SQE1 FLK2 Solicitors' Accounts

Client Money

Any money belonging to the client which a solicitor/firm has control over.

Should be kept in a separate client account

What falls under Rule 2.1 as client money?

money held/received by a law firm

1. for regulated services delivered by you to a client

2. on behalf of a third party in relation to regulated services (held as agent or stakeholder)

3. as a trustee or holder of an office (donee of power of attorney or trustee of an occupational pension scheme)

4. in respect of your fees and any unpaid disbursements if held or received prior to delivery of a bill

Examples of client money

1. unpaid disbursements (search fees, LR fees) expected to be paid in connection with a transaction

2. ‘on account of costs’ not yet paid

3. deposit money received and held as an agent or stakeholder on a property sale

4. money received in respect of firm’s fees before a bill is sent for those fees

Is money held or received in relation to a paid disbursement client money?

No - as it has already been paid. The money is business money, belonging to the firm.

Business Money / Non-client money

Money belonging to the law firm rather than to its clients

Business bank acount

Used by a law firm to receive, or make payments of, business money

Client Account

• used by law firm to receive, or make payments of client money

• account in England and Wales that has firm’s name and client in its name

• belongs to the firm, not the client but is where client money is held

Requirements for a client account

1. must be held at either a bank/building society in England/Wales

2. must be labelled with name of firm and ‘client’ - Simmons client account

Mixed Money / Payment

Includes both client and non-client (business) money

Fees / profits

Firm charges for legal and other regulated professional services it provides

Disbursements

Costs or expenses paid or to be paid to a third party on behalf of the client.

Does not include office expenses (postage)

Double-entry book-keeping

System used where for each transaction there is a debit and credit entry in two different ledgers which balance each other out

Ledgers

Record of financial transactions

Drawn up from the perspective of the business

1. DR = good for business

2. CR = bad for business

When would a ledger only have business columns?

If they only deal with transactions using business money. 3 columns:

1. business bank account

2. debts owed to firm (outstanding bills by clients)

3. liabilities owed by firm (loans to be paid etc)

Examples of ledgers with only business columns

1. asset ledgers (premises, fixtures, vehicles, software)

2. expense ledgers (wages, utility bills, fuel costs, maintenance etc)

3. profit costs ledger (legal work done by firm’s fee earners which clients have been billed)

Cash sheet

Ledger records payments into and out of firm’s bank account

Have one for business and client account

Balance columns (what side is DR and CR on?)

DR = left (we drive on the left)

CR = right (you’d crash on the right)

How to decide whether an entry is a debit or credit?

DEAD CLIC mnemonic

DEBIT (increases)	CREDIT (increases)
Expense (statement of profit/loss)	Liability (statement of financial position)
Asset (statement of financial position)	Income (statement of profit/loss)
Drawings/dividends (statement of financial position)	Capital (statement of financial position)

Decrease in EAD = credit

Decrease in LIC = debit

Summary of steps to record a transaction

1. identify the 2 ledgers where accounting entries will be made

2. is it business or client money?

3. which ledger has DR and CR entry - what you do to one, do the opposite to the other

4. check a debit and credit entry for equal amounts is made

Journal entries

Description/summary of accounting entries made in a firm’s ledger

Regulated services

Legal and other professional services regulated by SRA (acting as a trustee or as the holder of a specified appointment)

Money held as an agent

On behalf of seller only - deposit belongs to the seller from exchange rather than on completion

Money held as a stakeholder

On behalf of buyer and seller during the period between exchange and completion.

On completion, the deposit will belong to the seller

Money held to the sender’s order

Where a third party sends money to the solicitor to be held on their behalf until they confirm it can be released to the client, or they request the solicitor returns it

Requirement to pay client money into client account promptly

• Must ensure client money is paid promptly into a client account (directly or shortly afterwards)

  • if by cheque - next working day is reasonable

• Client is not to be used for day-to-day banking. Must use own bank account for business

What can be done to rectify where client money is not paid promptly into client account?

1. transfer money from firm’s business account into client account temporarily until money can be paid into client account

2. once paid into client account, transfer corresponding money back to business account

When can a firm withhold client money from promptly entering a client account?

