Client money - Accounting entries related to client money tr...

Learning Outcomes

This article explains the fundamental accounting entries required when dealing with client money transactions under the SRA Accounts Rules. It details the core principles of double-entry bookkeeping in solicitors' accounts, the distinction between client and business money, and the correct ledger entries for common scenarios such as receiving client money, making payments from client and business accounts, issuing bills, and transferring costs. It also covers mixed receipts and prompt allocation, VAT treatment of disbursements using the agency and principal methods, inter-client transfers, availability and prompt return of client money with the associated entries, stakeholder and agent deposits in conveyancing and mortgage advances, interest on client money and transfer steps, and breaches (including insufficient funds or dishonoured cheques) with the immediate corrective entries required by the Rules.

SQE1 Syllabus

For SQE1, you are required to understand the practical application of the SRA Accounts Rules concerning the recording of financial transactions involving client money, including the systems and controls firms must have in place, and to be able to identify and apply the correct accounting entries for various scenarios presented in SQE1-style multiple-choice questions, with a focus on the following syllabus points:

• The distinction between client money and business money and the requirement for separation.
• The principles of double-entry bookkeeping as applied to solicitors' accounts.
• The correct accounting entries (debits and credits) for receiving client money and business money.
• The correct accounting entries for making payments from the client account and the business account, including the rules around sufficient funds.
• The accounting entries required when issuing a bill for professional charges and VAT.
• The accounting entries required when transferring money from the client account to the business account to cover billed costs.
• The requirement to correct breaches promptly.
• The treatment of mixed receipts (Rule 4.2) and the need to allocate promptly to the correct account.
• The treatment of disbursements and VAT using the agency and principal methods.
• Inter-client transfers between clients or between matters for the same client.
• The rule against using the client account as a banking facility (Rule 3.3).
• Client money being available on demand and promptly returning money where there is no proper reason to hold it; residual balances.

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 accounts are typically debited and credited when a firm receives client money into its client bank account?
   1. Debit Client Ledger, Credit Cash Sheet
   2. Debit Cash Sheet, Credit Client Ledger
   3. Debit Business Cash Sheet, Credit Client Ledger
   4. Debit Client Ledger, Credit Business Cash Sheet
2. A solicitor needs to pay a disbursement of £150 for Client A. The client ledger shows a credit balance of £100 in the client account section and a zero balance in the business account section. From which account must the £150 payment be made?
   1. The client account only.
   2. The business account only.
   3. £100 from the client account and £50 from the business account.
   4. The solicitor cannot make the payment until the client provides further funds.
3. When a firm issues a bill to a client for £500 profit costs plus £100 VAT, which entries reflect this on the client's ledger account?
   1. CR £600 Client Account columns
   2. DR £600 Client Account columns
   3. DR £500 Business Account columns, DR £100 Business Account columns
   4. CR £500 Business Account columns, CR £100 Business Account columns

Introduction

Solicitors frequently handle money belonging to clients and third parties. The Solicitors Regulation Authority (SRA) Accounts Rules 2019 ('the Rules') impose strict obligations on how this money must be managed and recorded to ensure its safety and prevent misuse. Understanding the correct accounting entries for client money transactions is fundamental for compliance and for success in the SQE1 assessments. This article outlines the basic principles of recording these transactions using the double-entry bookkeeping system adapted for solicitors' accounts.

Key Term: Client Money
Money held or received by a firm relating to regulated services, including money held for clients or third parties, money held as a trustee, or money received for unbilled fees or unpaid disbursements (Rule 2.1). Receipts for disbursements already paid by the firm are generally business money.

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

To maintain separation, firms operate distinct bank accounts.

Key Term: Client Account
A bank or building society account held by the firm specifically for client money, identifiable by having 'client' in the account name (Rule 3).

