Accounting for Lawyers: 4 Basics You Need To Know

law firm finances guide

Chapter 2

Accounting for Lawyers: Four Basics You Need To Know

Welcome back to the PracticePanther Law Finance guide! The previous chapter discussed the six components of law firm finances and the various KPIs law firms should track to encourage continuous growth. With these details in mind, let's take a deeper dive into law firm financial management and discuss the importance of accounting for lawyers. Knowledge of basic accounting concepts enables law firms to evaluate a practice from a business management perspective and gauge general performance to identify areas of improvement. Accounting knowledge empowers firms to better manage relationships with banking institutions, abide by various ethical and regulatory guidelines, and prepare GAAP-compliant tax returns. Whether you want to comprehend your financial performance and valuation better or reduce complete reliance on CPAs and bookkeeping professionals for financial comprehension, take a look at the four basics you need to know about accounting for lawyers.

Accounting for Lawyers: Four Basics You Should Know

1. Understand the Fundamentals of Generally Accepted Accounting Principles (GAAP)

Generally Accepted Accounting Principles (GAAP) are common accounting rules, standards, and procedures developed by the Financial Accounting Standards Board (FASB). GAAP often serves as the foundation of the framework used by many law firms to help guide proper financial accounting and the preparation of financial statements. The overarching goal of GAAP is to ensure all companies, including law firms, consistently craft financial statements that are complete and comparable. The ability to remain consistent with your accounting needs and maintain meticulous record-keeping processes provides better protection to lawyers and their law firms in the event of an Internal Revenue Service (IRS) audit.

When you work with an accountant, they handle all the GAAP issues that are required to file taxes and address other accounting issues for your law firm. You shouldn’t be expected to know all the details of GAAP, as it’s a lot to learn. But knowing the basics can help you work with your accountant more easily, which benefits your law firm and all its employees. For example, is there a better way to track or provide the specific information you send to the accountant? Could you make changes to help your accountant prepare and complete financial documents for you?

Law firms have many accounting details that must be addressed, and accountants must make sure everything they are processing and providing to your firm, the IRS, and other required entities is following GAAP correctly. While it is the accountant’s job to handle this the right way regardless of anything else, working with the accountant to make things easier can be very valuable for your business relationship.

2. Know Which Accounting Method Your Firm Uses

Accounting is not just about getting all the accurate numbers into the right category to get information on how well your law firm is doing. There’s more than one accounting method, and they are not handled the same way. Even though it is your accountant doing the work, you should know what method of accounting your firm uses and understand the basics of how that method works. When it comes to accounting for lawyers, there are three standard methods for law firms to adopt:

  • Cash basis accounting is the most straightforward method, in which law firms record revenue the day it’s received rather than the day services are provided. Cash basis accounting is preferred by most, as it allows law firms to track cash on hand better and does not require lawyers to pay taxes on income until it reaches the bank account.
  • Accrual basis accounting, on the other hand,  records income the day it’s billed, regardless of when payment is received — though the IRS will automatically expect payment for taxes on that amount, no matter when the payment truly arrives. This GAAP-preferred accounting method helps law firms better visualize performance month to month for more effective firm budgeting and financial forecasting.
  • Modified cash basis accounting is an excellent middle ground for law firms. Also referred to as a hybrid model, modified cash accounting uses cash basis accounting for typical day-to-day bookkeeping needs and accrual basis accounting for long-term expenses, such as office rent. Regardless of your chosen method, remember that the IRS requires you to stick with just one to avoid tax compliance concerns.

3. Familiarize Yourself With the General Ledger

Bookkeeping for lawyers will always involve using and managing a general ledger. A general ledger is a complete record of a law firm’s financial transactions, separated into transaction types, including assets, liabilities, revenues, expenses, and owner’s equity. This data is required to create accurate, defendable financial statements. The general ledger will also be the basis for your double-entry bookkeeping system. The double-entry accounting method tracks where a lawyer’s money is coming from and where it’s going. Two entries are made for each financial transaction — a “debit” and a “credit.” These entries are recorded in the general ledger to demonstrate whether the funds are being transferred to or from an account.

If you have never seen your general ledger or don’t look at it very often, it is time to change that. Finances are one of the most critical areas of your law firm, and you should be involved with them. While your bookkeeper will be handling all the daily tasks of adding, subtracting, and balancing, you need to be aware of where your firm’s finances stand and how those finances got to where they are. A standard report can tell you the first piece of information but not the second one.

4. Learn How To Read the Three Key Financial Statements

Financial statements are the reports your law firm needs to have detailed information regarding where your finances stand and where they look to be heading. For example, if there is a problem with cash flow, it is always best to find that out sooner rather than later. If you aren’t looking at the key financial statements, though, or you don’t understand how to read them, you could miss crucial information you will require to make vital decisions about the future of your law firm. Accounting for lawyers boils down to three key financial statements:

  • The income statement demonstrates the performance of a law firm over a specific period by displaying total revenue at the top, total expenses in the middle, and total net income at the bottom.
  • The balance sheet displays a law firm’s assets (tangible or intangible items of value the firm owns) and liabilities (accounts payable, rent or mortgages, and general expenses), along with owner/shareholder equity (assets minus liabilities), at a certain point in time.
  • The cash flow statement describes how money enters the firm and how it is allocated over a set period, typically a month.

These three statement types serve as information resources to provide insight into a firm’s financial performance, strength, and overall value.


law firm finances accounting basics for lawyers

Top Three Accounting Issues Unique to Law Firms

Once you master the basics of accounting for lawyers, you can better navigate the everyday challenges unique to the legal industry. Here are the top three issues to look for in your practice, along with proven solutions to consider.

1. Client Trust Accounting

Client trust accounting is the process of monitoring and tracking the cash funds a lawyer has received on behalf of or belonging to a client or a third-party entity. Trust account funds must never be mixed with firm operating funds, as it can induce potential accounting mistakes — including reporting trust accounts as income, mixing client and business accounts, and charging clients processing fees. One way to manage recurring client trust accounting errors without putting more strain on your lawyers and paralegals is to leverage law practice management software. Practice management solutions provide custom reports for every client trust account and include built-in payment capabilities to encourage streamlined organized client payments.

2. Differentiating Income From Revenue

When bookkeeping for lawyers, differentiating income from revenue is a common challenge because a portion of the funds are used to cover incurred costs and should not be factored into income. Deploying law practice management software is a simple method to track incurred costs in real-time and correctly subtract them from firm income. Software solutions help accurately reflect proper income and even help avoid compliance issues come tax time and regulatory review.

3. Tracking Billable Time

Aside from revenue and income, tracking billable hours can also be challenging for busy lawyers and law firms. Tracking billable time is a time-consuming and error-prone task that can significantly disrupt workflow without good record-checking practices. As an essential component of law firm success, use law practice management software to track billable time in real-time from any device and maintain confidence that all billable hours have been documented.

Demystify Accounting for Lawyers With Four Fundamentals

If accounting for lawyers seems intimidating, a robust knowledge of the basics can help every practice avoid common mistakes. Familiarize yourself with the generally accepted accounting principles (GAAP) for financial statements that are complete and comparable. Then, review your general ledger to better understand your law firm’s financial transactions. Once you’re geared with this information, refresh your knowledge on how to read the critical financial statements for your practice, like the income and cash flow statements and balance sheets. From here, review common issues that complicate accounting for lawyers, so you can better navigate your financial management process and avoid the challenges other practices may face. Want more tips for bookkeeping for lawyers? In the next chapter of PracticePanther’s Law Finance guide, we’ll look at best practices for billing for lawyers and law firms.

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