In short
A three-way reconciliation of a trust account proves that three figures agree at the same date: the bank statement balance adjusted for uncleared items, the balance in the firm's trust account journal, and the total of all client ledger balances. If any one differs, client money may be missing or misrecorded. California, Florida and New Jersey require it monthly; the ABA model sets quarterly as a minimum.
Key takeaways
- A three-way reconciliation compares the adjusted bank balance, the trust account journal balance and the sum of every client ledger balance, all at the same date.
- The bank balance is adjusted by adding deposits the bank has not yet credited and subtracting checks that have not yet cleared.
- California's rule 1.15 standards and Florida Rule 5-1.2(d) require monthly reconciliation, and New Jersey R. 1:21-6 requires a reconciliation at least monthly.
- The ABA Model Rules on Client Trust Account Records set quarterly reconciliation as a minimum and describe monthly reconciliation as the preferred practice.
- Every difference must be traced to its cause and corrected, and a client ledger with a negative balance means other clients' money has been used.
What a three-way reconciliation is
A law firm trust account holds money for many clients in one bank account. The bank knows only the total. The firm knows, or should know, how much of that total belongs to each client. A three-way reconciliation proves the two views agree. It compares three figures at the same date, usually the last day of the month: the balance on the bank statement, adjusted for items that have not yet cleared; the balance in the firm's trust account journal, sometimes called the checkbook register; and the total of all individual client ledger balances.
A two-way reconciliation, the kind most businesses do, compares only the bank statement with the firm's own register. That proves the firm's cash records are right in total. It does not prove that the money is correctly divided between clients. The third leg, the client ledgers, is what catches a payment charged to the wrong client or a client whose balance has gone below zero. This is why bar rules describe the check as three-way. The rules behind it are covered in our guide to IOLTA trust account rules.
| Record | What it is | What it proves |
|---|---|---|
| Bank statement | The bank's record of the account balance | What money is actually held |
| Trust account journal | The firm's chronological record of every deposit and payment, with a running balance | What the firm believes it holds in total |
| Client ledgers | One record for each client or matter showing money in, money out and balance | Whose money it is |
How often it must be done, by state
The frequency depends on the state whose rules govern the account. The ABA's model recordkeeping rule asks for monthly trial balances and quarterly reconciliations as a minimum, and its commentary says monthly is the preferred practice. Several large states have made monthly mandatory. California's standards under rule 1.15 of the Rules of Professional Conduct require a monthly reconciliation balancing the client ledger, account journal and bank records. Florida Rule 5-1.2(d) requires monthly reconciliation of each trust bank account, a monthly comparison with the total of the client ledgers, and an annual list of the balance held for each client.
New Jersey's court rule R. 1:21-6(c) requires records showing that at least monthly a reconciliation has been made. The State Bar of Texas tells lawyers they need to reconcile their trust account every month. New York's Rule 1.15 sets detailed bookkeeping duties but no reconciliation interval, which is covered in our guide to New York attorney escrow account rules. In practice a monthly three-way reconciliation is the standard that satisfies every state.
| Jurisdiction | Frequency | Source |
|---|---|---|
| ABA model | Quarterly minimum; monthly preferred | Model Rules on Client Trust Account Records, Rule 1(i) and comment |
| California | Monthly | Rule 1.15(e) standards |
| Florida | Monthly reconciliation and comparison; annual client listing | Rule 5-1.2(d) |
| New Jersey | At least monthly | R. 1:21-6(c) |
| Texas | Every month (State Bar guidance) | State Bar of Texas, Trust Accounts |
| New York | No interval set in the rule | Rule 1.15(d) |
Step by step
Pick one date, normally the last day of the month, and make sure every receipt and payment up to that date has been posted to both the journal and the right client ledger. Then work through the steps below in order. The order matters: fixing the bank side first stops you hunting for a client ledger error that is really an uncleared check.
- Take the ending balance from the bank statement for the trust account.
- Add deposits in transit: money recorded in the journal that the bank has not yet credited.
- Subtract outstanding checks and transfers: payments recorded in the journal that have not yet cleared the bank. List each one by date, number and amount.
- Add or subtract any bank items not yet in the journal, such as a bank fee or a returned deposit, and record them in the journal before going further. The result is the adjusted bank balance.
- Calculate the journal balance: last month's reconciled balance, plus this month's receipts, minus this month's payments.
- List every client ledger with a balance and total them. Check that no client ledger is negative.
- Compare the three figures. If all three agree, the reconciliation is complete. If not, investigate each difference, record its cause, correct it and run the comparison again.
- Have the responsible lawyer review and sign the reconciliation, and keep it with the bank statement, the outstanding items list and the client ledger listing.
Worked example in dollars
A 25-lawyer personal injury and real estate firm reconciles its IOLTA account as at April 30. The bank statement shows $412,860.00. Two deposits made on April 30, totaling $18,500.00, appear in the journal but not yet on the statement. Three checks totaling $27,315.00 have been issued but not yet cleared. The adjusted bank balance is $404,045.00. The journal shows an opening balance of $389,200.00, receipts of $146,370.00 and payments of $131,525.00, giving $404,045.00. The bank and the journal agree.