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

The Rules include further practical requirements that frame the accounting entries covered below:

• Client money must be paid promptly into a client account, subject to limited exceptions (Rule 2.3).
• Client money must be available on demand unless a different written arrangement exists (Rule 2.4).
• Client money must be returned promptly when there is no longer a proper reason for holding it (Rule 2.5).
• Firms must never use the client account to provide banking facilities to clients or third parties (Rule 3.3).
• Withdrawals from client account must be for permitted purposes and only if sufficient funds are held for that specific client (Rules 5.1–5.3).
• Breaches must be corrected promptly, and any improper withdrawal must be replaced immediately (Rule 6.1).

DISTINGUISHING CLIENT MONEY AND BUSINESS MONEY

A core principle of the Rules is the separation of client money from the firm's own money (business money) (Rule 4.1). This distinction dictates which bank account and which set of ledger columns must be used for recording transactions.

Money received on account of costs and unpaid disbursements prior to delivery of a bill is client money (Rule 2.1(d)). By contrast, money received in payment of a delivered bill, or reimbursement for disbursements already paid by the firm, is business money. Treatment follows the “purpose and timing” of the receipt:

• Before billing: fees/unpaid disbursements = client money.
• After billing: fees/paid disbursements = business money.

Key Term: Mixed Receipt
A single receipt containing both client money and business money. Firms must allocate mixed payments promptly to the correct account (Rule 4.2). The whole receipt can be paid initially into either the client account or the business account, provided the correct element is promptly transferred to the other account.

Key Term: Available on demand
Client money must be readily accessible (usually via an instant access account) unless a different written arrangement with the client or relevant third party provides otherwise (Rule 2.4).

DOUBLE-ENTRY BOOKKEEPING FOR SOLICITORS' ACCOUNTS

Law firms use double-entry bookkeeping to record financial transactions. Every transaction affects two accounts, with one entry being a debit (DR) and the other an equal and opposite credit (CR). This ensures the accounts always balance.

Key Term: Double-entry bookkeeping
An accounting system where every transaction is recorded with equal debit and credit entries in two separate accounts.

Key Term: Ledger
A record of financial transactions relating to a specific person (e.g., a client ledger) or category (e.g., a profit costs ledger).

Key Term: Cash Sheet
The ledger recording movements of money into and out of the firm's bank accounts (often called cash book). Law firms typically maintain dual cash sheets (or columns) for business and client bank accounts.

To accommodate the separation of funds, key ledgers like the Cash Sheet and individual Client Ledgers have dual columns: one set for business money transactions and one for client money transactions. The fundamental rule is that the double entries for any single transaction must both be in the business columns OR both be in the client columns. You cannot mix them.

The rules for debits and credits depend on the type of account:

• Asset Accounts (e.g., Cash, Computer Equipment): Increase with a DR, decrease with a CR.
• Liability Accounts (e.g., Loans, Money owed to clients): Increase with a CR, decrease with a DR.
• Income Accounts (e.g., Profit Costs): Increase with a CR, decrease with a DR.
• Expense Accounts (e.g., Rent, Wages): Increase with a DR, decrease with a CR.

Key Term: Debit (DR)
An entry on the left-hand side of a ledger account, typically representing an increase in assets or expenses, or a decrease in liabilities or income.

Key Term: Credit (CR)
An entry on the right-hand side of a ledger account, typically representing an increase in liabilities or income, or a decrease in assets or expenses.

Where questions present options in journal-entry form, you can translate entries to ledger movements as follows:

• Cash sheet DR = money in; Cash sheet CR = money out.
• Client ledger CR (client columns) = money received for the client; Client ledger DR (client columns) = money paid out for the client.
• Client ledger DR/CR (business columns) = amount owed to/by the client in respect of the firm’s profit costs and VAT.

RECORDING RECEIPTS

The first step is always to determine if the money received is client money or business money.

Receiving Client Money

Client money must be paid promptly into a client account (Rule 2.3). The accounting entries reflect an increase in the money held in the client bank account (DR Cash Sheet) and an increase in the amount the firm owes to that specific client (CR Client Ledger).

