Exposed through passing of journal entries?

April 1st, 2018
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By the Practitioner Support Unit of the Attorneys Fidelity Fund

There are various definitions to what journals are, and for the purpose of this article, we will simplify the general definition of a journal entry (journal) to refer to the entries made in the trust accounting records of a legal firm, to adjust or correct an entry that has already been made. It is effectively movement of money from one account to another within the trust account of an attorney. While passing a general journal is an acceptable way of correcting or adjusting entries that are incorrectly entered in the accounting records, they are also prone to exposing firms to risks of misappropriation and fraud.

Please note that journals are not limited to trust accounts, but can also exist in the business accounts of the firm.

Before we look at various hypothetical scenarios of when journals are passed, we need to make the point that all journals passed must be overseen by a senior person, preferably a legal practitioner, and approved before they are passed. It is important though that the practitioner fully understands what the entries presented to them mean, the reasons for passing the journal, as well as establishing and satisfying themselves that the trust creditor/s (client/s) affected have authorised the passing of the journals between accounts, where applicable.

In the article ‘The ABC of Trust Audits’ (2018 (Jan/Feb) DR 18), the Practitioner Support Unit of the Attorneys Fidelity Fund indicated that trust journals should occur for related matters, and should be authorised by the trust creditor concerned. For every debit reflecting in a journal, there should be a corresponding credit or credits. We will now delve further on the various aspects of passing journals.

What should exist when passing a general journal?

  • There must be an existing entry in the accounting books.
  • There must be a compelling and valid reason to adjust or correct the entry.
  • Where a journal is passed between trust creditor/s accounts, the entries must be authorised by the trust creditor/s concerned.
  • Journals must be approved by a senior person, preferably a legal practitioner before they are passed.
  • For every journal passed, there must be a debit entry in one account, and at least one credit entry in another, so that the balance is nil when taking the debit and the credit/s. These entries must be recorded and reflected in a journal book.
  • The general ledgers of the accounts that have been affected by the journal must clearly reflect the entries that took place and make reference to the journal passed to correct or adjust the entry.

Readers are encouraged to read ‘Do you know whose money it was?’ (2015 (March) DR 14), where the Financial Forensic Investigation Team of the Attorneys Fidelity Fund discussed suspense accounts.

A suspense account in the trust accounting records is an account used to temporarily allocate money received into the trust bank account and that cannot be immediately allocated to a specific account. The main reason the money cannot be allocated is that the depositor perhaps did not put on a reference when making the deposit or put on an incorrect reference, therefore, making it difficult for the firm to know whose money it is. The money so received in the trust bank account gets allocated to the suspense account, until the depositor comes forth to claim the money as theirs by providing satisfactory proof thereof.

We will now explore various scenarios where journals are passed.

Scenario 1 – the correct way of adjusting entries

On 13 March 2017, client ‘A’ entrusted a legal firm, SKM Attorneys, with an amount of R 63 000 for a matter that the firm was engaged with. The firm, in their trust accounting records, opened an account referred to as ‘SKM – A’ for the client. However, on paying this amount into the trust bank account of SKM Attorneys, the client did not reflect their reference with the firm, and the firm could, therefore, not allocate the money received to its account. The firm allocated the received amount of R 63 000 to a suspense account, referenced ‘SKM – queries’ in the trust accounting records, pending identification of the owner of the money, by crediting that account with R 63 000.

The client later realised their mistake, and on 29 March 2017, the client informed the legal firm that they made the deposit for that amount, on 13 March 2017, but forgot to put a reference, and submitted proof of the deposit to SKM Attorneys. On receipt of the proof of payment by the firm, and on the firm satisfying themselves that the money belonged to client A, the money was moved out of the suspense account, and reallocated to client A’s account.

Based on this scenario, the following entries will be evident in the trust accounting records of SKM Attorneys:

In the trust journal book

Date Description Debit Credit Narration
29-3-2017 ADJ269 – (SKM – queries) R 63 000 Previously unidentified receipt has been
identified.
29-3-2017 ADJ269 – (SKM – A) R 63 000

In the affected individual ledger accounts

Date Description Debit Credit Balance
SKM – queries:
Opening balance R 10 000
13-3-2017 Receipt R 63 000 R 73 000
29-3-2017

Reallocation – ADJ269

(SKM – A)

R 63 000 R 10 000
SKM – A:
Opening Balance R 5 436
29-3-2017 Reallocation – ADJ269 (Queries) R 63 000 R 68 436

As it can be seen from the foregoing, the movements are recorded in the trust journal book to reflect which account was debited and which was credited with the full amount, and the two affected ledger accounts, the suspense and client A accounts, also reflect all the transactions.

Scenario 2 – the correct way of adjusting entries

Client ‘C’ has two matters that SKM Attorneys have dealt with. The first matter is a litigation matter, account ‘SKM – C (Lit)’ with a credit balance of R 645 235, and the second is a transfer matter ‘SKM – C (Conv)’ with a credit balance of R 2 503. On 24 October 2017, SKM Attorneys required the client to make a deposit of R 12 856 for the transfer matter that is about to register as there is not sufficient funds in that account.

