How to Keep Your Three-Way Reconciliation Accurate and Efficient

Most lawyers will handle a client trust account at some point in their careers. Settlement funds (ex: personal injury), retainers, third-party funds, or judgment funds all use client trust accounts.

In particular, the retainers that go into client trust accounts help ensure a law firm gets paid in a timely fashion for the work they do. Anyone who’s ever faced having client collections conversations understands the immense appeal retainers can hold.

But retainers, and therefore trust accounts, also usher in a complicated and sometimes nightmarish bookkeeping process.

At least, they did historically. As law firms shift the way they run their offices, the way they double-check trust account balances and fix issues is changing, too.

What is three-way reconciliation?

Three-way reconciliation is a key part of client trust account bookkeeping. In particular, it’s the part that has a reputation for being so painstaking.

In three-way reconciliation, you balance the accounts between three different sources: individual client accounts, the law firm’s books, and the bank’s statement. If as an adult you ever balanced a checkbook—or remember a parent doing so—the process is fairly similar, but with high stakes and a third account to balance.

The three-way reconciliation process depends on staunch—and legally required—recordkeeping.^[1] For every financial transaction at your law firm, you need to keep a record of the payor, the payee, the amount, the reason, and when the transaction took place.

When it’s time for three-way reconciliation, you will go through your detailed records for all your client trust accounts, the firm’s trust account books, and the bank’s statement for the trust account. In each of the three categories (clients, firm, bank), you use the records you’ve kept to calculate the balance from the last time you reconciled your books until now.

To do this, you simply add deposits and subtract withdrawals until you are all caught up to your present stopping point.

That said, this process needs to account for every cent, including interest. And depending on where you practice, it needs to occur every thirty or sixty days. Check with your state bar’s guidelines to see which timeline applies to you.

Why it matters

It’s fairly common for a lawyer and their client to agree to a retainer fee pay structure for legal work. This provides some security for the lawyer because they have a guarantee that the client can pay their legal bills. However, because the lawyer hasn’t actually done the work yet or billed the client, the money still legally belongs to the client. Therefore, the lawyer is holding it in trust for the client.

While practical, this type of financial relationship is clearly ripe for ethical violations. Therefore, state bars and the American Bar Association have developed regulations around how this money is handled to ensure that clients’ trust in their lawyers isn’t abused.

State bars are also seeking to prevent the commingling of funds, which is when client funds are placed in the attorney’s operating account or when money belonging to the law firm is in the client trust account. Keeping everything separate helps the money be more easily accounted for.

Trust account regulations stipulate that law firms must keep complete records of all client trust account transactions. As mentioned above, lawyers must also run three-way reconciliation every thirty to sixty days, depending on where they practice.

Additionally, lawyers must be prepared in the event of a trust account audit.^[2] The consequences for problems overturned in the audit exist across a range that includes fines and, in the most severe cases of mismanagement, disbarment.

Even the most diligent law firms may find themselves floundering a little if they get a letter that they’ve been selected for a random audit. In these cases, the one thing you can control is to be prepared ahead of time with solid record-keeping and regular three-way reconciliation.

What to do if the books don’t match

Knowing the stakes, what do you do if you’re running three-way reconciliation and the books don’t match up?

If two or even all three balances don’t agree with each other, then you need to track down the mistake. Before you get started on a great transaction hunt to find what’s throwing your books off, check to see if all recent transactions have cleared. Sometimes, the issue is as simple as a deposit not having cleared the bank yet.

That said, when the books don’t line up, it usually means that a transaction was entered wrong or not recorded somewhere. Review each transaction and check to see if it was entered differently into your legal billing software or bank statement.

Yes, the process is tedious, but it’s also necessary for all the aforementioned reasons. And the less frequently you run your three-way reconciliation, the greater number of transaction records you’ll need to check if there’s an error. Leave things too long, and it’s easy for the error or errors to get buried, creating a real problem to untangle.

The more often you run three-way reconciliation, the easier it will be to stay on top of it.

Tools for a more efficient process

If you think three-way reconciliation sounds time-consuming, we hear you. Fortunately, today’s practice management systems are equipped to handle the process for you in two ways.

First, look for legal-specific software with fully integrated billing and accounting. Not only will this save you time compared to trying to make a generic accounting program work for your firm by putting in extra hours on your end, but it will reduce the likelihood of data entry error.

Ultimately, the more integration in your practice management system, the less data entry you and your team need to do. By minimizing the chance of some good old-fashioned human error, you’re already making your bookkeeping a little easier.

Second, look for a program that can run three-way reconciliation for you. In a few clicks, modern tech can do what used to take hours.

Having computer-run three-way reconciliation makes it easier to stay on top of. And in the event of an audit, you can quickly generate the required three-way reconciliation report, greatly reducing the stress. After all, lawyers aren’t known for not having enough to do already.

References

1. 10 Principles of Trust Accounting
2. Model Rule for Random Audit of Lawyer Trust Accounts: Preface