• Debit (DR) Cash Sheet (Client column)
• Credit (CR) Client Ledger (Client column)

Worked Example 1.1

A firm receives a cheque for £5,000 from a new client, Mrs Jones, generally on account of costs and disbursements for her upcoming property purchase.

Answer:
This is client money (Rule 2.1(d)). The entries are:
DR Cash Sheet Client £5,000
CR Mrs Jones Client Ledger Client £5,000

Receiving Business Money

Business money, such as payment received for a bill already delivered, must be paid into the business account. The entries reflect an increase in the firm's business bank account (DR Cash Sheet) and a decrease in the amount owed to the firm by that client (CR Client Ledger).

• Debit (DR) Cash Sheet (Business column)
• Credit (CR) Client Ledger (Business column)

Worked Example 1.2

The firm from Example 1.1 later issues a bill to Mrs Jones for £1,200 (inc VAT). Mrs Jones pays this exact amount by bank transfer.

Answer:
This payment is for a delivered bill, so it is business money. The entries are:
DR Cash Sheet Business £1,200
CR Mrs Jones Client Ledger Business £1,200
(This reduces the DR balance created when the bill was issued – see below).

Mixed receipts (Rule 4.2)

A single receipt may contain both client and business elements (e.g., part payment of a bill plus money on account for future costs and disbursements). The Rules allow flexibility: pay the whole receipt into either the client account or the business account, provided the correct element is promptly transferred to the other account. Many firms prefer to bank mixed payments into the client account first, then transfer the business element to the business account.

Exam Warning
Mixed receipts must be allocated promptly to the correct account. An option that leaves business money in client account (or vice versa) is usually wrong unless it is immediately followed by a prompt transfer.

Worked Example 1.3

A client pays £1,000 by bank transfer comprising £600 to clear a delivered interim bill and £400 on account of future costs and disbursements.

Answer:
Treat as a mixed receipt. One compliant approach is:
Receipt: DR Cash Sheet Client £1,000; CR Client Ledger (Client) £400; CR Client Ledger (Business) £600
Prompt transfer of business element: DR Cash Sheet Business £600; CR Cash Sheet Client £600
(Alternative posting layouts may show both parts on one client ledger with dual columns; the double-entry effect must be the same.)

Deposits in conveyancing

Key Term: Stakeholder (deposit)
Deposit held on exchange as stakeholder is held for both buyer and seller until completion. It should be recorded in a stakeholder ledger or clearly identified as stakeholder money in the seller’s client ledger.

Key Term: Agent (deposit)
Deposit held as agent for the seller belongs to the seller from exchange and is recorded directly in the seller’s client ledger as client money.

Worked Example 1.4

On exchange of contracts, the seller’s solicitor receives a £25,000 deposit to hold as stakeholder.

Answer:
Receipt as stakeholder:
DR Cash Sheet Client £25,000
CR Stakeholder Client Ledger (Client column) £25,000
On completion, transfer to seller’s client ledger:
DR Stakeholder Client Ledger (Client) £25,000
CR Seller Client Ledger (Client) £25,000
(No cash sheet entry is needed for the inter-ledger transfer.)

RECORDING PAYMENTS

Again, the first step is to determine whether the payment should be made from the client account or the business account.

Payments from the Client Account

Client money can only be withdrawn from a client account for the purpose for which it is being held or on the client's instructions (Rule 5.1), and notably, only if sufficient funds are held for that specific client (Rule 5.3). Making a payment using one client's funds for another client is a serious breach.

The entries reflect a decrease in the money held in the client bank account (CR Cash Sheet) and a decrease in the amount the firm holds for that client (DR Client Ledger).

• Debit (DR) Client Ledger (Client column)
• Credit (CR) Cash Sheet (Client column)

Worked Example 1.5

The firm acting for Mrs Jones (Examples 1.1 and 1.2) needs to pay £300 for property searches. The firm checks Mrs Jones's client ledger and confirms there are sufficient funds remaining from her initial payment on account.

