Testing the regulatory framework for trust accounting records

December 1st, 2021

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The compliance framework for keeping of trust accounting records in terms of the Legal Practice Act 28 of 2014 (the LPA) and specifically r 54 of the Rules made under the authority of ss 95(1), 95(3) and 109(2) of the LPA (GG41781/20-7-2018) is now well-established. These rules stipulate certain requirements, which create a strict framework, within which records are to be kept and reports maintained. Compliance requires strict adherence to the regulatory framework. Unfortunately, without a clear understanding of the intended outcomes and a sound knowledge of the framework itself, trivialities become critical and major issues are often ignored. For practical purposes, the Financial Intelligence Centre Act 38 of 2001 and know your customer requirements are excluded in this discussion.

Rule 54.7 provides for International Financial Reporting Standards (IFRS) as a business accounting framework and standard accounting conventions are assumed. Trust accounts are not regular business books and typical reports, such as a trial balances and income statements do not exist. The rules governing legal practitioners trust accounts are both specific and voluminous, strict compliance with these rules is required.

Rule 54.10 states: ‘A firm shall update and balance its accounting records monthly and shall be deemed to comply with this rule if, inter alia, its accounting records have been written up by the last day of the following month’ (my italics). This suggests that reports should only be drawn, and inferences of non-compliance made, after completing all steps required to balance the books.

These requirements were introduced with the LPA and do not have a historic corollary. It implies certain behaviours and conditions. First, accounting records need to be kept updated on a continuous basis. Writing up of the accounting records in the final weeks leading up to the audit event, simply does not comply with this requirement. Compliance with this rule requires up-to-date records. This has other implications discussed below.

A simple conceptual framework for verifying the integrity of the trust account rests on the following three-way test. Imagine a diamond shape with four corners, aligned with a top and bottom corner, and two equal corners left and right.

The headline test

At month end, the total balances of all client accounts should be matched to all the balances of the trust banking accounts, including investments.

This is contained in r 54.15.1: ‘Every firm shall extract monthly, and in a clearly legible manner, a list showing all persons on whose account money is held or has been received and the amount of all such moneys standing to the credit of each such person, who shall be identified therein by name, and shall total such list and compare the said total with the total of the balance standing to the credit of the firm’s trust banking account, trust investment account and amounts held by it as trust cash, in the estates of deceased persons and other trust assets in order to ensure compliance with the accounting rules’ (my italics).

To satisfy the headline test, the trust specifically requires three primary reports:

  • The client balance list in terms of s 86(2).
  • The trust cash book.
  • The trust investment balance list in terms of s 86(4).

Simply compare the total of the client accounts with the trust cash book and investment accounts. It is worth noting that terms, such as customer and supplier, are business accounting concepts and best not used to describe the personal accounts of trust creditors.

The headline test is supported by two tests that confirm the accuracy of the totals used in the headline test.

The midline tests

  • Banks

While the headline test is a simple comparison of total values, these totals must be broken down and analysed to determine the accuracy and confirm the internal consistency.

This test requires an inspection of the external bank statements, as well as the reconciliation of these statements to the actual internal record books, specifically the trust cash book. The cash book analysis validates the cash book record by comparison to the external bank statement for the current trust account kept in terms of s 86(2). This requires bank statements for any investments in terms of ss 86(3) and 86(4).

Analysis of the trust cash book is primarily by way of bank reconciliation. Due to several factors, the trust cash book and bank statement balances may differ. The explanation must be sought in the bank reconciliation report. A classic example would be a transaction processed over month end but does not yet appear on the bank statement. Prompt depositing of trust money is required by r, which states that ‘all money received by it on account of any person is deposited intact into its trust banking account on the date of its receipt or the first banking day following its receipt on which it might reasonably be expected that it would be banked’. This difference will show up on the reconciliation report and should remedy itself within a very short time span.

Obvious, although overlooked, risks include –

  • overdrawn trust banking accounts;
  • multiple outstanding items;
  • items outstanding for a long period of time; or
  • simply bank reconciliations not done.