1. if held by a solicitor as a trustee or specific office appointment - may need to comply with other role-specific requirements which might conflict with general principle

2. money from Legal Aid for costs (will be only client money handled whilst acting for that client) so can go into business account immediately (even before bill is delivered)

3. alternative arrangements agreed on in writing (could hold in a third-party managed account)

Requirement to keep client money safe

Must safeguard money and assets entrusted to you by clients and others

Whose responsibility does the SRA Risk Outlook say it is to keep client money safe?

Every solicitor’s

According to the SRA Risk Outlook, what can client money breaches lead to for solicitors?

Lead to proceedings before the Solicitors Disciplinary Tribunal, with results that can include striking off

What recommendation does the SRA Risk Outlook make in respect of client money?

If client money is lost or taken, you must report this breach to the SRA promptly, even where the money has been replaced already

General client account

Main client account holding client money from lots of different clients and other third parties

When might a firm not need to have a client account to hold client money?

• only client money the firm receives is money for own fees and unpaid disbursements prior to a delivery of a bill

• firm doesn’t operate a client account for any other purpose; and

• firm has told clients in advance where and how money will be held

Limited exception - purely offering criminal litigation may benefit if only client money received is from Legal Aid.

Does the way money is received affect the ledger?

Doesn’t matter if received by cash, cheque or bank transfer

Journal entries for client money received (e.g. on account of costs)

Ledger	DR or CR
Client account	CR
Client cash sheet	DR

Journal entries for client money paid out (e.g. returning money to client)

Ledger	DR or CR
Client Ledger Account	DR
Cash sheet Client Account	CR

Journal entries for client money paid in and out

Ledger	Money in/out	CR or DR
Client account	In	CR
	Out	DR
Client cash sheet	In	DR
	Out	CR

Client account is easy to remember as same as own bank account

Then just do the opposite to your own bank account

Requirements to repay client money to client

• ensure client money is available on demand unless an alternative arrangement is agreed in writing with client or TP for whom money is held

• returned promptly to client or third party as soon as there’s no longer any proper reason to hold funds

Requirement to have client money available on demand

On demand = available immediately

Requires firms to maintain a general client account which is a current or deposit account with no notice period for withdrawals

What is the exception to client money being availabe on demand?

Firm agrees with client that it is not available on demand

Must be in writing

Example: legal matter requiring money held for a long time, might be held in separate designated deposit client account with better interest but often requires notice period to withdraw

Requirement for client money to be returned promptly

Must be returned to client/TP as soon as there is no longer any proper reason for holding.

Return as quickly as possible

What happens if a client stops giving instructions and firm still holds client money?

• if unable to contact client - return money to client

• if cannot locate client and don’t know where to return money - after reasonable time, firm can seek approval from SRA to withdraw balance and pay to charity

When do you need SRA approval to withdraw client money if you cannot locate the client?

If sum is +£500

What is the consequence of failing to return client money promptly?

Be at risk of providing banking facilities inadvertently

Breach of codes for holding money when there is no longer a proper reason to do so

When can a firm withdraw client money from a client account?

1. purpose for which it is being held

2. following instructions from the client or third party for whom it is held

3. following authorisation from SRA if client cannot be located and money is still held in account

What are the rules regarding withdrawals from a client account?

1. must be authorised and supervised by managers and COFA

2. only withdraw if sufficient funds are held on behalf of that specific client or third party

3. if business money is held in client account it must be transferred out to keep them separate

4. if a mixed payment was paid into client account, the non-client money element must be properly withdrawn and transferred into the business account

5. where client money has been held and some/all has been used to pay firm costs, a bill of costs must be sent to client before you transfer money - transfer specific sum identified in bill of costs

Manager

Responsible for running the firm (partner, LLP member, sole principal, director)

Have joint and several responsibilities to ensure firm complies with Accounts Rules

Compliance Officer for Finance and Administration (COFA)

Must have one.

Primary role - ensures firm compliance with Rules

Do not need to be legally qualified.

Should set up systems to minimise risks to client money and ensure all staff are trained to know how to comply with Rules

If there is insufficient money to withdraw from client account to client, what must you do?

