Client accounts - Solicitors' account entries and double-entry bookkeeping principles

Learning Outcomes

This article explains the core principles of double-entry bookkeeping as they apply to solicitors' accounts. It outlines the fundamental requirements of the SRA Accounts Rules for managing client money, distinguishing it from business money, and ensuring its safety. After reading this article, you will understand the basic mechanics of recording financial transactions, such as receipts and payments, in the required ledger accounts, providing foundational knowledge essential for SQE1 assessments involving client account management.

SQE1 Syllabus

For SQE1, you are required to understand the basic principles of double-entry bookkeeping and how these apply to the management of client and business money within a law firm. This includes the requirements set out in the SRA Accounts Rules. A core understanding of these principles is necessary to correctly interpret scenarios involving financial transactions in legal practice.

As you work through this article, remember to pay particular attention in your revision to:

• the concept of double-entry bookkeeping (debits and credits)
• the distinction between client money and business money
• the requirement to keep client money separate from business money
• the basic operation of client and business accounts within ledgers
• recording simple receipts and payments accurately.

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. Which accounting principle states that every transaction must be recorded with both a debit and a credit entry?
   1. Accruals concept
   2. Prudence concept
   3. Double-entry bookkeeping
   4. Going concern concept
2. Which of the following is generally considered 'client money' under the SRA Accounts Rules?
   1. Money received from a client in payment of a bill already delivered.
   2. Money received from a client on account of costs before a bill is delivered.
   3. Money belonging solely to the law firm for its operational expenses.
   4. Interest earned on the firm's business bank account.
3. A firm receives £5,000 from a client specifically to be held for a property purchase deposit. Which is the correct initial double entry?
   1. DR Cash Sheet (Business), CR Client Ledger (Business)
   2. DR Client Ledger (Client), CR Cash Sheet (Client)
   3. DR Cash Sheet (Client), CR Client Ledger (Client)
   4. DR Cash Sheet (Business), CR Client Ledger (Client)

Introduction

Understanding how law firms manage money is fundamental to legal practice. Solicitors frequently handle funds belonging to clients and must do so with accuracy and integrity, adhering to strict regulatory requirements. This involves applying basic accounting principles, particularly double-entry bookkeeping, within the framework of the Solicitors Regulation Authority (SRA) Accounts Rules. The primary aim of these rules is to ensure client money is kept safe and handled properly.

This article introduces the core concepts of double-entry bookkeeping and its application in recording solicitors' accounts transactions, focusing on the key distinction between client money and the firm's own business money.

Double-Entry Bookkeeping Explained

Double-entry bookkeeping is the standard system used worldwide for recording financial transactions. Its core principle is that every transaction has two equal and opposite effects on a business's financial position. To reflect this duality, each transaction is recorded twice in the accounts: once as a debit (DR) in one account, and once as a credit (CR) in another account.

Key Term: Double-Entry Bookkeeping
An accounting system where every transaction is recorded with equal debit and credit entries, ensuring the accounts always balance.

The terms 'debit' and 'credit' simply refer to the left-hand side (DR) and right-hand side (CR) of an account ledger, respectively. The rules determining whether an entry is a debit or credit depend on the type of account and the nature of the transaction:

• Debits (DR) record: Increases in assets, increases in expenses, decreases in liabilities, decreases in equity/capital, decreases in income.
• Credits (CR) record: Decreases in assets, decreases in expenses, increases in liabilities, increases in equity/capital, increases in income.

Understanding which side to use for different transaction types is critical for accurate record-keeping.

Business Money vs Client Money

A fundamental requirement of the SRA Accounts Rules is the strict separation of money belonging to the firm (business money) from money the firm holds or receives for clients or other third parties (client money).

Key Term: Business Money
Money belonging to the law firm itself, used for its operational costs, partner drawings, or profits.

Key Term: Client Money
Money held or received by a firm relating to regulated services, including money held for clients, third parties (eg, as stakeholder), as trustee, or for fees and unpaid disbursements before a bill is delivered. (Based on SRA Accounts Rules).

This separation ensures client funds are protected, particularly in the event of the firm's insolvency, and are not used for the firm's own purposes. To achieve this, firms must maintain separate bank accounts: a business bank account for business money and a client bank account for client money.

Key Term: Business Bank Account
A bank account held by the firm for its own money.

Key Term: Client Bank Account
A bank account held by the firm solely for holding client money, named to include the firm's name and the word 'client'.

Ledger Accounts in Practice

To track transactions accurately, firms use ledger accounts. For solicitors' accounts, a dual system is common, particularly for the Cash Account (often called the Cash Sheet or Cash Book) and individual Client Ledger Accounts. These ledgers have separate columns to record transactions affecting the business account and the client account.