The client ledgers, however, total $403,745.00, which is $300.00 short. The firm finds that a $300.00 reimbursement for a filing fee received on April 22 for one client was entered in the receipts journal but never posted to that client's ledger. Once the receipt is posted to the right ledger, the total becomes $404,045.00 and all three figures agree. The firm records the cause and the correction on the reconciliation. Had the ledgers instead totaled more than the bank, the firm would have needed to find out whether a payment had been recorded without leaving the bank, or whether money was missing.
| Line | Amount (USD) |
|---|---|
| Bank statement balance at April 30 | 412,860.00 |
| Add: deposits in transit | 18,500.00 |
| Less: outstanding checks (3) | (27,315.00) |
| Adjusted bank balance | 404,045.00 |
| Journal: opening balance April 1 | 389,200.00 |
| Journal: add receipts in April | 146,370.00 |
| Journal: less payments in April | (131,525.00) |
| Journal balance at April 30 | 404,045.00 |
| Total of client ledgers before correction | 403,745.00 |
| Difference: receipt not posted to client ledger | 300.00 |
| Total of client ledgers after correction | 404,045.00 |
| Unexplained difference | 0.00 |
Common differences and what they mean
Most differences fall into a small number of patterns. Where the bank and the journal disagree, the cause is usually a bank fee or interest entry not yet recorded, a deposit recorded at the wrong amount, or a check keyed with transposed digits. Where the journal and the client ledgers disagree, an entry has been posted to one record and not the other, or posted to the wrong client.
Some differences are more serious. A client ledger with a negative balance means the firm has paid out more for that client than it held. Funds belonging to other clients covered the gap, and that must be put right at once. Checks outstanding for months may mean money owed to a client or third party has never reached them. Each difference should be logged with its cause, owner and resolution, in a break log kept with the reconciliation.
| Symptom | Likely cause | Action |
|---|---|---|
| Bank lower than journal by a small round amount | Bank fee or wire charge not recorded | Record the charge; firm money may need to cover it if state rules require |
| Bank and journal differ by a multiple of 9 | Transposed digits in an entry | Check entries against deposit slips and check images |
| Journal agrees with bank, ledgers do not | Entry posted to journal but not to a client ledger, or to the wrong client | Post to the correct ledger and record the correction |
| One client ledger negative | Payment made before money was received, or charged to the wrong client | Restore the shortfall immediately and investigate |
| Old outstanding checks | Payee never cashed the check | Contact the payee; follow the state's unclaimed funds rules |
What to keep as evidence
A reconciliation that cannot be shown to a bar auditor is of little use. Keep, for each month and each trust account, the bank statement, the list of outstanding deposits and checks, the journal balance calculation, the client ledger listing with each balance, the three-way comparison itself, and a note of each difference with its cause and correction. California's State Bar lists monthly three-way reconciliations with supporting documents among the records lawyers must maintain.
Keep these records for at least as long as the governing state requires: five years after final distribution in California, six years in Florida and seven years in New Jersey. In California, the annual CTAPP self-assessment asks whether monthly reconciliations are performed, so the evidence matters each year, not only at audit.
The same check outside the United States
The three-way structure is not unique to US law. Ontario's By-Law 9 requires a monthly comparison of trust bank balances with client balances, completed within 25 days after month end, as explained in our guide to Law Society of Ontario trust reconciliation. Australia's Uniform General Rules require two monthly reconciliation statements within 15 working days, covered in trust account reconciliation for law practices in Australia. Payment companies run a different three-way check, matching ledger, processor and bank, which is covered in our three-way reconciliation guide for payment firms.
Safeheld reconciles client money every day for regulated firms, works every difference to its cause and keeps the record auditors ask for, and is extending that work to law firm trust accounting in the United States. If your firm holds client money in IOLTA or other client trust accounts, talk to us about law firm trust accounting.
Frequently asked questions
What is a three-way reconciliation of a trust account?
A check that the adjusted bank balance, the trust account journal balance and the total of all client ledger balances agree at the same date. It proves both that the money is there and whose money it is.
How often do you have to do a three-way reconciliation?
It depends on the state. California, Florida and New Jersey require it monthly, and the ABA model sets quarterly as a minimum with monthly preferred.
What is the difference between a two-way and a three-way reconciliation?
A two-way reconciliation compares the bank statement with the firm's register. A three-way reconciliation adds the client ledgers, which shows whether the money is correctly divided between clients.
What do you do if the three-way reconciliation does not balance?
Adjust the bank balance for uncleared items first, then trace each remaining difference to its cause, correct the record and run the comparison again. Record every cause and correction.
What does a negative client ledger balance mean?
The firm has paid out more for that client than it holds for that client, so other clients' money has been used. It must be corrected immediately.
Who should sign the trust reconciliation?
The lawyer responsible for the trust account should review and sign it. Delegating the preparation to a bookkeeper does not move the lawyer's responsibility.
References
- American Bar Association, Model Rules on Client Trust Account Records, Rule 1 Comment
- State Bar of California, Rules of Professional Conduct, Rule 1.15 and standards
- The Florida Bar, Chapter 5: Rules Regulating Trust Accounts
- New Jersey Courts, Office of Attorney Ethics, Trust and Business Accounting Outline
- State Bar of Texas, Trust Accounts
About Safeheld
Safeheld reconciles client money every day, resolves every difference and prepares every regulatory return for sign-off, for regulated firms in the United States, the United Kingdom, the European Union, Canada, Australia, Singapore and Hong Kong. To discuss your operations, contact us at safeheld.com/contact.
This article is for general information and does not constitute legal or regulatory advice.