This article will review basic accounting concepts for Trust/Escrow/IOLTA bank accounts. These are bank accounts that hold funds on behalf of someone else, such as an attorney holding funds in the form of a retainer from a client, or an attorney holding money for a property purchase. There may be some differences between Trust, Escrow and IOLTA bank accounts, but the underlying accounting concepts are typically the same. This article will focus on the basic accounting concepts related to this type of bank account. For purposes of writing about these types of accounts, I’m going to use the term “Trust” account but the entries could be applied to an IOLTA or Escrow account as well. Also please note that different locations and jurisdictions have different Trust bank account regulations. Please check your local area for those specific regulations.
Most attorneys will have a “Trust” bank account and an “Operating” bank account. The Trust bank account will be used for purposes of holding funds for someone else, and the Operating bank account will be used for general business purposes such as paying expenses and depositing earned income.
Any money that is deposited into a Trust bank account is recorded as a current liability or debt. Why would you put it in a liability account? Remember that the attorney is simply holding money on behalf of someone else. It’s not income at this point, although it may turn into income later in the case of a retainer that is used to pay for legal services. It’s also not an expense of the business, or property of the business. If the bank account had to be closed today, the money would have to be paid out to the owner. Therefore in accounting the money is treated as a current liability.
Let’s look at an example. Let’s assume an attorney collects $8,000 from a new client as a retainer for legal services. Since the attorney hasn’t provided any legal services yet, this is not earned income. The money would be deposited into the Trust bank account. The accounting entry would be:
Debit – Trust Bank Account 8,000 Credit – Trust Liabilities 8,000
Once the attorney provides legal services and sends the customer an invoice for legal services, money would be moved from the Trust bank account to the Operating bank account to pay the invoice. At this point revenue has been earned. For example, if the attorney invoices the client for $2,500 in legal services and uses the retainer to pay the invoice, the following entry would be done to show the money leaving the Trust bank account. Notice that it is simply a reversal of the first journal entry above.
Debit – Trust Liabilities 2,500 Credit – Trust Bank Account 2,500
There would also be an entry to show the revenue earned and the deposit to Operating. The following entry shows this:
Debit – Operating Bank Account 2,500 Credit – Legal Fee Income 2,500
The client still has $5,500 remaining as a retainer in the Trust bank account. And the attorney shows income of $2,500 on the Profit & Loss statement.
Please note that I showed the debits and credits in the above example. These debits and credits may be shown in your accounting software as journal entries, transfers, checks and/or deposits, depending on your typical company procedures.
Newberry Accounting Inc 