and correcting breaches while maintaining SRA compliance
- Tracing the effect of withdrawals, transfers, bills, disbursements and profit allocations on client liabilities and partners’ equity
- Analysing common SQE1-style scenarios and avoiding typical exam pitfalls in client account and partners’ capital/current account questions
- Linking the accounting treatment of transactions to key SRA Accounts Rules requirements on segregation, banking of client funds and withdrawals
- Using concise journal narratives and ledger postings to explain your reasoning step by step in exam answers and MCQ reasoning

## **SQE1 Syllabus**

For SQE1, you are required to understand the operation of client accounts, including the correct use of debits and credits in liability and equity accounts, with a focus on the following syllabus points:

- the double-entry bookkeeping system as applied to client accounts in legal practice
- how to record and interpret debits and credits in liability accounts (such as client ledgers)
- how equity accounts (such as partners’ capital and current accounts) are structured and updated
- the SRA Accounts Rules requirements for accurate and compliant record-keeping
- the impact of these entries on the firm’s obligations to clients and partners.
- the use of journal entries to summarise double-entry postings across cash sheet and client/business ledgers
- the separation of client money and business money and how to correct breaches promptly

## **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. When a law firm receives client money, which accounts are debited and credited in the double-entry system?
2. What is the effect of a credit entry in a client liability account?
3. How does a debit entry in a partner’s capital account affect the equity of the firm?
4. True or false? A payment out of the client account to a third party always results in a debit to the client liability account.

## **Introduction**

Client accounts are central to legal practice, ensuring that money held for clients is kept separate and properly recorded. Understanding how debits and credits work in liability and equity accounts is essential for both compliance with the SRA Accounts Rules and for accurate financial management. This article explains the double-entry bookkeeping principles as they apply to client accounts, focusing on liability (such as client ledgers) and equity (such as partners’ capital) accounts, and highlights common exam issues. It also clarifies how client money movements are captured on the cash sheet (client columns) and mirrored on the relevant client ledger, and how firm equity movements are recorded in partners’ capital and current accounts.

> **Key Term: double-entry bookkeeping**  
> A system where every financial transaction is recorded in two accounts, with equal and opposite debit and credit entries.

The main types of accounts relevant to client money are:

- Asset accounts (e.g., client bank account)
- Liability accounts (e.g., client ledger accounts)
- Equity accounts (e.g., partners’ capital/current accounts)

> **Key Term: client account**  
> A bank account used by a law firm to hold money on behalf of clients, separate from the firm’s own funds.
>
> **Key Term: cash sheet**  
> The primary record of receipts and payments into and out of the firm’s bank accounts. Most firms maintain business columns and client columns side by side. In the client columns, receipts are debits; payments out are credits.
>
> **Key Term: client ledger**  
> A ledger for each client/matter showing money held (client columns) and transactions relating to costs (business columns). Credits in the client columns increase the amount owed to the client; debits reduce it.
>
> **Key Term: journal entry**  
> A concise description of a double-entry posting identifying the ledgers and whether each entry is a debit (DR) or credit (CR).

## Double-Entry Bookkeeping and Client Accounts

Law firms use double-entry bookkeeping to record all financial transactions. Every transaction affects at least two accounts, with one account debited and another credited for the same amount. This ensures the accounting equation remains balanced.

> **Key Term: double-entry bookkeeping**  
> A system where every financial transaction is recorded in two accounts, with equal and opposite debit and credit entries.

The main types of accounts relevant to client money are:

- **Asset accounts** (e.g., client bank account)
- **Liability accounts** (e.g., client ledger accounts)
- **Equity accounts** (e.g., partners’ capital/current accounts)

> **Key Term: client account**  
> A bank account used by a law firm to hold money on behalf of clients, separate from the firm’s own funds.

In client money transactions, remember the accounting treatment:

- On the cash sheet client columns, receipts are DR (money in), payments out are CR (money out).
- On the client ledger client columns, credits increase the amount owed to the client (liability), and debits reduce it.

This opposite direction between the cash sheet and the client ledger is a frequent source of error; mapping the journal entries first reduces mistakes.

## Debits and Credits in Liability Accounts

Liability accounts in legal practice typically represent amounts owed by the firm to clients or third parties. The client ledger is the main liability account for each client matter.

- **Credit entries** in a client liability account increase the amount owed to the client (e.g., when client money is received).
- **Debit entries** decrease the liability (e.g., when money is paid out on the client’s behalf).

> **Key Term: client liability account**  
> A record showing the amount owed by the firm to a specific client, increased by credits and decreased by debits.

Common liability movements include:

- Receipts of client money (e.g., proceeds of sale; deposits; mortgage advances held for a lender): CR on the client ledger client columns; DR on the cash sheet client columns.
- Payments out for the client (e.g., completion monies; disbursements via agency method where invoices are in the client’s name): DR on the client ledger client columns; CR on the cash sheet client columns.
- Transfers from client to business account to pay the firm’s bill (after delivery): a two-step journal—client side DR client ledger client columns and CR cash sheet client columns; business side CR client ledger business columns and DR cash sheet business columns.