• Cash Sheet: Records all money received into and paid out of the firm's bank accounts. The business columns track movements in the business bank account, and the client columns track movements in the client bank account.
• Client Ledger: A separate ledger is maintained for each client matter. It also has dual columns (business and client) to track the firm's financial relationship with that specific client, showing both money owed to the firm by the client (in the business columns) and money held by the firm for the client (in the client columns).

Other ledgers, such as Profit Costs (recording income earned from fees) or specific expense ledgers, typically only require business columns as they relate solely to the firm's own finances.

Recording Basic Transactions

Applying double-entry principles to solicitors' accounts requires identifying whether a transaction involves business or client money and making the correct DR and CR entries in the appropriate ledgers and columns.

Receipts of Money

• Receipt of Client Money: When money is received from or on behalf of a client to be held by the firm (e.g., money on account of costs, purchase deposit), it must be paid promptly into the client bank account.

  • The double entry is: DR Cash Sheet (Client columns) / CR Client Ledger (Client columns).
  • This reflects an increase in the asset (cash in the client bank account) and an increase in the liability (money owed to the client).

• Receipt of Business Money: When money is received that belongs to the firm (e.g., payment of a delivered bill), it must be paid into the business bank account.

  • The double entry is: DR Cash Sheet (Business columns) / CR Client Ledger (Business columns).
  • This reflects an increase in the asset (cash in the business bank account) and a decrease in another asset (the debt owed by the client).

Worked Example 1.1

A firm receives a cheque for £500 from a new client, Mrs Patel, generally on account of costs and future disbursements for a litigation matter.

How should this receipt be recorded?

Answer: This is client money as no bill has been delivered (Rule 2.1(d) applies implicitly). It must be paid promptly into the client bank account. The double entry is: DR Cash Sheet (Client) £500 CR Mrs Patel Client Ledger (Client) £500

Payments of Money

• Payment from Client Account: Money can only be withdrawn from the client account for specific, authorised purposes (e.g., paying a disbursement for the client, returning funds to the client) and only if sufficient funds are held for that specific client (Rule 5.3 applies implicitly). Using one client's money for another client is a serious breach.

  • The double entry is: DR Client Ledger (Client columns) / CR Cash Sheet (Client columns).
  • This reflects a decrease in the liability (money owed to the client) and a decrease in the asset (cash in the client bank account).

• Payment from Business Account: If the firm pays an expense on behalf of a client using its own money (e.g., because there are insufficient client funds), the payment comes from the business bank account.

  • The double entry is: DR Client Ledger (Business columns) / CR Cash Sheet (Business columns).
  • This reflects an increase in an asset (money owed by the client to the firm) and a decrease in another asset (cash in the business bank account).

Worked Example 1.2

The firm acting for Mrs Patel (from Example 1.1) needs to pay a court fee of £150. The firm currently holds £500 for Mrs Patel in the client account.

How should this payment be recorded?

Answer: The firm holds sufficient funds (£500) for Mrs Patel in the client account to cover the £150 court fee. Therefore, the payment must be made from the client bank account. The double entry is: DR Mrs Patel Client Ledger (Client) £150 CR Cash Sheet (Client) £150 The client ledger balance for Mrs Patel (client columns) will now be £350 CR (£500 CR - £150 DR).

Exam Warning

A common error is making payments from the client account when insufficient funds are held for that specific client. This results in using other clients' money and is a serious breach of the SRA Accounts Rules (implicitly Rule 5.3). Always check the individual client ledger balance before authorising a payment from the client account. If funds are insufficient, the payment must be made from the business account.

Key Point Checklist

This article has covered the following key knowledge points:

• Double-entry bookkeeping requires every transaction to have equal debit (DR) and credit (CR) entries.
• Solicitors must strictly separate client money from the firm's business money, using separate bank accounts.
• Client money is money held for clients or third parties relating to regulated services, or for unbilled fees/disbursements.
• Business money belongs to the firm.
• Firms use dual-column ledgers (Cash Sheet, Client Ledgers) to track business and client transactions separately.
• Receipt of client money: DR Cash Sheet (Client), CR Client Ledger (Client).
• Receipt of business money: DR Cash Sheet (Business), CR Client Ledger (Business).
• Payment from client account: DR Client Ledger (Client), CR Cash Sheet (Client) – requires sufficient funds for that client.
• Payment from business account: DR Client Ledger (Business), CR Cash Sheet (Business).

Key Terms and Concepts

• Double-Entry Bookkeeping
• Business Money
• Client Money
• Business Bank Account
• Client Bank Account