Interest Flashcards
What is a law firm’s obligation to account for interest to the client?
General SRA principles would make it wrong for firms to earn interest on client money, without accounting to clients
SRA Accounts Rule 7.1 require that firms account to clients for a fair sum of interest on any client money held by the firm, unless they have come to a different arrangement by written agreement, but client must have enough information to give informed consent (Rule 7.2)
Firms can have their own policies on when interest is paid and how it is calculated + they can set a minimum level of interest required before any will be accounted for
- What is reasonable will depend on firm size and type of client
- The terms of the firm’s policy should be drawn to client’s attention at start of retainer
What are 2 ways that a firm can deal with interest owed to clients?
2 ways of dealing with interest
- (1) Pay client money into a general client bank account
- (2) Pay client money into a separate deposit bank account designated for that particular client’s money
In either case, the interest allowed must be a ‘fair sum’
A separate designated deposit bank account will usually only happen where a firm knows they will be holding a substantial amount for a long time, so they can just pass on all the interest in the account
For the general client account, the firm will decide the sum of interest, pay it from the business account + have the interest paid across from the client account to the business one
What factors will affect a firm’s choice as to which of the 2 methods of dealing with interest to choose?
Opening a separate account for every client would be difficult administratively
In a general client account, firms can keep interest earned over and above what is required to paid
- They must only pay the client the rate that is fair in relation to the amount held for that client
- This means firms may earn more interest on client money than is paid out to clients
How does the separate designated deposit bank account work in relation to interest?
Firm opens a deposit account, designated with the name of the client and pays the client money into it
Firm will account to client for all the interest allowed by the bank
Give an overview of the recording requirements for the separate designated deposit bank account
Client ledger account must show receipts and payments of client money dealt with through this account
- Might be a separate account or separate column on normal client ledger
Firm’s cash account must include **details of receipts and payments of client money **dealt with through this separate designated deposit bank account
- Might be a separate cash account or a combined one showing transactions on all designated deposit bank accounts
How would information related to the separate designated deposit bank account be recorded in the accounts. Give the DR and CR entries
The client ledger might have a business section, client section and client-deposit section
Transferring money from general client bank account to separate designated account – 2 stages:
(1) To record a payment out of the general client bank account:
- CR Cash - client section
- DR original Client ledger account - client section
(2) To record a receipt into the separate designated deposit bank account:
- CR Client deposit ledger account (or additional deposit column on original Client ledger account)
- DR Deposit cash account
- If money is received and paid immediately into a separate designated account, step 1 is not required
(3) Interest earned into the separate designated account:
- Recorded as CR on client’s new ledger account
- Recorded as DR on deposit cash account
Firms must usually transfer everything, including interest out of the deposit account into the general client account to get anything out of it
Give an example scenario of how a payment into the general client account and a subsequent transfer into a separate designated deposit bank account would be recorded (example continued in next flashcard)
Firm receives a cheque of money owed to client for £2200 and this is paid into the general client bank account
Firm is asked to hold it for 5 weeks in a separate designated deposit bank account
After 5 weeks, client then tells solicitor to close account + bank has allowed £18 interest. £2218 is transferred to general client bank account and is then sent to the client
Throughout all the example, everything is client money, back and forth and out to the client at the end, so the business account columns are not needed
(1) Money received as client money and paid into general client bank account:
- CR client ledger account – client section
- DR cash account – client section
(2) Transfer from general client account to separate designated deposit bank account:
- CR cash account – client section
- DR client ledger account – client section
Signifies money leaving general account
- DR deposit cash account
- CR on new client ledger account or client deposit section of ledger
Signifies money entering designated account
Continuing the previous example, from when money entered the separate designated deposit bank account, describe how the entries for the payment of interest and the total sum to the client would appear in the accounts
(1) Payments out to the client:
The interest earned is client money and is paid by the bank into the designated account
- DR deposit cash account
- CR new client ledger account or client deposit section of ledger, with the interest amount (£18)
The total (£2218) is paid out of the designated account
- CR deposit cash account
- DR new client ledger account or client deposit section of ledger
The total (£2218) is received into the general client account
- DR cash account – client section
- CR original client ledger account – client section
The client is paid the sum that the firm was holding
- CR cash account – client section
- DR original client ledger account – client section
How does the general client bank account work in relation to interest?
Firm must calculate a fair sum of interest and allow it to the client
Firms may always put a proportion of client money on deposit in a general deposit bank account, so it can keep this interest and, hopefully, will earn more than it must pay to clients
Often, the amount allowed in interest comes off the bill for professional charges
How is interest treated in the firm’s accounts when it is paid out of the general client bank account?
The interest payable is an expense of the business and is recorded on an interest payable ledger account, in the same way as paying electricity would be an expense
Give an example scenario on how the general client bank account works in relation to interest, but just up to when the initial money is paid into the account
Firm receives a cheque of money owed to client for £2200 and this is paid into the general client bank account
Firm is asked to hold it for 5 weeks
After 5 weeks, firm has allowed £18 interest and £2218 is sent to the client
(1) Money received as client money and paid into general client bank account:
- CR client ledger account – client section
- DR cash account – client section
Firm can account for interest and sum owed in 2 ways
With interest payable under the general client bank account, a firm can account for the interest in 2 ways.
Continuing the previous example, what is the 1st method a firm can use?
Send 2 cheques; one from the business account for £18 and one from the client account for £2200
(1) Recording money owed as interest
- DR interest payable ledger account – business section
- CR client ledger account – business section
Must be recorded here as it is a business expense
(2) Recording interest sent to client from business account
- DR client ledger account – business section
- CR cash account – business section
Must be recorded here as it is a business expense
(3) Recording sum owed sent to client from client account
- DR client ledger account – client section
- CR cash account – client section
Must be recorded here, as the sum owed was held as client money
With interest payable under the general client bank account, a firm can account for the interest in 2 ways.
Continuing the previous example, what is the 2nd method a firm can use?
Transfer the £18 interest from the business account to the client account and send the client the total from the client account (£2218)
(1) Recording £18 owed as interest
- DR interest payable ledger account – business section
- CR client ledger account – business section (shows firm owes client the interest)
Must be recorded here as it is a business expense
(2) Recording interest paid out of business bank account
- DR client ledger account – business section
- CR cash account – business section
(3) Recording interest received into client bank account
- CR client ledger account – client section
- DR cash account – client section
(4) Recording payment of total (£2218) to client from the client bank account
- DR client ledger account – client section
- CR cash account – client section
