The Three-Way Reconciliation Every Firm Owes Its Clients

Ask an attorney whether they reconcile their trust account and almost all of them will say yes. Ask them to produce a three-way reconciliation for last month and the room gets quieter.

The gap between those two answers is the single most common trust-accounting problem we find, and it is worth understanding precisely — because the version most firms are doing is not the version their state bar has in mind.

What “three-way” actually means

A three-way reconciliation compares three separate figures and requires all of them to agree exactly.

One: the adjusted bank balance. What the bank says you hold, corrected for timing. Take the statement balance, add deposits that have not yet cleared, subtract cheques that have not been presented. This is the same adjustment you would make on any bank reconciliation.

Two: the trust balance per your books. What your accounting system says is in the trust account. If your books are current and nothing has gone unrecorded, this matches the adjusted bank balance.

Three: the sum of all individual client ledgers. Every client with money in trust has their own running balance — deposits in, disbursements out, earned fees transferred to operating. Add every one of those balances together and the total must equal the other two figures.

Most firms do the first two. That is a bank reconciliation, and it is genuinely useful — it tells you your books are current and nothing has been missed. What it does not tell you is whether the money is correctly allocated among your clients.

Only the third leg tells you that.

Why the third leg is the one that matters

Here is the scenario that should make the distinction concrete.

Your trust account holds $84,250. Your books say $84,250. The bank statement, once adjusted, says $84,250. Two-way reconciliation: perfect.

Now add the client ledgers. Alvarez shows $32,500. The Chen estate shows $18,750. Northgate shows $15,000. Doyle shows $12,000. Ferris shows $11,000.

That totals $89,250 — five thousand dollars more than the account actually holds.

The bank agrees with your books. Your books agree with the bank. And you are still five thousand dollars short of what your clients collectively believe you are holding for them. Somewhere, one client’s funds have covered another client’s disbursement.

The two-way reconciliation cannot see this. It was never designed to.

The version that should worry you most

Run the same scenario with one change: Ferris shows negative $2,000.

Now the ledgers total $76,250 while the account holds $84,250 — a different discrepancy, but the negative balance is the finding that matters.

A negative client ledger means more money has gone out for that client than ever came in for them. Arithmetically, that money came from somewhere, and the only place it can have come from is another client’s funds.

The account total can reconcile perfectly while this is true. That is exactly why the third leg exists, and why a firm that only reconciles two ways can carry this problem for months without knowing.

Where variances actually come from

In our experience, the same handful of causes account for most of them.

Bank fees deducted directly from trust. The bank takes its monthly charge from the trust account, your books never record it, and the two drift apart. Worth handling carefully: in most jurisdictions the firm, not the clients, must bear the cost of maintaining the trust account, so a fee coming out of client funds is a problem in itself.

Deposits recorded at the account level but never posted to a client. The money is in the account. Your book balance is right. But no client ledger reflects it, so the third leg comes up short. This is the single most common cause we see.

Disbursements posted to the wrong client. Both ledgers are wrong, in opposite directions, and the total still balances. Only a line-by-line review finds it.

Earned fees transferred without updating the ledger. You move fees to operating, the account balance drops, and the client’s ledger still shows the higher figure.

Credit card processing fees taken from a trust deposit. A general merchant processor deducting its fee before the deposit lands means a firm expense has been paid with client money. Legal-specific processors are built to avoid this; general ones are not.

Doing it monthly is not a formality

Every one of the causes above is easy to find in the month it happens and genuinely difficult to find eleven months later.

A misapplied deposit in January silently corrupts every downstream balance for that client. Find it in February and it is a ten-minute correction. Find it the following December and you are rebuilding a year of ledgers to locate a single transaction — and you are doing it under time pressure, because something has prompted you to look.

The monthly reconciliation is not a compliance ritual. It is the thing that keeps the problem small.

What to do if yours does not balance

First, find it before you do anything else. Work backwards month by month until you reach a period that did reconcile, and the error is somewhere in the month after that. Tedious, but reliable.

Second, document what you find — what the variance was, what caused it, what you did about it. A discrepancy you found and corrected with a clear written record is a fundamentally different situation from a discrepancy discovered by someone else.

Third, and we cannot say this strongly enough: what you are obliged to do next is a legal and ethical question, not a bookkeeping one. Some variances carry reporting obligations. Your state bar’s rules and your ethics counsel govern that, and neither we nor any calculator can advise you on it.

What we can do is the accounting — find it, prove it, document it, and put a monthly process in place so the next reconciliation takes ten minutes instead of a fortnight.

If you want to check where you stand right now, our three-way reconciliation calculator will do the arithmetic in your browser. Nothing you enter is stored or sent anywhere.