Not withdraw money, otherwise you would be withdrawing another client’s money = serious breach of Accounts Rules

Prohibition on using a client account to provide banking facilities

Consequence - increased risk of involvement in money laundering

Examples of business money to be paid into business account

1. money received in payment for costs/disbursements following delivery of a bill

2. money received for paid disbursements, even before delivery of a bill

Accounting entries for receipt of business money (e.g. money received to reimburse you for a paid disbursement)

Credit client ledger business account

Debit cash sheet business account

Accounting entries for business money paid out (e.g. firm pays search fees out of business money due to insufficient money in client account)

Debit client ledger business account

Credit cash sheet business account

What is the general rule for breaches?

Any breaches of the Rules must be corrected promptly upon discovery

Prompt - reasonable for a firm to correct it unless it is money improperly withheld or withdrawn from client account (immediately)

Journal entries for client money paid into business account wrongly

Transfer out of BA: DR client ledger business account & CR cash sheet business account

Transfer into Client Account: CR client ledger client account and DR cash sheet client account

Journal entries for incorrect withdrawal of client money

Transfer out of BA: DR client ledger business account & CR cash sheet business account

Transfer into Client Account: CR client ledger client account and DR cash sheet client account

Once money is received: transfer back into business bank account (do the opposite as above)

Petty Cash

Small amount of business money used to pay for minor or incidental expenses

Rules for petty cash

• any payment made on behalf of client using petty must come from business account

• separate petty cash ledger to record this

Journal entries for petty cash used on client’s behalf

Debit client ledger business account

Credit cash sheet petty cash

What are the accounting entries for a receipt of mixed money?

Splitting cheque - pay client money into CA and business money into BA

	Client Money	Non-Client Money
Credit	Client ledger cash account	Client ledger business account
Debit	Cash sheet client account	Cash sheet business account

Requirement to pay interest on client money

Where firms hold large sums of client money for a long time, it is fair to pay the client actual interest earned or to pay them some money instead of interest

Separate designated deposit client account (SDDCA)

Account opened by a firm for an individual client

• separate from general client account

• designated in the name of an individual client

• deposit account earning more interest than a general client account

• labelled as a ‘client’ account

Sum in lieu of interest

Rather than paying actual interest, the firm applies its interest policy to decide what amount is fair and pays a sum instead of interest

Exceptions to the requirement to pay interest

If firm provides sufficient information to C in advance, it can agree alternative arrangements with the client with respect to interest.

Must be in writing.

How is fair interpreted in regards to payment rate of interest?

Likely to be interpreted by:

• firm’s written policy on how interest is calculated on client money and must inform clients accordingly

• policy should consider both amount of client money held and length of time it will be held

• consider what rates of interest are offered by FI

• de minimis provisions

De minimis threshold

Minimum threshold in the context of interest

Firms may choose not to make interest payments to any client if their entitlement to interest under the policy is below a certain minimum threshold

What should you look out for if a question relates to large sums of client money held for a long time?

1. check if there is a justifiable purpose to hold money - correct answer is likely to relate to fair interest payments

2. no good reason for holding money - correct answer would be to remedy breaches promptly by returning money to client, possibly with some interest

What are the methods for dealing with interest on client money?

1. transfer interest into CA to offset against firm’s bill or use future disbursements - common when a legal matter is not finished

2. pay interest directly to client, usually at end of matter

What method is used to deal with interest on client money held in the general client account?

Firm will pay a sum in lieu of interest, if fair to do so

Treated as an expense and recorded in an interest payable ledger

Interest payable

Expense of the firm.

Each firm pays a sum in lieu of interest to a client to be recorded in interest payable expense ledger

Accounting entries for client money held in the general client account

1. Record interest payable as business money

   • Credit client ledger BA (interest receivable ledger)

   • Debit interest payable (expense) ledger (only has B columns) (cash sheet BA)

2. Transfer sum in lieu of interest out of BA

   • Debit client ledger business account/interest payable ledger

   • Credit cash sheet business account

3. Transfer sum in lieu into CA

   • Credit client ledger client account

   • Debit cash sheet client account

Requirements for a SDDCA

• separate from general client account

• designated in the name of an individual client

• deposit account earning more interest than a general client account

• labelled as a ‘client’ account

Different terminology used for an SDDCA

• separate designated client account

• separate designated deposit bank accounts

• designated deposit accounts

Accounting entries for payment of interest earnt by a SDCA

Credit client ledger SDCA

Debit cash sheet SDCA

Accounting entries for transferring money from general client account to an SDDCA

