Records, Ledgers and Reconciliation — SQE1 FLK2 Solicitors Accounts

It is completion day. The seller's solicitors need £3,500 to complete your client's purchase of a shop. She has paid you £6,000, and it is sitting in the client account. And you cannot send the £3,500. Because what you hold for her is not £6,000. It is £3,100.

Two entries explain the difference. A £900 search fee you paid on her behalf. And £2,000 you transferred to the office account after you delivered a bill. Both were entirely proper. Both came off her ledger. And her ledger, not the client account, is what you may pay out of. This is Records, Ledgers and Reconciliation, the sixth topic in Solicitors Accounts. Keep her in mind.

Here is the route. The three books a firm keeps, and what each one is for. Then how a single transaction lands in all of them. Then reconciliation, which is the five-weekly check that the books tell the truth. Then what to do when it does not balance. Then bills and transfers, which is where firms get into trouble. And last, disbursements and VAT.

Start with why any of this exists. If the SRA ever asks how your firm handled client money, your records are your defence. Accurate, contemporaneous records demonstrate compliance. Poor records invite the assumption that you did not.

So what must be kept? A cash book recording all bank transactions. A client ledger for each client. Office ledgers recording costs incurred and recovered. And the supporting evidence: bank statements, paying-in slips, cheque stubs, bills. Electronic records are fine, provided they are backed up and keep a clear audit trail.

And one number to fix now. Records must be retained for at least six years, and the period runs from the date of the transaction, not from the date the file closed. A firm whose policy is five years from closure has the length and the trigger both wrong, and destroying records early is itself a breach.

Now the three books, starting with the one that matters most. The client ledger is the record of all money held for one particular client: every receipt, every payment out, and a running balance. That balance is what the firm currently owes that client. Each client, and preferably each matter, gets its own ledger.

Which is why combining two clients on one ledger is a serious breach, however tidy it looks. You cannot see at a glance what is held for either, and a shortage on one client's funds is masked by the other's balance. The pooled figure looking right is exactly the problem.

Then the entry convention, which feels backwards to everyone the first time. On a client ledger, credits increase the balance and debits reduce it. Money received for the client is a credit. Money paid out on their behalf, or transferred to office for billed costs, is a debit.

The reason is that a client ledger is not a record of the firm's money. It records what the firm owes the client, so a credit to a liability increases it. Receive £5,000, credit. Pay an £800 search fee out, debit. Balance: £4,200 held for that client.

The office ledger is the other side of the firm's life. It records what the firm has laid out on a client's behalf, and whether it has got that money back. Costs incurred are debited. Costs recovered are credited. It answers what the firm is owed, not what the firm holds.

So try this. A firm pays a £320 search fee out of the office account. No client money moves, so nothing goes on the client ledger at all. It goes on the office ledger as a cost incurred, and clears when the client is billed and pays.

And at the end of a matter, the client ledger is nil and the office ledger shows a debit balance of £700. Has client money gone missing? No. A debit balance there means the firm is £700 out of pocket on unrecovered costs. That is a cost-recovery problem for the firm, not a shortage on the client account. Bill it, recover it, or write it off with a partner's authority and a recorded reason.

The third book is the cash book, the firm's central record of banking. Every receipt into and payment out of both bank accounts, in date order. The usual format is columnar: date, description, then client bank payments, client bank receipts, office bank payments, office bank receipts.

Now put a transaction through all of it. A client sends £8,000 on account and you bank it. Two entries, made at once. In the cash book, the client bank receipts column. On her client ledger, a credit. Both when the money arrives, not when it is spent, because until then you cannot say what you hold for her.

Now pay a £250 expert's fee out of the client account. Cash book, client bank payments. Client ledger, a debit, reducing what you hold. And because the firm has incurred a cost, the office ledger is debited too. One payment, three entries, every one in the right direction if the account is to reconcile.

And before any payment leaves the client account, one check matters more than all the others. Does that client's own ledger hold enough to cover it? Not the client account, which may hold several hundred thousand pounds for everybody. That client's ledger. Pay out beyond what you hold for them and you have spent other clients' money.

