Learning Outcomes
After reading this article, you will be able to explain how debits and credits operate in client account records, especially in relation to liability and equity accounts. You will understand how double-entry bookkeeping principles apply to client money, how to record and interpret entries for client liabilities and firm equity, and how these relate to the SRA Accounts Rules. You will also be able to identify common exam pitfalls and apply your knowledge to SQE1-style scenarios.
SQE1 Syllabus
For SQE1, you are required to understand the operation of client accounts, including the correct use of debits and credits in liability and equity accounts. Focus your revision on:
- the double-entry bookkeeping system as applied to client accounts in legal practice
- how to record and interpret debits and credits in liability accounts (such as client ledgers)
- how equity accounts (such as partners’ capital and current accounts) are structured and updated
- the SRA Accounts Rules requirements for accurate and compliant record-keeping
- the impact of these entries on the firm’s obligations to clients and partners.
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- When a law firm receives client money, which accounts are debited and credited in the double-entry system?
- What is the effect of a credit entry in a client liability account?
- How does a debit entry in a partner’s capital account affect the equity of the firm?
- True or false? A payment out of the client account to a third party always results in a debit to the client liability account.
Introduction
Client accounts are central to legal practice, ensuring that money held for clients is kept separate and properly recorded. Understanding how debits and credits work in liability and equity accounts is essential for both compliance with the SRA Accounts Rules and for accurate financial management. This article explains the double-entry bookkeeping principles as they apply to client accounts, focusing on liability (such as client ledgers) and equity (such as partners’ capital) accounts, and highlights common exam issues.
Double-Entry Bookkeeping and Client Accounts
Law firms use double-entry bookkeeping to record all financial transactions. Every transaction affects at least two accounts, with one account debited and another credited for the same amount. This ensures the accounting equation remains balanced.
Key Term: double-entry bookkeeping
A system where every financial transaction is recorded in two accounts, with equal and opposite debit and credit entries.
The main types of accounts relevant to client money are:
- Asset accounts (e.g., client bank account)
- Liability accounts (e.g., client ledger accounts)
- Equity accounts (e.g., partners’ capital/current accounts)
Key Term: client account
A bank account used by a law firm to hold money on behalf of clients, separate from the firm’s own funds.
Debits and Credits in Liability Accounts
Liability accounts in legal practice typically represent amounts owed by the firm to clients or third parties. The client ledger is the main liability account for each client matter.
- Credit entries in a client liability account increase the amount owed to the client (e.g., when client money is received).
- Debit entries decrease the liability (e.g., when money is paid out on the client’s behalf).
Key Term: client liability account
A record showing the amount owed by the firm to a specific client, increased by credits and decreased by debits.
Worked Example 1.1
A firm receives £10,000 from a client for a property purchase. Which entries are made?
Answer: Credit the client liability account (increasing the amount owed to the client) and debit the client bank account (increasing the firm’s asset).
Worked Example 1.2
The firm pays £2,000 from the client account to the seller’s solicitor on completion. What entries are made?
Answer: Debit the client liability account (reducing the amount owed to the client) and credit the client bank account (reducing the asset).
Debits and Credits in Equity Accounts
Equity accounts represent the owners’ (partners’ or shareholders’) interest in the firm after liabilities are deducted from assets. In law firms, these include capital accounts (initial and subsequent investments) and current accounts (undistributed profits, drawings, etc.).
- Credit entries in equity accounts increase the firm’s equity (e.g., profit allocation, capital introduced).
- Debit entries decrease equity (e.g., drawings, loss allocation).
Key Term: equity account
An account showing the owners’ interest in the firm, including capital introduced, retained profits, and drawings.Key Term: capital account
A record of each partner’s or owner’s long-term investment in the firm.Key Term: current account
A record of each partner’s share of profits, losses, and drawings during the accounting period.
Worked Example 1.3
A partner introduces £20,000 capital to the firm. What are the entries?
Answer: Debit the firm’s business bank account (asset increases), credit the partner’s capital account (equity increases).
Worked Example 1.4
The firm allocates £60,000 profit equally to three partners. How are the entries made?
Answer: Debit the profit and loss account (closing profits), credit each partner’s current account with £20,000 (equity increases).
SRA Accounts Rules: Compliance and Common Pitfalls
The SRA Accounts Rules require firms to keep accurate records of all client money, ensuring that:
- Client money is paid promptly into a client account.
- Client money is not mixed with business money.
- Withdrawals from the client account do not exceed the amount held for each client.
Key Term: SRA Accounts Rules
The regulatory requirements governing how solicitors must handle and record client money.
Exam Warning
A common error is to reverse debits and credits in liability accounts. Remember: credit increases the liability (amount owed to the client), debit reduces it.
Recording Transfers Between Clients
Sometimes, money must be transferred from one client ledger to another (e.g., when part of a settlement is paid to a third party client).
Worked Example 1.5
Client A’s ledger shows a £5,000 credit. £1,000 is to be transferred to Client B. What are the entries?
Answer: Debit Client A’s ledger (reducing liability to A), credit Client B’s ledger (increasing liability to B). No change to the client bank account total.
Equity Accounts in Partnerships and Companies
In partnerships, each partner’s capital and current accounts must be kept up to date. In companies, equity is shown as share capital and retained earnings.
- Capital introduced: credit capital account.
- Drawings: debit current account.
- Profit allocation: credit current account.
Revision Tip
For exam questions, always identify the type of account (asset, liability, equity) before deciding whether a debit or credit increases or decreases the balance.
Key Point Checklist
This article has covered the following key knowledge points:
- Double-entry bookkeeping requires every transaction to be recorded as equal and opposite debits and credits.
- Client liability accounts are credited when client money is received and debited when money is paid out.
- Equity accounts are credited for capital introduced and profits, debited for drawings and losses.
- The SRA Accounts Rules require accurate, separate records for client money and equity.
- Transfers between client ledgers are recorded as a debit to one client and a credit to another, with no effect on the client bank account total.
- Correct identification of account types is essential for accurate entries and exam success.
Key Terms and Concepts
- double-entry bookkeeping
- client account
- client liability account
- equity account
- capital account
- current account
- SRA Accounts Rules
