Who’s (ac)counting?

Affinity Consulting

For many law firms without a trained bookkeeper or accountant, the general ledger is the aspect of accounting that confuses them the most. Debits and credits, journal entries, and the chart of accounts can feel like foreign concepts. Here’s a simplified breakdown of these bookkeeping/accounting concepts.

Chart of accounts 

The chart of accounts is the list of all accounts within your general ledger. There are typically six main types of accounts: 

— Asset accounts include your bank accounts, your furniture, your equipment, and any other assets the firm may own.

— Liabilities accounts include credit cards and banknotes owed by the firm.

— Equity accounts, sometimes grouped with liability accounts, show the amount of capital a partner or shareholder may have in the firm. These are grouped with liabilities as they represent the equity due to the shareholder or partner. 

— Income accounts reflect the amount of fee income, interest income, etc., that has come into the firm during a given period. 

— Expense accounts reflect the various expenses incurred by the firm for things like payroll, rent, supplies, and other overhead-related costs. 

— Retained earnings accounts are automatically calculated within the accounting system, based on how all other accounts on the financial statements add up. Essentially, retained earnings represent the cumulative net worth of the firm. 

Journal entries 

Every entry on the general ledger is two-sided – a debit and a credit. Most journal entries are made automatically by the accounting software based on the transaction you entered. Occasionally, however, you may need to make a manual journal entry. 

An automatic journal entry happens when you enter a payment from a client into the system. The payment is for fees only. The accounting system sees that and automatically debits the bank account and credits fee income. It also happens when you write a check to the landlord for rent. It would automatically credit your bank account and debit the rent expense account. 

The hardest thing for most people to understand is when something is considered a debit versus when it is a credit. Most transactions affect your bank account somehow. If you can remember that money going into the bank account is a debit, and money coming out of your bank account is a credit, then the other side of the transaction is always going to be the opposite.

Financial statements 

An income statement, sometimes referred to as a Profit & Loss (or P&L), is the net income of the firm for the current fiscal period. It shows income versus expenses. The difference between them is the net income for the period. At the end of every fiscal year, the income and expenses zero out and the new fiscal year starts fresh. The net income is used for tax reporting, and it moves over to the balance sheet as part of total retained earnings. 

A balance sheet compares the assets to the liabilities/equity. The difference between the two is the total retained earnings. The assets and liabilities do not zero out at year end, but rather carry from year to year. The current year retained earnings should always match the net income year to date on the income statement. 

A trial balance represents a combination of all accounts on the chart of accounts, giving the full financial picture, essentially combining the income statement and the balance sheet. It typically gives a starting balance for each account, shows the net change to the account, and the ending balance for it. For some accounts the net change will be a debit and for others it will be a credit. Therefore, the total net change for all accounts during a particular period should be equal. If they are not, then somehow your general ledger has gotten out of balance and should be corrected. Checking the trial balance at the end of each accounting period should be a standard procedure. 

Budgeting 

Budgets are very important. Any good back-office software product will allow you to budget expenses and income, realistically mapping out your cash flow for the year. As you print your financial statements month to month, you can see how your firm is faring compared to the budget number and compared to prior months or years. This will help you identify trends before it’s too late. 

Conclusion 

Lawyers went to law school and passed the bar to practice law, not to do accounting. But it is a fact of life that part of owning any business is cash flow and billing/accounting. Also, your firm has a duty to responsibly manage your clients’ funds and provide proper accounting of services to each client.

Follow the guidelines above, familiarize yourself with the Rules of Professional Conduct, and make sure you have some checks and balances in place. By doing this, your firm will be able to focus on the practice of law, rather than worrying about finances. 

Correction: This article was updated at noon on Jan. 15, 2025, to correct the description of “expense accounts.”