How do you reconcile a client trust account?

You reconcile a client trust account by proving, every month, that three figures are the same number: the bank statement balance adjusted for items still in transit, the balance of the firm's own trust account journal, and the sum of every individual client ledger. When the three agree and no client ledger is below zero, the account is reconciled; when they do not, the difference is traced to a specific entry and corrected before anything else is paid out.

This article describes the procedure as it applies to a law firm, and uses the rules of California for every requirement it states, as published by the State Bar of California. It is general information, not legal or accounting advice. Other states, and the regulators of title and escrow offices, set their own rules on frequency, records and reporting, so check the text that governs your own licence.

The method itself travels well. A title office, an escrow office or a property manager holding money for several principals in one pooled account faces the same arithmetic: one bank account, many owners, and a duty to show at any moment how much belongs to whom.

What is a three-way reconciliation?

A three-way reconciliation is a monthly comparison of three independent totals for one trust account: the adjusted bank statement balance, the trust account journal balance, and the total of all client ledger balances. It is called three-way because an ordinary bank reconciliation only compares two of them, the bank and the firm's cash record.

The third figure is what makes a trust account different from an operating account. The money in the account does not belong to the firm; it belongs to a list of clients, each in a precise amount. A two-way reconciliation can prove that the account holds $29,705.00 and still say nothing about whether one client's money has been used to pay another client's bill. The client ledgers answer that question.

Each of the three figures comes from a different record:

• The adjusted bank balance starts from the bank's own statement, which the firm does not control, and is adjusted for deposits and payments the firm has made but the bank has not yet processed.
• The trust account journal balance is the firm's running record of the account as a whole: every deposit and every payment, in date order, with a balance after each line. Some firms call it the checkbook register or the trust cash book.
• The total of client ledger balances is the sum of the separate records kept for each client, each showing only that client's money in and out.

Because the journal and the ledgers are posted from the same source documents but as separate entries, an error in one usually does not appear in the other. That independence is what lets the comparison catch mistakes.

Which three figures must agree, and in what form?

The three figures that must agree are the trust account journal balance, the total of the individual ledger balances, and the adjusted bank statement balance, all taken as of the last day of the statement period. The State Bar of California publishes a monthly reconciliation and review certification form that sets them out in exactly that order.

On that form, the second figure has two parts. The first part is the total of the individual client ledgers. The second is the balance of the firm's own money kept in the account to cover bank charges, which California's Rule 1.15 allows only in an amount reasonably sufficient for that purpose. The two parts are added, because the bank's balance includes both.

The third figure is built in three lines: the bank statement ending balance, plus outstanding deposits, less outstanding disbursements. The form then asks one question about the three totals: do they agree? If the answer is no, the form states that the account is not reconciled, that the errors must be identified, and that the reconciliation must be run again.

How do you perform the reconciliation step by step each month?

A monthly trust reconciliation follows a fixed order: complete the books, adjust the bank balance, total the client ledgers, compare the three figures, then trace and correct any difference before signing. The order matters because each step relies on the one before it.

The supporting package the California form asks to be attached is a good definition of "complete": the account journal, the individual ledgers, the bank statement with copies of the checks, a client ledger summary with balances, the list of outstanding deposits and the list of outstanding disbursements.

How do outstanding checks and deposits in transit affect the bank balance?

Outstanding checks reduce the bank statement balance and deposits in transit increase it, because both are transactions the firm has already recorded and the bank has not. Adjusting for them puts the bank's figure on the same date basis as the firm's books.

An outstanding check, or more broadly an outstanding disbursement, is a payment the firm has issued and deducted from the journal and the client ledger, but which the payee has not yet presented or the bank has not yet paid. The money is still in the bank's balance although it no longer belongs to anything in the firm's records, so it is subtracted.

A deposit in transit, which the California form calls an outstanding deposit, is money the firm has recorded as received by the end of the period that does not appear on the statement. It is added. A true deposit in transit clears in the first days of the next statement; one that does not is a warning, since it may be a deposit that was recorded and never made.

Timing items are not errors, but they age. The State Bar of California's guidance on supervisory review tells the reviewing lawyer to follow up on disbursements that have been outstanding for more than two months, and on deposits not made for more than 30 days. For an old check, the guidance is to confirm whether the payee received it and, if not, to stop payment and reissue. A check that sits uncashed for months leaves a client's or third party's money in the account long after the matter should have been closed.

What usually causes a difference, and how do you find it?

A difference in a trust reconciliation almost always comes from one of five causes: a transposed or mis-keyed amount, a bank charge not entered in the books, a payment drawn on a deposit that had not cleared, an entry posted to the wrong client, or a client ledger that has gone negative. Which two of the three figures disagree tells you where to look first.