> **Key Term: cash sheet**  
> The primary record of receipts and payments into and out of the firm’s bank accounts. Most firms maintain business columns and client columns side by side. In the client columns, receipts are debits; payments out are credits.

### **Worked Example 1.1**

A firm receives £10,000 from a client for a property purchase. Which entries are made?

> **Answer:** Credit the client liability account (increasing the amount owed to the client) and debit the client bank account (increasing the firm’s asset).

### **Worked Example 1.2**

The firm pays £2,000 from the client account to the seller’s solicitor on completion. What entries are made?

> **Answer:** Debit the client liability account (reducing the amount owed to the client) and credit the client bank account (reducing the asset).

### **Worked Example 1.3**

A final bill for £1,200 (profit costs £1,000 + VAT £200) is delivered and paid by transferring funds already held in the client account. Show the journal entries across the client and business sides.

> **Answer:** Client side: debit the client ledger client account and credit the cash sheet client account £1,200 (withdrawal reduces liability). Business side: credit the client ledger business account £1,200 and debit the cash sheet business account £1,200 (receipt into business bank).

### **Worked Example 1.4**

£500 is received “on account of costs and unpaid disbursements” before any bill. What entries are required?

> **Answer:** Credit the client ledger client account £500 (liability increases) and debit the cash sheet client account £500 (client receipt). This remains client money until a bill is delivered.

### **Worked Example 1.5**

A £1,000 cheque received on account of costs bounces after a £400 payment for a disbursement has been made from the client account. How should the firm correct the breach?

> **Answer:** Immediately transfer £400 from business to client account to restore the client account position (debit cash sheet client account £400; credit cash sheet business account £400). Record a corresponding credit on the client ledger client account and debit on the client ledger business account to reflect the temporary support, then unwind once cleared funds are received.

## Debits and Credits in Equity Accounts

Equity accounts represent the owners’ (partners’ or shareholders’) interest in the firm after liabilities are deducted from assets. In law firms, these include capital accounts (initial and subsequent investments) and current accounts (undistributed profits, drawings, etc.).

- **Credit entries** in equity accounts increase the firm’s equity (e.g., profit allocation, capital introduced).
- **Debit entries** decrease equity (e.g., drawings, loss allocation).

> **Key Term: equity account**  
> An account showing the owners’ interest in the firm, including capital introduced, retained profits, and drawings.
>
> **Key Term: capital account**  
> A record of each partner’s or owner’s long-term investment in the firm.
>
> **Key Term: current account**  
> A record of each partner’s share of profits, losses, and drawings during the accounting period.

Movements commonly tested:

- Capital introduced: CR partner’s capital account (equity rises); DR business bank (asset rises).
- Drawings: DR partner’s current account (reduces equity); CR business bank (cash out).
- Profit allocations: CR partners’ current accounts (equity rises); DR profit and loss appropriation or retained profits.

### **Worked Example 1.6**

A partner introduces £20,000 capital to the firm. What are the entries?

> **Answer:** Debit the firm’s business bank account (asset increases), credit the partner’s capital account (equity increases).

### **Worked Example 1.7**

The firm allocates £60,000 profit equally to three partners. How are the entries made?

> **Answer:** Debit the profit and loss account (closing profits), credit each partner’s current account with £20,000 (equity increases).

### **Worked Example 1.8**

A partner draws £5,000 during the year. What are the entries?

> **Answer:** Credit the business bank account £5,000 (cash decreases) and debit the partner’s current account £5,000 (equity decreases).

### **Worked Example 1.9**

A £30,000 loss is allocated equally between three partners at year end. What are the entries?

> **Answer:** Credit the profit and loss account £30,000 (recognising allocation) and debit each partner’s current account £10,000 (reducing equity).

## SRA Accounts Rules: Compliance and Common Pitfalls

The SRA Accounts Rules require firms to keep accurate records of all client money, ensuring that:

- Client money is paid promptly into a client account.
- Client money is not mixed with business money.
- Withdrawals from the client account do not exceed the amount held for each client.

> **Key Term: SRA Accounts Rules**  
> The regulatory requirements governing how solicitors must handle and record client money.

The core provisions to anchor your entries and decisions:

- Rule 2.1 defines client money (including money on account of costs and unpaid disbursements prior to billing).
- Rule 2.3 requires prompt payment of client money into a client account (the practical expectation is same or next working day).
- Rule 2.4 requires client money to be available on demand unless a written alternative is agreed (e.g., designated deposit accounts with notice).
- Rule 3.3 prohibits using the client account to provide banking facilities; withdrawals and deposits must be connected to regulated services.
- Rule 4.1 requires separation of client and business money; Rule 4.2 requires mixed payments to be promptly allocated to the correct account.
- Rule 5.1–5.3 govern withdrawals from client account: for their intended purpose; only with sufficient funds for that specific client; with appropriate authorisation and controls.
- Rule 6.1 requires breaches to be corrected promptly upon discovery.
- Rule 7 requires payment of a fair sum of interest on client money, subject to any written alternative arrangement (firms should hold a clear interest policy).
- Rule 8 requires accurate contemporaneous records and reconciliations at least every five weeks.

