Client money - Accounting entries related to client money transactions

Learning Outcomes

This article explains the fundamental accounting entries required when dealing with client money transactions, as governed by the SRA Accounts Rules. After reading this article, you will understand the core principles of double-entry bookkeeping within the context of solicitors' accounts, including the distinction between client and business money. You will be able to identify the correct ledger entries for common transactions such as receiving client money, making payments from client and business accounts, issuing bills, and transferring costs. This knowledge is essential for answering SQE1 questions accurately.

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. This includes the systems and controls firms must have in place. Your understanding should enable you to identify and apply the correct accounting entries for various scenarios presented in SQE1-style multiple-choice questions.

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

  • 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.

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.

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.

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).

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.

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.

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).

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 1.3

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).

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)

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 1.4

Following on from Example 1.3, 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.

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.

Exam Warning

A common error tested is making payments from the client account when insufficient funds are held for that specific client (breach of Rule 5.3). Remember, you cannot use other clients' money. The payment must be made from the business account, or the firm must advance funds into the client account first (Rule 14.2(b)), or the breach must be immediately rectified by a transfer from the business account (Rule 6.1).

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).
  • Payment from client account: DR Client Ledger (Client), CR Cash Sheet (Client). Only if sufficient funds held for that client (Rule 5.3).
  • Payment from business account (e.g., insufficient client funds): DR Client Ledger (Business), CR Cash Sheet (Business).
  • 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 to be delivered first. Involves payment out of client account and receipt into business account entries.
  • Breaches (e.g., overdrawing a client's balance) must be corrected promptly, and improper withdrawals replaced immediately (Rule 6.1).

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
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Pleased to share that I have successfully passed the SQE1 exam on 1st attempt. With SQE2 exempted, I’m now one step closer to getting enrolled as a Solicitor of England and Wales! Would like to thank my seniors, colleagues, mentors and friends for all the support during this grueling journey. This is one of the most difficult bar exams in the world to undertake, especially alongside a full time job! So happy to help out any aspirant who may be reading this message! I had prepared from the University of Law SQE Manuals and the AI powered MCQ bank from PastPaperHero.

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Senior Associate at Trilegal