If the journal and the ledger total disagree with each other, the error lies inside the firm's own posting: one of the two records has an entry the other lacks, or the same entry at a different amount. If the journal and the ledgers agree with each other but not with the adjusted bank balance, the bank has processed something the books do not show, or at a different amount.

The divisible-by-9 test is arithmetic, not a rule of thumb: swapping two adjacent digits always changes a number by a multiple of 9. A difference of $180.00 divides by 9, which suggests digits were swapped; a difference of $25.00 does not, which points to a missing entry of that exact amount.

The last three rows share a troubling feature: the three totals can agree while a client's money is misapplied. A payment made against a deposit that later fails, or before it is available, is paid with whatever else is in the pooled account, which means with other clients' money. The same is true of any disbursement larger than the client's ledger balance. This is why the reconciliation does not end at the comparison of totals, and why the California form asks separately whether every ledger is at or above zero.

What does a complete reconciliation look like, with an error traced and corrected?

A complete reconciliation shows the opening balances, every transaction of the month, the three figures as first computed, each difference traced to its entry, and the three figures again after correction. The example below is illustrative: a small firm, one pooled trust account, five client ledgers and a small amount of firm funds for bank charges, in US dollars.

The month opens with $71,990.00 in the account: Alvarez $42,500.00, Brandt $7,500.00, Chen $0.00, Dufour $3,200.00, Egan $18,640.00, and $150.00 of firm funds for bank charges. During the month the following happens.

• Day 2: a wire of $125,000.00 arrives for Chen. The bank charges a $25.00 incoming wire fee to the account.
• Day 4: check 2101 pays Alvarez $28,000.00, and check 2102 pays the firm's fee of $14,000.00 from the Alvarez funds.
• Day 9: check 2103 pays the firm $1,860.00 from the Brandt funds against a billed invoice.
• Day 12: Dufour deposits $2,000.00.
• Day 15: a wire of $118,500.00 goes out for Chen, and check 2104 pays $350.00 in recording fees for Chen.
• Day 18: check 2105 pays an expert $4,400.00 for Dufour.
• Day 24: check 2106 pays $6,000.00 to a beneficiary for Egan.
• Day 29: check 2107 pays $1,150.00 to a surveyor for Chen.
• Day 30: Brandt deposits $5,000.00, banked that afternoon.

The bank statement ends the month at $31,855.00. Checks 2106 and 2107 have not been presented, and the day 30 deposit is not on the statement. The bookkeeper ticks the statement against the journal and builds the first pass.

The outstanding disbursements of $7,150.00 are check 2106 at $6,000.00 and check 2107 at $1,150.00. None of the three figures matches another, so the account is not reconciled, and there are at least two separate problems.

First difference: journal against ledgers, $180.00. The journal is $180.00 above the ledger total, and $180.00 divided by 9 is exactly 20, so a transposition is likely. Comparing the journal with the Brandt ledger shows check 2103 entered in the journal at $1,680.00. The check copy attached to the bank statement shows $1,860.00, the amount in the ledger. The journal entry is corrected by a dated adjusting entry of $180.00 that names the check, and the journal balance becomes $29,730.00.

Second difference: books against bank, $25.00. Journal and ledgers now agree at $29,730.00, both $25.00 above the adjusted bank balance. The unticked line on the statement is the day 2 wire fee. It is entered in the journal and charged to the firm's bank-charge ledger, which falls from $150.00 to $125.00. All three figures now read $29,705.00.

Third problem: the totals agree, one ledger does not. The ledger summary shows Dufour at −$1,200.00 and Egan at $14,640.00. A negative ledger means $1,200.00 of other clients' money appears to have paid Dufour's expert. Going back to the Dufour file, the deposit slip of day 12 shows $2,000.00 received from Dufour, and the Egan file shows no receipt that day. The deposit was posted to the wrong ledger. A correcting entry moves $2,000.00 from the Egan ledger to the Dufour ledger, with a note of the reason and the date found. In this case no client's money was in fact used for another: Dufour had $5,200.00 available when the $4,400.00 check was written. The record was wrong, the account was not. Had the deposit not existed, the same −$1,200.00 would have been a real shortage.

After the three corrections the journal balance is $29,705.00, the ledgers total $29,705.00, of which $29,580.00 is client money and $125.00 is firm funds, and the adjusted bank balance is $29,705.00. No ledger is negative. The reconciliation can be signed, with the three correcting entries and the documents that support them attached. Note that the total of client money, $29,580.00, was the same before and after the Dufour correction: moving money between two ledgers never changes a total, which is exactly why totals alone cannot find that kind of error.