1. Transfer from general CA

   • DR client ledger client account

   • CR cash sheet client account

2. Transfer into SDDCA

   • CR client ledger SDDCA

   • DR cash sheet SDDCA

Accounting entries for transferring money from SDDCA to general client account (including interest)

1. Transfer from an SDDCA

   • DR client ledger client deposit account

   • CR cash sheet client deposit account

2. Transfer into general CA

   • CR client ledger client account

   • DR cash sheet client account

Accounting entries for transfers from client account to business account

Transfer out of CA: DR client account and CR cash sheet client account

Transfer into BA: CR business account and DR cash sheet business account

Profit costs

Sometimes called professional fees or charges

Firms charge client profit costs for legal services provided

VAT - Value Added Tax

Consumer tax that individuals and business pay when they buy goods and services.

Current rate is 20% (includes legal services)

Profit costs ledger

Record of all bills submitted by the firm.

Managers check this regularly to see how much has been billed by fee earners.

VAT ledger

Record of all the output VAT firm has charged when providing legal services to clients

Input VAT paid by firm for buying goods/services needed to run a business

Output VAT

What firm has charged when providing legal services to clients

Input VAT

All the VAT the firm has paid when buying goods and services it needs to run the business

How often does a firm need to complete and send HMRC a VAT return?

Every 3 months using records in VAT ledger

• if input exceeds output - HMRC pays firm a VAT refund

• if output exceeds input - firm pay different to HMRC

Accounting entries for issuing a bill plus VAT

• Debit client ledger business account with amount of bill of costs only

• Credit profit costs with amount of bill of costs only

Then: Debit BA with bill of costs including VAT and Credit VAT account with bill of costs including VAT

What do profit costs and VAT ledgers have in common?

Only have business columns

Why do accounting entries not include cash sheets when submitting a bill?

Client hasn’t paid yet

Ways to calculate VAT on profit costs

1. Multiply profit costs by 0.2

2. Calculate 20% of profit costs

3. Work out 1/5 of profit costs by dividing by 5

Abatement

Agreed reduction in a client’s bill

Accounting entries for abatement of bills

Abatement of profit costs: CR business account and DR profit costs ledger

Abatement of VAT: CR business account and DR VAT ledger

How to figure out the new bill post-abatement?

It is what the bill has been reduced by not what it’s reduced to

Original bill = £400 + VAT

25% abatement = £100 + VAT for accounting entries

Tip for remembering issuing and reducing a bill

Debits and credits are opposite way round

Money on account (of costs and disbursements)

Money collected from client before legal work is undertaken

Protects a firm by ensuring they can minimise the use of business money to pay for disbursements and a good indicator that C can pay their bill soon

Entries for money held on account of costs and disbursements

Same as client to business cash transfer

• DR client ledger client account and CR cash sheet CA

• CR client ledger business account and DR cash sheet BA

When must a business register for VAT?

If their turnover exceeds VAT registration threshold (currently £90,000 per year).

Can choose to register if turnover falls below this.

VAT return

Form completed by VAT-registered businesses every three months, usually online, detailing their input tax and output tax for that period.

Must submit form to HMRC

When do firms not need to charge VAT?

Disbursements for VAT purposes

What are expenses recognised as disbursements for VAT purposes?

Deemed separate from legal services provided by the firm (merely arranging for supply of TP service to client)

• SDLT

• LR registration fee

• Probate fees

• Court fees

What expenses are not recognised as “disbursements for VAT purposes”

• expenses treated as part of firm’s overheads in providing legal services to clients

  • Postage, photocopying, printing, travel expenses

• expenses deemed integral to legal services provided by firm (legal advice on a service supplied by a third party)

  • experts’ fees, some conveyancing searches

How are expenses treated on an invoice if they are recognised disbursements for VAT purposes?

Expense shown separately on firm’s invoice to client (without VAT)