Bear in mind that in terms of r 54.10 this bank reconciliation must be done monthly, and in a way that the activity date can be confirmed.

  • Ledgers

Where the cash book analysis focuses on comparing the internal records (cash books) to the external reports (bank statements) the ledger analysis is focused on the internal integrity of the accounting records.

The primary statement of the position of the trust account is defined by r 54.14.8, which requires a list of trust credit balances. Rule 54.14.9 stipulates that ‘a firm shall ensure that no account of any trust creditor is in debit’.

Trust bank charges and interest create certain pertinent issues. By simply comparing the trust cash book to the trust bank statement, any surplus or deficit caused by interest or charges cannot be identified. Rule designates the Legal Practitioners’ Fidelity Fund (LPFF) as the trust creditor for all trust interest in terms of s 86(2). Since the trust account does not have income and expense accounts, all related transactions should be processed to a single designated ledger. Only after processing all trust interest, bank charges and value added tax (VAT) refunds, can a determination be made concerning any deficit caused by trust bank charges. Where bank charges exceed interest, the firm must pay the trust bank charges from the business account.

Custom reports

The link between the cash books and ledgers, and the integrity of the ledgers is contingent on and determined using certain custom reports.

  • Transfers

Transfers are regulated in terms of r 54.11 and may be performed repeatedly during a month. Funds transferred from the trust banking account must be received into a business banking account. Funds transferred must be identifiable as far as the amount and the trust creditor is concerned. Only trust funds available to a trust creditor may be transferred. Note that this is a custom compliance report.

Using a manual one by one trust-payment-to-business-credit method is prone to error and increases bank charges. It also confuses the receipt of funds in business (which is a bank transaction) with fees and other business debits, which are journal entries. It also keeps focus on individual files subject to recent activity and may obscure fewer active matters and bank charge deficits.

Sophisticated legal practitioners’ trust account software ought to provide not only auto-corrects on trust deficits, but also categorise funds transferred to cover fees and disbursements. A single bulk transfer amount reduces both bank charges and the risk of error.

A regular, monthly trust-to-business transfer should also correct any deficits as they occur and provide the necessary reports and peace of mind that all client accounts end in either credit or zero balances.

  • Trust accounts not to be in debit

Rule 54.14.9 states: ‘A firm shall ensure that no account of any trust creditor is in debit’. This can be achieved using automated trust-to-business transfer software and monitoring the trust cash book balance.

Specific instances of non-compliance are listed and must be reported to the Legal Practice Council (LPC). Rule 54.14.10 deals with general deficits, where available trust cash is less than the balances recorded for trust creditors shown in its accounting records. Rule 54.14.11 requires that a firm shall immediately report in writing to the LPC should an account of any trust creditor be in debit. In both instances reports should be accompanied by a written explanation of the reason for the debit and proof of rectification.

This can be caused by bank charges exceeding interest and can be rectified using a trust-to-business transfer.

  • Payments from the trust

Withdrawals from the trust are subject to the following restrictions: Payments may only be made to the client (the trust creditor) or on the client’s instructions. Transfers from the trust to the business account obviously requires an accounting entry entitling the firm to the transfer, as this transfer constitutes payment to the business for disbursements incurred or services rendered.

Section 86(4) investments are further subject to r which specifies that ‘unless the firm has received written authorisation for the payment of any guarantees issued by a bank on the strength of a trust investment that any amount withdrawn by it from a trust investment account is deposited promptly by it in its trust banking account’. This implies the flow of investment funds should mainly be between s 86(2) and 86(4) bank accounts. Investment payment on guarantee should be supported by mandate and supporting documentation.

Compliant accounting is a process. It not only requires both technical compliance with specific rules, but that these activities be conducted in a limited time frame. Only by applying these rules in a theoretically robust framework can an effective practical result be achieved. Based on the above, it becomes possible to carefully consider both the structure and purpose of the various rules. Any redundant or superfluous rules should be removed or updated to provide a clear structure in which to operate.

Carl Holliday BProc LLB (NWU) is a legal practitioner in Pretoria and writes in his personal capacity.

This article was first published in De Rebus in 2021 (Dec) DR 22.

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