Who performs the reconciliation, and who reviews it?

A bookkeeper, employee or outside contractor may prepare the reconciliation, but in California a lawyer must review it and remains personally responsible for the funds. The State Bar of California's guidance says lawyers have a nondelegable ethical duty to safekeep clients' funds, and ties the duty to supervise the people doing the recordkeeping to Rule 5.3 of the Rules of Professional Conduct.

The State Bar's reconciliation form reflects this with two signature blocks. The preparer gives a name, position, signature and date. The lawyer then certifies having personally reviewed the report and its supporting documents, and acknowledges that the reconciliation is not complete until discrepancies are resolved and the balances agree, whoever prepared it.

A review is more than a signature under matching totals. The State Bar's supervisory review guidance describes a reviewer who obtains the whole package, confirms the adjusted balances agree, and then reads the activity: unusual or unexpected transactions, client names the lawyer does not recognise, and items the lawyer expected to see that are missing. The reviewer also checks whether firm funds held for bank fees exceed what is needed and has the excess moved to the operating account.

The same guidance recommends independent spot checks at least quarterly, such as downloading the bank statement directly from the bank and comparing its ending balance with the one in the package, and regular sampling of client files to confirm that copies of deposits and disbursements are saved in them.

How often is reconciliation required, and what records must be kept?

In California, a trust account must be reconciled monthly, and the reconciliations must be kept with the other trust records for at least five years after final appropriate distribution of the funds. Both requirements come from Rule 1.15 of the California Rules of Professional Conduct and the recordkeeping standards adopted under it.

Those standards list four records for client funds, and the reconciliation is the fourth:

• a written ledger for each client, showing the client's name, the date, amount and source of all funds received, the date, amount, payee and purpose of each disbursement, and the current balance;
• a written journal for each bank account, showing the name of the account, the date, amount and client affected by each debit and credit, and the current balance;
• all bank statements and cancelled checks for each bank account;
• each monthly reconciliation, which the standard describes as the balancing of the first three.

A separate journal is required for securities and other property held for clients, recording each item, the person it is held for, and the dates of receipt and distribution.

California also asks lawyers to account for their trust accounts once a year. Under Rule 2.5 of the Rules of the State Bar, a licensee who was responsible for client funds during the reporting period must certify knowledge of and compliance with the applicable rules, register each trust account, and complete an annual self-assessment. A licensee may also be selected for a compliance review, which under the State Bar's rules covers at least one year of trust activity, or an investigative audit covering at least three years. A firm whose monthly packages are complete can hand them over as they are.

The practical conclusion is that the retention clock does not start at the end of the month reconciled. It starts when the last of the money in a matter has been properly paid out, which for a long estate or a structured payout can be years after the first deposit.

What should you do when the trust account is short?

When a trust account is short, meaning the adjusted bank balance is less than what the client ledgers say the firm holds, stop paying out of the affected funds, establish the amount and the cause from the records, restore the money, and document every step. A shortage is different from a bookkeeping difference: the records are right and the money is not there.

The usual sources of a real shortage are the ones the ledger review looks for: a payment made against a deposit that was later returned, a payment larger than the client's balance, a bank charge or returned-item fee taken from client money because no firm funds were in the account to absorb it, a duplicate payment, or an unauthorised withdrawal.

A sound order of work, given as general practice and not as a statement of any state's rule, is the following.

• Fix the number first. Rerun the reconciliation to the day, so that the shortage is a precise amount attributed to a precise ledger, not an estimate.
• Identify the transaction that caused it and collect the documents: the returned item, the check copy, the wire confirmation.
• Hold further disbursements that would depend on the missing money. Paying one client in full from a pool that is short moves the loss onto the clients who remain.
• Restore the funds promptly, and recover what can be recovered: a duplicate payment from the payee, a returned deposit from the client who made it.
• Record the cause, the correction and the dates, and attach them to the month's reconciliation.
• Take advice on what must be disclosed, to the client and to the regulator. Where a state bar runs an ethics helpline, this is the kind of question it exists for.

On two points California's published material is specific. The State Bar's reconciliation form requires that a negative client ledger be explained in writing, together with the corrective action taken. And under section 6091.1 of the California Business and Professions Code, as the State Bar describes it for financial institutions, a bank holding attorney trust accounts must report to the State Bar when a properly payable instrument is presented against a trust account containing insufficient funds, whether or not the bank honours the instrument. A shortage that reaches the point of an overdraft is therefore reported by the bank itself. A firm that finds and documents the problem in its own monthly reconciliation is in a very different position from one that learns of it from that report.