Reconciliation next. The client account must be reconciled at least every five weeks, and the obligation does not bend to how busy the firm has been. A quiet period is no excuse. Two transactions in five weeks still needs a reconciliation, because a firm that has not checked cannot know whether its books agree.

And it agrees three ways, not one. The cash book against the bank statement. And the total of all the client ledger balances against both. Miss the third and you have not really reconciled: the bank can agree with your cash book perfectly while your ledgers say you owe clients more than you hold.

The order of work matters too. Write up the cash book first, completely, before you compare anything. Start by comparing an unfinished cash book to the bank statement and you will find a difference of exactly the transactions still sitting in the tray. Then spend the afternoon hunting for errors in ledgers that were never wrong.

Then compare line by line, list the outstanding items, pick up anything on the statement you have not recorded, check the ledger total, and document it. The statement is signed off by a manager of the firm. The rules do not say who does the work. They require competence and supervision, so an experienced bookkeeper whose work a partner signs is acceptable.

Outstanding items are the ordinary reason the two figures differ, and they are not errors. They are transactions you have correctly recorded which have not yet reached the bank statement. Unpresented cheques, written and posted but not yet paid in. And uncredited deposits, paid in but not yet credited by the bank.

So run the arithmetic. Cash book says £84,000. The bank statement says £91,500. Four cheques totalling £7,500 have not been presented. £84,000 plus £7,500 is £91,500 exactly. Nothing is wrong, nothing is corrected, and the outstanding items are simply listed. That is what a reconciliation is for.

But watch items that stop being timing differences. A cheque unpresented for seven months may be stale, and you cannot drop it off the reconciliation and treat the money as available. It is still client money held for the intended recipient. Investigate, contact the payee, and if necessary stop it and reissue.

Now the hard case: it does not balance. Two diagnostics are worth carrying into the exam. First, if the unexplained difference divides by nine, suspect a transposition, where two digits were reversed. Enter £319 as £391 and the difference is £72, which is nine times eight. That does not prove a transposition. It tells you where to look.

Second, if a receipt has been posted on the payments side, the balance moves by twice the amount. Once for the receipt now missing, once for the payment wrongly added. So a £150 item on the wrong side produces a £300 discrepancy. Reverse the wrong entry and post it correctly.

And the rule above all of it. Never force a balance. Entering an unexplained figure so the reconciliation agrees hides the error instead of finding it, and that is a serious breach of proper accounting practice. If a difference cannot be explained, it has to be found.

One worked example to fix the point. Bank statement £51,000, less £5,000 unpresented, plus £2,000 uncredited, gives £48,000, matching the cash book exactly. So far so good. But the client ledgers total £48,700. That means £700 more is owed to clients than is actually held. That is a shortage, and it must be investigated and corrected.

Bills now, and the date that matters is delivery. A bill is delivered when it is sent to the client, by post, by email or by hand. Not when it is written, opened, acknowledged or paid. Write the bill on the fifteenth and post it on the sixteenth, and the sixteenth is your date.

Why does that date matter? Because a bill of costs, or other written notification of the costs, must be given to the client before client money is used to pay them. The sequence is fixed. Bill first, transfer afterwards.

And when you do transfer, transfer only what the bill covers. Deliver an interim bill for £3,000, made up of £2,500 profit costs plus £500 VAT, on a client balance of £8,000, and £3,000 is what may move. The other £5,000 is unbilled client money and stays where it is. Delivering a bill does not entitle you to sweep the balance.

The mirror image is the reverse transfer. If a bill is reduced, or costs are written off, or a transfer was made in error, the firm has ceased to be entitled to the money. It reverts to being the client's. Money the firm is not entitled to cannot sit in the office account, so put it back promptly. Do not wait for the next bill to sort it out.

Last, disbursements and VAT, which is the highest-scoring thing in this topic. There are two methods, and one question decides which applies. Who is the customer of the third party?

If the firm engaged the supplier, was invoiced in the firm's own name and is the person they look to for payment, the firm is the customer. That is the principal method. The supply passes from the supplier to the firm, and then from the firm to the client. So the firm charges VAT to the client on the disbursement, and recovers the VAT it was itself charged.

If the client engaged the supplier, is invoiced by name and is the person they look to for payment, the client is the customer. That is the agency method. There is no supply from the firm to the client at all: the firm is simply settling the client's own liability and recovering the exact sum. No VAT is added, and none can be reclaimed, because none was ever charged to the firm.