Answer:
The payment can be made from the client account. The entries are:
DR Mrs Jones Client Ledger Client £300
CR Cash Sheet Client £300

Payments from the Business Account

If a payment is needed for a client matter but there are insufficient (or no) funds held for that client in the client account, the payment must be made from the firm's business account. Using other clients' money is prohibited (Rule 5.3). Occasionally, a firm may advance its own money to the client account to enable a payment (the advance then becomes client money), but it must be clear and recorded appropriately.

The entries reflect a decrease in the firm's business bank account (CR Cash Sheet) and an increase in the amount the client owes the firm (DR Client Ledger).

• Debit (DR) Client Ledger (Business column)
• Credit (CR) Cash Sheet (Business column)

Paying disbursements: agency and principal methods

Key Term: Agency Method
Where the third-party invoice is in the client’s name, the firm acts as agent in arranging and paying for the supply. The payment is a single VAT-inclusive amount and is usually made from the client account if funds are available. No entry is made to the firm’s VAT ledger.

Key Term: Principal Method
Where the third-party invoice is in the firm’s name, the firm is the principal for VAT purposes. The payment must be from the business account. The VAT element is recorded as input tax in the firm’s HMRC-VAT ledger. The cost is later recharged to the client within the firm’s own bill (with output VAT).

Worked Example 1.6

A probate solicitor receives a valuer’s invoice for £1,000 + £200 VAT addressed to the executors (client’s name on invoice). There are sufficient client funds.

Answer:
Use the agency method; pay £1,200 from client account:
DR Client Ledger (Client) £1,200
CR Cash Sheet Client £1,200
(No HMRC-VAT ledger entry because the supply is to the client.)

Worked Example 1.7

In a litigation matter, a medical expert’s invoice of £800 + £160 VAT is addressed to the firm (firm’s name on invoice). There are no client funds in the client account.

Answer:
Use the principal method; pay from business account:
DR Client Ledger (Business) £800
DR HMRC-VAT ledger £160
CR Cash Sheet Business £960
(The cost will be included in the next bill to the client. When the bill is paid, the normal business receipt entries apply.) Exam Warning
If the invoice is in the firm’s name, a payment from client account is not permitted; the business account must be used. If the invoice is in the client’s name, treat the payment as a single VAT-inclusive sum with entries in the client columns (no VAT ledger entry).

ISSUING BILLS AND TRANSFERRING COSTS

Billing for Profit Costs and VAT

When a firm issues a bill, no cash moves immediately. The entries record that the client now owes the firm money (DR Client Ledger) and that the firm has earned income (CR Profit Costs ledger) and owes tax to HMRC (CR HMRC-VAT ledger). These entries are always made in the business columns.

Key Term: Profit Costs
The firm's charges for the legal services provided to the client.

Key Term: VAT
Value Added Tax – a tax chargeable on the supply of most goods and services, including legal services.

The double entries are:

• Debit (DR) Client Ledger (Business column) – Profit Costs amount
• Credit (CR) Profit Costs ledger – Profit Costs amount
• Debit (DR) Client Ledger (Business column) – VAT amount
• Credit (CR) HMRC-VAT ledger – VAT amount

Transferring Costs (Rule 4.3)

Once a bill has been delivered, the firm can transfer money held for that client in the client account to the business account to pay the bill, provided sufficient funds are held for that client (Rule 4.3). This is a cash transfer involving two pairs of double entries:

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

These are often recorded on the same line in the ledgers for convenience.

Worked Example 1.8

Following on from the earlier examples, the firm issued a bill to Mrs Jones for £1,200 (inc VAT). Her client ledger (client column) shows a credit balance of £4,700 (£5,000 received - £300 paid). The firm transfers £1,200 from the client account to the business account to pay the bill.

Answer:
The transfer is permitted under Rule 4.3. The combined entries on the client ledger are:
DR Client Ledger Client £1,200
CR Client Ledger Business £1,200
(The corresponding entries are CR Cash Sheet Client £1,200 and DR Cash Sheet Business £1,200).
This clears the DR balance created by the bill and reduces the CR balance in the client column.

