Managing a successful law practice is no easy task, and the financial aspect is as complicated as it is important to your firm’s overall health.  

In an industry where precision and accuracy are paramount, proper accounting is crucial to safeguarding your client’s interests and keeping your practice afloat.  

By better understanding common legal accounting mistakes, you’ll be better equipped to maintain your firm’s financial integrity (while delivering the exceptional legal services your clients have come to expect).

What does legal accounting entail? 

Legal accounting is the process of analyzing and interpreting a law office’s financial data. Accountants and financial professionals use a law firm’s bookkeeping records to prepare tax returns, income and expense statements, and other financial documents. To do so correctly, they need accurate bookkeeping data.  

Detailed books and records help you grow your law practice by providing the data you need to allocate resources, create budgets, and identify high-yield areas of the practice. Furthermore, they ensure compliance with various tax laws, regulations, and the Model Rules of Professional Conduct, helping your firm avoid suspensions and disbarment for ethics violations and illegal practices.  

It’s no secret that legal accounting can be a convoluted and intricate process. The good news, though, is that by equipping yourself with the right knowledge and strategies, you can avoid the most common legal accounting pitfalls.  

The six most common legal accounting mistakes and how to avoid them  

Legal bookkeeping can seem overwhelming, with many possibilities for missteps. But your accounting system is a crucial element for understanding your business—and getting things right is essential.  

Watch out for these common mistakes when it comes to law firm bookkeeping and accounting.  

1. Failing to capture all billable hours 

If you have unbilled time at your law firm, you’re losing money.  

We get it—it’s easy to forget to immediately log time entries for every telephone call or task completed for a case. Busy lawyers and legal staff often move quickly between tasks, which increases the risk of missing billing opportunities.  

One of the best ways to avoid this legal accounting mistake is to use a fully-integrated practice management software. This software should integrate:  

• Time tracking 
• Billing 
• Document management 
• Tasks 
• Calendaring 
• And more 

Managing all areas of your law practice within a single system makes it easier to implement time-tracking procedures (and avoid losing billable hours). 

2. Not differentiating income and revenue  

There is a difference between income and revenue in a law firm—and your invoices should reflect that. For example, the payment of an invoice might include reimbursement for costs incurred by your law firm for the case. These costs must be recorded separately to ensure that they are not calculated as actual income.  

Avoid the problem of confusing income and revenue by creating invoices that include a detailed breakdown of the amount billed, showing how much of the invoice is billed as costs and how much of the invoice is billed as billable hours.  

When you receive payment for the invoice, refer to the invoice to correctly account for the payment in your records. 

3. Data entry errors  

Many law firms have separate systems for accounting and legal practice management. Staff members enter data into the practice management system to track tasks performed for a client and track case progress…and then re-enter that information into bookkeeping and accounting systems for billing and payment.  

Duplicate data entry increases the chance of human error. The best way to avoid this accounting mistake? Enter information once, using a system that integrates all aspects of your law practice.

4. Failing to accurately track and document matter costs  

Many law firms pay the direct costs of a case as they incur the expenses. Later, they bill their clients for those costs or receive reimbursement when they resolve the case.  

Examples of direct costs include: 

• Court reporter fees 
• Filing fees 
• Fees for medical records, accident reports, and other documents 
• Expert witness fees 
• Trial preparation 
• Investigation fees 
• Travel costs 

Indirect costs, on the other hand, include:  

• Phone and internet charges 
• Lease payments 
• Payroll 
• Advertising  
• Other operating expenses  

Even though indirect costs are not billed to a specific client, you must carefully track these expenses and post them as necessary to the correct account. Otherwise, you could increase your tax liability by counting these costs as income.  

5. Trust accounting mistakes 

A trust account holds a client’s funds until you earn them and bill for fees and costs. The funds in a trust account belong to the client—not the law firm.  

Trust accounting mistakes include: 

• Failing to keep an accurate accounting of how much each client has in their trust account 
• Commingling personal or law firm funds with trust funds 
• Failing to keep detailed records for each deposit and withdrawal from the trust account 
• Listing a trust account as an asset of the law firm 
• Failing to create a system of checks and balances to ensure the trust funds cannot be accessed without approval 
• Misallocating trust funds 
• Failing to reconcile the account each week 
• Not recording a transaction when it occurs 

One of the best ways to avoid accounting mistakes with your trust account is to stop using error-prone manual accounting systems. 

Instead, legal trust accounting software lets you quickly check balances and run reconciliations to ensure the trust account is correct. It also allows you to print reports for each client to quickly see the clients with trust funds and the balance for each client.  

6. Inaccurately reporting compensation  

The attorneys in a law firm decide how to allocate compensation. For example, the law firm might receive 10% of all amounts paid for billable hours. The billing attorney receives the remaining 90% of the compensation paid by a client.  

It’s crucial that the law firm correctly report compensation for each attorney. Accountants use the data in the law firm’s accounting records to create W2s, 1099s, and other income statements. If the information is incorrect, an attorney’s tax returns could be inaccurate, leading to tax liability and audits. 

The best way to avoid this legal accounting mistake is for everyone to understand the allocation of compensation. Automating the process using legal accounting software can also reduce the chances of a mistake. 

Take advantage of tech tools to eliminate accounting mistakes  

Embracing technology is a game-changer in preventing common legal accounting mistakes, and CosmoLex is committed to providing you with the most advanced and comprehensive solutions.  

Our integrated platform features are specifically designed to streamline your law firm’s accounting processes, allowing you to focus on delivering exceptional legal services.  

With CosmoLex, you can enjoy seamless integration of trust accounting, time tracking, billing, and financial reporting, all within a secure and user-friendly platform tailored to the unique requirements of the legal profession. 

Don’t let legal accounting challenges hold your firm back. Discover the transformative potential of CosmoLex by signing up for a free trial or scheduling a free demo today.