> **Key Term: Compliance Officer for Finance and Administration (COFA)**  
> The individual responsible for ensuring the firm complies with the Accounts Rules, including recording and reporting material breaches and overseeing prompt rectification.

### **Exam Warning**

> A common error is to reverse debits and credits in liability accounts. Remember: credit increases the liability (amount owed to the client), debit reduces it. On the cash sheet client columns, receipts are debits and payments out are credits; the client ledger client columns move in the opposite direction.

Other traps:

- Transferring business money (fees after bill) from client account without an identifiable bill amount—Rule 4.3 requires a bill or written notification before transfer.
- Paying disbursements from client account without sufficient funds for that client—Rule 5.3 prohibits using other clients’ money.
- Allowing client account to be used as a general pass-through unconnected to legal work—contrary to Rule 3.3.

### **Worked Example 1.10**

On completion, a client requests immediate return of a surplus £20,000 held in the client account. What entries and rule considerations apply?

> **Answer:** Debit the client ledger client account £20,000 and credit the cash sheet client account £20,000 (payment out reduces the liability). Rule 2.4 requires client money to be available on demand; absent a written alternative arrangement, funds should be returned promptly.

## Recording Transfers Between Clients

Sometimes, money must be transferred from one client ledger to another (e.g., when part of a settlement is paid to a third party client).

### **Worked Example 1.11**

Client A’s ledger shows a £5,000 credit. £1,000 is to be transferred to Client B. What are the entries?

> **Answer:** Debit Client A’s ledger (reducing liability to A), credit Client B’s ledger (increasing liability to B). No change to the client bank account total.

This type of inter-client transfer has no cash sheet effect (the money remains in the client account overall). Ensure authority and clear narration in both ledgers, and comply with any specific restrictions applicable to the matter (e.g., stakeholder arrangements, lender conditions on mortgage advances).

### **Worked Example 1.12**

An estate administration completes, and £10,000 is retained for a beneficiary’s house purchase handled by the firm. How is the transfer recorded?

> **Answer:** Debit the executors’ client ledger £10,000 and credit the beneficiary’s client ledger £10,000. No cash sheet entry (the total client account balance is unchanged).

## Equity Accounts in Partnerships and Companies

In partnerships, each partner’s capital and current accounts must be kept up to date. In companies, equity is shown as share capital and retained earnings.

- Capital introduced: credit capital account.
- Drawings: debit current account.
- Profit allocation: credit current account.

Equity balances reflect ownership interests and profit distribution policies. In partnership accounting, an appropriation account is often used to allocate net profit (or loss), salaries and interest on capital before posting to partners’ current accounts.

### **Worked Example 1.13**

Partners agree that interest on capital at 5% is credited before profit sharing. Capital balances are Partner X £100,000 and Partner Y £60,000; net profit is £50,000 split equally after interest. What entries are made?

> **Answer:** Credit X current account £5,000; credit Y current account £3,000; debit profit and loss appropriation £8,000. The remaining £42,000 is allocated equally: credit X current account £21,000; credit Y current account £21,000; debit profit and loss appropriation £42,000.

### **Revision Tip**

> For exam questions, always identify the type of account (asset, liability, equity) before deciding whether a debit or credit increases or decreases the balance. Map the cash sheet entry (client or business columns) and the corresponding client or partner ledger entry, then express the outcome as a journal entry.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Double-entry bookkeeping requires every transaction to be recorded as equal and opposite debits and credits.
- Client liability accounts are credited when client money is received and debited when money is paid out.
- On the cash sheet client columns, receipts are debits and payments out are credits; the client ledger client columns move in the opposite direction.
- Equity accounts are credited for capital introduced and profits, debited for drawings and losses.
- The SRA Accounts Rules require accurate, separate records for client money and equity, prompt banking of client money, withdrawals only with sufficient client funds, and prohibition on using the client account as a banking facility.
- Transfers between client ledgers are recorded as a debit to one client and a credit to another, with no effect on the client bank account total.
- Journal entries concisely summarise double-entry postings; use them to ensure both sides of the transaction are captured in the correct ledgers.
- Correct identification of account types and separation of client and business money is essential for accurate entries and compliance.

## **Key Terms and Concepts**

- double-entry bookkeeping
- client account
- client liability account
- equity account
- capital account
- current account
- SRA Accounts Rules
- cash sheet
- client ledger
- journal entry
- Compliance Officer for Finance and Administration (COFA)


Client accounts - Debits and credits in liability and equity accounts