Reducing a bill (abatement)

On occasion, a bill is reduced by agreement (for example, to reflect service issues). The entries are the reverse of those made on billing, limited to the amount of the reduction.

Worked Example 1.9

A client disputes part of a £600 bill (profit costs £500 + VAT £100). The firm agrees to reduce profit costs by £100 (with a corresponding £20 VAT reduction).

Answer:
Record the abatement in the business columns:
CR Client Ledger (Business) £100
DR Profit Costs ledger £100
CR Client Ledger (Business) £20
DR HMRC-VAT ledger £20 Exam Warning
Abatement entries reflect the amount reduced (what the bill is reduced by), not the new total.

CORRECTING BREACHES (RULE 6)

If a breach of the Rules occurs (e.g., withdrawing more money than held for a client, paying client money into the business account), it must be corrected promptly upon discovery (Rule 6.1). If money has been improperly withdrawn from a client account, it must be replaced immediately, usually by transferring funds from the business account.

Common breach scenarios include:

• Paying a disbursement from client account where there are insufficient funds for that client (breach of Rule 5.3).
• Using the client account as a banking facility (breach of Rule 3.3).
• Paying client money into the business account by mistake (breach of Rule 2.3).
• Drawing against uncleared funds that later dishonour, leaving a deficit for that client (breach of Rule 5.3 once discovered).

Worked Example 1.10

A client pays a £500 cheque on account into the client account. The next day the firm pays a £100 court fee from the client account. Two days later the bank notifies that the client’s cheque has been dishonoured.

Answer:
Reverse the original receipt, then rectify the shortfall immediately:
Reverse receipt (to cancel the original posting when dishonour is known): DR Client Ledger (Client) £500; CR Cash Sheet Client £500
The £100 paid left a deficit for this client, so immediately replace from business:
DR Client Ledger (Client) £100; CR Cash Sheet Business £100 (transfer from business to client), and
DR Cash Sheet Client £100; CR Cash Sheet Business £100 (the mirror leg if recorded as a two-part cash transfer).
On re-presentation and clearance of the client’s cheque, treat as a mixed receipt if part is now due to business for the court fee. Exam Warning
On discovery, an improper withdrawal from client account must be replaced immediately from business funds. A delayed correction is not compliant.

Return of client money and residual balances

When there is no longer any proper reason to hold client money, it must be returned promptly (Rule 2.5). If the client cannot be located after reasonable attempts, small residual balances may be withdrawn and paid to charity without prior SRA authority where the balance on the matter is £500 or less, provided the firm records the steps taken and keeps a central register. Larger amounts require SRA authorisation. These are not “breach corrections” but compliance steps once a matter has concluded.

Key Term: Inter-client Transfer
A paper transfer reallocating money already in client account from one client (or matter) to another. No cash sheet entry is required; entries appear only in the client columns of the two relevant client ledgers.

Inter-client transfers (between clients or matters)

No money leaves the client bank account. Record a debit on the ledger of the client (or matter) transferring the funds and a credit on the ledger of the recipient client (or matter).

Worked Example 1.11

Client A instructs transfer of £1,000 from their balance to Client B (both are clients of the firm).

Answer:
Record an inter-client transfer:
DR Client A Ledger (Client) £1,000
CR Client B Ledger (Client) £1,000
(No cash sheet entries.)

Conveyancing: mortgage advances

When acting for both lender and borrower on a purchase, the mortgage advance can be recorded using a single borrower ledger (clearly describing the lender and “mortgage advance” in the details) or using separate client ledgers for borrower and lender. In either case, receipt of the advance is client money and is recorded in the client columns.

Worked Example 1.12

A lender remits a £90,000 mortgage advance for a purchase where the firm acts for both parties. The firm uses a single borrower ledger.

Answer:
Record the advance in the borrower’s client ledger:
DR Cash Sheet Client £90,000
CR Borrower Client Ledger (Client) £90,000 (details should state the lender and “mortgage advance”) Exam Warning
Do not treat the lender’s advance as business money. It is client money held for completion.