Although SKM Attorneys are aware of the huge balance sitting in the litigation matter account, and the fact that the matter is far from completion, the client’s authorisation is required to move the amount from one account to another. On the same day, the client instructs SKM Attorneys to transfer the funds from the litigation matter, as there are no fees imminent in the near future.

The following is evident:

  • The instruction by the client to transfer money from the litigation account to the transfer account. Preference is given to a written instruction rather than a verbal or telephonic instruction.
  • The entries in the trust journal book, and in the two individual ledger accounts are affected as follows:

In the trust journal book

Date Description Debit Credit Narration
24-10-2017 ADJ423 – (SKM – C (Lit)) R 12 856 Authorised by the client.
24-10-2017 ADJ423 – (SKM – C (Conv)) R 12 856

In the affected individual ledger accounts

Date Description Debit Credit Credit
SKM – C (Lit):
Opening balance R 645 235
24-10-2017 Reallocation – ADJ423 (SKM – C (Conv)) R 12 856 R 632 379
SKM – C (Conv):
Opening Balance R 2 503
24-10-2017 Reallocation – ADJ423 (SKM – C (Lit)) R 12 856 R 15 359

In this case, the client who is the owner of the money in the trust account has authorised the transaction that happened.

Scenario 3 – an incorrect way of adjusting entries

Client ‘C’ has two matters that SKM Attorneys have dealt with. The first matter is a litigation matter, account ‘SKM – C (Lit)’ with a credit balance of R 645 235, and the second is a transfer matter ‘SKM – C (Conv)’ with a credit balance of R 2 503. On 24 October 2017, SKM Attorneys required the client to make a deposit of R 12 856 for the transfer matter that is about to register as there is not sufficient funds in that account.

SKM Attorneys is providing legal services to another client, client ‘H’ in another commercial matter, ‘SKM – H (Com)’. Client H is a nephew to client C, and this is common knowledge to the firm, since client C introduced client H to the firm as such. The commercial matter for client H was concluded on 14 September 2017, and the client was called on to make a payment towards the attorney’s fees for an amount of R 58 964. The firm sent numerous reminders to client H to no avail. As at 24 October 2017, the balance in client H’s account was R 500, and no money was received from client H towards the attorney’s fees as required.

On 24 October 2017, client C instructs SKM Attorneys to transfer the required amount of R 12 856 from the litigation account to the transfer account. SKM Attorneys remembers that client C’s nephew has not paid in the amount required for the commercial matter. The firm therefore resorts to taking the amount from the uncle’s account, by including this amount to that which client C authorised the firm to transfer. The aim is to refund that amount when client H hopefully pays in the required amount. Note that the firm has not received any authority from client C to take the fees for client H’s matter, but acts purely on their knowledge of the relations between the two clients, and the fact that client H was introduced to the firm by client C.

The written instruction received from client C explicitly authorises the transfer of the R 12 856 from the litigation account to the transfer account. However, the following transactions are evident in the trust accounting books of SKM Attorneys:

In the trust journal book

Date Description Debit Credit Narration
24-10-2017 ADJ426 – (SKM – C (Lit)) R 71 820 Authorised by the client.
24-10-2017 ADJ426 – (SKM – C (Conv)) R 12 856
ADJ426 – (SKM – H (Com)) R 58 964

In the affected individual ledger accounts

Date Description Debit Credit Balance
SKM – C (Lit):
Opening balance R 645 235
24-10-2017 Reallocation – ADJ426 (SKM – C (Conv)) R 71 820 R 573 415
SKM – C (Conv):
Opening Balance R 2 503
24-10-2017 Reallocation – ADJ426 (SKM – C (Lit)) R 12 856 R 15 359
SKM – H (Com):
Opening Balance R 500
24-10-2017 Reallocation – ADJ426 (SKM – C (Lit)) R 58 964 R 59 464

In this case, while there is a clear debit and credits of accounts affected, and the fact that the full amount debited was credited, the amount transferred from the client’s account is not in line with the client’s instruction. As a result, the narration in the journal books is incorrect and misleading as the client only authorised a portion of the amount, and not the full amount.

The firm has acted on the knowledge at the firm’s disposal about the two clients, and that is unacceptable. In some cases, a similar scenario could happen but with an unrelated client, who is unknown to the client or does not even exist, and that is equally unacceptable. These scenarios amount to misappropriation of trust money.

Assuming that the firm decided to reflect only the authorised transfer of R 12 856 on the credit side of the transaction, the transaction would have been out by R 58 964, which is also unacceptable. For every debit, there must be corresponding credit or credits.

Conclusion

Practitioners should at all times be alert to the risk of misappropriation of clients’ funds through passing of journals. This is a very common way of misappropriating trust funds, which the Attorneys Fidelity Fund have seen in practise when conducting investigations. At times there will be so many journal entries, which are clearly aimed at confusing the practitioner. Practitioners should always keep their cool, piece the transactions, and follow up on each and every journal individually, before approving journals.

Practitioners should never shy away from asking all the pertinent questions before approving journals, and should have controls that prevent the passing of journals without proper approvals in place.

The Practitioner Support Unit of the Attorneys Fidelity Fund is situated in Centurion.

This article was first published in De Rebus in 2018 (April) DR 15.

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