Two quick ones. You chose the expert, instructed her in the firm's name, and her invoice is addressed to you. Add VAT when you bill the client? Yes, principal. Now the client engaged a surveyor before instructing you, the invoice is addressed to the client by name, and you settle it as a convenience. Add VAT? No, agency. Look at whose name is on the invoice.

And put numbers on it. Profit costs £1,000, and a search fee of £200 that the firm itself engaged. VAT at 20% applies to both, because the search fee is a principal disbursement. £200 of VAT on the costs and £40 on the search fee, so the bill totals £1,440. Treat that search fee as a pass-through with no VAT and you are £40 short and wrong on principle.

A word on how SQE1 tests this. There are no cases in this topic at all. It is a rules subject, and you will not be asked to recite a rule number either. You get a scenario, five answers, and one instruction: pick the best. So learn what each rule makes you do.

If you keep only three things, keep these. Five weeks, and the reconciliation that has to agree three ways. Bill before transfer, always, in that order. And for any disbursement, one question only: who was the supplier supplying? Answer that and the VAT treatment follows.

Five traps. One: six years, and it runs from the transaction, not from when the file closed. A five-year-from-closure policy destroys records the firm is still obliged to hold. Two: never put two clients on one ledger. It looks tidy and it hides shortages, and the fact that the pooled total is right is no answer at all.

Three: the balance you check before paying out is the client's own ledger balance, never the client account total. The client account belongs to everybody. Four: reconcile even when nothing has happened, and never force a balance. An unexplained difference entered to make the figures agree is worse than the difference, because now nobody will look for it.

Five: transfers run in both directions and both are strict. You may not transfer to office without a delivered bill and a specific sum. And you may not leave money in office once you have ceased to be entitled to it. Cash flow is not an entitlement. If a bill is reduced, the difference goes back, and it goes back promptly.

Quick check. A firm holds £10,000 of a client's money in the client account. The work is finished and the firm has earned about £4,000 in costs, none of which the client has questioned. No bill has yet been prepared or sent. The firm is short of working capital this month. The managing partner proposes transferring the £4,000 to the office account now, with the bill to follow.

May the firm transfer the £4,000 before any bill is sent? Three candidate answers. One: yes, the costs have genuinely been earned and are undisputed. Two: yes, the client balance comfortably covers the sum. Three: no, a bill or written notification of the costs must be given to the client first. Pause here if you want a moment.

The answer is three. Where client money is to be used to pay the firm's costs, a bill of costs or other written notification must first be given to the client. And the payment must be for the specific sum identified.

So having earned the costs is not enough on its own. Neither is a healthy client balance. Until the bill goes out, that £4,000 is still the client's money, and moving it is a breach. What makes it painful is how easily it was avoidable. Send the bill today, transfer immediately afterwards.

Why the others fail. One mistakes entitlement in substance for entitlement in form. The costs being earned is what makes the bill honest, not a substitute for sending it. Two is the reasoning that gets firms into real trouble: a large client balance always looks like room to borrow from, and never is.

Five things to take away. One: three books. The client ledger for what you hold for each client. The office ledger for what the firm has laid out and not yet recovered. And the cash book for every movement through the bank. Two: on a client ledger, credits up, debits down, because the balance is what you owe.

Three: reconcile at least every five weeks, and make it agree three ways, cash book to bank statement to the total of the ledgers. Four: outstanding items are timing, not error. A difference that divides by nine is probably a transposition, and a figure on the wrong side moves the balance by twice the amount. Five: bill before transfer, and put back promptly anything you turn out not to be entitled to.

And your client, on completion day? Six thousand pounds paid in, a £900 search fee out, £2,000 properly transferred after a bill. £3,100 held, £3,500 needed. You cannot borrow the difference from the client account, because it is not yours to borrow. Get further funds from her, or pay the shortfall from office money. The ledger is not paperwork. Next time, Joint Accounts and Third-Party Accounts.

Practise this topic with exam-style questions at sqe1prep.co.uk. This episode is for education and exam revision only, not legal advice, and we are not affiliated with or endorsed by the SRA or Kaplan.