Interest on client money

Firms must account for a fair sum of interest on client money held, unless a different written arrangement is agreed (Rule 7.1–7.2). Interest on the general client account belongs to the firm, which then pays a fair sum to the client (treated as a business expense). Where money is held in a separate designated deposit client account for a particular client, the interest belongs to that client and is recorded in the client columns.

Key Term: Separate Designated Deposit Client Account (SDDCA)
A dedicated deposit account for a specific client’s money, typically used where significant sums are held for a period. Interest arising on this account belongs to that client.

Worked Example 1.13

The firm determines a client is due £25 in lieu of interest on funds held in the general client account.

Answer:
Two steps:

1. Record the expense: DR Interest Payable (business expense ledger) £25; CR Client Ledger (Business) £25.
2. Transfer from business to client account: DR Cash Sheet Business £25; CR Cash Sheet Client £25, and CR Client Ledger (Client) £25; DR Client Ledger (Business) £25.
   The client can then be paid from client account or the £25 can be offset against a billed balance if appropriate.

Prohibition on banking facilities (Rule 3.3)

The client account must not be used as a banking facility. Payments into or out of client account must be in connection with the delivery of regulated services. Holding sale proceeds to make regular rent or personal bill payments, or accepting funds unconnected with a legal transaction, risks a breach.

Exam Warning
A client’s convenience is not a justification for using client account as a banking facility. Look for a clear link to a legal transaction on which the firm is acting.

Key Point Checklist

This article has covered the following key knowledge points:

• Client money must be kept separate from business money (Rule 4.1) in designated client and business bank accounts.
• Solicitors' accounts use double-entry bookkeeping, often with dual client/business columns in ledgers.
• Receipt of client money: DR Cash Sheet (Client), CR Client Ledger (Client). Must be paid in promptly (Rule 2.3).
• Receipt of business money (e.g., bill payment): DR Cash Sheet (Business), CR Client Ledger (Business).
• Mixed receipts (Rule 4.2): may be banked into either account if promptly allocated; transfer the business element promptly to business account (or vice versa).
• Payment from client account: DR Client Ledger (Client), CR Cash Sheet (Client). Only if sufficient funds held for that client (Rule 5.3) and for a permitted purpose (Rule 5.1).
• Payment from business account (e.g., insufficient client funds): DR Client Ledger (Business), CR Cash Sheet (Business).
• Disbursements:
  • Agency method (invoice in client’s name): VAT-inclusive payment from client account; no VAT ledger entry.
  • Principal method (invoice in firm’s name): pay from business account, DR input VAT to HMRC-VAT ledger; recharge in the firm’s bill.
• Issuing a bill: DR Client Ledger (Business) for profit costs and VAT, CR Profit Costs ledger, CR HMRC-VAT ledger.
• Transferring billed costs from client to business account (Rule 4.3): Requires a bill first; involves payment out of client account and receipt into business account.
• Inter-client transfers: ledger-to-ledger entries in client columns only; no cash sheet entry.
• Deposits: stakeholder (held for both parties) vs agent (belongs to seller); record accordingly.
• Interest: pay a fair sum; general client account interest is a business expense; SDDCA interest belongs to the client.
• Breaches (e.g., overdrawing a client's balance, dishonoured cheques) must be corrected promptly; any shortfall must be replaced immediately from business funds (Rule 6.1).
• Never use the client account as a banking facility (Rule 3.3); ensure payments relate to regulated services.

Key Terms and Concepts

• Client Money
• Business Money
• Client Account
• Business Account
• Double-entry bookkeeping
• Ledger
• Cash Sheet
• Debit (DR)
• Credit (CR)
• Profit Costs
• VAT
• Mixed Receipt
• Agency Method
• Principal Method
• Inter-client Transfer
• Separate Designated Deposit Client Account (SDDCA)
• Stakeholder (deposit)
• Agent (deposit)
• Available on demand